Foreign market channel integration decisions of Canadian computer software firms

Pergamon

0969-5931(95)00031-3

International Business Review Vol. 5, No. 1, pp. 23-52, 1996 Copyright © 1996 Elsevier Science Ltd Printed in Great Britain. All rights reserved 0969-5931/96 $15.00 + 0.00

Foreign Market Channel Integration Decisions of Canadian Computer Software Firms Rod B. McNaughton* Department of Marketing, University of Otago, P.O. Box 56, Dunedin, New Zealand Abstract - - Firms that enter foreign markets must decide on the extent to which they will internalize their distribution channels. There is a continuum of choice, ranging from one extreme where the firm performs all marketing and distribution functions itself, to the other where intermediaries take title to goods for resale to foreign wholesalers or customers. The integration decision is a strategic one as the right balance between hierarchy and market can make the difference between success or failure in a foreign market. This paper reports the results of an empirical test of a transaction cost model of channel integration decisions among Canadian computer software exporters. The software industry provides a variety of experiences with respect to product customization and distribution channels within the same aggregate product category. Data on channel choice, channel volume, asset specificity, and external uncertainty were collected from Canadian computer software exporters via a mail survey. The results suggest that channel volume, asset specificity, volatility, and product customization have a significant effect on channel choice. Copyright © 1996 Elsevier Science Ltd Key Words - - Market Channels, Entry Mode, Transaction Cost Analysis, Software Developer, Foreign Sales Subsidiary, Joint Venture, Distributor/Wholesaler, Dual Channels, Asset Specificity, Channel Volume, External Uncertainty.

Introduction Global competition is motivating firms to seek innovative ways o f entering new markets. While traditional hierarchical and market m o d e s still dominate, firms are exploring a range o f new modes, including: joint ventures, "piggybacking", joint marketing agreements, and other forms of partnerships. As a result, marketing m a n a g e r s have " . . . a new responsibility for deciding which marketing functions and activities are to be purchased in the market, which are to be p e r f o r m e d b y strategic partners, and w h i c h are to be p e r f o r m e d internally" (Webster, 1992, p. 11). Further, m a n y firms (especially those in high technology, k n o w l e d g e intensive sectors like software development) are finding that marketing strategies b a s e d on pricing, product differentiation, or advertising do not yield long t e r m sustainable advantages in global markets.

*Rod B. McNaughton is a senior Lecturer in Marketing at the University of Otago, Dunedin, New Zealand. He received his Ph.D. in Corporate Geography from the University of Western Ontario in 1989. He is currently working on a Ph.D. in Marketing at the Management School, Lancaster University. His research interests are in the general areas of channel management, internationalization, and inter-firm cooperation.

23

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Thus, channels have become a strategic focus for foreign market entry. Selecting the right channel is the key to successful internationalization as channels are agents of both opportunity identification, and market response (Root, 1987). Further, channels provide the context in which firms interface with customers, and thus have strong linkages to all other components of the marketing mix. Channels are also more difficult to change than are other aspects of the marketing mix, so it is vital that they be carefully planned before market entry. This paper reports the results of research designed to further understanding of the foreign market channel integration decisions of high technology, knowledge intensive firms. What modes are used, and what factors are associated with the use of particular modes are the primary research questions. To address these questions, a model developed from transaction cost theory is tested using data gathered by a mail survey of Canadian software developers. Insight into integration decisions in this market provides a context for further development of transaction cost analysis (TCA). TCA has emerged as a significant theoretical development in the study of channel choice (and more generally, the organizational governance of market channels). This is primarily due to the work of Williamson (1975, 1979, 1981, 1985, 1991). Empirical studies of channel integration which test TCA have been conducted by Anderson and Schmittlein (1994), Anderson and Weitz (1986), D w y e r and Oh (1988), and Heide and John (1988, 1992). Applications to entry mode decisions are more limited, the primary examples being: Anderson and Gatignon (1986), Anderson and Coughlan (1987), Gatignon and Anderson (1988), and Klein (1989). Finally, tests of TCA in the context of foreign entry mode are limited to Klein et al. (1990), and Erramilli and Rao (1993). The research reported here furthers understanding of channel choice in three significant ways. First, the research provides an empirical description of channel choice by firms in a high technology, knowledge intensive sector. The particular circumstances of such firms has been overlooked by the extant literature which focuses on large manufacturing firms (see Woodcock et al., 1994 for a review of this literature). As a consequence, little is known about effective international marketing strategies for high technology industries (Samli and Wills, 1989). There is evidence, however, that market characteristics are sufficiently different in high technology sectors to warrant separate consideration (Gatignon and Robertson, 1989; Glazer, 1991; Norton and Bass, 1987). Compared to traditional manufacturing sectors, high technology sectors are characterized by higher levels of technological and strategic uncertainty, significant value added from science based technical knowledge, a higher level of R&D expenditures, and shorter product life cycles (Dermer, 1984; Calori, 1985). Marketing strategy in general, and channel design in particular, is very important to the success of high technology firms. Traynor and Traynor (1989) suggest that marketing effort is at least as important as technology in creating competitive advantage for high technology firms. In

25 the specific case of software development, Teach and Tarpley (1987) found that after code development, marketing is the key variable for firm success. Second, this research is industry specific. The intra-sectoral approach may be superior to cross-industry studies as there is at least partial control for other factors (e.g. government regulation) that influence channel governance, and firm p e r f o r m a n c e ( H a n s e n and W e r n e r f e l d t , 1989; W e r n e r f e l d t and Montgomery, 1988). As a result, industry specific studies are common in international marketing research (Ricks et al., 1990). From a managerial perspective, industry specific studies are more useful as the results can readily be translated into relevant recommendations for action. This is particularly important in the context of the Canadian software industry as it is a growth sector with considerable potential for both domestic and export development (Evans, 1983; Touche Ross, 1984; Zeman, 1984; Wills et al., 1985; Glen, 1988; I n f o r m a t i o n T e c h n o l o g i e s I n d u s t r y Branch, 1990).* H o w e v e r , marketing w e a k n e s s is often identified as a constraint which prevents Canadian software developers from realizing their full potential (Glen, 1988; Computing Canada, 1989; Sutter, 1989). Thus, an improved understanding of channel choice can be of practical use to the industry. The software industry was chosen for study because of its range of product customization, and the variety of marketing channels that are used. Some software products are highly standardized "shrink-wrapped" applications that require little contact between the developer and final users. Other products require considerable customization, and extensive contact with final users during both development and implementation. Software also has strong linkages to other emerging high technology, knowledge based industries such as t e l e c o m m u n i c a t i o n s , s y s t e m s integration, media, etc. It also has a considerable service component, and was included in Erramilli and Rao's (1993) recent study of service firms' foreign market entry mode. Finally, this research contributes to theoretical development by modifying TCA in an attempt to account for the peculiarities of channel choice in the software industry. As there have been no previous studies of channel choice in the software industry or similar sectors, Klein et al.'s (1990) TCA model of channel choice by Canadian manufactured goods exporters is used as a starting point. Their model is modified by reversing the assumption that firms prefer to rely on agents in the market to distribute their goods unless there are substantial transaction costs. Following Erramilli and Rao (1993) it is argued that there are a number of non-transaction cost reasons that lead firms to integrate distribution functions in direct channels. Further, the cost of *Canadian software finns are very reliant on export sales. The average export sales ratio for the largest 100 Canadian software finns is 58% (calculated from Financial Post, 1994). The domestic market (estimated at $C2b) is simply too small to support the rapid growth that is typical in this sector, especially in niche markets. The largest 100 firms increased their revenues an average 46% between 1992 and 1993. Such double digit rates of growth are common in this sector. However, as one industry observer noted: "Building a better mousetrap will not cause the world to beat a path to your door if there are no mice in the area" (Compass Hoby Ltd, 1988).

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integrating in some high technology and service oriented sectors may be less prohibitive than is implied for traditional manufacturing sectors. The remainder of this paper is divided into five sections. The first reviews TCA and recent empirical tests of this theory. The subsequent section presents an argument for the modification of TCA to account for the peculiarities of high technology, knowledge intensive markets, and develops several hypothesis about the relationship between TCA variables and channel choice. The collection of data from Canadian software developers to test these hypotheses is described in the following section. A separate section is devoted to a description of a multinomial logistic regression model of the data. Finally, the results and their implications for theory development and future research are discussed.

Transaction Cost Analysis The contemporary development of TCA is largely attributable to Williamson (1975, 1979, 1981, 1985, 1991), although the genesis of this theory can be traced to the work of Commons (1934), Coase (1937), and Alchain and Demsetz (1972) in economics, and Simon (1955) in organizational theory. Hallwood (1990) provides an excellent account of the development of this approach, and its various adaptations and variants in several disciplines. Heide (1994) provides a recent overview of TCA from the Marketing perspective, and a comparison with resource dependency theory (Pfeffer and Salancik, 1978), and relational contracting theory (Macneil, 1978, 1980) in terms of assumptions about interfirm relationships. See Perrow (1986) for a thorough critique of transaction cost theory. TCA sees the governance of economic exchange as a choice between the market and a hierarchical control structure. The choice between these two modes is assumed to be governed by an assessment of their relative efficiency. The process of exchange gives rise to transaction costs which may cause market failure in the sense that the market is an inefficient means of mediating exchange. Transaction costs are those relating to search and information gathering, and the costs of monitoring and enforcing contractual performance. The three aspects of exchange processes responsible for creating transaction costs are: (1) investment in transaction specific assets, (2) external uncertainty, and (3) internal (or behavioral) uncertainty (Williamson, 1985). Transaction specific assets are those which are dedidated to a particular relationship, and are not easily redeployed. As these assets are unique, they must be safeguarded to minimize the risk of opportunistic exploitation (Williamson, 1985). The "external" and "internal" components of uncertainty are judged relative to a contractual relationship. External uncertainty is a property of the decision-making environment, and refers to the extent that relevant contingencies are too numerous or unpredictable to be anticipated in a contract. Thus, mechanisms must exist to allow adaptations to occur as an exchange relationship develops. Internal uncertainty relates to the problem of ascertaining contractual compliance, and monitoring performance.

27 Williamson (1975) originally proposed that it is the interaction between asset specificity and external uncertainty that explains a firm's governance decision. However, these factors have generally been treated as separate explanatory variables in subsequent empirical work. Walker and Weber (1984), and Klein et al. (1990) present arguments for this separation. The implications of transaction costs for forward integration stem from their tendency to be low in highly competitive markets, thereby providing little incentive to substitute internal organization for market exchange (Klein et al., 1990). When the market is unable to impose pricing or behavioral constraints, firms are expected to internalize transactions to reduce the cost of exchange. A limit on integration is imposed by the existence of transaction costs within corporate structures. These are often referred to as organization or bureaucratic costs, and include investments in legal, administrative, and operating infrastructures (Davidson and McFetridge, 1985). While Williamson (1975) originally proposed that hierarchical governance was the only means to control transaction costs, recent theoretical extensions include the idea that the desirable features of internal organization can also be achieved within the context of interfirm relationships. Jeuland and Shugan (1983), McGuire and Staelin (1983), and Coughlan (1985), for example, argue that interfirm channel agreements can be structured so that they are virtually indistinguishable from integrated channels. Stinchcombe (1985) suggests that unilateral provisions can be included in contracts to give the functional equivalent of hierarchical authority, and even Williamson (1985, 1991) admits that bilateral trading relationships can be designed to minimize potential governance problems and costs. A n o t h e r c o n s i d e r a t i o n is that while TCA necessarily e m p h a s i z e s transaction rather than production costs (the cost of physical distribution), the implication is that the objective is to minimize the sum of transaction and production costs in making integration decisions (Williamson, 1985; Klein et al., 1990). Thus, channel volume is also an important variable as the costs of control can be spread over a larger number of units when channel volumes are high. In explaining channel choice, empirical tests of TCA have focused on three characteristics of market exchange: (1) asset specificity, (2) uncertainty, and (3) channel volume (e.g. John and Weitz, 1988; Klein, Frasier and Roth, 1990). The importance of these factors in determining channel integration has been examined by a number of researchers with mixed results. A few studies have found positive relationships with asset specificity (John and Weitz, 1988; Anderson and Coughlan, 1987; and Anderson 1985). John and Weitz (1988) found a significant relationship between external uncertainty and integration, and Klein et al. (1990) found partial support for this relationship. Channel volume was found by Lilien (1979) and Klein et al. (1990) to be positively related to integration, while John and Weitz (1988) found only one of their two production costs constructs to be significant. Many of the researchers who have used TCA to explain channel choice

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have found it necessary to adapt or extend the model to account for particular circumstances. Heide and John (1988, p. 21), for example, comment that "middle range theoretical e x t e n s i o n s . . , are needed to enable TCA to address specific classes of situations not a d e q u a t e l y a d d r e s s e d in the global specification". John and Weitz (1988) added motivational variables to the TCA framework to improve their explanation of sales force compensation. Heide and John (1988) drew on resource dependence theory to clarify how small firms with limited resources safeguard transaction-specific investments, and Heide and John (1992) extended TCA with relational norms to explain buyer control over suppliers. Klein et al. (1990), in the first attempt to use TCA to explain channel choice in foreign markets, improved on previous studies of domestic channel choice by distinguishing between multiple channel modes, and dividing the concept of external uncertainty into two components: (1) volatility (the rapidity of change, and the degree to which a firm is surprised by the actions of others), and (2) diversity (the number of sources of uncertainty). Finally, Erramilli and Rao (1993) recently modified the TCA to account for the peculiarities of international market entry by service firms. Aspects of these last two studies are discussed in following sections.

Research Model

Assumptions Regarding the Default Mode The dependent variable of interest is the mode used by software firms to export their software and associated services to foreign markets. From the TCA point of view, the salient characteristic of a channel is the extent to which the producer has control over the channel. Control is in turn equated with the extent to which the firm internalizes the channel (integrates forward into distribution). Thus, the basic choice is between a full control or a shared control channel.* TCA assumes that most markets are competitive, and that large numbers bargaining minimizes the need for monitoring and enforcing supplier behaviour (Hennart, 1989). In such markets, shared control channels are thought to be most efficient. The threat of replacement checks the tendency of firms to act opportunistically, so there is no need to expend resources to further monitor or influence behaviour in the distribution channel. Thus, the default choice is assumed to be a market channel. When markets fail and there are too few participants to adequately check the tendency to behave opportunistically (i.e. small numbers bargaining), firms must invest in

*In this paper the terms full control, hierarchical, and integrated channel are used interchangeably. They refer to situations where firms serve a foreign market directly from a domestic location, or have a foreign sales subsidiary. Following Erramilli and Rao (1993) the term shared control is used to refer collectively to market (contractual) and intermediate (e.g. joint ventures) modes.

29 stringent negotiation and supervision of market contract relationships (Dwyer and Oh, 1988). This greatly increases the transaction costs associated with shared control channels, and provides an incentive for firms to invest in hierarchical channels over which they have more control. If most markets are competitive, and there are no non-transaction cost benefits to integration, one would expect a preponderance of market channel use. However, this does not conform with empirical evidence that the majority of firms use direct distribution channels (John and Weitz, 1988), and (at least in North American markets) exhibit a preference for integration p e r se (Stopford and Wells, 1972; Gatignon and Anderson, 1988). The majority of Canadian software developers use integrated channels.* The survey undertaken for this study found that 40% of most important product-largest export market combinations are served directly from Canada, and another 14% through foreign sales subsidiaries. Similarly, Coviello (1994) in her study of the internationalization of New Zealand's software firms found that 50% of firms used direct channels, and half of those had overseas sales subsidiaries. Erramilli and Rao (1993) recently questioned the assumption of shared control channels as the default mode, especially in the context of service firms. They note that for this assumption to be true: (1) the only benefit of integration must be a reduction of transaction costs, and (2) the cost of integration must always be high. Neither of these is necessarily true in all sectors, and is less likely to be true in sectors (such as software) where there is a strong service component. Erramilli and Rao (1993) identify a number of non-TCA motives for integration. These include: facilitating coordination in multiple markets (Kobrin, 1988; Hill et al., 1990), extension of market power (Teece, 1981), profit retention (Anderson and Gatignon, 1986), and avoidance of problems with partners (Contractor and Lorange, 1988). In the case of knowledge intensive high technology sectors like software development, difficulties in appropriating the economic benefits of R&D investments also provide an incentive to integrate forward into foreign markets. Traditional legal methods of protecting intellectual property rights such as patents and copyrighting have proved ineffective in the context of software development (Rao and Klein, 1994; Estill, 1990).t The legal process *However, there is anecdotal evidence of a trend toward the use of market channels and partnerships in both domestic and export markets. Stuart (1985, 1989) suggests this is the result of end users demanding complete solutions. As few developers control the software necessary to market a turnkey system directly, alliances with computer hardware vendors, VARs, and other indirect channel members are a necessity. In the US domestic market, where sales of packaged rather than custom software dominates, Stuart (1989) estimates that up to 70% of new (as opposed to upgraded) software is sold through indirect value added channels. tSoftware firms have much to protect as the sector is very R&D intensive. A recent survey found the software industry to have the highest R&D to sales ratio (14%) of any high technology sector (Business Week, 1992). In addition to the ineffectiveness of legal protection, limited appropriability arises because of: open operating systems, customer demand for control of software, the "factory" or modular approach to software development, and short life cycles (Rao and Klein, 1994).

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for seeking compensation from those who have misappropriated the benefits of intellectual property is too expensive for smaller firms (especially in the international context), and too slow given the rapid technological progress of software products.* Thus, firms have looked to their marketing strategy and channel design to provide alternatives to legal recourse in attempting to overcome the appropriability problem.t The ability of a firm to appropriate the economic benefits of its R&D investment may be enhanced by investment in complementary marketing assets such as market research, promotion, and channel development (Rao and Klein, 1994). As a consequence, Canadian software developers have sought fine vertical and geographic market niches about which they can gather significant market intelligence (Competing Canada, 1989). Many also focus on the service dimension of software, building an infrastructure of support services within their channels that include installation, training, maintenance, and upgrades. This approach has generally been successful as the extent of post-sale service provided by vendors is often a more important criterion in software selection than is price (Input, 1991). For firms pursuing this strategy, their channels must be capable of identifying customers in a fine marketing niche, and handling both the original software product, and any accompanying ongoing service component. These capabilities are more likely to be found in hierarchical channels. A final argument in favour of assuming a hierarchical channel as the default mode is that the costs of integration are not equally high in all sectors. Erramilli and Rao (1993) point out that the costs of establishing a foreign sales subsidiary are low compared with those that would be experienced by a manufacturing firm. The cost of maintaining a foreign software sales subsidiary is $C260,000 to $C300,000 per year (Stuart, 1989). The cost of serving a foreign market directly from Canada is 50-60% of this amount. Thus, hierarchical modes are within the resource capabilities of much smaller software firms than would be the case for manufacturing firms. With these arguments in mind, this study assumes that by default software developers will choose to serve their foreign markets directly from their Canadian location. The factors which lead firms to integrate further and establish foreign sales subsidiaries, or to disintegrate and use a shared control mode are thus the variables of interest.

Description of Software Channels This section describes the channels that are used by software developers to distribute their products and associated services. Erramilli and Rao (1993) *Even the largest firms do not have the resources or tools to fully appropriate the benefits of their investments. The Business Software Alliance of the US estimates that pirated software cost US software firms $US351m in 1994, half of which is attributable to Microsoft alone (Financial Post, 1995). tSee Magee (1976, 1977) for a discussion of the role of appropriability in internationalization. Magee argues that the efficiency of a nation's legal system, and changes in industry structure provide incentives for direct investment as the preferred mode of foreign entry.

31 argue that from a TCA point of view, the most important characteristic of a channel is whether it is full-control or shared-control. They argue that the differences between market (contractual) modes and intermediate modes like joint ventures may be indistinguishable, and that empirical tests of TCA have had little success in distinguishing between multiple channel choices, especially where degrees of partnership are involved. Klein et al. (1990) included four categories of channels: foreign sales subsidiaries, serving the market directly from a domestic location, joint ventures, and market arrangements. They also considered the case of dual channels where products are delivered through more than one of the four categories. Although they conclude " . . . attempting to classify across four different options is difficult" (Klein et al., 1990, p. 204), their models were able to statistically distinguish between the modes. This study follows Klein et al. by including five categories, including dual channels. The variety of dual channel arrangements make them an especially heterogeneous group. The choice of dual channels is difficult to explain using a few factors. Dual channels are important in the software sector, and are worthy of additional study in themselves. Suggestions in this regard are discussed in the final section of the paper. Hierarchical, Intermediate and M a r k e t Modes. There are a number of distribution paths used to transfer software from the original developer to the end user (Fig. 1).* The possibilities range from a direct channel to rather lengthy channels with multiple intermediaries. Software developers include both designers and manufacturers. Designers are the original creators of a program, while manufacturers combine this role with that of a publisher. Publishers take a prototype and create a product that is ready to be marketed in quantity. This includes the production of technical and users guides, training products, packaging, and copies of the software itself. For the purposes of this research, no distinction is made between designers, and manufacturers (both are simply referred to as developers). The interest here is only the extent to which developers integrate forward into the distribution channel once the software is ready to be placed on the market. There are three types of intermediaries that may be involved in the distribution process: distributors/wholesalers, value added resellers (VARS), and retailers. Distributors/wholesalers obtain software once it is packaged and ready for sale. They plan or coordinate the advertising campaign, and provide customers with volume shipments of the product. Distributors occasionally contact end users directly. These are most likely mail order distributors, those who use telemarketing, or who employ outside sales representatives. More frequently, distributors deal with VARS and retailers. VARS serve specialized vertical markets, and usually provide turnkey hardware/software solutions. Resellers add value through their expertise, and ability to integrate hardware

*Note that Fig. 1 describes the entire channel from developer to end user. This paper is not concerned with the total channel (or channel length), but with the manner in which software products and associated services "enter" foreign markets, especially whether the firm is responsible for this activity itself, or if it employs an external agent.

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S o f t w o r e Producers

I

Software Designer

Manufacturer IOesi~ner + Publisher I

I

I |

I

Figure 1. Software Distribution Channels

Disfributor Wholesaler

J

End Users Adopfed from CWARC

(1992,8)

and software into a single system. VARS usually deal directly with end users, but occasionally operate through a retailer. In addition to these traditional marketing channels, a number of alternative modes are emerging that involve some degree of partnering with other finns. Common options include joint ventures, piggy-backing, and joint marketing agreements. Joint ventures involve collaborating with another firm (usually located in a foreign market) to create a new third firm that produces and distributes the software in a foreign market. In this study, joint ventures are classified as a shared control mode. Piggy-backing involves selling software through the marketing channel used by another finn for its product. The most common example of piggy-backing is the selling of a software product through a channel developed by a hardware firm. Finally, joint marketing agreements are agreements between two or more software firms to market each others' products through their own distribution channel. This allows firms to offer their customers a wider range of products, and reach more customers. In this study, piggy-backing and joint marketing agreements are classified as market modes. The final link in the channel chain are retailers who may obtain software directly from developers or from their distributors. Retailers advertise software through local media, and by in store displays. They provide limited training and customer support. There are a variety of types of retailers that

33 sell software. Some specialize only in software, others sell both hardware and software, and others are broad line retailers. All three may be independents or part of a chain or a franchise. Dual Channels. Dual channels arise for a number of reasons. For example, some developers have established direct sales forces to serve large corporate customers, while individuals in the mass market are left to resellers and retailers. In other cases, a kind of hybrid sales force has arisen where developers' representatives "evangelize" a product and then point buyers toward a local reseller (Parker, 1988a). Dual channels also emerge because of the need to upgrade software. Traditionally, upgrades of packaged software were handled directly even though original sales may have been through a reseller or retailer. Software companies are moving away from this model, making upgrades available through other channel members. Parker (1988b, p. 44) notes that "going through a local dealer reduces the upgrade hassle by allowing corporations to use existing purchase order forms and deal with an individual that the organization knows and trusts." This may be particularly important in export markets. Margins on upgrades are small, but many VARS and retailers want to handle upgrades as an additional service to their customers. However, tracking proof of ownership for upgrades becomes more cumbersome with longer channels. One result may be higher upgrade costs as software companies build the channel fee into the upgrade price (Parker, 1988b).

Hypotheses About Entry Mode Choice Following the TCA model developed by Klein et al. (1990), this paper attempts to explain channel choice in term of three primary explanatory variables: channel volume, asset specificity, and external uncertainty: Channel Volume. As noted in a previous section, firms are assumed to choose their channels so as to minimize the sum of production and transaction costs. In this case, production costs are the costs associated with distributing software and associated services. It is further assumed that where sufficient volumes exist, firms will serve foreign markets directly from a domestic location (the default mode). This allows firms to benefit from economies of scale facilitated by opportunities for internal specialization and division of labour. These economies enhance the firm's ability to recruit and retain marketing personnel who gain market and product knowledge beyond that which would be expected of external agents. Thus, the firm receives greater benefits from its channel expenditures than it would otherwise. In the case where channel volumes are too low to achieve internal economies of scale in distribution, shared control modes are expected to be used. When more than sufficient volumes are experienced, firms are expected to integrate further by establishing foreign sales subsidiaries. Thus, relative to the default option: Hi: Use of shared control modes is negatively associated with channel volume. H2: Use of foreign sales subsidiaries is positively associated with channel volume.

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Business Review 5,1

Asset Specificity. Markets in which there are many external agents who can distribute a particular product are self-policing in that an agent who behaves opportunistically can be easily replaced (i.e. large numbers bargaining). However, in the case where there are few agents, the market may be unable to police the behaviour of members, and market failure m a y r e s u l t (i.e. small n u m b e r s b a r g a i n i n g ) . The s e a r c h for a wholesaler/distributor to export software may result in a small numbers bargaining situation if either party must invest in physical or human assets that are unique to the exchange. This represents a commitment of resources that are not easily redeployed, increasing the cost of switching to a new relationship. If significant idiosyncratic investment is required to distribute software and its associated services in a foreign market, developers have an incentive to integrate. By integrating, they are able to substitute hierarchical control for the policing effect of a competitive market. Thus, relative to the default option:

H3: Use of shared control modes is negatively associated with asset specificity.

H4: Use of foreign sales subsidiaries is positively associated with asset specificity. External Uncertainty. Following Klein et al. (1990) external uncertainty is characterized by two dimensions: volatility and diversity. If a market is volatile, it is difficult to predict future outcomes, and to provide protection against negative contingencies by way of contracts. Instead, some form of institutional structure that allows for adaptive decision making is required. As such a structure is likely to have high transaction costs, a tendency toward channel integration is also likely. Further, as highly volatile foreign markets are difficult to serve from the firm's domestic location, it is expected that foreign sales subsidiaries are the preferred hierarchical form. Thus, relative to the default option: Hs: Use of shared control modes is negatively associated with volatility. H6: Use of foreign sales subsidiaries is positively associated with volatility. Diversity, on the other hand, reflects multiple sources of uncertainty in a market. A diverse market is one in which there are many customers and competitors. In such a market, a firm will need to adopt multiple strategies to meet varied and specialized demands. A more complex and flexible channel structure can be created by including independent channel members who can help gather and process the information required to deal with a heterogenous market. Thus, relative to the default option:

H7: Use of shared control modes is positively associated with diversity. Hs: Use of foreign sales subsidiaries is negatively associated with diversity.

35 Methods

Data Collection To test the hypotheses developed above, data were collected from Canadian software developers by a mail survey. Identifying the target population of software developers that sell their products and services in foreign markets is not an easy task. Statistics Canada (1992) reported 9,693 computer service firms from Revenue Canada files. Of these, 22% or 2133 firms primarily produced software products. Identification of these firms is problematic as Revenue Canada's files are confidential. Further, there is a high rate of turnover among these small firms, perhaps as high as 35% (Information Technologies Industry Branch, 1990). While some provinces produce directories of their software firms (e.g. S a s k a t c h e w a n E c o n o m i c Diversification and Trade, 1992; Alberta Technology, Research and Telecommunications, 1991; Minist~re de l'industrie, du Commerce et de la Technologie, 1991) these are often outdated and do not provide national coverage. A further problem is that none of these sources distinguish between firms that sell their products and services in foreign markets and those that have domestic sales only. Fortunately, there is one source which both identifies software finns, and their level of foreign sales. This is an on-line database called the Business Opportunities Sourcing System (BOSS) which is operated by the Federal Department of Industry, Science and Technology. The firms in this database were originally identified from a number of industry directories, and federal contract listings. There are over 32,000 firms listed in the database, of which more than 21,000 are manufacturing firms. The service sector finns include 780 computer software finns, of which 348 have foreign sales. The primary purpose of this database is to help foreign customers identify Canadian firms that export needed products and services. Information available for each finn includes: contact names, address(es), total and export sales, number of employees, countries exporting to, countries interested in, and services or products offered. This information is updated by an annual questionnaire. Calof (1994) recently used the BOSS database in a study of finn size and export propensity among manufacturing firms. He found that the BOSS included 53% of all Canadian manufacturing finns, but that the database is biased toward inclusion of larger firms. Interestingly, the database is not biased toward the inclusion of exporting firms as might be expected. BOSS includes about 37% of the number of software firms identified by Statistics Canada (1992). Its rate of identification of software firms with foreign sales may be higher. Abramson (1992) claims a population of only 176 firms which export to the US, while BOSS includes 296 such firms. Thus, the software firms that have foreign sales included in BOSS are likely a representative sample, and may be close to the population of such firms. A questionnaire was sent to the owner/general manager, or export manager of the 348 software firms with foreign sales. Thirty-eight of the questionnaires were returned as undeliverable, and the firm could not be traced through the

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above named directories. If these finns are presumed defunct, this yields a turnover rate of 11% considerably below the Information Technologies Industries Branch (1990) estimate. This may be accounted for by the BOSS data collection procedure which essentially requires the firm to have already survived for a number of years before it is identified and included. A total of 125 responses were received, of which 112 contained complete information for all relevant variables (32% of 348). Figure 2 shows the distribution of responding finns by total and foreign sales. The modal finn had $C1 million-$C5 million in total sales (34% of firms fell into this category), and 51% of their total sales were to foreign buyers. The Kolmorgorov-Smirnov statistic was calculated for the maximum difference between the distribution of foreign sales of responding firms and all finns in the sample. The statistic is significant (tx = 0.00). In particular, there are relatively fewer responding firms with foreign sales less than $C100,000. It may be that these firms do not consider exporting to be a significant portion of their business activities, and found the questionnaire to be of little relevance or interest. Consistent with previous descriptions of the industry, the majority of responding finns (70%) had less than 25 employees, and 87% of them were owner managed. They exported to a mean of 11 countries (the distribution is highly skewed as the median is only 5), and had a mean of 6 years export experience.

Operational Measures Consistent with the TCA argument, the unit of analysis is the transaction (Williamson, 1975, 1985). Previous empirical studies have defined this unit as

Number of Firms 250 -

200

I ii -

1.50

100-

SO-

Figure 2. Distribution of Total and Export Revenue

s-lou Saies ($C)

Toto!Sates tx~*

- Soml~e

37 aggregate annual sales of a particular product to a particular foreign market (e.g. Klein et al., 1990). Thus, respondents were asked to identify their firm's most important export product, and to answer a number of questions regarding the sale of this product in its largest foreign market. This most important product-largest market combination generated an average of 56% of the firms' total revenue, 54% of the sales of the product, and 52% of the products' users. It should be noted that the most important product-largest foreign market combination represents a biased sampling of all possible product-market combinations for each firm. Assuming limited resources, and that firms do not d i v i d e their r e s o u r c e s e v e n l y b e t w e e n m a r k e t s or p r o d u c t s , this product-market combination likely consumes the bulk of foreign marketing resources. This may bias the findings as more resources are available to enable integration in the largest foreign market. In terms of products, there is likely little bias as the majority of Canadian software finns are essentially single product companies (Cornish, 1994). Even the largest firms like Corel and Delrina have relatively little product diversification. It is difficult to overcome this sampling bias as questionnaire length quickly increases if information is collected on additional product-market combinations. Further, there are too few firms to employ an experimental design that would sample different types of combinations from different firms. Data were obtained for the study variables as follows. Entry Mode. Respondents were asked to describe the export arrangement for their most important product-largest market combination. A number of channel descriptions were provided, with an opportunity for the respondent to amplify the description in the context of their export arrangements. Two hierarchical modes emerged: (1) exporting to the market directly from Canada, and (2) establishment of a foreign sales office. These accounted for 40 and 14% of the cases, respectively. With both modes there were a number of variations in the way end users were actually served. The most frequent was direct contact through mail, telemarketing, or external salespersons. In a few cases a VAR or retailers were the "customers" who then resold the product to end-users. An intermediate mode, joint venture marketing arrangements, accounted for 15% of the cases. In all but two cases, both the second parent firm and the child venture were located in the export market. Again, the joint venture usually had direct contact with end users, but sometimes a VAR or retailer was involved. A market mode was used by 13% of the responding firms. This included distributors, wholesalers, and occasionally OEMs,* or VARs who were responsible for export arrangements

*The OEM includes the software as an integrated package with their hardware and exports it through their channel. This might technically be considered an indirect export rather than a market mode. The strong complementarity between hardware and software, and declining margins on hardware are increasing the popularity of this mode. Hardware firms are looking to increase their profits by using their established distribution channels to sell complementary software.

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38 International Business Review 5,1

to the foreign market. These agents typically took title to the software in Canada, and exported it to VARs, retailers, or end-users in the foreign market. Finally, 17% of the firms used a dual channel, which involved some combination of the above arrangements. Typically this involved serving some customers directly from Canada, while serving other customers through a distributor. Channel Volume. Channel volume can be measured in two ways: (1) the number of software packages or licenses sold to the foreign market in the previous fiscal year, and (2) the dollar value of those packages or licenses. These two measures are not significantly correlated. A highly customized program might cost $C25,000 and sell few copies per year, while packaged software might cost $C250 and sell hundreds or thousands of copies per year. Table 1 shows the mean annual volume by channel. For both measures, the means are significantly different between modes at p = 0.05. Note that the channel volume is highest for the market mode when measured by the number of packages, but is highest for the foreign sales subsidiary mode when measured by sales. These two modes represent opposite ends of the integration continuum, and the contrast between them is evident by their mean sales ($C26,979 versus $304). Sales subsidiaries are used for low frequency, high cost software products, while market modes are used for high frequency low cost software products. While both measures of volume provide interesting insight into the characteristics of sales through the different modes, sales is the more relevant measure of "channel volume". Sales is clearly a measure of the resources that are available to invest in channel integration, and the ability of the finn to benefit from economies of scale in channel investment. On the other hand, the information contained in the number of packages measure is theoretically related to the "packaged" versus "customized" segmentation of the software market. High sales frequency, low cost software is usually packaged, while low sales frequency, high cost software is more often customized. Thus, sales is used as a direct measure of channel volume. Asset Specificity and External Uncertainty. Asset specificity and uncertainty about the external environment were measured using a series of statements about which respondents indicated their level of agreement

Channel

Table 1.

Channel Volume

Direct from domestic location Foreign sales subsidiary Joint Venture Market Dual channel All channels combined

Mean annual sales through channel

Mean annual packages or licenses sold through channel

Mean sale through channel

$778,011 $6,55,833 $497,059 $756,267 $1,513,417 $1,647,757

287 243 151 2491 1114 670

$2,711 $26,979 $3,292 $304 $1,359 $2,349

39 (strongly disagree = 1, strongly agree = 7) (Table 2). The statements were adapted from those used by Anderson (1985), and Klein et al. (1990), with the wording changed to be specific to the software industry. The statements were randomly arranged and interspersed with other statement sets to guard against pattern answers. Asset specificity refers to the degree to which transaction specific assets are required for the export channel. Six statements measured both physical (statements 4 and 5 in Table 2), and human or knowledge (statements 6--9 in Table 2) assets. The statements relating to external uncertainty represent both volatility and diversity components. Volatility refers to the degree to which a firm is surprised by the actions of others, and is measured by statements 1-3. Diversity refers to the number of sources of uncertainty, particularly from users and competitors, and is measured by statements 10 and 11. Assessment of Multiple Item Measures, The constructs asset specificity, volatility, and diversity were all measured indirectly by multiple items. It is thus necessary to assess the validity and reliability of these measures, and to collapse the items into a single scale for each variable. To assess validity, the individual items were subjected to a factor analysis with varimax rotation. The items for all four scales were included in the same analysis to provide an

Statements 1. We are often surprised by the actions of retailers of our software. 2. We are often surprised by customer reaction to our software 3. We are often surprised by the actions of our competitors. 4. Specialized facilities/equipment are needed to market this software. 5. A large investment in facilities/equipment is needed to market this software. 6. It is difficult for an outsider to learn our way of doing things. 7. It takes a long time for a salesperson to gain a thorough knowledge of our software. 8. To be effective, a salesperson for our software has to take a lot of time to get to know the customer. 9. A salesperson's inside knowledge of our procedures would be very helpful to our competitors. 10. There are many competitors for our software in this market. 11. There are many users of our software in this particular market. Percent of variance explained by factor (%) NB: Loadings less than 0.25 are not shown.

F1

F2

F3

Foreign Channel Integration Decisions

F4

0.85 0.75 0.73

0.28 0.88 0.88 0.77 0.74

0-59

0-44 0.78

30.6

27.2

22-3

0.76 19.9

Table 2. Factor Analysis of Measurement Items

40 International Business Review 5,1

assessment of internal consistency (Gerbing and Anderson, 1988). An initial analysis suggested that a number of items be dropped. Notably, two of these were diversity measures. One was a reversed scaled statement used by Klein et al. (1990): "We have only a few immediate customers for our software in this market"; and the other attempted to include the notion of geographic diversity: "Our customers are widely spread geographically within this market". The results of a factor analysis of the reduced item set is provided in Table 2. All of the variance is explained by four factors. The items hypothesized to relate to volatility and diversity both load highly on separate factors (factors 1 and 4, respectively). The items relating to asset specificity, however, are split between factors 2 and 3. Items 4 and 5 load highly on factor 2, and relate to specialized facilities and investment needed to market a software product. Items 6-9 load highly on factor 3, and relate to specialized knowledge required to market a software product. While the transaction cost literature acknowledges asset specificity comes form different sources, these items have not split into separate components in previous studies. The results of the factor analysis suggest that the items hypothesized to related to control, diversity and volatility can be combined into single scales, but that the items for asset specificity should be separated into two scales. The items were combined into single scales for each variable by averaging their values. The mean and coefficient of variation (CV) for each variable is shown in Table 3. The physical asset specificity measure tends toward d i s a g r e e m e n t , indicating that on average relatively little specialized equipment or investment is needed to market software. The knowledge measure is almost mid-way on the scale, indicating relative ambivalence. There is also considerably more variation in the physical asset specificity measure than in the knowledge specificity measure. Cronbach's standardized alpha was calculated for each scale as a measure of reliability. In all cases this measure was acceptably large. Control Variables. Three control variables were thought to be important for inclusion in the model. The first is related to channel volume. Since information was collected on sales of only one product (albeit the most important one) to a foreign market, the possibility arises that the resources available to invest in integration are underestimated by the channel volume variable. If the firm is able to sell additional products through the same channel, additional economies of scale could be realized (Anderson and Coughlan, 1987). A binary variable was thus included which had a value of "1" when the channel was shared, and "0" otherwise. Because of the single Variable

Table 3.

Description of Variables

Physical asset specificity Knowledgeasset specificity Volatility Diversity

Mean

CV

1.8 3.3 2.1 3.1

0.78 0.55 0.57 0.42

Cronbach's 0.68 0.62 0.61 0.66

41 product nature of many software firms, only 40% of the responding finns sold another product through the same channel. A second control variable indicated whether the foreign market was the US (0) or another country (1). In 86% of the cases, the largest market was the U.S., while in 7% it was a European Union country, and 7% another country. The dominance of the US as an export market is not surprising given its proximity, size, rapid growth, and similarity of language and business procedures. The Software Publishers Association estimated that the US market for PC software alone was $US4.6 billion in 1990, making it by far the world's largest software market (Canadian Computer Reseller, 1991). The US accounted for 80% of Canadian computer service sector foreign receipts in 1990 (Statistics Canada, 1992). Pre-survey interviews indicated that Canadian software developers often regard the US as an extension of the Canadian domestic market rather than as a foreign market. For example, one developer commented "We treat the US and Canada as one domestic entity, i.e. North America". And another commented "Although the US is the largest export market for us we do not technically consider it international". "It is an extension of our domestic market". This view is enhanced by the complete removal of tariffs on s o f t w a r e , and i m p r o v e d m o b i l i t y for t e c h n i c a l p e r s o n n e l u n d e r the US-Canada Free Trade Agreement. Thus it is anticipated that all else the same, there will be a greater level of integration in the US market than in other markets. A final control variable is whether or not the software must be customized. Custom software has a strong service component - - there is close interaction between the developer and the final user at all stages from conceptualization through prototyping and implementation. The developer often provides training, and ongoing maintenance. It is assumed that this is facilitated by an integrated channel. In contrast, packaged software (often referred to as 'shrink wrapped' after a common form of packaging) are standardized products that are not customized for individual users (beyond what the customer or a VAR can do without the involvement of the original developer). Support for such software varies from notification of upgrades, to newsletters, and telephone help lines. Shrink wrapped software has more in common with a product than a service, and it is assumed that they can be more easily distributed by market channels that penetrate more diverse markets. This variable was coded "0" for shrink-wrapped software, and "1" for custom products.

Estimation Results Hypotheses about the relationship between entry mode and the explanatory variables were tested using multinominal logistic regression.* In the case *This technique is also referred to as polychotomous logistic regression, multi-valued logistic regression, or the generalized logistic model. Descriptions of this technique are available in Cox (1970), McCullagh and Nelder (1983), Hosmer and Lemeshow (1989), and many standard texts on the general linear model.

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42 International Business Review 5,1

were the values of a dependent variable are nominal (as is the case with channel choice), this technique enables estimation of the probability of a particular outcome of the dependent variable based on the values of the independent variables. If the value of y = 1, 2 , . . . , j, then the model assumes that:

p[y=j] =

e~ (1) 1 + ]~ eui

f o r j = l, 2 . . . . . j - l , and p[y =j] = 1 - ~] P[y =j]

(2)

where uj is a linear function of the independent variables (BMDP, 1992). As is evident from equation (2), one category of the dependent variable must be selected as the "base mode" because once j - 1 alternative probabilities have been estimated, the probability of the jth alternative is known. The default option of serving the market directly from a Canadian location was used as the base mode, and the utilities of other channel choices were estimated with reference to this choice. The parameters for three separate models were estimated (Table 4). The first compares shared control modes with the default option, the second compares the use of a foreign sales subsidiary with the default option, and the third compares the use of dual channels with the default option. Since the dependent variable for the last two models can only take on two values, they represent the special case of dichotomous logistic regression.* Separate models were estimated to enable assessment of the utility trade-offs involved in increasing integration (foreign sales subsidiaries) versus disintegration (joint ventures and market modes). As no specific hypotheses were developed for dual channels, their utilities were also estimated in a separate model. A number of alternative models were explored before producing the final models shown in Table 4. A stepwise procedure was used to determine which variables contributed significantly to the overall fit of the model. The diversity, specificity of human assets, country, and same channel variables and their associated parameters were found to be insignificant in all of the models. For the sake of parsimony, and to increase the degrees of freedom available for estimation of the remaining terms, these variables were omitted from the models. A number of interaction terms (notably between the asset specificity variables, the uncertainty variables and customization) were also tested. Again, none proved significant so were not included in the final model. *The first model was estimated using BMDP/Dynamic v.7 module PR (Stepwise Polychotomous Regression), and the remaining models were estimated using module LR (Stepwise Logistic Regression).

43 (A) Direct exporting from domestic location with shared control mode alternatives Joint Venture Variable Constant Volume Knowledge Asset Specificity Volatility Custornization

Market

Coefficient -6.36 -0.716 -1.05 -0.641 8.40

t

Coefficient

-1.98"* -2.83*** -2.92*** -1.47 2.68***

t

-8.02 -0.385 -0.538 -0.760 -0.113

Foreign Channel Integration Decisions

-2.55** -1.73" -1.60" -1.90" -0.344

*p < 0.10. **p < 0.05. ***p < 0.01. X2 (2*observed*In (observed/expected)) = 49.5, p = 0.91. Correct classification rate = 74%. (B) Direct exporting from domestic location with foreign subsidiary alternative Subsidiary Variable Constant Volume Knowledge Asset Specificity Volatility Customization

Coefficient

t

-9.52 0.700 1.40 1.28 0.824

-2.42** 3.35*** 3.08*** 2.75*** 2.77***

*p < 0.10. **p < 0.05. ***p < 0.01. log likelihood = - 9.95. X2 (2*observed*In(observed/expected)) = 19.9, p = 0.87. Correct classification rate = 91%. (C) Direct exporting from domestic location with dual channel alternative Dual Channel Variable Constant Volume Knowledge Asset Specificity Volatility Customization

Coefficient -12.2 -0.253 -0.741 -1.26 -0.313

*p < 0.10. **p < 0.05. ***p < 0.01. log likelihood = - 9.76. ~2 (2*observed*In(observed/expected)) = 19.5, p = 0.49. Correct classification rate = 85%.

-2.55"* -2.05** -2.02* 2.33* 0.843

Table 4. Results of Logistic Regressions

44 International Business Review 5,1

The overall efficacy of the final models is assessed by the goodness of fit chi-square. This test compares the differences between the observed and predicted frequencies for each cell in the data. Thus, relatively small chisquare values, and relatively large P values indicate a statistically significant model. All three of the models are statistically significant.* The predictive ability of the model is judged by the rate at which it can correctly classify observations into the categories of the dependent variable. This rate can then be compared with the classification rate that would be expected by random assignment to the categories. In all three models, the classification rate is higher than would be expected by chance alone. The significance of the individual coefficients can be tested by dividing them by their standard error to derive an approximate t statistic. Note that a statistically significant coefficient represents the extent to which the corresponding variable contribute to the utility of choosing that channel beyond its contribution to the utility of the default mode. It does not directly provide information about the probability of choosing an alternative channel. Such probabilities would have to be computed using equations (1) and (2). Hypotheses H1, H3 and H5 predict that the coefficients for volume, asset specificity, and volatility should be negative for shared control modes. That is, that as levels of these variables increase there is a disutility associated with use of a shared control channel. Similarly, hypotheses H2, H4, and H 6 predict that the coefficients for the same variables should be positive for use of a foreign sales subsidiary. That is, there is a positive utility associated with selection of this option. The coefficients reported for models A and B in Table 4 support these expectations, with one exception. Volatility does not have a significant effect on the selection of joint ventures. No support was found for hypotheses H 7 and Hs as diversity was not found to have a significant effect on channel choice, and was not included in the final models. In the third model which compares use of dual channels with the default mode, the coefficients for volume, physical asset specificity, and volatility are all negative and significant. This pattern mirrors that of the market option. Customization was expected to be negatively associated with use of shared control modes, and positively associated with use of a foreign sales subsidiary. Customization does have a positive utility in the case of foreign sales subsidiaries, however, contrary to the expectation, it also contributed positively to the selection of a joint venture, and is not significant in the case of market mode. It is also not significant in the selection of dual channels. The country (US or other), and use of channel for other products variables did not significantly effect channel choice, and were not included in the final models. *Examination of the cell frequencies revealed a larger than acceptable number of cells with expected values less than 5.0 in all three models. The goodness of fit chi-square statistic can give misleading results when cell frequencies are small. Thus, care should be taken in the generalization of these results. Also note that some researchers prefer to compare the predicted outcomes with the intercept only model rather than the original cell frequencies. In such tests, large chi-square values and small p values indicate significance.

45 Conclusions and Future Research The findings reported above provide support for H1 and Hv Channel volume was found to be positively associated with the use of foreign sales subsidiaries and negatively associated with the use of shared control modes, relative to the default option of serving the foreign market directly from Canada. The findings also provide support for H3 and H a a s asset specificity was found to be negatively associated with the use of shared control modes, and positively associated with the use of foreign sales subsidiaries. This finding has an additional element of interest. A number of items representing both human and physical assets were originally hypothesized to be associated with the construct "asset specificity". However, factor analysis revealed that the items should be split into two separate scales representing the specificity of "physical assets" and "knowledge assets". Only the level of specificity of physical assets was found to have a significant effect on channel choice. In terms of external uncertainty, the results provide partial support for Hs, and H 6. Volatility was found to be negatively related to the use of a market channel, but had no relationship to the use of joint ventures. Volatility is positively related to the use of a foreign sales subsidiary as expected. This implies that there is no significant difference in the utility of joint ventures versus serving the m a r k e t directly from Canada. Joint ventures are "intermediate" modes in that they share some characteristics of integrated modes, but also involve sharing of information, resources, and decisionmaking with a partner. It may be that, at least with respect to volatility, joint ventures are more like integrated modes than market modes. The results provide no support for H 7 and Hs as diversity was not found to be significantly related to choice of market channel. It is interesting to note that the specificity of knowledge assets, and diversity scales have the highest average values and smallest coefficients of variation (see Table 3). One would expect fairly high and consistent levels of knowledge specific assets from f'mns in a "knowledge intensive, high technology" sector. Similarly, anecdotal descriptions of the sector characterize its markets as diverse with highly variegated segments (Sutter, 1989). Software firms may have developed strategies to deal with the asset specificity of their knowledge, and market diversity that moderate the effect of these variables on channel choice. For example, there is evidence software firms control diversity by carving out very fine vertical or geographic market niches (Computing Canada, 1989). As a result, despite the diversity of the market as a whole, individual firms may have relatively homogeneous customers, and few direct competitors. Of the three control variables tested, only customization was significantly related to channel choice. Custom software is positively associated with the use of foreign sales subsidiaries as expected. However, it is also positively associated with the use of joint ventures, and is not related to the choice of a market channel. The expectation was that custom software would be negatively associated with the use of shared control modes. The positive utility associated with customization and the use of joint ventures may be explained by the fact that the requirements of customizing software in a

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46 International Business Review 5,1

foreign market actually motives some joint ventures. In a portion of the questionnaire set aside for qualitative comments, several respondents noted the importance of their joint venture partners in customizing software for foreign market. For example, the foreign partner may help with something as generic as translation, or as specific as implementing tax regulations into an accounting package. The country and same channel variables did not have a significant effect on channel choice. Contrary to the expectation, there was no significant utility attached to integration in the US. Similarly, the ability to sell other products through the same channel had no significant effect on integration. Both of these results may be the result of only sampling most import product-largest foreign market transactions. This sampling scheme is likely biased toward those transactions that receive the most foreign marketing resources, and thus have a tendency toward integration. Overall, the results lend support for the TCA model of channel choice. All three primary variables: channel volume, asset specificity, and uncertainty were found to have a significant effect on channel choice. However, the model can be further improved. Additional variables need to be included to enhance the models efficacy. Certainly the lack of significance for the knowledge specific assets and diversity variables requires further exploration. The measurement of the model constructs also needs further attention. Perhaps items more sensitive to particular industry conditions can be developed. This research also provided information about software export activity not previously available. This adds to a small, but growing academic literature on software marketing and strategy (e.g. Alic et al., 1991; Mosakowski, 199l; Eisenhardt, 1989; Bourgeois and Eisenhardt, 1988; Green, 1992; Abramson, 1992; and Coviello, 1994). In Canada, this sector is characterized by small firms that are very reliant on their export markets. As Klassen (1986, p. 58) describes the situation "It is simply not possible for indigenous Canadian software companies to thrive strictly on domestic markets". Several of the respondents reiterated the importance of export markets to the success of their firms. One commented "Without export markets our products would fail because Canada is too small". The significance and potential of exports in this sector make it an interesting one for continued study. One element that will greatly enhance the managerial relevance of this line of research is to link channel choice to performance. TCA is a normative model, which assumes firms use the optimal channel at any one point in time. As a result, longer term strategies for channel development are not considered. For example, TCA can not account for complex multi-step distribution strategies such as the Direct-Indirect-Direct (DID) approach (Stuart, 1989). In this case, a software firm initially penetrates a market using a direct channel. When a suitable channel partner is found, the product is handed over to the partner. The original firm eventually takes the product back, or buys out the partner to reclaim the distribution channel. Calof's (1993) recent study of the mode choice and change process provides some

47 direction for research which takes a longer term, developmental view of channels and their impact on export performance. Two recent dissertations have tangentially addressed the issue of channel choice and performance in the software industry. Green (1992) developed a comprehensive model of new product entry strategy and performance, and tested it in the US microcomputer word processing and business graphics markets. Her model included a binary variable "direct" versus "indirect" channels. Her model showed partial support for the hypothesis that direct channels are associated with higher sales performance. Abramson (1992) studied 76 Canadian software companies in an attempt to identify the relationship between corporate structure, coordination of US operations, and US sales performance. Firms that invested in their US activities by hiring A m e r i c a n market experts, and transferring activities related to the development, manufacture, marketing, sale and servicing of their products to a US location, were found to have higher performance measures. These studies provide sufficient evidence of a channel choice-performance link to warrant further study. Finally, this research suggests that an examination of the limitation and handling problems in the software industry would be of use.* The limitation problem arises because of constraints on a firm's resources. The relationships firms develop with customers are limited by their technology, organization and knowledge. Dunn e t al. (1991) argue that high technology buyers are demanding complete "enterprise solutions. One of the executives they interviewed described the situation: "As computers become more embedded in a buyer's business, they want total solutions, not operational tools. They are buying a complete house, not just tools like hammers, nails, and lumber" (Dunn e t a l . , 1991, p. 154). These complete solutions often go beyond hardware and software technology, to encompass the entire knowledge and business strategy of the buyer. As few firms have the resources to create these enterprise solutions themselves, alliances with other partners are becoming a necessity. These in turn are creating new forms of distribution channels. As one respondent pointed out " . . . standard measures of marketing success are difficult to use in our model of business development. The typical technology marketing channels - - distributors, representatives, etc. - - are not suitable. Technology alliances (watchword of the nineties) are the appropriate way to market a sophisticated and technologically ground breaking software product". Joint marketing agreements between firms with different but complementary sets of technology, organization and knowledge are one means of overcoming the limitation problem (Bucklin and Sengupta, 1993). These non-equity alliances are not easily explained using TCA, nor are they easy to empirically characterize. To the extent that these relationships play an increasing role in the marketing of knowledge intensive high technology products and services, *See Hakansson et al. (1977), Hakansson and Wootz (1979) and Hakansson (1982) for a description of the limitationand handlingproblemsin marketing.

Foreign Channel Integration Decisions

48 International Business Review 5,1

other more encompassing explanatory frameworks need to be explored for these sectors. Potentially fruitful examples include resource dependency theory, political economy theory, and the industrial network paradigm. Firms are also limited in terms of their allocation of resources between customers. Usually, customers whose purchases contribute disproportionately to revenues are given special treatment (Moody, 1992). An example in the software market is the use of manufacturer's representatives to service corporate customers, while individual purchases are handled through a distributor based channel. Upgrades are also often handled through a different channel than the original sale. The use and structure of dual channels might be explored using a portfolio model of the allocation of marketing resources to various customers. Anderson et al.'s (1987) model of the selling time allocated by independent sales agents to the principals they represent would be a useful starting point for this research. Acknowledgements - - The author would like to acknowledge funding provided by the University of Lethbridge Research Fund; the research assistance of Mark Laver who administered the survey and coded the responses; and the suggestions of three anonymous International Business Review reviewers.

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