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Section 3: Proposed internationalisation theory (10 Marks) - Proposed 350 words
3.2The Uppsala internationalization model
The stage model
During the 1970s, a number of Swedish researchers at the University of Uppsala (Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977) focused their interest on the internationalization process. Studying the internationalization of Swedish manufacturing firms, they developed a model of the firm’s choice of market and form of entry when going abroad. Their work was influenced by Aharoni’s (1966) seminal study.
With these basic assumptions in mind, the Uppsala researchers interpreted the patterns in the internationalization process they had observed in Swedish manufacturing firms. They had noted, first of all, that companies appeared to begin their operations abroad in markets that were fairly close geographically and only gradually penetrated more far-flung markets. Second, it appeared that companies entered new markets through exports. It was very rare for companies to enter new markets with sales organizations or manufacturing subsidiaries of their own. Wholly-owned or majority-owned operations were established only after several years of exports to the same market.
Johanson and Wiedersheim-Paul (1975) distinguish between four different modes of entering an international market, where the successive stages represent higher degrees of international involvement/market commitment:
• Stage 1: no regular export activities (sporadic export)
• Stage 2: export via independent representatives (export modes)
• Stage 3: establishment of a foreign sales subsidiary
• Stage 4: foreign production/manufacturing units.
The assumption that the internationalization of a firm develops step by step was originally supported by evidence from a case study of four Swedish firms. The sequence of stages was restricted to a specific country market. This market commitment dimension is shown in Figure 3.1.
Figure 3.1 Internationalization of the firm: an incremental (organic) approach
Sources: adapted from Forsgren and Johanson (1975, p. 16).
The concept of market commitment is assumed to contain two factors – the amount of resources committed and the degree of commitment. The amount of resources could be operationalized to the size of investment in the market (marketing, organization, personnel, etc.), while the degree of commitment refers to the difficulty of finding an alternative use for the resources and transferring them to the alternative use.
International activities require both general knowledge and market-specific knowledge. Market-specific knowledge is assumed to be gained mainly through experience in the market, whereas knowledge of the operations can be transferred from one country to another; the latter will thus facilitate the geographic diversification in Figure 3.1. A direct relation between market knowledge and market commitment is postulated: knowledge can be considered as a dimension of human resources. Consequently, the better the knowledge about a market, the more valuable are the resources and the stronger the commitment to the market.
Figure 3.1 implies that additional market commitment as a rule will be made in small incremental steps, both in the market commitment dimension and in the geographical dimension. There are, however, three exceptions. First, firms that have large resources experience small consequences of their commitments and can take larger internationalization steps. Second, when market conditions are stable and homogeneous, relevant market knowledge can be gained in ways other than experience. Third, when the firm has considerableexperience from markets with similar conditions, it may be able to generalize this experience to any specific market (Johanson and Vahlne, 1990).
The geographical dimension in Figure 3.1 shows that firms enter new markets with successively greater psychic distance. Psychic distance is defined by the individual manager’s perception of the differences in terms of factors such as differences in language, culture and political systems, which disturb the flow of information between the firm and the market. Thus firms start internationalization by going to those markets they most easily understand. There they will see opportunities, and the perceived market uncertainty will be low (Brewer, 2007).
Figure 3.2 Dimensions of internationalization
Sources: Welch and Loustarinen (1988). Reproduced with permission from The Braybrooke Press Ltd.
The original stage model has been extended by Welch and Loustarinen (1988), who operate with six dimensions of internationalization (see Figure 3.2):
1. Sales objects (what?): goods, services, know-how and systems.
2. Operations methods (how?): agents, subsidiaries, licensing, franchising management contracts.
3. Markets (where?): political/cultural/psychic/physical distance differences between markets.
4. Organizational structure: export department, international division.
5. Finance: availability of international finance sources to support the international activities.
6. Personnel: international skills, experience and training.
Of the six dimensions in Figure 3.2, three of these (4, 5 and 6) are concerned with an internal resource-based view, which is also consistent with a recent categorization of internationalization archetypes which uses the following six dimensions (Cerrati et al., 2015):
1. Internationalization from the demand side (ratio of foreign sales to total sales).
2. Resources located abroad (amount of resources that go overseas).
3. Geographical scope (number of countries or regions in which the firm operates).
4. International orientation (percentage of managers with international work experience).
5. Business networks (percentage of foreign sales that go through external agents/distributors vs own subsidiaries – FDI).
6. Financial internationalization (share of foreign ownership).
The underlying assumption in the Uppsala model is that internationalization is a slow, time-consuming and iterative process. This was confirmed by a case study on the Volvo heavy truck business, in which Vahlne et al. (2011) concluded that, when the industry is highly complex and uncertainties involved are immense, internationalization decisions made too quickly and too boldly run a real risk of failure, with potentially large and negative consequences. The globalization process of the Volvo heavy truck business showed that learning plays an important role and that the creation of new structures, systems and relationships is required. This means that the management has to accept that the globalization of the company may proceed at a slower pace to allow for learning and adjustment to take place.
Critical views of the original Uppsala model
Various criticisms of the Uppsala model have been put forward: one is that the model is too deterministic (Reid, 1983; Turnbull, 1987).
It has also been argued that the model does not take into account interdependencies between different country markets (Johanson and Mattson, 1986). It seems reasonable to consider a firm more internationalized if it views and handles different country markets as interdependent than if it views them as completely separate entities.
Studies have shown that the internationalization process model is not valid for service industries. In research into the internationalization of Swedish technical consultants – a typical service industry – it has been demonstrated that the cumulative reinforcement of foreign commitments implied by the process model is absent (Sharma and Johanson, 1987).
The criticism has been supported by the fact that the internationalization process of new entrants in certain industries has recently become more spectacular. Firms have seemed prone to leapfrog stages in the establishment chain, entering ‘distant’ markets in terms of psychic distance at an early stage, and the pace of the internationalization process generally seems to have speeded up.
Nordström’s (1990) results seem to confirm this argument. The UK, Germany and the US had become a more common target for the very first establishment of sales subsidiaries by Swedish firms than their Scandinavian neighbours.
The leapfrogging tendency not only involves entering distant markets. We can also expect a company to leapfrog some intermediate entry modes (foreign operation methods) in order to move away from the sequentialist pattern and more directly to some kind of foreign investment (Figure 3.3).
In market number 1 the firm follows the mainstream evolutionary pattern, but in market number 6 the firm has learned from the use of different operation methods in previous markets, and therefore chooses to leapfrog some stages and go directly to foreign investment.
Others have claimed that the Uppsala model is not valid in situations of highly internationalized firms and industries. In these cases, competitive forces and factors override psychic distance as the principal explanatory factor for the firm’s process of internationalization. Furthermore, if knowledge of transactions can be transferred from one country to another, firms with extensive international experience are likely to perceive the psychic distance to a new country as shorter than firms with little international experience.
Nordström (1990) argues that the world has become much more homogeneous and that consequently psychic distance has decreased. Firms also have quicker and easier access to knowledge about doing business abroad. It is no longer necessary to build up knowledge in-house in a slow and gradual trial-and-error process. Several factors contribute to this. For example, universities, business schools and management training centres all over the world are putting more and more emphasis on international business.
Probably even more important, almost continuous growth in world trade and foreign direct investment has resulted in an increase over time of the absolute number of people with experience of doing business abroad. Hence it has become easier to hire people with the experience and knowledge needed, rather than develop it in-house.
Figure 3.3 Internationalization pattern of the firm as a sum of target country patterns
Source: Welch and Loustarinen (1988). Reproduced with permission from The Braybrooke Press Ltd.
The spectacular development of information technologies, in terms of both absolute performance and diminishing price/performance ratios, has made it easier for a firm to become acquainted with foreign markets, thus making a leapfrog strategy more realistic (see also Section 3.5 on internet-based born globals).
In spite of the criticisms, the Uppsala model has gained strong support in studies of a wide spectrum of countries and situations. The empirical research confirms that commitment and experience are important factors explaining international business behaviour (Cumberland, 2006). In particular, the model receives strong support regarding export behaviour, and the relevance of cultural distance has also been confirmed.
In a more recent article, Johanson and Vahlne (2009) updated their model in parallel with the new findings on companies’ internationalization. In their updated model they have put more emphasis on networks (as initiated by Johanson and Mattson, 1988) and opportunity recognition within the internationalization process. They see a firm’s problems and opportunities as becoming less a matter of becoming familiar with certain export countries, and more related to relationships and networks. They recognize that new knowledge is mainly developed in relationships, and not so much in specific international markets.
Section 4: Proposed international marketing framework (40 marks) - Proposed 1400 words.
Chapter 9
Some approaches to the choice of entry mode
Learning objectives
After studying this chapter you should be able to:
• Identify and classify different market entry modes
• Explore different approaches to the choice of entry mode
• Explain how opportunistic behaviour affects the manufacturer/intermediary relationship
• Identify the factors to consider when choosing a market entry strategy.
9.1Introduction
We have seen the main groupings of entry modes available to companies that wish to take advantage of foreign market opportunities. At this point we are concerned with the question: what kind of strategy should be used for the entry mode selection?
Entry mode
An institutional arrangement for the entry of a company’s products and services into a new foreign market. The main types are export, intermediate and hierarchical modes.
According to Root (1994) there are three different rules:
1. Naive rule. The decision-maker uses the same entry mode for all foreign markets. This rule ignores the heterogeneity of the individual foreign markets.
2. Pragmatic rule. The decision-maker uses a workable entry mode for each foreign market. In the early stages of exporting, the firm typically starts doing business with a low-risk entry mode. Only if the particular initial mode is not feasible or profitable will the firm look for another workable entry mode. In this case, not all potential alternatives are investigated, and the workable entry may not be the ‘best’ entry mode.
3. Strategy rules. This approach requires that all alternative entry modes are systematically compared and evaluated before any choice is made. An application of this decision rule would be to choose the entry mode that maximizes the profit contribution over the strategic planning period subject to (a) the availability of company resources, (b) risk and (c) non-profit objectives.
Although many small and medium-sized enterprises (SMEs) probably use the pragmatic or even the naive rule, this chapter is inspired mainly by an analytical approach, which is the main principle behind the strategy rule.
9.2The transaction cost approach
The principles of transaction cost analysis have already been presented in Section 3.3. This chapter will go into further details about ‘friction’ and opportunism.
The unit of analysis is the transaction rather than the firm. The basic idea behind this approach is that in the real world there is always some friction between the buyer and seller in connection with market transactions. This friction is mainly caused by opportunistic behaviour in the relationship between a producer and an export intermediary.
In the case of an agent, the producer specifies sales-promoting tasks that the export intermediary is to solve in order to receive a reward in the shape of commission.
In the case of an importer, the export intermediary has a higher degree of freedom, as the intermediary itself, to a certain extent, can fix sales prices and thus base its earnings on the profit between the producer’s sales price (the importer’s buying price) and the importer’s sales price.
No matter who the export intermediary may be, there will be some recurrent elements that may result in conflicts and opportunistic actions:
• Stock size of the export intermediary
• Extent of technical and commercial service to be carried out by the export intermediary for its customers
• Division of marketing costs (advertising, exhibition activities, etc.) between producer and export intermediary
• Fixing of prices: from producer to export intermediary, and from the export intermediary to its customers
• Fixing of commission to agents.
Opportunistic behaviour from the export intermediary
In this connection the export intermediary’s opportunistic behaviour may be reflected in two activities:
1. In most producer–export intermediary relations, a split of the sales-promoting costs has been fixed. Thus statements by the export intermediary of too high sales promotion activities (e.g. by manipulating invoices) may form the basis of a higher payment from producer to export intermediary.
2. The export intermediary may manipulate information on market size and competitor prices in order to obtain lower ex-works prices from the producer. Of course, this kind of opportunism can be avoided if the export intermediary is paid a commission of realized turnover (the agency case).
As a consequence, high control modes (e.g. own foreign company in the form of a subsidiary) may be preferred by companies, in order to protect their brand equity from possible damage done by local partners’ inappropriate operations (Lu et al., 2011).
Opportunistic behaviour from the producer
In this chapter we have so far presumed that the export intermediary is the one which has behaved opportunistically. The producer may, however, also behave in an opportunistic way, as the export intermediary must also use resources (time and money) on building up the market for the producer’s product programme. This is especially the case if the producer wants to sell expensive and technically complicated products.
Thus the export intermediary carries a great part of the economic risk, and will always have the threat of the producer’s change of entry mode hanging over its head. If the export intermediary does not live up to the producer’s expectations, it risks being replaced by another export intermediary, or the producer may change to its own export organization (sales subsidiary), as the increased transaction frequency (market size) can obviously bear the increased costs.
The last case may also be part of a deliberate strategy from the producer: namely, to tap the export intermediary for market knowledge and customer contacts in order to establish a sales organization itself.
What can the export intermediary do to meet this situation?
Heide and John (1988) suggest that the agent should make a number of further ‘offsetting’ investments in order to counterbalance the relationship between the two parties. These investments create bonds that make it costly for the producer to leave the relationship, i.e. the agent creates ‘exit barriers’ for the producer (the principal). Examples of such investments are as follows:
• establish personal relations with the producer’s key employees;
• create an independent identity (image) in connection with selling the producer’s products;
• add further value to the product, such as a before–during–after (BDA) service, which creates bonds in the agent’s customer relations.
If it is impossible to make such offsetting investments, Heide and John (1988) suggest that the agent reduces its risk by representing more producers.
These are the conditions that the producer is up against, and when several of these factors appear at the same time, the theory recommends that the company (the producer) internalizes rather than externalizes.
9.3Factors influencing the choice of entry mode
A firm’s choice of its entry mode for a given product/target country is the net result of several, often conflicting, forces. The need to anticipate the strength and direction of these forces makes the entry mode decision a complex process with numerous trade-offs among alternative entry modes.
Generally speaking, the choice of entry mode should be based on the expected contribution to profit. This may be easier said than done, particularly for those foreign markets where relevant data are lacking. Most of the selection criteria are qualitative in nature, and quantification is very difficult.
The choice of ‘entry mode’ in Figure 9.1 is built on a ‘matchmaking’ of internal capabilities (internal factors) and the external environment (external factors), moderated by the ‘desired mode characteristics’ and ‘transaction-specific factors’. One of the other important preconditions of the model is that the ‘entry mode’ decision in a specific country is independent of other ‘entry mode’ decisions undertaken earlier on in the firm’s internationalization process. This is of course not a complete realistic assumption (Shaver, 2013), and this calls for ‘entry mode’ researchers to study longitudinal ‘entry mode’ interdependences more extensively (Hennart and Slangen, 2015). Figure 9.1 is based on the entry mode decision in a specific country, at a specific point in time.
As shown in Figure 9.1, four groups of factors are believed to influence the entry mode decision in a specific country:
1. Internal factors
2. External factors
3. Desired mode characteristics
4. Transaction-specific behaviour.
Figure 9.1 Factors affecting the foreign market entry mode decision in a specific country
In what follows, a proposition is formulated for each factor: how is each factor supposed to affect the choice of foreign entry mode? The direction of influence is also indicated both in the text and in Figure 9.1. Because of the complexity of the entry mode decision, the propositions are made under the condition of other factors being equal.
Internal factors
Firm size
Size is an indicator of the firm’s resource availability; increasing resource availability provides the basis for increased international involvement over time. Although SMEs may desire a high level of control over international operations and wish to make heavy resource commitments to foreign markets, they are more likely to enter foreign markets using export modes because they do not have the resources necessary to achieve a high degree of control or to make these resource commitments. Export entry modes (market modes), with their lower resource commitment, may therefore be more suitable for SMEs (Lin and Ho, 2019). As the firm grows, it will increasingly use the hierarchical model.
International experience
Another firm-specific factor influencing mode choice is the international experience of managers and thus of the firm. Experience, which refers to the extent to which a firm has been involved in operating internationally, can be gained from operating either in a particular country or in the general international environment. International experience reduces the cost and uncertainty of serving a market, and in turn increases the probability of firms committing resources to foreign markets, which favours direct investment in the form of wholly owned subsidiaries (hierarchical modes).
A high degree of international experience reinforces the use of an already preferred entry mode in subsequent entry decisions (Swoboda et al., 2015). Once a firm has had success with a particular entry mode, it will try to use the same entry mode in new markets, but there may also be a tendency to be less risk-averse with greater international experience, which could result in using higher-control modes in subsequent entry decisions.
Dow and Larimo (2009) conclude from their survey that practitioners should be aware that not all forms of experience are equal. International experience from similar countries (with low perceived psychic distance) is positively associated with the choice of a high control entry mode (i.e. entry by wholly owned subsidiary). This indicates that exploiting each geographic region in succession may be advisable, instead of ‘jumping’ from region to region. This would maximize the benefits of within-cluster experience.
Uncertainty in international markets is reduced through actual operations in foreign markets (experiential knowledge) rather than through the acquisition of objective knowledge. There is support for the idea that direct experience with international markets increases the likelihood of committing extra resources to foreign markets (Lin and Ho, 2019; Johanson and Vahlne, 1977).
Product/service
The physical characteristics of the product or service, such as its value/weight ratio, perishability and composition, are important in determining where production is located. Products with high value/weight ratios, such as expensive watches, are typically used for direct exporting, especially where there are significant production economies of scale, or if management wishes to retain control over production. Conversely, in the soft drinks and beer industry, companies typically establish licensing agreements, or invest in local bottling or production facilities, because shipment costs, particularly to distant markets, are prohibitive.
The nature of the product affects entry mode selection because products vary so widely in their characteristics and use, and because the selling job may also vary markedly. For instance, the technical nature of a product (high complexity) may require service both before and after sale. In many foreign market areas, marketing intermediaries may not be able to handle such work. Instead firms will use one of the hierarchical modes.
Blomstermo et al. (2006) distinguish between hard and soft services. Hard services are those where production and consumption can be decoupled. For example, software services can be transferred to a CD, or some other tangible medium, which can be mass-produced, making standardization possible. With soft services, where production and consumption occur simultaneously, the customer acts as a co-producer and decoupling is not viable. The soft-service provider must be present abroad from its first day of foreign operations. Blomstermo et al. (2006) conclude that there are significant differences between hard- and soft-service suppliers regarding choice of foreign market entry mode. Managers in soft services are much more likely to choose a high control entry mode (hierarchical mode) than those in hard services. It is important for soft-service suppliers to interact with their foreign customers, and thus they should opt for a high degree of control, enabling them to monitor the co-production of the services.
Products distinguished by physical variations, brand name, advertising and after-sales service (e.g. warranties, repair and replacement policies) that promote preference for one product over another may allow a firm to absorb the higher costs of being in a foreign market. Product differentiation advantages give firms a certain amount of impulse in raising prices to exceed costs by more than normal profits (quasi-rent). They also allow firms to limit competition through the development of entry barriers, which are fundamental in the competitive strategy of the firm, as well as serving customer needs better and thereby strengthening the competitive position of the firm compared to other firms. Because these product differentiation advantages represent a ‘natural monopoly’, firms seek to protect their competitive advantages from dissemination through the use of hierarchical modes of entry. For example, Lu et al. (2011) emphasize the importance for a fashion retailer to select a higher control entry mode to ensure a successful transfer of its special assets and brand equity across borders, which are important considerations in a fashion brand’s international expansion decision.
External factors
Sociocultural distance between home country and host country
Socioculturally similar countries are those that have similar business and industrial practices, a common or similar language, and comparable educational levels and cultural characteristics. Sociocultural differences between a firm’s home country and its host country can create internal uncertainty for the firm, which influences the mode of entry desired by that firm.
The greater the perceived distance between the home and host country in terms of culture, economic systems and business practices, the more likely it is that the firm will shy away from direct investment in favour of joint venture agreements or even low-risk entry modes like agents or an importer. This is because the latter institutional modes enhance firms’ flexibility to withdraw from the host market, should they be unable to acclimatize themselves to the unfamiliar setting. To summarize, other things being equal, when the perceived distance between the home and host country is great, firms will favour entry modes that involve relatively low resource commitments and high flexibility (Guidice et al., 2017). Dow and Larimo (2009) found that the perceived cultural distance (psychic distance) is much more than Hofstede’s cultural dimensions. Psychic distance is relevant not only on the country but also at the managerial levels. In particular, language difference seems to be one of the least important factors. Other issues, such as differences in religion, degree of democracy, industrial development and so on, have a much greater impact on the management’s entry mode choice.
Country risk/demand uncertainty
Foreign markets are usually perceived as riskier than the domestic market. The amount of risk the firm faces is a function not only of the market itself but also of its method of involvement there. In addition to its investment, the firm risks inventories and receivables. When planning its method of entry, the firm must do a risk analysis of both the market and its method of entry. Exchange rate risk is another variable. Moreover, risks are not only economic; there are also political risks.
When country risk is high, a firm would do well to limit its exposure to such risk by restricting its resource commitments in that particular national domain. That is, other things being equal, when country risk is high, firms will favour entry modes that involve relatively low resource commitments, i.e. export modes (Obadia and Bello, 2019).
References
Blackburne, G.D. and Buckley, P.J. (2019) ‘The international business incubator as foreign entry mode’, Long Range Planning, 52(1), pp. 32–50.
Blomstermo, A., Sharma, D.D. and Sallis, J. (2006) ‘Choice of foreign market entry mode in service firms’, International Marketing Review, 23(2), pp. 211–229.
Dow, D., Larimo, J. (2009) ‘Challenging the conceptualization and measurement of distance and international experience in entry mode choice research’, Journal of International Marketing, 17(2), pp. 74–98.
Giudice, M.D., Arslan, A., Scuotto, V. and Caputo, F. (2017) ‘Influences of cognitive dimensions on the collaborative entry mode choice of small- and medium-sized enterprises’, International Marketing Review, 34(5), pp. 652–673.
Heide, J.B. and John, G. (1988) ‘The role of dependence balancing in safeguarding transaction-specific assets in conventional channels’, Journal of Marketing, 52(January), pp. 20–35.
Hennart, J-F and Slangen, A.H.L. (2015) ‘Yes, we really do need more entry mode studies! A commentary on Shaver’, Journal of International Business Studies, 46(1), pp. 114–122.
Johanson, J. and Vahlne, J.E. (1977) ‘The internationalization process of the firm – a model of knowledge’, Journal of International Business Studies, 8(1), pp. 23–32.
Lin, F.-J. and Ho, C.-H. (2019) ‘The knowledge of entry mode decision for small and medium enterprises’, Journal of Innovation & Knowledge, 4, pp. 32–37.
Lu, Y., Karpova, E.E. and Fiore, A.M. (2011) ‘Factors influencing international fashion retailer’s entry mode choice’, Journal of Fashion Marketing and Management, 15(1), pp. 58–75.
Obadia, C. and Bello, D.C. (2019) ‘How to select an export mode without bias’, Business Horizons, 62, pp. 171–183.
Root, F.R. (1994) Entry Strategies for International Markets, revised and expanded edition. The New Lexington Press, Lexington, MA.
Shaver, J. M. (2013) ‘Do we really need more entry mode studies?’, Journal of International Business Studies, 44(1), pp. 23–27.
Swoboda, B., Elsner, S. and Olejnik, E. (2015) ‘How do past mode choices influence subsequent entry? A study on the boundary conditions of preferred entry modes of retail firms’, International Business Review, 24(3), pp. 506–517.