2014 is shaping up as a pivot point for Australian International Business with Free Trade Agreements now signed for the Big 3 markets in North Asia – Japan, South Korea & China and commitments well underway in Indonesia and now India to conclude agreements. Following on from the all-important Where to Go? Question as you plan your international business growth strategy is the “How to enter new markets?” Question. Following on from our How to enter…export blog post we now turn our attention to common contractual modes of market entry and examples highlighting the pros and cons of each entry mode.
Licensing is the contractual granting of intellectual property rights which could be in the form of technology, patents, or trademarks to brand usage with some common examples from the technology field being Intel or Dolby or in the field of brand trademarks Disney or Barbie. More often than not the licensee will pay a fee for licensing the technology or trade mark which could be a % royalty of sales or a fixed fee for the technology, product or service provision. Advantages for licensing are the rapid diffusion of technology or brand awareness for relatively low capital investment. Licensing is a low cost of entry mode and may lead to possible further direct investment with licensees down the line. A relatively safe and low risk way to test the market before significant capital investment. Risks include the limited contact with customers who are managed by licensees and reduced ability to control the end products or services delivery. You are relying on contractual enforcement of controls and in some markets it is difficult to use legal redress with business partners to disagreements upon implementation. You are also disclosing IP knowledge which can lead to technology transfer and future unwanted competition. Good examples of this are well documented in technology sector where O.E.M. (Original Equipment Manufacturers) later use their smarts developed from making others equipment to launch their O.B.M. (Own Brand Manufacture) often with additional features and benefits and disrupt the incumbents in their own industry e.g. ASUS laptops from Taiwan.
Franchise contractual market entry modes are commonly used in the quick serve restaurant industry globally and notably world renown examples include McDonald’s and Starbucks whilst closer to home Australian build brands like Boost have used Franchise market entry modes successfully to expand internationally. Another world renowned brand that uses wholesale franchising is the Coca-Cola Company of Atlanta granting franchise rights to global bottlers to manufacture, distribute and market their beverages in overseas territories. The Franchisor will retain the intellectual property rights to the recipes, formulas, ways of working or operating the businesses and grant the rights to operate and sell their products or services and brand usage rights to the franchisee in exchange for ‘key money’ and quite commonly a % royalty of sales in exchange for systems knowledge, operations manuals, training and development and often shared pooled marketing. Other examples of franchising in retail might include car dealer networks or petrol retailers who are franchise retail operators for the vehicle manufacturers or fuel manufacturers.
Advantages of the franchising entry model is similar to licensing lower capital outlay upfront and more rapid diffusion of brand and operating footprint leveraging franchisee capital investments. Controls using franchise agreements over operating procedures, product mix sold and pooled and managed marketing communications of the brand. Risks to manage include finding and managing the master franchise holders and individual franchisees. Reduced direct customer contact and requirement for sufficient customer service controls and reliance again on contractual modes of enforcement when disagreements arise between franchisor and franchisees. Lastly there is a profit sharing arrangement with franchisee operators inherent in the agreements as opposed to a wholly owned subsidiary type of operation so whilst upfront capital investment is less it is likely overall long term returns may also be diminished due to profit sharing with local operators.
Increasingly common and very widespread nowadays for a number of reasons. Contract Manufacturing is a contractual mode of market entry that can give your brand and company local manufacturing cost advantages whilst you still retain marketing, sales and distribution rights and responsibilities for your brand. Advantages of contract manufacturing or sub-contracting include saving in capital expenditure and reduced upfront risk associated vs. a Greenfield manufacturing plant in a foreign country. You are able to leverage skills and local capability and resourcing of your 3rd party manufacturing party and in some cases you may also be able to leverage their distribution and marketing and sales networks as well. There is opportunity for two-way technology transfer and learning and of course this is an associated risk to bear in mind with regards to intellectual property around your product composition or manufacturing process. Examples of contract or sub-contracted manufacturing include the car industry and in particular car parts for later assembly by the auto-manufacturer. It is widely used in the food industry by both retailers and manufacturers and may also be used in home as well as host markets. In beer for example where freight costs may be a high component to overseas markets and freshness is important you will often find major multinational global brands “Brewed and Manufactured under licence by…” as another example and in many cases they will leverage another brewers distribution, sales and marketing capability with contracts as well.
Turnkey Operations are contracts for construction of operating facilities that are transferred to the owner after commissioning for a fee. Most common in large multi-year projects like construction of infrastructure like airports, oil refineries, power plants, roads or railways they are a way for the owners to mitigate risk up front by contracting away the associated management risks of building a major project in a foreign nation. Advantages include contracting out some of the associated risks of managing a major construction project and the associated reduced management time as its more a case of fund it, get it build and then take over once it is commissioned. Risks include the associated technology transfer risks that the sub-contract manufacturer may become a future competitor in your industry with knowledge gained during the build phase.
Under a management contract mode of market entry one company provides another company with managerial expertise for a specified period of time. This maybe in exchange for a lump sum payment or a continuing fee on a % of sales value or volume for example. Sectors that commonly use management contracts are utilities services and it may be possible in developing markets where they need assistance from developed markets to manage new infrastructure like water management for example. Another example might be public council services such as lawn mowing and parks maintainenece and building management services provision which can also be international in scope and nature. Management contracts maybe useful entry modes where the home party has knowledge and expertise but cannot own the assets off-shore and the other party has a dependence or reason for management expertise. It can also serve as a useful lower risk learning experience into a foreign territory. Risks include reliance on the contract for enforcement and remuneration and the possible limited time span. In addition it may be hard to create and grow any brand equity or awareness in the case of some contract management services.
Contractual modes of entry will inherently rely on trust and relationship building between both parties and important criteria should be considered before you enter into contracts with companies in overseas markets. Firstly, are you talking to the right partners? Are they your perfect match? You also need to bear in mind the rule of law and alternative dispute resolution options in the host country. Many markets have different legal systems and different levels of respect for contracts as a means of doing business. Before considering contractual modes of entry our advice is to talk to professional services organisations with experience in this field and others in your industry at home to get a good understanding of the risks and rewards and how to mitigate risks and maximise the success criteria.
Please feel free to add your own comments and experience on contractual modes of market entry below and reach out to us for a follow-up face to face discussion at no obligation on your objectives for international business expansion.
Dermott Dowling is Managing Director @Creatovate, Innovation & International Business consultancy. Creatovate help businesses grow outside their home base from market entry strategy to route to market to go to market launch. Contact Dermott if your business needs help expanding your business internationally.