Identification of Reasons for Preference of Wholly Owned Subsidiaries Compared to IJVs - Essay Example

International collaboration Contents Contents 1 Introduction 2 Identification of reasons for preference of wholly owned subsidiaries compared to IJVs 3 Advantages and disadvantages of the JVC versus the wholly-owned subsidiaries 7 Conclusion 12 References 14 Introduction The companies while expanding into overseas market decides upon the entry mode strategy. There are various forms of entry modes such as franchising, exporting, licensing, forming a joint venture with a company already having its operations in the host country, or constructing a wholly owned subsidiary in the host country. Over the years international joint ventures have been a successful mode of entry into the host country. It benefits the foreign companies forming the joint ventures with the local company in two ways. Firstly, advantage of the local partner’s knowledge about the political systems, competitive conditions, culture, and business system of the host country. Secondly, the benefit of development cost and risk sharing with the local partner. In some countries these kinds of joint ventures is the only feasible market entry mode that is available to the foreign companies. On the contrary wholly owned subsidiary is the most costly mode of entry into the overseas market. However wholly owned subsidiary or rather setting up independent company owned by the parent company gives the full control to the company in terms of its operation handling and gaining the whole profit from its operations. The companies who adopt this kind of entry mode should be prepared to bear the risk and cost associated with having its expanded operations in the overseas market. The companies in the past years thought that the joint ventures will give them the expertise to acquire a position in the market, but this was not as easy as the local partner tie down the new entrant to the direction of its operations in his own way. For instance, Proctor & Gamble failed in India where they entered into the market through joint venture but succeeded in China through its wholly owned subsidiary. As the forecast states that China by 2050 would be a leading economy followed by U.S and India, so now the companies feel that setting up their own company in these markets would be necessary for their survival as well as for sustained growth. With the influence of WTO, which now provides less restriction on foreign owned companies in markets of China and India, many companies are now focusing on establishing their wholly owned subsidiary rather than going into any kind of international joint venture. Identification of reasons for preference of wholly owned subsidiaries compared to IJVs In the past few years there have been a significant growth in the foreign direct investment and multinational enterprises across the world. The wholly owned subsidiary as a foreign entry mode imparts a lot of control over the operations but has the disadvantage of investment of a lump sum amount for setting up the business operations in the host country and even includes risk at a greater level and less of flexibility. A company can only aim to adapt this kind of entry mode only when it has suitability in some conditions, such as, the firm may have some specific assets and these assets can be capable enough to generate high profits, in this situation the fir may not agree upon sharing its assets with the local partner and neither share the high revenues that it would be earning in the initial stages (Anderson and Gatignon, 1986, pp. 1-26). This resistance towards sharing of profit levels or of assets would prevent the company of entering into joint venture and focus more on wholly owned subsidiaries. The company can even possess some tacit asset that is internal to the organization and cannot be easily transmitted to an external through this joint venture. In such cases wholly owned subsidiaries would be more preferred by the companies irrespective of all the transaction costs that are linked with it in relation to the international joint ventures. In China and India which has a stable economic and political conditions the choice of the foreign companies have shifted from that of a joint venture to the wholly owned subsidiary entry mode into these markets (Anderson and Coughlan, 1987, pp. 71-82). This is simple because this form of entry mode give these companies the entire control over its operations and do not make the company be dependent on any other local partner. Though the risks would be high in this kind of approach but the profit and the revenue generated would be entirely for the company and not shared with any partner. In such kind of entry mode the parent corporation holds all of the stock of its subsidiaries. The wholly owned subsidiary that is formed by the parent company can be a part of the same industry in which the parent company operates or can be completely belonging to a different industry. The wholly owned subsidiary provides the parent company a vertical integration where all of the operations associated with the business is under the control of the owner. This mode even gives the company an opportunity to manage risk and diversify its business (Agarwal and Ramaswami, 1992, pp. 1-27). Diversification is a strategy by which a firm can reduce its risk level. In this different kinds of business is developed so that is one business is not performing up to the mark then profit can be generated from other business so as to keep the overall profit level of the company at a stable position. If a company wants to enter into emerging markets it can establish such subsidiaries and the minimum risk of loss can be imparted on the shoulders of the subsidiary. A firm can even purchase or create its own wholly owned subsidiary by expanding its business abroad. Sometimes a foreign company establishes its subsidiaries in other countries so that it receives favourable tax benefits from the government of these countries (Asiedu and Esfahani, 2001, pp. 647-662). So the major advantages that the wholly owned subsidiary have is that of risk management, vertical integration or a greater control over its business operations, diversification, and favourable tax benefits in the host country. Previously there were strict rules or entry barriers in China and India which prevented the company to take the risk of establishing their wholly owned subsidiary in these countries. The foreign companies preferred more of joint ventures with the local partners so as to expand their business operations. The local partners have the expertise in terms of knowledge of the competitive business environment prevailing in the country, knowledge, culture, and the political conditions. This expertise would benefit the foreign company to establish their business effectively in the market. However with the influence of WTO there has been a lot of flexibility in terms of entry barriers (Buckley and Casson, 1976, pp. 101-103). This flexibility have given the opportunity to the foreign companies to actually think for setting up their own subsidiaries rather than be dependent on any local partner. Often the foreign company that plans to expand globally has a successful base in its home country. The brand name that it has developed over the years can undergo negligence when it becomes associated with a completely different enterprise. The company however through its own subsidiary can utilize its established brand name and occupy its position in the market. It would not be required to share its brand equity with any local partner. The international joint ventures are a very complex structure of entering into a new market. This is simply because there are different techniques of profit sharing, and utilization of specific expertise into the business operations for its affective functioning (Dunning, 1993, pp. 57-59). If there is any kind of misunderstandings between the partners than it would directly affect the business operations. The partners on the other hand may not agree on the same decision this may lead to arguments in the system and it would result into time consuming process where there can be delay in strategy making and hence losing on an opportunity that could have been beneficial for the firm. In IJVs the firm needs to share all its assets with the local partner this might eventually prove more profitable for the local partner than the foreign company. The local partner would be more dominative in the joint venture as it would possess the required knowledge regarding the host country. This in turn would result into influencing the foreign company to perform the operations according to the ways of the local partner rather than having the flexibility of performing the operations in their own way (Kim and Hwang, 1992, pp. 29-53). The management of the partners entering into the joint venture is very difficult this is when the wholly owned subsidiary proves to be more beneficial. There can be various kinds of conflicts which makes the wholly owned subsidiary more beneficial for the firms compared to joint ventures. Such conflicts can be the joint venture exporting to other market belonging to other subsidiary of the foreign company. The conflict between the partners can even arise when the worldwide quality standards of the foreign company exceeds that of the local partner, and even when one of the two partners sells inputs to or buys output from the joint venture. These conflicts make the joint venture to be more costly. The cost arises from time and the resources spend to convince the partners to agree to one another or from the lost worldwide profits (Liu, Song, Wei and Romilly, 1997, pp. 313-330). In such a situation it may be more beneficial for the foreign company to expand into new markets through its own venture rather than opting for any kind of partnership, and if the conditions of the market to enter is not well diagnosed than it can even aim at going into a contract with any local partner so as to acquire its capabilities and enhance its market growth at a faster pace. The cost of monitoring, negotiating, and enforcing a contract would be less compared to the cost of managing a joint venture which encompasses a lot of conflicts between the partners. When a firm opts for establishing their own subsidiary there are certain matters of concern firstly is the entry negotiations with the host country and secondly is the preference of the firm. The government of the country should have flexible measures in terms of entry mode so as to attract the foreign companies in order to set up their operations in their country. The wholly owned subsidiary gives the chance to the foreign companies to explore their skills and knowledge into a completely new market and gain the maximum revenue from its business operations (Madhok, 1997, pp. 39-61). The major reason behind shifting into a wholly owned subsidiary entry mode by the firms is that in the highly competitive market where opportunities are less and competition is more firms are struggling to establish their market position so there is no time or resources vacant for them to resolve the conflicts that are most common in joint ventures. In China and India which is aiming at becoming the leading economy the scope of the foreign companies is very high and this have been supported by the influence of WTO in reducing the trade barriers to a convenient level. The growing economy of these two countries has led to firms not opting for IJVs anymore. The wholly owned subsidiary though encompasses the risk factor but even has the benefit of utilizing the entire revenue without any sharing. It can perform its business operations based on its own strategy and plan rather than agreeing on any local partner’s viewpoint. Advantages and disadvantages of the JVC versus the wholly-owned subsidiaries A joint venture is regarded as a cooperative effort to establish business operations in accordance to the interests of the partners. The joint venture involves effective cooperation from both the partners, where they help each other in terms of business plan formulation, investment sharing, risk sharing, etc. There are certain conditions under which the company prefers to enter into joint venture for entering into a new market. It is when there is strong nationalism, in terms that the consumers has the perception that the foreign companies produce products that are superior or when they cannot rely on a foreign company and more associated with the local company. It is preferred when the firm needs to establish credibility in market where the brand that the firm represents is completely unknown to the potential consumers. In such a situation the knowledge of the local partners regarding the market seems to prove beneficial for establishing the credibility in the market and earning profits from the initial stage of its business operations (Mutinelli and Piscitello, 1998, pp. 491-506). There can even be an advantage of tax benefits that motivates the firm to enter into market through the joint venture entry mode rather than any other kind of entry modes such as wholly owned subsidiaries. There are countries that provide special tax benefits to the foreign company on establishing a joint venture with a local partner which is otherwise not provided if the company plans to set up its own venture into such country. There is lot of risk associated with entering into completely new market having less knowledge regarding the policies and system of the host country. Such kinds of joint ventures have the major advantage of avoiding risk and perform the business operations in the country (Moon, 1997, pp. 43-64). As the local partners possess the required knowledge for starting up a business it would help a foreign company to develop certain strategies to avoid risk and hence it would not be burdened by any kind of loss at the initial stage of its operations. The wholly owned subsidiary needs to establish their own supply chain but the joint ventures has the advantage of operating on an existing supply chain of the local partner. While starting up a new business requires effective knowledge base of the market but it can be easily accessed in the form of local partners who already possess the local knowledge (Beasley, 2004, p.71). The local partners have established connections which would be very beneficial for the foreign company so as to earn the maximum revenue and expand its business at a faster rate. If the foreign company aims at going in for a joint venture it helps the company to at least discard one competitor from the market. The local partner can eventually turn out to be a competitor for the foreign firm if the company enters into the market through wholly owned subsidiary but this problem would be removed in joint ventures as the competitor turns out to be the partner of the firm. There even tax benefits for a joint venture which gives the foreign company an added advantage in the host country. However the main advantage is of risk sharing and understanding the political and economic situation well while entering into the host country. The joint ventures are often regarded as the safest mode of market entry compared to that of wholly owned subsidiary. There are few major disadvantages of Joint Venture Companies (JVC) as compared to wholly owned subsidiaries as an entry mode in foreign markets. These disadvantages can be categorized as follows. Cultural differences The cultural aspects play a very important role in the success of a selected entry mode in the international market. The cultural differences between the home country and the foreign country should be identified and managed by the business entering the new market. In case of establishment of a wholly owned subsidiary, the senior managers of the business in the foreign country come from the domestic country of the company. This ensures that the managers have the same cultural and social backgrounds. Therefore, the behavioural patterns and thinking of the managers are similar which reduces the chances of conflict between the managers (Parkhe, 2004, pp.579-601). Also, during the consideration of the strategic interests and objectives of the business, the senior managers give more importance to the long term goals and strategic objectives of the parent company. This helps in minimizing internal conflicts arising from cultural differences among the senior managers. On the other hand, the employees and managers in a joint venture company come from different cultural and social backgrounds and as a result they possess varying management styles, values and operational practices (Segalla, 2001, pp.27-31). This may create unavoidable internal conflicts when these people from various backgrounds work together. Control Rights The establishment of wholly owned subsidiaries in the foreign markets helps the parent company to have better control and say in the management and operational practices of the overseas business. In wholly owned subsidiaries, the parent company can regulate the management and investment activities, business development processes while the subsidiaries can regulate their own development. The evaluations, rewards and assessments are under the control of the parent company (Beamish and Kachra, 2004, pp.119-120). But in case of joint ventures, the control of the company entering the host market reduces to a high extent. Since, it is a joint venture; both the partner companies have equal say and can extend equal rights on the management, operational activities and business processes of the overseas business. Often, finding a suitable partner who would meet the necessary conditions and support the development of the company in the foreign market is difficult to find (Chen and Hu, 2002, pp.193-210). The venture is much dependent on the partnering company in the host market and a disagreement in the control rights may lead to a high degree of instability in the joint venture. Maintaining commercial secrets The wholly owned subsidiaries have more advantage with respect to copyrights and patents which helps to create a monopoly position for the business in the foreign market. The parent company can control the operations and the business secrets and ensure the protection of the business, technological and commercial secrets. Also, these companies are at a position to dispose profits and take decisions independently. In case of joint ventures, the company entering into the new market contribute to the technological, international and management support of the business whereas the local partner company contributes in the aspects of local knowledge, market conditions, government relations, customer groups and behaviours (Konopaske, Werner and Neupert, 2002, pp.759-771). For example, the foreign companies entering the emerging markets of China as a part of their international expansion often add to the technological capabilities. This has much disadvantage for the company entering into a foreign market because the trade secrets and the commercial and technological aspects unique to the company have to be shared with the partner companies and may be accessible to the competing companies in the host market (Luo, 2001, pp.241-264). Higher Returns The setting up of wholly owned subsidiaries helps the parent company to penetrate the market quickly and maximize the returns and value of the business in the host country. This entry mode may benefit the companies by optimally using the abilities of the company, increasing the international business experiences and establishing competitive advantage on a global business scale (Luo, 2004, pp.443-472). Joint venture companies, on the other hand invest lesser resources and capital into the overseas business and therefore they often get lower return and value creation for the business. This may reduce the profitability and sustainability of the international operations of the company and the company may have to take the exit route from the market. A lesser level of investment and risk taken indicates reduced profit for the joint venture companies. This reduces the future viability and return from the business (Youssef and Hoshino, 2003, pp.31-46). Conclusion The foreign expansions of businesses are critical activities in the current business world. The choice of entry mode is critical in deciding the short term as well as long term viability of the international expansion process. The entry mode helps the companies to evaluate the consequences of establishing their businesses in the chosen foreign location. Two major entry modes in international expansion are considered in the report which are Joint Venture Companies (JVC) and wholly owned subsidiaries. The choice of entry mode is dependent on the trade-offs between various factors like control rights, cultural aspects, higher returns, protection of business and commercial secrets, exit barriers, economies of scale, profits received and international experience. Wholly owned subsidiaries are considered better in terms of cultural differences, protection of commercial and technological capabilities, as compared to joint venture companies. On the other hand, joint venture companies are better than wholly owned subsidiaries in terms of operational risks, opportunity costs, input costs and exit processes. In case of joint ventures, the contribution of the local partners is critical in driving the success of the venture. The company also receives a high level of market knowledge support from the local partners. Wholly owned subsidiaries are considered as useful entry modes to penetrate the market faster and ensure more control over the overseas business. Since, China and India are emerging economies which have high potential for development, international businesses are considering wholly owned subsidiaries as better options as compared to joint ventures. However, it can be identified that it is difficult to select one entry mode as the perfect choice for all companies considering international expansion. This is because both the entry modes have advantages and disadvantages associated with the processes. The global political and economic environment is complex and perplexing which indicates that the parent companies should consider their capabilities and objectives while selecting the entry mode. References Agarwal, J. P., and Ramaswami, S. 1992. Choice of foreign market entry mode form: The impact of ownership, location and internalization. Journal of International Business. Vol. 54, pp. 1-27. Anderson, E., and Coughlan, A.1987. “International market entry and expansion via independent or integrated channels of distribution”, Journal of Marketing.Vol.51 (1), pp. 71-82. Anderson, E., and Gatignon, H. 1986. “Modes of foreign entry: A transaction cost analysis”, Journal of International Business Studies. Vol. 17, pp. 1-26. Asiedu, E., and Esfahani, H. S. 2001. “Ownership structure in foreign direct investment projects”, Review of Economics and Statistics. Vol. 83(4), pp. 647-662. Beamish P. W. & Kachra, A. 2004. Number of partners and JV performance. Journal of World Business. Vol. 39(1), pp. 119-120. Beasley, R. C. 2004. “Reducing the Risk of Failure in the Formation of Commercial Partnerships,” Licensing Journal. Vol. 24(4), p. 71. Buckley, P.J., and Casson, M. 1976. The future of the multinational enterprise. London: MacMillan. Chen, H. & Hu, M. Y. 2002. An analysis of determinants of entry mode and its impact on performance. International Business Review. Vol. 11(1), pp. 193-210. Dunning, J. H. 1993. Multinational Enterprises and the global economy. Wokingham: Addison-Wesley. Kim, W., and Hwang, P. 1992. “Global strategy and multinationals entry mode choice”, Journal of International Business Studies. Vol. 32, pp. 29-53. Konopaske, R., Werner, S. & Neupert, K. E. 2002. Entry mode strategy and performance. Journal of Business Research. Vol. 55(9), pp. 759–771. Liu, X., Song, H., Wei, Y. & Romilly, P. 1997. “Country characteristics and foreign direct investment in China: a panel data analysis”. Vol. 133 (2), pp. 313-330. Luo, Y. 2001. Business strategy, market structure, and performance of international JVs: The case of JVs in China. Management International Review. Vol. 35(1), pp.241–264. Luo, Y. 2004. Determinants of entry in an emerging economy: A multilevel approach. Journal of International Business Studies. Vol. 38(3), pp. 443–472. Madhok, A. 1997. “Cost, value and foreign market entry mode: the transaction and the firm”, Strategic Management Journal, Vol. 18, pp. 39-61. Moon, C. H. 1997. “The Choice of Entry Modes and Theories of Foreign Direct Investment,” Journal of Global Marketing. Vol. 11(2), pp. 43–64. Mutinelli, M., and Piscitello, L. 1998. “The entry mode choice of MNEs: an evolutionary approach”, Research Policy. Vol. 27, pp. 491-506. Parkhe, A. 2004. Inter firm diversity, organizational learning, and longevity in global strategic alliances. Journal of International Business Studies. Vol. 22(4), pp. 579-601. Segalla, M. 2001. Overview: Understanding Values and Expectations of Foreign Employees Creates a Better Company. European Management Journal. Vol. 19 (1), pp. 27-31. Youssef, B. K. & Hoshino, Y. 2003. The Choice between Joint Ventures and Wholly Owned Subsidiaries. Journal of Administrative Science. Vol. 17(1), pp.31-46. Read More