Theme Paper Dheeraj

A Theme Paper On Logic And Processes Of Internationalization By

Dheeraj K Pandey (FPM Second Year) Submitted To

Prof. M.R.Dixit

Indian Institute of Management

Ahmedabad

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Table of Contents Introduction: A lot of work has been done to understanding the basis for internationalization. The literature gives various theories which deal with the various aspects of Internationalization. This theme paper tried to look at the concept of internationalization and looks back into history and see the development of various internationalization theories which unfolds the different modes of internationalization that are possible for a firm. A clear understanding of the difficulties the firm is going to encounter prepares it for the process and the reaction of the firm shapes the whole process of internationalization. Organizations have various motives that prompt it for the internationalization and are affected in different ways by various internal and external factors which affect the success of the firm in internationalization. What is internationalization? Internationalization is a well-understood concept and it refers to the increasing economic interdependence among nations, as a result of liberalized, and technologically facilitated, economic exchange of capital, raw materials, intermediate goods (including knowledge), human resources, manufactured end products, and services. What are the various Internationalization theories? 2

Various theories exists which tries to answer the reasons behind the internalization as a process .Internationalization is a dynamic process , and the factors which used to drive this process fifty years ago are not the same as they are today. There has been also a lot of change in environment in terms of technology, communication and transport which have affected the speed with which internationalization happens now. Further there are changes in economic, political and legal scenarios along with other change and these all changes have given rise to many competing theories for explaining the process of internationalization. 1) Neoclassical trade theory: This was one of the first theories which attempted to explain the process of internationalization. This theory considers that trade exists because of the difference between interest rate between two countries. This theory believes that each investor maximizes his profits by investing where returns are highest perfect competition. It assumes no transaction costs, and believes that capital moves in response to changes in interest rate (or profit) differentials. However the existence of cross movements of capital may indicate that the interest-rate theory cannot by itself explain the movements of direct investment. So this theory because of its assumption which don’t hold true in the real world gives just one reason for going international and is the least comprehensively theory on internationalization.

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2) Stephen Hymer theory: This theory explains the internationalization process better than the “Neoclassical trade theory”. It attributes the possessions of some advantages by the firm as the cause of international operations. This theory believes that firms are by no means equal in their ability to operate in an industry. Certain firms have considerable advantages in particular activities. Hymer (1976) considers the possession of these advantages to cause the firms to have extensive international operations of one kind or another. .Hymer (1976) attributes the profits form controlling the foreign enterprise as the biggest motivator for investment abroad rather than higher interest rate. 3) Product-Life-Cycle (Vernon) theory: This theory developed out of critique of neoclassical comparative advantage theory because the neoclassical theory did not give any importance to the role of innovation in determining trade patterns and also because of its the lack of attention to the role of economies of scale in determining such patterns .The neoclassical theory also neglected the advantage a technology firm had in exports. This theory states that the average income in a market determines which market a product enters first. Because in the 1960s, the US had the highest average income, new products would be introduced first in the US (and by US firms).Additionally, US firms also were good at

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innovations, partly because of high labor costs there was a driving force to develop labor-saving equipment and machines. Initially production was located in the US, but as demand for the product expands in the foreign markets the firm started to serve foreign markets. Because the US has one of the highest labor costs, labor costs in these other markets will be lower this means that as demand there grows, it made sense to manufacture the products there. And once production was set up in these countries, it might make sense to also serve less developed countries from there. Later it might also make sense to re import from these locations to the US. 4) Transaction Cost Economics (TCE) This theory is more comprehensive than previous three theories. TCE explains the seemingly counterintuitive idea of existence of MNE’s. Their existence is counterintuitive because operating overseas is usually more costly than operating at home, because a foreign firm does not have the same contracts and knowledge of local customs and business practices as indigenous competitors, while being often subject to discrimination by host country governments and private institutions. Hence it is difficult to understand why firms based in one country would do business in another country. If a firm has some unique assets of value overseas, why not sell or rent these assets to local entrepreneurs, who could then combine them with local factors of production at lower costs than those experienced by foreign direct investors?(Hennart 2000, 73). 5

The TCE explains the existence of MNE’s to their focus on transactions. The theory compares concrete options of organizing transactions in particular between firm (authority mechanism) and market (price mechanism). It states that MNE’s depend upon hierarchies which are an efficient coordination mechanism than market prices. This theory focuses on the organization of international interdependencies, not on the internalization of ‘Firm-specific advantages’ .This theory considers that importance of combining the local and foreign inputs needed to operate in a foreign country. TCE gives two basic (and non-mutually exclusive) reasons about why do multinational firms expand abroad 1) To internalize the pecuniary externalities firms inflict on one another when they compete on the market for final products. MNE’s then arise to reduce competition. 2)

MNE’s internalize non-pecuniary externalities (resulting from ‘natural’ market imperfections)

5) Resource based view This theory stresses on the existence of distinctive resources within the firm which sets up internal capabilities and which can foster the internal competitive advantage such as investment in intangible assets (R & D and advertisement). The presence of distinctive resource gives rise to Ex Ante barriers and can be a source of competitive advantage to firm abroad.

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Since the investments in developing these intangible assets which gives competitive advantage to the firm is huge. To recover these costs the firms seek international presence early on for the domestic market may not be large enough to produce enough income. 6) Social capital theory of internationalization: The social capital theory stresses the firm’s capacity to use the cost advantages(

in

either

capital

or

labour)

through

the

external

capabilities, built on the relations with customers, suppliers and other partners in the firms, thus driving the external competitive advantages. This theory believes that internationalization can be a failure because of the liability of newness the firm carries. It states that newly established firms lack stable relationships to the external constituents. It highlights the importance of the acceptance by the market; by other firms; financial organizations, support organizations etc. This theory also brings out the issues of resource scarcity and lack of information. It states that in home market, the firm knows how to do business, where to find information etc. however these things are not easy in international market. It takes a view totally different from the “Traditional internationalization theories “which states that how foreign market knowledge is experientially learned. This theory believes that some of this experiential learning can be substituted by network knowledge. Mode of internationalization by the firms

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Firms have been found to internationalize selectively. The selectivity in internationalization has been found mainly to be a firm specific phenomenon. However such selectivity can be partly introduced at the macro-level, for example when countries decide to engage in regional trade and investment agreements, like the North American Free Trade Agreement (NAFTA) and the European Union (EU). This selectivity in internationalization is borne out of efficiency in terms of the chosen sequence in time of international trade agreements, as well as firm-level internationalization (e.g., in terms of geographic scope of sequential entry decisions and choice of entry modes) TCE (Transaction

cost economics)

addresses

this

selectivity by

developing a framework for MNE expansion patterns. Buckley and Casson (1976), Rugman (1981) and Hennart (1982), have addressed the choice of entry mode, and have recognized that the liability of foreignness varies among various host countries. However this selectivity has been viewed as largely exogenous and the choice of geographic scope as a key parameter and as a design variable driving managerial decision making on internationalization has been not much explored. So the current theories don’t address the bounded rationality problems of decision making on selectivity of location by MNE’s. Theories on the entry strategy of the firms? 1) Process Theory of Internationalization

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The PTI essentially builds on the behavioral theory of the firm (Cyert & March, 1963) and includes elements of Penrose’s Theory of the Growth of the Firm (1959). This view, developed by the Uppsala Group (Johanson & Vahlne, 1977, 1990), emphasizes the incremental nature of the various change processes that a firm undergoes. This theory explains various stages of the internationalization process in terms of three stages. It provides a dynamic or longitudinal explanation of the effects of three sequential stages that the companies go through when expanding internationally. It believes that at all three stages there are incremental benefits and incremental costs of adding another nation or market to firm’s existing portfolio of country. In stages 1 and 3 the incremental costs are greater than incremental benefits but in stage 2 incremental benefits are greater than incremental costs. In stage 1 cost are higher because setting new facilities in new location. In stage 2 (later internationalization).The context and situation of the firm makes a difference, for every additional international operation or market added, there would continue to be learning, coordination, local adaptation and legitimacy acquisition costs. Because of these comparative advantages in the stage-2 the firm makes the incremental benefits are more than the incremental costs. These benefits can arise out of knowledge acquired from abroad, or accessing cheaper inputs or the exploitation of firm specific assets

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carried to each foreign market or the combination of all these three things. 2) New Venture Internationalization Theory The New Venture Internationalization Theory (NVI) explains the expansion of many new firms in newer locations, particularly in knowledge-intensive industries, as they go international immediately or soon after their inception. What makes this early internationalization possible is

the increasing speed and efficiency of international

communication and transportation, and the increasing homogenization of

many

markets,

the

emergence

of

international

financing

opportunities, and the emergence of increasingly internationally mobile human capital. Reasons prompting internationalization: The various theories discussed in the previous sections, and other literature on Internationalization throws up the following reasons which prompt firms to internationalize. Economic logic: Economic logic suggests that firm would do things that help them create some competitive advantage over other firms. It is believed

that

the

geographic

scope

of

operations

may

yield

competitive advantage by permitting firm to exploit the benefits of performing more activities internally (Rugman, 1981). It may also allow firms

to

exploit

interrelationships

between

different

geographic areas or related industries (Porter, 1985).

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segments,

Competitive

advantage:

During

initial

stages

the

competitive

advantage the firm has can help it to overcome the “cost of foreignness”, and eventually the expansion in to the foreign market will increase its profits and may become a source of competitive advantage to it. So if the firm possesses any competitive advantage it encourages it to expand internationally. Maximizing

rents:

Countries

differ

along

many

dimensions,

economically, politically, legally, culturally etc. Economically these differences create market imperfections, and international companies want to exploit these imperfections (caves 1971). Risk Hedging: Hisley and caves (1985) say that firm takes the international diversification route to decrease the variability or risk of the firm’s revenue stream. Enhancing performance: Firm wants to internationalize because doing so increases the geographic scope of operations which increases the performance of the firm. This happens in two ways either by possession of proprietary assets or by addition of the intrinsic to the firm as a result of internationalization. What

are

the

factors

that

affect

the

process

of

internationalization? The process of internationalization is affected by many factors such as resource availability, the acquaintance level of the foreign market, the importance of communication networks, the perceived risk and/or

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incertitude, and the willingness of the manager to enter foreign markets. So under these environmental changes the theoretical internationalization model no longer holds true. Even Oviatt and McDougall (1994), who are the firm believers of the Internationalization Stages Theory, admit that the theory is less applicable in a growing number

of

situations

where

the

technology,

the

industry's

environment, and the capacity of an enterprise have changed. The literature on “Internationalization” considers these factors as important in their affect on the process of internationalization Cultural factors: Most of the times culture is measured and understood independently from that environment; however its affects on international strategy is closely interrelated with that of the institutional environment. National culture reflects the values of society which establishes the norms for the behavior. In turn the norms of behavior represent a dimension of the institutional environment. The strategic behaviors of firms are affected by the institutional environments of their home country and of the other countries in which they operate (Oliver, 1996). Essentially, economic and strategic behavior is embedded in networks of social relations represented by the institutional environment (Granovetter, 1985), hence cultural factors should guide the internationalization process. Environmental factor:

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Internationalization raises the issues of risk and uncertainty, cross cultural aspects of employee conduct and consumer behavior, market structure and competition, and political and regulatory dimensions; it also

provides

new

opportunities

for

growth,

profitability

and

organizational learning.

Institutional factors: They affects the internationalization process by setting constraints on the firm’s behavior (Peng 2002) .It has been observed that firm’s operational choices are heavily influenced by their country of origin and it has been observed that the firms characteristics matches their local environment and sets constraints on the firm. Path dependency: Change in location requires a firm to change its organization routines. Organization routines are the processes, mechanisms and procedures the firm follows without much explicit thinking .Since the development of such resources is path dependent, socially complex, and causally ambiguous (Barney 1991), making modification in firms ingrained routines a challenging task. Effect of (COO) factors on internationalization process: 1) Asian MNE’s:

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Unlike MNE’s from developed western countries, Asian MNE’s exhibit a preference for joint venture (Monkiewicz 1986; Ting, 1985). Further the preference in case of Asian MNE’s is for majority JV and control especially in production processes and in management. The internationalization strategies for the Asian MNE’s are based on cost-based

competencies

and

other

location-based

advantages,

brought together by ethnic networks and aided by government encouragement (Taiwan, South Korea and Singapore) and institutional framework (Sim and Pandian, 2003). However these elements have been neglected in conventional Internationalization theories. 2) Developed world MNE’s The

developed

countries

are

expected

to

follow

a

different

internationalization route because they have different physical and industrial capabilities; and the national governments economic and political policies are different. So we can see differentiating behavior in terms of strategic choices, operation modes and outcomes for countries from the developed world as compared to Asian MNE’s. The internationalization strategies of firms

from

developed

countries

are

either

based

on

superior

technology or quality of products. For e.g., Germany has a reputation of precision engineering and Japan has exceptional quality in consumer electronics .So this image is of considerable help particularly to relatively unknown companies entering to the foreign market from these countries.

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Effect of Size of economies on internationalization process: 1) Small economies Small economies are forced to compete in international market even at the early stage of their development, as such markets don’t provide for their survival in home market alone .On expansion these firms are required to change there routines to fit with the international markets. It has been found that in small economies there exists a positive linear relationship between internationalization and performance. 2) Large economies Firms in these economies are more likely have evolved independently of international market and competitors. Additionally the firm’s internalization is likely to take place in markets very similar to its own. Eriksson and Sharma 1997 found that since large firms have limited exposure to international competition in the home market a diversity of competitors would handicap such firms, who have a narrower range of experience and models to cope up with the increased demands (Miller/Chen 1996) In these economies the tendency to preserve the current routines and need to create new routines for new markets would create significant conflict within the organization (Meyer 2003).Conflict can also arise if

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there is change in behavior which fits with the new environment (Hout and Rudden 1982). It has been found that an inverted U relationship exists between level of

internationalization

and

performance

in

economies

that

are

relatively large and characterized by modest international trade. Marketing aspects of Internationalization Internationalization in marketing perspective is seen as an attempt to build brand equity. A global brand gives the perception of excellence and strength. Particularly in the case of brands from a developing world expansion into foreign market is treated as a testimony of strength and capability of the brand even in the home market. The importance of Geographical factor has also been recognized as constituting to the brand equity of the firm. Interbrand’s model develops

seven

guidelines

for

assessment

of

brand

strength:

Leadership, Market, Stability, Geographic spread, trend, support, protection. Murphy (1992) in his study has found that Geographical spread factor explains that firms that have become international are inherently having more intangible value than national or regional brands. However Internationalization as a strategy comes with its own challenges of integration of the global marketing effort because it becomes difficult to get relevant presence in all the markets with the same set of core values. Moore talks about the cultural factors which

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may contribute to the ease with which a brand can build its brand equity within a particular market place. One of the major issues is globalization vs. localization. The Cultural receptivity to the content of the

brand’s

advertisement

and

marketing

programme

is

also

determined before it is launched in new location. With respect to internationalization the firm has two opinions. Some researchers, such as Robinson (1967), Tookey (1975) and Attiyeh and

Wenner

(1981)

internationalization.

recommend

the

concentration

strategy

in

They support the traditional concept that great

market shares in a few key markets produce profits on the long term. This suggestion is empirically supported by the BETRO (1976) and ITI (1979) reports. Other authors like Hamermesh et al.(1978) and Piercy (1981a), recommends the market diversification strategy, basing their recommendations on the belief that lower participations in widely dispersed markets would be more profitable than concentrating on a few key markets. Conclusion: From the above discussion it comes out that managers should realize the importance of the environment in which the firm is operating and its impact on strategy outcomes. The internationalization decision should be location specific, since the internationalization as a process have different implication for firm contingent on the home country of the firm.

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Internationalization decisions are affected greatly in terms of the country in which firm is operating. For the firms operating in small economies need to operate in international arena may be difficult but there is future payoffs in developing routines for that. Managers operating in large economies have two broad options. One is to have modest international operations. Another choice would be to have extensive

international

operations

in

order

to

undergo

internationalization. For doing this the firms need to come out of home market bias and become “equidistant” (Ohmae , 1990) to all the major markets in which the firm operates. These findings are validated by literature on stock market behavior in terms of valuation and also by the brand valuation literature.

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1. Hitt

M.A,

Franklin

V,

Zhu

H

(2000).

Culture,

institutions

and

international strategy. Journal of International Management, Vol.12, pp 222-234. 2. Elango B, Prakash S.S (2007). An exploration of the relationship between

Country

of

origin

and

the

International

–Performance

Paradigm. Management International Review, Vol.47, No.3, pp 369-392. 3. Geringer J.M, Beamish P.W (1989). Diversification Strategy and Internationalization:

Implications

for

MNE

Performance.

Strategic

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A.B,

Pandian

J.R

(2003).Emerging

Asian

MNEs

and

Their

Internationalization Strategies—Case Study Evidence on Taiwanese and Singaporean Firms. Asia Pacific Journal of Management. Vol.20, pp2750.

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6. Glaum

M,

Oesterle

internationalization

M.

and

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(2007).

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More

of

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questions

on than

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Beamish

P.W.

(1999).

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Scope,

Product

Diversification, and the Corporate Performance of Japanese Firms. Strategic Management Journal, Vol.20, No.8, pp711-727. 8. Retrieved from http://www.babson.edu/entrep/fer/XXII/XXIIB/html/xxiib.htm#INTRODU CTION on 15 September 2007.

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