**1. Introduction**

A critical issue for firms that operate in a globalized world is the choice of the best entry mode to service international markets. The selection of the best strategy is of pivotal importance because of its impact on firm's performance. The options available to firms have extended in recent years and the two most widely options represented by exporting and foreign direct investment (FDI) - have become wider. The additional mode that we consider in this paper is the activity of fragmenting part of the production abroad either by international outsourcing (arm's length trade) or vertical foreign direct investment (FDI) in which all or parts of production is relocated to another country to affiliated firms. According to the literature, we define this entry mode as offshoring whose purpose is either accessing resources or a response to intensification of competitive pressures from abroad. Increasingly, it represents the internationalization mode that occurred most frequently in the last decades. This move is not only confined to cost saving activities but includes the reallocation of tasks and activities of the entire value chain.

The vast majority of Italian companies that choose to move their production facilities to foreign countries takes away also intangible capital and skills that have made famous the Made in Italy. The main reason is to reduce labour costs. The average salary in the South Eastern Europe - the geographical area where many Italian firms have offshored productions - is about three times less than the average wage in Italy. But the level of wages is not the only advantage to move production

#### *Outsourcing and Offshoring*

abroad: even tax conditions, less bureaucracy, a favorable regulatory environment are attractive factors for entrepreneurs. For these reasons, a large number of Italian companies has moved in that area 17,700 businesses [1].

All the internationalization choices require different levels of resource commitment: exporting is a low resource-commitment and a low risk entry-mode, whereas FDI and offshoring are associated with greater risks, higher fixed costs and organizational complexities. Thereby, the returns expected by these entry modes are higher for FDI and offshore-outsourcing and lower for exporting firms.

As reported by Greenaway and Kneller in their review article [2], the bulk of the empirical literature does not study simultaneously the productivity performances of all these different international choices but investigates separately firm performance for exporters against non-exporters, offshorers against non-offshorers and MNEs against some other form of internationalization, generally exporting. There are still few studies that put together all these different forms of foreign activity to bettering our understanding of the structure of foreign trade, characterized by a growing role of multinationals and a growing share of intermediate inputs in trade flows. The objective of this work is to assess the productivity performances of firms that undertake different overseas market-entry strategies.

Seminal works in international trade literature state that the entry modes of firms in international markets is endogenous and depends on ex-ante firm's productivity. From a theoretical point of view, the model that compares different entry-modes in international markets is that by Helpman et al. [3]. This model, adding heterogeneity across firms in the same industry shows that firms self-select their entry-mode (exports versus FDI) according to productivity levels of firms. This is done through a sequence of different fixed and sunk costs associated with the various forms of internationalization. In their model the choice to serve foreign markets is associated with different fixed and variable costs, which have important consequences for firm's strategy to enter into foreign markets. The fixed costs of Horizontal-FDI (HFDI) are greater than those of exporting. Since only the most productive firms can afford the duplications costs in establishing new plants in a foreign country, the main prediction of the model is that FDI firms are more productive than exporting ones.

This theoretical prediction is generally supported by a fairly extensive empirical literature. Studies by Bernard and Jensen [4] and Yeaple [5] confirm that U.S. firms with the lowest productivity stay domestic, those with higher productivity export, and those with the highest productivity invest abroad. Further validations come from UK firms [6], Irish firms [7], German firms [8, 9]. Other studies conducted on Japanese firms such as Tomiura [10], and Kimura and Kiyota [11], also confirm the sorting pattern of internationalization with respect to productivity. However, the HMY model refers only to the standard moves (exports versus FDI) but some of these empirical papers have extended the predicted ranking by including also offshoring.

More recently, Wakasugi [12] in his study on Japanese firms finds only a partial validation of the HMY predictions. The novelty in his study is the distinction among different destinations of the foreign activity of the Japanese firms. While the result is consistent with the HMY sorting of export and FDI in the case of USA and EU destinations, the reverse order holds in the case of Asian country destinations. This suggests that dissecting exports and/or the investment modes by producers in different foreign markets might be crucial to assess the validity of the predicted theoretical ranking. Many other studies have distinguished foreign activities by destination countries but in that case the analysis was directed only to exporting activity (i.e. [13–15], De Loecker [16] among others).

**71**

*Entry-Mode Selection and Firm's Productivity across Market Destinations: An Empirical…*

Following this literature, we use a database for a large sample of Italian manufacturing firms, which include both large and small-medium sized enterprises, to test different international entry-modes as well as the decision to stay domestic. The first move is horizontal foreign direct investment, the second move is offshoring and the third is exporting. More specifically, we test whether companies that choose horizontal FDI show a higher performance compared to offshoring firms and whether the latter outperforms, in terms of productivity, exporting firms. In turn, we test whether exporting firms outperforms purely domestic firms. Finally, we test whether the findings are consistent across different destinations of foreign activities. Our main measure of performance is Total Factor Productivity (TFP).

This paper contributes to the literature on market entry modes. Firstly, it adds a piece of evidence on the internationalization moves and their impact on firm's performances by investigating Italian firms. There are a number of research contributions that investigate the outcomes of entry-modes for individual countries by

Secondly, it uses a dataset that enables to separate firms' strategies according to destination countries in order to evaluate whether the ranking holds when firms'

Thirdly, in contrast to previous literature, our finding is that for Italy the best

In this section we recall some contributions of the literature to delineate the analytical context of our research. Prior of the HMY paper, other theoretical models have tried to incorporate the profound transformations that we observe empirically in the international context by incorporating sunk costs, heterogeneity, and uncertainty in dynamic models. This line of research, how rightly pointed out by James Tybout [17], dates from the late '80s. Recently, however, many interesting papers have been published that extend the literature on international choices of companies on the basis of a set of new stylized facts. The new approach to the analysis of cross-border trade and foreign investment has been developed in the canonical paper by Melitz [18], Bernard et al. [19], Antràs [20], Antràs and Helpman [21] and Helpman, Melitz and Yeaple [3] among others. These models, focusing on individual firm behaviour and participation in international markets, offer an explanation of why some companies stay in house while others go overseas as well as to the puzzle of international fragmentation of production. One of the most remarkable features of globalization and accelerated competition is that the reduction of transportation and communication costs have contributed to boost international trade and has pushed firms to find new ways of value creation. Among the motives for choosing different foreign strategies, the degree of heterogeneity within industries emerges as a result of productivity differentials across firms. What comes out from this literature is that the interaction of sunk costs and productivity heterogeneity is the key motive to explain the choices of globalized firms. The international strategies of corporations of exporting or investing abroad should depend on productivity cutoffs that make these different modes of internationalization profitable.

The remind of the paper is organized as follows. Section 2, briefly review the literature on entry-modes. Section 3 describes the data and present some preliminary descriptive statistics by taking special care at identifying the different strategies of internationalization in our data set. Section 4 reports the main findings of our

*DOI: http://dx.doi.org/10.5772/intechopen.95288*

providing mixed results.

productivity varies across destinations.

**2. Related theoretical literature**

performers in international markets are exporting firms.

tests. The last section summarizes and draws some conclusions.

#### *Entry-Mode Selection and Firm's Productivity across Market Destinations: An Empirical… DOI: http://dx.doi.org/10.5772/intechopen.95288*

Following this literature, we use a database for a large sample of Italian manufacturing firms, which include both large and small-medium sized enterprises, to test different international entry-modes as well as the decision to stay domestic. The first move is horizontal foreign direct investment, the second move is offshoring and the third is exporting. More specifically, we test whether companies that choose horizontal FDI show a higher performance compared to offshoring firms and whether the latter outperforms, in terms of productivity, exporting firms. In turn, we test whether exporting firms outperforms purely domestic firms. Finally, we test whether the findings are consistent across different destinations of foreign activities. Our main measure of performance is Total Factor Productivity (TFP).

This paper contributes to the literature on market entry modes. Firstly, it adds a piece of evidence on the internationalization moves and their impact on firm's performances by investigating Italian firms. There are a number of research contributions that investigate the outcomes of entry-modes for individual countries by providing mixed results.

Secondly, it uses a dataset that enables to separate firms' strategies according to destination countries in order to evaluate whether the ranking holds when firms' productivity varies across destinations.

Thirdly, in contrast to previous literature, our finding is that for Italy the best performers in international markets are exporting firms.

The remind of the paper is organized as follows. Section 2, briefly review the literature on entry-modes. Section 3 describes the data and present some preliminary descriptive statistics by taking special care at identifying the different strategies of internationalization in our data set. Section 4 reports the main findings of our tests. The last section summarizes and draws some conclusions.

### **2. Related theoretical literature**

In this section we recall some contributions of the literature to delineate the analytical context of our research. Prior of the HMY paper, other theoretical models have tried to incorporate the profound transformations that we observe empirically in the international context by incorporating sunk costs, heterogeneity, and uncertainty in dynamic models. This line of research, how rightly pointed out by James Tybout [17], dates from the late '80s. Recently, however, many interesting papers have been published that extend the literature on international choices of companies on the basis of a set of new stylized facts. The new approach to the analysis of cross-border trade and foreign investment has been developed in the canonical paper by Melitz [18], Bernard et al. [19], Antràs [20], Antràs and Helpman [21] and Helpman, Melitz and Yeaple [3] among others. These models, focusing on individual firm behaviour and participation in international markets, offer an explanation of why some companies stay in house while others go overseas as well as to the puzzle of international fragmentation of production. One of the most remarkable features of globalization and accelerated competition is that the reduction of transportation and communication costs have contributed to boost international trade and has pushed firms to find new ways of value creation. Among the motives for choosing different foreign strategies, the degree of heterogeneity within industries emerges as a result of productivity differentials across firms. What comes out from this literature is that the interaction of sunk costs and productivity heterogeneity is the key motive to explain the choices of globalized firms. The international strategies of corporations of exporting or investing abroad should depend on productivity cutoffs that make these different modes of internationalization profitable.

*Outsourcing and Offshoring*

abroad: even tax conditions, less bureaucracy, a favorable regulatory environment are attractive factors for entrepreneurs. For these reasons, a large number of Italian

higher for FDI and offshore-outsourcing and lower for exporting firms.

All the internationalization choices require different levels of resource commitment: exporting is a low resource-commitment and a low risk entry-mode, whereas FDI and offshoring are associated with greater risks, higher fixed costs and organizational complexities. Thereby, the returns expected by these entry modes are

As reported by Greenaway and Kneller in their review article [2], the bulk of the empirical literature does not study simultaneously the productivity performances of all these different international choices but investigates separately firm performance for exporters against non-exporters, offshorers against non-offshorers and MNEs against some other form of internationalization, generally exporting. There are still few studies that put together all these different forms of foreign activity to bettering our understanding of the structure of foreign trade, characterized by a growing role of multinationals and a growing share of intermediate inputs in trade flows. The objective of this work is to assess the productivity performances of firms

Seminal works in international trade literature state that the entry modes of firms in international markets is endogenous and depends on ex-ante firm's productivity. From a theoretical point of view, the model that compares different entry-modes in international markets is that by Helpman et al. [3]. This model, adding heterogeneity across firms in the same industry shows that firms self-select their entry-mode (exports versus FDI) according to productivity levels of firms. This is done through a sequence of different fixed and sunk costs associated with the various forms of internationalization. In their model the choice to serve foreign markets is associated with different fixed and variable costs, which have important consequences for firm's strategy to enter into foreign markets. The fixed costs of Horizontal-FDI (HFDI) are greater than those of exporting. Since only the most productive firms can afford the duplications costs in establishing new plants in a foreign country, the main prediction of the model is that FDI firms are more

This theoretical prediction is generally supported by a fairly extensive empirical literature. Studies by Bernard and Jensen [4] and Yeaple [5] confirm that U.S. firms with the lowest productivity stay domestic, those with higher productivity export, and those with the highest productivity invest abroad. Further validations come from UK firms [6], Irish firms [7], German firms [8, 9]. Other studies conducted on Japanese firms such as Tomiura [10], and Kimura and Kiyota [11], also confirm the sorting pattern of internationalization with respect to productivity. However, the HMY model refers only to the standard moves (exports versus FDI) but some of these empirical papers have extended the predicted ranking by including also

More recently, Wakasugi [12] in his study on Japanese firms finds only a partial

validation of the HMY predictions. The novelty in his study is the distinction among different destinations of the foreign activity of the Japanese firms. While the result is consistent with the HMY sorting of export and FDI in the case of USA and EU destinations, the reverse order holds in the case of Asian country destinations. This suggests that dissecting exports and/or the investment modes by producers in different foreign markets might be crucial to assess the validity of the predicted theoretical ranking. Many other studies have distinguished foreign activities by destination countries but in that case the analysis was directed only to exporting

activity (i.e. [13–15], De Loecker [16] among others).

companies has moved in that area 17,700 businesses [1].

that undertake different overseas market-entry strategies.

productive than exporting ones.

**70**

offshoring.

Indeed, Krugman [22] developed a model, (successively tested by [23]), in which firms trade-off proximity to consumers (FDI) against the scale economies achieved by production concentration in one location for export. The HMY model introduces firm-level heterogeneity to confirm the prediction of the proximity-concentration trade-off thus allowing this trade-off choice to differ across firms within the same industry through the assumption of different costs associated with serving the foreign markets. Firms tend to substitute FDI sales for exports when transport costs are high and plant-level returns to scale are low. But because of the higher fixed costs of FDI, this choice will be made only if the profit curve for subsidiary sales is steeper than that of exporting. More precisely, their results show the presence of a productivity cutoff which is a function of industry and destination country characteristics: firms with productivity below this cutoff export, whereas firms with productivity above the cutoff invest abroad. In addition, since foreign investors and exporters coexist in the same industry, it is possible to calculate the Export/FDI ratio by aggregating all firms in the same industry with productivities above their correspondent cutoffs and this ratio will be lower the larger the variable trade costs and viceversa. The main findings are embodied in the following sequences of outward orientation by firms: (i) the most productive firms serve foreign markets via subsidiary sales, (ii) intermediate productivity firms cover foreign markets through exports and (iii) lowest productivity firms serve only the domestic market.

The predictions of the HMY model have been confirmed by the empirical analysis conducted by the same authors. Using US export and affiliate sales data that cover 52 manufacturing sectors and 38 countries they show that cross-sectoral differences in firm heterogeneity predict the composition of trade and investment in analogy with the theoretical model. The research focus of our empirical analysis is to explore not just the decision to serve foreign markets through export and horizontal FDI but also vertical foreign investment decisions motivated by factor (labour) costs advantages. As pointed out by Antràs and Helpman [21] the model of HMY does not address the organizational choice of firms that need to purchase intermediate inputs, which is one of the most important form of international trade in the last decades.

There exists numerous studies in the international business literature that investigate the selection of these entry-modes. However, the research is fragmented and the issue of the link between selection of entry strategies and performances is limited or at least it is not posed in the perspective so far outlined. Also in this literature the two most widely options are exporting and FDI but the majority of studies investigated the determinants of the two choices. The approach followed is an incremental one: firms initially choose exporting and only after gaining experience in the host country may expand their operations through ownership of production [24, 25]. While FDI research focuses on the OLI framework of Dunning [26–28], which is expected to explain the majority of international strategy selection, export research relies instead on transaction costs theory (TCT), which provides valuable insights on how firms organize their activity abroad to increase their efficiency by selecting export channels [29]. Other recent approaches build on the research-based view and institutional theory to explain how firms can improve export performance by considering not only export channels but also the performance consequences of learning capabilities [30, 31]. More specifically, recent contributions by He et al. on exporting choice suggest that market orientation capabilities of firms, that is the effort to create value in the export market, is important to link export channel selection and export performance. These capabilities are not considered in the TCT but are crucial to assess exporter's performance. Indeed, capabilities help firm to learn about foreign markets and adjust "strategy and products to conform to market demand, which should result in superior export performance" (p.30)

**73**

questions:

make any FDI?

*Entry-Mode Selection and Firm's Productivity across Market Destinations: An Empirical…*

A different strand of the same literature has investigated offshoring performance in isolation with respect to the other entry-modes by looking at different aspects of performance such as corporate financial performance, cost saving, sales growth etc. [32–34], among many others) as well as general characteristics of the offshoring strategy [35]. However, also in the business practice the decisions of firms' internationalization are not taken in isolation, thus a joint analysis of entry strategies is conducive to a better understanding of the phenomenon. Our perspective is to compare the different productivity performances of all the three entry modes taken together, without investigating the determinants of these choices. The purpose is to stimulate a more intensive discussion that takes into account theoreti-

Therefore, entering offshoring in our analysis, Italian firms that decide to sell goods overseas have three options: (i) producing at home and export (ii) fragmenting production such that producing and selling of goods may occur in one or more different locations abroad (offshoring), (iii) opening up an affiliate in the destina-

Our firm-level data are drawn from the IX and X waves of the three-year Survey on Manufacturing Firms (Indagine sulle Imprese Manifatturiere) administered by the commercial bank Capitalia-Unicredit. The surveys used cover the period 2001- 2006 and was conducted in 2004 and 2007. These surveys report, through stratified samples by geographical areas, and industrial sectors several aspects of selected units with employees between 11 and 500 and a census of firms with more than 500 workers. Information is collected through questionnaires as well as quantitative data from firm's balance sheets for all the years covered by the Survey, regarding factor inputs, output, value added, and all data details necessary to our analysis. More importantly from the firm's interviews, we collected a rich set of information on

For our purpose, we pool together the two waves, adding the panel units to the non-panel components from the second survey for an entire sample of more than 4000 Italian manufacturing firms. In the cleaning process, we exclude observations revealing a value added, or capital stock or materials that are negative or missing for more than two years (or, alternatively, in the central year) over each three-year wave. Moreover, we consider as outliers firms where measures of value added or inputs (i.e. capital stock, the number of employee), over each wave's period fell

Namely, for our empirical analysis, we consider as a first category companies that perform horizontal FDI aimed at producing goods that will be sold into foreign countries. For this scope, in order to define horizontal FDI, we use the following

i.Within the three-year period (2001-2003 or 2004-2006), did the company

ii.Share of foreign production by destination: (a) sold in the place where the

<sup>1</sup> As in Helpman [36] with the term offshoring "we refer to the sourcing of good or service in a foreign

tion market and produce and sell goods in that location (horizontal FDI).1

*DOI: http://dx.doi.org/10.5772/intechopen.95288*

cal advances from different strands of literature.

**3. Data description and productivity measures**

different types of international engagements by Italian firms.

company was settled, (b) sold to third countries.

country, either from an affiliated or an affiliated supplier (p. 127).

within either the first or the last percentiles.

*Entry-Mode Selection and Firm's Productivity across Market Destinations: An Empirical… DOI: http://dx.doi.org/10.5772/intechopen.95288*

A different strand of the same literature has investigated offshoring performance in isolation with respect to the other entry-modes by looking at different aspects of performance such as corporate financial performance, cost saving, sales growth etc. [32–34], among many others) as well as general characteristics of the offshoring strategy [35]. However, also in the business practice the decisions of firms' internationalization are not taken in isolation, thus a joint analysis of entry strategies is conducive to a better understanding of the phenomenon. Our perspective is to compare the different productivity performances of all the three entry modes taken together, without investigating the determinants of these choices. The purpose is to stimulate a more intensive discussion that takes into account theoretical advances from different strands of literature.

Therefore, entering offshoring in our analysis, Italian firms that decide to sell goods overseas have three options: (i) producing at home and export (ii) fragmenting production such that producing and selling of goods may occur in one or more different locations abroad (offshoring), (iii) opening up an affiliate in the destination market and produce and sell goods in that location (horizontal FDI).1

### **3. Data description and productivity measures**

Our firm-level data are drawn from the IX and X waves of the three-year Survey on Manufacturing Firms (Indagine sulle Imprese Manifatturiere) administered by the commercial bank Capitalia-Unicredit. The surveys used cover the period 2001- 2006 and was conducted in 2004 and 2007. These surveys report, through stratified samples by geographical areas, and industrial sectors several aspects of selected units with employees between 11 and 500 and a census of firms with more than 500 workers. Information is collected through questionnaires as well as quantitative data from firm's balance sheets for all the years covered by the Survey, regarding factor inputs, output, value added, and all data details necessary to our analysis. More importantly from the firm's interviews, we collected a rich set of information on different types of international engagements by Italian firms.

For our purpose, we pool together the two waves, adding the panel units to the non-panel components from the second survey for an entire sample of more than 4000 Italian manufacturing firms. In the cleaning process, we exclude observations revealing a value added, or capital stock or materials that are negative or missing for more than two years (or, alternatively, in the central year) over each three-year wave. Moreover, we consider as outliers firms where measures of value added or inputs (i.e. capital stock, the number of employee), over each wave's period fell within either the first or the last percentiles.

Namely, for our empirical analysis, we consider as a first category companies that perform horizontal FDI aimed at producing goods that will be sold into foreign countries. For this scope, in order to define horizontal FDI, we use the following questions:


*Outsourcing and Offshoring*

in the last decades.

Indeed, Krugman [22] developed a model, (successively tested by [23]), in which firms trade-off proximity to consumers (FDI) against the scale economies achieved by production concentration in one location for export. The HMY model introduces firm-level heterogeneity to confirm the prediction of the proximity-concentration trade-off thus allowing this trade-off choice to differ across firms within the same industry through the assumption of different costs associated with serving the foreign markets. Firms tend to substitute FDI sales for exports when transport costs are high and plant-level returns to scale are low. But because of the higher fixed costs of FDI, this choice will be made only if the profit curve for subsidiary sales is steeper than that of exporting. More precisely, their results show the presence of a productivity cutoff which is a function of industry and destination country characteristics: firms with productivity below this cutoff export, whereas firms with productivity above the cutoff invest abroad. In addition, since foreign investors and exporters coexist in the same industry, it is possible to calculate the Export/FDI ratio by aggregating all firms in the same industry with productivities above their correspondent cutoffs and this ratio will be lower the larger the variable trade costs and viceversa. The main findings are embodied in the following sequences of outward orientation by firms: (i) the most productive firms serve foreign markets via subsidiary sales, (ii) intermediate productivity firms cover foreign markets through

exports and (iii) lowest productivity firms serve only the domestic market. The predictions of the HMY model have been confirmed by the empirical analysis conducted by the same authors. Using US export and affiliate sales data that cover 52 manufacturing sectors and 38 countries they show that cross-sectoral differences in firm heterogeneity predict the composition of trade and investment in analogy with the theoretical model. The research focus of our empirical analysis is to explore not just the decision to serve foreign markets through export and horizontal FDI but also vertical foreign investment decisions motivated by factor (labour) costs advantages. As pointed out by Antràs and Helpman [21] the model of HMY does not address the organizational choice of firms that need to purchase intermediate inputs, which is one of the most important form of international trade

There exists numerous studies in the international business literature that investigate the selection of these entry-modes. However, the research is fragmented and the issue of the link between selection of entry strategies and performances is limited or at least it is not posed in the perspective so far outlined. Also in this literature the two most widely options are exporting and FDI but the majority of studies investigated the determinants of the two choices. The approach followed is an incremental one: firms initially choose exporting and only after gaining experience in the host country may expand their operations through ownership of production [24, 25]. While FDI research focuses on the OLI framework of Dunning [26–28], which is expected to explain the majority of international strategy selection, export research relies instead on transaction costs theory (TCT), which provides valuable insights on how firms organize their activity abroad to increase their efficiency by selecting export channels [29]. Other recent approaches build on the research-based view and institutional theory to explain how firms can improve export performance by considering not only export channels but also the performance consequences of learning capabilities [30, 31]. More specifically, recent contributions by He et al. on exporting choice suggest that market orientation capabilities of firms, that is the effort to create value in the export market, is important to link export channel selection and export performance. These capabilities are not considered in the TCT but are crucial to assess exporter's performance. Indeed, capabilities help firm to learn about foreign markets and adjust "strategy and products to conform to market

demand, which should result in superior export performance" (p.30)

**72**

<sup>1</sup> As in Helpman [36] with the term offshoring "we refer to the sourcing of good or service in a foreign country, either from an affiliated or an affiliated supplier (p. 127).

#### *Outsourcing and Offshoring*

As a second type we include firms doing offshoring activities, that are those investments aimed at moving abroad the production of semi-finished goods or components, which are going to be re-imported into the domestic country and then either sold into the domestic country, or re-exported abroad or re-introduced into the domestic production.2 The definition of offshoring relies on the following questions:


We include in the analysis also offshoring in services which relies on the following questions:


The third category involves firms doing only exporting. In the internationalization part of the survey, firms answer at the following questions: (1) has the firm exported all or part of its output in the last year of the survey? (2) What is for each firm the percentage of its exports on total sales? Firms are asked to indicate the geographical area of destination as percentage sales exported for each destination, so that the total should be 100%. The nine geographical areas are EU (15), New Entrants in the EU in 2004, Russia, Turkey and other EU countries, Africa, Asia, China, Usa-Canada and Mexico, Latin America, Australia.

Finally, we take domestic firms, that are those that do not export and offshore either. Unfortunately, for Italy, these forms of internationalization do not fit exactly in the categories just described. In our data set, while there are pure exporters, there are not purely horizontal FDI and only a small number of firms are purely offshorers.

To compute an approximate TFP we follow Tomiura [10] using the following approximation formula:

$$TFP\_{\rm it} = \log\left(\frac{Sales\_{\rm it}}{L\_{\rm it}}\right) - \frac{1}{3}\log\left(\frac{K\_{\rm it}}{L\_{\rm it}}\right) \tag{1}$$

**75**

*1*

*table). 2*

**Table 1.**

EXP

Northern destinations (%)2

Southern destinations (%)

*counted in the statistics concerning specific destinations.*

*Distribution of different internationalization modes across destinations.1*

*Entry-Mode Selection and Firm's Productivity across Market Destinations: An Empirical…*

scale. However, it is a good measure of technical efficiency if there are constant returns to scale and 1/3 is a reasonable measure of the capital share. The fraction of 1/3 has been used also by Hall and Jones [38] and roughly corresponds to physical capital intensity in manufacturing. On the other hand, using the ordinary least square method to calculate TFP as a residual would likely produce biased coefficient estimates due to correlations between the exogenous variables and the

In the following we report some descriptive statistics on the whole universe of

reduce their horizontal FDI and increase offshoring activities over time.

As revealed by **Table 1**, across all destinations, firms performing only export are far more numerous than firms moving production abroad. Furthermore, among the latter group, the percentage of companies making offshoring (in materials) is larger than firms performing horizontal FDI. Over time, international activity seems to decrease from the triennial period 2001-2003 to the period 2004-2006. When we distinguish by destination of international activities, we first observe that the percentage of exporters to Southern destinations is larger than that of exporters to Northern destinations. Secondly, for investors, Southern destinations result to be preferred to Northern destinations in the period 2001-2003, but the opposite turns out to be true in the second period (2004-2006). Finally, investors to the North

The **Table 2** shows the number of firms across industries distinguished by their

Given the limited number of firms that invest abroad in some sectors, we aggregated the firms in 9 sectors. The strategies have been labeled as following: Horizontal FDI (HFDI), offshorers (OFF), Exports (EX) and Domestic (D). What emerges from the table is that the majority of firms across sectors decides to export while the percentage of firms that invest abroad chooses to do it by doing offshoring and only a small percentage of firms perform horizontal FDI. In particular, industries more involved into offshoring are Leather, Wood, Paper Products, Medical Apparels and Instruments and, at a lesser extent, Furniture, Printing

**Year All destinations (%) 2003 2006** HFDI 1,25 0,27 OFF 1,76 0.83

HFDI 0.24 0.14 OFF 0.11 0.23 EXP 65.71 †56.7

HFDI 0.79 0.05 OFF 0.62 0.16 EXP 71.82 60.9 N. Obs. 3683 4443

*HFDI= horizontal FDIs¡ OFF=arm's lenght trade and vertical FDI¡ E=only exporters D=domestic firms (in the next* 

*Note that not all the companies in the dataset reveal the destination of their foreign investment. Thus, they are not* 

71.82 60,9

*DOI: http://dx.doi.org/10.5772/intechopen.95288*

error term.

firms in our dataset.

international strategies.

This measure adjusts labour productivity by a fraction (in this case (1/3) of the capital intensity). As noted by Head and Ries [37] the drawback to this measure of productivity is that it reflects both technical efficiency as well as economies of

<sup>2</sup> Our measure of offshoring firms includes both international outsourcing (arm's length trade), in which one company hires an overseas firm to complete a function that was previously performed in-house and offshoring FDI (or intra-firm trade) that is the multinational tendency to fragment part of production to low wage countries. In other terms, we follow the recent classification of offshoring that includes all international relations without distinguishing whether the provider is external or affiliated within the firm. The identification of offshoring firms in this broad sense has been made by looking at the section devoted to overseas production relocation in the cited Survey and reported in the Appendix.

#### *Entry-Mode Selection and Firm's Productivity across Market Destinations: An Empirical… DOI: http://dx.doi.org/10.5772/intechopen.95288*

scale. However, it is a good measure of technical efficiency if there are constant returns to scale and 1/3 is a reasonable measure of the capital share. The fraction of 1/3 has been used also by Hall and Jones [38] and roughly corresponds to physical capital intensity in manufacturing. On the other hand, using the ordinary least square method to calculate TFP as a residual would likely produce biased coefficient estimates due to correlations between the exogenous variables and the error term.

In the following we report some descriptive statistics on the whole universe of firms in our dataset.

As revealed by **Table 1**, across all destinations, firms performing only export are far more numerous than firms moving production abroad. Furthermore, among the latter group, the percentage of companies making offshoring (in materials) is larger than firms performing horizontal FDI. Over time, international activity seems to decrease from the triennial period 2001-2003 to the period 2004-2006. When we distinguish by destination of international activities, we first observe that the percentage of exporters to Southern destinations is larger than that of exporters to Northern destinations. Secondly, for investors, Southern destinations result to be preferred to Northern destinations in the period 2001-2003, but the opposite turns out to be true in the second period (2004-2006). Finally, investors to the North reduce their horizontal FDI and increase offshoring activities over time.

The **Table 2** shows the number of firms across industries distinguished by their international strategies.

Given the limited number of firms that invest abroad in some sectors, we aggregated the firms in 9 sectors. The strategies have been labeled as following: Horizontal FDI (HFDI), offshorers (OFF), Exports (EX) and Domestic (D). What emerges from the table is that the majority of firms across sectors decides to export while the percentage of firms that invest abroad chooses to do it by doing offshoring and only a small percentage of firms perform horizontal FDI. In particular, industries more involved into offshoring are Leather, Wood, Paper Products, Medical Apparels and Instruments and, at a lesser extent, Furniture, Printing


*1 HFDI= horizontal FDIs¡ OFF=arm's lenght trade and vertical FDI¡ E=only exporters D=domestic firms (in the next table).*

*2 Note that not all the companies in the dataset reveal the destination of their foreign investment. Thus, they are not counted in the statistics concerning specific destinations.*

#### **Table 1.**

*Distribution of different internationalization modes across destinations.1*

*Outsourcing and Offshoring*

into the domestic production.2

components.

production.

production.

approximation formula:

questions:

ing questions:

As a second type we include firms doing offshoring activities, that are those investments aimed at moving abroad the production of semi-finished goods or components, which are going to be re-imported into the domestic country and then either sold into the domestic country, or re-exported abroad or re-introduced

i.Did the company move abroad the production of semi-finished goods or

ii.Share of foreign production by destination: (a) re-imported into the domestic market, (b). re-exported abroad¡ (c) re-introduced into the domestic

We include in the analysis also offshoring in services which relies on the follow-

ii.Share of foreign production by destination: (a) re-imported into the domestic market, (b) re-exported abroad, (c) re-introduced into the domestic

The third category involves firms doing only exporting. In the internationalization part of the survey, firms answer at the following questions: (1) has the firm exported all or part of its output in the last year of the survey? (2) What is for each firm the percentage of its exports on total sales? Firms are asked to indicate the geographical area of destination as percentage sales exported for each destination, so that the total should be 100%. The nine geographical areas are EU (15), New Entrants in the EU in 2004, Russia, Turkey and other EU countries, Africa, Asia,

Finally, we take domestic firms, that are those that do not export and offshore either. Unfortunately, for Italy, these forms of internationalization do not fit exactly in the categories just described. In our data set, while there are pure exporters, there are not purely horizontal FDI and only a small number of firms are purely offshorers. To compute an approximate TFP we follow Tomiura [10] using the following

*Sales K TFP*

<sup>1</sup> log log

This measure adjusts labour productivity by a fraction (in this case (1/3) of the capital intensity). As noted by Head and Ries [37] the drawback to this measure of productivity is that it reflects both technical efficiency as well as economies of

<sup>2</sup> Our measure of offshoring firms includes both international outsourcing (arm's length trade), in which one company hires an overseas firm to complete a function that was previously performed in-house and offshoring FDI (or intra-firm trade) that is the multinational tendency to fragment part of production to low wage countries. In other terms, we follow the recent classification of offshoring that includes all international relations without distinguishing whether the provider is external or affiliated within the firm. The identification of offshoring firms in this broad sense has been made by looking at the section

devoted to overseas production relocation in the cited Survey and reported in the Appendix.

*it it*

<sup>3</sup> (1)

*it it*

*L L* <sup>=</sup> <sup>−</sup> 

i.Did the company buy services from abroad?

China, Usa-Canada and Mexico, Latin America, Australia.

*it*

The definition of offshoring relies on the following

**74**


#### **Table 2.**

*Distribution of different internationalization modes across industries.*

and Publishing, Petroleum Products and Chemicals. On the other side, industries focusing more on horizontal FDI are Office Equipment and Computers, Electric Machinery, Electronic Materials and Transportation. Overall, firms in the whole sample seem to reduce the international activity in 2006 with respect to 2003. However, some industries increase their offshoring activity over time, such as Rubber and Plastics, Non-Metal Minerals, Metals, Metals Products and Furniture, while Food, Beverages, Textiles and Clothing increase their share in Horizontal FDI and, finally, Other Transportation raise their share in Exports.

**Figure 1** shows kernel densities of TFP for the four types of firms in our data set.

The ordering of the firms' productivity seems to be the following: both in 2001-2003 and 2004-2006, firms producing abroad are more productive than those exporting, being the latter more productive than domestic firms.

As the figure illustrates there are productivity differentials among firm groups. The differences are more pronounced for the period 2004-2006. The distribution of the log of total factor productivity (TFP) for the four types of Italian firms are those serving only the domestic market (domestic firms), those engaging in export (pure exporters), those engaging in horizontal FDI, and those engaging in offshoring. concentrated over larger TFP values with respect to exporters. In turn, the latter are better performers in TFP than domestic counterparts. However, the ranking of distributions of firms that perform horizontal FDI with respect to offshorers is not clear-cut as they seem to be almost overlapping.

**77**

available in Stata.

*Entry-Mode Selection and Firm's Productivity across Market Destinations: An Empirical…*

Since productivity is the key element of our study, in order to overcome simultaneity and andogeneity problems of parametric approximation of TFP, we use the semi-parametric method suggested by Levinshon and Petrin [39] and widely

functions using firm-level data and solves the simultaneity bias of correlation of productivity shocks and input choices by using a composite index of materials

where y, l, k, m are respectively the log of output, employment, intermediate inputs, and capital stock for firm i at time t and ws,t is the productivity shock observable by firms. Although also this method of computation of TFP suffers some significant identification problem, it allows us to limit endogeneity issues. The regression implemented sector-by-sector on each wave's three-year panels uses materials from the balance sheet data as well as white and blue collars as labour

<sup>3</sup> The Levinshon and Petrin measure of TFP has been calculated by implementing the levpet routine

<sup>4</sup> The method relies on a a function in which intermediate inputs are used to control for productivity and this has an advantage over the Olley and Pakes [40] method which uses investment to proxy for productivity. In our data set (as well as other firm-level datasets) this variable was not available.

(intermediates) to proxy unobserved productivity shocks.4

Consider the following Cobb-Douglas production function:

Specifically, this estimator permits to estimate production

*it l it k it it it y a al a k w u* =+ + + + 0 , , ,, (2)

*i t l it m it k it it it y a al a m a k w u* ,0 , , , , , =+ + + + + (3)

*DOI: http://dx.doi.org/10.5772/intechopen.95288*

**4. Empirical methodology**

*TFP kernel densities across different internationalization modes.*

for the LP estimation it becomes:

used in the literature.3

**Figure 1.**

*Entry-Mode Selection and Firm's Productivity across Market Destinations: An Empirical… DOI: http://dx.doi.org/10.5772/intechopen.95288*

**Figure 1.** *TFP kernel densities across different internationalization modes.*
