Operations: Overlaying Tactical Alternatives
Country Evaluation and Selection
! Discuss company strategies for sequencing the penetration of countries and for committing resources.
! Explain how clues from the environmental climate can help managers limit geographic alternatives.
! Examine the major variables a company should consider when deciding whether and where to expand abroad.
! Provide an overview of methods and problems when collecting and comparing information internationally.
! Describe some simplifying tools for determining a global geographic strategy.
! Introduce how managers make final investment, reinvestment and divestment decisions.
The country evaluation and selection process determines the geographical opportunities firms choose to pursue. Chapter 13 first discusses the challenges of marketing and production site location. It goes on to carefully examine the process by describing the choice and weighting of variables used for opportunity and risk analysis as well as the inherent problems associated with data collection and analysis. The chapter then introduces the use of grids and matrices for country comparison purposes, discusses resource allocation possibilities and concludes by noting the different factors considered as part of start-up, acquisition and expansion decisions.
OPENING CASE: Carrefour [See Figure 13.1, Map 13.1]
This case explores the location, pattern
and reasons for Carrefour’s international operations. Carrefour opened its
first store in 1960 and is now the largest retailer in Europe and
Teaching Tip: Review the PowerPoint slides for Chapter 13 and select those you find most useful for enhancing your lecture and class discussion. For additional visual summaries of key chapter points, review the figures and tables in the text.
Because companies lack the resources to take advantage of all international opportunities they identify, they must determine both the order of country entry as well as the rates of resource allocation across countries.
II. CHOOSING MARKETING AND PRODUCTION SITES, AND GEOGRAPHIC STRATEGY
In choosing geographic sites, a firm must determine both where to market and where to produce. The answer can be one and the same place if transportation costs are high and/or government regulations make local production a necessity. In many industries, facilities must be located near foreign customers; in others, market and production sites are continents away. Developing a site location strategy that helps a firm maximize its resources and competitive position is very challenging, given that many estimates and assumptions about factors such as future costs and prices and competitors’ reactions must be made.
III. SCANNING FOR ALTERNATIVE LOCATIONS
Scanning is useful insofar as a company might otherwise consider either too few or too many possibilities. Through the use of scanning, decision makers can perform a detailed analysis of a manageable number of geographic locations.
IV. CHOOSING AND WEIGHTING VARIABLES
To evaluate and compare countries, scanning techniques based on broad environmental variables that identify both opportunities and risks should be used. Ultimately, variables must be weighed against each other to effectively evaluate the potential success of a particular venture and to compare various ventures.
Opportunities are determined by competitiveness and profitability factors. Variables weighing heavily on the selection of market and production sites would include market size, ease and compatibility of operations, costs, resource availability and red tape.
1. Market Size. Market size is determined by sales potential. In some instances, past and current sales for either an existing product or a similar or complementary product are available on a country-by-country basis. In addition, data such as GNP, per capita income, population, income distribution, economic growth rates and levels of economic development will also be useful.
2. Ease and Compatibility of Operations. Companies are naturally attracted to countries that are located nearby, share the same language and offer market conditions similar to those in their home countries. Beyond that, proposals may then be limited to those countries that offer, among other factors, the appropriate plant size, the local availability of resources, an acceptable percentage of ownership and the sufficient repatriation of profits. However, the more time, money and energy a firm expends in examining a particular alternative, the more likely it is to accept it, regardless of its merits. This situation is known as the escalation of commitment. Feasibility studies should have clear decision points that prevent such a situation from occurring.
3. Costs and Resource Availability. Costs are a critical factor in production-location decisions. Productivity-related factors include the cost of labor, the cost of inputs, tax rates, and available capital, utilities, real estate and transportation. Often firms need to be located near suppliers and customers in an area where infrastructure will allow them to move supplies and finished products very efficiently. If a given production site will be used to serve multiple markets, the cost and ease of moving materials and products in and out the country will be especially important.
4. Red Tape. Red tape (disincentives) includes the difficulty of getting permission to operate, bringing in expatriate personnel, obtaining licenses to produce and market goods and satisfying government agencies on matters such as taxes, labor conditions and environmental compliance. Although not a directly measurable cost, red tape increases the cost of doing business.
Is it ever rational for a firm to invest in a country with high economic and political risk ratings? Such questions must be carefully weighed when making international capital-investment decisions.
1. Risk and Uncertainty. Firms usually experience higher risk and uncertainty when they operate abroad. In fact, the liability of foreignness refers to the fact that foreign firms have a lower rate of survival than local firms for the initial years after the start of operations. However, those foreign firms that manage to overcome their initial problems have long-term survival rates comparable to those of local firms. Firms use a variety of financial techniques to compare potential investments, including discounted cash flows, economic value added, payback period, net present value, return on sales, return on equity, return on assets employed, internal rate of return and the accounting rate of return. Given the same expected return, most decision makers prefer a more certain outcome to a less certain one. Often firms may choose to reduce risk through some form of insurance. As part of a feasibility study, the degree of acceptable risk should be determined so a firm does not incur unacceptable costs.
Competitive Risk. A firm’s innovative advantage may be short-lived, particularly if a
country offers little protection with respect to intellectual property rights. When pursuing a strategy known as imitation
lag, a firm moves first to those countries most likely to adapt and
catch up to the advantage. In some instances firms may seek those countries
where they are least likely to confront significant competition; in others they
may gain advantages by moving into countries where competitors are already
present. Firms may also seek “clusters” like
3. Monetary Risk. If a firm’s expansion occurs through foreign-direct investment, foreign-exchange rates and access to investment capital and earnings are key considerations. Liquidity preference refers to the theory investors want some of the holdings to be in highly liquid assets on which they are willing to take a lower return. Firms must carefully evaluate a country’s present capital controls, recent exchange-rate stability, balance-of-payments account, inflation rate and level of government spending.
4. Political Risk. Political risk reflects the expectation the political climate in a given country will change in such a way that a firm’s operating position will deteriorate. It relates to changes in political leaders’ opinions and policies, civil disorder and animosity between a home and host country. When evaluating political risk, decision makers refer to past patterns in a given country, expert opinions and country analysts. They also look for economic and social conditions that could lead to political instability, but there is no consensus as to what constitutes dangerous instability or how it can be predicted.
V. COLLECTING AND ANALYZING DATA
Firms perform research to reduce uncertainties in their decision processes, to expand or narrow the alternatives they consider and to assess the merits of their existing programs. The costs of data collection should always be weighed against the probable payoffs in terms of revenue gains or cost savings.
A. Problems with Research Results and Data
Numerous countries have agreed to standards for collecting and publishing various categories of national data. However, the lack, obsolescence and inaccuracy of data on other countries can make research difficult and expensive to undertake. Further, data discrepancies further increase uncertainty in decision-making.
1. Reasons for Inaccuracies. For the most part, incomplete or inaccurate data result from the inability of governments to collect the needed information. Both economic and educational factors will affect the quantity and quality of available data. Of equal concern, however, is the publication of false or purposely misleading information, as well as the non-reporting or under-reporting of information people wish to hide or distort.
2. Comparability Problems. Comparability problems result from definitional differences across countries (e.g., family categories, literacy levels, accounting rules), differences in base years, distortions in foreign currency conversions, the measurement of investment flows, the presence of black market activities, etc.
B. External Sources of Information
Both the specificity and cost of information will vary by source.
1. Individualized Reports. Market research and business consulting firms conduct country studies for a fee. The fact that a firm can specify the information it wants may make the cost worthwhile.
2. Specialized Studies. Certain research organizations generate specific studies about countries, regions, industries, issues, etc., that they make available for general purchase. The price is much lower than for an individualized study.
3. Service Companies. Most international service-related firms publish reports that are usually geared toward either the conduct of business in a given country or region or about some specific subject of general interest, such as tax or trademark legislation.
4. Government Agencies. Governments and their agencies publish tomes of information designed to stimulate business activity both at home and abroad.
5. International Organizations and Agencies. The United Nations, the World Trade Organization, the International Monetary Fund, the World Bank (IBRD) and the Organization for Economic Cooperation and Development are but a few of the multilateral organizations and agencies that collect and disseminate data. Many of the international development banks even help fund investment feasibility studies.
6. Trade Associations. Many trade associations collect, evaluate and disseminate a wide variety of data dealing with competitive and technical factors in their industries. Their reports may or may not be available to non-members.
7. Information Service Companies. Certain companies offer information-retrieval services; they maintain databases from hundreds of sources from which they will access data for a fee.
8. The Internet. The quantity of information available via the Internet is increasingly extensive. As with other sources, a researcher must be concerned about the reliability and validity of information gathered from Internet sources.
C. Internal Generation of Data
When firms have to conduct studies in foreign countries, they may find traditional data gathering and analytical methods do not reveal critical insights. In that case, a researcher must be extremely imaginative and observant. In some instances, useful information may be found by analyzing indirect or complementary indicators.
VI. COUNTRY COMPARISON TOOLS
Two common tools for analyzing information collected via scanning are grids and matrices. Also, once a firm commits to a location, it will need continuous updates regarding external conditions that might affect its operations there.
A. Grids [See Table 13.2]
A grid can be used to make country comparisons according to a wide variety of relevant factors, such as ownership rules, potential returns and perceived risk. Variables can be ranked and weighted according to specific criteria that reflect a firm’s situation and objectives. Although useful for establishing minimum scores and for ranking countries, grids often obscure interrelationships among countries.
B. Matrices [See Figures 13.5, 13.6]
Two matrices frequently used when doing country comparisons are the opportunity-risk matrix and the country attractiveness-company strength matrix.
1. Opportunity-Risk Matrix. An opportunity-risk matrix plots a country according to the perceived value of the opportunity the country offers, on the one hand, and the expected level of risk associated with operating in that country on the other. Which factors are good indicators of risk and opportunity and the weight assigned to each must be identified and assigned by the firm. Once scores are determined for each country being considered, they can be plotted and reviewed from a comparative perspective. A useful application of this technique is to develop both present and future scores for countries (e.g., five years hence) because a significant shift in a score in the future could have serious implications with respect to the country selection process.
2. Country Attractiveness-Company Strength Matrix. A country attractiveness-company strength matrix highlights a company’s specific product advantage on a country-by-country basis. Firms should concentrate their activities in those countries where both the country attractiveness and the competitive strength ratings are high. When opportunity ratings are high but company strength is not, a firm may decide to try to remedy its competitive weakness.
C. Environmental Scanning
Environmental scanning provides a systematic assessment of external conditions that might affect a firm’s operations. For country assessment, firms will likely collect economic, competitive, societal and political/legal information.
VII. ALLOCATING AMONG LOCATIONS
Over time, most of the value of a firm’s FDI comes from reinvestment. Thus, in deciding where to invest, firms must consider whether to reinvest or harvest, to what degree there is interdependence among their locations and whether they should diversify or concentrate their activities.
A. Reinvestment vs. Harvesting
Once a firm makes an initial investment, it will then need to decide whether to continue investing in that operation or to harvest the earnings (and possibly divest the assets) and use them elsewhere.
1. Reinvestment Decisions. Reinvestment refers to the use of retained earnings to replace depreciated assets or to add to a firm’s existing stock of capital. Aside from competitive factors, a company may need several years of almost total reinvestment (and often allocation of additional funds) in order to realize its objectives at a given location.
2. Harvesting. Harvesting refers to the reduction in the amount of an investment; a firm may choose to simply harvest the earnings of an operation or divest the assets there as well. If an operation no longer fits a company’s overall strategy, or if better opportunities exist elsewhere, it must determine how to exit that operation. When selling or closing facilities, firms must consider possible government performance contracts as well as potential adverse publicity, plus the possible difficulty in re-establishing operations in that country in the future.
B. Interdependence of Locations
It is often difficult to assess the true impact a particular foreign subsidiary has on other operations within an MNE if several operations are interdependent. In the case of intra-firm sales, transfer pricing strategy will definitely affect the relative profitability of one unit as compared to another. Likewise, the net value of a particular operation may be similarly distorted for corporate profit maximization purposes.
C. Geographic Diversification vs. Concentration
A firm may take different paths en route to gaining a sizable presence in most countries. At one end of the spectrum is geographic diversification, whereby a firm moves rapidly into many foreign countries and then gradually builds its presence in each. At the other end of the spectrum is geographic concentration, whereby a firm moves into a limited number of countries and develops a strong competitive position there before moving into others. When deciding which strategy, or perhaps some hybrid of the two, is desirable, a firm must consider a number of variables.
1. Growth Rate in Each Market. When the growth rate in each market is high, a firm will likely concentrate on a few markets because of the cost of keeping up with market expansion.
2. Sales Stability in Each Market. The more stable sales and profits are within a single market, the less advantageous a diversification strategy will be.
3. Competitive Lead Time. Sequential entry into multiple markets is more common than simultaneous entry. If a firm has a long lead time before competitors can copy or supercede its advantages, then it may be able to follow a concentration strategy and still beat competitors to other markets.
4. Spillover Effects. Spillover effects represent situations in which a marketing program in one country results in the awareness of a product in other countries. When a single marketing program can reach many countries (via cross-country media, for example), a diversification strategy is advantageous.
5. Need for Product, Communication and Distribution Adaptation. When companies find it necessary to alter products, promotion and/or distribution strategies in foreign markets, a concentration strategy will be advantageous because the associated costs cannot be spread over sales in other countries to capture economies of scale.
6. Program Control Requirements. The more a company needs control over a foreign operation, the more appropriate a concentration strategy because additional resources will be required to maintain that control.
7. Extent of Constraints. When a firm is constrained by limited resources, it will likely follow a concentration strategy because spreading resources too thinly can be a recipe for failure.
VIII. MAKING FINAL COUNTRY SELECTIONS
At some point, firms must make resource allocation decisions. For new investments they will need to develop detailed estimates of all costs and expenses and consider whether to enter a particular venture alone or with a partner. For acquisitions, firms will need to examine financial statements in great detail. For expansion within countries where they are already operating, country managers will most likely submit capital budget requests that include details of expected returns. To maximize expected gains, decisions must be made in a timely fashion.
Economic Efficiency, Non-economic Concerns, and Competitive Strategies: Are They Compatible?
Should countries work toward regulating FDI with global efficiency as their objective, or should each country continue to serve its own interests by competing for FDI? MNEs are frequently criticized when they shift their geographic emphasis in response to changing legal, political and economic environments. In particular, they are criticized for selling dangerous products abroad when domestic demand is dampened. MNEs tend to justify their moves on the grounds they promote global efficiency through low-cost production and high-level sales; they also note they may be responding to trade restrictions or government incentives, or to competitive conditions. Relativists maintain it is unethical to prohibit foreign sales because those sales are considered to be ethical in the countries in which they are made. Normativists, on the other hand, maintain it is unethical for a government to permit its firms to do abroad those things they are prohibited from doing domestically.
LOOKING TO THE FUTURE:
Will Locations and Location-Models Change?
The receptiveness of more countries to FDI and the global move toward privatization have combined to create even more opportunities for MNEs. However, international geographic expansion is a two-tiered decision. First, how much of a firm’s sales and production should be located abroad, and second, how should those activities be allocated across countries? A further consideration is the location of managers. Although technology may permit them to work from anywhere, evidence shows business travel has increased in concert with advances in communications.
Teaching Tip: Visit www.prenhall.com/daniels for additional information and links relating to the topics presented in Chapter 13. Be sure to refer your students to the on-line study guide, as well as the Internet exercises for Chapter 13.
CLOSING CASE: Royal Dutch Shell/Nigeria [See Map 13.2]
1. What specific political risk problems does Shell face in Nigeria? What are the underlying reasons for these problems?
First, Shell faces micropolitical risk in Nigeria because its investment there is so visible and so dominant. Such pressures could come from within Nigeria (e.g., sabotage) as well as from external stakeholders (e.g., boycotts of Shell products or opposition to their operations in other countries). Second, it faces macropolitical risk in the form of civil disorder and political leadership. In response to the shareholder resolution of 1997, Shell has worked to improve both the social and environmental impact of its Nigerian operations. It is investing heavily in community development programs. Nonetheless, potential civil disorder and disagreements about the fair distribution of revenues within Nigeria are ever present. Historically, many of the problems facing oil companies in Nigeria are linked to government mismanagement. If the government does not address development problems adequately and respond to concerns of its citizens, then all MNEs will find operating in Nigeria an increasingly risky and expensive proposition.
2. Given the high political risk in Nigeria, why doesn’t Shell go somewhere else?
The key to this question lies in whether Shell considers the risk of operating in Nigeria to be too high relative to the opportunity and sunk costs associated with operating there. Shell is in Nigeria primarily to secure oil-based resources, not to serve the Nigerian market. Thus, the opportunity side of Shell’s decision revolves around the probability of finding and refining oil-based resources there at an acceptable cost.
3. What actions can Shell take to quell criticism about its operations in Nigeria?
Shell has begun to take action in response to criticism from pressure groups, including becoming more transparent about its practices concerning human rights and the environment. In 2002 the firm announced a $7.5 billion oil and gas investment to be made in Nigeria over a period of five years. It reasons that such a massive expansion will demonstrate its commitment to the Nigerian people, the environment and to Nigeria’s civilian democratic government. However, whether the subsequent revenues generated by the investment go to neglected regions remains to be seen. On the other hand, Shell’s community development program in the Niger delta region should have a more immediate and direct impact.
Additional Exercises: Country Evaluation and Selection
Exercise 13.1. As the phenomenon of economic integration progresses, the process of country selection takes on new dimensions. Ask students to compare and contrast the opportunities and risks associated with establishing operations in the European Union to those in the NAFTA region. Would such investments be primarily resource or market seeking? Be sure students explain and give examples to support their ideas.
Exercise 13.2. Ask students to compare the costs and benefits of investing in an industrialized economy to the costs and benefits of investing in a developing economy from the standpoint of an MNE. Then ask the students to debate the idea that MNEs have a responsibility to work toward developing global efficiency, i.e., that economic considerations should be weighted more heavily than other factors in the country selection process.
Exercise 13.3. During the 1970s, a number of MNEs such as Coca-Cola and IBM made decisions to abandon operations in certain developing countries and not to enter others because of government restrictions. Ask the students to discuss the likelihood that MNEs will face such decisions in the future, given the progress of the WTO and movements toward economic integration in many parts of the world. Do the students foresee other factors that might cause more divestments in the future?