Business Environment of IKEA, Market Entry Modes, Impact of Entry Mode on Business Operations - Example

Business Report of the of the No. Contents Introduction 3 Literature Review 3 Business Environment of IKEA 3 Types of Market Entry Modes 5 Impact of Entry Mode on Business Operations and Success 6 Company Analysis 7 IKEA and its Business Internationalization 7 Business Position in Home and Foreign Country 8 Analysis and Discussion 9 Reasons of Expanding in Chinese Market 9 Modes of Entry 10 Conclusion and Implication 11 Introduction In the contemporary era, multinational companies conduct business operations according to transaction cost economies resource based view. According to this approach, the companies try to exploit their industrious resources in foreign markets after saturation of their domestic market’s demand. Companies of the modern era try to gain higher competencies in business by expanding the scope and scale of their internationalization process. By expanding business in foreign marketplaces, multinational companies increase their aggregate profitability and revenue in trade. This business report will throw light on the internationalization process of a popular multinational company originating from a western developed economy. The company chosen is IKEA and its current registered headquarters is at Leiden, Netherlands (IKEA Group, 2013a). This paper will focus on the evaluation of the international business expansion strategies implemented by the company. Many multinational companies based on western developed economies are presently expanding the scale of their operations in the Asian countries. From 1990 onwards, several Asian economies have experienced significant productivity growth due to increased industrialization (Abeles, 2001). These countries were primary agrarian economies in nature. After globalization, increased foreign direct and institutional investments expanded the industrial and tertiary sectors of these economies (Bloom & Finlay, 2008). Such circumstances enhanced the domestic demand and employability in these Asian countries and ultimately made these economies attractive investment hubs for western multinational companies. However each multinational company has selected dissimilar market entry modes for entering in different Asian markets. This business report will evaluate IKEA’s business expansion in China. China is an emerging Asian developing economy and is regarded as the primary investment hub for many multinational companies. The report will elaborate the market entry strategy utilized by IKEA in China and assess rationality of selecting a particular market entry approach. Finally the success of the company’s business expansion in China will be evaluated at the end of the business report. Literature Review Business Environment of IKEA IKEA is a multinational company and conducts its business in a global environment. The external business environment of the organization can be evaluated through the PESTEL model. Political IKEA’s trading affairs are subjected to the legal and political norms of different economies. The company pays different excise and corporate taxes across its different international marketplaces. However political authorities impose lower legal restrictions on the companies performing business in the furniture industry. IKEA gets adequate funding and grants from the political authorities of some developing countries such as Brazil and China (Isaksson & Suljanovic, 2006). The government authorities of these countries attract foreign investments for experiencing greater domestic productivity and employability in the long run. Economical The domestic market of IKEA is financially strong in the global forum. After the global financial crisis, the aggregate discretionary spending power of the consumers of several developed countries has declined (Hirsch, 2008). This has lowered the demand for comfort products such as furniture, in these countries. Most of the multinational companies are extending their business operations in Asian countries such as India and China for experiencing lower costs in operations (Bloom & Finlay, 2008). Considering the trends of global economic environment, IKEA is making strategic attempts to expand business in the emerging Asian economies such as China. However being a multinational company, IKEA is subjected to currency and exchange rate fluctuation issues. Social The aggregate disposable income thresholds of almost all economies have increased over time. Increased per capita income levels have improved the living standards of contemporary consumers. Under such circumstances, the demand for comfort products such as furniture has increased in the current epoch. However modern consumers prefer to consume eco-friendly sustainable products and services in business (Jonsson, 2008). Furthermore, the taste and preference patterns of European or other western buyers are significantly different from the demand features of Asian consumers. Social changes have helped to stimulate IKEA’s profit and global market share. The company implements new ways to manufacture economically sustainable products in the market but applies differentiated internationalization strategy in business. Technological The technological knowhow has significantly improved across all the major industrial segments in the modern era. Multinational companies try to differentiate their products and services with the essence of innovative technologies. Companies make large research and development investments for experiencing the competitive advantage of their patent technologies. IKEA also used creative technologies for lowering production costs and improving product competency in the global market. However the company needs to bear the expenses of patenting and legally protecting its unique technologies in the industry. Technological innovation has helped to improve global communication facilities. Better communication has facilitated IKEA’s business internationalization process (Isaksson & Suljanovic, 2006). Environmental Consumers of both developed and developing economies prefer to experience an environment friendly lifestyle. The political authorities of different countries provide additional incentives to the multinational companies against their environmental sustainable activities. However the environmental regulations are different for each economic system. IKEA tries to become environmentally responsible for enhancing its brand value in the market and augmenting the utility level of its business stakeholders (Isaksson & Suljanovic, 2006). Legal The behaviour of multinational companies is significantly affected by the changes in the legal norms of each country. The recent legal changes introduced by the European Union have affected IKEA’s business. The company is subjected to stricter labor regulations after these changes. Over time, the consumer protection rules have also become more rigid in each country. However the legal authorities of almost all the countries encourage multinational companies to maintain greater diversity at workplaces. IKEA follows the legal regulations of its domestic as well as foreign marketplaces (Isaksson & Suljanovic, 2006). The company encourages lower discrimination and greater diversity within all its global workplaces. Types of Market Entry Modes Multinational companies select their own specified market entry mode on the basis of execution risk, commitment and control of resources each entry method necessitate and investment returns they ensure to provide. Primarily there are two types of market entry modes, namely: Non-equity mode Equity mode International contractual agreements and exporting are types of non-equity market entry approaches. On the other hand, joint venture and subsidiary based business internationalization strategies are types of equity based market entry approaches (Cuñat & Fons-Rosen, 2009). Exporting Products manufactured in a particular country are sold to other foreign economies through the process of exporting. Advantages and Disadvantages A company can expand business internationally with relatively lower cost through exporting. It experiences economies of scale and greater profit margin through this method of market entry (Janicki & Wunnava, 2004). However the process of exporting can often be expensive due to unfavourable transportation costs. Even so, a company gain limited knowledge about the external environment of foreign economies through the process of international business (Cuñat & Fons-Rosen, 2009). Licensing Through the process of licensing, a company (licensing firm) provides certain patents, copyrights or trademarks to another firm (licensee) in the foreign market (Janicki & Wunnava, 2004). Against the legal consent, the foreign company produces and sells the products of the licensing firm in the foreign country. Advantages and Disadvantages Licensing is a low risk involving business internationalization approach. This method is primarily practiced by the public authorities of foreign countries for improving the state of technology in a particular country. However through licensing, a multinational company lack practical experience of conducting business in a foreign economy (Janicki & Wunnava, 2004). The legal costs involved in preparing licensing agreements are often high in nature. Joint Venture In a joint venture business, a multinational company enters into an equity based partnership with another company in a foreign country, where it intends to expand its business (Janicki & Wunnava, 2004). After the enactment of the business partnership, a third new firm is established in the foreign market. Advantages and Disadvantages Through this mode of international market entry, a company maintains a better control over its operations in the foreign market (Janicki & Wunnava, 2004). At the same time, the organization experiences lower risk in commerce with the help of the overseas partner’s business expertise in the foreign market. However the trading liabilities in the form of debts and obligations increase after establishment of a joint venture business agreement. Conflicts and legal disputes are often encountered between international venture business partners (Wheeler & Mody, 2000). Direct Investment Under this regime, a company makes a fresh Greenfield investment in a new foreign market. The organization establishes its own manufacturing unit through a direct investment method (Janicki & Wunnava, 2004). Apart from Greenfield investment, direct investment can also be practiced by a company through direct business acquisition. Advantages and Disadvantages Inflow of increased foreign direct investments helps to enhance the employability in the host country. Direct investments help to improve a company’s internal technological knowhow and infrastructure. It also lowers the operational cost of an organization due to economies of scale in manufacturing process. The investment cost involved in a direct investment process is often high (Pettis, 2013). The gestation period of such investments are long and involves business internationalization risks. Impact of Entry Mode on Business Operations and Success The effectiveness of a particular market entry mode depends on four primary factors. Transaction Asset Specificity These are types of investments having only one or few specific uses. According to this approach, international entry modes offer greater and more efficient control for proprietary processes and products (Johnson, 2013). Entry modes involving greater control are more proficient for customized user specific products. External Uncertainty It measures the extent of unpredictability experienced by an entrant, in the external business environment of a new market. The extent of unpredictability and uncertainty depends on the economic and political uncertainty of the new marketplaces (Johnson, 2013). Internal Uncertainty The uncertainty arising from the inability of the company in determining the performance of the agents based on output measures. The level of internal uncertainty in any foreign market (experienced by company) declines with the level of cumulative foreign business experience (Johnson, 2013). Free Riding Potential It measures the ability of an agent to obtain the benefits without experiencing the connected costs. According to this method, the foreign entry modes involving greater extent of control are more efficient if the brand value of a company is high in the market (Johnson, 2013). Company Analysis IKEA and its Business Internationalization IKEA designs, manufactures and sells assembled furniture across its domestic and foreign marketplaces. The organization commenced its business from 1943 onwards and has significantly expanded the scale of its internationalization over time (IKEA Group, 2013c). IKEA is known as the biggest home furniture manufacturing company in the world. At present the company offers its services in more than 38 countries around the world and owns approximately 325 retailing outlets in the global forum (IKEA Group, 2013c). The company proclaims to sell good quality products at economic prices to its prospective customers. Apart from assembling furniture, IKEA has its own restaurants in some marketplaces. Upholstered furniture, kitchen equipments, curtains, boxes, lights and bathroom articles are the primary products traded by IKEA. The company entered in the U.S. market long back in 1984. It sells its products in almost all the major western economies such as Germany, England and Italy. Most of its raw materials are procured from China, Italy and Germany (Hertz & Hultman, 2008). However after 1990 onwards, IKEA is making strategic attempts to expand its business in the developed and developing Asian economies of the world. As estimated in 2013, 6% of the gross revenue generated by IKEA is procured from its Asian marketplaces (Peltonen, Sousa, & Vansteenkiste, 2012). However Chinese market is considered to be the best Asian market for IKEA. IKEA had first opened its Chinese business branch in Beijing in 1998 (IKEA Group, 2013c). The store was re-constructed and designed in 2006. In 2005, IKEA opened its second Chinese retailing store in Guangzhou (IKEA Group, 2013c). China is considered to be a prospective foreign market for IKEA because the level of economic development and living standards is improving in the country over time. Business Position in Home and Foreign Country The following position map elaborates the primary global competitors of IKEA (both in home and foreign marketplaces) Figure 1: Position Map (Foreign) IKEA High Quality Wal-Mart Cratel & Barrel Low Price High Price Conrin Low Quality (Source: Author’s Creation) The above figure shows the potential domestic and foreign market rivals of IKEA. IKEA claims to provide high quality products at relatively lower prices in the market (IKEA Group, 2013b). The following position map shows the market position and primary competitors of IKEA in China. Figure 2: Position Map (China) IKEA High Quality Royale Furniture Holdings Limited Colorlife Wal-Mart Low Price High Price Low Quality (Source: Author’s Creation) The local Chinese furnishing companies and some other multinational furniture retailing firms are the primary business rivals of IKEA in China. The rational consumers of China often prefer to purchase the low priced products of companies such as Royale Furniture Holdings Limited instead of the products offered by IKEA. In both the domestic and foreign markets, IKEA is known to provide unique non imitable products at affordable prices (IKEA Group, 2013b). However the organization conducts its operations in a highly competitive business environment. Analysis and Discussion Reasons of Expanding in Chinese Market IKEA desired to expand its business in China due to the following primary reasons. China is the most populated country of the world and hence experiences highest domestic market demand The aggregate employability and per capita income levels of the Chinese consumers is significantly improving over time The public authorities of China are introducing more liberal trading policies on the foreign companies IKEA experiences lower operational cost in the Chinese market The living standards and discretionary spending propensity of the Chinese consumers are significantly improving over time The Chinese furniture industry in booming and experiencing steadily increasing market demand in the current epoch Modes of Entry Joint Venture IKEA first entered in the Chinese market in 1998, through a joint venture. The company’s venture business in China was materialized with its partnership with a local Chinese furniture manufacturing company. The joint venture was done by opening up a furniture retailing outlet in Shanghai. The venture business concern acquired the land for the Shanghai store from the government of China. Later on, through the joint venture business IKEA opened up other retailing outlets in Beijing and Guangzhou. It was rational for IKEA to select the joint venture means of market expansion in China, subjected to the legal norms introduced by the Chinese government authorities. The government of China encouraged inward oriented policies in the 19th century (Bloom & Finlay, 2008). Under this regime, any foreign company was allowed to conduct business in China only through a partnership deal with any local company of China (Isaksson & Suljanovic, 2006). The public authorities had introduced this norm for protecting the interests of the domestic firms of China (Abeles, 2001). Thus IKEA could enter in the booming economy only through a venture business. Direct Investments Foreign companies were allowed to establish their own independent business subsidiaries in Chinese marketplaces. After China attached itself with the World Trade Organization (WTO), Chinese government undertook more liberal policies in international trade since then. After China’s link with WTO, IKEA completely purchased the shares of its venture business and started to expand its own independent business in China through further direct investments (Isaksson & Suljanovic, 2006). These direct investments are portfolio investments in nature. At present, IKEA is expanding the scale of its operations in China by increasing the number of its wholly owned subsidiaries in the country. Thus IKEA has entered in the Chinese market initially through joint venture and later through expansion in the number of its wholly owned subsidiaries in its economy (Isaksson & Suljanovic, 2006). Advantages and Disadvantages of IKEA’s Joint Business in China Through the joint venture business IKEA could enter into the lucrative market of China, long back in 1998. After establishing a venture business, the productive tangible and intangible resources of IKEA and its local business partner in China had considerably increased. The company could launch giant retailing outlets in the busy and most strategic business locations of China, with the help of these resources (Tucker, 2010). Even so, the company gained knowledge about the Chinese market from its local venture business partner of China. The risks experienced by the company for international business expansion were relatively low due to the joint venture business deal. However it took adequate time for making the venture business relationship successful in China. The corporate and business level strategies of IKEA and its local Chinese business partner were different. The commercial prosperity of the company in China significantly depended on its venture business partner (Groh & Wich, 2012). Advantages and Disadvantages of IKEA’s Wholly Owned Subsidiary Growth in China Through the wholly owned subsidiaries, IKEA is able to control the procurement prices of its raw materials more efficiently than before. The company does not need to share its economic surplus with any other local firm of China. The subsidiaries of IKEA in China enjoy greater tax benefits at present (Donald & Schindler, 2003). Moreover the company has gained greater experience through this approach of business expansion. However IKEA often do not have absolute access to the cash flow of its auxiliaries in Japan. Despite of any legal obligations, IKEA often pays additional debts to its Chinese subsidiaries, for maintaining their brand image in the market. The cost of maintaining standardized legal and organizational norms in all the independent subsidiaries is often high (Casson & Wadeson, 2012). Conclusion and Implication A multinational company can successfully increase its revenue and profitability with the help of successful business internationalization. By expanding business beyond domestic limits, a company can experience increased market demand and brand value within its own competitive industry (Donald & Schindler, 2003). However success of a company’s international expansion significantly depends on the external business environment of a particular country. The above business report shows that IKEA is a successful multinational organization. The company strategically determines the path of its internationalization process. The organization is now expanding its business in the Asian market because many emerging Asian countries such as China and India is experiencing significant rise in domestic demand and employability at present (Bloom & Finlay, 2008). The government authorities of these economies have also introduced liberal policies for foreign companies. However the report shows that the mode of market entry adopted by a multinational company significantly depends on the external environment of a particular economy. IKEA selected a joint venture mode of entry in China, long back in 1998 (Jonsson & Foss2011). At that point of time, the government of China allowed foreign firms to enter in its economy only through a contract with local company of the country. However when such legal norms were abolished in the country, IKEA started to expand its business through wholly owned subsidiaries in China. However each mode of entry generates a corresponding positive and negative impact over a company. A multinational organization must select the entry mode according to its net benefit. References Abeles, T. P. (2001). Impact of Globalization. On the Horizon, 9(2), 2 – 4. Bloom, D. E. & Finlay, J. E. (2008). Demographic change and economic growth in Asia. HSPH. 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