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First Mover Advantages and Market Making Expenditures in Emerging Markets: A Conceptual Exploration Peter Enderwick Department of Marketing and International Management University of Waikato Private Bag 3105 Hamilton New Zealand Ph +64 7 8562889 Fax + 64 7 8384352 E-mail ipe@waikato.ac.nz Abstract This exploratory discussion introduces the concept of market making expenditures – the expenditures pioneering firms entering emerging markets need to make to achieve market development. They differ from the idea of pioneering costs in that market making expenditures can take the form of investment not simply cost, they arise from underdevelopment of markets rather than environmental uncertainty, and are discretionary for the investing firm. We define market making expenditures, explore the different types of expenditure, and examine strategies for maximizing the appropriability of market making investments. The implications for further research and refinement of the concept are also explored. Keywords: First mover advantages, market making expenditures; emerging markets

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First Mover Advantages and Market Making Expenditures in Emerging Markets: A Conceptual Exploration I Introduction The strong growth performance of emerging markets1, particularly the big emerging markets

of China and India, has attracted considerable interest from foreign investors. At the same

time, academic interest in this area has also increased significantly (Hoskisson et al 2000; Luo

2002; Pan, Li, and Tse 1999). This body of research addresses a number of the distinctive

issues that arise in doing business in emerging markets. With regard to overseas market entry,

the literature identifies the related questions of where to invest (the location decision), what

form to adopt (mode choice), and the issue of entry timing, whether the firm should be an

early or a late mover into an emerging market industry. It is the latter issue that is addressed in

this paper. In particular, we seek to understand a persistent research finding in emerging

markets that while there is generally a strong correlation between early entry and market

share, this is not always the case with regard to profitability (Li et al 2003; Luo and Peng

1998; Pan, Li and Tse 1999). In other words, while early entrants are able to attain significant

market share they may not be able to capitalize on this in terms of profitability.

Our explanation introduces the idea of market making expenditures in emerging markets.

These are expenditures that entrants must make to create, educate and develop the markets

that they enter. Such expenditures arise because of the incompleteness of market institutions

in many emerging and transitional economies. They differ from the more traditional concept

of ‘pioneer costs’ which are the additional costs faced by first mover firms. The principal

difference is that we suggest market making expenditures can take the form of both costs and

investments and those may be necessary expenditures when developing the market of an 1 Emerging markets are characterized by a low average level of per capita GDP, but high, and often variable rates of economic growth, that cause structural economic change.

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emerging economy. We also suggest that the concept of market making investments, and in

particular the problem of appropriating the full returns on such investments, could provide an

explanation for the contentious empirical findings that while first movers in emerging markets

seems to enjoy market share advantages, this is not necessarily the case with regard to

profitability.

The discussion is organized around five principal sections. The following section provides a

brief overview of the literature on first mover advantages and some of the weaknesses that

need to be addressed. Section III provides a conceptual analysis where we define market

making expenditures and outline seven principal types of market making expenditure. In

section IV we offer a simple diagrammatic analysis of market making expenditures and in the

light of the appropriability problem, identify a number of strategies that pioneering firms may

pursue to maximize the effectiveness of their expenditures. Section V provides a concluding

discussion of the analysis.

II Literature Review The timing of market entry and its implications for business performance has received

considerable research attention. Much of the early research focused on identifying and

understanding the nature of advantages likely to be enjoyed by early mover or pioneering

firms (Kerin, Varadarajan and Peterson 1992; Lieberman and Montgomery 1988;

Schmalensee 1982). These advantages have been classified as economic, preemptive,

technological and behavioral.

Economic advantages arise from the cost benefits that early movers enjoy through economies

of scale and scale, learning and experience curve effects and marketing advantages.

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Preemptive advantages result from the opportunities that early movers have to control

suppliers, distributors and market outcomes to the detriment of late entrants. They represent

effective barriers to entry (Bain 1956). Technological advantages stem from the ability of

early movers to determine industry standards, to maximize the proprietary returns of

innovation and to maintain a strong technological lead over time. Behavioral advantages are

created in the market place and reflect higher levels of brand loyalty and preference enjoyed

by pioneering firms (Carpenter and Nakamoto 1989), higher switching costs faced by

customers and greater market knowledge (De Castro and Chrisman 1995) and the

opportunities that early movers have for extending strong brands to related products under an

‘umbrella’ strategy.

These advantages available to first movers have to be offset against the disadvantages of

pioneering (or the advantages of late movers). Late movers may benefit from being able to

‘free-ride’ on the investments made by market pioneers, from higher levels of market

certainty, from technological discontinuities that provide opportunities for ‘leapfrogging’

incumbents as well as problems of incumbent inertia that limit their ability to adapt to

changing conditions (Lieberman and Montgomery 1988).

Empirical tests of these expected advantages offer mixed results. While the majority of

studies find early movers enjoy higher market shares, the link with profitability is less clear

De Castro and Chrisman 1995; Huff and Robinson 1994; Isobe, Makino and Montgomery

2000; Mascarenhas 1992). There are several probable reasons for the ambiguity of these

results (Vanderwerf and Mathon 1997). First, studies differ in their focus regarding new

markets. The early studies were based on domestic or cross-industry entry using PIMS data to

examine market share and performance outcomes. The studies that focus on international

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market entry, and in particular, entry into emerging markets, are a much smaller subset (Li et

al 2003; Luo and Peng 1998; Mascarenhas 1992; Mitchell, Shaver and Yeung 1994; Pan and

Li 2003). It is these studies that are of particular relevance to our analysis.

Second, it is only very recently that studies have begun to control for differences in firm type

and resources (Isobe, Makino and Montgomery 2000; Li et al 2003). This research recognizes

that the competitive strength of the firm, measured in terms of resources and strategic

orientation, is likely to determine the effectiveness of first mover advantages. This approach

echoes earlier calls to ground the research on first mover advantages with the resource based

view of the firm (Lieberman and Montgomery 1998).

Third, such a recognition raises the critical issue of how first movers are distinctive and what

differentiates them from other competitors. Currently the literature in this area suffers four

deficiencies. The first is that the source of first mover advantages is not well understood.

According to Lieberman and Montgomery such advantages result from luck or proficiency.

Luck relates to external market conditions that are not under the control of the firm. It

provides unique opportunities for the first mover firm. However, the theory does not explain

how certain firms are able to exploit these openings while others are unaware of, or unable to

take advantage of, such opportunities. Firm proficiency refers to factors under the control of

the firm, and processes by which the firm can align resources to exploit market opportunities.

In either case this raises a second weakness. Understanding the determinants of first mover

advantages requires a dynamic rather than a static explanation. If firms are to align strategies

and resources to market opportunities then this must occur as a dynamic process. Indeed, it is

recognized that firms seeking to maintain first mover advantages over time and in the face of

competitor entry, will need to invest to maintain such advantages (Lieberman and

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Montgomery 1988). A third weakness arises from poor integration of the competitive actions

of first- and subsequent movers. This weakness is the failure to recognize the importance of

appropriability in market making investments. Where early followers and late movers are able

to free-ride on the investments made by pioneering firms, the advantages of first movers will

be reduced and the attraction of later entry increased. Such a situation would be consistent

with pioneer firms enjoying significant market shares, but not necessarily high levels of

profitability. A fourth weakness is the assumption in most of the first –mover advantage

literature that markets are relatively well developed and that appropriate market-supporting

institutions both exist and function effectively. While such an assumption may hold in the

case of cross-entry within advanced markets, it may not hold in the case of many emerging

markets. In this case, pioneering firms may well need to undertake considerable expenditure

on marketing making activities.

It is because of these weaknesses, and the inconclusiveness of empirical results, that this

paper explores the idea of market making investments in an attempt to move beyond the

simple concept of pioneering costs to consider these as part of an investment strategy that

early movers may need to make in emerging markets.

III Conceptual Analysis

Definition of Market Making Expenditures

The term market making expenditures is used here to refer to the expenditures that foreign

firms incur when entering emerging markets as pioneers. This concept differs from the more

traditional idea of ‘pioneering costs’ (Carpenter and Nakamoto 1989) in three key ways. First,

pioneering costs refer to costs which are primarily attributable to the higher levels of

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uncertainty that are faced by early entrants. The price that early entrants pay is an

environment that is less predictable than that enjoyed by later entrants. This difference arises

from institutional and policy development over time, opportunities for learning that result

from incumbency in the market, and the ability to learn from the experience and mistakes of

early entrants. Second, our concept of market making expenditures allows for investment in

the creation of competitive advantage and not simply the incurrence of higher transaction

costs. In this way, our concept encompasses one of the key advantages associated with early

entry, the opportunity to undertake pre-emptive investments (Lieberman and Montgomery

1988). Thus market making expenditures may be seen as either a cost or an investment. Third,

market making expenditures are discretionary and are under the control of the investing firm.

As such, they form part of the strategy process. This compares with pioneering costs, the

extent of which are primarily determined by market and competitive conditions.

The Nature of Market Making Expenditures

As mentioned above, market making expenditures can take the form of a cost or of an

investment. Cost elements of market making expenditure are similar to pioneering costs. Of

greater significance to this discussion are the investment aspects of market making. Here we

may distinguish proprietary and non-proprietary investments. Proprietary market making

investments are those which are specific to the firm and which cannot be enjoyed by others.

An example is provided by local adaptation of a potential product which subsequently enjoys

enhanced appeal in the host market. Provided intellectual property rights are enforceable, such

investments should yield a return only to the firm owning the rights. In contrast, some market

making investments generate returns to a number of firms in the industry. This is likely, for

example, in the case of the creation of a supply base.

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Forms of Market Making Expenditures

When considering emerging markets we can distinguish seven principal categories of market

making expenditures. These relate to host country government relations, local product

adaptation, creation of a supply base, investments in distribution, the establishment of after-

sales service facilities, employee training and buyer education. Clearly, all of these refer to

stages of value-adding in market processes. In many emerging markets these elements may be

incomplete or underdeveloped. For example, an international automobile manufacturer

entering the Indian market cannot be assured that there will be a potential supply base

comparable in terms of numbers, experience, quality or performance to what might exist in

the home country. As a result, the investing firm may incur expenditures to help build this

base, perhaps by bringing suppliers from the home country or by assisting the upgrading of

local firms. We summarize these in Table 1.

We briefly examine each of these principal forms of market making expenditures.

Host Country Government Relations

The majority of emerging markets are characterized by a high level of government

involvement in economic affairs (Luo 2002). This is particularly likely to be the case in

transitional economies. Such economies are also subject to pervasive regulation. For these

reasons establishing sound relations with the host country government is of critical

importance, particularly for first movers. In the early stages of transition, regulatory policy is

likely to be complex and unpredictable. Early foreign investors have powerful incentives to

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invest in cultivating strong relationships with government in an attempt to gain better insights

into current and future policy, to potentially influence the direction of policy change, and to

enjoy the benefits that come from a perception of considerable and early commitment to a

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Table 1 Types of Market Making Expenditures and Levels of Appropriability Type of Market Making Expenditure

Ability to Appropriate Investment

Investment Mechanisms Maximizing Return on Investment

Host Country Government Relations

Medium Through the cultivation of firm specific relationships. Creation of ‘reciprocal’ benefits. Externalities could result from enhanced bargaining power of a better informed government and greater stability and predictability of the business environment

Formalize relationships perhaps through joint ownership. Set industry standards in conjunction with government officials. Encourage discriminatory policies effectively excluding or disadvantaging late movers.

Local Product Adaptation High Local market research and product adaptation to increase market acceptance. Externalities could arise from pioneering market growth and development for generic product types.

Strategies of strong branding and creating product distinctiveness. Exploitation of the most attractive market segments. Creation of customer/brand loyalty. Raising switching costs.

Creation of a Supply Base Low Attraction of existing suppliers from the home country. Investments enhancing the quality, performance and upgrade of local suppliers. Externalities very likely to result from the creation of a viable supply base. Generation of locational economies.

Sourcing supplies internally or from related affiliates. Encourage ‘exclusive’ supply relationships. Provide sufficient economies of scale to suppliers.

Distribution System Medium Opportunity for preemption of distribution facilities. Building brand and distributor loyalty. Externalities likely to arise from non-exclusive distribution arrangements and the creation of more sophisticated channels.

Exclusive distribution system. Acquire competing distribution systems.

After Sales Service Medium Opportunities for value adding enhanced customer service and brand acceptance. Externalities arise from non-exclusive service arrangements and reduced buyer uncertainty.

Exclusive after-sales facilities.

Employee Training Medium Investment in product, firm and market-specific training

Policies to reduce employee turnover. Attracting those with high levels of general training.

Buyer Education Low Creation of demand, pioneering market acceptance. Considerable externalities could result from the process of consumer education which may be enjoyed by all participants.

Create generic brand position. Premium pricing to exploit early market lead. Set (exacting) industry standards and consumer expectations.

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market. In addition, early entrants may also be able to create a situation of ‘mutual benefits’

where they form business associations with state-owned enterprises or political organizations.

While such market making investments clearly benefit the investing firm, they also generate

externalities for subsequent investors. This could occur as a host country government

becomes more sophisticated and experienced in its dealings with international investors. In

such a case later investors may find themselves forced into less attractive positions where host

government negotiators are able to capture a larger share of potential rewards. A positive

externality is enjoyed by subsequent investors if they face a lower level of risk because of the

influence of pioneering investors. It is apparent that in this case of market making investment,

a significant proportion of the returns remain proprietary.

As Table 1 suggests, there are mechanisms available to early entrants which can enhance the

proprietary nature of these investments. Formalization of ownership relations in the form of

joint ventures with host country officials could reduce the probability of undesirable

intervention. Cooperation on the establishment of industry standards (technical and

regulatory), may facilitate the creation of entry barriers against new competitors and ensure a

higher return for (early) incumbents. Negotiation of protectionist barriers in the form of

restrictions on imports or constraints on the number of industry licenses available may

effectively exclude or disadvantage late entrants.

Local Product Adaptation

Adaptation of products and services for the local market represent a sound investment in

terms of the ability to fully capture returns. Investments in local market research and product

adaptation can greatly increase market acceptance. Interesting examples are provided by

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Korean companies entering the Indian market. While western multinationals were amongst

the first to enter the Indian market following liberalization in the early 1990s, they undertook

little product adaptation. Ford offered the Escort and General Motors the Opel Astra, both

midsize cars with aging technology, retailing for more than $20,000. Hyundai realized that

such prices were beyond the means of most Indian consumers. Their first model was the

$7000 Santro, a mini-car incorporating the latest technology and designed specifically for the

Indian market. Samsung spent almost two years in India during the mid-1990s before

launching its products. Both Samsung and LG realized that there was a demand for higher

volume television sets in India because viewing often occurs in noisy family environments.

For a premium of 7 per cent both companies now market sets with more than 800 watts of

sound compared with the normal 200 watts (BusinessWeek 2003). These examples illustrate

that product adaptation can contribute to market acceptance, sales growth, and consequently a

larger market share. However, it is not the case that all of these benefits can be captured by

the pioneering firm. Product adaptation may also contribute to generic market growth and

development, benefiting all competitors in the market.

Pioneers undertake a number of activities designed to maximise their share of such benefits.

The most common are strong branding and the creation of a distinctive product/market

position. Early movers also have the opportunity to develop the most attractive market

segments. The result of these activities should be to increase brand and customer loyalty and

even to raise switching costs.

Creation of a Supply Base

Contributing to the creation of a supply base in the host market is an area where proprietary

investments may be limited. Investments in the development of local suppliers which improve

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technical and quality standards are likely to be enjoyed by all customers. Similarly, enhancing

the competitiveness of suppliers through programs of upgrading create a positive externality

for all those in the market. Positive externalities arise from the development of a viable supply

base and the generation of locational externalities. To maximize their private benefits,

pioneering firms in an emerging market may pursue a number of options. One is simply to

source components and services from within the related corporate network. This way such

transactions are effectively internalized. A second option is to attract suppliers from the home

country to the host market. This allows quality and performance standards to be achievable in

a short time after start-up. Furthermore, home country based suppliers are likely to have

stronger relations with multinational buyers than with local competitors. A third alternative is

for a multinational buyer to ensure a level of purchasing that allows a local supplier to achieve

minimum efficient scale. This might make it possible to then tie that supplier to an exclusive

relationship.

Distribution System

Early market entrants may enjoy opportunities for pre-emptive investment in distribution

systems. Where those systems are limited, perhaps enjoying monopoly status in some

emerging markets, control by early entrants can create a significant barrier for later entrants.

Even where there is more competition in distribution chains, early movers have an

opportunity to build both brand and distributor loyalty. Failure to capture all the private

benefits of such a move may result from an inability to ensure exclusive arrangements. If

scale of throughput is insufficient then distributors may be forced to handle a range of

competing products. Externalities may also be generated from the development of more

sophisticated and efficient distribution systems, irrespective of ownership. Strategies to

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maximize the returns to the investing firm include exclusive distribution systems and even the

anti-competitive move to acquire competing outlets.

After-Sales Service

Similar arguments apply to after-sales service facilities. Investment in such facilities provides

opportunities for value-adding, for enhanced customer service and greater brand awareness

and acceptance. An example is provided by Volkswagen who made considerable investments

in vehicle servicing facilities after entering the Chinese market as a major vehicle

manufacturer. Such facilities have allowed the company to enjoy a current market share of

some 52 per cent and have raised substantially customer switching costs. The proprietary

content of such investments is only modest because externalities arise from any non-exclusive

service arrangements and from a general reduction in perceived buyer risk. Companies seek to

maximize their returns on such investments through ensuring exclusive after-sales facilities

and in generating economies of scope. The entry of Honda into Vietnam provides a good

illustration. Honda has helped to establish both exclusive and more general after-sales

facilities for its motorcycle business. Over time as the Vietnamese market becomes a

significant one for car sales, Honda will be able to upgrade and utilize existing facilities for

both type of product.

Employee Training

Early mover investors need to make investments in building an effective workforce. For

pioneering firms there may be very few opportunities for poaching potential employees from

rivals. As a result investments may have to be made in product- , firm-, and market-specific

knowledge. Because of the difficulties of ensuring retention of employees, the appropriability

of such investments is only modest. Investing firms can attempt to increase the returns on

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such investments by discouraging turnover or through a preference for employing workers

with high levels of general training (tertiary qualifications and local market experience).

Buyer Education

While buyer education (market creation) investments may be necessary for an early entrant in

a new emerging market, such investments may not be easily captured by the firm undertaking

the expenditure. This is because of the considerable externalities that are likely to result. The

creation of demand and pioneering of market acceptance is a process that is likely to benefit

all firms in the market. Wal-Mart as a pioneer in China was instrumental in persuading

consumers to switch from specialty shops to a one-stop centre. While this has undoubtedly

benefited Wal-Mart it has also assisted the entry of other competitors such as Carrefour and

Ahold. For a number of pioneer firms such investments can create a generic brand position

such as Rollerblades, which many consumers see as a generic product description but which is

actually a specific brand. Pioneering firms may be able to maximize the return on such

investments through the use of a premium pricing strategy to exploit their early market lead.

Similarly, they may be able to set very exacting industry standards in terms of quality,

performance, price/value ratio and to positively influence customer expectations. This forces

later followers to make substantial investments in new technology or product features to

weaken brand loyalties. However, investments in buyer education, in anything other than a

monopoly market situation, may be the most difficult investments to appropriate.

IV A Diagrammatic Analysis of Market Making Expenditures

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Figure 1 provides a basic analysis of the concept of market making expenditures. The bottom

cost line shows production costs in the long run. This curve follows the traditional assumption

of economies of scale and a minimum efficient scale (0-X1). The early entrant is assumed to

be able to capture a market share sufficient to allow production at point X1 with a

corresponding production cost of PC1. However, if we are considering an emerging market

we cannot necessarily assume a level of market development and the effectiveness of market

institutions sufficient to allow the firm to achieve the necessary scale in the absence of any

additional investment. The necessary investment is shown by the vertical distance between the

production LRAC and the total LRAC. The difference between these two is assumed to be the

market making expenditures that a first mover firm must incur to attain the MES at point X1.

The effect of this is that the first mover firm actually faces a total cost position of TC1.

However, as shown in Figure 1 this is still less than TC2 which is the total cost level of a late

mover firm that is able to free ride on the market making investments of the pioneer firm. The

late mover at TC2 incurs only ‘production’ costs, making no investments in market making

costs. In this particular case, the late mover is at a cost disadvantage because it is unable to

capture sufficient market share to allow it to move down the long run average production cost

curve. Note, that this is merely an assumption and is by no means always the case. In this

simple case we are assuming that the late entrant makes no investments, even though some

investment in technological development may be necessary.

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Figure 1 Production and Market Making Costs in Emerging Markets

It should be clear that the outcome in Figure 1 (and whether it is better to be an early entrant

or a late mover), depends on the relative magnitude of the slope of the production LRAC and

the level of market making expenditures. The greater the importance of economies of scale

(the steeper the slope), all other things equal, the stronger will be the incentives for early

entry. The slope is determined by the nature of production conditions, and more precisely,

will be steeper the more sophisticated are technological activities and the greater are

opportunities for learning-by-doing.

Early mover

Cost/Expenditures

Scale

Total LRAC FM

Production LRAC

Market making expenditures

X1 X2 0

TC2

TC1

PC1

Late Mover

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The magnitude of market making expenditures depends on a number of considerations. The

most important of these are the level of development of the market, whether the market is in

transition (from planned to market), whether it is predominantly a relationship-based

economy, the prevalence of corruption and the number of competing firms.

The lower is the level of development of the market and market-supporting institutions, all

other things equal, the more early entrants will need to invest to overcome market failures.

Such failures are likely to be greater in a transitional economy where many market-supporting

institutions have never existed. Market making expenditures are likely to be greater in a

relationship-based economic system as market development (and the development of links

with suppliers, customers, distributors, and government) is a slower and more difficult

process (Peng and Heath 1996). Pervasive corruption also adds to market making

expenditures because it directly increases the cost of transactions when they must include an

illegal payment. The magnitude of such costs depends on how widespread corruption is, as

well as the ways in which the firm does business. Furthermore, the level of competition in the

market also affects the magnitude and effectiveness of market making expenditures. Where

there are many competitors there is likely to be greater opportunity for free-riding on the

investments of other firms. For an effective monopoly, while market making expenditures

may be greater, they are also likely to be more appropriable.

Strategies to Maximize the Effectiveness of Market Making Investments

The magnitude and difficulty of appropriating the full returns from market making

investments suggests that the early entrant to an emerging economy may attempt to try to

maximize the effectiveness (or minimize the level) of such expenditures. A number of

strategies designed to achieve this are identified in Table 2.

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Table 2 Maximizing the Effectiveness of Market Making Expenditures

Strategy Process Outcomes Integrate affiliate within the MNE network

Attempt to reduce costs of doing business by minimizing local activity

Defensive strategy for managing the liability of foreignness. Constraint on local market acceptance. May be vulnerable to competition from local firms and late entrants.

Localize management Reduce costs of market making by utilizing local knowledge and contacts

Difficulties of integration within the corporate network. Difficulties of transferring learning experiences.

Use of joint ventures Reducing costs and risks of market making by accessing local knowledge and resources

Firm may forego some internal scale economies and experience curve effects. Pressures for greater localization. Additional costs/problems of management.

Access locational externalities Locate to maximize positive externalities. Maximize use of local resources/policies through Special Economic Areas, EPZs, science parks and industrial clusters

Locational externalities may be very limited in emerging markets. General externalities may be difficult to appropriate.

Pressure host government to share some of the costs

Seek government provision of infrastructure, subsidies and market-supporting institutions

Could reduce the direct costs faced by early movers. May be difficult to appropriate.

Seek compensating protection Seek government controls on imports, restrictions on local firms and on later (foreign) entrants

Protectionism allows effective monopoly pricing and profits. May increase inefficiency.

The first strategy, one of integrating the emerging market affiliate within the MNE network, is

designed to minimize the need for market making expenditures. Here the idea is to reduce

local market involvement and to optimize supplies from, and outputs to, the parent company

and related affiliates. The principal motive for involvement with the emerging market is likely

to be simple processing for export rather than servicing the local market. This type of strategy

is most attractive in a small emerging market, particularly one which has very low costs or

unique resources. Some off-shore sourcing of software development in India appears to

follow this pattern.

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Such a strategy has a number of likely outcomes. One is that it offers a defensive approach to

the liability of foreignness (Zaheer 1995). By reducing dependence on the host country

environment, the investing firm is less vulnerable to environmental uncertainties. The

shortcoming of such an approach is simply that the firm does not effectively integrate into the

emerging market and is limited in its ability to achieve market penetration and development.

In many ways the firm becomes a ‘de facto late entrant’ when at some stage it switches to a

more offensive approach to local market development (Luo 2002). Such a strategy may also

expose the firm to high levels of competition from local producers and later foreign entrants

prepared to adopt a stronger local market orientation.

A second strategic option is to localize management. With this approach costs of market

making are reduced by tapping into local knowledge and contacts possessed by local

managers. Such a strategy is likely to be more successful in some areas of market making than

others. For example, political contacts could be usefully exploited in the service of the foreign

investor, but such contacts would be of limited value in establishing a supply base or

distribution system. The principal gains would be in increased cultural empathy and lower

search costs. A strategy of localization of management has two clear drawbacks. The first is

the increased difficulty of integrating the affiliate within the corporate network. Local

managers, while knowledgeable about the host market, may have little appreciation of broader

corporate values and procedures. This could result in a tendency towards fragmentation of

operations. A second, and related drawback, are the difficulties of transferring learning

experiences across the corporation. One way of reducing some aspects of market making is to

transfer relevant learning from one market to another. This becomes difficult when

management has strong local knowledge and orientation and limited ability to see the value of

generalizing learning opportunities.

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The third strategic option is the use of a joint venture as the entry mode. This strategy also

attempts to reduce market making expenditures by accessing the knowledge and resources of

a functioning local enterprise. The implications of a joint venture strategy are shown in Figure

2

Figure 2 The Impact of a Joint Venture on Market Making Expenditures

Figure 2 illustrates the assumption that total costs exceed production costs by a margin that

comprises market making expenditures. As shown above, the wholly owned subsidiary faces

total costs of Total costs (WOS). However, because the joint venture partner is assumed to

have considerable knowledge of the local market, and to be more efficient in market making,

Total costs (JV) are lower. The early foreign entrant incurs only the residual market making

Total costs (WOS)

Production LRAC

Scale

Cost/Expenditures Contribution of JV partner

Residual market making expenditures

Total costs (JV)

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costs (the difference between production costs and total costs of the joint venture). Note also

that the magnitude of residual market making costs is not constant. This follows from an

assumption that the contribution of the joint venture partner is likely to be greatest in the

earlier stages of establishment. It is at these stages that the joint venture partner’s political

connections and understanding of the marketplace will be most valuable. In the later stages

when minimum efficient scale has been achieved, costs of distribution and after-sales

servicing will become more significant. As such systems are unlikely to exist in the emerging

market their creation is more likely to be driven by the foreign investor.

While a joint venture relationship may result in lower total costs (production plus market

making costs), it can bring additional problems. The foreign investor, by sharing costs and

risks, may also forego some economies of scale and learning opportunities. A joint venture

structure also implies a greater degree of localization of activities and the desirability of this

depends on the overall strategy of the investing firm. Joint ventures in emerging markets are

also associated with higher costs of management and high rates of failure (Adarkar et al

2003).

A fourth strategy for minimizing market making expenditures is to maximize opportunities

for accessing positive externalities that may exist in the local market. As emerging markets

begin the development process they seek to create wider and deeper markets. Indeed, many

governments recognizing the resource and infrastructure constraints they face maximize the

utilization of such resources through concentration. This is the thinking that encourages the

creation of special economic zones, export processing zones, science parks and industrial

clusters more generally. Early investors may be able to tap into externalities where such

locations enjoy a concentration of resources and expertise. The infrastructure, workforce skills

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and supply base are likely to be more sophisticated in such areas than in the country more

generally. However, it is important to recognize that locational externalities may be quite

limited in such areas, particularly in the early stages of transition or development. Export

processing zones offer enhanced infrastructure and supply conditions, but because the

majority of output is exported, buyer education, distribution and branding are likely to be very

limited. Furthermore, the types of externalities that are created are likely to be very general

and difficult to appropriate.

Pressurizing the host country government to share some of the costs of market making is a

fifth strategy. Public investments are most likely to take the form of infrastructure and market

supporting institutions with the primary aim of increasing the attractiveness of the country to

foreign investors in general. It would be less likely that public investments would provide

proprietary assets for a foreign investor in the absence of some joint ownership arrangements.

Indeed, in many emerging markets early investors are assumed to enjoy substantial private

gains from the opportunity to make pre-emptive investments in distribution systems and the

most attractive joint venture partners. An exception might occur if an investment was seen as

‘flagship’ and likely to act as a magnet to further desirable and related investments. In such a

case a host government might be persuaded to incur costs which are equal to or even exceed

the public benefits of the pioneering investment if a sizeable stream of benefits is anticipated

from subsequent investments. The general case of the provision of incentives is illustrated in

Figure 3.

24

Figure 3 The Impact of Incentives on Market Making Expenditures

In this case the value of incentives can offset a proportion of market making expenditures.

Such incentives may be greater, or only available, to pioneering investors. China rewarded

early entrants with incentives, tax concessions and market access opportunities that were not

available to later entrants (Pan, Li and Tse 1999). For a host government, some of the costs of

providing incentives may be offset by the external benefits that accrue from a greater critical

mass of FDI or industry clustering.

A final strategy might be to seek compensating protection to offset the costs of market

making. In such a case early entrants seek forms of protectionism - import controls,

restrictions on local firms and on later foreign entrants – which contribute to a more attractive

operating environment. An effective monopoly position and the excess profits that result

provide partial compensation for investments in market making. While this may not be an

Total LRAC

Production LRAC

Scale

Cost/Expenditure Value of incentives

Market making expenditures

25

attractive option from the perspective of efficient resource use in the host country,

governments may be induced to provide such protection to target desired or favored industries

or firms.

It should be noted that we are not suggesting these as mutually exclusive strategies; clearly an

investor may pursue more than one strategy simultaneously.

V Discussion and Conclusions This paper has proposed a reexamination of the concept of first-mover advantages within

emerging markets. More specifically, we have suggested that the idea of pioneering costs fails

to capture the reality of market entry where processes and institutions are underdeveloped.

We suggest the more relevant concept is that of market making expenditures – the expenses

that pioneering firms must incur to penetrate emerging markets. These expenditures take the

form of both costs and investments and are subject to significant appropriability problems. In

this exploratory discussion we have examined the nature of such expenditures, the forms they

assume and strategies for maximizing appropriability of returns from market making

investments. The analysis suggests a number of implications.

First, it should be apparent that the concept of market making expenditures differs in a

number of ways from the more traditional idea of pioneering costs. In particular, market

making costs do not simply result from a higher level of uncertainty and are not solely caused

by higher transaction costs. Rather, market making expenditures are discretionary

expenditures that form part of the strategic decision making of the firm. In this way market

making expenditures help to explain how a pioneering foreign investor can enter an

underdeveloped emerging market: investments are required to realize the market’s potential.

26

We believe that the idea of market making expenditures represents a more meaningful way of

conceptualizing the challenges that first mover firms face in emerging markets.

Second, the concept of market making expenditures is potentially capable of reconciling a key

research finding in the area of first mover advantage: that first mover firms generally enjoy

greater market share than subsequent followers, but not necessarily higher profitability. Our

analysis explains this in terms of the need for pioneers to incur additional investment costs in

market development. While many of these investments undoubtedly assist in market growth

and development difficulties of appropriating returns means that some of the benefits can be

captured by later entrants. This effectively lowers the costs for such firms through ‘free-

riding. Where this is combined with technological discontinuities, lower levels of market

uncertainty, positive externalities that can be captured by other firms, opportunities for

learning through imitation and ‘incumbent inertia’ (Lieberman and Montgomery 1988) later

movers may enjoy higher levels of profitability than first movers.

Third, our discussion provides a more satisfactory explanation of how differential advantage

(whether arising through luck or proficiency), is developed and exploited over time. First

movers continuously invest to develop their initial advantages in ways that contribute to

market growth and profitability. While we have considered situations where later movers

benefit from the investments of pioneering firms, the reverse case may also arise. For

example, pre-emptive investments by pioneering firms can generate specific market making

costs for late followers. This could occur where a late mover is excluded from existing

distribution facilities and is forced to invest in secondary distribution channels. The

effectiveness of such strategies can be enhanced where pioneering firms pursue the sorts of

approaches outlined in Table 2.

27

Fourth, it is apparent that our discussion represents only a first exploratory examination of

this topic. Further work is required in a number of areas. One is to incorporate the

characteristics of first mover firms and relate these to the types and effectiveness of

investment in market making expenditures. The existing literature identifies factors such as

entrepreneurial focus, resources, size and strategy as being prime candidates. In addition,

when considering emerging markets, many of which in Asia are relationship-based, the ability

to forge and manage relationships may be an important advantage of first mover firms (Li et.

al. 2003). Furthermore, industry characteristics will also be relevant to analysis. The dynamic

interaction between market making expenditures and key industry characteristics such as

entry scale, minimum efficient scale, advertising intensity, response time and scope

economies have barely been explored (Kerin, Varadarajan and Peterson 1992).

Fifth, effective testing of these relationships will require novel research approaches.

Longitudinal studies of specific industry segments with a focus on the investment decisions of

pioneering firms and the abilities of subsequent followers to free ride on these investments

suggest themselves. Case studies and qualitative approaches would be useful in highlighting

the dynamic interactions of these different groups of firms. This would allow researchers to

better understand the importance of lapse time in competitive response and whether there are

differences between early followers and late followers as well as strategies of gradual

resource commitment (Pederson and Petersen 1998).

Finally, more thought needs to be given to the likely relationships between entry timing and

entry mode. Much of the research literature sees these two as separate considerations. Our

discussion suggests that they are likely to be related. We suggest that early movers in

28

emerging markets may have a strong incentive use joint ventures if they believe this is an

effective way of lowering market making investments or of increasing the effectiveness of

such expenditures. The benefits that joint ventures offer in this way must be offset against

higher management costs, greater inflexibility and a higher probability of failure. A further

consideration would be the relative attractiveness of acquisition and greenfield entry for first

and late movers. Acquisition may be particularly attractive to later entrants if it enables them

to acquire critical resources or overcome barriers to entry.

29

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