International Business

Chapter Twelve

Country Evaluation and Selection

Chapter Objectives
To grasp company strategies for sequencing the penetration

of countries To see how scanning techniques can help managers both limit geographic alternatives and consider otherwise overlooked areas To discern the major opportunity and risk variables a company should consider when deciding whether and where to expand abroad To know the methods and problems when collecting and comparing information internationally To understand some simplifying tools for helping to decide where to operate To consider how companies allocate emphasis among the countries where they operate To comprehend why location decisions do not necessarily compare different countries possibilities
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The Basics of Country Selection

Because firms lack sufficient resources to pursue all potential (international) opportunities, they must:

determine the order of country entry establish the rates of resource allocation across
countries

In selecting geographic sites, firms must decide:

where to market their products where to produce their products

If transportation costs are high and/or government regulations require local production, a firm may be forced to produce a product in the same country in which it sells it.
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Fig. 12.2: Place of Location Decisions in International Business Operations

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Scanning vs. Detailed Examination

Scanning techniques are based on broad vari
ables that identify both opportunities and risks. Scanning techniques help to assure that firms consider neither too many nor two few alternative countries.
[For the most part, scanning requires information that is readily available, inexpensive, and fairly comparable.]

Detailed examination generally requires on-site visits to

collect and analyze specific information that increasingly contributes to the final location decision process. A feasibility study should have clear-cut decision points to guide managers in the decision-making process.
Escalation of commitment: the more time and money

a firm invests in examining an alternative, the more likely it is to accept itregardless of its merits.

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Fig. 12.3: Flowchart for Choosing Where to Operate

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The Environmental Climate: Country Opportunities

Country opportunities are determined by competitiveness and profitability factors. Factors that have the greatest influence on country selection are:
market size [sales potential] ease and compatibility of operations costs and resource availability red tape and corruption

Some factors are more important for the market location decision, others for the production location decision. Some factors affect both decisions.
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Country Opportunities: Market Attractiveness

Market size, i.e., sales potential, is probably the most important market selection variable.

Market size predictors include:

Other factors to be considered include:

past and present sales data socioeconomic data [GDP, per capita income, population size, population growth rates, etc.] the obsolescence and leapfrogging of products price levels and elasticity income levels and elasticity income inequalities substitutability of products existence of trading blocs taste and other cultural factors
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Fig. 12.4: Aluminum Consumption and GDP per Capita

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Country Opportunities: Ease and Compatibility of Operations

Firms are attracted to countries that: are located nearby share a common language have market conditions similar to those in their home

Firms decision points regarding country selection may include: the ability to operate with product types, technologies,

countries present few market restrictions

and plant sizes familiar to their managers permissible levels of ownership and profit repatriation the availability of local resources [capital, viable partners, etc.]
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Country Opportunities: Costs and Resource Availability

Firms go abroad to secure resources that are either unavailable or too expensive at home. Increasingly, firms need to be near customers and suppliers in locations where (i) the infrastructure permits the efficient movement of people, materials, and products and (ii) trade restrictions are minimal. Productivity-related decision factors include:
the cost of labor utility costs tax rates real estate costs available capital costs transportation costs the cost of other inputs and supplies
[continued]

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 Labor costs are a particularly important factor in production location decisions. However,
labor is not homogeneous capital intensity may reduce the differences in production costs from one location to another there may be sector and/or geographic differences in wage rates within countries

When companies move to emerging economies because of labor cost savings, their advantages may be shortlived because:
competitors follow leaders to low-wage locations there is little first-in advantage for this type of production migration costs in emerging economies may rise quickly as a result of pressures on wages and/or exchange rates
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Country Opportunities: Red Tape and Corruption

Red tape: obstructive bureaucracy, i.e.,
disincentives related to the clarity of laws and whether and how they are enforced Red tape includes government obstacles with respect to:

beginning and continuing operations hiring and/or firing workers the use of expatriate personnel producing and marketing goods satisfying local agencies on matters such as taxes, labor conditions, and environmental compliance
[continued]

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Corruption: the illegal sale of rights by govern-

ment officials for their personal gain Corruption, i.e., the extortion of income or resources, may include:

requirements of illegal payments to win a contract requirements of illegal payments to receive government services requirements of illegal payments to operate in a particular location or industry
Firms are likely to avoid operating countries in which legal transparency is low and corruption is high.
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The Environmental Climate: Country Risks

Risk: the possibility of suffering harm or loss, or a

Returns tend to be higher in countries where operating

course involving uncertain danger or hazard

risks are higher. Firms may balance operations in low-return, low-risk countries with operations in high-return, high-risk countries. Firms may guard against currency fluctuations by locating operations in countries whose exchange rates are not closely correlated. Adverse situations may heighten the perceived needs for certain products.

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Country Risks: Risk and Uncertainty

Companies use a variety of financial techniques to
compare potential projects, including:
discounted cash flow economic value added payback period net present value return on sales return on assets employed internal rate of return accounting rate of return return on equity

Given the same expected return, most decision

makers prefer a more certain outcome to a less certain one.

Firms may acquire insurance to reduce risk and uncertainty.
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Comparison of ROI Certainty

ROI

0% 5% 10% 15% 20% Est. ROI

INVESTMENT A WEIGHTED PROBABILITY VALUE

.15 .20 .30 .20 .15

0.0 1.0 3.0 3.0 3.0 10.0%

INVESTMENT B WEIGHTED PROBABILITY VALUE

0 .30 .40 .30 0

0.0 1.5 4.0 4.5 0.0 10.0%

During the initial scanning stage a firm should weight the elements of risk and uncertainty; during a later feasibility study, the firm must determine whether the degree of risk is acceptable.
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Country Risks: Liability of Foreignness

Liability of foreignness: the lower survival rate of
foreign firms in their initial years of operation Firms may reduce the associated risks by:
first entering countries similar to their home countries enlisting experienced intermediaries to handle operations for them using operational forms that require a lower commitment of foreign resources initially moving to fewer, rather than more, foreign countries
Foreign firms that manage to survive their early years of operation actually have long-term survival rates comparable to those of local competitors.
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Fig. 12.5: The Usual Pattern of Internationalization

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Country Risks: Competitive Risk

Strategies designed to deal with the risks posed by competition include: the imitation lag: exploiting temporary innovative advantages

by moving first into those countries most likely to catch up the first mover advantage: becoming the first major competitor to enter a country in order to gain the best partners, the best locations, and the best suppliers the oligopolistic reaction: purposely crowding a market to prevent competitors from gaining advantages they might use to improve their competitive positions elsewhere clustering: locating in places where competitors are present to gain access to multiple suppliers, skilled personnel, an existing customer base, and information regarding innovations
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Country Risks: Monetary Risk

Liquidity preference: the theory that presumes that
investors generally want some of their holdings in highly liquid assets When considering monetary risk, firms must carefully evaluate a countrys:
present capital controls exchange rate stability balance-of-payments accounts inflation rates levels of government spending Investors are willing to accept a lower rate of return on liquid assets in order to be able to move them easily.

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Country Risks: Political Risk

Political risk: the expectation that the political climate
in a given country will change in such a way that a firms operating position will deteriorate
country by:
examining the countrys past patterns of political risk evaluating the direction of change in the views of government decision makers employing expert analysts tracking economic and social conditions
Political risk may arise from war, the expropriation of property, changes in political leaders opinions and policies, civil disorder, and/or animosity between a home and host country.
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Firms can evaluate the potential political risk of a given

Data Collection and Analysis

Firms conduct research to:
reduce uncertainties at all levels in their decision processes expand or narrow the alternatives they consider assess the merits of their existing programs

The cost of data collection must be weighed

against the probable payoff in terms of:
revenue gains cost savings

When firms conduct original studies in foreign countries, they may have to be extremely imaginative and observant and analyze indirect and/or complementary indicators.
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Problems with International Data and Research Results

The lack, obsolescence, and/or inaccuracy of

data regarding many countries make much research difficult and expensive to undertake. Reasons for data inaccuracies include:
the inability of governments to collect the needed information the publication of false or purposely inaccurate information designed to mislead constituencies the publication of conclusions based on too few observations, non-representative samples, and/or poorly designed research instruments
[continued]

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 Data comparability problems are rooted in:

definitional differences across countries [e.g., family categories, literacy levels, accounting rules] differences in base years and time periods distortions in foreign currency conversions differences in the measurement of investment flows the presence of black market activities
Many countries have agreed to similar standards for collecting and publishing various categories of national data in response to a recommendation of the IMF.

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External Sources of Information

The major types of external, secondary information
sources include:
individualized reports from market research and business consulting firms [commissioned for a fee] specialized studies from research organizations regarding countries, regions, industries, issues, etc. service firm reports regarding relevant business topics government agency socioeconomic and other reports international organization and agency reports

trade association reports information service company reports [fee-based databases]

Both the specificity and the cost of information will vary by source.
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[e.g., the UN, the IMF, the World Bank, and the OECD]

Country Comparison Tools

Grids can be used to:
depict acceptable or unacceptable conditions [e.g., ownership rights] rank countries according to selected, weighted variables [e.g., return or risk]
incorporate weighted indicators of a firms risks and opportunities in specific countries plot the scores to more clearly reveal respective positions for comparative purposes
It is useful to develop both present and future scores for countries; a significant shift in a future score could have serious implications with respect to the country selection process.
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Matrices can be used to:

Simplified Country Comparison Grid: Three Types of Information

VARIABLE WEIGHT I II
COUNTRY III

IV

1. Ownership a. Sole b. Jt. venture

No Yes

Yes Yes 4 3 7 0 0 0

Yes Yes 3 1 4 0 1 1

Yes Yes 3 3 6 3 2 5

Yes Yes 3 2 5 3 3 6
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2. Return [higher number preferred] a. Investment 0-5 b. Direct costs 0-3 Total 3. Risk [lower number preferred] a. Exchange risk 0-3 b. Political risk 0-3 Total

Fig. 12.7: Opportunity-Risk Matrix

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Country Resource Allocation: Reinvestment vs. Harvesting

Reinvestment: the use of retained earnings to replace
Over time, most of the value of a firms FDI comes from
reinvestment; it may take several years and even the allocation of additional funds to meet stated objectives.

depreciated assets or to add to a firms existing stock of capital

Harvesting: the reduction in the amount of an invest If an operation no longer fits a firms overall strategy, or if
ment, either by simply harvesting earnings or by divesting assets as well

better opportunities exist elsewhere, a firm must determine how to exit that operation.
Managers are more likely to propose investments than divestments.
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Country Resource Allocation: Diversification vs. Concentration

Geographic diversification: moving rapidly into
numerous foreign countries and then gradually building a presence in each Geographic concentration: moving into a limited number of countries and developing a strong competitive position in each
Factors to be considered when selecting a strategy (or perhaps a hybrid of the two) include:
market growth rates

market sales stability competitive lead time spillover effects

the need for adaptation program control requirements constraints

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Diversification vs. Concentration Strategies: Product and Market Factors

Factor Prefer Prefer Diversification Concentration if: if: low high low high short long high high low high low high

1. 2. 3. 4. 5. 6.

Market growth rate Market sales stability Competitive lead time Spillover effects Need for product adaptation Need for promotion and distribution adaptation 7. Program control requirements 8. Constraints

low low

high high
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Source: Marketing Expansion Strategies in International Marketing, Journal of Marketing, Spring 1979, p.89.

Final Country Selection Details and Non-comparative Decision Making

For new investments, firms must:
make on-site visits generate detailed estimates of all costs consider different locations within a given country evaluate partnership prospects

For acquisitions firms must examine financial

statements and operations in detail. For expansion within countries, decisions will most likely be made on the basis of capital budget requests.
[continued]

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Major factors restricting companies from comparing country investment opportunities in great detail are: coststhe additional time and resources required may increase costs to unacceptable levels timefirms may need to react quickly in order to capture first-mover advantages or respond to competitive threats
Many firms consider proposals one at a time and accept them if they meet minimum threshold criteria.
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Implications/Conclusions
Firms use both qualitative and quantitative

information to determine which markets to serve and where to locate production. Because each firm has unique competitive capabilities and objectives, the factors affecting the country selection decision will differ for each.
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 When allocating resources across countries,

a company must consider its need for reinvestment vs. divestment, its preference for diversification vs. concentration, as well as the interdependence of its operations. The interdependence of a firms operations may obscure the real impact of a given operation on overall corporate activity and profitability.

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