Advantages and Disadvantages of a Firm’s International Expansion

Updated on October 12, 2019
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Hanh has a Master's Degree in Economics. She enjoys researching and writing about economic and business issues.

Introduction

As globalization becomes a trend and technological advances have facilitated communication and transportation around the world, many companies start to look into international expansion as a key growth strategy (Smith, 2011). According to a report by the United Nations Conference on Trade and Development, global foreign direct investment (FDI) reached approximately USD 1.2 trillion in 2018, with stable growth in FDI inflows into developing countries, indicating companies and investors’ desire to open up their markets and explore foreign territories (UNCTAD, 2019). While there are obvious benefits of gaining a global presence, there are also risks associated with the process. This article attempts to analyse the advantages and disadvantages of a firm’s international expansion and make some concluding recommendations.

Advantages of Firms' International Expansion

  • Market Expansion
  • Resource Acquisition
  • Efficiency Improvement
  • Strategic Asset Acquisition

Disadvantages of Firms' International Expansion

  • High Cost Commitment
  • Intellectual Property Protection
  • Uncertainty in Host Country

Source

Advantages of International Expansion

1. Market Expansion

There are four main reasons for companies to expand internationally. First, companies wish to go global to develop their customer base and tap into the lucrative international market. For these companies, before entering a market, they considered such factors as the size of the host market indicating by population and GDP per capita, potential market growth, distance from home country to host country and proximity to other major regional and global markets, existing competitors, and customer preferences (Twarowska & Kąkol, 2013). For example, IKEA has been one of the global leading retailers in the home furniture industry ever since its establishment in Sweden in the 1940s. In the 1960s when the Swedish furniture market was saturated, the company took the initiative to venture out to other Scandinavian countries, then the whole Europe and North America. The company’s leadership decided early on that due to the relatively small size of the Swedish economy, going global was the only way for IKEA to grow (Twarowska & Kąkol, 2013). As a result of their decision and their continuous expansion, in 2018, the company was ranked 27th among the best brands globally (Interbrand, 2018).

Additionally, by fully immersing in a market, it is easier for the company to adapt to the local customers’ taste, needs, and preferences, and build relationship with local retailers and suppliers (Franco, et al., 2010). To illustrate, it is not a coincidence that the United States is among the world’s top three FDI magnets, attracting USD 226 billion dollars in 2018 (UNCTAD, 2019). With a market of more than 300 million people and one of the countries with highest GDP per capita (USD 54,541 in 2018), many foreign companies flocked to the United States to establish their subsidiaries to closely participate in this potential market. Take Toyota Motor Corporation as an example, at the beginning of 2019, it pledged to invest up to USD 749 million in its five U.S. production plants. The move was intended not only to help the company avoid tariffs but also to bring its new car models closer to the marketplace. Furthermore, Toyota also wanted to strengthen its partnership with local dealers and vendors, better understand the American users’ driving preferences, and comply to the local regulations (Shepardson & Carey, 2019).

2. Resource Acquisition

Second, another advantage of international growth for companies is to seek resources that are either not available (such as natural resources or raw materials) or too costly (such as labour or rent) at their home location (Noel & Hulbert, 2011). In the past, because many developing countries were thirsty for capital and technology and know-how transfer from the developed countries, they were eager to open up their economy and welcome foreign countries to invest in their natural resource extraction sectors such as mining, gas and oil, and so on. However, with the developing countries’ bargaining power growing and a surge in nationalism, the wave of natural resource seeking FDI investment seems to diminish (Barclay, 2015).

Recently, most resource seeking firms focus on another resource which is labour. A research by Rasiah (2005), which studied motivations of foreign investments into the electronic and garment sectors of selected economies, suggested that multinational firms have actively attempted to draw on the skills and expertise of workers in the host country (Rasiah, 2005). In particular, while wages and benefits in the developed world are increasing, labour costs in developing countries remain competitive and the quality of labour has been improving significantly. Hence, many companies move their operation abroad to take advantage of this trend. For example, Nike, a multinational corporation headquartered in Oregon, the United States, has been known for being a pioneer adopter of outsourcing and establishing hundreds of factories around the world. Even more surprisingly, 99 percent of Nike employees are foreigners (Peterson, 2014). The international expansion has allowed Nike to cut costs, increase its competitiveness, and withstand various downturns of the business cycles.

3. Efficiency Improvement

Third, firms go internationally to increase their efficiency by seizing the advantage of economy of scope and scale, exploiting locational advantages, and generating economic rent (Dunning, 1993). These firms are often export-oriented and wish to improve their overall cost efficiency. Hence, their newly-established subsidiaries are often part of their existing production network. In order to decide on a location, they have to consider a variety of determinants such as the costs of production, logistics cost, availability of local suppliers, and the possibility of cross-border technology and know-how transfer (Campos & Kinoshita, 2003). For instance, it has been suggested that the commercial success of Apple Inc., one of the Big Four technology companies, was made possible only thanks to its production base in Asia and elsewhere in the world. Originally established in California, the United States, in 1977, the company specialized in designing, producing and selling electronic devices, hardware and software. As early as 1981, Apple has already outsourced its production to its offshore facilities in Singapore and then China in 2000s, and other places in the world (Ernst, 1997). Partnership with different companies around the world enabled Apple to reduce its operation and production costs by taking advantage of the specific assets in different locations, while increase delivery efficiency and speed, which has been pivotal to Apple’s effective management (Chan, et al., 2013). For example, Foxconn, Apple’s biggest Taiwan-based contractor, which is responsible for assembling Apple’s products, offers Apple with low labor cost and generous investment incentives. STMicroelectonics, a France – Italy based company known for sophisticated semiconductor products, made Apple’s Gyroscope. Similarly, a Korean company produced Apple’s display and screen. By choosing the most competent partner companies for each part of its product, Apple has been able to ensure the highest overall quality of its final products (Kabin, 2013).

4. Strategic Asset Acquisition

Finally, firms go global to acquire strategic assets to gain access to the skillsets, competencies or business domain that they do not currently possess. This strategy also helps firm to have control of important assets and have a comparative advantage over its competitor (Wadhwa & Reddy, 2011). For example, in 2014, Google bought Deepmind, a UK start-up technology focusing on machine learning and developing technologies for e-commerce game, for more than USD 650 million. With this deal, Google was able to acquire Deepmind’s advanced algorithms and systems, subdue a potential competitor, and have control over the company’s data, Google’s most valuable assets (Gibbs, 2014).

In the recent years, the global merger and acquisition (M&A) activities have remained strong despite the global political and economic uncertainty with total transaction value estimated at USD 4.1 trillion in 2018, among which cross-border transactions accounted for over 30 percent of total M&A value (JP Morgan, 2019). This trend reflects the ever more competing nature of firms’ strategic asset seeking activities.

The world is getting closer
The world is getting closer

Disadvantages of International Expansion

As alluring as international expansion appears to be, going global is one of the most challenging business decisions that a firm makes. There are many underlying risks and disadvantages related to the process.

High Cost Commitment

First, establishing a presence abroad can be very costly. Generally, there are two entry methods for a company to break into a foreign market including non-equity method (such as direct export, franchising, licensing, and contracting), and equity method (such as joint venture, acquisition, and greenfield investments) (Franco, et al., 2010). For the equity entry method, the firm must commit very high initial capital to conduct market and location research, develop its own infrastructure, hire and train employees, and pay other overhead costs. In addition, it takes time and effort for the newly-established subsidiary to operate smoothly and generate profits. Regarding non-equity method, it also takes time and capital for the firm to research the new market and create and maintain relationships with its potential local partners (Kotler, 2003). In addition, the firm also must prepare for the worst scenario that despite all of its time and resource commitment, the expansion strategy still fails due to unforeseeable reasons or changing political and regulatory landscape of the host location.

Moreover, contrary to many firms’ hope that they can apply their business model and standardize their product globally to reduce costs, when moving across borders, they find out that they have to customize or adapt their products or business models to suit the local market, increasing the research and development and operation cost. For example, although Coca-Cola – the world leading beverage company with more than 100 years of experience in the industry – wanted to have a consistent branding in all markets it penetrated, the company realized that it needed a different branding for the products in China due to problems with linguistics in Chinese. The same issue arose when Coca-Cola entered Hong Kong and Shanghai markets, prompting the company to come up with a new branding (Svensson, 2001).

Intellectual Property Protection Concern

Second, intellectual property protection remains one of the greatest concerns of companies when investing in a country with weak legal framework and lack of law regarding intellectual protection. Intellectual property right refers to the exclusive ownership and right given to the creator of an idea, invention, process, design, formula, patent, trademark or business secret. It allows the owner to obtain commercial benefits from their ideas, and gain a competitive edge over the competitors (Alguliyev & Mahmudov, 2015). When partnering with foreign companies, the risk of exposing those intellectual properties become higher. Hence, if the host country does not have the legal framework to resolve the issues, the firm can easily lose to their local competitors. A research by Maskus on “Intellectual Property Rights and Foreign Direct Investment” concluded that as a country strengthens its protection for intellectual property rights, it becomes more attractive to foreign investors. Intellectual property right also promotes more competition and encourages local companies to become more innovative (Maskus, 2000).

Uncertainty in Host Country

Third, when entering a new country, firm is subject to both global and the host country’s political, social, economic and cultural conditions. If the host country rejects the firm or undergoes some political or economic turmoil, the firm will suffer accordingly. For example, in the past years, the tension between Japan and South Korea has risen, culminating in the first half of 2019, making many Japanese companies in South Korea the target of anti-Japanese boycott, strikes and demonstration (Lee & Reynolds, 2019). Similarly, according to a survey by the American Chambers of Commerce in China and Shanghai, fearing the consequences of the escalating United States and China trade war, many American companies revealed that they planned to leave or reduce their investment in China. The situation affects not only small and medium enterprises but also tech giants such as Google who previously intended to explore new business opportunities in China (Rapoza, 2019).

Conclusion

While providing companies with tremendous opportunities to expand its customer base, reduce cost, increase efficiency and competitiveness, international expansion can be very costly for firms and requires detailed planning. To successfully go global, there are several factors for firm to consider. First, the timing must be appropriate, with the firm being ready to embrace the change, and the local market being willing to accept a new player. Second, the firm must spend sufficient resources on learning about the new country in terms of political and economic conditions, culture, existing competitors, target customers, compliance cost, and local practice. In addition, going global has to align with the company’s long-term development strategy, and the leadership’s vision, organizational culture, and human resources. With careful planning and execution, the firm stands a higher chance of succeeding in joining the globalization movement.

References

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