The influence of industry structure on the entry mode choice of overseas entrants in manufacturing industries

Journal of International Management 10 (2004) 107 – 124

The influence of industry structure on the entry mode choice of overseas entrants in manufacturing industries B. Elango a,*, Rakesh B. Sambharya b,1 a

Management and Quantitative Methods Department, College of Business, Illinois State University, Campus Box 5580, Normal, IL 61790-6120, USA b School of Business, Rutgers University-Camden, 227 Penn Street, Camden NJ 08102, USA

Abstract This study examines the impact of industry structure on the foreign direct investment (FDI) entry mode decisions by multinational enterprises (MNEs) in manufacturing industries. We explore the notion that firms would seek to balance the risks due to industry structural barriers and liabilities of foreignness while seeking entry in international markets. A multinomial logistic regression model is used to test 336 entry decisions from 18 countries entering the United States over the period 1989 – 1994. Empirical evidence shows that underlying industries’ structural characteristics influence a firm’s preference for entry mode alternatives such as greenfield investments, acquisitions, and joint ventures. In concentrated and high-growth industries, foreign firms prefer entry by setting up greenfield operations rather than pursuing acquisitions or joint ventures. However, in industries characterized by high gross profits or higher plant scale, the preference is for joint ventures or acquisitions as an entry mode over greenfield operations. D 2004 Elsevier Inc. All rights reserved. Keywords: Entry modes; Industry structure; Joint ventures

1. Introduction The globalization of markets in recent years was primarily due to the explosive growth of foreign direct investment (FDI). FDI grew at a much higher rate in the 1980s and 1990s than world output and world exports (World Investment Report, 2000). World FDI inflows * Corresponding author. Tel.: +1-309-438-5930; fax: +1-309-438-5510. E-mail addresses: [email protected] (B. Elango), [email protected] (R.B. Sambharya). 1 Tel.: +1-856-225-6712. 1075-4253/$ - see front matter D 2004 Elsevier Inc. All rights reserved. doi:10.1016/j.intman.2003.12.005

108

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

dramatically rose from US$250 billion in 1990 to US$1.3 trillion by 2000 (World Investment Report, 2001). Given the enormous amount of FDI occurring in the world, the choice of modes of entry is an important research question. Typically, multinational enterprises (MNEs) employ three modes of entry into foreign markets that involve equity investments: creating wholly owned subsidiaries—either by establishing a greenfield venture or by an acquisition—or creating a joint venture with a local partner. The choice of entry mode is a very important decision for MNEs competing globally. There are several reasons for studying international modes of entry. First, given the sheer amount of FDI inflows in the world as noted above, it is useful for firms to identify which host country industry factors are important in choosing among the various modes of entry (joint ventures, acquisitions, or greenfield ventures). Second, international diversification through foreign market entry can result in high growth and profitability unavailable in home markets (Root, 1994). Several studies have examined the performance differences between wholly owned modes (acquisitions or greenfield ventures) and joint ventures (Nitsch et al., 1996; Pan and Chi, 1999; Pan et al., 1999; Shrader, 2001; Simmonds, 1990; Woodcock et al., 1994). Aulakh and Kotabe (1997) suggest that is the not just entry mode per se, but the ‘‘fit’’ between mode of entry and transaction-specific factors, organizational capability, and strategic factors that affect firm performance. A third reason this warrants some attention is the various modes of entry that can be effectively used to counter international competition by engaging foreign rivals on their home turf (Watson, 1982). Fourth, firms have the option of choosing the appropriate entry mode for international markets based on balancing their resources, capabilities, and international experience with their desire for ownership and control. Finally, equity entry mode choices are often massive and irreversible and can influence the long-term performance of the firm (Shrader, 2001). Brouthers’ (2002) model of international market entry essentially states that firms selecting their mode of entry based on the institutional context, transaction costs, and cultural context variables should achieve higher entry mode success than firms selecting modes of entry that do not take these factors into consideration. Previous studies on this topic have been valuable in increasing our understanding of entry mode decisions, but they overlook two issues. First, these studies use one or more industry structure variables, either as one of the independent variables in the study or as control variables, thereby ignoring the many dimensions of industry structure. Researchers have focused on the firm, industry, and country levels of explanatory variables for both home and host country characteristics. A review of the mode of entry literature indicates a preponderance of studies focusing on firm characteristics and host country characteristics. Industries are complex entities and multidimensional in nature, and the impact of industry structure on entry mode has been relatively unexplored in previous studies. Therefore, a more comprehensive study of the influence of host country industry characteristics is needed. Second, most studies do not consider all three entry mode options (greenfield investments, acquisitions, and joint ventures), with the exception of Caves and Mehra (1986), Kogut and Singh (1988), and Chang and Rosenzweig (2001). In most studies, the focus of empirical testing seems to be on two of the three options and does not reflect the range of choices available to the MNE. Hence, this study will focus on analyzing the impact of several dimensions of industry structure on the three types of entry mode in FDI.

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

109

As a first step, this largely exploratory study will empirically test for any linkages between the range of industry structure variables and choice of the mode of entry by firms. Testing the influence of industry structure on the entry mode decision of firms could help us understand how the dynamics of the host country market influences firm strategy. Such a study will contribute to future research in two important ways. First, it will help researchers identify the dimensions of industry structure that influence entry mode decisions. Second, this study will contribute to the development of entry mode literature by increasing our understanding of the influence of industry characteristics on a firm’s entry strategy. This study uses the United States as the host country for testing the influence of industry structure on entry mode choices. The usage of the United States as the host country provides this study with significant benefits. One, the United States is one of the biggest recipients of FDI. Investments by foreign direct investors to acquire or establish a business in the United States increased by 17% to US$320.9 billion in the year 2000 (U.S. Department of Commerce, 2001). Two, the number of countries setting up operations in the United States is varied and hence could potentially offer a generalizable home country sample needed for this study. Three, data available from various U.S. government departments make such a study possible. Finally, governmental role in distorting resource allocation and foreclosing entry options is relatively minimal in the United States, compared with most large economies in the world. Although an MNE can also enter international markets through licensing or through exports, both of these modes involve relatively minimal to no investment in the host country and are not considered FDI (Chang and Rosenzweig, 2001), so they will not be the focus of this paper. In the next two sections, the theoretical premise of this paper is explained and hypotheses are developed. Section 4 explains the data collection process and the research methodology used. The final section presents the results and discusses the study findings. It also presents the limitations of this study and concludes with managerial and public policy implications.

2. Conceptual framework This paper focuses on three modes of entry (greenfield, acquisition, and joint venture), all of which involve equity investments. All three options commit a firm to a strategic choice, as they cannot be changed easily and involve significant resource and time commitments. In a greenfield investment, a foreign firm starts operations on its own in a host country. This results in the creation of new capacity/supply in a particular industry. The onus is on the entrant to provide all the requisite resources and capabilities for the investment to overcome industry structural barriers, as well as risks due to liabilities of foreignness. In an acquisition, the foreign firm merges with or acquires an established entity in the host country. Acquisitions are used when time is an important issue in the investment decision, as it can be done much faster than a greenfield or joint venture entry. An important benefit of acquisition is that a foreign firm can be in control of an established firm, thereby overcoming industry structural barriers in the host country and the liabilities of foreignness rather quickly. An acquisition does not create new industry capacity, as do greenfield investments, and therefore does not increase industry supply. Both greenfield investment and acquisition

110

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

by the foreign firm result in ownership by a single firm, though the means to achieve ownership are different. A joint venture is a partnership wherein the venture (business) is jointly owned by two or more firms. It involves two or more firms investing in or sharing resources, thereby allowing for some degree of flexibility in the sourcing and deployment of resources to overcome industry barriers and minimizing the risks of liabilities of foreignness. While it is hard to accurately predict the influence of a joint venture on industry supply, joint ventures allow for risk pooling, thereby enabling the entrant to more effectively face industry structural barriers and risks due to liabilities of foreignness. The literature on modes of entry is extensive (Brouthers and Brouthers, 2001; Caves and Mehra, 1986; Davis et al., 2002; Hennart and Reddy, 1997; Kogut and Singh, 1988; Pan and Tse, 2000; Zejan, 1990). In a comprehensive review of choice of entry modes, Datta et al. (2002) report 14 studies that utilized host industry characteristics as predictors. Of these, only three used all three types of equity participation (acquisitions, joint ventures, and wholly owned subsidiaries) as modes of entry. In a study of 228 entries into the United States by foreign firms, Kogut and Singh (1988) found that industry R&D intensity was associated with the likelihood that joint ventures will be preferred over acquisitions, but advertising intensity was not a significant factor. Another notable study was by Caves and Mehra (1986), who looked at 138 entry decisions of foreign firms, considering many industry variables along with firm level variables. The two modes they looked at were mergers and greenfield entrants while controlling for joint ventures. They concluded by claiming that the type of goods produced (durable vs. nondurable), firm size, product diversity, and the extent of multinationality were likely predictors of acquisition as preferred entry mode, depending on the industry structure. Hennart and Reddy (1997) analyzed the choice between mergers/acquisitions and joint ventures for 175 Japanese entries into the United States. They reported that joint ventures would be preferred by firms in instances where nondesirable assets are linked with desirable assets, when the Japanese firm has previous experience, when there is good product compatibility, and where there is a growing market. Although these studies found support for the notion that industry structure influences the entry mode choice of firms, they only used two variables or less to capture that effect. Significant research exists at the firm level supporting the entry mode choice using a transaction cost approach (e.g., Anderson and Gatignon, 1986; Hennart, 1988) and firm characteristics (Chang, 1995). Transaction cost theory also suggests that the choice of entry mode depends on host country characteristics. Hennart (1991) argues that in resource- and technology-intensive industries, firms use shared-control modes to access local resources. Similarly, at the country level, the influence of national culture on entry mode choice has been supported (e.g., Kogut and Singh, 1988; Shane, 1994). Eclectic theory suggests that in developed countries, wholly owned subsidiaries have the highest long-term potential (Dunning, 1988). Erramilli et al. (1997) found that even the firmspecific advantages of Korean MNEs were dependent on host country location. Therefore, the influence of host country characteristics on entry mode, of which industry structure is an underlying element, is well established. An industry’s structure is comprised of technical and economic dimensions within which firms compete (Bain, 1972). The linkage among industry structure, firm conduct, and performance has been well articulated in the structure – conduct – performance (S-C-P)

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

111

paradigm. Stated briefly, the S-C-P paradigm is based on the following logic: Industry structure influences the types of strategic choice that firms within the industry use to compete against each other (Porter, 1980). For example, entry barriers prevalent in an industry protect all firms in an industry from new entrants (Bain, 1956). Even though firms in an industry will vary in terms of resources, capabilities, size, etc., all firms in an industry face the dynamics of a particular market (e.g., competition, product differentiation costs, market demand). This industry-specific confluence of dynamics, to a large extent, influences the response of all companies within an industry. Therefore, the structure of an industry and its underlying economics influence ‘‘competitive rules of the game as well as the strategies potentially available for a firm in an industry’’ (Porter, 1980) and consequently the profitability of all firms in that industry. Previous research suggests that a firm’s capacity to earn profits is highly correlated to the attractiveness and profitability of the industry in which the firm operates (for a review, see Schmalensee, 1989). Hymer (1976) proposed that firms exist because they possess ‘‘unique assets’’ in terms of products, processes, and skills. Examples of unique firm-specific assets and intangible wealth include established brand names, the firm’s reputation, favored access to suppliers and skilled manpower, and superior products and processes. These resources, when employed in a host country during overseas entry, serve to reduce rivalry, as they are imperfectly imitable (Kindleberger, 1969). The poor imitability of these unique assets enables a firm to gain ‘‘competitive advantage’’ or ‘‘market power’’ (Porter, 1980, 1985) over its rivals. Hence, the foreign entrant can be viewed as a special case of the multiplant firm operating in different countries due to market imperfections (Horaguchi and Toyne, 1990). Such firms integrate industries by owning assets or controlling activities across countries as a result of structural market imperfections and transaction cost advantages (Hymer, 1970; Teece, 1981). The concept of industry barriers, when applied to an overseas entrant, should be viewed as a case of market diversification by overseas firms, and as such traditional industry barriers need to be viewed differently. For instance, in many ways, foreign entrants are similar to diversifying entrants and are not likely to face the same disadvantages as some new entrants. As argued by Caves and Porter (1977) in the case of diversifying entrants, the overseas entrant also may possess advantages in ‘‘. . .intangible assets or excess capacity in tangible assets that can reduce the opportunity cost of entry or raise the return it can wrest by committing a given bundle of tangible assets to the market.. . .’’ Nevertheless, foreign firms are likely to be at a disadvantage in terms of understanding the local environment and culture. The international business literature is full of examples of foreign entrants stumbling and failing due to lack of managerial skills or knowledge of local contacts, regulatory issues, political nuances, customer idiosyncrasies, and other issues usually unknown to new foreign entrants. These disadvantages are commonly referred to as ‘‘liabilities of foreignness’’ (Hymer, 1976; Zaheer, 1995). It is also likely that the foreign firms will have different competitive norms and strategic approaches compared to domestic firms (Porter, 1980). An individual firm’s ability to successfully enter a new industry will vary based on the effectiveness of its conduct, i.e., choice of a particular strategy. In the context of this study, the ‘‘fit’’ achieved by the firm between its choice of entry mode and the characteristics or traits relevant to the industry entered (commonly referred to in the strategy literature as environmental consistency) would be critical in

112

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

determining firm-level competitive outcomes. Hence, when entering an overseas market, a foreign firm will attempt to choose an entry mode that would help overcome industry barriers that might prevent it from succeeding in that overseas market. Therefore, other conditions remaining equal, one would predict that industry characteristics of the host country would play a role in determining a firm’s choice of entry mode. Therefore, while seeking entry into international markets, foreign firms would seek to balance the risks (due to liabilities of foreignness and industry structural barriers) in operating in a new host country market and the resource advantages they have due to operations in other markets. Based on this premise, the following section will develop hypotheses regarding the relationship between the various dimensions of industry structure and entry modes chosen by overseas entrants.

3. Hypothesis development Industry structure refers to the relatively stable economic and technical dimensions of an industry that provides the context in which competition occurs (Porter, 1980). Three elements of industry structure are believed to be important, as they affect firm profitability in a given industry (Martin, 1979). They are as follows: (1) factors that influence the degree of rivalry (and the ease of collusion) in an industry, (2) entry barriers, and (3) demand conditions. Measuring these constructs directly is a difficult task, and because of this, past research has used surrogate measures to capture them. For example, ease of collusion is often a proxy through measures of seller concentration in the market and the amount of imports prevalent in the industry (Clarke, 1985). Similarly, entry barriers can be measured through scale economies present in the industry. Market growth rate and extent of fluctuation in demand (market volatility) is used as a proxy for demand conditions (Clarke, 1985). The following section explains each of the three elements of industry structure, and hypotheses are developed linking the outcome of a particular variable with an entry mode choice. 3.1. Degree of rivalry This dimension attempts to capture the extent of competition in the industry. Traditionally, measures of seller concentration in the market and the amount of imports have served as a proxy for industry rivalry (Clarke, 1985). In industries with intense competition, new entrants would find it difficult to enter and operate successfully. This dimension of entry barriers is operationalized through two measures: the degree of firm concentration in the industry and the extent of market share held by imports in the industry. In industries with a low concentration, foreign firms may be able to gain market share relatively easily and thus have a preference for greenfield operations as an entry mode. In highly concentrated industries, however, foreign firms would favor entry through merger or acquisition for two reasons. First, an acquisition avoids the creation of new capacity that could lead to a price war between incumbents and the entrant (Caves and Mehra, 1986). Second, it reduces the possibility of retaliation by existing incumbents in the industry. Therefore, in a highly concentrated industry, entry by foreign firms is more likely to be

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

113

through merger or acquisition, whereas in industries with low concentration, entry would more likely be by greenfield operations. Chang and Rosenzweig (2001) studied 950 entries by 119 Japanese and European firms into the United States over a 17-year period and found that market concentration was a significant factor in predicting choice among the three equity-based modes of entry. One caveat with this argument is that there are fewer candidates available for acquisitions in a concentrated industry. It is also unclear what effect concentration would have on joint venture formation. Therefore, we tentatively propose. Hypothesis 1. In industries characterized by concentration, firms are likely to prefer acquisitions (over greenfield operations) as a market entry mode. The influence of import competition on industry profitability and firm behavior is well known in the literature (e.g., Cubbin and Geroski, 1987; Turner, 1980). Though this variable has not been specifically tested in the entry mode literature, other studies on this topic (e.g., Caves and Mehra, 1986) have incorporated import market share in other variables (such as industry concentration) in entry mode models. As this study focuses on industry structure, we decided to test the influence of import market share separately. In industries with high levels of import market share, foreign entrants are likely to use greenfield operations as a favored mode of entry over acquisitions or joint ventures. This will happen because foreign entrants might be more confident in succeeding by setting up operations on their own, considering the fact that they or other foreign firms have had some degree of success selling their products in the host nation. Hypothesis 2. In industries characterized by import intensity, firms are likely to prefer greenfield operations (over acquisitions or joint ventures) as a market entry mode. 3.2. Entry barriers A common barrier to entry in manufacturing industries is scale economies. Scale economies refer to the need to build a plant at a particular size (in terms of quantity of output) to produce goods at a reasonable cost. Stated differently, this concept refers to the change in operational costs associated with the change in size of the firm. Scale economies arise due to the ability of the firm to perform value activities efficiently at a larger volume (Porter, 1980). According to Porter (1980, p. 21), scale economies result from ‘‘less than proportional’’ increases in costs or increased efficiencies in operation associated with particular levels of production volume. When plants are built to scale, the production costs of goods are lowest when operated at capacity (Harrigan, 1981; Scherer, 1980). Industries characterized by plant scale economies have significant barriers to entry, as entrants are forced to make significant investments to enter the industry at a particular size. Second, new entrants could face a strong competitive reaction from existing incumbents due to these firms’ sunk costs. Third, the creation of new capacity in such industries would hurt all firms, including the entrant. In industries characterized by plant scale economies, entrance through mergers/acquisitions or joint ventures can significantly minimize risk. Therefore, the presence of scale economies requires large investments to be made by the foreign firm, encouraging firms to enter foreign markets though joint ventures or

114

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

acquisitions. To the best of our knowledge, no study on mode of entry has incorporated this important explanatory variable. Hypothesis 3. In industries characterized by plant scale economies, firms are likely to prefer acquisitions or joint ventures (over greenfield operations) as a market entry mode. 3.3. Demand conditions Demand conditions are a proxy in this study through two measures (i.e., market growth rate and demand variability). In growing industries, incumbents are less likely to get involved in a price war or react adversely against new foreign entrants, as all firms would have the opportunity to grow. Hence, foreign firms attempting to enter growth industries in host country markets may not have to fight hard to gain market share. Highgrowth industries also represent many unique opportunities for firms, and greenfield operations are likely to be a preferred mode of entry over acquisitions or joint ventures. This is because an industry with growing demand will be able to absorb additional capacity created through greenfield investment. On the other hand, lack of industry growth and tapering of market demand usually sets a ‘‘cap’’ on a firm’s growth and profitability, thereby forcing it into a desperate battle for market share and resulting in increased competition in the industry (Oster, 1994). In such circumstances, the foreign entrant is likely to face significant competitive risk in establishing a foothold in the host country market. Caves and Mehra (1986) also reported that in low-growth industries, foreign firms are likely to acquire local firms, as they may find prices for acquisitions attractive due to the depressed market prospect and the need to avoid adding new capacity in a low-growth market. Therefore, in such instances, a foreign firm is likely to prefer an acquisition or joint venture to enter the host country market. The empirical evidence again is mixed. Caves and Mehra (1986) found that acquisitions are likely to be preferred when growth is either very low or very high. Hennart (1991) found that joint ventures are preferred over wholly owned subsidiaries in high-growth industries in the entry of Japanese firms to the United States. However, Makino and Neupert (2000) reported that industry growth is positively associated with the preference of wholly owned subsidiaries over joint ventures. Hypothesis 4. In industries characterized by growing markets, firms are likely to prefer greenfield operations (over acquisitions or joint ventures) as a market entry mode. Demand variability refers to the year-to-year change in shipments within an industry. In industries characterized by frequent changes in demand annually, there is a higher level of operational risk for new foreign entrants. In such industries, foreign entrants will attempt to minimize this risk by either acquiring or engaging in a joint venture with a local partner. By acquiring or teaming with a local firm, the foreign entrant is able to secure a position in the market quickly, allowing for a greater ability to cope and to manage variations in demand. Foreign firms would not want to be burdened with a new plant in industries with a potential for market contraction. However, in industries characterized by relatively lesser demand changes, foreign firms would be able to forecast more effectively and plan for the

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

115

most appropriate entry strategy. This would allow foreign firms to be more confident in entering industries with minimal variation in demand through greenfield ventures. Hypothesis 5. In industries characterized by demand variability, firms are likely to prefer acquisitions or joint ventures (over greenfield operations) as a market entry mode.

4. Data collection and methodology The following section will elaborate the process undertaken for data collection and the statistical methodology used in the testing of the hypotheses. 4.1. Data collection The sample for this study is limited to manufacturing firms due to the nature of this study, and as a result, only firms with SIC codes between 2000 and 3999 were included in the sample. The sample is drawn from the U.S. Department of Commerce listing of transactions made by overseas investors in the United States during the years 1989 –1994. As this study’s focus is on three types of entry modes, we selected firms that made an investment in the United States either through an acquisition, greenfield venture, or joint venture. These independent transactions were matched with the corresponding industry and firm variables based on the year the transaction took place. This resulted in a crosssectional data set with a sample of 336 transactions made by firms from 18 nations occurring anytime during the 1989 –1994 time frame. These transactions represented 210 acquisitions, 41 joint ventures, and 85 greenfield entries by overseas firms, which in aggregate percentages are roughly representative of the types of overseas investments in the United States reported by the U.S. Department of Commerce during the years 1989 – 1994. The sample distribution of firms across two-digit industry categorizations is presented in Appendix A. To segregate the effect of industry structure on entry mode choice, we incorporated five control variables into the regression model: four at the industry level and one at the firm level. At the industry level, we incorporated industry shipments, gross profit, research intensity, and advertising intensity based on a review of industry variables studied in the FDI literature (e.g., Caves and Mehra, 1986; Harzing, 2002; Kwon and Konopa, 1992; Kogut and Singh, 1988; Zejan, 1990). Needless to say, these four variables represent important industry characteristics (profitability, size, and product differentiation barriers) and would play a part in influencing foreign firms’ motivation towards a particular entry mode. Therefore, they need to be controlled in hypothesis testing. At the firm level, we incorporated firm size as a control variable based on past research (Hennart and Larimo, 1997). The rationale for the inclusion of firm size is that larger firms are likely to have greater resources and ability to absorb higher risk compared to smaller firms, thereby influencing entry mode decisions differentially (Erramilli and Rao, 1993). The operationalization of the variables and the sources of information for the variables in the study are described in Appendix B. The operationalization of the variables was either based on previous research in the industrial organization literature (e.g., Sakakibara

116

1. Concentration 2. Industry imports ratio 3. Plant scale 4. Growth rate 5. Demand variation 6. Industry shipments 7. Gross profit 8. R&D intensity 9. Advertising intensity 10. Firm size

Mean

S.D.

665.88 0.1994 0.1373 50.70 85.62 21,271 35.40 3.99 1.88 49,718

682.35 0.1803 0.1761 35.495 34.529 28,220 5.97 1.90 1.38 76,184

* Significant at the 5% level, using a two-tailed test. ** Significant at the 1% level.

1

2 1 .147** .411** .166** .053 .458** .261** .010 .128* .207**

3 1 .087 .335** .347** .145** .015 .256** .179** .030

4

1 .002 .037 .550** .298** .179** .260** .116*

5

1 .632** .160** .269** .212** .041 .052

6

1 .017 .004 .106 .237** .050

7

1 .223** .022 0.137* .229**

8

1 .385** .247** .053

1 .106 .061

9

10

1 .007

1

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

Table 1 Descriptive statistics and correlation matrix (n = 336)

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

117

and Porter, 2001) or represent standard accounting ratios. Descriptive statistics of the variables, along with correlation values, are presented in Table 1. A review of the correlations indicated a potential problem. The correlation between demand variation and growth rate is .63. We conducted statistical analyses and looked at the variance inflation factor (VIF) to address the multicollinearity issue (the VIF numbers were 1.646, 1.290, 1.386, 1.269, 1.678, 2.503, 2.141, 1.911, 1.546, and 1.092). A VIF of less than 10 is considered indicative of the data having no multicollinearity problems. This conclusion is also supported by the fact that leading references in econometrics and statistical methodology have offered, as a rule of thumb, that collinear relationships under .7 should not create potential problems (or statistical confounds) related to multicollinearity (Anderson et al., 1996; William et al., 1993). 4.2. Statistical methodology The impact of entry barriers on entry mode choices is analyzed using a multinomial logistic regression model. Multinomial logistic regression was chosen because the dependent variable (mode of entry) is a categorical variable (greenfield, merger/acquisition, and joint venture). The multinomial logistic model estimates the effect of the explanatory variables on the probability (differential odds) that one of three alternatives will be selected. To avoid overestimation, the program estimates the parameters by setting the betas of one of the alternatives to zero (Kogut and Singh, 1988). We coded the three entry modes in three different sequences so that three separate analyses could be conducted, wherein each one of the entry modes served as a baseline case (allowing for three-way comparison). Table 2 presents the results of one analysis wherein the greenfield operations beta was set to 0. For reasons of parsimony, the results of the other analyses are presented in the text of the paper as required. The estimates should be interpreted as Table 2 Multinomial logistic results Variable

Greenfield

Intercept Concentration Industry imports ratio Plant scale Growth rate Demand variation Industry shipments Gross profit R&D intensity Advertising intensity Firm size Pseudo-R2 v2 Correct classification

0 0 0 0 0 0 0 0 0 0 0 .30 97.79*** 69.6%

* Significant at the 10% level, using a two-tailed test. ** Significant at the 5% level. *** Significant at the 1% level.

Acquisition 0.989*** 0.577*** 0.364* 0.944*** 0.434* 0.346* 0.737*** 0.756*** 0.115 0.102 0.147

Joint venture 0.797*** 0.783*** 0.288 1.151*** 0.929*** 0.429* 0.222 0.622** 0.452* 0.333 0.539**

118

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

representing the marginal utility of choosing a merger/acquisition or joint venture over a greenfield venture. In addition, the statistical output reports whether the total model is significant along with a pseudo-R2 and likelihood ratio tests of each of the variables.

5. Study results and discussion 5.1. Study results The study findings are reported in Table 2. The beta for greenfield ventures is set to 0 based on past research practice (Aulakh and Kotabe, 1997). Hypotheses 1 and 2 dealt with industry rivalry. Hypothesis 1 stated that firms in concentrated industries would prefer acquisitions over greenfield entry. This hypothesis received statistical support with parameter estimates of 0.577 ( P < .01), with directional loadings contrary to what is proposed by the hypothesis. No prediction was made in the case of joint ventures in this study due to a lack of understanding of the influence of concentration. The study findings indicate that firms prefer greenfield operations over joint ventures (parameter estimate = 0.783, P < .01) in concentrated industries. Hypothesis 2 dealt with industry imports, and it was proposed that in industries characterized by imports, firms would prefer greenfield operations over acquisitions and joint ventures—the other two options considered in this study. This hypothesis received only partial support for greenfield operations over acquisitions. As predicted in Hypothesis 3, entries in industries characterized by plant scale preferred joint ventures or acquisitions over greenfield entries. This hypothesis received statistical support with the largest estimates among all variables in both instances, with a parameter estimate of 1.151 ( P < .01) for joint ventures over greenfield entries and a parameter estimate of 0.944 ( P < .01) for acquisitions over greenfield entries. Hypothesis 4, which dealt with demand conditions in the industry, was statistically supported with parameter estimates of 0.929 ( P < .01) for greenfield over joint ventures, but parameter estimates were marginally significant for greenfield over acquisitions. The results of this study indicate that greenfield entry is preferred by firms seeking entry into the United States in industries characterized by high growth rates. Hypothesis 5 focused on demand variation, proposing that foreign firms are likely to seek acquisitions or joint ventures over greenfield operations during entry. This hypothesis was only marginally supported in both instances (for acquisitions over greenfield entry and joint ventures over greenfield entry). This study also included five control variables. Four of them were at the industry level and measured industry shipments (representing industry size), gross profits (representing industry profitability), and research and advertising intensity (representing product differentiation). The study’s findings indicate that industry size influences entry mode choice of foreign firms. Larger industries seem to encourage greenfield entry and joint ventures over acquisitions (parameter estimates of 0.737, P < .01, and 0.514, P < .01, respectively). However, the size of an industry does not seem to have a role in influencing the choice between greenfield operations or joint ventures (parameter estimate = 0.222, nonsignificant). Industry profitability (measured in terms of gross profits) seems to encourage entry by acquisitions or joint ventures over greenfield entry (parameter

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

119

estimates of 0.756, P < .01, and 0.622, P < .05, respectively). However, in profitable industries, firms did not have any specific preference between acquisitions or joint ventures. In industries characterized by investments in R&D, firms prefer acquisitions over joint ventures (parameter estimate = 0.567, P < .01).2 In industries characterized by investments in advertising, there was no statistical support for one entry mode over another. The fifth control variable measured firm size using the natural logarithm of the number of employees. It was found that firms with a large number of employees prefer greenfield entry and acquisitions over joint ventures (parameter estimates of 0.539, P < .01, and 0.329, P < .05, respectively), but firm size does not seem to influence the choice of acquisitions versus greenfield operations. 5.2. Discussion This study tested for the influence of host country industry structure variables such as entry barriers, nature of demand, and degree of rivalry on entry mode choice—a hitherto neglected area in this literature. Results indicate support for the notion that industry structure influences entry mode. The findings indicate that concentrated industries seem to discourage entry by acquisitions. This was contrary to what was proposed in Hypothesis 1 based on previous research findings. The rationale for the hypothesis was that foreign firms would seek to avoid competition and addition of new capacity in a concentrated industry. However, reflecting on the findings, we believe there are three reasons that foreign firms might not choose acquisitions as the preferred mode of entry in concentrated industries. One, there may be fewer opportunities or targets to acquire. Two, it is possible in concentrated industries that the targets could be too large and expensive. In such instances, the foreign firm must be willing to invest huge sums in acquiring the target and face postacquisitions risk. Third, it may be difficult to acquire firms in certain industries, such as defense and media, due to regulatory and political concerns. To overcome entry barriers, it was proposed that plant scale economies would encourage entry by acquisitions or joint ventures. This entry pattern reflects a choice by foreign firms to avoid intense competition. This behavior is encouraging to incumbent firms in that foreign firms are not attempting to influence competitive balance and thereby do not serve as a threat to industry profitability. This has troubling implications for public policy because foreign entrants do not increase competition. Growing markets seem to encourage entry of foreign firms by greenfield operations. These markets offer foreign firms some degree of protection from intense competition by local rivals, thereby allowing for a greater chance of success. Foreign firms also have greater motivation in growing industries to set up greenfield operations and gain the potential long run benefits of independent operations. The following section discusses the limitations of the study and concludes with implications for theory and practice. 5.2.1. Study limitations As with any study, this one has several limitations by virtue of its research question and repeated cross-sectional design. Hence, the study’s results need to be interpreted with due 2

The logistic results comparing acquisitions versus joint ventures are not reported in tabular form.

120

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

caution, as it does not attempt to measure changes that may occur longitudinally. Being exploratory in nature, the emphasis of this study was to test the influence of many industry structure variables, thereby ignoring the dynamic effects within an industry. The dynamic effects that take place within an industry can be captured only with few variables and a modest number of industries at best. However, this study is oriented toward a large sample and hence uses secondary data. Second, in the interest of parsimony, firm- and countrylevel variables were largely ignored in the analysis. Future studies need to explore this avenue further. Third, this study focused on three modes of entry in FDIs. While this approach captures the majority of entry modes in overseas markets, it fails to capture ‘‘hybrid’’ entry modes wherein, for instance, a firm forms a joint venture (with a second firm) to make a greenfield venture or make an acquisition. Further research in this regard would provide interesting findings to supplement our current understanding on this topic. Fourth, a missing link in this study is that it fails to test whether the degree of fit between entry mode strategy chosen by the firm and underlying industry structure leads to successful outcomes. While such an analysis would be interesting, this could be done only in a longitudinal study, as outcomes can be measured only at a later time period. Finally, temporal factors and events that took place during this period of time, which might have led to a particular choice of entry mode, are not controlled in this study. Replication of the reported findings in other contexts will lead to greater external validity of this study. 5.2.2. Study implications The results of this study present implications for managers, public policymakers, and researchers. One significant implication is that firms need to examine the salient host country industry characteristics that might influence their mode of entry choices. For instance, study findings indicate that in industries characterized by high concentration, there are two reasons why firms are less likely to pursue acquisitions. First, it is likely that overseas entrants find a dearth of good candidates to acquire. Second, the potential risks associated with postacquisition integration may significantly outweigh other advantages an acquisition may bring to the overseas entrant. Despite arguments offered in the earlier section of the paper, one would advise overseas firms to avoid acquisitions in concentrated markets. Growing demand conditions encourage greenfield entry by overseas entrants. Therefore, one may suggest that firms preferring to enter overseas markets through greenfield operations may want to enter these growing markets. A growing market may allow an overseas entrant to successfully overcome the initial disadvantages associated with operating in an alien market, as it is likely to be more tolerant of managerial missteps. Greenfield operations also offer the flexibility for the foreign firm to enter the industry with a lower investment/overhead initially, allowing for later expansion as demand materializes. The reverse is true for industries characterized by high plant scale economies. Overseas entrants may want to acquire an existing firm or team up with partners during entry rather than attempting entry on their own. When planning entry into profitable industries, overseas firms tend to avoid greenfield operations. The implication is that newer capacity would needlessly depress prices and profitability, leading to detrimental effects for everyone in an otherwise profitable market. One other reason could be that an acquisition or joint venture offers a quicker route to profitability in such industries, as creation of monopolistic advantages with greenfield operations would take time.

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

121

At the public policy level, this study’s findings do not support the belief that in industries with high profit, new foreign investment leads to increased competition. Foreign firms’ entry mode strategy in such industries seems to be towards acquisitions or joint ventures, which might not lead to an increased number of firms. Hence, it is advisable for host nations to make a closer review of foreign investments that take place in order to encourage competition. For researchers working on the topic of entry mode, the strong showing of concentration, scale economies, industry growth rate, and industry profitability brings the need to incorporate these variables into future studies. Previous scholars suggested that the link between mode of entry and firm performance was dependent on the ‘‘fit’’ between mode of entry and transaction-specific factors, organizational capability, and strategic factors that affect firm performance (Aulakh and Kotabe, 1997; Brouthers, 2002). The results of the present study indicate support for the premise that foreign firms seek to reduce the risk posed by host country industry barriers by choosing modes that attenuate industry barriers or stabilize industry structural characteristics in host countries during entry. This strategy by the overseas entrant, during entry, allows it to participate in the host country industry with current incumbents while maximizing its own performance.

Acknowledgements The authors wish to acknowledge Chris Anderson, Vance H. Fried, and the anonymous reviewers for the comments offered on the earlier drafts of the manuscript. All other disclaimers apply.

Appendix A . Sample distribution of firms across two-digit SIC industries

SIC

Industry

Number of firms

Percentage

20 22 23 24 27 28 29 30 32 33 34 35 36 37 38 39

Food and kindred products Textile manufactures Apparel and other textile products Lumber and wood products Printing and publishing Chemicals and allied products Petroleum and coal products Rubber and miscellaneous plastics products Stone, clay, glass, and concrete products Primary metal industries Fabricated metal products Industrial machinery and equipment Electrical and electronic equipment Transportation equipment Instruments and related products Miscellaneous manufacturing industries Total

13 2 3 3 2 70 1 4 6 27 20 58 63 27 32 5 336

3.9 0.6 0.9 0.9 0.6 20.8 0.3 1.2 1.8 8.0 6.0 17.3 18.8 8.0 9.5 1.5 100.0

122

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

Appendix B . Variable description and data sources

Variable

Description/data source

Concentration

1992 Herfindahl – Hirschman Index Measure of Concentration of the four-digit SIC industry. Source: Census of Manufactures, Department of Commerce. Total imports of the four-digit SIC industry is divided by industry shipments of the four-digit SIC industry for the corresponding year the transaction took place. Source: NBER (Feenstra) Database. Total number of employees divided by the number of establishments of the four-digit SIC industry. Source: Census of Manufactures, Department of Commerce. Growth in industry shipments of the four-digit SIC industry over an 8-year period 1987 – 1994. Source: Census of Manufactures, Department of Commerce. Absolute variation in the year-to-year shipments of the four-digit SIC industry over a 10-year period. Source: Census of Manufactures, Department of Commerce. Total shipments in the four-digit SIC industry for the corresponding year the transaction took place. Source: NBER-CES Manufacturing Industry Database. Industry gross profit divided by sales of the four-digit SIC industry for the corresponding year the transaction took place. Source: Dun and Bradstreet Information Services. Industry research and development expenditure divided by industry sales of the three-digit SIC industry. Source: Compustat Database. Industry advertising expenditure divided by industry sales of the three-digit SIC industry. Source: Compustat Database. Natural logarithm of the number of firm employees. Source: Worldscope Global Database.

Industry imports ratio

Plant scale Growth rate Demand variation Industry shipments Gross profit

R&D intensity Advertising intensity Firm size

References Anderson, E., Gatignon, H., 1986. Modes of foreign entry: a transaction cost analysis and propositions. J. Int. Bus. Stud. 17, 1 – 26. Anderson, D.R., Sweeney, D.J., Williams, T.A., 1996. Statistics for Business and Economics. West Publishing, St. Paul, MN. Aulakh, P.S., Kotabe, M., 1997. Antecedents and performance implications of channel integration in foreign markets. J. Int. Bus. Stud. 18, 145 – 175. Bain, J., 1956. Barriers to New Competition. Harvard Univ. Press, Cambridge, MA. Bain, J., 1972. Essays in Price Theory and Industrial Organization. Little, Brown, Boston. Brouthers, K.D., 2002. Institutional, cultural and transaction costs influences on entry mode choice and performance. J. Int. Bus. Stud. 33, 203 – 222. Brouthers, K.D., Brouthers, L.E., 2001. Explaining the national culture distance paradox. J. Int. Bus. Stud. 32, 177 – 189. Caves, R.E., Mehra, S.K., 1986. Entry of foreign multinational into U.S. manufacturing industries. In: Porter, M.E. (Ed.), Competition in Global Industries. Harvard Business School Press, Boston, MA, pp. 449 – 481. Caves, R.E., Porter, M.E., 1977. From entry barriers to mobility barriers: conjectural decisions and contrived deterrence to new competition. Q. J. Econ. 91, 162 – 245. Chang, S.J., 1995. International expansion strategy of Japanese firms: capability building through sequential entry. Acad. Manage. J. 38, 283 – 407.

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

123

Chang, S.J., Rosenzweig, P.M., 2001. The choice of entry mode in sequential foreign direct investment. Strateg. Manage. J. 22, 747 – 776. Clarke, R., 1985. Industrial Economics. Basil Blackwell, New York. Cubbin, J., Geroski, P., 1987. The convergence of profits in the long run: Inter-firm and interindustry comparisons. J. Ind. Econ. 35, 427 – 441. Datta, K.D., Herrmann, P., Rasheed, A.A., 2002. Choice of foreign market entry models: critical review and future directions. Adv. Int. Manage. 14, 85 – 153. Davis, P., Desai, A.B., Francis, J.D., 2002. Mode of international entry: an isomorphism perspective. J. Int. Bus. Stud. 31, 239 – 258. Dunning, J.H., 1988. The eclectic paradigm of international production: a restatement and some possible extensions. J. Int. Bus. Stud. 26, 461 – 492. Erramilli, M.K., Rao, C.P., 1993. ‘Service firms’ choice of foreign-market entry modes: an empirical analysis using a modified transaction-cost framework. J. Mark. 57, 19 – 38. Erramilli, M.K., Agarwal, S., Kim, S., 1997. Are firm-specific advantages location-specific too? J. Int. Bus. Stud. 28, 735 – 757. Harrigan, K.R., 1981. Barriers to entry and competitive strategy. Strateg. Manage. J. 2, 395 – 412. Harzing, A.W., 2002. Acquisitions vs. Greenfields: international strategy and management of entry modes. Strateg. Manage. J. 23, 211 – 227. Hennart, J.F., 1988. A transaction costs theory of equity joint ventures. Strateg. Manage. J. 9, 361 – 374. Hennart, J.F., 1991. The transaction costs theory of joint ventures: an empirical study of Japanese subsidiaries in the United States. Manage. Sci. 37, 483 – 497. Hennart, J.F., Larimo, J., 1997. The impact of culture on the strategy of multinational enterprises: does national origin affect ownership decision? J. Int. Bus. Stud. 29, 515 – 538. Hennart, J.F., Reddy, S., 1997. The choice between mergers/acquisitions and joint ventures: the case of Japanese investors in the United States. Strateg. Manage. J. 18, 1 – 12. Horaguchi, H., Toyne, B., 1990. Setting the record straight: hymer, internationalization theory and transaction cost economics. J. Int. Bus. Stud. 21, 487 – 494. Hymer, S.H., 1970. The efficiency (contradictions) of multinational corporations. Am. Econ. Rev. 60, 441 – 448. Hymer, S.H., 1976. The International Operations of National Firms: A Study of Foreign Direct Investment. MIT Press, Cambridge, MA. Kindleberger, C., 1969. American Business Abroad: Six Lectures on Direct Investment. Yale Univ. Press, New Haven. Kogut, B., Singh, H., 1988. The effect of national culture on the choice of entry mode. J. Int. Bus. Stud. 19, 411 – 432. Kwon, Y.-C., Konopa, L.J., 1992. Impact of host country market characteristics on the choice of foreign market entry mode. Int. Mark. Rev. 10, 60 – 76. Makino, S., Neupert, K.E., 2000. National culture, transaction cost, and the choice between joint venture and wholly owned subsidiary. J. Int. Bus. Stud. 31, 705 – 713. Martin, S., 1979. Advertising, concentration, and profitability: the simultaneity problem. Bell J. Econ. 24, 197 – 201. Nitsch, D.P., Beamish, P., Makino, S., 1996. Entry mode and performance of Japanese FDI in Western Europe. Manage. Int. Rev. 36, 27 – 43. Oster, S.M., 1994. Modern Competitive Analysis, 2nd ed. Oxford Univ. Press, New York. Pan, Y., Chi, P.S.K., 1999. Finacial performance and survival of multinational corporations in China. Strateg. Manage. J. 20, 359 – 374. Pan, Y., Tse, D., 2000. The hierarchical model of market entry modes. J. Int. Bus. Stud. 31, 535 – 554.

124

B. Elango, R.B. Sambharya / Journal of International Management 10 (2004) 107–124

Pan, Y., Li, S., Chi, P.S.K., 1999. The impact of order and mode of market entry on profitability and market share. J. Int. Bus. Stud. 30, 80 – 101. Porter, M.E., 1980. Competitive Strategy. Free Press, New York. Porter, M.E., 1985. Competitive Advantage. Free Press, New York. Root, F.R., 1994. Entry Strategies for International Markets. Lexington Books, San Francisco, CA. Sakakibara, M., Porter, M.E., 2001. Competing at home to win abroad: evidence from Japanese Industry. Rev. Econ. Stat. 83, 310 – 322. Scherer, F.M., 1980. Industrial Market Structure and Economic Performance. Rand McNally, Chicago. Schmalensee, R., 1989. Inter-industry studies of structure and performance. In: Schmalensee, R., Willing, R. (Eds.), Handbook of Industrial Organization, vol. II. Elsevier, New York, pp. 952 – 1009. Shane, S., 1994. The effect of national culture on the choice between licensing and direct foreign investment. Strateg. Manage. J. 15, 627 – 642. Shrader, J.M., 2001. Collaboration and performance in foreign markets: the case of young hightechnology firms. Acad. Manage. J. 44, 45 – 60. Simmonds, P.G., 1990. The combined diversification breadth and mode dimensions and the performance of large diversified firms. Strateg. Manage. J. 11, 399 – 410. Teece, D., 1981. The multinational enterprise: market failure and market power considerations. Sloan Manage. Rev. 22, 3 – 17. Turner, P.P., 1980. Import competition and the profitability of United Kingdom manufacturing industry. J. Ind. Econ. XXIX, 155 – 165. U.S. Department of Commerce, 1991 – 1998. Census of Manufactures (various issues) Bureau of Economic Analysis, Washington, DC. U.S. Department of Commerce, 1991 – 2001. Survey of Current Business (various issues) Bureau of Economic Analysis, Washington, DC. Watson, C.M., 1982. Counter competition abroad to protect home markets. Harvard Bus. Rev. 60 (1), 40 – 42. William, E.G., Hill, C.R., Judge, G.G., 1993. Learning and Practicing Econometrics. Wiley, New York. World Investment Report, 2000. Cross-border Mergers and Acquisitions and Development United Nations, New York. Woodcock, C.P., Beamish, P., Makino, S., 1994. Ownerships-based entry modes strategies and international performance. J. Int. Bus. Stud. 25, 253 – 273. World Investment Report, 2001. Promoting Linkages. United Nations, New York. Zaheer, S., 1995. Overcoming liability of foreignness. Acad. Manage. J. 32, 341 – 363. Zejan, M.C., 1990. New ventures or acquisitions. The choices of Swedish multinational enterprises. J. Ind. Econ. 38, 349 – 355.