This report aims to provide executives of Grupo Arcor S.A with justified recommendations for its continued expansion in the Chinese confectionary market. First, the report will reiterate the previous recommendations made to Arcor, then some of the current risks associated with entering the Chinese market will be explored. Following this, the recommended actions will be presented and necessary risk management and mitigation will be discussed. Next, the capability of Arcor to implement this strategy will be considered, before potential operational and cross-cultural issues arising from the strategy are examined. Finally, there will be a summary of the report's suggestions for Arcor's expansion.
Prior to the writing of this report, a full research project and TOWS analysis (Appendix 1) of strategic options was presented to Arcor. It was found that the health and safety of food products is important to consumers, and that a new innovative oat chocolate product has reached the market. The unpredictability and power of the Chinese government was also discussed. Using these findings and the knowledge of Arcor's strengths and weaknesses, the suggested actions (Appendix 2) were as follows:
- to innovate a healthier oat chocolate product
- to enter into a joint venture with a Chinese firm
- to focus on quality and safety of products
- to seek cheaper financing methods.
This report will lead on from the previous findings and suggestions, accounting for the most pressing current risks to Arcor when considering further expansion in China, which are discussed in the following section.
2.0 Current risks and uncertainties associated with the Chinese market
It is important to note the difference between risks and uncertainties in a business context. An uncertainty is about a lack of predictability, where future events cannot be known. A risk, in contrast, is measurable. It involves the probability of the potential outcomes and their significance to the risk-taker. Due to this, risks can be controlled and minimised, whereas uncertainties can only be acknowledged as by their very nature it is impossible to know their outcome. According to Miller (1992), uncertainties take three main forms: general environmental, industry, and firm-specific.
2.1 General environmental uncertainties and associated risks
2.1.1 Macroeconomic factors
China's year-on-year GDP growth rate fell from 10.6% to 6.9% between 2010 and 2015 (Mintel 2016b), which has caused uncertainty over future growth prospects of the country. If China goes into recession, there will be a drop in consumption leading to reduced demand for Arcor's products. The slowdown in the economy has largely been caused by the secondary sector (Mintel 2016b). This presents risks to Arcor regarding placing production facilities in China due the industry's uncertain future, such as a lack of appropriate labour or materials if the sector declines further.
Despite the risks of sector decline and economic downturn, China may well continue to grow; Arcor would benefit from taking advantage of the increasing potential profits by expanding in the country.
2.1.2 Government and political factors
There is also a risk of loss due to government action, including the risk of corruption when obtaining permits and licenses. Despite recent moves towards a more free-market economy the Chinese government still has roots in communism, which exacerbates the risk of expropriation of Arcor's property; Credendo Group's (2015) statistic for China's expropriation risk is high, at 5/7.
China's government are also unpredictable in their actions and their view on foreign businesses could change with little notice, leaving Arcor at risk from changes in taxes and regulations that could be difficult to follow.
3.2 Industry uncertainties and associated risks
3.2.1 Demand risks
As consumer trends point towards the desire for a healthy lifestyle (Mintel 2016a), confectionary demand is at risk of falling due to high sugar and fat content. The significance of this risk is low if Arcor opts for a risk avoidance strategy: developing a healthier product. However, in doing this Arcor may be exposed to a higher level of competitive pressure as other confectionary firms also look to move towards healthier snacks in the market.
3.2.2 Policy risks
The increased regulation of the food industry by organisations such as the Ministry of Health and the State Food and Drug Administration (Jia and Jukes 2013) signals potential for further intervention from the state; there's a risk of disruption of production if products have to be altered to meet new rules. This risk is of a high probability considering the government's strong influence in the economy. However, Chinese consumers place a large weight on the safety of food, so if Arcor is confident in its ability to adhere to high standards of health and safety this could instead be a competitive advantage to the firm.
3.3 Firm-specific uncertainties: supply risks
Arcor's vertical integration in South America allows it to minimise risks as it sources a vast amount of inputs from subsidiaries, however this is only viable as all of its production facilities are in South America. If Arcor opens a plant in China, it will be necessary to create an entirely separate supply chain. Manuj and Mentzer (2008) cite Schmidt and Wilhelm (2000) in saying that uncertainty over lead times and supplier reliability are ‘critical to the performance of a global supply chain', and given that cocoa is a commodity, price uncertainty must also be considered. Issues in the supply chain could halt production, damage Arcor's reputation, or reduce profit margins.
Cocoa beans are the most important input and hence it is imperative to consider the risks associated with their supply. The price of cocoa beans is highly volatile, as shown in Figure 1 from the International Cocoa Organisation.
Currently Arcor is able to minimise transport risks by sourcing its beans from South America, where no sea or air travel is necessary and therefore transport costs are lower. But if producing in China, beans must be transported by sea from Africa or Indonesia. According to the European Parliament (2009), changes in the price of crude oil have a direct impact on the price of marine fuel, which in turn effects transportation costs for Arcor; the cost of crude oil can form up to 50% of total maritime transport costs. This sensitivity to volatile oil prices poses a large risk to Arcor as costs will be uncertain.
Together, the recommendations below create an effective strategy for Arcor's expansion in China, as each manages and mitigates a different set of risks. Discussing each action separately shows how both are necessary in order to create a strategy that minimises as wide a range of risks as possible.
4.1 Joint venture
Rugman and Collinson's explanation of the ‘internationalisation process' (Appendix 3) shows that Arcor currently sits near the bottom, by simply exporting products to China. For Arcor to expand in the market it must deepen its involvement, which a joint venture successfully achieves. Joint ventures and strategic alliances are becoming increasingly commonplace, with 63% of China CEOs wanting new strategic partners according to the Global CEO Survey (PwC 2016). Hence, Arcor would not struggle to find a suitable partner firm.
4.1.1 Risk management and mitigation
Cooperation is one of Miller's (1992) suggested responses to environmental uncertainties. As explained in the presentation, a joint venture would provide Arcor with access to established supply chains and trusted contacts in China, which significantly reduces the risk of production associated with developing new and reliable relationships with suppliers.
Partnering with a Chinese firm allows all risks to be shared; Arcor's initial investment would be halved, which mitigates the potential loss associated with the risk of failure of expansion. This is especially important given the current uncertainty over growth prospects of the Chinese market.
The Chinese government is also less likely to take action against a domestic firm, so this strategy reduces the risks associated with regulation of foreign firms, corruption and expropriation.
4.2 Healthier product
The other appropriate action for Arcor to pursue is product development, which Ansoff's matrix (Appendix 4) defines as placing a new product in an existing market. Developing an oat chocolate product allows Arcor to appeal to Chinese tastes, preferences and values, including the desire for healthier snack options. This would therefore increase Arcor's potential sales.
4.2.1 Risk management and mitigation
Arcor must be responsive to trends and changing preferences in order to reduce risk. The top reasons preventing consumers eating chocolate are health-based: the worry that it will cause weight gain, and that it is bad for your teeth (Mintel 2016a). Creating a healthier product allows Arcor to mitigate the risk of losses occurring from reduced demand for its other products in the market.
The innovation of a new product is an opportunity to adhere to all new regulations and guidelines, and to go beyond this. By accounting for as many potential regulations as possible in the production of the new product, the risk of having to alter products if regulation becomes stricter is reduced. Arcor will also have the competitive edge; competitors may have to alter their products and production techniques leading to temporarily reduced supply, and some may exit the market if they cannot afford to adhere to the new rules.
With innovation comes risk, and Arcor must prepare for the possibility that the product will not be successful. Products using oat chocolate innovation are already being sold, so Arcor will be a late entry to the market which substantially reduces the risk of failure. Arcor can learn from the first mover's mistakes and analyse the market to make informed decisions about the market positioning its product should take in order to gain maximum market share.
5.0 Capability of strategy implementation
5.1 Joint venture
Arcor's current structure does not fully support a joint venture. With China's operations being one of multiple responsibilities of an executive vice president, the commitment and resources necessary for a successful joint venture cannot be met. It is advised Arcor creates a new division of the company solely responsible for Chinese operations. With this, a team would be able to form good working relationships with the partner firm, to ensure the collaboration ran smoothly and could be closely monitored.
5.2 Innovation of a healthier product
Arcor is highly experienced in innovation, so when these skills are combined with a domestic firm's knowledge of consumer tastes and preferences, Arcor will be able to successfully develop a new oat chocolate product with its current innovation capabilities. However, marketing will require heavy involvement from the Chinese firm as Arcor's knowledge of the local market is insufficient, hence why a joint venture is paramount in Arcor's expansion.
5.3 Ability to cope with potential losses
Arcor's size and diversification means it can cope with the potential losses associated with expansion; if China does fall into a recession, the joint venture reduces the potential losses, and Arcor's South American activities can offset them.
6.0 Cross-cultural management issues
There are large disparities between Argentinian and Chinese values and business practices, as Hofstede shows in Figure 2; the division of Arcor involved in the joint venture will need extensive training in this area.
Unlike Argentina, Chinese culture is long-term oriented, meaning they would rather accept short-term losses in exchange for long-term success. Arcor's Chinese division will need to consider the long term implications of decisions to ensure that they are in keeping with their Chinese partner's interests, and short-term targets will not be appropriate for use.
The power distance between workers and their bosses is much higher in China, and informal communications between the two should hence be avoided. Arcor will need to ensure polite and formal meetings are arranged between leaders of the venture and the workers to respect this.
Arcor will need to structure its Chinese division slightly differently to comply with the importance of collectivism in their culture. Targets need to be more team-based and focus on collective achievements, and more tasks should be delegated to small groups of workers rather than to individuals.
7.0 Operational issues
Operational issues and risks are incurred between the point at which inputs leave suppliers to reach the plant, and the point at which they are delivered to the customer (Manuj and Mentzer 2008).
There are inevitable difficulties in the management and day-to-day running of joint ventures regarding who is responsible for each aspect. Arcor will need to clearly set out with its partner firm the roles of each firm, to include things such as sourcing inputs, accounting, licensing and customer service. It is highly likely that there will be disputes between the firms even if the relationship is clearly contracted; this can lead to the breakdown or mismanagement of the joint venture, and hence reduced profits.
To reduce the risk of this, Arcor must conduct extensive research on potential partner firms, to ensure they have similar views and compatible management styles. Alongside this is the previously discussed need for Arcor to adapt its management style to suit Chinese business culture and worker values. The Harvard model of Human Resource Management should be adopted to ensure the cooperation and loyalty of workers to the joint venture.
Another potential operational issue is that of information security. Entering into a joint venture and collaboratively innovating a new product means Arcor must decide what information to share with its partner firm. Withholding valuable information will be detrimental to the joint venture's prospects, however in sharing confidential information with a partner firm there is the risk that the firm may use this information to compete with Arcor outside the joint venture.
Solving this issue can be difficult as it is hard to control what the partner firm will do once the joint venture has ended. However, including clauses in the contract specifying that no use of confidential information or technology is to be permitted will reduce this risk. Another way to avoid this is for Arcor to control the parts of operations that involve the use of their confidential information or technology. This ensures that only Arcor's team are involved in the use of this information, however this may be hard to achieve in reality.
To conclude, despite the current risks of the Chinese market such as potential economic downturn and expropriation, expansion in China could be very profitable for Arcor if it proceeds with the suggested strategy which reduces the overall risks of expansion for the company.
The combination of a joint venture and an oat chocolate product provides Arcor with the most appropriate strategy. Developing a healthier product will allow Arcor to reach a wider audience and hence increase sales prospects, as well as enabling the firm to account for potential stricter regulations in its production. Meanwhile, entering into a joint venture overcomes the issues surrounding Arcor's:
- limited local contacts
- lacking knowledge of Chinese business culture, government actions and regulations
- lack of local production facilities.
However, Arcor must create a division entirely focused on Chinese operations in order for this strategy to be successful, as strong relationships must be formed with the partner firm, as well as changing management practices to account for the cultural differences between the countries.
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