Evaluation of Joint Ventures as a Mode of Entry into the Chinese Market
The case of Volkswagen and Shanghai Automotive Industry Corporation
List of Contents
List of Abbreviations
2 Foreign Markets Entry Mode
2.2 Joint Ventures
3 Example: Volkswagen and SAIC Motors
List of Abbreviations
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Globalization, in recent times, has generated a lot of interest in the business world. More companies are now seeking to escape their comfort zones (home markets) and enter into international markets to expand their businesses. Internationalization has seen several factors as its driving force. More countries have opened their markets to foreign entrants through liberalization and deregulation of previous trade-inhibiting laws. Consumers, in most parts of the world, have also exhibited a homogenous behavior that encourages internationalization. Products that sell well in one part of the world have shown the likelihood to perform the same in other areas, which has motivated more companies to explore international markets.
Other external driving factors are an improvement in technology and logistics. It is now possible for companies to communicate and track the activities of each of its subsidiaries or branches in the world. Technology has offered a business with an appropriate infrastructure that ensures smooth running of their affairs worldwide. Some products also exhibit shorter life cycles; thus, limiting the amount a company can produce. Internationalization offers such company's ability to produce more by expanding their reach beyond local/home markets. Expansion into international markets by a company is motivated by several factors. One of the major factors is to spur growth and increase profitability.
Many companies are seeking to enter into foreign markets to expand their influence and increase their sales and revenue. Internationalization for such companies means an access to a wider customer base, which implies more product sales and more revenues. Expanding the size and scope helps achieve the economies of scale. This affords the company an opportunity to spread its risks across markets and ease the risks' hold on the company. International markets enable them to increase their product volume, which causes a reduction in the unit price of the product. Additionally, selling products across different countries helps a company diversify risks by reducing its exposure to political and economic instability within single markets.
China, in the recent past, has proved to be a major player in the economy of the world. China has the fastest growth rate of any economy in the world (9%) and currently stands as the world's third largest economy. By 2050, China will become the world's largest economy if it keeps at its current growth. China's middle-class, which is the category involved with most of the purchases done in the world, comprises of more than six hundred million people with their economic status rising day by day. Therefore, China presents an excellent market for the products of most companies. As a result, many companies seeking to enter international markets see China as their first choice. A company has always had to decide on the appropriate strategy towards market entry and the proper mode to enter a market.
This term paper will firstly give an overview about the existing foreign market entry modes. Secondly there is a description of the joint ventures in general by analyzing the typical the motives and risks for using this specific mode of entry to internationalize. In the end of the second part the issue of the situation on the Chinese market is broached to lead the reader to the concrete business case of Volkswagen and SAIC Motors in the third part. At the end this paper gives a short conclusion by evaluating the success of this joint venture on the Chinese market.
2 Foreign Markets Entry Mode
In today's global economy, there are several ways through which a company may seek to enter into a foreign international market. Foreign market entry methods vary in their suitability to a particular international market, including the safety and practicality of the method. Companies take the time to consider all the options available for the entry methods before deciding on which one to adopt. Entry methods can be broadly categorized into two groups: strategic alliances and standalone entries. In typical cases, a company would not choose to share in the profits it expects from a given market, but alliances are sometimes chosen because starting from scratch is an expensive endeavor and riskier in international territories.
Some of the inadequacies that result in a company choosing to form alliances include knowledge and experience about the market, technology, regulations involving companies, and restrictive laws that prohibit foreign investors from starting their venture. Strategic alliances are of a complimentary nature. A foreign company looking for partnership with a local company is usually interested in the resources of the local company that could help establish its presence in that market. The local company too looks out for resources that a foreign investor has that could increase their presence in the local market.
Types of strategic alliances available for companies to choose from include contract manufacturing, exporting, licensing, franchising, and joint ventures. Standalone entries are usually chosen by companies that believe in their capacity to take risks and are ready to take time and study the new market while they do business. Such companies invest in information gathering to ensure they have knowledge on market trends, consumer preferences, and other aspects that influence the given market to make informed decisions on their way forward.
Contract manufacturing is often used as a complement to other strategies, but not as an entry method on its own. A company may sometimes enter a market with an activity that is not core to its business as the manufacturing of consumer goods or clothes. Rather than seeking to establish a more permanent image in the market, the company may choose to contract a local manufacturer of its choice to produce the goods to the specifications of the market. Such companies may be more involved in marketing or research, and contract manufacturing allows them to produce goods to their liking without distracting them from their core business.
Advantages of the approach are that it is less capital intensive, less risky, and has minimal complications when one chooses to exit. Disadvantages are that it offers limited product control in the market and presents a myriad of scalability problems. Contract vendors need to be chosen carefully by any company that chooses to use contract manufacturing as an entry method into foreign markets. For companies that exhibit distinctive and legally protected assets, licensing is an option available to them. The legally protected assets provides a good offer for local companies as they can produce already established brands and share in the profits with the parent company.
Licensing involves developing a contract where a company gives rights to a local company to share in its trademarks, patents, technological know-how, and intellectual property. The local company in return promises to pay royalties to the parent company for using its legally protected assets to conduct business. Licensing has proven to have the capability of delivering a high return on income because little investment is required on the licensors part. However, other potential returns from the market may be lost as the licensee is solely responsible for producing and marketing the product.
Advantages offered by licensing as an entry method into foreign markets include no capital requirements to establish production in the outside market, rapid expansion as the licensing process takes a little time, and more quick returns realized. Another significant advantage is that the business essentially takes a local shape that eliminates barriers such as regulation and local tariffs. The licensing company is thus capable of establishing a market in the new region without fear of the regulations that such regions impose on foreign investors. A disadvantage of licensing is that the licensing company may lose control over marketing and manufacturing over its use of assets.
Franchising is another method used for rapid expansion into a foreign market. It has been very common and successful amongst fast food chains, business services, and consumer service businesses such as car rentals and hotels. Franchising involves one party (the franchiser) granting another (the franchisee) the rights to produce and distribute goods or services in the franchisee's area of interest for a fee. A franchisor capitalizes on intellectual property and the enthusiasm other parties have towards his brand to seek rapid expansion into foreign markets. Some franchise agreements are more sophisticated. They involve arrangements, such as precise business framework that a franchisee should adhere to in carrying out the business to guarantee a common customer experience throughout the franchiser's network.
Franchises are suitable when there is a need to replicate a business model or format. However, one certain limitation of this method is its ability to adapt to a certain market. This is because the guidelines for operating the business are usually fixed; hence, making it a key consideration when one seeks to use the method to enter a foreign market. Major franchisers in the recent past have shown some ability to let their business models adapt to their current markets and suit local preferences. McDonalds, for example, which is a fast food franchise, has let it franchisees in different markets offer different menu items than its parent company in the United States.
Exporting is another method companies can use to seek entry into international markets. This model involves products from one country being marketed and sold in another through distribution channels. Exporting has been the traditional method used by most companies to venture into international markets. It is also the most established form still in existence today. Exporting requires heavy investments in marketing and distribution in the areas of interest. Two forms of export have been in use since the onset of globalization; direct and indirect export.
In direct export, the company appoints a distributor or an agent in its market of interest. The agent is responsible for receiving goods from the company and distributing in the market. The company may also choose to offer competitive bidding for individuals interested in supplying its products in a given region. The individuals are vetted to ensure that they meet the company’s terms and conditions, and at least one of them is offered to distribute the company's products. The arrangement is contractual, and it is usually renewed after a specified time to check compliance of the distributor to the company's terms and conditions. Both the company and the distributors are jointly involved in the marketing of the product in the region.
Indirect export involves exporting goods through export management companies, trading companies, counter-trade, and piggybacking. This mode of export is usually common for raw material commodities such as cocoa, cotton, and tea. The management companies have vast knowledge regarding trade of a particular product in a region, and the exporter relies on this expertise to venture into the market. This offers one of the advantages of indirect exporting; the exporter need not have sufficient knowledge or expertise in the market in which he/she is venturing. Counter-trade involves establishing a trade link with an interested party in the market of interest.
The company is then supposed to supply to the interested party its goods and expect him/her to supply in the local market. However, unlike direct export, the interested party acts as a buyer while the company acts as the seller. The company delivers its products to the buyer, gets paid and waits till the buyer is interested in more products. The company is also required to market the product in the buyer's local market as it will help in liquidating the existing stock and allow the buyer to make more purchase. Indirect exporting is common among pharmaceutical companies as they supply their products to an interested party in a region and visit doctors to create demand and help liquidate the stock.
2.2 Joint Ventures
The joint venture is a form of strategic alliance where a local company and a foreign entrant agree to share equity in running a partnership together. The equity participation of both companies varies concerning their agreement. Major forms include majority stake, equal stake, minority stake or a controlling stake. A joint venture has a number of advantages it affords a foreign entrant. It eliminates the need to start over from scratch in a new territory which could be a risky and a capital intensive endeavor. The local company's distribution, manufacturing, and retailing facilities are also leveraged to produce service to the foreign entrant.
The entrant also benefits from the local company's managerial skills in the local market, which allows for focus in producing products suitable for the market. Joint ventures are a complex and sometimes long process that has had many companies avoid them. The complexities are brought about by the need to adapt to foreign market regulations and the process of reaching into agreeable terms with the local company regarding the sharing of stakes. Most countries have regulations that manage the formation of joint ventures between their local companies and foreign entrants. The regulations are mostly meant to ensure that the people and the economy of the country benefit from the merger as the joint venture will be using resources from the host country.
This particularly becomes sensitive when the host nation is a lower economy compared to the economy of the country of the foreign entrant. China has a policy that requires all foreign companies interested in doing serious businesses in the country to take on joint ventures before setting shop. China uses the policy to ensure that no foreign company is capable of taking over any industry in the country. India also has the same policy, which has seen multinational capable of setting their shop being forced into joint ventures. In such cases, the foreign entrant weighs the benefits of venturing into the market with the risks associated and makes an informed decision.
China has been a preferred market destination for many companies seeking to expand their markets. Since their policy requires a joint venture, most companies have had to weigh the benefits they will accrue before joining the market. China is first known for its affordable labor. A company forming a joint venture with a Chinese local company will benefit from the affordable labor and reduce its production costs significantly. Secondly, China is known as an emerging economy with a growing middle-class population. The middle-class population forms the backbone of most businesses as they are the ones who frequently participate in buying of products.
Currently, China boasts of a middle-class population of six hundred million individuals. This means that for a foreign entrant, there is a market that may yield results if a product is well positioned and marketed to the population. Joint ventures come bundled with a number of risks. The most common one is the complication of the exit strategy if the foreign entrant later wishes to leave the market. An exit strategy is a very important aspect to consider when one joins a foreign market. Due to the nature of joint ventures, foreign entrants find it difficult to leave afterward as the exit strategy is complicated by the agreement between the two companies or government policies. This could spell disaster in a case where a foreign company in a venture is not meeting its objectives and would wish to pull out of the market.
3 Example: Volkswagen and SAIC Motors
Shanghai Automotive Industrial Company (SAIC) entered into a joint venture with Volkswagen in 1984 to form Shanghai Volkswagen. SAIC is a state-owned Chinese automotive manufacturing company while Volkswagen group is a German automotive car manufacturer. According to Holweg & Oliver (2009), Volkswagen was drawn into the Chinese market because of the opportunities it saw of growing its business while reducing its production costs significantly.
China is the world greatest producer and exporter of rare earth metals. Its exports account for 93% of total exports of rare earth metals in the global market. Rare earth metals are vital minerals in manufacturing metal components for cars.
Additionally, rare earth metals are used in the manufacture of electronics that are ubiquitous in cars. For Volkswagen, setting shop in China would mean increasing access to the raw materials involved in cars production thereby cutting down on production costs significantly. China is also a haven for cheap labor. This is largely due to affordable energy costs that are instituted and regulated by the Chinese government. China has huge power projects ranging from hydroelectric to solar power that it uses to encourage investments and spur economic growth. The Chinese government is responsible for setting power tariffs that are usually low to encourage investments. Low energy costs and a huge population that guaranteed affordable labor seemed very attractive to Volkswagen.
In terms of the market, Volkswagen saw a ready and growing market in the Chinese middle-class. Volkswagen was specializing in luxury limousines and family vehicles that are a common buy for the middle-class population. SAIC had succeeded in offering such vehicles to the population, but Volkswagen believed it had something unique to offer. Volkswagen had been in the automotive industry longer than SAIC and had superior technology, design, luxury limousines, and family vehicles. The joint venture enabled SAIC to gain from Volkswagen's expertise that improved its brand power and consumer satisfaction in the market. On the other hand, Volkswagen gained from the increased market presence that vastly increased its revenues.
It also benefited from low production costs in its foreign market, which contributed for great savings. The original contract was to last twenty-five years and was renewed in 2014. The contract requires that Volkswagen owns no more that 50% stake in the joint venture. China is the world largest automobile market with Volkswagen and SAIC joint venture forming the biggest automotive conglomerate. Sales of Volkswagen cars in the global market have increased by 16% due to the merger while sales of SAIC vehicles in China have doubled since the merger. The two companies still enjoy a partnership deal that is to last another twenty-five years.
 Cf. Zucchella, A. et al. (2007), p. 271.
 Cf. Li, B., Tu, Y. (2015), p. 3.
 Cf. Decker, W. (2004), pp. 102-105.
 Cf. Barnett, A. D. (2007).
 Cf. Buckley, P. J., Casson, M. C. (2008).
 Cf. Hill, C. (2008).
 Cf. Johnsohn, J., Tellis, G. J. (2008), pp. 3-7.
 Cf. Luo, Y., Tung, R. L. (2007), pp. 483-485.
 Cf. Morschett, D. et al. (2010), pp. 60-61.
 Cf. Aspelund, A. et al. (2007).
 Cf. Oviatt, B. M., McDougall, P. P. (2005), pp. 540-546.
 Cf. Zahra, S. A. (2005), p. 23.
 Cf. Lockstroem, M. et al. (2010), p. 245.
 Cf. Chin, G. T. (2010).
 Cf. Chin, G. T. (2010).
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