Factors to Consider Before Establishing Subsidiaries - Essay Example

? International Business Finance College Lecturer International Business Finance Factors to consider before establishing subsidiaries Competition The company needs to conduct an extensive research of the existing suppliers of similar products within the intended regions. This would involve critically analysing the business strategies utilised by competitor companies, and product quality, within these regions. This would enable the company to make informed decisions and implement strategies aimed at handling the competition effectively. Through competitor analysis, the company can differentiate the products supplied to these new regions, and effectively overcome the impeding competition from existing suppliers (Johnson 2012). Overcoming competition remains fundamental towards ensuring successful entry into international markets. Competitor analysis could assist the company in reaching competitive edge within the international business ventures. The production methods utilised by competitors can provide the company with possible production methods to use within these regions. This will also enable the company to analyse possible production technological advancements that could be introduced, and improve the production. Introduction of new production technology could enhance production and reduce production costs. Economic status The economic status shall include the analysis of the economic systems, within these regions, and institutions. This would provide the company with information regarding the availability of essential natural and human resources within the target regions. The available human resources could enable the company establish the best production methods, sustainable within these regions. The economic status shall enable the company to decide on strategic approaches to take when making market entries into these regions. In a libertarian economy, for example, market entry would be easier because of limited interference from governments (Glaeser, 2010). Most economies of Eastern Europe, Africa and Asia remain relatively static with considerable government regulation. Understanding of these factors would enable the company to strategise on effective methods of coping with the government influence (Jethani 2011). Government influence in these economies limits the freedom of conducting business and could frustrate investors when assumed. Political system The company should consider the political systems in existence within the target markets. The political system immensely affects the policy formulation and economic stability of any country. The political systems within different countries determine the influences of government owned enterprises on private businesses. While the operation of government owned enterprises depends on political systems, their influence on private businesses could affect the operations of private enterprises (Hatch, et al. 2011). Political systems could therefore, affect private businesses through offering government enterprises better operating environments, hence instigating unfair competition. Bureaucratic political systems implement controls on private enterprises while letting government owned businesses to operate freely, giving government enterprises a competitive edge. International conflicts, influenced by political systems, could also have adverse effects on international businesses. Countries experiencing international conflict could have sanctions imposed on them, and participation in international activities, including business, significantly affected. Legal factors The legal system within any country affects the capacity to effectively conduct business. An analysis of the legal systems remains essential in enabling the company to determine best operating methods, applicable within the legal systems. Existence of corruption within numerous African countries could become a hindrance towards stability of operations. Corruption could become deeply rooted vice in a country’s culture that it becomes inculcated into national values in some countries, presenting a huge challenge towards marketing the company’s products freely. The analysis of these elements would also assist in establishing ideologies and cultural values, nationally held by people within target regions. Certain ideologies, like patronage, significantly affect the operations of multinational enterprises within these countries (Daniels, et al. 2007). Such cultural values could enable the company to predict the expected reception, and acceptance of its products into the market. Understanding the legal systems could potentially assist the company in making informed decisions, regarding incorporation of these cultural values, and ideologies into its operations. Potential risks and risk management strategies Risks remain inevitable within any business operation, especially new market, venturing opportunities. Analysis of potential risks could enable the company to formulate effective market entry strategies to overcome this impediment (Miles 2011). Business risks can be classified into internal and external risks, based on their cause and association. Internal risks The company faces numerous internal risks within its organisational structure that could hinder the performance of intended subsidiaries. The availability of human capitals within target countries, that can match that utilised within the British environment. The levels of literacy within these countries remain low and there could be shortage of professional individuals to be involved in production. Technological advancements and limitations within these countries potentially affect the implementation of subsidiary operations within these countries. Most of the target countries fall into the category of developing, and third-world countries. The application of technology in production within these regions, therefore, remains limited to the development levels of particular countries. The ability to access credit within these countries could also present another potential risk in the development of subsidiaries. Management of these internal risks would involve early implementation of policies to curb the risks. The company can conduct transfer of numerous employees from the British headquarter into subsidiaries to ensure maintenance of standards across the production line. These employees would also be able to conduct internal training for human capital hired from the hosting countries. The company should consider importation of the technology applied in the British manufacturer into countries with technological limitations. This would ensure product standardisation through standardised production methods globally (Jolly 2003). In managing credit related risks within the developing and underdeveloped countries, the company could seek local partners to aid in establishing subsidiary production plants. Where partners cannot be available, the company should consider utilising internal financing options, when developing subsidiaries within the specified countries. External risks The potential external risks present a surmountable challenge to the company when venturing into the international business. The pricing process presents a potential risk as the company must develop commodity prices suiting users in the numerous target countries. Pricing of the commodities within different countries should remain compliant with the systems utilised within these countries. Another risk present in these regions would be compliance with existing production regulations within different regions. These regulations could potentially compromise the company’s product quality. A compromise on quality can have adverse effects on the capability of the company to successfully market its products elsewhere. Government regulations towards international businesses in some countries also come as risk factors as regulation could limit the company potential. In the Asian counties, natural disasters remain a frequent cause of concern when undertaking this venture. The company should utilise pricing methods based on the production price for commodities. This could ensure that products produced within any region have prices relative to the production costs. Prices for these commodities should also be given using local currencies of respective regions/countries for easy comprehension by local people. The company can involve international compliance assessment firms, like Societe Generale de Surveillance (SGS S.A.), to provide internationally acceptable testing and verification of product standards. Verification of these standards using such systems could ensure the products receive improved acceptance from the hosting country population. When constructing production plants in disaster prone countries, the company should consider regions having limited disasters recorded. This shall reduce the possibility of disaster effects on production plants. Through assessment of similar plants within different countries, the company can also establish the various disaster protection plans utilised by these companies. These methods can be incorporated into the company’s strategy for disaster management. Other foreign entry strategies While the company considers entry into the international market, numerous methods can be applied to enhance success of the subsidiary businesses. These entry methods could be utilised in ensuring quick stability within foreign markets. Franchising – this involves allowing other companies to be created and operate within the standards set by Mother Company. IBF plc could utilise this method through identifying capable companies in target countries, willing to begin operations using the IBF name. This strategy could significantly help the company to eliminate some external risks like political instability (UNIDO 2008). Licensing – the company could license manufacturers of similar products to produce and market products in their native countries. This method could be utilised in countries with static economies as manufacturing using local companies’ remains more appealing to local people (Daniels, et al. 2007). This would increase the volume of sales realised by the company from their products in foreign countries. Joint ventures – the company could search for partners who could contribute in the equity of businesses in foreign counties. This method could be utilised to seek experienced business operators within the specified regions or countries. The company can also adopt other methods like exporting products and components used for production into hosting countries. This method could be efficient in regions with limitations in resources of human capital and raw materials (Periasamy 2009). The company would only establish assembling plants, to assemble imported parts. Wholly owned subsidiaries could also be utilised but in a limited extend where operating conditions are very close to those experienced in Britain. Question 2 International business relies heavily on the existing exchange rates for different currencies within the trading countries. Changes in the exchange rates might present significant impact on the businesses being undertaken between countries using different currencies. Joe’s company and businesses are bound to become affected by changes experienced within the exchange rates (Madura 1999). Invoicing using the sterling pound ensures the prices for the company’s products remain fixed while easing the invoicing process. Strengthening of the Euro could lead to increased sales being achieved. When customers within the Euro zone receive the invoices, a strong Euro currency will mean reduced prices when purchasing using the Euro. A strong Euro will increase the purchasing power of customers purchasing using the currency. The chemical prices will appear to depreciate when the Euro strengthens since the sterling pound has higher value. The method of invoicing using the sterling pound remains the best choice for Joe’s company, since all other companies use the same currency. Weakening of the currency could however, have negative effects on the sales volume. Weakening would mean that customers pay increased amount, in Euros, than previously paid. The purchasing power of the customers within the Euro zone shall become significantly reduced through the requirement to pay more Euros for same products. An increase in price could potentially drive customers into seeking alternative sources for their chemicals. A lengthy weakening of the Euro could affect the global chemical market in different ways depending on the currencies used by manufacturing companies. Companies invoicing using sterling pounds could experience a decline in sales. This could be attributed to relatively high prices of chemical when converted into Euros. These companies might be forced to lower prices, an element that could significantly reduce their profitability. Those invoicing using the Euro could experience minimal changes in the increase in manufacturing costs, caused by increase in prices of raw materials. This could probably drive the companies using Euros to increase their prices in trying to maximise profits. The long-term effects of the companies shall be determined by the magnitude of the changes. The chemical companies should therefore establish a joint initiative on how to relatively implement price adjustments as a result of exchange rate changes (Keohane, et al. 2013). Manufactures of chemicals outside Europe would become beneficiaries of lengthened Euro weakness. Customers would seek supplies from American and Asian markets, whose prices might remain relatively low. Since American and Asian currencies remain weaker than the Euro, the option of purchasing from manufacturers from these markets would become increasingly appealing. Asian and American chemical manufactures would experience increased sales while European manufacturers’ sales reduce, following a continued weakening of the Euro. Question 3 Part a The assessment of capital budget of subsidiaries should be assessed using the cash flow of the parent company for uniformity of accounting. The subsidiary remains a project of the mother company and capital investments regarding the subsidiary always emanate from Mother Company (Periasamy 2009). Using the parent company shall ensure presentation of figures using a single currency and avoid financial constraint resulting from changes in exchange rates. Income generated from subsidiaries constitutes income generated by the company hence capital budgeting for subsidiaries should always be considered from the parent’s perspective. Capital budget involves making budgetary allocation for equipment improvement of purchase. This could be equated to expanding the subsidiary, and expansion budgets always involve the parent company. Part b Market exchange rates for currencies used within the trading countries should be considered when establishing a capital budget for an international subsidiary. This would be important in establishing the amount of financial investment required to propel the projects (Periasamy 2009). A consideration should also be made regarding the changes that might occur in the exchange rates. This would enable companies to develop measures aimed at countering the effects of exchange rate changes. Weakening of the currency for the parent company could lead into financial shortage during the implementation process. This could lead the company into cutting budgetary allocations for other functions, in order to sustain the subsidiary. The exchange rate factor is only considered for multinational subsidiaries. Another factor considered for multinational subsidiaries is the dependency of the project on the parent company. When budgeting, the subsidiary’s dependency on the parent company remains an important factor to consider. This helps in establishing the amount of support the parent company shall offer the subsidiary. Subsidiaries can either be mutually exclusive of independent. Mutually exclusive subsidiaries depend on other factors for them to be implemented (Brigham & Houston 2009). These subsidiaries must be suspended until the anticipated event necessitating their implementation occurs or fails. The failure or occurrence of such event will enable the policy-makers to make decisions regarding development of the intended subsidiary. This factor might not bear significant importance in domestic projects when compared to multinational projects. Part c The cost of capital for multinational companies can be affected by various company characteristics. The international operation of the company could affect the capital cost through changes experienced in exchange rates globally. Just like the exchange rates, the capital cost for internationally operating company remains bound to change. The giant size characteristic could initiate increased capital costs. The expenses and revenues of these companies reach supernormal figures estimated in billions (Khanna 2012). The size of these organisations could potentially increase the capital costs of the companies. Majority of these companies are characterised by spontaneous evolution. This evolution can present significant difficulties in estimating the capital cost for the company. Through the spontaneous evolution, estimation of expected results becomes increasingly difficult. The companies are also characterised by oligopolistic structures, resulting from increased take-overs, and mergers. Since the companies never operate as single units, mergers and take-overs affect the capital costs of multinational companies through sudden changes. Most companies utilise multilateral resource transfer, in human resource, raw materials among others. These transfers can immensely affect the capital costs through the constant changes in values when these resources become transferred. Lastly, multinational companies continue to be characterised by American dominance, with a high percentage of these firms having American origin. The presence of many American MNCs could instigate operations using the American currency. This could have effect on capital costs of other multinational companies using different currencies. Part d Within the automobile industry, economies of scale become measured in relation to the industry. The production costs are spread throughout and they change through the entire industry. In external economies, cost of unit production depends on the industry size and not firm size. Reaping considerable benefits from such an enormous industry would mean increasing production while lowering fixed costs for the firms (Sullivan & Sheffrin 2003). While increasing geographical operation allows access to larger markets through economies of scale, the method utilised in achieving these global markets determines the benefits achieved from the economies of scale. Ram Plc remains more likely to benefit from economies of scale. This would be attributed to the utilisation of distributorship subsidiaries which maintain fixed production costs. Setting up manufacturing plants imposes other production related costs within the host countries; distributorship eliminates these production costs, which increase unit cost. Part e Comparative advantage could be defined as the ability for companies to produce goods at lower opportunity and marginal costs, when compared to others producing similar goods. Comparative advantage enables trading between countries to occur as production efficient for similar goods varies between countries. Varying factors affecting production create the existing discrepancies between countries, creating comparative advantage over others. The theory of comparative advantage is applied in international trade through companies choosing to produce certain goods in region where production costs remain relatively low (Baker & Powell 2009). Some factors which give reduced opportunity costs include availability of technology and skilled labour, utilised in production. Fixed costs in different countries significantly affect the overall comparative advantage between the specified countries. High comparative advantages in different countries encourage international trade, as they become incentives for establishing production plants in those countries. In modern business environment, comparative advantage could be utilised when strategising on the entry method for international business. Companies could consider setting up manufacturing plants in countries with high comparative advantage when expanding, rather than using distributors. High comparative advantages in different countries continue to increase companies’ appeal into venturing into international business (Maneschi, 1998). This could also be utilised in deciding on the countries in which companies intend to venture when becoming multinational. Analysis of the comparative advantage could enable companies make informed decisions on the capability of conducting manufacturing business. Since majority of international business revolves around manufacturing, comparative advantage remains essential in the modern international business advantage. References Baker, H. K. & Powell, G., 2009. Understanding Financial Management: A Practical Guide. 2nd ed. Cambridge: Blackwell Publishers. Brigham, E. F. & Houston, J. F., 2009. Fundamentals of Financial Management. 12th ed. Stamford: Cengage Learning. 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Patterns of Internationalization for Developing Country Enterprises (Alliances and Joint Ventures). Vienna, United Nations Industrial Development Organization. Read More