Abstract
Organizations work towards achieving long-term goals; hence, must choose a strategy that fits their long-term visions. Many forces influence the extent at which MNE's achieve their goals. Organizations with the goal of entering international competition have to work on the choice of market. The most attractive market for an MNE is the one that creates a big market potential with the least distance. The following paper reviews literature related to the influence of institutional distance on firms' market entry mode in foreign countries. The analysis uses the institutional theory to determine the role of formal and informal institutional distances on the choice of foreign country entry mode.
Introduction
Multinational enterprises (MNE) are seeking unique strategies to help them explore different business environments and win the global competitive. Companies are more attracted to global opportunities but do not realize numerous challenges associated with conducting business in a foreign market. Many factors influence the organization’s entry mode into the international business environment in the contemporary business environment. One of the factors that MNEs should carefully consider is the distance. MNE always look for new market opportunities in foreign countries and developing strategies to ensure they take up the opportunity, but the issue of distance brings a great challenge. The concept of institutional distance explains International business strategies and business operations across different countries. An organization will only assume threats associated with big distances between the host country and the organization center if the target market offers a probability of high-profit margins (Antell and Wallgren 13).
On the other hand, experts in fields of economics and marketing have developed various theories and models to explain the influence of distance on MNE’s market entry mode in a foreign country. One of the most significant models of understanding international market entry is the Hierarchical model of market entry. Under the hierarchical entry model, organizations enter the foreign market directly without developing any partnership in the host country. The model argues many factors influence the foreign market entry mode both at equity and non-equity levels.
The distance between the host country and the center of the MNE manifests itself under four dimensions. These are cultural, administrative, geographic, and economic (CAGE) dimensions (Ghemawat, 138). The CAGE Distance Framework assists managers in identifying and assessing impacts caused by distance while thinking beyond borders. The entry strategy adopted by the MNE should focus on managing these dimensions to achieve the expected outcome. The following paper will focus on formal institutional distance and the informal institution distance to explain the influence of institutional distance on the mode of market entry into a foreign country. The institutional approach is explained using the formal and informal institutional distance. Previous researchers have studied the concept of formal and informal institutional distance, but none did the investigation by combining both concepts. Combining both concepts plays a critical role in determining the influence of institutional distance on the mode of market entry of MNE in a foreign country.
Theoretical framework
The theoretical framework used in this paper helps in linking the concept of formal and informal institutional distance to the organization's choice of entry mode in a foreign country without developing a partnership. The paper utilizes themes of a multinational business perspective and an international business perspective.
Institutional distance
The institutional environment consists of fundamental social, economic, political, and legal rules that determine the basis of production, distribution, and exchange of goods and services in a region. Institutional norms have significantly evolved over years that have resulted into the emergence of new rules defining how organizations should function under the modern international business. The institutional theory argues that these rules have a lot of implications for MNE's and international businesses. The world has undergone an overhaul of institutional arrangements where institutional environments now emerge across countries through the interaction of communities (Tihanyi, Timothy and Torben 44). A community network must exist regardless of the geographical boundary. However, rules and regulations governing the opposite side of the boundary influence the type of the network. The presence of rules and laws help in stabilizing both communities and creating peace and order.
Scott made a lot of contribution to the institutional theory by introducing three institutional pillars, namely: normative, regulative, and cognitive. The differences between normative, regulative, and cultural cognitive norms of the home and the host country are a reflection of the institutional distance. (Scott 47). The regulatory pillar reflects the formal institutions while normative and cultural-cognitive pillars are best related to the informal institution. Modern organizational managements are still ignorant about the formal and informal institutions. However, as the world advances and people discover new and modern ways of doing business the organizations have shown a big progress. Additionally, many studies on the influence of institutions on businesses have shed more light to entrepreneurs. The research by Antell and Wallgren found out that the market is becoming more homogenous because of the decrease in relevance of physical distances (Antell and Wallgren 13).
The development of the institutional theory focused on three streams of research. The first stream referred to as emerging looks at the interjections of strategic responses and institutional forces. The stream argues that an organization gains legitimacy only from specific sources depending on its business practices. The approach has a lot of relevance in the MNE’s environment where there are multiple demands and high uncertainties (Xu and Shenkar 609). The second stream researchers on the creation of industries and organizations facing new institutional environments. Organizations are seeking strategies that help them reshape their institutional environments and seek social, political legitimacy. The stream argues that institutions under the same environment follow one another into new markets. However, young institutions lack experiences that lead them into liabilities while practicing international businesses strategies (Xu and Shenkar 609). The final stream relates to inter-organizational relationships. An organization may be located in multiple institutional fields and work under different institutional pressures. Institutional pressures may be local or international. The stream plays a significant role in relating the institutional theory to the MNE operating under more than one institutional environment and varying pressures (Xu and Shenkar 609).
Institutions fall under the formal and informal categories. These categories are based on the type of rules, incentives, and constraints that govern the running of the institution. Formal institutions use formal methods of communicating and executing activities, ideas, and information and they have ownership and authority. Equity positions such as contractual terms, firm boundaries, and explicit incentives define formal institutions. Formal institutions function through promoting change within the management by seeking their optimization. On the other hand, informal institutions operate based on implicit understandings. Information flow through the institution does not necessarily need to take a written form or delivered through any formal position. Informal institutions are characterized by routines, political processes, and social norms. Informal institutions demonstrate the true behavior of the organization in the international market. The informal means of operations plays a critical role in influencing activities of the firm and political processes influence most decisions (Zenger, Lazzarini, and Poppo 1-2).
The type of institution embraced by a country determines the mode of entry of the MNE. Different countries have varying institutional arrangements; hence, every organization willing to enter a foreign country market must conform to laws, rules and belief systems adopted in the host country’s environment. The concept of institutional distance assists in explaining the degree of similarities or differences between cognitive, regulatory, and normative institutions of the home country and the host country. Additionally, the institutional distance may influence the ability of the organization to enter a foreign market. For example, distance has an influence on the cost of transportation, integration, coordination, and monitoring. Many researchers who have investigated the influence of distance argue an increase in distance leads to a significant increase in the cost of management as organizations find it complex managing dispersed networks (Hutzschenreuter, Kleindienst, and Lange 6-7).
The choice of entry mode to the foreign country-400
MNE use different strategies to enter the foreign market depending on the type of business and the size of the firm. The international market entry modes happen in two classes; equity-based and non-equity-based. Equity entry modes follow the foreign-direct investment while non-equity modes follow the contractual modes. The equity-based international market entry mode is divided into equity joint ventures and wholly owned ventures. On the other hand, the non-equity-based mode is divided into export and contractual agreements (Pan and Tse 535). The foreign direct investment refers to a cross-border expenditure that a firm uses to acquire and expand the control of productive assets.
A firm that aims at entering the foreign market through foreign direct investment must consider the element of ownership. The firm can practice a joint venture where two or more MNEs enjoy partial ownership or a wholly owned subsidiary where the organization enjoys full ownership of the business. Three pillars; ownership-specific factors, internalization factors, and location-specific factors control the ownership of a business entity. Location-specific factors have become very important when it comes to influencing the organization’s foreign operations. Additionally, all three factors have a significant impact on business transaction costs (Pan and Tse 537).
A firm may enter the foreign market through the contractual mode divided into exports and contractual agreement. The above entry mode must involve a local partner. MNEs can easily access the knowledge of local businesses under the contractual mode of entry. However, the mode may be risky because the firm may end up losing all its values including technology and resources to the partnering firm. The level of risk present in the host country affects the MNE's choice of the entry mode. international business risks fall contextual and transactional risks categories. Contextual risks refer to external risks found in the new market environment. Examples of contextual risks include control risk, political risk, operations risks, and transfer risks. Transactional risks result from internal factors such the firm's failure to oblige to the marketing rules (Pan and Tse 539-540).
MNEs experience both types of risks upon undertaking an international business operation. Understanding rules and regulations set by the host country helps the organization plan for a better entry mode even if experts claim it may be hard to predict how the situation would become after entering a foreign market (Pan and Tse 540). Pan and Tse’s Hierarchical model of market entry modes plays a crucial role in influencing the firm's choice of the foreign market entry mode. The theory bases the selection on two perspectives the multinational business perspective or the international business perspective.
The integration of institutional distance and the mode of entry
The formal and informal institutional distances determine the firm’s choice of the entry mode. Each category of the institutional distance influences the choice of the market entry mode in a different manner. Rules and regulations that MNE must follow when planning the mode of entry to use in the foreign market must occur under the formal institutions. The formal institutional distance describes the differences between the home country and the laws, regulations, and legal institutions of the host country. A country whose formal institutional distance different is big discourages firms from investing because they are afraid of consequences. Additionally, firms distance themselves from such institutions because all business operations follow formal procedures of rules and norms that may conflict with those of the country of origin (Xu and Shenkar 610-612).
MNE will be forced to make a choice between obtaining external and internal legitimacy when the host country presents greater institutional differences. However, the firm needs external legitimacy to survive in the foreign land’s institutional environment. MNE will seek for a strategy to have a higher involvement in the host country where there is a larger formal institution difference to achieve an external legitimacy. Eventually, the firm opts for a joint-venture entry mode. The above analysis shows that external legitimacy carries more weight when it comes to overcoming internal and external pressures for the MNE to survive in the host country.
Proposition 1: MNEs are more likely to enter the host country through joint ventures rather than wholly owned subsidiaries when there is a high formal institutional different between the home and foreign country.
Informal institutional distances also influence the firm’s mode of entry to a foreign market. The ideological and cultural distance between the home and the host country represents the informal institutional distance. Informal institutional distance is a choice of mode of entry preferred by many small enterprises. Under a joint venture, the local firm is frequently assigned the tasks of managing local cultures and ideologies. The foreign country enjoys the benefit of conducting business in an environment free from cultural factors. However, the foreign firm incurs more cost out of the joint venture and enjoys a lower percentage of ownership. The increasing cultural and ideological distance between the host country and the MNE declines the foreign firm’s ability to have full control over the business ownership. The local firm demands more share of profits and other benefits because informal management operations demand more resources and higher risks are associated (Xu and Shenkar 613). Thus:
Proposition 2: MNEs will favor the joint venture subsidiary to wholly owned subsidiary while entering a foreign market with the increasing informal institutional distance between home and host country.
Conclusion
A complementary analysis of the international management theories plays a significant role in understanding international business operations. Organizations base their strategies on these two modes in both organizational level and country levels. The type of mode selected by the organization depends on the risk they present to the firm, return on investment, and the control and commitment of resources. The analysis has revealed that multinational organizations either use the equity or non-equity modes of entry to a foreign country. The analysis of the institutional theory shows that despite the fact that most firms would wish to enter the foreign market using the wholly owned subsidiary, institutional distance prohibits the strategy and forces many firms to have joint ventures. The integration of the institutional distance and mode of entry suggested two propositions. The first proposition argues MNEs are more likely to enter the host country through joint ventures rather than wholly owned subsidiaries when there is a high formal institutional different between the home and foreign country. The second proposition argues MNEs will favor the joint venture subsidiary to wholly owned subsidiary while entering a foreign market with the increasing informal institutional distance between home and host country. An empirical study would assist in testing these propositions and validating the claims from the institutional theory.
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