Introduction to Internationalization & Its Stages - International Business | International Business - B Com PDF Download

Introduction

The new era of industrialization, coupled with supportive government policies, has led to the expansion of company boundaries and horizons. Every firm aims to move towards internationalization, making it crucial to understand this process. Internationalization refers to the involvement of business organizations in international markets. Most contemporary business houses begin their operations domestically and, as they grow and expand, they gradually internationalize, resulting in thinning boundaries and changing landscapes.

This unit aims to help explain the process and reasons for internationalization, describe various stages and phases of internationalization, discuss the operating advantages and disadvantages of multinational corporations (MNCs), and understand the importance of various models of internationalization.

Reasons for Internationalization

• Diversification: Expanding into new or related industries for growth and profitability. This can involve entering new businesses, vertical integration, mergers and acquisitions, or entering new industries independently. 
• Economies of Scale: Expanding globally to achieve economies of scale by entering larger international markets. This may involve differentiating products or services to exploit unique advantages in foreign markets. 
• Government Incentives: Some governments encourage foreign investment by providing incentives for firms to build manufacturing capabilities in the host country or through institutional investments that enhance business opportunities and profits. 
• Market Growth: Global expansion increases profitability by enlarging the market size and customer base. 
• Joint Venture Opportunities: International business allows for entering markets through joint ventures, providing access to a large customer base, distribution capabilities, and opportunities to share knowledge and technology.

Reasons for Internationalization

• Market Saturation: When domestic markets become saturated, firms look for new opportunities abroad to sustain growth. 
• Competitive Pressure: Intense competition in the domestic market may push firms to seek less competitive environments internationally. Risk Diversification: Expanding into international markets helps spread risk across different geographies and economies. 
• Access to Resources: Internationalization may be driven by the need for specific resources that are more readily available or cheaper in other countries. 
• Strategic Asset Seeking: Firms may internationalize to acquire strategic assets such as technology, brand, or expertise that can enhance their competitive advantage.

Stages of Internationalization

Stage 1: Domestic Operations

• At this initial stage, firms operate solely within their home country.
• They typically have an ethnocentric orientation, focusing on domestic markets and not considering international expansion.
• As growth in the domestic market stagnates, these firms may begin to explore diversification within their home country.
• Eventually, declining prospects domestically and emerging opportunities internationally prompt a shift in strategy towards exploring foreign markets through methods like direct exports, franchising, and licensing.

Stage 2: Foreign Operations (Export)

• In this stage, firms begin to expand their markets by exporting goods produced in their domestic facilities to foreign countries.
• The focus is on countries with high demand for their products.
• For example, Indian firms export various goods such as nuts, spices, textiles, jute, and rice to markets around the world.
• Firms at this stage still have an ethnocentric orientation, primarily engaging in exporting as their initial form of internationalization.

Stage 3: Joint Ventures or Subsidiaries

• At this stage, firms begin to establish a physical presence in foreign countries through joint ventures or subsidiaries.
• Joint ventures involve partnering with local firms in the host country, sharing costs, profits, and management responsibilities.
• This marks a transition from being primarily international operators to expanding investments in foreign markets, moving towards multinational and transnational status.

Stage 4: Multinational Operations

• Firms become full-fledged multinational corporations (MNCs) with multiple production facilities established across various locations worldwide.
• This stage requires greater decentralization in decision-making, although key decisions are still made at the corporate headquarters.
• The orientation shifts from ethnocentric to polycentric, with subsidiaries managing operations independently while adhering to corporate guidelines.
• MNCs at this stage respond to market differences, including social, cultural, and legal requirements, and each foreign subsidiary is treated as an independent entity reporting to the global headquarters.

Stage 5: Transnational Operations

• Transnational firms achieve a balance between global efficiency and local responsiveness.
• Decision-making is highly decentralized, with business units given the freedom to make decisions with minimal oversight from the corporate headquarters.
• While pure transnational firms are rare, these organizations exhibit characteristics of global corporations, integrating local responsiveness with global coordination.

Conclusion

• The stages of internationalization illustrate the progression of firms from domestic operations to becoming transnational entities.
• Each stage involves increasing levels of commitment and involvement in foreign markets, with firms gradually developing a global outlook and expanding their operations internationally.

Attributes of the Firm at Different Levels

Operating Advantages and Disadvantages of MNCs

By themselves, Multinational Corporations (MNCs) possess a unique set of advantages and disadvantages in their operations that set them apart from firms operating solely within their domestic borders. Some companies have the capability to internationalize efficiently, overcoming disadvantages and capitalizing on internal advantages to a greater extent. This varies according to the nature of individual corporations and the type of business involved.

Operational Advantages of MNCs
(i) Superior Technical Know-how:

• MNCs benefit from advanced technical knowledge, which is a crucial advantage.
• They have access to better technology, either developed in-house or acquired, in areas such as Management, Operations, and Production.

(ii) Large Size and Economies of Scale:

• MNCs, due to their large size, enjoy economies of scale.
• Increased production volume lowers per-unit fixed costs, ultimately reducing production costs.
• This makes their products more competitive and easier to sell, particularly in capital-intensive sectors like Steel, Petrochemicals, and Automobiles.

(iii) Lower Input Costs Due to Large Size:

• MNCs, because of their large production levels, can purchase raw materials in bulk.
• This allows them to negotiate better prices with suppliers and gain significant price advantages through bulk buying.

(iv) Ability to Access Raw Materials Overseas:

• MNCs can reduce production costs by sourcing raw materials from countries where they are abundant and inexpensive.
• This capability helps them lower input costs significantly.

(v) Economies of Scale for Shipment, Distribution, and Promotion Costs:

• MNCs achieve lower costs for Shipment, Distribution, and Promotion due to their large volume of freight.
• Their substantial business volume enables them to negotiate lower rates with service providers.
• For instance, large corporations in the petroleum sector often justify ownership of their transport facilities due to their extensive transport requirements.

(vi) Brand Image and Goodwill:

• Many MNCs have product lines with established reputations for quality, performance, value, and service.
• This reputation extends abroad through exports and promotion, enhancing the MNC’s brand image and goodwill.
• MNCs leverage this goodwill by standardizing their product lines in different countries, achieving economies of scale.
• For example, Playstations are produced in standardized versions for the global market, with minimal modifications for different countries.

(vii) Access to Low-Cost Financing:

• MNCs, being large-scale organizations, require substantial financing, which they obtain from financial institutions at relatively lower rates.
• Their size and reliability make them attractive to banks, allowing them to borrow at lower costs.

(viii) Financial Flexibility:

• MNCs have the flexibility to shift their manufacturing facilities to different locations, enhancing their international competitiveness.
• This ability to relocate production helps them adapt to changing market conditions and optimize costs.

(ix) Information Advantages:

• Operating in various international locations provides MNCs with in-depth knowledge of global markets.
• This knowledge enables them to collect, process, analyze, and exploit global resources effectively.
• MNCs can identify new market opportunities for existing products based on their comprehensive market insights.

Operational Advantages of MNCs

• Access to Advanced Technology: MNCs often have access to advanced technology and research and development capabilities, allowing them to innovate and improve their products and services more effectively than local firms.
• Economies of Scale: MNCs can benefit from economies of scale due to their large size and global operations. This means they can produce goods at a lower cost per unit, giving them a competitive advantage in pricing.
• Global Supply Chains: MNCs can optimize their supply chains on a global scale, sourcing raw materials and components from different countries at lower costs and ensuring efficient production and distribution.
• Diversification of Risk: MNCs can diversify their risks by operating in multiple countries and regions. Economic downturns or adverse conditions in one country can be offset by better performance in another, reducing overall risk.
• Brand Recognition and Reputation: Established MNCs often have strong brand recognition and reputation, which can help them attract customers and gain a competitive edge in new markets.
• Access to Capital: MNCs typically have better access to capital markets and financial resources, allowing them to invest in new projects, technologies, and market expansion more easily than local firms.

Operational Disadvantages of MNCs

• Business Risks: MNCs face greater unforeseen risks compared to domestic firms because they operate in multiple countries. They deal with foreign exchange fluctuations, which can significantly impact their profit margins.
• Regulations in the Host Country: MNCs encounter challenges due to varying regulations in different host countries. Understanding and complying with these diverse and dynamic regulations require modifications in their operations.
• Different Legal Systems: MNCs must operate under the legal systems of each host country, which may have complex legislative and judicial processes. Some laws may prohibit certain business activities that are common in the MNC's home country.
• Political Risks: MNCs are exposed to political risks arising from changes in government and other factors in host countries. Political risk is higher in countries with unstable and frequently changing governments.
• Operational Difficulties: MNCs face substantial operational challenges due to varying business environments. Familiarity with local market conventions and business practices is essential, as these may differ significantly from those in the MNC's home country.
• Cultural Differences: MNCs encounter difficulties stemming from cultural differences. Expatriate executives may struggle to adapt to the local culture, leading to product failures and issues in dealing with local customers, government officials, and business partners.

Models of International Trade

The models of international trade encompass a wide range of aspects, including the international environment and firms acting as conglomerates under various conditions and situations. Internationalization reflects the remarkable diversification of a firm, systematically presented by researchers through different models. These models illustrate the key components and mechanisms of international activities that firms should consider at any given time.

Frank Bradley's Model

• In 1995, Frank Bradley proposed that the main model of internationalization is based on the product life cycle, foreign direct investment, and transaction costs.

Sorensen's Classification of International Trade

• Progressive Models:Product Life Cycle Model and Uppsala Model
• Contingency Models:REM (Resource-Based View), Transaction Cost Model, and Eclectic Model
• Interactive Models:Business Network Model

Uppsala Model

• The Uppsala model is a widely recognized framework for understanding internationalization.

Transaction Cost Model and International Business Network Model

• According to Rubaeva (2010), the Transaction Cost Model and the International Business Network Model are considered scientific approaches to internationalization.
• Rubaeva also discussed the REM and Eclectic Models as additional frameworks for understanding international trade.

International Product Life Cycle Model (1966)

• In 1966, Vernon proposed the International Product Life Cycle Model, emphasizing the connection between internationalization and the product life cycle. This model illustrates how trade patterns shift over time and how firms expand their production capabilities across borders.

Stages of International Product Life Cycle:

• New Product Stage:. firm in a developed country introduces a technologically advanced product to high-income consumers in its home market. Initially, production is local to minimize risk, and exports to similar markets may occur to increase revenue.
• Mature Product Stage: As the product gains acceptance, it is exported to other advanced countries. Local production in foreign markets becomes economically viable, and the design of the product and process stabilizes. Foreign direct investment (FDI) in production reduces unit costs, and local firms in advanced countries increase competition.
• Standardized Product Stage: At this stage, principal markets become saturated, and the focus shifts to cost reduction rather than product innovation. Production processes become standardized, leading to economies of scale. Labour is increasingly replaced by capital, and manufacturing operations become more mobile, with cost of labour being the primary differentiating factor between locations.

The International Product Life Cycle Model explains how firms evolve from local production to global manufacturing as products mature and competition increases. It highlights the dynamic nature of comparative advantage and the importance of specialization in high-value product categories.

To address price-related competition and trade barriers or simply to satisfy local demand, production facilities are now being shifted to countries with lower incomes and reduced production costs. This allows for cost-effective manufacturing at lower prices to meet the needs of people living in lower-income countries. Local competitors in advanced countries gain access to firsthand information and can start producing similar products, leading to increased competition.

As a result, the demand for the original product in the domestic market declines due to the emergence of new technologies and the establishment of highly price-sensitive markets. The remaining market gets shared among international competitors. Multinational corporations (MNCs) will maximize offshore production in countries with low labor costs, while the domestic market will import relatively capital-intensive products from low-income countries. The machinery operating these plants stays in the country where the technology was initially developed.

In summary, at this third stage of the product life cycle model, firms explore new market opportunities when the product reaches maturity and decline, prompting a shift to developing countries and new markets. This stage offers advantages such as knowledge acquisition and cost reduction during the transition from one stage to another.

Developing and developed countries illustrate the differences in production costs, with firms from developed countries utilizing licensing, subcontracting, franchising, and acquisitions in countries with cost differentials. Transferring production to developing countries significantly reduces production costs for firms. For instance, Company X has shifted its entire production to China and sources products globally based on demand.

Uppsala Internationalization Model (1977)

The Uppsala Internationalization Model, developed by Johanson and Wiedersheim-Paul in 1975 and later refined by Johanson and Vahlne in 1977 at Uppsala University in Sweden, focuses on the process of internationalization. Through their research on manufacturing firms in Sweden, the authors observed patterns in the internationalization process and identified several key stages and factors influencing market commitment.

• Initial International Operations: Firms typically begin their international operations in nearby markets and neighboring countries.
• Mode of Entry: Exporting is usually the initial mode of entry into foreign markets.
• Gradual Investment: Organizations do not initially enter foreign markets with their own sales organizations and manufacturing subsidiaries. Instead, after several years of exporting to the same markets, they may invest in wholly owned or majority-owned operations.

Johanson and Wiedersheim-Paul differentiated between four modes of entering international markets, representing increasing levels of market commitment and international involvement:

• Stage 1: Sporadic Export (Irregular exporting)
• Stage 2: Export Modes (Exports through independent representatives)
• Stage 3: Establishment of Foreign Sales Subsidiary
• Stage 4: Entry through Production and Manufacturing Units

Case studies of Swedish firms indicate that internationalization develops gradually and is specific to particular country markets.

• Market Commitment: Comprises two factors:
• Amount of Resources Committed: Reflects the level of investment in the market, including marketing organization and personnel.
• Degree of Commitment: Relates to the difficulty of finding alternative uses for resources and transferring them to other uses.
• Knowledge and Experience: International business requires knowledge of specific markets and businesses, which is gained through experience and higher levels of involvement. Operational efficiency can be achieved through experience and transferred from one country to another.
• Direct Relationship:. direct relationship exists between market knowledge and commitment.

Uppsala Model: Key Features

• Knowledge Acquisition: Initially, knowledge is acquired in the home market before expanding to international markets.
• Gradual Expansion: Initial overseas operations begin in countries that are geographically, culturally, and religiously similar, gradually expanding to more diverse and distant nations.
• Risk-Averse Entry: Most organizations start internationalization through export facilities, which are less risky compared to investment models. Once successful in export ventures, they progress to operational modes like sales subsidiaries and manufacturing facilities.
• Long-Term Manufacturing Goals: While investing in manufacturing facilities in all markets is an objective, it takes considerable time to establish.
• Incremental Market Commitments: Market commitments are made in small, incremental steps, selecting geographic markets that are convenient to explore with narrow psychic distance and choosing entry modes with lower additional risks.

Contingency Models
The REM model is a three-factor framework that outlines the stages of decision-making within a company when considering internationalization. 

•  R Factor. This refers to the reasons for internationalization, which can be influenced by both internal and external business environment factors. 
•  E Factor. This pertains to the conducive environment factors that facilitate international expansion. 
•  M Factor. This involves the mode of entry into foreign markets. 

R Factor: Reasons for Internationalization

Proactive Reasons: These are factors that encourage firms to seek international markets actively.

• Financial Goals: Aiming for higher profits and revenue growth.
• Uniqueness of Product: Firms with unique products may seek international markets to leverage their competitive advantage.
• Excess Capacity: Companies with excess production capacity may look for foreign markets to utilize their resources effectively.
• Cost Reduction: Exploring international markets can lead to lower production costs.
• Market Opportunity: Identifying potential markets with growth opportunities.

Reactive Reasons: These are factors that drive firms to internationalize in response to external pressures.

• Competitive Pressure: Increased competition in the domestic market may push firms to explore international opportunities.
• Saturated Domestic Market:. decline in sales due to a saturated domestic market can prompt firms to look abroad.
• Unsolicited Foreign Market Orders: Receiving unexpected orders from foreign markets can initiate international expansion.

Other Considerations:

• Proximity to International Markets: Geographic closeness to potential markets can facilitate internationalization.
• Managerial Interest: The interest and willingness of management to pursue international opportunities.
• Psychological Distance: The perceived cultural and operational distance to foreign markets.
• Access to Required Resources: Availability of necessary resources to venture into foreign economies.

Environment or E Factor

• Initially, firms prefer to expand into nearby countries during the early stages of internationalization due to the familiarity and ease of understanding the business environmental factors. This approach helps in reducing risks and uncertainties associated with entering a new market. Additionally, geographical distance plays a crucial role in influencing economic factors such as per capita income and the standard of living in the target country, which are vital considerations for businesses.

Mode of Entry or M Factor
The mode of internationalization is influenced by various factors, including:

• Objectives of Internationalization: The goals and purposes behind entering a new market.
• Cost of Entry: The expenses involved in entering the foreign market.
• Profitability: The expected profits from the international venture.
• Commitment Variables: The degree of commitment to the internationalization process.
• Control Mechanism: The systems in place to monitor and manage the international operations.
• Benefits of Investment: The advantages expected from the investment in the foreign market.
• Risk Involved: The potential risks associated with the investment.

Transaction Theory

• In 1937, Coase introduced a theory that serves as the basis for the Transaction Cost Analysis (TCA) model. This theory emphasizes the importance of costs in decision-making processes. Coase argued that a firm will continue to expand until the cost of organizing an additional transaction internally equals the cost of conducting the same transaction in the open market.
• This implies that a firm will handle internally those activities that it can perform at a lower cost through efficient internal management systems while relying on external parties, such as intermediaries, agents, or distributors, when it is more cost-effective. Transaction costs arise in situations where markets do not operate under perfect competition (friction-free conditions). In a perfectly competitive market, transaction costs would be zero, and there would be little incentive to hinder free exchange and trade. However, in reality, there is always some friction between buyers and sellers, leading to transaction costs. This friction is often attributed to opportunistic behavior.
• The Transaction Cost Analysis (TCA) framework posits that cost minimization drives structural decisions within firms. Firms internalize or vertically integrate to reduce transaction costs. Transaction costs are further categorized into different types related to the transactional relationship between buyers and sellers. The TCA equation outlines the components of transaction costs as follows:
  Transaction Cost = Ex-Ante Costs (Search Costs + Contracting Costs) + Ex-Post Costs (Monitoring Costs + Enforcement Costs)
• The TCA theory is based on the premise that firms will internationalize until the transaction costs of operating within the firm match those of conducting the same transaction in the market. It evaluates the divergent interests and opportunistic behavior of exporters regarding internationalization, emphasizing the need for a thorough analysis of transaction costs.
• The analysis suggests that if the transaction costs in a foreign market are lower than those of internal operations, firms will opt for internationalization and seek business relationships with foreign partners through licensing, exports, subcontracting, and joint ventures.

Key Features of Transaction Cost Theory

• Focus on costs incurred by a firm and their impact on market choices and modes of entry into international business.
• Emphasis on organizational structure as a crucial arrangement for establishing and safeguarding transactions and reducing costs across national boundaries.
• Coverage of all enforcement costs, including information search, negotiation, and monitoring costs across borders.

Eclectic Model

• The Eclectic Model, developed by Dunning, outlines the conditions favorable for a firm's internationalization through Foreign Direct Investment (FDI) rather than exports. This model proposes the suitability of conditions for FDI and presents a three-factor theory known as OLI to explain a firm's suitability for entering foreign markets through FDI.

O (Ownership Advantages): This factor emphasizes the benefits of ownership that a firm possesses compared to other firms in foreign markets. Ownership advantages can include factors such as resources, technical assets, product innovations, property rights, and organizational expertise. These advantages can be categorized into asset advantages (e.g., product innovations, marketing systems) and transaction advantages (e.g., economies of scale, resource availability).

L (Location Advantages): Location advantages refer to the immobility of certain characteristics at the international level that benefit the host country for FDI. These advantages arise from economic disparities between countries and can include factors such as labor, energy, and resource costs, as well as market infrastructure and regulatory conditions.

I (Internalization Advantages):

• Internationalization advantage refers to a benefit in transactions that arises as a type of ownership advantage.
• This advantage becomes private property when it is transferred outside the company.
• Companies aim to leverage their ownership advantage by making investments and reducing the transaction costs associated with sharing knowledge and skills between firms.
• The evolution of this investment is a key part of the Eclectic model.
• This model is based on five stages of development, which are outlined below:

1. Pre-Industrial Stage:

• During this stage, there is a lack of Foreign Direct Investment (FDI), and only small investments are attractive.
• The internal advantages of national firms are insufficient for direct investment in terms of input and output.
• The domestic market is characterized by low incomes, inadequate infrastructure, weak authority, and a lack of economic and political stability, resulting in minimal advantages.

2. Initial Stage:

• This stage is linked to the previous one, where the government's role in attracting FDI is limited.
• A legal system and business infrastructure are developed to create a favorable investment environment.
• FDI flows increase, focusing on resource-intensive industries, production sectors with labor intensity, and areas such as sales, distribution, transport, and construction.

3. Middle Stage:

• In this stage, cheap foreign investment is replaced as the main vehicle for investment.
• Location advantages, which were created in the second stage, become the primary focus for attracting investment.

4. Advanced Stages:

• The last two stages of investment output develop as firms reach a certain level of maturity.
• Foreign firms seek to use their ownership advantages to acquire new assets in the market.

According to this theory, FDI is beneficial if a firm possesses OLI advantages. If a firm lacks location advantages, exporting and licensing are more suitable for entering foreign markets. Successful foreign market entry through FDI requires all three advantages: Ownership, Location, and Internalization.

Interactive Models

Interactive models propose that the market consists of anonymous actors engaging in continuous interactions to establish long-term business relationships, thereby forming a business network. The firm's model of business network is a significant driver of its internationalization, as it involves producing resources in collaboration with partners. Firms can be independently or dependently networked, with increased dependence indicating a greater reliance on the resources of other firms for mutual benefit. Business networks operate through exchange relationships, and the firm's position within a network is a key concept in this model.

The following three strategies facilitate a firm's internationalization:

• Extension: When a firm has established relationships with firms and networks in new markets.
• Penetration: When a firm aims to deepen its relationships within existing international networks.
• Coordination: When a firm seeks to improve existing relationships across various networks in different markets.