Interested in expanding your business internationally and learning more about international modes of market entry? Pick up a copy of my latest book, Business Beyond Borders: Take Your Company Global.
In my previous posts, I discussed two of the lower-risk strategies when it comes to international mode of market entry – trading strategies like exports and e-commerce, and transfer strategies like franchising and licensing. Today I’ll talk about investment strategies, which have varying levels of risk and investment.
Investment strategies include strategic alliances, joint ventures, mergers and acquisitions and establishing a presence in-market. At one end of the scale you have strategic alliances, which can be as simple as a temporary collaboration between two companies, at the other there are mergers (two companies joining forces permanently), acquisitions (one company buying out another), or setting up a subsidiary or a branch of your domestic company in the new country.
There are a range of reasons for a company to consider making direct investments in a foreign market:
- Some governments prohibit or limit imports of goods produced in other countries, but a company can build a production site in the foreign market and produce locally.
- Producing goods in the target market avoids import duties and other taxes and the requirement for import permits. Read more on international barriers to entry.
- Companies can obtain the services of skilled employees in the target market or gain intelligence held by people in that market.
- In certain countries, companies can take advantage of lower costs, such as cheaper labour and in doing so become more competitive.
International Strategic Alliances
A strategic alliance is a relationship between two or more organisations that – through the combination of resources – can create significant and sustainable value for everyone involved. That’s a very broad definition, but we can narrow it down somewhat by applying five key criteria developed by Cisco, a leader in the strategic alliance space.
According to Cisco, to be a strategic alliance, an arrangement must deliver:
- Significant business impact with sustainable value – Significant is always defined relative to the stakeholders and sustainable means generating acceptable profit margins over a multi-year period.
- Broad and deep initiatives – Broad means several and deep means significant initiatives in the alliance that cut across the value chains of both companies.
- Strong organisational commitment – from the CEO down.
- Substantial investment by both companies – investment can be capital, people, IP, or all three.
- Strategic alignment and fit – the companies’ strategies in the target space must be well aligned. Although the cultures may be different, the companies must be able to establish an environment of trust.
Pros and cons
Like any international expansion model, there are pros and cons. On the upside, an in-country alliance partner will already have networks and market intelligence that it would otherwise take you years to recreate, and a strategic alliance enables cost sharing and allows each party to capitalise on the strengths of the other.
On the downside, a strategic alliance always entails the risk of conflict between partners – not to mention the creation of a future local, or international competitor if the alliance does not last.
Some years ago, I had a bad experience with a strategic alliance in the Middle East. I was approached by the founder of a firm that provided services that were complementary to the work my team did. He asked whether we would consider partnering with his company to introduce companies to investors in the Middle East. I didn’t know the guy from a bar of soap, but as he was based in the Middle East and I was in Australia, the idea seemed to make sense.
Stupidly, I didn’t do much due diligence on the guy or his firm, and started working with him several months later.
As time passed, I began to realise that we didn’t share the same values – I was committed to providing great service and results for clients, my partner was more interested in collecting fees. I wasn’t impressed with his work and he saw my company as a competitor to his. Trust eventually broke down between us and we went our separate ways – it was a sobering experience and a lesson in how not to do strategic alliances.
Read more on how to source and engage trusted international partners in my blog post.
What does a great strategic alliance look like?
Spotify and Uber
BMW and Louis Vuitton
Although they might seem very different, French fashion house Louis Vuitton and German carmaker BMW are both exclusive luxury brands that focus on craftsmanship.
Because of their shared audience, goals, and values, the two brands partnered up to create a collection of Louis Vuitton bags, custom made to pair with the BMW i8 sports car. According to Patrick-Louis Vuitton, Head of Special Orders at Louis Vuitton, “This collaboration with BMW epitomizes our shared values and creativity, technological innovation and style.”
The bags’ sleek black outer color and electric blue lining match the car’s design perfectly, and they’re made of an innovative, unlikely material–carbon fiber, just like the i8’s passenger cell. Plus, the four-piece set of bags fits perfectly into the i8’s parcel shelf. The set may have retailed for a whopping $20,000, but that’s a reasonable price for someone who already had a car worth over $135,000.
A client of mine, Jeremy Streten, used a strategic alliance to launch his law tech product, the Business Legal Lifecycle platform into two key markets, the United Kingdom and the United States. The product helps business owners to diagnose what kind of legal support their company requires, before they engaging a lawyer, and lawyers and accountants can direct clients to platform as a precursor to paying for advice. Jeremy created alliances with professional services firms in Britain and the States, enabling him to reach much larger numbers of end users than he would have been able to alone.
International Joint Ventures (IJVs)
Pros and cons
- A means to enter international markets while reducing risk.
- Quick access to new markets and distribution networks via your local partner’s established networks.
- Access to the knowledge, know-how and contacts of a local partner who can add value by filling gaps in your knowledge relating to the customs and tastes of local consumers.
- Local partner proficiency in the local language and customs.
- Sharing of risks and costs with a partner.
- Access to greater resources, including specialised staff, technology and finance.
Additionally, joint ventures often enable growth without having to borrow funds or look for outside investors. You may be able to:
- Use your joint venture partner’s customer database to market your product,
- Offer your partner’s services and products to your existing customers, and
- Join forces in purchasing, research and development.
A joint venture can also be very flexible. For example, the structure can have a limited life span and only cover part of what you do, limiting the commitment for both parties and the business’ exposure.
But … you have to get it right!
On the other hand, partnering with another business can be complex and it takes time and effort to build the right business relationship. That’s one of the reasons that joint ventures can be risky. Approximately 50% of all joint ventures fail and in India for example, 90% of joint ventures between Indian and foreign companies fail.
Here are some of the key risks and drawbacks to the joint venture model:
- Clashes in corporate culture and disputes about control and operational decisions are common. For example, which financial, ethics, or operational policies should the new joint venture follow? If the parties disagree about strategies and investment, who should make the final decision?
- Finding balance is often difficult. Too little oversight can mean lack of direction, or damage to your company’s brand or reputation. Too much oversight or control can result in frustration, and value destruction rather than creation.
- Joint ventures are often difficult to capitalize as an entity, particularly in respect to debt, because they are finite in their duration and therefore lack permanence. Unless an IJV is adequately capitalized, its debt financing, if available at all, may have to be guaranteed, in whole or in part, by the joint venture partners, which can increase their level of risk in the venture.
- Depending on the country, you may be limited to a minority share in the joint venture.
Problems are likely to arise in a joint venture if:
- The objectives of the venture are not clear and communicated to everyone involved,
- The partners have different objectives for the joint venture,
- The partners bring in different levels of expertise, investment or assets into the venture,
- Different cultures and management styles result in poor integration and co-operation, or
- The partners don’t provide sufficient leadership and support in the early stages.
When does it make sense to enter a joint venture?
An international joint venture could make sense for your company if you:
- Have identified a high potential marketplace and a good prospect partner, or local regulations require you to have one,
- Have substantial international expansion experience – joint ventures are usually a bad option for newbies,
- Are able to partner effectively, while balancing risk vs. control,
- Can afford to provide the necessary capital and internal and external resources,
- Are seeking a lower-risk, albeit slower, way to make local acquisitions.
Making a joint venture work
In the initial phases, success in a joint venture depends to some extent on thorough research and analysis of aims and objectives. For the venture to work at all, you must effectively communicate the business plan to everyone involved.
Each of the businesses involved needs to understand what it wants from the relationship. Normally, you will be looking for a partner who is compatible with your business. This partner can be:
- a larger business – which can offer you their resources such as a strong distribution network in the target market, specialist employees and finance.
- a smaller business – which may be more flexible, innovative or simply provide you with access to new products or intellectual property.
- a supplier – which can offer you its knowledge of new technologies / the local market and a better quality of service, in return for a guaranteed volume of sales to you.
As well as your own needs, you should think about what your joint venture partner will be hoping to get from the arrangement. You will need to agree objectives that suit both of you, as well as things like:
- the structure of your joint venture
- who will manage the venture and how
- who will finance the venture and how
- the assets and resources you will both contribute
- who will own any intellectual property that comes out of the venture
- how you will share profits and any potential losses
- how you will handle any potential disputes
When a cross-border joint venture is created, there are also a range of complex employment, tax, financial, and compliance issues to be considered – as well as preparing for possible termination or acquisition — they can be costly to set up. You should always retain experienced legal counsel to draft your joint venture agreement. It requires an investment, but can prevent a lot of headaches if things don’t go according to plan.
Once the structure is up and running, there is still a likelihood of early problems; a significant portion of cross-border alliances suffer financial and operational challenges during the first years of operation. The key to their continued survival and success after “hitting the wall” requires ownership flexibility and long-term support.
It’s important to keep in mind from the start that joint ventures are generally temporary arrangements, and that they normally end, either when the objectives of the venture are met, or things go awry. That’s why you should plan your exit strategy from the beginning, to make sure you get a return on your investment in the joint venture.
Bear in mind that when a joint venture dissolves, the technology and know-how shared with your local partner can create a strong competitor, particularly in countries with weak intellectual property protection.
International Mergers and Acquisitions
If your company already has a track record of international sales, a merger or acquisition can be a good way to expand your international footprint. For example, one of my clients – the manufacturer of an elaborate welding product – is acquiring a company in the US that produces the fluid that the machine needs to operate. This will enable my client to significantly increase its sales of consumables across North America.
It’s worth noting that although mergers and acquisitions are usually bundled into one term, they are fundamentally very different creatures.
Pros and cons
What are some of the reasons that you might consider an international merger or acquisition? And what are some of the drawbacks?
Economies of Scale
Underpinning all of M&A activity is the promise of economies of scale. The benefits that come from becoming bigger include:
- Increased access to capital,
- lower costs as a result of higher volume, and
- better bargaining power with distributors.
Greater value
A merger or acquisition adds more value to the combined entity than either individual company can produce on its own.
New markets at lower cost
A merger or acquisition provides almost instant access to a new market for the party trying to enter that country. By joining forces with another entity which knows the target market, you save enormous amounts of time and money, which would otherwise be spent learning the market and ‘reinventing the wheel’ when it comes to doing business there.
Increased market share
One of the more common motives for undertaking M&A is increased market share. Historically, retail banks have looked at geographical footprint as being key to achieving market share and the Spanish retail bank Santander has made the acquisition of smaller banks an active policy. Consequently it has become one of the world’s largest retail banks.
Tax advantages
Some governments offer tax cuts when a merger or acquisition is completed. For example, Singapore is one jurisdiction that is extremely M&A-friendly and opening a business in Singapore by merging or acquiring a smaller existing company can attract substantial tax advantages.
Access to talent
Mergers and Acquisitions allow the acquiring company to immediately access an established workforce with the skills it needs in the new geography, rather than having to build its talent pool from the ground up.
Accelerated strategy implementation
Mergers and Acquisitions are sometimes the best way to achieve a long-term strategy in a much shorter timeframe. Suppose a British company wanted to enter the Canadian market; it could build from the ground up and hope that it reached the desirable scale in five to ten years. Or it could purchase a business, and leverage its established client base, distribution, and brand value.
Despite the benefits of M&A, there are a range of factors which make it a reasonably high-risk option for international expansion.
Time-consuming and complex
Mergers and acquisitions have a reputation for being lengthy and complicated because the process usually involves multiple parties and a complex decision-making process.
Employee upheaval
Mergers and acquisitions can create distress within the employee base of each organization, as staff deal with the uncertainty and change that shifts in company ownership, structure and management bring.
More debt
Acquiring another business is a relatively expensive process and usually increases the amount of debt the acquiring company owes.
Clash of cultures
Merging two businesses frequently highlights and aggravates differences in the corporate culture of each company. These are often difficult to resolve and in extreme cases can lead to an eventual unwinding of the deal.
Offshore incorporation
And finally, offshore incorporation.
Once your company has experience in international sales, the next step may be to set up a more permanent presence in a particular country or region. If you are planning to set up your own company in a new international market, the options vary from country to country.
In many markets, the possibilities range from a single-person sales office to full manufacturing operations. You don’t always have to set up a fully separate legal entity to start with; it might be sufficient to set up a representative office, and graduate to another company form later. When choosing which kind of legal entity to establish, keep in mind that your choice will dictate what functions the office is allowed to carry out, and how you are taxed.
Representative office
Branch offices and subsidiaries
The definition of branch offices and subsidiaries varies depending on the country, but generally speaking, a branch office is not a separate legal entity of the parent corporation. Accordingly, operating a branch office is essentially having the foreign parent corporation operating in the target market, which can expose your core business to increased legal risk in the foreign jurisdiction.
A subsidiary on the other hand, is a separate legal entity from the parent. Although it is owned by the parent corporation, it has a separate legal personality and provides the parent company with an extra layer of protection from risk in the international market.
In some countries (such as some of the Arab Gulf states), the law requires that all locally-incorporated companies are at least 51% owned by a local national or local company. In these jurisdictions, you will need a local partner or nominee structure, unless you set up in a free trade zone.
Pros and cons
Complete control and autonomy
Unlike the scenario in which you merge with another offshore entity, or acquire a smaller international company, offshore incorporation gives you complete control over day-to-day operations in overseas markets. If the business does not succeed, you have the ability to unilaterally wind up the company and withdraw from the market.
Asset protection
An offshore company can also be used as a mode of asset protection. For example, you might choose to run international sales through an offshore structure, to protect the parent company in case of legal action in another jurisdiction. Or you may opt to house your intellectual property in a vehicle in another jurisdiction, to protect your business’ inherent value in the event that your company is sued.
Tax minimisation
To attract inbound investment, some countries promote attractive tax regimes on defined activities or sectors. In jurisdictions like Vanuatu, Samoa, the Bahamas, Cayman Islands, Ireland, UAE and Switzerland, commercial laws and policies are geared to minimize the taxes levied on local corporations. To benefit from reduced taxes, businesses use lawful foreign incorporations to vest their assets.
Other low tax or no tax jurisdictions like Anguilla provide shielding and exemptions from stamp duties and excise on transactions. They also waive tax on net profits, capital gains tax on foreign investment, salaries and transmission of shares to new holders, all of which helps to reduce the business operating expenditure.
Privacy and confidentiality
Many offshore financial centres
Simple Corporate Regulations
A number of jurisdictions, including New Zealand and Singapore have created simplified corporate laws in an effort to attract foreign companies and individuals by simplifying regulations and by lowering the amount of bureaucratic red-tape Others, like the Cook Islands have including no auditing nor financial reporting requirements.
While there are many good reasons to consider incorporating internationally, there are also some downsides.
Resource intensive
Going it alone
Higher costs and liability
Although offshore incorporation is less expensive and risky than a merger or acquisition, it is more expensive and riskier than acting through an agent or with a partner.
Proving ownership may be difficult
If you incorporate in a jurisdiction with stringent privacy and banking rules or no public registers, proving ownership of a company registered offshore can be difficult. While anonymity can be an advantage for overseas companies, it can become a disadvantage if the owner later wants to declare themselves as the beneficial owner.
Bringing the money back exposes you to taxation
Depending on the jurisdiction and company structure that you choose, the remittance and distribution of the assets and income of an offshore company can have downsides. Once funds reach the country in which the shareholders are headquartered, they are subject to taxation and in some cases double taxation, which can negate the initial benefits of a low or no-tax environment.
To sum up…
With the exception of strategic alliances, investment strategies usually involve higher initial costs and risks, and are usually more appropriate for companies with significant international experience and a demonstrated track record in the target market. If you do choose to pursue an investment strategy, engaging advisors who can provide sound legal and tax advice is a must.
Interested in expanding your business internationally and learning how to choose a mode of market entry? Pick up a copy of my latest book, Business Beyond Borders: Take Your Company Global.
