GBS CH 6 COUNTRY EVALUATION AND SELECTION

IBM 641 (GBS) UITM

1. CHAPTER 6 Country Evaluation and Selection LEARNING OBJECTIVES Elaborate on the significance of location in IB operations Illustrate why comparing countries through scanning is important and how it connects to final location choices Discern major opportunity and risk variables and how to prioritize and relate them when deciding whether and where to expand abroad Summarize the sources and shortcomings of comparative country information Explain alternative considerations and means for companies to allocate resources among countries Recognize why companies make non-comparative decisions when choosing where to operate abroad 1

2. Introduction Since most companies have very limited resources, they must be careful in making the following decisions: 1. In which countries to locate sales, production, and administrative and auxiliary services e.g. R&D 2. The sequence for entering different countries 3. The amount of resources and efforts to allocate to each country where they operate 2

3. Location Decisions Affecting International Operations In choosing international location, a company should look at its objectives, strategies, capabilities and environmental factors that fit with the company conditions 3

4. Location Decisions Process 4 OBJECTIVES STRATEGY CHOICE OF COUNTRIES CHOOSING NEW LOCATIONS ALLOCATING AMONG LOCATIONS MAKING FINAL DECISIONS *Flexibility is crucial as country competitive conditions can change.

5. Scanning versus Detailed Analysis Step 1 – Scanning. It allows managers to examine most or all countries broadly and then narrow them to the most promising ones. In scanning, managers compare country information that is readily available, inexpensive, and fairly comparable—usually without having to incur the expense of visiting foreign countries . They need to analyze publicly available information, such as from the Internet e.g. http:// www.doingbusiness.org and communicate with others in the industry. Without scanning, a company may: Overlook opportunities and risks Examine too many or too few possibilities Step 2 – Detailed Analysis. Once managers narrow their consideration to the most promising countries, they need to compare the feasibility and desirability of each. At this point, unless they are satisfied enough to outsource all their production and sales, they almost always need to go on the location to analyze and collect more specific information. * The more time and money the company invest in examining the location, the higher the merits to accept the location – a situation called as an escalation of commitment . 5

6. Opportunity and risk variables Opportunities Sales Expansion Resource Acquisition Risks Political Foreign exchange Natural disaster Competitive 6 Companies need to consider opportunity and risk indicators that could significantly affect their success or failure when seeking for overseas location.

7. Opportunity and risk variables 7

8. Opportunity and risk variables: Sales Expansion 8 Expansion of sales i.e. profit is probably the most important factor motivating companies to engage in international business. Companies must consider variables other than income and population when estimating potential demand for their products in different countries. Some primary considerations when examining economic and demographic variables for sales expansion are listed below : 1. Obsolescence and leapfrogging of products Consumers in developing economies do not necessarily follow the same patterns as those in higher-income countries. In China, for example, consumers have leapfrogged the use of landline telephones e.g. from having no telephones to using cellular phones exclusively . 2 . Prices If prices of essential products are high, consumers may spend more on these products than what one would expect based on per capita GDP, thus having less to spend on discretionary purchases e.g. the expenditures on food in Japan are higher than would be predicted by either population or income level because food is expensive and work habits promote eating out.

9. Opportunity and risk variables: Sales Expansion (continues) 9 3. Income elasticity A common tool for predicting total market potential is to divide the percentage of change in product demand by the percentage of change in income in a given country. The more that demand changes in relation to income changes, the more elastic is the demand. Demand for necessities such as food is usually less elastic than is demand for discretionary products such as flat-screen TVs . Substitution Consumers in a given country may more conveniently substitute certain products or services than consumers in some other countries e.g. there are fewer automobiles in Hong Kong than one would expect based on income and population, because the crowded conditions make the efficient mass transit system a desirable substitute for automobiles.

10. Opportunity and risk variables: Sales Expansion (continues) 10 Income Inequality Where income inequality is high, the per capita GDP figures are less meaningful, because many people have little to spend and many others have substantial income to spend, as in our example of luxury product sales in India . Cultural Factors and Taste Countries with similar per capita GDPs may have different preferences for products and services because of values or tastes e.g. the large Hindu population in India reduces per capita meat consumption there. However, there is a large niche market of Indians who are neither Hindu nor vegetarian.

11. Opportunity and risk variables: Sales Expansion (continues) 11 Trading Blocs A country may have a small population and GDP, but, its presence in a regional trading bloc gives its output access to a much larger market e.g. Uruguay has a small domestic market, but its production has duty-free access to three other countries in the Southern Common Market (MERCOSUR).

12. Opportunity and risk variables: Resource Acquisition 12 Companies undertake international business to secure resources that are either not sufficiently available or too expensive in their home countries. They may purchase these resources from another organization, or they may establish foreign investments to exploit them. In either case , they must prioritize where they can best secure what they want such as in term of : Labor Infrastructure External Connections Government Incentives and Disincentives

13. Opportunity and risk variables: Resource Acquisition (continues) 13 1. Labor Scanning allows companies to examine such factors as labor market size, minimum and ongoing wages , required and customary fringe benefits, education levels, and unemployment rates. When companies move into emerging economies because of low labor-wages, their advantages may be short-lived for one or more of three reasons : Competitors follow leaders into low-wage areas. There is little first-mover advantage for this type of production migration. The costs may rise quickly as a result of pressure on wage or exchange rates. 2. Infrastructure Poor internal infrastructure escalates costs e.g. Cadbury and Nestlé, use their own costly power generators because of frequent power outage in the countries they operate as to prevent assembly line stoppages and spoilage of food products.

14. Opportunity and risk variables: Resource Acquisition (continues) 14 3. External Connections IB requires various cross-national integration that incurs time and costs. HQ personnel shall visit foreign locations for direct control efforts. Companies also need a smooth flow of shipments as they import and export among their facilities in different countries. Relatedly, countries with few trade restrictions and efficient customs offer advantages of reduced tariff costs and shorter clearance times . 4. Government incentives and disincentives Many countries compete to attract investors by offering incentives, through regulations or negotiations, that lower companies ’ costs of operating. These incentives include lower taxes, training of employees, loan guarantees, low-interest loans, exemption of import duties, and subsidized energy and transportation. Differences in tax rates are particularly important when deciding where to produce within a regional trading bloc, in as much as companies can serve the entire region from any country within the bloc .

15. Factors to Consider in Analyzing Risk 15 RISK: Companies and their managers differ in their perceptions of what is risky, how tolerant they are of taking risk, what they expect returns should be for the risk they take, and the portion of their assets they are willing to put at risk. One company’s risk may be another’s opportunity. For example, companies offering security solutions (e.g., alarm systems, guard services, insurance, weapons) may find their biggest sales opportunities where other companies find only operating risks. There are means by which companies may reduce their risks other than avoiding locations, such as by insuring, but all these options incur costs that decision makers should take into account. There are trade-offs among risks. For instance, avoidance of a country where political risk is high may leave a company more vulnerable to competitive risk if another company earns good profits there. Risks may occur for suppliers and within suppliers’ supply chains , thus companies need to examine the complex external dependencies and vulnerabilities of its suppliers .

16. Political Risk Analyzing Past Patterns Predicting foreign companies’ risk on the basis of past political occurrences is problematic because situations may change for better or worse e.g. unrest that leads to property damage and disruption of supplies or sales may be limited geographically. Moreover , with few exceptions, government takeovers of companies have been highly selective, primarily affecting operations that have a visible widespread effect on the country because of their size or monopoly position. Evaluating Opinions M anagers should evaluate statements by political leaders both in and out of office to determine their philosophies toward private business, foreign business relations, the means of effecting economic changes, and their feelings toward given foreign countries because these influential people may sway future political events affecting business. They should also access polls showing different leaders’ likelihood of gaining political office. 16 Managers use three approaches to predict political risk: analyzing past patterns, evaluating opinions, and examining potentially risky social and economic conditions.

17. Political Risk (continues) Examining Social and Economic Conditions Countries ’ social and economic conditions may lead to unrest if population segments have unmet aspirations. Frustrated groups may disrupt business by calling general strikes and destroying property and supply lines. Moreover, political leaders might harness their support by blaming problems on foreigners and foreign companies. This may lead to boycotts or rule changes for foreign companies or even expropriation of their properties . 17

18. Foreign Exchange Risks Exchange Rate Changes Differences in the exchange rates can create gains or losses Mobility of Funds Liquidity among countries varies 18 There are two types of foreign exchange risks:

19. Foreign Exchange Risks 19 There are two types of foreign exchange risks: Exchange-Rate Changes The change in foreign currency value is a two-edged sword, depending on whether you are going abroad to seek sales or resources. Let’s say a U.S. company exports to India; deterioration in the Indian rupee’s value makes the exports less competitive because it takes more rupees to buy them. 2. Immobility of Funds When a company exports to or invests in a foreign country, it prefers international mobility of its sales receipts, earnings, and capital there. Without the mobility, many firms either forgo operations or expect a higher rate of return there than elsewhere. Simply , their liquidity preference results from their needs or desires to make near-term payments, such as for dividends, unexpected contingencies (such as stockpiling materials before a threatened strike), and shifting of funds to possibly more profitable opportunities.

20. Natural Disaster Risks 20 There are two types of mother nature risks, which are the adverse “mother nature” catastrophes and widespread debilitating diseases : Mother Nature Catastrophes Each year, hundreds of millions of people are exposed to risks from earthquakes, cyclones, flooding, drought, volcanic eruptions, rising ocean levels, mudslides, and tornados. These disasters upset markets, infrastructure , and production while damaging companies’ property, injuring their personnel , and increasing their insurance costs . 2. Debilitating diseases The World Health Organization has developed global atlases of infectious diseases,30 many of which occur where medical facilities are weakest because of the diseases’ association with poverty. They are also associated with catastrophic events, such as cholera and malaria outbreaks after flooding, and tend to follow geographic patterns . For example, malaria kills about 2 million people a year, mainly in Africa.

21. Competitive Risk Compatibility for Companies’ Operations (see Distance Framework table). Diversification of Locations Following Competitors of Customers Heading Off or Avoiding Competition 21

22. Competitive Risk 22 Due to risk, managers initially prefer to operate where they perceive conditions to be more similar to their home country—provided, of course, that the location also offers sufficient opportunities. In fact, MNEs have a lower survival rate than local companies for many years after they begin operations, a situation known as the liability of foreignness. In short, managers feel more comfortable doing business where the per capita GDP is comparable and where there is a similar language, culture, and legal system e.g. US, UK, Canada . Compatibility for Companies’ Operations

23. Distance Framework Cultural Distance Administrative Distance Geographic Distance Economic Distance Attitude Creating Distance Different language Different ethnicities: lack of connective ethnic or social networks Different religions Different social norms Absence of colonial ties Absence of shared monetary/political association Political hostility Government policies Institutional weaknesses Physical remoteness Lack of a common border Lack of sea or river access Size of country Weak transportation or communication links Different in climates Difference consumer incomes Different costs and quality of: natural resources financial resources human resources infrastructure intermediate input information or knowledge The distance framework helps managers identify and assess the impact of distance of different types ( Pankaj , 2001). 23

24. Competitive Risk 24 Operating in economically diverse countries whose business cycles (peak, trough, contraction, and expansion via looking at real gross domestic product or GDP) are not highly interrelated may enable companies to smooth their sales and profits, which, in turn, is an advantage in raising funds. Given the growth in product complexity, technology content, and companies’ product specialization, there is a need to tap knowledge emanating from foreign subsidiaries from multiple countries . Diversification of Locations

25. Competitive Risk 25 Managers may purposely crowd a market to prevent competitors from gaining advantages there that they can use to improve their positions elsewhere—a situation known as oligopolistic reaction . Companies can gain absolute performance in terms of profit from: imitating the location decision made by a competitor’s action to lower their location evaluation cost. having clusters of competitors (known as agglomeration) attract multiple suppliers, personnel with specialized skills , and buyers who want to compare a number of product and service options in a single location e.g. Bridgestone Tires followed Toyota , into the United States. First, its track record with Toyota gave it an advantage over other tire companies in the U.S. market. Second , if another tire manufacturer were to develop a strong U.S. relationship with Toyota , it might use this to undermine Bridgestone’s sales to Toyota in Japan. Following Competitors of Customers

26. Competitive Risk 26 Companies may seek competitive advantage by being first into a foreign country, avoiding country entry where competition is strong, and moving as quickly as possible by whatever operating mode into many markets is advantageous within an industry with very rapidly changing technology. Heading Off or Avoiding Competition

27. Collecting and Analyzing Data Companies undertake business research to reduce outcome uncertainties from their decisions and to assess their operating performance. Questions such as: Can we hire qualified personnel? Will the economic & political climate allow us to reasonable foresee our future? What is our market share? To answer those questions, information is needed at all levels of control and companies should compare the cost of information with its value. 27

28. Problems With Research Results and Data Limited Resources Misleading Data Reliance on Legally Reported Market Activities Poor Research Methodology Noncomparable Information 28

29. External Sources of Information Individualized Reports e.g. sold by consulting firms like Frost & Sullivan, etc. Specialized Studies e.g. directories of companies that operate in a given locale Service Companies e.g. most companies providing services to international clients like bank, transportation firms, etc. publish reports. Government Agencies e.g. US Dept. of Commerce compiles news about individual foreign countries, in Malaysia, info can be sought at MITI and MATRADE. International Organizations and Agencies e.g. info can be gathered from United Nations, WTO, IMF, OECD Trade Associations e.g. trade journals publish by the associations like FAMA, MPOB, etc. 29

30. Country Comparison Tools There are 2 most common tools in scanning 1. Grids May depict acceptable or unacceptable conditions Rank countries by important variables 2. Matrices allow companies to: Decide on indicators and weight them Evaluate each country on the weighted indicators 30

31. Simplified Market-Penetration Grid Variable Weight Country A Country B Country C Acceptable (A) or Unacceptable (B) 1. Allow 100% ownership B A A Return (higher rating is better) Size of investment Direct Cost Tax rate Market size Market share Total 0 - 5 4 2 3 4 1 3 3 4 2 2 3 4 1 3 4 Risk (lower rating is better) Exchange problems Political instability Loose business laws Corruption Index Total 0 - 5 1 2 4 3 3 2 1 2 2 3 2 2 31

32. OPPORTUNITY RISK MATRIX Which country is most desirable? Decreased Risk Increased Opportunity A F E B C D 32

33. Shortcomings of Comparative Country Information Inaccuracy Noncomparability 33

34. Alternatives for Allocating Resources Among Locations There are three complementary strategies for international expansion . Alternative Gradual Commitments Geographic Diversification versus Concentration Reinvestment and Harvesting 34

35. Alternative Gradual Commitments Companies may reduce risks from the liability of foreignness by: • Going first to countries with characteristics similar to those of their home countries e.g. Malaysia & Indonesia • Having experienced intermediaries handle operations for them. • Operating in formats requiring commitment of fewer resources abroad. • Moving initially to one or a few, rather than many, foreign countries. 35

36. Geographic Diversification versus Concentration Growth rate in each market Sales stability in each market Competitive lead time Spillover Effects Need for product, communication, and distribution adaptation Program control requirements 36

37. Reinvestment and Harvesting FDI-financial and human capital invested abroad Depending on the success of the investment, the company may reinvest or consider using the capital elsewhere 37

38. Noncomparative Decision Making Most companies examine proposals one at a time and accept them if they meet minimum threshold criteria. 38

39. Future: Will Prime Locations Change? Future growth rates will have implications for locations of markets and labor forces Technological innovation allows for new trends in urbanization as more people are able to work from locations of their choosing 39