FINS Group Negotiation Strategy Report

Megatronics Inc.

Recommendation
Megatronics Inc. the world’s leading producer of microanalyzers is looking to continue its growth utilizing foreign market entrance strategies of either a wholly-owned subsidiary or a highly advantageous licensing agreement. The markets that we will be targeting aggressively for this expansion are the emerging markets of China and Brazil. Our primary goal is to establish a wholly owned subsidiary within the Chinese market with our secondary goal being to do the same for the Brazilian market. Entering these markets in this fashion will allow us to upkeep our management preferences of maintaining full ownership control to integrate our marketing and manufacturing strategies on a global scale. Financially it should provide an approximately 11.4% return on invested capital (See Appendix 2 for NPV calculations). This will help Megatronics to increase the financial health of the business by gaining new revenues from high growth markets. These measures will proactively ward off competitors Eurodata and Tanaka who are attempting to encroach on Megatronics market share and lead to wealth creation for our firm.
Support
The foreign markets which have been seen as worthwhile to pursue are the Chinese and Brazilian markets. These markets are projected to have 180% growth over a six year period (See Appendix 2). This high growth rate makes these countries appealing to enter. Additionally, we are looking not only to leverage arbitrage opportunities but to look at countries which are closely aligned to the cultural dimensions of our home country. Both of these countries had values of Hofstede’s Cultural dimensions that held strong positive correlations to the same values for Mexico. Brazil had a correlation coefficient of approximately 0.89 and China had a value of 0.73 (See Appendix 1). Utilizing Hofstede’s cultural dimensions to determine if the foreign country bears similarities to our home country also helped as conclude that India and Mexico do not have a strong positive correlation as the correlation co-efficient was approximately 0.3.

As much as we are looking for cultural similarity you cannot ignore that, “the best known type of economic arbitrage is the exploitation of cheap labor,” which we will benefit from entering either Brazil and/or China. Currently the typical wage rates per annum in Mexico are $15,000, which is greater than the values in Brazil ($12,000) and China ($5,000). China’s labour rates being significantly lower than Mexico’s make it a very attractive option to operate within their borders.

When selecting a mode of entry strategy we were constrained by our management preferences of retaining total control over business operations so this eliminated using joint ventures as a strategy. Exporting was not seen as a desirable entrance strategy as well due to tariff and transportation costs being approximately 15 to 50 percent of the selling price of a microanalzyer. Additional constraints faced by the business were the demand of these emerging markets. The forecasted demand based on the world microanalyzer market as summarized in Appendix 2 does not support the capacity to build a maxi-plant within either Brazil, China or India (demand<100,000 units). Although typically Megatronics looks to build maxi-plants demand is a constraint as Megatronics prides itself on being a highly efficient and cost-effective producer of microanalyzers and will not have idle capacity. Addition support for the standard plant is that it is the only plant that would generate a positive NPV (See Appendix 2).

Using a wholly-owned subsidiary entrance strategy, “gives a company the kind of tight control over operations in different countries that it needs if it is going to engage in global strategic coordination,” which is the goal of Megatronics.This entrance strategy hedges against exchange rate risk as the, “gradual appreciation of the Yuan against the U.S. dollar may also have added to concern among exporters, theoretically making Chinese products less attractive,” to export beyond China’s borders. This means that because we are focused on establishing our market presence in China and servicing the Chinese market we avoid having to worry about the appreciation of the Yuan affecting sales. The strategy also protects against the risks of intellectual property theft as China has a history of infringement upon intellectual property rights. This is detailed as, “Infringement of IPR is a fact of life in China. It's very difficult not to accept it. It's enormously widespread.” As this is the current situation, by using a wholly-owned subsidiary Megatronics better insulates itself against these threats undermining the heavy investment we have made in our technology.

Our secondary target market of Brazil also employs a floating exchange rate which poses risks if the Brazilian currency appreciates vs. other currencies. Again utilizing a wholly-owned subsidiary to focus on the markets needs will bypass most of these risks. Unlike our Chinese counterparts Brazil is more conducive to foreign direct investment. “FDI has been growing faster than any other kind of investment. In a report published in early May, Brazil's central bank forecasted that US$55 billion of FDI will enter the country this year, up from US$24.4 billion in 2010.” This illustrates we are likely to attain government support for a wholly-owned subsidiary and is one of the reasons why Brazil is viewed as such a market opportunity. Brazil however, is still the secondary market we are looking to penetrate as its economic arbitrage opportunities are not as significant.

Both markets are financially viable as the forecasted cash flows in Appendix 2 are also applicable for the Brazilian market which is of the same market size. The conclusions drawn from the financial projections are that both markets as best served by a standard plant. The $10,252,336 NPV of the standard plant does fall short of the general 30% requirement for return on investment. However, these calculations do not take into account possible contributions from governments on our initial investment or advantageous tax breaks. Additionally, servicing these markets to gain entry into high growth regions is a key to maintaining market share over our competitors.

Plan of Action
To achieve our goal of wealth creation through the expansion into the Brazilian and Chinese emerging markets we must make connections with their respective governments in the negotiation process. The negotiation team of Daniel Swatridge (Chief Legal Counsel), Dan Campagna (VP of Marketing and Manufacturing) and Stephen Storey (VP of Finance) will each lend their expertise through the negotiation process. In order to maintain a cohesive group and present a united front we will not be splitting up to pursue multiple discussions. We will make our decision on which governments we negotiate contract terms with dependent on whether they accept our strategy of building a wholly-owned subsidiary or if they are insistent on some form of licensing agreement. If we succeed in convincing these two countries of the need for a wholly-owned subsidiary we will be negotiating for government incentives ranging from tax breaks to contributions for our initial investment. We will be looking to exploit tax arbitrage opportunities through achieving tax savings within these foreign markets. Negotiations for licensing (if they occur) will focus around the royalty fees; we will be attempting to target a rate of no lower than 5%. The outline of who is focused on which aspect of the negotiation is outlined below:

* Tax incentives, Possible contribution from the government to an initial investment, royalty rates (if needed) – Stephen Storey (VP of Finance) * Benefits we offer by establishing a wholly-owned subsidiary – Dan Campagna (VP of Marketing, Manufacturing) * Protection against intellectual property theft, contract duration, legal bounds – Daniel Swatridge (Chief Legal Counsel)
We believe that our size and the market opportunity we present will give us the upper hand over our competitors. We also have devised a few tactics we will utilize in order to enhance our chances of being successful in our negotiations with foreign governments. One negotiation tactic we will utilize is the “cards on the table” tactic as we are the market leader and can use this to entice governments to offer incentives and create deals. We have a few non-negotiable items including: maintain control of our technology and engage in an alliance as a limited partner. A secondary tactic we plan to utilize is the “quivering quill” strategy which is attempts to get small concessions right before the signing off any contract.
The emphasis on our negotiations will be to secure the Chinese contract first with a secondary goal of eventually establishing a standard plant in China and Brazil. For both these markets it is important to demonstrate that our presence in the market will offer long term development for the country in terms of providing employment and knowledge to workers. Doing so will start negotiations off positively and help convince China and Brazil of the positives of welcoming our wholly-owned subsidiaries to their countries. Successful negotiations will lead to contracts being signed with our target markets helping to accomplish the ultimate goal of generating wealth creation for Megatronics Inc

Appendix 1 – Hofstede’s Cultural Dimensions

| Power Distance | Individualism | Masculinity | Uncertainty Avoidance | Correlation with
Home Country | Mexico** | 81 | 30 | 69 | 82 | N/A | China | 80 | 20 | 66 | 40 | 0.7259 | India | 77 | 48 | 56 | 40 | 0.2969 | Brazil | 69 | 38 | 49 | 76 | 0.8914 |

**Home Country

Appendix 2 -Financial Projections Financial Projections China Market | Year 1 Mini-Plant Standard Plant Maxi-Plant | Contribution Margin | $13,500,000 | $29,640,000 | $42,120,000 | Less: Dep | | $5,700,000 | $9,000,000 | $16,000,000 | Increase in labour | $106,667 | $83,200 | $55,467 | Increased Manu Costs | $- | $38,263,680 | $29,652,480 | Net Income | | $7,693,333 | $(17,706,880) | $(3,587,947) | Tax (25%) | | $1,923,333 | $(4,426,720) | $(896,987) | Cash Flow | | $5,770,000 | $(13,280,160) | $(2,690,960) | | | | | | Year 2 | Contribution Margin | $13,500,000 | $36,480,000 | $51,840,000 | Less: Dep | | $5,700,000 | $9,000,000 | $16,000,000 | Increase in labour | $109,511 | $85,419 | $56,946 | Increased Manu Costs | $- | $29,982,720 | $34,283,520 | Net Income | | $7,690,489 | $(2,588,139) | $1,499,534 | Tax (25%) | | $1,922,622 | $(647,035) | $374,884 | Cash Flow | | $5,767,867 | $(1,941,104) | $1,124,651 | | | | | | Year 3 | Contribution Margin | $13,500,000 | $43,320,000 | $61,560,000 | Less: Dep | | $5,700,000 | $9,000,000 | $16,000,000 | Increase in labour | $112,431 | $87,696 | $58,464 | Increased Manu Costs | $- | $28,600,320 | $38,085,120 | Net Income | | $7,687,569 | $5,631,984 | $7,416,416 | Tax (25%) | | $1,921,892 | $1,407,996 | $1,854,104 | Cash Flow | | $5,765,676 | $4,223,988 | $5,562,312 | | | | | | Year 4 | Contribution Margin | $13,500,000 | $50,160,000 | $71,280,000 | Less: Dep | | $5,700,000 | $9,000,000 | $16,000,000 | Increase in labour | $115,430 | $90,035 | $60,023 | Increased Manu Costs | $- | $25,006,080 | $41,057,280 | Net Income | | $7,684,570 | $16,063,885 | $14,162,697 | Tax (25%) | | $1,921,143 | $4,015,971 | $3,540,674 | Cash Flow | | $5,763,428 | $12,047,914 | $10,622,022 | | | | | | Year 5 | Contribution Margin | $13,500,000 | $57,000,000 | $81,000,000 | Less: Dep | | $5,700,000 | $9,000,000 | $16,000,000 | Increase in labour | $118,508 | $92,436 | $61,624 | Increased Manu Costs | $- | $19,200,000 | $43,200,000 | Net Income | | $7,681,492 | $28,707,564 | $21,738,376 | Tax (25%) | | $1,920,373 | $7,176,891 | $5,434,594 | Cash Flow | | $5,761,119 | $21,530,673 | $16,303,782 | | | | | | Year 6 | Contribution Margin | $13,500,000 | $63,840,000 | $90,720,000 | Less: Dep | | $5,700,000 | $9,000,000 | $16,000,000 | Increase in labour | $121,668 | $94,901 | $63,267 | Increased Manu Costs | $- | $11,182,080 | $44,513,280 | Net Income | | $7,678,332 | $43,563,019 | $30,143,453 | Tax (25%) | | $1,919,583 | $10,890,755 | $7,535,863 | Cash Flow | | $5,758,749 | $32,672,264 | $22,607,590 | | | | | | Year 7 | | $5,758,749 | $32,672,264 | $22,607,590 | Year 8 | | $5,758,749 | $32,672,264 | $22,607,590 | Year 9 | | $5,758,749 | $32,672,264 | $22,607,590 | Year 10 | | $5,758,749 | $32,672,264 | $22,607,590 | | | | | | Total Cash Flow | $57,621,836 | $185,942,632 | $143,959,754 |

NPV of Projects NPV of Projects | | | 1) Investment in Mini Plant | $57,000,000 | NPV of Cash Flows | | $38,706,426 | NPV of Mini Plant | | $(18,293,574) | | | | | 2) Investment in Standard Plant | $90,000,000 | NPV of Cash Flows | | $100,252,336 | NPV of Standard Plant | | $10,252,336 | | | | | 3) Investment in Maxi Plant | $160,000,000 | NPV of Cash Flows | | $82,404,956 | NPV of Maxi Plant | | $(77,595,044) |

Projected Sales | | Projected | Worst (60%) | Best (90%) | Year 1 | 20.8 | 15.6 | 23.4 | Year 2 | 25.6 | 19.2 | 28.8 | Year 3 | 30.4 | 22.8 | 34.2 | Year 4 | 35.2 | 26.4 | 39.6 | Year 5 | 40 | 30 | 45 | Year 6 | 44.8 | 33.6 | 50.4 |

Additional Information Sales Price | Current Sales price to distributor | $4,000 | Tariff | | | 30% | Effective Sales Price | | $5,200.0 | Sales Price to Chinese Market | $4,500.0 |

| | Mini | Standard | Maxi | Margin per Sale | $675 | $1,425 | $2,025 | Inflation Rate China | 4% | | | Increase in Labour Costs | 2.67% | | | | | Mini | Standard | Maxi | Manufacturing Costs | 3150 | 2400 | 1800 | Mexico Prime Rate:4.35% | | |

Labour Rates | Brazil | China | India | Mexico | US | GNI | 8070 | 3650 | 1220 | 8960 | 46360 | Employment | 64% | 71% | 56% | 57% | 65% | Yearly Rate | $12,609 | $5,141 | $2,179 | $15,719 | $71,323 |

Statistics Taken: * http://www.clearlycultural.com/geert-hofstede-cultural-dimensions/power-distance-index/ * http://data.worldbank.org/indicator/NY.GDP.DEFL.KD.ZG * http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a4xBOOD1I2ew * http://data.worldbank.org/indicator/NY.GNP.PCAP.CD * http://data.worldbank.org/indicator/SL.TLF.CACT.ZS * http://www.worldwide-tax.com/china/china_tax.asp

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