Motives & Entry Modes Of SMEs in China - Research Paper Example

FOREIGN DIRECT INVESTMENTS: A RESEARCH ON MOTIVES & ENTRY MODES OF SME’s IN CHINA TABLE OF CONTENTS Page 3 2 Introduction 4 3 Internationalization of Trade 5 3.1 Hypothesis 6 4 Motives 7 5 Modes of Entry 10 6 Research Methods 13 6.1 Qualitative Data Collection Methods 13 6.2 Case Studies 14 7 Conclusions 16 8 Bibliography 18 1 Abstract China has attracted the maximum FDI recently and this is proving to be the engine of its spectacular growth. This study has undertaken to evaluate whether SME’s are also playing a substantial role in this FDI. A study of the literature reveals that there are enough motives for the high tech SME’s to enter China. It also discusses the various modes of entry available to them with special attention on their being China centric. The Hypothesis that requires testing has been laid out as a result of the study and a research methodology, along with data collection methods and analysis required has been suggested. This will lead this enquiry to its logical conclusion. 2 Introduction. The Chinese economy is said to be growing between 9% and 11% per annum for over a decade. Most of this growth can be attributed to FDI. There was rapid growth from 1996, and by 2002 China became the largest global receiver of FDI (OECD, 2003). FDI as a proportion of GDP has risen from 5% in 1995 to 17% in 2005. (National Bureau of Statistics of China, 2004; USCBC, 2005b). In China Foreign Companies provide 28% of its industrial added value and 20% of its taxation. These companies also export 57% of its products and services and employ over 11% of its workforce. This is a direct result of China’s open market policies that attract FDI. The crux of these policies are preferential treatment to these companies, low cost human resources, the burgeoning local population with increasing purchasing power and general improvement in the market environment. Investments have flown in grater amounts after China entered the World Trade Organization (WTO) and has made it the favorite destination for global investments. (Yunshi and Jing, 2005) Ever since the adoption of open market policies China has offered incentives for attracting Foreign Direct Investment (FDI). A country’s success can be gauged by its ability to attract FDI from the developed world (Hanes, 1998) and a large number of Multinational companies have taken advantage of the facilities offered to set up wholly owned, joint ventures and franchise businesses. However a noteworthy number of new ventures constitute of the high-tech Small and Medium Industries (SME). The attraction of investment in China has been mainly on grounds of its huge market potential and most Multi-National Companies (MNC) as has been found out in extensive interviews reported by Nunnenkamp (2002). While this holds good for MNC’s for the SME the reasons are somewhat different. The position of information and communications technologies (ICT) is universally held to be very significant for economic development. But it requires greater domestic use of ICT as an engine of economic growth along with export of these products. According to Miller (2002), China is the world’s topmost ICT spending nation. China’s ICT market has seen an average of 27% compound annual growth rate since 1993.which is the higher than any other country. It has grown by over 15% in 2001 alone. This paper will attempt to study the motives, their rationality and the modes of entry that were adopted by the SME’s in China. 3 Internationalization of Trade The Product Life Cycle (PLC) theory by Raymond Vernon in 1960 concluded that there are four stages of lifecycle of a product and international trade is related to them. In the first innovation stage the product is developed in its home country; in the second when it reaches its growth level it is produced in another developed country; when it is in maturity it is produced in a developing country and in the last stage where it reaches the declining stage of its life it may be produced just anywhere. The PLC theory may be a motive for FDI for some low tech consumer products, but generally this does not apply to SME’s investing in China. However, world production is increasingly dominated by MNC’s looking for greater market share. They make strategic decisions for their target markets that have important implications for business, home and host country employment, transfer of knowledge and technological improvements. In turn their choices are affected by domestic and international trade policies in ways that are not covered by in traditional trade models that focus on competitive markets and the role of comparative advantage. It is thought that when a firm chooses FDI as a means to enter overseas markets it becomes a multinational enterprise and is then defined as a firm that holds significant controlling interest by way of majority share or by setting up a subsidiary in a foreign country (Markusen, 1995). Innovation has been said to be another reason why firms invest abroad. The eclectic paradigm of Dunning (1981, 1988, 1993, 2000) and the internalization perspective also point to the fact that while internationalizing their activity firms heavily depend on innovations of products. Finding skilled labour for research and development as well as production is a good incentive for FDI in host countries. In recent times there is agreement on the fact that investments are made abroad not only in pursuit of innovative capability but in order to enhance such capabilities (Cantwell, 1989; Cantwell and Janne, 1999; Kuemmerle, 1999; Peng and Wang, 2000). Sullivan and Bauerschmidt (1990) also found that innovative capacity creates a positive influence on internationalization, product development capacity and classification; while (Leonidou, 1995) opined that it may provide specific advantages that can be exploited at the international level. 3.1 Hypothesis Based on above this paper will test the following hypothesis: SME’s come to China with a) Motive to exploit the internalization advantage of their unique knowledge, and b) Their preferred mode of entry is through Ownership or Contractual Joint Ventures. 4 Motives Among the variables that increased FDI by SME’s the most common are small domestic market and the unique knowledge or technology possessed by them and the attraction of variety of alliances and relationships available in the host country (Freeman et al 2006). At the same they have also identified lack of economies of scale, shortage of financial and knowledge resources and dislike to risk taking as main deterrents for smaller, newly internationalized, firms. But Buckley (1989) has argued that owner-managers of such small companies may very well greater risk takers than other types of decision makers. He expounded that there are two significant relationships between firm size and market size. The smaller firm faces closure or bankruptcy when many small firms try to capture a small market. It is equally difficult for a smaller firm to face competition from larger rivals where the optimal scale is large. In such situations the smaller firms can fill the role of a niche player in the market and this becomes a major advantage. This competitive advantage offers the opportunity to go International. SME’s have limited resources and this leads them to look for international alliances (Coviello & Munro, 1992) and in turn this offers them growth opportunities (Brush 1992). This is the way to managing international risk and SME’s are attracted to it despite their small size (Shrader et al 2000). This brisk internationalization of new and small ventures is an important anomaly but quite unlike the expansion of the Japanese keiretsu model (Dunning, 1993; Johanson & Vahlne, 1990), where small firms operate as totally dependent suppliers to large, established, multinational corporations. Motives for FDI may be summarized in a categorization formulated by Behrman (1972) and Dunning (1993) who introduced a model of internationalization including four different categories of motives. These categories are market seeking, resource seeking, efficiency seeking and strategic resource seeking motives. To this a fifth category, network seeking motives (Dimitratos & Plakoyiannaki, 2003) has been added for recognizing networks as a significant part of internationalization corresponding to recent research. Market and Resource seeking motives have been the two most recognized categories of motives (Dunning 2000). These two are the main reasons for most first time internationalization attempts by firms. Yet, efficiency seeking and strategic asset seeking motives increase in importance and are more common as motives for those companies who are already engaged in multinational activity. Dunning also confirms that closer relations with customers and durable relations with suppliers were equally important motives. Besides, he suggests that internationalization was driven by opportunities abroad rather than threats at home. Opportunity has been described in a different vein by Williamson (1975). He states that incomplete contracts and missing markets gave rise to opportunistic behaviour and to fill the void SME’s chose to face the challenge by replacing external contracts by direct ownership and internal hierarchy. This has been confirmed by Dunning’s eclectic paradigm and internalization theory of Rugman (1984). The eclectic paradigm suggests that three conditions determine FDI. First, the firm must possess specific, ownership advantages not available to other firms. These advantages can be tangible like a superior technology or patent; or firm size that can generate transferable economies of scale and scope. Or the advantages can be intangible, may even be embodied in a brand name, trademark or other indication of product quality, or derived from the fact that the firm’s is having favored access to particular customers. Secondly, the foreign market should offer some locational advantage. It should be profitable to serve the overseas market by local production rather than by exporting. Important factors in this case are market size, tariff and non-tariff barriers or rigorous anti-dumping regulations that restrain the firm’s ability to price its exports and offers opportunity to locate itself within the market. Thirdly, there should be an internalization advantage. Ownership advantages are best exploited internally rather than offered to other firms through some contractual arrangement such as licensing, a joint venture or management contracting. The problems of unenforceable and uncontrollable contracts with overseas partners can be overcome with direct ownership. The eclectic paradigm shares much in common with Rugman’s internalization theory in this respect. The main difference between the two paradigms has been described by Dunning himself stating that his eclectic paradigm is different from Rugman’s internalization theory in that it treats the competitive (so-called O-specific) advantages as endogenous or internal rather than as exogenous external variables (Dunning, 1995) 5 Modes of Entry Various factors may account for the choice of a particular mode for entry into a foreign market. It may depend on product features such as degree of differentiation, importance, age, and technological content (Gatignon and Anderson, 1987; Goodnow, 1985; Stopford and Wells, 1972). It may also be determined by external environmental factors like host country trade and investment restrictions, market size, geographic and cultural distance, and its exchange rate fluctuations (Baek and Kwok, 2002; Bauershmidt, et al. 1985; Goodnow and Hansz, 1972). Besides, a number of cultural and behavioural practices affect decisions in international marketing involvement, choice of markets and choice of foreign market entry modes (Aharoni, 1966; Cavusgil, 1980; Erramilli and Rao, 1990; Johanson and Vahlne, 1977). Yet again, the original mode of entry may not be related to subsequent sequential entries (Chang and Rosenzweig, 2001). Many an entry into China has been through an agency office in the early stage. This gives the opportunity to feel the terrain. But as contractual failures and missed market opportunities rise, as explained earlier, firms feel more confident to go for wholly owned subsidiaries (WOS) or contractual joint ventures (CJV). Most companies prefer WOS where advantages like knowledge of the local market have been built up or understood. Yet problems can be noticed in such ventures due to differences in management style, culture, facilities and training. The issues involving the bureaucracy, administrative procedures and inefficiencies in the co-ordination with government departments; unclear or contradictory laws, and unpredictability of legal and other processes also pose roadblocks along the way. It is for these reasons SME’s, especially those in the technology intensive industries exploited these advantages through export and not so much through direct investment. These firms are more specialized and enjoy higher competitive advantages in these sectors. The original research of the Harvard Multinational Enterprise Project (Vermon 1972) shows that industrial sectors demonstrate signs of different preferences for internationalization. For instance, Advertising power and R&D potency have been mentioned as a cause of higher direct investment abroad (Agarwal and Ramaswami, 1992; Erramilli and Rao, 1990; Gatingnon and Anderson, 1988; Pan and Tse, 2000). This type of SME would rather have CJV to cater to the market for its services. Elsewhere in this paper one of the motives that has been mentioned is the network seeking motive. This can be useful under any kind of entry mode. A new term social capital explains this as it is a form of bridging the divides rather than bonding the divides. This can be of great value as it has the potential to add new information, ideas and opportunities. Networks can be described as social capital that is intangible but that drives the international growth of entrepreneurial firms, particularly those in High Technology. The network is based on reciprocal responses, individual relationships, mutual respect, and trust. Confidence in each other to deliver is the basic and core element of a successful network and it is developed through repeated interactions. Trust also determines the solidity and reliability of the network link. In the Chinese context networking is most essential with its beurocracy. It is impossible to be impersonal in China. Guanxi personalizes interpersonal relationships even in formal business organizations. It plays a vital role in the internalization process of SME’s. Government in China controls the rare resources and the access to huge markets, which are available through permissions and licenses that are the personal fiefdoms of the governors at different levels who hold the monopoly of their control over them. It is from these assets that they exact rents and a personal networking with them is necessary. A profitable growth is the result of successfully managing uncertainty. The Guanxi is the method to deal with this uncertainty that needs to be managed in China for any measurable success by an SME. The equation has to be manipulated with deep understanding of human behavior. There is no doubt that as compared to large MNC’s, the SME lacks resources to expand internationally. Networking solves this problem for the SME who are then able to expand simultaneously both domestically and internationally. The importance of networks in international business and entrepreneurship in China is an undeniable fact. Indeed the entrepreneur of the SME has the capacity for better networking compared to an MNC. 6 Research Methodology 6.1 Qualitative Data Collection Methods In this research, the qualitative data collection will be employed. Qualitative data collection is done in cases where it is not possible to obtain information that can be quantified and can be used for analysis purposes thereon. This is typical in case social issues that have only preferences and not any quantitative data. Qualitative methods include Action and Participatory Action Research Methods, Ethno methodology and Conversation Analysis, Event Structure Analysis, Narrative Inquiry Phenomenography and Phenomenology, Q Methodology and Personal Construction Psychology Though all these methods are available and every one of them has their own preferences and areas of work that they could be employed in, in the current situation where interviews could be conducted with the people available in the targeted companies, research can be done based on the information thus obtained. The target company is a case study and follows the rules to conduct a case study as exemplified by Yin (1984). The study conducted can be single case study or multiple studies that would improve the strength of the results obtained. A single case design is not, naturally, as strong as the multiple cases that could be considered in a given situation. Yin (1984) indicates that the multiple case studies are better to do since the results are more dependable. Where such qualitative data collection is to be done, it is better to have case study conducted which would give the ideas of a number of employees are identified and feedback to the management or decision makers in the case (Feagin, Orum & Sjoberg, 1991). A case study would provide more information on the qualitative aspects of the research than an interview or a discussion with the respective people and information sources identified. A case study is chosen since the data is too large and a single case is taken as a sample case to identify the multiple issues that throng the work environment. Qualitative data analysis can be conducted using any of the methods earlier described. However, the entire research may be carried out using the following roadmap: A design of the case study of the target company is to be carried out. Based on the design, a set of questions are to be prepared and will be followed by direct interviews. Answers from the interview will be used for establishing the nature of practices that are in place at the company. This will then be further analyzed and the results will be presented. 6.2 Case Studies A field study would be most suitable in the context of this research study. Dunning (1993) clarifies that field studies enhance the understanding of the role of FDI in establishing motives and entry modes. This will also complement the identification of other variables. It is suggested a suitable number of cases of different SME’s in a variety of industrial sectors be examined to confirm or negate the above research. Single or sample case studies are conducted in the social scenario to identify the nature of the work that has been done and required to be done in order to collect the right set of information, the work can be in single or in multiple cases even for the sample lot (Yin, 1984). In order to understand the entire set of work that has to be carried out, it is generally a practice to conduct a pilot study to know the impact of the case study and whether the approach is in right direction. It is normally very descriptive in the case of study that is done and all the details are thus collected and then laid out for further analysis. The discussion and case study covers the entire depth and scope of the study, in many cases, primarily addressing the need to confirm an hypothesis (Bent Flyvbjerg, 2006). While designing case studies according to Yin (1984) major linkages need to be taken care of. They are the study questions and propositions that are being held for this study to identify whether these are validated or invalidated, setting the unit of analysis and logically linking the data with the propositions already made to determine the criteria for interpreting the findings. These factors form the core of the case study that has to be carried out and then later on analyzed. Questions for the case study need to be defined and then follow this up with propositions based on the questions already framed. However, there is no need for all studies to be propositioned. There can also be case studies without any legitimate proposition. The Unit of analysis will be either individuals, groups, companies or even countries. Linking the data with the propositions thus made or the targets set for the entire case study along with the criteria that will be used to evaluate the findings will define the entire case study. Unlike in other sampling methods, where normally for research purposes an average sample is selected, in case studies an extreme case is taken up, expecting the same to produce edge conditions that would cover all possible requirements that might arise during the survey or during the study. Only then will the case study remain exhaustive. The case study methodology follows a standard practice in most cases and these have to be respected if scientific results are too expected be derived out of it (Yin, 1984). A typical case study for the research purposes should be having an overview of the case study project with field Procedure and case questions as well as a guide for the case study reports. The over view of the case study should indicate the objectives, issues and the topics of the case study. It will also ensure that the reader knows about the topic and the purpose of the story as much as any other person in the company. Appropriate procedures have to be laid down for collecting the data and bring it for further analysis in the field procedures. Every case study would involve a number of questions followed by the guide to the case study reports. The case study questions will be decided by the framer of the questions. 7 Conclusions China is an enigma in business as in life. The vast differences of culture, language, behaviors and beliefs and the barriers of tariffs, regulations and legal codifications creates as much challenges as opportunities. Doing business with China has become a forgone conclusion ever since it adopted open market policies and threw open its doors to international trade. As was expected the MNC’s were to take fist step but SME’s were not far behind. Not withstanding disadvantages of lack of economies of scale and resources, these entrepreneurial firms have found that their strengths lay in their high technology and niche products and services and have therefore made space for themselves in the lucrative market. Their motives have been their unique knowledge or technology and their internalization advantage. Denning’s eclectic paradigm with its three principles of ownership, location, and internalization comprehensively supports the motives that move the SME towards China. Since it is a niche market that these SME’s wish to address, the ideal entry mode for them would be either wholly owned subsidiary, if they are capable of financially supporting it; otherwise a contractual joint venture could easily solve the problem. However for ultimate survival the network seeking SME will succeed where others will eventually fail to achieve the desired objectives. 8 Bibliography Agarwal, S. and Ramaswami, S.N. 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