Being Subcontractors to Foreign Enterprises As production networks and value chains expand
Being Subcontractors to Foreign Enterprises
As production networks and value chains expand, businesses become increasingly global, and more and more SMEs are drawn into these systems as subcontractors to multinational enterprises. Subconstracting refers to the sourcing of different parts of a product or process from different companies. A subcontractor provides commissioned work, such as specific parts and components, processes and services, or in some cases finished products9.
Being either higher- or lower-tier subcontractors10, SMEs experience greater specialization in production networks or global value chains. This opens up opportunities for SMEs to achieve economies of scale and scope11. For example, in Indonesia, Remula Inti Rekayasa has been providing stanless steel tanks to Coca Cola and other multinational companies to store liquids12.
Having Foreign Subcontractors
Instead of being subcontractors, SMEs could have foreign subcontractors which is another means of internationalization. This usually starts with the appointment of foreign sales representatitves and distribution agents. Although the number of SMEs with foreign subcontractors is significant13, this
form of internationalization is a recent phenomenon and has not been widely documented and studied.
Cooperation with Foreign Enterprises
Besides the above activities, SMEs also engage in cooperation with foreign enterprises to internationalize. According to studies conducted on European SMEs, international cooperation contributes significantly to SMEs’ competitiveness14.
A joint venture is an entity set up by two or more independent firms, who share the control over the joint venture and are jointly accountable for the costs and profits. In the context of SME internationalization, at least one independent firm is a local SME and the other is a foreign firm. Contrary to FDI where the investor could have total managerial control, the control of a joint venture is distributed among investing firms. In certain cases, joint venture is the only way for SMEs to gain access to foreign markets.
Non-equity alliance is also called strategic alliance. It is characterized as a formal agreement between two or more independent firms for a common strategic goal15. A non-equity alliance does not involve equity arrangement, hence it has no impact on control or management. Partners provide strategic resources to each other, such as products, distribution channels, manufacturing service, capital, know-how and intellectual assets. Non-equity alliance with foreign enterprises helps to lower the business risk for SMEs to enter into a new market.
Licensing refers to a local SME giving a foreign enterprise access to its intangible property for a certain time period in return for a royalty fee from the receiver16. Licensing is usually short-term oriented, and is more prevalent in the pharmaceutical sector.
Franchising refers to a local SME acquiring the right from a foreign enterprise to conduct a particular business activity based on a royalty
payment. The local SME would provide certain goods and services under the name of the foreign enterprise. Franchising is usually long-term oriented17.
Although of a different nature, these internationalization activities can complement and support one other – SMEs could and usually carry out more than one type of internationalization activity simutaneously.
The Uppsala Internationalization Model, developed in 1970s, is the earliest theory on the specific sequences that SMEs follow to access international markets. It describes a gradual process to internationalize – starting from intermittent exporting, and then exporting via agents, and then moving on to cooperation with foreign firms via sale subsidiaries, joint ventures, licensing and franchising, and eventually achieving FDI in the overseas markets18.
Later on, complementary to the Uppsala Model, the Network Theory Model was developed at the time when global production networks and value chains became more prominent. The Model places all the firms into networks of suppliers, subcontractors, customers and other market actors19, and SMEs start to internationationalize from selling to or buying from multinational companies via global production networks or value chains.
The internationalization process has implications on the grouping of SMEs. Both the Uppsala Model and the Network Theory Model describe an incremental process for SMEs to internationalize, i.e. SMEs start as domestic firms, and gradually develop their international business capacity and become active in the international markets. Firms that fall under this group are classified as “incremental internationalization SMEs”.
Other SMEs start with a global vision and devote resources towards international activities from the onset. These are classified as “born-global SMEs”,
and they are usually in knowledge-intensive sectors and supply niche markets20.
For these two groups, the main barriers to access international markets are different, and policies to assist them would therefore require different approaches. In the case of incremental internationalization SMEs, since cost is a major factor in decision making, the governments can implement trade facilitation measures for SMEs; remove information barriers; and guide them in meeting corresponding standards. For born-global SMEs, lack of financial resources is often a main concern. Policies facilitating access to credit would thus be relevant for these SMEs21.
For policy makers, it will be helpful to have an idea about the degree of SME internationalization in their respective economies. A good understanding of the process and extent of internationalization could make policies more specific and targeted. Internationalization is also closely linked with industrial development strategies aiming to improve economic competitiveness. Indeed, research by the European Commission found that “innovation and internationalization share a positive causal effect in competitiveness22.” Successful born-global SMEs are good examples of this.
Measuring SME internationalization though is a challenging task. Various attempts have been made to measure international activities at the micro and macro levels. However, the reliability and validity of these measurements are debatable. Although over 97% of the companies in the APEC region are SMEs23, obtaining data on SMEs’ business activities is not easy. On one hand, SMEs are usually not part of any representative business association promoting their interests, and many of them do not necessarily keep detailed records of their activities. On the other hand, business patterns are constantly evolving and this makes it difficult to find a sound methodology to measure the degree of internationalization across time.