There is a myth that only large MNEs dobusiness abroad and that SMEs mostlyoperate domestically. This myth, based onhistorical stereotypes, is being increasinglychallenged as more and more SMEs are nowgoing international.

For example, some start-ups attempt to dobusiness abroad from inception. These areoften called born global firms.

This lecture examines how entrepreneurialfirms internationalize.

Compared with domestic transaction costs (the costs of doingbusiness), international transaction costs could be relativelyhigher.

Some costs are due to numerous differences in formalinstitutions and informal norms.

Other costs, however, may be due to a high level ofdeliberate opportunism that is hard to detect and remedy.◦ For example, suppose an unknown Canadian importer

places an order from a Ghanaian exporter, but theGhanaian exporter cannot verify that the Canadian side willdeliver payment upon receiving the goods.

◦ whether or not the firms in the transaction will bedeliberately opportunistic, is not easily assessed.

As a result, many small firms may simply say “Forget it!” whenreceiving an unsolicited order from abroad. Conceptually, thisis an example of transaction costs being so high that manyfirms may choose not to pursue international opportunities.

Entering foreign market

Staying in domestic markets

▪ Direct exports▪ Franchising/licensing▪ Foreign direct investment (strategic alliances, green-field wholly owned subsidiaries, and/or foreign acquisitions)

▪Indirect exports through export intermediaries▪ Suppliers of foreign firms▪ Franchisees or licensees of foreign brands▪ Alliance partners of foreign direct investors▪ Harvest and exit (through sell-off to and acquisition by foreign entrants)

SMEs have three broad modes for entering foreign markets:

(1) direct exports,

(2) licensing/franchising, and

(3) foreign direct investment (FDI)

First, direct exports involve the sale of productsmade by entrepreneurial firms in their home countryto customers in other countries.

This strategy is attractive because entrepreneurialfirms are able to reach foreign customers directly.

However, a major drawback is that SMEs may not haveenough resources to turn overseas opportunities intoprofits.

Export transactions are complicated. One particularconcern is how to overcome the lack of trust betweenexporters and importers when receiving an orderfrom unknown importer abroad.

This transaction risk can be eliminated if there is afacilitator such as a bank through a letter of credit.

Letter of credit is a financial contract stating that theimporter's bank (e.g. bank of Canada) will pay aspecific sum of money to the exporter (e.g. throughBank of Ghana) upon delivery of the commodity.

It has several steps.

First, the Ghanaian exporter may question theunknown Canadian importer's assurance that he/shewill promptly pay for the goods. An L/C from thehighly reputable Bank of Canada will assure theGhanaian exporter that the importer has goodcreditworthiness and sufficient funds for thetransaction. If the Ghanaian exporter is not surewhether Bank of Canada is a credible bank, it canconsult its own bank, Bank of Ghana, which willconfirm that an L/C from Bank of Canada is as goodas gold.

Second, with the assurance through an L/C, theGhanaian exporter can release the goods, whichgo through a Ghanaian freight forwarder, then ashipping company, and then a Canadian customsbroker. Finally, the goods will reach theCanadian importer.

Finally, once the Ghanaian exporter has shippedthe goods, it will present to the Bank of Ghanathe L/C from Bank of Canada and the shippingdocuments. On behalf of the Ghanaian exporter,Bank of Ghana will then collect payment fromBank of Canada, which, in turn, will collectpayment from the Canadian importer.

In summary, instead of havingunknown exporters and importersdeal with each other, transactionsare facilitated by banks on bothsides that have known each otherquite well because of numeroussuch dealings. In other words, theL/C reduces transaction costs byreducing the transaction risks.

A second way to enter international markets isthrough licensing and/or franchising.

Usually used in manufacturing industries,licensing refers to Firm A's agreement to giveFirm B the rights to use A's proprietarytechnology (such as a patent) or trademark(such as a corporate logo) for a royalty fee paidto A by B.

Assume (hypothetically) that Firm A (AbundantKente Enterprise (AKE), Ghana) cannot keep upwith demand in UK. It might consider grantinga UK firm the license to use its technology andtrademark for a fee.

Franchising is essentially the same idea, except it istypically used in service industries such asinsurance and healthcare administration

A great advantage is that SME licensors andfranchisors can expand abroad while riskingrelatively little of their own capital. Foreign firmsinterested in becoming licensees or franchiseeshave to put their own capital up front.

But licensors and franchisors also bear some riskbecause they may suffer a loss of control over howtheir technology and brand names are used.◦ E.G. If AKE’s licensee produces sub-standard products that

damage the brand and refuses to improve quality, AKE isleft with difficult choices – sue its licensee in an unfamiliarUK court or discontinue the relationship. Either choice iscomplicated and costly.

A third entry mode is FDI, which may involve strategic alliances with foreign partners (such as joint ventures), foreign acquisitions, and/or green-field wholly owned subsidiaries.

FDI has several distinct advantages. ◦ By planting some roots abroad, a firm becomes more

committed to serving foreign markets.◦ It is physically and psychologically closer to foreign

customers. Relative to licensing and franchising, a firmis better able to control how its proprietary technologyand brand name are used.

However, FDI has a major drawback: ◦ its cost and complexity. It requires both a high capital

outlay and a significant managerial commitment which many SMEs are unable to meet.

In general, the level of complexity andresources required increases as a firm movesfrom direct exports to licensing/franchisingand finally to FDI.

Traditionally, it is thought that most firms willhave to go through these different stages andthat SMEs (perhaps with few exceptions) areunable to undertake FDI from the outset.

Known as the stage model , this idea positsthat SMEs that do eventually internationalizewill do so through a slow, stage-by-stageprocess.

However, enough counter-examples of rapidlyinternationalizing entrepreneurial firms, knownas born globals, exist to challenge the stagemodels.

Consider Logitech, now a global leader incomputer peripherals. It was established byentrepreneurs from Switzerland and the UnitedStates, where the firm set up dual headquarters.Research and development and manufacturingwere initially split between these two countriesand then quickly spread to Ireland and Taiwanthrough FDI.

In spite of the fact that most SMEs’behaviour still fit the stereotype of slow(or no) internationalization, someentrepreneurial SMEs seem to be bornglobal.

Hence, the key question is: What leadsto rapid internationalization?◦ The key differentiator between rapidly and

slowly (or no) internationalizing SMEs seems to be the international experience of the entrepreneurs.

◦ If the entrepreneur has previousexperience abroad (such as workingand studying overseas and/orimmigrating from other countries),then doing business internationallymay not be so intimidating.

◦Otherwise, the apprehensionassociated with the unfamiliar foreignbusiness world may take over, andentrepreneurs will simply want toavoid trouble overseas.

As indicated on the table shown early on, a number of strategies exist for entrepreneurial SMEs to internationalize without leaving their home country.

The five main strategies are:(1) export indirectly through export intermediaries

(2) become suppliers of foreign firms,

(3) become licensees or franchisees of foreign brands,

(4) Become alliance partners of foreign direct investors, or

(5) harvest and exit through sell-offs.

First, whereas direct exports may be lucrative, many SMEs simply

do not have the resources to handle such transactions.

However, they could still reach overseas customers through indirect

exports , which involve exporting through domestic-based export

intermediaries.

Export intermediaries perform an important middleman function by

linking domestic sellers and overseas buyers who otherwise would

not have been connected.

Being entrepreneurs themselves, export intermediaries facilitate the

internationalization of many SMEs. Intermediaries such as trading

companies and export management companies handle about 50% of

total exports in Japan and South Korea, 38% in Thai-land, and 5% to

10% in the United States (Peng, 2010)

A second strategy is to become asupplier to a foreign firm that isdoing business in the domesticmarket.

Acting as suppliers to foreignfirms in the domestic economy,SMEs suppliers may be able tointernationalize by piggybackingon the larger foreign entrants.

Third, an entrepreneurial firm may consider becoming licensee or franchisee of a foreign brand.

Foreign licensors and franchisors provide training and technology transfer to them for a fee .

Consequently, an SME can learn a great deal about how to operate at world-class standards.

A fourth strategy is to become an alliancepartner of a foreign direct investor. Facing anonslaught of aggressive MNEs, manyentrepreneurial firms might not successfullydefend their market positions. Hence, it makesgreat sense to follow the old adage, “If you can'tbeat them, join them!”

Such alliance could be equity or contract alliance.

Equity relationships allow firms to have some direct control over joint activities on a continuing basis whereas contractual relationships usually do not.

Finally, as a harvest and exit strategy, entrepreneurs may sell an equity stake or the entire firm to foreign entrants.

In light of the high failure rates of start-ups, being acquired by foreign entrants may help preserve the business in the long run.