Institutions, resources, and internationalization of emerging economy firms

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Abstract

An important step in the internationalization process of emerging economy firms is the shift from exports to foreign direct investment (FDI). We integrate the resource- and institution-based views to suggest that firms that can use unique institutional advantages are more likely to make this shift. We test these arguments with a longitudinal sample of 28,563 firm-year observations (1989–2005). We found that firms that are affiliated with a business group, have more firm- and group-level international experience, have more technological and marketing resources, and operate in service industries are more likely to shift from exports to FDI.

Introduction

The number of emerging economy (EE) firms expanding into international markets has grown exponentially in recent years, usually through exports (Aulakh et al., 2000, Yiu et al., 2007) although increasingly through foreign direct investment (FDI) (Luo & Tung, 2007). This strategic change, shifting from international operations based primarily on exports to a high-commitment method (FDI), is notable for firms in general (Barkema & Drogendijk, 2007) but for EE firms undergoing accelerated internationalization in particular (Mathews & Zander, 2007). The literature provides limited insights into which factors might induce such a strategic shift though.

As two distinct strategies of internationalization, exports and FDI exhibit different motivations, resource requirements, cost structures, risks, and consequences. Exporting is a low risk strategy for operating in international markets. It requires fewer resources and can be easily reversed. In contrast, FDI demands a greater commitment of resources (McDougall & Oviatt, 2000) and usually cannot be easily reversed. This makes it far more risky as well as more promising, in terms of its high potential returns (Lu & Beamish, 2001). The strategic shift from an international operating strategy based on exports to one that combines FDI with exports represents a major change in the firm's international commitment (Barkema & Drogendijk, 2007) and involves several challenges. A natural question thus emerges: Which factors enable EE firms to make this strategic change? In this study, we adopt a multi-theoretical approach, integrating the resource-based view (RBV) and institution-based view (IBV), to address this question, together with empirical evidence gathered from a large, novel panel data set that describes firms from the second largest EE, namely, India.

We contribute to the literature in three ways. First, by integrating the RBV and IBV, we provide a useful theoretical framework for analyzing the internationalization process by EE firms. Emerging economy firms may suffer weak resource bases in terms of traditional resources (Hitt, Dacin, Levitas, Arregle, & Borza, 2000). However, they often compensate for this weakness by using non-traditional, network-based resources that arise from the unique institutional and industrial characteristics of the environment in which these firms are embedded (Cuervo-Cazurra and Genc, 2008, Elango and Pattnaik, 2007). Outward FDI offers a means to escape the weak home country institutional environment (Witt & Lewin, 2007) for many EE firms. The institutional evolution that characterizes many EEs has led to rapid transformation in the competitiveness of certain key industries, such as business process outsourcing (BPO), in India (Peng, Wang, & Jiang, 2008). The quick rise to global dominance of these EE industries is largely attributable to the liberalization of industrial policies, including vast private and foreign participation. Noting these complex linkages among resources, institutions, and industries, we offer an inclusive, integrative theoretical framework for studying EE firm internationalization (Contractor et al., 2007, Yamakawa et al., 2008).

Second, this study offers a clearer understanding of the antecedents of the change from exports to FDI. The stages model of firm internationalization suggests that internationalization typically occurs in a set of steps, from licensing to exporting to FDI (Johanson & Vahlne, 1977). Each step has different requirements and reflects a different set of strategic choices. An organization thus learns from each form of internationalization and moves to the next more complex form over time as it establishes a critical mass of knowledge and discovers new opportunities. The stages model is extensively studied, but it has not previously been applied to the shift from exports to FDI. We thus conceptualize internationalization as a “package” of international operating strategies, which the firm uses to increase its commitment to internationalization (Benito, Petersen, & Welch, 2009).

Third, with our unique study context, we help augment understanding of the stages model. Strategic change literature recognizes the importance of resources as enablers of strategic change. In an EE context, a firm's resources are constrained, and the institutional environment is less structured than in a mature economy. We need to analyze what enables firms to change from one strategy to another (Bruton, Ahlstrom, & Han-Lin, 2010). Situating our study in an emerging market context enables us to investigate this theoretical issue. Several scholars similarly have suggested that EE markets provide laboratory settings for effective tests of new theoretical insights and arguments (Wright, Filatotchev, Hoskisson, & Peng, 2005).

In contrast, most research on EEs has focused on developed economy firms entering EEs or domestic competition within EEs (Hoskisson, Eden, Lau, & Wright, 2000). Research pertaining to internationalization by EE firms offers deeper insights on the factors that affect EE firm exports (Aulakh et al., 2000, Filatotchev et al., 2009) or FDI (Buckley et al., 2007, Yiu et al., 2007) but do not address the strategic change between them. Hitt, Tihanyi, Miller, and Connelley (2006), in a review of international diversification literature, note that studies of EE firms’ internationalization would add value to international management research. We respond to this call and seek to develop a better understanding of factors effecting change in a firm's international operating strategy.

Section snippets

Background

Multi-theoretic approaches can be used to examine complex strategic choices, such as those related to firm internationalization in emerging markets (Yamakawa et al., 2008). For example, the RBV and IBV, both which appear in prior work that seeks to explain the strategic behavior of EE firms (Meyer et al., 2009, Peng et al., 2008) likely interact. It is often difficult to compartmentalize the effects of resources versus institutions (Meyer et al., 2009). Accordingly, we develop our theory for

Setting

We use the international expansion of Indian firms as the setting for this study. Two important features of Indian firms’ international expansion make this empirical context appropriate for testing our hypotheses. First, Indian firms arrived on the international stage relatively late, compared with their counterparts from other EEs, such as China and South-East Asian countries. India was a closed economy until 1991. Most international expansion by Indian firms has happened in past 10 years.

Results

Table 1 contains the correlation matrix and descriptive statistics for all variables in our models. Although FDI among Indian firms remained relatively uncommon, we found a high level of export intensity, with a mean of 19%. The group-level FDI variable correlated highly with the group affiliation variable, raising concerns about the deleterious effects of multicollinearity on our coefficient estimates. To address this problem, we entered the group affiliation and group FDI variables in two

Discussion

We investigated an important phenomenon in the internationalization process of EE firms, namely, the change from exporting to FDI. Firms that are rich in both traditional and non-traditional resources, which reflect the unique institutional characteristics of EEs, find it easier and are more likely to make this change to operate and profit from international operations. Specifically, we suggested and found a positive link between firm-level international experience, as measured by export

Managerial relevance

Our study provides several pointers for managers. First, we propose a comprehensive view of the antecedents of a change in international operation modes. As EE firms increase the scope of their international operations, they need to shift from low involvement modes, such as exports and licensing, to high involvement modes, such as joint ventures and wholly owned subsidiaries. The successful implementation of these strategies demands a clear understanding of the factors that underlie a

Limitations and further research directions

Additional research should address the limitations of our study. First, the empirical setting of our study is India, which limits the generalizability of our findings to other EEs. Even though the theoretical arguments we have proposed are context free and should apply to other EEs in which firms enjoy institutional advantages, such as those arising from networks, it would be helpful to validate our arguments in other settings. Second, we only analyze a change in international operating

Acknowledgements

This research was supported by grants from Rutgers University Research Council and Rutgers Business School. The authors thank the participants at the 2009 Academy of Management and Academy of International Business conferences for comments on previous versions of this article. This article benefited greatly from comments and advice provided by Associate Editor Pervez Ghauri and three anonymous reviewers.

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    The three authors contributed equally to the development of the manuscript and are listed in alphabetical order.

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