In this paper, we investigate the entry mode choice of a leading Taiwanese food company in setting up regional distributors in China's 312
sales districts. Our study shows that, in entry mode decisions, the institutional factors are more important than transaction cost considerations.
Both formal and informal institutions are considered. Formal institutions refer to government prescribed institutions (laws and regulations), wh
ile
informal institutions refer to rules prescribed by the industry and the society. Both institutions are shown to affect the entry mode choices but one
important type of institution, professional norms, is conspicuously missing in China. Professional norms exert peer pressures on the practitioner
s
in the same profession, forcing their behaviors to conform to a common pattern. In the absence of professional norms, the roles of network ties and
mimetic behaviors are heightened and they become a proxy for professional norms. As a foreign enterprise operating in China's local markets, the
Taiwanese food company attained legitimacy by forming alliances with local wholesalers and by following its predecessors in selecting
organization forms.
Entry mode choice, which determines the ownership
percentage and governance mechanism in business activities
when multinational corporations (MNCs) operate in a foreign
market, is vital to the survival and performance of the MNCs
(
Anderson & Gatignon, 1986; Shaver, 1998; Wind &
Perlmutter, 1977; Woodcock, Beamish, & Makino, 1994
). In
the past, entry mode studies were investigated mainly on thebasis of transaction cost theory (
Anderson & Gatignon, 1986;
Erramilli & Rao, 1993; Ga
tignon & Anderson, 1988;
Palenzuela & Bobillo, 1999
), with some being investigated
using resource-based theory (
Ekeledo & Sivakumar, 2004;
Isobe, Makino, & Montgomery, 2000; Sharma & Erramilli,
2004
) or eclectic views (
Hill et al., 1990
). Recently some
scholars have adopted cultural and institutional perspectives to
explore entry mode decisions (
Brouthers, 2002; Kogut & Singh,
1988; Meyer, 2001; Yiu & Makino, 2002
). In this paper, we
propose studying the entry mode choice in a transitional
economy, China, from an institutional perspective, and compare
it to the transaction cost theory. Our aim is to find out which
approach is more relevant to a transitional economy.
China launched its economic reforms as recently as 1978
after the demise of Mao Tse-tung and his style of command
economy which emphasized collectivism. The business opera-
tions existing in China today are still deeply embedded in the institutions inherited from the command economy (
Park & Luo,
2001
). In a transitional economy, institutions are volatile and
immature, exerting a large environmental uncertainty on foreign
investors, particularly when considering the institutional
environments established under communist rules that were
drastically different from those in Western countries (
Clague,
1997; Meyer, 2001
). Even in developed countries, many schol-
ars have found that the entry mode choice model would be more
complete if the institutional environment were considered along
with the transaction cost variables (
Brouthers, 2002; Delios &
Beamish, 1999; Yiu & Makino, 2002
).
In the case of China, we postulate that the institutional theory
can offer more explanatory power than the transaction cost
model with regard to entry mode selection. This is because
when entering a transitional economy like China, reducing
institutional risks is a more important concern than enhancing
efficiency on which the transaction cost approach has focused.
By institutional risks, we refer to the risks caused by uncertainty
or non-transparency of local institutions. We will not only
examine the influences of formal institutions such as laws and
government regulations, but also those of informal institutions.
Informal institutions refer to rules and norms established by the
industry or the society. Informal institutions are not bestowed
with coercive power, but just like formal institutions, they
restrain the behaviors of the relevant actors. We use the sales
district as the unit of analysis, and our sample is composed of
the entry mode choices of the regional distributors of Taiwan's
largest food company, President Food Co., in its 312 sales
districts in China locating in 267 of China's major cities. By
studying the entry mode of the distributor in each sales district,
we highlight the impacts of institutions, which vary across
regions, on entry mode choice.
Today, China is widely known as the
“
world's factory
”
with a
cheap labor force and an immense manufacturing power. Most
studies on foreign investment in China have focused on the
manufacturing aspects, but little research has been conducted on
the marketing channels. By setting their eyes on the enormous
market opportunities, many multinational firms have begun to
explore the fast-growing domestic markets of China. This paper
sets out to study the determinants of the entry mode choice of
distributors in different sales districts in China. The paper offers
two distinctive features: First, it studies the differences in regional
institutions in determining entry mode choices in a single country
for a single company; second, it highlights the importance of
institutions even when the differences in national cultures seem
to be small between the source and the host country.
We hypothesize that institutional environments are more
important than transaction cost factors in determining the entry
mode choice. To test the hypothesis, we will incorporate both
institution and transaction cost related variables in the entry
mode decision model and show that transaction cost variables
are dispensable. Three sets of informal institutions will be
assessed in our study: network ties, mimetic behaviors and
professional norms. Network ties, known as
“
guanxi
”
in China,
refer to personal and business connections which have been
proven to be critical to business operations in China (
Xin &
Pearce, 1996
). Mimetic behaviors refer to a tendency to follow the market leaders, the successful peers, or the predecessors
originated from the same country (
Haunschild & Miner, 1997
).
Professional norms refer to expectations about the behaviors
that are shared by practitioners in the same professions
(
DiMaggio & Powell, 1983
).
In this paper we have studied the entry mode choice of
regional distributors in the China market by a leading Taiwanese
food company, President Food Co. Our findings indicate that
the institutional environment is more important than tran-
saction cost considerations in the entry mode choice. In fact,
transaction cost-related variables provide insignificant expla-
natory power to the entry mode choice when institutional
variables are present. We can almost say that it is only
institutions that matter. We attribute this result to the fact that
China is a transitional economy with incomplete or immature
market institutions exerting a high risk to foreign investors,
which would have to concentrate their efforts on risk control
rather than cost minimization. The key message of the
institutional theory is that organizations have to adopt certain
forms and processes in order to attain legitimacy in the
community in which the organization operates. Legitimacy is
critical to the reduction of risks in a volatile environment,
especially for a foreign enterprise that offers food products for
people's daily consumption.
Our study found that both formal and informal institutions
are important constraining forces in the entry mode decision.
Among informal institutions, network relations stand out as a
very influential factor. However, one important informal
institution, which is understood to be vital in mature market
economies but is conspicuously missing in China, is profes-
sional norms. This is probably due to the fact that China's
privately-owned businesses constitute only a small proportion
of the economic activities, and professionalism has yet to be
recognized in the Chinese society as it had been deliberately
suppressed in the past, particularly during the time of the
Cultural Revolution. In the absence of professional norms, the
power of network ties is inflated and serves as a proxy for
professional norms. In the food distribution industry that we
studied, political institutions and network ties are important
powers in the event of dispute settlements and for protecting
property rights. Foreign investors are subject to
“
institutional
liabilities
”
in the sense that they are often under more stringent
regulatory controls and stronger social pressures than the
indigenous firms. The more the institutional liabilities they face,
the lower the control mode they will choose in entering the host
country. Therefore, wholly-owned subsidiary may be avoided
even if the government does not forbid it.
The other interesting finding of this study is that late-coming
foreign investors tend to follow their successful predecessors in
entry mode selection. This mimetic behavior not only serves the
purpose of risk reduction, but also enables the followers to take
advantage of the network assets that the predecessors have
already accumulated. In a sense, the predecessors have paid the
sunk costs for network-learning and have helped construct a
web of working relationships, which the followers can exploit.
This mimetic behavior may eventually contribute to the
formation of an industry norm, to which the market leaders
will benefit most, however. We interpret this as a positive
cumulative process of building institutions. In this process, the
legitimacy of the practices is attained by business success,reflecting an old Chinese proverb:
“
the successful one is the
king; the failing ones are all outlaws.
”
A few caveats must be noted, however. First, the data is from a
single company, PFC. Although the company is large enough to
provide observations on entry mode in all major cities of China,
caution must be exercised when generalizing the results as some
company-specific features may contaminate the data. Second,
theremaybemorevarietiesininstitutionsthanintransactioncosts
across regions, as transaction costs tend to be more related to
product characteristics than to regions. Therefore, institutions
have more explanatory power than transaction costs probably
because we are analyzing the regional differences. Third, due to
the difficulty in obtaining sophisticated survey data, measure-
ments on institutional factors have been simplified to a manage-
able level. This may conceal some important information
regarding institutional environments in China.