Foreign Market Entry

Essential summary

With the exception of a few firms that were “born-globals”, most of the world’s leading MNEs grew up in a home market where they were able to achieve the critical mass they felt was necessary before venturing abroad. This means that at one point in time, each had to make a conscious decision to internationalise — with the question then becoming how (see Figure 6.1) and why they made the decisions they did. Analysis here involves both the strategic elements typifying each kind of market entry mode as well as more subjective factors like managers’ “commitment to internationalisation’’ and attitudes towards cross-border risk.

Ladder of internationalisation choices

Figure 6.1 Ladder of internationalisation choices.

Internationalisation mindsets and strategies

Prime theories

The seminal construct in international business studies is Swedish professors Johanson and Vahlne’s famous “Uppsala model”, which views foreign expansion as a gradual learning process where firms only commit resources abroad as they become accustomed to working in new environments. This “stages of internationalisation” approach predicts that managers first cross borders via trade modes committing fewer resources — simple import or export contracts — before engaging in Foreign Direct Investment (FDI) modes, which require a greater commitment of assets and therefore entail greater risk. The model also assumes that managers tend to prefer that their company’s first move abroad be to a neighbouring country characterised by a lesser “psychic distance” from their home market — and that it is only once they have developed confidence in their ability to operate internationally (and process previous experiences) that they will venture even further afield.

The key factor here is the variability of human reactions to the uncertainty associated with the relative “foreignness” of a given environment. Uppsala views international business decision-making as highly subjective. Hence its focus on practitioners’ risk attitudes and mindsets (“domestic” or “global”), with company size being another relevant factor.

Other theories place greater emphasis on more strategic thinking. Network theory, derived from work done by American sociologist Mark Granovetter, infers for instance that it is actors’ desire to link into a powerful cluster of activities that drives behaviour such as internationalisation. In this view, more objective factors like business potential have greater weight than the subjective risk attitudes highlighted in Uppsala theory. Otherwise, there is the value chain approach — largely constructed on the back of insights formulated by the economist Alfred Marshall — asking whether a MNE seeks to reduce uncertainty by engaging in the same sorts of activities abroad as at home (so-called horizontal internationalisation) or else pursues “vertical” integration by controlling different upstream or downstream activities overseas. Lastly, “transaction cost” analysis, based on theories developed by economists like Oliver Williamson, view market entry decisions as attempts to minimise the costs of locating different value chain activities in different countries — an approach which includes consideration of the fact that for companies operating in geographically isolated and/or saturated (hence low-margin) home markets, the decision not to internationalise may be the riskiest of all.

Trade vs FDI, or the “borders of the firm” debate

The easiest way to engage in international business is not to change the business “configuration” (what it does where) and simply trade from home, that is, import inputs from foreign suppliers or export outputs to foreign customers. This keeps a company focused on its tried and tested core competencies and frees it from having to develop international manufacturing, sales or logistics capabilities.

A decision to enter foreign markets via trade as opposed to FDI might also be a reflection of the general paradigms underlying executives’ action. The main debate here is between a “small is beautiful” willingness to outsource some activities to (foreign) specialists capable of performing them better and/or more cheaply versus the argument that companies should maximise control and internalise value chain margins by doing everything themselves via FDI. Viewed in this light, internationalising via trade is an example of a construct developed by British economist Ronald Coase where managers draw narrower “boundaries of the firm” (see Figure 6.2). Note that this calculation can be based on financial considerations (with import/export becoming an interesting option if FDI costs are higher than the value added that the trade-only MNE would otherwise share with foreign suppliers and/or vendors) but also on psychological factors (executives’ risk-averse preference for limited intervention).

Of course, where companies’ only internationalisation involves trading with other value chain intermediaries, they become dependent on the latter, something that can cause problems. Import/export contracts might be incomplete and not cover certain troublesome scenarios (bad quality, unreliable deliveries, late payments). There is also the risk that

Value added and the boundaries of the firm

Figure 6.2 Value added and the boundaries of the firm.

an opportunistic supplier or vendor might appropriate the company’s know-how and expand its own operations up or down the value chain to become a direct competitor.

Horizontal us vertical FDI

This explains many firms’ preference for internationalising via FDI, whose flows account directly today for anything between 3% and 5% of global GDP, vs. less than 1% before the early 1990s. As aforementioned, one key delineation at this level is whether the FDI is horizontal in nature and therefore involve a relatively straightforward transfer of knowledge from one country to another, or if it is vertical, with the MNE incurring the risk of having to develop a new kind of activity in a new environment. Horizontal FDI tends to dominate in high-tech sectors where protecting the confidentiality of a company’s intellectual property is paramount. Having said that, it also costs more since it duplicates activities on several sites. Moreover, output from an MNE’s horizontal plants will tend to reduce exports from its existing units, affecting the latter’s economies of scale.

On the other hand, these are losses only felt by the MNE’s individual plants — at the broader level of the company as a whole, horizontal FDI can increase economies of scale due to the fact that many assets (especially intangible ones) will not in fact have to be reproduced everywhere. This goes a long way towards paying horizontal FDI’s duplication of overheads.

Vertical FDI, on the other hand, will often see a company build specialist “focused factories” in different countries, with each engaged in just one specific value chain activity. The advantage of this configuration is that each unit benefits from the competitive advantages inherent to its location, thereby achieving site-specific economies of scale and learning. More and more internationalisation is based on this intra-firm logic today, with MNEs’ “offshoring” of various functions culminating in in-house units trading with one another up and down the value chain.

The downside for MNEs with this configuration is that increased shipments between international sites raise “trade costs” like packaging, transit time, freight and tariffs. Some MNEs try to reduce these costs by focusing production on fewer sites, mainly ones with good transport links to the plants where the final product will be assembled. At a certain juncture, however, managers may decide that vertical integration’s overall trade costs exceed the benefits. They may then transition to “vertical disintegration”, drawing the boundaries of their own firm more narrowly and increasing trade with external partners

Foreign market entry 69 instead of the offshore units owned by the MNE itself. This logic has been a key factor driving the decades-long explosion in international outsourcing (see Chapter 8), with some studies indicating that intermediate goods have accounted for something like 60% of all global trade in recent years.

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