- Market Entry Strategies: Should Your Business Enter a New Market Directly, Via a License Agreement, or through a Joint Venture?
- September 8, 2014
- Law Firm: Barley Snyder - Lancaster Office
Is your business growing? Do you plan on exploring opportunities in new product lines or previously untapped markets? Businesses often pursue expansion opportunities, and a key element to any company’s success is effective growth management. Whether your business is expanding its reach domestically or entering into a new foreign market, a fundamental question is what type of vehicle your business should use to best achieve its market entry objectives. Considerations related to corporate structure, risk management and investment goals are central to formulating an effective market entry strategy. While this article will focus on the decision points relevant to entering a foreign market, many of the principles discussed herein are equally applicable to various domestic expansion scenarios, such as, entering a new product / service market or selling existing products in a previously untapped region of the country. This article will begin with a discussion of some general considerations related to operating in a foreign jurisdiction and will then highlight three common market entry strategies: 1) direct presence; 2) licensing agreements; or 3) a joint venture.
The Foreign Market: Key Considerations
Expanding your business into a foreign jurisdiction entails substantial and sometimes unforeseen operational costs. Foreign countries may have vastly different legal systems, economic structures and social constructs. All of this creates uncertainty which complicates market entry. Thus, a cost-benefit analysis (including market potential) is an important first step prior to entering any foreign market. Similar to the case of a domestic merger or asset acquisition, it is important to conduct thorough due diligence on any potential foreign market.
When considering market entry strategies, some important initial considerations include:
- Production. Does entry into the market require that any goods sold actually be produced in the foreign market, or is importing an option? In addition, are any other import/export restrictions applicable (including as to technology)? Does production capability already exist in the market? Is a local “partner” available?
- Distributors and/or Sales Agents. Can market entry be accomplished through distributors or sales agents?
- Foreign Investment / Local Ownership Controls. Are there any legal restrictions on foreign “inbound” investment in the new market (or local ownership percentage requirements)?
- Personnel issues. Operating in a foreign market, regardless of the form, will present employment issues such as: travel, hiring and/or personnel transfer (immigration).
- Professional Advisors. Entry into a foreign market will generally require the advice of suitable professional advisors in the new market (i.e., legal, accounting, QA/RA, etc).
- Culture. Have cultural, religious and language differences been examined to identify any non-legal barriers to product entry and success in the target market?
- Miscellaneous. Are other legal or non-legal issues presented? Some potential issues are: antitrust/unfair competition; cross-border taxation; or accounting.
- Exit strategy (monetizing the new venture). Consider the means of exit under both good and bad circumstances.
The aforementioned considerations regarding foreign market conditions, when coupled with an analysis of the market entrant’s specific goals, are crucial to determining which market entry structure is preferable. These factors can all significantly impact the level of risk and financial investment required to effectively enter a new market.
Market Entry Strategies: Specific Options
Direct Market Entry
One possible market entry strategy is to form a corporate presence in the foreign jurisdiction and to acquire market production capacity (including any required intellectual property rights and regulatory authorizations). Direct market entry is most commonly accomplished by either merging/acquiring a previously established company in the jurisdiction, or forming a new wholly owned operational entity in the target locality. Direct participation can be simpler from a management and operational perspective. Unlike the license agreement or the joint venture, the success of direct participation is not dependant on cooperation with a local “partner” (see below). Direct market entry therefore allows for a high level of control, but also requires significant up-front investment, particularly considering that start-up costs in a new jurisdiction can often be rather high (from both a personnel and financial standpoint). As there is no “partner,” it is important to note that in some jurisdictions, direct participation in a foreign market may be hampered by laws limiting foreign investment or requiring that a stated percentage of the entity be locally owned (local ownership requirements).
License or Joint Venture?
As an alternative to direct entry, two common market entry strategies are to license specific intellectual property to a local affiliate (generally in exchange for royalties) or partnering with a local affiliate to produce and/or sell the products in the foreign jurisdiction (a joint venture).
In the context of intellectual property (“IP”) law, a “license” is a grant from the owner of an IP right (the “licensor”) to another entity (the “licensee”) permitting the licensee to make certain uses of the IP, for example, to distribute products under the licensor's trademark or manufacture products using the licensor's patent protected process, trade secrets or know how.
A joint venture generally involves a commercial collaboration between two or more independent entities, formed for either a single purpose project or a continuing business. Joint ventures can be formed: (i) as new entities, jointly owned or owned in an agreed proportion by the joint venture parties; (ii) when one party buys an interest in an existing entity's start-up or developing business; or (iii) through a contractual relationship without the use of a separate entity (sometimes referred to as alliances or strategic alliances).
Comparison of a License and a Joint Venture
License: As a general rule, licensing or other transfers of IP/technology entail less costs and difficulty than a joint venture, but also generate less financial return than actually “making” the product in the market (license agreements generally provide for a “royalty fee,” which is often either a flat annual fee or a stated percentage of sales). A licensing agreement usually enables a firm to enter a foreign market quickly, and poses fewer financial and legal risks than owning and operating a foreign manufacturing facility or participating in an overseas joint venture. This is because licensing rarely requires significant levels of capital investment and does not require that the parties work closely together or demand continuous attention. Licensing also permits U.S. firms to overcome many of the tariff and nontariff barriers that frequently hamper the export of U.S. manufactured products.
There are also various drawbacks to a license in addition to the reduced profits. For instance, the licensor has reduced control over the product quality, distribution and marketing policies. The licensor will also have less control over the essential support services personnel employed for the purpose of manufacturing/selling the product or technology. Furthermore, if consideration is based on sales volume, the licensor must rely on the honesty of the licensee to report units sold.
Joint Venture: Joint ventures often involve additional costs and expense, but allow for both greater control and greater potential profits. As noted above, the income on a license agreement is usually limited in some way (a royalty based on a percentage of sales, etc). This is not the case for a joint venture, although the parties may agree to split any profits however they see fit. In addition, an international joint venture enables a firm to actually establish a marketing or manufacturing presence abroad with the assistance of a local foreign partner (whereas as licensor would generally have a much more limited presence in the new territory). The local partner may also provide added value through their knowledge of government workings, regulations, internal markets and distribution know-how. This knowledge may be particularly valuable in an unfamiliar or volatile region.
Additionally, a number of potential disadvantages are associated with a joint venture. A joint venture will likely require a greater investment than a license agreement (in both time and resources). Moreover, when compared to a license, there are additional risks inherent to a joint venture as they require significant levels ongoing cooperation between the parties and a greater presence in the foreign country. For example, if a disagreement or dispute between the parties results in reduced operational control, the U.S. company may experience reduced profits, increased operating costs, inferior product quality, exposure to product liability, and environmental litigation and fines. U.S. firms that wish to retain effective managerial control will find this issue important in negotiations with the prospective joint venture partner.
Thus, a choice between a license and joint venture will often turn on issues such as a potential market entrant’s level of risk aversion and expectations regarding inter-entity cooperation, up-front investment costs, and profit margins.
Selecting a Partner
Regardless of whether a license agreement or a joint venture is selected as the appropriate vehicle, it is generally necessary to “partner” with another entity, although the level of cooperation varies depending on the specific type of market entry strategy and the scope of operations. Thus, selection of an appropriate “partner” is important, whether they are a licensee, partner, investor, etc. Selection of a partner is especially important with regards to considerations of quality control and regulatory compliance, both critical needs that will be fulfilled at the foreign location.
Deficiencies in any of the areas identified below would suggest that a potential “partner” must be examined with extraordinary care:
- Are the market entrant and the potential partner “culturally compatible” (both in terms of corporate culture and foreign social culture)?
- How does the potential partner, and its business operations, fit within the market entrant’s overall strategic plan?
- What is the reputation of the potential partner within the foreign market generally and the specific industry (i.e., among customers, suppliers, regulators, and/or consumers)?
- What is the potential partner’s organizational (i.e., management) level of skill and sophistication? What support financially and logistically will the potential partner require?
- What are the financial resources of the potential partner? Do they have sufficient access to capital? Is there any danger of insolvency?
- What financial reporting standards are applicable to the potential partner? Are third parties available to confirm compliance?
- With respect to IP, does the potential partner have sufficient technical and operational skill?
- If applicable, what is the potential partner’s prior history with respect to the use or licensing of IP? Has it been involved in any previous litigations which involved claims of misappropriation of IP?
- Does the potential partner have sufficient manufacturing, distribution, and logistical experience?
- What is the potential partner’s sales/marketing experience and capabilities?
- What is the potential partner’s regulatory compliance capabilities and history?
- Technology Transfer
- The final issue to be considered are questions regarding technology (IP) transfer. As IP laws can differ based on the jurisdiction, entry into a foreign market may pose various risks related to an entrant’s IP rights. Consequently, whether a license or joint venture is used to enter a foreign market, it is critically important to protect (i.e., prevent the exploitation of) any IP rights licensed or contributed to a joint venture vehicle.
- A potential market entrant should carefully consider each of the following questions in order to best protect its IP / trade secrets and maximize its return on investment:
1. (a) If technology (as opposed to trademarks or names) is to be transferred:
1. (i) Is the IP patented in the U.S.? Has the IP been patented in the new market? If not, when will this be possible?2. (ii) How will know-how or trade secrets be protected? It is important to be very careful when considering how the applicable law and other issues in the foreign jurisdiction will impact the protection of specific forms of IP. Poor choices can put key assets at risk.3. (iii) Pricing the transfer. Will a royalty be used or some other approach? Will the royalty be based on a flat fee or a percentage of sales? Will there be a minimum royalty?
1. (b) If trademark/name/etc. is to be licensed:1. (i) Have appropriate filings been made in both the U.S. and the foreign jurisdiction? If not, when?2. (ii) Is prior use a requirement for registration in the foreign jurisdiction?
2. (c) Is the involvement of key personnel required to complete the transfer? Can they be spared? May their knowledge be legally transferred?
3. (d) Despite the legal arrangements, should key aspects of technology or know how remain under trade secret protection?
4. (e) May the technology be legally exported/imported?
This article has reviewed various strategies and considerations relevant to operating in a foreign jurisdiction. Not only is it critically important that a business carefully select new markets, but equally important is selecting the proper market entry vehicle (and the selection of a related “partner,” if applicable). We have experience advising clients on matters related to direct market entry, licensing agreements, joint ventures and technology transfer, and would welcome the opportunity to discuss any of these matters further.