1 March, 2013
Informal Institutions as Substitutes for Formal
Institutions in the Internationalization Process of
Iranian SMEs
Master thesis by
Aryan Rasoul Poor Masouleh
Supervised by
Dr. ir. Haibo Zhou
University of Groningen
Faculty of Economics and Business
Warmoesstraat 7a
9724 JH Groningen
(06) 5387 7452
aryanrasoulpoor@yahoo.de
2
Abstract
Within the last centuries, a number of small-medium enterprises (SMEs) have increased their international expansion efforts through investments in foreign markets. Nevertheless, firms in some countries are confronted with increased barriers in their internationalization process due to environmental limitations. The purpose of this thesis is to draw research attention to internationalizations processes of Iranian SMEs and provide practical implications for firm owners that aim to expand abroad.
Empirical evidence is provided after interviewing five Iranian SMEs in a qualitative case study. Before the interviews, an introduction to the topic as well as a literature review were conducted. The subsequent conceptual framework provided the base for the interviews which were carefully planned as explained in the research method section.
It is argued that a low degree of international access leads to stronger SME reliance on institutions. In particular, governmental limitations to reach international markets cause SMEs to increased activities with informal institutions. Informal institutions are also seen as better options as they are able to adapt to SME needs and increase chances to build competitive advantage. Furthermore, a relationship between increased SME cooperation with informal institutions and a change in entry modes is showed. The stronger SMEs work with informal institutions, the stronger expansions through own power without foreign alliancing is preferred.
1. Introduction
3 during the last centuries and have been expanding to diverse foreign markets. However, there are also many examples of expansion failures. The orientation to foreign markets requests a selective adaption in strategic orientation in order to respond to the changed economic landscape adequately (Yip, Biscarri & Monti, 2000).
In international expansions, firms are often confronted with entry barriers and uncertainties which include political, economic, social, technological, environmental and legal differences (Gellespie, 2011). Furthermore, the cultural aspect plays an important role in deciding where you want to expand to, and also in what way. Because culture is not really measurable and diverse in respective societies, managers have to have a good sense for handling it the right way (Egan & Bendick, 2008). In order to overcome those issues, SMEs increasingly make use of institutions which supply them with relevant knowledge and connections of host country markets. More than that, institutions act as stability factor which lowers risks of internationalizing while encouraging firms to take the chance and expand overseas. (Busse & Hefeker, 2007)
4 SMEs, as they function as social networks that can act as major success factor (Meyer, Estrin, Bhaumik & Peng, 2009). The main advantages of those forms of networks are that they save time as well as resources during adaption to new environments. Ozcan and Eisenhardt (2009) describe the role of such networks more detailed as providers of information, flexibility and benefits which are likely to enhance firm performance.
Both types of institutions are used by SMEs in their expansion plans. If formal institutions are well developed and able to provide SMEs adequate help, firms will rely on them. However, if SMEs perceive that their pool of informal institutions is similarly developed and capable of providing more help than formal institutions can, they will prefer using informal institutions in their expansion processes. (Berkowitz, Moenius, & Pistor, 2006; Freeman, Edwards & Schroder, 2006). It needs to be explored what a lack of one type of institution, in this case a lack of formal institutions, means for the overall degree of success in internationalization processes of SMEs. More interestingly, it needs to be analyzed what factors influence firms decisions concerning the choice between formal and informal institutions. Besides, it should be better understood to what degree informal institutions are capable of substituting formal institutions and how such a choice influences entry modes of firms to foreign markets.
5 governmental institutional infrastructure. The present thesis will explain how SMEs overcome such domestic underdevelopments in their internationalization process.
The intended contribution to existing literature is a clearer picture of SME internationalization processes. Most specifically, the influence of informal institutions in SME expansions shall be clarified and the extent to which they can substitute formal institutions. Moreover, Iran is being focused as research environment which provides insights into a non-western Islamic republic that has not been researched very extensively. After this research further insights about the Iranian market as well as its governmental issues may be derived. In the following chapter a literature review shows which findings former literature has presented about this topic so far. The remaining chapters are organized as follows: Chapter 3 presents a developed conceptual framework for the research, based on existing literature. Chapter 4 explains the research method in addition to providing a pilot case that includes additional insights for the research. Afterwards, findings are presented and the outcomes are concluded, containing limitations and propositions for future studies.
2. Literature review
6 distances concerning culture, legislative matters and business practices can be reduced by experiencing intangible knowledge abroad (Johansson & Vahlne, 1990). The downside is that experiential knowledge is costly and not always easy to reach, especially for SMEs who are often limited in resources (Dierkes, Berthoin, Child & Nonaka, 2003)
Later research, dealing with internationalization processes, put stronger emphasize on the individual characteristics of respective actors (Saravathy, 2001). In her paper, Saravathy states that stronger emphasize should be given on individuals as they are carriers of knowledge and main actors in decision making processes. Johansson and Vahlne (2009) add that networks are vital for successful internationalization. The authors notice that firm internationalizing depends no longer on being foreign but instead on outsidership; meaning the degree of internationalization success depends on the network firms are active in (Johansson & Vahlne, 2009). This is emphasized by Oviatt and McDougall (2005) by defining international networking and knowledge as two key sources for internationalization processes. Networks imply relationships of partners which are characterized by knowledge exchange, trust and commitment. Nahapiet and Goshal (1998) already explained the importance of interplays between learning processes and trust development in order to create opportunities. Higher knowledge, trust and commitment towards partners increase the efficiency of creative processes (Johansson & Vahlne, 2009).
7 institutions “include chambers of commerce, contacts with government and quasi-government agencies dedicated to business support and professional and trade organizations” (Parker, 2008, p.628). Informal institutions, in comparison, act as social networks which are webs “of personal connections and relationships for the purpose of securing favors in personal and/or organizational action” (Zhou, Wu & Luo, 2013, p. 674). Both types of institutions play a major role in the choice of entry modes of firms in their internationalization process (Meyer, Estrin, Bhaumik & Peng, 2007). Depending on institutional access and support, firms may vary in their respective entry modes. The relationship between both institutional forms is recursively related. (Islam & Reshef, 2006). In other words, when formal institutions fail to provide SMEs with adequate support in their internationalization process, a shift towards informal institutions occurs. Such a shift also applies the other way around, so from informal institutions to formal institutions. Nevertheless, a shift from one type of institution to another one does not necessarily offer a solution to the problem. Especially in the business environment, institutional effectiveness is strongly shaped by the combination of both types of institutions (Farrell & Heritier, 2003).
Another influential factor on the internationalization process is the degree of international access. Continuous globalization with increasing interconnections between entities around the world led us to the so called „communication age‟ (Lull, 2001). Especially internet developed from its technological form towards a communication medium which opens up boundless possibilities (Lull, 2000). Also, business practices are strongly influenced by international access. Due to established and reproduced knowledge transfers, SMEs are capable to learn common business behaviors of other regions and overcome cultural differences (Greig, 2002; Maskell, Bathelt & Malmberg, 2007).
8 institutional usage. Furthermore, there is little known to what extent formal institutions are substitutable by informal ones and if changes have consequences on international entry modes of SMEs.
The present thesis analyses what effects low international access has on SMEs‟ dependency on institutions. Furthermore, research is done if lacks in formal institutional support lead to a switch towards informal institutional usage and if those can substitute adequate support. Lastly, variances of entry modes are looked at to find possible relationships between choice of institutional type and entry mode.
3. Conceptual framework
Degree of international reach
9 Consequently, a lower international reach may decrease independent knowledge gathering and make SMEs more reliant on external institutions.
Lohrke, Franklin and Frowenfelter-Lohrke (2006) examined, based on transaction cost analysis, that SMEs increase information exchange with foreign firms through internet usage. In comparison, SMEs that make less or no use of internet need to transmit and receive knowledge like product information and asset specificities from other sources. Similarly in the past, the era before internet, firms needed to rely on alternative international connection methods. During that time, there were mainly institutions which supported SMEs to gain knowledge of foreign markets, industries and companies (Mathiason, 2008). As a consequence, it could be assumed that a lower internet infrastructure pushes SMEs towards stronger institutional usage. In the case of Iran, there is one main difference to be made to the era before internet. In contrast to the post-internet era, Iran already has technological possibilities to develop more international reach for the population. However, it is the government which restricts further developments due to political reasons. Such governmental limitations of international reach could also change SMEs‟ decisions using formal and informal institutions. This is because formal institutions are mainly led by the same government that limited international reach in the first place. Consequently, relationships to governmental entities could be harmed or avoided by SMEs due to frustration. An in-depth analysis should help explaining how lower international reach in Iran influences SME dependency on institutions and if it also changes what type of institutions SMEs choose for.
Formal and informal Institutions
10 & Heritier, 2003). Both types of institutions are important for internationalization processes of SMEs but differ in the way they can help firms. Formal institutions are mainly governmental or semi-governmental even though this is no necessity. The main forms of formal institutions include chambers of commerce, official legislative facilities (Bjornskov, Dreher & Fischer, 2010) and any governmental and quasi-governmental entity that firms can refer to when facing difficulties (Parker, 2008). Böröcz and Southwest (1998) describe interactions with formal institutions as relationships which are explicit, mainly functional and impersonal. Informal institutions, in contrast, describe private and social networks of individuals and SMEs. They provide support on a personal base and are not bound to any legal arrangements (Rank, 2008). This also leads to increased flexibility and individuality. Examples for informal institutions are relatives, friends or business partners. Informal institutions are characterized by low fixed costs and high marginal costs. Whereas formal institutions have high fixed costs but relatively low marginal costs (Rodrik, 2008). Moreover, formal institutions differ from informal ones in the way that they are more harmonized and thus lowering transaction costs (Williamson, 1985; Dunning, 2010). Also, formal institutions are able to enforce sanctioning misbehavior and thus lowering risks through legal systems much easier than informal institutions (Rodrik, 1998).
11 foreign firms. Strategic partnership entry modes would involve excessive uncertainties without sufficient legal backup due to a lack of possibilities protecting SME rights (Kale, Singh & Perlmutter, 2000). In comparison, informal institutions have the advantage of being so flexible that they can provide SMEs very adjusted what they need and demand. Moreover, intangible knowledge can be provided through close relationships with SMEs. As legal protection is not given by informal institutions, alliances with foreign companies can be risky. However, SMEs perceive being able to reach competitive advantages which may lead to acquisitions or building up foreign subsidiaries on their own (Anne-Wil Harzing, 2001). This, however, also depends on how the different institutional types are used by the interviewed SMEs which will be examined more in the finding section.
Entry mode
12 Direct/ indirect exporting
A rather fast way of entering a foreign market with a low degree of risks is indirect exporting. Daniels and Radebaugh (2008) describe that this form of internationalizing is one of the simplest and only requires a mediator for trading abroad. One step further would be direct selling which skips the mediator of the relationship and focuses on selling directly to foreign entities. Here, increased control over products and also increased profitability compared to indirect exporting are recognizable. On the downside, SMEs need to invest more time and money into the relationship building.
Strategic Alliances (Licensing, JV)
Licensing
In this entry mode brand reputation, production processes and trade secrets are offered in exchange to compensation fees (Kotler & Armstrong, 2009). This form of alliance allows SMEs to enter overseas with comparably low risks and be able to adapt fast to new technologies. Next to that, firms can also improve domestic services through gained knowledge. But it has to be kept in mind that profitability is not very high and the danger of potential rivals can still be a major issue.
Joint ventures
After a relatively high initial investment firms are able to establish a new and independent entity. This way of alliance enables SMEs to gain technical and market knowledge and also overcome political and economic barriers (Tanganelli & Shaan, 2011). Nevertheless, such entry modes also need a high degree of trust in order to be efficient and maximize returns (O‟Farrel & Wood, 1998).
FDIs
Acquisitions
13 knowledge about the foreign market and the company that is going to be acquired (Bell, Naughton & Young, 2001). This mode of entrance can be accomplished by full acquisitions as well as part acquisitions. The advantage is that skills and infrastructure of an unfamiliar market do not need to be built up in time consuming processes. Firms build up competencies faster and with own control but also with higher risks and potential cultural clashes. (Fabian, Molina & Labianca, 2009).
Wholly owned subsidiaries
A rather risky entry mode with high potential of gaining intangible knowledge abroad is through wholly owned subsidiaries. Firms choose to enter into foreign markets by full ownership and consequently most possible control (Sharma & Blomstermo, 2003). If the market is unknown to the firm, such an entry strategy might require much time and resources. This type of entry strategy is usually preferred when close contact to customers is required or firms are active in knowledge intensive industries (Hitt, 2009).
Based on what was discussed so far a conceptual framework as shown in figure 1 is the outcome.
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4. Research method
This thesis has the purpose of understanding the influence of international reach on SMEs‟ internationalization processes and what influence international reach has on the choice of institutional types. Moreover, informal and formal institutions are investigated with respective effects on international entry modes.
Since influences and relationships are investigated that cause decision making processes, a qualitative case study will be the most appropriate research method (Easton, 1995). Moreover, a qualitative case study has the advantage of having strong explanatory power (Yin, 1989). Besides, this approach proved to have distinct advantages when questions like „how‟ or „why‟ are asked about events, over which the investigator has little or no control (Monroy et al., 2010). Five internationalizing SMEs, listed in table 1, which are all headquartered in Iran, are interviewed with a prepared questionnaire. The questionnaire is based on qualitative questions of former academic literature as well as suggestions from a pilot case. The pilot case was conducted with an Iranian person that has business relations in various countries while also bringing years of experience from his job in a German institution. With the help of the supervisor of this thesis the questions were then adapted to this research in order to fully meet the purpose of the study.
In order to have reliable interview results and ensure appropriate actions during the interviews the questionnaire is developed according to the interview guide of Emans (2004). Following instructions are relevant and considered for the interviewer:
1. Keep to the order of the questions as they appear in this interview guide.
15 3. Questions should be read calm, clear and repeated if there are doubts that the
interviewee has heard the question well enough.
4. Check before beginning the interview whether the audio equipment works.
5. Write the name and company name of the respondent as well as your name and the date above each questionnaire.
6. Be well prepared to conduct the interview. Make sure appearance is appropriate, that there are no disturbing actions during the interview (like using a chewing gum). Remember that you only have one chance to make a first impression.
7. Tell interviewee that if he/she has any questions about parts of the interview guide or about the questions, there should be not hesitate to contact Aryan Rasoul Poor.
8. Begin the interview by introducing the interviewer. Don‟t forget to tell that the position of the interviewer is being a student. Refer to the e-mail of announcement that was sent to the interviewee. Bring the following points to the attention of the interviewee before asking the first question:
- The organization that research project (Master thesis) is delivered to will be the University of Groningen.
- The purpose of the research is to have a clearer picture of the internationalization process of SMEs headquartered in Iran and the role of institutions and international reach.
- The questions in the interview deal primarily with action undertaken by the company of the interviewee and opinions he/she has about these activities
- The final report will be send to the company if required as soon as the thesis is finished
16 not hand it to another party. Also the file will be deleted when the research project is done.
During the interviews the respondents are first asked the questions that were prepared in beforehand. After researching their international reach, questions are asked about the role of institutions in which the contrast between formal and informal ones should be clarified. Also, the internationalization process itself is described as the interview proceeds. Next to this, the main formal institution that is responsible for (international) trading in Iran and their subsidiary in Germany are contacted. This order enables to see first, what SME responses about formal institutions are and then to countercheck their responses first hand. Table 1 summarizes an overview of most relevant information of all firms.
Case 1 Case 2 Case 3 Case 4 Case 5
Year of firm establishment
1981 1933 2005 2005 1977
Headquarters Mashad- Iran Mashad- Iran Teheran- Iran Teheran- Iran
Teheran- Iran Industry Apparel and
Leather
Food Chemicals Tobacco Trading
/transportation Main products Shoes, jackets,
handbags and accessories made of leather Pistachios, dried fruits, rosewater, walnuts and saffron Paint-color for textiles and plastics Cigarettes Transportation of consumer goods and intermediate products # of countries company is present 5 (Iran, UK, France, Germany, Italy) 1 (Iran) 2 (Iran, UK) 1 (Iran) 2 (Iran, Germany)
Table 1: Overview of interviewed firms
17 shall decrease any hesitance of the interviewees to answer questions truthfully. Otherwise, results might be misleading and not going enough into detail.
Overall, all companies are headquartered in Iran and doing business across country borders. As being seen, three of our five cases have subsidiaries abroad. Each company is active in a different industry so that no conclusions are drawn based on a single industry.
Pilot Case
Existing literature already described a significant amount of explanations about how and why formal institutions can have an impact on the internationalization process of SMEs. Nevertheless, Iranian SMEs are active in a different context than organizations of Western countries. In order to ensure that this research fits to the particular circumstances of SMEs in the institutional context of Iran, a pilot case is necessary. For the pilot case Dr. A. was interviewed, whose personal information will be kept anonymous to ensure that his responses will not cause political problems for him or his relatives in Iran. Dr. A. was born and raised in Iran until he was 23 years old. For his studies, he moved to Germany where he later worked for a governmental institution for over 40 years. During his career, Dr. A. regularly visited Iran and was involved in various business relations that included cross-border activities from and to Iran. His main function was to consult companies during international expansions. When the research topic was introduced to Dr. A. with the conceptual design he gave advice to consider following:
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your expansion process if you don‟t have adequate connections abroad. Actually, one of the main problems is the international reach that is intensively limited compared to Western countries. In Europe, for example, you have various ways to connect to other geographical regions. In Iran such an option is not really given. The government restricts many activities. The Internet is in many cases filtered, getting a Visa to leave the country requires long-lasting procedures and such restrictions often also apply for foreigners who want to enter the country. Depending on what quality of connections SMEs have to foreign entities they will decide on what type of institution, governmental or non-governmental, they will include in their internationalization process.”
Taking Dr. A‟s contribution into account, “degree of international reach” is validated in the present conceptual framework. This variable will help to better understand the dependency on institutions for SMEs. Furthermore, institutions are divided into two categories that are formal and informal ones. As the pilot interview indicates it is highly important to explore the type of institution SMEs have a relationship with in their expansion process. In the case of Dr. A. we see informal institutions which are mainly friends and family members. During the interviews it can be further explored if this is also the case for the interviewed Iranian SMEs or if there are other informal institutions that need to be considered.
5. Findings
19 institutions are substitutable by informal institutions while understanding how the choice of institutional type influences international entry strategies of SMEs.
International reach:
The dependency in Iran on foreign institutions might not be understandable so easily from the Western perspective. However, this picture gets clearer when you gain more detailed knowledge about national and international reach of SMEs. Overall, Iran has an underdeveloped infrastructure for internet compared to Western countries and even countries in the Middle East. This is also strongly related to political issues within the country. Figure 2 summarizes the amount of internet users as percentage of overall populations in Iran and other areas in comparison.
Figure 2: Internet users as percentage of total population
20 hindered by the overall low telecommunication infrastructure. In order to access these areas, companies have to fulfill some requirements in terms of size and sales, which is often not met by smaller firms and so leads to exclusion. The terms are nowhere clearly stated and also depend to some extent on your connections to governmental institutions or unofficial agreements.
Even having access to such areas does not mean that firms have similar possibilities as in Western countries. The government strictly controls and filters access to media that it considers as dangerous or harmful to the population. This includes social media like blogs, facebook, twitter and skype but also platforms like youtube or parts of google search results. By such actions companies are limited in their possibilities to exchange knowledge within the country and with the outside world. Nevertheless, four out of five cases claimed to have relatively stable or acceptable access to international markets. Only case 4 clearly complained about increased complications due to governmental limitations concerning internet access. Case 4: “There are diverse forms of so called “filter-crushers” which enable us to go around
the filters and still make use e.g. facebook or other media. But those programs cost money, need to be updated regularly and slow down your internet speed. And then only those people have access to our services who make use of such tools as well”
The residual firms have diverse reasons to claim differently. Case 1, 3 and 5 all have foreign subsidiaries which enable them to reach international markets. However, without their foreign subsidiaries they would be much more limited. Consequently, internationalization is used as a strategic move to access markets with fewer limitations than Iran and to compensate domestic disadvantages.
Case 1: “Because we have subsidiaries abroad it is easier for us to get access to resources
21 Case 3: “… most of our international activities are handled via our subsidiary in the UK.
Without our presence in the UK we would be much more restricted to local limits and regulations of Iran. So it is also a strategic move for us to have a subsidiary abroad.
In the situation of case 5 the foreign subsidiary has to be closed soon because of current sanctions from the West on Iran. The SME owner is frustrated and thinks about closing the whole firm. Especially when considering international access dependency of his companies‟ industry, the trading and transportation industry. The SME owner does not see further success chances if he has to proceed his business mainly from Iran and rely on limited international access offered by the Iranian environment “… when we are solely active in Iran we will feel
much stronger what it means to have limited access to international markets”(case 5).
The owner of case 2 also agrees that governmental restrictions concerning international reach have been hindering him to internationalize properly. Actually the company had a foreign subsidiary before the revolution but due to domestic policy changes after the revolution the firm was forced to set back their international activities. Nowadays, further internationalizing is not considered due to various reasons. Firstly, the SME owner reached an age in which internet activities are perceived as too difficult to learn “I do not
really have the energy and desire for too much trouble anymore”(case 2). Moreover, the
owner sees the unstable exchange rates with the Iranian currency as too unsecure to invest in more international activities. “…the risk of not having a stable currency is too heavy for a
small business in internationalization processes”(case 2).
22 to the government. It is also recognizable that SME owners do not have issues with international reach as long as they have foreign subsidiaries through which they can reach international markets. However, when they are confronted with the case of having to rely on international access only provided by Iran, they perceive limitations in business opportunities. All interviewed firms have the feeling that governmental limitations concerning international access hinder SME internationalization processes. Consequently, SMEs tend to distance from Iranian governmental entities like formal institutions and try to rely on own networks as informal institutions.
Case 3 explains the relationship to Iranian formal institutions as distressed “not
because they cannot help you better but often we perceive that they don‟t want to help us”.
Similarly case 2 describes freedom of business actions in Iran as “controlled by the
government and there is a strong tendency to distrust governmental organizations, even the chamber of trade”. Also case 5 describes formal governmental institutions as “not really considered as reliable and helpful organizations” in Iran. So in the case of Iran, it can be
summarized that SMEs associate lower degree of international reach with purposeful limitations set by the government. This in turn decreases the willingness of SMEs to work with formal governmental institutions and search for other options. All cases describe informal institutions as more important in internationalization processes. This is due to the fact that informal institutions are trusted more as well as providing more flexible options to reach international environments.
Role of Institutions:
Formal Institutions
23 because of distrust to the government which sets diverse limitations for SME owners. In order to understand the role of Iranian formal institutions better, more detailed questions were asked about this topic during the interview. The replies show that all firms were confronted with some issues when trying to reach international markets across their national border. More importantly, it turns out that SMEs do not perceive support from formal institutions as effective as it was claimed by the institutions themselves.
All interviewed SMEs are either not aware of the support, the Iranian chamber of trade provides “we knew about the chamber of trade but we did not know about their international
activities” (case 5). Or the firms have no trust in being sufficiently helped by the formal
institution “Iranian governmental institutions nowadays cost you time and resources but you
end up with developing very slowly or not at all” (case 1). Case 2 is the only SME, out of the
five, who actually tried to use the help of the chamber of trade in their internationalization process, even though they were skeptical about the help they would receive. However, the SME owner describes processes as long lasting and exhausting while not being helpful at all. More than that, getting into contact with those institutions is perceived with being limited and controlled rather than being helped “we were also asked to provide them information about
our contacts abroad even though we felt that this did not really have anything to do with our expansion plans”(case 2). Due to the fact that the level of trust to the government is in many
cases not very high in Iran, SME owners often hesitate to make use of institutions set by the current regime.
Countercheck with formal institution:
24 visits companies to analyze strengths and weaknesses in order to provide relevant information. Besides, meetings with organizations of interest can be arranged in order to make contact easier and help firms right from the beginning. To reach someone who can answer questions for the present thesis, numerous phone calls to the chamber were made before someone finally replied. Nevertheless, it was still difficult as employees of the chamber constantly put on hold in order to find the right contact person. It needs to be stated that in Iran such matters are usually done in face-to-face meetings and not by phone. Moreover, a student that plans to ask questions for his thesis is probably treated differently than a person that is seriously considering doing business. At the end, it was requested to send an e-mail with the concerns. As such a procedure requires Iranian writing and this created difficulty, a try to contact the German subsidiary of the Iranian chamber of trade was done. On the website of their German subsidiary the same services are offered to foreign firms who want to do business with Iran.
Institution: “We offer support and advice to firms that aim to do business with Iranian
companies. We have a pool of over 2300 companies from different industries and help companies to contact them and also arrange meetings. We also offer help with gaining Visa and organizational matters during your visit in Iran as well as translations and language courses… Often companies do not have sufficient knowledge about our country, its infrastructure and linked organizations and this leads to avoidance of doing business.”
25 institution and its services need to be evaluated carefully. Also, such results emphasize the mistrust many Iranian SMEs showed during the interviews.
Informal institutions
According to the respondents, formal institutions in Iran seem to provide little to no help for internationalization processes of SMEs. All of the interviewed SMEs responded that informal institutions were the main source for their expansion processes. Personal networks such as family, friends and business partners show to be an effective alternative to formal contacts. Not only is trust to private entities higher, but also efficiency plays a major role here as respond rates are faster and adapted to the SMEs.
There is strong distrust recognizable towards governmental entities which in turn decrease the willingness of SME owners to contact formal institutions. Four of the five interviewed SMEs believed formal institutions are too static and not flexible enough to adapt to SME needs in a timely manner “when you want to make a decision you want it to happen
fast and exactly fitted to you. This is not possible for big institutions who want to help different people from different industries and diverse needs (case 4). Also, support is most
often through standardized knowledge and not individually fitted to SMEs which hinders gaining a competitive advantage “the problem with formal institutions is that if they help you
they also do that with other companies and you do not really have an advantage (case 5). The
SME owners claim that in order to reach a competitive advantage firms need to use informal institutions that are unique and not used by others, at least not for the same purpose. Moreover, all firms agree on the fact that informal institutions have the advantage of letting SME owners control how much benefit the relationship provides to the SME. Meaning, if individuals put more energy into a network relationship they can also increase degree of success “you mostly have direct influence on the relationship to informal institutions. The
26 whom to work with are influenceable based on respective capabilities of SME owners “getting to know such people is strongly correlated to your ability to connect to people and
feel what they appreciate” (case 3). The oldest interviewee (mid-seventies) explains relationships to informal institutions as cultural phenomenon of Iran which is deeply rooted in its traditions. So the cultural background of all SME owners should not be forgotten when evaluating the strong tendency to social networks in Iran “this is typical for Iranian
relationships, you help each other out for the overall good and also need to be helpful when you are demanded by others” (case 2).
For the interviewed firms the lack of formal institutions is not a major problematic issue. All of them see informal institutions not only as a substitute but more as the superior form of institute for internationalization processes. Except for legal safety, all discussed support elements that can be provided by institutions are seen as better provided through informal institutions. Nonetheless, there is also a requirement set and approved by all five SMEs. The degree of success is dependent on the SME owners‟ capabilities to build up and nurture trustful as well as valuable relationships to informal institutions. Only then informal institutions are able to help SMEs expanding abroad and being more helpful than formal institutions.
Entry mode
When looking at the entry strategies of all interviewed firms, three of five firms have wholly owned subsidiaries (case 1,3 and 5) and the residual two SMEs do exporting (case 2 and 4). Even during the process of internationalization, none of the companies expanded abroad through strategic partnerships. All firms perceive that international activities should start until enough feedback, experience and resources are gathered to build foreign subsidiaries on their own “Whenever we are strong enough in Iran we will also expand with own subsidiaries
27 pre-step before owning a foreign subsidiary. However, the SME owner still sees such a move as rather risky and would only advise doing so if a proper network is existent to SME owners
“one barrier could be that you do not have a proper pool of people and contacts that can help you overseas. But having such a pool is also dependent on you“(case 3). Similarly, case 5
started with building up a foreign subsidiary pretty simultaneous with its domestic subsidiary. Also in this case, the SME owner sees his way of internationalization more as an exemption
“I had the luck to study abroad and get into the market on my own. Many others are not in such a position”(case 5).
Other entry forms are not even considered by any interviewed firm because of diverse reasons. Firstly, governmental support is considered as relatively low which creates an instability factor for all SMEs. Consequently, the common attitude is that expansion should only be considered when they are fully single-handedly manageable “our approach for the
processes is being self-sufficient and wholly owned” (case 1). Secondly, an independent legal
system is missing in Iran. So companies are treated differently, based on what kind of connections to legal entities they have “what would help us mostly would be an independent
legal system which ensures the fair treatment of all entities” (case 4). Such an influence
results in a very passive and careful behavior when it comes to sharing essential resources with externals. This is a very relevant factor in partnership activities, especially with partners abroad. Thirdly, Iranian SME owners tend to work mainly with informal institutions in internationalization processes. As all interviewees have high degree of trust and confidence in their informal contact partners abroad, they feel to be able to reach competitive advantage internally, without sharing resources with other firms “what was very important for me was to
experience first-hand…” (case 5).
28 corrupt, strategic alliances are not really applicable. SMEs see partnerships as risky because in case of problems they are vulnerable and might lose essential resources. All SME owners preferred keeping control by maximizing self-sufficiency.
6. Discussion and conclusion
This thesis aimed to research to what extent informal institutions can substitute formal institutions. Former literature lacked researching that topic adequately, especially in non-western countries like Iran. In order to find answers for the research questions, a framework is proposed that discusses the relationship between degree of international reach and choice of formal and informal institutions. Moreover, the relationship of institutional choice and entry modes of SMEs is analyzed. The results of this thesis reveal that Iranian SMEs prefer using informal institutions in their expansion processes. A low international reach plays major contribution to the choice between formal and informal institution. Limitations to reach the international environment are perceived to be set by the unpopular government and formal institutions are not very well developed in Iran. Thus, formal institutions are tried to be avoided by SMEs in their internationalization processes. In fact, informal institutions are seen as a better alternative which can substitute formal institutions in most issues. Legal matters were the only area in which informal institutions lacked to provide adequate support. However, this is also influenced by a corrupt legislative system and an unsupportive government in Iran. In all other matters informal institutions were even seen as better options due to their individuality and flexibility. The preference of informal institutions influences entry modes because a lack of legal protection hinders SMEs to control partnerships to other firms adequately. Consequently, SMEs are forced to internationalize self-sufficiently without the help of others through exports or wholly owned subsidiaries abroad.
29 institutions are able to function as substitutes for formal institutions. Lastly, it should be clarified to what degree the choice of institutional type influences entry modes of the respective SMEs. The present thesis explored internationalization processes of five Iranian SMEs.
Concerning international reach, all of the interviewed firms claim that Iran has an underdeveloped communicational infrastructure. Official statistics verify this perspective. The country has slowly adapted towards telecommunication standards that are set by many Western(ized) countries. Nonetheless, the overall lack of communication possibilities is clearly palpable. Especially the low internet infrastructure, due to governmental limitations, hinders SMEs to make use of their full capacities. For most of the firms it gets too difficult and expensive to build up connections to the outside world and make use of foreign goods and services on their own. Thus, firms need to rely stronger on external entities like institutions in their internationalization processes.
30 contacts and to retrieve knowledge from informal institutions.
The preference for informal institutions also has effects on entry strategies of SMEs in their internationalization processes. Informal institutions do not provide legal security. Therefore, firms are able to gather knowledge and connections to externals devoid of legislative securities. This lack of juridical protection is increased by low governmental support for SMEs and a fraudulent legal system. Under such circumstances, tendencies of aiming partnerships with other firms through strategic alliances decrease, especially on international scale. The risk of being unprotected in case of problems is simply too high. Entry modes in foreign markets are usually tried to be executed self-sufficiently without the help other firms.
31 with others and constantly increase their social network, domestically as well as abroad. The theoretical contribution for further studies is to provide insights concerning SME internationalization processes in less developed countries. The differences between formal and informal institutions shall be distinguished stronger as well as the substitutable power of informal institutions needs further acknowledgement. Moreover, the choice between both types of institutions should also be seen in a political context as well as including possibilities of firms to reach international markets on their own. Lastly, entry mode strategies have to be analyzed more carefully as those could be results of various influence factors that are not clearly visible in the first place.
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7. Appendix
Questionnaire:
Background of interviewee and the firm Name of Respondent
Position in the firm
Year of Service with this firm
Could you tell me briefly about specifics of your firm?
only info that I could not find should be asked concerning date of establishment, type of product/industry, no. of employees, board members/decision makers, etc
Measurement of international reach
How is your access to the international market characterized?
Are there restrictions? Do you have limits? Are you able to reach the international market easily?
When you face difficulties to access to the international market, to whom do you seek for help?
e.g. Family, friends, government institution, information institutions. First ask interviewees to name them, then ask why for each of them
About the role of institutions (get contrast between formal/informal institutions) During the internationalization process, what type(s) of networks has/does your firm utilize?
Would you consider formal, informal or both institutions as relevant for your internationalization process? Mention examples for each
formal: public-funded advisory offices, export promotion-council, chambers of commerce, business incubators, R&D institutions, industrial clusters, government-backed credit guarantee and financing for export/FDI, specific government assistance programs etc
33 Can you describe what type of help these institutions may have provided your firm?
Informal: associated activities Formal : associated activities
How did your firm become aware of the institutional support?
How easy or difficult is it to get contact with them or access resources available through the networks?
Informal: associated activities Formal : associated activities
About internationalization
Could you tell me the reasons why you decide to involve in international activities? How did you enter the foreign market?
categorize yourself later: wholly owned; control by acquisition; joint venture;
consortium; licensing/franchising; management/manufacturing contract; direct/indirect exporting or importing; etc
Could you tell me the process of your firm‟s internationalization?
For example when, where, what, who, and how that involve your firm‟s decision to internationalize
Would you state that your internationalization process developed step by step and in distinct stages?
e.g. started with export and ended up with strategic alliance
What are the barriers or difficulties that your company has to face in different stages of your internationalization activities?
What would have made your internationalization process easier in terms of environment?
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Questionnaire including responses
Measurement of international reach
How is your access to the international market characterized?
Are there restrictions? Do you have limits? Are you able to reach the international market easily?
Case 1: Our reach to the international market is comparably good. Because we have
subsidiaries abroad it is easier for us to get access to resources than other Iranian companies. Usually it is a bit more difficult for Iranian companies to have proper access to the international market.
Case 2: If you compare our situation to ten years ago we made huge steps. Back in the
days there were only two ways for us to contact our partners abroad, telephone and fax. There was already Internet existent in Iran but only in control of universities and governmental organizations. Around six years ago the Internet expansion reached the main population. Since then, many procedures got easier for us. Nowadays, we update stocks of products internally and with partners on a regular basis which helps us a lot… Of course some internet areas are restricted by the government but I am sure that this will change in future.
Case 3: We have actually a stable access to the international market. It depends what
kind of resource we need or want to offer but most of our international activities are handled via our subsidiary in the UK. Without our presence in the UK we would be much more restricted to local limits and regulations of Iran. So it is also a strategic move for us to have a subsidiary abroad.
Case 4: Well, we are still a young company and were so far focusing more on the
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our business it gets more and more important to advertise our products online so that we can keep up in our country with global cigarette players like Marlboro or Kent.
Case 5: So far, it has been acceptable. Even though we needed to compensate some
disadvantages that we had from Iran it was mostly not a very big issue to access international markets. However, we have to close our German subsidiary due to the sanctions. So when we are solely active in Iran we will feel much stronger what it means to have limited access to international markets.
When you face difficulties to access to the international market, to whom do you seek for help?
e.g. Family, friends, government institution, information institutions. First ask interviewees to name them, then ask why for each of them
Case 1: It depends on the issue we have and where we have difficulties. In Iran we
mostly rely on our private network. They are safe and fast. Our subsidiaries abroad have a bigger pool as especially in Germany and in the UK you have some good organizations that are much more effective as we would be with our private contacts.
Case 2: Before the revolution we were in good contact with the government. Iranian
food was highly demanded and the relationship between the Iranian government and the US and Britain was very good. So we contacted first organizations in Iran as we could reach them relatively easy and often we were directed to foreign offices and institutions that helped us with our issues. But you also need to know that the overall procedures were slower than nowadays. There was nothing like the internet during that time. At the moment we have a pool of reliable partners with whom we handle issues. Those are mostly other firms that we stay in good contact with and also do business for a long time. This is typical for Iranian relationships; you help each other out for the overall good and also need to be helpful when you are demanded by others.
Case 3: For discrete handling we only use our business partners to whom we have a
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specific help you suddenly see that the same institutions that were very slow and ineffective suddenly are able to help you out with much more issues.
Case 4: If we are confronted with issues we try to find solutions together with people
we know who can help directly or have connections to others that are useful for us. The advantage is that those sources are usually cheaper and for some of them it is even not a big issue to help as they have direct access to the sources which we need. In contrast we also help out others if we have good relationships to them. You never know if you will need their help one day.
Case 5: During the years we built up a social network with people all over the world.
And when we have situations which we can‟t solve ourselves we contact them to ask how they can help us out. In Germany you also have governmental institutions that link you to other companies. German institutions have helped us a lot especially in during the later stages when we set up our company.
About the role of institutions (get contrast between formal/informal institutions)
During the internationalization process, what type(s) of networks has/does your firm utilize?
Case 1: Mainly private connections. Before the revolution, there were some
institutions involved but since 1979 this is not so much the case anymore.
Case 2: The most used network is our business network. So suppliers and customers.
We also had situation in which we were working together with competitors. For example when we had short comes in products or we thought that aligning is useful to reach similar interests against the government or other competitors.
Case 3: Our relatives were very important in our internationalization process. They
connected us also to foreign institutions.
Case 4: Family members and consultants.
Case 5: I studied in Germany and already built up good connections over there during
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make use of resources required to start my business… You can say that I started my business in Iran and Germany at the same time.
Would you consider formal, informal or both institutions as relevant for your internationalization process? Mention examples for each
formal: public-funded advisory offices, export promotion-council, chambers of commerce, business incubators, R&D institutions, industrial clusters, government-backed credit guarantee and financing for export/FDI, specific government assistance
programs etc
informal: business partners, friends and family, in general privately known persons
Case 1: To be honest, working with Iranian governmental institutions nowadays cost
you time and resources but you end up with developing very slowly or not at all. We had to wait a very long time before reaching someone to help. When they finally got into contact with us procedures were characterized by bureaucracy and confusion. It is always better not to rely on governmental institutions but have a strong community on your own.
Case 2: Formal institutions in Iran are very inefficient compared to foreign ones, at
least the ones we had experience with. You can use them as additional help but may stronger rely on informal ones. You mostly have direct influence on the relationship to informal institutions. The more you invest the more you get. But when you work with formal institutions you need to do what they tell you and might end up with useless results.
Case 3: We did not have anything to do with Iranian formal institutions in our
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competitors who are still only locally active even though they would also internationalize if it would be possible for them
Case 4: It is now for a while that governmental restrictions hinder companies to
expand abroad; so it is not a new phenomenon for foreign entities to find solutions concerning that topic....There are also private organizations in Iran who are able to help you with such matters as the expansion abroad, but this is very costly and no guarantee is given what quality you get.
Case 5: I had really good experience with both types of institutions. Depending on
what kind of help you need you can consider the respective type of institution.
Can you describe what type of help these institutions may have provided your firm?
Informal: associated activities Formal : associated activities
Case 1: In our case formal institutions could have helped us with legal issues like
explaining us about our rights and what we need to consider when expanding to areas where we hardly have knowledge about the culture and how business is done. Informal institutions can also help you a lot with cultural knowledge. In some cases even better.
Case 2: Especially after the revolution we needed a better security against extreme
exchange rate fluctuations. This may not be easily to manage by a single institution but the risk of not having a stable currency is too heavy for a small business in internationalization processes.
Case 3: Even though we managed to build up everything on our own and with our
family and friends it would have been much easier for us if there would have been help form the chamber of trade for example. But we need a change in our governmental system before there is a possibility to change actions of single institutions. The institutions could help SMEs with consultants, data and advice about firm processes.
Case 4: We experienced very limited amount of help by the chamber of trade. In
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not aim to expand to. There are also private organizations in Iran who are able to help you with such matters as the expansion abroad, but this is very costly and no guarantee is given what quality you get. So there should be a better balance. Consulting work for SMEs should be subsidized by the government to make it affordable for SMEs and their help should be much more focused on the need of the firms.
Case 5: I would say that formal institutions are important for formal and
organizational matters. Informal ones connect you to relevant partners and potential customers and suppliers.
How did your firm become aware of the institutional support?
Case 1: When we had meetings with banks to finance our project we were advised by
some of them to talk to the chamber of trade. They also wanted us to talk to them in order to reduce their own risks for the loan they gave us.
Case 2: Especially in our business you have a lot of contact with Iranian companies.
All of them exchange ideas and you talk to them often about what possibilities you have and what you are allowed to do. Often when you do not know the answer there is only the chamber of trade that you can ask.
Case 3: In the UK, our relatives linked us to the institutions. But it was also much
easier to reach them. If they are not able to help you appropriately they make an appointment for you with someone that can help you for sure. In Iran you have long waiting times, are send form department to department, and at the end of the day you are not even sure if the information you got is totally right.
Case 4: In Iran we did not receive any help at all. Me and my partners had relatives in
Turkey as well as some good friends in Russia who helped us getting into contact with business partners abroad. They arranged meetings with locals but also asked institutions over there what kind of possibilities Iranian companies might have.
Case 5: We knew about the chamber of trade but we did not know about their
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not really believe that there is a lot help that you can count with. Governmental institutions are not really considered as reliable and helpful organizations in our society here
How easy or difficult is it to get contact with them or access resources available through the networks?
Informal: associated activities Formal : associated activities
Case 1: It depends what type of relationship you have to business partners or friends. If
you have a good relationship it is not difficult to get information. However, this also means that you need to share information yourself.
Case 2: After we contacted the chamber of trade in Teheran we were told to fill in forms
in which we needed to explain in detail what we are planning to do and what goods and services we want to trade with abroad. We were also asked to provide them information about our contacts abroad even though we felt that this did not really have anything to do with our expansion plans...Because many actions in our country are controlled by the government there is a strong tendency to distrust governmental organizations, even the chamber of trade
Case 3: If you know the right people, no matter formal or informal institutions you can
get any information. But getting to know such people is strongly correlated to your ability to connect to people and feel what they appreciate.
Case 4: You need to find your own way to the information. Relying on institutions like
governmental one does not help you out with many matters. Because when you want to make a decision you want it to happen fast and exactly fitted to you. This is not possible for big institutions who want to help different people from different industries and diverse needs.
Case 5: We actually had good access to resources through customers that we had a
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also do that with other companies and you do not really have an advantage. For informal institutions it is in your hands how much effort you put and how much you gain.
About internationalization
Could you tell me the reasons why you decide to involve in international activities?
Case 1: Our first idea was to increase our sales and get a higher price in foreign
markets for our products. During the internationalization process we gained additional advantages that we did not expect in beforehand like knowledge diverse customer needs and a much bigger pool of suppliers.
Case 2: We were actually pulled into foreign markets. Iranian food products are
highly demanded abroad.
Case 3: The biggest customers that we have are from abroad. This was also the first
idea that came into my mind when I discussed my business idea with my cousin. The demand outside Iran is much bigger and due to the unstable situation in the Iranian market it was necessary. Without a backup abroad you are very vulnerable to political instabilities in the country.
Case 4: For our cigarettes we implemented new kinds of filters (charcoal-filters) and
a new design for our packages. Without our international partners it would have been impossible to get access to such knowledge. Whenever we are strong enough in Iran we will also expand with own subsidiaries abroad to increase our control on foreign activities.
Case 5: I saw the demand in Germany during my studies and knew about
complementary services that Iran can offer. It was simply combining the ideas and it constantly grew.
How did you enter the foreign market?
categorize yourself later: wholly owned; control by acquisition; joint venture; consortium; licensing/franchising; management/manufacturing contract; direct/indirect exporting or importing; etc
42 Case 2: At the moment we focus again on exporting our products directly to foreign
companies. I do not really have the energy and desire for too much trouble anymore.
Case 3: We waited until we had enough resources on hand to build up everything on our
own… We wholly own our foreign activities.
Case 4: The complexity is too high for us to do such activities on our own. We mainly
focus on selling our products to trading companies.
Case 5: I built up the two subsidiaries, the one in Germany and the one in Iran, at the
same time. Both of them were wholly owned as we needed to have full control of our actions.
Could you tell me the process of your firm‟s internationalization?
For example when, where, what, who, and how that involve your firm‟s decision to internationalize
Case 1: Our first foreign subsidiary was rented and very small. We tried to test the
growth opportunity and market behavior in France. Luckily it worked out very fine for us and we were able to grow from that point on.
Case 2: In our first expansion we started with exports to trading companies in Iran
until we got more knowledge and developed to export directly to foreign customers. After many years of experience we started then building up a subsidiary abroad.
Case 3: Well, as I already told before, we contacted foreign institution and potential
business partners. But this happened after we saved enough resources to build up everything on our own our own. From the interactions with the business partners we used mostly advice and made business with them later on. The institutions were mainly helping us out with market data and also linked us to some other businesses.
Case 4: After importing at the beginning parts and knowledge for our cigarettes we
