Software and Internationalization

Literature Review

December 5, 2013


The presente text looks to analyze the internationalization of Software As A Service (SaaS) companies. The internationalization of services is different from the internationalization of products, where a company can choose from many entry modes. However, as Javalgi et al. (2003) have pointed out, for services, the internationalization is rather different due to their specific characteristics, such as intangibility. The authors refer another work from Erramili (1990) where the latter compares services as either soft-services or hard-services. Soft-services are the ones where production and consumption can be separated, such as the development of a software in a country that can be “consumed” abroad, over the Internet; Hard-services, on the other hand, are those where consumption takes place where it is delivered, such as lodging.

When it comes to software, the distinction between service and product is still not clear in the literature. Software depends on a physical device to run, whether it is a computer, a phone, or any other kind of machine, this is what is called the hardware. However, due to technological advances, nowadays a software can be accessed from a machine which does not have that software installed in it, but, instead, in another machine. This brings business models and cost opportunities for both the developer and the consumer. By not having to buy the physical software, the consumer is able to access it, over the Internet at any time, with few hardware constraints. This also makes it possible for the consumer to get instant updates, by not having to upgrade to a new software, or even a new machine. The software firm, on the other hand, is able to deliver the software directly to the consumer, saving on transportation costs and, internationally, by not having to incur in the typical export costs, such as shipping, trade tariffs, among others.

The software industry is a global market due to its intangible nature and niche market approach, where highly technological micro, small and medium enterprises (SMEs) compete to acquire and create new market segments (Ojala & Tyrväinen, 2007). Empirically, literature suggests that most of these companies are “born global” from inception because of their business model and a high-level integration of Information and Communication Technologies (ICT) in their businesses.

Due to the characteristics of the software industry, software is an intangible product and, therefore, the business model of software companies is different from others (Ojala, A. & Tyrväinen, P., 2006). Also, as Moen et al, 2004 have stated, “many computer software firms may be classified as service providers engaged in international markets.” With the emergence of Cloud computing - on the definition of which common understanding still has not been found in the literature -, companies worldwide are adopting the use of external infrastructures to store their software and are using the Internet to deliver it (Cloud computing). As this suggests, barriers concerned with the costs of exporting a physical software stored in a, for example, CR-Rom, disappear and the costs of reproduction of the software are virtually related to the costs of storing it on an external infrastructure. Although this new paradigm announces a new haven for software and other Services related industries, new and old barriers exist and the present work aims at finding out how they affect these business models on Portuguese firms.

Considering software is easily replicated, either physically or digitally, software firms depend heavily on their intangible resources, and not so much on their tangible ones, since the Internet provides a free access platform with reduced costs. Being a worldwide industry in constant change, most of these SMEs are global from inception. The majority of the literature has shown that they follow a focalized strategy and depend heavily in innovation (Chetty & Stangl, 2010). Because it is a highly innovative industry, there has been many attempts to institutionally regulate the Internet platform, while other countries are expecting to create their own separate Internet networks. This (de)regulation brings barriers for the firms who are either passively, or actively, trying to internationalize using the Internet has the main platform or as a support. Because the Internet is becoming more a viable platform, with many businesses running solely online, software companies have been able to provide their products digitally alone.

The Internationalization of Software

The internationalization models of software companies have been studied since the 1990’s, with authors analyzing how internationalization theories applied to these particular enterprises (Bell, 1995; Coviello & Munro, 1997). These studies had the particularity of analyzing on-premises, or shrink-wrap software, which means that the software in order to be used by the consumer had to be in, and installed, on a physical unit.

The Uppsala Model, or stage theory (Johanson & Wiedersheim-Paul, 1975), complemented by Johanson & Vahlne’s 1977 study, viewed the internationalization of firms on a stage model, where a company’s decision to internationalize to foreign markets was constrained by the market size opportunity and how it was psychologically closer to the home base, taking into account such characteristics as language, culture, development level and geography, thus reducing uncertainty that a new market might bring. Lack of information would make companies internationalize in “small steps” as they learn more about the new markets. The authors have provided a mechanism to explain the states and change aspects of the internationalization, where market knowledge affects the commitment decisions and, thus, market commitment affects the current activities (Johanson & Vahlne, 1977). In the Uppsala model, companies wouldn’t internationalize before they had a firm domestic market that would later be able to support the internationalization venture, where there weren’t many resources and knowledge. The learning process of the stage model would decrease uncertainty and, therefore, the risk (Johanson & Wiedersheim-Paul, 1975). For the authors, these four stages are what they call the “establishment chain”:

  • No regular exports;
  • Export via independent agents;
  • Establishment of a sales subsidiary;
  • Establishment of a production/manufacturing unit in the host country.

Each stage implies a different level of commitment by the company, but may not actually follow the entire chain proposed by the authors. This is true for the Internet-enabled Born Global companies, where the geographical and psychic distance are less relevant. Ojala and Tyrväinen (2007) have analyzed how (1) cultural and (2) geographic distances, and (3) market size influence the internationalization process of software SMEs. In their findings they have concluded that those three elements weigh 70% in the decisions. Therefore, closer cultural aspects and geography are taken into account when internationalizing. Has for the geographic distance, although the authors consider that software may be distributed electronically via the Internet, they don’t consider the distribution of the Software-as-a-Service (SaaS), where requirements for installation and maintenance are on the server side (the software provider) and not on the client side (the software user). However, in their findings, the weight of cultural and geographic distance is exchanged by the purchasing power of the target markets has they internationalize. Their study has allowed for a clearer evidence on traditional internationalization theories for the Software SMEs.

Reuwer et al. (2013) and Bell (1995) suggest that there is no single theory to explain the internationalization of software companies. This can be explained by the specificities of the industry, which poses different internationalization processes when compared to other industries where business models rely on the production of physical goods. Bell (1995) suggested that small and medium sized software firms internationalized mainly for three reasons: (1) domestic and foreign client followership, (2) targeting small niche markets, and (3) due to the specifications of the industry of these companies. When compared to other industries, the success of the internationalization of these firms is due to the fact that they offer intangible products and do not require heavy investments in equipment and in facilities to produce their products/services. The investments are mainly in highly-skilled human resources that program a software that can later be easily reproduced (Ruokonen & Saarenketo, 2007). Besides, according to Saarenketo et al. (2004), internationalization is fast for the Information and Communication Technologies (ICT) companies due to several factors, mainly the organizational ones. These are related to the fact that most companies operate in niche markets, have high research and development (R & D) costs, and compete in a very fast changing environment where their products become obsolete very quickly.

The old internationalization theories do not fit entirely in the Software industry. This argument is associated with those small, knowledge intensive, internationally focused companies which the literature has recognized as “knowledge intensive” (Bell, 1995) firms, and to whom the old theories do not apply. As the names suggest, these are companies which have highly-skilled human resources and make use of the advancements of the ICT. Knowledge intensive firms are those that depend on the output created by its knowledge in order to gain a competitive advantage (Arenius, 2005). The nature of these businesses depend highly on new technological innovations and on human interaction. According to Kuermmele (2002), an international venture is created accordingly to the flow of knowledge. The author mentions that an entrepreneur gains an idea by living in a foreign environment, where he starts planning the new venture and expanding his contact network in order to gain access to resources, capital, as well establishing the future supply chain. The home base location of the new firm will depend on several factors, such as the importance of several markets to target, and can be constrained if the founders of the company are from several different countries. In the example, the author mentions that “large corporations carry out foreign direct investment (FDI) for two reasons: either to augment the firm’s knowledge base or to exploit the firm’s knowledge base.” The first reason is an expansion opportunity where the company tries to take advantage of knowledge in the host market, which, according to Dunning’s OLI paradigm (Dunning, 2008), suggests that the company is looking out for localization advantages. This can either be permanently or temporarily, has the goal is to gain access to new knowledge either for the creation of a new product, service, business model, among others. While the second reason is for the company to better exploit the existing knowledge in newer markets (Ownership advantage - Dunning, 2008), with the goal of selling or launching marketing strategies in order to expand their markets. Dunning’s (2001) OLI paradigm (or eclectic paradigm) was proposed as a way to explain Multinational Enterprise’s (MNE) expansion to foreign markets. The acronym OLI stands for Ownership, Localization, and Internalization:

  • Ownership: a company internationalizes because it has certain proprietary advantages (for example, oil companies own specific technological know-how on how to drill oil);
  • Localization: the internationalization is driven in order to explore - continuing with the oil example -, certain natural resources specific to a region beyond the national borders where the company is located;
  • Internalization: a firm can either work with outside partners to, for example, transport the oil from the exploration site to the firm’s home market, or proceed with every activity related herself.

As Dunning (2001) explains “the significance of each of these advantages and the configuration between them is likely to be context specific, and in particular, is likely to vary across industries (or types of value-added activities), regions or countries (the geographical dimension) and among firms.” Although focused on the MNE, the OLI paradigm can be viewed as a framework to explain how small Software companies internationalize. According to Filippov (2011), software companies’ internationalization is driven by innovation seeking. As SaaS companies are able to deliver their software over the Internet, without having to worry about computational power, they have an Ownership (software) advantage, but also Localization (the Internet) advantage, since their markets are at one ‘click’ distance. However, the question of how they reach those markets via the Internet remains. As for the Portuguese case, these questions need to be answered:

One Which business models are Portuguese Software as a Service companies using?

Two How does it compare to normal strategies of on-premises software business models?

Kuermmele’s (2002) knowledge access explanation could apply to SaaS companies, where one, acting in niche markets, may also need to engage in foreign activities, either to gain new customers, while acting from the home base, since the software is developed and distributed from there, and, at the same time, to learn about the industry which is inserted in order to innovate in their offerings. When applied for the Portuguese case, we need to know if:

Three Is the development and distribution of the software solely done in the home market?

Four Does the entrepreneur engage in international activities in order to gain access to knowledge?

Because of their limited resources and niche markets, literature has focused on how informal relationships affect the internationalization of such companies. According to (Zain & Ng, 2006), a network is “the relationship between a firm’s management team and employees with customers, suppliers, competitors, government, distributors, bankers, families, friends, or any other party that enables it to internationalize its business activities.” The authors argue that such relationships allow companies to obtain more market knowledge and business information. However, the question arises if such is true in an online distribution channel where software vendors can reach several markets by distributing their product in a unified platform, such as Google’s Play Store of Apple’s iTunes store, over the Internet.