Effective mitigation strategies for liability of foreignness and liability of origin : the case of Huawei in the Netherlands

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Effective mitigation strategies for liability of

foreignness and liability of origin: The case of

Huawei in the Netherlands

.

Final version Master thesis

Author: Kasper Verhoog | Student number: 11203633

MSc. Business Administration | International management track

Amsterdam Business School | University of Amsterdam

First supervisor: Dr. M.P. Paukku

12

th

January 2016

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Statement of Originality

This document is written by student Kasper Verhoog who declares to take full responsibility

for the contents of this document.

I declare that the text and the work presented in this document is original and that no sources

other than those mentioned in the text and its references have been used in creating it.

The Faculty of Economics and Business is responsible solely for the supervision of

completion of the work, not for the contents.

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I would like to thank my thesis supervisor Dr. Markus Paukku for his useful advice

and for the time that he devoted to make the best out of my thesis. Without him I would never

have come this far. I am really grateful for his guidance through the whole process. I would

also like to thank Stefan Luiken and Jiyoung Min, the reviewers who helped me to put this

paper in a much better shape. I also want to thank my mom and my girlfriend Tianhui Qu,

they always gave me mental support during the whole process of writing my thesis. Lastly, I

would like to thank all the employees of Huawei who cooperated and were willing to conduct

an interview. Without their valuable input, I could never write my thesis.

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5 Abstract

A lot of researchers analyzed the additional costs that foreign firms face compared to

local firms when going overseas, which is known as the liability of foreignness. Most

researchers have analyzed developed market multinationals investing in emerging markets To

overcome this geographic bias, this paper focuses on liability of foreignness (LOF) within the

context of emerging market multinationals investing in developed markets. In this paper LOF

is divided into two main components: Environmentally-derived LOF and firm-based LOF.

This paper includes the liability of origin (LOR) in order to describe the full range of

additional costs an emerging market multinational faces. This paper analyzes LOF and LOR

taking the perspective of an emerging market multinational, specifically the Dutch subsidiary

of Huawei. The purpose of this study, is to explore which strategies are effective in

mitigating different forms of liability of foreignness and liability of origin. The researcher

gathered qualitative data by conducting seven interviews with multiple employees of Huawei.

Based on this data, this paper found that emerging market multinationals can use local

employees to mitigate firm-based LOF and environmentally-derived LOF effectively.

Furthermore, this paper finds support for other effective strategies mitigating firm-based LOF

namely organizational learning, sending experienced managers and creating a mutual cultural

understanding. Several effective mitigation strategies for liability of origin have been found:

Brand building, delivering good products/services and bringing the consumers to the facilities

of EM MNEs. This paper argues that firm-based LOF should be divided into two concepts:

internal firm-based LOF and external firm-based LOF. These concepts are not mentioned in

the literature yet.

Keywords: Costs of doing business abroad, liability of foreignness, liability of origin,

emerging market multinationals, Huawei, environmentally-derived LOF, firm-based LOF,

internal firm-based LOF and external firm-based LOF.

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1. Introduction

In 2016 one of the highest bidding ever, was made in the chemical sector by

ChemChina. This Chinese state owned company bid an enormous amount of money in order

to acquire a Swiss company named Syngenta (Blackstone, 2016). ChemChina bid $43 billion,

which is the second highest bidding in the chemical sector in the past year. The companies

agreed in terms with each other and it is expected that ChemChina will acquire Syngenta at

the end of the year. A year before ChemChina acquired the Italian tire manufacturer Pirelli

and a German firm manufacturing polymers (Stoye, 2016). This series of acquisitions show

that multinationals from emerging markets (EM MNEs) are investing seriously in the

developed markets. ChemChina and many other EM MNEs such as Huawei show that FDI is

no longer a one-way street from developed markets into emerging markets.

When multinationals operate outside their home country, they face additional costs

which indigenous local firms do not have. These additional costs arise because foreign firms

are stemming from a country which differs from the country they invest in. Foreign firms

suffer because they lack local knowledge, are subject to local discrimination and have

difficulties operating and coordinating their subsidiary (Eden & Miller, 2004). This

phenomenon is known as the liability of foreignness (LOF). In this paper LOF is defined as

“The additional social costs foreign subsidiaries face, compared to well-embedded

indigenous firms, when they operate outside their home country”.

Most research about liability of foreignness examines multinationals venturing from

developed markets into emerging markets. However nowadays more multinationals from

emerging markets are investing in developed markets themselves (UNCTAD, 2015). The

majority of articles, written in the last 10 years, about LOF took a dyadic perspective from

developed markets into emerging markets, so there appears to be a geographic bias. Denk et

al confirm this bias and state that: “Research appears to lag behind recent developments in

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Peng et al acknowledge a geographic bias as well: “Given IB's traditional focus on

MNEs from developed economies, we currently know very little about how firms from

emerging economies internationalize” (Peng et al, 2008, p.931). To overcome this geographic

bias, this paper shifts away from the traditional focus. This paper takes a different dyadic

perspective from emerging into developed markets. LOF within this dyadic perspective has

not been extensively studied yet, which makes this topic scientifically relevant.

Denk et al state the following “These as yet little understood interdependencies

between LOFs hazards and mitigation strategies prevent researchers from identifying the

optimal mix of strategies for managing the outcomes of LOFs. This gap causes managers to

engage in trial-and-error approaches. We therefore encourage the investigation of this

paradox in future studies and the development of effective solutions that take into account the

complexities of LOFs solutions” (Denk et al, 2012, p.329). This paper will explore which

strategies are effective in mitigating different forms of liability of foreignness and liability of

origin (LOR). Therefore, this study gives rise to the call proposed by Denk et al which makes

this paper scientifically relevant as well.

This study finds mitigation strategies EM MNEs can use to overcome the specific

types of LOF and LOR they face when setting up a subsidiary in a foreign country. Managers

can use these strategies to overcome different types of LOF and LOR instead of the

trial-and-error approaches they are using now (Denk et al, 2012). As more and more EM MNEs invest

abroad an effective mitigation strategy for LOF and LOR would be very valuable in practice.

Therefore, this research is also practically relevant.

This paper is structured as follows: The next section contains the literature review.

This part defines various concepts related to the research question. In the end of this section,

the research question is posted and the scientific and practical relevancy is identified.

Afterwards, a theoretical framework is posted which contains six working propositions about

firm-based LOF, environmentally-derived LOF, LOR and effective mitigation strategies to

overcome them. The methodology section explains how this study gathers and analyzes first

hand data. The results section presents anecdotal support for the findings of this study. In the

discussion, the findings are compared to the existing literature. In this section, the theoretical

contribution of this paper is clarified as well. Afterwards, several limitations of this study are

mentioned. Furthermore, some directions for future research and practical implications for

managers are given. In the last section, the main findings are summarized in the conclusion.

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2. Literature Review

This literature review compiles a list of different articles which can be related to firms

who internationalize. This review start conceptualizing the constructs costs of doing business

abroad (CDBA), liability of foreignness (LOF) and liability of origin (LOR). To fully

understand LOF, this paper analyzes this construct using the theoretical lens of Eden &

Miller. Afterwards, this paper uses a different dyadic perspective by applying LOF and on

emerging markets multinationals entering a developed market. LOF is split into two

concepts: Environmentally-derived LOF and firm-based LOF. Liability of origin is

incorporated in this section to identify all the additional costs EM MNEs face when they

venture abroad. At the end of the literature review a research question is posted and a

scientific gap is identified.

Costs of doing business abroad

Hymer was the first scholar who argued that foreign firms face additional costs when

doing business abroad, which he called the costs of doing business abroad (CDBA). In his

paper he argued that foreign multinational enterprises face costs that indigenous firms do not

have. In his original work he stated: “National firms have the general advantage of better

information about their country: its economy, its language, its laws, and its politics “(Hymer,

1976, p.34). In the last forty years a lot of research has been conducted which build upon the

influential theory of Hymer.

More recently, the influential scholar Zaheer elaborated on the work of Hymer. In this

paper the author stated that MNEs face liability of foreignness when operating abroad.

Zaheer defined liability of foreignness (LOF) as “All additional costs a firm operating in a

market overseas incurs that a local firm would not incur” (Zaheer, 1995 p.343).

By comparing the previous mentioned authors, the constructs liability and foreignness

and CDBA seem synonymous to each other. However, these definitions are not exactly the

same. According to a more recent paper of Zaheer these definitions differ. CDBA consists of

“Additional costs that foreign firms have when entering abroad, which indigenous firms do

not have”. One type of costs, which are a precursor of CDBA, are economic costs. Economic

costs are related to geographic distance such as exporting costs. Zaheer stated that economic

costs are not related to LOF (Zaheer, 2002).

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CDBA can be divided into 2 costs: Infinite and finite. One type of the costs could be

quantified and anticipated (Calhoun, 2002). These costs can be finite, such as the costs of

exporting. The second type of the costs are difficult to quantify, anticipate, and manage.

These costs are related to uncertainty and persist over time (Calhoun, 2002). The finite type

of costs resembles the market-driven costs. The infinite type resembles the liability of

foreignness as proposed by Zaheer in 2002. Therefore, the market driven-costs can be

anticipated, measured and easily be managed. Following the same logic this paper argues that

liability of foreignness is not easy to measure, manage and it is infinite. The main problems

for managers of MNEs arise because their firms face liability of foreignness. Therefore, this

paper will focus on LOF instead of CDBA.

Zaheer & Mosakowski found that LOF decreased the chance of survival in a foreign

market of foreign firms. Domestic trading rooms had a higher chance of survival, compared

to foreign ones (Zaheer & Mosakowski, 1997). Another quantitative study in the banking

sector found that domestic firms are more efficient compared to foreign MNEs. Therefore,

the financial performance of domestic banks was higher (Miller & Parkhe, 2002). These

studies show that LOF matters and that foreign firms are heavily influenced by it. Therefore,

this paper focuses on the concept of LOF in-depth.

Liability of foreignness

Zaheer was the first scholar who introduced the term “liability of foreignness” (LOF).

The author used this term to state that foreign firms face additional costs compared to local

firms, when they operate outside their home country (Zaheer, 1995).

In her first paper about LOF she argued that liability of foreignness can be divided

into four different costs (Zaheer, 1995). Firstly, there are costs resulting from a geographic

distance between a home and a host country. These costs are labeled as spatial distance costs.

Secondly, a foreign firm faces firm specific costs. These cost occur when the foreign firm has

insufficient knowledge about the local environment and their practices. Thirdly, there are

costs resulting from the host location. These can be costs that arise because of lack of IP

rights or because there are people in the host location who favor national over foreign brands.

Lastly, there are cost due to the rules in the home country of the foreign firm. These costs can

arise because of the legislation in the home country. For example, when a foreign firm is not

allowed to export products from their home country (Zaheer, 1995).

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In 2002, Zaheer analyzed LOF in a different way: The author stated that LOF consists

of two types of costs: structural/relational costs and institutional costs. The former describes

the costs which occur due to a lack of access to the local network and a lack of relations with

important local actors. The latter describes the costs which occur because the MNE is

operating in different institutional environments (Zaheer, 2002).

Eden & Miller analyzed LOF using another perspective. They state that foreign

subsidiaries face extra costs because they are operating in an environment with different

institutions. Eden and Miller argued that LOF is decomposed into three costs: Unfamiliarity

costs, discrimination costs and relational costs. Firstly, subsidiaries face unfamiliarity costs

because they lack local knowledge and experience. Secondly, subsidiaries are discriminated

because local stakeholders favor national firms. Lastly, subsidiaries face extra organizational

costs when they venture abroad (Eden & Miller, 2004).

Liability of foreignness is an empirical concept, which states that foreign firms face

additional costs compared to local firms when expanding abroad. Many articles analyzed

LOF, using different perspectives (Zaheer, 1995); (Zaheer, 2002); (Eden & Miller, 2004).

This paper uses the structural analysis which was proposed by Eden and Miller to identify

this concept. This paper is used because it is one of the most cited and influential paper in the

literature of LOF. In the following table, the most important articles that analyzed LOF are

shown in a visual way. In the following section LOF is examined through the lens of Eden &

Miller, which is indicated by the arrow.

Author(s) , Year

Definition LOF

LOF Consist of

Zaheer, 1995

“All additional costs a firm operating in a market overseas incurs that a local market would not incur”

1 Spatial distance costs 2 Firm- specific costs 3 Host country costs 4 home country costs

Zaheer, 2002

“All social costs a firm operating in a market overseas incurs that a local market would not incur

1 structural relational costs 2 institutional costs

Eden & Miller, 2004

“All the social costs of doing business abroad”

1 Unfamiliarity costs 2 Discriminatory costs 3 Relational costs

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Unfamiliarity costs

“Unfamiliarity costs reflect the firm’s lack of local knowledge of or experience in the

host country, which places the foreign firm at a disadvantage compared to local firms” (Eden

& Miller, 2004, p. 10). Often local firms have more knowledge, compared to foreign firms,

about the institutions and the local culture because they are already operating in their home

country for a long time (Elango, 2009).

Local knowledge consists of know-how about the local economy, culture, politics and

business customs for example. A qualitative study showed a positive relationship between the

amount of local knowledge and performance. When firms possess more local knowledge they

can make more efficient decisions, this improves their performance (Makino & Delios,

1996). Therefore, this paper argues that a lack of local knowledge results in costs for a

foreign firm.

Local firms are often more socially embedded in a network compared to foreign

firms. Therefore, local firms have more long-lasting embedded relations with other

unaffiliated organizations (Elango, 2009). In an embedded relation there is extensive

communication between firms which can be beneficial for enhancing organizational learning

(Uzzi, 1996). In an embedded relation firm A may learn about the local context from firm B

and vice versa. This embedded relations help the local firms to acquire local knowledge.

Foreign firms lack embedded relations, so they are more likely to acquire less local

knowledge.

According to the literature, foreign firms lack local knowledge because they spend a

short time in a host country and they lack embedded relations. This paper assumes that the

low degree of local knowledge is the main driver of unfamiliarity costs, and this assumption

is important in this study. This paper will focus on the degree of local knowledge that EM

MNEs have when they venture into developed markets.

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Discrimination costs

Discrimination costs are the second component of the LOF. Discrimination costs are

“Costs which a foreign firm faces when they go overseas because they are treated differently

compared to the local firms in the host country”. Companies can be treated differently by

local stakeholders such as customers, suppliers and governments because they are foreign.

When foreign firms enter a host country they face a different institutional environment

compared to their home country which can put them at a disadvantage (Eden & Miller, 2004).

An institutional environment can be characterized by three pillars: regulative,

cognitive and normative. The regulative pillar consists of all the rules and laws which

promote or restrict certain behavior. The cognitive pillar reflects the cognitive categories

widely shared by the people in a particular country. This is the framework people use to

assess the reality, for example American citizens use a monetary perspective to explain

whether a firm is doing well or not. Lastly the normative pillar consists of the values and the

norms which are held by the people (Scott, 1995).

North defines institutions as “The humanly devised constraints that structure political,

economic and social interaction” (North, 1991, p.97). Institutions are the rules of the game,

which determine how the economic game is played. Institutions influence transaction and

production costs. These costs affect profitability and affect the feasibility of engaging in

economic activities (North, 1991). “According to new institutional economists institutions

matter and are susceptible to analysis” (Matthews, 1986, p.903). Therefore, it is important to

take the institutional context into account.

North defines 2 types of institutions: Informal and formal. The former is about the

social norms, taboos, customs, traditions and codes of conduct which are in place (North,

1991). These rules are based on implicit understanding of rules and they are not written down

in a book. It derives more from a social perspective, these rules “should be followed”. The

latter is about the rules which are more explicit. These rules are written down in books and

have to be followed. Examples of this are laws and property rights. These rules derive more

from a legal perspective. These formal rules “must be followed” (Zenger et al, 2001)

Slangen & Beugelsdijk argued that formal and informal institutions create

institutional hazards for companies. They argued that formal institutions cause the highest

institutional hazards for a foreign firm because foreign MNEs are not able to resolve them.

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A low quality government system increases the risk of less favorable policies towards foreign

companies. In their study they showed that cultural distance and a low quality government

system increases the risk of institutional hazards (Slangen & Beugelsdijk, 2010).

Informal rules, which are related to the normative and cognitive pillar, can cause

institutional hazards for foreign firms. These institutional hazard arise because firms are

treated different by customers, vendors or suppliers in an informal way:

Consumers may display consumer ethnocentricity, which means that consumers see

the foreign firm as an “outsider” (Lantz & Loeb, 1996). A quantitative study showed that

Canadian customers prefer domestic over foreign products. Interestingly, the net effect was

greater when the foreign firm was coming from a developing country compared to a

developed country (Lantz & Loeb, 1996). Canadian people have the custom to value

domestic over foreign brands, which causes costs in terms of missed sales for foreign firms.

Local suppliers and vendors can have national tendencies as well, therefore they

rather do business with local firms compared to MNEs (Elango, 2009). To overcome these

national tendencies MNEs need to obtain external legitimacy (Eden & Miller, 2004).

Legitimacy is achieved when the company has a license to operate. MNEs can obtain

legitimacy by constantly acting in a way which is desirable or appropriate within some

socially constructed system of norms, values, beliefs, and definitions (Suchman, 1995).

Governments can discriminate a particular MNE by setting up formal institutions

which affect them negatively, such as high taxes or the presence of tariff barriers (Henisz &

Williamson, 1999). This is done in order to protect the domestic industry or it can be driven

by strategic concerns (Ramachandran & Pant, 2010). Host firms may approach governments

to set up rules which are negative for the foreign MNE as well (Lantz & Loeb, 1996).

Discrimination costs arise because MNEs are facing a different institutional context

when they go abroad. This paper assumes that a MNE faces discrimination costs when formal

and informal rules favor local over foreign firms. This assumption is important in this study.

This paper focuses on informal and formal institutions that cause extra costs for EM

MNEs. This study will investigate if there are any formal regulations that discriminate EM

MNEs when they enter a developed market compared to local firms. Furthermore, this paper

will assess whether suppliers, governments, vendors or customers discriminate EM MNEs in

an informal way when they enter a developed market compared to local firms.

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14 Relational costs

Lastly, relational costs play a role when looking at LOF. Relational costs are

“Additional organizational costs a MNE faces when they go overseas”. Firms have two kinds

of organizational costs: Intra-organizational costs and inter-organizational costs.

Intra-organizational costs occur because the organization has to be managed

internally. An MNE has to manage different subsidiaries from a distant location (Eden &

Miller, 2004). Geographic distance creates difficulties managing the subsidiary. For example,

when distance increases employees will deploy behavior which will benefit themselves

instead of the firm. This kind of behavior results in higher costs (Hennart, 2001).

When firms operate in multiple countries, managers have to deal with differences

between subsidiaries. Every subsidiary has employees stemming from different cultures, this

makes it highly complex and increases the management costs substantially (Hitt et al, 1997).

For example, Research conducted by Mezias has shown that foreign subsidiaries have more

labor lawsuits in America compared to their domestic counterparts as they are not able to

fully understand the motivations of their employees (Mezias, 2002).

Inter-organizational costs arise because an organization needs to manage their

relations with other external stakeholders. Foreign firms have difficulties setting up a

trust-based relation because they lack the capability to set up this kind of relations with third

parties. Furthermore, MNEs stem from a foreign country with a different language, culture,

business practices and habits. This makes it harder for them to set up a trust-based relation

with a local firm compared to other indigenous firms. Trust decreases the monitoring costs

and it decreases the chance that the other party ends the relation. Therefore, a trust-based

relation decreases inter-organizational costs (Uzzi, 1996).

Based on the previous paragraphs this paper states that relational costs derive from 3

main drivers: The fact that subsidiaries need to be managed from a geographic distance, the

diversity of employee’s cultures and the inability to set up trust-based relations.

This paper will investigate whether EM MNEs venturing into a developed market face

additional organizational costs. The focus on this paper is on the two last drivers. It will

investigate if the inability to set up trust-based relations and the cultural differences between

employees are causing relational costs.

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Liability of foreignness: A different dyadic perspective

A lot of research has been conducted which covers the topic of liability of

foreignness. Most scholars researched LOF using a dyadic perspective from a MNE coming

from a developed market investing in an emerging market. A minority of all the articles in the

last 10 years about LOF took a dyadic perspective from emerging markets into developed

markets (Denk et al, 2012). This geographic bias was justified because most of the FDI was

done by MNEs from developed markets (DM MNEs) into emerging markets.

Nowadays more MNEs from emerging markets (EM MNEs) are investing foreign

direct investment into developed markets. In 2014 the level of outward foreign direct

investment (FDI) from developing countries reached the highest level ever. In 2014 this

outward FDI increased by 23 percent to $468 billion (UNCTAD, 2015). In 2015, the FDI

outflows from developing economies decreased by fifteen percent. However, the FDI outflow

from developing economies still remains 23 percent of the total FDI outflow. Some

developing countries do increase their FDI outflow: China spend in 2015 $128 billion, an

increase of 4 percent. China remains third on the world ranking list for FDI outflows, only

Japan and America have more FDI outflows compared to China (UNCTAD, 2016).

EM MNEs are still an important factor, as their portion of total outward FDI almost

equals 25 percent. The amount of investment from EM MNEs investing in developed markets

increased significantly compared to five years ago (UNCTAD, 2016). This phenomenon

turns EM MNEs into a very interesting unit of analysis. In the past scholars had the tendency

to research DM MNEs. In order to overcome this geographic bias and to acknowledge the

fact that EM MNEs are becoming more important, this paper will take a different dyadic

perspective: From emerging markets into developed markets.

The unit of analysis of this paper is the subsidiary of Huawei that is operating in a

developed market, namely the Netherlands. In this paper the definition of an EM MNE will

be in line with Luo & Tung. This paper defines an EM MNE as “International firms that

originate from an emerging market, that perform outward FDI in one or more foreign

countries in which they undertake value-adding activities and exercise effective control” (Luo

& Tung, 2007, p.482). EM MNEs have to undertake value-adding activities overseas to be

recognized as such. Therefore, this paper excludes MNEs which operate overseas because of

tax reasons and EM MNEs which are just exporting.

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The unique traits of EM MNEs and the link with LOF

EM MNEs have unique traits, for example these firms lack the precious firm specific

advantages that DM MNEs possess. EM MNEs don’t have the same capabilities and

resources compared to their counterparts from developed markets, this is known as the

capability/resource gap (Gaur et al, 2011). EM MNEs lack capabilities and assets, such as a

strong brand name, managerial expertise and technological know-how. However, they do

possess some unique firm specific advantages, such as the ability to perform low-cost

products and the ability to offer the right mix of price-quality products (Ramamurti, 2012).

Johansson and Vahlne argued that DM MNEs internationalize in a gradual way,

which is known as the Uppsala model. This model states that DM MNEs expand overseas in

small incremental steps. First a DM MNE expands to a foreign country which is close to their

home country in terms of psychic distance. Later, a DM MNE invests in countries that are

more distant (Johanson & Vahlne, 1977).

DM MNEs take small incremental steps in order to learn “How to internationalize”.

For example, DM MNEs learn how to set up operations in a foreign market and how to get

access to local knowledge (Johanson & Vahlne,1977). By internationalizing in small

incremental steps DM MNEs learn how to become embedded in a network in a foreign

context. Furthermore, they get a better understanding of their own capabilities when they

internationalize incrementally (Johanson & Vahlne, 2009).

Other authors hold an opposing view: They argue that DM MNEs are doing

international business from inception because they want to leverage their firm specific

advantages, this is known as the born-global view. These firms see international markets

from the beginning as an opportunity to increase their sales. Therefore, they are present in

multiple countries from inception (Chetty & Campbell-Hunt, 2004).

The internationalization process of EM MNEs is different compared to DM MNEs.

EM MNEs do not internationalize according to the Uppsala model nor are they born-global.

EM MNEs expand a few years after inception immediately to a country which is totally

different than their home country, this is known as springboard behavior (Luo & Tung,

2007). EM MNEs springboard for different reasons: First to compensate for their competitive

disadvantages. By acquiring foreign firms, they buy firm specific advantages such as

technological know-how, brand image and managerial expertise. Secondly, EM MNEs use

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springboard behavior as a way to bypass trade barriers and to avoid the domestic institutional

constraints. Thirdly, firms from emerging markets want to secure preferential treatment by

their home government. By going abroad EM MNEs can benefit from the preferential

treatment which foreign firms take advantage of, such as lower taxes. Lastly, EM MNEs want

to exploit their firm specific advantages. In developed markets EM MNEs can offer lower

price products as they are specialized in mass production (Luo & Tung, 2007).

The springboard behavior of EM MNEs doesn’t allow them to accumulate

international experience and places them in a country which is very distant from their home

country. Because of these reasons they have difficulties going overseas. Moreover, EM

MNEs lack precious firm specific advantages such as a strong brand name and managerial

expertise which can help them overcome these difficulties.

EM MNEs possess less firm specific advantages and they springboard to other

countries. Because of these reasons Gaur et al state that MNEs which internationalize from an

emerging market into a developed market face a high degree of LOF (Gaur et al, 2011).

Given that EM MNEs face a high degree of LOF and still invest in developed markets it is

questionable whether LOF is a huge issue for EM MNEs. This makes it very interesting to

research liability of foreignness within the context of EM MNEs investing in developed

markets. The following figure is a visual representation of the unique traits of EM MNEs and

the link with LOF.

Gaur et al argue that EM MNEs face two sources of LOF: Environmentally-derived

LOF and firm-based LOF. Environmentally-derived LOF has its source in the home and host

country, as the institutional context between these countries differ. Environmentally-derived

LOF states that firm faces LOF because of external sources, it deals with the exogenous

nature of LOF. Firm-based LOF derives from firm specific characteristics. Firm-based LOF

increases, for example, when EM MNEs lack management expertise or local knowledge

(Gaur et al, 2011). Firm-based LOF deals with the endogenic nature of LOF.

EM MNEs springboard

to other countries

EM MNEs lack firm

specific advantages

EM MNEs face a high

degree of LOF

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Environmentally-derived LOF and the link to discrimination costs

Environmentally-derived LOF arise because firms are doing business in a particular

environment. In this paper environmentally-derived LOF is defined as “Costs EM MNEs face

when they invest overseas because the institutions in the host country are less beneficial for

them, compared to the local firms”. In the business environment of EM MNEs institutions

play a major role (North, 1991)

This paper argues that discrimination costs are related to the environmentally-derived

LOF. Firms are getting discriminated by actors in the environment of the firm such as the

government, suppliers, vendors and customers. This happens because the institutional context

in the host country is different. Therefore, this paper relates discrimination costs to

environmentally-derived LOF.

EM MNEs have to operate in an institutional context that is very different compared

to their home country (Gaur et al, 2011). Therefore, it is likely that EM MNEs face a high

degree of environmentally-derived LOF when they invest in developed markets.

Environmentally-derived LOF put EM MNEs at a disadvantage because it creates extra costs

for the firm.

Environmentally-derived LOF can be a significant issue for an EM MNE. Therefore,

this paper investigates whether environmentally-derived LOF is an issue for Huawei in the

Netherlands or not. This paper assumes that environmentally-derived LOF only consists of

discrimination costs.

This study analyzes environmentally-derived LOF by looking at discrimination costs.

It analyzes whether formal and informal regulations in the Netherlands create

environmentally-derived LOF for Huawei. Huawei is present in multiple environments: they

are selling IT business solutions to other businesses and they sell consumer goods like mobile

phones and routers. This paper analyzes whether Huawei faces environmentally-derived LOF

by looking into multiple industries. It analyzes the environmentally-derived LOF in the

context of the B2B business and the B2C business.

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19 Firm-based LOF and the link to unfamiliarity/relational costs

The second type of LOF EM MNEs face when expanding to developed markets is

firm-based LOF. This LOF is based on endogenous factors which are related to the

capabilities/assets a firm has. In this paper we define firm-based LOF: “Costs EM MNEs face

when they go overseas because they do not have the same firm capabilities/assets which

enhance their competitive advantage, compared to the local firms in the host country”.

Firstly, EM MNEs often lack local knowledge. These unfamiliarity costs can be

classified as firm-based LOF. Secondly EM MNEs lack managerial expertise. Thirdly, EM

MNEs have difficulties setting up trust-based relations because EM MNEs are unable to set

up these relations according to the local business practices (Ramachandran & Pant, 2010).

These relational costs are an example of firm-based LOF as well, because specific firm

characteristics are causing this type of LOF.

This paper argues that relational costs and unfamiliarity costs are related to firm-based

LOF. Both costs are arising because the firm itself has some capability/resource gap when

they enter a developed market. This paper will investigate whether EM MNEs lack the

resource local knowledge but it will also investigate if EM MNEs are lacking more resources.

Furthermore, it will investigate whether EM MNEs are facing a capability gap, such as the

inability to set up trust-based relations. This paper will investigate if EM MNEs are lacking

capabilities that DM MNEs do have. This paper will also investigate if cultural differences

between employees have an influence on firm-based LOF.

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20

Liability of origin

Environmentally-derived LOF and firm-based LOF are not sufficient to describe the

full range of costs EM MNEs face when entering a developed market. This paper introduces

another concept that complements LOF, the liability of origin (LOR). LOR is defined as “The

disadvantages foreign firms face because of their national origin”. LOF and LOR both state

that foreign firms face costs when they go abroad, but they are not exactly the same concepts.

LOF assumes that firms face costs because local firms have advantages over foreign firms.

LOR assumes that firms face costs as a consequence of where they are from (Ramachandran

& Pant, 2010).

To clarify this distinction between LOF and LOR this paper applies these concepts to

discrimination costs. Before this paper stated that consumers have nationalistic tendencies so

they like to buy products which stem from local firms. This is an example of LOF, as the

consumers do not like to buy foreign products.

Next to this firms can be discriminated because they are coming from a particular

foreign country, the country of origin. A study in 2011 showed that consumers, both in

developed and emerging markets, prefer to buy products from developed markets over

products from emerging markets. Consumers in developed markets hold a very negative

image about countries from emerging markets. The country of origin lowered consumer’s

purchase intention from emerging market products significantly. This example shows that

country of origin matters and that emerging market multinationals present in developed

markets suffer from this. EM MNEs venturing into a developed market are more likely to

suffer from liability of origin because consumers living in developed markets are more likely

to buy products from DM MNEs (Sharma, 2011).

This paper will focus on liability of origin by taking a look at the image consumers

and governments hold about the country of origin of Huawei as perceived by this EM MNE.

This paper assumes that a negative brand image of a country harms the brand and that it

results in missed sales. In this way liability of origin causes costs for EM MNEs.

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21

Literature overview

The image below provides an overview of the literature review so far. CDBA is the

overarching concepts which consists of LOF and LOR. Based on the literature LOF can be

divided in environmentally-derived LOF and firm-based LOF. This paper argues that

discrimination costs are related to environmentally-derived LOF. Furthermore, it states that

unfamiliarity and relational costs are related to firm-based LOF.

Costs of doing business abroad (CDBA):

“

Additional costs that foreign firms have when entering

abroad which indigenous firms do not have”

Liability of foreignness (LOF): “The additional social costs foreign

subsidiaries face, compared to well-embedded indigenous firms,

when they operate outside their home country”.

Liability of origin (LOR):

“The disadvantages foreign

firms face because of their

national origin”

Environmentally-derived LOF: “Costs

EM MNEs face when

they invest overseas

because the institutions

in the host country are

less beneficial for

them, compared to the

local firms”

Firm-based LOF: “Costs EM MNEs face

when they go overseas because they do not

have the same firm capabilities/assets

which enhance their competitive

advantage, compared to the local firms in

the host country”

Discriminations costs:

“Costs which a foreign

firm faces when they

go overseas because

they are treated

different compared to

the local firms in the

host country”

Relational

costs:

“Additional

organizational

costs a MNE

faces when

they go

overseas”.

Unfamiliarity costs:

“Unfamiliarity costs

reflect the firm’s lack of

local knowledge of or

experience in the host

country, which places

the foreign firm at a

disadvantage compared

to local firms”

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22 Gap and research question.

“To succeed in a target foreign market firms need to overcome LOF” (Dunning,

1995). For an EM MNE it is not easy to overcome LOF as these costs are classified as

infinite and they are not easy to measure (Calhoun, 2002). Managers have difficulties

managing LOF as they don’t know which methods are viable to overcome this problem.

Managers engage in trial-and-error approaches to find the solution that can overcome the

LOF their company is facing (Denk et al, 2012).

This paper will explore which strategies are effective to mitigate different forms of

LOF and LOR EM MNEs face. This paper includes the liability of origin because LOF itself

does not describe the full cost range EM MNEs face (Ramachandran & Pant, 2010). The

research question that this paper tries to answer is the following:

How do EM MNEs mitigate environmentally-derived LOF, firm-based LOF and

liability of origin when they expand to a developed market?

In the past FDI was a one-way street: DM MNEs invested FDI into developing

markets. However, nowadays EM MNEs invest FDI themselves in developed markets. The

amount of FDI from EM MNEs which are investing in developed markets is increasing every

year. India, China and Brazil are all increasing their outward FDI into developed markets

(UNCTAD, 2015). This research question incorporated this trend by focusing on EM MNEs

investing in developed markets.

EM MNEs concern about LOF as these costs are not easy to manage. LOF affects

financial performance negatively because it lowers the efficiency (Miller & Parkhe, 2002).

Firms which experience a high degree of LOF are less likely to survive and therefore it is

important to mitigate LOF (Zaheer & Mosakowski, 1997). Firms would be highly interested

in methods which can help them overcome specific LOFs they have to face. This research can

help in developing a successful method which decreases a specific type of LOF. Therefore,

this research is practically relevant.

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23

A lot of researches have been conducted which investigate FDI flow from a

developed market into an emerging market. A minority of recent papers about LOF took the

dyadic perspective from emerging markets into developed markets. Given that it is not proper

to generalize the LOF concepts from DM MNEs to EM MNEs, as they fundamentally differ,

more research has to be done which research the degree of LOF that EM MNEs face (Denk et

al, 2012). In order to overcome the geographic bias this paper takes the dyadic perspective

which is under-researched. This makes the research question scientifically relevant.

Furthermore, Denk et al state that there is a lack of knowledge about which mitigation

strategies are viable for which LOF. This gap prevents researchers from identifying the

optimal mix of strategies for managing the outcomes of LOF.

Denk et al state that “We

therefore encourage the investigation of this paradox in future studies and the development of

effective solutions that take into account the complexities of LOFs solutions” (Denk et al,

2012, p.329). This paper will explore which strategies are effective to mitigate different

forms of LOF and LOR EM MNEs face. In this way, this paper develops effective solutions

that take the complexity of LOF and LOR into account. In this way, this paper contributes to

the existing literature.

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24

3. Theoretical Framework

In this section, several working proposition are posted which make predictions about

the degree of environmentally-derived LOF, firm-based LOF and liability of origin EM

MNEs face. Furthermore, based on the literature, mitigation strategies for different types of

LOF and LOR are incorporated in the working propositions. Six working propositions are

written down, and these propositions will guide the direction of this paper. In the end of this

section a model is presented that is a visual representation of the theoretical framework.

A high degree of Environmentally-derived LOF

The first type of LOF is the environmentally-derived LOF. Environmentally-derived

LOF is defined as “Costs EM MNEs face when they go abroad because the institutions in the

host country are less beneficial for them, compared to the local firms”. The main driver of

environmentally-derived LOF is the fact that foreign firms are discriminated by governments,

suppliers, vendors or consumers in a formal or informal way. Foreign face a disadvantageous

institutional context compared to local firms. Eden and Miller argued that institutional

distance and environmentally-derived LOF are positively related to each other (Eden &

Miller, 2004).

EM MNEs face a high institutional distance when they venture into a developed

market (Gaur et al, 2011). For example, in China Guanxi is an effective method to form

relations. Guanxi are inter-personal relations between an MNE and people in the local

community such as suppliers, government officials, buyers and wholesalers. In China Guanxi

is developed first, afterwards managers start to talk about business and they set up contracts.

In the West it is the other way around: Managers start doing business by setting up contracts,

afterwards they develop personal relations (Luo et al, 2002).

Because of the different business practices, which are reflected in a high institutional

distance, it is likely that EM MNEs cannot secure preferential treatment by governments.

Furthermore, it is likely that suppliers and vendors value domestic firms over EM MNEs

because it is easier to do business with them.

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25

Consumers tend to value domestic products over foreign products. This effect is

stronger when a foreign brand is coming from a culture which is very dissimilar. The study

from Watson confirmed that cultural distance plays a role: Consumers from New Zealand

were less likely to value Italian products over domestic products compared to German

products. This happened because of cultural distance: Italy and New Zealand are culturally

more distant from each other compared to New Zealand and Germany (Watson, 2000).

Therefore, multinationals which venture abroad into very dissimilar cultures are more likely

to be discriminated by the consumers.

EM MNEs are more likely to face a high degree of cultural dissimilarity when they

venture into a developed market. EM MNEs stem from a country that possess totally different

business practices, a different language, different rituals, different values etc. Therefore, it is

more likely that EM MNEs get discriminated by consumers when they venture into a

developed market.

These, and many other examples show that the institutional context in an emerging

market is totally different compared to the institutional context from a developed market.

This distance results in discrimination costs, EM MNEs get discriminated in a formal or

informal way. Based on this section and on the literature review the following proposition is

made:

Proposition 1: EM MNEs venturing into developed markets face a high degree of

environmentally-derived liability of foreignness.

A high degree of firm-based LOF

The second type of LOF is the firm-based LOF. Firm-based LOF is defined as “Costs

EM MNEs face when they go overseas because they do not have the same firm

capabilities/assets which enhance their competitive advantage, compared to the local firms in

the host country”. This firm-based LOF is especially a problem for EM MNEs because they

engage in springboard behavior and because they lack precious firm specific advantages that

DM MNEs do have (Gaur et al, 2011). This paper argues that the unique traits of EM MNEs

increase the costs associated with firm-based LOF.

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26

Most of the EM MNEs are considered as latecomers in Europe because they started

engaging in outward FDI many years later compared to DM MNEs. EM MNEs didn’t have

the same time to develop their capabilities. Therefore, they suffer from a capability gap such

as managerial expertise. Furthermore, EM MNEs face a resource gap: They do not possess a

lot of local knowledge and a valuable brand name because they just ventured into developed

markets. This creates extra costs for EM MNEs that local firms and even DM MNEs do not

have (Ramamurti, 2012).

EM MNEs internationalize in a fast way: They springboard immediately to a country

which is totally different from their home country (Luo, & Tung, 2007). Contrary, DM MNEs

internationalize by taking many small incremental steps (Johanson, & Vahlne, 1977). DM

MNEs “learn how to internationalize” by doing this. They learn for example how to set up

trust-based relations with third parties. EM MNEs deploy springboard behavior which does

not allow them to acquire these skills.

EM MNEs face high cultural distance when they venture into Europe. This cultural

distance will cause difficulties managing the foreign subsidiary. The employees working in

Europe are likely to have different norms, beliefs and values compared to the employees of

the home country. It is difficult for EM MNEs to manage their employees effectively, as the

management style needs to be adapted to the local culture. Furthermore, employees might

have difficulties understanding or accepting the corporate culture because it is based on a

culture which is very distant. It is more likely that conflicts arise between the management

and the employees (Chang et al, 2012). Especially for EM MNEs this is an issue because they

lack managerial expertise.

The previous paragraphs have shown that EM MNEs are likely to face firm based

LOF. Firstly, EM MNEs face a capability gap: DM MNEs have more capabilities such as

managerial expertise and the ability to set up trust-based relations. Secondly, EM MNEs face

a resource gap: DM MNEs possess more assets like local knowledge and a valuable brand

name. Thirdly, EM MNEs are more likely to suffer from different employee’s cultures

because they lack managerial expertise. This leads to the following working proposition:

Proposition 2: EM MNEs venturing into developed markets face a high degree of firm-based

liability of foreignness.

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27 A high degree of Liability of origin

Liability of origin assumes that EM MNEs have extra costs because they are coming

from a particular country, which is called the country of origin. A study conducted by

Magnusson et al confirms this: Consumers leverage associations from the country of origin to

the brand, these associations affect product evaluations and buying behavior. Consumers

leverage negative and positive associations from the country of origin to the brand. Brands

can use country of origin in their favor: Volkswagen is emphasizing that their cars are

“German made” to leverage the association quality from Germany. For some brands the

country of origin is negative. “Haier” is a Chinese brand that adopted a German name to

avoid negative associations from China (Magnusson et al, 2011).

Customers have perceptions, stereotypes and beliefs regarding products or service

quality which is associated with the country of origin (Ramachandran & Pant, 2010). Country

of origin matters a lot: Veale and Quester showed that country of origin heavily influences

the buying decision of consumers. The country of origin was more influential compared to

the taste of wine (Veale & Quester, 2009). Another study conducted in 2008 found that

Australian status-seeking students did not want to buy any fashion products which were

“made in China”. Chinese fashion products were regarded as inferior to products which were

made in Australia, Japan or Italy (Phau & Siew Leng, 2008). Products made in China were

labeled as cheap and low quality.

Governments can discriminate a particular firm as well based on where they come

from. In 2008 the France government initially rejected a takeover from Arcelor by an Indian

company because they preferred a takeover by a Russian company (Ramachandran & Pant,

2010). This is an example of LOR because this rejection was based on the country of origin.

The consumers in developed markets have more negative perceptions about the

country of origin from EM MNEs compared to DM MNEs (Ramachandran & Pant, 2010).

Furthermore, governments from developed countries are more likely to hold negative

perceptions about the country of origin from EM MNEs. Therefore, it is likely that EM

MNEs face a high degree of LOR. The following working proposition is based on this.

Proposition 3: EM MNEs venturing into developed markets face a high degree of liability of

origin.

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28 The use of local employees

Luo and Tung stated that offensive and defensive mechanisms can be deployed to

mitigate LOF. One of the offensive strategies that can be used to mitigate LOF is local

networking. “Local networking can reduce LOF via localization by making use of local

production factors such as workers, engineers, and managers” (Luo et al, 2002, p.288).

EM MNEs must understand the formal government structures that dictate their

relation with other external parties like the government, vendors, suppliers and consumers.

However, they also have to understand the informal practices that play a role in the business

environment. The information asymmetry between foreign firms and indigenous firms is the

highest with respect to informal practices (Calhoun, 2002). Hiring local employees is an

excellent way to overcome this issue because they know about these local informal practices.

A local employee can build a relationship more effectively with local government

officials. Employees from emerging markets will try to build a relationship with the

government in a way that does not match the local practices. Therefore, local employees are

more likely to secure governmental preferential treatment compared to foreign employees.

Secondly, a local employee like an account manager is more likely to form profitable

relationships with external parties such as vendors and suppliers. People sharing the same

cultural traits have a more profitable relationship when the two parties engage in an

aggressive bargaining strategy. Participants who share the same culture can withstand the

tension and achieve a better outcome together (Ribbink & Grimm, 2014).

Lastly, local marketers know how to target consumers in a developed market. They

know the local marketing practices and the environment. Furthermore, they have no barriers

in language and they share cultural traits. Therefore, they are able to target consumers in a

more effective way (Liu & Li, 2002). This will result in campaigns which make the brand

more valuable for the consumer, which decreases the discrimination costs by the consumers.

Because local employees act in a local way they are an excellent mean for EM MNEs

to mitigate environmentally-based LOF. Therefore, the following working proposition is

posted:

Proposition 4: The use of local employees is an effective mitigation strategy to overcome

environmentally-derived LOF.

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29 Organizational learning

Organizational learning consists of two things which occur not simultaneously. First

organizations learn when they are present in a particular country. Firms learn and retrieve

information about their environment and their own organizational capabilities for example.

Secondly, firms use this information to change the status quo in order to build a more

efficient organization. This paper uses the definition of organizational learning that is widely

used: “Organizational learning means the process of improving actions through better

knowledge and understanding“(Fiol & Lyles, 1985, p.1).

Organizations consist of people, if employees are learning about the local

environment the organization as a whole becomes more acquainted with this matter. When a

subsidiary of an EM MNE learns about their local environment, they can make decisions

based on the preferences of the local market. This results in a more efficient organization

(Daamen et al, 2007). In this way the firm-based LOF is decreased.

When a subsidiary learns it can alter their strategies or procedures to tackle certain

problems. “Organizational learning can be observed when strategies or procedures change

as a result of previous experience” (Daamen et al, 2007, p.30). Employees, working in a

subsidiary of an EM MNE can acquire knowledge which allows them to build a trust-based

relationship. They can use this knowledge to alter their strategy and become more effective in

setting up these relations. In this way the organization as a whole becomes more skilled and

develops capabilities that helps them to decrease firm-based LOF.

EM MNEs face management problems because they have to manage a subsidiary

from a distance and they have to manage employees from different cultures. EM MNEs

should learn as an organization and get managerial expertise to solve this issue. Firstly,

managers should learn how to set up a foreign subsidiary. Secondly, managers and employees

need to learn about each other’s culture and trust each other. Thirdly, it is important that

managers and employees know and accept the organizational culture (Daamen et al, 2007)

Organization learning is important because subsidiaries of EM MNEs acquire assets

and develop capabilities in this way. Therefore, the following working proposition is posted:

Proposition 5: Organizational learning is an effective mitigation strategy to overcome

firm-based LOF.

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30 Brand Building

Ramachandran and Pant argued that EM MNEs should manage their brand image to

mitigate the LOR they are facing. In this paper brand image is defined as “Perceptions about

a brand as reflected by the brand associations held in memory” (Keller, 1993, p.3). EM

MNEs have to build positive aspects of their image and downplay the negative ones, to suffer

less from liability of origin. Furthermore, EM MNEs should use brand-building tools which

help them to create a more positive brand image (Ramachandran & Pant, 2010).

EM MNEs are suffering from their country of origin. Emerging countries like China

are often associated with “low quality” and “cheap products”. These associations cause costs

for the EM MNE (Phau & Siew Leng, 2008). EM MNEs can build a brand image that doesn’t

incorporate any associations with the country of origin. In this way, the EM MNE downplays

the negative effect because the brand is not linked to the country of origin. Another method is

to link a brand to another country, this is called a foreign branding strategy. The Chinese

company Qingdao refrigerator changed their name into Haier. This German name helped

them to generate a more positive brand image (Magnusson et al, 2011).

EM MNEs can use brand-building tools to create a positive brand image. EM MNEs

can leverage positive associations by sponsoring events or using endorsers. These events or

endorsers can build brand image in a positive way (Gwinner & Eaton, 1999).

Alternatively, a more positive brand image can be created by linking the brand to an

organization that has a non-economic, social objective. For example, BMW devoted 1 dollar

for every driven mile to Susan G. Komen Breast Cancer Foundation (Hoeffler & Keller,

2002). Lastly, EM MNEs can form alliance partnerships with other credible firms to build

their own brand image. EM MNEs can partner up with partners that hold strong, unique and

favorable associations. If there is a degree of fit positive associations can transfer between

partners, in this way the brand image becomes more positive (Ahn et al, 2009).

Positive associations can counter the effect of liability of origin. If the brand image is

positive enough, people will buy the product despite the country of origin. Based on this text

the following working proposition is posted:

Proposition 6: Brand building is an effective mitigation strategy to overcome liability of

origin.

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31 Visual model theoretical framework

In the previous section, this paper argued that EM MNEs face extra costs due to a

high degree of environmentally-derived LOF, firm-based LOF and liability of origin.

Environmentally- derived LOF, firm-based LOF and liability of origin are positively related

to costs. Based on the literature, several effective mitigation strategies have been found.

Firstly, local employees can mitigate the costs related to environmentally-derived LOF.

Secondly, organizational learning can mitigate the costs related to firm-based LOF. Lastly,

brand building is an effective mitigation strategy for EM MNEs to overcome the costs related

to the liability of origin. These mitigation strategies moderate the positive relationship

between LOF/LOR and the costs associated with it. This is summarized in the following

model.

Visual model mitigation strategies

I

II

III

Environmentally-derived LOF Costs

Costs Firm-based LOF

Liability of origin Costs

Use of local employees

Organizational learning

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32

4. Methodology

In this section, the methodology used in this research is explained. In this study

qualitative research is conducted in order to obtain rich empirical data. The research method

this study engages in is a single case study. These choices will be justified and explained in

the following paragraphs. The case studied in this research is the subsidiary in the

Netherlands of the Chinese MNE Huawei. In the last part of this section, information about

Huawei Netherlands B.V. is given.

Qualitative single case study

This paper opts for a qualitative singe case study. A case study is defined as “A

research strategy that can be qualified as holistic in nature, following an iterative-parallel

way of preceding, looking at only a few strategically selected cases, observed in an

open-ended way, making use of analytical comparison of cases or sub-cases, and aimed at

description and explanation of complex and entangled group attributes, patterns, structures

or processes” (Verschuren, 2003, p.137)

According to the influential scholar Yin a case study is appropriate when: The

research question is a “why” or “how” question and the contextual conditions are important

and (Yin, 2003). This paper analyzes different strategies EM MNEs can use in order to

overcome LOF, therefore a “how” research question is used. Contextual conditions are

important for this study, as LOF and LOR are highly dependent on the context namely the

firm itself and the environment they are operating in.

LOF and LOR are complex constructs which are hard to measure by conducting a

quantitative study. The use of figures, numbers and tables are not appropriate in order to find

several strategies which help firms to overcome LOF and LOR. The strategies which are

developed now are developed and used within the context of a firm. Therefore, a research

strategy which takes into account the context, such as a case study is a good option.

Effective mitigation strategies for liability of foreignness and liability of origin : the case of Huawei in the Netherlands