The Effect of Network Competence and Environmental Hostility on the Internationalization of SMEs

Transcription

1 The Effect of Network Competence and Environmental Hostility on the Internationalization of SMEs Abstract Research findings suggest that networks offer small and medium-sized enterprises (SMEs) opportunities to internationalize successfully. However, the role of internal organizational competence in the process of developing and maintaining such networks in hostile external environments has received little attention. The aim of this study is to shed light on the relationship by examining the positive influence that the network competence of SMEs has on their propensity to internationalize, and on their subsequent international performance. Given that the willingness of firms to enter and perform well in markets appears to also depend on environmental hostilities, this external influence on SME internationalization is incorporated into the study. We also examine whether the level of environmental hostility moderates the relationship between network competence and SME internationalization. The empirical part of the study comprises a web survey of 298 Finnish SMEs representing five different industry sectors: metal, food, furniture, software, and knowledge-intensive business services. Confirmatory factor analysis and regression models are used in the analysis. The results indicate that higher levels of network competence are positively related to the propensity of SMEs to internationalize, as well as to their international performance. Conversely, the level of environmental hostility has a negative effect on the performance measure, but not on the internationalization propensity. Additionally, the influence of network competence is not moderated by environmental hostility. The results indicate that internal network competence and external environmental hostility play a role in SME internationalization, and that the positive influence of network competence exists independently of the hostility in the environment. Keywords: network competence, business networks, environmental hostility, internationalization of SMEs, international performance We would like to thank the two anonymous reviewers and the editor, Professor Hamid Etemad, for their comments, which in our view have helped to improve the paper significantly.

2 INTRODUCTION This study examines how organizational network competence and environmental hostility together influence the propensity of small- and medium-sized enterprises (SMEs) to internationalize, and their subsequent international performance. Network competence is defined here as the ability of firms to develop and manage relations with key partners, such as suppliers, customers and other organizations, and to deal effectively with the interactions among these relations (Ritter et al. 2002; Ritter 1999; Ritter 1998). The context of the internationalizing SME seems particularly relevant to the selected approach, given the evidence that networks allow them to overcome size-related constraints on internationalization (Sasi and Arenius 2008; Loane and Bell 2006; Saarenketo et al. 2004; Coviello and Munro 1997 and 1995). On the other hand, although networks may provide SMEs with the additional resources they need to internationalize, external environmental hostility may temper their willingness to do so and the subsequent potential for international growth. This hostility may relate to industry and market characteristics, such as governmental actions and highly dynamic and competitive market conditions (Kuivalainen et al. 2004; Zahra and Garvis 2000; Covin and Slevin 1989). The latter affect internationalizing SMEs in highly knowledge-intensive industry sectors, such as the software industry, in particular (e.g., Bell et al. 2004; Bell 1995). However, whether higher levels of network competence enable SMEs to achieve better success in international markets and overcome their perceived environmental hostilities, is still an open question. Some earlier studies have examined partnership-related competences as such (e.g., Schreiner et al. 2009), and the relationship between managerial board linkages and environmental uncertainties (Boyd 1990), and have provided big-picture exploratory frameworks of rapid SME internationalization involving networking and external forces (Osarenkhoe 2009). However, studies on relationship-specific competences in which environmental factors are taken into account seem to concentrate on the dyadic level (e.g., Kale and Singh 2009; Barringer and Harrison 2000), and thus mostly tend to forgo the network level. Indeed, organizational network-level competence in itself has not received much attention in research on SME internationalization, and even less when external environmental factors are incorporated into the examination. This could be due to the fact that many of the traditional stages and network models in which many of the network studies on firm internationalization originated do not consider an external hostile environment as such to exist at all (Johanson and Vahlne 2009; 2003). However, the extant research on SME internationalization still considers environmental factors very real and important (see e.g., Ruzzier et al. 2006). Given that organizational network competences have not previously been linked to internationalizing SMEs facing environmental hostilities, although this is likely to be relevant to smaller internationalizing firms in particular, we aim to establish such a link in this study. We discuss the theoretical background of the study in the next section, and in the following one set out 2

3 the research aims and formulate our hypotheses on the relationships between network competence, environmental hostility and SME internationalization. Subsequently we describe the research method and the data, give the results and draw conclusions from them. A REVIEW OF THE LITERATURE Firms have long been recognized as embedded in networks comprising professional and social exchange relationships with other network actors (Gulati et al. 2000; Håkansson and Snehota 1989; Granovetter 1985), including customers, suppliers and strategic allies (Walter et al. 2006; Achrol 1997; Anderson et al. 1994). The realization that being embedded in these networks results in internationalization dates back to the traditional stages models. The network approach to internationalization (Johanson and Vahlne 2003; Johanson and Mattsson 1988) first saw the internationalization of firms as a learning process in which the aim was to establish positions in networks to which they were new. The original Uppsala model (Johanson and Vahlne 1977; Johanson and Wiedersheim-Paul 1975) provided a basis for the network approach, but has since been amended in terms of network implications. Specifically, in their 2009 article, Johanson and Vahlne identified networks as vehicles for learning about foreign markets, thus incorporating the idea of network-related internationalization directly into their influential 1977 model. The underlying driving factor behind increasing international commitment for a given firm is therefore considered to be its attempts to enter new networks, some of the actors in which may be located in foreign markets, about which they can thus provide incremental knowledge. Networks of exchange relationships contribute to competence development (Awuah 2007), and the ability to develop and maintain network relationships calls for network-related insight from firms and managers (Mouzas et al. 2008), not through gut feelings but by acting analytically and proactively (Freytag and Ritter 2005). The abilities of firms to network are a potential source of positive outcomes in terms of international strategies and performance, and of sustainable competitive advantage (Ziggers and Henseler 2009; Dyer and Singh 1998). They have been found to vary, as evidenced by recent findings of various organizational relational capabilities and competences (e.g. Kale et al. 2002; Sivadas and Dwyer 2000). Some see the ability as dyadic, between partners, others also taking into account the existence of multiple partners in a set of networked relationships. They are often defined as either capabilities, based on the dynamic capabilities framework, or as competences. In practice, however, the terms capability and competence are used casually and interchangeably in the research literature (Zerbini et al. 2007; Ritter 2006). In semantic terms, dynamic capabilities could be seen as abilities in firms to integrate, build and reconfigure internal and external competences in order to cope in rapidly changing environments (Teece et al. 1997). Eisenhardt and Martin (2000) define them as firm processes that consume resources in order to match and create market change, which makes them organizational and strategic routines aimed at shaping the available resource base, competences 3

4 and processes while also creating new ones. Competences can accordingly be defined as complex bundles of skills and accumulated knowledge, which are then used by firms in their organizational processes and subsequently facilitate the coordination of activities and the exploitation of assets (Day 1994). Some of them are considered core (Prahalad and Hamel 1990), in that the competitiveness of a firm derives from its main competences and products: in other words, the tangible results are its core competences. Mascarenhas et al. (1998) define core competences as something in which a firm is good at and is inimitable while benefiting consumers. Thus, a core competence refers not only to technological knowledge, but also (for example) to the ability to maintain close relationships with partners and customers. Network competence is one of the developed relational abilities of an organization, and a core competence (Ritter et al. 2002). It is defined as the ability of firms to develop and manage relations with key suppliers, customers and other organizations and to deal effectively with the interactions among these relations (Ritter et al. 2002, 119). Although there are studies illustrating the positive effect of network competence on innovation performance (e.g., Chiu 2009; Ritter and Gemünden 2004 and 2003;), the role it plays in the firm s strategy in different contexts has not been researched, despite calls to clarify its influence in processes related to survival and growth, including its international performance (Ritter and Gemünden 2003; Ritter et al. 2002). There are reasons to assume that the influence of network competence on firm internationalization is especially strong in SMEs. They are often small, mostly knowledge-intensive and hightechnology firms seeking to internationalize rapidly straight after their foundation, termed born globals (Madsen and Servais 1997; Rennie 1993) or international new ventures (Oviatt and McDougall 1994). The emergence of these types of small firms has challenged the traditional stages theories, including the network approach and the revised Uppsala model. For one thing, these SMEs are often operating in niche markets and have no choice but to internationalize quickly, leaving no time for gradual knowledge accumulation and the resulting slowly increasing international commitment. This makes the network approach inherently problematic in these contexts. But SME internationalization in particular has been found to arise through their networks (Chetty and Campbell-Hunt 2004). One reason for this is, as Loane and Bell (2006) report, that in order to leverage the internationalization process smaller firms need to be able to build new networks and utilize their existing ones. It seems that all their market selection and entry initiatives originate from opportunities created through these network contacts, rather than solely from the strategic decisions of their managers (Coviello and Munro 1995). Various factors are involved in this development. First of all, SMEs often lack the necessary specialized resources (Knight and Cavusgil 2004), which can be obtained externally through cooperative networked relationships. Parties embedded in different networks have bonds bridging the separate ones (Fletcher 2008). Therefore, the internationalizing SME could use its domestic networks to establish bonds with foreign networks, allowing them to join them and, subsequently, to form network relationships with foreign actors. 4

5 In addition to enabling SMEs to internationalize, networks and alliances are considered fruitful in terms of increasing the firm s overall international competitiveness (Majocchi et al. 2005), and foreign-market connections have been found to be a main factor enhancing export-related performance in general (Doole et al. 2006). This is especially important for SMEs, for which exporting may be the preferred growth strategy (Bonaccorsi 1992). Business networks determine this export performance to a great extent (Naudé and Roussouw 2010), as do firm competences more generally (Zou and Stan 1998). Therefore, in the case of already internationalized SMEs, the firms have to possess internal organizational competences (such as network competence) that support both early internationalization and subsequent success in foreign markets (Knight and Cavusgil 2004). The reconfiguration of capabilities has been identified as a factor influencing international performance (Jantunen et al. 2005), and network competence could be understood as an internal organizational capability (i.e. competence) to continuously reconfigure businessrelationship activities depending on the need in specific situations. Thus, possessing high levels of such competence should result in better international performance. Therefore, it could be argued that in the SME context in particular, firm-level network competence directly affects decisions on foreign-market entry and, when successful choices are assumed to lead to successful internationalization, performance therein. We note that networking has some drawbacks for firms as well. Firstly, developing network relationships with other businesses takes time and assumes willingness to share information with network partners. SMEs aiming to protect their organizational know-how face a trade-off between doing so and being willing to transfer confidential information required to maintain close network relationships. Resources have to be committed to maintain contact with network partners, and larger networks will have more partners to commit them to. Therefore, an SME lacking in resources to begin with faces a challenge of committing its small resources to develop network ties, which may in time potentially enable them to make use of the additional resources possessed by other network actors. Firms can be limited by their networks as well as be empowered by them. As Hitt et al. (2002) note, businesses may be unable to seize opportunities because the network, while providing access to some additional resources, does not provide access to the appropriate ones to do so. They point out that this may lead to additional opportunity costs and path dependence, which may be critical for SMEs with small margins of error in their business activities. However, in the end SMEs will often need to develop and maintain their business networks to go international, so for them, being able to network well and with right partners well is crucial. Additionally, some external factors may also inhibit the aspirations of SMEs to go international. Another reason why the traditional network approach may be a problem for the SME context is that it restricts the perspective of the market environment to the network, and assumes that potential barriers to market entry manifest themselves in the establishment and development of relationships within the network rather than in the external environment (Johanson and Vahlne 2003). This is to say that the business and market environment in this case consists of the 5

6 network itself (Johanson and Vahlne 2009). SMEs, in contrast, are known to face various kinds of market- and industry-based barriers in their internationalization efforts, and their perception of the barriers varies depending on whether or not the firm is operating in foreign markets (Shaw and Darroch 2004). According to Zahra et al. (2000), these barriers, or the levels of hostility perceived by the firm, arise due to institutional, industry and organizational factors that vary across markets and countries. Johanson and Vahlne (2003) also refer to the discussion on these kinds of environmental barriers that is prevalent in the current literature on international business. Additionally, Keupp and Gassmann (2010), in their review of the literature on international entrepreneurship, formulate an integrative framework of the relevant studies, and identify certain environmental factors such as government policy, industry structure and competition as antecedents of internationalization. It seems, then, that in the context of emerging SME internationalization there is indeed an environment external to the network to be considered, and although networks may present unique opportunities for SMEs to internationalize, environmental hostility may conversely add to challenges facing individual firms. As there are various definitions of what the terms environment and environmental hostility actually mean, further clarification here is needed. The external environment that firms face can be conceptualized and operationalized at various levels. It has often been conceptualized to consist of dimensions of complexity, dynamism (uncertainty) and munificence (Bluedorn 1993; Rajagopalan et al. 1993; Dess and Beard 1984). Further sub-dimensions have also been suggested, such as Miller (1988) with two dimensions of environmental uncertainty, dynamism and unpredictability. However, alternative levels of environmental factors have been operationalized, as well. For example, Duncan (1972) found the external environment of firms to consist of customer, suppliers, competitor, socio-political and technological dimensions. Bourgeois (1980) also took a different view of the environment and categorized it as objective and perceived states. However, in this study we constrain our view of the environment to refer to the environmental hostility that firms perceive. This environmental hostility, also called turbulence, is conceptually part of the dynamism dimension (Dess and Beard 1984), and encompasses the level of regulatory, technological, competitor and customer hostilities (Zahra et al. 2000). The effects of network competence and environmental hostility on SME internationalization may be intertwined. The effect of environmental hostility has been found to vary in SMEs across industries, and turbulent environments are considered especially prevalent in industries involving high knowledge intensity (Kuivalainen et al. 2004). There are also industry-specific differences in internationalizing through networks, especially in comparisons between knowledge intensive hightechnology industries and low-technology sectors (Bell 1995). Internationalizing born globals rely especially strongly on their networks (Madsen and Servais 1997), and the international trade is becoming increasingly knowledge-intensive in general (Contractor and Lorange 2002). Within specific industries, local competitors in foreign markets may well be more adept at meeting market 6

7 demands because they possess the necessary know-how concerning local consumer preferences, government regulations, and market trends (Rugman and Collison 2004). International new ventures often reside in emerging high-technology industries (see e.g., the review by Rialp et al. 2005), which are characterized by dynamic markets and technological uncertainty (Moriarty and Kosnik 1989). Given that there is a degree of environmental hostility towards such firms in foreign markets, inter-firm relationships can help those functioning in these kinds of uncertain environments to adapt more easily (Heide and John 1990). Firms operating in more hostile markets need each other in order to keep up and thus overcome the challenges this kind of environmental hostility would give them individually (Bucklin and Sengupta 1993). In other words, a hostile environment in particular calls for the development of networks (Chakravarthy 1997). Furthermore, turbulent foreign environments specifically call for proactive networking and the use of relationships (Mainela and Puhakka 2009) in order to absorb the high entry risks (Li and Qian 2008). Welch and Welch (2004) found that the structure of the networks of internationalized firms vary depending on environmental characteristics such as the industry structure and governmental involvement. They point out that investing in foreign networks is essential in order to alleviate perceived hostilities in political and market terms. As a result, internationalized SMEs with strong networks can perceive less hostility in those markets than non-internationalized firms with weaker networks. The findings of Pinho and Martins (2010) indirectly support this: whereas exporting SMEs perceived issues such as logistics as their biggest barriers in foreign markets, non-exporters emphasized the hostilities arising from market and governmental environments. Being embedded in networks with local firms gives SMEs access to lacking market knowledge and know-how, and forming strong business relationships and facilitating the transfer of this knowledge leads to more positive outcomes in especially hostile environments (Lee and Cavusgil 2006). Moreover, a volatile environment in the first place leads to further cooperation between firms, and thus to better performance in foreign markets (Matanda and Freeman 2009). There seems to be an intertwining effect in this regard: a hostile environment can lead to additional networking, which helps to weaken the perception of hostility through the mutual exchange of knowledge. RESEARCH AIMS As we discussed in the literary review above, both internal organizational network competences and external environmental hostilities may in theory influence the internationalization decisions of SME. Our purpose therefore is to examine if they do so together and whether their influences are intertwined or not. We aim to study the influences in the Finnish SME context, as SMEs in similar small open economies have in earlier studies been found to be particularly suitable for this purpose. This is firstly due to their small domestic markets and developed industry sectors, which results in comparatively large proportion of SMEs compared to larger firms, and prevalence of 7

8 born global -type small firms in knowledge-intensive industries that need to internationalize rapidly. They also face somewhat similar domestic political and legal environments, in that they come from comparatively democratic free-market societies. Secondly, earlier research has found influences of networks to internationalization of small firms often in these kinds of economies. For example, in Sweden, Sharma and Blomstermo (2003) found that the selection of foreign entry modes is determined by network ties of born global SMEs. In New Zealand, market and entry mode choice and the overall growth and internationalization processes of SMEs have been found to be largely determined by their networks (Coviello 2006; Coviello and Munro 1997; Coviello and Munro 1995). Further linkages between networks and SME internationalization have been found in other small open economies, such as in Ireland (Loane and Bell 2006; Bell 1995), Norway and Finland (Bell 1995). As the extant research finds networks to drive SMEs to international markets and to facilitate their growth once they successfully internationalize, the leap to discussing their varying organizational competences to develop and manage networks is not a large one. After all, according to Coviello (2006), the networks of rapidly internationalizing SMEs are both intentionally managed and pathdependent in nature. We can subsequently ask whether in SMEs there is a positive link in between possessing better organizational network competence and becoming successful internationally. If networks enable SMEs to overcome their inherent resource constraints and achieve better results in international markets, then logically higher levels of network competence should also result in correspondingly higher propensities among SMEs to turn international and higher levels of performance once there. Therefore, we hypothesize that: H1: The higher the level of network competence of a firm, the more likely it is to operate internationally. H2: The higher the level of network competence of a firm, the better is its international performance. Environmental hostilities should in contrast have adverse effects. SME suffering from lack of resources find it difficult to become international in the first place, but if the regulatory, competitor and product-related factors present them with additional hurdles, they might decide to stay domestic after all. For knowledge-intensive born globals, becoming international is by definition a must, but environmental hostilities might cause them to fail in their efforts to do so. After all, if they cannot obtain the necessary financial resources due to governmental restrictions, if keeping up with their competitors requires large investments to product development and marketing, and if the overall market demands for their products are declining, it might be impossible for them to find the further additional resources needed for internationalization. This may lead them to fail to become international. And even when they manage to launch international activities, those hostilities may influence them to do so only in smaller scale, slowing down their initial drive to 8

9 multiple worldwide markets. In many ways, then, environmental hostilities may have the opposite effect to SME internationalization and network competence does: H3: The higher the perceived environmental hostility of a firm, the less likely it is to operate internationally. H4: The higher the perceived environmental hostility of a firm, the worse is its international performance. The effect of internal network competence and external environmental hostility on the internationalization of small firms may also be intertwined, as explained in the literary review above. A hostile environment that calls for additional resources may cause SMEs to increase their efforts to network in order to acquire them, and those firms with better network competence may be better able to succeed in developing and managing their networks. It follows then that those firms perceiving more hostility in their environment may be especially driven to network and, as a consequence, exhibit higher levels of network competence. That in turn may, as an organizational core competence, give them competitive advantage in relation to their industry rivals and enable them to succeed even better in their international strategies. We therefore also hypothesize that there is an interaction effect between network competence and environmental hostility in the SME internationalization context: H5: The level of environmental hostility moderates the positive relationship between network competence and the likelihood that a firm operates internationally. H6: The level of environmental hostility moderates the positive relationship between network competence and international performance of firms. In sum, in line with the above hypotheses, it is argued that network competence, environmental hostility and industry-related knowledge intensiveness are linked to the internationalization of SMEs (see Figure 1). (Figure 1 here, please) RESEARCH METHOD Data collection The empirical data to be used in the research was collected during the summer of 2008 from Finnish SMEs representing five industry sectors: metal, food, furniture, software and knowledgeintensive business services (KIBS). As mentioned above, the industry selection was based on the assumption that the knowledge-intensive industries in which internationalizing SMEs operate tend to differ from more traditional manufacturing industries. KIBS and software firms were therefore 9

10 intended to represent knowledge-intensive industries in this data, whereas more traditional manufacturing represented the other three. The term SME is used to characterize companies termed small or medium-sized on different scales, such as the number of employees and/or the annual turnover. These category thresholds vary between countries, as do the sizes of the economic sectors. The Organisation for Economic Co-operation and Development (OECD) terms them non-subsidiary, independent firms which employ fewer than a given number of employees (OECD 2008). The European Commission, on the other hand, has created a unified definition in stating that a medium-sized firm is one that lists less than 250 employees and whose yearly turnover or yearly balance-sheet total is less than 50 million and less than 43 million euros, respectively (European Commission 2003). On the other hand, in Canada and the USA, for example, the threshold between a large and a medium-sized firm is considered to be 500 employees (OECD 2008). In accordance with these guidelines, in this study we designated a firm as an SME if it had fewer than 500 employees and if its reported turnover was less than 50 million euros at the time of the data collection. We identified the SMEs to be contacted and asked to complete the survey through the Amadeus database, and restricted the selection to Finnish firms with between 10 and 500 employees in the above-mentioned five industries. We then collected data via a web survey conducted between February and July in The survey included additional items on internationalization indicators for the internationalized firms, but was otherwise similar for all the respondents. It differed in some general questions concerning the age, scope and scale of international activities,,and the international firms were also given a set of items on which they were asked to give a subjective managerial assessment of the firm s international performance in terms of having reached the strategic goals it had set. Statements related to network competence were adapted from the original scale, as were those covering environmental hostilities. Some of the items were negatively worded in order to avoid agreement bias. From the 1,147 inquiries, we received 298 responses, a response rate of 26 percent. The response rates varied across industries, from 16 percent (metal industry) to 31 percent (furniture). More respondent firms were domestic (179) than international (119). They had been in existence for 18 years on average, and SMEs in the software industry were the youngest with an average age of 13 years. Most of the respondents were managing directors (191) or owners (59), and 40 identified themselves as other key person. The average turnover of the respondent firms was 5.7 million euros, ranging between 3.3 million in KIBS to 6.2 million in the food industry. The average number of employees per firm was 40, ranging from 33 (furniture industry) to 43 (food industry). Scale development and evaluation 10

11 Network competence as a construct encompasses the business-relationship competences of a firm, and divides them into two distinct dimensions: task-execution activities and individual qualifications, with the former being further classified along relationship-specific and crossrelational dimensions (Ritter 1999; Ritter et al. 2002). The qualifications dimension of network competence concerns people dealing with relationships, and relies on specialist and social qualifications (Ritter 1999). Overall, network competence as a construct encompasses the competence in the firm to manage both dyadic, i.e. individual one-to-one, partnerships (relationship-specific tasks) and networks of partnerships (cross-relational tasks), and also incorporates the competence of individual employees to deal with the network relationships. Although it is recognized that firms have a multitude of core competences and capabilities related to acting in business relationships and networks (for reviews, see e.g., Pagano 2009 or Äyväri and Möller 2008), the question of how to describe and measure them remains unresolved (Jarratt 2008). Network competence as a quantitative scale serves this need directly. There have been calls for overall validation and generalization of the established network competence scale across industries and cultures (Ritter and Gemünden 2004; Ritter et al., 2002). As Churchill (1979) pointed out, validating and developing scales call for retest and replication studies. We measured network competence on a scale comprising statements related to network competence and task execution adapted from the original 93-item scale in the Ritter, Wilkinson and Johnston study (2002). We made the following changes to the original scale: We removed the word technical from items referring to technical partners in order to generalize over different business relationships such as suppliers and customers, and to reduce ambiguity; In the initiation sub-scale we combined several items regarding ways of searching for partners to form a single item, We search actively for new partners, in order to shorten the scale while retaining the contents; Similarly, we combined several items regarding ways of discussing shared requirements and objectives with partners in a single item: We share the same goals as our partners. In order to form a reliable and valid network-competence scale for the SME context we first reduced the number of items by means of an exploratory principal-component factor analysis (PCA). We used Varimax rotation and SPSS 17 for Windows software, but this did not result in a satisfactory construct. We therefore considered it necessary to further shorten the scale through confirmatory factor analysis. In forming the resulting network-competence construct we used LISREL 8.50 software and confirmatory factor analysis (CFA) (Jöreskog and Sörbom 1996). In addition, we used PRELIS 2.50 to calculate the covariance matrix and maximum likelihood subsequently applied as the estimation method. The model turned out not to fit the data sufficiently with all the items included, and we therefore improved it by removing individual items one by one, basing the removal decisions on residual patterns (Anderson and Gerbing 1988; 1984; 1982) and modification indices (Bagozzi and Yi 1988). According to the theoretical model of network 11

12 competence, the cross-relational scale should consist of planning, organizing, staffing and controlling sub-scales, and the relationship-specific scale of initiation, exchange and coordination sub-scales. Three alternative models were developed in line with these criteria: Model 1 was formed through removing the items showing the least fit until a sufficient fit was achieved, as indicated by measures of parsimonious, incremental and absolute fit (Hair et al. 1998); Model 2 comprised the entire set of items used in the survey, i.e. the first exploratory factor analysis scale mentioned above; Model 3 was a one-factor model, in which network competence was deemed a unidimensional construct in a single factor. Model 1 turned out to outperform models 2 and 3 (Table 1). The root mean square error of approximation (RMSEA) was below 0.7, and most of the fit indices were above 0.90: the goodness-of-fit index GFI was 0.91, the comparative fit index CFI 0.95, and the normed fit index NFI 0.91, with the adjusted goodness-of-fit AGFI reasonably close to the threshold at The t- values for the factor loadings were each statistically significant. (Table 1 here, please) The parsimonious-fit measures also indicated a fitting model: Akaike s information criterion (AIC) was 247 and the normed chi-square value Therefore, the model achieved an acceptable fit, and was deemed an acceptable measure for network competence in this study. The final result of the CFA is illustrated in figure 2. The complete set of items for the network competence scale used in the analysis included items from all the seven sub-scales of the original network-competence task-execution scale, and provided a sum scale incorporating both relationship-specific and crossrelational dimensions of network competence. Appendix A lists the individual items in detail. (Figure 2 here, please) With regard to the individual items in the network-competence construct, we determined reliability through their path coefficients and squared multiple correlations. We used the Cronbach s alpha and composite reliability values, and average variance extracted in determining the reliability of the latent indicators. The reliability statistics for the network competence scale can be observed in table 2. All of the individual items related significantly to their constructs. The Cronbach s alpha values ranged between 0.68 and 0.85, and the composite reliabilities between 0.67 and0.83, both exceeding the suggested threshold of 0.60 (Hair et al. 1998). The AVE values were also above 0.50, as recommended by Diamantopoulos and Siguaw (2000). Therefore, the network competence construct was found to be sufficiently reliable. (Table 2 here, please) 12

13 We assessed the construct validity of the network-competence scale in terms of convergent and discriminant validity. Significant factor loadings and correlating factors within a construct give some confirmation of convergent validity (Bagozzi and Yi 1991). Given that the factor loadings were all statistically significant and above 0.60, and that the factors in both the cross-relational and relationship-specific constructs all illustrated statistically significant (at the 0.01 level) and reasonably strong ( ) correlations, convergent validity was deemed sufficient. Discriminant validity requires the components not to be perfectly correlated, with correlation values of 1 (ibid.). AVE values for each factor relative to its shared variance with the other components also point to discriminant validity (Fornell and Larcker 1981). As Table 3 shows, the squared correlation was lower than the AVE value for all the factors, and all of the correlations between the components were different from 1 (all were significant at the 0.01 level). Therefore, although the components measure different aspects of the same construct, it can be concluded that they still measure unique dimensions of it. Thus, we considered the formed network competence construct both reliable and valid for the purposes of this study. (Table 3 here, please) We defined the measure of international performance as a sum scale of subjective and objective measures in order to take into account the degree of internationalization of the firms on the one hand, and their success in achieving the set strategic goals for internationalization on the other. The former lacks a common definition, but the recommendation is to make it a multi-item measure (Sullivan 1994). Consequently, we defined the objective aspect of international performance, i.e. the degree of internationalization, as consisting of the scope and the scale of international activities. The scope dimension comprised the number of countries in which the SME had international activities. In terms of scale, the proportion of its turnover generated from foreign markets could vary depending on the industry, and as such may not be indicative of its overall success during the early stages of internationalization. An incumbent firm having started its internationalization process decades previously may well generate a bigger proportion of its turnover in foreign markets than recently internationalized SMEs, even if the latter have better annual performance and grow on the international scale more rapidly. This applies to born-global SMEs in particular (McKinsey and Co. 1993; Rennie 1993). In order to take this into account, we calculated the scale aspect of the degree of internationalization as the foreign share of turnover three years after going international. Zou and Stan (1998) find that subjective measures of performing in foreign markets have been used too little as international performance measures, while Leonidou et al. (2002) in contrast find that the majority of international performance measures in the literature seem in fact to be subjective. We therefore took into account not only the degree of internationalization but also subjective managerial assessment of success in achieving the strategic outcome, and included the following set of seven Likert-scale items in the international part of the survey questionnaire: 13

14 Generally speaking, we are satisfied with our success in the international markets. We have achieved the turnover objectives we set for internationalization. We have achieved the market share objectives we set for internationalization. Internationalization has had a positive effect on our company's profitability. Internationalization has had a positive effect on our company's image. Internationalization has had a positive effect on the development of our company's expertise. The investments we have made in internationalization have paid themselves back well. The objective measures of scale and scope and the sum scale of this subjective scale were standardized and then calculated into a sum variable, thereby forming the measure of SME international performance. The items measuring environmental hostility were as follows: Access to capital is difficult. Products become obsolete quickly. Bankruptcy among companies in the industry is high. Demand for industry products is declining. Our company must often change its marketing practices to keep up with the competitors. The first four of these items encompass regulatory, technological, competitor and customer hostility, respectively, as in Zahra et al. (2000), and the last one was adapted from Naman and Slevin (1993). The items were similarly calculated into a sum variable. Finally, several control variables were added to the analyses. In addition to controlling for firm size (number of employees) and age, we included an industry variable. Given that internationalization tends to differ in knowledge-intensive industries and in more traditional industries, software and knowledge-intensive service firms were separated from those in the furniture, food and metal industries to form the dichotomous variable high-knowledge-intensive versus non-knowledgeintensive SMEs. The descriptives and intercorrelations for all the measures described here and used in the analysis are illustrated in table 4. (Table 4 here, please) As the table shows, the measures of network competence and environmental hostility correlated somewhat positively with each other. International performance correlated rather strongly and significantly with both network competence and environmental hostility, indicating potential positive support of the hypotheses through regression analysis. The control variables seemed not to make much difference to the performance outcomes in that the correlation with international 14

15 performance was not significant. The number of employees and the knowledge-intensiveness correlated significantly, although rather weakly, with the level of environmental hostility. RESULTS We tested H1 and H3 by means of binary logistic regression. We also controlled for the effects of firm size (number of employees), age and industry. The results are presented in Table 5. (Table 5 here, please) The model was significant, although the Nagelkerke and -2 log likelihood values indicated that the fit was not very good. However, the Hosmer and Lemeshow test statistic (sig.=0.612) indicated that the estimates fitted the data adequately. H1 received support, as network competence had a significant positive and an adequately large coefficient (0.4). Environmental hostility had a negative coefficient (-0.3), although it was only significant at the 0.10 risk level and therefore does not constitute adequate support for H3. Therefore, higher levels of network competence and lower levels of environmental hostility have positive links to propensity of an SME being international, but only the former highly significantly. The less statistically significant result on the environmental hostility variable may be due to the born global phenomenon: While knowledgeintensive SMEs may face dynamic industry environments, in the form of shorter product cycles for example, they still have to make an effort to internationalize in order to survive. As a consequence, our data might also have included some survivor bias for this very reason, as those that have failed to become international may have died out earlier, instead of having been available to respond to the survey. We suspect this kind of effect being behind the rejection of H3, as the industry control variable was highly positive and significant. The interaction variable of network competence and environmental hostility was not significant, however. It thus seems that the effects of network competence and environmental hostility in the internationalization propensity of SMEs are not intertwined and thus, H5 received no support. We tested the effect of network competence and environmental hostility on international performance by means of linear regression analysis. The same controlling variables were included as before. The results of this linear regression are presented in Table 6. (Table 6 here, please) The adjusted R 2 value for the model was.299, indicating that it explained almost a third of SME international performance. It was significant at the 0.05 level. This result shows, firstly, that both network competence and environmental hostility have a significant effect, in other words a higher level of network competence and a less hostile environment explain the international performance of SMEs. The coefficients for both were as expected from the hypotheses, but their interaction 15

16 variable was again non-significant, and therefore they seemed to have an independent explanatory power. The effects of firm age, size and industry were not significant, indicating that network competence and environmental hostility explain SME performance in foreign markets independently of each other and of other firm characteristics. Therefore, both H2 and H4 were supported, whereas H6 was not. These results resemble the analysis shown in Table 5 to some extent, although the environmental hostility coefficient was strongly significant in the international performance model, further indicating that network competence and the experienced level of hostility affect SME internationalization significantly but separately. Here, one might consider the fact that the environmental hostility construct correlated positively with network competence, and negatively with the internationalization variables, and come to the conclusion that the SMEs with more hostility in their environment may have had to develop better network competence in order to overcome it, leading in turn to more successful internationalization. In statistical terms, however, such a phenomenon might lead to the canceling out of the actual interaction variable in the regression model in that it was close to zero in both of the models tested. Alternatively, it may be that managers of early internationalizing SMEs do not consider networks as such a tool for overcoming hostility, but rather see them as a tool enabling them to become international, and eventually to be successful in international markets. CONCLUSIONS AND DIRECTIONS FOR FUTURE RESEARCH The aim of this study was to provide further evidence of the important role of the competences in SMEs to develop and handle relationships in the business networks in which they are embedded, and to assess the effect of market, technological, regulatory and competitive environmental hostility on their internationalization efforts. In the process we formed a reliable and valid shortened network-competence scale for the SME context. The results illustrate firstly, that the higher the level of network competence in SMEs, the more likely they are to have become international and the better international performance they have reached. These findings are in line with those reported in earlier studies indicating that the ability of firms to manage business relationships opens up new avenues through which to internationalize and perform in foreign markets (e.g., Hanna and Walsh 2008; Mort and Weerawardena 2006; Walter et al. 2001; Coviello and Munro 1995; Bell 1995). However, this is the first time we know of where the level of measurable organizational network competence has been linked to internationalization outcomes among SMEs. As such, our study contributes to SME internationalization discussion and its network context, as well as to literature on competence development and operationalization. Additionally, the results indicate that both the level of network competence and a lack of perceived environmental hostility explain performance in international markets. While more hostile environments were not found to strongly affect the propensity of SMEs to internationalize, we suspect some influence of the existence of born globals in our data to have caused this result. Perceiving less hostility in their environment was positively linked with international performance 16

17 among SMEs, however. This is in line with studies linking environmental hostility, or turbulence, with firm performance (e.g., Boyne and Meier 2009; Kuivalainen et al. 2004; Li and Atuahene- Gima 2001; Zahra and Garvis 2000). Earlier research has also indicated that a weaker perception of market hostility enhances the internationalization process in general (Shaw and Darroch 2004; Zahra et al. 2000), and in the network context in particular (Matanda and Freeman 2008; Lee and Cavusgil 2006). Our study further contributes to this discussion by finding that network competence and environmental hostility have opposite effects on internationalizing SMEs, but that the negative effects of hostile environment on the internationalization process can be offset by better organizational network competence. Contrary to some earlier results (e.g., Zahra and Garvis 2000; Covin and Slevin 1989), environmental hostility did not have a significant moderation effect in our analysis, but was independent. In other words, it turned out that the positive effect of network competence on the propensity of SMEs to internationalize and on their subsequent performance was not intertwined with environmental hostility as an interaction effect. Instead, network competence and a lack of perceived hostility both led to better results as far as the internationalization process was concerned, and together explained almost a third of the performance, but the effects were separate. Perhaps it could be said, then, that although the effect of the environment on SME internationalization matters, the network itself does not incorporate consideration of that environment. In other words, both developing and maintaining network relationships enhance internationalization as an environment in itself, as implied in the network approach. At the same time, regulatory and market environments in different industries and countries vary in terms of how hostile internationalizing SMEs perceive them to be, and have an additional independent effect on the process as a whole. Environmental factors may sometimes override the availability of business networks in the first place, as noted by Evers (2010). Still, the results of this study confirm that, along with network competence, the perceived hostility of the environment has an effect on the international performance of SMEs. In this study, we measured international performance of SMEs as a composite scale consisting of both subjective and objective dimensions. As such, it included the scale and scope aspects of internationalization on the one hand, and a subjective assessment of success of the internationalization process in strategic terms on the other. Therefore, better network competence and less environmental hostility are linked not only to more rapid and intense internationalization, but also to SMEs fulfilling their internationalization strategies more successfully. The implication here is that when SMEs are making plans to enter foreign markets and to achieve international growth, their overall strategy should include plans to improve their network competence and find creative ways to overcome any hostilities they perceive relating to their external environment. Coviello and McAuley (1999) suggest in their review of the literature on SME internationalization that, in the end, internationalization of SMEs boils down to networks rather than other firmspecific explanatory variables. We found some support for this in the sense that, although firm 17

18 characteristics related to knowledge intensity, age and size seemed to affect the likelihood that the SME would go international in the first place, they seemed to have no effect on the consequent performance outcome in international markets. This indicates that for born-global-type firms operating in knowledge-intensive fields in particular, the decision to internationalize depends largely on the networks in which they are embedded and on the resulting potential effect of overcoming the perception of hostility, which often acts as deterrent in terms of entering a foreign market. Our results are in line with this, as firms already operating in foreign markets seem to exhibit higher levels of network competence, and their international performance, measured in terms of both scale and scope, as well as strategically, is in part attributable to this competence. A further implication is that when it is deemed necessary to find out the level at which the firm is able to conduct its business relations, network competence offers a reliable and a valid scale. If, as the results suggest, the better use of one s networks through network competence is not moderated by perceived environmental hostility in terms of consequently lowering it, then the perception remains, and the way to overcome it is to improve network competence even more. Several limitations in the study should be noted. Firstly, the fact that no firms with more than 500 employees were included in the sample should be kept in mind in attempts to generalize the results further. Secondly, given that the data were gathered in 2008 before the main effects of the international global market downturn in 2009 were felt, the environmental hostility faced by firms has probably changed somewhat. Longitudinal examination of the selected firms might therefore be useful. Longitudinal research would also eventually give more information about the long-term effects of network competence on international performance, as some benefits may not be realized quickly: in Asian markets, for example, the development of trust takes time. It might also lead to explaining how network competence in practice develops in SMEs over time. Moreover, only part of the network-competence scale was used in the survey. Some items on task execution were dropped, and the qualifications sub-scale was not included at all. One could argue that the importance of individual network competence is heightened in small entrepreneurial firms as they have fewer employees, and therefore the qualifications part of the original scale should be included in all SME contexts. This claim has some merit, and therefore it would be interesting to see whether similar or stronger results would be obtained using the complete original networkcompetence scale (as defined by Ritter et al. 2002), or one in which both the task-execution and qualifications parts are equally represented. The same applies to our measure of environmental hostility, which only contained five adapted items. It would also be worth considering in subsequent research changing the context to include a larger range of firm sizes and more industries in order to increase generalizability. While our empirical data included SMEs across five industry sectors, sample size issues restricted our ability to make more refined industry-specific observations. With the recent emergence of born globals, new knowledge-intensive industry sectors, and the concentration of extant network-related SME research on those types of firms, industry-level analysis could prove a promising avenue for further research. Naturally, the cultural context of the results is also highlighted by the fact that the 18

19 data were constrained to Finnish SMEs, and subsequent studies could include SMEs from other countries as well. We believe, however, that our results should be generalizable to similar small open economies. This is due to similarities in market and governmental environments, comparatively small domestic markets, and large proportions of SMEs compared to MNCs in these countries. In addition, much of the earlier research that has found linkages SMEs networks and their internationalization have been conducted in small open economies, such as Sweden (Sharma and Blomstermo 2003), Ireland (Loane and Bell 2006; Bell 1995) and New Zealand (Coviello 2006; Loane and Bell 2006; Coviello and Munro 1997; Coviello and Munro 1995). Finally, it would be worth investigating to what extent SME business-relationship competences, as evidenced by their network competence, are moderated (or act as moderators of) other previously examined determinants of their international performance, such as market orientation (e.g., Ruokonen et al. 2008), entrepreneurial orientation (Jantunen et al. 2005), and other types of strategic orientation. The role of relationships and networks in international markets is recognized in the literature, but their manifestation as firm-specific competences, their interplay with other capabilities and core competences, and their consequences in terms of SME internationalization in different environments would merit further study. 19

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29 APPENDIX A. The adapted network competence scale. Planning sub-scale: We evaluate the way our relationship with each partner helps our relations with other technical partners. (PART_4) We evaluate the way the results of collaboration with each of our partners fit together. (PART_6) We compare our partners in terms of their technical knowledge. (PART_8) Organizing sub-scale: We share the same goals with our partners. (PART_1) We initiate meetings and discussions among those in our firm involved in relationships with our partners. (PART_12) Staffing sub-scale: We assign people to each relationship with our partners. (PART_13) We coordinate the activities involved in different relationships with our partners. (PART_14) Controlling sub-scale: We assess how much effort our people put into relationships with partners. (PART_15) We monitor the extent to which relationships with our partners work to our advantage. (PART_16) Initiation sub-scale: We search actively for new partners. (PART_18) We visit potential partners in order to get to know them. (PART_19) Exchange sub-scale: We exchange confidential information with our partners. (PART_21) We inform others in our firm about the requirements of our partners. (PART_23) Coordination sub-scale: We put people from our partners in contact with key people in our firm. (PART_24) We put people in our firms in contact with key people from our partners. (PART_25) 29

30 Figure 1. The tested links between constructs based on the hypotheses 30

31 Figure 2. The network-competence construct formed for the SME context. Table 1. Network competence model scale comparisons Model 1 Model 2 Model 3 Absolute fit measures GFI RMSEA Incremental fit measures CFI NFI Parsimonious fit measures AGFI Normed chi-square ,92 AIC