Value Creation Strategies from International Presence- Valutrics
The degree of corporate internationalization has increased, making companies more dependent on their foreign markets. Size has apparently become an important weapon to win against competition and satisfy demanding shareholders, but home-country consolidation is no longeran option. Foreign countries with specific factor endowments can also make the provision of services less costly and in many instances also of higher quality (i.e. faster and more reliable).
Creating value from international presence forces managers to make decisions and solve trade-offs in at least three areas: (a) adaptation versus standardization, (b) market entry speed, and (c) risk versus control.
Adaptation versus Standardization
The adaptation versus standardization trade-off is probably the most difficult to solve in most businesses. To what extent do financial services need to be adapted to local market requirements? Too much local product adaptation would increase product variety and compromise scale and scope effects. Banks often perceive the creation of a new product as not very costly compared to the revenues generated by those products. Many thousands of different certificates are issued every year and only a few of them are sold in more than one national market. Fancy names are developed for them: airbag, double-up, reflex, x-pert, wave, etc. The costs to develop those products are hard to calculate: market research, product design, formal approval by local authorities, IT system costs, product introduction costs such as marketing and the education of the local sales force, to name just a few. To reduce these costs, financial services firms are reducing the complexity of their international product portfolio at the expense of local adaptation.
By answering the question of how much adaptation of products is required and considering the costs of local product differentiation, managers also need to be concerned with the timing of adaptation. Product adaptation, if needed, might be planned and executed before the product is offered in a foreign market or, alternatively, after consumer tests reveal what adaptation is needed after entering the market. Key differences among companies in addressing these questions are most likely dependent on how consumer feedback can be gathered and implemented, as well as the costs of product adaptation and variation. After the introduction of the A-Class series, Mercedes found out that the new model did not pass the Elk manoeuvrability test, and it was costly to repair image damage as well as redesign and re-launch the car. If only a few customers buy the latest certificate on biogas companies, it is quick and relatively easy for banks to modify product features and re-launch a new version of the product.
Extensive market research before product design makes sense in the car industry but would not be appropriate for most banking segments as the lack of prior market research opportunities limits the usefulness of extensive market research. Or in other words, how managers address the adaptation–standardization trade-off depends on the specific characteristics of goods sold.
Market Entry Speed
A second trade-off concerns how quickly a financial services firm should penetrate international markets. Should a firm penetrate a particular market rapidly or slowly? Should a firm enter several markets rapidly or carefully expand from one market to another? The essential trade-off managers face is either speeding up internal market penetration at higher costs and risks or slowing it down and ceding (at least in the short run) market share to competitors who move faster. Key differences among companies in addressing these questions partly depend on how fast consumer feedback can be gathered and changes can be implemented. The marginal costs of re-production of additional services, the transportation costs of goods, as well as the costs of product adaptation and variation have a strong impact on the speed of market penetration. As a result, a web-based bank will be able to penetrate the market faster than a traditional retail bank. Simultaneous market entry in many different countries is also easier to plan and execute.
Risk versus Control
The third trade-off is associated with risk exposure. Reaping returns to international presence requires risk awareness and active management of control, especially for financial services firms as the fall of the Medici Bank or the Barings Bank disaster can attest. The risk of international presence comes from several sources including language and cultural barriers, as well as legal factors, which differ between countries. A firm faces liabilities of foreignness, in essence, the disadvantages a firm faces due to lack of local market knowledge. In addition, risk exposure depends, inter alia, on country- specific resource commitment in assets that cannot be easily divested or redeployed to other markets. There is no easy solution to control for the risks of international presence. For example, to prevent hold-up and deceit by foreign trading partners, a firm might seek control through FDI. This, however, often requires substantial resource commitment to increase asset exposure risks. The essential challenge is thus controlling foreign liability risks without driving up asset exposure risks. Key differences among companies in addressing this third trade-off again depend to a large extent on the characteristics of products sold in international markets. A private banking branch is not as resource-intensive as a retail business and not as risky as investment banking activity.
Digital versus Physical products impact on internationalization strategies
The comparison of IKEA and eBay illustrates how product differences impact internationalization strategies. IKEA, the Swedish furniture retailer, has offered highly standardized, low-cost furniture, in huge suburban stores since its inception in 1940. IKEA started a conservative policy to internationalization entering first Norway (1963) and Denmark (1969), later expanding to Switzerland (1973) and Germany (1974)—all countries culturally similar to the home market in Sweden. Until 1991, IKEA maintained its careful international expansion strategy while leaving products largely unchanged and standardized. It was only in response to difficulties in the United States (1985–1991) that major local product adaptations were made to reflect local tastes. Across all countries IKEA entered slowly, either through wholly owned subsidiaries or through franchising, while seeking reliable linkages to local suppliers to keep risks related to foreign liability and asset exposure low.
Founded in 1995 in the United States, eBay entered language-related markets in the UK and Australia during 1999 and simultaneously the culturally distant German market. Later market presence was established simultaneously during 2000 in Canada, Japan, and France. eBay established presence in the UK, Canada, France, and Italy through hiring local management teams and a combination of grass roots and online marketing programmes. Acquisitions of companies already established in local online auction activities were used in Germany and Korea. The acquisition of IBazar augmented eBay’s presence in France and Italy and established business in Spain, Portugal, the Netherlands, Belgium, Brazil, and Sweden. Alliance strategies were used in Australia and Japan. Throughout its short existence, eBay has constantly adapted auction categories offered to the local markets.
eBay and IKEA are two success stories of international expansion but with substantially different approaches. These examples suggest to generalize the proposition that an internationalization process of a company offering physical products differs substantially from that of digital information goods providers like ING Direct or Egg, the online provider of borrowing, saving, and insurance services. If a producer of physical goods aspires to do business in foreign countries, the internationalization process is most often incremental and slow paced due to a lack of market knowledge.
Market penetration follows a path of increasing commitment, from no regular export activities by agents to establishing own subsidiaries and production facilities. For companies like Egg, the nature of strategic decisions during an internationalization process changes substantially. Decisions on location of sites, logistics, product adaptation, and the level of output have little long-term impact on the company and are easy to reverse. As a consequence, single market entry choices and expansion across markets show fundamentally different patterns. The number and impact of strategic decisions during an internationalization process decreases with an increasing level of digitalization of the products and services of a firm.
The challenge for managers is therefore to assess to what extent their product is digital and adapt their internationalization strategies accordingly. The level of digitalization is just one out of many product characteristics to be considered when planning and executing an internationalization strategy.
Most financial services products are experience goods as they are characterized by the fact that quality and price are difficult to observe before consumption. When getting a simple loan or a mortgage, the most important service parameters can be evaluated before contacting a bank. A mortgage can therefore be classified as a search good. Some financial services products are neither search products nor experience goods, but rather credence goods, that is, many clients are not able to evaluate the performance of the bank even after the experience was made. If a customer invests in a leveraged certificate and gets an annual return of 4.8 per cent, is that good or bad? Market conditions, the construction of the product, the service fees, and other parameters would have to be compared to other products and service providers—an effort that customers make intuitively, but most often not based on objective parameters.
In such situations, brands are extremely important. To offer search goods, providers do not necessarily need a strong brand or a large branch network with competent consultants. Getting a loan is as simple as buying a new laptop at the computer hardware discounter Vobis. Consulting activities are hardly necessary. Creating a pension plan is more complex and requires more sophisticated consulting services and the customer has to have an elevated level of trust in the consultant and the service provider in general.
The description of the characteristics of physical versus digital service goods has made evident the inherent differences between the two categories. Contextualizing internationalization theory with product characteristics modifies and extends existing explanations with regard to entry choices in single markets and internationalization paths across countries. To convert global presence into global competitive advantage, firms with digital product and/or process components may discuss several strategic implications.
Strategy 1: Identify the degree of digitalization of products and activities
It is crucial for companies to assess to what extent their products and business activities are underpinned with digital processes and to what extent the business processes are tied to physical transactions. Decisions on market selection, market entry mode, product adaptation, exploitation of economies of scale and scope, as well as the speed of internationalization differ even within the category of Internet companies. Amazon still relies heavily on physical storage and distribution of goods and is therefore less digitalized than Zopa. Amazon therefore faces different effects of local adaptation of products and services on the company’s cost structure and can realize fewer economies of scale. On the contrary, ING Direct was able to use a high degree of digitalization to its advantage. Search goods, such as a mortgage loan, that do not require a high level of trust, can be processed significantly faster, saving face-time for the customer and the company. As a result, the application for a mortgage loan usually takes seven minutes on average to fill out, is absolutely paperless due to full automation, and no bank fees are charged. ING Direct was able to offer higher interest rates for simple savings accounts to its customers, which increased its product attractiveness.
Even in the cement industry, differences in the degree of digitalization of the value chain activities and products may be observed. The Mexican cement producer CEMEX is well known for its strongly developed IT systems that connect its plants with a network of subsidiaries as well as business partners. The competitive advantage CEMEX gains from the digitalization of its business processes impacts the acquisition processes during international expansion. CEMEX has a fast and radical post-merger integration process of 8 to 12 months compared to its competitors Heidelberg Cement and Holcim, which both integrate their acquisitions with a 5–10-year horizon using a process of incremental improvement.
Traditional retail banking is more cost-intensive regarding marginal cost and requires people on site to serve the client. This does not apply for ING Direct as due to its high level of digitalization, ING Direct does not have many physical costs. Once the initial fixed costs are set, there are low marginal costs in reproduction of services, as mentioned in the previous section. This strengthens its position as a financial discounter and enables a faster market entry as well as penetration. It can also apply to faster product development and tailoring of services to the customer due to the possibility of direct or quicker customer feedback.
Strategy 2: Select foreign markets for entry that have high Internet penetration
Digital service goods providers should plan their market entry strategies according to the availability of advanced information and communication technologies, considering as well the use of those technologies by consumers.
The size of the potential market matters more than the cultural distance of the target countries. The presence of strong competitors often indicates that there is a market to attack and may therefore be seen as a positive signal for entry. It can be more costly for digital information goods providers to develop a market from scratch than to gain market share from existing competitors. Highly digitalized firms choose their locations according to government incentives and human resource availability rather than proximity to customers or logistical infrastructure. eBay, for example, entered the German market with headquarters in Kleinmachnow near Potsdam in the eastern part of the country. The rate at which Yahoo! has spread internationally is astounding, with three to four countries entered annually. The first European headquarters was founded in London in September 1996, and just a month later Yahoo! entered France and Germany. Japan came next. ING Direct started its internationalization process in Canada in May 1997, entered both Australia and Spain in August and October 1999, respectively, followed by France in March 2000 as well as the United States in September of the same year. Finally, it entered Italy in 2001. This list shows that markets were chosen that are big and have a developed ICT infrastructure. Geographical proximity was not an issue.
Strategy 3: Enter new markets with low-cost but high-control modes
Markets for digital information goods often show instantly high growth rates due to the introduction of new technologies or other favourable market conditions. It is therefore important to be present with a local organization when the market takes off. However, due to the specifics of the business, it is not necessary to develop full-blown local subsidiaries. Yahoo!, for example, has hardly used acquisitions to open a new subsidiary and has always built local headquarters from scratch, making greenfield investments that could be kept low by making start-ups with no more than 10 people per subsidiary. Yahoo! only considers acquisitions for the purpose of boosting its online product development, as seen with the purchase of Geocities. With this acquisition in 1999, Yahoo! reached the largest possible community of people who created their own websites. Digital information goods providers can make small-scale foreign direct investments and thereby combine high control with low-cost entrance strategies. It is necessary to achieve highcontrol entry modes because of the crucial aspects of branding and access to a local customer base. Contractual agreements like licensing or franchising are difficult to develop due to the risk of losing control over the brand or customer base. Partnerships accelerate international market development but need to be managed carefully. The web of inter-firm networks should not lead to a dispersion of control over the brand and customer base.
ING Direct chose to enter the Canadian direct retail bank market using an organic growth mode. The risk attached to that strategy was twofold: on the one hand, ING Direct had no experience in starting direct online retail banking from scratch. Furthermore, no financial services firm had yet positioned itself as a discounter and demonstrated that a low-cost strategy with high volumes would work in the direct retail banking sector. But that is exactly what ING Direct pursued at the beginning of 1997 in the Canadian banking market which was mature, middle-sized, and overbanked.
Electronic banking was just in its beginnings. But customers were sensitive to low interest rates and high service charges. ING Direct believed it could be successful by acquiring a strong customer base through a price leadership strategy and delivering high service at the same time. This resulted in a branchless banking and customer support via telephone service 24 hours per day and 7 days a week. That keeps operational costs low and can be converted into high interest rates for clients and no service fees charged. Despite the subprime crisis hitting the markets, ING Direct became the first mutual fund dealer in Canada in 2008 that offers paperless application to its clients regarding a new index-based product called ‘Streetwise-Fund’. After four years of operating in Canada, ING Direct reached the break-even point in 2001 and grew until 2008 to become Canada’s largest direct bank serving 1.5 million customers with around USD 23 billion in total assets. As mentioned previously, ING Direct reached break-even in the larger US market after two years of entry and it became the largest online bank in the country after just six years.
Strategy 4: Value customer learning as high as company learning
It is often more difficult for customers to get acquainted with the products and services of the digital information goods provider than it is for the company to learn about the local preferences and adapt accordingly. The liability of foreignness firms face still matters but can be seen as a bilateral phenomenon with a focus on customer learning rather than company learning. Post-entry product adaptations can be done rapidly due to quick customer feedback and the use of a mix of global content and locally adapted elements. Local adaptations can be developed with a network of independent local content providers as shown by Yahoo!. The cost–benefit decisions of local adaptation can be made in a flexible way without increasing fixed costs. Building on a central technical infrastructure, local product adaptation is done in a disciplined way. Yahoo!’s policy regarding content is straightforward: translate it into the local language. The local news is taken from trusted news agencies like ANSA, Reuters, etc. and interventions are made only in extreme cases. Other topics are simply adjusted to country characteristics. There are some dedicated producers who take the standard technical structure of a yahoo.com product, and then change its content, an example of which is Yahoo! Cinema.
In the United States, the hot period for films is August, which is different from Europe. The control that Yahoo! headquarters has on subsidiaries is even clearer once we look at how there is no freedom of choice whatsoever for graphical aspects of the website. All texts have to be approved, and even if one country offers an extra online product, all of its pages have to be checked for colours, text, and writing style to get the go-ahead. This way, local adaptation can be achieved without losing the benefits of global integration. However, this procedure eventually slows production. In Italy, a special Formula 1 section was put on the web only after having undergone strict control from headquarters and several weeks of discussions.
ING Direct’s strategy was to offer a fairly standardized set of products and helped the customers to appreciate their services. The online provider did not make strong efforts in trying to understand customers’ needs but emphasized the importance of facilitating customer learning, or as the CEO of ING Direct, Arkadi Kuhlmann, once stated: ‘To some extent, you need to reengineer the customers as well’. Customers that were not able or willing to understand and follow the service procedures of ING Direct were ‘kindly asked to move their business elsewhere’. To rely too much on call centres and to ask for too many exceptions from the standard is generating too many costs.
Strategy 5: Leverage learning from customers by developing a highly interactive subsidiary network
Once a country is picked, Yahoo! staffs with strictly local people. New employees must undergo a rigorous training programme that introduces them to the Yahoo! world and culture. Those in technical positions are sent on a 10-day course in London or the United States, while employees who will work in less specific positions will follow a 3- to 4-day training programme at headquarters. There they learn everything about the company. This rigorous training programme demonstrates the strength of headquarters’ control over subsidiaries. Local subsidiaries are built up by local managers, supported in the first year by an experienced start-up manager from headquarters. To manage operational business, Yahoo! started a weekly report activity for subsidiaries that has now become routine. These are reports of all kinds; each and every employee prepares a report on the closing and coming week’s activities to be given to the head of that specific subsidiary, who then summarizes them and prepares one of his own. This last report is finally sent to the country head who, after having read all of the other reports from the other country subsidiaries, makes the final country report. There are frequent conference calls with London and the United States in which all employees participate. There are also some functional meetings every three months where data and strategy analyses are made, and a regular European conference call appointment was set last year. Yet, these are only a few of the ways that Yahoo! keeps its employees up to date with what is going on inside the company. The need for all of these intra-company communications resides in the fact that Yahoo! now boasts more than 400 people working for the company in Europe alone.
To optimize the costs for its IT architecture, ING Direct tries to keep the different subsidiaries in close contact. This also facilitates a smooth process flow as information is retrieved from diverse departments at the same time. ING, the traditional banking parent of the online firm, is eager to create synergies between its different businesses across countries. The CEO of ING Direct declared its general willingness to comply with this request and increase the cross-border synergies—but not at any price. Too high a level of integration within the traditional ING business might damage the rebellious and differentiated image of the company. To be innovative, ING Direct attempted to leverage the learning among its own subsidiaries but kept a certain distance from its traditional parent company businesses.
Strategy 6: Penetrate foreign markets rapidly—but not at all costs
In their international expansion phase, most digital information goods providers entered three to four markets each year. Extending their global reach, they manage to benefit from economies of scale in production and demand (positive network externalities). Even though the credo of the late 1990s ‘get big fast or it will be too expensive to build later’ may not have proven completely accurate, it is still essential to cover international territory quickly, but not at all costs. One can frequently observe that small firms operate internationally early in their existence despite limited resources and capabilities. Early-mover advantages can come from network externalities (i.e. the more users are part of the eBay platform, the more valuable the eBay service is for the single user) as well as customer switching costs (e.g. when switching from eBay to Yahoo!, an individual trader would lose his trading history and associated reputation). However, experience shows that new entrants may win over local competition and lure customers away without necessarily buying them. New entrants use the technological superiority of their products and their speed in new product development. Successful digital information providers show competitive entry patterns that have the creation of a differentiation advantage through marketing, innovation, product quality, or service at their core. Differentiation through innovative products is often combined
with a clearly focused strategy on niche markets. ING Direct steadily increased its stake in the German DiBa AG throughout 1998–2003 when full ownership was reached. ING Direct penetrates these markets executing an approved low-cost leader strategy which is mainly achieved by efficient application of IT and aggressive marketing which are valued as core competencies. A complete distribution via Internet or telephone contributes to an efficient cost structure. ING Direct was able to quickly acquire customers attracted by differentiation advantages such as simple and easy products, high-paid interest rates, no minimum balances, no fees or service charges. At the same time high-quality service was provided through a call centre open 24 hours a day. Eighty per cent of incoming calls were answered in 20 seconds and customers were never redirected. The processing speed is even tied to an employee bonus. Employees receive a broad and intensive training covering 5 products in 20 days. These and other measures helped ING Direct to gain a certain level of market share to be able to afford their infrastructural investments.