Conventional wisdom says that repetition leads to efficiency. The firm that produces 1,000 widgets should be more efficient at making widgets than the firm that only makes 100. We’ve seen this paradigm applied to many aspects of business over the last 30 years, including the internationalization of multinational corporations. Some maintain that the more countries a firm enters, the more efficient it is and the better its chances of success.
However, in a recent study I found that the conventional wisdom doesn’t hold up when it comes to understanding the impact of country selection on internationalization patterns and firm performance. I looked at whether it’s beneficial for firms to have prior experience before deciding to enter a new country and, if so, which experiences will help versus hinder success. My main question was: When does prior experience pay and are there penalties for having the wrong type of experience?
I focused on three categories: similar regulatory experiences, breadth of regulatory experiences, and depth of regulatory experiences. My research showed that all three factors can have a strong impact on a firm’s likelihood of success in a new country, but that similarity and depth are the strongest indicators.
When it comes to similarity, if the host country regulatory environments are similar to places where the firm has prior experience, it prolongs the survival of the investment. For example, if the company headquarters is based in Spain and then the firm enters a Spanish-speaking country in Latin America, it can accelerate its learning in the host country and have a better chance of success because of the similarity of institutions.
In contrast, not having any similar prior experience makes the firm six times more likely to fail. By failure, I mean an unintentional exit from the new market. So a firm utilizing regulatory experiences gained in the U.S. to enter South Korea pretty much has the odds stacked against them to fail because of the steep learning penalty for using the wrong knowledge in a different regulatory context.
As for breadth of experiences, my research shows that – unlike widgets – increasing the number of countries entered won’t necessarily make a company more efficient at expansion. This is because the firm might only be entering a specific type of culture or regulatory environment. For example, a firm that only enters Spanish-speaking locations won’t create a broader base of knowledge that can be applied elsewhere. For breadth to add value, a firm needs to acquire a range of institutional experiences.
Gaining breadth of knowledge sets up a company to have depth of knowledge across a variety of institutional conditions. Depth is what really allows managers to navigate the regulatory hurdles because they’ve already seen what can possibly happen in other countries and are able to put strategies in place unique to the subsequent host country.
For example, one of the executives I interviewed suggested that it works this way in their firm: “[We] have very strong coordination among all the different operators in the different countries, and our relationship with headquarters is quite strong. I rely on my counterparts [in other affiliated subunits] … in terms of knowledge. We have what we call ‘competence centers.’ We have people here who have already passed through this experience three, four, five times before. And they can say what’s going to happen. The parallels are not just in the environments, but also in how to navigate the environments, and that’s where the knowledge transfers occur. This kind of learning happens from experience. I think it makes a difference.”
Indeed, depth of experience is very important when it comes to the likelihood of success or failure in a new country context. It can decelerate time to failure or increase the odds ratio of surviving by 1.3.
A takeaway from this study for investment managers of less seasoned multinational firms is the importance of the learning curve. To improve a firm’s chances of more immediate success, they should first choose countries with similar institutional environments to their home country where they have adaptable competencies. Then they can work on building breadth and depth.
Another lesson is to avoid the pitfall of following the hype. Five years ago, the hype was all about the BRIC countries, but if firms stopped to assess their knowledge base then they probably would have identified other markets in which they’d have had higher chances for success based on leveraging institutional similarities. Now, we’re hearing about multinational firms failing in China and it’s not a surprise because it’s a hard market to navigate without the right kind of prior institutional experiences.
So how does an investment manager assess a firm’s knowledge base? They need to ask: What type of international experience does the company have? How similar is that experience to the subsequent investment environment? How might the company leverage its existing knowledge based on its breadth and depth of other country experiences?
This is an underdeveloped area in our training of investment managers, but the sequence of internationalization – as opposed to the sheer number of countries – can make a tremendous impact on the company’s chances of success in a new market.
Prof. Susan Perkins is visiting MIT Sloan School of Management from the Kellogg School of Management. She is the author of “When Does Prior Experience Pay? Institutional Experience and the Case of the Multinational Company.”