Institutional theory is one the most renowned theoretical approaches to internationalization process of firms. From the 70s, there have been publications supporting and developing this theory by researchers such as Di Maggio, Powell, Scott, Meyer or Rowan. Nonetheless, some other alternative theories, such as OLI paradigm or TCE model, have also proven themselves quite significant. Shortell and Kalunzy (2000, p. 4) state that organizations must face certain external factors such “external or societal norms, rules, and requirements that an organization must conform to, in order to receive legitimacy and support”; which are two basic factors for a successful internationalization process.
Nowadays, it is essential to determine the accuracy of internationalization theories because corporations need to respond to the challenges of a globalized world. This essay aims to examine the applicability of the main assumptions of this theory in order to explain the internationalization decisions made by firms? anagers. For that purpose, key aspects such as its scope, current importance or empirical support will be evaluated. Meyer and Rowan (1977), Di Maggio and Powell (1983), and Scott (1987) state that, in order to obtain legitimacy, firms must face “isomorphic pressures” from the external context. Di Maggio and Powell (1983) define isomorphism as “constraining process that forces one unit in a population to resemble other units that face the same set of environmental conditions” and they remark that firms are forced to compete for legitimacy and political influence apart from customers and resources.
Scott (1995) specified that there are three types of isomorphic pressures: regulatory, cognitive and normative. Regulatory pressures can be defined as the rules, legislation and sanctions established by government that companies must follow. Cognitive pressures refer to the shared vision of how the world works by the members of an institution or societal entity able to affect a corporation. Normative pressures can be described as the values, norms or other cultural aspects within a country that can influence a firm.
In other words, for this theory, any internationalization or foreign direct investment (FDI) operation respond to a legitimacy seeking procedure in order to have access to key resources such as public funding or customer support. Nevertheless, this theory does not cover all the possible dimensions of an internalization process. Dunning (1993) states that there are 4 main motivations for an internationalization process: market seeking, resource seeking, efficiency seeking and strategic asset seeking. Market seeking can be explained as penetrate into other market and avoid dangerous factors such as tariffs or exchange rate risk.
Resource seeking refers to many factors such as location in a cluster, information, or less costly or more efficient resources. Efficiency seeking can be defined as cost reduction (transport and transactions) and the economies of scope and scale that can be reached in a internationalisation process. Strategic asset seeking is all the rest of different motivations such as imitating competitors, prevent competition or follow consumers. Therefore, Institutional Theory does not seem to cover fully those aspects because no economic considerations are made under this theory.
On the other hand, there are theories that cover more accurately economic considerations in internationalisation issues. Buckley and Casson (1976), and Rugman (1981); under Internalisation Theory, state that existing markets may not offer the most efficient conditions to companies and making those markets “internal” will reduce the transaction costs of operating with those markets. Dunning (1980) argues, in this OLI paradigm, that firms operate in international market in order to seek for different kind of advantages: Ownership advantages (i. e. rademark or know-how), Locating advantages (i. e. low salaries or taxation) and Internalisation advantages (same advantages mentioned in Internalisation Theory). Hence, it is obvious that Institutional theory has a limited scope as long as it covers political and social aspects of internationalisation, but it does not give any hint about economic concerns. Since the year 2000, according to a report written by the United Nations (2013), FDI going to BRICS countries (Brazil, Russia, India, China and South Africa) has tripled reaching an amount of $263 billions in 2012.
This amount represents 20% of FDI in the world. Moreover, Hall (1976) states that there are certain countries that can be described as High-context cultures that are based in interpersonal relationships. Those are countries where factors like trust or legitimacy are crucial for business and BRICS are considered as high-context countries. Therefore, firms need to gain legitimacy in order to operate in those markets and Institutional provides an excellent theoretical framework for defining success in those markets.
Nonetheless, it cannot be assumed that firms just comply with external pressures in order to gain legitimacy. Di Maggio (1988) argues that agents and organizations have their own interests and have the ability to implement strategic actions in order to fulfil their ambitions. Scott (1995) also states that companies and organisations do not react in a passive way to institutional environment and they behave actively. Araujo (2000) determines that, although organisations are under external pressures, companies will decide their own response to the environment.
Hence, companies are influenced by external factors, but they can decide what to do regarding those factors. On the other hand, there is some evidence that companies tend to mimic their strategic moves. Leroux, Pupion and Sahut (2011) state that companies are influenced by the choices made by the leaders of their sectors. Lieberman and Asaba (2006) argue that firms tend to imitate each other in order to deal with the uncertainty of the environment and reduce risks. For those authors, there two explanations for business imitation: information-based explanation and rivalry-based explanation.
Information-based ones assume that companies imitate the ones who seem to have ”superior” information. Rivalry-based ones that companies copy their strategic moves in order to limit rivalry or keep stable competitive parity. There are some researchers who have tried to deduct whether Institutional theory is reliable or not for explaining an internationalization process. Bianchi and Arnold (2004) state that Institutional theory is the best theoretical framework in order to explain the failure of the Internationalization process of the American retail company Hot Depot into the Chilean market in 1998.
Their research determined that the main cause of the failure of this process was the scarcity of legitimacy of Hot Depot in Chile because they were not able to offer a confortable shop atmosphere for their customers and the range of products was not satisfactory for Chilean clients. Also, Hot Depot failed because its competitors were capable of anticipating and responding to its competitive advantage. Moreover, Cao and Perderzoli (2012) determine that institutional environment is very significant in the decision making process of retailing companies while operating in an emerging economy.
They also state that the creation of shared added value in those economies and the engagement between the company and the host market will increase the adaptability of those companies to institutional environment in emerging economies. Nonetheless, there are some other papers that determine that the effect of external environment in a company depends of its profile. Walsh and Yu (2010) state that institutional factors do not have relevance in primary sector companies while they are relevant in manufacturing and services corporations as it is shown in their research using econometric methods.
Additionally; Wrightley, Coe and Currah (2005) and, Bianchi and Ostele (2006) determine that retail companies are more vulnerable to institutional issues than other kinds of companies. Therefore, there is empirical evidence that shows the relevancy of this theory for corporate internationalization operations during the last 20 years. Otherwise, this relevance depends of the sector of the company and it seems to be a relation between the level of impact of institutional factors and their level of interaction with final customers. Furthermore, it is important to discuss whether Institutional Theory is relevant or not for managers.
Porter (1990) and Welford (1995) affirm that the external environment makes a strong influence on corporate strategy. Aguilar (1967) states that the environment is crucial in corporate strategy and he created the ETPS (Economic, Technical, Political and Social) model, which would become PEST model in the future, in order to analyse the external environment. Learned, Christiansen, Andrews and Guth (1969) determine that external environment is crucial for business strategy as long as it is a key element of their SWOT (Strengths, Weaknesses, Opportunities and Threats) model, where Opportunities and Threats are external elements.
Thus, it cannot be denied that Institutional Theory is relevant for managers because environment is crucial for any strategic planning and if managers ignore those factors, they will be destined to fail in internationalisation process. Furthermore, external pressures have relevance in other essential aspects of corporate management. Zaheer (1995) states that companies operating abroad may suffer “liability of foreignness” which are economic and social problems that can affect their performance, so they would tend to modify their organizational structure in order to make it similar to local firms? tructure. Also, Barkemeyer (2007) state that institutional pressures encourage companies to develop CSR (Corporate Social Responsibility) programmes in order to gain legitimacy in the host country. Therefore, external environment can exert a strong influence in all sorts of aspects of corporate management such as Organisation or CSR in order to be legitimate to operate in a foreign market and managers be aware of this situation. As a conclusion, it can be said that environmental pressures are a crucial element for business performance in international markets.
During the last decade, legitimacy has proven itself as a key resource in FDI processes as long as emerging economies are becoming one of the main receptors of foreign investment and, for those countries, it is necessary “being legitimate” in order to be supported by customers, local authorities and other social actors. As a contrast, this theory has some drawbacks as long as it assumes, in its early version, which companies just comply with external pressures and it does not consider in depth economic aspects.
Nevertheless, in spite of those weaknesses, Institutional Theory provide an excellent theoretical framework to managers that encourage them to be sensitive to the cultural elements (aesthetics, beliefs, norms or attitudes) and macro environment of their host markets, so they can improve their performance. Therefore, being able to provide such an important capacity to international managers is the best strength of this theory and it is what makes it relevant today.
Courtney from Study Moose
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