INFLUENTIAL VARIABLES
INFLUENTIAL VARIABLES
The following discussion highlights the factors mentioned most often as influencing where sales and production emphasis will be placed. Some of the variables are more important for the sales-allocation decision; others are more important for the production-location decision. Some, of course, affect both decisions, especially when foreign investment is necessary for serving a given foreign market.
The ranking, or prioritizing, of countries is useful for aiding decision makers in (1) determining the order of entry into potential markets and (2) setting the allocation and rate of expansion among the different markets. The former determination assumes that a firm cannot or does not want to go everywhere at once; consequently, it chooses to allocate its resources first to those more desirable locations. The latter assumes that a firm already is selling or producing in many locales, perhaps even in all that are feasible, but wishes to decide how much of its effort should be expended in one country rather than another.
Market Size
The importance of sales potential cannot be overlooked when comparing countries as markets or as production locations. Sales probably are the most important variable in ascertaining which locations will be considered and whether an investment will be made. The assumption, of course, is that sales will be made at a price above cost; consequently, where there are sales, there will be profit.
As was the situation in the Ford case, many firms begin sales to an area very passively. They may appoint an intermediate firm to promote sales for them or a licensee to produce on their behalf; if there is a demonstrated increase in sales, the company may consider investing more of its own resources. The generation of exports to a given country is an indication that
sales may be made from production located in that country as well. As long as there is no threat to export sales, however, there is little to motivate a firm to shift to production abroad.
In some cases a firm may obtain past and current sales figures on a country-to-country basis for the type product that the company would like to sell; in many cases, however, such figures are unavailable. Regardless, management must make projections about what will happen to future sales. Such data as GNP, per capita income, growth rates, size of the middle class, and level of industrialization often are used as broad indicators of market size and opportunity. Then, groups of countries may be broken down even further by such variables as the dependence on private versus government spending or inflation rates.5
The triad market of the United States, Japan, and Western Europe accounts for about half of the world's total consumption and an even higher proportion of purchases for such products as computers, consumer electronics, and machine tools.6 It is not surprising therefore that most international firms expend a major part of their efforts on these areas.
Ease of Operations/Compatibility
Geographic, Language, and Market Similarities Recall in the Ford case at the beginning of the chapter that earnings and vehicle sales were smoothed because of operations in various parts of the world. Because investors generally prefer smoother performance patterns, they are even willing to pay more for assets in internationally diversified firms.7 Therefore, it might seem that companies would seek to go first to those countries whose economies are least correlated with that of the home country. For example, economic cycles in the United States have marked differences from those in major Latin American countries so one might expect U.S. companies to be motivated to smooth earnings by investing heavily in Latin America.8 Evidence, however, suggests the contrary, whether companies go abroad in related or unrelated operations in terms of marketing systems, production technologies, or vertical or horizontal products.9
Regardless of the industry involved, U.S. firms usually make their first direct investment in Canada; the United Kingdom and Mexico alternate for the second and third positions; and Germany, France, and Australia have most of the fourth, fifth, and sixth positions.10 This fairly remarkable similarity in patterns among dissimilar industries seems due to the fact that decision makers perceive a greater ease of operations in those countries that are near the home country. Canada and Mexico rank high because of their geographic proximity, which makes it easier and cheaper for U.S. firms to control these foreign subsidiaries. The common language helps to explain the appeal of Canada, the United Kingdom, and Australia to investors. Managers feel more comfortable in operating at early stages of international expansion in their own language and in similar legal systems evolving from British law. The language and cultural similarities may also lower operating costs and risks. Finally, market similarity tends to exert a considerable influence on the early location of foreign operations. All the leading countries except Mexico have high per capita incomes, and all except Canada and Australia have large populations. Once companies have sequenced their market entries, they may grow at different rates within those markets.
Since the United States, Japan, and Western Europe share many economic and demographic conditions, firms from those areas place their relative emphasis on these areas as well.11
Red Tape One of the things that companies frequently try to factor into their comparison of country-by-country opportunities is the degree of red tape necessary to operate in a given country. Red tape includes such things as the degree of difficulty in getting permission to bring in expatriate personnel, to obtain licenses to produce and sell certain goods, and to satisfy governmental agencies on such matters as taxes, labor conditions, and environmental conditions. Red tape is not directly measurable; therefore, firms commonly have people familiar with operating conditions in a group of countries rate them as high, medium, or low on this factor.
Fit with Company Capabilities and Policies After the alternatives are pared to a reasonable number, firms must prepare much more detailed feasibility studies, which are expensive. Firms very often become committed to locations that are far from optimal for them because the more time and money they invest in examining an alternative, the more likely they are to accept that project regardless of its merits.12 Companies first should examine very carefully their motives for considering a commitment. The project manager should have broad experience so that a corporate point of view is maintained. The feasibility study should have from the start a series of clear-cut decision points so that sufficient information is gathered at each stage and so that, if a study is unlikely to result in an investment, it may be terminated before it becomes too costly.
One way to make the surveys more manageable is to ensure that proposals fit the organization's general framework. These proposals, if presented to management decision makers, will have a higher probability of acceptance.13 For example, consideration may be limited to locales where such variables as product and plant size will be within the experience of present managers. In fact, so many guidelines and policies may be set up that very few possibilities are investigated for final feasibility. From a policy standpoint, management may find it useful to ensure that its proposal group includes personnel with backgrounds in each functional area—marketing, finance, personnel, engineering, and production. While various factors might cause ultimate decision makers to reject a proposal once a feasibility study is completed, two factors stand out as sufficiently important to sway large numbers
of organizations. These are restrictions on the percentage of ownership that can be held and the maximum allowed remittance of profits.14
Another consideration is the local availability of resources in relationship to the company's needs. Most foreign operations require combining imported resources with local inputs, which may severely restrict the feasibility of given locales. The international company may, for example, need to find local personnel who are sufficiently knowledgeable about the type of technology being brought in. Or the international firm may need to add local capital to what it is willing to bring in. If local equity markets are poorly developed and local borrowing is very expensive, the company may consider locating in a different country.
The fit for a particular country is important. Take marketing capabilities, for example. Assume that a company already has developed a product in one country that has been marketed successfully through mass advertising methods. Normally it is far easier and less costly to move that product into a country where product alterations are minimal or unnecessary and where there are few advertising restrictions.
Costs and Resource Availabilities
costs—espcciaiiy labor So far the discussion has centered on market-seeking operations. Companies costs—are an important are engaged internationally in the pursuit of foreign resources as well. If this
factor m the production- . . rii . ■ >■ ■
location decision. 1S a resource to be transferred, such as a raw material or technology, the anal-
ysis is somewhat simpler than for a resource that will be used in producing a product or component abroad for export into other markets. Eventually a firm must examine the costs of labor, raw material inputs, capital, taxes, and transfer costs in relation to productivity to approximate a least-cost location. Before all of this information is collected within a final feasibility study, there are indicators that will aid decision makers in narrowing the alternatives to be considered.
Employee compensation is the most important cost of manufacturing abroad for most companies, accounting for over 60 percent of costs besides taxes.15 In most cases, therefore, current labor costs, trends in the costs, and unemployment rates are useful ways to approximate cost differences among countries. Labor, though, is not a homogeneous commodity. If the country lacks the specific skill levels required, the company may have to go through an expensive alternative to use the labor, such as training, redesigning production, or adding supervision. If the country already turns out competitive products embodying inputs that are similar to those required in the production being considered, labor costs most likely will be sufficiently low in the planned operation.
Any other important costs should be added into the analysis. If precise data are unavailable, useful proxies on operating conditions may be used, such as the degree of infrastructure development and the openness to imported components.
Firms should consider dif- The continual development of new production technologies makes cost
ferem ways to produce comparison among countries more difficult. With increases in the number of the same product. ways the same product can be made, a firm must compare, for example, the
cost of producing by using a large labor input in Malaysia with the use of
robotics in the United States.16
The following discussion highlights the factors mentioned most often as influencing where sales and production emphasis will be placed. Some of the variables are more important for the sales-allocation decision; others are more important for the production-location decision. Some, of course, affect both decisions, especially when foreign investment is necessary for serving a given foreign market.
The ranking, or prioritizing, of countries is useful for aiding decision makers in (1) determining the order of entry into potential markets and (2) setting the allocation and rate of expansion among the different markets. The former determination assumes that a firm cannot or does not want to go everywhere at once; consequently, it chooses to allocate its resources first to those more desirable locations. The latter assumes that a firm already is selling or producing in many locales, perhaps even in all that are feasible, but wishes to decide how much of its effort should be expended in one country rather than another.
Market Size
The importance of sales potential cannot be overlooked when comparing countries as markets or as production locations. Sales probably are the most important variable in ascertaining which locations will be considered and whether an investment will be made. The assumption, of course, is that sales will be made at a price above cost; consequently, where there are sales, there will be profit.
As was the situation in the Ford case, many firms begin sales to an area very passively. They may appoint an intermediate firm to promote sales for them or a licensee to produce on their behalf; if there is a demonstrated increase in sales, the company may consider investing more of its own resources. The generation of exports to a given country is an indication that
sales may be made from production located in that country as well. As long as there is no threat to export sales, however, there is little to motivate a firm to shift to production abroad.
In some cases a firm may obtain past and current sales figures on a country-to-country basis for the type product that the company would like to sell; in many cases, however, such figures are unavailable. Regardless, management must make projections about what will happen to future sales. Such data as GNP, per capita income, growth rates, size of the middle class, and level of industrialization often are used as broad indicators of market size and opportunity. Then, groups of countries may be broken down even further by such variables as the dependence on private versus government spending or inflation rates.5
The triad market of the United States, Japan, and Western Europe accounts for about half of the world's total consumption and an even higher proportion of purchases for such products as computers, consumer electronics, and machine tools.6 It is not surprising therefore that most international firms expend a major part of their efforts on these areas.
Ease of Operations/Compatibility
Geographic, Language, and Market Similarities Recall in the Ford case at the beginning of the chapter that earnings and vehicle sales were smoothed because of operations in various parts of the world. Because investors generally prefer smoother performance patterns, they are even willing to pay more for assets in internationally diversified firms.7 Therefore, it might seem that companies would seek to go first to those countries whose economies are least correlated with that of the home country. For example, economic cycles in the United States have marked differences from those in major Latin American countries so one might expect U.S. companies to be motivated to smooth earnings by investing heavily in Latin America.8 Evidence, however, suggests the contrary, whether companies go abroad in related or unrelated operations in terms of marketing systems, production technologies, or vertical or horizontal products.9
Regardless of the industry involved, U.S. firms usually make their first direct investment in Canada; the United Kingdom and Mexico alternate for the second and third positions; and Germany, France, and Australia have most of the fourth, fifth, and sixth positions.10 This fairly remarkable similarity in patterns among dissimilar industries seems due to the fact that decision makers perceive a greater ease of operations in those countries that are near the home country. Canada and Mexico rank high because of their geographic proximity, which makes it easier and cheaper for U.S. firms to control these foreign subsidiaries. The common language helps to explain the appeal of Canada, the United Kingdom, and Australia to investors. Managers feel more comfortable in operating at early stages of international expansion in their own language and in similar legal systems evolving from British law. The language and cultural similarities may also lower operating costs and risks. Finally, market similarity tends to exert a considerable influence on the early location of foreign operations. All the leading countries except Mexico have high per capita incomes, and all except Canada and Australia have large populations. Once companies have sequenced their market entries, they may grow at different rates within those markets.
Since the United States, Japan, and Western Europe share many economic and demographic conditions, firms from those areas place their relative emphasis on these areas as well.11
Red Tape One of the things that companies frequently try to factor into their comparison of country-by-country opportunities is the degree of red tape necessary to operate in a given country. Red tape includes such things as the degree of difficulty in getting permission to bring in expatriate personnel, to obtain licenses to produce and sell certain goods, and to satisfy governmental agencies on such matters as taxes, labor conditions, and environmental conditions. Red tape is not directly measurable; therefore, firms commonly have people familiar with operating conditions in a group of countries rate them as high, medium, or low on this factor.
Fit with Company Capabilities and Policies After the alternatives are pared to a reasonable number, firms must prepare much more detailed feasibility studies, which are expensive. Firms very often become committed to locations that are far from optimal for them because the more time and money they invest in examining an alternative, the more likely they are to accept that project regardless of its merits.12 Companies first should examine very carefully their motives for considering a commitment. The project manager should have broad experience so that a corporate point of view is maintained. The feasibility study should have from the start a series of clear-cut decision points so that sufficient information is gathered at each stage and so that, if a study is unlikely to result in an investment, it may be terminated before it becomes too costly.
One way to make the surveys more manageable is to ensure that proposals fit the organization's general framework. These proposals, if presented to management decision makers, will have a higher probability of acceptance.13 For example, consideration may be limited to locales where such variables as product and plant size will be within the experience of present managers. In fact, so many guidelines and policies may be set up that very few possibilities are investigated for final feasibility. From a policy standpoint, management may find it useful to ensure that its proposal group includes personnel with backgrounds in each functional area—marketing, finance, personnel, engineering, and production. While various factors might cause ultimate decision makers to reject a proposal once a feasibility study is completed, two factors stand out as sufficiently important to sway large numbers
of organizations. These are restrictions on the percentage of ownership that can be held and the maximum allowed remittance of profits.14
Another consideration is the local availability of resources in relationship to the company's needs. Most foreign operations require combining imported resources with local inputs, which may severely restrict the feasibility of given locales. The international company may, for example, need to find local personnel who are sufficiently knowledgeable about the type of technology being brought in. Or the international firm may need to add local capital to what it is willing to bring in. If local equity markets are poorly developed and local borrowing is very expensive, the company may consider locating in a different country.
The fit for a particular country is important. Take marketing capabilities, for example. Assume that a company already has developed a product in one country that has been marketed successfully through mass advertising methods. Normally it is far easier and less costly to move that product into a country where product alterations are minimal or unnecessary and where there are few advertising restrictions.
Costs and Resource Availabilities
costs—espcciaiiy labor So far the discussion has centered on market-seeking operations. Companies costs—are an important are engaged internationally in the pursuit of foreign resources as well. If this
factor m the production- . . rii . ■ >■ ■
location decision. 1S a resource to be transferred, such as a raw material or technology, the anal-
ysis is somewhat simpler than for a resource that will be used in producing a product or component abroad for export into other markets. Eventually a firm must examine the costs of labor, raw material inputs, capital, taxes, and transfer costs in relation to productivity to approximate a least-cost location. Before all of this information is collected within a final feasibility study, there are indicators that will aid decision makers in narrowing the alternatives to be considered.
Employee compensation is the most important cost of manufacturing abroad for most companies, accounting for over 60 percent of costs besides taxes.15 In most cases, therefore, current labor costs, trends in the costs, and unemployment rates are useful ways to approximate cost differences among countries. Labor, though, is not a homogeneous commodity. If the country lacks the specific skill levels required, the company may have to go through an expensive alternative to use the labor, such as training, redesigning production, or adding supervision. If the country already turns out competitive products embodying inputs that are similar to those required in the production being considered, labor costs most likely will be sufficiently low in the planned operation.
Any other important costs should be added into the analysis. If precise data are unavailable, useful proxies on operating conditions may be used, such as the degree of infrastructure development and the openness to imported components.
Firms should consider dif- The continual development of new production technologies makes cost
ferem ways to produce comparison among countries more difficult. With increases in the number of the same product. ways the same product can be made, a firm must compare, for example, the
cost of producing by using a large labor input in Malaysia with the use of
robotics in the United States.16
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