Foreign operation mode switching

Companies conducting international operations at some point will experience switches of FOMs. Companies switch FOMs either as a correction of managerial mistakes or as an adaptation to new circumstances as foreign operations develop. Some companies can come up with standard routines for the FOM switches. Mode switching enables more intensive operations to be developed in the particular market, supporting a strategy or deeper market penetration. Mode switching can recover a problem situation in a foreign market related to present mode use. To avoid the high switching costs will demand managers to prepare the mode switch well ahead of the actual event. The managers need to create a mode switch strategy and follow it. (Welch et al. 2007, 361-363) Mode switch strategy aims to eliminate switching costs and to ensure that local operators see the mode switch as a natural and acceptable part of the collaboration. (Welch et al. 2007, 372)

Internationalization is a typical result of mode switches which means a change from serving the foreign market through an outside agent to an in-house operation in that market usually in the form of an FDI. For instance switches from independent distributors to sales subsidiaries, from licensing agreements to production subsidiaries and from franchised to company-owned outlets. Nevertheless, mode switches in the form of externalization are also possible. For instance a conversion of company-owned shops into franchised shops, and outsourcing of foreign subsidiary production to local contract manufacturers. Internationalization and externalization are inter-mode switches, which refer to a change of organizational form (mode). However, entrant firms can make also intra-mode switches. In this case the entrant company keeps the FOM but a new local operator is appointed. (Welch et al. 2007, 361-363)

There can be situations were external factors change noticeably after the initial foreign market entry therefore making the entry mode less suitable.

Usually the situations involve changes on the local market, on the local operator or on the entrant company itself. Therefore, local market growth can be driver behind the mode switch. For instance it can be more suitable to have a local production instead of serving the market via exporting from home. This can lead not only to shift of location, but in addition change of ownership of the operation mode. Klein et al. (1990) noticed that sales volume is a discriminating factor in the selection between independent, local operator (foreign distributors and sales agents) and in-house arrangements (sales subsidiaries and home-based sales forces) where large sales volumes favor employee sales arrangements. In addition, change of local government policy on foreign ownership is a possible external factor. Governments in emerging markets can have restrictions on foreign ownership of companies especially in strategic industries. This forces entrant companies to alliances with local companies, in practice to form JVs with them. When these restrictions are removed entrant companies usually switch to wholly-owned subsidiaries. This market liberalization has been for many years a primary cause of shift from international JVs to wholly owned subsidiaries. Moreover, learning more about the local market and go-alone FOMs can induce mode changes when the entrant company has accumulated more knowledge from the target market. (Welch et al. 2007, 364-369)

However, it can be also that market integration and lowering of production costs pull in the opposite direction. Not being satisfied with the local operator is a usual reason behind intra-mode shifts, but less so for inter-mode changes. If the company can't appoint a new operator, for example there aren't any suitable operators available, then the entrant company can internalize its local operations. Changes of the management in the entrant company can be also a driver behind the mode shift. A new management team can be more eager to do changes to the existing FOMs. Manager can think of doing a mode shift if the advantages of

replacing a FOM with another are greater than the estimated switching costs. Mode shifts are in practice problem-solving devices rather than systematic ways of streamlining the entrant company's organizational structure. (Welch et al. 2007, 364-366)

Change can also come from the entrant company itself. In the moment of foreign market entry, the entrant company may be limited in terms of capital and management resources. (Ali & Camp 1993; Welch &

Luostarinen 1998) Thus, company does not choose any operation mode that demands vast requirements of capital and/or management resources, selecting instead some low-commitment mode in terms of capital and management resources such as independent distributors (Albaum et al.

2004), licensing (Contractor 1981) or franchising agreements (Oxenfeldt &

Kelly 1969). However, in the future the entrant company can acquire capital and generate excess management resources, as an outcome of realized managerial scope economies (Lafontaine & Kaufmann 1994;

Penrose 1956, 1959). In this situation it would be more suitable to change the low-commitment FOM to in-house arrangements such as sales subsidiaries and company-owned outlets. Finally, the company can grow bigger and become less risk-averse which can cause a FOM switch.

(Welch et al. 2007, 367-368)

Switching modes is not always possible because there can exist barriers to mode switch. These barriers can be distinct and tangible or they can be more subtle. Usually switching barriers are not about expected costs but more about the opportunity costs of sales revenue that may be abandoned as a price for dismissing an outside agent who keeps strong bonds with local customers. Therefore, switching barriers refers to costs and possible loss of revenues. For instance, a change from a foreign sales agency to a sales subsidiary may include switching cost that can be severance payment to the former sales agent to compensate for the too early cancellation of its contract. (Welch et al. 2007, 370)

The choice, development and change of operation modes are illustrated in the framework of Benito et al. (2009, 1464-1465) in figure 7. The base of

the framework is a behavior theory of the firm which implies that decision drivers are influenced by past experiences and present operations. Mode choice and change process is influenced by the vast amount of possible FOMs, however managers are custom to rely on their former experience and prefer modes that were good in other situations or restrict the mode choice set. These former experiences can have an impact on positive or negative bias which can lead to mode inertia. (Benito et al. 2009, 1464-1466.)

Mode inertia occurs when the manager prefers to use an existing mode rather than seek for other possibilities. Moreover, mode comparison and evaluation refers to how managers restrict decision intricacy so that the range of mode options evaluated can be extremely restricted. Next, mode choice and mode action phases can have very little mode alteration or package change to the degree that can reach to full mode change.

Nevertheless, applying a specific mode is connected with the outcomes it creates. General market performance and different types of learning are these outcomes. To conclude, these changes and outcomes feedback into a company’s mode experience, bias and competence base therefore having an impact on future mode decision processes. (Benito et al. 2009, 1464-1466)

Figure 7. Mode choice and change (adapted from Benito et al. 2009, 1465).

According to Pedersen et al. (2002, 18) mode shifts are the result of changes of organizational and environmental conditions and of the switching costs associated with a shift. Therefore, the mode shift decision implicates a cost-benefit analysis. There can be so-called "set up switching cost" which means that recruitment and training costs influence negatively on the exporters’ will to change their foreign intermediaries into sales subsidiaries and/or home-based sales forces. Moreover, lack of international experience may be a barrier to mode shift. (Pedersen et al.

2002,18)

According to Williamson (1985), a long relationship leads to asset specificity between the parties. Thus, in practice switching costs will increase as a relationship continues. However, as a relationship advances, the need for a mode shift decreases. Finally, according to internationalization process theory, over time companies become better prepared to involve themselves in market servicing modes that include a higher degree of resources and commitment (Pedersen et al. 2002,19).