Internationalisation of Manufacturing SMEs: The Case of Indonesia Diana Sari * Abstract ___________________ This study is an empirical research investigation on the role of human capital of Small-Medium Enterprise (SME)s owner-managers in internationalisation process. Research on the internationalisation of SMEs and Multinational Enterprises (MNEs) has been done by many scholars and identifies an array of factors related to firm internationalisation. Entrepreneurship literature has examined management know-how (MKH) and international business skills (IBS), as human capital resources or decision- maker characteristics may influence the export activity of the firm (Cavusgil & Naor 1987). This study examines internationalisation by using the scale of multi-dimensional construct of internationalisation developed by Ruzzier, Antoncic and Hisrich (2007), using the main dimensions of international performance (IP), market, mode, time and product (Ruzzier, Antoncic, & Hisrich 2007). Interesting findings are found in this research with research findings applicable in developing countries, such as Indonesia. ______________________ *Padjadjaran University Indonesia – Lecturer Monash University Australia – PhD Candidate INTRODUCTION Research scholars of internationalisation of Small-Medium Enterprises (SMEs) and Multinational Enterprises (MNEs) identify an array of factors related to firm internationalisation. Internationalisation is defined as “the outward movement in a firm‟s international operation” (Turnbull 1987, P??)). Others define internationalisation as the “sequential and orderly process of increased international involvement and associated changes in organizational forms” (Johanson & Vahlne 1977). Management literature has examined top managers or management team characteristics; Entrepreneurship literature has examined management know-how and international business skills, as human capital resources or decision- maker characteristics may influence the export activity of the firm (Cavusgil & Naor 1987). This study examines internationalisation by using the scale of multi-dimensional construct of internationalisation developed by Ruzzier, Antoncic and Hisrich (2007). Their related study of entrepreneur‟s human Page | 1

capital in Slovenia measured the degree of internationalisation of firms using the main dimensions of international performance, market, mode, time and product (Ruzzier, Antoncic, & Hisrich 2007). Findings on the relationship between firm internationalisation and firm performance are mixed. Researchers have limited understanding of the performance benefits of intangible resources such as human capital in manufacturing firms (Radulovich 2008). Therefore this research will address this gap in order to examine the role of entrepreneurial human capital in internationalisation of the firm, using multi-dimensional construct suggested by Ruzzier et al. (2007) The Indonesian government has acknowledged SMEs as a key source of domestic income growth and employment creation, noting that 99 percent of all businesses in Indonesia are SMEs). While SMEs are recognised as a source of domestic income through export activity, Indonesian SMEs only play a small role compared to Large Enterprises (LEs). Indonesian SME exporters represent only 21 percent of non-oil and gas exports. Most of the studies of exporting SMEs in Indonesia focus on macroeconomic factors, such as regulation, infrastructure and programs to assist SME development. Only a small number of studies focus on the entrepreneurship of the owner manager (Papanek 2006; Tambunan 2007; Warouw 2006). Therefore it appears that considerable potential for internationalisation of SMEs has not fully used. Consequently this study investigates how the internationalisation can be enhanced by examining the relationship between entrepreneurship human capital and internationalisation.

THE STAGE THEORY The internationalisation process is depicted as an incremental development which occurs in discrete stages (Gankema, Snuif, & Zwart 2000). The stage model of internationalisation is a combination of a number of stage models (Cavusgil 1980; Johanson & Vahlne 1977; Johanson & Wiedersheim-Paul 1975; Welch & Luostarinen 1988) as there is no single model which Page | 2

comprehensively covers all aspects of internationalisation. An underlying assumption of all these models is that firms are well-established in the domestic market before venturing abroad (Bell, McNaughton, Young, & Crick 2003). The well-known model of stage theory is the U model or Uppsala Internationalisation model.

U Model - Uppsala Internationalisation Model The Uppsala internationalisation model, also known as the U-model (Johanson & Vahlne 1977; 1990; Wiedersheim-Paul, Olson, & Welch 1978), posits that international expansion is influenced strongly by managerial learning, and this determines that internationalisation begins with low risk, indirect exporting to psychically or culturally close or similar markets. Over time and through experience, a firm‟s foreign market knowledge improves and, consequently, it increases its foreign market commitment and expands to more psychically distant markets (Eriksson, Johanson, Majkgard, & Sharma 2000; Eriksson, Majkgard, & Sharma 2000; Johanson & Vahlne 1977; 1990; Johanson & Wiedersheim-Paul 1975; Wiedersheim-Paulet al. 1978). Further, Eriksson et Al. (2000) explain that: In the initial stages of internationalisation, a firm’s accumulated stock of internationalisation knowledge is limited. This restricts learning by internationalising firms and constricts the steps they take in the international market. The more novel the foreign environment, the more difficult it is for the internationalising firm to add to its knowledge and to apply its current stock of knowledge in foreign markets. The closer the relation between the foreign environment and a firm’s stock of knowledge, the more applicable this knowledge will be abroad.

The initial research conducted by Johanson and Wiedersheim-Paul (1975) focused on the assumption that internationalisation of a firm develops according to a chain of establishment and was supported by four case studies of Swedish firms. Johanson and Wiedersheim-Paul (1975) distinguished four levels of international market entry: Stage 1: no export activities; Page | 3

Stage 2: export via an independent representative or agent; Stage 3: the establishment of an overseas sales subsidiary; Stage 4: the installation of overseas production or manufacturing units. The assumption behind Johanson and Wiedersheim-Paul‟s research is that the firm first develops in the domestic market and that internationalisation is the consequence of a series of incremental decisions that begin by exporting where there is low risk assumed and and eventually moving to higher risk, i.e., direct investment. The work of Johanson and Wiedersheim-Paul (1975) has been further developed and refined by Johanson and Vahlne (1977; 1990). Johanson and Vahlne (1977; 1990) state that the „aim is ... to contribute to an understanding of the incremental nature of the internationalisation process‟. Johanson and Vahlne (1977; 1990) expect that „the internationalisation process, once started, will tend to proceed regardless of whether strategic decisions in that direction are made or not‟. The core assumption of the model is that (increased) market knowledge will lead to (increased) market commitment, and vice versa. Proponents of this approach have suggested a generally positive relationship between the decision–maker‟s knowledge of foreign markets and the level and pace of the firm‟s resource commitment to these markets. In sum, the Uppsala model explains how international actors learn and increase their foreign market knowledge over time primarily through experience, and then start or increase their foreign market commitments and later expand to more psychically distant markets (Oviatt & McDougall 2005). Ruzzier, Antoncic and Hisrich (2007) assert that, once a company starts its international business activity, it will gradually change its entry mode decision in a fairly predictable fashion. This international engagement increases their commitment, with the typical pattern being from exporting via an agent to a sales subsidiary (Welch & Luostarinen 1993). The model also explains how foreign market risks are managed by acquiring tacit knowledge about foreign markets and incrementally changing their commitments to those markets. However, the Uppsala Model is focused on traditional cross-border behaviour, Page | 4

not on accelerated internationalisation or on entrepreneur behaviour (Oviatt & McDougall 2005).

RESOURCE-BASED VIEW As has been discussed previously, internationalisation of the firm cannot be separated from its firm strategy, which includes resources in the firm, in order to be able to enter international markets. This subsection will elaborate the resources of firms from the Resource Based View (RBV). The RBV incorporates traditional strategy insights concerning a firm‟s distinctive competencies; furthermore, it also provides value-added theoretical propositions that are testable within the diversification strategy literature (Andersen & Kheam 1998). The RBV of the firm is a theoretical framework for understanding the source of a firm‟s competitive advantage and how it can be sustained over time (Barney 1991; Eisenhardt & Martin 2000) .Chatterjee and Wernerfelt (1991) refer to a substantial body of literature that classifies „resources‟ into three categories: physical, intangible and financial. Another classification by Barney (1991) classifies resources as: physical, human and organisational capital. Physical capital resources include the physical technology, the firm‟s plant and equipment, its geographic location and its access to raw materials. Human capital resources include the training, experience, judgment, intelligence, relationships and insight of individual managers and workers in a firm. Organisational capital resources include a firm‟s formal reporting structure, its formal and informal planning, controlling and coordinating systems, as well as its informal relations among groups within a firm and between a firm and others in its environment. The RBV identifies firms as different collections of physical assets and intangible capabilities (Barney 1991; Chatterjee & Wernerfelt 1991). It helps to determine how well-positioned a company is to succeed in a challenging external environment.

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Loane and Bell (2006) acknowledge that the RBV has applicability for the growth of small firms and also for their internationalisation activities. Further, improved export knowledge will significantly reduce perceived barriers to and complexity of exporting and help to implement proactive export marketing strategies. Singer and Czinkota (1994) found that export knowledge increases pre-export activities such as decision, planning, contacts and channels (Shamsuddoha & Ali 2006). Based on RBV, our focus is on human capital resources or the decision-maker characteristics, since these may influence export activity of the firm (Cavusgil & Naor 1987). More detail about the variables of human capital will be discussed in the next subsection.

HUMAN CAPITAL As part of human resources capital, managers or entrepreneurs become essential factors in internationalisation of SMEs. Many empirical researchers have shown that there are an array of factors influencing internationalisation of firms, including the manager or entrepreneur in the company, the characteristics of the organisation or company and environmental characteristics (Antoncic & Hisrich 2000). Shepherd and Wiklund (2005) in their book show the importance of managers of small business in exerting substantial influence on small business growth and performance. Further, Shepherd and Wiklund (2005) argue that the destiny of a small business is not completely determined by the characteristics of the environment and other factors outside the control of the small business but is highly dependent upon the decisions its management makes. Previous research has conceptualised human capital as a resource endowment that significantly influences the firm‟s survival and growth, as well as its potential to generate organisational rents (Greene et al., 2001). In a similar manner, human capital is defined as the know-how, information, relationships, and general capabilities that individuals bring to bear on behalf of the firm through their employment relation (Galunic & Anderson 2000, p. 3). Page | 6

The entrepreneur is regarded as an important element in studying SME internationalisation and in the central factors that explain a firm‟s international behaviour (Andersson 2000). Wiedersheim-Paul, Olson and Welch (1978) developed a model that stresses the importance of a firm‟s activities and its „pre-export‟ behaviour. The important factors include information and characteristics of the decision maker, the enterprise environment, and extra-regional expansion of the firm. Other empirical studies have shown that individual characteristics affect the processing of export-related information and influence exporting behavior (Reid, ???); Cavusgil & Naor, (1987) Aaby & Slater (1989), and Ruzzier et al., (2007), and the firm‟s strategic orientation and the patterns and pace of internationalisation (Miles, Snow, Meyer, & Coleman 1978). Further, Knight and Kim (2009) have added that, although SMEs tend to lack substantial financial and human resources, they may leverage a collection of more fundamental, intangible resources that facilitate their international success. These resources consist largely of the knowhow, skills, and overall business competences that reside in the managers who work at these firms. Based on these arguments, we look at management know-how and international business skills in this current study. This paper proposes a conceptual model which focuses on personal entrepreneurship, and will include characteristics such as International Business Skills (IBS), and Management KnowHow (MKH) and their relationship to Internationalisation, International Performance (IP), Market and Time, H1 to H6 and will test the relationship of Internationalisation (IP, Market and Time) to Firm Performance (FP), H7 to H9.

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IP

H1

H7

H4

MKH

H2

Market

H8

H5

IBS

H3 H6

FP

H9

Time

Figure1. Conceptual Model of Internationalisation of SMEs

METHOD Data and Samples The study is cross-sectional and samples of 241 Indonesian exporting SMEs are gathered through mail surveys. Respondents are selected randomly from the Indonesian National Agency for Export Development (NAFED) database. The owner-manager or a manager in the company are chosen as the key informant, since these positions are likely to be the most knowledgeable about the overall situation of the firm. Most of the responses come from Java and Bali; this aligns with the concentration of SMEs in Indonesia in those areas. Scales of MKH, IBS, IP, Market, and Time are tested for reliability and validity. In addition, this study used path analysis to look at the effect of Entrepreneur Human Capital upon Internationalisation and FP using Structural Equation Modelling (SEM) with AMOS 19.0.

Measures International Business Skills were measured with three-items scale developed by Manolova (Manolova, Brush, Edelman, & Greene 2002), and modified by Ruzzier et al. (2007). Respondents were asked to rate the extent on the three international business skills items (i.e. negotiating, verbal communication and international networking) and described themselves on a

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scale ranging from 1= very poor to 5= excellent. These three items were average to yield an IBS score (α=.83). Management Know-How are assessed by three items adapted from (Ruzzier, Antoncic, Hisrich, et al. 2007). Respondents were asked to indicate the extent of management Know-How that they possess (i.e. motivating employees, interpersonal skills, and team building management). The scale range from 1=very poor to 5=excellent. These three items were averaged to yield a MKH score (α=.75). The Internationalisation scale use in this current study has been used and validated by Ruzzier et. al. (2007). Ruzzier et al. developed a scale to measure internationalisation of a firm and examine internationalisation as a multi-dimensional construct, that is, International Performance, Market and Time. For International Performance (IP) scale, respondents were asked the percentage of foreign sales, percentage of all products sold abroad and the extent of the time that employees dedicate to international operations using a five-point Likert scale ranging from 1 = less than 10% to 5 = more than 75%. These two items were average to yield an IP score (α=.77). In terms of Market, it measures how many countries the products are sold in and in which country group the products are sold; the scale ranges from 1 = 1-5 countries to 5 = more than 20 countries. For the question as to in which countries the products are sold, we use countries groups such as South-East Asia, East Asia, the Middle-East, Europe, Africa, America, and Other. We use a five-point Likert scale ranging from 1 = 1 country group to 5 = 5 country groups. These two items were averaged to yield a Market score (α=.63). With regard to measurement of Time, respondents were asked when the company started their international activities; when their company reached 10 percent of foreign sales in total sales; and when their company reached 20 percent of foreign sales in total sales. A five-point Likert scale is employed ranging from 1 = more than 6 years to 5 = at inception. These three items were averages to yield a Time score (α=.95) Page | 9

Firm Performance (FP) was measured with a single variable, sales growth, as an outcome for internationalisation. The reason for using sales growth is because information regarding FP, especially financial measurement, is not easy to obtain from Indonesian SMEs. Sales growth has been extensively used to measure SME FP by, for example, (Bloodgood, Sapienza, & Almeida 1996; Styles, Patterson, & Ahmed 2008; Zhou, Wu, & Luo 2007). On FP after becoming involved in international markets in the last three years, we asked for approximate annual sales, using a five-point Likert scale ranging from 1 = extremely decreased (more than 20 percent) to 5 = extremely increased (more than 20 percent).

RESULT Structural equation modelling (SEM) analyses were conducted with AMOS 19.0 program to test the 8 hypotheses. Results from the SEM used in this research study provide empirical evidence of internationalisation of manufacturing SMEs and the relationship with FP. The overall model fit was acceptable (2 = 6.39, df = 2, p = 0.04; CMIN/df = 2.26; RMSEA = 0.09, SRMR= 0.04, GFI = 0.99; CFI = 0.94; IFI = 0.99) except for RMSEA which was slightly above the recommended value. However, the RMSEA less than 0.1 can still be employed (Cudeck 1993). From eight hypotheses, four hypotheses were supported. SEM results found most Indonesian SMEs delay their entry into the international market after inception period and that MKH is strongly associated with SME internationalisation. Even though the results regarding the relationship between MKH and IP, and MKH and number of markets are not positive or statistically significant, the relationship with time to internationalise is negative and statistically significant, proving that postponement of time to internationalise will result in better performance for SMEs. This constitutes the important substantive finding of this study, and supports the traditional view of incremental internationalisation advanced by Stage Theory. As Page | 10

Stage Theory still applies in the Indonesian situation, the INV perspective is not likely to be an appropriate theory for elucidating SME internationalisation in Indonesia. The current study also shows that IBS has a positive and statistically significant relationship with IP and number of markets. The outcome suggests that SME owner-managers with high IBS, unique and inimitable to the enterprise, will have better IP and a greater number of markets, and then, in turn, better FP, thus supports RBV of the firm.

IMPLICATION FOR MANAGERS AND POLICY-MAKERS This paper will be of practical value to entrepreneurs and policy-makers. Managers or owners of manufacturing exporting SMEs in Indonesia will benefit from a better understanding of the role that entrepreneur human capital characteristics play in the internationalisation. The results may have implications for SMEs‟ strategy to internationalise. The findings of this research also extend knowledge about the factors influencing the internationalisation in developing countries, particularly in the manufacturing sector.

ORIGINALITY Most previous studies consider human capital and internationalisation as one construct. This paper empirically tests a newly hypothesised relationship between dimensions of human capital (IBS and MKH) and dimensions of internationalisation (IP, Market and Time) to provide insight into factors that affect manufacturing SMEs internationalisation and FP. Further the study is based on Indonesian SMEs, which have different characteristics to SMEs in developed countries. Therefore the study offers a different perspective on the internationalisation of manufacturing SMEs to previous research, which has concentrated largely on developed countries.

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