Internationalization and Performance: An Organizational Learning Perspective

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vol. 43, 2003/1, pp. 6383
vol. 43, 2003/1
Authors
Winfried Ruigrok/Hardy Wagner
Internationalization and Performance:
An Organizational Learning Perspective
Abstract
For over 30 years, researchers have investigated the relationship between cor-
porate internationalization and performance. While most recent findings indi-
cate that the link may exhibit a non-linear form, researchers disagree on the
exact shape of the statistical curve.
In this study, the relationship was examined through cross-sectional and longi-
tudinal statistical analyses of data from 84 German manufacturing companies
during the 5-year period 19931997.
Key Results
A standard-U form of the internationalization-performance relationship was
found across all statistical techniques applied. Organizational learning appears
to accompany the internationalization process of multinational corporations
(MNCs).
Winfried Ruigrok, Professor of International Management and Director of the Research Institute for
International Management, University of St. Gallen, St. Gallen, Switzerland.
Hardy Wagner, Dr. oec., former Research Assistant at the Research Institute for International Mana-
gement, University of St. Gallen, currently International Management Associate, DaimlerChrysler.
Manuscript received April 2001, revised September 2001.
63
Introduction
The relationship between the internationalization and the performance of corpo-
rations has triggered extensive interdisciplinary research throughout the last three
decades (for reviews of the literature see Annavarjula/Beldona 2000, Ramaswamy
1992, Sullivan 1994a). Researchers have examined the link between performance
and the degree of internationalization, attempting to prove empirically the theo-
retical argument that international expansion represents a precondition for super-
ior financial success. Postulating only the benefits of internationalization, early
studies in the 1970s and 1980s hypothesized a linear relationship between the
degree of internationalization (DOI) and firm performance. The findings of these
inquiries have been inconsistent and contradictory.
Recognizing that internationalization can be subject to risk and failure,
researchers in the 1990s acknowledged that internationalization brought both
benefits and costs, with costs exceeding benefits at high levels of internatio-
nalization (Daniels/Bracker 1989, Geringer/Beamish/daCosta 1989, Gomes/
Ramaswamy 1999, Ramaswamy 1995). In the inverted-J curve of the relations-
hip, researchers identified an ‘internationalization threshold’, a point in firms’
expansion process at which global complexity starts to strain managerial and or-
ganizational capacity. The downturn in performance at high levels of internatio-
nalization was interpreted as implying that companies may benefit from targeting
a certain universally applicable, or at most an industry-specific, ratio of domestic
to foreign operations.
This prescription was soon questioned. Sullivan (1994b, p. 166) vehemently
challenged the notion of a static and undifferentiated ‘threshold of internationa-
lization’, arguing that the supposition of a “deterministic relationship between
financial performance and internationalization, seemingly irrespective of the type
or strategy of the MNC, questions the premise of proactive management.” His sta-
tistical analyses indicated that the internationalization-performance relationship
“is characterized by at least one, if not a series of, ‘convergence, decline, reori-
entation, convergence cycles’.” More recently, the findings by Riahi-Belkaoui
(1998) confirmed the existence of such an horizontal-S form of the link.
In our study, we attempted to further illuminate and resolve some of the con-
troversies surrounding the internationalization-performance link. Using a com-
pany sample from Germany and with the help of multiple statistical techniques,
we examined the relationship for the period 19931997. The article is structured
as follows. First, we depict the settings, conceptual frameworks, and methodolo-
gical procedures of previous inquiries into a non-linear DOI-performance rela-
tionship. In particular, we discuss two seemingly opposed theoretical foundations
on which prior investigators have based their arguments. A synthesis leads to hy-
pothesis formulation. We then describe our company sample, applied variable con-
Winfried Ruigrok/Hardy Wagner
64 vol. 43, 2003/1
ceptualization/operationalization, and analysis techniques. This is followed by the
presentation of results. Sections on discussion/conclusions and limitations/re-
commendations close the article.
Literature Review
Previous Theoretical Frameworks, Methodologies, and Results
Early investigators shared a strong focus on the benefits of international expan-
sion and a consequent suggestion of a positive, linear form of the internationa-
lization-performance relationship. These inquiries have produced inconsistent and
contradictory findings. Most prominent researchers in the field now argue that the
omission of internationalization costs in the theoretical frameworks of early in-
quiries would largely explain the ambiguous results (Gomes/Ramaswamy 1999,
Hitt/Hoskisson/Kim 1997, Sullivan 1994b).
Addressing this conceptual shortcoming, researchers in the late 1980s started
to discuss the benefits as well as the costs of corporate internationalization in their
studies, suggesting a curvilinear form of the relationship. Table 1 contains a brief
overview of the seven studies identified that have examined a non-linear DOI-
performance link. Whereas early researchers touched only lightly on the issue of
internationalization costs (e.g., Daniels/Bracker 1989 merely used the expression,
“operating risks”, p. 48), authors in the 1990s elaborated both the benefits and
costs and their potential interplay.
Benefits of Internationalization
The benefits of internationalization are suggested and described by two core theory
streams: theories of foreign direct investment (FDI) and theories of the multina-
tional firm.
FDI theories, which are primarily economics-driven and hence focused on
factors located in the firm’s external environment, aim to explain why multina-
tional companies exist. Imperfections in international product, factor, and finan-
cial markets are postulated to benefit firms that internationalize. Whereas scho-
lars in international business and industrial organization economics normally
emphasized economies of scale and scope (e.g., Buckley/Casson 1976, Caves
1971), researchers in financial economics stressed portfolio diversification and
its effect on companies’ risk-return performance (e.g., Lessard 1976, Levy/Sar-
nat 1970).
Internationalization and Performance
vol. 43, 2003/1 65
Winfried Ruigrok/Hardy Wagner
66 vol. 43, 2003/1
Author(s) and Sample and Theoretical Key Variables Statistical Result(s)
Year Time Period Framework Operationalization* Technique
Daniels/Bracker 116 US FDI; operating DOI: FSTS and ANOVA, six intervals Identification of internationalization
1989 companies in risks FATA; Performance: (0–10; 10 –20; 20– 30; threshold within ‘50% and above’
eight industriesa; after-tax ROS and 30– 40; 40–50; 50 DOI interval; threshold
1974– 1983 ROA and above) industry-specific
Geringer/Beamish/ 100 US and European FDI; internal and DOI: FSTS; ANOVA, five Identification of internationalization
daCosta 1989 companies, external costs Performance: after- intervals (0.1– 19.9; threshold within ‘60– 79.9%’
respectively; tax ROS and ROA 20– 39.9; 40–59.9; DOI interval
1977– 1981 60– 79.9; 80–99.9)
Sullivan 1994 75 US companies FDI, organizational DOI: multi-item ANOVA, five Relationship between DOI and
dominantly in evolution theories, index; Performance: intervals based on performance characterized by
seven industriesb; comparative after-tax ROS and DOI index series of ‘convergence, decline,
1988– 1990 management; internal ROA reorientation, convergence’
and external costs cycles (trigonometric wave)
Ramaswamy 1995 25 US companies FDI, theories of DOI: FATA; Pooled cross- Identification of internationali-
in the drug and locational choice; Performance: after- section/ time-series zation thresholds at a DOI of
pharmaceutical internal and external tax ROS, ROA, analysis; control for 0.56 for ROA, 0.82 for ROS,
industry; 1980– 1987 costs and ROVA size and 0.64 for ROVA
Hitt/Hoskisson/ 295 US companies; FDI, theory of the DOI: entropy measure Classical regression Relationship between DOI
Kim 1997 1988– 1990 multinational firm, (sales diversification analysis; control for and performance characterized
organizational across four distinct size, industry, capital by an inverted-U (full sample
learning; internal regions); Performance: structure, and interna- and moderate diversifiers),
and external costs ROA and R&D intensity tionalization mode standard-U (nondiversifiers), and
linear shape (high diversifiers)
Riahi-Belkaoui 1998 100 US companies; FDI DOI: FSTS; Classical regression Relationship between DOI and
1987– 1993 Performance: ROA analysis with three performance characterized by
DOI-range variables a horizontal-S shape (negative
(0– 14; 14–47; 47 and within low and high range,
above); control for size positive within middle range)
Gomes/ Ramaswamy 95 US companies FDI, theory of the DOI: multi-item index; Pooled cross- Relationship between DOI and
1999 in four industriesc; multinational firm; Performance: ROA section/ time-series performance characterized by
1990– 1995 internal and external and OCTS analysis; control for an inverted-J shape
costs size and industry
a Specialty equipment and materials; branded foods; auto suppliers; drugs; health care; aerospace-defense; production equipment; electrical equipment
bFood; chemical and allied products; pharmaceuticals; petroleum and refining; industrial machines; electronics; transportation
cChemical; drug and pharmaceutical; computers and office equipment; electrical and electrical goods
* FSTS: Foreign sales to total sales; FATA: Foreign assets to total assets; FDI: Foreign direct investment; DOI: Degree of internationalization
Table 1. Previous Inquiries Into a Non-linear DOI-Performance Link: Sample Characteristics, Theoretical Frameworks, Methodologies, and Results
Adopting a more managerial perspective, theories of the multinational cor-
poration (MNC) focus on the organization’s internal environment. The main
source of benefits from internationalization is not seen in the reactive exploita-
tion of external opportunities, as proposed by FDI theories, but in the proactive
induction and exhaustion of intra-firm comparative advantages. Fayerweather
(1978) suggested that international resource transfer and the integration potential
of worldwide corporate structures, systems, and processes can provide MNCs with
company-specific competencies not available to the domestically operating firm.
Similarly, the resource-based view of the firm (Wernerfelt 1984) proposed that
global resources and core competencies promote organizational learning and kno-
wledge development. Finally, the theory of operational flexibility (Kogut 1989)
proposed arbitrage and leverage opportunities in MNCs, especially those that suc-
cessfully developed a global network structure.
Costs of Internationalization
The costs of internationalization are suggested by several, partially overlapping,
theories from different academic disciplines.
Siddharthan and Lall (1982) were among the first to indicate that increasing
degrees of internationalization and concomitant organizational and environmental
complexity may eventually exhaust managerial capacity. Difficulties arise from
high information-processing demands, which themselves are seriously aggravated
by cultural problems accompanying global expansion. Likewise, researchers en-
gaged in cross-cultural studies have posited communication, coordination, and
motivation problems stemming from cultural diversity in the firm (e.g., Hofstede
1980). Some of these concepts are integrated in transaction cost (Jones/Hill 1988)
and agency (Doukas/Travlos 1988, Roth/O’Donnell 1996) theories. As interna-
tional expansion increases, governance and transaction costs increase exponen-
tially due to the geographical and cultural dispersion of the various principals and
agents in the multinational firm.
Addressing external costs of internationalization, researchers emphasized the
financial and political risks accompanying foreign expansion. Financial risk as if
exchange-rate fluctuations and inflation (Reeb/Kwok/Baek 1998) offset advanta-
ges of earnings stability derived from worldwide portfolio diversification. Politi-
cal uncertainty may arise when foreign governments enforce unanticipated change
to the business environment of the firm, including boycotts, fund remittance con-
trol, and expropriation (Boddewyn 1988).
Internationalization and Performance
vol. 43, 2003/1 67
The Interplay
Obviously, MNCs encounter both the benefits and the costs of internationaliza-
tion. Hence, internationalization per se is not a sufficient condition for superior
performance. Hypothesizing a monotonic linear internationalization-performance
relationship is thus an over simplistic approach to theory construction. More pro-
mising is an assessment of the interplay between costs and benefits along firms’
internationalization trajectory. The conceptual frameworks applied by researchers
who investigated a curvilinear DOI-performance link provide a starting point for
broaching the complex cost-benefit trade-off.
In summarizing the theoretical frameworks of previous inquiries (cf. Table 1),
one may distinguish two contrasting camps. Daniels and Bracker (1989), Gerin-
ger et al. (1989), Ramaswamy (1995), and Gomes and Ramaswamy (1999) seem
to hypothesize a rather deterministic, at most industry-specific, inverted-J form
of the internationalization-performance link, characterized by a ‘threshold of in-
ternationalization’: a global performance maximum identified at a DOI (ratios of
foreign sales to total sales, foreign assets to total assets, etc.) somewhere between
5082%. Performance appears to increase monotonically up to this critical zone,
climax and then decrease monotonically.
This argument is best exemplified by the theoretical framework of Gomes and
Ramaswamy (1999). Central to their explanation is the assumption of incremen-
tal internationalization (Johanson/Vahlne 1977). Firms are said to internationa-
lize on an evolutionary path, starting in geographically and culturally close
markets, then successively progressing toward cognitively and physically more
distant environments. Initial expansion into countries that exhibit a close simila-
rity in terms of consumer tastes, market systems, and institutional settings eases
the transfer of marketing techniques, human resources, and technology. Likewise,
organizational structures, leadership approaches, and corporate control mecha-
nisms need only small adjustment when dealing with foreign settings closely
resembling home markets. Finally, financial and political risk is perceived to be
minor for companies operating in homogeneous business environments: “[I]t can
be argued that firms have much to gain during their initial foreign market entries
because they can deploy their home based skills and resources to achieve econo-
mies of scale and/or scope . . . without huge cost increases” (Gomes/Ramaswamy
1999, p. 176). However, as soon as corporations enter unfamiliar territories that
require major reconfiguration of internal processes, structures, and mechanisms,
the costs of internationalization dramatically increase and eventually exceed the
benefits. Following this argument, one readily infers that the inverted-J curve is,
to a high degree, pre-determined, and that firms should avoid crossing the iden-
tified thresholds of internationalization.
The second theoretical camp is less uniform, but Sullivan’s (1994b) and Hitt
et al.’s (1997) conceptual bases are significantly similar, both relying largely on
Winfried Ruigrok/Hardy Wagner
68 vol. 43, 2003/1
organizational learning theory. In particular, Sullivan follows theories of meta-
morphic transformation (Chandler 1962), periodic reorientation (Mintzberg/
Waters 1982), and gestalt reconfiguration (Miller/Friesen 1980), suggesting that
internationalization creates the need for, and thus is accompanied by, internal
change. As firms expand, their existing structures, systems, and other internal set-
tings at some point will fail to fit the new global environment, resulting in a
gradually deteriorating corporate performance. Avoiding retrenchment or “de-in-
ternationalization” (Benito/Welch 1997, p. 7), firms are compelled to reconfigure
internal systems. If they find a new match between internal settings and external
contexts, their performance recovers and they enter the so-called ‘convergence
phase’ (Tushman/Romanelli 1985).
Hitt et al. (1997) also follow theories of organizational evolution and lear-
ning. In particular, they hypothesize and empirically confirm that managerial ex-
perience with complex environments, derived from the mastering of high product
diversification, provides organizations with indispensable knowledge for main-
taining superior performance at high degrees of internationalization. Their fin-
dings indicate a positive linear relationship between internationalization and per-
formance for firms with high product diversification, a standard-U form for non-
diversified companies, and an inverted-U shape for corporations with moderate
product diversification. Interestingly, the finding of a positive linear relationship
for firms with long experience in managing high complexity suggests that, if pro-
perly prepared, firms may not experience declining performance at all. Compa-
nies that encounter such a monotonically linear internationalization-performance
relationship most likely anticipate, and thus react promptly to, the costs of inter-
nationalization.
In summary, the second theoretical camp emphasizes the dynamic nature of
the internationalization threshold itself. In contrast to the first camp, it suggests
that corporations are not doomed to experience declining performance at a cer-
tain point on their expansion path, but that managers can proactively shape the
internationalization-performance relationship by shifting existing thresholds or
avoiding them altogether.
Synthesis and Hypothesis
Integrating these differing theoretical viewpoints may at first appear difficult. Yet,
a re-examination of the fundamental concepts involved suggests a method of
reconciliation.
Although not explicitly mentioned by Gomes and Ramaswamy (1999),
Johanson and Vahlne’s (1977) theory of incremental internationalization or loca-
Internationalization and Performance
vol. 43, 2003/1 69
tional choice has, at its core, organizational learning processes. Indeed, their se-
minal article is titled “The internationalization process of the firm – A model of
knowledge development and increasing foreign market commitments”. Learning
opportunities along the internationalization path provide the firm with cumula-
tive knowledge, preparing it for further successful expansion. Thus, the impres-
sion given by Gomes and Ramaswamy’s argument -that firms are largely con-
demned to decreasing performance at high degrees of internationalization- runs
counter to the theory that they themselves rely on.
The notion of a deterministic and universal ‘internationalization threshold’ is
also at odds with research suggesting the existence of vast benefits for firms that
are internationally diversified into culturally heterogeneous markets. Hitt et al.
(1997, p. 774), for example, argue that cognitive inputs from a culturally diverse
workforce are necessary for effective corporate innovation and technological pro-
gress. Here, culturally unrelated international diversification “provides the op-
portunity for new and diverse ideas from a variety of market and cultural per-
spectives.” Indeed, researchers in cross-cultural management, international
human resource management, global leadership, and knowledge management
have stressed that firms capable of generating, combining, and transferring in-
tangible assets or tacit knowledge within operating units that span a variety of
cultural environments obtain the most valuable internationalization benefits (e.g.,
Dunning 1998, Hofstede 1980, Johansson/Yip 1994). Corroborating these theo-
retical arguments, empirical research findings tend to confirm the existence of
competitive advantages for companies that expand into culturally unrelated mar-
kets (e.g., Doukas/Travlos 1988, Morosini/Shane/Singh 1998).
Admittedly, mainly in contrast to initial benefits derived from economies of
scale, benefits available at high degrees of internationalization and in culturally
diverse markets need to be proactively induced and managed. As noted above, be-
fore any profits can be realized, firms need to reconfigure internal structures,
systems, and processes to fit the new market environment. While some corpora-
tions will fail to do so and thus face stagnant profit development, internationally
diversified MNCs such as Dow Chemical (US), ABB (Sweden/Switzerland), and
Nestlé (Switzerland) have shown that high degrees of internationalization, cultu-
ral diversity, and high corporate performance are not mutually exclusive.
The theories described above, including those of locational choice, organiza-
tional evolution, and global knowledge development, suggest that the form of the
internationalization- performance relationship is likely to be determined by
organizational learning processes. Firms that initially consider foreign activities
merely as an “adjunct to domestic business or as a source of quick profits”
(Magaziner/Reich 1985, p. 8) will be able to exploit economies of scale and/or
scope and thus achieve high performance outcomes. In the course of further in-
ternational expansion and gradual adoption of a culturally unrelated strategy, firms
face an increasing imbalance between external environments and internal com-
Winfried Ruigrok/Hardy Wagner
70 vol. 43, 2003/1
petencies. Triggered by performance pressures accompanying such misalignment,
organizational learning sets in and firms begin to reconfigure internal systems,
mechanisms, and processes to match their new global environment. Successfully
passing through the reorientation period, corporations experience a point of
reversal and restore positive performance development. Supported by viable or-
ganizational settings, companies are now in a position to exhaust the benefits
available at high degrees of internationalization. Reflecting this line of argument,
we hypothesize a standard-U form of the DOI-performance relationship.
Hypothesis: The relationship between ‘degree of internationalization’ and ‘per-
formance’ exhibits a standard-U form, with performance being high
at low degrees of internationalization, low at medium degrees of in-
ternationalization, and high again at high degrees of internationa-
lization.
Research Methodology
Sample and Data Sources
For this study, we made use of a company sample from Germany, the European
Union’s largest economy. The final set of firms was distilled in a multi-step pro-
cess. Initially, we identified Germany’s largest 500 manufacturing companies by
sales in 1997 (Germany’s Top 500, Frankfurter Allgemeine Zeitung Information
Services 1999). Because internationalization benefits (in particular economies of
scale) and costs outlined above are of major relevance only to companies of suf-
ficient size, only firms with annual sales of at least DM 150 million (equivalent
to approximately $US100 million) during 19931997 were included.
Next, we sorted firms according to the availability of internationalization data.
Under German company law, firms are required to provide data on geographical
sales distribution only, not on asset, employee, or subsidiary dispersion between
home country and host nation(s). Thus, to acquire a statistically valid sample size,
we had to rely on the ratio of foreign subsidiary sales to total sales (FSTS) as the
‘degree of internationalization’ measure (Handbuch der deutschen Aktiengesell-
schaften 19951998, Hoppenstedt Verlag). Companies that did not distinguish
between export and foreign subsidiary sales and those that did not provide the
figures necessary for calculating the ratio were removed from the sample.
Performance data over the five-year period were obtained from Dafne (1999),
a database with financial figures for major German companies. The few missing
data points were calculated by the authors according to Dafne-provided formulas
Internationalization and Performance
vol. 43, 2003/1 71
with original data from annual reports and/or financial manuals (Handbuch der
deutschen Aktiengesellschaften 19951998, Hoppenstedt Verlag). Cross-
checking primary and archival ratios provided support for the accuracy of the data.
Firms that did not provide the required accounting data for any of the years ex-
amined were removed from the sample.
Finally, in smoothing performance variation due to ownership idiosyncrasies,
we deleted all companies that were dominantly government- or foreign-owned
(determined by voting majority) in 1995. Complete data for the five-year period
19931997 were available for 84 German companies evenly distributed across
four industries: Automobiles (21); Chemicals (22); Metals (20); and Machinery
(21). In summary, the company sample is representative for medium to large
German manufacturing firms with FDI in the period 19931997.
Variable Conceptualization and Operationalization
Degree of Internationalization
Researchers may conceptualize firms’ degrees of internationalization on three
dimensions: structural, financial, and psychological (Sullivan 1994a). The struc-
tural dimension comprises asset, subsidiary, or employee distribution between
companies’ home countries and host nation(s). Financial internationalization cap-
tures organizations’ monetary or revenue dependence on foreign markets. Finally,
psychological or ‘qualitative’ internationalization reflects the international dis-
position of firms’ top management teams (e.g., members’ educational and pro-
fessional experience in foreign countries; the breadth of nationalities on board;
top management team’s cultural heterogeneity).
In the German setting, selecting the conceptualization/operationalization tech-
nique for the internationalization variable is largely restricted by the non-availa-
bility of data. As noted above, reliable and complete internationalization data for
the five-year period under study was obtainable only in FSTS form; we therefore
had to depend on the financial dimension of the degree of internationalization.
This has its merits. As mentioned above, next to structural internationalization it
captures a core dimension of the degree of firms’ foreign activity. Equally im-
portant, FSTS is the DOI measure most used in previous inquiries, facilitating
valid cross-study comparison of findings and therefore sustained research pro-
gress.
Performance
Corporate performance can be conceptualized on two core dimensions: financial
and operational (Venkatraman/Ramanujam 1986). Financial performance may be
Winfried Ruigrok/Hardy Wagner
72 vol. 43, 2003/1
further divided into those measures based on accounting data (reflecting past per-
formance) and those grounded in capital market values (reflecting investors’
expectations of future performance). By contrast, operational performance indi-
cators do not reflect direct monetary outcome but determine core underlying
processes that ultimately result in financial performance (e.g., cost efficiency,
technological capability).
Intending to provide adequate research validity and comparability, we chose
to conceptualize performance on both dimensions, financially and operationally.
Return on assets (ROA) was the applied financial performance indicator. The ac-
counting measure has been used intensively in prior inquiries on the DOI-perfor-
mance relationship and thus allows for cross-study comparisons. To control for
country-specific tax regulations and practices, we used pre-tax ROA figures.
Operating costs to total sales (OCTS) was chosen as the operational perfor-
mance measure. It is defined as the sum of the ratios of firms’ material costs to
sales and employee costs to sales, and thus reflects cost efficiency. The OCTS mea-
sure was selected for three reasons. First, it allows for testing the widely held be-
lief that reduction of material and labor costs represents a major benefit of inter-
national expansion (Porter 1985). Second, exemplifying an underlying process or
value-adding activity in MNCs, cost efficiency allows for more direct measurement
of the impact of internationalization than aggregate firm-level profitability ratios
(Ramaswamy 1992). Finally, OCTS was used by Gomes and Ramaswamy (1999)
in their recent systematic examination of the DOI-performance relationship for US
companies, and thus permits valid comparison between the two countries.
Control Variables
Carrying out regression analysis, we controlled for two major factors: organiza-
tional size and industry membership. Size was measured as the natural logarithm
of total employees or total assets. In the case of ROA (which is a function of
total assets) as the dependent variable, total employees represented the size
measure, whereas OCTS (which is a function of total employees) prompted us to
choose total assets. Industry dummy variables encompassed I1= Automobiles,
I2= Metals, and I3= Machinery. The residual industrial sector was represented by
Chemicals.
Analysis Techniques
To date, researchers who revealed a non-linear relationship between the degree
of internationalization and performance have utilized three statistical approaches
to data analysis (cf. Table 1). Some applied ANOVA techniques on averaged data
(Daniels/Bracker 1989, Geringer et al. 1989, Sullivan 1994b), drawing (mean)
Internationalization and Performance
vol. 43, 2003/1 73
performance comparisons over firms at different levels or ranges of internationa-
lization. Others used classical multiple regression analysis on three-year averaged
data for the variables under study (Hitt et al. 1997). Common to both statistical
approaches was the use of data averaged over multiple years. Whereas this pro-
cedure may help to smooth out annual variations due to accounting practices, aver-
aged data is also likely to disguise important tendencies or cyclical movements
over time. Realizing this disadvantage, in their recent examinations of the DOI-
performance relationship Ramaswamy (1995) and Gomes and Ramaswamy (1999)
employed pooled time-series/cross-sectional regression analysis. Combining
cross-section and time-series data makes it possible to reveal individual explora-
tory variables as well as their dynamics over time.
In our study, we made use of all three analysis techniques previously employed
in inquiries of this kind. ANOVA procedures were applied on a four-interval DOI
scale (139.9%; 4059.9%; 6079.9%; 8099.9%) with firms categorized on
the basis of their five-year averaged FSTS ratio (N =84). Classical multiple re-
gression analysis was carried out on five-year averaged data for the DOI, perfor-
mance, and size variables (N =84). Finally, pooling cross-section and time-series
data, we relied on Kmenta’s (1986, pp. 618–620) cross-sectionally heterosceda-
stic and timewise autoregressive model (N =420). His approach to panel data ana-
lysis subjects each individual observation to a double transformation before app-
lying a final ordinary least squares analysis. Initially, regression residuals are used
to estimate the statistical parameters (ρfactors) needed for eliminating autocor-
relation. In the second stage, residuals variance is calculated for each sample com-
pany and used to remove data heteroscedasticity. Altogether, the use of multiple
statistical approaches (cross-sectional and longitudinal) allowed us to assess the
validity of our results. In case the findings converged across multiple techniques,
evidence of robustness would have been provided.
Results
Table 2 shows descriptive statistics for the five-year averaged data (N =84, a) and
pooled data (N =420, b), respectively. Regression diagnostics did not indicate
problems of multicollinearity for the averaged data. With respect to the pooled
data, the problems most likely to occur, nonconstant variance (heteroscedasticity)
and autocorrelation, are minimized through the application of Kmenta’s genera-
lized regression technique.
The statistical results unambiguously indicate a significant non-linear rela-
tionship between companies’ degree of internationalization and performance.
Supporting our hypothesis, we found convincing evidence for a standard-U form
of the relationship across all statistical techniques applied.
Winfried Ruigrok/Hardy Wagner
74 vol. 43, 2003/1
Internationalization and Performance
vol. 43, 2003/1 75
S.d. 2345
Variables Mean a b a b a b a b a b
1. ROA 0.07 0.04 0.06 –0.54** 0.431** –0.065 –0.012 –0.213 –0.164** 0.183 –0.137**
2. OCTS 0.77 0.11 0.11 –0.223*0.22** 0.029 0.023 –0.014 –0.015
3. FSTS 0.60 0.15 0.16 0.28** 0.274** 0.356** 0.354**
4. Size (Empl.) 4.10 0.62 0.62 0.976** 0.974**
5. Size (Assets) 3.40 0.69 0.69
aN=84; bN=420 Size (Empl.) = log of total employees; Size (Assets) = log of total assets
* p < .05 ** p < .01
Table 2. Means, Standard Deviations, and Correlations
Table 3. Results Obtained Through Regression Analysis
Figure 1 depicts the relationship as identified through ANOVA techniques.
Performance differences between firms located in varying DOI intervals are sta-
tistically significant at p < 0.04 for ROA and p < 0.006 for OCTS. With regard to
ROA, the relationship starts high at interval 1, and exhibits a global minimum at
interval 2 that is followed by a point of inflexion at interval 3, signifying an in-
creasing positive slope (concave upward) at high degrees of internationalization.
As expected, the relationship between OCTS and degree of internationalization
comes close to a mirror image. Starting off already high, operating costs increase
toward interval 2, climax and exhibit a point of inflexion at interval 3, depicting
an increasing negative slope (convex downward) at high DOIs. For both ROA
and OCTS, boundary points of the curve (global minimum and global maxi-
mum, respectively) can be located within the second DOI interval (4059.9%
FSTS).
Regression analysis largely confirmed the results found through ANOVA tech-
niques (cf. Table 3). For both classical and pooled cross-section/time-series ana-
lysis, the inclusion of a squared FSTS term significantly increased the proportion
of variance explained (for both OCTS and ROA). The finding of a significant
squared term with the hypothesized positive sign for ROA suggests a standard-U
form of the DOI-performance relationship. Again roughly mirror-imaging this
relationship, operating costs (OCTS) exhibited an inverted-U shape, dropping
rapidly at high degrees of internationalization. Regression analysis also allowed
us to identify maximum and minimum points with greater precision. Partial deri-
vatives with respect to the FSTS variable revealed global minima at 61% (classi-
cal) and 58% (pooled cross-section/time-series) FSTS for ROA. With respect to
OCTS, global maxima are identified at 54% FSTS through both classical and pa-
nel data analysis.
Winfried Ruigrok/Hardy Wagner
76 vol. 43, 2003/1
Figure 1. Results Obtained Through ANOVA Techniques (N =84)
Discussion and Conclusions
This study set out to further illuminate the debate about the ‘degree of interna-
tionalization-performance’ relationship. A review of previous inquiries at first
seemed to indicate a conceptual controversy. Yet organizational learning proces-
ses could be identified as a common denominator among constructed frameworks.
Theoretical synthesis thus prompted us to hypothesize a standard-U form of the
internationalization-performance relationship.
Statistical analysis of data from a German company sample across the
19931997 time period confirmed our presumption. Starting at high financial per-
formance levels, MNCs’ profitability declines to the 60% FSTS mark, after which
profit development reverses and exponentially increases. The concave shape of
the curve at high DOIs signifies that once firms get past this threshold, they tend
to catch up very fast. From this one may deduce that, once effectively adapted,
MNCs are in a good position to rapidly reap the benefits flowing from high de-
grees of internationalization.
With respect to cost efficiency or operational performance, internationalizing
companies encountered a time-lagged convex learning curve, starting at a 54%
FSTS ratio. This finding suggests that, in contrast to widely-held beliefs, opera-
ting costs may not be reduced by initial foreign expansion. The benefits that stem
from access to cheap raw materials and low labor costs appear to be exploitable
only by firms that exhibit high degrees of internationalization. Again, companies
most probably have to undergo a period of learning to come up with appropriate
structures, mechanisms, and processes that allow for the effective exploitation of
imperfections in global factor markets. Similar to financial performance, once re-
versed, operational performance or cost efficiency increases exponentially (i.e.,
OCTS decreases exponentially).
Altogether, the impression given by previous research, that the costs of inter-
nationalization inevitably outweigh the potential benefits beyond a certain ‘thre-
shold’, is not confirmed. Rather, our findings suggest that MNCs pass through an
organizational learning process characterized by internal reconfiguration that
allows for superior performance development at high DOIs. The relatively long
period of performance deterioration that accompanies this adjustment process may
explain why many firms eventually resign and de-internationalize again before
reaching the turn-point.
Given the consistency of our results across multiple statistical techniques, we
need to ask why previous inquiries normally revealed an inverted-J form of the
internationalization-performance relationship. In view of the wide range of indu-
stries spanned by preceding research (cf. Table 1), largely covering the industrial
sectors examined in this study, industry seems to be a poor explanatory variable.
In searching for other reasons, one may argue that the varying time periods ex-
Internationalization and Performance
vol. 43, 2003/1 77
amined, ranging from the early 1970s to the mid-1990s, explain the differing em-
pirical results. Yet Gomes and Ramaswamy’s (1999) finding of an inverted-J form
was generated from data spanning the years 19901995, a period partially over-
lapping this study’s period of investigation. Finally, in choosing the variable con-
ceptualization/operationalization and statistical techniques to apply to data ana-
lysis, we made an effort to cover all approaches used in previous inquiries. Hence,
methodological divergence is also unlikely to provide a convincing explanation
for the differing empirical results. In what follows, we argue that country-speci-
fic idiosyncrasies are a more likely explanation.
If one looks at the country of origin of the data analyzed in previous studies,
it becomes evident that researchers have predominantly relied on US organiza-
tions. Geringer et al. (1989), the sole author team that included non-US firms in
their analysis, merged firms from several European countries into one aggregate
sample, thus largely blurring nation-specific impacts. In conclusion, our study re-
presents one of the first single-country examinations of a curvilinear DOI-per-
formance relationship for non-US organizations.
German and US firms differ in terms of prevalent type of international ex-
pansion (culturally related versus unrelated). As described by several scholars,
the average US MNC locates initial foreign activities in Canada, the United King-
dom, and Australia (Davidson 1980, Johansson/Yip 1994, Makhija/Kwon-
gsoo/Williamson 1997). From this, one may conclude that US corporations, at the
beginning of their internationalization, are engaged in culturally related rather
than unrelated expansion strategies. Apparently also confirming theories of in-
itial foreign location based on the ‘psychic distance’ premise, German companies
are likely to target Switzerland and Austria. However, both countries are very
small markets and thus have never been able to attract substantial German FDI.
Instead, the average German firm expanded early into other European, North Ame-
rican, and Asian countries, nations characterized by higher psychic distance. We
may infer that, unlike US firms, German companies have been obliged to pursue
culturally unrelated strategies at the outset of foreign expansion.
Country-specific expansion strategies can help to explain the seemingly contra-
dictory empirical results drawn from the German and US company samples. As
German firms move into culturally unrelated markets already at low DOIs, they
are rapidly confronted with performance pressures caused by the mismatch
described above between external business environments and internal settings.
Managers soon realize that future financial success in far-flung global markets
requires immediate reconfiguration of corporate structures, mechanisms, and pro-
cesses. Having successfully adapted, companies experience a positive feedback
loop in the subsequent expansion process.
The average US MNC is likely to pursue a culturally related expansion stra-
tegy at the outset of internationalization. As Gomes and Ramaswamy (1999,
p. 176) note: “Market familiarity pre-supposes relatively similar administrative
Winfried Ruigrok/Hardy Wagner
78 vol. 43, 2003/1
mechanisms, similar consumer tastes and distribution systems compared to cul-
turally . . . distant locations. Therefore, it is plausible that firms would be able to
leverage their home country competencies in these locations more easily, trans-
lating into superior profitability.” Internationalization thus increases US firms’
performance up to a threshold at which culturally unrelated expansion is inaugu-
rated (inverted-J curve). From then on they will pass through a standard-U curve
comparable to the one German MNCs have experienced. Figure 2 illustrates our
rationale for the apparently conflicting findings of previous research on a non-
linear DOI-performance relationship.
Limitations and Recommendations for Future Research
Putting the findings of this study into proper perspective, we need to point out the
core conceptual and methodological limitations circumscribing the research ef-
fort. Before we are able to announce generalizations on the exact nature of the
DOI-performance relationship, further research that addresses these issues will
be necessary.
Conceptual
In accordance with theories of organizational learning, our findings indicate that
intra-firm reconfiguration processes are likely to be induced by performance pres-
sures that companies encounter along their internationalization path. Recon-
Internationalization and Performance
vol. 43, 2003/1 79
Figure 2. Degree of Internationalization and Performance: The Role of Prevailing Country-speci-
fic Type of Expansion (Culturally Related/Unrelated)
structed ‘fit’ between internal mechanisms and external environments then allows
for the exploitation of benefits at high DOIs. Given that companies learn on their
way to high degrees of internationalization, a central question arises: which are
the organizational capabilities most critical for successful operation in increa-
singly complex foreign market environments? Our findings obviously fall short
of advising companies as to the exact nature of decisive areas for reconfiguration.
Here, researchers are called upon to quantitatively identify core organizational
moderators of the DOI-performance relationship (e.g., organizational structure,
top management team composition, control system).
Although our findings suggest that the U-curve pattern is a ‘one-off pheno-
menon’, one may ask about the possibility of multiple successive U-formations
during firms’ internationalization process. If companies face multiple ‘fit-misfit-
fit’ sequences in the course of their international expansion, we need to assume a
certain time schedule for the emergence of particular problems and respective
needs for adjustment. Suppose, for example, the existence of a triple-U curve:
may we hypothesize that performance will initially decline because of an orga-
nizational structure misfit, subsequently (i.e., at higher DOIs) because of pro-
blems in top management team demography, and finally because of problems in
corporate controlling? Our findings convey the notion of an emergence of misfit
simultaneously in multiple areas, all of which companies need to address con-
currently through effective and efficient reconfiguration. However, the search for
contingency relationships as suggested above, besides clarifying the distinct na-
ture of required internal reconfiguration, could also shed further light on the is-
sue of parallel or sequential adjustment demands in the course of firms’ interna-
tionalization.
Methodological
Due to the non-availability of data, we had to rely on FSTS as the DOI measure.
As pointed out by Sullivan (1994a), single-item measures of firms’ DOI may be
less suitable than multi-criterion composites. Therefore, we urge future investi-
gators to consider alternative conceptualization and operationalization techniques
for the ‘degree of internationalization’ variable. Researchers who can select from
a wide range of measures could also choose indicators that more purely reflect
cultural dissimilarity (e.g., entropy measures or Herfindahl variants based on Hof-
stede’s (1980) culture scores). Such replication would be able to directly assess
the validity of our presumption that different forms of the DOI-performance link
can be explained by country-specific types of expansion (culturally related ver-
sus unrelated).
With regard to the country of origin of data samples, we found that earlier
investigators of a curvilinear DOI-performance relationship almost exclusively
Winfried Ruigrok/Hardy Wagner
80 vol. 43, 2003/1
relied on US-based companies. However, as argued above, there is reason to as-
sume that MNCs from many European nations have been obliged to address or-
ganizational needs at high degrees of internationalization and in culturally diverse
business environments at an earlier stage than their average US counterparts. To
illustrate, in 1996 the average US firm exhibited a transnationality index (aver-
age of three ratios: foreign assets to total assets, foreign sales to total sales, and
foreign employment to total employment) of about 43%, whereas the average
companies from Switzerland and the Netherlands showed a degree of internatio-
nalization above 80% (UNCTAD 1999). As depicted in Table 2, the German com-
panies in our sample had an average FSTS ratio of 60%. In Gomes and Ramas-
wamy’s (1999) and Riahi-Belkaoui’s (1998) study, the average US company
exhibited a FSTS ratio of 42% and 37%, respectively. Signifying an even larger
internationalization ‘gap’, Sullivan’s (1994b) US sample had an average degree
of internationalization (FSTS) of merely 27%.
Mainly because of their small home markets, MNCs located in many Euro-
pean countries have been forced to direct most of their business operations to-
ward foreign countries. ABB (Switzerland/Sweden) and Nestlé (Switzerland), for
example, have for many years successfully drawn more than 90% of their sales
and employees from outside their headquarters’ cultural setting. Given this, con-
tinuous limitation to US company samples may represent a major hurdle to ad-
vancing knowledge in this line of inquiry. Particularly, we may be able to sim-
plify and speed up the identification of intra-firm organizational needs in the
course of foreign expansion by examining European pioneers that have already
managed to achieve a ‘transnational’ capability at high degrees of internationa-
lization and in culturally diverse markets.
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