The Strategy and Structure of International Business

part five The Strategy and Structure of International Business15

©ITAR–TASS Photo Agency/Alamy Stock Photo

Entry Strategy and

Strategic Alliances

LEARNING OBJECTIVES

After reading this chapter, you will be able to:

LO15–1 Explain the three basic decisions firms must make when they decide on foreign expansion: which

markets to enter, when to enter those markets, and on what scale.

LO15-2 Compare the different modes firms use to enter foreign markets.

LO15-3 Identify the factors that influence a firm’s choice of entry mode.

LO15-4 Recognize the pros and cons of acquisitions versus greenfield ventures as an international market

entry strategy.

LO15-5 Evaluate the pros and cons of entering into strategic alliances when going international.

Gazprom and Global Strategic Alliances

credits to offset industrial activities, while Gazprom’s

trading arm in the United Kingdom could market any

excess credits.

Gazprom has also engaged in a strategic “arctic” alli–

ance with Lukoil, another Russian company. Lukoil is one

of Russia’s largest oil companies with about $150 billion

(U.S.) in annual sales. This alliance is more narrowly de–

fined than many others in that the two companies intend

to support each other in bids for offshore projects and,

by collaborating, counter the power of Rosneft. A key

part of the cooperation will unfold in the Barents Sea (a

sea of the Arctic Ocean, located off the northern coasts

of Norway and Russia). Interestingly, founded in 1993,

Rosneft is a $92 billion (U.S.) oil company that is also ma–

jority owned by the government of Russia. Gazprom and

Rosneft discussed a merger in 2005 that ultimately fell

through.

Gazprom has also entered into alliances with countries,

one such strategic alliance being with China. The Chinese

alliance came about as the Kremlin intensified efforts to

focus more on East Asia to offset some of the constraints

imposed on the company by Europe as a function of the

Ukrainian crisis, as well as its continued conflict with

Turkey. Consequently, Gazprom and China National Petro-

leum Corp (CNPC) signed an agreement on the

cross-border section of the Power of Siberia gas pipeline,

including the subwater link across the Amur River. The

deal also involves the “Eastern” gas pipeline route.

Sources: “Gazprom and Shell Committed to Broader Cooperation in

LNG Sector,” June 16, 2016, gazprom.com/press/news/2016/june/

article276698; Andrew E. Kramer, “Gazprom and Dow Chemical

Expand Emissions Alliance,” The New York Times, June 18, 2009; Atle

Staalesen, “Gazprom, Lukoil in Arctic Alliance,” Barents Observer,

May 20, 2015; Sergei Blagov, “Russia Seeks to Strengthen Energy

Alliance with China,” Asia Times, December 18, 2015.

OPENING CASE

Gazprom (gazprom.com) is a Russian company with head–

quarters in Moscow. It was founded in 1989 and is focused

on the business of extraction, production, and sale of petro–

leum, natural gas, and other petrochemicals. The company

name is a combination of the Russian words Gazovaya Pro–

myshlennost (Russian: газовая промышленность, mean–

ing “gas industry”). Gazprom has more than 400,000

employees, annual sales of ₽5.59 trillion rubles (roughly

$110 billion U.S. dollars), and with the Russian government

as the owner. However, Gazprom also has 55 subsidiaries in

which it has 100 percent ownership, 32 ventures with more

than 50 percent ownership, and 21 strategic alliances where

its share is less than 50 percent.

One of the strategic alliances that Gazprom has en–

gaged in is with Royal Dutch Shell—the $235 billion (U.S.)

company headquartered in The Hague, Netherlands, but

incorporated in the United Kingdom. From the vantage

point of Gazprom, the strategic alliance with Shell allows

the Russian gas giant to penetrate new markets. Addition-

ally, the Gazprom-Shell agreement makes the expansion

of the firms’ joint $20 billion liquefied natural gas plant on

the eastern island of Sakhalin (a Russian island in the

Pacific Ocean, north of Japan) come to fruition.

Another alliance in which Gazprom is involved is with

Dow Chemical Company—the $60 billion American

multinational chemical corporation headquartered in

Midland, Michigan, in the United States. The alliance

between Gazprom and Dow is to expand trading in car–

bon dioxide emission credits intended to slow climate

change. Gazprom agreed to look at opportunities where

Dow’s technologies could potentially be involved in

helping to reduce carbon emissions. The outcome would be

that Dow could then use some of the carbon emissions

431

432 Part 5 The Strategy and Structure of International Business

Introduction

This chapter is concerned with three closely related topics: (1) the decision of which for–

eign markets to enter, when to enter them, and on what scale; (2) the choice of entry

mode; and (3) the role of strategic alliances. Any firm contemplating foreign expansion

must first decide on which foreign market or markets to enter and the timing and scale of

entry. Oftentimes, small and medium-sized companies decide to enter one international

market at a time, while larger companies choose strategically one or more markets to

enter. For example, a large company could decide to enter all five Scandinavian countries

(Denmark, Finland, Iceland, Norway, and Sweden), or a subset of them, at the same time

since those countries are similar in makeup and customers’ needs and wants. Meanwhile,

most small and medium-sized enterprises (SMEs) would not undertake such an expansion

internationally due to cost constraints and market entry challenges.

For both large and SME companies, the choice of which international markets to enter

should be driven by an assessment of relative long-run growth and profit potential. Some

companies took this to mean that they needed to enter China, India, and other markets

with large populations. However, the entry decision is much deeper and should be thought

out more strategically with a focus on long-run growth and profit potential.

The choice of mode for entering a foreign market is another major issue with which interna–

tional businesses must wrestle. The various modes for serving foreign markets are exporting,

licensing, or franchising to host-country firms; establishing joint ventures with a host-country

firm; setting up a new wholly owned subsidiary in a host country to serve its market; and acquir–

ing an established enterprise in the host nation to serve that market. Each of these options has

advantages and disadvantages. The magnitude of the advantages and disadvantages associated

with each entry mode is determined by a number of factors, including logistics costs, trade bar–

riers, political risks, economic risks, business risks, costs, and firm strategy. The optimal entry

mode varies by situation, depending on these factors. Thus, whereas some firms may best serve

a given market by exporting, other firms may better serve the same market by setting up a new

wholly owned subsidiary or by acquiring an established enterprise.

The final topic of this chapter is strategic alliances. Strategic alliances are cooperative

agreements between potential or actual competitors. The term is often used to embrace a

variety of agreements between actual or potential competitors including cross-shareholding

deals, licensing arrangements, formal joint ventures, and informal cooperative arrangements.

The motives for entering strategic alliances are varied, but they often include market access,

hence the overlap with the topic of entry mode.

Gazprom, for example, has strategically put together a mixture of subsidiaries, joint ven–

tures, and strategic alliances to engage in the global marketplace. The Russian company, with

headquarters in Moscow, is focused on the business of extraction, production, and sale of

petroleum, natural gas, and other petrochemicals. In fulfilling its competitive objectives in

those areas, Gazprom engages in several of the mode of entry options that we discuss in this

chapter. For example, Gazprom has 55 subsidiaries in which it has 100 percent ownership,

32 ventures with more than 50 percent ownership, and 21 strategic alliances where their

share is less than 50 percent. This is a unique mixture of ownership and global engagement

to both manage and strategically leverage in the international marketplace. Some of the part–

nerships are with large and with very established companies such as Royal Dutch Shell (The

Netherlands) and Dow Chemical (United States) and others are with small and medium-

sized companies, including several companies from Gazprom’s home country of Russia.

Did You Know?

Did you know increasingly

more companies are “born

global”.

Visit your instructor’s

Connect® course and click on

your eBook or SmartBook®

to view a short video

explanation from the authors.

INTERACTIVE RANKINGS

Entering foreign markets is the focus ofChapter 15. The selection of country markets to

choose from is getting larger for many product categories as more countries see their popu–

lations’ growing purchasing power. With more than 200 countries in the world, the data are

overwhelming, and even the starting point for analysis is not always an easy decision. The

Entry Strategy and Strategic Alliances Chapter 15 433

Interactive Rankings on globalEDGE can serve as a great pictorial view of the world on some

50 important variables in categories covering the economy, energy, government,health,

infrastructure, labor, people, and trade and investment (globaledge.msu.edu/tools-and-

data/interactive-rankings). Active data maps such as the Interactive Rankings maps are a

good starting point for analysis to evaluate data for a specific country as well as the coun–

tries in a region. This allows for a focus on entry into one market now and a strategy for

expansion later on to nearby countries with similar characteristics. Which are the top three

countries for Internet users?

Basic Entry Decisions

A firm contemplating foreign expansion must make three basic decisions: which markets

to enter, when to enter those markets, and on what scale.1

WHICH FOREIGN MARKETS?

There are now 196 countries and more than 60 territories in the world, and they do not all

hold the same profit potential for a firm contemplating foreign expansion.2 Ultimately, the

choice must be based on an assessment of a nation’s long-run profit potential. This poten-

tial is a function of several factors, many of which we have studied in earlier chapters.

Chapters 2 and 3 looked in detail at the economic and political factors that influence the

potential attractiveness of a foreign market. The attractiveness of a country as a potential

market for an international business depends on balancing the benefits, costs, and risks

associated with doing business in that country.

Chapters 2 and 3 also noted that the long-run economic benefits of doing business in a

country are a function of factors such as the size of the market (in terms of demograph–

ics); the present wealth (purchasing power) of consumers in that market; and the likely

future wealth of consumers, which depends on economic growth rates. While some mar–

kets are very large when measured by number of consumers (the top six countries—all with

more than 200 million people—are China, India, the United States, Brazil, Indonesia, and

Pakistan), one must also look at living standards and economic growth. On this basis,

China and India, while relatively poor, are growing so rapidly that they are attractive tar–

gets for inward investment. Alternatively, weak growth in Indonesia implies that this popu–

lous nation is a far less attractive target for inward investment. And, while the economy of

Pakistan is the 25th largest in the world for purchasing power parity, many companies stay

away from Pakistan due to the political instability and risks.

As we saw in Chapters 2 and 3, likely future economic growth rates appear to be a func-

tion of a free market system and a country’s capacity for growth (which may be greater in

less developed nations). Also, the costs and risks associated with doing business in a for–

eign country are typically lower in economically advanced and politically stable demo–

cratic nations, and they are greater in less developed and politically unstable nations. That

said, the long-term stability in many developed European countries also means that they

have limited growth potential compared with higher-risk emerging countries. These issues

provide a confluence of factors that should be taken into account when deciding on which

foreign markets to enter.

The discussion in Chapters 2 and 3 suggests that, other things being equal, the benefit–

cost–risk trade-off is likely to be most favorable in politically stable developed and develop–

ing nations that have free market systems, and where there is not a dramatic upsurge in

either inflation rates or private-sector debt. The trade-off is likely to be least favorable in

politically unstable developing nations that operate with a mixed or command economy or

in developing nations where speculative financial bubbles have led to excess borrowing.

Another important factor is the value an international business can create in a foreign

market. This depends on the suitability of its products to that market and the nature of

indigenous competition.3 If the international business can offer a product that has not

LO 15–1

Explain the three basic

decisions firms must make

when they decide on foreign

expansion: which markets to

enter, when to enter those

markets, and on what scale.

MANAGEMENT FOCUS

stake in Global, a 43-store, state-owned grocery chain. By

2017, Tesco was the market leader in Hungary, with more

than 200 stores and additional openings planned, ac–

counting for 1 percent of the whole economy of Hungary!

A year after the Hungary expansion, Tesco acquired 31

stores in Poland from Stavia. The following year, in 1996,

Tesco added 13 stores that the company purchased from

Kmart in the Czech Republic and Slovakia; and the follow-

ing year it entered the Republic of Ireland. Tesco now has

more than 450 stores in Poland, some 80 stores in the

Tesco, founded in 1919 by Jack Cohen, is a British multina-

tional grocery and merchandise retailer. It is the largest

grocery retailer in the United Kingdom, with a 28 percent

share of the local market, and the second-largest retailer

in the world after Walmart measured by revenue. In 2017,

Tesco had sales of more than £62 billion ($70 billion U.S.

dollars), more than 480,000 employees, and 6,553 stores

in 13 countries.

In its home market of the United Kingdom (with a head-

quarters in Chestnut, Hertfordshire, England), the compa–

ny’s strengths are reputed to come from strong

competencies in marketing and store site selection, logis–

tics and inventory management, and its own label product

offerings. By the early 1990s, these competencies had al–

ready given the company a leading position in the United

Kingdom. Tesco was generating strong free cash flows,

and senior managers had to decide how to use that cash.

One strategy they settled on was overseas expansion.

As managers looked at international markets, they soon

concluded the best opportunities were not in established

markets, such as those in North America and western

Europe, where strong local competitors already existed,

but in the emerging markets of eastern Europe and Asia,

where there were few capable competitors but strong un-

derlying growth trends.Tesco’s first international foray was

into Hungary in 1995, when it acquired an initial 51 percent

Tesco’s International Growth Strategy

Checkout section of a large Tesco supermarket in Malaysia.

©Rob Walls/Alamy Stock Photo

been widely available in a market and that satisfies an unmet need, the value of that prod-

uct to consumers is likely to be much greater than if the international business simply of-

fers the same type of product that indigenous competitors and other foreign entrants are

already offering. Greater value translates into an ability to charge higher prices and/or to

build sales volume more rapidly. By considering such factors, a firm can rank countries in

terms of their attractiveness and long-run profit potential. Preference is then given to en–

tering markets that rank highly. For example, Tesco, the large British grocery chain, has

been aggressively expanding its foreign operations, primarily by focusing on emerging mar–

kets that lack strong indigenous competitors (see the accompanying Management Focus).

TIMING OF ENTRY

Once attractive markets have been identified, it is important to consider the timing of

entry. Entry is considered to be early when an international business enters a foreign mar–

ket before other foreign firms and late when it enters after other international businesses

have already established themselves in a market. The advantages frequently associated

with entering a market early are commonly known as first-mover advantages.4 One first-

mover advantage is the ability to preempt rivals and capture demand by establishing a

strong brand name and customer satisfaction. This desire has driven the rapid expansion

434

Czech Republic, more than 120 stores in Slovakia, and

more than 100 stores in Ireland.

Tesco’s Asian expansion began in 1998 in Thailand

when it purchased 75 percent of Lotus, a local food re–

tailer with 13 stores. Building on that base, Tesco had

more than 380 stores in Thailand by 2017. In 1999, the

company entered South Korea when it partnered with

Samsung to develop a chain of hypermarkets. This was

followed by entry into Taiwan in 2000, Malaysia in 2002,

Japan in 2003, and China in 2004. The move into China

came after three years of careful research and discus–

sions with potential partners. Like many other Western

companies, Tesco was attracted to the Chinese market by

its large size and rapid growth. In the end, Tesco settled

on a 50–50 joint venture with Hymall, a hypermarket

chain that is controlled by Ting Hsin, a Taiwanese group,

which had been operating in China for six years. In 2014,

Tesco combined its 131 stores in China in a joint venture

with the state-run China Resources Enterprise (CRE) and

its nearly 3,000 stores. Tesco owns 20 percent of the joint

venture.

As a result of these moves, by 2017 Tesco generated

sales of about $21 billion outside the United Kingdom (its

UK annual revenues were roughly $41 billion). The addition

of international stores has helped make Tesco the second-

largest company in the global grocery market behind only

Walmart (Tesco is also behind Carrefour of France if profits

are used). Of the three, however, Tesco may be the most

successful internationally. By 2017, all its foreign ventures

were making money.

In explaining the company’s success, Tesco’s managers

have detailed a number of important factors. First, the com–

pany devotes considerable attention to transferring its core

capabilities in retailing to its new ventures. At the same time, it

does not send in an army of expatriate managers to run local

operations, preferring to hire local managers and support

them with a few operational experts from the United Kingdom.

Second, the company believes that its partnering strategy in

Asia has been a great asset. Tesco has teamed up with good

companies that have a deep understanding of the markets in

which they are participating but that lack Tesco’s financial

strength and retailing capabilities. Consequently, both Tesco

and its partners have brought useful assets to the venture, in–

creasing the probability of success. As the venture becomes

established, Tesco has typically increased its ownership stake

in its partner. For example, by 2017 Tesco owned 100 percent

of Homeplus, its South Korean hypermarket chain, but when

the venture was established Tesco owned 51 percent. Third,

the company has focused on markets with good growth

potential but that lack strong indigenous competitors, which

provides Tesco with ripe ground for expansion.

Sources: Angela Monaghan, “Tesco Boss’s Bonus Cut Despite First

Sales Growth in Seven Years,” The Guardian, May 12, 2017; P. N. Child,

“Taking Tesco Global,” The McKenzie Quarterly3 (2002); H. Keers,

“Global Tesco Sets Out Its Stall in China,” Daily Telegraph, July 15,

2004, p. 31; K. Burgess, “Tesco Spends Pounds 140m on Chinese

Partnership,” Financial Times, July 15, 2004, p. 22; J. McTaggart,

“Industry Awaits Tesco Invasion,” Progressive Grocer, March 1, 2006,

pp. 8–10; Tesco’s annual reports, archived at www.tesco.com; “Tesco

Set to Push Ahead in the United States,” The Wall Street Journal,

October 6, 2010, p. 19.

435

by Tesco into developing nations (see the Management Focus). A second advantage is the

ability to build sales volume in that country and ride down the experience curve ahead of

rivals, giving the early entrant a cost advantage over later entrants. This cost advantage

may enable the early entrant to cut prices below that of later entrants, thereby driving

them out of the market. A third advantage is the ability of early entrants to create switch-

ing costs that tie customers into their products or services. Such switching costs make it

difficult for later entrants to win business.

There can also be disadvantages associated with entering a foreign market before other

international businesses. These are often referred to as first-mover disadvantages.5

These disadvantages may give rise to pioneering costs, costs that an early entrant has to

bear that a later entrant can avoid. Pioneering costs arise when the business system in a

foreign country is so different from that in a firm’s home market that the enterprise has to

devote considerable effort, time, and expense to learning the rules of the game. Pioneering

costs include the costs of business failure if the firm, due to its ignorance of the foreign

environment, makes major mistakes. A certain liability is associated with being a foreigner,

and this liability is greater for foreign firms that enter a national market early.6 Research

seems to confirm that the probability of survival increases if an international business

enters a national market after several other foreign firms have already done so.7 The late

entrant may benefit by observing and learning from the mistakes made by early entrants.

436 Part 5 The Strategy and Structure of International Business

Pioneering costs also include the costs of promoting and establishing a product offer–

ing, including the costs of educating customers. These can be significant when the product

being promoted is unfamiliar to local consumers. In contrast, later entrants may be able to

ride on an early entrant’s investments in learning and customer education by watching

how the early entrant proceeded in the market, by avoiding costly mistakes made by the

early entrant, and by exploiting the market potential created by the early entrant’s invest–

ments in customer education. For example, KFC introduced the Chinese to American-

style fast food, but a later entrant, McDonald’s, has capitalized on the market in China.

Similarly, FedEx had permits to operate in China some 10 years before it actually could

convince the Chinese customers its service was valuable relative to the shipping operations

already, at that time, available to them.

An early entrant may be put at a severe disadvantage, relative to a later entrant, if regula–

tions change in a way that diminishes the value of an early entrant’s investments. This is a

serious risk in many developing nations where the rules that govern business practices are

still evolving. Early entrants can find themselves at a disadvantage if a subsequent change

in regulations invalidates prior assumptions about the best business model for operating in

that country. Another potential disadvantage of being a pioneer in a country is the need to

educate customers about your company’s products, especially if those products have not

been available in that marketplace before (e.g., FedEx in China had no natural competitor

before UPS, DHL, and others joined the marketplace).

SCALE OF ENTRY AND STRATEGIC COMMITMENTS

Another issue that an international business needs to consider when contemplating market

entry is the scale of entry. Entering a market on a large scale involves the commitment of

significant resources and implies rapid entry. Consider the entry of the Dutch insurance

company ING into the U.S. insurance market. ING had to spend several billion dollars to

acquire its U.S. operations. Not all firms have the resources necessary to enter on a large