The Uppsala internationalization model and psychic distance

The product cycle theory identified income and cost levels of would-be-host countries as the key factors affecting firms’ ability to expand internationally. Work conducted by a group of Scandinavian researchers at Uppsala University, however, questioned the explanatory power of the product cycle theory by emphasising the limited knowledge of the individual investing firm as the most significant determinant.

In examining the increasing outward involvement of four Swedish organizations, Johanson and Wiedersheim-Paul (1975) identified a fourstage sequence leading to international production. Firms begin by serving the domestic market, then foreign markets are penetrated through exports. After some time, sales outlets are established abroad until, finally, foreign production facilities are set up. Johanson and Vahlne (1977) qualified the underlying logic of this sequential internationalization process, arguing that this stepwise, evolutionary development is based on the gradual acquisition of knowledge of the foreign market, and use of foreign-based sources of
intelligence. It is this process of incremental, experiential learning that justifies and determines successively greater levels of commitment to foreign markets.

Research at Uppsala also observed that the typical FDI pattern of Swedish firms was that they first set up foreign production facilities in one of the closest Nordic countries, such as Norway. Later on, they established subsidiaries in countries such as Germany, Holland and the UK. And only then, if still successful, they would venture into ‘psychically distant’ markets.

Although the concept of ‘psychic distance’ can be traced back to the mid-1950s (see Beckermann, 1956), its use in this context was operationalized in terms of uncertainty about would-be-host markets due to differences in culture, language and levels of education and economic development. Some studies have confirmed the existence of a gradual process characterising
firms’ international expansion (see, for example, Yoshihara, 1978), while others have provided support to the idea that psychic distance makes firms shy away from full-ownership foreign involvement (Gatignon and Anderson, 1988). Kogut and Singh (1988) also showed that firms are more likely to choose a joint venture (Jv) entry mode over wholly owned subsidiaries as means of reducing their uncertainty in relation to investments in psychically distant markets.

The Uppsala model, however, has not escaped criticism. Millington and Bayliss (1990), for example, found that the postulated stepwise development did not reflect the actual internationalization process of UK companies expanding in the European Community (EC). This was because knowledge based on experiential learning could be leveraged and translated across countries and product markets, and these economies of scope allowed firms to bypass some or all of the intermediate stages of the postulated sequential process. Like the product cycle theory, the Uppsala model is also incapable of explaining the emerging phenomenon of firms that are ‘born global’. These are small to medium-sized companies which rather than slowly building their way into foreign markets, almost from inception expand by investing overseas.

This is often evident in operations whose market entry strategy is driven by franchising, and the investment element is exemplified in their having to establish wholly owned subsidiaries in the overseas markets as a prelude to franchising in other markets. According to an Australian report by McKinsey& Co. (1993) 80 per cent of the firms studied ‘view the world as their marketplace
from the outset’ (p. 9). McDougall, Shane and Oviatt (1994) also found that none of the 241 firms in their sample pursued a gradual incremental process when going international. It is important to note that, much, if not all, of the literature treating the ‘born global’ phenomenon has thus far focused on the activities undertaken by such firms in developed markets, particularly within new industries and high-technology-based sectors.

Default FixSim_112007