Theories as Explanations of the Process of Business Internationalisation - Report Example

Theories as Explanations of the Process of Business Internationalisation By Introduction Globalisation made it easy for firms to enter foreign markets because this process eliminated cross border trade barriers. In the current context of today’s highly competitive market environment, firms consider global expansion as a potential strategy to minimise their exposure to market risks and contingencies and to take advantages of the economies of scale. This situation points to the need of internationalisation, the process through which a business expands outside the national (domestic) market. Luostarinen defines internationalisation as “a step by step process of international business development whereby a firm becomes increasingly committed to and involved in international business operations through specific products in selected markets” (Kauda, 2000, p.78). There are many ways through which a company could internationalise its business operations. The major approaches of internationalisation include Greenfield investment, joint venture, franchising, licensing, exporting, or M&A. Although the process of internationalisation provides firms with a range of potential benefits, it may deliver some unintended outcomes if the business is not expanded to the right market at the right time. Therefore, internationalisation is really a complex process that involves months/years of planning and execution. There have been a number of theories proposed in relation to internationalisation that can assist domestic marketers to obtain a deep understanding of various aspects of global expansion. This paper will critically compare and contrast between three theories such as Dunning’s eclectic paradigm, Kruger’s first-mover advantage theory, and Vernon’s product lifecycle theory as explanations of the process of business internationalisation. Eclectic Paradigm The eclectic paradigm theory, also known as the OLI-Model or OLI-Framework, is an expansion of the internationalisation theory and is published by John H. Dunning in 1993. The internationalisation theory, which is based on the transaction cost theory, states that if the transaction costs on the free market exceed the internal costs then transactions are carried out within an institution. Dunning thought that the structure of the organisation should not be the only factor to be considered, and hence he added three more factors to the theory such as ownership advantages, location advantages, and internationalisation advantages (Jones & Wren, 2006, p.36). According to the theorist, ownership advantages can be referred to the competitive advantages specific to enterprises that seek to engage in foreign direct investment, and these advantages may include trademark, entrepreneurial skills, and production technique. If an enterprise possesses greater competitive advantages, then it is more likely to engage in foreign production. Location advantages indicate the location specific attractions in the region where the enterprise is planning to make an investment. Location advantages comprise low wages or taxes, special tariff rates, and existence of raw materials. According to Dunning, the internationalisations advantages reflect the benefits derived from own production rather than engaging in a partnership arrangement such as joint venture or licensing. The author adds that a firm will prefer to enjoy own production advantages when the merits of internalising foreign intermediate product markets are greater (Rugman, 2010). The diagrammatic representation of the Dunning’s eclectic paradigm theory is shown below. (Source: Hill, 2013, pp.256-257) This theory provides a three-tiered framework for an organisation to identify the right time for pursuing direct foreign investment. Dunning proposed this theory based on the fundamental assumption that institutions would prefer to stay away from transactions in the open market when internal transaction costs are lower. To sum up, a firm should consider investing in a foreign country only if all the three advantages (ownership advantages, location advantages, and internationalisation advantages) are present. First Mover Advantage Theory According to the first-mover advantage theory, the initial significant occupant of a marketplace enjoys a set of competitive advantages, which are collectively referred to as technological leadership. The first entrant enjoys this advantage because he/she can gain perfect control over various resources that subsequent entrants may not be able to match. According to Jordan-Korte (2011, p.44), when a company is the first to enter a specific market segment or industry, it can take advantages of superior brand recognition and customer loyalty. Under this particular market scenario, the business obtains enough time to perfect its product or service. According to Suarez and Lanzolla (2008), it is identified that first movers often enjoy a monopoly-like status and they may be rewarded with attractive profit margins. However, sometimes the first-movers may fail to capitalise on its status of being the first entrant and consequently they leave the opportunity for subsequent entrants. Such enterprises may acquire a second-mover advantage. There are three major factors that lead to first-mover advantages, including technological leadership, pre-emption of limited assets, and switching costs and uncertain buyer choice. An organisation is able to gain first-mover advantages if it maintains unique technologies and a powerful R&D wing. The technological pioneers may enjoy their advantages over a long time if they are able to keep their technology updated or successfully keep the technology as a trade secret. Similarly, if the first-mover firm is properly informed of the market conditions, it can purchase scarce assets at lower prices than they would be purchased at a later point of time in the evolution of the market. In addition, the first-mover can choose the most productive niches and take strategic actions to limit the amount of space available for later entrants. The switching costs refer to the additional resources that later entrants must introduce to intrude into the existing market of the first-mover. Finally, buyers may be satisfied in the products/services offered by the first brand and hence they may be hesitant to switch to a new brand. Product Lifecycle Theory Product lifecycle theory is a business economic theory developed by Raymond Vernon to describe the pattern of international trade. This theory was proposed in response to the failure of the Heckscher-Ohlin model. According to the product lifecycle theory, all the parts and labour associated with a particular product come from the area it was originally invented in the early stages (Kallianiotis, 2013, p.200). Once the product becomes widely recognised and adopted in the market, production eventually moves away from the point of origin. In some situations, the product may be even imported by its original country of invention. For instance, although the personal computer was invented in the United States, today the country largely imports this product from other countries. This model is generally applicable to labour-saving and capital-using products that cater the needs of high income groups. The product lifecycle model reflects dynamic comparative advantage. The country that enjoys the comparative advantage in the production changes over time from the country of origin to the developing countries (Stark, 2011, p.66). According to the theorist, a product’s lifecycle is comprised of five stages such as introduction, growth, maturity, saturation, and decline. In the first stage, new products are introduced in the market to meet local or national needs and are exported to countries with similar needs, preferences, and incomes. In the growth phase, the point of production may be moved to other countries based on the cost of production. The industry contracts and concentrates in the maturity stage and ultimately the lowest cost producer dominates the market. Saturation is a point where sales reached its peak and there is no possibility of further sales. Hence, the marketer seeks to develop alternate uses of the product. In the decline stage, the market demand of the product falls significantly and only poor countries provide the market for the product (Yoo, 2010). Different stages described in the product lifecycle theory are illustrated below. (Source: Northern Ireland Business Info) Critical Reflection The concept of eclectic paradigm was formed by the merging of several isolated theories of international economics and it gives due attention to the three fundamental forms of international activities of firms such as export, FDI, and licensing. As discussed already, the OLI factors (ownership advantages, location advantages, and internationalisation advantages) constitute the basic framework of the eclectic paradigm. The availability of net ownership advantages, which could be both material and immaterial, is one of the preconditions of the global expansion of a firm. The term net ownership advantages reflect advantages that a business organisation can enjoy in unknown foreign markets. According to Dunning, there are two different types of FDI such as resource seeking investments and market seeking investments. Resource seeking investments intend to gain potential access to raw materials and other input factors whereas market seeking investments facilitate the entry in an existing market or the establishment of a new market. In addition, Dunning introduced other terms like efficiency seeking investments, strategic seeking investments, and support investments to make a closer distinction between different types of FDIs. The eclectic paradigm contrasts a country’s location advantages such as geographical position with the firm’s ownership advantages such as resources. Referring to the OLI-Model, if the country possesses potential location advantages, then strong domestic firms are likely to promote exporting. However, if the country does not have strong local firms (for instance, most of the developing countries), the trend may be reversed. These conditions are in line with those put forward by Porter’s diamond model of national competitiveness. Based on the categories of advantage identified, it is easy for firms to choose the most appropriate form of international activity (Lopes, 2010). To explain, if an organisation has ownership advantages such as deep knowledge of the target market abroad, staff with foreign language skills, and information about tariffs and imports permission, licensing can be a better expansion strategy for the firm. Licensing is a less cost-intensive form of internationalisation as compared to other approaches. If the organisation maintains internationalisation advantages, it may be better for the company to invest more capital abroad. This can be achieved by establishing an exporting subsidiary abroad. According to the eclectic paradigm model, a company should choose the FDI as the international expansion strategy only if the target country has location advantages. This strategy can be executed by purchasing or completely constructing factories abroad. The most potential feature of the eclectic paradigm is that it assists firms to choose the most suitable internationalisation strategy that would provide the business with a set of competitive advantages over the rivals in the marketplace. In addition, this theoretical framework can benefit organisations to examine whether the market conditions prevailing in an overseas market match their specific skills and advantages. Such an evaluation may aid the management to make sound decisions in relation to global expansion. As compared to the eclectic paradigm that considers ownership, location, and internationalisation factors for expanding a business abroad, the first-mover advantage theory seems to be less comprehensive one as it is based on the common assumption that a company earns a kind of competitive advantage by being the first to enter a particular market or industry. Michael Spence (1981) stated that first-movers tend to sell their products below the cost in an effort to form a deep understanding of the market or to gain intelligence and subsequently control the market’s cost. Innovative companies such as Coca Cola and eBay are the examples of firms that enjoyed first-mover advantages. Both these companies set low prices to penetrate into new markets and they completely controlled market prices over the long run. It is clear that eBay was the first internet marketer to take the auction process online and Coca Cola was the first cola producer. Hence, both the companies enjoyed the status of being the first entrant of the industry. At the time of the market entry of Coca Cola, people were not knowledgeable about cola products and hence they were eager to taste the soft drinks offered by the Coke brand. Since the Coca Cola was the first to enter the industry, there were no competitors and this favourable situation assisted the company to acquire superior brand recognition and customer loyalty. This situation was similar in case of eBay too. When the first-mover advantages theory pays attention to the superior benefits enjoyed by the first entrant of a market or industry, the eclectic paradigm suggests how a running business can spread into a foreign market where competition is a factor of concern. As discussed already, the mechanisms leading to first-mover advantages include technological leadership, pre-emption of limited assets, and switching costs and uncertain buyer choice. Technological leadership has assisted many firms to enjoy the first-mover advantages. For instance, Procter & Gamble could successfully promote their disposable diapers in the US market on the strength of its technology leadership. Based on its deep knowledge in technology, the company invested in low-priced European synthetic fibre and this manufacturing approach in turn helped the firm offer diapers at a cheaper but more profitable price. The technological leadership suggested in the first-mover advantages theory seems to be a type of ownership advantage described by the eclectic paradigm. Similarly, the pre-emption of scarce assets could be achieved by managing the natural resources effectively. Main (1955, pp.78-81) provides a good example of pre-emption of limited assets. According to him, concentration of high-grade nickel in single geographic territory assisted the first entrant in the area to gain almost complete control over the supply of nickel in that particular area. Since then, the company has controlled a significant percent of the world’s production and distribution of nickel (Ibid). If the first-mover can claim a great control over the limited resources in the area, it would be really a cumbersome task for subsequent entrants to establish their business in that area. The pre-emption of scarce assets can be linked to the location advantages described by eclectic paradigm. Finally, a customer would not like to switch to another brand as long as long as he/she is satisfied in the current brand. This is the reason why many people switched from Windows Phones to Android Phones or iPhones recently. Compared to eclectic paradigm and the first-mover advantages theory, the product lifecycle theory is the more simpler and popular one. It specifically states five phases in the lifecycle of a product such as introduction, growth, maturity, saturation, and decline. Using this theory, it is easy for a marketer to determine the stage in which a product is in and to choose the most appropriate strategy to promote the sales in each stage of product development. When a product is newly launched in a particular market, there would be a rapid growth in sales volume due to unmet market demand. As more and more people buy the product, the demand level would equal the sales level. When the market demand has been completely satisfied, the product sales may start to decline. In a global market context, the product lifecycle is really accelerated due to the presence of the follower economies that tend to imitate the successful product innovations of other countries (Hirooka, 2006, p.203). Those economies introduce low-cost models of the actual product and experience a faster market saturation and decline. An effectively marketed product will be capable of meeting a well defined need in its target market. The marketer might have conducted market surveys and identified the estimates for market composition and buyer spending. Since competition is low in the initial stages of product lifecycle, sales volume grows rapidly. This phase is characterised with high prices, increased profits, and comprehensive product promotion. In addition, suppliers may try to export the product to foreign countries to grow sales in this stage. In the maturity stage of the product lifecycle, demand level falls and sales volume grows at a slower rate (Ozcan, 2005). Imitations appearing in foreign market and declining export sales contribute notably to the slowly increasing sales volume. At this juncture, the actual producer may cut down the price to promote sales and to maintain the market share. Although profit margins may reduce at this point due to lower prices, the business still remains attractive because of the high sales volume. In final phase of the product lifecycle (decline), the sale volume drops significantly and sometimes the product goes out of the market. At this point, the follower economies would have developed the imitated version of the original product and they may be able to export the imitations to the country of actual innovation. This situation would worsen the sales and prices of the original marketer. Under this circumstance, the original marketer can no longer produce the commodity competitively and therefore he/she tries to generate some return by selling out the remaining stock at discounted rates. An experienced marketing manager can predict how long a particular product would take to reach the saturation stage and thus he/she can frame appropriate pricing strategy to earn maximum profits. While planning overseas business expansion, the product lifecycle theory can greatly benefit firms to identify the influence of imitation threats on the sales and to develop counter-measures to address the situation. Conclusion From the above discussion, it is clear that all the three theories described in this paper are extremely useful while planning the global expansion of a business. The eclectic paradigm suggested by Dunning is based on the transaction cost theory which states that transactions are carried out within an institution if the transaction costs on the free market are greater than the internal costs. This theoretical framework takes three factors into account such as ownership advantages, location advantages, and internationalisation advantages so as to provide firms with a clear direction with regard to global expansion. The most appealing feature of this theory is that it can suggest firms when to expand abroad and which type of market entry may be appropriate. Compared to the eclectic paradigm, the first-mover advantages theory is a less comprehensive one as it is based on the mere assumption that the first entrant of a specific market or industry can enjoy a set of distinct advantages. The theorist claim that technological leadership, pre-emption of limited assets, and switching costs and uncertain buyer choice are the major elements that would lead to first-mover advantages. Coca-Cola and eBay are the examples of two companies that enjoyed first-mover advantages as being the first entrants of the market. Finally, the product lifecycle theory is the most popular theory among the three and it clearly defines the five major stages of product development, including introduction, growth, maturity, saturation, and decline. This theoretical approach assists marketers to identify the development stages of their products and to be well informed of the presence of follower economies and their impacts on the business. To conclude, the eclectic paradigm appears to be the most effective approach that can closely manage and monitor each stage of internationalisation. References Hirooka M (2006) Innovation Dynamism and Economic Growth: A Nonlinear Perspective. US: Edward Elgar Publishing. Hill W (2013) International Business: Competing in the Global Marketplace. NY: McGrow- Hill Companies Inc. Jones J & Wren C (2006) Foreign Direct Investment and the Regional Economy. Ashgate Publishing, Ltd. Jordan-Korte K (2011) Government Promotion of Renewable Energy Technologies: Policy Approaches and Market Development in Germany, the United States, and Japan. US: Kuada (2000) Internationalisation and Enterprise Development in Ghana. US: Adonis & Abbey Publishers Ltd. Kallianiotis JN (2013) International Financial Transactions and Exchange Rates: Trade, Investment, and Parities. US: Palgrave Macmillan. Lopes TS (2010) The Entrepreneur, Ownership Advantages and the Eclectic Paradigm. 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