One of the biggest mistakes companies make when they expand internationally, intending to sell into new markets, is their failure to recognize the cultural, regulatory and economic factors (among others) driving their market in the target country.
Cultural Factor
Understanding local cultural norms and blending with them is critical when entering a new market. In the Far East, status is very important. For example, in Japan, setting up a subsidiary company (a GK or a KK) conveys commitment to the local market and gives status and credibility to the local manager compared to setting up a branch.
At a different level, another well-known example is Nike, which generated backlash in China through a single ad that showed a basketball player defeating Chinese cultural symbols, including the dragon. China banned the ad for insulting national dignity and blaspheming traditional culture.
Starbucks succeeded from the start by blending with local culture to create localized offerings—including tea-based beverages and festival foods—and never attempted to alter the Chinese tea culture, which is deeply embedded.
Regulatory Factor
Regulatory concerns broadly subdivide into laws governing IP, laws governing sales agents and employment, and laws/regulations governing taxation, payroll and accounting.
IP Regulation
IP concerns typically hinge around the available legal remedies if a theft occurs and structuring the business in a way that ensures that the IP sits in the location of choice rather than the location where it is being developed. This can be done using widely accepted transfer pricing methodologies.
Sales Agent Protection
A good example relating to sales agents is in Belgium, illustrative of the protections afforded by the Belgian Commercial Agency Act of 13 April 1995. Hypothetically, a venture-backed U.S. company hired a sales agent, and that agent was so successful that the company wanted to employ him. He declined and chose to retain his independence. The company then terminated his agency, giving him the appropriate notice as per the contract and employed another person.
That agent could successfully sue the company utilizing provisions in the Belgian Commercial Agency Act of 13 April 1995, which overrides contract terms as a matter of mandatory law. The company would be forced to effectively buy him out, paying a hefty sum. Under Belgian agency law, a terminated agent may seek compensation beyond the notice period, including a goodwill indemnity capped at one year’s average annual commission, though additional damages may be awarded above this cap.
Taxes
Another example relates to Germany where, if the business functions of a German company are moved out of the country at a subsequent date, an exit tax triggers that broadly corresponds to the tax that would have been payable if the German company had been sold. This arises under Germany’s rules on Funktionsverlagerung (relocation of functions), enacted in 2008, which require that whenever a function is relocated within a multinational company from Germany to another country, the net present value of the transferred functional income must be taxed in Germany.
In an illustrative example of the kind of scenario that has generated tax disputes under these rules, consider a company that wants to move its assets from Germany to Ireland, including selected employees. The customer contracts with the German company are terminated and new contracts are set up with the Irish company. Under Germany’s disentanglement tax, the company could face a large German tax bill corresponding to the tax that would have been payable had the German company been sold—even though no IP would be formally transferred. This is because the disentanglement tax applies to the transfer of assets including long-term contracts abroad, and relocating German business abroad always results in a notional sale of the company in Germany.
Economic Factor
This relates primarily to taxes and subsidies.
For example, the 2014 “Make in India” Initiative by the Government of India offers tax incentives that companies can avail of, as well as indirect tax refunds and exemptions in specific sectors. By contrast, Indonesia does even better by offering a tax holiday of five to 20 years in specific priority sectors, such as manufacturing or infrastructure development. Eighteen pioneer industries qualify, including energy, petrochemicals, EVs, data centers, pharmaceuticals and infrastructure projects.
Many of these incentives apply only before any investment is made, so you must plan very carefully.
Final Thoughts
To summarize, international expansion, correctly done, can yield dividends. However, it can be tricky to achieve if you don’t account for all factors. Proceed with caution and learn from others’ failures.