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How Companies Can Limit the Effects of the Liability of Foreignness

HCLI Research

Published 31 August 2015

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HQ Asia sat down with Professor Michael Witt for a discussion on liability of foreignness, the five ‘market’ clusters that exist within Asia and what companies need to be aware of when entering a new cluster, or region.

HQASIA: Can you briefly describe the liability of foreignness for companies in APAC? How can companies limit this risk?

MW: “Liability of foreignness” (LOF) is the biggest problem companies face when doing business abroad – in fact, decades of research have shown it to be the number one killer of international business ambitions. While LOF has many aspects, the basic logic is quite straightforward: most companies first figure out how to run their business, and then they go abroad.  If they run into trouble abroad, is it then not because they do not know how to run their own business, but because they do not know how to do so there.

This challenge is universal. Whether a company from Asia goes to Europe or an American firm comes to Asia, LOF will always be there. At a conceptual level, there is a simple countermeasure to LOF: you need to understand how the host country in question works and, where needed, take steps to mitigate the impact of differences between home and host country.

In practice, this can be quite challenging. There are many aspects to LOF: cultural aspects such as communication patterns or tastes, institutional angles such as labor laws or corporate governance and accounting rules, political challenges such as the risk that government may take your investment from you, and logistical barriers such as distribution networks, just to name a few. Getting a clear view of all of these facets of LOF is possible. However, many companies and managers do not take the opportunity to be forearmed and thus forewarned, often because of lack of awareness and skills.

In addition, companies that have been present in international markets for a long time often fall into the trap of believing that they have figured things out. But in most organisations, “figuring things out” happens at the level of the individual managers, who keep changing as they are rotated through international assignments. So with every new manager occupying an international position, a new round of learning and analysis is needed, but rarely undertaken.

HQASIA: How do the five clusters influence the way business is conducted in Asia?

MW: Research has shown that a key source of LOF is differences in the rules of doing business – labour regulations, HR practices, corporate governance practices, management styles and so on. These are known as “institutional” factors or rules. There is evidence to suggest, that these are a bigger challenge for firms than cultural differences, which many firms feel they can handle fairly well through standard training programs.

My colleague Gordon Redding and I have been exploring these institutional differences for many years. In 2014, we completed a large-scale effort to map these variations, with the details published in the Oxford Handbook of Asian Business Systems. When we looked at the overall data, we found that 13 major Asian economies – from India to Japan – form essentially five clusters: (post-) socialist, advanced city, emerging Southeast Asian, advanced Northeast Asian and Japan in a category of its own.

Countries that are in the same cluster have relatively similar ways of doing business. As a result, LOF for firms moving to countries within the same cluster is relatively smaller than that for firms moving between clusters.

To use a concrete example, a typical Singaporean company will find it far less challenging to operate in Hong Kong, as they are in the same cluster, than it would in a separately-clustered country like South Korea.

HQ ASIA: How does culture shape the structure and function of operations in markets and institutions in Asia?

While culture does affect businesses and their operations, its influence is often overestimated.  This is in part because “culture” has become a shorthand description for all kinds of problems in dealing with foreign operations, many of which are not really cultural aspects.

When it comes to cultural factors, many Asian societies are actually very similar. The big cultural differences are between, say, Asia and Anglo-Saxon societies. Yet Asian managers routinely find that things work very differently in other Asian economies.

While there are many cultural differences in the details, the causes of the challenges often lie elsewhere, especially in institutions. This is really where the opportunities for reducing liability of foreignness and getting a leg up on the competition exist.

Learn how to lead your business in ASEAN through our ASEAN Leadership Programme: https://hcli.org/programmes-events/asean-leadership-programme