The Choice of Entry Mode in India

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to Global Competitiveness Report (GCR) in 2012-2013, India has one the most attractive domestic market size index, ranking 3rd out of 144 countries; the average real GDP growth rate from 2013 to 2017 is estimated at 7.5% (World Bank, 2015). India is therefore proving to be a country with a tremendous growth potential.

Country risk is related to the economic and political risks of a country (Nordal, 2001). According to the GCR (2012-2013) India has a relatively unstable macroeconomic environment. Inflation rate is quite high, ranking India 116th out of 144 countries, Government debt and budget balance indicators are also performing poorly, ranking respectively 111th and 136th; gross national savings and credit rating slightly compensate those poorly performing indicators, ranking Indian overall macroeconomic environment 99th. India is also not free from political instabilities. According to Transparency International (2015) and GCR, Public trust in politicians (106th), business cost of terrorism (114th) and corruption (85th out of 175) represent the most worrying indicators as far as political instability is concerned, while judicial independence and strength of investor protection are ranked 45th and 39th. Investor protection implies variables such as transparency of transactions, liability for self-dealing and shareholder’s ability to sue directors for misconduct; the higher performance of this indicator might help reducing the perceived risk of foreign investors, making Indian political scenario a bit less worrying in the eyes of investors.

Strengths

- Growth potential (7.5% av. GDP growth)

- Market size and demand growth (3rd)

- Low cost labour availability

- Availability of qualified engineers make India a prime target for the establishment of R&D departments (16th)

- Financial market development (21st)

- Availability of raw materials and natural resources

- Business impact of rules on FDIs (62nd)

- Extent and effect of taxation (44th)

Weaknesses

- Inadequacy of infrastructure (84th)

- Inefficient and slow bureaucracy

- Health and primary education (101st)

- Macroeconomic instability (99th)

- Corruption (85th)

- N° of procedures to start a business (121st)

- Trade Tariffs (126th)

- Total Tax rate, as % of profits (123rd)

Opportunities

- Metallurgical industry

- Automotive and trucks

- Furniture industry

- Clothing industry

- Industrial machinery and equipment

Threats

- Federalism and political instability due to the increasing autonomy and power of each Union Member

- Infrastructure: the poor transportation network increases costs for companies

Table 2: SWOT analysis of Indian environment. Source: Global Competitiveness Report 2012-2013, Transparency International 2015, Foreign Markets Report 2015 (ranks in brackets are out of 144 countries analysed, except for corruption which is out of 175)

Legal barriers include quotas, tariffs and trade regulations: the more a country decides to raise import tariffs, the more companies will opt for an equity entry mode. Also, countries that are limiting foreign ownership and have high FDI restrictions, will lead firms to choose non-equity modes of entry. In India, FDI operations made by non-residents – in shares or convertible bonds – are allowed in almost all economic sectors, including the service sector, and can include up to 100% of ownership in shares (Ahluwalia, 2002). India is ranked 62nd in terms of business impact of rules on FDIs. Strengths and weaknesses in Table 2 summarize Indian legal barriers and country risk indicators according to GCR 2012-2013.

Types of entry modes

Table 3 reviews the main modes of entry with the key factors to consider for each of them. Equity modes generally require a higher commitment in resources and a higher risk, with a potentially higher return on investment. This type of entry mode is preferred when firms are willing to transfer intangible assets overseas (Rugman and Brewer, 2001). Non-equity modes require less risk, less capital investment and less involvement in foreign operations: it is generally the choice made by SMEs. However, there are some exceptions: for instance, McDonald’s owns 18.5K restaurants outside the USA and 80% of them are managed with franchising agreements. Nevertheless, McDonald’s decided to enter Indian market with two 50/50 JVs with local companies. McDonald’s realized the necessity to meet specific customer needs and respect local culture, and reputed that the benefits deriving from the access to more local knowledge would have compensated any possible integration issue (McDonald’s annual report, 2013).

Entry modes

Advantages

Disadvantages

Potential key factors to consider

Equity modes

High commitment

Greenfield

Full control and possibility to duplicate existing processes

Slow implementation, larger capital required, higher financial risk, increased competition

Infrastructure, Labour market efficiency, market size and growth, Institutions, FDI regulations, international experience

Full Acquisitions

Faster entry method, full control over operations and capabilities

Possible integration issues, high up-front investment

Market size and growth, Institutions, international experience, FDI regulations, cultural distance

Medium commitment

Joint