Internationalization of Service SMEs: An Integrated ... · Internationalization of Service SMEs: An...

Internationalization of Service SMEs:An Integrated Perspective from theEngineering Consulting Sector

Nicole E. Coviello andKristina A.-M. Martin

ABSTRACT Internationalization traditionally has been examined using asingle theoretical framework in the context of large manufactur-ing firms. The authors argue that it is more relevant to examineforeign direct investment (FDI) theory (including transactioncost analysis), the stage models of internationalization, or net-work theory in an integrated and holistic manner. Using casestudies offourNewZealand-hased engineering consulting firmsclassified as small or medium-sized enterprises (SMEs), thestudy identifies and analyzes patterns and infiuences related tothe smaller service firm's decision to internationalize, subse-quent internationalization, market selection, and mode of entry.The findings show that SME internationalization in the engi-neering consulting sector is a complex process, and concepts in-herent in FDI theory, the stage models, and the networkperspective are all evident. These results support the argumentthat service internationalization is too broad a concept to be de-fined exclusively or examined by any one theoretical frame-work. Implications are drawn for research and practice.

Small and medium-sized enterprises (SMEs) are increasinglyactive in international markets (Bonaccorsi 1992; Erramilliand D'Souza 1993; Haahti, Hall, and Donckels 1998). Assuch, the activities and processes siurounding their interna-tionalization are important phenomena to understand fromboth a research and a managerial perspective. An under-standing of SME internationalization is also of interest be-cause small firms differ from larger firms in their managerialstyle, independence, ovirnership, and scale/scope of opera-tions (O'Farrell and Hitchins 1988). They are also likely to belimited in financial, management, human, and informationresources (Buckley 1989; Erramilli and D'Souza 1993), withdifferent managerial processes and structures that are lessrigid, sophisticated, and complex than those in larger firms.As stated by Shuman and Seeger (1986, p. 8),

Smaller businesses are not smaller versions of big busi-ness ... smaller businesses deal with unique size-relatedissues as well, and they behave differently in theiranalysis of, and interaction with, their environment.

Therefore, the internationalization literature should recog-nize and account for the patterns and processes of smallerfirms. A similar argument can be made for service organiza-

Submitted September 1998Revised February 1999

© Journal of Internationa] MarketingVol. 7, No. 4, 1999, pp. 42-66

ISSN 1069-031X

42

tions. Similar to smaller firms, service firms are active in in-ternational markets (Dunning and Kundu 1995; O'Farrell,Wood, and Zheng 1998). Furthermore, in the same way thatsmaller firms differ from large firms, services generally areconsidered different than goods (Zeithaml, Parasviraman, andBerry 1985). For example, Buckley, Pass, and Prescott (1992)note that the distinguishing characteristics of services aretheir intangibility, inseparability of production and con-sumption, heterogeneity, and perishability.

In spite of the involvement of both small and service firms ininternational trade, the internationalization literature tradi-tionally has emphasized the activities of large firms in manu-factin-ing sectors. More important, prior research has tendedto examine internationalization in the context of a single the-oretical framework (e.g., network theory or patterns of foreigndirect investment [FDI]), and as a result, the internationaliza-tion concept often is discussed from a unilateral and perhapsmyopic perspective. Therefore, we seek to integrate three ma-jor areas of internationalization research: FDI theory, the es-tablishment chain or "stage" models of internationalization,and the network perspective on internationalization. We em-pirically examine the internationalization of SMEs that arealso service organizations.

We proceed with a summary of the internationalization liter-ature discussed in the specific context of smaller servicefirms. This review highlights the need for integrated interna-tionalization research on service SMEs and leads to a state-ment of research purpose. The literature review is followedby a discussion of the research method and the results of thestudy. We then present conclusions focusing on implicationsfor research and managerial practice.

Efforts to understand the internationalization concept havebeen many, and as simmiarized by Johanson and Vahlne (1990),three general research areas have emerged in the literature:

1. FDI theory,

2. The establishment chain or stage models of international-ization, and

3. The network perspective.

We introduce each of these areas briefiy, followed by a sum-mary of the extant internationalization literature on serviceSMEs.

The general body of FDI theory has emerged from several dif-ferent theoretical developments. For example, the theories ofmonopolistic advantage/market imperfections (Caves 1971)and internalization (Rugman 1981) have led to the use of

Internationalization of Service SMEs

LITERATURE REVIEW

Three Areas ofInternationalization Research

43

transaction cost analysis to explain internationalization. Thisview argues that firms choose their optimal structure for eachstage of production hy evaluating the costs of economictransactions. Firms therefore choose the organizational formand location for which overall transaction costs are mini-mized. Transactions perceived to be high risk and requiringsignificant management time or other resource commitmentsare more likely to be internalized as part of a hierarchicallystructured organization. In contrast, the eclectic paradigm(Dunning 1980, 1988] suggests that economic costs are notthe only factor influencing internationalization. This theoryargues that for a firm to invest in a foreign market (undertakeFDI), internalization, ownership-specific, and location-specific advantages must be present.

A second area of internationalization research is that cap-tured by establishment chain theory (commonly referred toas the "stage models" of internationalization). Research inthis area argues that international expansion is influencedstrongly by managerial learning. One of the most commonlycited theories suggests that internationalization begins withlow-risk, indirect exporting to "psychically close" or similarmarkets (Johanson and Vahlne 1977). This first step to inter-nationalization improves the firms' foreign market knowl-edge. Over time and through experience, firms increase theirforeign market commitment and expand to more "psychi-cally distant" markets. This expansion further enhances mar-ket knowledge, which leads to additional commitment,including equity investment in offshore manufacturing andsales operations.

Other versions of the stage model approach have found thatinternationalization is reflected in differences in the attitudi-nal and behavioral commitment of managers. For example,Cavusgil (1984) empirically identifies five stages (preinvolve-ment, reactive/opportunistic, experimental, active, and com-mitted involvement). Andersen (1993) summarizes thisincremental approach as a result of innovation adoption be-havior in which the manager's perceptions and beliefs bothinfluence and are shaped by foreign market involvement.

A third area of internationalization research draws on thetheories of social exchange and resovirce dependency and fo-cuses on firm behavior in the context of interorganizationaland interpersonal relationships. Referred to as the "networkperspective," this view argues that organizational boundariesincorporate both formal and informal relationships (Johan-son and Mattsson 1988). As a result, it offers an alternativeconceptual view of internationalization, because FDI theorydoes not account for the role and influence of social relation-ships in business transactions (Johanson and Mattsson 1987).Internationalization also emerges as patterns of behavior in-

44 Nicole E. Coviello and Kristina A.-M. Martin

fluenced by network members, whereas FDI theory assumesrational strategic decision making. Compared with the stagemodels' unilateral process, the network perspective intro-duces a more multilateral element to internationalization (Jo-hanson and Vahlne 1990). That is, though foreign marketentry still may occur over time, it is a result of interactionand the development of a multitude of relationships (Johan-son and Vahlne 1992).

The areas of internationalization research discussed previ- = ^ = = = ^ ^ = i = = ^ = = =ously are well developed, with much of the current interest Internationalizationfocused on the network perspective. A large portion of the lit- and the Service SMEerature also emphasizes manufactming firms, though serviceindustries increasingly have received attention (Buckley,Pass, and Prescott 1992; Dunning and Kundu 1995; Edvards-son, Edvinsson, and Nystrom 1993; Erramilli 1989, 1991; Er-ramilli and Rao 1993; Li 1994; Sharma 1988; Sharma andJohanson 1987; Sijbrands and Eppink 1994).

With regard to firm size, however, the general patterns in theextant literature suggest that the primary interest has been inlarge firm activities. This emphasis is supported by the find-ings of Coviello and McAuley's (1999) review of research onthe internationalization of SMEs. For example, during theten-year period ending in mid-1998, Coviello and McAuley(1999) identify only sixteen journal articles specific to theprocess of SME internationalization (not including thebroader literature on SME export practices and performance,FDI characteristics, and so forth). Only five of these studiesfocus on service firms: three investigate the software sector,one compares traditional service firms and manufacturing or-ganizations, and one examines a variety of business servicesectors. Even a recent eight-nation study on SME internation-alization (Haahti, Hall, and Donckels 1998) is focused solelyon manufactvu-ing firms.

On the basis of these patterns, contemporary research on theinternationalization of service SMEs appears quite limited.Coviello and McAuley (1999) also raise the concern that (1)the three general areas of internationalization research tendto be examined independently of one another, and therefore(2) the literature has become overly specialized as differenttheories compete to explain the concept of internationaliza-tion. As discussed by Van de Ven (1989, p. 487), the dangerexists, in that "proponents for each theory engage in activi-ties to make their theory better by increasing its internal con-sistency often at the expense of limiting its scope." Thisspecialization is of concern, because none of the three theo-retical frameworks may be truly distinct. This was first evi-denced by Aharoni's (1966) findings that FDI reflects a stagedmanagerial learning process. In addition, more recently, Lau(1992) found evidence of both internalization and incremen-

Internationalization of Service SMEs 45

RESEARCH PURPOSE

RESEARCH METHOD

tai internationalization in SMEs. Yet other studies concludethat SME internationalization encompasses aspects of boththe stage models and the network perspective (Bell 1995;Coviello and Munro 1997).

Such findings suggest that FDI theory, the stage models, andthe network perspective provide complementary rather thandistinct views on the internationalization concept. Only onestudy has heen identified, however, that attempts to examineSME internationalization by integrating all three areas of theliterature (Zafarullah, Ali, and Young 1998). In the context ofan exploratory study on manufacturing SMEs in Pakistan,their study shows little support for aspects of FDI and thestage models and concludes "the importance of contacts andconnections in all aspects of internationalization is support-ive of network theory" {Zafarullah, Ali, and Young 1998, p.21). Unfortunately, though this investigation is unique in itsdiscussion of all three theoretical frameworks, it seems simi-lar to other research that examines more than one theory.That is, Zafarullah, Ali, and Young's (1998) primary intent isto investigate the applicability of individual theories relativeto one another. Few, if any, efforts therefore have approachedthe challenge of understanding SME internationalization in acomprehensive and integrative manner, in spite of findingsthat suggest this is appropriate.

If internationalization is too dynamic and broad a concept tobe defined exclusively by any one area of research, perhaps itencompasses several representations that should be exploredwith greater coherence. Therefore, the objective of this studyis to examine empirically the internationalization of serviceSMEs in the integrated context of FDI theory, the stage mod-els, and the network perspective on internationalization. Byintegrating the three major internationalization theories, thisresearch should enable the development of a more holisticand relevant understanding of key managerial processes.Similarly, by focusing on service SMEs, this research offersinsight to the internationalization of service firms and SMEs,both of which are underrepresented in the literature.

The investigation involves case research across fovu- SMEs inone service sector. The case approach is deemed most appro-priate for this research problem, in that richly detailed infor-mation is likely to be obtained. This method also allows forcomparison across other case research that examines multi-ple conceptualizations of internationalization (for example,Zafarullah, Ali, and Young 1998).

The choice of SMEs was governed by the research purpose.Three of the selected sites have between 23 and 55 employ-ees and thus fit within the Organization for Economic Coop-eration and Development small business criterion of 200


employees, as well as within Erramilli's (1989) criterion of100 employees in a service firm. Although one site is overthis limit (250 employees), it falls well within the limit of500 employees often used to define SMEs (Bonaccorsi 1992;Erramilli 1991). Moreover, all four sites meet generally ac-cepted criteria for small firms (Beamish, Craig, and McLellan1993), with annual sales ranging from US$4 million to $15million (at time of data collection). Although this exceeds Er-ramilli and D'Souza's (1993) cut-off of US$2.5 million for en-gineering and architecture firms, the case firms still can beconsidered SMEs.

One population was used to select the case sites: NewZealand-based engineering consulting firms (ECFs). Thechoice of a single sector within tbe service industry recog-nizes tbat tbe internationalization process is embedded intbe sectoral context (Melin 1992) and tbat service organiza-tions can be very different in tbeir nature (Boddewyn, Hal-bricb, and Perry 1986; Lowendabl 1993; Vandermerwe andCbadwick 1989). Engineering consulting firms were cbosenbecause tbey are considered tecbnical consulting firms, aswell as professional business organizations (Erramilli 1989;Vandermerwe and Cbadwick 1989). Tbe results tberefore canbe compared witb tbe existing literature on tecbnical consul-tants (Lowendabl 1993; Sbarma 1988; Sbarma and Jobanson1987) and ECFs (O'Farrell, Wood, and Zbeng 1998). Fvirtber-more, because tbe extant literature on tbe internationaliza-tion of service SMEs bas focused primarily on tbe activitiesof software firms, it is important to examine anotber servicesector.

Sites were generated on tbe basis of several different cbarac-teristics, as recommended by Eisenbardt (1989). Tbe casefirms bad sligbtly differing product and market cbaracteris-tics, and individual sample elements were senior managersresponsible for internationalization activities. Tbus, tbe keyinformant for tbree of tbe case sites was tbe cbief execu-tive/company founder (supported by otber relevant man-agers). The key informant at tbe fourtb site was tbe seniorexecutive wbo bas been responsible for tbe company's inter-nationalization efforts.

Data were collected from multiple sources and focused onidentifying tbe general process and pattern of international-ization, decisions surrounding initial and subsequent inter-nationalization, market selection, mode of entry, andinfluences on tbese decisions (including tbe role of variousmarket relationsbips). Tbus, information was obtained to en-able analysis relative to tbe tbree tbeories of internationaliza-tion of interest in tbis investigation. Tbe primary source ofinformation was taped and transcribed interviews, supportedby veirious internal documents. Tbe interviews were con-


RESULTS

Table 1.Case Summaries

(at time of data collection)

ducted over a six-month period, with eight to ten hours spentin each organization. Interview's were open-ended yet semi-structured, with each informant receiving a case protocol andlist of questions in advance. After primary and secondarydata collection was completed, a biographic case history ofinternationalization issues was developed for each site. Thecases were checked for accuracy by each informant, revised ifnecessary, and released to the authors for data analysis.

Data analysis involved pattern matching and explanationbuilding, as developed by Yin (1989). This approach wasaided by a variety of analytical tools applied within andacross the cases, as suggested by Miles and Huberman (1984).For example, checklists, time-ordered matrices, and eventlistings were used to identify and chronicle critical eventspertaining to international decision making and expansion.Because of the historical perspective of the research, allanalysis was conducted chronologically; the basic sequenceof cause and effect should not be inverted. Furthermore, amajor area of the internationalization literature focuses on se-quential stages; thus, chronological analysis is relevant. As isconsistent with qualitative research methods, no attempt wasmade to operationalize and measure concepts on an a prioribasis. Rather, transcripts were content analyzed, then inter-preted and coded as a means for labeling dimensions thatemerged in the process of data collection. In most cases, di-rect quotes from case informants were used, because theybest reflect the phenomena under investigation.

This section presents the research findings, beginning with asummary of the firm characteristics. Based on within andcross-case analysis, patterns are presented in four areas: (1)the decision to internationalize, (2) subsequent international-ization, (3) market selection, and (4) mode of entry.

Summary characteristics of the four case firms are high-lighted in Table 1. Although specific sales revenues are confi-dential, total annual sales at time of data collection rangedfrom US$4 million to $15 million. Overall, these four firmsaccounted for most of the international business undertakenby the New Zealand engineering consulting sector and wereregarded by industry reports as the firms with the greatest in-ternational experience.

CaseSite

1

2

3

4

Firm Size(employees)

250

23

55

25

Firm Age(years)

8

5

25

11

YearsOffshore

7

3

14

4

Percentage Salesfrom OJfehore'

30

10-2025-30

5

First ForeignMarket

Cook Islands

India

Papua New Guinea

Fiji

'Actual per annum sales levels are confidential.


Prior to internationalization, three of the fovir case firms pos-sessed internal resources in the form of personnel with sig- The Decisionnificant offshore experience. Using this expertise, both Firms to Internationalize1 and 2 made early decisions to internationalize and ex-plored avenues for developing their international businessthrough external agencies: the Asian Development Bank(Firm 1) and New Zealand government trade initiatives (Firm2), Firm 3, in contrast, did not possess similar in-house expe-rience. Its decision to internationalize occurred when a firmin its network of relationships approached Firm 3 for specifictechnical knowledge to tender for an offshore project. As thekey informant at Firm 3 explained.

It was a time when New Zealand consultants were look-ing over their shoulders at opportunities offshore in de-veloping regions. I know [we] did not think about itconsciously. It was an [alliance] with another companycalled [ ]. They had a strong wish to operate on an inter-national basis. It might only be the circumstances of thiscompany, but we were influenced by [ ] ... this devel-oped out of a very strong personal relationship at the di-rector level of both companies.

The initial opportunities for Firms 1 and 2 arose early intheir life cycles and were initiated by other companies seek-ing their technical expertise and experience. Both firms werein a position to take advantage of the opportunity becausethey already had decided to develop offshore, possessed theexcess capacity required to provide the service, and per-ceived the project to be low risk. In contrast, though Firms 3and 4 possessed international expertise emd excess capacity,they did not make the decision to pursue offshore businessuntil they were well established. For example. Firm 4 did notconsider internationalization until seven years after beingfounded. At that time, it too was approached by an organiza-tion seeking the firm's expertise.

The decision to internationalize was, for Firms 1 and 2, a de-cision based on (1) the acknowledged, specialized, knowl-edge-based nature of their service; (2) the underlying desireto spread risk; and (3) the realization that the opportunity forgrowth in the domestic market was limited. As the key infor-mant in Firm 2 noted.

We [the directors] thought that in the mid- to long-term,we have got to have an offshore presence, because weare a service, it's marketable overseas, so we thoughtwhy not? There isn't sufficient demand for our specialtyin New Zealand if we want to grow.

Thus, Firms 1 and 2 are considered active in their approachto internationalization, whereas Firms 3 and 4 are more reac-


tive, in that prior to their first offshore activity they were notseeking proactively to internationalize. This is due in part tothe timing of their international expansion efforts. For exam-ple, when Firm 3 was approached to go offshore in the early1980s, it already was enjoying a climate of substantial buoy-ancy for the domestic engineering consulting market. As forFirm 4, the internationalization of competitor firms provideda significant void in the New Zealand market. This firmtherefore chose to focus on meeting domestic demand andthen respond to international demand as it arose. In contrastto both these cases, Firms 1 and 2 were established in a timeof an acknowledged downturn in the domestic market, thusprompting internationalization.

In all four cases, the stimulation for initial offshore businessoriginated in each firm's extensive social and technical net-works. As noted by the key informant at Firm 4,

The engineering business is like this, it's nine parts oldcontacts and one part just walking around and makingnew contacts. In our case, one of our directors was ap-proached due to his past work in Fiji—he was ap-proached directly.

Similarly, the key informant at Firm 2 commented:

The first client was an English company. I used to workfor them and when I came back here [to New Zealand]and they needed someone to work on a specific projectin India, they thought of me. They did not have any ex-pertise in the necessary area.

In three firms (Firms 1,2, and 4), initial networks were basedon previous formal relationships between employee and em-ployer, in which the employee worked offshore and gainedexperience prior to founding or joining one of the case firms.However, the relationships that actually stimulated interna-tional expansion were informal and personal in nature, be-cause they resulted from collegial and friendship-basedrelationships that emerged from the original, formal contacts.In contrast. Firm 3 had no personnel with international expe-rience prior to internationalization, and its initial activitywas in response to a request from a firm within their formalnetwork. Note, however, that this opportunity arose becauseof the friendship between directors in each company.

In summary, the major demand that stimulated international-ization was generated from networks of relationships, bothformal and informal as well as technical and social. Althoughthere was some desire to minimize the risk associated with alimited domestic market, none of the firms specifically initi-ated foreign market expansion as a result of specific


cost/benefit analysis or explicit desire to achieve, for exam-ple, economies of scale.

Two of the case firms (1 and 2) became committed interna- = = = = = = ^ ^ ^ ^ ^ ^ ^ ^ ^ = = ^tional firms within two years of their establishment. Their Subsequentfounders had decided early on to be internationally active Internationalizationand, thus, focused their efforts on building international con-tacts and recruiting experienced personnel. Market identifi-cation was not, however, a controlled or planned process.Rather, it arose from the opportunities presented by variousactors in each firm's network. Since international expansionbegan. Firm 1 has served as many as nine markets. Of these.Firm 1 has had ongoing involvement in four. Similarly, Firm2 has served a total of six markets, with ongoing involvementin three. Market exit appears to reflect the ECF's project-based service, as well as managerial decisions to seekwork actively in markets in which it has an establishedtrack record and a strong network of formal and informalrelationships.

In contrast to the internationalization of Firms 1 and 2, Firm3 did not go offshore for 11 years. After Firm 3 first went off-shore in 1981, no further expansion occurred until 1986(though that first contract resulted in business that lasted for7 years). In 1985, however. Firm 3 was restructured, and thisis considered by the key informant to be the driver behindproactive internationalization. Since 1986, Firm 3 has serveda total of five foreign markets in addition to New Zealand,four of which are ongoing. Similar to Firms 1 and 2, Firm 3now has decided to focus on existing markets to build repu-tation and profile.

Firm 4's overall pattern of internationalization has been, incomparison, more reactive. It entered its first foreign marketat year 7 and has served only two markets outside NewZealand. Both opportunities were generated by a potentialclient seeking the acknowledged expertise and experience ofthe firm's consultants. Management now recognizes the needto expand international operations if the company is to con-tinue to grow. To facilitate this, the organization is changingits structure and work processes and has a stated commit-ment to recruiting personnel with international experience.

The factors influencing subsequent internationalization deci-sions for the case firms are much the same as the factors in-fluencing the initial decisions of Firms 1 and 2 (discussedpreviously). Three notable additions are, however, the im-portance of (1) government stimulation, (2) client follower-ship, and (3) network contacts with other contractors.Although Firm 1 initially commented that it had not usedgovernment assistance, government aid funding was a notedfactor in driving the firm to seek offshore contracts. Ulti-


mately, Firm 1 made the decision to move away from aidwork and not compete with other New Zealand firms tender-ing for such contracts in the Asia-Pacific region. Rather, it de-cided to "go it alone" and seek out projects before they wereput up for tender. This necessitated the focused developmentof networks of relationships, as discussed previously. In thecase of Firm 2, government stimulation came in the form ofan advisory/education service. Firm 2 also has pursued astrategy of using government contacts to develop its offshorehusiness. This strategy has developed to the point that one ofthe professionals (the key informant) is involved with NewZealand government trade missions to Asia-Pacific nations.

Client followership is identified in three case firms (Firms 1,2, and 3). Successfully completed projects stimulated contin-ued demand from clients, especially in the aid for develop-ment and host government sectors. In another example. Firm2 followed a client to Germany for a one-off project. This re-flects the nature of ECFs, because projects generated throughclient followership are often overseas term contracts. Simi-larly, examples of piggybacking are identified across Firms 1,2, and 4, in which the ECF acted as subcontractor to anotherfirm, a firm that drove market entry. Again, however, theseopportunities arose through network contacts.

Overall, subsequent internationalization of the ECFs hasbeen rapid and facilitated largely by network relationships(with government contacts, clients, and other contractors).Changes in management structure and increased manage-ment experience also influence internationalization.

All initial offshore business for the case firms was in theMarket Selection Asia-Pacific region: Cook Islands, India, Papua New Cuinea,

and Fiji. Also, subsequent markets were primarily in theAsia-Pacific, including Cambodia, Vietnam, Indonesia, thePhilippines, and Laos (though Firm 1 entered the UnitedStates, and Firm 2 entered Cermany and Sweden on a tempo-rary basis for short-term projects). The Asia-Pacific locationswere considered by key informants to be geographicallyclose, which therefore maximized the ease of conductingbusiness offshore. As noted by Firm 3 in particular, PapuaNew Cuinea was considered "close enough" to reduce anyrisk associated with conducting business overseas. This,combined with the seemingly unlimited demand for special-ized engineering services in the region, has led to the percep-tion that the Asia-Pacific market is lucrative for ECFs. Thekey informant at Firm 2 commented:

We are not chasing work in Africa or Afghanistan, butwe are chasing a project in Laos, because we know com-panies who have a presence there.... [We're not chasingprojects in Afghanistan and Africa] because we have no


contacts there, we are nobody. It's too far away, andthere is more than enough work to do in Asia, and wemust make the maximum use of our marketing dollars.

Market selection did not appear to be influenced by sophisti-cated cost/benefit analysis, government initiatives or require-ments, local infrastructures, or psychic distance. This latterpoint is of particular interest because the Asia-Pacific mar-kets are all psychically distant from New Zealand, in thatthey have significantly different cultures, political systems,trade practices, and so forth. Overall, however, psychic dis-tance was not considered important because the firms, in asense, already had overcome this barrier by employing inter-nationally experienced personnel of many different national-ities. Furthermore, because they entered markets throughnetwork contacts, psychic distance also was reduced.

To summarize, case analysis shows that the choice of initialand subsequent market(s) was driven mainly by the locationof clients and network contacts. Related to this, each firm'sstrategy was to operate wherever the project opportunitieswere. However, the key informants also are focused con-sciously on geographically close markets because of the per-ceived growth opportunities in the Asia-Pacific region.Therefore, though the firms appear to react opportunisticallyin their entry in certain markets (e.g.. Firm 2's short-termcontract in Sweden), they are focused on entrenching theirposition in established markets. Finally, managers do notperceive psychic distance as a barrier to internationalizationin the Asia-Pacific region.

In the entry modes for the case firms, the degree of invest- ==^=^=^^==^^^=^=^^ment presence and control in foreign markets varies. Al- Mode of Operationthough the primary mode of entry is a form of exporting,other mechanisms include joint ventures, partnerships, in-formal alliances, and the establishment of branch offices.

Firms 1,2, and 4 began internationalization by achieving atemporary market presence through exporting key personnelon a term basis, personnel who ultimately return to NewZealand. For example, though Firm 2 merged with a smallNew Zealand-based ECF in 1994 to broaden its domestic skillbase, its primary mechanism for internationalization was toexport knowledge and expertise by acting as the contractor toa foreign client or, occasionally, as subcontractor for other or-ganizations (i.e., piggybacking). Although the traditionalview of exporting implies no physical movement by the ser-vice provider, this form of market entry continues to be themost common method to service foreign markets.

Although Firm 3 began internationalization through an al-liance with a New Zealand-based firm in Papua New Guinea,


most of its international activity since then has relied on ex-porting. Firm 3 also develops informal alliances for the dura-tion of specific projects. Since Firm 3 became committed tointernationalization, it has targeted two markets: Cambodiaand Thailand. Informal relationships bave been made witbkey decision makers in governments of botb countries; tbesecontacts arose from Firm 3's evolving network. To illustratetbe nature of some of tbese relationsbips. Firm 3's key infor-mant comments:

It all came out of a cbance job we did ... we did a majorbouse design for a New Zealander wbo was involvedwitb tbe United Nations in Cambodia. Tbey were look-ing for someone to do emergency work on tbe roads tomake tbem passable to repatriate tbe people, but moreimportantly to set up a network and transport system sotbey could actually bave democratic elections. Tberewas so mucb arguing going on internally and nptbingwas being done, tbat we were asked to get someonetbere on tbe ground. We did, and in tbe end, be wasworking as project manager for all emergency works.

Tbe firm took advantage of tbis opportunity to enter Cambo-dia and seconded several key staff members to tbe Cambodiangovernment. Furtber work in neigbboring Tbailand bas beengenerated directly from tbese employees working witbin tbeCambodian government. Of note, bowever, is tbat all work intbese markets continues to involve exporting, witb personnelremaining based in New Zealand in tbe long term. As notedpreviously. Firm 4 began internationalization by exporting,but more recently, consideration bas been given to allying it-self witb otber organizations. Altbougb not finalized, tbe op-portunity to joint venture bas resulted from tbe firm'sincreased international visibility and expertise, and it basbeen approacbed by Canadian, Britisb, and Japanese firms intbis regard.

Tbere is also some {albeit limited) evidence of FDI by Firm 1.Tbis company recognized tbe need for private investment intbe Pbilippines power generation market and, as a result, in-vested considerable resources in personnel training. Initiatedby Firm 1, a joint venture was formed witb two NewZealand-based investment/finance firms in 1995. Firm 1 is,bowever, a nonequity partner and contributes only tbe inter-national expertise and contacts.

Finally, in botb tbe Pbilippines and Indonesia, Firm 1 basformed a partnersbip witb a local ECF and establisbed officestbere. Tbis decision was made for tbe purpose of meetingbost government regulations, and control still is maintainedin New Zealand (witb key decisions being made by NewZealand-based personnel). Firm 1 also bas establisbed a


brancb office in Australia. No otber investment is apparent intbe form of FDI, mergers, acquisitions, or establisbment of afiill-scale subsidiary. Only Firm 3 "invested" key personnelby seconding employees to tbe Cambodian government.

In terms of subsequent modes of entry. Firms 1 and 4 botbevolved from exporting to using alliances or joint ventures,and Firm 1 took tbe furtbest step down tbe establisbmentcbain by opening brancb offices. However, no similar patternis apparent for Firms 2 and 3, and even Firm 1 uses a varietyof mecbanisms in parallel, wbicb reflects tbe nature of tbeclient and bost country requirements.

In general, tbe small ECF's mode of operation does not reflectrational, planned borizontal or vertical integration. Tbemode of operation is decided by tbe project or market andgenerally guided by tbe desire to retain control of serviceprovision, as well as client requirements, tbe bost govern-ment regulations, and tbe extent of tbe firm's ability to per-form tbe services required. Tbis bas led to a variety ofdifferent initiatives by tbe case firms to secure internationalbusiness, tbougb none bas been involved witb significant eq-uity investment. Ratber, tbe case firms provide tbe tecbnicalexpertise and experience, and bost country governments, for-eign aid. New Zealand partners, or foreign investors providetbe equity.

Tbis researcb identifies several factors tbat influence tbe ma- ^^^^^^^~~~~~~~~~~~~'^^^jor internationalization decision areas for ECFs. Tbese are DISCUSSIONsummarized in Table 2 and discussed in tbe context of tbetbree general areas of internationalization researcb.

Preinternationalization, tbe case firms exbibited different at-titudes to international expansion, and tbe degree to wbicbeacb firm sougbt international business varied. Tbis con-firms Sbarma's (1988) observation of tbe active and reactivestrategies for tecbnical consulting firms. Internal cbaracteris-tics and firm resources (ratber tban external stimuli) are aconsistent factor driving internationalization; tbis perbaps isexpected given tbe "pure" nature of service in tbese firms. Adominant force stems from tbe opportunities and demandinitiated tbrougb tbe firm's network of relationsbips, and re-gardless of wbetber tbe firm is an active or reactive interna-tionalizer, network relationsbips influence tbe initial andsubsequent decision to internationalize, as well as market se-lection. Tbis supports Sbarma's (1988), Edvardsson, Edvins-son, and Nystrom's (1993), and Sijbrands and Eppink's(1994) work. Otber major influences are tbe knowledge, ex-perience, and background of tbe ECF's professional serviceproviders, tbe international experience of employees, andtbe firm's desire to ensure control of service provision. Tbissupports Bell's (1995) and McDougall, Sbane, and Oviatt's


Table 2.Factors Influencing Initial and

Subsequent Internationaliza-tion Decisions

InfluencingFactorsFinn ResourcesSpecialized, knowledge-based nature of service

Professionals withinternational experience

Networks of formal andinformal relationships

Desire to minimizerisk/enhance control

Changes in organizationalstructure

Increased managementexperience

External StimuliLack of domestic growthdue to competitivedomestic market

Government tradeinitiatives

Host governmentregulations

Client requirements/foUowership

Foreign market sizeand growth rate

Geographic location

Maior DecisionDecision to

InternationalizeInitial Subsequent

• •

• •

• •

•

•

• •

• •

• •

•

•

•

• •

Choice of Market

Initial Subsequent

• •

• •

• •

•

• •

•

• •

• •

• •

• •

• •

• •

Mode

• •

•

• •

• •

• •

• •

•

Key: • Active intemationalizer. • Reactive intemationalizer.

Contribution of FDI Theory

(1994) work. The most consistent external influence is clientrequirements/followership. Again, this stimulus affects mostdecision areas, regardless of whether the firm takes an activeor reactive approach to internationalization.

Vandermerwe and Chadwick (1989) propose that consultingand engineering firms, as an example of a pure service with ahigh degree of consumer/producer interaction, will favor afully integrated mode of international operation, such as FDI,mergers, acquisitions, or the establishment of subsidiary op-erations. Similar arguments are offered by Dunning (1989),Buckley, Pass, and Prescott (1992), and Erramilli and Rao(1993). None of the case firms has entered this level of inte-gration, likely because the capital intensity required to pro-duce the service provided by ECFs is comparatively low, thusdecreasing risk and the need for more fully integrated modesof operation. Although one case firm established offices in


foreign markets as a base for operations, control and all majorstrategic decisions continued to be made from headquartersin New Zealand. If a partnership or branch office is estab-lished, it is for the purpose of meeting statutory governmentrequirements rather than specifically decreasing uncertaintyand risk for the case firm or responding to rising costsof integration. Thus, Erramilli and Rao's (1993) work is notsupported.

At the same tinie, the results show evidence of transactioncost thinking in a manner similar to that found by Zafarullah,AH, and Young (1998). However, though Zafarullah, Ali, andYoung find little hard evidence of economic analysis, theEGFs clearly seek to invest in and capitalize on their owner-ship-specific advantage of technical knowledge and exper-tise. Furthermore, they prefer to maintain modes of operationthat ensure their knowledge-based work processes are con-trolled tightly, with information internalized (in support ofO'Farrell, Wood, and Zheng 1998). The EGFs also tend to actopportunistically and do what is necessary to secure con-tracts, maximize control, and minimize risk and costs. Gon-trol is retained by remaining in New Zealand andestablishing joint ventures or informal alliances overseas.

The financial resources of the service firm (Edvardsson, Ed-vinsson, and Nystrom 1993) and the drive for economies ofscale (Sijbrands and Eppink 1994) have not been shown inthis research to influence the initial or subsequent interna-tionalization decisions of the service SME. This can be ex-plained by Sharma's (1988) argument that the major tasks fortechnical consultancy firms are planning, thinking, and com-bining different solutions to a problem. Thus, financial re-sources are not a significant limiting factor to EGFs (insupport of Dunning 1989), and economies of scale are in-significant (in support of Buckley, Pass, and Prescott 1992).

In examining the nature of service and its effect on entrymode, Erramilli and Rao (1993) argue that there will be sub-stantial variation in entry mode choice when firms are char-acterized by low asset specificity. Overall, the results of thisstudy show only some variation in entry mode, in that a formof exporting is used most commonly. Variations on this ap-proach appear to be a function of client and government re-quirements. If a specific project or contract requiresresources that are outside the capabilities of the case firm, thefirm forms temporary alliances to enable it to complete theproject. This supports O'Farrell, Wood, and Zheng's (1998)and Lowendahl's (1993, p. 176) conclusions that technicalconsultancy joint ventures were "extremely frequent, yetthey often seemed to be designed as temporary co-operativearrangements." This also is reflected in any piggybacking ac-tivities that occur.


The preference for a form of exporting also contradicts Bod-dewyn, Halbrich, and Perry (1986), who argue that exportingper se is only appropriate for service commodities. Further-more, it challenges Buckley, Pass, and Prescott (1992, p. 43),who argue that foreign involvement hy service industries islikely to involve licensing and other contractual agreementsand FDI "at the expense of exporting." At the same time,these results support Vandermerwe and Chadwick's (1989)observation that traditional ways of thinking about interna-tionalizing services are falling away and new, hybrid modesof market entry are in evidence.

^^^^^—^^——^^^^^—-^^ Similar to the patterns for manufacturing SMEs examined byContribution of the Zafarullah, Ali, and Young (1998), the research results fail to

Stage Models support fully the argument that firms move through a seriesof stages, at least in terms of entry mode (in support of Bell1995; Coviello and Munro 1997; Erramilli 1989; Sharma1988). Such results are perhaps not surprising, because theECFs appear to reflect Johanson and Vahlne's (1990) excep-tions to their stage model. That is, (1) market knowledge canbe gained without the need for experience, (2) the conse-quences of commitment are small relative to the resourcesavailable, and (3) the firm can generalize similar experiences.For example, these service SMEs, wanting to grow their in-ternational commitment faster than can be achieved throughincremental activity over time, recruit personnel with knowl-edge of foreign markets and expertise in the client's requiredarea. The case firms also increase these capabilities throughmaintaining relationships with other players that are activeinternationally. The ECF's financial commitment to interna-tionalization is relatively small, and it has the excess capabil-ity to meet client demand. Thus, it perceives few negativeconsequences of undertaking international projects. Finally,the skills and expertise required of these service firms are notmarket-specific but generally can be transferred to many dif-ferent markets (particularly if focused in the Asia-Pacific re-gion). As a result, though some of the case firms are focusedon developing specific markets over time, internationaliza-tion also is characterized by an entry-exit behavior that re-fiects their project-based service.

Although the basic tenets of Johanson and Vahlne's (1977)model are not supported and two of the firms leapfroggedearly stages, the ECFs show an evolutionary process of attitu-dinal change. Thus, there is some support for the models thatreflect innovation adoption (e.g., Cavusgil 1984). There is alsosupport for other aspects of the Johanson and Vahlne (1977)model, in that geographic proximity influences market choice(also in support of Buckley, Pass, and Prescott 1992; Covielloand Munro 1997). This, however, is relevant for the activefirm's subsequent market choice decisions, whereas initial


market selection is governed primarily by the location of theclient that initiated the business relationship (in support ofO'Farrell, Wood, and Zheng 1998). At the same time, tiie find-ings of this study contradict O'Farrell, Wood and Zheng's(1998) conclusion that international market selection is unsys-tematic. Although ECFs are influenced by clients or networkcontacts offering international tender or piggybacking oppor-tunities, market entry is becoming more strategic. This isbased on increased knowledge, experience, and the develop-ment of strong country networks. As such, market entry deci-sions are now focused on coimtry rather than project choice.

None of the four firms considered any market more psychi-cally distant than others. This is a result of their internal andinternational experience and their ability to recruit person-nel and/or use network relationships. Nevertheless, psychicdistance influences internationalization decisions, becausethe ECFs have developed specific strategies to lessen the im-pact of this factor. This supports the findings for technicalconsultancy firms (Sharma 1988; Sharma and Johanson1987) and also the more general literatvue (Bell 1995).

This research has shown that networks of formal and informalrelationships are a major influence on internationalization Contribution ot the Networkand therefore supports Sharma and Johanson (1987), Johan- Perspectiveson and Mattsson (1988), and Johanson and Vahlne (1992).For example, ECF market selection can be driven by an op-portunity that emerges out of a network relationship (as foundby O'Farrell, Wood, and Zheng 1998). As such, the firm capi-talizes on a location-specific advantage, which arises from us-ing assets tied to a particular foreign location (e.g., a networkcontact) that the ECF finds valuable when combined with itsown assets. These patterns are somewhat similar to thoseidentified by Zafarullah, Ali, and Young (1998) except thatthe ECF networks go beyond ethnic ties, relatives, and friendsto include more diverse and formal connections.

The choice of entry mode also is influenced strongly by net-work relationships in the form of client preferences, and of-ten, the formal client—service provider exchange relationshipemerges from the firms' informal and formal networks. Thissupports the link between the firm's networks and the modeof operation observed by Sharma's (1988) examination oftechnical consultancy firms; O'Farrell, Wood, and Zheng's(1998) study of ECFs; and findings in the software industry(Bell 1995; Coviello and Munro 1997). Of note, the impor-tance of client foUowership in service firms (Bell 1995) issupported for both initial and subsequent internationaliza-tion decisions. This conflicts with Li (1994), who findsacross ten different service sectors that firms tended to followthe client at the beginning of internationalization and followthe market leader at later stages.


Finally, as a consequence of conducting work with otherfirms, combined with their acknowledged expertise in spe-cialist areas, personnel at the case firms develop and main-tain lasting relationships. Client demand, piggybackingopportunities, and bid information for international con-tracts for the ECFs came primarily from network relation-ships that were specific to individuals within the firm, ratherthan from relationships at the firm level. This finding pro-vides support for McDougall, Shane, and Oviatt (1994), whorecommend that examination be narrowed from the level ofthe firm to that of an individual or small group.

^^^^~'~^^~~~"^^"^^~~"^^^~" This research involves an empirical examination of the inter-CONCLUSIONS nationalization of knowledge-based service SMEs (specifically

AND IMPLICATIONS New Zealand ECFS) in the context of three major conceptual-izations of internationalization: FDI theory, the stage models,and the network perspective. Rather than assess the merits ofeach theory in an effort to prove one is better than another, thisstudy seeks to identify how all three might be relevant to ourvmderstanding of the internationalization of service SMEs.

Overall, the findings show that the internationalization ofECFs is influenced by several key organizational characteris-tics: (1) a product embodied in skilled personnel, (2) a rela-tively high degree of client involvement, (3) relatively lowcapital intensity, and (4) the project-based natinre of the busi-ness. These characteristics reflect the pure service compo-nent of the ECF. The findings also show that none of the threetheoretical frameworks fully explains the internationaliza-tion of this type of service SME in its own right. Thus, thestudy offers some support for the argument that the interna-tionalization of service firms is not reflected in the modelsderived from the observation and investigation of manufac-turing firms (Bell 1995; Coviello and Munro 1997; Erramilli1989; Sharma 1988; Sharma and Johanson 1987; Vander-merwe and Chadwick 1989).

When the results of this study are compared with those of Za-farullah, Ali, and Young's (1998), two interesting points arise.Certain patterns identified for the service SMEs in this studyare similar to those found for manufacturing SMEs. For exam-ple, the internationalization of both types of SMEs is influ-enced strongly by a variety of network relationships. This leadsto the question of whether industry influences are less impor-tant than those related to size. On the basis of the findings ofthis study, it might be argued that the internationalization ofsmaller firms (regardless of sector) reflects the structural, man-agerial, and resource characteristics of such organizations. Thisis not necessarily to suggest that small firm internationaliza-tion is categorically different from that of larger firms. Rather, itcan not be captvired easily in the theoretical frameworks devel-oped in the context of large organizations.


However, the research also shows that the internationaliza-tion of engineering consulting SMEs is a more complexprocess than that previously identified for small manufactur-ing firms by Zafarullah, Ali, and Young (1998). That is, SMEinternationalization is not explained solely by network rela-tionships, because concepts inherent in FDI theory, the stagemodels, and the network perspective are all evident in the in-ternationalization of smaller ECFs, and they also are interre-lated. For example, we see support for the networkperspective in that

• Internationalization is influenced heavily by the firm'snetworks of formal and informal relationships (rela-tionships involving clients, competitors, colleagues,government, friends, and so forth), and

• These network relationships influence initial marketselection and also mode of entry.

Similarly, we see evidence of the stage models of internation-alization as

• Psychic distance is acknowledged but overcome byleveraging network relationships and/or recruiting per-sonnel with expertise in psychically distant markets,

• Geographic distance is recognized and planned for(though it is not regarded as a barrier to international-ization), and

• Changes in attitudinal commitment and behavior areevident over time.

Finally, aspects of FDI are evident as

• The firms internationalize in a manner that maximizescontrol, minimizes costs and risk, and internalizesfirm-specific assets; and

• Location-specific advantages emerge through variousnetwork relationships, and these advantages are bothprotected and managed as a key cost consideration.

Because all three theoretical frameworks have relevance forECFs, we argue that comparative approaches to the study ofinternationalization are not only beneficial but also critical tooui understanding of the complexity of the processes and is-sues faced by managers in smaller service organizations. Byexamining internationalization in an integrative manner, thelimitations inherent in focusing on a single theoretical frame-work can be overcome, and a more holistic and realistic viewof internationalization may be developed.


At the same time, a limitation of this study is that it focuseson a single service sector. With the acknowledged hetero-geneity of service firms, it would be inappropriate to general-ize the results too widely. We therefore identify futureopportunities for research to enhance the generalizability ofthe current findings. The research context could be extendedto other professional business service sectors, both withinand outside New Zealand. These sectors include manage-ment consultants, other technical consultants in the scien-tific field, accounting, and legal services. Although they areall professional business service firms, there may be differ-ences between those sectors that are predominantly project-based and those that undertake continuous contracts (e.g., anauditing function). Market exit behavior (in the context of in-ternationalization) is worth investigating across both types oforganizations. Beyond professional business service firms,the research could be extended to service sectors with ahigher involvement of goods and/or a lower degree of con-sumer-producer interaction. This would allow for compari-son across a variety of service sectors.

Because of the similarities in findings across this study andthose of Zafarullah, Ali, and Young (1998), it is also impor-tant to study more closely the service/manufacturing di-chotomy in the context of internationalization. Furtherinvestigations comparing SMEs across different service andmanufacturing sectors would be useful. It is also important toinvestigate and compare these patterns across firms of differ-ent sizes to understand more fully the influence of size (andentrepreneurial behavior) on internationalization.

In the specific context of ECFs, this study could be extendedto include alternative forms of data collection, with researchconducted longitudinally. This would allow for greaterbreadth in the data generated and provide the opportunity tounderstand if and how internationalization patterns evolveas the smaller ECF grows and/or becomes more establishedand experienced. For example, the role of network relation-ships may change over time, or more explicit FDI and stagemodel patterns might emerge. Longitudinal research is sug-gested because of the relatively recent nature of the interna-tional activity of the case firms examined in this study.Further research also should examine internationalization,specifically networks, at the level of the individual ratherthan the firm. This is particularly relevant in the context ofentrepreneurial or small organizations.

With respect to managerial practice, this research highlightsthe need for managers of service-intensive firms to have acomprehensive understanding of the impact of network rela-tionships on their international market development. Theserelationships are at both the formal business level (e.g., client


relationships) and the informal individual level (e.g., previ-ous employers, colleagues, friends). Although O'Farrell,Wood, and Zheng (1998) conclude that foreign market entryis a relatively casual process for ECFs, this need not he thecase. Managers within the firm should appreciate the impor-tance of network management and network growth and,therefore, need to ensure that efforts to develop networks arenot neglected. Part of this involves understanding the net-works of relationships specific to individuals in the organiza-tion, relationships that might be nurtured or leveraged tofacilitate internationalization. Following this approach mightallow for the growth of the service SME to be managed morestrategically than opportunistically. Related to this, manage-ment can take a proactive stance on leapfrogging traditionalbarriers to internationalization by actively recruiting interna-tionally experienced personnel and maintaining the networkcontacts of these individuals.

Beyond an understanding of the role of networks, it is alsoclear that opportunities must be evaluated in the context ofresource allocation and protection of firm-specific assets. Be-cause of the pure nature of the service embodied in a techni-cal consulting or similar firm, efforts to retain quality andservice control are critical and must be balanced against theopportunities presented through network relationships.

Finally, there is a wealth of internationalization knowledgeand experience inherent in the case study firms investigated;however, this often is kept within the organization. Similarpatterns perhaps could be identified in other service and/ormanufacturing sectors. Managers should build actively onthe domestic information exchange networks currently in ex-istence to ensure efficient use of the knowledge capital ona sectorwide basis. Many firms with different areas of spe-cialization (that are therefore not direct competitors) arespending considerable time and money on knowledge accu-mulation and network development. Ideally, these invest-ments could be shared across firms competing in the samegeographical market to the benefit of the sector as a whole.

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THE AUTHORS

Nicole E. Coviello is associateprofessor of marketing atUniversity of Calgary.

Kristina A.-M. Martin is nationalbusiness planning manager forCorrs Chambers Westgarth,Sydney, Australia

ACKNOWLEDGMENTS

The authors gratefully acknowledgethe comments of the participantsfrom the International Conference onClobalization and Emerging Busi-nesses held at McCill University inSeptember 1998, the insight and sug-gestions of three anonymous JIM re-viewers, and the comments of HughMunro and Pervez Chauri.

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