The Electrosteel Castings case is about an Indian ductile iron pipe (DIP) and cast iron pipe (CIP) manufacturer’s decision to internationalize. The central issue is about the choice of where to go, and the choice of the type of investment the company will pursue. This paper will analyze the options available for the company and recommend the best solution. 1. Electrosteel options As for the location, Electrosteel has two options: France and Vietnam.
France is attractive because it could be used as a strategic base to access the entire European Union because a manufacturer located in any EU country is considered a local supplier for all other EU countries. The European market is large, stable and has common standards. Country risk is low with fewer political and bureaucratic problems compared to developing countries, and there are a variety of domestic project funding sources available.
As for the customers, DIP was a well-established and accepted material however buyers preferred local suppliers due to government regulations and approval processes, resulting in a 12% premium over international prices. On the other hand there are potential risks. Firstly, high labor costs would result in higher operating costs. Secondly, there is a language barrier for the management. Third, it is difficult to predict how the strong local competitor, St. Gobain Group would react to Electrosteel. In contrast, Vietnam has the potential of growth.
Not only is it the second largest country in Southeast Asia, 80% of the country lacks sufficient water supply meaning that there is an enormous area of development. The country is offering a credit loan which is an incentive and becoming a local supplier is also beneficial in terms of premiums. On the other hand there is a large country risk. In terms of investment, Electrosteel has three options: opening a branch sales office, build both a casting operation and a finishing line, build a finishing line.
Opening a branch sales office is the less risky option, it will cost US$120,000 for Vietnam and US$400,000 for France. To build a casting operation and a finishing line it will cost about US$42 million. And to build a finishing line would cost about US$2 million. Also, building facilities involves higher risk. Other options for Electrosteel are the ways of investment. It can choose between wholly owned subsidiary and a joint venture. 2. Analysis of the options: There are several factors that have to be considered upon evaluating the options.
First, the competitive advantage of the company. Unfortunately it is not clear to what extent Electrosteel has a cost advantage over its’ competitors. Judging from the information provided in Exhibit 4, labor costs amount to 10% of the total cost. One can assume that these labor costs would be lower than OECD countries which could be an advantage. However, the industry seems to be a capital intense industry rather than a labor intense industry therefore it is hard to judge the advantage.
In terms of knowledge or innovative products, Electrosteel has been investing in its facilities in India resulting in higher quality of the products however the products that are being made do not seem to be differentiated. One can assume through this experience Electrosteel has obtained some advantageous knowledge but it is not clear if this could be counted as an ownership advantage. Overall it is difficult to judge that Eletrosteel has a unique advantage over European competitors. Therefore it is difficult to justify Electrosteel to physically move into France.
Even though there are merits to become a local supplier in a large market, it still does not seem possible to overcome the liability of foreignness. On the other hand, the Asian market still lacks local manufacturers. Not only Vietnam but Cambodia, Brunei and Singapore do not have local manufacturers. If Electrosteel could move quickly and establish itself as a high quality local manufacturer, this could be a source of competitive advantage. The low labor cost would also contribute as a benefit.
In the best case scenario, Electrosteel could use Vietnam as a production base to serve the entire Southeast Asia market, not just Vietnam. However, some risk factors have to be taken into consideration. One would be the fact that earlier record of foreign manufacturers in Vietnam had been poor. It would be necessary to conduct further research to determine the reasons behind the failure. Another issue would be port facilities. Do the port facilities meet the needs and standards required? A third issue would be the skill of the labor force because the manufacturing process for the DIP requires expertise at each step.
Demand for DIP could also be a potential problem because in general, developing countries tended to favor lower cost pipe alternatives due to restricted funding. 3. Recommendation Given the analysis, I would recommend Electrosteel to build a finishing line in Vietnam and utilize its’ existing facilities in India to for the casting process. The DIP production line has excess capacity of 20,000 tonnes that can be sent to Vietnam as raw DIP. Although the weight of the raw DIP is 90 per cent of the finished DIP, there still would be some transport savings.
Moreover, having the finishing line in Vietnam would qualify Electrosteel to be a local supplier allowing a premium of 15 per cent over international prices. A finishing line with the capacity of 50,000 tonnes would cost approximately US$2. 2 million. This could be covered by the 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 needed for a casting line. This reduces capital risk and also reduces the risk of labor quality. It can also be seen as an option, to delay the decision to build.
If the operations of the finishing line succeed in Vietnam, Electrosteel could then decide to build a casting line. Concerning the choice between a joint venture and a wholly owned subsidiary would depend partly on the attitude of the Vietnamese Government. It is common in a socialist country that the government asks the foreign company to form a joint venture. If so, there would be not much of a choice. If not, a Greenfield investment approach could be the solution. This way it could maintain a strong grip on operations and other strategic decisions such as pricing.
In addition to the investments in Vietnam, I would also recommend Electrosteel to open a branch sales office in France. The task would be to cultivate the niche segments that were identified through the analysis conducted by Electrosteel. Namely, the segments where clients were hesitant to deal with larger incumbent firms. The annual volume was projected to be 30,000 tones. This is substantial number worthwhile pursuing. And an investment of US$400,000 is not much compared to the risk and amount of investment required to become a local manufacturer.