4.3 Active Exporting Once a firm realizes that it wants to exploit the possibilities that sales abroad can bring and decides to become involved in export activities, a number of alternatives open up. Several alternatives are possible, differing not only in the level of involvement of the exporter, but also in the strategies pursued by the exporter.6 4.3.1 Agent An agent is usually a small firm or an individual located in the im- porting country who acts as a manufacturer’s representative for the ex- porter. The agent sells the manufacturer’s products to customers in the importing country, using the terms of sale—price, delivery, discounts— determined by the exporter. An agent does do not buy product, but arranges sales directly from the principal to the customers. For this work, an agent is paid a commission, calculated as a percentage of the sale price of the product to the customer, and collected after the cus- tomer has paid the principal. An agent often has several principals and generally sells a group of complementary products rather than products that compete directly with one another. The agent will handle all of the sales functions for the exporter, from the initial prospecting for customers to the close. The agent is usually given varying support by the exporter: some exporters provide only the bare minimum of a sales brochure and a price list, while the more experienced exporters provide training on the product’s characteristics, analysis on the competitors’ products, information on the sales and service philosophy of the company, sales support in the form of samples, catalogs (translated or adapted), trade advertisingand financial support to attend trade shows, technical visits by corpo- rate engineers, participation in sales incentive programs, and so on. Agents, as a whole, like to keep control over their schedule and over their sales approach, but the exporter’s support of their efforts is crit- ical to their success and to the extent to which they expend a lot of effort selling the exporter’s product. In particular, requests for quotes and pro forma invoices should be handled quite promptly, and negotia- tions on price and delivery done diligently, so as to not delay the agent’s sales efforts; time differences sometimes exacerbate the perception of a lack of responsiveness on the part of the exporter. Sometimes, there is the suggestion that, given a set of guidelines, the agent could be trusted to reach decisions and negotiate with the cus- tomer on critical aspects of the sale: price, delivery, terms of trade (see Chapter 6), terms of sale (see Chapter 7), and collection. However, it is critical that all such negotiations be handled by the principal, with the agent acting as an intermediary between the exporter and the importer. If the agent is allowed to negotiate directly with the importer, then the agent is considered by a large number of countries’ governments as a binding agent, and the exporter is considered to have a permanent establishment in the country of import. This determination has signif- icant taxation implications; the profits realized on the sales made in that country are now considered taxable by the country of import. If there is no permanent establishment, the profits are not taxable in the country of import, although they are obviously taxable in the country of export. After the sale is concluded between the agent and the importer, all of the other aspects of the transaction, from the pro forma invoice to the actual collection of payment, from packaging to shipping the goods, are handled directly and solely by the exporter. Finally, the agent does not get paid until after the exporter has been paid by the importer. The choice of an agent should obviously be made on a large number of criteria: its ability to represent the exporter and its product accu- rately, its ability to sell, its contacts, its knowledge of the industry that the exporter wants to target, the compatibility of its objectives with those of the exporter, and so on. Moreover, the choice of an agent is a long-term commitment; although the contract is often based on one- year increments, the duration of an effective relationship between an exporter and its agents is much longer. There are several alternative routes to finding agents in foreign coun- tries; among the most commonly used methods are contacts made at trade shows, participations in trade missions, inquiries with the com- mercial attachés of the exporter’s country’s consulates, and contacts with other successful exporters. The use of an agent is generally driven by several factors, one or more of which can be enough to trigger this strategic decision
1. When the firm estimates that its potential sales in that market are small (perhaps no more than 5 or 10 percent of its domestic sales), with moderate or no growth potential 2. When the product is not a stock item, but a product specifically designed and made for a particular customer 3. When the product is a very expensive item, such as operating ma- chinery 4. When the company expects a short product life cycle 5. When the product does not require frequent after-sale service 6. When the exporter is unlikely to ever become one of the dominant players in the market and will remain a niche player 7. When the company is reasonably well equipped to handle export sales 8. When the company is not pursuing a top-of-the-line strategy and does not attempt to collect premium prices 9. When the company wants to keep a reasonable amount of control over its prices and delivery policies 4.3.2 Distributor Another entry strategy is to use a firm located in the importing country— or, sometimes, in a neighboring country—that buys the goods from the exporter. Such an intermediary is called a distributor, that takes ti- tle to the goods, sells them, and earns a profit on the sales it makes. What characterizes a relationship with a distributor is that there are two sets of invoices: one set of international invoices between the ex- porter and the distributor, who is also the importer of record; and a set of domestic invoices between the distributor and its customers, who see these transactions as domestic sales of a foreign product. A distrib- utor is therefore carrying inventory of the exporter’s goods, and it also often carries inventory of spare parts and provides after-sale service. A distributor will carry complementary products but also may carry products that compete directly with those of the exporter. A distributor is taking much more risk in its relationship with the exporter than does an agent, and experiences much higher costs. The distributor carries the traditional risks associated with inventory and invests a considerable sum of money in the inventory; should the goods not sell well, the distributor is saddled with the unsold or obsolete goods. In addition, it is traditional for a distributor to participate in the costs of advertising, trade show attendance, and so on. In exchangethe distributor has much more freedom in setting prices, negotiating terms with customers, and managing all matters not directly related to the exporter’s trademarks or copyrights. However, there is a large number of exporting firms that attempt to limit these freedoms, specif- ically on price, in order to maintain a standard strategy from country to country and to eliminate or reduce “parallel imports” (see Section 4.5 on page 139). A distributor should also be considered a long-term partner. Be- cause it makes a substantial investment in inventory and in the training of its employees, the distributor considers itself involved for a long pe- riod of time, and great care should be taken in finding the right partner. The choice of a distributor should be made on a large number of crite- ria: its ability to represent the exporter and its product accurately, its ability to invest in the exporter’s products, to sell them, and to provide after-sale service, as well as its employees, their contacts, its knowl- edge of the industry, the compatibility of its objectives with those of the exporter, and so on. There are several alternative routes to identifying potential distribu- tors in foreign countries; among the most commonly used methods are trade shows, trade missions, the commercial attachés of the exporter’s country’s consulates, and contacts with other successful exporters. The use of a distributor is generally driven by several factors,7 one or more of which can be enough to trigger this strategic decision: 1. When the firm estimates that the market is substantial (perhaps 20 or 25 percent of its domestic sales) or when it estimates that there is substantial growth potential 2. When the product is a stock item, and generally not tailored to the needs of a specific customer 3. When the product is a rather moderately priced item 4. When the company expects a fairly long product life cycle 5. When the product requires (frequent) after-sale service and/or main- tenance parts 6. When the company estimates it will not become much more than a minor player in the market 7. When the company prefers to handle export sales with only one customer 8. When the company is not pursuing a prestige pricing strategy with premium prices and service 9. When the company is comfortable relinquishing control of its price and delivery terms.
4.3.3 Additional Issues in the Agent-Distributorship De- cision There are two other issues to consider when determining whether an agent or a distributor would be the most appropriate partner—both issues are legal in nature. First, some countries will not allow agents at all, or will not allow agents to represent foreign manufacturers, or will mandate a physical after-sale service presence on the country’s soil, all requirements that mandate the use of a distributor. The second issue is more complicated: many governments make a substantive differentiation in the way agents and distributors are con- sidered by their judicial systems. Most often, because agents tend to be individuals or very small firms, many countries have decided to place them under the protection of labor law, the code of laws that deals with the relationships between employers and employees (see Section 5.3.1 on page 156). In many countries, notably in Europe, labor law tends to be very restrictive in terms of what an employer can and cannot impose on an employee and, in those countries in which labor law applies to agents, what an exporter can and cannot require of an agent. For exam- ple, even though the principal-agent contract may call for a termination notice of thirty days and no compensation, labor law may call for a six- month notice and six-month loss-of-income compensation, overruling the terms of the contract. There are similar restrictions on the num- ber of hours worked, the payment of taxes, the legal requirements of certifications, licenses, and so on. In contrast, distributors, because they tend to be larger and are as- sumed to be more sophisticated, are covered in almost all countries by contract law. Contract law is much less restrictive, and courts tend to render judgments based upon the terms of the contract; the only restrictions are limited to contracts that are obviously biased or co- erced, a situation very unlikely to be observed if one of the International Chamber of Commerce model contracts or an equivalent is used. There is another distinction that is often made between an agent and a distributor that presents some potential for misunderstandings; it is often said that a distributor has risks (it invests in inventory), whereas the agent does not. While it is a useful distinction, it is incomplete. It is correct to understand that the distributor has substantial financial risks, because it invests in inventory and is faced with the possibility of unsold inventory. However, the agent often has considerable risks as well. It invests time and effort in obtaining a sale for which it will not be compensated until after the product is delivered and paid. In some cases, especially if the product is custom-made for the importer, there may be a lag of several months between the sale and the receipt of the commission check4.3.4 Marketing Subsidiary Finally, a firm may decide, rather than employ an agent or a distribu- tor (over neither of which it has much control), to create its own sales or marketing subsidiary in a foreign country. A marketing subsidiary is a foreign office staffed by employees of the exporting firm who will sell its goods in the foreign market. A subsidiary is incorporated in the foreign market, so it is the importer of record as far as the foreign gov- ernment is concerned, and the “export” takes place between two legal entities that are part of the same company, at a transfer price. Although transfer prices can sometimes create problems in the process of clear- ing Customs, the process is very smooth altogether, as the traditional concerns of payment, terms of sale, and terms of trade are eliminated. All sales made by the foreign subsidiary to its customers are domestic sales and therefore are simpler to manage. All profits earned in the importing country are taxable to the importing country’s government. The costs of a marketing subsidiary are higher, and a good portion of them are fixed: a building must be rented, an inventory built, and employees hired and trained before measurable sales can offset these expenses. This is in stark contrast with sales through an agent, which are variable-cost sales (the commission is paid only if the agent sells) or sales through a distributor, where that distributor is the one bearing the costs of establishing the business in the foreign market. These investments obviously also require a long-term commitment on the part of the exporting firm. The choice of a sales or marketing subsidiary is made when the com- pany wants to retain control over its sales in that country, usually when the company is faced with one or more of the following situations: 1. When the firm estimates that the market potential is considerable (more than 25 percent of its domestic sales) or when it estimates that there is very substantial growth potential or very substantial profits to be made 2. When the product is technology driven, with substantial intellec- tual property content 3. When the product is rather complicated to sell 4. When the company expects to be involved