Strategic Management in Global Environment

What is Globalization?

Globalization means increasing economic interdependence among countries due to increasing cross-border flows of goods and services, capital, people, and know-how. With faster communications, transportation, and financial flows, the barriers between nations have disappeared and the world is becoming a borderless market. Products developed in one country – Hollywood movies, McDonald’s hamburgers, Nike shoes, and Arrow shirts – are finding enthusiastic markets all over the world.

The term ‘Globalisation’ is generally used to cover three topic areas:

• The globalization of economies, trade activities, and regulatory regimes: World economies are slowly coming together, with barriers to trade being lowered.
  
  
• The globalization of industries: Entire industries like the car industry, the aerospace industry, and the paper and pulp industry are beginning to trade as one market rather than as a series of regional markets.
  
  
• The globalization of companies: Companies operate in many countries and treat the whole world as one market and one source of supply. A company buys raw materials, borrows money, manufactures and sells its products, recruits employees, etc., by treating the whole world as one marketplace.

Several forces are responsible for Globalisation. They are:

• Technological progress
  
• Opening up of national borders
  
• Strides in telecommunications
  
• Advancements in transportation
  
• Internet
  
• Opening up of economies such as India, China, etc.

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Need for Globalisation

Globalization has become an important driver of a country’s economic growth. Countries have contributed to this and benefited from it.

Globalization also poses some risks.

Opportunities

The following are the opportunities available for firms due to Globalisation:

Economies of Scale

Firms need a large customer base to achieve economies of scale. Global markets offer exciting opportunities to exploit the latest demand in world markets and expand their production volumes.

Performance Enhancement

Globalization helps in improving the performance of the firm. For example, Microsoft’s decision to establish a corporate research laboratory in Cambridge, England, helped it to build and sustain world-class excellence in selected value-creating activities. This strategic decision helped Microsoft gain access to outstanding technical and professional talent, which in turn helped in improved performance.

Reduced Costs

Firms all over the world are under pressure to reduce costs by locating their production facilities in countries where they can be produced more economically.

Homogeneity of Demand

Homogeneity of demand means that irrespective of where customers are physically located, they are likely to prefer the same kind of product or service worldwide.

Spreading of R&d Costs

In some industries such as pharmaceuticals and aircraft manufacturing, Research and Development (R&D) costs are so high that unless there are worldwide sales, the cost of development cannot be covered.

New Customers

Globalization helps in increasing the customer base of the firm. Many multinationals view the Indian and Chinese markets with their huge population base as very attractive for expansion.

Exploit Local Advantages

The most important reasons for international expansion are low-cost labor and the availability of natural resources in various parts of the world. Countries such as India, China, Taiwan, and Israel are becoming important engineering, manufacturing, and development centers for key skills in software and computer design.

The availability of cheap labor, cheap land prices, low energy costs, etc., in countries such as China, India, Indonesia, and other South-East Asian countries has encouraged many Japanese, Korean, and American companies to build production units there.

Government Incentives

Government incentives in the form of subsidies, tax concessions, and export incentives have motivated many domestic firms to expand their operations globally. Generous loans, subsidies, etc., given by the South Korean government have encouraged many of their firms such as Hyundai, Samsung, Daewoo, LG, etc., to invest huge sums in new technology and build global-sized plants all over the world.

Risks

Despite the above advantages, firms face many risks when expanding globally. They are:

Political and Economic Risks

Some countries are not stable politically. Forces such as social unrest, military turmoil, demonstrations, and even violent conflicts and terrorist attacks can pose serious threats. In some countries, the legal system is not reliable.

Currency Risks

Currency fluctuations can pose substantial risks. A company with operations in several countries must constantly monitor the exchange rate between its currency and that of the host country. Even a small change in the exchange rate can result in a significant difference in the cost of production or net profit when doing business overseas.

Management Risks

Managers face several risks in foreign markets. These take a variety of forms; culture, customs, language, income levels, customer preferences, distribution systems, and so on.

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Types of International Companies

In analyzing international company activity, Barlett and Ghoshal distinguished between three different types of international expansion. These types represent how Globalisation passes through three distinct stages, starting from a domestic company.

Domestic Company

A “domestic company” acquires essentially all of its resources and sells all of its products or services within a single country. The focus of its business is its domestic operations.

International Company

When the focus of a business is its domestic operations, but a portion of its activities are outside the home country, it is called an “International Company”. In other words, an international company is primarily based in a single country but acquires some meaningful share of its resources or revenues from other countries.

Multinational Company

When a company operates in many countries, though it may still have a home base, it is called a “multinational company”.

Global Company

When the company treats the whole world as one market and one source of supply, it is called a “global company”. There is only a limited response to local demand.

The focus of the business is one world market, with each of the operating units contributing to that activity. Although a global company is stateless and boundaryless, no business has truly achieved this level of international expansion.

However, Nestle comes close. Nestle is based in Switzerland, has a German CEO and gets more than 98% of its revenues, and has more than 95% of its asset outside of Switzerland. The only aspect that makes Nestle a Swiss company is that its headquarters are in Switzerland and Swiss investors still own the majority shares.

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Development of Global Corporation

The following are different ways in which a firm can compete in global markets:

Exporting

This means selling the products in other countries through an agent or a distributor. This choice offers avenues for larger firms to begin their international expansion with a minimum investment.

Merits:

• Less expensive
  
• No need to set up manufacturing facilities abroad

Demerits:

• Not suitable for bulky, perishable, or fragile good
  
• Import duties make the product expensive
  
• High transportation costs
  
• Cannot avail lower production costs in the host country

Licensing

Licensing is an arrangement whereby a firm allows another firm to use its trademark, technology, patent, copyright, or other rights in return for a fee or royalty. The firm thus gains entry into another country at little risk, and the licensee, in turn, gains product expertise, brand name, etc.

Merits:

• A firm need not incur capital costs in setting up a unit
  
• Firm gets a stream of revenues

Demerits:

• Does not allow for economies of scale
  
• Technological know-how may be misused
  
• Licensee may become a competitor
  
• May damage the image of the firm if a licensee does not adhere to quality standards.

Franchising

Franchising is a form of licensing in which the firm provides the foreign franchisee with a complete package including equipment, product ingredients, trademark, managerial advice, and standard operating practices. Franchisee agreements generally require payment of a fee upfront and then a percentage of revenues.

Merits:

• The firm gets a stream of revenues
  
• No capital costs
  
• No active involvement of the firm in getting local clearances etc.

Demerits:

• Franchisees might not adhere to standards
  
• Lack of control over the franchisee
  
• Loss of the firm’s image if the franchisee does not adhere to standards.

Sales Subsidiary

In this case, the firm retains production in its home country and sets up a sales subsidiary in a foreign country, which performs marketing, sales, and service of the product.

Merits:

• The firm remains close to customers
  
• Less costly than setting up production facilities
  
• Firm can have economies of scale

Demerits:

• High transportation costs
  
• Firm has to bear import duties
  
• Firm misses an opportunity for low production costs in the host country

Wholly-owned Subsidiary

In this case, the firm establishes a wholly-owned subsidiary in the host country, which will look after all production, sales, and service activities needed to operate in that country. There are several advantages of having a wholly-owned subsidiary.

Merits:

• The firm has complete control over its operations in that country
  
• Profits remain as the firm’s own
  
• Technology or trade secrets need not be shared with outsiders
  
• Firm gains more experience internationally
  
• Allows strategic coordination worldwide
  
• Especially useful for technologically intensive firms

Demerits:

• High cost of capital
  
• Risky if the firm is unfamiliar with the host country
  
• Misses the expertise of the local partner

Joint Ventures

In a joint venture, two firms contribute equity to form a new venture, typically in the host country to develop new products or build a manufacturing facility or set up a sales and distribution network.

The commonly cited advantages are:

• Improvement of efficiency
  
• Access to knowledge
  
• Dealing with political risk factors
  
• Collusions may restrict competition

Merits:

• Two partners bring complementary expertise to the new venture
  
• Both parties share capital and risks
  
• Helps to meet host country regulations

Demerits:

• Two partners may fail to get along
  
• The firm has to share profits with the partner
  
• Host country’s culture may pose problems

Strategic Alliances

This is a collaborative partnership between two or more firms to pursue a common goal. Each partner in an alliance brings knowledge or resources to the partnership. Such an alliance is generally formed to access a critical capability not possessed in-house.

Offshoring

When the world globalizes, a firm may outsource some of its activities to firms abroad. US firms have been outsourcing many activities for years. Functions that are most often outsourced are those that a firm does not consider integral to its main business and which can be done more efficiently by an outside firm. The prime driver of outsourcing is lower costs – coming primarily as a result of lower wages.

Choosing the Pattern of Expansion

As we observe from the above discussion, there are merits and demerits to all the paths of international expansion. The path to be taken depends on such factors as experience and capabilities of the firm, the cultural and business practices, differences between the home country and host country or laws and regulations in the host country etc.

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Complexity of Global Environment

Complexity is today often considered the latest business buzzword – it reflects a current common reality but not a lasting one. When introducing the complexity concept to executives in globally operating companies, complexity is multiplied to its current heightened level.

Due to Globalisation, many types of boundaries have faded. Trade liberalization allows for a substantially easier flow of goods, capital, people, and knowledge around the globe. The world has moved beyond the key trade markets.

Sometimes abolishing boundaries create new homogeneity in a larger area (e.g. the Euro currency), but mostly it doesn’t. Various motives rank high on the list of possible drivers for foreign expansion, such as learning, spreading risk, gaining access to new customers, realising economies of scale and scope, or optimising one’s value proposition with partners. But the road to the promised land turns out to be more demanding than expected, and complexity is the most common and pervasive challenge that arises.

A core challenge of globalized companies is, complexity cannot be made simple, and it is not going away shortly. Managing complexity must therefore become a core competency of top executives and management. As a first step, it is crucial to understand what drives complexity.

What generates complexity? In our research, we’ve identified four major sources that interact together to create today’s environment. Each of these sources of complexity was created by the erosion of boundaries, but their effects are different from each other.

Diversity

Global organizations face a complex set of challenges characterized by diversity both inside and outside the organization – across every aspect of the business itself and its strategy drivers. Inside the organization, executives must manage and respond to more diversity in the (internationalizing) HR pool; more variety in the management systems; more variation in the means and ends ranging from simple financial goals to a more comprehensive view; and different business models for different types of business units.

Outside the organization, there is higher diversity: heterogeneous customer needs; differing cultural values; a plethora of stakeholders with different claims (investors, customers, employees, regulators, etc.); various political, economic, and legal environments; and finally, competitors’ differing strategies. Most firms today increasingly face each of these types of diversity. Managing the differences is not trivial, and reducing diversity often means being less responsive.

Interdependence

Companies must manage the effect of global interdependence to an unprecedented degree: everything is related to everything else, and the impact is felt more rapidly and pervasively. Value webs have replaced traditional value chains. Reputation, financial flows, value chain flows, top management and corporate governance issues have reached advanced levels of interdependence.

The less clear-cut the boundaries of a company become, the more it is exposed to impacts on the value chain flow through mistakes, frictions, reverse trends, or even shocks. Interdependence creates opportunities for Globalisation, but taking advantage of these opportunities raises difficult challenges.

Ambiguity

The business world today is characterized by too much information with less and less clarity on how to interpret and apply insights. A diversity of accounting standards renders financial figures ambiguous. Studies, scenarios, survey results, and reports become less reliable due to ever-increasing uncertainty. Many businesses find it more and more difficult to discover what their clear value drivers are. Are they image, price, related services, privileged relationships, speed, knowledge, or something else? The cause-effect relationships become blurred.

Flux

As if these three complexity drivers were not enough, managers have to face yet another one, flux or change. Even if you figure out temporary solutions regarding interdependence, diversity, and ambiguity for your specific company, industry, and personal situation, the situation can change the next day. Today’s solutions may be outdated tomorrow. Business environments are increasingly being characterized as being VUCA (volatile, uncertain, complex, and ambiguous). While there are strategies to mitigate risks associated with VUCA, it is impossible to obliterate them.

Many people have tried to simplify complexity, and contemporary management literature is misleading when trumpeting the success factor. Studies typically examine successful companies to see what managers “did”, then conclude that all managers should do the same thing.

As unpredictability makes us uncomfortable, delusions are created about performance as a voluntary matter of choice (companies can choose “to be great”); we like the certainty promised by these solutions. But in an interdependent world, much depends on contingencies, with no clear correction between input and output. Accountability of managers has therefore become an arbitrary element: yes, managers are responsible, but results are influenced by factors beyond their control.

Navigating through this complexity requires a different way of thinking, acting, and organizing than the typical “control” mentality. A long list of advantages lures companies into globalizing. Geographic expansion abroad offers the vast potential benefits of a much larger market arena, spread risks, scope/scale/location-based cost advantages, and exposure to a variety of new product and process ideas.

The practical consequence of complexity is that a managerial dilemma often shapes the decision-making process when there are two or more conflicting legitimate goals to meet demands. Both cannot be simultaneously achieved with the given resources. Companies in the financial service industry set up competing distribution channels, but expect far-reaching cooperation across the company (shared services and product platforms) to reap economies of scale.

In manufacturing, one ongoing dilemma is between global standardization and response to local market needs. Any required priority decision nevertheless results in ongoing tension. As dilemmas cannot be solved, they need to be managed- continuously.

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Industry Analysis

Internal analysis is also referred to as “internal appraisal”, “organizational audit”, “internal corporate assessment” etc. Over the years, research has shown that the overall strengths and weaknesses of a firm’s resources and capabilities are more important for a strategy than environmental factors. Even where the industry was unattractive and generally unprofitable, firms that came out with superior products enjoyed good profits.

Managers perform internal analysis to identify the strengths and weaknesses of a firm’s resources and capabilities. The basic purpose is to build on the strengths and overcome the weaknesses to avail of the opportunities and minimize the effects of threats. The ultimate aim is to gain and sustain a competitive advantage in the marketplace.

Importance of Internal Analysis

Strategic management is ultimately a “matching game” between environmental opportunities and organizational strengths. But, before a firm starts tapping the opportunities, it is important to know its strengths and weaknesses. Without this knowledge, it cannot decide which opportunities to choose and which ones to reject. One of the ingredients critical to the success of a strategy is that the strategy must place “realistic” requirements on the firm’s resources.

The firm therefore cannot afford to go by some untested assumptions or gut feelings. Only a systematic analysis of its strengths and weaknesses can be of help. This is accomplished in internal analysis by using analytical techniques like RBV, SWOT analysis, Value chain analysis, Benchmarking, IFE Matrix, etc.

Thus, systematic internal analysis helps the firm:

• To find where it stands in terms of its strengths and weaknesses
  
• To exploit the opportunities that are following its capabilities
  
• To analyze and find ways to rectify its weaknesses.
  
• To defend against threats
  
• To assess gaps in its capability and take steps to enhance its capabilities to achieve its growth objectives.

This exercise is also the starting point for developing the competitive advantage required for the survival and growth of the firm.

SWOT Analysis

SWOT stands for strengths, weaknesses, opportunities, and threats. SWOT analysis is a widely used framework to summarise a company’s situation or current position. Any company undertaking strategic planning will have to carry out a SWOT analysis: and establish its current position in the light of its strengths, weaknesses, opportunities, and threats.

Environmental and industry analyses provide the information needed to identify opportunities and threats, while internal analysis provides the information needed to identify strengths and weaknesses. These are the fundamental areas of focus in SWOT analysis.

SWOT analysis stands at the core of strategic management. It is important to note that strengths and weaknesses are intrinsic (potential) value-creating skills or assets or the lack thereof, relative to competitive forces. Opportunities and threats, however, are external factors that are not created by the company but emerge as a result of the competitive dynamics caused by ‘gaps’ or ‘crunches’ in the market.

We briefly mentioned the meaning of the terms opportunities, threats, strengths, and weaknesses. We revisit the same for purposes of SWOT analysis.

Strengths

Strength is something a company possesses or is good at doing. Examples include a skill, valuable assets, alliances or cooperative ventures, experienced sales force, easy access to raw materials, brand reputation, etc. Strengths are not a growing market, new products, etc.

Weaknesses

A weakness is something a company lacks or does poorly. Examples include a lack of skills or expertise, deficiencies in assets, inferior capabilities in functional areas, etc. Though weaknesses are often seen as the logical ‘inverse’ of the company’s threats, the company’s lack of strength in a particular area or market is not necessarily a relative weakness because competitors may also lack this particular strength.

Opportunities

An opportunity is a major favourable situation in a firm’s environment. Examples include market growth, favourable changes in competitive or regulatory framework, technological developments or demographic changes, increase in demand, opportunity to introduce products in new markets, turning R&D into cash by licensing or selling patents etc. The level of detail and perceived degree of realism determine the extent of opportunity analysis.

Threats

A threat is a major unfavorable situation in a firm’s environment. Examples include an increase in competition; slow market growth, increased power of buyers or suppliers, changes in regulations, etc. These forces pose serious threats to a company because they may cause lower sales, higher cost of operations, higher cost of capital, inability to make break-even, shrinking margins or profitability, etc. Your competitor’s opportunity may well be a threat to you.