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TWO THEORIES ON INTERNATIONALISATION OF FIRMS

TWO THEORIES ON INTERNATIONALISATION OF FIRMS

 

 

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INTRODUCTION

‘Internationalisation’ is the process by which a business or an enterprise expands its operations to or increases its involvement in foreign or international markets. The reasons for entry into international markets can vary and these partly define the mechanisms by which the process takes place. (Calof and Beamish 1995)

Internationalisation is usually driven by a set of factors that can fall into either of two possible categories. To put it simply, firms are either attracted by the advantages and possibilities for growth offered by unexplored international markets, or else they are compelled to seek further arenas for operation when the domestic market no longer offers scope for expansion. (Ibid.) Usually, the latter scenario occurs when the domestic market is saturated and the firm faces a great deal of domestic competition to the extent that supply far outstrips demand. It can also occur due to factors such as lack of market stability or various outside factors such as political changes that also affect business. It is also possible that while the present situation is stable, the company may anticipate such challenges in the future and determine to seek other avenues for business abroad.

In instances where a foreign market is as yet untapped or where the competition is relatively low, internationalisation offers lucrative opportunities for expansion. Being the first to get to a new market allows the company to establish itself and exploit the benefit of monopolising that sector until competition springs up. Another advantage of doing so is the possibility of risk diversification. In other words, the company is able to spread out the risk over a more expanded market, which means that it is less vulnerable to changes in consumer trends. Additionally, an expanded consumer base allows for economy of scale thus leading to a greater competitive advantage.

In modern times, globalisation has been one of the most significant driving factors for internationalisation of firms both large and small. The historical process of colonisation demonstrated some of the advantages of having a presence across multiple markets. As we have seen, colonisers used their colonies as captive markets for their goods. Arguably, the bigger advantage was the possibility of access at low prices to resources that may not have been available to them otherwise. Examples of such resources include land, labour, and raw materials. Hence, one of the prime motivations for internationalisation is often the search for certain kinds of resources.

Now that we have discussed some motivations for firms to go international, it is important to consider how they do this and in what form. Often, the process is a gradual and incremental one, and companies may opt to initiate it by means of imports and exports. This may be likened to a testing of the waters.

Yet another way to gain a foothold in an international market is by way of licensing or by entering into a joint venture with a local firm. Another option is foreign direct investment and this is seen in instances where the firm demonstrates a clear intention to develop long-term operations in the foreign market. The method eventually chosen depends on the stimuli, rationale, intentions, and scale of the firm in question. (Wakasugi and Tanaka 2009)

There exist multiple theories that attempt to describe and understand the process of internationalisation of businesses/firms. These theories also offer templates for firms interested in expanding to foreign markets to base their strategies on. In this essay, we shall consider two theories in particular, namely, the Uppsala model and the Transaction Cost Analysis or TCA model. We shall pay attention specifically to how these models account for the motivations behind internationalisation and how they explain the ways in which this process plays out. Finally, we shall consider some limitations and criticisms of these models.

UPPSALA MODEL

The Uppsala Model was introduced by Swedes Johanson, Wiedersheim-Paul, and Vahlne in 1975 (Johanson and Wiedersheim-Paul 1975) and later in 1977.(Johanson and Vahlne 1977)  More recently, in 1990 (Johanson and Vahlne 1990) and 2009,(Johanson and Vahlne 2009) the model has been updated to reflect key paradigm shifts in the field.

Theories current in the 1970s prioritised costs, risks, and objective market characteristics as the main factors to be taken into consideration when formulating a strategy for internationalising a business. The Uppsala researchers observed that these theories did not adequately account for cultural differences and how these factors could determine the challenges faced and the path that companies might choose to adopt for internationalisation.

One of the key features of this model based on behavioural theory, therefore, is that it stresses the concept of knowledge accumulation and ‘psychic distance’, explaining the incremental steps taken by companies as they expand from domestic markets into foreign ones. In business terms, ‘psychic distance’ refers to perceived cultural differences between foreign markets and domestic ones. Psychic distance does not correlate with physical or geographical distances. Rather, it refers to modes of operation, work ethics, politics, language barriers, and various other cultural determinants that can have an empirically demonstrable impact on businesses. Two countries with shared professional practices and cultural beliefs would be considered psychically close whereas two countries with strong differences in these aspects would be psychically distant.

According to the Uppsala model, businesses initiate their process of internationalisation by engaging first with those markets that are relatively psychically close through imports and exports. Knowledge and insight are prioritised here. In a market that is deemed psychically nearby, the company has the benefit of a deeper understanding of the market and operational practices as well as enhanced control over resources. Hence, the chances of a positive payoff are enhanced. As the company accretes experiential knowledge through this engagement, it begins gradually expanding into markets that are psychically distant.

The four successive stages of international expansion as outlined by the Uppsala model are given below:

1: Sporadic exports.

2: Regular export through an independent representative.

3: Setting up a foreign sales subsidiary.

4: Establishment of production and manufacturing in a foreign country.

As we can see, this model postulates a growing business commitment and deeper engagement as knowledge and confidence are gained. In fact, the authors of the theory have even developed a matrix showing the linear progression of internationalisation in ever more psychically distant markets as knowledge grows. However, this concept has been criticised for being too deterministic and for not accounting for the multiple modes through which entry into international markets often takes place in practice. Businesses often opt for mixed modes of entry without necessarily going in for the traditional import-export method outlined here. They may skip or shuffle up the stages listed above. In fact, the possibility of licensing (another popular choice) was also not accounted for in the original iteration of the theory. Additionally, it has not been empirically demonstrated that assuming that greater prospects are available, the growth of experiential knowledge inevitably leads to a proportionate increase in market commitment. (Carneiro et al 2008)

One of the strengths of this model, as acknowledged by theorists and practitioners alike, is that it accounts for the cultural differences that are likely to determine the strategies a company must employ when it seeks to expand beyond the home market. The model of operations employed in the home culture cannot be transplanted wholesale in a foreign business environment and the process must necessarily be one of adaptation and trial and error. Elaborating on the model in 1990, the authors added that it was not always necessary to start from the ground up when entering a foreign market.(Johanson and Vahlne 1990) If the firm had already accrued experience of conducting business in a few foreign markets, this knowledge could under some circumstances be generalised sufficiently to allow a smoother transition into subsequent international markets.

A later re-working of the theory adopted a more network-based conceptualisation of markets and this point of view proved more enriching and amenable towards developing the idea of relationships and how being an insider or outsider can define opportunities for growth in a foreign market. (Johanson and Vahlne 2009)

TRANSACTION COST ANALYSIS

Transaction cost economics adopts a specific approach towards formulating a theoretical framework for positing when and under what conditions certain economic actions might be undertaken by a firm. In the field of economics, a ‘transaction cost’ is defined as a cost that is incurred for participating in an economic activity or transaction of some sort. (Williamson 1981)

Thus, conditions that engender lower transaction costs tend to encourage the growth of economic activities. To put it differently, a firm would always seek to adopt the pathway that ensures the lowest transaction costs when conducting any sort of economic activity and this applies equally to internationalisation strategies. (Ibid.)

The term ‘transaction cost’ was coined by Ronald Coase although the concept of economic actions being based on transactional lines is, of course, much older. (Ibid.) This framework, when adopted as a lens through which to examine internationalisation, provides a certain understanding of the motives and the strategies employed by firms in order to expand operations beyond the home market. In contrast to the Uppsala model, this theory takes a far more objectivist approach.

In particular, it underlines that close consideration of transaction cost and the best strategies to minimise it have direct implications for the choice of entry mode.(Anderson and Gatignon 1986) For instance, if collaboration with a local partner helps to keep transaction costs lower as compared to foreign direct investment, then the former would be the optimal choice. Hence, these choices directly influence the organisational structure of the firm as an international presence.

Of course, the exact nature of transaction costs varies from one industry to the other. In general, though, transaction costs include (but are not limited to), the time and resources spent on obtaining information about the market and buyers, conducting negotiations, creating agreements, monitoring, legal enforcement, and so on. In a more competitive market, multiple suppliers are available, and opportunism is disincentivised which means that greater efficiency is encouraged, keeping transaction costs lower. (Reid 1983)

This model has been criticised as incomplete and impractical. It has needed to be extended to include production costs besides transaction costs in order to make it more well-rounded and useful. (Ghoshal and Moran 1996) The Eclectic Paradigm grew out of the TCA model in this manner. To sum it up, the Eclectic Paradigm is based on the premise that firms will avoid transactions on the open market when the costs of conducting transactions internally are demonstrably lower. Therefore, in order for foreign direct investment to serve as a viable action, there must be three kinds of advantages. These are a comparative advantage, ownership advantage, and internalisation advantage. (Rugman 2010)

Another criticism is that it has also been demonstrated through empirical experience that sometimes, opportunistic expansion under less than optimal conditions eventually leads to stabilisation and lowering of transaction costs.

CONCLUSION

The two theories described in this essay adopt fundamentally distinct approaches toward the subject of internationalisation of firms. The Uppsala model, in fact, has been dubbed a ‘behavioural’ model,(Forsgren 2002) in contrast to others like the TCA model which is rooted in a more traditional paradigm of economics. The latter takes a highly objective and rational viewpoint towards internationalisation while the former accounts for subjective differences that may have great significance in the context of practice.

However, both frameworks have been modified in response to the emergence of the more recent network model,(Hakansson and Johanson 2002) which takes into account both inter-organisational and inter-personal relationships. (Agndal and Chetty 2007)

REFERENCE LIST

Agndal, H. and Chetty, S., 2007. The impact of relationships on changes in internationalisation strategies of SMEs. European Journal of Marketing41(11/12), pp.1449-1474.

Anderson, E. and Gatignon, H., 1986. Modes of foreign entry: A transaction cost analysis and propositions. Journal of international business studies17(3), pp.1-26.

Calof, J.L. and Beamish, P.W., 1995. Adapting to foreign markets: Explaining internationalization. International business review4(2), pp.115-131.

Carneiro, J., Rocha, A.D. and Silva, J.F.D., 2008. Challenging the Uppsala internationalization model: a contingent approach to the internationalization of services. BAR-Brazilian Administration Review5(2), pp.85-103.

Forsgren, M., 2002. The concept of learning in the Uppsala internationalization process model: a critical review. International business review11(3), pp.257-277.

Ghoshal, S. and Moran, P., 1996. Bad for practice: A critique of the transaction cost theory. Academy of management Review21(1), pp.13-47.

Hakansson, H. and Johanson, J., 2002. 3.2 A model of industrial networks. Understanding Business Marketing and Purchasing: An Interaction Approach, p.145.

Johanson, J. and Vahlne, J.E., 1977. The internationalization process of the firm—a model of knowledge development and increasing foreign market commitments. Journal of international business studies8(1), pp.23-32.

Johanson, J. and Vahlne, J.E., 1990. The mechanism of internationalisation. International marketing review7(4).

Johanson, J. and Vahlne, J.E., 2009. The Uppsala internationalization process model revisited: From liability of foreignness to liability of outsidership. Journal of international business studies40(9), pp.1411-1431.

Johanson, J. and Wiedersheim‐Paul, F., 1975. The internationalization of the firm—four Swedish cases. Journal of management studies12(3), pp.305-323.

Reid, S., 1983. Firm internationalization, transaction costs and strategic choice. International marketing review1(2), pp.44-56.

Rugman, A.M., 2010. Reconciling internalization theory and the eclectic paradigm. Multinational Business Review18(2), pp.1-12.

Wakasugi, R. and Tanaka, A., 2009. Firm heterogeneity and different modes of internationalization: Evidence from Japanese firms.

Williamson, O.E., 1981. The economics of organization: The transaction cost approach. American journal of sociology87(3), pp.548-577.

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