Chapter 8: Strategy in the Global Environment 1
CHAPTER 8
Strategy in the Global Environment
Synopsis of Chapter
This chapter looks at the strategies companies adopt when they expand outside their domestic marketplace and start to compete on a global basis. The chapter opens by discussing how global expansion creates value for a company. The focus is on the ability of global companies to transfer distinctive competencies across national markets, to realize location economies from basing individual value-creation activities in the optimal location for that activity, and to ride down the experience curve more rapidly than competitors that are focused on just their domestic market.
Next the chapter examines two types of competitive pressures that firms competing in the global marketplace typically face: pressures for cost reductions and pressures to be responsive to local conditions. These pressures place conflicting demands on a company.
The discussion then turns to the different strategies that companies can pursue in the global arena. Four different strategies are reviewed in some detail, and a link is made between the appropriateness of different strategies and the pressures for cost reductions and local responsiveness.
We then discuss the basic entry decisions a company faces when going international. In particular, we look at decisions about which markets to enter, when to enter, and on what scale to enter.
In the next section, which reviews various options that a company has for entering a foreign market, the five basic options—exporting, licensing, franchising, joint ventures, and the establishment of a wholly owned subsidiary—are compared and contrasted.
A discussion of global strategic alliances closes the chapter. It assesses the advantages and disadvantages of entering into strategic alliances with global competitors and highlights ways of improving the probability of a successful alliance.
Teaching Objectives
1.Familiarize students with the importance of global competition and global competitors.
2.Describe the benefits that global firms enjoy and also the costs they must bear.
3.Discuss the pressures for cost reductions and local responsiveness that face global companies.
4.Discuss the pros and cons of four different strategies for competing in the global marketplace: an international strategy, a multidomestic strategy, a global strategy, and a transnational strategy.
5.Understand how global companies make decisions about which markets to enter, when to enter, and on what scale to enter.
6.Discuss the advantages and disadvantages of various modes of entry into foreign markets.
7.Identify the factors that determine which way of entering a foreign market is best for a particular company.
8.Review the benefits and potential pitfalls of building global strategic alliances with competitors, and discuss ways of improving the probability of success for global strategic alliances.
Opening Case: MTV Has to Sing a New Song as It Expands Globally
MTV Networks is one of the most successful businesses at globalization, with 29 distinct channels reaching 330 million subscribers, generating a profit of over $1 billion annually. In 1987, its first year of overseas operations, MTV managers naively assumed that Europeans would be interested in American pop stars and commentary. Soon, copycats began to offer local programming, spurring MTV to create separate, regional channels, including eight in Europe and six in Asia. Forty percent of the programming and 70 percent of the music videos feature local performers, and all of it is delivered by local VJs (video jockeys). Ratings are growing and the threat from copycats is much less. Even more importantly, advertising revenues are up, especially revenues from local advertisers.
Teaching Note: This case illustrates the way in which a firm that experienced success in its home country began the process of globalization. MTV’s experience with globalization was hesitant and error-prone at first, but they learned from those experiences. To discuss this case in class, ask students to consider the benefits that MTV has received from its globalization efforts. Then ask them to describe MTV’s current global strategy, and point out any potential weaknesses that must be addressed.
Lecture Outline
I.Overview
A.This chapter considers the contribution of global strategy to the process of building and maintaining a competitive advantage, outlining and discussing global strategies.
B.Also covered are the decisions managers make about when and how to enter a foreign market.
C.Multinational companies, companies that do business in two or more countries, are also discussed, as are global strategic alliances.
II.Increasing Profitability Through Global Expansion
A.Expanding globally lets both large and small companies increase their profitability in a number of ways not available to purely domestic enterprises.
B.One way for firms to increase their profitability through internationalization is the realization of location economies, those benefits that arise from performing a value-creation activity in the optimal location for that activity, wherever in the world that might be.
1.One benefit of location economies is the lowering of costs for raw materials, power, labor, and so on. This is consistent with the business-level strategy of cost leadership.
2.Another benefit of location economies is the firm’s improved ability to differentiate its product, consistent with a differentiation business-level strategy.
3.However, a negative consequence of pursing location economies is the potential for increased transportation costs and unfavorable trade barriers.
4.Another possible negative consequence is the increased political and economic risk in regions where governments are unstable or implementing unfavorable business policies.
C.Another way that firms can benefit from global expansion is through the increased ability to ride down the experience curve, reducing the costs of production over the life of a product. Moving down the experience curve is consistent with the business-level strategy of cost leadership.
1.Global markets are larger than domestic markets, and therefore companies that serve a global market from a single location are likely to build up accumulated volume quickly.
2.The cost advantages of serving the world market from a single location will be all the more significant if that location is also the optimal one for realizing location economies.
D.Yet another benefit of global expansion is the ability to further exploit distinctive competencies. Companies with valuable distinctive competencies can often realize enormous returns by applying those competencies to foreign markets, where indigenous competitors lack similar competencies.
Strategy in Action 8.1: McDonald’s Is Here, THere, and Everywhere
As the U.S. fast food market became saturated, McDonald’s began to open global franchises. Today, 90 percent of their new restaurant openings are overseas. And the firm is planning further expansion to increase penetration, especially in developing countries. However, McDonald’s has had to adjust its business model. In the U.S. tight relationships with suppliers and standardization help to drive down costs. Overseas stores prepare American staples, but they also have the flexibility to offer foods suited for local tastes.
McDonald’s biggest problem has been to replicate its U.S. supply chain in foreign countries. The firm maintains rigorous specifications for all raw materials, but local suppliers are less willing to make the investments required to meet them. McDonald’s approach in Russia was to vertically integrate through the entire supply chain, managing dairy and vegetable farms and building a $40 million food-processing plant. Increasingly, the firm is finding that its foreign franchisees are a source of valuable new ideas.
Teaching Note: McDonald’s is using the distinctive competencies they developed in their home country, such as cost cutting and input standardization, to gain advantage in foreign markets, where competing restaurants do not have those skills. Their business model is so successful and so strongly ingrained in the company’s operations that when a piece of the puzzle is missing, as it was in Russia, then McDonald’s takes on the heroic task of providing that piece themselves, rather than change the model. To generate discussion, have students think critically about McDonald’s attachment to its business model. Does it always make sense, for example, as in Russia? What are the benefits of their approach? What are the negative consequences?
E.Another benefit of global expansion is the ability of multinational firms to leverage the skills of global subsidiaries. Multinational firms with foreign subsidiaries can have valuable competencies arise in any of their locations, and then share that knowledge with other subsidiaries. This creates important new challenges for managers.
1.Managers must recognize that competencies can develop anywhere, and be on the lookout for those new competencies.
2.The firm must have an incentive system for local subsidiaries to develop new competencies.
3.Managers must be able to identify new competencies and help to transfer them within the company.
Strategy in Action 8.2: Hewlett Packard in Singapore
Hewlett Packard needed a low-cost overseas location for manufacturing facilities, and Singapore was ideal, with low labor costs, an educated, English-speaking workforce, a stable government, and good national infrastructure. Singapore officials also negotiated a favorable tariff agreement with HP. The factory began manufacturing basic components, but as they demonstrated their capability, HP managers began to trust them with more sophisticated manufacturing tasks. Then, in the early 1980s, HP gave the Singapore workers responsibility for a complete redesign of a handheld calculator. Singapore took over the redesign of ink jets and keyboards, typically reducing manufacturing expenses by 30 percent. Today, the Singapore facility is responsible not just for manufacturing, but also for the redesign of many HP products for Asian markets.
Teaching Note: This case shows how HP benefited far more than it expected in its relationship with its Singapore managers. The relationship was so successful as a result of actions taken on both sides. The workers at the Singapore facility were talented, motivated, and persevering in their tasks. HP officials saw the talent at Singapore, gave the workers the resources and training to expand their abilities, and rewarded them for high performance by giving them more autonomy. Students may be inclined to think of the relationship between a large U.S. company and its overseas facilities as exploitative, an opinion based perhaps on media coverage of problems uncovered at Nike and other manufacturers. You can use this case to show by counterexample that the relationship can be mutually beneficial and still be cost-effective for the U.S. firm.
III.Pressures for Cost Reductions and Local Responsiveness
A.Companies that compete in the global marketplace face competitive pressures for cost reductions and pressures to be locally responsive. These competitive pressures place conflicting demands on a company.
1.Responding to pressures for cost reductions demands that a company try to minimize its unit costs. To accomplish this, a company must base its activities at the most favorable low-cost location, wherever in the world that might be. It must also offer a standardized product to the global marketplace in order to ride down the experience curve as quickly as possible.
2.Reacting to pressures to be locally responsive requires a company to differentiate its product offering and marketing strategy from country to country. It must try to accommodate the diverse demands arising from national differences, which can lead to significant duplication and a lack of standardization, raising costs.
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Figure 8.1: Pressures for Cost Reductions and Local Responsiveness
B.Pressures for cost reductions arise from several sources.
1.Pressures for cost reductions are intense in industries producing commodity-type products that serve universal needs. For these products, differentiation on nonprice factors is difficult and price is the main competitive weapon.
2.Pressures for cost reductions are also strong in industries where major competitors are based in low-cost locations, where there is persistent excess capacity, and where consumers are powerful and face low switching costs.
3.Liberalization of the world trade and investment environment in recent decades has generally increased cost pressures by facilitating greater international competition.
C.Pressures for local responsiveness arise from several sources.
1.One source of strong pressures for local responsiveness emerge when consumer tastes and preferences differ significantly between countries, for historic or cultural reasons. Products and marketing messages have to be customized for local tastes and preferences, leading to the delegation of production and marketing functions to national subsidiaries.
a.However, some observers claim that consumer demands for local customization are on the decline worldwide, because modern communications and transportation technologies have led to a convergence of tastes and preferences. The result is the emergence of enormous global markets for standardized consumer products.
b.However, other commentators have observed that in some industries, consumers have reacted to an overdose of standardized global products by showing a renewed preference for products that are differentiated to local conditions.
2.Another source of pressures for local responsiveness emerge when there are differences in infrastructure and traditional practices between countries, creating a need to customize the product. This may necessitate the delegation of manufacturing and production functions to foreign subsidiaries.
3.Pressures for local responsiveness may arise when a company’s marketing strategies have to be responsive to differences in distribution channels between countries. This may necessitate the delegation of marketing functions to national subsidiaries.
4.Economic and political demands imposed by host country governments may require a degree of local responsiveness. Examples of threats from host governments include protectionism, economic nationalism, and regulations to ensure local content.
IV.Choosing a Global Strategy
A.Companies use four basic strategies to enter and compete in the international environment: (1) international strategy; (2) multidomestic strategy; (3) global strategy; and (4) transnational strategy. Each of these strategies has advantages and disadvantages. The appropriateness of each strategy varies with the extent of pressures for cost reductions and local responsiveness.
B.A firm must balance the pressures for costs reductions with the pressures for local responsiveness. In order to customize products to respond to local demands, the firm may have to give up some of the potential cost savings. Also, the firm may not be able to fully leverage its distinctive competencies.
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Figure 8.2: Four Basic Strategies
1.One global strategy is the international strategy, in which a firm tries to create value by transferring valuable skills and products to foreign markets where indigenous competitors lack those skills and products.
a.International companies create value by transferring differentiated product offerings developed at home to new markets overseas. They centralize product development functions at home.
b.However, international companies also establish manufacturing and marketing functions in each major country. They undertake limited local customization of products and marketing strategy, but the head office retains tight control over these.
Strategy in Action 8.3: IKEA’s Swedish Ways
Since its founding in the 1940s, IKEA has grown to be one of the world’s largest furniture retailers, selling a “typically Swedish” mix of products in every country in which it does business. IKEA’s international expansion began in 1974, and today the firm generates only eight percent of its sales in Sweden. IKEA products are known for their European stylishness and their good value for money. Their sales volume gives the firm high economies of scale and volume discounts from suppliers. However, when the firm entered the North American market in 1985, the stores were not immediately profitable. It turns out that American tastes differed significantly from Swedish preferences, for example, in the size of beds, drinking glasses, dresser drawers, and windows. After six years of struggling, IKEA managers began to tailor products to American needs, and sales have taken off.
Teaching Note: IKEA began its globalization efforts with a pure international strategy, in which products that were designed for Swedish customers were sold to buyers around the world. One reason this strategy worked so well is that Swedish furniture design is admired by many. However, the designs did not suit the tastes of American consumers, and the firm had to change to somewhat of a transnational strategy, in which the firm centralizes some tasks, but also learns from its regional offices. Some American firms make the same assumption when selling products overseas—that consumers worldwide will have the same taste as Americans do. For a lively classroom discussion, ask students who have lived or visited overseas to describe how American products are perceived in different parts of the world. The class can also debate the extent to which a firm should tailor its products to local preferences. For example, Mattel’s Barbie dolls, with their unrealistic bosoms and long legs, aren’t popular children’s toys in many European countries, so the firm’s European dolls have more life-like proportions.
c.An international strategy can be very profitable if a company has a valuable distinctive competency that indigenous competitors lack and if the pressures for local responsiveness and cost reductions are relatively weak.
d.However, when pressures for local responsiveness are strong, companies pursuing this strategy lose out to companies that customize products for local conditions. Moreover, because they must duplicate manufacturing facilities, international companies suffer from high operating costs.
2.Another global strategy is the multidomestic strategy, in which a firm orients itself toward achieving maximum local responsiveness.
a.Multidomestic companies transfer skills and products developed at home to foreign markets, however, unlike international companies, they extensively customize both their product offering and their marketing strategy.