Limits of Internationalization Theories in an Unlimited World - Essay Example

Limits of Internationalization Theories in an Unlimited World Introduction In recent decades, enterprises are increasingly engaging in the international markets especially due to globalisation and the resulting competition. Although there is no agreed definition of internationalisation, the concept is often used to mean the increased involvement of enterprises in international markets. Depending on country specific factors and industry specific factors, firms enter foreign markets using different entry modes such as direct exports, indirect exports, licensing, joint ventures, subsidiaries, mergers and acquisitions among others. Whatever entry mode a firm chooses, to be successful, the entrepreneurs of such firms should have a clear understanding of international cultures. What works in the home country may not work in the host country as people have different attitudes, values and behaviours that influence their buying behaviour. There exist various theories that try to explain why firms seek to internationalise both traditional and behavioural theories. The question that needs to be answered is; do these theories fully explain the patterns of internationalisation especially in today’s global economy? This is the question this essay will be seeking to answer. To answer this question, the essay will be divided into xxx sections. First, the traditional theories will be discussed followed by a discussion of the behavioural or process theories of internationalisation. The next section will analyse how well these theories explain the internationalisation process by drawing from examples of different companies especially small micro enterprises (SMEs) from developing countries. From these examples, we shall observe a deviation from traditional theories due to globalisation and liberalisation. These theories depict a stage or step-by-step incremental process of internationalisation but most companies rapidly internationalise and also defy psychic distance assumptions. Lastly, a brief summary of main points will be given. Traditional Theories Sachse (2012, p. 13) differentiates between traditional and behavioural perspectives of internationalisation. He views the traditional perspective as economic in nature while behavioural or process-related theories treat internationalisation as an evolutionary and dynamic process. Traditional theories include: Transaction cost, eclectic, foreign direct investment, and real options theory. On the other hand, process theories include: Uppsala, born global, relationship network, GAINS approach, and Three level model and path dependency theory among others. An overview and description of each of these theories will be given. The Transaction Cost (TC) theory was developed by Ronald Coarse in 1937 and further developed by Williamson in 1975 and 1985. This theory indicates that market interactions are influenced by internal allocation of resources by firms. According to Sachse the central tenet of this theory is that “the decision between market and organisation is based on considerations of emerging cost” (2012, p. 14). As such, cost-effectiveness is based on which strategy is lowest cost. If the domestic market is operating at low cost then there is no need to internationalise but if costs rise, then internationalisation may be considered. This was further developed by Buckley and Casson (1993) whose model involve choosing between exporting, licencing and operating within the firm or what they called hierarchy. Firms in this case choose to locate where transaction costs can be minimised but if investment requires time management and resource commitment then internalisation is preferred. This is part of hierarchically structured organisation. The theory is criticised for various reasons. First, it gives little consideration to coordination costs such as planning, organising, and communication. Secondly, it is difficult to operationalise transaction costs in international management and lastly, observing changes occurrence without efficacy perspective is insufficient (Sachse, 2012 quoted in Kutscher & schmid 2006). The eclectic paradigm was developed by John H. Dunning (1977, 1998 & 2000) and is often referred as the OLI-Model. According to Dunning, there are four factors that influence internationalisation. These include structure, ownership, location advantage and internalisation advantage. The ownership advantage entails such items as trademarks, entrepreneurial skills, production technology and returns to scale. Location advantages on the other hand include raw materials, low wages, and special taxes and tariffs while internalisation advantages involve ability to produce through a partnership arrangement such as a joint venture or licencing (Dunning 2006; Hunt 2002). It is based on the assumption that if transaction costs on free market are higher than internal costs, then transactions will be made within the institution instead of internationalising. The foreign direct investment (FDI) theory is whereby a firm makes investments in another country in terms of physical assets. In this case, the domestic enterprise and the foreign company so established form a multinational company (MNC). However, Ingham (2004) asserts that the parent company must have control (own 10% or more ordinary shares) over the affiliate company in order to qualify as an FDI. MNC are often founded by large companies in large countries or developed countries. This is because it requires high capital investment which small firms may not have. It also requires extensive knowledge of the foreign country in terms of culture, laws and regulations hence extensive research is required before investing. The real options theory (Fisch 2004; Copeland & Tufano 2004) is based on the premise that ‘in case of uncertainty, irreversible investment bear risk of loss which can be reduced through flexible timeframe” (Sachse 2012, p. 18). This implies that decision makers or entrepreneurs have adequate time to gather all the information they need to make the right decision whether to internationalise or not as they are not required to make the decision immediately. They have the option to wait, withdraw or expand or use alternative resources which were not originally planned for (exchange) after gaining sufficient information. However, according to Copeland and Tufano (2004) success is better achieved only if conditions can be predicted with high probability. If conditions are unpredictable, then it is difficult to make real options. Fisch (2004) on the other hand, deems this theory fit for making FDI decisions since it is capital intensive and high risks involved. Investment decision can be made if the investment will result in further options but it is expected to result into loss then decision can be delayed. The agency theory of internationalisation takes agency problems as the basis for internationalisation (Sachse 2012). This is because transaction and coordination costs may be too high to allow such a decision. Agency is a relationship between the owner and an agent appointed by the owner to act on his behalf. A problem arises due to asymmetric information and uncertainty especially if the agent is not trustworthy. In this case, transaction costs rise due to agents pursuing own interests instead of those of the owners especially if they are deceitful (Kutscher & Schmid 2006). These agents have access to much information regarding the foreign market as they are the ones managing the branch or subsidiary hence may misrepresent information to owners for their own advantage. This may explain why firms chose to invest directly rather than use licencing or contracting or use of sales representatives and agents. Behavioural or Process-related Theories These view internationalisation as an evolutionary and dynamic process not a result of rational decision making as portrayed by traditional theories. The most commonly used theory is the Uppsala model developed by Johanson and Wiedersheim-Paul (1975) and developed further by Johanson and Vahlne (1977 & 1990). This theory explains how firms gradually intensify into the foreign markets as a result of gained experience and expertise from the domestic market. The theory also utilises the concept of psychic distance whereby firms are believed to begin foreign operations from culturally and/or geographically close countries and move gradually to more distant locations (Johanson & Vahlne, 1977, 1990; Johanson & Wiedersheim-Paul 1975). Firms also in this case are assumed to start operations by use of exports especially indirect exports and later intensify to other modes such as establishment of subsidiaries. Therefore, internationalisation activities occur incrementally as firms gain more knowledge on the foreign market and become more committed in time. Sachse (2012) gives an example of a firm starting with indirect exports then moves to direct exports which entails use of independent distributors, sales branches or subsidiaries and finally engages in FDI. More knowledge gained through managerial learning in this case helps the manager to commit further to more distant markets. As such, time is of essence. The first step in this process is choosing a market entry mode such as licencing, joint ventures, acquisitions and mergers, exporting among others. This decision may be influenced by many factors such the culture of host country, legal environment, product lifecycle, and trade barriers such as tariffs by home or host country (Kutschker & Schmid 2006). Each of these market entry strategies have own advantages and disadvantages and it is the work of the entrepreneur to evaluate available information to make the right decision regarding the mode. After market entry, the firm then may decide to switch the operation mode in mode based on knowledge and experience, therefore, the process takes a relatively longer period. Sachse (2012, p. 20) views Uppsala model as a “combination of deliberate (systematic) and emergent (ad hoc) approaches. This is because the firm chooses carefully an entry mode but may be forced by circumstances, for example, new knowledge to switch to another mode or intensify to more distant markets. The Uppsala model builds on the growth of firms theory since at different stages of growth, the firm engages in different activities and expands its products or markets hence internationalisation. The criticism levelled against this theory is that its empirical support is not conclusive. Sachse (2012) observes that the theory ignores leapfrogging of stages as well as certain manifestations of internationalisation such as joint ventures and web-based sales. He also notes that it concentrates on future growth and ignores those who intentionally fail to proceed as a form of withdrawal from foreign market. Some firms also do not follow the stages as they enter distant markets early especially with growth of internet (Benito et al. 2002). It is also clear that some firms are born global; they are global in nature right from founding hence do not follow this model of gradual and incremental growth. Relationship or network perspective is another theory that tries to explain internationalisation. The theory emphasises on business and social relationships in enhancing internationalisation instead of firm-specific factors. These networks include suppliers, customers, competitors, friends, family members, and private and public support agencies (Sachse 2012). These are sources of information needed to make a decision whether to intensify into foreign markets. It is the opposite of TC theory which assumes decision makers are rational and not influenced by social actors. According to this theory, success of market entry depends on relationships within current market rather than market specific or cultural characteristics hence it is more multilateral than the stage theories such as Uppsala (Whitelock 2002). These networks are essential especially in an era of globalisation. The Gestalt-Oriented Approach of International Business Strategies (GAINS approach) by Macharzina and Engelhard (1991) gives a holistic view of internationalisation. It analyses the “environment-structure-strategy-process in context of three categories: Non-exporter, Reactive exporter and Active exporter” (Sachse 2012, p. 26). In this case, internationalisation is an inherent part of corporate development. The theory also views revolutionary periods and incremental periods of change as occurring in alternation. For others like Kutschker and Schmid (2006) the internationalisation process is a “trial and error” process involving periods which are episodic, evolutionary and epochal. Evolution in this case refers to incremental changes in daily running of business which are intentional or unintentional. Episodes are revolutionary; epochs re intensive changes over long period and within these epochs occurs sporadic changes followed by evolution (Sachse 2012, p. 27). This explains more of what actually happens in internationalisation process than the systematic process described by Uppsala model. Application of Theories All these theories try to explain how companies internationalise but how well do they explain the patterns of internationalisation in today’s global economy? Research (Oviatt & McDougall 1997; Axinn & Matthyssens 2002) revealed that the risk-averse and incremental nature of internationalisation described by traditional process theories inadequately explain this historical change. This is due to the fact that many firms do not internationalise gradually but rapidly while some new ventures are international from inception hence do not follow the path described. For Whitelock (2002) only a model incorporating key elements of each approach can present a more realistic and comprehensive picture of market entry decision. In a multilateral case study of four service MNEs (Riku, Fred & Georges 2009) results revealed that the companies deviated in many areas from those suggested by the theories and concluded that the theories can only best explain the large manufacturing companies or large service MNEs but not MNEs from small and open economies. This is because these theories are based on large MNEs from large countries like US, Germany, Britain. These traditional theories also focus on why large MNEs exist and how they come to be. They also stress on rational economic actions of firms and not human behaviour or environment. On the other hand, process theories focus on changes over time and emphasise on gradual and incremental changes and psychic distance. These theories thus cannot explain internationalisation of all companies especially service companies which are more global and do not follow a systematic process; rather they are influenced by government actions and behaviour of entrepreneurs (Clark et al. 1996; Knight & Cavusgil 1996). Riku et al (2009) assert that service industries have unique characteristics that pose a challenge to existing theories. They are intangible, inseparable and heterogeneous hence require different modes of operation. For example, theories indicate that firms begin with indirect exportation but exportation may not be applicable to most services. The small MNEs face stiff competition from large companies and as such engage in strategic alliances to compete effectively in the market. Most avoid direct competition with global MNEs hence defy the psychic distance concept envisaged by Uppsala model. They prefer to trade with other smaller countries even if at far distance instead of their neighbours. For example, Soneva of Finland began its activities in Africa and South East Asia. Telecommunication companies are capital intensive thus risky to internationalise. As such, they result to minority joint-ventures to share risks and not fully owned FDIs (Oviatt & McDougal 2005). Most of them also start with direct investments hence more commitment at the beginning and not later as suggested by traditional theories. This is due to their intangibility characteristic. For Riku et al (2009) these companies follow their customers while internationalising. Another research (Sandberg 2009) on Chinese firms showed that take-off deviated from the assumed paths due to the disadvantages apparent in Chinese markets. Firms first engaged in indirect export hence could not gather information needed to help in further expansion. The companies also faced different environment to fit the traditional western models hence their internationalisation could only be explained partially by existing models. References Axinn, Catherine N and Matthyssens, Paul. (2002). Limits of internationalization theories in an unlimited world. International Marketing Review, 19 (5), pp. 436-449. Benito, G. R. G., Larimo, J., Narula, R. and Pedersen, T. (2002) Multinational enterprises from small economies. International Studies of Management and Organization, 32(1), pp. 57-78. Buckley, P. J and Casson, M. (1993). A theory of international operations. In: Buckley, P. J. and Ghauri, P. N. (eds.). The internationalization of the firm. a reader. London, The Dryden Press. Clark, T., Rajaratnam, D and Smith, T. (1996) Toward a theory of international services: marketing intangibles in a world of nations. Journal of International Marketing, 4 (2 ), pp. 9-28 Dunning, J. H. ( 2006). New directions in international business research. Academy of International Business Insights, 6 (2), pp.3-9. Hunt, EK. (2002). History of economic thought: a critical perspective. M.E Sharpe Ingham, Barbara. (2004). International economics: a European focus. Pearson Education Johanson, J and Vahlne, J.-E. (1977). The internationalization process of the firm: a model of knowledge development and increasing foreign market commitments. Journal of International Business Studies, 8 (1), pp. 23-32. Johanson, J./Vahlne, J.-E. (1990). The mechanism of internationalization. International Marketing Review, 7(4), pp. 11-25. Johanson, J and Wiedersheim-Paul, F. (1975). The internationalization of the firm: four Swedish cases. Journal of Management Studies, 12 (3), pp.305-322 Knight, G and Cavusgil, S. T. (1996). The born global firm: a challenge to traditional internationalization theory. Advances in International Marketing, 8: pp. 11-26. Oviatt Benjamin M and McDougall, Patricia Phillips. (1997). Challenges for internalization process theory: the case of international new ventures. Management International Review. 37(2), pp. 85-99 Oviatt Benjamin M and McDougall, Patricia Phillips. (2005). The internationalization of entrepreneurship. Journal of International Business studies 36(1), pp. 2-8. Riku, Laanti., Fred McDougall and Georges, Baume. (2009). How well do traditional theories explain internationalization of service MNEs from small and open economies?-case: national telecommunication companies. Management International Review, 49 (1). Available from: [Accessed 22 March, 2014]. Sachse, Uwe. (2012). Internationalisation and mode switching: performance, strategy and timing. Germany, Gabler Verlag. Sandberg, Susanne. (2009). Internationalization patterns of Chinese private owned SMEs : Initial states of international and cluster as take-off node. Progress in International Business Research, 4: 89-114. Whitelock, Jeryl. (2002). Theories of internationalisation and their impact on market entry. International Marketing Review, 19(4), pp. 342-347. Read More