Discuss trade based contractual and equity based entry models in terms of control and commitment.
What will be an ideal response?
Contractual entry modes in international business refer to activities such as licensing and franchising, where the firm engages in agreements with international partners enabling the partner to use their intellectual property in exchange for fees.
Investment entry modes or equity based business activities involve direct investment abroad. The investment may result in joint ventures, wholly owned subsidiaries, mergers and acquisitions, depending on the type of deal. But, all such strategies involve ownership of equity and investment of capital.
In contractual entry modes or business activities, commitment of the foreign firm is often lower when compared to equity based entry modes or business activities. In contractual business relations, firms generally do not provide significant levels of financial or managerial resources. In such arrangements, the foreign firm often has minimal control over the operation.
The acquisition of control is often parallel with higher commitment. In equity based business arrangements, the foreign entrant shows a higher commitment displayed by the greater level of resources directed to the business. The higher commitment enables the foreign firm to attain control over the activities.
A firm’s continuous exposure to multiple experiences abroad leads to experiential knowledge which lowers perceived costs of internationalization, thereby increasing the firm’s commitment. Experiential knowledge consists of business, market and institutional knowledge. Then, the movement across the stages is generated by increased experience resulting in experiential knowledge which reduces the psychic distance and enables the firm to increase commitment (Johanson and Vahlne, 1977). International expansion helps companies to acquire market knowledge, and adapt to differences among markets (Bianchi, 2009). Firms with limited exposure to a market often choose to start with trade-based entry strategies in an effort to minimize risks stemming from unfamiliarity
In choosing an entry form, control has been regarded as a critical factor because by holding control the firm ensures that it retains the responsibility of decision making, coordinating actions and pursuing or changing strategies and assuming a larger share of the profits. However, control has a high price in the form of resource commitment and creating additional responsibilities for the firm as well as switching costs (Anderson and Gatignon, 1986). In parallel, higher degrees of control demand higher levels of commitment. Risk and flexibility are also dominant considerations in choosing an entry mode (Mascarenhas, 1982). Entry modes which require substantial commitment are more risky. As it is harder to cease operations after high levels of resources are committed and further commitments are made in operating in a foreign country, the flexibility also decreases with entry strategies associated with high levels of control. For instance, a company can direct their exports to another market if the regulations are changed in one of their markets, but it would be considerably more difficult for the company to divest from a wholly owned venture without incurring significant costs. Each entry mode such as licensing or having a subsidiary indicates different levels of control for the firm. In parallel, each form of entry is related to different levels of resource commitment by the firm (Ghauri and Cateora, 2010).
If the firm is engaging in home-based international trade activities, then it does not necessarily have to commit a significant amount of resources in the host country. The level of this commitment can increase if the firm is engaged in considerable levels of global sourcing or exporting, and is dependent on these types of activities in its business, however, the firm does not invest in the international trade partners. The firm at the active or committed stage is more dependent on exports than are the firms at non-exporting or reactive exporting stages.
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