Does investing abroad improve firm performance?

The rise of micro-multinational enterprises

This article is based on research by Xavier Mendoza

The days of large multinationals as the only companies able to invest abroad are over. Recent years have seen the rise of micro-multinationals, a new type of small and medium-size enterprises (SMEs) that are well equipped to exploit opportunities abroad.

What sets these companies apart? Compared to pure exporting SMEs, micro-multinationals are more entrepreneurial, more internationalised and more actively use their organisational networks to obtain in-depth foreign market knowledge.

These firms provide superior customer service and collect exceptional feedback on local market conditions that allow them to adapt and innovate.

Micro-multinationals are more entrepreneurial

To find out whether establishing a direct presence in foreign markets improves firm performance, PhD student Joon-ho Shin and Esade Associate Professor Xavier Mendoza analysed more than 1,000 highly internationalised Spanish SMEs in the service sector operating over an 8-year period.

"Due to the 2007 financial crisis, internationalisation became an attractive option for growing revenues for firms of all sizes in Spain," says Mendoza. "We chose to focus our study on SMEs because over 60% of Spanish parent companies with subsidiaries abroad are SMEs and service internationalisation is less understood and more challenging compared to manufacturing internationalisation."

Firm performance

The study investigates the relationship between multinationality (measured by an index based on the number of foreign subsidiaries and countries where these are located) and firm performance (measured by ROA) and whether this relationship varies between capital-intensive and knowledge-intensive service firms.

Types of micro-multinational service firmsMultinational firms

What is capital intensity?
Capital intensity is the amount of fixed or real capital present in relation to other factors of production, especially labour.

The degree of capital intensity varies significantly across service firms. Thus, the higher the capital intensity the higher the financial burden for engaging in international expansion.

What is knowledge intensity?
Knowledge intensity can be defined as an extent in which the knowledge processes are performed and knowledge resources are utilised.

Likewise, the degree of knowledge intensity also varies significantly across service firms. Knowledge-intensive services embed a higher degree of intangible or tacit knowledge and require a higher level of client interaction and local adaptation, which implies higher heterogeneity in the services provided and higher costs in transferring critical organisational knowledge and capabilities to foreign markets.

Knowledge-intensive service firms perform better in the early stages of international expansion

The study confirms that these differences have important implications for firm performance. "Our research reveals that firms providing knowledge-intensive services are more likely to increase their performance in their initial stages of international expansion compared to companies providing capital-intensive services, although the picture is the opposite in more advanced stages."

Knowledge-intensive services

Why do knowledge-intensive service firms perform better in the early stages of international expansion? The authors of the study point to lower financial burden, because the value of these firms' services relies on intangible assets that are largely embedded in their human resources, and the fact that most of them pursue a client-following strategy.

"Knowledge-intensive service firms face less severe costs of internationalisation at the outset, which allows them to reap the benefits of internationalisation faster," according to Mendoza.

This improvement in performance, however, is temporary. Knowledge-intensive services are more affected by cultural and institutional differences and are more difficult to scale.

The study shows that as the level of multinationality increases, managing and controlling increasingly diverse international activities becomes more complex and may create severe pressures on a firm's key resources (people) and managerial capacity.

"Our findings suggest that knowledge-intensive service firms encounter a threshold of internationalisation at relatively low levels of multinationality – in the study, this point is reached when a company is present in more than three countries or has more than four foreign subsidiaries. Expanding beyond that point can be highly detrimental to the firm's performance."

Moreover, client-following firms may be prone to over-internationalise because their managers tend to underestimate the long-term costs of establishing foreign operations. While these firms enjoy an obvious advantage in the early phase of market entry, they might face more difficulties than expected at a later stage, seeking new local clients once the initial projects that brought them to a country have been completed.

Capital-intensive firms

Although capital-intensive service firms experience negative performance effects at the beginning of their international expansion, their performance increases as they further internationalise.

Capital-intensive service firms increase their performance as they further internationalise

"The high initial costs associated with the liabilities of internationalisation and insufficient access to economies of scale appear to be the most important hurdles these firms face when first entering foreign markets," says Mendoza.

Most of the capital-intensive firms in the study follow a strategy of market concentration to overcome these hurdles. Expanding in few foreign markets allows these firms to reach the minimum local operations scale needed to be competitive. In this way, they can deploy their limited resources more efficiently and foster the accumulation of knowledge and learning about these markets, reducing the costs associated with the liabilities of internationalisation.

Further, a strategy of market concentration reduces the organisational complexity of coordinating and controlling international operations. All these aspects help explain why these firms perform better at medium and high levels of multinationality without facing a threshold of internationalisation.

"The high initial costs of internationalisation capital-intensive service firms face should not discourage managers, as the net performance impact will be positive in the long run," concludes Mendoza.

This article is based on research published in the journal International Business Review.

All written content is licensed under a Creative Commons Attribution 4.0 International license.