Overcoming the Liability of Foreignness with Isomorphism

An examination of the effectiveness of isomorphic strategies used by German MNEs engaging in foreign direct investment in Africa


Bachelor Thesis, 2020

43 Pages, Grade: 1,0


Excerpt

Contents

1 Introduction

2 Literature Review
2.1 The Liability of Foreignness
2.1.1 Business Impact of the LOF
2.1.2 Deriving a Common Framework
2.2 The Impact of Institutional Distance on the LOF of German MNEs in Africa
2.3 Overcoming the Liability of Foreignness with Isomorphic Strategies
2.3.1 Institutional Theory
2.3.2 Isomorphism
2.3.3 Building a Framework for Isomorphic Strategies

3 Hypothesis Development

4 Methodology

5 Results
5.1 Unfamiliarity and the Lack of Relationships
5.2 Discrimination
5.3 Legal and Political Environment
5.4 Cultural Differences

6 Discussion and Conclusion
6.1 Findings
6.2 Practical Implications
6.3 Limitations and Further Research

References

Appendices

Overcoming the Liability of Foreignness with Isomorphism

1 Introduction

“We are improving”, said the German chancellor Angela Merkel at the G20 Investment Summit in 2019 as she reported on Germany’s efforts to encourage private investment in Africa. In an interview with the German ARD public television, she mentioned the “promising numbers” of the German investments in Africa; a continent that promised “more chances than risks” (Ulrich, 2019). Indeed, although German investments in Africa are still on a low level, Africa’s importance to Germany as an external trade partner has significantly increased (Afrika-Verein, 2012). However, these opportunities have considerable costs and risks attached. One cost factor that is crucially important for German multinational enterprises (MNE) in Africa, as it is amplified by institutional distance, is the ‘liability of foreignness’ (LOF). The LOF describes the additional costs that a firm operating in a market overseas incurs compared to the domestic firms (Zaheer, 1995).

In recent years, researchers like Zaheer, Eden and Miller, and Mezias have laid the foundation for multiple theoretical approaches that aim to overcome the LOF. However, there is still a considerable research gap concerning actionable strategies MNEs can apply in practice. Building on the work of these researchers, this thesis aims at contributing to the current literature by taking the perspective of institutional theory. In particular, it examines the effectiveness of isomorphic strategies, inter alias, processes of adaption and imitation of legitimated practices, in reducing the LOF (DiMaggio &Powell, 1983).

First of all, I use existing literature to construct frameworks to categorize the cost dimensions of the LOF and several isomorphic strategies. Furthermore, using semi-structured expert interviews, this paper evaluates the effectiveness of adaption strategies employed by German MNEs in Africa for different cost dimensions. I argue that isomorphism, i.e., adaption strategies, are of high importance for the success of German investments in Africa. More specifically, I show that networking, the adaption of formal structures, and the adaption to the institutional environment are effective in reducing the LOF by lowering market entry risks, facilitating knowledge acquisition as well as enhancing legitimacy in the host market.

2 Literature Review

2.1 The Liability of Foreignness

Despite the potential benefits of foreign investments for MNEs, investments can imply significant costs and competitive disadvantages relative to more embedded domestic companies (Denk, Kaufmann & Roesch, 2012). In 1976, Stephen Herbert Hymer was the first to mention the ‘costs of doing business abroad’ (CDBA) caused by the lack of information, a persisting “stigma of being foreign” (p.40), and currency risks.

After Hymer, Zaheer was one of the first to ‘open the black box‘ of the costs of going abroad and introduced the concept of ‘the liability of foreignness’(LOF); a more specific advancement of the CDBA since it chooses national firms as a benchmark for cost comparison (Eden & Miller, 2001). She defines the LOF as “all of the additional costs that a firm operating in a market overseas incurs compared to a local firm” (Zaheer, 1995, p.6).

Hereby, the LOF is part of the concept of the ‘lack of fit’ which is the “notion from the main strategy paradigm denoting disadvantages when the strategic behaviour of the firm (...) is not aligned with its environment” (Sethi & Guisinger, 2002, p. 228). Furthermore, it shows overlaps with the ‘liability of newness’ which explains the high rates of failure of new companies; both foreign and domestic (Sethi & Guisinger, 2002). It is important to mention that this LOF is not a purely exogenous construct that can only be derived from a company’s environment but much rather a result of a firm’s interaction with its environment and firm- specific characteristics (Gaur, Kumar & Sarathy, 2011). This combined examination of environmentally derived LOF and firm-based LOF adds a new dynamic element to the concept which, according to Gaur, Kumar and Sarathy (2011), is particularly important when dealing with emerging markets such as Africa.

2.1.1 Business Impact of the LOF.

The consequences of the costs of the LOF for companies are multifaceted. According to Denk et al. (2012), the outcomes of LOFs can get separated into three categories. The first category describes the potential negative impact of the LOF on the success of an MNE in a foreign market including various performance measures like profitability, growth, and return on assets as well as its survival rates (Zaheer, 1995; Denk et al., 2012). The second category summarizes the impact on intra-organizational processes concerned with the way a company internationalizes (Denk et al., 2012). To reduce the negative effects, companies require strong firm-specific advantages, effective internal knowledge transfer, and a high local resource commitment (Denk et al., 2012). Lastly, Denk et al. (2012) emphasize the significant influence of the LOF on the interactions between international businesses. A high LOF results in losses in organizational attractiveness, reputation, and a higher probability of lawsuits (Denk et al., 2012).

2.1.2 Deriving a Common Framework.

Despite its indisputable economic impact, the LOF is still an elusive concept whose costs cannot be easily anticipated and that may continue for an indeterminable time (Johanson and Vahlne, 1977). As a consequence, there is no agreed-upon framework that dissects the sources, determinants, and additional costs of the LOF’s different aspects. For this paper, a new framework has been developed based on the work of Zaheer (1995), Calhoun (2002), Mezias (2002) and Eden and Miller (2001). A depiction of the framework development can be found in Appendix A.

According to Eden and Miller (2001), the LOF focuses on relational, institutional, and social costs of access and acceptance. These inherent costs are generally driven by the unfamiliarity of a foreign firm with its environment leading to a lack of embeddedness, knowledge, and legitimacy (Halaszovich, 2019; Eden & Miller, 2001). The severity of these drivers and therefore the costs rise with increasing institutional distance, which includes cultural, institutional, linguistic, and spatial distances as well as differences in economic development and firm characteristics (Eden & Miller, 2001; Denk et al., 2012).

To better examine this concept, it was broken down into five main categories: (1) costs associated with spatial distance, (2) firm-specific costs based on a particular company's unfamiliarity and lack of relationships, (3) costs specific to the host country, (4) costs from the home country environment, and (5) costs due to cultural differences.

The first category is directly taken from Zaheer (1995) and describes the costs driven by spatial distance, geography, and time differences. The second category; the firm-specific costs that are based on unfamiliarity and a lack of relationships, is the result of merging Zaheer’s work from 1995 with the unfamiliarity hazard and the relational hazard (Eden & Miller, 2001). The unfamiliarity with the environment is driven by insufficient information about the market and business practices and, therefore, leads to costs that the MNE must incur to achieve the same level of knowledge as national firms as well as costs due to missed opportunities (Eden & Miller, 2001; Denk et al., 2012). Additionally, the lack of relationships limits the access to relevant networks and increases transaction costs of search, monitoring, dispute settlement, and trust building (Denk et al., 2012; Halaszovich, 2019).

The third category describes the costs based on the host country environment due to the lack of legitimacy of foreign firms, economic nationalism, and regulations as described by Mezias (2002) as well as limited access to resources, for example, due to discriminatory treatment (Eden & Miller, 2001). In contrast to Zaheer’s version from 1995, this category is supposed to include all costs incurred due to protectionism and an aversion against anything perceived as foreign regardless of the severity of cultural differences. In addition to discriminatory treatment, this category also includes the general legal and political environment of the host country and the costs associated with either the lack of conformity with processes, rules and regulations or costs induced by the restrictive nature of regulations. Category four is concerned with costs connected to the home-country like export restrictions or laws like the Foreign Corrupt Practices Act (Zaheer, 1995).

The last category is based on the work of Calhoun (2002) and identifies the cultural dimension of the LOF whose importance does not get sufficient attention in other frameworks. It deals with the information asymmetry caused by informal and unwritten norms, practices, and procedures (Calhoun, 2002). A high cultural distance leads to differences in use and understanding of symbols, language, religion, nonverbal communication, values, habits, etc. These differences can negatively affect a company’s internal environment, for example through non-aligned values or language barriers, as well as cause costs regarding interactions with third parties (Calhoun, 2002).

2.2 The Impact of Institutional Distance on the LOF of German MNEs in Africa

One aforementioned key driver of the LOF is institutional distance; a concept which Kostova and Zaheer (1999) described as the „difference or similarity between the regulatory, cognitive, and normative institutional environments of the home and the host countries of an MNE“ (p. 68). According to Eden and Miller (2004), a high institutional distance increases the level of unfamiliarity, discrimination, and relational hazards, resulting in increased LOF. This is, among other things, due to the fact that institutional distance impedes a foreign firm's understanding of the local market (Salomon & Wu, 2012). Moreover, it makes the interactions between stakeholders more difficult and decreases the legitimacy of foreign firms (Salomon & Wu, 2012). Therefore, a large institutional distance increases the pressures on the MNEs for local responsiveness and the difficulty of global integration (Eden & Miller, 2004). Due to its amplifying effect on the LOF, it is important to assess the institutional distance between Germany and Afrika.

One of the most widely accepted frameworks for measuring institutional distance is Ghemawat’s CAGE framework which examines the cultural, administrative, geographic, and economic distance (Garcia Morales, 2016). First of all, the cultural dimension is concerned with a country’s cultural attributes, which determine how people interact with one another and with companies and institutions (Ghemawat, 2001). To assess the distance created by differences in culture, this paper used Hofstede’s cultural dimensions theory which describes the effects of culture in the value of the society and how these values can influence to their behaviour in international business (Garcia Morales, 2016). Using the data on Hofstede’s web page, the cultural distance between Germany and Africa can get approximated by comparing Germany’s values to the average values of the African countries (Appendix B). There is a considerable distance in all categories, especially in power distance, individualism, and long-term orientation. The other categories masculinity, uncertainty avoidance, and indulgence showed less extreme, however, still considerable differences. In this context, it is important to mention that the values for indulgence show big fluctuations which makes the difference appear to be smaller than it is. All in all, the numbers suggest a rather big cultural distance between Germany and Africa.

Concerning the political distance, the extent of historical and political associations shared by countries greatly affects trade between them (Ghemawat, 2001; Garcia Morales, 2016). To assess the political distance, this analysis used the Corruption Perceptions Index (CPI) which gets published annually by Transparency International since 1995, which ranks countries by their perceived levels of public sector corruption (Transparency.org, n.d.).

This data implies a drastic difference in perceived corruption between Germany with rank 9 and the African countries with an average rank of 118,2 which has several implications about the complexity and way business is conducted (Appendix C). Concerning colonial ties, Liou and Rao-Nicholson (2017) show in their paper that firms can use colonization history to mitigate the negative impacts of the institutional distance since it alleviates the legitimacy threat derived from a political distance. Germany invested in colonies relatively late due to its late nation-building process. Starting in 1884/1885 after the Berlin Conference, Germany established colonies in South-West Africa, East Africa, parts of Papua-New Guinea, and throughout the Pacific Islands (Humanityinaction.org, 2005). However, due to the Versailles Treaty, Germany lost all colonies after the First World War and the freed territories were claimed by other European countries (Humanityinaction.org, 2005). Therefore, there is no German presence in the former colonies today (“The Guardian view,” 2016). As a consequence, Germany’s weak colonial ties cannot be expected to have a significant mediating effect on the LOF.

Looking at the geographic dimension, it is obvious that there is a considerable distance from Germany to Africa, for example, considering the actual physical distance ranging from 2.307 km (Tunesia) to 13.257 km (South Africa) as well as the climate with a temperate and marine climate in Germany compared to the semiarid to tropical climate in Africa (Creese & Pokam, 2016). According to Ghemawat (2001), this high distance is important since the farther one is from a country, the harder it will be to conduct business in that country.

Lastly, the economic distance describes the wealth or income of consumers as the most important economic attribute that creates distance between countries (Ghemawat, 2001). Therefore, this analysis used the data provided at worldbank.org to look at the GDP per capita (current US$), which is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products (Garcia Morales, 2016). As can be seen in Appendix D, there is a big difference between Germany’s GDP/capita of $53.074 and the average GDP/capita of the African countries of $6.482,4. The minimum distance here is about $23.000 (Seychelles). Moreover, another interesting index to look at is the Economic Freedom Index 2020 published by heritage.org. It measures the fundamental right of every human in a country to control his or her labour and property (Heritage.org, 2020). One can see that Germany with a score of 73,5 appears to have a considerably bigger economic freedom than African countries with an average score of 55,3 which implies relevant differences in prosperity, opportunity and regulations (Appendix E).

This analysis shows that there is a rather large institutional distance between Germany and Africa which increases the LOF for MNEs. This conclusion gets supported by the observation of Gaur, Kumar, and Sarathy (2011) that an internationalizing firm that moves to similar environments will experience less LOF than a firm that moves to dissimilar environments. The data implies that the host country Germany has an amplifying effect on the companies’ LOF, regardless of their firm characteristics. This circumstance further emphasizes the importance of examining the strategies with which German companies can reduce the negative effects of the LOF.

However, it is important to mention that the CAGE framework is designed for the comparison of countries and that Africa with its 54 member states is extremely heterogeneous. Therefore, this CAGE analysis is mostly based on averages and tendencies and, as a consequence, has a limited validity since it cannot account for differences among the African countries and, like every average, is heavily influenced by outliers. However, for this paper, it is sufficient to illustrate general tendencies to get a rough impression of the institutional distance.

2.3 Overcoming the Liability of Foreignness with Isomorphic Strategies

Several schools of thought have developed theories on how to overcome the LOF. For example, research suggests that foreign entrants choose the host country based on the fit between their institutional environments or by choosing an appropriate entry mode (Salomon & Wu, 2012). In the context of this paper, where the host country and the entry mode are set, one strategy the firms can decide to adopt is the strategy of local isomorphism where foreign subsidiaries can reduce their overall LOF by imitating strategies that were proven as locally legitimate by its institutional environment (Salomon & Wu, 2012). Based on the facts that 1) there is a significant institutional distance between Germany and most African countries; 2) firms with higher distance experience a higher LOF (Salomon & Wu, 2012); and 3) firms with higher distance are most likely to adopt isomorphic strategies (Salomon & Wu, 2012), one can not only derive that most German MNEs in Africa face a significant LOF but also the high importance of isomorphic strategies as a mediator for these costs.

The following sections will deliver an overview of the concept of isomorphism, institutional theory as its theoretical foundation, and provide a framework to categorize different isomorphic strategies.

2.3.1 Institutional Theory.

Institutional theory is a research tradition from the field of behavioural theory, which examines the processes by which social structures are established and change over time (Scott, 2012). Nowadays, research is most concerned with environmental influences like the dispersion of institutionalized practices among companies which are shaped by their institutional environment (Greve & Argote, 2015). According to the definition of Henisz and Delios (2000), the institutional environment includes political institutions, economic institutions, and socio-cultural institutions such as informal norms. Scott (2012) described the institutional elements with a three-pillar framework including regulative, normative, and cultural-cognitive elements contributing to institutional construction, maintenance and change. In order to maintain conformity with these institutional elements, institutionalized practices developed which, beyond material resources and technical information, also stress legitimacy as a necessity for a firm’s survival (Greve & Argote, 2015). Institutional theory, therefore, sees a firm’s ability to adapt to and organize along these prescribed lines as one determinant of its success (Meyer & Rowan, 1977). Based on this logic, it can get used to solve organizational problems regarding the development of new organizations as well as learning and adaption processes (Greve & Argote, 2015).

2.3.2 Isomorphism.

Based on the premises of institutional theory, isomorphism constitutes a way in which organizations respond to institutional forces (Jang, Lee & Nelson, 2014). DiMaggio and Powell (1983) describe it as “a constraining process that forces one unit in a population to resemble other units that face the same set of environmental conditions” (p. 149). This is due to isomorphic pressures that push firms towards homogenization (DiMaggio &Powell, 1983). As a result, organizational characteristics get altered in the direction of increasing compatibility with environmental characteristics (Meyer & Rowan, 1977; DiMaggio &Powell, 1983). This adaption is a learning process in which decision-makers learn appropriate responses and adjust their behaviour accordingly (DiMaggio &Powell, 1983). Furthermore, firms do not only adapt to their general environment but also organizations within it (DiMaggio & Powell, 1983). Institutional isomorphism takes into account the interactions with organizations with which they compete for political power, legitimacy, and economic fitness (DiMaggio &Powell, 1983). In the context of institutional isomorphism, one can identify three mechanisms driving organizations towards greater homogeneity.

Coercive isomorphism stems from political influence and the problem of legitimacy based on formal and informal pressures from organizations like governments, the legal environment, and cultural expectations (DiMaggio &Powell, 1983). The mimetic isomorphism constitutes a response to uncertainty. For example, a new firm entering a foreign market might respond to uncertainty by modelling itself after other, established businesses by imitating their best practices (DiMaggio &Powell, 1983; Salomon & Wu, 2012). Lastly, DiMaggio and Powell (1983) describe the normative isomorphism as a consequence of professionalization which is the collective struggle of members of an occupation to define the conditions and methods of their work. Therefore, the professionals within an organization show many similarities to their counterparts in other organizations (DiMaggio &Powell, 1983). By giving in to these pressures, companies can improve their success and their chances of survival (Meyer & Rowan, 1977). The use of legitimated structures and procedures increases the commitment of stakeholders as well as their tolerance in the case of declining performance (Meyer & Rowan, 1977; Salomon & Wu, 2012).

Since this paper investigates the suitable adaption strategies for German companies in the African market, where the main problems are uncertainty and legitimacy, the normative isomorphic pressures associated with homogeneity within professions is not relevant in this context. The focus, therefore, lays on the exploration of strategies that respond to the coercive and mimetic pressures.

[...]

Excerpt out of 43 pages

Details

Title
Overcoming the Liability of Foreignness with Isomorphism
Subtitle
An examination of the effectiveness of isomorphic strategies used by German MNEs engaging in foreign direct investment in Africa
College
Jacobs University Bremen gGmbH
Course
IBA
Grade
1,0
Author
Year
2020
Pages
43
Catalog Number
V1030632
ISBN (eBook)
9783346462862
ISBN (Book)
9783346462879
Language
English
Tags
Liability of foreignness, foreign direct investment, FDI, LOF, Isomorphism, Africa, Investment, Germany, MNE, isomorphic strategies, liability of newness, institutional, theory, framework
Quote paper
Julia Kaiser (Author), 2020, Overcoming the Liability of Foreignness with Isomorphism, Munich, GRIN Verlag, https://www.grin.com/document/1030632

Comments

  • No comments yet.
Read the ebook
Title: Overcoming the Liability of Foreignness with Isomorphism



Upload papers

Your term paper / thesis:

- Publication as eBook and book
- High royalties for the sales
- Completely free - with ISBN
- It only takes five minutes
- Every paper finds readers

Publish now - it's free