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developing new theories of international business to explain why and how companies internationalize. Internationalization theories are ...
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Authors
Mohibul Islam Masum & Alejandra Fernandez
Group: 1964
Date: 03 June, 2008.
Level: Master Thesis in International Business and Entrepreneurship, 10p (15 ECTS).
Authors: Mohibul Islam Masum Alejandra Fernandez Student ID: 820101-P312 Student ID: 811231-P Västerås Stockholm
Title: Internationalization Process of SMEs: Strategies and Methods.
Tutor: Tommy Torsne.
Research Issue: Nowadays, technological advancements, declining trade barriers etc are driving the world economy to become more and more integrated and this rapid globalization is enabling SMEs to become international in a quicker yet effective manner. The basic issue of our research was to describe the internationalization process of SMEs with a focus on the roles of the three theories.
Research Purpose: The purpose of this research was to gain a better understanding of
the internationalization process of SMEs, particularly the application and usefulness of the three main theories: the Uppsala Model, Network Theory and International Entrepreneurship Theory.
Research Question: What are the roles of the three theories in describing, explaining and guiding the internationalization process of SMEs? Which aspects of these theories are most useful to the SMEs’ internationalization process?
Method: Both qualitative and quantitative research methods has been applied in this study. Data were gathered by conducting closed interviews and an attempt was made to measure them statistically.
Conclusion: Our research shows the application and usefulness of the three theories to these SMEs, especially their heavy reliance on network relationships. The findings also indicate that firms use a combination of variables from all three theories and some aspects of the much criticized Uppsala model are still significant in describing the internationalization process behavior of SMEs.
Keywords: Internationalization, SMEs, Uppsala Model, Network Theory, International Entrepreneurship Theory, INVs.
CEO Chief Executive Officer FDI Foreign Direct Investment IET International Entrepreneurship Theory INT Internationalized SMEs INVs International New Ventures MNEs Multinational Enterprises Non-INT Non-internationalized SMEs SMEs Small and Medium Enterprises U-model Uppsala Internationalization Process Model USA United States of America UK United Kingdom
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1. Introduction
In this chapter we will present the background of our study and state the purpose and target group of it. Then we will discuss the research questions and delimitations and the structure of the study.
As the students of international business, we recognize that small and medium enterprises or SMEs and various aspects of their businesses especially the internationalization process has been of much attention to the scholars, academics and businesspeople during recent years. SMEs have been drawing a lot of attention of scholars by playing an increasingly active role in international markets during recent years. SMEs rapidly expand their businesses to international markets and use international diversification as an important strategic option to achieve growth. The topic area brings some of the ‘much talked about’ theories and models into action such as The Uppsala Internationalization Process Model, Network Theory, International Entrepreneurship Theory as well as some interesting and significant phenomenon of today’s business world such as International New Ventures (INVs) or Born Globals.
Long ago, academics explained the internationalization process by using a stage model, which follows a step by step process where the firm starts from no international activity and goes on to engage in some international activity and then ends up owning subsidiaries abroad. Such is the case of the Uppsala model proposed in 1977 by Johanson and Vahlne. Right from the beginning this model has been criticized and after much criticism by scholars and other authors such as Andersen (1993), Johanson and Mattsson (1988) introduced a new model known as ‘The Network Approach’, where they explained the importance of relationships with suppliers, customers and market that can stimulate or help a firm to go abroad. While studying SMEs’ internationalization process we find that some of these types of firms are international from inception. McDougall and Oviatt (1994) introduced the concept of International New Ventures (INVs) and Born Globals to explain the characteristics of such firms. Later on McDougall and Oviatt (2000) approached internationalization by explaining the role entrepreneurship in the process with the international entrepreneurship theory (IET).
Nowadays, technological advancements, declining trade barriers etc are driving the world economy to become more and more integrated and this rapid globalization is enabling SMEs to become international in a more quick yet effective (in some cases) manner. Some scholars question the validity of the Uppsala model now and argue that the model can no longer successfully explain the internationalization process of firms; especially in the cases of some SMEs and Born Globals or international new ventures (INVs). Therefore, the researchers tried to explain the internationalization process of firms more efficiently and came up with the network theory and the international entrepreneurship theory.
For the past few decades researchers have been debating over existing theories and developing new theories of international business to explain why and how companies internationalize. Internationalization theories are explaining different
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Questions
What are the roles of the three theories in describing, explaining and guiding the internationalization process of SMEs?
Which aspects of these theories are most useful to the SMEs’ internationalization process?
Both academics and business people will find this study valuable and will be able to make use of the implications and results that we shall provide. This research will help academics understand the process of internationalization within SMEs. While business people can find ideas of how other SMEs gained internationalization and how the tools given by the different theories that we will discuss in this study will be useful or not to their specific case.
Many factors, internal as well as external, influence a firm’s internationalization process. Factors such as economic conditions, business culture, technology, infrastructure and so on has an impact upon the strategy and methods applied by SMEs from a particular country. One significant limitation of our study is that we will explore the internationalization process of SMEs in general, with a focus on the application of three major theories. Another limitation is that we will only focus on SMEs and exclude MNEs from our study.
The thesis is divided into five major parts, they are: introduction; literature review; research methodology; data analysis, and; findings and conclusion.
The introduction part contains background description of the topic, research purpose, questions, target group and delimitations.
In the literature review part, we will present the definitions and brief descriptions of some of the major terms and phenomenon used in this study followed by a discussion regarding SMEs’ motives for internationalization. Then we will present an extensive literature review of the three theories: the Uppsala model, network theory and international entrepreneurship theory along with a discussion on the critics to them. We will conclude this part by presenting our conceptual framework.
In the research methodology part, we will explain the research purpose, approach, strategy and data collection method.
Then we will present our analysis of the gathered empirical data.
In the conclusion and further research part, we will present our findings and conclusions in brief as well as possible further research on the topic.
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2. Literature Review
In this chapter we will begin with presenting some definitions and then we will discuss and analyze the three theories. We have chosen Uppsala Model, Network Approach and International Entrepreneurship, since these theories seem to be the most influential in explaining the internationalization process of the firms.
2.1.1 Internationalization
From a historical perspective, internationalization of businesses and firms began with mankind’s ability to travel across the seas and borders. Scholars and academics have tried to define internationalization on many occasions using many different perspectives and variables. The term ‘internationalization’ is ambiguous and definitions vary depending on the phenomenon they include. Penrose’s (1959) point of view on the topic focuses on the firm’s core competences and opportunities in the foreign environment. Welch and Luostarinen (1988) defined internationalization as the process in which firms increase their involvements in international operations. Johanson and Vahlne (1977) agree with that. By some scholars internationalization is also defined as the process by which firms both increase their awareness of the direct and indirect influences of international transactions on their future and establish and conduct transactions with other countries. Later on, Calof and Beamish (1995, p. 116) defined internationalization as “the process of adapting firms operations (strategy, structure, resource, etc.) to international environments”.
2.1.2 Strategy
Strategy is the determination of the basic long-term goals of the enterprise, and the adoption of courses of action and allocation of resources necessary for carrying out these goals (Chaffee, 1985). It consists of integrated decisions, actions or plans that will help to achieve goals. Business strategy is then used as an umbrella term to denote the broad range of strategic options open to the firm, including both organizational and functional management strategies, product/market strategies, and diversification strategies (Barringer & Greening, 1998).
2.1.3 SMEs
The concept of small and medium enterprise or SME has many connotations among researchers and they apply quantitative criteria to identify SMEs. From this perspective, SME refer to firms in all sectors as long as they do not exceed a particular size. Researchers propose a number of indicators such as profits, total capital, market position, number of employees and turnover in order to define the size of SMEs. However, number of employees and turnovers are often used as the most appropriate quantitative criteria. For our case we would like to use the definition given by the European Commission (2005, p. 5) that states “The category of micro, small and medium-sized enterprises (SMEs) is made up of enterprises which employ fewer than 250 persons and which have
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SMEs to gain internationalization from inception. This happens when the market has the need to have that innovative product or service in that specific foreign market. Another definition of INVs or born globals is given by Knight and Cavusgil (1996) who suggest that these are small firms that strive to achieve competitive advantage based on technology and from the earliest days of their foundation operate in multiple international markets. While McDougall and Oviatt (1997, p. 48) state that “INVs are not a phenomena that occurs in a specific industry, but that can happen in a wide range of them”.
INVs have flexible operating procedures which enable them to react faster to changing environments. Often the CEO or the owner or the founder does business deals personally and makes decisions on the spot. So, in the cases of INVs, foreign market commitments are less likely to be influenced by organizational routines and internal politics than in established firms (McDougall & Oviatt, 1997). Born globals are known to be firms whose competitive advantage is the great knowledge and the technologic know-how they posses; that combined with managers and/or entrepreneurs with experience in the international market, will easily move abroad. The knowledge they posses allow them to make a move fast by choosing the right entry mode to go abroad.
2.1.5 International Entrepreneurship
McDougall and Oviatt (2000, p. 903) defined international entrepreneurship as “a combination of innovative, proactive, and risk-seeking behavior that crosses national borders and is intended to create value in organizations”. This definition has been one of the most widely accepted. Afterwards, they embraced a deeper concept of entrepreneurship, defining it as the discovery, enactment, evaluation, and exploitation of opportunities across national borders to create future goods and services (McDougall & Oviatt, 2005)
McDougall and Oviatt (2005, p. 540) explain their definition as follows:
a. Discovery: refers to finding innovative opportunities b. Enactment: means to proactively put opportunities into use acquiring a competitive advantage. c. Evaluation: is required to interpret the actions taken developing experience and knowledge. d. Exploitation: refers to the future development of the opportunity.
Most literature in international business indicates that export is the major international business activity. Traditionally, internationalization by exporting has been considered as a way to increase growth of firms. Exporting is still significant, but during the last decade, firms has been focusing on different business activities as ways of internationalization and considering them to be important to achieve competitive advantage. Partnerships with foreign companies, foreign investments and cross border networking have become increasingly important as ways of facilitating exchange of
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technology and knowledge which enable SMEs formulate strong international business strategies. Globalization, technological, political and economic changes are some of the main drivers for the increasing internationalization of SMEs in today’s world. Various theories of internationalization process suggest that certain types of SMEs internationalize by following the ‘stage model’, expressing a cautious and progressive behavior; whereas there are other types of SMEs that are considered as born globals and internationalize at an early stage of establishment.
2.2.1 SMEs’ motives for Internationalization
There are several different motives behind internationalization of SMEs indicating a diversified approach to internationalization. One of the most frequent motives is to gain access to new and larger markets in order to achieve growth. Firms expand the market for their products by exporting or creating subsidiaries or joint ventures abroad. Many firms go abroad to have access to know-how and technology in order to remain competitive. This indicates that various different internationalization processes are undertaken by firms to achieve different strategic goals.
Before a firm starts its internationalization, someone or something either from inside or outside the firm must initiate the strategy of the internationalization process (Hollensen, 1998). The intention of a firm’s internationalization is influenced by the opportunities of the foreign market (Albaum, Stranskov & Duerr, 1998). Those opportunities are stimuli only if the company has the resources to enter that market. There are two ways to analyze why SMEs decide to gain internationalization. Firms can receive internal or external stimuli in the decision making in initialization of export, where both internal qualities and environmental factor play an important role (Cavusgil, 1982). When the firm plans internationalization, the management team should be aware of which activities should they exploit in order to meet with market opportunities. This kind of export stimuli is known as proactive (pull factors), whereas the stimuli received from the reaction to changing conditions and passive attitude to export opportunities (push factors) (Cavusgil, 1982).
2.2.1.1 Proactive factors
Proactive factors indicate that the choice a firm has to internationalize is influenced by internal means: interest in exploit unique ideas and competences, as well as the opportunities that the foreign market offers. The managerial team has the desire, drive, enthusiasm, commitment to the market and motivation. By knowing the local and international market, and by exploiting the competitive advantage the firms has over other companies in a specific, soon to be, host country, the managerial team would be able to act proactive and start planning a strategy to internationalize. The examples mentioned above are internal factors. The environment also provides the management team with tools to plan a strategy to begin the process. Knowing about a foreign market will allow the firm to see and undertake the opportunities offered by that specific location.
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resources (Dalli, 1995) and certain degree of market knowledge and experience (Root, 1994). Hill (2007, p. 487) explains both advantages and disadvantages of exporting. One Advantage for a firm that exports is that it avoids the cost of manufacturing in the host country. This might also been seen as a disadvantage if the costs of producing the good are cheaper in the host country. The firm can gain a substantial scale economy from its global sales volume, when it is producing in the home country and exporting to the host country. Another important advantage is that the firm will gain experience and even more knowledge from the host country. At the same time exporting firms face disadvantages such as the costs of transportation, and even the low cost of the production of the goods in that host country (Hill 2007, p. 487). From country to country there are different laws that protect the home market. Some of them will do this by adding a tariff barrier which can make exporting more expensive.
2.3.2 Turnkey projects
This is a kind of project where two entities/firms are responsible for putting up a plant or equipment (e.g., oil plants). This kind of market entry is used by firms in specific industries such as: construction, metal, petrochemical refining, chemicals and pharmaceutical. This type of entry mode is useful where foreign direct investment (FDI) is limited by the host country’s government. One firm can posses the resources needed for the production but needs the technological know-how to proceed with the production. The other firm, “the contractor” is the one that handles the project for the foreign client. The contractor offers his client the training of the operative personnel, the contract itself and the “key” to a plant in full operation (Hill, 2007). In other words, a turnkey project is seen as a way to export know-how to other countries. The benefits from a turnkey project are the great economic assets that the know-how offers, since they are valuable assets for the firms (Hill, 2007). On the other hand, once the project ends, the contractor won’t have a long-term interest in the foreign country. This can be seen as a disadvantage if the country proves to be a major market for the output of the process that has been exported (Hill, 2007). The creation of an inadvertently competitor might happen. The firm’s process of technology and know-how are a valuable asset as well as a competitive advantage for the firm, but at the time of selling it, the firm is selling its competitive advantage to potential and/or actual competitor.
2.3.3 Licensing
A licensing agreement is an arrangement where the licensor grants the right over intangible property to another entity for a specific period, and in return, the licensor receives a loyalty fee from the license (Hill, 2007). This type of agreement is common in the pharmaceutical industry, where patents, inventions and formulas are common. When a firm enters a host country they do not deal with the cost and risk of entering it. This kind of entry mode is good for firms that do not have the capital to production abroad. It is also used when a firm wants to enter a foreign market, but there are some government regulations that won’t allow them enter that specific market. Firms that have an intangible property that they are not going to develop, tend to use this entry mode. The disadvantages of this kind of agreement are the scarce control over production, marketing and strategy used in the development and sale of the product. Licensing limits the firm’s ability to coordinate strategic moves across countries by using profits earned in one country to support competitive attacks in another (Hill,
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2007). Once again, technological know-how when sold to other firms is taking the risk of generating competition with the other firm by providing them with the firm’s competitive advantage.
2.3.4 Franchising
Franchising involves longer-term commitments, whereas licensing involves a shorter term. Franchising is the right a firm acquires from another firm that allows them to do particular business activities, such as selling the good or the service, under the name of a specific firm, e.g. McDonalds. Franchising is a specialized form of license, where the franchisee agrees to follow strict rules about how to carry with the business activities: the type of service, setting of the physical space, etc. The firm selling the franchise will receive a royalty payment, which is related to the franchisee’s revenues. The firm that sells the franchise avoids many of the costs and risks of opening in a host country by its self. A firm whose entry mode is franchise can build great presence all over the world in a short period of time, at a relative low cost and risk (Hill 2007, p. 492). One of the problems when using franchising is quality control: customers of Best Western Hotels, look for the same kind of attention when they go to their hotels in different parts of the world.
2.3.5 Joint Ventures
A joint venture is an entity formed by two or more independent firms working together. The firms agree to join together sharing revenues and costs, as well as the control of the new firm. The venture can be just a project or a long-term relationship as Sony Ericsson, for example. Joint ventures are often seen as a very viable business, since the companies involved can complement their skills. Both companies can gain international presence; e.g. Sony provided its technology know-how to Ericsson and started with the manufacturing of cell phones (Ericsson) with camera and innovative designs (Sony). Typical joint ventures where two parties are involved are 50/50 ventures, though it can also be other combinations depending on the agreements of the parties involved. Such agreements are stated in contracts, which also state the role and kind of participation each firm will commit to. The advantages stated by Hill (2007, p. 493) are as follows: a firm benefits from local partner’s knowledge of the host country’s competitive conditions, culture, language, and political and business systems. Costs and risks are shared. In some countries this is the only way to entering that market. The firm can also overcome some risk by giving control of its technology to the other part involved. This kind of relationship between two companies does not give a firm the tight control over the subsidiaries both local and international, leading to conflicts and battles over the control, if the strategies of both companies differ on the way things should be done in order to fulfill their goals (Hill, 2007).
2.3.6 Wholly Owned Subsidiaries
In a wholly owned subsidiary the firm owns 100 percent of the stock. There are two ways to gain internationalization by using this entry mode. The first one is by setting up a new operation in the host country, often referred to as a Greenfield venture, or it can
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State aspects are the resources committed to the foreign market: market knowledge and commitment decisions that would affect the firm’s opportunities and risks (Johanson & Vahlne 1977, p. 27). Market commitment stands for those resources that will be committed as well as the degree of involvement. Market knowledge helps the managerial team to make decisions. There are two main types of knowledge: objective knowledge, which can be transferred from one market to another and experiential knowledge, which is gained by experience, learning by doing or acting. Change aspects are the results of the state aspects. Once the firm know about the market they can decide the way the firm will commit to that market, and will therefore be able to plan and execute the current activities needed to complete the cycle by committing to the market.
The basic assumption of the Uppsala Model is that market knowledge and market commitment affects both the commitment decisions and the way current decisions are performed—and this, in turn, changes market knowledge and commitment. The amount of knowledge of foreign markets and operations is influenced by the amount of commitments of resources in foreign markets, and vice versa (Johanson & Vahlne, 1977). Incremental growth also suggests that companies begin internationalization process in markets that have less psychic distance. Psychic distance is defined as factors such as differences in language, culture, political systems, etc., which disturb the flow of information between the firm and the market (Johanson & Wiedersheim-Paul 1975, p. 308).
In figure 2, the path followed by firms following this stage model states that the firms with no exporting activity will start by exporting via an agent. Sales subsidiaries can follow exporting. Firms can also use the entry modes such as joint ventures, licensing, franchising, depending on the nature of the firm. The last step into the chain is wholly owned subsidiaries.
Figure 2: Uppsala model process, adaptation from the theory.
2.4.1.1 Critics to the Uppsala model
From the beginning, the Uppsala-model has been widely criticized on both theoretical and operational levels (Mitgwe, 2006). Some researchers have found it invalid in some cases while some others accepted it with modifications. Researchers have tested the model’s applicability, strengths and weaknesses through different studies. The model has been criticized from different perspectives and its basic assumptions have been challenged by a number of empirical studies (Andersen, 1993). Andersen (1993) argues that the main problem of the model is that there is no explanation on why or how the process starts or the nature of the mechanism whereby knowledge affects commitment. Figure 3 explains the theory from two view points; the
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development in a specific country is explained as the four stages the firms with go through, while the development across the countries explains the importance of psychic distance and the choice of new markets.
Figure 3: Operational levels, adaptation from the theory (Andersen 1993, p. 223)
The development across countries predicts that firms that enter to a new market with successively greater psychic distance. Psychic distance is defined as the distance between home market and a foreign market resulting from the perception, learning and understanding of business differences. Johanson and Wiedersheim-Paul (1975) defined it as the differences in language, culture, politic systems, etc., that makes it hard or easy for a firm to enter the new market. When a firm has chosen where to go, the psychic distance is assumed to reduce to the increased market-specific knowledge. If knowledge can be transferred from one country to another, firms with an extensive international experience are likely to perceive the psychic distance to a new country as shorter than firms with little international experience.
Some critics focus on the theoretical aspects while others argue against its practical implications. The Uppsala model’s basic argument is that while internationalizing, firms pass through four consecutive stages of increasing commitment to international activities. Andersen (1993) criticizes that the stages mostly lack an explanation of the mechanisms that takes the firm through them. After testing the incremental internationalization hypothesis, Sullivan and Bauerschmidt (1990) concluded that the empirical evidence did not support this hypothesis.
Many critics argue against the incremental, step-by-step character of the model since studies have found that it is possible for firms to skip some of the stages and achieve internationalization rapidly rather than doing gradually (Chetty & Campbell, 2003).
