Liability of Foreignness: Disadvantages of Operating in Foreign Countries

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INTERNATIONAL BUSINESS

Liability of Foreignness
(Disadvantages of being foreign)

MIGUEL GONZALEZ DEL ALAMO
G20130317
Introduction

Liability of foreignness (LOF) is considered as the cost of doing business abroad. This term was conceptualized by Hymer (Appendix) as the disadvantages that face foreign companies when they operate in other countries compare to the difficulties the home nation’s firms face.

The foreign firms face many kinds of different costs. The ones that stand out the most are: unfamiliarity with the language or the economic system, as well as economic costs and social costs. Other important cost is also the cost of information which is really cheap for home-country firms but really expensive for foreign firms and exchange currency fluctuations must also be taken in account when talking about liability of foreignness.

Foreign firms also may face other issues as difficulties arising from the unfavourable treatment of host governments added to the economical cost establishing in other location. Some host governments may set restrictions for foreign firms.

Resource costs, communication costs, operating costs, unfamiliarity with the culture (and the way of doing business) and travelling costs also must be taken in consideration. Some of this costs can be overcome overtime but there are others can persist longer and are really difficult or even impossible to completely overcome.

Zaheer suggested that LOF can be overcome in two ways: becoming isomorphic to local firms and using their ownership advantages. Liability of foreignness is smaller and smaller as times goes by because firms gain experience in the host country

In these paper I will discuss the main sources of the liability of foreignness (LOF) as well as the home country (or economy/market) can determine the degree of disadvantages that a firm can face when doing business abroad

1st Argument- Environmental factors affect LOF

The environmental factor affecting the liability of foreignness (LOF) comes not only from the host country as many people can think but also from the home country. The difference in the institutional development is the key issue of this argument.

Regarding the institutional environment we can distinguish three aspects affecting LOF which are the regulatory dimension (regulations or laws from the states), normative dimension and cognitive dimension (values and beliefs within a society). As everyone knows emerging markets have institutional voids due to the lack of competitive institutions and this is a serious challenge for foreign firms operating in emerging markets.

Joining business groups can result in a good way to avoid institutional voids since the have already a target market and the needed structures to do business. These measures or strategies can help firms when doing business in emerging markets but not the other ways around (or at least in the same proportion) since in developed countries is expected to have already well developed institutions.

It is also well known as mentioned before that the institutional environment can affect LOF in different ways. Firms from developed markets (good institutional environment) face less LOF when doing business abroad than the one that experience firms from emerging markets entering a well developed market. So in developed markets its much easier to perform a riskier strategy than in an emerging market.

Also the uncertainty that some firms have when doing business abroad (specially in emergent markets) is higher than doing business in developed markets as the quality advice in countries with developed institutions is much better so international diversification is good when you perform in markets that are similar to yours. This concept is called institutional distance and refers to the similarity (or dissimilarity) between the three aspects (mentioned in the introduction) of institutions between home and host...
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