Globalization and International Business
- Reasons for going global
- Multinational companies and transnational companies
- Strategies to enter the international market
International business involves international trade and investment. For example, companies rely on foreign markets for their sales. Meanwhile, they produce domestically. In other cases, companies invest abroad by controlling and operating production facilities in several countries through their subsidiaries.
Companies grew from a startup. As a result, they usually focus on the domestic market. And when they mature, going global may be their next option for growth.
There are various reasons for domestic companies to choose to go global. First, the global market is more significant than the domestic one. Second, globalization makes it easier to enter foreign markets. Third, advances in technology contribute to reducing production costs and information exchange. Fourth, trade liberalization and deregulation reduced trade barriers.
Globalization is a process by which countries are increasingly interconnected through trade, migration, investment, capital flows, and technology. This ultimately leads to economic integration and homogenization around the world.
Globalization opens opportunities as well as challenges for businesses. For example, companies easily access international markets, which are much more significant in size than the domestic market.
However, companies may have to deal with cultural differences and local tastes. In addition, regulation changes and political instability could also expose their businesses to risks.
Characteristics of globalization
Globalization is characterized by the following:
- Fast-expanding international trade
- Increased capital flow
- Increase in international travel
- Instant and easy global communication
- Homogenized cultures, tastes, and preferences
- Free movement of labor
- Increasing trade agreements
Fast-expanding international trade. This allows products and services to flow to various countries. The market has become increasingly integrated and is leading to a free market. Several factors drive the increase in international trade, including:
- The push towards free markets by eliminating trade protections such as tariffs and quotas
- Regional cooperation toward economic integration
- Reducing logistics costs with advances in technology
- Advances in information technology, enabling people around the world to be increasingly connected
Increased capital flow. Capital flows are increasingly flowing between countries, both portfolio and direct investments. Portfolio investors pursue higher returns by investing in foreign capital markets. Meanwhile, multinational companies expand their investment and target key countries by acquiring existing companies or setting up production facilities.
How globalization impacts business
Globalization and international markets contribute to various aspects and provide benefits for businesses, including:
- More significant opportunity to generate revenue by selling goods in other countries
- Easier access to foreign markets through reduced trade protection and capital controls
- Increased competitiveness by adapting technological advances abroad
- High need to be more innovative and more competitive internationally
- Larger customer base from different countries
- Higher economies of scale through increased production to meet global demand
- More external growth opportunities because the overseas market is much more significant in size than the domestic market
- More options to raise capital, such as by issuing global stocks or bonds in developed countries
However, globalization also introduces limitations or risks for businesses, including:
- Foreign competition pressure because foreign companies have more unrestricted access to the domestic market
- Threat to domestic companies, and if they are inefficient, they can be taken out of the market
- Higher customer requirements where customers easily seek better alternatives abroad
- Opposition from the public or government in the destination country because foreign companies are considered unfriendly to local interests
- Decreased market profitability as foreign companies bring additional supply to the market
Reasons for going global
Several reasons underline why a company wants to become a multinational corporation. They include:
- To increase revenue by achieving sales in various countries, more significantly than the domestic market
- To find new markets because the domestic market has been at a saturation point
- To secure inputs and lower production costs, such as operating near raw materials or in other countries with cheaper labor
- To achieve higher economies of scale because companies can produce on a larger scale
- To circumvent trade barriers – such as tariffs and quotas – by establishing subsidiaries or acquiring foreign companies
- To spread the risk by targeting different countries for different business activities – some countries as production locations and others as markets
- To benefit from differences in taxation between countries
Multinational companies and transnational companies
Multinational companies are involved in business in more than one country. They control or manage production and distribution facilities in several countries. They usually have a head office in their home country to coordinate and manage their global activities.
Multinational companies are slightly different from transnational corporations. Transnational companies usually do not consider a country as their home.
Transnational companies combine multinational and global strategies. They compete through product standardization worldwide but remain open to adaptation through adjustments to local conditions. In other words, they pursue low-cost and differentiation strategies through the various subsidiaries under their control. In addition, they also encourage synergy through skills transfer between subsidiaries.
Operating as a multinational corporation offers several advantages, including:
- More profits through increased revenue and reduced costs
- Increased revenue by targeting global markets
- Higher economies of scale by producing more output
- Lowering costs through increasing economies of scale and operating in countries with low-cost inputs
- Diversify risk by selling and spreading business activities in different countries
- Diversity to promote innovation by recruiting talent worldwide
But, multinational companies also have to face some risks, such as:
- Unstable politics in the destination country, resulting in policy changes
- Opposition from the government or people in the destination country because multinational companies are considered unfriendly to local interests
- The contagious effect, where disturbances in one country spread to businesses in other countries
- Negative impact due to changes in economic conditions and socio-demographics
How do multinational companies impact destination countries?
Investments by multinational companies reap the pros and cons in several countries. Some of the cons – and therefore their drawbacks – are:
- Considered exploiting labor and the environment
- Taking shortcuts by ignoring social responsibility
- Forcing local businesses out of the market
- Unequal competitive capacity where multinational companies have more resources
- Profits transfer to the country of origin and are not retained in the destination country
However, multinational companies also contribute positively to destination countries, including:
- Encouraging economic growth by increasing output
- Create jobs for local workers
- Introducing new skills and technologies
- Promote competition and, therefore, encourage innovation
Strategies to enter the international market
There are several ways to develop an international business, including:
- Strategic partnerships and alliances
- Joint ventures
- Direct investment
Companies produce output in the domestic market and sell it abroad. This strategy is relatively fast with low risk. However, companies are vulnerable to changes in trade policy by governments in destination countries.
There are two ways to export:
- Direct export
- Indirect export
Under direct export, companies sell goods directly to foreign customers. The advantages are:
- Companies have full control over sales and distribution
- Companies do not need to incur commissions to pay intermediaries, saving costs
- Companies can collect feedback directly from customers
However, indirect exporting presents challenges or limitations such as:
- Businesses lack knowledge of overseas customers and markets
- Jobs and tasks add up, and businesses have to be busy arranging transportation and storage facilities
- Companies may have to hire additional employees to deal with foreign buyers
Indirect export involves intermediaries in international trade, such as agents or trading companies. This method offers several advantages, such as:
- Opportunities for successful selling are higher, leveraging agent knowledge
- Agents manage processes ranging from transportation and administrative procedures
- Companies do not need to add new workers to handle exports
Relying on the indirect export method has some limitations, such as:
- Costs increase because companies have to pay commissions to agents
- Agents may not be fully committed because they also have to service other companies
- Companies miss opportunities to get closer to customers
Franchising sells franchise rights to parties abroad with royalties or fees as compensation. Franchisees have the right to use trademarks, logos, recipes, and promotional materials.
This entry strategy is relatively fast, low cost, and low risk. However, the company lacks control, and third parties may become competitors in the future.
Going global through franchising offers several benefits for companies, such as:
- Less initial cost to expand in foreign markets
- Not overly preoccupied with franchised business operations
- Combining external resources to grow
- Earning income from royalties
- Spreading business risk by assigning rights to different parties in different countries
However, franchising strategies also contain risks such as:
- Reputation damage due to negligence by franchisees
- Lower control over the franchised business
- Costs for providing support such as training and promotion
- Potential legal disputes
- Less close to customers
Licensing is another way to enter international markets by leasing intellectual property rights to other parties. It involves contractual agreements to distribute products or services in exchange for a fee.
Different from franchising, licensing applies to registered trademarks. Meanwhile, the franchise agreement relates to all brands and business operations.
Licensing offers several advantages, including:
- The company (licensor) earns income from fees without being involved in running a business
- The licensee bears most of the business risk
- The company can avoid trade barriers
- Licensees are more likely to be successful because they are familiar with local markets and customers
However, licensing also carries risks such as:
- The company lost control of the marketing process
- The contract can be terminated at any time
- The company’s reputation is damaged by the licensee’s unethical practices
Strategic partnership and alliance
Partnerships involve cooperating with other parties, such as established companies in the target country – for specific projects and mutual benefits. It reduces risk by sharing costs, knowledge, and resources with partners.
Strategic partnerships and alliances offer several advantages, such as:
- Complementary resources and knowledge
- Shared contribution to resources and investment
- Lower risk than joint ventures without forming a separate new entity
However, strategic partnerships and alliances also have drawbacks, such as:
- Less permanent and, therefore, shorter life cycle
- Failure due to communication barriers and conflicting cultures and management styles
- Reputation damage due to partners’ mistakes and negligence
A joint venture may sound similar to a strategic alliance. However, the two are slightly different. Joint ventures involve partners forming a new separate entity but not with a strategic alliance. They share ownership, returns and risks, and governance of the entity.
Going global through a joint venture offers several advantages, such as:
- The risk is shared among the partners
- Partners share skills, knowledge, and resources for success
- Trade barriers are irrelevant
But, building a joint venture also has drawbacks, such as:
- Conflicts may occur between partners due to poor communication
- Differences in management styles and cultures may lead to clashes or disagreements
- The company may lose control if the partner is too dominant
- Partners may not have incentives to be efficient
Direct investment involves companies investing in assets or buying shareholdings in companies located in the destination country. Compared to the above methods, direct investment is the riskiest because the company has to be more deeply involved to control or operate the business in a foreign country.
Direct investment can be:
- Greenfield investment
- Merger and acquisition
Greenfield investment requires companies to set up subsidiaries or production facilities overseas. As a result, this growth strategy is slow to achieve an established market position.
Greenfield investment has several advantages, such as:
- Avoiding trade barriers because it can directly produce and sell products in the destination country
- Gaining government support, especially when the destination country wants to spur economic growth by inviting foreign investors
- Flexible in managing the organization and developing a successful strategy
- Closer to customers because it manufactures in their country
However, greenfield investing is the riskiest compared to other market entry strategies. There are several reasons explaining this:
- Setting up a new company is expensive and complex
- Must understand how to do business, including regulatory issues and rules
- Takes longer to become established and achieve success, unlike acquisitions
- Vulnerable to changes in the business environment, such as government policies and political stability
The acquisition involves a company taking over a target company in the destination country. To achieve higher economies of scale and a strong market position instantly, the company may acquire two target companies and combine them into one entity (merger).
Mergers and acquisitions are relatively quick to reach an established position. Other advantages are:
- Does not reduce market profitability because mergers and acquisitions do not add new supply to the market
- Minimize the potential for retaliation by competitors
- Reducing failure due to not starting a business from scratch
However, mergers and acquisitions carry high risks and costs. Other drawbacks are:
- Opposition by management, leading to a hostile takeover
- Synergy failure due to culture clash and management style
- Paying too high for the premium
- Strict scrutiny by regulators due to compliance with competition regulation and antitrust laws