In our report we will look into the expansion opportunities of the company aa , a leading India based clothes manufacturer and retailer into the European market.

Executive summary

Based on our research we have pointed out several criteria with regards to the selection of the country to expand our operations in, which are

Applying these criteria to Cyprus, we came up to the decision that it was the best possible pathway to follow in entering the EU having in mind our capabilities and constraints discussed in this report.

A brief analysis of the macro environment regarding that region which shows the economic growth and political stability, the encouragement of foreign investment by low taxation, its excellent infrastructure (telecommunication and logistics) as well as the cultural of the countries provided us with a platform of selecting a joint venture as the mode of entry.

At the very last pat of this report we will be dealing with our selection of our partner in Cyprus. In doing this we have strongly taken into consideration our future partners knowledge of the local and European Market and industry and its ability to contribute and meet the requirements of the investment as well as their reputation in the local market.

01. Introduction

AA is an Indian textile manufacturing company with its headquarters in Bombay and about 20 retail outlets scattered around the country. Though the business is doing very well amongst its competitors, the recent policy by the government and the World Trade Organisation members to lift quotas and, therefore end all quantitative limits on textiles and clothing by next year as well as the saturation of the Indian market has caused the top management to consider further expansion of its business beyond the borders of India into a wider market in order to survive and also to establish itself within a region of huge market potential. Since US textile makers have lobbied for tariffs on Asian textiles and clothing, the largest market to consider entering is the European Union (EU) with a population of over 500million. The whole idea is to facilitate sales in the region and not to replace our domestic production. The EU currently consists of 25 member countries. Rahman (2003) suggests that the major reason why new markets fail abroad is due to poor market selection. This happens as a result of inadequate or inappropriate evaluation of markets with outcomes almost more expensive than the cost associated with systematic evaluation.

As our long-term objective is to expand our operations throughout the member states of the EU, we have decided to identify the best mode of entry into this region. This, we intend to achieve by reviewing literature about factors that influence investment decisions abroad and mode of entry after which we will apply the resulting criteria to our case.

02. Strategy for internationalisation:

Globalisation has resulted in intense competition in the clothing market therefore, the strategy of internationalisation should be made carefully taking into consideration as many relevant factors as possible.

Francisco José Mas-Ruiz et al (2002) state that ‘From the international marketing perspective, such a long-term decision requires (Ayal and Zif, 1979):

the identification of potential markets and the establishing of an order of priority for its entry into these markets;
it must decide on the extent of the marketing effort to which it will commit itself; and
decide on the timing of such expansion and the extent of marketing effort it will invest in each of these potential markets. ‘

They further state that ‘Focusing on this third aspect, two strategic alternatives for expansion into external markets have been thoroughly debated in the existing literature: first, market concentration, which characterizes the company that directs its marketing efforts towards a few key markets and expands gradually in time into new markets; and second, market diversification, which describes the rapid entrance into a great number of markets at the same time, the company dividing its marketing efforts among them all.’

They argue that by securing large market shares in a few key markets, firms using a concentration strategy are able to generate higher performance results than firms using a geographic diversification strategy. This view is also consistent with that of the internationalization stage theory (Olusoga, 1993). For firms without international experience, Anderson and Gatignon (1986) have characterized this incremental approach as the more efficient method for international involvement, since it allows firms to acquire the necessary international knowledge and experience at low cost.’ Poh-Lin Yeoh (2004). Given that AA is an organisation which holds a significant market share in its domestic retail market and has the necessary internal resources for expansion, it is important to choose an internationalisation strategy which would minimise risks of failure and maximise learning opportunities at minimum cost. As such, the market concentration strategy explained above is ideal to enter into the EU. A country will be chosen among the 25 countries, this will serve as our base, once AA gains a good position in that market, we would gradually expand into the region by taking full advantage of the free trade that exists within the EU.

03. Market selection:

According to Cavusgil, (1990) and Johansson, (1997), the most important barriers that can make access to foreign markets difficult include tariff barriers, governmental regulations, distribution access, natural barriers (market success and customer allegiances), advanced versus developing countries and exit barriers. As the EU region has similar tariff systems and regulations, the factors that will be considered in choosing the ideal country are distribution access, natural barriers and advanced vs. developing countries.

The country to be selected should have an easy and cheap distribution channel to other member states as well as to India. This, in our opinion, is direct access to a port. Austria, Finland, Luxembourg, Hungary and Slovakia do not have ports.

Likewise Denmark, Latvia, Lithuania, Estonia, Poland and Sweden are further disqualified as they lie in the North and their ports are relatively less feasible for shipping from India to Europe. Therefore, the options available have narrowed down to Belgium, France, Germany, Netherlands, Cyprus, Italy, Spain, Greece, Portugal, Malta, Ireland, United Kingdom and Slovenia.

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The next elimination is based on natural barriers and highly developed countries. Given that the organization does not have experience in foreign trading, entry into a highly competitive and developed market would increase the risk of failure. If the organization enters a less competitive market it could learn through its experience, establish itself and then expand its operations. Consequently, Cyprus, Greece and Malta are short-listed. Cyprus, in addition, is strategically positioned around the Mediterranean, at the crossroads of three continents. Therefore, our base would be Cyprus.

04. Selecting a mode of entry:

Selecting an institutional arrangement - a mode for entering or expanding in a foreign market - is one of the most crucial strategic decisions that an international firm has to make (Root, 1994). The success or failure in the new market would extensively depend upon environmental factors. These should therefore be the main factors that help determine the mode of entry into the new market. However, prior to analysing these environmental factors, we would consider the best options available to us.

4.1 MODE OF ENTRY OPTIONS

Various options available to us range from mergers and acquisitions to joint ventures, direct exports, indirect exports, licensing, franchising, wholly owned subsidiaries and strategic alliances.

According to Mulbacher et al (1999), in developing a market entry strategy, three rules can be followed. They are:

The naïve rule in which only one entry mode is considered- its main disadvantage is that one might miss other attractive or better options thereby leading to inappropriate solution.
The pragmatic rule in which the company starts serving local markets with a low-cost entry mode and if successful, it then changes to a more complex and costly alternative. Though this might save time and cost, the company might fail to identify other solutions with higher potential for fast and lasting market success and it may end up engaging high cost to change the mode of entry eventually adopted.
The strategic rule suggests that there is no one best mode of entry to internationalize a company neither are there laid down steps to be followed from one entry mode to another, the success depends mainly on the level of globalisation of the firm product-market as well as the level of internationalisation of the company. The figure below illustrates this.

Level of globalisation of product-market

LOW HIGH

Level of internationalisation

of the firm LOW

HIGH

Fig 1.1: typical market entry situations

Source: Johanson, J & L.G Mattson (1992)

(As seen in Mulbacher et al)

Our firm falls into the class of late starters, as our level of internationalisation is low and the level of globalisation of our product-market is high. Mulbacher et al suggests that for a firm of fairly large size as ours, the best way is to buy market share through modes of entry that need substantial investment such as participation in or acquisition of local firms.

This therefore narrows our options from those listed above to strategic alliances, joint ventures and wholly owned subsidiary by acquisition of existing local firm. These three are briefly discussed below.

STRATEGIC ALLIANCES

David K. Tse et al (1997) state that ‘Faced with rapid technological advances, changing market structures, and increasing global competition, firms are motivated to form alliances with other firms to reduce investment risks, share technology, improve efficiency, enhance global mobility, and strengthen global competitiveness [Auster 1987; Harrigan 1988]’. Although there may be room for problems associated with the level of control, sharing of profits, and technological risk, strategic alliance with a local company in the host country provides a valuable mode of entry.

JOINT VENTURE

This would reduce the risks associated with the investment in comparison to the wholly owned subsidiary or acquisition methods. Furthermore, both companies could benefit from the expertise of each other. Argarwal and Ramaswami (1992) state that ‘The joint venture mode involves relatively lower investment and hence provides risk, return, and control commensurate to the extent of equity participation of the investing firm.’

WHOLLY OWNED SUBSIDIARY BY ACQUISITION

Acquisition of a local company, operating in the same industry, in the host country as well as opening a wholly owned subsidiary will minimise the transaction costs. Level of technological risk will be minimum or zero as technological knowledge shall not be transferred to an external party. The level of control will be high and therefore the level of autonomy will be high. Profits will not have to be shared

However the following risks may be there

a. The risk of failure due to the inadequate knowledge regarding the institutional factors as well as the cultural factors is high.

b. High levels of resource commitment may be required. Therefore the risk associated too will be higher accordingly.

ENVIRONMENTAL ANALYSIS

While Wood, Van R; Robertson, Kim (2000) discuss six dimensions that should be taken into consideration when evaluating the potential of a new market, Keith D. Brouthers (2002), and Osland, Taylor and Zue (2001) have provided a valuable insight to the criteria that should be considered in the choice of mode of entry.

4.2.1 Application of the Wood and Kim’s dimensional framework to retail clothing market in Cyprus:

Politics: Although Cyprus is divided into two areas, controlled by Turkish Cypriot government and the other by Greek Cypriot government, Cyprus maintains strong relationships with the foreign governments. This is particularly important taking into account the geographic location of Cyprus. is at the crossroads of three continents. This offers potential to expand not only to EU but to other areas as well. The Cypriot government views foreign investments favourably and provides incentives.

Market potential: As stated above Cyprus offers the opportunity to expand to the EU as well as to the Middle East. Though Cyprus has a population of 802,500 people as at 2003 (www.animaweb.org) with a population growth rate of around 3.6% (http://epp.eurostat.cec.eu.int/), it will only serve as a base on the long run, therefore the market potential is that of the EU populace, about 500 million with a growth rate of 4%. The clothes exported will have to be designed and developed according to seasonal changes as well as consumer preferences of the market. The main competitors in the Cyprus clothing market include companies such as the Zara, Avenue stores which is owned and managed by Debenhams, Vavel stores Marks & Spencer.Therefore, the market is competitive. Competition is also severe within the EU market, which ……………should take into account. The competition within the EU market ranges from global brands to small scale clothing importers as well as producers.

Economic environment: The gross domestic product of Cyprus is $12.7 billion with an annual growth in GDP amounting to 2%. Per capita GDP income for the year 2003 for Greek Cypriots--$17,644 and it was about $5949 for Turkish Cypriots as per the statistics revealed by the US department of State. Therefore, this gives an idea of the purchasing power of the population. The main markets of the Cyprus economy are the European market, middle east and Russia, which is an advantage for us in terms of its plans for its future expansion. In July 2004 the unemployment rate was 3.4% with Wage rates lower than the EU average - this is an advantage in terms of cost efficiencies.

Culture: The dressing culture of Cyprus is not very different from the rest of the EU. As such there are no strict cultural factors affecting the trends of the clothing market. These trends are set by that of the European market, giving the ideal opportunity to develop clothes in terms of designs, quality and price, which suit the European market. However, 70%of employees are unionised though the number of man-days lost to strikes each year (currently at about 45 per 100.000) is low by international comparisons. Cypriots are said to be hardworking, adaptable and honest’. (). Further, Cyprus offers a well-trained and versatile work force. The importance of taking into consideration the national culture of the new market has been emphasised by Bouthers(2002), this, he refers to, as the ‘cultural context’. The ‘cultural context is an important factor which should be taken into consideration in choosing the mode of entry into a new market. The mode of entry should ensure minimum risk and maximum potential. As local knowledge is important, the presence of a local partner seems ideal

Infrastructure: There is a wide network of air-routes connecting Cyprus with Europe, Africa and Asia. The island is rapidly becoming a major international transit station for commercial air transportation with excellent connections within the entire region. Cyprus has renewed port system comprising the multi-purpose ports of Limassol and Larnaca,. About 100 shipping lines include Cyprus in their regular schedules while over 5,000 ships visit the ports each year. Limassol and Larnaca handle two thirds of the total volume of seaborne cargo. Both ports are increasingly being used as regional warehouse and distribution centres. Supplementing one another in terms of facilities and traffic, they constitute a major container trans-shipment centre in the eastern Mediterranean. The facilities provided include, in addition to minimal customs formalities, free trade facilities and a very reliable handling and delivery system, the extension of berthing priority to their carriers and special rates for their long-term storage. Cyprus has one of the most developed telecommunications infrastructures in the world which includes automatic telephone connection with almost the entire world. In addition, services provided include telefax, packet switched data transmission, mobile telephony (GSM and NMT900), voicemail, paging, telex, telegraphy, maritime, TV transmission/reception, private leased circuits, audiotex and videoconferencing. The national net-work uses state-of the-art technology such as digital switching and transmission systems and fibre optic cables.

Legal environment: Taxation for offshore entities is very light, and Cyprus is unusual among low-tax countries in having double tax treaties with 27 other countries including India. These include the CIS and many Eastern European countries as well; therefore Cyprus has developed particularly close links with that region.‘All offshore companies are taxed at 4.25% of profits; offshore branches of foreign companies with management and control in Cyprus are also taxed at 4.25%; branches with management and control outside Cyprus are exempt from tax on profits derived from sources outside Cyprus’. () The standard rate of value added tax is 17%. There are no withholding taxes for payments to non residents as an incentive to encourage foreign investments.

Larnaca industrial free zone

Businesses operating within the Free Zone are subject to minimal customs formalities; they may import plant, machinery, equipment and raw materials duty-free, while their foreign employees are liable to only 50% of the normal rates of income tax. For a variety of reasons, the Free Zone has not been very successful.

Investment by foreigners

Keith D Bouthers(2002) too stresses the importance of taking into consideration the ‘institutional context’ in choosing the mode of entry. In that he states that factors such as legal restrictions on ownership too determines the mode of entry as it specifies whether a company could set up a business with 100% ownership such as a subsidiary or if there is a restriction imposed on ownership. The formal position in Cyprus remains that Central Bank approval is required, and if the level of participation exceeds 49% or if the investment exceeds CY£750,000, then the Ministry of Commerce, Industry and Tourism also becomes involved. The chances of rejection are now only significant if projects seem likely to cause environmental problems or to compromise national security; investments below CY£300,000 may also be refused if more than 49% participation is proposed.

Having evaluated different options of mode of entry and based on the main factors highlighted, it is evident that local knowledge is a critical success factor in this market. Also considering our low level of internationalisation, it is best we opt for the Joint Venture mode of entry.

THE JOINT VENTURE

Having chosen this mode of entry, the next decision to be made is with whom to enter into a JV with and working out the modalities of the venture. We have two options.

Our Partner (1)

|AA| is an investor based in Cyprus and proposes to invest 50% of the cost with us. The resulting company will however, start from scratch as aa has no previous experience in this industry nor any infrastructure on ground. Manufacturing will be based in larnaca free industrial zone in Cyprus.This deal will, however, delay our entry into the market and will cost more, as our setup cost will be higher

Our Partner (2)

|BB| is based in Nicosia and was engaged in production and retail of garments under the brand name ‘X’. The company has its Production facility based in Larnaca and has four major high street retail outlets and one each in Greece, Spain and Poland.

The business environment in Cyprus, especially in the garment industry has seen a gradual rise in Labour costs as well as an increase in competition due to the accession into the EU. This has encouraged imports and outsourcing of manufacturing function abroad. |BB| is unable to compete effectively cost wise and has decided to close its manufacturing sector and outsource it. It wants to use its manufacturing as well as its local and European market expertise to assist its production counterpart and focus on its primary activity - High Street Retail as it still enjoys a healthy goodwill.

The transactional cost theory as defined by Brouthers (2002) are the cost of finding and negotiating with an appropriate partner, and the costs of monitoring the performance of the partner firm. This is consistent with Williamson, (1985) who argues that transaction cost variables are concerned with the costs of integrating an operation within the firm as compared with the costs of using an external party to act for the firm in a foreign market. The transaction cost that will have to be incurred if AA is chosen will be higher than that of BB.

Osland, Taylor and Zue (2001) state that based on previous research (Maignan and Lukas(1997) Woodcock et al,(1994)), a decision should depend on three factors which are:

Quantity of resource commitment required

Resource commitment refers to the investments required for intangible as well as tangible assets. One’s choice should depend on the level of investment required in obtaining the necessary intangible assets such as the relevant knowledge and managerial skills, and tangible assets such as machinery, equipment and premises. The choice of mode of entry should depend on the level of investment the company can or is willing to undertake. Choosing BB would reduce the quantity required.

Level of control

Level of control refers to the degree to which the company wishes to influence the decision making process in the foreign market. Both have however insisted on a 50% stake.

Level of technology risk

This refers to the transfer of technological knowledge of an organisation to a local firm unintentionally if the mode of entry is not wholly owned. This could result in a loss of competitive advantage in the long run. As production would still be based in India, going into partnership with BB is considered safe.

Based on the analyses above, we have decided to choose BB and the emerging company will be registered as OLA ……

OLA

Ola will be a JV company consisting of XX and BB owning 50% shares each.

The main function of this JV will be Product Development, Design, sales and Marketing. |BB|’s experience and brand value and XX’s financial contribution are therefore justified. The Product will be designed and developed by JV in Cyprus, produced in India, exported to Cyprus and warehoused at Larnaca (local tax benefits) and sold through |BB|’s current 4 retail outlets which will be bought by Ola. BB will however, retain its other outlets outside Cyprus in the time being, until Ola is ready to expand into those countries. The proposal has been accepted by |BB| and is currently awaiting approval by the Central bank of Cyprus.

6.0 Conclusion

For XX, Cyprus is just a pit stop for final destination that is bigger markets in EU like Germany, France, Italy and UK. Like any racing, in order to reach the chequered flag pit stop strategy and implementation has to be perfect. So for XX, expansion into bigger EU states depends on the success of Cyprus market. There will be bump in the road, lead might change and other players can take the lead. But in long run riding the joint venture will take XX to the chequered flag.

References:

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Volume 6 Number 2 2003

Root, F.R, 1994, Entry Strategies for International Markets, Oxford : Maxwell Macmillan International

Poh-Lin Yeoh , ‘International learning: antecedents and performance implications among newly internationalizing companies in an exporting context’, International Marketing Review Vol. 21 No. 4/5, 2004 pp. 511-535

Francisco José Mas-Ruiz, Juan Luis Nicolau-Gonzálbez, Felipe Ruiz-Moreno ‘Foreign expansion strategy and performance’, International Marketing Review, 2002,vol 19, no:4, pp348-368

Wood, Van R; Robertson, Kim R’Evaluating international markets’, pp35-54
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Gregory E Osland; Charles R Taylor; Shaoming Zou, ‘Selecting international modes of entry and expansion’, Marketing Intelligence & Planning journal, 2001 Vol 19 No 3 pp 153 - 161

Keith D. Brouthers ‘ Institutional, cultural and transaction cost influences on entry mode choice and performance.’ Journal of International Business Studies, 2002 vol33, no:2, pp203

David K. Tse; Yigang Pan; Kevin Y. Au. ‘How MNCs choose entry modes and form alliances: the China experience. (multinational corporations)’

Journal of International Business Studies, 1997 vol:28 no:4 pp779

Sanjeev Agarwal; Sridhar N. Ramaswami. ‘Choice of foreign market entry mode: impact of ownership, location and internalization factors.’ Journal of International Business Studies, 1992 vol:23 no:1 pp1

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Websites

In their study Van R. Wood, Kim R. Robertson (2000) developed a valuable framework which describes six dimensions and 17 subdimensions which they found to be the most important factors that affect the success or failure of international ventures.

01. Politics

(1) the nature of present and future political stability in the export market as measured by the degree of centralization of political power, and the extent of representation and confidence of the people in their government;

(2) the nature of diplomatic relations between the foreign government and home government and its effect on trade; and

(3) the foreign government's internal policies, attitudes, and actions toward private enterprise.

02. Market potential

(1) Opportunities for exporters due to the export market's current and future demand for products or services, and that market's ability to pay for such products or services;

(2) Adaptation costs associated with products or services in the export market; and

(3) Internal and external competition in the export market.

03. Economic environment of the foreign market.

(1) The current position of the export market's development as measured by broad economic performance standards;

(2) The strength of the export market in terms of its production of goods and services; and

(3)Product consumption trends in the export market.

04. Culture of the foreign country

(1) The degree of cultural unity and national integration and the extent of ethnic and cultural differences in the export market; and

(2) The cultural differences (distance and similarities) between the export market and the home market (in this case the US domestic market).

05. Infrastructure of the foreign country.

(1) The extent and nature of the export market's physical distribution infrastructure; (2) The extent and nature of the export market's communications infrastructure; and

(3) Geography and climatic conditions that affect the business enterprise in the export market.

06. The legal environment of an export market

This refers to the degree to which it prevents or restrains business activities and imports. The three subsidiary dimensions here include:

(1) Tariffs and taxes in the export market;

(2) Non-tariff barriers of the export market; and

(3) Other legal considerations besides tariff and non-tariff barriers (e.g. visa requirements, laws affecting agents, intellectual property protection).

* this can go as an appendix to the report so that the number of words used is reduced.