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The determinants of foreign pharmaceutical firms' FDI entry mode choices between joint venture and sole venture into China
Fuming Jiang
Charles Sturt University, NSW
Chris Christodoulou
Swinburne University, VIC
Ho-Ching Wei
Overseas Chinese Institute of Technology, Taiwan
Abstract
The popularity of foreign direct investment (FDI) activities in China also applies to the pharmaceutical industry. Foreign pharmaceutical firms invest their capital and technology in what is likely to be developed as the world's largest pharmaceutical market in the future with the expectation they will earn an excellent return in a longer term.
This study aims to investigate the determinant factors that affected foreign pharmaceutical firms' decisions in choosing either a joint venture or sole venture entry mode into the Chinese pharmaceutical manufacturing industry.
This research shows that the probability for establishing a joint venture in China is positively related to the importance of China's investment environmental and market factors. A marginal significant positive relationship between sole venture entry mode and the importance of parent firm's decision task related factors is found.
Keywords
foreign pharmaceutical firm, FDI, entry mode, sole venture, joint venture, China
Article Text
In servicing a foreign market, a manufacturer may choose between three main entry modes: exporting, contractual (e.g. licensing) and investment (eg establishing an overseas operation) (Root, 1994). Where firms choose to establish an overseas operation, they must decide whether to pursue the venture alone or with a joint venture partner. This paper seeks to analyze these decision processes for foreign pharmaceutical firms' (FPFs) ventures located in China.
Foreign pharmaceutical firms started direct investments into the Chinese pharmaceutical manufacturing industry as early as 1980. There are now over 1,500 foreign invested pharmaceutical firms (FIPCs) distributed in almost every part of China. FPFs who entered into China during the period from 1980 to 1998 basically chose either a joint venture (JV) or a sole venture (SV) entry mode, and over 84% of FPFs chose a JV rather than a SV, even though foreign investors have been allowed to set up 100% foreign owned SV operations since the passage of 'Law of the people's Republic of China on Enterprises Operated Exclusively with Foreign Capital' by the Chinese central government in April 1986. 'For most manufacturers that want to invest abroad, the first-best entry strategy remains the SV, and JV would be a second-best invest entry strategy' (Root 1994:148-149), because JV is inferior to SV which allows investing firms to maximise the returns on ownership-specific advantages (Caves, 1982) and to have full control over the business operations. This study attempts to answer why the majority of FPFs selected a JV rather than SV as their entry mode for entering into the Chinese market. The research focuses on the comparison between SV and JV as alternative modes of entry and examines the determinant factors that affected FPFs' choice between the two entry modes.
Entry mode literature
Most past studies on foreign market entry modes have emphasized 'ownership advantage theory' (Hymer 1960, 1976; Kindleberger 1969), 'location specific advantage theory' (Franko 1971; Stopford & Wells 1972), 'internalization theory' (McManus 1972; Buckley & Casson 1976), 'transaction cost theory' (Williamson 1975; Buckley & Casson 1976; Casson 1982; Caves 1982; Anderson & Gatignon 1986; Kogut & Singh 1988; Erramilli & Rao 1993), 'strategic behaviour approach' (Harrigan 1985; Kogut 1988) and 'resource based theory' (Wernerfelt 1984; Barney 1986; Collis 1991; Peteraf 1993). Some recent studies have been trying to combine a number of theories into one-eclectic framework to explain the entry mode choice decision. Dunning's (1980, 1988) 'eclectic paradigm' denoted that the choice of entry mode decision is influenced by three types of factors: ownership-specific factors of a firm, location-specific factors of a market and internalization advantages of integrating transactions within the firm. Hill, Hwang and Kim (1990) developed their 'eclectic theory of the foreign entry mode choice' by combining transaction cost theory, internalization theory and strategic behaviour approach. Bell (1996) created a new eclectic framework to exam Dutch firms' entry mode decision by adding resource based theory into Hill, Hwang and Kim's eclectic mode.
Following Stopford and Wells's (1972) pioneering study on entry mode choice decision between SV and JV using the Harvard Multinational Enterprise Database, a number of important empirical studies have been conducted. These empirical studies revealed that the probability of setting up SVs is positively related to the level of parent firms' international experience (Gatigon & Anderson 1988; Erramilli 1991; Agarwal & Ramaswami 1992; Madhok 1994; Benito 1996; Mutinelli & Piscitello 1998), host country experience (Stopford & Wells's 1972; Gomes-Casseres 1989 & 1990; Padmanabhan & Cho 1996; Mutinelli & Piscitello 1998), parent firm size (Gomes-Casseres 1990; Agarwal & Ramaswami 1992; Erramilli & Rao 1993; Benito 1996), marketing intensity of parent firm (Stopford and Wells 1972; Gatigon & Anderson 1988; Gomes-Casseres 1989), research and development intensity of parent firm (Stopford & Wells 1972), asset specificity of parent firm (Gatigon & Anderson 1988; Erramilli & Rao 1993; Padmanabhan & Cho 1996), and perceived market potential of the host country (Agarwal & Ramaswami 1992).
JV entry mode would be preferred when cultural distance is large between the host and the home countries (Erramilli & Rao 1993; Agarwal 1994; Benito 1996; Barkema, Bell & Pennings 1996). The probability for forming JVs is positively related with the level of host country welfare (Gomes-Casseres 1989 & 1990; Shane 1993), the level of host government restrictions (Fagre & Wells 1982; Lecraw 1984; Gatigon & Anderson 1988; Gomes-Casseres 1989 & 1990; Shane 1993; Padmanabhan & Cho 1996) and level of competition in the host country (Gomes-Casseres 1990). Firms would be more likely to establish JVs when the firm enter into a research and development intensive industry (Kogut & Singh 1988b; Mutinelli & Piscitello 1998), and a growth industry (Hennart 1991).
Bell's (1996) study of 114 Dutch firms revealed some distinctive findings. It suggested that firms with host country experience has a positive effect on the likelihood of JVs. The level of competition and the size of the foreign subsidiary turned out to have a negative effect on the likelihood of JVs. Bell also suggests that host country policy did not have an effect on the choice between JV and SV in the case of Dutch firms' direct investment in over 20 countries.
Firms' entry mode decisions may be heavily influenced by a host country's investment policies. Joint ventures, for instance, are popular in China because there are direct or indirect government rules requiring them in a certain circumstance (Davidson 1987; Eiteman 1990). Tse, Pan and Au (1997) suggested that longer diplomatic ties between China and investing firm's home country assume more equity-based operations including JV and SV rather than non-equity-based entry modes like exporting or licensing agreements, and firms chosen equity-based entry modes are more likely to work with Chinese municipal governments.
The success of each foreign market entry is affected by many factors. Firms that want to invest in a foreign market need to consider possible impacts of these factors (Bell 1996). Root (1994), Mockler and Dologite (1997) have given a set of more clear and complete elaboration of factors affecting the decision choice of entry mode. They suggest that an initial concept of an entry mode can be determined by studying host country environmental, market, production, parent firm's home country, parent firm's product and resource commitment factors. However, Kumar and Subramaniam (1997) deemed that the existing literature on the choice of entry modes into international markets is based on the assumption that the mode of entry choice is a function of various exogenous factors, but an alternate view could be that certain factors endogenous to the decision task affect the choice of mode of entry. This view holds that a decision made by a manager depends not only on the relevant external factors but also on characteristics of the decision task, characteristics of the manager, and the manager's expectations about the quality of the information available to reach the decision as managers of multinational corporations may face time and resource constraints when making the decision.
Conceptual framework and hypotheses
This study focuses on FDI entry mode choice between either the JV or SV mode option only. The main reason for this is because JV and SV were the only two entry modes adopted by FPFs in the population where the sample was drawn. Theories revealed from previous studies are inappropriate for this study. The important reasons are as following: Firstly, most previous studies on entry mode choice decision with wide range of mode options including exporting, licensing, equity-based investment (eg joint venture and sole venture), etc, whereas the present study focuses on SV and JV entry modes only. Secondly, as stated earlier, most studies were based on US and European firms and some Japanese firms' FDI. The present study includes FDI from Non-Japanese Asian countries/regions. Finally, the direction of FDI flows in previous studies were 'one-to-one' or 'one-to-many'; ie from one country to one or many destination countries. The present study looks at a 'many-to-one' situation.
Bell's (1996) study is an important contribution to the theoretical framework on entry mode choice decision with only two options either JV or SV. However, Bell's study was based upon Dutch firms' FDI into many different countries (one-to-many). Although Tse, Pan & Au's study revealed some research findings on foreign firms' entry mode choice into China based on 'many-to-one' FDI direction, the study concerned the entry modes choice among exporting, licensing and equity-based investment (SV or/and JV). More importantly, a critical shortcoming of their study is that the study selected invest firms' external factors only with a total of seven variables included in their conceptual framework for the testing, and ignored investing firms' internal factors. How an investing firm responds to external factors in choosing an entry mode depends on internal factors such as investing firms' product, firms' financial, management resource and commitment factors (Root 1994). The archival data were used for their study, an important shortage of archival data is that it ignores the managers' perceptions on the entry mode decision.
Entry mode decision into China is a complex process. As Bell (1996) noted that the real world is so complex, and no single approach can adequately encapsulate and elucidate all the factors that affect the choice of entry mode decision. In this study, the relevance of Kumar and Subramaniam's (1997) contingency approach is acknowledged. As a result, this approach will be incorporated in Root (1994) and Mockler & Dologite's (1997) conventional framework, which serves as a basis for the conceptual framework of this study. Root's (1994) foreign market entry mode framework combined with Mockler & Dologite's (1997) model of decision making on the selection on international market entry mode does not narrow itself into any specific entry mode approach, but emphasises both a firm's internal and external factors, which include host country's (China's) environmental, market and production factors, parent firm's home country/region, parent firm's product and resource factors. It recognises the complexity of the international business environment with multinational cross-cultural management considerations. As a consequence, a more complete framework that incorporates China's environmental factors, China's market factors, China's production factors, a firm's product factors, a firm's resource and commitment factors, and a firm's decision task related factors will be used as the conceptual framework for this study. Most independent variables were identified and selected based on Root's (1994), Mockler & Dologite's (1997), Kumar & Subramaniam's (1997) frameworks, and other previous empirical studies and the researchers' observations. A couple of variables that were found significant in Tse, Pan & Au's study were also added into the framework for the present study. Figure 1 is an elaboration of the conceptual framework which explains the hypotheses relationships and the key groups of factors in the decision making process of FDI entry mode choice into China.
Figure 1. Conceptual framework & hypothesis relationship on FDI entry mode
Hypothesis 1 (H1): China's environmental factors would have significant impacts on a firm's FDI entry mode decision. China's environmental factors are measured by a number of sub-groups of factors including political and economic conditions, social-cultural differences, technology conditions, geographic distance between parent firms' home country/region and China, and business operation location in China. Political condition variables comprise of political stability in China, government policies and regulations, import restrictions, level of the Chinese government to deal with, the status of political relationships between China and parent firm's home country/region, and length of diplomatic ties between China and parent firm's home country/region. Economic condition variables include role of the Chinese government in the economy, size of the economy, size of population, growth rate of population, growth rate of gross national product, growth rate of per capita income, distribution of personal income, changes in employment, relative importance of the pharmaceutical industry in the economy, and the status of economic co-operation between China and parent firm's country/region. Social-cultural variables consist of employees' loyalty to company, hardworking characteristics of employees, language, social society structure, Chinese people's way of life, and way of doing business in China. Technology condition variables concern about availability of infrastructure, quality of infrastructure, availability of qualified scientific and technical personnel, and research & development intensity.
H1: The probability for a firm to choose a JV is positively related to the importance of China's environmental factors.
Hypothesis 2 (H2): China's market factors would have significant impacts on firms' decisions in choosing an FDI entry mode for entering into the Chinese market. These factors include market size and growth (sales potential) for investment project's product line, competitive situation in the Chinese market, availability and quality of marketing infrastructure, availability and quality of distribution infrastructure, required cost of marketing effort, and export sales potential of investment project's product line.
H2: The probability for a firm to choose a JV is positively related to the importance of China's market factors.
Hypothesis 3 (H3): Production factors in China would have significant impacts on firms' decisions in choosing an FDI entry mode for entering into the Chinese market. The production factors consist of availability and cost of plant site, availability and cost of local raw materials, effectiveness of energy supply, labour cost, quantity and quality of products of the Chinese domestic producers, quality and cost of transportation facilities, quality and cost of communication facilities, and quality and cost of port facilities.
H3: The probability for a firm to choose a JV is positively related to the importance of China's production factors.
Hypothesis 4 (H4): A firm's home country/region factors would have significant impacts on the firm's decision in choosing an FDI entry mode for the Chinese market. These factors include the market size and competitive situation in the home market, production costs in the home country/region, government policies on foreign investment and export, and cultural dimension in the home country/region.
H4: The probability for a firm to choose a SV is positively related to the importance of the firm's home country/region factors.
Hypothesis 5 (H5): A firm's product factors including the ability of the firm to differentiate and adapt products, and research and development capacity for new products would have significant impacts on its decision in choosing an FDI entry mode for the Chinese market.
H5: The probability for a firm to choose a SV is positively related to the importance of the firm's product factors.
Hypothesis 6 (H6): A firm's resource commitment factors would have significant impacts on a firm's decision in choosing an FDI entry mode for the Chinese market. The resource commitment factors are the size of foreign parent firm, availability and cost of working capital, availability and cost of long-term investment capital, availability and value of the Chinese government's financial incentives, technology availability of foreign parent firms, research and development intensity of foreign parent firms, production skills, management capacity, sales & marketing skills, and foreign parent firm's international business experience. The incentives provided by the Chinese government could be regarded as indirect resources for an investing firm.
H6: The probability for a firm's to choose a SV is positively related to the importance of the firm's resource commitment factors.
Hypothesis 7 (H7): A firm's decision task related factors including characteristics of the decision task, characteristics of the decision-maker, the decision-maker's expectations about the quality of the information available to reach the decision, attitude of the decision-maker and decision-maker's previous FDI experience would have significant impacts on the firm's FDI entry mode choice for the Chinese market.
H7: The probability for a firm's to choose a SV is positively related to the importance of the firm's decision task related factors.
4. Data and method
4.1. The population definition
A total of 117 foreign pharmaceutical firm invested pharmaceutical companies (FPFIPCs) in Mainland China were defined as the population for the research based on the following four sources: 1) Catalogue of Chinese Pharmaceutical Enterprises with Foreign Investment which was published by the China Centre for Pharmaceutical International Exchange, an agency of State Pharmaceutical Administration of China. 2) Market Reports of National Trade Data Bank of the United States of America (1996). 3) MIMS Asia (1998) and the report of Shanghai Pharmaceutical (Group) Corporation (1999). Pharmaceutical companies that had capital investment by non-pharmaceutical firms such as business trading companies, investment development firms, etc. Medical devices or machinery producers were not defined as part of the population for this research.
4.2. The sample size
Over 84% of FPFIPCs were located in the east China's 13 provinces and municipalities including Hainan, Guangdong, Fujian, Zhejiang, Shanghai, Jiangsu, Anhui, Shangdong, Hebei, Tianjin, Beijing, Liaoning and Hellongjiang. Less than 16% of FPFICs were distributed in China's middle and west areas. A total of 98 FPFICs distributed in the three major regions in east China and which accounted for 83.76% of the population were defined as the sample size for this research. These FPFICs in the sample include 29 in South East Region (SER), 38 in Middle East Region (MER) and 31 in North East Region (NER). The SER comprises of Guangdong and Fujian provinces. The MER covers Shanghai municipality, Jiangsu, Anhui and Zhejiang provinces. The NER consists of Beijing and Tianjin municipalities, Liaoning, Shandong and Hebei provinces.
4.3. Data collection
A questionnaire was designed in both English and Chinese versions and was pretested with six pretest respondents for the data collection. The research fieldwork was mainly conducted in China between early April and late June in 1999. The data was collected through both personal interviews, and a mail questionnaire survey. Personal interviews were conducted with senior executives of foreign business partners in FPFICs in China, and the posted questionnaires were addressed to foreign general managers/representatives in FPFICs in China. In total 44 companies participated in this research, and 82% of answered questionnaires were obtained through personal interviews. Of the responding FPFICs, 21 FPFICs had investment by eastern pharmaceutical firms including 4 Japanese and 17 Non-Japanese Asian pharmaceutical firms. The rest had western firms' investment including 14 from USA and 9 from European countries or regions. 3 companies including 2 in Guangdong and 1 in Jiangsu were found to have ceased operations during the fieldwork. Also 1 company in Guangdong had the foreign partner's share sold to its Chinese partner before this survey conducted. Therefore the real sample size was reduced from an estimated 98 to 94 FPFICs, which means that a 46.74% response rate was achieved.
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