A strategy of local market orientation is frequently adopted by foreign SMEs aiming to capture potential market opportunities in emerging economies, but this strategy does not necessarily generate similar levels of profit for SMEs.
Our study offers insight into the contention that foreign SME performance
depends on the strength of local legal and financial institutions, as well as agglomeration economies. First, if contractual arrangements governing exchanges between foreign SMEs and local resource exchange parties can be legally enforced by legal institutions, then foreign SMEs adopting a local market orientation will be able to secure their property rights, reduce transaction costs, and enhance their performance. Second, foreign SMEs often need external financial support to continue innovating and to meet consumers’ needs. If SMEs can locate within a region characterized by well-established financial institutions, then this can help them gain financial assets, expand markets, and enhance growth.
Third, given the fact that knowledge tends to be localized, foreign SMEs characterized by a local market orientation likely benefit from knowledge spillovers within an industry-specific foreign-firm agglomeration by absorbing advanced technological knowledge and applications. Fourth, by locating within diversified agglomeration economic institutions, foreign SMEs can exploit various knowledge spillovers across industries, enabling them to boost their financial performance through the cross-fertilization of ideas and the transmission of innovation from one industry to another. Due to liabilities of foreignness and smallness, we suggest that both specialized and diversified agglomeration economies enable foreign SMEs to combine intra-industry and inter-industry knowledge with their own technical resources. Specialized agglomeration economies can provide more depth-learning and cost-efficient benefits, while they may limit breadth learning - that is, the agglomeration of firms within the same industrial district is likely to generate intra-industry inertia or routines that may prohibit foreign SMEs from pursuing unexploited opportunities. Thus, foreign SMEs also need diversified agglomeration economies to break down path-dependent lock-in situations and then to create new business opportunities and to reinforce performance. Similarly, McCann and Folta (2011), examining a sample of biotechnology firms, and Knoben (2009), surveying a sample group of Dutch automation services, find that both specialized and diversified agglomeration economies can improve the innovative performance of firms. In sum, the local market orientation/performance relationship is much more complex than has been commonly presumed, since institutional environments likely moderate the strength and direction of this
relationship.
This study is motivated by our awareness of a theoretical gap in the literature. First, traditional strategy research typically holds that the value of a certain strategy is driven by firm-specific resources and capabilities (Barney, 1991). This study, however, highlights the support of a particular institutional framework encountered by foreign SMEs (North, 1990). Specifically, foreign firms’ strategic behaviors do not proceed in isolation, but are supported (or not) by external environments. Second, although most research has involved large, well-established firms, SMEs are a key source of employment and economic growth, especially in emerging economies. Furthermore, although recent researchers have acknowledged the role of supportive environments in the growth of firms, and especially for SMEs, they have devoted relatively less attention to different institutions. This study extends recent efforts to disentangle such institutions as legal and financial institutions, as well as agglomeration economies. Third, given the condition of bounded rationality and the potential for opportunistic behavior, the ability of foreign SMEs to adapt to potentially unforeseen changes is limited. Effective legal enforcement, as well as financial institutions capable of extending credit, would likely prove conducive to the growth of SMEs. Fourth, due to the inconsistent results of agglomeration economies, we divide agglomeration into two broad categories:
specialized and diversified agglomeration economies. Building on previous works, we further examine their distinct impact on the relationship between local market orientation and the performance of foreign firms.
Our study provides some empirically-based suggestions for managers. We argue that, because foreign SMEs from emerging economies often possess fewer globally transferable firm-specific resources, they more than likely suffer from a significant disadvantage in their international expansion efforts. In such cases, emerging economy foreign SMEs should be aware of the differences of their host institutional environments and choose a location most likely to help them overcome their deficiencies. Given the fact that foreign SMEs have limited abilities to anticipate all environmental conditions or to specify all requirements in written contracts, locating in regions that have well-developed legal institutions will at least enable them to settle transactional conflicts, navigate market volatility, and finally to enhance the performance of their local operations.
Additionally, local market-oriented foreign SMEs need to cultivate market sensors and to place a high priority on collecting market intelligence and integrating it with strategic decision-making processes. Accordingly, foreign SME managers likely purchase sophisticated industrial machinery and consumer goods relevant to their local customers. Regions characterized by the availability of financial credit typically allow foreign SMEs to acquire the financial resources necessary to take advantage of local market opportunities.
Finally, market intelligence comes from outside–in processes that link with spanning processes. Given the fact that foreign SMEs are often superior in combining and integrating outside technologies with their own resource base, specialized and diversified knowledge spillovers help increase their capacity to implement modifications and commercialize them quickly. Diversified agglomeration economies matter more to SMEs’ product innovation capabilities, because they have a positive effect on the scope of SMEs’ external search and increase their odds of finding commercially valuable new knowledge combinations.
The implications of this study should, however, be evaluated in light of the following limitations. First, due to the heterogeneity of emerging market economies, some of our measures may fail to accurately estimate the strength of the institutions in question, when the measures are adopted in other emerging economies. Future research should seek to identify survey instruments that could identify separate constructs for institutional factors. Second, while our observed institutional effects may hold for foreign SMEs from one emerging economy entering another emerging economy, they may not hold true for foreign SMEs from developed countries. Further research might usefully consider this heterogeneity by incorporating samples of firms from both emerging economies and developed economies. Third, we selected foreign manufacturing SMEs to align our analysis with previous works on foreign performance, but research on internationalization is increasingly recognizing that there are important differences between the manufacturing and service sectors in terms of their influence on crucial strategies. Future research might usefully consider differences in the behavior of firms from the manufacturing and service sectors.
Fourth, we have compared the differences of foreign SMEs’ performance between ex-ante and ex-post periods of China’s liberalization act related to
allowing citizens to lawfully own private property in 2004. However, given the availability of data, our study only uses results in 2003 to compare with results derived from 2004-2006. Therefore, generalizability of our results related to the ex-ante and ex-post periods of the liberalization act may be limited.
Similarly, Cai, Boateng, and Guney (2019) also note that their data for European Union firms investing in China are limited to 2008 due to the absence of more recent EU firm data compiled by the National Bureau of Statistics of China.
Future researchers thus might wish to extend the sample period and provide a further contribution in the field. Fifth, this study not only has made use of return on assets to proxy for performance, but also has taken up return on equity to examine the robustness test. Based on the similar results provided by these two proxy variables, the generalization of our research seems to be, to some extent, justifiable. However, in the future researchers might want to utilize a market-based measure (e.g., Tobin’s Q) to investigate this issue.
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