Deck 7: Government Policy and International Trade

Question 1

What are the advantages of a joint venture entry mode for Starbucks over entering through wholly owned subsidiaries? On occasion, Starbucks has chosen a wholly owned subsidiary to control its foreign expansion (e..in Britain and Thailand) Why?

Answer 1

S is a US retailer of coffee with stores across the globe. As part of its global expansion plan, S used the licensing format initially. However, over due course it became dissatisfied the strategy and opted for joint venture agreements with local players. This leads to the discussion about the advantages of entering into joint venture agreements rather than setting up wholly owned subsidiaries and the reasons for S to use wholly owned subsidiaries as a part of its global expansion. There are two easier methods to enter foreign countries such as licensing and joint ventures. Joint venture is a less risk mode of entry into foreign countries. The main challenge for S to set up foreign operations is its goal for providing uniform and consistent services across all of its outlets. A pure licensing format does not allow S to hold control of over the licensee and its operations and was unable to gain knowledge about the local market in countries like J and SK. At this junction, S shifted to joint venture partnerships to hold a certain percentage of stakes in the local partnerships. In joint venture, both S and the local company have control over the operations. Both partners have to face the market risks. So, S was able to share its risks with a local player and reduce its cost if expansion. Joint ventures increased its international expansion rates by setting up of more outlets in foreign countries. Though S was able to gain a local foothold, it still lacked complete control over its operations. So it planned to create wholly owned subsidiaries. Operating a wholly owned subsidiary allows expanding into global markets quickly as S was able to obtain faster access to the local food and beverages market. For instance, in country T, S acquired its licensee C creating a subsidiary. As a result, S opened more than 100 outlets in a span of 7 years. Similarly, in country B, S acquired company SC to offer its US-styled services to local customers. Through wholly owned subsidiaries, S was able to gain complete control over its operations in countries B and T. This was a time saving and cost control measure. Joint ventures and wholly owned subsidiaries provided S with authority over operation to ensure the uniformity of service offered across the globe.

Question 2

Reread the Management Focus on Cemex and then answer the following questions:
a)Which theoretical explanation, or explanations, of FDI best explains Cemex's FDI?
b)What is the value that Cemex brings to the host economy? Can you see any potential drawbacks of inward investment by Cemex in an economy?
c)Cemex has a strong preference for acquisitions over greenfield ventures as an entry mode.Why?
d)Why do you think Cemex decided to exit Indonesia after failing to gain majority control of Semen Gresik? Why is majority control so important to Cemex?
e)Why do you think politicians in Indonesia tried to block Cemex's attempt to gain majority control over Semen Gresik? Do you think Indonesia's best interests were served by limiting Cemex's FDI in the country?

Answer 2

a. C#'s FDI decision can be explained by three reasons: i. The fact that its products, cement and ready-mix cement, were not suitable for export.
• Cement has a very low value-to-weight ratio and hence the transportation costs would be comparatively high making the landed price un-competitive.
• The ready-mix cement had to be used within 90 minutes of being mixed. This makes it impossible to export. ii. C# has a unique way as to how it does business which cannot be licensed:
• It funds its dealers and distributors to buy their own trucks for their cement business.
• They have an incentive plan that rewards the dealers with C# stock based on performance iii. C# would like to maintain control not only on its operations but also its expansion plans. It normally enters into on country in the region and tends to expand into the neighboring countries over a period of time. This decision could be explained by the principle of internalization. b. C# brings in a lot of pluses for the host country. i. It makes the country self-reliant in Cement. This is a product that every developing economy requires since construction is the basis of any economic development. ii. It provides direct employment in its cement plants. iii. It also provides indirect employment at all its distributors and dealers. iv. It boosts the host country's economic development by increasing the income levels. Many of the countries that C# has invested in are politically unstable like Venezuela and Egypt or are facing economic difficulties like Spain. Therefore, there is a real danger of either the industry may be nationalized or some punitive taxes may be enforced on foreign investors. These are the risks that C# may face regarding its FDI. c. Cement is an industry that requires a well-defined distribution network as well as a lot of capital investment to start a manufacturing plant. This process takes a lot of time. By acquiring an existing company rather than making a greenfield investment C# achieves the following: i. It saves time in getting started.ii. It gets a readymade marketing and distribution network. iii. It gets staff which is experienced in working in that country. iv. It acquires a network of suppliers. v. It gets a brand that has been established in that country. These would be a great advantage. Also if it has taken over a stagnant companies like it did in Spain or a company working well below its capacity, it can see immediate profits by just boosting the production. Its superior marketing and management skills should be able to affect a turnaround very quickly.

Question 3

Which theory of FDI best explains the international expansion strategy adopted by Starbucks?

Answer 3

S is a US retailer of coffee with stores across the globe. As part of its global expansion plan, S used the licensing format initially. However, over due course it became dissatisfied the strategy and opted for joint venture agreements with local players. Later it set up wholly owned subsidiaries to reign more control over operations in global markets. This shows that S uses internalization theory of foreign direct investments (FDI) The success of S is dependent on its ability to offer uniform services across its stores located all over the country. When S tried to replicate this success formula at the global level, in encountered challenges related to its authority over operations. S wanted to retain similar services, quality and brand image as developed in the US to its global markets. This means the application of its success formula to new cultures where people have different preferences towards beverages and methods of operating business units. In order to expand globally, it used licensing format. Licensing is an agreement in which one company, for instance S, gives permission for another company in a different country to manufacture is products and use its trademarks for a specified duration in a certain market catering to customers in that location. But, S did not have any control over the operations of the licensee. This restricted the rate of expansion of S due to limited control over operations. This leads to the application of theory of internalization. As per the theory of internalization, foreign direct investments are preferred over licensing when the company is unable to secure its intellectual properties, when the company needs increased control over foreign operations and licensing operations are not in line with its goals and expertise. For instance, S licensed its trademarks and roasting techniques to local players which may lead to theft of its techniques and S was unable to protect it. S lacked control over its operations as retail outlets are managed by local licensees on their own accord. S wanted to ensure uniformity of services across all global outlets which was not achievable through licensing due to lack of authority. Hence, S opted for horizontal FDI in which it shifted its expansion strategy to joint venture partnerships with local players in foreign markets. In joint venture, both S and the local company have control over the operations. Both partners have to face the market risks. So, S was able to share its risks with a local player and reduce its cost if expansion. Joint ventures increased its international expansion rates by setting up of more outlets in foreign countries. This increases the profit margin of S as it has support from other local companies. In order to further consolidate its authority, S took over its local partners as wholly owned subsidiaries. Thus, internalization theory is applicable as S expanded globally to increase its earning potential replicating its success strategy in the US which requires more control over its operations. Hence, it shifted from licensing to joint venture partnerships and setting up wholly owned subsidiaries.

Question 4

You are the international manager of a US business that has just invented a revolutionary new personal computer that can perform the same functions as PCs, but costs only half as much to manufacture.Your CEO has asked you to decide how to expand into the European Union market.Your options are (a)to export from the United States, (b)to license a European firm to manufacture and market the computer in Europe, and (c)to set up a wholly owned subsidiary in Europe.Evaluate the pros and cons of each alternative and suggest a course of action to your CEO.

Question 5

Initially Starbucks expanded internationally by licensing its format to foreign operators.It soon became disenchanted with this strategy.Why?

Question 6

In 2004, inward FDI accounted for some 24 percent of gross capital formation in Ireland, but only 0. percent in Japan.What do you think explains this difference in FDI inflows into the two countries?

Question 7

Use the globalEDGE Resource Desk (http://globalEDGE.su.du/ResourceDesk/)to completethe following exercises:
You are working for a company that is considering investing in a foreign country.Management has requested a report regarding the attractiveness of alternative countries based on the potential return of FDI.Accordingly, the ranking of the top 25 countries in terms of FDI attractiveness is a crucial ingredient for your report.A colleague mentioned a potentially useful tool called the " FDI Confidence Index " which is updated periodically.Find this index and provide additional information regarding how the index is constructed.

Question 8

Why do you think Starbucks has now elected to expand internationally primarily through local joint ventures, to whom it licenses its format, as opposed to a pure licensing strategy?

Question 9

Compare and contrast these explanations of FDI: internalization theory, Vernon's product life cycle theory, and Knickerbocker's theory of FDI.Which theory do you think offers the best explanation of the historical pattern of horizontal FDI? Why?

Question 10

Use the globalEDGE Resource Desk (http://globalEDGE.su.du/ResourceDesk/)to completethe following exercises:
Your company is considering opening a new factory in Latin America and management is evaluating the specific country locations for this direct investment.The pool of candidate countries has been narrowed to Argentina, Brazil, and Mexico.Prepare a short report comparing the foreign direct investment ( FDI )climate and regulations of these three countries, using the Country Commercial Guides prepared by the U..Department of Commerce.