FIRM DETERMINANTS OF EXPORT INTERNALIZATION AND THE CHOICE BETWEEN COMMERCIAL ALLIANCES AND PROPRIETARY DISTRIBUTION CHANNELS 

Jose Manuel Campa 
International Business Area 
Stern School of Business, New York University 
and 
Mauro F. Guillen 
Sloan School of Management, Massachusetts Institute of Technology 
January 1995 

We are grateful to the Carnegie Bosch Institute for Applied Studies in International Management 
for research support, and to Spain's Ministry of Commerce for providing access to the database on 
Spanish exporters. We also thank Gunnar Hedlund and other participants at the 1994 Carnegie Bosch 
conference on international management, and William Ocasio, for their comments and suggestions. 
Montserrat Luengo and Carlos Pereira provided research assistance. 

Firm Determinants of Export Internalization and the Choice between Commercial Alliances and Proprietary Distribution Channels

The choice to internalize export activities is presented as a forward vertical integration problem and 
studied in the light of the predictions of the theories of transaction cost economics, contingency 
organization, and industrial organization. The results from a sample of 843 Spanish firms suggest 
that the use of mass production technologies decreases a firm's likelihood of internalization, while the 
firm's levels of intangible assets, size and export orientation increase it. Firms producing non-standarized 
products in industries with high levels of intangible assets tend to internalize through commercial alliances 
while large firms with export experience internalize by investing in proprietary distribution channels. 

THE INTERNALIZATION OF EXPORTS

Firms may export to foreign markets using a variety of alternatives ranging from direct exports to 
investing in proprietary distribution facilities. Intermediate options include using independent agents 
or distributors and engaging in a strategic alliance in distribution with a foreign firm. From an economic 
point of view, the decision facing the firm is one of forward internalization or integration. The research 
on multinational activity has traditionally concentrated on the problems of: (1) horizontal integration 
to overcome protectionist barriers or avoid transportation costs; (2) horizontal integration to internalize 
licensing agreements and other kinds of contractual arrangements by which the firm cedes its proprietary 
assets for a particular market and time; or (3) backward vertical integration, i.e. the make-or-buy decision 
for raw materials and intermediate products such as parts, components, and semi-processed goods. 
As a form of internationalization, export internalization provides an interesting topic for research because 
it is an indication of the competitive or ownership advantages of firms. 

Our empirical results from a sample of 843 Spanish export firms show that the likelihood of 
internalization of exports increases with the level of intangible assets, the use of technologies other 
than mass production, export intensity, export growth, foreign capital participation, and total revenues. 
Firm size and the relative importance of export activities, as measured by total revenues and export 
intensity, respectively, increase the likelihood of proprietary distribution but not of commercial alliances. 
Likeliest to engage in commercial alliances are firms of all sizes in advertising-intensive industries 
not using mass-production technologies. 

The rest of the paper is organized as follows. The next section shows the importance of export 
internalization in total FDI activity and discusses its relationship with the level of economic development 
of the home country. Section 3 summarizes the existing theoretical and empirical literature on 
internalization and its implications for export activities. Testable hypotheses are presented drawing 
on the literatures of transaction cost economics, contingency organizational theory, and industrial 
organization. Section 4 describes the data and variables used in the analysis. Section 5 presents 
the results. Finally, Section 6 presents conclusions and suggests some avenues for further research. 

EXPORT INTERNALIZATION AND ECONOMIC DEVELOPMENT

The internalization of exports is a central aspect of the process of internationalization of emerging 
MNEs based in middle-income countries because they tend to have very limited international 
operations in general. Middle-income countries such as Spain, Ireland, Greece or Portugal are 
very active exporters, but the sales of their overseas subsidiaries are small relative to their total 
exports. While the sales of foreign subsidiaries of MNEs headquartered in the European Union 
(EU), the US or Japan amount to between 3 and 6 times the value of their home country's exports, 
the ratio for Spain is 0.07. As Spanish outward foreign direct investment escalated since the mid-1980s, 
the ratio increased to 0.13 by 1992 (Campa and Guillen 1995). Countries slightly more developed 
than Spain such as Italy also have relatively low ratios, except for in areas like Latin America where 
Italian multinationals have traditionally made large investments in both manufacturing and distribution 
(see Table 1; Onida and Viesti eds. 1988). 

                  TABLE 1:  INTERNATIONALIZATION OF EXPORTS


SUBSIDIARIES' SALES TO HOME COUNTRY'S EXPORTS


HOME COUNTRY    EU      USA     Japan   Latin America   TOTAL
------------    --      ---     -----   -------------   -----

EU (1990)       - -     5.10    1.25    .               .
USA (1990)      6.30    - -     1.25    .               .
JAPAN (1990)    4.25    3.50    - -     .               .
SPAIN (1986)a   0.08    0.14    0.01    0.14            0.07
ITALY (1985)b   0.17c   0.16    .       1.75            0.19

Notes:  

a.) Data for Spain include in the numerator sales of exported goods 
by all types of affiliates.


b.) Data for Italy include in the numerator total sales of manufacturing 
affiliates. 

c.) EU is EEC-9.

Sources:  

Encarnation (1994:212); Secretaria de Estado de Comercio (1989:225-226); 
Onida and Viesti eds.  (1988:7, 9, 51, 54)

    TABLE 2:    SPAIN'S OUTWARD FDI IN DISTRIBUTION, 1975-78 AND 1988-92




                NUMBER OF                VALUE OF TRANSACTIONS:
                TRANSACTIONS:


YEAR            n       % of Total      Million         % of    Per
                                        Current         Total   100,000  
                                        Ptas.                   GDP
----            -       ----------      -------         -----   -------

1975            52      42              435             22      7.2
1976            96      49              1028            24      14.1
1977            88      30              1436            11      15.6
1978            139     33              1425            11      12.6
1975-78         375     36              4325            13      - -
1988            903     50              23.349          11      58.1
1989            1148    47              45.237          16      100.4
1990            1387    47              90,648          19      180.9
1991            1050    45              97.774          14      178.4
1992            600     42              130,997         24      222.6
1988-92         5088    46              388,005         18      - -

Sources:    Nueno Iniesta et al. (1981:96, 102-105, 149-153); 
Ministry of the Economy.

        TABLE 3:   SPAIN'S OUTWARD FDI IN DISTRIBUTION. BY HOST COUNTRY 
                               (1975-78 AND 1988-92) 


   


HOST            NUMBER OF       VALUE OF TRANSACTIONS:          Percent
COUN-           TRANSACTIONS:                                   of Total
TRY:                                                            FDI

A: 1975-78      n       % of    % of    Million % of    % of
                        Total   FDI in  Current Total   FDI in
                        Distrib Distrib Pesetas Distrib Distrib
                        ution   ution           ution   ution
                        FDI by  to Total        FDI by  to Total
                        Country FDI             Country FDI
----------      --      ------- --------------- ------- ---------------

EU              240     64.0    65.0    2,284   52.8    33.2    21.1
USAa             48     12.8    70.6    740     17.1    39.4    5.8
Latin America    54     14.4    13.4    858     19.8    4.3     61.0
TOTAL           375     100.0   36.4    4,325   100.0   13.3    100.0

B: 1988-92

EU              3276    64.4    50.9    199,091 51.3    15.9    56.8
USA             404     7.9     45.2    38,541  9.9     22.0    7.9
Latin America   627     12.3    40.1    50,201  12.9    25.9    8.8
TOTAL           5088    100.0   46.2    388,005 100.0   17.6    100.0

Notes:  a Includes Canada
Sources:  Nueno Iniesta et. al. (1981:143, 152-153); Ministry of the Economy. 

THEORETICAL FRAMEWORK

A firm will choose to internalize its foreign distribution activities rather than to perform them through 
market transactions when the expected total costs of internalizing are compensated by the expected 
benefits of direct managerial control. The existing theoretical explanations for this internalization decision 
usually emphasize particular aspects of the problem. First, one can focus on the trade-off between 
minimizing costs and satisfying the perceived managerial need to control operations. Cost minimization 
basically entails a comparison between the administrative costs of internalized distribution and the cost 
of negotiating and monitoring contracts with independent distributors or with end-users (Hennart 
1982:81-83; Buckley, Pass and Prescott 1990). Second, the firm may consider internalization to the 
extent that managerial control over distribution activities provides better market feedback, greater 
customer satisfaction or easier coordination among the different stages of the value-added chain, i.e. 
manufacturing, wholesaling, retailing, and after sales service (Chandler 1977:287-314). Third, the firm 
may find internalized distribution a better way of using and/or protecting its assets, resources, and 
capabilities from imitation by potential competitors (Caves 1982). Finally, firms engage in internalization 
to overcome informational asymmetries related to market access or knowledge (Borys and Jemison 
1989; Contractor and Lorange 1988). 

Transaction cost economics (TCE) addresses the question of how a firm should organize its boundary 
activities with the market and with other firms. According to TCE the firm will arrange transactions so 
as to minimize its total costs, i.e. the sum of production and transaction costs. It is generally assumed 
that markets provide lower production costs but that the transaction costs from monitoring arms-length 
transactions may become so large that it would compensate to internalize and trade off an increment in 
production cost resulting from transacting internally rather than through the market, if this internalization 
brings about a big enough reduction in transaction costs (Williamson 1985). Firms will minimize ex ante 
costs related to informational problems between buyer and seller in establishing contact, knowing 
reciprocal preferences and wants, and agreeing over price (Casson 1985). Ex post costs may accrue 
from the opportunistic behavior of the other party (the end-user, agent, wholesaler or retailer), and 
have to do with the monitoring and enforcement of the contract. TCE is relevant to the problem of 
internalizing foreign trade transactions because it makes clear predictions as to the circumstances 
under which a firm would be expected to bring the transaction into its boundaries. TCE would argue 
that internalization pays off only if the ex ante and ex post transaction costs are so onerous that 
internalization as an alternative to arms-length transaction becomes overall less costly. Product and 
market characteristics such as asset specificity, market uncertainty or transaction frequency are 
associated with high transaction costs and therefore with a higher probability that the firm will 
internalize the transaction. 

Empirical studies have provided some evidence in support of the transaction cost argument. Nicholas 
(1982, 1983) has presented archival information showing that British multinational investment in 
distribution prior to 1939 had to do with attempts to reduce transaction costs. Anderson and 
Coughlan (1987) found asset specificity to be the most robust predictor of internalization of 
distribution in a study of 94 introductions of semiconductor products in foreign markets by US firms. 
Klein and Roth (1990) studied 477 Canadian exporting firms and found experience in international 
markets to increase the likelihood of internalization in the presence of low asset specificity but 
not in the presence of high asset specificity. 

In our empirical analysis we will focus on product and technology differences across firms to test the 
effects of transaction costs. We will distinguish between firms manufacturing standardized products with 
mass production technologies and other types of firms. We argue that ex ante transaction costs related 
to establishing contact with customers or distributors, and to agreeing over product features, 
performance and price will be relatively higher in the case of non- standardized products manufactured 
by flexible or small-batch technologies. Ex post transaction costs will also be greater because the 
variability in the transactions will make monitoring and enforcement of the contracts more difficult. 
We therefore expect that 
H1a. Firms manufacturing standardized goods with mass production technologies are less likely to 
internalize export activities than other types of firms.  

One can also consider the problem of export internalization from the vantage point of how it may help 
top managers enhance operational control and achieve stability for the firm. Contingency organizational 
theory focuses on the impact that technological and environmental conditions have on the firm's 
organizational structure and domain, i.e. its range of value-added activities (Thompson 1967). 
Contingency theory argues that organizations would incorporate into their domains those activities 
or products that if left outside would become sources of uncertainty and constraint. 

Contingency theory predicts different ways of expanding the firm's domain depending on the nature 
of the technology used. According to the theory, firms using technologies such as assembling goods 
from a multiplicity of components or continuous-flow production typically expand their domains through 
vertical integration (Thompson 1967:20, 40-43). This implies that internalizing export activities would 
yield more benefits in the case of firms with technologies that require stability, predictability, or at least, 
the ability to forecast change in order to operate efficiently. The paramount example of such a 
technology is the mass production of standardized goods (Perrow 1967). This theory argues that 
once the investments in mass-production technology are in place the firm is expected to engage in 
backward and forward vertical integration as the need to buffer its core production activities from 
fluctuations and uncertainties in input and output markets arises. 

Chandler (1977:287-314) makes a similar argument for the internalization of marketing and 
distribution by U.S. firms at home and abroad. According to him the mass producer of goods 
needs to keep the heavy investments in specialized machinery fully employed. By exerting direct 
managerial control over branding and advertising, inventories, delivery schedules, and cash flows the 
firm can maximize long-term profits. He presents historical evidence showing that the mass producers 
of such packaged goods as cigarettes, matches, flour, breakfast cereals, canned products and 
photographic film integrated into wholesaling during the 1880s so as to achieve faster throughput, 
coordinate production and distribution with greater precision, reduce uncertainties, and anticipate 
market changes. In the case of standardized assembled goods, Chandler argues that service, repair 
and credit requirements invited firms to integrate into retailing as well as into wholesaling. Chandler's 
thesis is remarkably similar to Thompson's and Perrow's in its emphasis on the need for managerial 
coordination and control when mass production technologies requiring intensive and smooth 
operation are in place. These theorists make a prediction alternative to hypothesis H1a above: 
H1b. Firms manufacturing standardized goods with mass production technologies are more 
likely to internalize export activities.  

A third explanation for a firm's decision to internalize value-added activities rather than perform 
arms-length transactions emphasizes the role of intangible assets (Caves 1982; Kogut 1988; Kogut 
and Singh 1988). This perspective predicts that a firm will internalize value-added activities when it 
possesses intangible assets with the characteristics of a public good. For an arms-length transaction 
to be implemented at the economic value perceived by the exporting firm the intangible asset will have to be 
explained to the other party in the transaction. Given the public good characteristic of this asset, it is difficult 
to write up a contract to prevent the other party from using this public good for its own benefit, usually in 
direct competition with and in detriment of the parent firm. To avoid this dissipation of rents from the 
intangible asset the parent company will choose to internalize its operations. 

Prior research has found robust effects of intangible assets on the degree of internalization of exports. 
Benvignati (1990) used export data on 249 lines of business in U.S. manufacturing finding R&D and 
human capital intensity to be significant predictors of intrafirm versus arms-length exports, with capital 
and advertising intensities being insignificant. Siddharthan and Kumar (1990) came across similar 
relationships with a sample of 32 manufacturing industries. We follow the literature in this area and 
measure intangible assets by the ratios of expenditures in R&D (technological intangible assets) and 
in advertising (brand reputation) to sales. We therefore expect that 
H2. The larger the level of the firm's R&D and advertising expenditures relative to firm sales, the 
higher the likelihood of internalization of export activities. 

Another potential explanation for export internalization emphasizes the role of the structure of 
competition in the industry. Several authors have pointed out the key role that industry rivalry among 
domestic and foreign producers plays in the decision to internalize international operations. The research 
by Knickerbrocker (1973) and later studies have shown that competitive rivalry in moderately 
concentrated industries lead to higher levels of foreign investment by U.S. multinational corporations. 
This effect has been associated with imitative behavior by firms in an oligopoly. Kogut and Singh 
(1988) and Contractor and Lorange (1988) argue that an oligopolistic industry structure induces 
both interfirm linkages and greater internalization through joint ventures. However, they also point 
out that this effect might be negative in highly concentrated industries since for these industries a 
greenfield investment will increase overall industry capacity and will be likely to lead to competitive 
reactions by other firms. This negative effect applies to FDI that results in increases in industry capacity. 
Therefore, it is not likely to be important in our sample since we are measuring internalization of the 
foreign distribution of goods produced in the home country, which does not necessarily imply an 
increase in productive capacity. Accordingly, we expect that 

The above hypotheses speak to the likelihood of internalization of exports in general, not to the 
likelihood of different types of internalization. If the firm faces informational problems because of access 
barriers to foreign markets or because of lack of experience, it may affect the mode of internalization. 
We will distinguish between internalization by establishing a commercial alliance with a foreign partner 
and by investing in proprietary distribution channels abroad. Commercial alliances would be more 
likely if by teaming up with a partner the firm acquires capabilities or resources not available otherwise 
(Borys and Jemison 1989). Contractor and Lorange (1988) refer to international alliances in distribution 
as a step in "vertical quasi integration," i.e. an intermediate solution between pure arms-length 
transactions and wholly-owned subsidiaries. They argue that commercial alliances will occur if lack 
of knowledge about the foreign market is an impediment to higher exports or if the firm encounters 
access barriers that do not affect its competitors in the export market. 

The choice between commercial alliance and proprietary distribution will also be affected by the firm's 
experience in foreign markets (Contractor and Lorange 1988; Kogut and Singh 1988; Oliver 1990). 
Firms with no or little experience are more likely to need the assistance of a foreign partner. 
By establishing a strategic alliance the export firm can acquire the required knowledge about the 
local market, enhance its legitimacy and reputation, break through other types of entry barriers, and 
accumulate the necessary experience. Therefore, we expect that 
H4. If lack of knowledge about foreign markets, restricted access, or scarce export experience are 
perceived as limitations to the firm's export activity, the likelihood of internalization by commercial alliance 
will increase. 

Finally, this literature typically emphasizes resource constraints as a key factor behind the occurrence 
of international collaborative agreements. Investing in proprietary distribution may be an option only 
for relatively large firms which have the resources or can bear the risks of foreign direct investment. Therefore, 
H5. Firm size increases the likelihood of internalization by proprietary distribution. 

DATA AND METHODS

     TABLE 4:    USE OF PROPRIETARY DISTRIBUTION (PD) FOR EXPORT IN 1992a



                        Firms                   % Exports       Export 
                                                Through         Intensity
                                                Proprietary
                                                Distribution                                                                    (PD)

Type of Firm:           n       % of Exports    Mean a          Mean b
-------------           -       ------------    ------          ------

No Foreign Capital      997     50.9            20.1            29.2
   With PD              198     22.8            56.2            32.4
   Without PD           799     28.1            0.0             27.0
Foreign Capital < 75%   147     16.4            36.3            31.7
   With PD              56      9.2             76.7            33.8
   Without PD           91      7.2             0.0             29.3
Foreign Capital >= 75%  211     32.7            41.4            29.4
   With PD              122     19.0            80.9            27.6
   Without PD           89      13.7            0.0             32.3
All firms with PD       376     51.0            69.6            30.7

TOTAL                   1355    100.0           29.7            29.6


Notes:   

a.) Firms with less than 25 employees are excluded.
b.) Weighted by firm exports.
c.) Percentage of exports to sales. Weighted by firm revenues.

Source:  Instituto de Comercio Exterior 1992 Survey of Exporters.

     TABLE 5:    USE OF COMMERCIAL ALLIANCE (CA) FOR EXPORT IN 1992a



        Type of Firm            n       Percentage of           Export 
                                        Exports                 Intensity c
        ------------            -       -------------           -----------

No Foreign Capital              997     50.9                    29.2
   With CA                      146     9.1                     26.1
   Without CA                   848     41.7                    30.0
Foreign Capital < 75%           147     16.4                    31.7
   With CA                      41      6.0                     30.3
   Without CA                   105     10.3                    33.7
Foreign Capital >= 75%          211     32.7                    29.4
   With CA                      49      4.8                     20.8
   Without CA                   158     26.0                    31.1
All Firms with CA               236     19.9                    30.7

TOTALb                          1355    100.0                   29.6



Notes:  

a.) Firms with less than 25 employees are excluded.
b.) There are 8 firms with missing data.
c.) Weighted by firm revenues.

Source:  Instituto de Comercio Exterior, 1992 Survey of Exporters.

The Data Appendix defines the variables and sources used in the analysis. Firms with mass-production 
technologies are denoted by a dummy variable (MASS). R&D expenditures over sales were measured 
for each firm (RANDD) and advertising expenditures over sales for each industry (ADVERT). The 
five-firm industry concentration ratio based on sales in Spain (C5PRO) is the proxy for industry rivalry. 
We use two indicators for measuring difficulty of access to foreign markets: a dummy variable of 
whether the firm perceives lack of knowledge about export markets as a limitation (KNOW), and 
a three-point measure of the perception that its level of access to distribution channels in foreign 
markets is an advantage for the firm relative to its competitors, neither an advantage nor a 
disadvantage, or a disadvantage (ACCESS). We also use two indicators for export experience: 
exports over sales (EXPINT), and the growth export rate between 1987 and 1992 (EXPGRTH) 
for each firm. Total firm revenues (REVENUE) were also measured for each firm. Finally, firms with 
foreign ownership participation are distinguished from firms with no foreign ownership by a dummy 
variable (KFOREIGN). 

We specify dichotomous and multinomial logit models to analyze the predictors of the internalization 
of exports and the form of such internalization. The dichotomous model compares firms with either 
commercial alliances or proprietary distribution to all other firms, i.e. firms with no internalization of 
exports. For the multinomial model we classify firms in the sample into one of three categories: 
(1) firms with neither commercial alliances nor proprietary distribution; (2) firms with a commercial 
alliance but no proprietary distribution; and (3) firms with proprietary distribution regardless they have 
a commercial alliance or not. The multinomial logit model produces separate parameter estimates and 
significance t-tests for firms in the latter two categories compared to those in the first (baseline) 
category. Thus, we report two sets of parameter estimates and significance tests all compared to the 
reference category of no internalization of exports. We also compare results using firm absolute values 
and firm values adjusted for industry means in the cases of R&D expenditure over sales, exports over 
sales, and total revenues in order to test if the observed effects are attributable to industry-level or 
firm-level differences. Out of 843 firms in the final sample for analysis, 84 had a commercial alliance 
alone but no proprietary distribution channels, and 174 had proprietary distribution channels. 

RESULTS

       Table 6: LOGIT REGRESSIONS ON THE INTERNALIZATION OF EXPORTS 
    BY EITHER COMMERCIAL ALLIANCE OR PROPRIETARY  DISTRIBUTION, OR BOTH 



                            Relative to Industry Averagesa:


                A               B               C               D
                -               -               -               -

Constant     1.7536          -2.1121         -1.5382         -1.7160
             7.854           8.575           7.174           7.724
MASS        -0.4440**       -0.5431**       -0.4485**       -0.4706**
             1.987           2.398           2.049           2.120
ADVERT       0.2070*         0.1920*         0.2904***       0.3319***
             1.814           1.668           2.580           2.911
RANDDa       0.1096***       0.1028***       0.0012          0.0008
             4.175           3.861           0.487           0.333
C5PRO       -0.3104         -0.3908         0.0404          0.0028
             0.563           0.697           0.073           0.005
EXPGRTH      0.2819**        0.3070**        0.2770**        0.2888**
             2.230           2.370           2.241           2.299
EXPINTa      0.5649          0.4869          0.1067***       0.1047**
             1.622           1.381           2.603           2.539
REVENUEa     0.0524***       0.3734***       7.9699***       40.1920***
             4.818           4.616           2.851           4.637
REVENUESQa                  -0.0123***                      -147.2700***
                             4.017                           3.938
KFOREIGN     0.9345***       0.9087***       1.0697***       0.9500***
             3.857           3.739           4.537           3.930
Model Log-      
Likelihood -460.30         -452.20         -452.77         -444.75
N           843             843             780             780

Note: 

a.) For models C and D the following variables were redefined relative 
    to industry averages: RANDD, EXPINT, REVENUE and REVENUESQ.

t-ratios reported beneath regression coefficient.


* p < 0.10

** p < 0.05

*** p < 0.01

The five-firm concentration ratio is never significantly different from zero, suggesting no relationship 
between home industry concentration and the likelihood of export internalization. Firms with foreign 
capital participation (KFOREIGN) are likelier to internalize than wholly Spanish-owned firms. Firm 
size as measured by revenues predicts a higher likelihood of internalization at both the firm and 
industry levels. Its effect, however, levels off as firm size increases, reaching a maximum value 
towards the upper end of the sample distribution. Firms with export intensities (i.e. exports over sales, 
EXPINT) higher than the average in their industry (rather than those with high export intensity in the 
sample) are also more likely to internalize their operations. Finally, export growth over the last five 
years (EXPGRTH) is confirmed as a positive predictor of internalization. 

Table 7 reports the results from the multinomial logit regressions. The results differ depending on 
whether internalization takes place through commercial alliances or through proprietary distribution 
channels. Firms participated by foreign capital, with R&D intensities higher than the average in their 
industry, and high export growth over the last five years are positive predictors of both forms of 
internalization. Commercial alliances are likeliest among firms not employing mass production 
technology and firms in advertising-intensive industries. By contrast, the likelihood of proprietary 
distribution, unlike that of a commercial alliance, increases with export experience, as measured by 
export intensity (EXPINT), and with resource availability, as measured by firm size (REVENUE). 
Export growth (EXPGRTH), however, increases the likelihood of both forms of internalization. 
It seems, therefore, that sheer size and export volume are the drivers of investments in proprietary 
distribution, while firms in advertising- intensive industries that do not make standardized products 
using mass production technologies, regardless of their size, opt for commercial alliances with a 
foreign partner over proprietary distribution abroad. 

   Table 7: MULTINOMIAL LOGIT REGRESSIONS ON THE INTERNALIZATION OF EXPORTS



                Relative to Industry Averagesa: 

Commercial      A               B               C               D
----------      -               -               -               -

Constant        0.3955          0.2525          0.8039          0.6499
                0.466           0.294           0.972           0.777
MASS            -0.6806*        -0.6938*        -0.6804*        -0.6850*
                1.904           1.925           1.907           1.919
ADVERT          0.3218**        0.3125*         0.3005*         0.3180*
                1.992           1.933           1.851           1.958
RANDDa          0.1032***       0.1008***       0.00004         -0.0003
                2.722           2.650           0.009           0.062
C5PRO           0.5464          0.4891          0.8230          0.6771
                0.686           0.616           1.018           0.829
EXPGRTH         0.3765*         0.3772*         0.3693*         0.3849*
                1.833           1.835           1.787           1.840
EXPINTa         -0.3426         -0.3484         0.0141          0.0183
                0.619           0.629           0.209           0.270
REVENUEa        0.0099          0.0805          -5.4769         11.4700
                0.564           0.665           0.852           0.780
REVENUESQa                      -0.0028                         -108.1300
                                0.599                           0.794
KFOREIGN        0.9687***       0.9388***       1.0152*         0.9859***
                2.820           2.737           2.962           2.866
ACCESS          -0.4804***      -0.4661***      -0.5228***      -0.5096***
                2.926           2.833           3.117           3.039
KNOW            -0.5366         -0.5298         -0.6181         -0.6010
                1.475           1.456           1.623           1.576

Note: 

a.) For models C and D the following variables were redefined relative 
to industry averages: RANDD, EXPINT, REVENUE and REVENUESQ.

t-ratios reported beneath regression coefficient.

* p < 0.10 

** p < 0.05

*** p < 0.01

       Table 7: MULTINOMIAL LOGIT REGRESSIONS ON THE INTERNALIZATION OF 
                         EXPORTS (CONTINUED)



             Relative to Industry Averagesa:

Proprietary     A               B               C               D
Distribution
------------    -               -               -               -

Constant        0.3272          -0.3810         1.3751          1.3068
                0.487           0.549           2.148           2.035
MASS            -0.3651         -0.5054**       -0.3551         -0.3600
                1.443           1.966           1.438           1.453
ADVERT          0.1051          0.0864          0.1650          0.2090
                0.798           0.651           1.267           1.583
RANDDa          0.1110***       0.1020***       -0.0044*        0.0036
                3.723           3.356           1.698           1.307
C5PRO           0.4121          0.3057          0.8889          0.7742
                0.678           0.486           1.447           1.243
EXPGRTH         0.2625*         0.2932*         0.2667*         0.2920**
                1.757           1.912           1.821           1.974
EXPINTa         0.4977          0.4245          0.1141**        0.1169**
                1.239           1.043           2.502           2.557
REVENUEa        0.0577***       0.4972***       0.5936          7.0559***
                5.113           5.119           1.375           2.581
REVENUESQa                      -0.0167***                      -3.4298**
                                4.579                           2.389
KFOREIGN        0.8672***       0.8426***       1.1043***       1.1238***
                3.175           3.081           4.137           4.203
ACCESS          -0.3067**       -0.2603**       -0.4469***      -0.4384***
                2.391           2.009           3.512           3.426
KNOW            -1.0931***      -1.0961***      -1.0343***      -1.0342***
                3.281           3.261           3.149           3.139
Model Log-
Likelihood      -615.64         -604.88         -598.68         -595.28
N               843             843             780             780


Note: 
a.) For models C and D the following variables were redefined relative to 
industry averages: RANDD, EXPINT, REVENUE and REVENUESQ.

t-ratios reported beneath regression coefficient.

* p < 0.10 

** p < 0.05

*** p < 0.01

CONCLUSIONS

The paper drew on existing theoretical work on internalization to develop a set of testable hypotheses. 
Internalization is more beneficial to the firm than exporting through an arms-length transaction when the 
information differential between exporter and final consumer is likely to be high. This high information 
differential can be due to the complexity of the product or to the existence of firm specific assets. On 
the other hand, a firm with a mass production process will have the incentive to internalize its export 
operations so as to minimize possible fluctuations in market demand that would lead to disruptions in the 
production flow. 

We found that firms mass-producing standardized goods are less likely to internalize their operations. 
This result appears to be inconsistent with the prediction from contingency organizational theory that 
firms using mass-production technologies should integrate downstream to minimize the impact of 
fluctuations. We also found that firm specific assets, measured by R&D and industry advertising 
intensity, encourage internalization. To the extent that standardized products require less information 
to be transmitted from producer to consumer the previous results are consistent with the hypothesis 
that internalization minimizes the information costs between seller and buyer of the product. 

In distinguishing between internalization by commercial alliance and by proprietary distribution we 
found firm size and export intensity to be significant predictors of the establishment of proprietary 
distribution channels. This result is consistent with the prediction that higher transaction frequency, i.e. 
export intensity, makes exports through expensive proprietary distribution channels abroad more 
efficient as the cost of the investment can be spread over a larger export volume. Commercial alliances 
where most likely in firms producing non- standardized products in industries with high levels of 
intangible assets. 

The results reported in this paper do not provide sufficient evidence to be able to reject a particular 
theoretical explanation of the internalization process in favor of a specific alternative. Even under ideal 
empirical conditions, it is not clear whether such an approach would prove useful since these theories 
do not make competing claims but rather tend to emphasize different motives for internalization. The 
goal of the paper was to provide some empirical evidence concerning particular hypotheses so that 
future theoretical work can build on the existing knowledge in the direction that will be most likely to 
represent reality. 

This paper has not dealt with an important aspect of the problem of export internalization, i.e. the 
sequential process by which firms take steps towards internalizing export activities. We have no 
information regarding the sequence of internalization across foreign markets, product lines or types 
of internalization. For instance, one would expect a firm to establish alliances and proprietary 
distribution in markets ripe with uncertainty first, or to internalize exports of products that entail high 
asset specificity or R&D expenditure before other kinds of products, or to use joint ventures in 
distribution before they commit resources to wholly-owned subsidiaries. 

DATA APPENDIX 

MASS: Equal to 1 if the firm manufactures standardized goods with a mass- production technology; 
equal to zero otherwise. Source: ICEX 1992 Survey. 

ADVERT: Industry nominal advertising expenditure as a percentage of industry nominal sales in 
Spain. Source: Encuesta Industrial 1988. 

RANDD: For each firm, R&D expenditure as a percentage of sales. Midpoint values were allocated 
to each of four closed intervals. Upper open-ended interval was assigned a value of 10 percent. Source: 
ICEX 1992 Survey. When relative to industry average: Ratio of R&D expenditure to sales for each firm 
over ratio of R&D expenditure to sales for the industry. Source: INE R&D 1991 Survey. 

C5PRO: Five-firm industry concentration ratio equal to the ratio of the sales for the five largest firms 
in an industry to the industry's total sales in Spain. Source: Encuesta Industrial 1990. 

EXPGRTH: For each firm, exports as a percentage of sales in 1992 minus exports as a percentage 
of sales in 1987 over exports as a percentage of sales in 1992. Source: ICEX 1992 Survey. . 

EXPINT: Export intensity, i.e. ratio of exports to sales for each firm. Source: ICEX 1992 Survey. 
When relative to industry average: Ratio of exports to sales for each firm over ratio of exports to sales for the 
industry. Source: Encuesta Industrial 1986. 

KNOW: Equal to 1 if the firm perceives that lack of knowledge about foreign markets represents a 
limitation to its export performance; equal to zero otherwise. Source: ICEX 1992 Survey. 

ACCESS: Equal to 1 if the firm perceives that its level of access to distribution channels in foreign 
markets is an advantage relative to its competitors; equal to 2 if it is neither an advantage nor a 
disadvantage; equal to 3 if it is a disadvantage. Source: ICEX 1992 Survey 
. 

REVENUE: Total firm revenues in billions of pesetas. Midpoint values were allocated to each of 
seven closed intervals. Upper open-ended interval was assigned a value of 25 billion pesetas. 
Source: ICEX 1992 Survey. When relative to industry average: Ratio of each firm's sales in billions 
of pesetas over industry sales in billions of pesetas. Source: Encuesta Industrial 1990 

REVENUESQ: REVENUE squared. 

KFOREIGN: Equal to 1 if the firm had foreign ownership participation of less than 75 percent; 
equal to zero if no foreign ownership. Source: ICEX 1992 Survey 
. 

REFERENCES

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Burgers, Willem P., Charles W. L. Hill, and W. Chan Kim. 1993. "A Theory of Global Strategic 
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Chandler, Alfred D., Jr. 1977. The Visible Hand. Cambridge: Harvard University Press. 
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Dunning, John. 1988. Explaining International Production. London: Unwin Hyman. 

Encarnation, Dennis. 1994. "Investment and Trade by American, European, and Japanese 
Multinationals across the Triad." In Mark Mason and Dennis Encarnation eds., 
Does Ownership Matter? Oxford: Oxford University Press, pp. 205-227. 

Hamel, Gary. 1991. "Competition for Competence and Interpartner Learning within 
International Strategic Alliances." Strategic Management 12:83-103. 

Hergert, Michael, and Deigan Morris. 1988. "Trends in International Collaborative Agreements. 
" In Farok J. Contractor and Peter Lorange, eds., Cooperative Strategies in International Business.  
Lexington, Mass.: Lexington Books, pp. 99-109. 

Klein, Saul, and Victor J. Roth 1990. "Determinants of Export Channel Structure: The Effects of 
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27-38. 

Knickerbocker, F.T. 1973. Oligopolistic Reaction and Multinational Enterprise. Boston: Division of 
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Kogut, Bruce.1988. "Joint Ventures: Theoretical and Empirical Perspectives." Strategic Management  
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. 

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. 

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FDI broken down by goal of the investment is not available for other time periods. Campa and Guillen 
(1995) found that FDI in distribution, as opposed to asset- seeking or factor-seeking FDI, was inversely 
related to the GDP per capita and the stock of Spanish FDI in the host country and directly related to the 
share that trade with Spain represents in the host country's total trade. Holding constant for product 
differentiation and prior introduction mode. The authors found no effects for product age and service 
requirements. No information on asset specificity is available from the dataset used in our analysis. 
This point is also emphasized by resource-dependence theorists (Pfeffer and Salancik 1978). 
Chandler provides several examples of these goods: sewing machines, agricultual equipment, 
office machinery, pumps, boilers and different kinds of electrical equipment. An alternative explanation for 
the relevance of intangible assets would argue that firms with high levels of them will tend to produce 
relatively sophisticated products which are likely to widen the informational gap between buyer and 
seller, particularly if they are located in different countries. This information- based explanation is 
conceptually different but empirically indistinguishable from the argument based on the public good nature 
of intangible assets. See also Hergert and Morris (1988) and Oliver (1990). 1992 Survey of Exporters 
conducted by the Instituto Espa-ol de Comercio Exterior (ICEX), an agency of the Ministry of 
Commerce. The margin of error is +/- 2.5 percent. This unexpected relationship might be due to 
the importance of (non- proprietary) franchise-type distribution channels for certain export products 
like autos. The reasons behind this wide difference are unclear to us. One possibility is that the 
wholly-owned greenfield subsidiaries of foreign multinationals, most of which are major exporters, 
tend not to use commercial alliances to sell their Spanish- made products abroad. This subsample 
represents 85 percent of all firms with 25 or more employees and 67 percent of all exports. 
Only 7 percent of all firms accounting for 12 percent of exports had both proprietary distribution and a 
commercial alliance. We cannot do a similar comparison for advertising expenditures since data at the 
firm level are not available. We also allowed for a non-linear effect for industry concentration with 
the same insignificant results. Of course, there is the possibility of an endogeneity problem in that having 
proprietary distribution abroad could increase the export intensity of the firm. As shown in Table 4, 
however, export intensities are very similar for firms with and without proprietary distribution abroad. 
An endogeneity effect may be at work because firms that have internalized their export activities are 
more likely not to perceive lack of knowledge or access to distribution channels as obstacles to 
better export performance. 

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Re-engineering of Business Processes in Multinational Corporations

Katholische Universitat Eichstatt, Germany 

Working Paper No. 95-4 

The research for this paper was supported by a grant from the Carnegie Bosch Institute and was presented at the Institute's International Research Conference, November 2, 1994. 

Re-engineering of Business Processes in Multinational Corporations

Prof. Dr. Michael Kutschker

Abstract

Contents

• Introduction 
• International Business Processes 
• - Management of Ongoing Business Processes 
• - Improvement of Business Processes 
• - Re-engineering of Business Processes 
• Management of International Business Processes 
• - Coordination 
• - New Information Technologies 
• Re-engineering of International Business Processes 
• - Characteristics 
• - Information Technology -
•  Deeper Structure 
• - Internationality 
• - Complexity 
• Conclusion

Introduction

Both the characteristics of international management and the process orientation underlying the philosophy of BPR have been the reasons to present a paper at this conference. Fifty in- depth interviews in 30 large Multinational Corporations (MNCs) of Germany and Switzerland constitute the background for the authorÕs comments on Business Process Re-engineering in an international context. 

International Business Processes

Management of Ongoing Business Processes

Improvement of Business Processes

Re-engineering of Business Processes

However, in most cases the holistic approach ends at national borders. There are two possible reasons for ignoring the international dimension of business processes. Either the redesign of international processes is deemed to be unimportant or the international dimension is perceived not to change the character of BPR substantially. In view of the increasing internationalization of many industries, the first reason is rather academic. Therefore only the second reason may be accepted, raising the question: What is special about international BPR? The answer to this question is one of the objectives of this paper. 

Practitioners as well as academics and consultants have differing views about business processes. In the survey conducted for this research the interviews showed considerable variation in their understanding of business process issues. Some companies had improved or redesigned some isolated business processes, others had changed process systems, and only very few had introduced a comprehensive process re-organization, decomposing the ongoing activities of the company into a well defined set of business processes. Some authors stress organizational aspects of processes, others concentrate on aspects of improving processes or Business Process Re-engineering. Consultants often sell old concepts under the name of the new concept, BPR. Although perceptions and understanding of business processes are different, their common focus is to optimize the efficiency of an organization. Efficiency can be increased by a planned change of appropriate processes, thus shifting the attention of organization theory from structure to process. 

Management of International Business Processes

Coordination

Obviously, each subsidiary has its distinctive set of context factors, implying that a firm has to control different headquarter-subsidiary relationships in different ways. Empirical results confirm that firms are successful when they adapt the coordination instruments to the subsidiaries' specific situation. Moreover, it may be assumed that the coordination pattern of the headquarter-subsidiary relationship also varies with the character of strategic business units and of functional departments . 
A process orientation assumes that managers adapt the application of coordination instruments to the specifics of the business process. Therefore, the above mentioned four business processes were analyzed with respect to their political and structural character. The interviews with managers in German and Swiss MNCs clearly supported the view that managers do vary their use of coordination instruments according to the character of business processes. Personal instruments such as face-to-face meetings, personal instructions, and visits are more often used in political and ill-structured processes like strategic planning. In contrast, managers often apply technocratic instruments of coordination such as rules, programs and written documents in operational and well-structured decisions, such as physical distribution and warehousing. The processes of product launch and budgeting have a mix of personal and operational elements. In these processes managers vary the use of coordination instruments over the course of time, preferring face-to-face meetings in value-intensive soft phases and exchanging formalized documents in the operational phases of budgeting or product introduction. 

Managers construct the reality of their firms, subsidiaries, departments, and strategic business units. They design the structures of their units, develop organizational cultures, expand the internationality of their departments, and decide on "appropriate" coordination instruments in general. However, this self-created static frame of contingencies can only deliver a partial explanation of organizational behavior. Within the business processes, individuals constantly construct reality anew, accepting, ignoring or inventing new contingencies on the base of their perceived and assessed reality. So, it is not so much the absolute character of a business process that determines the selection of coordination instruments, but rather the perception of process complexity that dictates the use of coordination instruments. The interviews strongly support the view of "bringing mind back in . 
New Information Technologies

New Information Technologies (IT) are said to have a major impact on the coordination of headquarter-subsidiary-relations. New IT such as electronic mail, corporate and public data bases, application systems, fax, video and computer-conferencing , are considered to be some of the driving forces of internationalisation. 

However, very little academic research has focused on the interface between International Management, Organization Theory and Information Systems. Only a few authors have considered the fit between global business strategy and global IT strategy. Even though the strategic importance of IT is asserted, few studies closely investigate the relationship between state of the art applications of IT in MNCs and their impact and importance for coordinating dispersed activities and business processes. Research linking IT and coordination focuses either on domestic inter-unit coordination , or lacks empirical content. Some studies have the right research focus, but they are outdated because of the rapid change of IT. 

Regarding the enabling role of IT for the internationalization process, the interviews conducted produced mixed results. On the one hand more companies than expected have developed worldwide communication networks. These networks include E-mail as well as internal fax networks. On the other hand, the stereotype that IT pushes globalization was not supported. Firms change IT to facilitate the management of international business processes and renew the communications hardware when higher levels of internationalization ask for it. IT follows internationalization, but not vice-versa. 

New IT influences the interaction between headquarters and subsidiaries and may have an impact on the use of coordination instruments. In many interviews the influence of IT on coordination in MNCs was discussed. IT helps to solve problems which are intensified by the international scope of business processes: geographical distances that have to be overcome, scattered members in a decentralized organization who need to create and process information in many places, and different time zones between senders and recipients of information that pose additional problems. 

Our hypothesis that the impact of IT varies among the four business processes has been confirmed. Operational, well-structured processes like logistics tend to be more supported by IT than political, ill-structured processes like strategic planning. 

The perception of the surveyed respondents was that new IT does not lead to a substitution of coordination instruments. In those companies using global networks for the exchange of data and written information, the frequency and intensity of personal visits abroad have not decreased. The major reason for this lies in the fact that confidence and personal relationships can not at all be established by computer or video-conferencing. 

The four business processes do not only vary concerning the use of IT and coordination mechanisms, but also have different international orientations. An initial assumption was that internationalization will be realized by a well designed and orchestrated strategic planning process. Surprisingly, operational business processes are much more mutually dependent and linked than political processes. Operational processes appear to be better designed for the purpose of international coordination than strategic planning processes. Applying Perlmutter's framework , strategic planning is more ethnocentric with a strong orientation towards centralized decision-making, whereas R&D or logistics processes resemble more a geocentric network of mutually coordinating partners. However, the greater bulk of the sample is far away from having realized the vision of a transnational network organization - at least at the strategic level. 

The research was started with a traditional view on coordination instruments which can be considered as central subjects of the theory of international management. Throughout the interviews it was recognized that the question of international coordination is certainly interesting to managers. It was also evident that managers do not bother very much about traditional coordination instruments. Centralization, standardization, or formalization were found to be less important than questions of international team-building or the participation of foreign managers in strategic decisions. 

Decision arenas provide opportunities to exchange values, opinions, data, and test theories and thereby form organizational identity. Thus corporate culture controls and coordinates activities. The interviews show that traditional coordination mechanisms are supplemented or even replaced by such "new" forms of coordination. Norms and organizational culture play an increasingly important role in managing business processes. 

The internationalization of firms increases the dynamics and complexity of their relations with the environment. Rapid external change makes MNCs so vulnerable that they cannot fully rely on adaptive structural changes. They have to organize their business processes in ways that allow greater flexibility. Organizing for more flexibility means deliberately to design or re-design existing international business processes. 

Re-engineering International Business Processes

See Handelsblatt (1994), No. 117, June 21, 1994.
See for instance Davenport and Short (1990), Hammer (1990), Harrington (1991), Knorr (1991), Barton
(1993), Davenport (1993), Hammer and Champy (1993).

 These interviews have been carried out together with Professor Krcmar, Chair of Information Systems at the 
University of Stuttgart-Hohenheim,  and  two research assistants, Ulrich Hanfeld  and  Dr. Bettina Schwarzer, 
both being financed by the generosity of the Carnegie Bosch Institute.

  The terms business process re-engineering  and  business process redesign are used synonymously throughout 
the paper.

  See for instance Stopford and Wells (1972), Franko (1976), Doz (1980), Welge (1981). 
  The criteria for selection are taken from literature pertaining to individual  and  collective problem solving. See 
for instance March and Simon (1958). The selection was performed to obtain a large variance representing the 
spectrum of processes found in organizations.
  From an external point of view this situation leads to disjointed incrementalism; see Lindblom (1964).
  See on interface problems for instance Lim and Reid (1992) or Brockhoff and Hauschildt (1993).
  See Harrington (1991), Short and Venkatraman (1992), O`Sullivan and Geringer (1993).
  See Kane (1986), Belmonte and Murray (1993), Davenport (1993), Hammer and Champy (1993).
  The problem of coordination mechanisms originates in the bureaucratic model of Max Weber. Here we refer 
to Kenter's classification of coordination instruments. See Kenter (1985). 
  For exhaustive reviews of the literature see Khandwalla (1975), Welge (1981), Baliga and Jaeger (1984), 
Egelhoff (1988), Martinez and Jarillo (1989), Wolf (1994).
  See Prahalad and Doz (1987).
  See Brandt and Hulbert (1976), Prahalad and Doz (1981), Ghoshal and Nohria (1989), Roth and Nigh (1992).
  See Macharzina (1992), Sullivan (1992), Kutschker (1994).
  See Brandt and Hulbert (1977), Welge (1981), Kenter (1985).
  This was the title of an article stressing the role of the manager; see Pondy and Boje (1976).
  For a complete listing  and  interpretation see Conger (1988).
  See Manheim (1990), Jarvenpaa and Ives (1991).
  See for instance Jarvenpaa and Ives (1990), Jarvenpaa and Ives (1991), Ives and Jarvenpaa (1991).
  See for one of these studies Samiee (1984), Sethi and Olson (1991), Palvia and Saraswat (1992). 
  See Conger (1988), Moynihan (1985).
  See Malone (1988).
  See Mandell (1975), Brandt and Hulbert (1976), Mandell and Grub (1979).
  See Keen (1991), Manheim (1991).
  See Heenan and Perlmutter (1979).
  See Bartlett and Ghoshal (1989).
  See Etzioni (1968), Deal and Kennedy (1987), Bartlett and Ghoshal (1989), Nohria and Ghoshal (1994).
  See on flexibility Boudette (1989), Bleicher (1990), Maljers (1992), Amburgey, Kelly and Barnett (1993). 
  See Striening (1988), Hammer (1990), Gilbert and Siong (1993), Harrison and Pratz (1993), Girth (1994).
  See Gaitanides (1983), Peters (1988), Davenport and Short (1990), Holst (1991), Davenport (1993).
  See Kane (1986), Davenport (1993), Scheer (1993).
  See on process owners Striening (1988).
  See Pall (1987), Vantrappen (1992), Blattberg and Deighton (1993), Hammer and Champy (1993).
  See Handelsblatt-Karriere (1994), No. 29, July 29-30,1994, Fischer et. al. (1994).
  See Davenport (1993).
  See Gaitanides (1983), Bellmann (1991), Striening (1988).
  See Simon (1989), Fromm (1992).
  The sample consisted of an undifferentiated sub-sample of German MNCs  and  two Swiss  and  German sub-
samples in the electronics  and  the pharmaceutical industries.
  For instance Davenport, Ernst&Young or Hammer and CIC or Scott-Morgan and ADL.
  See for example Fischer et al. (1994) who give a disillusioning report.
  See Davenport (1993).
  See Kane (1986).
  See Brandes et al. (1989), Davenport and Short (1990), Hammer (1990), Venkatraman (1991), Scheer (1993), 
Benjamin and Levinson (1993), Hauser and Thurmann (1993).
  See for instance Schwarzer, Krcmar and Kutschker (1993), Schwarzer (1993), Schwarzer and Krcmar (1994).
  See Etzioni (1968). For the interplay of data, values,  and  theory in science see Galtung (1978), Kirsch 
(1991).
  The distinction between surface structures  and  deeper structures is based on ChomskyÕs concept on the 
syntax of a language; see Chomsky (1965), Kirsch (1991), Kirsch (1992).
  See for instance Kirsch, Esser and Gabele (1979), Kirsch (1991), Hedberg (1981), Meffert (1984), Stata 

(1989).

  See Handelsblatt Karriere (1994).
  See however Scott-Morgan (1994).
  See on co-orientation Kirsch (1992).
  See Etzioni (1968), Ouchi (1981), Nohria and  Ghoshal (1994).
  See Eisenhardt (1989), Yin (1990), Wollnik (1992), Schmid (1994).
  See for instance Adler (1991).
  See Porter (1985), Porter (1986), Bartlett and Ghoshal (1988), Bartlett and Ghoshal (1989).
  See Bellmann (1991), Wildemann (1993)