Introduction

According to the International Monetary Fund’s Balance of Payments Manual, “FDI is an investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of the investor, the investor’s purpose being to have an effective voice in the management of the enterprise”. 

Foreign direct investments (FDI) in wholly owned manufacturing subsidiaries are considered by global firms for many reasons. It is done for acquiring raw materials, operate at lower manufacturing cost, for avoiding tariff barriers and satisfy local content requirements, and for penetrating the local market.

Manufacturing of FDI is very beneficial for market penetration. It helps in local production means price escalation caused by transport costs, local turnover cost custom duty fee can be either nullified or can be reduced. Generally the resellers are being assured for the availability of the product, minimizing the channel conflicts, eliminating delays for ultimate buyers. Location of the production may help the country which may lead to more uniform quality.

There are several problems or demerits to FDI in manufacturing, among which the main is the risk exposure that comes with the resource commitment on the scale usually needed. Joint ventures are also not free from this type of commitment and risks since most agreements stipulate heavy costs for one partner’s withdrawal. There is potential problem in overseas manufacturing when country – of – origin effects are strong.

Companies entering foreign markets have to decide on more than the most suitable entry strategy. They also need to arrange ownership either as a wholly owned subsidiary in a joint venture or more recently in strategic alliance.

Foreign manufacturing strategies with direct investment include:

1. Joint Ventures,

2. Strategic Alliances,

3. Merger,

4. Acquisition,

5. Wholly-Owned Subsidiary,

6. Assembly Operations, and

7. Integrated Local Manufacturing.

1. Joint Ventures

A joint venture is any kind of cooperative arrangement between two or more independent companies which leads to the establishment of a third entity organisationally separate from the “parent” companies.

Whilst two companies contributing complementary expertise might be a significant feature of other entry methods, such as licensing, the difference with joint ventures is that each company takes an equity stake in the newly formed firm. The stake taken by one company might be as low as 10 per cent but this still gives them a voice in the management of the joint venture.

A joint venture may be the only way to enter a country or region if government contract negotiation practices routinely favour local companies or if laws prohibit foreign control but permit joint ventures. Besides operating to reduce political and economic risk, joint ventures provide a less risky way to enter markets with regards to legal and cultural issues than would be the case in an acquisition of an existing company The strategic goals of a joint venture are focused on the creation and exploitation of synergies as well as the transfer of technologies and skills. The equity share of the international company can range between 10% and 90% but is generally 25-75%.

Joint venture is a very important foreign market entry and growth strategy employed by Indian firms. It is an important route taken by pharmaceutical firms like Ranbaxy, Lupin and Reddy’s, etc. In several cases joint ventures, as in the case of foreign subsidiaries, help Indian firms stabilize and consolidate their domestic business, besides the expansion of the foreign business. Esser Gujarat’s joint ventures in countries like Indonesia and Bangladesh to manufacture Cold Rolled (CR) steel have resulted from a strategy to create an assured market for its Hot Rolled (HR) coil mother plant at Hazira (HR coils are inputs for manufacturing CR steel products).

Essel Packaging has taken the joint venture route to expand its business abroad. The joint ventures abroad convert the laminate into tubes to be marketed in foreign markets. The centralization of the laminates production in India enables the company to reap enormous economies of scale.

The high cost of transportation of tubes over laminates makes the conversion at laminates into tubes in the foreign markets more profitable. Further, the establishment of tube production facilities in foreign markets helps to pre­empt competition.

The liberalization of policy towards foreign investment by Indian firms along with the new economic environment seems to have given joint ventures a boost Not only the number of joint ventures is increasing, but also the number of countries and industries in the map of Indian joint ventures is expanding Further liberalization, like enhancement of the investment limit of automatic clearance, is needed for a fast expansion of the Indian investment abroad.

Characteristics of Joint Venture

1. Critical Driving Forces

There should be compelling forces which push the alliance together. Without these forces, there is no true reason for the alliance.

2. Strategic Synergy

There should be complementary strengths – strategic synergy – in the potential partner. To be successful, the two or more participants must have greater strength when combined than they would independently. Mathematically stated; “1 + 1 > 3” must be the rule; if not, walk away.

3. Great Chemistry

There should be co-operative efficiencies with the other company. There should be a co-operative spirit. There must be a high level of trust so that executives can work through difficulties that will arise. Don’t “sell” your company’s “beauty”, it must be desired by the prospective partner, not sold.

4. Win-Win

All members of the Alliance must see that the structure, operations, risks and rewards are fairly apportioned among the members. Fair apportionment prevents internal dissension that can corrode and eventually destroy the venture.

5. Operational Integration

Beyond a good strategic fit, the there must be careful co-ordination at the operational level where actual implementation of plans and projects occurs.

6. Growth Opportunity

There should be an excellent opportunity to place the company in a leadership position – to sell a new product or service, to secure access to technology or raw material. The partner should be uniquely positioned with the “know-how” and reputation to take advantage of that opportunity.

7. Sharp Focus

There is a strong correlation between success of a venture arid clear overall purpose – specific, concrete objectives, goals, timetables, lines of responsibility and measurable results.

8. Commitment and Support

Unless top and middle management are highly committed to the success of the venture, there is little chance of success

Reasons for Joint Ventures

1. Cost Savings

A common rationale is the objective of saving costs by- achieving synergy benefits through rationalization of employment or other fixed costs or by sharing with a joint venture partner or partners the costs of Research and Development (R&D) or capital investment programmes (a particular feature given the magnitude of investment costs involved in many industries such its electronics, defense, pharmaceuticals, telecommunications and aero engines).

2.Risk Sharing

A similar rationale behind many ventures is the wish to share with another party or parties the significant financial risks which may be involved in undertaking a speculative or capital intensive project. Projects of considerable size, such as power stations and other natural resource or infrastructure projects, are frequently undertaken as joint venture projects.

3. Access to Technology

Joint ventures may provide a route for a party to gain access to and learn from, a co-venture’s technology and skills and thus accelerate entry into a particular technology or market. Joint ventures are common in industries where technology plays a key role and where that technology is rapidly changing. Technical skills and experience often comprise “organisationally embedded knowledge” where the resource is inherently tied to the organisation and cannot be easily extricated. In these cases, integration of the two organisational structures through a joint venture is necessary for the parties to gain effective access to their respective technical experience.

4. Expansion of Customer Base

International joint ventures can provide the most effective route for a party to expand the scope of its customer base by utilizing a co-venture’s strength in different geographic markets or by buying into a co-venture’s distribution or sales network.

5. Entry into Emerging Economies

Joint ventures may also provide the best and sometimes only realistic, route for gaining entry to new emerging markets in areas such as Eastern Europe or Asia where access to local knowledge, contacts or sponsorship is often a practical necessity.

6. Entry into New Technical Markets

The rapid pace of technological change is itself producing new markets. Effective entry into those markets can often be accelerated by participation with another company which already has a technical start in that field or provides complementary skills; a “go-it-alone” strategy may simply take too long or cost too much.

7. Pressures of Global Competition

On an international scale, the merger of similar businesses between two or more participants may be desirable in order to establish the economies of scale, global customer reach, purchasing power or capital investment resources necessary to meet the strength of international competition.

8. Leveraged Joint Venture

Joining forces with a financial partner can be a method of financing an acquisition which would not otherwise be affordable – or, sometimes, structuring art acquisition in a way which can avoid consolidation of the acquired business as a subsidiary for balance sheet purposes.

9. Creeping Sale or Acquisition

A joint venture may be first step in an eventual full disposal or acquisition of a business – with a further tranche of the disposal or acquisition being contemplated, but perhaps not specified, for a later time.

10. Catalyst for Change

Sometimes there is a less obvious reason – perhaps simply a wish, by bringing in a partner, to create a catalyst for change or to stimulate more entrepreneurial activity in a particular area of a party’s business.

Advantages of Joint Ventures

1. Joint ventures provide large capital funds. Joint ventures are suitable for major projects.

2. Joint ventures spread the risk between or among partners.

3. Different parties to the joint venture bring different kinds of skills like technical skills, technology, human skills, expertise, marketing skills or marketing networks.

4. Joint ventures make large projects and turn key projects feasible and possible.

5. Joint ventures provide synergy due to combined efforts of varied parties

6. They have more direct participation in the local market and thus gain a better understanding of how it works

7. Companies entering joint ventures are able to exert greater control over the operation of the joint venture.

Disadvantages of Joint Ventures

1. Joint ventures are also potential for conflicts. They result in disputes between or among parties due to varied interests. For example, the interest of a host country’s company in developing countries would be to get the technology from its partner while the interest of a partner of an advanced country would be to get the marketing expertise from the host country’s company.

2. The partners delay the decision-making once the dispute arises. Then the operations become unresponsive and inefficient.

3. Decision-making is normally slowed down in joint ventures due to the involvement of a number of parties.

4. Scope for collapse of a joint venture is more due to entry of competitors, changes in the business environment in the two countries, changes in the partners’ strengths etc.

5. Life cycle of a joint venture is hindered by many causes of collapse.

6. The other disadvantages of this form of market entry compared to, e.g., licensing or the use of agents is that a substantial commitment of investment of capital and management resources must be made in order to ensure success. Many companies would argue that the demands on management time might be even greater for a joint venture them for a directly owned subsidiary because of the need to educate, negotiate and agree with the partner many of the operational details of the joint venture.

2. Strategic Alliances

Whilst all market entry methods essentially involve alliances of some kind, during the 1980s the term strategic alliance started to be used, without being precisely defined, to cover a variety of contractual arrangements which are intended to be strategically beneficial to both parties but cannot be defined as clearly as licensing or joint ventures. Bronder and Pritzl have defined strategic alliances in terms of at least two companies combining value chain activities for the purpose of competitive advantage.

A Strategic International Alliance (SIA) is a business relationship established by two or more companies to co-operate out of mutual need and to share risk in achieving a common objective. Strategic alliances grew in importance over the last few decades as a competitive strategy in global marketing management.

SIAs are sought as a way to shore up weaknesses and increase competitive strengths. Opportunities for rapid expansion into new markets, access to new technology, more efficient production and marketing costs, strategic competitive moves and access to additional sources of capital are motives for engaging in strategic international alliances. Finally, there is some evidence that SIAs often contribute nicely to profits.

Strategic alliance is also sometimes used as a market entry strategy. For example, a firm may enter a foreign market by forming an alliance with a firm in the foreign market for marketing or distributing the former’s products. For example, Tata Tea had entered in to a strategic alliance with Tetley for marketing tea abroad. Later, Tetley was acquired by Tata Tea.

Types of Strategic Alliances

1) Technology-based Alliances:

Many alliances are focused on technology and the sharing of research and development expertise and findings. The most commonly cited reasons for entering these technology-based alliances are access to markets, exploitation of complementary technology, and a need to reduce the time it takes to bring an innovation to market.

2) Production-based Alliances:

A large number of production-based alliances have been formed, particularly in the automobile industry. These alliances fall into two groups:

i) There is the search for efficiency through component linkages that may include engines or other key components of a car.

ii) Companies have begun to share entire car models, either by developing them together or by producing them jointly.

3) Distribution-based Alliances:

Alliances with a special emphasis on distribution are becoming increasingly common. General Mills, a U.S.-based company marketing breakfast cereals, had long been number two in the United States, with some 27 per cent market share, compared to Kellogg’s 40 to 45 per cent share. With no effective position outside the United States, the company entered into a global alliance with Nestle of Switzerland.

Forming Cereal Partners Worldwide (CPW), owned equally by the two companies, General Mills gained access to the local distribution and marketing skills of Nestle in Europe, the Far East, and Latin America. In return, General Mills provided product technology and the experience it had acquired competing against Kellogg’s. CPW was formed as a full business unit with responsibility for the entire world except the United States. In 2004, CPY reached sales of $1 billion and a market share outside the United States of 25 per cent.

Advantages of Strategic Alliances

The advantages or merits or strategic alliance are as follows:

1. Spread and Reduce Costs

To produce or sell abroad, a company must incur certain fixed costs. At a small volume of business, it may be cheaper for it to contract the work to a specialist rather than handle it internally. A specialist can spread the fixed costs to more than one company. If business increases enough, the contracting company then may be able to handle the business more cheaply itself. Companies should periodically reappraise the question of internal versus external handling of their operations.

2. Specialize in Competencies

The resource-based view of the fan holds that each company has a unique combination of competencies. A company may seek to improve its performance by concentrating on those activities that best fit its competencies and by depending on oilier firms to supply it with products, services, or support activities for; which it has lesser competency. Large, diversified companies are constantly realigning their product lines to focus on their major strengths. This realigning may leave them with products, assets, or technologies that they do not wish to exploit themselves but that may be profitably transferred to other companies.

3. Avoid or Counter Competition

Sometimes markets are not large enough, to hold many competitors. Companies may then band together so that they do not have to compete with one another.

4. Secure Vertical and Horizontal Links

There are potential cost savings and supply assurances from vertical integration. However, companies may lack the competence or resources needed to own and manage the full value-chain of activities. Horizontal links may provide finished products or components. For finished products, there may be economies of scope in distribution, e.g., sales reps may be able to offer a full line of products, thereby increasing the sales per fixed cost for a visit to potential customers.

5. Gain Location-Specific Assets

Cultural, political, competitive, and economic differences among countries create barriers for companies that want to operate abroad. When they feel ill-equipped to handle these differences, such companies may seek to collaborate with local companies that will help manage local operations.

6. Overcome Governmental Constraints

Many countries limit foreign ownership. For example, the United States limits foreign ownership in airlines that service the domestic market and i in sensitive defence manufacturers. Mexico Unfits ownership in the oil industry. China and India are particularly restrictive, often requiring foreign companies either to share ownership or make numerous concessions to help them meet their economic and sovereignty goals. Thus, companies may have to collaborate if they are to serve certain foreign markets.

7. Diversify Geographically

By operating in a variety of countries (geographic diversification), a company can smooth its sales and earnings because business cycles occur at different times within the different countries. Collaborative arrangements offer a faster initial means of entering multiple markets. Moreover, if product conditions favour a diversification rather than a concentration strategy, there are more compelling reasons to establish foreign collaborative arrangements.

8. Minimize Exposure in Risky Environments

Companies worry that political or economic changes will affect the safety of assets and their earnings in their foreign operations. One way to minimize loss from foreign political occurrences is to minimize the base of assets located abroad – or to share them. A government may be less willing to move against a shared operation for fear of encountering opposition from more than one company, especially if they are from different countries and can potentially elicit support from their home governments.

Disadvantages of Strategic Alliances

The Disadvantages or demerits or strategic alliance are as follows:

1.Adverse Selection

One serious problem with alliances is the adverse selection of partners. Potential co-operative partners can misrepresent the skills, abilities, and other resources that they will bring to an alliance. The partner may promise to bring to the alliance certain resources that it either does not control or cannot acquire

2. Moral Hazard

Partners in an alliance may possess resources and capabilities of high quality and of considerable value but fail to make them available to alliances partners. For example, a partner, in an engineering strategic alliance may agree to send only its most talented and best trained engineers to work in the alliance but then actually send less talented, poorly trained ones. These engineers may not be able to contribute a great deal to the success of the alliance, but may learn from more qualified and talented personnel sent by other partners.

3. Hold Up

A hold up may take place even without an adverse selection. Once a strategic alliance has been formed, partners may make investments that have value only in the context of that alliance and in no other activities.

4. Access to Information

Access to information is another drawback of strategic alliance. For collaboration to work effectively, one alliance partner (or both) may have to provide the other with information it would prefer to keep secret. It is often difficult to identify information needs ahead of time.

5. Distribution of Earnings

This is the most serious problem between alliance partners. As the partners share risks and costs, they also share profits. This amounts to over-simplification of the issue. There are other financial considerations that can cause conflict

6. Potential Loss of Autonomy

Loss of autonomy is another potential drawback of a strategic alliance. It was for this reason that the late Dhirubhai Ambani never countenanced the idea of an alliance. He bought technology for his PFY plant at Patalaganga from DuPont but refused their equity participation.

7. Changing Circumstances

Changing circumstances may also affect the viability of a strategic alliance. The economic conditions that motivated the co-operative arrangement may no longer exist, or technological advances may render the alliance obsolete.

3. Merger

Merger is an external strategy for growth of the organisation. A merger is a combination (other terms used: amalgamation, consolidation, or integration) of two or more organisations in which one acquires the assets and liabilities of the other in exchange for shares or cash, or both the organisations are dissolved, and the assets and liabilities are combined and new stock is issued. For the organisation, which acquires another, it is an acquisition. For the organisation, which is acquired, it is a merge) If both organisations dissolve their identity to create a new organisation, it is consolidation.

A merger is a combination of equals. Therefore it is usual for the Board of a merged company not to be dominated by the management of either of its predecessors. As a merger is necessarily an agreed (by the Boards) transaction, this is anyway likely as Directors are not likely to agree to a merger that would deprive too many of the Board of their jobs.

A merger is not likely to involve a payment of significant premiums to the shareholder of either predecessor company. This makes it less likely to destroy shareholder value. Like acquisitions, the synergies that provide the usual rationale for a merger may not actually happen, and integration is almost always difficult and costly.

Some mergers appear to be an attempt by Directors to scale-up sufficiently to deter acquisitions. Mergers often require clearance from competition regulators. In some case they are blocked, or only allowed subject to conditions (such as the sale of particular businesses).

Foreign investment by Indian companies was very limited until recently. The attractiveness of the domestic market, lack of global orientation, government regulations, etc., were responsible for this. Recently, however, there has been a substantial increase in foreign investments by the Indian companies. Foreign investments may be for establishing wholly-owned subsidiaries, joint ventures, assembly facilities or marketing infrastructure. Foreign investments are also caused by cross,- border Mergers and Acquisitions (M&As).

Mergers and Acquisitions (M&As) are very important market entry as well as growth strategy. M&As have certain advantages. It may be used to acquire new technology. M&As would have the effect of eliminating/reducing competition. One great advantage of M&As in some cases is that it provides instant access to markets and distribution network. As one of the most difficult areas in international marketing is the distribution, this is sometimes the most important objective of M&As.

A number of Indian companies have resorted to acquisition of companies abroad to gain a foothold in the foreign market and to increase the overseas business. For example, companies like Asian Paints and Essel Propack (earlier Essel Packaging) entered some of the foreign markets and substantially expanded their global business by acquisitions. M&As is a very important globalization strategy of a number of Indian companies.

Reasons for Merger

A number of mergers, takeovers and consolidation have taken place in the recent times. The major reason cited, for such mergers, is the liberalization of economy. Liberalization is forcing companies to enter new business, exit from others, and consolidate in some simultaneously.

The following are the other important reasons for mergers:

1. Economies of Scale

An amalgamation company will have more reasons at its command that the individual companies. This will help in increasing the scale of operations and the economies of large Scale will be available. These economies will occur because of more intensive utilization of production facilities, distribution network, research and development facilities, etc. These economies will be available in horizontal mergers where scope of more intensive use of resources is greater.

2. Operating Economies

A number of operating economies will be availed with the merger of two or more companies. Duplicating facilities in accounting, purchasing, marketing, etc., will be eliminated. Operating inefficiencies of small concerns will be controlled by the superior management emerging from the amalgamation. The amalgamated company will be in a better position to operate than the amalgamating companies individually.

3. Synergy

Synergy refers to the greater combined value of merged firms than the sum of the values of individual units. It is something like one plus one more than two. It results from benefits other than those related to economies of scale. Operating economies are one of the various synergy benefits of merger or consolidation. The other instances which may result into synergy benefits includes, strong R&D facilities of one firm merged with better organised facilities of another unit, enhanced managerial capabilities, the substantial financial resources of one being combined with profitable investment opportunities of the other.

4. Growth

A company may not grow rapidly throw internal expansion. Merger or amalgamation enables satisfactory and balanced growth of a company. It can cross many stages of growth at one time through amalgamation. Growth through merger or amalgamation is also cheaper and less risky. A number of costs and risk of expansion and taking on a new product line are avoided by the acquaint of a going concern. By acquiring other companies a desired level of growth can be maintained by an enterprise.

5. Diversification

Two or more companies operating in different lines can diversify their activities through amalgamation. Since different companies are already dealing in their respective lines there will be less risk in diversification. When a company tries to enter new lines of activities then it may face a number of problems in production, marketing, etc., where some concerns are already operating in different lines, they must have crossed many obstacles and difficulties. Amalgamation will bring together the experience of different persons in various activities. So amalgamation will be the best way of diversification.

6. Utilization of Tax Shield

When a company with accumulate losses merges with a profit making company it is able to utilize tax shields. A company having losses will not be able to set-off losses against future profits, because it is not a profit making unit. On the other hand if it merges with a concern making profits then the accumulated losses of one unit will be set-off against the future profits of the other unit. In this way the merger or amalgamation will enable the concern to avail tax benefits.

7. Increase in Value

One of the main reasons of merger or amalgamation is the increase in value of the merged company. The value of merged company is greater than the sum of the independent values of the merged company.

8. Elimination of Competition

The merger or amalgamation of two or more companies will eliminate competition among them. The companies will be able to save their advertisement expenses thus enabling them to reduce their prices. The consumers will also benefit in the form of cheap goods being available to them.

9. Better Financial Planning

The merged companies will be able to plan their resources in a better way. The collective finances of merged companies will be more and their utilization may be better than in the separate concerns. It may happen that one of the merging companies has short gestation period while the other has the longer gestation period. The profits of the company with short gestation period will be utilized to finance the other company. When the company with the longer gestation period starts eating profits then it will improve financial position as a whole.

10. Economic Necessity

It may force the merger of some units. If there are two sick units, government may force their merger to improve their financial position and overall working. A sick unit may be required to merge with the healthy unit to insure better utilization of resources, improve and better management. Rehabilitation of sick units is a social necessity because their closure may result in unemployment, etc.

Types of Merger

1. Horizontal Mergers

Horizontal mergers take place when there is a combination of two or more organisations in the same business, or of organisations engaged in certain aspects of the production or marketing processes. For example, a company making footwear combines with another footwear company, or a retailer of pharmaceuticals combines with another retailer in the same business.

2. Vertical Mergers

Vertical mergers take place when there is a combination of two or more organisations, not necessarily in the same business, which create complementary, either in terms of supply of materials (inputs) or marketing of goods and services (outputs). For example, a footwear company combines with a leather tannery or with a chain of shoe retail stores.

3. Concentric Mergers

Concentric mergers take place when there is a combination of two or more organisations related to each other either in terms of customer functions, customer groups, or the alternative technologies used. Thus, a footwear company combining with hosiery firm making socks or another specialty footwear company, or with a leather goods company making purses, handbags, and so on.

4. Conglomerate Mergers

Conglomerate mergers take place when there is a combination of two or more organisations unrelated to each other, either in terms of customer functions, customer groups, or alternative technologies used. For example, footwear company combining with pharmaceutical firm.

5. Reverse Mergers

Reverse merger, also known as a back door listing, or a reverse merger, is a financial transaction that results in a privately-held company becoming a publicly-held company without going the traditional route of filing a prospectus and undertaking an initial public offering (IPO).

Rather, it is accomplished by the shareholders of the private company selling all of their shares in the private company to the public company in exchange for shares of the public company.

While the transaction is technically a takeover of the private company by the public company, it is called a reverse takeover because the public company involved is typically a “shell” (also known as a “blank check company”, “capital pool company” or “cash shell company”) and it typically issues such a large number of shares to acquire the private company that the former shareholders of the private company end up controlling the public company.

Advantages of Merger

1. Economies of Scale

This occurs when a larger firm with increased output can reduce average costs. Different economies of scale include:

i) Technical Economies

If the firm has significant fixed costs then the new larger firm would have lower average costs.

ii) Bulk Buying

Discount for buying large quantities of raw materials.

iii) Financial

Better rate of interest for large company.

iv) Organisational

One head office rather than two is more efficient.

A vertical merger would have less potential economies of scale than a horizontal merger, e.g., a vertical merger could not benefit form technical economies of scale.

2. International Competition

Mergers can help firms deal with the threat of multinationals and compete on an international scale.

3. Mergers May Allow Greater Investment in R&D

This is because the new firm will have more profit. This can lead to a better quality of goods for consumers.

4. Greater Efficiency

Redundancies can be merited if they can be employed more efficiently.

Disadvantages of Merger

1. Integration Difficulties

These include combining two disparate corporate cultures, linking different financial and control systems, building effective working relationships (particularly when management styles differ) and resolving issues concerning the status of the newly acquired firm’s executives. An American manager, having learned that a friendly pat on the arm or back would make workers feel good, took every chance to touch his subordinates in a newly acquired firm. His Asian employees hated being touched and thus started avoiding him, and several asked for transfers.

2. Inadequate Evaluation of Target

The failure to complete an effective due-diligence process (thorough evaluation of the target firm) often results in the acquiring firm paying an excessive premium (disproportionate to the performance gains).

3. Large Debt Burden:

Firms are often encouraged to utilize significant leverage to finance large acquisitions. The large debt burden may put the firm in a messy situation, especially when the returns are poor (e.g., India Cements acquisition of Raasi Cements, CCI, Visaka Cements in quick succession increased its debt burden to over Rs 1800 crore. It is now forced to sell all its prized acquisitions to stay in the business). It also prevents the firm from investing in Research and Development activities.

4. Inability to Achieve Synergy

The acquisitions, often, fail to achieve intended synergy because of various reasons (managerial failures, non-cooperation from employees, skepticism, emotional doubts, etc.).

5. Too much Diversification

Over diversification may be counter productive. The merger mania that gripped the 1980s did not yield any concrete gains to conglomerates. In fact excessive diversification forced may of these firms to divest the under performing units after some time.

6. Too Large

Increased size has its own inherent limitations. Achieving consistency in terms of decisions and actions may be difficult. Formalized rules and policies may come in the way of flexibility and innovation. 

7. Others

1. Higher prices leading to allocative inefficiency.

2. Lower Quantity and reduction in consumer surplus.

3. Monopolies are more likely to be productively inefficient and not produce on the lowest point on the average cost curve.

4. Easier to collude.

5. If there is less competition complacency amongst firms then it can lead to lower quality of products and less investment in new products.

6. Fewer firm, therefore less choice for consumers.

7. With increased supernormal profits, the firm can engage in cross subsidization or predatory pricing increasing barriers to entry.

8. The new firm can pay lower prices to suppliers.

9. Mergers can lead to job losses.

10. If the firm becomes too big it may suffer from diseconomies of scale.

11. The motives for mergers are often poor, e.g., managers may prefer to work for a big company where they get higher salaries and more prestige.

4. Acquisition

Acquisitions is acquiring or purchasing an existing venture. It is one of the easy means of expanding a business by entering new markets OT new’ product areas. An entrepreneur must be careful in structuring the payment so that he will not be financially overburdened. He must create a scope for phase wise payments so that the company generates funds to pay.

An acquisition strategy is based upon the assumption that companies for potential acquisition will be available, but if the choice of companies is limited, the decision may be taken on the basis of expediency rather than suitability.

The belief that acquisitions will be a time-saving alternative to waiting for organic growth to take effect may not prove to be true in practice. It can take a considerable amount of time to search and evaluate possible acquisition targets, engage in protracted negotiations and then integrate the acquired company into the existing organisation structure.

The process of acquisition is a case of dominance of one company over the other. Here a bigger company will take over the shares and assets of the smaller company and either run it under the bigger company’s name or might run it under a combined name.

An acquisition is a transaction in which a firm buys a controlling interest in another firm with the intention of either making it a subsidiary business or combining it with its current business or businesses. It is important to understand that for some firms, an acquisition is a “one-time only” event. For example, a firm using a differentiation business-level strategy might decide to acquire only one other company because it has truly specialized skills that the local firm requires to create unique value for its customers. It is rare, though, for a firm to complete only a single acquisition. Most firms involved with acquisitions form an acquisition strategy. An acquisition strategy is an action plan that the firm develops to successfully acquire other companies. An effective acquisition strategy enables significant firm growth.

Reasons for Acquisition

1. Increased Market Power

A primary reason for acquisitions is to achieve greater market power. Market power exists when a firm is able to sell its goods or services above competitive levels or when the costs of its primary or support activities are below those of its competitors. Market power usually is derived from the size of the firm and its resources and capabilities to compete in the marketplace. It is also affected by the firm’s share of the market.

Therefore, most acquisitions that are designed to achieve greater market power entail buying a competitor, a supplier, a distributor, or a business in a highly related industry to allow the exercise of a core competence and to gain competitive advantage in the acquiring firm’s primary market. One goal in achieving market power is to become a market leader.

2. Overcoming Entry Barriers

Barriers to entry are factors associated with the market or with the firms currently operating in it that increase the expense and difficulty faced by new ventures trying to enter that particular market. Facing the entry barriers created by economies of scale and differentiated products, a new entrant may find acquiring an established company to be more effective than entering the market as a competitor offering a good or service that is unfamiliar to current buyers. In fact the higher the barriers to market entry, the greater the probability that a firm will acquire an existing firm to overcome them. Although an acquisition can be expensive, it does provide the new entrant with immediate market access.

3. Cost of New Product Development and Increased Speed to Market

Developing new products internally and successfully introducing them into the marketplace often require significant investments of a firm’s resources, including time, making it difficult to quickly earn a profitable return. Also of concern to firm’s managers is achieving adequate returns from the capital invested to develop and commercialize new products. Acquisitions are another means a firm can use to gain access to new products and to current products that are new to the firm. Compared with internal product development processes, acquisitions provide more predictable returns as well as faster market entry.

4. Adequate and Easy Terms Working Capital

Acquisition not only secures the necessary working plant and equipment more quickly than building up its own, but also helps the firm by making available desired amount of working capital. It means that by making available the much needed working capital, the problems of supply of inputs and distribution of final products are solved.

5. Access to Resourceful Management

Management or managerial competencies play important role in running the business, in expanding it either by intensification or diversion and reaching new heights. The firms which have failed need both financial and managerial resources to repair the existing loss and achieving new heights of progress and prosperity. This is possible by acquisition

6. Increased Diversification

Acquisitions are also used to diversify firms. Based on experience and the insights resulting from it, firms typically find it easier to develop and introduce new products in markets currently served by the firm. In contrast it is difficult for companies to develop products that differ from their current lines for markets in which they lack experience.

7. Reshaping the Firm’s Competitive Scope

The intensity of competitive rivalry is an industry characteristic that affects the firm’s profitability. To reduce the negative effect of an intense rivalry on their financial performance, firms may use acquisitions to lessen their dependence on one or more products or markets. Reducing a company’s dependence on specific markets alters the firm’s competitive scope.

8. Learning and Developing New Capabilities

Some acquisitions are made to gain capabilities that the firm does not possess. For example, acquisitions may be used to acquire a special technological capability. Research has shown that firms can broaden their knowledge base and reduce inertia through acquisitions. Therefore, acquiring a firm with skills and capabilities that differ from its own helps the acquiring firm to gain access to new knowledge and remain agile.

Types of Acquisition

There are four types of acquisitions:

1. Friendly Acquisition

Both the companies approve of the acquisition under friendly terms. There is no forceful acquisition and the entire process is cordial.

2. Reverse Acquisition

One way for a company to become publicly traded, by acquiring a public company and then installing its own management team and renaming the acquired company.

3. Back Flip Acquisition

A very rare case of acquisition in which, the purchasing company becomes a subsidiary of the purchased company.

4. Hostile Acquisition

Here, as the name suggests, the entire process is done by force. The smaller company is either driven to such a condition that it has no option but to say yes to the acquisition to save its skin or the bigger company just buys-off all its share, their by establishing majority and hence initiating the acquisition.

Advantages of Acquisition

The advantages of acquisition are as follows:

1. Assets Acquisition

While acquiring the buyer has an advantage of choosing exactly which assets to acquire (e.g., liquid assets, real estate or intellectual property), as well as which liabilities it can cover (leases, bank loans, mezzanine loans and so forth).

2. Gain Experience and Assets

One of the benefits of an acquisition is that the company can quickly gain the experience, goodwill and assets of the other business. If the acquired business can complement the business the company does, the merger can improve the overall efficiency. With the increase in staff and assets, the company can increase output and improve profits.

3. Excite the Shareholders

An acquisition can breed excitement among the shareholders. When shareholders of a public company hear of an acquisition, they tend to have a positive outlook on the value of (lie company as veil as the one for sale. Taking steps toward an acquisition often leads to an increase in the stock price and the equity of their investments.

4. Combining Organisation Cultures

One of the most important advantages of acquisition is that it combines the cultures of two different organisations.

5. Reducing Costs and Overheads

A company can reduce it costs and overheads through shared marketing budgets, increased purchasing power and lower costs.

6. Accessing Funds or Valuable Assets for New Development

Better production or distribution facilities are often less expensive to acquire than build. Look for target businesses that ate only marginally profitable and have large unused capacity which can be bought at a small premium to net asset value.

Disadvantages of Acquisition

The disadvantages of acquisition are as follows:

1. Cost

Purchasing a larger company is expensive. The company may not have the cash available to buy the second firm, and if it does have enough cash, it will not be able to use this cash on other projects. If the company has to row money to purchase the second firm, this increases the company’s total debt burden. The company can also issue stock so it can afford the purchase, although the current stockholders will lose some control and ownership rights.

2. Employee Retention

In an acquisition, the company will have employees at both firms performing similar jobs after the purchase is complete. The buyer commonly fires excess employees if it has too many workers doing the same tasks after the buyout- Because employees are concerned about a future layoff, some employees will start looking for other jobs or quit after the company announces its acquisition plan.

3. Productivity

Combining two firms depends on the culture at each firm. A company that has a hierarchical and authoritarian structure may purchase a company which is much more flexible and allows workers more control over their job tasks. Workers may not be happy with the new management and productivity may decrease, if the purchaser makes many changes to previous workplace policies.

4. Letter of Intent

In an acquisition, the acquisition letter of intent is very important. Acquisition letters of intent often include a confidentiality agreement, because the buyer can otherwise ai.cel the purchase and use the seller’s trade secrets to compete against it. The letter of intent may allow the buyer to take advantage of the seller if it is not written fairly.

5. Value

Valuation of the combination is important. The seller’s assets include intangible assets such as brand strength and goodwill, which the buyer pays as part of the purchase price. The business acquisition itself can destroy some of these assets. If an oil company that is responsible for a major oil spill purchases a solar panel manufacturer, the goodwill of the solar firm may become impaired because of the buyer’s negative reputation.

6. Duplication

An acquisition can lead to unnecessary duplication. When two similar companies are combined, many of the positions held in one business will be at work in the other. This leads to two people or departments doing the same job.

5. Wholly-Owned Subsidiary

For any firm the most expensive method of market entry is likely to be the development of its own foreign subsidiary, as this requires the greatest commitment in terms of management time and resources. It can only be undertaken when demand for the market appears to be assured.

In order to have complete control and ownership of international operations, a firm opts for foreign direct investment to own foreign operations. Tata Tea which entered into a joint venture with Tetley Group, UK, in 1994 acquired Tetley in 2000 to become one of the largest integrated branded tea companies in the world.

When a subsidiary is considered to be wholly-owned, this indicates that all of the outstanding common stock that is currently issued by the company is in the hands of a single holding company. Essentially, a wholly-owned subsidiary is a business that is completely owned by another entity. The subsidiary continues to operate with the permission of the holding company, either with or without direct input from the controlling entity.

There are several reasons why a company would choose to operate a wholly-owned subsidiary, rather than simply absorbing the acquired company into the central corporate operation. One of the most common reasons is a matter of location. The wholly-owned subsidiary may physically reside in a different country from the holding company. When this is the case, there may be compelling financial and regulatory factors that make it much more financially sound to allow the company to continue more or less autonomously.

Another common reason for the operating the wholly-owned subsidiary separately from the owner company could be name value. Often, a well- known and respected corporation is acquired by another entity that has no name recognition in that particular market.

Rather than spend huge amounts of time and resources to create a reputation, the holding company will simply decide to remain in the background. This allows the wholly-owned subsidiary to continue to enjoy the current name recognition and market share, while being able to work with the resources of the parent company to find ways to enhance that reputation.

Tata Megraw Hill is one of the most popular marketing companies of India. It is the Indian subsidiary of the McGraw-Hill Companies and also the market topper in educational books encompassing books on variety of subjects and interest. Their main activity is reprinting, publishing and marketing of McGraw-Hill books. This company was founded in 1970.

Noted among the top Indian marketing companies, Godrej aims at innovation. It deals in fast moving consumer goods and operates in India and other cities across the globe. The company provides variety in the brands like cosmetics, toiletries, hair care, fabric care, baby care, household care and many others.

The ITC is undoubtedly one among the premier marketing companies of India. The company has a market capitalization of about $19 billion and turnover of more than $1.5 billion. It is also rated among the world’s best big companies. It specializes in hotels, agri-business, FMCG products, personal care, and branded apparel. Their business motive is to create multiple drivers from corporate strategies. They have peerless distribution reach, great supply chain management, and effective brand building.

Tata International is considered as the gateway of Tata Group’s business to the world. The company was founded in the year 1962.The global business units of the company are minerals, engineering, steel, chemical and bulk commodities. This marketing company also markets consumer products and IT services. It has offices in Thailand, India, UK, Singapore and across other countries of the world.

Advantages of Wholly-Owned Manufacturing Subsidiary

• No risk of losing technical competence to a competitor thus gaining a competitive edge.

• It provides tight control over operations.

• It provides the ability to realize learning curve and location economies.

• Protection of technology can be well executed.

• It provides ability to engage in global strategic coordination,

• It provides ability to realize location and experience economies

Disadvantages of Wholly-Owned Manufacturing Subsidiary

Company bears full cost and risk,

• An effective supervision and direction is needed which increases rigidity.

• It faces several hurdles in the forms of regulations and taxations in foreign countries.

• Heavier pre-decision information gathering and research evaluation.

• Political risk.

• Country-of-origin effects can be lost by manufacturing elsewhere. 5.2.7.6. Assembly Operations

6. Assembly Operation

A foreign owned operation might be set up simply to assemble components which have been manufactured in the domestic market. It has the advantage of reducing the effect of tariff barriers, which are normally lower on components than on finished goods. It is also advantageous if the product is large and transport costs are high, e.g., in the case of cars.

There are other benefits for the firm too, as retaining component manufacture in the domestic plant allows development and production skills and investment to be concentrated, thus maintaining the benefit from economies of scale. By contrast, the assembly plant can be made a relatively simple activity requiring low levels of local management, engineering skills and development support.

There is an argument that assembly plants do not contribute significantly to the local economy in the long-term. In initially attracting Nissan, Honda and Toyota assembly plants, the UK government claimed that many jobs would be created at relatively low cost but critics claimed that the number of jobs created in the assembly plants was not very significant and, unless the components were made locally, little transfer of technology would be achieved and the assembly plants could relatively easily be; moved to a new location.

In practice as other car manufacturers withdrew from the UK market these Japanese manufacturers became the only major established firms. Both to counter threats such as this and also: to generate further employment, countries can take steps to develop the component supply business either by interrupting the component Supply chain through imposition of import or foreign exchange rate restrictions or, as in the case of Czech Invest, the inward investment arm of the Czech Republic, by supporting local component manufacturer who can supply ‘just in time .For the international firm, of course, using the assembly option-presents an opportunity, to move plant from country to country in order to take advantage of lower wage cost and government incentives.

A manufacturer who wants many of the advantages that are associated with overseas manufacturing facilities and yet does not want to go that far may find, it desirable to establish overseas assembly facilities in selected markets. In a sense, the establishment of an assembly operation represents a cross between exporting and overseas manufacturing.

Having assembly facilities in foreign markets is very when there are economies of scale in the manufacture of parts and components and when assembly operations are labour intensive and labour is cheap in the foreign country. It is also popular when exporting the product as Completely Built Unit (CBU) makes transportation cost very high and there is import duty differential between and CBU and CKD (Completely Knocked Down) or SKD (Semi-Knocked Down) imports.

Assembling the product meant for the foreign market in the foreign market itself has certain other advantages, besides the cost advantage. Assembly operations would satisfy the ‘local content’ demand, atleast to some extent. Because of the employment generation, the foreign government’s attitude will be more favourable than towards the import of the finished product. Another advantage is that the investment to be made in the foreign country is very small in comparison with that required for establishing complete manufacturing facilities.

The political risks of foreign investment are, therefore, not much. Facilities for servicing of the product may also be established along with the assembly facility. Some Indian auto firms have such facilities abroad. The leader in establishing manufacturing bases abroad is the Aditya Birla group. Aditya Birla, whom the Forbes called India’s only international businessman, made this strategic move as early as 1970s.

The Ballapore Industries of the Thapars are setting up a giant paper mill in Indonesia at an estimated cost of? 1800 crore A plantation put up on 2, 50,000 hectares of land will feed the mill. Any surplus pulp may be exported to India to feed Thapar paper mills here. The significance of this should be viewed against the possible wood and pulp shortage in future in India.

7. Integrated Local Manufacturing

Establishing a fully integrated local production unit is the greatest commitment a company can make for a foreign market. Building a plant involves a substantial capital outlay. Companies do so only where demand appears ensured. International companies can have any number of reasons for establishing factories in foreign countries.

These reasons are related primarily to market demand or cost considerations. Often, the main reason is to take advantage of lower costs in a country, thus providing a better basis for competing with local firms or other foreign companies already present. Also, high transportation costs and tariffs may make imported goods non-competitive.

Although most manufacturing tends to shift from developed to developing countries, Mexican firms are moving production to the United States. The DuPont Company sold three plants to Alfa, SA. Alfa is refitting the former textile plants to produce plastics used in beverage containers and frozen-food trays. Since 1994 Mexico has moved from number thirty-three to the sixth largest investor in the United States.

Establishing Local Operations to Gain or Defend Market Position:

Some companies build a plant to gain new business and customers. Local production can represent a strong commitment to a market and is often the only way to convince clients to switch suppliers. This is of particular importance in industrial markets, where service and reliability of supply are main factors in the choice of product or supplier. In some developing countries, establishing local operations may be the only way to enter a local market, although this requirement is becoming more rare with the spread of trade liberalization and the impact of the World Trade organisation.

At other times, companies establish production abroad to protect markets already built through exporting. Such markets can be threatened by protectionist government policies or by relative changes in currency exchange rates. In the late 1980s, the surge in market share of imported Japanese cars prompted the United States to threaten Japan with import quotas if it didn’t place voluntary restrictions on car exports to the United States. Also, the Japanese yen had begun to appreciate against the dollar, making Japanese imports more expensive. In response to these threats, Japanese car manufacturers began to build factories in the United States to protect their market share. In 1982, Honda became the first Japanese car manufacturer to set up production in the United States. By 1993, Japanese car manufacturers produced more cars in the United States than they exported there from Japan. Japan’s major producers are Toyota, Honda, Nissan, Mitsubishi, Mazda, and Suzuki.

Following an established customer can also be a reason for setting up plants abroad. In many industries, important suppliers want to nurture a relationship by establishing new offices near customer locations. When customers move into new markets elsewhere, suppliers move, too Deutsch Advertising, a North America advertising firm, had worked with Novartis since 2002 on the anti-fungal drug Lamisil. Now Deutsch is following Novartis into Italy, Germany, the United Kingdom, and Switzerland.

Shifting Production Abroad to Save Costs:

Firms can shift production abroad to save costs in order to be competitive in the host market. When Mercedes-Benz was looking at new opportunities in the automotive market, the company targeted the luxury sports utility vehicle segment, in the United States, its major market, the company was suffering a 30 per cent cost disadvantage against major Japanese and U.S. competitors in this segment. Despite the fact that the company had never before produced cars outside Germany, Mercedes-Benz decided to locate a new factory to produce such vehicles in the United States, where total labour, components, and shipping costs were among the lowest in the developed world.

Some products may be too costly to transport long distances, and this makes them poor candidates for export. Fresh orange juice is one such product. Brazil is currently the top producer of orange juice in the world, whereas the United States consumes 40 per cent of all orange juice. The U.S. market has a strong demand for fresh, not from- concentrate orange juice that sells for higher prices.

This fresh product is particularly costly to ship because it consists mainly of water. During the 1990s, Brazilian orange juice firms bought land to develop orange groves in Florida. By 2001, multinationals with Brazilian ties accounted for about half of Florida’s orange juice industry.

Sometimes, international firms with plants in Taiwan, Malaysia, Thailand, and other foreign countries may have little intention of penetrating these markets with the help of their new factories. Instead, they locate abroad to take advantage of favourable conditions that reduce the manufacturing costs of products that are sold elsewhere. This strategy has been employed by many U.S. companies in the electronics industry and has more recently been adopted by Japanese and European firms as well.

Morinaga, Japan’s leading dairy company built a new powdered-milk plant in China not so much to enter the Chinese market as to establish a low-cost base from which to capture share in other Asian markets. Such decisions of a sourcing or production nature are not necessarily tied to a company’s market entry strategy but may have important implications for its global competitiveness.