Performance implications of international strategy:
An empirical study of foreign-invested enterprises in China
Luo, Yadong
Group & Organization Management.
Abstract
A study explores the systematic relationship between business unit-level-performance and strategic
dimensions of international strategy. On the basis of cross-sectional empirical analysis of the data on
foreign-invested enterprises (FIE) operating in China, it is found that: 1. among business strategy variables,
product quality, sales force marketing, and liberal credit granting have significantly positive influences on
FIE performance, 2. among investment strategy variables, industry selection and timing of entry are
significant ones affecting venture's return and market growth, 3. interactions between business strategy and
investment strategy significantly impact on FIE performance.
This study explores the systematic relationship between business unit-level performance and strategic
dimensions of international strategy. To capture the "match" effect between differentlevel strategies, this study
examines parent-level investment strategy and subsidiary-level business strategy together within an integrated
model. On the basis of a cross-sectional empirical analysis of the data on foreign-invested enterprises (FIE)
operating in China, it is found that (a) among business strategy variables, product quality, sales force marketing,
and liberal credit granting have significantly positive influences on FIE performance; (b) among investment
strategy variables, industry selection and timing of entry are significant ones affecting venture's return and market
growth; (c) interactions between business strategy and investment strategy significantly impact on FIE
Business strategy and investment strategy are central components of international strategy for multinational
corporations (Dunning, 1993; Porter, 1986). This is because the firm-specific and location-specific
advantages of international businesses are largely determined by strategic decisions along these two
dimensions (Kogut, 1989). Within an international strategy framework, business strategy is primarily
concerned with subsidiary-level strategic decisions such as product quality, R&D intensity, advertising, and
firm size. The decision about, and the operation of, these business strategy variables in a specific host
country are based on the degree of local responsiveness (Doz & Prahalad, 1991) and geographic locality
contingencies (Rugman & Verbeke, 1993). Alternatively, an international strategy at the parent firm level is
primarily concerned with the integration among subsidiaries and national responsiveness (Bartlett, 1986).
The elaborate decisions and actions about the coupling between these two dimensions in the field of foreign
direct investment (FDI) constitute the major concern of a parent firm's investment strategy. Project-type
selection, location selection, equity distribution, industry selection, and investment timing are in the domain
of this concern.
The international management literature has identified the subsidiarylevel business strategy and the parent
firm-level investment strategy as important in relation to international expansion performance (Beamish,
1993; Caves & Mehra, 1986; Gomes-Casseres, 1989), but the two-level strategies have rarely been
analyzed together. Instead, researchers have attempted to use coordination and configuration to study
international strategies (Bartlett, 1986; Porter, 1986). However, coordination and configuration are structural
decisions rather than strategic dimensions (Galbraith & Kazanjian, 1986). These structural decisions are
virtually made on the basis of aspects such as the centralization of decision making and the coordination of
operating units rather than strategic decisions with respect to project, product, market, and/or competitive
weapons to employ. In an effort to fill the gap on the issue, it is necessary to link international strategy with
more managerialoriented strategic decisions such as business and investment strategy components.
Moreover, as a result of heterogeneity, multidimensionality, complexity of the investment environment (Doz
& Prahalad, 1991), and requirements for optimising global internalization (Kogut, 1989), business strategy
and investment strategy variables must be developed and assessed both independently and
interdependently.
Because of the paucity of research on international strategy pertaining to the environment of transitional
economies, little has been known about the performance implications of international expansion strategy in
this context. However, as the major host of FDI, these economies are playing an increasingly important role
in the world economy. The opening up of formerly centrally planned economies, most notably China, has
significantly contributed to the global integration of international business. Foreign-invested enterprises
(FIEs) including equity joint, cooperative joint, and wholly foreign-owned ventures-have made China
currently the second biggest foreign capital recipient in the world in terms of contractual amount of
investment (Foreign Investment in China, 1996). Although the booming economy offers attractive
opportunities, China remains an unfamiliar territory for many international firms. One of the challenges for
these firms is to formulate realistic investment and business strategies. To do so, the relationship of
business and investment strategy to foreign venture performance must be examined. The primary objective
of this study is hence to examine the impact of business and investment strategy variables on the
performance of FIEs operating in China.
FOREIGN-INVESTED ENTERPRISES
Transnational investors have established an increasing number of FIEs in transitional economies in recent
years. The strategic motivations varyincluding efficiency seeking, local market seeking, and global
integration seeking (Hergert & Morris, 1988; Lall, 1987; Nunez, 1990). Nevertheless, few studies address
the relationship between business and investment strategy variables and the performance of FIEs,
particularly those operating in transitional economies. Empirical linkages have been found between firm
performance and such business strategy variables as product quality (Dawar & Parker,1994), R&D intensity
(Hoskisson & Johnson,1992), firm size (Calof, 1994), pricing (Padmanabhan & Bass, 1993), and advertising
(Chauvin & Hirschey,1993). However, these may not be applicable to FIEs in transitional economies.
Earlier FDI investigations have focused on either equity distribution (Beamish, 1993; Blodgett, 1987;
Gomes-Casseres, 1989; Killing, 1983) or industry selection (Caves & Mehra, 1986; Kogut & Singh, 1988;
Lecraw, 1983). Little research empirically links other investment strategy variables such as location
selection, timing of investment, and project-type selection to FIE performance. Location selection can affect
an FIE's cost of production factors, receipt of preferential treatment, and environment of business
operations (Luo, 1995; Shan, 1991). Timing of entry can affect an FIE's accessibility to indigenous
resources, prospective gains from evolving industry and market structure, and competition position vis-a-vis
its rivals (Caves & Mehra, 1986). Project-type selection refers to an investor's decision about the options for
project category such as import substitution, export oriented, technologically advanced, and domestic
oriented. This decision can affect an FIE's application of its distinct competencies, receipt of monetary and
nonmonetary treatment from local authorities, and accessibility to a local market (Beamish, 1993; Shenkar,
1990).
As noted above, a few researchers have examined the effect of equity distribution and industry selection on
venture performance in market economies (Awadzi, 1987; Blodgett, 1987; Gomes-Casseres, 1989). Some
of their findings are inconclusive. For instance, Killing (1983) observed a correlation between dominant
equity control by one investor and superior firm performance. Awadzi (1987) and Kogut (1988) concluded
that there was no relationship between sharing arrangement and venture performance. Blodgett (1987),
Shenkar (1990), and Beamish (1993), however, found a positive relationship between split equity
distribution (50-50) and high performance. The above findings are contradictory because these scholars
use different methodologies, especially for the measurement of FIE performance. For instance, some use
traditional financial return or subjective assessment of parent satisfaction (e.g., Beamish,1993; Luo,1995;
Teagarden & Von Glinow, 1990); others use an FE's survival, duration, or instability of ownership (GomesCasseres, 1989; Killing, 1983; Kogut, 1988). In light of the diverse strategic objectives of transnational
investors, this study uses the multidimensional performance measures including return on investment
(ROI)/return on asset (ROA), domestic sales growth, and export growth. Indeed, these measures logically
correspond to efficiency seeking, local market seeking, and global integration seeking, respectively.
In addition, because FDI is an ongoing and dynamic process, some business strategy variables and some
investment strategy variables are likely to interact with each other. For instance, value-generating assets
are increasingly taking the form of created assets, like human capital, rather than natural assets (Dunning,
1993). Many created assets are intangible and are firmspecific resources. Therefore, certain investment
strategy variables-for example, equity distribution-are likely to moderate the association between firmspecific business strategy variables and performance. Multinational Corporations (MNCs) are also
becoming more pluralistic in their motives for global involvement. Locality-specific factors and firm-specific
factors interact to provide global competitive advantage (Rugman & Verbeke,1993). The required coupling
between business and investment strategy is reinforced in transitional economies because the investment
environment in these countries is more uncertain than that in developed market economies (Boisot & Child,
1988; Nee, 1992).
STUDY BACKGROUND
RECENT SITUATIONS ABOUT FIEs IN CHINA
China officially opened its door to foreign investment in 1979 through the promulgation of its joint venture
law. Until the end of 1995, Chinese authorities had approved over 258,444 FIEs involving $393.04 billion in
foreign capital. About 120,000 FIEs representing $133.04 billion investment have commenced operation
(Foreign Investment in China, 1996). The formation and operation of these FIEs have played a principal
part in China's opening and economic development. The industrial output and import/export volume of FIEs
have reached to 13% and 39.10% of the nation's total, respectively, and about 16 million Chinese people
are currently employed in FIEs (Foreign Investment in China, 1996).
Sino-foreign FIEs can be classified into four main forms, which are also the entry modes foreign investors
can opt for. These forms or modes include (a) equity joint ventures, which account for 52.02% of total
amount of actual FDI in 1994 (see Table 1); (b) wholly foreign-owned enterprises, which represent 25.46%
of total value of FDI; (c) contractual (or cooperative) joint ventures, which are about 19.71% of actual value
of FDI; and (d) joint exploration projects (e.g., offshore oil exploration consortia), which constitute 1.82% of
total FDI value in 1994.' Although the percentage of wholly foreign-owned ventures in total FDI has been
growing in recent years (about 7% prior to 1990 versus 25.46% in 1994), as shown in Table 1, equity joint
ventures remain a dominant entry mode selected by foreign investors.
THE EFFECT OF ENVIRONMENTAL ISSUES ON BUSINESS STRATEGY VARIABLES
Foreign ventures face less government intervention at the business unit level than at the corporate level.
Nevertheless, there are still restrictions on product quality, pricing, and advertising.
According to China's product quality law, producers are prohibited from manufacturing products that are
deemed by the state to be obsolete. Producers that fail to comply with this provision may be ordered to
cease production and have their business license revoked and sales proceeds confiscated. At a minimum,
all products must meet the standard product quality requirements, which are determined by quality
supervision and control authorities at various levels. China has also established a spot-check system,
whereby central or local authorities examine the quality of major industrial products. Results of these spot
checks are made public.
The pricing of FIE products is regulated by the provisions of the joint venture law. According to its
guidelines, ventures can freely set the price of their exports, except those controlled by Chinese foreigntrade corporations. As for products sold on the domestic market, their prices depend on their classification
into one of the three categories determined by law. These include fixed pricing, managed pricing, and free
pricing. In practice, FIEs do not produce the type of goods that are rigorously controlled by the Chinese
government. Indeed, it is highly unlikely that the authorities will be forthcoming in granting the necessary
approvals for a production project of this nature (Luo, 1996; Shenkar, 1990).
In China, advertising for domestic and foreign products was reinstituted in 1979 after a ban instituted during
the Cultural Revolution. Advertising volume is now growing at about 30% annually (Xu, 1992). A variety of
media have been used by the foreign ventures to advertise their products and services in China. Despite
the positive function of advertising, the Chinese government does, in fact, have regulations in place
designed to control advertising practices. The regulations stipulate that advertising must be clear and
truthful and may not "hoodwink or deceive end users and consumers." Nor may advertisements include
contents that contradict state policies, divulge state secrets, and be harmful to the dignity of China's
nationalities.
In the process of implementing their business strategies, foreign ventures have to face Chinese business
practices that often are sharply dissimilar to those prevalent in their home countries (Boisot & Child, 1988;
Child, 1990; Shenkar & Von Glinow, 1994). As a result, sensitivity to local Chinese business conditions,
such as the importance attached to personal relations (guanxi) with customers, or the practice of extending
credit terms in marketing, must be developed (Luo & Chen, 1996). In particular, cultivating and extending
firm's guanxi should be a preoccupation for business success. Given the pervasive influence of guanxi in
Chinese societies, sales force marketing is a crucial selling tool for firms operating in these environments.
Likewise, the provision of preferential terms of payment for customers is common across firms and in every
economic sector in China.
THE EFFECT OF ENVIRONMENTAL ISSUES ON INVESTMENT STRATEGY VARIABLES
The pattern of project-type selection varies in its focus in recent years. The percentage of capital- and
technology-intensive projects has increased to about 35% of total number of ventures in 1994, and the
investment growth rate is much higher in telecommunications, transportation, and electric power than in
other sectors ("New Patterns," 1995). It seems that foreign investors in these capital- or technologyintensive industries rely on their distinct competencies in an effort to achieve monopolistic competition
advantages from Chinese market structure imperfections. On the other hand, the laborintensive light
industrial products continue to constitute major export items, and the processing-exporting pattern remains
unchanged (Beamish, 1993). Apart from the obvious benefit of low labor cost, the preferential treatment
accorded to export-oriented products by the authorities may also contribute to the pattern (Teagarden dE
Von Glinow, 1990).
Despite great improvements in recent years, China's industrial structure remains one of bottlenecks
hampering economic development (Child, 1990; Nee, 1992). Some major structural problems include (a)
inadequate power supply, (b) slower growth of raw material industry as compared with the manufacturing
industry, (c) obsolete manufacturing technologies, and (d) poor communication and transportation
infrastructures. To solve these problems, the central government encourages foreign investors to invest in
high export ratio projects and in new equipment or new materials that match with domestic needs,
particularly in energy, transportation, and telecommunication industries (National Council for US-China
Trade, 1991). In other areas, especially those that have already been developed domestically, those that
involve the use of widely available technologies, or industries assembling imported parts or producing for
the domestic market, foreign investors face many restrictions. For instance, tax treatment is discriminated
over the type of project. For FIEs whose exports exceed 70% of their total output (export oriented) or that
bring in advanced technology (technologically advanced),2 the income tax is cut by half, from 30% to 15%
(Luo & Chen, 1995).
Enlarge 200%
Enlarge 400%
TABLE 1
One prominent piece of foreign investment legislation in China is the Provisions to Encourage Foreign
Investment, often called "22 articles," initiated by China's State Council in October 1986. In addition to a
series of preferential policies, this law contains provisions that substantially decentralize the ratification
power, simplify the approval procedure, and liberalize the bureaucratic framework. It also authorizes local
governments at different levels to establish the Economic and Technological Development Zone (ETDZ) in
their own jurisdictions to attract foreign investment. For FIEs located within ETDZs, the income tax rate has
been reduced to 15%, only a half as opposed to that for those located outside ETDZs (Luo & Chen, 1995).
Foreign investors face less government intervention in timing of investment and sharing arrangement than
in other investment strategy variables. Nevertheless, foreign investors should keep a wary eye on the "red
tape" and potential hinderance from various local authorities, either horizontal or vertical (Teagarden & Von
Glinow,1990). The horizontal authorities include at least three levels: provincial, regional, and county. The
vertical authorities include foreign economic relations and trade commissions, foreign exchange
administration bureaus, tax administration bureaus, customs houses, open affairs offices, local planning
and economic commissions, and industrial administration bureaus.
HYPOTHESIS DEVELOPMENT BUSINESS STRATEGY VARIABLES
In recent strategic management and international business literatures, an increasing attention has been
paid to examining the underlying determinants of corporate success and to identifying appropriate
competition strategies for maximum long-run profitability (Harrigan, 1988). In its bid to succeed in a host
market, a foreign investor has to be concerned with the application of home-tested business strategy
variables in a new environment.
Product Quality
Dawar and Parker (1994) and Phillips and Chang (1983) have empirically shown that product quality has a
significant positive impact on a firm's economic performance. Indeed, product quality is widely recognized
as an important business strategy variable, which is made up of not only physical attributes but also brand
name, product image, innovation, and service. It constitutes a major component of product differentiation,
which creates a competitive advantage for firms. Producers in China are specifically prohibited from
manufacturing products that are deemed by the state to be obsolete. Producers that fail to comply with this
provision may be ordered to cease production and risk to see their business license revoked and their sales
proceeds confiscated. Chinese consumers, on the other hand, tend to value quality above many other
product attributes. In sum, both supply and demand forces contribute to an environment where product
quality is likely to increase the efficiency and effectiveness of the venture. Following the above line of
reasoning, the first hypothesis states:
Hypothesis 1: FIMs with a high product quality have a higher performance in terms of accounting return and
market growth than do FIEs with a low product quality, other things being equal.
Pricing
According to microeconomic theory, a firm's pricing level is generally negatively associated with its sales
and influenced by both demand and supply elasticities. This negative relationship seems to be
fundamentally maintained in China, because Chinese consumers are fairly sensitive to cost and price of
products. The magnitude of the relationship between pricing and accounting return is an empirical question
and depends on the contextual settings. In strategic management literature, Farris (1979) and Gallego and
VanRyzin (1994) summarized their findings that pricing is positively linked with a firm's profit and mediated
by policy and market factors. A major market/product factor mediating the linkage between pricing and firm
performance is the phase of the product life cycle. Because only since 1979 has China begun to open its
door (the majority of FIEs commenced operations after 1985) and most FIEs in China manufacture
innovated products that are new to Chinese consumers and in an introduction phase when produced, the
length of a venture's operation can thus be a proxy of the phase of the cycle in the Chinese market. In view
of the above, it is proposed that:
Hypothesis 2: FIEs with a lower pricing level vis-h-vis rivals have a higher performance in terms of local
market growth than do FIEs with a higher pricing level vis-h-vis rivals; among FIEs with a same pricing level
vis-A-vis rivals, those with a greater length of operation have a higher performance in terms of accounting
return than do those with a shorter length of operation.
Advertising
Strickland and Weiss (1976) and Chauvin and Hirschey (1993) have offered evidence that advertising
creates and maintains product differentiation and hence positively relates to a firm's profitability. A variety of
media have been used by foreign ventures to advertise their products and services in China today. China
has over 100 television stations, 122 local and national radio stations, over 500 newspapers, and 4,000
magazines (Xu, 1992). FIEs usually have four possible channels for advertising in China: (a) direct to the
media, (b) through an offshore media representative, (c) through a TV or radio program supplier, and (d)
through a Chinese advertising corporation. As their choices expand as a result of opening up, and
liberalization of, the Chinese economy, Chinese consumers tend to have more interests in buying foreign
products than in buying domestic goods. It is therefore predictable that FIEs' advertising is positively linked
with their local sales growth. As noted above, FIEs advertising their products at the current stage have an
"earlier mover" advertising advantage, which can lead FIEs to have a high level of efficiency. Noting the
above considerations, the following hypothesis states:
Hypothesis 3: FIEs with a high advertising intensity have a higher performance in terms of accounting return
and local market growth than do FIEs with a low advertising intensity, other things being equal.
R&D Intensity
Kogut and Singh (1988) and Hennart (1991) have demonstrated that ownership structure and subsequent
performance of FlEs are influenced by the expected strategic importance of the foreign firm's R&D intensity.
Industrial organization economists maintain that R&D intensity is a major contributor of product
differentiation and firm competence and thereby is positively related to firm performance. A number of laws
and rules have been enacted by the Chinese government to attract more technologically advanced
investments likely to benefit the national economy. Specifically, technologically advanced products benefit
from (a) a reduced corporate income tax; for instance, the current rate for these privileged projects is 10%
to 24%, whereas the rate for nontechnologically advanced and domestic-oriented products is 33%; (b)
reduced land-use fees; and (c) exemption from the profit remittance tax. As a result, technologically
advanced projects are likely to outperform others in terms of accounting return. On the other hand, it is
recognized in the literature that the return reimbursements for R&D expenditures usually take longer time
than for other business strategy variables (Harrigan, 1988). On the basis of the above, it is proposed:
Hypothesis 4: FIEs with a high R&D intensity have a higher performance in terms of accounting return and
market growth than do FIEs with a low R&D intensity; among FIEs with the same R&D intensity, those with
a great length of operation have a higher performance in terms of accounting return than do those with a
short length of operation.
Firm Size
Caves and Mehra (1986) and Kogut and Singh (1988) have demonstrated that size of FDI influences the
entry mode and subsequent market performance of the venture. Hall and Weiss (1967) also found that
greater asset size leads to higher profitability. According to current Chinese policy, there are no maximum
or minimum limits to foreign investment level. The venture size is likely to have a positive effect on FIE
performance because greater size implies an ability to benefit more from economies of scale and scope and
invest in advanced equipment and technology. Therefore, the following hypothesis states:
Hypothesis 5: FIEs with a great asset size have a higher performance in terms of accounting return and
market growth than do FIEs with a small asset size, other things being equal.
Liberal Credit Granting
According to a recent report by the Chinese State Statistical Bureau, the average age of domestic accounts
receivables is growing. Two major reasons can be advanced to explain this situation. First, in China,
preferential terms of payment-particularly temporal extension of payment deadlines-are widely used as a
primary marketing tool. This credit-granting practice may be, to some extent, a reflection of culture. In a
country where personal relations are painstakingly nurtured and the maintenance of harmony is of
paramount importance, sellers would do their utmost to avoid embarrassing customers temporarily unable
to pay. Second, a sustained tight monetary policy, reflected in an increase in interest rates and a reduction
in bank lending (a situation of "credit crunch"), has resulted in liquidity problems for many businesses. In
such a case, the practice of permitting customers to delay payment for a longer period becomes a crucial
selling tool for firms operating in China.
However, the practice results in greater credit costs (interest expense and bad debt allowance) as well as
financial risk (transaction and economic exposures) for the seller. On the basis of the preceding
observations, it is hypothesized that:
Hypothesis 6: FIEs with a high-growth rate of domestic accounts receivables have a higher performance in
terms of local market growth and a lower performance in terms of accounting return than do FIEs with a
low-growth rate of domestic accounts receivables, other things being equal.
Sales Force Marketing
Chinese nationals tend to rely heavily on personal relationships (guanxi) in business dealings (Punnett &
Yu, 1990). Guanxi pervades the business world in Chinese society. No company in the Chinese business
world can go far unless it has extensive guanxi. As a result, in economic sectors where market-oriented
firms have become dominant, sales force marketing, an activity relying on guanxi, has become an
increasingly popular and effective marketing means. The marginal contribution of sales force expenditure to
profit is usually high. Thus:
Hypothesis 7: FIEs with a high sales force intensity have a higher performance in terms of accounting return
and local market growth than do FIEs with a low sales force intensity, other things being equal.
INVESTMENT STRATEGY VARIABLES
Industry Selection
Caves and Mehra (1986) provided particular evidence that the association of FE performance with its
business strategies is moderated by the characteristics of the industry (e.g., industry sales growth). In
China, where the industry and market structures are still far from perfection, some sectors of the economy
are fully privatized, whereas others are not. The dual-pricing system remains in some industries. When
government-instituted supply side controls are lifted in an industry, a rapid initial development will ensue,
reflected in a surge in industry sales and profit growth. This surge enables FIEs operating in the industry to
benefit more with respect to profitability and domestic sales growth.
Moreover, there is evidence of interindustry variances in strategic objectives of transnational firms' foreign
subsidiaries (Kogut & Singh, 1988). Perhaps not surprisingly, whenever the Chinese market for a particular
industry appears to grow dramatically, FIEs are likely to concentrate their operational goals on exploring or
exploiting the booming local market rather than on exporting to home or international markets. Therefore:
Hypothesis 8: FIEs investing in fast-growing industries have a higher performance in terms of accounting
return and local market growth and a lower performance in terms of export growth than do FIEs investing in
slow-growing industries, other things being equal.
Timing of Investment
The length of operation can be regarded as a hybrid of the negotiated duration of FIE agreement and the
timing of FIE formation. FIE agreements with China usually stipulate a fixed duration. Typically, the foreign
partner agrees to liquidate its share in the venture to the Chinese party either with or without compensation
at a prespecified time. In either case, FIEs of shorter duration are more risky, other things being equal,
because there is a higher probability that the venture will expire before sufficient return can be generated or
before the full potential of the FIE transpires. Even if the venture is renewable, the shorter duration specified
in the contract may mean more frequent renegotiation, which introduces uncertainties to the foreign partner.
Because social, cultural, political, economic, and institutional environments in China are fundamentally
different from those in the West, it takes time for foreign investors to learn business environments and
practices in China. Thus earlier foreign investors and longer duration agreement may lead to achievement
of a more valuable experience and less uncertainties. Thus:
Hypothesis 9: FIEs with a great length of operation have a higher performance in terms of accounting return
and market growth than do FIEs with a short length of operation, other things being equal.
Project Type
In the body of FDI literature, very little research has directly analyzed the effect of project-type selection on
FIE performance in either market economy or non-market-economy context. As noted earlier, this
investment strategy variable is important to FIEs because it can influence FIE's application of venture's core
resources, receipt of monetary and nonmonetary treatments from local authorities, and accessibility of local
markets. Indeed, according to the Chinese State Council's provisions, the "export-oriented" or
"technologically advanced" type of projects are provided with the following further preferential treatments:
(a) exemption from paying labor subsidies beyond labor insurance, welfare costs, and housing subsidies;
(b) reduction in landuse fees; (c) exemption from the profit remittance tax; and (d) receipt of "priority" in
obtaining water, electricity, transportation, and communication services. Therefore:
Hypothesis 10: FIEs investing in technologically advanced or export-oriented types of projects have a
higher performance in terms of accounting return than do FIEs investing in other types of projects, other
things being equal.
Cross-Region-Location
The analysis of an influence of cross-region difference on FIE performance is an environment-specific
question. Earlier studies in Chinese FIE literature have investigated the effect of location across major large
provinces or metropolises, such as Shanghai, Shengzhen, and Beijing (Shan, 1991). No study to date,
however, has examined the regional location effect across such areas as open coastal cities, open
economic regions, and other areas within one specific province. This article will focus on the regional
location effect within the Jiangsu province.3 In fact, neither the level of economic development nor the
economic reform process is even across these cities. The open coastal cities and open economic regions,
referred to as "open areas," have historically been more developed economically and thus are able to
provide foreign investors with better infrastructures (transportation, communication, production, business
service, etc.) than nonopen areas. Moreover, open areas have been provided with greater autonomy and
authority by the central government to conduct economic activities. Furthermore, open areas generally
provide more Western-style business facilities and cultural atmosphere. Finally, FIEs located in open areas
are preferably treated in terms of income tax and other respects compared with those in nonopen areas.
For instance, income tax on FIEs established in the open cities along the coast is levied at the reduced rate
of 24%, whereas the rate for ventures located in nonopen areas is 33%. In addition, FIEs in open areas are
exempted from paying industrial and commercial consolidation tax (ICCT) for their (a) imported production
equipment, business facilities, building materials, and vehicles; (b) raw materials, spare parts, components,
or packing materials imported for producing export products; and (c) export products. In sum, open areas
are likely to be perceived as more efficient places than are nonopen areas. In light of the above
considerations, the following relationships are hypothesized:
Hypothesis 11: FIEs located in open regions have a higher performance in terms of accounting return than
do FIEs located in nonopen regions, other things being equal.
If-ETDZ-Location
Since October 1986, China has encouraged each city of both open and nonopen areas (down to the county
level) to set up one ETDZ in its own jurisdiction. Almost every city can thus be classified into two parts:
ETDZ and the rest of city. The ETDZ is often located near a harbor and is designed to attract foreign
investment in export-oriented and technologically advanced projects. Its emergence became the most
pervasive and substantial magnet to FDI in the past years. In these zones, export-oriented or
technologically advanced FIEs benefit from preferential treatment in a number of areas such as enterprise
income tax (EIT), customs duties, ICCT, and land rent. For instance, EIT is 15% for these types of FIEs in
ETDZs, 24% for their counterparts in the rest of city. Consequently:
Hypothesis 12: FIEs located within ETDZs have a higher performance in terms of accounting return and
export growth than do FIEs located outside ETDZs, other things being equal.
Equity Distribution
The contractual and wholly-owned FIEs can be regarded as two extreme cases of equity joint ventures. The
equity distribution will affect the ability and propensity of an FIE to influence environmental factors (Schaan,
1988). It has been shown that the degree of interdependence of a multinational network, and the relative
strength of an FIE's position within that network, has a negative effect on its vulnerability to host
government intervention (Poynter, 1982). This indicates that when an FIE is more interdependent on the
Multinational Enterprises (MNE) network, it will be relying less on the local environment and will hence have
a greater capability to reduce and avoid local risks and uncertainties. On the other hand, because the
foreign partner's control over local operations is positively related to its equity status (Shan, 1991), the
higher ownership hence will lead to the lower degree of dependence on local relationship for the FIE. As a
result, it is likely that the greater the portion of equity owned by foreign investors, the lower risks and
uncertainties of FIEs are assumed (Killing, 1983). Moreover, in developing countries, including China,
foreign investors are typically able to exercise somewhat greater control than their equity levels would
suggest (Beamish, 1993), ascribable to the nature of their contribution (e.g., advanced technology) or a
more sophisticated knowledge of the control mechanisms available (Schaan, 1988). This greater control as
a result of competence advantages and managerial efficiency may lead to a better asset efficiency than
otherwise could be. In light of the above discussions, the following relationship is hypothesized:
Hypothesis 13: FIEs in which foreign investors own a dominant share have a higher performance in terms of
accounting return than do FIEs in which foreign investors own a nondominant share, other things being
equal.
RESEARCH DESIGN
A difficulty in conducting research on business in China is the scarcity of reliable data. Only in recent years
has China begun to make data available on foreign investment activities. However, current state databases
regarding foreign investment reflect only some aggregate figures about FDI activities. The firm-specific
financial data are available only from the local authorities, such as commissions of foreign economic
relations and trade, foreign exchange administrations, and taxation bureaus. Foreign researchers who
attempt to gain access to this resource for the survey purpose can obtain it through contacting numerous
local state-owned international consulting companies.
In this study, cross-sectional data for 127 random FIEs from 1989 up to 1991 in Jiangsu Province were
obtained from the Provincial Commission of Foreign Economic Relations and Trade. Nevertheless, the data
on 7 FIEs included in this study are incomplete. To remedy this limitation, an empirical measure has been
used, that is, missing values are tested by using the pairwise deletion method (compute the
covariance/correlation matrix using pairwise information). Among these sample firms, 59 are invested by
Western multinationals, the remaining 68 are funded by those coming from developing countries.
Jiangsu now ranks second in China in terms of gross domestic product (GDP) and level of foreign
investment absorption, as reflected in the number of foreign invested ventures and the total volume of
foreign capital. According to the National Council for US-China Trade (1991) report (Washington, DC), the
policies, rules, and measures adopted in Jiangsu province vis-A-vis FDI have been widely applied
elsewhere in the country, suggesting a fair representativeness of the province for the country.
The time frame of this analysis (1989-1991) is appropriate because this horizon is an overall operating
rather than start-up phase nationwide as far as foreign investment is concerned. The government policies,
rules, and regulations concerning foreign investment are much more exhaustive during the period. Although
the Chinese business settings are highly dynamic, this time frame indeed represents a picture of what is
happening today.
Specifically, the data are based on a survey of sampling FIEs' external financial statements (including
related notes) that ventures are required to submit to the above commission. These statements are: 01
Balance Sheet, 02 Income Statements, 03 Detailed Sheet of Expense and Expenditure, 04 Detailed Sheet
of Goods Sold. According to the government requirement, these statements were officially audited by the
independent certified public accountants before they were submitted. The Chinese FIE financial standard
and accounting principles are quite similar to the generally accepted accounting principles (GAAP) of the
United States. The data on industry sales growth are obtained from three consecutive years' China
Statistical Yearbook (19891991). Other secondary data are surveyed from three years' Annual Statistics
Report of Jiangsu Province (ASRJP) from 1989 to 1991, published by Jiangsu Statistical Bureau. The
variable code, measurement, and calculation are summarized in Table 2.
RESULT AND DISCUSSION
Forward selection regression (Table 3) and general linear model (GLM) statistics (Table 4) provide the
following results.
BUSINESS STRATEGY
Quality and pricing. Product quality (QUAL) is a significant variable positively affecting all four performance
measures, whereas the pricing measure is significantly and inversely associated with domestic sales growth
(SGR). This means that lower pricing policy relative to the dominant competitor will enhance the growth
level of domestic sales. It supports an argument that Chinese consumers tend to value low cost over other
product attributes, despite a tremendous growth in real purchasing power (Mahatoo, 1990). Moreover,
pricing is significantly interacted with length of operation (Table 4), suggesting that the FIE's pricing policy is
associated with its product life cycle in China. Therefore, both Hypothesis 1 and Hypothesis 2 are
supported.
Enlarge 200%
Enlarge 400%
TABLE 2
Advertising and R&D intensity. Inconsistent with the above prediction, advertising (ADVT) is found to have
no significant influence on FIE performance except a moderate positive effect on sales growth. Therefore,
Hypothesis 3 is only partially supported. The high cost (FIEs pay foreign exchange and at a higher rate,
whereas local firms pay Chinese yuan and at a lower rate) and quality of advertising may explain the
rejection of positive association between advertising and profitability. R&D intensity demonstrates a
marginally significant influence on FIE performance. Although positively associated with market measures,
R&D intensity is negatively related to accounting performance. Because the majority of sampling FIEs of
this study were set up after 1984, the time frame of this study might not be a thoroughly mature period to
achieve the R&D return yet. As a result, R&D has begun to stimulate a firm's domestic sales and export, but
it seemingly needs more time to accomplish a positive return for FIEs from sampling units' perspective. Yet,
according to Table 4, the interactions of R&D intensity with length of operation and if-zone-location are
statistically significant, suggesting that R&D intensity is likely greater in, or more important to, those firms
that are either located in ETDZs or have an earlier timing and longer duration. Accordingly, Hypothesis 4 is
partially supported. Size, sales force, and credit. As shown in Table 3, firm size (SIZE) has a significant
positive impact on ROI, domestic sales, and export growth. Hypothesis 5 is thereby supported. Indeed,
greater size implies an ability to benefit from economies of scale and scope and to invest in advanced
equipment and technology. These are among the competencies needed for foreign investors to outperform
the Chinese local firms. Tables 3 and 4 reveal that sales force expenditure (SFMK) and domestic accounts
receivable growth (DARL) have a significant and positive effect on accounting return and domestic sales
growth. Thus Hypothesis 7 is fully supported, but Hypothesis 6 is not. Contrary to our preceding proposition,
accounts receivables growth is found to have a significantly positive influence on profitability. This result can
seemingly be explained by the fact that (a) FIEs have maintained relatively better credit customer network in
general, (b) negative impact on profit has been excessively offset by extra sales gross margin, or both.
INVESTMENT STRATEGY AND ITS INTERACTION WITH BUSINESS STRATEGY
Industry selection. As shown in Table 3, industry sales growth has a significant and positive impact on ROI,
ROA, and domestic sales growth, but negative influence on export growth. Hypothesis 8 is hence
supported. As a reflection of the imperfection of industry structure in China, a particular industry may
experience a sudden burst of sales growth. When this happens, FTEs may tend to exploit the rapid local
expansion rather than to export. In addition, Table 4 presents that the industry structure variable interacts
significantly with certain, but not all, business strategy variables. Thus industry structure has not been
independently affecting FIE performance. Specifically, industry growth is apparently interacted with R&D,
advertising, and pricing; and these interactions have a strong and favorable effect on FIE's accounting
return and local market growth. According to the typology of Sharma, Durand, and Gur-Arie (1981), the
above evidence suggests that industry growth is a quasi-moderator that moderates the form of relationships
between these business strategy variables and a firm's return and sales growth.
Investment timing. Length of operation (LEOP), a proxy of timing of investment, is found to be positively
related to all four performance measures at a significant level. Thus Hypothesis 9 is supported. This
demonstrates that earlier movers and longer presence in the Chinese market can help ventures gain a high
accounting and market performance after trading off both advantages and disadvantages. This evidence
corroborates with previous studies based on market economies with respect to preemptive investment
effect (e.g., Lambkin, 1988; Mascarenhas, 1992) and international expansion learning effect (Kogut, 1983).
Table 6 also reflects that length of operation significantly interacts with R&D intensity, advertising, and
pricing policy on either accounting return or market performance. This suggests that LEOP is also a quasimoderator affecting the form of relationships between FIE performance and its pricing, advertising, and
R&D intensity.
Project-type selection. This study finds no systematic linkage between type of products (TYPE) and FIE
performance, except that import substitution (IS) is marginally associated with accounting return. Thus
Hypothesis 10 is rejected. This result seems to indicate that the incentives offered by the Chinese
government may not influence foreign investment decisions. Strategic orientation of a foreign venture is
important for its growth. However, its effect may not be fully mirrored in the performance dimensions
examined in this study. For instance, the project orientation could possibly influence the degree of
interdependence of the venture on local settings, thus determining the operational risks facing the venture.
Location selection. Tables 3 and 4 suggest that project location in ETDZ is significantly and positively
related to FIE's export growth. Hence Hypothesis 12 is supported as far as export growth is concerned.
However, cross- region-location (REGN) does not appear as a necessary condition for FIE's successful
performance, because they have no significant influences on any one of four dependent variables.
Therefore, Hypothesis 11 is rejected. The major reason for the rejection of Hypothesis 11 is that (a) the
central government has in recent years adopted a more uniform policy toward different regions, and (b) an
infrastructure-worse region tends to furnish more attractive treatment to foreign investors than open coastal
areas to offset its infrastructure disadvantages.
Sharing arrangement. Sharing distribution (SHAR), measured by the equity percentage owned by a foreign
investor, has no significant impact on FIE performance, leading to a rejection of Hypothesis 13. One
explanation for the rejection of Hypothesis 13 is that firms differ in their perception of, and ability to take,
risks and manage uncertainties. Because an increasing number of diversified large MNCs entered into the
Chinese market, the firms with more global experience are likely to be less risk averse and to have greater
capability to manage risks and exposures. As a result, share control may no longer be a necessary
prerequisite, nor a single efficient option to monitor their risks and uncertainties in this situation. This
evidence seems supportive to Awadzi (1987) and Kogut (1988), who found no relationship between equity
control and firm performance in the market economy context. This result should be interpreted with caution
because the "percentage" measurement approach cannot capture whether or not "split" equity status
outperforms other types of arrangements. According to the interaction shown in Table 4, with few
exceptions, SHAR, REGN, and TYPE neither significantly interact with business strategy variables nor
significantly influence the performance measures independently. This demonstrates that in most cases, they
are homologizers that only moderate the strength, rather than the form, of the relationship between
predictors and criteria. This strength will depend on the size of error variance when partitioning the total
sample into homogeneous subgroups. The study leaves the solution to this problem to future research.
In addition, Table 4 displays that the aggregate multivariate effects from the whole explanatory factors on
accounting return and domestic sales growth are statistically significant. Particularly, the aggregate impacts
on domestic sales growth appear to be the greatest, whereas they are not significant on export growth.
SUMMARY OF THE FINDINGS
This article examines the impact of both business and investment strategy variables on the
multidimensional performance of foreign-invested enterprises in China. The findings of this study are
summarized here. First, among business strategy variables, sales force promotion and preferential terms of
payment have significant and positive influences on FIEs' accounting and market performance. The study
also demonstrates that product quality, pricing, and firm size affect FIE performance significantly, whereas
R&D intensity and advertising are either not systematically linked with venture performance or negatively
related to certain dimensions of FIE performance. Second, among investment strategy variables, industry
selection, if-zonelocation, and timing and duration of investment are significant ones, influencing both
accounting return and market growth of foreign ventures. This result supports a theoretical view that
multinational firms can attain their internationalization and internalization advantages by exploring the
benefits derived from market imperfection, location advantages, and organization learning and adaptation
(Buckley & Casson, 1988). Third, interactions between business and investment strategy variables are
evident; in particular, timing of investment and industry selection are significant quasi-moderators that
moderate the form of relationships between some business strategy variables such as pricing, R&D
intensity, and advertising, and FIE performance. This result confirms our earlier claim that FDI is an ongoing
process in which antecedent decisions (investment strategy variables) can mediate or intervene in the form
or strength of the relationship between concurrent decisions (business strategy variables) and outcome
(venture performance). Finally, different business or investment strategy variables have varying influences
on heterogeneous dimensions of venture performance. The correspondence between strategic roles by
foreign ventures and investment and business strategies is of paramount importance to the success of
foreign businesses. The same conclusions could possibly be drawn in other transitional countries,
especially those that have some commonalities with China. However, additional tests are needed to verify
these conclusions in the context of other transitional economies. The study leaves this question open for
future research.
The primary goal of this empirical study is to begin to investigate the systematic relationship between
business and investment strategy variables and foreign venture performance. This is seen by the
researcher as central to a better understanding of the issue of foreign venture performance. What this study
does not address, and was not designed to address, is the question of the effect of local investors' strategy
and characteristics on equity-joint FIE performance. This, however, is an area worthy of examination
because local partner selection can influence overall mix of available skills and resources, operating
policies and procedures, and short- and long-term variability of a foreign venture (Harrigan, 1988). This
question is proposed as an agenda for future research.
PRACTICAL IMPLICATIONS
The present study has important managerial lessons for international executives active in the Chinese
market. First, foreign investors should attach the utmost importance to the host country-specific business
variables, which can systematically affect all the dimensions of venture performance. Two guanxi-related
business determinants, sales force marketing and credit liberalization, are found to have a significant
influence on all the major aspects of venture performance. Indeed, it has long been recognized that a key
difference between Chinese and Western business practices lies in the relative importance of guanxi in the
former, as opposed to the specification and enforcement of contracts in the latter. It is clear that the
Chinese market cannot be tackled effectively and efficiently today without paying due attention to the
construction and maintenance of good guanxi. Second, foreign investors must gauge different effects of
certain home market-used business variables in a host market. For instance, inconsistent with the reports
based on the market economy environment, advertising and R&D intensity are not significantly associated
with firm efficiency or market growth in the Chinese context. With the constraints of limited resources,
foreign investors need to accommodate their business strategies to the local market conditions in the host
country. Third, transnational investors should devote their attention to the match between business and
investment strategies. A good match between FIE-level business strategies and parent-level investment
strategies could engender high sustained profitability, local market expansion, and risk reduction for
investors. A realistic and effective planning and control system at the parent level is essential to this end.
Fourth, all the investment strategy variables that this study examines are essential in practical business
situations. Each investment strategy variable, however, affects FIE performance differentially. For example,
sharing arrangement is not found as significant as investment timing and industry selection in relation to
major dimensions of firm performance. An in-depth understanding of means-end correspondence between
parent's investment strategy and FIE performance is of fundamental importance to transnational investors.
Finally, the objective performance measures designed in this study are also of value in practice. Those
multidimensional measures are relatively thorough and readily operationalizable. In short, it is hoped that a
general guideline is offered on how to effectively link a foreign investor's strategic goals with FIE
performance and how to adopt business and investment strategies that are most likely to help realize
specific objectives.
[Footnote]
NOTES
[Footnote]
1. According to China's statistical approach, compensation trade, international leasing, and processing and
assembling are also included in foreign investments. In fact, these investment forms neither involve the formation
of legal entities nor represent major forms of foreign direct investment (FDI) (only 0.99% of total FDI in 1994). As
a result, in examining FIE performance, we do not deal with these forms.
2. The definition of "advanced technology" explained by the Ministry of Foreign Trade and Economic
Cooperations (MOFTEC), People's Republic of China (PRC), is very obscure. In practice, foreign investors need
to check with local authorities about whether or not their technologies belong to "advanced."
3. In Jiangsu province, PRC, open coastal cities (OCCs) include Nantong and Lianyuangang; open economic
regions (OERs) include Nanjing, Suzhou, Wuxi, and Chanzhou.
[Reference]
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[Author Affiliation]
The author would like to thank two anonymous reviewers for their helpful comments. This research is supported,
in part, by the Research Relations Fund, University of Hawaii.
[Author Affiliation]
Yadong Luo (Ph.D., Temple University) is an assistant professor of international management in the College of
Business Administration at the University of Hawaii. He teaches strategic management, multinational
management, and Chinese management at the undergraduate and MBA levels. His research interests are in the
area of international management, with a focus on global strategy, international cooperative ventures, foreign
direct investment, and Chinese management. His recent research has appeared in such journals as Journal of
International Management, International Business Review, Management International Review, The International
Executive, Long Range Planning Business Horizons, Bulletin of Economic Research, and Asia-Pacific Journal of
Management, among others. He served as a provincial official in charge of foreign direct investment and
import/export administration in China.