From Central to Virtual Internationalization

From Central to Virtual Internationalization

“Half the family-run companies in Germany with a turnover exceeding 50 million Euros now have production sites abroad.” (source: IFM Bonn 2011)

This not only applies to German medium-sized enterprises: the word “international” has become part of our global language. Regional representatives, export offices and foreign field agents are commonplace in many businesses. Indeed, only those companies whose services are performed exclusively in the home country still have a purely local presence. Examples for that are car dealers, transport firms and clinics.
A few years ago, the term “internationalization” was still understood to be the shifting of production sites in order to optimize costs and logistics routes or as an extended workbench. However, since the financial crisis in 2008/2009, it has not been the production sites in the developing and emerging countries which have led to a more rapid recovery of the old economies in Europe and the US. Instead, the consumer markets in the BRICS states (Brazil, Russia, India, China and South Africa) are now the driving force behind growth.

The potential of these BRICS states can be illustrated by a simple example: India is a rapidly growing nation with more than 1,200 million inhabitants. Around 30% of the Indian population belong to the middle class and have an average annual income of more than 20,000 USD. Estimates for 2014 indicate that 70 million Indians plan to buy their first fridge. Sales of other goods, such as TVs and cars, are also expected to rise.

These opportunities are very tempting for many companies, although a purely reactive, opportunistic approach will lead to mistakes and failed efforts. Throughout this article, we aim to illustrate how businesses can develop the visionary strength to succeed with their internationalization strategies.

Global trade volumes

The world has become more interwoven

It is a fact that our world has become a more interwoven network. The global trade volume has grown exceptionally over the last 60 years (see diagram 1).

Parallel to this, the number of internationally operating companies is rising. Many businesses today have foreign sales branches or operating sites. These transnational companies are not just opening branches in a single location but are increasingly active in various different countries.

These companies do not only include big brand consumer products, such as McDonalds, Starbucks, the Hilton group, Segafredo, Coca-Cola or Audi, but also B2B corporations e.g. BASF, Novartis, Schneider Electric and Siemens. They have representatives in most countries around the world and their products are available everywhere, helping to create what we perceive as a global village.

At the same time, the value-adding activities are spread across the world. China has already overtaken Germany, the home market for the premium car producers BMW and Audi, as the largest sales market (Sueddeutsche Zeitung, 11.04.2012). This is one of the reasons why these companies have factories in China or why Mercedes, for example, has even moved one of its Advanced Design Centers there. The identification of tastes and trends should be performed in the place where the target customer lives. Mercedes also has a R&D site in India, for CAD construction, as there the company finds easy access to highly qualified IT specialists.

This international trend can also be measured in figures. 8.4% of the largest family-run companies in Germany use foreign countries both for procurement and for selling their products (BDI, 2011). A different picture was drawn in the Eurostat statistics for 2001 – 2006, although industrial companies in the UK procure over 50% of resources for their core business from abroad (Eurostat, 2008) (see diagram 2).

International procurement

A networked world is of equal relevance to all companies. Not all firms are transnational or can extend the range of their business model at will. This applies in particular to service providers, such as tradesmen or local construction companies. However, these firms are still affected by global competition. Cemex, for example, a company from Mexico with 15.14 billion USD turnover, successfully positioned its cement business on a global footing during 2011 - the sales radius of cement factories is generally limited by logistics costs - by buying up local cement firms.

Foreign activities need to be considered

We have seen that stepping into foreign markets is nothing new for companies but we should still look at the reasons why they take this risk.

The decision to pursue sales or production in another country is often a reactive decision. There may be pressure to reduce costs, as the unit wages are too high in the home country, making it difficult to remain competitive in the world market. Production is then moved to a cheaper site, as we have seen all too often with machinery manufacturers or textile producers.

Another reason may be that the home market is saturated and any further growth is only possible in a different country. A producer of doorbells, for example, was faced with a saturated home market and, as market leader, any additional acquisition of market share could only have been achieved at great cost and effort. This company was forced to decide whether more growth would be possible in a different country. As this was confirmed, the firm moved to the mentioned country.

Internationalization often means minimization of cyclical risks for many companies. The European market, characterized by its seasons, only offers a short seasonal period for selling specific textiles, agricultural products etc. This means, that for the agricultural chemicals industry, activities in the southern hemisphere can compensate for the “natural fluctuation” in the utilization of their factories.

Lessons learned

Internationalization as a spontaneous entrepreneurial reaction is often only successful over the short term and is not sustainable. Many companies underestimate the risks to product quality from a potential loss of technology or image. It is therefore not surprising when we see these companies moving their production sites back to the home country.

“40% of British industrial companies are fetching their production back out of fear of natural catastrophes or drastic changes in the economic situation.” (Telegraph,13.08.2012)

Over time, experts have identified a range of foreseeable risk factors, such as quality assurance, logistics costs, market growth, social and political stability, underlying economic conditions, legal security, infrastructure, exchange rate risks, reliability of business partners, climate, emigration support and business customs. The challenge is to estimate these risks as precisely as possible and to plan the internationalization strategy diligently. Scoring models have been proven to be pragmatic instruments for determining the best site location.(Diagram 3)

Scoring
An opportunistic approach also means that a company is only following those internationalization trends which are currently present on the market but is never actually taking on leadership in that market. In the example of unit wage costs, we know that many companies have moved their production sites to China. As part of the strong economic growth there, many workers are now demanding higher wages so the “production caravan” moves on to the next low wage country e.g. Vietnam and sets up business there. Bearing this in mind, it now seems inadvisable to think about considering a commitment in China.

It makes sense to think carefully in advance about which countries will be suitable in the future for production sites and with which products a company could enter those markets.

Planning the Internationalization Strategy

Visionary strength

To recap, we understand active thinking not only as an analysis of the status quo but, above all, as an in-depth examination of the future. As well known, this is difficult to foresee and there is a wide range of possible situations. This is where a company’s management needs to develop “visionary strength” and to think the internationalization plans right through to the target - the vision. Visionary strength is the ability to free oneself from the step-by-step, reactive corporate planning and to think matters through from the beginning to the end. The vision is decisive for all entrepreneurial decisions. The actual plan of action is then derived from the total number of steps needed to achieve this target. The planning period should be a long term one, up to 20 years. In relation to internationalization and from a current viewpoint, we think that a vision which integrates and takes into account all future information and communication technologies must see its corporate functions as virtual. These should not be tied to physical structures and should allow the company to adapt to its changing tasks as flexibly as possible – a virtual Center of Excellence.

Virtual Center of Excellence

Before examining the idea of a virtual Center of Excellence, let us look at two examples.

Example 1: a large share of wealth owned by European high net value individuals is now invested in Asia. In view of this, a major bank has decided to open an office for its customers in Singapore. Although we may initially be surprised by the long distance to the customers, the decision is intelligent as the management of these monies is easier and more effective from an Asian office.

Example 2: McDonalds has test centers at three sites in America, Asia and Europe, in which the global quality standards of key products are compared under the same conditions. The quality assurance staff meet for blind tastings and thereby ensure that the taste of core McDonalds products remains the same the world over.

From these examples we can derive key features of the corporate concept. Virtualized corporations are decentral, more complex and can be steered more easily.

The complexity stems, for example, from various national and local factors, cultural differences and so on. This complexity can be handled with the help of standards, which define globally valid guidelines and specifications, like the quality standards at McDonalds. End-to-end IT systems are used to control the virtual centers. This ensures uniform data quality and integrity, providing capacity to act. Uniformity is also important for the corporate identify, otherwise decentral companies would turn into a conglomerate or lone fighters without a common goal. The information andcommunication systems available to us in this day and age, such as laptops, video conferences and Skype, make distributed working technically easy to handle, thereby preventing coordination problems. We no longer need to have all colleagues united under one roof.

Table 1 illustrates some of the global/local topics we consider important, in selected corporate functions.

Selection of global and local topics

We are not describing a central office with central services but, instead, an organizational structure in a virtual Center of Excellence, the members of which will work together in the future on global subjects, while being distributed on an international level. This situation is created alone from the fact that markets, talents and raw materials are also just as internationally fragmented.

A globally positioned medium-sized company with an organization of virtual centers of excellence could look something like the following diagram:

Global virtual center of excellence organization of a SME
A global distribution of functions also harbors other benefits. In a triadic system, for example, work can continue around the clock or market research can be conducted locally in a different country, using the methods of specialists from that country.

Tools for Internationalization

In order to develop “visionary strength” and plan an internationalization strategy, certain tools are of key importance. It is vital to define a platform from which the first step is to be taken. Secondly, the procurement and sales markets need to be examined and, thirdly, an analysis of megatrends gives insight into comparably stabile developments over a longer period. Last but not least, technological development lines and rejects i.e. takeover opportunities via leapfrogging have to be examined.

Definition of platform
The first step of an internationalization strategy is to define the starting platform. This is used to document the status quo of the company in its primary areas, such as R&D, production and sales, just to name a few. This is necessary to lay a firm basis for the steps to follow, just as a marathon runner defines his speed in line with his fitness, before he starts running. The corporate fitness can be identified using SWOT analyses, benchmarks and so on.

Integrating megatrends
Megatrends, such as the demographic development, mobility, the green revolution etc. can be used to anticipate the future.

“Megatrends (are) major social, economic, political and technological changes (…), they influence (us) for a certain period – between 7 and 10 years or longer” (Naisbitt, 1982). An analysis of these stabile, long-term developments reduces insecurity about the future and allows a company to think about the coming situations on a strategic basis from the current moment in time.

The relevant national or global megatrends should be examined and their future influence on industry and the business model estimated. During this process, it helps to ask questions like those listed below:

  • Which technology will be of significance in future?
  • How will my customers’ benefit categories change?
  • Which potentially new uses could arise for my products?

After prioritizing the individual megatrends, they can be used to derive guidelines for the strategy. Megatrend clusters include, for example:

  • Social trends
  • Industry-specific trends
  • Consumer-related trends
  • Ecological trends
  • Economic trends
  • Political trends
  • Regional trends
  • Technological trends

Analysis of procurement and sales markets
When it comes to production, potentially optimum production locations can be selected based on the procurement situation for raw materials. When viewed from the perspective of “visionary strength”, this also means to think a step further and to include the added value of the primary products and their raw materials in the analysis.

When analyzing the sales markets, a useful tool for the first step is to form classic positioning portfolios using the market appeal and competitive position in a country comparison. This preselection can then be used to examine the relevant markets in detail using a scoring model (see diagram 5).

Market sie and Market growth

The individual benefit categories should be analyzed in the individual countries e.g. How decisive is the price? However, when examining these benefit categories, we should note that this is performed using current estimates and does not produce an image of the future. Additional expert interviews and models should be added to this. By comparing sales criteria in various markets e.g. developing countries, emerging countries and industrial countries, future changes can be estimated.

To model future sales, we recommend using diffusion models and similar tools.

Leapfrogging
At this stage, we refer to the use of so-called leapfrogging. This means the overtaking of individual technological development stages. For example, many companies jumped straight from Windows XP to Windows 7, without getting Windows Vista. Almost all Indians have a cell phone, while the landline network is highly underdeveloped. The Indian population has experienced such a rapid economic development that it has jumped right from “having no telephone” to “smartphone user”, without going through the typical development stages known to us in Europe. Leapfrogging in companies means to critically examine traditional corporate development, without losing sight of the business environment around the company. A clear example of this is Somalia which, although it may have the lowest wage costs for production, also has a current political environment which is very insecure. Finally, we advise that you do not blindly follow the competition but consciously think the consequences through to the end and have the courage to tread new paths. This approach then makes it possible to overtake the competition.

Detailed preparation of local market entry
As described above, there are very specific challenges in international markets. As an example, a major producer of water and waste water fittings is confronted with totally different markets world-wide. The German market is driven by replacement investment in an existing network of pipes, whereas other countries may still have to develop these networks. In Germany, many thousand local authorities award small volume orders to companies. Markets such as Saudi Arabia see companies managing major engineering, procurement and construction projects. A Key Account Management solution is needed for these few complex customers. The market processing is therefore totally different to that known to us here in Germany. The producer also finds that only certain individual products from his range are of relevance for specific countries.
Each country should therefore be planned with the respective market expertise and with its own market entry and market processing strategy.

Final Comments

Visionary strength is not an art but the result of systematic rethinking future situations. Medium-sized companies which are currently faced with a potential move to a different country or with a redesign of their structure, will know about the variety of organizational design options on the international playing field. As soon as the vision has been defined, it must be clearly communicated throughout the company and the decision rigorously pursued.

By Dr. Heiko Frank, Tefen Germany