New Country, New Business

How to choose an international business model.

Planning to expand internationally? Your domestic business model may not work overseas. Here are some considerations you need to make before you lay foundations in a new country.

Businesses contemplating expansion into international markets face the daunting task of answering a myriad of questions when determining their expansion strategy. Among these, the issue of selecting the most appropriate business model is key. There is more than ample anecdotale evidence to demonstrate how the selection of an inappropriate business model has contributed to the failure of many international expansion efforts.

Given the evidence, the question is: what issues should businesses consider when selecting their intended international business model, or models?

Deciding Factors

Any business contemplating expansion into international markets should meet the three key non-negotiables:

1. The business must be proven, profitable and have sufficient cash flow to fund the desired business model, regardless of what that might be.
2. The business must have strong and stable processes, systems, and procedures.
3. The business must be able to fund a key executive whose sole responsibility is to focus on the international development strategy and its implementation.

The business stands a significant chance of failing to achieve its international growth objectives if these three factors are not met. Any business model, frequently referred to as a distribution or channel model, can be described in terms of cost, control and coverage. Cost refers to the cost to serve the channel: what it takes in terms of support, training and services given the division of roles and responsibilities between the channel partner and the principal.

The business owner will also need to look at how much control the model provides the channel principal, over what elements, and ask how much is actually required, given the nature of the products, selling cycle, customer buying behaviour and strength of the brand.

Then, the business needs to look at whether the model provides sufficient coverage of the target market or market segments. Is there a sufficiently large pool of prospective channel partners from which the channel principal can select good quality partners?

Each type of channel model exhibits a different mix of these three characteristics. The key to selecting a business or channel model for expansion is understanding the interplay between these characteristics and the resulting implications for the channel principal. Cost, control and coverage are often represented on a spectrum with cost and control working in direct correlation with each other, and coverage in the opposite direction as in the diagram below.

There are many channel model variants that we could discuss, but the most common could be grouped into three main categories: company owned operations, either as a wholly owned or joint venture arrangement; tied distribution models, such as franchising and licensing; and non-tied distribution models such as agents, stockists, distributors and wholesalers. Each of these three has a different combination of cost, control and coverage and is, therefore appropriate in different situations.

Company or Joint Venture Operations

Company owned or joint venture operations usually have relatively high cost and therefore offer generally comparatively lower coverage of a given market. Company operations typically provide the channel principal with a high degree of control of the channel its operations and performance.

Key reasons for adopting a company-owned or joint venture channel include greater control of branding, especially if customers have a high propensity to switch brands and the brand is synonymous with a particular level of service or support. If the sales process or product is highly technical, or if the perception of product quality depends on the quality of its installation or application, then it also makes sense to set up in the country. Other factors may point to a company owned or local joint venture strategy in an international context, such as the level of local regulatory acceptance of foreign investment and businesses, relatively relaxed foreign exchange controls and no local citizen directorship requirements. On a market level, indicators that this model may suit include if the customer base is readily identifiable or substantial in size and/or of strategic importance, and there is a low cost of establishing a channel to market.

Joint venturing may be an appropriate strategy for your business in situations where:

• Capital requirements exceed the business’ capacity.
• The business risks are unacceptably high for a company-owned operation.
• Local language, culture and networking play a significant role in ‘doing business’.
• The business requires additional expertise, know-how or management skills.

Tied Distribution Models

Tied distribution models reger to models where the channel is required to sell the channel principal’s products and/or services. While they may be some flexibility around the range of products or services to be offered, the channel is ‘tied’ to the channel principal, offering a relatively high degree of certainty around the distribution of its products and services. There is a wide range of tied distribution models, from full format franchises, such as the major fast food networks, to simple banner groups, as in many of the real estate groups. These exhibit quite different levels of cost, control and coverage. However, it would be reasonable to say that most tied distribution models offer a relatively high degree of control.

The cost of operating and supporting tied distribution also varies considerably, but in general, the channel partner – a franchisee, licensee or similar – takes on the major cost of operationand relieves the channel principal of these obligations and the associated costs.

Tied distribution models allow for moderate to high levels of coverage. In the most common form of tied distribution, full format franchising, the franchisee bears the establishment costs of the business. Therefore, the channel principal can expand the network at virtually no capital cost to itself. As a result, coverage can be relatively high providing the channel principal, usually the franchiser or licensor, can attract the appropriate number of willing participants.

In an international context, a tied distribution model may come to life through a master franchise, licence or area developer model.

Such models are often applied in situations where:

• Limited capital is available for expansion.
• There are easily replicable methods of operation, processes and systems.
• There is systemised method of doing business.
• The sales cycle is relatively simple.
• The product or service is associated with a strong brand identity.

Tied distribution models are quite often used in circumstances where local regulatory structures restrict foreign company operations and local language, culture and networking play a significant role in ‘doing business’, or the business requires a degree of refinement for application in each local market. In the example of fast food, this may mean refining the menu offer. In other businesses, this may mean changing the look and feel of the retail outlet, type of products on offer or the seasonal cycle.

Tied distribution models in general, and franchising in particular, are becoming increasingly regulated around the world and the types of regulations vary considerably. Any consideration of business models in the international context must include the consideration of local regulatory regimes and their implications.

Non-tied Distribution Models

Non-tied distribution models include distributors, wholesalers, stockists, resellers and agents. Again, the range of cost, control and coverage is quite vast but, in general, this group of channel models has relatively low cost to serve and offers relatively high coverage. The ability to control these types of channels is usually substantially lower than either tied distribution or company owned models.

Non-tied distribution models are often applied in situations where product or service is not the complete solution and may require accessories or other products to complete the sale, or the target market is either highly defined and identifiable or extremely broad and diverse. If the industry or products offered are highly specialised, third party suppliers may be a typical form of distribution in the relevant industry.

The key issue with adopting a non-tied distribution model is that the individual channel partners may not be fully committed to the channel principal’s products or services. The channel principal often competes for ‘head space’ among the range of similar or complementary products and services. Consequently, businesses intent on adopting a non-tied distribution model need to consider commitment and capability.

Commitment refers to the propensity of the channel partner to support a particular principal’s products or services. Partners consider a wide range of factors that can be summed up in a simple equation: return on effort. Ther will almost invariably favour products and services that provide a higher return on their effort.

Capability regers to the channel’s ability to close the sales. Almost certainly, capability depends on the quality of training, development and sales tools the channel principal provides. As such, driving channel capability has a significant effect on the cost to serve a particular channel.

More To Consider

While the choice of business model in the international context can be determined at a high level by comparing the cost, control and coverage requirements in a given situation, the final choice must also consider other issues

• Recruitment: How large is the pool of qualified channel partners of potential employees? Is this sufficiently large so the channel principal can select a range of quality channel partners?
• Legal structure: What legal structure will be used and how will this be manigested in any legal agreements to protect the channel principal’s interests?
• Ongoing management: How will the channel principal provide any required ongoing support, training and development? What will be the implications on the principal’s organisation structure, information systems, processes and procedures?
• Induction: How will the channel principal induct hew channel partners into the network? What initial training is provided, where, in what language, why? How often should this be followed up?
• Culture: What business models and ways of doing business are present and accepted in the target countries and markets?
• Compliance: How will the channel principal deal with any legal compliance issues relating to product sagety, chemical composition, food and drug approvals and other such regulatory regimes?

Getting It Right

The selection of an appropriate business model is a critical step in developing an international expansion strategy. But it is only one of the steps involved. A business owner must ensure the business is ready, according to the three non-negotiables, and objectively select the target countries and markets rather than simply relying on gut-feel or subjectivecriteria.

Preparation should include testing and evaluating the financial implications of various models and the benefits all participants might receive under each and ensuring adequate protection of key intellectual property. The business also needs to develop a clear division of roles and responsibilities for each model employed and determine the most appropriate corporate structure. This should take into account that effective international expansion is not a case of one-size-fits-all, and it is highly likely multiple models will be required for any one business.

Successful international expansion requires considerable planning, development and forethought and encompasses a wide range of issues. Selecting the right business model is a critical step that must be considered in the light of a range of other equally important issues.