Internalization Theory and the International Diversification: Performance Conundrum

Abstract

We start by looking at the arguments put forth as to why having operations evenly spread in a large number of countries should make firms more profitable. Kim, Hwang, and Burgers (1993) argue, for example, that global market diversification, which they measure as the dispersion of a firm's business between seven global market areas, provides a series of advantages that should allow globally diversified firms to earn both higher return on assets and lower risk. Because their arguments are complex and multifaceted, I cite them in extenso.First, global market diversification offers possibilities for exploitation of economies of scale and scope above and beyond the potential of product diversification (Grant, Jammine, & Thomas, 1988). Second, the diversity of national markets exposes firms to multiple stimuli which provides [sic] with a broader learning opportunity and the ability to develop more diverse capabilities than are available to purely domestic firms…. Third, different nations have different factor endowments which, in the absence of efficient markets, lead to intercountry differences in factor costs. Global market diversification allows firms to gain cost advantages by configuring their value added chain in such a way that each link is located in the country which has the least cost for that link (Kogut, 1985a). Global market diversification thus provides firms with unique opportunities to increase returns by spreading its [sic] activities [emphasis in original] across multiple global market areas, rather than by choosing higher risk activities.At the same time, global market diversification endows firms with three unique options [emphasis in original] over domestic firms which are reasoned to reduce the level of corporate risk. First, global market diversification provides a firm with multiple national market bases from which it can retaliate against aggressive moves made by competitors (Hamel & Prahalad, 1985; Kim & Mauborgne, 1988). This option reduces the risk for the global firm of having to face aggressive challenges from its competitors. Second, the multiplicity of national markets allows firms to minimize the effect of adverse changes in a country's interest rates, wage rates, and commodity and raw material prices by providing the added option to more readily shift production and sourcing sites to other more favorable national markets (Kogut, 1983, 1985b; Porter, 1986). Finally, global market diversification releases firms from the mercy of supply and demand fluctuations of any one national market, smoothing the peaks and troughs of firms’ revenue streams. In sum, the spreading of activities across global market areas provides the firm with operational flexibilities that will serve to reduce earning and profit fluctuations. Taken together, the above discussions suggest that the unique opportunities and options of global market diversification may simultaneously increase firms’ returns and reduce their risk.” (Kim et al., 1993, pp. 276–277)

Citation

Hennart, J.-F. (2005), "Internalization Theory and the International Diversification: Performance Conundrum", Verbeke, A. (Ed.) Internalization, International Diversification and the Multinational Enterprise: Essays in Honor of Alan M. Rugman (Research in Global Strategic Management, Vol. 11), Emerald Group Publishing Limited, Leeds, pp. 75-93. https://doi.org/10.1016/S1064-4857(05)11006-7