Growing your fashion brand can entail a series of challenges when addressing international markets.
One of the biggest hurdles has to do with keeping your sales profitable when taking into account international trade tariffs.
Tariffs are essentially taxes levied by a country to protect the internal market from unfair competition, or even to simply profit from allowing access to their consumer market.
As your business scales, tariffs can become an increasingly difficult problem to solve, and in this post, we’re looking at the typical strategic evolution businesses undertake as they move from export all the way to foreign direct investments.
There’s a lot to discuss, so let’s dive right in!
Stage #1 Export
In the first stage of a firm’s expansion, the most common way to reach international markets is through exports.
Exports are a very low-risk approach to connecting with new international customers, as an export strategy will allow you to respond to unsolicited foreign orders by shipping your products abroad.
Moreover, considering the risks associated with launching your brand internationally, fashion brands can use export as a testing stage to evaluate which products or what pieces of the brand’s collection work best with a new customer population.
If a brand focuses on exports chances are that:
- The brand has a low volume of international business and has no need to develop the organization further to tap into foreign markets more profitably.
- The brand is growing internationally, but before committing to new markets, it is testing which regions or areas provide the highest chances of success by tracking market growth. Exports and volumes of sales can provide a good measure of international growth potential.
In either case, however, the presence of tariffs can easily take a toll on your profits.
To put this in context we can see that usually, companies reach high levels of profitability due to two main reasons: they either sell a lot of products by acquiring a large market share, or they make more money per each sale, by applying a premium pricing strategy and increasing their margins.
In both these cases what we can see is that a tariff, or tax, to be paid at the border can put a company in a position where their profit margin has to be reduced if they don’t want to end up pricing their products above market price.
Unless a brand takes tariffs into account, customers will be affected by what we call “pricing escalation”, where on top of traditional channel upsell, the import cost could make the product unaffordable.
In a broader context, the situation is not usually that bleak. As stated, many businesses can use exports profitably for a series of reasons, which may include, managing unsold inventory.
At the same time, however, if your brand is strategically set to tackle new international markets, then it could consider developing a plan connected with other international entry modes.
The first upgrade to this strategy may be connected to a “family” of entry strategies that are broadly called “contractual” or “intermediate” modes of entry.
We’re going to discuss these approaches in the next section of our post.
Stage #2 Contractual Modes
Once a business has realized that the volume of international trade has reached a point of high potential growth, it may be possible to explore new alleys towards international expansion.
By developing a relationship with a local manufacturer, (or a manufacturer within an area of economic integration) a business can overcome tariff costs and produce a collection locally, within the target market.
This is a form of outsourcing that can be often seen as a way to reduce costs and compromise on quality, but in reality, by working with large, established companies, a brand can access a pooling capacity that would not be possible for the brand to acquire otherwise.
When it comes to fashion however there are a few additional considerations to make.
Due to the high intellectual property value of fashion products, managing the production of your collection through a third party can be challenging. All in all, fashion brands need to maintain high-quality consistency and this can be difficult to do when working through intermediaries.
This is why fashion brands often take advantage of contractual terms which are centered around copyright and brand licensing. The two contractual formats are: franchising and licensing.
When two parties enter a franchise agreement a company (the franchisor) licenses its trademark and business format to a third-party company ( the franchisee) in exchange for recurring payment or percentage of gross sales.
Franchising is a common entry strategy for fashion, but in many cases, it is connected to client-facing activities, such as the management of retail and sales.
If you’re interested in understanding franchising in further detail. Here’s an article that can help you with that.
Licensing entails gaining permission from a company (the licensor) to manufacture and sell one or more of its branded products within a defined market area.
The third-party manufacturer (licensee) will pay back the licensor with a royalty fee as compensation for the added value that the intangible brand equity brings to the product.
If you’d like to read up more on licensing, here’s an article that can help.
In any of these contractual formats, the brand will not pay tariffs as it is operating from within the country. The issue, however, is that by operating through a third-party company, it may lose control over the processes that take place beyond the border.
This is why some fashion companies may decide to go the whole nine yards by approaching international expansion through foreign direct investment. We’re going to discuss this topic in the next section of our post.
Stage #3 Foreign Direct Investment
Foreign direct investment is an approach to international expansion, according to which fashion brands invest capital to develop a company-controlled foreign presence.
In the context of luxury, this can be considered a relatively common option, as luxury brands need to enforce total quality management, and are subject to more strategic limitations when outsourcing their manufacturing to third-party companies.
By entering a foreign market through foreign direct investment, your position towards the market will change, as you will have shown a long-term commitment to the growth of your business and the chosen target market as well.
When it comes to entering a foreign market through foreign direct investment there are two possible approaches to follow: mergers and acquisitions and greenfield operations.
Mergers and Acquisition
A merger takes place when two separate business entities combine forces to create a new, joint organization. An acquisition instead refers to the takeover of one entity by another.
A greenfield operation is when instead of entering the foreign market by acquiring an existing company, you are developing a new entity from the ground up, therefore avoiding any limitation of restriction due to prior conditions.
The choice between these two approaches is usually conducted on the grounds of a financial analysis, which allows the firm to see which of the two projects is likely to yield better financial results.
If you’d like to learn more about these financial tools, and firm valuation, in this article, we’re looking into the topic in greater depth.
Great! In this post, we’ve outlined a way to move through a three-step strategy that allows firms to address tariffs and other challenges to international business by moving from low-risk\low profit approaches (export) all the way to high-risk\high-profit strategies (foreign direct investment or FDI).
Now that we’ve touched upon all relevant information it’s time to draw a few conclusive remarks.
There you have it! In this post, we’ve discussed a simple step-by-step approach to managing tariffs when developing your business internationally.
If you’re interested in this topic, we have an additional resource for you to read: Entry Modes in International Marketing Explained. In this article we delve deep into all of the possible approaches and strategies to take your product to international markets.
Don’t hesitate to explore our blog, you’ll be able to find a wealth of information on international marketing and fashion business. Enjoy!