Internationalization theories

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Internationalization theories

Introduction

Having discussed the barriers to starting internationalization in Chapter 2, we will begin this chapter by presenting the different theoretical approaches to international marketing and then we will choose three models for further discussion in sections 3.2, 3.3 and 3.4.

Historical development of internationalization

Much of the early literature in internationalization was inspired by general marketing theories. Later on internationalization dealt with the choice between exporting and FDI (foreign direct investment). During the last 10-15 years there has been much focus on internationalization in networks, by which the firm has different relationships not only with customers but also with other actors in the environment.

The traditional marketing approach

The Penrosian tradition (Penrose, 1959; Prahalad and Hamel, 1990) reflects the traditional marketing focus on the firm's core competences combined with opportunities in the foreign environment.

The cost-based view of this tradition suggested that the firm must possess a 'compensating advantage' in order to overcome the 'cost of foreignness' (Kindleberger, 1969; Hymer, 1976). This led to the identification of technological and marketing skills as the key elements in successful foreign entry.

'Life cycle' concept for international trade

Sequential modes of internationalization were introduced by Vernon's 'Product Cycle Hypothesis' (1966), in which firms go through an exporting phase before switching first to market-seeking FDI, and then to cost-oriented FDI. Technology and marketing factors combine to explain standardisation, which drives location decisions.

Vernon's hypothesis is that producers in advanced countries (ACs) are 'closer' to the markets than producers elsewhere; consequently the first production facilities for these products will be in the ACs. As demand expands a certain degree of standardisation usually takes place. 'Economies of scale', through mass production, become more important. Concern about production cost replaces concern about product adaptations. With standardised products the less developed countries (LDCs) may offer competitive advantages as production locations. One example of this is the movement of production locations for personal computers from ACs to LDCs. The 'life cycle' concept is illustrated in Figure 15.3.

The Uppsala School approach

The Scandinavian 'stages' models of entry suggest a sequential pattern of entry into successive foreign markets, coupled with a progressive deepening of commitment to each market. Increasing commitment is particularly important in the thinking of the Uppsala School (Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977). The main consequence of this model is that firms tend to intensify their commitment towards foreign markets as their experience grows. Closely associated with the stages models is the notion of 'psychic distance', which attempts to conceptualise and, to some degree, measure the cultural distance between countries and markets (Hallen and Wiedersheim-Paul, 1979).

The internationalization/transaction cost approach

In the early 1970s intermediate forms of internationalization such as licensing were not considered interesting. Buckley and Casson (1976) expanded the choice to include licensing as a means of reaching customers abroad. But in their perspective the multinational firm would usually prefer to 'internalise' transactions via direct equity investment rather than license its capability. Joint ventures were not explicitly considered to be in the spectrum of governance choices until the mid-1980s (Contractor and Lorange, 1988; Kogut, 1988).

Buckley and Casson's focus on market-based (externalisation) versus firm-based (internalisation) solutions highlighted the strategic significance of licensing in market entry, internationalization involves two interdependent decisions - regarding location and mode of control.

The internalisation perspective is closely related to the transaction cost (TC) theory (Williamson, 1975). The paradigmatic question in internalisation theory is that, upon deciding to enter a foreign market, should a firm do so through internalisation within its own boundaries (a subsidiary) or through some form of collaboration with an external partner (externalisation)? The internalisation and TC perspectives are both concerned with the minimisation of TC and the conditions underlying market failure. The intention is to analyse the characteristics of a transaction in order to decide on the most efficient, i.e. TC minimising, governance mode. The internalisation theory can be considered the TC theory of the multinational corporation (Rugman, 1986; Madhok, 1997, 1998).

Dunning's eclectic approach

In his eclectic Ownership-Location-internalisation (OLI) framework Dunning (1988) discussed the importance of locational variables in foreign investment decisions. The word 'eclectic' represents the idea that a full explanation of the transnational activities of firms needs to draw on several strands of economic theory. According to Dunning the propensity of a firm to engage itself in international production increases if the following three conditions are being satisfied:

Ownership advantages: A firm that owns foreign production facilities has bigger ownership advantages compared to firms of other nationalities. These 'advantages' may consist of intangible assets.

Locational advantages: It must be profitable for the firm to continue these assets with factor endowments (labour, energy, materials, components, transport and communication channels) in the foreign markets. If not, the foreign markets would be served by exports.

Internalisation advantages: It must be more profitable for the firm to use its advantages rather than selling them, or the right to use them, to a foreign firm.

The network approach

The basic assumption in the network approach is that the international firm cannot be analysed as an isolated actor but has to be viewed in relation to other actors in the international environment. Thus the individual firm is dependent on resources controlled by others. The relationships of a firm within a domestic network can be used as connections to other networks in other countries (Johanson and Mattson, 1988).

In the following three sections we will concentrate on three of the approaches presented above.

The Uppsala internationalization model

The stage model

During the 1970s a number of Swedish researchers at the University of Uppsala (Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977) focused their interest on the internationalization process. Studying the internationalization of Swedish manufacturing firms, they developed a model of the firm's choice of market and form of entry when going abroad. Their work was influenced by Aharoni's seminal (1966) study.

With these basic assumptions in mind, the Uppsala researchers interpreted the patterns in the internationalization process they had observed in Swedish manufacturing firms. They had noted, first of all, that companies appeared to begin their operations abroad in fairly nearby markets and only gradually penetrated more far-flung markets. Second, it appeared that companies entered new markets through exports. It was very rare for companies to enter new markets with sales organizations or manufacturing subsidiaries of their own. Wholly owned or majority-owned operations were established only after several years of exports to the same market.

Johanson and Wiedersheim-Paul (1975) distinguish between four different modes of entering an international market, where the successive stages represent higher degrees of international involvement/market commitment:

Stage 1: No regular export activities (sporadic export).

Stage 2: Export via independent representatives (export modes).

Stage 3: Establishment of a foreign sales subsidiary.

Stage 4: Foreign production/manufacturing units.

The assumption that the internationalization of a firm develops step by step was originally supported by evidence from a case study of four Swedish firms. The sequence of stages was restricted to a specific country market. This market commitment dimension is shown in Figure 1.

Figure 1. Internationalization of the firm: an incremental approach

Source: adapted from Forsgren and Johanson, 1975, p. 16.

The concept of market commitment is assumed to contain two factors - the amount of resources committed and the degree of commitment. The amount of resources could be operationalised to the size of investment in the market (marketing, organization, personnel, etc.), while the degree of commitment refers to the difficulty of finding an alternative use for the resources and transferring them to the alternative use.

International activities require both general knowledge and market-specific knowledge. Market-specific knowledge is assumed to be gained mainly through experience in the market, whereas knowledge of the operations can be transferred from one country to another; the latter will thus facilitate the geographic diversification in Figure 3.1. A direct relation between market knowledge and market commitment is postulated: knowledge can be considered as a dimension of human resources. Consequently, the better knowledge about a market, the more valuable are the resources and the stronger the commitment to the market.

Figure 3.1 implies that additional market commitment as a rule will be made in small incremental steps, both in the market commitment dimension and in the geographical dimension. There are, however, three exceptions. First, firms that have large resources experience small consequences of their commitments and can take larger internationalization steps. Second, when market conditions are stable and homogeneous, relevant market knowledge can be gained in ways other than experience. Third, when the firm has considerable experience from markets with similar conditions, it may be able to generalise this experience to any specific market (Johanson and Vahlne, 1990).

The geographical dimension in Figure 3.1 shows that firms enter new markets with successively greater psychic distance. Psychic distance is defined in terms of factors such as differences in language, culture and political systems, which disturb the flow of information between the firm and the market. Thus firms start internationalization by going to those markets they can most easily understand. There they will see opportunities, and there the perceived market uncertainty is low.

The original stage model has been extended by Welch and Loustarinen (1988), who operate with six dimensions of internationalization (see Figure 3.2):

sales objects (what?): goods, services, know-how and systems:

operations methods (how?): agents, subsidiaries, licensing, franchising management contracts;

Figure 2. Dimensions of internationalization

Source: Welch and Loustarinen, 1988. Reproduced with permission from The Braybrooke Press Ltd.

markets (where?): political/cultural/psychic/physical distance differences between markets;

organizational structure: export department, international division;

finance: availability of international finance sources to support the international activities

personnel: international skills, experience and training.

Critical views of the original Uppsala model

internationalization transaction network marketing

Various criticisms have been put forward. One criticism is that the model is too deterministic (Reid, 1983; Turnbull, 1987).

It has also been argued that the model does not take into account interdependencies between different country markets (Johanson and Mattson, 1986). It seems reasonable to consider a firm more internationalized if it views and handles different country markets as interdependent than if it views them as completely separate entities.

Studies have shown that the internationalization process model is not valid for service industries. In research into the internationalization of Swedish technical consultants - a typical service industry - it has been demonstrated that the cumulative reinforcement of foreign commitments implied by the process model is absent (Sharma and Johanson, 1987).

The criticism has been supported by the fact that the internationalization process of new entrants in certain industries has recently become more spectacular. Firms have lately seemed prone to leapfrog stages in the establishment chain, entering 'distant' markets in terms of psychic distance at an early stage, and the pace of the internationalization process generally seems to have speeded up.

Nordstrom's preliminary (1990) results seem to confirm this argument. The United Kingdom, Germany and the United States have become a more common target for the very first establishment of sales subsidiaries by Swedish firms than their Scandinavian neighbours.

The leapfrogging tendency not only involves entering distant markets. We can also expect a company to leapfrog some intermediate entry modes (foreign operation methods) in order to move away from the sequentialist pattern and more directly to some kind of foreign investment (Figure 3.3).

In market no. 1 the firm follows the mainstream evolutionary pattern, but in market no. 6 the firm has learned from the use of different operation methods in previous markets, and therefore chooses to leapfrog some stages and go directly to foreign investment.

Others have claimed that the Uppsala model is not valid in situations of highly internationalized firms and industries. In these cases, competitive forces and factors override psychic distance as the principal explanatory factor for the firm's process of internationalization. Furthermore, if knowledge of transactions can be transferred from one country to another, firms with extensive international experience are likely to perceive the psychic distance to a new country as shorter than firms with little international experience.

Nordstrom (1990) argues that the world has become much more homogeneous and that consequently psychic distance has decreased. He expects that recent starters are willing and able to enter directly into large markets as some of these are now as close to Sweden in a cultural sense as are other Scandinavian countries. Hence the explanatory value of psychic distance has decreased.

A similar way of reducing uncertainty is offered by international consulting firms. The consulting industry has experienced tremendous growth during the last 20 years.

Figure 3. Internationalization pattern of the firm as a sum of target country patterns

Source: Welch and Loustarinen. 1988. Reproduced with permission from The Braybrooke Press Ltd.

It is possible to buy knowledge about legal and financial standards from international accounting firms and investment banks. Local and international consulting firms offer information about competitors, market potential, distribution systems, local buying standards, possible entry modes, etc. Thus there is a well-developed market for knowledge about foreign markets.

Firms today also have quicker and easier access to knowledge about doing business abroad. It is no longer necessary to build up knowledge in-house in a slow and gradual, trial-and-error process. Several factors contribute to this. For example, universities, business schools and management training centres all over the world are putting more and more emphasis on international business.

Probably even more important, the absolute number of people with experience of doing business abroad has increased. Hence it has become easier to hire people with the experience and knowledge needed, rather than develop it in-house. The number of people with experience of doing business abroad has increased over time as an effect of continuous growth in world trade and foreign direct investment.

The spectacular development of information technologies, in terms of both absolute performance and diminishing price/performance ratios, has made it easier for a firm to become acquainted with foreign markets, thus making a 'leapfrog' strategy more realistic (see also section 3.6 on Internet-based 'Born Globals').

In spite of the criticisms the Uppsala model has gained strong support in studies of a wide spectrum of countries and situations. The empirical research confirms that commitment and experience are important factors explaining international business behaviour. In particular, the model receives strong support regarding export behaviour, and the relevance of cultural distance has also been confirmed.

The transaction cost analysis (TCA) model

The foundation for this model was made by Coase (1937). He argued that 'a firm will tend to expand until the cost of organizing an extra transaction within the firm will become equal to the cost of carrying out the same transaction by means of an exchange on the open market' (p. 395). It is a theory which predicts that a firm will perform internally those activities it can undertake at lower cost through establishing an internal ('hierarchical') management control and implementation system while relying on the market for activities in which independent outsiders (such as export intermediaries, agents or distributors) have a cost advantage.

Transaction costs emerge when markets fail to operate under the requirements of perfect competition ('friction free'); the cost of operating in such markets (i.e. the transaction cost) would be zero, and there would be little or no incentive to impose any impediments to free market exchange. However, in the real world there is always some kind of 'friction' between buyer and seller, resulting in transaction costs (see Figure 3.4).

Figure 4. The principles of the TCA model

The friction between buyer and seller can often be explained by opportunistic behaviour. Williamson (1985) defines it as a 'self-interest seeking with guile'. It includes methods of misleading, distortion, disguise, and confusion. To protect against the hazards of opportunism, the parties may employ a variety of safeguards or governance structures. The term 'safeguard' (or alternatively 'governance structure') as used here can be defined as a control mechanism, which has the objective of bringing about the perception of fairness or equity among transactors. The purpose of safeguards is to provide, at minimum cost, the control and 'trust' that is necessary for transactors to believe that engaging in the exchange will make them better off. The most prominent safeguard is the legal contract. A legal contract specifies the obligations of each party and allows a transactor to go to a third party (i.e. a court) to sanction an opportunistic trading partner.

The transaction cost analysis (TCA) framework argues that cost minimisation explains structural decisions. Firms internalise, that is, integrate vertically, to reduce transaction costs.

Ex ante costs

Search costs: include the cost of gathering information to identify and evaluate potential export intermediaries. Although such costs can be prohibitive to many exporters, knowledge about foreign markets is critical to export success. The search costs for distant, unfamiliar markets, where available (published) market information is lacking and organizational forms are different, can be especially prohibitive (e.g. exports from the United Kingdom to China). In comparison, the search costs for nearby, familiar markets may be more acceptable (e.g. export from United Kingdom to Germany).

Contracting costs: refer to the costs associated with negotiating and writing an agreement between seller (producer) and buyer (export intermediary).

Ex post costs

Monitoring costs: refer to the costs associated with monitoring the agreement to ensure that both seller and buyer fulfil the predetermined set of obligations.

Enforcement costs: refer to the costs associated with the sanctioning of a trading partner who does not perform in accordance with the agreement.

A fundamental assumption of transaction cost theory is that firms will attempt to minimise the combination of these costs when undertaking transactions. Thus, when considering the most efficient form of organizing export functions, transaction cost theory suggests that firms will choose the solution that minimises the sum of ex ante and ex post costs.

Williamson (1975) based his analysis on the assumption of transaction costs and the different forms of governance structure under which transactions take place. In his original work, Williamson identified two main alternatives of governance markets: externalisation and internalisation ('hierarchies'). In the case of externalisation, market transactions are by definition external to the firm and the price mechanism conveys all the necessary governance information. In the case of internalisation, the international firm creates a kind of internal market in which the hierarchical governance is defined by a set of 'internal' contracts.

Externalisation and internalisation of transactions are equated with intermediaries (agents, distributors) and sales subsidiaries (or other governance structures involving ownership control) respectively.

In this way, Williamson's framework provides the basis for a variety of research into the organization of international activity and the choice of international market entry mode. We will return to this issue in Part III of this book.

The conclusion of the transaction cost theory is:

If the transaction costs (defined above) through externalisation (e.g. through an importer or agent) are higher than the control cost through an internal hierarchical system, then the firm should seek internalisation of activities, i.e. implementing the global marketing strategy in wholly owned subsidiaries. Or more popularly explained: if the 'friction' between buyer and seller is too high then the firm should rather internalise, in the form of its own subsidiaries.

Limitations of the TCA framework. Narrow assumptions of human nature

Ghoshal and Moran (1996) have criticised the original work of Williamson as having too narrow assumptions of human nature (opportunism and its equally narrow interpretation of economic objectives). They also wonder why the theory's mainstream development has remained immune to such important contributions as Ouchi's (1980) insight on social control. Ouchi (1980) points to the relevance of intermediate forms (between markets and hierarchies), such as the clan, where governance is based on a win-win situation (in contrast to a zero-sum game situation).

Sometimes firms would even build trust with their externalized agents and distributors by turning them into partners. In this way the firms would avoid large investments in subsidiaries around the world.

Excluding 'internal' transaction costs

The TCA framework also seems to ignore the 'internal' transaction cost, assuming zero friction within a multinational firm. One can imagine severe friction (resulting in transaction cost) between the head office of a firm and its sales subsidiaries when internal internal transfer prices have to be settled.

Relevance of 'intermediate' forms for SMEs

One can also question the relevance of the TCA framework to the internationalization process of SMEs (Christensen and Lindmark, 1993). The lack of resources and knowledge in SMEs is a major force for the externalisation of activities. But since the use of markets often raises contractual problems, markets in many instances are not real alternatives to hierarchies for SMEs. Instead, the SMEs have to rely on intermediate forms of governance, such as contractual relations and relations based on clan-like systems created by a mutual orientation of investments, skills and trust building. Therefore SMEs are often highly dependent on the cooperative environment available. Such an approach will be presented and discussed in the next section.

Importance of 'production cost' is understated

It can be argued that the importance of transaction cost is overstated and that the importance of production cost has not been taken into consideration. Production cost is the cost of performing a particular task/function in the value chain, such as R&D costs, manufacturing costs and marketing costs. According to Williamson (1985), the most efficient choice of internationalization mode is one that will help minimise the sum of production and transaction costs.

The network model. Basic concept

Business networks are a mode of handling activity interdependences between several business actors. As we have seen, other modes of handling or governing interdependences in a business field are markets and hierarchies.

The network differs from the market with regard to relations between actors. In a market model, actors have no specific relations to each other. The interdependences are regulated through the market price mechanism. In contrast, in the business network the actors are linked to each other through exchange relationships, and their needs and capabilities are mediated through the interaction taking place in the relationships.

The industrial network differs from the hierarchy in the way that the actors are autonomous and handle their interdependences bilaterally rather than via a coordinating unit on a higher level. Whereas a hierarchy is organised and controlled as one unit from the top, the business network is organised by each actor's willingness to engage in exchange relationships with some of the other actors in the network. The networks are more loosely coupled than are hierarchies; they can change shape more easily. Any actor in the network can engage in new relationships or break off old ones, thereby modifying its structure. Thus business networks can be expected to be more flexible in response to changing conditions in turbulent business fields, such as those where technical change is very rapid.

It can be concluded that business networks will emerge in fields where coordination between specific actors can give strong gains and where conditions are changing rapidly. Thus the network approach implies a move away from the firm as the unit of analysis, towards exchange between firms and between a group of firms and other groups of firms as the main object of study. However, it also implies a move away from transactions towards more lasting exchange relationships constituting a structure within which international business takes place and evolves.

Evidently, business relationships and consequently industrial networks are subtle phenomena, which cannot easily be observed by an outsider: that is, a potential entrant. The actors are tied to each other through a number of different bonds: technical, social, cognitive, administrative, legal, economic, etc.

A basic assumption in the network model is that the individual firm is dependent on resources controlled by other firms. The companies get access to these external resources through their network positions. Since the development of positions takes time and depends on resource accumulations, a firm must establish and develop positions in relation to counterparts in foreign networks.

To enter a network from outside requires that other actors be motivated to engage in interaction, something which is resource demanding and may require several firms to make adaptions in their ways of performing business. Thus foreign market or network entry of the firm may very well be the result of interaction initiatives taken by other firms that are insiders in the network in the specific country. However, the chances of being the object of such initiatives are much greater for an insider.

The networks in a country may well extend far beyond country borders. In relation to the internationalization of the firm, the network view argues that the internationalizing firm is initially engaged in a network which is primarily domestic.

The relationships of a firm in a domestic network can be used as bridges to other networks in other countries. In some cases the customer demands that the supplier follows it abroad if the supplier wants to keep the business at home. An example of an international network is shown in Figure 3.5. It appears that one of the subsuppliers established a subsidiary in Country B. Here the production subsidiary is served by the local company of the subsupplier. Countries E and F, and partly Country C, are sourced from the production subsidiary in Country B. Generally it can be assumed that direct or indirect bridges exist between firms and different country networks. Such bridges can be important both in the initial steps abroad and in the subsequent entry of new markets.

The character of the ties in a network is partly a matter of the firms involved. This is primarily the case with technical, economic and legal ties. To an important extent, however, the ties are formed between the persons engaged in the business relationships. This is the case with social and cognitive ties. Industries as well as countries may differ with regard to the relative importance of firm and personal relationships. But it can be expected that the personal influence on relationships is strongest in the early establishment of relationships. Later in the process routines and systems will become more important.

When entering a network, the internationalization process of the firm will often proceed more quickly. In particular, SMEs in high-tech industries tend to go directly to more distant markets and to set up their own subsidiaries more rapidly. One reason seems to be that the entrepreneurs behind those companies have networks of colleagues dealing with the new technology. Internationalization, in these cases, is an exploitation of the advantage that this network constitutes.

Figure 5. An example of an international network

Four cases of internationalization

The Uppsala internationalization model treated internationalization independently of the situation and the competition in the market. In the following we will try to combine these two important aspects. A 'production net' contains relationships between those firms whose activities together produce functions linked to a specific area. The firm's degree of internationalization shows the extent to which the firm has positions in different national nets, how strong those positions are, and how integrated they are.

The network model also has consequences for the meaning of internationalization of the market. A production net can be more or less internationalized. A high degree of internationalization of a production net implies that there are many and strong relationships between the different national sections of the global production net. A low degree of internationalization means that the national nets have few relationships with each other.

We will distinguish between four different situations, characterised by, on the one hand, a low or a high degree of internationalization of the firm and, on the other, a low or high degree of internationalization of the market (the production network) (Figure 3.6).

Figure 6. Four cases of internationalization of a firm

The early starter

In this situation competitors, customers, suppliers and other firms in the domestic market as well as in foreign markets have no important international relationships.

The people behind the Uppsala internationalization model have described this situation and its transition to the lonely international (section 3.2). Gradual and slow involvement in the market via an agent, leading to a sales subsidiary and then a manufacturing subsidiary, is primarily a process by which market knowledge gives the basis for stronger commitments.

The lonely international

In this situation the firm has experience of relationships with others in foreign countries. It has acquired knowledge and means to handle environments that differ with respect to culture, institutions and so on. The knowledge situation is also more favourable when establishing the firm in a new national net.

Initiatives to further internationalization do not come from other parties in the production nets, as the firm's suppliers, customers and competitors are less internationalized. On the contrary, the lonely international has the competences to promote internationalization of its production net and, consequently, the firms engaged in it. The firm's relationships with, and in, other national nets may function as a bridge to those nets for its suppliers and customers.

The late starter

In a situation with international customers and competitors, the less internationalized firm can be 'pulled out' of the domestic market by its customers or complementary suppliers to the customers. Sometimes the step abroad can be rather large in the beginning.

How will the firm go abroad in this situation? Here we will differentiate between SMEs and LSEs.

SMEs going abroad in an internationalized world probably have to be highly specialised and adjusted to solutions in specific sections of the production nets. Starting production abroad is probably a question of what bonds are important to the customers, and in this matter SMEs are very flexible.

LSEs that have become large in the domestic market are often less specialised than small firms, and their situation is often more complex than that of the small firm. One possibility is to get established in a foreign production net through acquisition or joint venture.

In general, it is probably more difficult for a firm that has become large at home to find a niche in highly internationalized nets. It cannot, as the small firm can, adjust in the flexible way which may be necessary in such a net.

Compared to the early starter, the late starter often finds it difficult to establish new positions in a tightly structured net. The best distributors are already linked to competitors. Competitors can, more or less legally, make the late newcomer unprofitable by predatory pricing. When we compare early and late starters we can see how important timing is in global marketing.

The international among others

In this situation the firm has the possibility of using positions in one net to bridge over to other nets, with regard to both extensions and penetration. There is a strong need for coordination of the international activities along the value chain (e.g. R&D, production and marketing/sales). Operations in one market may make it possible to utilise production capacity for sales in other markets. This may lead to production coordination by product specialisation and increased intra-firm trade across borders.

Establishment of sales subsidiaries is probably speeded up by high internationalization because the international knowledge level is higher and there is a stronger need to coordinate sales and marketing activities in different markets.

The relevance of the network model for the SME serving as a subcontractor

Until now a network has been connected with development of mutual trust and interests between firms in the network. In the following, domination and control characteristics will form the starting point for the formation of a more power-balanced network.

In the SME context it is clear that where, for example, a small firm derives a significant proportion of its turnover and profits from acting as a subcontractor to another, often larger firm, the small firm becomes dependent on the latter. In turn, the large firm may acquire power over its subcontractor. This power can be measured in terms of the larger company's influence on decision making within the smaller firm in areas such as pricing and investment.

Exchange networks are based on control, coordination and cooperation. By 'control' is understood quasi-hierarchical relationships allowing one company to dominate another: for example, the relationship that traditionally obtains in the car industry between the major manufacturers and their subcontractors. By 'coordination' is understood a situation in which a 'leading' or 'hub' firm in the network orchestrates the value-adding chain. This allows firms to specialise in those components of the value chain in which they have competitive advantage, abandoning and farming out those activities in which they are disadvantaged to network partners that do have strengths in these areas.

'Cooperation' is the result of increasing specialisation in small market niches, which has tended to encourage interdependency between firms in the value-added chain. Whereas in many subcontracting relationships in the past the subcontractor simply followed instructions of the dominating firm on design and manufacture, the need to adjust to ever-quicker changes in the marketplace can have the effect of making the subcontractor a more equal partner in the whole design to production process. The nature of the relationship between subcontractor and buyer thereby changes. Greater trust is required to make the partnership a success. Greater coordination is also required, creating a role for companies that simply 'manage' the value chain. In order to meet the pressures of these new circumstances the small firm will depend on the nature and number of its links to other firms. As a result the need for and value of networking have increased.

Where the network is dominated by a single firm and relationships are of the 'traditional' subcontracting kind, competition on price (or prices simply being imposed by the dominating firm) is the rule. Also, cooperating firms know that, while optimal networking is an effective strategy to reduce risk, less optimal networking will increase risk by increasing their dependence on, for example, a potentially unreliable supplier. To overcome the danger of dependence, 'traditional' risk reduction strategies can be implemented, such as the implementation of multiple sourcing by the purchasing company, or client diversification by the selling company.

Internationalisation of SMEs

In the face of globalization threats many SMEs attempt to expand their sales into foreign markets. International expansion provides new and potentially more profitable markets; helps increase the firm's competitiveness; and facilitates access to new product ideas, manufacturing innovations and the latest technology.

At the macroenvironment and industry levels, globalization gives rise to market turbulence, increased competition from (especially) multinational firms, loss of protected markets due to trade liberalisation, and the emergence of international marketing opportunities, all of which can affect the operations and performance of the SME. In such an environment possession by management of an entrepreneurial orientation is expected to provide certain benefits.

It may be more appropriate to take a holistic view of the very small, entrepreneurial, or start-up firm's cross-border business activities, rather than to focus on discrete entry mode types. The challenge facing most entrepreneurial firms is to establish and develop a viable, competitive and sustainable business, usually with limited resources, and often by adopting flexible, imaginative and innovative business practices. International business activity for many firms, and particularly high-technology firms, may be an integral part of that process. In that respect too, internationalization is a firm-specific behaviour, in relation to and encompassing its international business activities.

The assumption made here therefore is that internationalization, for entrepreneurial firms, is a growth and development process. It may involve one or a number of value chain activities, some of which may be more internationalized, or more frequently subject to internationalization, than others. Internationalization may be part of the process, but for very small and very young firms internationalization is more likely to occur, in the first instance, through links and transactions with organizations and individuals in the external environment. The process may include both inward and outward links - see Table 1 and Figure 2.2 - and these are likely to reflect the firms' current areas of competence and expertise, and/or its current level of needs and perceived inadequacies.

Table 3.1 SMEs Inward-outward cross-border business activities

Initial international expansion may involve specific combinations of inward/outward value chain activities, which are not necessarily directly reciprocal. Efficiency and synergy in linkage combinations is an important concern for internationalizing firms.

The element of time is considered more important here than development stages, that, even if specifically determined, would vary considerably between firms.

Importance of personal factors

International entrepreneurship argues that the founders of international new ventures are more 'alert' to the possibilities of combing resources from different national markets because of the competences they have developed from their earlier activities.

Research results by Manolova and Brush (2002) indicate that owners/founders are likely to draw on their international experience, skills, or overall competences when internationalizing their own firms. Therefore, for managers with these sets of skills and positive environmental perceptions, the process of internationalization has 'less uncertainty', and hence is more likely to be pursued than it is for managers without comparable skills or perceptions.

Manolova and Bush (2002) clearly indicate that 'personal factors' matter with respect to SME internationalization but, more importantly, 'some personal factors matter more than others'. Owners/founders or managers who have more positive perceptions of the international environment would also be more likely to internationalize their own small businesses.

The most important finding from Manovala and Bush (2002) is that internationalization is not a function of 'demographies', but is instead a function of 'perceptions'. If the owner/founder or manager perceives that there is a lower level of environmental uncertainty in a particular international market, or perceives that there is the requisite skill set to internationalize, then chances are high that the small firm will be pursuing a strategy of internationalization. Additionally, the findings show that public policy directives, as well as education and training programmes, need to recognise that there are significant differences in small firm internationalization that are based upon the technology sector. Knowledge of these differences can be used to guide the development of small firm internationalization initiatives that match sector characteristics.

Entrepreneurial orientation is associated with opportunity seeking, risk taking, and decision action catalysed by a strong leader or an organization possessed of a particular value system. SMEs with an entrepreneurial orientation engage in product market innovations, undertake relatively risky ventures, and initiate proactive innovations.

Innovativeness refers to a corporate environment that promotes and supports novel ideas, experimentation and creative processes that may lead to new products, techniques or technologies. Risk taking reflects the propensity to devote resources to projects that entail a substantial possibility of failure, along with chances for high returns. Proactiveness is the opposite of reactiveness and implies taking initiative, aggressively pursuing ventures, and being at the forefront of efforts to shape the environment in ways that benefit the firm. Autonomy suggests the independent action of a person or a team in giving birth to an idea or a vision and then carrying it through to fruition. Finally, competitive aggressiveness refers to the firm's tendency to challenge its competitors intensely and directly in order to outperform them in the marketplace.

However, SMEs may lack the resources to compete head to head with larger rivals at home and invasions from abroad. Globalization may pose many challenges and can make the business milieu substantially more hostile for smaller firms. But all in all, given the turbulence posed by globalization, it is expected that SMEs with an entrepreneurial orientation will fare better than those that lack such an orientation.

Technology acquisition is one way of enabling the firm to compete more effectively or launch products that better satisfy customer needs. Innovation arising from acquired technology is a key source of competitive advantage, particularly in turbulent environments, that can enable firms to market new or improved goods faster than competitors. Technology acquisition can give rise to products that are better adapted to the specific needs of foreign markets. Firms can gain additional benefits by responding to the forces of globalization. SMEs that respond by appropriately adapting their marketing and other strategies to globalization demands are likely to perform better than firms which do not. Nature and pace of internationalization are conditioned by product, industry, and other external environmental variables, as well as by firm-specific factors. Therefore, at any given point in time, SMEs will be in a state of internationalization, which will be subject to both backward and forward momentum, instead of progressing through stages, as in the Uppsala model.

The SME's internationalization is unlikely to come off well unless the firm prepares in advance. Advance planning has often been regarded as important to the success of new ventures. Such planning is especially important in international ventures, in which the business environment can be considerably more complex than at home. Thus internationalization preparation describes a firm's efforts to prepare in advance as it seeks to expand into foreign markets. Such preparation involves conducting international market research; committing human, financial and other resources to supporting the international venture; and adapting products to suit the needs of target foreign markets.

In the next section we will look at a special case of SME internationalization - the so-called 'Born Globals'.

Born Globals

In recent years research has identified an increasing number of firms that certainly do not follow the traditional stages pattern in their internationalization process. In contrast, they aim at international markets or maybe even the global market right from their birth.

A 'Born Global' can be defined as: 'a firm that from its inception derives competitive advantage from the use of resources and the sale of outputs in multiple countries' (Oviatt and McDougall, 1994, p. 49).

Born Globals represent an interesting case of firms operating under time and space compression conditions that have allowed then to assume a global geographic scope since their start up. This 'time-space compression' phenomenon (Harvey, 1996) means that geographical processes can be reduced and compressed into 'here and now' trade and information exchange over the globe - if available infrastructure, communication and IT devices are put in place together with skilled people. The global financial market is a good example of the phenomenon (Tdrnroos, 2002).

Oviatt and McDougall (1994) grouped Born Globals (or 'International New Ventures' as they call them) into four different categories, dependent on the number of value chain activities performed combined with the number of countries involved. For example, they distinguish the 'export/import start-up' from the 'global start-up', whereby the latter -contrary to the former - involves many activities coordinated across many countries.

Born Globals are typically characterised by being SMEs with less than 500 employees and annual sales under $100 million - and reliance on cutting-edge technology in the development of relatively unique product or process innovations. But the most distinguishing feature of Born Global firms is that they tend to be managed by entrepreneurial visionaries, who view the world as a single, borderless marketplace from the time of the firm's founding. Born Globals are small, technology-oriented companies that operate in international markets from the earliest days of their establishment. There is growing evidence of the emergence of Born Globals in numerous countries of the developed world.

More recently the concept of born-again global firms has been proposed, i.e. long-established firms that previously focused on their domestic markets but that suddenly embrace rapid and dedicated internationalization (Bell et al., 2001).

The Born Global phenomenon suggests a new challenge to traditional theories of internationalization.

Born Globals are challenging traditional theories

Born Globals may be similar to the 'late starter' or the 'international among others' (Johanson and Mattson, 1988). In the latter situation both the environment and the firm are highly internationalized. Johanson and Mattson (1988) point out that internationalization processes of firms will be much faster in internationalized market conditions, among other reasons because the need for coordination and integration across borders is high. Since relevant partners/distributors will often be occupied in neighbouring markets, firms do not necessarily follow a 'rings in the water' approach to market selection. In the same vein their 'establishment chain' need not follow the traditional picture because strategic alliances, joint ventures, etc., are much more prevalent; firms seek partners with supplementary skills and resources. In other words internationalization processes of firms will be much more individual and situation specific in internationalized markets.

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