Penrose’s theory of the firm in an era of globalisation

ABSTRACT

Penrose analysed why some firms succeed in growing – what the factors are that enable growth, and the ways in which success can breed success, with enhanced capabilities enabling growing market share (or sales), and with increased revenues and profitability enabling those capabilities to be further developed. There is a separate question as to why firms expand their operations internationally. In this paper, we analyse a sector that in Edith Penrose’s day operated almost exclusively domestically, namely the ‘consulting engineering’ sector. We consider why firms in this sector are now increasingly operating internationally. In doing so, we consider whether the factors identified – by Penrose and others – as causing firms to grow are also relevant to the expansion of these firms overseas. Our findings support Penrose’s Resource-based Theory, which argues that unique strategic resources that are inimitable and non-substitutable can provide firms with competitive advantages. Internationalisation provides consulting engineering firms with the opportunities to explore and obtain different kinds of expertise and resources from other regions. With a larger pool of expertise to draw from, firms can develop their firm-specific strategic assets and technical advantages.

KEYWORDS:

• Penrose
• mutinationals
• transnationals
• globalisation

JEL CLASSIFICATION:

• D21
• D22
• D23
• L25
• L84

1. Introduction

What causes firms to grow, and what causes firms to expand their operations overseas? These are important questions, which are related yet distinct. The question as to why firms grow, and what causes this growth, has always been a fundamental question for economists. Central to Adam Smith’s discussion of the Wealth of Nations was the process by which the growth of the firm created the basis for the increased division of labour which in turn enabled and facilitated productivity growth and hence cost reductions, with the concomitantly lower prices enabling increased sales, in other words increased markets (whether increased market share or an expanded market, or both). This theory linking the division of labour and the extent of the market was conducted implicitly within a national context. Competition between firms was implicitly assumed to be between firms within the locality or region. Similarly with Marshall’s analysis of industrial districts: these were implicitly regions within the country.

Penrose’s work likewise analysed and described why some firms succeed in growing – what the factors are that enable some firms to succeed, and the ways in which success can breed success, with enhanced capabilities enabling growing market share (or sales), with increased revenues and profitability enabling those capabilities to be further developed. All the above analyses, from Adam Smith to Edith Penrose, can be pursued within the context of a national economy.

There is then a separate question of why firms expand their operations internationally and globally. In this article, we analyse a sector that in Edith Penrose’s day did indeed operate almost exclusively domestically, with none of the companies in the sector operating much overseas, namely the ‘consulting engineering’ sector. We consider why firms in this sector are now increasingly operating internationally and globally. In doing so, we consider whether the factors identified – by Penrose and others – as causing firms to grow are also relevant to the expansion of those firms overseas and globally.¹

We also consider the nature of firms’ decision-making regarding the international location of their activities, and their choice as between co-operating with other firms already based in overseas locations, as opposed to establishing their own overseas subsidiaries. We analyse these issues using existing data sets, and by analysing data generated through our own questionnaire surveys and follow-up interviews. Williamson (1975) in his Transaction Cost Theory argues that it is likely for firms to internalise the transaction within its own organisation and structure of governance when they are faced with the risk of opportunism by other parties, when there are limited numbers of partners to choose from, and uncertain or complex market condition. Dunning (1989) in his research on the importance of transaction costs in explaining the growth of multinational service activities, finds that foreign direct investment tends to be the preferred entry mode for professional services activities rather than by contractual relationships due to the risk of imitation once competitors have access to the knowledge and geographical diversification which provides advantages to firms. We research the choice of foreign direct investment (FDI), joint venture (JV), and acquisition. Rugman (1979), and Miller and Pras (1980) argue that foreign operations stabilise overall returns due to the fact that different economic conditions tend to be uncorrelated across different international markets; we also study the effect of internationalisation on firm performance.

2. The literature

Penrose (1959) argued in The Theory of the Growth of the Firm that while firm size is a by-product of growth, there is no necessary limit to the growth of firms, which will depend rather on ‘enterprising managers’ and administrative effectiveness, whilst being limited by the extent of the growth of knowledge within the firm. Thus, Penrose argued that the growing experience of management, its knowledge of the resources within the firm, and the potential of using these in different ways, creates opportunities for further expansion of the firm. For Penrose, there is no necessary reason why a firm should limit the prospects of growth and productive opportunities to its existing markets, and from this follows a theory of diversification where firms may expand internationally when the existing market becomes less profitable and the prospect of new markets become more attractive. Hence, The Theory of the Growth of the Firm sets out the forces that would lead one to expect firms – including consulting engineering firms – to expand internationally, and what the factors are that both encourage and restrict that process.

Dunning’s Eclectic Theory explains the influence of ownership (O), location (L) and institution (I) advantages on the international production of firms, postulating that firms must possess advantages specific to the nature or nationality of their ownership to compete with local firms of the host country, and these advantages must be sufficient to compensate for the cost of setting up and operating in host countries. Dunning (1988) and Kogut (1985) argue that firms carry out international operations if there are transaction gains likely to result from the common governance of activities in different locations, including enhanced arbitrage and leverage opportunities, market hedging, better coordination of financial decisions, multiple-sourcing strategy, the possibility of gains through transfer price manipulation, leads and lags in payments, and so on. There are also long-term factors which will influence whether firms invest in foreign countries such as the size of the domestic market, geographical distance between the home country and its market, psychic distance, and the industrial structure of investment (Dunning 1979). The ‘internalisation theory’ of Buckley and Casson (2009) posits that firms will internalise the market when the expected benefits of doing so outweigh the expected costs, and that this will be influenced by exogenous factors such as policy changes and technological improvements, which may thus encourage the globalisation of firms.²

There are similarities between the Eclectic Theory, the Transaction Cost Theory and the Internalisation Theory in explaining the root cause of the internationalisation of firms, where the focus has been predominantly on lowering transaction costs or achieving cost efficiency and to protect and utilise firm specific advantages. The key motives for consulting engineering firms (CEFs) to internationalise are for market seeking and future growth, and to gain transaction cost benefits and improve cost efficiency via production in lower cost countries. Thus, this paper focuses on both the tangible and intangible benefits which encourage the internationalisation of services firms, such as the desire to develop a global brand, and enhance their international reputation. Firms capitalise on their internationalisation activities to develop further firm-specific advantages, and thus to increase the resilience of their business operations.

The Real Options Theory and Penrose’s The Theory of the Growth of the Firm argue that internationalisation provides firms with options for future growth due to the increase in market size. Internationalisation may provide firms with opportunities to develop their position in the international market, to capitalise on their global branding, and increase their resilience in the face of different economic cycles in different world regions. The internationalisation of consulting engineering firms has been a strategic response of firms to international market opportunities, not merely a process of optimising transaction costs or protecting firm-specific advantages – rather, it has enabled firms to augment their firm-specific advantages and promote future growth.

The 1977 Uppsala Model and Real Options Theory suggest that a foreign direct investment (or organic growth) strategy provides firms with the opportunity for incremental investment and learning when internationalising. Contractor, Kundu, and Hsu (2003), Lu and Beamish (2004) and Abdelzaher (2012) argued that professional services firms are more likely to follow a meore cautious internationalisation process due to the unique features of professional services. However, Buckley and Casson (2009) argued that firms can be born global and do not have to internationalise incrementally, which is relevant for consulting engineering firms since the capital investment involved in FDI for a consulting engineering firm is usually lower than for a manufacturing firm due to the nature of the services offered, enabling them to expand internationally at a more rapid pace. Also, information and communication technologies enable firms to set up a regional office to serve several countries within the same region at once, again leapfrogging the incremental expansion process.

Johanson and Vahlne (2009) in the context of the 2009 Uppsala model, argued that a firm’s internationalisation strategy is likely to be influenced by its existing relationships and networks, and that a functioning business relationship could be considered as an asset which can provide advantages to firms involved. This could be relevant to the internationalisation of consulting engineering firms, where firms have decided either to follow their client to invest abroad using the FDI strategy, or to involve a joint venture investment arrangement with their existing business partner to capitalise on the market knowledge or network of their client or partner. Johanson and Vahlne argue, in the context of the 2006 Uppsala Model on commitment and opportunity development, that an acquisition is more likely to be successful following exchanges between the acquirer and acquiree to establish the commitment between the two parties.

Brouthers and Brouthers show that the cost of governing a partner in a joint venture arrangement will have an impact on the survival of foreign subsidiaries. In the context of the entry mode choice of consulting engineering firms, the effect of transaction costs could become significant when firms are involved in international joint ventures (i.e. forming a consortium with other international competitors on large scale projects), or when firms are involved in mergers or acquisitions. The effect of transaction costs in governing an FDI is expected to be less significant for consulting engineering firms due to the nature of the services offered (i.e. there is no requirement to set up manufacturing facilities).

Williamson (1975) postulates that firms will internalise their transactions where there is a risk of opportunism by others. This argument highlights the importance of the level of control in affecting the internationalisation strategy of firms. A higher level of control is required where the investment involves the intellectual properties of firms, and where there is also a high risk of appropriation by others. This is particularly important for consulting engineering firms due to the nature of the services provided and the intellectual properties involved in the process.

Johanson and Vahlne (2009) argue that the lack of knowledge of firms during internationalisation may affect their perception of the cost of internationalisation. The Real Options Theory argues that real options provide firms with the flexibility of whether to undertake any future investment when new information becomes available. The International Diversification Theory postulates that a multinational corporation has a lower systematic risk relative to similar domestic firms. Rugman (1979), and Miller and Pras (1980) propose that foreign operations have the effect of stabilising overall returns of firms, as economic conditions tend to be uncorrelated across different international markets.

3. Research questions and methods

It is clear that when it comes to the theory of the growth of the firm into overseas markets, a key gap in our knowledge arises from a comparative lack of detailed analysis and application of theories of multinational (or transnational) enterprises to knowledge intensive service sector industries, as compared with production sectors. This paper therefore considers why firms internationalise, what are the factors affecting their internationalisation strategies, and how internationalisation affects the performance of – and risks faced by – firms, focussing specifically on the ‘consulting engineering’ sector.

Financial data for UK based consulting engineering firms were obtained from the FAME database. In addition, questionnaires were distributed to the top 50 UK-based consulting engineering firms (ranked by total revenue), with follow up interviews to collect information on factors affecting the firm’s internationalisation decision. Questionnaire returns were received from 20 firms (a 40% return). Of these, 70% (fourteen firms) participated in the follow-up interviews.

4. Results: factors driving internationalisation

Globalisation has changed the landscape of the professional services sector. Historically professional services firms were small local organisations where services were delivered locally to consumers. To serve clients who are themselves already global, services firms are building their integrated ‘global professional networks’ so that they can provide services in countries which their clients operate (Brock 2012).

We analysed the financial data of the top 50 UK based consulting engineering firms, finding 55% received over 50% of their income from overseas activities. We found a positive correlation between internationalisation and firm performance. The question of why they internationalise, and the factors affecting the internationalisation outcomes were then put to the top management of consulting engineering firms via a questionnaire, with follow-up interviews to gather further information and insight. These interviews revealed a series of internal and external factors promoting internationalisation: internal stimuli factors included to provide growth options or opportunities for future growth; increase performance, turnover and profitability; gain or increase international economic and technical advantages through internalisation; gain or increase international competitiveness and market share; develop or enhance international reputation and brand image; reduce risk through achieving greater geographical diversification; and support global clients. External stimuli factors included competition in the domestic market, the home market economic condition, and the economic growth of foreign regions. This is consistent with Barkema and Vermeulen (1998), Hitt, Hoskinson, and Kim (1997), Lu and Beamish (2001), and Vermeulen and Barkema (2001), who suggest firms internationalise to seek revenue growth opportunities, compete against global competitors, increase market power, support global customers, access global knowledge leading to stronger capabilities and innovation, and achieve efficiency in managing value-chain activities through economies of scale and scope.

Firms were asked to rate the importance of having an overseas presence based on the following factors, with 1 being the least significant and 5 being the most significant: turnover, market share, profitability, brand image, reputation, overall performance, and future growth. All had an average score of 3.5 or above, with a median and mode score of 4 or above. Firms perceived internationalisation as a long-term investment strategy that provides opportunities for the future growth of their firms. ‘Brand image’ and ‘reputation’ had mean scores of 4.26 and 3.96 respectively. Our questionnaire data were then analysed using the Likert-type Scale Method based on a sample of 25 respondents: the S score is obtained by summation across all the weighted categories; N is the number of respondents; r is the number of equally-spaced categories; V is the variance; and the Z score is calculated as: Z = (S-(N(r + 1))2)/(√N(r²-1)/12). Table 1 summarises our results:

Table 1. Summary of qualitative research analysis.

The importance of having an overseas presence
	Average scores	Likert-scale analysis Z-scores
Turnover	3.92	3.32 (p-value= 0.0005)
Market share	3.50	1.91 (p-value= 0.0281)
Profitability	3.54	2.05 (p-value= 0.0202)
Overall performance	3.92	3.18 (p-value= 0.0007)
Brand image	4.26	4.40 (p-value= 0.00003)
Reputation	3.96	3.46 (p-value= 0.0003)
Future growth	4.58	5.59 (p-value= 0.00003)

4.1. Market seeking

The internationalisation of services firms can be reactive (demand-oriented) or proactive (market-seeking) (Majkgard and Sharma 1998; Sharma 1989; as cited in Krull, Smith, and Ge 2012). The reactive strategy is sometimes referred to as the ‘client following strategy’ where firms follow and customise their services to a key client’s requirement to invest overseas. Professional services firms are often dependent on a set of key clients whom they are likely to follow into new markets. Cohen (2007), Inkpen and Ramaswamy (2005) and Abdelzaher (2012) have highlighted the benefits for firms of the ‘client following strategy’. Firms were asked in the questionnaires the significance of ‘turnover’ and ‘market share’ in their internationalisation decisions. The Z score of 3.32 is significant at .01 level and the value of S = 98 is significantly greater than the expected value of E(S) = 75. So, increasing the turnover of their firms is one of the factors driving their overseas presence. And with a Z score of 1.91 significant at .01 level and the value of S = 88 significantly greater than the expected value of E(S) = 75, increasing ‘market share’ was a significant motive. Firms reported that internationalisation also increased opportunities in the home country, providing services required by foreign clients in the home country market. The proactive strategy emphasises that firms create competitive advantages by actively seeking new markets and clients (Bagchi-Sen and Kuechler 2000; Erramilli 1990; Erramilli and Rao 1990).

4.2. Efficiency seeking

The interviews indicated a key reason to expand internationally is for efficiency enhancement. Internationalisation provided firms with a higher degree of human asset fluidity and efficiency. Due to the different economic cycles in different world regions, firms with international offices have the flexibility of moving work around different world regions to improve their resource and cost management, providing firms with a higher degree of resilience during economic downturns.

4.3. Strategic asset seeking

Strategic asset seeking foreign direct investment relies on the intellectual capital of firms being located in more than one country, and that it is economically preferable for firms to acquire or create these assets outside, rather than within, their home countries (Dunning and Lundan 2008). According to ‘resource-based theory’, firms gain competitive advantage by possessing unique strategic resources that are inimitable and non-substitutable. This includes firm-specific resources, capabilities, competencies, and access to markets (Barney 1991; Barney, Wright, and Ketchen 2001; Peng 2001; Teece 2009).

4.4. Ownership advantages

Firms were asked about the importance of internationalisation in enhancing their ‘reputation’, for which the Z score of 3.46 was significant at .01 level and the value of S = 99 is significantly greater than the expected value of E(S) = 75. Porter (1980, cited in Child, Faulkner, and Tallman 2005) argued that the relative position that firms occupy within their industry’s structure determines the generic strategies that are the most viable and profitable for them. Firms were asked in the questionnaires the importance of internationalisation in enhancing the ‘brand image’ of firms. The analysis indicates the Z score of 4.40 is significant at .01 level and the value of S = 102 is significantly greater than the expected value of E(S) = 72. Our interviews confirmed the importance of being internationally recognised. Working internationally with signature architects and global clients provides firms with international portfolios and brand building opportunities. Aronson (2007), in his research on the upsurge in mergers of services firms, provided a similar argument, rejecting the claim that internationalisation is simply a response to client demand for global service delivery or ‘one-stop shopping’ – he argues that the difficulty in measuring the quality of services means professional services firms have to compete on the basis of reputation.

Knickerbocker (1973), and Graham (1978, cited in Li and Guisinger 1992) suggest that MNEs often adopt a ‘follow the leader’ or ‘exchange of threats’ in their foreign investment strategy to secure competitive advantages over their competitors or as a defence strategy against their competitors. The ‘Industry-based view’ argued that the right positioning of firms in the industry leads to their competitive advantages (Krull, Smith, and Ge 2012). Internationalisation also provides consulting engineering firms with the access to different types of expertise from other world regions, and it is an effective strategy for firms to gain or secure their international competitiveness. This is consistent with Inkpen and Ramaswamy’s (2005) argument that gaining access to knowledge outside the home country is often a strategic necessity for survival in the knowledge-based industry.

4.5. International diversification

Interviews revealed a main reason for cross-border investment is for risk diversification and mitigation. This is consistent with Rugman’s Risk Diversification Theory (Rugman 1979), which suggested that MNEs will normally prefer to geographically spread the portfolio of their foreign investments. International investments provide options for firms to deal with unanticipated changes that would otherwise pose risk (Sanchez 1993, 1995). For example, firms with offices in Asia and Australasia were able to bring work back into the UK from countries with stronger growth, such as China and Australia, during the UK recession in 2009. Building on Real Options Theory, networks of international investments of firms provide valuable options for addressing uncertainty in any given market (Allen and Pantzalis 1996; Tang and Tikoo 1999). The multinational investments of MNEs can be viewed as a collection of valuable options that permit the choice of moving activities from one country to another (Kogut and Kulatilaka 1994).

4.6. Growth options and future growth

Internationalisation provides growth opportunities by deploying resources and capabilities in new areas (Canals 1999). Firms were asked about the importance of internationalisation for firm growth, with the Z score of 5.59 significant at .01 level and the value of S = 114 significantly greater than the expected value of E(S) = 75. Kogut (1983, 1989) stresses the importance of international firms having options to tap into growth opportunities in different countries which firms with only domestic operations do not.

4.7. Optimum size of firm

The literature shows that firm size has a positive impact on the international behaviour of services industries (Terpstra and Yu 1988; cited in Li and Guisinger 1992). Our interviews confirmed that internationalisation provides firms with opportunities such as access to funding, and bigger bases to absorb risks. These factors enable larger firms to make investments in high risk, unexplored markets to gain first-mover advantage – as with Kulatilaka and Perotti’s (1998) study of strategic growth options, where under uncertainty and imperfect competition, firms that make early investments in a new market can gain a competitive advantage by pre-empting future growth opportunities.

5. Internationalisation strategy

Entry mode choice is contingent on a range of factors including the level of ownership or control, the level of commitment, firm size, the level of risk, international experience, market size, psychic distance and the nature of local market and competition (Rosenbaum and Madsen 2012; Hsieh, Shen, and Lee 2010; Madhok 1996). Entry modes with a higher degree of control will provide safeguards against opportunism (Oxley 1997, 1999; Williamson 1985). Rosenbaum and Madsen (2012), researching the foreign entry mode choice of professional services firms, find firms prefer high control entry modes when there are uncertainties, such as when partnering with unfamiliar firms and when the services delivered involve a high degree of tacit knowledge. Erramilli and Rao (1993) observed that firms have a lower tendency to share the control of their foreign operation if it involves high-intensity capital investment. Erramilli (1991) postulates a U-shape relationship between experiential knowledge and the tendency of firms to adopt high control entry modes during internationalisation. Daniels, Ogram, and Radebaugh (1976) and Shetty (1979, cited in Erikson et al. 1997) report a shift toward licensing and joint ventures as the experiential knowledge of firms grew. Davidson and McFetridge (1985) and Hedlund and Kverneland (1985, cited in Erikson et al. 1997) showed a decrease in the reliance on wholly owned subsidiaries as the foreign experience of firms increases. International business scholars such as Contractor, Kundu, and Hsu (2003), Lu and Beamish (2004) and Abdelzaher (2012) argue that professional services firms are more likely to follow a cautious internationalisation process. Our interviews certainly indicated that the entry mode choice and internationalisation strategy of firms are influenced by the nature of the services offered, and the market and the client it is targeting.

Consulting engineering firms were asked in our questionnaire to provide information on the entry mode choice of their international investments, and about the number of acquisitions, joint ventures and foreign direct investments they had been involved with. Foreign direct investment was the most frequently used entry mode (73 in total), followed by acquisition and joint venture (with a total of 69 each). There was no consistent influence of firm size on entry mode choice.

5.1. Internationalisation stages

Based on our interviews, the internationalisation process of firms consists of four stages: exploration, initial implementation, consolidation, and growth. Internationalisation strategy of firms could be either systematic or ad-hoc. The systematic approach includes conducting formal strategic planning and market research, considering different countries and entry modes, and developing risk management strategies for long-term investment. However, there are occasions where consulting engineering firms were required to adopt an ad-hoc internationalisation strategy, such as when the firm has to follow an existing client, or where a firm is faced with competition and ad-hoc investment is required in order to protect the firm’s advantages.

5.2. International joint venture (IJV)

Dunning (1993) defined cooperative alliances as cooperative relationships between firms, rather than market or hierarchical relationship. Child, Faulkner, and Tallman (2005) refer to cooperative strategies as attempts by firms to realise their goals through cooperation. Cooperative alliances provide firms with the opportunities to have a pool of complementary strengths and to secure creative synergies between them. The rationale behind the cooperative strategy is that it allows firms the opportunities to seek particular competencies or resources that they lack, by securing the competencies through links with other firms. The cooperative alliance also makes it easier for firms to gain access to new markets, and to acquire opportunities for mutual learning and internalising of knowledge flow without incurring the full set-up costs of a merger (Buckley and Casson 1996). For example, firms may gain access to the partner’s advanced technology, or may share the cost of developing new technologies through research and development. Child, Faulkner, and Tallman (2005) argue that cooperation with competitors may enhance a firm’s position in the industry – it could be a defensive alliance against dominant firms, or an offensive alliance with stronger competitors. There are also scenarios, for example in some developing countries where partnering with local firms is the only way of entering the market.

For Child, Faulkner, and Tallman (2005) and Kanter (1989), alliances are partnerships between firms which are normally formed as a strategic response to major challenges or opportunities that the partners face. There are three fundamental types of alliances: Multi-company service consortia – normally to create a pool of resources to meet the requirement of large-scale activities; Opportunistic alliances – where each partner supplies the competencies that the other lacks; and Stakeholder alliances – usually between companies at different points of the value chain.

Our interviewees reported the following stimuli factors for IJVs. Firstly, internal: Economic advantages – partnering firms share resources and costs to achieve economies of scale and to lower transaction costs through vertical integration; Risk sharing – notably in terms of capital requirements, and the opportunity to spread financial risk; Complementary alliance and resources dependency – sharing of technical or niche technical resources; Risk mitigation – IJVs were predominantly project-specific, providing firms opportunities for a swift withdrawal from the investment when required; Strategic advantages – to gain access to the partnering firm’s specific assets, or to gain complementary skills and technical expertise; Geographical coverage – IJVs provide firms with a wider geographical presence. Secondly, external: IJV reduces the capital investment of partnering firms in comparison to a wholly owned arrangement, therefore reducing the financial risk to firms; and restrictive government policy or other barriers to a foreign market, which an IJV may overcome.

The key findings from our interviews were largely consistent with the existing literature, such as Kogut (1989), Child, Faulkner, and Tallman (2005) and Faulkner (1995), where the basic motivations for a joint venture are to lower transaction costs, gain a strategic position and enhance market power, gain additional resources and acquire organisational learning opportunities, and to spread financial risk. However, interviewees also highlighted the ‘country factor’, where an IJV was seen as the only option to access the local market due to government policy and investment restrictions applied to foreign firms.

Firms may be able to get a large share of a market early on through an IJV (Child, Faulkner, and Tallman 2005). There are two common motives for IJV arrangement by consulting engineering firms: firstly, joint ventures with similar sized international or local competitors to access a local market or to bid for major international projects; and secondly joint ventures with local firms with good technical skills in lower cost developing countries to achieve cost efficiency in design production. Efficiency-seeking IJVs amongst consulting engineering firms in developing countries are becoming increasingly popular, with medium or small-scale consulting engineering firms using a joint venture with local firms in developing countries to set up production offices. Firms reported that while transaction costs would have an impact on the consideration for entry mode choice, transaction costs on their own is unlikely to be sufficient to determine the entry mode choice, and firms will take into consideration the intangible benefits of joint ventures, such as gaining fast-track access to a certain market, risk sharing, or acquiring resources.

One of the significant factors leading towards a joint venture strategy, as opposed to acquisition or FDI and organic growth, is the requirement of firms to limit risk. Child, Faulkner, and Tallman (2005) argue that globalisation and international economic uncertainties are stimuli for alliance formation. There are two main types of risks that consulting engineering firms face when internationalising: financial risks associated with the investment of firms when internationalising, and operational and reputational risks that arise due to insufficient local knowledge and experience when operating in the host country. Our interviews found that one of the main risks faced by firms when internationalising is having insufficient local knowledge and experience of operating in the market, including an insufficient understanding of the local client base, local institutional arrangements, and local design standards. Cross-border collaborations with local firms allow them to develop vital knowledge and capabilities for their operations in foreign markets and to acquire knowledge about international markets. This is consistent with Child’s, Faulkner, and Tallman (2005) argument that cross-border collaboration is likely to increase the chances of success of firms in foreign markets – and is directly and positively linked to the internationalisation of knowledge-based services firms.

Our interviewees reported that due to the cyclical nature of the economy across world regions and the inconsistency of the availability of opportunities, consulting engineering firms may require to be a ‘hunter’ (where firms bid for projects in a country and move on after completing the project), rather than a ‘farmer’ involving longer-term investment. The key advantages of IJVs is speed to set up, and being carried out on a project-by-project basis. This is consistent with Faulkner’s research findings (Faulkner 1995) where he reported that the speed to market is an important factor. Consulting engineering firms also viewed IJVs as a ‘transitory arrangement’ in a situation where there is a lack of knowledge or understanding of a specific market, the absence of a local network and when it is necessary for firms to cooperate with local firms to start working in the country. In an IJV arrangement, collaboration with local partners provides firms with opportunities to learn about the market and to access the local network of clients.

A joint venture may provide a firm with the opportunities to learn about a technology, product, or market in a way that allows the entrant access to some share of the current revenue stream, and full access to developing knowledge about the putative investment, all for a fraction of the investment of a full acquisition. The capital saved can be used for further investment in the future when uncertainties are reduced or when the investment offers a more positive future outcome. If the joint venture investment fails to perform, the firm has the option of selling the share to a third party or the joint venture can be dissolved. This has, therefore, provided firms with greater flexibility than does either outright ownership or an alternative involving no equity stake (Buckley and Ghauri 2004). Our interviewees saw cooperative alliances as an option for firms to learn more about the market with a relatively small amount of investment and without any major commitment. IJVs with local firms had provided them with opportunities to learn about the foreign market and as a preparatory strategy for setting up their own offices in the future, at a lower level of investment in comparison to greenfield investment or acquisition. IJVs provide firms with access to local networks of clients and the opportunity to understand local institutional arrangements.

5.3. Merger and acquisition

Kogut and Singh (1988) defined acquisition as ‘the purchase of stock in an already existing company in an amount sufficient to confer control’. Acquisition can be a strategic option for consolidation and reorganisation, as a vehicle for growth and could also be a form of cooperation strategy with other players in the industry (Faulkner, Teerikangas, and Joseph 2012). Interviewees reported gaining immediate access to a new market or opportunities as the main reason for acquisitions. Despite the increasing popularity of mergers and acquisitions in recent years amongst larger firms, the majority of firms interviewed indicated that acquisition is a less preferred strategy in comparison to the joint venture or foreign direct investment due to the risk of integration failure and the risk of diluting the company’s culture post-merger. This is supported by several other research studies of companies post-merger (King et al. 2004; Schoenberg 2006) – that acquiring firms create little or no value from M&A and most of the firms engaging in M&A activity did not achieve the sought-after performance targets. Interviewees reported the main benefits from M&A as being to gain immediate access to new markets, create an immediate boost to the share price of listed firms, acquire new capabilities, enhance the brand and reputation of firms, enhance value creation of firms, and reduce the effect of country-specific factors, such as the psychic distance between the home and host country. Based on the resource-based view, cross-border M&A provides firms entry into foreign countries to acquire local resources (human resources, technology and local business networks) and to gain access to government officials (Barney 1991; Sirmon, Hitt, and Ireland 2007).

5.4. Foreign direct investment (FDI)

87% of interviewees reported FDI as their main internationalisation strategy. FDI is an organic expansion strategy and is perceived by firms as a low risk and low capital investment strategy. The international office is usually set up to follow clients, to work on major international projects. During the project delivery stage, firms could explore the new international market and decide whether there are sufficient opportunities for them to remain in the host country or region, once existing commissions have been completed. One of the key distinguishing features of greenfield FDI investment, when compared to the acquisition or IJV, is that it is established from scratch and does not come with established workers and practices. Our interviews with large UK based international consulting engineering firms revealed that non-listed consulting engineering firms tend to prefer FDI in comparison to acquisition or IJV due to the flexibilities it offers. FDIs can be created to suit the need and culture of the parent company and allow firms to grow at an acceptable pace.

6. Internationalisation and firm performance, economic growth, and firm size

This section investigates the effect of firms’ internationationalisation on their performance, and considers the factors affecting the decision by firms to internationalise, such as economic growth and firm size. OLS regressions were used to investigate the correlation between internationalisation and firm performance, UK and world economic growth, and firm size. A sample of 50 top consulting engineering firms from the FAME database, 2000 to 2010 were used for the fixed effect panel estimation. The sample is an unbalanced panel; the database was missing financial data for some firms in some periods, and the firms with too many periods of missing data were dropped. Profit after tax was used as a measure of performance, and overseas revenue was used to measure the firm’s international investment. Other explanatory variables were the firm’s total assets and liabilities, firm size (measured by number of staff), and UK and world GDP growth, with a dummy variable for the financial crisis (year 2009 with recession = 1; all other years without recession = 0)(Table 2).

Table 2. Table of variables (definition and source).

Variables	Definition and Source of Data
LogPATax	Log of annual profit of firms after tax (1 unit = £1m) (Source: FAME database and firm’s annual report)
LogTORev	Log of annual overseas revenue of firms (1 unit = £1m) (Source: FAME database and firm’s annual report)
LogTAsset	Log of total asset of firms (1 unit = £1m) (Source: FAME database and firm’s annual report)
LogTLiab	Log of total financial liabilities of firms (1 unit = £1m) (Source: FAME database and firm’s annual report)
NoStaff	Firm size (measured by number of staff) (Source: firm’s annual report)
UKGDP	UK’s GDP growth rate (%) (Source: UNCTAD Handbook of Statistics 2017)
WGDP	The world’s GDP growth rate (%) (Source: UNCTAD Handbook of Statistics 2017)
FinCris	Financial crisis Year 2009 financial crisis = 1, all other years = 0 with no financial crisis.

6.1. Internationalisation and firm performance

To examine the determinants of internationalisation, we considered:

(1) $\mathrm{LogPATa}{\mathrm{x}}_{\mathit{it}}=B_i+B_1\mathrm{LogTORe}{\mathrm{v}}_{\mathit{it}}+B_2\mathrm{LogTAsse}{\mathrm{t}}_{\mathit{it}}+B_3\mathrm{LogTLia}{\mathrm{b}}_{\mathit{it}}+B_4\mathrm{NoStaf}{\mathrm{f}}_{\mathit{it}}+B_5\mathrm{UKGD}{\mathrm{P}}_{\mathit{it}}+B_6\mathrm{WGD}{\mathrm{P}}_{\mathit{it}}+\mathrm{FinCri}{\mathrm{s}}_t+{\epsilon }_{\mathit{it}}$(1)

A summary of the OLS regression results is presented in Table 3. The OLS analysis indicates that the variables are statistically significant, and the regression model has explanatory power. Firms with higher overseas revenues tend to have higher post-tax profits, even when controlling for their size (measured by assets, liabilities, staff numbers), other trends in the economy (GDP, etc), and factors specific to each firm (eliminated by the fixed effects regression). The highest-performing firms are those most likely to be able to compete internationally; whatever the direction of causation, there’s a positive association between firm performance and internationalisation.

Table 3. Summary of OLS regression results.

VARIABLES	Model 1
LogTORev	0.195**
	(0.0822)
LogTAsset	0.857**
	(0.355)
LogTLiab	−0.394
	(0.265)
NoStaff	0.000124***
	(4.65e-05)
UKGDP	−0.225**
	(0.112)
WGDP	0.239***
	(0.0765)
FinCris	−0.454
	(0.525)
Constant	−1.985***
	(0.656)
Observations	239
Number of companies	38
R-squared	0.451

Standard errors in parentheses.

*** p<0.01, ** p<0.05, * p<0.1.

6.2. Firm internationalisation, the home country, and world economic growth

(2) $\mathrm{LogTORev}{ }_{\mathit{it}}=B_i+B_1\mathrm{LogTAsset}{ }_{\mathit{it}}+B_2\mathrm{LogTLiab}{ }_{\mathit{it}}+B_3\mathrm{NoStaff}{ }_{\mathit{it}}+B_4\mathrm{UKGDP}{ }_{\mathit{it}}+B_5\mathrm{WGDP}{ }_{\mathit{it}}+\mathit{\hspace{0.17em}}\mathrm{FinCris}{ }_t+{\epsilon }_{\mathit{it}}$(2)

A summary of the OLS regression is presented in Table 4; the variables are statistically significant and the regression model has explanatory power. There is a negative correlation between overseas revenue and UK GDP growth, and a positive correlation between overseas revenue and world GDP growth.

Table 4. Summary of the OLS regression.

VARIABLES	Model 1
LogTAsset	0.366
	(0.242)
LogTLiab	0.323*
	(0.187)
NoStaff	2.43e-05
	(3.56e-05)
UKGDP	−0.331***
	(0.0841)
WGDP	0.167***
	(0.0581)
FinCris	−1.076***
	(0.404)
Constant	0.00756
	(0.465)
Observations	279
Number of companies	38
R-squared	0.565

Standard errors in parentheses.

*** p<0.01, ** p<0.05, * p<0.1.

6.3. Internationalisation and firm size

(3) $\mathit{LogTORevit}=\mathit{Bi}+\mathit{B}1\mathit{NoStaffit}+\mathit{B}2\mathit{UKGDPit}+\mathit{B}3\mathit{WGDPit}+\mathit{FinCrist}+\mathit{\epsilon it}$(3)

A summary of the OLS regression is presented in Table 5, with the variables statistically significant and the regression model having explanatory power, indicating a positive correlation between overseas revenue and number of staff. Larger firms may have more capacity to bid for international work, encouraging internationalisation. Conversely, taking on international projects may generate greater profits, allowing the firm to employ more specialists and so raising staff numbers.

Table 5. Summary of the OLS regression.

VARIABLES	Model 1
NoStaff	0.000151***
	(3.49e-05)
UKGDP	−0.616***
	(0.0796)
WGDP	0.348***
	(0.0578)
FinCris	−1.929***
	(0.413)
Constant	2.208***
	(0.180)
Observations	288
Number of companies	39
R-squared	0.453

Standard errors in parentheses.

*** p<0.01, ** p<0.05, * p<0.1.

6.4. Qualitative analysis

Firms were asked in the questionnaires the importance of internationalisation in influencing the overall performance of their firms(Table 6). The Z score of 3.18 is significant at .01 level and the value of S = 97 is significantly greater than the expected value of E(S) = 75, suggesting overseas presence is correlated with performance.

Table 6. Likert-type scale analysis: influence of overall performance on internationalisation.

Overall performance
Rating	1	2	3	4	5
No. of times this rating was chosen	0	1	8	9	7
Weighted score	0	2	24	36	35
No. of correspondents, N=	25
Summation of all weighted score, S=	97
The expectation of S, E(S)=	75
Variance, Var (S)=	50
z score=	3.18	At 0.01 level, p= 0.0007, <0.05 therefore the Overall Performance factor is significant

All those interviewed reported that internationalisation had improved their firm’s performance – providing avenues for growth, opportunities to gain firm-specific advantages (economic and technical advantages), and enhanced resilience against external competition and adverse economic conditions. Both the quantitative analysis (of firms’ financial data) and the qualitative research (questionnaire analyses and follow-up interviews) indicated consistent results, that the overall performance of firms is positively correlated to the degree of internationalisation.

Our questionnaire asked whether the 2009 global recession has increased or decreased the degree of internationalisation Table 7. The data were analysed using the Likert-type Scale Method based on a sample of 24 respondents, with the S score obtained by summation across all the weighted categories, N the numbers of respondents, r the numbers of equally-spaced categories, V the variance, and the Z score calculated as Z = (S- (N(r + 1))2)/(√N(r²-1)/12).

Table 7. The effect of the 2009 global recession on the degree of internationalisation.

Do you think whether the 2009 recession has increased or decreased the degree of internationalisation of your firm? (1= decreased, 5= increased)
Rating	1	2	3	4	5
No. of times this rating was chosen	0	3	5	7	9
Weighted score	0	6	15	28	45
No. of correspondents, N=	24
Summation of all weighted score, S=	94
The expectation of S, E(S)=	72
Variance, Var (S)=	48
z score=	3.25	At 0.01 level, p= 0.0007 <0.05 = significant, therefore the 2009 recession has increased the degree of internationalisation

The Z score of 3.25 is significant at .01 level and the value of S = 94 is significantly greater than the expected value of E(S) = 72. The findings are consistent with the quantitative analysis, that the 2009 recession increased internationalisation.

7. Conclusion

We analysed financial data for the top 50 UK based consulting engineering firms to review their internationalisation, and the factors related to this. The question of why they internationalise, and the factors affecting internationalisation outcomes were then put to the top management of consulting engineering firms via both a questionnaire and follow-up interviews. Internal stimuli factors included to provide opportunities for growth; improve the performance, turnover and profitability of firms; gain economic and technical advantages through internalisation; increase international competitiveness and market share; develop international reputation and brand image; reduce risk through greater geographical diversification; and to support global clients. External stimuli factors include the degree of competition in the national market, the home market’s economic condition, and the foreign region’s economic growth.

These findings support Penrose’s theory of the growth of the firm, which argues that unique strategic resources that are inimitable and non-substitutable can provide firms with competitive advantages. Firms can gain sustainable competitive advantages through the accumulation of tangible and intangible resources. Internationalisation was found to provide consulting engineering firms with the opportunities to explore and obtain different kinds of expertise and resources from other regions. With a greater pool of expertise to draw from, firms were able to develop their firm-specific strategic assets and technical advantages in order to ensure the uniqueness of their firms and to distinguish themselves from their competitors.

Our research found that the motives for internationalisation influenced the entry mode choice. Consulting engineering firms viewed FDI as an organic expansion strategy, perceived as a low risk and low capital investment strategy. We found that smaller consulting engineering firms tended to follow their clients to go overseas when internationalising, and to grow their international offices organically in the longer term. We found that larger firms were more likely to adopt acquisition as their internationalisation strategy when entering a new market or region. Acquisitions enable the acquiring firm to obtain immediately a readily available market, framework and skills, and this can be carried out on a large-scale basis. Gaining immediate access to new markets or opportunities was reported by consulting engineering firms as the main reason for their firms pursuing acquisitions. Acquisition of a competing firm with a good track record in both international and local markets may enhance the brand and reputation of the acquiring firm in the host region or country. Our findings in this regard are consistent with the Penrosian resource-based view of the firm.

Acknowledgment

We are grateful for helpful comments from an anonymous referee and Professor Oughton.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. This paper draws on Chia Huay Lau’s DPhil thesis on ‘The Global Trading Activities of Consulting Engineering Firms: Managing Risk and Geographical Choice’, Kellogg College, University of Oxford, 2019.

2. We take the fact of ‘globalisation’ as given, but on what that means in practice, see the various authors collected together in Michie (ed.)(2017 and 2019).