Individual Research Personal Development Report

Course: International Business Strategy Professor: Annabel T. H. Sels, PhD

Written by: Benjamin Lim

Chosen paper: Choice of Foreign Market Entry Mode: Impact of Ownership, Location and
Internalization Factors

Author(s): Sanjeev Agarwal and Sridhar N. Ramaswami

Source: Journal of International Business Studies, Vol. 23, No. 1(1st Qtr., 1992), pp. 1-27

The chosen paper written by Agarwal and Ramaswami seeks to determine the factors that
affect a firms choice of entry mode when engaging in internationalization strategies. Thus
far, we have only been introduced to three factors that are taken into consideration when
choosing the optimal entry mode. These factors are the degree of control, the level of
resource commitment and the dissemination risk (Hill, Hwang, & Kim, 1990). This paper
further expands upon these existing factors and instead analyzes the firms choice of
foreign entry based on three determinant factors. Furthermore, as most of the current
literature only deal with each factor in isolation, Agarwal and Ramaswami attempts to
identify how the interaction amongst these factors actually impact the firms
internationalization decisions. Thus, it recognizes that foreign entry mode decisions are not
based upon a single dominating factor but rather a complex interaction of a multiple of
factors in favor of a certain chosen mode.

The factors that were identified for the testing in the model were based on the OLI-model
or eclectic paradigm developed by Dunning in 1993. The three umbrella determinant
factors detailed in Dunnings framework are ownership advantage, location advantage and
internalization advantage. Firstly, ownership advantage refers to the size of the firm and
multinational experience; the both of these often have a high correlation. In addition, the
ability to develop differentiated products and proprietar (Agarwal & Ramaswami, 1992)
(Dunning, 2000)y technology is another factor under ownership advantage. Next, location
advantage refers to market potential and investment risk. Market potential has often been
listed as the first decision factor to consider. Investment risk refers to economic, political
and government policies which are essential to the survival of the firms operations. Lastly,
internalization advantage deals mainly with contractual risk and the risk that other firms in
the target host country could actually gain possession of the technology or control over the
asset and thus compete with the internationalizing firm.

The first hypothesis that the authors suggested were that larger firms with greater
multinational experience prefer sole ventures in countries with low market potential. It was
believed that larger firms are not overly concerned with risk reduction perspective but
instead prioritize strategic control when entering foreign markets. In addition, these large
firms often require sufficient control over foreign operations in order to maximize overall
profit potential. Conversely, the second hypothesis stated in the paper is that smaller firms
which tend to have less multinational experience are more likely to engage in joint ventures
when entering a country with high market risk. It is uncommon for small firms to enter high
market risk countries but in the event that they do so, it is postulated that their main
consideration is one of risk reduction. Furthermore, resource limitations will steer these
firms toward the choice of a joint venture instead of sole ventures.

For the third hypothesis, it was suggested that firms with ability to develop differentiated
products have greater ability to enter into countries with high investment risk, based on
empirical evidence. In such host countries, firm size is not of importance but instead the
foreign governments are more concerned with the firms proprietary knowledge or product
which cannot be easily replicated elsewhere. As such, Agarwal and Ramaswami believed
that these firms will opt for a sole venture for risk reduction reasons to prevent any
unexpected changes of investment risk enforced by the host government.

The fourth hypothesis of the paper is concerned with the interaction between ownership
advantages and contractual risk. The main concerns when analyzing contractual risk are
one of the dissemination of the firms proprietary knowledge and costs of enforcing the
contract. Contractual risks are a significant factor of consideration for firms that have
proprietary knowledge or products. Hence, such firms will need to insulate themselves from
the risk of dissipation and will tend to choose a sole venture mode of entry.

The fifth and last hypothesis considered an interesting variation of a country with high
market potential but also high investment risk. Existing evidence and literature at the time
of writing of the paper did not provide any conclusive results on the effects of such an
interaction. Hence, Agarwal and Ramaswami speculated that firms will tend to hold the
market potential factor higher in regard. However, it is believed that firms will choose
exporting or joint venture in a bid to reduce investment risk.

The methodology employed for testing the five stated hypotheses was through the
application of the FDI theory to the US equipment leasing industry. Operational measures
were utilized to represent the identified determinant factors. Factors under ownership
advantages and internalization advantages were relatively easier to quantify as there were
readily available operational measures for use. When evaluating location advantages,
market potential and investment risk included managerial perception. This was particularly
useful in quantifying an otherwise almost virtually unquantifiable factor. However, a
significant drawback would be the subjectivity of such managerial perception and its
reliability when used in the regression. Data collection for the paper involved the sending
out of surveys to CEOs and Presidents of a representative of firms. The authors then
performed a factor analysis and multiple regressions to identify the interaction of variables
that account for the choice of a particular mode of entry.

The results of the model largely validate the hypotheses on interaction effects that Agarwal
and Ramaswami had suggested. Hypothesis 1 was confirmed by the results showing the
association of large firm size and high market potential. Thus, it was observed that when in
this situation sole ventures are preferred due to the strategic considerations involved.
Hypothesis 2 was also confirmed as seen from the preference for not investing by small
firms with low multinational experience in countries with high market potential. This could
be explained by the resource limitations of such firms. Hypothesis 3 was not supported by
the results from the model as it was seen that firms who possess the ability to develop
specialized products do not tend towards a single mode of entry when entering into
countries with high investment risk. Where it was proposed by the authors that such firms
will prefer sole ventures, the results showed weak positive coefficients for both the solve
venture and joint venture modes. Hence, there could be a weak preference for these modes
of entry but it fails to confirm the hypothesis. Hypothesis 4 was confirmed and it was seen
that firms with significant ownership advantage prefer investment mode of entries when
faced with high investment risk. Lastly, hypothesis 5 was only partially supported as it was
observed that firms preferred exporting into markets with high market potential but also
high investment risk.

Three interesting results were also observed from the study; i) small firms with limited
multinational experience prefer joint venture into countries with high market potential ii)
firms with ability to develop specialized products prefer investment modes in high
contractual risk countries iii) significant investment risks can turn firms away from investing
in high market potential countries. The model also showed that firms draw leverage and
market power not by sheer size but by the ability to develop differentiated products. In
essence, most internationalization strategies are considered primarily with contractual risk
and investment risk in the host countries. Thus if governments wish to attract FDI, it is of
paramount importance that policies reducing such risks are set in place.

The application of the above study in the context of the course provides further perspective
on the motivations behind why firms lean towards certain mode of entries. Thus far, we
have only considered these factors in isolation. As such, the paper explores firm decision
when conflicting factors are present in the host country. From the results of the model, it
can be (Hill, Hwang, & Kim, 1990) seen that firms now view their business operations
through a global viewpoint. This also explains why investment modes of entry are highly
preferred due to strategic considerations, despite the risk exposure. Furthermore, the
paper provided a wider variety of factors as compared to those listed in Chapter 11 by Hill,
Hwang and Kim. It is important not only to understand how to succeed in each mode of
entry but also to understand the factors that will lead to the choice of a particular mode.
Thus, the theoretical contributions of the paper are extremely useful and in fact have been
widely cited since its writing in 1992.

It is also evident that there are some limitations to the paper and the model used, however
these deficiencies do not severely cripple the validity of the results. Firstly the data
collection method was one where surveys were sent out. Survey sampling methods allow
for high potential of bias. This could be due to an unrepresentative sample due to
nonresponse bias as seen from the 22.8% response rate that the survey yielded. Hence, the
responses obtained from the survey might provide a sample group that in fact may not be
representative of the entire industry. Another limitation of the paper was the industry
chosen for the purpose of the study and data collection. The choice of the US leasing
industry provides a rather limited scope and may possibly be too specialized in nature.
Without considering the time and effort required, the study would have been further
improved if other industries were analyzed as well. Possible alternatives will include
industries where operations involve the sale of goods and not services or even the use of
industries in other major countries besides the US. Results collected from these studies
may yield largely different results as it is possible that preferences and factors motivating
firms towards a particular entry mode may be based on locality and the type of operations.

The paper also utilized managerial perception heavily when exploring location advantages.
This is a heavily subjective measure of the factor and could negatively influence the results
obtained due to the poor reliability. Quantifiable measures have been used in other papers
to quantify the location advantage aspect of the OLI-model as seen in Dunnings updated
paper on the eclectic paradigm. In his updated paper Dunning states that as the current
state of the world changes due to globalization, the L aspect of the framework is
increasingly important and dynamic. Traditional application of the OLI-model largely
attributed natural resources found in the various country or market size as part of location
advantages. However, Dunning believes that location advantage is currently characterized
more by the presence of location bound assets in the host country such as indigenous firms
in the host countries. Furthermore, various measures have been suggested for use in
quantifying the location advantage of the model such as exchange rate risk, political risk
and even inter-country cultural differences (Dunning, 2000). In addition, countries are now
more aware of the need for a sound institutional framework for which internationalizing
firms can operate in. As such, the institutional framework such as the provision of economic
and social infrastructure is increasingly important towards helping the firm engage in value-
adding activities in the host countries. Dunning also suggested that scholastic literature of
recent years has discovered that location advantages are heavily linked towards the assets
that the host country provides. Thus, the paper in question could be better served by
including a parameter for such a factor as market potential and investment risk gradually
decline in importance in the recent years.

Musso and Francioni performed a similar study of foreign entry mode choice and the
factors motivating them but instead with a focus on SMEs in Italy. The results were
particularly interesting and provided some contrasting opinions to those suggested by
Agarwal and Ramiswamis work. This is indicative of the possible inability to generically
apply the theories suggested in the chosen paper across the board to all the different types
of firms. In this paper, the correlation between entry mode choice and organizational
culture was statistically significant and deemed as the primary motivating factor (Musso &
Francioni, 2009). In contrast to the chosen paper, it was found that multinational
experience possess no impact on the entry mode choice. In addition, it was also discovered
that market attractiveness had no effect on the choice of entry mode which was once again
conflicting with Agarwal and Ramiswamis findings. Musso and Francionis model also
revealed that country risk, or more specifically investment risk, had no influence over the
choice of entry mode. As can be seen from the above, it is evident that Agarwal and
Ramiswamis findings are not entirely reflected when discussing SMEs.

In conclusion, Agarwal and Ramiswamis paper has provided much of the foundational base
for many of the current studies on foreign entry mode. It is one of the first of its kind to
discuss the impact that complex interaction of factors have on internationalization strategy.
The paper will gain better coverage if other frameworks such as the transaction cost theory
or resource-based theory was used on top of the OLI-model. In recent years, various studies
have uncovered nuanced differences when applying the findings to other firm and industry
types.
Bibliography

Agarwal, S., & Ramaswami, S. N. (1992, 1st Qtr.). Choice of foreign market entry mode: impact of
ownership, location and internalization factors. Journal of International Business Studies,
23(1), 1-27.

Dunning, J. H. (2000). The eclectic paradigm as an envelope for economic and business theories of
MNE activity. International Business Review, 9, 163-190.

Hill, C. W., Hwang, P., & Kim, W. C. (1990, February). An eclectic theory of the choice of international
entry mode. Strategic Management Journal, 11(2), 117-128.

Musso, F., & Francioni, B. (2009). Foreign markets entry mode decision for SMEs. Key factors and
role of industrial districts. Munich Personal RePEc Archive.