Advances in telecommunication and transportation and lower trade barriers have decreased cross-border trade cost and risk for small and medium-sized enterprises (SMEs) and enabled them to pursue international strategies. Generally internationalization refers to the process of increasing involvement in international markets1.
Internationalization benefits SMEs in many ways. First, it helps SMEs to disperse business risk across different markets. Second, it generates more revenue to invest in technology and production, which are key to SMEs’ growth. Third, by cooperating with foreign enterprises, SMEs can gain access to more advanced technology and improve innovative capacity. And fourth, internationalization allows SMEs access to foreign markets, which assists to improve operational efficiency and tap production potential2. Internationally active SMEs are also found to grow faster than SMEs that focus only on their domestic market, especially right after entering the foreign market3.
There are concerns however, that international markets are more complex and competitive and SMEs may not have sufficient resources and expertise to deal with international business risks. As noted by the OECD, policymakers can play an essential role in creating a conducive environment for SMEs to minimize such risks. The most significant challenges faced by SMEs in external markets are the compatibility of standards, protection of intellectual property rights, political risk of foreign economies, corruption and graft, as well as transparency of the rule of law4, all of which can be addressed by governments through properly designed policy packages.
To formulate the appropriate policies for SME internationalization, policymakers will require information about SMEs in their domestic economy. This policy brief looks at the different forms and process of SME internationalization, and discusses a few methods of measuring the degree of internationalization. It then examines the current state of SME internationalization in APEC, and suggests possible ways to measure SME internationalization.
Forms of internationalization
There is a broad variety in the internationalization activities of SME. They can be classified into six categories, namely: 1) direct exporting; 2) direct importing; 3) investment abroad; 4) being subcontractors to foreign enterprises; 5) having foreign subcontractors; and 6) cooperation with foreign enterprises under joint ventures, non-equity alliances, licensing, and franchising (Figure 1).
Figure 1 SME Internationalization Activities
Source: Author based on literature.
Direct Exporting and Importing
Direct exporting and importing of goods and services are the best known forms for SMEs to access international markets, and often SMEs begin their international activities by importing of goods and/or services5. Export and import of goods are easy to comprehend – they are goods moving through the borders involving a change of ownership. This includes movements through customs warehouses and free zones.
Export and import of services are more complex. They are defined by the territorial presence of the supplier and the consumer at the time of the transaction. There are four modes of export and import of services6:
•Cross border supply: services are produced inone territory and supplied to clients in another territory;
•Consumption abroad: consumers of oneterritory go to another territory to purchaseservices;
•Commercial presence: a service supplier fromone territory sets up a commercial presence inanother territory to provide services; and
•Presence of natural persons: natural personsfrom one territory go to another territory toprovide services.
A study on European SMEs has shown that importing is more common than exporting, and that importing often triggers exporting by SMEs7.
Investment abroad covers both foreign direct investment (FDI) and foreign portfolio investment (FPI). FDI reflects the investment of an enterprise from one economy to an enterprise in another economy in a long-term relationship. It involves direct acquistition of a foreign firm, construction of a facility, and setting up of proper fixtures, machinery and equipments. FDI usually requires direct or indirect ownership of 10% or more voting power in the foreign enterprise and a significant degree of influence on its management. If the investing enterprise controls 100% ownership of the invested firm, such FDI could be called a wholly owned subsidiary.
FPI involves purchasing a share or a security of a foreign enterprise, which amounts to less than 10% equity of the invested enterprise, and hence no ensued voting power8. Compared with FDI, FPI offers greater liquidity should the SME investor choose to liquidate its investment or not to engage in the control and management of the invested enterprise. However, FPI requires the investor to have specialized knowledge in order to monitor the foreign financial markets and the performance of the portfolios abroad, which SMEs may find challenging and costly. Therefore, although FPI offers more flexibility than FDI, FPI is not very common in the internationalization activities of SMEs.
Being Subcontractors to Foreign Enterprises
As production networks and value chains expand, businesses become increasingly global, and more and more SMEs are drawn into these systems as subcontractors to multinational enterprises. Subconstracting refers to the sourcing of different parts of a product or process from different companies. A subcontractor provides commissioned work, such as specific parts and components, processes and services, or in some cases finished products9.
Being either higher- or lower-tier subcontractors10, SMEs experience greater specialization in production networks or global value chains. This opens up opportunities for SMEs to achieve economies of scale and scope11. For example, in Indonesia, Remula Inti Rekayasa has been providing stanless steel tanks to Coca Cola and other multinational companies to store liquids12.
Having Foreign Subcontractors
Instead of being subcontractors, SMEs could have foreign subcontractors which is another means of internationalization. This usually starts with the appointment of foreign sales representatitves and distribution agents. Although the number of SMEs with foreign subcontractors is significant13, this
form of internationalization is a recent phenomenon and has not been widely documented and studied.
Cooperation with Foreign Enterprises
Besides the above activities, SMEs also engage in cooperation with foreign enterprises to internationalize. According to studies conducted on European SMEs, international cooperation contributes significantly to SMEs’ competitiveness14.
A joint venture is an entity set up by two or more independent firms, who share the control over the joint venture and are jointly accountable for the costs and profits. In the context of SME internationalization, at least one independent firm is a local SME and the other is a foreign firm. Contrary to FDI where the investor could have total managerial control, the control of a joint venture is distributed among investing firms. In certain cases, joint venture is the only way for SMEs to gain access to foreign markets.
Non-equity alliance is also called strategic alliance. It is characterized as a formal agreement between two or more independent firms for a common strategic goal15. A non-equity alliance does not involve equity arrangement, hence it has no impact on control or management. Partners provide strategic resources to each other, such as products, distribution channels, manufacturing service, capital, know-how and intellectual assets. Non-equity alliance with foreign enterprises helps to lower the business risk for SMEs to enter into a new market.
Licensing refers to a local SME giving a foreign enterprise access to its intangible property for a certain time period in return for a royalty fee from the receiver16. Licensing is usually short-term oriented, and is more prevalent in the pharmaceutical sector.
Franchising refers to a local SME acquiring the right from a foreign enterprise to conduct a particular business activity based on a royalty
payment. The local SME would provide certain goods and services under the name of the foreign enterprise. Franchising is usually long-term oriented17.
Although of a different nature, these internationalization activities can complement and support one other – SMEs could and usually carry out more than one type of internationalization activity simutaneously.
The Uppsala Internationalization Model, developed in 1970s, is the earliest theory on the specific sequences that SMEs follow to access international markets. It describes a gradual process to internationalize – starting from intermittent exporting, and then exporting via agents, and then moving on to cooperation with foreign firms via sale subsidiaries, joint ventures, licensing and franchising, and eventually achieving FDI in the overseas markets18.
Later on, complementary to the Uppsala Model, the Network Theory Model was developed at the time when global production networks and value chains became more prominent. The Model places all the firms into networks of suppliers, subcontractors, customers and other market actors19, and SMEs start to internationationalize from selling to or buying from multinational companies via global production networks or value chains.
The internationalization process has implications on the grouping of SMEs. Both the Uppsala Model and the Network Theory Model describe an incremental process for SMEs to internationalize, i.e. SMEs start as domestic firms, and gradually develop their international business capacity and become active in the international markets. Firms that fall under this group are classified as “incremental internationalization SMEs”.
Other SMEs start with a global vision and devote resources towards international activities from the onset. These are classified as “born-global SMEs”,
and they are usually in knowledge-intensive sectors and supply niche markets20.
For these two groups, the main barriers to access international markets are different, and policies to assist them would therefore require different approaches. In the case of incremental internationalization SMEs, since cost is a major factor in decision making, the governments can implement trade facilitation measures for SMEs; remove information barriers; and guide them in meeting corresponding standards. For born-global SMEs, lack of financial resources is often a main concern. Policies facilitating access to credit would thus be relevant for these SMEs21.
For policy makers, it will be helpful to have an idea about the degree of SME internationalization in their respective economies. A good understanding of the process and extent of internationalization could make policies more specific and targeted. Internationalization is also closely linked with industrial development strategies aiming to improve economic competitiveness. Indeed, research by the European Commission found that “innovation and internationalization share a positive causal effect in competitiveness22.” Successful born-global SMEs are good examples of this.
Measuring SME internationalization though is a challenging task. Various attempts have been made to measure international activities at the micro and macro levels. However, the reliability and validity of these measurements are debatable. Although over 97% of the companies in the APEC region are SMEs23, obtaining data on SMEs’ business activities is not easy. On one hand, SMEs are usually not part of any representative business association promoting their interests, and many of them do not necessarily keep detailed records of their activities. On the other hand, business patterns are constantly evolving and this makes it difficult to find a sound methodology to measure the degree of internationalization across time.
There have been attempts to construct internationalization indices, reflecting features
such as the structure, activities, and evolution of firms overseas. For example, the United Nations Conference on Trade and Development (UNCTAD) constructed the Transnationality Index as a synthetic measurement on international operations of multinational enterprises24. It combines the share of foreign assets in total assets; share of foreign sales in total sales; and share of foreign employment in total employment, with equal weights to reflect the spread of the firms’ businesses in overseas markets.
However, internationalization is much more complex than can be encapusulated in a single index, thus other measurements tend to adopt a discrete or mixed approach combining quantitative and qualitative elements. The most comprehensive so far is the measurement by Dunning and Lundan. They use seven indicators to capture the internationalization of a firm25:
1.the number of foreign markets involved;
2.the number and revenue of foreign affiliates;
3.the proportion of foreign assets, sales, profit orstaff of the firm;
4.the proportion of foreign ownership ormanagement in the firm;
5.the value of R&D conducted abroad;
6.if the firm controls international networks; and
7.the extent the management of the firm isdevoted to foreign affiliates.
While the above measurements are constructed for multinational enterprises, they can be adapted for SMEs. For instance, instead of looking at foreign affiliates, the indicators could look at the number of SMEs being subcontractors to foreign companies and/or having foreign subcontractors. Instead of value of R&D conducted abroad, the indicators could reflect the extent of SMEs’ participation in joint ventures, licensing and franchising arrangements.
Ideally, the macro level measurement of SME internationalization should be an aggregrate of the data at the micro level. Taking into consideration the different forms of SME internationalization and micro level measurements, the following indicators
would be able to present a valid picture on the stage of SMEs internationalization26.
1.number of SMEs exporting directly and valueof SMEs’ direct exports;
2.number of SMEs importing directly and valueof SMEs’ direct imports;
3.number of SMEs investing abroad and value ofSMEs’ investment abroad;
4.number of SMEs being subcontracted byforeign enterprises and value of sales of SMEsbeing subcontracted by foreign enterprises;
5.number of SMEs subcontracting foreignenterprises and value of purchase of SMEsfrom foreign subcontractors;
6.number of SMEs cooperating with foreignenterprises under joint ventures, non-equityalliances, licensing and frenchising and valueof SMEs’ revenue from cooperation withforeign enterprises.
However, most statistical agencies do not collect or even if they do, collect minimum SME-related data. In many economies, only basic data on the number of SMEs and SMEs’ economic contribution is collected, while data on SMEs’ involvement in international trade, investment, and cooperation, is scarce.
To measure SME internationalization, two feasible options are suggested, namely: 1) by economic surveys; and 2) by census.
The European Commission conducts an assessment on internationalization of European SMEs every three years using a survey approach. For the most recent 2010 report on Internationalization of European SMEs, the European Commission conducted 9,480 extended interviews based on a disproportional stratified sample (Appendix 1). The study found that a considerable number of European SMEs were engaged in international activities. Although exporting and importing were still the most prominent activities, European SMEs were also actively engaged in technological cooperation, subcontracting with foreign enterprises, and foreign direct investment in overseas markets27.
2)Census ApproachJapan utilizes the results from an Economic Census in an effort to understand SMEs’ internationalization activities. The Economic Census consists of two sub-censuses, namely: 1) Economic Census for Business Frame identifies the basic structure of establishments and enterprises; and 2) Economic Census for Business Activity identifies the situation of economic activities of establishments and enterprises. Each census is conducted once every five years by the Japanese Government, with the help from prefectural municipal governments and enumerators. The results are then reflected in the White Paper on SMEs in Japan. For example, the White Paper on SMEs in Japan 2014 utilized the results from the Economic Census for Business Frame in 2009 and the Economic Census for Business Activity in 2012, and captured the overseas expansion by Japanese SMEs in these three dimensions: 1) direct exports, 2) indirect exports28, and 3) direct investment. It also provided valuable data on SMEs’ business cooperation with foreign enterprises.
Measuring SME Internationalization in APEC
The APEC SME Working Group has been discussing ways to improve SME access to markets and promote SME internationalization since its inception in 1994. They had addressed the issue of barriers to full participation of SMEs and micro enterprises in international trade/markets within APEC in their Strategic Plan 2009-201229. In their current Strategic Plan 2013-2016, one of the priority areas is on addressing the critical issues pertaining to the strengthening of the business environment, market access and internationalization of SMEs.
In 2013, in order to measure the progress of implementing the Strategic Plan 2013-2016, the members of the working group agreed to collect APEC SME Monitoring Indices, covering all priority areas of the Strategic Plan 2013-2016. In the area of internationalization, members agreed to use the percentage of SMEs’ contribution to exports (i.e. SMEs’ share in total exports) and the number of SMEs making direct investments abroad (i.e. percentage of SMEs investing abroad in total