In this section, we look at three basic decisions that a firm contemplating foreign expansion must make: which markets to enter, when to enter those markets, and on what scale.

Which Foreign Markets?

There are more than 160 nation-states in the world, but they do not all hold the same profit potential for a firm contemplating foreign expansion. Ultimately, the choice must be based on an assessment of a nation's long-run profit potential. This potential is a function of several factors, many of which we have already studied in earlier chapters. In Chapter 2, we looked in detail at the economic and political factors that influence the potential attractiveness of a foreign market. There we noted that the attractiveness of a country as a potential market for an international business depends on balancing the benefits, costs, and risks associated with doing business in that country.

Chapter 2 also noted that the long-run economic benefits of doing business in a country are a function of factors such as the size of the market (in terms of demographics), the present wealth (purchasing power) of consumers in that market, and the likely future wealth of consumers. While some markets are very large when measured by numbers of consumers (e.g., China and India), low living standards may imply limited purchasing power and a relatively small market when measured in economic terms. We also argued that the costs and risks associated with doing business in a foreign country are typically lower in economically advanced and politically stable democratic nations, and they are greater in less developed and politically unstable nations.

However, this calculus is complicated by the fact that the potential long-run benefits bear little relationship to a nation's current stage of economic development or political stability. Long-run benefits depend on likely future economic growth rates, and economic growth appears to be a function of a free market system and a country's capacity for growth (which may be greater in less developed nations). This leads one to the conclusion that, other things being equal, the benefit - cost - risk trade-off is likely to be most favorable in politically stable developed and developing nations that have free market systems, and where there is not a dramatic upsurge in either inflation rates or private-sector debt. The trade-off is likely to be least favorable politically unstable developing nations that operate with a mixed or command economy or in developing nations where speculative financial bubbles have led to excess borrowing (see Chapter 2 for further details).

By applying the reasoning processes alluded to above and discussed in more detail in Chapter 2, a firm can rank countries in terms of their attractiveness and long-run profit potential. Preference is then given to entering markets that rank highly. In the case of Merrill Lynch, its recent international ventures in the private client business have been focused on the United Kingdom, Canada, and Japan (see the opening case). All three of these countries have a large pool of private savings and exhibit relatively low political and economic risks, so it makes sense that they would be attractive to Merrill Lynch. The company should be able to capture a large enough proportion of the private savings pool in each country to justify its investment in setting up business there. Of the three countries, Japan is probably the most risky given the rather fragile state of its financial system. However, the large size of the Japanese market and the fact that the government seems to be embarking on significant reform explain why Merrill has been attracted to this nation.

One other fact we have not yet discussed is the value an international business can create in a foreign market. This depends on the suitability of its product offering to that market and the nature of indigenous competition.¹ If the international business can offer a product that has not been widely available in that market and that satisfies an unmet need, the value of that product to consumers is likely to be much greater than if the international business simply offers the same type of product that indigenous competitors and other foreign entrants are already offering. Greater value translates into an ability to charge higher prices and/or to build sales volume more rapidly. Again, on this count, Japan is clearly very attractive to Merrill Lynch. Japanese households invest only 3 percent of their savings in individuals stocks and mutual funds (much of the balance being in low-yielding bank accounts or government bonds). In comparison, over 40 percent of US households invest in individual stocks and mutual funds. Japan's own financial institutions have been slow to offer stock-based mutual funds to retail investors, and other foreign firms have yet to establish a significant presence in the market. Merrill Lynch can create potentially enormous value by offering Japanese consumers a range of products they have previously not been offered and that satisfy unmet needs for greater returns from their savings.