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International growth

International business development: which direct investments are available when expanding internationally?

Victanis Advisory Services GmbH
2018-11-06
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When a business seeks to expand internationally, there is usually a robust decision making process to confirm the opportunity and finalise the way forward. Work goes into analysing the situation, securing funding, and selecting the target country – all of which are essential steps in building a secure, sustainable and properly conceived project. One of the most clearly defined tasks is the process of selecting the form of direct international expansion to meet the business’s goals and address its challenges most effectively.

Which form of establishing an international subsidiary directly within the target country involves the lowest levels of risk for the business, while meeting the project’s growth targets? Which options involve the lowest cost when launching an international development project? Selecting the best option involves obtaining a thorough knowledge of all options that are available, then carrying out an analysis of the advantages and disadvantages of each. Following in the footsteps of the 26% of French businesses with more than 20 employees that already have an international presence**, here is an overview of the various forms of on-the-ground presence that you may wish to consider in the context of international expansion.

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1- Representative office

Also known as a liaison office, this form of international expansion generally paves the way for sales activity with a number of specific tasks: coordinating a local network, acting as an intermediary between local customers and head office, or providing marketing and communications services. It does not have a separate legal entity or any tax status of its own, and as such, it cannot perform any sales functions.

Benefits

  • A representative office allows the business to optimise its existing sales strategy for the new market it is seeking to win: learning about customers’ expectations on the ground and in the local cultural context.
  • Head office can use this office to enter the new territory at its own pace, establishing a trusted partnership with the local authorities and potential future customers.

Disadvantages

  • The head office bears all the financial risks in relation to a representative office and remains the only legal decision maker. If this option is to be successful, relevant skills need to be acquired or recruited to ensure professional conduct and value creation. It is often preferable to seek professional advice before embarking on this process.
  • A representative office is generally no more than a first step in a business’s international development strategy, and as such, it has a limited lifespan.

To read: The main mistakes to avoid when growing your company internationally

2- Branch office

This is a secondary organisation, with the aim of expanding the role and extending the reach of the head office. Unlike a representative office, a branch office has the right to perform a commercial function: it can adopt the role of a sales arm, with the primary role of getting closer to the desired market, supporting existing customers, and building a customer base of its own.

Benefits

  • Establishing a branch office gives the business valuable implementation about how its approach to sales is being implemented.
  • This type of establishment is a relatively low-cost option: relatively few administrative formalities need to be completed, while the business can retain all profits on its sales.

Disadvantages

  • Branches inherently have restricted autonomy: they cannot perform any strategic activities or develop their own sales contracts. As such, the scope for development (whether internally or externally) is limited.

3- Subsidiaries

A subsidiary is a secondary company, created and controlled by a parent company which holds more than 50% of the subsidiary’s share capital. It is a legal entity in its own right (i.e., it has its own legal personality) which means that it can have its own management, take initiative in its own right and take advantage of sales opportunities or tax benefits that may arise. More than 37,000 foreign subsidiary companies are owned by French parent companies, in over 190 countries*.

Benefits

  • A subsidiary established in a foreign territory is rightly considered to be a local company, maximising its chances of being a success in the local market and achieving substantial market penetration.
  • All sales, financial and logistical operations are managed in the foreign territory, as a result of which it may be possible to achieve economies of scale.

Disadvantages

  • A subsidiary is inherently dependent on local legislation: choosing this mode of international expansion requires extensive knowledge, particularly in terms of labour law, taxation, and legal processes.
  • Forming a subsidiary of this kind involves substantial financial investments and can be too resource-intensive for some companies to take on at an early stage of their international development.

4- Joint Ventures

These involve establishing a new company, or merging an existing company, to form a collaborative arrangement with a company that already has a local presence in the target market. The aim of this type of direct establishment is to pool knowledge, technology, or services offered in order to maximise the competitive advantage of the companies in the alliance. This collaborative arrangement results in shared knowledge and skills, which creates values for both international partners.

Benefits

  • This option for setting up a local business is generally required in closed economies such as China or the United Arab Emirates, where 100% foreign-owned companies cannot be created.
  • Forming a joint venture provides the parent company with an easier way to enter the local market: a product that is treated as a domestic product, simplified administrative procedures, and direct access to local distribution channels.
  • This form of cooperation between two businesses involves shared financial risk.

Disadvantages

  • Profits generated by the joint venture are divided between both parties. Establishing over-ambitious budgets is also a common feature in the early years of a JV, as a result of a lack of preparation and advice and of the time it takes for two separate parties to learn how to cooperate and work in good harmony.
  • This form of international expansion still features all the risks that are inherent in all multicultural ventures: strategic disagreements, difficulties in overcoming cultural barriers, intellectual property interests, conflicts of interest, and other areas where the parties’ economic interests are not aligned.

5- Acquisition

This involves growing the business externally to achieve a permanent presence in the target market. This approach requires a very precisely defined strategy to identify the correct acquisition criteria (business sector, role and services, size, profitability, geographic location, and more), in part to enable effective screening of targets.

In summary, there are two major acquisition types: when a company absorbs a local business with activities that complement each other locally, or even compete against one another, the merger is said to be horizontal with the strategic aim of offering a more broadly-based range of products or services. If a customer absorbs one of its suppliers, the acquisition is said to be vertical with the aim of optimising the supply chain or to achieve a stronger presence in a clearly defined market sector.

Benefits

  • It provides the acquiring company with an enhanced reputation, both in the host territory and in the domestic market, with a faster route to market.
  • It can make it possible to diversify the company’s business and encourage innovation.

Disadvantages

  • This strategy for expanding into foreign markets often requires more time to adapt than required: for example, instructions or guidelines from new owner can encounter resistance among employees and management of the acquired company.
  • It is not unusual for acquisitions to fail: acquiring a business abroad is a risky process that needs to be assisted by professionals who have the skills to identify potential acquisition targets that are not merely affordable, but which align with the acquiring company’s values, culture, and strategy.

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6- VIE (Volunteering in International Enterprises)

Volunteering in International Enterprises (VIE) is a legal option that is only available to French headquartered companies, whereby these can send young French graduates to work internationally, at an affordable cost and in order to enhance their presence in the target market. These “volunteers” can be entrusted with a variety of tasks: preparing to set up a production facility, carrying out market research, developing a customer base, or reinforcing technical resources that are already in place.

Benefits

  • This is an economically attractive option thanks to a mix of national and regional financing made available to French companies (“Prêt Croissance International” offered by Bpifrance, “A3P insurance” managed by Bpifrance Assurance Export). Financial support for the 13 French regions also exist albeit can differ widely in its nature***: the Pays de la Loire Region pays the costs up to 100% for a 12-month period for a sales position, whereas the region of Brittany only offers 30% coverage for all types of position over an 18-month period.
  • This option is highly flexible: the business can choose the nature of the role(s) assigned to one or more volunteers and the duration of the assignment(s), which makes it an interesting alternative to traditional expat contracts.
  • Administrative management of VIE is delegated to Business France, and there is no direct contractual link between the business and the volunteer.

Disadvantages

  • The benefits of this solution can disappear quickly if the VIE is not well supported by the company : a miss-judged recruitment, a lack of training for the volunteer, an absence of coaching, or communications difficulties can all lead to failure.

Conclusion

When weighing up the criteria to be taken into consideration to choose the right form of local establishment, a business will undoubtedly ask questions about the degree of control that it wishes to retain during the process of international expansion, the speed with which it wishes to enter a new market, the existing ecosystem and partnership opportunities that may be available, and the way in which it wishes to support some of its international customers.

When faced with the various different options that have been covered in this article, albeit briefly, it may be beneficial for businesses to obtain the services of an international development consultancy. In addition to delivering executable recommendations and bringing critical experience to the table, a partner of this kind can carry out an initial strategic assessment of your organisation to ensure that it has successfully prepared for its investment in terms of its organisational structure and maturity, its competencies, its strategic intent and its financial robustness.

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