Amsterdam Business School The Role of Culture in Foreign Market Entry Modes: Investigating the Relationship between Cultural Distance and Entry Mode Choices for Dutch MNEs. By: Sean Hickman Student Number: 6077277 Submission Date: 11-08-2014 MSc. in Business Studies – International Management Track First supervisor: Stephan von Delft Second Supervisor: Ilir Haxhi Abstract This study investigated entry mode decisions by Dutch firms engaging in foreign direct investment (FDI). In particular, it studied a potential inverted U-shaped relationship between entry mode choice and cultural distance, as opposed to the traditional linear relationship in which these variables are thought to interact. The major rationale behind the study was the so far inconsistent results on the matter. Building on a previous study that found this type of non- linear association between the variables for Japanese firms, this study failed to replicate those findings. The results do show a significant interaction between entry mode and cultural distance, but this interaction appears to be linear for Dutch firms. Furthermore, other factors such as firm performance, industry, and host country development did not significantly influence entry mode choice, but firm size did have a significant effect. 1 Table of Contents 1. Introduction……………………………………………………………...…………………4 2. Theoretical Framework………………………………………………………….....…….10 2.1 Internationalization Process…………………………………………………………….10 2.1.1. Transaction Cost Approach…………………………………………………....…..11 2.1.2. Uppsala Internationalization Model……………………………………………….12 2.1.3. Eclectic Paradigm…………………………………………………………………13 2.1.4. Organizational Capability Perspective………………………………………….…14 2.2 Entry Mode Choices………………………………………………………………….…15 2.3 Entry Modes’ Impact on Performance………………………………………………….16 2.4 Culture & Cultural Distance……………………………………………………………17 2.5 Effect of Cultural Distance on Entry Mode Choice…………………………………….18 3. Methodology & Hypothesis Formulation……………………………………………….22 3.1 Sample…………………………………………………………………………………..22 3.2 Hypothesis Formulation………………………………………………………………...23 3.3. Measures……………………………………………………………………………….25 3.3.1. Control Variables………………………………………………………………….25 3.4 Analytical Approach……………………………………………………………………28 4. Results…………………………………………………………...………………………...30 4.1 Descriptive Statistics for Main Hypothesis……………………………………………..30 4.2 Regression Analysis…………………………………………………………………….34 4.3 Descriptive Statistics and Analysis for 2nd Hypothesis…………………………………36 4.4 Descriptive Statistics and Analysis for 3rd Hypothesis…………………………………38 4.5 Descriptive Statistics and Analysis for 4th Hypothesis…………………………………39 2 4.6 Descriptive Statistics and Analysis for 5th Hypothesis………………………………...40 5. Discussion……………………………………………………………………………….…41 6. Limitations……...…………………………………………………………………….…...45 6.1 Sample…………………………….……………………………………………….……45 6.2 Measures………………………………………………………………………….…….45 6.3 Analysis………………………………………………………………………………...46 7. Future Research…………………………………..………………………………………47 8. Conclusion…………………………………………………………………………………48 9. Bibliography………………………………………...…………………………………….51 10. Appendices……………………………………………………………………………….56 10.1 Appendix A……………………………………………………………………………56 10.2 Appendix B……………………………………………………………………………60 3 1. Introduction In an era of growing globalization many companies are increasing their international business activities, but while this was traditionally done through the means of imports and exports, there is an increasing trend of directly investing abroad, as foreign direct investment (FDI) rates have increased drastically throughout the world in recent decades (Bende-Nabende, 2002). However, the way in which investment abroad takes place varies significantly per company and country, as a range of factors contribute to companies’ entry modes into foreign markets differing from case to case. Pan & Tse (2000) distinguish equity-based from non-equity-based foreign market entry modes. Non-equity-based entry modes are those traditional ones such as exports and contractual agreements, while equity-based entry modes are examples of more contemporary means of international business activities in the form of foreign direct investment. Pan & Tse (2000) also identify four main and general forms of FDI activities, namely greenfield investments, acquisitions, joint ventures, and the acquiring of shares. Investment abroad by means of greenfields and acquisitions lead to wholly owned subsidiaries (WOS) of a company that have no association with or dependence on any other firm, while collaborating with local firms lead to equity joint ventures in which two or more firms have a stake in the newly established subsidiary. The choice of entry mode has been extensively studied in international business research, with its effect on performance being regarded as one of the foremost reasons why. Brouthers (2002) shows that the choice of entry mode indeed has implications for firm performance, which makes it essential for companies to carefully make a choice as to what entry mode will be used when entering foreign markets, as firms will evidently want to choose the entry mode which will yield the highest performance. 4 There are a number of factors which likely play a role in the choice of entry mode, yet the extensive empirical research on the topic has yet to provide us with concrete information as to which factors are of greatest influence in determining entry mode choice. According to Kogut & Singh (1988), firms will likely face cultural challenges resulting from entering less known markets when determining FDI decisions and entry mode choices, and as such culture is considered a major factor that will influence companies’ entry mode decisions. International business research on entry modes has therefore also emphasized culture as a potential influencer, yet results on this show no clear consensus (Wang & Schaan, 2008; Morschett, 2010). This lack of consensus amongst researchers on the topic is highly problematic, as internationalizing companies and their managers are unaware of the consequences of their entry mode choices, which will likely prevent them from yielding the greatest potential performance from their international business activities. The cost of doing business abroad is undoubtedly affected by the culture of those where the foreign business is taking place, as international business activities inherently involves interactions with local populations, and these interactions are likely to be affected by their culture. Without properly assessing the cultural implications of doing business in certain countries, even successful firms with proven track records in one country might miserably fail in another country, which further emphasizes the need to establish the extent to which cultural factors have an effect on international business performance. A noteworthy and recent example of where a successful firm turned out to be much less successful in a foreign market is the case of Home Depot in China (Gao, 2013). Since its foundation in the United States in the late 70s, the company grew out to be the leader in the US home improvement and DIY market. The business model which proved to be so successful in the American market turned out to be a failure in the Chinese market, which is mostly attributed to the cultural differences that Home Depot failed to foresee, which in this particular case generally came down to the differences in the Chinese 5 home improvement market and the lack of experience with the DIY concept. As such, after years of losses, Home Depot decided to shut down all its remaining stores in China by 2012 and fully exited the market (Gao, 2013). The company’s unsuccessful venture in China was not unique however, with Mattel Inc. and Best Buy, two major American retail companies, having faced similar problems in the past, which had resulted in both companies withdrawing from the Chinese market. These cases prove that a replication of a successful strategy in a home country will not necessarily lead to that strategy being as successful in other host countries. Firm characteristics will undoubtedly have an effect on performance, with companies such as Home Depot having initially become so successful due to their unique business models, yet it is a common and erroneous assumption that these successful models can be replicated in other countries. External factors clearly also play a role in the extent to which a company’s performance is successful, and when entering foreign markets culture is likely to be one of the most influential external factors. It is therefore of interest to both companies and their managers to carefully assess and analyze the different modes of entering foreign markets, so that the eventual chosen entry mode best reflects the interest of the firm whilst simultaneously addressing the cultural difference with the country/market they are entering. This research on culture is most commonly focused on the concept of cultural distance, developed by Geert Hofstede (1980). He found that people from different countries have different cultures by measuring four distinct attributes or values, later adding a fifth, which are work-related and therefore have an influence on business. These attributes, or dimensions, include power distance, individuality versus collectivism, masculinity versus femininity, uncertainty avoidance, and long term versus short term orientation. According to Hofstede, these attributes differ per country, and the differences between these dimensions give rise to the concept