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2 European Management Journal (2009) 27, journal homepage: The moderating effects of home region orientation on R&D investment and international SME performance: Lessons from Korea In Hyeock Lee *, Matthew R. Marvel Department of Management, Gordon Ford College of Business, Western Kentucky University, 1906 College Heights Blvd., Bowling Green, KY , United States KEYWORDS Regional strategies; Home region orientation; Firm-specific advantages; R&D investment; Firm performance; Small and medium-sized enterprises Summary Drawing from the resource-based view, we investigate how firm and country combinations affect international SME performance. Using a sample of 2676 international Korean SMEs, we explore the relationships among SME R&D investment, home region orientation and financial performance. Results show that R&D investment has a horizontally inverted S-shaped relationship with performance reflecting cost leadership, stuck in the middle, and differentiation strategies. We also find that a home region orientation moderates the relationship between R&D investment and performance. Home region orientation positively moderates the relationship when R&D investment reflects cost leadership or differentiation but negatively moderates a stuck in the middle strategy. ª 2009 Elsevier Ltd. All rights reserved. Introduction How small and medium-sized enterprises (SMEs) effectively internationalize and achieve greater firm performance is an important question. SMEs play an increasing role in international trade and economic growth. Advances in information technology and globalization are leading to SMEs that are more active in international markets than ever before (Knight, 2001). Considering the vast majority of firms are * Corresponding author. Tel.: ; fax: addresses: ian.lee@wku.edu, inhyeock@gmail.com (I.H. Lee), matt.marvel@wku.edu (M.R. Marvel). SMEs (i.e. less than 500 employees) and generate the majority of all new jobs across countries, one can expect attention to SME internationalization and performance to gain momentum (e.g., OECD, 2005; OECD and APEC, 2007). Understanding how international SMEs reap greater performance has rich theoretical and practical implications. High levels of performance facilitate firm growth that, in turn, can yield employment gains and contribute to the general economic health of a nation. Given the resource constraints of small firms and their susceptibility to distress, hardship and outright failure, a better understanding of the contributing factors for higher performance is desirable. To examine international SME performance we use RugmanÕs (2005) extension of the resource-based view (RBV) and combine firm and country-level advantages. While RBV /$ - see front matter ª 2009 Elsevier Ltd. All rights reserved. doi: /j.emj Electronic copy available at:

3 The moderating effects of home region orientation on R&D investment 317 considered firm resources and capabilities, country or context was conceptually outside the purview of the theory. We argue that to adequately explain effective internationalization strategies, and their outcomes, region differences outside that of the home country must be considered. Therefore a main goal of this undertaking is to examine performance implications of regional strategy differences of international SMEs. RugmanÕs theoretical framework of firm-level advantages and country-level advantages has been useful in explaining multinational enterprise (MNE) internationalization and performance. However, the theoretical framework has not been applied to international SMEs, representing a gap in the literature. We address this gap, and explore how different combinations of firm and country attributes translate to international SME performance. To investigate these relationships we use international Korean SMEs. We define an international Korean SME as a firm with less than 500 employees that has an international operation (i.e. export, international joint venture, foreign investment for acquiring equity, R&D unit, or subsidiary) located outside of Korea. Drawing from the firm and country theoretical framework, we first assert firm investments in R&D are critical to explaining performance. Innovation efforts lead to market share and sales growth by increasing the customers in existing markets or attracting new customers by opening new markets to the firm (Zahra and Nielsen, 2002). We define R&D investment as the ratio of total R&D expenditures compared to total sales. To investigate country level attributes we use region orientation differences across international Korean SMEs. We use RugmanÕs (2005) geographical conceptualization of Asia, the European Union, and North America making up a triad that shares some commonalities. A home region orientation is defined as the magnitude of sales occurring within Asia and not the European Union or North America. Therefore, higher sales within Asia result in a greater home region orientation of Korean international SMEs. Lower magnitudes of sales within Asia result in a lower home region orientation. Through this undertaking, we make a number of contributions. First, we increase our understanding of Korean international SMEs by examining both their R&D investment and the region orientation of their internationalization strategy. Second, we test the direct effects of R&D investment on SME performance using return on assets. Finally, we explore how a home region orientation for SME internationalization moderates the relationship between R&D investment and performance. The Korean context Over the last 50 years, Korea has successfully transformed its economy and achieved self-sustaining development and growth (World Bank, 1993; Dahlman and Andersson, 2000). Korean SMEs play a vital role in job creation, increasing income as well as contributing to economic growth through innovation and improved product quality. Consequently, in 1996 the Korean government began to pay close attention to the development of SMEs and created the Small and Medium Business Administration (SMBA) to encourage economic growth. As of 2006, there were 3 million SMEs in Korea which account for about 99% of all Korean companies. Korean SMEs account for 88% of total employment which equates to about 10 million jobs. Dana (2007) points out that between 1991 and 1999, Korean SME employment rose by about 30%. Recent research on Korea suggests the country is a highly entrepreneurial society. The 2002 Global Entrepreneurship Monitor (GEM) survey of entrepreneurial activity around the world indicates that KoreaÕs average total entrepreneurial activity rate is about 15%, one of the highest in the world (Reynolds et al., 2002). GEM research indicates entrepreneurial activity in Korea is motivated by opportunity rather than necessity. An aspect of the GEM survey is that it also tracks entrepreneurial activity within firms, referred to as Firm Entrepreneurial Activity (FEA). Findings indicate that 4% of the Korean population is involved in these entrepreneurial firms, the second highest level in the world (Reynolds et al., 2002). The Convention on the Organization for Economic Cooperation and Development (OECD) monitors trends, as well as analyses, and forecasts economic developments across countries. Among these, they monitor R&D investment compared to GDP. Korea invests more than 3% of its GDP in R&D, which is high compared to other OECD countries. However, the total amount of R&D investment lags most leading OECD countries (OECD, 2008). Nevertheless, the R&D investment made by Korean SMEs has increased over the last decade (Gregory et al., 2002). In terms of international activities, Korean SMEs are aggressively attempting to transform into more innovative and knowledge based businesses to take advantage of changing markets (Gregory et al., 2002). Korean SMEs are increasing cooperation with overseas enterprises or making entry to foreign markets to prepare for increased market globalization. According to Export Import Bank of Korea, an agency that provides support to Korean enterprises, in 2006 more than 30% of total Korean exports originated from SMEs. Further, about 40% of all outward foreign direct investments from Korea derive from SMEs. Continued advancements by Korean SMEs in the new millennium depends both on the ability to sustain improvements and gain advantages in new foreign markets. Theoretical framework We use a well known theoretical framework from the international strategy literature to shed light on international SME performance. International strategy scholars have long distinguished between both country-level effects and firmlevel effects. Rugman (1981, 2005) describes countryspecific advantages and firm-specific advantages as the two basic building blocks for international strategy. Consistent with the RBV, firms with superior resources and capabilities will out-perform their competitors by achieving stronger competitive advantages (Wernerfelt, 1984; Teece et al., 1997). Similar to RBV, Rugman (2005) argues different firm and country combinations lead to different outcomes. While RBV initially focused on firm specific combinations exclusively, this expanded theoretical framework concerns combinations both within the firm as well as outside the firm, or the region of internationalization. Therefore, country-specific factors provide an additional source of competitive advantage by which firms can achieve higher performance.

4 318 I.H. Lee, M.R. Marvel Drawing from the framework, there is first a set of firmspecific attributes that affect the competitive advantage of an organization, referred to as firm-specific advantages. These are unique firm capabilities that may be based on marketing, distribution systems or innovation capabilities among others. The advantages possessed by an international firm are based ultimately of its internalization of an asset, such as production, marketing or R&D capabilities over which the firm has control. The second major part of the framework is country level factors. These are especially relevant to firms engaged in international trade and investment as country-specific advantages link to performance outcomes. Rugman (2005) describes potential sources of country advantages as political, cultural, economic, and financial factors exogenous to the organization. Countries or regions will have varying advantages when combined with unique firm attributes. The firm and country framework has been especially useful in explaining multinational enterprise behaviors (Rugman, 2005; Rugman and Verbeke, 2004) however the framework has not been applied to international SMEs. As seen in Figure 1, we suggest that both firm-specific attributes and country-specific advantages affect international SME performance. To develop these arguments we first turn our attention to firm-level R&D investment and then address home region orientation. R&D investment strategy Small businesses are one of the greatest drivers of innovation domestically and abroad. Acs and Audretsch (2003) compared data sets and found they provide similar results regarding important differences associated with innovation by SMEs compared to large firms. Among the findings, small firms contribute about two and a half times more innovations per employee than do large firms. Further small firms tend to produce more breakthrough or radical innovation compared to their counterparts (Baumol, 2006). Considering SMEs have an innovation advantage compared to larger firms, R&D investment may be of unique importance to international SME performance. Investments in innovation have been identified as an important source of competitive advantage for firms. Numerous studies have found support for R&D investment promoting performance and promoting economic growth (Pakes, 1985; Romer, 1990; Delios and Beamish, 1999; Kotabe et al., 2002; Qian and Li, 2003; Zachariadis, 2003; Belderbos et al., 2004; Chiao et al., 2006). However, a few scholars have also reported a negative relationship or no relationship at all between the constructs (Souitaris, 1999; Sundaram et al., 1996). One explanation for these contradictory results may be because the relationship between R&D investment and SME performance is not as straight-forward, or linear, as previous research has assumed. To accurately explain the relationship among R&D investment and performance, SME innovation strategy must be taken into account. PorterÕs (1980, 1985) generic strategies of cost leadership and differentiation have become a dominant paradigm in the strategy and international business literature. Each of these represents a fundamentally different approach to creating a competitive advantage and promoting performance. According to Porter (1985) the firm must make a choice between low cost leadership and differentiation or it will become stuck in the middle. On one hand, a cost leadership strategy requires little R&D investment. On the other hand, a differentiation strategy is especially costly and requires high levels of innovation investment (Porter, 1985). Although Porter recognized that firms can pursue both a low cost and differentiation strategy successfully, he viewed these circumstances as temporal. When the firm pursues both a low cost and differentiation strategy it is vulnerable to the emergence of a capable competitor that stresses either differentiation or low cost. Put another way, Porter stressed that the combination of both low cost and differentiation is unlikely to produce sustainable competitive advantage. SMEs are especially resource constrained compared to larger firms and therefore we argue that PorterÕs theory of executing either a low cost or differentiation strategy is critical to their performance. Both strategies have risks but also the potential for improved performance. A low cost strategy involves standardized products with features acceptable to many customers at the lowest competitive price. In order to be the low cost leader there is a constant effort to reduce production costs and overhead. A common approach is minimizing costs of sales, service and especially R&D (Hitt et al., 2000). This approach constrains innovation costs and instead increases focus on economies of scale based on volume advantages (Porter, 1985). Effective low cost strategies can be based on standardizing value-chain activities such as design, sourcing, manufacturing, and retailing rather than modifying them to cater to specific niche markets. Therefore, in many cases, SMEs can implement a cost leadership strategy successfully by expanding their volume through internationalizing in foreign markets Firm-Specific Advantages (R&D Investment) H1 Firm Performance (Internationalized SMEs) H2 Country-Specific Advantages (Home Region Orientation) Figure 1 Firm-specific advantages, country-specific advantages, and firm performance.

5 The moderating effects of home region orientation on R&D investment 319 (Qian and Li, 2003). On the other hand, a differentiation strategy requires a greater investment in R&D to develop unique properties of their products and services. Differentiation requires a firm to innovate earlier than competitors and establish first mover advantages. These firm-level advantages act as barriers to entry to deter other firms from entering the market. As such, when SMEs go abroad to realize their firm-specific advantages with a differentiation strategy, it is inevitable for them to increase R&D investment so that they can add new features to their current products or services, leading to further profit from foreign markets. Consistent with Porter (1980, 1985) we argue low cost leadership and differentiation strategies promote SME performance in international markets. For example, low level R&D investment indicates low cost leadership whereas high R&D investment indicates differentiation strategy. Both of these strategies are expected to increase SMEsÕ performance. In contrast, those SMEs with a moderate R&D investment exemplify the middle ground and therefore are stuck in the middle. This middle ground is expected to be associated with decreased international SMEs performance. Therefore, we propose the following hypothesis. Hypothesis 1: R&D investment will have a horizontally inverted S-shaped curvilinear relationship to performance. Home region orientation strategy The R&D investment of SMEs and the impact on performance should be studied in light of contextual factors. Location of internationalization has emerged as an important determinate of firm survival and performance (Fotopoulos and Louri, 2000; Littunen, 2000; Li, 2004). SMEs wish to locate in countries or regions where they can exploit their firm-specific advantages and maximize profits. Therefore, where to internationalize is an important question. However, while location specific research has emerged very little examines international SMEs. This is surprising considering recent evidence suggests the region of internationalization is an important area when considering performance (Rugman and Verbeke, 2004; Rugman, 2005). To consider region orientation many studies draw on RugmanÕs (2005) geographical conceptualization of a triad comprised of Asia, the European Union, and North America. Overall, each of these geographies share some commonalities such as relatively low macro-economic growth, similar technological infrastructure, the presence of capital, and knowledge intensive firms across most industries. Recent research supports the idea that firms tend to internationalize within their home region of the triad compared to outside of their home of operation (Rugman and Girod, 2003; Rugman and Brain, 2003; Rugman and Collinson, 2004, 2005, 2006; Oh and Rugman, 2006; Collinson and Rugman, 2007). In the case of large-sized MNEs on the Fortune Global 500, most actually operate on a regional basis within the triad (Rugman, 2005). Using a sample of 320 MNEs with geographical sales segments, Rugman and Verbeke (2004) found that about 80% of sales result from their home region of the triad. Delios and Beamish (2005) used a sample of 1229 Japanese MNEs to provide additional evidence that most firms have a preference of a home-region orientated strategy. The geographic orientation of internationalization is a vital aspect of performance that needs to be considered in the SME context. We argue that when SMEs internationalize, they are better able to realize their firm-specific advantages in the home region of the triad compared to other regions. Essentially intra-region foreignness is preferable compared to an inter-region foreignness when considering internationalization. Goerzen and Beamish (2003) refer to this region orientation for internationalization as anchored compared to far-flung MNEs. Numerous explanations have been offered as to why intra-region foreignness is preferred over inter-region foreignness (Rugman and Verbeke, 2007). Among them is the explanation that firms are better able to reduce transaction costs by operating in more similar markets to their home country (von Hippel, 1998; Doz et al., 2001; Oh and Rugman, 2007). Another explanation is that by internationalizing within the home region of the triad firms are better able to acquire information about local business practices as well as consumer tastes. Learning can take place more efficiently and effectively because the country is culturally related and nearby in proximity (Ruigrok and Wagner, 2003; Lu and Beamish, 2001; Schenkar, 2001). Recent evidence also suggests that firms are better able to deal with formal and informal institutional constraints of intra-regions rather than across inter-regions (Peng, 2002; Peng and Zhou, 2005; Peng and Delios, 2006). The argument of a greater home region orientation for internationalization as being more favorable compared to a lower home region orientation can be applied to R&D investment as well. When SMEs plan and implement a R&D investment strategy with geographic orientation in their home region, we expect them to reap the location benefits described above. Based on the accumulation of skills and an existing base of firms more similar to their domestic market, we expect the relationship between R&D investment and performance to be strengthened in their home region of the triad (Cohen and Levinthal, 1990). For example, in the early stages of development, SMEs can respond to the specific needs of intra-regional customers more directly and promptly by capturing and incorporating them into the R&D process. On the other hand, during the later stage of the R&D investment, they are better able to cater to markets of nearby countries within their home region. Because customers and markets are less foreign compared to outside the home region, less modifications to products are needed. Because less uncertainty exists within a home region the lead time between initial R&D investment and commercialization is shorter. Consequently, the financial burdens of the SMEs can be reduced because new products are commercialized sooner, rather than later. Overall, a greater home region orientation is expected to positively affect the realization of profits for SMEs. Therefore, we argue that a greater home region orientation compared to a lower home region orientation of SMEs will positively enhance the effects of R&D investment on performance. This leads to the following hypothesis.

6 320 I.H. Lee, M.R. Marvel Hypothesis 2: Home region orientation moderates the curvilinear relationship between R&D investment and performance in such a way that a greater home region orientation will relate to greater performance compared to a lower home region orientation. Research design Sample To procure a sample of international Korean SMEs we drew on survey data collected by the Korean Small and Medium Business Administration (KSMBA) in The KSMBA is a branch institution of the Korean government with a mission of formulating and implementing public policy measures to promote the development of Korean SMEs. The survey was sent to the SME President or CEO registered with the KSMBA and was returned with a response rate of about 53% (6023 observations out of 11,392 firms). After selecting firms with at least one international reach outside Korea and with less than 500 employees (Acs and Audretsch, 1988) 2767 SMEs remain. Since 91 of these did not reveal information on the country of destination for foreign operations they were removed from the sample. From the remaining 2676 observations used in the study, we observed that only 5 had multiple international reaches. Consequently, more than 99% of all international Korean SMEs were doing business in only one foreign market. The single largest foreign market that Korean SMEs were doing business with was the U.S. which equates to about 26% of all international Korean SMEs. The second and third largest foreign markets that international Korean SMEs were doing business with were China (24%) and Japan (18%), respectively. Of all international Korean SMEs about 71% operated in manufacturing industries. When the regional scope of internationalization was examined, about 60% of all international Korean SMEs had an international reach in their home region of the triad and not outside the Asia region. Not surprisingly, a home region orientation was more prevalent in service industries rather than manufacturing. Performance variables Following previous literature on firm performance, we use return on total assets (RoA) as the dependent variable a widely accepted performance measure 2 (Grant,1987; Kotabe et al., 2002; Qian and Li, 2003; Ruigrok and Wagner, 2003; Delios and Beamish, 2005; Li, 2005; Qian et al., 2008). For robustness, we use two accounting and taxation conventions as variants of the performance measure. These include ordinary return on total assets (Ordinary RoA: the ratio of ordinary profit to total assets) and net return on total assets (Net RoA: the ratio of net profit to total assets). Ordinary return indicates the profit earned in the normal course of businesses without extraordinary items. Net return is the money 2 The return on total equity (RoE) produced the same results as those from using RoA in the subsequent regressions in terms of qualitative interpretation. When the return on total sales (RoS) was used, the home region orientation of Korean SMEs did not satisfy the conditions for being a moderator in our empirical setting. left over on the bottom line of the income statement after subtracting all types of expenses, including extraordinary expenses and taxes from the companyõs sales revenue. R&D investment variable R&D investment was measured using the ratio of total R&D expenditures to total sales often referred to as R&D intensity. This is consistent with numerous other studies (e.g. Kogut and Chang, 1991; Morck and Yeung, 1991; Delios and Beamish, 1999, 2005; Kotabe et al., 2002; Goerzen and Beamish, 2003; Qian and Li, 2003; Qian et al., 2008). Home region orientation variable To assess home region orientation, we use the magnitude of sales in the home region. Home region orientation is measured as total sales within the Asia region of the triad. Therefore, greater amounts of sales within Asia represent a greater home region orientation for international Korean SMEs. On the other hand, lower amounts of sales within Asia indicate a lower home region orientation. Control variables Based on the previous research, we control for various characteristics which may influence performance. First, firm age is measured by the number of years since the inception of SME operation (Qian and Li, 2003; Qian et al., 2008). Second, firm size is represented by the number of employees that each SME has (Chang and Thomas, 1989; Goerzen and Beamish, 2003; Qian et al., 2008). Third, we control for manufacturing industries (Li, 2005; Contractor, 2007) via a dummy variable. Fourth, to control for different capital structures we use a financial leverage ratio calculated as total debt to assets (Bühner, 1987; Goerzen and Beamish, 2003; Li, 2005). Fifth, we control for marketing intensity measured as the ratio of total selling, general, and administrative expenses to total sales (Kogut and Chang, 1991; Morck and Yeung, 1991; Delios and Beamish, 1999, 2005; Kotabe et al., 2002; Goerzen and Beamish, 2003; Qian and Li, 2003; Qian et al., 2008). Sixth, degree of internationalization is controlled for and represented as the ratio of foreign to total sales of each SME (Grant, 1987; Tallman and Li, 1996; Qian and Li, 2003; Li, 2005). Finally, we include four dummy variables to control for the different entry modes of internationalization. These include exports, international joint venture, foreign investment for acquiring equity, an R&D unit, and subsidiary (Contractor, 2007). Table 1 displays the descriptive statistics and correlations across the variables. Model specification When using cross-sectional data a potential heteroskedasticity problem is a rule rather than an exception (Greene, 2000). In order to address the issue of heteroskedasticity, we use a two-stage feasible generalized least square (FGLS) regression method in the empirical analyses. Based on the theoretical framework and the description of the variables in the previous sections, the empirical model used herein can be specified as follows:

7 Table 1 Descriptive statistics and correlation matrix a. Variable N Mean SD Return on assets (ordinary profits) 2. Return on assets *** 1.00 (net profits) 3. R&D intensity *** 0.11 *** Home region orientation 5. Firm age Number of employees * 0.41 *** Manufacturing industry ** 0.04 ** 0.04 ** *** 0.04 ** Financial leverage *** 0.20 *** 0.19 *** Marketing intensity *** 0.10 *** 0.33 *** ** 0.19 *** Internationalization *** 0.12 *** 0.46 *** 0.16 *** ** 0.23 *** 0.15 *** 1.00 (FS/TS) 11. Entry mode dummy *** 0.07 *** (EQUITY) 12. Entry mode ** 0.04 ** *** 0.15 *** *** 1.00 dummy 2 (IJV) 13. Entry mode dummy 3 (EXPORT) *** 0.18 *** *** 0.46 *** 1.00 a Significance levels: * P < 0.1, ** P < 0.05, *** P < The moderating effects of home region orientation on R&D investment 321

8 322 I.H. Lee, M.R. Marvel Table 2 Regression results with ordinary RoA a,b. Independent variables Model 1 Model 2 Model 3 Model 4 Intercept 1.34 ( 0.68) 1.67 ( 0.85) 1.66 ( 0.85) 1.70 ( 0.88) Firm age 0.15 (1.11) 0.15 (1.13) 0.15 (1.13) 0.15 (1.17) Number of employees 0.01 (0.36) 0.01 (0.25) 0.01 (0.25) 4.8E-3 (0.24) Manufacturing industry 2.12 (1.39) 2.02 (1.33) 2.02 (1.33) 1.92 (1.27) Financial leverage 0.07 *** (6.44) 0.08 *** (6.77) 0.07 *** (6.75) 0.07 *** (6.60) Marketing intensity 0.02 * (2.41) 0.01 (1.16) 0.01 (1.16) 0.01 (0.55) Internationalization (FS/TS) *** (4.17) (1.77) (1.79) * (2.15) Entry mode dummy 1 (EQUITY) 2.50 ( 0.70) 3.04 ( 0.86) 3.04 ( 0.86) 3.14 ( 0.89) Entry mode dummy 2 (IJV) 6.11 * ( 2.27) 5.99 * ( 2.24) 5.99 * ( 2.24) 6.02 * ( 2.27) Entry mode dummy 3 (EXPORT) 1.15 ( 0.64) 1.11 ( 0.62) 1.11 ( 0.62) 1.05 ( 0.59) R&D intensity 0.38 *** (5.29) 0.38 *** (5.24) 0.41 *** (5.42) R&D intensity 2 1.5E-3 *** ( 5.37) 1.5E-3 *** ( 5.34) 1.5E-3 *** ( 5.08) R&D intensity 3 1.2E-6 *** (5.19) 1.2E-6 *** (5.16) 1.3E-6 *** (4.60) Home region orientation of SMEs 4.0E-9 ( 0.30) 7.9E-9 ( 0.60) R&D intensity home-region 2.7E-7 ** (2.71) R&D intensity 2 home-region 2.4E-9 ** ( 3.02) R&D intensity 3 home-region 2.0E-12 ** (3.06) N F R a Significance levels: P < 0.1, * P < 0.05, ** P < 0.01, *** P < b Coefficients are followed by t-statistics in parentheses. RoA i ¼ b 0 þ b 1 R&D i þ b 2 R&D 2 i þ b 3 R&D 3 i þ b 4 HomeRegion i þ b 5 ðr&d i HomeRegion i Þ þ b 6 ðr&d 2 i HomeRegion i Þþb 7 ðr&d 3 i HomeRegion i Þ þ X b c ControlVariable ci þ e i where RoA i is return on total assets; i stands for each SME; R&D i is measured as the ratio of total R&D investment to total sales, R&D 2 i and R&D 3 i are the squared and cubic terms, respectively; HomeRegion i is measured as a continuous sales magnitude metric of each SME i in the Asia region; Control Variable ci stands for the seven control variables used in the current study. Results 3 We conducted the Glesjer test to check for the presence of heteroskedasticity in the data using the residuals from ordinary least squares (OLS). Results indicate the number of employees (EMPL i ) was the cause of heteroskedasticity. For a functional structure of Varðe i Þ¼r 2 exp½a 0 þ a 1 EMPL i Š the Glesjer test rejected the null hypothesis of homoskedasticity at the 99% level of confidence (p < 0.01). Therefore, each dataset observation including intercept terms was divided by the predicted value of Varðe i Þ to transform the data before the FGLS regressions. Tables 2 and 3 report the regression results using both Ordinary RoA and Net RoA as dependent variables. 3 A number of the control variables affected the performance of international Korean SMEs. Financial leverage has a positive and significant effect across both measures of performance. The degree of internationalization also has a positive and significant effect when ordinary profits are used to calculate the return on total assets. Of particular interest, the choice of international joint ventures as an entry mode has a significant and negative impact consistently across both performance measures. We observe that marketing intensity has a statistically significant effect in the base model (Model 1) of the regressions. However, marketing intensity is not statistically significant when the direct effects, or the interaction, among the variables of interest were entered into the analyses. There was no evidence of age, size, industry, or other types of entry mode translating to international SME performance. Both regression analyses reveal that R&D investment has a horizontally inverted S-shaped relationship with performance. Models 2 4 show R&D intensity and its cubic term are statistically significant and both exhibit positive signs. They also show the squared term of R&D investment is statistically significant and exhibits a negative sign. Therefore R&D investment is positively related to performance at both low and high levels, but negatively related to the performance when in the middle range. Thus, Hypothesis 1 is supported. To examine the moderating effects of home region orientation, we turn our attention to the interaction terms in Model 4 of the analyses. Both regression models provide evidence that a home region orientation moderates the relationship between R&D investment and performance. We employ a diagrammatic representation to illustrate these effects. In Figure 2, the horizontal axis represents R&D intensity and the vertical axis represents performance measured by RoA. The two curves and corresponding inflection points are depicted and calculated based on two scenarios. From the regression results, we plotted two cubic curves to depict the relationship between R&D investment and performance for Korean internationalized SMEs. The dotted curve represents the curvilinear relationship between R&D

9 The moderating effects of home region orientation on R&D investment 323 Table 3 Regression results with net RoA a,b. Independent variables Model 1 Model 2 Model 3 Model 4 Intercept 1.23 ( 0.63) 1.64 ( 0.85) 1.64 ( 0.85) 1.73 ( 0.90) Firm age 0.15 (1.11) 0.15 (1.12) 0.15 (1.12) 0.15 (1.19) Number of employees 0.01 (0.41) 4.6E-3 (0.24) 4.5E-3 (0.24) 4.4E-3 (0.24) Manufacturing industry 1.89 (1.23) 1.75 (1.16) 1.75 (1.16) 1.66 (1.11) Financial leverage 0.09 *** (7.87) 0.09 *** (8.37) 0.09 *** (8.36) 0.09 *** (8.21) Marketing intensity 0.02 ** (2.59) 0.01 (0.88) 0.01 (0.88) 3.4E-3 (0.32) Internationalization (FS/TS) ** (3.08) 2.27 (0.20) 2.16 (0.18) 8.19 (0.67) Entry mode dummy 1 (EQUITY) 2.00 ( 0.56) 2.66 ( 0.76) 2.66 ( 0.76) 2.76 ( 0.80) Entry mode dummy 2 (IJV) 5.81 * ( 2.16) 5.48 * ( 2.07) 5.47 * ( 2.07) 5.48 * ( 2.09) Entry mode dummy 3 (EXPORT) 1.12 ( 0.62) 1.03 ( 0.58) 1.02 ( 0.58) 0.95 ( 0.54) R&D intensity 0.48 *** (6.76) 0.48 *** (6.74) 0.51 *** (6.86) R&D intensity 2 1.8E-3 *** ( 6.62) 1.8E-3 *** ( 6.61) 1.9E-3 *** ( 6.29) R&D intensity 3 1.4E-6 *** (6.34) 1.4E-6 *** (6.33) 1.5E-6 *** (5.56) Home region orientation of SMEs 5.3E-10 (0.04) 3.1E-9 ( 0.23) R&D intensity home-region 2.1E-7 * (2.18) R&D intensity 2 home-region 2.0E-9 * ( 2.52) R&D intensity 3 home-region 1.7E-12 * (2.57) N F R a Significance levels: P < 0.1, * P < 0.05, ** P < 0.01, *** P < b Coefficients are followed by t-statistics in parentheses. Firm Performance (RoA) Home Region Oriented SMEs Internationalized SMEs R&D Intensity Interval I: Cost Leadership Interval II: Stuck-in-the-middle Interval III: Differentiation Figure 2 Moderating effects of home region orientation on the performance of internationalized SMEs. investment and performance without accounting for the moderating effect of home region orientation. Therefore, we use a value of 0 for the home region orientation and the mean values of all other independent variables. The dotted cubic curve exhibits a horizontal inverted S-shaped relationship as forecasted. This supports the notion that SMEs reap performance advantages only when they commit R&D investment to one of the two extreme levels of cost leadership or differentiation. On the other hand, the solid cubic curve represents the relationship between R&D investment and SME performance after accounting for the moderating effects of home region orientation. By taking the mean values for home region orientation as well as the other independent variables in the same regression equation, we produce the solid cubic curve. Figure 2 shows that SMEs with a greater home region orientation achieve higher performance in Interval I and Interval III reflecting cost leadership and differentiation. The effect of R&D investment on performance is amplified when a greater magnitude of sales occurred in the home region of the triad. Therefore, when SMEs clearly execute a cost leadership or differentiation R&D strategy and have a greater

10 324 I.H. Lee, M.R. Marvel home region orientation they reap performance advantages. When there is a middle of the road R&D investment, as seen in interval II, a home region orientation negatively moderates performance. Therefore Hypothesis 2 is only partially supported. Discussion The purpose of our study was to explore how firm and country level combinations contribute to international SME performance. The results support and extend previous international business and strategy research. For example, geographic orientation of MNEs has been an important issue in international business. Despite a common use of global strategy, empirical evidence has shown most MNEs operate regionally, not globally (Rugman and Verbeke, 2004; Rugman, 2005). Subsequent studies tested the robustness of these findings in the context of different countries and industries, and confirmed that most MNEs are regionally based in their home region of the triad (Oh and Rugman, 2006; Collinson and Rugman, 2007). This tendency to favor a home region orientation for internationalization appears to also apply to SMEs. This is not necessarily surprising considering SMEs have less resources and capabilities compared to large and established companies. About 60% of all international Korean SMEs internationalized in their home region of the triad the Asia region. This tendency was more intensified in service industries compared to manufacturing. The age of SMEs was not related to regional aspects of foreign operations. An unexpected finding was that Korean SMEs tended to elect a single country strategy for internationalization. Among the 2676 SMEs included in the study, only 5 had multiple international reaches. Therefore, more than 99% of all international Korean SMEs were doing business in only a single foreign market. As the Korean economy continues to develop and grow, we may expect the number and scope of internationalization to increase in efforts to leverage firmspecific advantages. However, the vast majority of Korean SMEs seemingly execute a very narrow international strategy. R&D investments have long been identified as a vital source of competitive advantage (Pakes, 1985; Romer, 1990; Delios and Beamish, 1999; Kotabe et al., 2002; Qian and Li, 2003; Zachariadis, 2003; Belderbos et al., 2004; Chiao et al., 2006). However, a few scholars have also reported a negative relationship, or no relationship at all between the constructs (Souitaris, 1999; Sundaram et al., 1996). Our findings provide some explanation of these conflicting reports. The presence of R&D investment alone is not enough. Instead, SMEs must execute a clear strategy in order to reap performance advantages. The relationship between R&D investment and SME performance is not a linear, straight-forward, relationship as much research has assumed. When international SMEs have low levels of R&D investment this reflects a low cost leadership strategy where performance improves. When a middle of the road approach to R&D investment is taken, performance dips and R&D investment becomes negatively related to performance. This situation reflects the stuck in the middle situation described by Porter (1985). However, when SMEs employ a differentiation strategy and invest in R&D at high levels there is a positive relationship to performance. These findings underscore the vitality of a clear R&D strategy execution and avoiding a middle of the road approach to innovation and strategy. The pattern of the R&D investment and performance relationship reflects a horizontally inverted S-shaped curve supporting PorterÕs (1985) theory. Perhaps most importantly, results from our study support the growing body of research exploring country-level advantages (Rugman, 2005; Rugman and Verbeke, 2004). We find that regional characteristics of internationalization have critical performance implications for SMEs. This supports the view that countries, or regions, have varying advantages for firms. Further, there are important implications to consider when internationalization strategies are combined with unique firm attributes. We find that a home region orientation moderates the relationship between R&D investment and performance. However, the moderating effects of home region vary by R&D investment strategy. A home region orientation positively moderates the relationship when either a low cost leadership or differentiation strategy is executed. However, when a stuck in the middle R&D strategy is present, home region orientation for internationalization negatively affects performance. Findings suggest that when SMEs internationalize into their home region of the triad firm advantages can be better exploited and reap greater levels of performance. A low cost leadership R&D investment yields more positive performance when a greater home orientation strategy is present. However, performance is maximized when both a home region orientation and a differentiation strategy are collectively executed (i.e. Interval III of Figure 2). Taken together, the evidence suggests SMEs are able to realize their firm advantages more easily and profitably in their home region of the triad compared to other regions. We attribute this finding to intra-region foreignness as an advantage over inter-region foreignness (Rugman and Verbeke, 2007). Because SMEs have an accumulation of skills and an existing base of firms more similar to their domestic market, the relationship between R&D investment and performance was strengthened in their home region of the triad. By internationalizing within the home region SMEs can better acquire critical information about local business practices and consumer preferences. SMEs learn more efficiently because the country is culturally related and nearby in proximity (Ruigrok and Wagner, 2003). In the early stages of development, SMEs can respond to the specific needs of intra-regional customers more easily by capturing and incorporating them into the development process. On the other hand, during the later stage of the R&D investment, they are better able to cater to markets of nearby countries within their home region. Because customers and markets are less foreign compared to outside the home region, less modifications to products are needed. Less uncertainty exists within their home region and consequently the lead time between initial R&D investment and commercialization is shorter. The financial burdens can be reduced because new products are commercialized sooner, rather than later. Conclusion This study contributed to international strategy research by demonstrating the systematic influence of firm and country

11 The moderating effects of home region orientation on R&D investment 325 level characteristics on international SME performance. This is perhaps the first empirical study that explicitly examines international SMEs and the relationships among R&D and international strategy. Several limitations of this study warrant discussion. First, the use of cross-sectional data limits the causal conclusions that can be reached (Cohen et al., 2003). Future studies examining relationships like those studied here would be advised to utilize longitudinal designs. Also, because the sample was made up entirely of international Korean SMEs, the applicability of the findings may not generalize to other geographic regions or cultures. Future work should consider expanding the geographic and cultural representativeness of the sample relative to studies of firm and country combinations. Overall, the study provides empirical evidence of a horizontally inverted S-shaped relationship among R&D investment and performance reflecting low cost, stuck in the middle and differentiation strategies. More importantly, we find a home region orientation moderates the relationship among R&D investment and performance. Home region orientation positively moderates the relationship when either a cost leadership or differentiation strategy is executed. These results have important implications for future research and may help inform strategic decision making. However, there is still much work to be done to untangle how firm and country attributes affect performance. Considering the amount of variance explained in SME financial performance within this study, other important firm and country level advantages must exist. 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Strategic Management Journal 23(5), IN HYEOCK LEE (Ian) is an Assistant Professor of International Strategy in the Department of Management at Western Kentucky University. Prior to joining academia he worked as Deputy Director at the Ministry of Commerce, Industry & Energy (MOCIE) in Korea. He received his Ph.D. from the Indiana University at Bloomington. His research program includes the location choices of firms contributing to cluster formation. Other research interests involve how regional strategies of multinational enterprises and international new ventures link to performance. MATTHEW R. MARVEL is an Assistant Professor of Entrepreneurship in the Department of Management at Western Kentucky University. He received his Ph.D. from the University of Illinois at Urbana-Champaign where he supported multidisciplinary research on serial innovators. Matt was awarded the Kauffman Dissertation Fellowship for his thesis investigating how technology entrepreneurs use human capital to create radical innovations. His research program focuses on knowledge and learning within the venture creation process. His experience includes the marketing of new products and co-founder of a technical training and consulting venture.