3  How Do Firms Approach Exporting?

The following sections will explore the issues facing firms as they move into exporting. The first section looks at the fixed costs of moving into exporting. There is some reason to believe that the one-off fixed costs and risks facing New Zealand firms as they move into exporting are comparatively high. The second section shows that the strategies used by some New Zealand firms in entering export markets differ from the international norm. These differences in strategy may indicate differences in the size and nature of hurdles to entering exporting that are faced by New Zealand firms. Whether these hurdles prevent some firms from entering exporting entirely is difficult to tell – it is an area that requires further research.

The third section suggests that New Zealand firms may also face an ongoing hurdle to exporting, preventing them becoming truly global firms. The establishment of truly world-class distribution and marketing networks seems to pose difficulties for most New Zealand firms. It seems to take considerable scale to achieve (which is difficult with a small domestic market), and appears to be beyond the capability of most New Zealand firms, except those involved in resource industries. The absence of large New Zealand multi-national enterprises suggests that this is an issue. Indeed, the weight of evidence for the existence of an ongoing hurdle is reasonably strong.

3.1  The existence of fixed costs of entering export markets

The analysis of Roberts and Tybout (1997), Clerides, Lach and Tybout (1998), Castellani (2001) and Bernard & Jensen (2001) all shows that data on exporting firms is consistent with the existence of fixed costs to entering exporting. Bernard and Jensen (2001) show for instance that US firms are 36% more likely to be exporting tomorrow if they are exporting today. When firms do enter and leave exporting, it tends to be for sustained periods. This is consistent with the presence of fixed entry costs to exporting. They also demonstrate that larger firms are more likely to export, and argue that this is because larger firms find it easier to meet the costs of exporting. Clerides, Lach and Tybout (1998) find similar results for Mexico, Colombia and Morocco, showing that exporting firms have larger capital stocks and that exporters are more likely to continue exporting. Castellani (2001) repeats these findings for Italy. In addition, Roberts and Tybout (1997) find a far higher continuance rate from past exporting experience, making a firm 60% more likely to continue exporting. They add that for Colombia’s case the “sunk cost” appears to depreciate very quickly. After two years of not exporting a firm is as equally likely to export as other firms.

The fixed cost model has also been used to explain the existence of “hysteresis” in trade flows. Baldwin and Krugman (1989), and Roberts and Tybout (1997) note that firms often display a delayed reaction in trading to movements in the exchange rate. Their explanation is that the fixed costs of entering foreign markets means that firms are not willing to incur costs to enter the export market for what they perceive to be a brief period of prosperity before exchange rates rise again. Conversely some firms continue to export in times of high exchange rates – seemingly to avoid needing to repeat the sunk cost to re-enter exporting when the exchange rate falls.

The reason for these fixed costs is still unclear. Roberts and Tybout (1997) speculate that the speed with which the fixed cost investment tends to dissipate suggests that it is intangible (probably information) rather than anything tangible. The consensus view appears to be that “these [fixed costs] might include the cost of information about demand conditions abroad or costs of establishing a distribution system (Bernard and Jensen (2001)). Information on overseas demand conditions may seem a fairly innocuous concept, but this information often necessitates product changes or the development of new product ranges. This may be due to foreign quality demands, particular tastes, or even regulatory issues such as product safety and registration.

Qualitative research sheds more light on the source of these fixed costs by looking at the experience of firms. The fixed costs of entering foreign markets can be grouped as follows:

• Cultural differences – necessitating market research and resultant alterations to products and marketing strategies. This should not be under-estimated, even New Zealand companies moving into Australia are struck by the differences in this regard.
• Regulatory costs – each new market has new tariff levels, non-tariff barriers, product registration, differences in safety standards as well as new tax systems.
• Setting up distribution, marketing & product support – this involves an investment in arranging transportation networks, warehousing and retail, as well as establishing and maintaining a brand.

3.1.1  Applications for New Zealand firms

Overseas evidence summarised in Campbell-Hunt and Chetty (2001) suggests that firms tend to focus on their domestic market before they move into exporting. Given the small size of the domestic market, it seems likely that New Zealand firms will therefore tend to be smaller than overseas firms when they start exporting. It is also reasonable to expect that they will need to go global at an earlier stage of development than overseas firms. For small firms the fixed costs of finding markets, adjusting products, marketing, establishing distribution channels, and making mistakes are likely to be more serious than they are for larger firms.

There is plenty of anecdotal New Zealand evidence to support the existence of fixed costs related to moving into exporting. One firm in the recent Infometrics Manufacturing Exports survey (Infometrics 2002) took four years of intensive effort to sell their first product in the United States. A total re-design of their product range was required to make them applicable and appealing in the American market. Another firm included in this survey spent 15 years and $NZ5 million on establishing a distribution network in the United States. Even launching a new product can be expensive – one firm spent $NZ1 million (on top of all the product development costs) simply to launch a new product in the United States market.

Source; NZ Business Dec (2001), p13

The fixed costs associated with the move into exporting, in combination with the small size of New Zealand firms when they begin exporting, could be enough to deter some small firms from making the step.

3.1.2  Risks of the Move into Exporting

Even once overseas orders are secured, the lure of exporting is not without difficulties. For many firms exporting is the only way to expand, however for small firms the rapid expansion required can be a difficult undertaking.

Foreign buyers may also incur fixed costs in switching to a new supplier from a new country. To justify the up front costs of using new suppliers, purchasers (or intermediaries) will often require orders of a reasonable size from the New Zealand firm. Given that the size of overseas markets are far bigger than the domestic market, often these orders are many times larger than a New Zealand firm is used to supplying. This is a consistent message from New Zealand firms moving into exporting.

Campbell-Hunt and Chetty (2001) look at the difficulties of this exporting transition. They emphasise that even once an export order is obtained, the key issue that a firm often faces is a rapid (and proportionately large) capacity increase to cope with the size of the order. This size increase puts pressure simultaneously on many of the company’s key areas of competitiveness. Human resources is a key area as there is a need to rapidly hire and train a large amount of people while maintaining the company culture. Firm leadership can be placed under strain – managing a rapid growth spurt challenges the skills of the typical small business owner (see the Gallagher example below). To compensate owners either require bountiful energy or a lot of support. The reputation of the firm can be placed at risk during this difficult phase, mistakes at an early stage can cause reputation damage (reputation is vital in overseas markets where distributors want reliable supply). Also production often requires scaling up and this in turn can drain the firm’s working capital.

This expansion is likely to be proportionately larger for New Zealand firms, and as such the impact on the firms is likely to be greater. Qualitative evidence suggests that the impact of this rapid expansion should not be underestimated. Many firms put their competitive advantage down to a package of key subtle elements, for example, learning culture, service, dynamic leadership and devoted employees. While rapid expansion is not impossible (obviously many companies have successfully managed the process), smaller firms are likely to find these issues more difficult to deal with. As such, some or all of the company’s advantages could easily be destroyed, leaving the firm stripped of the key competencies that it originally displayed. Slow and steadier expansion is more likely to leave the firms competencies intact, however it is difficult to achieve as exporting begins.

Having a more tangible competitive advantage, namely a world-beating product, may improve the firm’s chances of surviving this rapid expansion. This is consistent with the work of Campbell-Hunt and CANZ[10] (most global firms they surveyed had an innovative product).

Source; Campbell-Hunt/ CANZ (2001)

Source; NZ Business Dec (2001), p24

Source; Campbell-Hunt/ CANZ (2001)

For some firms the risks of this rapid expansion are enough to deter them from reaping the full benefits of their innovation. Despite a world-beating product they take a more gradual approach to exporting expansion[11].

Source; Campbell-Hunt/ CANZ (2001)