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SOME VARIABLES AFFECTING CHOICE
In terms of resources, the modes of foreign operations differ in terms of both the amount a firm commits to foreign operations and the proportion of the resources that is located at home rather than abroad. Exports may, for example, result in a lower additional resource commitment than direct foreign investment if there is domestic excess capacity. If a firm must increase capacity, then this increase may take place by investing the resources either at home or abroad. The former involves a substantial commitment to foreign operations, although the assets are not in a foreign location. In exporting, in direct investment, and in some of the other forms of foreign operations, a firm may be able to reduce its total resource commitment by making contracts with other companies to conduct activities on its behalf or by sharing ownership in international business endeavors. Before examining these other operational forms it is useful to discuss some of the major factors that firms should consider when selecting a form of operation in a given market. We will cover them more intensively when we discuss specific operational modes.
Throughout this discussion, keep in mind that there are trade-offs. For example, a decision to own 100 percent of a foreign subsidiary will normally increase the parent’s fulfillment of the objective of controlling decisions; however, it may simultaneously reduce the parent’s fulfillment of the objective of minimizing exposure to political risk.2
Legal Conditions
As was indicated in the case on Grupo Industrial Alfa, a firm may be constrained in its choice of operating mode regardless of its preferences. Some of the foreign firms discussed, such as Ford, may have preferred a wholly owned Mexican operation but were not legally permitted. In addition to the outright prohibition of certain operating forms, other legal means may influence the choice. These include differences in tax rates, differences in the maximum funds that can be remitted, actual or possible enforcement of antitrust provisions, and stipulations on the circumstances in which a proprietary asset will be in the public domain and available for others to use.
Cost
In order to produce or sell abroad, certain fixed costs must be incurred, so that at a small volume of business it may be cheaper for a firm to contract the work to someone else than to handle it internally. A specialist can spread the fixed costs over services to more than one firm. If business increases enough, a firm may be able to handle the activities more cheaply itself than by buying outside services. Firms should therefore periodically reappraise the question of internal versus external handling of their varied operations.
Another reason that the external contracting of operations may be lower in cost is that another firm may have excess production or sales capacity that can be easily utilized. This utilization also may reduce start-up time and thus result in an earlier cash flow. Furthermore, the contracted firm may have environmental-specific knowledge, such as how to deal with Mexican regulations and labor, that would be expensive for the contracting firm to gain on its own.
Cooperative ventures may, however, increase operating costs. There are additional expenses to negotiate with another firm. There are usually added headquarters, costs of ongoing relationships with another firm. There may be additional control costs as reports must comply to the needs of more than one firm.
Experience
In their early stages of international development few companies are willing to expen(j a large portion of their resources on foreign operations; they may
not even have sufficient resources to expand abroad rapidly. As a result, they
usually move through stages of increased levels of international involvement. In the early stages they attempt to conserve their own scarce resources and to maximize the portion of the resources that are at home rather than abroad. This leads them to operational forms that transfer the burden of foreign commitment to outsiders. As the firms and their foreign activities grow, they will tend to view the foreign portion of their business differently. Then there is a movement toward the internal handling of more operations and locating a larger portion of resources abroad.3
Competition
When a firm has a desired, unique, difficult-to-duplicate resource, that firm is jn a „00(j pOSjUOn to choose the operating form that it would most like
to utilize. When there are competitive possibilities, a firm may have to settle on a form that is lower on its priority list; otherwise, a competitor may preempt the market. The possibility of competition also may lead to a strategy of rapid international expansion, which may be possible (because of limited resources) only by developing external arrangements with other firms.
Minimization of competition in given markets also may be achieved through cooperative arrangements that exclude entry, share resources, or divide output. The effectiveness will depend in part on the type of mode selected as well as the permissiveness of governmental authorities to the specific agreement.
There are many types of risk. However, the possibility of political or economic changes affecting the safety of assets and their earnings is often at the forefront of management’s concern in foreign operations. One way of minimizing loss from the seizure of assets in foreign operations is to minimize the base of assets located abroad. This may dictate external arrangements so that the asset base is shared by others. This move might also make a government less willing to move against an operation for fear of encountering opposition from more than one firm.
One way of spreading risk is to place operations in a number of different countries. This strategy reduces the chance that all foreign assets will simultaneously be subject to such adversities as confiscation, exchange control, or even a slowing of sales caused by a local recession. The maximum losses as well as the year-to-year changes in consolidated earnings thus may be minimized. For companies that have not yet attained widespread international operations, operational forms that minimize their own resource expenditures may permit a more rapid dispersion of operations. These forms will be less appealing for companies whose activities are already widely extended or who have ample resources to so extend.
Control
The more a firm deals externally, the more likely it will lose control over decisions that may affect its global optimization, including where output will be expanded, new product directions, and quality. External arrangements also imply the sharing of revenues, a serious consideration in undertakings with high potential profits. They also risk giving information more rapidly to potential competitors. Some analysts suggest that the loss of control over flexibility, revenues, and competition has been the most important variable guiding firms’ priorities for a mode of operation.4
Product Complexity
There are costs associated with the transfer of technology to another entity. Usually it is cheaper to transfer within the existing corporate family, such as from parent to subsidiary, rather than to another company. The cost difference is especially important when the technology is complex because subsidiary personnel are apt to be more familiar with approaches that the firm is using. For this reason, it has been noted that the higher the level of technology, the more likely a company will expand abroad with its own facilities rather than contracting with another firm to produce abroad on its behalf.5
Prior Expansion of the Company
When a company already has operations in place within a foreign country, some of the advantages of contracting an external firm to handle production are no longer as prevalent. In other words, the company knows how to operate within the foreign country and may have excess capacity that can be used to add new production. Much depends, however, on whether the existing foreign operation is in a line of business that is closely related to the product or service that is being transferred abroad. When there is similarity, such as a new type of office equipment in a company that already produces office equipment, there is the highest probability that the new production will be handled internally. In highly diversified companies, the existing foreign facility may be producing goods so dissimilar to what is being transferred that it is easier to deal with an experienced external company.
Similarity of Country
The degree of similarity among countries is a two-edged sword. On the one hand, management is more confident of its ability to operate in those foreign countries that it perceives to be similar to its home environment. U.S. companies, for example, are much more apt to handle operations internally in other English-speaking countries than in countries where the language is different. On the other hand, language and cultural differences impede communications and increase coordination costs among firms, especially if technology is being transferred. In these situations there may be a need to make some level of foreign direct investment so that personnel are more likely to move to the foreign locale to facilitate cross-national information flows.6
i irom Under a licensing agreement a firm (the licensor) grants rights on intan-
gible property to another firm (the licensee) for a specified period of time, and the licensee ordinarily pays a royalty to the licensor in exchange. The rights may be exclusive or nonexclusive. The U.S. Internal Revenue Service (IRS) classifies intangible property into five categories: