The nature of knowledge and the entry mode decision

Abstract

Previous work on the choice of mode of entry into foreign markets highlights the central role of knowledge and the attributes of knowledge in choosing an appropriate governance form for its transfer internationally. The literature suggests that protection of knowledge from the threat of opportunism posed by licensees and business partners in other contractual modes is a primary driver of the choice of mode. However, the knowledge construct itself is oversimplified in the entry mode literature and needs more explication to enable a clearer understanding of its implications for entry mode choice. In this article, I examine in depth the variety of different types of knowledge held by firms and how these relate to each other and combine to constitute a source of advantage. A qualitative case-based analysis of semi-structured interviews in firms entering foreign markets suggests that the combination of different knowledge types held by a firm is an important factor in reducing the risk of misappropriation of knowl edge by business partners. This has important implications for the choice of mode of entry. When a firm's competitive advantage lies in a combination of multiple types of knowledge, especially experiential knowledge held by individuals, teams, and the organization rather than just easily codifiable and understandable basic technical knowledge, the threat of opportunism is mitigated to such a degree that it is often unimportant in mode of entry decisions. Hence, firms have greater flexibility in choosing a mode of entry than is suggested by current literature. In light of these findings, I suggest that it may be more useful to conceptualize a firm as a knowledge entity, rather than a contractual entity, for examining entry mode decisions.

Keywords: knowledge, professional service firms, transaction costs theory, choice of entry mode, opportunism

Introduction

Choosing an appropriate mode of entry into a foreign market is a key strategic decision faced by internationalizing firms as it entails substantial commitment of resources, both in terms of time and money (for example, Anderson and Gatignon 1986; Root 1987). Modes of entry are alternative routes or means available to a firm for transferring resources from the home country to the host country (for example, Anderson and Gatignon 1986; Hennart 1982; Hill et al. 1990). Firms choose from a variety of modes, including exports, licensing, greenfield investments or wholly owned subsidiaries, acquisitions, and different types of joint venture. There are other forms such as franchising, management contracts, turnkey contracts, subcontracting or associations, and consortiums that lie in a gray area between arms-length exports and wholly or majority-owned foreign subsidiaries (for example, Hennart 1989).

As multinational activities have increasingly focused on the transfer of knowledge, the nature of knowledge has become strongly interwoven with the choice of mode of entry. Transaction costs theory, which has emerged as the dominant paradigm for exploring entry mode choice, suggests that the transactional characteristics of knowledge make its transfer susceptible to the threat of opportunism from licensees or partners in other contractual modes (for example, Anderson and Gatignon 1986; Buckley and Gasson 1976; Hennart 1988; Teece 1981; Williamson 1975). This points toward the need to transfer knowledge within the firm or choose high-control governance structures such as wholly owned or majority-owned ventures. Protection of knowledge from the threat of opportunism is, therefore, a primary driver of entry mode choice. Despite the centrality of knowledge to this theoretical explanation for the choice of an appropriate mode, there is an incomplete understanding of knowledge itself in the entry mode literature. T he transaction costs framework of entry mode oversimplifies the knowledge construct by characterizing it only in terms of its generic attributes of proprietariness and tacitness. It does not delve into what the knowledge is about, where it is held, and what form it takes to constitute a source of advantage for the firm, which is fundamental to understanding the nature of the risk emanating from a threat of opportunism from licensees or business partners. In this article, I explicate the notion of knowledge to understand and assess its susceptibility to the threat of opportunism and, consequently, shed light on what that means for the choice of entry mode. The study demonstrates that a variety of knowledge types are held in firms and applied to the creation of a product or service, but that they combine together and relate to each other in various ways to confer a source of advantage on the firm. Such combinations of knowledge are not amenable to the threat of opportunism, mitigating it to the extent that it b ecomes unimportant for the choice of entry mode decision.

Transaction Costs Explanation for Entry Mode Choice and Knowledge

The transaction costs (TC) model of entry mode choice argues that the risk of exposure of knowledge to the threat of opportunism from licensees or partners in other contractual modes leads to a higher propensity for firms to choose high-control modes, such as wholly owned or majority-owned ventures, to ensure protection of knowledge (for example, Anderson and Gatignon 1986; Hennart 1988; Hill et al. 1990; Teece 1981; Williamson 1975). Within the TC framework knowledge is characterized in terms of its tacitness and its proprietary nature (Anderson and Gatignon 1986; Hennart 1988; Hill et al. 1990). Tacit know-how is difficult to codify and put on paper. The parties to a transaction involving the transfer of such knowledge may behave opportunistically to exploit the situation to their own advantage (Hennart 1988). Proprietary knowledge is defined as a firm-specific advantage that a firm going overseas enjoys relative to host-country enterprises.