James M. Bloodgood
University of South Carolina
Harry J. Sapienza
University of South Carolina
James G. Almeida
University of South Carolina
This study examined the antecedents and outcomes of the extent of internationalization of new high potential ventures at the time of the IPO. Results from 61 firms indicate that the extent of internationalization is directly related to the use of product differentiation as a source of competitive advantage, the international work experience of the board of directors, and size at the point of the IPO. The use of low cost or product differentiation as a source of competitive advantage, and size at the point of the IPO were directly related to sales growth in the two year period following the IPO. Finally, the level of internationalization at the time of the IPO is positively related to profitability two years later.
Aimed at expanding the knowledge of the determinants of the success of efforts to operate on a multi-country basis, this study examined the antecedents and outcomes of the extent of internationalization of new high potential ventures. Increased homogeneity of international markets (Hedlund & Kverneland, 1985) and improvements in the efficiency of international communications and transportation (Porter, 1990) render rapid internationalization a more attractive option than ever before. This globalization of the world economy affects not only larger, more established businesses but also newer entrepreneurial firms seeking growth and struggling to survive. Oviatt and McDougall (1994) argued recently that the formation of organizations that are international from inception is an increasingly common, and hence important, phenomenon. They labeled such ventures "international new ventures" (INVs) and defined an INV as "a business organization that, from inception, seeks to derive significant competitive advantage from the use of resources and the sale of outputs in multiple countries" (1994: 49). Some new high potential ventures (Timmons, Smollen & Dingee, 1986) plan to operate on an international basis at start-up, while others plan to sequence, delay or avoid international operations altogether. For those entrepreneurs who plan on operating on an international basis at start-up, it is important for them to understand the determinants of internationalization and the potential benefits or drawbacks associated with internationalization for the new venture. As of yet, the specific internal and external conditions which drive entrepreneurs to take on the additional risk of competing across borders is poorly understood (Oviatt & McDougall, 1994). According to Oviatt and McDougall, traditional "stage" (e.g., Stopford & Wells, 1972) and "scale" models of internationalization (e.g., Chandler, 1986) are no longer appropriate for understanding how and why firms internationalize. They suggest that important advantages may be obtainable for new ventures that establish themselves immediately on a global scale; yet existing theory emphasizes the risks of deploying assets and activities across national borders. Theory that integrates the realities of the changing international environment with traditional perspectives is necessary to explain the choice of whether or not to seek rapid internationalization of activities. Our perspective will be that INVs seek an international presence for one of two reasons. First, industry conditions may "require" an international presence to be competitive. For example, customers may require global characteristics from their suppliers, or rivals' strategies may force new entrants to internationalize in order to be competitive. Second, a venture may seek a global presence to capitalize on its unique set of resources (e.g., management team experience in global markets, new technologies or innovations, or access to resources). We will argue that such conditions must be present for rapid internationalization to be viable and that some conditions are more important than others.
Thus, for entrepreneurs contemplating international activities it is not only important for them to evaluate their industry's requirements for internationalization, but to evaluate their firm's strategic and structural characteristics as well. Certain strategic and structural characteristics will be more critical to have when attempting to effectively internationalize. Knowing which of these characteristics are more instrumental in assisting the new venture in internationalizing is valuable. This study focused on determining the strategic and structural characteristics that were most important at the time of the IPO, while the ventures were still new. Since the firms in this study were all venture capital-backed, the benefits of knowing which characteristics are most conducive to successful internationalization accrue to venture capitalists as well. This study also examined the effects of internationalization on sales growth and profitability for the two years following the IPO. Understanding the role internationalization has in impacting subsequent sales growth and profitability is also important to entrepreneurs and venture capitalists, both at the inception of high potential ventures and during their early years of operation.
Ventures can be conceptualized under the resource-based view as "unique bundles of accumulated tangible and intangible resource stocks" (Roth, 1995: 200). These resource stocks comprise the assets, capabilities, processes, routines, and knowledge possessed by the venture (Barney, 1991; Wernerfelt, 1984). These unique resource stocks are a source of competitive advantage to the venture provided they are valuable, inimitable, and non-substitutable (Barney, 1986, 1991; Dierickx & Cool, 1989). Thus, ventures which have some combinations of these resource stocks may have a greater proclivity towards internationalization as opposed to ventures that do not possess those stocks. Internationalization, following Oviatt and McDougall (1994), is the use of resources and sale of outputs in multiple countries. For our purposes, we will define the extent of internationalization as the number of primary activities in the value chain (Porter, 1985) engaged in by the firm outside of the United States.
The top management team (TMT) is a key source of competitive advantage for a venture, since the quality of decisions made by a venture is very much a reflection of its top management team. Thus, the composition of the TMT can be a critical, "intangible" resource stock. A key characteristic that distinguishes entrepreneurs from other people is their "alertness" to the potential for profitably combining resources when others are not as aware of these opportunities (Barreto, 1989). This alertness is influenced by any previous experience possessed by the entrepreneur (Casson, 1982). Executives who have been exposed to the international competitive arena may be more likely to comprehend the dynamics of those markets and be more alert to any extant profit opportunities than those who have not. Consistent with this finding is McDougall, Shane, and Oviatt's (1994) observation that founders of INVs are often immigrants who have family and personal contact overseas.
According to Roth (1995), mere exposure to the international arena is not adequate enough to develop a deep understanding of the international arena. Rather, the experiential aspect of assignments is much more valuable than mere nonexperiential exposure through responsibility for international functions. Thus, executives who have had international work experience and/or have attended schools in countries other than the U.S. would be familiar with the market conditions outside the United States. Consequently, they are more likely to perceive profit opportunities in international markets and will influence the decision towards rapid internationalization of the venture.
Hypothesis 1. The number of executives on the top management team of the venture who have international work experience and/or have been educated outside the U.S. is positively related to the extent of its internationalization at the time of the IPO.
> According to Porter (1980, 1985), a firm may enjoy preferential access to raw materials, may possess some proprietary technology, and may pursue economies of scale and/or scope. These represent sources of cost advantage and lead the firm towards being the low-cost leader in its industry. The raw materials may be available exclusively outside the home country, or there may exist a significant price differential between procuring the material from suppliers in other countries and procuring it from within the home country. In the case of some products (e.g. medical diagnostic equipment), a single domestic market may not be large enough to render the operations of the firm cost-effective. In the case of some other products, significant economies can be achieved only by operating in multiple countries. Thus, a firm that has adopted a strategy of achieving cost leadership in its industry will find it advantageous to become international from its inception.
Hypothesis 2. The adoption of a cost advantage strategy by the new venture is positively related to the extent of its internationalization at the time of the IPO.
> Miller (1991) argued that the differentiation strategy as originally conceptualized by Porter (1980) was comprised of two dimensions. The first which was based on product innovation he labelled product differentiation. The second which was based on the use of marketing techniques to achieve some perceptual distinction was labelled market differentiation. Prahalad and Doz (1987) argued that as firms try to compete in international markets, they have to simultaneously achieve the states of global integration and local responsiveness. Thus, if the features of a product can be modified to meet the needs of local markets while simultaneously permitting integration of activities across geographical markets, the firm is more likely to operate as an international venture. Hypothesis 3. The adoption of a product differentiation strategy by the new venture is positively related to the extent of its internationalization at the time of the IPO.
> A venture that adopts a market differentiation strategy will attempt to distinguish the perceptions that customers have for its product from the perceptions that they have for the competitors'. Perceptual differentiation requires the venture to understand its market in a comprehensive fashion. A venture that adopts such a strategy would then keep away from unfamiliar markets. Consequently, a venture that adopts a market differentiation strategy is less likely to venture into the international arena, at least at its inception. The organizational capacities that generate its competitive advantages in the domestic arena are different from those that create competitive advantages in the international markets (Ghoshal, 1987).
Hypothesis 4. The adoption of a market differentiation strategy by the new venture is negatively related to the extent of its internationalization at the time of the IPO.
> A venture that uses innovations to gain a competitive advantage over its rivals has to very often maneuver quickly so as to preempt competitor moves. All innovations are susceptible to imitation eventually, although firms attempt to delay this process, for instance, by seeking recourse through patent protection. If a venture has some proprietary product or technology, it will seek to establish its patent rights across geographical markets. However, competitors, especially in foreign markets, may be able to circumvent the patent laws by making minor product modifications. Consequently, the venture will have to move quickly in the international market, if it intends to preempt the competition and protect its investments.
Hypothesis 5. The greater innovativeness of the new venture, the greater the extent of its internationalization at the time of the IPO.
>Ventures that operate in the international arena have to be flexible in their operations (Bartlett & Ghoshal, 1989; Prahalad & Doz, 1987). Researchers have argued that large, established firms typically face "inertial pressures" that inhibit their flexibility. These pressures could be, for example, in the form of organizational routines (Dosi, Teece, & Winter, 1990), structural impediments to change (Hannan & Freeman, 1977), or perceptual biases of managers (Bower, 1970). Thus, large domestic firms may find it difficult to operate in the international market. Small firms, on the other hand, may not possess the resources to enter the international market. Since start-up activities demand large amounts of resources (McDougall, Shane, & Oviatt, 1994), small firms will be constrained in their intentions to enter the international markets. However, larger new ventures are less likely to face problems of inertia; at the same time, they will have greater resources upon which to build an international basis. Thus, these ventures are more likely to be international.
Hypothesis 6. The size of the venture is positively related to the extent of its internationalization at the time of its IPO.
> We have earlier posited that a venture will seek to internationalize in order to capture potential profit opportunities outside the home market or to withstand competitive pressure Thus, factors that influence the venture to internationalize should also contribute to its increased profitability. This logic suggests that realizing greater internationalization at the point of the IPO should be positively associated with subsequent performance. This logic suggests the following two hypotheses regarding the impact of initial conditions and extent of internationalization on venture performance. Hypothesis 7. Resource factors at IPO will have the same relationship with subsequent performance as they had with initial internationalization.
Hypothesis 8. The level of internationalization of the venture at the time of the IPO is positively related to subsequent performance.
The sample of 61 venture capital backed firms was drawn from a population of 76 firms that had an IPO in 1991 and were less than five years old at the time of the IPO. The 15 firms not used in the study either did not have an IPO prospectus from 1991 available from the Securities and Exchange Commission or they did not have any 1993 information from the Compact Disclosure database. The size of the firms studied ranged from zero sales in 1991 to $660 million in sales with a mean of $79 million and a median of $13 million. The number of employees ranged from 18 to 47,000 with a mean of 1668 and a median of 171.
We selected high potential firms because Oviatt and McDougall (1994) identified these types of firms as internationalizing in a manner dissimilar from traditional theories and models of internationalization. In order to further refine Oviatt and McDougall's (1994) inquiry into this phenomenon, we attempted to identify the firms within the set that were more likely to internationalize. Within this set of firms we were able to investigate why some of them internationalize and why some do not, and what impact internationalization has on performance.
Criterion and Predictor Variables
Extent of internationalization:
Qualitative information from the IPO prospectus was content analyzed separately by all three co-authors to arrive at the extent of internationalization in 1991. The five primary activities in Porter's (1985) value chain framework were used to provide a means for assessing the extent of international activities engaged in by the firms. The five categories are inbound logistics, operations, outbound logistics, marketing and sales, and service. Each category was coded with a zero or one to signify whether the firm had international activities in that category. The five individual category values were summed and then divided by five to arrive at the percent of primary activities that were international activities. This percent was the internationalization rating and it ranged from zero to one. The initial level of agreement among the three co-authors on this measure was 92.3%. All discrepancies were resolved through discussion.
International exposure of the top management team:
Qualitative information from the Management section of the IPO prospectus was used to determine the number of directors with previous international work experience and the number of directors with international schooling. The Management section of the IPO prospectus lists each directors' school and work experience. The number of directors with international exposure was used rather than the percentage of the directors with international exposure because we feel the total amount of exposure is more critical than the percentage with exposure. For example, a firm with 20 directors, of whom 10 have international exposure, would have much more international experience to draw from than a firm with two directors, of whom both have international exposure. The latter firm has a higher international experience ratio, but has a much smaller resource to draw from than the former firm. The international schooling or international work experience measure ranged from zero to four.
Sources of competitive advantage:
Qualitative information from the IPO prospectus was content analyzed separately by each co-author to determine if the firm uses any of Porter's (1980) three competitive weapons, cost advantage, product differentiation, and market differentiation. A zero or one was used for each possible competitive weapon to signify whether or not the firm used it as a source of competitive advantage. The initial level of agreement among the three co-authors on this measure was 95.8%. All discrepancies were resolved through discussion.
Firm innovation was calculated by dividing research and development expenses by total expenses excluding interest and taxes. This information was obtained from the income statement contained in the IPO prospectus. Some of the firms in this study did not have sales in 1991, and therefore a typical measure of innovation such as R & D divided by sales could not be used because of the computation problem that would be incurred in the analysis by having a zero in the denominator. In this case R & D, divided by total expenses excluding interest and taxes more accurately reflects the innovative effort the firm is engaging in (see the discussion of performance for why interest and taxes are excluded). The range of the innovation ratio was from zero percent to 100 percent, with a median of 11 percent.
The logarithm of the number of employees was used to measure the size of the firms. Since the firms were relatively new, some of them did not have any sales at the time of the IPO. Here, we believe that employees would be a better representation of the size of the firm. In this study the number of employees more accurately reflects the activities the firm is engaging in. Because of the wide variance in the number of employees (18 to 47000) the logarithm of employees was used. The median number of employees was 171.
Two important measures of performance for high potential new ventures is sales growth and income. We used both measures to provide a more comprehensive evaluation of the predictor variables' impact on performance. The change in sales from 1991 to 1993 was divided by 1991 sales to determine the growth in sales. The growth in sales from 1991 to 1993 was used rather than 1993 sales in order to control, to some extent, for the initial level of sales. Sales growth ranged from a negative 100% to a positive 800% for all but one firm which had sales growth of 88275%. The median increase in sales was 84%. This information was taken from the income statements located in the IPO prospectus and the Compact Disclosure database.
Earnings before interest and taxes was used as the measure of income. This was used instead of net income in order to reduce the impact of financing on firm income through interest charges. Earnings before interest and taxes better reflects the performance of operations in a multi-country study because exchange rates and differences in tax laws may distort net income. Taxes were excluded because of the variance in net income caused by tax deductions from items such as losses being carried forward, which can be common in new firms. Income before interest and taxes ranged from a $179 million loss to a $151 million gain, with a median of a $2 million loss. This information was taken from the 1993 income statement located in the Compact Disclosure database.
There is very little consensus on the method by which the performance of new ventures should be evaluated (Biggadike, 1976; McDougall, Covin, Robinson, & Herron, 1994). We measured performance in terms of growth in sales and earnings before income and taxes (EBIT). McDougall et al. (1994) have argued that the use of return on sales (ROS) as a performance indicator can lead to ambiguous interpretations, especially in high growth industries since some ventures may prefer to reinvest their earnings in the business so as to keep pace with the industry. Consistent with their recommendation we chose to capture venture performance in terms of sales growth. We used EBIT instead of net income so as to minimize the effect of any accounting or tax treatments on the earnings of the venture.
In order to focus on the variation in the extent of internationalization, income, and sales growth due to the criterion variables we controlled for variation due to differences in financing methods.
> Leverage: Consistent with the standard method for calculating leverage of dividing debt by equity, this study divided total liabilities by total equity. Debt can be incurred in a variety of ways including loans, trade accounts, lease liabilities, etc. Using total liabilities best accounts for these various types of debts. The range of this ratio was from -226.4 to 103.0, with a median of .27. These figures were taken from the balance sheets located in the IPO prospectus.
> Table 1 presents summary statistics for and zero order correlations among all the variables.
The first set of hypotheses were tested by regressing internationalization against the six predictor variables and the one control variable. The last two sets of hypotheses were tested by regressing sales growth and income against the original six predictor variables, the level of internationalization, and the one control variable. Computationally we could not use a zero value for the denominator of the dependent variable in the sales growth regression so the seven firms with zero sales in 1991 were eliminated from that analysis. Table 2 presents results of the tests of the hypotheses.
Impact of Initial Conditions on Internationalization
Hypothesis 1, which predicted that internationalization will be higher in new ventures in which members of the board of directors had international work experience and international schooling, was partially supported. International work experience was positively related to internationalization, while international schooling was not significant. Hypothesis 2, which predicted that internationalization will be higher in new ventures that used low cost as a source of competitive advantage, was not supported. Hypothesis 3, which predicted that internationalization will be higher in new ventures that used product differentiation as a source of competitive advantage, was supported. Hypothesis 4, which predicted that internationalization will be lower in new ventures that used market differentiation as a source of competitive advantage, was not supported. Hypothesis 5, which predicted that internationalization will be higher in new ventures in which innovation is high, was not supported. The relationship was marginally significant but negative. This was opposite of the predicted relationship. Hypothesis 6, which predicted that internationalization will be higher in new ventures that are larger, was supported.
Impact of Initial Conditions and Internationalization on Performance
Hypothesis 7, which predicted that performance would be higher in new ventures in which board members had international work and school experience, used low cost or product differentiation as a source of competitive advantage, used more innovation, and were larger, and that performance would be lower in new ventures that used market differentiation as a source of competitive advantage, was partly supported. Three of the predictor variables, low cost, product differentiation, and size were positively and significant related to sales growth. Innovation was also positively related to sales growth but only at a marginally significant level. Innovation, however, had a significantly negative relationship with income.
Hypothesis 8 predicted that sales growth and income would be higher in new ventures that had higher levels of internationalization. This hypothesis was partially supported. Internationalization was positively, but weakly, related to income, but was not related to sales growth.
This study examined the relationships among initial conditions, degree of internationalization at the point of initial public offering, and performance two years later for 61 venture capital-backed firms. Using a resource-based framework, we examined the initial conditions leading to more or less internationalization at IPO and the impact of these initial conditions and the degree of internationalization on venture performance two years later. Consistent with Oviatt and McDougall (1994), we observed that many high potential ventures were indeed substantially internationalized even at the very earliest stages of their development. However, we found that the development of early international activities varied in some systematic ways depending upon the firm-specific conditions facing the ventures. As hypothesized, we found that venture size and pursuit of product differentiation at IPO were positively associated with greater internationalization; we also found partial support for our prediction that the international experience of the ventures' officers would have a positive impact on the initial degree of internationalization. In terms of subsequent performance, we found initial conditions and the degree of internationalization significantly associated with venture performance two years after IPO. Initial cost advantage, product differentiation, and size were positively related to sales growth from 1991 to 1993. Innovation was also found to be positively and significantly related to sales growth, but only marginally so. As predicted, the degree of internationalization at IPO was positively related to income two years later; however, contrary to expectations, innovation had a negative impact on income.
Our results show that the specific resource base of new ventures influences how internationalized they are early on. Ventures with more employees at the point of IPO were significantly more internationalized than smaller firms. Given the increased scope of international operations, this finding is not the least surprising. However, if early internationalization does bring competitive advantages, it adds an additional reason to those already suggested by Timmons et al. (1985) as to why new ventures with growth aspirations ought to "think big" and "start big" from the beginning. Further, ventures were significantly more internationalized if they were seeking competitive advantage through product differentiation; this finding is consistent with our reasoning that ventures internationalize earlier on in order to exploit a distinctive competence or feature. For our sample, it is possible that firms are moved to internationalize early when their products are perceived by management to be especially unique outside the U.S. Finally, our data show that international experience of the venture's officers is associated with the extent of international operations. Whether this relationship is a reflection of international networks established through experience or of specific international knowledge acquired cannot be ascertained from our data.
Initial resource conditions and extent of internationalization appear to affect growth in sales differently than they do earnings. The extent of internationalization was not significantly related to growth in sales, but venture size, low cost advantage, product differentiation advantage, and innovation were all positively associated with the rate of sales growth in the two years following IPO. The lack of a significant change in sales for internationalized firms may reflect the fact that such firms already had a significant lead in sales at the point of IPO and therefore did not grow significantly. Forty-eight percent of the firms in this study had at least some international operations. Supplementary analyses of the data show that firms with an international presence in 1991 had on average $105 million in sales, while those with no such presence had $55 million in sales. T-tests reveal that this difference is significant at p=.07. The extent of internationalization was marginally related to earnings two years after IPO; advantages may accrue to those with a greater international presence, but we consider these results too weak to be more than "suggestive" at this point. Finally, the lack of a highly significant relationship between innovation and growth and the unanticipated negative relationship between innovation and earnings merit comment. One explanation for these results is that the two year period under consideration is too short a time for the positive effects of investments in research to be reflected in operational results; this explanation is consistent with the lack of a strong relationship with sales growth and with the negative impact incurring such expenses would have on earnings prior to the commercialization of research efforts. A second explanation is simply that R&D expenses as a percent of total expenses does not capture innovation well in new ventures.
Our results hold several important implications for entrepreneurs, prospective entrepreneurs, and researchers of entrepreneurial and international business phenomena. First of all, our results suggest that entrepreneurs need not necessarily follow a slow, sequenced pattern to effectively enter international markets. Indeed, it may be that the rapid globalization of markets require that certain firms compete internationally virtually from the outset. At the same time, however, certain resource conditions appear more amenable to rapid internationalization of new high potential ventures. Ventures with more top managers experienced in international markets appear to realize international aspirations more readily than those with fewer such managers. Similarly, those ventures that start bigger and pursue product differentiation are initially operating on a more fully internationalized basis.
> We are hesitant to speculate about performance implications at this point. While Oviatt and McDougall (1994) suggest that certain competitive advantages are likely to accrue to ventures capable of establishing international presence and operations from the outset, we can only say that our results are not inconsistent with this position. To a certain extent, we will have to allow more time to pass and re-examine the progress and positioning of the ventures in our sample and to expand the sample before we can feel confident in our judgment regarding the likely impact of early internationalization on performance of new high potential ventures. In fact, we have argued that early internationalization will be more appropriate under some circumstances than under others. This logic suggests that early internationalization is neither uniformly good nor uniformly bad but rather is contingent upon the industry and resource conditions faced by the venture at founding and soon thereafter. It remains a significant research challenge to articulate and test these contingencies.
Limitations and Future Directions
Our sampling choice of venture capital-backed IPOs allowed us to control somewhat for the impact of differences in the growth aspirations of new firms on the extent of their internationalization at IPO. At the same time, such a constraint may limit the generalizability of our findings to firms receiving substantial initial backing from outside sources. However, the greatest limitation of this study arises from exactly the opposite problem. Because we did not focus on one industry but included all ventures meeting our criteria, the danger existed that industry effects would overpower any effects which resources might have on internationalization and subsequent performance. Nonetheless, the fact that significant effects are and that a substantial proportion of variation is accounted for in all models provide strong evidence that resource factors and internationalization are related across settings. In terms of performance effects, the time period examined may have been too short for more permanent effects to be realized, and, consequently, our confidence in these results must be tempered.
> This research stream is somewhat in its infancy, but the above methodological limitations suggest some improvements future researchers may wish to keep in mind in pursuing this line of investigation. First, studies done on an industry-by-industry basis may more fully reveal what resource considerations are most critical in different industries, and a comparison of such studies may help to reveal why. Further, studies which are done across industries may seek additional data (e.g., average industry R & D spending, profitability) to help control for cross-industry differences. Tracking ventures over a longer period of time or examining longer gaps between startup or IPO and later measures may also prove fruitful. This type of inquiry will allow us to investigate the dynamic nature of this phenomenon. This study took an important first step by examining high potential ventures at the time of IPO. Still, the dynamics of development require longitudinal investigation.
> Clearly, there are many fruitful paths which follow-up studies may take. How do outside circumstances impact the propensity to start international and the likely success of doing so? How do these circumstances interact with the types of resource-based considerations studied here on the success of these efforts? Is there a proper "fit" between environment, resources, and degree of internationalization? What is the performance impact, in the short run and in the long run, for such a "fit"? Does it matter what the country of origin is for the international new venture? Are firms starting in smaller markets more compelled to compete internationally early on? Does this give them an advantage?
In summary, our research shows that, as suggested by Oviatt and McDougall (1994), there may be good cause to question the conventional wisdom that firms which eventually become internationalized proceed through a relatively predictable set of stages and that substantial internationalization of operations is somewhat uniformly the last of these stages. Our findings do not so much contradict the rationale behind such a process model, but rather they suggest that the circumstances which foster internationalization may be more commonly faced by new ventures than was the case in the past or at least was imagined to be the case. While our results do not necessarily lead us to conclude that ventures which rapidly internationalize clearly outperform others, it is clear that those which do are performing at least as well, at least in the short run. We hope that this study adds impetus to those interested in examining the antecedents and consequences of being an international new venture.
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1This study was funded in part by the Center for International Business Education and Research at the University of South Carolina. ??