Chapter TWELVE
Country Evaluation and Selection
OBJECTIVES
• To grasp company strategies for sequencing the penetration of countries
• To see how scanning techniques can help managers both limit geographic alternatives and consider otherwise overlooked areas
• To discern the major opportunity and risk variables a company should consider when deciding whether and where to expand abroad
• To know the methods and problems when collecting and comparing information internationally
• To understand some simplifying tools for helping to decide where to operate
• To consider how companies allocate emphasis among the countries where they operate
• To comprehend why location decisions do not necessarily compare different countries’ possibilities
Chapter Overview
The country evaluation and selection process determines the geographical opportunities firms choose to pursue. Chapter Twelve 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.
Chapter Outline
OPENING CASE: Carrefour
[See Figure 12.1, Map 12.1]
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 Latin America and the second largest worldwide. Its stores depend on food items for nearly 60 percent of sales and on a wide variety of non-food items for the remainder. Carrefour plans to accelerate its growth between 2006 and 2008 after opening one million square meters of new space in 2005. Worldwide Carrefour has five different types of outlets: hypermarkets, supermarkets, hard discount stores, cash-and-carry stores and convenience stores. Country selection criteria include a country’s economic evolution, sufficient size to justify additional store locations and the availability of a viable partner. Aside from financial resources, Carrefour brings to a partnership expertise on store layout, clout in dealing with global suppliers, highly efficient direct e-mail links with suppliers and the ability to export unique bargain items from one country to another. Carrefour also considers whether a country or regional location within a country can justify sufficient additional store expansion to gain economies of scale in buying and distribution. Recently, Carrefour has used acquisition as a way to capture additional scale economies. Carrefour depends primarily on locally produced goods but also engages in global purchasing when capable suppliers are found. Whether Carrefour can ultimately succeed as a global competitor without a significant presence in the United States and the United Kingdom remains to be seen.
Teaching Tip: Review the PowerPoint slides for Chapter Twelve 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.
I. INTRODUCTION
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. 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. Figure 12.3 shows the major steps international business managers must take in making these decisions.
II. SCANNING AND DETAILED EXAMINATION COMPARED
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. Managers can usually complete the scanning process without having to incur the expense of visiting foreign countries. Instead they rely on analyzing information found on the Internet and other publicly available sources, as well as communicating with people familiar with the foreign countries they are interested in. The more time and money companies invest in examining an alternative, the more likely they are to accept it regardless of its merits—a phenomenon known as escalation of commitment. Companies should be careful about taking forced actions based on peer and/or media pressure and should instead carefully weigh important variables when comparing countries of interest.
III. WHAT INFORMATION IS IMPORTANT?
Environmental climate—the external conditions in a host country that could significantly affect an enterprise’s success or failure—reveals both opportunities and risk whose combination should determine what actions to take.
A. Opportunities
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. Other important economic variables pertaining to market size include:
• Obsolescence and leapfrogging of products. Consumers in some emerging economies skip entire generations of technology in favor of more recent technologies, such as Chinese consumers going from having no telephones to using cellular phones almost exclusively.
• Prices. The relative prices of essential and non-essential good can have a significant impact on consumption patterns. Higher prices for necessary goods leave less discretionary income for non-essentials.
• Income elasticity. Market potential can be calculated by dividing the percentage of change in product demand by the percentage of change in income in a give country. Income elasticity varies by product and income level, with demand for necessities being less elastic than demand for luxuries.
• Substitution. Depending on local conditions, consumers in some countries may be more willing to substitute some products or services for others. For example, people in high population density areas typically substitute mass transit for automobiles.
• Income inequality. Even in areas where per capita incomes are low, there may be middle- and upper-income people with substantial income to spend due to income inequality.
• Cultural factors and taste. Countries with similar income levels may exhibit different demand patterns based on differences in cultural values and tastes.
• Existence of trading blocs. Countries with small populations and/or low per capita incomes may have a much larger market due to participation in a regional trading block.
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.
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. When companies move into emerging economies because of labor cost differences alone, their advantages may be short-lived. Competitors often follow leaders into low-wage areas, there is little first-in advantage for low-labor cost production migration, and the costs can rise quickly as a result of pressure on wage or exchange rates. The quality of a country’s infrastructure can be very important in location decisions. Firms often need to locate in an area that 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 and Corruption. Red tape 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. Government corruption may include requirements of payments to win a contract or receive government services, such as mail delivery or visa issuance. Although not always a directly measurable cost, red tape and corruption increase the cost of doing business.
B. Risks
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. 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. Companies may reduce risk or uncertainty by insuring, however, insuring against things such as nonconvertibility of funds or expropriation is likely to be costly. As part of a feasibility study, the degree of acceptable risk should be determined so a firm does not incur unacceptable costs.
2. Liability of Foreignness. 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.
3. Competitive Risk. A firm’s innovative advantage may be short-lived. 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. By being the first major competitor in a market, companies can more easily gain the best partners, best locations, and best suppliers—a strategy to gain first mover advantage. Companies may also reduce risk by avoiding overcrowded markets, or conversely, they may purposely crowd a market to prevent competitors from gaining advantages therein that they can use to improve their competitive positions elsewhere, a situation known as oligopolistic reaction. Firms may also seek “clusters” like Silicon Valley that attract multiple suppliers, customers and highly trained personnel in order to gain access to new products, technologies, and markets.
4. 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.
5. 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.
DOES GEOGRAPHY MATTER?
Don’t Fool with Mother Nature
Natural disasters have a huge impact on people and property every year, often hitting the poorest nations of the world hardest. Companies should take the risk of natural disasters and their potential impact into account when choosing locations for doing business. The United Nations Development Programme is developing a Disaster Risk Index that could be used as a tool for companies to compare and prepare for disaster risk. Natural disasters can also trigger outbreaks of disease, which should also be considered when choosing locations for global operations.
IV. COLLECT AND ANALYZE 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.