Outward FDI in Manufacturing from Portugal:
Internationalisation strategies from a new foreign investor (a)

 

Peter J. Buckley
Leeds University Business School

Francisco B. Castro
Leeds University Business School and
Faculdade de Economia do Porto (University of Porto)

 

 

Address:
Centre for International Business (CIBUL)
Leeds University Business School
ESS Building
University of Leeds
LEEDS LS2 9JT
United Kingdom

Tel: +113 233 4646
Fax: +113 233 4465

email: ecofbc@leeds.ac.uk

 

 

 

 

(a) We would like to thank Leonor Sopas (Catholic University at Porto) for her advice on data collection and for the invaluable suggestions made during our informal discussions. This research was partially financed by Programa Praxis XXI.

 

 

Outward FDI in Manufacturing from Portugal:
Internationalisation strategies from a new foreign investor

 

ABSTRACT

Portuguese firms are relatively recent entrants into foreign direct investment (FDI) activities. This interview-based study presents evidence on a high proportion of the population of Portuguese outward investors in manufacturing industries (18 case studies). The new empirical evidence presented shows the major role played by linguistic and cultural (former imperial) contacts in the choice of location, particularly of early foreign investments made by the firms. It demonstrates the timing of the investments, the constraints on successful investment and the mode of entry utilised. The industry of activity, key motives and control policies are also investigated. It is surprising to find that Portuguese FDI does not match the industrial structure of the home economy, in that capital-intensive FDI dominates and a specialised variety of asset-seeking motive is predominant. The interaction of inward and outward FDI is also suggestive of a key underlying dynamic in Portuguese internationalisation.

 

1. Introduction

Economic growth and political liberalisation are redefining the characteristics of international production. The geographical distribution of FDI has dramatically changed over the past three decades, and new production and marketing strategies are being adopted by MNCs (Dunning, 1993, p.131). This evolution is largely powered by rising living standards, which contribute to enlarge domestic markets, and by economic integration and the widespread of capitalism, the sources of new investment opportunities. This includes the privatisation programs that became particularly popular in recent years. Governments across the globe now actively seek to attract foreign direct investment (FDI), while the emergence of a growing number of newly industrialised countries (NICs) is diversifying the sources of that investment.

Their own development often fuelled by past inward investment, firms from NICs can be expected to be in many respects distinct from those from more developed nations. First, they are smaller than the long established MNCs they will compete with. Second, they are likely to lack strong ownership advantages, which will be much dependent on the characteristics of the home locations (Dunning, 1981a, 1981b, 1986). Third, as pioneers in their home countries in terms of internationalisation, they face explicit and implicit costs ignored by firms from more developed countries. As Dunning (1993, p.64), we do not argue that the different characteristics, motivations and problems that we suspect are typical of MNCs from newly industrialised countries require a new paradigm or even new theories. But they will certainly challenge existing theories in their emphasis and scope.

This research intends to contribute to this discussion providing evidence from a very recent international investor. The analysis is based on 18 cases of recent internationalisation by Portuguese manufacturing firms, supported by interviews with top managers at each company, and by secondary data. The option was to concentrate on the establishment of production subsidiaries. This represents a deeper form of internationalisation, which was expected to focus the research on the more mature of Portugal’s nascent MNCs.

The article starts with a brief description of recent economic trends in Portugal, including inward and outward FDI flows. It follows with the characterisation of population and sample, just before the analysis and discussion of the internationalisation of Portuguese firms. A summary and conclusions can be found in the last two sections.

2. The Portuguese economy

A small open economy of recent industrialisation, Portugal is better known as a host for foreign direct investment than a source country. The opening of the economy in the 1960s marked the beginning of significant inflows of FDI. However, it was after 1983, following the membership agreement with the EEC (which Portugal joined 3 years later) that FDI picked up. From an average of 0.5 per cent of GDP over the previous two decades, FDI inflows reached, on average, over 2 per cent of GDP between 1984 and 1994. It stabilised again around 0.5 per cent of GDP since then (see Buckley and Castro, 1998a, 1998b, for a more detailed analysis).

As for the internationalisation of the Portuguese firms, it is a much more recent phenomenon (Buckley and Castro, 1998a). A nascent stream of outward investment to the African colonies had taken place in the first half of the 1970s. But this short lived international expansion was destroyed with the independence of the colonies in 1975. Almost all subsidiaries created in the Portuguese-speaking Africa between 1971 and 1974 were either nationalised by the governments of the newly independent countries or had their buildings and equipment destroyed in the civil wars that followed independence.

As a result, it was not until the early 1990s that internationalisation became a common word among Portuguese owned companies. But the change has been remarkable. In 1995 outward FDI surpassed inward flows for the first time, and the gap has been widening ever since (Buckley and Castro, 1998a). In the case of manufacturing firms, the subject of this article, internationalisation was even slower to pick up. Few of the companies analysed started the internationalisation of their production capacity before 1995, and none before 1990. Little data was published so far on industry distribution of outward FDI. But one unavoidable fact is that manufacturing FDI represents a fairly small percentage of the total. From assorted news, it can be estimated that, in the first half of the decade, financial services represented the major stake, having been replaced in more recent years by telecommunications, electricity distribution, and retailing. That is, contrarily to other countries (Dunning, 1993), in Portugal the service sector internationalised before the manufacturing industry.

3. Population. method and sample

Population

The first problem that afflicts any researcher involved in studies of internationalisation is the definition of the concept itself. Welch and Luostarinen (1988, p.84) propose a broad definition of internationalisation as "the process of increasing involvement in international operations". Established in a very open economy that is part of the biggest trading block in the world, the internationalisation of an increasing number of Portuguese firms is no surprise (Simões, 1997, p.138). However, most do no more than exporting through agents, often with little or no knowledge at all of the market conditions for their products. Sales or production subsidiaries are rare.

The aim of this project - to study the motivations and strategies of nascent MNCs - suggested, however, a restrictive criterion. The choice was to concentrate the analysis on companies that possess a productive foreign subsidiary, or manifested a clear intention to create one in the near future. It was hoped that this solution would concentrate the research on those firms with a more mature internationalisation process, believed to be more relevant for the objectives of the study. Services firms, for their idiosyncrasy (Buckley et al., 1992; Coviello and Munro, 1997), were not considered.

The population was identified from a mix of official (such as ICEP, FIEP and IAPMEI) and non-official sources (industry associations and business newspapers and magazines). Only 27 manufacturing companies could be identified as having production outside Portugal, or clear projects to do so in the near future. It must be said that no processes of pure commercial expansion were identified. It must be admitted, however, that the information gathering strategy, concentrated on production capacity, may have failed to identify examples of international commercial networks when not associated with foreign production.

Method and Sample

The method adopted was to conduct a survey based on short case studies, supported by semi-structured interviews and assorted secondary data. On the face of the elements being analysed, the interviews had to be conducted at the highest level of the organisations, preferably the board of directors. After telephone contacts at all 27 firms identified as the population, it was possible to include 18 in the study. A brief characterisation of the sample is provided in table 1.

 

Due to unavoidable time restrictions, only one interview was conducted at each firm. Interviews were carried out in September 1998 with only one exception, which took place in January 1999. They were recorded on tape when allowed by the interviewee. All interviews were conducted by the same researcher, which guaranteed homogeneity of treatment between different companies, both during the interviews and in terms of reporting.

Typically, the interviewees were invited to make a brief description of the company’s history and to provide basic figures on the firm. This allowed to cross information with previously collected data, testing the reliability of the different sources. Next, the internationalisation process was discussed in more detail. The topics proposed were the reasons for the choices made and the alternatives considered, what operations exist in each host country, and how every step affected the whole organisation in Portugal. The interviewees were then required to assess the company’s competitive advantages and to describe other international links the company or the top managers may have or had in the past.

4. The internationalisation of Portuguese manufacturing firms

The 18 companies analysed presented apparently very distinct internationalisation processes. They cover a wide range of industries and present different motivations and choices of mode of entry. The regularities are stronger when it comes for timing of the internationalisation process and location of foreign production subsidiaries.

Industries

Empirical evidence collected by Dunning (1993, pp. 28-40) suggests that, worldwide, the industries that are favoured by MNEs are: (i) capital-intensive processing industries, often producing natural-resources intensive products, but also differentiated consumer goods with high income elasticity; (ii) technology and human capital intensive industries; (ii) industries that can benefit from large economies of scale. The relative importance of these industries will, naturally, vary across countries due to their idiosyncrasies. Different natural and created endowments, different stages of development and different industrial traditions will result in distinct structures of outward FDI.

Portugal is a recent exporter of capital (Buckley and Castro, 1998a) largely specialised in labour-intensive industries with little product differentiation, such as textiles, clothing and footwear (Castro, 1993). Henceforth, the industrial structure of outward FDI could be expected to be quite different from that of the more developed economies, home to most MNEs. However, the data collected shows that traditional, labour intensive, sectors are almost absent from the process. Among the firms studied, only one operated in these sectors, and its management admitted that productive direct investment remained no more than a project.

From the population identified for this research project, the industry distribution of the Portuguese manufacturing outward investment seems not to differ much from that of small developed countries (see Figure 1). In contrast with the country’s industrial and exports’ structures, capital-intensive industries with significant economies of scale are dominant among the most internationalised firms. Highly skilled labour is the rule, and a majority of the industries represented can be considered to be technology-intensive.

In fact, the internationalisation of the Portuguese firms does not seem to depend on industry, factors intensity, or technological level. Rather, the aggregator factor seems to be the stage of maturity of the domestic markets. Over half the companies in the sample operate in fully mature domestic markets. In a small country, mature stagnant markets, make internationalisation a question of survival, as will be seen later.

The number of industries represented in the population is surprisingly high. However, most are represented by only one firm. In a small domestic market, the most successful company in each industry is likely to grab a very high share. This will be especially true if economies of scale are strong, but not exclusively, since rather limited management and capital resources can easily become concentrated in a few companies. The result is that often only the industry leader is able to develop the competitiveness (ownership-advantages) necessary to venture abroad, as it seems to have been the case in Portugal.

An apparent exception are the auto-components producers, which represent 1/3 of the sample. However, this is not exactly one industry, but an amalgamation of industries. Electric batteries, metal parts, plastics components, power cables and textiles are the segments represented in this sample. Auto-components producers, nevertheless, have several common characteristics. In particular, they share the final clients - the car assemblers - so they all are constrained by similar industry and market characteristics. In this global industry, Portuguese companies tend to play a very secondary role, even in the domestic market. It seems that this combination of factors contributed to the internationalisation of rather small firms.

Location

The study of the location of foreign investment at the firm level has been strongly influenced by the works of the "Uppsala School" (e.g. Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977). These authors suggest a path of foreign expansion marked by the firm’s own past experience, the size of potential markets, and, most importantly, the firm’s psychic distance to each potential host country. Psychic distance depends on factors such as differences in language, culture, political systems, level of education, or level of industrial development. But in the case of production establishments Johanson and Wiedersheim-Paul (1975, p.29) argue that "it is hard to observe any correlation with psychic distance". Cultural proximity is normally associated with geographic proximity. Low transport costs encourage trade but discourage investment in production capacity.

The case studies presented here, however, suggest otherwise (see table 2). Psychic distance seems to be a very strong determinant of the location of the first foreign productive venture. In the sample, Brazil and Spain were the most popular destinations (respectively 47% and 20% in terms of first choices). A revealing element is that when asked why was Brazil the destination of the first foreign investment, a frequent answer was that Angola or Mozambique were first considered, but political instability, small domestic markets, despite their potential for growth, and a very unskilled workforce discouraged investment. This reference to the PALOP was also common among the other firms in the sample. For those that invested in Brazil, the explanation tended to be complemented with references to language and cultural proximity.

Companies that expanded to Spain cited geographic and cultural proximity as the most important determinants. In this case, the language is not the same, but it is close enough to be understood by most Portuguese speakers. There are also strong similarities (clearly stronger than with Brazil) in terms of political system, level of education, and level of industrial development. But geography seems to be unquestionably relevant. "The whole Iberian Peninsula is our natural market" was the expression used by at least 5 of the managers interviewed and sometimes printed in the Annual Reports.

Nevertheless, it seems that, as suggested by Johanson and Wiedersheim-Paul (1975, p.29), geographic proximity is reducing the number of Portuguese firms creating production establishments in Spain. Although with different levels of engagement, all 18 firms in the sample exported to Spain. For most, Spain has been the first foreign market. Hence, the figure of 22% mentioned above seems to be an underestimation of the importance of the Spanish market for the Portuguese firms. The sample suggests that only when economies of scale are strong and economic resistance to transport high it makes economic sense to supply the Spanish market from Spanish plants.

There is, however a strategic element to be considered. It was pointed out during some of the interviews that the acquisition of an existing firm in Spain is not simply to acquire production capacity or to reduce transport costs. More important is often that it also permits to acquire market share and to eliminate a competitor, or to prevent competitors from expanding. In the presence of increasingly integrated economies and growing international awareness by the Portuguese firms, these strategic moves can be expected to be ever more frequent.

One fact that must be discussed is why other European countries have such a small presence in the sample. The explanation may be a combination of locational advantages and rather thin ownership advantages. In the European Union, which accounts to some 80 per cent of the country’s international trade, Portugal remains the lowest cost location. In labour-intensive industries, exports and sub-contracting have been growing in recent years, translating stronger comparative advantages. One of the ceramics producers interviewed referred explicitly that expansion in Europe (including Eastern Europe) had been considered but abandoned on the face of relative costs: "European retailers are sub-contracting their production in Portugal more then ever before, including to us. We must infer that it does not make economic sense for us to produce anywhere else".

On the other hand, the economic, social and political changes that were referred in section 2 (see also Buckley and Castro, 1998a) are too recent to permit the full development of local firms. Ownership advantages are still very much dependent on locational factors. This obstructs Portuguese firms from engaging in expansionary strategies in the more mature European economies. Evidence comes again from the reactions when asked about alternative locations. Europe was immediately ruled out by a substantial number of managers with the argument that it is impossible to compete in markets dominated by long established firms from the more developed European countries.

Another interesting observation from the sample is that, despite the relevance given to cultural proximity, all companies that expanded either to Spain or to Brazil confessed problems in understanding local markets and local business culture. "Spain is a completely different market", "you do not sell in Spain the same way you sell in Portugal", were frequent comments. The interviewees seemed to agree that consumer behaviour and business practices are in Spain quite distinct. Markets also tend to be less concentrated than in Portugal, with obvious implications in terms of strategic behaviour. Similar observations were made for Brazil ("in Brazil, everything is different"), along with references to the problems generated by red tape and economic structures still trying to adapt to the end of hyper-inflation.

This suggests two comments. First, psychic distance may influence the location choice, but it is no guarantee of problem-free investments. In fact, proximity (geographic and/or cultural) may induce companies into overlooking the differences between host and home countries. The risks involved are well document by O’Grady and Lane (1996) for Canadian investment in the US. They concluded that "although cultural differences were perceived by the executives to be important, (...) it was the recognition of those differences, prior to entry, that differentiated performance" (p. 401). In our sample, it is the failure to recognise those differences that explains the collapse of Cin and Renova’s first attempts in the Spanish markets, as the respective managers admitted themselves. Unfortunately, expansion to Brazil is too recent to be assessed in these terms.

A second comment concerns people’s assessment of cultural differences. As referred above, it is surprising how frequently cultural proximity with the host country was invoked, but at the same time there were complains over the difficulties posed by different market structures, different consumer behaviour, different business practices, awkward attitudes by business partners or civil servants. This can only be explained because, regardless of its complexity, perceived cultural proximity is very much influenced by one single factor - language.

A strong correlation between language and culture proximity is unquestionable, not least because language similarity is almost always associated with historic ties. Moreover, being able to understand and speak the language makes it easier to grasp alien cultures and reduces the risk of misunderstandings. However, when the same language is spoken, or when languages are close enough to be mutually understandable, a sense of familiarity is generated and cultural proximity tends to be overstated. The risk is an erroneous sense of "being at home", reduced vigilance, and an increasing chance of cultural clash.

A final note is due to Efacec, which is probably the most interesting case among the few companies in the sample not starting their internationalisation in Brazil or Spain. This producer of equipment for power generation and distribution started its international expansion in the Far-East. Efacec’s management explained the choice as based on market conditions. This was the fastest growing area in the world at a time (1989) that Latin America and Africa offered very risky environments. The European market, completely dominated by MNCs several hundred times bigger than Efacec, was not considered. However, Efacec had in the Far-East privileged contacts - the agents of its former (foreign) owners. And Macao (which is due to be returned to China in December 1999, after almost 5 centuries under Portuguese administration) was the place chosen to establish the regional headquarters and the first production subsidiary.

Timing

It is only logical to expect that older firms start internationalisation earlier. That seems to be the case with the four cases studied by Johanson and Wiedersheim-Paul (1975), even if the more recent firms were faster to internationalise their activities - younger firms can learn from the experience of older ones. These factors, nevertheless, should guarantee a distribution more or less homogeneous of international investment overtime. However, firms’ internationalisation is also influenced by the international political and economic conditions. There will be few new subsidiaries in periods of high protectionism (e.g. the 1930s) or economic crisis (the 1970s). The opposite will happen in periods of economic expansion and liberalisation (e.g. the 1960s). This contrast is quite clear in Johanson and Wiedersheim-Paul’s (1975) sample (see figures 1-4).

The home country’s level of economic development is another variable to be considered. The international expansion of companies from developed countries can be expected to be essentially dependent on the firm’s characteristics and strategy. However, firms from less developed countries are more dependent on national factors. To start with, their ownership advantages tend to be connected to the characteristics of the home country (Dunning, 1981a, 1981b, 1986). Second, less developed countries normally do not have a tradition of outward investment, which increases the risks and potential costs of venturing abroad for the forerunners.

Our sample makes the relevance of this last element very clear (see table 2). Bearing in mind the analysis is concentrated on production establishments, a striking feature is that all firms in the sample started expanding abroad in the present decade, with particular incidence in the second half. This coincidence in time made many in the country to argue that the whole process is simply a "fashion". This includes two of the managers interviewed, whose firms were among the first to venture abroad. Although the "band wagon" effect is a recognised internationalisation force (Aharoni, 1966, p.9), it is a limited explanation. The Investment Development Path (Dunning, 1981a, 1981b, 1986) provides a more relevant justification.

The IDP suggests that, after several years as recipients of FDI, countries are likely to see home firms developing the necessary ownership advantages to internationalise. This will eventually make the country a net foreign investors, first in terms of flows and later also in terms of stocks. Buckley and Castro (1998a) showed that Portugal reached in the middle 1990s that transitional stage. That is, the wave of outward FDI is the result of economic development and the consequent maturity of markets, industries and firms. What must be stressed is that the influence of these changes is in the case of Portugal amplified by the small size of domestic markets. In these conditions, market maturity and industry consolidation tend to happen rather quickly. If they are to retain the growth rates of previous years, firms from small countries are forced to internationalise sooner than those with big domestic markets. This is true for a substantial number of industries, as can be attested in our sample.

The opinion of the managers interviewed supports this analysis. International investment was frequently explained as "natural in the face of market conditions" or "the obvious step following the position reached in the domestic market". In the same line is the argument that international expansion was a way of making use of "managerial overcapacity". The stability of operations in Portugal reduced the need for this intangible asset, leaving firms to find new uses for the capacity created during the years of domestic growth.

Another element that was revealed particularly important in our research is the role of economic and political conditions in potential host countries. We saw above that Portuguese managers seem to have a strong preference for Portuguese-speaking countries. Together with the apparently thin ownership advantages of the firms studied, this largely restricts the investment opportunities. And even more so on the face of the economic and political instability that traditionally afflicts Brazil and most of the PALOP. It should be reminded that the 1970s flow of investment to Angola and Mozambique was not transferred to other potential locations when interrupted by these countries’ independence.

On the face of this, the coincidence between the recent growth of outward FDI and the economic stabilisation of Brazil after 1996 assumes particular relevance. Almost all firms in the sample that chose a destination other than Brazil started their expansion before that year. All firms that expanded to Brazil did so after 1996. This dependency highlights the weakness of the Portuguese industrial structure and that of the firms in the sample as well. The automotive components producers are a case in point. They tend to explain their expansion with their clients’ decision to invest in Brazil (see next). Nevertheless, the car manufacturers have long been expanding to other markets. It seems that few Portuguese suppliers were able (possessed the ownership-advantages?) to follow their clients to other, more distant, locations. The few that managed to do so (Tavol, Simoldes) expanded first to Brazil.

Motivation

There was a generalised believe in the sample that internationalisation was critical for long term survival. All firms interviewed seemed to worry with the limited potential in the domestic market and the need to gain weight to face suppliers, clients, and competitors. Nevertheless, there are among these firms different patterns of motivations, and it is possible to distinguish 4 groups, not all equally homogeneous (see table 3).



One such group is formed by those firms that started internationalisation in response to the saturation of domestic markets. This group of ‘market leaders in mature markets’ includes Autosil, Cimpor, Cin, Colep, Efacec, and Vista Alegre. With the exception of the latter, these are the companies that seemed to have a surplus of management capacity after years of expansion and consolidation in the domestic market. However, despite their position in the domestic markets, these companies are fairly small in international terms. An important motivation to internationalisation was quite clearly the need to grow in order to improve their relative position vis-à-vis competitors, clients, and suppliers. That is, their foreign investments are as much strategic asset-seeking as they are market seeking.

For Efacec internationalisation is just another vector of the company’s growth strategy. For many years, Efacec was restricted to the domestic market, and its management anticipated the maturity of the domestic market for the company’s traditional products by diversifying to related but less mature businesses. When the restrictions to internationalisation disappeared, product diversification was complemented with market diversification. It is interesting to note that the first division to be expanded abroad was power equipment, the most competitive of the mature businesses, but product diversification is now taking place in foreign markets as well.

Contrarily to Efacec, Cimpor, Cin, Vista Alegre stuck with their core businesses (respectively cement, paint and ceramics), but expanded internationally through acquisitions. Cimpor has now over 50 per cent of its production capacity outside Portugal, essentially in developing countries. However, the three tend to apply in the foreign markets the strategic solutions adopted at home, just like Efacec. That is, being located in a foreign country is almost the only element that distinguishes international activities. Cin is the perfect example. Its leadership in the Portuguese market is still recent, and requires consolidation. It has been doing so with a mix of organic growth and acquisitions. After acquiring the third biggest Spanish producer, Cin transposed to Spain the strategy developed in Portugal.

A different case is Autosil. This producer of electric batteries was in the early 1990s the leader in the Portuguese market for replacement equipment for automobiles, with only a small presence in the segment of new equipment and in industrial batteries. The strategy initially drawn was to expand the main business through exports, to be supported with a small plant in France. However, the chance of buying a company in France, 3.5 times bigger than Autosil, radically changed its future. ¾ of the group’s turnover is now produced in France, while new equipment represents an important percentage of the sales. The initially planned greenfield investment in France has been adapted to produce industrial batteries.

Chance also played a decisive role in Colep’s internationalisation strategy. As Autosil in its main investment in France, Colep (a producer of metal containers) had a largely passive role in its expansion to Spain. The suggestion came from one of its clients, who had decided to sell the Spanish subsidiary. Colep has now a more pro-active attitude, which resulted in a recent investment in Poland. But its clients still maintain a relevant role, with the guarantee of contracts since the very early stages of the project.

A second group of companies that can be identified in the sample comprises the car parts manufacturers. As referred above, this is a highly heterogeneous lot, uniformed by the share of the downstream activities of their value chains. Their strategies are intrinsically dependent on the global trends of the automobile industry, which they do not control, and they are subjected to a fiercely competitive environment. These are the firms for which international expansion is more critical in terms of medium/long term survival. The car industry is going through a process of global concentration (Simison, 1999), and the firms’ ownership advantages, including dimension, will be crucial.

It must be noted that before considering production abroad, most of these companies already exported to other European countries a very high percentage of their production (essentially France, Spain and Germany). By large, the interviewees attributed their competitive advantage to technical ability. But data collected by ICEP (cited in Coutinho, 1998) suggests that low labour costs must be taken into account. The role of country specific competitive advantages seems to be supported by the growth of exports also registered by foreign firms established in Portugal. Furthermore, despite the generalised market success, only Simoldes created a productive subsidiary in Europe. Symptomatic is that Simoldes’s investment in France does not seem to be financially motivated. Simoldes’ management explained that the aim was simply to make the company more visible to its clients, and to demonstrate its technological and financial capacity. As with many other firms in the sample, Simoldes still has to fight Portugal’s image as a low-tech country exclusively dependent on cheap labour.

The trouble with the Portuguese car parts manufacturers is that they are very small in the face of the big multinationals that dominate the industry. It was generalised belief among this group of firms that they were unable to defy the German or French competitors "in their backyard". This seems to include other EU countries, but also non-EU Central and Eastern Europe. In this context, the opening of Brazil to FDI was momentous. When the car manufacturers started to invest in Brazil, the Portuguese suppliers seemed to be well positioned to follow them. Psychic distance - as assessed by the Portuguese companies but also by their clients - and the role of language similarity (see above) seem to have played a very important role.

Most of these internationalisation processes are still too recent for an evaluation. It is also too soon to know if the experience in Brazil will facilitate expansion to other countries, but there are already positive signs. Simoldes has a joint venture in Argentina, while Tavol is expanding to Argentina and Mexico. Nor surprisingly, Simoldes and Tavol are the only companies in the group that sell directly to the car assemblkers. All the others are subcontracted by the direct suppliers, normally big MNCs themselves.

Defensive investment seems to be the best description of the internationalisation of Dan Cake, Renova and Riopele (cookies and pastries, tissue paper, and textiles, respectively). The move was largely a response to the erosion of their traditional markets, under attack by cheaper imports (the main competitors are Spanish for the first two, from the Far-East in the case of the latter). As could be expected, this group includes some of the companies in the sample with less success in their internationalisation. The problems faced in the domestic markets absorbed important, and scarce, managerial and financial resources. Renova is the exception. It met with serious problems in its first approach to the Spanish market, but it seems to have been able to correct it with the adoption of a new market strategy.

Faiart, Neoplástica and Quintas & Quintas are the last three cases to be discussed. Quintas & Quintas is the only firm in the sample which had a clear objective of reducing labour costs. Portugal is the last producer of ropes in Europe, and the sector’s cost competitiveness is still eroding. Quintas & Quintas management believes that the solution is the progressive delocalisation to Brazil, a source of raw materials with much lower labour costs than Portugal. Brazil’s market, 17 times the population of Portugal, was, nevertheless, a secondary motivation.

Faiart’s motivation is very similar to that of the companies in the first group identified - market expansion in a mature industry. The difference for that group is that Faiart is not market leader. A medium size ceramics producer, it preferred foreign expansion to acquisitions in Portugal, where it would have to face some of its bigger domestic competitors.

Neoplástica’s is also an original case. It is one of the few Portuguese companies that expanded to Europe before considering other locations. Also unusual among Portuguese firms is that its first foreign investment, in the Netherlands, had a very strong emphasis in the marketing function. The creation of productive facilities was essentially for visibility. As Simoldes realised several years later, having a plant "in the heart of Europe" (sic) is the most efficient way of overcoming the barrier that Portugal’s image often represents. Neoplástica’s expansion is a clear example of strategic-asset seeking investment (Dunning, 1993), even if an intangible one - marketing capacity.

Constraints

"The first foreign investment decision is to a large extent a trip to the unknown. It is an innovation and development of a new dimension" (Aharoni, 1966, p.9). For that reason, it is a management intensive activity (Buckley, 1989, p.105), which may be a serious liability, in particular for smaller firms. First, they rarely have specialist managers to face the new conditions. Second, limited management time and personalised decision making processes limit smaller firms’ ability to evaluate all the possible investment alternatives both in terms of location and of mode of entry. This may lead to sub-optimal decisions. Third, smaller firms are normally family owned and ran. Reluctance to loosen up family control is normally a restriction to the expansion of management skills and to the very growth of the firm.

Shortage of capital is another factor that may affect foreign investment by smaller firms. The access to the capital markets is much more difficult than for big firms, while self financing is limited by the very size of the firm. When they do receive financial support, smaller firms are often made to pay a premium, the cost of being less known to the markets and potentially more vulnerable to competitors. Buckley (1989) argues that financial constraints tend to be secondary to managerial constraints.

This is clearly supported in our sample. Capital constrains were considered much less important than skilled management shortages by almost all the managers interviewed, even if there was a close association between the two: when financial restrictions were considered relevant, management constraints were normally assessed as very restrictive. In general, those firms classified above as "defensive" in their motivation to internationalise were more severely affected by financial restrictions. The same can be said of those auto components manufacturers with less stable relationships with their customers. Not surprisingly, there seems to be a strong negative correlation between success in the domestic market and the impact of capital constraints on the internationalisation of the firm. Apart from the "defensive investors", few firms acknowledged any limitation to internationalisation imposed by restrictions on capital. It does not mean, however, that they were irrelevant. The entry strategies of, for example, Vista Alegre, assumedly on a less than optimal scale, and Efacec, based on minority participation (see next), seem to be shaped by the need to restrict financial involvement.

The shortage of skilled management seems to have been far more important in the sample, even if there were exceptions. These are the bigger firms, above identified as "leaders in mature domestic markets" - Autosil, Cimpor, Cin, Colep, Efacec, but also Neoplástica and Simoldes. Although some of them are controlled by one family with active participation in daily management, the management teams can be considered fully professional. In fact, excess management capacity was among the motivations for internationalisation (see above).

For the remaining firms, however, internationalisation created a management problem. In most of them international expansion has stretched the often already overloaded management function. Many grew very fast in the three or four years previous to international expansion abroad, and few fully adjusted their management teams to the new conditions. A recurrent complain in the interviews was that internationalisation had either diverted management’s attention from the domestic market or was not being followed as efficiently as it ought to due the management’s concentration in domestic affairs.

Part of the problem is that many companies are reluctant to hire local managers for top positions in their foreign subsidiaries, which may translate the weaknesses associated with earlier stages of internationalisation. Lacking international experience, new MNCs may find it too expensive and risky to recruit locally, not only financially but also in terms of the time needed to efficiently identify and evaluate potential candidates. On the other hand, there seems to be a shortage of experienced managers in Portugal, even more so when the position involves working as expatriate. Companies like Simoldes chose to provide in house training to recent graduates, apparently more keen to work abroad. But this is necessarily slow, time consuming for the other members of the management team, and expensive.

In the sample, other restrictions to international expansion were identified, but almost always ranked much lower than the two mentioned above. Some are in fact a consequence of managerial and/or capital constraints: difficulties to obtain information on potential destinations or targets for acquisition; deficient support by state controlled institutions; the almost non existence of truly venture capital in Portugal.

Nevertheless, an important difficulty often mentioned was the prevailing image of Portugal as a poor backward country dependent on low labour costs. This was normally dealt with by inviting potential partners, potential customers, and government officials to visit the plants in Portugal and to witness the changes that the country endured in recent years. But it certainly represents a hidden cost that does not affect companies from countries long established as outward investors (and with a longer industrial tradition). It is well demonstrated by the investments Neoplástica and Simoldes were "forced" to make in the Netherlands and in France, respectively. Furthermore, it might be a very substantive cost in what it may represent in terms of missed opportunities for the Portuguese economy.

Mode of entry

The choice of the mode of entry is the concern of a vast body of research. Of particular influence have been the studies at the University of Uppsala (e.g. Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977, Johanson and Mattsson, 1988; Vahlne and Nordstrom, 1988). They suggest that internationalisation is an incremental process. Firms fight restrictions in terms of resources (e.g. capital or management) and knowledge with progressive exposure to international markets. Hence, the first internationalisation move can be expected to be exports through agents, which will successively evolve to the creation of sales subsidiaries and production subsidiaries. Each new step represents a deeper commitment and a better knowledge of foreign markets. It is also suggested that firms with international experience may be able to "burn" stages. The knowledge acquired in one country may facilitate the involvement in other locations.

This internationalisation path is only partially found in our sample (see table 4). All firms contacted seem to have started exporting through agents, although in some cases exports were not very significant due to resistance to transportation of largely standardised products. This was normally followed by the creation of sales subsidiaries in the most important markets, often through the acquisition of the agents or in association with them. However, this picture holds essentially for Europe and Asia. In the case of expansion to Brazil, the internationalisation path is much less linear.

Despite being the most popular destination in the sample, none of the companies analysed had an operation sales subsidiary in Brazil before the creation of the production subsidiary. Most had never exported at all to that country. Three reasons explain this. First, exports were, and still are, discouraged by geographic distance and a punitive tax system. Second, Brazil’s economic instability until 1996 made the country little attractive. Third, psychic proximity - being able to speak the local language, and a strong sense of common heritage as well as cultural proximity - may have permitted to jump stages in the internationalisation process.

It is important to highlight that only one example of licensing (Efacec) was registered in the sample, not very different from what is reported by Simões (1997), who found none. This certainly translates the characteristics of the firms involved and their motivations to internationalise. As discussed above, many internationalisation processes were defensive reactions to import penetration in the domestic markets or to the concentration forces in the industry. In this conditions, internationalisation is not a mean of maximising ownership-advantages, but simply a way of avoiding their degradation. Neither licensing is a solution when ownership-advantages are based on intangible assets, such as management capacity, as seems to be the case with several other firms in the sample.

In fact, even Efacec is not a pure case of licensing. Its licensees are joint-ventures with local partners (usually the main customer), and are seen by Efacec’s management as subsidiaries. Although the company’s stake rarely exceeds 1/3 of the joint ventures’ capital, Efacec’s management argue that control is exerted through the firm’s role as supplier of the technology.

Efacec’s mode of entry seems to support the internalisation model (Buckley and Casson, 1981), even if with minor adjustments. Efacec follows an explicit strategy of progressive involvement in each foreign market that always starts with exports through agents and evolves to the establishment of sales subsidiaries in the most promising markets. In this strategy, licensing seems to be an intermediate solution between the sales subsidiary and the production subsidiary. The choice of minority joint ventures for licensees permits to maintain a certain degree of control with a minimum capital requirement. Efacec’s management argue that a local partner is absolutely necessary in an industry where the major clients are normally government controlled utilities. But the strategy adopted suggests a limited financial capacity, unable to sustain the high fixed costs associated with a majority stake in a production subsidiary.

Another characteristic of our sample is that acquisitions seem to be preferred to greenfield developments (see table 5). However, this seems to be determined more by industry characteristics than by the firms’ choice. First, the sample includes a very high number of firms operating in mature industries, where overcapacity is frequent. Second, the sample is biased by the conditions in Brazil. Several years of hyper-inflation created an industrial structure completely oriented towards the financial function, where production, stock management and sales were almost irrelevant. Most of these companies could not adjust fast enough to the new economic conditions, and in just two years many were facing bankruptcy. Several managers in the sample claim that they were studying the possibility of a greenfield investment when came across the opportunity to buy an existing firm in favourable conditions, even after paying out the huge debts (which most did immediately). In at least one case the initial project was not even to invest in production capacity but to create a sales subsidiary. It was abandoned when an existing company with a reasonably efficient plant turned up on sale.

A different aspect of the mode of entry is the option between joint ventures and wholly owned subsidiaries. The former was only chosen by 4 companies (see table 5), and capital restrictions were always the main reason presented by the interviewees. The Portuguese firms provided the technology, while local partners were expected not only to provide capital but also to supply information on labour markets, bureaucracy and the products markets. That is, a local partner was a short cut to avoid the time and management consuming task of acquiring the necessary information to invest and market in a foreign country.

The small size of the firms involved may explain the limited number of joint ventures registered in the sample. That was the suggestion of Buckley et al. (1988), who found a similar result for a sample of small UK firms. Buckley (1989, p.107) claims that "whilst such operations [joint-ventures and licensing] economise on capital outlay, they tend to be management-intensive and this may choke off the ability of small firms to enter into the more complex forms of such arrangements".

Another theoretical suggestion that can be briefly tested using our sample is the transaction cost analysis of foreign modes of entry proposed by Anderson and Gatignon (1986). This is particularly interesting in that our sample seems to reject several of the propositions presented by these authors. First, we did not find any correlation between the level of control and the maturity of products or their technological intensity (propositions 1-4). High-control modes were in the sample as common among companies producing mature products as they were among manufacturers of less mature ones. Highly proprietary products appeared associated with low- or medium- control modes of entry in several cases.

Second, greater country risk (proposition 5) was in the sample associated with lower rather than higher control. For example, wholly owned subsidiaries were the role in Europe, certainly the lower risk location among those chose in the sample. On the other hand, the suggestion that the degree of control is positively related to the firms’ cumulative international experience (proposition 6) seems to be supported in our sample. The remaining propositions could not be tested.

One last point is the much frequent claim in the sample that internationalisation started well before exports took place. This believe is particularly common among those firms that have or had as clients big MNCs established in Portugal (e.g. the auto-components segment) and is also reported by Simões (1997, p.139). In fact, sales to the subsidiaries of leading MNCs can very much be compared with exports, given that these supply contracts are normally fought in purely international markets. Even the advantage of being a local firm is frequently just theoretical, since the competitors are often long established subsidiaries of MNCs.

The suspicion is that this "extra-light form of internationalisation" will be common in countries long established as hosts of FDI. Furthermore, its importance may be growing with the increased relevance of business networks in the world economy (Buckley and Casson, 1998). The case of Simoldes is paradigmatic. Their present success is based on the position acquired as direct supplier of Renault. But this was gained before exports were significant, when Simoldes’s produced essentially for Renault’s assembly plant in Portugal. Most auto-components producers claimed that if they are internationally competitive today it is because, to become suppliers of MNCs in Portugal, they were forced long ago to improve quality and to develop products and technology.

Companies like Autosil or Cin also claim that their internationalisation started well before their products started crossing the Portuguese border. The argument presented by both firms is that they always had to face competition in the domestic market from multinationals. In other words, they had to become internationally competitive before they compiled the capital and management resources necessary to sell their products across borders. They both claim that the benchmark they were able, and forced, to make against those foreign competitors was a major determinant in the competitiveness (ownership advantages) that later allowed them to enter foreign markets.

5. Summary

The results of this exploratory study can be summarised in a few points:

1. Most Portuguese nascent MNCs operate in capital-intensive industries. Internationalisation in traditional labour-intensive industries is incipient.

A most surprising finding given Portugal’s industrial structure is very much specialised in labour-intensive industries. This traditional industries are responsible for most of Portuguese exports, but are very much dependent on foreign agents to market their products. It seems that the success they enjoy as passive exporters works as an anaesthetic in terms of international expansion.

2. Efficiency-seeking FDI is still rare in Portugal.

Builds on number 1. Portugal seems to maintain a cost-advantage in the European context, which is supported by the sustained success of traditional exporters (Portuguese or foreign owned). So far, few Portuguese firms found it necessary to move operations to lower costs locations, but eventually with much lower productivity and a low skilled work force. There was only one case in our sample of efficiency-seeking investment, in Brazil.

3. Evidence is not clear in terms of the importance of strategic asset-seeking investment.

There was only one company in the sample clearly engaged in strategic-asset seeking investment. However, in other cases it proved very difficult to distinguish the latter from market-seeking FDI. Internationalisation was often presented by the managers interviewed as a question of survival for their companies. That is, market expansion provided a strategically critical asset - size. At least for those firms that expanded to more developed countries, there seems to be an unavoidable element of strategic asset-seeking in their market oriented investments.

4. Portuguese firms are increasingly engaging in market-seeking investment in less developed or adjacent territories.

As predicted by Dunning (1981a, 1981b, 1986), the most common destination of market-seeking investment are countries less developed than Portugal or neighbouring territories, notably Brazil and Spain. However. the firms involved are small in international terms. As argued above, it is never clear whether they are seeking to maximise their existing resources, or they seek in new markets the size on which they will build their competitive advantages.

5. Psychic distance, and language in particular, proved to be a major locational determinant of FDI.

It is strongly suggested by the statements made in the interviews that, more than any other element, language determines psychic distance. Furthermore, language and cultural distance were critical determinants in the location of foreign subsidiaries. With very few exceptions, the managers interviewed had a very strong preference for Portuguese-speaking countries. Spain and Spanish-speaking Latin America, in that order, were next in this ranking.

6. Political and economic instability are critical locational determinants of FDI. But once a certain ‘level of stability’ is attained, they become largely irrelevant.

Suggested by Buckley and Castro (1998c), it seems to be supported here. Although assessed as very relevant locational determinants in the sample, political and economic instability only overshadowed psychic distance when risk was very high. Before the stabilisation program of 1996, economic and political risk were indeed deterrents of foreign investment in Brazil. The same can be said of present instability in Angola, another much favoured location. Brazil is now a much more stable location, but the interviewees seemed to agree that risk still is high. However, Portuguese firms demonstrated that they prefer now Brazil to less risky alternatives.

7. Labour skills are also relevant as locational determinants of FDI.

The attractiveness of Brazil is very much influenced by its huge potential market (see number 4), but also by its long industrial tradition. This is attested by how common acquisitions were in the sample, and the good assessment made of the subsidiaries’ production capacity. By contrast, Mozambique is still attracting little manufacturing FDI despite the recent economic and political stability. The explanation seems to be in part its small domestic market, but also the very low skills of the labour force. Both examples seem to support the results obtained by Buckley and Castro (1998b, 1998c) for inward FDI in Portugal and in other peripheral European countries.

8. Inward FDI had a very important role in the development of the ownership-advantages of Portuguese firms.

Several firms in the sample highlighted the role of foreign firms operating in Portugal in the development of their international competitiveness. Foreign subsidiaries can force the Portuguese firms to develop new capacities and strengths when they buy their products, but also when they compete with them for the Portuguese market.

9. Countries do seem to follow an investment path similar to the one proposed by Dunning (1981a, 1981b, 1986).

The simultaneous internationalisation of a substantial number of Portuguese firms seems to coincide with the maturity of domestic markets and industries. This seems to support the IDP’s prediction that Portugal is in a transition period between ‘stage 2’ and ‘stage 3’ (Buckley and Castro, 1998a). The relevance of the IDP is also supported by number 8.

10. The major constraint to internationalisation faced by small firms is the shortage of skilled management (Buckley, 1989).

Most companies in the sample agreed that a shortage of management skills was the major obstacle to internationalisation. Nevertheless, this opinion was not shared by a small number of (bigger) firms which saw internationalisation as the way of making use of the management overcapacity created during the years of fast domestic growth.

11. Psychic (language?) proximity permits to ‘jump stages’ in the internationalisation process, in particular when geographic distance is relevant.

Very few of the companies in the sample that invested in Brazil had ever exported to the country. Distance and tariff barriers seem to have been an efficient deterrent. However, this does not seem to have affected their ability to invest in production subsidiaries. In the case of European and Asian countries, firms seemed to follow a more traditional internationalisation path (Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977).

12. Licensing and joint-ventures are not popular among small firms new to internationalisation.

There was only one case of licensing in the sample, and just five firms involved in joint-ventures. That both are management intensive deals (Buckley, 1989) may be the explanation. For smaller firms licensing seems to be an entry mode that represents an intermediary stage between the establishment of commercial and productive subsidiaries (Buckley and Casson, 1981).

13. A negative correlation between the level of control and product maturity, and a positive one with technological intensity could not be found.

Anderson and Gatignon (1986) proposed these relationships under a transaction costs model of modes of entry. However, they were clearly note supported in the sample. In the case of technological intensity, the result obtained was exactly the opposite: the level of control was lower in technology intensive industries. For product maturity, no clear tendency could be found for the sign of the relationship.

14. Greater country risk was found to be associated with lower forms of control.

Contrarily to the suggestion of Anderson and Gatignon (1986), licensing and joint ventures were most common in countries with a higher risk. In the Europe Union, associated with low political and economic risk, total control of the subsidiaries was the rule among the firms in the sample.

On the face of high country risk, firms opted to reduce the level of engagement. This translates limited management capacity, but also capital restrictions and the very size of the firms. For these rather small firms, the capital required to establish a foreign subsidiaries often represents a substantial percentage of the parent’s equity (in some cases over 100 per cent).

6. Conclusion

A first surprising conclusion of the present study is that Portugal’s nascent FDI outflow does not come out of the country’s traditional industrial structure. Labour intensive industries, which dominate Portuguese exports, are largely absent from the internationalisation process that is gaining moment among Portuguese manufacturing firms. This probably explains why efficiency-seeking investment is still rare. The first companies to expand production abroad were, in the case of Portugal, those that operate in capital-intensive industries for which the domestic market became too small. In some cases, this restrictive domestic market means that it is not possible to exploit efficiently the resources available. But for many more it is seen as a threat to the very survival of the firm. Internationalisation is the solution to reach a critical dimension in terms of ability to compete with foreign firms, abroad and at home.

The current internationalisation, nevertheless, needs consolidation. The still thin ownership advantages of most of these firms is revealed in several elements. First, the limited number of countries chosen as destination of FDI. 2/3 of the firms expanded either to Brazil or Spain. Second, the importance that psychic distance, and language in particular, assumes in the choice of those locations. The managers interviewed manifested, in general, a very strong preference for Portuguese-speaking countries, followed by areas where Spanish is the official language. Third, the recurrent shortage of management skills, especially among smaller firms. The risks of this constraint to the internationalisation process cannot be underestimate. These firms are likely to rely upon less than optimal decision-making processes, ignoring more profitable alternatives or not fully assessing the costs associated with their decisions.

Another important conclusion is that psychic proximity does help firms to ‘jump stages’ in the internationalisation process. Contrarily to Europe or Asia, investment in production establishments in Brazil was in most cases the first form of involvement in the country. Necessarily, geographic distance and high tariffs reduced in many cases the alternatives to: (A) ignore the Brazilian market; or, (B) establish a production subsidiary. That is, the point is not that psychic distance will make redundant less deep forms of foreign involvement, but that it facilitates the entry even when exports or sales subsidiaries are not efficient alternatives or not possible at all.

A fourth point regards strategic-asset seeking. The results clearly suggest that in the case of relatively small firms this concept must have a broad interpretation. Big MNCs see market-oriented foreign investment as a way of maximising the profitability of proprietary assets, being them technology, international brands or management skills. However, smaller firms, in particular those from small countries, often expand to foreign markets from a weak position. Internationalisation is the means to gain size that can critically affect their competitive position. Despite being market oriented, this investment fits better the concept of strategic-asset seeking than that of market-seeking (Dunning, 1993).

Finally, the sample provides full support for the interaction between inward and outward FDI, and between the two and countries’ economic development. The role of foreign firms in the development of the ownership-advantages of Portuguese firms was clearly assumed by a very high percentage of those interviewed. Interestingly, it seems that foreign subsidiaries seem to represent that role not only when they are clients but also when they are the main competitors of local firms. In both cases Portuguese firms were forced to upgrade products, technology and production and management processes. When the stagnation of demand due to the maturity of domestic markets is matched with this ‘forced’ development of internationally competitive Portuguese firms, the recipe for foreign expansion is assured. A more direct relationship was revealed by three of the eighteen firms interviewed, which were created as subsidiaries of foreign companies.

 

 

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