Read the case study and do the assignment below;

1 Identify the key criteria and considerations that need to be taken into account in evaluating BFSI entry in the proposed foreign markets.

2 Of the countries under consideration, which five would be most suitable for the immediate establishment of a BFSI subsidiary? Highlight the key issues for each of the selected countries and discuss the reasoning behind your recommendation.

3 Which countries would be unsuitable for a BFSI subsidiary at this time, and what are the basic shortcomings in each case?

4 What is the recommended mode of entry in the selected countries and what are the key considerations in support of this recommendation?

Evaluating Markets to Invest Abroad
E. N. Roussakis and Anastasios Moysidis
This case deals with the key considerations when planning an international
expansion through direct investment in foreign markets. These considerations must be
addressed by a finance company seeking to establish foreign subsidiaries to support the
international sales of its parent firm, a U.S.-based multinational enterprise (MNE). The
company already operates three foreign subsidiaries–in Canada, Mexico (both NAFTA
members), and the United Kingdom–but wishes to increase this network further through
entry into additional markets. Ten candidate countries are being considered to determine
the five most suitable for entry. Hence the need for a rational decision of where to invest.
Keywords: Subsidiaries; multinational enterprise; transnational activities; foreign direct
investment; g r e e n f i e l d i n v e s t m e n t ; l e v e r a g e d i n s t i t u t i o n ; w h o l e s a l e
f i n a n c i n g ; c a p t i v e finance company; retail installment contract
1 Introduction
Victoria Pernarella is a recent university graduate in business administration and a new
hire in Bertos Financial Services, Inc., a major finance company in Nashville, Tennessee.
After a month long rotational t r a i n i ng to gain insights into the company’s scope
of activities, she was placed in the international department where she has been assigned
to work on a project. Bill Pappas, her manager, had asked her to analyze a select number
of foreign countries to determine the best prospects for the local establishment of
subsidiary finance companies. He went on to clarify that the mode of entry into the foreign
markets– acquisition of an existing company or a greenfield investment (from the ground
up, that is, from a green field)–was not a primary consideration at this stage. The
candidate countries were Au s t r a l i a , Bulgaria, Qatar, Serbia, Argentina, Malaysia, Botswana,
Kenya, Uruguay, and Costa Rica. With finance companies highly leveraged institutions,
the firm was prepared to provide the initial amount of equity capital needed for the
establishment of five such institutions. At this stage therefore, the study ought
to limit its recommendation to a corresponding number of foreign countries.
With this information at hand, Victoria started reflecting on the approach to use for
her analysis. Sensing the need to prove her capabilities by delivering a high quality study
for her first company assignment, she thought appropriate to first familiarize herself with
the pertinent literature on the international expansion of multinational enterprises (MNE)
in general and banks in particular, a n d then review background i n f o rma t i o n
o n her employer, and the scope of activities of its financial subsidiary. Hence the
sequence of the following sections which address the internationalization process
(literature review on the development of MNEs), the modes of bank entry into foreign
markets, background of parent company, financial subsidiary and scope of activities, and
developing criteria for country recommendation.
2 Internationalization Process–A Theoretical Perspective
Recent decades have witnessed the internationalization of operations of many companies
around the world, and especially U.S. corporations. Although the extent, form and pattern
of their transnational a c t ivi t i e s vary according t o the characteristics o f the firms,
the products t h ey p roduce, a n d the markets i n which they operate, t h e y a l l
reflect t h e dynamics of a changing and increasingly competitive international
environment. Of the theories that have sought to explain the transnational activities of
enterprises, the eclectic paradigm (Dunning, 1988) enjoys a dominant position. This concept
provides a broad framework for the alternate channels of international economic
involvement of enterprises and focuses on the parameters that influence individual MNE
foreign investment decisions (Buckley and Casson, 1976; Dunning, 1977). Specifically, the
eclectic paradigm identifies three important determinants in the transnational activities of
firms– ownership, location and internalization (OLI). The first condition of the OLI
configuration states that a firm must possess certain owner-specific competitive advantage
in its home market that can be transferred abroad if the firm’s foreign direct investment
(FDI) is to be successful. This advantage must be firm specific, not easily copied,
transferable, and powerful enough to compensate the firm for the potential disadvantages
and risks of operating abroad. Certain ownership-specific competitive advantages enjoyed
in the home market, such as financial strength and economies of scale, are not necessarily
firm specific because they can be also attained by other firms. Similarly, c e r t a in types
of technology do not ensure a firm – specific advantage because they can be purchased,
licensed or copied. Production and marketing of differentiated products, too, can lose
their competitive edge to modified versions of such products promoted by lower pricing
and aggressive marketing.
The second strand in the OLI model stands for location-specific advantages. That
Is, the foreign market must possess certain characteristics t h a t will allow the firm to
exploit its competitive advantages in that market. Choice of location may be a function of
market imperfections or of genuine comparative advantages of particular places. Other
important considerations that may influence the locational decision may include a lowcost
but productive labor force, unique sources of raw materials, formation of a custom
unions or regional trading bloc, defensive investments to counter a firm’s competitors, or
centers of advanced technology.
The third component of the OLI paradigm is internalization and refers to the
importance for a firm to safeguard its competitive position by maintaining control of its
entire value cha in in its industry. This can be accomplished through f o r e i g n
d i r e c t investment r a t h e r t han licensing o r outsourcing. Transferring
p r o p r i e t a r y i n f o rma t i o n across national boundaries within its own organization
would enable a firm to maintain control of its firm-specific competitive advantage.
Establishment of wholly owned subsidiaries abroad r e d u c e s t h e f i n a n c i a l agency
c o s t s t h a t a r i s e f r om a s ymme t r i c information, lack of trust and the need to
monitor foreign partners, vendors, and financial intermediaries. Further, if the parent firm
funds the operations of its foreign subsidiaries, self-financing eliminates the need to
observe specific debt provisions that would result from local financing. If a
multinational firm has access to lower global cost and greater availability of capital why
subject its operations to local financial norms or share these important advantages with
local joint venture partners, distributors, licensees, and banks that would probably have a
higher cost of capital.
Of t h e t h r e e p r emi s e s o f t h e p a r a d igm described a b o v e , t h e
s e c o n d s t r a n d (locational a dva n t a g e ) h a s been the subject of increased
t r e a t i s e . Although i n theory market imperfections and comparative advantage are key
considerations in determining the attractiveness of particular locations, in practice firms
have been observed to follow a search pattern influenced by behavioral factors. As
rational decisions require availability of information and f a c t s , d e t e rmi n i n g
where t o i nves t a b r o a d f o r t h e f i r s t t i m e i s significantly more challenging than
where to reinvest abroad. The implication is that a firm learns from its operations abroad
and what it learns influences subsequent decisions. This premise lies behind two related
behavioral theor i e s of foreign direct investment decisions–the behavioral approach
and international network theory. The former, exemplified b y the Swedish School o f
economists (Johansen and Wiedersheim-Paul, 1975; Johansen and Valhne, 1977),
sought to explain b o th the initial and later FDI decisions of a sample of Swedish
MNEs based on these firms‟ scope of international operations over time. The study
identified that these firms favored initially countries in “close psychic distance”; that is,
they tended to invest first in countries that possessed a similar cultural, legal, and
institutional environment to that of Sweden’s, e.g., in such countries as Denmark, Finland,
Norway, Germany and the United Kingdom. As the firms gained knowledge and
experience f rom their initial operations, they tended to accept greater r i s k s both in
terms of the countries’ psychic d i s tance a n d the s ize of their investments.
The development and growth of Swedish companies over time, contributed to a
transformation i n the nature of the parent/foreign-subsidiary relationship. The
international network theory addresses this transformation by identifying such changes as
the evolution of control from centralized to decentralized, nominal authority of the parent
firm over the organizational network, foreign subsidiaries competing with each other and
with the parent for resource allocations, and political coalitions with competing internal
and external networks.
Some authors (Eiteman et al., 2010) view the internationalization of operations as
an outgrowth o f sequential s t a g e s in the development o f a firm. They refer to
this progression in the scope of business activity as the globalization process and identify
three distinct phases. In the domestic phase, a company sells its products to local
customers, and purchases i t s manufacturing a n d service inputs f rom local vendors.
As the company grows to become a visible and viable compe t i tor a t home,
imper fect i ons i n foreign national markets or comparative advantages of particular
locations translate into market opportunities and provide the impetus for an expansion
strategy. Entry into one or more foreign markets will make the company attain the
international trade phase. At this stage the company im p o r t s i t s inputs f rom
f o reign suppl ier s and expor ts i t s products and services to foreign buyers. In this
facet, the firm faces increased challenges of its financial management, over and above the
traditional requirements of the domestic-only p h a s e . Exports and imports expose the
firm to foreign exchange risk as a result of currency fluctuations in global markets.
Moreover, they expose the firm to credit risk management; assessing the credit quality of
the foreign buyers and sellers is more formidable than in domestic business. When the firm
senses the need to set up foreign sales and service affiliates, manufacture abroad or
license foreign firms to produce and service its products, it progresses to the third phase,
the multinational phase. Many multinational enterprises prefer t o invest i n whol ly
own e d s u b s id i a r i e s t o maintain e f f e c t i v e c o n t r o l o f their competitive
advantage and any new information generated through research. Ownership of assets and
enterprises in foreign countries exposes the firm’s FDI to political risk– political events that
can undermine the economic viability and performance of the firm in those countries.
Political r isk can range from seizure of property (expropriation) a n d ethnic strife to
conflict with the objectives of the host government (governance risk) and limitations on
the ability to transfer funds out of the host country (blocked funds).
Figure 1 portrays the sequential s tages in a firm’s international e xpa n s ion and
provides an overview of the globalization process and the FDI decision. For a firm with a
competitive advantage in i t s h o m e m a r k e t , a t y p i c a l sequence in i t s
i n t e r n a t i o n a l expansion would be the reach to one or more foreign markets by first
using export agents and other intermediaries before engaging in direct dealings with foreign
agents and distributors. As the firm learns more about foreign market conditions,
payment conventions and financial institutions it feels more confident in establishing its
own sales subsidiary, service facilities and distribution system. These moves culminate
in foreign direct investments and control of assets abroad. Some of these assets may have
been built from the ground up, or acquired through purchase of an existing firm or
facility. As the level of physical presence in foreign markets increases so does the size
of foreign direct investment.
3 Modes of Bank Entry into Foreign Markets
Unlike industrial and manufacturing firms, whi ch have expanded internationally along
the patterns suggested above (eclectic paradigm and globalization process), financial
institutions h a v e entered foreign markets primarily i n response to the needs of
their business clients. Indeed, this has been the case for commercial banks, the oldest and
most dominant institution of the U.S. financial system. The growth of multinational
corporations and the accelerating pace of globalization in business activity increased the
demand for international financial services and i n d u c e d the e x p a n s i o n of
b a n k s ’ international operations a n d p r e s e n c e a b r o a d . Whether p r o a c t i v e l y
(to enhanc e o w n growth and profitability) or defensively (to deny a competitor the
benefit of the client’s business), banks have sought to enter foreign markets early and
quickly to gain from the first-mover advantage. The rush of Western banks into Central
and Eastern Europe in the
1990s exemplifies the drive to gain this first-mover advantage (Hughes and MacDonald,
In weighing entry into a foreign market a number of factors must be taken into
account, including the bank’s resources (both financial and human), projected volume of
international business, k n o w l e d g e o f –and e x p e r i e n c e w i t h –foreign markets,
b a n k i n g structure a n d r egulat ion i n the count r i e s t a r g e t e d f o r ent ry, t a x
cons ide r a t ions , and customer profile. A key variable in the decision process is the
vehicle to be used in the delivery of international services. Major banks around the
world have used anyone or a combination of vehicles to structure their international
operat ions. The lowest possible level of presence in a foreign market may be attained
through a correspondent banking relationship–using a native institution to provide the
financial services needed in that market. This approach may be duplicated in one or
more countries abroad, as needed, for the p roce s s ing o f i n t e rna t i ona l transactions.
It ent a i l s n o i nve stment and h e n c e n o
Exposure to the foreign market. Extension of services may be based on a reciprocal
deposit account between the banks or an individual fee per transaction. A representative
office enabl e s a physical p r e s e n c e i n a foreign mar k e t . However, i t cannot
p r o v i d e traditional banking services; it can only engage in such activities as serving
as a liaison and performing marketing function for the parent bank. As it does not
constitute a legal entity it has no legal or tax liability. An agency may perform more
functions than a representative office but cannot perform all banking functions (e.g., in the
United States a foreign b a n k agency may extend l ocal loans b u t cannot a c c e p t
l o c a l dep o si t s ). The principal vehicle used by U.S. banks in the conduct of their
activities internationally is the branch office. This office is a legal and operational part of
the parent bank, backed the full resources of the parent in the performance of the banking
functions permitted by the host country. Although it requires a sizable investment it
enables the provision of full banking services, which the prior vehicles do not. A
branch o ff ice is subject t o two sets of regulation–those of the home country and
those of the host country. A subsidiary is a separate legal entity organized under the
laws, and hence regulated by the authorities, of the host country. It is the second most
important vehicle used by commercial banks for the conduct of banking business, and may
be established as a new organization or through the purchase of an existing institution.
Whatever the approach used in its establishment, a subsidiary offers two important
advantages over a branch: it may provide for a wider range of services, and it limits the
liability of the parent bank to the amount of its equity investment i n that enti ty. The
main disadvantage o f a subsidiary i s that it must be separately capitalized from the
parent bank, which may often entail a greater start up investment than a branch (Rose and
Hudgins, 2010).
U.S. finance companies interested to expand their activities internationally take
into account many of the same criteria used by banks. In structuring their international
operations U.S. finance companies favor the subsidiary organizational form because of the
advantages associated with this type of vehicle. Just as in U.S. financial markets, foreign
financial subs idiar ies a r e heavy users of debt in financing t hei r operations.
Principal sources of borrowed funds include bank credits and issues of debt (e.g., bonds)
in capital markets to finance their lending activities in their respective market s
(Madura, 2011; Gitman et al., 2010). Finance companies are extremely diversified in their
credit granting activities, offering a wide range of loans, leasing plans and long term
credit to support capital investment. One of the most important markets for finance
companies has been the extension of business-oriented financial services including working
capital loans, revolving credit and equipment lease financing.
4 Background of Parent Company
Bertos Manufacturing Corporation (BMC) is one of the largest companies of the country
in the manufacturing of construction and mining equipment, and engines. BMC draws its
origin in a California firm organized in 1890 to manufacture steam-powered tractors for
farming. The firm was nominally capitalized and aspired to make inroads in the local
market by having its tractors plow California fields. However, soon after the turn of the
century, a n abandoned man u f a c t u r i n g p l a n t b y a fai led t racto r c omp a n y i n
a major manufacturing cent e r in Illinois was instrumental in the relocation of
operations in the
Midwest. The l o c a t i o n of t h i s c e n t e r on t h e Mississippi River made i t a
prime transportation hub offering important prospects for the young company. Indeed, the
move proved a turning point in the development of the company. Domestic sales grew so
significantly that by 1911 the factory employed a little over 600 individuals. A natural
consequence o f the domest ic m o m e n t um w a s the f i rm’ s entry i n t o f o r e ig n
m a r k e t s through tractor exports to Argentina, Mexico, and Canada.
World War II was a company milestone as it created a sharp increase in the
demand for tractors to built airfields and other military facilities in strategic sites of the
Pacific. However, it was during the post-war construction boom that the company grew at
a rapid pace. A series of mergers and acquisitions diversified operations into the current
scope of products and contributed to BMC’s growth to an industrial company of national
and international dimension. A successful export-oriented strategy led to the establishment
of a manufacturing venture outside the United States in 1950, which marked the beginning
of BMC’s development into a multinational corporation.
The company operates in two primary lines of business: machinery and engines.
The machinery line of business designs manufactures and sells construction, mining, and
forestry machinery, including track and wheel tractors, hydraulic excavators, pipe layers,
log loaders, off highway trucks, and related parts. The engines business line designs,
manufactures and sells diesel and natural gas engines and gas turbines, which, in addition
to their use in the company’s own machines and vehicles, provide power for boats, ships
and locomotives.
The r ecent f i n a n c i a l c r i s i s (2008) l e d t o t he restructur ing of
operat ions a n d renewed management’s commitment to fuel efficiency, quality,
technology and safety of the company’s machinery and engine products. Overall, BMC
manufactures some 400 products, which are sold both at home, and abroad through a
network of dealers. The company has a worldwide network of 220 dealers: 63 dealers in
the United States and 157 in other countries. To accommodate domestic and international
demand for its products and components the company has built 109 plants in different part
of the world. Of these, 51 plants are located in the United States and 58 in foreign
countries, namely, Australia, Belgium, Brazil, Canada, England, France, Germany, Hungary,
India, Indonesia, Italy, Japan, Mexico, the Netherlands, Northern Ireland, the People’s
Republic of China, Poland, Russia, South Africa and Sweden. The c ompa ny a l s o
l i c e n s e s o r s u b c o n t r a c t s t h e manufacture of BMC-branded clothing, hats,
footwear, and other consumer products. To s uppor t higher v o l u m e s , growth a n d
n ew p r o d u c t i n t r o d u c t i o n s , BMC’s worldwide employment is a little over 100,000,
split evenly between the United States and the rest of the world. Consolidated revenue last
year amounted to about $45 billion and net profit (after taxes) $3.5 billion (Table 1).
More than half of the total revenue was generated outside the United States, while the
North American market was the single largest source. A breakdown of revenues by
geographic region is provided in Table 2.
Although this performance represents the culmination of an effective international
strategy, BMC has been increasingly concerned about its future potential in the global
market place. Its board of directors has recognized that although opportunities for future
growth exist, international competition may undermine the maximization of consolidated
after-tax returns. To offset the effects of such a trend, the board, in its last meeting,
decided t o e x p l o r e n ew a v e nue s f o r g r o w t h . A top p r o s p e c t was t h e
i n t e r n a t i o n a l expansion of financial services to support the overseas dealer sales of
BMC products.
5 Financial Subsidiary and Scope of Activities
Following the practice of other industry leaders (e.g., General Electric, Motorola, and
Ford Motor Company), BMC established a wholly-owned, and separately incorporated,
finance company to perform a dual function–to accommodate the credit needs of the
parent but most importantly to finance parent company sales (hence the reference to such
a f i rm a s a c a p t ive f i n a n c e c omp a n y ). Established i n Nashvi l le,
T e n n e s s e e , Bertos Financial Services, Inc. (BFSI) promotes the sale of the parent’s
products and services by engaged in the extension of credit. Specifically, BFSI extends
wholesale financing to, and purchases r e tai l installment c o n t r a c t s f rom, f ranchised
d e a l e r s . Also, it offers various forms o f in surance t o customers a n d dealer s t o
suppor t t h e p u rchas e a n d l ease o f equipment. Table 3 identifies the location of
BFSI offices in the United States and the geographical market covered by each office.
The company’s domestic network includes 10 regional offices and a wholly owned
subsidiary, w h i c h engages solely in the financing and leasing of construction and
trucking industry equipment on a national scale. Table 3 also identifies BFSI ’s current
p r e s ence a b roa d , which is limited to three subs idiar ies located in the following
count r i e s –Canada and Mexico (both member s o f the North American Free Trade
Agreement), and the United Kingdom.
In its last meeting the BMC board felt that if the spectrum of credit activities
pursued a t home could be duplicated abroad it would add important impe t u s i n the
company’s international g rowth momentum. The board believes that establishment o f
finance companies in a n a d d i t i o n a l number of s e l e c t foreign countries would
be instrumental in maximizing corporate investment returns. To this end it has requested
an in-house study to screen foreign prospects and expressed the interest to review
recommendations in its forthcoming meeting. It was under these circumstances that Bill
Papas assigned the task for this study to Victoria.
6 Developing Criteria for Country Recommendation
To screen the best five prospects among the ten candidate countries for the establishment
of subsidiary finance companies, Victoria thought appropriate to develop a set of criteria
on which to base her recommendation. Although she could read idly identify several key
criteria, she felt she should g ive also due consideration t o the rules and regulations
governing bank operations in the candidate countries. Granted that the objective was not
to set up commercial banks but finance companies; however, the banking regulatory
framework provided a n i ndi c a t i on of the k ind o f c r e d i t a n d f inanc i a l
environment prevailing in these countries.
Although the focus of her study was the best five foreign prospects, s h e felt
important t o defend h e r r ecommenda t ion by also address ing t h e weaknesses
o f the excluded countries. She realized that this classification was only pertinent under
present circumstances and that some of the excluded countries could realize latent
opportunities to qualify for entry at a later time.


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