Pacific Science Review B: Humanities and Social Sciences 1 (2015) 76e84

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Pacific Science Review B: Humanities and Social Sciences

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Internationalization and firm performance of Indian firms: Does

product diversity matter?
Nufazil Altaf*, Farooq Ahmad Shah 1
School of Business Studies, Central University of Kashmir, India

a r t i c l e i n f o a b s t r a c t

Article history: The purpose of this study is to investigate the relationship between internationalization and firm per-
Received 19 April 2016 formance and to determine the moderating role of product diversity on this relationship. This study
Accepted 23 May 2016 utilizes secondary financial data of 180 Indian manufacturing firms obtained from CMIE PROWESS and
Available online 1 July 2016
pertains to a period of five years. Correlation analysis has been used to make an initial investigation of
whether the variables present certain problems of multicollinearity. Pooled Cross-Section/Time-Series
Keywords:
regression analysis has been used to test the aforementioned relationships. Results of this study
Internationalization
confirm a U-shape relationship between internationalization and firm performance and a significant
Product diversification
Firm performance
negative effect of product diversity on firm performance. In addition, results indicate that product di-
Emerging market versity strengthens the relationship between internationalization and performance.
Copyright © 2016, Far Eastern Federal University, Kangnam University, Dalian University of Technology,
Kokushikan University. Production and hosting by Elsevier B.V. This is an open access article under the CC
BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).

1. Introduction relationships: linear (monotonic) and curvilinear (non-monotonic).

Liberalization, privatization and globalization (LPG) measures
adopted by countries all over the globe have led to the reduction in
trade barriers and allowed for the smooth flow of goods and ser-
vices across borders. Due to adoption of LPG measures, a large
number of firms in both developing and developed economies are
entering global markets to take advantage of the availability of
cheap labour, inexpensive land and abundant resources. Recent
decades have witnessed rapid growth in international business and
because of this rapid internationalization, MNEs now consider the
entire world as one market (Hsu, 2006). Accordingly, internation-
alization is perceived as an important component of corporate
strategy that promotes sustained growth (Porter, 1990). Scholars
have devoted considerable time and effort to explain the relation-
ship between internationalization and performance (Hitt et al.,
2006; Hsu, 2006). However, empirical studies regarding the rela-
tionship between internationalization and performance report
conflicting results. Studies report two different types of
* Corresponding author. Tel.: þ91 9086666846.
E-mail addresses: nahangar113@gmail.com (N. Altaf), farooq_dms@cukashmir.
ac.in (F.A. Shah).
Peer review under responsibility of Far Eastern Federal University, Kangnam
University, Dalian University of Technology, Kokushikan University.
1
Tel.:þ91 9419073693.
With regard to linear (monotonic) relationships, empirical studies
have reported negative linear (Singla and George, 2013; Collins,
1990) and positive linear relationships (Hajela and Akbar, 2013;
Contractor et al., 2007; Nachum, 2004) between internationaliza-
tion and firm performance. However, with regard to curvilinear
(non-monotonic) relationships, empirical studies have docu-
mented U-shaped (Capar and Kotabe, 2003; Ruigrok and Wagner,
2003; Contractor et al., 2003) and inverted U-shaped relation-
ships (Gomes and Ramaswamy, 1999; Hitt et al., 1997; Sullivan,
1994) between internationalization and firm performance. From
an extreme perspective, certain studies have reported the existence
of an S-curve relationship (Heyder et al., 2011; Ruigrok et al., 2007;
Hsu, 2006) between internationalization and firm performance.
In addition, these studies have mostly focused on samples from
developed nations. Few studies have examined the relationship
between internationalization and performance in emerging Indian
market firms (Singla and George, 2013; Hajela and Akbar, 2013;
Contractor et al., 2007). Prior studies focused on the examination
of the moderating role of exogenous factors (e.g., culture and in-
stitutions) on the relationship between internationalization and
performance (Li, 2007; Hitt et al., 2006); however, firm-specific
factors or endogenous factors (e.g., product diversification, size,
and firm-specific assets) have been largely ignored.
This study attempts to fill the research gap by examining the
relationship between internationalization and performance in

http://dx.doi.org/10.1016/j.psrb.2016.05.002
2405-8831/Copyright © 2016, Far Eastern Federal University, Kangnam University, Dalian University of Technology, Kokushikan University. Production and hosting by Elsevier
B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).
 N. Altaf, F.A. Shah / Pacific Science Review B: Humanities and Social Sciences 1 (2015) 76e84
Indian firms and explaining the moderating role of product di-
versity (endogenous or firm specific attribute) on this relationship.
Accordingly, this study would advance international business
literature in following ways. First, unlike previous studies regarding
the relationship between internationalization and performance
that largely focused on samples from developed nations, this study
focuses on firms in an emerging market, India, and thus tests the
applicability of the three-stage theory of internationalization in
emerging market firms. Second, this study seeks to expand on the
divergent results of prior studies regarding the relationship be-
tween internationalization and performance. Finally, as argued by
Ruigrok et al. (2007) that studies regarding the relationship be-
tween internationalization and performance should focus on the
role of certain moderating variables, this study adds to existing
knowledge and has both managerial and academic relevance. This
study explores the moderating role of product diversity on the
relationship between internationalization and performance in In-
dian firms. To the best of our knowledge, this topic has not been yet
explored in the Indian context. Furthermore, it must be acknowl-
edged that India possesses certain unique characteristics that
provide a natural setting for testing the relationship between
internationalization and performance. For instance, among all
developing countries, India has altogether different institutional
factors such as culture, economic development, and the political
and regulatory environment (Singla and George, 2013). Indian
multinational corporations (MNCs) face intense competition from
foreign MNCs that have developed firm-level capabilities such as
adaptive skills, better competitive ability and faster learning (Gaur
et al., 2014). Indian MNCs possess comparative advantages that
include a competency to successfully manufacture skill-intensive
products and services, quality managers and a low cost base
(Ramamurti, 2009). All these factors along with the lack of empir-
ical data regarding the relationship between internationalization
and performance and the moderating effect of product diversity on
this relationship, makes India a unique country for testing these
relationships.
This paper is divided into four sections. The “Review of theory
and empirical evidence” section contains a brief literature review of
theory and empirical results pertaining to the relationship between
internationalization and performance and the moderating role of
product diversity. The “Methodology” section is an operative
component of the study that outlines the methodology employed
to arrive at the results. The “Results” section presents empirical
results from the analytical tools used in the study. The “Concluding
observations” section summarizes the study outcomes.
2. Review of theory and empirical evidence
The phenomenon of internationalization has been discussed
broadly in international management literature. For instance, the
resource based view (RBV) asserts that “firm as a bundle of re-
sources that are linked together” (Rumelt, 1997). The RBV argues
that firm resources determine its international activity. An exten-
sion of the RBV is the knowledge based view (KBV) that recognizes
firms as knowledge hubs. The KBV implies that learning is central to
acquiring the new knowledge and capabilities required to enter
international markets (Kuivalainen, 2003). While the RBV and the
KBV explain what determines internationalization, the Uppsala
school of thought and the New Venture Theory of internationali-
zation explain when firms decide to enter foreign markets. Ac-
cording to the Uppsala school of thought, firms enter foreign
markets only when they have an established domestic base (Bilkey
and Tesar, 1977). Conversely, the New Venture Theory of interna-
tionalization argues that firms internationalize their operations
from the beginning (Oviatt and McDougall, 1994). Although these
77
theories provide a possible explanation of what determines inter-
nationalization and when firms decide to engage in international
business, they fail to explain the possible effects of internationali-
zation on the growth of firms (Zahra, 2005; Sapienza et al., 2006).2
With regard to the impact of internationalization on firm perfor-
mance, Li (2007) reports that decisions to enter foreign markets are
based on a cost and benefit analysis. This scholar further purports
that a firm may benefit from internationalization only when the
marginal returns of foreign markets outweigh the marginal returns
of domestic markets.
2.1. Benefits and costs of internationalization
The primary logic for internationalizing operations is to explore
the unique benefits and minimize costs related to global market
participation (Hsu et al., 2013). Prior studies regarding international
management demonstrate unique benefits exist for firms3 adopting
the resource based view (RBV) and that resources are heteroge-
neous with high mobility. The benefits arising from global market
participation foster competitive advantage and boost the perfor-
mance of an organization. Certain benefits of global market
participation that have been widely discussed in studies regarding
international management follow.
First: Economies of scale occur due to higher factor specializa-
tion because of increased production. Higher specialization of fac-
tors of production leads to potential cost reductions.
Second: Economies of scope (efficiencies wrought by variety,
not volume) occur when a firm is able to jointly produce two or
more products cheaper than producing each product individually.
Ghoshal (1987) reports that scope economies arise for a diversified
firm that possesses the ability to spread investments and costs
across the same or different value chains when its non-diversified
counterparts cannot.4
Third: Learning and innovation benefits occur when a firm
conducts business in global heterogeneous markets. The diversity
of global markets exposes firms to an assortment of stimuli and
provides an opportunity to enhance learning and develop new
capabilities that can be then deployed throughout the organization.
Thus, international diversity fosters innovation and helps firms
achieve positive results in a dynamic environment (Aulakh, 2007;
Kim et al., 1993).
Fourth: Access to key resources benefits globally diversified
firms because they have access to a greater variety of resources
(Kumaraswamy et al., 2012; Laanti et al., 2007; and Zhou et al.,
2007). An internationally diversified firm may select a location
that provides resources at the lowest possible cost. Nations differ in
factor endowments that lead to differences in factor costs. Thus, an
internationally diversified firm may configure their value-added
chain in such a way that each link is located in the country that
results in the least cost for that specific link.
Fifth: Risk reduction benefits an internationalized firm because
it may spread its operations throughout multiple countries from
where it can retaliate the aggressive moves made by competitors
(Kim and Mauborgne, 1988; Hamel and Prahalad, 1985). Operating
in multiple markets allows firms to offset the losses of one national
2
Other theoretical frameworks that explain the process of internationalization
are the foreign direct investment theory (Li, 2007); the multinational enterprise
theory (Gomes and Ramaswamy, 1999); the organization learning perspective
(Ruigrok and Wagner, 2003) and others.
3
The resource-based view (RBV) implies that a firm can achieve sustained
competitive advantage through a unique bundle of resources that are at the core of
the firm (Gaur et al., 2014; and Ramamurti, 2009).
4
Both economies of scale and scope offer benefits that are beyond the potential
of product diversification (Caves, 1996).
78 N. Altaf, F.A. Shah / Pacific Science Review B: Humanities and Social Sciences 1 (2015) 76e84
market by the returns from a different market. Furthermore,
globalization minimizes the effect of adverse changes in one
country's interest rates, wage rates, and commodity and raw ma-
terial prices by providing the option to readily shift production and
resourcing sites to other favourable markets (Porter, 1986; Kogut,
1985). Lastly, internationalization gives a firm power to bargain
because it reduces the risk of fluctuations in supply and demand
found in national markets and smoothens the peaks and troughs of
a firm's revenue stream (Kim et al., 1993).5
Thus, internationalization provides firms with a set of benefits
that will increase revenues and enhance performance. Conversely,
internationalization also exposes firms to certain risks that increase
costs thereby reducing performance (George et al., 2005). The lack
of knowledge regarding foreign markets and the environment in
the initial stages of internationalization are significant risks that
may deteriorate performance in international markets. This notion
is known as the liability of foreignness. Furthermore, increased
internationalization can increase transaction costs and other costs
of processing information, thus reducing performance (Hitt et al.,
1994). The limited ability of mangers to adjust to the interna-
tional environment further exerts a negative influence on perfor-
mance (Stulz, 1990). Internationalization may lead to agency
problems with free cash flows in firms that have a larger debt ca-
pacity and easy access to free cash flow. Managers of these com-
panies tend to invest free cash flows in projects with a negative net
present value (NPV) to pursue their own interests (Jensen, 1986).
Thus, if firms internationalize their operations to exploit economies
of scale, scope and learning, they must also consider other costs
associated with this type of expansion (Hsu et al., 2013).
2.2. Internationalization and firm performance
From the prior studies previously reviewed, it may be asserted
that internationalization is associated with both risks and rewards.
If costs outweigh the rewards, then internationalization will have a
negative impact on firm performance. Conversely, if rewards
outweigh the risks, then internationalization will have a positive
impact on firm performance. However, the interaction of risks and
rewards in the internationalization process depends to a great
extent on the stage of internationalization. Empirical studies
regarding the relationship between internationalization and per-
formance have reported two different types of relationships: linear
(monotonic) and curvilinear (non-monotonic) (Knight and Liesch,
2016). The logic underlying the curvilinear relationship relies on
an analysis of the incremental benefits and costs of international-
ization.6 With regard to linear (monotonic) relationships, empirical
studies have reported negative linear and positive linear relation-
ships between internationalization and firm performance. How-
ever, with regard to curvilinear (non-monotonic) relationships,
empirical studies have documented U-shaped and inverted U-
shaped relationships between internationalization and firm per-
formance. From the extreme perspective, certain studies have re-
ported the existence of an S-curve relationship between
internationalization and firm performance.
The relationship between internationalization and performance
indicates no unique pattern. However, these results cannot be
considered as ambiguous, rather, they confirm the three-stage
model of internationalization proposed recently by Contractor
5
The ability of a firm to move assets quickly between countries smoothens de-
mand, supply and revenue fluctuations (Thomas and Eden, 2004).
6
The word incremental here refers to the benefits (increase or decrease) and
costs (increase or decrease) with one-unit increase or decrease in degree of inter-
nationalization (Ruigrok et al., 2007).
et al. (2003) and Lu and Beamish (2004). Prior to explaining the
three-stage model or S-Shaped internationalizationeperformance
relationship, let us first explain the positive linear relationship, the
negative linear relationship, the U-shaped relationship and the
inverted U-shaped relationship.
2.2.1. Positive linear relationship
A number of studies (Hajela and Akbar, 2013; Contractor et al.,
2007; Nachum, 2004) have reported a positive linear relationship
between internationalization and firm performance thus doc-
umenting the assertion that as internationalization increases, firm
performance also increases. To clarify, there is a direct relationship
between internationalization and firm performance. This implies
that one unit of increase in internationalization results in one unit
of increase in performance. This phenomenon indicates that ben-
efits of internationalization are greater than the costs spent on the
expansion. However, Gomes and Ramaswamy (1999) argued that
because of the expansion inherent in internationalization, a firm's
profits will increase, but at a diminishing rate. Thus, scholars from
this school of thought believe that internationalization generally
benefits firms.
2.2.2. Negative linear relationship
Contrary to the above theory, certain studies (Singla and George,
2013; Geringer et al., 2000; Collins, 1990; Kumar, 1984) report a
negative linear relationship between internationalization and firm
performance indicating that as internationalization increases, a
firm's performance decreases. To clarify, an inverse relationship
exists between internationalization and firm performance meaning
that a one unit increase in internationalization causes a one unit
decrease in performance. Furthermore, a plausible explanation of
this phenomenon has been proposed by (Geringer et al., 2000): as
firms internationalize their operations, the costs of expanding
outweigh the benefits. Therefore, these scholars believe that
internationalization deteriorates a firm's performance.
2.2.3. U-shaped relationship
Recent empirical literature regarding the relationship between
internationalization and performance literature has given an alto-
gether different explanation as to how internationalization affects
firm performance. Certain researchers (Contractor et al., 2007;
Capar and Kotabe, 2003; Ruigrok and Wagner, 2003) argue that
the relationship between internationalization and performance is
non-linear (U-shaped). These scholars argue that during the initial
stages of internationalization, firm performance decreases, but as
the firm becomes acquainted with international markets, it may
eventually increase its performance. Hence, the curve will initially
indicate a negative slope and after a turn, it becomes positive. Thus,
according to these scholars, internationalization will benefit the
firm only when it adjusts to foreign market conditions.
2.2.4. Inverted U-shaped relationship
Numerous studies have reported a curvilinear (inverted U-sha-
ped) relationship between internationalization and firm perfor-
mance (Chao and Kumar, 2010; Gomes and Ramaswamy, 1999; Hitt
et al., 1997). These scholars argue that during the initial stages of
internationalization, benefits will cover all costs. However,
increased internationalization increases transaction costs and thus
performance eventually declines. Chao and Kumar (2010) provided
a plausible explanation for this phenomenon. These scholars argue
that the initial stages of international expansion provide a firm with
numerous opportunities such as economies of scale and scope and
easy access to resources. However, because of continued expansion,
increased transaction costs result in a decline in performance. Thus,
 N. Altaf, F.A. Shah / Pacific Science Review B: Humanities and Social Sciences 1 (2015) 76e84
the curve will show a positive slope initially and then becomes
negative.
2.2.5. S-shaped or sigmoid relationship
Prior studies regarding international management recognize the
S-Shaped or Sigmoid relationship as a thorough explanation to
illustrate the impact of internationalization on firm performance.
This model was utilized by Lu and Beamish (2004) and Contractor
et al. (2003) to propose the three-stage theory of the relationship
between internationalization and performance. Stage I is charac-
terized by a negative slope implying that the initial stages of
internationalization will result in negative returns to the firm. This
is because a firm is unfamiliar with foreign market conditions and
faces a higher level of uncertainty (Ozdemir and Upneja, 2016;
Contractor et al., 2007; George et al., 2005; Herrmann and Datta,
2005). Furthermore, during the initial stage of internationaliza-
tion, learning costs are highest, what Hofstede (1980) refers to as
acquiring new cultural knowledge. Other costs include high
transport and tariff costs, coordination and communications costs
(Chen et al., 2015), local adaptation costs and isomorphism
(Ghoshal and Bartlett, 1990). Thus, during the initial stage of
internationalization, firms' costs outweigh the benefits resulting in
decreased performance.
Stage II is characterized by a positive slope signifying that after a
certain time period of internationalization, firms began to benefit
from global diversification. The benefits of internationalization are
experienced only after firms pay the initial threshold costs of
internationalization and further expansion in foreign markets re-
sults in fewer costs. If further expansion in international markets
would not benefit firms, then companies would not seek to engage
in global operations. However, if firms can overcome initial costs
and capitalize on new investment opportunities and new knowl-
edge, then performance will improve (Contractor et al., 2003). Prior
studies regarding international management identify benefits that
may arise for a firm in Stage II. These benefits include risk diver-
sification (Coombs et al., 2009), exploitation of market imperfec-
tions (Caves, 1971), economies of scale and scope (Caves, 1996;
Contractor et al., 2007), and the ability to lower cost inputs
(Kogut, 1985). The benefits that a firm enjoys during the middle
stages of internalization outweigh costs. Thus, a positive relation-
ship is expected during the middle stages of internationalization
(Contractor et al., 2003).
Stage III is characterized by a negative slope implying that during
this stage of internationalization, firm performance will decrease.
This notion as explained by (Tallman and Li, 1996) implies that ben-
efits of internationalization are not infinite, rather, benefits arising
from internationalization increase up to a particular point known as
the “international threshold”, after which costs will outweigh the
benefits. At this point in time, performance will reach its apex and
further expansion results in value deterioration. Furthermore,
expansion in foreign markets limits capacities of managers to cope
with a more complex environment where costs outweigh benefits
(Contractor et al., 2003). Prior studies regarding international man-
agement mention certain costs that a firm incurs during this stage of
internationalization, these include increased environmental and
regulatory diversity (Gaur and Kumar, 2010), information overload
(Hitt et al., 1997), information loss, and distortion in governance
(Gaur et al., 2014). Therefore, a negative relationship is expected
during the final stage of internationalization.
Furthermore, there is a dearth of empirical studies that discuss
the following proposition: Does the three-stage inter-
nationalizationeperformance relationship hold true for emerging
market firms, or, are the results of firms in developed economies
generalizable to firms in emerging economies? Firms operating in
emerging economies tend to be smaller (Contractor et al., 2007)
79
and resource-deficient (Lall et al., 1983; Wells, 1983). Furthermore,
many firms operating in emerging markets have not yet fully
developed decision-making capabilities because they are young or
recently privatized (Lyles and Baird, 1994). Moreover, regulations in
emerging markets tend to constrain private enterprises (Kumar and
McLeod, 1981). However, Rugman (1979) demonstrates that these
characteristics of emerging markets incentivize firms to globalize
because foreign markets minimize the impact of market failure on
the account of dependence on domestic resources. Furthermore,
Mathews (2006) reported that the pace of internationalization was
greater and different for emerging market firms operating in the
Asia Pacific region when compared to western multinationals. In
addition, Sinha (2005) indicated that the ability of emerging mar-
ket firms to develop strategic innovations has reduced risks asso-
ciated with a lack of managerial capabilities and has helped these
firms pursue rapid internationalization. Indian companies such as
Tata steel, Zydus Pharmaceuticals, and United Breweries have
engaged in rapid internationalization and provide evidence to this
phenomenon. Two distinguishing strategic innovations that have
resulted in rapid internationalization for emerging market firms are
product diversification (Yeung, 1999) and business group affiliation
(Khanna and Rivkin, 2001). Product diversification fosters rapid
internationalization because it helps to build corporate identifica-
tion such as Godrej Consumer Products and Zydus Pharmaceuticals
experienced; expanding internal experience in managing acquisi-
tions also helps in achieving scale economies for corporate func-
tions such as finance, marketing, operations and human resources
management. Business group affiliation fosters rapid internation-
alization because it provides member firms access to capital and
technology needed to enter foreign markets. On the basis of the
previously mentioned studies, the following hypothesis has been
articulated.
H1. The relationship between internationalization and perfor-
mance is S-shaped or sigmoid.
2.3. The moderating role of product diversification on the
relationship between internationalization and firm performance
An important component of strategy is synergy (Nielsen and
Gudergan, 2012; Zaheer and Bell, 2005) that occurs when two
businesses collectively offer greater benefits than they do by
operating individually. Synergy can exist only when firms use
similar resources (Vithessonthi and Racela, 2016). Thus, diversifi-
cation of strategic assets may enhance asset utilization (Markides
and Williamson, 1994; Rumelt, 1982). However, if firms diversify
non-strategic assets, coordination costs may increase and lead to a
reduction of benefits (Palich et al., 2000). While (Bowman, 1982)
argued that a poorly performing firm may undertake unrelated
product diversification due to growth prospects in other unrelated
product areas, Markowitz (1952) argued that solely implementing
product diversification strategies does not benefit a firm. This
notion has been supported by Sambharya (1995) who argued that a
firm may exploit the benefits of product diversification only when it
is combined with global diversification.
Firms engaging in global operations face a problem of econo-
mies of scale and governance costs on account of cross-border
processing of strategic assets. Furthermore, diversification leads
to these same problems (Tallman and Li, 1996). Considering that
similar problems are caused by two different strategies, if firms
adopt both strategies simultaneously (internationalization and
product diversification) there may be an interaction between the
two strategies. Scholars have argued that international diversifi-
cation and product diversification strategies cannot benefit a firm if
they are implemented individually. Instead, they must be enacted
80 N. Altaf, F.A. Shah / Pacific Science Review B: Humanities and Social Sciences 1 (2015) 76e84
simultaneously to exploit maximum benefits (Sambharya, 1995).
Thus, product diversity must moderate the relationship between
internationalization and performance. This phenomenon is sup-
ported by Zhao and Luo (2002) who argued that firms must
diversify product lines to meet foreign market demand. Further-
more, the founder of the portfolio diversification theory, Markowitz
(1952), argued that the combination of product and geographic
diversification strategies reduces volatility in firm profits.
However, there is dearth of empirical studies highlighting the
role played by product diversification in moderating the relation-
ship between internationalization and firm performance. Prior
studies have not reached any particular consensus. For instance,
Hsu (2006), Delios and Beamish (1999), and Hitt et al. (1997) re-
ported that significant product diversity played a positive role in
moderating the relationship between internationalization and
performance. Product diversity complements international diver-
sification because it adds variety to firm offerings, thus helping it
compete easily in the international marketplace. Contrary to this
opinion, Tallman and Li (1996) and Franko (1989) reported a sig-
nificant negative role of product diversity in moderating the rela-
tionship between internationalization and firm performance. It has
been argued that increasing diversification in firm offerings tends
to increase collocation costs that would reduce the performance of
a highly diversified firm. Furthermore, prior studies suggest that
highly product diversified firms tend to use resources recklessly
and this results in a decline in performance (Tallman and Li, 1996).
(See Table 1).
Because prior studies confirm the moderating role of product
diversification on the relationship between internationalization
and firm performance (positively or negatively), we present the
following hypothesis.
H2. The relationship between internationalization and firm per-
formance is moderated by product diversity.
3. Methodology
3.1. Sample, data and period of study
This objective of this study is to test the S-shape relationship
between internationalization and firm performance and to under-
stand the moderating role of product diversity on this relationship.
This study uses a sample of 180 Indian manufacturing sector firms
operating in the industries of pharmaceuticals, fast moving con-
sumer goods, personal care and automobiles. This study used
balanced panel data collected from secondary sources (consoli-
dated financial statements) provided by the CMIE Prowess data-
base. The data collected and used for this study included five years
of organizational information (2010/2011 to 2014/2015) and 900
observations were collected from 180 Companies.
3.2. Variables used in study
For the purpose of this study, the following variables have been
identified:
Dependent variable: Consistent with prior studies, return on
assets (ROA), measured as net profit divided by total assets, is used
to represent firm performance. This measure has been used by Wu
et al. (2016), Hajela and Akbar (2013), Contractor et al. (2007) and
other scholars.
3.2.1. Independent variables
3.2.1.1. Internationalization (INT). INT is measured as foreign sales
divided by total sales multiplied by 100. This measure is consistent
with Contractor et al. (2007), Hsu (2006) and other scholars.
3.2.1.2. Product diversity (PD). For this study the entropy measure
of diversification has been utilized. This measure was used by Hsu
(2006) for measuring the moderating effect of product diversity on
the relationship between internationalization and performance.
This entropy measure of diversification was developed by
Jacquemin and Berry (1979) and has been a highly accepted mea-
sure of product diversification in strategy studies. The entropy
measure of diversification is calculated as
X
E¼ Pi log Pi
i
where Pi represents the share of the firm accounted for by the ith
product. E can take values from 0 to log n, where n is the number of
product lines. When E equals to 0, concentration will be extreme
and when E equals to logn concentration is minimum and diversi-
fication is maximum.
3.2.1.3. Control variables. Apart from the independent variables,
other measures that affect the performance of the company have
been used as control variables. Thus, in order to separate interna-
tionalization from other variables that affect performance, the
following control variables have been used:
3.2.1.4. Advertisement intensity (ADV). ADV is measured as adver-
tisement expenses divided by total sales multiplied by 100 and is
used as a representative variable for firm-specific advantages that
explains firm performance. Because advertisements may leverage
the sales of the company in international markets, it is considered
as a predictor of performance of global companies. This measure
has been used as a control variable in a number of studies such as
Hsu (2006) and others.
3.2.1.5. Company size (Ln sales). Company size is measured as the
logarithmic function of a firm's total sales and is included as a
control variable because of the significant association between the
size of the company and its performance. This measure is consistent
with Wu et al. (2012), Hsu (2006), Li and Qian (2005) and the work
of other scholars.
3.2.1.6. Firm leverage (LEV). LEV is measured as total debt divided
by equity. The leverage ratio indicates the relative position of
lenders and investors in the firm. A high leverage ratio indicates
that more earnings are used to pay interest on debt, while a low
leverage ratio implies that a firm has more retained funds that can
be used for further expansion. A number of studies have controlled
the relationship between internationalization and performance
with firm leverage, for instance, Wu et al. (2012), Hsu (2006), Li and
Qian (2005) and other scholars.
Finally, dummy variables are introduced to take into account
industry specific factors that may affect firm performance. Consis-
tent with (Contractor et al., 2007), the number of dummy variables
introduced is one less than the number of sub-sectors being tested;
i.e., three dummy variables are introduced for four sub-sectors in
the Indian manufacturing industry.
3.3. Research models
This study utilizes a pooled cross-section/time-series regres-
sion, a cross-section heteroskedastic model, and a time-wise
autoregressive model. This model examines the variations among
cross-sectional units simultaneously with the variations within
individual units over time (Hsiao, 1995). This process is based on
the assumption that regression parameters indicate temporal sta-
bility (i.e., do not change over time) and cross-sectional stability
 N. Altaf, F.A. Shah / Pacific Science Review B: Humanities and Social Sciences 1 (2015) 76e84 81

(i.e., do not differ between various cross-sectional units). By pooling
time series data and cross-sectional data, reliability of the coeffi-
cient estimates is enhanced. However, certain problems may
emerge because of such pooling. Examples of problems includes
the non-constant error variance that arises between subject dif-
ferences in a cross-sectional analysis (Neter et al., 1990) and
problems of auto correlated errors due to the correlations among
variables over time in a time-series analysis (Nerlove, 1971). To
minimize these problems of cross-sectional heteroskedasticity and
time-series autocorrelation, this study uses the autoregressive-
heteroskedastic model developed by Kmenta (1986) and used by
Contractor et al. (2007), Hsu (2006) and Gomes and Ramaswamy
(1999) in their studies. EViews 8 (Enterprise Edition) has been
utilized to run the autoregressive-heteroskedastic models
mentioned below.
To test the S-shape relationship between internationalization
and firm performance, we first begin with the introduction of the
linear term for the internationalization variable in Model 1 and
then with the quadratic term in Model 2 followed by the cubic term
in Model 3. Furthermore, to test the effect of product diversity on
the relationship between internationalization and performance, we
used the interactive regression model. In addition, three dummy
variables (to capture the sub-sector effect) and control variables
were introduced in all regression models.
Model 1 (Linear model)
ROAit ¼ b0 þ b1 ðPDÞit þ b2 ðINTÞit þ b3 ðSIZEÞit þ b4 ðADVÞit
þ b5 ðLEVÞit þ DV1 þ DV2 þ DV3 þ εit
Model 2 (Quadratic Model)
ROAit ¼ b0 þ b1 ðPDÞit þ b2 ðINTÞit þ b3 ðINTÞ2it þ b4 ðSIZEÞit
þ b5 ðADVÞit þ b6 ðLEVÞit þ DV1 þ DV2 þ DV3 þ εit
Model 3 (Cubic Model)
ROAit ¼ b0 þ b1 ðPDÞit þ b2 ðINTÞit þ b3 ðINTÞ2it þ b4 ðINTÞ3it
þ b5 ðSIZEÞit þ b6 ðADVÞit þ b7 ðLEVÞit þ DV1 þ DV2
þ DV3 þ εit
2) The sign for the coefficient of INT is negative and significant and
the sign for the coefficient of INT2 is positive and significant for
Model 2.
3) The sign for the coefficient of INT is negative and significant, the
sign for the coefficient of INT2 is positive and significant for
Model 2 and the sign for the coefficient of INT3 is positive and
significant in Model 3.
Hypothesis 2 will be supported if the sign for the coefficient of
(PD)  (INT) is either negative or positive but is significant.
4. Results
Table 2 summarizes descriptive statistics and the correlation
among variables. Correlation analysis has been performed to verify
whether the variables present any problems of multicollinearity.
Inter-correlation coefficients of the full set of independent variables
are moderate, suggesting that there is no major problem of multi-
collinearity. No multicollinearity averts the formation of unstable
beta coefficients in regression analysis. Table 2 reports a positive
correlation among INT, ADV and SIZE with ROA. Moreover, a
negative correlation is indicated between PD and LEV with ROA.
Table 3 displays the results of the pooled cross-section/time-
series regression analysis for Model 1, 2 and 3. Model 1 tests the
linear relationship of the degree of internationalization (INT) and
product diversity along with other control variables on return on
assets (ROA). Results of model 1 indicate that both INT and PD have
a significant negative relationship with ROA. The negative sign of
the INT construct implies that the relationship begins as a regular
U-Curve. Another explanation for the negative sign of INT is that
during the initial stages of internationalization, a company's costs
outweigh the benefits, often referred to as “liability of foreignness
and newness” (Zaheer, 1995). Furthermore, during the initial stages
of internationalization, firms suffer initial learning costs and
insufficient economies of scale. In addition, the negative relation-
ship between PD and ROA implies that international diversification
and product diversification strategies cannot benefit a firm if they

Model 4 (Interactive Model) Table 1

Summary of empirical studies regarding the relationship between internationali-
ROAit ¼ b0 þ b1 ðPDÞit þ b2 ðINTÞit þ b3 ðPDÞit  ðINTÞit zation and firm performance.

þ b4 ðSIZEÞit þ b5 ðADVÞit þ b6 ðLEVÞit þ DV1 þ DV2 Author Year Direction of relationship

þ DV3 þ εit Qian 1998 Positive Linear

Gomes and Ramaswamy 1999 Positive Linear
Nachum 2004 Positive Linear
where, Contractor et al. 2007 Positive Linear for Indian
Service Industries
i ¼ cross-sectional component, Hajela and Akbar 2013 Positive Linear
Siddharthan and Lall 1982 Negative Linear
t ¼ time-series component (2010/2011 through 2014/2015),
Kumar 1984 Negative Linear
ROA ¼ firm performance measure, Collins 1990 Negative Linear
INT ¼ internationalization, Singla and George 2013 Negative Linear
PD ¼ product diversity, Capar and Kotabe 2003 U-Shaped
SIZE ¼ firm size, Ruigrok and Wagner 2003 U-Shaped
Contractor et al. 2007 U-Shaped for Indian
ADV ¼ advertising intensity, Manufacturing Sector
LEV ¼ leverage, Sullivan 1994 Inverted U-Shaped
DV 1, 2, and 3 are dummies to control for subsector effects and Hitt et al. 1997 Inverted U-Shaped
3it ¼ error item. Gomes and Ramaswamy 1999 Inverted U-Shaped
Chao and Kumar 2010 Inverted U-Shaped
Riahi-Belkaoui 1998 S-Shaped relationship
Hypothesis 1 will be supported if the following conditions are Contractor et al. 2003 S-Shaped relationship
met: Lu and Beamish 2004 S-Shaped relationship
Chin-Chun Hsu 2006 S-Shaped relationship
1) The sign for the coefficient of INT in model 1 is negative and Ruigrok et al. 2007 S-Shaped relationship
Heyder et al. 2011 S-Shaped relationship
significant.
82 N. Altaf, F.A. Shah / Pacific Science Review B: Humanities and Social Sciences 1 (2015) 76e84

Table 2 indicate a significant positive relationship between INT2 and ROA.

Descriptive statistics and correlations of variables. These results are consistent with the existence of a curvilinear
Mean S.D ROA PD INT SIZE ADV LEV relationship between INT and firm performance. The negative sign
ROA 26.83 10.45 1.00
of INT in the linear model and the positive sign in the quadratic
PD 4.80 2.24 0.28 1.00 model imply that during the initial stages of internationalization,
INT 76.79 28.66 0.08 0.06 1.00 costs outweigh benefits. However, as a firm becomes acquainted
SIZE 3.67 0.79 0.47 0.27 0.67 1.00 with the international environment, profits increase during the
ADV 3.29 6.57 0.05 0.12 0.02 0.30 1.00
middle stage because experiential learning reduces the cost of
LEV 0.03 0.078 0.07 0.09 0.18 0.40 0.08 1.00
foreignness. Furthermore, geographically diversifying reduces
overall risks of political instability, technological risk, fluctuations
in exchange rates and risks posed by economic policy changes.
Table 3
Pooled cross-section/time-series regression results of Model 1e3. Model 3 tests the sigmoid or S-curve relationship between INT
and firm performance. The non-significant negative coefficient of
Model 1 Model 2 Model 3
INT3 implies that an S-curve relationship does not exist. The non-
C 1.346* 1.743* 1.788* existence of the S-curve relationship is also supported by the
(6.17) (7.22) (5.28) decreasing Adjusted R2 and F-values for Model 3. The adjusted R2
SIZE 0.621*** 0.801*** 0.808***
(10.01) (11.92) (8.77)
falls from 37.36% to 35.83% and is coupled with a fall in F-values
LEV 0.506* 0.536* 0.749** from 35.88 to 30.21.
(3.95) (4.06) (2.34) According to the results from Models 1e3, there is no evidence
ADV 0.007 0.088 0.095 of a sigmoid relationship between internationalization and per-
(0.77) (0.62) (0.60)
formance for Indian manufacturing firms. On the basis of these
PD 0.127* 0.290** 0.286*
(3.37) (7.54) (4.58) results, H1 is rejected. Implicitly, it may be safely concluded that a
INT 0.081*** 0.092** 0.079 U-shaped relationship exists between internationalization and firm
(10.94) (11.92) (3.86) performance. These results are in alignment with the results of
INT2 0.095*** 0.001 Ruigrok and Wagner (2003), Contractor et al. (2007) and other
(12.89) (2.99)
INT3 0.020
scholars.
(4.34) Model 4 tests the interaction effects of INT and PD on firm
DV1 0.13* 0.32* 0.17 performance. The significant positive coefficient of IND  PD in-
(1.72) (1.93) (1.10) dicates that the relationship between internationalization and firm
DV2 0.23** 1.78*** 0.99**
performance is moderated by product diversity. These results
(2.74) (11.94) (9.78)
DV3 1.86** 2.88*** 1.93* presented in Table 4, suggest that internationalization and product
(10.63) (12.74) (5.68) diversification strategies should be adopted simultaneously in or-
R2 37.35% 38.22% 36.98% der to reap benefits. These results are supported by the increase in
Adjusted R2 36.76% 37.36% 35.83% the adjusted R2 and F-value for Model 4. The adjusted R2 rises from
Durbine 1.96 2.03 1.95
Watson stat
37.36% (for Model 2) to 38.85% (for Model 4) coupled with the rise
F-Value 34.76** 35.88** 30.21** in F-values from 35.88 (for Model 2) to 37.99 (for Model 4). These
N 900 900 900 results confirm H2; i.e., product diversity has a positive moderating
Notes: Figures are regression coefficient estimates, and t values are shown role on the relationship between internationalization and perfor-
in parentheses below coefficient estimates. ***, **, and *, respectively, mance. These results are in accordance with the results of Hsu
indicate significance levels at 0.1%, 1%, and 5%. (2006) and other scholars.
Furthermore, in all regression models (1e4) SIZE indicated a
significant positive relationship with ROA, implying that the larger
are implemented individually. Instead, they must be enacted the size of the company, the better the chances of the firm to do
simultaneously to exploit their benefits. well in international markets. In addition, a larger size offers
Model 2 tests the quadratic relationship of INT and PD along companies economies of scale; thus, larger firms benefit from su-
with other control variables on ROA. Results of the quadratic model perior performance that is ultimately reflected in corporate per-
formance. Furthermore, firm leverage (LEV) is negatively related to
performance and indicates that as firm debt increases, its perfor-
Table 4
Pooled cross-section/time-series regression results of Model 4. mance decreases. The coefficient of advertisement intensity is
negative, but non-significant; the non-significant coefficient of ADV
C 1.198** (13.07)
may have resulted because advertisement expenses are fruitful for
SIZE 0.826*** (11.91)
LEV 0.698* (6.82) a company in the long run and this study utilized data covering only
ADV 0.002 (3.34) five financial years. Thus, the benefits of advertisement cannot be
PD 0.352** (6.44) verified for a short period of time.
INT 0.076** (8.60)
INT  PD 0.054*** (11.64)
DV1 1.98** (9.72)
5. Concluding observations
DV2 2.74** (17.28)
DV3 1.76** (9.86) This study examined the relationship between internationali-
R2 40.02% zation and firm performance and the moderating role of product
Adjusted R2 38.85%
diversity on this relationship. The results do not support the exis-
DurbineWatson stat 2.08
F-Value 37.99** tence of an S-curve relationship between internationalization and
N 900 firm performance. However, a U-shaped relationship received
Notes: Figures are regression coefficient estimates, and t values are shown in pa-
support from the existing data set. Thus, internationalization of
rentheses. ***, **, and *, respectively, indicate significance levels at 0.1%, 1%, and 5% Indian manufacturing companies is represented by a U-shape as a
levels. statistical “fit.” Furthermore, results indicate a strong moderating
 N. Altaf, F.A. Shah / Pacific Science Review B: Humanities and Social Sciences 1 (2015) 76e84
role of product diversity on the relationship between internation-
alization and performance. Numerous underlying reasons for the
U-shaped relationship exist. For instance, the firms analysed in this
study belong to an emerging market and Indian firms tend to be
smaller and resource-deficient when compared to firms operating
in developed countries. The firms analysed in this study have been
able to deploy approximately only 20 percent of human resources
and 30 percent of their assets across international borders. With
such a small resource base, it becomes difficult for Indian com-
panies to achieve a large degree of internationalization. The LPG
measures were adopted by India in the late 1990s, and thus, borders
for trade and commerce were opened very late when compared to
developed countries. Because of late privatization and globaliza-
tion, Indian firms have not yet developed their decision-making
capabilities to compete in foreign markets, and as a result, they
have not experienced all three stages of internationalization.
Furthermore, stricter regulation in emerging markets constrains
firms and makes it difficult to internationalize operations. The re-
sults of this study are consistent with those of Contractor et al.
(2007), Capar and Kotabe (2003), and Ruigrok and Wagner (2003)
who all reported a U-shaped relationship between internationali-
zation and firm performance.
With regard to the moderating effect of product diversity on
internationalization and firm performance, this study determined
that when product diversity is coupled with internationalization,
firms experience increased performance; or to clarify, product di-
versity positively moderates the relationship between interna-
tionalization and performance. Our results are consistent with prior
studies regarding international management that demonstrate in-
ternational diversification and product diversification strategies
cannot benefit a firm if they are implemented individually, rather
they must be implemented simultaneously to exploit their benefits
(Sambharya, 1995). These results are consistent with the portfolio
diversification theory (Markowitz, 1952) that implies a combina-
tion of product and geographic diversification strategies reduces
volatility in firm profits. These results are consistent with the
empirical results of Hsu (2006), Delios and Beamish (1999), and
Sambharya (1995).
Moreover, it must be noted that these results do not necessarily
imply that Indian companies can increase their performance by
continuing to diversify product lines and enter foreign markets.
Rather, an optimal level of product diversification and internation-
alization, as well as an optimal combination of both strategies is
needed. This dynamic relationship is important to grasp because
managers have the ability to close operations in a given geographical
area and operate in other areas that result in better payoffs; this
enhances performance and reduces costs. The optimal combination
of product diversification and internationalization is important
because if firms continue to expand international operations, they
would eventually reach an unrealistic point where all domestic op-
erations would cease. Thus, balance is needed between domestic
operations and international operations. Furthermore, to exploit
synergies, it is important to deploy an international strategy that is in
alignment with the firm's finite resources and the managers' abilities.
It must be acknowledged that pooling data for product diversity
is purely subjective and may result in methodological weaknesses.
Furthermore, as mentioned in prior studies, the two distinguishing
strategic innovations that have resulted in rapid internationalization
in emerging market firms are product diversification (Yeung, 1999)
and business group affiliation (Khanna and Rivkin, 2001). Future
research can be conducted by using business group affiliations as a
moderating variable for the relationship between internationaliza-
tion and performance. Future research can also analyse the rela-
tionship between internationalization and performance in different
industries or similar industries in different emerging markets.
83
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