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THE INTERNATIONALIZATION OF PRODUCER SERVICES

Sharmistha Bagchi-Sen and Torsten Schunder

Introduction

Theoretical and empirical research explaining international transaction behavior of multinational enterprises (MNEs) continues to enhance our understanding of International Business. While mostly applied to manufacturing, an increasing body of literature explores foreign direct investment (FDI) in services, and especially cross-border investments in producer services as this specific subset of services is enabling other businesses to operate more successfully by supplying them with expertise. Advanced producer and professional service firms include financial, business, and ICT services and are facilitators of business, International Business, and globalization as they enable clients to expand, optimize, and work in global environments, and are a key measure of the importance and power of cities around the globe. Given this important key function in the global economy, we focus on this subset of the service industry in this chapter. Producer services distinguish themselves from other services by mainly serving the intermediate demand of producers rather than meeting the final demand of consumers. Financial and legal services, advertising, accounting, and insurance services are seen traditionally as part of this subgroup but now other creative services (e.g., including R&D services) supplying knowledge to other corporations are increasingly seen as part of this subgroup.

The service sector accounted for over 50% of GDP in high-income and middle-income nations in 2014. The share is increasing substantially in developing economies (World Bank, 2015) and constitutes a big part of global cross-border investments (UNCTAD, 2004). The formation of major trading blocs (i.e., NAFTA, EU) and increasing globalization have supported the growth of multinational firms in producer services (PS). Since 1995, cross-border mergers and acquisitions (M&As) in the service industry, except in 2011, have been responsible for more than 50% of the total global M&As. The PS sector comprises the majority of those service M&As (including financial, business, and ICT services). PS firms seem to be susceptible to economic downturns with a significant decline in their performance in the following periods: recession in the early 1990s, dot.com bust in 2002, and the 2007/2008 financial crisis.

In this chapter, we will explore what PS are, how they emerge in contextual relationship to manufacturing, and how they internationalize. In regards of internationalization, we explore the internationalization process, the motivation and entry modes of PS, the role of culture for PS internationalization, and how institutions affect PS. Additionally, we will examine the activities of PS in emerging/transitional economies, as well as the internationalization of PS from emerging/transitional economies.

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Definition of PS

In contrast to manufacturing, services are characterized by intangibility, perishability, inseparability, and heterogeneity. Services are categorized into private (marketed) and public (nonmarketed) sectors (Enderwick, 1989). The private service sector contains profit-oriented business operations whereas the public service sector is nonprofit oriented. The marketed services are usually categorized as consumer (final demand) and producer (intermediate) services; however, these categories are not necessarily mutually exclusive, and a firm can fulfill intermediate and final demand. PS firms provide services to other business and government organizations (Beyers & Lindahl, 1996; Faulconbridge, Hall & Beaverstock, 2008). They have the expertise and experience to adapt to customer needs and are thus focused on flexible economies of scope (Enderwick, 1989). This constitutes the major difference within the service sector, meaning that companies have to adapt to the preferences and needs of different customer groups.

A variety of definitions of advanced producer exists in the literature. The OECD (2000) defines advanced PS/professional services (OECD) as all activities contained in the following International Standard Industrial Classification (ISIC) sub-groups: business and professional services, financial services, insurance services, and real estate services. The North American Industry Classification Systems (NAICS) classifies PS with the NAICS Codes 51, 52, and 54 (Table 30.1) (Thompson, 2004). All are characterized by mainly addressing intermediate demand serving businesses/producers rather than final demand.

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Other definitions seek to separate services based on their characteristics. Boddewyn, Halbrich and Perry (1986) distinguish services based upon locational mobility into three groups: (1) foreign tradeable services which generate products separable from the production process and are thus exportable (e.g., music and software); (2) location-bound services which are tied to the production process (e.g., hotel accommodation, retailing services, business and professional services, and commercial banking); and (3) combination services which are partially tradeable while other parts are location bound (e.g., in remote data-processing information from the customer is sent to the producer to be processed while input and delivery are location bound). Erramilli (1991) divides internationally traded services into hard and soft services where hard services are characterized by production that is separable from consumption, and soft services are simultaneously produced and consumed which has implications for the facilities needed to create and deliver services. For hard services, service production and delivery are not bound to a specific location, whereas soft services require the compresence of producer and consumer. Others (Contractor, Kundu & Hsu, 2003; Sanchez-Peinado, Pla-Barber & Hébert, 2007) divide services into knowledge-intensive services and capital-intense services, where capital intensity represents the volume of investment in fixed assets that are necessary to begin production and operations in a given industry (Erramilli & Rao, 1993). Capital intensive services require substantial equipment investments resulting in internationalization patterns similar to patterns found in manufacturing. Knowledge-intensive firms do not require substantial equipment investment in the host country, and thus traditional variables influencing international trade patterns might be not applicable.

A subgroup of knowledge-intensive services are Knowledge-Intensive Business Services (KIBS) containing a range of services from ICT and software services to R&D services. Definitions are based on the share of non-routine tasks, formal education, and patent activity in an industry (Zieba, 2013) (see Table 30.2).

It must be noted that the industries included in the above definitions vary considerably. This relates to the degree of standardization of products, which is for example relatively higher in accounting than in consulting. Business interactions differ as well as the length of service delivery. Whereas law and accounting firms often have continuous relationships with clients, other companies such as those in engineering consulting, often are project-based (Ball, Lindsay & Rose, 2008; Abecassis-Moedas et al., 2012; Faulconbridge & Jones, 2012). The output of services also differs considerably resulting in different degrees of exportability – whereas blueprints and digital media can be easily transported, contextual information can be effectively communicated mostly in an interactive face-to-face environment (Ball, Lindsay & Rose, 2008; Rugman & Verbeke, 2008), thus encouraging FDI. These differences result in different internationalization pathways and modes as well as how different types of producer services enter and engage with international markets. The heterogeneity of the service sector and the increasing complexity of its clients make it difficult to apply a single theory or conceptual framework to explain the patterns of internationalization in the past twenty years.

Growth of producer services

Traditionally, the growth of a producer service complex in a country is seen as a function of linkages between manufacturing and producer services. Guerrieri and Meliciani (2005) investigate the relationship between industrial specialization and international competitiveness of PS (e.g., financial, communication, and business services) using country-level data. ICT usage, labor cost, and the use of services as intermediary inputs in manufacturing and services are discussed as determinants of competitiveness. They use country-level data from OECD and Eurostat including ICT expenditures (i.e., the GDP share of information and communication gross fixed capital formation), intermediate use of services within manufacturing specialization captured by calculating specialization in manufacturing weighted by the use of services by manufacturing industries and services, and labor cost (i.e., costs measured as the share of labor costs in total production costs). They find that a country’s PS sector competitiveness depends on a specialized manufacturing sector using PS. Countries with specialized manufacturing industries relying heavily on PS have advantages reinforcing growth and competitiveness in PS. On the other hand, Dicken (2007) shows that more than 50% of the output from service industries is sold to other service industries, indicating that service firms are significant contributors to the growth of the overall service sector and these consumers are driving the demand (Beyers, Alvine & Johnson, 1985; Goe, 1990; Bagchi-Sen & Sen, 1997; Sako, 2015). However, in emerging markets, the strong relationship between industries and services might remain a major factor in the development of the producer/professional service industry.

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Demand for producer/professional services is driven by changes in production inputs, composition, and changes in regulations in a country (Thompson, 2004; Faulconbridge, Hall & Beaverstock, 2008; Xinya, Jie & Ye, 2011). Also, technological developments (e.g., mobility, communication, ICT) fostering global trade and the expansion of multinational corporations have influenced the growth in PS (Sassen, 2001; Guerrieri & Meliciani, 2005; Dicken, 2007). The development of ICT has allowed service firms to separate tasks such as routine or standardized back-office functions and specialized or front office functions (Zaheer & Manrakhan, 2001; Roberts, 2002; Ball, Lindsay & Rose, 2008); back office functions have often moved offshore.

As companies become more specialized to fulfill a growing market for differentiated products, business functions are also externalized to reduce cost, increase efficiency, and gain access to specialized knowledge (Noyelle & Stanback, 1984; Piore, 1986; Thompson, 2004). This process of externalization has continued to influence the growth of PS. While organizational structures change and organizational complexity increases in a global economy, the need for (internationalized) professional services goes up (Bagchi-Sen & Sen, 1997; Roberts, 2002):

The demand-side factors include the increasing differentiation of goods and services, emphasis on how diverse goods and services are being produced, the complex international and national business environment, government intervention and regulation, the growing internal complexity of the firm, cost considerations, flexibility, risk reduction, and the need for specialized expertise driving the share of indirect labor involved in production. The supply-side factors have been associated with advances in telecommunications, information, and computer technology and the capability of PSF [Producer Service Firms] to recognize business opportunities, changing buyer needs, changes in government regulations, and in input costs.

(Bagchi-Sen & Sen, 1997, p. 1155)

While a strong focus on FDI from developed economies exists, Gammeltoft (2008) showed by analyzing outward FDI from the BRIC and related nations that India invests in ICT and broadcasting, China in trade and services, South Africa in finance, and Brazil in all types of services. Nevertheless, market expansion of the service sector has been predominantly local (Beyers, Alvine & Johnson, 1985; Rugman & Verbeke, 2008). The degree of internationalization of service MNEs compared to manufacturing is complex given the need for local adaptation (Rugman & Verbeke, 2008). Thus, service firms are more likely to remain local or engage in their home market due to low cultural and institutional distance. The nonlocal market expansion is driven by specific considerations. In developed economies changes in industrial organization, changes in household structure, growth in income, the income elasticity of demand, and labor productivity in services are important factors for growth in the PS sector (Bagchi-Sen & Sen, 1997). In the context of emerging economies, growth in PS is driven by manufacturing industries and the absolute market size but also by the demand of developed nations for outsourcing to access skilled professionals at relatively lower wages compared to their home markets (Tuan & Ng, 2003; Outreville, 2008).

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Explanations of internationalization of producer services

Theories of FDI by MNEs explain why business enterprises invest in other countries instead of trading in goods and services (Kindleberger, 1969; Buckley & Casson, 1976; Hymer, 1976; Dunning, 1979, 1993; Rugman, 1981; Caves, 1996; Bagchi-Sen & Sen, 1997; Coffey, 2000; Faulconbridge, Hall & Beaverstock, 2008; Taylor et al., 2014). Key elements explaining the emergence of MNEs, such as firm-specific or ownership-specific advantages, location-specific advantages, and internalization advantages have been identified and combined by Dunning (1989, 1993) in his eclectic paradigm (referred to as the OLI concept). A combination of those advantages and sectoral specificities ‘determine the pattern, extent, and growth of MNE activities’ (Bagchi-Sen & Sen, 1997, p. 1157).

The OLI concept combines firm-specific or ownership-specific advantages, location-specific advantages, and internalization advantages. Ownership-specific advantages are a product of the home market environment – imperfect markets favor those with competitive advantages such as patented technology, unpatented, secret know-how, large capital requirements, economies of large-scale production, and expertise in differentiating products. These firms are often fierce competitors in the host country and can offset the cost of involvement in a foreign market. In this concept, large firms erect barriers to entry for smaller firms, and internationalization decisions are often based on competitors following to protect market share and to minimize risks (Bagchi-Sen & Sen, 1997). Nachum (2003a) argues that not all firms in a home country can exploit specific advantages; firm characteristics determine competitiveness based on how firms can actively shape advantages to facilitate national and international operations.

Firm-specific or ownership-specific advantages alone cannot explain the decision to engage in FDI. Firms engage in FDI if internalization of operations (e.g., production activities) or knowledge provides the firm with advantages in exploiting a firm-specific advantage by either protecting knowledge, ensuring quality, facilitating the flow of intermediaries, or reducing opportunistic behavior by high degrees of control (Rugman, 1981; Caves, 1996; Buckley & Casson, 2009; Hennart, 2010). Industries relying on strong customer interaction are considered more likely to engage in FDI (Oldenski, 2012). Oldenski (2012) expands the proximity-concentration trade-off literature exploring the decision between FDI and export by evaluating the cost of communicating complex information using a two-level OLS estimator on inward US FDI in manufacturing and services from the Bureau of Economic Analysis and secondary data about exports derived from the U.S. Census (BEA survey). While communication intensity is related to FDI, complex information activities (non-routine) are more likely to be sold via export. This might represent the comparative advantage of the US regarding human capital. The author concludes that FDI has a hidden cost in the form of communication cost of complex information adding to traditional transportation cost and transaction cost. The effect is stronger than GDP, distance, tax rates, wages, institutions, or education variables.

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Location-specific factors such as policies (e.g., trade barriers), market size, input costs, and factor productivity affect FDI decisions. The existence of trade barriers, for example, favors the establishment of local subsidiaries. Producers, especially professional services, are known as key elements of command and control functions within the global world city hierarchy (Sassen, 2001; Taylor, 2004). Taylor (2005) examines a dataset of 446 MNEs from the Fortune 500 and creates a taxonomy of global cities (Table 30.3). Frankfurt, Chicago, Tokyo, New York, and London are at the top of the hierarchy, but there are considerable differences across service sectors, and thus no global service geography exists (Taylor, 2004, 2005). Service patterns are thus products of distinctive origins and uneven opportunities.

The applicability of FDI theories derived from manufacturing examples to services is contested (Brouthers & Brouthers, 2003; Tuan & Ng, 2003; Ramasamy & Yeung, 2010). While Ramasamy and Yeung (2010) concluded that the determinants for both manufacturing and service sectors are similar and that established FDI theories can be applied to the service sector, others argue that both sectors differ considerably. Characteristics of services (e.g., intangibility, perishability, inseparability, and heterogeneity) require special attention in the application of established FDI theories limiting their explanatory power. Furthermore, service MNEs differ from manufacturing MNEs regarding size (e.g., service MNEs being smaller) and scope of activities. Based on transaction cost theory, Brouthers and Brouthers (2003) argue that manufacturing and service industries differ regarding their reaction to transaction costs. Analyzing 227 cases of German, Dutch, and British service and manufacturing companies involved in Central and East European countries, Brouthers and Brouthers (2003) find that the entry mode choice of manufacturing is strongly influenced by risk propensity and environmental uncertainty due to their capital intensive nature, while service firms are influenced by trust propensity and asset specificity due to their reliance on people and interaction.

Rugman and Verbeke (2008) analyzed the flexibility of value chains of manufacturing and service MNEs and concluded that manufacturing MNEs have greater flexibility in separating their up and downstream activities, while in service MNEs upstream and downstream activities are closely linked together in a complex system requiring local adaptation. Regulation and liability of foreignness constitute high barriers to entry leading to a lower degree of internationalization of service MNEs, and the authors conclude that the degree of globalization of service MNEs is low preferring investments in spaces culturally and institutional close to the country of origin.

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While differences between services and manufacturing are widely discussed, it must be noted that interdependencies between those sectors exist given that the manufacturing industry is a major client of producer services. Analyzing the determinants of inward FDI in business services across European regions, Castellani, Meliciani and Mirra (2016) find that at the regional level, adjusting for spatial effects and including country dummy variables, only market size measured using GDP and the existence of manufacturing industries are significant explanatory variables explaining the location of business service FDI. They acknowledge that variables differ across spatial scales and while traditional determinants work at the country level, the location within a country is ultimately driven by demand.

Tuan and Ng (2003) analyze the impact of agglomerations on manufacturing and service FDI flows in China based on Krugman’s core-periphery model. The analysis of a joint venture dataset of firms (e.g., 15.5% are service joint ventures) who invested in Guangdong shows that the location of FDI in manufacturing and services is highly correlated. In contrast, Jones and Wren (2016) find that service and manufacturing FDI in the UK have distinct patterns with no evidence that the location of FDI in services converges with the location of manufacturing FDI over time. Trade and investment data of FDI inflows from 1996–2005 are obtained from the UK government agencies for the above study.

A capability approach and a network approach based on organizational learning and organizational resources, and embeddedness in institutional and relational contexts, supplement the framework focused on firm-specific advantages (Nachum, 2003b; Reihlen & Apel, 2007). The capabilities approach emphasizes intra-organizational dynamic learning enhancing the capabilities (managerial or organizational) via experiential knowledge, defined as ‘knowledge that firms accumulate by being active in foreign markets’ (Blomstermo et al., 2004, p. 356). Thus firms become more experienced and exposed to new knowledge by acquiring assets such as human talent or local knowledge in foreign locations. Tacit knowledge is an important driver of internationalization, and building tacit firm capabilities via internationalization supports subsequent internationalization enhancing capabilities iteratively as Scott-Kennel and von Batenburg (2012) show by exploring the importance of knowledge and learning in internationalization, studying a weather forecast service firm. Based on a constructivist perspective, learning in producer service firms is a result of local socio-cultural embeddedness and interaction, and the establishment of networks (Reihlen & Apel, 2007).

Networking enables firms to establish relationships, actively seek clients, and learn from partners (O’Farrell, Wood & Zheng, 1998). The production of services requires ‘multiple simultaneous inputs and feedbacks’ (Sassen, 2001, p. 71) making embeddedness in networks with immediate access to experts/assets a competitive advantage (Sassen, 2001; Ball, Lindsay & Rose, 2008) – these networks require trust and reciprocity to be functional (Glückler & Armbrüster, 2003; Hanlon, 2004). Face-to-face communication with colleagues, clients, competitors, and other agents is the main mode of knowledge transfer (Beaverstock, 2004; Kipping and Clark, 2012) and is additionally relevant in building trust, quality control, and acquiring clients. Markets are characterized by institutional and transactional uncertainty, and networks based on trust and reputation allow clients to reduce uncertainty. Networks increase competitive advantages in internationalization, determining access to information/clients and local knowledge, and often reduce uncertainty by providing access to customers from the home country who are also engaged in the same host region targeted by the internationalized PS firm (Jung, 2004; Ball et al., 2008; Freeman & Sandwell, 2008; Faulconbridge & Jones, 2012). Guler and Guillén (2010) find that the higher the network centrality of a firm, a representation of its social status and brokerage relationships measured by co-investments, the greater the likelihood of foreign market entry. Those results are reinforced by Spies (2010) who finds that common borders, local demand, as well as existing firm networks, determine the location of foreign companies in Germany.

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The topic of supply chains in producer services is not widely addressed (Ellram, Tate & Billington, 2004; Baltacioglu et al., 2007). In contrast to manufacturing industries, service MNEs face a sector-specific complex relationship between closely linked upstream and downstream activities requiring local adaptation for both value chains. Thus both upstream and downstream value chains are subject to market regulations (e.g., banking) and liability of foreignness, resulting in lower degrees of internationalization of service firms and an investment concentration in the home region facilitated by low cultural and institutional distance. However, the separability of service tasks is enhanced by technological progress enabling the internationalization of advanced PS (Zaheer & Manrakhan, 2001; Roberts, 2002; Ball, Lindsay & Rose, 2008). Knowledge-intensive services with a high degree of heterogeneity cannot easily separate activities of the value chain – a highly integrated service supply chain adapted to the specificities of an industry sector has to consider information flow, capacity and skill management, relationship management with suppliers and customers, cash flow, delivery, as well as technology and information management as they consider internationalization (Ellram, Tate & Billington, 2004; Baltacioglu et al., 2007).

The internationalization process

The internationalization process of producer services is characterized by the decision to enter a foreign market, market selection, and the choice of entry mode, product, and market diversification strategies (Coffey, 2000). Historically, empirical research on the internationalization process of service firms focused mostly on banking and finance and on professional and business services, but increasingly specialized studies of subgroups of PS have been conducted showing the variability and differences between divergent service industries and their varying internationalization strategies. A variety of studies continues to assess specific service sectors outlining the determinants and pathways to internationalization within sub-groups (Sanchez-Peinado, Pla-Barber & Hébert, 2007; Castellani, Meliciani & Mirra, 2016): design, executive staffing, and engineering consultancy, real estate, banking, and insurance (Wu & Strange, 2000; Lai & Fischer, 2007; Faulconbridge, Hall & Beaverstock, 2008; Outreville, 2008; Abecassis-Moedas et al., 2012).

Key resources in internationalization vary across firms and sectors. Abecassis-Moedas et al. (2012) analyzed interviews with 11 European design consultancies, which is an example of KIBS, to identify key resources in their internationalization process. They identified three distinctive categories of firms and resource sets to be relevant. Star-based creative KIBS (e.g., architecture) rely on the reputation/talent of a specific designer establishing contact with customers via popularity/competitions and international exhibitions. Process-based creative KIBS rely on organizational capital mainly represented as formalized creative collective processes and methods which are exported to their customers via human capital or import of clients. Glocality-based creative KIBS rely on physical capital (field offices) and organizational capital maintaining direct relationships with their clients while better understanding their needs via localized market research and expanding their services to other clients with similar needs in the host market.

Human capital, that is, professionals embodying knowledge, skills, practice, and trustworthiness, is a major factor in advertising and marketing services. Thus, employee talent, reputation, and experience have a significant impact on the firm’s reputation (Beaverstock, 2004; Hitt et al., 2006; Abecassis-Moedas et al., 2012). Hitt et al. (2006) highlight the role of resources in the internationalization of professional business firms by analyzing the performance of 72 law firms. Resources are defined as human capital resources in the form of partner education and experience, client relational capital in the form of the number of top 250 US firms a company has a relationship with, and relational capital with foreign government based on lawsuits represented. They show that human capital and client relational capital interact and affect internationalization positively. Corporate client relational capital, along with high levels of human capital advantages, are effective in enhancing performance. Human capital positively affects firm performance in the context of internationalization (measured as the ratio of worldwide net income to total firm revenue), and a similar effect can be found for client relational capital. Government client relational capital is associated with lower levels of performance. While the interaction term of human capital and internationalization positively affects performance, interaction terms of internationalization and relational capital (corporate and government) show no moderating influence on firm performance.

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Motivating factors

The literature identifies diverse not mutually exclusive motivations and strategical considerations for the internationalization of producer service firms. Internationalization decision and entry modes for knowledge-intensive services are driven by strategic considerations of global markets and exploitation, whereas strategic considerations are, except for client following, less important for capital intensive services (Sanchez-Peinado, Pla-Barber & Hébert, 2007). Resource-oriented approaches are only feasible for highly standardized elements of the service production, while relocation of specific aspects of the value chain in services (e.g., KIBS) relying heavily on face-to-face contact, trust, and tacit knowledge, are market oriented (Roberts, 2002). Motivations for internationalization can be active or passive (Ball, Lindsay & Rose, 2008). Passive forms include following clients, which is driven by internationally operating clients of a firm and the necessity to provide services abroad to prevent the loss of business to foreign or other domestic competitors. Following domestic competitors is a protective form of internationalization driven by the interest to protect overall market share. Active forms of internationalization are driven by strategic considerations of market exploitation, customer/market seeking, and asset acquisition, whereas the latter relates to human capital, knowledge, location, prestige, or network access (Jung, 2004, Faulconbridge & Jones, 2012). Other factors influencing the internationalization decision and motivation are the risk propensity, attitude, and experience of a company’s management as well as the personal disposition of decision makers (Herrmann & Datta, 2006).

Producer service firms internationalize to increase their global influence, gather intelligence for innovation, gain market knowledge, and improve connectedness of markets (Faulconbridge, Hall & Beaverstock, 2008; Sassen, 2011; Taylor et al., 2014). Specific locations provide innovative advantages due to their specific resource endowment. While New York, London, and Hong Kong foster financial innovation (Lai, 2012), Palo Alto fosters innovation in deal making, start-up advisory, venture capital access, and M&A activities (Reiffenstein, 2009; Taylor et al., 2014). While acquiring new knowledge helps these firms diversify with new knowledge-intensive products, new markets are characterized by uncertainty. These realities motivate firms to develop specialized market knowledge and can be seen as an asset-seeking strategy with regards to specific resources.

Consumer perception of quality and reputation are important factors for the success of professional service firms and essential in acquiring clients. To ensure high levels of quality, PSFs tend to internalize processes leading to the establishment of subsidiaries to exert control (Coffey, 2000; Hennart, 2010). PS firms require high degrees of customization and interaction with clients thus requiring intensive contact and exchange of ideas in intra- and inter-organizational communication – therefore, the need for proximity leads to internationalization.

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Client following is an important motivation and protective form of internationalization. Firms internationalize to follow clients preventing the loss of business to foreign or domestic competitors. This not only fulfills the demand of the internationalized client but also reduces the risk of internationalization for the service firm by providing initial customers in the new market (Ball, Lindsay & Rose, 2008). US accounting firms, for example, started following their clients in the 1950s (Bagchi-Sen & Sen, 1997).

Changing institutional environments provides opportunities attracting PSFs, and changes are accommodated by an increasing presence of foreign firms taking advantage of economic integration and deregulation. PSFs tend to enter those countries to exploit arising opportunities or in anticipation of change. For example, after China became a WTO member, multinational banks become more involved (Xiaogang, Skully & Brown, 2005). The case of the Chinese real estate industry shows that international companies entered the market in anticipation of change. With developments in ICT, PSFs are increasingly able to separate tasks of the value chain allowing them to pursue an international division of labor, thereby profiting from wage differentials and professional labor pools. This affects standardized functions like accounting and software which are outsourced/offshored to India, while data processing relocates to the Philippines and the Caribbean (Sanderson et al., 2015). Non-routine tasks and front office functions are not outsourced.

Increasing market presence is another motivation. Large PSFs tend to establish a presence in major cities globally to establish and project their reputation and can be found in accounting (big four), financial institutions, and staffing agencies (Beaverstock, 1996; Coe, Johns & Ward, 2007; Wójcik, 2011). First- mover advantages can be observed for the advertisement industry – firms with previous international experience can exploit them indicating that firms with a vast subsidiary network develop competitive advantages through international experience, and although such advantages cannot universally be observed among PSFs, in certain cases it might motivate expansion (Magnusson, Westjohn & Boggs, 2009).

Entry mode

Multinational producer service firms’ entry modes in overseas markets depend on the regulatory constraints as well as the institutional and cultural distance of the host country (Faulconbridge, Hall & Beaverstock, 2008). Depending on firm strategy, entry modes may include fully owned offices (e.g., traditional FDI, greenfield, or acquisition), joint ventures/cooperation with a local partner, licensing, or export market development (Ball, Lindsay & Rose, 2008). These entry modes coincide with literature related to the overall service sector, although the analysis of the overall service sector still emphasizes producer services (Grönroos, 1999). The transaction costs associated with each mode decrease with higher resource commitment, hence opportunism is reduced with higher levels of control (Hennart, 2010). In the context of advanced producer and professional services, a high interaction intensity with clients is assumed requiring frequent face-to-face contact with clients, thus favoring permanent foreign facilities. This view is challenged by Ball, Lindsay and Rose (2008), who claim that advanced services have less resource-intensive ways of entering foreign markets. While elements of the service delivery process requiring customer interaction are either exported or located in a host country, other unrelated parts of the service delivery process (e.g., data processing and analysis) can be located at different locations given a sufficient ICT infrastructure. ICT facilitates the separation of tasks in the value chain and thereby reduces the need for resource-intensive involvement.

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Different entry modes across a company’s portfolio are not mutually exclusive, and companies might follow different strategies in different markets depending on its global expansion strategy (McQuillan & Scott, 2015). Faulconbridge, Hall and Beaverstock (2008) show, for example, that firms might maintain full subsidiaries only in strategic places (e.g., Frankfurt, London, and New York) while use less resource intense entry modes in less strategic places. Determining factors for entry mode choice are (perceived) risk (economic, political) and transaction cost considerations, and especially in the context of advanced services, human capital, market size, and market potential (Tuan & Ng, 2003; Outreville, 2008; Njegomir & Stojic, 2012). Firm size is an important determinant in entry mode decision (Tuan & Ng, 2003). Large firms have considerable resources and managerial capabilities favoring fully owned subsidiaries; smaller companies often lack the resources to establish resource intensive operations in foreign markets, thus relying on export markets or collaborations to mitigate risk and reduce the cost of involvement. Firm experience and strategy influence the choice as well as the individual experience of decision makers (Herrmann & Datta, 2006; Abecassis-Moedas et al., 2012; Muzychenko & Liesch, 2015). Increasing international experience endows firms with tacit knowledge enhancing the possibilities of gaining from further internationalization. Strategies and motives are also associated with entry modes. Global business approaches, asset exploitation motives, and experience with previous full control modes, for example, are associated with a preference for full control modes. Firms with previous experience in shared control modes are more prone to shared control modes if they have explorative or offensive/aggressive strategies (Sanchez-Peinado, Pla-Barber & Hébert, 2007).

The characteristics of individuals in a firm can have a significant impact on internationalization and entry mode choice. CEOs have substantial influence and act based on experience (e.g., tenure, age, internationalization). Studying internationalization events, Herrmann and Datta (2006) find that age and experience are associated with the use of joint ventures and a lower risk propensity, whereas CEOs with increasing international experience tend to prefer high control modes favoring greenfield investments over acquisitions. CEOs with a background in operations and finance tend to prefer acquisitions over other entry modes given their increased experience with financial tools. In smaller firms, entrepreneurs have a substantial impact on internationalization due to their ability to realize opportunities and use these based on perceived risk (Muzychenko & Liesch, 2015). Additionally, individual factors like a desire for cross-cultural encounters support opportunity identification from relationship-building experiences. Business models can be built around the talent and reputation of a single individual and can be found in creative industries such as architecture. In this case, contact with customers is established via popularity/competitions, invitations, and international exhibitions, thus making the internationalization highly dependent on the contacts and reputation of a single person (Abecassis-Moedas et al., 2012; McQuillan & Scott, 2015).

Cultural distance

Cultural distance, predominantly measured by the Hofstede Index or five dimensions, is a recurring decisive factor for market selection and an important determinant for intrafirm communication, whereas large distances are disadvantages causing friction (Capar & Kotabe, 2003; Nachum, 2003a; Boussebaa, 2009). Services delivered in a host country need to be adapted to the local specific demand requiring adaptation to cultural and linguistic differences thereby increasing transaction cost (liability of foreignness) (Capar & Kotabe, 2003). Liability of foreignness applies to services and represents all tacit and social costs of getting involved in foreign markets that are not incurred by local companies (Zaheer, 1995; Zaheer & Mosakowski, 1997) and is decreasing over time with increased adaptation and local acceptance. Cultural proximity encourages FDI, while with increasing distance other modes become more likely. Jung (2004) specifically analyzed the impact of cultural distance on the decision between joint ventures and wholly owned subsidiaries, finding that with increasing cultural distance joint ventures with local partners are sought to minimize risk and rely on local networks to access local knowledge and acquire customers. Networking with clients and adaptation (services and routines) can help offset these costs as Freeman and Sandwell (2008) show using three case studies of professional service firms from Australia entering emerging markets. Firms rely on social networks to overcome entry barriers (e.g., face-to-face communication, language, cultural, work practices, and government regulations) using local contacts to overcome the liability of foreignness. Collaborative entry or client following reduces cost allowing a reputation to be gained while already serving established clients from the home country (Ball, Lindsay & Rose, 2008). Nachum (2003b) questions the general existence of liability of foreignness showing that London shows no signs of liability of foreignness, which is either a result of superior firm-specific advantages compensating for disadvantages or a limited importance of home country effects in this highly integrated place. Additionally, firm characteristics strongly impact the effects of the liability of foreignness on firm operations. Thus, Nachum suggests that a reconceptualization of the liability of foreignness concept is necessary.

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Cultural distance can also become an intra-organizational problem. Advanced producer services are individualized contextual services favoring an autonomous governance mode for subsidiaries to adapt to the local context. Based on case studies of four polycentric global professional firms located in London, Boussebaa (2009) identifies a common misalignment between center and subsidiary regarding quality standards and staff quality (language), which leads to problems with global clients expecting the highest service standard of the center and causing reputational damage if subsidiaries underperform. Cultural differences reinforce tension, especially for US-centric firms with a belief in a global set of values, thereby alienating subsidiaries. Additionally, intra-organizational friction arises in cross-country projects if compensation mechanisms for the host country subsidiary are lacking, encouraging subsidiaries to focus high-level resources on local client acquisition, thereby reducing the quality of cross-country projects. Because clients expect global quality and access to knowledge on a global scale (Beaverstock, 2004), managing intra-organizational friction is important.

Institutions

While trade liberalization in the wake of the WTO 2000 service negotiations reduced tariff barriers, non-tariff entry barriers remain an important determining factor for FDI in services (Roberts, 2001). Regulatory barriers have a strong sector-specific impact on producer service firms. Common issues related to regulation are the protection of firm-specific assets including property rights and knowledge and intangible assets, but also access to markets or professions (e.g., standards, certifications) (Roberts, 2001; Falkenbach, 2009; Sako, 2015). Furthermore, regulations can force specific entry modes requiring the involvement of local parties or imposing regulations on specific occupations (Sako, 2015). Deregulation of professions and markets is beneficial for firms, hence it allows them to separate work processes and outsource/offshore tasks to non- or semi-professionals. By doing so, they can focus on high-value tasks demanding the attention of professionals and allowing firms to utilize advantages of different markets via outsourcing or offshoring (Sako, 2015).

Barattieri, Borchert and Mattoo (2014) evaluate the role of policy and inter-sectoral linkages in M&As in the service sector, which is an understudied field. Using the Thompson Reuters Platinum Database, the authors acquired a comprehensive dataset of global M&As (firm level) from 2003–2009 and collected policy data from the Services Trade Restrictions Database at the country level. The analysis using probit models show that trade barriers reduce M&A inflows although the negative effect of trade barriers can be mitigated if the GDP of a country has certain structural characteristics (e.g., high manufacturing share). Falkenbach (2009) analyzes market selection determinants for international real estate investments. The study uses descriptive statistics based on questionnaire data from real estate investors who made investments in Europe. A total of 22 complete samples from mostly northern European investors is used. Most important factors commonly identified are the safety of property rights and the expected return on investment. Institutional factors are of importance as well as the maturity of markets. The presence of professional services and indirect investment opportunities are only identified by a part of the sample, indicating that management strategies might also be an important factor in market selection.

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Hurmelinna-Laukkanen and Ritala (2012) argue that appropriability regimes are important drivers of service firm internationalization. While intellectual property rights (IPR) protection is identified as an external market condition, the authors argue that firms can actively construct their appropriability regimes thus making it an internal factor. The authors identified 762 individual Finnish firms with more than 100 employees. A questionnaire survey yielded 209 responses, which are separated into service- and product-oriented firms based on the share of sales derived from products/services. Using logistic regression, the authors show that the development of formal and informal means of IPR protection are important factors for internationalization for both groups, while internationalizing service industries have strong appropriability mechanisms in place. Limitations of the study are the small cross-sectional sample.

Emerging markets and transitional economies

Emerging markets are becoming increasingly important actors providing a pool of well-educated human capital at comparatively lower prices, investing in developing countries with market seeking intentions, and investing in developed economies to acquire assets. Emerging markets have the highest growth rates of knowledge-intensive business services and:

[k]nowledge-based services have emerged as important engines for economic growth in emerging markets that are evolving into knowledge economies. Emerging markets in KIBS sectors are gaining prominence and achieving equal status with partners that are based in advanced economies.

(Javalgi et al., 2011)

The quality and knowledge intensity of services offshored to emerging markets increases over time with R&D decentralization (Massini & Miozzo, 2012). Due to agglomeration and cluster effects, offshore destinations, mainly India but also China, have emerged as an important source of innovation. Transitional economies have a rising demand for PS and are characterized by institutional changes increasing economic integration and reducing regulation (Keren & Ofer, 2002; Roberts, 2002; Faulconbridge, Hall & Beaverstock, 2008). For example, after China became a WTO member, multinational banks wanted to become more involved in FDI in China (Xiaogang, Skully & Brown, 2005), but central planning does result in high barriers of entry (regulation) making immediate utilization of those markets difficult (Keren & Ofer, 2002).

Firms entering emerging markets from developed economies have to cope with differences in language, cultural, work practices, and government regulations (Freeman & Sandwell, 2008). In this context, social networks and personal contacts are actively used to enter emerging markets and overcome communication and governmental barriers as well as to acquire market knowledge influencing the strategic entry decision. Foreign network actors are valuable assets with a strong influence on the entry decision, process, and mode. Investments from emerging countries in services have been growing since 1995 (Gammeltoft, 2008). While investments into resource extraction are common, in several countries the service sector has become an important destination for FDI. For example, Indian outward FDI has increased substantially since 1995 (Pradhan, 2003). During 1996–2001, a substantial share was directed towards professional services – 56.17% of service outward FDI have been made in IT, communication and software, followed by 33.65% in media, broadcasting, and publishing. Other sectors are financial services (2.62), civil, contracting, and engineering services (0.64), consulting (0.30), trading and marketing (0.25), transportation (1.69), and other professional services (1.96). Main investment destinations were Western Europe (39.68%, of which the UK is 90.65%), North America (32.65%), and developing countries (27.1%). Buckley et al. (2014) research the impact on the performance of developed market service and manufacturing firms which have been acquired by emerging market MNEs. They use the Thompson Reuter One database to develop a panel data set from 1999–2008 based on 79 deals measuring firm performance before and after acquisition, yielding 570 observations (note: the share of service MNEs is low). The nature of the acquiring emerging market MNE is undisclosed. Using a lagged performance variable in a panel regression, the authors find that the impact of the previous experience of the MNEs is limited to specific conditions. Experience is only beneficial if similar endeavors are undertaken (e.g., acquisition in a developed country followed by another acquisition in a developed country), whereas negative impacts on performance are observed if new forms of engagement are used. The findings suggest that intangible resources of emerging market MNEs are insignificant in determining success, supporting a view that these MNEs are mainly sourcing assets through FDI.

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Conclusion

Producer and professional services are a heterogeneous group with varying definitions. This variety makes comparisons among studies difficult and might hamper the theoretical development in the field. While studies explore the specific subfield of advanced producer services, they serve to highlight the specifics of the observed industry. It remains in general unclear how, except for the sector specific variables, the observed industry sets itself apart from general services or producer services. Defining what sets producer services apart from consumer services and how that relates to different internationalization pathways from consumer services seems to require more attention as the general service sector encompasses an even wider variety of firms ranging from retail to legal services.

The heterogeneity of PS regarding key factors and resources is widely analyzed. Additionally, it seems to be necessary to evaluate how those differences in key resources and determinants affect internationalization pathways. The different requirements of firms and key factors for success strongly impact the internationalization decision as well as the mode of entry together with the resource endowment of the firm. The behavior of architecture companies to follow prestigious competitions to generate reputational value differs greatly, for example, from the internationalization pathways of accounting firms motivated initially by client internationalization. While studies identify this for single industries, overall comparisons are lacking. Questions remain if those differences would allow us to characterize a unified sector of (advanced) producer services and how conclusions about the overall sector can be drawn from all the existing case studies. This also affects other aspects of the discussed elements. For example, is cultural distance important for all types of producer services or only for specific types (e.g., technological consulting versus business services)? In the context of emerging markets, a rise of producer services in their domestic markets with international spillovers can be observed. But it remains unclear if these corporations face additional obstacles based on their origin (e.g., India, Indonesia) or just from a competitive perspective (e.g., resource or knowledge base).

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This chapter draws upon selected literature to discuss the internationalization of PSFs. The studies focus on the drivers of internationalization, but data limitations make it difficult to understand the evolution of the development of those investments (e.g., ownership advantages) over time (Puck, Holtbrügge & Mohr, 2009). Furthermore, the world city hierarchy of producer services shows that a global theory of service geography is not easy to develop given the inherent heterogeneity of advanced producer services. A related issue is the transferability of theories of FDI by MNEs in manufacturing to the service sector. The inclusion of strategic considerations does show the importance of human and relational capital, as well as the experience of the CEO. One other complicating factor is the involvement of small- and medium-sized firms who are born globals. Factors that are noted as significant in deepening the internationalization process include the reduction of transaction cost with the acquisition of local knowledge, adaptation, and increased experience. Whether reduced transaction costs encourage conversion of joint ventures into wholly owned subsidiaries has not been established for service companies. Therefore, much-needed research is required to understand the life cycle of the producer service firms once they enter a foreign market.

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