Basic Types and Theoretical Explanations of Foreign Operation Modes
The choice of a foreign operation mode is considered one of the most important components of an internationalization strategy, since the operation mode determines the type and intensity of control over the foreign market activity, the necessary resource transfers as well as the associated risks. In this Chapter, an overview of different operation modes is given, characteristics of operation modes are highlighted and theoretical explanations for the choice of a foreign operation mode presented.
A company planning to conduct any business activities in a foreign market must choose an appropriate operation mode for this activity. Each task can be performed in various ways, including by vertically integrated organizational units in the foreign country (wholly-owned subsidiaries), by external organizational units (e.g. distributors in the foreign market), or jointly (cooperative arrangements).
The foreign operation mode can be defined as an institutional arrangement for organizing arid conducting international business transactions (Andersen, 1997, p. 2.9). The choice of a foreign operation mode is strategically highly relevant. It is a core component of the internationalization strategy and it exerts a strong and lasting influence on many other activities and options of the company. It is seen as a crucial success factor, also because it is not easily reversible in the short- and mid-term.
In many textbooks, the issue of foreign operation modes is discussed under the heading of market entry modes. For two main reasons, throughout this book the term “foreign operation mode” is used instead: First, the issue is also of relevance when the entry context no longer applies (Welch/Henito/ Petersen 2007, p. 10). In the last decades, the focus has shifted from “going international” to “being international” (Bäurle 1996, p. 123). Thus, (or a MNC, the initial market entry mode is often less important than the operation mode chosen at a certain point in bine. Second, the term market entry’ suggests that the international activities are sales-related. Even though this Chapter mainly focuses on this dimension, foreign operation modes are broader, and also apply to procurement activities, R&D activities, production activities, etc.
The Basic Types of Foreign Operation Modes
To classify foreign operation modes, different schemas can be found in the literature. Very commonly, a distinction is made between
• export modes (indirect export, direct export via agents, etc.)
• contractual modes (e.g. licensing, franchising, contract manufacturing)
• investment equity entry modes (e.g. joint ventures, wholly-owned sub-sidiaries)
Here, generally, an increasing level of vertical integration can be seen: Export modes are – at least when intermediaries in the host country are used – market modes (see Chapter 13), contractual and equity alliances are cooperative modes (see Chapter 14) and wholly-owned subsidiaries constitute the highest level of vertical integration (i.e. «hierarchy”) (see Chapter 15) It has to be noted, though, that export modes can significantly differ. If, e.g, a MNC exports with a direct customer relationship to a foreign customer, this allows a very high level of control by the MNC over this transaction.
More concretely, the choice of a foreign operation mode involves several different dimensions: Where to locate production whether to cooperate and whether an investment abroad by the MNC should be undertaken. Considering the establishment process, joint ventures and wholly-owned subsidiaries can be established by a greenfield investment, i.e., the (joint) building of a new facility in the host country, or by acquisition of existing facilities.
Location of Value Added
Considering the location decision, different determinants have been investigated in the literature. In the early economic approaches, international trade (and, thus, the location of value-added) was explained, e.g., with comparative cost advantages (Ricardo) or, building on these, with relative factor endowments in a country (Heckscher-Ohlin).
Later, dynamic approaches were developed. In the international product lifecycle theory of international trade, Vernon (1966) argued that new product innovations are usually developed and produced in the home country of a company, even if factor costs are high. In the early stage, cost is of secondary importance due to the monopoly situation of the innovating company Also, demand is difficult to predict. In the later stage of a maturing product, competition raises, foreign demand also and cost pressure by new competitors.
Production is partly shifted to foreign countries, closer to the new sales markets. Finally, in the third stage (standardized product), industrialized countries may still the most important markets, but they have become too expensive for production. Thus, production is shifted to emerging countries. From there, the MNC (or competitors) exports the product to the relevant markets.
Generally, location theories of internationalization assume that the decision for value-added in a specific country is determined by location characteristics. Relevant characteristics are market factors (age market size, market potential) and cost-related factors (e.g. differences in labour costs, input goods, taxes). Another relevant location factor is the country risk. In cases of high risk, exporting or contractual arrangements reduce the risk exposure of the MNC compared with a wholly-owned subsidiary where the commitment of the MNC’s own resources is substantial.
The configuration decision is discussed in more detail for the different value-chain activities, i.e., production (Chapter 16) and R&D (Chapter 17).
Cooperation vs. Hierarchy
The decision whether to establish foreign value-added via cooperation or in a hierarchical operation mode depends on many influence factors. A comprehensive study by Morschett, Schranım-Klein and Swoboda (2008a, 2008b) has shown that a number of aspects have a strong influence on this decision.
A fourth characteristic of foreign operation modes is the so-called “dissemination risk”, i.e., the risk that knowledge is absorbed by another company who uses this knowledge against the interest of the MNC (Agarwal/Ramaswami 1992). Since the technological know-how and the marketing know-how are seen as crucial competitive advantages of a company, it is important to secure the company against uncontrolled knowledge outflows, since this may reduce the income a company cart generate from its knowledge. Protection against knowledge dissemination is, thus, a main criterion for the choice of an operation node (Driscoll/Paliwoda 1997, p. 66). In particular, cooperative operation modes, where a partner company (e.g. a licensee) is actively provided with the company’s knowledge, are characterised by a high risk of knowledge dissemination. The lowest risk exists in the case of wholly-owned subsidiaries (or by direct exports to a foreign customer).
To explain the choice of international market entry mode, a number of different theories are used in the literature4 The most important ones will be discussed briefly in the following past of this Chapter.
Stages Models of Internationalisation
The stages models of internationalisation (in particular the “Uppsala model” by Johanson and Vahlne (1977)) are railed in the behavioural theory of the firm. These models propose an assodafiort between the knowledge of the decision makers in the company and the level of resource commitment in a foreign market, The core assumption is that companies with low market knowledge about a specific foreign market prefer a low commitment in this market Lea, market-based operation modes. Once in the market, the coin pan accumulates experiential knowledge and this, in turn, leads to the willingness to commit addifioruil resources. In the so-called establishment chain, the model proposes that foreign operation modes in a specific foreign country are switched along a certain path:
• no international activities
• export activities via agents
• export activities via own sales subsidiaries
• establishment of production subsidiaries in the foreign country
in addition, the Uppsala model suggests that companies often select foreign markets based on the psychic distance to that market and that internationalisation often occurs along a “psychic distance chain”, with psychologically