International Business Strategy -Chapter 6 The entrepreneurial firm

Entrepreneurship and entrepreneurial firms

Today’s small and medium-sized enterprises (SMEs): firm with fewer than 500 employees in the US or with fewer than 250 employees in the EU, will become tomorrow’s multinational enterprises (MNEs). Firm size and age does not define the characteristics of entrepreneurship: identification and exploitation of previously unexplored opportunities – the individuals are entrepreneurs, mostly referred to as founders and owners – international entrepreneurship: combination of innovative, proactive, and risk-seeking behavior that crosses national borders and is intended to create wealth in organizations – on average, SMEs tend to be more entrepreneurial than large firms.

A comprehensive model of entrepreneurship

Strategy tripod with three leading perspectives:

(a) industry-based considerations; exemplified by Porter’s five forces; (1) intensity of inter-firm rivalry; direct impact on probability that new start-up will make it – the fewer the incumbents, the more likely they will collude to prevent newcomers from gaining market shares, (2) entry barriers; new firm entries cluster around low entry-barrier industries (restaurants) – capital-intensive industries hinder chance of success, (3) bargaining power of suppliers; when it becomes too large, may take advantage (Mircrosoft-Linux), (4) bargaining power of buyers; entrepreneurs who can reduce bargaining power, may see themselves succeed (Amazon), and (5) substitutes; if entrepreneurs can bring in substitutes that can redefine the game, can create a competitive advantages,

(b) resource-based considerations; VRIO framework; (1) value; entrepreneurial resources must create value, (2) rare; best-performing entrepreneurs tend to have the rarest knowledge/deeper insights, (3) inimitable; should not be possible, and (4) organizational; resources must be organizationally embedded, and

(c) institution-based considerations; both formal and informal institutions – (a) formal; whether entrepreneurship is facilitated significantly depends on formal institution governing start-ups in terms of registration, licensing and incorporation – governments in develop economies impose fewer procedures and lower total cost, conversely in poor countries entrepreneurs have to put with harsher huddles – the more entrepreneurfriendly the formal institutional requirements are, the more flourishing entrepreneurship is and the more developed economies become, and (b) informal; e.g. cultural value/norms – entrepreneurship take more risk, individualistic and low uncertainty avoidance societies tend to foster relatively more entrepreneurs.

Five entrepreneurial strategies

Five strategies: (1) growth, (2) innovation, (3) network, (4) financing/governance, and (5) harvest/exit – possible sixth one: internationalization.

Growth – excitement associated with growing attracts them – growth can be viewed as an attempt to more fully use currently underutilized resources and capabilities – entrepreneurial firm can leverage vision, drive and leadership in order to grow. Innovation – innovation is at the heart of the mindset – innovation strategy is a specialized form of differentiation strategy, offers three advantages; (1) allows potentially more sustainable basis for competitive advantage, (2) innovation should be regarded as broadly – most start-ups reproduce existing organizational routines, but recombine them to create some novel product, and (3) entrepreneurial firm are uniquely ready for innovation – many SMEs are founded by former employees or large firms who were frustrated by their inability to translate innovative ideas into realities – innovators are better able to reap financial gains fueling their motivation to charge ahead.

Network – network strategy refers to intentionally constructing and tapping into relationships, connections – two kinds; personal and organizational – prior to founding phase these two networks overlap significantly – three attributes distinguish entrepreneurial networking; (1) urgency; to develop and leverage networks – confront liability of newness: inherent disadvantage that entrepreneurial firms experience as a new entrants – lack track record, legitimacy, (2) intensity; network relationships can be classified as strong ties: more durable, reliable, and trustworthy relationships cultivated over a long period of time, and weak ties: relationships characterized by infrequent interaction and low intimacy – efforts to develop strong ties are more intense, may change over time, and (3) impact; contributions of entrepreneurs’ personal networks tend to have a stronger impact on firm performance – being private owners, entrepreneurs can directly pocket the profits if their firms perform well. overall, strong network represent significant resources and opportunities – more centrally located network positions are helpful.

Financing and governance – 4F sources of financing; family, friends, founders and fools – in reality, strategic investors (angels), banks, government agencies, venture capitalists: investor who invests capital in early-stage, high-potential start-ups, are not fools – examine business plan, require strong management and scrutinize financial reviews – demand assurance (collateral) – turning weak-tie contacts into willing investors is always challenging, may be more formal – demand equity stake, seats on board of directors, set of formal rules – odds of survival during crucial early years are significantly correlated with firm size (the larger, the better) – extent to which entrepreneurs draw on resources of family/friends vis-à-vis formal outside investors is different internationally – innovative solution, microfinance: practice to provide microloans ($50-$300) to start small businesses with intention of ultimately lifting the entrepreneurs out of poverty. Harvest and exit – different routes; (1) selling equity stake - can substantially increase value of firm – offer excellent harvest option – however, must be willing to give up some ownership/control rights, (2) selling the firm to other private owners – may be done with painful discount, or carry happy premium – selling out does not necessarily mean failure, (3) merging with another company – drawbacks; lose independence, some entrepreneurs may personally exit – lackluster entrepreneurial firm is not in a great position to bargain for a good deal, if properly structured and negotiated a merger will allow entrepreneurs to reap the rewards, (4) initial public offering: first round of public trading of company stock – goal of many entrepreneurs – advantages; financial stability – no longer begging for money – stock options can be issued as incentives retaining capable employees – great signal firm has “made it” – enhanced reputation enables firm to raise more capital – disadvantages; subject to rational and irrational exuberance of financial market – founding entrepreneurs may gradually lose majority control – have to look after interests of outside shareholders – constraint freedom of action, and (5) declare bankruptcy; taking a firm through an IPO is way to harvest, many entrepreneurial firms do not have such luxury.

Internationalizing the entrepreneurial firm

Myth; large MNEs go abroad and SMEs operate domestically – myth is challenged – born global firms/international new ventures: start-up company that attempts to do business abroad from inception.

Transaction costs and entrepreneurial opportunities – international transaction are qualitatively higher – some costs are high due to differences in formal institutions/informal norms, or high level of deliberate opportunism that is hard to detect – may not choose to pursue international opportunities – therefore, entrepreneurial opportunities exist to lower transaction costs and bring distant group of people/firms together – can internationalize by entering foreign markets, or add international dimension without actually going abroad.

International strategies for entering foreign markets – three broad modes: (1) direct exports: directly selling products made in the home country to customers in other countries – able to reach foreign customers directly, may compensate for domestic downturns – drawback; may not have enough resources, (2) licensing: firm A’s agreement to give firm B’s the rights to use A’s proprietary technology or trademark for a royalty fee paid to A by B (typically in manufacturing), or franchising: firm A’s agreement to give firm B the rights to use A’s proprietary technology or trademark for a royalty fee (typically in service industries) – SME can expand abroad while risking relatively little of their own capital, and (3) foreign direct investments; may involve greenfield wholly owned subsidiaries, strategic alliances, and acquisitions – become more committed to serving foreign markets – physically/psychologically closer to foreign customers – better able to control proprietary knowledge – drawback; its cost and complexity. Overall, majority of SMEs will be unable to go abroad.

International strategies for staying in domestic markets – five main strategies for SMEs to internationalize without leaving home country; (1) indirect exports: exporting indirectly through domestic-based export intermediaries: firm that performs an important middleman function by linking domestic sellers and foreign buyers that otherwise would not have been connected – facilitate internationalization, (2) supplier of foreign firm; piggybacking on larger foreign entrants, (3) franchisee/licensee of foreign brand; foreign licensors/franchisors provide training and technology to operate at world-class standards – if enough learned, possible to discontinue relationships and reap greater entrepreneurial profits, (4) become alliance partner foreign direct investor; many firms may not be able to successfully defend their market positions – better than being crushed so join them, and (5) sell equity stake or entire firm to foreign entrants; being acquired by foreign entrants may help preserve business in the long run.

Debates and extensions

Traits versus institutions – what motivates entrepreneurs? – “Traits” school of thought; personal traits matter – more likely to possess stronger desire for achievement, more willing to take risks and tolerate ambiguities – serial entrepreneur: entrepreneur who starts, grows, and sells several businesses throughout his/her career – critics: such traits are not limited to entrepreneurs – diversity among entrepreneurs makes any attempt to develop standard psychological profile futile. Look at institutions; environments that set formal and informal rules of the game – able to facilitate more entrepreneurial success, encourage or constrain entrepreneurship. Beyond macro societal-level institutions, micro institutions matter too – family background, educational attainment correlate with entrepreneurship – overall, extension of debate nature versus nurture.

Slow internationalizers versus born global start-ups – two components that should be considered; (a) can SMEs internationalize faster than suggested by traditional stage models: models that suggests firms internationalize by going through predictable stages from simple steps to complex operations, and (b) should SMEs rapidly internationalize? – dust has largely settled on first component; it is possible for some SMEs to make very rapid progress in internationalization – second component; advocates argue that every industry has become global and that entrepreneurial firms need to rapidly go after these opportunities - however, stage models suggest that firms need to enter culturally and institutionally close markets first and gradually move from primitive modes (exports_ to sophisticated strategies (FDI). Key issue; whether it’s better for entrepreneurs to start the internationalization process soon after founding or to postpone – firms following stage models must first overcome substantial inertia because of their domestic orientation, conversely firms that internationalize earlier need to overcome fewer of these barriers – SMEs without established domestic orientation may outperform rivals that wait longer.

Anti-failure biases versus entrepreneur-friendly bankruptcy laws – What can we (government, financial institutions, consumers, society at large) do prevent bankruptcies? – Efforts to rescue failing firms from bankruptcies stem from an antifailure bias – this bias leads to strong interest in entrepreneurial success – entrepreneurfriendly suggests bankruptcies may be good for the society – laws need to be reformed to become more entrepreneur-friendly by making it easier to declare bankruptcies and to move on – resources stuck with failed firms can be redeployed in a socially optimal way. Debate how to treat failed entrepreneurs who file for bankruptcy – let them walk away or punish them? – Entrepreneur-friendliness and bankruptcy laws are like an “oxymoron” (bankruptcy laws are usually harsh). Many governments recently realized entrepreneur-friendly bankruptcy laws can not only lower exit barriers but also entry barriers – at present difficult to predict which start-ups will fail – from institution-based standpoint; if entrepreneurship is to be encouraged, there is need to ease the pain associated with bankruptcy to allow entrepreneurs to walk away from debt – harsh bankruptcy laws become exit barriers/entry barriers – fewer decide to launch new ventures. Societal level – if many entrepreneurs would abandon ideas in fear of failure there will not be a thriving entrepreneurial sector. Institutionally – urgent need to remove some of anti-failure bias and design entrepreneur-friendly bankruptcy policies so that failed entrepreneurs are given more chances – societal level – failures may be beneficial since through many experimentations the winning solutions will emerge and economies will develop.

The savvy strategist

Entrepreneurs and engines of the “creative destruction” process underpinning global capitalism – all three leading perspectives shed light on entrepreneurship; (a) industrybased; suggests entrepreneurial firms tend to choose industries with lower entry barriers, (b) resource-based; posits that it’s largely intangible resources (vision, drive) that fuel entrepreneurship, and (c) institution-based; larger institutional frameworks explain about the differences in entrepreneurial and economic development around the world. Four important implications; (1) establish intimate understanding of your industry to identify gaps and opportunities or to avoid/exit from it if threats are too strong, (2) leverage entrepreneurial resources and capabilities; such as drive, innovative capabilities and network ties, (3) push for more entrepreneur-friendly formal institutions; e.g. governing how to set up firms and how to go through bankruptcy, and (4) when internationalizing, be bold but not too bold; do be reckless – possible to internationalize without going abroad. Fundamental questions; (1) and (2) personal characteristics of their founders, (3) how successful entrepreneurs can expand their business, and (4) depends on whether entrepreneurs can select right industry, leverage their capabilities and take advantage of formal/informal institutional resources (at home and abroad).