Portfolio configuration and foreign entry decisions: A juxtaposition of real options and risk diversification theories

• Author: René Belderbos,Shubin Wu,Tony W. Tong
• Published date: 01 July 2020
• Date: 01 July 2020
• DOI: http://doi.org/10.1002/smj.3151

RESEARCH ARTICLE

Portfolio configuration and foreign entry

decisions: A juxtaposition of real options and

risk diversification theories

René Belderbos

1,2

| Tony W. Tong

3

| Shubin Wu

4

1

Department of Management, Strategy and Innovation, Faculty of Economics and Business, KU Leuven, Leuven,

Belgium

2

UNU-MERIT and School of Business and Economics, Maastricht University, Maastricht, The Netherlands

3

Leeds School of Business, University of Colorado, Boulder, Colorado

4

University of Liverpool Management School, University of Liverpool, Liverpool, UK

Correspondence

Shubin Wu, University of Liverpool

Management School, University of

Liverpool, Chatham Street, Liverpool L69

7ZH, UK.

Email: wushubin@liverpool.ac.uk

Funding information

Research Foundation - Flanders, Grant/

Award Number: G.0.497.11.N.10;

National Natural Science Foundation of

China, Grant/Award Numbers: NSFC-

71672105, NSFC-71972121; Program for

Innovative Research Teams of the

Shanghai University of Finance and

Economics (IRTSHUFE)

Abstract

Research Summary: Research on foreign market

entry has rarely considered that multinational firms'

new entries may be affected by the configuration of

their existing affiliates. We argue that in making entry

decisions, firms take into account how an entry into a

new location helps increase the operational flexibility

of their affiliate portfolios due to options to switch oper-

ations across affiliates in case of diverging labor cost

developments across host countries. We juxtapose this

real options-based explanation with a risk diversifica-

tion explanation. Analysis of Japanese multinational

firms' foreign entry decisions suggests that the two

explanations are complementary. We also establish

portfolio-level boundary conditions to the influence of

operational flexibility considerations on entry, in the

form of product diversification and the nature of disper-

sion of labor cost levels.

Managerial Summary: When deciding on whether to

enter a foreign market, managers of a multinational

Received: 11 June 2014 Revised: 2 October 2019 Accepted: 27 December 2019 Published on: 12 April 2020

DOI: 10.1002/smj.3151

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and

reproduction in any medium, provided the original work is properly cited.

© 2020 The Authors. Strategic Management Journal published by John Wiley & Sons, Ltd. on behalf of Strategic Management Society.

Strat Mgmt J. 2020;41:1191–1209. wileyonlinelibrary.com/journal/smj 1191

firm are intuitively aware that they need to consider

how the economic environment of the target host coun-

try is related to the environments of the existing coun-

tries in which the firm operates. The less the

environments are correlated with each other, whether

in terms of input cost or market demand conditions,

the greater the chance that the firm may capture cost

savings and reduce sales volatility globally. These bene-

fits arise from a switching option to shift operations

flexibly across countries and from an ability to reduce

risk by holding a portfolio of diversified global invest-

ments. Our findings support both sets of considerations,

suggesting that companies do give due attention to cor-

relations in labor cost and market demand between the

target host country to enter and the existing host

countries.

KEYWORDS

flexibility, market entry, multinational firm, portfolio, real options,

risk diversification

1|INTRODUCTION

Multinational firms' foreign entry decisions have long occupied an important place in strategic

management research. To date, scholars have applied a variety of theoretical perspectives to

examine antecedents of foreign entry, including agglomeration effects and organizational

agglomeration (Belderbos, Olffen, & Zou, 2011), competitive interactions between firms

(Belderbos & Sleuwaegen, 2005; Gimeno, Hoskisson, Beal, & Wan, 2005), firm-specific charac-

teristics such as experience and intangible assets (Shaver, Mitchell, & Yeung, 1997), as well as

various environmental attributes such as industry growth (Kogut & Chang, 1996), market

uncertainty (Chi & Seth, 2009), host country political risk (Henisz, 2002), and home and host

country institutions more generally (Meyer, Estrin, Bhaumik, & Peng, 2009).

While prior research has significantly increased our understanding of the determinants of

firms' foreign entry decisions, it has primarily treated each entry as an independent event and

has rarely considered that entry decisions may be affected by how firms' existing portfolio of

overseas affiliates is configured. In this paper, we draw on real options theory of multinational

investment and argue that firms' new entries depend on characteristics of the configuration of

their existing affiliate portfolios. Multinational firms take into account the contribution that an

entry into a new location makes toward increasing the operational flexibility of their

manufacturing affiliate portfolios, which represents a unique advantage of multinationality

compared to purely domestic operations (Chi, Li, Trigeorgis, & Tsekrekos, 2019; de Meza & van

der Ploeg, 1987; Kogut, 1985, 1989). In the parlance of real options, such increase in operational

flexibility derives from the enhanced options to switch value-added activities across

1192 BELDERBOS ET AL.