The concept of "psychic distance" and its meaning for the global activity of small, medium, large sized businesses operating in foreign markets

Table of Content

1 Introduction

2 Psychic Distance

3 Business Size

4 Politcal Factors

5 Entry modes in foreign markets

6 Example Starbucks

7 United States vs. South Korea

8 Recommended Entry Mode

9 Conclusion

List of referneces

1 Introduction

This assignment explains the concept of psychic distance and what this means for the glo- bal activity of small, medium, large sized businesses operating in foreign markets. After giving a literature review about psychic distance, it’s influencinng factors and different entry modes in foreign market, an example of Stabucks Corporation acting global in South Korea is clearly presented. The example specifies all the different factors like eco- nomy, environment, politics etc. which are important in this case between the United Sta- tes and South Korea. Moreover the pontential benefits, risks, drawbacks and a recommend entry mode are explained.

The goal is to give an overview about the topic psychic distance and to show which factors contribute to this particular type of distance especaiily for the global work of Starbucks operating in South Korea.

2 Psychic Distance

The role of psychic distance is one of the most discussed themes on the internationalizati- on of firms. The psychic distance concerns the distinction between a nation of origin bu- siness environment and an external one, which is the foreign market place. The first con- cept was defined around 1970 by a group of researchers in Uppsala as: „Factors preven- ting or disturbing the flows of information between firm and market.“ (Johnson & Turner, 2003)

The concept of psychic distance is basically the perception of the differences between the home and the foreign country (O’Grady and Lane, 1996). Psychic distance within the internationalization process is not only based on the nature of the specific business and the degree of adjustment, but also on authoritative and administrative qualities. Therefore the distinction between different environments, the country of origin, as well as the foreign marketplace establish the concept of psychic distance.

The following graphic displays the great amount of authors and researchers who were in- volved in studies regarding psychic distance. All researches are somehow linked to Hof- stede’s study and model, however, it is also obvious that several different views of psy- chic distance exist. While many authors share a general opinion, some views greatly dif- fer; consequently several definitions and views on psychic distance have remained over time and the topic is further researched.

Copyright by Santos & Reis, Reprinted with Permission

The general belief is that a larger psychic distance creates instabilities that might affect a company's entrance into any market. Differences within the social and business environ- ment of two markets create distance, which can cause uncertainty and instability. Such differences incorporate society, culture, language, economic development, religion, edu- cation, representation, governmental issues, financial conditions, market structure, and business practices.

A study conducted by Lado, Martinez-Ros and Valenzuela (2004) found out that the degree of similarity to the specific home country makes some foreign market more attrac- tive than others. The researchers established that the psychic distance between the domes- tic and the foreign market play a guiding role in the selection but also in strategic decision within the internationalization of companies. Especially firms that lack international ma- nagement knowledge and expertise tend to internationalize in psychically close markets. While larger companies are mostly interested in mature markets, small and medium sized firms concentrate on developing and growing markets with low psychic distance where they are comfortably competing for growth and market opportunities. (Griffith et al, 2003; Sekarya, Eckman & Hyllegard, 2007 )

While there is general understanding with respect to the constituent components of psychic distance, the essential source of current discussion identifies the way in which psychic distance is operationalized. While it is perceived as a measure of uncertainty resulting from cultural, geographical, political and economic factors that often create barriers to learn about overseas markets, it is a perceptual construct rationalized by cultural indices. Numerous factors impact the psychic distance between countries and its impacts to firms’ international activities and it is hard to measure. One possibilty to measure these factors are Hofstede’s (2001) cultural dimensions.

For the last decades Hofstede’s model of culture has guided the cross-cultural science. The model, which involves Power Distance, Individualism, Masculinity and Uncertainty Avoidance, is widely used to study and describe national cultures (Hofstede, 1983; Min- kov & Hofstede, 2011). Organizational cultures, and also management, leadership and a company’s strategies, are strongly affected by culture (Zabid, Rashid, Sambasivan & Rahman, 2004). In international business it is essential to take cultural differences into ac- count and enure a balance between culture and strategy within the foreign market. Foreign cultures are harder to predict and consequently careful preparation is crucial. International businesses need to understand that what works in their home market and culture may not be working in foreign markets (Ekwall & Karlsson, 1999). When culture and strategy are in balance, there is a greater possibility for success. (Minkov & Hofstede, 2011)

As stated by Dow and and Karunaratna (2006) cultural distance is an essential factor impacting psychic distance, however, in their opinion it has been slightly overemphasized in literature. Culture not only influences people’s behavior, and communication but may also have a big influence on managerial decisions in regards of international business. Communcation between people from different markets and culture is highly affected by language, religion and educational level. These factors also influence the manner and interpretation of information, and can lead to unwanted miscommuncation. Language differences highly increase transaction risks and cost, while differences in might result in increased risk and uncertainty on management level.

Fenwick et al. (2003) argue that cultural differences’ are closely linked to companies’ international performance. Cultural values guide companies’ organizational and managerial processes and practices. Core values of a culture are forming a company’s managerial practices. According to Fenwick et al. (2003) „the positioning and hierarchy of significant and less important values determine perceived cultural differences.“ Their study examines that differences in management style and business practices tend to occur even between relatively close markets when psychic distance exists. These differences can cause crosscultural conflicts and challenge a company’s market entry strategy.

But culture is only one dimension of psychic distance. It is perceived that psychic distance alone cannot clarify varieties between nations in firm business execution. Different vari- ables, for example the nature of the business and the degree of adjustment affect the hie- rarchical accomplishment of international business as well. First, the political factors, which includes regional group memberships, state stability as well as the prevalence of peaceful relations between the home and the foreign country. Second, economics, which includes the government, control over business, stability of the foreign economy, the ex- tent of the currency fluctuations as well as the firm size. Third the geographic and cultural practices which include the structure of the market, the language relations as well as differing business practices.

Psychic distance is highly subjective and is therefore not only influenced by macro-level indicators, but also by the individuals’ perception. A recent study of Dow and Karunarat- na (2006) puts emphasis on the importance of educational factors, international experi- ence, and the impact of age on a decision maker’s sensitivity to psychic distance. Conse- quently, several authors such as Petersen & Pedersenen, as well as Sousa & Bradley have argued that psychic distance needs to be measured on individual levels since it is rather linked to personal experiences and skills than macro-level differences between two mar- kets. The study of Sousa & Bradley (2006) further indicates that “psychic distance cap- tures the manager’s individual perception of the differences between the home and the host country and is a highly subjective interpretation of reality”. Consequently, psychic distance does not impact employees within a firm equally. Some employees might be mo- re conformable to differences between their home and the specific target country than others. According to Petersen and Pedersen (1997) psychic distance should be established based on the perceived psychic distance of a company’s managers and decision-maker.

Other researchers argue that a lack of knowledge about foreign markets and international operations is an essential barrier to international expansion. Consequently, knowledge also affects companies’ performance within international markets. A study by Johanson and Vahlne (1977) states that the lack of essential knowledge resulting from psychic distance factors highly affects the decisions made in regards of international operations. Additionally, the authors state that the main characteristics of global operations are comprised of several psychic distance factors.

Adapted by: Ekroos & Sjöberg, The effect of management’s perception of psychic distance on organizational performance in a foreign market, 2012.

The researchers Evans and Mavondo (2002) recently pointed out that psychic distance can also have positive impacts on a company’s performance. Due to the perception of cultural differences in psychically distant markets can cause the feeling of a high level of uncertainty. In order to reduce this feeling, companies tend to invest a greater amount of time and money on researching the foreign market, gaining more knowledge about poten- tial differences, and planning of the market entry strategy. This new knowledge leads can be used for better decision making and lead to an improved performance. This concpet of- ten applies when companies enter psychically close markets and face unexpected prob- lems.

The authors further argue that assumed similarities between two markets can cause poor performance. Based on the perceived psychic closeness actions can result in subtle but es- sential differences. Additionally, companies often have difficulties in differentiation of products while operating in a psychically close market. As a result they face stronger competition from local companies, which could negatively impact the performance.

3 Business Sizes

The size of a company is primarily based on the number of employees, but also takes its capital as well as its revenue into account. It is important to note that measuring the size of a firm also depends on the specific industry. While business within the service indust- ries heavily rely on human resources and measure their size based on number of employees, manufacturing companies focus on capital, which has a greater importance within this sector.

Small businesses tend to have an employee number of less than fifty, a profit margin of ten million dollars, and an equivalent balance sheet of the same value. The meaning of "small" generally shifts by industry, however, revenue of less than six million dollar is an indicator for a small business.

In middle-sized businesses, the number of employees is between 50 and 249 with an overall profit margin of maximum 25 million dollars and a balance sheet of the same amount. Small and medium sized enterprises, so-called SMEs, are an advantageous term for fragmenting organizations and different associations, and have been characterized by the European Union as an independent business with less than five hundred workers. Large companies, on the other hand, employ at least 250 people, and generate revenue greater than 25 million dollar. According to Anderson et al.,(2013 p 262), an organization with less than workers than the set amount, however with a yearly turnover of more than

1.5 billion Euros and a record financial aggregate of more than 2 billion Euros is likewise thought to be a large enterprise.

Besides the level of resources a company is willing to use for entering a new market, also the size of the company directly affects psychic distance. Since psychic distance can influence the level of perceived risk, and the choice of market, it is crucial to take the size of a firm into account. A study conducted by Lado et al (2004) states that large companies entering new markets have greater resources and are less sensitive to risk, which improves their competitive advantage. Consequently, it can be concluded that the perceived risk of foreign markets decreases with growth of the company size.

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