1 THE INTERNATIONAL PERFORMANCE OF STANDARDIZING and CUSTOMIZING SPANISH FIRMS: THE M CURVE RELATIONSHIPS 2 THE INTERNATIONAL PERFORMANCE OF STANDARDIZING and CUSTOMIZING SPANISH FIRMS: THE M CURVE RELATIONSHIPS By Paloma Almodvar* * Paloma Almodvar (Corresponding author) Senior Lecturer in Strategic Management inComplutense University of Madrid Visiting research fellow in Henley Business School Email: paloma.almodovar@ccee.ucm.esTel: +34 91 394 25 05 Fax: +34 91 394 23 72 Acknowledgement I would like to gratefully acknowledge the invaluable support and involvement of Prof. Alan M. Rugman, without his guidance, mentorship, and patience this research would have not been possible. I would also like to thank Fundacin SEPI, and especially to Prof. Diego Rodrguez-Rodrguez and Isabel Snchez-Seco, for kindly providing and assisting with the data. 3 Abstract Purpose This paper sheds new light on the multinationality- performance debate by examining the performance of standardizing versus customizing firms from Spain. Approach The reasons for variations in performance of exporting firms builds upon the industrial organization and resource-based views of strategy, which are shown to be linked to the integration (standardization) versus responsiveness (customization) framework of International Business. We also incorporate the Uppsala model and the home region nature of international business activity. We develop hypotheses for both standardizing and customizing paths of international expansion for exporting firms. Design/methodology We use the Survey on Business Strategies which has the support of the Ministry of Industry of Spain. This databank collects data of a representative sample of the Spanish manufacturing sector. We use fixed-effects regression models for the period 2000-2008.Findings We provide evidence on how firms with a strategy of product standardization follow an M-curve -fourth degree polynomial- relationship between the degree of internationalization (DOI) and performance. In contrast, product-customization firms are observed to follow an inverted M-curve relationship. Furthermore, by using both models, we can suggest an appropriate level of internationalization.Originality/value We provide theoretical and empirical support for the different relationships of standardizing and customizing firms when expanding abroad. This paper is one of the first to find empirical support for an M-curve relationship between the DOI and performance; and certainly the first one testing and corroborating an inverted M curve. Keywords Internationalization; exporting; performance; M curve; standardization/customization; home region; inverted M curve. 4 Paper type Research paper. 5 THE INTERNATIONAL PERFORMANCE OF STANDARDIZING and CUSTOMIZING SPANISH FIRMS: THE M CURVE RELATIONSHIPS 1.INTRODUCTION The contribution of this paper is to better align recent empirical work in international business with a mainstream issue in international marketing. As referenced below in the next section, the traditional empirical research in international business on multinationality and performance has recently been transformed with the introduction of a four-phased M-curve relationship. Here we first review and then extend this thinking to international marketing. In particular, we examine the basic standardization versus customization issue, but in an international context. These two topics are considered as key themes by a Delphi study conducted by Griffith, Cavusgil and Xu (2008): (a) multinationality and performance; and (b) standardization/adaptation and performance. Briefly, we find, empirically, that exporting firms with a standardizing orientation perform differently from customizing firms as the degree of internationalization (DOI) increases. There are complex interactions between financial performance and the DOI in which standardizing firms follow an M-shaped relationship, whereas customizing firms follow an inverted M-curve relationship. As detailed below in the empirical section, we test the M-curve effect over time across a set of Spanish exporting firms. Using a large and reliable data set based on a mandatory annual survey of firms collected by a Spanish governmental institution, we obtain a distinctive set of standardizing firms which can be contrasted with a separate set of customizing firms. The data set allows us to include key control variables that cover basic international marketing 6 propositions, while simultaneously allowing us to construct and test a fourth degree polynomial relationship between the DOI and performance. Scholars have found various relationships between the DOI and performance: there is either a positive linear relationship (Errunza and Senbet, 1981, Kim and Lyn, 1986, Ramaswamy, 1995); a negative linear relationship (Harveston et al., 1999, Kumar, 1984, Siddharthan and Lall, 1982); an inverted U-shaped relationship (Garbe and Richter, 2009, Geringer et al., 1989, Hitt et al., 1997); or a U-shaped relationship (Capar and Kotabe, 2003, Lu and Beamish, 2001, Ruigrok and Wagner, 2003); or an S-shaped relationship (Bae et al., 2008, Bowen, 2007, Contractor et al., 2003, Thomas and Eden, 2004). There is even an inverted S-shaped relationship (Contractor et al., 2003, Chiang and Yu, 2005, Ruigrok et al., 2007) and, recently, a four-phased M curve (Lee, 2010).In an international marketing context, part of these discrepancies could stem from not considering the standardizing or adapting marketing strategy followed by the firm. While more than 300 papers have highlighted the relationship between the international marketing strategy standardization/adaptation and firm performance (Schmid and Kotulla, 2011), few have allied this work to the parallel research in international business.In the international marketing context, there are papers focused on several international marketing variables (Lages et al., 2008, Theodosiou and Leonidou, 2003); while others focus on one single variable: for promotion see Hultman, Katsikeas and Robson (2011); for price see Tan and Sousa (2011); for place see Dimitrova and Rosenbloom (2010); and for product see Hultman, Robson and Katsikeas (2009). To simplify the complex relationship between standardization/adaptation and performance, which is contingent on other factors (Schilke et al., 2009, Zou and Stan, 1998), we focus on product marketing strategy and attempt to answer the research question: How do standardizing firms perform compared to customizing firms in the international arena?. To 7 address this issue here we study separately exporting firms whose main product marketing strategy is standardization and companies whose main marketing strategy is product customization1. We analyze the relationship between performance and the DOI of these two groups. A major contribution of this paper is derived from contrasting the M-curve behavior followed by standardizing firms and the inverted M curve followed by customizing firms. Thus, once managers from manufacturing businesses have prioritized the standardizing or customizing nature of their exports, we can suggest the optimal levels of internationalization for enhancing firm economic performance.The paper is set out as follows: First, we introduce the theoretical background of the study. Second, we present the theoretical arguments for explaining the M-curve relationship between the DOI and performance that is followed by standardizing firms, and we propose our hypotheses. Third, we explain the conceptual arguments for the inverted M-curve shaped by customizing firms, and we put forward the rest of our hypotheses. Fourth, we define the data set and the measurement of the variables. Fifth, we explain our statistical analyses and present the results of the fixed-effects panel data models for the nine-year period 2000-2008. Sixth, we discuss the academic and managerial implications, and we present the limitations and some guidelines for future research. 2.THEORETICAL BACKGROUND Building on the well known industrial organization approach to strategy and the resource-based view (RBV), as well as the Uppsala internationalization model and some prior international business and marketing studies, we examine the relationship between internal/external factors and firm strategy, and how this fit affects performance. Industrial 8 organization-based theory, in particular the structure-conduct-performance paradigm, posits that the industry structure determines firms strategy (conduct) which, in turn, conditions firm performance. Thus, environmental or external factors must be considered when choosing the best marketing strategy for maximizing firm performance.Building on this focus of environmental factors, the Integration-Responsiveness (I-R) framework captures the environmental pressures faced by the firm when going international (Roth and Morrison, 1990). The I-R framework was first developed2 by Fayerweather (1960) distinguishing between unification (integration) and fragmentation (responsiveness). It was given analytical content by Prahalad (1975) and Doz (1976), subsequently published as Prahalad and Doz (1987). They enumerate as pressures for local responsiveness (or adaptation strategies): the need for substitutes and product adaptation; differences in distribution channels; differences in customer needs; government regulations; and market structure. And as pressures for global integration (or standardizing strategies): cost reduction; multinational competitors; multinational customers; universal needs; access to raw materials and energy; and high technological intensity. The aforementioned pressures are considered by the marketing literature as external determinants of the degree of adaptation or standardization of the marketing-mix framework (Chung, 2003, Jain, 1989, Katsikeas et al., 2006, Powers and Loyka, 2007).According to the structure-conduct-performance paradigm, the industrial structure or external factors are the ones expected to play a critical role in choosing the strategy and, as a result, determining performance. Internal organizational factors do not appear to be relevant and firms seem to be treated as abstract economic entities or even as black boxes (Zou and Cavusgil, 1996). The RBV solves this fissure (Zou and Cavusgil, 1996, 2002) with its focus on the link between internal firm characteristics and performance (Barney, 1991). It states that firms within the same industry may be heterogeneous in the resources they control, and 9 these resources can lead to a sustained competitive advantage when they are rare, valuable, imperfectly imitable and non-substitutable. These firm resources -also calledcore competencies (Hamel and Prahalad, 1994); proprietary/ownership advantages (Dunning and Narula, 1996, Eden and Li, 2010, Lundan, 2010) or firm specific advantages (Hymer, 1960/1976, Rugman, 1981, 2010, Rugman et al., 2011b)- are strengths that firms use to decide and support their strategies (Barney, 1991). Internal resources endowment determines the strategy and, therefore, firm performance as well.We consider, as external factors in the international arena, the liability of foreignness (LOF); which is defined as the costs of doing business abroad (Zaheer, 1995) and may be due to hazards of unfamiliarity, discrimination for being a foreigner, institutional differences among countries and relational hazards (Chen et al., 2006, Eden and Miller, 2004). We discuss, as internal factors, the role of different kinds and levels of firm specific advantages (FSAs) -unique capabilities owned by the organization (Collinson and Rugman, 2008) such as managerial capability, financial capability, R&D and marketing capabilities, experience, and firm size (Rugman et al., 2011a). When companies expand abroad, they need to exploit and further develop their FSAs in order to overcome the LOF. Firms may built these FSAs upon product or process technology, marketing, or distributional skills (Rugman, 2005) and, if they do it correctly, they will obtain better performances (Kirca et al., 2011). Finally, it is convenient to study separately firms which follows a product standardization strategy from customizing firms because Bartlett and Ghoshal (1989) demonstrate that global economic integration (standardization strategy), with FSAs in scale, brand and focus, can be separated from potential FSAs in national responsiveness (adaptation strategy). Because the DOI is defined as the extent to which a firm expands beyond its domestic market into other countries (Hult, 2011), we assume that it is a continuum which ranges from low export commitments to high export commitments. We will use some of the thinking of the 10 Uppsala model (Johanson and Vahlne, 1977, Johanson and Wiedersheim-Paul, 1975) to propose four phases for each product marketing strategy (standardization versus customization). More specifically we follow the Uppsala tradition by incorporating two key points: (a) export commitments (or DOIs) increase over time according to firms international learning; and (b) firms enter foreign countries with successively greater psychic distance, what implies that companies will approach countries in the home region first (Rugman, 2000, 2005, Rugman and Brain, 2003). In every phase we examine the level of FSAs against LOF and we propose our hypotheses about their impact on firm performance. 3.CONCEPTUAL MODEL AND HYPOTHESES 3.1 Standardizing Firms and Performance Although Levitts seminal paper (1983) about accelerated convergence of international markets into a flat environment has been criticized, similarities within regions have been identified (Rugman, 2001). Our research focus is upon the European Union which is the home region of Spain for its geographic proximity along with its consideration as a single internal market characterized by the free movement of goods and no quantitative restrictions on exports or imports. Furthermore, there is harmonizing legislation which establishes one set of common rules or standards for selling products in all Member States.We define a product standardization strategy as the one where the product needs minimal or no modifications (Powers and Loyka, 2007) and this common product is sold on a worldwide basis (Jain, 1989) to consumers with homogeneous needs. Among its advantages we find that it enables: cost reduction, via scale economies; uniformity in implementation; rapid introduction of new products in foreignmarkets; consistent worldwide image; decision simplifications; and operational efficiency (Chung, 2003, Theodosiou and Katsikeas, 2001, 11 Zou and Cavusgil, 2002). Thus, we examine the effect that the DOI is likely to have in the performance of those firms whose main marketing strategy orientation is product standardization. This relationship is illustrated in Figure 1. (Introduce Figure 1) Phase One: In a first phase, domestic firms decide to initiate their international activities through exports in response to unsolicited orders from foreign customers; the identification of new foreign opportunities or potential extra sales abroad, among other stimuli (Leonidou, 1995, Leonidou et al., 2007). These firms can rapidly introduce their products into new countries (Theodosiou and Katsikeas, 2001) and can exploit their current mass production systems to serve these international markets with a homogeneous product. Under these circumstances, we can assume that they will experience an initial increase in their performance derived from these first orders and, in a small extent, from achieving some economies of scale. Hypothesis 1: With low degrees of internationalization, standardizing firms will experience an increase in performance. Phase Two: Based on the apparent success of their first international incursion, companies are likely to search for new business opportunities and expect further increases in performance. This misperception that a company can be successful in going international without developing and aligning its FSAs into an appropriate designed international strategy is called a global illusion (Rugman and Almodvar, 2011). The global illusion emerges by default because this kind of opportunistic behavior usually has positive results in the short term when the company can make use of its existing FSAs and infrastructure to serve overseas customers with standardized products. 12 However, as firms attempt to increase their penetration abroad, the LOF will arise from the psychic and geographic distance between the domestic and the host country and will affect negatively the performance because of the extra costs of doing business abroad such as higher information costs derived from different market characteristics; higher transportation costs; and higher coordination costs, among others (Zaheer, 1995).Even if we consider that exporters usually expand first in their home region (Rugman et al., 2012) and that firms approaching countries with similar environments or with low geographic distances will face lower LOF (intra-regional LOF) (Chen et al., 2006, Rugman and Verbeke, 2007), we do not expect them to have developed sufficient FSAs to overcome the intra-regional LOF. FSAs require significant investments and time in order to make use of them successfully in host countries (Rugman and Verbeke, 2007). Furthermore, Petersen and Pedersen (2002) conclude standardized products will delay the enrichment of the FSAs to overcome the cost derived from the intra-regional LOF, so firm performance is expected to decrease. Hypothesis 2: With medium-low degrees of internationalization, standardizing firms will experience a fall in performance. Phase Three: In a third phase, exporters eventually learn from the local environment (Salomon and Shaver, 2005) how to strengthen their FSAs built upon technological, marketing or managerial skills (Collinson and Rugman, 2008) in order to overcome the intra-regional LOF. Therefore, a well developed product standardization strategy may result in cost savings because costs derived from the intra-regional LOF will decline after firms gain knowledge on the host environment -managerial and marketing FSAs- and through the enhancement of economies of scale -technological FSA. This assumption is suitable due to the homogeneous 13 nature of the products whose production is concentrated in the domestic market and delivered mainly within the home region with few trade barriers (Rugman, 2005). Thus, the enrichment of FSAs is expected to overcome the LOF and to impact positively on firm performance (Contractor, 2007b, Contractor et al., 2003).Hypothesis 3: With medium-high degrees of internationalization, standardizing firms will experience an increase in performance. Phase Four: Firms going through a successful international path may associate a higher DOI with better performance and might overpass the optimum level of export commitment. Some associated advantages of standardized marketing strategies such as uniformity in implementation; decision simplifications; and operational efficiency; might be exceeded by overinternationalization costs such as greater complexity, coordination and information costs (Contractor, 2007a, Matysiak and Bausch, 2012).Derived from the homogeneous nature of standardizing products which can saturate the home regional market, or the business trend toward approaching further and greater psychic distance countries over time; companies may enter countries out of the home region and, therefore, face an inter-regional LOF that will increase their costs even more (Contractor, 2007a) and diminish FSAs transferability (Rugman and Verbeke, 2004, 2007). Consequently, overinternationalization is expected to have a negative impact on firm performance (Lee, 2010, Matysiak and Bausch, 2012, Ruigrok et al., 2007). Hypothesis 4: With high degrees of internationalization, standardizing firms will experience a fall in performance. We do not expect standardizing firms to go through a fifth phase, with a final positive relationship between performance and their DOI, because several scholars have pointed out 14 how companies entering a different region of the triad (North America and Asia) will need to adapt their business model and implement new strategies (Ghemawat, 2007, Rugman, 2005). Apart from a few exceptions, a unique standardized product might be suitable within a region, but it does not appear to be appropriated across cultural, political and geographic distant regions of the Triad. 3.2 Customizing Firms and Performance A customization strategy is defined as the degree to which a product is modified to meet heterogeneous consumers preferences and values (Calantone et al., 2006, Hultman et al., 2009). In an international context for firms to offer a large variety of personalized products, according to the attributes demanded, requires high levels of information not only about the home market, but also about every host market and specific client. Despite the improvements of telecommunications and information systems, which help companies to better understand overseas customers, collecting information and manufacture tailored products involve extra time, effort, and cost (Leonidou et al., 2007). Basically going abroad brings high initial start up costs, so initially performance is negatively affected as the DOI increases. However, according to Theodosiou and Katsikeas (2001), these disadvantages might be overcome by a deeper penetration of international markets; better understanding of foreign markets; higher monitoring market skills; and, related to the aforementioned issues, a faster respond capacity to changing customer preferences. Thus performance is supposed to increase eventually as the level of customization fits customers needs. Thus, we study the effect that the DOI is expected to have on the performance of those firms whose overall marketing strategy orientation is product customization. This relationship is illustrated in Figure 2. 15 (Introduce Figure 2) Phase One: In an initial phase characterized by a small amount of exports (DOI), foreign countries are a new market and companies are not likely to have invested enough to develop FSAs in adapting their manufacturing systems for international consumers. So, companies have an immature and basic international customization strategy in this early phase.There are related circumstances that affect firm performance when companies carry out a traditional product customization strategy. These companies usually implement craft and batch production systems; they do not carry significant inventories; and they usually follow a make-to-order philosophy according to which they start producing after receiving the order on a first-come, first-served basis (Parlaktrk, 2009). In the international arena, these characteristics will lead to limited capacity and customers may face customizing delays that are likely to increase with the volume of orders (Mendelson and Parlakturk, 2008). So, as the DOI increases, the greater the expected delay as a result of possible bottlenecks derived from the increasing international demand for customized products. Furthermore, companies which are in an early phase of internationalization will face an intra-regional LOF (Zaheer, 1995). Thus, the lack of FSAs and the intra-regional LOF both has a negative impact on firm performance. Hypothesis 5: With low degrees of internationalization, customizing firms will experience a fall in performance. Phase Two: After learning from the host environment, managerial and marketing FSAs are expected to better align with more sophisticated skills in adapting offerings to the international 16 environment. Therefore, the firm is overcoming the intra-regional LOF. This intra-regional LOF should be easier to overcome due to regulatory and other institutional similarities inside the home region (Beleska-Spasova and Glaister, 2009, Rugman and Verbeke, 2007).Furthermore, as the DOI increases, companies may reduce lead times and lower costs by better developing their technological and tacit knowledge-based FSAs. Companies might evolve towards a mass customization system (Duray, 2002) where mass production technologies are applied for manufacturing customized goods. Thus, customizing companies could achieve economies of scale and scope (Alptekinoglu and Corbett, 2008). In general, in Phase Two the FSAs overcome the LOF. Hypothesis 6: With medium-low degrees of internationalization, customizing firms will experience an increase in performance. Phase Three:As companies realize increasing returns from international markets, they will be tempted to further increase their DOI. This may lead to overinternationalize beyond the home region and this could affect negatively the performance of the company due to capacity constraints and challenges to the business model as new regions of the triad are entered (Contractor et al., 2003). Therefore, company performance is likely to decrease as the business model does not work well across all regions of the triad because of the inter-regional LOF (Rugman and Oh, 2010, Rugman and Verbeke, 2007). The inter-regional LOF is hard to overcome and it may result in longer lead times, poorer customized products and overall increasing costs. Thus, in Phase Three higher DOIs are expected to impact negatively on firm performance. Hypothesis 7: With medium-high degrees of internationalization, customizing firms will experience a fall in performance. 17 Phase Four:Firms whose main orientation consists of customizing the product will find new challenges when going outside the home region because the adaptation process is expected to be more demanding and the inter-regional LOF even higher. However, the main routines and skills of these companies have been oriented from the beginning to deal with heterogeneous consumers and adapt their products to satisfy their needs. Thus, companies with some experience and history in the market may persist in increasing their DOI, essentially expanding their FSAs to global markets. In doing so, companies will develop what we have called global customization competences, which is a type of dynamic capability3 developed by customizing firms through the experiential learning of international markets. These firms will be more prone to strengthen their FSAs to overcome the inter-regional LOF and are expected to experience a final upkick in their performance. Hypothesis 8: With high degrees of internationalization, customizing firms will experience an increase in performance. 4.METHODOLOGY 4.1 Definition of the Data Set The proposed model and hypotheses are tested through a Spanish panel data set for the period 2000-2008. Such a longitudinal study can better test the relationship between the DOI and performance over time. The sample is drawn from the Survey on Business Strategies, conducted by the governmental institution Foundation SEPI with the support of the Ministry of Industry of Spain. The main characteristics of this survey are: (a) its representativeness of the Spanish manufacturing industry is assured; (b) it has multiple respondents; (c) it guarantees anonymity; (d) most of the questions used in this research are objective 18 measurements; and (e) Foundation SEPI applies different criteria for content validity (if data do not fulfill consistency controls, the Foundation requires the submission of documental justification for its validation). Additionally, we run longitudinal analysis with non-linear terms. Consequently, and in accord with Podsakoff et al. (2003) and Chang, Van Witteloostuijn, and Eden (2010), common method bias is not a threat for the validity of our results and conclusions.Initially, for the selection of the sample we identify Spanish manufacturing firms that carry out exports and are home region oriented. We classify a company as home region oriented when the regionalization ratio (regional sales to total sales: R/TS) is higher than 50 per cent (Almodvar, 2011, Rugman, 2005). Thus, for the nine year period we find around 1800 companies on average; 1132 of these are exporting firms (63 per cent) and 1085 of these are home region oriented (96 per cent). So, around 96 per cent of Spanish exporting firms have more than 50 per cent of their total sales concentrated in the European Union. Secondly, we divide the sample into two subsamples according to their main product strategy orientation, one for standardizing companies and another one for customizing companies. Being aware that complete standardization or complete customization is unreal (Calantone et al., 2004), we classify companies according to their main orientation (Baalbaki and Malhotra, 1995, Waheeduzzaman and Dube, 2002, Zou et al., 1997). In the Survey of Business Strategies, Spanish manufacturing firms must state one or none of the following two options: (a) The products are very standardized; in most cases, the same for all buyers; or (b) Most of the products are designed specifically for each customer. We only consider those firms which have effectively answered one of these two options. Therefore, our final sample has 1067 firms per year on average. To compensate for the simplicity of the dichotomization, compared to other marketing papers which use several items related to the product strategy to establish its level of standardization, 19 we have double checked the samples. First, we have run an ANOVA test in order to examine if the patterns between these two groups are significantly different from each other. Table 1 reports the F tests to compare the means of these two groups (standardizing versus customizing firms). We observe that all the variables studied in this paper for these two groups behave significantly different from each other.(Insert here Table 1) Second, we have run a complementary chi-square test to examine if there is a relationship between two categorical variables (product strategy orientation and manufacturing production system). The results indicate that there is a statistically significant relationship between the use of mass or continuous production systems and the development of a standardized product strategy (p-value