RSM Resources

More midsized service companies — attracted by the sharp rise in economic growth and disposable income in overseas markets — are considering global expansion to develop new revenue streams.

But business leaders should recognize the path to international growth may be strewn with more than a few hidden obstacles, any one of which can trip up an otherwise well-intentioned plan, says an international marketing expert.

"When a U.S. company says it needs to go abroad simply because the domestic market has little or no new growth, that’s a bad reason," says Aneel Karnani, a professor of corporate strategy and international business at the University of Michigan. "Too many times, that kind of thinking results in adding a lot of new costs that don’t deliver new value."

Approximately 60 percent of midsized U.S. companies said they planned to grow by expanding their customer base, according to a recent survey of more than 3,700 senior executives sponsored by software giant SAP. One-third of the leaders of midsized American companies said they planned to explore new geographic markets for growth, especially Brazil, China, India and Russia; while senior business leaders in Asia and Europe were more focused on cost controls and streamlining.

The drive for growth and "first-mover advantage," a hallmark of American business, can lead midsized firms onto dangerous ground. For that reason, Karnani and other experts say companies need to avoid four key dangers during international expansion. The warning signs include:

Misjudging the size and characteristics of an international market. Many midsized service companies assume if their offerings are successful in the United States, their services will be equally appealing elsewhere. More often than not, the speculative approach fails because the service doesn’t fit the market, or the pricing is out of line with what consumers or business customers are willing to pay. When hurdles inevitably arise, these companies will oftentimes pull back or abandon their efforts.

A more successful method, experts say, is for service companies to follow existing clients when expanding into international markets. This strategy is a win-win: It positions the service company as a key resource helping ensure the client’s successful expansion, and it provides a solid base of business in the new market.

If building on a client’s international expansion is not an option, a company’s second approach to consider is a strategic acquisition. For example, if a laboratory testing provider can find a local partner to complement its market strategy and testing services, a purchase or alliance would enable the U.S. firm to leverage existing contacts, manage local legal and regulatory issues, and get to market with fewer costly delays.

"Regardless of steps you take to get started, you need to be committed for the long term and believe the investment has a reasonable chance of improving both your bottom line and prospects for future growth," says Karnani. "If you expand your service business overseas, and that choice delivers only 5 percent to 10 percent in new revenue after a few years, you’ll spend far more attention on that venture than it’s worth."

Miscalculating operating costs. While veteran entrepreneurs take pride in telling colleagues how they started or expanded a business on a shoestring, that tactic carries much higher risks outside the United States — especially for service companies for whom "speed to market" is a critical issue.

Bob Burdett, managing director of international services for RSM McGladrey, says companies often fail to take a realistic look at the built-in operating costs of the new market, such as taxes, fees, and assessments. Such an oversight can lead to expensive consequences.

For example, consider what would happen if a company’s business development team closed a $5 million deal for services — only to learn later that the contract did not account for a 25 percent hit from local value-added taxes (VAT). That discovery would cripple — if not eliminate — the company’s profit margin.

"Midsized business leaders need to remember that opening offices in Mexico, China or other global locations isn’t like opening a domestic branch office," says Burdett. "It’s important to engage knowledgeable people in these nations who can provide solid, fact-based information for better operating and financial decisions."

Financial control problems that lead to theft and loss. In a typical start-up office for a global service expansion, companies will frequently deploy a small team of employees to support existing clients and develop new business. The early financial issues of an expansion office revolve around expenses — such as location costs, travel, meals, housing, and new business development — before gradually shifting to revenue management as business grows.

However, experts say U.S. companies don’t do enough to provide experienced, local oversight of day-to-day finances. This leaves companies open to fraud or outright theft. In contrast, most European- and Asian-owned businesses will assign a financial professional to oversee expansion teams, a step that greatly reduces the odds of substantial loss.

Problems with tax and statutory compliance. Many service firms have successfully avoided the other three dangers of international expansion but have run into problems complying with local laws. For example, most nations require business tax and accounting records be maintained in the local jurisdiction — not in a central office thousands of miles away. Even businesses that are paying their share of local tax obligations can discover the wrong documentation may lead to big penalties.

If a company does not have an internal resource skilled in international tax laws, experts say the next best step is to retain a business services provider that can handle payroll, bookkeeping, compliance and regulatory issues. Karnani says this step can provide a competitive advantage, because many midsized firms try to navigate the dangers without a trusted guide.

"It is surprising how often business leaders seek to globalize a company without really getting to know the countries into which they want to expand," he says. "If you do go, it’s wise to partner with some resources that can head off these problems and help you get a real feel for the marketplace."