For most organisations who have successfully gained market foothold in their target market, the next logical step is to look at market expansion opportunities. Growth opportunities typically include setting up either a foreign subsidiary or overseas branch office. What are the key differences between both and when should organisations go with either option?
Definition of a Foreign Subsidiary and an Overseas Branch Office
According to Globalization Partners, a foreign subsidiary is a corporation that is owned by the parent company but operates as a separate entity. The parent company typically has a 51% to 100% ownership stake in the subsidiary. In most cases, the subsidiary will not conduct businesses of the same nature as the parent company.
When it comes to accounting and legal matters, the parent company often does not have any accountability or oversight. The subsidiary typically maintains separate accounting books from the parent company and may even be sold to another company if the subsidiary becomes unprofitable. Likewise, the parent company does not have any liability for the subsidiary should there be any legal disputes that the subsidiary faces.
On the other hand, an overseas branch office is connected to the parent organisation and is expected to report to the Head Office. When it comes to operational matters, the branch office is completely controlled by the parent company.
In terms of accounting matters, the overseas branch office typically maintains a joint account with the Head Office and may be subjected to closure if the operations become non-profitable. When it comes to any legal disputes, the parent company owns 100% liability of the branch office. This means that the legal liability also extends to the parent company.
Pros and cons of opening a Foreign Subsidiary
Given that a subsidiary is independent of their parent organisation, it makes it easier for subsidiaries to conduct businesses, be it exploring new partnerships or venturing into new markets. This independence also gives subsidiaries more flexibility when it comes to investment, as they can issue stocks and bonds to third-parties such as investors, partners and venture capitalists. Similarly, they can also opt to be listed on the public stock exchange and issue public stocks. Since a subsidiary is considered as a separate legal entity, it offers greater legal protection for shareholders of the parent company as they will have no liability if the subsidiary faces any litigation.
While these are attractive incentives, opening a subsidiary has its fair share of challenges. Opening a subsidiary is relatively costly as it may require additional facilities such as a manufacturing facility or a research and development arm. Given that a subsidiary is operating independently in a foreign country, it is essential for the parent company to understand and consider the cultural, economic and political nuances. It may help if there is a strong local ownership of the subsidiary to help the parent company understand the local market conditions.
A major setback to opening a subsidiary is if the subsidiary ends up losing money. While a parent company can easily close an overseas branch office, a money-losing subsidiary is likely to incur hefty and costly financial and legal negotiations.
Pros and cons of opening an Overseas Branch Office
Opening an overseas branch office is less costly as compared to opening a subsidiary. For example, there is no need to negotiate local ownership and parent companies simply need to consider only overhead costs such as rental space and paying employees. A branch office also offers the parent company greater tax benefits given that revenue earned will be handled by tax treaties where the parent company is based and where the branch office is located, eliminating double taxation. Overall, an overseas branch office is generally the simplest and easiest way a parent company can take to expand its brand into a foreign market without incurring hefty costs.
While opening an overseas branch office is a fairly easy way to venture into new markets, the activities that a branch office can operate is largely restricted to that of the parent company. Likewise, if the branch office incurs any debts or litigation, the parent company is liable. This often puts the stakeholders at risk. An overseas branch office may be subjected to quotas on the number of foreign workers that they can bring, limiting the type of talent they can bring in.
Deciding between a subsidiary versus a branch office in a foreign market can be a complex and difficult issue, particularly if companies are keen to expand quickly into new markets. That said, it is always best to weigh the pros and cons to determine which best fits the organisation's needs and constraints. Organisations can also consider engaging external consultants to recommend an appropriate approach along with transition strategies.
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