Critical Role of Market Orientation in SMEs - Example

SMEs in an International Context [Full name of the author] [Qualification for which the thesis is submitted] [Name of the university in which it is presented] [Date (month and year)] [17 Pages] Table of Contents Page Table of Contents 2 1.0 TERMS OF REFERENCE 3 2.0 PROCEDURES 4 3.0 FINDINGS 5 3.1 RISK ASSESSMENT FOR SMEs WITH GLOBAL OPERATIONS 8 5.0 RECOMMENDATIONS 15 List of References 16 1.0 TERMS OF REFERENCE This report is written for a small textile manufacturer based in the UK which is looking for internationalizing its business through trade. The following pages give an assessment of the advantages, disadvantages and opportunities and threats of expanding outside the home country for the firm. 2.0 PROCEDURES The author of this report referenced relevant theories and literature on the topic and took into account the individual needs of the manufacturer. Factors like spare capacity and the limited knowledge about the export processes of the management were also taken into account for. After assimilating relevant theories with the specific situation of the company, the author has come up with a report that will help the management make more informed decisions when expanding abroad. 3.0 FINDINGS Small and medium-sized enterprises are significant exporters in many developed countries (Fletcher, 2004).Most high tech and manufacturing SMEs are increasingly expanding abroad and have been entering the international market at earlier phases. As such, the incentive for having an international presence is clear and lucrative. Even so, small firms face significant challenges in attempts to expand internationally. This limits to a significant extent their ability to realize the potential profits that (Katsikeas and Morgan, 1994). Those SMEs who rely on exports for a significant part of their revenue are among the fastest growing segments in the markets of several developed countries. Export obstacles are crucial for small businesses as well as public policymakers. Prior research on exporting offers a basis for the specifics of strategy for internationalization as well as the implications for small firms. The lack of finances, foreign government restrictions as well as inadequate knowledge with regards to foreign business practices are among the chief problems faced by small companies looking to expand abroad. Inadequate distribution and poor networking in new markets represent other important issues faced by firms looking to export. Limited resources, management skills as well as factors like language inability and cultural differences along with psychic distance can all potentially inhibit exports by SMEs (Fletcher, 2004; O’Farrell et al., 1998). The initial problems faced by firms who are looking to have an international footprint include identifying overseas opportunities and export documentation along with start-up costs. In the longer term challenges faced by exporting SMEs include adequately managing export operations including management and sales challenges. Rapid internationalisation is a strategic option for established domestic SMEs, which can successfully embrace intense international expansion later in their development (Bell, McNaughton, & Young 2001). This may be triggered by some critical ‘episode’, a downturn in the home market or the generation of a new radical innovation with international potential. Rapid internationalisation has generally been considered an entrepreneurial activity of small firms (Jones & Coviello 2005, Knight & Cavusgil 2004) since these companies very proactively search for opportunities in global markets (Zahra 2005). There are a lot of challenges and threats that can derail and potentially end up costing the company significant capital. These threats and challenges are discussed in more detail below. As an entry mode, FDIs in sales subsidiaries or acquisitions, for example, require more resource commitment and involve higher risks than exporting and contractual arrangements (Erramilli & Souza 1993), and have therefore traditionally been considered feasible for large companies but not for small firms with limited resources. The challenge facing foreign units established as a result of an FDI is that they need to be able to cope with problems of human-resource management and customer service almost from day one. Further challenges for smaller firms relate to staff turnover and the quality of the personnel, and a lack of experience in managing foreign units (Vachani 2005). All these challenges facing FDI operations call for very good marketing and management skills to enable the high risks and costs to be compensated with high returns. Obtaining customer information and managing sales networks becomes important, as does headquarters-subsidiary communication to coordinate all dispersed units. Thus, it could be said that it is vital for small companies engaged in resources-committing foreign operations to understand and satisfy their customers in order to enhance their business performance (Vachani 2005). 3.1 RISK ASSESSMENT FOR SMES WITH GLOBAL OPERATIONS Country risk in international markets is considered to be a composite of political, economic and social risks. These risk factors are the most salient in a firm's decision to enter a specific international market (Cosset & Roy 1991). Risks that prevail in a particular country can be categorized as either those that must remain outside the boundaries of the firm, or ones which may be internalised. Country (risks are most commonly related to external events which cannot be predicted, and therefore cannot be influenced significantly by SMEs. Country risk has several constituents, including political and also financial default risk. A country's political risk indicates the likelihood that political forces, often a reflection of underlying societal tension and unrest, may cause drastic changes in a country's business environment that may prove detrimental to foreign business interests. Corruption is a major component of country risk, influenced by national culture and institutions. It becomes a real problem for international SMEs when it becomes arbitrary, e.g. when the payment of bribes secures no guarantee of delivery. Similarly, an economic collapse in the host country, much like what occurred during the civil war following the breakup of the former Yugoslavia, can render a foreign firm's assets worthless. In less extreme cases, changes in a country's political regime may result in taxes increasing, limiting or prohibiting the repatriation of firm profits to the home country, or imposing exchange rate controls and restrictive technology licensing practices; all of these factors make a country less attractive for international market entry. In a similar fashion, a country's economic risk points to economic forces that may result in drastic changes in the business environment that is detrimental to business interests. Exchange Rate Exposure Business firms that operate in foreign countries are exposed to sudden and unexpected changes in exchange rates. Such changes may result in a purchased raw material becoming more expensive, products sold may generate less revenue, or the production in foreign subsidiaries may become less competitive. Consequently, such firms are exposed to foreign exchange risk. Even firms with no international activities may be hit by changes in exchange rates. Such a change may result in foreign competitors obtaining substantial cost advantages in the domestic market. Therefore, most firms are exposed to foreign exchange risk. Foreign exchange exposures originate from trade and from financial activities. Exposures from trade start from the moment of signing purchasing contracts, of pricing final products, or of delivering tender offers; they terminate when the payments are settled. There are several kinds of foreign exchange exposures. One is economic exposure: this is a long-term measure that includes future earnings and net assets. Many small businesses having international exposure act simultaneously as buyers and sellers on the international markets for both commodities and services. That implies that they have to manage both payables and receivables in a single foreign currency. Usually the payables precede the receivables. A firm that operates with a large number of payables and receivables may estimate at certain points in time the aggregated transaction exposure as a sum of contracted receivables less the sum of contracted payables. It is obvious that the aggregated transaction exposure changes over time as it stems from the set of cash flows entering and leaving the firm at different dates. Effective risk management involves recognizing these risks, then identifying, evaluating, measuring, analyzing, resolving, and monitoring them on a consistent basis. Calculations can be applied to decisions in both day-to-day operations and capital investment planning, such as choices about plant location. Psychic distance and the liability of foreignness Social and cultural differences while doing business in far away markets are inevitable. Foreigners have difficulty trying to break into the local social market. For instance, foreign investors have a great task of facing up to red tapes and governmental regulations protecting the local market in a country like China. The level of foreignness raises with market entry barriers such as unfamiliarity with culture, unfavourable political conditions, and competitive market environments. Each of these barriers increases the costs and risks of carrying out business abroad (Insch & Miller 2005). Entry barriers of foreign markets are directly associated with the “psychic distance factor” upsetting the course of knowledge and information between the market and the SME and consequently, increasing the local adaptation costs. For instance, foreign firms have to familiarize their product and technology with local market expectations and conditions. Accordingly, organizations need to adapt more technology under great uncertainty for the purpose of maintaining control over sub-units, which increases control costs. Furthermore addition to the costs of internalization is from unfavourable political conditions linked with foreign control and ownership. Significant such difficulties are because of the threats of expropriation and also the discrimination against foreign SME, for instance, through government support of native products. Therefore, for net profits of internationalization to be obtainable stable political conditions between the nations concerned are crucial (Chen & Griffith & Hu 2006). The level of internationalization depends upon industry characteristics. For example, various industries have high competition with many competitors, while, others have a few dominated major players and the competition is more expected. The intensity of competition in the host market also plays a significant role. Firms that avoid internal organization usually do better in such markets as these markets tend to be yield a lesser amount of profits and hence, do not validate high resource commitment (Insch & Miller 2005). When entering into a certain foreign market, small firms are inclined to choose either one of the patterns of internationalization. First, is the evolutionary internationalization process and second, is the revolutionary internationalization process. The evolutionary (gradual) internationalization process is to shift in foreign production stage after engaging in export stage, while the revolutionary (rapid) internationalization process is to start foreign production at entering instead of engaging in export stage. The rationale behind choosing the evolutionary pattern of internationalization is to avoid foreign operations as they are risky because of high foreign business costs due to foreign market entry barriers. Most small firms tend to prefer low-resource commitment mode than a high-resource commitment mode in the early stages of internationalization in order to keep the risks and costs to minimum for doing foreign business. Only when a firm would be certain about high rates of return from the foreign market, it will shift from the low-resource commitment mode to the high-resource commitment mode. Hence due to the influence of liability of foreignness, most SME would prefer the evolutionary pattern of internationalization in the occurrence of high cultural, competitive and political foreign market entry barriers, whereas, the revolutionary pattern is mainly to be adopted in the occurrence of lower barriers. Trust and affection are often highlighted to be basic to the development and maintenance of good business relationships and hence, crucial in internationalization of SME. It takes a long time of recurrent repetitive interactions of mutual approval to build up the level of trust and affection for fine and reliable relationships. The longer the relationship leads to deeper acceptance between the parties, and hence, the higher the likelihood to develop compulsory mutual trust and affection. Strong ties, particularly blood ties of family, have an inherited high level of trust and affection. Hence, the risks and uncertainties concerned in dealing with parties of stronger ties are therefore comprehended to be the lowest (Zaheer & Harris 2006). Strong-tie interpersonal network system often engages high interdependence and reliance amongst members, and hence enables an advanced level of risk bearing, vital information and knowledge, rare resource sharing, synergy exploitation among parties and legitimacy establishment (Gambetta 1988). From a market efficiency point of view, trust-based networks of strong ties permit an advanced flexibility of business activities at low transaction costs as of lower perceived uncertainties and opportunistic behaviour. This proves that a way of trust-based networking leads to a more effectual selection of alliance partners, management and sustaining of relationships, creation and leveraging of relational capital, and therefore, higher likelihood of success of business relationships. SME rely heavily on social networks for business dealings and partnering. Likewise, businesses are often made on goodwill trust, and business agreements (contracts) are mostly made verbally on an informal basis. Critical Role of Market Orientation For decades there has been debate among marketing researchers about what the concept of marketing entails. Consequently, the construct of market orientation was developed at the turn of the 1990s to determine how marketing should be, in concrete terms, implemented in companies. In its market orientation a business aims at sustainable competitive advantage and business performance by creating superior value for its customers (Narver & Slater, 1994). Recently, the literature has introduced the concept of innovativeness into the discussion in the classification of market orientation as proactive (responding to latent customer needs) or reactive (responding to existing customer needs). Yet, SMEs very often cannot avoid internationalisation due to the limited potential on their home markets, and thus need to manage marketing not only at home but also during their expansion into turbulent global markets. Existing studies on market orientation have confirmed the relationship of business performance with internationalisation in both manufacturing (Narver & Slater, 1994) and high tech companies. The concept of market orientation could be considered an outcome of the debate concerning the longstanding discussion about the implementation of the marketing concept. Terms such as customer orientation and marketing orientation, are so close to each other that hardly any distinction among them could be established — as long as the company understands its markets and the people who decide whether to buy its products or services. The construct of market orientation could be summarised as gathering customer- and competitor-related information, disseminating it through the organisation and exploiting it to satisfy the needs of the current market. In the internationalisation context, the issue of proactive and reactive market orientation is strongly linked to the time-to-market of the innovation. This is suggested to be a vital consideration, especially in the case of companies developing standardised high technology products since they are under constant pressure to innovate and to beat the competition in delivering the product quickly. The important decision of timing the market entry could be considered an indication of how managers perceive the current and future needs of the foreign target customers. Targeting their latent needs too proactively may lead an SME to enter the foreign markets too early before the customers are ready to adopt its software solution. On the other hand, too intensive a management focus on existing customer needs and a failure to innovate may result in the launching of the products after the competitors have already taken over the international market with more innovative solutions. 5.0 RECOMMENDATIONS As an SME operating in the textile manufacturer, the company faces both opportunities and threats if it focuses on international expansion for the purpose of selling its products as well as to procure raw materials and semi-manufactured products. Being successful in its domestic market operations, the company currently operates at two-thirds of its capacity and as such, the opportunities and advantages for internationalizing the business are clear. As mentioned above the company has to take into account factors such as political and economic risk along with specific culture needs of the target markets when expanding internationally. The company can utilize the additional capacity requiring relatively small capital investment to manufacture products and sell abroad to developed countries in Europe, North America and the Far East. Options like hedging foreign currency exposure and conducting detailed risk assessment before entering a foreign market are some of the tools that can be employed to offset potential losses while boosting profits. List of References Bell, J. McNaughton R. & Young S. (2001). ‘Born-again global’ firms — An extension to the ‘born global’ phenomenon, Journal of International Management 7, pp. 173–189. Chen, H., Griffith, D. A., & Hu, M. Y. (2006). The influence of liability of foreignness on market entry strategies: An illustration of market entry in China. International Marketing Review. 23, 636-649. Cosset, J.-C., & Roy, J. (1991). The Determinants of Country Risk Ratings. Journal of International Business Studies. 22, 135-142. Erramilli K.M. & Souza D.E., (1993). Venturing into foreign markets: The case of the small service firm, Entrepreneurship Theory and Practice 17/4, pp. 29–41. Fletcher, D. (2004), International entrepreneurship and the small business, Entrepreneurship and Regional Development, Vol. 16, pp. 289305. Gambetta, D. (1988). Trust: making and breaking cooperative relations. New York, NY, USA, B. Blackwell. Insch, G. S., & Miller, S. R. (2005). Perception of Foreignness: Benefit or Liability? Journal of Managerial Issues : JMI. 17, 423-438. Jones, M.V. &Coviello N.E. (2005). Internationalisation: Conceptualising an entrepreneurial process of behavior in time, Journal of International Business Studies 36/3, pp. 284–303. Katsikeas, C. and Morgan, R. (1994), Differences in perceptions of exporting problems based upon firm’s size and export experience, European Journal of Marketing, Vol. 28 No. 5, pp. 1735. Knight G.A. & Cavusgil S.T. (2004). Innovation, organizational capabilities, and the born global firm, Journal of International Business Studies, 35/2, pp. 124–141. Slater, S. F., & Narver, J. C. (1994). Market oriented isn't enough: building a learning organization. Cambridge, Mass, Marketing Science Institute. Vachani S., (2005) Problems of foreign subsidiaries of SMEs compared with large companies, International Business Review 14, pp. 415–439. Zaheer, A. & Harris, J. (2006) Interorganizational trust, In O. Shenkar and J. J. Reurer (eds.), Handbook of Strategic Alliances, Thousand Oaks: Sage: 169-197. Zahra, S.A., ( 2005). A theory of international new ventures: a decade of research, Journal of International Business Studies 36 (1), pp. 20–28. Read More