PART II:INTERNATIONALIZATION

AND MODE OF ENTRY ISSUES

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CONCEPTUAL FRAMEWORKS ONSMES’ INTERNATIONALIZATION:PAST, PRESENT AND FUTURETRENDS OF RESEARCH

Alex Rialp and Josep Rialp

ABSTRACT

This study attempts to facilitate the future development of a more generaltheory relative to the nature of small business internationalization andprovides a step toward a more holistic understanding of this process. Moreconcretely, its general goal is to draw attention to this potential: the possi-bility of better examining this process – and developing a more accurateexplanation of it – by encouraging future writers to consider the consol-idated contributions of four major streams of research in the internationalbusiness literature: FDI theories, the stage models, entry-mode researchand the network approach. Some relevant conclusions and implicationsare derived from this holistic approach.

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Reassessing the Internationalization of the Firm, Volume 11, pages 49–78.Copyright © 2001 by Elsevier Science Ltd.All rights of reproduction in any form reserved.ISBN: 0-7623-0795-1

INTRODUCTION: THE INTERNATIONALIZATIONPHENOMENON AND SMES

Business internationalization is a very complex issue to conceptualize. So far,there is not even a general agreement on its definition beyond one indicatingthe growing involvement of a firm in a variety of operations of internationalcharacter (Turnbull, 1987; Welch & Loustarinen, 1988; Andersen, 1993). Thus,a single, universally accepted definition of the term “internationalization”remains elusive. This fact has logically led to a number of alternative inter-pretations of this concept being found in the literature.1

For instance, several researchers have conceived of internationalization as apattern of investment in foreign markets basically explained by rationaleconomic analysis (Buckley & Casson, 1993; Dunning, 1988). A second traditional perspective seems to consider this phenomenon as an on-goingprocess of evolution whereby the firm increases its international involvementas a function of increased knowledge and market commitment (Bilkey & Tesar,1977; Johanson & Vahlne, 1977; Cavusgil, 1980): this is a sequential learningprocess of increased international involvement and gradual resource commit-ment. Still more recently, another [strategic] process-based view of internationalization has emerged (Melin, 1992; Root, 1994), which sees thisprocess of increasing involvement in international operations not necessarily asa “smooth, immutable path of development,” and including both “outward” and “inward” patterns of international expansion (Welch & Loustarinen, 1988,1993). In this context, Calof and Beamish (1995, 116) have suggested the following definition of internationalization: “the process of adapting firm’s operations (strategy, structure, resources, etc.) to international environments.”In the same line, Andersen (1997, 29) conceptualizes it as “the process of adapting exchange transaction modality to international market (characteris-tics).”

In our opinion, any accurate definition of internationalization should be wideand specific enough to simultaneously focus on complex decision-makingprocesses that can be empirically observable. Consequently, it is worthwhile atthe outset of this paper to indicate that, business internationalization is here tobe understood as a set of operations that facilitate the establishment of morestable relationships between a firm and the international markets throughout alearning process of growing international involvement and patterns of devel-opment that may be simultaneously inward and outward. It is, then, a highlycomplex process that continuously redefines the degree of international involve-ment and commitment adopted by an organization (Welch & Loustarinen, 1988;Root, 1994).

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50 ALEX RIALP AND JOSEP RIALP

Our conceptualization of the internationalization issue can be considered tobe holistic in the following sense. First, it integrates the behavioral, learning-based issues in play with the economic components affecting any large or smallorganization. Second, this process-based definition of internationalization isintrinsically dynamic and evolutionary in nature, i.e. a time-dependent process.Third, it admits both inward and outward patterns of activities abroad; andfourth, this definition also implies that relationships established through inter-national transactions might influence the firm’s growth and expansion to othercountries.

In spite of this general view of the internationalization phenomenon, it is notvery difficult to see that much literature in this field has tended to rely basi-cally on the large multinational firm as the traditional unit of (economic)analysis. However, one can also easily observe that Small and Medium-sizedEnterprises (SMEs) are increasingly active in international markets, due mostlyto the recent but unstoppable effects of globalization. In other authors’ opinion(Coviello & McAuley, 1999), this historical emphasis on larger firms is of addi-tional concern given the argument that smaller firms seem to differ from largerones in terms of their managerial style independence, ownership structure andscale/scope of operations. Consequently, their structures and processes aregenerally seen to be less rigid, sophisticated and complex compared to thosetypically existing in larger firms.

Although in the context of internationalization size issues do not seem to beso a relevant barrier after all (Bonaccorsi, 1992; Calof, 1994), it has been gener-ally argued that SMEs usually face internal and external constraints whenpursuing international development. This could be due, among other factors, totheir more limited capital and management system, lack of time, experience,and information resources, some environmental restrictions, and so on, whichlead one to expect that the internationalization phenomenon of SMEs woulddiffer from that of larger firms.

Many of these aspects have been particularly stressed in the extensive SMEexport literature. This really vast stream of research encompasses general and specific studies focusing basically on the behavior and strategies associated withexporting, on the relationship existing between size and export behavior, and onthe organizational and managerial determinants of exporting (Leonidou, 1998;Leonidou et al., 1998). However, the concept of internationalization is not neces-sarily synonymous with export activity, and beyond this extremely dispersedamount of export-related literature, the analysis of internationalization amongSMEs, as a wider and intrinsically meaningful stream of research, has only begunto emerge. Consequently, a rather limited number of papers are available that pro-vide a systematic consolidation of the increasing body of literature in this area.2

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Thus, this paper presents a more integrated framework from which to studythe phenomenon of internationalization mainly, but not exclusively, amongSMEs. The main purpose of this paper is therefore to identify the evolutionarytrends of theoretical research focused on small business internationalization inrecent decades in order to consolidate the extant literature and identify furtherresearch avenues. In this sense, the state of the art will be widely examined bymeans of a systematic review and objective assessment of the most traditionalas well as contemporary conceptual frameworks that have successively emergedin this field.

After this brief discussion of the internationalization concept in the contextof SMEs, this paper proceeds as follows: a brief theoretical description of thetwo most orthodox schools of internationalization research: the multinational-related and economic approach labeled as Foreign Direct Investment (FDI)theory (e.g. Hymer, 1976; Buckley, 1990; Dunning, 1979), and the behavioralschool of the stage models of the internationalization process or “gradualistapproach” (e.g. Johanson & Valhne, 1977; Cavusgil & Godiwalla, 1982, amongothers). Then other contemporary contributions resulting from the increasingforeign entry modes literature (e.g. Anderson & Gatignon, 1986; Root, 1994)and the relationship school of the international network perspective (Johanson& Mattsen, 1988) are also taken into account. Finally, as a result of our reviewand assessment, a more integrative and synthethic approach to the nature ofSME internationalization is presented, leading to a further discussion of futureresearch issues as well as to some managerial implications.

TRADITIONAL EXPLANATIONS OF FOREIGN DIRECTINVESTMENT

The predominant branch of interest in the literature on the international firmhas traditionally focused on the analysis of the foreign operations of the so-called multinational corporations (MNCs) and, more specifically, their directinvestment activities abroad. Thus, the main explanations of these direct invest-ments and/or of the existence itself of the multinational firm constitute a set ofinterpretations notably overlapping among themselves without yet being ableto constitute a single theoretical approach in this field (Calvet, 1981; McDougallet al., 1994).

Such explanations analyze foreign direct investment (FDI) from the perspec-tive of the theory of the firm and industrial organization theory, both sharingthe same initial assumption: the potential investment capacity of a businessabroad is based upon its control or possession of some type of asset and/orfirm-specific advantage, generally of an intangible character. Such firm-specific

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advantages would tend to compensate the firm for possible disadvantages of alocalized nature resulting from the greater knowledge that local firms haveregarding the conditions of their own markets, allowing the multinational toexploit its own advantage in other markets outside its home market. Thefollowing discussion presents some recent contributions that have been devel-oped in two different directions: one that is more tied to the effect of marketimperfections, and the other, more related to the analysis (though of a staticcharacter) of transaction costs.

Thus, according to monopolistic advantage theory, associated with interpre-tations of the emergence of multinationals proposed by Kindleberger (1969)and Hymer (1976), the existence of such companies is due to the fact that theyhave some type of knowledge or competitive advantage (of a productive, technological, organizational, managerial and/or commercial origin) whosenearly monopolistic nature permits them to compete with the local firms which,in spite of being better established and having a greater familiarity with theirown markets, would become obliged to assume the cost of developing thisadvantage, so they cannot really compete with the foreign firm. Furthermore,so that such advantages do in fact lead to a direct investment decision, theyshould truly be specific to the investing firm, as well as easily transferableacross national borders and/or of sufficient magnitude and durability so as towithstand the competitive erosion coming from rival firms.

In this way, Kindleberger and Hymer describe the specific advantages of thefirm as a manifestation of the structural imperfections of the market and of theexistence of oligopolistic profits. Hence, the motive for the establishment ofFDI appears related to the capacity of the multinational company to take advan-tage of certain market imperfections of an endogenous nature, reinforcing thealready existing levels of inefficiency: the specific advantages of the multina-tional firm are related to the exercise of market power, revealing thecharacteristics of a quasi-monopolistic advantage (Alonso, 1993b).

Nevertheless, this oligopolistic concept of direct investments is not able tocompletely explain why firms choose FDI as the mechanism of operation abroad.Why not pursue a strategy of licensing? In this way (by means of a license)the licensor can provide the technical know-how, while the licensee providesthe market knowledge. Theorists focusing on “internalization advantages”address this issue.

The possession of quasi-monopolistic advantage based upon structural imper-fections of the market might not be enough to explain the existence ofmultinationals. MNCs could also emerge from the frequent “market failures,”or imperfections of a more natural character, related to the market’s relativeincapacity to monitor some transactions, with the MNC then becoming an

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alternative and more efficient mechanism for serving the marketplace. Althoughthe idea that the market could show itself to be inefficient in carrying out deter-minate transactions was initially proposed to explain the origin of the integratedfirm with multiple plants (Coase, 1937; Williamson, 1975, 1985), it also appearsto fit pretty well in the case of the multinational. It is toward the analysis ofthis type of imperfection that a new approach emerges, conferring a significantrole to the transaction costs derived from the mobilization of intangible assetsbeyond national borders. Following this line of thought we have the theory ofinternalization and the eclectic paradigm.

According to the approach known as internalization theory (Buckley &Casson, 1976, 1985; Rugman, 1981, 1986; Caves, 1982; Hennart, 1982;Buckley, 1988, 1990; or Casson, 1986, 1992), the internationalization of thefirm is based upon two basic axioms: “in the first place, the firm locates itsactivities wherever costs are fewer (locality advantages); second, the firm growsby internalizing markets to the point in which the profits from such internal-ization compensate its costs (internalization advantages)” (Buckley, 1988,181–182).

Hence, this theory emphasizes the importance of market failures in the transactions of certain intangible and specific assets before the presence of hightransaction costs inherent in the use of the market mechanism. In order to avoidthem, the firm should exploit those assets under its control if it intends to keeptheir value, at least as long as the transaction costs of the market overcome theadministrative costs associated with the organizational form itself. These caseswould tend to occur more, the more intensive the knowledge and the morespecific the assets of the company were.3 This would not depend, in principle,upon whether the market in which this asset was exploited was domestic orforeign. However, if the market were foreign, then the existence of transporta-tion costs and other commercial barriers would encourage FDI. Therefore, itappears that the internalization approach was developed with the aim ofbecoming a general theory of the multinational although, given its own theoretical generalness, it ends up operating at a very high conceptual level,which makes giving it greater empirical content difficult (Buckley, 1990).

The eclectic paradigm (Dunning, 1979, 1980, 1988) attributes to firm-specificadvantages, as well as to location and internalization advantages, the explana-tion of the capacity and willingness of the firm to internationalize its activitiesof production in the form of FDI. Thus, the firm should possess, in the firstplace, a specific advantage associated with some intangible asset, which wasas least temporarily inaccessible for local competitors. With such advantagebeing supposed, the firm should decide whether to opt for internalizing it inforeign markets, by means of the mechanism of export and/or investment, or

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decide whether it cedes such advantage to another firm by contract or license.When preferring the investment formula, it should be more profitable to exploitsuch advantage together with some other location factor unique to the targetmarket; otherwise the company would prefer to export instead of investing.

As its own name indicates, this last paradigm attempts to link, in one singleproposal, the specific firm-based advantages with those of internalization andthose derived from the cost conditions of the market receiving the investment.Although it has been used as a reference framework in several empirical studieson the choice among different modes of entry in foreign markets (Agarwal &Ramaswami, 1992; Woodcock et al., 1994), it has not remained free fromreceiving some criticisms addressed, basically, toward the justification given tosome of the distinct types of advantages cited (Buckley, 1988; Itaki, 1991;Piggot & Cook, 1993).

In general terms, the several explanations concerning FDI are characterized,principally, by being based upon economic analysis. Hence, they tend to basetheir main explanatory variables in transaction costs as well as in factor costs,starting from the assumption of rational decision making on behalf of the invest-ing firm abroad. Nevertheless, all of these proposals seem to suffer from a lackof dynamic considerations and from a limited application to SMEs.4 Moreover,they do not appear to adequately distinguish between firms that initiate theirprocess of internationalization and those others already located in more advancedstages of this process. They have, otherwise, a notoriously static character oninvestigating the reasons that motivate such direct investments without makingspecial emphasis in the time dimension of the investing phenomenon.

Consequently, all of these classical theories focusing on FDI usually focuson firms of very large size and/or considerable presence abroad, typically multi-nationals, as their only valid empirical reference, without analyzing the evolutionfollowed by SMEs in their internationalizing process, nor investigating thechoice of other alternative modes of entry which these specific firms usuallyuse (Welch & Loustarinen, 1988; Forsgren, 1989; Alonso, 1993b, 1994).

THE STAGE (PROCESS) MODELS OFINTERNATIONALIZATION: THE “GRADUALIST”

APPROACH

An alternative and well-known theoretical framework in this field, the interna-tionalization process or stage models, is based upon a purely behaviorist viewof the organization (Cyert & March, 1963), thus making several assumptionsrelated to the lack of complete information and the importance of the risk oruncertainty in managerial decision making. This quite traditional explanation,

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more directly related to SMEs, has usually been labeled as the “incrementalistor gradualist approach,” as it considers the internationalization of the firm as alearning process based upon a gradual accumulation of experiential (foreign)market knowledge.

The highly innovative nature that seems to characterize the first steps of theinternationalization process, mainly those which constitute the adoption of theexport activity, allows one to assume a more incremental logic in the decisionmaking process and a more gradual pattern in the firm’s behavior through time.In this sense, the scarce initial knowledge that SMEs in particular usually haveregarding foreign markets, as well as the uncertainties that they associate withthe decision of going international, clearly influence the process (Cavusgil &Godiwalla, 1982; Andersen, 1993). A focus on the initial steps of the exportprocess is thus expected to be critical as these steps might form the foundationfor all future international activity.

In fact, the main reason to focus on the exercise of export activity by SMEsis due to the fact that this mechanism constitutes, in its multiple facets, theirfirst and most frequent mode of operating abroad, principally during the earlystages of their internationalization processes (Miesenböck, 1988). Frequently,the export method is considered as the most favorable mode of entry at thebeginning, since it permits the firm to adjust its exporting effort as it achievesmore or less positive results abroad. In this way, exporting becomes, generallybefore any other method, a learning experience in the international arena (Root,1994). A certain consensus exists when considering export as the basis of anexperiential learning process through which the firm gradually increases its levelof foreign knowledge, implication and commitment. During the developmentof export activity through time, this mechanism converts itself into a key deter-minant factor: the slow, although increasing, accumulation of experienceresulting from such performance abroad originates a learning process whichaugments (market) knowledge as well as the capabilities of the exporting firm(Alonso & Donoso, 1994).

In this sense, the abundant empirical research carried out about the exportingbehavior of SMEs proposes, basically, to determine how and in which mannerthey engage in export activities, by identifying the motives and exporting strate-gies of these firms, their capabilities for exporting and the type of interactionwhich they establish with their environment (Miesenböck, 1988; Aaby & Slater,1989). Although the majority of empirical work related to the decision to exportdoes not explicitly break down the existing stages in the adoption of this inter-national activity, a few studies do conceive of the participation of the firm inexport operations as a process of gradual development which takes place inseveral phases or stages and during a relatively long period of time. Thus, many

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empirical models have emerged which offer a certain conceptualization (thoughhighly descriptive and partial) of the dynamic nature of the exporting processof small firms.

Although the number of proposals developed from this incremental view ofthe exporting process is certainly considerable, the Uppsala model of the inter-nationalization process (U-Model) stands out as the most significantcontribution. In fact, a wide variety of empirical work attempting to establishlevels of the firm’s exporting development relies on the U-Model as a generalframework. So, it should be considered the pioneer model in the interpretationof the internationalizing phenomenon as a process of gradual development overtime. In this sense, the U-Model places special emphasis in the sequential natureof the learning obtained by means of a series of steps which reflect a growingcommitment to foreign markets.

In the Model’s original empirical version, authors Johanson and Wiedersheim-Paul (1975) cited the lack of knowledge and/or resources, and the resultinguncertainty to the firm, as the principal obstacle to internationalization. Thisproblem would be reduced by means of an incremental process of learning anddecisions related to foreign markets and operations. Hence, the development ofactivity abroad would take place through a series of successive stages that repre-sent a greater degree of involvement of the firm in its international operations.This sequence, generally known as the “chain of establishment,” was limitedfor each specific country or market.5

At the same time, in terms of the international extension of such operations,the proponents of this approach resorted to the concept of “psychic or psycho-logical distance,” according to which a firm’s entry abroad would tend to occurfirst for the country psychologically nearest to the firm’s home market, giventhat it would show a lesser degree of uncertainty for it. From there, the organization would gradually proceed extending its foreign activities towardother new markets, each time a little more distant from a psychological pointof view. In this way, new foreign markets would slowly be taken on whosepsychic distance from the firm’s country of origin would be greater and greater.

Later, Johanson and Vahlne (1977, 1990) reformulated a dynamic conceptionof the firm’s internationalization process in terms of a more permanent interactionbetween the development of knowledge about markets and foreign operations, onthe one hand, and a growing commitment of resources toward international mar-kets, on the other hand. The basic structure of the U-Model is represented by thedistinction made by these authors between the “state aspects” and “changeaspects” of the internationalization variables (Fig. 1). They assert that the “currentstate of internationalization is an important explanatory factor of the course whichthis will follow in the future” (Johanson & Vahlne, 1977, 26).

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Fig

. 1.

The

Bas

ic M

echa

nism

of

Inte

rnat

iona

lizat

ion.

So, from the U-Model, business internationalization is considered as a graduallearning process based upon experiential knowledge and capable of generatingnew opportunities by means of relaxing part of the uncertainty present in foreignmarkets.6 Thus, accumulated experience becomes a driving force in the inter-nationalization process. Nevertheless, such experience is, to a great degree,specific for each market in the sense that “it cannot be generalized to othermarkets or countries easily” (Johanson & Vahlne, 1990, 12). For this reason,as a general rule, additional commitments in the foreign market will developin the form of small, increasing steps.

As the most representative version of such evolutionary-behavioristapproaches, the U-Model constitutes one of the main contributions existing inthe analysis of the firm’s international activities and, perhaps, the most citedreference from the perspective of the export behavior models. However, resultshave usually been mixed when trying to empirically validate its two principalassumptions: the concepts of establishment chain and psychological distance(Hedlund & Kverneland, 1985; Turnbull, 1987; Welch & Loustarinen, 1988).In spite of this, the U-Model’s focus on gradualism is particularly useful indescribing the export behavior of SMEs placed in the initial stages of theirinternationalization process, as demonstrated through empirical research(Forsgren, 1989; Johanson & Vahlne, 1990; Alonso, 1993a). Thus confirmingthe importance of the gradual and/or incremental accumulation of experiencefor explaining the international behavior of the exporting SMEs.

Other behavioral models also argue that SME internationalization is incre-mental, with various stages reflecting changes in the attitudinal and behavioralcommitment of managers and the firm resulting international orientation (Bilkey& Tesar, 1977; Reid, 1981; Cavusgil, 1980; Cavusgil & Godiwalla, 1982).These models argue that the perceptions and beliefs of managers both influ-ence and are shaped by incremental involvement in foreign markets. As aconsequence, their firms gradually pursue active expansion into more unknownmarkets and become increasingly committed to international growth. As summa-rized by Thomas and Araujo (1986) and Andersen (1993), this pattern explainsinternationalization in terms of the innovation-adoption of export behavior.

Thus, according to the different stage models, the internationalization processshows a cumulative character, given that the firm tends to ascend toward greaterlevels of commitment once it accumulates experience in the previous steps.Hence, this process is supposed to be evolutionary in nature, mostly when itaffects SMEs and/or firms with rather limited experience abroad. This is becauseof the expected effect of the learning process followed by the firm on the reduc-tion of the levels of uncertainty with which it operates in international markets.More concretely, such experiential knowledge, gained through undertaking

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activities directly in these markets, should mitigate the conditions of uncertaintyin which decisions tied to the commitment of resources abroad will be adopted.

In summary, this gradualist approach does not seem to conceive of businessinternationalization as a rational and/or deliberately planned sequence, but ratheras a pattern of slow and evolutionary development in time, where the incre-mental nature of learning becomes a key factor through the course (apparentlypredetermined) of a sequence of successive stages. The central feature of thisapproach lies, therefore, in assuming that a large part of the capabilities requiredby firms for internationalizing their activities are acquired through a process ofsequential and accumulative learning, in the form of a series of phases thatreflect a higher commitment to foreign markets (Melin, 1992). An additionalcontribution of this model lies in emphasizing the importance of the perceptionof opportunities and risks on behalf of the firm’s managers and, thus, establishing their leading role in international decision making (Dichtl et al.,1990).

However, the excessively descriptive nature of this proposal does not fullyexplain the decision dynamics that lead the firm to move from one level ofinternational commitment to another. Thus, the U-Model, as well as other relatedbehavioral approaches, describes the path followed by the firm throughout itsexporting trajectory, but; collectively, these approaches show themselves to besomewhat weak in identifying the explanatory causes of such a progressionalong the phases or stages considered. In addition, its “dynamic” view of theprocess neither reflects the growing proliferation of mixed formulas of a contrac-tual nature (licenses and/or franchises) nor other more recent mechanisms forthe international extension of the firm such as international joint ventures. Evenin the same area of export activity, some authors, such as Reid (1983, 1984),point out that the structures that are finally adopted are highly specific, basi-cally depending upon the heterogeneity of the transactions performed. Hence,the structural arrangement finally chosen for organizing this activity constitutesa relevant strategic choice, which makes the diversity of the firm’s exportbehavior stand out.

Thus, to enhance the explanatory power of the stage process model in thecontemporary international business environment, its assumptions must berevised. Greater flexibility is needed, given the apparently indeterminate andeminently selective nature of the firm’s strategic options in the internationalcontext. Upon freeing it of its excessively deterministic view of the interna-tionalization process, these models could be empowered to explain both theemergence of new, more adaptable, flexible and innovative modes of entry, andsimultaneously, the acceleration of the international involvement of firms(Alonso, 1993a, b, 1994).

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CONTEMPORARY MODELS OFINTERNATIONALIZATION: THE FOREIGN ENTRY

MODES LITERATURE AND THE NETWORKAPPROACH

This section’s main intention is to present and discuss some current streams ofliterature: (1) strategic mode of entry choices – firmly based on the transactioncost approach; and (2) the network perspective (as applied to the internationalcontext). This review and assessment of several contemporary models of inter-nationalization is intended to better inform our understanding of the strategicdecisions and the kind of relationships established by the firm throughout itsinternational projection.

Foreign Entry-mode Research

Focusing on an extremely critical dimension of the internationalization process,the (foreign) market entry mode issue, several studies facilitate some additionalrefinement and a more successful accommodation of a variety of earlier frame-works about firm internationalization. Accordingly, a wide range of institutionalarrangements or alternative ways of penetration in foreign markets are becomingintegrated within this emerging stream of research.7 These mechanisms arebelieved to be susceptible to change over time as the firm itself redefines itslevels of international presence.

Such a recent approach in the field of international business, labeled as theentry-mode literature, also seems to be grounded on the existence of some firm-specific advantage/s (of a productive, technological, organizational, managerialand/or commercial character) capable of being exploited, at least temporarily,in foreign markets by means of a variety of foreign modes of entry and/orgeneric international trajectories among which firms can strategically choose(Calof, 1993; Albaum et al., 1994; Bradley, 1995). Hence, a firm could servethe foreign markets by means of exporting from its own domestic context,understood as a mechanism of international activity that could be internalizedto a greater or lesser degree. Also, it could try to exploit specific advantagesby investing directly in foreign markets when some factors (advantages of location, commercial barriers and/or high transport costs) seem to favor suchlocal exploitation, by locating productive capacities abroad by means of thesetting up of its own manufacturing subsidiaries (FDI). Additionally, an inter-national firm could co-invest with other firms (international joint ventures).Finally, the possibility also exists of transferring this advantage to another entity(generally, a foreign firm) through a contractual arrangement, in exchange for

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some type of royalty or economic compensation (international licenses, fran-chises, etc.).

Thus, internationalizing firms are supposed to select among a number ofdifferent modes available to penetrate foreign markets that have been usuallyclassified based on the corresponding level of risk, return characteristics, and/ordegree of control and resource commitment each mode provides the entrantfirm (Anderson & Gatignon, 1986; Kumar & Subramaniam, 1997). Thesevarious strategic options, and the different levels of commitment which thesealternative entry modes usually imply, can be seen in Fig. 2. The existence ofa certain trade-off between the degree of control and operational risk desiredin foreign operations and the volume of resources committed by the firm at anyspecific moment is also shown.

We must recognize here that the upper right-hand corner of Fig. 2, the establishment of production facilities abroad, does not necessarily represent thehighest level of internationalization. In fact, a firm whose activities were distrib-uted across all nodes should be considered even more internationalized.8

However, in general terms, moving toward higher levels of internationalizationinvolves obtaining a greater degree of experiential knowledge on an interna-tional scale, due to the cumulative learning process followed by the firmthroughout its international evolution (Root, 1994; Alonso & Donoso, 1994;Rialp & Rialp, 1996).

Each one of these generic, potentially overlapping, paths of internationaldevelopment (export entry mode, contractual agreements, and foreign directinvestment), represents a continuum of increasing international involvement withdiverse levels of control, risk, flexibility and commitment of assets and resourceson behalf of the firm going international. Hypothetically, movement along this“continuum” is expected to be driven by the degree of foreign market knowl-edge that the firm acquires abroad. However, it is also important to point outthe fundamentally strategic nature of the deliberate choice between these alter-native trajectories of internationalization, even though such decisions usuallycome highly conditioned – though not totally predetermined – by the sequencethat the firm has created and followed throughout its internationalization. So,one must acknowledge that managers, in making strategic decisions, are contin-ually faced with situations shaped by the specific and dynamic resources andcapacities of their firm and its environment.

Such a view of the phenomenon of business internationalization describes aprocess of growing international involvement which admits not only one, buta wide variety of institutional forms or paths of penetration abroad. These formsreflect, in turn, distinct degrees of commitment and, hence, different levels ofcontrol and/or operative risk for the firm. Additionally, the process is eminently

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strategic and dynamic per se, in the sense that such modes of operation varyin time as the firm increases and consolidates its presence in the internationalarena.

Thus, at least theoretically, the choice of foreign market entry mode shouldbe based on several trade-offs between risks and returns, the desirability ofcontrol over foreign operations, resource availability and the interrelationshipexisting among these several factors. Consequently, a number of studies haveappeared that try to establish different models and analytical frameworks forinvestigating the selection among all the available modes of entry abroad

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Fig 2. Evolution in a Manufacturer’s Decision on Foreign Modes of Entry.

Source: Adapted from Root (1994, 39) and Rialp and Rialp (1996).

(Anderson & Gatignon, 1986; Nicholas, 1986; Hennart, 1989; Hill et al., 1990;Agarwal & Ramaswami, 1992; Erramilli & Rao, 1993; Alonso, 1993b, 1994;Root, 1994; Driscoll, 1995). Each one of these studies introduces strategic selec-tion criteria preceeding the options that the firm is facing at the moment ofexploiting its specific advantage/s beyond national borders. Some of the mostimportant contributions in this line of inquiry are summarized and also system-atically compared in Table 1.

Many of these theoretical and empirical frameworks have been amply reinforced by the abundant literature based upon transaction costs analysis(TCA) (Coase, 1937; Williamson, 1975, 1979, 1981). Also according toAndersen (1997), in the last decade applications of TC approach have becomefairly common in the entry-mode research. In fact, this approach contributes tothe formulation of the firm’s international strategy, and more specifically to

Table 1. Selection models of the foreign mode of entry based on theTransaction Cost Approach.

Author/s Main objective Operationalization Results/conclusion

Anderson & Gatignon (1986)

Nicholas (1986)

Hennart (1989)

.

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To explain the choicebetween joint venturesand foreign (production)subsidiaries.

To elaborate a dynamicmodel of the choice of theforeign mode of entry.

To explain the principaltraits associated with thedistinct types of contrac-tual arrangements, whichdo not involve property –new forms – as opposedto the realization of FDI –traditional forms.

The structure of ownershipassociated with the exerciseof control over each modeof entry is fully deter-mined.

Starting from the “struc-ture” or organizationalforms for the performanceof international transactionsand from the “process” orpossible changes betweenthem, the firm’s transitionbetween such alternativemodes in function of thecosts they generate is considered.

Identification of the trans-action costs linked to thesenew and traditional formsfor organizing internationalexchanges.

The factors which tend toincrease transaction costs arepositively associated withthe degree of control obtain-ed over the mode of entry.

The variables frequency oftransaction, nature of theproduct – especially if itrequires the performance ofspecific investments – andthe presence of scaleeconomies constitute thefactors which most deter-mine the cost associatedwith the distinct alternatives.

The new contractual formscan be more efficient thanFDI for conducting some ofthem, but they are seen tobe highly inefficient for theacquisition of specific typesof technological knowledgeand/or access to foreignmarkets.

predicting entry mode, to the degree that an adequate analytical frameworkwhere exploring the relative advantages in terms of the relative costs of thedifferent organizational forms and under distinct environmental conditionsallows. In particular, the firm would prefer to internalize international transac-tions, with formulas that determine its direct presence in foreign markets, thegreater the transaction costs involved in servicing these markets.

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Author/s Main objective Operationalization Results/conclusion

Hill et al. (1990)

Alonso (1993b, 1994)

Root (1994)

Driscoll (1995)

.

To establish an “eclecticframework” for the choiceamong foreign entrymodes.

To analyze the selectionprocess among the firm’smode of entry in interna-tional markets byapplying a dynamic viewof transaction costs.

To list the variables thatwill help managers todecide about the mostappropriate mode of entryin each case.

To determine the theoreti-cally expected impact ofthe variables which regulate the selectionbetween the desired andobserved levels of the distinct characteristics relative to each mode ofentry.

To know how the distinctmodes differ with respect toresources commitment, thelevel of control inherent ineach mode and the risk thatfirm-specific advantages(particularly knowledge)disseminate abroad.

Submitting transactioncosts to an evolutionarydynamics in such a waythat their perception variesdepending on previouslyaccumulated experience bythe firm.

Definition and applicationof criteria for the identifi-cation of relevant factorsfor the selection of themode of entry abroad.

The different methods ofentry abroad (FDI, contrac-tual modes and mecha-nisms for exporting) aredefined, characterized andrelated in terms of thedegree of control, risk,commitment of resources,strategic flexibility andlevel of ownership whicheach one has.

The interaction, which isproduced between deter-mined variables of astrategic, environmental andtransactional nature with therequirement of resources,levels of control and risk ofdissemination of the busi-ness knowledge attributableto each mode of entry, deter-mines its final selection.

The apparently indeterminatenature of the diverse concur-ring forces in the selectionprocess of the paths of pene-tration abroad necessitates amore detailed analysis of thefirm’s core competencies andits environment.

The main critical factorsseem to be: those of themarket, environment andproduction in the targetcountry; those in the countryof origin and those factorsrelated to the product,resources and the firm’sdegree of commitment.

The selection of the mostappropriate institutionalarrangement for entry ininternational markets is anextremely critical decisiondue to its impact on the suc-cess or failure of the firm’sinternational operations,mainly in the initial phases ofits internationalization.

Moreover, most of the studies on foreign market entry modes have had tointroduce some modifications of TC theory to include non-transaction cost bene-fits derived from increased control or integration, such as coordination strategiesin multinational firms (Hill et al., 1990). This rather modified TC approachgenerally predicts a positive relationship between asset specificity and propen-sity for high-control entry modes. The strength of this relationship is contingentupon the influence of moderating factors, such as external or internal uncer-tainty and firm size (Anderson & Gatignon, 1986; Erramilli & Rao, 1993).

However, concerning this explanatory framework, at least a couple of prob-lems still limit its possibilities of further empirical testing. First, the unit ofanalysis should be, according to the TC theory, the transaction in play; whilemost TCA studies on entry mode decision widely concerned about other issuesaffecting a firm’s decisions have used the firm-level as their unit of empiricalinterest. Second, too often relevant transaction costs in consideration of entrymodes can be only indirectly assessed by means of indicators such as degreeof asset specificity and internal or external uncertainty level. Consequently,more efforts should be made in reaching the necessary fit between the theo-retical and operational levels in these kinds of studies (Andersen, 1997).

International Network-related Research

In order to study the internationalization of a firm we need to understand thecontext in which it operates, such as, environmental conditions and the firm’srelationships with other entities (Madsen & Servais, 1997). More concretely,how do firms – especially smaller ones – make use of business networks and/orcollaborations when they internationalize?

Referred to as the network perspective, an emerging area of SME interna-tionalization research focuses on non-hierarchical systems where firms investto strengthen and monitor their position in international networks. This contem-porary approach draws on theories of social exchange and resource dependence,and focuses on firm behavior in the context of a network of inter-organizationaland interpersonal relationships. Moreover, researchers of networking have transposed the social exchange perspective of social networks to businessnetworks. There is “a set of two or more connected business relationships, inwhich each exchange relation is between business firms that are conceptualizedas collective actors” (Chetty & Blankeburg Holm, 2000, 79). Thus, businesstakes place in a network setting, where different business actors are linked toeach other through direct and indirect relationships.

Johanson and Mattson’s (1988) network approach to internationalization ispreferentially chosen here as a relevant theoretical framework because it

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includes a dynamic element by focusing on network relationships. This modeluses social exchange theory to illustrate and also explain how firms developnetworks organically to internationalize. More concretely, these authors considerbusiness networks as the relationships a firm has with its customers, distribu-tors, suppliers, competitors and government, i.e. the actors in a business network.They argue that as the firm internationalizes, the number and strength of therelationships between different parts of the business network increases. By inter-nationalizing, the firm creates, develops and maintains business relationshipswith counterparts in other countries. This occurs in different ways: first, byforming relationships with counterparts in countries that are new to the firm(international extension). Second, by increasing commitment in already estab-lished foreign networks (penetration). Third, by integrating their positions innetworks in various countries (international integration). However, internation-alization in all of these cases implies “an exploitation of the advantage thisnetwork constitutes” (Johanson & Vahlne, 1990, 20).

Clearly, the network perspective provides valuable insight into the dynamicsof internationalization in that a network-based approach is linked to strategicdecision making. More specifically, developing and managing business andsocial relationships can help reduce the smaller firms’ dependence to their owninternal resources and, consequently, increase their propensity to internation-alize. Thus, by means of these network relationships, SMEs are able to overcomethe size-related constraints so often identified as limiting their growth. In thissense, “smallness” (measured in terms of physical resource availability) mightbe irrelevant when examining internationalization. Also, the generally consid-ered less rigid and more fluid managerial processes in the smaller firm, ascompared to larger ones, may be driven very often by the strong influence ofthe owner/manager of the SME and his/her personal contact network.

As we have seen, the activities in the network allow the firm to form rela-tionships, which help it to gain access to resources and markets. An assumptionin this model is that a firm requires resources controlled by other firms, whichcan be obtained through its network positions. Johanson and Mattson also usethe term net to specify certain sections of a network. For instance, national netrefers to networks in other countries, and production net refers to a firm’s rela-tionships that revolve around activities in a specific product area. Furthermore,and precisely depending upon the degree of internationalization of the market(production net) and the degree of internationalization of the firm itself, theseauthors theoretically identify four categories of international firms (see Table2): the Early Starter, the Lonely International, the Late Starter and theInternational Among Others, whose characterization has been largely discussedelsewhere (Johanson & Mattson, 1988; Chetty & Blankenburg Holm, 2000).

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Precisely by inquiring what network relationships drove internationalizationfor the firms in each of these four theoretical categories, Chetty andBlankenburg’s (2000) case-based research illustrates the dynamics of how firmsinteract with their network partners to extend, penetrate and integrate their inter-national markets. In their opinion, networks can help firms expose themselvesto new opportunities, obtain knowledge, learn from experiences, and benefitfrom the synergistic effect of pooled resources. However, they also identifyfrom their findings several weaknesses of this model, the most relevant onebeing that the cases under analysis illustrated that there are other dimensionsto the network – such as customers and governments – that drive firms to inter-nationalize rather than just the production net which Johansson and Mattsonemphasized in their model.9 These flaws should be removed to advance thenetwork related literature.

CONCLUDING REMARKS AND IMPLICATIONS OFINTEGRATING PAST AND CONTEMPORARY

CONCEPTUAL FRAMEWOKS

This study has attempted to facilitate the future development of knowledgeabout the nature of small business internationalization and to provide a steptoward a more holistic understanding of this process. More concretely, it hasbeen the general goal of this paper to encourage future writers to consider theconsolidated contributions of four major streams of research in the internationalbusiness literature: FDI theories, the stage models, the entry-mode research, andthe network approach. Although generally considered in an isolated, non-relatedway, all of them have been empirically applied in SME internationalizationresearch. However, this segmented approach, using only one theoretical frame-

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Table 2. Johanson and Mattsson’s Network Approach to Internationalization.

Degree of internationalization of the market

(production net)

Low High

Degree of internationalization Low The Early Starter The Late Starterof the firm

High The Lonely International The InternationalAmong Others

Source: Reproduced from Johanson and Mattsson (1988, 298).

work at a time, does not seem to be the most appropriate research strategy tocapture the internationalization issue using only one theoretical framework.Thus, more integrative approaches to the study of internationalization willundoubtedly benefit our understanding of the overall concept.

Consequently, this article’s main contribution lies in the following generalassumption: none of the traditional approaches (FDI’s classical explanations andthe gradualist approach), individually considered, provides a truly completeexplanation of the complex nature of the SME internationalization process.However, it is our belief that by viewing past contributions more integratively,and incorporating new research findings from the growing literature on foreignmodes of entry and the network perspective, significant progress can be achievedin terms of theory development in this field. In our opinion, the reviewed theo-retical frameworks provide complementary views of the internationalizationconcept. Hopefully, such a theoretical refinement and better combination of theextant approaches would critically help other researchers, and also managers,to obtain a more advanced comprehension of this highly challenging phenom-enon.

Figure 3 graphically illustrates the evolutionary pattern of research focusingon internationalization that has been presented in this paper. Also, some futuredirections for promoting further theory development in light of our review andcritical assessment of the literature in this field are also addressed.

As discussed previously, the general theory of FDI has developed fromneoclassical and industrial trade theory and supports internalization of a firm’sactivities in international expansion. This view explains internationalization withthe argument that firms choose the organizational form and location for whichoverall transaction costs are minimized. In other words, firms choose theiroptimal structure to perform foreign production by evaluating the cost ofeconomic transactions. Transactions perceived to be high risk and requiringsignificant resource commitment are more likely to be internalized as part of ahierarchically structured organization. However, critics of this theory argue thatresearch in this area is used primarily to explain a pattern of investment interms of its extent, form, and location of international production, somethingthat is rather applicable to already established MNCs, and not a long-termprocess of international expansion.

Contrarily, the several stage models draw on organizational growth, behavior,and learning theory to capture internationalization and are generally argued tobe more “dynamic” than FDI theory (Melin, 1992; Johanson & Vahlne, 1990).These models suggest that internationalization activities tend to occur incre-mentally and are influenced by increased market knowledge and commitment.By emphasizing managerial learning, business internationalization is described

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70 ALEX RIALP AND JOSEP RIALP

Fig

. 3.

Res

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h T

rend

s in

Int

erna

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lizat

ion

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ory.

in terms of market selection and the mechanisms used for market entry. Overtime and through experience, firms increase their foreign market commitmentand this, in turn, enhances market knowledge leading to further commitment inmore distant markets. Thus, the firm is eventually expected to internalize itsactivities by moving over time from purely domestic operations to establishinghost country operations, based on a process of managerial learning. This isperhaps the reason why some authors acknowledge that the stage models, inspite of their several limitations, also appear to reflect the essence of FDI(Coviello & McAuley, 1999).

On the other hand, the contemporary schools of research also reviewed herestress some relevant issues that have been “forgotten” or remained misunder-stood in previous research programs, many of which deal with some factorsaffecting SME internationalization. Hence, by adopting a more dynamicperspective of the transactions costs in play and the non cost-related issuesaffecting any firm’s international expansion, several entry-mode studies seemto relate them more successfully to the development of more efficient strate-gies of penetration in foreign markets. Moreover, these strategies becomecapable, by themselves, of making the sequence followed by any type of orga-nization – either large or small – more flexible than normally assumed inprevious theoretical explanations, i.e. FDI theories and the stage models of inter-nationalization.

In a similar vein, the international network perspective offers a complemen-tary view to FDI theory because the latter does not account for the role andinfluence of social relationships in business transactions. Internationalizationdecisions and activities in the network perspective emerge as patterns ofbehavior influenced by various network members, while FDI theory merelyassumes rational strategic decision making applied by the firm’s managementsystem. Also, when compared with the “unilateral” process of internationaliza-tion suggested by the stage models, the network approach convenientlyintroduces a more “multilateral” and interactive view of this phenomenon. Thusthe process is not merely intra-organizational but also inter-organizational. Inrelation to the U-model, it can be assumed that market (i.e. network) knowl-edge is based on experience obtained from current business activities, or currentbusiness interactions. Recent studies of the internationalization issue in thecontext of exchange networks have found that, although foreign market entrycan be considered to be a gradual process (thus partly supporting the stagemodels), it results basically from interaction, development, and maintenance oflasting business relationships with other business actors or parties over time(Johanson & Vahlne, 1990). Organizational boundaries therefore should incorporate both business (formal) and social (informal) relationships. Such

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relationships can involve customers, suppliers, competitors, private and publicsupport agencies, family, friends, and so on.

Thus, according to our assessment of the theoretical evolution in this field,we can affirm that the internationalization literature, even that one focused onSMEs, has evolved to actually encompass: (1) the analysis of transaction costand structural market imperfections in the context of FDI; (2) the examinationof managerial learning and organizational commitment in the process of international expansion; (3) the consideration of multiple forms of foreignmarket entry available to the firm; and (4) a more recent approach that recog-nizes the potential influence of formal and informal networks relationships oninternationalization. In other words, by further interrelating all these approaches– as Fig. 3 attempts to do – a more holistic view of the process of businessinternationalization emerges. Its main traits are only being introduced here.

Due to its holistic character, this more integrated perspective seems capableof interweaving a certain degree of gradualism, based upon a learning process(absolutely critical during the initial phases), with a highly dynamic conceptionof the modes of entry abroad in following stages. At the same time, managersare highly influenced by the amount of international experience acquiredaccording to the previously chosen trajectories. In this way, the international-ization process provides an open and quite flexible path due to the wide rangeof modes of entry available to the firm throughout its international involve-ment. The strategic selection among all of these possible forms will depend,consequently, upon the already acquired levels of commitment on behalf of thefirm, as well as upon the volume and/or quality of the resources and assets thatit is willing to move to the target markets at any one moment. However,according to the network view, internationalization also depends on the organization’s set of network relationships that result from interaction with othercounterparts rather than solely on a firm-specific advantage. Such differentnetworks may be more or less international to the extent that the connectionsbetween them in different countries are more or less developed. It also can beexpected that the international extension of these networks has strong implica-tions for the internationalization of the firm (Johanson & Vahlne, 1990).

Therefore, by integrating these several lines of inquiry, it is possible to derivea more general conceptualization of the internationalization process, a moresophisticated view that becomes relevant to both small and large firms, not asingle model which is limited by the size and/or resources of the firm whosebehavior it is designed to explain. But, what would the main characteristics ofthis perspective be? This research question could open an interesting debatetheme from an academic perspective in the future. However, any further development of such an integrated and multidisciplinary framework would hold

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the potential to mend the rift in international business theory that has arisen defacto from the different starting points of individual researchers whose primaryinterest has been explaining the behavior of a particular type of firm – that is,MNC-oriented research versus SME-oriented research. Contrarily, futureresearchers in the general field of international business should focus onimproving the integration of these extant views of internationalization, recog-nizing that no single view may be considered valid, and also thatinternationalization is a dynamic and longitudinal process, thus it must be empir-ically investigated in this way too.

Moreover, this holistic perspective of internationalization also offers relevantmanagerial implications as it holds the potential, if examined properly, toenhance the operating performance of any firm. Those managers and decisionmakers involved in international affairs could benefit from this more consoli-dated approach which basically stresses the more universal concerns ofknowledge-based development, business network relationships, and strategicmanagement, rather than focusing on the obvious differences in internalresources between large and small firms. Certainly, some of the concerns ofmanagers of MNCs firms and SMEs are unique to their structural conditions.However, other issues extensively covered in this paper, such as the access toforeign market knowledge and other external resources, could not depend somuch on size and structure dimensions.

NOTES

1. Related bodies of literature referring to the explanatory causes of trade between coun-tries, as well as international competitiveness at a specific country-sector level (Porter,1991), are conceived of as alternative approaches to the internationalizing phenomenonthough of a rather macroeconomic nature. So, they are explicitly excluded from this study,which is directly linked to the (micro) organizational approaches to internationalization.

2. For very useful summaries of theoretical and empirical research examining thesmaller firm and export-related issues see Bilkey (1978); Dichtl et al. (1984); Thomas andAraujo (1986); Miesenböck (1988); Aaby and Slater (1989); Andersen (1993); Leonidouand Katsikeas (1996); or Rialp (1997). See Coviello and McAuley (1999) for a studyexamining how integrative the empirical literature on internationalization of SMEs is. Thisclearly demonstrates the current regency of the SME internationalization literature.

3. The examples that are typically associated with this internalization process wouldbe the factor markets and/or intermediate goods of a rather more specific and intangiblenature, such as technological assets, managerial, marketing or production skills, humancapital, etc., due to the “public good” character attributable to such knowledge (Buckley& Casson, 1976). This internalization, nevertheless, cannot be done gratuitously andusually creates problems – and, consequently, costs – of communication, coordinationand control.

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4. In terms of SME-related research using this theoretical framework, a rather limitednumber of studies seem to be available (Newbould et al., 1978; Buckley, 1989). Amongthe most relevant ones, Newbould et al. (1978) found FDI to be a managerial process.By means of several interviews with managers of UK manufacturing firms, an evolu-tionary approach to internationalization was indeed suggested, reflecting incrementalinvestment resulting from a process of ongoing managerial learning.

5. Specifically, the following phases are considered: (i) irregular exports; (ii) regularexports via independent agents and/or distributors; (iii) the establishment of foreign salessubsidiaries; and (iv) (eventually) the establishment of production facilities abroad.

6. Penrose (1959) is followed here in the distinction of two types of knowledge: an objective and generic one, which can be codified, acquired and/or transmitted quiteeasily; and a specific one, which is rather tacit, idiosyncratic and directly linked to experience, which can only be acquired by means of an eminently practical learningprocess. It would basically be the prominence of this last type of knowledge that would condition the gradual sequence of the process. Later on, Eriksson et al. (1997)have gone into this question in depth, clearly distinguishing between different classes of knowledge based upon experience – i.e. experiential knowledge – and establishing their relations with the costs to be perceived during the internationalizationprocess.

7. Given its condition of “frontier research issue” (Hill et al., 1990), it would besimply interminable to try to enumerate and fully discuss here all the conceptual frame-works that have been put forward concerning the foreign entry mode decision making.Thus, within this section the number of perspectives for assessing the mode of entryissue is restricted somewhat. Other recent and quite helpful contributions are availableelsewhere (Sarkar & Cavusgil, 1996; Andersen, 1997).

8. The authors gratefully acknowledge this pertinent comment made by one of thereviewers.

9. Other weaknesses of this network model were related to some of the followingissues: (i) The criteria used to differentiate each category in the matrix are not distinc-tive and thus overlap, (ii) The importance of decision-makers’ attitudes and firmcharacteristics in taking up opportunities for international extension, penetration, andintegration that emerge from the networks is not fully addressed, (iii) The model doesnot discuss how the firms overcome the problems experienced in internationalizationthrough their network relationships, (iv) It also excludes the influence of certain externaland uncontrollable factors that propel a firm toward internationalization, (v) The networkmodel does not address how firms shift positions in the matrix. And finally, (vi) themodel only considers relationships that evolve organically (Chetty & Blankenburg Holm,2000, 89–90).

ACKNOWLEDGMENTS

We thank Dr. Catherine N. Axinn, from Ohio University, and the anonymousreviewers from AIM for their useful comments to earlier versions of this paper.Also support from the Dirección General de Enseñanza Superior (PB-95-0616)is gratefully acknowledged.

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