INTERNATIONAL BUSINESS REPORT (2500 words)

Assignment backgroundOne of the important decisions that businesses need to make in its internationalisation is to choose an appropriate entry mode to foreign markets. Imagine you are working for a Singapore company listed on Singapore Exchange (see below for more details) and have been asked to expand the company’s product/service to Australia. Your task is to choose the most appropriate entry mode for your company based on your analysis on a range of related factors.Which company shall I choose for this assignment?A list of Singapore companies will be provided to you.What products/services of the company should I focus on?Most of the given companies have more than one segment of products/services. In this assignment, you ONLY need to focus on one product/service of the company. Assignment questionWhat is the most appropriate market entry mode, and why?In this assignment, you need to choose the most suitable entry mode for the chosen company and MUST justify it by analysing the followings:• Company analysis: justify your choice of entry mode by analysing the company’s resources and the nature of its main products/services• Context analysis: justify your choice of entry mode by considering the cultural, legal, political, economic and market environments related to the product/service in the target (Australian) market;• Scale analysis: why do you think your choice of the entry mode suits the company in terms of scale, risk level, return level, control level and integration level (level of integrating with local market)?FormatThis assessment task should be presented as a report and should include the following sections:• Title page (title of your report, your name, student number and word count)• Introduction (up to 200 words)• Entry mode and Analysis ( what is the most suitable entry mode and why – you can make your own sub-headings in this section)• Conclusion (up to 200 words)• Reference List (is excluded from word counts)Other requirements A minimum of seven (7) academic journal articles must be used in your report. The assignment must be well-structured and well-presented. The clarity of expressions together with the appropriate use of grammar, spelling and punctuations are important to maintain. Any use of comments, information, data or quotations from any sources (books, journals, newspapers, web etc.) must be cited using Harvard referencing style. The 12 point font in Times New Roman should be used throughout. Appropriate spacing (1.5 lines) and margins on all sides (at least 2 cm) need to be maintained.  Number each page.

BUSM1227International Business Semester 2 2013 SIM

List of companies that you can choose for assignment

The following list comprises 112 Singapore companies. All these companies are listed on SGX in

order to give you easier access to their company profiles, annual reports etc. You need such

information to complete your assignment. Choose any ONE of the following companies, imagine

you are working for this company, and complete the tasks spefified in the assignment.

International Business: Actions
Internationalisation Theories and Practices (I)
Business College
School of Management

Key Learning Objective
This session will help you to understand the concepts of:

1) Internationalisation of business organisations
2) Key international business theories
3) Complexities of choices and approaches in internationalisation

Key Questions
How do organisations internationalise?

How does international business manage its internal operations?

How does international business manage its external operations (e.g. relationship with the host country/communities)?

Internationalization?
BHP Expansion
http://www.youtube.com/watch?v=TiaNjJNIDkg
Pacific Brands Story

http://www.youtube.com/watch?v=BpiC-FSid7w

Goverments attitudes towards FDI

Statistics:
FDI and its relationship with Internationalisation

Statistics: UNCTAD (2009)

Activity 1: Discussion
In your opinion, what are they key factors for MNCs to invest in the new foreign market such as Myanmar? Why?

Literature on MNCs and Internationalisation
Mainstream MNC Theories
After the Second World War, the rapid development of MNCs and their FDI caused widespread interest among western scholars. They adopted different research methods and created basic assumptions towards different research objects, and consequently created various MNC theories.

The Uppsala Internationalisation Model
Swedish manufacturing companies begin their internationalisation process by establishing in the Nordic countries.
According to the stage model the Swedish researchers stressed that Swedish manufacturing companies began to operate abroad in a nearby market and then slowly penetrated markets far away. This model was developed in the 1970s and has lately been criticised for no longer being relevant.

Uppsala Model
A basic assumption of the model is that lack of knowledge about foreign markets is a major obstacle to internationalization, but that this obstacle can be overcome through learning about foreign market conditions.
The firm’s own current operations are the main source of this kind of learning. In turn, this reasoning leads to a second assumption of “learning by doing” (cf. Lindblom, 1959; and Johnson, 1988).
Investment decisions and actual investment commitments are made incrementally as uncertainty is successively reduced.
The more the firm knows about a foreign market, the lower the perceived market risk will be and, consequently, the higher the actual investment by the firm in that market tends to be.

Criticisms
The Uppsala internationalisation model has been criticized as deterministic (Reid, 1981) and, if firms were to develop in accordance with the model, individuals would then have no strategic choices (Andersson, 2000).

Another bigger challenge is that today many firms simply do not follow the traditional pattern of internationalization proposed by stage theory. Some firms are international from their birth and have been called: international new ventures (Oviatt and McDougall, 1994, 1995), born global (Madsen and Servais, 1997), and global start-ups (Oviatt and McDougall, 1995).

Activity 2: Debate
The Uppsala Internationalisation model helps us to understand the internationalisation process of MNCs in 1970s-1990s. Please discuss new factors that change the validity of this concept in the contemporary international business.

Source: Adapted from Sumantra Ghoshal & Nitin Nohria, ‘Horses for courses: Organizational forms for multicultural corporations’, Sloan Management Review, Winter 1993, pp. 27, 31.

International strategy
Create value by transferring valuable core competencies to foreign markets that local competitors lack.
Centralise product development functions at home
Establish manufacturing and marketing functions in local country but head office exercises tight control over it
Limit customization of product offering and market strategy
Strategy effective if firm faces weak pressures for local responsive and cost reductions

Multi-domestic strategy
Main aim is maximum local responsiveness.
Customize product offering, market strategy including production, and R&D according to national conditions
Generally unable to realize value from experience curve effects and location economies.
Possess high cost structure.

Global strategy
Focus is on achieving a low cost strategy by reaping cost reductions that come from experience curve effects and location economies.
Production, marketing, and R&D concentrated in few favorable functions.
Market standardized product to keep cost low.
Effective where strong pressures for cost reductions and low demand for local responsiveness.

Transnational strategy
To meet competition firms aim to reduce costs, transfer core competencies while paying attention to pressures for local responsiveness
Global learning
Valuable skills can develop in any of the firm’s world wide operations
Transfer of knowledge from foreign subsidiary to home country, to other foreign subsidiaries
Transnational strategy difficult task due to contradictory demands placed on the organization
Example : Caterpillar

Why firms become multinational?
1. The OLI Paradigm (Dunning J.)
One of the dominant frameworks for explaining the existence of MNCs and the determinants of FDI
O = Ownership
L = Location
I = Internalization

*Note: The modern paradigm of OLI is well discussed in Dunning and Lundan (2008), Institutions and the OLI paradigm of the Multinational Enterprise, Asia Pacific Journal of Management, 25:573-593.

Ownership
The firm that invests abroad has a competitive advantage (to exploit) and out-compete the firms that operate in the country where the investment is done.
Economies of scale connected to large-sized company
Possess technologies that give an advantage on the subsidiary abroad
Monopolistic advantages in terms of priviledged access to inputs or outputs markets
Skills of management

Location
Advantages of the foreign location:
Different nations have different factor endowments:
Natural resources:
Cheap labour force
Skills and capabilities
Country characteristics (political stability, regulations, cultural distance)

Bolivia happens to possess up to 54% of the world’s Lithium deposits
Underneath the salt lies the world’s largest lithium reserves

Internalization
Internalization occurs when a firm expands its operations in another country, by acquiring the property of the assets that are abroad
Ownership of foreign assets more convenient than the market
Why?
Information asymmetries (transaction costs can be too high) -> Market failures
Keeping skills and capabilities internal to the firm

Why firms become multinational?
Ghoshal (1987)
Becoming multinational to search a competitive advantage:
National differences: Exploiting national differences in factor costs
Scale Economies
Scope Economies

1. National differences
Different nations have different factor endowments:
A firm can gain cost advantages by configuring its value chain so that each activity is located in the country which has the least cost for the factor that the activity uses most intensively
E.g. Land in Honduras, cheap labour force in China, cheap but skilled engineers in India…(changing over time)

2. Scale economies
A firm expanding its total volume of sales, reduces its average costs in a given period of time
It is thus important to expand to several markets as to produce more of a product
Higher volumes also favour experience economies (learning by doing)
However, large scale also implies higher complexity and organization is critical

3. Scope economies
Scope economies: when the cost of the joint production of two or more products can be less than producing them separately
Scope economies achieved though:
Shared equipment, brands, and other assets
Shared external relations
Shared knowledge

Main strategies for setting up subsidiaries (Dunning)
Natural-resource seeking
Efficiency seeking
Market seeking
Capability seeking

Venezuela

Activity 3: Internationalization of Chocolate
Please visit www.ferrero.com and read business mission and Ferrero in the world section, then discuss Ferrero’s reasons to internationalise into almost all parts in the world? Why Ferrero has been successful in the internationalisation process of the company?

Born Global

The ‘Born Global’ concept was coined in a survey for The Australian Manufacturing Council by the McKinsey Consultants
In Australia, a new breed of exporting companies, which contributed substantially to the nation’s export capital, was then emerging. The creation of these exporters though not unique to the Australian economy, reflects 2 fundamental phenomena of the 1990s:

1.Small is beautiful
2.Gradual internationalization is dead

Born Global
Amongst the Born Global firms, in Australia, there are several high-tech firms, but the typical firm uses well-known technology.
These firms have experienced higher growth rates than other industries in Australia and a large growth in their export compared to their home-market sales.
A major factor in the explanation of the Born Global phenomenon (McKinsey & Co., 1993) is the management’s commitment to internationalization.
Another major factor is the firm’s ability to standardize production, marketing, etc. in a global niche instead of developing customized products.

Factors Supporting ‘Born Global’
Dramatic increases in speed, quality and efficiency of international communication and transportation have reduced the transaction costs of multinational interchange.
Increasing homogenization of many markets in distant countries has made the conduct of international business easier to understand by everyone.
International financing opportunities are increasingly available.
Human capital is internationally mobile.

References
Ghoshal, S., & Nohria, N. (1993), “Horses for courses: Organizational forms for multicultural corporations”, Sloan Management Review, Winter 1993, pp. 27, 31.
Johanson, J., Vahlne, J.-E. (1977), “The internationalization process of the firm – a model of knowledge development and increasing foreign market commitments”, Journal of International Business Studies, Vol. 8 No.1, pp.23-32.
Madsen, T.K., Servais, P. (1997), “The internationalization of born globals: an evolutionary process?”, International Business Review, Vol. 6 No.6, pp.551-81.
Oviatt, B.M., McDougall, P.P. (1994), “Toward a theory of international new ventures”, Journal of International Business Studies, Vol. 25 No.1, pp.45-64.
Oviatt, B.M., McDougall, P.P. (1995), “Global start-ups: entrepreneurs on a worldwide stage”, Academy of Management Executive, Vol. 9 No.2, pp.30-44.

International Business: Actions
Entry mode (I)
Business College
School of Management

Aims of the Session:

To understand different forms of internationalisation and market entry.
To consider the benefits and problems of firm internationalisation from different perspectives.

Key Questions
How do organisations internationalise?

What are the advantages and disadvantages of various types of market entry?

Recap
We examined the key IB theories last week.
In this week, we will look at foreign market entry modes and the advantages and disadvantages associated with them.

Modes of Entry
Organisations contemplating foreign expansion must consider the following:

Which foreign market(s) to enter
Timing of entry
What form of entry to use
What scale of entry to establish
Which mode of entry to adopt

Entry Decision Making Under Uncertainty: Trade-off Between Flexibility and Commitment
Timing: When is a good time to enter?
Potential gain from waiting
Cost of delay
Scale of entry
Small scale: Establish a foothold to learn
Large scale: Acquire first mover advantage
Speed of expansion: How fast to grow?
Value of learning
Preemption of competitors
Constraints of internal resources
Mode
Some modes have more flexibility embedded
Some modes reduce resource requirements

Which Foreign Markets
The choice must be based on an assessment of a country’s degree of alignment with firm strategy and likely contribution to revenue and profit
The attractiveness of a country depends upon balancing the various associated benefits, costs, and risks
These relate to: customer identification, production capabilities, or financial opportunities
Benefits may relate to: market expansion, production flexibility, investment opportunity, etc.
Risks may be competitive, political, financial, etc.

Timing the Entry
‘First-mover advantages’ that may be derived from entering a market early:
Preempting rivals and capturing demand
Establishing a strong brand name
Building sales volume
Creating ‘switching costs’ for customers and clients
‘First-mover disadvantages’ may derive from:
Pioneering costs that early entrant incurs
Unanticipated political, legal, regulatory etc. risks
Additional costs of entry that may not be recouped before competition increases and profit margins decline

Scale of Entry
Large scale entry:
Involves ‘strategic commitment’ – a decision with long-term impact that is difficult to reverse
May lead rivals to rethink market entry
May prompt competitive response from existing players
Small scale entry:
Requires limited financial and other resource commitment
Provides time to learn about market
Reduces exposure to risk

Activity 1: International Market Choice
Considering concept of Timing/Scale/Speed, please return to the case of e-retail market in China and discuss potential success or failure of Walmart e-retail in China. Why China?

http://www.youtube.com/watch?v=VThkcxEqa7I

Choice of Market Entry Mode
Modes? Markets? Art? Science?

Complementarity of Resources
Local Firm’s Resources
Imitating capabilities
Older technology and know-how
Country-specific marketing expertise
Country specific organization skills
MNC’s Resources
Innovative capabilities
Advanced technology and know-how
Industry-specific marketing expertise
Organization structure and systems

Going it Alone: Export
Export of Goods
MNC
Revenues
Customers

Going it Alone: Export
Advantages
Low initial investment
Reach customers quickly
Complete control over production
Benefit of learning for future expansion
Disadvantages
Potential costs of trade barriers
Transportation cost
Tariffs and quotas
Foregoes potential location economies
Difficult to respond to customer needs well
When Is Export Appropriate?
Low trade barriers
Home location has cost advantage
Customization not crucial

Licensing Agreement
Local Firm
HOME COUNTRY
HOST COUNTRY
MNC

Licensing Agreement
Advantages
Low initial investment
Avoids trade barriers
Potential for utilizing location economies
Access to local knowledge
Easier to respond to customer needs
Disadvantages
Lack of control over operations
Difficulty in transferring tacit knowledge
Negotiation of a transfer price
Monitoring transfer outcome
Potential for creating a competitor
When Is Licensing Appropriate?
Well codified knowledge
Strong property rights regime
Location advantage

Activity 2: Licensing Case Discussion
You and your team are the assistant to the CEO of a small textile firm that manufactures quality, premium-priced, stylish clothing (Italian Brand). The Italian CEO has decided to see what the opportunities are for exporting or licensing and has asked you and your team for advice as to the steps the company should take. What advice would you give the CEO?

Foreign Acquisition
Local Firm
HOME COUNTRY
HOST COUNTRY
MNE

Foreign Acquisition
Advantages
Access to target’s local knowledge
Control over foreign operations
Control over own technology
Disadvantages
Uncertainty about target’s value
Difficulty in “absorbing” acquired assets
Infeasible if local market for corporate control is underdeveloped
When Is Acquisition Appropriate?
Developed market for corporate control
Acquirer has high “absorptive” capacity
High synergy

Compensation Trade
HOME COUNTRY
HOST COUNTRY
MNE
Local Firm
Common reason: Local firm’s lack money to buy equipment
Economic benefits
Enhanced incentives for MNE to make sure that equipment works
MNE’s skills in marketing the products in its home country

Activity 3: Merger and Acquisition
Please watch this clip on international merger and acquisition http://www.youtube.com/watch?v=EKArEQ_8xFM

Then, list factors affecting the success of international merger and acquisitions.

International Business: Actions
Entry modes (II)
Business College
School of Management

Key Learning Objective
This session will help you to understand the concepts of:

1) Internationalisation of business organisations
2) Key international business theories
3) Complexities of choices and approaches in internationalisation

Aims of the Session:

To understand different forms of internationalisation and market entry.
To consider the benefits and problems of firm internationalisation from different perspectives.

Key Questions
How do organisations internationalise?

How does international business manage its internal operations?

How does international business manage its external operations (e.g. relationship with the host country/communities)?

Recap
We looked at the concept of ‘internationalisation’ of firms and rationale behind their decision-making process.
Advantages and Risks of internationalisation

Modes of Entry
Organisations contemplating foreign expansion must consider the following:

Which foreign market(s) to enter
Timing of entry
What form of entry to use
What scale of entry to establish
Which mode of entry to adopt

Going it Alone: “Green Field” Entry

New Subsidiary Company
HOME COUNTRY
HOST COUNTRY
MNE
Investment
Profit

Going it Alone: “Green Field” Entry
Advantages
Normally feasible
Avoids risk of overpayment
Avoids problem of integration
Still retains full control
Disadvantages
Slower startup
Requires knowledge of foreign management
High risk and high commitment
When Is “Green Field” Entry Appropriate?
Lack of proper acquisition target
In-house local expertise
Embedded competitive advantage

Between 2007 and 2011, a total of 1,243 foreign direct investment (FDI) projects were recorded in Australia from 933 companies. This represents an average annual growth rate of 15.4 per cent with a total capital investment of US$122 billion. Greenfield investments accounted for 84.8 per cent of projects over this five year period.
(Brisbanemarketing, 2012)

Activity 1: Hyundai goes greenfield in Czech Republic
In 2008, Hyundai invested in the form of greenfield investment in Czech republic (http://www.eurofound.europa.eu/eiro/2006/04/articles/cz0604029i.htm). Please discuss the choice of doing greenfield investment. Why this strategy? What are the benefits and pitfalls for Hyundai?

Management Contract

Local Firm
HOME COUNTRY
HOST COUNTRY
MNE
Wholly-Owned Subsidiary
Managerial Service
Management Fees
Technological Inputs
Profit

Contractual entry modes
Management contracts
One company supplies another with managerial expertise for a specific period of time
+ Low risk
+ Receive awards from governments
+ Governments use to develop the skills of local workers
– Managers’ lives in danger when countries are undergoing political or social turmoil
– Can create future competitors
Licensing
Franchising
Management contracts
Turnkey projects

Management Contract
Advantages
Access to local management skills
Avoids buying unwanted assets
Retains strategic control
Disadvantages
Potential incentive problem
Potential adverse selection problem
How do you know the competencies of the manager?
When Is a Management Contract Appropriate?
Manager has a reputation to protect
Hotels
Consulting companies
Performance-based contract provides no perverse incentives

Turnkey projects
One company designs, constructs, and tests a production facility for a client firm
+ Permit firms to specialize in their core competencies
+ Allow governments to obtain designs for infrastructure projects from the world’s leading companies
– Company may be awarded project for political reasons
Can create future competitors
No long term interests.
Licensing
Franchising
Management contracts
Turnkey projects
Contractual entry modes

Joint Venture

Joint Venture Company
MNE
Local Firm
HOME COUNTRY
HOST COUNTRY
Inputs
Share of Profit
Inputs
Share of Profit

Joint Venture
Advantages
Access to partner’s local knowledge
Reduction of concern about overpayment
Both parties have some performance incentives
Significant control over operation
Disadvantages
Potential loss of proprietary knowledge
Potential conflicts between partners
Neither partner has full performance incentive
Neither partner has full control
When Is a Joint Venture Appropriate?
Both partners contribute hard-to-measure inputs
Large expected mutual gains in the long-run
Trade secrets can be walled off

Air Asia – Tata Joint Venture
This is the story of IJV between TATA and Air Asia in India:

Case Study
RMIT University
School of Management
*
School of Management

Activity 3: International Joint Venture Case Study
Please read this IJV case study and answer the following questions:

http://cws.cengage.co.uk/doole5/students/case_studies/chap_07

What are the factors that MNCs should consider when deciding to use an international joint venture as a market entry strategy?
What are the potential benefits and risks in taking this course of action?
RMIT University
School of Management
*
School of Management

Common Market Entry Modes

Joint Venture Company
Licensing
Acquisition
Joint Venturing
Local Firm
New Subsidiary Company
“Green Field” Entry
HOME COUNTRY
HOST COUNTRY
Export
MNE

Int’l Sourcing

HOME COUNTRY
HOST COUNTRY
MNE
Local Firm
Applicable to manufacturing of mature products (e.g., shoes)
Access to location economies
Competition among OEM producers lowers costs.
Design, spec and/or technology

OEM goods
Payment

Activity 3: Is Nigeria an attractive place for FDI?
Please watch this and discuss the question.

Modes of entry
Exporting Contractual Agreement Joint
Venture Acquisition Greenfield Investment
Risk Low Low Moderate High High
Return Low Low Moderate High High
Control Moderate Low Moderate High High
Integration Negligible Negligible Low Moderate High

Future Reading
Anderson, Erin and Hubert Gatignon. 1986. Modes of Foreign Entry: A Transaction Cost Analysis. Journal of International Business Studies, 17: 1-26.
Kogut, B. and H. Singh. 1988. The effect of national culture on the choice of entry mode. Journal of International Business Studies, 19: 411-432.
– Hennart, J.-F. and Y.-R. Park. 1993. Greenfield vs. acquisition: The strategy of Japanese investors in the United States. Management Science, 39(9): 1054-1070.
– Hennart, J. F., and Reddy, S. 1997. The Choice Between Mergers/Acquisitions and Joint Ventures: The Case of Japanese Investors in the United States. Strategic Management Journal 18: 1-12.
– Barkema, H. G. and Vermeulen, F. 1998. International Expansion Through Start-up or Acquisition: A Learning Perspective. Academy of Management Journal 41: 7-26.
– Brouthers, K. D. and Brouthers, L. E. 2000. Acquisition or Greenfield Start-up? Institutional, Cultural and Transaction Cost Influences. Strategic Management Journal 21: 89-97.

International Business: Actions(III)
Business Functions within the MNCs
Business College
School of Management

Key Learning Objective
This session will help you to understand the concepts of:

1) Internationalisation of business organisations
2) Key international business functions
3) Complexities of choices and approaches in internationalisation

Aims of the Session:

To understand aspects of various functions in the international business organisations.
To consider the benefits and problems of the internationalisation in human resource and knowledge management in IB organisations.

Key Questions
What are the key functions in the process of internationalisation of firm?

How does international business organisation manage its internal operations?

How does international business organisation manage its external operations (e.g. relationship with the host country/communities)?

Recap
We looked at the concept of ‘internationalisation’ of firms and rationale behind their decision-making process.
Advantages and Risks of internationalisation

http://www.youtube.com/watch?v=KGfrN8jvgko : a BBC report on China and Chinese Business Expansion.

Corporate Governance within the MNC
Corporate governance refers to the way in which company boards oversee the running of the corporation by its managers and how board members are accountable to shareholders and the company in general (Johnson and Turner, 2010)

The corporate Governance for IB organisation:
Issues to be aware of
Company Transparency;
Relationship with stakeholders in the host countries;
Shareholder rights;
Labour relations;
Fair competition;
Tax and pension policy;
Disclosure requirement.

(Source: Brooks et al, 2004)

Function: International Human Resource Management (IHRM)
IHRM is distinct from generic HRM on two grounds:
The complexity of operating across multiple national environment.
Employing different national categories of workers.
This function requires careful attention from MNC.

Tapping the World’s Innovation Hot Spots
(Source: Gao, 2009)
Changing dynamics of global innovation: “What are the implications of this new “Innovation World?”
System Integration Approach: companies can take advantage of the differences in national environments through innovation arbitrage
4 Innovation Models: some exist in pure form while others are a component of a nation’s overall innovation strategy

Model 1: The Focused Factory
What is a focused factory?
Clear strategic intent
Infrastructure
Talent
Examples: Denmark, Singapore (Biopolis, Fusionopolis)
Key players: GSK, Novartis.

Model 2:Brute Force
What is “Brute Force”
Large source of low-cost labour
Innovation opportunities
Law of averages
Examples: India, China
Players: Microsoft, Berkshire Hathaway

Model 3: Hollyworld
What is “Hollyworld
– Forming a global creative class (Silicon Valley Effect)
Developing an enticing innovation destination
Examples: India/ Singapore

Model 4: Large Scale Ecosystems
Large-Scale Ecosystems : end to end innovation systems
Self-contained environments
Alliance-management skills needed
Examples: Finland – Focus on education, science and technology (Aalto university)

Driving Forces of Global Innovation
Innovation as a currency of global competition- pursuing the “global dream”; countries in-source American culture
Global war for talent- talented young innovators can be attracted anywhere through incentives and opportunities
Innovation as a national agenda- nations increasing embrace innovation as a national priority
Power of networks – global networks are becoming increasingly intertwined

Activity 1:
How could each of these companies take advantage of the innovation models?
You will be divide into groups and please select one of these companies.
Brainstorm how leveraging these models could benefit the strategic way the company do business.
Share with the class.

IHRM: Approaches to Staffing
Factors affecting approaches to staffing
General staffing policy on key positions at headquarters and subsidiaries
Constraints placed by host government
Staff availability
Ethnocentric
Polycentric
Geocentric
Regiocentric

Ethnocentric
Strategic decisions are made at headquarters;
Limited subsidiary autonomy;
Key positions in domestic and foreign operations are held by headquarters’ personnel;
PCNs manage subsidiaries.

Polycentric
Each subsidiary is a distinct national entity with some decision-making autonomy;
HCNs manage subsidiaries who are seldom promoted to HQ positions;
PCNs rarely transferred to subsidiary positions.

Geocentric
A global approach – worldwide integration;
View that each part of the organization makes a unique contribution;
Nationality is ignored in favor of ability:
Best person for the job;
Color of passport does not matter when it comes to rewards, promotion and development.

Geocentric Staffing Requirements
(Source: Brooks et al, 2008)

Regiocentric
Reflects a regional strategy and structure;
Regional autonomy in decision making;
Staff move within the designated region, rather than globally;
Staff transfers between regions are rare.

Ethnocentric Approach
Advantages:
To ensure new subsidiary complies with overall corporate objectives and policies
Has the required level of competence
Assignments as control
Disadvantages:
Limits the promotion opportunities of HCNs, leading to reduced productivity and increased turnover among the HCNs
Longer time for PCNs to adapt to host countries, leading to errors and poor decisions being made
High cost
Considerable income gap, high authority, and increased standard of living may relate to lack of sensitivity

Polycentric Approach
Advantages:
Employment of HCNs eliminates language barriers, avoids adaptation of PCNs, reduces the need for cultural awareness training programs
Employment of HCNs allows a multinational company to take a lower profile in sensitive political situations
Employment of HCNs is less expensive
Employment of HCNs gives continuity to the management of foreign subsidiaries (lower turnover of key managers)

Polycentric Approach
Disadvantages:
Difficult to bridge the gap between HCN subsidiary managers and PCN managers at headquarters ( language barriers, conflicting national loyalties, cultural differences)
HCN managers have limited opportunities to gain experience outside their own country
PCN managers have limited opportunities to gain international experience
Resource allocation and strategic decision making will be constrained when headquarter is filled only by PCNs who have limited exposure to international assignment

Geocentric Approach
Advantages:
Ability of the firm to develop an international executive team
Overcomes the federation drawback of the polycentric approach
Support cooperation and resource sharing across units
Disadvantage:
Host government may use immigration controls in order to increase HCNs employment
Expensive to implement due to increased training and relocation costs
Large numbers of PCNs, HCNs, and TCNs need to be sent across borders
Reduced independence of subsidiary management

Regiocentric Approach
Advantages:
Allow interaction between executives transferred to regional headquarters from subsidiaries in the region and PCNs posted to the regional headquarters
Provide some sensitivity to local conditions
Help the firm to move from a purely ethnocentric or polycentric approach to a geocentric approach
Disadvantages:
Produce federalism at a regional rather than a country basis and constrain the firm from taking a global stance
Staff’s career advancement still limited to regional headquarters, not the parent country headquarters

Parent-Country Nationals
Advantages
Organizational control and coordination is maintained.
Rising stars are given international experience.
PCNs may be the best people for the specific job due to special skills and experience.
An assurance that the subsidiary will comply with company objectives & policies.
Disadvantages
Promotional opportunities of HCNs are limited.
Time and performance costs associated with adaptation to the host country.
PCNs may impose an inappropriate HQ style.
Compensation for PCNs and HCNs may differ.

Host-Country Nationals
Advantages
Language and other barrier eliminated
Reduced hiring costs
Continuity of management
Government policy may require hiring HCNs
Possible increased morale because of increased career potential
Disadvantages
Hiring of HCNs may encourage a federation of national rather than global units
HCNs have limited career opportunity outside the subsidiary
Control and coordination of HQ may be impeded
Hiring HCNs limits opportunities for PCNs to gain foreign experience

Third-Country Nationals
Advantages
Salary and benefit requirements may be lower than for PCNs.
TCNs may be better informed than PCNs about host-country environment.
Disadvantages
Transfers must consider national animosities.
Host government may resent hiring TCNs.
TCNs may not want to return to their own countries after assignment.

Determinants of IHRM Approaches and Activities

Activity 2: Management of IHR policies
An Australian mining company (operating in Laos, Cambodia and Chile) is facing HR crisis. They can’t retain their staff and need some ideas to improve their policies. In your team please discuss the best IHR policy for the industry, company and explain why your team consider that policy.

Reasons for International Assignments
Position filling, e.g.
Skills gap, launch of new endeavor, technology transfer
Management development
Training and development purposes, assisting in developing common corporate values
Organizational development
Need for control, transfer of knowledge, competence, procedures and practices

Types of International Assignments
Short term: up to 3 months
Troubleshooting
Project supervision
A stopgap until a permanent arrangement is found
Extended: up to 1 year
May involve similar activities as short-term assignments
Long term
Varies from 1 to 5 years
The traditional expatriate assignment

Roles of an Expatriate
Agent of direct control
Agent of socialization
Network builder
Boundary spanner
Language node
Transfer of competence and knowledge

A Glamorous Life
International business travelers cite the positives as:
Excitement and thrills of conducting business deals in foreign locations
Life style (top hotels, duty-free shopping, business class travel)
General exotic nature

But a High Level of Stress!
Home and family issues
Frequent absences
Work arrangements
Domestic side of position still has to be attended to
Travel logistics
waiting in airports, etc.
Health concerns
Poor diet, lack of sleep, etc.
Host culture issues
Limited cultural training

Various Roles of Corporate HR
Centralized HR Companies Decentralized HR Companies Transition HR Companies
Large well-resourced HR departments Small HR departments Medium-sized HR departments
Key role: Managing all high-grade management positions worldwide Key role: Managing elite corporate managers Key role: Management and development of senior managers and expatriates
Key activities: Planning international assignments and performance management globally, identifying high-potential staff Key activities: Influencing operating units to support international assignments, supporting decentralized HR Key activities: Persuading divisional managers to release key staff using informal and subtle methods, strategic staffing.
Source: Based on H. Scullion and K. Starkey, in Search of the Changing Role of the Corporate Human Resource Function in the International Firms, International Journal of Human Resource Management, V 11, N 6 (2000) pp. 1061-1081.

RMIT University
Slide *
Reasons for Expatriate Failure
US multinationals
Inability of spouse to adjust
Manager’s inability to adjust
Other family problems
Manager’s personal or emotional immaturity
Inability to cope with larger overseas responsibilities
European multinationals
Inability of spouse to adjust
Japanese Firms
Inability to cope with larger overseas responsibilities
Difficulties with the new environment
Personal or emotional problems
Lack of technical competence
Inability of spouse to adjust
(Source: Hill, 2010)

RMIT University
Slide *
Expatriate Selection
Reduce expatriate failure rates by improving selection procedures
An executive’s domestic performance does not (necessarily) equate to his/her overseas performance potential
Employees need to be selected not solely on technical expertise, but also on cross-cultural fluency

RMIT University
Slide *
4 Attributes that Predict Success
Self-Orientation
Possessing high self-esteem, self-confidence and mental well-being
Others-Orientation
Ability to develop relationships with host country nationals
Willingness to communicate

RMIT University
Slide *
4 Attributes that Predict Success
Perceptual Ability
The ability to understand why people of other countries behave the way they do
Being nonjudgmental and flexible in management style
Cultural Toughness
Relationship between country of assignment and the expatriate’s adjustment to it

RMIT University
Slide *
Training and Management Development
Training: Obtaining skills for a particular foreign posting
Cultural training: Seeks to foster an appreciation of the host country’s culture
Language training: Can improve expatriate’s effectiveness, aids in relating more easily to foreign culture, and fosters a better firm image
Practical training: Ease into day-to-day life of the host country

RMIT University
Slide *
Training and Management Development
Development: Broader concept involving developing manager’s skills over his or her career with the firm
Several foreign postings over a number of years
Attend management education programs at regular intervals

Activity 3: Life of Expat.
Imagine you are working with the HR team from an automobile MNC. Now you need to set up a training package for 3 Australian engineers who are going to work in Singapore for 3 years.
Please outline the content of your training and explain why your team propose such activities.

RMIT University
Slide *
Repatriation of Expatriates
A critical issue in the training and development of expatriate managers is preparing them for reentry into their home country
Repatriation should be seen as the final link in an integrated, circular process that selects, trains, sends, and brings home expatriate managers
Research shows that there is a problem with the repatriation process

Why IHRM matter?
Human capital provides competitive advantages to the firm.
Personal and organisational knowledge can be transferred across locations (and firms).
Management of HR across locations involve local knowledge and expertise.
The sharing of knowledge across functions can be done through proper IHRM process.

Activity 4: Final Discussion
In your team, please discuss factors influencing success and/or failure of HR practices in multinational corporations.

References
Brooks, I., Weatherston, J. and Wilkinson, G. (2008), The International Business Environment: Challenges and Changes. London: Prentice Hall.
Hill, C. (2010), International Business (7th Ed.), McGraw Hill: NY.
John, D. and Turner, C. (2010), International Business: Themes and Issues in the Modern Global Economy. Oxon: Routledge.

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CanadianSocial Science

Vol. 6, No. 5, 2010, pp. 169-177

ISSN 1712-8056 [Print]
ISSN 1923-6697[Online]

www.cscanada.net
www.cscanada.org

169

A Preliminary Research on Self-Initiated
Expatriation as Compared to Assigned Expatriation

UNE RECHERCHE PRÉLIMINAIRE SUR L’EXPATRIATION
AUTO-INITIÉE PAR RAPPORT À L’EXPATRIATION

AFFECTÉE

HU Mo1

XIA Jian-ming2

Abstract: The ever changing complexity of global staffing calls for a fundamental
reassessment of international assignment, among which self-initiated expatriation is one
of the burgeoning patterns. This paper discusses the basic characteristics of self-initiated
expatriates compared with those who known as assigned expatriates, and finds out that
the new born group of expatriates not only differ with those assigned expatriates in the
visible, or called the “outside” part, as the technical skill set, career boundary, career
stages, financial support, and time boundary, etc; but more important, the inherent, or
called the “inner” part, as for motivation, information focus and value concern, and so on.
Moreover, it reveals the so far neglected cross-cultural adjustment abilities of SIE and
gives advice for human resource management practice.
Keywords: Expatriation; Self-initiated expatriates; Assigned expatriates

Résumé: La complexité du personnel global est en constante évolution et elle exige une
réévaluation fondamentale de l’affectation internationale, dont l’expatriation auto-initiée
est l’un des modèles en plein essor. Cet article examine les caractéristiques de base des
expatriés auto-initiés par rapport à ceux qui sont connus sous le nom des expatriés
affectés, et découvre que le nouveau groupe des expatriés diffèrent avec des expatriés
affectés non seulement dans le visible, ou la partie extérieure autrement dit, comme
compétences techniques définies, contraintes de carrière, étapes de carrière, soutien
financier et limite de temps, etc, mais ce qui est plus important, c’est l’inhérent, ou sous
l’appellation la partie «interne», comme motivation, information ciblée, conception des
valeurs, et ainsi de suite. En outre, il révèle les capacités de l’adaptation interculturelle
des expartriés auto-initiés, ce qui est pour lontemps négligé et donne des conseils pour la
pratique de gestion des ressources humaines.
Mots-clés: Expatriation; expatriés auto-initiés; expatriés affectés

1 PhD candidates of Organization Management, SUFE. School of International Business Administration, Shanghai
University of Finance and Economics, Shanghai, 200439, China. Email: mhu@rsm.nl.
2Professor of Organization Management, SUFE. School of International Business Administration, Shanghai University
of Finance and Economics, Shanghai, 200439, China. Email: xjm@mail.shufe.edu.cn.
*Received 13 June 2010; accepted 10 September 2010

HU Mo; XIA Jian-Ming/Canadian Social Science Vol.6 No.5, 2010

170

1. INTRODUCTION
The last decades have witnessed the changing of organizations from multinational to global perspective,
which has lead to the integration of globe human resource market. The international management literature
has gained a magnificent increase in international assignments research, where expatriate management
remains a critical concern (Collings & Scullion, 2006; Lazarova, 2006; Stahl & Bjo¨rkman, 2006).
According to the existing literature, staffing issues are becoming more and more complex in the
international environment, inter alia: changing HR strategies for effective implementation of global
strategies during international mergers and strategic alliances; the high select ratio of qualified international
managers, especially for emerging markets where fierce competition exists, and the utilization of
knowledge flow brought by those global talents (Schuler, et.al., 2004; Minbaeva &Michailova, 2004;
Evans, et.al., 2002).

While the context for managing international staffing has altered significantly, research suggests that
many MNCs continue to underestimate the complexities involved (Tung, 1998). Issues surrounding the
conventional expatriate assignment (EA) keep on rising due to high costs and low returns (Morley & Heraty,
2004; Scullion&Brewster, 2001). Some of the old challenges consist of expatriate failure, costs and
performance evaluation. Others like increasing demand for expatriates in a broader range of organizations,
especially on emerging markets; low supply for global career and specifically dual careers, and the impact
of 9/11, can be considered newer challenges (Collings et al., 2007).

As a result, organizations and academics must take a more strategic view of global staffing
arrangements, in order to maximize their use of talented human resources (Lazarova & Cerdin, 2007;
Selmer & Leung, 2003; Paik, Segaud & Malinowski, 2002). One of the new key themes is the emergence of
self-initiated expatriate (SIE) assignments, which means “someone who chose to leave (their) homeland to
live or work in another country, usually for a long period of time” (Vance, 2005). Researchers argue that
SIEs may have different motivations than traditional assignees, vary on financial support origins, personal
skill set, career stages, and other issues (Collings et al., 2007; Thomas et al., 2005; Suutari & Brewster,
2000; Inkson et al. 1997). The increasing number of SIEs is one of the options offered to organizations to
enlarge the candidate pool for international positions at a lower cost than traditional expatriates. However,
there is a dearth of empirical research both on the individual issues faced by SIEs on how to establish
themselves in the new environment and on the HR issues facing organizations who seek to employ them.

In order to make a holistic view of the underestimated SIE phenomena, this research will try to explore
the basic characteristics of SIE experiences through an extended review of the existing literature.

2. THE CHARACTERISTICS OF SIE

Within the globalization, the nature of an international assignment is ever changing, from the concept of a
traditional company-assigned expatriation, to a more diverse set of international employees (Capellen &
Janssens, 2005). Professionals nowadays often initiate their own expatriation for overseas experiences,
more work opportunities and a bunch of other factors (Myers & Pringle, 2005; Harrison, Shaffer, &
Bhaskar-Shriaivas, 2004), which reflect the basic differences of company expatriates and SIEs. A seminal
article by Inkson et al. (1997) was the first to address such differences. Since then, numerous calls come out
for more information on this group (Bonache et al., 2007; Banai and Harry, 2005).

2.1 The extrinsic factors

2.1.1 Career assignment

Prior to this decade, the international mobility happened, to the most part, on expatriate assignment, which
referred to the deployment of expatriates in international subsidiaries by companies (Suutari and Brewster,
2000). However, recent research in the US shows that due to the current international climate and continued
concerns about terrorist attacks post-911, potential international assignees remain reluctant to go overseas
(Konopaske & Werner, 2005). Yet MNCs must more than ever before encourage staff to work abroad to
better understand the global markets and to develop the skills required to work effectively across cultures
(Collings, et al., 2007). Thus the potentially bigger population “who relocates voluntarily to a foreign

HU Mo; XIA Jian-Ming/Canadian Social Science Vol.6 No.5, 2010

171

country on his or her own initiative, independently of any employer and without organizational assistance”
(Crowley-Henry, 2007) calls for deep consideration.

2.1.2 Career boundary

For most overseas assignments, expatriates will subsequently return to another position in the same
company in the original country and hopefully, the experience will result in career development for the
individual (Inkson, 1997). However, as market becomes increasingly globalised, the movement of labor
across organizational and national boundaries become flexible and permeable (Sullivan and Arthur, 2006).
In this era, boundaries between and within companies are dissolving (Inkson, 1997), and careers are
becoming increasingly fluid, characterized more and more by temporary assignments and centered on
building skills across companies rather than ascending hierarchies within companies. Research illustrates
professionals who are self-initiate expatriated are undergoing a shift from organization-based career to one
that is more independent, “boundaryless”, which denotes the very concept of SIE (Fitzgerald &
Howe-Walsh, 2008; Yan et al, 2002; Arthur et al., 1999). In the traditional career perspective, individuals
were expected to stay within the same organization to gain seniority with time and age (Arthur and
RousSIEau, 1996; Arthur, 1994). While in the boundaryless career, they are taking their own responsibility
for career development. They typically search for opportunities outside the company or country (Feldman
and Ng, 2007; Hudson and Inkson, 2006), replace corporate security or intervention with autonomy and
flexibility (Thorn, 2009). Birscoe and Hall (2006) consider the boundaryless career in broad terms along
“dimensions of physical and/or psychological mobility”. Evidently, the physical mobility would not only
be accompanied by, but also initiated from, the changing psychological focus on transforming one’s own
career.

2.1.3 Career Stage

Early research showed that SIE was popular among young people who care for overseas experience (OE)
rather than seize the opportunity to improve their career opportunities (Myers and Inkson, 2003). In this
case, employment tends to be ad hoc and casual, usually at a beginning or relatively low career stage. They
sometimes obtain more permanent employment as a result of serendipitous networking arises. Later, Myers
and Pringle (2005) developed the term “free agents” as refer to people who are usually older than the OE
stereotype and self initiate for a wide range of reasons, including planned career development, financial
improvement, or simply because they now have the opportunity to seek out new experiences (Helyer,
2004).Thus the career stages for SIE are actually quite wide spread, covering all levels from beginner to
seniority.

Whereas Inkson et al. (1997) refer to SIEs as individuals in their early career phase with mainly
recreational and social motives, Suutari and Brewster (2000) later-on expanded the group of self-initiated
foreign expatriates by more experienced people who deliberately chose an international career.

2.1.4 Time boundary

Assigned expatriates always leave their home countries for two or three years (Thorn, 2009). After a period
from a few months to several years duration, the person returns home, seeking to resume his or her career,
or possibly start a new one (Inkson, 1997). On the contrary, SIEs are hired as locals in the foreign country.
In addition, SIEs are not repatriated to their home-country organization but decide for themselves whether
and when they return to their home country (Crowley-Henry, 2007; Suutari and Brewster, 2000). They feel
they themselves have a high impact on the course of their career, their current organization being only an
intermediate step (Biemann & Andresen, 2010).

2.1.5 Financial Status

As those who choose to expatriate by themselves, typically, he or she will save money to bankroll the trip.
Thus, SIE is, by definition, a personal odyssey, initiated and resourced by the SIElf (Inkson, 1997). They do
not like their comparatives, the assigned expatriates, who always have company salary and expenses, plus
funded travel and family settling down as well.

To Summarize, the basic extrinsic factors of an SIE compared to AE can be listed as follows:

HU Mo; XIA Jian-Ming/Canadian Social Science Vol.6 No.5, 2010

172

Table 1: Self-initiated expatriation versus Assigned expatriation

(Summarized by the author from literature review)

2.2 The intrinsic factors

The fundamental characteristic that distinguishes SIE international workers and expatriate assignees is the
initiator behind the decision to work internationally (Biemann & Andresen, 2010). Far less attention has
been devoted to the differences in their individual orientations and motivations. The career orientation of
SIEs as a key driver that impacts the SIEs’ decision to work abroad and is therefore a distinguishing feature
of SIEs compared to AEs (Biemann & Andresen, 2010).

2.2.1 Motivation

As for the assigned expatriation, Stahl et al., (2002) found that most of the German managers accepted a
position in foreign countries not because they wanted to, but because of the fear of ruining their current job.
Nearly 70 per cent of the respondents believed they “could not refuse a posting more than once without this
having a negative impact on future career with that company”. Thus the initiative for SIE differs quite a lot
from the traditional one (Richardson and Mallon, 2005). For the most part, individual motivations for
working abroad are described as an adventurous, youths seeking geographical mobility facilitated by
self-learning and self-support (Richardson & Mallon, 2005; Vance, 2005; Inkson et al, 1997), regarding as
a“backpacker culture”which is evident among young people (Inkson and Myers, 2003), especially for
New Zealanders and Australians who view overseas experience as a “rite of passage” (Mason, 2002, p. 93).
Later research by Richardson and Mallon (2005) found that the search for adventure and travel is the most
influential initiative for all SIEs, despite of age, gender and children conditions. Their psychological
mobility for exploration and novelty actually leaded to the physical movement (Birscoe and Hall, 2006).
Sullivan and Arthur (2006) developed a 4 quadrants model, and those choosing to be an SIE are found in
Quadrant four with both high physical and psychological mobility.

Other factors like family reasons, career opportunities, as well as financial improvements are subsidiary
reasons. Further research by Richardson (2006) discusses family involvement in the SIE decision and finds
the “centrality of personal relationships in this particular form of career decision”. However, research on
Australian managers by Tharenou (2003) indicates that marriage and family interest set up barriers to
expatriation. Research from a small sub-group of four women following international careers indicates that
family and personal life and not their careers are at the top of their priority list (Crowley-Henry & Weir,
2007).

To summarize, there are a mixture of economic, cultural, family and career elements that operate as
‘push’ and ‘pull’ factors in the decision of SIE (Carr et al, 2005).

2.2.2 Information focus

Due to the corporate mission they must pursue abroad, such as knowledge transfer or ensuring that
headquarters’ policies are carried out locally, the assigned expatriation commissions are among the most
important objectives (Stahl et al., 2002) that require sound company-specific knowledge and social capital,
which first needs to establish over time. As a result, those who are set to be assigned expatriates will focus
more on internal company network so as to achieve better performance with in the organization. However,
SIEs who pursuing a boundaryless career will not progress through the career stages in the same way as
AEs do. In line with the above argumentation, it is to be expected that instead of waiting for an opportunity
to be opened up by their employer, SIEs will autonomously look for a position abroad. Moreover, during

Self-initiated expatriation Assigned expatriation
Career assignment and
finance

By the expatriates themselves By the company

Career stages All stages Always with developed careers and
higher positions

Career boundary Mobile across organizations Within the organization
Time boundary Unknown time period Fixed term

HU Mo; XIA Jian-Ming/Canadian Social Science Vol.6 No.5, 2010

173

their staying abroad, they will probably focus more on the external information network outside the current
company so as to gain more opportunity for self development and future career progress.

3. CROSS-CULTURAL ADJUSTMENT OF SIE
In the case of assigned expatriation, the overseas job requires both knowledge of the company’s strategy,
procedures, etc., and the ability to work and live successfully in a foreign environment (Inkson, 1997).
While expatriate assignment may be presented as a career opportunity (Oddou, 1991), and may facilitate
short-term career progress, most returning expatriates report that the net effect is not positive (Oddou &
Mendenhall, 1991). According to Napier and Peterson (1991), 40% of expatriates return early from their
assignments. Birdseye and Hill (1995) and Engen (1995) report high rates of quitting the company by
repatriates. The costs may be high—$50,000 to $150,000 for a failed expatriate assignment (Stephens &
Black, 1991), and over $250,000 for the loss, and replacement, of an employee leaving the company after
return from assignment (Murray & Murray, 1986).

3.1 Job reliance of SIE

How to get through the culture paradox for a successful cross-cultural adjustment? Among those
researchers, Osland (1995) is the first try to de-trivialize expatriate experience in the way of telling “tales
told by expatriates”. Expatriate experience is thus personalized, and takes on the rich texture of adventure
stories in exotic locations. He uses “myth of the hero’s adventure” to show how the expatriate heeds the call
of adventure, push him or her self into the unknown world, goes through transformation and spiritual
rebirth, and finally become the master of two worlds, which is called a successful cross-cultural adjustment.
Osland’s stories, collected from returned US expatriates, demonstrate that the cultural differences between
home and the host land not only provide physical tests and obstacles, but also throw up paradoxes which
provide the opportunity for cross-cultural learning.

In the case of self-initiated expatriation, the individual’s career progress must be monitored much more
closely by the individual itself than in case of long-term career planning by the organization. Existing
research indicates that SIEs experience weaker job reliance than AEs when planning an international move.
First of all, ties or responsibilities of SIEs are primarily to their own overall well-being rather than to their
employer due to the boundarylessness career (Crowley-Henry, 2007). Second, long-term planning and a
double sense of responsibility towards the home and the host company, as well as the package of monetary
and fringe benefits (such as education/housing allowances, assignment and travel insurance) that are
usually paid to AEs but not to SIEs (Howe-Walsh and Schyns, 2010; Suutari and Brewster, 2000) can make
it more difficult for AEs to break organizational links. Third, the achievement of specific company goals is
less important for SIEs than for AEs since the sacrifice of leaving is also comparatively higher for AEs.
SIEs usually ultimately leave the organization without having the expectation to return to it after the period
of working internationally is completed.

3.2 Personal agency of SIE

As international organizations today compete in a more globally connected market place (Tarique et al,
2006), the global competencies of job candidates become more important (Vance, 2005; Yan, et al, 2002).
Individuals cannot afford to depend upon organizations, but should be active agents in their own career
development and assert themselves in developing and utilizing their global competencies (Hall, 2002).
While AEs analyzed in their study value a foreign work experience for the better possibilities it offers for
skill acquisition and personal development, SIE’s identity is less based on their job or the organization they
work for, as in the case of traditional careers, but is developed around skills and competencies. Accordingly,
they are more prepared to make an inter-organizational move, which means that their foreign work
experience is considered to be enhancing their internal rather than their external careers (Jokinen et al.,
2008; Schein, 1996).

In sum, comparing AEs and SIEs, AEs expect company-supported career guidance, whereas SIEs
assume sole responsibility for the planning and management of their career, taking more control, which
means they have a greater responsibility to actively define success and make efforts to achieve it. The SIE
are expatriates who already got a global mindset and more culturally aware and adaptable. Thus, they

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174

probably have a better cultural-adjustment result and which in turn, is a precursor for success on an
international assignment. Bringing in self-initiated expatriates who are highly qualified and skilled are
crucial to business success, and international organizations should do more to develop appropriate
strategies.

3.3 Self-value-adding process

Globally competent managers are characterized by their ability to interact effectively with people who are
culturally different, to deal with various competitive and political environments, and to See rapid change
and uncertainty as an opportunity (Evans et al., 2002; Early and Ang, 2003).

Based on the career theory, SIE’s career development is an outcome of complex forces, including
individual self-direction as well as organizational career frameworks (Arthur, Hall, & Lawrence, 1989).
There is much evidence that this group of people “sculpt” their own careers rather than allowing themselves
to become corporate sculptures (Bell & Slaw, 1989). The less long-term planning as compared to AEs may
explain the stable and enduring career orientation at a later age. On one hand, SIE takes a proactive role in
controlling his or her own life and in building company and cross-company expertise; on the other,
individual career behaviors create organizational patterns and inadvertently build company expertise and
shape company structures (Weick, 1996).

Generally, employees with a strong career orientation exhibit a deeper personal investment in their work
and mark their achievements through upward movements within the occupational structure they work in
(Heslin, 2005). Nevertheless, the career motive of SIEs becomes weaker with increasing age and at later
stages of the career (Richardson and Zikic, 2007). It can be assumed that the career orientation remains
stronger for SIEs than for AEs since the career progression of the former is less predictable due to more
frequent changes of employers and a comparably lower career support by their employer.

4. IMPLICATIONS AND FUTURE RESEARCH
Companies nowadays always face the problem of adequate international managers in that assigned
expatriate managers are often reluctant to be relocated to many different places (Mahroum, 2000). SIEs, on
the contrary, can provide an extended pool with greater willingness to move to other countries throughout
their careers while showing the same learning outcomes and career capital as AEs (Jokinen et al., 2008). In
the context of boundaryless career, SIE forms a new basis for building competencies in individuals as well
as in organizations in a way that their career become an “repository of knowledge” (Bird, 1996), which can
enhance the transfer of knowledge between organizations. Thus, SIEs who can complete the overseas
assignment competently and make organizational learning through the transfer of new skills and knowledge
will experience advantages over AEs for both individual and organizational development. As a result,
human resource management should make a shift from planning toward knowledge-centered approaches.

However, we must see clearly that this apparent advantage as planned and desired in many
organizations could also turns out to be problematic since SIEs in nature lack the potential organizational
reliance. As a consequence, a comparison of their career motivation to that of the group of AEs is of major
interest for global organizations, in order to choose between assigned expatrites, SIEs, and local human
capitals. From a corporate perspective, knowledge about career expectations and plans of SIEs in contrast
to AEs is of importance in order to find out in how far the management of SIEs must differ from that of
assigned expatriates.

Within the globalizing nature of our times, the very notion of international assignments is ever changing
and expanding. This paper summarizes the characteristics of SIEs as a valuable alternative for assigned
expatriates in that it is ponderable for organizations which aim to achieve competitive advantage on the
global front. As careers change, and as the economy becomes increasingly global, SIE may become a more
prominent option for international recruitment worldwide. It offers greater flexibility to leverage the career
development of the individuals involved, and the competencies of specific organizations within which they
move. Hence, there is a need for comparative studies of SIEs and AEs on the one hand and for a
differentiation of research results according to their characteristics on the other. While contributing to
existing theory by giving a theoretical framework of comparing SIE and AE on international adjustment,
empirical testing is required to assess the effectiveness of this theoretical structure. To get helpful insights

HU Mo; XIA Jian-Ming/Canadian Social Science Vol.6 No.5, 2010

175

about the investigated issue, both quantitative and qualitative research are needed to explore the experience
of SIE and AE. First, quantitative data is necessary for the evaluation of both groups’ adaptation to
international environment, as well as to what extent do motivation and employee reliance have an effect on
international adjustment in different areas. Besides, qualitative studies are useful in finding other factors
that lie behind those adjustment differences as they offer better understanding of under-researched
phenomena, and helps to explain some of the relationships within the analysis of the survey data.

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Available online at

http://www.anpad.org.br/bar

BAR, Curitiba, v. 5, n. 2, art. 1, p. 85-103,
Apr./June 2008

Challenging the Uppsala Internationalization Model: a Challenging the Uppsala Internationalization Model: a Challenging the Uppsala Internationalization Model: a Challenging the Uppsala Internationalization Model: a

Contingent Approach to the Internationalization of Contingent Approach to the Internationalization of Contingent Approach to the Internationalization of Contingent Approach to the Internationalization of

ServicesServicesServicesServices

Jorge Carneiro *
E-mail address: jorgemtc@iag.puc-rio.br
IAG – Pontifícia Universidade Católica do Rio de Janeiro
Rio de Janeiro, RJ, Brazil.

Angela da Rocha
E-mail address: angela@coppead.ufrj.br
Instituto Coppead de Administração – Universidade Federal do Rio de Janeiro
Rio de Janeiro, RJ, Brazil.

Jorge Ferreira da Silva
E-mail address: shopshop@iag.puc-rio.br
IAG – Pontifícia Universidade Católica do Rio de Janeiro
Rio de Janeiro, RJ, Brazil.

AAAABSTRACTBSTRACTBSTRACTBSTRACT

Some authors have questioned whether the well-known Uppsala internationalization model would be
generalizable to services. We take one of the model’s assumptions – that firms will follow a gradually increasing
resource commitment path in each country – and challenge whether it would hold up under specific service
characteristics or particular combinations of environmental variables and service characteristics. We review the
literature in search of more appropriate dimensions for the classification of services that would allow for the test
of the Uppsala model’s assumption. Based on purely conceptual reasoning, supported by previous empirical
studies, we propose some hypotheses about how service firms would be expected to behave – in terms of their
choice of foreign entry mode – under certain circumstances and what the performance implications would be
expected to be. These hypotheses are contrary to the Uppsala model’s predictions. This paper is solely
conceptual, so the key constructs (environment and service-specific variables) would still require
operationalization before the hypotheses can be empirically tested.

Key words: firm internationalization; international business; services.

Received 03 February 2008; received in revised form 22 April 2008.

Copyright © 2008 Brazilian Administration Review. All rights reserved, including rights for
translation. Parts of this work may be quoted without prior knowledge on the condition that
the source is identified.

*Corresponding author: Jorge Carneiro
Rua Dezenove de Fevereiro, 127 / 201, Botafogo, Rio de Janeiro, RJ, 22280-030, Brazil.

Jorge Carneiro, Angela da Rocha, Jorge Ferreira da Silva

BAR, Curitiba, v. 5, n. 2, art. 1, p. 85-103, Apr./June 2008 www.anpad.org.br/bar

IIIINTRODUCTIONNTRODUCTIONNTRODUCTIONNTRODUCTION

The Uppsala model (Johanson & Vahlne, 1977, 1990) is one of most frequently cited models in the
internationalization literature (c.f. Andersen, 1993; Langhoff, 1997; Oviatt & McDougall, 1994). The
model states that firms will tend to internationalize first to psychically close countries and gradually
move to more psychically distant markets. The model also states that, as a firm chooses a new foreign
country, it will start from a low resource-commitment mode and only move to higher commitment
modes as it gains experiential knowledge in the foreign market.

The model has been tested mainly in manufacturing industries. However, considering the growing
importance of services in the world economy, it is questionable whether the model assumptions would
also apply to services.

Services are defined as “…deeds, performances, and efforts that provide benefit to customers”
(Cloninger, 2000, p. 9). Such a definition is broad enough to cover all types of services, including
those embodied in a product offer. Nevertheless, our focus here is on service industries, i.e., those
industries whose products are predominantly intangible. We suggest here that the usual categorizations
– such as, services vs. goods, services industries boundaries, hard vs. soft services – may not be the
best way to approach the particularities of services and their impact on the internationalization path of
services firms. Other strategic dimensions of services may help to shed more light on this issue.

By contrasting and integrating the conceptual and empirical literature, this paper advances
hypotheses that can help one to test whether the Uppsala internationalization model can properly
explain the international expansion of different types of services industries, discussing whether the
generic assumption of a gradually increasing commitment path would hold under different
combinations of environmental circumstances and service configurations. Such a discussion provides
conceptual support for a contingency approach to the internationalisation of services. We contend that
the assumption of a gradual commitment path might not hold for service industries, and that the effect
of some variables on the foreign entry mode chosen by service firms might depend on the level of
other variables.

Moreover, one ought to investigate not only how firms actually behave under a given combination
of circumstances (contingencies) – i.e., a descriptive perspective –, but also how they should behave
in order to improve their results (in the sense of economic return or financial performance) under a
given combination of circumstances (contingencies) – i.e., a normative perspective. In this paper we
have focused the discussion on one of the variables used to characterize the internationalization
process of firms: the entry mode.

Paraphrasing Brouthers, Brouthers and Werner (1999), the research questions here revolve around
the following theme: can the Uppsala internationalization model be used to describe the most
commonly selected entry modes for service firms (descriptive power) and can the Uppsala
internationalization model also predict the best performing entry modes (normative power)?

Recognizing that (i) theoretical models and empirical research have mostly been based on
manufacturing industries, (ii) differences between services and goods may imply differences in
internationalization decision-making and processes, (iii) differences across types of services may also
have implications for the specific internationalization path followed and the performance results
obtained, and (iv) that there may be complex interactions among environmental and service-specific
variables, this paper addresses three main objectives:

. Identify relevant services dimensions and characteristics that can help account for differences
between the internationalization paths for goods and services in addition to differences across
service categories;

Challenging the Uppsala Internationalization Model: a Contingent Approach to the Internationalization of
Services

BAR, Curitiba, v. 5, n. 2, art. 1, p. 85-103, Apr./June 2008 www.anpad.org.br/bar

. Advance hypotheses to assess the descriptive power of the Uppsala internationalization model, as far
as the assumption of a gradually increasing commitment path is concerned;

. Advance hypotheses to assess the normative power of the Uppsala internationalization model as far
as its (albeit implicit) implications associated with the impact of entry mode on performance are
concerned.

In this paper our intention is to advance hypotheses, supported by a conceptual discussion, although
we do not actually test them here. The key constructs in the hypotheses (specifically, some
environmental and also some service-specific variables) need to be operationalized before data can be
properly collected and the hypotheses empirically tested.

The paper is organized as follows. Following this introduction, we briefly present the assumptions of
the Uppsala internationalization model and address the foreign entry mode decision. We then discuss
differences between goods and services and link them to differences in internationalization patterns.
We move on to present typologies of services that highlight some dimensions that might explain
differences in internationalization paths across types of services and then review previous empirical
studies on the internationalization of services. In the next section we advance testable hypotheses that
challenge the assumption of a gradually increasing resource-commitment path of the Uppsala
internationalization model – as illustrated by certain service-specific variables and environmental
circumstances – and also propose performance implications thereof. Some final remarks and
suggestions for future research close the paper.

TTTTHE HE HE HE UUUUPPSALA PPSALA PPSALA PPSALA IIIINTERNATIONALIZATION NTERNATIONALIZATION NTERNATIONALIZATION NTERNATIONALIZATION MMMMODEL AND ODEL AND ODEL AND ODEL AND FFFFOREIGN OREIGN OREIGN OREIGN EEEENTRY NTRY NTRY NTRY MMMMODE ODE ODE ODE DDDDECISIONECISIONECISIONECISION

Assumptions of the Uppsala ModelAssumptions of the Uppsala ModelAssumptions of the Uppsala ModelAssumptions of the Uppsala Model

The Uppsala Internationalization Model (Johanson & Vahlne, 1977, 1990) was initially developed
based on case studies of Swedish manufacturers (Johanson & Wiedersheim-Paul, 1975) adopting a
behavioral perspective (Andersen & Buvik, 2002; Björkman & Forsgren, 2000) inspired by the work
of Penrose (1959), Cyert and March (1963), and Aharoni (1966). The model asserts that a firm’s
market knowledge (or lack thereof) would be the driving force of its internationalization path. Market
knowledge is seen as a function of psychic distance between home and host countries and the firm’s
accumulated experience in each given market. The model contends that (i) firms choose new countries
for expansion according to their psychic closeness to the host country, moving to more psychically
distant countries only as they gain experiential knowledge from past international operations; and (ii)
resource commitments in each selected country increase in incremental steps as the firm gains
experience in each market.

Foreign Entry Mode DecisionForeign Entry Mode DecisionForeign Entry Mode DecisionForeign Entry Mode Decision

The foreign entry mode choice includes two basic decisions (Erramilli, 1992). The first decision is
whether production should be conducted in the host country or in the home country. So this is a
decision about foreign (local) production versus exporting. The second decision relates to who should
control production. This comes to a decision between full control, or sole ownership, modes (either
sole exporting or wholly-owned FDI) versus shared control modes (e.g., exporting by agents,
licensing, franchising, joint ventures).

Hill, Hwang and Kim (1990) proposed three underlying variables that would influence the entry
mode decision: level of control desired, amount of resource commitment and dissemination risk (i.e.,
risk that information may leak and be inadvertently used by a third party, usually a supposedly
trustable partner, with the consequent loss of revenues). They considered three general entry modes:

Jorge Carneiro, Angela da Rocha, Jorge Ferreira da Silva
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licensing, joint ventures and wholly-owned subsidiaries. Depending on the level of each variable,
different entry modes could be more appropriate, and trade-offs would have to be accepted when
choosing one entry mode over another.

It can be reasonably assumed that managers will choose one entry mode over another in expectation
of getting a higher risk-adjusted return on investment., i.e., they will choose the highest risk-adjusted
return on investment from the feasible set of entry options (Agarwal & Ramaswamy, 1992).
Therefore, higher control would supposedly be chosen if it would expectedly raise returns (e.g.,
through better management of operations) or reduce risks (e.g., through more decision freedom and
responsiveness). Much by the same token, lower commitment would be sought in order to reduce
investment (the denominator of the ROI formula). As for the intention to reduce dissemination risk,
firms may seek protective action, either by means of contractual and monitoring agreements or,
alternatively, by the internalization of foreign activities.

However, classical assumptions of perfect information, symmetry in risk aversion, and rational
decision-making – which would tend to lead to some optimal and predictable outcome – may not
occur in real circumstances (Bazerman, 2001) and decision-makers tend to suffer from bounded
rationality (March & Simon, 1958). Therefore, it may be interesting to investigate whether firms
actually behave as suggested by theoretical considerations and whether those which do actually tend to
outperform those which do not.

SSSSERVICES ERVICES ERVICES ERVICES VVVVISISISIS—-ÀÀÀÀ—-VISVISVISVIS GGGGOODS OODS OODS OODS IIIINTERNATIONALIZATION NTERNATIONALIZATION NTERNATIONALIZATION NTERNATIONALIZATION PPPPATTERNSATTERNSATTERNSATTERNS

Relevance of Services in International TradeRelevance of Services in International TradeRelevance of Services in International TradeRelevance of Services in International Trade

Services represent a major part of the world GDP and account for a significant share of international

trade (Axinn & Matthyssens, 2002; Dahringer, 1991). Furthermore, the internationalization of services
has been growing at a rapid pace (Dunning, 1989; Javalgi, Griffith, & White, 2003; Mathe & Perras,
1994). Whereas in the 1970s it represented around 25% of the world’s FDI stock, by the early 2000s it
accounted for 60% of the stock and two-thirds of FDI inflows (United Nations Conference on Trade
and Development [UNCTAD], 2004). As for exports, in 2006 world exports of services amounted to
around 2.8 trillion US dollars (UNCTAD, 2007), accounting for approximately 19% of world exports
in that year (around 14.9 trillion US dollars, including merchandise and services, cf. UNCTAD, 2007)
and representing approximately 6% of world GDP (around 48.5 trillion US dollars in 2006, cf. World
Bank, 2008). Yet, despite the importance of services in the international economy, most research into
the internationalization of firms has focused on manufacturing industries (Axinn & Matthyssens,
2002; Erramilli, 1992; Javalgi & White, 2002).

Differences between Goods and Services and across ServicesDifferences between Goods and Services and across ServicesDifferences between Goods and Services and across ServicesDifferences between Goods and Services and across Services

There are important differences that distinguish services from goods. Services tend to be intangible,

heterogeneous, perishable, and their production tends to be inseparable from their delivery and
consumption (Grönroos, 1990; Lovelock & Wright, 2001; Nicolaud, 1989). These differences between
goods and services notwithstanding, some services may in several aspects be similar to goods in that
their production and consumption may be separable, and heterogeneity and perishability concerns may
not be relevant. On the other hand, it would be naïve to consider that all non-separable services would
be very similar to one another; in fact, they may differ in relevant strategic dimensions so as to make
universal approaches less justifiable. Therefore, an explanation of similarities and differences is
crucial for a better understanding of strategic and operational implications (Bouquet, Hebert, & Delios,
2004; Patterson & Cicic, 1995).

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Services

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Some researchers have suggested that internationalization approaches developed to explain
manufacturing firms’ foreign expansion might very well apply to service industries (Boddewyn,
Halbrich, & Perry, 1986; Terpstra & Yu, 1988). Other researchers believe that the factors affecting the
internationalization of goods cannot be directly generalizable to services (Ekeledo & Sivakumar, 1998;
Erramilli, 1990; Erramilli & Rao, 1993; Sanchez-Peinado & Pla-Barber, 2006; Sharma & Johanson,
1987). Some have argued that research should draw on other theoretical background besides
traditional empirical work on the internationalization of manufacturing firms, providing evidence that
the complex nature of services may require the use of novel perspectives (Bouquet, Hebert, & Delios,
2004; Sanchez-Peinado, Pla-Barber, & Hébert, 2007).

Johanson and Vahlne (1990) – two of the proponents of the Uppsala model – argued that theoretical
approaches to internationalization would not be directly generalizable to services and suggested that
differences between manufacturing and service firms would call for a context-specific approach in
order to understand internationalization processes of services.

A sequential stages model applied to the service context adapted from the Uppsala model was used
by Roberts (1999). The empirical results of the study, however, did not provide support to the
proposition of sequential stages in the internationalization of service firms. The conflicting
conclusions may be attributed to the fact that relevant control variables and interaction effects, as well
as certain service dimensions, were not considered in previous studies.

Typologies of ServicesTypologies of ServicesTypologies of ServicesTypologies of Services

Similarities and differences between manufacturing and service firms as well as across service

industries may be subtle, so that more fine-grained dimensions and categorization guidelines are in
fact necessary to explain variation in the internationalization processes followed by service firms and
the resulting firm performance.

Several classification schemes for the characterization of services have been proposed in the
literature, which seek to highlight relevant dimensions that would distinguish among different
services. Typologies, or classification schemes, capture the essence of the relevant characteristics,
simplifying the understanding and visualization of complex combinations (Hambrick, 1983). The
categories of a typology allow the researcher to include the conjoint impact of distinct combinations of
variables, which interact in a complex manner, instead of considering just the independent, direct
effects of each variable (Namiki, 1994). Furthermore, a classification scheme is crucial in order to
make it possible to arrive at conclusions and generalizations (Clark, Rajaratnam, & Smith, 1996).

In this discussion we make use of four service typologies extracted from the literature. They were
selected because their classificatory dimensions are deemed relevant to the understanding of the
contingent approach to internationalization advocated in this paper.

Patterson and Cicic (1995), building on Vandermerwe and Chadwick (1989), proposed a typology
based on two dimensions – degree of tangibility and degree of face-to-face contact with the client in
service delivery – and two levels for each dimension (Table 1).

Table 1: Vandermerwe and Chadwick’s (1989) Services Typology

Degree of face-to-face contact with client in service delivery

Low High
Pure services

Location-free professional services
Location-bound customized

projects

D
eg

re
e

ta
ng

ib
ili

Services bundled
with goods

Standardized service packages Value-added customized services

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. Location-free professional services. In this type of service, professionals may stay in their own
countries most of the time, traveling to the client’s country only to identify needs, sign a contract,
and present results. Thus, physical facilities are not needed in the country of destination. Since
contacts with the client are not very intense, such services tend to be more standardized. Examples
are executive recruitment, transportation, finance and insurance, IT and architectural projects.

. Location-bound customized projects. Such services require closer and more frequent contact with
clients in order to better serve them or to adapt the service to their needs. They tend to be long-range
services and demand the presence of a professional in the client’s country. Technical consulting in
general (management, engineering, human resource development), legal assistance, or an advertising
agency fit into this category.

. Standardized service packages. These services are usually associated with physical goods and are
more likely to be exported in a traditional way. Examples are software development, configuration
and maintenance of electronic equipment, and distance education.

. Value-added customized services. These services demand a high degree of interaction with the
client, thus adding considerable value to the basic offer. Examples are on-site technical training and
support and management of large facilities.

Lovelock and Yip (1996) proposed a similar taxonomy, based on the nature of the process (tangible
or intangible) and on the degree of involvement of the client (physical presence or absence during the
rendering of the service) (see Table 2).

Table 2: Lovelock and Yip’s (1996) Services Typology

Degree of involvement of the client

Low (physically absent) High (physically present)

Tangible Possession-processing services People-processing services

P
ro

ce
ss

tu
re

Intangible Information-based services

. Possession-processing services. These services involve tangible actions that increase the value of the
object. Some examples are freight transport, warehousing, equipment installation and maintenance,
car repair, facilities security, veterinary services, laundry services and disposal of industrial waste.
The object must be physically involved, but the client need not be. Depending on the service, the
factory could be fixed or mobile. It will be fixed when the service must be rendered in a specific
location a number of times, and mobile when technology allows the service to be rendered at a
distance.

. People-processing services. These services are tangible actions to clients who must be physically or
mentally present. Clients become part of the production process, which is simultaneous to the
consumption. Examples are passenger transportation, medical assistance, restaurants, hotels, and
museums. The client goes to the location where the service is rendered (a plane, a hospital or a
restaurant, for example), or the service provider goes to the client (medical assistance). In either
case, the service provider needs to maintain physical facilities near the location of interaction with
the client.

. Information-based services. These services involve the collection, treatment, interpretation and
transmission of information, such as accounting, banking and insurance, training, legal assistance,
news production and broadcasting, and marketing research. The physical involvement of the client is
usually low and electronic channels can be used for delivering the service to any part of the world.
Physical presence can be limited to contact equipment and telecommunications infrastructure,
permitting remote access.

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Clark, Rajaratnam and Smith (1996) proposed a classification scheme based on who or what crosses
the border (Table 3).

Table 3: Clark, Rajaratnam, and Smith’s (1996) Services Typology

Types of international services
Contact-based Vehicle-based Asset-based Object-based

Who or what
crosses the border

People
Electromagnetic

signals
Capital, organizing

principles
Objects

. Contact-based services. In this type of service, people (either the provider or the consumer) move to
other countries. Examples are consulting and tourism services.

. Vehicle-based services. This type of service is rendered by vehicles such as satellites, cables, and
antennas; electromagnetic signals cross the border. Examples are TV programs, telephone calls,
news broadcasts, and data transferred via the Internet.

. Asset-based services. Physical assets are necessary in the host country for the service to be provided.
Some examples are banks, hotels, hospitals or traditional retail chains.

. Object-based services. Objects impregnated with services cross the border, such as DVDs with
movies, software recorded in electronic media, air or train transportation, and maintenance contracts
together with parts supplied.

Lovelock (1983) proposed several services typologies, one of which categorizes services according
to the degree of standardization vs. adaptation. There are two dimensions of customization: the degree
of flexibility allowed by the characteristics of service production and delivery; and the level of
interference of the service provider in the configuration of the service (Table 4).

Table 4: Lovelock’s (1983) Services Typology

Extent to which service characteristics are customized
Low High

Low
Standardized services with little

influence by contact personnel

Customized services with little influence
by contact personnel

E
xt

en
t t

o
w

hi
ch

st
om

er
c

on
ta

pe
rs

on
ne

l e
xe

rc
is

e
ju

dg
m

en
t i

n
m

ee
tin

g
in

di
vi

du
al

cu
st
om

er
n

ee
ds

High
Standardized services with considerable

influence by contact personnel
Customized services with considerable

influence by contact personnel

. Standardized services with little influence by contact personnel. Some services are very
standardized. For example, train transportation has timetables and fixed routes, and many restaurants
offer little flexibility of their menu.

. Customized services with little influence by contact personnel. Telephone services allow the client
to choose a series of items beyond the basics, such as follow me, an alarm clock, or a detailed bill.
The same happens with banks or good hotels, which offer an extensive list of services clients can
choose from. Contact personnel, however, have little freedom to change service characteristics
beyond the pre-defined options.

. Standardized services with considerable influence by contact personnel. Some services allow each
provider to leave its particular mark, even though every client receives a service very similar to what

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other clients receive in each particular occasion of service rendering. For example, each teacher
chooses his/her own material and pedagogic methods, which differentiate him/her from other
teachers. Each of his/her students, however, receives basically the same type of class.

. Customized services with considerable influence by contact personnel. These imply a high degree of
customization and, at the same time, demand that contact personnel have considerable discretion
over the service offered to each client. Clients do not play a passive role. Such services require that
contact personnel achieve a high degree of training and capacity to understand and satisfy clients’
needs. Some examples are medical treatment, legal and tax assistance, architectural design, and
hairdressing and make-up services.

VVVVARIABLES ARIABLES ARIABLES ARIABLES AAAAFFECTING THE FFECTING THE FFECTING THE FFECTING THE IIIINTERNATIONALIZATION NTERNATIONALIZATION NTERNATIONALIZATION NTERNATIONALIZATION OF OF OF OF SSSSERVICESERVICESERVICESERVICES

Erramilli (1990) examined variation in entry mode choice across service industries and concluded

that hard services firms (where production can be decoupled from consumption) tend to choose
similar entry modes as would product firms, but soft services firms (where production and
consumption occur simultaneously) tend to use more integrated (higher-control) entry modes.
Moreover, as the need for customization becomes stronger, service firms would tend to resort to more
integrated entry modes. Ekeledo and Sivakumar (1998) supported Erramilli’s (1990) generic
argument, indicating that entry mode decisions differ significantly between hard and soft services, but
that hard services showed similarities with goods.

Other researchers studied the extent to which the classic dimensions of services (intangibility,
simultaneity, heterogeneity, and perishability) affected the internationalization of services. Erramilli
and Rao (1990) concluded that the separability aspect of services moderated the relationship between
motives to internationalize (client-following vs. market-seeking) and entry mode selection. Bouquet,
Hebert and Delios (2004) and Sanchez-Peinado and Pla-Barber (2006) also found empirical evidence
that separability had an influence on the choice of entry mode. Cloninger (2000) determined that
services that were less intangible, less perishable and less simultaneous had a higher probability to
internationalize, and that intangibility was a predictor of entry mode (more tangible services were
associated to a higher-control entry mode).

Erramilli (1991) investigated the impact of a service firm’s international experience on the type of
foreign country chosen and the mode of entry selected. He found that, in support of generally accepted
internationalization theory, as service firms become more experienced (both in length – number of
years – and scope – geographical spread), they tend to expand to more psychically distant countries.
However, contrary to what he expected, he found a curvilinear (U-shaped) relationship between
experience and the degree of control of the entry mode selected – i.e., less experienced service firms
tended to prefer higher-control modes, moving to lower-control modes as they gained moderate
experience, and moving again to higher-control modes as they reached higher levels of experience.
Sanchez-Peinado and Pla-Barber (2006) found that cultural distance did not significantly influence the
choice of entry mode by service firms. They found, nevertheless, a negative relationship between
international experience and the choice of higher-control entry modes, partially supporting Erramilli’s
(1991) results and contradicting Uppsala’s predictions.

The influence of external and internal factors on service firms’ choice of entry mode was studied by
Erramilli (1992). He concluded that service firms tended to use more integrated (higher-control) entry
modes the larger the foreign market size and the greater the unavailability of host country suitable
partners and the firm’s corporate policy on keeping control of operations. On the other hand, service
firms tended to use less integrated (lower-control) entry modes the greater the restriction on foreign
ownership, the firm’s aversion to environmental risk, the desire to get rapidly established, and the
constraints on internal resources. Sanchez-Peinado and Pla-Barber (2006) found that market potential
significantly impacted entry mode choice: firms tended to choose higher-control entry modes when

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entering markets with higher growth rates. However, these authors did not find support for the impact
of country risk on entry mode.

As to the impact of external uncertainty, Erramilli and D’Souza (1995) concluded that the
probability of service firms employing FDI modes tended to decrease as external uncertainty
increased, but only when capital intensity was high. Furthermore, the inhibiting impact of external
uncertainty on FDI mode choice was shown to be stronger with smaller firms, especially when they
moved from a country characterized by low uncertainty to another with high uncertainty. However,
contrary to expectations, they found that for larger firms an increase in external uncertainty seemed to
increase the probability of choosing FDI (i.e., higher-control) modes.

Earlier works have approached and operationalized services from general and broad categories, for
example, hard (separable) vs. soft (non-separable), or from the perspective of the four classic
dimensions related to the nature of services. Other have used various service industries, and later
speculated on which characteristics of these industries seemed to lie behind differences in the choice
of entry mode.

The complexity of services, however, has led some authors to study the internationalization process
from the perspective of one single service industry, thus avoiding the issue of differences across
industries. For example, specific studies have been done on the internationalization of business
services (O’Farrell, Wood, & Zheng, 1996; Roberts, 1999), engineering consulting (Baark, 1999;
Coviello & Martin, 1999), financial services (Álavarez-Gil, Cardone-Riportella, Lado-Cousté, &
Samartín-Sáenz, 2003; Cardone-Riportella, Alvarez-Gil, Lado-Couste, & Sasi, 2003; Katrishen &
Scordis, 1998), hospitality (Alexander & Lockwood, 1996; Dunning & Kundu, 1995), professional
services (Skaates, Tikkanen, & Alajoutsijärvi, 2003), and software (Ojala & Tyrväinen, 2007).

PPPPROPOSITION OF ROPOSITION OF ROPOSITION OF ROPOSITION OF TTTTESTABLE ESTABLE ESTABLE ESTABLE HHHHYPOTHESES YPOTHESES YPOTHESES YPOTHESES

It is reasonable to assume that firms, all else being equal, will prefer less risk to more risk. This

would justify the preference to expand to psychically-close countries and to commit resources in a
gradual manner. However, some services may exhibit certain characteristics that either make psychic
distance less relevant or preclude a gradually-increasing resource commitment path, thereby violating
two basic assumptions of the Uppsala Internationalization model.

For example, location-bound customized projects, contact-based services, people-processing
services and customized services with considerable influence by contact personnel, tend to skip low
involvement entry modes because: (i) they require the physical presence of the service provider, thus
ruling out exporting; (ii) they need to be offered on an integral basis from the outset due to
simultaneity of production, delivery and consumption; (iii) they are difficult to standardize, which
makes licensing less possible; and (iv) they may demand more control and involvement (and therefore
a higher resource commitment) owing to the need for quality and image control as well as
responsiveness and failure recovering.

Furthermore, service firms may be more prone, vis-à-vis manufacturing firms, to choosing higher
commitment modes not only because some services require a smaller amount of financial resources
(e.g., an office vis-à-vis a factory), but also because they may entail less risk since resources
committed tend to be more flexible and more easily transferable to other locations and alternative
applications (e.g., personal and managerial skills vis-à-vis factory or other physical facilities).

As for the relevance of psychic distance, some services may not be affected in the same way as
others. Some (though not all) less tangible services may be more prone to a client-following pattern
(e.g., consulting, advisory or auditing services); in some object-based (e.g., fast-food) as well as in
some people-processing services (e.g., hotels chains) clients may value standardization across

Jorge Carneiro, Angela da Rocha, Jorge Ferreira da Silva
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countries; standardized services with little influence by contact personnel are more immune to
cultural differences since they are less dependent on personal interaction. All these examples make it
clear that psychic distance may not universally and homogenously affect all types of services.

The picture just painted gets more complicated, though, since entry mode decisions can have
multiple consequences. For example, given that higher control may help reduce some risks (e.g.,
dissemination risk, cf. Hill, Hwang, & Kim, 1990), but at the same time may imply an increase in
other types of risk (due to the raising of exit barriers or the likelihood of local government retaliation),
it might be necessary to include in the analysis additional interacting and contingency variables (both
external as well as internal to the firm) instead of hoping for a universal recommendation.

Much by the same line of reasoning, the literature often seems to offer contradictory
recommendations, i.e., given the level of some environmental variable, a high (low) control entry
mode would be recommended, but the level of a different environmental (or firm- or service-specific
for that matter) variable might recommend a different entry mode. Therefore, certain trade-offs have to
be accepted (Anderson & Gatignon, 1986) in order to maximize the expected risk-adjusted return on
investment. The proper consideration of the interaction between pairs of variables may help resolve
some of the apparent conflicts.

In fact, multiple interactions are expected to occur, but they may be difficult to model and test.
Resorting to a bivariate approach may be a satisfactory compromise between a totally reductionist
perspective versus a totally holistic perspective (Venkatraman & Prescott, 1990).

Choice of the Explanatory VariablesChoice of the Explanatory VariablesChoice of the Explanatory VariablesChoice of the Explanatory Variables

It is worth noting that the proponents of the Uppsala Internationalization Model themselves stressed

that its predictive power value (in terms of the description of the internationalization paths to be
followed by firms) might be limited. However, they were thinking of some specific explanatory
variables that had been left out of the model, such as “the decision style of the decision-maker himself
and, to a certain extent, the specific properties of various decision situations” (Johanson & Vahlne,
1977, pp. 32-33).

We fully agree with them and have, in fact, gone a step further by choosing a particular set of
explanatory variables – i.e., specific dimensions and characteristics of services and their interplay with
specific environment circumstances – and discussed how some particular combinations of
environment and service configurations might affect the internationalization path chosen and, as a
matter of fact, challenge the assumption of a gradually increasing commitment path.

Several explanatory variables have been suggested which are supposed to have an influence in the
internationalization processes of services. For example: environment-related factors (legal
requirements and restrictions, market potential, political and economic risk, degree of external
uncertainty, psychic distance, existence of capable potential licensees); firm-related factors (a firm’s
possession of financial and managerial resources (usually related to firm size) or other complementary
resources, market knowledge, motivation to go international, advantages of global coordination of
activities); and service-specific factors (capital intensity, degree of investment irreversibility, degree
of tangibility, degree of inseparability, degree of personal interaction, extent of customization
requirements, need for quality assurance or image control, need for local assistance and
responsiveness, transportation costs, extent of knowledge transferability, stage of the technology life
cycle, level of information asymmetry between would-be licensor and potential licensees, contractual
risks, dissemination risks) (Anderson & Gatignon, 1986; Cicic, Patterson, & Shoham, 1999; Ekeledo
& Sivakumar, 1998; Erramilli, 1992; Nicolaud, 1989; Sanchez-Peinado, Pla-Barber, & Hébert, 2007).

This is a long list of variables, which could be expanded even further. Nevertheless, in order to keep
the complexity and size of this paper manageable, we decided to circumscribe our discussion to some
environment-related and some service-specific variables, leaving firm-related variables out of our
conceptual framework.

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We chose particular variables to question some of the Uppsala model’s assumptions:

. environment-related: environmental uncertainty and psychic distance; and

. service-specific: capital intensity, level of customization and closeness of contact, need for quality
assurance (control), need for image control, degree of tangibility, degree of face-to-face contact with
client in service delivery, and level of standardization

Impact of Environmental Uncertainty and Capital IntensityImpact of Environmental Uncertainty and Capital IntensityImpact of Environmental Uncertainty and Capital IntensityImpact of Environmental Uncertainty and Capital Intensity

Erramilli and D’Souza (1995) found that service firms tend to use FDI as their preferred entry mode

(the authors investigated only the first entry movement into a new country) when external uncertainty
is high and at the same time capital intensity is low. They explain this unexpected finding by resorting
to arguments first advanced by Klein and Roth (1990): “FDI modes allow firms to be closer to their
markets and, in markets characterized by high volatility, proximity gives them the ability to identify
fluctuations in the local market more quickly and respond to them faster” (Erramilli & D’Souza, 1995,
p. 57).

Since many services demand very little capital, firms expanding to highly uncertain environments
might tend to internalize their activities and produce the service locally even if it could have been
exported or, in some cases, licensed. This might be the case with some location-free professional
services (e.g., executive recruitment, market research packages, architectural projects) and also
possession-processing services (although, in this case, capital intensity may not be so low) even if
technology would have allowed the service to be rendered from a distant place (e.g. diagnostic and
support services). In fact, a preference for high-control may also be expected to be found when
external uncertainty is low: low perceived risk would encourage firms to commit more resources
(specially if their total amount is low) in order to keep control. Intermediate levels of uncertainty
might prompt service firms to partner with some local company in order to share part of the risk. From
this reasoning, the following two hypotheses are suggested (the suffixes D and N mean, respectively, a
hypothesis to test the descriptive power and a hypothesis to test the normative power):

HD1: For services that demand low capital intensity, there will be a U-shaped relationship between
environmental uncertainty and the preference for higher control (usually higher commitment) modes:
at low levels as well as at high levels of (perceived) environmental uncertainty, the proportion of
low-capital service firms that will choose higher-control modes will be greater than the respective
proportion when environmental uncertainty is moderate.

HN1: Low-capital service firms that choose a higher-control entry mode in countries where
environmental uncertainty is high, as well as in countries where environmental uncertainty is low, will
on average outperform those that choose a lower-control entry mode (supposedly due to higher
revenues from responsiveness in the first case and to lower negotiation and monitoring costs in the
second case).

Impact of Level of Customization and ClosenImpact of Level of Customization and ClosenImpact of Level of Customization and ClosenImpact of Level of Customization and Closeness of Contact, Need for Quality ess of Contact, Need for Quality ess of Contact, Need for Quality ess of Contact, Need for Quality

Assurance, and Need for Image Control Assurance, and Need for Image Control Assurance, and Need for Image Control Assurance, and Need for Image Control

International operations may face some types of contractual risks (Agarwal & Ramaswami, 1992). In

the case of services, such risks may be of a particular nature:

. Dissemination risk and free-riding potential, i.e., risk that knowledge will be dissipated and may be
expropriated by partner or licensee – A partner might learn by doing and then become a competitor,
especially because most services cannot be patented.

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. Obstacles and costs to appropriately transfer knowledge (to partners or licensees) as well as to sign,
monitor and enforce contracts – When the service demands a case by case solution for each client, it
may be difficult to codify the routines and transfer knowledge.

. Inadequate quality or image control – For some services, preserving the reputation of the service
provider is essential for success, especially when the results are difficult to evaluate objectively (as
is the case with medical, legal and consultancy services) and, as a consequence, confidence in the
service provider has significant impact on how much a client may be willing to pay. In these cases, it
might be worthwhile to internalize activities (higher control), lest a licensee might undermine the
firm’s reputation.

In case of high contractual risks, service firms would be expected to choose full-control entry modes
(e.g., sole exporting, if possible, or FDI) over licensing or joint ventures. Location-bound customized
projects, value-added customized services, contact-based services, standardized services with
considerable influence by contact personnel, and customized services with considerable influence
by contact personnel involve more tacit, and thus less codifiable, knowledge, so they are less prone
to licensing and it would be difficult to properly write and monitor a contract specifying how such
services should be rendered. For these reasons it is hypothesized that service firms that offer such
services would rather choose higher-control entry modes since the very beginning. If the service has to
be provided locally this higher-control would also entail higher-commitment (because of physical
facilities) and, as such, skipping some earlier stages of gradual commitment.

HD2: Firms that provide services that (i) demand significant customization and close contact with
clients, or (ii) demand rigorous quality assurance (e.g., by highly skilled professionals), or (iii) depend
on a strong image or reputation will tend to resort to full-control (higher-commitment) entry modes
(due to own personnel and local facilities) from the outset rather than following a sequential path from
exporting through licensing, and eventually FDI.

HN2: Firms that provide services that (i) demand significant customization and close contact with
clients or (ii) demand rigorous quality assurance or that (iii) depend on a strong image or reputation
will on average reach higher performance results if they choose higher-control entry modes than if
they choose lower-control entry modes.

Impact of Impact of Impact of Impact of Degree of Degree of Degree of Degree of TTTTangibility and of faceangibility and of faceangibility and of faceangibility and of face—-totototo—-face Contact with Client in Service face Contact with Client in Service face Contact with Client in Service face Contact with Client in Service

DeliveryDeliveryDeliveryDelivery

Firms that offer location-free professional services or rather standardized service packages

(recall Vandermerwe & Chadwick’s (1989) typology), where interaction and involvement with the
client is done on just a few discrete occasions and production can be decoupled from delivery (e.g.,
executive recruitment, finance and insurance, IT, and architectural projects), specially if bundled with
physical goods (software development, configuration and monitoring of electronic equipment), are
likely to find that the costs of having local facilities and personnel outweigh the (infrequent) traveling
and transportation costs. Moreover, customers will probably not value responsiveness and extensive
adaptation enough as to be willing to pay more for it. This means that services such as these will tend
to be exported and, in fact, may never move on to higher-commitment modes. However, as a relatively
high number of customers is gained in a given host country, the costs of keeping local facilities and
personnel may be less than the traveling and transportation costs that would otherwise be needed. At
this stage, local production may be a better mode as compared to exporting. This means that the
internationalization path would probably not follow a smooth and gradual increase in commitment and
involvement, but would in fact present a step function pattern.

HD3: Firms that provide location-free professional services or standardized service packages will
tend to export them rather than produce them locally in the target countries. However, as the number
of clients in a given host country becomes high, firms will tend to produce such services locally rather
than export them.

Challenging the Uppsala Internationalization Model: a Contingent Approach to the Internationalization of
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HN3: Firms that provide location-free professional services or standardized service packages will
achieve higher performance if they export their services rather than offer them locally in the target
countries. However, as the number of clients in a given host country becomes high, performance will
be higher for firms that produce such services locally as compared to firms that export them.

Interaction between Level of Service Standardization, Capital Intensity and Psychic Interaction between Level of Service Standardization, Capital Intensity and Psychic Interaction between Level of Service Standardization, Capital Intensity and Psychic Interaction between Level of Service Standardization, Capital Intensity and Psychic

DistanceDistanceDistanceDistance

As for standardized services, the type of knowledge is usually easier to transfer to partners or

licensees. However, when psychic distance is high (e.g., differences in culture, tastes, business
practices, legal environment, infrastructure), it may be necessary to conduct adaptations to the service
package, although no customer-by-customer customization is necessary.

The specific modifications required may not always be clear from the start. Therefore, a service firm
may choose a higher-control entry mode, whereby it would be able to introduce the necessary
adaptations in a “learn by doing” fashion. Once satisfied with the adapted service package, it may
decide to license it to third parties. Therefore, in the case of high (perceived) psychic distance, an
inverted (to the Uppsala model’s expectations) sequence of expansion might be observed, from higher-
to lower-control modes.

On the other hand, if psychic distance is perceived to be small, service firms may not be averse to
resorting to higher-control (usually higher-commitment) modes, especially in the case of services that
demand low capital requirements and, as such, lower perceived risks.

Given the fact that the low (in an absolute sense) amount of financial capital commitment and the
perceived psychic closeness may lead to less perceived risk, firms may prefer a full-control entry
mode (e.g.: sole exporting, if possible, or FDI). When psychic distance is moderate, firms may tend to
resort to local partners, either by licensing, if the service routines can be codifiable, or by joint
venturing. In both cases, the partner could contribute with specific knowledge and business
connections in the local market. Such contributions by a partner would also be important when psychic
distance is high, but the partner might not be able to fully understand the implications of service
adaptations, leading firms to favor internalization (full control) in their initial steps in a new market.

HD4a: For standardized services that demand low capital intensity, the relationship between the initial
entry mode and psychic distance will be U-shaped, with higher-control modes being preferred at both
low and high (perceived) psychic distance and shared-controls modes (e.g., licensing or joint
venturing) preferred at moderate (perceived) psychic distance.

HD4b: When internationalizing to a psychically distant country, firms that offer standardized services
of high capital intensity will tend to follow a reverse commitment path, first choosing higher-control
entry modes and later on migrating to lower-control entry modes as the expansion in the respective
country moves on.

HN4a: For the expansion of standardized services that demand low capital intensity into psychically
distant countries, firms that choose higher-control modes for the initial market entry will on average
outperform those that choose lower-control modes.

HN4b: For the expansion of standardized services of high capital intensity into psychically distant
countries, firms that follow a reverse commitment path (i.e., from higher- to lower-control entry
modes) will on average outperform those that follow a gradually increasing commitment path.

Jorge Carneiro, Angela da Rocha, Jorge Ferreira da Silva
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Challenges to the Uppsala Internationalization ModelChallenges to the Uppsala Internationalization ModelChallenges to the Uppsala Internationalization ModelChallenges to the Uppsala Internationalization Model

We now provide the reader with a brief recap of the hypotheses presented above and explain exactly

where they would challenge the Uppsala model. Table 5 presents the variables used in each
hypothesis.

Table 5: Variables Used in the Hypotheses

Independent variables Dependent variables
Environment Service-specific

HD1 � environmental uncertainty � capital intensity

intensity of control
(commitment)

HD2 � level of customization and
closeness of contact

� need for quality assurance
(control)

� need for image control

intensity of control
(commitment)

HD3 � degree of tangibility
� degree of face-to-face contact

with client in service delivery

location of production (as it
associated with resource
commitment)

HD4a psychic distance � level of standardization
� capital intensity

intensity of control
(commitment)

HD4b psychic distance � level of standardization
� capital intensity

intensity of control
(commitment)

What would the Uppsala model predict in each case?

Hypothesis HD1 – The Uppsala model is a risk-aversion or risk-avoidance model (Bjorkman &
Forsgren, 2000), which contends that firms would only move to higher commitment modes as they
gained experience in a given foreign market (or other foreign markets also, if this experience could be
transferred). Whether or not the level of environmental uncertainty would affect the rate of knowledge
gained by the firms is not explicitly addressed by the model. This silence notwithstanding, the fact is
that a preference for higher commitment from the beginning (despite of being a possible way to deal
with risk) goes against the assumptions of the Uppsala model.

Hypothesis HD2 – The Uppsala model does not address the impact of the characteristics of specific
services (or goods, for that matter) on the internationalization path. Nonetheless, a preference for
higher commitment entry modes from the beginning, as suggested by hypothesis HD2, would
contradict the Uppsala model’s prediction.

Hypothesis HD3 – The Uppsala model predicts a sequential path, starting from lower commitment
modes (e.g., exporting) and only later on, as the firm gains experiential knowledge, gradually moving
to higher commitment modes (e.g., FDI). Hypothesis HD3, nevertheless, states that such a move to
higher commitment modes might not be gradual and might even not occur at all, despite the
experience (in years, not in customers) gained in the foreign market.

Hypotheses HD4a and HD4b – According to the Uppsala model, the choice of level of commitment
would be independent of psychic distance, i.e., firms would tend to follow a gradual path from lower-
to higher-commitment modes in each country, irrespective of the psychic distance from the home
country. This pattern is contradicted by both HD4a and HD4b.

Challenging the Uppsala Internationalization Model: a Contingent Approach to the Internationalization of
Services

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FFFFINAL INAL INAL INAL CCCCONSIDERATIONSONSIDERATIONSONSIDERATIONSONSIDERATIONS

Boddewyn, Halbrich and Perry (1986, p. 54) recommended that “specific analyses of each service
sub-sector should prove more fruitful than the creation of a general category of ‘service MNEs’ in
view of the heterogeneity of this group”. Although these authors were considering “service
subsectors”, in this paper a different categorization of services, based on strategic dimensions and not
on industry boundaries, was deemed to better reveal the characteristics of services that might influence
internationalization paths and performance results. This is in accordance with Erramilli’s (1990, p. 60)
comment: “the entry mode options available to the manager in the same [service] industry, or even
firm, could be different for different services”.

This paper has cast some doubts as to whether a usually taken-for-granted assumption of the well-
known Uppsala internationalization model – that of a gradual commitment of resources in each host
market – would universally apply to services. Some hypotheses were advanced as a suggestion for
future studies. As Coviello and Martin (1999, p. 42) have put it, “service internationalization is too
broad a concept to be defined exclusively or examined by any one theoretical framework”.

Anderson and Gatignon (1986, p. 3) criticized the literature on entry mode choice for making “little
direct mention to risk or return”, concentrating instead on “the degree of control each mode affords the
entrant”. In partial response to their plea, normative hypotheses about the performance of service firms
under different mode choices and moderating circumstances were advanced herein.

For the development of the theoretical reasoning and the hypotheses, it was assumed that service
firms would have managerial freedom to choose from a set of distinct entry modes. Of course, in
countries where government restrictions limit the choice of entry modes, the present considerations
may not apply. Moreover, a desire for higher-control may not always be accompanied by a capacity to
commit the necessary resources to warrant control (Erramilli & Rao, 1993). Also the hypotheses
proposed here are valid only if the service firm’s objective for the particular service business under
expansion is market seeking and economic return. In the case of other motivations to go international
– such as resource-seeking or strategic reasons – other considerations might apply.

As a general recommendation, future researchers should be advised not to treat services as a
homogeneous class. Some progress has already been made since several classification schemes have
been proposed. However, although illuminating, the services typologies reviewed here may not be
fully adequate to evaluate the implications of specific service characteristics for the
internationalization process and the resulting (expected or observed) variation because (i) such
typologies may not tap into other relevant dimensions for the internationalization decisions and (ii)
there may be substantively different types of services that would be similar in a given aspect as to
occupy the same categorical box in a given typology but whose differences are important as far as the
internationalization path is concerned. For example, Ekeledo and Sivakumar (1998) mention
Lovelock’s (1983) typology, which places education (an exportable service) and psychotherapy (a
non-exportable service) under the same heading – people-processing services.

Since it seems reasonable to expect that factors influencing the appropriate mode of entry will
interact with one another, it is important to control for the impact of covariates in order not to
overemphasize the role of some variables or to reach supposedly universal conclusions that in fact
would not hold under specific circumstances. In addition, researchers should bear in mind that ceteris
paribus conditions may not always be present (Hill, Hwang, & Kim, 1990).

It should be underscored that a rejection of any null descriptive hypothesis and at the same time a
failure to reject the respective null normative hypothesis may be due to the fact that the theory
discussed here describes well what firms typically do, but it has not much to say about what they
should do – i.e., its normative power is low. This is to say that in terms of performance it would not
really make much difference whether firms behave as suggested by the theory expressed in the

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100

descriptive hypothesis or not. A failure to reject any of the null hypotheses may also be due to the
existence of intervening (moderating or interacting) variables that were not included in the explanatory
model.

The main contributions of this paper can be summarized as follows. An important assumption of the
Uppsala model was challenged as far as services internationalization is concerned. Also, recognizing
the complex interplay of environmental and service-specific variables, a plea for the use of
multivariate, or at least bivariate, research designs was presented. Furthermore, a call for the
investigation of performance implications was advocated in sharp contrast with mere descriptive
accounts or implicitly taken-for-granted assumptions of the type: if firms behave as suggested by the
theory they will fare better. As a final contribution, some descriptive and normative hypotheses were
set forth as a suggestion for testing in future studies.

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International Business Research Vol. 5, No. 5; May 2012

Published by Canadian Center of Science and Education 147

Evaluating Mergers and Acquisition as Strategic Interventions in the
Nigerian Banking Sector: The Good, Bad and the Ugly

B. E. A Oghojafor

Professor of Strategic Management, Department of Business Administration

Faculty of Business Administration, University of Lagos, Nigeria

Tel: 234-803-300-0522 E-mail: akpoyomareo@yahoo.com

Sunday Abayomi Adebisi (Corresponding author)

Senior Lecturer in the field of Business Administration, Department of Business Administration

Faculty of Business Administration, University of Lagos, Nigeria

Tel: 234-802-826-3032 E-mail: yommysun@yahoo.com

Received: November 17, 2011 Accepted: March 9, 2012 Published: May 1, 2012

doi:10.5539/ibr.v5n5p147 URL: http://dx.doi.org/10.5539/ibr.v5n5p147

Abstract

This study evaluated Merger/Acquisition as an intervention strategy in the Nigerian banking sector. The objective
was to identify whether this strategy has actually achieved the desired result for which it was purposed, especially,
in the popular Nigerian merger of 2005. To this end, the study was carried out using both primary (questionnaire)
and secondary (banks financial statements) data. 100 copies of questionnaire were administered on the management
members of the sampled banks. From the three hypotheses that were tested; hypothesis 1 result revealed the
calculated t-statistics (t = 6.591 P < 0.05) signifying that, Merger/Acquisition had helped to curb the distress that would have occurred in the Nigeria banks during the period it was executed. Hypothesis 2 which measured performances in pre and post-merger showed that, the average capital of banks sampled in pre Merger period was N1433.20 million while post Merger period was N6358.76 million and the difference was statistically significant at 0.05 level (t = 6.755, P < 0.05). Profit recorded for pre Merger period was N 2192.48 million while post Merger profit was N16839.12 million thereby creating significant differences between pre and post Merger profit which was statistically significant at 0.05 level (t = 5.276, P < 0.05), implying that, banks performance in post Merger was significantly different from the performance before Merger. Hypothesis 3 evaluated whether bad corporate governance was responsible for this merger; the calculated t-statistics was (t = 3.197, P < 0.05) and it was decided that there would not have been need for merger if good corporate governance had been in place. Based on these findings, it was recommended that merger/acquisition should not be hastily implemented; rather, it should be carefully applied when the objective for the intending firms is to achieve synergy; and that, corporate governance should be given priority attention by both the regulatory agencies and shareholders so that erring bank directors can be sanctioned appropriately.

Keywords: Merger, Acquisition, Consolidation, Portfolio investment, Central Bank of Nigeria (CBN), Post-merger
period, Intervention fund and corporate governance

1. Introduction

The Nigerian banking sector regulator; Central Bank of Nigeria (CBN) employed merger/acquisition as a
consolidated instrument to correct the deficiencies in the financial sector in 2005. This was done under the
leadership of the then CBN Governor; Professor Charles Soludo. The economic rationale behind this domestic
consolidation policy as at this time was highly indisputable. The justifications being that, Nigeria as at this time had
89 banks with 3,382 branches predominantly situated in the urban centers as at June 2004 (Soludo, 2006). Besides,
these branches were characterized by structural and operational weaknesses such as; low capital base, dominance of
a very few banks, insolvency and illiquidity, overdependence on public sector deposits and foreign exchange trading,
poor asset quality and weak corporate governance, low depositors’ confidence, banks that could not effectively
support the real sector of the economy and banking sector with credit to the domestic economy at 24% of GDP
compared to African average of 87% and 272% for developed countries (Soludo, 2006). Given these bedeviled

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circumstances, it became sensible to ensure quick and spontaneous intervention strategies to save the system from
total collapse. Therefore, the driving forces behind the consolidation (merger and acquisition) agenda included;
better risk control, advancement of marketing and product initiatives, improvement in overall credit risk and
technology exploitation, effective banking supervision, evolution of a strong and safe banking system, improved
transparency and accountability, cost reduction and effective global competition, depositors’ trust among other
factors . These drivers were anticipated to improve the operational efficiencies and operations of the players in the
banking sector that will survive the consolidation era. However, Forlong (1998) claimed that, merger and acquisition
in the banking industry has had more impact on the structure rather than the performance which has been harder to
discern. The decade (1995 and 2005) was particularly traumatic for the Nigeria banking industry, with the
magnitude of distress reaching an unprecedented level, thereby making it an issue of concern not only to the
regulatory bodies but also to the public. It was this that actually necessitated the need for an overhauling strategy of
the entire financial system which made the CBN introduced a very major reform agenda that changed the banking
landscape of the country in 2004. The reform was a 13 agenda reform which main thrust was the prescription of a
minimum capital base of 25 billion Naira. This reform further led to merger and acquisition in the industry and
scaled down the Nigeria banks from 89 to 25 and much later 24. This study aims to evaluate the effects (positive and
negative) that merger and acquisition as a consolidation strategy had had on the performance of banks in Nigeria
since 2005. It is interested to measure the extent to which this twin strategy has fared among the emerged banks
from the consolidation and the attendant effect on the nation’s aggregate economy.

2. Review of Literatures

The decision of an organization to merger or acquire another is a decision that requires much deliberation and
consideration. Some of the considerations must involve: why merger? What are the problems associated with
merging? What benefits will the organization derive from the merger? However, merger and acquisition is the
process by which a company acquires another company (Obuh 2003). However, Kay (1993) opined that mergers
and acquisition often form part of the strategic options expected to transform company performances. In the opinion
of Lynch (1997) he said that, mergers usually arise when neither company has the scale to acquire the other on its
own weaker company; expansion can be created by entrepreneur that is already established through mergers
agreement. He can merge with another company producing similar products to form a new strong identity that will
be of a greater advantage to both. While in mergers both merging firms lose their registering name to becoming a
new company entirely, acquisition involves the stronger organisation swallowing the smaller or weaker one entirely
without the stronger firm changing its identity. Merger is simply the metamorphosing of two independent firms with
different names into one single business entity emerging from the agreement. Merger actually has the capacity of
bringing about synergy.

It is not an understatement to state that, the Nigerian banking reform exercise and consolidation between 2004 and
December 2005 later ended up becoming a serious reflection of merger and acquisition. The reason being that, the
major strategy of escaping the sledge hammer of the CBN (should the 25 billion Naira capital base not met) was for
the banks to hurriedly pool their resources together to meet the book value of the minimum capital base. Since the
essence of any reform is to bring about greater efficiency not only to the organizations but also their contributions to
economic development of the nation, then it became important to raise a fundamental question in this study about
whether the consolidation exercise (merger and acquisition) has impacted positively on the performance of the bank
and the economy in general. Pautler (2001) opined that, the value gain that alleged to accrue to the larger and
growing wave of merger and acquisition activity has not been verified. The adoption of financial reforms has often
been postponed reversed shortly after being implemented or partially implemented for fear of recessionary
consequence. In support of this statement, it is a known fact that, prior to 2005, bank distress had being a serious
issue or problem which had made many citizens lost interest in the banking system without the regulatory authorities
having the boldness to address it.

There is no doubt that, banks are lifeline of the economy of any country. They occupy central position in the
country’s financial system and are essential agents in the development process. By intermediating between the
surplus and deficit savings units within an economy, banks mobilize and facilitate efficient allocation of national
savings, thereby increasing the quantum investments and hence national output (Afolabi, 2004). Through financial
intermediation, banks facilitate capital formation (investment) and promote economic growth. The banking industry
in Nigeria has witnessed a remarkable growth, especially since the de-regulation of the financial services sector in
the last quarter of 1986. In terms of headcount for instance, the number of banks increased by about154.8% from 42
in 1986 to 107 in 1990. It further increased by about 12% to120 in 1992. By 2004, however, the number had
reduced to 89. This was because some banks had to be liquidated on account of their dwindling fortunes. The
number of bank branches also rose from 1,394 in 1986 to 2,013 in 1990; 2,391 in 1992 and by 2004 in spite of the

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reduction in number of banks, it had reached 3,100. This translated to an inter-temporal increases of 44%, 18.8%
and 29.7%, respectively. (Ebong, 2005)

Recapitalization in the banking industry has raised much argument among the bank regulators. Historically, the
failure of pioneer 1930’s and 1940’s financial system brought about the enactment of banking ordinance of 1952.
Banking ordinance of 1952 then prescribed an operating license and emphasized on minimum equity for all banks
(Onoh, 2002). Since then, raising the banking capital has become the hallmark response policy of the Nigerian
monetary authorities. Capitalization is an important component of reforms in the banking industry, owing to the fact
that, a bank with strong capital base has the ability to absorb losses arising from non-performing liabilities (NPL).
Attaining capitalization requirement is achieved through consolidation, convergence as well as the capital market.
Thus, banking reforms are primarily driven by the need to achieve the objectives of consolidation, competition and
convergence. (Deccan, 2004). In view of the low financial base of these 89 banks, they were encouraged to merge
because out of the 89 banks that were in operation before reform, not more than ten of them were very strong. As a
result of this, more than 80% (75) of them merged into 25 banks while 14 that could not finalize their consolidation
exercise before the expiration of deadline were liquidated. To a large extent, this consolidation (merger and
acquisition) was based on the proposition that there will be gains accruing from expenses reductions, increased
market power, reduced earnings volatility and encourage economies of scale. In theory, merger is expected to
enhance value by raising the level of bank diversification by either broadening the geographic reach of an institution
or increasing the breadth of the products and service offered. Moreover, the simple addition of newly acquired assets
and deposits were expected to facilitate diversification by increasing the number of bank customers. Greater
diversification provides values by stabilizing returns while lower volatility may raise shareholder wealth in several
ways. First, the expected value of bankruptcy costs may be reduced. Second, if firms face a convex tax schedule,
then expected taxes paid may fall, raising expected net income. Third, earning from lines of business as a result of
customers’ value for bank stability which will necessitate more patronage.

2.1 The Position of the Banks Immediately after Merger/Acquisition

There were glowing performances immediately the consolidation exercise was concluded in the Nigerian Banking
sector. For example, in the case of Skye bank two years after the consolidation era, it received a positive rating from
a financial analysis firm; RTC Strategy and Advisory in 2008, which described the bank’s current performance as
being achieved on some strategic realities coming out from the mergers of five banks namely; Prudent Merchant
Bank Plc., EIB International Bank Plc., Bond Bank Ltd., Reliance Bank Ltd and Cooperative Bank Plc. Skye bank’s
financial performances for the year ended 2008 showed that, it crossed the 1 Trillion mark in total assets and
achieved a profit before Tax of N 21billon ( RTC Strategy and Advisory, 2008). According to the analyst, the bank’s
ratio of non-performing loans steadily reduced from 22.60 percent in 2006 to 5.34 percent in 2007 and 3.70 percent
in 2008, indicating an improved asset quality. It was also noted by the analyst that, the Skye bank’s net earnings
increased by an average of 65% over the last three years, with net interest margins at 58.96% percent which was
seen as very strong. Return on average assets equally steadily improved from 1.98% in 2006 to 2.07% in 2008. On
technology and development payment channels, the analyst noted that the bank was clearly punching above its
weight, having become known as the bank whose Automated Teller machine (ATM) always works.

Similarly, examining Wema bank Plc which acquired National Bank Plc during the consolidation era revealed an
immediate tremendous change since the last reform. Some of the benefit as appraised by the analyst included branch
network increased, total deposits grew by 157% from N32.78 billion to N84.28 billion in 2006, total assets base
increased by 203% from N44.1 to N133.6 billion, shareholders’ fund stood at N26.2 billion as at 31st December.
2005 after the consolidation; a growth of 595%, gross earnings increased by 89.4%, the bank was then ranked among
the top 10 banks in Nigeria because all the110 branches as at 2006 were fully connected real time on line. (See Table
1)

Examining the immediate post-merger performance of the United Bank for Africa (UBA) also revealed ground
breaking record of a balance sheet size of N1.05 trillion, for its financial year ended, September 30, 2006 (Annual
Report 2006). UBA bank Plc emerged after the consolidation from the merger with Standard Trust Bank Plc.
Despite huge interpretation cost associated with the successful merger, which included interpretation, harmonization
of staff salaries and a voluntary exit programme, the bank posted a healthy profit of N12.8 billion. The bank
management even stated that without the attendant merger costs which UBA had prudently decided to absorb in one
financial year, the bank’s profit would have been much higher. The bank then quickly declared a dividend of N1 per
share, which was the highest ever in its history, plus a bonus of 1 share for every 10 shares currently held. Besides,
UBA’s annual account showed that the bank’s deposit base soared 278% from N 205 billion in 2005 to N776 billion
in 2006, with gross earnings rising by 247% from N26.1 billion in 2005 to N90.27 billion in 2006 which was seen as
unprecedented results.

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Intercontinental Bank was the same success story after consolidation having acquired Gate Way Bank, Equity Bank
of Nigeria and Global Bank. It also witnessed tremendous change after the merger and acquisition. Its half year
gross earnings grew by 149% from N13.62 billion in the corresponding period in 2005 to N33.93 billion in Q2-2006
while profit after tax rose to N6.34 billion from N3.32 billion in Q2-2005, an increase of 91%. Soon after this, the
third quarter (Q3-2006) result was released with more promising future as gross earning stands at N59.1 billion and
profit after tax equal to N10.1 billion, translating a quarter-on-quarter growth of 94% and 84% respectively over the
corresponding period in 2005. (Annual Report, 2006; see Table 2)

However, Afri-bank was not left out, its profit after Tax in 2007 was N6.93 billion with total asset of over N182
billion (Afribank Financial Statement, 2007)

2.2 Were These Performances Sustained?

The tragedy that befell the Nigerian banking sector was as a result of the over-blowing performances immediately
after the merger which did not actually allow for caution to be taken by the banks. Given the results presented above,
a quick conclusion could have been drawn that the strategic intervention of merger and acquisition worked the
magic that the Nigerian banking sector needed during the period under review. But shortly after the consolidation
exercises, the World experienced the global economic melt-down which was an acid test for the various
consolidated banks in Nigeria. The weaknesses of the various mergers and acquisitions were blown open in Nigeria
immediately the world entered the centre of the economic meltdown. The global financial crisis began in the United
States of America and the United Kingdom at a point when the global credit market came to a stand-still in July
2007 (Avgouleas, 2008). Unfortunately for the Nigerian banks, this time was the period most of them were trying to
justify the consolidation exercise in Nigeria. Many of these banks were posting very huge profits to actually show
the success of the consolidation exercise (by way of merger and acquisition) when the global economic melt-down
struck.

The financial crises that hit the entire world included stock market crashes and the bursting of other financial
bubbles, currency crises, and sovereign defaults (Kindleberger & Aliber, 2005; Laeven & Valencia, 2008). The
world economists attributed the cause of this crisis to a number of factors which include; housing and credit markets,
which developed over an extended period of time. Some of these include: the inability of homeowner to make their
mortgage payments, poor judgement by the borrower and/or lender, speculation and overbuilding during the boom
period, risky mortgage products, high personal and corporate debt levels, financial innovation that distributed and
concealed default risks, central bank policies, and regulation (Stiglitz, 2008). Similarly, Avgouleas (2008)
enumerated the causes of the crisis as: breakdown in underwriting standards for subprime mortgages; flaws in credit
rating agencies’ assessments of subprime Residential Mortgage Backed Securities (RMBS) and other complex
structured credit products especially Collaterized Debt Obligations (CDOs) and other Asset-Backed Securities(ABS);
risk management weaknesses at some large US and European financial institutions; weak regulatory policies,
including capital and disclosure requirements that failed to mitigate risk management weaknesses.

At the initial stage of this economic crisis, the Central Bank of Nigeria, the Finance Ministry as well as other
government commentators argued that Nigeria economy was partially insulated from the direct effects of the
financial crisis. But, as the nation’s economy is integrated with that of the US and the UK to a greater extent, in no
mean time, Nigerian financial system began to feel the heat of the indirect impacts of the crisis. Specifically, the
financial system was affected in the areas of foreign direct investment (FDI) and equity investment which came
under very serious pressure. Also, withdrawals of portfolio investment as a result of contagion effects began to
cause a reduction in stock prices which eventually led to the crash of global stock and the Nigerian stock market.
The crisis equally led to the downward trend in oil price which put further downward pressure on crude oil prices;
this adversely affected the liquidity of the banking sector of the nation because the country depends on revenue from
oil to finance its budget and the countries that were mostly hit by the crisis were the primary market for Nigerian oil.
For instance, commercial lending came under pressure in developed countries and banks were unable to lend as
much as they have done in the past as a result of bad margin loans that bedevilled all the Nigerian banks.

Immediately after the consolidated banks posted these stupendous financial results in year-end 2008, the crisis that
swept away five managing directors in a day as a result of bad management and falsification of banks’ financial
performances began. The Central Bank of Nigeria (CBN) under the leadership of Mallam Sanusi Lamido Sanusi
conducted an examination of the books of 10 banks jointly with the Nigerian Deposit Insurance Corporation (NDIC).
What was found out was very alarming. It was discovered by CBN and NDIC that 5 out of the 11 banks were
deep-down in financial crisis. The banks were; Intercontinental Bank, Union Bank, Finland Bank, Afri-Bank and
Oceanic Bank. All these banks were among banks that claimed a very huge performance in the year-end 2008. The
apex bank (CBN) had to quickly intervene by sacking the five Managing Directors on 14th August, 2009. They

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included: Dr. Erastus Akingbola (Intercontinental); Dr. Barth Ebong (Union Bank); Mr. Okey Nwosu (Fin-Bank); Mr.
Sebastian Adigwe (Afri-bank); and Mrs. Cecilia Ibru (Oceanic bank). These Managing Directors were further handed
over to Economic and Financial Crimes Commission (EFCC) for further prosecution. In justifying this action, the
CBN Governor (Mallam Sanusi Lamido) and Deputy CBN Governor Operations (Babatunde Lemo) revealed to
Nigerians that, it was margin loans that got banks into trouble as a result of banks’ exposure to the capital market. The
CBN said, eleven of the 24 banks in the country are carrying the burden of N421.7 billion as margin lending including
loans to individuals, stockbrokers or loans to corporate bodies backed by share certificates. CBN put the total estimate
of the facilities banks granted individuals, stockbrokers as well as lending secured with share certificates at N1.2
trillion. It further reiterated that, available figures show that the top 11 banks in the country granted a total of N229.9
billion to individuals and corporate bodies as facilities to purchase shares. A breakdown of the data indicated that
Intercontinental Bank tops the list of banks with heavy exposure to margin loans of N85.2 billion. The amount was
said to be made up of N36.9 billion facilities granted to individuals and stock brokers and a total of N 48.3 billion
granted to other corporate entities who used share certificate as collateral. It was followed closely by GT Bank which
had a total margin loan portfolio of N70.3 billion made up of N18.9 billion loans to individuals and stock brokers to
buy shares and N51.4 billion to other corporate entities who used share certificate as collateral. In CBN analyses, it
further mentioned Eco-bank as third in the high profile margin loan saga with a margin loan exposure of N59.2 billion.
First Bank was not left out, it had a total share loan exposure of N58.8 billion, but its balance sheet showed that it did
not join the race for granting margin loans during the share boom years to individuals and stock brokers but corporate
bodies that used share certificates as collateral. Others were: Access Bank Plc, with a total exposure of N33.5 billion of
which N20.1 billion is as a result of loans granted to individuals and stock brokers for share trading while N13.4
billion was granted to other corporate entities which backed up the loans with share certificates; Oceanic Bank Plc,
which granted a total of N22 billion as facilities for share trading to individuals and stock brokers; United Bank of
Africa with a loan portfolio of N21.6 billion backed by share; Diamond Bank with a balance sheet total of N20.2
billion margin loans portfolio made up of N19.6 billion granted to individuals and stock brokers and N0.6 billion
granted as facilities to other corporate bodies with share certificate as collateral; Union Bank, with a total of N17.8
billion margin loan facilities; Stanbic/IBTC bank with a total of N10.1 billion made up of N5.2 billion granted for
share trading while N4.9 billion was granted to other corporate bodies backed with share certificates. (CBN Governor
Press Briefing on the Managerial Restructuring and Developments of some Nigerian Commercial Banks, 14th August,
2009)

It was amazingly revealed from the investigation that, transparency was weak in Nigeria. With the exception of
Guarantee Trust Bank (GTB), bank financial statements were only presented in local GAAP (Generally Accepted
Accounting Principles). However, Nigerian GAAP do not require the same levels of detailed disclosure as IFRS
(International Financial Reporting System), which always made most Nigerian banks not to provide supplementary
information of their Tier-1 and total capital adequacy ratios and detailed information regarding their loan portfolios in
their annual reports. During the period under review by the CBN, First Bank was the only bank in the sector that
disclosed its share lending exposure at end 2008 in its annual report. Share backed and margin lending were features of
many Nigerian banks over the past two years before this examination was conducted. The CBN estimated sector wide
exposure to this type of lending to be about N200 trillion at end 2008 which CBN said represented 30 per cent to 45 per
cent of system wide share holder funds in 2008. Of this amount, the CBN estimated that about N400 billion related to
margin lending. These facilities were primarily to individuals and stock brokers for the purpose of acquiring shares.
After this exposure that revealed that all the performances after the consolidation were window dressed, the CBN then
required all banks to make appropriate provision for non-performing loans and disclose them so that at the end of that
quarter, all banks would have cleaned up their Balance Sheets.

The ugly part of this scenario is the facts that, most of these emerged banks (from the consolidation exercise) are
presently among the troubled banks. After the exercise of the examination of the 10 banks in 2009, the second round
that examined 11 banks found out many more non-performing loans and insiders’ abuse. This led to the sack of
Bank PHB and Spring bank Managing Directors and finally the revocation of licenses and nationalization of the
three most troubled banks namely; Bank PHB (Now key Stone Bank Ltd), Spring Bank (Now Enterprise Bank Ltd)
and Afri-Bank (Now Main-Street Bank Ltd). They were on 5th August, 2011 handed over to Asset Management
Corporation of Nigeria, (AMCON), through a nationalization process designed by Central Bank of Nigeria, (CBN)
to protect depositors money. However, 30th September, 2011 was set as deadline for weak banks to recapitalize in
Nigeria for the country to possibly experience a new era in the banking industry. The earlier five rescued banks, viz:
Oceanic Bank International Plc, Finbank Plc, Union Bank of Nigeria Plc, Equitorial Trust Bank Limited (ETB) and
Intercontinental Bank Plc were lucky to scale through by securing core-investors. Oceanic Bank is operating under a
Transaction Implementation Agreement (TIA) with Ecobank Transnational Incorporated (ETI); Union Bank sealed
another merger deal with African Capital Alliance Consortium; Fin-bank acquired again by First City Monument

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Bank; Intercontinental bank acquired by Access Bank and Equitorial Trust Bank acquired by Sterling Bank Plc. in
just about 5 years after the first consolidation exercise (through mergers and acquisitions) there was a compulsory
need for anther consolidation to rescue the nation’s banking sector. “THE BIG QUESTION IS”: if the first
consolidation exercise did not work, what is the assurance that this repeated exercise will make a significant
difference? However, the CBN Governor is very hopeful that the crisis in the banking sector would be over by 30th
September, 2011; the last date, all commercial banks must have been capitalized with very strong liquidity rate and
very low non-performing loans (NPL) to ensure efficiency in their operations. So was the 2005 consolidation
exercise CBN Governor (Professor Charles Soludo) was so hopeful. It is hoped that, the good of this strategic
exercise will be witnessed in Nigeria now and not the bad nor the ugly. However, world record still showed that
only 1 out of 3 mergers always succeed after the merging exercise. The 2005 Nigerian Banking Sector
Consolidation exercise did not even record this percentage (i.e. 33.3%). Virtually all the consolidated banks through
mergers and acquisition have failed in the sector. The very few banks that have been adjudged to be a bit healthy
like First Bank, Zenith Bank, and Guarantee Trust Bank did not engage their strategic positioning during the
consolidation exercise in 2005 by ways of merger and acquisition. Instead, they recapitalized with maximum
assurance to their shareholders of their readiness to ensure quality return on shareholders’ wealth. This therefore put
a big question mark on the possibility of merger and acquisition being the strategic solution to the Nigerian turbulent
banking sector.

3. Methodology

In carrying out empirical investigation on this study to actually measure (statistically) the significance of merger and
acquisition as an intervention strategy in the banking sector, the authors purposively selected five banks for survey
(i.e. Intercontinental bank, Skye bank, Afri-bank, Wema bank and United Bank of Africa). Besides the survey study
which was carried out by the use of primary data (questionnaire), the authors went ahead to examine and analyze the
books of these selected banks. Data (secondary) were extracted from the financial records of the banks for analyses
by considering financial records of ten years; comprising of five-year financial record before the
recapitalization/consolidation exercise (that brought about merger and acquisition) and five-year financial record
after the merger and acquisition strategy has been consummated. Twenty (20) copies of the questionnaire were
randomly administered on the management staff of each of these banks making a total of hundred (100) copies.
However, Eighty-seven (87) copies were returned by the respondents signifying 87% administration success. In
analyzing the data (both primary and secondary) Ordinary Least Square (OLS) and t-test methods were used.
Collated data were analyzed by the use of tables for classification purpose and OLS used in measuring the linear
association between a dependent variable (Y) which is predictive and independent variable X which is the predictor
(i.e. Y = a + β0X, where: Y = dependent variable; X = independent variable; and ‘a’, β0 = are constants)

3.1 Hypotheses, Models Specification and Results

The following hypotheses and models were formulated to consider the empirical investigation carried out on this
study and the results are equally presented:

3.1.1 Hypothesis One

Merger and acquisition as a strategic intervention has not significantly curb distress in Nigeria banking sector.

The regression model to test this hypothesis is formulated thus:

DTR = f (MCQ)

i.e DTR = b0+b1 MCQ+U1,

Where: DTR = Distress in Nigeria banks; MCQ = Merger and Acquisition, and U1 = Stochastic Error term.

Results: (see Table 3)

DTR = -9.514 + .281 MCQ + U1

Std. Error = (2.389) (.043)

t = (-3.983) (6.591)

R = .582, R2 = .338, R2 =330, F = 43.446, DW = 2.217

The result presents the effect of Merger and Acquisition on curbing distress in Nigeria banks. The result showed
that, calculated t-statistics (t = 6.591) for parameter MCQ is greater than tabulated t-statistics (t = 1.980) at 0.0

level of significance. The coefficient of MCQ in the estimated regression model is .281 which implies that 28% of
the decrease in DTR was accounted for by the MCQ. The coefficient of determination (R2) is .338 indicating that
34% of variation in DTR is caused by variation in MCQ. The remaining 66% unexplained variable is largely due to

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variation in other variables outside the regression model which are otherwise included in the stochastic error term.
The relationship between DTR and MCQ is moderately high, positive and statistically significant at 0.05 level (t
= .582, P < 0.05). The Durbin-Watson statistics is 2.217 which showed that autocorrelation is absent in the regression model. The overall regression model is statistically significant in terms of its overall goodness of fit (f = 43.446, P < 0.05). As a result of this the study accepts the alternatively hypothesis (H1) meaning that Merger and Acquisition had helped to curb distress in Nigeria banks.

3.1.2 Hypotheses Two

There is no significant difference between the performance of banks before the merger and the post-merger period.

In conducting this test, the performances of banks were compared on the basis of their capital and profit before and
after Merger using independent sample t-test statistics at 0.05 alpha level. (see Table 4)

Table 4 presents the performances of the banks before and after Merger periods. The result showed that, the

average

capital of banks sampled in pre-Merger period was N1433.20 million while post-Merger period recorded average
capital of N6358.76 million. Therefore, the mean difference between Pre-Merger and Post-Merger period was
statistically significant at 0.05 level (t = 6.755, P < 0.05). Similarly, the sampled banks recorded average profit of N2192.48 million during the pre-Merger period while the post-merger period increased significantly to N

16839.12

million. The mean difference between banks’ profit in pre-merger and post-merger periods was equally statistically
significant at 0.05 level (t = 5.276, P < 0.05). Therefore, the alternative hypothesis (H1) was accepted which implied that, banks’ performance in post-Merger was significantly different from the performances before Merger.

3.1.3 Hypotheses Three

Bad corporate governance is not responsible for the forceful consolidation exercise in the Nigerian banking sector
in 2005 and the recent one in 2011.

The regression model is specified thus:

BCG = f(MCQ)

BCG = b0 + b1 MCQ + U1

Where: BCG = Bad Corporate Governance; MCQ = Merger and Acquisition; U1 = Stochastic Error term.

Results: (see Table 5)

BCG = -7.959 + 1.059 MCQ + U1

Std. Error = (18.533) (.331)

t = (-.429) (3.197)

R = .328, R2 = .107, R2 = .097, F = 3.197, DW = 0.207

The result above measured whether bad corporate governance was responsible for the compulsory merger and
acquisition in 2005 and the one being currently consummated in 2011. The result revealed that, calculated t-statistics
(t = 3.197, P < 0.05) was greater than tabulated t = statistics (t = 1.980) at 0.05 level of significance. The coefficient of determination (R2) was 0.107 which implied that 11% of the variation in BCG was caused by variation in MCQ. The remaining 89% unexplained variation is caused by other variables outside the regression model which are otherwise included in the stochastic error term. The relationship between BCG and MCQ is low and positive but statistically significant at 0.05 alpha level (r = .328, P < 0.05). The Durbin Watson statistic was 0.207 which implied that autocorrelation exists in the model. However, the regression model is statistically significant in terms of its overall goodness of fit (F = 10.221, P < 0.05) hence the alternative hypothesis was accepted. This implied that, bad corporate governance was actually responsible for the 2005 hasty merger and the one being currently executed in the banking industry in Nigeria.

4. Conclusion

This study has combined theoretical and empirical investigations to evaluate the intervention roles of merger and
acquisition strategy in repositioning the ailing banking sector in Nigeria. However it was discovered that, the merger
and acquisition that was consummated in 2005 only addressed the dangerous position of the nation’s banking sector
then in a ‘fire-brigade’ approach. Immediate results after the consolidation were only window-dressed success that
eventually did not last. However, the Enron Corporation saga in 2001 made a repeat of itself in Nigeria after the
consolidation. As highlighted in this study, the various posted financial results of the banks made many Nigerians to
borrow fund from them (the banks) to pursue the acquisition of banks’ shares. This eventually led to the demise of
many when the actual status of the banks was revealed in 2009; the shock that the economy has not recovered from

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up till date. This study actually tested three hypotheses; from the tests, it was evident that, merger and acquisition
was able to rescue the banks from the brink of collapse in 2005 and that, financial indices showed an improved
performance after the merger. But this did not translate into fulfilling the objective of repositioning the banking
sector for effective performance for the aftermath effect of the consolidation exercise was another round of failure
that has led to the recent merger and acquisition of the rescued banks. The last hypothesis actually provided answer
to our curiosity for it established that, bad corporate governance was what necessitated the 2005 fire-brigade merger
and acquisition; the marriage of many strange bed fellows.

5. Recommendations

In view of the findings from this research, the following are hereby suggested:

Merger/acquisition is a strategic tool that must be cautiously applied and implemented. The maturation period of the
merger must be allowed so that the financial records of the intending firms coming together can be properly
scrutinized by the board of directors of each firm and the regulatory agencies. Merger/acquisition is supposed to be
an intention of which either of the parties to the merger/acquisition can opt-out if hanky-panky (fraud or deceit) is
discovered as being perpetuated. Merger/acquisition is supposed to be consummated when organisations want to
leverage on the benefit of synergy and not a strategy to escape liquidation or meet statutory requirements to still
continue to exist even with toxic assets which was the type of 2005 merger/acquisition. Therefore, Central Bank of
Nigeria (CBN) and other regulatory agencies should take caution in rushing the ailing banks into another
compulsory merger/acquisition. The process this time around should be painstakingly scrutinized to ensure that the
emerged balance sheet of the new firm from the merger/acquisition is not doctored nor containing ghost financial
figures that will further deceive the investors and injure our economy after the consummation.

It was evident from this study that ab initio, there would not have been need for the 2005 forced merger/acquisition
if the various banks have gotten their corporate governance right. As a matter of fact, insiders’ abuse and bad
financial management were responsible for weaknesses of the 89 banks before 2005 that merged into 25 banks and
later 24 banks. Corporate governance is regarded as a system of checks and balances so that value is created by the
organization in ethical ways to ensure that firms achieve their strategic objectives and meet their specified
obligations in the most appropriate manner. Good corporate governance therefore, should be enforced by the
regulatory agencies with stringent penalties. This will definitely build financial confidence that will help the firms to
achieve their strategic objectives, and that of the shareholders. Good corporate governance is enough a strategy to
enhance desired productivity and performance in the banking sector if all the cow-boys directors who do not uphold
the tenets and fundamental principle of banking are shown the way out to pave way for an effective and efficient
banking sector in Nigeria.

Finally, since the board of directors are responsible for implementing corporate governance in any firm, the
shareholders should better organise themselves (with their votes) to always ensure selections that will respect
integrity, professionalism, probity and accountability. Complete end should come to an era of very powerful
Managing Directors that can put the banks in their pockets. To avoid controversies that trailed the sack of the five
managing directors by CBN in 2009, shareholders should be alive to their responsibilities by protecting their wealth
through spontaneous reaction (in the future) to any banks’ Managing Directors that are found culpable of bad
corporate governance. This will rather save us from hastily approaching merger/acquisition without a specific
objective.

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Table 1. Five-year annual financial statements summary of Wema Bank

2006

#billion

2005

#billion

2004

#billion

2003

#billion

2002

#billion

Total assets 133.60 97.91 71.42 61.32 44.10

Deposit liabilities 84.28 61.28 55.07 43.76 32.78

Loan $ advance 70.73 57.99 42.31 24.63 18.25

Current assets 45.04 40.17 27.07 35.02 24.50

Shareholder’s fund 26.26 24.26 8.04 7.22 3.77

Gross earning 15.00 15.29 12.86 9.72 7.92

Profit before tax 3.13 1.00 1.42 2.28 2.29

Source: Wema Bank Presentation at the London Stock Exchange (2007).

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Table 2. Five-year annual financial statements summary of Intercontinental Bank Plc

Profitabilitilty ratio
Post-merger

Feb. 06

14 months

ended Feb. 05
Dec 03 Dec 02 Dec 01

5 year

average

Gross earnings 50.65% 41.93% 38.82% 34.89% 32.48% 39.75%

Gross earnings/total assets & contingent liabilities 9.81% 11.42% 19.54% 6.93% 5.41% 10.62%

Profit after Tax/ Gross earnings 21.16% 23.89% 17.00% 17.66% 13.22% 18.79%

Gross operating margin 79.57% 78.25% 65.99% 64.62% 60.35% 69.78%

Net interest margin 27.21% 30.45% 21.23% 20.48% 16.95% 23.26%

Return on average assets (pre-tax) 4.20% 5.69% 5.69% 5.54% 4.09% 5.04%

Return on equity 15.96% 15.40% 29.98% 25.30% 27.50% 22.81%

Source: www. Intercontinentalbankplc.com: Trend in Performance 2001-2006.

Table 3. Regression showing whether Merger/Acquisition has curbed distress in Nigeria Banks

Model Coefficient Std. Error T Sig. T

Constant -9.514 2.389 -3.983 .000

Merger and Acquisition .281 .043 6.591

.000**

Source: Field Survey 2011.

Note: ** means significant results.

Table 4. ‘t’-test showing the Banks’ performances in pre and post-Merger periods

Variable Period N Mean SD t-cal t- tab Sig.

Capital Pre-Merger

Post-Merger

1433.20

6358.76

823.40

3551.57

6.755

2.00

.001**

Profit Pre-Merger

Post-Merger

2192.48

16839.12

1847.17

13755.78

5.276

2.00

.000**

Source: Financial records of the selected banks (2001-2010).

Note: ** means significant results.

Table 5. Regression on whether bad corporate governance is responsible for Merger/Acquisition

Model Coefficient Std. Error T Sig. T

Constant -7.959 18.533 -.429 .669

Merger and Acquisition 1.059 .331 3.197 .002**

Source: Field Survey 2011.
Note: ** means significant results.

www.ccsenet.org/ibr International Business Research Vol. 5, No. 5; May 2012

Published by Canadian Center of Science and Education 157

All values in million

Afrik bank

Pre-Merger Capital Profit Skye bank Capital Profit

2001 552 116 500 203

2002 552 2231 1524 523

2003 552 2471 1524 854

2004 1104 1566 1524 918

2005 2354 231 2264 743

Post-Merger

2006 2554 3695 3245 2091

2007 2554 5081 3752 7519

2008 2554 12361 5792 20425

2009 3548 16024 6812 24623

2010 5760 20425 6923 26736

UBA

Pre-Merger Capital Profit Wema bank Capital Profit

2001 850 1585 675 800

2002 850 2238 779 2294

2003 1275 4816 1527 2286

2004 1275 5618 1555 1420

2005 1530 6239 4452 1002

Post-Merger

2006 3530 12514 4542 (7200)

2007 5748 22827 5035 1879

2008 8622 45805 5496 3456

2009 9324 48343 6212 9867

2010 19086 50198 6981 12133

Intercontinental

Pre-Merger Capital Profit

2001 1436 1343

2002 1794 1523

2003 1794 2380

2004 1794 3414

2005 1794 6706

Post-Merger

2006 5362 11030

2007 5362 22316

2008 9733 9960

2009 10121 11231

2010 10320 13239

Source: www.google.com.

Compiled from CBN bulletins 2002-2010.

InternationalBusiness Research; Vol. 5, No. 8; 2012

ISSN 1913-9004 E-ISSN 1913-9012

Published by Canadian Center of Science and Education

160

Barriers to Developing Competition in the

Polish Electricity and Gas Market

Sylwia Słupik1

1 Department of Social and Economic Policy, Faculty of Economics, University of Economics in Katowice,
Katowice, Poland

Correspondence: Sylwia Słupik, Assistant Professor, Department of Social and Economic Policy, University of
Economics in Katowice, 1 Maja 50 St. 40-287 Katowice, Poland. Tel: 48-32-257-7565. E-mail:
sylwia.slupik@ue.katowice.pl

Received: April 30, 2012 Accepted: May 31, 2012 Online Published: July 20, 2012

doi:10.5539/ibr.v5n8p160 URL: http://dx.doi.org/10.5539/ibr.v5n8p160

Abstract

The paper presents main barriers of creating a competitive energy market in Poland. Polish energy and gas sector
in space of few recent years underwent breakthrough changes as far as regulations, structure, organisation and
ownership are concerned. Drivers of change included the necessity to align national regulations with EU
standards through transposition, and creating entities strong enough to finance their own investment outlays. As a
result of those changes, both private and public producers and providers can compete for customers whilst using
the regulated network infrastructure. Through those changes regulatory bodies were established and some of the
following measures were used: TPA rule, accounting unbundling, legal unbundling and functional unbundling,
merger & acquisition supervision on the national and regional level, state aid programmes and a range of other
instruments facilitating consumer access to competitive power purchase offers concerning energy and natural gas.
However, electricity and gas markets still remain dominated by market incumbents plus the competition is still
limited, particularly so in the natural gas market. Among barriers impeding development of Polish energy sector
and liberalisation of electricity and gas markets are: vertical consolidation in the sector; wrong architecture of the
wholesale market; unstable regulatory environment; maintaining retail prices for households regulated; low
consumer activity in the energy market.

Keywords: Poland, electricity market, gas market, liberalisation, main barriers

1. Introducation

The energy sector is centrepiece to development of every contemporary country. Its sustainable development is
crucial to guarantee national energy security. Key component of that development is keeping electricity supplies
at a safe level meeting nationwide demand, providing energy at competitive prices and in line with current
legislation, including environmental regulations and social expectations. Current energy situation worldwide
requires adaptive measures to adjust legislation, because long-term forecasts are not conclusive as to prospective
difficulties with finding new sources of energy. Energy resources, especially threat of short supply of resources,
could be used as an instrument influencing international relations. The highly competitive electricity and gas
markets pose a challenge to assure safety of energy supplies both short-term and long-term. Conditions required
to meet that objective is to secure adequately high and well-structured energy investments. Under normal
circumstances, those investments are subject to lengthy administrative procedures and are capital intensive. That
means the market cannot respond to signals issued by its participants as that reaction is usually sluggish and
ultimately late. Investment and pro-growth energy policy are fundamental as they guarantee safety of energy
supplies, rational energy generation costs and compliance with ecological requirements.

Polish energy and gas sector in space of few recent years underwent breakthrough changes as far as regulations,
structure, organisation and ownership are concerned. Drivers of change included the necessity to align national
regulations with EU standards through transposition, and creating entities strong enough to finance their own
investment outlays. In accordance with EU law all member states are obliged to implement into national
legislation provisions of the 3rd energy package, which came into force on March 3rd 2011. The process of
implementing EU regulations has not been concluded, however, once it comes into full effect, the new legislation
will facilitate integration of the energy market and will speed up sluggish rate of development restraining

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161

competition in Polish electricity and gas market.

This is essential as there are numerous challenges in front of the Polish market. The necessity of fundamental
and far-reaching modernisation tied in with increasing capacities converges with inevitable adapting measures to
comply with costly requirements stipulated by the European Climate Package. Poland is obliged to limit its O2
emissions and switch to low energy economy at the same time. High energy demand, inadequate generating, fuel
transport and energy infrastructure, substantial dependence on external natural gas supplies and as near as makes
no difference complete dependence on external petroleum supplies as well as environment protection obligations
– including climate related – require taking decisive actions to outset the threat of fuel and energy

consumers

being worse off.

Well-oiled and healthy markets are absolutely key to assure safety of supplies and improve efficacy and quality
of services. Over recent few years, Poland has made inroads into liberalising its electricity and natural gas
markets. Liberalisation, however, is a continuous process and as it was in case of other countries, there is loads
yet to be done before a fully robust market emerges from the process. Electricity and gas markets still remain
dominated by market incumbents plus the competition is still limited, particularly so in the natural gas market.

2. Characteristics of the Polish Energy Sector

In 1990 Poland entered the arduous transition process of shifting from centrally planned economy to market
economy. The energy sector managed to carry out considerable social, political and economic reforms. As a
result of dropping industrial output and growing GDP energy consumption fell. This was particularly evident in
demand for electricity and coal due to closures of energy-intensive heavy industry facilities. Among the most
important changes which took place over that period in Polish energy sector are (European Investment Bank,
2008):

 “rationalisation” of energy consumption aimed at decreasing already high energy consumption in Poland
and increasing efficiency of the energy sector, improving quality of produced coal, reducing heat waste etc.
It involved starting the energy saving process which is yet to be concluded both from supply and demand
point of view,

 reform of energy pricing strategies aimed at restoring the link between prices and market conditions which
often ends up with higher energy prices,

 restructuring reform involving transforming vast, ineffective enterprises into separate companies.

The energy sector is one of the fastest developing parts of the economy. Growing world population, economic
growth and giant technological leap over recent years are all factors fostering increasing energy demand. Poland
owns some of the biggest coal deposits in Europe, hence it became the mineral of choice for the energy
generating industry. In 2011 86% of Polish primary energy supply came from fossil fuels, whereas the remaining
part was provided by biomass and biogas. While the dominance of coal in national fuel consumption has
significantly loosen its grip – 76% in 1990 down to 56% in 2008, the aggregate reliance on fossil fuels has
decreased only by 5% over the same period from 98% to 93% due to increasing importance of petroleum and
natural gas (OECD/IEA, 2011).

Use of coal as key fuel, on one hand makes Poland independent of foreign energy supplies, on the other though,
it may generate additional costs and decrease competitiveness of this fuel among other energy sources. Tight link
between the power and coal industries creates the danger of electricity sector becoming vulnerable to economic
and social hardship experienced by the mining industry. This is observed through pressures on increasing and
“regulating” prices to the power industry for coal and fuel deliveries.

Historically, petroleum has been the second most important fuel and its consumption has nearly doubled since
1990 by reaching 25% in 2009. Also noteworthy is maintaining for few years now increasing production of
renewable energy. Consumption of gas and biomass grew by 4% over past three decades by reaching 13% and
6% respectively in 2008. It should be emphasized that other power stations have also increased their output thus
underlining shooting up importance of distributed generation (in 2009 30% increase year-on-year) (Energy
Regulatory Office, 2011a).

The processes taking place in Polish energy market in 2010 characterised with growing output and consumption
of electricity. In 2010 national demand for electricity was 154.98 TWh which translates to 5.5% increase
compared to 2006. The same year Polish commercial and utility power stations generated a total of 157 TWh of
energy. That is 21% more the Ministry of Economy forecasted (Ministry of Economy, 2009).

According to PSE Operator SA reports national electricity consumption increased in 2010 4% year-on-year,

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whilst energy output grew over the same period by 3.59%. Note, this comparison concerns 2009 – the year of
economic downturn.

Table 1. Domestic production of consumption of electricity (TWh) according to PSE Operator SA

2010 2009 2010/2009

TOTAL OUTPUT 156 337 150 912 3.59%

Commercial power stations: 146 104 141 874 2.98%

Water power stations 3 266 2 751 18.72%

Thermal power stations

– black coal fired

– brown coal fired

– Gas-fired power stations

142 835 139 120 2.67%

89 208 84 272 5.86%

49 459 50 796 -2.63%

4 164 4 049 2.84%

Other renewables 10 21 -53.81%

Wind farms 1298 820 58.29%

Utility power stations 8 923 8 203 8.78%

National energy consumption 154 983 148 721 4.21%

Source: PSE Operator SA.

Renewables consumption in Polish energy sector increased according to 2010 data. Output of run-of-the-river
power stations increased by almost 18% whilst wind farms’ by 58%. Output level has also increased at biomass
and biogas fired power stations. Furthermore, renewables are gaining ground on a regular basis, what finds
reflection in generating capacity dynamics. Compared to year before, by year-end 2010 renewable energy plant
had 19% more operational generating capacities. Consequently renewables-based energy output increased as
fraction of total energy output from 5.8% in 2009 to 6.2% in 2010 (Grant Thornton Frackowiak, 2010). Higher
renewable energy production is stimulated by putting in place certain mechanisms. There are two fundamental
systems supporting renewables investment in force in Europe. First – feed in tariff, practised in majority of EU
Member States. Polish Energy Law (Energy Law, 1997) act imposes on electricity distributors requirement to
buy from their suppliers a predetermined quotas of renewable energy. The system of so called colour certificates
is a vital factor supporting renewable energy production. However, despite it being in place already since 2005,
fraction of renewables in total energy output in Poland remains still inconsiderable. In 2010 it reached as much
as 6.8%. This means that despite renewables consumption increased by 26%, set out by the Ministry of Economy
target of 7.5% renewables fraction in total national energy output was not met (Minister of Economy, 2010).
Note that European Union requires Poland to produce 15.5% of its total energy output from renewables by 2020.

Dynamic fast-paced boost in production of renewable energy was caused above all by wind energy. Power
output from renewables increased in 2010 by almost half. Wind energy production also did strengthen thereby
confirming the long-term upward trend for consumption of this type energy. Wind energy has growing stake in
total renewable energy output which grew during 2010 from 13% to over 15%.

Another renewable energy source which plays an increasingly important role in the Polish energy sector is
biomass. Polish investors tend to put greater resources behind biomass-based projects (either biomass
combustion or co-firing with coal) aimed at generating electricity and thermal energy. Investment in
biomass-fired power station is planned by both major energy conglomerates (i.a. Tauron, DGF, SUEZ or Dalkia
Poland) and local cogeneration plants. Polish energy policy forecasts increasing consumption of that energy
particularly as far as biogas is concerned. In accordance with Ministry of Economy estimates, biogas fraction in
total renewable energy output will shoot up over next 20 years from 4% to 17% and will provide 11% of total
heat energy compared to current 1%. Those forecasts are confirmed by data from the Energy Regulatory Office.
They show that generating capacity of biomass-fired plants increased in Q1 of 2011 by 42.86 MW to 399.05
MW i.e. by over 12% (Grant Thornton Frackowiak, 2010).

Total consumption of natural gas in 2010 in Poland was 158.1 TWh. 110.4 TWh/year of imported gas was
complemented by nationally extracted gas i.e. 46.3 TWh/year which covered approx. 30% of domestic natural
gas demand. Compared to 2009, total gas consumption soared by 7.8%, imports by 9% whereas domestic
extraction sprung by just 2.7% at constant generating capacities. Total gas imports in 2010 featured gas from
Russia, Ukraine and intra-Community supplies from Germany and Czech Republic. The highest share of gas
imports was provided by Russia as part of agreement concluded in 1996 between PGNiG SA and Gazprom
Export. Under that contract 99 TWh of natural gas was purchased translating to 89% of total gas imports into

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Poland, whereas transit of fuel gas fed through Polish part of the Yamal-Europe pipeline was 259.41 TWh/year.
The remaining demand was satisfied with supplies from Germany, Ukraine and Czech Republic. Total volume of
gas supplies provided under provisions of gas import agreements was 1 038 million m3, which equalled approx.
11% of total gas imports to the Polish territory. In 2010 only two entities purchased gas for further resale. It was
a relatively small amount – just over 18 thousand tonnes of liquefied natural gas, bought without using the TPA
rules (Energy Regulatory Office, 2011b).

Table 2. Gas supplies in 2010

Item Quantity [million m3]

Imports, including: 10066.4

– Yamal LNG agreement 9028.4

Intra-Community purchase/Country of origin

a. Czech Republic

b. Germany

0.3

1031.9

Other imports/Country of origin

a. Ukraine

5.9

Domestic extraction 4220.4

Gas reserves (change in reserves) 272.1

Source: PGNiG SA.

3. Companies and Concentration of the Electricity Market

Over recent years Poland has made inroads into liberalisation of energy markets through implementing EU
regulations concerning liberalisation of energy markets and supplies security faster than other EU Member States
where transition processes had already taken place. Despite positive transformations, however, Polish electricity
and gas market still shows little competitiveness.

Current composition of the energy sector and concentration of their operations are effect of horizontal
consolidation processes followed by vertical M&As of companies owned by State Treasury. Both the electricity
production sector and the wholesale market remain under strong concentration. The industry leader as far as
generation is concerned is PGE Capital Group SA. The sector of energy providers is dominated by Tauron Group
SA. The consolidation process which in fact has not concluded, will have had major impact on opportunities for
building a competitive wholesale marketplace. The lion’s share of generated electricity (90%) is sold under
bilateral agreements. Fraction of energy sold in the spot market (stock exchange, electricity trading platforms)
remains low in spite of increases observed in 2009. Sheer dominance of bilateral agreements and capital group
concentrated trade have their impact on suppressing wholesale market liquidity and causes the pricing policies to
remain murky. An open and robust wholesale market would be key to have real competition (OECD/IEA, 2011).

In 2010 the sales structure at the wholesale market looked similar to previous years. The main electricity
consumers at the energy wholesale market were energy distributors. Sales were generally made between capital
group companies. Polish Power Exchange (TGE SA) showed fast-paced growth dynamics in 2010. Main reason
for increasing energy sales through exchange were amending provisions to the Energy Law act coming into force
by August 9th 2010. They obligated all energy producers to sell through the stock exchange either 15% or 100%
of their generated output (concerning producers qualifying for the long-term contract programme). Volume of
trade at the Polish Power Exchange reached 3 TWh a mere 2% of total electricity consumption in 2009.
Nonetheless that was a 45% increase year-on-year. Further 4.36 TWh, i.e. 2.93% of domestic electricity
consumption was sold through On-line Electricity Trading Platform. Due to growing trading volumes at TGE SA,
Polish energy market is liquid enough to give third party access to interconnection with the Scandinavian market
through market coupling mechanisms i.e. implicit auctions made at power exchanges: Nordpool Spot and TGE
SA. The cross-border transmission capacity of monopolar high-voltage direct current (HVDC) submarine cable
between Poland and Sweden (SwePol Link) is 600 MW. This high voltage cable enables members of TGE and
Scandinavian NordPool Spot Exchange to sell generated energy to other markets and purchase cheaper energy
from neighbouring markets. The main issue, however, in the way of full integration between Polish and
neighbouring markets are insufficient cross-border transmission capacities (Energy Regulatory Office, 2011b).

The Polish retail electricity customer market is shaped by 16 million end-consumers, 85% of which are
households. Electricity sold to households makes up for approximately 24% of total electricity sold. Polish

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transmission grid is maintained by state-owned PSE Operator SA supervised by the Ministry of Economy. Apart
from end-consumers, participants of the retail market are distribution system operators (DSO) and electricity
providers (energy trading companies). The biggest sellers of electricity are incumbent companies, which
emerged after separating out distribution system operators (currently seven entities) as parties to comprehensive
agreements i.e. agreements combining provisions of purchase-sale agreement and power purchase agreement
concluded with consumers. They operate in capacity of ex officio distributors for households, which did not
make the decision to switch suppliers. Apart from the big seven there are also other providers (approximately
twenty active members), whose origins do not trace back to old distribution companies. There are also approx.
200 other vertically integrated industrial electricity suppliers which apart from selling also offer distribution
services. The number of entities holding electricity distribution licences totals approx. 300 companies (Energy
Regulatory Office, 2011b).

Bearing in mind the majority of distribution system operators are incorporated into groups owning both
production and supply units, the process of becoming downright and fully independent is a slow one, however,
all formal and legal obligations concerning DSO independence have been fulfilled. The division responsible for
supplies in each of the groups, sells energy mainly to consumers connected to distribution network owned by
that group. Energy Regulatory Office stresses DSOs achieved a significant milestone in 2009, whereby they
worked out equal terms for all users of the system and equal access to distribution networks for third parties. The
competition beyond operating area of DSOs increases gradually at a slow pace though due to closely matched
competitive offers (OECD/IEA, 2011).

Initiated in 1998 liberalisation process of Polish electricity sector entered the stage when fully
competition-promoting measures were in place by July 1st 2007, when in accordance with EU directives
consumers were empowered to choose electricity suppliers. Consumer activity on Polish electricity market
measured by number of customers switching suppliers remains low. In 2009, over 1060 local clients (located
within operating area of given supplier) changed suppliers. In 2008 that same number was 905, and in 2007 – 541.
Fraction of connected external customers (measured by energy consumption) was significantly lower than of
households. Increasing compared to previous years number of companies switching providers in 2009 was linked
to economic downturn which pressured businesses to cut costs thus find better energy offers. In 2008 the
administrative procedure of switching providers was shortened and simplified. Regardless of that improvement,
other barriers of different character were still in the way. There still are not enough competitive offers what
explains low interest among consumers. As far as residential customers are concerned, the state of affairs is
down to tariff regulations concerning households, which show little differentiation between suppliers. According
to Energy Regulatory Office, among other barriers is “lengthy process of concluding power purchase agreements
and unfavourable provisions putting consumers at a disadvantage once they decided to switch providers”.
Moreover, knowledge on possibility and procedures for switching suppliers is deficient, especially among
households putting additional constrain on competition.

Table 3. Consumers switching providers in 2006-2009

Year

Consumers switching providers by energy consumption (%)
Number of renegotiated

agreements
Large industrial

consumers

Average industrial and commercial

consumers

Small business and individual

consumers

2006 15.84 0.012 0 47

2007 16.95 0.128 0.001 44

2008 15.95 0.309 0.005 No data

2009 22.39 1.150 0.03 No data

Note: * renegotiation of agreement is synonymous with amending agreement with previous supplier.

Source: Energy Regulatory Office.

However, despite the number of consumers who took advantage of their right to switch suppliers in 2010
remains low, it nevertheless is an increase on 2009 figures. Study factoring in different tariff groups, proves that
in 2010 the number of consumers who decided to change their energy provider grew in excess of 300%
compared to 2009. In tariff groups A, B, C (commercial consumers) that number was approx. 500% and in tariff
group G (individual consumers) – approx. 17%. When evaluating those indicators, however, one should bear in
mind that very few consumers (mere 0.05% of all consumers) have already taken advantage of their right to
switch.

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4. Companies and Concentration of the Gas Market

Natural gas is one of key energy resources. Poland consumes just shy of 14 billion m3 of natural gas per annum.
Most of it comes from a single dominating supplier (PGNiG SA) which in turn buys the resource from Russian
Federation. This state of affairs will probably not change in forthcoming several years. Polish gas market in its
current shape does not promote intensive competition, nonetheless one of most important sources of competitive
advantage is access to natural gas sources (Buczkowski, 2009). PGNiG (72.5% owned by State Treasury, 12.7%
owned by eligible employees, the remaining shares are free float) is the market leader both in terms of upstream
and downstream sectors. It is virtually an exclusive gas importer – entitlement to 100% of transmission capacity
of all entry points. Moreover, by being the biggest gas extraction company (98% of domestic output), PGNiG is
calling the shots in the natural gas wholesale market. Gas trading companies outside the PGNiG Capital Group
have no stake in gas wholesaling (OECD/IEA, 2011).

In 2010 gas was traded still under provisions of bilateral agreements. Thus far gas has not been sold in Poland
through stock exchanges or hubs.

Apart from PGNiG Capital Group there are approx. 30 independent entities operating on the Polish market
dealing with distribution and sales of gas. How dynamically they develop is contingent on formalising the
process of designing and building gas networks. Technical capabilities of existing transmission infrastructure and
its development also play an important role.

Part of market reform in the Polish gas sector was separating out in terms of ownership operations linked to
transmission of natural gas, which originally were governed by PGNiG. In 2004 a new state unit was formed as
part of PGNiG – completely independent transmission system operator OGP GAZ-SYSTEM SA, which went on
to become state controlled in 2005. In June 2007 six distribution companies were legally disassociated from
PGNiG, which were granted by Energy Regulatory Office status of a distribution company. They remain a
hundred percent owned by PGNiG.

The fact which substantially influenced the landscape of Polish natural gas market, including managing and
operating gas transmission, was delegating Gaz-System SA to become the operator of Polish part of the
Yamal-Europe Transit Gas Pipeline System (TGPS). By decision of the Energy Regulatory Office President of
November 17th 2010, that company was appointed gas transmission system operator for Polish part of the
Yamal- Western Europe pipeline until December 31st 2015 (Energy Regulatory Office, 2011b).

High saturation in Polish gas market caused by dominant position of PGNiG Capital Group has taken its toll for
many years on the structure of retail market and its transition rate. Still 98% of natural gas is sold by the
monopolist, whereas the remaining 2% represents several dozen entities, which aspire to develop and strengthen
their market position (G.EN Gaz Energia, CP Energia, EWE Polska, Enesta SA and KRI S.A.). Best part of those
companies sells gas through own local distribution networks. Exception here is EWE Polska, which also imports
natural gas from West through its own network using the EU transmission system. In 2009 is imported from
Germany approx. 35.65 million m3 of natural gas under agreement with EWE AG.

The TPA rule in force since June 1st 2007, which counteracts discriminatory practices toward third party access
to network thus gives right to freely choose and switch gas supplier, remains redundant as in practice the
switching rights are not exercised. Providers independent of PGNiG – due to low commercial quantities – are not
obligated to give third party access to their distribution networks, even though from the legal standpoint the
consumer is entitled to switch supplier twice a year free of charge. Moreover, PGNiG is the sole proprietor and
operator of the storage system as ruled by the Regulator in 2008 for the period of 17 years. In 2010 PGNiG
owned 100% of underground gas storage capacities. The company provided in 2010 for Gaz-System SA 50
million m3 of gas due to the enterprise acting in capacity of transmission system operator. The remaining storage
capacity was used entirely for purposes of PGNiG SA operations.

In 2010 active capacity of underground gas storage was approx. 17.9 TWh.

In accordance with art. 24 of Act on Reserves of crude oil, petroleum products and natural gas and procedures
applying to situations threatening domestic energy security and oil market disruptions (Journal of Laws No. 53
item 343, 2007) companies importing gas fuel into Poland are obligated to maintain minimum reserves and keep
them available throughout Polish territory by using storage installations connected with Polish transmission
system. Due to storage capacity deficit and barred access to storage services, imposing the requirement on
entities importing gas to hold reserves of gas fuel effectively denied them the opportunity to enter the market of
new suppliers, thus hampering its development (Buczkowski, 2009).

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Table 4. Polish underground gas storage in 2010

No Storage name Type of storage Active capacity [million m3] Reading by the end of reporting period [million m3]

1 Wierzchowice mature gas field 575.00 386.564

2 Brzeznica mature gas field 65.00 41.153

3 Strachocina mature gas field 150.00 98.964

4 Swarzow mature gas field 90.00 49.521

5 Husow mature gas field 350.00 270.313

6 Mogilno salt caverns 370.00 302.308

7 Daszewo mature gas field 30.00 8.825

8 Bonikowo mature gas field 200.00 47.371

TOTAL 1837.890 877.203

Source: PGNiG SA

5. Liberalisation of Electricity and Gas Sector Objectives

Polish energy policy is determined by EU directives and requirements to a great extent. Poland has to liberalise
its natural gas and electricity market in particular by implementing competition mechanisms. Not only will a
competitive marketplace stimulate improvement of operational efficiency and cost-optimising measures on the
supply side, but also more efficient energy consumption and deployment on the demand side. This will be
achieved through incentivising economic signals. Developing a competitive market environment is one of
objectives set out by Polish Energy Policy until 2030 (Ministry of Economy, 2009). PEP 2030 and its Executive
Actions Programme for 2009-2012 envisages a range of short-term measures intended to increase competition in
electricity and natural gas markets. According to that document, liberalisation aims to assure undisrupted energy
market and thus counteract excessive price rises.

Among specific objectives are:

1) Lifting barriers obstructing supplier switching.

2) Developing competition mechanisms as the main measure rationalising energy prices.

3) Regulating naturally monopolised markets in best interest of all market participants.

4) Limiting red tape in areas where competitive markets operate and develop.

5) Co-building regional gas and electricity market with international trade being the main focus.

6) Implementing and effective electricity balancing mechanism increasing energy supplies security, supporting
futures and intraday trading, and facilitating identification and allocation of individual costs of energy
supplies.

7) Creating a liquid spot market and futures market.

Objectives of Polish energy markets liberalisation comply with target objectives of European energy policy –
competitiveness, sustainable development and energy security.

Table 5 shows a matrix of specific objectives for liberalisation of electricity markets, from both short-term and
long-term perspective.

Liberalisation of the energy market entails predominantly measures within the framework of energy policy. They
concern introducing and extending competition mechanisms deployed in liquid fuels, natural gas and coal
markets. Poland, as EU member state actively contributes in creating joint Community energy policy, and also
delivers on its main objectives in specific domestic environment. In doing so, consumer interests need to be
protected, whilst keeping strong grip on current energy reserves as well as technological consideration regarding
energy production and transmission.

One of key objectives of Community’s energy policy is creating an internal, EU-wide electricity market after
other commodity markets in order to enable free flow of goods (energy) and services (transmission, distribution).
The process of creating EU-compliant energy market depends above all on rebuilding structurally the energy
industry. That in turn involves disjoining electricity production and trading from transmission and distribution,
putting TPA rules into practice, deregulation of wholesale and retail prices, counteracting further consolidation
(horizontal in particular), modernising energy infrastructure, and passing adequate legislation. Furthermore, for
the first time, already at the stage of developing energy sector and building administratively electricity market,
consumer interest is actually on the list of priorities for the changes. Hence it is fair to say that together with

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pro-competitive rules for electricity market being put in place, companies operating in the energy sector are
going to – similarly to common practice – become increasingly customer-centric i.e. striving to explore customer
needs and catering for them. This will be a departure from current situation where best consumer interest is
neglected (Office of Competition and Consumer Protection, 2011).

Table 5. Specific objectives of Polish electricity market liberalisation

Item Short-term perspective Long-term perspective

Technical  maintaining proper operating condition

of generating, transmission and

distribution infrastructure and devices

 replacement and development investments in generation and

transmission/distribution,

 new generation technologies,

 improvement of generating and transmission efficiency,

 expanding cross-border networks and connections

Economic  energy price covers energy generation

and provision costs

 good organisation of energy trading

which would not hamper market

access (i.a. unjustified participation

fees)

 effective system protecting against

anti-competitive practices and abusing

market leader position by sector

members

 energy price covers investment outlays, enables developing

market mechanisms favourable for electricity sales at prices

justified by current energy prices and distribution costs,

discarding the “socialisation” cost

 effective system protecting against anti-competitive

practices and abusing market leader position by sector

members

Economic

and Social

 protection of vulnerable consumers, ex

officio providers (backup), social

programmes

 ex-ante periodic price control

 consumer protection against unfair

practices of energy providers and

distributors

 promotion of energy saving

 systemic protection of socially vulnerable indifferent to

competition mechanisms

 consumer protection against unfair practices of providers

 efficient energy consumption

 economic growth at sustainable energy consumption

Source: Roadmap of price deregulation for all electricity consumers “Towards consumer tights and efficient competition in energy sector”.

Energy Regulatory Office, Warsaw 2008, p. 17.

The objective declared key for energy sector reform, has been and remains increasing efficiency of the energy
sector predominantly through competition. Hence expected are fall in electricity prices, better service quality,
assuring comparative energy prices in member states, consumer right to switch provider and boosting activity in
the sector which eventually would reduce needs concerning building and maintaining generating and
transmission capacities. Changes in the Polish electricity market have to be aimed at giving birth to
fundamentally strong enterprises, which would be capable of assuring sustainable energetic development. The
overarching objective for ushering in the reforms should be national energy security, achieved through
investment increasing generating, transmission and distribution capacities underpinned by reliable supplies.
Transitions in the market should decrease costs and harmonise the energy sector. Cost minimisation as objective
of energy policy will bring about better efficiency of energy companies, which should be stimulated by
favourable regulatory policy. Consolidation will generate economies of scale and synergies within the market
causing energy production costs to drop. As a result of those measures Polish companies will have become more
competitive in the integrating international electricity market and our energy sector will actively participate in
developing the international electricity commerce.

Another objective of Polish Energy Policy until 2030 is also injecting competitiveness into gas markets.
Liberalisation of natural gas market – dictated by EU directives – will have diminished the importance of coal.
This will enable market mechanisms to shape the structure of domestic energy market, allowing in turn natural
gas prices to be more competitive and consequently improving energy security of Poland.

6. Barriers to Developing a Competitive Energy Market in Poland

The process of creating a competitive energy market in Poland has been in progress for 10 years now. There
were spells of fast tracking and regress, where accelerating and decelerating factors have blended together. In the
process, changed were monopolistic structures holding a strong grip over extracting, processing and providing

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energy into diversified businesses (state-controlled to a variable extent) with extensive portfolios and operating
under different forms of ownership. As a result of those changes, both private and public producers and providers
can compete for customers whilst using the regulated network infrastructure. Through those changes regulatory
bodies were established and some of the following measures were used: TPA rule, accounting unbundling, legal
unbundling and functional unbundling, merger & acquisition supervision on the national and regional level, state
aid programmes and a range of other instruments facilitating consumer access to competitive power purchase
offers concerning energy and natural gas (Swora, 2010).

History of Polish electricity market reforms and implementing competition mechanisms into the electricity
market, proves it was inconsistent and unsuccessful. It is the end-consumer who bears the cost of incomplete
programmes, forsaken measures or measures not followed through correctly, lengthening of the legislation
process (especially in terms of implementing European legal provisions).

The act – Energy Law, passed in 1997 was to some extent a summary of transitions in the energy sector, which
took place over the course of profound reforms after changing the Polish economic-political system, and
introducing an independent regulatory body. At the same time, however, a regulatory mechanism was introduced
based on so called reasonable costs, and the amount of long-term contracts concluded between producers and an
operator as the single buyer did literally explode. Establishing an energy stock exchange and introducing the
balancing market both in 1999 was beyond doubt a pro-market solution. Over the course of that evolution,
however, consistency was missing – the energy stock market in Poland thus far remains marginalised. At the next
stage of market development, whilst implementing the so called II liberalisation package, distribution system
operators were legally unbundled and transmission system operator functionally unbundled. Termination of
long-term agreements was also due in that period. This was supposed to increase competition in the sector. On
the other hand, that period was dictated by vertical consolidation as result of which four entities were formed –
vertically integrated groups incorporating companies dominating the market (Swora, 2010). Lack of competition
resulting from closing energy trade within consolidated groups, causes fundamental problems with accounting
for state aid, which was intended to compensate producers – parties of KDT – for losses incurred due to their
participation in the market.

As far as legislation is concerned, among key positive changes which took place in 2010 are:

1) Passing extensive amendment to the act – Energy Law, which apart from regulations implementing the
directive concerning safety, includes also provisions introducing obligation to participate actively in stock
exchange trading, applicable to producers granted state aid due to KDT termination.

2) Appointing the Ministry of Economy the new corporate supervisor of the PSE Operator company instead of
the previous Ministry of Treasury, consequently strengthening unbundling (separating commerce from
distribution, transmission and storing services) of transmission system operator.

3) Change in pricing policies for co-generated heat, based on reference prices.

Creating pro-competition conditions fostering its development is set out as strategic objective both in Polish
Energy Policy as well as the act Energy Law. In 2010, however, actions put in place fell short of the goal.
Although EU provisions were implemented, at the same time rigorous legislation was put in force which had
negative impact on existing companies and effectively barred new entities from entering the market.

Polish Confederation of Private Employers Lewiatan (Polish Confederation of Private Employers Lewiatan,
2011) points toward key barriers impeding development of Polish energy sector and liberalisation of electricity
and gas markets. Among those barriers are:

1) Authors of the report list the following regulatory barriers concerning the electricity market:

 not transparent legislative process,

 no reliable ex ante / ex post analyses and studies into deliverables of regulatory changes,

 no schedule of introducing changes into Polish Law to aligned it with EU legal changes,

 unstable regulatory environment, which poses a threat to successful execution of investment projects in the
generation sector. Such unfavourable circumstances could not even be offset by high electricity prices thus
discouraging for undertaking investments,

 regulatory risk influencing decisions of transmission and distribution system operators e.g. ERO President’s
ruling on power purchase prices compensating grid losses, causing operators to incur massive financial
losses considerably decreasing their investment capabilities,

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169

 convoluted legislation inconsistent with executive acts, difficult to interpret and use, additionally causing
extra risk factor to market strategies of energy companies,

 independence and discretion of regulator’s decisions.

2) In terms of barriers concerning legal forms and ownership of energy companies the following were listed:

 vertical consolidation in the sector – increased market power of some entities, decreased the number of
wholesalers and caused energy to be generated and sold predominantly within consolidated groups – this was
detrimental to transparency of market conditions and prices. In practice this caused an oligopoly to form.

 low transparency of the wholesale electricity market, slowing down investments due to low investor
confidence,

 withheld privatisation of the energy sector resulting in low energy and economic efficiency of the sector as
well as reduced investment capabilities,

 monopolistic practices in the balancing energy market caused by vertical consolidation of the energy sector,

 wrong architecture of the wholesale market,

 flawed model of offsetting costs incurred by the operator through balancing market operations through
transmission tariffs forcing operators to apply measures reducing that cost – with mixed success for
balancing market participants.

3) Barriers in the retail energy market:

 maintaining retail prices for households regulated,

 low consumer activity in the energy market,

 incorrect implementation of EU directive concerning supplier of last resort,

 unclear regulation concerning duties of and choosing “reserve supplier” and/or “emergency supplier”,

 inconsistent rules on switching energy suppliers by consumers (including customers of energy companies
without the status of distribution system operator),

 obligation upon consumers to adapt their meters when switching energy supplier to other than local trading
company.

Moreover, among main barriers impeding creation of competitive electricity market report authors listed undue
compensations for stranded costs, discriminative prices for companies outside consolidated groups, incomplete
cost restructuring within energy groups and excessive fiscalism of State Treasury which have had its reflection in
energy price rise caused by insufficient competition in the wholesale market. Fiscal and parasifcal charges built
into energy prices are 25% and 50% for industrial consumer and household respectively. Excise for electricity is
five to ten times higher than minimum rates in the EU. Complicated procedures of settling excise for trading
companies and consumers cause impose additional charges on energy consumers. Another vital matter still
hanging in the air is building cross-border connections. Hence, in the medium-term Poland will not be able to
participate in the Integrated Energy Market, which will take its toll on Polish energy security and will restrain
new suppliers from coming into the market, thus having negative impact on competition. Another issue raised by
report authors is unjustified subsidising amortised renewable energy sources (big hydroelectric plants). Through
that practice, the green producers increase their profit at cost of all energy consumers – without having to
increase their renewable energy production (Polish Confederation of Private Employers Lewiatan, 2011).

Current shape of the gas market has been inherited after long-standing single-supplier market where the
monopolist called the shots. Technical and price barriers to entry for new entities were also contributing factors.
One of fundamental barriers to creating a competitive energy market is the regulatory policy, where PGNiG
calculates the tariffs effectively obtaining undervalued gas price. PGNiG throws costs of imported gas and
domestically produced gas together into one basket. Maintaining the price basket for PGNiG is unfavourable for
competition in domestic market. Companies showing possible interest in providing Poland with gas, remark that
entering the market are virtually impossible, because the new market actor would not be able to offer comparable
prices. Bearing in mind decommissioning the PGNiG price basket would above all increase prices for the
end-consumer, it should not be expected the regulator would take that decision anytime soon (Buczkowski,
2009).

One of key barriers to developing the gas market in Poland is restricted access to natural gas resources for new
entrants (PGNiG claims practically the entire imported natural gas plus on top of that it remains the largest gas

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170

producer in Poland). Limited access to underground gas storage is another barrier to developing competition
within the sector. PGNiG is the sole proprietor and designated operator of underground storage capacities and
practically the only user at that. What is missing are clear and effective rules assuring equality in access to
storage capacities for all market actors, which should be rigorously pursued. An independent storage system
operator could be the best solution to provide non-discriminatory third-party access to storage capacities.

Another factor holding back potential competition from entering the market are stringent rules on maintaining
particular gas reserves. Another obvious step in direction of competitive gas market is improving connections
with neighbouring countries. Today’s gas transmission system in Poland is still relatively isolated from other
countries. It enables only unidirectional flow (East-West). Gas Transmission Operator GAZ-SYSTEM SA,
however, plans to implement a range of investment projects in 2009-2014 which are aimed to change that.
Long-term agreement between PGNiG and Gazprom as well as no third party access to the Yamal pipeline are
also a considerable hurdle in way of developing competition (OECD/IEA, 2011).

To summarise, current barriers to entry for new wholesale gas suppliers and developing competition are:

 no inter-system connections,

 no storage infrastructure,

 gas price in domestic market dictated by the “price basket”, which disenables reflecting the true market
value of gas,

 rigid rules on calculating tariffs making impossible to have flexible and competitive client approach.

7. Conclusions

A competitive marketplace is the driving force behind any market economy. One of key conditions underlying
competition is favourable market structure. It cannot be excessively concentrated. In case of monopolization and
stiff competition it is difficult to talk about real competition.

In Poland, liberalisation is more advanced in the electricity sector. Both the production and wholesale sector
remain under fierce competition. The forward-moving vertical consolidation of the energy sector produced
situation where there is a limited number of energy groups enjoying strong market power. The Polish electricity
market could be described as illiquid. Among key factors capable of influencing that, is large fraction of bilateral
contracts, and despite having made notable progress still insignificant fraction of stock exchange transactions.
The new regulations ordering producers to trade 5% of generated electricity either on energy stock exchange or
the regulated market are supposed to increase competition in the wholesale sector. That legislation was critical to
the wholesale electricity market and higher liquidity of the Polish wholesale market enabled implementation of
market coupling mechanisms through the monopolar high-voltage direct current (HVDC) submarine cable
between Poland and Sweden.

Although the Polish electricity market opened its doors to retail competition as of June 1st 2007, the right to
switch energy provider remains – in accordance with EU Directives – limited. This is above all due to no
alternative, attractive offers for households, justified to some extent by regulated tariffs set on comparable levels.

The energy market is undergoing continuing restructuring and privatisation. Electricity and gas markets have
been dominated by market incumbents for years what restrained competition, in the gas market in particular,
which is one of the markets showing little competition and high concentration. Restructuring of the gas sector is
under way – including establishing structures stipulated by the second EU liberalisation package i.e. independent
and state-owned transmission system operator and six distribution system operators. In spite of these efforts, the
gas market remains still strongly monopolised. PGNiG SA goes on to maintain its dominant position both in
upstream and downstream sectors. By being the sole domestic gas importer and producer it effectively controls
the wholesale market. PGNiG is also the dominant force in the retail market. Market share of all the other
companies operating in the sector is a mere 2%. This “incumbent structure” creates situation where measures
aimed at promoting and increasing competition meet with far more hurdles than in the electricity sector.

Restrained competition in the Polish energy sector is unfavourable for improving operational efficiency of
energy companies and causes too heavy of a burden for end-consumers. Track record of market reforms in form
of 81 TWh of electricity sold on the stock market compared to production of 157 TWh, just under 9 thousand
consumers switching their provider out of 16.5 entitled prove that effects delivered by the changes are
unsatisfactory. Balance of costs and benefits could and should provoke reflections. This state of affairs is yet to
be affected by discussions over investment crisis, reproduction and development needs as well as the climate
package – solving those problems could not harm efforts aimed at bringing about efficient competition. It would

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171

be hard to come by something better than a competitive market to trust it with creating a rationally operating
economy.

References

Buczkowski, M. (2009). Factors influencing competition in the Polish gas market. Professional Gas Industry,
strony, 68-69.

Energy Law. (April 10, 1997).

Energy Regulatory Office. (2011a). Report of the President of Energy Regulatory Office. Warsaw: Energy
Regulatory Office.

Energy Regulatory Office. (2011b). National Report of the President of the Energy Regulatory Office 2011.
Retrieved from
http://www.ure.gov.pl/portal/pl/424/4258/Raport_Krajowy_2011_Prezesa_URE_dla_Komisji_Europejskiej
.html

European Investment Bank. (2008). Gas market study for Poland by 2035. Final report. European Investment
Bank.

Grant Thornton Frackowiak. (2010). Polish energy market. Summary 2010. Retrieved from
http://grantthornton.pl/images/raporty/Raport_Rynek%20energetyczny_w_Polsce

Minister of Economy. (2010). National Action Plan for renewable energy. Warsaw: Minister of Economy.

Ministry of Economy. (2009a). Polish Energy Policy until 2030. Warsaw: Ministry of Economy.

Ministry of Economy. (2009b). Projection of demand for fuels and energy until 2030. Warsaw: Ministry of
Economy.

OECD/IEA. (2011). Energy Policy of MAE countries. Poland 2011. Review. OECD/IEA.

Office of Competition and Consumer Protection. (2011). Consumer on the electricity market. Warsaw-Wroclaw:
Office of Competition and Consumer Protection .

Polish Confederation of Private Employers Lewiatan. (2011). Barriers in the energy sector. Warsaw: Polish
Confederation of Private Employers Lewiatan.

Swora, M. (2010). Poland in the process of integrating EU member state markets. Eneregy Market, I(V).

Modern Economy, 2012, 3, 920-925

doi:10.4236/me.2012.38115 Published Online December 2012 (http://www.SciRP.org/journal/me)

Motivations and Barriers of the Model of Non-Traditional
Market Economy: A Case to Study in BRICS

Nguyen Tan Phat
University of Economics and Law, Vietnam National University HCMC, Ho Chi Minh City, Vietnam

Email: ngtaphat@yahoo.com

Received August 29, 2012; revised October 7, 2012; accepted October 17, 2012

ABSTRACT

Emerging economies including Brasil, Russia, India, China and South Africa known as a growing force with the power
of economy, finance and enormous potentials are considered as massive motivations affecting greatly the rest parts of
the entire world. Theirs characteristics of politics, political geography and economic policy are not identical to tradi-
tional market economies in Europe and the US BRICS can be called the model of non-traditional market economy. The
rise and the great effect of BRICS can change the order of the current world which has long been dominated by western
nations during the past 2 decades. However, BRICS itself contains challenges and barriers for the socio-economic de-
velopment such as hot growth, poverty, low living standards and environmental pollution, etc. The political affiliations
and violence in declaring the sovereignty of seas, islands and territory reveal the latent unstability that can drive to con-
flicts and arms race, etc. Brics is a force without lack of necessary motivational factors that can enhance the develop-
ment but also contain inside challenges and barriers for the rest parts of the modern world.

Keywords: BRICS; Traditional Market Economy; Non-Traditional Market Economy; Motivations; Barriers

1. Introduction

Most nations nowadays comply with the model of market
economy but have 2 distinct operations. One is the model
of traditional market economy in western countries and
developed nations in Northeast Asia like Japan, Korea,
Singapore, Hongkong and Taiwan. The other operates
according to the non-traditional market economy in
emerging nations like Brasil, India, China and South Af-
rica called BRICS group.

The 2008 global financial crisis destroyed severely the
finance of western countries that have obeyed traditional
economy and public debt has overwhelmed the whole
Europe. In the early 21st century appeared the rather vio-
lent rise of the non-traditional economies, namely BRICS,
which have had a pervasive influence not only on eco-
nomics but also on global political issues.

The appearance of BRICS and its growing impact is
regarded as a ruler for the imperfection of non-traditional
model the theories of which must be reconsidered to have
a more convincing explanation of its imperfection and
inefficiency when facing modern economic problems.
This appearance is also expected to supplement the lim-
ited aspect of this model, so BRICS has become vital for
the rest parts of the world due to the world’s largest
population, the second largest in economics just after the
US and the place that frequently provides the world with
natural resources. However, is BRICS perfect? Abso-

lutely no. BRICS itself is confronting numerous serious
problems and its actions are worrying much many other

countries.

2. Reviewing Theories of the Model of
Traditional Market Economy and Its
Inefficiency towards the Current
Economic Issues

The operation of this economy obeys the discourse on
method and the thoughts of the 2 most remarkable scien-
tists, Adam Smith and John Maynard Keynes.

The thoughts and discourse on method of Adam Smith
(1723-1790) in resolving issues of free market economy
in the 18th century and its influence until the present
time.

Despite the fact that economic issues and principles
had been written a lot before Adam Smith, most people
considered him the Father of economics. He was given
such an honor owing to the recognition of capital market
economy as an economic system that made the entire
people become rich. He was the first seeing benefits from
more competitiveness and had arguments in favor of
policy that enhance competitiveness, which requires
State’s less intervention into the economy but takes
proper measures to prevent exclusiveness. It comes from
the thought and discourse on method about market
economy of Adam Smith. This characteristic has become

N. T. PHAT 921

the truth for the model of traditional market economy.
The praise of individual benefits when human’s eco-
nomic activity brought richness to capitalists and by
chance brought benefits for the community itself, which
went beyond the original intention under the guide of an
invisible hand. Such recognition has been lasting through
the centuries and has come the predominant thought en-
couraging business production activities and promoting
the abruptly rapid growth of capitalism in the pharse of
free competitiveness. It was believed as the period of the
glorious evolution of a new production method and radi-
cal thought. His thought coincided accidentally with
practice, doubling the development on the basis of eli-
minating the old feudal relation so as to set up a novel
socio-economic structure named capital market economy
with an auto-adjustable market mechanism reliant on
objective principles of economics. Thus, all economic ac-
tivities must be on the foundation of free competitiveness
without State’s intervention [1].

Adam Smith’s thought and his method kept on being
backed by the New Classic, especially the theory of Ge-
neral Balance of Leon Waras and the new Liberalism and
later became the legal principles of international financial
institutions such as WB, IMF, WTO, etc.

Yet Adam Smith could have had the second thought if
he had witnessed the exclusiveness of capitalism, eco-
nomic crises since the early 19th century and particularly
the self-interests of operators in financial corporations
which triggered financial corruption and the incredible
abrupt collapse of the 2008 financial crisis. The fact that
personal gain of economic human factor in Adam
Smith’s theory was distorted to turn into the global fi-
nancial corruption beside the uncontrolable fiscal deals
becomes an enormous challenge of the 21st century.

The thoughts and discourse on method of John May-
nard Keynes (1883-1946) in dealing with market eco-
nomic problems in the crisis period.

John Maynard Keynes was seemingly born in order to
save the market economy out of massive economic crises
thanks to the direct interference of State into the econ-
omy to stimulate investment and consumption, creating
employment, income increase, and economic growth.

Financial and monetary policies as incentives of con-
sumption and investment fuel economic development
produce jobs and curb unemployment. Welfare policies
such as tax relief and an increase on unemployment al-
lowance and health insurance, etc. are really vital for
people when crises occur. So, The General theory of em-
ployment, interest and money of Keynes, the core of
which is the role of State in solving economic crises and
ensuring the macro balance is believed as an economic
guidebook towards politicians, businesspeople and school-
ars during the crises and post-economic crises.

Keynes’s measures really work in case a crisis erupts

in the capital market economy. The theory is high-ap-
plied in dealing with crises not only due to the content of
its thought and the characteristics of his discourse on
method but also due to the macro tools and the relatively
perfect financial institutions that create a material prem-
ise in practice when being performed [2].
− Changes that askew the orbit of traditional market

economy to shape the non-traditional market economy.
+ Consequences from the general principles of Adam

Smith’s discourse on method.
Once basic principles of traditional market economy

become general rules for pledges and international nor-
mal practice in trading, investment, finance, and forming
international institutions like WB, IMF or WTO, etc., to
regulate the global economy, problems arise in terms of
such general principles. Financial corruption, environ-
mental pollution, devaluation of domestic currency, trade
fraudulence or economic speculation etc., are the results
of economic human factor—personal benefits are put the
top but severely ruin the society. Restricting it is a ma-
thematics problem that could hardly find the answer be-
cause with a correct answer, it is obligatory that parame-
ters (general principles) be changed, which could upset
entirely the whole system and global principles.

As a result, many countries have to return to trade
protectionism, curb investment and control finance, etc.,
while on the traditional market economies themselves to
overcome such difficulty.

+ The consequences of monetary and financial tools in
Keynes’ discourse on method.

As the above-mentioned analysis, one of the factors
that make Keynes’ application fast and powerful is fi-
nancial tools (tax and government’s expenditure in the
form of investment), currency (interest and open market
skills), and organizations of credit and finance. Yet there
has been a too rapid growth of banks and such organiza-
tions with a great deal of radical, strange, diverse and
unmanageable credit business in the 10 recent years. This
system has gone beyond its conventional functions, gen-
erating an outbreak of investment and speculation on the
sensitive markets such as petroleum, real estate, stocks
and insurance, etc., hence an artificial demand-supply
and inevitable crises. Financial crisis, in fact, is melting
the cream layer of economic crisis. The virtual values of
risky investment and speculation shown on the outside
cover layers of stocks or mortgage credit break and get
back to the true value of the economy. While some banks
and leading American-European financial organisations
went bankrupt or needed urgent assistance to get out of
the collapse, car manufacturers also sent signals of imm-
mediate help. The fact that economic crisis in which fi-
nancial crisis is the first starting-point of the system then
spreads to industries of auto manufacture and construc-

N. T. PHAT

922

3.1. Motivations tion material, etc., beside the luxurious spending for pub-
lic sector and social welfare is the cause of crisis of pub-
lic debt in Europe and makes it much more severe.

Market and financial motivations for other nations.
The market power of BRICS is thanks to the world’s

largest population and the second biggest economy. Ac-
cording to the 2010 World Bank’s figures (Table 1),
BRICS’s population was 29,496 million people, making
up 42.78% of the world’s population; the economic scale
was 12.1 billion USD, accounting for 19.26% compared
with the global economy, and just behind the US with
14.5 billion USD. The value of export goods was
2494953687243.75 USD, making up 16.67% of the whole
globe, and the value of import goods
2123041584183.19 USD, 14.42% of the world. Import
and export surplus was 371912103060.56 USD, 152.73%
bigger than the global surplus, which increased the total
foreign currency reserves including gold and foreign
currency by 4025 thousand billion USD, making up 37.37%
of the world.

+ Consequences of the ties owing to the regional and
international affiliation.

The wider regional and international link helps the
market economy operate according to group benefits, but
when troubles arise, it is hard to find out creative solu-
tions due to the general principles. In contrast, it doesn’t
happen to the non-traditional market economy as there is
no general rule in these nations.

For this reason, it is visible that the non-traditional
model demonstrates itself an economic institution with a
more clever and flexible use of the theories of Adam
Smith, Karl Marx and John Maynard Keynes depending
on specific circumstances. This unconventional institu-
tion reveals itself a more automatic system with swifter
reactions, more tools yet less general principles [3].

The motivation of high economic growth lasting in
many years has promoted the pervasion to other related
economies.

3. An Analysis of Figures and a Discussion of
the BRICS Economic Model:
Motivations and Barriers The statistics of the World Bank in the phase between

2002 and 2010 indicated that all members of BRICS had
a speed of economic growth higher than the world’s av-
erage speed. Among them are the 2 power houses, China
and India, with 2.5 – 3.0 times higher than the world’s
average growth (Figure 1). The high and stable eco-
nomic growth has helped the very great ability of accu-
mulation, investment and purchasing power of the eco-
nomies in BRICS.

Political geographical location: The group of emerging
economies—BRICS including Brasil, Russian Federation,
India, China and South Africa—is in the 4 most impor-
tant continents in the world. China and India are in Asia,
Russia in Europe and South Africa in Africa. All nations
of BRICS are located on top important positions in each
continent and on crucial sea routes connecting Indian and
Atlantic Oceans; Pacific and Indian Oceans; Atlantic-
Indian Oceans. In addition, most of them are trade surplus (Table 2)

and possess a great deal of foreign currency reserves,
which is an incentive for trade and finance of the entire
world. The role of BRICS has specially become impor-
tant towards the financial crisis and public debt in Europe,
which has changed the face of financial economy and
politics. Moreover, it has also modificated the structure
being willing to buy government bonds, bank’s bondsor
stocks on financial markets. The voice of BRICS now
seems to be more powerful in multilateral and bilat

Map: BRICS’ geographical location, Source: [4].

Table 1. Norms of population, GDP and total foreign currency reserves of BRICS.

Population GDP Total foreign currency reserves, gold and US dollars
BRICS

(Calculated unit: persons) (Calculated unit: USD) (Calculated unit: USD)

Brazil 194946000.00 2087889553821.68 288574603559.64

Russian Federation 141750000.00 1479819314058.23 479222291459.01

India 1224615000.00 1727111096363.26 300480145803.63

China 1338300000.00 5926612009749.61 2913711653593.96

South Africa 49991000.00 363910425627.97 43819537259.82

Total 29496020.00 12185342399620.75 4025918531676.06

The world 6894594843.86 63256970222854.90 10773352665144.90
Percentage compared

with the world
42.78% 19.26% 37.37%

Source: Calculated by the author from [5-7].

http://vi.wikipedia.org/wiki/T%E1%BA%ADp_tin:BRICS �

N. T. PHAT 923

Source: [8].

Figure 1. Speed of economic growth of BRICS and the world in the phase 2002-2010.

Table 2. Value of goods import and export in BRICS, 2010.

BRICS Export value (BOP, Current US$) Import value (BOP, Current US$) Import-export surplus

Brazil 201915285335.00 181768427438.00 +20146857897.00

Russian Federation 400419230000.00 248738063000.00 +151681167000.00

India 225501718165.03 323435448109.98 −97903729944.95

China 1581417481957.48 1327237584592.67 + 254179897364.81

South Africa 85699971786.24 81862041042.54 +3837930743.71

Total 2494953687243.75 2123041584183.19 +371912103060.56

The world 14968765616569.10 14725261325258.00 +243504291311.10

Percentage compared with the world 16.67% 14.42% 152.73%

Source: Calculated by the author from [9,10].

eral forums.

Motivation of low production cost thanks to low-priced
laborers and the profuse supply source of various kinds
of laborers has stimulated manufacturing investment of
international corporations in BRICS.

BRICS has a large population with low living stan-
dards, so low salary is an advantage of providing low-
priced labor force for developing countries. BRICS has
become a gigantic construction site for the world’s enor-
mous manufacturers, producing a wide range of products
from high-tech items like computer production, elec-
tronic components, automobiles to labor-intensive items
such as garment and leather footwear, etc.

An advantage of resources export such as petroleum,
gold, race earth and agricultural products to many
countries and collecting a lot of foreign currency.

BRICS has the advantage of all kinds of natural re-
sources and agricultural products with a big demand of
consumption currently such as petroleum, gold (Russia),
race earth (China), gold and diamond (South Africa),
precious stones, coal, and rice (India), coffee, cocoa and
timber (Brasil). Resources export has brought a great
source of revenue for these nations and also become a
tool in bargaining trade, economics and politics with other

countries.

3.2. Barriers

Low incomes, impoverishment and social conflicts.
Among the nations in BRICS group, Russia and Brasil

have per capita income as high as or a little higher than
the one of the world. According to 2010 statistics from
the World Bank, Russia made up 113.78% and Brasil
was 116.73% compared with the averge income of the
world. This rate was even much lower in nations with
dense populations like India (15.37%), China (48.26%)
and South Africa (79.34%) (Figure 2).

Supposing that poverty standard is considered below 2
USD per day, the poor in India in 2010 would make up
68.72%, equivalent to 829 million people. China, 2008, ac-
counted for 29.79%, equivalent to 394 million people. Bra-
sil, 2009, 10.82%, 20.9 million people. South Africa in
2009 was 31.33%, 15.42 million people and Russia, 2009,
0.05%, 0.071 million people. The overall poor population in
BRICS was approximately 1259 million people, account-
ing for 18.26% of the world’s total population in 2010
[11]. Thus, it is clear that the majority of the poor living on
earth now chiefly concentrate in BRICS, except Russia.

N. T. PHAT 924

Living in the poverty is the root of social injustice
disputes, crimes and illiteracy, etc. The exploitation of
children and women laborers in hard coal mines, slumps,
male chauvinism, HIV disease, environmental pollution
and manufacture of counterfeit products, etc. are all in
BRICS. This trouble is regarded as the most enormous
barrier for social progress, civilization and democracy.

Energy for the demand of socio-economic growth is a
challenge for BRICS. The electricity power consumed in
2009 accounted for 31.12% of the world’s. Particularly,
this rate in China was 61.21% of the entire BRICS and
19.05% of the global energy (Table 3).

It is remarkable that the increase speed of electricity
consumption is higher than the average rate of the world,
especially China. This pace in 2006 compared with 2004
in BRICS was 16.94% whereas it was 8.71% in the
world, and particularly China was 30.14%. The rate in
BRICS was 16.02% in 2008 compared with 2006, 6.72%
in the world and 21.64% in China. 4.05% in 2009 com-
pared with 2008, 0.71% for the globe and China was
7.66% (Figure 3).

Despite the great volume of power consumption, it is
hardly to meet the demand of socio-economic growth as
the per capita output of consumption in BRICS nations

Figure 2. Per capita average income in BRICS and the
world.

Table 3. Energy consumed in BRICS nations (Unit: million
Kwh).

Years 2004 2006 2008 2009

Brazil 359,971 390,509 428,500 426,340

Russia 811.653 872.393 913.506 870.331

India 492.806 572.943 671.878 689.537

China 2055.968 2675.737 3254.152 3503.397

South Africa 217.066 228.964 232.230 223.520

Total 3937.464 4740.546 5,500.266 5723.125

The world 15964.190 17355.506 18521.968 18390.614

Percentage of
BRICS compared

with the world
24.66% 27.31% 29.69% 31.12%

Source: [12].

such as China, India and Brasil is lower than the average
of the world and even much smaller than it is in devel-
oped countries like Japan, America, Singapore and Ger-
many. In 2009, this average rate in India was 20.36%
compared with the globe, and China was 93.87%. But in
comparison with the US, this ratio was just 20.37%,
33.65% Japan, and 33.10% Singapore (Table 4).

China is growing fast, so the great energy sources are
very in need whereas its petroleum sources are consid-
ered as the lowest among other countries and coal supply
is also limited. Thus, it is the key reason for China to
suggest arbitrarily and unacceptably the U-shaped line
and trigger assaults on nations in the East Sea such as
Vietnam, the Philippines, Japan Sea and Hwang Hai Sea
with Korea.

Political connections, disputes and arms race in the
whole globe.

Currently, the 2 nations of BRICS, China and Russia
are permanent members of UN Security Council. The
changing tendency of the world and diplomatic measures
to reform the UN will be likely to focus mainly on ex-
panding it by admitting India, Brasil and South Africa to

Source: Calculated by the author from [12].

Figure 3. Speed of energy consumption of BRICS, the world
and China.

Table 4. Per capita energy consumed in BRICS in com-
parison with the globe and other nations (Unit: kWh).

Year 2002 2003 2005 2007 2009

The world 2425.24 2491.25 2656.17 2829.57 2803.23

India 400.26 417.49 455.86 539.48 570.93

China 1184.94 1379.38 1783.22 2329.26 2631.40

Brasil 1810.94 1884.10 2019.92 2174.94 2206.20

South
Africa

4527.37 4619.37 4703.90 4938.40 4532.02

Russia 5304.66 5479.99 5784.97 6317.24 6135.57

Japan 7915.67 7815.31 8212.69 8489.65 7819.18

The US 13296.18 13307.49 13704.58 13657.45 12913.71

Singapore 7756.23 8113.64 8507.20 8513.71 7948.91

Germany 6900.78 6983.34 7113.41 7184.31 6778.66

Source: [13].

925

this organization owing to their important roles in their
own continents. The new growing axis of politics and
militay is shown by the relationship between Russia and
China; China-Russia and their partners in Latin America
and Africa is revealed by the China’s investment in most
nations in Africa and Latin America, etc.

On the surface, the affiliation of BRICS is merely for
their self-interests but each of the nations itself, even the
neighboring nations like Russia, China and India, have
had conflicts and envy of each other for history, eco-
nomics and politics as well. Disputes at the thousands-
long road border, charges against each other due to the
support of protesters and the hatred of history are still
problems that BRICS could hardly defeat.

4. Conclusions

Theoretical matters of the model of the conventional
market economy and the general principles for interna-
tional financial institutions such as WTO, WB, and IMF,
are showing lack of efficiency upon confronting the
modern economic problems such as the long-lasting fi-
nancial crisis, public debt, inflation and unemployment.

In contrast, BRICS is typical of the unconventional
economic model with the characteristics of economic-
political institutions representing for countries with emerg-
ing economy. BRICS has had a wide effect on the face of
economy and commerce owing to the world’s largest
population, and the second biggest economy after the US
BRICS’s power has been much enhanced since the 2008
global economic crisis and the European public debt, and
currently they are seemingly more powerful thanks to the
massive foreign currency reserves, the export of high-
valued resources and labor-intensive products with low
prices.

Besides, BRICS are confronting hard problems such as
poverty, low living standards, environmental pollution
and pressures of energy for growth. Moreover, the high
rate of impoverishment but enormous foreign currency
reserves is a paradox of development process, which re-
veals that BRICS fails to become an ideal model for the
redistribution of wealth for community.

BRICS is attempting to show off their power by using
non-traditional ways to solve economic issues, imposing
to rob the sovereignty on the boundary, seas and islands
of neighboring nations with vaguely and ambiguously
historical arguments, and trying to create disputes re-
gions so that they could force smaller countries to nego-
tiate with them, otherwise they will use military strength

to conquer them (a case in China now).
The fact that BRICS is establishing a new world order

by the affiliation with economic-political-military poli-
cies that do not comply with international general rules is
much worrying the modern world now.

REFERENCES
[1] A. Smith, “Wealth of Nations,” W. Strahan and T. Cadell,

London, 1776.

[2] J. M. Keynes, “The General Theory of Employment, IntEr-
est and Money,” Palgrave Macmillan, Hampshire, 1936.

[3] N. T. Phat, “Financial Corruption—A Challenge of Glo-
bal Economic Security in the 21st Century,” Economic
Studies, Hanoi, 2010.

[4] The Wikipedia, “BRICS,” 2012.
http://vi.wikipedia.org/wiki/BRICS

[5] The World Bank, “Population, Total,” 2012.
http://search.worldbank.org/data?qterm=Population&lang
uage=EN

[6] The World Bank, “GDP (Current US$),” 2012.
http://search.worldbank.org/data?qterm=GDP&language=
EN

[7] The World Bank, “Total Reserves,” 2012.
http://search.worldbank.org/data?qterm=Total%20reserve
&language=EN

[8] The World Bank, “GDP Growth (Annual %),” 2012.
http://search.worldbank.org/data?qterm=rate+of+Growth
+GDP&language=EN&format=

[9] The World Bank, “Goods Export (BOP, Current US$),”
2012.
http://search.worldbank.org/data?qterm=Goods%20Expor
t%20%28BoP%2C%20current%20US%24%29&languag
e=EN

[10] The World Bank, “Goods Import (BOP, Current US$),”
2012.
http://search.worldbank.org/data?qterm=Goos%20Export
%20%28PoB%2C%20current%29&language=EN

[11] The World Bank, “GDP per Capita (Current US$),” 2012.
http://search.worldbank.org/data?qterm=GDP&language=
EN

[12] The World Bank, “Electronic Power Consumption (kWh),”
2012.
http://search.worldbank.org/data?qterm=Electronic+powe
r+consumtion+&language=EN&format=

[13] The World Bank, “Electronic Power Consumption (kWh
per Capita),” 2012.
http://search.worldbank.org/data?qterm=Electric+Power+
Consumtion+per+capita&language=EN&format=

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