INDITEX INTERNATIONALIZATION PROCESS. Author: Rocío Sánchez Heres Supervisor: Jens Vestergaard

Transcription

1 INDITEX INTERNATIONALIZATION PROCESS Author: Rocío Sánchez Heres Supervisor: Jens Vestergaard Aarhus School of Business MSc. in Finance & International Business February / 2007

2 TABLE OF CONTENTS ABSTRACT INTRODUCTION BACKGROUND Inditex brief history REASONS BEHIND INDITEX INTERNATIONALIZATION DEFINITION OF INTERNATIONALIZATION Motives for Internationalization REVIEW OF RELEVANT THEORIES Traditional Internationalization Approach Transaction Cost Approach / Internalization Theory Eclectic Paradigm Theory Product Cycle Hypothesis Internationalization Process Model Uppsala Internationalization Model Network Approach WHY DOES INDITEX GO ABROAD Spanish Retailing Industry Political / Legal factors Economic factors Technological factors Socio - cultural factors Competitive Advantage / Manufacturing Process Industry Analysis Porter s Five Forces Actual Competitors Demand Market Share Demand Analysis SWOT Why does Inditex go abroad? INDITEX INTERNATIONALIZATION PROCESS Spanish Market towards Internationalization The internationalization of the Spanish companies Inditex international evolution Zara goes abroad How companies enter into foreign markets? Factors Influencing Entry Mode Selection How does Inditex enter into foreign markets? CONCLUSION REFERENCES APPENDIX

3 ABSTRACT This study intends to be a useful guide for companies thinking about entering the international arena, alternatively, constitutes an explanatory analysis of the conditions leading firms to expand their activities to foreign markets. Through the different sections of this paper, I have carried on an analysis of the factors influencing the internationalization of the firms, taking as a reference the growth process of the company Inditex, a big Spanish multinational with a high international presence, examining its distinctive characteristics together with the most relevant internationalization theories. In this research some questions were formulated in order to gain insights about the international growth of the company. These questions were; why does Inditex enter international markets? What are the internal and external motivations faced by the company on its internationalization process? How does Inditex select its foreign markets? And finally, how does Inditex choose its mode of entry into foreign markets? To be able to answer these questions, useful analysis of the existing literature were conducted as well as the environment, like the SWOT analysis or Porter s Five Forces model. Once the internationalization is examined, the study focuses on the choice of modes of entry providing not all, but the main strategies followed by the company and its reasons to choose those strategies. Finally, the last part of the study addresses the findings which shows that none of the models observed in the previously exposed literature is fully suitable, but instead, the whole set of theories provides good answers for the formulated questions. After the conclusion, some suggestions for further research are proposed

4 1. INTRODUCTION The present study integrates different analysis, conceptual issues and trends related with the motivations and alternatives available for firms to expand its activities towards foreign markets, analysing these concepts in relation with those steps followed by the Spanish retailing company Industria del Diseño Textil S.A. - Inditex- to increase its presence in the international arena. This paper reviews the main theories of the international growth of companies, paying attention to its causes and motivations, the influence of these factors in the company. It also provides an explanation about the causes leading the company to choose between the different modes to entry new markets. I consider internationalization as an especially relevant issue for firms nowadays since domestic businesses are becoming increasingly international as a result of trade agreements and the emergence of a borderless workforce. There are fast advances in information technology enabling the rapid flow of data around the world. Companies are concern about the complexity of global environmental, political and social issues affecting businesses locally. International markets are characterized by their complexity, diversity and interconnectedness. The field of internationalization is extensive; consequently there are many situations that companies face when extending their activities, some of these circumstances can be foreseen, although there are still many which are unexpected, both kind are numerous and complicated. Existing theories provide good explanations and guidelines for companies aiming to expand its businesses, analyzing several factors in order to avoid unexpected circumstances. Though these approaches are fundamentally relevant, none of they are able to explain by themselves, isolated, the intricate nature of the process which requires a wider perspective gathering the main theoretical frameworks. This perspective should contain and relate both the dynamism of the process as well as the existence of special features of the company. By reviewing those theories this paper provides a general view of the development of Inditex. It also aims to show further insights on the impact caused by these factors in the strategies chosen by the firm, as well as competitive considerations of the company

5 The purpose of this thesis is not only to describe the development of the firm, but also to analyze and explore the reasons and thus the pattern followed by Inditex, S.A. on its internationalization and consequently, the strategies chosen by the company to enter foreign markets, going through the most important literature published and related to the process of internationalization. My contribution, with this paper, is a detailed analysis of these factors, due to the importance of their impact on the multinationals and their future performance, by using the process of Inditex. Through the analysis of the most relevant theories I will give explanation to the following matters. The main research questions are, Why does Inditex enter international markets? What are the internal and external motivations faced by the company on its internationalization process? How does Inditex select its foreign markets? How does Inditex choose its mode of entry into foreign markets? The research method of this paper is an exhaustive review of the relevant literature; consequently through this study I conduct an analysis to answer my questions. This study is built combining relevant scientific articles and books. The paper focuses on both international and domestic situations of Inditex, and the factors leading to these situations. Those factors are important in order to understand the reasons of the company to expand its activities, and one of the most important reasons is the domestic situation of the Inditex Group. Thus, other international perspectives such as timing of entry are ignored. The Inditex Group constitutes a good opportunity to analyse relevant issues in the international business field, topics like the reasons leading companies to their international expansion, its motivations, the way that these firms conduct their expansion and also the selection of the target markets. This is the reason why I have chosen the company as it is one of the most developed Spanish companies in the international arena constituting a complete framework for the analysis due to its fast expansion and variety of strategies followed. Finally, an additional factor is the access - 5 -

6 to relevant information resources in terms of language, availability and local environment understanding. The paper is structured as follows, is divided into five sections or chapters. The first section tries to give an idea or insight of the main subject of the thesis and also about the questions that I will try to solve or explain through it, as we have said before these questions are related to the process of Inditex as I consider important to get in touch with the company by a brief description of its evolution through the time, I will describe these issues through chapter One. Chapter Two aims to be a frame of reference consisting of a review of the most relevant theories and previous investigations that conceptualize the main aspects of Internationalization, including its motivations and processes. Trough Chapter three the different data related to the growth and evolution of the company, regarding its domestic environment is analysed in order to have an idea of its local conditions. For this purpose various analyses as the SWOT framework of the company or the five forces model are developed. With this information together with the previous theories we are able to explain factors affecting the company and its international evolution. Across the fourth Chapter I analyze the situation of the Spanish companies and the factors leading to their international performance, paying special attention to Inditex. During this chapter I provide different explanations on the topic of the choice of International entry modes, and I also analyze several factors influencing this choice. By using these frameworks I will try to give an explanation about the strategies used by the company to expand its international activities. Finally we find the last chapter, Chapter five, where the main conclusions and findings derived from the research are presented all together with answers to the previous research questions as well as suggestions for further research in this field BACKGROUND In this part of the paper first I will make a brief introduction of the company and its activities so we will have a broader view, second I will describe how Inditex - 6 -

7 developed historically to be able to understand the development of the company to understand its circumstances nowadays. The Company is one of the biggest fashion retailers of the world. At the end of this paper, Inditex shops are present in 62 countries, and the manufacturing process of its products are distributed into several production facilities employees and over one hundred companies related with design, manufacturing and distribution of textile articles, comprise the group. These companies and processes turn Inditex into one of the most important fashion distribution groups INDITEX HISTORY Even though Inditex was not created until 1985, its beginnings are linked to the origin of the managerial activity of its president, Amancio Ortega Gaona, in the decade of the sixties (1963). In the beginning, the activity of the company was centred on the manufacture of fashionable clothes, until 1975; during this year the first store of Zara, of a large list, opened its doors to the public in La Coruña. Right alter this first opening, between 1975 and The Company established more Zara shops in different cities of its region, Galicia -La Coruña, Santiago, Vigo, Lugo, etc...-. In the first eighties Inditex grew inside the national market and its initial expansion followed the pattern of rings in the water, its establishments were coming progressively to more remote points of the Spanish geography, first the company reached the northwest and later the rest of the country. From 1983 to 1986, Inditex inaugurated new shops in the main Spanish cities -Madrid, Barcelona, Valladolid, Zaragoza, Seville, Malaga, Valencia and Bilbao-. The first international opening took place in the Portuguese city of Porto and this was in the late 1988, precisely when Zara had already reached the number of 60 shops in Spain. One year after Porto, in 1989, Zara opened a shop in New York and another year later; in 1990, the company inaugurated its first shop in Paris. Both shops -New York and Paris- supposed a relevant variation in the process of expansion followed up to the date. Beside of giving the first steps on two of the most important fashion markets worldwide, it also gave a return to Zara in terms of brand identity and prestige, by placing Zara in two of the world capitals of Fashion

8 Throughout the decade of the nineties, Inditex, with Zara mainly, is implanted progressively in an increasing number of countries, up to 62, with establishments. Inditex primary centre of manufacturing is located in Arteixo, La Coruña, where they produce the most of the products that we can find on Zara stores, but the company has facilities located in Catalonia, The Valencian Community, Zaragoza and nowadays new platforms are being built in Madrid and León. YEAR OF INDITEX's ENTRY ON ITS DIFFERENT MARKETS YEAR COUNTRY Spain Portugal United States France México Greece Belgium, Sweden Malta Cyprus Norway, Israel Argentina, United Kingdom, Venezuela, Lebanon, Arabs Emirates, Kuwait, Turkey, Japan Netherlands, Germany, Poland, Saudi Arabian, Bahrain, Canada, Brazil, Chile, Uruguay Andorra, Qatar, Austria and Denmark Puerto Rico, Jordan, Ireland, Iceland, Luxembourg, Czech Republic, Italy Finland, Switzerland, El Salvador, Dominican Republic, Singapore Slovenia, Slovakia, Russia, Malaysia Hong Kong, Morocco, Estonia, Latvia, Romania, Hungary, Lithuania, Panama Monaco, Indonesia, Thailand, The Philippines, Costa Rica Serbia, Continental China, Tunis Figure 1. Inditex - 8 -

9 This evolution it has been based on a model of business characterized by the flexibility and the capacity of adjustment, it also attends to different combinations of entering new markets. As consequence of the incorporation of new formats, The Group increases its activity, in a few cases by acquiring existing businesses, as it happened with Massimo Dutti in 1991, or with Stradivarius in 1999, and in the rest of the cases by creating the new chains; Pull & Bear in 1991, Bershka in 1998, Oysho in 2001, Kiddy s Class in 2002, and finally the most recent format Zara Home in REASONS BEHIND INDITEX INTERNATIONALIZATION At the moment, internationalization is getting more and more important. Companies have to face transformations in their business processes as they experience environmental changes, since the world evolves everyday. Nowadays, economies in different countries influence to one another more than ever before. As many companies have found domestic markets narrow and they have to look for new chances and opportunities to keep their business update increasing its operational fields. They have to reach broader areas following the trends in a global and changing world. This paper is expected to provide basic insights about the expansion process of a multinational like Inditex, especially about the basic steps and problems of the complete internationalization process that companies face when going international. Those steps are essential for the future position of a growing company, because during those steps, they must collect enough information and data to be able to make decisions about starting their international route. To be able to do so, this paper offers background information and a theoretical frame for this information, analyzing different strategies and stages, comparing the ways of entry to diverse markets with relevant theories of internationalization, in order to establish the relevant connections between those theories that provide us different explanations of Inditex internationalization process DEFINITION OF INTERNATIONALIZATION If we take a look at the origin of international business relations, we will find out that first economic relations between countries took the form of importing and exporting, - 9 -

10 and companies today start its new ventures in the international marketplace by using the same method. Johanson and Vahlne defined internationalization of firms like a process in which the firms gradually increase their international involvement. Internationalization can be perceived as a part of the ongoing strategy process of most business firms (Melin, 1992). As a way of diversifying risks (Rugman, 1981) or as a network of relationships leading to foreign markets (Johanson and Mattson, 1988), these are some of the views of the process. When talking about the international progression of firms we find several theoretical points of view that provide us with different explanations to this phenomenon. Increasing globalisation entails a higher interdependence between economies of different countries as well as growing amount of international operations as sources search, investment, manufacturing and marketing activities MOTIVES FOR THE INTERNATIONALIZATION One of the most significant issues when talking about the process of internationalization of a company is related with the reasons or motivations which induce it to go abroad, and with the strategic goals that are chased with the expansion. It is important to know those motives which have a direct impact on the way companies expand their activities to foreign countries. The next section will provide us with different points of view about determinants of a company to go international. As we go through the literature concerning the motivations that push a company towards the International markets we can find several classifications arising from previous studies. We are going to establish a relation between relevant theories and the reasons that moves the group towards the international markets All of the companies have goals or aims to accomplish. We can make different classifications depending on the nature of such goals, the first goal that comes to our heads may be related to profits, and the main motive for most companies for getting into new markets is to make money (Hollensen, 2001). Firms make decisions taking into account whether or not those decisions increase their profits. So here we can find the first classification; Profit oriented goals include expansion. Companies want to expand its presence in order to increase its returns. Nevertheless firms are also

11 concern about increase their presence on the markets where they are already developing their activities. Companies also look for stability. Objectives that are essentially non profitable contain a desired market position. Firms also want to reinforce their market image, as images associated with companies are powerful purchase influencers. Increasing its market share is another reason as the company tries to gain customers, trying to fill an available market sector or at least to increase its presence on it. Some companies look for optimizing its products technology. Companies can take advantage of using their techniques to enter new markets with a less degree of development or learn from more developed ones. The security of the management and the rest of the employees can be included between these non-profit drivers, together with the ones described before leading firms to convert its domestic environment into an international one. The first step for a company to take is to be aware of the multiple business opportunities that international markets offer in order to commit resources to this market. Whilst the motivations can be different from one company to another, some authors Czikota, Ronkainen & Moffet (1996) have identified a number of influential factors and they split them into two different categories; The proactive and the reactive motivations, this classification is similar to the one made by other authors (Albaum et al., 1989) which classify these drivers into two different groups as a consequence of two opposite purposes, one defensive and the other offensive. Defensive purposes lead the company to keep its position reacting to internal and external changes or pressures like the reactive motivations, while the offensive factors are based on direct actions coming from the inside of the company and thus, affecting its own position in the market. The proactive motivations come from the inside of the company, leading it to a strategic change. Hollensen argue that firms are likely to increase its profits; this is the main proactive motivation. Managerial urge understood as the enthusiasm of managers towards foreign market activities. A new market can be seen as an attractive source of profit derived from a particular characteristic of the product that makes it unique, a new technology, or exclusive information as a way to distinguish a company from its competitors. Consequently, the company is eager to take advantage of that

12 market that is not accessible for rivals and is likely to get more market share than them, al least until its rivals will be able to copy its product or unique asset. This motivation is connected with the first-mover advantage (Sternquist, 1998) concerning to the advantage of being the first company of certain characteristics entering a market without competitors on its category. The firm will try to raise its profits until its competitors follow it to the new market even though the company lacks of a specific or unique characteristic and its advantage derivates from superior resources respecting its rivals. When a company is the first-mover it also can take advantage from its location, since it has more possibilities of finding an attractive location or suitable place deriving from its access to clients or sources. The vision of the new market depends on the expectations about it, the information available regarding its situation, and the perspective about the own company s capacity. According with the existing literature related with Foreign Direct Investment, economies of scale (Hymer, 1960; Kindlerberger, 1969; Vernon, 1966, Dunning, 1988, 1993) constitute another motivation included in the proactive category, as the company saves costs by expanding its outputs. Firms go abroad increasing their production volume and also searching a reduction on their production costs domestically. Tax benefits also encourage exporting activities, allowing firms to get higher profits. The second kind of motivations are reactive motivations, these come from the outside of the company and influence it to get adapted to environmental changes. A relevant one is competitive pressure since companies are scared of losing their position in the market because of the competitors. Firms are also pushed abroad due to saturated state of domestic markets. Home markets can be a trigger for the local company to go abroad, once the introduction and growth stages of the market are over and local market is getting old (Sternquist, 1998; Vernon, 1966) companies will not continue growing in sales and firms will tend to search for new and less developed markets in the first stages described in Vernon s Product Cycle Hypothesis. In these foreign markets, the old products of domestic markets can be perceived as innovative goods. But there is one factor motivating to go abroad which reduces fluctuations in Vernon s Cycle, extended sales of products with seasonal nature. This factor is a strong incentive for companies that have specific products for different seasons when

13 considering going abroad (Hollensen, 2001). Once the season is over, the demand of certain kind of products decrease and companies can sell those products in countries where the season is starting securing superior stability in sales (Albaum, Strandskov and Duerr, 1998). Another factor related to the maturity of the market and its saturation is the limitation of space on the domestic market (Dawson, 1994), since the existence of public local regulations controlling and limiting the market share of a company (Sternquist, 1998). Companies can also take advantage of the overproduction redirecting it to foreign countries and they can also benefit from the excess of capacity increasing the utility of their excess. Finally, another strong reactive motivation is the proximity to customers or resources, in terms of physical and psychical closeness, which can make firms, grow internationally. The factor of the closeness to customers is discussed by some authors (Weinstein, 1977, Dawson, 1994); it influences the company to follow their clients to new marketplaces. An additional classification of factors affecting companies to go abroad is the one proposed by Crick and Chaudhry (1997), they make a difference between Internal change agents and external change agents this categorization is similar to the one between the factors coming out of the company and its workers, and environmental factors pushing the company, made by Ghauri. There also exists a relation between proactive and reactive classification of factors and Internal and External agents (Albaum, Strandskov and Duerr, 1998). While internal change agents include the advantages of the companies by means of differentiation, accumulated stocks that can be reallocated abroad, available manufacturing capacity to satisfy new markets and economies coming from additional orders; internal factors arise from the goals or aims of the individuals inside the company, from their perspective and capacity to recognize business opportunities. The previous experience of the management team in international business is an important asset to identify new chances (Hollensen, 2001). This experience and knowledge about the market will give to the company an additional advantage respecting its competitors. The company itself as a whole regarding strategies,

14 capabilities and sources and its internal specific events such as overproduction are also Internal Factors. External change agents contain variables like the market demand, government stimuli, unexpected orders coming from abroad, banks, other companies or trade associations; economic environment conditions in both domestic and foreign markets. Similarly environmental factors of Ghauri alternative listing refers to legal aspects, taxes, regulations, financial elements, type of industry, investigation and research costs and potential profit possibilities, in the internal and external market. The increasing removal of some entry barriers (Dawson, 1994) also generates new opportunities for the company. PROACTIVE INTERNAL Managerial Urge Marketing Advantages Economies of scale Unique product competence EXTERNAL Foreign Market opportunities Change Agents REACTIVE Risk Diversification Extended sales of a seasonal product Excess capacity of resources Small or declining domestic market Figure 2. Albaum, Strandskov and Duerr, 1998 Brewer (2000) and other authors highlight the importance of the business factors, including the general attractiveness of a market, which is calculated as a function of its sales potential -size and growth- and risk (Agarwal and Ramaswami, 1992) and some strategic factors like meeting its clients demands. The so called Business Factors are similar to the Proactive motivations mentioned above. Risk diversification (Rugman, 1981, 1982) represents an important driver for internationalization by means of reducing the risk associated to variations in the local regulation or derived from changes in the politics of the country. If a firm expands its business to a number of different foreign markets, it will also reduce considerably its risk respecting those firms which limit their activities to the domestic marketplace (Albaum, Strandskov & Duerr, 1998). By diversifying locations, companies balance their total results in other markets when there turns out to be affected the sector of consumption of a specific one, this is because the economic situation changes drastically from one country to

15 another, this kind of diversification can be seen as a substitute of the company s internationalization, this means that the company will reduce its systematic risk diversifying its investments through different countries to ensure its final profits. Diversification is an evolutionary factor and is more common during the first stages of the Internationalization process; furthermore all the motivations for the expansion of the company are dynamic generally, following a sequential process (Vernon, 1966, Johanson and Vahlne, 1977). Another driver for the company to go abroad arises from the natural evolution of the industry, related to the fast expansion of the rest of competitors of the firm. This particular way of interacting with its environment might be included in the defensive strategies mentioned before. According to the existing literature (Dunning, 1993) we can find a classification which distinguishes between four different group of companies concerning their motivations to move towards international markets; market seeking, resource seeking, efficiency seeking and strategic asset seeking. Every company may be included in any of the groups and in some cases in more than one. The companies included on the market seeking group search for better alternatives available in other markets coming from the specific situation of the country, regarding tariff barriers, favourable variations in host regulations or other factors associated to the foreign country like a less developed market compared to the domestic one of the company. The firm entering this young market can take advantage of the situation, due to its superior performance compared with the activities of the existing companies. Comparing these motivations to the ones exposed above, we find this determinants related with the mentioned maturity stage of the local market, although here, the relevance of the new market gains weight. Additionally, production or establishment costs can be also lower respecting the ones of domestic markets. Efficiency seeking firms try to take advantage from expanding their activities to more than one country so they can restructure their organization in order to increase efficiency by using economies of scale and scope, this expansion also minimises the potential risk associated to specific markets providing the company with a higher degree of flexibility

16 The companies expanding abroad can also be included in the resource seeking category. In this group companies search for a country where raw materials are more accessible in terms of location conditions, regulation and price. Strategic Asset Seeking companies are the ones looking for a location with a specific research and development level or a more specialised labour, which can be transferred to their home countries REVIEW OF INTERNATIONALIZATION THEORIES During more than 40 years, the internationalization process of organizations has been the subject of a broad amount of research in the frame of temporal and geographical expansion of international activities and processes carried on by firms. Many authors and researchers of this area have found common paths between companies going international and by focusing on these patterns; they have developed interesting explanations of internationalization of firms. The increasing investments in foreign countries, as a result of different factors related to economic development, and intensified by technological progress, telecommunications advances, and political changes might have as a result the transformation of the strategies of goods and services industries (Dunning, 1988), in a particular way the increasing of the liberalization practices in the industry has contributed to accelerate business expansion and the growth of multinational companies playing and important role in the Internationalization of the economic activity. The following theories review is a collection of findings of relevant researchers, written during the last decades regarding the internationalization topic. I have had the opportunity to have access to these approaches in different journals and books and although the most of the theories are not new, they still constitute an obligatory reference as well as a useful tool when writing about this subject. As independently these models are not able to explain completely, the international process, by combining them a wider framework to analyse the international growth of the company is created

17 TRADITIONAL INTERNATIONALIZATION APPROACH Following Penrose s (1959) line of thinking, internationalization is based on the combination of two factors; it is focused on the core competencies of the company concerning the opportunities available in the foreign environment. This approach constitutes the essence of the Traditional Marketing theories. There are some theories based on the imperfections of the market place. Traditional internationalization models would be incomplete explaining why companies go abroad if we do not pay attention to the fact that markets are not perfect organizations. If competitiveness was perfect, the possibility of increasing benefits would not be available due to the lack of chances to make the market more effective. The existence of specific advantages of certain companies means that multinational firms are not in a competitive world (Caves, 1971) and considering this doctrine we state that international investment takes place in imperfect markets. According to this thinking we find the first studies providing powerful insights about foreign entry modes, Hymer (1976) on his thesis affirmed that the main reasons leading organizations to look for an international presence are based on the existence of special advantages of the companies, but he is not the only one as Kindleberger (1969) also mention competitive advantages as a driver towards international arenas. This means that firms might have some superior attributes that should be firmspecific, easily transferable across national borders within the company - and strong enough to resist rivalry erosion through time. A firm must possess specific advantages to compensate the cost of foreignness (Hymer, 1976), cost understood as all supplementary cost in which a firm operating in a foreign market incurs that a local firm would not face (Zaheer, 1995) of doing business abroad. These specific advantages are used to compensate the cost of foreignness explained above, advantages like superior technological skills, that foreign firms might have arising from resources not available in the country in which this firms operate, or marketing skills as core competencies, special manufacturing facilities, product differentiation or a particular way of managing. These are some of the factors which can allow firms to take advantage of Scale economies in order to surpass its competitors, high value factors in textile market. Companies use these characteristics as long as they can to raise market share respecting local competitors. Just the simple existence of the

18 factors mentioned above implies oligopoly situations or not perfect markets, and it also means a good motivation to go abroad. Hymer and Kindlerberger (1969) maintain that firms expanding internationally compensate their handicaps in new markets with their advantages while local competitors spend money in order to reach those advantages. They also describe those superior characteristics as a reflection of market structure failures which outcome on oligopolistic benefits. Kindlerberger in addition, specifies some assets with the aim of allowing a company to compete successfully in a foreign environment. These assets are the following; economies of scale, managerial knowledge, brand power, commercialization ideas and technology access. Hirsch (1976) and Horst (1972) give special attention to knowledge focused on technological skills and also marketing knowledge acquired by using R+D as core factors of a company going overseas. Following this line of thoughts we have to talk about Porter s diamond model, where he settles the conditions that must be fulfilled to create or to promote the competitive advantages of the companies. Those advantages might be generated by increasing innovation in products, processes, logistics or new marketing strategies. The diamond model allows analyzing why some industries within nations are more competitive than others. It suggests that the national level of sophistication of an organization plays an important role in helping a company to achieve advantages on a global scene. The domestic market conditions of a company provide four core factors, which trigger or not the advantages of a firm in global competition. Those determinants are -homedemand conditions as regards of consumers needs, scope and growth; factor conditions concerning a country skilled labor or infrastructures; Firm structure, strategy and rivalry meaning management and organization of the company and its interaction with local competitors; related and supporting industries in relation to the existence or inexistence of internationally competitive supporting or supplying industries. These patterns related to the competitive and intangible advantages that a company uses successfully to compete in other countries are able to explain partially the internationalization of the companies. But we find a certain weakness in these theories in relation with the lack of a detailed explanation of the factors affecting the choice of location or alternative ways of foreign investment as well as the ownership advantage. Why not yield the know-how

19 or commercialize a differentiated product to other companies that, in turn, have the proper information about the conditions of a certain local market? -By means of a license for example-. The answer to this question has permitted to formulate further models aiming to explain internationalization as an alternative way to allocate resources overseas. FIRM STRATEGY, STRUCTURE AND RIVALRY FACTOR CONDITIONS DEMAND CONDITIONS RELATED AND SUPPORTING INDUSTRIES Figure 3. Diamond model, Porter, 1991 Towards the analysis of this type of blemishes there has gone a wide amount of later literature. Granting a transcendent role to the costs of transaction derived from the mobilization of intangible assets beyond the national borders. In this line it is necessary to stand out, the so called theory of the internalization as well as the eclectic paradigm TRANSACTION COSTS APPROACH / INTERNALIZATION THEORY Most of the internationalization theories revised previously are not complete to provide us an explanation of why local companies chose to take advantage of their monopolistic advantages by using foreign direct investment instead of exporting or licensing their products. Transaction cost theory presents powerful insights into the development of the multinational company. There are a variety of contractual arrangements, including market transacting, cartels, licenses, agencies, long-term contracts, franchises,

20 subcontracting and vertical integration of firms. When an enterprise has to choose between alternative exporting modes, then transaction costs factors are the core determinants of entry mode choice. To use the internalization model the transaction costs of each contractual arrangement must be estimated. According to Coase (1937) - A company will be likely to grow until the cost of an extra transaction inside the company turn out equal to the cost of carrying out the same transaction on the open market-. This approach is also known as the Theory of the Internalization (Burkley and Carsson 1976, 1985; Rugman, 1981; Caves, 1982; Hennart, 1982; Buckley, 1988, 1990 or Carson, 1992), Internationalization of a company is a process that is based on two basic premises; the first one is related with the localization advantages, a company may locate its facilities where costs are lower, and the other premise is that companies grow by internalizing markets until the profits of that internalization overcome or avoid the costs, such as taxes, governmental regulations or tariffs existing in external markets. Coase goes one step further and makes a deeper classification of transaction costs emerging from frictions between sellers and buyers. This classification distinguish between Ex ante costs -previous to the transaction like the of compiling information about potential market intermediaries, contracting costs arising from negotiation with a possible export partner or direct costs like taxes- and Ex post costs -later costs like monitoring costs associated with the control of the agreement to ensure that obligations from both parts are fulfilled or costs derived from the enforcement in case of sanctioning an intermediary who does not achieve the goals of the agreement-. Transaction costs theory assumes that firms will try to minimize these costs when taking to the end transactions, consequently the most efficient performance for a company is the one that allows the lowest combination of ex-ante and ex-post costs. Essentially, this internalization concept is based on the existence of market failures in the transaction of intangible or specific assets facing the presence of high transaction costs inherent to the use of this mechanism. Those imperfections in markets act as a barrier to free commerce, as a consequence the company should perform internally and keep control of its sources if it wants to extract the value that it grants them, while relying on the market those activities in where other companies have a cost advantage. Those associated costs would be learning, or establishment costs derived from the extension of the activities of the company in a foreign market. This situation would

21 me more common as it grows the intensity of knowledge or the specificity of the asset, Magee (1977) states that the higher the know-how, the most probable the use of internalization as a way of increasing the benefits of the company. Derived from this line of thinking, those companies with a high level of R+D would tend to expand its international production internalizing its activities via Foreign Direct Investment. But this behaviour does not depend on domestic or foreign market since if this situation was held in the foreign scene where logistics, distribution costs or commercial barriers were favouring its local exploitation would constitute a stronger reason for a company to implement foreign direct investment. The essence of the transaction costs theory is to explain the reason why a company decides to exploit its assets as a replacement for transferring them to another company. For Rugman (1982) the assignation of property rights to a company and the use of those rights by the company in the internal market to supervise and control the use of a specific advantage as the knowledge, constitute the main foundation of the Internalization theory. When costs within the organization are lower than inside markets, Internalization carries an increase in business benefits as well as a better use of scale and scope economies and it also makes transaction costs -related with opportunism, uncertainty and information- decrease, (Caves, 1982). Even if this theory turns into a very useful tool when explaining the form in which companies go international, is not able to describe the level of commitment with international markets, the choice of location or the structure of international facilities. Internalization theory, as currently specified, cannot explain the last stage in the evolution of the multinational enterprise, the shift from a sale to a production plant. The decision to replace a sales subsidiary with a production facility is essentially an investment decision analyzed in terms of location theory and production theories. To give a broader view of these issues we will pay attention to Dunning's OLI framework or the so-called Eclectic Theory where internalization is supplemented by location characteristics and ownership advantages to shape a wider model of the multinational organization

22 ECLECTIC PARADIGM THEORY As its own name states an eclectic theory is a conceptual approach that does not hold strongly to a single set of assumptions, but instead draws upon multiple theories, to gain additional ideas into a subject. Surely the most known theory for its eclectic character is Dunning s approach. Dunning (1988) has combined elements of internalization of processes with another factors such as location advantages into an eclectic theory of foreign direct investment, a general framework which describes not just the reasons but also the distribution among the different countries in which the investment takes place. Dunning holds that the eclectic nature of his theory avoids a wider approximation as well as an explication of the foreign direct investment -FDI-, he also advises that each of the earlier theories explaining FDI determinants are incomplete stating that those previous theories are partially correct and partially incorrect as regards of specific example of FDI (Graham, 1992). The basic premise of the Dunning OLI model is that companies will undertake FDI if three conditions are fulfilled at the same time: ownership advantages (O), location advantages (L), and internalization incentives (I), hence OLI. First condition is related to ownership, by means of a specific advantage that a company must possess related to any intangible asset, during some time at least, inaccessible for local competitors of the foreign market, such as monopoly control over particular technologies, processes or resources. Once a company possesses that advantage, the firm might decide whether or not make of it an international advantage by using market intermediaries or by internalizing it. To be able to decide the most beneficial alternative, organization should combine this condition with additional factors of location in the new market; otherwise, firms would choose the exportation instead of the investment, as a way of entry. The second condition states that the firm must have internalization advantages; that is, once the first condition is satisfied, there must be some advantages deriving from a decrease of the transaction costs -like taxes, governmental costs or partners search costs- internalization of externalities or a reduction of uncertainty, which make more

23 beneficial for the company to exploit its ownership advantages internally, through a subsidiary, than by leasing or selling these advantages to independent foreign firms. The third condition, after first and second conditions are achieved, establishes that the firm must determine where the ownership and internalization advantages can be optimized in combination with specific advantages accessible in particular foreign locations, that is, the location advantages. The location choice is the answer to a maximization problem in which the ownership and internalization are involved. Location advantages respecting domestic markets are derived from the quality, availability or cost of inputs as well as physic distance, transportation and communication costs. The last condition, Dunning (1988) the role of location advantages is described as a core variable that it may be both necessary and sufficient to initiate the act of foreign direct investment. Neither Dunning's theory is exempt from critiques, although it is a complete and popular pattern of study nowadays and a reference framework in different analysis. It has been said that is not a suitable way of explaining joint-ventures, acquisitions or licenses, all of them are common ways of going abroad. It is Dunning's himself who checks his own approach and adapts it for alternative ways of international alliances. As he states, is eclectic due to the fact that the role of each of the requirements as determinants of FDI, can change in each specific situation. The main changes are related to the role of innovation to keep and increase competitive advantages. He also pays more attention to the territorial aspect of the location advantage, inside this concept it should have been given more importance to the across-border alliances increasing the competitiveness of the company. He considers that the traditional concept that a company s capacity is restricted by its ownership limits is no longer acceptable when the quality of decisions is influenced by cooperation agreements with other companies. Eclectic paradigm has been also accused of being redundant when explaining the difference between ownership advantages or company specific advantages and advantages derived from the internalization of the firm (Buckley, 1988; Itaki, 1991). The most widespread critique to the eclectic paradigm -and similar theories- refers that the identified variables are so many, that their value of prediction is void and

24 generally, lacks of dynamic considerations, at the time of describing why a company goes international, Dunning s paradigm pays little attention to the way investments are developed throughout time dimension. Dunning and Narula (1994) try to describe how the constant interaction of OLI variables influence the evolution of the international production across time, and the strategy of the company which will determine the new combination of OLI variables for future periods. The evolution in the internationalization theories let us consider that companies choose the optimal strategy to follow depending on its development stage and considering different variables and costs of getting updated facing changes in markets and demands PRODUCT CYCLE HYPOTHESIS In 1966, Vernon introduces the product cycle hypothesis; this theory is based on consecutive stages of development of the product of a company, and its strong influence in the internationalization process in which companies go through an exporting phase before changing first, towards a foreign direct investment FDI-, and finally to cost orientated FDI. Vernon stands out the technological innovation role, scale economies and uncertainty in commerce patterns between countries in this framework. He describes how companies shift the location of production as products go through their life cycle which consists on four sequential stages increasing the level of commitment of market resources, those stages are; introduction, growth, maturity and decline. Firstly companies with a new or innovative product increase their benefits due to the absence of substitutes, production is centred in domestic market as it is more easy and familiar for the firm, Vernon assumes the success of the firm creating the dominant product, the second stage is centred on the company s privileged position, in this situation and without the threat of loosing domestic market share, the firm is able to export and to search for alternative markets to take advantages of location of sources, labour costs or economies of scale, by licensing a foreign producer or establishing its own subsidiary. Thus during the product maturity, when new competitors enter the market and as time passes the product becomes standardized. Once this period of time is over, the price decreases, as a result competition is based mainly in price but the