Country location choices of service multinationals:: An empirical study of the international hotel sector

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Country location choices of service multinationals:: An empirical study of the international hotel sector
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   Journal of International Management5 (1999) 299–317 1075-4253/99 $ – see front matter © 1999 Elsevier Science Inc. All rights reserved.PII: S1075-4253(99)00017-4  Country location choices of service multinationalsAn empirical study of the international hotel sector  Sumit K. Kundu   a,  *, Farok J. Contractor   b   a  School of Business and Administration, Saint Louis University, 3674 Lindell Boulevard, St. Louis, MO 63108, USA   b   Department of International Business, Rutgers University, 180 University Avenue, Newark, NJ 07102, USA  Abstract  This article examines international country location choices for equity investment undertaken byglobal hotel chains. Why do certain host countries attract more hotel investment than others? A secondunderlying issue that we tackle in this article is whether the traditional foreign direct investment deter-minants used in past studies on manufacturing also apply to services—or whether service sector-spe-cific determinants are better explanatory variables for understanding the distribution of service foreigndirect investment across countries.© 1999 Elsevier Science Inc. All rights reserved.  Keywords: Service foreign direct investment; Location; International hotels  1. Introduction  The service sector has grown rapidly in importance in both developed and developingcountries in the past 25 years. Yet our understanding of the factors that impel or retard for-eign direct investment (FDI) is still drawn largely from manufacturing. The bulk of literatureon FDI determinants concerns manufacturing, and not services. The share of services in thegross domestic product (GDP) of 55 out of 78 countries has increased in the last three de-cades (World Bank, 1992). In 1990, it averaged 45 percent and 61 percent for developing anddeveloped countries, respectively (World Bank, 1992). Table 1 gives indicators for selecteddeveloped nations.The situation in developing nations varies substantially by country. For example, in Thai-land by 1990, the share of services was approximately 25.0 percent, in Pakistan 40.1 percent,for Chile 62.2 percent, for Venezuela 70.6 percent, and for Turkey 35.6 percent. Because ser-vice multinationals have emerged as a dominant economic force in several countries, several  *Corresponding author: Tel.:   1-314-977-3601; fax:   1-314-977-7188.   E-mail addresses  : kundusk@slu.edu (S.K. Kundu), farok@andromeda.rutgers.edu (F.J. Contractor)   300  S.K. Kundu, F.J. Contractor / Journal of International Management 5 (1999) 299–317   host governments induce inward investment through various economic and noneconomicmeasures.One objective of this article is to see if location determinants of inward service foreign di-rect investment can be supported by traditional explanations from manufacturing, or whetherhotel sector-specific explanations are needed. Most scholars have studied why firms in themanufacturing sector prefer to locate in some countries and not in others (Hirsch, 1967;Schollhammer, 1974; Agarwal, 1980; Davidson, 1980; Dunning, 1981; Dunning and Nor-man, 1983, 1987; Grubaugh, 1987; Culem, 1988; Pearce, 1991; UNCTC, 1991). The generalconsensus for manufacturing is that market size and growth, operationalized by indicatorssuch as GDP, population, and GDP growth, have been powerful explanations of inward FDI.Some studies also have found political risk, exchange rate changes, and the exports/GDP ra-tio to be lesser but significant explanatory variables.Studies on the determinants of international investment in services are far fewer, with across-sectional (cross-country) locational determinants approach even less common. One of the earliest, on overseas expansion and problems encountered by U.S. multinational servicefirms in advertising, consulting, and legal practice, was done by Gaedeke (1973). The authoridentified the importance of overseas profit opportunities, following U.S. clients abroad, andseeking new markets abroad as the critical factors influencing the overseas expansion. Com-mon initial problems encountered in the overseas ventures were staffing problems and cul-tural adjustment difficulties. Seymour (1987) using Dunning’s (Dunning, 1988) eclectic par-adigm identified ownership, location, and internalization advantages for internationalconstruction firms. Key factors were the size of firm, size of the domestic market, nationalityof consultant, quality of human capital, quality control, operational integration of productionand marketing, and repatriation of profits by transfer pricing as the significant factors ex-plaining the internationalization of firms in the construction industry. In their study of the in-ternationalization of professional services Daniels et al. (1989) identify the causes and spatiallocational outcomes of the recent emergence of multinational accountancy conglomerates.They demonstrated that organizational arrangements together with the effects of competi-tion, and active attempts to create new markets by colonizing locations not previouslyserved, had been significant for the overseas expansion. The behavioral aspects of the over-seas investment decisions of U.S. multinational advertising agencies was tackled by Wein-  Table 1Share of services in GDP and Employment in Selected Developed CountriesGDP (%)Employment (%)Country196019701980199019801990Canada52.858.558.257.462.579.2W. Germany38.744.152.559.053.064.0Japan—48.455.356.056.068.4U.K.47.753.656.562.063.075.5U.S.A.58.363.264.669.072.078.9Source: World Bank, 1984, 1990, 1991, 1992.   S.K. Kundu, F.J. Contractor / Journal of International Management 5 (1999) 299–317   301  stein (1974, 1977). Both external (stage of economic development of the country and theyear of the initial investment) and internal (size of the agency and amount of overseas expe-rience) parameters are important variables influencing the internaional investment decisionsof U.S. advertising firms. Terpstra and Yu (1988) examined firm-specific ownership, and lo-cation-specific factors for U.S. advertising agencies. Their findings reveal the statistical sig-nificance of geographic proximity, firm size, international experience, oligopolistic reaction,and presence of home country customers abroad.A number of studies in the service sector focus on banking. The determinants of U.S.banking activity abroad were examined by Goldberg and Johnson (1990). Explanatory vari-ables found to be significant were foreign direct investment, exports to GNP, population, lo-cal deposits, and relative exchange rates. The role of location-related factors in U.S. bankinginvolvement abroad also was analyzed by Nigh et al. (1986). Using pooled time-series(1976–1982), cross-sectional (30 countries) regression analysis, they observed that U.S.business presence in a foreign country had a strong positive effect on U.S. branch bankingactivity in the host country, but local market opportunities appeared to have no significant ef-fect. Cho (1983) used the eclectic paradigm to explain the growth of multinational banks.The author conducted a cross-section multiple regression analysis on U.S. multinationalbanks with branches in Singapore and Korea for 1975, 1978, and 1980. Empirical testsshowed that size of the bank, host country regulation, and availability and ease of transactionwere important determinants of growth for the U.S. banks abroad. Goldberg and Saunders(1981) investigated the determinants of foreign banking activity in the United States. Theirfindings reveal that size of interest rate differentials between U.S. and foreign deposit andloans, net foreign direct investment in the United States, the persistent depreciation of dollar,and the restrictive nature of international banking act were statistically significant. (Othersimilar studies include Khoury, 1979; Goldberg and Saunders, 1980; Ball and Tschoegl,1982; Goldberg and Johnson, 1990; Li and Guisinger, 1992).  2. Is there a theory of FDI locational determinants?  A number of factors influence international expansion and location choices. By their verynature, these factors are multifaceted and to the extent that they can be grouped into catego-ries can be called an eclectic theory as in Dunning (1981, 1988). But Dunning’s “ownership”or firm-specific factors cannot be used in cross-sectional (across countries) studies from amacro perspective, when a country is the unit of analysis as in this article. For country-basedstudies, the FDI determinants literature identifies three groups of country-specific explana-tory variables:1.The size of the host nation’s market, as measured by a variety of macroeconomic. Thisis seen to be important for both manufacturing and services, as a dominant explanatoryfactor.2.Indices of the host nation environment, such as political and economic risk, culturaland social factors, and the host government’s policies towards foreign direct invest-ment (Horst, 1972; Hollander, 1984; UNCTC, 1991).3.The degree of internationalization of the host economy. In addition, we can reasonablyhypothesize that in addition to the above general criteria,   302  S.K. Kundu, F.J. Contractor / Journal of International Management 5 (1999) 299–317   4.Factors peculiar to a sector may be equally important in explaining spatial distributionacross nations for that particular sector. This is, in fact, one of this article’s objectives—tofind what is important for international hotel operations. This approach is relatively rarein the literature, which for the most part has mainly used general country variables.A secondary objective of this article is to see if proxies for general macroeconomic andpolitical conditions in the host nation coming from the literature, or hotel sector-specificvariables, more powerfully explain the distribution of hotel FDI across nations. In particular,over the years the importance of tourism has increased in both the developed and developingcountries. It is one of the world’s largest sectors in terms of revenue generation and employ-ment and has both direct and indirect impact over other industries, such as transportation,construction, telecommunications, and finance/banking. By the same token, at least one priorstudy (Dunning and McQueen, 1981) put forward the hypothesis that inward hotel invest-ment is influenced by the rate of inward FDI coming into a nation. Both of these are hypoth-eses that FDI in hotels is determined by two customer types, namely tourists and foreignbusiness persons, respectively.Because services, for the most part, have to be delivered on site, service FDI is more pronethan manufacturing to the “follow-the-client abroad” imperative. This follow-the-customerlogic has seldom been tested, except in very few studies such as Gaedeke (1973), Nigh et al.(1986), and Terpstra and Yu (1988). It has not been done for hotels.The following is a list of hypotheses for FDI determinants in the international hotels sector(for a country as the unit of analysis):1.Market sizeGDPPopulation2.Internationalization of host economy   1  Exports/GDP ratio3.Index of host country business environmentCountry political/economic/financial risk indicators4.Sector-specific determinantsTourism receiptsInward FDI   1  3. Market size determinants  3.1. EV1  Market size in the FDI receiving nation is the single most common explanatory variableused in studies of FDI determinants. With appropriate caveats, GDP frequently has been usedas a proxy for market size in manufacturing FDI literature (Agarwal, 1980; Davidson, 1980;Hollander, 1984; Grubaugh, 1987; Culem, 1988). UNCTC’s (UNCTC, 1991) study of 47 na-   1  In one sense, this amounts to testing whether, across nations, hotel FDI is correlated with total FDI for all  sec-tors (manufacturing and all services). Were we to know this already, the exercise would be a tautology.   S.K. Kundu, F.J. Contractor / Journal of International Management 5 (1999) 299–317   303  tions concluded that despite the growth of export-oriented investment motivations, the mar-ket-seeking type of investment still predominated. It is still true overall that host market-seeking motivations considerably predominate over efficiency-seeking or cost-reducing FDI,as a generalization. And for hotel services that have to be provided on site, the market-seek-ing motivation is the only one involved. Some of the studies on service FDI arrive at a simi-lar conclusion, namely the importance of the local GDP of the nation as a proxy for marketsize (Terpstra and Yu, 1988; Goldberg and Johnson, 1990; Li and Guisinger, 1992). We hy-pothesize therefore that:Countries with a large GDP would attract more hotel investment in a cross-sectionalcomparison.  3.2. EV2  Population size should signify large internal markets, but of course, this is true only forbasic services and commodities. The limitation of using population size as an FDI indicatorhas been amply documented and does not bear much repetition here. Suffice to say that onlya few manufacturing studies have found population to be a significant indicator of FDI flows.Services may possibly provide a better correlation. In part, the problem in using populationas a proxy for market size stems from internal income maldistribution, and because popula-tion does not always correlate with purchasing power. Especially in poorer nations, despite alarge population, only a small upper-income segment of the populace may be able to affordthe product or service in question. This is less  of a bias as we look at richer nations (where,for example, a majority of the population may use hotels at various times). Hence the extentof overall bias, for the world as a whole, depends on the relative shares of poor and rich na-tions in the sample or data. Secondary data in the hotel industry reveal that 65 percent of theinternational investment in the hotel industry has taken place in developed countries. In thesample used in this study (see Table 2) from two-thirds to three-quarters of the data may bedescribed as falling into the developed nation category. Even in the developing country cate-gory, studies by Warren and Ostergren (1990) and Bull and Church (1996) indicate the sig-nificant impact of population growth in the middle income group on the level of recent inter-national hotel investment. Thus despite caveats about the use of population size as anexplanatory variable, We will test the hypothesis that:Population size will have a positive impact on the level of hotel investment.  4. Internationalization of host economy  4.1. EV3  The degree of internationalization of the host nation economy should correlate with thelevel of investment by international hotel chains. Several studies in the past have linked theimpact of the exports to GDP ratio on the international competitiveness and internationaleconomic performance of countries. These include Fagerberg (1988), Esfahani (1991), andBraga et al. (1994). The extent of internationalization of a nation’s economy as measured bythe exports to GDP ratio reflects the extent to which the country is economically interdepen-
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