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  • Subject area(s): Marketing
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  • Published on: 14th September 2019
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1. Introduction

Investment can take many forms. Foreign direct investment (FDI) consists in making capital available from one country for carrying out an economic activity in another country, with a view to exercising a form of control, such as the ability to influence business decisions. The most common form of FDI is the creation or acquisition of a company. The European Union (EU) supports the movement of capital as it is essential in generating economic growth, jobs and reducing poverty. The EU is the largest source and destination of FDI in the world measured by stocks and flows (European Commission, 2015). The European Commission outlined its approach for the EU's future investment policy in its Communication "Towards a comprehensive European international investment policy" in 2010. One of the main aspects of this approach is increasing the market access for foreign investment.

Foreign market access is an important topic in the strategies of multinationals. The choice of market entry strategies is an important topic in an international business context as well (Ekeledo and Sivakumar, 1998; Erramilli and Rao, 1993; Malhotra et al., 2003; Mayrhofer, 2004; Chen et. al., 2006). The chosen market entry strategy is important as it determines the manner in which multinational enterprises (MNEs) develop and implement marketing programs, coordinate business activities both within and across markets, and ultimately the MNEs' success in foreign markets (Chen et. al., 2006). Overcoming the so called liability of foreignness is one of the most important challenges faced by firms when performing an entry mode strategy.

Firms operating in a foreign market face additional costs compared to domestic firms due to unfamiliarity with the local market (Kindleberger, 1969; Hymer, 1976; Zaheer, 1995). The disadvantage that arises from these extra costs is referred to as the liability of foreignness. One of the ways to (partially) overcome the liability of foreignness, is by choosing the right entry strategy when entering a foreign market (Erramilli and Rao, 1993; Malhotra et. al., 2003; Chen et. al., 2006).

Most previous research on this issue is limited to entries of companies located in a single country (Mayrhofer, 2004). Furthermore, a majority of the existing literature compares a firm which faces liability of foreignness with a firm that doesn't face liability of foreignness. It can be concluded that a significant research gap exists in this area because to date, we have only a limited understanding of how LOFs affect MNEs' decision-making processes prior to their market entry (Denk et. al.,2012). Additionally, this paper adopts the statement of Miller and Richards (2002), that not all firms face the same degree of liability of foreignness. This difference arises from the fact that some firms are more familiar with the host country because of, among others, geographic proximity. This study will focus on the influence of different levels of liability of foreignness firms face when entering a foreign market on the choice of entry mode strategy when entering the European Union.

This paper will first review the existing literature on the liability of foreignness and entry mode strategies to illustrate the literature that triggered this research. Next, the purpose of this paper will be translated to multiple hypotheses in order to test the central research question of the influence of different levels of liability of foreignness on the choice of entry mode strategy. A method section will provide information about the statistical methods used, next the hypotheses will be tested. The results of this test will be discussed in the results section, followed by implications, limitations and directions for further research.

2. Literature

The central research question in this paper can be decomposed to three central topics. These topics are investment climate in the European Union, liability of foreignness, the concept of distance and the entry mode strategies. All of the relevant literature on these topics will be briefly discussed in this section.

2.1 The European Union

‘'As foreign investors regain confidence, foreign direct investment in Europe hits a new record'' says Ernst & Young in their attractiveness survey Europe 2015. This survey reflects a positive trend in Europe. Investors believe that Europe has cut loose from the recession and is now on the way back to growth. The 2014 figures already showed an increase in investment flows towards Europe. ‘'Now, though cautious, they suggest a breakthrough that is perhaps even more momentous: the possibility that Europe has so improved its capacity to create and innovate, it could plausibly harbor the next Google, and that it has pulled further ahead of China as the world's most attractive investment destination'' (Ernst & Young, 2015).

Global growth slowed down last year and foreign direct investment flows all over the world stood still. Europe however attracted US$305 billion of investment funding, an increase of 36% compared to 2013. Fast recovery and cheap resources triggered a comeback of the US, but Western Europe convinced even more investors that it is now the place to be. And 59% of them believe that Europe's attractiveness will improve still further during the next five years (Ernst & Young, 2015).

Where America first had the monopoly on building big companies that dominate the digital transition, cautious confidence in European culture and creativity, business skills and entrepreneurship is regained by investors. The capacity to acquire economic growth and competitiveness is demonstrated by multiple countries around Europe.

So are there any negative sides on investing in Europe? In other words, what could be a potential form of liability of foreignness for investors? ‘'Excess bureaucracy and slow growth are still seen as major impediments. Geopolitical unrest on the frontiers of Europe, energy insecurity and public deficits are deterrents that pale in comparison to the complexity of rules that straitjacket European employers and entrepreneurs. Yet countries that have moved to enhance labor market flexibility, simplify regulations and lighten burdens on companies are seeing the benefits via faster growth, increased employment and enhanced investment inflows. To make the best out of Europe's comeback, both in terms of economic growth and as a leading destination for FDI, and sustain these trends in the upcoming years, policymakers should continue to remove obstacles to business efficiency'' (Ernst & Young, 2015).

This analysis confirms the fact that investing in Europe becomes increasingly interesting for foreign investors. Nevertheless, liabilities attached to this potential investments are also present. Investors now believe this is Europe's comeback time, this paper anticipates on this phenomenon by looking at the foreign direct investment that flows to the European Union.

2.2 Liability of Foreignness

Hymer (1976) provided us with the theoretical base of the liability of foreignness theory. Hymer states that the earlier mentioned extra costs faced by internationalizing firms arise from:

• an MNE's unfamiliarity with the foreign environment in which it engages in operations;

• discriminatory attitudes of customers, suppliers, government agencies, etc.; and

• additional costs associated with operating internationally.

Zaheer (1995) focused on the sources of the liability of foreignness, which can be categorized in the following categories:

• spatial distance between home and host countries;

• lack of roots in a local environment;

• host country environment; and

• home country environment.

Furthermore, Eden and Miller (2001) divided the liability of foreignness concept into three categories: unfamiliarity hazards, relational hazards and discrimination hazards. Unfamiliarity hazards include a market assessment that doesn't fit, a lack of (quality) information and a lack of knowledge of the host country's culture, norms, values and business practices (Caves, 1971; Eden and Miller, 2004; Petersen and Pedersen, 2002). Increased cost for internal and external transactions are the causes of relational hazards (Caves, 1971; Masten et al., 1991). Communication within firms become more complex when distance increases (Eden and Miller, 2004). Furthermore, relational hazards arise in business to business interactions because of a lack of embeddedness in local networks and distrust (Eden and Miller, 2004; Ring and Van de Ven, 1992). When a foreign firm is treated unfavorable compared to local firms, the literature states that discrimination hazards arise. Examples are political hazards which occur by an ‘unfair' treatment by the government (Henisz and Williamson, 1999) and discrimination from consumers (Balabanis et al., 2001).

Existing research on the liability of foreignness focuses primarily on the sources of the liability of foreignness (Hymer, 1976; Zaheer, 1995). While some research focuses on the liability of foreignness in relation to the used entry strategy (Chen et. al., 2006), none of them examine the European Union. The literature states that the degree of foreignness affects the choice of entry mode, but the debate on the relationship between entry mode and foreignness in the literature is inconclusive (Chen, 2006). This statements strengthens the relevance of this research and further indicates the research gap that this research attempts to fill. Chen (2006) states that firms that wish to penetrate foreign markets should choose an entry mode that allows them to exploit their firm-specific advantage to the maximum extent possible while controlling for the risks arising from market uncertainty.

Combining these two findings in the literature indicates a potential relationship between the degree of the liability of foreignness and the choice of entry mode, which this research attempts to elaborate on.

2.3 The concept of distance

The concept of ‘distance' has been a topic in many international business scholars' researches when they attempted to explain variations in international business strategies and operations across countries. The more distant a host country is from the organizational centre of a multinational enterprise (MNE), the more it has to bridge differences in culture, in laws and regulation, and in organizational practices and routines (Ionascu et. al., 2004). The MNE has to adapt its entry strategies, organizational forms, and internal procedures to manage these differences (Johansen and Vahlne, 1977; Kogut and Singh, 1988; Kostova and Roth, 2002). The existing literature developed a so called concept of ‘'psychic distance'', however this is based on perception and will therefore not be used in this research.

Multiple studies use the Kogut-Singh index to show that the distance between FDI's host and home countries influences strategies pursued by MNE, for example entry mode choice (Kogut and Singh, 1988; Anderson and Gatignon, 1986; Agarwal, 1994). Aspects other than cultural norms also influence business strategies (Ghemawat, 2001; Shenkar, 2001). MNEs interact with a complex local context when they enter a foreign market, that also includes regulatory and cognitive institutions (Ionascu et. al., 2004; Scott, 1995/2001). MNEs have to adjust to the multifaceted institutional environment of each country where they operate (Meyer, 2001; Henisz, 2003; Peng, 2003), and this adjustment gets more challenging, when the foreign environment differs more from the MNE's home territory.

This research will make a distinction in the degree of liability of foreignness faced by companies when entering a foreign market. This degree will be based on the cultural distance between the home country of the firm that is investing and the European Union. This way of working can be strengthened based on the fact that a lack of roots in the local environment is often most evident in social and cultural differences between countries (Chen et. al., 2006). In this research this statement is translated to the assumption that these differences increase when the cultural distance increases and therefore cause an increase in the liability of foreignness.

The starting point of making the earlier mentioned distinction is based on the research of Hofstede (2001). In his research, Hofstede developed multiple dimensions on which the cultural distance can be based. These dimensions are the following:

• Power distance

This refers to the degree to which the less powerful members of a society accept and expect that power is distributed unequally. The most important issue here is how a society handles inequalities among people. A large degree of Power Distance represents a country that accepts a hierarchical order in which everybody has a place and which needs no further justification. A low Power Distance refers to people who strive to equalize the distribution of power and demand justification for inequalities of power.

• Individualism versus Collectivism

Individualism is referred to as a preference for a loosely-knit social framework in which individuals are expected to take care of only themselves and their immediate families. Its opposite, collectivism, represents a preference for a tightly-knit framework in society in which individuals can expect their relatives or members of a particular in-group to look after them in exchange for unquestioning loyalty.

• Masculinity versus Femininity

Masculinity is expressed by a preference in society for achievement, heroism, assertiveness and material rewards for success. The society is in general more competitive. Femininity represents a preference for cooperation, modesty, caring for the weak and quality of life. Society at large is more consensus-oriented.

• Uncertainty avoidance

Uncertainty Avoidance reflects the degree to which the members of a society feel uncomfortable with uncertainty and ambiguity.

• Long-term versus short-term orientation

A low score on this dimensions represents, for example, a preference to maintain time-honored traditions and norms while viewing societal change with suspicion. A high score refers to societies that take a more pragmatic approach.

• Indulgence versus restraint

Indulgence characterizes a society that allows basic and natural human drives related to enjoying life and having fun.  Restraint stands for a society that suppresses needs and regulates it by means of strict social norms.

Based on the scores of these six dimensions, the home country of the firms that is investing in the European Union will be qualified as either a high or low liability of foreignness country.

2.4 Entry mode strategies

The literature on entry mode strategies generally indicates three key strategies (Chen et. al., 2006; De Bliek and Burger, 2015). This research will adopt those three key strategies:

• Market-seeking strategy

Market-seeking, i.e. entering a new market to expand the firm's operations, is often a primary strategy of MNE expansion (Chudnovsky and Lopes, 2004; Dunning, 1993; Luo and Park, 2001; Luo, 2003; Chen et. al., 2006).

• Resource-seeking strategy

Resource-seeking, i.e. entering a market to capitalize on resources in the host country, is often a primary goal of MNE expansion (Dunning, 1993; Vernon, 1966). Resource-seeking investments, often driven by price pressure, dictate facilities should be built in locations to capitalize on low cost resources of labor and raw materials (Chen et. al., 2006).

• Control-oriented strategy

Control-oriented strategies, i.e. where an MNE maintains decision authority over foreign operations, are employed by MNEs to minimize uncertainties that arise due to unfamiliarity with a host country's environment and local management (Buckley and Casson, 1976; Gatignon and Anderson, 1988; Chen et. al., 2006 ).

3. Hypotheses development

In the previous section the relevant topics were discussed. In this section, the different market entry strategies will be discussed in further detail as well as their relationship to liability of foreignness. Based on these relationships, several hypotheses will be developed.

3.1 Market-seeking strategy

Entering a new market to expand the operations of an MNE is often a primary strategy (Chudnovsky and Lopes, 2004; Dunning, 1993; Luo and Park, 2001; Luo, 2003; Chen et. al., 2006). In their research, Chudnovsky and Lopes (2004) argue that, when a company aims at exploiting the host country's market and are motivated by the size and growth prospects of the market, market-seeking activities are performed. It is assumed that the liability of foreignness has a direct effect on a firm's ability to execute a market-seeking strategy. A motivation for this statement is that that investors from high liability of foreignness countries emphasize the market opportunities (and fail to understand market segments) of new global markets believing that they can overcome inherent obstacles, such as the need to reduce the negative biases in the consumer marketplace toward the firm (Chen et. al., 2006).

On the other hand, when a company from a low liability of foreignness country is investing, they are able to better recognize potential challenges in the market where they are expanding to due to their smaller geographic, cultural and environmental distance. Based on this, it is assumed that a company from a low liability of foreignness country is not only drawn to a market because of a big market potential.

It can therefore be concluded that companies from low liability of foreignness countries do not approach the market from a market-seeking standpoint, while companies from high liability of foreignness countries are drawn by market size, assuming that they can overcome the challenges.

This can be translated to the first hypothesis:

Hypothesis 1: Companies from high LOF countries are more likely to use a market-seeking strategy when investing in the European Union, compared to companies from low LOF countries

3.2 Resource-seeking strategy

The central aim of a company that employs a resource-seeking strategy, is acquiring particular types of resources that are not available in the home country (like natural resources or raw materials) or resources that are available at a lower price than in the home country, for example cheaper workers (Franco et. al., 2008).

‘'Often driven by price pressure, resource-seeking strategies dictate facilities should be built in locations to capitalize on low cost resources of labor and raw materials. However, while access to low cost resources is advantageous to all, the costs related to obtaining those resources are not. Specifically, we argue that LOF can influence the costs incurred by entering firms'' (Chen et. al., 2006).

This statement by Chen et. al. can be further explained by the fact that companies from low liability of foreignness are have a lower cultural distance to the market of the host country than companies from high liability of foreignness countries, and will therefore be able to better manage the operations which leads to reduced costs. In addition to that, companies from low liability of foreignness countries also have a lower geographical distance and are therefore better able to monitor their operations in the host country. This ability to better monitor the operations will have a positive effect on cost reduction. It is clear that this positive effect will reduce the negative effect caused by liability of foreignness, which translates to the second hypothesis:

Hypothesis 2: Companies from low LOF countries are more likely to use a resource-seeking strategy when investing in the European Union, compared to companies from high LOF countries

3.3 Control-oriented strategy

A control-oriented strategy is characterized by a company that maintains authority over the decisions that have to be made in relation to the foreign operations, this type of strategy is used to reduce uncertainties caused by unfamiliarity with a host country's environment (Buckley and Casson, 1976; Gatignon and Anderson, 1988; Chen et. al., 2006). It is generally believed that companies who have a higher degree of control, can better coordinate their foreign operations (Buckley and Casson, 1976; Gatignon and Anderson, 1988). Further elaborating on this fact, it can be said that a small distance (on multiple levels) between home and host country reduces the liability of foreignness. Therefore firms are expected to be less triggered to use a control-oriented strategy because the degree of uncertainty is also reduced.

On the other hand, if the distance on multiple levels between home and host country is large, and because of this the degree of uncertainty will also increase, it is more likely that a control-oriented strategy is used (Rosenzweig and Singh, 1991). This can be summarized and captured into the following hypothesis:

Hypothesis 3:  Companies from high LOF countries are more likely to use a control-oriented strategy when investing in the European Union, compared to companies from low LOF countries

4. Methodology

4.1 Data

The sample data needed for this research is collected from Eurostat, the database which provides all kinds of data related to the European Union. Foreign Direct Investment (FDI) data is used to determine which countries are entering the European Union. This data consists of 43 countries or parts of countries (e.g. North-America, Northern Africa, etc.). These countries are labeled as high or low liability of foreignness countries. After this distinction is made, the investment data from these countries is qualified as a market-seeking, resource-seeking or control-oriented strategy based investment.

4.2 Measurement

If a country has to be qualified as either a high or low liability of foreignness country, is decided based on the earlier mentioned dimensions of Hofstede's concept of distance. Based on the scores of all the European Union members, an average score for every dimension is determined for the European Union as a whole. Subsequently, the scores of all non-EU countries investing in the European Union are determined. If the score of an investing country deviates more than 50 points from the average European Union score, this country will be treated as a high liability of foreignness country. If the score of an investing country deviates 50 points or less from the average European Union score, this country will be treated as a low liability of foreignness country.

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