Significant Factors for Choice of Entry Mode in a Foreign Country Essay Sample
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Companies which are able to survive through the years of competitive business have no other sensible path but to expand its range (Lovén 2007). Growth is usually equated to the infiltration of these escalating companies to the international business scene (Estrin and Meyer 1999). A firm, first and foremost, needs to determine the partner country in which it will consolidates itself into. Next to this is the critical decision of choosing the appropriate entry mode to be used in the foreign country (Yip 1982).
This paper aims to evaluate the theories presented from the paper “The Effect of National Culture on the Choice of Entry Mode” written by Kogut and Singh in the late 1980’s. This study postulated two hypotheses related to the entry mode choice of foreign investing firms in the United States of America. From this article, the points that are still applicable to the modern international market will be emphasized, and the obsolete theories will be enumerated and their corresponding alternative theories will be specified at the same time. It is also the objective of this paper to include recent studies addressing the topic of entry mode used by countries in the 21st century, in consideration with the present state of the international market.
The Effect of National Culture on the Choice of Entry Mode by Kogut and Singh: The Concepts
The work of Kogut and Singh presented in their 1988 paper may have been one of the proponents of how entry mode is influenced by various factors. What may have been true for the market in that decade may not be that applicable in the current international scene since the business world is constantly changing. Differences between market situations in a single industry in a country may be markedly changed in a span of as little as five years. As an example, in such countries as Poland and Hungary, the number of foreign investing firms had been observed to increase from 10% to 60% from the years 1994 to 1999. With just five years, the face of their local markets had been dramatically changed by the presence of increasing number of foreign investors (Thi and Vencappa 2007). In order to determine the relevant points from Kogut’s work, it is imperative to dissect the theories presented. From the cited article, there were two hypotheses from the two ends of the spectrum; one postulated that entry mode is influenced by the differences in the cultural aspect of the foreign and the host country and the other suggested that it is the attitude of the foreign investor towards uncertainty avoidance which determines the entry mode. From this two working theories, Kogut then presented various studies which supported their claims.
Before these studies are enumerated and discussed, it is important to define commonly used terms for this topic. First, the differences between acquisition, greenfield and joint venture. The first two were cited as the choices for a firm on how to enter a foreign country for business purposes, while joint venture may pertain to the degree by which a firm may own or control a company. These terms which are used to describe entry mode have two parameters to describe: one, ownership and two, the creation of a new entity or firm (Jakobsen and Meyer 2007). Acquisition is when a company procure stocks enough for the investor to take control. They then use the local resources, facilities, sales force and the like of their local counterpart while taking over the managerial side.
In this set-up, the investing firm may possess a business that does not necessarily fit the system and structure of the original firm. Acquisition implies a faster penetration of a foreign investor into the local business scene when compared with the other entry mode (Estrin and Meyer 1999). Greenfield on the other hand, pertains to the approach of starting a company from the ground up once a foreign market is penetrated. As another opposite characteristic to acquisition, greenfield can build a company homologous to the original firm. Entrance to the foreign market scene is slower since the new company is to be assembled from the most basic level (Ngowi 2002). When asset control is considered, joint venture is the ownership of a company’s assets by more than one firm. The stock holders then share all of the executive aspect of running the company, as well as the profit that may be obtained.
Another term that was mentioned in the article is psychic distance. This term is related to the theory of cultural difference as the driving force behind the choice of mode of entrance. Psychic distance pertains to the degree of uncertainty of a firm regarding a prospect foreign market. This uncertainty can be dictated by the difference in the language and the culture of the firm and its target company.
Kogut and Singh indicated that when revenues to be generated by the company is taken away from the equation, the significant factors that managers will consider when choosing the mode of entrance into a foreign market will largely depend on the costs and the management of the new firm. The least possible amount of investment should be used for the chosen entry mode. At the same time, the effective supervision of the local counterpart must be correlated with the entry mode of choice.
Focusing on the influence of cultural difference between the local and the investing country, two analyses were enumerated in the study of Kogut. First, when there is a glaring difference between the cultures of the two companies, the preferred mode of entrance would be greenfield as well as joint venture. Acquisition will not be favoured since common grounds for running the company may not be met if administrative practices, influenced by cultural disparity are quite different. Second, when the investing firm has a high propensity to avoid uncertainties in their investment, the chance of choosing greenfield and joint venture is greater than choosing acquisition.
Various studies had been cited by the article which supported these analyses. It was stated that the tendency to acquire is influenced by a number of variables. One, when there is a significantly small dissimilarity in the cultural setting of the companies then acquisition would be more likely to be the choice of entry. Physical barrier may also dictate acquisition mode. Similar to cultural setting, the tendency to acquire is greater when the physical barrier between the two countries is smaller. When experience of the investor firm in the international market is considered, this is positively correlated to acquisition; the more experience they have in investing in other countries, the higher is the tendency to acquire. Diversification is also positively related to acquisition-the higher the desire of a company to diversify, the higher is the chance of choosing acquisition.
When the investor firm have a wide range of products, as well as a high degree of multinationality and the production of durable goods, entry mode in a new country is usually through acquisition. It was also seen that smaller firms had a higher tendency to acquire than larger firms. But, this entry mode is seen to be less favoured when the firm to be invested in is in a country which is an LDC. Also, if the investing firm had an affinity to avoid uncertainties, then acquisition was not the mode of entry choice. Different sectors of the industry were analyzed to determine their choice of entry. Natural resources, miscellaneous manufacturing industries and financial services were seen to be leaning towards acquisition as seen from the data obtained by the Department of Commerce (USA) from the years 1981 to 1985. In relation to this, the greater portion of investing firms in America in the years 1976 and 1983 (50%) was introduced to the market through acquiring an American company. In 1979, 79% was the observed value for acquisition in the country.
The factors which influenced investors to use greenfield as their mode of entry were also enumerated. When the research and development aspect of the foreign firm is thoroughly developed, greenfield is favoured over partial ownership. This is also true for companies which had an intense advertising campaign. Firms which had more experience in investing also tend to choose greenfield entry mode. At the same time, if the products to be produced in the invested firms were homologous to the products produced in the core business, then greenfield was again the ideal choice. A closer look at the American-investing industries indicated that specific economies favoured greenfield over acquisition and joint venture, and these were the chemical and electrical machinery industries.
A number of factors were seen to be negatively correlated to the use of joint venture by foreign firms. One was the state of the marketing, multinationality, research and development and advertising of the investing company. If these aspects were intensified, then the tendency to joint venture was discouraged. It was also seen that acquisition was inversely correlated for companies to dwell in joint venture. The sectors which leaned towards joint venture were the electrical and non-electrical machineries industries, chemical and pharmaceutical companies.
If these firms will be quantified based on the mode of entry in USA, the least used by foreign investors was through greenfield entry, with only 85 companies out of the 506 that were analyzed. Joint venture was used by 147 companies while acquisition had been chosen by 274 firms, the highest among the three modes of entry. By country, the leading investors in the States were United Kingdom and Japan, the former having 141 investments and the latter with 114. The United Kingdom was able to penetrate USA market mostly through acquisition with 111 companies gaining entrance to the market through this entry mode. For Japan, most of its investments were made through joint ventures, totalling to 46 companies-the highest among all of the countries which used this type of entry mode.
These theories paved the way for the construction of Kogut and Singh’s hypotheses mentioned above. The variables (multinationality, research and development etc) enumerated were quantified and input into a probability equation in order to determine which of these influenced investing countries to use acquisition, greenfield or joint venture. To simplify the results obtained, it was determined that a high number of foreign firms had statistically favoured joint venture over acquisition. For the individual variables, the manufacturing industry had favoured greenfield entry mode over acquisition at a significant level. With an intensive research and development department in a firm, acquisition was ultimately discouraged and joint venture was favoured over this. For advertising, the opposite was true; acquisition was favoured when there was strong advertisement of the investing firm and a lower chance for joint venture or greenfield to be chosen by the companies. Lastly, when an investor is a diversified firm, then the tendency to choose joint venture or greenfield was higher than in choosing acquisition.
The data that was first generated were largely affected by the presence of an outlier investor, the Japanese firms. The rise in the number of companies invested by Japan in the United States was postulated to have a biased impact on the results, since it was evident that this culture was very much different from the invested country. Moreover, these firms were considered to be greenfield or joint venture firms. In order to negate these biased tendencies, Japanese investments were taken away from the computations. Unexpectedly, the effect of this outlier did not significantly change the earlier obtained results. It was still evident that if a foreign country had a high propensity to avoid risk, greenfield and joint venture were still the two obvious choices over acquisition while the opposite was true for cultural difference.
The authors concluded that the two factors, cultural difference and avoidance of risk were shown to dictate the choice on how an investing firm may enter a foreign country, as patterned from what was seen in the United States of America. It was also indicated that the validity of this claim may only be significant for a certain period in time. When this study was conducted, data used was from the time when Europeans were the primary foreign investors in the USA. It was postulated that with the rise of Asian firms such as Japan, the factors affecting entry mode will not be as clear-cut as was enumerated. The role of oligopolistic competition was also mentioned. This was the tendency for b
usinesses to speedily gain entrance into a country for competitive purposes. The authors stated that
this is a new avenue to be considered when studying for the choice of entry mode, in addition to cultural difference and avoidance of risk (Kogut & Singh 1988).
Recent Studies Concerning Entry Modes
Although the work of Kogut and Singh had been written for almost over 20 years, the significance of cultural disparity in influencing the mode of entrance of foreign firms are still mentioned and considered in the most-recent studies. From the study conducted by Hutzshenreuter and Voll in 2008, the complexity of penetrating the international business scene was attributed to a number of things. Distance was the first and foremost consideration. This word does not only denote the physical separation of one country to another, but also includes the difference in the economic status of the investing and local firm, the distinct institutional characteristics of the two and the disparity in the innate cultural upbringing of the two companies. One of the significant findings of this work was the correlation of increasing cultural distance with the performance of the multinational enterprises. It was observed that a firm must take into consideration the amount of cultural distance between itself and the local company added per unit of time. If there is tremendous strain due to cultural difference added to the investing company, the expected profit is expected to be negatively affected in the process (Hutzshenreuter and Voll 2008). This study showed that companies are expected to limit cultural differences between them and the country to be invested in since revenue will be put at stake.
From the work of Jakobsen and Meyer, aside from numerous factors cited to have an influence in the mode of entry of investors, such as governmental influence, location and subsidiaries size, the concluding remark still included the importance of cultural status of the two countries from which the merging firms originated from (Jakobsen and Meyer 2007).
As another support to the paper of Kogut and Singh, a study from The Netherlands had shown that the choice of greenfield over acquisition in culturally distant countries is favoured. This was true if the following parameters were answered: the investing firm has considerable international market experience, the firm also had previous relationship with the local market and if the autonomy to be given to the invested counterpart is limited (Hennart and Slangen 2008).
Another study from Singapore arrived at a conclusion related to Kogut’s work. When the longevity of a joint venture was investigated, first, a Japanese with another Japanese venture and second, a Japanese with an American firm venture, it was established that the former had a longer longevity than the latter. Since other factors that may affect the longevity of the business deal was controlled, the findings of this study was determined to be significantly related to the nature and similarity or dissimilarity of the two cultures in question (Hennart and Zeng 2002).
Through the years, due to the evolution of the market towards a more complex economy, the factors influencing the mode of entry of investors were not just confined to cultural differences and uncertainty avoidance. In a joint project by the German Institute of Economic Research and the National Advisory Council of Korea, it was determined that the entry mode were a function of the following: tariff costs, market size, transport costs and foreign direct investment fixed costs. To some extent, the size of the local country also influenced the type of entry mode used by the investing corporation. For relatively large countries, the preferred entry mode was through acquisition. For intermediate sized countries, trade was mostly observed, and for small countries, no investing firms penetrated the market (Eicher and Kang 2005). Another significant factor to be considered is the presence of governmental policies which limits the degree of acquisition status of a company.
A firm will not choose to acquire a local investment in countries which had limiting policies. Governmental influences can be strongly seen in transition economies, where the employees and the industry sectors are closely monitored and controlled by the government. Despite the fact that an acquired firm falls under the complete jurisdiction of an investor, the government can impose their own policies that may be different from the foreign firm. In this scenario, companies tend to shy away from the acquisition mode of entrance and lean towards joint venture or shared ownership. The importance of maintaining a good relationship between the local government and the foreign firms was seen from the survey results conducted in Vietnam, Poland, Hungary, Egypt, South Africa, Lithuania and India. From all of these countries, the rate of five in the Likert scale was given when asked how important the relationship of the company to the local government, with one indicating a lack of importance and five with the utmost importance (Jakobsen and Meyer 2007).
It can be seen that despite the inhibitions caused by government intervention, companies would not jeopardized their relationship with the local government. Instead of defying the imposed managerial laws in the foreign firms, the more logical choice would be to choose an entry mode which is not synonymous to having full control of the company, since this will not be possible in a transitional economy. Another recent development in the choice of entry mode is the inclusion of technology. If a firm has considerable advanced technological capabilities, this ultimately can dictate which entry mode should be taken by the company. Acquisition would be favoured over greenfield if the company’s own technology is sufficient. The international strategies that the investor uses in its investment approaches can also influence the mode of entry of an investor in a foreign country (Dikova 2007).
In relation to the international market as an avenue for competitive business ventures, the European Central Bank determined that the type of entry mode used by most of the foreign firms can dictate market competition of the businesses in the local scene. Presence of competitive businesses in turn affects local banks’ interest rates for loans. It was said that if investors chose to enter through greenfield entry mode, competition becomes stronger, which then decreases the rate of interest in bank loans (Claeys and Hainz 2006). This information can then be used as a guide for potential investors to resort to greenfield entry mode due to the associated positive effects in the market as well as in the banking scenario.
Additional guidelines for entry mode can be seen in the OLI paradigm. This was theorized by Dunning in 1992. This proposes the presence of three dimensions in order for investors to venture into a foreign firm. OLI stands for ownership, location and internalization. The first letter pertains to a foreign firm’s ownership of a local company that may be advantageous for the part of the investor. Locational advantages on the other hand, refer to the presence of positive factors in the location of the invested firm which will encourage the production of the merchandize locally. Finally, there should be internalization of control for the new company, making it easily managed by the investing foreign firm (Jakobsen and Meyer 2007).
After enumerating the different factors affecting the choice of entry mode, it is also worthy to note the variations of entry mode from those introduced in the Kogut article. Aside from greenfield and acquisition, the term brownfield is now also used as a mode of entry. This type refers to a special form of acquisition but with additional traits paralleled to greenfield. As an illustration, brownfield entry mode could start with the acquisition of a firm from another country. Once the company was bought, internal rearrangement and reconfiguration will be done by the investor, leaving very few original assets from the local firm. In the end, brownfield operates much like a greenfield venture despite the fact that it started as an acquisition. This type of entry is favoured since access to the market is relatively faster as compared with greenfield, since the investor only needs to purchase an existing firm in order to penetrate a new country. Also, the market share of the original firm can be taken advantage by the investor; an established niche would be immediately at the new firms’ disposal such as an international brand name, technology and manpower resources (Estrin and Meyer 1999).
Another new entry mode is partial acquisition. If brownfield is a combination of acquisition and greenfield, partial acquisition is the combination of joint venture and acquisition. The ownership of a firm also starts with the purchase of stocks, just like in acquisition. But its difference lies in the degree of control it can exercise over the invested firm. Since the purchased assets are not enough to exercise full managerial control, partial acquisition can only so much change the system of the acquired firm. Advice can be given and directions be suggested by the investor, but in the end, total control is not possible. In this aspect, partial acquisition is homologous to joint venture. Partial acquisition (PA) is favoured over the other entry modes when investment in a market is considered to be a risky one, especially in transition and emerging economies. Since the risk of having full control of a company is synonymous to greater investment uncertainty, firms will prefer to commit lower equity, thus the advent of partial acquisitions (Canal and Duarte 2004).
The number of documented PA supports the claim that this type of entry mode is slowly being introduced and used by investing firms in the international market. In the study by Jakobsen and Meyer, among seven countries, the most number of partial acquisitions was observed in Poland, where 16 firms were purchased through PA. The next highest number of partial acquisitions was observed in South Africa, where there were 14 PA’s documented. The total number of partial acquisitions in these countries was 80, out of the 698 firms analyzed. Even though PA only made up 11.4% of the total entry modes used in foreign direct investment, it is still considered to be an attractive way of entry due to its advantages (Jakobsen and Meyer 2007). As a support to this claim, in a study conducted in Taiwan as an investing country in NAFTA, Hong Kong, EU, ASEAN and Japan, it was determined that brownfield was favoured over acquisition and greenfield when the technology of the Taiwanese firms were needed to be transferred to the invested country. To avoid competition of these Taiwanese companies with similar industries in the international market, brownfield was also chosen over the two modes of entry (Cheng 2006).
Kogut and Singh Article: Revisions for Modern Adaptation
After enumerating new findings for influencing choice of entry mode in a foreign firm, it is critical to embed these into Kogut and Singh’s famous article. First, additional choices for modes of entry should be added to greenfield, joint venture and acquisition. Partial acquisition and brownfield, based on the given studies mentioned above, are significant enough to be lined with these three. If there are more entry modes to be studied, a truer picture of the international market scene can be painted.
Secondly, new sectors of the industry should be included in the analysis, sectors such as outsourcing. This refers to the use of an outside work force and resources for a foreign firm’s functions. This relatively new industry is slowly gaining recognition as a lucrative business endeavour. In the United States alone, there are $ 100 billion of profit made in the last five years, an estimate that is still growing up to the present day. The most famous countries for outsourcing to be invested in are those in Asia, such as China, Philippines, India and Singapore (Ramamurti, 2004). Including a novel type of business in the paper will increase its scope of validity. Also, this will update the authors’ points that will make it more applicable to the modern market.
Thirdly, the article should also include the new dimension of acquisition, in lieu with the present restrictions imposed by governments in transition economies. Acquisition should now be defined as the procurement of stocks of a foreign firm that will render the purchaser in control of the acquired company. However, control of the investor is limited as imposed by the government, in countries where this imposition is applicable. Limitation can be in the form of managerial control and allotted time to handle the purchased firm (Jakobsen and Meyer 2007). With this updated definition of acquisition, firms that are planning to invest in a foreign land may consider the added features of this entry mode before this is actually used.
Fourthly, the study should also discern the dominant, existing entry modes that were used by the firms already established in the country of concern. Knowing these facts may also determine the tendency of investors to choose an entry mode over another, for example, favouring greenfield over acquisition, as cited from the work of Claeys and Hainz in 2006.
Fifth, another interesting approach to further improve the Kogut article would be to determine the relationship between cultural difference and mode of entry when one, two or three variables will be added into the equation. These variables must not be mentioned and used by Kogut and Singh in the original study. For example, it was determined that the favoured entry mode for an investor which has diminutive cultural difference to the foreign firm was through acquisition. But, would this still hold true if the foreign firm is in a transition economy, run by a an intervening government? Will the entry mode change or not? If it will change, to what mode will it lean towards to? Adding another variable can be used to measure the strength of entry mode. Strength would mean the adherence of a firm to a predetermined mode of entry without the confounding variables. In this new quantitative value, acquisition, greenfield, brownfield, joint venture and partial acquisition can be differentiated, not only through qualitative definitions, but also through numerical means.
Sixth, it would be interesting to determine the gradual change of a country’s culture through the years, both the investing and the sought country. With the advent of technology linking all corners of the world, it is not impossible for cultural differences between nations to decrease since 1988. What would be true for that year may not be true for 2008, especially with the birth of technology such as the World Wide Web. If possible, the difference and gradual decrease in difference of the cultures in the world should also be quantified, as to have a mathematical basis for this claim. Investigation of this must be facilitated by a sociologist who is more equipped in dealing and analyzing the sociological changes that happened in the last two decades.
There are various ways in which the article in question can be improved. Additional information that can only be obtained after 20 years since the article’s publication would be of significant help. But, even though there are points that are lacking in the Kogut and Singh study, majority of their theories still hold true to this day, as supported by modern market studies. The significance of cultural differences in the choice of entry mode is still observed in the international business scene. It was also seen to affect longevity of two companies’ partnership as showed by Hennart and Zeng. And in any study concerned about factors influencing entry mode of an investing firm, cultural background from both ends of the firms is always mentioned and investigated. With the constant influx of new concepts in the realm of entry mode, such as partial acquisition and brownfield, continuous effort for the part of the scientific community is needed to keep up to the latest significant factors that can dictate the state of the international market scene.
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