Theories of Firm Internationalisation

Firms internationalisation decisions can be driven by various motives, taking this into account, discuss in particular the choice of a firm of how to internationalise its production activities in terms of a trade off between ownership and market transactions.

After the World War II, there has been rapid growth in international trade in both goods and services, resulting in various transactions across national borders for the purpose of satisfying the needs of individuals and organisations. The result of this global competition has forced organisations to expand their business by finding out new markets at home and foreign countries making them ‘Transnational firms’. Dicken (2007) defines Transnational Corporations (TNC) as “A firm that has power to co-ordinate and control operations in more than one country, even if it does not own them”. Rugman and Hodgetts, 2003 says Multinational corporations, defined as “A company headquarter in one country but having operations in other countries”. The significance of TNC lies mainly in its ability to co-ordinate and control different transactions within transnational production networks, ability to take advantage of distribution factors of production and ability to be flexible in locations.

The growing TNCs led to various patterns and trends in international business like rapid growth in world trade and investment, cross border mergers and acquisitions resulting in the process of Internationalization. Internationalization is the process of increasing involvement in international operations across national borders which comprises both changed perspectives and positions. (Buckley and Ghauri, 1999)

Internationalization is one potential strategy that is being used increasingly by business firms to maximise size of the firm, increase their profitability, increasing their market share and becoming industry leader. It is a major attribute of the current strategy process of most business firms which determines the ongoing development and change in the international firm in terms of values, scope, principles, business ideas, action orientation, nature of work and converging norms. The internationalization dimension is related to all these aspects of the strategy process and thus making the firms become ‘Transnational’. In this global competition, it is important for the firm to become transnational and internationalization process focuses mainly on the development of the individual firm on its gradual acquisition, integration, and use of knowledge about foreign markets and operations. (Dicken, P., 2007)

Firms’ internationalization decision is mainly to acquire profits. The origins of the internationalisation of the industry are described by both macroeconomics approach, regarded as a general-system approach which is focused on the capitalist system as a whole, and microeconomics approach, based upon a firm-specific level. In a macroeconomics approach, the expansions of firms’ activities into foreign countries are explained by the circuits of capital and the theory of new international division of labour. A microeconomics approach entails the Dunning’s eclectic paradigm and the theory of product life cycle. As most TNC’s are capitalist enterprises, they behave according to basic rules of capitalism, the ways in which firm acquires profits along with various motives like increasing their market share, becoming industry leader or simply making firm bigger. But above all, the most important factor for internationalization is the pursuit of profits. In this competitive economy, competition between firms is becoming increasingly global and much more volatile not just confining them to national level but with firms across the world. Thus TNCs simply explain the need for internationalization at macro level in pursuit of profits and performance better in the global competitive economy. (Dicken, P., 1992)

The new international division of labour, proposed by Stephen Hymer, is used to explain the shift of industrial production from the core (the industrialised countries) to the periphery (the developing countries). Firms in developed countries due to increasing wages in their home countries are forced to seek the alternative locations providing cheap labour, which are the third world countries. Dicken (1992) points out that even though this concept has some validity in explanation of internationalisation process, it also contains several drawbacks as it is excessively narrow and one-dimensional and it overstates the extent to which industrial production has been relocated to the global periphery.

Micro level approach is an approach to understand the internationalization of economic activity through the TNC which is much as firm specific. The decision to become global firm is made by individual firms or more by decision makers in the firm rather than focusing upon the decisions at capitalist system as a whole like in macro level approach. According to Hymer’s pioneering study in 1960, domestic firms will have natural advantage over foreign firms in terms of better understanding of local market conditions and business environment. But, a foreign firm wishing to produce in any other market would have to posses some firm specific assets which overcome the natural advantages of domestic firm. These firm specific assets are like size of the firm and economies of scale, access to raw materials, marketing skills, technological expertise, reduced transaction costs or access to cheaper sources of finance, which makes a foreign firm to compete domestic firm in its home country. Hymer’s study expressed that the firm wishing in transnational production would have its own set of qualifying principles specific to ownership which overcome the advantages of indigenous firms in the country of production. (Nilsson, J.E, Dicken, P., Peck, J., 1996)

In 1966, Vernon developed the product life cycle to explain the observed pattern of international trade. The theory suggests that in the earlier stages of product’s life cycle all the production activities of a product is done in the place in which it was invented. Once the product is used in the markets, production gradually moves away from the point of origin to the places with low production costs and high market activity, in order to acquire high profits by the firm. There are four stages in product life cycle: Introduction, growth, maturity and decline. The location of production depends on the stage of the cycle. In the introduction stage the firm seeks to build product awareness and develop a market for the product. In the growth stage, the firm tries to increase brand preference and market share. At maturity stage, the strong growth in sales decreases due to heavy competition between similar products. At this stage the primary objective of the firm is to defend the market shares by expanding into new markets or low developing countries (LDCs) to maximize profits. In the final stage, due to decline in the sales, the firm tries to maintain the product by adding new features and targeting new markets. (Dicken 2003)

According to Dunning’s Eclectic Paradigm, a firm will engage in international production when each of the following three conditions is present: 1. Owner specific advantages, 2. Location specific advantages and 3. Internalization advantages. As the three principles are derived from variety of theoretical approaches such as the theory of the firm, organization theory, trade theory and location theory, dunning labelled his approach as ‘eclectic’ which integrates various strands of explanation of international production.

Owner specific advantages or Firm specific advantages are assets which are internal to firm. Every firm must possess certain ownership specific advantages which are unique compared to their competing firms from other countries. These firm specific advantages are intangible and transferred within the TNC at low cost (e.g., technology, brand name, and benefits of economies of scale) which either provides higher revenues or lower costs that can reduce operating costs compared to its competitors in a foreign country.(Wattanasupachoke, 2002)

A firm must possess location specific advantages to exploit its assets in foreign rather than domestic country. Therefore the location specific advantages of different countries are important in determining which will become host countries for the transnational corporations. They constitute economic, political and socio cultural advantages which are important factors in the context of transnational production. (Wattanasupachoke 2002)

Transnational corporations choose internalization where the market does not exist or functions poorly. There must be internalization advantages to the firm from exploiting its advantages itself, rather than selling them or leasing them. The more uncertain the environment faced by the firm (which may be due to price, quality and availability of raw materials) the more likely a firm internalize its operations. Internalization occurs in the case of knowledge and technology, where many firms spend huge sums of money on various research and development. To ensure satisfactory returns on the investment without selling or leasing the technology to other foreign firms, the firm itself exploits its technological advantage directly by setting up its own production facilities. (Whitley, R., 1994)

Under ‘eclectic theory’ other theories of internationalization are more concerned with the processes that a firm must go through. Sequential theory of internationalization is a process in which a firm enters into the foreign market. It is also called as ‘Uppsala model’ and the firm enters other markets through four discrete stages: Intermittent exports, exports via agents and through licensing, overseas sales through knowledge agreements with local firms (example franchising) and foreign direct investment (FDI) in the foreign market.

Initially, the firm is purely a domestic firm in terms of both production and markets. Once the firm reaches saturation point in its domestic market, it looks into foreign markets in order to maintain growth and profitability. During early stages, the firm does this through exports using the services of overseas sales agent, who are independent of the exporting firm. In the second stage, the process of gaining control over its foreign sales is achieved by setting up its own sales outlets. This can be done in two ways, either by setting up an entirely new outlet or by acquiring local firm. When the firm performs better and acquires good profits, it decides on establishment of entire production facilities with consideration of its favourable factors in a foreign market. Figure1 shows the path of development of a firm in the evolution of a transnational corporation. (Wall and Rees, 2004)

In a network perspective, the process of internationalization is like creating new relationships or building on existing relationships in international markets, with the focus shifting from the organizational to that of social. It is people who make decisions and take the actions. The series of networks are considered at three levels: Macro, Inter-organizational and Intra-organizational. (Wall and Rees, 2004)

In network theory, the business environment is seen as a set of diverse interests, powers, characteristics which advances on national and international business decisions. At macro- level, a firm has to break old relationships or add new ones to enter new markets. A new entrant finds difficult to break into a market that already has stable relationship. Such firms are able to reconfigure the existing networks, thus more successful in internationalization process. At Inter-organizational level, firms are good in different relationships to one another in different markets. They may be competitors in one market, collaborators in other and ‘suppliers and customers’ to each other in a third. Thus, if one firm internationalizes it draws other firms into international production. At intra-organizational level, relations within the organization influence the decision making process. If a transnational corporation has its subsidiaries in other countries, decisions taken at the subsidiary level increases the degree of international involvement of the parent TNC, depending on the degree of decentralization of decision making by the firm. (Wall and Rees, 2004)

The various theories explain the process of internationalization and results in the firm’s motivation for engaging in transnational operations. When a firm decides to establish a production facility in the foreign market it mainly focuses its interests in terms of size of the market and availability of requirements which are useful for the production facility. Though firm’s motivation in transnational production is highly individual, still it can be broadly classified into two categories: Market Orientation and Asset Orientation. (Dicken, 2007)

Most foreign direct investment in the process of transnational production is designed to serve a specific location market by taking consideration of market size and other conditions. The goods and services produced in the foreign country are almost identical to that being produced in the firm’s home country but the firm modifies its products slightly in order to gain the tastes and preferences of the local market. Market oriented investment is a form of horizontal expansion across national boundaries which concentrates on three factors in making up the decision of the location. The most important factor is a size of the market measured in terms of per-capita income rather than in terms of population. For example, countries in Europe and US, though they have less population, their per-capita income is high. Population in countries with low income levels spend larger portion of their income on basic necessities while people in countries with high income levels spend higher portion of their income on higher order manufacture goods and services. The last important factor for market oriented production is accessibility into the markets (transportation) and other political barriers. (Dicken, 2007)

The choice of strategy for transnational production will be influenced by the reasons for becoming transnational. Foreign direct investment is designed to take advantage of the fact that the various assets that a firm needs to produce are not available in the same quantity and quality everywhere. So, it is important for a firm to consider about asset orientated production when it becomes transnational. It is broadly classified into two ways: Technology and labour. Firm benefits from the production costs if there are low labour costs along with high technology. Variations in wage costs, labour productivity and knowledge and skills constitute asset based advantages to the firm becoming transnational.

Once a firm has decided to go international, it takes place in wide variety of ways, most of which can be classified into three broad categories:

• Export based methods
• Non- equity methods
• Equity methods

Export based methods for internationalization

It is the most common way in which a firm becomes international, by producing its products in the domestic markets but exports a proportion of its products to foreign markets. Exporting is an oldest and straight forward way of carrying international business. Its growth can be reduced to the liberalisation of trade that has taken place globally and within regional trading blocs due to concept of free trade like European Union (EU), NAFTA (North American Free Trade Association), ASEAN (Association of South East Asian Nations), and APEC (Asia Pacific Economic Corporation). The export based methods of internationalizing are divided into ‘indirect exporting’ and ‘direct exporting’. (Wall and Rees, 2004)

Indirect exporting: When a firm does not have any international activity by itself then it operates through intermediaries for physical distribution of goods and services in the foreign market. Initially an export house buys products from domestic firm and sells them abroad on its own account. A confirming house acts for foreign buyers where it brings sellers and buyers into direct contact and guarantee payments on a commission basis. Finally a buying house performs functions in seeking out sellers to match buyer’s particular needs.

Direct exporting: In this form a firm is directly involved in distributing and selling its own products to the foreign markets. It is long term commitment to a particular foreign market with the firm choosing local agents and distributors specific to that market. It allows the exporter to monitor developments and competitions in the host market. It promotes interaction between producer and end user with long term commitments such as providing after sales services to encourage repeat purchases.

Non- Equity based methods for internationalization

In this form of internationalization, the firm either sells technology or do business in the form of contract, involving patents, trademarks and copyrights. It is often referred to as intellectual property rights and form major part of international transactions. This non-equity method of internationalization takes into forms of licensing, franchising or other types of contractual agreement. (Wall and Rees, 2004)

Licensing: It is a permission granted by the licensor (proprietary owner) to a licensee (foreign party) in the form of a contract to engage in an activity which is otherwise legally forbidden. The licensee buys the right to exploit technology and products from the licensor, which is protected by the intellectual property rights like patent, trademark or copyright. The licensor benefits from the licensee’s local knowledge and distribution channels; also it is a low cost strategy for internationalization since the foreign entrant makes little or no resource commitment. This type of agreement is mostly found in industries like R&D and other industries where fixed costs are high. (Rugman and Hodgetts, 2003)

Franchising: In this form, the franchisee purchases the right to undertake business activity using the franchisor’s name or trademark rather than any patented technology. Many firms choose franchising as a means of internationalizing as it establishes firm’s business in short time with relatively little direct investment and creates global image through standard marketing approach. It allows franchiser a high degree of control and enables to understand the local taste and preferences in the foreign country. For example, Coca-Cola’s franchising arrangements with various partners in different countries has given an advantage over its arch rival PepsiCo. Franchising also helps in building up global brand which can be cultivated and standardised overtime. (Wall and Rees, 2004)

Other contractual modes of internationalization: Besides licensing and franchising, Management contracting is another form of internationalization where a supplier in one country provides certain ongoing management functions to a client in another country. Examples include technical service agreements are provided across borders, as when a company outsources its operations to a foreign firm. Contract-based partnerships are also formed between different nationalities in order to share the cost of an investment. For example, pharmaceutical companies, automobile companies make agreements between themselves to include cooperation, co-research and co-development activities. (Wall and Rees, 2004)

Equity based methods for internationalization

When a firm physically invests in any another country, it is referred as Foreign Direct Investment (FDI). The major advantage of this method is that the firm has greatest level of control over its proprietary information and technology. A firm can use different ways to FDI by acquiring an existing firm, creating equity joint ventures, merging or establishing a foreign operation by its own (green-field investment). (De Propris, L., 2009)

Acquisition and Establishment of a firm by its own (green-field investment): Acquisition of an existing foreign company has a number of advantages compared to green-field investment. For example, it allows an immediate presence in the market which results in a fast returns on capital and ready access to knowledge of the local market. Also, problems associated with green-field investments such as cultural, legal and management issues are avoided.

Joint Ventures: It involves creating a new identity in which both the initiating partners take active roles in formulating strategy and making decisions. It helps to share technologies and lower the costs of high risks in various development projects. Joint Ventures make firm to gain economics of scale and scope in value adding activities on a global basis. It creates a firm to secure access to partner’s technology and accumulate learning process which is used for more effective future competition in the industry. Joint Ventures are common in high technology industries; it usually takes one of the two forms: Specialized Joint Ventures and Shared value added Joint Ventures. (Wall and Rees, 2004)

In Specialized Joint Ventures, each partner brings a specific competency like one firm might indulge in a function of production and other does with marketing. For example organizations like JVC (Japan) and Thomson (France) have been into specialized Joint Venture where JVC contributed the specialized skills involved the manufacturing technologies needed to produce optical and compact discs, semiconductors while Thomson contributed the specific marketing skills needed to compete in European markets. In Shared value added Joint Ventures, both partners contributed to same function or value added activity. For example in the case of Fuji-Xerox, it is a shared value added Joint Venture with the design, production and marketing function all shared between two firms.

Merging with a firm: In this equity based method for internationalization, a firm uses FDI by merging with a firm in the foreign country by buying its stake and holding appropriate ownership in the form of equities. It helps to extend its business rapidly and can use its infrastructure and knowledge about local market to improve its market share compared to its competitors.

In equity based methods for internationalization, creation of consortium is one of the oldest forms of foreign direct investment. East Asian business models like Japanese Keiretsu and South Korean chaebols are more successful in building cross industry consortia when compared to western countries. Consortium of these types are sophisticated forms of strategic alliances designed to maximise the benefits like risk sharing, cost reductions, economies of scale etc .They tend to have long term and stable inter firm relationships based on mutual obligations in order to be forerunner of technology based industries. The Japanese Keiretsu is a combination of 20-25 different industrial companies centred on a large traditional company where transactions conducted through alliances of affiliated companies. It is divided into two forms, horizontal keiretsu which consists of highly diversified groups which are organized around core bank and general trading company (For example, Mitsubishi, Mitsui and Sanwa). Vertical Keiretsu is organized around a large parent company in a specific industry like Toshiba, Toyota and Sony etc. There are strong linkages between these two forms and the organization is extremely complex and wide reaching. (De Propris, L., 2009 and Wall and Rees, 2004)

The South Korean chaebols, usually dominated by the founding families are similar consortia which are centred on a holding company. While a Keiretsu is financed by group banks and run by professional managers, chaebols get their funding from governments and are managed by family members. Examples include Samsung, Daewoo etc are industrialist families and the company keeps the stock in family hands. (Wall and Rees, 2004)

When a firm becomes transnational, it has specific impacts on both host economies and home economies. The impacts like transfer of resources, capital, technology, an increase of employment, concerns about sovereignty and trade and balance of payments occur on the host economy. The specific impacts on home economies will be like loss of technology, sovereignty, loss of employment and tax avoidance.

Conclusion

In the process of globalisation, a firm operates their activities globally and the internationalisation process is one of the primary sites of attention. The changes in the technology in the fields of telecommunications and computer lessen the costs of cross border operations and encourage firms to engage in transnational production activities. Internationalisation is a sequential process where firms internalise their economic activities characterised in terms of aggressiveness and motivated by either internal or external triggers or a combination of both. It is one of the key strategic decisions for firms to maximise or at least sustain profits to survive in the world of uncertainty and complexity. The global economic expansion has been largely facilitated by the growth of TNCs. They dominate world trade and capital movement with turnover exceeding the GNP of some countries. These corporations continue to grow and influence the landscape of the world economy.

The various motives for the firms internationalization process has been discussed and the ways in which firm use FDI to engage in the transnational production makes it to compete globally. It seems clear that theories of internationalization make the firm to take up decision to become transnational with each specifying its implications and benefits. Dunning’s eclectic paradigm emphasis on OLI advantages, stating a firm will engage in international production when each of the following three conditions is present.

The various theories explain the process of internationalization and when a firm decides to establish a production facility in the foreign market it focuses mainly on the market size. Though firm’s motivation in transnational production is highly individual, still it is classified into Market Orientation and Asset Orientation which states the conditions for the firm to become transnational corporation. When firm decides to go international the various methods of internationalization like equity based, non equity based, export based are used to engage its production activities in terms of a trade off between ownership and market transactions.

References

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