A Transaction Cost Perspective

Introduction

International entry mode choice is considered a critical strategic decision. In an attempt to understand this choice, scholars have primarily focused on transaction cost theory

Previous literature have failed to examine how the transactional cost model applies to smaller entrepreneurial firms." Small and medium-sized enterprises (SMEs) are not smaller versions of larger companies, but mainly due to their size they tend to interact differently with their environment.

The Authors could identify no studies of SME entry mode choice that have examined the three main causes of transaction costs: asset specificity, behavioral uncertainties, and environmental uncertainties. By examining the entry mode behavior of SMEs, they can determine whether they follow similar patterns as their larger counterparts and whether the strategic decision processes that influence success for larger companies have validity in smaller firms.

In this article they hope to make two important contributions to the SME international literature. First, by examining the applicability of transaction cost theory to SME inter- national entry mode choice, we hope to extend the generalizability of transaction cost theory for entry mode choice to this large and growing sector of the global economy

Transactional costs and mode choices

Transaction cost (TC) theory has been widely used in entry mode research to explain why large companies utilize different modes in expanding abroad. The existing literature suggests that companies adopt a certain organizational structure--markets (non-equity modes) versus hierarchies (equity modes)--when expanding abroad based on how efficient one structure is compared with the alternative structure.

Transaction cost theory suggests that asset specificity, behavioral uncertainties, and environmental uncertainties create two main costs: market transaction costs and control costs

Asset specificity

Asset specificity refers to the physical and human resources, which may lose value in another use, that a company employs to complete a specific task. A firm that possesses unique technology and know-how has to take extra precautions (and incur additional costs) in order to protect its differentiated assets from falling into the hands of competitors. When asset specificity is low, firms will incur few costs in protecting their know-how from competitors. Low asset-specific investments involve the use of generally available knowledge; hence, firms are not concerned about protecting this knowledge from competitors, since competitors already have access to the knowledge. When asset specificity is low, firms tend to use market-based non-equity modes of entry. When asset specificity is high, firms are more concerned with protecting proprietary knowledge or technology from competitors.

Hypothesis1: SMEs will tend to prefer non-equity modes of entry when assets specificity is low, but tend to prefer equity modes of entry when asset specificity is high.

Behaviour uncertanty

Transaction cost theory suggests firms face two types of uncertainty: behavioral and environmental. Behavioral uncertainties arise from the inability of a company to predict the behavior of individuals in a foreign country. According to transaction cost theory, behavioral uncertainty may lead to opportunistic behavior involving cheating, distortion of information, shirking of responsibility, and other forms of dishonest behavior. Internationalization theory suggests that firms develop skills at controlling international operations through experience. Through learning, firms develop expertise in managing foreign operations (either independent operations like license agreements or more complex operations like wholly owned subsidiaries). Firms lacking international control-related experience tend to prefer non-equity modes of entry, as a means of controlling the behavior-related uncertainties of foreign expansion. High behavioral uncertainties may discourage SMEs from organizing foreign operations in a hierarchical form

Hypothesis 2: SMEs will tend to prefer non-equity modes of entry when they have not developed internal control mechanisms, but will tend to prefer equity modes of entry