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Why and How Firms Internationalize

The ever-increasing levels of globalization have resulted in developments like more international integration and lower trade barriers which have created crucial economic and institutional conditions for various growth strategies of firms from both developing and developed nations.   For instance, firms whose home markets are limited may consider venturing into foreign markets as presence in such markets is an important tool for growth. The domestic demand may be too low, or the industry too narrow; factors that may prompt a firm to go abroad. As it were, such a move, referred to as internationalization, presents firms with new opportunities to expand and reach new customers in spite of the challenges that may be faced by so doing. This paper discusses the internationalization process and uncovers reasons that motivate firms to become international enterprises.

Although the concept of internationalization has been extensively employed, not very many attempts have been made to give a precise and operational definition of the same. Nevertheless, some scholars have fronted some presentations meant to shed light on what the term internationalization means, an excellent example being an early one given by Turnbull (1985) and Piercy (1981). According to these authors, internationalization refers to the outward movement of the operations of a firm.  Arguably, this simple expression can be embellished to better define the concept as the process of increasing a firm’s involvement in the international arena (Welch, &Luostarinen, 1988). Indeed, the latter definition is better as it considers both the outward and inward growth of international enterprises. For instance, counter-trade growth as in the form of buy-back arrangements or barter exchanges shows how inward and outward growth are related. It cannot be disputed that this definition is not only easily interpretable and concise, but is also adequately holistic as it factors in multiple factors that are usually associated with a firm’s international expansion.

The process of internationalization has been the central subject of widespread empirical investigation from which arises an inference that any firm can take an array of potential paths during the internationalization process. Contemporary understanding of this process has been aided by a wide range of perspectives and approaches. A number of econometric, economic, managerial, and organizational marketing models have been developed in explaining the behavioral and structural issues underlying the theory of internationalization (Prashantham, 2008). Some of them shall be highlighted as they help understand what motivates firms to become international enterprises.

According to the market imperfections theory, firms are constantly seeking market opportunities. As such, their decisionto become international enterprises can be explained as one strategy of trying to capitalize on capabilities that are not shared by competitors in the foreign countries they (the firms) are venturing into (Thai, & Turkina, 2014). The mentioned capabilities or simply advantages enjoyed by firms are effectively explained by imperfections in the market for various goods as well as factors of production.  As per the perfect competition theory, the same homogenous products are produced by firms whose access to existing levels of production is the same. However, an imperfect competition theory (as reflected in the theory of industrial organization) dictates that firms possess differing forms of competitive advantages, which are also of varying degrees. Notably, although the market imperfection theory does well in giving insight into why firms internationalize, it fails to give an account as to why foreign production emerges as the most desirable and preferred means of optimally harnessing a firm’s competitive advantage. To cover this gap, the international production theory has been developed. The theory suggests that the propensity of a firm to initiate foreign production depends on particular home country attractions compared with the advantages as well as resource implications of operating in another country (Marinov et al, 2012). Here,it is made explicit that the firm’s advantages and resource differentials have a role to play in influencing its investment activities in other countries. In this breath, it cannot be disputed that the actions or omissions of a foreign government where a certain firm is interested in may significantly alter the entry-conditions and the piece-meal attractiveness for foreign firms. Another concept closely linked to the foreign investment theory is internalization which revolves around the assertion that firms are constantly aspiring to develop and expand their own internal markets where transactional costs can be as cheap as possible within the firm. Hence, the internalization process entails a kind of vertical integration that brings new activities and/or operations that were formerly conducted by intermediate markets under the firm’s governance and ownership.

As to why and how firms go international, international management research presents that the long-term success and survival of organizations depends on a strong presence in the international arena  Barkema, &Vermeulen, 1998). The benefits of internationalization include leveraging of knowledge and R & D across countries as well as responding to or facing foreign competitors in their home ground.  Firms are also better positioned to access more customers and increase the range of cultures. International diversification leads to better performance for the firm. These and other positive effects that form the basis of firms’ motivation to internationalize arise from contextual market opportunities, returns stabilization, and greater market power besides a return to more intangible assets.

Despite the advantages of going international, academicians have warned against associated risks such as the challenge of having to operate in unfamiliar, cultural, legal, and business environments where the organization is not well known (Ford, 2003). It has been suggested that services and products produced from emerging economies suffer from what has been termed as a liability of origin since they are oftentimes seen as being of poor quality as opposed to those emanating from more developed countries.

The international management theory also sheds more light as to why and how organizations internationalize. Some of the earliest research on this topic includes that conducted by Vermon (1966) and Hymer (1976). The former explains an innovative product’s life cycle from the time it is initially manufactured in a developed country such as the USA to the when it is eventually produced in other countries, even developing ones. This theory explains that product innovation (during the early stages of the product’s life cycle) takes place in developed countries. As the product slowly matures, techniques of mass production are used and the international demand for that particular product goes up, prompting its export. In the end, the product is standardized and firms begin to manufacture it in developing countries which are oftentimes considered low-cost locations. By so doing, the product is brought nearer to the point of consumption. It is common to have it exported back to the home country from the foreign locations where it is produced. This theory finds applicability to emerging economies which are low-manufacturing locations that are appealing for firms to operate in. Meanwhile, Hymer (1976) built on his doctoral dissertation (presented in 1960) to suggest that firms go international so as to leverage special advantages that include product market power, advanced techniques of production, input markets imperfections, and other first-mover advantages. With such special advantages, a firm could be more profitable outside its home country in spite of higher costs that may result if it ignores local conditions that may exist abroad (Conconi et al., 2013).

Prominent research that followed the works highlighted above explained internationalization as the behavior by firms to try to copy the actions of its competitors during oligopolistic competition by effectively matching their investments in foreign locations (Marinov et al., 2012). The concept under discussion has also been approached through a transactional cost lens where firms make decisions between utilizing the market as a means of exporting goods and internalizing involved activities so as to minimize the costs incurred in the process. Most of the advantages of internationalization are explained by the eclectic paradigm that identifies and groups them as ownership-specific advantages (includes property rights and advantages tied or related to intangible assets), location-specific advantages, and internationalization-incentive advantages.

There is general agreement among academicians that there is no given specific ways of firms going international, rather different firms can organize their internationalization activities differently. It is argued that the internationalization process adds complexities to the task of management, more so because the firm has to learn and develop different procedures and skills before successfully merging the new/internationalization activities into the wider operational system (Conconi et al., 2013). The internationalization process is said to take place in the following steps:

• In the initial phase, foreign subsidiaries tied to the parent firm are established, albeit via loose financial ties as in a holding company.
• Later on, there takes place organizational consolidation leading to the development of an international division. This division is regarded as an independent part of the firm that is not subject to the similar organizational and strategic planning as is applied in the parent firm’s domestic activities.
• The third phase involves consistent, and perhaps, worldwide strategic planning that involves altering the firm’s foreign activities in such a manner as to yield closer links with the rest of its operational and/or organizational structure. This may be in terms of a global structure of the product whereby the product divisions are tasked with responsibility on a global basis, or an areas structure whereby each division is assigned responsibility for one geographical section of the global market (Choi, 2011). Some instances may involve a mix of the two where particular product lines are handled/ managed by specific areas divisions and others are managed on a global basis.

Acknowledging that many models have been developed to explore and explain how firms go about the internationalization process, it is appreciated that not all can be discussed exhaustively, especially considering the limited scope of this paper. The internationalization model developed by Johansen and Vahle (1977) shall be used to illustrate the concept under discussion. This model is founded upon early theoretical presentations about the theory of the firm and the related theory explaining the growth of the firm.  A critical assumption here is that a decision’s outcome, or more precisely a cycle of events informs the input of the next.  As per this model, the international engagement of a firm increases gradually. A distinction is made between the change and state variables of the internationalization process. Whereas the former involve decisions on committing resources to foreign markets and conducting business activities in such a climate, the latter entail market commitment in a foreign location and knowledge about the same. Market knowledge and market commitment are said to influence a firm’s decisions on committing resources to new/foreign markets and the manner current operations are carried out (Choi, 2011). In turn, market commitment and market knowledge are affected by commitment decisions and current activities. According to this model, internationalization is considered a causal of cycles.

Under the present model, internalization was initially considered a process that is internally induced. Theory had it that the process was initially initiated and conducted by the firm seeking to become an international enterprise without giving due consideration to other firms that could be encountered in the course of the company’s operations. In their more recent presentation, Johansen and Vahlne (2003) assert that a focal firm’s role in shared by other players in the same market. More specifically, the notion of internationalization is addressed as an action that a focal firm initiates and carries out in conjunction or collaboration with other actors or partners in the scene. Simply stated, it is an inside-out process that involves the active and decisive participation of the focal firm in co-operation with others in the network. More often than not, firms that are internationalizing may decide to carry out active research about the foreign market they are planning to venture into. For instance, such can happen through attending trade fairs. In the same context, it is adequately appreciated that other independent actors could also be engaging in the same research with an aim to attract and as well as offer to represent other business enterprises/firms that are looking for foreign markets. Such a coincidence offers a perfect opportunity for a firm intending to internationalize its operations to conveniently meet an independent actor who convinces it to make a choice to enter and start operations in the independent actor’s home market. Sometimes the independent actor may offer to be the foreign firm’s representative. In such a case, the independent actor shares (with the foreign firm) objective and/or experimental knowledge about his or her own market. That way the foreign market is convinced to make a decision to enter the unfamiliar foreign market because it will rely on the independent actor’s knowledge and advice in its operations. When the two players fit and suit each other well, they interact and share knowledge as to what role each has to play in the operations to be embarked on. Such knowledge is useful when determining mode of entry and other market decisions. In this context, internationalization emerges as a process that is internally initiated by the focal firm and determined by its interactions and relationships with an external actor as well as other players in the network. In the resulting operational arrangements, each party is expected to act according to the promises and agreements as laid down.

The internationalization process as explained here has been observed in many Swedish companies venturing into foreign markets, for instance Turkey (Rutihinda, 1996). Similarly, Indian firms going international have been observed to adopt this model, much the same way as Chinese firms venturing into the European scene. A specific example shall be explored in detail. Kanthal AB, an industrial firm was founded in Hallstahammar, Sweden, in 1931. It supplies metal and ceramic resistance materials for household and industrial appliances. Most of the company’s central resources for manufacturing as well as for research and development of new products are situated in its Hallstahammar head office. Exports account for 98% of the firm’s sales, implying the company has chose to have representatives in many countries around the world so as to serve its wide customer base. Kanthal became part of a Swedish international firm, the Sandvik Group, in 1997. How did the company go about becoming an international enterprise? More specifically, how did it enter the Turkish stage?

Notably, the firm’s entry into the Turkish scene was not initially a conscious strategic decision. Quite contrary, the decision was initiated by an external (independent) actor with which the company interacted. The actor, Isac Alaton, came in contact with the firm’s products during a workshop in Motala, Sweden.  At that time, he was planning on starting his own company back home. He contacted Kanthal to enquire if the company would be interested in using him in Turkey as an agent of its products. The firm weighed this option seriously since it no real investment cost on its side, meaning it has a chance to venture into this new market with reduced risk. Its resource investment in the scenario consisted only of training new personnel and a few employees from its marketing department. At that time, the company did not consider the Turkish market as one with great potential hence its apparent lack of interest. It also considered its resource investment to be sufficient that time.

A series of steps followed, with the company initially seeking more information about the Turkish business climate from the Swedish Trade Council. Employees at Alarko also assisted in carrying out market survey. Contextual reports and others submitted by independent consulting firms in Turkey informed that indeed the country was characterized by high level of modernization and therefore high growth potential (Forsgren, 2015). It also emerged that Alarko’s sales were much higher and that not much regard was given to Kanthal products. This prompted the company to reconsider its operations in Turkey. Later on, its representatives at Alarko were asked if they were willing to work fully for the company. Their response was in the affirmative since they figured out they would hold important company positions, just as it turned out to be later. Based on advice by the Swedish Trade Council, probable forms of establishment were examined.  The marketing department explored three options. The firm would starts its own company, establish a joint venture with Alarko, or open its own representative office. Before making a decision, Kanthal consulted with other Swedish companies (most of whom were based in Istanbul) that had already experienced the Turkish business climate (Forsgren, 2015). The firm settled on the option of establishing a representative office. As it were, this business form was beneficial because it enabled the firm to have better control, better profit opportunities, and a more motivated workforce. The establishment of a representative office also implied lower costs since a greater portion of the capital required would be for salaries and rent for the business premises. Imperatively, the Kanthal explored the risk of having Alarko become a competitor or agent but this risk diminished since their business relation had come to a positive end. Parallel to determining this business relation, suitable premises besides office equipment were searched for, eventually seeing the establishment of an office on the European side of Istanbul. The firm received necessary help from the Swedish Trade Council office in Istanbul in drawing up crucial contracts and contacting relevant authorities and organizations as may be prompted by the setting up of a company. Thus Kanthal successfully internationalized.

 In conclusion, internationalization literature may not be exhaustively explored within such a limited scope. Nevertheless, it is believed what has been presented adequately informs why and how firms internationalize. The example given (of Kanthal AB) is adequately informative on the model highlighted.