Costco in International Venture - Case Study Example

Introduction and Brief Overview of Costco Costco operates a chain of membership warehouses, that carry brand, quality items at a discount rate.Costco is designed to help small to medium sized businesses purchase goods for everyday business use at a substantially lower cost than retail. Costco is also geared towards individuals with personal needs. Costco is only open to members, who pay an annual fee for membership. (Investor Relations). At the present time, Costco operates 572 warehouses, and the bulk of these warehouses are in the United States and Puerto Rico, with 416 warehouses in these two countries combined. It operates in 40 U.S. states. Other countries in which it operates is Canada, with 79 warehouses; the United Kingdom, with 22 locations; Taiwan, with 6 locations; Korea, with 7 locations; Japan, with 9 locations; Australia, with 1 location; and Mexico, with 32 locations in 18 Mexican states (Investor Relations). The annual revenues of Costco is $71.4 billion, with over 57 million cardholders, representing 31.3 million households. Costco employs over 100,000 people in the United States alone, and around 150,000 worldwide (Investor Relations). At the moment, Costco is concentrated in North America, with just a few stores in Europe and fewer stores in Asia. There is therefore a great need to diversify the presence of Costco worldwide, and there is a great opportunity to do so. There are many promising markets that may be explored for market entry. Each country will have rewards, but will also present challenges and pitfalls that must be examined before entering that market. For the purposes of this strategic report, two markets will be examined, one in Asia and one in Europe. The European market that will be examined will be Russia; the Asian market will be Saudi Arabia. However, before these two countries will be profiled, an analysis of the general issues that face companies entering foreign markets, any foreign markets, will be explicated, and solutions will be offered. Entry Methods There are three possible entry methods – acquiring a foreign firm or setting up a joint venture (JV) abroad with a foreign partner JVs require that Costco be partially integrated; acquiring a foreign firm requires full integration (Ackerman, 2007, p. 2). Alternatively, Costco can choose a greenfield plan, in which staff is recruited and chained individually, and the institutional arrangement can resemble that of the parent company (Estrin et al., 2007, p. 8). Cultural distance, explained below, has an impact on the entry mode. Generally, when both firms are either Asian or non-Asian, the higher the cultural distance, the more likely a JV should be formed, “since the potential for external conflict outweighs the potential for internal conflict” (Ackerman, 2007, p. 22). If one firm is Asian, and the other is non-Asian, cultural distance seems irrelevant in the entry method. This indicates that managers deal differently with Asian firms than with non-Asian firms (Ackerman, 2007, p. 22). General Problems with Foreign Market Entry There are certain considerations that any multi-national firm (MNF) account for when entering a foreign market. “When firms go abroad, become multinational enterprises, and compete in foreign market, they have to find ways to transfer or adapt their institutional arrangements.” (Estrin, et al., p. 3). The first consideration is cultural distance, which refers to how different the origin country and the target country are in terms of culture (Ackerman, 2004, p. 5). There are four dimensions to cultural distance: power distance – how unequal are people of different statuses treated, and how much is the hierarchy of power valued; uncertainty avoidance – to what degree are the people of the culture threatened by uncertain or unknown situations; individualism – are the ties of the people loose or tight; masculinity – how distinct are gender roles. Cultural distance is determined by calculating the square root of all the dimensions for each country, then comparing the results (Ackerman, 2004, p. 5). The degree of cultural distance can pose many problems for the company that is attempting to enter a foreign market. Each country might have a different business culture or strategy. Therefore, a Costco operating in a country that has a substantially different culture than the United States will attempt to operate differently, and maybe go against long-standing policies of the company. For instance, in Saudi Arabia, one of the countries that will be profiled, perhaps will not allow women to shop in these stores. This might cause conflict between Costco and the stores operating in Saudi Arabia, as this offends Costcos western principles. This is one aspect that needs to be considered and studied in great detail before making a move. Another problem that is presented with cultural distance is the dealing with local governments and supplies. Ignorance of how either one of these entities operates can lead to conflict (Ackerman, 2004, p. 6). Moreover, there are other dimensions of distance that must be considered as well. Institutional distance is another dimension, and this is made up of both informal and formal aspects. The informal aspects of institutional distance encompasses the cultural differences explained above, along with organizational differences. Informal aspects of institutional distance requires experience to overcome and be understood, and this would necessitate a partner to help the organization understand (Estrin et al., 2007, p. 4). Examples of formal aspects of institutional distance are regulatory and legal differences, and, because of the transparency of rules and regulations, these do not require experience so much as it requires knowledge and study (Estrin et al., 2007, p. 4). Informal distance between the subsidiary and headquarters “inhibit the ability to attain legitimacy in the local context.” (Estrin et al., 2007, p. 10). The problem with informal distance, which includes cultural distance, is that “knowledge about other cultures is often tacit” and these informal rules are difficult for a foreign company to understand. The foreign companys cultural knowledge is lacking, and this makes it difficult to communicate with local peers in the target country, and it is difficult to acquire tacit knowledge (Estrin et al., 2007, p. 10). One solution to the informal distance problem is partnering with a local firm that will provide knowledge about the informal business environment in the target country. This local firm can contact local suppliers, authorities and distributors and help create legitimacy for the foreign company. Another strategy would be for the originating company, Costco, to acquire tacit informal knowledge of the target country in a gradual way. (Estrin et al., 2007, p. 11). Formal distance, which encompasses regulations and other legal barriers are easier for the originating company to understand, as they are formalized, written down and transparent. At the same time, formal distance, such as regulatory distance, may present another barrier to the originating company, in that high regulatory distance could indicate that the transfer of business practices will be inhibited. Local laws and regulations could make changing existing practices difficult. (Estrin et al., 2007, p. 12). In this way, formal distance might be a higher hurdle to overcome than informal distance. Therefore, in order to evaluate the countries that are profiled, it is crucial to know the cultural, informal and formal distances. Russia The first country that will be examined for foreign entry is Russia. Russia is selected as it represents an golden opportunity to enter a foreign market in the worlds largest country with “business opportunities equal its size.” (Fey & Shekshnia, 2008, p. 2). Russian economy grew at the rate of 7.5% between the years 2001-2005. There are approximately 144 million people in Russia, has substantial purchasing power growth, and has one of the fastest growing GDPs in the world. Moreover, certain sectors have a lack of competitors. All of this makes Russia very attractive for entering as a foreign company. Large companies that have penetrated Russias market, such as McDonalds, Wrigley, Mars, Phillip Morris and Telenor have already paved the way, showing that there is money to be made in Russia. (Fey & Shekshnia, 2008, p. 4). However, there are risks associated with this market as well. To help overcome these potential pitfalls, therefore grab more of the rewards, businesses must obey certain commandments. The first commandment is to have leadership that is authoritative but not authoritarian (Fey & Shekshnia, 2008, p. 5). The Russian people have great respect for charismatic leaders, hearkening a tradition of powerful leaders such as Peter the Great and Josef Stalin. However, a foreign CEO does not automatically garner the same revere as a Russian CEO would. The foreign CEO must earn the respect of the Russian people by demonstrating “superior competence and deliver[ing] tangible results.” (Fey & Shekshnia, 2008, p. 6). This actually takes advantage of the Russian persons belief that foreign managers a more progressive than Russian ones, and if the leader displays competence and brings results, the Russian people “can peform wonders.” (Fey & Shekshnia, 2008, p. 4). Related to strong leadership is a strong organizational culture. The culture must emphasize fairness, transparency, meritocracy and a chance for every individual employee to feel important (Fey & Shekshnia, 2008, p. 7). Employees need to be empowered. Mistakes need to be tolerated and corrected, not severely punished. Employees should participate in the decision-making process, by encouraging them to generate ideas. In short, employees must feel valued and heard, and, since Russian companies have a tradition of severe punishment for mistakes, there must not be this kind of punishment for honest mistakes, but the mistakes should only be made once (Fey & Shekshnia, 2008, p. 7). Another commandment is that one must obey local customs and rules, yet make ones own road. What this means is that the culture and rules must be respected, but the company cannot succeed by merely copying another local company. The company must adapt their own rules to the local climate, as opposed to becoming a cookie cutter of another company. At the same time, it is vital that businesses form good relationships with local government agencies, as these agencies are notorious for using their power in an arbitrary way that can hurt ones business (Fey & Shekshnia, 2008, p. 13). Developing a good relationship with these authorities helps cut down on these arbitrary uses of negative power. This does not necessarily mean a pay-off, however. What it does mean is personal contact with government officials and basic “rear end kissing.” (Fey & Shekshnia, 2008, p. 14). Related to this is controlling corruption. Russia is rife with corruption at all levels, and a business must learn to circumvent this. One way is to employ local companies to deal with authorities in matters such as bidding, dealing with regulatory authorities, and land acquisition. These local companies and individuals must be adept at getting around corruption, knowing who to kick back and how much. Another strategy is pre-emption - take the initiative to cooperate on the companys own terms. The third strategy is to enter into business when the situation is more stable and transparent. The fourth strategy is simply to abstain from certain practices and deals, if these deals do not meet ethical standards (Fey & Shekshnia, 2008, p. 11). In short, Russia has a different culture that needs to be adhered to. Leaders must be hands-on, employees must be respected and local authorities must be “wined and dined” if a company wants to make inroads into this market. Saudi Arabia Saudi Arabia is an oil-based country and the government has strong control over major economic activities. With 20 percent of the worlds oil reserves, it is the largest exporter of petroleum. The private sector is encouraged by the government, in an effort to lessen the countrys dependency on oil and to increase employment opportunities for its citizens. Private sector and foreign investment participation in power generation and telecom sectors have recently begun to be permitted. Saudi Arabia is a part of the World Trade Organization (WTO), as it needs to attract foreign investment and diversify the economy. (Nelson, 2009, p. 325). It has plans to establish six “economic cities” that will be situated in different parts of the country, and will be used to promote development and diversification. (Nelson, 2009, p. 325). There is therefore much good news from Saudi Arabia, as its need to attract foreign investment may entice the government to make a lucrative offer to Costco to come into the country. However, there are pitfalls as well. Saudi Arabia is almost uniformly Muslim, and because of this, Westerners must know the customs associated with this religion, or else they will get into trouble. For instance, one must adhere to the Muslim work week, and observe all Muslim holidays. (Stanat, 1998, p. 290). Other protocol that must be observed is to not use ones left hand for dining, passing documents or greeting; never allow the sole of ones shoe to be exposed to someone, as when sitting; avoid touching the head of anybody, even small children; do not drink alcohol or eat pork; always respect the religion. (Stanat, 1998, pp. 292-293). There are other risks with Saudi Arabia as well. One of the major risks is that there is the potential for instability in the ruling government. This may come from either a power struggle within the Royal Family, the death of the King or the potential for the Taliban to seize control and institute religious Shariah law. This could result in a major change in the way Saudi Arabia does business, including instituting discrimination in securing business tenders; restrictions on the repatriation of profits; business closure; reduced budget allocations in certain sectors; and a negative effect on trade with the United States (Rao, 2007, p. 4). Internal political turmoil due to the demand for democracy might lead to a slackening of the Saudi Economy. There also might be regulatory hurdles, such as Saudization, which refers to the Saudi policy of encouraging businesses to hire Saudi nationals by threatening to withhold government contracts if a business does not. This might result in a loss of skilled workforce. Trade unions might lead to lock outs and slowdowns (Rao, 2007, p. 6). Other factors potentially affecting Saudi Arabia is a decline in oil prices might send the economy and GDP of Saudi Arabia reeling. This would affect new business projects and obviously affect the Saudi peoples ability to buy Costco products, if the economy starts to hurt and unemployment rises because of it. A high unemployment may, in turn, lead to social unrest and an anti-foreign sentiment (Rao, 2007, pp. 6-13). On a PEST grid, which analyses political, economic, social and technology, risk assessment matrix indicates that the possibility of the Taliban seizing control represents the highest risk, yet the lowest probability; the possibility of internal power struggle, internal turmoil, rise of militancy, volatility of stock market, labor laws changing to favor the workforce, commercial laws changing to favor domestic companies, depreciation of Riyal currency depreciating due to weak United States dollar, and increase in customs duty and interest rates all represent low probability and medium risk; inflation growing beyond 3%, growth in anti-west sentiment and rigid implementation of Shariah law all represent medium risk and medium probability. Representing low risks and low probability are that the king will change, trade unions will strengthen, oil prices will fall below $50 U.S. dollars per barrel, there is a budget deficit, corporate taxes increase, and human rights deteriorate. Saudization, denial of womens rights and increase in corruption all represent low risk and medium probability. Conclusion and Recommendations Before entering a company, it is crucial that Costco know the informal and formal distance between the United States and the countries to which they want to enter. The formal distance, which represents laws and regulations, is easy to ascertain. The informal distance, which includes cultural and organizational distance, is much more difficult to penetrate. In Russia, the informal distance that needs to be considered is that there is a different way of doing business there than what most countries are used to. Corruption is rampant, and regulatory agencies use their power arbitrarily. For these issues, it is important that Costco employ a local company to deal with regulatory agencies in the right way, and this company must be effective at doing so. Otherwise, Costcos venture may never get off the ground because of all the arbitrary red tape. Other issues are that the management must be hands-on, otherwise the manager will be perceived as weak and ineffective. This will mandate a visible presence in the community, and personal attention to problems and details. Delegating is not effective in Russia, as the corruption is institutionalized and companies in the past have found out the hard way that delegating responsibilities leads to embezzlement and strife. The corporate culture is such that employees need a lot of attention and the ability to speak their minds. These are all factors that need to be attended to before Costco attempts to enter this market. In contrast, the hurdles in Saudi Arabia have to do with its religious customs. Westerners must be well aware of all of these customs before they step foot in the country, or else they will offend. There is also some degree of risk involved in social and economic upheaval, but the risk assessment grid indicates that there is no high risk that is highly probable, and that most of the problems are of the low risk variety. At any rate, it is important that there is a good local contact in each of these countries to deal with the regulations and the cultures, and train Costco on the informal aspects of cultural and organizational differences in each of these countries. In other words, it is vital to go slow and really learn, by experience, about the tacit acculturation of these countries and all the ins and outs of day to day operations before opening a branch in either of these countries. Sources Used Ackerman, A. (2005). The effect of the target countrys legal environment on the choice of entry mode. Retrieved from: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=622822 Estrin, S., Ionascu, D. & Meyer, K. (2007). Formal and informal institutional distance, and international entry strategies. Retrieved from: http://papers.ssrn.com/sol3/papers.cfm? abstract_id=665110 Fey, C. & Shek, S. (2008). The key commandments for doing business in Russia. Retrieved from: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1116663 Investor Relations. Costco.com. Retrieved from: http://phx.corporate-ir.net/phoenix.zhtml? c=83830&p=irol-homeprofile Rao, D.N. (2007). Analysing risks of foreign direct investment in emerging economies: A case study of Saudi Arabia. http://papers.ssrn.com/sol3/results.cfm?RequestTimeout=50000000 Read More