Sales Agent versus Employee Sales Force Determining The Most Effective Foreign Mode Of
Operation in The Czech Republic & Slovakia
Wouter Mooi
Sales Agent versus employee sales force: determining the most effective foreign mode of operation in the Czech Republic and Slovakia
Wouter Mooi 1304550
Final thesis report International Business Faculty of management and organization University of Groningen, The Netherlands
Supervisors:
University of Groningen:
drs. R.W. de Vries drs. A.R.M. Gigengack
Hanover, Germany, July 2005
‘The author bares full responsibility for the content of the thesis report; the copyright of the thesis report rests with the author’
‘De auteur is verantwoordelijk voor de inhoud van het afstudeerverslag; het auteursrecht van het afstudeerverslag berust bij de auteur’
Preface
This thesis marks the end of my studies at the University of Groningen. The basis for this thesis was a research conducted at ABC in The Netherlands. I would like to thank drs. A.R.M Gigengack and drs.
R.W. de Vries, from the University of Groningen, for their support in writing this thesis.
I want to thank my parents mother and my father for having trust in me and for providing me with the will and opportunity to study. I owe a special gratitude to Karin, for being a great girl and a great support and friend, and Erik for being my ‘partner in crime’ and friend for the last 10 years.
Hanover, July 2005 Wouter Mooi
Management summary
ABC, part of the ABC Company, is one of the largest manufacturers and distributors of high performance engineering thermoplastics. For several years ABC has used a sales agent to sell their products in the Czech Republic (CZ) and Slovakia (SK). Due to strong economic growth and foreign direct investment, revenues for ABC have increased significantly in recent years. The increase in revenues have resulted in significantly higher commissions that have to paid to the sales agent while the added value, from ABC’s point of view, of the sales agent has decreased. Therefore ABC wonders whether it makes economically sense to replace the sales agent with an employee sales force in the Czech Republic and Slovakia.
Research objective:
To provide ABC with insight in the benefits, costs and risks of replacing the sales agent in the Czech Republic and Slovakia with an employee sales force to enable them to choose the most successful foreign mode of operation for serving these markets.
Research questions:
What are the impetuses, impediments and the associated financial implications for ABC of replacing the sales agent in the Czech Republic and Slovakia with an employee sales force.
Macro economic outlook of the Czech Republic and Slovakia
The main macro-economic indicators, in terms of GDP growth, monetary policy, fiscal policy and the external sector, in the Czech Republic and Slovakia are positive:
• The economic growth outlook for the years 2003-07 is positive for both countries, with growth figures well above the EU average.
• Fiscal reforms are an important issue for both countries. Although budget deficits are planned to be reduced in coming years, Slovakia's entry to the European Monetary Union (EMU) will be at 2006 at the earliest and the Czech Republic's entry to the EMU will be in 2010 at the earliest.
• Inflationary pressures do not present a concern in both countries.
• The strong currency of both countries will continue to be a concern as it has a negative affect on the exports. The current account deficits of both countries are easily financed by the large inflows of foreign direct investment that are projected during the next years.
Outlook main market segments in the Czech Republic and Slovakia
Automotive and electronics are the main market segments for ABC in the Czech Republic and Slovakia.
Both market segments are expected to develop positively over the forecast period:
• The automotive segments in both countries will receive major investments by car manufacturers that will double the auto production in both countries. This will give an enormous boost to the entire automotive sector.
• In the electronics market segment many new manufacturers are investinig and many currently active manufacturers are expanding production. The output of the Czech Electronics industry was EUR 8.0 billion in 2002 and is forecasted to grow with 40% to EUR 11 billion in 2009. In 2002 the Slovakian Electronics recorded EUR 1.1 billion in sales and is forecasted to grow with more than 60% in the next years to EUR 1.9 billion in 2009.
Sales forecast 2004-2006 Czech Republic and Slovakia
The main drivers for ABC’s increase in revenue from EUR 7.4 million to EUR 20.1 million were:
• Customers received orders from new OEM’s (ii.e. Orignial Equipment Manufacturer)
• Companies started operations in CZ/SK
• Customers received more orders from OEM’s
Both three of the main drivers of growth are set to develop positively over the forecast resulting in project sales of EUR 50 million in 2006, more than double the size of 2002. The projected sales act as a strong impetus to change the foreign mode of operations in the Czech Republic and Slovakia.
Set up costs
The set up costs will sum up to approximately EUR 80.000 for recruitment and legal costs. The majority, however, of the set up costs will consist out of the cost of running an employee sales force which will add up to approximately EUR 650.000 yearly.
Take down costs
Substantial costs will have to be made when ABC would switch from the sales agent to an employee sales force. The take down costs will sum up to approximately EUR 1 million in terms of goodwill compensation and EUR 3 million of sales revenue is at risk being lost due a strong relationship between the sales agent and the several customers (and by the lack of relationship between ABC and these customers).
Together the set up and take down costs mentioned above act as a impediment to switch the foreign mode of operations in the Czech Republic and Slovakia.
Financial implications:
Revenues for the employee sales force option are expected to reach EUR 31 million in 2004 increasing to EUR 51 million in 2006. Yearly costs are expected to reach EUR.7 million in 2004, due to the one time goodwill compensation, and will level around EUR 650.000 in the 2005-06.
Revenues for the sales agent option are expected to reach EUR 30 million in 2004 increasing to EUR
Switching to an employee sales force is financially the most attractive option. The net present value (NPV) of the employee sales force is in all scenarios higher than the sales agent. The minimium NPV difference is EUR 5 million, expected difference is EUR 1 million and the maximum is EUR 19 million.
This ‘large’ variance is caused by uncertainties about the revenues of several key customer. Therefore the recommendation to ABC is to switch from the sales agent to an employee sales force in the Czech Republic and Slovakia.
Contents:
1 Problem statement ...6
1.1 The ABC Company ... 6
1.2 Customer & reasons for research ... 6
1.3 Conclusion... 6
2 RESEARCH DESIGN ...6
2.1 Research objective... 6
2.2 Research question... 6
2.3 Research boundaries... 6
2.4 Conceptualization ... 6
2.5 Conceptual model... 6
2.6 Sub-questions and operationalization... 6
2.7 Data collection, sources and analysis: ... 6
2.8 Structure of the thesis ... 6
3 Macro-economic outlook Czech Republic and Slovakia ...6
3.1 International assumptions... 6
3.2 Macro-economic outlook of the Czech Republic... 6
3.2.1 Introduction to the Czech Republic... 6
3.2.2 Economic growth outlook ... 6
3.2.3 Fiscal policy ... 6
3.2.4 Monetary Policy ... 6
3.2.5 External sector ... 6
3.2.6 Foreign direct investments ... 6
3.3 Macro-economic Outlook Slovakia... 6
3.3.1 Introduction to Slovakia ... 6
3.3.2 Economic growth outlook ... 6
3.3.3 Fiscal policy ... 6
3.3.4 Monetary policy ... 6
3.3.5 External sector ... 6
3.3.6 Foreign direct investments ... 6
3.4 Conclusion... 6
4 Outlook main market segments...6
4.1 Main market segments and determinants of growth in the Czech Republic ... 6
4.1.1 Main market segments... 6
4.1.2 Drivers of growth in automotive market segment... Error! Bookmark not defined. 4.1.3 Drivers of growth in the electrical/electronics market segment... Error! Bookmark not defined. 4.2 Main market segments and determinants of growth in Slovakia ...Error! Bookmark not defined. 4.2.1 Main market segments... 6
4.2.2 Drivers of growth in electrical/electronics market segment... 6
4.3 Conclusion... 6
5 Sales forecast 2004-2006...6
5.1 Outlook main market segments Czech Republic and Slovakia... 6
5.1.3 Outlook electronics market segment Czech Republic... 6
5.1.4 Outlook electronics market segment Slovakia ... 6
5. Explanation of spreadsheet model and Crystal Ball... 6
5.2 Sales forecast 2004-2006... 6
5.2.1 Key sensitivities ... 6
5.2.2 Potential extra sales by going direct... 6
5.2.3 Potential sales that is lost by not going direct ... 6
5.3 Conclusion... 6
6 Switching Costs...6
6.1 Take down costs ... 6
6.2 Set up costs ... 6
6.3 Conclusion... 6
7 Financial Analysis ...6
7.1 Potential range of costs and revenues of employee sales force... 6
7.2 Potential range of costs and revenues of staying with the sales agent ... 6
7.3 Which foreign mode of operation is financially more attractive?... 6
7.4 Key sensitivities ... 6
8 Conclusion ...6
8.1 Impetus to switch: ... 6
8.2 Impediments to switch: ... 6
8.3 Financial implications: ... 6 Enclosure A: Schematic overview financial model... Error! Bookmark not defined.
Enclosure B: Explanation Financial Model ...Error! Bookmark not defined.
Enclosure C: Assumptions Sales Forecast ...Error! Bookmark not defined.
Enclosure D: Assumptions Sales Forecast modeled with probability distribution Error!
Bookmark not defined.
Enclosure E: Assumptions Volume at risk by not switching to employee sales force Error! Bookmark not defined.
Enclosure F: Volume at risk by switching to an employee sales force ... Error!
Bookmark not defined.
Enclosure G: Potential extra volume by switching to employee sales force... Error!
Bookmark not defined.
Enclosure H: Cost assumptions ...Error! Bookmark not defined.
Enclosure I: Costs assumptions modeled with probability distribution... Error!
Bookmark not defined.
Enclosure K: Contribution margin and commission per product Error! Bookmark not defined.
References ...Error! Bookmark not defined.
Figures:
Figure 1: Structure of ABC Company (source: ABC Company)... 6
Figure 2: Basic supply chain of ABC (source: ABC) ... 6
Figure 3: Commercial structure of ABC (source: ABC)... 6
Figure 4 : Sales processes in the CZ/SK market (Source: ABC) ... 6
Figure 5: Sales (in 000 EUR) for automotive and non-autmotive in the CZ/SK market from 1999-2002 (Source: ABC)... 6
Figure 6: Commission (in 000EUR) paid for automotive and non-autmotive from 1999-2002 (source: ABC)... 6
Figure 7: Conceptual model ... 6
Figure 8: Geographic position of the Czech Republic and Slovakia ... 6
Figure 9: Economic growth in Czech Republic 2001-2007 (EIU, 2003)... 6
Figuure 10: Budget balance Czech Republic (EIU, 2003) ... 6
Figure 11: Exchange rates Czech Republic (EIU, 2003) ... 6
Figure 12: Consumer prices Czech Republic (EIU, 2003)... 6
Figure 13: Current account balance Czech Republic (EIU, 2003)... 6
Figure 14: Foreign direct investment ($billion) in the Czech Republic (EIU, 2003) ... 6
Figure 15: Economic growth Slovakia (EIU, 2003)... 6
Figure 16: Budget balance Slovakia (EIU, 2003) ... 6
Figure 17: Exchange rates Slovakia (EIU, 2003)... 6
Figure 18: Consumer prices Slovakia (EIU, 2003) ... 6
Figure 19: Current account balance Slovakia (EIU, 2003) ... 6
Figure 20: Foreign direct investments Slovakia (EIU, 2003) ... 6
Figure 21: Structure of demand... 6
Figure 22: Sales revenue (Million EUR) Czech Republic 1999-2002 ... 6
Figure 23: Share of total revenue main market segments 1999-2002 ... 6
Figure 24: Sales revenue main market segments (Million EUR)... 6
Figure 25: Share of total revenue main customers in Automotive market segment (Million EUR)... Error! Bookmark not defined. Figure 26: Sales Autopal and revenue for ABC from Autopal Error! Bookmark not defined. Figure 27: Share of total revenue main customers in Electronics market segment (Million EUR)... Error! Bookmark not defined. Figure 28: Sales revenue (million EUR) Slovakia ... 6
Figure 29: Share of total revenue main market segments ... 6
Figure 30: Share of total revenue main customer in Electronics marfket segment (Million EUR)... Error! Bookmark not defined. Figure 31: Main drivers of growth for ABC as % of total growth 1999-2002... 6
Figure 32: Outlook Car Prodocition 2002 = 100 (Source: www.csmauto.com)... 6
Figure 33: Outlook Electronics industry Czech Republic and Slovakia. 2002= 100 (Global insight, 2003)... 6
Figure 34: Sales forecast CZ/SK market (Displayed is mean value in million EUR) ... 6
Figure 35: Range of revenues for employee sales force 2004-2006 ... 6
Figure 36: Range of costs for employee sales force 2004-2006 ... 6
Figure 37: Range of revenues sales agent 2004-2006... 6
Figure 38: Commission sales agent 2004-2006 ... 6
Figuur 39: Financial analysis Sales agent and Sales Force (Displayed are Mean values) ... 6
Figure 40: Difference in Net Present Value (million EUR) ... 6
Tables:
Table 1: Activities performed by ABC and by the sales agent (Source: ABC) ... 6 Tabel 2: Customer in Electronics market segment and their main OEM/Supplier ... Error!
Bookmark not defined.
Table 3: Revenue customers Electronics market segment and their customers (000 EUR) ... Error! Bookmark not defined.
Table 4: Future activties of Automotive customers in the Czech Republic... 6 Table 5: Future activities Automotive customers Slovakia... Error! Bookmark not defined.
Table 6: Future activities Electronics customer Czech Republic... Error! Bookmark not defined.
Table 7: Future activies Electronics customers Slovakia ... Error! Bookmark not defined.
Table 8: Statistics Sales Forecast (in million EUR) ... 6 Table 9: Key senstivies to sales outlook 2003-2006 ... Error! Bookmark not defined.
Table 10: Statistics Variable Costs (in thousands EUR)... 6 Table 11: Key sensitivies to Net Present Value difference ... 6
1 Problem statement
The purpose of this chapter is threefold. First a brief introduction to the company will be given.
Second it will be indicated where the research takes place and for whom it is conducted. Thirdly, the problem will be identified that made ABC decide that this research was desirable. The information for this chapter was collected by holding several open interviews with ABC employees1 and by analyzing company documents.
1.1 The ABC Company
Figure 1: Structure of ABC Company (source: ABC Company)
ABC Plastics
ABC manufactures and distributes high performance engineering thermoplastics. ABC employs about 11.000 employees worldwide and sales in 2002 were $ 5.2 billion. The plastic is sold in pellet, film or sheet form that is then moulded or designed as components of end use products. Customers cover a wide range of industries such as automotive (fenders, bumpers, dashboards), business equipment (monitors, printer housings), telecommunications (cell phones), and optical media (CDs and DVDs).
In most cases ABC does not deliver directly to the companies producing the end products. The basic supply chain shown in figure 2 gives an idea of the different players. The supply chain starts with the exploration and refining of oil. The petro-chemical industry transforms the oil into raw materials that are used by producers of plastics. ABC can be categorized as a plastics producer. The plastics are used by compounders and moulders to produce plastic parts which are used by Original Equipment Manufacturers (i.e. OEM’s) to produces products for the end consumers.
Figure 2: Basic supply chain of ABC (source: ABC)
1.2 Customer & reasons for research
This research takes place within the commercial organization of ABC. ABC’s commercial organization is split in a global automotive division (targeting automotive customers) and a commercial division taking
Oil Exploration and Refining
Petro- Chemical
Industry
Plastics Producers
Compounders, and Moulders
OEM’s
care of sales to non-automotive customers (see figure 3). Both division are organized geographically into the Asia-Pacific, EMEA (Europe, Middle East and Africa) and Americas. Both divisions are active in the Czech Republic and Slovakia with their European poles. The focus of this research will be on the way ABC is operating in the Czech Republic and Slovakia (as will be explained in depth later in this paragraph) and therefore this research will have two customers:
- Vice President Europe Non-Automotive - Vice President Global Automotive
From now onwards we will refer to the customer of this research as ABC, which stands for both the automotive & non automotive division.
Figure 3: Commercial structure of ABC (source: ABC)
There are several reasons for ABC to order this research. The sections below will outline these reasons and together they are serving as input for the problem statement where the research objective and questions are formulated.
ABC in the Czech Republic and Slovakia
ABC has been active in the Czech Republic (CZ) and Slovakia (SK) for several of decades and both countries are treated within ABC as a single market. During the communistic regime business had to be done through a state owned sales agent and it was not possible to choose any other foreign mode of operation. After the fall of the iron curtain the structure with the state owned sales agent disappeared. ABC choose to set up a joint venture with a sales agent, named Agent Y, which was also responsible for the sales in Swiss and Austria. Due to economical reasons ABC decided in the early 90’s to move out of this joint venture and Agent Y became the sales agent for the CZ/SK market.
Current structure in the CZ/SK market
The sales agent, Agent Y, is located in Prague in the Czech Republic. Via a contract it is arranged that Agent Y will handle all sales and will develop the market in exchange for an on average 5%
commission (the exact amount of commission depends on the product) of the total sales. The contract also dictates that Agent Y is not allowed to sell any competing products from other companies. They are allowed though, to sell complementary products from other firms. Furthermore, Agent Y does not take physical possession of the products,does not arrange for its shipping and handling, and does not
take any credit, market or exchange risk. Agent Y currently serves the market with nine employees of which five have a sales function and four have an administrative function. The sales force of Agent Y regularly visits customers to identify their needs and solve any problems that might have arisen.
Figure 4 shows the different sales processes that can be identified in the CZ/SK market.
Figure 4 : Sales processes in the CZ/SK market (Source: ABC)
In most cases the customer will place an order at the sales agent. The sales agent will notify ABC of this order and ABC will deliver the products directly to the customer. An increasing number of customers, however, use the ABC website to order their products. The order from the customer is received by ABC without interference of the sales agent and the products will be delivered directly to the customer. The sales agent, however, still receives the 5% commission on the sales of the products via the ABC website. A very small amount of the total sales, less than 1%, falls into the category of distribution business. In this case the sales agent orders products from ABC and they also take physical possession of the products. Consequently they sell and deliver the products directly to the customers. The sales agent does not receive any commission for these sales, but instead they receive a discount on the product price.
Next to Agent Y several ABC employees are involved in the sales in the CZ/SK market. One ABC employee, permanently located in the Czech Republic, is responsible for developing the market. Five other ABC employees make regular customer visits to important customers. Furthermore ABC employees provide technical support in case customers have any problems or questions about the products. As said before in the description of the sales processes, the logistics is done by ABC. Table 1 shows what functions ABC and Agent Y perform in the CZ/SK market.
Table 1: Activities performed by ABC and by the sales agent (Source: ABC)
Strong growth in the past
After the fall of the iron curtain reforms took place in the CZ/SK economies, creating a strong
Market development Sales Logistics Technical support
ABC / Sales agent ABC / Sales agent ABC ABC
the Czech Republic and in the Volkswagen plant in Slovakia created a huge growth in the automotive market segment for ABC. In the late 90’s also the non automotive market segment started to grow heavily due to foreign direct investments by Philips, Sony and Matsushita among others. Both of these developments made the once relatively small CZ/SK market grow significantly. As can be seen in figure 5, sales grew from EUR 7 million in 1999 to EUR 20 million in 2002.
.
Figure 5: Sales (in 000 EUR) for automotive and non-autmotive in the CZ/SK market from 1999-2002 (Source: ABC)
Commission have been rising fast
The strong growth in the years 1999-2002 have also created a strong growth in the commission paid to the sales agent. Figure 6 shows that the commission has grown from EUR 350.000 in 1999 to almost EUR million in 2002, which is a 160% increase. Due to the increasing commission ABC wonders whether it might be economically more attractive to serve this market ‘direct’ (i.e. serve the market with an employee sales force).
Figure 6: Commission (in 000EUR) paid for automotive and non-autmotive from 1999-2002 (source: ABC)
The added value of the sales agent
As discussed earlier in this chapter more and more customers are ordering their products online at the ABC website. When these customers order online the involvement of Agent Y is minimal because most activities are performed by ABC. The Sales Agent receives the full 5% commission from these online sales. The added value from Agent Y for these online sales is according to ABC rather low.
Many multinationals are among the customers of ABC in the CZ/SK market. Although the actual sales take place in the CZ/SK the activities that eventually lead to the sale of products often takes place outside the CZ/SK at the regional or global headquarters of the customers. The sales agent has no role at all in attracting the customer but will receive its commission of all the products that are ordered from this customer in the CZ/SK market. These same multinational companies often require the direct involvement of ABC employees because of their specific knowledge.
Besides the activities performed outside the CZ/SK by ABC employees, a full-time marketing development specialist from ABC is dedicated to the CZ/SK market. This marketing development specialist is looking at opportunities to sell products to new customers. For any of these newly acquired customers by the marketing development specialist full commission is paid to the Sales Agent.
As a result of the above issues, ABC is not satisfied with how the CZ/SK market is served with the current sales agent structure. Although a considerable amount of commission is paid to sales agent the added value of the sales agent is low and ABC has to commit significant resources. Together these issues create an incentive for ABC to look into the opportunities of replacing the current sales agent with an employee sales force.
Costs and implications of changing the foreign mode of operation
ABC lacks the knowledge what the costs would be of changing the foreign mode of operation and what the costs would be for running an employee sales force in the CZ/SK market. The current structure with Agent Y is arranged in a contract and terminating this contract will have certain implications. ABC lacks the information on the legal implications that might follow from a change in foreign mode of operation. These implications could be a termination fee, a period of notification, competition clauses, and other unforeseen issues. Most importantly, however, ABC wants to know the possible loss of business in CZ/SK by changing the foreign mode of operation. Agent Y has build up long relationships with the customers in CZ/SK and by replacing Agent Y with an employee sales force these relationships can potentially hurt ABC because customers might choose not to do business with the ABC employee sales force.
Sales outlook
The attractiveness for ABC of switching from the sales agent to an employee sales force also depends on the future sales in the CZ/SK market. As indicated above certain costs might have to be made to change the foreign mode of operation. These costs can be seen as an investment that has to be paid back by a more efficient foreign mode of operation. Economically, both foreign modes of operation are equally attractive when the costs for running an employee sales force plus the costs for the initial investment are equal to the costs in commission paid to the sales agent over a certain period of time.
There is a certain sales volume, however, where the amount of commission is lower than the costs and initial investment of changing the foreign mode of operation over a certain period of time. The reasoning behind this is that the amount of commission is completely related to the sales volume and decreases when the sales volume decreases. The cost and initial investment, however, do not vary on a one to one basis with the sales volume because there will be a certain amount of fixed costs. This means that sales lower than a certain level will favour the sales agent and sales higher than a certain level will favour an employee sales force. Therefore it is important for ABC to have insight in the future growth of the sales in CZ/SK in order to determine the most attractive (i.e. cost-effective) foreign mode of operation.
Insight in the future sales is also desirable for ABC because decision whether to change or not is a strategic decision. Once this decision has been made it will have a long-term effect: for example, contracts have to be terminated, employees recruited and customers will have to be informed. Before committing their resources, ABC wants to have insight in the developments external environment, which influences the future sales and thus attractiveness of the CZ/SK market.
Financial implications of making a decision with uncertainty
Decision within ABC has to be based on a financial analysis. This means that there need to be a clear picture of the future revenues and costs of the two different foreign mode of operation. The future revenues and costs will be based on certain assumptions. Each assumption will be made with a certain level of uncertainty. Uncertainty creates a certain level of risk. ABC wants to know what the main risks are to the future revenues and costs for both foreign mode of operations for the years 2004 to 2006.
1.3 Conclusion
This chapter gave an introduction to ABC, ABC and the way ABC operates in the Czech Republic and Slovakia. Following from the description of ABC’s operations in the Czech Republic and Slovakia the main reasons for ordering this research have been described;
• Commissions paid to the sales agent have increased 160%
• The added value from the sales agent is perceived as low.
• There is a lack of knowledge about the costs and implications of changing the foreign mode of operation.
• There is a lack of knowledge about the external developments in the CZ/SK and what their impact is on the future sales and thus attractiveness of the markets.
• There is a lack of knowledge about the financial implications of this decision and what the main risks are on the financial implications.
This information will be used in the next chapter to formulate the research objective and research questions.
2 RESEARCH DESIGN
The previous section indicated what the key reasons are for ordering this research. This section will translate these key reasons in a research objective and research question.
2.1 Research objective
The research objective describes for whom the research is conducted, what they get from the research and why this is relevant for them (De Leeuw, 2002). This leads to the following research objective:
To provide ABC with insight in the benefits, costs and risks of replacing the sales agent in the Czech Republic and Slovakia with an employee sales force to enable them to choose the most successful foreign mode of operation for serving these markets.
ABC: The commercial organizations of ABC Europe and ABC Global Automotive Most successful: most profitable in the medium to long-term future.
2.2 Research question
The research question defines the main question that corresponds with the research objective but is formulated in for the research accessible terms (De Leeuw, 2002). This means that the research question will have to fit the conceptual model, which will be presented in later in this chapter. The research question is:
What are the impetuses, impediments and the associated financial implications for ABC of replacing the sales agent in the Czech Republic and Slovakia with an employee sales force.
ABC: The commercial organizations of ABC Europe and ABC Global Automotive
2.3 Research boundaries
In this section the boundaries of the research will be presented. The research boundaries describe the limits to the results and methods of the research. This also includes the requirements and conditions imposed by the customer of this research. The research boundaries are:
• The findings of the research are confidential. Therefore two reports will be created. One report with the all the information and one with report that will consist of only non- confidential information. The confidentiality agreement is arranged in a contract between ABC and the author of this report.
• It is not possible to contact the sales agent or customers of ABC, because the research company does not want to inform them about this research
• The insight for the costs, benefits and risks will be presented for the years 2004 - 2006.
• The research will only look at the possibility of termination the sales agent and replacing it with an employee sales force. Integration will not be considered, as this is not desirable by the customer of this research.
• The research will only look at the possibility of termination the sales agent and replacing it with an employee sales force. Replacing the sales agent with another sales agent is not desirable by the customer of this research.
2.4 Conceptualization
The goal of this section is to anchor the research question within the field of theory. In this research the goal is to provide insight in the costs, benefits and risks of replacing the sales agent with an employee sales force. The concepts sales agent and employee sales force for serving a foreign market are both ways of doing business in a foreign market and fall into the category of foreign operation mode decisions. Two streams in the international business literature have paid considerable attention to the concept of foreign operation mode decisions, namely the economics-strategy school and the process-behavioural school (Benito 1999). The economics-strategy literature has looked at the decision on foreign mode of operations from a basically static perspective, focusing on the way firms enter or operate in a foreign market at given points in time (Anderson & Gatignon, 1986). Once an foreign mode of operation has been chosen it is assumed that this is the most suitable given the circumstances. Switching to another mode of operation is assumed to happen only in case of drastic changes and will be difficult and costly. This means, for example, that if a company has chosen initially to do business via a sales agent it will be difficult and costly to change this to an employee sales force.
The process-behavioural stream in research has focused on the incremental aspect of companies’
international expansion. It is assumed that companies undergo a gradual development from one foreign mode of operation to another over time. Furthermore, the process-behavioural school, recognizes changes of foreign modes of operations as commonplace and is to be expected given the nature of the internationalisation process itself (Pedersen, 2002). This means that companies should be expected to move from one type of operation to another as they gain more experience in a particular market. Little is said, however, of what factors explicitly are determining a change in the foreign mode of operation. This means, for example, that it is expected that an company initially operating in a foreign market with a sales agent its expected to move to an employee sales force as they gain more experience in that foreign market.
By combining the findings from both research streams Benito (1999) have focused specifically on why and how often these changes in foreign modes of operations occur. By determining the likelihood of a shift in a foreign mode of operation, they have focused on switch motivators and switching costs.
Switching costs, derived from the economics-strategy stream are conceptualized as "a broad spectrum of barriers to mode change, ranging from relatively easy-to-measure costs of dismantling operations to barely quantifiable perceptions of risk in connection with setting up a new foreign operation arrangement" (Benito, 1999). Anderson and Weiss (1992) divided these switching costs into two categories: take down and set-up costs. Take down costs refer to the costs and revenues losses
incurred by dismantling an existing operation. Set-up costs are the costs and revenues losses of setting up a new foreign operation.
Switching motivators, derived from the process-behavioural school, are factors motivating a firm to make a shift in the foreign operation mode. Although the company might initially have installed the most appropriate mode of operation, changing circumstances within the company, sales agent and export market can make an employee sales force more preferable.
What follows now is a description of the switching costs (take-down & set-up costs) and switching motivators that are discussed in the literature.
Take-down costs Contractual restrictions
One obstacle to exiting from a relationship with a foreign intermediary can be the nature of the contract (Root 1987). According to Pedersen et al. (2002) some contracts include clauses that make termination difficult for the exporter. The difficulties exist of a long period of notification, a stipulated right to compensation upon termination and the exporter might have to make lawsuit expenses.
Loss of local sales revenue
Heide and John (1988) indicated that terminating the local intermediary could result in a loss of local sales revenue because customers can stay loyal to the terminated intermediary. The local sales agency might offer service to the customers and this can make these customers dependent on the local sales agency. The sales agent could also have build up long-lasting relationships with the customers. If the terminated sales agency starts selling products that are close substitutes to the manufacturing company, a considerable risk could occur that customers will continue to buy their products from the sales agency instead of the newly founded employee sales force from the manufacturer.
Set-up costs
The set-up costs can be derived from the process-behavioural school. According to their view a foreign operation must accumulated knowledge about the foreign market in order to shift in mode, but also to be successful in serving that market. The most important set-up costs mentioned by Pedersen et al.
(2002) are:
Recruitment and training costs
If the sales agent, which can be an experienced player in the market, is terminated an adequate replacement need to be arranged. New personnel may therefore need to be identified and recruited either among existing employees or from the outside. Also, the new personnel might need training to achieve an adequate level of performance.
Foreign operation learning costs
Being a novice in international business, an exporter must expect to make several initial failures. The probability of failure is likely to increase whenever an action represents a fairly large step into the unknown, such as when a company chooses to "go direct" rather than using local agents.
Switch motivators
So far the emphasis has been on the difficulties of making a switch in the foreign operation mode. The next part of this section looks at the factors motivating a firm to make a shift in the foreign operation mode. Several switch motivators have been suggested in previous studies:
Diminishing satisfaction with the foreign intermediary
At the time of appointment, the exporter will expect the performance of the sales agent at an adequate level. If over time the exporter satisfaction about the sales agent performance declines, the relationship between them will be affected in a negative way. According to Stern and El-Ansary (1992) dissatisfaction is a fundamental reason for relations to change.
Exporter’s accumulation of market knowledge
As already described in the introduction of this section the advocates of the process-behaviour school argue that accumulation of foreign market knowledge is a key reason for firms to shift from low- commitment modes to higher commitment modes.
Export market growth
Klein, Frazier and Roth (1990) show that if the sales volume for a product is relatively low in a foreign country, the firm is likely to prefer a market exchange whereby intermediaries can handle the product line more economically through assembling product lines from many firms. When sales volumes are high, however, the production cost advantage of the market mode can be reduced to zero. This means that small sales volumes would favour the use of a sales agent and high volumes should favour an employee sales force.
The above describes the motivation to switch resulting from past growth of the export market. In the same vein, however, high sales prospects should favour the switch from sales agent to an employee sales force.
Growth of exporting company
An employee sales force is more resource demanding than a foreign sales agent. Smaller companies do not have the same resources available as large companies. Pedersen et al. (2002) argue that when firms experience growth over time they might start considering a wider range of foreign operation methods.
Pedersen et al. (2002) have tested the above-mentioned factors motivating or demotivating a switch from a sales agent to an employee sales force in a foreign market in an empirical research. What appeared from their research is that the prediction of mode shift is to be found in an interplay between, on the one side, changes of organizational and environmental circumstances, and, on the other side, the switching costs associated with a shift. Furthermore it appears that the mode shift decision seems to be a cost-benefit analysis. In an earlier study by Benito et al. (1999) it was noted that if the discounted, risk-adjusted value of switching costs more than outweighs the discounted, risk-adjusted benefit (in terms of net income streams) of switching to another foreign operation method, the entrant firm will retain its existing operations (They exclude any non-financial arguments). And, of course, this works the other way around as well.
2.5 Conceptual model
Based upon the previous section a conceptual model is developed (see figure 7). This conceptual model should enable understanding of the problems of ABC and it must be possible to be operationalized (De Leeuw, 2002). It follows the argumentation from Pedersen et al. (2002) that the decision whether to switch from a sales agent to an employee sales force or not, is to be found in an interplay between, on the one side, changes of organizational and environmental conditions, and, on the other side, the switching costs associated with a shift. As such the, the mode shift decision seems to implicate a cost-benefit analysis.
The changes of organizational and environmental conditions are included in the conceptual model as internal and external developments. The switching costs are included in the conceptual model as the costs for setting up an employee sales force and the costs for dismantling the current sales agent.
All four factors influence the decision to switch the foreign mode of operation (indicated by the box in the centre) in a possible positive or negative way (indicated by the plus & minus). The box in the centre also represents a cost-benefit analysis that will influence the decision to switch.
Figure 7: Conceptual model
The next paragraph will translate the factors from the conceptual model into measurable and accessible terms. All factors derived from the literature influencing a decision to switch are taken into
+ / - + / -
External Developments
Internal Developments
Decision to Change
Take-down Costs
Set–up Costs + / -
+ / -
account, except for those factors that cannot me be made operational. What follows below is an explanation why certain factors are not included in the conceptual model.
Accumulation of foreign market knowledge
The accumulation of foreign market knowledge is according to the process-behavioural school a factor that explains the movement from low to high commitment modes of operation in foreign markets. No notion, however, has been given how this accumulation of foreign market knowledge can be measured. Pedersen et al. (2002) have used the numbers of years a company is active in a foreign market as a proxy. Following their example would not result in any spectacular findings in this research except to find that ABC has been active in this market for more than 15 years. This does however say nothing about the fact that they might have had the same level of knowledge already 5 to 10 years ago or if they have acquired any foreign market knowledge at all. Because of these limitations in measuring the foreign market knowledge this factor is not included in the conceptual model of this research.
Foreign learning costs
The set-up costs resulting from foreign market learning costs is not included. The reason is that these costs fall into the category of costs that can hardly be quantifiable and there is no indication at all in the literature how these costs can be measured. It is therefore assumed in this research that the costs of foreign market learning are incorporated in the training costs of the employee sales force.
Besides the two factors discussed above which cannot be operationalized, two other factors from the theoretical section are not included in the conceptual model:
Growth of exporting company
The literature describes that as a company grows more resources become available to the firm which where not available at the moment the foreign mode of operation decision was made restricting the choice of higher-commitment foreign mode of operations. ABC is part of the ABC Company, which is one of the largest companies in the world measured by market capitalization for decades. It is very unlikely that a lack of sufficient resources at the moment the foreign mode of operation decision was made restricted ABC from choosing a higher-commitment foreign mode of operation. Therefore this factor has been left outside the conceptual model.
Diminishing satisfaction with the sales agent
In the literature the diminishing satisfaction of the sales agent has been indicated as a factor motivating a switch in the foreign mode of operation. As described in the problem statement earlier in the chapter one of the main reasons for ABC for ordering this research has been the low level of
factors motivating a change in the foreign mode of operation. It is, however, excluded from the conceptual model because it does not have to be researched anymore.
2.6 Sub-questions and operationalization
The goal of this section is to translate the concepts from the conceptual model into measurable and accessible terms. This translation will result in sub-questions that together will provide an answer to the research question. It is followed by a list of definitions of terms used in the-sub questions.
Subsequent for each of the sub-questions the methods for data-collection and data sources will be described.
1. What is the influence of external developments on the decision to switch?
a) What are the developments in the macro-economic environment, in terms of GDP growth, monetary policy, fiscal policy and the external sector, in the Czech Republic and Slovakia and how does this affect the impetus to change?
b) What are the main market segments for ABC in the CZ/SK market?
c) What developments in the main market segments of the CZ/SK market have created the growth in sales for ABC in the years 1999-2002?
d) How will these developments, indicated in sub-question 1c, in the main market segments evolve in the next five years and how will this affect the impetus to switch?
2. What is the influence of internal developments on the decision to switch?
a) What are the potential sales for ABC in the CZ/SK market for the years 2004-2006 and does this affect the impetus to change?
b) What will be the costs for commission based on the growth of sales for the years 2004-2006 and how does this affect the impetus to change?
c) What is the potential range of extra sales, resulting from more price freedom, by switching to an employee sales force?
3. What is the influence of the set-up costs on the decision to switch?
a) What are the costs for recruiting and training an employee sales force?
b) What are the costs for installing and running an employee sales force?
4. What is the influence of the take-down costs on the decision to switch?
a) What are the contractual implications of terminating the sales agent?
b) What is the potential loss of revenue of switching to an employee sales force?
5. What are the financial implications for the years 2004-2006 of switching to an employee sales force and of staying with the sales agent?
a) What is the potential range of costs and revenues of switching to an employee sales force for the years 2004-2006?
b) What is the potential range of costs and revenues of staying with the sales agent?
c) What foreign mode of operation is financially, in terms of net present value, the most attractive for the years 2004-2006?
Sub-question definitions:
External developments: developments forming the outer surface of ABC, which cannot be influenced in a direct way and influence the impetus to switch to an employee sales force.
GDP (Gross domestic product): the total flow of services and goods produced by an economy, over a quarter or a year, measured by the aggregate value of services and goods at market prices.
Monetary policy: a government economic policy concerning a country’s rate of interest, its exchange rate, and the amount of money in the economy.
Fiscal policy: The central government's policy on lowering or raising taxation or increasing public or decreasing public expenditure in order to stimulate or depress aggregate demand
Market segment: A part of the CZ/SK market that has distinctive characteristics.
Internal developments: developments situated inside ABC, which can be influenced directly, and influence the impetus to switch to an employee sales force.
CZ/SK market: the combined markets for ABC of the Czech Republic and Slovakia, which are treated as one by ABC.
Non-financial benefits: benefits that cannot be expressed in a monetary value.
Set-up costs: the costs for setting up and running an employee sales force that constitute hindrance to switching from a sales agent to an employee sales force for serving the CZ/SK market.
Recruitment: the activity of employing workers for the employee sales force in the CZ/SK market.
Training: activities designed to facilitate the learning and development of skills necessary to achieve an adequate level of performance for the sales activities of the personnel for an employee sales force in the CZ/SK market.
Take down costs: the costs and revenue losses incurred by dismantling the sales agent in the CZ/SK market that constitute a hindrance to switching to an employee sales force.
Contractual implications: the period of notification and severance payment.
Financial implications: the discounted value of the switching costs (take down costs and set up costs) and the discounted benefit (in terms of net income streams) of switching to an employee sales force.
Net present value: the value of an investment calculated as the sum of its initial cost and the present value of expected future cash flows.
Sales agent: the intermediary, named Agent Y, who acts on behalf of ABC in the Czech Republic and Slovakia to sell ABC's products in exchange for a commission of all sales.
2.7 Data collection, sources and analysis:
This section will describe how the sub-question will be answered. More specifically the method of data collection, sources and analysis for each sub-question will be described. Enclosure J gives an detailed overview with the name and function of each person that was interviewed for each of the sub questions.
Sub-question 1
a) This question is answered with secondary data from economic research agencies.
b) This question is answered with financial documentation of the CZ/SK market from ABC.
c) This question is answered with financial documentation from ABC, secondary data from economic research agencies and secondary information about the main market segments from online databases with newspapers.
d) This question is answered with secondary from economic research agencies, secondary information about the main market segments from online databases with newspapers and information from sub-question 1c.
Sub-questions 2
a) This question is answered with information from in-depths interviews with the sales managers responsible for the CZ/SK market (see enclosure J).
b) This question is answered with information from sub-question 1a.
c) This question is answered with information from in-depth interviews with ABC sales organization (see enclosure J).
d) This question is answered with information from in-depth interviews with ABC employees (see enclosure J).
Sub-question 3
Sub-questions 3a and 3b are answered with information from company documents, in-depth interviews with ABC employees and interviews with consultancies (see enclosure J).
Sub-question 4
a) This question is answered with information from company documents and in-depth interviews with the ABC legal department (see enclosure J).
b) This question is answered with information from in-depth interviews with the ABC sales organization (see enclosure J).
Sub-question 5
This question is answered with information from sub-question 1 to 4.
2.8 Structure of the thesis
The structure of this thesis will mainly be based on the way the sub-questions have been described in the previous paragraph. In chapter 3 an answer will be given to sub-question 1a and 1b by giving an overview of the macro-economic outlook of the Czech Republic and Slovakia and by describing how this outlook influences the decision to switch. Chapter 4 will provide an answer to sub-question 1c by discussing ABC’s main market segments and by looking at the main drivers of growth in these market segments in the past years. In chapter 5 the outlook for the main market segments will be discussed and it will be analysed how this will affect future sales for ABC and thereby answering sub-question 1d. Subsequently a sales and commission forecast will be given for the next years that will provide an answer to sub-question 2a-c. Chapter 6 discusses the switching costs associated with a possible change in the foreign mode of operation and gives an answer to sub-questions 3 and 4. A financial analysis, answering sub question 5a-c, in chapter 7 will determine which foreign mode of operation is most attractive. Chapter 8 follows with a conclusion that provides an answer to the main research questions and subsequently it will be assessed whether the research objective has been fulfilled.
3 Macro-economic outlook Czech Republic and Slovakia
This chapter will answer question 1a:
“What are the developments in the macro-economic environment, in terms of GDP growth, monetary policy, fiscal policy and the external sector, in the Czech Republic and Slovakia and how does this affect the impetus to change?”
The sources used for answering these questions are four reports from the Economist Intelligence Unit, unless another source is mentioned, which can be found in the references.
The Czech and Slovakian economies are both very trade-dependent and are influenced to a large extent by international developments, most notably developments within the EU that is by far the largest trading partner of both countries. This means that the forecasts that will be provided in this chapter are subject to international assumptions in the world economy. Therefore this chapter starts with international assumptions where the economic outlook of both countries is based upon. The macro-economic outlook of both countries will start with a brief introduction and economical background information. Subsequently a five year outlook on economic growth, fiscal policy, monetary policy, external sector and foreign direct investment will be given for both countries. The chapter ends with a conclusion that will give an answer to question 1a.
3.1 International assumptions
It is assumed that global growth will be disappointing in 2003 and is expected to accelerate only gradually in 2004. The European growth outlook is not optimistic since the US economy is recovering only slowly, threatening European exports, and domestic demand in Europe is weakening. Real GDP in the EU, which grew by only 1% in 2002, is expected to increase by a mere 0.7% in 2003. A moderate acceleration in 2004, to 1.8% and 2.2% in 2005 is expected. The main risk to the forecast is that of a renewed slowdown in the US as a result of consumer and investor retrechment, wich would cause the EU recovery to stall. There is also the risk that the US dollar may collapse against the euro.
3.2 Macro-economic outlook of the Czech Republic
3.2.1 Introduction to the Czech Republic
Czechoslovakia was founded in 1918 after the collapse of the Habsburg Empire. A communistic regime was installed in 1948 that lasted until the 1989 "Velvet Revolution". The first free election was held in 1990, and the Czech Republic emerged in 1993 as one of the successors of the Czech and Slovak federal Republic. The Czech Republic is located at the heart of Europe, neighbouring, Germany to the west, Poland to the north, Slovakia to the east, and Austria to the south (see figure 8). It has a population of approximately 10.3 million, which is comparable to other medium-sized European nations (e.g. Hungary, Austria), GDP in 2002 measured US$ 69.5bn (at market exchange rates) and GDP per head was estimated at US$ 6.810 (at market exchange rates) in 2002.
Figure 8: Geographic position of the Czech Republic and Slovakia
Political structure
The Czech Republic is a parliamentary democracy. The parliament consists of a 200-member Chamber of Deputies (the lower house of parliament) and an 81-member Senate (the upper house). Executive power is exercised by the prime minister, and the president is elected by parliament for a five-year term. A presidential election took place in January and February 2003, and after several rounds, Vaclav Klaus was elected as successor to Vaclav Havel. The general election in June 2002 enabled the formation of a coalition government of the Czech Social Democratic Party (CSSD), the Christian Democratic Union-Czechoslovak People’s Party (KDU-CSL) and the Freedom Union, with a majority of two seats. The prime minister is Vladimir Spidla.
Policy issues
The government’s main task is to prepare for EU accession and this will require wide-ranging legislative and administrative reform. Another important issue is the current reform of the fiscal system, which will be discussed in paragraph 3.2.3, which is vital for the country's eventual conversion to the euro, when it joins the European economic and monetary union. Although the government coalition received a short-term boost from an overwhelming "yes" vote in the EU accession
