A new economic era is quickly replacing the old, affecting virtually every aspect of Canadian life. Many assumptions no longer seem to apply — yet new realities still need to be defined. These ambiguities are causing Canadian companies to question their business tactics and reassess their strategies.

For centuries, an abundance of natural resources was known to secure a nation's competitive advantage. This is being replaced by human skills. Many of our largest corporations that dominated our landscape for decades are being pushed aside by leaner, knowledge-intensive companies.

These massive changes are challenging every Canadian business and in many cases forcing them to expand internationally — or risk losing ground to foreign and domestic competition. More and more Canadian companies have come to realize that international expansion is key to succeeding in the 21st century.

Peter Berger, Managing Partner for the Americas for Arthur Andersen located in New York City, says "Everybody is thinking about going global." As a result, he says the number of Canadian companies expanding internationally is growing at a very fast rate.

Once the decision is made to expand internationally, the hard work begins. Strategies to achieve this must be developed and examined carefully.

Strategies Differ

There are many strategies a Canadian company can choose from to expand internationally. These include exporting, establishing a joint venture or strategic alliance in a foreign market, acquiring a firm through direct investment or licensing technology abroad.

The benefits and risks associated with each method are contingent on many factors, including your type of product or service, the need for support, and the foreign economic, political, business and cultural environment you are seeking to penetrate. The strategy that is best for your company will depend on the level of resources and commitment, and degree of risk your firm is willing to incur.

Berger says a number of questions must be answered before committing to a joint venture or acquisition in a particular country with a specific partner. "You must know the environment," he says, and "understand how you'll be doing business there." What it will take to be successful, how to staff, integrate distribution, finance operations and remedy currency risks should be analyzed ahead of time, he says.

A primary concern, Berger says, is to know your partner and how to terminate an agreement if the arrangement doesn't work. Additionally, he says, it's essential to determine the political risk and the propensity for business disruption.

Gail Rockburne, President of Rockburne Associates-Connections North America based in Winnipeg, assists Canadian companies to expand internationally. Rockburne says Canadian firms based in western Canada have a different perspective than firms in the East with regard to methods of expansions. "Western Canadian companies are typically risk adverse and more cautious." This affects their strategies and methods for international development, she says.

Joint Ventures

A joint venture is a cooperative business venture established by two or more companies. Prior to commencing operations, partners usually allocate resources, consign risks and potential rewards, and delegate operational responsibilities to each member while preserving autonomy. Upon completion of the project, the joint venture is usually disbanded. It, however, may also be a permanent relationship, maintaining, for example, a long-term production schedule.

In The Spotlight

An international joint venture enables a firm to establish a marketing or manufacturing presence abroad with the assistance of a local foreign partner. The partner may provide knowledge of government workings, regulations, internal markets and distribution know-how. This knowledge may be particularly valuable to you in unfamiliar territory.

A strategic alliance is similar to a joint venture in many ways—yet very different. An alliance may be formed when one organization grants another the authority to exploit technology, research and development knowledge, marketing rights and so forth, but does not create a separate entity. A typical example of a strategic alliance is the basic manufacturer-independent sales representative relationship.

To solidify this informal arrangement, a handshake or simple written agreement may suffice. A strategic alliance is often less formal and a preliminary step to creating a joint venture. Consequently, both allow a company to quickly respond to a changing environment and contribute complementary strengths in order to quickly seize opportunities.

In some foreign markets, such as China, a joint venture with a Chinese partner may be the only legal way to enter the market, except under very special circumstances.

Licensing Technology

Through a strategic alliance or joint venture, a Canadian firm may wish to license its technology, know-how or intellectual property to a foreign company for use in a geographic area for a limited period of time. This may include patents, trademarks, production techniques, and technical, marketing and managerial expertise.

Licensing is particularly attractive to small- and medium-size firms because it affords international expansion while significantly limiting risks.

Licensing is particularly attractive to small- and medium-size firms because it affords international expansion while significantly limiting risks. It rarely requires capital investment and does not require the parties to work closely together, demanding continuous attention. Generally, small firms typically do not have the expertise, staff or resources to satisfy requirements demanded by other methods of expansion.

In many cases, licensing is the only viable strategy for any size firm to securely enter a foreign market that lacks hard currency, severely restricts the repatriation of profits and foreign direct investment, maintains unreasonable trade barriers, and/or is economically or politically unstable.

As with each market-entry method, licensing has its disadvantages. For example, the licensor loses control over the quality, distribution and marketing policies, and essential support services employed for the purpose of selling the product or technology. If compensation is based on sales volume, the licensor must rely on the honesty of the licensee to report units sold. Additionally, earnings are usually less than those provided by most other entry methods.

A typical licensing agreement may call for an up-front fee, royalties based on a percentage of future earnings, and consulting and training assistance. Many licensing agreements evolve into joint ventures, while some joint ventures or strategic alliances are eventually converted to simple licensing agreements when one party’s interests diverge from the original purpose.

Reduce Risk and Taxes

A small company with limited capital, manpower and the need to reduce and share risks may find a joint venture an ideal entry strategy in an overseas market. By utilizing the management skills, experience and knowledge of the foreign market by the local partner, a Canadian firm can significantly reduce the learning curve and share its risks with a partner that has a similar agenda.

Many Canadian service firms tend to choose joint ventures and strategic alliances as their method of international expansion, Rockburne says. The primary reason for this is their need to satisfy the various government regulations in foreign countries, she says. "Canadians often prefer to leave these tasks to their foreign partners."

A joint venture is also safer that a full-scale acquisition should an unproven host government legislate adverse policies affecting foreign investment. Or, as a result of social unrest, the host country becomes embroiled in violence resulting in property damage and the disruption of business.

Gary Webb, Tax Partner for Deloitte and Touche based in Toronto, favors joint ventures over many other methods of expansion. He says they allow companies to "target the exact activity you are looking for rather than tie up capital in areas you're not interested in." And from a tax perspective, partners "can form a structure so that their income crosses the fewest possible borders.

Profits, Rapport and Compromise

While there are significant potential advantages associated with joint ventures, there are also limitations. For example, in a typical joint venture your profits are shared. Additionally, there are many factors that can lead to disagreements between the partners, such as a dispute over efforts and marketing strategies, differences in management philosophies, etc. The ability to compromise and "work together" is essential, regardless of cultural differences.

Rockburne's company has built its reputation on relationship marketing, which she says is the soft or personal relationship between partners. Many of her smaller companies, she says, "have not invested the necessary level of commitment to understanding the culture or developing a strong personal relationship with their joint venture or strategic alliance partners abroad." This, she says, is key to a successful partnership. "The soft issues are what's going to keep these things going."

From the outset, the level of compatibility between potential partners is difficult to assess. Many auto analysts speculated that the joint venture between Toyota and General Motors that created New United Motors Manufacturing, Inc. in the United States in 1984 would not succeed due to differences in management styles. It appears, however, that the analysts' predictions were wrong.

Conflicts can often arise with regard to interests in second markets. For example, say a Canadian-Mexican joint venture in Mexico sells its products to Argentina. Should the Canadian partner wish to establish a second joint venture in Argentina with an Argentinean partner, the second joint venture would compete with the first. This can and has resulted in many disputes.

Foreign Acquisition

Through foreign direct investment, a company can acquire an interest in another firm located abroad. This decision is often part of a company's long-term strategy to strengthen its presence abroad. More often, a company will complete a foreign acquisition once a market is proven, usually after years of exporting or a high degree of success has been experienced through a preexisting joint venture.

According to the Investment Group at Industry Canada, the number of Canadian acquisitions abroad and the amount of Canadian direct investment used to expand existing acquisitions has increased substantially. From 1985 to 1995, for example, cumulative foreign direct investment abroad increased from $57.2 billion to $142.3 billion, a jump of almost 149%. To a large part, according to Industry Canada, these investment are being made in Latin America.

The degree of ownership desired is often a choice of whether the foreign operation is to be wholly owned (either as a branch or separate subsidiary) or partially owned. If the investor or group of investors desire controlling interests, the stock purchase will range from 51% to 100%. If the company is successful, the revenue generated can often exceed profits obtained through other types of international expansion methods.

Controlling interests will provide full authority over all policies, including marketing strategies, financing, cost cutting, expansion programs, production, and quality control. A foreign acquisition can also position the investor to accept host government incentives.

"Canada is a nation of compromise," Webb says. Canadian firms generally don't have a need to control and are often comfortable with a 50/50 ownership split, he says. On the other hand, U.S. companies tend to favor 51/49 or greater splits.

Although the greater degree of control may allow the new owners to dictate management policy, Webb advises clients to respect and value the input provided by existing managers. He says a very successful acquisition strategy is one where the new owners study preexisting management styles and seek to understand what management thinks of proposed policy changes and incorporates their input. Typically, Webb says, "new owners don't usually do this."

After NAFTA

On December 9, 1994, the leaders of 34 Western Hemisphere nations met in Miami for the Summit of the Americas. The goal: to establish a free trade area of the Americas by the year 2005, further building on the achievements of the North American Free Trade Agreement (NAFTA).

During the Summit, Chile was invited by Canada, the United States and Mexico to begin negotiations to accede to NAFTA. Although the process has been slowed, Chile will inevitably become a partner. And this will likely increase the value of Chilean companies, says George Clarke, a Toronto-based consultant who advises Canadian companies on trade and investment in Chile.

Chile is offering Canada a wealth of investment opportunities as the country moves closer toward accession to NAFTA, says Clarke. Whenever possible, Canadian companies should acquire Chilean operations over joint ventures in order to better take advantage of these opportunities, he says.

"Canadian investment has skyrocketed over the last four years, particularly in the mineral and chemical sectors, making Canada one of Chile's largest investors." This will only increase, Clarke says.

Jonathan Slater, a former international economic development specialist living in Montreal, says "Quebec firms have aggressively entered the Mexican market since the North American Free Trade Agreement was signed, and they are not waiting for formalization of any agreement with other Latin American countries -- numerous businesses from Quebec are streaming into Chile and Argentina."

According to Industry Canada, since the implementation of NAFTA, Canadian cumulative foreign direct investment in Mexico increased from $201 million to $1.131 billion by the end of last year -- a sizeable jump of 463%. And from 1990 to 1995, cumulative foreign direct investment in Central and South America increased 183%, from $2.3 billion to $6.5 billion.

Perceptions, Service and Cultural Affinity

Nationalist consumers tend to favor goods produced in their country. As a result, it sometimes makes sense to establish a manufacturing presence in the host country through an acquisition to achieve this benefit.

In addition to this, Rockburne says both acquisitions and joint ventures allow for more effective servicing of their products in distant markets leading to more satisfied customers. Many Japanese automobile manufacturers, for example, service the European market through their manufacturing facilities in the United Kingdom. The savings in response time and shipping costs alone can make this type of venture worthwhile -- ultimately benefiting the customer.

Establishing a foreign base to service a particular region is also beneficial for cultural reasons. For example, it's predicted that more U.S. companies operating in Mexico will use the country as a base to service smaller Latin American countries. The cultural affinity among the Mexicans and Central and South Americans can make assimilation less difficult and sales easier.

Large Resources Required

Foreign acquisitions usually require an abundance of resources and the exposure to risk is considerably higher compared with other methods of foreign market entry. As a result, large companies are usually better suited for this type of undertaking.

Changes in government policy can subject these resources to great risk. Transfer risk, for example, arising from adverse government policies can restrict the transfer of capital, payments, products, technology, and persons into or out of the host country. Operational risk can constrain the management and performance of local operations in production, marketing, finance, and other business functions. These types of risks, and others, can financially ruin a foreign acquisition.

Secure Your Future

Regardless of which method of expansion you choose, keep in mind that mistakes will undoubtedly be made. Expanding internationally can be more difficult and costly than expanding to the next province -- but also more financially rewarding. Importantly, by seeking to penetrate foreign markets and gaining foreign market share, you're securing your company's future as you navigate into a new era.

With the advent of NAFTA and its likely expansion southward, the recent passage of the GATT Uruguay Round Agreements and developments in the European Union and East Asia, your international trade and investment opportunities will flourish -- but not without a commensurate level of risk.

Expanding globally through joint ventures and foreign acquisitions can become a primary key to economic growth in the years to come. But this can't be achieved without a sufficient level of commitment on your part to cope with the new and rapidly evolving global environment.

This article appeared in Hemisphere Magazine, May 2006.
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John Manzella
About The Author John Manzella [Full Bio]
John Manzella, a world-recognized author and speaker on global business, competitive strategies, and today's new economic realities, is editor-in-chief of The Manzella Report, and president of Manzella Trade Communications Inc., a strategic communications, publishing and public affairs firm.




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