An analysis of the theory of the market entry modes

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  • Many thanks for the slides. At the moment am doing Global strategic management and It really helped me to understand the concept of Market entry strategy.
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An analysis of the theory of the market entry modes

  1. 1. An analysis ofthe Theory Ofthe Market EntryModes byMrinal Singh
  2. 2. For a corporation to survive in the global economy internationalization is a process that they have to take to operate in a better manner (Bartlett, Ghosal). The oft quoted process of Internationalization takes place through the process of An Entity which is first national but then due to trying to have a broader market reach it ventures into the international arena by the medium of exporting moving towards the mode of joint venture and then having a wholly owned subsidiary. This process of internationalization of a firm has been defined in literature as a market entry mode. Market Entry modes are defined as the forms of capital participation in International Enterprise. (Calantone&Yushan 2001 Firms enter a new market because of many reasons, but prominent reason being a) Spreading the risk- When a firm is operating in a single country it has access to a small closed market where it has to consider the cyclical nature of the nature of the business in which the firm has to consider the constant fluctuation in demand while making production schedules as well as other activities that have to take place ion the firm. To overcome this cyclical nature of the business a firm has to diversify its operations in a number of countries. b) Maintaining Oligopolistic Competition (Roy Trond, Dibrell, C. Clay 2002)-A Corporation has to observe the way its competitors are moving and act accordingly. If we observe the trend in any of the global corporation we can see a movement in a common direction for nearly all the corporations that are operating in a global arena.1
  3. 3. c) International Scale Advantage-Many Researchers like C.K.Prahlad have propounded the advantages of International scale. This global capacity advantage has an implicit assumption and that is that as the capacity is increased exponentially the fixed and the variable cost do not do so at the same rate thus leading to a cost advantage for the operators of this venture. Corporations entering a new market have to take into considerations many market entry modes that are available from exporting to opening up a wholly owned subsidiary The course that is taken by the corporation is affected by some factors like: (Gorg, Holen, 2000). Degree of control that the corporation wants to have over its operation. a) The level of risk that it is accepting to take for example indirect exporting will be a less risk involved venture than a wholly owned subsidiary. b) Skill required-The type of competency required in running an operation is a factor that affects the corporation in the type of venture that it runs. For example when Japanese corporations venture abroad instead of tying up with new operators in that country they take along with them there partners from home country as the type of competency that is required is found in there home partners only. c) Dissemination Risk-If the venture to be formed is technologically advanced where the key source of differentiation is because of the technology involved the corporation may not want to opt for a joint venture as the processes involved may be duplicated and the technology may2
  4. 4. be copied elsewhere. So we may observe in case of many high technology industries the preference for exporting or the setting up of a wholly owned subsidiary. d) Flexibility. e) Ownership. Based on these parameters a corporation has many options to start its operations in a foreign location the options as referred earlier range from 1. Exporting 2. Foreign Manufacturing. 3. Joint Venture Formation 4. Wholly owned subsidiaries. 1.EXPORTING There are various options available to a corporation and Exporting is one of them. Even exporting can be divided in two parts 1.1Indirect Exporting (Mutlec, Esin Can 2002)-This is one of the types of exporting options that is available to the firm. In this strategy the products of the form are carried over to the other country by a third firm and then sold there. This in classic business theory was considered one of the earliest stages of the firm going international with a very little resource involved in the selling of the products. (Anderson, 1997)3
  5. 5. 1.2 Direct exporting (Mutlec, Esin Can 2002)-In this strategy the level of involvement becomes a bit higher and all the work of exporting is done in-house. In this all the work that is to be done is to be done in-house. An exporting department is created that looks after all the exporting deals that come to the corporation. Also all the international affairs are dealt with within the corporation. 2.FOREIGN MANUFACTUR ING (MUTLEC, ESIN CAN 2002) Another strategy that is available to the corporation is that of foreign manufacturing. In this one strategy the firm can adopt various strategies 2.1 The first strategy that it could adopt is that of manufacturing in the home country and then assembling all the components in the market where it has to sell its products. 2.2 The other option that is available to the firm is that of contract manufacturing in this the product is made in the foreign market by a third firm 2.3 Another option that is available to the firm is that of Licensing, in this the corporation passes some technical know how to a third firm who in turn manufactures the product for it. Licensing in involves a longer term of commitment than the other options. As in this the from that is the licenser gives the licensee something of value that can be Patent rights, Trademark Rights, copyrights, or know how.4
  6. 6. 3.JOINT VENTURE FORM ATION It is another type of entry option that is available to the corporation. Then ties between the partner firms are strongest in the case of the joint ventures amongst all the cases that have been described till now. Joint Ventures are gaining increasing relevance in the market entry strategy as corporation realize there importance in being able to gain to gain market know how before going in for a further commitment of resources. Joint ventures benefit the foreign partner by giving it the market characteristic of the market that it is entering which otherwise it would have found difficult to understand. Also in many cases like China Joint ventures are necessary because of the government regulation. (Calantone Roger. J. Sam; Yushan 2001) 5. WHOLLY OWNED SUBSIDI ARIES Corporation can also chose wholly owned subsidiaries as their market entry modes. A firm can choose from three options (GorgHolen, 2000) 5.1 Acquisition of an existing low technology firm 5.2 Acquisition of an existing high technology firm 5.3 Setting up an entirely new Greenfield venture. 5.1 Acquisition of an existing low technology firm- In this option the firm presumably has an advantage as it being a global corporation it is assumed that its level of technology would be higher thus bringing the foreign corporation some advantages and more so as the existing players profitability lowers in the market. 5.2 Acquisition of an existing high technology firm- In this scenario the market characteristic remains nearly unchanged as with the acquisition5
  7. 7. of the high technology firm the overall market characteristic remains unchanged. But the effect on the lower technology firm is apparent, as the consequence of a presence of a big player emerging is that of reduced profitability of the lower technology firm. (Gorg, Holen, 2000) In this final scenario due to new capacity being added up it leads to an increase in the level of competition. 6. A further elaboration on the market entry modes 6.1 Exporting- often referred to as the first step in the internationalization process. As discussed earlier Exporting can be divided in two parts Indirect Exporting - This in most cases reduces costs and risks involved with market entry. The reason behind this is that the firm is able to utilize the marketing channel of an existing player so the firm is assured of an assured market and as a result the revenues start flowing in a short span of time. A drawback of this strategy is that by adapting this strategy the corporation is tied to a channel that may have an inadequate marketing network or there may be an incompatibility between the two partners. Direct Exporting - In this strategy the level of control is much higher this involves a higher level of investment on the part of the firm and. In this strategy the level of risk for the firm is also higher. The benefit that the corporation entails by following this strategy is that it provides an opportunity for the firm to understand in a better6
  8. 8. manner the market characteristic of the firm; also it provides an access to the market information. 6.2 Strategic Alliances (Calantone Roger. J. Sam; Yushan 2001)- These are formed between two or more firms’ and is usually in the form of licensing/Franchising or joint venture. Licensing does not require a heavy investment of resources and is less risk prone but he licensor of the technology has to consider the fact that licensing also involves a lesser control over the process. Licensing is very prevalent in manufacturing industries, an equivalent of licensing in service industry is franchising. a) Unlike Licensing and franchising joint ventures are a more risk prone options. There are a number of opinions about why joint ventures are formed. (Calantone, Roger. J; Zhao, Yutan Sam 2001) Firms form joint ventures to gain knowledge for increasing their global competitiveness. Learning in this case should not be construed only as the smaller firms learning from there bigger counterparts but it also happens that when a bigger firm enters a country and forms a joint venture to learn about the country that it is entering. This also ultimately increases the global competitiveness of the firm.(Calantone, Roger. J; Zhao, Yutan Sam 2001) b) Firms are likely to form joint ventures when they have a highly complementary resource base (Calantone, Roger. J; Zhao, Yutan Sam 2001) In many of the cases firms opt for joint venture because they have a highly complementary resource base.7
  9. 9. d) In many countries formation of the joint ventures takes place due to a requirement of the host country, which says that there should be a equity participation in the venture that a firm is forming For the formation and successful running of a joint venture communication plays an important role. As stated there may be a difference in the objective of the partners in a joint venture for example one partner of the firm may have the objective of profit maximization while the other may have the objective of market share so for the successful and smooth running of the venture effective communication is a necessity. 6.3 Wholly owned Subsidiaries Establishing a wholly owned subsidiary is the most risky way of entering a market. Many firms utilize this mode of entry as it gives them the ability of controlling the operation, as they want. Increasingly acquisitions are becoming a common way of having a wholly owned subsidiary. With the cost of capital being low and also due to its easy availability it is easy for corporation to go in for acquisition. Also when acquiring the asset of an existing company the multinational is able to get an established network in the host country along with an option of being able to control the enterprise. In many of the cases the corporation that is acquired can be the one that is the market follower in the category that it is operating in, when this corporation is acquired by the multinational it can develop on itself8
  10. 10. the ability to market its product effectively. This happens because the resources that are available to this corporation have increased. All these entry strategies have been interpreted in various ways by the various theories. For Example the Eclectic theory of market entry tries to analyse the firm’s decision to invest in a market by the Ownership, Location and Internalisation factor. (Dunning, John .H, 1970) Whereas the Bargaining power theory suggests that there is a struggle that is going on between the firm and the host government over the issue of control of the enterprise and various factors affect this. This theory is in some ways the extension of the Internalisation theory of Eclectic framework. Transaction cost theory suggests that tasks could be outsourced or that it could be internalized. In the case of the Behavioral theory approach the hypothesis is based on that a firm takes the decision to invest in a market based on the knowledge that it has of that market. 6.4 AIM OF THE REPOR T The aim of the report is to study the theories of the market entry mode. OBJECTIVE OF THE REPORT9
  11. 11. There exists a lack of the comparison of the theories that are there in the market entry modes. All the studies that have been done have been done on the basis of one or two theories never trying to encompass all the major theories extensively in there report the objective of my study will be to 1.Study the Eclectic theory of market Entry mode (Dunning, John .H, 1970) 2. Study the Bargaining power theory of market Entry mode (Fagre; Nathan, Wells; T, 1983) 3. Study the Transaction Cost theory of market Entry mode (Ghosal, Sumantra1996) 4. Study the Behavioral Theory of market Entry mode (Erramillii. M.Krishna, Rao C.P. 1990) 5. Interpret the various finding and draw suitable conclusion LITERATURE REVIEW10
  12. 12. ECLECTIC THEORY OF MARKET ENTRY MODE- John. H. Dunning propounded this theory on market entry mode (Dunning, 1980). This theory analyses the market entry of the firm on the basis of three factors. (Tse et al, 1997) These three factors are referred to as (Roy & Dibrell, 2002) 1.Location 2.Ownership 3.Internalisation. An aspect of Eclectic theory that needs to be observed is that not only it encapsulates the functioning of a firm but that it this theory has also been extended by John. H. Dunning to nation as well. (Dunning, 1985) Eclectic Theory theorizes that for a firm to internationalize it ought to have certain advantages for it to be able to compete effectively with the home country firms. (Roy & Dibrell, 2002) Now we discuss the three factors of Eclectic framework a) Ownership- Rugman and Gestrin have described this as the factor which provides the company the ability to compete effectively in the market place. They further elaborate that the advantages can be either production based or marketing based. (Moore, & Lewis, 1998) Country specific advantage is a part of ownership (Moore, & Lewis, 1998). Dunning describes these country specific advantages as those variables in the production function like input cost, labor, productivity, market size etc. (Moore, & Lewis, 1998)11
  13. 13. Ownership specific advantage was distinguished by three factors a) Privileged access to assets. b) Advantages enjoyed by a branch rather than a new plant. c) Because of location or it being a multinational. These advantages arise from unique ownership of specific assets in comparison with a corporation which functions is a single country. For example the ability of a corporation to provide products that are unique in nature is a unique ownership advantage (Pang, 1996). In a joint venture when one of the parties is foreign the losses that can accrue to the foreign partner could be much more than the local partner that is why we observe the tendency of foreign partners who try to have effective control over the joint venture that they have formed. When assets are being deployed it is inevitable for a firm to deploy fixed assets. The higher the commitment to the foreign market the higher is the investment in the fixed assets. (Pang, 1996) As a result we can observe that the corporation always usesthe higher involvement decision-making process. Dunning eclectic theory propounds that a firm will choose a strategy that effectively differentiates its products. That is an entry strategy where the resources required are quite high. (Roy & Dibrell, 2002) According to Madhok while extrapolating on the Dunning’s Eclectic Theory model said that a firm will collaborate if market knowledge is high. (Andersen, 1997) An important issue related to Eclectic paradigm is that when a corporation opts for multinational production they must try to hand over their ownership within organization.12
  14. 14. A point to be observed here is that ownership advantage is not solely the prerogative of a multinational corporation or of an international organization, but these advantages can be enjoyed can be enjoyed by a company that is operating in a domestic environment also. (Dunning, 1980) THE ADDED ADVANTAGE THAT IS ENJOYED BY THE ENJOYED BY THE FORMER TWO ARE BECAUSE THEY ARE INTERNATIONAL TRANSACTIONS THAT GIVE THEM ADDED BENEFIT LIKE TRANSFER PRICING. ALSO WHEN A CORPORATION HAS MULTINATIONAL ACTIVITIES IT CAN HEDGE ITS RISKS. FOR EXAMPLE IF PRODUCTION IN ONE UNIT SUFFERS BECAUSE OF SOME REASONS THE SUBSIDIARY CAN GET ITS GOODS FROM SOME OTHER UNIT. Certain type of skills an entity acquires within itself or through acquisition. When one corporation acquires another it is not only acquiring the ownership but along with it some proprietary information. On the type of firms that go on to internalize processes Dunning’s Hypothesis that the higher the internationalization of a firm the more the resources will that firm invest in foreign sources. (Roy & Dibrell, 2002) Firms that are having lesser international experience will tend to be cautious in there approach as most of the managers in these corporations will not be having international exposure and so will be lacking the ability to take decision which are international in nature. (Roy & Dibrell, 2002) Within an organization also where assets are equally deployed a division that is having more international exposure will favor a higher international market entry exposure. For example within an organization the marketing division which has had a greater international market exposure will have a greater enthusiasm for foreign market entry than that organization’s relatively lesser internationalized finance counterpart 2. Location- Location is used to describe the where of production. (Dunning, 1985)13
  15. 15. The business functions on the traditional hypothesis of value addition. A corporation has to add value in the process for it to be able to run the business successfully and to be profitable. This value addition that occurs by the way of transformation of inputs. In this transformation some variable are available to all corporation whatever their size or nationality, but these variable as such are fixed to a particular area and so can be utilized only in that area. (Dunning, 1980) These variables are not only the traditional variable like labor, market & Natural resources. Hut also comparison of factors like legal framework, and Government regulation. But it also comprises factors like legal framework and government legislation. The decision to locate the corporation in a particular country is taken after much consideration. Corporation will opt for production only in the case where they feel at there is some value that is being added in the host country that otherwise they would not be having in the home country. (Dunning, 1985) Entry in a new market may not be solely based on the basis of the value that is being added. In a foreign location. Entry is also made on the basis of the changing government policy, many developing countries it is a regulatory for the Foreign Corporation to invest in a joint venture than a wholly owned subsidiary. (Pang, 1996)For example in the case of China even the premier may not be able to change regulation for me. (Pang, 1996) But this is not the only reason why a corporation would opt for investing in a foreign location. There may be other facts or endowments that may affect a corporation to invest in a country.14
  16. 16. The advantages that a corporation has when it invests in another country are The ability to distribute the risk to many nations. (Dunning, 1985) If a corporation is solely dependent on one single country then any negative movement that that economy may have will lead to problems for the corporation. (Dunning, 1985) Today transfer pricing has emerged as a major tool in the hands of the multinational corporations. Through a complex web of cross holdings a corporation is able to accrue all its profit at a location where the tax rates are lowest resulting in big savings for the corporation. Location preferences It is dependent on many factors but some prominent reasons for selecting a location are location familiarity and market Attractiveness. a) Location familiarity-This is judged by the familiarity of the managers of the managers of a corporation to the location where the investment is being made. If we observe the behavior of many American corporations we will observe that these corporations invest much easily in the economies of Canada and Australia or Europe the reason behind this is the managers familiarity with the cultures of these countries. (Roy & Dibrell, 2002) b) Market Attractiveness-The corporation decision to invest in an economy will also be defined by the market size of the15
  17. 17. corporation that it is investing in. When we refer to market size we not only are referring to the buying power of that nation but also we are referring to the population which tells us more about the market is its Gross national product. Internalisation This factor in Eclectic theory refers to a situation in a company where it has to take the decision on corporation’s decision to sell or lease its assets to its competitor. This asset has been gained or can be gained by the corporation on favorable terms. The reason for internalization is based on the hypothesis that multinational corporation thrive by capitalizing in a lacunae in the market by creating a market where no market exists. (Moore, & Lewis, 1998) One of the major reasons behind firm’s internalization is to capitalize a market imperfection. (Dunning, 1980) Market Imperfection being the inability of a firm to form a symbiotic relationship with another firm, the reason being that the Negotiation or Transaction is too steep, or where there is no economy of scale when a corporation goes in for outsourcing of an activity that is if a corporation goes in for outsourcing of an activity it will not be able to build global capacities. (Dunning, 1980) Internalising can be observed from two perspectives, that of a seller and then that of a buyer. (Dunning, 1980)From a buyers perspective the uncertainty is in terms of timely delivery of goods and little control over pricing. In the case of transaction it has been observed that some value is lost when a tacit nature of resource is being transferred. Secondly16
  18. 18. if there is no perfect understanding between the two partners the relationship has to have checks and balances to it. An observation that has been made regarding internalization and that is that some activities are more easily internalized than others. (Dunning, 1985)For example the distance between resources and the cost involved in the transportation is key reason behind internalization of a factor is that the ability to create a particular asset is present everywhere and there is no cost involved its being transferred. (Dunning, 1985) BARGAINING POWER THEORY This theory hypothesizes that there is a struggle for ownership or control of the enterprise between the multinational corporation and the host nation. (Nathan & Wells, 1982)In this theory it has been observed17
  19. 19. that the host nation capitalizes on its control over the market while the multinational uses its ownership as a source of bargaining power. This theory also assumes that typically the struggle is based on the struggle for ownership. (Deng, 2003) This theory further observes that the vehicle used for entering a new market is based on the relative bargaining power of the involved parties. (Taylor et al, 2000) There are many variables that affect the bargaining power of the firms and the nations with each other. They are as follows a) Capital-Capital can be a source of bargaining power for a corporation especially if the hoist nation is from a developing nation and promoted investments by multinational corporations. (Lecraw , 1984) A corporation if it is investing a large sum will have a higher bargaining power. Another effect that can be observed is that of the size of the corporation if a corporation is very large it has a more bargaining power in comparison with a smaller firm, some authors have commented that large corporations have even more bargaining power than nations as a result o the increased bargaining power that these firms have the probability of there equity being diluted will be minimum. Capital Intensity is not an end in itself fro many nations especially the developing ones the creation of new jobs is also a deciding factor so not only if a corporation is investing in a venture that is capital, intensive it will be having an upper hand while bargaining but if there is a corporation which is investing in a country which is going to create jobs in that economy it will have a bargaining power that will be equal to that of the firm that is bringing in more capital than this corporation. c) Market Accessibility-Some multinationals will only invest in manufacturing in a country if they know that they can build global capacities that will help them compete on a global scale. (Nathan & Wells, 1982)Another case may be that a corporation18
  20. 20. invests in a market on the basis of the host countries buying power. In both the cases we can infer that the bargaining power will be in the hands of radically different parties. Where the firm is exporting a significant part of the produce the host country will have to part with a significant part of control to the firm especially if the firm is operating in a developing nation. (Nathan & Wells, 1982)But if the firm wants to access more of the local market it will have to concede more control to the host nation, as in this case the bargaining power will be more in the hand of the host nation. d) Management Expertise- It is one of the factors that affect the bargaining power of the firm. (Lecraw , 1984)The management expertise that is provided to the corporation’s subsidiary gives the firm an upper hand in its ability to bargain with the host country. But if the host country wants to develop this potential within itself then it may insist on its own managers being given the opportunity to handle the operation. e) Technology-Technology plays an important role in bargaining power theory. A firm with a high degree of proprietary knowledge will strive for a high control entry mode. The higher the proprietary knowledge a firm has the more influence it can exert on a nation. This assumption is more relevant in case of a developing nation. As if a developing country wants to enter a particular high technology industry segment it cannot do so without the help of a developed nation corporation. (Nathan & Wells, 1982)The reverse is also as much relevant in this theory if a certain product category is more mature the amount of control that a firm will want will be much less. f) Product differentiation-When marketing skills are important for an industry the firm is in an advantageous position as it will be having more bargaining power in comparison to the country. (Nathan & Wells, 1982)These firms especially those that have high advertising power will tend to have a high equity stake in there venture as they understand that launching a new product in the market and establishing it involves high advertising cost19
  21. 21. which a local partner may not be comfortable with or it may not be able to afford. The multinational corporations consider that if the host nation firms become joint venture partners in the venture they will not have a comfortable relationship, as there will be a lot of disagreement over the strategy that should be adopted and the action that should be taken. The multinational corporation also assumes that if a high capital is utilized in the marketing of the venture an equal relationship cannot exist with the host country firm. g) Product Range- As referred to in chapter one many corporations have to opt for a joint venture because of the restrictive government policies being practiced by the host country. (Deng, 2003) For example during 1980’s China was practicing restrictive trade policies due to which the corporations that wanted to enter this country had to opt for joint venture with the state owned corporation. (Deng, 2003) There can be a wide degree of variance in the government’s policy amongst nations; in fact even within a nation the government policies can be different h) Familiarity-How much the managers of a corporation are familiar with the culture of a nation will affect the ownership level of the firm, a corporation if it is familiar with the culture of a country will be requiring less level of control so the bargaining will be less. This familiarity does not diminish or increase the bargaining power instead what it does is that the corporation becomes comfortable with diluting its equity if the corporation observes that the managers of the host country act in accordance with the culture of the multinational corporation. i) Country Risk-This factor considers variables like political stability, economic fluctuation and currency strength. (Deng, 2003)Wherever the country risk is high the corporation should try to minimise the level of commitment for that country. As if the level of commitment is too high the corporation’s ability to switch location is reduced.20
  22. 22. TRANSACTION COST ANALYSIS THIS THEORY PROPOUNDS THAT ENTRY STRATEG Y IS BASED ON THE ISSUE OF CONTROL (DENG, 200 3). ACCORDING TO THIS THEORY ALL THE CORPORATIONS THAT WANT TO ENTER A FOREIGN MARKET HAVE TO KEEP THIS IN CONSIDE RATION. THE DEGREE OF CONTROL CAN VARY FROM A HIGH LEVEL OF CO NTROL TO A LOW LEVEL. ALSO THERE ARE TWO B ASIC ASSUMPTIONS THAT ARE MADE. ONE IS THAT PEOPLE ACT RATIONALLY BUT THAT THEY ARE CONSTRAINED, AS THEY DO NOT HAVE ACCESS TO ALL THE INFORMATION THAT IS TH ERE ALONG WITH THIS ACCESS TO INFORMATION TH EY ARE ALSO BOUNDED BY THE FACT THAT THEY DO NOT HAVE THE ABILITY TO LOGICALLY ANALYZE ALL THE INFORMATION.(SHRADER , 2001) The second assumption that is made is that people are opportunistic that is they will always be motivated by there own selfish self-interest. (Shrader, 2001) The factor to be considered while formulating the entry strategy in a foreign market in terms of control is how much control a corporation wants, for a high degree of control a high investment is required which also increases the risks of the corporation while though the second option gives a lower level of control it also requires a lower level of investment. As already propounded in the first chapter the lower level of control can be utilized for entry modes where the level of control can be less that is it does not require a high level of involvement of proprietary technology. The Benefit of higher control is not only that it gives a corporation a higher level of say in strategy formulation but that it also entails a higher level of returns. (Deng, 2003) Transaction cost plays an important role as it can directly have an impact on the bottom line of the firm, for example if a firm opts for internalization it has to incur certain costs (administrative costs), on the other side suppose a firm opts for collaboration it has to ensure21
  23. 23. proper checks and balances so that it is able to fully gain the benefit of the collaboration these checks and balances in the form of contract and legally enforcing those contracts. (Shrader, 2001) Transaction cost also emphasizes the benefit of low control (It starts with the basic assumption that corporation should opt for low control entry mode). If a corporation forgoes this option when it had an opportunity to do so it is unnecessarily increasing its costs also it would be forgoing the benefit that accrues to a corporation when it takes the route of a joint venture while it is entering a foreign country in terms of increased market knowledge and also higher internalization costs related to integration. Vice versa if a firm opts for collaboration when the strategy that it should have adopted was of internalizing the also it is increasing its costs as suppose the technology that it is marketing is an arcane one then it is very difficult for the firm to communicate the processes involved in the manufacturing the products. (Shrader, 2001) When a firm opts for a high control entry mode it has to observe whether the cost of gaining this control is equivalent to the returns that it is supposed to get. If a high rate of return is not there then there is no need for the corporation to venture for a high control mode. (Deng, 2003) Transaction cost analysis starts with an assumption that is it hypothesizes that a low level of control is preferable until proven otherwise (Deng, 2003). The reason behind this is if that in a market there are a large number of suppliers then it is easy for the manufacturers to get the goods at very competitive rates so there is no reason for a corporation to integrate. By not integrating the firm saves on costs. The inverse may also be suitable for the organization this case would arise when it becomes an oligopoly for the supplier that is only few suppliers are having control over all the supply base. Following factors effect the decision of a corporation in making the decision for the corporation about the kind of control that it wants for a corporation22
  24. 24. 1. Asset Specificity- The greater the degree the asset specificity in an enterprise the greater will be the propensity of the corporation to have a high level of stake in the venture. (Deng, 2003) 2. Technology- If there is proprietary information involved in the manufacturing process there is a propensity of the corporation to do the manufacturing themselves as it becomes difficult for the parent corporation to evaluate the value of the technology especially if the technology involved is a new one. (Roy & Dibrell, 2002) An aspect that can be observed in this relation with this is those corporation which have a higher expenditure on R&D will in more cases opt for wholly owned subsidiaries. Also in case of esoteric technologies and processes the level of control that is required for the corporation is high as the corporation will find it difficult to transfer the process know how and technology across boundaries. When the technology that is required to manufacture a product is well developed then as the preliminary assumptions suggests there is no need of the corporation to integrate the process within itself When a new technology is developed it is necessary for the corporation to have control on the handling of the operations as it has to ensure that the technology being a new one the market and also the process controllers have knowledge of the technology involved, with the passage of time as this technology is diffused and this technology starts to diversify the corporation can also let the control to be diluted. (Deng, 2003) With high technology being involved the multinational has also to ensure that the proprietary nature of the information is not lost and so also it has to maintain control as once it has shared the knowledge about its product it can easily be utlised. (Roy & Dibrell, 2002) 3.Product- A product that requires a high degree of customization will require a high degree of control in the venture by the multinational, as where a high degree of customization is required in the product it will be necessary for the corporation to be in constant touch with its customer. (Deng, 2003)23
  25. 25. 4.Complementary Assets- As stated in the assumption that the strategy of the corporation should be to opt for low level of control. From this can be derived the point that corporation can have low level of control if it opts for a joint venture. For a corporation to form a joint venture it ahs to ensure that there are complementary assets involved between the partners. The foreign partner is in an advantageous position if it has the opportunity to enter the market where there are a large number of corporations that it can form this partnership with. (Deng, 2003) 5.Risk- The theory has put forward the hypothesis that the higher the level of risk in a country the lower should be the degree of control. (Andersen &Gatignon, 1985) as we can observe this is the assumption on which Transaction cost theory operates. This theory elaborates that for a corporation to lower its risk it has to opt for a venture where it has lower ownership. That is it has to opt for a joint venture. As already mentioned in the first chapter formation of a joint venture is an advantage that both corporations can enjoy the benefit of collaboration. 6. Brand- If we observe the market entry timing of multinationals we can observe that any major players in an industry are not far behind each other when they enter the market and increasingly in case of multinationals it is important for the firm that is entering the market to have awareness about the consumers that are there in the market. With the increasing role of bodies like WTO it is becoming easy for multinational to have collaboration with partners as they are now much more certain of there rights being protected by these institutions. Even otherwise free riders can try to take advantage of the situation by taking advantage of the situation and using the brand name and selling inferior products and services but even they cannot enjoy the benefit for long. (Shrader, 2001) 7. Government Policy- Government rules and regulation play an important role in the market entry of a multinational, for example if we observe the case of China since 1980’s it has considerably liberalized the policy of multinational market entry as a result there is an24
  26. 26. increasing number of corporations that are entering China.2 But in the same aspect we have to observe that for entering China in many of the instances the firm has to utilize the mode of entry of a joint venture because of the government policy. In a similar manner a corporation will make its decision about entering a market based on the government policies. The higher the restriction that is imposed on foreign participation the lesser will be the equity that will be invested in the venture. By the foreign firm. (Deng, 2003) 8. Experience- a corporation will invest more in a country where it has more market knowledge about the factors that govern the market. (Deng, 2003) for example if we observe the investment that is being made in China quite a substantial sum is being invested by Non resident Chinese, the reason being already stated that the firms invest more comfortably in those market where they have more market know how.25
  27. 27. BEHAVIORAL THEORY APPROACH- One of the last theory of this discussion on market entry mode this theory in unique in the manner in which it analyses the market entry theories. This theory states that market entry commitment of a firm are based on the corporations knowledge of the market, it further states there is a proportional positive relationship between the resources that are committed and the knowledge of the firm about the market that it is entering. (Erramillii&Rao, 1990) The amount of market commitment that a corporation has for a given market is assumed to be composed of two factors 1. The amount of resource that have been committed 2. The degree of commitment. The degree of resource that has been committed can be judged by the amount of integration that that facility has with the other facilities of that corporation and also how much is the facility vertically integrated. The commitment of resources is not dependent on the fact that that facility has to be based in the market that it is supposed to sell its product but the resource commitment can also be a facility that though is operating in the home country but that has committed its resources for another country is also resource commitment, though the hypothesis behind resource committed states that the resource that has been committed should not be easily transferable and it can be assumed that if the manufacturing is taking place in the home26
  28. 28. state the resource committed may be less but this is not so as even though the resource have been committed at the home state level separate allocation has been made for the facility. (Johanson&Vahlne, 1977) The amount of the resource that has been committed can be easy to grasp it is dependent on the value of investment that is being made for a particular market. (Johanson&Vahlne, 1977) Having discussed the commitment, the factor that controls the amount of commitment has to be studied. This theory states that there are two types of knowledge that a corporation can have about a market 1. Objective- This is the knowledge that a corporation can have by it being told about the market factors that it will face by experts from the industry. (Erramillii&Rao, 1990) 2. Experiential- This is the knowledge that is gained by the corporation only through actually entering the market, (Erramillii&Rao, 1990) that is why we observe the process of many of the corporation that enter into a market in a sequential manner. Some corporation keeping this experiential learning in mind start there market commitments in a sequential manner, that is when they plan to enter a market they do it by first exporting to that market and then opening up a trading subsidiary, going in for a joint venture formation and ultimately moving towards a manufacturing unit. When a corporation plans to invest in an economy it will have the greatest if the returns are thought to be constant the corporation will invest in that economy which it thinks will cost it the minimum to operate in that country. And as culture play an important role in governing the cost structure, the lesser the culture distance the more comfortable the corporation will be in investing in that country. (Kogut& Singh, 1998)27
  29. 29. When corporations are investing in a foreign market will opt for a joint venture due to the reason that the local partner will be able to understand the culture of the country that it is investing in, the local partner will resolve many of the problems that a OK CHAPTER 3 An Empirical evaluation: of the theories. In the previous chapter prominent theories were discussed of the market entry modes. Putting forward many hypothesis that in this chapter will be discussed in an empirically. The first theory that is to be tested and discussed is the Eclectic theory of market entry mode 1. Eclectic theory of market entry mode- J.Dunning was one of the main propagators of this theory, this theory based its hypothesis of investment on three factors that is. (Dunning, 1980) a) Ownership. b) Location Advantage. c) Internalisation. Ownership - various studies have been conducted on the Dunning’s eclectic theory it being one of the oldest theories that were put forward. One of the studies that have tested Dunning’s eclectic Theory’s ownership advantage is that of Yigang Pan, This study was conducted in China on 4223 international joint ventures that at the time of study were 16.4% of all the joint venture population. (Pang, 1996)28
  30. 30. The study studied many effects of ownership, for example this study observed that higher the advertising expenditure the more likely would be the tendency of the multinational corporation to opt for either an equal equity stake or a majority stake. (Pang, 1996) Another hypothesis states that the investment in a country is dependent on the risk that a corporation observes in that country. The hypothesis when tested in this study proved this hypothesis, in this study it was observed that as risk situation in China improved the multinational corporation was more comfortable investing up to 50% of the equity. But this study had an added observation and that was that5 in a country like China a corporation will increase its investment till 50% of the equity on the changing of the investment climate for the better but this does not portray that a corporation will increase its investment from more than 50%, this observation has been made and corroborated to a limited extent. (Pang, 1996) Location- Dunning described location advantage hypothesis as that a corporation will choose a location as its production location that provides this corporation with all the variables that it requires for fulfilling its objectives. The factors that Dunning was concerned about was a) The size and character of the market (Dunning, 1980) b) Production and transfer cost.(Dunning, 1980) Dunning carried out his research on American multinational across fourteen manufacturing industries in seven countries. The corporations were studied on the basis of their exports to a particular nation in conjunction with the production that is taking place in the country. The hypothesis compared the ratio of local production to exports from America, the higher the ratio the higher is the commitment of that corporation to that country.(Dunning, 1980) The study revealed that the main advantage of the U.S firms lay in one location specific variable and that is the relative market size and one ownership specific variable that is the skilled employment ratio .In his study Dunning observed that both the factors were significant at 99% level of significance.(Dunning, 1980)29
  31. 31. Internalisation- This is the third factor that is studied in theEclectic theory. A study was conducted on the process of internalization on Upjohn Corporation a pharmaceutical company. (Fina&Dugman, 1996) The case study considered Upjohn’s operation in 61 countries. This study observed the market entry in nine stages in terms of the commitment to that country. (Fina&Dugman, 1996) This study observed that market entry in a foreign normally took the route of 1) Exports 2) F.D.I 3) Licensing This study observed that this is the route that was taken by Upjohn Corporation in most of the nations that it invested in. The reason this study gave for this movement was that internalisation moves on the assumption that the information that is passed to a licensee is secure which is not possible in the early stages of the market entry. The study observed that in 61 countries where the company was observed in 38 of them Upjohn operated initially by exporting, in 16 or other cases the entry was through host country representatives who also were initiated usually after there being coming to an agreement with the local distributor. In two cases that is of China and Hong Kong the investment was made directly in sales office. In case of Germany the investment was made directly in a subsidiary but that was because of regulatory country specific reasons. In Turkey, Spain and Ex-Czechoslovakia the investment was made in licensing, a point to be observed here is that though all the entry modes have been made the preponderance is that of the first investment is being made in indirect exporting. Also in none of the cases is the investment being made in a wholly owned subsidiary.30
  32. 32. 2) Bargaining Power Theory- This theory propagates that a corporation propensity would be to have control on the venture that it is investing in. (Nathan & Wells, 1982) One of the most important studies done on this theory was by Fagre and Wells. They conducted a research on United States multinationals operation in Latin America. (Nathan & Wells, 1982) The research had several hypotheses. a) The bargaining power of the corporation was affected by the technological factor The result tat were observed were consistent with the hypothesis that is the percentage of sales that is spent on the R&D is positively related to bargaining success. (Nathan & Wells, 1982) R&D EXPENDITURE AS A % OF SALES AND THREE MEASURE OF PARENT’S OWNERSHIP % Of sale spent Average ownership level on R&D Actual Firm-Corrected Country- Corrected 0-.75 88 18 -1 .75-2.5 86 15 -1 b) T h 5 & Over 99 20 10 e second factor that was affecting the bargaining factor was31
  33. 33. product differentiation. The study proved that the corporations that spend more than 7% of there sales on advertisement had greater bargaining power. Some 202 corporations that were among the highest spending corporations were from pharmaceutical or cosmetic industry; this study observed that this bargaining power was not only for some particular industry but also for all the sectors.(Nathan & Wells, 1982) LEVEL OF ADVERTISING AND THREE MEASURE OF PARENT’S OWNERSHIP % Of sale spent on Average ownership level c) M advertising a Actual Firm-Corrected Country- r Corrected k 0-1 85 14 3 e 1-7 89 17 0 t Over 7 98 21 9 Access-This theory hypothesized that a corporations ability to export 50% or more of there products gave it a bargaining power, the corporation that were studied exported to both within themselves and also outside. (Nathan & Wells, 1982) THE % OF OUTPUT TRANSFERRED WITHIN THE PARENT SYSTEM AND THREE MEASURE OF PARENT’S OWN ERSHIP % Of sale spent on Average ownership level advertising Actual Firm-Corrected Country- Corrected 0-10 80 15 -1 d) C 10-50 91 21 2 a p50-100 95 23 8 ital-The hypothesis brought forward in this theory was that the amount of capital that is being invested in a firm is also a source of bargaining power for that firm.(Nathan & Wells, 1982) The observations that were made were not too conclusive for example it was observed that for investment up to dollars 10032
  34. 34. million the corporation was able to gain no significant bargaining power. Another observation that was made was when an investment of more than Dollar 100 million was being made, that corporations invested in those countries that were more liberal in allowing that investment to be made and were willing to give the controlling stake to the corporation. (Nathan & Wells, 1982) THE FINANCIAL SIZE O F THE AFFILIATE AND THREE MEASURE OF PARENT’S OWNERSHIP % Of sale spent on Average ownership level advertising Anot Actual Firm-Corrected Country- her Corrected stud 0-10 80 15 -1 y 10-50 91 21 2 that teste 50-100 95 23 8 d some of the hypothesis of the bargaining power was one by Bobillo&Palenzuela this study was conducted on 60 Spanish corporations, an observation that was made that was made contrary to the traditional bargaining theory was regarding asset specificity, in the bargaining power theory it was observed that corporations with high asset specificity will invest in higher control mode, in case of Spanish it was observed that corporations on increasing there asset specificity opted for shared control mode. (Palenzuela&Bobillo, 1999) 3) Transaction cost Theory- Transaction cost theory is an important theory in terms of explaining the market entry mode of a corporation. This theory hypothesizes that a corporation will make its investment decision on the basis of the most efficient market structure. (Deng, 2003)33
  35. 35. Anderson&Gatignon(Andersen &Gatignon, 1985) put several hypotheses forward that were not tested empirically by them but an empirical study conducted by Beamish and Delios(Deng, 2003)did do this. This study was conducted in Asia the corporations that were studied were based in Japan; this was so done as in the past nearly all the corporations that were studied were based in America. That data was obtained from 1,043 firms (Deng, 2003) As hypothesized by Anderson and Gatignon that there exists a positive relationship between asset specificity and level of ownership. This study observed ht same. This study was conducted on both firm level and industry there was a discrepancy in the results, on observing on the level of the firms it was observed that either there is no relationship between asset specificity and ownership or that there is an inverse relationship, this result should give the followers of this theory a word of caution.(Deng, 2003) Another observation that was made by Beamish and Delioswas that the Japanese firms did not try to reduce transaction costs as hypothesized by the transaction cost theory. The reason observed in the study did not question the observation in the theory instead the observation that was made by the authors that the reason behind this is the fact that the Japanese corporations did not spend such a large sum on either R&D or on advertising, However an observation that was made for the corporation that invested in a country after 1984 was that R & D investment was significantly related to the level of ownership, but this observation was limited to those investment that were made after 1984 and not prior to that.(Deng, 2003) It may be interpreted as that this study was studying the behavior of only the Swedish Corporations but this also was refuted by JohansonandsVahlne, when they quoted the study conducted by several researchers in there study. Another study that has been conducted and which has further strengthened this behavior model is that by Bruce Kogut and Harbir Singh, The study was conducted on 228 entries in the market in the form of joint venture, acquisition and Greenfield investment, The34
  36. 36. research proved the hypothesis that had already been stated by the previous study and that was that the effect of cultural distance is to increase the probability of choosing a joint venture instead of acquiring a firm 4) Behavioral Theory Approach- This is the last theorythat was observed in this study. This study hypothesized that a corporation makes its investment decision on the basis of the market knowledge that it has about a market that it is entering. This theory observed that the more the market knowledge of a firm the more it will be comfortable in making the investment in that country. There have been two major studies that have contributed to the literature of Behavioral theory, these two studies I have also referred in my study. (Johanson&Vahlne, 1977) The first study being that of Jan Johanson and Jan-Erik Vahlne conducted by them in University of Uppsala on Swedish firms, in this study it was observed that the Swedish firms take there investment decision in small incremental steps.(Johanson&Vahlne, 1977) In another study that was done by Johanson and Vahlne they observed that the firms that want to make an investment follow the route of no regular export, sales through an independent agent, export through a subsidiary finally moving on to production seems to be the move that these firms seem to follow. (Johanson&Vahlne, 1977) In the study it was observed that of the 63 sales subsidiaries the agents preceded (Andersen &Gatignon, 1985) This observation was there for all the firms. When these researchers observed the production subsidiaries they found a difference between Sandvik and Atlas Copco on one side and Facit and Volvo on the other, in the former twenty-two of the twenty seven were preceded by sales subsidiaries, whereas in the latter it was observed that five out of seven occurred without the firm35
  37. 37. having establishing any sales subsidiary of any kind.(Johanson&Vahlne, 1977) Conclusion. All the four theories that have been observed are major theories that discuss the major factors that affect the market entry mode in an international market, but these theories are not complete in themselves as they all have some limitation inbuilt as all the aspect36
  38. 38. have not been studied in a single study. The first limitation that is observed in the eclectic theory a) The factors that decide on a firm’s decision and the factors that affects a country decision to promote foreign investment can be diabolically opposite, they are not related to each other, for example a firm that decides to invests in an economy may be doing so because of the corporations internal policies instead of the market attractiveness of that economy, therefore the factors that correlate these two are missing and it is difficult to relate these two. (Macharzina& Engelhard 1991) b) The variables that have been selected have not been properly tested, so though the variables seem to be very relevant they may not be so as they have not been tested empirically, so the factors that are used to study the various factors in the Eclectic theory investment have themselves to be studied, leading to invalidating so many results that have been made through the use of this study.(Macharzina& Engelhard 1991) c) The third aspect that the Eclectic model lacks is that there is no consideration for the behavior of the managers of the corporations of the world towards there strategy of decision making, so we observe is a generalization in the factors that affect the market entry mode across.(Macharzina& Engelhard 1991) d) The motive of the different firms that make there decision regarding the investment in different countries will be different when considering the Organisation, Location and Internalisation factors, so a generalization is not an effective tool to be used while using eclectic paradigm as the sole decision making toll in an investment decision. e) The three factors of Organisation, Localisation and Internalisation have been considered from a macro perspective though the corporation while taking their investment decision face factors at a much more micro level. The other major theory that has been studied and where some shortcoming of the theory has been pointed out by authors like37
  39. 39. SumantraGhosal and Peter Moran has been Transaction Cost Framework. Ghosal and Moran have criticized this theory oft used by many researchers as a foundation for studying decision making of corporations and also widely used in many socio-economic issues for the following issues. 1. GhosalAnd Moran commented that Transaction cost Framework does not take into consideration the human aspect of the functioning of an organization and only consider the technological aspect, whereas in many organizations assets are its people. (Kogut& Singh, 1998) 2. Ghosal and Moran have criticized Transaction cost theory because they comment that opportunism is not only the tendency of human’s but also of corporations, this aspect of corporations also being opportunistic has not been discussed by the Williamson in his Transaction cost framework. (Kogut& Singh, 1998) The areas of study in Bargaining power and behavior theory is quite new in relation to the other two theories that have been discussed and so there is relatively lesser literature that was available for this study, the major drawback that these theories face are a) These theories are complementary that is that they are not independent theories that can on there own discuss the strategy that is utlised by corporations for entering the market, for example the behavior theory hypothesizes that a corporation invests comfortably in a market when it has got knowledge about that market. But market knowledge is no the singular factor that affects a corporations market entry other factors like market size and market Attractiveness’ play an important role in the decision making process. IMPLICATION OF THE STUDY38
  40. 40. An area of further study and with much more detail and also more resources would be to hypothesize and prove a theory that is able to amalgamate the basic assumptions of all the four major theories that is why we observe that some researchers are moving in the area of trying to study the entry modes on the basis of more than one theories like Palenzuela&Bobillo who have tried to study the entry mode using both Transaction cost and Bargaining power theory REFERENCES 1. Andersen, Erin; Gatignon, Hubert, 1985, Modes Of Foreign Entry: A transaction cost analysis and proposition, Journal of39
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