Methods of Internationalization

In the process of globalization, a firm operates their activities globally and the internationalization process is one of the primary sites of attention. The changes in the technology in the fields of telecommunications and computer lessen the costs of cross border operations and encourage firms to engage in transnational production activities. Internationalization is a sequential process where firms internalize their economic activities characterized in terms of aggressiveness and motivated by either internal or external triggers or a combination of both. It is one of the key strategic decisions for firms to maximize or at least sustain profits to survive in the world of uncertainty and complexity. The global economic expansion has been largely facilitated by the growth of TNCs. They dominate world trade and capital movement with turnover exceeding the GNP of some countries. These corporations continue to grow and influence the landscape of the world economy.

Once a firm has decided to go international, it takes place in wide variety of ways, most of which can be classified into three broad categories:

  1. Export based methods
  2. Non- equity methods
  3. Equity methods

1. Export Based Methods for Internationalization

It is the most common way in which a firm becomes international, by producing its products in the domestic markets but exports a proportion of its products to foreign markets. Exporting is an oldest and straight forward way of carrying international business. Its growth can be reduced to the liberalization of trade that has taken place globally and within regional trading blocs due to concept of free trade like European Union (EU), NAFTA (North American Free Trade Association), ASEAN (Association of South East Asian Nations), and APEC (Asia Pacific Economic Corporation). The export based methods of internationalizing are divided into ‘indirect exporting’ and ‘direct exporting’.

  1. Indirect exporting: When a firm does not have any international activity by itself then it operates through intermediaries for physical distribution of goods and services in the foreign market. Initially an export house buys products from domestic firm and sells them abroad on its own account. A confirming house acts for foreign buyers where it brings sellers and buyers into direct contact and guarantee payments on a commission basis. Finally a buying house performs functions in seeking out sellers to match buyer’s particular needs.
  2. Direct exporting: In this form a firm is directly involved in distributing and selling its own products to the foreign markets. It is long term commitment to a particular foreign market with the firm choosing local agents and distributors specific to that market. It allows the exporter to monitor developments and competitions in the host market. It promotes interaction between producer and end user with long term commitments such as providing after sales services to encourage repeat purchases.

2. Non-Equity Based Methods for Internationalization

In this form of internationalization, the firm either sells technology or do business in the form of contract, involving patents, trademarks and copyrights. It is often referred to as intellectual property rights and form major part of international transactions. This non-equity method of internationalization takes into forms of licensing, franchising or other types of contractual agreement.

  1. Licensing: It is a permission granted by the licensor (proprietary owner) to a licensee (foreign party) in the form of a contract to engage in an activity which is otherwise legally forbidden. The licensee buys the right to exploit technology and products from the licensor, which is protected by the intellectual property rights like patent, trademark or copyright. The licensor benefits from the licensee’s local knowledge and distribution channels; also it is a low cost strategy for internationalization since the foreign entrant makes little or no resource commitment. This type of agreement is mostly found in industries like R&D and other industries where fixed costs are high.
  2. Franchising: In this form, the franchisee purchases the right to undertake business activity using the franchiser’s name or trademark rather than any patented technology. Many firms choose franchising as a means of internationalizing as it establishes firm’s business in short time with relatively little direct investment and creates global image through standard marketing approach. It allows franchiser a high degree of control and enables to understand the local taste and preferences in the foreign country. For example, Coca-Cola’s franchising arrangements with various partners in different countries has given an advantage over its arch rival PepsiCo. Franchising also helps in building up global brand which can be cultivated and standardized overtime.
  3. Other contractual modes of internationalization: Besides licensing and franchising, Management contracting is another form of internationalization where a supplier in one country provides certain ongoing management functions to a client in another country. Examples include technical service agreements are provided across borders, as when a company outsources its operations to a foreign firm. Contract-based partnerships are also formed between different nationalities in order to share the cost of an investment. For example, pharmaceutical companies, automobile companies make agreements between themselves to include cooperation, co-research and co-development activities.

3. Equity Based Methods for Internationalization

When a firm physically invests in any another country, it is referred as Foreign Direct Investment (FDI). The major advantage of this method is that the firm has greatest level of control over its proprietary information and technology. A firm can use different ways to FDI by acquiring an existing firm, creating equity joint ventures, merging or establishing a foreign operation by its own (green-field investment).

  1. Acquisition and Establishment of a firm by its own (green-field investment): Acquisition of an existing foreign company has a number of advantages compared to green-field investment. For example, it allows an immediate presence in the market which results in a fast returns on capital and ready access to knowledge of the local market. Also, problems associated with green-field investments such as cultural, legal and management issues are avoided.
  2. Joint Ventures: It involves creating a new identity in which both the initiating partners take active roles in formulating strategy and making decisions. It helps to share technologies and lower the costs of high risks in various development projects. Joint Ventures make firm to gain economics of scale and scope in value adding activities on a global basis. It creates a firm to secure access to partner’s technology and accumulate learning process which is used for more effective future competition in the industry. Joint Ventures are common in high technology industries; it usually takes one of the two forms: Specialized Joint Ventures and Shared value added Joint Ventures. In Specialized Joint Ventures, each partner brings a specific competency like one firm might indulge in a function of production and other does with marketing. For example organizations like JVC (Japan) and Thomson (France) have been into specialized Joint Venture where JVC contributed the specialized skills involved the manufacturing technologies needed to produce optical and compact discs, semiconductors while Thomson contributed the specific marketing skills needed to compete in European markets. In Shared value added Joint Ventures, both partners contributed to same function or value added activity. For example in the case of Fuji-Xerox, it is a shared value added Joint Venture with the design, production and marketing function all shared between two firms.
  3. Merging with a firm: In this equity based method for internationalization, a firm uses FDI by merging with a firm in the foreign country by buying its stake and holding appropriate ownership in the form of equities. It helps to extend its business rapidly and can use its infrastructure and knowledge about local market to improve its market share compared to its competitors.

In equity based methods for internationalization, creation of consortium is one of the oldest forms of foreign direct investment. East Asian business models like Japanese Keiretsu and South Korean chaebols are more successful in building cross industry consortia when compared to western countries. Consortium of these types are sophisticated forms of strategic alliances designed to maximize the benefits like risk sharing, cost reductions, economies of scale etc. They tend to have long term and stable inter firm relationships based on mutual obligations in order to be forerunner of technology based industries.

The Japanese Keiretsu is a combination of 20-25 different industrial companies centered on a large traditional company where transactions conducted through alliances of affiliated companies. It is divided into two forms, horizontal keiretsu which consists of highly diversified groups which are organized around core bank and general trading company (For example, Mitsubishi, Mitsui and Sanwa). Vertical Keiretsu is organized around a large parent company in a specific industry like Toshiba, Toyota and Sony etc. There are strong linkages between these two forms and the organization is extremely complex and wide reaching.

The South Korean chaebols, usually dominated by the founding families are similar consortia which are centred on a holding company. While a Keiretsu is financed by group banks and run by professional managers, chaebols get their funding from governments and are managed by family members. Examples include Samsung, Daewoo etc are industrialist families and the company keeps the stock in family hands.

When a firm becomes transnational, it has specific impacts on both host economies and home economies. The impacts like transfer of resources, capital, technology, an increase of employment, concerns about sovereignty and trade and balance of payments occur on the host economy. The specific impacts on home economies will be like loss of technology, sovereignty, loss of employment and tax avoidance.

One thought on “Methods of Internationalization

  1. Thanks for this article, it’s very useful for my graduation work! But I would be very grateful if you could tell me about the sources of information for your article. Thank you!

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