A test of internalization theory and internationalization theory: the Upjohn Company.
The Upjohn Company experienced a pattern of international expansion which is fully consistent with the theory of internalization.
This work analyzes strategies of penetration in international markets by multinational enterprises (MNEs) by focusing on one firm's historical process of internationalization. We report a careful analysis of the choice of entry mode and internationalization process of one specific MNE in one specific industry. This enables us to determine the factors that a firm considers during its expansion abroad and the relative importance of internationalization versus internalization theories, see Rugman (1980). (1981). The MNE analyzed is the Upjohn Company of Kalamazoo. Michigan, U.S.A.
The roots of internalization theory go back to Ronald Coase (1937) who argued that there are conditions under which it is more efficient for a firm to create an internal market rather than enter foreign ones; such conditions are the transaction costs of foreign activities. The work of Coase was extended (in a largely domestic context) by Williamson (1975, 1985). About the same time, internalization theory was further developed and applied to MNEs by researchers associated with the "Reading School" in England such as Buckley and Casson (1976), Dunning (1980), Casson (1982), Rugman (1980, 1981), Hennart (1982) and others, as summarized and extended by contributors to Buckley and Casson (1992).
According to internalization theory researchers market failures (such as information costs, opportunism and asset specificity) are the main reason an MNE must use direct investment instead of licensing. An MNE with technological or marketing know-how has firm-specific advantages which are protected within its internal market. An MNE seeks expansion by direct investment when it has competitive advantages over other firms and the firm specific advantage needs to be protected by its organizational structure, i. e., an MNE internalizes its foreign market activity. Internalization theorists suggest that foreign direct investment occurs when the benefits of internalization outweigh its costs. Exporting is often a mere "stepping-stone" toward foreign direct investment. Other modes of foreign involvement such as licensing risks the loss of know-how and technology and is a later entry mode.
The theory of internationalization, on the other hand, as in Johanson and Wiedersheim-Paul (1975), Johanson and Vahlne (1977), Luostarinen (1979), Welch and Luostarinen (1988), Luostarinen and Welch (1990), Vahlne and Nordstrom (1988) and others, argues for a slow internationalization process from country-to-country. This is typically sequential because of the aquired knowledge that the firm gathers as it expands from country to country. Researchers like these, from the Scandinavian "Uppsala School", emphasize an evolutionary pattern of international activity. A typical foreign entry pattern is by exports through local agents in new markets followed later by licensing and a wholly owned subsidiary/manufacturing plant. The theory of internationalization relies on a slow and progressive process of internationalization, during which organizational learning takes place. although it is difficult to generalize, Sullivan and Bauerschmidt (1990). Internationalization researchers consider exporting to be a valuable means of diffusion and expansion. They argue that internalization theorists, by not recognizing the importance of exporting, lack a marketing perspective.
Critics of the early version of internationalization theory have objected that it is too simplistic and have brought up cases such as the Italian and Israeli paradoxes where, they argue, these countries' exporters have not progressed sequentially into deeper modes of foreign penetration (such as creating branches or subsidiaries or manufacturing plants) but have instead increased their communications efforts with their distributors as a means of more efficient diffusion, see Reid (1987) and Bonaccorsi and Dalli (1990). Internationalization theorists have defended themselves by stating that while the simple evolutionary theory was appropriate to the internationalization of firms until the midseventies when markets were not as globalized and integrated, they do not regard it as an adequate theory for our times. Indeed, Johanson and Mattson (1988) have argued that perhaps the two theories complement each other. They develop a network model which offers different degrees of internationalization circumstances as parameters to the internationalization process while taking into account the firm's degree of internationalization. Certain competitive advantages can be easily used in international expansion, though with very different entry methods. We would agree that, today, the theories complement each other, since organizational learning takes place within MNEs and this intangible firm specific advantage is common to both theories.
Rugman (1981) has characterised the two approaches as follows. In internalization, new foreign activities typically have three stages: 1) exporting; 2) FDI; and 3) licensing. The conditions for successful licensing, namely that foreign markets are fully segmented and that dissipation of firm-specific advantages can be avoided, are unlikely to be realized in practice, so licensing occurs only at a late stage of maturity of the product cycle. These three stages in servicing a foreign market over time are almost the reverse of the process of internationalization, which is the process of going abroad slowly through: 1) licensing; 2) exporting; 3) establishment of local warehouses and direct local sales, 4) local assembly and packing; 5) formation of a joint venture; and 6) foreign direct investment. We now report a test of these two approaches.
The Internationalization Process of the Upjohn Company
The main contribution of this paper is to apply these fairly well known theories of internationalization and internalization to the actual experiences of the Upjohn Company, a very large U.S.-owned pharmaceutical company. The observations on Upjohn's corporate history in this section, and the analysis of entry modes reported in the next section, are based upon multiple sources, as reported in Fina (1992).
The sources used were of three types. First, published public documents were consulted. These included: -- the annual reports of the Upjohn Company and its subsidiaries; the Upjohn Intercom (an employee newsletter); the Scripp-World Pharmaceutical News (an industry data base and information service published by PJB Publishing Ltd. of London). Second, company materials were consulted; these are based in the Upjohn library at Kalamazoo, Michigan, U.S.A. Third, interviews were conducted with former officials in the international division of Upjohn. It should be emphasized, however, that this article is the result of independent analysis by the authors and that it builds upon an interpretation of the corporate history and sequencing of international activities as described in greater detail in the doctoral thesis of Fina (1992). This paper does not necessarily represent the views of company officials.
The Upjohn Company was founded in 1886 by Dr. William-Erastus Upjohn in Kalamazoo Michigan, U.S.A. Dr. William Upjohn's discovery of a pill that was friable inside a person's stomach initiated such a demand from doctors in the area that he soon found out he could not keep up the supply from solely rudimental production. He installed a small plant which by 1912 manufactured enough pills to earn a million dollars in sales. Major discoveries of the time like the anti-malarial "Quinine", still used today, helped the process. The Upjohn Company, though, did not become world famous until after the end of World War II with the discovery of "Medrol", a steroid that had fewer the side effects than others.
Today, the Upjohn Company, with a reputation for high quality products, has become one of the major pharmaceutical marketing firms in the United States and abroad. Its firm-specific advantage in brand name pharmaceutical products has led many foreign companies to ask Upjohn to market their products inside the U.S. market. Over its corporate history, the Upjohn Company has developed competitive advantage based on its own high quality best-selling products such as the contraceptive "Depo-Provera", the antibiotic "Lincocin", the sedative "Halcion", the anti-depressant "Xanax", the steroid "Solu-Medrol", and the hair growth product "Rogaine". Upjohn has also acquired licenses that later became top-selling products like "Motrin" and "Ansaid", both anti-inflammatory pharmaceutical licensed from the Boots Company, England, and "Orinase" and "Micronase" anti-diabetics, licensed from the Hoechst GmbH, Germany.
The Upjohn Company began its first operations abroad at the beginning of the century when its New York branch received an order from an Egyptian pharmacist asking for "Quinine" and Upjohn's line of pills. The branch sent the medicines to Egypt with a complimentary catalog written in Arabic. Although this was not a big success, Carlisle (1987), it was, nonetheless, the initiation of a cautious exporting rapport that would last for another thirty years. The New York branch was soon engaged in exporting operations throughout South America by furnishing doctors with the anti-malarial pill "Quinine", mainly to fulfil western travellers' needs of the livesaving pill when going to these nations, Carlisle (1987). By the early 1930's sales representatives were establishing contacts in all of South America, while the branch in San Francisco begun exporting operations in Asia, including Shanghai, and Hong Kong. The San Francisco branch also struck its first distribution agreement abroad with a local company: the Thakore Company of India. In 1935 Canada became the first foreign country to ever install an Up-john branch.
In 1957 the Upjohn Company decided to transfer its exporting operations from the New York and San Francisco branches to its headquarters in Kalamazoo and the international division was established. The result was the prompt installment of offices throughout South America. The Upjohn Company had paid little attention to Europe until this time, although an exception was the attempt of sending nuns to sell the candy format laxative "phenolax" door-to-door throughout England, Carlisle (1987). It was not until the late 1950's that Upjohn had an organized strategy for the European market. Thus, it was late to enter Europe in contrast to its competitors whose internationalization process was already at the manufacturing stage, with some (Merck, Pfizer and Parke/Davis) already making as much as 30 percent of their profits in the European market. Thus, in retrospect, Upjohn's entry inside European markets was as a "late starter". Ray T. Parfet Jr., CEO of the company at the time, justified this tardiness in an interview in Forbes (1967) aptly titled "postponing the problem" where he stated: "It was a managerial strategic decision to concentrate in our domestic market", a clear reference to the late entry to the European market.
As it became increasingly difficult to enter the European market, Upjohn's management made an important strategic decision. It would undertake strategic alliances as a means of entry and diffusion in European markets. Strategic alliances are defined to include sales offices and marketing agreements with local distributors and joint ventures with local, host-country, manufacturing firms. Upjohn enjoyed a strong reputation for its steroid discovery of "Medrol", and it had just launched another important pharmaceutical called "Lincocin". Upjohn was an MNE with valuable know-how, technology information and highly skilled methods of fermentation; these were attractive to foreign companies and led to strategic alliances. Upjohn's name recognition among doctors in Europe helped to obtain patents, fast medicine approvals and acceptable prices from local governments. Another important factor that led Upjohn's management to believe this strategy would work was the competitive advantage that Upjohn was obtaining in the marketing field in the United States, which foreign partners could see as a fine opportunity for their own products. In 1953 the first of these European strategic alliances was created with the Boots Drug Company of England. The same strategy was used in every other country in Europe.
Table 1 contains examples of strategic alliances, showing that Upjohn's entry strategy in Europe built upon its experience with strategic alliances elsewhere. Upjohn's internationalization strategy worldwide was a sequential set of strategic choices. It was a successful strategy, so much so that by the end of the 1950's Upjohn had already installed manufacturing plants in Canada (1954), Great Britain (1956), Australia (1959) and Mexico (1960). For example, in Great Britain the strategic alliance with Boots in the 1950s meant that sales representatives from both Boots and Upjohn asked British doctors to prescribe both products to their patients. In political terms the Boots connection made for easier compliance with British regulatory procedures. In Japan, there was a joint venture for distribution with Sumimoto (very recently Upjohn has bought out the share of its partner in their joint venture and now has a wholly owned subsidiary).
Table 1. Some of Upjohn's Strategic Alliances Used as Means of Entry-Expansion
NATION Strategic Alliance Brazil Rhodia S.A. France SIFA S.A., Roussel S.A. Japan Sumimoto Chemical Co. Great Britain Boots Drug Co. India Thakore Co. Indonesia Tempo Ltd. Italy Zambeletti S.p.a. New Zealand Warner Lambert Co. Pakistan St. John's Pharmaceuticals, Anglo/French Drug Co. Portugal CILAG - Medicamentas S.A., Essex S.A. Spain Laboratories Malo de Molinas S.A. South Korea YUYU Industrial Switzerland Diethelm Co.
During the 1960's and 1970's Upjohn began manufacturing in itself (i.e., FDI) in seven European countries, and between the 1970's and 1980's nine other countries were added to the list. Among them was Belgium (1962), a nation whose many incentives offered to pharmaceutical companies made it Upjohn's European headquarters with responsibilities for exports and other operations to Africa and Asia. Today, Upjohn Belgium is second in production only to the Kalamazoo plant. Puerto Rico, rich in fiscal incentives for the pharmaceutical industry, was chosen as South American headquarters thus leaving the Kalamazoo plant to focus entirely on its internal U.S. market. Many offices, spread throughout the world, evolved into branches and wholly owned subsidiaries; in some countries joint ventures with local companies were established as a form of strategic alliances.
Upjohn's Worldwide Modes of Entry
To gain a better understanding of the worldwide internationalization process of the Upjohn Company, and to further develop our analysis, we report on its international evolution on a country-by-country basis, as shown on Table 2. In Table 2, the sequence of the numbers progressively reports Upjohn's presence and involvement in that nation, with 1 being the first mode of entry. Table 2 is rather complex, reflecting the presence of Upjohn in over 60 countries. The five pages of Table 2 are listed by geographic region: -- first, the Americas, basically Latin and Central America, Mexico, and Canada; second, Europe; third, Africa and the Middle East; fourth, the Asia Pacific region. There are a total of 61 countries with an Upjohn presence. The analysis in Table 2 is reported within the nine columns, which represent a more detailed breakdown of the possible modes of entry to a foreign market than is normally employed. We need the nine stages, rather than the three stage of exporting, FDI and licensing in Rugman (1980), due to the complexity of Upjohn's foreign involvement.
[TABULAR DATA 2 NOT REPRODUCIBLE IN ASCII]
In Table 2 column 1 represents "indirect" exporting by Upjohn, in the form of an agreement with a local distributor or agent in the host-country. In this case Upjohn manufactures the pharmaceuticals in the United States (or in a third country subsidiary) and supplies the local distributors or agents. Columns 2 through 5 represent "direct" exports where Upjohn again produces the pharmaceuticals in the United States or a third country, but now becomes involved itself in the local host-country in a marketing capacity. In column 2 an Upjohn representative office has an agreement with a local distributor. In column 3 there is a slightly greater degree of foreign involvement and an Upjohn sales office has an agreement with a local distributor (a form of strategic alliance). In columns 4 and 5 an Upjohn branch or subsidiary now has an even higher degree of host country marketing and sales involvement, and depending on each individual case, may or may not have agreements with local distributors.
In columns 6 through 8 Upjohn switches manufacturing from the U.S. home base to the oversees country. It does this, in column 6, by a manufacturing contract with a local producer - this is essentially a form of subcontracting. In column 7 Upjohn forms a joint venture with a local host-country manufacturer, where there is a new partnership with joint control over the manufacturing. In column 8 there is a wholly owned subsidiary with its own distribution capacity, the classic definition of FDI, but a mode of entry not used by Upjohn. Finally, column 9 represents licensing, where both manufacturing and distribution is done by a local host-country firm and Upjohn has no control over its products.
The data in Table 2 provide interesting observations. As column 1 shows, of the 61 countries analyzed Upjohn commenced operations in 38 of them by exporting indirectly (making an agreement with a local distributor). As shown in column 2, in 16 other cases we found that the first mode of entry was through one or more host-country representatives, usually preceding an agreement with a local distributor (in some countries with local governmental distributors, in others with local pharmaceutical companies and/or agents). As shown in column 3, in two cases (China and Hong Kong), sales offices were installed directly. In Germany, a rare exception, and Upjohn subsidiary was installed directly for regulatory country-specific reasons (column 5). In Turkey, Spain, and Ex-Czechoslovakia the first entry mode was by licensing (column 9). In Ex-Yugoslavia the first entry mode was through a joint venture (column 7) and a licensing agreement (column 9). In no case was the initial entry mode by a wholly owned subsidiary (column 8).
An important finding in Table 2 is that 20 of Upjohn's 61 entries have already completed, often progressively, all the possible phases of the process of internationalization. In the other 41 cases, for various country-specific reasons, only a part of the internationalization model has been completed. It should be noted that in several cases, the mode has "regressed", e. g., in Pakistan, Nigeria, Greece and Iran.
The strategic process that Upjohn most often used to internationalize consisted of these four fundamental stages:
1) Agreement with a local distributor/agent (column 1);
2) Upjohn Sales Office, branch or subsidiary in agreement with a local distributor that was often a local pharmaceutical firm (columns 2, 3, 4, 5);
3) Manufacturing contract to a subcontractor or other local firm (columns 6, 5, 4, 3);
4) Acquisition of a local distributor and commencement of operations with a wholly-owned subsidiary (column 8).
Table 2 confirms that the process of internationalization by the Upjohn Company in many instances followed a progressive form of penetration. It often began from nearby countries and used exports as a means of diffusion. The higher the degree of internationalization of a country (given the high degree of internationalization of the pharmaceutical industry), the more Upjohn found strategic alliances to be effective.
We also found in our research that when the Upjohn Company followed other entry modes it was usually due to governmental incentives or other favorable governmental policies, as in the cases of Puerto Rico and Belgium. There were also special cases, as in Japan, where cultural barriers made it difficult to succeed alone. Germany also provided a large market for Upjohn's medicines and enticed it to install a subsidiary directly. In Franco's protectionist Spain, there was no other alternative other than to do a licensing agreement, which was also true (at the time) for Ex-Yugoslavia and Ex-Czechoslovakia. Where a long learning process of cultural assimilation was indispensable, joint ventures were the successful instrument typically used as in Japan and South Korea. Joint ventures were also used in Ex-Yugoslavia, Pakistan and Colombia. We find that Upjohn's internationalization policies are consistent with the progressive model of Johanson and Mattson (1988).
By 1992, as Table 2 shows, Upjohn operated in 30 nations with wholly-owned subsidiaries or branches, and 21 of these manufactured their own pharmaceuticals. Overall, Upjohn manufactured in 33 different nations. In only nine of the 61 cases were there licensing agreements: Ex-Yugoslavia (where Upjohn also has a manufacturing joint venture), Greece, India, Ex-Czechoslovakia, Egypt, Marocco, Turkey, Argentina and Brazil (these latter two being undertaken because of high inflation). There were only three joint ventures: Japan, South Korea and Pakistan.
In some countries Upjohn helps its licensee contractors to better promote Upjohn products with sales offices or branches. Examples of offices or branches like these are found in Greece, Ex-Czechoslovakia and Egypt. Other examples of collaborations include those between Upjohn sales offices and government sole distributors in countries such as Norway and Russia. Occasionally, government distributors collaborate with local Upjohn distributors as in the cases of Sweden, Kenya, Saudi Arabia, Pakistan and Austria. While Upjohn uses local distributors in 15 countries without a formal linkage to Upjohn offices (some of these have been developed distinctively by Upjohn's foreign wholly-owned subsidiaries), there are a number of Upjohn representatives active in most of them.
From Table 2 it is apparent that Upjohn uses multiple entry modes at the same time. This provides flexibility in an industry which is very dependent on political factors and is often dictated to by changes in host-government regulations. In nations where the government erected entry barriers, the process of internationalization was subjected to governmental pressures.
It is also important to keep sales volumes in mind. While Upjohn has 33 manufacturing plants around the world with approximately 36 percent of its sales, of the latter, eight percentage points derives solely from the Japanese subsidiary, leaving 26 percentage points of total sales from the other 32 foreign manufacturing locations. In contrast, one American plant can satisfy the U.S. domestic market, which comprises 54 percent of total sales by Upjohn. Recently, like many other pharmaceutical MNEs, Upjohn has had to undergo a major restructuring. This resulted in a 5 percent downsizing of its workforce and organizational capacity. This has also given Upjohn the chance to convert itself from an international company into a globalized one.
The internationalization process of the Upjohn Company is consistent with both the theory of internalization and the theory of internationalization. This detailed case analysis of Upjohn's postwar expansion provides evidence that both theories are relevant, as recognized in the reconciliation article by Johanson and Mattson (1988). While Upjohn has largely followed the sequential process of entry mode (predicted by internationalization theory) it has also moved broadly from exporting to FDI to licensing (as predicted by internalization theory). Upjohn has also used strategic alliances, which is a mode compatible with both theories when government regulation and other country-specific factors are considered. Moreover, alliances can occasionally permit a more efficient penetration of markets and more effective commercial strategies in host-country regulated markets.
On 20 August 1995, a merger was announced between the Upjohn Company and Pharmacia AB, a Swedish pharmaceutical company. The new company, merged on a fifty-fifty basis, is to be calied Pharmacia and Upjohn, effective November 1995. Upjohn and Pharmacia are approximately the same size and together will become the ninth largest pharmaceutical company in the world. The new company will have a combined workforce of 34,500 employees and a combined stock market capitalization of around U.S. $3 billion. This merger reflects the changing international strategic environment which calls for a smaller number of global firms in major industrial sectors.
(1) The authors wish to acknowledge the valuable help of Professor Alberto Marcati of the University of Bologna and Dr. Erminia Pansera, University of Parma. This article is drawn from a longer study by Dr. Erminio Fina (1992). We are also grateful to the Upjohn Company for their support and contribution of material, without which this work would not have been possible.
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Manuscript received May 1995, revised July 1995.