Could sunk costs leave your business shipwrecked in a foreign market?

05/02/2016

Sunk Costs

Sunk CostsSunk costs are a major economic barrier for many smaller companies. Sunk costs are those expenses necessarily incurred to enter a new market, that cannot be recouped if the market entry fails.

These include monies invested in research and development, marketing and advertising, and development of facilities in overseas markets.

In many cases, a substantial investment will need to be made to break into a new country. If none of these costs can be recovered in the event that the venture fails or the company must pull out of the country, then many companies will be unable to take a chance on entry.

Know the risk before you start exporting

Sunk costs become more of an issue in countries that are politically or economically unstable. As with political instability, economic uncertainty can be a practical barrier to market entry.

A company seeking funding to invest in or sell products to countries wracked by weak or fluctuating currency, high inflation, poverty or unemployment is not likely to be successful.

In markets with these conditions, customers are less likely to purchase goods and services and market entry becomes more risky.

Some markets present a barrier in the form of restrictions on the flow of currency into or out of a country.

Many countries control their currencies by fixing exchange rates. They also control how much foreign currency can be exchanged for local money, how much can be changed back into currencies that can be easily traded internationally and how much money can be taken out of a country.

Foreign exchange controls in closed-currency countries also determine what and how much can imported, because payments to foreign suppliers must be made in hard currency. A government-controlled central bank will often monitor trade transactions, and might even arrange for payments.

Payment in some markets can present major problems. Establishing reliable credit ratings is normally difficult, and it is of no use in societies where currency is controlled and cannot be exchanged freely.

Unless insured by reliable government agencies, credit terms always carry with them some risk of nonpayment. Advance payment terms or letters of credit require time and additional expense.

What else do I need to track to understand my risks?

Other economic entry barriers include the following:

Market wage rates: For companies considering conducting business in a market, high wages constitute a major economic barrier. A substantial proportion of production and service provision costs are tied up in employee wages. Companies often select markets in which labour wages are lower.

Land costs: For companies investing in production sites or branch offices, the cost of land or rents can present a barrier to entry.

Construction costs: If a company is considering a Greenfield investment, in which facilities are built in the foreign market, high construction costs or poor quality construction will present a substantial barrier.

Costs for raw materials and resources: If a company wants to manufacture goods or supply services in a market, high costs for raw materials and resources will make entry more expensive.

Profit repatriation: Repatriation restrictions have a negative impact on the net income or dividends remitted to foreign headquarters. These restrictions might include an imposed limit on the amount of cash that can be sent from a market, or a tax imposed on monies sent from the market. In some countries, companies must obtain permission from the government or central bank to repatriate earnings.

Tax rates: Corporate income tax rates greatly influence a company’s profitability. In some markets, the tax rates on corporate income are far higher than others, or are higher for foreign companies. Some countries also impose substantial taxes on payrolls.

Get ahead on your problems with these proactive strategies

In markets in which customers cannot afford a product, companies might look for ways to cut costs to gain a foothold. Alternatively, they might reposition the product as a luxury item rather than an item of mass consumption.

Even if a society is generally poor, there may be affluent pockets within it that can be lucrative marketing targets.

For example, many people consider India to be a country of extreme poverty, and certainly the majority of India’s people are poor.

However, the Indian middle class is growing rapidly and is estimated to number over 250 million, making it the largest middle class market of any country in the world.

Companies can deal with high inflation by specifying payment in more stable currencies. They can minimize the impact of fluctuations in exchange rates by using a variety of hedging techniques.

Exporters offering a product in high demand may be in a position to demand payment in advance, before shipment.

Is your company concerned about its sunk costs? What can you do to maximize the investments you’ve already made?

This content is an excerpt from the FITTskills International Market Entry Strategies textbook. Enhance your knowledge and credibility with the leading international trade training and certification experts.

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About the author

Ewan Roy

Author: Ewan Roy

I'm a Digital Marketing Specialist for the Forum for International Trade Training (FITT). My background is in writing and research, and I am passionate about communicating new ideas and telling stories that matter to you.

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