CHAPTER TWELVE COUNTRY EVALUATION AND SELECTION

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

CHAPTER OVERVIEW
The country evaluation and selection process determines the geographical opportunities firms choose to pursue. Chapter Twelve first discusses the challenges of marketing and production site location. It goes on to carefully examine the process by describing the choice and weighting of variables used for opportunity and risk analysis as well as the inherent problems associated with data collection and analysis. The chapter then introduces the use of grids and matrices for country comparison purposes, discusses resource allocation possibilities, and concludes by noting the different factors considered as part of start-up, acquisition, and expansion decisions.

CHAPTER OUTLINE
OPENING CASE: Carrefour [See Figure 12.1, Map 12.1] This case explores the location, pattern, and reasons for Carrefours international operations. Carrefour opened its first store in 1960 and is now the largest retailer in Europe and Latin America and the second largest worldwide. Its stores depend on food items for nearly 60 percent of sales and on a wide variety of non-food items for the remainder. Carrefour plans to accelerate its growth between 2006 and 2008 after opening one million square meters of new space in 2005. Worldwide Carrefour has five different types of outlets: hypermarkets, supermarkets, hard discount stores, cash-and-carry stores and convenience stores. Country selection criteria include a countrys economic evolution, sufficient size to justify additional store locations and the availability of a

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viable partner. Aside from financial resources, Carrefour brings to a partnership expertise on store layout, clout in dealing with global suppliers, highly efficient direct e-mail links with suppliers and the ability to export unique bargain items from one country to another. Carrefour also considers whether a country or regional location within a country can justify sufficient additional store expansion to gain economies of scale in buying and distribution. Recently, Carrefour has used acquisition as a way to capture additional scale economies. Carrefour depends primarily on locally produced goods but also engages in global purchasing when capable suppliers are found. Whether Carrefour can ultimately succeed as a global competitor without a significant presence in the United States and the United Kingdom remains to be seen. Teaching Tip: Review the PowerPoint slides for Chapter Twelve and select those you find most useful for enhancing your lecture and class discussion. For additional visual summaries of key chapter points, review the figures and tables in the text. I. INTRODUCTION Because companies lack the resources to take advantage of all international opportunities they identify, they must determine both the order of country entry as well as the rates of resource allocation across countries. In choosing geographic sites, a firm must determine both where to market and where to produce. The answer can be one and the same place if transportation costs are high and/or government regulations make local production a necessity. In many industries, facilities must be located near foreign customers; in others, market and production sites are continents away. Developing a site location strategy that helps a firm maximize its resources and competitive position is very challenging, given that many estimates and assumptions about factors such as future costs and prices and competitors reactions must be made. Figure 12.3 shows the major steps international business managers must take in making these decisions.

II. SCANNING AND DETAILED EXAMINATION COMPARED Scanning is useful insofar as a company might otherwise consider either too few or too many possibilities. Through the use of scanning, decision makers can perform a detailed analysis of a manageable number of geographic locations. Managers can usually complete the scanning process without having to incur the expense of visiting foreign countries. Instead they rely on analyzing information found on the Internet and other publicly available sources, as well as communicating with people familiar with the foreign countries they are interested in. The more time and money companies invest in examining an alternative, the more likely they are to accept it regardless of its meritsa phenomenon known as escalation of commitment. Companies should be careful about taking forced actions based on peer and/or media pressure and should instead carefully weigh important variables when comparing countries of interest.

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III. WHAT INFORMATION IS IMPORTANT? Environmental climatethe external conditions in a host country that could significantly affect an enterprises success or failurereveals both opportunities and risk whose combination should determine what actions to take. A. Opportunities Opportunities are determined by competitiveness and profitability factors. Variables weighing heavily on the selection of market and production sites would include market size, ease and compatibility of operations, costs, resource availability and red tape. 1. Market Size. Market size is determined by sales potential. In some instances, past and current sales for either an existing product or a similar or complementary product are available on a country-by-country basis. In addition, data such as GNP, per capita income, population, income distribution, economic growth rates, and levels of economic development will also be useful. Other important economic variables pertaining to market size include: Obsolescence and leapfrogging of products. Consumers in some emerging economies skip entire generations of technology in favor of more recent technologies, such as Chinese consumers going from having no telephones to using cellular phones almost exclusively. Prices. The relative prices of essential and non-essential good can have a significant impact on consumption patterns. Higher prices for necessary goods leave less discretionary income for non-essentials. Income elasticity. Market potential can be calculated by dividing the percentage of change in product demand by the percentage of change in income in a give country. Income elasticity varies by product and income level, with demand for necessities being less elastic than demand for luxuries. Substitution. Depending on local conditions, consumers in some countries may be more willing to substitute some products or services for others. For example, people in high population density areas typically substitute mass transit for automobiles. Income inequality. Even in areas where per capita incomes are low, there may be middle- and upper-income people with substantial income to spend due to income inequality. Cultural factors and taste. Countries with similar income levels may exhibit different demand patterns based on differences in cultural values and tastes. Existence of trading blocs. Countries with small populations and/or low per capita incomes may have a much larger market due to participation in a regional trading block. 2. Ease and Compatibility of Operations. Companies are naturally attracted to countries that are located nearby, share the same language and offer market conditions similar to those in their home countries. Beyond that, proposals may then be limited to those countries that offer, among other factors, the appropriate plant size, the local availability of resources,

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an acceptable percentage of ownership and the sufficient repatriation of profits. 3. Costs and Resource Availability. Costs are a critical factor in production-location decisions. Productivity-related factors include the cost of labor, the cost of inputs, tax rates, and available capital, utilities, real estate, and transportation. When companies move into emerging economies because of labor cost differences alone, their advantages may be short-lived. Competitors often follow leaders into low-wage areas, there is little first-in advantage for low-labor cost production migration, and the costs can rise quickly as a result of pressure on wage or exchange rates. The quality of a countrys infrastructure can be very important in location decisions. Firms often need to locate in an area that will allow them to move supplies and finished products very efficiently. If a given production site will be used to serve multiple markets, the cost and ease of moving materials and products in and out the country will be especially important. 4. Red Tape and Corruption. Red tape includes the difficulty of getting permission to operate, bringing in expatriate personnel, obtaining licenses to produce and market goods and satisfying government agencies on matters such as taxes, labor conditions and environmental compliance. Government corruption may include requirements of payments to win a contract or receive government services, such as mail delivery or visa issuance. Although not always a directly measurable cost, red tape and corruption increase the cost of doing business. B. Risks Is it ever rational for a firm to invest in a country with high economic and political risk ratings? Such questions must be carefully weighed when making international capital-investment decisions. 1. Risk and Uncertainty. Firms usually experience higher risk and uncertainty when they operate abroad. Firms use a variety of financial techniques to compare potential investments, including discounted cash flows, economic value added, payback period, net present value, return on sales, return on equity, return on assets employed, internal rate of return and the accounting rate of return. Given the same expected return, most decision makers prefer a more certain outcome to a less certain one. Companies may reduce risk or uncertainty by insuring, however, insuring against things such as nonconvertibility of funds or expropriation is likely to be costly. As part of a feasibility study, the degree of acceptable risk should be determined so a firm does not incur unacceptable costs. 2. Liability of Foreignness. The liability of foreignness refers to the fact that foreign firms have a lower rate of survival than local firms for the initial years after the start of operations. However, those foreign firms that manage to overcome their initial problems have long-term survival rates comparable to those of local firms. 3. Competitive Risk. A firms innovative advantage may be shortlived. When pursuing a strategy known as imitation lag, a firm moves first to those countries most likely to adapt and catch up to the advantage. In

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some instances firms may seek those countries where they are least likely to confront significant competition; in others they may gain advantages by moving into countries where competitors are already present. By being the first major competitor in a market, companies can more easily gain the best partners, best locations, and best suppliersa strategy to gain first mover advantage. Companies may also reduce risk by avoiding overcrowded markets, or conversely, they may purposely crowd a market to prevent competitors from gaining advantages therein that they can use to improve their competitive positions elsewhere, a situation known as oligopolistic reaction. Firms may also seek clusters like Silicon Valley that attract multiple suppliers, customers and highly trained personnel in order to gain access to new products, technologies, and markets. 4. Monetary Risk. If a firms expansion occurs through foreign-direct investment, foreign-exchange rates and access to investment capital and earnings are key considerations. Liquidity preference refers to the theory investors want some of the holdings to be in highly liquid assets on which they are willing to take a lower return. Firms must carefully evaluate a countrys present capital controls, recent exchange-rate stability, balanceof-payments account, inflation rate, and level of government spending. 5. Political Risk. Political risk reflects the expectation the political climate in a given country will change in such a way that a firms operating position will deteriorate. It relates to changes in political leaders opinions and policies, civil disorder, and animosity between a home and host country. When evaluating political risk, decision makers refer to past patterns in a given country, expert opinions and country analysts. They also look for economic and social conditions that could lead to political instability, but there is no consensus as to what constitutes dangerous instability or how it can be predicted. DOES GEOGRAPHY MATTER? Dont Fool with Mother Nature

Natural disasters have a huge impact on people and property every year, often hitting the poorest nations of the world hardest. Companies should take the risk of natural disasters and their potential impact into account when choosing locations for doing business. The United Nations Development Programme is developing a Disaster Risk Index that could be used as a tool for companies to compare and prepare for disaster risk. Natural disasters can also trigger outbreaks of disease, which should also be considered when choosing locations for global operations.

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IV. COLLECT AND ANALYZE DATA Firms perform research to reduce uncertainties in their decision processes, to expand or narrow the alternatives they consider and to assess the merits of their existing programs. The costs of data collection should always be weighed against the probable payoffs in terms of revenue gains or cost savings. A. Problems with Research Results and Data Numerous countries have agreed to standards for collecting and publishing various categories of national data. However, the lack, obsolescence and inaccuracy of data on other countries can make research difficult and expensive to undertake. Further, data discrepancies further increase uncertainty in decision-making. 1. Reasons for Inaccuracies. For the most part, incomplete or inaccurate data result from the inability of governments to collect the needed information. Both economic and educational factors will affect the quantity and quality of available data. Of equal concern, however, is the publication of false or purposely misleading information, as well as the nonreporting or under-reporting of information people wish to hide or distort. 2. Comparability Problems. Comparability problems result from definitional differences across countries (e.g., family categories, literacy levels, accounting rules), differences in base years, distortions in foreign currency conversions, the measurement of investment flows, the presence of black market activities, etc. B. External Sources of Information Both the specificity and cost of information will vary by source. 1. Individualized Reports. Market research and business consulting firms conduct country studies for a fee. The fact that a firm can specify the information it wants may make the cost worthwhile. 2. Specialized Studies. Certain research organizations generate specific studies about countries, regions, industries, issues, etc., that they make available for general purchase. The price is much lower than for an individualized study. 3. Service Companies. Most international service-related firms publish reports that are usually geared toward either the conduct of business in a given country or region or about some specific subject of general interest, such as tax or trademark legislation. 4. Government Agencies. Governments and their agencies publish tomes of information designed to stimulate business activity both at home and abroad. 5. International Organizations and Agencies. The UN, the WTO, the IMF, the OECD, and the EU are but a few of the multilateral organizations and agencies that collect and disseminate data. Many of the international development banks even help fund investment feasibility studies.

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6. Trade Associations. Many trade associations collect, evaluate, and disseminate a wide variety of data dealing with competitive and technical factors in their industries. Their reports may or may not be available to nonmembers. 7. Information Service Companies. Certain companies offer information-retrieval services; they maintain databases from hundreds of sources from which they will access data for a fee, or sometimes for free at public libraries.

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C. Internal Generation of Data When firms have to conduct studies in foreign countries, they may find traditional data gathering and analytical methods do not reveal critical insights. In that case, a researcher must be extremely imaginative and observant. In some instances, useful information may be found by analyzing indirect or complementary indicators. POINTCOUNTERPOINT: Should Companies Forego Direct Investments in Violent Areas? POINT: MNEs should not make investments in violent areas because it puts MNE personnel at risk. MNEs are visible and therefore vulnerable to attack by antiglobalization groups, kidnappers, groups opposed to foreigners, as well as others. It is unethical to put employees in excessively dangerous situations. Employees who will take dangerous assignments are usually either difficult to control, excessively nave, or addicted to the thrill of danger. Any country subject to extreme violence is not the kind of country to do business in. COUNTERPOINT: Where theres risk, there are usually rewards. Companies need to take risks, as they have in the past, to develop markets. Violence is only one of many risks and should not be looked at in isolation. Risks from activities such as terrorism are the same whether you are in London, Madrid, Caracas, or New York. All areas have their risks, and many countries traditionally viewed as risky may actually be less risky than the United States or Britain. Some industries, such as petroleum, have to operate in violent areas because that is where the resources are. MNEs should operate anywhere there are opportunities, and develop plans to manage and react to risks as effectively as possible.

V.

COUNTRY COMPARISON TOOLS Two common tools for analyzing information collected via scanning are grids and matrices. Also, once a firm commits to a location, it will need continuous updates regarding external conditions that might affect its operations there. A. Grids [See Table 12.2] A grid can be used to make country comparisons according to a wide variety of relevant factors, such as ownership rules, potential returns, and perceived risk. Variables can be ranked and weighted according to specific criteria that reflect a firms situation and objectives. Although useful for establishing minimum scores and for ranking countries, grids often obscure interrelationships among countries. B. Matrices [See Figure 12.7] One matrix frequently used when doing country comparisons is the opportunityrisk matrix. When using this matrix, the manager plots a country according to

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the perceived value of the opportunity the country offers, on the one hand, and the expected level of risk associated with operating in that country on the other. Which factors are good indicators of risk and opportunity and the weight assigned to each must be identified and assigned by the firm. Once scores are determined for each country being considered, they can be plotted and reviewed from a comparative perspective. A useful application of this technique is to develop both present and future scores for countries (e.g., five years hence) because a significant shift in a score in the future could have serious implications with respect to the country selection process. VI. ALLOCATING AMONG LOCATIONS Over time, most of the value of a firms FDI comes from reinvestment. Thus, in deciding where to invest, firms must consider whether to reinvest or harvest, to what degree there is interdependence among their locations and whether they should diversify or concentrate their activities. A. Reinvestment versus Harvesting Once a firm makes an initial investment, it will then need to decide whether to continue investing in that operation or to harvest the earnings (and possibly divest the assets) and use them elsewhere. 1. Reinvestment Decisions. Reinvestment refers to the use of retained earnings to replace depreciated assets or to add to a firms existing stock of capital. Aside from competitive factors, a company may need several years of almost total reinvestment (and often allocation of additional funds) in order to realize its objectives at a given location. 2. Harvesting. Harvesting or divesting refers to the reduction in the amount of an investment; a firm may choose to simply harvest the earnings of an operation or divest the assets there as well. If an operation no longer fits a companys overall strategy, or if better opportunities exist elsewhere, it must determine how to exit that operation. When selling or closing facilities, firms must consider possible government performance contracts as well as potential adverse publicity, plus the possible difficulty in reestablishing operations in that country in the future. B. Interdependence of Locations It is often difficult to assess the true impact a particular foreign subsidiary has on other operations within an MNE if several operations are interdependent. In the case of intra-firm sales, transfer pricing strategy will definitely affect the relative profitability of one unit as compared to another. Likewise, the net value of a particular operation may be similarly distorted for corporate profit maximization purposes. C. Geographic Diversification versus Concentration A firm may take different paths en route to gaining a sizable presence in most countries. At one end of the spectrum is a diversification strategy, whereby a firm moves rapidly into many foreign countries and then gradually builds its presence in each. At the other end of the spectrum is a concentration strategy, whereby a firm moves into a limited number of countries and develops a strong competitive position there before moving into others. When deciding which

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strategy, or perhaps some hybrid of the two, is desirable, a firm must consider a number of variables (see Table 12.3). 1. Growth Rate in Each Market. When the growth rate in each market is high, a firm will likely concentrate on a few markets because of the cost of keeping up with market expansion. 2. Sales Stability in Each Market. The more stable sales and profits are within a single market, the less advantageous a diversification strategy will be. 3. Competitive Lead Time. Sequential entry into multiple markets is more common than simultaneous entry. If a firm has a long lead time before competitors can copy or supercede its advantages, then it may be able to follow a concentration strategy and still beat competitors to other markets. 4. Spillover Effects. Spillover effects represent situations in which a marketing program in one country results in the awareness of a product in other countries. When a single marketing program can reach many countries (via cross-country media, for example), a diversification strategy is advantageous. 5. Need for Product, Communication, and Distribution Adaptation. When companies find it necessary to alter products, promotion and/or distribution strategies in foreign markets, a concentration strategy will be advantageous because the associated costs cannot be spread over sales in other countries to capture economies of scale. 6. Program Control Requirements. The more a company needs control over a foreign operation, the more appropriate a concentration strategy because additional resources will be required to maintain that control. 7. Extent of Constraints. When a firm is constrained by limited resources, it will likely follow a concentration strategy because spreading resources too thinly can be a recipe for failure. VII. NONCOMPARATIVE DECISION MAKING Companies often examine one opportunity at a time rather than ranking a set of foreign operating proposals using predetermined criteria. This sequential process leads to go-no-go decisions and is often necessary due to the speed with which companies need to respond to opportunities as they arise. Decision makers often need to react quickly for both offensive and defensive motives. The cost of conducting an extensive analysis of multiple opportunities simultaneously can also sometimes be prohibitive. VIII. MAKING FINAL COUNTRY SELECTIONS At some point, firms must make resource allocation decisions. For new investments they will need to develop detailed estimates of all costs and expenses and consider whether to enter a particular venture alone or with a partner. For acquisitions, firms will need to examine financial statements in great detail. For expansion within countries where they are already operating, country managers will most likely submit

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capital budget requests that include details of expected returns. To maximize expected gains, decisions must be made in a timely fashion. LOOKING TO THE FUTURE: Will the Prime Locations Change? There are several important demographic shifts that are expected to occur over the next several decades. Population growth in high income countries is expected to slow and populations are actually expected to decline in countries such as Japan and Italy. Meanwhile, population growth in low-income countries is expected to be robust. Since there is a positive relationship between the changes in the size of the working-age population and per capita GDP, the growth in per capita GDP should be higher in todays emerging economies than in todays high-income countries. These changes could have significant implications for the location of markets and the location of labor forces. Another trend that could influence country selection is the propensity of innovative people to converge on places that develop reputations for facilitating creativity and innovation. Even with technologies that allow people to work from home or in virtual office environments, face-to-face contact will continue to be importantespecially among the best and brightest.

CLOSING CASE: FDI in South Africa [See Map 12.2] Many expected that the post-apartheid government of South Africa would take revenge against the previous elites of the country, including foreign companies, and discourage new foreign investment. Instead, the new government has adopted a largely pro-business attitude and has actively courted FDI. The results of this policy have been somewhat mixed. Despite enormous opportunity, many foreign investors have been reluctant to enter the South African market due to low economic growth rates, continued political instability, and high security risks. Questions 1. What are the costs and benefits to South Africa of having more foreign direct investment? Of having less? Due to its traditionally high unemployment rates, jobs are perhaps the biggest benefit to South Africa from increases in FDI. Economic growth would also be increased through FDI, especially since South Africas internal savings and investment rates have been too low to finance much business expansion. FDI in state-owned enterprises could also improve the quality of goods and services produced by these companies, and competition from foreign firms could provide incentive to local firms to innovate more. Finally, FDI would help diversify the South African

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economy. Less foreign investment would likely mean fewer jobs, slower growth, lower quality goods and services, less innovation, and a less diverse economy. 2. How might a company try to weigh fairly the opportunities and risks of investing in South Africa? Managers need to look at a comprehensive array of economic, political, and geographic factors in assessing the suitability of South Africa for investment. Market size is a positive in South Africa, but economic growth has been erratic and slow at times. The political situation is relatively stable and government corruption is low, but crime rates are high, including the highest murder rate in the world. Getting expatriates to relocate to South Africa has been challenging for many foreign companies. Still, opportunities in Africa are only likely to improve in the future and South Africa could serve as an effective base for future expansion into other African markets. If South Africa is to receive more foreign direct investment, how should it prioritize policies to attract it? The most important thing the South African government could do in the short term would be to reduce the crime rate and improve the security situation in the country. Also, easing restrictions and regulations that hamper FDI would help as well. Finally, South Africa needs to do a better job of marketing its investment opportunities to foreigners. An aggressive public relations campaign on a global scale could help to raise awareness of the positive aspects of investing in South Africa and improve the image of the country in the minds of foreigners. Assume you represent a non-South African company and are considering foreign expansion. What factors would you consider when comparing South Africa with other emerging markets where you might locate? What about in terms of developed markets? What about in terms of other African markets? As a non-South African company, I would look at investing in South Africa from two perspectives. My analysis of the country would focus on the market size and potential demand for my products and/or services, as well as the viability of South Africa as a site for those goods or services to be produced and possibly exported to other countries within Africa and beyond. The market potential of the country is large due to the relatively large population. Higher income growth would make this market even more attractive. I would also look at South Africa as an attractive jumping off spot for serving other emerging markets in Africa. I would be concerned, however, about the security situation and quality of life issues. I would also prefer a more friendly welcome from the government, with incentives such as tax breaks and infrastructure improvements. South Africa compares favorably to other African markets, but continues to lag behind most developed markets.

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WEB CONNECTION Teaching Tip: Visit www.prenhall.com/daniels for additional information and links relating to the topics presented in Chapter Twelve. Be sure to refer your

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students to the online study guide, as well as the Internet exercises for Chapter Twelve. _________________________ CHAPTER TERMINOLOGY: environmental climate, p. 418 liability of foreignness, p. 424 imitation lag, p. 426 first mover advantage, p. 426 oligopolistic reaction, p. 426 liquidity preference, p. 427 _________________________ grids, p. 435 divesting, p. 435 harvesting, p. 437 diversification strategy, p. 438 concentration strategy, p. 438 spillover effects, p. 439

ADDITIONAL EXERCISES: Country Evaluation and Selection Exercise 12.1. As the phenomenon of economic integration progresses, the process of country selection takes on new dimensions. Ask students to compare and contrast the opportunities and risks associated with establishing operations in the European Union to those in the NAFTA region. Would such investments be primarily resource- or market-seeking? Be sure students explain and give examples to support their ideas. Exercise 12.2. Ask students to compare the costs and benefits of investing in an industrialized economy to the costs and benefits of investing in a developing economy from the standpoint of an MNE. Then ask the students to debate the idea that MNEs have a responsibility to work toward developing global efficiency, i.e., that economic considerations should be weighted more heavily than other factors in the country selection process. Exercise 12.3. During the 1970s, a number of MNEs such as Coca-Cola and IBM made decisions to abandon operations in certain developing countries and not to enter others because of government restrictions. Ask the students to discuss the likelihood that MNEs will face such decisions in the future, given the progress of the WTO and movements toward economic integration in many parts of the world. Do the students foresee other factors that might cause more divestments in the future? Exercise 12.4. Have the students use the simplified grid to compare countries for market penetration (Table 12.2) to compare South Africa, Ireland, and Argentina for a possible investment. Encourage them to use outside data sources such as www.doingbusiness.org, www.worldbank.org, and www.nationmaster.com to gather information and make meaningful comparisons. Which of these three countries would be most suitable for investment? Why?

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