Global Enterprise and Competition 66.511.202 Fall 2007 Ashwin Mehta, Visiting Faculty

1. Global Enterprise and Competition 66.511.202 Fall 2007 Ashwin Mehta, Visiting Faculty

2. Competitive Strategies: Modes of Entry and FDI

3. Enron India What risks did Enron face going into the Dabhol project? • Political risk: expropriation of investment • Political risk: renegotiation of contracts after investment • Contract risk: problems with local partners • Currency risk • Market risk: costs of energy and demand for electric power • Recovery of investment costs (FDI)

4. Enron India How did Enron prepare for the risks of the project? • Long term contracts: purchase agreement, Maharashtra State Electrical Board was a credible buyer • Political risk: participation of Overseas Private Investment Corp, US Export-Import Bank, International Finance Corp. • Revenues tied to US dollar • Partners GE and Bechtel • Substantial research

5. Enron India How could Enron have dealt with risk more effectively? • Enron could have relied less on FDI • Enron could have emphasized transactions, making arrangements for construction, power supply contracts, and technology transfer • More reliance on local partners to construct and operate project • Greater participation of other Indian institutions

6. Enron India Why did Enron choose ownership (FDI)? • To exercise control over assets in investment projects • To control technology due to limits on intellectual property rights • To improve operational effectiveness • To learn about market for future projects • To avoid expected contract risk

7. International Strategy Exporting Licensing Franchising Joint Ventures Acquisitions Green-Field Development Production Sharing Turnkey Operations BOT Concept Management Contracts Strategy Options

8. International Markets Entry Mode Experimental – selected exporting Comfort levels Minimal cultural/political differences (little or no psychic distance) Active Involvement – systematic approach Identify International markets Allocate resources Global involvement – broad business activities Develop Competitive advantage Cyclical, causal process: Market knowledge leads to Commitment decisions Market commitments Results from Current Activities Before, an incremental process Now, Rapid Internationalization a more preferred approach knowledge, tools, facilitating institutions Managers are more prepared (outsourcing, technology transfers) Partnering/alliances

9. Entry mode is affected by Product related factors Product offering range/scope Product life cycle stage and market strategies Need for adaptation Foreign-based partners (advantages?, risks?) Market based factors Strategies for target markets Available distribution channels Psychic distance Experience level Geographical coverage (# of locations/countries) Relative priority of each market Organizational Factors Communication Control Amount of assets/resources committed leads to type of Control e.g. direct selling, manufacturing, R&D require high control

10. Global Market Assessment Importance of Market research AT&T’s missed opportunity in China Many sources, including US and State level departments Do not rely on a single source Trade fairs, trade delegations, direct promotion, collaborate with suppliers and distributors Some questions to ask: · Which countries offer the best prospects? · In which foreign markets can company products be sold profitably? · Does the foreign market require any modification of the product? · What distribution channels and arrangements should be employed in selling to a particular country? · How sensitive is market demand to product price? · What should the landed and retail prices be? · What sales volume and margins can be expected in each market? · What performance criteria should be used to monitor company activity in each foreign market?

11. Competitive Strengths Low High Dominate/Divest Invest/Grow High Joint Venture Selective Country Attractiveness Strategies Harvest/Divest Low Combine/License Portfolio Matrix for Plotting Products by Country

12. FDI includes cross-border business investment and M&A. (not portfolio investment) World FDI inflows: $209 billion (1990) (Cross-border M&A: $151 b.) $1,492 billion (2000) (Cross-border M&A: $1,144 b.) $735 billion (2001) (Cross-border M&A: $594 b.) $651 billion (2002) (Cross-border M&A $ 370 b.) $560 billion (2003) (Cross-border M&A $ 297 b.) Compare with world total gross fixed capital formation: $7,294 b. (2003) FDI

13. World FDI inward stock: $8,245 billion (2003) Sales of foreign affiliates: $17,580 billion (2003) (Compare with international trade of $9,228 billion (2003) Gross product of foreign affiliates: $3,706 billion (2003) (Compare with world GDP of $36 trillion in 2003). Total assets of foreign affiliates: $30,362 billion (2003) Employment of foreign affiliates: Over 54 million people (2003 estimated) Data from United Nations World Investment Report and UNCTAD website FDI

14. FDI

15. FDI – whether M&A or company growth – puts full value at risk. Toyota factory, Wal-Mart store Managers of an international business choose the mode of entry based on a trade-off between risk versus control in the particular supplier or customer country Joint ventures, not only share knowledge, but also share investment costs and value at risk Spot or contract sales can substantially reduce value at risk International modes of entry and value at risk

16. M&A Growth Alliances/ Joint Ventures Licenses Contract Spot Increase in control, Increase in commitment and risk International modes of entry and value at risk • Choice of entry mode jointly determines degree of control and extent of risk • Degree of commitment depends on contractual duration and vertical integration • With less knowledge of other country’s market, choose lower degree of commitment • As knowledge increases over time, can increase degree of commitment to get closer to desired entry mode. • Contractual transactions may give optimal mix of control and commitment

17. Costs of investment project Estimate potential expected returns Determine risks associated with revenues and costs in host country -- Best estimates of expected cash flow Apply appropriate risk-adjusted discount rate Manager considers trade off between risk and return Choosing target countries for FDI

18. Production or distribution facilities in a country can reduce costs of trade (transportation, tariff and nontariff barriers, transaction costs, and time) – Toyota in US Production within a country takes advantage of domestic sourcing of parts, components, services Investment and employment in host country gain political support for the international business: “quid pro quo investment” – Cemex and Southdown Why is FDI so common in international business? Advantages of FDI

19. Closer to customers for manufacturers Necessary for retail and wholesale companies – Wal Mart, Carrefour, Ingram Micro Take advantage of low-cost labor, highly-skilled labor, and proximity to resources Reduce costs of trade from import/export Why is FDI so common in international business? Advantages of FDI

20. Coordination advantages through the value chain Access to production facilities, sourcing networks and distribution networks Keeping technology and intellectual property in-house Substitution of internal transactions for market transactions Advantages of vertical FDI

21. M&A acquisition of competitors for market power or cost savings M&A to achieve economies of scale and scope (Daimler/Chrysler, VW) M&A to purchase of technology M&A to acquire brand names Production avoids costs of trade relative to export As hedge against demand and supply fluctuations -- Cemex Market power in international purchasing (e.g. Vodaphone/Airtouch purchases wireless equipment for its many operations) Advantages of Horizontal FDI

22. Risk that firm many not recover investment and returns to investment in supplier country FDI increases capital investment, reduces flexibility FDI ties business to particular country locations for production or distribution Vertical FDI makes the firm more vertically integrated Disadvantages of FDI

23. Shift of investment mix toward services About half in 1990, about two thirds in 2000 Shift of investment to outsourcing abroad (offshoring + outsourcing) – reduction in vertical integration Globalization (lower costs of trade) leading to reduction in vertical FDI Globalization (market integration) likely to lead to increases in horizontal FDI UNCTAD World Investment Report 2004 FDI Trends

24. Why is FDI more prevalent than technology licensing? Licensing agreements depend heavily on international enforcement of intellectual property rights International licensing also entails costs of trade International licensing is quite common amongst developed countries, reaching levels up to 1/3 of domestic R&D expenditures International licensing experiencing rapid growth Licensing versus FDI

25. FDI a major feature of international business – composition of FDI undergoing transformation – from vertical to horizontal FDI offers advantages in terms of ownership and control and avoiding trade barriers Choose target countries based on expected cash flow and costs of investment and discount using risk adjusted rate of return Adjust level of investment to reflect expected cash flow and risk-adjusted rate of return Overview and Take-Away Points

26. Cooperative Strategies: Collusion Active cooperation of firms to reduce output and raise prices Explicit Tacit Cooperative Strategies

27. Strategic Alliance: Partnership of two or more corporations or business units to achieve strategically significant objectives that are mutually beneficial. Agreements between firms to do business together in ways that go beyond normal firm-to-firm dealings but fall short of merger or full partnership More effective in combating competitive disadvantage than in gaining competitive advantage!

28. Continuum of Strategic Alliances Mutual Service Joint Venture Value-Chain Consortia Licensing Arrangement Partnership Weak and Distant Strong and Close Source: Suggested by R. M. Kanter, “Collaborative Advantage: The Art of Alliances,” Harvard Business Review (July-August 1994), pp. 96–108.

29. International Markets Entry Issues and Concerns: R&D Marketing Logistics Sourcing

30. Global R&D Network Configure for cost and manage for value Distribution of R&D centers: Rising costs Opening of markets (India, China) Information Technology Scarcity of scientists and engineers US/Western Europe/Japan Proximity to technology/research clusters, markets/customers, qualified workers In developing countries (India, Eastern Europe) Lower cost, access to markets, pool of skilled workers

31. The Internationalization of R&D: The R&D footprint of most companies is becoming more global, with China and India seeing significant growth “Innovation: Is Global the Way Forward?”, Booz, Allen Hamilton & INSEAD, 2005

32. Multinational logistics Logistics: flow of goods and material multiple borders crossed (laws/regulations of each country multiple transportation modes Complex process and challenging management Logistics costs – a significant portion of total costs Multinational transportation Infrastructure (highways, railroads, air, etc.) Modes (ocean shipping, air shipping) Selection (time, predictability, cost, Governmental factors) Inventory issue (order cycle time, customer service levels, storage) Logistics Management Centralized Decentralized Outsource

33. Multinational Marketing Issues · Multinational Marketing Strategies· Market-Related Factors· Mix-Related Factors· Company-Related Factors 4 P’s Product (positioning, PLM, counterfeit markets, etc.) Placement (Channels design) Promotion (advertising, PR, etc.) Pricing (export pricing, transfer pricing, foreign market pricing, coordination)

34. Multinational Sourcing Purchasing, Procurement, Acquisition, sourcing/strategic sourcing Centralized Vs Decentralized function Worldwide sourcing has increased --- challenges to purchasing managers culture, language, laws, etc. Why source Worldwide cost, access to technology, quality, more options Barriers to WW sourcing Paperwork (LOC, Bill of Lading, licenses, etc.) Inertia Logistical challenges Security concerns (causing time delays) Sourcing process Establish needs/objectives/strategies RFP’s Evaluation and Selections Countertrades

35. Modes of Entry and FDIFlextronics in India © Professor Daniel F. Spulber

36. Flextronics With fiscal year 2007 revenues of USD$18.9 billion, Flextronics helps customers design, build, ship, and service electronics products for OEMs in the automotive, computing, consumer digital, industrial, infrastructure, medical, and mobile market segments. Flextronics has a network of facilities in over 30 countries on four continents. This global presence provides design and engineering solutions that are vertically integrated with manufacturing, logistics, and component technologies to optimize customer operations by lowering costs and reducing time to market.

38. “Flextronics Design creates innovative, market-leading products for our customers. We partner at any phase of the product development cycle from concept to production launch. Our flexible engagement models allow customers to utilize Flextronics’ global engineering team for complete, full turnkey product development or for a specific contract design service. “ “By balancing stylish product design with the realities of manufacturing in today's global economy, Flextronics helps customers rapidly move from concept to production launch while optimizing resources and reducing costs.” www.flextronics.com Flextronics InternationalManufacturing operation Bangalore

39. June, 2004: Flextronics acquires Hughes Software Systems. • August, 2004, Flextronics acquires Chennai-based Future Software Ltd that provides software solutions to telecom firms. • November 2004: Flextronics acquires Emuzed, multimedia solutions provider with R&D centres in Bangalore and Chennai. • December, 2004: Flextronics acquires Deccanet that provides software and hardware design services.

40. Flextronics enters India through M&A by acquiring four companies – FDI Flextronics further expands its design capabilities by establishing facilities in India – FDI Design is vertically integrated with Flextronics manufacturing – vertical FDI Acquiring and protecting intellectual property are the main strategic motivations Management control and hiring skilled labor are also outcomes of M&A Choice of modes of entry