IKEA: Expanding through franchising to the South American market - Essay Example

ADVISORY: IKEA EXPANSION INTO BRAZIL 1.0 Introduction: Situational Premise IKEA Svenska AB, was founded 1943. Today it is one of the world’s largest furniture retailer and specializes in stylish but inexpensive Scandinavian designed furniture. At the center of its business strategy is the franchising of low-cost, high-quality customer-assembled furniture kits. As of 2007, they have grown to 237 stores located in 35 countries. It is now considering whether or not it should expand into South America via the Brazilian market. The purpose of this report is to provide an assessment of the IKEA’s prospects in expanding in South America, and if it finds in the affirmative, to provide an advisory as to the market entry strategy that would afford IKEA the best possibility of success. 2.0 Situation Analysis The situation analysis shall be conducted in accordance with the following framework: L Source: Kotelnikov, 2009 The framework calls for analysis in three levels: the general (external) environment, the operating environment, and the internal environment. 2.1 General environment The general environment deals with the existing politico-socio-economic milieu that the business currently is and expects to be thriving in. They include discussion on the shareholders, employees, government policy, the economy, and society. 2.1.1 Shareholders IKEA retail stores around the world are held by its parent company, Ingka Holding, which in turn is owned by Stichting Ingka Foundation, a Dutch-registered, tax-exempt, non-profit-making legal entity. As a non-profit making entity, the company may not declare dividends for its shareholder; its legal nature as a foundation also preclude it from doing so. 2.1.2 Employees IKEA employees number 90,000 worldwide, testament to its size and reach as one of the largest multinational retail furniture companies in the world. As of now, not having any presence yet in Brazil, it does not have any employees in that potential host country. 2.1.3 Government policy (Brazil) With regard to its proposed entry into Brazil, it bears noting that the Brazilian government is intent on building up its reputation as a premiere destination for foreign direct investments as well as joint partnerships and co-ventures with foreign companies. It has simplified its process for obtaining import and business licences, and its tariff-based import system has a reasonable rate of 5%-15% ad valorem tax on CIF value of imports. It is possible for these tariffs to be further reduced pursuant to the international commitments of Brazil 2.1.4 Economy (Brazil) The Brazilian economy, as of the writing of this case study, was straddled with high interest rates that discourage businesses from seeking debt financing, thus reducing demand for bank loans. Furthermore, due to the spread of the contagion on account of the Asian and Russian crisis, the local currency suffered a devaluation against international tenders, thus dampening imports due to the higher costs of imported goods in terms of the Brazilian currency. 2.1.4 Society (Brazil) Brazilian society is contemporary, and economic progress have attuned the urban culture with international trends. Although formerly malls were viewed as exclusively for the rich, consumer attitudes have changed so that malls and shopping centers have gained in popularity. The locals still express preference for local products although there is growing acceptance and demand for international brands and goods. 2.2 Operating environment In line with the framework of analysis, a discussion of the operating environment will deal on the proposed expansion into Brazil and its implications on new customers, new competitors, new suppliers and new products. 2.2.1 New customers The Brazilian market for imported furniture are comprised of the residential sector (which accounts for 60% of the imported furniture market), office sector (25%), and institutional organizations (15%). Aside from the end-user, it is also propitious to target interior decorators and architects, who are also considered decision-makers because they recommend brands and styles to their clients. The major end-users of imported furniture are known to prefer well-reputed and reliable suppliers. Large end user may import directly from foreign sources, but are always concerned with the after-sales service. Technical assistance and availability of replacement parts are very important consideration in the purchase decision. The physical presence and prominence of the supplier in the market is important for large end users to decide in favour of availing of their products. 2.2.2 New competitors As with its stores in other countries, there is not expected to be any direct competitor to IKEA’s business of top-quality, low-cost, self-assembled furniture kits. There are, however, alternatives to this type of furniture, both imported and domestically produced. In Brazil, there are some13,500 Brazilian furniture manufacturers, mostly small and typically family-owned. They are also mostly concentrated in Southern Brazil in large population density areas, situating them close to their raw materials source in the Brazilian planted forests. There are no major distributor chains in Brazil. Furniture importation are made through direct importers and a few from local manufacturers merely to complement their product line. It is noteworthy that Brazilian furniture imports fell to $96 million in 2001 from $111 million in 2000. The breakdown of the imported furniture industry is as follows: The domination of USA and two European countries is indicative of the taste and preference of this segment of the furniture market; however, it must be born in mind that the imported furniture industry comprises only 3% of the entire furniture industry in Brazil. 2.2.3 New suppliers IKEA has a centralized raw materials supplier system. It may consider, however, the inclusion of Brazil as a possible source of wood for furniture. Brazil has 4.6 million hectares of planted forests located in the south. Also, particleboard production in the country has strong growth of 13% per annum, 80% of which is used by the furniture industry. Since materials costs in this country is low compared to other countries, it may present a viable option to IKEA. 2.2.4 New products IKEA’s policy presently allows its franchisee in host country autonomy in designing of new products for their local market, as long as it carries the 12,000 core products. There is autonomy in the design of products pertaining to host countries, although it presumably would be within the strategic direction determined by headquarters. There is no reason to expect a deviation from this policy in the case of Brazil. 2.3 Internal environment In discussing internal environment, the focus shall be on the Company (IKEA), suppliers, competitors and customers. 2.3.1 Company IKEA Svenska AB, was founded 1943. Today it is one of the world’s largest furniture retailer and specializes in stylish but inexpensive Scandinavian designed furniture. At the center of its business strategy is the franchising of low-cost, high-quality customer-assembled furniture kits. As of 2007, they have grown to 237 stores located in 35 countries, and employs 90,000 people. Its parent company, Ingka Holding Group (IHG) is conservatively financed and records high earnings; using PER of Target (closest listed counterpart) of 20X, IHG would probably be worth €28 billion ($36 billion). Its international approach is through franchising. Sales in 2002 was €15 billion worldwide. Because it largely thrives on franchising and has not manufacturing operations, it has little capital investment and realizes a high return on investment. 2.3.2 Suppliers Currently, there is a centralized logistics system in place in IKEA that allows it to realize economies of scale. There is one supplier, or one may say one limited group of suppliers, which is appointed to provide raw materials to all the stores around the world. IKEA maintains a close liaison of company with suppliers, for the purpose of arriving at the best possible design at the lowest cost. 2.3.3. Competitors It is specified that there are no direct competitors to IKEA. There are alternatives, however, in the form of conventional ready-made furniture from the imported and domestically-produced sectors in each host country. From experience, despite the existence of these indirect competitors, IKEA has the advantage of catering to a market to which these competitors are not particularly attracted, thus posing little risk to IKEA. 2.3.4 Customer IKEA’s products are top quality though affordable, and are for customers who do not mind assembling the furniture kit themselves. Thus, the customer base of IKEA are comprised typically young, low- to middle-income families who would find the furniture assembly more cost-efficient than conventionally manufactured furniture. 3.0 Strategic analysis (SWOT) This section integrates into a concise and comprehensive format the strengths and weaknesses of IKEA and view them against the opportunities and threats of the proposed environment, the Brazilian market. The SWOT diagram is presented on the next page, with strengths and opportunities in blue on the left and weaknesses and threats in red on the right. A discussion on the entries follows. 3.1 Company Strengths What is probably the greatest strength of the company is the manner by which it combines the benefits of economies of scale of a large multinational company while avoiding the pitfalls of bureaucracy of such a firm. Instead, by insisting on host-country autonomy concerning design and tactical goals, IKEA has kept the entrepreneurial approach that allows it to expand quickly while treading lightly as it comes into new host countries, thereby enjoying strong sales while keeping costs down. It has developed an expertise in retail furniture marketing by identifying the basics, reducing them to workable kits that are easily and accessibly transported and stored, with the main thrust always of cost leadership. Strategically, aside from the unique furniture assembly designs, the company is able to keep down costs by maintaining a highly efficient value chain: sourcing from the lowest-priced suppliers worldwide; subcontracting manufacturers worldwide, thus incurring little fixed cost or capital outlay; engaging customers as co-producers aided by catalogues, equipment, transportation, shopping list, and instructional website; and designing items to be packed compactly in flat standardized packaging, allowing for stacking & small storage space. Through this emphasis on the continued improvement of the value chain, IKEA is able to maintain a low-margin, high-volume business that ensures high returns. IKEA’s global distribution network is another source of competitive advantage, with its unique centralized logistics system. Furthermore, the company provides excellent support service for suppliers, customers, and franchisees, supporting a centralized strategic direction tempered by a balanced approach to country-level autonomy. Finally, its brand name and track record since the early forties has ensured for it a strong brand equity unrivalled in its business. 3.2 Company Weaknesses (Challenges posed to the system) There are a few challenges posed by the new environment to which IKEA proposes to expand. Firstly, the complexity of the logistics system will increase because of the new geographic destination involved. Secondly, there may be difficulty in responding to national needs and cultural sensitivity issues. These two challenges, however, are nothing new to IKEA, as it has encountered these problems many times in the past half century. Other than cultural factors, it may be possible that franchisees may demand more operational control, and that the focus strategy might be pressured to broaden due to emerging demographic trends in response to varying nation-level consumer groups. The third situation may be problematic only if the legal arrangements fail to take these into account during the formulation of the contract establishing the relationship between host country entity and IKEA. As for the last, all businesses are prone to consumer reaction to their feedback, but IKEA will have to deal with this on a case-to-case basis, depending on the issue currently at hand. 3.3 Threats The environment poses threats to the smooth operation of the business. In any market entry bid, there is always the tendency of customers to patronize their customary, well known and reliable suppliers, and in Brazil this would include the capability of existing domestic suppliers to tailor their products to satisfy market niches that demand differentiated products. Brazilian competitors are strengthening their design and development, with lower investments and state-of-the art equipment. However, the unique approach of IKEA’s self-assembly kits may be sufficient enticement for certain buyers to opt for the new product. Thirdly, furniture imports in 2000 was at $111 million, amounting to only 3.1% of total furniture market in Brazil. This decreased to P96 million in 2001, and appears to indicate the faltering appeal of this (imported) market segment among the people. Finally, the case cites economic instability, difficulties in obtaining financing at reasonable interest rates, and customs barriers for certain imports as additional threats posed by the environment. A good look, however, will show that these are but temporary problems that would eventually resolve themselves. 3.4 Opportunities There are several opportunities that present themselves in the Brazilian market. The merging trends in consumer tastes will make it easier to develop a standard yet tasteful design for the furniture. There is much room for market expansion, with only 3% of the market being devoted to furniture importation. Furthermore, Brazil’s encouragement of trade liberalization resulted in a more open and competitive economy. The reduction in US exports may be attributed to the fact that it tended to concentrate on new-design office furniture, and high-end, high-value-added residential furniture. Furthermore, it is determined in the case that institutional demand is seen to fuel and increase in imports in this sector. Because the past devaluation has already removed the bubble (excesses) in asset prices, the economy will tend to improve from this point on. Also, high-end furniture having gotten more expensive, customers will seek reasonably priced foreign product. Finally, competitors are disadvantaged because they have to import equipment such as wood-drying machinery, finishing machinery, and tools, which tended to be expensive in the face of the currency devaluation. 4.0 Analysis of market entry strategies On the page following is a table summarizing the four dominant market entry strategies. Source: Internet Center for Management and Business Administration, 2007 The preceding table diagrams the advantages and disadvantages of each market entry mode, as well as the conditions that would tend to indicate the propriety of using any one of the particular modes. The four modes are given in order of the increasing commitment of the entering company into the host country, with exporting entailing the least commitment of resources, and direct investment the firmest. The four modes are also listed according to the degree of risk it perceives itself addressing in the new environment. Thus exporting involves the least risk to the company, and is the speediest mode, while entailing the shortest duration; and direct investment involves the greatest risk to the company, with the longest period to develop and the most difficult to liquidate. Direct investment requires the greatest degree of certainty by the company, and exporting the least degree of certainty. It was given that upon entering a new market IKEA policy is not to immediately open a retail store; instead, it shall establish a supplier link with the host country. Franchising is used for unknown, relatively small and high risk markets. Franchising is granted on the basis of strong financial backing and proven track record in retail. Headquarters regularly audits and provides extensive training and operational support, as well as catalogues and promotional advertising. In determining solutions to international marketing decision problems, it is important to focus on the value chain (Food and Agriculture Organization, 2009). Three major issues should be faced: marketing, sourcing, and control and investment. Of the three issues, IKEA will have to rely on local partnership for the first in order that marketing may be more organized and effective. Sourcing, in large part, will be undertaken by IKEA’s existing centralized logistics system which is already well-developed on the basis of the company’s multinational presence and long experience. From the earlier situation analysis, it is apparent that Brazil does not pose extraordinary (political or economic) risk to the company as it enjoys relative stability, or at least no more instability than most countries in a period of systemic crisis. In fact, the type of product that IKEA should continue producing is the same as had formed it core list, which satisfies the basic needs of most consumers, even as it explores new designs for the new market. The low cost is a particular help to the populace undergoing economic turmoil. In the table preceding, the blue highlights indicate conditions that appear to be apparently present based on the case study, and those in yellow highlights indicate a more definite presence than those in blue. From a cursory inspection, it appears that among the likely modes of exporting, licensing or franchising, and joint ventures, it is joint ventures that has the most yellow highlights. There is no doubt that IKEA will enjoy the same high sales potential it has realized in other countries. There is some economic risk, but not very much, as Brazil still appears to be fundamentally sound and the cause of the economic instability is external. If IKEA is to make a strong showing in the Brazil market and use this as a take-off point for the South American region, it must find a partner that could lend its name to IKEA’s initial entry. It will be recalled that Brazil has a flourishing furniture industry that entails lower production costs and that it has a penchant for established names in quality and reliability. This is the reason why it would be important for IKEA to be seen as an insider, and to be able to avail of local company expertise, resources and domestic distribution networks. As to the disadvantages, as already previously mentioned in the SWOT threats, questions of control and the chance that the partner may become a competitor may be managed by the proper contract terms and sufficient communication and collaboration between the two companies. 5.0 Conclusion From the foregoing discussion, it is respectfully submitted that IKEA consider commencing operations in the Brazilian market, and from then explore the possibility of expanding in adjoining South American states. The mode of entry proposed from this preliminary study is the joint venture approach, although sufficient screening and deliberation should be devoted to the determination of the partner most suitable for the purposes of IKEA. Should one not prove available, the next alternative would be to undertake the franchising mode, pursuant to IKEA’s policies for expanding into new markets. [wordcount = 3,000 excluding title] References Certo, S C 2009 “Modern Management", Eleventh Edition. 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