A Theme Paper

On

Logic

And

Processes

Of

Internationalization
By

Dheeraj K Pandey

(FPM Second Year)

Submitted
To

Prof. M.R.Dixit

Indian Institute of Management

Ahmedabad

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 Table of Contents
Introduction:

A lot of work has been done to understanding the basis for

internationalization. The literature gives various theories which deal
with the various aspects of Internationalization. This theme paper tried
to look at the concept of internationalization and looks back into
history and see the development of various internationalization
theories which unfolds the different modes of internationalization that
are possible for a firm.

A clear understanding of the difficulties the firm is going to encounter

prepares it for the process and the reaction of the firm shapes the
whole process of internationalization. Organizations have various
motives that prompt it for the internationalization and are affected in
different ways by various internal and external factors which affect the
success of the firm in internationalization.

What is internationalization?

Internationalization is a well-understood concept and it refers to the

increasing economic interdependence among nations, as a result of
liberalized, and technologically facilitated, economic exchange of
capital, raw materials, intermediate goods (including knowledge),
human resources, manufactured end products, and services.

What are the various Internationalization theories?

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Various theories exists which tries to answer the reasons behind the
internalization as a process .Internationalization is a dynamic process ,
and the factors which used to drive this process fifty years ago are not
the same as they are today.

There has been also a lot of change in environment in terms of

technology, communication and transport which have affected the
speed with which internationalization happens now. Further there are
changes in economic, political and legal scenarios along with other
change and these all changes have given rise to many competing
theories for explaining the process of internationalization.

1) Neoclassical trade theory:

This was one of the first theories which attempted to explain the
process of internationalization. This theory considers that trade exists
because of the difference between interest rate between two countries.
This theory believes that each investor maximizes his profits by
investing where returns are highest perfect competition. It assumes no
transaction costs, and believes that capital moves in response to
changes in interest rate (or profit) differentials.

However the existence of cross movements of capital may indicate

that the interest-rate theory cannot by itself explain the movements of
direct investment. So this theory because of its assumption which don’t
hold true in the real world gives just one reason for going international
and is the least comprehensively theory on internationalization.

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2) Stephen Hymer theory:

This theory explains the internationalization process better than the

“Neoclassical trade theory”. It attributes the possessions of some
advantages by the firm as the cause of international operations.

This theory believes that firms are by no means equal in their ability to
operate in an industry. Certain firms have considerable advantages in
particular activities. Hymer (1976) considers the possession of these
advantages to cause the firms to have extensive international
operations of one kind or another. .Hymer (1976) attributes the profits
form controlling the foreign enterprise as the biggest motivator for
investment abroad rather than higher interest rate.

3) Product-Life-Cycle (Vernon) theory:

This theory developed out of critique of neoclassical comparative

advantage theory because the neoclassical theory did not give any
importance to the role of innovation in determining trade patterns and
also because of its the lack of attention to the role of economies of
scale in determining such patterns .The neoclassical theory also
neglected the advantage a technology firm had in exports.

This theory states that the average income in a market determines

which market a product enters first. Because in the 1960s, the US had
the highest average income, new products would be introduced first in
the US (and by US firms).Additionally, US firms also were good at

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innovations, partly because of high labor costs there was a driving
force to develop labor-saving equipment and machines.

Initially production was located in the US, but as demand for the
product expands in the foreign markets the firm started to serve
foreign markets. Because the US has one of the highest labor costs,
labor costs in these other markets will be lower this means that as
demand there grows, it made sense to manufacture the products
there. And once production was set up in these countries, it might
make sense to also serve less developed countries from there. Later it
might also make sense to re import from these locations to the US.

4) Transaction Cost Economics (TCE)

This theory is more comprehensive than previous three theories. TCE

explains the seemingly counterintuitive idea of existence of MNE’s.
Their existence is counterintuitive because operating overseas is
usually more costly than operating at home, because a foreign firm
does not have the same contracts and knowledge of local customs and
business practices as indigenous competitors, while being often
subject to discrimination by host country governments and private
institutions.

Hence it is difficult to understand why firms based in one country

would do business in another country. If a firm has some unique assets
of value overseas, why not sell or rent these assets to local
entrepreneurs, who could then combine them with local factors of
production at lower costs than those experienced by foreign direct
investors?(Hennart 2000, 73).

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The TCE explains the existence of MNE’s to their focus on transactions.
The theory compares concrete options of organizing transactions in
particular between firm (authority mechanism) and market (price
mechanism). It states that MNE’s depend upon hierarchies which are
an efficient coordination mechanism than market prices. This theory
focuses on the organization of international interdependencies, not on
the internalization of ‘Firm-specific advantages’ .This theory considers
that importance of combining the local and foreign inputs needed to
operate in a foreign country. TCE gives two basic (and non-mutually
exclusive) reasons about why do multinational firms expand abroad

1) To internalize the pecuniary externalities firms inflict on one another

when they compete on the market for final products. MNE’s then
arise to reduce competition.
2) MNE’s internalize non-pecuniary externalities (resulting from
‘natural’ market imperfections)

5) Resource based view

This theory stresses on the existence of distinctive resources within the

firm which sets up internal capabilities and which can foster the
internal competitive advantage such as investment in intangible assets
(R & D and advertisement). The presence of distinctive resource gives
rise to Ex Ante barriers and can be a source of competitive advantage
to firm abroad.

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Since the investments in developing these intangible assets which
gives competitive advantage to the firm is huge. To recover these costs
the firms seek international presence early on for the domestic market
may not be large enough to produce enough income.

6) Social capital theory of internationalization:

The social capital theory stresses the firm’s capacity to use the cost
advantages( in either capital or labour) through the external
capabilities, built on the relations with customers, suppliers and other
partners in the firms, thus driving the external competitive advantages.

This theory believes that internationalization can be a failure because

of the liability of newness the firm carries. It states that newly
established firms lack stable relationships to the external constituents.
It highlights the importance of the acceptance by the market; by other
firms; financial organizations, support organizations etc.

This theory also brings out the issues of resource scarcity and lack of
information. It states that in home market, the firm knows how to do
business, where to find information etc. however these things are not
easy in international market. It takes a view totally different from the
“Traditional internationalization theories “which states that how foreign
market knowledge is experientially learned. This theory believes that
some of this experiential learning can be substituted by network
knowledge.

Mode of internationalization by the firms

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Firms have been found to internationalize selectively. The selectivity in
internationalization has been found mainly to be a firm specific
phenomenon. However such selectivity can be partly introduced at the
macro-level, for example when countries decide to engage in regional
trade and investment agreements, like the North American Free Trade
Agreement (NAFTA) and the European Union (EU).

This selectivity in internationalization is borne out of efficiency in terms

of the chosen sequence in time of international trade agreements, as
well as firm-level internationalization (e.g., in terms of geographic
scope of sequential entry decisions and choice of entry modes)

TCE (Transaction cost economics) addresses this selectivity by

developing a framework for MNE expansion patterns. Buckley and
Casson (1976), Rugman (1981) and Hennart (1982), have addressed
the choice of entry mode, and have recognized that the liability of
foreignness varies among various host countries. However this
selectivity has been viewed as largely exogenous and the choice of
geographic scope as a key parameter and as a design variable driving
managerial decision making on internationalization has been not much
explored. So the current theories don’t address the bounded rationality
problems of decision making on selectivity of location by MNE’s.

Theories on the entry strategy of the firms?

1) Process Theory of Internationalization

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The PTI essentially builds on the behavioral theory of the firm (Cyert &
March, 1963) and includes elements of Penrose’s Theory of the Growth
of the Firm (1959). This view, developed by the Uppsala Group
(Johanson & Vahlne, 1977, 1990), emphasizes the incremental nature
of the various change processes that a firm undergoes.

This theory explains various stages of the internationalization process

in terms of three stages. It provides a dynamic or longitudinal
explanation of the effects of three sequential stages that the
companies go through when expanding internationally. It believes that
at all three stages there are incremental benefits and incremental
costs of adding another nation or market to firm’s existing portfolio of
country. In stages 1 and 3 the incremental costs are greater than
incremental benefits but in stage 2 incremental benefits are greater
than incremental costs.

In stage 1 cost are higher because setting new facilities in new

location. In stage 2 (later internationalization).The context and
situation of the firm makes a difference, for every additional
international operation or market added, there would continue to be
learning, coordination, local adaptation and legitimacy acquisition
costs.

Because of these comparative advantages in the stage-2 the firm

makes the incremental benefits are more than the incremental costs.
These benefits can arise out of knowledge acquired from abroad, or
accessing cheaper inputs or the exploitation of firm specific assets

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carried to each foreign market or the combination of all these three
things.

2) New Venture Internationalization Theory

The New Venture Internationalization Theory (NVI) explains the

expansion of many new firms in newer locations, particularly in
knowledge-intensive industries, as they go international immediately
or soon after their inception. What makes this early internationalization
possible is the increasing speed and efficiency of international
communication and transportation, and the increasing homogenization
of many markets, the emergence of international financing
opportunities, and the emergence of increasingly internationally mobile
human capital.

Reasons prompting internationalization:

The various theories discussed in the previous sections, and other

literature on Internationalization throws up the following reasons which
prompt firms to internationalize.

Economic logic: Economic logic suggests that firm would do things that
help them create some competitive advantage over other firms. It is
believed that the geographic scope of operations may yield
competitive advantage by permitting firm to exploit the benefits of
performing more activities internally (Rugman, 1981). It may also allow
firms to exploit interrelationships between different segments,
geographic areas or related industries (Porter, 1985).

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Competitive advantage: During initial stages the competitive
advantage the firm has can help it to overcome the “cost of
foreignness”, and eventually the expansion in to the foreign market will
increase its profits and may become a source of competitive advantage
to it. So if the firm possesses any competitive advantage it encourages
it to expand internationally.

Maximizing rents: Countries differ along many dimensions,

economically, politically, legally, culturally etc. Economically these
differences create market imperfections, and international companies
want to exploit these imperfections (caves 1971).

Risk Hedging: Hisley and caves (1985) say that firm takes the
international diversification route to decrease the variability or risk of
the firm’s revenue stream.

Enhancing performance: Firm wants to internationalize because doing

so increases the geographic scope of operations which increases the
performance of the firm. This happens in two ways either by
possession of proprietary assets or by addition of the intrinsic to the
firm as a result of internationalization.

What are the factors that affect the process of

internationalization?

The process of internationalization is affected by many factors such as

resource availability, the acquaintance level of the foreign market, the
importance of communication networks, the perceived risk and/or

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incertitude, and the willingness of the manager to enter foreign
markets. So under these environmental changes the theoretical
internationalization model no longer holds true. Even Oviatt and
McDougall (1994), who are the firm believers of the Internationalization
Stages Theory, admit that the theory is less applicable in a growing
number of situations where the technology, the industry's
environment, and the capacity of an enterprise have changed. The
literature on “Internationalization” considers these factors as important
in their affect on the process of internationalization

Cultural factors:

Most of the times culture is measured and understood independently

from that environment; however its affects on international strategy is
closely interrelated with that of the institutional environment. National
culture reflects the values of society which establishes the norms for
the behavior.

In turn the norms of behavior represent a dimension of the institutional

environment. The strategic behaviors of firms are affected by the
institutional environments of their home country and of the other
countries in which they operate (Oliver, 1996). Essentially, economic
and strategic behavior is embedded in networks of social relations
represented by the institutional environment (Granovetter, 1985),
hence cultural factors should guide the internationalization process.

Environmental factor:

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Internationalization raises the issues of risk and uncertainty, cross
cultural aspects of employee conduct and consumer behavior, market
structure and competition, and political and regulatory dimensions; it
also provides new opportunities for growth, profitability and
organizational learning.

Institutional factors:

They affects the internationalization process by setting constraints on

the firm’s behavior (Peng 2002) .It has been observed that firm’s
operational choices are heavily influenced by their country of origin
and it has been observed that the firms characteristics matches their
local environment and sets constraints on the firm.

Path dependency:

Change in location requires a firm to change its organization routines.

Organization routines are the processes, mechanisms and procedures
the firm follows without much explicit thinking .Since the development
of such resources is path dependent, socially complex, and causally
ambiguous (Barney 1991), making modification in firms ingrained
routines a challenging task.

Effect of (COO) factors on internationalization process:

1) Asian MNE’s:

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Unlike MNE’s from developed western countries, Asian MNE’s exhibit a
preference for joint venture (Monkiewicz 1986; Ting, 1985). Further the
preference in case of Asian MNE’s is for majority JV and control
especially in production processes and in management.

The internationalization strategies for the Asian MNE’s are based on

cost-based competencies and other location-based advantages,
brought together by ethnic networks and aided by government
encouragement (Taiwan, South Korea and Singapore) and institutional
framework (Sim and Pandian, 2003). However these elements have
been neglected in conventional Internationalization theories.

2) Developed world MNE’s

The developed countries are expected to follow a different

internationalization route because they have different physical and
industrial capabilities; and the national governments economic and
political policies are different.

So we can see differentiating behavior in terms of strategic choices,

operation modes and outcomes for countries from the developed world
as compared to Asian MNE’s. The internationalization strategies of
firms from developed countries are either based on superior
technology or quality of products. For e.g., Germany has a reputation
of precision engineering and Japan has exceptional quality in consumer
electronics .So this image is of considerable help particularly to
relatively unknown companies entering to the foreign market from
these countries.

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Effect of Size of economies on internationalization process:

1) Small economies

Small economies are forced to compete in international market even at

the early stage of their development, as such markets don’t provide for
their survival in home market alone .On expansion these firms are
required to change there routines to fit with the international markets.

It has been found that in small economies there exists a positive linear
relationship between internationalization and performance.

2) Large economies

Firms in these economies are more likely have evolved independently

of international market and competitors. Additionally the firm’s
internalization is likely to take place in markets very similar to its own.
Eriksson and Sharma 1997 found that since large firms have limited
exposure to international competition in the home market a diversity of
competitors would handicap such firms, who have a narrower range of
experience and models to cope up with the increased demands
(Miller/Chen 1996)

In these economies the tendency to preserve the current routines and

need to create new routines for new markets would create significant
conflict within the organization (Meyer 2003).Conflict can also arise if

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there is change in behavior which fits with the new environment (Hout
and Rudden 1982).

It has been found that an inverted U relationship exists between level

of internationalization and performance in economies that are
relatively large and characterized by modest international trade.

Marketing aspects of Internationalization

Internationalization in marketing perspective is seen as an attempt to

build brand equity. A global brand gives the perception of excellence
and strength. Particularly in the case of brands from a developing
world expansion into foreign market is treated as a testimony of
strength and capability of the brand even in the home market.

The importance of Geographical factor has also been recognized as

constituting to the brand equity of the firm. Interbrand’s model
develops seven guidelines for assessment of brand strength:
Leadership, Market, Stability, Geographic spread, trend, support,
protection. Murphy (1992) in his study has found that Geographical
spread factor explains that firms that have become international are
inherently having more intangible value than national or regional
brands.

However Internationalization as a strategy comes with its own

challenges of integration of the global marketing effort because it
becomes difficult to get relevant presence in all the markets with the
same set of core values. Moore talks about the cultural factors which

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may contribute to the ease with which a brand can build its brand
equity within a particular market place. One of the major issues is
globalization vs. localization. The Cultural receptivity to the content of
the brand’s advertisement and marketing programme is also
determined before it is launched in new location.

With respect to internationalization the firm has two opinions. Some

researchers, such as Robinson (1967), Tookey (1975) and Attiyeh
and Wenner (1981) recommend the concentration strategy in
internationalization. They support the traditional concept that great
market shares in a few key markets produce profits on the long term.
This suggestion is empirically supported by the BETRO (1976) and ITI
(1979) reports. Other authors like Hamermesh et al.(1978) and Piercy
(1981a), recommends the market diversification strategy, basing
their recommendations on the belief that lower participations in widely
dispersed markets would be more profitable than concentrating on a
few key markets.

Conclusion:

From the above discussion it comes out that managers should realize
the importance of the environment in which the firm is operating and
its impact on strategy outcomes. The internationalization decision
should be location specific, since the internationalization as a process
have different implication for firm contingent on the home country of
the firm.

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Internationalization decisions are affected greatly in terms of the
country in which firm is operating. For the firms operating in small
economies need to operate in international arena may be difficult but
there is future payoffs in developing routines for that. Managers
operating in large economies have two broad options. One is to have
modest international operations. Another choice would be to have
extensive international operations in order to undergo
internationalization. For doing this the firms need to come out of home
market bias and become “equidistant” (Ohmae , 1990) to all the major
markets in which the firm operates. These findings are validated by
literature on stock market behavior in terms of valuation and also by
the brand valuation literature.

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5. Sim A.B, Pandian J.R (2003).Emerging Asian MNEs and Their

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