Strategies of Multinational corporations in the emerging markets China and India

MA-Thesis / Master von Andreas van de Kuil

Abstract:

In recent years, China and India have become two of the most important markets in terms of sales, low-cost manufacturing and R&D operations. The future progress will increase the competitive advantage for both countries and attract MNC’s from all over the world to invest. Nevertheless, success is not guaranteed, even with the large business opportunities that China and India provide. A MNC has to be aware of various challenges that both countries pose, such as government interventions, underdeveloped infrastructures or copyright violations. Hence, MNC’s need efficient strategies in order to compete and improve their position in these markets. Particularly the implementation of an efficient innovation and knowledge strategy has become a crucial aspect. Effectiveness in local product adjustments, globalizing R&D, tailoring talent management, mastering the complexity of global value chains, and managing risks are success factors that have to be considered. This, however, is not an easy task. Multiple failures of MNC’s in China and India demonstrate that it is important to adapt a company’s strategy to the local customer needs and to obtain a competitive advantage in the field of innovation.

The purpose of this master thesis is to discuss all these aspects and present crucial factors for the implementation of an efficient strategy for the two markets China and India, with a focus on innovation and knowledge. Obviously, there are limits to the scope of this dissertation. Some aspects as for example the cultural background of both countries, governmental restrictions, the role of outsourcing or the availability of financial resources have either not been considered or are only discussed briefly. Moreover, this dissertation will only provide a general overview as the business environment of MNC’s in each market will differ.

Introduction:

In the last 10 to 20 years the term emerging market has become very important in the international business context because countries such as China or India grew heavily and created new, enormous market segments. Companies from all over the world are seeking to do business in economically developing countries because of their great potential. Gross domestic product (GDP) per capita figures exceeding 10 per cent a year, a business environment of over five billion people (approximately 80 per cent of the global population), a growing domestic customer group of wealthy people, excellently educated workers and opportunities for low-cost production are changing emerging markets as South Korea, Mexico or India on a daily basis. Global companies like Coca-Cola, IKEA, Microsoft or Procter & Gamble have already realized the enormous potential and have expanded their business greatly into these markets. For example, HP benefited from the target segment in the Chinese computer industry that nearly doubled each year since 1996 (from a market value of $ 3.34 billion in 1996 to over $ 35 billion in 2006). Already today, the 10 largest emerging markets have a GDP of more than $ 14 trillion (which is as big as the economy of the United States) and can not be ignored by multinational corporations (MNC`s) due to their huge business opportunities.

The most important emerging markets for MNC`s are China and India, for which reason the master thesis will focus primarily on these two countries. They are representative for the success of emerging markets during the last 20 years. In the next 10 to 20 years these two markets will become even larger in their size than mature countries as Germany, Japan or the United Kingdom (UK). China and India are expected to grow from 6 per cent of the world’s output today to 20 per cent by 2025. As a result of that, China will be the second and India the fourth largest economy in the world by the year 2025. In contrast, today’s advanced economies will lose significance in the world’s economy and the accompanying shifts in spending could provide substantial opportunities for all global companies.

Furthermore, China and India have the highest residential figures which account for approximately 37 per cent of the world’s population. In both countries roughly 700 million people will be living in the mid-income segment by 2010, which is more than the population of the United States (US), Europe and Japan combined. In fact, this segment is growing everyday. This means that a large number of people to sell new products/services to is emerging.

Being involved in crucial markets as China and India will become an increasingly important strategic choice for MNC’s. It is no easy task to identify the right strategy to enter the two markets as in most cases their environment differs from mature countries. However, especially an efficient innovation strategy is essential for MNC`s because domestic customers are more demanding and enterprises need to adapt their products towards the local needs to gain regional market share. An increasing number of global companies are already highly successful by shifting their competences to China and India. For instance Volkswagen, which has been active in research and development (R&D) in China since the mid 1990s, has sold more cars in China than in its German home market since 2002. Other emerging market leaders like Unilever or Colgate-Palmolive already earn 5 per cent to 15 per cent of their global revenues from the two markets India and China, mainly because they successfully implemented an efficient strategy focusing on innovation.

Table of Contents:

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Chapter 3.4, The Role of MNC’s from China and India in the World’s Economy: In the 1960s French managers were afraid as global US enterprises as IBM, Ford or Dow Chemical opened their first locations in Europe. The same scenario occurred as Japanese companies pushed into the US market in the 1980s and MNC’s such as Toyota or Sony increased their market presence. The latest trend reflects a new and fundamental shift. In today’s globalized business, emerging economies are creating their own gigantic MNC’s. Already 69 out of the recent Fortune Global 500 list of 2007 are multinational companies from emerging markets, especially from China and India (in total: 30 out of the Fortune Global 500 list). In the last years these MNC’s heavily increased their investments. A study carried out by the Boston Consulting Group found that in 2006 FDI from enterprises of developing economies had reached $ 174 billion.

A good example for a successful MNC from an emerging market is China’s Haier, which at the moment is the top selling firm of compact refrigerators in the US (approximately 50 per cent market share). The company is one of the biggest Chinese MNC’s with total revenues of $ 13.9 billion and a presence in over 70 countries worldwide. Another example, as already mentioned in the previous chapter, is Lenovo. China’s number one PC manufacturer successfully competes against global computer giants like Dell or HP due to its competitive advantages of low-cost manufacturing, a strong domestic customer base and an efficient value chain. Especially the fact that the Chinese enterprise acquired the global personal computer division of IBM for $ 3 billion in 2004, which was three times its size and represented new operations in more than 100 countries, made Lenovo to one of the biggest players in the worldwide computer industry. Moreover, Lenovo was able to decrease its dependency on its domestic Chinese market and raised its presence in new, developed markets as Europe or North America. As a result of that, Lenovo is currently the third largest PC vendor in the world with revenues of $ 16.4 billion in 2007.

An example for a rising Indian MNC is Mittal Steel. In June 2006 Mittal Steel decided to merge with Arcelor in order to create a new company called Arcelor Mittal. This merger made Mittal Steel the largest steel maker in the world, with a control of approximately 10 per cent of the global steel output. Due to its enormous increase in revenues to $ 58.87 billion in 2007 Arcelor Mittal is ranked number 99 in the Fortune Global 500 list. The enterprise is a real global corporation and operates with its 330,000 employees in over 60 countries worldwide.

The primary advantage of these growing MNC’s from China and India is that they grew enormously due to the recent success in their domestic markets. Thus, they already gained experiences in their home countries before expanding their businesses internationally. Moreover, these companies exploit the low-cost advantage in developing countries before moving on to more sophisticated markets. As a result of this, enterprises as China Mobile Communications or Indian Oil have a strong customer base in their own domestic markets but also in other rising countries as Brazil, Russia or Malaysia. MNC’s from emerging markets begin to recognize that they can not continue to rely on other countries innovations to move their enterprises forward. Therefore, companies from China and India are focusing their business spending more on R&D to further increase their influence in the world economy.

Chapter 4, STRATEGY: Chapter 4.1, Definition of Strategy: Tracing its roots to the Greek word strategia, the term strategy originally refers to how a given objective is achieved. In the present business context, strategy continues to bear a notion of victory as it did in the antiquity where it was mainly adopted by the military. Consequently, strategy is an approach by which a company plans to obtain its goals, and intends to compete against its rivals. A strategy usually determines the means for utilizing resources in the areas of production, finance, research and development, personnel, and marketing to reach the organization’s goals. According to Porter the essence of strategy is to perform activities differently than rivals do.

Clearly, there is no general solution for a successful strategy due to the fact that it is always linked to a company’s environment and market circumstances. In order to implement a successful strategy a company has to go through four different stages (environmental scanning, strategy formulation, strategy implementation, evaluation and control). Every company evaluates these factors differently and hence, we find varying approaches within same market segments. For example, in the Airline Industry the strategy of Southwest Airlines (Cost Leadership Strategy) differs from that of United Airlines (Differentiation Strategy).

Despite the importance of a strategy, in today’s business world there are examples were organizations survive for a period of time without applying an efficient strategy. Nevertheless, if an enterprise, especially in an international environment, wants to succeed in the long term an appropriate approach is always needed.

By developing a corporate strategy, managers determine the company’s overall direction: its vision, general goals, ethical perspective on the social environment, and corporate identity, as well as the scope of its operations. However, the formulation of a corporate strategy is usually too broad to effectively improve the competitive position. Therefore, firms devise business strategies that are concerned with the relationship between the company and its environment. This type of strategy describes how an enterprise plans to respond to competitors, governmental authorities, suppliers and customers in the market. In the following chapters the dissertation will mainly focus on this context.

Chapter 4.2, Market Entry Strategy: Many enterprises in the world successfully operate in their national markets without ever exploiting new opportunities. However, due to the progress of globalization, most businesses can achieve increased sales, more brand awareness and enhanced business stability by entering new markets. Especially the recent development of many emerging markets, as mentioned in chapter three, makes these countries very attractive for foreign investors. A lot of MNC’s have already entered emerging markets to gain market share and enhance their businesses. But there are still a lot of companies that are planning to expand internationally, predominately in developing countries.

An appropriate entry strategy into these markets has thus become immensely relevant to many companies in the world. According to Kumar and Subramaniam the mode of entry is one of the most critical strategic decisions in emerging markets because it affects all future decisions and is the first part of a successful business strategy. Due to this importance, the dissertation will mainly concentrate on the theoretical background of an efficient market entry, with focus on the two emerging markets China and India.

Chapter 4.2.1, Types of Entry Modes: In this chapter the four most important approaches of an international market entry strategy will be explained. Obviously, other important strategic decisions have to be considered, as for example pricing, market barriers, product positioning, marketing or environmental restrictions. However, due to limitations this paper will focus only on the general types of a market entry. In addition, in Appendix 22 and 23 all main entry modes will be summarized and an overview about the advantages and disadvantages of each type will be given.

Exporting: Exporting is the easiest and most common entry strategy. Products are manufactured in the home country and shipped to the foreign target country. Whilst no direct production is required in an overseas country, only significant investments in marketing are needed. Exporting demands coordination among four market players, namely the exporter, importer, transport provider and the government.

Contractual Arrangement: Contractual arrangements generally include licensing and franchising. Licensing involves granting the rights and methods for production to a host-country firm in return for a royalty fee. Franchising is a form of licensing, which combines the franchisee’s local knowledge, capital, and entrepreneurial energy with the franchisor’s standard bundle of products, management expertise, and support systems. In the last years franchising has grown to a popular approach to enter new markets. Fast-Food MNC’s as McDonald's or Subway are famous examples of expansion via franchising.

Joint Venture: A joint venture involves two companies that form a partnership and operate under a new corporate name. The most effective way to enter a new market may be a joint venture with an already established business. The partner company knows the market, has the distribution framework in place and less capital is required. Therefore, joint ventures are popular among large, international oriented businesses which are seeking to expand from their maturing home markets, or which are seeking for new sources of raw materials. Especially in the two largest emerging markets China and India joint ventures are a common entry mode. In certain emerging countries there are regulations for market entry. For example, in China equity ownership by foreign companies in some industries (e.g. Automotive Original Equipment Manufacturers) is limited to a maximum of 50 per cent and joint ventures are the only way of doing business.

Foreign Direct Investment: Foreign direct investment is the movement of resources (including capital, technology and personnel) across national frontiers in a manner that grants the investor control over the asset, such as a wholly-owned subsidiary created by a Greenfield investment or an acquired local company. A Greenfield project gives the investor the opportunity to create an entirely new organization to its own specifications. However, this option usually implies a gradual market entry. On the other hand, an enterprise could acquire an existing firm to enter a new market. A purchase facilitates a fast entry to the local market and access to different resources. But the acquired firm will not necessarily match to the organization of the investor. In emerging markets, acquired firms often extensively restructure to resemble a Greenfield investment.

The most appropriate mode of entry differs according to the circumstance in which an MNC finds itself. For example, Walt Disney faced the challenge of building a theme park in Europe in 1992. Disney's mode of entry in Japan in 1983 has been licensing. However, the firm chose a direct investment in its European theme park, owning 49 per cent with the remaining 51 per cent held publicly due to its new company philosophy.

Chapter 4.2.2, Application in Emerging Markets: Dissimilarities in infrastructure, level of technology, and political-, legal-, economic- or cultural environment create obstacles to successfully enter emerging markets. You can not simply take a North American version of an entry strategy, move it to China or India, and just flip the switch. It will not work is a statement by the CEO of an US manufacturing MNC. Therefore, the choice of an appropriate mode of entry is a key strategic decision for MNC’s. The selection of an entry strategy may depend on various factors, such as the size of the market, the business environment, managerial understanding of the market, internationalization objectives, the product-market fit, the level of asset commitment for the target market, and the nature of competition in the target market. However, literature suggests that firms normally invest in an emerging market for one of the following three reasons.

Market seeking: An enterprise is attracted to a market due to its size and potential; Efficiency seeking: A company wants to enter a market because it has special capabilities in a certain industry; Resource seeking: A firm invests in a market to obtain access to a crucial resource; Besides this decision, a MNC has several options to enter an emerging market in terms of timing. Firms that expand internationally do it primarily through incremental direct investments. Usually, an enterprise first exports their products, later establishes sales subsidiaries, and eventually invests in wholly-owned manufacturing subsidiaries. The logic behind this incremental approach is that it allows companies to gradually learn about foreign markets and increase commitments over time. By doing so, firms can maximize the benefits of learning and reduce the hazard of failure. However, international enterprises may pursue rapid internationalization by entering multiple markets simultaneously to reach a global scale faster and to capture an early mover advantage. By being the first mover, MNC’s can enjoy the advantages of having the first choice of partners, sites, and other resources. These companies are also able to establish their products quickly and build up brand loyalty. This international expansion strategy enhances firm performance especially in industries where globalization pressures are high, by enterprises with less lead-time of their home-country rivals, and in countries where they could benefit as an early mover. A disadvantage could be the high loss potential in terms of brand reputation and costs.