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The Internationalization of Chinese Firms: A Need for Theoretical Elaboration Autoria: John Child, Suzana Braga Rodrigues Abstract This paper examines the patterns of, and motives for, internationalization by prominent Chinese overseas-investing firms. It compares the factors that appear to influence their internationalization with those emphasized in existing theories. Case studies of Chinese firms indicate that they are seeking technological and brand assets to create a competitive position in international markets. Rather than conducting outward direct investment to exploit competitive advantages, Chinese firms are generally making such investment in order to address competitive disadvantages. They are internationalizing, or preparing, for entry into international markets, through three main routes: partnerships via original equipment manufacturing [OEM] or joint ventures, acquisitions, and organic expansion abroad. Each route offers certain benefits coupled with its own challenges or risks. The paper concludes that an elaboration of existing theorizing is required to take account of the late-comer status of Chinese firms to the global economy, their distinctive internationalization paths and, above all, the impact of their institutional legacy. The case of China strongly suggests that international business theory needs to take fuller account of the potential relevance of domestic institutional factors in emerging and transitional economies. Introduction China is accounting for the largest wave of internationalization among all the emerging economies. By the end of 2003, its overseas direct investment totaled US$33.2 billion (Ministry of Commerce 2004). Mainland Chinese firms had established 7,470 companies in over 160 countries or regions by the beginning of 2004 (Chung 2004). It is therefore important to understand the forms this is taking and the factors behind it. China’s emerging system of capitalism has developed its own special characteristics (Boisot and Child 1996), and this prompts the question how well theories of FDI and firm internationalization derived from western experience can account for what is observable for Chinese firms. This issue is made the more intriguing by the fact that outward FDI by Chinese firms has several distinctive features. First, it is difficult to explain its rapid growth in terms of the advantages that mainstream theory usually identifies as incentives for firms to invest abroad. For Chinese firms appear to lack such advantages, especially ownership strengths. A second distinctive feature of China’s outward FDI lies in the relatively high proportion that is concentrated in a few developed countries. By 2001 as much as 30 per cent of Chinese government-approved outward direct investment had gone to just the USA, Canada and Australia (Yang 2003). The reasons for this need to be explored, since again mainstream theory would expect Chinese firms to invest primarily in neighboring developing countries. A third distinctive feature is the close involvement of domestic governmental institutions in the internationalization of Chinese firms, with outward FDI requiring official approval and much of it in the past being subject to administrative direction through state trading companies or state-owned enterprises (Cai 1999). This paper examines the patterns of, and motives for, internationalization by prominent Chinese overseas-investing firms. It compares the factors that appear to influence their internationalization with those emphasized in existing theories. In the absence of more systematic firm-level data, we shall rely upon case study evidence. The purpose of the paper is to stimulate discussion in a new area of study rather than to provide definitive general conclusions. The following section briefly summarizes the explanations for patterns of internationalization that are offered by current theorizing. We then examine evidence from 1

Chinese firms. This evidence provides a basis for suggesting key features of Chinese internationalization and reasons for these. The closing discussion develops the broader implications of the analysis including the need for theoretical elaboration that it suggests. Current theories of firm internationalization Conventional theories of international business assume that firms will internationalize on the basis of a definable competitive advantage that allows them to secure enough return to cover the additional costs and risks associated with operating abroad (Caves 1971, Buckley and Ghauri 1999). The eclectic paradigm developed by Dunning (1981, 2001) draws together elements of previous theories to identify ownership, location and internationalization (OLI) advantages that motivate internationalization. Ownership advantages are firm-specific factors such as superior proprietary resources or managerial capabilities that can be applied competitively in a foreign country. Location advantages can account for decisions to invest in foreign countries that offer market or production opportunities superior to those available elsewhere and/or opportunities to secure valued inputs. Internalization advantages accrue to firms that can reduce transaction costs by investing abroad so as undertake transformation or supporting processes more effectively than can be achieved through market transactions (Buckley and Casson 1976; Safarian 2003). Internalization may offer clear efficiency advantages in the management of interdependencies concerning know-how, reputation, the value chain, and marketing, and these advantages offer a powerful explanation for the rise of the multinational enterprise (Hennert 2001). The realization of internalization advantages depends on ownership capabilities and, in general, the latter have been accorded prominence in mainstream explanations for FDI and internationalization. Ownership factors also enter into theorizing on the choice of location made by foreigninvesting firms. It has been widely assumed that firms will normally prefer to invest in countries where their existing ownership capabilities will not be too disadvantaged. If a firm chooses to invest in countries that present less ‘psychic distance’ from its domestic country, in terms of their cultural, economic, institutional, linguistic, political, and physical features, the firm’s existing capabilities can be more readily applied without the need to acquire new ones (Johanson and Wiedersheim-Paul 1975, Johanson and Vahlne 1977). This argument suggested the ‘stages’ model of internationalization, which predicts that firms will begin their internationalization by moving to countries they can most readily cope with and then to more ‘distant’ countries only later on. Moreover, the stages argument predicts that foreign entry mode will also follow an incremental pattern, with an agency operation using an international trade intermediary preceding investment in a joint venture, which in turn will be a step before a wholly owned subsidiary. However, subsequent research focusing on the cultural aspect of psychic distance, has often failed to support the stages model (e.g. Benito and Gripsrud 1992), suggesting that other more ‘rational’ economic considerations may have greater explanatory power. It is noteworthy that these influential theories and perspectives have derived from research on large western enterprises, which can be presumed to enjoy considerable domestic strengths before they internationalize. The predominant assumption in mainstream theory has been that internationalization is motivated by a firm’s wish to exploit its existing ownership advantages. The conventional view therefore focuses on the overseas possibilities for assetexploitation. Although the psychic distance perspective recognizes the potential difficulties of realizing ownership advantages in foreign locations, it is nevertheless consistent with the assumption that firms will normally seek to internationalize so as to take advantage of the market entry possibilities offered by their competitive strengths. By contrast, the possibility that some firms undertake FDI in order to seek assets, because they are entering international business to address a relative competitive disadvantage has not 2

attracted so much attention in the literature (Wesson 1999). Here, the notion of ‘late development’ can help fill the gap. The ‘late development’ thesis was classically applied to nations, initially Japan (Dore 1973), and subsequently the emergent new economies of East Asia, notably Taiwan, South Korea, Hong Kong and Singapore. China’s recent emergence as a major industrial power also qualifies it to join the same category. These countries had to ‘catch up’ with early developing countries in terms of technology and know-how, as well as in the development of business environments supportive of international competitiveness. The comparable notion of the ‘late coming’ firm draws attention to late entrants to international competition from those countries, firms that have become remarkably successful like Samsung and LG from Korea, and Acer and TSMC from Taiwan. It is significant that latecomer firms did not start from positions of strength, but rather ‘from the resource-meager position of an isolated firm seeking some connection with the technological and business mainstream’ (Matthews 2002: 471). While such firms had some initial competitive advantages, such as low labor costs, these became less crucial as the firms moved into more sophisticated markets with higher-value products. The significance of the latecomer perspective lies in the way it directs attention to internationalization as a means of addressing an initial competitive disadvantage. It points to the possibilities of links that can be made, and resources that can be acquired or leveraged, in the wider international economy. There is every reason to suppose a priori that these considerations will feature strongly in the thinking of Chinese business leaders who are ambitious for the competitive development of their firms. Moreover, the familiarity to Chinese business leaders of networking as a means of reducing transaction costs and exploring new opportunities may be expected to make them particularly active in fashioning wider international connections through this means (Boisot and Child 1996). It is also noteworthy that mainstream perspectives on the internationalization of the firm view the subject primarily through an economic lens. Even references to the impact of cultural factors tend to be interpreted in terms of their effects on risk and transactions costs. However, China may provide a good instance of the need to expand international business theory to take greater account of the political and sociological factors that operate through a country’s institutions (cf. Toyne and Nigh 1998). Emerging and transition economies are typically characterized by active governmental involvement in business, both through ownership and through regulation (Peng 2000). This is certainly the case in China, which in the literal sense remains a political economy despite the development of a market system (Child and Tse 2001). It would appear that the consequences for the internationalization of Chinese firms could be both manifold and inconsistent. For instance, many of the larger Chinese firms, which have been singled out as ‘national champions’, receive financial support and protection from governmental authorities. Yet these very firms which might be expected to internationalize from a position of strength may in practice be weakened by the way they remain beholden to administrative approval and bear a legacy of institutional dependence. This legacy can inhibit strategic action either through promoting a conservative attitude or through more direct constraints (Lewin et al.1999). There have, for example, been instances in which Chinese governmental authorities have removed leaders of state-owned enterprises who demonstrated the kind of entrepreneurial initiative on which internationalization depends (Nolan 2001). Internationalization among Chinese firms Several scholars have traced the way that the internationalization of Chinese enterprises has evolved through a number of stages (e.g. Cai 1999, Tseng 1994, Warner, Ng and Xu 2004). The earlier stages up to the 1990s were largely experimental and subject to strong state regulation. The 1990s witnessed a significantly greater spread of overseas Chinese affiliates, 3

but problems often arose from a lack of strategic focus, from the limited scale and fragmentation of many projects, and from inexperience of coordinating overseas operations (Zhang and Van Den Bulcke 1996, Warner, Ng and Xu 2004). It is only recently that a number of leading Chinese firms have emerged that are internationalizing with a view to becoming global players in international markets. They are characterized by a more focused and longer-term strategic view and appear to be developing the capacity to organize overseas operations systematically. It is on these firms that we shall concentrate. We shall not focus on those state-owned material processing enterprises that are also investing heavily abroad, particularly in developing countries, with the purpose of securing raw material supplies, badly needed to power the country’s consistently rapid economic growth. For these latter enterprises are not going abroad with the primary intention of competing in international markets. Paths towards internationalization Three paths towards the internationalization of Chinese firms can be identified, which are not mutually exclusive. These are (1) partnership through OEM or joint venturing, which offers a preparation for internationalization per se, (2) acquisition, and (3) organic expansion. 1. Preparation for internationalization through OEM and joint ventures Forming joint ventures with foreign enterprises, or entering into a partnership with them through original equipment manufacturing [OEM], is a route chosen by many Mainland enterprises. Evidence suggests that partnership with a multinational enterprise, more so than with an overseas Chinese firm, can be an effective means of transferring modern practices to the Chinese firm thereby helping to strengthen its international competitiveness (Child and Yan 2001). OEM combines the cost advantage of a Chinese enterprise with the brand advantage of a foreign firm. Galanz illustrates the successful application of this strategy. A township and village enterprise [TVE] based in Shunde, Guangdong Province, Galanz has become the world’s largest manufacturer of microwave ovens. It also commands two-thirds of the Chinese domestic market. Originally, Galanz wanted to build its own brand in the international market, but failed to do so. It then chose the OEM route, producing microwaves for many different international brands (its website claims as many as 250). In so doing, Galanz has moved towards an ‘Intel-inside’ strategy. As it grew into a dominant manufacturer, and as its bargaining power increased accordingly, so it was able to print the label ‘made by Galanz’ on all the microwaves it produces. Its website now invites prospective customers to order directly from Galanz. Clearly, this strategy is enabling the company to build up its own strong international brand in the future (Zhang 2003). Moreover, Galanz has invested US$20 million in an R&D center in Seattle in order to improve its own independent technological capability (Chung 2004). The Chinese authorities have consistently favored international joint ventures as a means of transferring technology and expertise to Chinese firms (Peng 2000). Huawei provides an example of the joint venture route to strengthening the capabilities of a Chinese firm. Huawei, a collective enterprise founded by a former army officer in 1988, exports over 20 percent of its sales and is seriously challenging Cisco Systems in the field of network equipment. It has entered into a number of joint ventures – for example, to develop and make 3G phones with NEC and Siemens, and with the Electronic Data Systems Corporation to market Huawei’s equipment in the USA. In 1999 it established a software development center in Bangalore (Business Week 2003). In the process of developing sufficient corporate reputation for the eventual launching of an international brand, the OEM route offers Chinese firms the advantages of preserving their 4

own identity, achieving economies of scale, and gaining a reputation in their own right for manufacturing excellence. OEMs can also permit an accumulation of financial resources that can be used to acquire international assets later on. By contrast, the formation of a joint venture with a foreign partner ties a Chinese firm more closely into the internal network of that partner. This can offer a more effective channel for the transfer of tacit knowledge to the Chinese partner, not just in production and distribution but also in other areas where internationally competitive standards need to be achieved. The transfer of tacit knowledge can be especially important for enabling the Chinese recipient to make good use of technology. However, the Chinese partner’s identity tends to be subsumed into that of the joint venture, which is often associated with the foreign partner’s name and reputation rather with those of the Chinese partner. The Shanghai Automotive Industry Corporation [SAIC], discussed in the next section, is a case in point. Thus, while joint ventures may offer an effective path towards securing the technological basis for a differentiation advantage, they may not be as effective as the OEM route for Chinese firms to build up an independent international reputation. 2. Acquisition The number of international acquisitions by Chinese firms has grown markedly in recent years. They were valued at US$ 2.85 billion in 2003 and have been forecast to reach as much as US$ 7 billion in 2004 (Business Week 2004a). As of October 2004, the 44 foreign acquisitions by Chinese companies were one-third higher than in the previous year (McGregor and Guerrera 2004). The largest overseas acquisitions have been undertaken by large state materials processing corporations with the intention of securing supplies from abroad. However, since these acquisitions are not motivated principally by the desire to become competitive in international markets, we shall not consider them further here. The dominant motive among non-primary producing Chinese companies for undertaking foreign acquisitions has, by contrast, been to accrue market strength. They have undertaken acquisitions to gain access to technology, to secure research and development skills, and to acquire international brands. Acquisition provides a fast route to these benefits and it can also deny them to competitors. The ‘push’ factor of domestic institutional restriction can also apply in that while international acquisitions by Chinese firms are usually officially encouraged, domestic acquisitions often are not, which removes one path for growth. Governmental authorities concerned at the political consequences of creating industrial giants have sometimes thwarted the take-over by Chinese firms of other enterprises within China, and local officials have opposed them even more frequently because of their fears of losing control of the local firms that are acquisition targets (Meyer and Lu 2004). The Holly Group provides an example of foreign acquisition aimed at securing proprietary technology (Warner, Ng and Xu 2004). Holly, which began in 1970 as a rural township and village enterprise [TVE], specializes in the production of energy-meter equipment and instruments. In 2000, it published an ‘Internationalization Strategy for the 21st Century’, in which it stated its objective of positioning itself as a successful multinational enterprise on the basis of acquiring highly competitive competencies in its specialized field. A major step forward towards implementing this strategy was Holly’s acquisition in September 2001 of the CDMA hand-set reference design operation from Philips Semiconductors in the USA. Through this acquisition, Philips Semiconductors transferred to Holly its equipment, assets, know-how and intellectual property rights connected to hand-set reference designs. Holly also secured an exclusive license to process the CDMA software protocol that Philips had earlier developed. Moreover, Philips undertook to supply Holly with key silicon components thus enabling the latter to continue to develop and market the licensed products. 5

The acquisition by Lenovo (previous Legend) of IBM’s PC division for US$1.75 billion, announced in December 2004, allows it to use the IBM brand for five years and gives it control of the Think trademark of IBM’s popular ThinkPad laptops. The deal not only provides Lenovo with IBM’s brand; it also enables it to acquire IBM’s laptop production lines, product developers, and distribution networks. The President of Lenova clearly stated that this move was intended to make it possible for his company to challenge Dell and HP in global markets. He is quoted as saying that ‘we are not satisfied to be only number three’ (Financial Times 2004a). This particular acquisition illustrates a number of factors of importance in an analysis of Chinese internationalization. First, there is the impact of tough domestic conditions, which both impel a Chinese company to enhance its competitive advantage and also add to the attraction of foreign markets. Lenova’s margins have come under increasing pressure in its domestic market from local and foreign competitors. Although still China’s PC market leader, its position has come under growing attack, especially from Dell. Its share price fell by 23 percent in 2004. Its gross margins have been less than 15 percent, while IBM’s gross margins in its PC business are 20 percent. Second, the acquisition offers Lenova a dramatic step up the world league table, quadrupling its annual sales to over US$12 billion, so long as it can retain IBM’s customers and employees, and manage a large foreign business. It is, however, a major challenge for a Chinese firm without significant international experience to manage global expansion of this order. The management of this major internationalization will have to overcome major differences in managerial culture and style. A third, related, factor concerns a Chinese firm’s ability to build a global reputation rapidly so as to retain loyalty to the acquired brand in the international marketplace. Doubts have been raised about Lenovo’s ability to preserve confidence in the IBM PC brand; for example, one IBM user commented that ‘it feels uncomfortable; international IBM has become domestic Lenovo’ (Financial Times 2004b). In order to reduce these risks, Lenova is appointing a senior IBM vice-president as its chief executive, transferring its head office to New York and retaining IBM as the preferred supplier of after-sales service outside China. IBM will also take an 18.9 percent stake in Lenova. A further condition for value in an international brand is that it needs be a strong rather than a failing one. This condition is not always met. An example was SAIC´s interest in acquiring the fading Rover car marque. TCL’s purchase of a controlling stake in France’s Thomson gave it a loss-making business with a severely faded TV brand (RCA). Moreover, in the case of TCL and Thomson, major differences in culture and corporate practice have created greater management problems than expected, especially over issues such as pay levels and communication across two languages (The Economist 2004b). In short, the acquisition route for securing international differentiation and brand advantage is being favored by an increasing number of Chinese firms. It appears to offer a rapid advance toward achieving these objectives, though it is too early to assess the extent to which Chinese companies can handle post-acquisition integration and management challenges successfully. Such problems can be formidable for acquisitions in general, and international ones in particular (Child, Faulkner and Pitkethly 2001). Nevertheless, an increasing number of Chinese companies are undertaking international acquisitions. While some are achieving reasonable profits - for example, Lenovo made a profit of US$128 million in 2003, despite falling domestic margins, and TCL’s profit was US$163 million – it is unlikely that they could bear the financial risk without support from governmental authorities whose approval is in any case required. It is anticipated that if and when the Chinese Yuan is revalued against the US dollar, the consequent reduction in price of foreign assets will

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accelerate the process of acquiring foreign assets, just as the strength of the Yen encouraged a wave of Japanese foreign acquisitions in the 1980s. 3. Organic international expansion This path toward international expansion involves the greenfield establishment of subsidiaries and facilities within targeted markets. It is initially aimed at securing differentiation advantages in terms, for example, of adjustment to local market needs and tastes. It may, as in the case of the Haier Group, also be the main component of a strategy aimed at gaining global brand recognition. It is also a route that maximizes managerial control and the possibilities for global integration. Haier is the best-known example of a Chinese firm that has internationalized primarily through the organic expansion route. It was also one of the first Chinese enterprises to implement an internationalization strategy, when it started to export to Europe and the USA in 1990 and to Japan in 1991. Today, Haier is considered to be ‘the official template for the Chinese MNC of the new millennium’ (Warner, Ng and Xu 2004: 334), and its CEO Zhang Ruimin is probably the most respected Chinese business leader worldwide (Zhang 2003). Haier began in 1984 as a collectively-owned enterprise - the Qingdao Refrigerator Factory. Its range of manufactured goods today includes various white goods, air conditioners, microwave ovens, and color TVs. It has 19 production factories outside China and two ‘production parks’ in the USA and Pakistan. Although it established subsidiaries after 1996 in nearby developing countries such as Indonesia, the Philippines and Malaysia, its main internationalization thrust has been directed at highly developed regions. Thus Haier started exporting to Europe, Japan and the USA in the early 1990s, in keeping with the philosophy of CEO Zhang, namely ‘enter a difficult advanced market first, then go to easy, underdeveloped markets’ (Kiran 2004: 2). The idea behind this strategy is to build an international brand name by competing in the markets that are the hardest to enter and then gradually to expand to other markets. Addressing difficult markets first is seen as a way of obliging the company to achieve high quality, innovation and customer service, foundations on which a recognized brand can be built. Despite undertaking some acquisitions and joint ventures in its overseas expansion, Haier has to an important extent followed the path of organic diversification. This has been particularly apparent in the United States. Haier started to export to the US market in 1990, but realized that it was handicapped by not having a locally recognized brand name. Returning in the late 1990s, it invested US$40 million in a new production plant in South Carolina that started operation in 2000. It established a design center in Los Angeles and a trade center in New York. Haier initially aimed its US production at niche segments in the household appliances market with innovative products, having the intention to enter the regular white-goods market later. After gaining customer loyalty through product differentiation, such as small refrigerators and wine coolers where US manufacturers had a small presence, Haier’s products started to be sold in large chain stores such as Wallmart and Sears. By 2003, it had gained 50 per cent of the compact refrigerator market and 70 per cent of that for wine coolers (Kiran 2004). Haier is at present an unusual case among Chinese internationalizing firms, but it is nonetheless a leading example that others may follow. Its policy of opening up sophisticated foreign markets with direct investment after only a short period of exporting does not conform to the economic argument that firms will engage in international business on the basis of factor advantage. On that basis, Haier should have concentrated its entry to international markets on the advantage of low-cost production from China, producing conventional appliances of standard quality for developing country markets. Instead it has 7

opted for local manufacture at a relatively early stage, most notably in the USA but with a similar pattern now established in Europe and emerging in India. Nor does Haier’s overall pattern of geographical expansion conform exactly to the stages theory. Although it has targeted some ‘easier’ developing country markets in south east Asia, it focused on Europe and the USA quite early on. Despite the apparent success of its strategy so far, judgment has still to be reserved. For Haier could be said to be pursuing a high risk policy, and the company does appear to be incurring high initial investment costs which have been financed by a steady cash stream from its domestic operations. Doubts have been expressed as to how long this policy can be maintained in view of the mounting pressures it is facing on margins in its domestic market (Business Week 2004b). Moreover, the company’s distinct approach is very much a reflection of an outstanding CEO and it also remains to be seen whether it can support its rapid international expansion with sufficient management in depth. Internationalization through organic expansion exhibits elements both of assetexploitation and asset-seeking. Haier had worked hard to establish domestic strengths based on a combination of innovativeness and high quality. These become assets that it exploited when entering sophisticated developed country markets. In Germany, for example, it helped to establish its local reputation for quality through encouraging the ‘blind’ testing of its products against those of local manufacturers. In the US market, the company soon became known for the innovative extra features that its products offered. On the other hand, the fact that Haier felt obliged to establish design, manufacturing and marketing facilities in the USA, staffed by Americans, indicates that it was continuing to seek appropriate assets in its internationalization. Discussion 1. Pros and cons of different paths to internationalization We have identified three primary strategies related to internationalization by Chinese firms: OEM and joint ventures; acquisition; and organic expansion. Each offers certain advantages, but is at the same time accompanied by its own challenges or risks. The OEM/JV path enables the firm to capitalize on low cost production in China and normally involves less financial commitment and risk. At the same time, it offers an opportunity to learn international practices and standards, which in turn should provide a basis for it to build a sound reputation that will later stand it in good stead when it seeks to launch its brand in the international market. As against the lower risk, this mode tends to subject the Chinese firm to the dominance of its foreign partner(s) in regard to technology and identity, and it may incur the opposition of those partners if it launches its own brand and turns into a international competitor. In manufacturing, the acquisition path is aimed primarily at securing technology and/or brands quickly, and it can preempt similar moves by competitors. It is an attempt to add differentiation and brand advantages to existing cost advantage. The challenges experienced in effecting this internationalization mode are those that normally accompany acquisitions: the danger of over-paying, the need to ensure that assets acquired are not failing or tarnished ones, and the very large challenge of overcoming the ‘liability of foreignness’ in managing acquired assets and preserving the equity of the acquired brand. The organic international expansion path is likely to prove a slower route to internationalization. As with Haier, it may well involve the establishment of production abroad in addition to technical and marketing facilities. It therefore tends to be a high investment path that can impose financial risk and strain on the company. On the positive side, organic expansion makes it easier to integrate its practices to local competencies and circumstances. By being present as a local company in a highly critical and competitive market such as the USA, organic expansion strengthens the acceptability and credibility of 8

the company’s brand. Since that brand and supporting technology both emanate from within the company itself, organic expansion should offer the best chance for the firm to achieve a high level of global integration. It combines asset-exploitation and asset-acquisition. 2. Drivers and facilitators The pursuit by Chinese firms of internationalization through these several paths has to overcome the usual challenges identified by studies on the internationalization of firms from other countries (Buckley and Ghauri 1999). These include cultural differences and other aspects of psychic distance, inexperience of international business, limitations of management, the need secure appropriate technology, and the need to have a respected brand or corporate reputation. On the other hand, there are a number of factors conducive to internationalisation by Chinese firms, especially relating to the state and its institutions. These are more distinctive to the Chinese case and therefore suggestive of new insights for international business studies. Some of these factors act as drivers towards investing abroad, while others are facilitators of the process. Drivers: Domestic conditions are significant drivers of internationalization. China has already established a clear exporting advantage based on low-cost production. However, cost advantage tends to be accompanied by low margins so long as the technology applied to products and their manufacture remains only of a conventional standard and so long as those products do not enjoy any brand advantage. Cost and price has become a dominant competitive factor in domestic markets to the extent that it is increasingly hazardous for Chinese firms to depend on a cost-leadership strategy on those markets. This provides an incentive to go further and attempt to secure the differentiation and brand advantages that hold the promise of higher margins. The cases examined indicate that internationalization is seen as an important way of securing these sought-after assets. This is particularly the case when foreign firms are willing to sell or share their technology, know-how and brands, due to financial exigency (as was the case of MG Rover vis-à-vis SAIC) or because that part of their business is relatively unprofitable (as in the case of IBM). Technology and brands are assets that Chinese firms may seek to acquire through internationalization. Some have argued that an important driver behind internationalization by Chinese firms is the desire to escape domestic bureaucratic restrictions, and institutional and logistical deficiencies (e.g. Boisot 2004). The beneficial arrangements to be mentioned shortly suggest that the situation is rather more nuanced than this argument allows. Institutional constraints such as legal uncertainties, obstruction of domestic acquisitions, and regional protectionism through license restrictions do remain a problem (Peerenboom 2001), but it seems that successful firms have found ways to accommodate or circumvent them. Logistical problems also remain an impediment, through again the situation is improving with massive expenditures on transport and telecommunications. It would therefore probably be correct to conclude that, in comparison with the pressures arising from domestic competition, the ‘push’ factor of seeking to escape institutional and structural impediments is of less significance. Facilitators: The state and its various agencies continue to play an unusually active role in the Chinese business system, and in this respect the country has by no means completed a transition from socialism (Child and Tse 2001). In some respects, this situation facilitates the internationalization of Chinese firms, especially when they retain some (but not total) state ownership or are regarded as national exemplars. For example, the Chinese government holds a 57 percent stake in Lenovo, which will reduce to 46 percent following the IBM deal (Business Week 2004 c). This has given Lenovo privileged access to domestic government and educational markets, as well as to state sources of scientific and technical research. These domestic advantages have made Lenovo a more attractive partner for IBM to enter into the deal that takes Lenovo into the international arena and provides IBM with a stake in the 9

company. Despite the government’s significant ownership stake, Lenovo enjoys the entrepreneurial freedom of being classified as a ‘state-owned, non-government managed enterprise’. Haier is a collectively-owned company that has nevertheless benefited from financial and other support from the state, without this unduly restricting its entrepreneurial freedom. It was restructured in its early days with funds raised from state banks and government agencies, was permitted to grow through a series of mergers and acquisitions with domestic firms, and was able in 1993 to go for an IPO and to become listed on the Shanghai stock exchange. CIMC, a producer of marine shipping containers was by 2002, earning some 95 percent of its sales revenues from exports. CIMC is a joint venture with two major state-owned parent companies, and has been able to secure considerable managerial freedom through its joint venture status. This arrangement has been conducive to its successful competition in the international market on the basis of domestic production strengths built up through a series of acquisitions of other domestic container producers. The acquisitions not only provided additional production capacity but also access to refrigeratedcontainer-manufacturing technology through a 1997 purchase of Hyundai’s container-making operations in China. CIMC has thus been able to build a strong international competitive base through gaining government support for a domestic M&A policy while at the same time retaining its entrepreneurial freedom (Zeng and Williamson 2003, Meyer and Lu 2004). Institutional support therefore has to be counted as a factor that can help lay the foundations for the internationalization of Chinese firms, so long as at the same time those firms retain their freedom to pursue their own strategies. Many earlier instances of outward FDI from China were governmentally directed and they under-achieved (Cai 1999). It is hardly a coincidence that many of the currently successful internationalizing Chinese firms are either non state-owned enterprises or enjoy arrangements that insulate them from bureaucratic interference. For example, Galanx and Holly are township and village enterprises [TVEs], while Haier and Huawei are collective enterprises. Lenovo and TCL do have major government ownership stakes, but that ownership is now shared with other investors including multinationals such as IBM (Lenovo), and Toshiba and Sumitomo (TCL). CIMC also enjoys considerable managerial autonomy, as just noted. Zeng and Williamson (2003) call these ‘hybrid’ arrangements, which provide the firms concerned with competitive advantages because they permit them the support of institutional arms of the state without having to pay the penalty of governmental interference. Moreover, it is likely that success abroad generates goodwill with governmental authorities, which further reduces interference from them. While the ownership status of these successfully internationalizing firms helps to distance them from bureaucratic intervention, their relative autonomy also owes something to the ability and prestige of their leaders. One of the important entrepreneurial competencies displayed by the leaders of firms like Haier lies in their ability to negotiate a degree of strategic freedom from the bureaucracy while retaining its support. The relationship between institutional and entrepreneurial factors is thus reciprocal in that arrangements that lessen dependence on the state give greater scope for entrepreneurial initiative, while the exercise of that initiative is partly directed to increasing the autonomy of firms to raise capital abroad and in other ways further their internationalization policy. Networking capability is another factor that some have argued to be conducive towards the internationalization of Chinese firms. Yang (2003) maintains that networking has been a significant factor in explaining the pattern of China’s outward FDI, but unfortunately he does not provide any firm-level data in support. Zeng and Williamson (2003) illustrate how highly flexible low-cost producing networks of domestic firms have generated exporting advantages in sectors such as garments, toys and Christmas decorations. We have noted how networking through joint ventures between domestic Chinese firms with foreign partners has provided the 10

former with access to international technology and sometimes markets. Although Chinese firms are increasingly purchasing foreign technology, and sometimes brands as well, they also have to learn how to use those assets and incorporate them into a viable international business strategy. For this reason, we can expect many Chinese firms to continue to form joint ventures with foreign firms with a view thereby to accessing tacit knowledge and intangible assets though social networking. 3. The need to elaborate conventional theory The internationalization of Chinese firms suggests that there is a need to elaborate existing theory in several respects. One concerns the latecomer to international business. Our conclusion is that Chinese internationalization conforms more closely to the latecomer perspective than to analyses derived from the exploitation of firm-specific advantages by already strong companies. While exporting from China is based primarily on the intrinsic advantage of low-cost labor, combined in some cases with modern production facilities that may have been developed with foreign inward investment, outward FDI is generally assetseeking rather than asset-exploiting. Much of it is aimed at securing resources or at remedying capability deficiencies. The assets being sought are intangible, such as reputation and how to manage a global corporation, as well as tangible. The increasingly important instance of developing-country latecomers to international business raises the issue of the relationship between domestic and international asset-seeking. Domestic acquisitions have in some cases, like CIMC and Haier, led to competitive advantages that have subsequently been leveraged internationally. This leveraging, however, requires complementary capabilities to be developed or secured, so as to obtain differentiation and brand advantages. It has always been the intention of Chinese policy makers that Sino-foreign joint ventures and other partnerships with foreign firms would provide an effective channel for domestic firms to acquire the capabilities needed to compete internationally. Outward FDI from China that secures technological and reputational assets should in turn enhance the ability of the firms concerned to compete in the domestic market, which following WTO entry is becoming an increasingly open one. The Chinese case also calls for further reflection on the process of internationalization through time. The paths followed by companies like Haier, Galanz and Lenovo do not conform closely to the stages theory. They have not attached priority to entering geographically proximate developing country markets. Rather, the attractions of large developed country markets appear to more than offset any problems of psychic distance. Indeed, Haier’s CEO has explicitly rejected the assumption underlying the stages thesis by stating his belief in the long-term payoff of targeting the hardest markets first. In any case, modern information and communication technologies, coupled with the diffusion of sophisticated methods of managerial control and coordination, serve respectively to ‘compress’ and ‘bridge’ psychic distance and render it less of a problem than in former times (Child, Ng & Wong 2002). Moreover, the notion of stepwise internationalization so as to minimize psychic distance assumes that firms are searching for as much ‘familiarity’ in their foreign host environments as possible. Haier provides at least one notable exception to this assumption, as does the fact that one-third of Chinese outward direct investment has gone to ‘distant’ developed countries like the USA, Canada and Australia. In addition to the appeal of their markets, such destinations provide the source of the crucial technological and brand assets that are being sought to support a globalization strategy. A third, more far-reaching, consideration is that the process of internationalization by Chinese firms appears to be significantly impacted by institutional factors. Because the close ‘relational framework’ (Meyer and Scott 1986) that Chinese firms enjoy with supporting governmental agencies is extremely confidential, its economic and psychological significance 11

cannot be assessed precisely. However, Warner et al. (2004:340) are likely to be correct in their speculation that ‘the State’s sponsorship and funding support are a key factor that may make possible the frequent acquisitions initiated by the PRC-based enterprises as a ‘normal’ mode of entering and penetrating a host economy’. We have seen how companies that have entered the international market in a major way, such as CIMC, Haier, Huawei and Lenovo, have benefited significantly from government support at critical stages in their development. The case of China strongly suggests that international business theory needs to take fuller account of the potential relevance of domestic institutional factors in emerging and transitional countries. It is significant that many other developing countries are also characterized by a heavy institutional and political involvement in their business systems. To date, when account has been taken in international business studies of institutional conditions, the focus has tended to be on the role of such conditions in the host countries for FDI than in the domestic environments of internationalizing companies. A major issue that is raised by an institutional perspective concerns the extent to which the pattern of firm internationalization is path-dependent rather than path-creating. Institutional theory tends to assume the former, in that it conceives of isomorphism in structures and behaviors between institutions and firms as resulting from the embeddedness of business in the social and economic relations of a society, including the constraints that governmental and other agencies impose on business actions (Granovetter 1985, Scott 1995). This implies that although the motivation to internationalize among Chinese firms can be explained in terms of the same competitive factors that apply to western firms, such as the need to compete by exploiting or seeking assets, the decisions that they make about the pattern of internationalization will be informed by established mind-sets and existing practice, reinforced by institutional norms. Evidence on the internationalization of Chinese firms up to approximately the mid-1990s does point to a heavy path-dependence stemming from pre-transition conditions in that strong administrative guidance continued to be imposed, low risk investments were preferred, and little strategic analysis was evident (Cai 1999). Path-dependence might appear to be a low risk internationalization pattern in that it conforms to what are perceived as tried and tested, as well as socially acceptable, modes of behavior. It involves the exploitation of existing assets in known ways – in the case of Chinese firms this would include the exploitation of cost advantage through exporting, and OEM or joint venture partnerships. In conditions of global competition, however, pathdependency carries a high risk of longer-term failure because it may inhibit the achievement of differentiation and/or brand advantages through path-creating initiatives that require the seeking of new assets and competencies. What precisely characterizes the emerging generation of Chinese internationalizing firms is their willingness to become path-creators in the sense of moving away from crystallized social practice, regulations, or institutions by combining innovative, proactive and risk seeking behavior (McDougall and Oviatt 2000, Rialp 2004). The success of the major Chinese internationalizers appears to rest quite heavily on the vision and drive of their leading entrepreneurs, to an extent that it raises some doubts as to whether they have the management in depth to be able to sustain international diversification and organize complex international networks. These entrepreneurs appear not so much to have ‘escaped’ domestic institutional restrictions as to have found ways of co-opting political support that give them the freedom to pursue internationalization strategies of their own choosing. In that sense they exemplify the creation of new paths. These new paths are seen in both the dynamic capabilities that these firms have developed through their domestic evolution, and in the development of new capabilities through the three paths to internationalization that we have described. 12

The advantages and challenges (risk profiles) of these three internationalization paths reflect different degrees of path-dependence versus path-creation. Organic expansion abroad involves the greatest degree of path creation, but at the same time tends to incur the highest risk. Major acquisitions such as Lenova’s also open up major new paths for the company and carry a high level of risk. The OEM and joint venture path involves the least path creation, but also the least risk. While each path can assist Chinese ‘late-comers’ to catch up in the global business world, the higher-risk more path-creative path offers Chinese firms the prospect of greater independence based on achieving differentiation and brand recognition. By contrast, the OEM/JV path is more likely to see Chinese internationalization taking the form of satellite or sub-contracting dependence on foreign multinationals. Moreover, it leaves the companies involved vulnerable to shrinking margins due to increasing competition for OEM opportunities Figure 1 brings together schematically the factors we have postulated as pertinent to an understanding of the internationalization of Chinese firms. They inherit a strong institutional legacy in which dependence on government agencies, state ownership and administrative fiat rather than legal regulation were normal. However, the cases we have described suggest that the impact of this legacy upon firms is variable and subject to negotiation. A relationship whereby governmental institutions continue to support Chinese firms without intervening directly in their strategies is conducive to successful internationalization. It appears that nonstate ownership, or at least the presence of private business investors, facilitates the attainment of this degree of independence. At the same time, the dynamic capabilities of firms, notably the abilities of their entrepreneurial leaders, also moderate the negative aspects of the institutional legacy through the relational framework they have with government agencies. The dynamic capabilities developed by these firms not only interact with their institutional legacy, but also play a direct role in furthering their internationalization. These capabilities can include some comparative advantages, such as low-cost OEM facilities. Important among them is the entrepreneurial competence to formulate an internationalization strategy and to recognize the assets that have to be obtained to realize that strategy. The cases presented suggest that the internationalization strategy of Chinese firms is a product of these processes involving institutional legacy and dynamic capabilities. Neither factor can be ignored. Strategies can range between those that are primarily exhibit pathdependency to those that create new paths. The former involve the exploitation of existing assets, whereas the latter entail the seeking of significant new assets in search of differentiation and brand advantages. This balance of asset exploitation and asset exploration is reflected in the three paths to internationalization that the case studies have illustrated. The analysis presented in this paper and summarized in Figure 1 is offered as an aid to the eventual systematic investigation of Chinese internationalization. Some conclusions drawn from the Chinese case could well apply to other highly institutionalized developing economies from which firms are beginning to internationalize. The internationalization of Chinese firms is therefore of future interest not only for the ways in which it extends current theorizing but also for the policy lessons it may offer. References Benito, G. and Gripsrud, G. 1992. The expansion of foreign direct investment: discrete rational location choices or a cultural learning process? Journal of International Business Studies, 23: 461-476. Boisot, M. 2004. Notes on the internationalization of Chinese firms. Unpublished paper. Boisot, M. and Child, J. 1996. From fiefs to clans and network capitalism: Explaining China’s emerging economic order. Administrative Science Quarterly, 41: 600-628. 13

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McDougall, P.P. and Oviatt, B.M. 2000. International entrepreneurship: The intersection of two research paths. Academy of Management Journal, 43: 902-906. McGregor, R. and Guerrera, F. 2004. Chinese companies acquire a taste for western targets. Financial Times, October 19: 20. Meyer, J.W. and Scott, W.R. (eds.) (1983). Organizational Environments: Ritual and Rationality. Beverly Hills, CA: Sage. Meyer, M.W. and Lu, X. 2004. Managing indefinite boundaries: The strategy and structure of a Chinese business firm. Management and Organization Review, 1: 57-86. Ministry of Commerce 2004. China Outbound Investments Statistics Report for 2003. Beijing: Ministry of Commerce and State Statistical Bureau. Nolan, P. 2001. China and the Global Economy. Basingstoke: Palgrave. Peng, M. W. 2000. Business Strategies in Transition Economies. Thousand Oaks, CA: Sage. Peerenboom, R. 2001. Globalization, path dependency and the limits of law: Administrative law reform and the rule of law in the People’s Republic of China. Berkeley Journal of International Law, 19: 161-264. Rialp, A., Rialp, J. and Knight, G.A. 2004. The phenomenon of early internationalizing firms: What do we know after a decade (1993-2003) of scientific inquiry? International Business Review, XX: 1-20. Safarian, A.E. 2003. Internalization and the MNE: A note on the spread of ideas. Journal of International Business Studies, 34: 116-124. Scott, W.R. 1995. Institutions and Organizations. Thousand Oaks, CA.: Sage. The Economist 2004a. China’s business links with Africa: A new scramble. November 27: 84, 87. The Economist 2004b. Chinese business: Champ or chump? December 11th: 68-69. Toyne, B. and Nigh, D. 1998. A more expansive view of international business. Journal of International Business Studies, 29: 863-876. Tseng, C-S. 1994. The process of internationalization of PRC multinationals. In Schűtte, H. (ed.). The Global Competitiveness of the Asian Firm. Basingstoke: Macmillan. Warner, M., Ng S-H and Xu, X. 2004. ‘Late development’ experience and the evolution of transnational firms in the People’s Republic of China. Asia Pacific Business Review, 10: 324-345. Wesson, T. 1999. A model of asset-seeking foreign direct investment driven by demand conditions. Canadian Journal of Administrative Sciences, 16: 1-10. Yang, D. 2003. Foreign Direct Investment from Developing Countries: A Case Study of China’s Outward Investment. Unpublished PhD thesis, Victoria University, Melbourne. Zeng, M. and Williamson, P.J. 2003. The hidden dragons. Harvard Business Review, October: 92-99. Zhang, H.Y and Van Den Bulcke, D. 1996. International management strategies of Chinese multinational firms. In Child, J. and Lu, Y (eds.). Management Issues in China: International Enterprises. London: Routledge: 141-164. Zhang, W. 2003. Brand value and strategy. Working paper, Guanghua School of Management, Peking University, China.

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Cost advantages

Dynamic Capabilities Entrepreneurial competencies, including an internationalization strategy, ability to negotiate favorable institutional arrangements and to utilize social networking

Ownership status

Material, regulative or psychological dependence on, and sponsorship by, the state

Institutional Legacy

Path-creating (assetseeking to open up new strategic possibilities, primarily through acquisition or organic expansion)

Path-dependent (exploitation of existing assets, primarily through exporting or OEM/JV)

Internationalization Strategy

Figure 1. A schematic representation of the internationalization of Chinese firms

Organic expansion

Acquisition

OEM/JV

Internationalization Route

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