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What barriers do firms face in entering foreign markets?

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This paper proposes a dissertation on the barriers first time entrants in international markets face particularly regarding the problems arising from cultural differences. It explores some of the relevant literature on the subject and defines the aims, objectives and methodology for further analysis. The problem described in this dissertation is related to the cultural barriers most firms face in entering international markets. The process of entering international markets is important for the continuity of a lot of firms worldwide. However, apart from the financial investments made, a degree of risk is associated, increasing as there are more and more cultural differences. This is widely discussed in the literature and an analysis to three groups of countries will be presented: Europe, Middle East; and North America.

1. Introduction

Firms traditionally face barriers to enter the market. This is widely studied in the literature but different nuances from this subject can be analysed. If there is uncertainty associated to the fact that a firm enters a new market, larger levels of risk may be present when firms enter markets in different countries, where the presence of cultural differences may undermine the success of the new venture.

In a scenario in which globalisation plays a major role in most domestic economies, the subject of entering foreign markets is more and more pertinent. In addition, in certain industries the domestic market is not enough to cover all the production of the firm, and therefore, the firm needs entering foreign markets to, for example, find the funding for expansion. Thus, the entry in foreign markets in this context may not be an option but rather an imposition.

Business decisions are very much embedded in a sociological context, in which culture and communication play a major role. To that extent, an important barrier to enter international markets can be cultural differences that may undermine the process of entering the market of the success of the international venture.

The entry decision incorporates a decision of the spending of resources – usually there are resources that need to be allocated to the decision of international entry, and that managers need to commit to the process of entry. Mascarenhas (1998) refers to these resources and finds that larger initial resources commitments are not positively related to larger market shares in these markets or to the market survival in these markets. In order to succeed in the international markets, the managers should strive to enter the international markets before their competitors. In addition, the study also demonstrates that first entrants usually need to place fewer resources in the process of entering the market, and therefore this strategy can be pursued by firms with limited resources if they are first entrants.

There are several forms of entering in new markets, and the form of entry may impact on the success of the entry. Moreover the form of entry also has an important impact on the result of the new venture. Hill et al. (2006: p. 117) refer to the mechanisms that lead firms to chose certain forms of entering in international markets:

“This framework identifies three underlying constructs that influence the entry mode decision. These constructs are linked to considerations that have been previously discussed in the literature. It is argued that a firm’s choice of entry mode depends on the strategic relationship the firm envisages between operations in different countries. A particular entry decision cannot be viewed in isolation. It must be considered in relation to the overall strategic posture of the firm. Further, the paper argues that different variables often suggest different entry modes, and that resolving these differences involves accepting trade-offs.”

The modes of entry refer to the process the firm decides to enter the market. The modes of entry include: Exports (direct or indirect), contractual methods (licensing and franchising); and direct foreign investment (jointly with other companies, or wholly owned subsidiaries) (Armstrong and Sweeney (1994).

There is also an important aspect that needs to be related to the process of internationalisation: Experience. The process of entering international markets by new ventures provides firms with knowledge that can be used to build additional value by the creation of skills (Barkema & Vermeulen, 1998; Ghoshal, 1987). According to Zahra et al. (2000) “New ventures competing in international markets, for instance, draw from multiple knowledge bases in their different business operations and learn new skills that augment current capabilities.” This perspective serves to highlight the fact that after the first experiences in terms of international ventures, firms are more confident of the process and therefore there is a lower risk associated to the entry in international markets. However, a major challenge for firms entering in new ventures in international markets for the first time is to bridge the distance to the host culture. Cultural distance is defined by Luostarinen (1980: 131-132) as “the sum of factors creating, on the one hand, a need for knowledge, and on the other hand, barriers to knowledge flow and hence also for other flows between the home and the target countries”.

A very important aspect of the process of internationalization is the distance between certain cultures. This issue is very central to the international Business literature, as it can be confirmed by Sousa and Bradley (2006: p. 49)

Cultural distance and psychic distance are two concepts that are widely used in the international business literature. A large number of studies use both concepts interchangeably with no clear distinction between them. The authors propose a new model to assess cultural distance and psychic distance separately. Through the use of survey data of more than 300 managers, this article shows that both concepts are conceptually different and that psychic distance is determined by cultural distance and the individual values of the managers.

According to Hofstede (1984) some cultures are more distant than others. For example, Mediterranean countries share very similar cultures, as well as Anglo-Saxon countries. On the other hand, if a British company wishes to internationalise to Middle East countries, it is likely that a cultural gap is found and this has to be taken into account. The existence of cultural barriers can be partially eliminated by an evolutionary process of entry in foreign markets. Hashai and Almor (2004: p. 465) demonstrate this gradual process of entering the market that can be used as an argument in favour of the actual difficulties in entering international markets, since three levels of entry are referred.

Results show […] the following internationalization sequence over time: (1) exports are employed initially in order to serve customers in psychically close foreign markets; (2) subsequently, greenfield marketing subsidiaries are established in these markets; (3) finally, firms engage in mergers and acquisitions, create subsidiaries that incorporate several value-adding activities and penetrate psychically distant foreign markets.

Hofstede (1989), refers to the risk of international markets, suggesting that despite the existence of some cultural gaps, which may not be very disruptive or are even complementary, differences between two cultures in uncertainty avoidance can become a potential source of problems for international cooperation due to the correlated differences in tolerance toward risk, formalization, and the like.

This perspective is very important, and it can be related to the resource- based perspective. In order to invest in international markets, firms need also to invest in their knowledge and adaptation to these countries. Nonetheless, as a result of the internationalisation process, firms are likely to acquire knowledge about foreign sites, institutional characteristics and other site-specific knowledge (Barkema et al., 1996) as much as being more open to transactions with new cultures.

Finally, as an example of entry barriers in foreign markets Smith et al. (2006: p. 54-55) summarises five factors that may act against the introduction of exports in international markets:

From the review of the earlier empirical literature, five frequent export barriers have been summarized. First, non-exporting firms tend to perceive obstacles differently from exporting firms. They put more emphasis on factors inhibiting the initiation of export activities, whereas exporting firms stress operational, procedural and market-related problems. Second, the nature, as well as the severity of export impediments varies not only between export stages, but also among firms at the same stage of export development process. Third, the external environmental factors prevailing in each country largely influence perceived export obstacles. Fourth, industry-specific factors are often responsible for variations in the perceived severity of export barriers across industries. Finally, the size of the firm often determines the nature and influence of export barriers, with smaller firms feeling their inhibiting impact more strongly.

2. Aims and Objectives

The aim of this dissertation is to look at the processes of entering new markets (internationally) and to evaluate the extent to which cultural characteristics of the host country can contribute to the decision making. Therefore, in this dissertation it will be sought to find a relationship between the cultural distance of three groups of countries and the strength of their international trade. In other words, one can point out to research the following question: Is a firm more likely to invest in countries that are culturally closer?

Therefore, the aim of this dissertation is to evaluate the extent to which the cultural distance plays an important role on the decision of participating in the economy of a certain country. To that extent, this research is evaluating, ultimately, if the cultural proximity of certain countries is a factor of attraction by firms for an investment. In order to evaluate the role of cultural proximity, one will evaluate the cultural barriers firms face in entering foreign markets. The focus of this dissertation is first timers in terms of international ventures. For that reason the issue of cultural distance is analysed so narrowly. This is also based that firms entering markets with some experience in international ventures are less exposed to risk when entering a new market. The basic hypothesis in this argument is that cultural distance plays a major role in first time entrants than in other firms.

In order to pursue this objective, a perspective on the resources necessary to enter an international investment will be the basis for the explanations sought. The hypothesis is that, entering in markets in which there is a higher cultural gap embodies higher risk and, therefore, more resources are necessary for the process of investment.

4. Methods

4.1 Data

In order to evaluate the relationship between the cultural distance of the country and the processes of internationalisation of the firm, three main sources of data will be used. The first set of figures is collected from Hofstede work (Hofstede, 2008). This dataset contains a description of each country and therefore allows comparing countries in relation to their cultural distance. The framework developed by Hofstede (2001) provides a set of variables that permits the comparison of cultures with regard to different business approaches. This study was carried out using data collected from IBM employees in different countries around the world. Despite being a good method of analysis in that it isolates the possible side effects from analysing employees under different organisations (and hence different opinions and behaviours led by the organisation), it may fail to capturing fully the originality of each country, as these individuals are also influenced by IBM policies.

The framework is developed around 5 different dimensions:

Power distance (PDI): measures the extent to which less powerful actors accept and expect that power is equally distributed.

Individualism (IDV): refers to the degree to which individuals are integrated in groups. It is the opposite of collectivism.

Masculinity (MAS): relies on the distribution of roles between genders. Women in feminine countries have the same modest and caring values as men, whilst in masculine countries they are less assertive and competitive than men, hence a higher gap between men’s and women’s values.

Uncertainty avoidance index (UAI): represents the society tolerance for uncertainty and ambiguity. It shows the levels of comfort by the society members towards unstructured situations [1] , created by the culture.

Long term orientation (LTO): associates values with thrift and perseverance (on long term orientated cultures) and with respect for tradition, fulfilling social obligations and ‘saving face’ (in short term orientation).

The second source of data is related to the exports. Data was collected from the WTO (2008) and contains information for the countries and groups of countries, below:

European Union (27)

Middle East

North America

Finally, it will be sought, in different sources data regarding the flows of foreign direct investment between each pair of groups of countries. The information for this dataset will be collected for each pair of countries individually and therefore different sources will be used.

The study of the closeness of the relationship between any pair of countries can be compared to the results on the cultural distance obtained by Hofsted. This will help to test the hypothesis that firms are more willing to trade with countries that are culturally closer.

4.2. Analysis Techniques

In order to evaluate the extent to which the cultural distance plays an important role on the decision of participating in the economy of a certain country, an individual analysis to each pair of countries will be conducted. This analysis will incorporate a measure of the relative distance of the two countries, and an evaluation of the relative weight of the exports and of FDI in the total exports and FDI of each country. The data will provide an opportunity to focus on the relationship between the cultural distance and the actual international liaison of firms in the two groups of countries, with statistical techniques. This analysis will be complimented with relevant particulars of the culture of the two countries.

5. Expected Outcome

It is expected that countries with similarities in terms of culture verify higher levels of international trade, not only in terms of exports, but also in what regards to international trade. The theory on the resources applied in the participation of a new joint venture can also provide a contribution in this respect. Countries with higher similarities may embody a lower risk of investment and therefore, firms will be seeking to invest firstly in countries in which they know what to expect. However, it is also certain that after having invested in a number of countries to which cultural similarities are found, a firm may be seeking to expand to other countries, culturally more distant. This may be due to two reasons: the first one is related to the need of expansion, and once all countries to which cultural proximity is found already have the presence of the firm; the second one is related to the international experience and the confidence of investment the firm has gained in the countries it has invested previously, and is now ready to take a step further and to operate at a higher risk.

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