W y b r e n R i e n k s
S 1 6 1 2 2 4 7
T h e s i s c o o r d i n a t o r s : J a a n K e t s & C l e m e n z L u t z R i j k s u n i v e r s i t e i t G r o n i n g e n
S m a l l B u s i n e s s & E n t r e p r e n e u r s h i p 1 4 / 1 2 / 2 0 1 1
2 Abstract
The theory on internationalization and the influence on internationalization on firm performance is reviewed in this study. An overview on the most common themes of and theoretical perspectives on, the concept of internationalization is presented. Furthermore, a new Integrated perspective on internationalization is developed and a new measurement tool for SME Internationalization Performance (IP) constructed. Both the new theoretical perspective as the new multidimensional measurement concept is then tested using a number of case studies, consisting of five Dutch SMEs and one larger multinational. The new Integrated perspective was found to have real-world validity, while a few adjustments to the new SME IP multidimensional measurement concept had to be as a result of case study findings. The new perspective and measurement concept are combined into a final model, which adheres to three propositions and illustrates which concepts relating to internationalization are relevant, how they influence the different themes of internationalization and how these themes in turn influence the firms’ internationalization decision and the amount and type of measures the firm uses to measure IP.
Key words: Internationalization, Internationalization Performance, Internationalization perspectives, Integrated perspective, SME, IP multidimensional measurement concept, Internationalization themes.
3 Table of Contents
1. Introduction ... 4
2. Literature Review ... 6
2.1. Definition of Internationalization ... 6
2.2. Literature review approach ... 7
2.3. Internationalization ... 8
2.4. Different themes of internationalization ... 9
2.4.1. Timing of Internationalization ... 9
2.4.2. Mode of Internationalization ... 10
2.4.3. Market theme of Internationalization ... 12
2.4.4. Unit of analysis (i.e. the firm or the entrepreneur) ... 13
2.5. Different theoretical perspectives on internationalization ... 14
2.5.1. Foreign Direct Investment Theory ... 15
2.5.2. Stage Model Theory ... 16
2.5.3. Network Theory ... 18
2.5.4. International New Venture Theory ... 19
2.5.5. Integrated perspective of Internationalization ... 21
2.5.6. Overview of the theory on Internationalization ... 24
2.6. Measurement of Internationalization ... 25
2.6.1. Degree of Internationalization ... 26
2.6.2. Internationalization Performance ... 27
2.6.3. Internationalization Performance measures ... 29
2.7. Influence of Internationalization on Performance. ... 32
2.8. Literature review conclusion ... 35
3. Research Methodology ... 37
3.1. Data collection ... 38
3.2. Sample ... 38
3.3. Internationalization and IP measurement... 38
3.4. Data analysis ... 42
4. Findings ... 43
4.1. Unit of Analysis ... 43
4.2. Time ... 44
4.3. Market ... 45
4.4. Mode ... 47
4.5. Network ... 48
4.6. Internationalization Performance (IP) ... 49
4.7. Influence of internationalization on firm performance ... 54
5. Conclusion and Implications ... 57
6. References ... 62
7. Appendix ... 68
4
1. Introduction
The expansion of a business by international diversification has been one of the main strategic options for large and small firms. During recent years, a significant development within the broad internationalization trend has been the increasingly active role played by small and medium-sized enterprises (SMEs) in international markets (Oviatt & McDougall, 1994). SMEs are expected to increasingly use the strategic option of internationalization since the world economy is continuing to move to its ‘global village’ image because of the decline in government-imposed barriers and continuing advances in technology.
Because of the increasing importance of the internationalization phenomenon, more and more researchers in the fields of international business, strategic management and entrepreneurship are showing interest in the topic. Researchers of international business and strategy already consider international diversification as a traditional domain, but the focus of these studies was generally on large, well established firms (McDougall & Oviatt, 1996). However, SMEs are not small large firms.
There are significant differences between small and large firms when it comes to ownership, amount of available resources, organizational structures and processes, as well as management systems (Carrier, 1996). These differences could very well influence the outcome of the internationalization process of an SME, which is a notion that will be examined in this study.
While SME internationalization research has expanded with some issues being reviewed (McDougall
& Oviatt 1997, Dana et al. 1998, Antoncic & Hisrich 2000, Zahra & George 2002), the SME internationalization concept that is central to SME internationalization research has been paid limited research attention and still no comprehensive construct of SMEs’ internationalization has been developed (Christophe & Lee 2005). Furthermore, up to now, there is little knowledge about the way the performance of SMEs’ internationalization should be measured (Covin & Slevin, 1991; McDougall
& Oviatt, 1996; Coviello & McAuley, 1999, Lu & Beamish, 2001). Only a few scholars have looked into the way the Internationalization Performance (IP) of SMEs should be defined and how to measure this concept (Bloodgood et al. 1996, Autio et al. 2000, Zahra et al. 2000, Ruzzier et al. 2007). These are two research gaps that will be dealt with by this study.
Therefore, more attention should be devoted to researching how SMEs internationalize, and whether it is possible to develop a universal instrument to measure Internationalization Performance for SMEs in general. This is important since managers in any international firm face the difficult task of having to compare the internationalization performance that results from being present, and/or selling multiple products/services, in multiple countries. This comparison is not an easy task, because there is no general agreement among managers and/or stakeholders about which performance goals they
5 should use and how the degree of achievement of these goals should be measured. Since managers often do not have the knowledge on how to solve this problem, they may refrain from setting clear and measurable goals, which is, of course, dangerous because internationalization activities may have a decisive impact on the firm's future survival and economic wellbeing. Therefore, this study will develop an internationalization performance measurement tool for SMEs based on the literature review and then test it for its applicability on a number of real-world SMEs.
This leads to the following main research question:
What are the different forms of SME internationalization and what is their relation to the measurement of Internationalization Performance (IP).
The first part of the research will be a study of the available literature about the concepts of internationalization, performance, and the indicators of performance and internationalization. This is illustrated by figure 1. The journals of international business studies and of small business of internationalization will be the starting point of the literature study and will be used to construct working definitions for the main concepts of this research.
Furthermore, the following research questions will have to be answered about internationalization and internationalization performance:
1.) What is it?
2.) What are the different theoretical perspectives on the concept of internationalization?
3.) Which are the main themes, or criteria, used in previous research explaining internationalization?
4.) How is Internationalization Performance measured?
5.) What is the relationship between Internationalization and firm performance?
Figure 1. Overview of literature review
The second part of the research will be the testing of the theory with the use of six case studies. These case studies will be five Dutch SMEs, and one larger multinational, that are active internationally.
Internationalization Perspectives
Themes
Internationalization Performance indicators &
Measurement
6
2. Literature Review
In order to get an understanding about internationalization and the other concepts that deal with it, a review of the concerning literature is made. First, literature will provide an overview of the concept of internationalization and how it has been explained in previous research. After this the themes that influence internationalization and the concept of internationalization performance will be explained through the review of the relevant literature.
2.1. Definition of Internationalization
One of the main problems with the internationalization research that was found by Coviello &
McAuley (1994) in their literature review was the lack of a universal definition for the concept of internationalization. Therefore, they developed the following definition that was based on Beamish (1990. p. 77), which adhered to the three main theories on internationalization at that time (Foreign Direct Investment theory, Stage Model theory, and Network theory, see paragraph 2.5.):
“… The processes by which firms both increase their awareness of the direct and indirect influence of international transactions on their future, and establish and conduct transactions with other countries.”
This definition is considered to be most useful for it combines aspects of all the other views. It connects the internal learning that goes on within the organization with the patterns of investments that are done by the organization. Therefore, it affirms that both economic and behavioral components influence internationalization. The second aspect is that the definition is process-based. This entails that internationalization is an evolutionary and dynamic concept. Although the International New Venture theory, which will be explained elaborately later in this review in paragraph 2.5., was developed after the definition of Beamish (1990) was constructed, it is interesting to see that this definition also fits with the characteristics of the INV theory, admitting that for the INVs the concept could be better described as revolutionary since it does not occur in small incremental steps. However, it is correct that the internationalization of a company is often a process that builds up in a number of steps, but it is important to note that the size and pattern of those steps differ for each company.
Thirdly, unlike in the traditional view of internationalization, with this definition it is not restricted to just outward patterns of internationalization, but a firm can also perform inward internationalization activities like importing. With outward patterns, the following is meant; the penetration of foreign markets through various means (Johanson & Vahlne 1990, Welch & Luostarinen 1993). The inward internationalization can be seen as a mirrored but equivalent process of outward internationalization as companies develop foreign sourcing activities (Welch & Luostarinen 1993).
7 The final aspect is that the definition also implies that relationships are being established by performing internationalization activities and that these relationships can influence the firms’ actual growth and its expansion decisions to other countries. With this final aspect, a parallel can be found with the network theory of internationalization. This theory is explained by Johanson & Mattsson (1993) in the following way: “Firms, as embedded actors in their business networks, invest in networks that are new, whereas when they penetrate they develop positions and increase resource commitments in networks in which the firm already has positions.” Therefore, when relationships between different firms are seen as a network, one could say that firms perform internationalization activities because other firms in their network are doing so.
With the arrival of new theories and perspectives, it will require further evaluation if the definition is still usable. However, for the reasons explained above, with regard to the different theories on internationalization that are widely accepted, the definition by Beamish continues to be well suited to explain the concept of internationalization in this time, as it was two decades ago. Since a general definition for the main concept of this study is presented, it is time to continue with the following paragraph which will explain the approach that was used for the analysis of the literature.
2.2. Literature review approach
To study the concept of internationalization and assess the concept of internationalization performance in the literature, a number of study parameters were established to set some boundaries for the research that was done for this paper. The parameters are established to clearly identify what was undertaken, and to clearly identify and explain the possible limitations. For the purpose of this study, internationalization was defined as the processes by which firms both increase their awareness of the direct and indirect influence of international transactions on their future, and establish and conduct transactions with other countries (Beamish, 1990. p. 77). Although the strength of definition is its broadness which means it applies to pretty much everything concerning internationalization, it is also its weakness for it does not impose any limits to the research. In order to decrease the scope of the research to a sufficient level the choice was made to apply the following limitation: this study will focus solely on outward internationalization, which means that forms of inward internationalization are not accounted for. Although inward patterns are part of internationalization, previous research showed that there is only limited attention for this compared to outward internationalization.
The following steps were taken to structure the literature review. First, studies examining the subjects of internationalization and internationalization performance were identified and examined. Second, a time period of examination was established. Following Hult et al. (2008), that the ‘‘citation half-life’’
of premier journal articles is approximately 10 years, a conservative approach was undertaken, and an 11-year window (i.e., 2000–2011) was used. This approach follows the argument that the incremental
8 gain of analyzing articles beyond 11 years after publication provides considerably less benefit to the advancement of knowledge (Chung et al. 2001; Bergh et al. 2006). There were some exceptions made for this time frame, but solely for older articles of which the theories were still widely accepted to this day and that were still quoted on a regular basis in top journals. This ensures that the majority of research that remains influential is covered in the study.
Although the focus of this study is meant for SMEs, the literature includes research and theories for larger firms. However, studies were included that are specifically focused on SMEs for this will improve the applicability of this study both on the subject of SME internationalization and performance as on the case firms that will be used in the empirical part of this study. In order for the selection of the journals that would be included in this study, the following process was used. First, the EBSCOhost electronic database was used to identify the studies for this review that would be the major sources of information. In order to perform a focused search pattern, the SOM and ABS list were used to identify the top journals in the fields of Entrepreneurship and Small Business Management, International Business and Area Studies, Economics, and International Marketing. SOM stands for Systems Organization and Management and is the research institute of the University of Groningen in the Netherlands, where ABS stands for the Association of Business Schools. Both present an annual list with ratings of journals in the research fields presented above and for this research only the journals were selected that scored a very good- or top rating in these two lists. Given these criteria, the journals in our sample were Academy of Management Journal, International Small Business Journal, Journal of International Business Studies, Journal of Business Venturing, Journal of International Marketing, Journal of Small Business Management, and Small Business Economics.
From this literature, a review was made about the theoretical background for the concepts of internationalization and international performance, which is presented in the next section of this study.
2.3. Internationalization
One of the main ways for a firm to grow is through the path of selling its outputs to international markets, also known as internationalization. Especially for smaller firms that find themselves in a geographically confined business scope this is an important growth strategy (Barringer & Greening, 1998). When these markets have different market conditions, for example a lower intensity level of competition or a greater customer base, there is a growth opportunity for ‘foreign’ firms from another geographic market. These firms are able to achieve greater production and/or sales volumes and eventually business growth by entering new geographic markets. Furthermore, firms can capitalize on market imperfections by leveraging resources in different markets and consequently acquire a higher level of returns on their resources. Eventually, SMEs will decide to implement an internationalization
9 strategy to pursue higher returns on resources and/or growth possibilities by leveraging core competencies across a broader range of markets (Zahra et al. 2000).
Recent approaches to conceptualize the SME internationalization process reflect an emerging consensus that SME internationalization is an entrepreneurial activity (Knight 2000, Lu & Beamish 2001). In contrast to the bigger firms, SME’s internationalization is often not a result of extensive research, rational decision making and clear development plans. Instead, it is often influenced by personal ambitions, experience and knowledge of the entrepreneur or management team, which dive into the internationalization process without a clear structured plan or market research (Jones and Coviello, 2005).
The expansion into new geographic markets has presented a major growth opportunity and a chance for value creation for firms. However, the actual implementation of these strategies is often found to be far more difficult compared to the traditional domestic growth of SMEs. This is because expanding into a new geographic market comes with many unique challenges, like cultural differences and dissimilarities concerning government regulation etc., which must be added to those that are faced with domestic growth. This has led to the inception of many different forms of internationalization strategies but also a number of different views of about this concept of internationalization and how it should be defined. The main perspectives found in the literature on internationalization are; the Foreign Direct Investment perspective, the Stage-model perspective, the Network perspective and the International New Venture perspective. Besides the different perspectives on internationalization, there are also wide arrays of themes that are brought forward in the literature which relate to the concept of internationalization. The themes that have proven over time to influence, or be influenced by, internationalization are; the Timing of internationalization, the Mode of Internationalization, the Market theme of internationalization, the Unit of Analysis concerning internationalization, and the Performance theme of internationalization. These perspectives and themes are highly interrelated and therefore an overview of these different perspectives, combined with the effect these views have on the different themes of internationalization, will be presented in the next paragraph.
2.4. Different themes of internationalization
For this section of the study, the literature was reviewed on which themes were associated with the concept on internationalization. The themes that were used most often and continually through time, are presented below.
2.4.1. Timing of Internationalization
The timing of when a firm internationalizes is an important distinguishing factor between the traditional view of internationalization and that of international entrepreneurship or INV theory. In the former view that advocates the stage model, internationalization is the end result of a sequence of steps
10 that start in the home market and which follow a strategic plan. This view originated in the 1970’s with a large group of authors supporting the internationalization theory that suggested that many firms started to incrementally enter international markets, but only after they had operated in their home markets for a few years. Luostarinen (1979) also supported this view, although he did identify that there were exceptions that started with international activities very quick after their start-up, but he argued that their numbers where too small to form new conclusions about the stage model. Since that time there have been many things that changed and the world has seen a sharp increase in the number of companies that start with international activities very quick after their inception. The characteristic which distinguishes these companies is the high proportion of resources that they commit soon after inception in one or more foreign markets. These resources range from people to financing, material and the time that a new company puts into internationalizing. The main difference with companies that follow the stage model is that these international new ventures (INV’s) start off with proactive international strategy which means that a decision was made about this before the inception of the new firm (Oviatt and McDougall 1994, 1995). These INV’s are often considered to be organizations that try to create, from their inception on, a significant competitive advantage by using resources and selling output in more than one country. The INV’s have the advantage that they don’t have to unlearn any procedures that were focused on the development of a domestic market presence. McDougall et al (1994) argued that this relates to the fact that entrepreneurs that focus on internationalization persistently try to avoid becoming domestic path-dependent by creating new ventures with routines that focus on the management of multicultural workforces, that help coordinate resources that are located in different national markets, and for the simultaneous targeting of customers that are in multiple geographic locations.
In the context of this research, time is seen as part of the ongoing strategy of internationalization for it represents a bridge between internationalization in an incremental fashion and internationalization at the firm’s inception. Furthermore, it relates to the strategic decision of when to enter or exit specific (foreign) markets. These two features make time crucial as a theme of internationalization.
2.4.2. Mode of Internationalization
One of the most important international marketing decisions for any entrepreneur or manager is the way he or she decides to enter a new foreign market. This mode of internationalization has the potential to affect the way their business will develop from that time on. Many authors have stated that there is no such thing as an ideal market entry strategy. It has been shown that different market entry modes can be adopted by different firms entering the same market and/or by the same firm in different markets (Ruzzier et al. 2007). However, although this might be true, the operating modes that firms use are often considered to be an effective way of assessing the internationalization pattern of the firm.
11 Since the process that is involved by operating internationally is a dynamic one, this same nature can also be seen for the different modes of entry and operations. They have been evolving with time and are now much higher in number compared to the 1970’s when the first researches on the topic were published. According to O’Farrell et al. (1998), firms have the possibility to internationalize by using a variety of modes and each of these modes has its own control, cost, and risk issues that should be considered by the SME. A major difference is the number of combinations that are now used concerning different modes of entry and operations. These new modes have led to an increasing number of classification schemes that are proposed by scholars. For this research, a chronological review of these classification schemes is provided.
Punnet and Ricks (1992) based their classification on criteria of ownership: they classified the modes between joint ventures, no-foreign ownership, and sole ownership. They were followed by Buckley &
Ghaury (1993) who used the classification system of scheme of exporting, international licensing and foreign investments. Doole and Lowe (1999) used four groups: they advocated direct and indirect exporting, and the diversification between foreign manufacturing strategies with or without direct investments. Root (1994) made the following classification: export entry modes, investment entry modes, and contractual entry modes. Finally, Acs et al. (2001) advocated the more basic classification between direct entry modes and indirect or intermediate entry modes. The most frequently mentioned modes of internationalization are direct exporting without a foreign base, or the establishment of a foreign base through a form of foreign direct investment (FDI) like a joint venture, acquisition or a Greenfield site. This last classification will be used in this study when dealing with internationalization modes.
What is interesting to see is that after a company starts with its international activities, they are following a rather predictable process concerning how their entry modes decisions will gradually change. A review of Nordic studies that was done by Welch and Luostarinen (1993) provided the conclusion that as firms increase the level of their international involvement, they have the tendency to also increase commitment to the foreign market.
The stage model theory suggests that the general pattern is to start with exporting using an agent, followed by a sales subsidiary and eventually investing in a production subsidiary. The trend is that firms decide to use entry modes that give them greater control over their foreign marketing operations (Doole and Lowe, 1999). For a company to gain this greater control of its foreign activities, it must commit an increasing amount of resources to the foreign markets and consequently assume higher risks. This risk can be subdivided into political, market, financial and other types of risk and are in general all affected. The further the company goes along this internationalization process, the bigger its confidence in its ability to compete in foreign markets influences the company’s trade-off between the levels of control of risk. Often, this trade-off transfers in favor of control. Therefore, as a consequence, the company becomes increasingly more willing to invest in equity as it is evolving in the international activities it performs. However, this stage model has attracted extensive criticism and
12 studies that focus on start-ups of technology-based firms suggest that these firms are highly capable in developing networks. This increases the probability that they will select a joint venture to enter a new foreign market (Dana and Wright, 2004). Not only does this change the type of internationalization mode is preferred, it also allows firms to skip the internationalization modes that stage model theorist suggest that SMEs should start with when internationalizing, like exporting. These assumptions are now widely accepted and have given rise to a general perception that all SMEs, no matter in which industrial activity they are operating, can start internationalizing and enter new foreign markets through FDI. (EIM, 2005)
2.4.3. Market theme of Internationalization
For the market theme of internationalization it is important to consider the differences between the target market and the home markets as well as the degree target markets differ from each other. A company often determines its target market strategy based on these differences. Johanson and Vahlne (1990) hypothesized in their Uppsala model that companies start off internationalizing by entering countries they can understand most easily. This understanding of the new market makes it easier to identify opportunities and consequently there is less perceived market uncertainty. From this new market success, which is a boost of confidence for the company, new potential entry markets are considered that have an increasingly greater ‘psychic distance’. According to Johanson and Vahlne (1990): “Psychic distance is a sum of factors that prevent the flow of information between the firm and the market.” They adopted this definition from Luostarinen (1979) who used three themes of psychic distance for his analysis on how a company determines which market strategy to use: cultural, institutional and geographical distance.
The issue of how to determine which market to target is, as explained, highly related to the distance between the home and target market. This distance impacts the level of knowledge that the company has on the target market. This means that the greater the distance is between the home and target market, the greater will the differences be between the two markets. Consequently, the company will have a lower level of knowledge that is needed for successfully enter the target market since it differs so much from the home market that the company can’t re-use the knowledge obtained in that market.
Shrader et al. (2000) argues if it is the case that the target foreign market are similar to the domestic market, it will be less complex and less risky to enter this market. This is because the market knowledge can be transferred from to home market to the foreign market. An often seen result of selecting a target market after use of the psychic distance procedure is that the markets that are targeted are limited to the company’s immediate neighbor countries. This is because knowledge and information on these countries is easier obtained because of their geographical proximity to the home market. The selection of a target market by using the psychic distance procedure is interesting for this research because it is an often used procedure by small firms that are still early in their
13 internationalization process. This is because this non-systematic approach is quite simple and does not require a lot of resources (time, money etc.).
Papadopolous and Denis (1988) presented a second traditional approach which is more systematic.
This approach uses formalized decision processes to analyze the potential of different target markets by the involvement of various stages and statistical methods. Other authors like Root (1994) and Koch (2001) propose models that assume that the market selection process has three stages: screening, in- depth screening/identification, and selection. A third relationship approach was proposed by Andersen
& Buvik (2002) which, unlike the non-systematic and systematic approaches that focus on the country, takes the foreign customer as unit of analysis for determining the selection of the target market.
According to Koch (2001), the entry-mode and market selection should be used as two different aspects of a single decision process and he proposes a model that integrates the selection of both.
2.4.4. Unit of analysis (i.e. the firm or the entrepreneur)
In the traditional internationalization theories the unit of analysis was almost without exception the firm. Although this literature covers the many important issues from the firm perspective, it neglects the point of view from the entrepreneur who is often the person to discover and/or create the opportunities in foreign target markets. The entrepreneur-specific variables are not considered by the far majority of international entrepreneurship studies, or when they are, it is in a limited way. For example Autio et al. (2000) considered owner-managed firms in their research, but they didn’t consider the internationalization experience of the entrepreneur. Zahra et al. (2000) did consider internationalization experience, but then only at the firm level. However, this entrepreneur perspective is important because in the early stages of the firm’s development, the characteristics of the owner, not those of the organization, are of vital importance for shaping the internationalization strategy (Kunda and Katz, 2003). This is because in many SMEs, the entrepreneur (or entrepreneurial team) is the key resource of the firm. Wright et al. (2007) explain this with the following reasoning: “the entrepreneur or entrepreneurial team can accumulate human capital and social capital leading to industry and management know-how; physical and financial capital needed to develop a venture; and the organizational capital that enables the competitive production of goods and services offered by a firm in both domestic and international markets.” Therefore, it can reasonably be assumed that entrepreneurs (and entrepreneurial teams) can leverage and acquire knowledge about foreign markets and businesses, foreign institutions, and in general on internationalization.
It was proposed by Storey (1994) that an entrepreneur’s knowledge and capabilities can severely impact and influence on a firm’s performance. Therefore, it can be asserted that firm level analysis may ignore important aspects that influence the internationalization process of SMEs and its performance. Previously acquired experiences, capabilities, resources, learning, and knowledge that is,
14 or can be, mobilized by an entrepreneur (or team) may lead to the discovery, creation, and exploitation of foreign market opportunities (Bloodgood et al. 1996).
According to Jones and Coviello (2005), who created a model of entrepreneurial internationalization, the three constructs that relate to the entrepreneur are the entrepreneur’s philosophical view as well as their human and social capital. They argue that entrepreneurs who have had contact with foreign markets may, this as a result of the acquired personal experience, develop an orientation that makes them favor an international way of doing business. The owner of a firm may have possibly started other firms which put him in the position where the entrepreneur could acquire international experience. Whether or not these firms were a success is not very important here because the point is that entrepreneurial experience provides the entrepreneur with, what Shane and Khurana (2003) call episodic knowledge, which in turn contributes to the entrepreneurs’ specific human capital. According to these authors, the episodic knowledge that is acquired by owning a business such as managerial experience, better access to financial institutions, improved reputation, and stronger business and social networks can be used to identify and capitalize business opportunities in foreign markets.
By a number of recent studies on SME internationalization that had the entrepreneur as the unit of analysis, the human resources were found to be the main resources that were associated with firms that internationalized when the comparison was made with firms that didn’t have foreign business (Brush et al. 2002). This review showed that independent firms which had older principal founders, which have stronger and broader contact- and information networks, relatively more resources and considerable management know-how are far more likely to internationalize.
Therefore, there is a need to consider the role that the entrepreneur (or entrepreneurial team) plays in the internationalization process of SMEs. There could be, for example, significant learning and/or behavioral differences between the novice and experienced entrepreneur (Westhead et al. 2005)
These differences have not, however, been examined by previous research and there still remains a need to identify insights in the relation between the internationalization process and the prior business ownership and international experience of the entrepreneur.
This concludes the overview of the main themes relating to the concept of internationalization. This study continues with a review of the different theoretical perspectives on internationalization combined with the effect of the perspectives on the different themes.
2.5. Different theoretical perspectives on internationalization
Coviello & McAuley (1999) wrote in their review of SME internationalization, that there were three major schools of research which focus on the concept of internationalization, which all apply a different definition. These schools are; the Foreign Direct Investment theory, the Stage model theory
15 and the Network theory. Although the review is more than a decade old, it has withstood the test of time for it is still quoted in many of the top academic articles, which build upon its theoretical foundation. To this day, the three different views of internationalization are still the main theories that try to explain the internationalization process and an overview of these will be presented in the following section. However, also a new view on internationalization has emerged and has become widely accepted, called the International New Venture theory. This theory will also be included in the overview, combined with the different outcomes these perspectives have on the themes of internationalization. At the end of the paragraph a concluding section will be presented in which an integrated perspective of the concept of internationalization.
2.5.1. Foreign Direct Investment Theory
The general theory of this Foreign Direct Investment theory has its origin in the industrial trade theory and supports the internalization firm activities in international expansion (Williamson 1975, Buckley
& Casson 1993). According to this view, firms choose an optimal structure for each phase of the production and this is done by the evaluation of the costs of the firms economic transactions. Because of this, a firm will choose the location and organizational form which has the lowest overall transaction costs. This is why this theory is also often called the transaction cost theory. Transactions that are considered to have a high level of risk and that will require a significant amount of resources, for example management time, are more likely to be internalized as part of a hierarchically structured organization (Coviello & McAuley, 1999). This view explains the choice of the optimal location and organizational form of a firm, in other words, it explains the process of internationalization.
However, not all agree with this view. The main criticism on the Foreign Direct Investment theory is that the research in this area is primarily used to explain a firms pattern of investment (in terms of its form, extent, and location of international production), and not as a long-term process that explains the firms international expansion (Melin, 1992). This long-term process is however the basis of the next view on internationalization.
The effect that the FDI theory has on the different themes of internationalization is mainly influenced by the transaction cost that is related to the new international market. With regard to the timing of internationalization, this is at the time the transaction cost for the firm decrease as a consequence of entering a new market. Concerning which mode is used in order to internationalize, the FDI theory prefers the mode that corresponds with the lowest possible transaction cost for the entire firm. This is also the case for the decision on which market to enter. Finally, the unit of analysis with the FDI theory is the firm. Although the entrepreneur may be the one making the decisions, the FDI theory focuses solely on the transaction costs of the firm. A graphical representation of the FDI theory is presented by figure 2. This figure shows which concepts influence the different themes of internationalization, which in turn influence a firms’ internationalization decision (in this figure the only concept is
16 transactions costs and the only theme is the choice of which internationalization mode and- market in this figure).
Figure 2. FDI theory illustrated
2.5.2. Stage Model Theory
The Stage model theory draws from the behavior-, organizational growth-, and learning theory in order to explain internationalization, and according to Johanson & Vahlne (1990) and Melin (1992) these models are general more dynamic than the FDI theory. There are several Stage models, however, the first and most influential was developed by Johanson & Vahlne in 1977. Their model, which is known as the Uppsala model, suggests that internationalization is an ongoing evolutionary process where the firm increases its level of international involvement as a direct function of both the increased level of knowledge about the foreign market and the market commitment. Although the model emphasizes the importance of managerial learning, internationalization itself is described through the concepts of market selection and the different market entry modes. The Stage model advocates that firms increase their knowledge of foreign markets by starting off expansion with low risk, indirect exporting activities to foreign markets that are physically close. As time goes on and the firms increase their experience with dealing in foreign markets, they will continue with increasing their foreign market commitment. This in turn enhances the market knowledge, leading to further commitment in markets that a more distant, which also include equity investments in offshore sales- and manufacturing operations.
Although Johanson & Vahlne (1990) belief that “the eclectic paradigm of the Stage model theory and the FDI theory are inconsistent as the basic assumptions are so different”, there is an overlap between the Uppsala model and FDI theory. In both theories, the firm should ultimately and over time internalize its activities by changing from a solely domestic firm to a firm with foreign production facilities, and management learning is the principal driver of this process. This important role of the manager is also represented in other behavioral models by Reid (1981) and Cavusgil (1984). In their models internationalization is also incremental, with different stages that reflect the change in attitude and commitment by the manager and the resulting international orientation of the firm. These models suggest that the beliefs and perceptions of the management both influence, and are shaped by, the incremental activities of the firm in foreign markets. These activities, or involvement, result in an
Firms’
internationalization decision Transaction
costs
Choice of internationalization
mode and -market This
influences:
Which in turn influences:
17 evolutionary pattern that starts with the managers having little or no attention for foreign markets, to evaluation of, and low risk initiatives in, physically near markets. After this the management will expand more actively into more unknown and challenging markets and become increasingly committed to international expansion and growth (Coviello & McAuley, 1999).
However, a number of new views argue that this Stage theory view has its limitations, especially when it’s applied to start ups in the 21st century. One of the critiques comes from Welch & Luostarinen (1993), who proclaim that internationalization is a processed-based concept, but that it does not always involve a “smooth, immutable path to development,” and may include both ‘outward’ and ‘inward’
patterns of international expansion. Another difference is that Johanson & Vahlne (1990) argue that increasing international involvement primarily becomes apparent in the number of markets entered and which mechanism is used for the market entry. Welch & Luostarinen (1988) disagree and say that it can also be derived from the firm’s organizational capacity, market offering, structure, and personnel.
The Stage theory has a clear effect on the different themes of internationalization. With regard to the timing of internationalization, it suggests that at the firms’ inception the focus is on the home market.
Later on, with increased foreign market knowledge and experience, the firm will start entering incrementally more challenging markets. This is also the case for the choice of which mode is used. A firm will start off with exporting, for it has the lowest risk and requires the least amount of foreign market knowledge and experience. Over time, the firm will continue to incrementally use more demanding modes of internationalization, with probably first a joint venture and finally the acquisition of a subsidiary or even a Greenfield investment. The market theme for the Stage theory is again interrelated with the time dimension and the concept of psychic distance. In the beginning, a foreign market with very little psychic distance will be chosen, for it represents low risk and a bigger chance for success. Later on, which increased foreign market experience and knowledge, markets that have a higher psychic will be chosen, since the firm now has enough confidence from the previous foreign markets. The unit of analysis for the Stage theory is the firm, for the experiences and knowledge of the firm in general, not the entrepreneur, determine which stage of internationalization is appropriate for the company. A graphical representation of the Stage model theory is presented by figure 3.
Figure 3. Stage model theory illustrated
Firms’
internationalization decision
Internationalization knowledge
Internationalization experience
Psychic distance
Choice of internationalization
mode and -market This
influences:
Which in turn influences:
18 2.5.3. Network Theory
The Stage model theory and the FDI theory have represented the two main traditional schools of internationalization research: 1.) the behavioral school and 2.) the economics school (Benito & Welch 1994). Both theories suggest that firms show some form of strategic-decision making behavior over time, with the planning of this process being centered in the hub or headquarters of the firm.
A more recent area of the internationalization research has developed a different theory, which focuses on non-hierarchical systems in which firms invest to monitor and strengthen their position in international networks (Sharma 1992, Johanson & Mattsson 1993). This third school of research is referred to as the Network theory of internationalization. It draws from the theories of resource dependency and social exchange, and focuses on the behavior of a firm in a context of a network of interpersonal and interorganizational relationships (Axelsson & Easton, 1992). These relationships can be with competitors, suppliers, customers, public and private support agencies, friends, families etc.
Therefore, the organizational boundaries of a firm include not only formal business relationships, but also informal social relationships. The Network theory argues that internationalization depends not so much on a firm specific advantage, but rather on the set of network relationships of the organization.
Interestingly, the Network theory is based on externalization in contrast to the two previous schools of research that focus on internalization. The FDI theory does not account for the influence and role of social relationships in business transactions, and therefore, the Network theory offers a complementary view on the concept of internationalization. Furthermore, in the Network theory the internationalization activities and decisions come forth as patterns of behavior that are influenced by different network members, while in the FDI theory these would emerge through rational strategic decision-making. According to Johanson and Vahlne (1992, p. 12) themselves: “the Network theory offers a more multilateral element to internationalization, when compared to the unilateral process suggested by the stage models.” It is interesting to see that concepts of the Stage model, like psychic distance, can be made obsolete by the Network theory. In the Stage model, internationalization decisions, especially ones about which mode to use and which market to enter, were significantly influenced by the psychic distance of the proposed markets. The Network theory advocates that this concept can be neglected because a firm can use its network in order to gain knowledge and experience about a foreign market. This way, the psychic distance between the home market and the foreign market is diminished, together with the risk of internationalization.
A major downside of the Network theory is that does not provide a clear explanation on why a firm choses for a certain type of market entry mode for a specifically chosen market. It helps explain that a firm often gets advice from, or decides to work with a network member that has an interest in a foreign market. It may be true that a firm choses a particular country to internationalize to because of network member influences, but there are more decisions in the internationalization activity that have to be
19 made by the firm itself, for example the mode of internationalization. These types of decisions are often not accounted for by network members, which make it a weak spot of the Network theory.
Just like the FDI theory, the Network theory can be related to the different themes of internationalization in a general way. Whether it is when the firm internationalizes (time), how it internationalizes (mode), and where it internationalizes (market), it always depends on the influence of the network members. When the firm has the right internal and external network members, who can provide the resources, knowledge, and agreement that the firm must internationalize from the outset, this becomes a possibility. On the other hand, it is also possible that network members agree that the focus should be on the domestic market and that foreign markets are of later concern. The mode of internationalization depends on the nature of the network resources that new market access requires. If the new market requires the experience of one of its own domestic professionals, the use of an agent for exporting might be an option. When it is needed to bring experiences from the home market to the new market, a joint venture, subsidiary, or Greenfield investments are suitable modes of internationalization. Concerning on which market to enter, the Network theory places great importance on the experiences and advice of the network members. It is highly possible that, even though the firm does not have any knowledge about, or experience with, the proposed foreign market, it will rely on those of its network members and make the decision to enter this market. Finally, the unit of analysis for the Network theory is a combination of the entrepreneur and the firm. The entrepreneur is part of the firms’ network, and the firms’ network consists of all the networks of its employees which it can use for, or which can influence, its internationalization. On the other hand, the personal and professional network of the entrepreneur or general manager often has the greatest influence on the internationalization of the firm, especially with SMEs, which makes the entrepreneur not just a firm’s employee. Therefore in the Network theory the unit of analysis, especially for SMEs in which the entrepreneurs still have the majority of the power, is more the entrepreneur than the firm. A graphical representation of the Network theory is presented by figure 4.
Figure 4. Network theory illustrated
2.5.4. International New Venture Theory
Another view on internationalization, one that is not covered by Coviello & McAuley (1999) since it is a relatively new theory on internationalization, is called the International New Venture (INV) theory.
Firms’
internationalization decision Internal &
External Network relationschips
Choice of internationalization
mode and -market This
influences:
Which in turn influences:
20 The main difference INV theory and the traditional theories (FDI-, Stage- and Network theory), is the timing of internationalization. The INV theory draws from learning/knowledge- and strategic choice theory, which both criticize the Stage model theory for they argue that many new SMEs internationalize from their inception of business activities (Autio et al., 2000).
The INVs are seen as organizations that, from their inception, seek to attain a significant competitive advantage by using their resources and sales in more than one country (Wright et al., 2007). Named
‘Born Globals’ by Zahra (2005) these INVs achieve substantial international sales from an early stage in their development, despite the limited resources that usually characterize new businesses. They internationalize rapidly with the period from domestic establishment to initial foreign market entry is often three or fewer years. Furthermore, INV theorist advocate that many firms no longer see international markets as simple complements to the domestic market. Oviatt & McDougall (1994, 1997) already wrote in their studies that SMEs that have specific competitive advantages that are linked to their product/service characteristics and technological level may from the outset be on the lookout for opportunities in foreign markets. Therefore, these firms that have this opportunity-driven mentality do not follow an internationalization path that is incremental as is suggested in the traditional theories (Bell et al., 2001).
A limitation of the INV theory is that it is a theory that does not account for all internationalizing firms. It was developed as a reaction to the fact that not all firms go through stages, or take a long time to internationalize as was advocated by earlier theories. True as this may be, there are many firms that are not planning to become multinational from the very start. Therefore, the INV theory is not a generally applicable theory but can be better seen as an addition to earlier theories.
The theme of timing of internationalization is very important when it comes to the INV theory. The theory was developed because researchers saw that the other theories could not adequately explain why there were a lot of companies that immediately started to internationalize from their inception.
The INV theory explained how these born globals internationalize, which made an important contribution to the timing theme of internationalization. The mode that firms use for internationalization, according to the INV theory, should be one with corresponds to a high degree of control for the firm. The reason for this is that because these firms internationalize so quickly, they need a firm mode which enables the greatest amount of learning for the firm for the firm itself does not have a lot of experience. Therefore modes like, subsidiary, joint venture, and Greenfield investments are highly suitable modes of internationalization according to the INV theory. The INV theory does not propose any guidelines on which market should be chosen, but the unit of analysis is primarily on the entrepreneur for an INV often has limited staff and experience, which makes the entrepreneur the most important and powerful part of the company. A graphical representation of the INV theory is presented by figure 5.
21 Figure 5. INV theory illustrated
2.5.5. Integrated perspective of Internationalization
When one compares the previous views with the internationalization paths and strategies of SMEs in the real world, there is something to say for every one of them. Yes, there are firms that adhere to the FDI view of internationalization, look at the many multinationals that outsource to India or China because of the lower transaction costs. However, there are also many firms that base their internationalization path on foreign market knowledge and experience and start of internationalizing to a neighbor-country before trying their luck in more distant markets. On the other hand, there are plenty of new start-ups that immediately start selling their products/services and foreign markets (especially software or IT-firms) without any knowledge or experience. Therefore it’s impossible to say which view is right or wrong, but it is possible to have an opinion on which view is best in explaining what determines firm internationalization today. On their own, each theoretical perspective has too many limitations to be generally applicable to a large population of firms. The FDI theory, which argues that a firms’ internationalization is determined by which market provides the lowest transaction cost, is usable to some extent since there are still internationalization decisions being made which are (partly) determined by transaction costs. However, this theory neglects the influence of knowledge, international experience, and psychic distance on the internationalization of the firm. Also, it neglects the influence that a firm’s network member, or the entrepreneur itself, can have on the internationalization. These are all concepts that were proven by the Stage-, Network-, and INV theory to have a significant influence on the internationalization of a firm, and a theory that neglects these concepts cannot sufficiently explain a multidimensional concept like internationalization. However this is also true for all the other individual theoretical perspectives. The INV theory is only applicable to a small section of firms and is therefore only usable as an addition to other theoretical perspectives.
The Stage theory has been very important for the field of internationalization, however because it does not take into account the influence of networks, and the possibility of born globals, it has lost much of its relevance in today’s world. The fact that the concept of psychic distance can be disregarded by the use of network members and firms can be international from the outset without going through the stages shows that new development have caught up with this theory and made it outdated. The Network theory has become one of the most important theories on internationalization because it is so widely applicable. Almost all firms use their networks in one way or another when it comes to their Firms’
internationalization decision
Internationalization intention form theoutset
Entrepreneur(ial team)
Choice of
internationalization timing
Choice of
internationalization mode This influences:
Which in turn influences:
22 internationalization. However, as a single perspective it too has its limitations. It is too simple to say that all internationalization decisions are determined by network members. They may have had an influence, but often the main influence for the decision comes from within the firm itself. For example, many firms do use transaction cost advantages as a reason to internationalize. It can be that network members are then used to provide market knowledge or experience, in order to see which market is most suitable, but the internationalization decision is still mainly based on transaction costs.
This is an important limitation of the Network theory, although it is widely applicable, there is need for other theoretical perspectives to provide the entire explanation for the internationalization.
In this chapter, an overview of the strengths and weaknesses of the main theoretical perspectives has been provided. Although on its own each perspective is too limited for its purpose, it is possible to see them as puzzle pieces of a greater whole. Since it took an integrated definition by Beamish (1990) to most adequately explain the concept of internationalization, maybe an Integrated perspective, which combines the different theories of internationalization will be suited best to the actual internationalization behavior of SMEs. Interestingly, this notion was recently suggested first by two researchers that had spent years developing and defending the Stage theory. Johanson and Vahlne (2009) have recently developed an adjusted Uppsala model, which in their words includes: “a business network view of the environment faced by an internationalizing firm.” In their new model, the business environment is viewed as a web of relationships, or as someone else may name it, a network.
Outsidership, in relation to the relevant network, more than psychic distance, is the root of uncertainty.
The change mechanisms in the revised model are essentially the same as those in the original version, although trust-building and knowledge creation are added to the model, the latter to recognize the fact that new knowledge is developed in relationships (Johanson & Vahlne, 2009). This adjusted Uppsala model combines the Stage and Network theory, but neglects to incorporate the FDI and INV theory. In this study, a new Integrated perspective will be developed which will incorporate all the four theoretical perspectives into one new perspective. The following section will provide further explanation why there is a need, and why it is logical, to integrate these perspectives.
First, let’s assume the Stage theory. Although globalization has supposedly turned the world into a global village, studies still prove that firms internationalize first to countries that are the least distant, both in culture as in geographical measurement (Ruzzier, 2007). This decision to internationalize however, is often influenced by, or even based on, network members or relationships that provide the foreign market knowledge or experience that the firm lacks. Furthermore, the benefits of assured orders in an unknown foreign market coupled with the availability of market information from network partners can likely be a source of competitive advantage for the internationalized SME (Ku- Ho Lin & Chaney, 2007). This last argument connects the Network theory to the FDI theory, which is about the creation of a competitive advantage through the entry in foreign markets. Even the Born
23 Globals or INVs use networks in order to internationalize more rapid and effectively. In their study, Zhou et al. (2007) found support for this mediating role of social networks on the internationalization of Born Global firms. This mediating mechanism is attributed to three information benefits of social networks: (1) knowledge of foreign market opportunities; (2) advice and experiential learning; and (3) referral trust and solidarity.
When one takes these arguments into account, it seems right to conclude that there is no one right view on internationalization. However, it is interesting to see that the Network theory can be linked to all other views, which says something about its applicability and the necessity of including the role of networks in internationalization theory. Therefore, an Integrated perspective like the model presented by Johanson & Vahlne (2009) seems to be the most widely applicable to internationalization, with the addition that it focuses on the four theoretical perspectives instead of two.
When related to the different themes of internationalization, it is clear to see the influences of the other views with the Stage- and Network theory as most important contributors. With regard to the timing of internationalization, this depends on the firm but it is possible to internationalize from the outset according to the Integrated perspective. This is possible, if the firm has the right network members that have sufficient experience and knowledge about internationalizing from the outset. On the other hand, it is just as well possible to internationalize later on when domestic experience and knowledge are acquired, but even then there will be an influence of network members. When it comes to the mode to internationalize, the Integrated perspective provides explanations. When there is lack of knowledge and experience about the foreign market in the firm and its network, it requires an incremental internationalization process which starts with low-control entry modes like exporting or the use of an agent (which could be another network member). When sufficient experience and knowledge is collected, it is more suitable to use high-control modes like subsidiaries, joint ventures, or Greenfield investments. When it comes to choosing a market, the Integrated perspective proposes that the market should be chosen that has a demand for internationalization knowledge and experience that does not exceed the internationalization knowledge and experience base that is held by the firm and its network.
When knowledge and experience requirements of the new market are too great, it can be still be a possible market for entry; however, a lower-control entry mode like exporting will be more suitable.
The unit of analysis for the Integrated perspective is a combination of the firm, the entrepreneur and their networks, with a difference main ‘player’ for every firm. For example, a firm that has started internationalizing from its inception, because the entrepreneur has the right network members, will have a unit of analysis that focuses on the entrepreneur and network aspects, and to a lesser degree focus on the firm. This is different for every firm however. A graphical representation of the Integrated perspective is presented by figure 6. The figure integrates all the influential concepts and themes that influence, and are influenced by, the internationalization decision. This is illustrated in the second block of the figure, which is very clearly the combination from the 4 previous theories. The only
24 concept that is missing is the psychic distance concept, for the reasoning presented in paragraph 2.5.3.
that network members can diminish the influence of psychic distance.
Figure 6. Integrated perspective illustrated
2.5.6. Overview of the theory on Internationalization
The literature review has provided a considerable amount of information regarding the concept on internationalization. In order to clearly combine and summarize the theory on internationalization, the following table (Table 1.) is constructed for an understandable overview.The cause of the differences in views and theories on the concept of internationalization partly comes from the fact that there are many different definitions of internationalization. Continuing, the following section will give an overview on which measures of internationalization have become most used in the theory on this subject.
Table 1. Different theoretical perspectives on SME internationalization
Traditional internationalization theories
International entrepreneurship theories
Theme FDI theory Stage model theory
Network theory
INV theory Integrated theory
Time SMEs can internationalize from the outset
Depends on transaction cost
No, build resources and experience first in domestic market
Possibly, if the firm has the right internal and external network members
Yes Possibly, if the firm has the right network members that have sufficient experience and knowledge about internationalizing.
Firms’
internationalization decision
Transaction costs
Internationalization knowledge
Internationalization experience
External & Internal network members
Internationalization intention form the outset
Entrepreneur(ial team)
Choice of
internationalization mode and –market
Choice of
internationalization timing
This
influences: Which in turn
influences:
