International Business: The of IKEA - Case Study Example

International Business - IKEA Table of Contents Executive Summary 3 Introduction 4 IKEA 6 Foreign Direct Investment Strategies 6 IKEA’s Motivational Factors for Investment in China 7 Chinese FDI Policies 7 The Economy and the Market of China 9 IKEA’s Foreign Direct Investment Selection Criteria 11 Entry Strategy of IKEA in China 12 Corporate Strategy of IKEA 15 Summary and Conclusion 17 References 19 Executive Summary IKEA is one of the largest furniture manufacturers and wants to invest in the foreign markets. Its prime objective behind foreign investment is growth, expansion, reducing cost of production and beating competition globally. After deep analysis, IKEA has chosen Chinese market because it is one of the most cost effective markets among developing countries and also provides many added advantages to IKEA and its future plans. The report, which is prepared for Merrill Lynch, at the outset, discusses Merrill Lynch and IKEA and the overview of FDI in Chinese market. In order to analyse the appraisal, the report focuses upon four important factors like that of motivation of IKEA for going international, the selection of the market, the entry strategy of the company in the selected market and the corporate strategy. The report also has a dedicated section reinstating the major points in the summary and conclusions. Introduction Established in the year of 1943 by a teen ager named Ingvar Kamprad (who was only seventeen years old), IKEA came a long way to be an industry leader in the arena of home products that include furniture, accessories, kitchen and bathroom all across the globe. The acronym IKEA stands for ‘Ingvar Kamprad Elmtaryd Agunnaryd’ and is managed by a Dutch registered foundation. This retail giant has total employee strength of more than 127,000 and the core competency of the company is that of manufacturing and selling assembled furniture. The company basically works with the concept of franchisee. This leading furniture brand targets to encompass major part of the society as it believes in providing world class products to the mass. For the purpose, it inculcates the strategy of competitive pricing. The company also has strong initiatives in the aspects of social responsibilities and environmental programs along with charitable involvements. It can be said without doubt that these factors have been instrumental for the success of the organizational in the international market. Merrill Lynch Bank of America along with the US investment bank, Merrill Lynch is one of the world’s largest brokerage firms. It has a client asset of $ 2.2 trillion. More than 15000 financial advisors are associated with the company to serve its clients from 150 countries. In United States, its portfolio covers 99% of US fortune 500 companies and 83% of Fortune Global 500 companies. It is a global leader on services in investment banking solutions which includes global high-yield debt, global M&A, commercial lending and global equity. The investment bank serves it clients through alpha generating research analysis which has been helpful on creating commercial products and effective capitalization strategies that helps their client to capitalize on the emerging markets. The investment bank also provide its clients with portfolio recommendations, market outlook, industry outlook , investment strategies and forecast for strategizing effective future investment plans globally (Merrill Lynch, n.d.). This report is prepared on behalf of Merrill Lynch assessing the entry strategy of IKEA in one of the fastest growing economies i.e. the Chinese market. IKEA IKEA is the world’s largest Scandavian retailers. It is into the business of manufacturing modern and stylish furniture, budget furniture, and flat – pack and home furnishing accessories. In 2008, the company has collected total revenue of $ 32 billion from its global network spreaded in 36 countries with 296 stores (IndiaRetailBiz, 2009). IKEA has a huge product range and classic customer service approach. Customers can purchase furniture from both offline and online mediums. IKEA is famous for its high quality, designer as well as trendy customized products. Foreign Direct Investment Strategies Foreign Direct Investments are of two types namely horizontal and vertical. Horizontal FDI deals with establishing production locations closer to customers and vertical FDI deals with taking advantage of cross border cost differences. Multinational companies can go for FDI in another country through exporting, licensing, joint venture or direct investment in companies or in its shares. Licensing consists of intangible products like that of trade mark, patents, copyrights and production techniques. Joint ventures, on the other hand, have many benefits attached to it like the political connection, increased networking and efficient distribution of channel. It has five objectives involved which include market entry, technology sharing, risk reward sharing, complying with the government regulations as well as joint product developments. Joint venture gives a benefit of ownership, self control, pricing benefits, local firm’s capabilities, and availability of local resources, technology transfers, period of agreements and the good intentions of the government. Direct investment also gives ownership power and it can be done by adopting the path of mergers and acquisitions (Quick MBA, n.d.). IKEA’s Motivational Factors for Investment in China Motivational factors behind IKEA’s foreign direct investment in Chinese markets are the flexible and regularly renewed FDI policies, its continuous growth, low production cost, long production unit, huge availability of cheap human resource and increasing local customer’s preference and demand towards technologically advanced products. Chinese FDI Policies The year of 1993 was a turning point in the domain of Chinese foreign direct investments. In the year 2003, the country had collected $ 500 billion in FDI. Foreign funds are invested in China through corporative enterprises, solely foreign owned companies and joint ventures. China encourages favorable FDI policies and gives more preference to them compared to domestic companies. Its policies are segregated on the bases of industry and region. Each special economic zones of China have different policies among which Develop China’s West Blast is for encouraging FDI form western countries. China follows a guiding directory which has been first promulgated in 1995 and then revised in 1997 and again amended in 2002. In this directory, FDI involved projects are divided into 4 different categories. These categories are the one allowed, prohibited, restricted and encouraged in China. They have also subdivided these 4 categories into 75 restricted projects, 262 encouraged projects and 34 prohibited projects. Foreign investment on export climbed to 54.81 % from 1.94% in 17 years from 1986 to 2003. FDI’s can be categorized into domestic market seeking where investors seeks to enter local market of the host country and export oriented or efficiency pursuing where investors establish their own production base in the host country (Long, n.d.). Chinese trade policy exempts from tariffs and value added taxes on input import for export by foreign companies. There are two types of trades in China, they are trade processing with imported material (PTI) and trade processing with client supplied material (PTS). The revised tax reform in 1994 has reduced VAT to 17% and also it provided 10% exempt on the automobile companies on excise duty. In China, imported raw materials and all other parts used by export processing industry are exempted from tariffs and VAT but it is so if only it is sold in the domestic market. China also have exempted tariff and other import taxes on all equipments and technology supporting FIE’s laboratory for purpose of pilot testing. Income from transfer of technology is exempted from sales tax (China WTO, n.d.). FIEs are also allowed to sale their high – tech products in local market on trial basis. Its regional government also offers reduction on fees on land used and assistance to foreign companies in employee requirement processes. China provides a huge fiscal incentive to foreign investors in local market. Reasons behind China’s open foreign direct policies are scarcity of financial resources, literacy level and huge unemployment ratio. The Economy and the Market of China There is almost no doubt that the Chinese market is one of the most preferable foreign investment markets. The low production cost, huge availability of cheap human resource and co-operative government policies are the main influencers toward foreign investments in China. Chinese government has large area dedicated for industrial use which results into long and massive production units. Studies have shown that China is an ideal location for low cost production of manufacturing goods. It is world’s most populated country and its huge population has resulted into increase in unemployment rate. China’s literacy level also does not match with the global demand and therefore, it has low skilled labourers and low rates of brain drain. China population is majorly dependable on foreign multinational companies for their employment and financial requirements. All these factors ultimately directs toward the availability of cheap labour. China is also rich of natural resources and the FDI policies exempt taxes and tariff rates on exporting technologies and equipments for research and production use. Combination of cheap labour cost and easy and comparatively low priced availability of raw material makes China a low cost production house for IKEA’s manufacturing unit. IKEA has an asset of seeking advantage because of high demand of technological furniture not only in Chinese market but also in the whole of Asian market. China market facilitates IKEA to interconnect with Asian market and also leads to efficient supply chain management (Wesson, 1999). China market also provides market seeking advantage to IKEA because of its tax and investment incentives, less competition, cheap labour, and availability of natural resources, high demand and supportive FDI policies. Chinese market also provides comparative advantage to IKEA because of its low cost of production (Cavusgil & Riesenberge, n.d.). China has abundance forest and wood which is the main raw material for IKEA’s furniture. Along with these, government policy helps it to get resources easily. Both the factors combined provide resource seeking advantage to IKEA. OLI framework talks about the FDI advantages of IKEA in three stages. OLI stands for Ownership, Location and Internalization. In China, major focus of customer lies towards price rather than quality of product. The prices of IKEA product are high as compared to products available in China’s local market. The technological advantage is the core competency of IKEA but in order to sustain in Chinese market it has to be more innovative towards reduction of production cost. Investment in China provides IKEA that advantage (The University of Manchester, 2008). With respect to location, China is in the mid of Asian market with huge industrial areas and long production units. It is also a good source of raw materials needed in manufacturing process of IKEA. IKEA also enjoys management control in every process of manufacturing. Internalization advantage in China can be achieved through sharing of skilled human resources advanced equipments under manufacturing and centralized effective management. IKEA’s Foreign Direct Investment Selection Criteria IKEA’s foreign direct investment is based on many - fold motives. Few of the objectives include expansion, growth, lower supply chain cost, beating competition, search for lower rate labour, lower tax rate and trading with exchange rate fluctuations. Chinese market gives a high opportunity of expansion, growth, cost reduction and long term business possibility. These factors are the main selection criteria for IKEA. The low cost labour, high rate of unemployment because of huge population, increasing demand for more advanced technological products, and research forecasted long term growing market support all these criteria for IKEA in the country. China has become the most attractive destination for FDI market. The trend suggests that many MNC’s are investing in Chinese markets this would provide huge opportunity to IKEA for global networking and connections. China is centrally located in Asian market so it also gives the country, a great opportunity to expand in neighboring markets and establishing relationship with them. All this also helps IKEA in its positive branding and knowing the consumer buying behavior in the Asian market. In the emerging market like China, where foreign exchange is the biggest source of income and FDI investment plays big part on its GDP and per capita income, risk associated with investment is less in margin compared to the developed markets. China also provides low cost structure of production, attractiveness due to its low cost market structure and supportive government with regard to FDI policies. Chinese government is quite supportive towards FDI and facilitates with many incentive programs to attract FDI in China. Trade off between China and IKEA will also be smooth and profitable because both parties’ need each others’ support equally. It can be said without hesitation that China provides attractive trade of human resource, raw materials and advanced technology and equipments. Entry Strategy of IKEA in China The management of IKEA is planning to invest in a foreign country for many reasons. It wants to increase its market share, profitability, brand awareness and beat global competition. For the purpose, they researched and analysed a market which is cost effective and have huge demand and opportunity for growth and future expansion. Market chosen by IKEA for investment is that of China because of its attractive FDI policies, cost effectiveness, efficient supply chain, high demand and future growth and expansion opportunities. Chinese market provides IKEA a clear advantage over existing domestic and international players and new prospective entrants. This is because of IKEA’s very advanced technology and strong core competency in the market. China also gives IKEA a demodulation opportunity to move form niche market segment towards lower end market segment. IKEA also gets the advantage of knowing the buying behavior of the Asian markets and their preferences. In China, the market with the help of local analysis and technologies can develop into innovative and economical products which will assist it in future expansion strategy in the emerging economies of the continent. IKEA will get all these features in China in a highly cost effective way. Chinese market also has an unhappy customer range because of its low quality products. As the switching costs of these customers are low and therefore IKEA has a highly demandable market in domestic China. With regard to the timing of entry, IKEA should be the fast mover because fast movers have better opportunity to grab the maximum market share. It also has an opportunity to learn the market and changing trend towards the industry. Early market entry has many advantages. It decreases the bargaining power of suppliers and customers because it will be the only international low cost brand in China, reduces the effect of new entrants and substitutes in market. At the same time, it would need more innovations for sustaining in the market. Its brand name would also acts as a barrier for other new and existing domestic and global organizations. IKEA follows a strategy of testing and learning from small markets before moving to the big markets. Early entry would also provide IKEA with primary untouched data for further deep analysis that will assist in knowing new markets of same kind and its expansion on future. Due to early entry, IKEA will receive more governmental support compared to the late arrivals. IKEA stands perfect in Michael Porter’s five force model if they invest early in the Chinese market. It can reduce effect of new entrants, new substitutes, lower the bargaining power of both suppliers and customers and also that of the big competition. Chinese market is an open house of opportunities for IKEA. Entry mode of IKEA to enter China market is through foreign majority owned joint venturing with certain local furniture company. Joint venture is preferred because it has many benefits within it. In joint venturing, the Chinese counterpart should be a leading company in Chinese market. IKEA can have control on technology, research and development. This will give IKEA benefit of ownership and control because domestic partner has to obtain approval from IKEA for any technological implementation or any other processes too. It also facilitates sharing of local firm’s capabilities, technology sharing, easy reach to local resource and high end networking and publicity too in the market. Chinese FDI policies also give many favorable benefits to those firms that invest with their local counterparts. IKEA will receive more preferences in every process than other competitive domestic firms, tax and tariff fiscal incentives. Because of joint venture, IKEA will be allowed to sale its high end products in Chinese local market and will also receive reduction in land fees. Also, implementation of OLI framework is possible in joint venture market entry strategy. If IKEA go for franchising it cannot get access of the local market and will have no control on the processes in China. If it goes for direct investment, IKEA has to face huge competition and political and social obstacles form domestic firms and citizens too. But foreign majority owned joint venture will help it to gain OLI framework of ownership with control and internalization. Through joint venture with a branded firm, IKEA can easily gain fame and goodwill in Chinese market and among the valuable customers. IKEA don’t have to worry about and managing inventory and supply chain because all those will be done by domestic company. IKEA will also get a pre established distribution network and customer base. These features will help in its long term vision of full ownership and control. After few years, IKEA is expected to have a strong network, a huge existing and potential customer base along with much required knowledge about market and the exposure to its management, so that it can start on their own. Investment scale of IKEA will be shared but the larger proportion will be made by IKEA. This will help IKEA on holding maximum share and maximum control. Investment scale plays a very major role in decision making process of any organization. In a joint venture, firm having maximum share have higher voting power and higher authority in every process of organization. IKEA’s large investment in Chinese market with small proportion of Chinese company will give them an ownership and decision making power. Having more market share, it will help IKEA to slowly capture rest of the market share and convert from joint venture towards fully owned corporation. Corporate Strategy of IKEA IKEA’s corporate structure is a combination of The IKEA Group: Service B.V and IKEA Service AB, Inter IKEA Holding S.A, Inter IKEA System BV, IKEA stores, INGKA Holding B.V and Stichting INGKA Foundation (Europa, n.d.). Its business strategy consists of its mission to create better every day life for its customers. It targets all high to middle including the low income families’ globally. Its motive is to delight its customers with customized products that can suite their unstated needs and wants. IKEA follows a centralized control structure over all functional activities like purchasing, manufacturing and selling and distribution. Its corporate structure is also focused on low cost but enhanced quality products and business processes. IKEA’s strategy to invest in China is primarily aimed to achieve its low cost of production strategy and controlling the whole of Asian furniture market. IKEA’s global strategy is highly focused on cost reducing measures and diversification programs. For the purpose of reducing competitor - risk and cost of production, IKEA has decided to invest its production unit in China because China is one of the fastest emerging countries in the Asian market and it has wide geographical and industrial location and large unemployed population. It also follows the two way value system so that every stakeholder can get the satisfaction on working with IKEA and they can maintain a long term relationship with every stakeholder. IKEA’s corporate strategy is customer focused. For the purpose, IKEA investigates first and manufacture goods matching consumer cultural, geographical, financial and economical differences. IKEA was earlier focused towards high cost, high technology and luxurious products. Later with the changing demand of customers and their declining demands of high priced products, IKEA has changed its corporate strategy and target market too. In the run of being present as the international brand in every country, IKEA has modulated its corporate strategy according to the country consumer needs (Gawor, K & Et. Al., 2008). In China, consumer prefers high technological products but cheap in price. IKEA has undertaken strategies not to go by franchising and export and sell finished goods to Chinese customers but adopt a way of joint venture and jump into the way of Chinese market, lower the cost of production, share technology and knowledge, focus more on research and development of new cost effective but high quality products. All these features would help IKEA to reduce its product price in China and Asian market and increase its sales and profitability with global expansion. Summary and Conclusion From the above analysis it seems that Chinese market is the most preferable foreign investment market for IKEA. China matches all the corporate strategies of IKEA of being cost effective, expansion and meeting all type customer needs. Chinese market also essentially provides a low cost production unit with cheap labour and governmental support with tax and tariff incentives and many exemptions. China market is a market that can fulfill vision of IKEA to be a global leader in furniture sector. The entry strategy in the Chinese market should ideally be that of joint venture as it has been discussed earlier as to why it is presumed to be the best method over and above other options. References Cavusgil, K & Riesenberge, No Date. Theories of International Trade and Investment. International Business Strategy, Management & the New Realities. 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