The research investigates the impact that the formal institutions in both developed and emerging economies have on the global entry strategies of firms. There are different institutional environments in several countries and this is quite influential on the development of a global strategy. Adjustments need to be made on the strategy that can be relevant to the specific needs of a nation. First, the difference in the institutional environment of developed and emerging economies is analyzed and the two markets are compared with regards to three institutions, which are business regulations, trade barriers, and property rights. Second, the impact of those differences in terms of global entry strategies is discussed and the results show that countries with weak institutions in emerging economies require different global strategies as compared with those with strong institutions found in developed economies. Finally, recommendations are made on the global entry strategies that are effective in countries with weak formal institutions and those with strong formal institutions.
Global Entry Strategies
There has been a rapid growth in emerging economies and globalization and this has made companies experience numerous challenges as regards to entry into particular markets. Companies globally use different strategies and most focus too much on their internal resources and capabilities when determining what foreign market entry strategy to engage in. It is imperative that before a company develops the strategies of entry into a global market, they should also consider other factors like the particular institutions that influence international trade (Eyring, 2011). Formal institutions have profound impact on global strategies of businesses as they are solely determined on the basis of industry and government directive. These institutions have a direct effect on how well multinational companies can formulate and implement their strategies. Formal institutions form the basis for the rules that govern businesses in an industry and knowing such rules can influence the success or failure of global businesses. Formal institutions are defined as being regulative, cognitive, and normative structures and activities that provide meaning and stability to any social behavior. The World Bank adds to the definition by stating that institutions are sets of informal and formal rules that govern the actions of organizations and individuals while in the ordinary course of business (Anand, 2002).
Formal institutions have formally accepted written rules and regulations that are to be implemented to make up the economic and legal set-up of a country thereby defining its regulator pillar that is meant to administer both firm and individual behavior. Formal institutions comprise of the judicial system, investment laws, business regulations, and property rights while informal institutions include cultures, ethics, and norms that might have an effect on the business. The main function of institutions within a nation is to reduce the rate of uncertainty that can create transaction costs, which is the cost of doing business. The biggest concern for businesses is the uncertainty of currency risk that can lead to great losses especially when the currency falls in value suddenly. Businesses are more likely to conduct their operations in countries where there is low uncertainty to reduce their risk of doing business. Institutional frameworks are quite relevant for the reduction of uncertainty and they are lower in nations with strong formal institutions as compared to those with underdeveloped institutional structures where informal institutions play a larger role in reducing uncertainties.
Formal institutions tend to vary from one country to another and they have to be carefully considered before engaging in entry strategies. Institutional structures tend to differ especially between developed and emerging economies and they can be either strong or weak. Institutions are said to be strong when they support the voluntary exchange underpinning the effective market mechanism and are weak if they undermine markets or even fail to ensure the effectiveness of such markets. Most businesses often choose to penetrate into foreign markets that seem to have formal institutions that are either similar or stronger than those in their parent locations. However, there is a trend for businesses to move into emerging economies with weaker institutions despite the risk of uncertainty being higher. For businesses to succeed when they expand their businesses to nations with either strong or weak formal systems, they need to analyze the institutional environment and adapt to the global strategy that can guarantee success even in emerging economies that offer great opportunities for development (Tonoyan, 2010). The research focuses on the formal institutional differences that are often found between developed economies and emerging economies and how they affect the global entry strategies of multinational companies. The institutions that are widely elaborated on in this paper are business regulations, trade barriers, and property rights with Germany being used as an example of a developed economy and India being an emerging economy. The research seeks to analyze how institutional differences between emerging and developed economies can have an impact on the kind of entry strategy a global business decides to engage in when penetrating a market. Its main purpose is to propose viable market entry strategies that multinationals can use when gaining entry into either an emerging or a developed economy. Specific research questions that will be answered in this research are:
- What are the differences in the institutional environment of developed and emerging economies in the global market?
- What is the impact of those differences in terms of global entry strategies?
- What recommendations can be made on the global entry strategies that are effective in countries with weak formal institutions and those with strong formal institutions?
- Formal Institutions in the Global Market
- Business Regulations
All corporations gaining entry into foreign markets are subject to the local regulations that guide the establishment process of business and are considered as new ventures. Most Small and Medium-sized Enterprises (SMEs) that get into business often engage in entrepreneurship by identifying and exploiting opportunities that have not been explored before. SMEs are the backbone of any private sector at all levels of developing countries as the contributions they make towards economic performance significant and universally accepted. Since institutions differ across countries, so does the treatment accorded to new ventures where each country has individual rules that regulate the entry of new businesses. The procedures for registering a business vary across countries in matters regarding obtaining permits, notifications, verifications, and licenses. The developed economies are more friendly to startup businesses as compared to emerging economies because it takes a shorter time to register a business for instance in Australia it takes 2 days to register a business while in India it take about 77 days. The ease of starting a business in a nation also determines the ease of doing business that involves dealing with construction permits, registration of property, protection of investors, payment of taxes, enforcement of contracts, and closure of business (Tonoyan, 2010).
Developed economies are preferred when it comes to global expansion because they have economies that are friendly to entrepreneurship. These economies have properly structured institutional frameworks that are quite effective in lowering the costs involved with establishing a business. It is with this analogy that new businesses that are based in emerging economies quickly expand their activities to developed economies to enjoy business freedom that entail shorter start up processes, reduced procedures, and lowers costs of business. An example of a developed economy is Germany where it takes an average of 18 days to set up a business and the process involves 9 procedures. The cost associated with starting a new business can be equated to 4.8% of income per capita leading to a business freedom index of 89.6. The business freedom in Germany is guaranteed and well protected by the regulatory framework that fosters business formation and innovation.
The case is different in emerging economies where institutional structures are not friendly to entrepreneurship amidst their continued efforts to improve business regulations. Even though these countries are experiencing positive economic development, they do not support new ventures as SMEs are often discriminated against by governments that would rather support large multinational investors. The cost and time needed to set up a business and begin operations is quite high like in India it takes an average of 30 days to set up a new venture and the process involves 13 procedures. The costs of setting up a business in India is quoted at 56.5% of the income per capita effectively placing the business freedom index of the nation at 36.9 as new businesses experience severe challenges in their operations. The problems are mainly centered on the burdensome regulatory framework within the nation and weak legal framework that does not support business.
- Trade Barriers
These are any restrictions that have been imposed on free trade and are divided into three that include tariff and nontariff barriers, restrictions on entry modes, and local content requirements. These barriers are often imposed by government to protect their domestic corporations from the adverse effects of foreign competition and also to collect revenue. When trade barriers are utilized on a worldwide scale, they increase the costs of companies thus making it less viable to conduct business. Emerging economies tend to have higher trade barriers as compared to developed economies because they rely more heavily on trade taxes for revenue.
Developed economies have trade friendly environments that are regulated by strong institutional frameworks responsible for controlling tariffs and other trade restrictions. Strong institutional structures essentially lower the cost of doing business because even though trade barriers are still present in developed economies, their cost of business is lower because they have reduced risk. Germany is a member of the European Union and has to adhere to its policies key among them being the reduction of trade barriers. The average tariff for members of the European Union as at 2009 was 1.2% with the international organization setting high tariffs on manufacturing and agricultural products (Tonoyan, 2010). The non-tariff barriers include manufacturing and agricultural subsidies, import restrictions, and quotas. It is rare to find total import bans in countries within the European Union and if there are then they are only imposed due to public environmental and health reasons. The only problem that Germany has as regards to trade barriers is its bureaucratic procedures and regulations where the country has a complex safety standard that restricts the entry of foreign companies. They have also implemented anti-dumping protection in a bid to protect its domestic firms from being driven out of business by foreign competition.
Emerging economies on the other hand have a very restrictive trade environment where they impose higher trade barriers in the belief that they are protecting their domestic firms. A good example of a nation that engages in setting high trade barriers is India that applies high tariff rates in a bid to raise revenue for government operations. Import taxes are easy to collect and provide nations with an easy source of income especially for the low income economies. India, for instance, has a weighted average tariff rate of 7.9% where high tariff rates are reported on agricultural products (Meyer, 2009). The country imposes various kinds of custom duty in all imports in a bid to protect its local industries from injury and it also uses anti-dumping protection laws heavily to deter foreign corporations from penetrating the market. Foreign direct investment is heavily curtailed where no foreign investments are allowed on land and it is restricted on other industries. Emerging economies like India often pursue unofficial policies that favor local companies thereby discouraging foreign investors.
- Property Rights
Formal institutions are supposed to protect property rights that effectively protect the accumulated private properties of both firms and individuals. For a country to experience sustained economic growth, it must protect private property rights that include intellectual property, ownership, and enforcement of contracts. Nations with weak formal institutions do not implement the protection of property rights and hence businesses set in these places do business at high risk. There is a variance in the degree of property rights enforcement across countries where some have limited property rights while other simply lack enforcement of the existing rights.
Developed economies tend to have strong formal institutional structures that ensure that property rights are fully protected. The governments are focused on guaranteeing the enforcement of property rights through a court system that efficiently enforces contracts and punishes unlawful acts. Corruption in these countries does not exist and if they do they are at very low levels. Germany has a high property right index of 90 indicating that it guaranties the security of property rights of both foreigners and locals. Foreigners are allowed to own and control property freely and intellectual property rights are well protected with the country being an active member of the World Intellectual Property Organization (Meyer, 2009).
In emerging economies, the case is different where property rights are not well protected due to the lack of a strong formal institutional structure. These countries either have limited laws to protect property or just lack the enforcement of the existing laws that guide the ownership of property. The judicial systems in these countries are corrupt and heavily influenced by other branches of the government making in difficult to engage in independent decision making. Taking the example of India, when Coca-Cola wanted to set up shop in the country they demanded that the company had to share their secret formula. The property index of the country is 50 indicating the unsecure property rights within the nation mainly because of an inefficient judiciary system. There are very low levels of intellectual property rights and even though copyright laws exist, they are often not enforced due to biasness in the judiciary process. The country is not a member of the World Intellectual Property organization and the government can never protect any proprietary test results that are submitted to it for marketing approval by pharmaceutical corporations.
- Managerial Implications
There are formal institutional differences between emerging economies and developed economies and these have a critical impact on the global strategy of the business. When entering developed economies, the process calls for a different global strategy as compared to when gaining entry into an emerging economy. For example, new ventures will be treated differently in emerging economies than in developed economies and this is a fact that businesses need to take seriously if they want to succeed. Gaining entry into an emerging economy can be more costly and risky as compared to gaining entry into a developed economy that has a shorter star-up process and fewer procedures. Furthermore, it is easier for a multinational company to gain entry into emerging economies as compared to SMEs as they can take advantage of economies of scale to have reduced costs and they might receive superior support from the government. It is easier for SMEs to gain entry into developed economies since they face reduced costs, a shorter start-up process, and a lower capital requirement. An analysis is hereby undertaken to identify the best global entry strategy that can be used by corporations when gaining entry into both emerging and developed economies.
4.1 Global entry strategies for emerging economies.
Entry barriers are quite numerous in emerging economies and they often determine the kind of strategy that an organization can use to enter that market. These economies often impose limits on foreign direct investment especially in certain industries that they consider significant to the domestic industries. Due to such restrictions, market entries in the emerging markets can only be achieved through joint ventures and contractual agreements.
- Joint ventures
A joint venture is simply a partnership between an international company or a company seeking to enter the new market and a national company that has been operating in the market for a certain period. The international company has to ensure that is has enough equity stake in the partnership to have control of the business but not necessarily enough to completely dominate that venture. A recommended percentage share would be a 51/49 percent that would guarantee control so that decision within the venture has to be acknowledged by the international company. Such an entry strategy would ensure that the company benefits from the complementary advantages offered by the local company that has been performing well in the emerging economy.
- Contractual agreements
The contractual agreements are referred to as strategic alliances where two corporations, the international company and the local company get into a contract to enhance their competitive advantage. The objective here is to share research and development, marketing relationships, manufacture-supplier relationships, and technological swaps in order to boost one another. Such an entry strategy would be beneficial to the international company as it gives it the avenue to enter into the market quickly while reducing on the political and economic risks of doing business in the emerging economy.
4.2 Global entry strategies for developed economies.
The environment for trade in developed economies is considerably free and highly favors direct foreign investment. Two market entry strategies that are highly effective in developed economies are Greenfield operations and acquisitions.
- Greenfield operations
This is a strategy where the parent company decides to establish a completely new subsidiary in the developed country that it wants to do business in. Even though such ventures require large capital investments, they are viable in the long term specifically if the corporation has a competitive advantage that is based on their technological competency. Since institutions are well coordinated, intellectual rights protected, and easy setup of business is guaranteed in a developed economy, such an entry strategy is less risky and quite effective.
This is an expansion strategy into a new market where an international company buys off a corporation in the local market that is in line with its business. Most organizations indulge in this in an effort to increase their market power in the new market, minimize the risks involved, and acquire any technology that might improve their production process. This is a viable plan in a developed economy since the acquisition process is well documented and proper institutions can facilitate the process thereby ensuring the company is in in business within the shortest time possible (Anand, 2002).
The drive towards globalization has significantly changed the social, political and economic landscape. The business environment has been profoundly affected, both negatively and positively, by the globalization policies implemented in various geopolitical regions. Globalization has broadened and diversified the labor and commodity markets giving companies to diversify their employee and customer bases. However, globalization has an inherent problem of heightened competition and lack of a uniform policy across various regions. Understanding and adapting to these changes is imperative for success in the modern day business arena. The research has established that there are fundamental differences between formal institutions in developed economies and those in emerging economies. It is imperative that businesses consider the kind of differences that exist in institutional structures before making a decision on the most effective entry strategy that they want to engage in. In emerging economies, there exists weak institutional frameworks that call for joint ventures and contractual agreements market entry strategies. In developed economies, there are strong institutional structures that can facilitate Greenfield operations and acquisitions market entry strategies
Anand, J. a. (2002). Absolute and relative resources as determinants of international acquisitions. Strategic Management Journal, 119-134.
Eyring, M. J. (2011). New business models in emerging markets. Harvard Business Review, 89-95.
Meyer, K. E. (2009). Institutions, resources, and entry strategies in emerging economies. Strategic Management Journal, 61-80.
Tonoyan, V. S. (2010). Corruption and entrepreneurship: How formal and informal institutions shape small firm behavior in transition and mature market economies. Entrepreneurship theory and practice, 803-831.
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