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A transaction cost approach to a paradox in international marketing
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Management S C A N D I N AV I A N J O U R N A L O F
Scand. J. Mgmt. 21 (2005) 61–76 www.elsevier.com/locate/scaman
A transaction cost approach to a paradox in international marketing$ Kjell Grønhaug, Sven A. Haugland Norwegian School of Economics and Business Administration, Breiviksveien 40, N-5045 Bergen, Norway
Abstract Why do firms that make specific downstream investments as they start international operations, sometimes turn to more market-like arrangements as they gain international experience and their international sales increase? This paradox in international marketing is the key question to be addressed in this article. We use the concept of dynamic or temporary governance costs to examine the paradox. The pattern of internationalization in the Norwegian farmed salmon industry provides an example whereby Norwegian exporters established their own sales offices in several international markets in the early stages of internationalization, but subsequently disintegrated vertically and came to rely on more market-like arrangements. An analysis of the internationalization of this industry suggests that, over time, the market provided better capabilities than vertical integration. This reduced the transaction costs, thus making vertical disintegration an efficient strategy. r 2005 Elsevier Ltd. All rights reserved. Keywords: Internationalization; Disintegration; Dynamic governance costs
$ The authors are listed alphabetically and have contributed equally to the article. The authors gratefully acknowledge the constructive comments and suggestions offered by guest-editor, Professor Nicolai J. Foss, and the anonymous reviewers. Corresponding author. Tel.: +47 55 95 94 60; fax: +47 55 95 94 30. E-mail addresses: [email protected] (K. Grønhaug), [email protected] (S.A. Haugland).
0956-5221/$ - see front matter r 2005 Elsevier Ltd. All rights reserved. doi:10.1016/j.scaman.2005.02.004
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1. Introduction This article addresses an apparent paradox in international marketing. In some industries, firms making downstream specific investments when they start their international operations often turn to more market-like arrangements as their presence in international markets becomes stronger and their international sales increase. One example of this is the international farmed salmon industry, which will be addressed here. Such disinvestment appears paradoxical for at least two reasons. First, the standard wisdom offered by the international marketing literature is that firms make specific investments successively as they expand their international operations. The influential Uppsala internationalization model, for example, describes firms going through a series of stages ranging from no regular export activities, through export via independent representatives, on to the establishment of a foreign sales office, and finally to the establishment of foreign production units (e.g., Johanson & Vahlne, 1977; Johanson & Wiedersheim-Paul, 1975). The history of internationalization in a variety of industries also suggests that such successive involvement followed by increased specific investments seems to be a valid description. Even in the case of firms described as being ‘‘born global’’, some sort of stepwise—albeit rapid—internationalization, followed by rising levels of specific investment seems to be the pattern. We refer to Andersen (1993), Bjo¨kman and Forsgren (1997), and Liesch et al. (2002) for recent overviews of Nordic contributions to internationalization research. A basic assumption underlying the gradual internationalization model is that firms move away from the ‘‘known’’, i.e. the domestic market, and towards the ‘‘unknown’’, i.e. new markets which, due to their novelty and the firms’ consequent lack of knowledge, are often regarded with a high degree of uncertainty. When perceived uncertainty is high, risk-averse firms are expected to abstain from making specific investments. The process model can be described as a ‘‘test-thewater’’ approach. Firms first undertake minor investments in order to learn. Then as they gradually learn to handle new markets and positive outcomes are achieved, perceived uncertainty declines. Firms thus become more confident and willing to make specific investments. This can be described as a kind of risk-reduction behavior. Firms will not make substantial specific downstream investments until they have learnt the new marketing environment and feel that they possess the necessary competencies. Moving towards market-like arrangements seems to indicate that specific investments are being abandoned and represent sunk costs. If firms make specific investments in the initial stages of their international operations, but later discover that the expected sales and profits will never be realized, then such behavior is understandable. However, the focus here is on vertical disinvestment in growing markets. We study firms operating in the international farmed salmon industry, and many firms in this industry made specific investments in foreign sales offices as they embarked on international operations. Over time, however, most of these firms have moved on to more market-like arrangements, such as spot market transactions or long-term relationships with foreign importers.
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The article is organized as follows. In the next section we review some of the main characteristics of internationalization, as reflected in the international marketing literature. We then present a combination of transaction cost economics (TCE) (Williamson, 1985, 1991) and the resource-based view (RBV) (e.g., Wernerfelt, 1984; Barney, 1991; Teece, Pisano, & Shuen, 1997; Teece, 2003) as an alternative perspective to the internationalization model. Thereafter we describe the farmed salmon industry and the internationalization behavior of firms in this industry. This description is based on prior research (e.g., Grønhaug, 1996; Haugland & Grønhaug, 1996; Haugland, 1991) as well as press reports. We then analyze and explain the paradox of forward vertical disintegration in the expanding and growing international farmed salmon industry, and finally close with a discussion of our main findings.
2. Characteristics of internationalization as reflected in the international marketing literature Internationalization means that firms move beyond their domestic borders to do business abroad. Firms do this for several reasons. Saturated or even declining domestic markets are frequently part of the picture, as is stiffer competition from foreign products. Domestic operations may thus have become less profitable, and redirecting activities towards international markets may be one way of compensating for falling sales and profits in the domestic market. Increasing international competition is often followed by international specialization. Both firms and countries pursue what they do best (e.g., Porter, 1990). Firms may also become aware of new and exciting business activities abroad, even though they are enjoying success and growth at home. The importance assigned to foreign markets as an alternative to domestic operations varies considerably between industries, and even among firms operating in the same industry. This may indicate that firms have different market foci as they may evaluate opportunities and threats differently, and make different decisions in their choice of markets and activities. Firms starting international operations are moving from the ‘‘known’’ to the ‘‘unknown’’. Moving outside their domestic markets implies not only that the geographical distance between sellers and buyers increases, but that the ‘‘mental’’ or ‘‘psychic’’ distance increases as well (Johanson & Vahlne, 1977). Firms know ‘‘the rules of the game’’, and how they should act, in the home market. Moving out implies greater uncertainty as the new environments have to be adequately understood. Customers are new and a crucial challenge is to overcome ‘‘the liability of foreignness’’ and to become accepted (Nachum, 2003). Customers’ requirements may be different, and adequate ways of operating may also differ from those of the home market. Most international marketing textbooks pay particular attention to potential differences among international environments with respect to political, economic, social and cultural conditions (e.g., Usunier, 1996; Jeannet & Hennesey, 1995). An important point, however, is that the challenges are perceived as being greatest at the outset, when the entrant’s knowledge about a new foreign market is
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small or non-existent. Not surprisingly, one of the most prominent questions addressed in the international marketing literature concerns the entry mode decision, i.e. how to enter a new foreign market (Root, 1983). This is not a surprise, it is after all in the initial phase of internationalization that perceived uncertainty is highest, and the learning requirements are greatest. It is thus likely to be more demanding to become than to be international. Internationalization is often conceived as a stepwise evolutionary process. Johanson and Vahlne (1977) and Johanson and Wiedersheim-Paul (1975) were among the first to conceptualize internationalization as a gradual process, making a distinction between the four following steps: (1) no regular export/no investments abroad, (2) exports to close-lying and similar countries via independent representatives/agents, (3) exports to distant markets/establishing own sales offices abroad, and (4) manufacturing abroad using own resources. A multiplicity of models of the internationalization process exists, varying not only in the number of steps included, but also in their underlying assumptions (e.g., Czinkota, 1982; Line, Sharkey, & Kum, 1991). However, the models do share some common assumptions, for example, that learning about new foreign environments is necessary, that learning evolves slowly and is costly, and that the development over time is the outcome of incremental decisions frequently associated with resource commitments. However, these models have also been criticized. For example, they have been attacked for paying too little attention to the underlying ‘‘drivers’’ of the internationalization process (e.g., Cavusgil & Zou, 1994). It has also been argued that it is difficult to determine the stage that the internationalization of a specific firm has reached. The most severe criticism is that many firms do not become international in the way described by the model. Even though some firms embark on internationalization by way of sporadic exports, others may start direct with heavy investments. Yet others build up to a certain level of export and then remain there without making further investments. In a Norwegian study, 10 different internationalization paths were identified, and the process described by the Uppsala model was one of them (Reve, Haugland, & Grønhaug, 1995). Further, many firms grow in foreign markets while at the same time reducing their domestic activities (e.g., Dagens Næringsliv, May 28, 2003, p. 6; NOU, 1996:17). For example, Levi Strauss has decided after 150 years of operations to close down its factory in San Antonio and to move it to a low-cost country. Several questions remain unanswered, however. Why, for example, should firms internalize their international activities? This question goes beyond simple issues like why firms move their manufacturing operations to low labor-cost countries, or when they move them due to lower transportation costs. Several explanations have been offered. Firms internalize their international activities due to market failure, or because the market mode allows insufficient control over foreign activities. Further, international markets must be ‘‘created’’ and invested in, before the harvest can be gathered. If internationalizing, and thus resource commitment too, is deemed to be important and necessary, why then adopt the step-wise development as described in the Uppsala model? One explanation is that international investment is inherently
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uncertain, as outcomes will first be realized in the future. More knowledge and less uncertainty may emerge, thus bolstering the willingness to make foreign investments. The following proposition can be advanced: Proposition 1. Firms operating in a growing international market will vertically integrate their international activities gradually over time.
3. Transaction cost economics and the resource-based view In this section we present a combination of TCE and the RBV, with particular attention to the concept of dynamic capabilities, as an alternative to the approach offered by the internationalization literature. Over the years TCE (e.g., Williamson, 1985) has become one of the theories most frequently used for explaining vertical integration and firm boundaries (Rindfleisch & Heide, 1997). Firms should integrate activities or transactions characterized by high levels of asset specificity, as market contracting in such cases will be very costly due to the need for extensive safeguards. The internal governance costs (bureaucratic costs) will be lower than the external transaction costs. The borderline between internal organization and market transaction is thus determined by the relative cost advantage between these two forms of governance. The RBV has a less clear-cut conception of vertical integration and firm boundaries. Here the firm is regarded as a unique bundle of resources and competencies, and the direction and speed of the firm’s growth and expansion is determined by its stock of resources and competencies (e.g., Nelson & Winter, 1982; Penrose, 1995 [1959]; Wernerfelt, 1984). 3.1. Transaction cost economics TCE views the firm as a governance structure. The theory identifies the transactions that are conducted most efficiently within firm boundaries or in markets. A crucial idea is that the borderline between internal organization and market exchange depends on the relative size of the bureaucratic costs of internal organization on the one hand and the transaction costs of market relations on the other. This implies, as Langlois puts it, that ‘‘whatever lowers bureaucratic costs on the margin will increase the extent of integration; whatever lowers transaction costs will reduce the extent of integration’’ (1997, p. 289). The transaction is the unit of analysis, and the governance of transactions is regarded as a contracting problem. Contracts imply future consequences, as fulfillment of the agreement will occur at some future time, and most contracts are therefore considered to be incomplete. Klein (1980) contends: ‘‘Contracts are incomplete of two reasons. First, uncertainty implies the existence of a large number of contingencies, and it may be very costly to know and specify in advance all of these possibilities. Second, contractual performance, y may be very costly to measure’’ (1980, p. 365). Organizing transactions within firm boundaries is thus one way of responding to incomplete contracts.
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The core notion of TCE is that the costs of organizing transactions differ, depending on the characteristics of the transaction in question. These characteristics are: (1) asset specificity, (2) uncertainty and (3) frequency of the transaction (Williamson, 1985). Asset specificity refers to the need for making durable investments in order to realize transactions (Williamson, 1985). Such investments impose contractual problems, as actors need to safeguard specific investments against potential opportunistic behavior. Transactions usually imply some degree of uncertainty because transactional outcomes are first experienced ex post. The frequency of the transaction, i.e. how often a transaction will take place, is also assumed to have implication for the way the transaction will be organized. For example, a transaction involving a high level of asset specificity but with low frequency, can be more efficiently performed by hybrid governance than by vertical integration, due to the fact that the costs of developing an internal governance solution cannot be justified since they have to be distributed across the number of transactions. Although all three dimensions are expected to affect the choice of governance mode, asset specificity is the most important: ‘‘Asset specificity is both the most important dimension for describing transactions and the most neglected attribute in prior studies of organization’’ (Williamson, 1981, p. 555). Numerous empirical studies have investigated the effect of asset specificity on governance, and the hypothesis that asset specificity leads to vertical integration is largely supported (e.g., Joskow, 1988; Mahoney, 1992; Rindfleisch & Heide, 1997; Shelanski & Klein, 1995). However, empirical studies have not been able to find a positive relationship between transaction frequency and vertical integration (e.g., Rindfleisch & Heide, 1997), and the effect of uncertainty on governance is mixed. Empirical results suggest that uncertainty may reduce the use of vertical integration and control (Harrigan, 1986), as well as increasing the use of vertical integration and control (Walker & Weber, 1987). The transaction cost perspective includes two behavioral assumptions: (1) bounded rationality and (2) opportunism. The bounded rationality assumption is based on cognitive limitations, implying that human actors must cope with uncertainties with limited knowledge, foresight and skills. The assumption of opportunism implies that economic actors act in their own interest, and are willing to pursue their own interests, even though this may imply actions such as cheating and lying (Williamson, 1985). A distinction can be made between ex ante opportunism, i.e., exploiting a situation when entering into the transaction, and ex post opportunism, i.e., to commit fraud after entering into the agreement. 3.2. The resource-based view The RBV has recently gained widespread acceptance within the discipline of strategy (for an overview see Foss, 1997, 2003). Although the perspective has been criticized for being tautological (Priem & Butler, 2001) and for offering little guidance (Hoopes, Macken, & Walker, 2003), it has attracted considerable attention in strategy research and practice. According to this view, a firm’s competitive
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advantages stem from its resources. It is assumed that resources may yield sustainable competitive advantage when they are valuable, rare, difficult to imitate and well organized (e.g., Barney, 1991). More recently, Hoopes et al. (2003) looking at the RBV as part of a broader theory of competitive heterogeneity, claim that only ‘‘value’’ and ‘‘difficult to imitate’’ are ultimately important. The terms resources, competencies and capabilities are used in many different ways, and the current literature does not provide coherent definitions that clearly distinguish them from each other (Dosi, Nelson, & Winter, 2000; Teece, 2003). While the firm is often defined as consisting of a unique bundle of resources and competencies, capabilities are often associated with knowledge, or as Langlois puts it: ‘‘y, organizations possess a pool of more-or-less embodied ‘how to’ knowledge useful for particular activities’’ (1997, p. 286). Further, dynamic capabilities are defined as ‘‘processes to integrate, reconfigure, gain and release resources—to match and even create market change’’ (Eisenhardt & Martin, 2000, p. 1107). Teece argues that dynamic capabilities are related to ‘‘the firm’s ability to effectuate change’’ (2003, p. 7). As noted above, the RBV has a less clear cut approach to vertical integration and firm boundaries than TCE. Although it argues that the speed and direction of firm growth is determined by the firm’s existing stock of resources and competencies, the perspective does not explain which activities should be performed within the boundaries of the firm and which should be performed in the market. However, since any firm is dependent upon outside actors in the value chain, all firms have to rely on the capabilities possessed by other firms (Langlois, 1997). For example, firms need access to complementary resources such as distribution channels, service providers and so on, and never possess or have any advantage from internalizing and running all these activities themselves. Langlois (1997) suggests that the question of firm boundaries can be analyzed by comparing the relative strength of internal capabilities with the capabilities offered by outside actors or by the market. This line of reasoning rests on an assumption that capabilities influence transaction costs. Since capabilities are related to knowledge and learning, transaction costs may change over time. This implies that the transaction costs associated with performing a given transaction may vary over time, depending on whether or not the firm acquires new knowledge. Transaction costs are dynamic or temporary in their nature, and a shift in what is the most efficient way of organizing the transaction may occur, even though there has been no change in actual attributes of the transaction. Langlois argues that dynamic transaction costs are ‘‘the costs of persuading, negotiating, coordinating and teaching outside suppliers’’ (1997, p. 293). This seems to be particularly important in what we know as ‘‘thin markets’’, or markets that are not fully developed. In such markets the costs of persuading, negotiating, coordinating and teaching outside actors can be very high, due to the fact that outside actors have limited knowledge about the products in question. The market offers weak capabilities, and a firm has to rely on internal capabilities in order to succeed, resulting in the vertical integration of the activities in question. ‘‘When the market cannot provide the right capabilities at the right time, vertical integration may result; and when the firm lacks the right capabilities at the right time, vertical
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disintegration may occur’’ (Langlois, 1997, pp. 293–294). As such markets become more developed, the capabilities of outside actors will become stronger, and the costs associated with persuading, negotiating, coordinating and teaching actors will gradually be reduced. Firms that have vertically integrated activities in thin markets may thus find this to be inefficient as the market becomes more developed, and they may decide to disintegrate these activities. Whereas TCE argues that transactional characteristics determine the level of transaction costs and the resulting level of vertical integration, the RBV implies that capabilities affect the level of transaction costs, and the relative strength of internal capabilities and external capabilities varies over time as markets develop, which means that efficient firm boundaries will not remain static over time. In particular we can expect that firms will rely heavily on vertical integration in markets with weak capabilities, followed by vertical disintegration as the capabilities of the market become stronger over time. We advance the following proposition: Proposition 2. Firms operating in international markets characterized as thin or underdeveloped will vertically integrate activities in the early stages of internationalization, and disintegrate the activities successively as the markets become more developed.
4. The farmed salmon industry1 Fish farming is nothing new. It existed, for example, more than a 100 years ago in Norway and several 1000 years ago in China. As an industry, however, fish farming is a fairly recent phenomenon. After some pioneering efforts in the 1960s, the more systematic farming of salmon started in Norway in the early 1970s. Less than 100 metric tons were produced in 1971. Production started to take off in the late 1970s, amounting to approximately 4100 tons in 1980, 165,000 tons in 1990 and 422,000 tons in 2000. Salmon farming in Norway occurs along the coast. There are close to 800 farmers (Bjørndal, Knapp, & Lem, 2003), mainly selling their production to national buyers and exporters. Approximately 150 firms are registered as exporters, although not all of them conduct regular export. Apart from Norway, other large producers of farmed salmon include Chile, Scotland and Canada. Salmon farming in these countries started and expanded mainly after the rapid growth in Norway in the 1980s. Norway is still the largest producer, but the country’s share of total production has dropped from 57.8 per cent in 1980 to 43.5 per cent in 2000. Appendix A shows the production of farmed salmon world-wide. Today more than 95 per cent of Norway’s production is exported to countries round the world. The EU-countries represent the most important market, but substantial quantities are sold to Japan and other Asian countries. More recently the Russian market has opened up. Earlier the US and Canada represented important 1 This section builds on secondary sources (Grønhaug, 1985, 1996; Haugland & Grønhaug, 1996; Haugland, 1991), annual reports from the export council for fish and larger companies, data on production and exports, and reports in the business press.
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markets for Norwegian salmon, but export to these countries declined dramatically after Norway was accused of dumping. Also in the EU-market, Norwegian exporters have been accused of dumping, something which has caused serious problems. Most of the salmon is exported fresh or frozen, and further processing takes place mainly abroad. Processed products represent only a modest fraction of Norway’s total sales of farmed salmon. Over the years it has repeatedly been argued that Norwegian firms should undertake the further value-creating activities that are now taking place in other countries. So far Norwegian firms have been very reluctant to do so. This can be partly explained by differences in trade tariffs for unprocessed and processed products, especially within the EU-countries. The lowest trade tariffs in the EU-countries are for unprocessed products such as fresh and frozen salmon. Furthermore, Norwegian firms have argued that it is most profitable to concentrate on salmon farming, and that processing and distribution activities require large and very risky investments that can be undertaken better by others. Efforts have also been made by some firms to ‘‘customize’’ salmon, for example, by varying the size, color and fat content. Several Norwegian salmon producers have pursued this strategy, but without any success. The surcharge (1–2 per cent) that the producers have been able to realize has been far from sufficient to cover the extra costs of customizing. It should also be mentioned that, in cooperation with the public authorities, the industry has established a Generic Marketing Organization for Norwegian salmon in order to develop new markets, to expand consumption in established markets, and to create loyalty to Norwegian salmon (Eksportutvalget for fisk, 2003). To reach international markets, access to foreign distribution channels is needed. Today Norwegian salmon is sold mainly to importers, wholesalers and at fish auctions, and to some extent direct to retail and restaurant chains. Some degree of integration and quasi-integration does occur, but this is primarily backwards towards farming and packing. In the earlier stages of internationalization, several Norwegian exporters had their own representatives and sales offices in several foreign markets, a trend that has been observed for several firms by detailed tracing of the firms’ international activities over time (see Grønhaug, 1985, 1996 for a detailed description). Today most business is handled from home, although the larger customers are visited and ‘‘cultivated’’. Norwegian exporters usually have a fairly small number of customers and focus on one or a few selected markets.
5. Analysis In this section we will analyze the reported internationalization of the Norwegian farmed salmon industry. We are particularly concerned to explain the growth and development of a world-wide industry with decreasing specific investments and limited forward integration of activities. When the farmed salmon industry emerged, salmon was regarded as a luxury product only eaten by a few on special occasions, and access to new distribution channels and customer groups was meager. The great majority of potential
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customers were located in foreign markets, but had almost no experience of this product. Thus, as is common in most emergent industries or thin markets, there was much technical and market uncertainty (e.g., Porter, 1980; Utterback, 1994). Technical uncertainty was encountered in the shape of unforeseen diseases, quality variations and so on. Market uncertainty was reflected in the buyers’ unfamiliarity with and lack of knowledge about the product. For example, potential customers were unfamiliar with the product, and were unsure how to judge its quality, or to handle and prepare it. In other words, the market had to be educated to realize its potential. Market uncertainty goes some way to explaining the investment in local representatives and sales offices. The Norwegian exporters had to be close to the customers, in order to convince and teach them about the new product and how to handle it. In such cases the imagery of the medieval fair in which the market for the good already exists is irrelevant, or as Auerbach, Campbell, and Stone (1992) put it: ‘‘it may be precisely the manager’s task to create a market for this product by, for instance, persuading or manipulating a catchment of potential customers’’ (1992, p. 116). The specific downstream investments were apparently made in order to elicit potential sales in foreign markets. Although the internationalization literature suggests that firms should not adopt a strategy of heavy involvement in the early stages of internationalization, the Norwegian exporters faced the challenge not only of launching international sales for a new product, but also of developing the market for it. This last challenge required a closeness to the market that could not be achieved without the exporters being present there. The build-up of local representatives and sales offices in international markets in the early stages can probably be attributed to the nature of the market as being thin or underdeveloped. The market did not offer the right capabilities, and the Norwegian exporters had to rely on vertical integration. Over time, as intermediaries and consumers learned about farmed salmon, including how to evaluate its quality and how to handle and prepare it, the intermediaries and the consumers both gained more knowledge, which helped to reduce transactional uncertainty. Continued growth in the production and export of salmon over more than 20 years has contributed to its widespread acceptance. Over time the farmed salmon industry has become an almost perfect market characterized by standardized products and multiple sellers and buyers. The easy flow of information should also be emphasized. Prices are regularly reported and are easily accessible, and switching costs are low for both sellers and buyers. The market capabilities have become successively stronger, and it has become less important for Norwegian exporters to be present in the market, with vertical disintegration as the result. Further processing, distribution and so on are mainly undertaken by actors outside Norway. Further value-creation, including processing and distribution, requires additional and complementary skills and resources (e.g., Teece, 1986). For example, smoked salmon is known as a delicacy in many countries. However, taste and smoking processes vary from country to country. This requires resources and skills that the Norwegian producers and exporters lack. Moreover, involvement in
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such activities may not only require capital and investments; it may also entail specific capacity problems. For instance, involvement in processing may force a producer to become a buyer in order to utilize the processing capacity (e.g., Besanko, Dranove, Shanley, & Schaefer, 2003). Thus, involvement in this kind of activities may not only require additional—and different—resources; it may also impose new economic challenges. In a similar vein, integration into distribution is not only a question of economic resources, but also a question of contacts with and knowledge about various foreign markets, where it is difficult to see that Norwegian producers or exporters have any advantage at all. It is interesting to note that some of the sellers have sought to establish long-term agreements with buyers. Such agreements are primarily a token of intent without exact agreement on prices and volumes. The reason for pursuing such strategies seems to be that perceived uncertainty is reduced, and the exporters consider it to be advantageous to do business with the same customers rather than to operate in a pure market mode (for some recent findings, see Grønhaug & Fuglseth, 2004). It can also be noted that most sellers tend to focus on a fairly limited number of customers, in one or a few geographical markets. This kind of behavior is likely to bring some benefits. Since it takes time to attract customers and to discover their preferences and requirements, and since the capacity to store, interpret and make use of information is limited, human actors try to economize on their scarce cognitive resources (Shugan, 1980). Another important point is that past behaviors and learning guide people’s future actions. When an actor has had positive experience of a particular market or a particular buyer, that actor tends to stick to the same market or buyer. The story of the Norwegian farmed salmon industry contradicts the internationalization process as portrayed in the literature. Further involvement in international markets over time did not occur as predicted by the international marketing literature, as also reflected in our Proposition 1. In the early stages of internationalization the Norwegian exporters faced a situation characterized by high costs for negotiating, coordinating with and learning about importers, retailers and final customers. The exporters had to develop the market and found themselves in a situation characterized by a high degree of uncertainty. Since the market did not offer the right capabilities, forward vertical integration was necessary. Over time the local actors in the markets (importers, retailers and final consumers) have acquired more knowledge about farmed salmon and learned how to handle the product. The local actors have thus developed stronger capabilities. On the other hand, the Norwegian exporters have learned that it is not possible to possess the right capabilities to perform international activities in a variety of different markets. For example, a close presence in many different markets is likely to result in high governance costs, as the exporters cannot rely on the same ‘‘routines’’ in all markets. They simply lack the right capabilities to undertake marketing activities in many different international markets simultaneously. Vertical disintegration has thus been an efficient solution, as predicted in Proposition 2. This story seems to be consistent with the point made by Langlois (1997) that capabilities have an impact on transaction costs, and that capabilities are related to learning. The market (importers, retailers and final consumers) did not possess the
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required capabilities at the outset, but over time the market has acquired the capabilities needed. Our case demonstrates that transaction costs may change over time. They are thus dynamic. When market capabilities are weak, transactions are likely to require a high level of specific investments, due to various kinds of uncertainty and the high costs of interacting and coordinating with buyers. Vertical integration occurs in response to the large transaction costs of market exchange. As the market learns, and the actors are able to evaluate the product, transactions become easier to conduct, the transaction costs of market exchange are reduced, and vertical disintegration offers an efficient solution.
6. Discussion The purpose of this article has been to explain an apparent paradox in international marketing. The traditional view of the internationalization process as portrayed in the international marketing literature, is that firms can be expected to become gradually more involved in downstream activities in foreign markets as firms and the industry both become more international. However, contrary to the prediction in Proposition 1, Norwegian exporters established sales offices and sales representatives in several foreign markets in the early stages of internationalization and, as time passed, they disintegrated despite rising sales and a growing dependence on foreign markets. Our analysis showed that the farmed salmon industry was characterized by high levels of market and technical uncertainty in the early stages. Downstream investments were undertaken in these early stages in order to learn about and to educate the market. These investments can be explained mainly in terms of buyers’ lack of knowledge. As the industry developed, the various uncertainties were mitigated and the local actors learnt to appreciate, evaluate and use the product, so that it became easier to conduct transactions with them. The gradual build-up of knowledge among customers can explain the move towards the market-mode of organizing international transactions as predicted in Proposition 2. Greater knowledge and less uncertainty also correspond with the claim made by Langlois that ‘‘when the market provides the right capabilities there is no need for vertical integration because governance costs are reduced substantially’’ (1997). Vertical integration is considered to be an appropriate safeguard against concern about hold-ups and opportunistic behavior. This applies particularly in smallnumber markets for transactions requiring specific investments. However, in the international farmed salmon industry, both buyers and sellers are numerous, and the product is a non-durable good easy to evaluate. Hold-up problems are here of less importance. Furthermore, the transparency in the market and the modest switching and adjustment costs make concern about opportunistic behavior less acute. However, concern about opportunistic behavior can be observed among sellers when dealing with new buyers in recently opened markets, for example by charging guarantees for payment prior to delivery (e.g., Grønhaug, 1996). Many of the
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empirical studies underlying the internationalization process model have been conducted in small-number markets that offer heterogeneous and complex products requiring specific investments (e.g., Johanson & Wiedersheim-Paul, 1975). Thus, it is possible that the model is biased, as it may be influenced by the specific firms and industries studied. Our analysis also reveals that the boundaries of the firm depend in part on the relative strength of the firm’s capabilities versus the market’s capabilities. If other actors are able to perform specific activities in a more efficient way, then internalizing the activities will not benefit the focal firm. This will also apply when firms have been heavily involved in international markets over a long period of time. The combination of TCE and the RBV, particularly the link between capabilities and transaction costs showing the temporary nature of transaction costs, seems to throw further light on the question of firm boundaries. As regards managerial implications, our study indicates that there are many ways of becoming an international company and of organizing international activities, and that there is no one-to-one relationship between a company’s degree of internationalization and the level of its investments in foreign markets. Managers need to recognize that specific international activities which may be conducted most efficiently in local markets during one period, may be carried out more efficiently from the home market during another period. Mangers should thus carefully evaluate the different options available for organizing their international activities. In evaluating different options, particular attention should be paid to the firm’s own capabilities and to what existing companies in the local markets are good at. A comparison between firm capabilities and market capabilities may be a useful tool for determining how international activities should be organized. In this article we have advanced two competing propositions. The first was based on the internationalization literature, while the second was based on a combination of TCE and the RBV. As noted above, our second proposition yields both explanatory and predictive power, suggesting that this combination of theories may be useful in broadening our knowledge about the complex phenomenon of internationalization. In order to develop a better understanding of the internationalization processes, future research should be based on explicit theories allowing us to identify the drivers of the processes, firm boundaries and changes over time. Future efforts should also include empirical studies in several industries. Key industry characteristics should be explicitly taken into account, so that the descriptive and predictive validity of the theories and the explanations, as well as their limits, can be adequately examined. One timely question to be raised is whether we actually need a specific theory or theories of internationalization. Future empirical studies should use common and accepted theories to a larger extent, and apply the theories on various international settings. In this way international factors can be explicitly taken into account, the specific features of international business may be focused more clearly, and our understanding of the importance and specific effects of international dimensions can be compared to other theoretical explanations.
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Appendix A. Production of farmed salmon The production of farmed salmon world-wide is given below (Table 1).
Table 1 Production of farmed salmon
Norway Chile Scotland Canada The Faeroe Islands USA Ireland Japan Other countries Total Norway’s share of total production
1980
1990
2000
4143 0 598 163 0 392 21 1855 0 7172 57.8
165,000 23,100 32,000 19,000 10,000 8000 10,000 23,600 9300 300,000 55
422,000 262,800 130,800 82,200 30,000 22,400 19,300 13,100 12,400 995,000 42.4
Sources: Grønhaug (1996) and Bjørndal et al. (2003).
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Management S C A N D I N AV I A N J O U R N A L O F
Scand. J. Mgmt. 21 (2005) 61–76 www.elsevier.com/locate/scaman
A transaction cost approach to a paradox in international marketing$ Kjell Grønhaug, Sven A. Haugland Norwegian School of Economics and Business Administration, Breiviksveien 40, N-5045 Bergen, Norway
Abstract Why do firms that make specific downstream investments as they start international operations, sometimes turn to more market-like arrangements as they gain international experience and their international sales increase? This paradox in international marketing is the key question to be addressed in this article. We use the concept of dynamic or temporary governance costs to examine the paradox. The pattern of internationalization in the Norwegian farmed salmon industry provides an example whereby Norwegian exporters established their own sales offices in several international markets in the early stages of internationalization, but subsequently disintegrated vertically and came to rely on more market-like arrangements. An analysis of the internationalization of this industry suggests that, over time, the market provided better capabilities than vertical integration. This reduced the transaction costs, thus making vertical disintegration an efficient strategy. r 2005 Elsevier Ltd. All rights reserved. Keywords: Internationalization; Disintegration; Dynamic governance costs
$ The authors are listed alphabetically and have contributed equally to the article. The authors gratefully acknowledge the constructive comments and suggestions offered by guest-editor, Professor Nicolai J. Foss, and the anonymous reviewers. Corresponding author. Tel.: +47 55 95 94 60; fax: +47 55 95 94 30. E-mail addresses: [email protected] (K. Grønhaug), [email protected] (S.A. Haugland).
0956-5221/$ - see front matter r 2005 Elsevier Ltd. All rights reserved. doi:10.1016/j.scaman.2005.02.004
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1. Introduction This article addresses an apparent paradox in international marketing. In some industries, firms making downstream specific investments when they start their international operations often turn to more market-like arrangements as their presence in international markets becomes stronger and their international sales increase. One example of this is the international farmed salmon industry, which will be addressed here. Such disinvestment appears paradoxical for at least two reasons. First, the standard wisdom offered by the international marketing literature is that firms make specific investments successively as they expand their international operations. The influential Uppsala internationalization model, for example, describes firms going through a series of stages ranging from no regular export activities, through export via independent representatives, on to the establishment of a foreign sales office, and finally to the establishment of foreign production units (e.g., Johanson & Vahlne, 1977; Johanson & Wiedersheim-Paul, 1975). The history of internationalization in a variety of industries also suggests that such successive involvement followed by increased specific investments seems to be a valid description. Even in the case of firms described as being ‘‘born global’’, some sort of stepwise—albeit rapid—internationalization, followed by rising levels of specific investment seems to be the pattern. We refer to Andersen (1993), Bjo¨kman and Forsgren (1997), and Liesch et al. (2002) for recent overviews of Nordic contributions to internationalization research. A basic assumption underlying the gradual internationalization model is that firms move away from the ‘‘known’’, i.e. the domestic market, and towards the ‘‘unknown’’, i.e. new markets which, due to their novelty and the firms’ consequent lack of knowledge, are often regarded with a high degree of uncertainty. When perceived uncertainty is high, risk-averse firms are expected to abstain from making specific investments. The process model can be described as a ‘‘test-thewater’’ approach. Firms first undertake minor investments in order to learn. Then as they gradually learn to handle new markets and positive outcomes are achieved, perceived uncertainty declines. Firms thus become more confident and willing to make specific investments. This can be described as a kind of risk-reduction behavior. Firms will not make substantial specific downstream investments until they have learnt the new marketing environment and feel that they possess the necessary competencies. Moving towards market-like arrangements seems to indicate that specific investments are being abandoned and represent sunk costs. If firms make specific investments in the initial stages of their international operations, but later discover that the expected sales and profits will never be realized, then such behavior is understandable. However, the focus here is on vertical disinvestment in growing markets. We study firms operating in the international farmed salmon industry, and many firms in this industry made specific investments in foreign sales offices as they embarked on international operations. Over time, however, most of these firms have moved on to more market-like arrangements, such as spot market transactions or long-term relationships with foreign importers.
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The article is organized as follows. In the next section we review some of the main characteristics of internationalization, as reflected in the international marketing literature. We then present a combination of transaction cost economics (TCE) (Williamson, 1985, 1991) and the resource-based view (RBV) (e.g., Wernerfelt, 1984; Barney, 1991; Teece, Pisano, & Shuen, 1997; Teece, 2003) as an alternative perspective to the internationalization model. Thereafter we describe the farmed salmon industry and the internationalization behavior of firms in this industry. This description is based on prior research (e.g., Grønhaug, 1996; Haugland & Grønhaug, 1996; Haugland, 1991) as well as press reports. We then analyze and explain the paradox of forward vertical disintegration in the expanding and growing international farmed salmon industry, and finally close with a discussion of our main findings.
2. Characteristics of internationalization as reflected in the international marketing literature Internationalization means that firms move beyond their domestic borders to do business abroad. Firms do this for several reasons. Saturated or even declining domestic markets are frequently part of the picture, as is stiffer competition from foreign products. Domestic operations may thus have become less profitable, and redirecting activities towards international markets may be one way of compensating for falling sales and profits in the domestic market. Increasing international competition is often followed by international specialization. Both firms and countries pursue what they do best (e.g., Porter, 1990). Firms may also become aware of new and exciting business activities abroad, even though they are enjoying success and growth at home. The importance assigned to foreign markets as an alternative to domestic operations varies considerably between industries, and even among firms operating in the same industry. This may indicate that firms have different market foci as they may evaluate opportunities and threats differently, and make different decisions in their choice of markets and activities. Firms starting international operations are moving from the ‘‘known’’ to the ‘‘unknown’’. Moving outside their domestic markets implies not only that the geographical distance between sellers and buyers increases, but that the ‘‘mental’’ or ‘‘psychic’’ distance increases as well (Johanson & Vahlne, 1977). Firms know ‘‘the rules of the game’’, and how they should act, in the home market. Moving out implies greater uncertainty as the new environments have to be adequately understood. Customers are new and a crucial challenge is to overcome ‘‘the liability of foreignness’’ and to become accepted (Nachum, 2003). Customers’ requirements may be different, and adequate ways of operating may also differ from those of the home market. Most international marketing textbooks pay particular attention to potential differences among international environments with respect to political, economic, social and cultural conditions (e.g., Usunier, 1996; Jeannet & Hennesey, 1995). An important point, however, is that the challenges are perceived as being greatest at the outset, when the entrant’s knowledge about a new foreign market is
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small or non-existent. Not surprisingly, one of the most prominent questions addressed in the international marketing literature concerns the entry mode decision, i.e. how to enter a new foreign market (Root, 1983). This is not a surprise, it is after all in the initial phase of internationalization that perceived uncertainty is highest, and the learning requirements are greatest. It is thus likely to be more demanding to become than to be international. Internationalization is often conceived as a stepwise evolutionary process. Johanson and Vahlne (1977) and Johanson and Wiedersheim-Paul (1975) were among the first to conceptualize internationalization as a gradual process, making a distinction between the four following steps: (1) no regular export/no investments abroad, (2) exports to close-lying and similar countries via independent representatives/agents, (3) exports to distant markets/establishing own sales offices abroad, and (4) manufacturing abroad using own resources. A multiplicity of models of the internationalization process exists, varying not only in the number of steps included, but also in their underlying assumptions (e.g., Czinkota, 1982; Line, Sharkey, & Kum, 1991). However, the models do share some common assumptions, for example, that learning about new foreign environments is necessary, that learning evolves slowly and is costly, and that the development over time is the outcome of incremental decisions frequently associated with resource commitments. However, these models have also been criticized. For example, they have been attacked for paying too little attention to the underlying ‘‘drivers’’ of the internationalization process (e.g., Cavusgil & Zou, 1994). It has also been argued that it is difficult to determine the stage that the internationalization of a specific firm has reached. The most severe criticism is that many firms do not become international in the way described by the model. Even though some firms embark on internationalization by way of sporadic exports, others may start direct with heavy investments. Yet others build up to a certain level of export and then remain there without making further investments. In a Norwegian study, 10 different internationalization paths were identified, and the process described by the Uppsala model was one of them (Reve, Haugland, & Grønhaug, 1995). Further, many firms grow in foreign markets while at the same time reducing their domestic activities (e.g., Dagens Næringsliv, May 28, 2003, p. 6; NOU, 1996:17). For example, Levi Strauss has decided after 150 years of operations to close down its factory in San Antonio and to move it to a low-cost country. Several questions remain unanswered, however. Why, for example, should firms internalize their international activities? This question goes beyond simple issues like why firms move their manufacturing operations to low labor-cost countries, or when they move them due to lower transportation costs. Several explanations have been offered. Firms internalize their international activities due to market failure, or because the market mode allows insufficient control over foreign activities. Further, international markets must be ‘‘created’’ and invested in, before the harvest can be gathered. If internationalizing, and thus resource commitment too, is deemed to be important and necessary, why then adopt the step-wise development as described in the Uppsala model? One explanation is that international investment is inherently
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uncertain, as outcomes will first be realized in the future. More knowledge and less uncertainty may emerge, thus bolstering the willingness to make foreign investments. The following proposition can be advanced: Proposition 1. Firms operating in a growing international market will vertically integrate their international activities gradually over time.
3. Transaction cost economics and the resource-based view In this section we present a combination of TCE and the RBV, with particular attention to the concept of dynamic capabilities, as an alternative to the approach offered by the internationalization literature. Over the years TCE (e.g., Williamson, 1985) has become one of the theories most frequently used for explaining vertical integration and firm boundaries (Rindfleisch & Heide, 1997). Firms should integrate activities or transactions characterized by high levels of asset specificity, as market contracting in such cases will be very costly due to the need for extensive safeguards. The internal governance costs (bureaucratic costs) will be lower than the external transaction costs. The borderline between internal organization and market transaction is thus determined by the relative cost advantage between these two forms of governance. The RBV has a less clear-cut conception of vertical integration and firm boundaries. Here the firm is regarded as a unique bundle of resources and competencies, and the direction and speed of the firm’s growth and expansion is determined by its stock of resources and competencies (e.g., Nelson & Winter, 1982; Penrose, 1995 [1959]; Wernerfelt, 1984). 3.1. Transaction cost economics TCE views the firm as a governance structure. The theory identifies the transactions that are conducted most efficiently within firm boundaries or in markets. A crucial idea is that the borderline between internal organization and market exchange depends on the relative size of the bureaucratic costs of internal organization on the one hand and the transaction costs of market relations on the other. This implies, as Langlois puts it, that ‘‘whatever lowers bureaucratic costs on the margin will increase the extent of integration; whatever lowers transaction costs will reduce the extent of integration’’ (1997, p. 289). The transaction is the unit of analysis, and the governance of transactions is regarded as a contracting problem. Contracts imply future consequences, as fulfillment of the agreement will occur at some future time, and most contracts are therefore considered to be incomplete. Klein (1980) contends: ‘‘Contracts are incomplete of two reasons. First, uncertainty implies the existence of a large number of contingencies, and it may be very costly to know and specify in advance all of these possibilities. Second, contractual performance, y may be very costly to measure’’ (1980, p. 365). Organizing transactions within firm boundaries is thus one way of responding to incomplete contracts.
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The core notion of TCE is that the costs of organizing transactions differ, depending on the characteristics of the transaction in question. These characteristics are: (1) asset specificity, (2) uncertainty and (3) frequency of the transaction (Williamson, 1985). Asset specificity refers to the need for making durable investments in order to realize transactions (Williamson, 1985). Such investments impose contractual problems, as actors need to safeguard specific investments against potential opportunistic behavior. Transactions usually imply some degree of uncertainty because transactional outcomes are first experienced ex post. The frequency of the transaction, i.e. how often a transaction will take place, is also assumed to have implication for the way the transaction will be organized. For example, a transaction involving a high level of asset specificity but with low frequency, can be more efficiently performed by hybrid governance than by vertical integration, due to the fact that the costs of developing an internal governance solution cannot be justified since they have to be distributed across the number of transactions. Although all three dimensions are expected to affect the choice of governance mode, asset specificity is the most important: ‘‘Asset specificity is both the most important dimension for describing transactions and the most neglected attribute in prior studies of organization’’ (Williamson, 1981, p. 555). Numerous empirical studies have investigated the effect of asset specificity on governance, and the hypothesis that asset specificity leads to vertical integration is largely supported (e.g., Joskow, 1988; Mahoney, 1992; Rindfleisch & Heide, 1997; Shelanski & Klein, 1995). However, empirical studies have not been able to find a positive relationship between transaction frequency and vertical integration (e.g., Rindfleisch & Heide, 1997), and the effect of uncertainty on governance is mixed. Empirical results suggest that uncertainty may reduce the use of vertical integration and control (Harrigan, 1986), as well as increasing the use of vertical integration and control (Walker & Weber, 1987). The transaction cost perspective includes two behavioral assumptions: (1) bounded rationality and (2) opportunism. The bounded rationality assumption is based on cognitive limitations, implying that human actors must cope with uncertainties with limited knowledge, foresight and skills. The assumption of opportunism implies that economic actors act in their own interest, and are willing to pursue their own interests, even though this may imply actions such as cheating and lying (Williamson, 1985). A distinction can be made between ex ante opportunism, i.e., exploiting a situation when entering into the transaction, and ex post opportunism, i.e., to commit fraud after entering into the agreement. 3.2. The resource-based view The RBV has recently gained widespread acceptance within the discipline of strategy (for an overview see Foss, 1997, 2003). Although the perspective has been criticized for being tautological (Priem & Butler, 2001) and for offering little guidance (Hoopes, Macken, & Walker, 2003), it has attracted considerable attention in strategy research and practice. According to this view, a firm’s competitive
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advantages stem from its resources. It is assumed that resources may yield sustainable competitive advantage when they are valuable, rare, difficult to imitate and well organized (e.g., Barney, 1991). More recently, Hoopes et al. (2003) looking at the RBV as part of a broader theory of competitive heterogeneity, claim that only ‘‘value’’ and ‘‘difficult to imitate’’ are ultimately important. The terms resources, competencies and capabilities are used in many different ways, and the current literature does not provide coherent definitions that clearly distinguish them from each other (Dosi, Nelson, & Winter, 2000; Teece, 2003). While the firm is often defined as consisting of a unique bundle of resources and competencies, capabilities are often associated with knowledge, or as Langlois puts it: ‘‘y, organizations possess a pool of more-or-less embodied ‘how to’ knowledge useful for particular activities’’ (1997, p. 286). Further, dynamic capabilities are defined as ‘‘processes to integrate, reconfigure, gain and release resources—to match and even create market change’’ (Eisenhardt & Martin, 2000, p. 1107). Teece argues that dynamic capabilities are related to ‘‘the firm’s ability to effectuate change’’ (2003, p. 7). As noted above, the RBV has a less clear cut approach to vertical integration and firm boundaries than TCE. Although it argues that the speed and direction of firm growth is determined by the firm’s existing stock of resources and competencies, the perspective does not explain which activities should be performed within the boundaries of the firm and which should be performed in the market. However, since any firm is dependent upon outside actors in the value chain, all firms have to rely on the capabilities possessed by other firms (Langlois, 1997). For example, firms need access to complementary resources such as distribution channels, service providers and so on, and never possess or have any advantage from internalizing and running all these activities themselves. Langlois (1997) suggests that the question of firm boundaries can be analyzed by comparing the relative strength of internal capabilities with the capabilities offered by outside actors or by the market. This line of reasoning rests on an assumption that capabilities influence transaction costs. Since capabilities are related to knowledge and learning, transaction costs may change over time. This implies that the transaction costs associated with performing a given transaction may vary over time, depending on whether or not the firm acquires new knowledge. Transaction costs are dynamic or temporary in their nature, and a shift in what is the most efficient way of organizing the transaction may occur, even though there has been no change in actual attributes of the transaction. Langlois argues that dynamic transaction costs are ‘‘the costs of persuading, negotiating, coordinating and teaching outside suppliers’’ (1997, p. 293). This seems to be particularly important in what we know as ‘‘thin markets’’, or markets that are not fully developed. In such markets the costs of persuading, negotiating, coordinating and teaching outside actors can be very high, due to the fact that outside actors have limited knowledge about the products in question. The market offers weak capabilities, and a firm has to rely on internal capabilities in order to succeed, resulting in the vertical integration of the activities in question. ‘‘When the market cannot provide the right capabilities at the right time, vertical integration may result; and when the firm lacks the right capabilities at the right time, vertical
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disintegration may occur’’ (Langlois, 1997, pp. 293–294). As such markets become more developed, the capabilities of outside actors will become stronger, and the costs associated with persuading, negotiating, coordinating and teaching actors will gradually be reduced. Firms that have vertically integrated activities in thin markets may thus find this to be inefficient as the market becomes more developed, and they may decide to disintegrate these activities. Whereas TCE argues that transactional characteristics determine the level of transaction costs and the resulting level of vertical integration, the RBV implies that capabilities affect the level of transaction costs, and the relative strength of internal capabilities and external capabilities varies over time as markets develop, which means that efficient firm boundaries will not remain static over time. In particular we can expect that firms will rely heavily on vertical integration in markets with weak capabilities, followed by vertical disintegration as the capabilities of the market become stronger over time. We advance the following proposition: Proposition 2. Firms operating in international markets characterized as thin or underdeveloped will vertically integrate activities in the early stages of internationalization, and disintegrate the activities successively as the markets become more developed.
4. The farmed salmon industry1 Fish farming is nothing new. It existed, for example, more than a 100 years ago in Norway and several 1000 years ago in China. As an industry, however, fish farming is a fairly recent phenomenon. After some pioneering efforts in the 1960s, the more systematic farming of salmon started in Norway in the early 1970s. Less than 100 metric tons were produced in 1971. Production started to take off in the late 1970s, amounting to approximately 4100 tons in 1980, 165,000 tons in 1990 and 422,000 tons in 2000. Salmon farming in Norway occurs along the coast. There are close to 800 farmers (Bjørndal, Knapp, & Lem, 2003), mainly selling their production to national buyers and exporters. Approximately 150 firms are registered as exporters, although not all of them conduct regular export. Apart from Norway, other large producers of farmed salmon include Chile, Scotland and Canada. Salmon farming in these countries started and expanded mainly after the rapid growth in Norway in the 1980s. Norway is still the largest producer, but the country’s share of total production has dropped from 57.8 per cent in 1980 to 43.5 per cent in 2000. Appendix A shows the production of farmed salmon world-wide. Today more than 95 per cent of Norway’s production is exported to countries round the world. The EU-countries represent the most important market, but substantial quantities are sold to Japan and other Asian countries. More recently the Russian market has opened up. Earlier the US and Canada represented important 1 This section builds on secondary sources (Grønhaug, 1985, 1996; Haugland & Grønhaug, 1996; Haugland, 1991), annual reports from the export council for fish and larger companies, data on production and exports, and reports in the business press.
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markets for Norwegian salmon, but export to these countries declined dramatically after Norway was accused of dumping. Also in the EU-market, Norwegian exporters have been accused of dumping, something which has caused serious problems. Most of the salmon is exported fresh or frozen, and further processing takes place mainly abroad. Processed products represent only a modest fraction of Norway’s total sales of farmed salmon. Over the years it has repeatedly been argued that Norwegian firms should undertake the further value-creating activities that are now taking place in other countries. So far Norwegian firms have been very reluctant to do so. This can be partly explained by differences in trade tariffs for unprocessed and processed products, especially within the EU-countries. The lowest trade tariffs in the EU-countries are for unprocessed products such as fresh and frozen salmon. Furthermore, Norwegian firms have argued that it is most profitable to concentrate on salmon farming, and that processing and distribution activities require large and very risky investments that can be undertaken better by others. Efforts have also been made by some firms to ‘‘customize’’ salmon, for example, by varying the size, color and fat content. Several Norwegian salmon producers have pursued this strategy, but without any success. The surcharge (1–2 per cent) that the producers have been able to realize has been far from sufficient to cover the extra costs of customizing. It should also be mentioned that, in cooperation with the public authorities, the industry has established a Generic Marketing Organization for Norwegian salmon in order to develop new markets, to expand consumption in established markets, and to create loyalty to Norwegian salmon (Eksportutvalget for fisk, 2003). To reach international markets, access to foreign distribution channels is needed. Today Norwegian salmon is sold mainly to importers, wholesalers and at fish auctions, and to some extent direct to retail and restaurant chains. Some degree of integration and quasi-integration does occur, but this is primarily backwards towards farming and packing. In the earlier stages of internationalization, several Norwegian exporters had their own representatives and sales offices in several foreign markets, a trend that has been observed for several firms by detailed tracing of the firms’ international activities over time (see Grønhaug, 1985, 1996 for a detailed description). Today most business is handled from home, although the larger customers are visited and ‘‘cultivated’’. Norwegian exporters usually have a fairly small number of customers and focus on one or a few selected markets.
5. Analysis In this section we will analyze the reported internationalization of the Norwegian farmed salmon industry. We are particularly concerned to explain the growth and development of a world-wide industry with decreasing specific investments and limited forward integration of activities. When the farmed salmon industry emerged, salmon was regarded as a luxury product only eaten by a few on special occasions, and access to new distribution channels and customer groups was meager. The great majority of potential
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customers were located in foreign markets, but had almost no experience of this product. Thus, as is common in most emergent industries or thin markets, there was much technical and market uncertainty (e.g., Porter, 1980; Utterback, 1994). Technical uncertainty was encountered in the shape of unforeseen diseases, quality variations and so on. Market uncertainty was reflected in the buyers’ unfamiliarity with and lack of knowledge about the product. For example, potential customers were unfamiliar with the product, and were unsure how to judge its quality, or to handle and prepare it. In other words, the market had to be educated to realize its potential. Market uncertainty goes some way to explaining the investment in local representatives and sales offices. The Norwegian exporters had to be close to the customers, in order to convince and teach them about the new product and how to handle it. In such cases the imagery of the medieval fair in which the market for the good already exists is irrelevant, or as Auerbach, Campbell, and Stone (1992) put it: ‘‘it may be precisely the manager’s task to create a market for this product by, for instance, persuading or manipulating a catchment of potential customers’’ (1992, p. 116). The specific downstream investments were apparently made in order to elicit potential sales in foreign markets. Although the internationalization literature suggests that firms should not adopt a strategy of heavy involvement in the early stages of internationalization, the Norwegian exporters faced the challenge not only of launching international sales for a new product, but also of developing the market for it. This last challenge required a closeness to the market that could not be achieved without the exporters being present there. The build-up of local representatives and sales offices in international markets in the early stages can probably be attributed to the nature of the market as being thin or underdeveloped. The market did not offer the right capabilities, and the Norwegian exporters had to rely on vertical integration. Over time, as intermediaries and consumers learned about farmed salmon, including how to evaluate its quality and how to handle and prepare it, the intermediaries and the consumers both gained more knowledge, which helped to reduce transactional uncertainty. Continued growth in the production and export of salmon over more than 20 years has contributed to its widespread acceptance. Over time the farmed salmon industry has become an almost perfect market characterized by standardized products and multiple sellers and buyers. The easy flow of information should also be emphasized. Prices are regularly reported and are easily accessible, and switching costs are low for both sellers and buyers. The market capabilities have become successively stronger, and it has become less important for Norwegian exporters to be present in the market, with vertical disintegration as the result. Further processing, distribution and so on are mainly undertaken by actors outside Norway. Further value-creation, including processing and distribution, requires additional and complementary skills and resources (e.g., Teece, 1986). For example, smoked salmon is known as a delicacy in many countries. However, taste and smoking processes vary from country to country. This requires resources and skills that the Norwegian producers and exporters lack. Moreover, involvement in
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such activities may not only require capital and investments; it may also entail specific capacity problems. For instance, involvement in processing may force a producer to become a buyer in order to utilize the processing capacity (e.g., Besanko, Dranove, Shanley, & Schaefer, 2003). Thus, involvement in this kind of activities may not only require additional—and different—resources; it may also impose new economic challenges. In a similar vein, integration into distribution is not only a question of economic resources, but also a question of contacts with and knowledge about various foreign markets, where it is difficult to see that Norwegian producers or exporters have any advantage at all. It is interesting to note that some of the sellers have sought to establish long-term agreements with buyers. Such agreements are primarily a token of intent without exact agreement on prices and volumes. The reason for pursuing such strategies seems to be that perceived uncertainty is reduced, and the exporters consider it to be advantageous to do business with the same customers rather than to operate in a pure market mode (for some recent findings, see Grønhaug & Fuglseth, 2004). It can also be noted that most sellers tend to focus on a fairly limited number of customers, in one or a few geographical markets. This kind of behavior is likely to bring some benefits. Since it takes time to attract customers and to discover their preferences and requirements, and since the capacity to store, interpret and make use of information is limited, human actors try to economize on their scarce cognitive resources (Shugan, 1980). Another important point is that past behaviors and learning guide people’s future actions. When an actor has had positive experience of a particular market or a particular buyer, that actor tends to stick to the same market or buyer. The story of the Norwegian farmed salmon industry contradicts the internationalization process as portrayed in the literature. Further involvement in international markets over time did not occur as predicted by the international marketing literature, as also reflected in our Proposition 1. In the early stages of internationalization the Norwegian exporters faced a situation characterized by high costs for negotiating, coordinating with and learning about importers, retailers and final customers. The exporters had to develop the market and found themselves in a situation characterized by a high degree of uncertainty. Since the market did not offer the right capabilities, forward vertical integration was necessary. Over time the local actors in the markets (importers, retailers and final consumers) have acquired more knowledge about farmed salmon and learned how to handle the product. The local actors have thus developed stronger capabilities. On the other hand, the Norwegian exporters have learned that it is not possible to possess the right capabilities to perform international activities in a variety of different markets. For example, a close presence in many different markets is likely to result in high governance costs, as the exporters cannot rely on the same ‘‘routines’’ in all markets. They simply lack the right capabilities to undertake marketing activities in many different international markets simultaneously. Vertical disintegration has thus been an efficient solution, as predicted in Proposition 2. This story seems to be consistent with the point made by Langlois (1997) that capabilities have an impact on transaction costs, and that capabilities are related to learning. The market (importers, retailers and final consumers) did not possess the
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required capabilities at the outset, but over time the market has acquired the capabilities needed. Our case demonstrates that transaction costs may change over time. They are thus dynamic. When market capabilities are weak, transactions are likely to require a high level of specific investments, due to various kinds of uncertainty and the high costs of interacting and coordinating with buyers. Vertical integration occurs in response to the large transaction costs of market exchange. As the market learns, and the actors are able to evaluate the product, transactions become easier to conduct, the transaction costs of market exchange are reduced, and vertical disintegration offers an efficient solution.
6. Discussion The purpose of this article has been to explain an apparent paradox in international marketing. The traditional view of the internationalization process as portrayed in the international marketing literature, is that firms can be expected to become gradually more involved in downstream activities in foreign markets as firms and the industry both become more international. However, contrary to the prediction in Proposition 1, Norwegian exporters established sales offices and sales representatives in several foreign markets in the early stages of internationalization and, as time passed, they disintegrated despite rising sales and a growing dependence on foreign markets. Our analysis showed that the farmed salmon industry was characterized by high levels of market and technical uncertainty in the early stages. Downstream investments were undertaken in these early stages in order to learn about and to educate the market. These investments can be explained mainly in terms of buyers’ lack of knowledge. As the industry developed, the various uncertainties were mitigated and the local actors learnt to appreciate, evaluate and use the product, so that it became easier to conduct transactions with them. The gradual build-up of knowledge among customers can explain the move towards the market-mode of organizing international transactions as predicted in Proposition 2. Greater knowledge and less uncertainty also correspond with the claim made by Langlois that ‘‘when the market provides the right capabilities there is no need for vertical integration because governance costs are reduced substantially’’ (1997). Vertical integration is considered to be an appropriate safeguard against concern about hold-ups and opportunistic behavior. This applies particularly in smallnumber markets for transactions requiring specific investments. However, in the international farmed salmon industry, both buyers and sellers are numerous, and the product is a non-durable good easy to evaluate. Hold-up problems are here of less importance. Furthermore, the transparency in the market and the modest switching and adjustment costs make concern about opportunistic behavior less acute. However, concern about opportunistic behavior can be observed among sellers when dealing with new buyers in recently opened markets, for example by charging guarantees for payment prior to delivery (e.g., Grønhaug, 1996). Many of the
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empirical studies underlying the internationalization process model have been conducted in small-number markets that offer heterogeneous and complex products requiring specific investments (e.g., Johanson & Wiedersheim-Paul, 1975). Thus, it is possible that the model is biased, as it may be influenced by the specific firms and industries studied. Our analysis also reveals that the boundaries of the firm depend in part on the relative strength of the firm’s capabilities versus the market’s capabilities. If other actors are able to perform specific activities in a more efficient way, then internalizing the activities will not benefit the focal firm. This will also apply when firms have been heavily involved in international markets over a long period of time. The combination of TCE and the RBV, particularly the link between capabilities and transaction costs showing the temporary nature of transaction costs, seems to throw further light on the question of firm boundaries. As regards managerial implications, our study indicates that there are many ways of becoming an international company and of organizing international activities, and that there is no one-to-one relationship between a company’s degree of internationalization and the level of its investments in foreign markets. Managers need to recognize that specific international activities which may be conducted most efficiently in local markets during one period, may be carried out more efficiently from the home market during another period. Mangers should thus carefully evaluate the different options available for organizing their international activities. In evaluating different options, particular attention should be paid to the firm’s own capabilities and to what existing companies in the local markets are good at. A comparison between firm capabilities and market capabilities may be a useful tool for determining how international activities should be organized. In this article we have advanced two competing propositions. The first was based on the internationalization literature, while the second was based on a combination of TCE and the RBV. As noted above, our second proposition yields both explanatory and predictive power, suggesting that this combination of theories may be useful in broadening our knowledge about the complex phenomenon of internationalization. In order to develop a better understanding of the internationalization processes, future research should be based on explicit theories allowing us to identify the drivers of the processes, firm boundaries and changes over time. Future efforts should also include empirical studies in several industries. Key industry characteristics should be explicitly taken into account, so that the descriptive and predictive validity of the theories and the explanations, as well as their limits, can be adequately examined. One timely question to be raised is whether we actually need a specific theory or theories of internationalization. Future empirical studies should use common and accepted theories to a larger extent, and apply the theories on various international settings. In this way international factors can be explicitly taken into account, the specific features of international business may be focused more clearly, and our understanding of the importance and specific effects of international dimensions can be compared to other theoretical explanations.
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Appendix A. Production of farmed salmon The production of farmed salmon world-wide is given below (Table 1).
Table 1 Production of farmed salmon
Norway Chile Scotland Canada The Faeroe Islands USA Ireland Japan Other countries Total Norway’s share of total production
1980
1990
2000
4143 0 598 163 0 392 21 1855 0 7172 57.8
165,000 23,100 32,000 19,000 10,000 8000 10,000 23,600 9300 300,000 55
422,000 262,800 130,800 82,200 30,000 22,400 19,300 13,100 12,400 995,000 42.4
Sources: Grønhaug (1996) and Bjørndal et al. (2003).
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