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Under what conditions can exports exert a positive influence on profitability?


* Should companies increase their exports so as to increase their profitability? The research into this question has given contradictory results. This article tries to further the debate by investigating the contingency factors likely to affect the apparent relationship between the export rate and the profitability rate.

* The three contingency factors taken into account are: the size of the companies, the rate of growth of the domestic market and the structure of the business portfolio.

* The tests carried out on a sample of German engineering firms enable the observation that, under certain conditions, a positive link appears between the export rate and the profitability. This then loads to now questions being raised.

Key Words

* The influence of the Export Rate on Profitability is related to contingency factors. However those factors vary according to economic circumstances.


Jacques Liouville, Senior Lecturer, University of Nancy 11 (Technological Institute), Member of the Research Centers ERESTRATE (Nancy II) and CESAG (University R. Schuman, Strasbourg), France.

Manuscript received January 1991, revised November 1991.


According to the classical strategic discourse, exports benefit business at several levels, particularly by increasing their profitability[2]. In turn, this profitability enhances competitiveness[3] and it should therefore be in the interest of every business to strive for the three main benefits that exports bring, i.e.:

- the lengthening of a product's life cycle[4];

- an increase in the volume of sales, hence lower costs through economies of scale and experience effect[5];

- an improvement of business know-how[6], which means that customers are better satisfied and that profit margins can be increased without ruining competitiveness[7].

Nevertheless, empirical tests have not always verified that exports increase profits[8]. Consequently, in an environment tending to convince more and more businesses to turn to exports, it becomes necessary to lay out which are the most favorable circumstances for a businesses to choose, i.e. national or international ...

In order to contribute to the debate, this article proposes to analyse the results and conclusions of a test concerning a sample of 137 German businesses dealing in mechanical engineering. The necessity to test the three following hypotheses is all the more relevant as there does not seem to be any correlation between the export ratio and the profit ratio in this sample.

Three Working Hypotheses

Hypothesis 1: The size of business

A number of studies conclude that a positive correlation exists between the size of a business and its profit-making export capacities[9]. The reasons for this hypothesis vary: among others, the in-depth knowledge of the markets and the capacity to manage the risks inherent to exporting (i.e. change fluctuation) may be proportional to the size of the business[10]. Moreover, it is a well-known fact that domination of competition abroad implies tying up more capital than is the case on domestic market, investing more in R&D and in marketing[11]. It thus becomes evident that the means necessary to achieve these investments cannot be independant from the size of a business[12].

Consequently, the first hypothesis to test is the existence of a positive association between the size of the business involved, their export ratio and their profitability. This in turn implies that such a positive relation is expected between these 3 variables.

Hypothesis 2: The growth of the domestic market

In 1986, the CESAG published the results of a study which showed that the secondary sectors of the German mechanical engineering industry standing above average as far as their export ratio is concerned, are usually facing a declining domestic market. This tends to prove that exports are profitable when they compensate for a declining domestic market. In these circumstances exports boost sales and can add to the "volume" of the profits. On the other hand, should exports not compensate for a deficient domestic market, this "volume" effect will disappear. In this specific case, businesses have the choice between expanding either on the home market or abroad.

Consequently, the second hypothesis to test is the existence of a positive link between the export ratio and profitability, confining this study solely to businesses working in a declining home market.

Hypothesis 3: Global diversification

The decision of a company to go into exports can be interpreted as a will to diversify geographically the outlets of a product. However, a company can also choose to diversify its type of product or activity, thereby going into "business portfolio" diversification.

Consequently, companies that operate both a geographical as well as a business portfolio diversification face complex management problems. This very complexity leads to the idea that for any business, global diversification is a difficult way of increasing profit. Two types of diversification are nonetheless conceivable: diversification in related activities and in unrelated ones. According to R. Rumelt (1974) related diversification generates synergy effects which are positively reflected by the profits. Unrelated diversification, on the other hand, does not provoke such beneficial effects; this is the reason why its influence on profits seems negative.

We are therefore left with the third hypothesis to test (according to the research of R. Buhner 1987): geographical diversification should be beneficial to specialized business or to those also diversifying in related activities. In this case, geographical diversification allows companies to benefit from economies of scale and of the experience curve through a greater use of production capacities. These companies should therefore show greater profitability than those who are specialized or diversified in related activities but centered on the domestic market, or than those who diversify in unrelated activities. The businesses who show very little profitability should therefore be those characterized by the most widespread global diversification, i.e. important foreign orientation and diversification in unrelated activities.

Sample Presentation

Study period and size of the companies involved

The data were collected over the years 1970, 1974, 1978, 1980 and 1982. There were two reasons for this choice. Firstly, spreading the data over a relatively long period allows for stability of relations during that same period. Secondly, this punctual approach can prove sufficient to show up changes, especially as during the years covered by the study, the management techniques of the German companies specializing in mechanical engineering have been profoundly modified[13]

As shown by the following, the sample concerns only middle-sized and big companies.
Chart 1. Breakdown of the Work force and Turnover in the Sample
 Salaried work force Turnover in millions D.marks
 1970 1982 1970 1982
Smallest unit 181 169 8 16
First quartile 885 750 48 96
Median 2,457 2,186 132 288
Third quartile 6,006 5,507 467 1,180
Biggest unit 95,810 85,904 5,192 15,575
Source: CESAG.

Analysis of the export rate of the sample companies

Interest for exports varies a lot among the companies selected. The following charts shows in fact that there is a difference of over 80 points between the least export-oriented company and the most export-oriented one. Nonetheless, it is also evident that exports are becoming more attractive, as the export rate increases by over 10 points during the test period. It is also interesting to underline that the sample companies have an export rate lower than the national average of the German mechanical industry: 41% in 1970 and 63% in 1982 for the whole industry against 36% and 48% respectively among the sample companies.

This discrepancy is due to the fact that smaller companies are much less represented in the sample group, when in fact over 90% of the companies in the German mechanical industry employ less than 200 workers. Due to a very high degree of specialization, they take a large world market share. Consequently, from a statistical point of view, these smaller businesses pull the average export rate of the German mechanical industry upwards.
Chart 2. Evolution of the Export Ratio in the Sample
 1970 1982
Minimum 4% 10%
First quartile 22% 36%
Median 33% 47%
Third quartile 46% 60%
Maximum 90% 92%
Source: CESAG.

Measuring the diversification of the sample companies

The proposed sampling method is derived from Rumelt's in order to appreciate the degree of diversification within the companies' activities. Six categories have been selected from a total of 33 sectors concerning the mechanical industry[14].

- Specialized businesses: at least 90% of their turnover comes from one sector of the industry. The specialization ratio reaches 90% because tertiary activities (maintenance, etc....) represent an average of 10% of the turnover in the sample companies.

- Diversified businesses with related activities: their main activity covers less than 70% of the turnover. On the other hand, at least 70% of their production uses the same manufacturing and/or marketing mode, or are aimed at the same clientele.

- Diversified businesses with unrelated activities: their specialization ratio, together with the relation between their activities, is under 70%.

- Businesses with a dominant activity and related secondary activities: their specialization ratio oscillates between 70% and 90% and the secondary activities are essentially linked to the main activity.

- Businesses with a dominant activity and unrelated secondary activities: their special ratio oscillates between 70% and 90% and their secondary activities are mainly disconnected from the main one.

- Vertically integrated business: the integrated activities must reach at least 70% of the turnover, the integration ratio taking into account firstly the percentage of the turnover realized by raw materials, secondly the intermediate products and thirdly the finished products issued from the same manufacturing-process. In this study, businesses considered as integrated are also characterized by an added-value ratio above the average of the German mechanical industry. When this is not the case, these companies are classed as businesses with related or unrelated activities depending on their liaison ratio.

As far as geographical diversification is concerned, the companies have been divided into two groups, depending on whether their export ratio reaches 40% or not.[15] If this is the case, they are called businesses with foreign orientation. If it doesn't reach 40%, the businesses are said to be domestically oriented.

Analysis of Results and Comments

Is the "size effect" relevant?

In order to test the first hypothesis, the profitability of businesses with a similar export ratio but different in size has been compared, taking into account the fact that this size variable is not directly correlated with profitability.

This variable was divided into 4 classes.

- small businesses: turnover lower than 50 million D.M.

- middle-sized businesses: turnover between 50 and 150 million D.M.

- big businesses: turnover between 150 and 500 million D.M.

- giant businesses: turnover higher than 500 million D.M.

Five point forks have been empirically determined in order to define equivalent export ratios. Each fork contains at least ten companies with different sizes and their profitability ratio has been submitted to the non parametrical Kruskal-Wallis test (i.e. one-way analysis of variance). The following chart shows that there is no significant result, therefore export profitability is independant of the size of the companies[16].


Does the export ratio necessarily produce an effect on profitability as a function of the evaluation of demand on the domestic market?)

In order to test this, activities have been put into three categories: activities in full growth, stagnating or declining. Domestic demand, i.e. production and imports-exports, was used as a variable for the classification. Only companies whose sales on markets with similar tendancies reached at least 90%, were considered for this test. The statistical method implemented consisted in searching for a correlation, for each given year, between the export ratio and the profitability in the three categories representing the tendancies of the domestic market.

The following chart 4 clarifies plain the results of the test. The liaisons are as expected, but only in the year 1970 is it possible to confirm the hypothesis of a positive impact of exports on the profitability of activities actually declining on the domestic market. This result shows clearly that companies facing a declining domestic market were able to avoid decreasing their profitability by producing more for their foreign markets before the first petrol crisis.

On the other hand, as the decline because more obvious after 1975 and as international competition intensified, the positive impact of export on profitability decreased.

Therefore, it would seem necessary to know both the domestic market dynamics and the degree of international competition in order to be able to foresee the profits expected form an export policy.

Does the global degree of diversification determine profitability?

A comparison of the profitability of the twelve groups was abandoned when it was realized that the companies do not have the same profitability in each category of business portfolio.

The investigation was then pursued in the six business portfolio categories by comparing the profitability ratio of foreign-market oriented companies to the profitability of domestic-market oriented companies.

The non parametrical Mann-Whitney test (one way analysis of variance) does not lead to the conclusion that specialized businesses and diversified businesses with related activities show a greater profitability when their export ratio exceeds 40%.

Two arguments can be put forward to explain this result which is contrary to that expected. Firstly, even capital goods need specific adaptations in order to be exported: different safety norms, changes in the sizes of the machines (equipment in order to adapt it to the average heights of the local populations, etc....). It becomes necessary, therefore, to increase the number of variants of

[TABULAR DATA OMITTED] a product in order to export. G. Stalk has established that such a situation implies an unavoidably negative experience effect. According to him, every time the number of variants doubles, there is a 20% to 30% cost increase. This cost increase can be controlled through flexible technological methods, but nonetheless the doubling of the product variants leads invariably to a 10% to 15% increase.

On the other hand, a stepwise discriminant analysis which was carried out on the financial structures of both businesses with a strong export drive and those with a weak one (superior to 50% and inferior to 30%) proved that heavy involvement on foreign markets is financially constraining.

The stock and debt level is markedly higher for the big exporters, these variables having a discriminating effect. It is interesting to note that this results is similar to that found in the French case study by Kaplan and Bert. Another variable enables the two groups to be discriminated: the asset turnover ratio (turnover/assets), which is highest in the group of businesses that export least.

This unexpected result leads to doubt the hypothesis that economies of scale might be made by the most export oriented businesses. In this sample, the least export-oriented businesses have the best overall efficiency. This may also mean that businesses that export little find enough domestic markets and therefore do not find it necessary to implement sustained efforts in order to export.

If the first part of the third hypothesis is rejected, chart 5 nonetheless shows that as far as businesses with unrelated diversification are concerned, one has to accept the hypothesis of a change of profitability in relation to geographical diversification except for the year 1978. However between 1970 and 1982, the influence of exports shows an inverted ratio. In 1970 and 1974, the foreign-market oriented businesses are most profitable, while in 1980 and 1982 it is the turn of the domestically oriented ones to show the best profits. The interaction between the two dimensions of diversification is far from certain, as the results are inverted depending on the period. Therefore it is mandatory to come back to the environment question in order to find some explanations for these inverted results.


In search of a compensating effect

In the sample, the businesses with unrelated diversification generally show the lowest profitability ratio. This ratio is noticeably lower than the ratio of the most profitable businesses, i.e. those which specialized in 1970, 1974 and 1980 and those with a dominant activity and an unrelated secondary one in 1980 and 1982.

As a result and as the profitability of businesses diversifying in unrelated activities varies with the export ratio, it becomes quite interesting to see whether this incidence is marginal, or whether it noticeably affects profitability.

One way to find this out consists in comparing for every year, the profitability ratio of four types of businesses, taken two by two: - The profitability of domestically oriented businesses tending to diversify in unrelated activities to the profitability of domestically oriented business having chosen the most profitable business portfolio. - The profitability of foreign market-oriented businesses diversifying in unrelated activities to the profitability of those the same type having chosen the most profitable business portfolio.

The aim of this test is to verify how much the differences in profitability due to the nature of the business portfolio owe to the contingence effect of exports.


The results shown in chart 6 confirm our predictions. Just as in 1970 and 1974, an unrelated diversification programme linked with a foreign-market orientation proves as profitable as a specialization with a foreign-market option; in 1978, when the comparison is limited to foreign-market oriented businesses, the business portfolio effect also disappears. On the contrary, comparing the profitability of domestically-oriented businesses verifies the hypothesis of the negative impact of an unrelated diversification on the profits of 1970, 1974 and 1978. This means that, until the second oil crisis, a meaningful involvement in foreign markets helped to compensate for inadequate profitability due to unrelated diversification. However, the tendancy switch already observed is confirmed in 1980 and 1982. At that time, businesses with unrelated diversification and foreign-market orientation are less profitable than businesses benefitting from the structure of their business portfolio. On the contrary, the effects of this structure disappear when the businesses become domestically oriented. One can therefore conclude that businesses with unrelated diversification benefitted from an export bonus up to the second oil crisis, but the soothing effect of exports could not be felt beyond that period.

These observations suggest that, at a time when international competition was still limited - up to the second oil crisis - developing foreign markets allowed for compensation for limited profits due to unrelated diversification. Later on, as international competition intensified, export- oriented companies had to adapt their products to the target markets without being able to increase their sales price. Under such conditions, businesses which could not benefit from any synergy effect due to the diversification of their production programme were in fact penalized by their efforts towards foreign markets. On the contrary, businesses which, after 1978, centralized their efforts on the domestic market in order to sell a heterogeneous production have not felt the same pressure on their margins. In fact, they managed to make similar profits to those of businesses benefitting from their business portfolio. All these elements confirm that the vitality characterizing export-oriented businesses is not the sales factor that explains their profitability. On the contrary, the very composition of the business portfolio and the state of the international environment, among others, are non-negligeable elements when attempting to understand how exports interact with profits.


This analysis leads to the conclusion that, as far as the German mechanical industry is concerned, the degree of involvement in exports does not directly determine business profitability. Neither is this result modified when one searches for any influence of the export ratio on profitability, taking into account differences of scale. The hypothesis according to which large sized businesses would be better able to benefit from exports than small ones is therefore not defendable.

Nonetheless, it is generally admitted that in the face of an international environment with little competition, businesses that are confronted with a recession on their domestic market can improve their profitability by intensifying exports. Unfortunately, such an environment is now a thing of the past.

This investigation leads to two other particularly interesting results: firstly, it is impossible to confirm that specialized businesses are able to increase their profitability by investing more on foreign markets. This is due to the fact that exports mean added costs: product adaptation, stock increase, credit increase (therefore also more unpaid bills). Consequently, specialized businesses may realize economies of scale in production when they increase exports. But unfortunately increased management costs are expected, to such an extent that a foreign-market policy is no more beneficial than a domestic market one.

Secondly, it becomes obvious that businesses diversifying in unrelated activities benefitted from exports when the international environment was more peaceful. But since the second oil crisis, a thoroughly-lead global diversification no longer guarantees satisfactory profitability. Indeed, businesses going global have to face a very complex situation, experiencing difficulties in mastering costs and keeping up an acceptable level of productivity.

In short, a strategy based on a strengthening of exports must be elaborated very carefully and on the sole condition that the company has sufficient financial reserves, as there is no guarantee of immediate profitability, mainly because of the decreasing productivity which ca appear. It would be interesting to find out how to limit these management expenditures. The solution may be partnership deals, but of course this needs to be tested.

Notes 1 The author thanks Josiane Lautour-Biggs for her assistance with the translation. 2 See for example Daniels and Bracker, or Aaly and Slate. 3 See De Woot. 4 See Leroy. 5 See Bea and Beutel, and Schwalbach. 6 See Urban et al., and Cavusgil et al. (1979). 7 See De Woot. 8 See for example the review by Liouville (1990), or by Reid. 9 See for example Lee. 10 See for example Jatusripitak. 11 See Audretsch and Yamawaki, Juul and Walters, Seifert and Ford. 12 See Cavusgil (1984). 13 This result stems from a factor analysis (correspondant analysis) based on aggregate financial data issued by the German mechanical industry for the years 1970-1982. For more information, see Liouville (1990). 14 This division is proposed by the Professional Union of German Machine Manufacturers: Verband deutscher Maschinen und Anlagenbau e.V. or V.D.M.A. 15 This ratio has been chosen as it clearly separates the businesses in the sample and also because (according to Buhner), in Germany, it is used as an "international structure" proxy variable. 16 The profitability indicator is in fact the operating profit ratio: profit before interest and tax.

References Alby, N.E. and Slater, S.F.: Management Influences on Export Performance: A Review of the Empirical Literature 1978-1988, International Marketing Review, Vol. 6/4 (1989), pp. 7-26. Audretsch, D.B. and Yamawaki, H.: Import Share under International Oligopoly with Differentiated Products: Japanese Imports in U.S. Manufacturing. Wissenschafts-Zentrum Berlin, Discussion Papers, IIM/IP 87-3 (1987), p. 30. Bea, F.X. and Beutel, R.: Die Bedeutung des Exports furthe Entwicklung der Kosten und die Gestaltung der Preise. In: Dichtl, E. et al. (eds.): Exporte als Herausforderung fur die deutsche Wirtschaft, Deutscher Instituts Verlag, Koln 1984. BMDP: Biomedical Computer Programs, University of California, Los Angeles 1985. Buhner, R.: Assessing International Diversification of West German Corporations, Strategic Management Journal, Vol. 8/1 (1987), pp. 25-37. Cavusgil, T. et al.: A Note on the Export Behaviour of Firms: Exporter Profiles, Journal of International Business Studies, Spring/Summer (1979), pp. 91-97. Cavusgil, T.: Organizational Characteristics Associated with Export Activity, Journal of Management Studies, Vol. 21/1 (1984), pp. 3-22. Daniels, J.D. and Bracker, J.: Profit Performance: Do Foreign Operations Make a Difference?, Management International Review, Vol. 29/1 (1989), pp. 46-56. De Woot, P.: Les entreprises de haute technologie et l'Europe. Economica, Paris 1988. Jatusripitak, S.: The Exporting Behavior of Manufacturing Firms. UMI Research Press, Ann Arbor, Michigan 1986. Juul, M. and Walters P.G.: The Internationalization of Norwegian Firms: A Study of the U.K. Experience. Management International Review, Vol. 27/1 (1987), pp. 58-66. Kaplan, M.C. and Bert, P.: Enquete sur les entreprises performantes. Document roneote du Credit National, Paris 1984. Lee, C.S.: Export Market Expansion Strategies and Export Performance: A Study of High Technology Manufacturing Firms. Ph.D. (B.A.) University of Washington 1987. Leroy, G.: Le cycle de vie international du produit. Revue Francaise de Gestion, 5, Mai/Aout 1976, pp. 111-125. Liouville, J. et al.: L'industrie mecanique allemande - adaptation au changement: 1970-1985, CESAG - Universite de Strasbourg III 1986. Liouville, J.: Choix de developpement et rentabilite de l'entreprise: Le cas de l'industrie mecanique allemande - These pour le doctorat es Sciences de Gestion, Strasbourg, 1990. Reid, S.D.: Expansion Strategies and Performance of Small Manufacturing Firms: The Internationalizing Dilemma - Proceeding of the XVth Annual Conference of the EIBA, Helsinki 1989, pp. 668 709. Rumelt, R.: Strategy, Structure and Economic Performance. Harvard University Press, Cambridge, Mass. 1974. Schwalbach, J.: Economies of Scale and Intra - Community Trade, Wissenschafts-Zentrum Berlin, Discussion Papers, FS IV 88/11, Berlin, 1988. Seifert, B. and Ford, J.: Are Exporting Firms Modifying Their Product, Pricing and Promotion Policies? International Marketing Review, Vol. 6/6, pp. 53-68. Stalk, G.: Zeit, die entscheidende Waffe im Wettbewerb - Harvard Manager 1989/1, pp. 37-46. Urban, S. et al.: Les entreprises ouest - allemandes et le marche francais. Verlag Anton Hain, Meisenheim am Glan 1978. V.D.M.A.: Statistisches Handbuch fur den Maschinenbau. Maschinenbau Verlag, Frankfurt/M. 1989.
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Author:Liouville, Jacques
Publication:Management International Review
Date:Jan 1, 1992
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