Nature of the relationship between international expansion and performance: The case of emerging market firms

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1 Journal of World Business 42 (2007) Nature of the relationship between international expansion and performance: The case of emerging market firms Farok J. Contractor a, *, Vikas Kumar b,1, Sumit K. Kundu c,2 a Rutgers Business School, Rutgers University, 111 Washington Street, Newark, NJ 07102, USA b Department of Management, Bocconi University, Viale Isonzo 23, Milan, Italy c Florida International University, SW 8th Street, University Park, RB 345B, Miami, FL 33199, USA Abstract Internationally expanding companies would like to see how they compare with rivals in terms of the effect of internationalization on financial performance (for their sector and their firm). Virtually all such studies have focused on advanced nations. This study, on internationalization of firms based in an emerging economy (India), provides a unique research setting and sheds additional light on this relationship. It tests for the shape of the internationalization performance curve for emerging market firms, and investigates differences between service firms and manufacturers in the threshold effect between the initial and later stages of internationalization. We find a U-shaped curve depicting the internationalization performance relationship of Indian firms. Service sector firms tend to gain the positive benefits of internationalization sooner than manufacturing companies. # 2007 Elsevier Inc. All rights reserved. The relationship between degree of international expansion and firm financial performance is a salient research issue. It is also important to international strategists as firms can track or map their performance against rival companies in their sector. The notion that international expansion is good is a core argument of International Management studies. While this is true over a considerable range of international growth, the recently proposed three-stage theory 3 suggests that the * Corresponding author. Tel.: ; fax: addresses: farok@andromeda.rutgers.edu (F.J. Contractor), vikas.kumar@unibocconi.it (V. Kumar), kundus@fiu.edu (S.K. Kundu). 1 Tel.: ; fax: Tel.: ; fax: We explain the three-stage theory of international expansion in a later section (The General Theory of International Expansion and Emerging Market Firms). For detailed conceptual development refer to Contractor, Kundu, and Hsu (2003) article in Journal of International Business Studies. effect of international expansion on performance is not monotonic. It is negative in the initial stage of early internationalization, as well as in a third stage wherein some firms may over-internationalize (Contractor et al., 2003; Lu & Beamish, 2004). (Stage 1: initial international expansion has a negative effect on financial performance; Stage 2: further internationalization produces a positive effect on performance; Stage 3: excessive internationalization in some companies again results in a negative slope.) This produces an overall horizontal S-shaped curve for all three stages, on the performance versus internationalization graph. This is not just of academic interest. Company strategists and financial analysts may also be interested in graphing an individual firm s position in the performance internationalization map to see (i) how it compares with rival firms in the sector and (ii) find the inflection point for its sector from negative to positive performance, i.e., from Stages 1 to 2. Such a graph will give company strategists some idea of the threshold point, or level of /$ see front matter # 2007 Elsevier Inc. All rights reserved. doi: /j.jwb

2 402 F.J. Contractor et al. / Journal of World Business 42 (2007) internationalization, beyond which positive performance effects may be anticipated. With this knowledge, managers and consultants can plan future strategies based on the projected or potential path for the firm s international expansion. Knowledge and empirical studies on this topic have been limited to multinationals from developed economies. Our study seeks an explanation of the complex relationship between degree of internationalization and performance from an emerging market company context, by analyzing data from Indian companies that have internationalized. This paper makes the following major contributions. First, we revisit the three-stage theory of international expansion in the unique context of an emerging market and thus further strengthen the applicability of the model to the nascent body of research on the internationalization performance link of emerging market firms (Nachum, 2004; Thomas, 2006; Wan, 1998). Second, in the process of depicting the internationalization performance relationship of Indian firms, we seek to shed light on the divergent findings of prior studies. 4 Furthermore, we treat manufacturing and services sectors separately, since there are a priori reasons to believe that the two sub-sectors will behave differently. The data includes 142 Indian manufacturing companies and 127 Indian service sector firms. This will broaden existing knowledge on the internationalization versus performance link. 1. Review of the theory and literature In this section, we review the general three-stage theory which reconciles the seemingly disparate results of past empirical work. While this is not the major objective of this paper, it is worth pointing out that a consensus on the nature and shape of the relationship between the performance of firms as a function of their degree of internationalization, is only now emerging. Table 1 summarizes a relevant sample of 27 studies between the years 1977 and Different studies show a positive, or a negative, or curvilinear (U-Shaped 4 Since the introduction of the three-stage theory or the S-curve model, further studies have debated the applicability of the model in different institutional and industrial contexts. While Li (2005) shows support for the three-stage theory with a sample of US service firms, Ruigrok, Amann, and Wagner (2007) with a sample of Swiss multinationals conclude that the internationalization-performance relationship is context dependent. Moreover, Hitt, Bieman, Uhlenbruck, and Shimizu (2006) in their study of US professional service firms find a positive linear relationship. Thus, there exists a need for greater theoretical and empirical investigation of the three-stage theory. or Inverted U-Shaped) effect of increasing international expansion on performance. For example, two studies by Siddharthan and Lall (1982), and Kumar (1984) show a negative relationship. Alternately, Buckley, Dunning, and Pearce (1977) and Grant (1987) exhibit results suggesting a positive relationship between internationalization and performance. Some studies have proposed a non-linear relationship between Internationalization and Performance (Haar, 1989; Grant, Jammine, & Thomas, 1988; Hitt, Hoskisson, & Kim, 1997; Gomes, & Ramaswamy, 1999). But even here, the results are incongruent as some show a U-shaped link, while other results are inverted U-shape. Ruigrok and Wagner (2005) surveyed over 100 empirical studies in the field over the past 30 years, (with a bibliography that exceeds 180 references) and analyzed 62 that met their criterion for a meta-analysis. They found no consistent pattern in the empirical results. We mention past empirical work in order to show how the general threestage or S-Curve model, discussed next, reconciles and incorporates the results of previous studies that showed seemingly disparate results, ranging from linear (monotonic) to curvilinear (U-shaped and inverted U- shaped) The general theory of international expansion and performance Firms can be classified into three groups depending on their degree of internationalization: early internationalizers (Stage 1) are companies that have just begun their international expansion. Such firms suffer the negative impact, or threshold costs, of initial foreign growth. Mature internationalizers (Stage 2) are firms that are well into the internationalization process and are now reaping the positive benefits of global scale. Highly internationalized firms (Stage 3) are some companies that may have over-expanded so that the incremental benefits of further internationalization are lower than the incremental costs of further expansion. Hence firms in the third stage suffer, once again, a negative effect on performance. In this section we further amplify the theory of the Stages model of international expansion recently proposed by Contractor et al. (2003) Stage 1 (negative slope) The firm expanding in a new, unfamiliar foreign environment will incur significant learning, coordination, and set up costs that, for a while, will exceed the benefits of expanding into the foreign market. As Caves (1971) put it:

3 F.J. Contractor et al. / Journal of World Business 42 (2007) Table 1 Past internationalization performance research No. Author(s) Year Source/journal/book Direction of relationship 1 Buckley, P.J., Dunning, J.H., and Pearce, R.B Weltwirtschaftliches Archives Weak positive 2 Siddharthan, N.S. and Lall, S Oxford Bulletin of Economics and Statistics Negative 3 Kumar, M.S Growth, Acquisition and Investment, Negative Cambridge University Press 4 Shaked, I Journal of International Business Studies Inconclusive results 5 Michel, A. and Shaked, I Journal of International Business Studies Not positive 6 Grant, R.M Journal of International Business Studies Positive 7 Grant, R.M., Jammine, A.P., and Thomas, H Academy of Management Journal Positive 8 Haar, J Management International Review Inconclusive results 9 Daniels, J.D. and Bracker, J Management International Review Positive 10 Kim, W.C., Hwang, P., and Burgers, W.P Strategic Management Journal Inconclusive results 11 Geringer, J.M., Beamish, P.W., and dacosta, R.C Strategic Management Journal Inverted U-shaped 12 Collins, J.M Journal of International Business Studies Not positive 13 Jung, Y Journal of Business Research Positive 14 Sullivan, D Journal of International Business Studies Inverted U-shaped 15 Sullivan, D Management International Review 16 Ramaswamy, K Journal of International Management Inverted U-shaped with moderating effect of configuration 17 Sambharya, R.B Management International Review No effect 18 Tallman, S. and Li, J.T Academy of Management Journal Not highly positive 19 Hitt, M.A., Hoskisson, R.E., and Kim, H Academy of Management Journal Inverted U-shaped 20 Qian, G Management International Review Positive 21 Han, K.C., Lee, S.H., and Suk. D.Y Multinational Business Review Weak positive 22 Qian, G Multinational Business Review Positive 23 Gomes, L. and Ramaswamy, K Journal of International Business Studies Inverted U-shaped 24 Kotabe, M., Srinivasan, S.S., and Aulakh, P.S Journal of International Business Studies Moderating effect of R&D and Adv. 25 Capar, N. and Kotabe, M Journal of International Business Studies U-shaped 26 Contractor, F., Kundu, S.K., and Hsu, C.-C Journal of International Business Studies S-shaped curve 27 Lu, J. and Beamish, P Academy of Management Journal S-shaped curve The foreign enterprise must pay dearly for what the native has acquired at no cost to the firm (because it was part of the entrepreneur s general education) or can acquire more cheaply (because as it were the native knows where to look). The notion of the liability of foreignness, and the additional burden or costs that the internationally expanding firm must initially endure (Tallman & Li, 1996; Zaheer & Mosakowski, 1997) is implicit in the incremental internationalization theory proposed by Johanson and Vahlne (1977). Any new venture entails transaction costs. However, firms first going abroad face higher levels of uncertainty due to unfamiliarity with foreign market conditions (Anderson & Gatignon, 1986). Hennart (2001) and Roth and O Donnell (1996) observe that agency costs, at this internationalization stage, can be very high from shirking and opportunism by distant staff. Similarly, learning costs at the initial internationalization Stage 1 are highest. These include acquiring new cultural knowledge (Hofstede, 1980), and learning about foreign market conditions. Doz, Santos, and Williamson (2001) aver that, increasingly, the key to success in foreign operations is the ability to detect and assimilate local knowledge, and then, transmit it back home and to other operations. Such knowledge management skills would have the highest costs in early internationalization. The international firm also has to learn about local social structures and institutions. Kostova and Zaheer (1999) emphasize that institutional setups vary significantly across nations. It takes time and energy for a foreign company to acquire institutional legitimacy and, until such time, it will suffer de facto discrimination when compared to locally embedded firms. Other Stage 1 costs may include local adaptation costs and isomorphism (Ghoshal & Bartlett, 1990), increased coordination and communications costs (Rosenzweig & Singh, 1991), and high transport and tariff costs as trade accompanies foreign direct investment. Of course, many of the costs described would occur at any stage of international expansion. But in terms of the impact on profits, or performance, the negative

4 404 F.J. Contractor et al. / Journal of World Business 42 (2007) effects would be most felt in Stage 1 because the high initial upfront costs are spread over a smaller base of operations. In addition, early internationalizers are yet to reap sufficient foreign sales in the first stage, to adequately cover the incremental costs of early internationalization. The negative performance effect of early internationalization in Stage 1 amounts to a combination of high upfront threshold costs (such as learning, cultural adaptation and discrimination) and a global scale that is, as yet, inadequate to justify the international expansion. Since many emerging market firms are small and operate at an uneconomical scale in their domestic markets, even small levels of internationalization may significantly complement their domestic operations. As such, economies of scale benefits will kick-in earlier leading to a shorter stage 1 for some of the emerging market firms Stage 2 (positive slope) In Stage 2, the international enterprise accrues benefits from geographical diversification, in terms of diversification of risk, global scale and scope, knowledge acquisition and transfer. The Stage 2 arguments are familiar enough in the literature (Buckley & Casson, 1976; Stopford & Louis, 1972) that we need only summarize them here. Benefits from international expansion derive from the following: (a) exploitation of proprietary, firmspecific assets (Buckley, 1988; Caves, 1996; Delios & Beamish, 1999; Jung, 1991); (b) exploitation of market imperfections (Caves, 1971); (c) economies of global scale and scope (Buckley & Casson, 1976; Caves, 1996; Hymer, 1976). Such economies are especially beneficial to firms based in emerging markets with relatively small home markets (Yeung, 1999). Other sources of benefits include: (d) internalization benefits at a global scale that circumvent market failure, and avoidance of trade barriers, moral hazards, and broken contracts (Dunning, 1993); (e) arbitrage on a global scale; (f) ability to source lower cost inputs, including but not restricted to labor; (g) accumulation of market power in some cases (Kogut, 1985); (h) access to knowledge in foreign locations and the ability to transfer this knowledge to other affiliates (Ghoshal & Bartlett, 1990); (i) risk diversification from operating in multiple markets in terms of political instability, fluctuations in exchange rates, natural disruptions, etc. Risk diversification also stems from the fact that economic cycles of different nations are imperfectly correlated with each other (Annavarjula & Beldona, 2000; Siddharthan & Lall, 1982). The positive effects of international expansion in Stage 2 follow only after an initial reduction in performance in Stage 1. Once the firm has crossed the threshold of initial foreign growth, the incremental benefits of further global expansion described above are hypothesized to outweigh incremental costs. As Stage 2 benefits accrue, a positive slope is expected between performance and degree of internationalization. Firms based in emerging markets can undoubtedly also enjoy Stage 2 benefits Stage 3 (negative slope again) Some firms over-expand internationally beyond a desirable optimum level. For such firms, further international expansion is detrimental to overall global performance, and the performance slope becomes again negative. There are several reasons for the Stage 3 downturn in performance. These include high coordination costs from increasing environmental and regulatory diversity (Sunderam & Black, 1992), limits to the capacity of managers to cope successfully with greater geographical scope (Grant, 1987), information overload (Hitt et al., 1997), information loss or distortion in governance (Hoskisson & Turk, 1990), and cultural and institutional diversity (Bartlett & Ghoshal, 1989). Siddharthan and Lall (1982) also suggest that while firms can achieve economies of scale through FDI, excessive internationalization may lead to increased managerial constraints due to legal barriers, and physical, cultural, and linguistic distance. In a nutshell, beyond some level of internationalization, the coordination required for multiple transactions among many geographically diverse units, may cost more than the benefits derived from sharing resources and exploiting opportunities (Hitt et al., 1997). Finally, we have the simple fact that most of the world s nations comprise rather small markets and economies. 6 Hence, Stage 3 posits once again, a negative relationship for the degree of internationalization performance link. 5 A contribution of this paper is to show how the inflection points (transition points from one Stage to another) would vary by firm type, sector, and home base. Different sectors will have different shaped curves in their empirical results. 6 The 51st ranked economy, by GDP (in PPP terms), is Hungary, having a population of a mere 9.96 million. That leaves 143 lower ranked nations with economies that are even smaller than Hungary s (Central Intelligence Agency, 2007).

5 F.J. Contractor et al. / Journal of World Business 42 (2007) Using this concept of different stages, Contractor et al. (2003) endeavored to reconcile the seemingly contradictory results of past studies by proposing a unified three-stage theory which they tested on an 11 country sample. The validity of the three-stage theory was also supported in Lu and Beamish (2004) who used data on internationalization of Japanese companies and in Thomas and Eden (2004) who used US company data. The exact shape of the curves representing the relationship between financial performance and degree of internationalization, and their slopes may be different for emerging market firms. Moreover, it is questionable whether all 3 stages will be present for emerging market-based companies. Finally, this relationship is likely to vary by sector, even within an emerging market context Emerging market firms How are emerging market firms different from those based in advanced nations? How do these differences show up in their internationalization strategy? Most of the emerging market firms tend to be much smaller, even in the large emerging nations such as India. Scholars such as Lall (1983) and Wells (1983) studied developing country multinationals and depicted most of them as typically small and resource-deficient, besides being distant from the major markets of North America and Europe. Besides being small, most of the emerging market firms that are international tend to be young or recently privatized. This means that the management capabilities and decision-making processes are not fully developed (Lyles & Baird, 1994). Moreover, they have a stronger need for legitimacy and resources in the international context (Hitt, Dacin, Levitas, Arregle, & Borza, 2000). The home markets of emerging-country firms are tiny to small when compared to advanced economies. Consequently, they operate at an uneconomically small scale in many sub-sectors. This has two implications relevant for our analyses: (a) international expansion, for some fraction of these companies, powerfully complements local market size and enables them to achieve scale economies (Lall, 1983). (b) In management terms, several issues facing these firms echo those encountered by small and medium sized enterprises in advanced nations. For example, many of the largest firms based in Asia and elsewhere are still family run or controlled (Yeung, 1999). Emerging market firms operate in relatively higherrisk home economies subject to uncertain structural changes (Nachum, 2004). Many emerging markets are still heavily regulated, with constraints on private enterprise (Kumar & McLeod, 1981). Such emerging market characteristics make incentives to internationalize very high. By diversifying into international markets, emerging market firms can, to some extent, minimize the impact of market failure in depending on resources and supplies only from their home country. Thus, they can avoid the significant risk of focusing on one single market (Rugman, 1979). These reasons demonstrate both the difficulty for emerging market firms internationalization as well as their high incentives to expand abroad. There are certain attributes of emerging market firms that have enabled them to internationalize and, in many cases, do so successfully. One such distinguishing aspect, highlighted in the literature, is emerging market compaines affiliation to business groups (Khanna & Rivkin, 2001; Yiu, Bruton, & Lu, 2005), usually accompanied by a greater degree of unrelated product diversification (Yeung, 1999). While unrelated product diversification is a concept currently out of fashion in the strategy of advanced nation firms, many successful internationalizers based in the emerging world belong to diversified business groups. Business groups act as fillers of institutional voids by creating efficient internal markets for capital, labor, and products (Khanna & Palepu, 1997). Member firms, thus, can benefit from easy access to much needed capital and managerial expertise when internationalizing into foreign markets. Unrelated product diversification boosts domestic firm performance in certain emerging markets (Khanna & Palepu, 1999), in other respects as well, including a common brand or corporate identification (e.g., Samsung or Tata or Haier), accumulated internal experience in identifying and managing acquisitions, and developing minimum efficient scale in certain centralized corporate functions such as finance or human resources management. Such advantages better prepare the firm to endure the usually costly initial internationalization process. In a study of emerging market firms from the Asia- Pacific region, Mathews (2006) shows that their internationalization was very rapid and different from that of the conventional western multinationals, and also from that of the erstwhile developing country multinationals in the 1960s and 1970s. Mathews and Zander (2007) describe this as accelerated internationalization. Newer multinationals from emerging markets have been able to pursue rapid internationalization owing to their distinctive ability to come up with organizational and strategic innovations compensating for their lack of financial and managerial

6 406 F.J. Contractor et al. / Journal of World Business 42 (2007) capabilities. The harsh environmental conditions such as a weak institutional context, demanding yet pricesensitive consumers, and challenging distribution networks in their home markets, instead of acting as impediments, have helped emerging market firms to develop unique competencies, to be later used to compete successfully in foreign markets (Sinha, 2005). The rise of companies such as Ranbaxy Laboratories from India, Samsung from Korea, and Acer from Taiwan, into powerful global giants clearly demonstrates this phenomenon. Of relevance to this study is the greater propensity for non-traditional international expansion strategies, where exporting and FDI are used simultaneously. Consider an Indian company, Satyam Computer Services Ltd. In the EU, they have FDI operations in 12 countries, for crucial marketing functions and clientinterface with European customers. However, development centers based in India generate, for the European clients, services (such as strategic IT consulting, ERP and ERP application deployment, data warehousing, knowledge management, software development and maintenance, product development services, chip design, embedded systems robotics, R&D services, and business processes) which are exported from Bangalore, Chennai, Hyderabad, and Shanghai but with critical support from Satyam s onsite (FDI) European client presence and near shore center (in Hungary). Satyam s European subsidiaries and branches perform crucial marketing and customer liaison functions, as well as local adaptation and customization to European needs. Once orders are received, activity shifts to India where the services are generated, assembled into a package and then transmitted by satellite to the European affiliate and end-user there. So is this a case of internationalization via an Exporting Strategy, or is it an FDI-based strategy? It is a simultaneous use of both strategies, with the value-chain spread over several countries. The historical or textbook version of Foreign Market Entry entails a choice between Exporting, Licensing and FDI as alternative means of reaching the foreign customer. But in today s globally integrated world, where the value chain is disintegrated and functions dispersed over different geographical regions, Exporting and FDI are frequently a combined and simultaneous strategy, rather than being distinct alternatives (Contractor, 2002). Where an internationally expanding company, traditionally, was supposed to first export and later engage in FDI, many Indian and emerging market firms appear to be engaging sooner in both. Another example, from the manufacturing sector, is a medium sized Indian leather garment producer, with its Italian FDI affiliate (Ultima Italia Srl) in Milan. The Italian office is involved in marketing and sales activities of leather garments to retail stores across Europe. More interesting and importantly, the Milan affiliate engages in garment design and brand building activities for their market in Italy and other European nations. The designs are transmitted to manufacturing facilities based in India (near Delhi) and China (near Shanghai). From a managerial or strategy point of view, one cannot say whether the company s internationalization is based on exports or FDI. The answer is both. While conceding the theoretical validity of the overall three-stage model, there are a priori grounds for doubting that any of these emerging market firms will currently have over-internationalized, or reached Stage 3, because of their relatively smaller size and because the international expansion of emerging market firms is a relatively new phenomenon. If the population of emerging market based companies principally occupies only Stages 1 and 2, we should expect to see in the empirical results only an initial negative slope followed by a positive slope on the performance versus internationalization plot. In the statistically fitted curve one would expect only a U-shaped curve, despite specifying first, second and third order terms for degree of internationalization. Thus: Hypothesis 1. The shape of the performance internationalization curve for emerging market firms will be U- shaped (i.e., emerging market firms will occupy only the first two stages of the three-stage model) Services versus manufacturing sub-sectors The services sector is quite different from manufacturing because of its unique characteristics, which include one or more of the following attributes such as inseparability, heterogeneity, intangibility and perishability (Bodewyn, Halbrich, & Perry, 1986). Services can be more government-related than manufacturing (Campbell & Verbeke, 1994). Due to intangibility as well as simultaneity of production and consumption, for some services, storing and managing inventory is impossible (Habib & Victor, 1991). Some services require extensive customization and cultural adaptation (Knight, 1999). The service sector is already predominant in the world economy as a whole and is still increasing its relative share in trade, with FDI opening up in Eastern

7 F.J. Contractor et al. / Journal of World Business 42 (2007) Europe (Meyer, 2001) and more liberal trade and investment policies for services being instituted in emerging nations. UNCTAD (2003) reported that the share of the service sector in total foreign direct investment (FDI) stock now amounts to some 60 percent compared to 50% a decade ago... Emerging nations are beginning to not only develop a significant share in service exports and FDI, but at far higher growth rates than in manufacturing (Braga, 1996; Svetlicic & Rojec, 2003). It is ironic, therefore, that virtually all the empirical studies on performance versus internationalization in the past 30 years have been in manufacturing. Recent work on service firms suggests that the initial decline in their profitability (during initial international expansion) might be smaller than for manufactured goods due to the knowledge-intensity of the service under consideration. Unlike manufactures, most services are less capital intensive (Contractor et al., 2003). Service sectors also have a higher potential to benefit more quickly from social and relational capital (Hitt et al., 2006). We concur with this logic and argue that, in service firms, the threshold costs, or investment required for the initial international expansion in Stage 1 would be far lower than for manufacturing (Hughes & Wood, 2000). We argue that this would be the case in emerging nations like India, where knowledge-intensive services such as software, IT, engineering, and healthcare predominate in international expansion. These sectors are less prone to severe adaptation or cultural assimilation costs because such service offerings, we hypothesize, may be more standardized and more culture-neutral. Also, the social and relational capital from the Indian diaspora has been very effective in providing know-how, market access, capital, and overall guidance in the United States and Europe (Kapur & Ramamurti, 2001). Such information and assistance is important throughout the internationalization process, but more crucial during the initial stages in terms of reducing initial transaction costs. Moreover, many Indian service firms internationalize by first entering into developed economies where the market for such services is better developed. The better institutional environment of the developed economies aids in maintaining high profitability levels even during the initial internationalization stage for these service firms. As a consequence, we hypothesize that Stage 1 will be shorter and/or shallower for service sector firms, when compared to manufacturers. For the majority of service sub-sectors, such as information technology, advertising, engineering services, or any involving knowledge-based activities, the comparative capital costs are lower and operations can be scaled up or replicated in foreign locations fairly easily. The negative impact of the internationalization decision on service firms performance would be lower than for manufacturers. It is true that the other negative aspects of early international expansion liabilities of foreignness such as discrimination against foreign firms maybenodifferent(zaheer and Mosakowski, 1997) for services. However, the higher risk owing to higher costs of capital investment involved in the expansion of manufacturing activities would be avoided. Hence the hypothesis that: Hypothesis 2. The negative effects of initial international expansion in Stage 1 will be significantly lower for services as opposed to manufactures Firm size and age 7 The size of a firm is indicative of its broad resource base. Firm size has been considered an important determinant of profitability (Rugman, 1983) and its effect has been tested in internationalization performance research (Haar, 1989). It is a common variable related to firm performance used to control for economies and diseconomies of scale at the corporate level. As we observed earlier, few of even the largest of Indian firms have achieved a globally competitive scale (Ray, 2004). The future performance of small firms being problematic (Stuart, 2000), this makes it important to explore the explanatory power of firm size. Larger firms do not suffer from the liabilities of smallness (Aldrich & Auster, 1986), and they are more likely to survive in some form or the other compared to smaller firms (Stuart, 2000). External agents, particularly foreign actors, such as customers, suppliers, employees, and investors tend to feel more comfortable interacting with larger firms because their larger size is reflective of greater reliability and ability to conduct business (Hannan & Freeman, 1984; Stinchcombe, 1965). In the internationalization process, access to capital is more difficult, especially for smaller firms, a factor that can affect performance negatively (Coviello & McAuley, 1999). The negative effects of initial internationalization in Stage 1 on performance would be partially mitigated if the firm has a large capital and domestic sales base. Li, Li, and Dalgic 7 Methodologically speaking, if firm size and age are significantly correlated, then the independence of hypotheses numbers 3 and 4 could be compromised and the model affected by multicollinearity. However, correlation coefficients for size, age and DOI are not high and VIFs in the regression runs remain acceptably low.

8 408 F.J. Contractor et al. / Journal of World Business 42 (2007) (2004) describe the internationalization process as groping forward and iterative. Larger firms, with more managers, are more likely to include some with international experience. Bloodgood, Sapienza, and Almeida (1996) find that the smaller the firm, the more difficult it will be for it to hire internationally experienced managers. Such difficulties will likely translate to poorer performance for smaller firms. Here, we are interested in testing the relationship between the performance of emerging market (Indian) firms and their size, at various internationalization stages, ceteris paribus. Other things being equal, this would favor larger firms at all stages. Hence: Hypothesis 3. Other things being equal, performance of internationalizing firms will be positively associated with their size. It would also be useful to check for the effect of firm age, or time-period of existence on firm financial performance. Age is considered to be an important determinant of firm performance because of its implicit impact on the number of stable relationships and amount of sufficient resources a firm can possess in a given timeperiod (Baum, Calabrese, & Silverman, 2000). Young firms have typically a very high failure rate due to liabilities of newness as conjectured by Stinchcombe (1965) and later supported by Carroll (1983) and Freeman, Carroll, and Hannan (1983). Older firms are more experienced, command greater reliability and legitimacy, receive the benefits of learning, and are associated with first mover advantages (Douma, George, & Kabir, 2006). However, older firms are more prone to strategic inertia and less flexible in terms of adapting to changing external conditions. This may be more valid for the relatively larger emerging market firms, many of which have grown in a protected home market under traditional family controlled environments. Such opposing arguments have been supported in the strategy literature, with conflicting findings on the relationship between firm age and performance. Birley and Westhead (1990) and Bracker and Pearson (1986) associated higher performance with increased age, while Begley and Boyd (1988) suggested a negative relationship. There is little consensus in the internationalization literature about the effects of firm age on internationalization. When it comes to the link between firm age and financial performance of internationalizing companies, there is little evidence and it tends to be equivocal. For example, in a study partially devoted to this question (Brush, 1995) did not find a strong relationship. However, Yeung (1999) describing the internationalization process of Asian companies, and Autio, Sapienza, and Almeida (2000) indicate a positive association between time-period of existence and performance. Due to arguments supportive of both, positive and negative, relationships in the strategy and internationalization literature, we treat this issue as an empirical question and test the following. Hypothesis 4. There will be a positive association between performance and firm age, other things being equal. 2. Methods and data 2.1. Data and sample The data used in this study covers 269 Indian firms over a 5-year period, from 1997 till The Indian economy started to open up in As it takes some time for government policies to take effect, the 5-year period from 1997 to 2001 is appropriate and it represents a period of relative stability for Indian firms. 8 We have 142 Indian manufacturing companies (in Pharmaceuticals, Chemicals, Textiles, Food Processing, and Personal Care) and 127 Indian service sector firms (in Construction, Trading, Engineering services, and Computer Software) from the annual database, CAPITALINE, provided by Capital Market Ltd., an Indian information services firm. All firms for which complete information on foreign sales, total sales, year of incorporation, return on sales, return on assets, and return on equity were available, entered our analyses. Since our focus is on India-based firms, we dropped from the analysis foreign direct investment (FDI) related firms (i.e. Indian firms which had foreign equity participation of greater than 10%). The final list of firms and industries chosen for our analyses is representative of the Indian economy at large. The CAPITALINE database is built on data obtained from reports filed with regulatory agencies of a large number of companies. It provides panel data on about 10,000 listed and unlisted companies in India from 115 industrial categories. It does not include fully foreign-owned firms, nor unlisted joint ventures. This did not pose any limitations to our analyses since we were concerned with Indian firms. Previous studies, (Banga, 2006; Douma et al., 2006; Ramaswamy, 2001) have used this database for research on emerging markets. 8 The exchange rate was stable during this period and roughly indexed by the Indian government according to PPP (Purchasing Power Parity) calculations, to maintain an effective real value.

9 F.J. Contractor et al. / Journal of World Business 42 (2007) India was chosen as the setting for this study for the following reasons. First, India s economy is classified as emergent or developing, a category of countries that contrasts with contexts such as the United States where most prior research on internationalization has been focused (Ramaswamy, Li, & Veliyath, 2002). Second, the Indian economy has recorded impressive growth rates in recent years. A particular bright spot has been the growth in the services sector which contributes significantly to the overall growth of the economy, putting India amongst the world s best performers (Karmakar, 2004). Exports and FDI (both inward and outward) in Services such as the outsourcing of software, call centers, radiological analysis, contract R&D (to name just a few examples), have been growing at rates approaching or exceeding 20 percent per annum. We are particularly interested in observing differences in the performance internationalization link between services and manufacturing for Indian companies international expansion Methodology The methodology involves Pooled Cross-Section/ Time-Series analysis in a cross-sectionally heteroskedastic, time-wise autoregressive model, that enables researchers to examine variations among cross-sectional units simultaneously with variations within individual units over time (Hsiao, 1995; Sayrs, 1989). It assumes that regression parameters do not change over time and do not differ between various crosssectional units. This technique enhances the reliability of the coefficient estimates. Nerlove (1971) pointed out that autocorrelated errors are frequently encountered when dealing with timeseries analysis, because of correlations among variables over time. To minimize autocorrelation and heteroskedasticity problems, the autoregressive-heteroskedastic model is used, as done in Gomes and Ramaswamy (1999), Boecker and Goodstein (1991), and Hill and Phan (1991). The assumptions of a generalized linear regression model in a two-stage generalized least squares (GLS) regression allows for non-constant variance and corrects for autocorrelation. The autoregressive-heteroskedastic model was used in a special econometrics software package called EViews Testing for shapes of curves To test for a U-shaped model, we introduced linear and quadratic terms for the internationalization variable in one of the models. We tested two different models: one with just the linear term, and second with the squared term added. Each of the two models was tested separately for manufacturing (five sub-sectors) and services sector (four sub-sectors). Four dummy variables were introduced to capture the sub-sector effect in manufacturing, and three dummy variables in services Models 9 Model 1 (Linear Model): This is our baseline model: PERF it ¼ b 0 þ b 1 SIZE it þ b 2 Age þ b 3 DOI it þ DV1 þ DV2 þ DV3 þ DV4 þ e it Model 2 (U-shaped): PERF it ¼ b 0 þ b 1 SIZE it þ b 2 Age þ b 3 DOI it þ b 4 ðdoi it Þ 2 þ DV1 þ DV2 þ DV3 þ DV4 þ e it where i represents the companies in the study (crosssectional component), t corresponds to the different periods (time series component, ), PERF is a financial performance variable (ROE, ROA, and ROS), SIZE is a proxy for company size (natural log of total sales), AGE is a proxy for the number of years the company has been in operation, DOI is the degree of internationalization = Ratio of Foreign Sales/Total Sales (FSTS), DOI 2 is a second-order item = (FSTS) 2 and DV 1, 2, 3 and 4 are dummies to control for the subsector effects. The overall U-shaped curve (Hypothesis 1) would be supported if the following conditions were met: (1) the signs of the coefficients of DOI and DOI 2 change alternatively (from a negative sign for DOI, to positive for DOI 2 ). (2) The coefficient values of DOI and DOI 2 are significant. (3) The R 2 and Adjusted R 2 for Model 2 (representing the U-shaped curve) is higher than in Model Variables Dependent variable Similar to past studies, the financial performance measures chosen are: 9 We also introduced the cubic term (FSTS 3 ) in the model (as model 3), but as anticipated it failed to achieve significance, and hence not shown in either Table. The theory may include three stages, but for firms based in emerging countries, Stage 3 is not likely to be present (Contractor, 2007). With internationalization by Indian companies only being a recent phenomenon, few of them are likely to be over internationalized. Few would populate Stage 3. Hence the statistical fit does not support the cubic term, or Stage 3.

10 410 F.J. Contractor et al. / Journal of World Business 42 (2007) (1) ROA (return on assets) has been widely used in many previous studies on the relationship between degree of internationalization and performance (Daniels & Bracker, 1989; Gomes & Ramaswamy, 1999; Haar, 1989; Ramaswamy, 1995). (2) ROE (return on equity) is a commonly employed accounting measure in business research (Qian, 1997). Return on equity focuses on the relative efficiency with which the resources available have been utilized by a firm to earn profit on behalf of its shareholders. (3) ROS (return on sales) is a measure of performance in an Income Statement sense, and reflects the size of profit margins and competitive conditions (Ramaswamy, 1995) Independent variables The degree of internationalization is measured by the ratio of foreign sales to total sales (FSTS). This is a measure frequently used in the performance internationalization literature (Agmon & Lessard, 1977; Buckley et al., 1977; Buhner, 1987; Haar, 1989; Hughes, Logue & Sweeny, 1975; Michel & Shaked, 1986; Siddharthan & Lall, 1982). FSTS could include both exports and sales of foreign affiliates compared with alternative measures that only focus on FDI (Lu & Beamish, 2004; Ramaswamy, 1995). But is this an appropriate index for degree of internationalization? Certainly, many of the Indian companies in our study combine (or simultaneously use) exporting and FDI in various pieces of the value chain. This treats the crucial question, What exactly do we mean by internationalization? In today s globalized and cross-border integrated world the classical distinction between exports and FDI, as alternate foreign market-entry strategies, has been blurred. Earlier, we saw how, in the case of Satyam Computer Services Ltd., in Balance of Payments terms, the satellite transmission of the service package is recorded as an export. However, without the local European presence by way of FDI affiliates, European sales would not have occurred. The Indian company s European affiliate may not record the sale in its accounts, but the affiliate s local work with European customers may be as important as the services offshored, or exported from the Indian base. When the value-chain is disaggregated over several countries, it is difficult to say whether the internationalization strategy is exportbased, or FDI. In either case, FSTS is an appropriate index with which to compare a firm s degree of internationalization with others. In any event, in a globally integrated world, FSTS comprises an adequate index of the degree of a firm s internationalization whether it be based on pure exports, exports complemented by FDI affiliate inputs, or simply FDI affiliate sales. FSTS maybe a more, legitimate measure than some found in prior studies such as a simple count of the number of foreign affiliates, or number of countries in which the firm has FDI affiliates. Firm size and age are the other explanatory variables introduced into the model. Firm size was measured by the natural logarithm of total sales for all models, a transformation often applied to variables that are not taken as ratios. Log transformation will make the results easy to interpret because the changes in the logarithm domain represent relative changes in original metric. It will also make the distribution of the data closer to normality. Age of the firm is measured by the company s number of years of operation since inception. Finally, we will introduce dummy variables for industry sub-sectors, to take into account any industryspecific factors that could affect firm performance. The number of dummy variables is one less than the number of sub-sectors being tested four dummy variables for five sub-sectors in manufacturing, and three dummies for four sub-sectors in the services. 3. Results The three alternate dependent variables, ROA, ROE, and ROS, exhibit an acceptably low level of intercorrelation. Inter-correlations among the full set of predictor variables were sufficiently low to preclude the generation of unstable beta coefficients in regression analysis. Tables 2 and 3 summarize the descriptive statistics for the manufacturing and services subsamples. Tables 4 and 5 show the results for regressions, using the three different indexes for performance. There is consistency in general, across the three performance measures, ROA, ROE and ROS, which indicates the robustness of the data and analysis. (The only minor exception appears to be the Age variable.) The F-values for all models are strongly significant and adjusted R 2 s range from 0.25 to The U-shaped curve in Hypothesis 1 was only partially supported, for the manufacturing sector. Table 4, for manufacturing firms, shows first and second order terms for FSTS. Model 1, using only the first order term FSTS, shows a positive and significant relationship between performance and degree of internationalization. This confirms the fundamental argument that international business or geographic diversification is beneficial. In Model 2, after the second

11 F.J. Contractor et al. / Journal of World Business 42 (2007) Table 2 Summary statistics for manufacturing firms Mean Median Maximum Minimum Standard deviation Observations Cross-sections ROA ROE ROS Firm size Age FSTS Notes: Firm size is in rupees crores (1 crore = 10 million). Age is in number of years since start of firm. Table 3 Summary statistics for service firms Mean Median Maximum Minimum Standard deviation Observations Cross-sections ROA ROE ROS Firm Size Age FSTS Notes: Firm size is in rupees crores (1 crore = 10 million). Age is in number of years since start of firm. order term FSTS 2 is introduced, the sign of the coefficient for FSTS is consistently negative, and FSTS 2 positive. This confirms Stages 1 and 2 of the theory that financial performance first declines, and later increases with higher degree of internationalization. These statistically significant results suggest a U- shaped relationship between the performance of manufacturing companies and their degree of internationalization. Table 5 for service sector companies, shows only Model 1, using only the first order term for FSTS, since the second order term failed to achieve significance. The coefficient of FSTS remains consistently positive for all the three dependent variables. These results suggest that in terms of statistical Table 4 Regression results for manufacturing firms ROA ROE ROS Model 1 Model 2 Model 1 Model 2 Model 1 Model 2 Firm size 1.81 *** (0.33) 4.10 *** (0.28) 3.57 *** (0.34) 3.73 *** (0.34) 1.42 *** (0.18) 1.52 *** (0.19) Age 0.13 *** (0.03) 0.08 *** (0.02) (0.03) (0.03) 0.05 *** (0.01) 0.06 *** (0.01) FSTS 0.02 (0.01) 0.17 *** (0.05) 0.05 *** (0.01) 0.14 ** (0.06) 0.04 *** (0.01) 0.07 ** (0.03) FSTS *** (0.0006) *** (0.0007) *** (0.0004) DV (1.47) 1.71 (1.54) 0.27 (1.77) 1.53 (1.86) 1.83 * (0.97) 2.95 *** (1.02) DV *** (1.51) 3.86 *** (1.56) 6.20 *** (1.82) 4.63 ** (1.88) 1.1 (1.0) 0.12 (1.03) DV * (1.71) 2.02 (1.71) 5.20 ** (2.06) 4.23 ** (2.07) 2.08 * (1.13) 1.48 (1.14) DV *** (1.48) 3.94 *** (1.47) 6.23 *** (1.78) 5.71 *** (1.78) 0.88 (0.98) 0.55 (0.98) R Adjusted R F-statistic *** *** *** *** *** *** Durbin Watson statistic Notes: The cubic term FSTS 3 is not shown as it failed to achieve significance. DV1: pharmaceuticals; DV2: chemicals; DV3: food processing; DV4: textiles; the 5th sub-sector is Personal Care. Standard error in parenthesis. *** p < ** p < * p < 0.10.

12 412 F.J. Contractor et al. / Journal of World Business 42 (2007) Table 5 Regression results for services firms ROA (Model 1) significance, a positive and linear relationship best describes the link between service sector profit performance and the firms degree of internationalization. Manufacturing companies incur the negative effects of international expansion far more than service sector companies Post hoc analyses ROE (Model 1) ROS (Model 1) Firm size 1.81 *** (0.33) 1.54 *** (0.30) 1.03 *** (0.33) Age 0.13 *** (0.03) 0.03 (0.03) 0.01 (0.03) FSTS 0.06 *** (0.02) 0.10 *** (0.02) 0.16 *** (0.02) DV (2.09) 0.33 (1.91) 5.05 ** (2.11) DV (2.15) 0.26 (1.97) 0.66 (2.17) DV ** (1.58) ** (1.44) 1.53 (1.59) R Adjusted R F-statistic *** *** *** Durbin Watson statistic Notes: Models 2 and 3 not presented as FSTS 2 and FSTS 3 are nonsignificant. DV1: trading; DV2: construction; DV3: computers; the fourth sub-sector is Engineering Services. Standard error in parenthesis. *** p < ** p < For further insights from our data, we conducted additional analyses by dividing the sample firms into high FSTS and low FSTS, based on whether they were above, or below, the 5-year mean FSTS value (of 27% for manufacturing and 22% for services) as the cut-off mark. 10 We conducted independent sample t-tests to compare the two groups in terms of age, performance (ROA, ROE, ROS) and size (total sales). We did these tests over the 5-year study period. Age for the two groups was significantly different for both manufacturing and service firms. Interestingly, the firms with high FSTS were significantly younger than the ones with low FSTS. This finding, though slightly contrary to normal belief, is supportive of the kind of accelerated internationalization that some emerging market firms have successfully pursued. The ROA is significantly different for the two groups. While in the case of manufacturing the high FSTS firms perform poorly in terms of ROA, it is the opposite in the case of service firms. This finding, to 10 Any cut off is in a sense arbitrary, but using mean values to divide samples is common. some extent, supports Hypothesis 2 and our expectation that Indian service firms tend to benefit more from internationalization as compared to their counterparts in the manufacturing sector. While we find similar support for high FSTS service firms in terms of their higher average ROE and ROS compared to low FSTS service firms, we do not find any significant difference in ROE and ROS for high and low FSTS manufacturing firms. Overall, our t-tests pertaining to the performance comparisons support our arguments for the two sectors benefiting differently from their respective internationalization. 4. Discussion 4.1. The three-stage model The results do not invalidate the three-stage model. Rather, for emerging nation companies, only selected portions of the S-shaped curve are significant in each case. Take for instance the results for Indian manufacturing companies in Table 4. India s liberalization and opening to global commerce did not start until the 1990s (Ray, 2004). Few Indian firms, even today, are likely to have over-internationalized and occupy Stage 3 of the theory. On a priori grounds, it is not surprising, therefore, that the third order term FSTS 3 failed to be significant. There are, indeed, very few firms in the sample whose FSTS exceeds 80 percent. 11 But these cases are relatively rare, and the bulk of Indian manufacturing companies populate Stage 1 (negative slope) and Stage 2 (positive slope). For all the three dependent variables (ROA, ROE and ROS), in model 2, the coefficient of FSTS remains negative while that of FSTS 2 is positive. This suggests that Stages 1 and 2 taken together produce a U-shaped curve for manufacturers. Hypothesis 1 is confirmed for the manufacturing sector. Results in Table 5 for service companies are a bit more problematic to interpret. We had hypothesized a 11 Incidentally, an FSTS over 80% is rather extraordinary even for the Fortune Global 500 firms as demonstrated by Rugman and Verbeke (2004). However, finding a very small number of Indian companies with a very high FSTS is not surprising, in retrospect. Such a phenomenon is one of the distinguishing aspect of a handful of emerging market firms accelerated internationalization process (Mathews, 2006). A few of the new emerging market multinationals, especially those based in small home markets, achieve very high levels of internationalization in a decade or less, something that took much longer for the conventional rich or large nation based multinationals to achieve. At any rate, such cases are rare in the sample. Hence, removing them as outliers and redoing the analyses made no significant difference in our findings.

13 F.J. Contractor et al. / Journal of World Business 42 (2007) U-shaped curve, albeit one different from that of the manufacturers. In Hypothesis 2, we had supposed that since service firms are generally less capital-intensive than manufacturing companies, the negative effect or downturn in performance in Stage 1 would be lower. For example, Contractor et al. (2003) show that service sectors also underwent Stage 1, but the more knowledge-intensive the service sub-sector, the shorter was its Stage 1. This may possibly be the case, but the data in this study does not support statistical significance for (either an S-shaped or) a U-shaped curve. The second (and third) order terms for FSTS were non-significant, and are consequently not shown in Table 5. Instead, in Table 5, we only have the first order or linear term FSTS which is highly significant for all measures of performance: ROA, ROE, as well as ROS Service firms versus manufacturers There are some ex post explanations. Perhaps Stage 1 is so brief, or short, for Indian service firms that these firms very quickly move on to enjoy the benefits (positive slope) of internationalization. For service sector companies, Stage 1 may be very brief, and Stage 2 quickly reached. This makes the best statistical fit to be simply a positively sloped linear function. As we argued on a priori grounds, compared to manufacturers, service firms (i) can scale up more readily, (ii) expand with far lower capital investment cost, (iii) are subject to lower foreign operation risk, and (iv) will appropriate the benefits of internationalization more readily. For example, the service sub-sectors in our sample include Trading, Construction Services, Computers, and Engineering Services, which are not capital-intensive. The dominant result in Table 5 is a single positive slope for the performance degree of internationalization link for services. A result we had not anticipated at all is revealed by plotting the performance levels against the increasing degree of internationalization for manufacturing and service firms (figures available on request). For all three measures of performance, it appears that for domestic companies, as well as early or initial internationalizers, service sector companies have a lower financial performance. The figures show that internationalization enables service firms to catch up with, and surpass manufacturers in profitability, with further internationalization. While manufacturing companies unmistakably suffer the negative effects of Stage 1 before the benefits of further internationalization in Stage 2 are achieved, service firms appear to reap the positive benefits of internationalization quickly. The post hoc analyses for service firms with high and low FSTS supports this Firm size and age variables There is across the board support in Tables 4 and 5, for all three performance measures, that the larger the firm, the more positive the effect on performance, thus confirming Hypothesis 3. For the age variable, Hypothesis 4, the results are equivocal. The effects of company longevity appear to be positive on ROA, but negative on ROS (in manufacturing only). Assuming that older companies have a more depreciated asset base while tending to sell more mature products with lower profitability would explain this finding. However, this is only an ex post hypothesis, which we are unable to verify. 5. Conclusions and managerial implications This paper contributes to the existing body of knowledge in two ways. First, it extends the scope of the internationalization performance literature with empirical tests in an emerging market context. It traces the internationalization path and profitability of 269 Indian companies, from five manufacturing sub-sectors and four service sub-sectors, over a 5-year period. As such, this study attempts to further elucidate and check the applicability of the three-stage theory of international expansion proposed by Contractor et al. (2003), and later by Lu and Beamish (2004) in a different context and setting. Second, it explains how, in the 30- year history of this literature, results which appear seemingly inconsistent are actually not contradictory, but merely represent different stages of the three-stage theory rendered significant in the statistical analyses. For instance, in some samples, the statistical results, despite the model specifying all three variables, FSTS, FSTS 2, and FSTS 3, may only be U-shaped (because only Stages 1 plus 2 were significant), or Inverted-Ushaped (Stages 2 plus 3 only) (Contractor, 2007). In this study, for instance, the internationalization of Indian manufacturing companies is represented by a U-shape (Stage 3 being absent) while the effects of Indian service firms internationalization on performance is best captured by a positive sloped straight line as a statistical fit. This does not mean that the negative effects of Stage 1 were absent or invalid. Rather, service firms in general may be able to shorten and mitigate the negative threshold effects of early internationalization far better, and more quickly, than manufacturing companies.

14 414 F.J. Contractor et al. / Journal of World Business 42 (2007) A more recent survey on the number of university graduates in science and engineering in by Economist, places India much ahead of not only China, but also EU, US, and Japan. This is particularly true with service firms in India which have benefited greatly by the advances made in education in the past fifty years. Over the last 15 years, the number of academic institutions for higher learning more than doubled from 6761 in 1991 to 14,143 in This has resulted in a much larger pool of qualified personnel in India. The total number of doctoral degrees awarded in science and engineering disciplines increased by 81% from 5049 in 1996 to 9131 in 2000 ( com). 12 In addition, Indian service sector companies have been able to pursue aggressive international expansion because of (i) lower initial capital requirements, (ii) the ability to separate the value chain across international boundaries between core activities (e.g., back-end software program development performed in India) and supplementary activities (such as front-office consulting and marketing activities, performed in Europe or the USA), and (iii) significantly lower government controls and interference over online business activities (Contractor & Kundu 2004). All this has contributed to the greater international success of Indian services compared to that of Indian manufacturing. Diaspora effects have also helped Indian companies in the software and other knowledge-based industries (Kapur & Ramamurti, 2001). One such company is ICICI, in the financial service sector, that has successfully entered into foreign markets like Singapore, UAE, China, USA, UK, and Canada, at a rapid pace by following customers of Indian origin and focusing on India-related businesses rather than competing against global banks for global clients. For Indian companies, international expansion enables service companies performance to catch up and then surpass that of manufacturers. This is consistent with the recent dramatic international growth seen in Indian service companies, particularly, in areas such as computers and software (NASSCOM 2001). Managers and strategists would like to know how their company compares with others in their sector, in terms of financial performance versus degree of internationalization. By drawing a map and plotting the position of companies, a company can learn, for example, whether it is underperforming, and by identifying the stage in which their company is located, what it can expect from further international expansion. Managers have to weigh the benefits of internationalization against its costs. In early international expansion, many firms will encounter initial costs that exceed early benefits of internationalization (Stage 1). Managers in manufacturing firms, which collectively exhibit a U-shaped curve, should realize that in growing from domestic to international operations, significant and prolonged threshold costs will have to be incurred in Stage 1, in the form of a downturn in performance. Later in Stage 2, as the benefits of international expansion in the form of scale, learning, and geographic diversification kicks in, resulting in enhanced firm performance. Stage 3 hypothesizes that a few firms may expand internationally too much, which is detrimental to their performance (as confirmed by the inverted U- shaped curves in some prior studies such as Hitt et al. (1997) and Gomes and Ramaswamy (1999). (However, Stage 3 was not seen for India-based firms in our sample because few Indian companies are, as yet, overinternationalized.) For internationalizing firms from emerging economies (such as India), there is only partial support for the overall or full S-shaped relationship between firm financial performance and degree of internationalization, which requires companies to populate all three stages. Limitations in data availability allowed for examination of only nine sub-sectors from only one country (India). Future research can include additional subsectors, as well as data from other emerging economies. This would help strengthen the results, and provide further validation for the findings. It would also be interesting to make a direct comparison in the relationship between degree of internationalization and performance for the same sectors based in different geographical regions such as North America, Europe and Asia. Acknowledgements This research was supported by the Bocconi University DIR research grant (no ). We thank participants of the ISEA seminar (December 2005), Amanda Bullough, the two anonymous reviewers and action editor Gregory Dess for helpful comments on earlier versions of this paper. Research support is also acknowledged from Florida International University and Rutgers Business School s Research Resources Committee. References Agmon, T., & Lessard, D. R. (1977). Investor recognition of corporate international diversification. Journal of Finance, 32:

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