The Electrosteel Castings case discusses the decision of an Indian manufacturer of ductile iron pipes (DIP) and cast iron pipes (CIP) to expand internationally. The main issue revolves around deciding where to expand and the type of investment to pursue. This paper will analyze the available options and make a recommendation. 1. Electrosteel’s options consist of two locations: France and Vietnam.
France is an appealing choice because it offers the advantage of being a strategic base for accessing the entire European Union. This is due to the fact that any manufacturer situated within an EU country is regarded as a local supplier for all other EU countries. Additionally, the European market is sizable, stable, and upholds common standards. As a result, the country risk is relatively low and there are fewer political and bureaucratic obstacles compared to developing nations. Moreover, there are numerous domestic funding sources available for projects.
Regarding customers, DIP was widely recognized and accepted, but due to government regulations and approval processes, local suppliers were favored, leading to a 12% higher price than international prices. However, there are potential risks. One potential risk is the higher operating costs caused by high labor costs. Another concern is the language barrier for management. Additionally, it is uncertain how the strong local competitor, St. Gobain Group, would respond to Electrosteel. In contrast, Vietnam offers growth potential.
Despite being the second largest country in Southeast Asia, 80% of the country is devoid of proper water supply, signifying a vast potential for development. The country is providing a credit loan as an enticing offer, and becoming a local supplier also comes with advantageous premiums. However, there is a significant risk associated with the country. Regarding investment, Electrosteel has three choices: establishing a branch sales office, constructing both a casting operation and a finishing line, or solely building a finishing line.
Opening a branch sales office is the less risky option, with costs of US$120,000 for Vietnam and US$400,000 for France. Building a casting operation and a finishing line would cost approximately US$42 million, while building just a finishing line would cost about US$2 million. However, building facilities carries higher risk. Another option for Electrosteel is to invest in a wholly owned subsidiary or a joint venture.
2. Analysis of the options: There are multiple factors to consider when evaluating these options.
Uncertainty surrounds the competitive advantage of Electrosteel due to a lack of clarity on its cost advantage compared to competitors. Exhibit 4 indicates that labor costs make up just 10% of the total cost, implying the potential for lower labor costs in comparison to OECD countries and thus potentially offering an advantage. However, as the industry seems to be more focused on capital than labor, it is challenging to ascertain the exact extent of this advantage.
Electrosteel has been investing in its facilities in India, resulting in higher quality products. However, there is no differentiation in the products being made. Although this investment has provided advantageous knowledge, it is unclear if it can be considered an ownership advantage. Hence, it is challenging to determine if Electrosteel has a unique advantage over European competitors. Consequently, it is hard to justify Electrosteel’s physical expansion into France.
Although being a local supplier in a large market has its advantages, overcoming the liability of foreignness remains challenging. However, there is currently a lack of local manufacturers in countries like Vietnam, Cambodia, Brunei, and Singapore within the Asian market. If Electrosteel can act quickly and establish itself as a high-quality local manufacturer, it could potentially gain a competitive advantage. Furthermore, benefitting from lower labor costs would enhance this advantage.
Ideally, Electrosteel could utilize Vietnam as a manufacturing hub for the entire Southeast Asia market, beyond just Vietnam. However, several potential risks need to be acknowledged. Firstly, it is important to investigate the previous unsuccessful experiences of foreign manufacturers in Vietnam. Understanding the reasons behind these failures is crucial. Secondly, assessing whether the port facilities satisfy the necessary requirements and standards is also essential. Lastly, considering the skill level of the labor force is important since expertise is required at every stage of the DIP manufacturing process.
The demand for DIP may pose a potential issue as developing countries typically prefer cheaper pipe alternatives due to limited funds. Based on the analysis, I recommend Electrosteel to construct a finishing line in Vietnam and use their current facilities in India for the casting process. Their DIP production line has an extra capacity of 20,000 tonnes, which can be transported to Vietnam as raw DIP. Even though the raw DIP weighs 90% of the finished DIP, there would still be some transportation cost savings.
Moreover, having the finishing line in Vietnam would qualify Electrosteel to be a local supplier allowing a 15% premium over international prices. The cost of a finishing line with a capacity of 50,000 tonnes is approximately US$2.2 million, which could be covered by a US$3.1 million credit loan provided by the Vietnamese government. This scheme is advantageous because it allows Electrosteel to avoid the high capital investment required for a casting line, reducing both capital risk and the risk of labor quality. Additionally, it can be viewed as an option to delay the decision to build.
If the finishing line operations in Vietnam are successful, Electrosteel may decide to build a casting line. The choice between establishing a joint venture or a wholly owned subsidiary will depend partly on the Vietnamese government’s attitude. Typically, socialist countries request foreign companies to form joint ventures. In this situation, there would be little choice. However, if it is not mandatory, Electrosteel could consider a Greenfield investment approach which would enable them to retain control over operations and crucial strategic decisions such as pricing.
I suggest that Electrosteel not only invest in Vietnam, but also open a branch sales office in France. The office would focus on developing the specific market segments that were identified through Electrosteel’s analysis. These segments consist of clients who are reluctant to engage with larger established firms. The projected annual volume for these segments is 30,000 tons, which is a considerable amount worth pursuing. Compared to the risk and investment needed to become a local manufacturer, the investment required for this office is only US$400,000, which is relatively low.
