The internationalization process of firms: From exports to FDI?

We describe a simple model in which domestic firms decide whether to serve a foreign market through exports or horizontal foreign direct investment (FDI). This choice involves a trade-off between the higher variable trade costs associated with exports and the higher fixed set-up costs associated with establishing foreign subsidiaries. Crucially, firms are uncertain about their profitability in foreign markets and can only learn it by operating there. To obtain market-specific knowledge, firms may follow an “internationalization process”, serving the foreign market via exports first and eventually, in some cases, switching to local subsidiary sales. To assess the validity of the predictions of our model, we use firm-level data on export and FDI decisions in individual destination markets for all companies registered in Belgium over the period 1997-2008. We show that firms’ strategies to serve foreign markets depend not only on the variable and fixed costs associated with exports and FDI, but also on the export experience they have acquired in that market.