Would you invest in Baby Care?
The investment in Baby Care Ltd. for the China market would be evaluated by looking at the advantages and disadvantages of investing in the company.
The unique sales strategy of the company of using its own distribution channel in the Chinese market would be an advantage because it utilizes its own customer representatives which are paid a basic salary and commissions for their sales. They are accountable for new sales generation as well as maintaining existing sales in the market. They are also tasked to recruit ‘downline' representatives. The commissions are structured in such a way that they get 20% of new sales and 10% of sales to repeat customers. Additional incentives are also given to them based on performance. This structure of direct sales combined with its special service of giving advice and service to mothers provide impetus for sales generation as had been proven in their previous experience in their home market. As the customer representatives recruited were mothers themselves, they would be able to understand and empathize with the mothers also in the Chinese market. Moreover, the retail centers that provide training to mothers would facilitate sales of the products of the company.
As China is the biggest market for this product, it is logical that the company would go into the fastest growing market in the world. The health supplement market doubled from $3 billion in 1998 to $6 billion in the year 2000. This $6 billion dollar market is the target market for the company wherein 350 million urban residents out of 500 million residents purchased health supplements.
Furthermore, this unique sales channel is better than using distributors because it is very expensive in using it since distribution cost used up 35 to 50 percent for every dollar sales. Also, the large account receivables being kept by them made cash flows hard for the manufacturers.
The disadvantages of investing in Baby Care would be such factors as the risk of investing in an emerging market such as China and the cash cycle problem wherein stock orders from the United States would take some time for so many weeks before it can reach China. Thus, this requires about six months inventory which requires huge cash to maintain.
How is (or isn't) BabyCare's business model tailored to the idiosyncrasies of an emerging market?
Baby Care's business model is I think tailored to the idiosyncracies of the Chinese market since the company tracked a nine stage needs cycle that involved mother, father and child through nine stages which included the pregnancy period, infancy stage as well as the pre-school years from ages three to six. A curriculum was developed for each stage of development and these trainings would provide mothers and fathers excellent service for the care of their child and thus provide impetus and facility in the sales of the baby health supplements.
A fundamental factor in the Chinese market is that there is a growing trend towards self-medication since it is a major expense for them to go to doctors and medical services. Thus, through the business model of Baby Care, they can save through using the health centers of the company and their trained customer representatives for medical advice and services.
How would you evaluate BabyCare's funding opportunities?
Baby Care would have four funding options as follows:
1. Small investment, low valuation. Current investors offered to give $1 million of capital for expansion but gave a low valuation of $8 million. The business model of the company would further be tested and expanded and more capital will be infused if the market would have another six months to recover.
2. Large investment, higher valuation. A leading private equity firm in the healthcare industry proposed $6 million with a valuation of $26 million. It is based in the United States and the private equity firm has good connections with the major healthcare companies which can support the expansion of BabyCare.
3. Desired investment, mid-range valuation. A baby accessory company which is based in Hongkong proposed $2.5 million with a valuation of $19 million. Their would be synergy opportunities with them in terms of product development, market expansion, and cost savings. Mumford is a bit worried that having a strategic investor as a partner could complicate things later if the company would be offered for sale.
4. Desired investment, innovative structure. A convertible instrument which would finance $2.5 million for a period of four years with 10% convertible note is being offered by Templeton Investments. It also proposed a valuation of $22 million. It also further offered a $1 million fixed rate note to sweeten the transaction.
In option 1, there is no requirement of partnering with another company since the existing stockholders are the ones proposing to further invest in the company. However, the investment amount which is $1 million is much lower than the desired amount which is $2.5 million needed as expansion capital. As such, I think this option is not a good one.
However, options 2, 3, and 4 would involved some kind of an international joint venture and before we can make some kind of a decision we must first consider some studies about it as will be discussed in the following sections.
A strategic alliance is defined as a partnership wherein companies would decide that they are in a better position if their companies would go hand in hand to join their resources in pursuing mutually agreed goals( Blanchard, 2006). On the other hand, global strategic alliances involve partnerships between two or more companies located across national boundaries and increasingly across industries. International ventures can be made also between firms and governments of other countries (Blanchard, 2006).
A joint venture (JV) thus is a strategic alliance between two or more companies, while an international joint venture (IJV) involves a global strategic alliance between organizations. JVs involve the creation of an independent company by the two or more parent organizations who are the parties to the business agreement. These JVs may be one of two types:
• Equity strategic alliances, wherein alliances between firms can be made with shares in the equity varying from one another. For instance, in a JV involved three parent companies, one may have 50% equity, while the remaining two may have 25% equity each. These are also called equity joint ventures.
• Non-equity strategic alliances, understanding among the partners are mainly based on contracts and not because of ownership. These are also called contractual joint ventures.
There are four distinct forms of IJVs based on the IJV partners' nationality and equity affiliation. These four types are: 1) IJVs that are formed between affiliated home-country based firms; 2) IJVs that are formed between unaffiliated home-country based firms; 3) IJVs that are formed between home-country based and local firms; and
4) IJVs that are formed between home-country and third-country based firms. Each of these different IJV forms differ in terms of incidence, performance, and likelihood for survival.
Blanchard (2006) presents four significant challenges in implementing global alliances. First, partnerhips are safe and expedient means of going into international operations, however, it is extremely complex to fashion out global linkages especially where many interconnecting systems are involved. These interconnecting systems form intricate networks, and there are also partnerships which ended up as not a success and were bought by the other party.
Second, usually the means of managing their firms are major factors in the success of their business venture because of the predominant use of high technology in areas such as computers, pharmaceuticals, and semiconductors. Cross-border partnerships often become a sort of “race to learn” wherein the faster learner later ends up dominating the alliance and practically changing their condition. At any rate, an alliance may actually emerge as a new form of competition between the parent organizations involved (Blanchard, 2006).
Third, partnerships in other countries may have problems in handling matters in other crucial collaborations. This breeds mistrust and secrecy, which undermines the very purpose of the alliance. The difficulty that these organizations are facing is called the dual features in partner hips wherein it is characterized through the benefits of forming alliances but also coupled with the risk of going into competition by merging their given talents and technologies (Blanchard, 2006).
Fourth and last, Blanchard (2006) in his research contends that even though partnerships across countries have tremendous benefits, there could also be the risk of technology and management knowledge losses which could be caused by certain disagreements in strategy, culture, and control of the company
The most significant contribution of Vaidya's (2006) research study is that the author provides for a theoretical framework in understanding IJVs, particularly with regard to the relationship between the motives for setting up the IJV and the actual formation of the IJV. In discussing the motives behind IJV formation.
The study of Vaidya (2006) regarding the motives behind forming IJVs concluded that there are three distinct strategies which correspond to the choice of IJV ownership structure:
1) opportunity to make use of the competitive advantage specific to a parent organization;
2) or to a pre-existing relationship; and
3) complementing local partners' competitive advantage.
In their study, Ainuddin et al. (2007) identified four key resource attributes which affect the successful performance of 96 IJVs in Malaysia. The study determined the extent to which four resources - product reputation, technical expertise, local business network and marketing skills - exhibited the following attributes:
3) imperfect imitability; and
The results of their studies showed that value, rarity and non-sustainability were significant drivers of performance for IJV assets, while value, rarity and non-imitability were key attributes for organizational capabilities.
In his research, Kogut (1988) suggests an approach to understanding the motives for IJV formation that differs from Vaidya's (2006) approach. Kogut (1988) outlines the following three motives behind IJC formation:
• Transaction cost approach.
Based on this approach, the motives behind setting up an IJV is to minimize the cost of production for the companies. Strategic behavior approach. Companies opt to enter into IJVs to optimize returns on revenue and reduce risk of exploiting opportunities.
• Organizational learning approach.
Pursuant to this approach, companies go into ventures to increase their knowledge.
The study by Beamish and Berdrow (2003) however provides for an argument to the organizational learning approach that contradicts Kogut's (1988) contention. According to Beamish and Berdrow (2003), it is not always true that IJVs are in fact motivated by a learning imperative, or that organizations enter into IJVs to provide opportunities for each partner to gain access to existing knowledge and to develop new knowledge. The authors measured the following processes in existing IJV agreements: 1) transfer of existing knowledge between them; 2) transformation of knowledge through IJV to create new knowledge; and 3) harvesting of information and technology from the other firm to the other partner. The findings of the study showed that production-based IJVs are not typically motivated by learning outcomes, and as to these types of IJVs, there is no conclusive evidence of linking partnership ventures and performance through learning. The authors assert that only a minority of the firms showed strong indirect learning outcomes, especially with regard to partnering and market knowledge (Beamish & Berdrow, 2003).
The organizations may be driven by any or all of the motives enumerated by Blanchard (2006), Kogut (1988), and Vaidya (2006) in their studies, as previously discussed in the preceding sections of this chapter. It is important that a company conducts analysis of feasibility before entering into an IJV or even before making the decision to enter into a global strategic alliance. Evidence from related research shows that although IJVs are inherently unstable organizational forms, successful IJVs survive because the foreign partner organization arms itself with thorough knowledge of the local economic, political, and cultural environments of the IJV and the partner organization (Beamish & Berdrow, 2003).
Beamish (2006) stresses the importance of being thoroughly prepared before entering into an IJV, and suggests that IJV research should be published so that it would have a larger impact on practitioners, academics, and governments involved in global strategic alliances.
In his research presentation Blanchard (2006) emphasized the importance of selecting a company which possesses similar characteristics such as in strategy and directions before fully entering into an IJV. It is important that the alliance sought to be formed will be with an organization or organizations with skills, products, and markets which can complement each other. Previous studies also stress the importance of selecting the right IJV partner. According to Vaidya (2006), the selection of a partner is the most important strategic decision that companies make before actually forming a joint venture. Vaidya (2006) provides for the following reasons why IJVs fail, based on wrong partner selection: incompatibility of partners, partner not fulfilling their promises, inability of managers from different parent organizations to work effectively together, and disappearance of markets (Vaidya, 2006).
Before selecting a partner for an IJV, the organization must first identify its needs. In his research, Beamish (2006) provided for five different classifications of partners' needs:
• Items readily capitalized.
Companies may need capital, raw materials, or new technology or equipment.
• Human resource needs.
The organization may need domestic employees and managers.
• Market access needs.
The company may need better access to a local market for goods produced there. It may also need speed of entry into foreign or local markets.
• Government needs.
Existing laws or government regulations may require a foreign company to enter into a joint venture with a local partner in order to penetrate the latter's market.
• Knowledge needs.
The firm may need local knowledge on the market, factory and government regulations, marketing methods, local culture and customs, business traditions, etc., especially if it has the intention of entering a specific local market wherein it has no prior experience or exposure.
It should be noted however that selecting a partner also involves certain challenges. Culturally-different partners may have difficulty communicating or in seeing eye-to-eye on certain business traditions or customs. Differences in cultural values on long-term orientation and uncertainty avoidance may cause conflict in the IJV performance. It is difficult for partners to trust one another if they are in conflict on so many areas of the business operations. Unfortunately, sometimes these differences are too deeply rooted, especially when they are based on each organization's cultural values.
It should also be noted that alliance with very diverse networks experience lower economic performance on average, as compared to IJVs between those with less diverse alliance networks (Goerzen & Beamish, 2005). What this implies is that joint ventures between too radically different or too diverse organizations will most likely result in poorer performance.
Choi and Beamish (2004) suggest a possible solution in resolving conflicting styles or cultural clashes between two parent organizations. The authors suggest the split control management approach to IJVs wherein parent firms split control by choosing that each partner is to control, so that those chosen activities can be matched with each company's respective firm-specific advantage.
As based on the above studies, I think it is best to choose option no. 3 since it can provide the desired financing of $2.5 million with a good valuation of $19 million. Furthermore, since the company is based in Hongkong it has a better feel of the Chinese market. It is also compatible with BabyCare since it is also in the Baby market producing baby accessories. As already stated the venture financing would also provide synergy opportunities with them in terms of product development, market expansion, and cost savings.
I would not recommend option 2 since although it offers a $6 million venture financing and a $26 million valuation, it is s based in the United States and does not know anything about the Chinese market. It is an equity firm in the healthcare industry but not focused on the baby care market which option 3 can provide.
I cannot also recommend option 4 since it is only focus on providing financing and their would be no synergy in other areas which can help contribute to the company. Besides, the 10% interest on the financing would be additional cost to the company which it does not need.