MASTER THESIS in MASTER OF BUSINESS ADMINISTRATION
Small firms in the big world: how government can help
Commercial Diplomacy and the Internationalization of Small and Medium Sized EnterprisesA case study research on the effectiveness and impact of governmental support during the international expansion of Small and Medium Sized Enterprises from the Netherlands
Student name: Mees van Ojik Student number: 6145671
Date of completion: March 1st, 2015
Supervisor: Mrs. Suzana Rodrigues
Co reader: Mrs. Michelle Westermann-Behaylo
Institution: University of Amsterdam/Amsterdam Business School Department: Faculty of Economics and Business
Statement of originality
This document is written by Mees van Ojik. Herewith he declares to take full responsibility for the contents of this document.
“I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.”
The University of Amsterdam, Faculty of Economics and Business is responsible solely for the supervision of completion of this work, and cannot be hold responsible for its content.
Acknowledgements
The thesis lying before you is the final work of five years of education at the University of Amsterdam. More precisely, it is the result of six months of internship and six months of intensive research. I would like to use this opportunity to gratefully thank everyone who has supported me during the process. If it were not for their support, you would not be reading this right now.
Foremost, I would like to thank my thesis supervisor, professor Mrs. Suzana Rodrigues. Suzana’s enthusiasm woke me up when I was down, and her professionalism was of great support to me. While she was in her sunny hometown of Belo Horizonte – and I found myself in snowy New York or rainy Amsterdam – she provided me with valuable insights and feedback that helped me achieve the final result. The singing birds in the background had a calming effect, and Suzana’s continuous struggle with technology (“can you hear me?”) made us both laugh during our Skype sessions. Suzana, thank you for your time and support.
I would also like to thank my co-reader Mrs. Michelle Westermann-Behaylo for the pleasant collaboration.
I am very grateful to the Consulate General of the Netherlands in New York for granting me the opportunity to intern with them. In particular, I would like to thank Consul General Rob de Vos and my supervisor, Marjan Blumberg. This experience will never be forgotten, and I am truly grateful for that.
Furthermore, a warm ‘thank you’ goes to my ex-colleagues Maartje Smitshuysen and Menno Schrok. Their advice during the initial stage of this project was of enormous help.
Another big ‘thank you’ goes to everyone that participated in my research. All interviewees cleared their busy schedules to talk to me. Without their commitment and collaboration this thesis could have never been written.
Last but not least, I would like to thank my family and friends. In particular, a special ‘thank you’ goes to my parents. Thank you for the unconditional love and support you have given me over the years, allowing me to pursue my dreams. I am deeply grateful.
A new chapter is about to begin.
Amsterdam, The Netherlands, March 1st, 2015
To Maarten
“ Op een heldere dag zie je voor altijd ”
Abstract
As the world is increasingly becoming an open economy, with strong global competition, governments are doing their best to promote and support national firms overseas. In the light of the economic recession and economic power shifts, this support is of the utmost
importance in order to maintain a healthy economy and safeguard GDP growth.
The execution of this governmental support, in the form of commercial diplomacy, to Dutch internationalizing Small and Medium Sized enterprises is of subject in this study. It
investigates the effectiveness and true added value of commercial diplomacy by focusing on the concept of Liability of Foreignness. From both literature and primary case study analysis, it concludes that effective commercial diplomacy is only achieved when a strong focus lies on the business network of a foreign post and the accumulated experience of the commercial diplomats that work at the foreign post. Also, it concludes that, in order to be of positive impact on a firm’s ability to overcome LOF, commercial diplomacy must concentrate on networking and problem solving activities. By doing so, maximum added value is delivered by only executing those activities that the market cannot provide.
Accordingly, a discussion is initialized focusing on the boundaries of commercial diplomacy. This implies that the use of commercial diplomacy is not always desirable, and when it is, one might question what particular services are preferably offered. These services must be
economically feasible from the government’s perspective, desirable from the client’s perspective and at the same time not be of deregulating force to the free market.
Furthermore, this research finds that the awareness of the service offering of commercial diplomacy is low, and that the overall image and reputation is negative. It provides practical implications of how to further improve the service and increase the added value of
Table of content
CHAPTER ONE: INTRODUCTION 8
CHAPTER TWO: THEORATICAL FRAMEWORK 16
2.1 Internationalization 17
2.2 Internationalization of SMEs 21
2.3 Liability of foreignness 24
2.4 Commercial diplomacy 26
CHAPTER THREE: FOCUS ON THE DUTCH CASE 30
CHAPTER FOUR: METHODOLOGY 35
CHAPTER FIVE: FINDINGS 42
5.1 The effectiveness of commercial diplomacy 43
5.2 The true added value of commercial diplomacy: overcoming LOF 49
5.3 Other findings 57
CHAPTER SIX: DISCUSSION 58
CHAPTER SEVEN: CONCLUSION 63
LITERATURE LIST 68
Chapter one: Introduction
Sooner or later, many firms expand their geographic scope from domestic to foreign markets. As world citizens, we are witnesses of an increasingly unified economy. While travelling it is no longer needed to bring your favourites along, as most probably you can find the exact same product thousands of miles away from your hometown’s grocery store. Globalisation is certainly one of the most dominant research streams on today’s agenda. Buying the same goods (e.g. Unilever products, Coca-cola, Heineken beer) and enjoying the same services (e.g. Hilton Hotels, Starbucks Coffee, Burger King burgers) both at home and abroad comes at a price. Not only an ethical price - many argue that multinationals destroy value for local companies and often don’t conduct business in a sustainable way - but also a true price: tax-paying citizens pay for government initiatives to stimulate (a) foreign direct investment (FDI) in their home country and (b) international expansion of domestic firms. Nowadays, a trade-intensive country like the Netherlands has few companies without any form of international cooperation or activity, whether on the supply, demand or production end of the business. This is partly the result of an economically and commercially focused foreign policy, in which firms are stimulated and supported to do business overseas. Foreign ministers travel the world on trade-missions with a dozen of companies in their wake. Contracts are signed and construction projects kick-started on the spot. For a small country it is only logical that a large part of GDP is earned abroad. Most scholars agree that firms from small countries like the Netherlands have to be outward focused in order to grow. The role of the government and other institutions in this process however, is ever hardly evaluated. The effectiveness and true value of this foreign economic policy, executed as commercial diplomacy, is unveiled in this research paper. This first chapter serves as an introduction and sets the scene.
1.1 Internationalization
Geographic expansion (i.e. internationalization or international expansion1) is one of the most important paths for firm growth. By broadening their customer bases through entering into new markets, firms are able to achieve a larger volume of production, and grow (Lu and Beamish, 2001). Further, there are differences in market conditions across different
1 (‘’Internationalization’’ and ‘’international expansion’’ are used interchangeably throughout this paper)
geographic areas that can lead to increased demand or lower costs. By spreading activities across different markets, firms are in a position to achieve higher returns on their overall resources. Therefore, in the pursuit of growth and/or higher return on resources, firms will chose a geographic expansion strategy and start operating across a broader range of markets (Zahra, Ireland, and Hitt, 2000).
Extensive research has been done into international expansion, as the “internationalization phenomenon” has captured the interest of many researchers in strategic management, international business and entrepreneurship alike. For researchers in the strategy and international business areas, internationalization is a known domain, with the focus mostly on large, well-established firms (MNEs) (McDougall and Oviatt, 1996). Another group of researchers have paid attention to small and medium sized enterprises (SMEs) as their primary focus, as those researchers view the entering of new geographic markets as an act of entrepreneurship (Lu and Beamish, 2001). The recent focus on SMEs when talking about international expansion doesn’t come as a surprise: over the years, academic interest in the field of small business/ entrepreneurship has grown dramatically as we witnessed an increasingly important role of small business in the global economy. For example, small firms have accounted for approximately 90% of all new jobs generated in the United States during the past 10 years (Barringer and Greening, 1998). Therefore, it must be clear that the importance of the so-called SMEs cannot be neglected when looking at international economic activity either, and we will solely focus on the internationalization of SMEs hereafter.
1.2 Internationalization of SMEs
As said, numerous scholars have looked at internationalization, as growth by international expansion is an important strategic option for both small and large firms2. More recently, a development within the broad internationalization field has been the increasingly active role played by SMEs in international markets (Oviatt and McDougall, 1994). The internationalization of SMEs can be expected to even gain more importance as the world economy is becoming increasingly integrated through bilateral cooperation and trade treaties and continued advances in technology. This makes conducting international business much
2 (E.g., Special Issues in Entrepreneurship Theory and Practice, 1996 and Academy of Management Journal, 2000, and many more)
easier for all and therefore, more than ever, accessible to small firms too (Lu and Beamish, 2001). But, what do we know about SME internationalization?
What is an SME?
According to a EU definition SMEs comprise three firm size categories:
Micro-enterprises: < 10 employees; turnover or balance sum < 2 million Euros p.a. Small-enterprises: < 50 employee; turnovers or balance sum < 10 million Euros p.a.
Medium-sized-enterprises: < 250 employees; turnovers < 50 million Euros or a balance sum < 43 million Euro.
These firms (< 250 employees) are the focus of this research paper. Furthermore, qualitative characteristics differentiate SMEs from large corporations (MNEs): for example: SMEs are specialized in individual products and services on customer demand; Relationships between employees and management are informal and personal; SMEs have a low degree of formalism and bureaucracy and SMEs can rapidly react to environmental changes (Hötzinger, 2012).
SMEs tend to move into foreign markets as exporters and/or as foreign investors (Reynolds, 1997). Exporting and foreign direct investment (FDI) are also common strategies used in the international activities of large, multinational firms, as they are a good way to explore unknown terrain. While expanding into new geographic markets presents an important opportunity for growth and cost reduction (as discussed above under 1.1, Internationalization), the implementation of such a strategy involves many unique challenges in addition to the common ones associated with domestic growth. Many of the challenges are typical of the difficulties associated with the liabilities of foreignness – LOF - (Hymer, 1976) and the liability of newness – LON - (Stinchcombe, 1965). These difficulties occur when the target markets are dissimilar to the original markets, or if new subsidiaries are established (Lu and Beamish, 2001).
In the former liability, LOF, significant differences between markets mean that the knowledge and capabilities that an SME has developed by operating in its original markets, are often not suited to operations in the new market. New knowledge and capabilities need to be acquired or developed to successfully enter the new markets. In the latter liability, LON, a new subsidiary faces many of the same challenges as a domestic start-up. It needs to build business
relationships with stakeholders, the subsidiary needs to establish its legitimacy, and it must recruit and train new employees to start new operations (Barringer and Greening, 1998). These challenges are compounded when entering an international market because of the differences between host and home markets on political, economic, legal, institutional and cultural dimensions. To make the international expansion a success requires firms to change many of its ways of doing business that were developed in the domestic context (McDougall and Oviatt, 1996).
In order to overcome these challenges - liability of foreignness and liability of newness - internationalizing firms (especially smaller SMEs) seek help. They find this helping hand, amongst others, in the form of governmental support (see below, section 1.4). Interestingly, little is known about the exact role of governments and institutions during the internationalization process of SMEs as the helping hand for SMEs to overcome the liability of foreignness. Furthermore, if they do help SMEs to overcome these challenges, we need to know how effective they are in doing so and reveal the true add-value activities of government. In other words, do they practice what they preach and do they really facilitate, support and add value to an SME’s international expansion3?
1.3 Objective, Research Question & Focus
This research will take a close look at just that: the effectiveness and impact of government support on a SME’s ability to successfully overcome its liability of foreignness. More specifically, this research will only look at how aid is given to Dutch SMEs who are expanding abroad. As SMEs are the main target group of the Dutch foreign economic policy, we wonder what the true added value of their support really is –
Therefore, the questions guiding this research are:
Introductory question
• Q 1: How do government institutions stimulate and support the international expansion of small and medium sized firms?
3 (A more extensive explanation of this matter will be provided in chapter two: literature review)
Main research questions
• Q 2: How effective is the given support, and what determines effectiveness?
• Q 3: How does governmental support add true value by impacting a SME’s ability to overcome its liability of foreignness?
Discussion question
• Q 4: What is the desired role of governments in the internationalization process of small and medium sized firms?
To address these questions, a qualitative study based on previous research and self gathered data is conducted. As intern at the Economic Section of the Consulate General of the Netherlands in New York, (February till August 2014) I conducted interviews with (a) Dutch and (b) New York state/city government officials, as well as (c) with Dutch SMEs entering the New York market for the first time with support from the Dutch government. Therefore, the The Netherlands – New York City case will serve as example throughout this paper.
1.4 Foreign economic policy & commercial diplomacy
I argue that more attention should be devoted to exploring whether and how value is created by the support of governments during the internationalization process of SMEs. Various reasons motivate this quest and stress the importance of this research.
First, the global economic power shift towards the East (putting pressure on the competitive position and GDP of the West) has forced governments of developed economies in the West to support national businesses that are involved in the process of expanding across borders (Ruel and Zuidema, 2012). This support, focused at helping internationalizing firms to overcome its liability of foreignness, is called commercial diplomacy. It provides a mean for governments to increase their international trade and to stimulate their national economies.
Second, in line with this global trend, the Dutch government has recently put commercial diplomacy on the top of her foreign agenda. This means that money that was previously spent on, in the government eyes, outdated policies, such a traditional development aid, now has a new destination: supporting Dutch firms, big and small, with their operations abroad. This support comes is various forms, as will be outlined later in this paper.
Third, as emerging economies will most likely remain a fact, and as they will function as the economic growth engines in the coming decades, governments of developed economies need to strengthen the instruments they use such as commercial diplomacy to keep their economies healthy. At the same time, these instruments are at risk due to severe budget cuts. The process of maintaining a healthy economy by supporting international expansion briefly consists of three steps:
(a) At home, foreign economic policy sits high on the agenda and a forms key point for the government. Budget is allocated to government institutions supporting international businesses.
(b) At home, various government institutions that now have a budget inform and support outgoing (e.g. internationalizing) firms. They host meetings and consultation hours, but also provide funding for example.
(c) Abroad, foreign posts - embassies and consulates, in close cooperation with their colleagues at home - play a crucial role in offering effective commercial diplomatic support for these incoming international firms.
Commercial diplomacy is often confused with economic diplomacy and other types of diplomacy such as trade diplomacy and financial diplomacy. Economic diplomacy is concerned with general economic policy issues and trade agreements. Even though both have an economic objective, commercial diplomacy is much more specific and focuses on the business support side as provided by an embassy or consulate. A more detailed review of diplomacy will be given in chapter 3, literature review (Ruel and Zuidema, 2012).
1.5 Motivation
Following politics closely and with a special interest in foreign economic policy, I applied for an internship at the Economic Department of the Dutch Consulate General in New York in November 2013. This is one of the frontlines of commercial diplomacy. Throughout the United States, the Dutch diplomatic network, consisting of the Embassy in Washington and four Consulates-General (New York, Chicago, Miami, San Francisco) employs about 50 professionals with the sole object to support Dutch companies in the US.
Promoting and selling ‘your’ industries of excellence has become big business for countries. Doing what you do best, but now on an international scale is often key in foreign economic strategies. For the Netherlands for example, this means a strong focus on water management , creative industries and disruptive technologies. This new approach towards diplomacy, wealth creation and the genuine use of public money interests me greatly and therefore motivated me to conduct this research.
1.6 Research gap & contribution
Summarizing all the above, a clear research gap can be identified. Studies in international business and strategic management literature have long explored the outcomes of international expansion strategies of both large and small firms. Numerous researchers have argued that higher levels of internationalization lead to higher firm performance4 (Lu and Beamish, 2001), provided that liability of foreignness and newness are overcome. We also read that international expansion is especially a hard step for small and medium sized enterprises as they traditionally have a small financial base, a domestic focus and a limited experience (Barringer and Greening, 1998). Therefore, many hurdles are to be overcome. Note that it has been well argued that smaller businesses ‘are not smaller versions of big businesses’. Rather, they differ fundamentally from larger firms in ownership, resources, organizational structures and processes, as well as management systems (Lu and Beamish, 2001). These differences therefore ask for a unique stream of research into the drivers and facilitators of SME internationalization, as done in this study.
After an extensive literature review, one finds that a particular facilitator, government, gets very little attention. Insufficient research into the field of commercial diplomacy, (i.e. government as facilitator) points the focus of this paper to commercial diplomacy and particularly on how it helps to overcome the liability of foreignness, as theory on that is close to non existent. Prior research on internationalization has mainly focused on competitive factors in home or host countries, the influence of social capital and financial markets. The effect of many factors, internal (e.g. resources, capital, firm’s structure and ownership) and external, (e.g. distance and ease of doing business) on the process (and success) of internationalization has been discussed in the past (see chapter two: literature review).
However, the impact of government aid in this process has been largely neglected, and little is known about how this support works in practice.
It is this support that forms the subject of this paper. I hope to contribute, or rather extend the existing literature on a government’s influence on the successful internationalization of SMEs. Ultimately, I hope that this thesis can also serve as a practical ‘guidebook’ to firms willing to expand abroad, and as a piece of advice to the various government institutions involved in this process, as it provides recommendations on how government can be of the greatest added value to internationalizing firms.
1.7 Structure
The remainder of this paper is structured as follows. The next chapter, chapter two, will review existing literature on the domains of SME internationalization, Liability of foreigness and role of governments during SME internationalization, namely commercial diplomacy. When all relevant literature is discussed, chapter three will focus on the Dutch case and set the boundaries of this research. Chapter four will present and motivate the methodology as used in this research. Hereafter, chapter five presents the findings, where theory and practise meet and recommendations are formulated.
Chapter six forms a discussion, based on the findings as presented in chapter five. Finally, the last chapter, number seven, forms the conclusion of this paper.
Chapter two: theoretical framework
In the previous chapter, an introduction was given into the relevant topics with regard to the internationalization of Dutch SMEs. The introduction recognized the importance of more research on the field of governmental support during the internationalization of SMEs. In this chapter, relevant literature from various streams will be reviewed to provide a theoretical basis for the investigation into the effectiveness and added value of commercial diplomacy, as proposed in chapter one.
The following fields of research will be reviewed successively:
2.1 Internationalization
2.2 Internationalization of Small and Medium sized Enterprises (SMEs) 2.3 Liability of Foreignness
2.3 Commercial diplomacy
Although this review is not exclusive and will not discuss all research ever done, it attempts to give a clear overview of the relevant literature. All main theories will be touched upon and discussed in the light of the central argument of this paper, and steers towards institutional (i.e. governmental) support given to internationalizing Dutch SMEs.
To clarify, the relationship between these fields of research is as follows:
Section 2.1, Internationalization, serves as an introduction into the field of SME internationalization (2.2).
2.1. Internationalization
Internationalization is a synonym for the geographical expansion of economic activities over a national country’s border and is a major dimension of the strategy process of most firms (Melin, 1992). The process of becoming an international player means that a lot will change in the firm in terms of scope, strategy, organization, and the nature and division of managerial work (Melin, 1992). Therefore it is not surprising that a vast amount of studies have been conducted on the theme. In this first section of the literature review, an overview of the most important research streams on internationalization will be given. However, the amount of research done on the topic is vast and this section therefore only includes the work of relevance to this study.
2.1.1 Internationalization versus Globalization
The internationalization process rapidly gained importance in the post-second-world-war era and was on top of the research agenda until the early 1970s, when a new phenomenon of globalization started to emerge (Melin, 1992).
Globalization usually refers to a stage in which a firm’s operations are managed on a global scale, not in just a few selected countries: “It is characterized by the worldwide integration of competitive markets and companies facing global competition (Gjellerup, 2000).” It is often stated that three forces are driving the globalization of businesses. Though globalization concerns multiple countries cq global operations, and internationalization can also be the expansion into a single foreign country, the three forces equally apply to internationalization (from Gjellerup, 2000):
The first is the rapid growth of low-cost technology connecting people and locations wherever they are. This works in two ways: better information and communication technology (e.g. the internet as explorative tool) is creating greater awareness of international economic opportunities. Now, once these foreign opportunities are identified and targeted, ICT allows for easier relationship management with business partners or clients overseas. An actual presence in the country of operations is no longer necessary. Firms can be active, and have clients globally while only being present in a few or even a single country. Web based products or companies (e.g. Face Book) are good examples of this.
The second force behind the globalization of business is the steady break down of trade barriers, opening borders and creating a global market space. Free-trade agreements have generated a more level playing field for firms from all over the world.
The third force motivating the globalization of business is the widespread economic restructuring and liberalization that followed the fall of socialism in Russia and Central/Eastern Europe, as well as the fast expansion (and increase in purchasing power) of markets in Asia, particularly China. These previously closed or unappealing areas are now new markets and magnets for investment, creating further opportunities for growth and investment (Gjellerup, 2000).
2.1.2 Selected internationalization theories
The beginning of internationalization research in the late 1950s and 1960s focused on large multinational companies and their international activities. The approach that most researchers followed resulted in a vast body of theoretical data. Some of the main theories on the internationalization of MNEs include: the internalization theory, the transaction cost theory, the eclectic paradigm, and the monopolistic advantage theory (Mitja et al., 2006). The abovementioned theories are dominant approaches in MNE research and will be presented in brief here:
Internalization theory centres on the notion that firms want to develop their own internal markets so that transactions can be made at a lower cost within the firm (from one division cq country to the other) and will continue until the benefits and costs of internalization are optimized (Buckley and Casson, 1993). Internalization can involve a form of vertical integration bringing new operations and activities, formerly carried out by others on the market, under the ownership and governance of the firm. This is especially beneficial when markets are imperfect or short of players, creating shortages on the supply side or opportunities on the demand side. Internalization of transactions beyond national borders leads to the creation of multinational enterprises (Mitja et al., 2006).
The transaction cost approach, as introduces by Teece in 1986, is very similar to the internalization theory. As Mitja et al. (2006) puts it: “At one level the internalization school
and the transaction cost approach are one and the same. Both see the firm as a response to market failure. Profit-seeking firms internalize operations and by so doing the costs of organizing and transacting business will be lowered. The difference of both theories is that in the transaction cost approach the unit of analysis is the transaction itself and not the firm as a whole.”
The eclectic paradigm, also known as the OLI Paradigm, is based on the internalization theory and tries to explain the different forms of international production as well as the selection of a country for foreign direct investments (Mitja et al., 2006). According to the founder of this theory, Dunning (1988), the internationalization of economic activity is determined by the realization of three types of advantages: “first, ownership advantages which are specific to the company and related to the accumulation of assets, technological capacities or product innovations. Second, the internalization advantages stemming from the capacity of the firm to manage and coordinate activities internally in the value-added chain. Third, location advantages referring to the institutional and productive advantages present in a particular geographical area. These arise when it is better to combine products manufactured in the home country with factors and products of another location (Mitja et al., 2006).”
The monopolistic advantage theory holds that MNEs exist because a firm has unique sources of superiority over foreign firms in their own markets (As invented by Hymer, 1976, cited in Mitja et al., 2006): “ the advantages belong to the MNE and cannot be acquired by other firms. One type of monopolistic advantage is superior ability.” Hymer (1976) argued that MNEs have superior knowledge, as found in the form of superior manufacturing processes, brand names, differentiated products, organizational talents, or patented technology. Monopolistic advantage theory holds that “once a firm has developed this superior knowledge, it can exploit this advantage overseas at virtually no additional cost over that of exploiting that advantage in the home market. Since local entrepreneurs have to pay the full cost of developing this knowledge, they are unable to compete with the foreign firm despite their advantage in local market knowledge (Mitja et al., 2006).”
A newer view on internationalization comes with the network approach or network base perspective. Johanson and Vahlne (1990) examined the internationalization process by applying a network perspective: their theory includes networks that are new to the firm as well as developing stronger positions in networks in which the firm already has positions. If
the relationships between firms are seen as a network, it can be argued that firms internationalize because other firms in their (inter) national network are doing so too. Within the industrial system, firms engaged in the production, distribution and use of goods and services depend on each other due to their specialization. Certain industries or types of markets are more likely to be internationalized through networks given the configuration of the world economy (Andersen, 1993). Much of the network-based research on international business focuses on the management of international relationships. In these studies, the firm is viewed as a set of interlinked relationships (between people from various firms) connecting it with other firms. Knowledge embedded in long-term relationships is often concentrated in one person in the firm, who will have a substantial impact on internationalization through close social relationships with other individuals. Such social relationships are extremely important for entrepreneurs and their business. This social network is a sub-network within the business network and is of equal importance to the more formal and structured business network (Mitja et al., 2006). In other words, if firms in your network expand internationally, you might want to do so too.
Based on existing models, a resource-based perspective on internationalization is currently emerging. The objective is to develop a dynamic capabilities/resource-based theory of the firm – whether this firm is domestic, international or global.
The resource-based view focuses on sustainable and unique costly-to-copy attributes of the firm as the sources of economic value (i.e. as the fundamental drivers of sustainable competitive advantage needed for internationalization). A firm’s ability to attain and keep profitable market positions depends on its ability to gain and defend its position with regard to relevant resources important to the firm. To sustain a long-term competitive advantage, authors have proposed different characteristics that these resources must posses. Barney (1991) for example, argued that resources must be valuable, rare, imperfectly imitable and not substitutable. The possession and development of these resources drive internationalization for both small and large firms (Mitja et al., 2006).
The above section gave a brief summary of well-known internationalization theories. For a long time, mature multinational corporations played a dominant role in internationalization theory, whereas SMEs have only recently attracted more interest. This reflects the fact that several countries have attempted to increase the international activities of their SMEs by conducting so called commercial diplomacy, in order to boost economic growth and lower
unemployment. Their operations abroad benefit national GDP, as we will see later in the paragraph on economic and commercial diplomacy.
In the following part of this literature review, we will zoom in on the level of analysis that is the subject of this paper, the SME.
2.2 Internationalization of Small and Medium sized Enterprises (SMEs)
SMEs are increasingly facing similar international opportunities and problems as larger firms. While previously SMEs were considered passive victims of the global market place rather than active players, evidence indicates that this view is no longer valid. In the last few decades, many SMEs have successfully set up activities beyond their home markets and their role in contributing to overall economic growth is gaining importance (Gjellerup, 2000).
For many SMEs it is no longer possible to act in the marketplace without taking into account the risks and opportunities presented by foreign and/or global competition. Globalization caused borders to fade and created a levelled playing field for large and small, national and international firms alike. Especially the rapid spread of the Internet powered a global market space, where the small (SMEs) have to compete with the big (MNEs). Although this might be a big challenge for small firms, it also opens up opportunities to grow as never experienced before. Success can now much easier be multiplied by electronically selling across borders for example. In this section, a closer look will be taken at literature concerning the international expansion of SMEs.
It is becoming increasingly difficult, if not practically impossible for independent small firms to flourish by only operating in their traditionally protected markets (Fraser & Oppenheim, 1997) and survive on their ‘isolated island’. In this line, several reasons underlie the desire of SMEs to become internationally active:
• Increased competition (need to react),
• Unified market needs and demand (need to act)
• Increased supply opportunities (with the possibility of decreasing costs) • Increased ease of doing business internationally
Regardless of size, firms are forced to compete side-by-side and must now become at least regionally, if not globally, competitive to survive in competitive “interlinked” markets. Even if firms decide not to enter international markets and only compete in their home market, international firms may enter their home market and compete with them (Etemad, 2004).
2.2.1 Selected SME internationalization theories
As seen in section 2.1 Internationalization, Dunning, Hymer, Rugman, Vernon and many other researchers have focused on the internationalization of larger firms, especially MNEs. Notably, only few scholars (including Buckley and those in the Uppsala School of Internationalization, for example Johanson & Vahlne) have put the SME in the centre of their research in the past. Unfortunately, apart from these “Stage Theories of Internationalization” few theories are 100% applicable to SMEs or have offered theoretical guidance to smaller firms aspiring to internationalize. More recently, however, research is being conducted on the field of SMEs’ international expansion. This research stream highlights the factors affecting the foreign expansion of SMEs, and shows how they can overcome the liability/disadvantages associated with it. Some classical models that are discussed above under Internationalization theories are also applicable to SMEs, such as the resource based view (RBV) and the network based perspective (NBP).
The RBV, in which firms are seen as collections of unique bundles of resources (these sets of firm-specific resources and competences form the basis of the strategic behaviour of a firm, including its internationalization choices) creating a competitive advantage, has been discussed at large. Also, the NBP, where internationalization is defined as the process of developing networks of business relationships in other countries, has been touched upon sufficiently above.
Stage models
Another way of looking at SME internationalization is through stage models. Two stage models will be briefly discussed here, namely the he Uppsala Internationalization Model (U-model) and the Innovation-related Model (I-(U-model).
Johanson and Vahlne developed the Uppsala Internationalization Model in 1997. In this dynamic model, internationalization of the firm is seen as a process of increasing a company’s
international involvement as a result of different types of learning. According to the model, “the general and experiential market knowledge and resource commitment of firms (state aspects) affect commitment decisions and current business activities (change aspects) (cited by Mitja et al., 2006)”. “The change aspects, in turn, increase the market knowledge and stimulate further resource commitment to foreign markets in the subsequent cycle”.
This model implies that firms increase their international involvement in small incremental steps within those markets in which they currently operate. Firms will then later enter new markets lying at a greater “psychic distance” due to differences in languages, education, business practices etc. This accumulated knowledge from conducting international operations further drives internationalization decisions and influences the entry-mode and country/market selection. Market knowledge, which can be gained from experience with foreign activities, is therefore the key factor influencing the time and direction of international development, as only experience reduces the uncertainty associated with international expansion.
This stage model therefore provides some guidelines for the internationalization of SMEs and emphasizes two key points for international success:
• The possession of knowledge of foreign markets prior to internationalization; • The importance of the learning processes during internationalization.
The second stage model is the Innovation-related model, of which multiple varieties exist. These models all see internationalization as a staged process. They all focus on a number of fixed, sequential stages, although the number of stages varies considerably between models, ranging from as few to as many as six. Andersson (2000) pointed out that “generally the models are relatively similar and the differences tend to be in the number of stages and terminology used. Being behaviourally oriented to a significant extent, these models treat individual learning and top managers as important aspects in understanding a firm’s international behaviour (Andersson, 2000, as cited by Mitja et al., 2006 ).”
Born globals
The relatively new phenomenon of ‘born globals’ – companies that are international from their birth or shortly afterwards – has challenged the traditional view of internationalization.
Firms that are international from the beginning of their activity are also known as ‘global start-ups,’ ‘early internationalizing firms’ or ‘international new ventures’ (Antoldi et al., 2011). Many born globals are rather small, and are therefore SMEs. They develop strategies to exploit international opportunities simultaneously in various markets. Born global firms internationalize rapidly by developing international networks, relying on innovation, and offering customized products. Here, their small size becomes an advantage instead of a challenge. Given their ability to adopt and deliver fast, they are flexible in terms of location as well as customer demands and needs. With a faster speed to market, born globals are quick adopters on the world stage and have the ability to fill the gaps often created (or left unexploited) by MNEs.
2.2.2 Internationalization motives and challenges of SMEs
While opportunities seized by internationalization (i.e. the motives to internationalize) are evident (larger market, increased demand, efficient or cheaper supply etc) and previously discussed, they are also heterogeneous amongst firm type: SMEs mostly have the same internationalization motives as the larger MNEs. The speed, pattern and strategy they undertake however differs much. Dozen of papers have been written on these internationalization aspects of SMEs versus MNEs. Motives and challenges of internationalization, two of the most studied topics in International Business (Etemad, 2004) will therefore not be widely discussed in this paper, with an exception of the Liability of Foreignness (LOF) that SMEs face. This is also done in order to introduce the reader to the need of commercial diplomacy, aimed at overcoming the challenges associated with LOF (2.3).
In this section a short overview was given on the most important literature streams concerning the internationalization of SMEs. Respecting the scope of this research, it must be noted that a lot of SME research is left out due to time and length constrains. For example, one can fill pages about motives, entry modes, strategic stages, barriers (internal and external) and patterns of internationalization. However, this chapter will now move on to liability of foreignness and commercial diplomacy.
2.3 Liability of foreignness
Forced to compete with multinational enterprises and globally competitive and regionally dominant national firms, at home and abroad, smaller firms face even larger challenges than their larger counterpart. They must develop capabilities to “fight with the big guys” with only the few constrained resources they posses (Etemad, 2004). This battle is very similar to what for example smaller grocery stores in the Netherlands go through. With the rapid expansion of a few giant super market chains (e.g. Albert Heijn) it is extremely hard for the individual retailer to compete and stay in business. This is due, amongst others, to the fact that the big chains (a) posses strong resources (capital, stock) and (b) enjoy profitable economies of scale due to their wide spread operations and large number of clients. The same goes for the internationalizing SME in the scope of this paper. While they see and recognize the opportunities across borders, they find themselves in a difficult position. The larger competitor has more money, more knowledge and lower costs. This gives them international bargaining power as well as the absorption to fail: when a MNE’s operations in a certain country are not successful, they pull out without major harm to the firm. However, when an SME makes a similar misstep or expansion error, most often the whole firm goes out of business. This is what I like to call the vulnerability of the small in a big world.
Apart from the big – small battle (in which the smaller firm often has a disadvantage) all firms operating in foreign countries have higher costs than local firms due to factors such as lack of local information and market knowledge, and unfamiliarity with the local culture and business environment (Hymer 1976). This disadvantage is known as the ‘liability of foreignness’ (LOF). For this reason, firms need to accumulate on, and take advantage of, their firm-specific advantages in order to successfully expand abroad and gain a superior competitive position over local firms (Antoldi et al., 2011).
The central notion of the liability of foreignness, or costs of doing business abroad (CDBA, as initiated by Hymer in 1976), is that firms that enter unfamiliar environments face costs due to political, economic and cultural differences as compared to their home country.
The costs associated with LOF can arise from four sources (Eden & Miller, 2004):
• Unfamiliarity with local environment (e.g. lack of information and business network) • Host country environment costs (e.g. economic nationalism, bad treatment from host
country government, buyers and suppliers) • Institutional distance (taxes, rules & regulations)
Local competitors do not occur these costs of doing business abroad. Furthermore, they face costs associated with the need of coordination across geographic distance. To compete successfully against local firms, both MNEs and SMEs need to overcome the LOF. To do so, most scholars argue that that firms need to capitalize on firm specific advantages, and employ these overseas, such as successful managerial capabilities (Buckley & Casson, 1976). Resource based views, as discussed earlier, have stressed the importance of firm specific resources in providing firms with a sustainable competitive advantage. To do so, firms will import capabilities from home, such as brand name or superior technology. On the other hand, various studies argue that firms are most successfully locally if they try to be similar to local competition. This means that they should not transfer valuable resources from the home market, but instead should adopt business practices of local firms (Zaheer, 1995). So, in order to compete against purely local firms, companies can chose to either rely on imported firm specific resources and capabilities, or rather imitate local organizational practices.
Disregarding the outcome of this trade off – in which a combination is possible too – firms can seek help in order to overcome their liability of foreignness. Zaheer (1995) concludes that LOF arises “mainly from the foreign firm not being sufficiently embedded in the information networks in the country of location.” Eden and Miller (2004) on the other hand argue that the institutional distance between the home and host countries is the key driver behind LOF. As LOF is mostly caused by unfamiliarity of the local market (including the institutional environment) and the lack of a valuable network, it is common practice for firms to seek local advice. Apart from hiring consultants or partnering with local firms, this advice can be found at the government: home country governments help and support firms to overcome the LOF. In order to do so, they conduct commercial diplomacy, which will be discussed hereafter.
2.4 Commercial diplomacy
In this section the notion of commercial diplomacy will be further elaborated on. Diplomacy is the art and practice of conducting negotiations between representatives of states: “it usually
refers to international diplomacy, the conduct of international relations through the intercession of professional diplomats with regard to issues of peacemaking, trade, war, economics, culture, environment, and human rights (Barston, 2006).” Diplomacy comes in many forms and is conducted for several reasons. In this paper, we only focus on bilateral diplomacy (meaning between country A and B) and its economic or commercial applicability.
2.4.1 Diplomacy
In capital cities all around the world, diplomatic representations are present. The Kingdom of Netherlands for example, has 150 of these posts abroad, consisting of embassies, consulates, permanent representations (an NL embassy at a international organisation, such as at the United Nations in New York or Geneva) and Netherlands Business Support Offices (NBSOs). With the Dutch Ministry of Foreign in The Hague as their headquarter, about 5000 employees (civil servants and diplomats) work in The Hague and abroad to conduct diplomacy on a wide range of topics. In short, the Dutch government uses diplomacy to participate in the creation of a safe, stable and wealthy world. In doing so, diplomats around the global are committed to fight against conflict, poverty and injustice, and promote the interests of Dutch nationals abroad. These interests can be of consular kind (providing consular aid) as well as of economic kind.
2.4.2 Economic versus commercial diplomacy
In the existing literature on the subject, the concepts of economic and commercial diplomacy are often used interchangeably. Definitions of both concepts differ, and consequently the relationship between them is also described in different ways (Reuvers et al., 2012). Some authors argue that commercial diplomacy is a part of economic diplomacy (Okano-Heijmans & Ruël, 2011). It is certain that both kinds of diplomacy are closely connected and interlinked. Since the definitions of commercial and economic diplomacy used in the literature vary significantly and since in practice there is not much of a difference between the two, we will solely use `commercial diplomacy ́ as an umbrella term for both – economic and commercial diplomacy – in this paper. Commercial diplomacy will now be further defined.
In a broad sense, “economic diplomacy (ED) is defined as a form of diplomacy where diplomatic means are used to achieve economic foreign policy goals (Reuvers et al., 2012).”
As a consequence, “economic diplomacy is the process through which countries tackle the outside world, to maximize their national gain in all the fields of activity, including trade, investment and other forms of economically beneficial exchanges, where they enjoy comparative advantage. It has bilateral, regional and multilateral dimensions, each of which is important” (Quote from Reuvers et al., 2012).
Commercial diplomacy (CD), on the other hand, emphasizes the government’s role in the more concrete action of helping and promoting national companies abroad. CD can be defined as “[national] government services to the [national] business community, with the aim to develop and support successful international business ventures.” It includes “the work of diplomatic missions in support of the home country’s business sector” and aims at “the promotion of inward and outward investment, as well as trade” (Quote from Reuvers et al., 2012). Commercial diplomacy therefore includes all aspects of business support and promotion given to national firms during their expansion abroad. CD stimulates flows of trade, investment, tourism, science, and technology between two countries.
The definition of use in this paper includes aspects of both economic and commercial diplomacy, as phrased by Reuvers et al. (2012): “commercial diplomacy is the use of diplomatic means to support commercial activities, such as export and foreign direct investment promotion. It is pursued with resources available to the home country, aiming at outputs such as economic stability, home country welfare and a national competitive advantage.” It includes support given to national firms who want to start operations in a foreign country. For example, if a Dutch company wants to start operations, or look for clients, in Brazil, the network of commercial diplomats (stationed at the embassy in Brasilia, and at the consulates in Sao Paulo and Rio de Janeiro) is there to provide support and help. On the other hand, when a Brazilian company wants to expand to the Netherlands, Dutch diplomats will help him too. This means, as a firm, you can expect support both from your own country and your country of destination.
2.4.3 Why conduct commercial diplomacy?
The world economy is a dynamic environment full of opportunity and risk for international businesses, small and big alike. The borderless world of today creates new political and economic space for the development of international business opportunities all around the
world. In specific, extra commercial diplomatic attention is given to developing economies (including Brazil, China and India) where large opportunities arise but where big risks are at stake.
The economic power shift is evident if we look at the growth of new international businesses headquartered in the East such as in the United Arab Emirates or China, as well as to the Southwest in Mexico or Brazil. We witness a wave of increasing investments from emerging economies in the older economies of the West (e.g. Tata Motor’s purchase of Jaguar Land Rover from Ford Motors in 2009), increasing the overall competition on the global market place. This power shift has caused governments of developed economies in the West to strongly support national businesses that are involved in the process of expanding across borders (Ruel and Zuidema, 2012). Commercial diplomacy provides a means for governments to give this support, and by doing so increase their international trade and grow their national economies.
The idea that successful international business is just a matter of a clear business strategy and good business management (solely internal capabilities) is naive and outdated. Therefore, the main driver behind CD is to tackle a business’ unfamiliarity with the political, institutional and legislative contexts of new markets and their apparent struggles to enter these new markets. Government – business collaborations and diplomatic support for international business is needed more then ever in this competitive global marketplace for firms to operate successfully abroad.
In sum, commercial diplomacy can be divided into three main activities to pursue its goal of international trade and investment growth:
• Commercial intelligence & information gathering • Business support & lobby for individual firms
• Industry specific or general promotional campaigns & advocacy
After having outlined various research streams on the field of internationalization and commercial diplomacy, the next chapter will take a focused approach and zoom in on the subject of this paper: commercial diplomacy applied to Dutch SMEs expanding to the United States. In chapter three, the Dutch approach will be outlined.
Chapter three: focus on the Dutch case
In line with the global trend as discussed in chapter two, the Dutch government has recently put commercial diplomacy on the top of her foreign agenda. This means that money that was previously spent on other aspects of foreign policy, such a traditional development aid, now has a new destination: supporting Dutch firms, big and small, with their operations abroad. This support comes from various institutions, as will be outlined in this chapter.
3.1 The significance of commercial diplomacy in the Netherlands
Historically, commercial diplomacy has always been around, be it in less apparent forms. In an historic overview of commercial diplomacy & international trade (Ruel et al., 2012) we read:
“From the Mesopotamians employing trade as an aspect of diplomacy and the Romans using trade to spread their culture even beyond the borders of the Roman Empire to Medieval times when English trade with the German Hanseatic League was supported by continuous diplomatic bargaining, trade and diplomacy have always been closely related. All in all, commercial diplomacy has in some sense been around for a considerable amount of time and the concept is nothing new.”
As long as trade exists, so does commercial diplomacy. In 1655, the Netherlands established an embassy in China with the specific objective to improve trade between the two nations. Today, CD is of the top of the government’s agenda. The Dutch government spends 150 million Euros annually on commercial diplomacy. This includes expenditures on trade mission and sector promotion, but excludes the (high) costs of the foreign-post network of embassies and consulates (Compernolle, 2014). Post trade mission rapports communicate the economic value of the mission: minister of foreign trade and development cooperation, Mrs. Ploumen, proudly states that the 2014 trade mission to China accounted for Euro 300 million of new contracts for Dutch firms, directly adding the sum to our national GDP. The question remains however whether the large sum of money spend on CD, plus all the ‘hidden costs’ accumulated by the foreign posts (man-hour, office space, network receptions, local trade show presence etc), is really worth it. If the advantages or returns (national GDP growth
through national firms’ revenue increase) do indeed outweighs the costs, the question remains whether we make optimal use of the ‘magical tool’ called commercial diplomacy. Does the current policy and execution optimize the yield or is it possible to achieve a higher return on the investment? As such, CD is nothing more than state aid, and the effectiveness and legitimacy are, and should, therefore be publically be questioned, as public money is a common good and should be used to the best of our ability, even more so in difficult economic times.
In 2012, the Policy and Operations Evaluation Department (IOB) of the Ministry of Foreign Affairs of the Netherlands conducted an extensive study into the effectiveness of commercial diplomacy. In this report, the inspectors state that due to ED the Netherlands gained a strong competitive advantage on the Brazilian maritime market. This was the result of a ten-year ED focus on the maritime sector with multiple trade visits of Dutch firms to Brazil (and vice versa), the signing of political treaties and full commitment of the embassy’s staff. These resources combined – including a partnership with the Port of Rotterdam – resulted in a strong position and a vast market share of Dutch maritime companies on the Brazilian market. However, the report also concludes that the Netherlands does not always apply its ED policy and execution in a strategic manner. The bottom line of the report states that the greatest gains can be made (e.g. the most value added) if the government solely focuses on those aspects of international trade and investment that the market cannot solve or settle on their own. In other words, government should not do things (i.e. prevent overlap) that private companies can do too, or even do better (e.g. legal advice). This tension between government’s involvements versus the free market is of great interest to governments and businesses alike (more on the legitimate and desired role of governments during internationalization will follow in chapter six: discussion) (Compernolle, 2014).
The provision of information about a certain country and its culture is something often done by an embassy. Entrepreneurs willing to enter their market (the country where the embassy is located, that is) can expect many information booklets and power points about the market basics. The IOB report however indicates that this is not the role of the embassy and that the Internet – or consultants in home and home country – should be the one providing this basic information. That said, it does not mean that the government has no role in internationalization, as it can do many things that consultancy firms cannot do. But what is it that governments should and should not do? To answer that question, I conducted interviews
with Dutch SMEs that are currently expanding to the United States. Also, interviews were conducted with several commercial diplomats and other government officials to depict their view on CD and governments involvement during internationalization.
The next chapter (4) will outline the methodology that was of use. In chapter five, the findings of the case studies will be presented. Before we do so, the next paragraph will give a short overview of the main actors within commercial diplomacy. Which institutions are involved and how do they offer support?
3.2 Main actors of commercial diplomacy in the Netherlands
In this paragraph, short descriptions will be given of the government institutions involved in commercial diplomacy in the Netherlands.
Ministry of Foreign Affairs in The Hague (MOFA)
“The Ministry of Foreign Affairs promotes the interests of the Kingdom of the Netherlands abroad. The Ministry coordinates and carries out Dutch foreign policy at its headquarters in The Hague and through its missions (embassies, consulates etc) abroad. It is likewise the channel through which the Dutch Government communicates with foreign governments and international organisations. Two members of cabinet head the MOFA: Mr. Bert Koenders, Minister of Foreign Affairs (responsible for overall Dutch foreign policy) and Mrs Lilianne Ploumen, Minister for Trade and Development Cooperation, responsible for policy on trade, development cooperation and foreign aid (government.nl, 2014).”
The ministry is divided into five Directors-Generals who serve the political leaders within specific spheres of foreign policy:
• Directorate-General for European Cooperation (DGES) • Directorate-General for Political Affairs (DGPZ)
• Directorate-General for International Cooperation (DGIS)
And, as far as commercial diplomacy is concerned;
Directorate-General for Foreign Economic Relations (DGBEB)
“DGBEB boosts international economic activity, creates favourable conditions abroad for Dutch multinationals and encourages foreign firms to settle permanently in the Netherlands (in close cooperation with the Ministry of Economic Affairs and her outposts of the Netherlands Foreign Investment Agency (NFIA)). Its mission is to promote the competitiveness of the Netherlands both at home and abroad. To achieve this mission, DGBEB promotes international enterprise and offers support to Dutch businesses in promising markets and sectors abroad (government.nl, 2014).“
Diplomatic missions (embassies, consulates, permanent representations & business support offices)
The Dutch diplomatic missions all around the world serve as the eyes and ears of the ministry and are the official representations of the Kingdom and its government. Amongst others, their tasks include maintaining relationships with the host government, providing consular services to Dutch nationals and providing promotional and supportive activities to Dutch firms abroad, as well as to foreign firms willing to invest in the Netherlands. The Dutch consulate in New York City is of particular interest in this study:
The Dutch Consulate in New York has three departments: press and cultural affairs (PCZ), consular affairs (AZ) and economic affairs (EA). With a staff of twenty, the consulate provides help to Dutch in need, but also supports Dutch businesses, entrepreneurs and cultural initiatives. The economic section provides assistance to Dutch firms and entrepreneurs, either currently present in the New York City greater area, or those planning to go there. Services provided at the Economic department include:
• Business Partner Scans (in collaboration with RVO (see below)) • Hosting network receptions (opening up CG professional network) • Answering specific trade and business related questions
• Promoting Dutch expertise at expo’s, trade shows and conferences
• Organizing topic specific introduction programs to the NYC market (e.g. bootcamp for tech startups)
