Understanding Internationalisation Theories To Grow Your Firm

Thomas Brownlees

Thomas Brownlees

CEO and Founder,
440 Industries

Introduction

The evolution of international marketing theories stems from an evolution regarding the perception of international trade as an approach to growing profits and developing an organization. Traditionally the approach to international marketing was developed on the grounds of a less internationally developed world. The first academics to address the matter were:

  • Penrose (1959) saw international marketing as an opportunity to merge a firm’s core competencies with opportunities in a foreign environment.

  • Others (Kindleberger 1969) instead suggested that firms must possess a compensating advantage in order to compensate for the ‘cost of foreignness’.

  • Vernon’s Product Life Cycle hypothesis whereby companies consider international marketing as a form of extension of the product’s life cycle to initiate international trade.

In internationalisation theories, a key distinction is made between cultural distance and psychic distance. 

  • Psychic distance. The psychic distance is defined as the individual’s perception of the difference between two markets, in terms of country and people characteristics. This psychic distance disrupts the flow of information, goods and services between the firm and the market.

  • Cultural Distance. This is divided into country characteristics and people characteristics. Country Characteristics distance: level of economic development, communication infrastructure, marketing structure, technical requirements and competitiveness. People Characteristics distance: per-capita income, the purchasing power of customers, customer lifestyle and preferences, level of education, language and cultural values are the elements to consider as you develop your firm’s internationalisation approach.

While taking into account the evolution of this subject in this post, we’re going to discuss the most relevant internationalisation theories:

  1. The Uppsala Internationalisation Model
  2. The TCA Model
  3. The Network Model
  4. Born Globals Model
  5. Conclusions

1. The Uppsala Internationalisation Model

The Uppsala Internationalisation Model is a very relevant and reasonable theory in international marketing. The most relevant observation they made in order to deliver this theory was based around the behaviour of Swedish manufacturing firms, who appeared to begin their operations abroad in markets that were geographically close and only penetrated gradually in more far-flung markets. Also, they noted that mode of entry in new was often export. 

This model is based on the experience we can collect from our past performance, it is by exploiting this that we can develop a sustainable international expansion. This is because psychic distance can block or disrupt the flow of information. 

According to this model, there are four different stages of entering an international market according to the Uppsala model, each with a higher degree of involvement\commitment.

  • Stage 1: no regular export activity (sporadic export)
  • Stage 2: export via independent representatives (export mode)
  • Stage 3: establishment of foreign sales subsidiary
  • Stage 4: foreign production/manufacturing units.

This model is step-by-step because, in theory, one should move to the next step only when the previous was accomplished successfully. The fundamental idea is that in this model ‘market knowledge’ is by all means equated to other typologies of resources, without which further development is not possible.  Market commitment will be carried out in small sequential steps. However, there are exceptions.

  • Firms that have large resources experience small consequences of their commitments and can take larger internationalisation steps.
  • When market conditions are stable, relevant market knowledge can be gained in ways other than experience.
  • When a firm has considerable experience from markets with similar conditions it may be able to generalize this experience to any specific market.

There are however some criticisms to this model, as:

  • This model is not apt to apply to service industries.
  • Due to globalisation, psychic distance has become less of an obstacle and therefore companies have ways of acquiring information without going through the process of necessarily conducting business abroad before entering a new market.

2. The TCA (Transaction Cost Analysis) Model

The principle followed by this model is that a firm will tend to expand until the cost of organising an extra transaction within the firm will become equal to the cost of carrying out the same transaction by means of exchange in the open market.

In other words, the goal of an organisation is to minimize the cost of exchanging resources in the environment (e.g. negotiation, transport)  and the cost of managing them inside the organisation (e.g employee time).

Sources of Transaction cost is for instance:

  • Environmental uncertainty and bounded rationality (we cannot collect all the information and it’s too much to process, so we can never make fully certain decisions as we cannot process all the information as we have limited capacity to acquire and process information).
  • Opportunism and small numbers. (this is when supplier coalition to increase prices)
  • Risk and specific assets (risks of developing innovation for limited companies).

The costs, therefore, arise from protecting a company towards these risks.

Transaction Costs are friction between buyer and seller which is due to opportunistic behaviour, defined simply as self-interest. This theory, therefore, states that cost minimization explains structural decisions, as firms ‘internalise’ or integrate vertically to reduce transaction costs. These costs are either:

Ex-ante costs:

  • Search costs. Costs of gathering information to identify and evaluate potential export intermediaries.
  • Contracting costs. Costs associated with negotiating and writing an agreement between the seller and buyer.

Ex post costs:

  • Monitoring costs. Costs associated with monitoring an agreement to ensure that both seller and buyer fulfil their obligations.
  • Enforcement costs. These refer to the costs associated with the sanctioning of the trading partner, who does not perform in accordance with the agreement. 

So in a nutshell
If the transaction costs through externalisation (importer or agent) are higher than the control costs through an internal hierarchical system, then the firm should seek internationalisation of activities, through wholly-owned subsidiaries.

Limitations
In this theory, the human nature is oversimplified by being called opportunistic, as now business is much more oriented towards a non-zero-sum game. Also, SME need to base much of their internationalisation strategy on creating the premises for cooperation with a variety of intermediaries, so their perspective is not to minimize cost in transactions as much as to prevent unfruitful investments. This latter issue is addressed with the next theory.

3. The Network Model

Business networks are a way of handling activity interdependence between several business actors. In a market model, the relationships between different actors are regulated through market price, in a network instead interaction is mediated through relationships. These relationships are flexible and may alter according to rapid changes in the environment, as the glue keeping relationships together are personal ties.  

The strength of networks is given by the fact that actors are motivated to engage in the interaction, need to invest time and effort to create a relationship. This relationship will be developed domestically, because of the need to create ties which may be grounded on commonalities and shared business circumstances. However, according to the network model, the relationship that a firm has in a domestic network can be used as bridges to other networks in other countries. This will increase the pace of internationalisation, as it will provide to the company a preferential set of contacts to reach its expansion objectives.

4. Born Globals

Born Global is what you call a firm that since its birth, globalises very rapidly without any precedent long-term internationalisation period. A born global is defined as a firm that from its inception pursues a vision of becoming global and globalises rapidly without any preceding preparation stage.

Initially, the first definition of born globals (1976) is simply that these companies internationalise quickly. Later though the element of competitive advantage was added to indicate that fast growth was a point of strength for the company, leading to:

  • Born globals grow sales by operating in more countries.
  • Born globals receive a first-mover advantage in the new markets they operate in.

But these are more consequences of a mindset, but what are the internal motivations? Usually, this is what actually ties into the concepts of entrepreneurship.

5. Conclusions

In this post we’ve explored the theoretical framework that explains the behaviour of firms when growing in international markets. These theories in fact allows us to understand the particular challenges that companies may need to address in terms of dealing with different cultures, but at the same time they help managers build onto the assets that their organisations have developed to have better chances of success. 

In general these theories, were designed around the model of a manufacturing firm, but they have shown to respond well to the test of time, as they are still applicable in today’s global business environment.

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Understanding Internationalisation Theories To Grow Your Firm Internationalisation theories help international managers understand how to make a company develop and grow internationally. Let's see how.
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Thomas Brownlees

Thomas Brownlees

I am an Anglo-Italian business lecturer and consultant based in Florence, Italy. In 2017 I started 440 Industries, an education and training company focused on fashion, music, and technology. Our mission is to help students, entrepreneurs and managers in overcoming the challenges of starting, developing and scaling their business in the creative industries. When there's a will, there's a way!

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