Vol. 0, No. 0, xxxx–xxxx 2012, pp. 1–13 DOI 10.1111/j.1937-5956.2011.01311.

x
ISSN 1059-1478|EISSN 1937-5956|12|0|0001 © 2012 Production and Operations Management Society

Emerging Market Penetration, Inventory Supply, and

Financial Performance
Chaodong Han
College of Business and Economics, Towson University, Towson, Maryland 21252, USA, chan@towson.edu

Yan Dong, Martin Dresner

Robert H. Smith School of Business, University of Maryland, College Park, Maryland 20742, USA, yandong@rhsmith.umd.edu,
mdresner@rhsmith.umd.edu

ealizing potential benefits from emerging market penetration requires firms to address inherent supply chain chal-
R lenges. A major challenge is for firms to manage costly inventories to address demand and supply risks in
emerging markets. However, emerging market penetration may offer opportunities for firms to lower inventory levels,
reduce costs, and improve operating performance. Using data for 482 manufacturing firms over the 5-year period,
2003–2007, obtained from the COMPUSTAT Industrial and Segment Databases, this article examines the relationships
between emerging market penetration, inventory supply, and financial performance. Our results show that a multina-
tional firm’s sales penetration into emerging markets is associated with fewer days of inventory supply and improved
financial performance. As emerging market penetration may allow firms to operate with lower inventory supply, the
positive effect from emerging market penetration, such as labor cost reductions, may be enhanced due to inventory
cost savings.
Key words: emerging markets; inventory; financial performance; multinational firms; manufacturing
History: Received: December 2008; Accepted: April 2011, after 3 revisions.

in emerging markets as a fraction of a firm’s total

1. Introduction
In the aftermath of the global recession of 2008–2009,
emerging markets, such as China and India, have
been among the first to recover. It is estimated that
40–50% of revenues and profits of Standard & Poor’s
(S&P) 500 companies now come from foreign sales,
especially from sales in emerging markets (Fortune
Magazine 2010). In his comments about the Chinese
automobile market, Bob Lutz, vice chairman of Gen-
eral Motors, stated, “[W]e do want to make sure that
we’re successful in the world’s largest and fastest-
growing automobile market – and a market which
will ultimately be as big as the European market
and the U.S. market combined” (National Public
Radio 2010). According to the Directory of American
Firms Operating in Foreign Countries, over 4000 US
firms operate more than 63,000 subsidiaries in 191
foreign countries (Uniworld 2007). A large percent-
age of these firms have established a substantial
presence in fast-growing, developing countries,
known as “emerging markets.” Although multina-
tional firms may have various forms of operations
in emerging markets, most notably outsourcing or
contract manufacturing, this study focuses on sales
penetration into emerging markets, defined as sales
1
sales.
Anecdotal evidence indicates that emerging market
penetration is positively associated with firm perfor-
mance. For example, Coke reported strong earnings
in the fourth quarter of 2008. One of the major rea-
sons cited was its strong sales penetration in rapidly
growing emerging markets (Caplan 2008). Texas
Instruments, whose sales from emerging markets con-
tributed 43% of total sales in 2006, reported a robust
return on net sales of 32% (Texas Instruments 2006).
In addition, academic research has suggested that
emerging market penetration may help firms reduce
costs, develop new markets, and increase world-wide
sales for their products (Khanna et al. 2005, Pacek
and Thorniley 2007).
However, penetration into emerging markets has
inherent costs and risks. For example, as Johnson and
Tellis (2008) note, Unilever launched 14 joint ventures
in China between 1986 and 1999, most of which ended
in failure. Emerging markets are often associated with
dramatic but unpredictable economic growth, poorly
developed infrastructure, little transparency in social
and political systems, and shortages of market inter-
mediaries. Multinational firms often have a poor
understanding of their customer base in emerging

2 Production and Operations Management 0(0), pp. 1–13, © 2012 Production and Operations Management Society
markets, and thus must rely on distributors and
other intermediaries to service the local markets. The
use of intermediaries may lengthen supply chains
and obscure demand conditions from the multina-
tional firms. A natural option is for the multinational
firms to maintain costly safety stocks to buffer against
these supply and demand risks, suggesting an unde-
sirable consequence of a firm’s emerging market
penetration—higher levels of safety stock and, conse-
quently, increased operating costs (Aeppel 2004).
It has been well documented that a firm’s penetra-
tion into emerging markets can have significant direct
effects on financial performance (Garten 1997, Khanna
1997). However, given both the opportunities and
risks inherent in emerging market penetration, little is
known about how emerging market penetration may
directly influence inventory supply and, indirectly,
financial performance. If emerging market penetra-
tion is associated with higher inventory levels, then
the positive direct effects on financial performance
from the penetration may be offset by the negative
effect from increased safety stocks.
Focusing on emerging market penetration, inven-
tory supply, and financial performance of multina-
tional firms, we conduct an empirical study using a
panel dataset consisting of 482 global manufacturing
firms over 5 years, from 2003 to 2007, obtained from
the COMPUSTAT Industrial and Segment databases.
Our results show that a firm’s penetration into
emerging markets is associated with reduced inven-
tory levels and improved financial performance,
despite the increased exposure to risks inherent in
these markets. Although these associative findings
are meaningful to both researchers and managers, it
must be cautioned that survival bias may exist in our
sample selection (e.g., firms with unsuccessful inter-
national operations may withdraw from interna-
tional markets and, thus, may not be included in our
sample) and causal connections still need to be estab-
lished between emerging market penetration and
inventory and financial performance.
The rest of this article is organized as follows: We
first discuss the theoretical background for this article
and review related literature. Next, we present our
econometric model and describe our data. Third, we
present our regression results and discuss theoretical
implications from the results. Finally, we draw con-
clusions and discuss research limitations and future
research steps.
2. Theoretical Framework and
Literature Review
Our conceptual model, shown in Figure 1, proposes
two possible links between emerging market penetra-
tion and financial performance: a direct link and an
Han, Dong, and Dresner: Emerging Market Penetration
Figure 1 Conceptual Model
Inventory
Supply
Emerging Financial
Market Performance
Penetration
indirect link through inventory supply. The two links
are discussed below.
2.1. Emerging Market Penetration and Firm
Financial Performance
Although there is little literature on the impact of
emerging market penetration on profitability, the
larger context of “globalization” offers some insight
(e.g., Hitt et al. 1994). As Khanna (1997) outlines, there
are both benefits and costs associated with a firm’s
global presence. On the positive side, market imper-
fections create arbitrage opportunities, such as cost
savings, ease of market entry, tax arbitrage, or other
institutional differences (Adler and Dumas 1983,
Denis et al. 2002). Arbitrage may enable multinational
firms to extend product life cycles by moving prod-
ucts between markets at different consumption stages
(Smith 1980), and to take advantage of the move-
ments in foreign exchange rates, and cost differences
between markets. Multinational firms can exploit
market imperfections and cross border transactions
(Capar and Kotabe 2003), and allocate corporate
resources along their supply chains with more effi-
ciency (Kobrin 1991). Globalization may also improve
financial performance due to economies of scale,
scope, and learning (e.g., Ghoshal 1987, Grant 1987,
Kim et al. 1989, 1993, Kogut 1985, Vernon 1971).
In contrast, arguments for the negative impacts of
globalization on firm performance are concerned
with theories of agency costs and transaction costs,
among others. For example, the complexity of global
operations may lead to high coordination costs
(Denis et al. 2002). Information asymmetry between
head offices and subsidiary managers may increase
monitoring and coordination costs (Harris et al. 1982,
Myerson 1982). Multinational firms may cross sub-
sidize less profitable business units and divisions in
global operations, resulting in inefficient allocations
of resources (Meyer et al. 1992, Rajan and Zingales
1995, Scharfstein and Stein 2000). Finally, managers
may choose a value-reducing globalization strategy
Han, Dong, and Dresner: Emerging Market Penetration
Production and Operations Management 0(0), pp. 1–13, © 2012 Production and Operations Management Society
due to selfish motivations, such as prestige, power
fulfillment, and higher compensation gained by run-
ning a large, global firm (Jensen 1986, Jensen and
Murphy 1990).
2.2. Emerging Market Penetration and Firm
Inventory Supply
There is little research directly connecting emerging
market penetration with a firm’s inventory perfor-
mance. However, emerging market penetration may
be associated with a number of factors that have
direct impacts on inventory. Among these factors are
holding costs, advanced inventory management prac-
tices and technologies (e.g., continuous replenish-
ment, vendor managed inventory), supply chain
glitches, and economies of scale (see, e.g., Chang and
Lee 1995, Chen et al. 2005, Gaur and Kesavan 2005,
Gaur et al. 2005, Hendricks and Singhal 2005, Huson
and Nanda 1995, Lieberman et al. 1996). In addition,
macroeconomic factors, such as economic growth
rates and inflation rates, may influence emerging mar-
ket penetration and can also affect firm inventory
decisions.
Emerging markets are often characterized by high
but variable growth rates, making demand difficult to
forecast. Multinational firms selling in emerging mar-
kets often have limited knowledge of these markets
and have to use local intermediaries, thereby obscur-
ing demand conditions and increasing the difficulty
in demand forecasting. Unpredictable fluctuations in
economic activity, changes in political conditions and
demographics, and market trends may leave multina-
tionals with either inventory overstock or stockout.
To guard against such high risks, firms that enter
emerging markets may have to carry additional safety
stock.
Emerging market penetration may also increase
the exposure to supply uncertainty. Many emerging
markets have poor physical infrastructure, as evi-
denced by substandard highways, ports, and ware-
housing facilities, resulting in long and variable
transportation lead times and disruptions to supply
chains. A report on Indian logistics, for example,
documents that “transportation delays and inade-
quate cold storage cause nearly half of all domesti-
cally grown fruit and vegetables to rot before
delivery” (Kline 2007). In line with poor physical
infrastructure, institutional infrastructure, including
regulations, policies, and logistics procedures, may
add to the riskiness of emerging market penetration.
In addition, foreign suppliers may be less reliable
compared to domestic suppliers due to differences in
business rules, standards, and business cultures.
Poor infrastructure, inefficient regulations, supply
uncertainties, and market inefficiencies may all lead
to higher inventory levels for firms operating in
3
emerging markets (Guasch and Kogan 2001, Lai
2005, 2006a, 2006b).
On the other hand, firms selling in emerging mar-
kets also have unique advantages that may lead to
lower inventories. First, having endured poor cus-
tomer service standards in the past, consumers in
emerging markets may be less sensitive to service
quality, such as product availability, than their coun-
terparts in developed countries. Second, contract
manufacturing is commonly used in emerging mar-
kets, thus allowing multinationals to operate their
own manufacturing facilities at a steady state. In addi-
tion, contract manufacturers may carry inventory that
would normally be on the books of the multinational
firms.
2.3. Inventory Supply and Firm Financial
Performance
Inventory represents both a cost and a potential bene-
fit to manufacturers (e.g., Zipkin 2000). Reductions in
inventory decrease the holding cost of inventory, thus
potentially improving profitability for the firm as the
funds released from the inventory investment are put
to better uses. On the other hand, inventory holdings
provide product availability, which supports cus-
tomer service and reduces the likelihood of stockouts.
Thus, holding additional inventory increases the
potential revenue stream for a multinational firm both
from short-term product margins and from long-term
customer value. In practice, a firm may optimize
its inventory supply to meet its customer service goal
(e.g., 95% fill rate). If the inventory supply is below
the optimal level, increasing inventory allows the firm
to capitalize its benefits from higher product availabil-
ity and customer service, suggesting that inventory
supply is positively associated with financial perfor-
mance. If the inventory supply is beyond the optimal
level, increasing inventory heightens the cost of hold-
ing extra inventory, suggesting a negative association
between inventory supply and the firm’s financial
performance. Overall, we expect a curvilinear associa-
tion between inventory supply and financial perfor-
mance.
3. Econometric Models
As noted above, a firm’s penetration into emerging
markets may be associated with changes in inventory
supply which in turn affects financial performance.
Meanwhile, the firm’s emerging market penetration
can be directly associated with its financial perfor-
mance due to factors unrelated to inventory. We,
therefore, propose a model to capture both the direct
and the indirect associations between emerging mar-
ket penetration and firm financial performance as
follows:

4 Production and Operations Management 0(0), pp. 1–13, © 2012 Production and Operations Management Society
Inventory Supply ¼ a0 þ a1 Emerging Market
þ a2 Demand Uncertainty
þ a3 Emerging Market  Demand Uncertainty
ð1Þ
þ a4 Debt Cost þ a5 Gross Margin
þ a6 Capital Intensity þ a7 Firm Size
þ Industry Effects þ Firm Effects þ 1
Financial Performance ¼ b0 þ b1 Emerging Market
þ b2 Demand Uncertainty þ b3 Emerging Market
 Demand Uncertainty þ b4 Inventory Supply
þ b5 Inventory SupplySquared þ b6 Leverage Level
þ b7 R D Intensity þ b8 Capital Intensity
þ b9 Firm Size þ Industry Effects þ Firm Effects þ 2
ð2Þ
where:
• Inventory_Supply is the dependent variable in
the inventory model (Equation 1) and an inde-
pendent variable in the financial performance
model (Equation 2). In the financial perfor-
mance model, Inventory_Supply may have a cur-
vilinear effect on the dependent variable, with
Financial_Performance increasing in Inven-
tory_Supply when the inventory level is lower
than optimal but decreasing in Inventory_Supply
when the inventory level is greater than opti-
mal. Therefore, a squared term for this variable
is included in the financial performance model
to capture this curvilinear relationship.
• Financial_Performance is the dependent variable
in the financial performance model.
• Emerging_Market is our focal independent vari-
able in both equations, representing the extent
to which a firm is engaged in selling in emerg-
ing markets.
• Demand_Uncertainty, a control variable in both
equations, represents market dynamics faced
by a firm, and is an important driver of
inventory decisions, most notably safety stock
levels. Demand_Uncertainty is expected to have
a negative association with firm financial
performance, ceteris paribus. As argued above,
Demand_Uncertainty may be particularly high in
emerging markets; thus an interaction term
between Emerging_Market and Demand_Uncer-
tainty is included in both equations.
• Debt_Cost, a control variable in the inventory
model, is used as an instrument for inventory
holding cost. It is conjectured that higher debt
costs (and hence higher inventory holding
costs) are associated with lower inventory
levels. Prior research has provided empirical
evidence for this relationship (e.g., Chen et al.
2005, Roumiantsev and Netessine 2007a).
Han, Dong, and Dresner: Emerging Market Penetration
• Gross_Margin, a control variable in the Inven-
tory_Supply model, is used to capture the oppor-
tunity cost of a stockout. As gross profit margin
increases, the desired service levels and inven-
tory levels will likely increase as well, as firms
may be more reluctant to lose sales. Therefore,
it is expected that inventory supply is positively
associated with gross profit margin, ceteris pari-
bus. This logic is well developed from an analyt-
ical perspective in Roumiantsev and Netessine
(2007a) and Gaur et al. (2005). In addition, Gaur
et al. (2005) provide empirical evidence from
US retailers, and Roumiantsev and Netessine
(2007b) provide empirical evidence from public
firms in Organization for Economic Cooperation
and Development countries.
• Capital_Intensity is a control variable in both
models. Capital investment by manufacturing
firms includes fixed investment in manufactur-
ing plant and equipment, distribution facilities
(e.g., warehouses), and information technolo-
gies (e.g., EDI, JIT, and real-time tracking).
Investments in plant and equipment may
increase worker productivity and speed the
flow of work-in-process inventory, whereas
investments in warehouse facilities may
increase inventory turns and reduce inventory
waste and errors. In addition, information tech-
nology investments may improve communica-
tion and hence inventory visibility along a
firm’s supply chain. Gaur et al. (2005) find that
capital intensity at retailers is positively associ-
ated with inventory turnover, and Harris and
Katz (1988) report that profitability is positively
correlated with information technology capital
intensity in the insurance industry. Therefore, it
is expected that Capital_Intensity is associated
with reductions in inventory supply and
improvements in financial performance.
• Firm_Size is used as a control variable in both
models. Economies of scale may exist for inven-
tory management due to better utilization of
labor, and better use of distribution networks
and transportation capacity (Gaur and Kesavan
2005, Roumiantsev and Netessine 2007a). As
well, large firms may exercise power when
bargaining with upstream suppliers and down-
stream customers, and thus may be able to
push inventory backward to suppliers or for-
ward to customers. In a retailer setting, Gaur
and Kesavan (2005) report a positive correla-
tion between inventory turnover and firm size.
Hence, it is expected that Inventory_Supply
decreases with Firm_Size. Firm size may also
have a positive association with Financial_Per-
formance, as large firms generally have more
Han, Dong, and Dresner: Emerging Market Penetration
Production and Operations Management 0(0), pp. 1–13, © 2012 Production and Operations Management Society
resources than small firms, including manage-
rial skills.
• Leverage_Level is a control variable in the financial
performance model. Higher leverage levels may
be associated with better financial performance
during profitable years and poorer financial per-
formance during lean years, given potential tax
benefits associated with debt financing.
• R&D_Intensity is a control variable in the finan-
cial performance model which may reflect a
firm’s innovative capability and may be associ-
ated with better performance. However, there
is mixed empirical evidence for this relation-
ship. For example, although O’Regan et al.
(2008) report that R&D drives competitive
advantage and firm financial performance,
Lantz and Sahut (2005) report a negative rela-
tionship between R&D investment and financial
performance based on an analysis of publicly
traded technological firms.
• Industry_Effects and Firm_Effects are included as
control variables in both models. Three-digit
North American Industrial Classification System
(NAICS) codes are used to classify industry sec-
tors.1 Inventory supply may vary depending on
industry idiosyncratic characteristics. In North
America, industry sectors are classified primar-
ily based on production processes and technolo-
gies, both of which may affect inventory supply.
Product variety, competitive intensity, demand
predictability, production processes and proce-
dures (build-to-stock or build-to-order), and
other industry-specific characteristics also may
affect inventory supply and financial perfor-
mance.
4. Data Collection
Annual data for emerging market sales were col-
lected from the COMPUSTAT Segment database,
which reports a firm’s annual sales breakdown by
product segments and by geographic segments. To
construct our measure for emerging market penetra-
tion, we first extracted annual data on all manufac-
turing firms from the COMPUSTAT Segment
database over the period 2003–2007, based on 6-digit
NAICS industry codes ranging from 311111 to
339999, resulting in 9573 sales records (entries) on
1409 unique firms since a firm reports sales break-
down by multiple geographic segments and each
segment is reported as a row in the COMPUSTAT
data file. Second, we removed 143 firms which did
not have any international sales. Third, we identified
a firm’s emerging market sales by checking geo-
graphic origins for a firm’s sales against a list of 24
5
major emerging market countries. Although there is
no consensus on what constitutes an emerging mar-
ket, we referenced the list of emerging market coun-
tries from the Morgan Stanley Capital International’s
(MSCI) 2006 Emerging Market Equity Index. The
2006 MSCI emerging market list identified the
following countries: Argentina, Brazil, Chile, China,
Colombia, Czech Republic, Egypt, Hungary, India,
Indonesia, Israel, Korea, Malaysia, Mexico, Morocco,
Pakistan, Peru, Philippines, Poland, Russia, South
Africa, Taiwan, Thailand, and Turkey. Similar to the
emerging market list published by The Economist,2
the MSCI list is commonly used in emerging market
studies.3 If a firm clearly did not have any sales from
emerging markets, its emerging market sales were
recorded as zero. If a reported segment for a firm
was too broad to differentiate emerging market sales
from nonemerging market sales, this firm was
removed from further analysis. For example, some
firms may report segment sales under “Pacific Rim”
or “East Asia,” which potentially contained revenue
from both emerging and nonemerging markets (e.g.,
China and Japan), and therefore were excluded from
final analysis. As a result, a total of 668 firms were
removed. Fourth, we summed sales generated from
different emerging markets to obtain total emerging
market sales for a particular firm. This step resulted
in a variable for emerging market sales that varied
annually over the 5-year period for each firm
included, which allowed us to calculate the emerging
market penetration variable by dividing emerging
market sales by a firm’s total sales. Fifth, based on a
firm’s permanent identifier (GVKEY), defined by
COMPUSTAT to track a firm over time although the
company name or ticker may change over time,4 we
were able to match emerging market penetration
data with firm financial and operational data, con-
structed from the COMPUSTAT Industrial database,
which includes net income, inventory, assets, liabili-
ties, interest expenses, and capital expenditures from
public firms captured by COMPUSTAT. We further
removed 116 firms due to the lack of data on key
variables—inventory and financial performance. The
end result was a panel dataset of 2258 firm-year
records with 482 unique firms captured for the
5-year period from 2003 to 2007. Note that in our
regression analysis, the actual sample sizes vary due
to missing data for certain other variables and the
use of lags for all explanatory variables.
5. Measures of Variables and
Descriptive Statistics
Inventory_Supply is measured as (365 9 Total Inven-
tory)/Cost of Goods Sold, assuming a 365-day year,
 Han, Dong, and Dresner: Emerging Market Penetration
6 Production and Operations Management 0(0), pp. 1–13, © 2012 Production and Operations Management Society

following Chen et al. (2005). This variable, therefore,
reflects an inventory level, relative to Cost of Goods
Sold. Financial_Performance is measured by return on
sales (ROS), calculated as net income divided by net
sales following Roumiantsev and Netessine (2007b)
and Geringer et al. (1989). In addition, we use return
on assets (ROA) as an alternative performance mea-
sure. Net returns are used to measure financial perfor-
mance since (i) bottom line profitability is most
important to firms and (ii) net returns reflect many
nonoperating charges which may be directly associ-
ated with emerging market penetrations, such as
inventory write-offs, inventory financing charges,
local tax benefits, and foreign exchange income or
losses. Emerging_Market is measured as a firm’s
emerging market sales penetration rate, as discussed
above. Demand_Uncertainty is measured by the stan-
dard deviation of de-trended annual sales during a
rolling 5-year period. For example, for a firm in 2003,
demand uncertainty is measured by the standard
deviation of annual sales during 1998–2003 after con-
trolling for time trends. The actual period may be
<5 years if no sales data were available for the full
5 years. Debt_Cost is measured by a proxy, total inter-
est expenses/total liabilities, since most firms do not
report actual cost of debt. Gross_Margin is calculated
as cost of goods sold/total sales. Capital_Intensity is
measured as capital investment normalized by total
sales.
Firm_Size is measured by firm sales. To ensure com-
parability across time, all firm sales are deflated to the
year 2007 based on industry-specific producer price
indexes (PPI).5 Leverage_Level is measured by total
liabilities as a percentage of total assets. R&D_Intensity
is measured by a firm’s research and development
(R&D) expenditures normalized by total sales.
We include industry and firm dummy variables in
both models to capture both Industry_Effects and
Firm_Effects.
Firm characteristics and the distribution of firms by
industry are presented in Table 1. According to the
data, all US manufacturing sectors, except textile
product mills, are represented in the sample with
over 40% of firms in the computer and electronic
products sector, 11% in chemical manufacturing, and
8% in machinery manufacturing. Other industries,
including leather, wood, printing, nonmetallic miner-
als, and furniture, have lower representation in the
dataset. Average firm sales are about $2.35 billion,
with wide variation across industries. Sales for firms
in the nonmetallic minerals and wood manufacturing
sectors average over $10 billion, the highest mean in
our sample, with petroleum and coal production
firms in the third position with average annual sales
of $8.9 billion. Firms in the primary metal, food, and
transportation equipment sectors are also relatively
large, with annual sales averaging above $5 billion
per firm.

Table 1 Distribution of Firms by Industry

No. of Avg. firm Avg.

No. of unique sales Avg. EM inventory Avg. Avg.
NAICS industry firm-years firms ($MM) penetration days ROS ROA
Food (311) 42 10 5235 29% 82 6% 6%
Beverage and Tobacco (312) 45 10 4316 27% 77 3% 2%
Textile Mills (313) 19 4 478 24% 76 1% 6%
Apparel (315) 44 9 1546 9% 109 1% 2%
Leather (316) 10 2 190 0.4% 165 6% 3%
Wood (321) 9 2 10,485 20% 118 4% 2%
Paper (322) 59 13 3933 8% 64 3% 2%
Printing (323) 15 3 323 25% 65 4% 6%
Petroleum and Coal (324) 33 7 8871 36% 36 6% 6%
Chemical (325) 240 53 1879 19% 119 12% 4%
Plastics and Rubber (326) 73 17 478 26% 67 4% 5%
Nonmetallic Mineral (327) 15 3 11,381 2% 76 7% 4%
Primary Metal (331) 66 15 6585 11% 92 2% 3%
Fabricated Metal (332) 101 21 1311 9% 109 4% 4%
Machinery (333) 197 40 1833 16% 122 7% 1%
Computer and Electronics 930 195 1627 29% 100 5% 1%
(334)
Electrical Equipment (335) 130 28 1100 24% 95 10% 2%
Transportation Equipment 166 36 5439 19% 60 5% 2%
(336)
Furniture (337) 11 3 2848 2% 77 1% 2%
Other durable (339) 53 11 254 11% 122 3% 45
Average (*Total) 2258* 482* 2350 22% 98 4% 1%
Han, Dong, and Dresner: Emerging Market Penetration
Production and Operations Management 0(0), pp. 1–13, © 2012 Production and Operations Management Society 7

In terms of emerging market penetration, firms Demand_Uncertainty and Emerging_Market. Variance

with operations in petroleum and coal (36% of sales), inflation factors (VIF) tests for multicollinearity were
computers (29%), and food (29%) have the highest then run for all sets of variables. Tests show that VIF
degree of penetration in emerging markets. In con- scores for all variables are low to moderate, with the
trast, firms in leather (0.4%), nonmetallic minerals highest score being 4.68, lower than the commonly
(2%), and furniture (2%) have the lowest levels of maximum acceptable level of 10 (e.g., Lunt 2003,
emerging market penetration. Firms in leather, Lynch 2003).
machinery, wood, chemical, and other durable indus-
tries have relatively high inventory supply, while
firms in petroleum, paper, and printing have much
6. Estimation Models and Regression
lower inventory supply, on average. In terms of finan- Results
cial performance, firms in nonmetallic mineral, food, To control for both industry- and firm-level effects,
petroleum, wood, and fabricated metal industries we estimate nested random coefficients models since
have, on average, positive ROS and ROA, although firm effects are nested in industry effects for our
firms in the chemical, electrical equipment, machin- 5-year panel setting. In estimating these models, we
ery, leather, and transportation equipment industries assume that the association between emerging market
demonstrate negative ROS and ROA, on average. penetration and firm inventory levels and financial
To reduce potential biases from extreme values performance includes random coefficients and
(outliers) on regression results, we follow a common random intercepts at the industry level, and, due to
Winsorization approach by replacing high extreme data limitations since our panel dataset spans
values with 95 percentiles and low extreme values only 5 years for each firm, only random intercepts at
with 5 percentiles (see examples in Chen et al. 2005, the firm level.6 All variances and covariances are
2007, Gompers et al. 2005, Lai 2006a, 2006b). Mean also distinctly estimated. To avoid contemporary
statistics for variables used in the regressions are pre- correlations, all explanatory variables are lagged by
sented in Table 2. 1 year. Note that the sample size for different models
The average inventory level for all firms in the sam- is further reduced when lagged variables are used.
ple is 98 days of supply. The average ROS for this For the financial performance models (ROS and
sample is 4% with a median ROS of 5%. The average ROA), the same set of explanatory variables is used.
ROA for this sample is 0.6%with a median ROA of Finally, we obtain the best linear unbiased predictions
4%. The average emerging market penetration rate is of the random effects.
22%. Other statistics are as indicated in the table. Regression results for fixed coefficients for all
Due to the high correlation between the linear term, explanatory variables are presented in Table 3. Ran-
Inventory_Supply, and the squared term for Inven- dom coefficients and random intercepts of emerging
tory_Supply, we adopted a de-meaned approach. As a market penetration at the industry level are presented
result we transformed these variables by centering in Table 4.7
the natural logarithm term of Inventory_Supply at its Overall, all three models have significant Wald Chi-
mean and then squaring the de-meaned variable squared statistics. For the inventory model, the Wald
(Hart and Lence 2004). We also applied the de- Chi-squared statistic is 73.27 and highly significant
meaned approach to the interaction term between (p < 0.001). For the financial performance models, the
Wald Chi-squared statistic is 73.13 and highly signifi-
cant (p < 0.001) for the ROS model, and 78.60 and
Table 2 Mean Statistics of Variables Used in the Regressions highly significant (p < 0.001) for the ROA model.
Variable Mean Std Min Max Notably, likelihood ratio tests for the presence of ran-
Inventory_Supply (Days) 98 60 26 252
dom effects are all highly significant (1274.02 for the
ROS 0.04 0.27 0.99 0.21 inventory model, 578.37 for the ROS model, and
ROA 0.006 0.15 0.45 0.19 476.12 for the ROA model), indicating the existence of
Emerging_Market 0.22 0.29 0.00 0.94 these random effects at industry and firm levels.
Demand_Uncertainty ($Million) 394 730 1.25 2735 In the inventory model (Equation 1), the fixed
Emerging _Market 73 253 0.00 2462
9 Demand_Uncertainty
coefficient for Emerging_Market is 0.17 (p < 0.05),
Capital_Intensity 0.05 0.05 0.006 0.20 suggesting that on average sales penetration into
Debt_Cost 0.03 0.04 0.005 0.22 emerging markets is associated with lower inventory
Gross_Margin 0.36 0.17 0.09 0.70 supply. The coefficient for Demand_Uncertainty is 0.01
Leverage_Level 0.48 0.27 0.11 1.11 (p < 0.10), indicating that Demand_Uncertainty is
Firm_Size ($Million) 2350 4758 0.56 18,948
R&D_Intensity 0.01 0.02 0.0002 0.06
associated with higher inventory supply, as
expected. The interaction term between emerging
 Han, Dong, and Dresner: Emerging Market Penetration
8 Production and Operations Management 0(0), pp. 1–13, © 2012 Production and Operations Management Society

Table 3 Regression Results for Nested Random Coefficient Models

Equation 1 Equation 2.1 Equation 2.2

Inventory _Supply Financial_Performance Financial_Performance
DV (natural log term) (ROS) (ROA)

Coefficients Coefficients Coefficients

IV (standard error) (standard error) (standard error)
Intercept 4.20*** (0.07) 0.12*** (0.03) 0.05*** (0.02)
Emerging_Market 0.17** (0.08) 0.08*** (0.03) 0.03* (0.02)
Demand_Uncertainty 0.01* (0.005) 0.03** (0.01) 0.04* (0.02)
Emerging_Market 9 Demand Uncertainty 0.06*** (0.02) 0.02** (0.01) 0.05* (0.03)
Capital_Intensity 0.49** (0.24) 0.13* (0.03) 0.05*** (0.02)
Firm_Size 0.02*** (0.004) 0.02*** (0.003) 0.01** (0.005)
Debt_Cost 0.60** (0.31)
Gross_Margin 0.58*** (0.09)
Debt_Structure 0.51*** (0.15) 0.23*** (0.09)
R&D_Intensity 0.89 (0.59) 1.03 (0.97)
Inventory_ Supply 0.71*** (0.19) 0.55*** (0.11)
Inventory_Supply Squared 0.08*** (0.22) 0.06*** (0.01)
# of firm-years 1665 1202 1202
# of unique firms 463 434 434
Model Wald Chi-squared 73.27 73.13 78.60
Model probability (>Chi-squared) 0.000 0.000 0.000
Industry-level variance (emerging_market) 0.05 0.03 0.006
Industry-level variance (intercept) 0.04 0.002 0.0004
Firm-level variance (intercept) 0.24 0.04 0.01
Variance (residual) 0.06 0.02 0.01
Likelihood ratio test vs. linear regression (Chi- 1274.02 578.37 476.12
squared)
Probability (>LR Chi-squared) 0.000 0.000 0.000

*, **, and *** denote 10%, 5% and 1% significance levels for two-tailed tests, respectively.

market penetration and demand uncertainty is posi-
tive (0.06) and significant (p < 0.01), suggesting a
stronger positive association between demand uncer-
tainty and inventory supply when a firm’s emerging
market penetration is high.
In the financial performance ROS model (Equa-
tion 2.1), the fixed coefficient for Emerging_Market is
0.08 (p < 0.01), indicating that on average penetration
into emerging markets is positively associated with
firm financial performance. The results for the regres-
sion on ROA are largely consistent with the results for
the ROS regression, and are therefore not discussed in
detail. See Table 3, Equation 2.2. The coefficient for
Inventory_Supply is 0.71 (p < 0.01), whereas the coeffi-
cient for the squared term for Inventory_Supply is
0.08 (p < 0.01), suggesting a curvilinear relationship
between inventory and financial performance. This
inverted U-shaped relationship between inventory
and financial performance peaks at about 85 days of
inventory supply, 13% below the average inventory
level (98 days), and indicates that financial perfor-
mance may decline when inventory supply is either
too low or too high. The coefficient for Demand_Uncer-
tainty is negative (0.03) and significant (p < 0.05),
indicating that firm financial performance is lower
when a firm is faced with highly uncertain demand.
The interaction term between emerging market pene-
tration and demand uncertainty is negative (0.02)
and significant (p < 0.05), indicating that the positive
association between emerging market penetration
and firm ROS may be offset by increased demand
uncertainty in emerging markets.
Note that coefficients for a number of control vari-
ables show expected signs across all models. For
example, results indicate that Debt_Cost is negatively
associated with firm inventory supply, and Gross_
Margin is positively associated with firm inventory
supply. The coefficient for Firm_Size is negative and
significant for inventory supply and positive and
significant in the financial performance models, sug-
gesting that large firms operate with lower inventory
supply and achieve better financial performance than
their smaller counterparts, on average.
As shown in Table 4, the association between
emerging market penetration and firm inventory lev-
els and financial performance varies across industries
in the form of random slopes and random intercepts.
In the inventory model, we note negative random
slopes for emerging market penetration in 12 indus-
tries, including beverage and tobacco, apparel,
leather, paper, petroleum and coal, plastics and rub-
ber, nonmetallic mineral, primary metal, machinery,
computer and electronics, furniture, and miscella-
neous durable goods. For example, for firms in the
Han, Dong, and Dresner: Emerging Market Penetration
Production and Operations Management 0(0), pp. 1–13, © 2012 Production and Operations Management Society 9

Table 4 Industry-Level Random Coefficients of Emerging Market Penetration and Intercepts

Model (dependent variable)

Log of inventory days ROS ROA

Coefficient of emerging Industry level Coefficient of emerging Industry level Coefficient of emerging Industry level
market penetration intercept market penetration intercept market penetration intercept
NAICS industry (standard error) (standard error) (standard error) (standard error) (standard error) (standard error)
Food (311) 0.22* (0.12) 0.03 (0.13) 0.02** (0.01) 0.01 (0.01) 0.03* (0.02) 0.002 (0.01)
Beverage and 0.09** (0.04) 0.18* (0.11) 0.01 (0.03) 0.01 (0.05) 0.02 (0.07) 0.02 (0.11)
Tobacco
(312)
Textile Mills 0.13* (0.08) 0.07 (0.16) 0.002 (0.05) 0.002 (0.03) 0.004 (0.01) 0.01 (0.01)
(313)
Apparel (315) 0.21 (0.18) 0.11 (0.14) 0.08** (0.04) 0.02 (0.02) 0.04* (0.03) 0.02** (0.01)
Leather (316) 0.04 (0.23) 0.12 (0.17) 0.02 (0.11) 0.01 (0.01) 0.02 (0.03) 0.01 (0.04)
Wood (321) 0.01 (0.23) 0.14 (0.17) 0.02 (0.10) 0.0002 (0.05) 0.003 (0.06) 0.0003 (0.01)
Paper (322) 0.06** (0.03) 0.11* (0.06) 0.43*** (0.15) 0.05* (0.03) 0.14** (0.06) 0.02 (0.03)
Printing (323) 0.20* (0.13) 0.08 (0.16) 0.10* (0.06) 0.02 (0.13) 0.01** (0.005) 0.01 (0.02)
Petroleum and 0.04 (0.14) 0.34*** (0.14) 0.06* (0.04) 0.002 (0.02) 0.05* (0.03) 0.001 (0.02)
Coal (324)
Chemical (325) 0.02** (0.01) 0.15* (0.08) 0.16*** (0.06) 0.04** (0.02) 0.04** (0.02) 0.02* (0.01)
Plastics and 0.04** (0.02) 0.20* (0.12) 0.06 (0.23) 0.01** (0.005) 0.03*** (0.01) 0.003 (0.01)
Rubber (326)
Nonmetallic 0.01 (0.16) 0.01 (0.17) 0.01* (0.006) 0.002 (0.01) 0.01** (0.005) 0.02 (0.03)
Mineral (327)
Primary Metal 0.11* (0.06) 0.15** (0.07) 0.07 (0.09) 0.02 (0.02) 0.04 (0.05) 0.01 (0.01)
(331)
Fabricated 0.20** (0.09) 0.14 (0.10) 0.003 (0.01) 0.03* (0.02) 0.01 (0.02) 0.01 (0.03)
Metal (332)
Machinery 0.42*** (0.15) 0.19** (0.09) 0.10 (0.07) 0.01 (0.04) 0.06 (0.04) 0.003 (0.01)
(333)
Computer and 0.05* (0.03) 0.03 (0.02) 0.003*** (0.001) 0.01** (0.005) 0.01*** (0.003) 0.002 (0.003)
Electronics
(334)
Electrical 0.17** (0.09) 0.08 (0.09) 0.15*** (0.06) 0.05* (0.03) 0.07** (0.03) 0.02** (0.01)
Equipment
(335)
Transportation 0.18* (0.12) 0.22*** (0.09) 0.004** (0.002) 0.02*** (0.007) 0.02** (0.01) 0.01 (0.01)
Equipment
(336)
Furniture (337) 0.003 (0.24) 0.01 (0.17) 0.004 (0.01) 0.002 (0.008) 0.001 (0.003) 0.0004 (0.005)
Other durable 0.04 (0.13) 0.10 (0.09) 0.08 (0.06) 0.03 (0.02) 0.03 (0.04) 0.01 (0.01)
(339)

*, **, and *** denote 10%, 5%, and 1% significance levels for two-tailed tests, respectively.

computer and electronics industry, the combined
(fixed plus random) slope for emerging market pene-
tration equals 0.22 (= 0.17  0.05). This finding
suggests that in those 12 industries, further emerging
market penetration may be associated with additional
decreases in inventory levels. We also note positive
random slopes for emerging market penetration in
the inventory model in the other eight industries,
including food, textile mills, wood, printing, chemi-
cal, fabricated metal, electrical equipment, and trans-
portation equipment. For example, for firms in the
fabricated metal industry, the combined slope of
emerging market penetration equals 0.03 (= 0.17 +
0.20), resulting in a positive association between fur-
ther emerging market penetration and inventory
levels. This finding indicates that the negative associa-
tion between emerging market penetration and inven-
tory levels may be offset in those 8 industries by
industry-specific effects. We further find that random
intercepts vary across industries. Eight industries
have negative intercepts whereas 12 industries have
positive intercepts at the industry level. Notably,
firms in fabricated metal, printing, electrical equip-
ment, and transportation equipment have higher
inventory, on average, due to positive industry level
effects. The heterogeneous association between
emerging market penetration and firm inventory lev-
els may be attributed to industry-specific characteris-
tics including demand patterns, product features, and
production processes. For example, firms in computer

10 Production and Operations Management 0(0), pp. 1–13, © 2012 Production and Operations Management Society
and electronics tend to use local contract manufactur-
ing in emerging markets for assembly and face rap-
idly growing demand, both requiring relatively low
inventory levels to support market penetration;
whereas firms in transportation equipment may likely
face pressure to carry additional inventory due to the
use of key components (e.g., engines) that can only be
supplied from outside the emerging markets.
In the ROS model, we note positive random slopes
for emerging market penetration in six industries,
including food, textile mills, wood, paper, petroleum
and coal, and nonmetallic minerals, indicating that
emerging market penetration may be associated
with further increases in financial performance. For
example, for firms in the electrical equipment indus-
try, the combined slope of emerging market penetra-
tion can be as high as 0.23 (= 0.08 + 0.15). However,
we also note negative random slopes for emerging
market penetration in the other 14 industries, indicat-
ing the positive average association of emerging mar-
ket penetration with financial performance may be
offset by industry effects. For example, for firms in
the chemical industry, the combined slope of emerg-
ing market penetration can be as low as 0.08 (=
0.08  0.16). We also note that random intercepts
vary across different industries, with positive inter-
cepts in 14 industries and negative intercepts in six
industries. The random coefficients and intercepts for
the ROA model show a similar pattern. In summary,
the heterogeneous association between emerging
market penetration and firm financial performance
may be attributed to industry structural characteris-
tics including market competition, bargaining power
of upstream suppliers and downstream distributors,
and overall operating costs in emerging markets.
For example, firms in the electrical equipment sector
may be more profitable due to the lack of competition
from local brands, whereas firms in the chemical
industry may be subject to higher operating costs
and tighter local regulation in emerging markets,
which offsets, to some extent, the positive associa-
tion of emerging market penetration, and financial
performance.
7. Discussions, Limitations,
Conclusions, and Future Research
As multinational firms increasingly penetrate into
emerging markets, they are faced with various chal-
lenges and opportunities in managing their global
operations (Alvarez and Marsal 2008). In this study,
we focus on inventory supply as a key component
of a firm’s global supply chain, and connect inven-
tory supply with firm financial performance.
A major finding of our research—that penetration
into emerging markets is associated with lower
Han, Dong, and Dresner: Emerging Market Penetration
inventory supply—is significant, given the risky
environment that characterizes emerging markets.
Our results indicate that a firm’s emerging market
penetration does not necessarily lead to higher
inventory levels, which could in turn adversely
affect a firm’s financial performance. Finally, we find
a direct, positive relationship between emerging
market penetration and financial performance after
controlling for industry- and firm-level effects using
nested random coefficients models.
In summary, this research is the first, to the best of
our knowledge, in the operations management litera-
ture to empirically examine the relationship between
a firm’s emerging market penetration, inventory sup-
ply, and financial performance. The findings on the
direct and indirect relationships may help change the
perception that operations in emerging markets, with
poorer infrastructure, and longer supply chains, will
necessarily contribute to higher inventory levels and
hence lower a firm’s profit potential.
Furthermore, this research provides relevant mana-
gerial implications to operations managers. Our key
findings indicate that emerging market penetration is
associated with higher firm financial performance
through reductions in inventory costs. However, we
also note that heterogeneous random effects at the
industry level need to be considered when applying
the encouraging findings in certain industries, where
emerging market penetration may not necessarily
lead to lower inventory levels or higher financial per-
formance after combining random effects. For exam-
ple, although computer companies such as Dell may
benefit from lower inventories from its increasing
penetration into emerging markets, transportation
equipment companies such as Polaris and Arctic Cat
may have to increase inventories to match their fur-
ther penetration into emerging “Siberian” markets. To
management, emerging market penetration should
not be a bandwagon decision but a comprehensive
decision with direct and indirect effects evaluated in
an industry-specific context.
A major limitation of this exploratory investigation
is that we do not map a causal link between emerging
market penetration, inventory supply, and financial
performance, due to the limitations of the empirical
analysis conducted in the article. Despite the finding
that emerging market penetration is significantly
associated with lower inventory levels and higher
financial performance, this research does not provide
causal evidence. In fact, a reverse causality may exist
such that “lean” firms with low inventory levels may
be better able than their competitors to increase sales
penetration into emerging markets. A second major
limitation of this research is the presence of survival
bias in the selection of our sample. Emerging market
penetration is not a decision variable but an outcome
Han, Dong, and Dresner: Emerging Market Penetration
Production and Operations Management 0(0), pp. 1–13, © 2012 Production and Operations Management Society
variable of a firm’s decision to invest in emerging
markets. Firms that choose to invest in emerging mar-
kets but subsequently withdraw from these markets
are not included in our sample; thus the selection bias.
Future research should be conducted to overcome
both limitations.
We also recognize a limitation in our research due
to data availability. In particular, key operational
data are not systematically reported to financial
authorities, and therefore are not captured by the
COMPUSTAT database. We cannot, therefore, dis-
tinguish between firms with the same sales penetra-
tion in a country, but with different operational
procedures (e.g., company-owned plants vs. contract
manufacturing). Certainly, different operating mod-
els will result in differential effects on inventory
supply and financial performance for the firms.
Research projects that utilize case study methodolo-
gies, rather than the large dataset approach used for
this article, may be able to deepen our under-
standing of how operating strategies impact the
relationship between inventory supply, financial
performance, and emerging market penetration. In
addition, the sample of 482 unique firms used for
this analysis is not complete, although the firms in
our sample do resemble the larger population of
firms in the COMPUSTAT database in terms of
industry representation and average firm size. Alter-
native datasets may be used in the future to exam-
ine the relationships between emerging market
penetration and inventory and financial perfor-
mance. In addition, different measures of emerging
market operations can be investigated. Sales pene-
tration was used for this research; however, other
measures, such as the percent of manufacturing
conducted in emerging markets, may provide
additional insights into the relationship among the
variables studied. Other data-related limitations
include the measures used for financial perfor-
mance. Our dependent variables (ROS and ROA)
are accounting-based and subject to limitations on
the usefulness of accounting data. Market-based mea-
sures, such as Tobin’s q, could be used for future
research.
Notes
1 Chang, D., S. M. Lee. 1995. Impact of JIT on organizational perfor-
There are 21 three-digit manufacturing sectors according
to the NAICS coding system, including food manufactur-
ing (311); beverage and tobacco product manufacturing
(312); textile mills manufacturing (313); textile product
mills (314); apparel manufacturing (315); leather and
allied product manufacturing (316); wood product manu-
facturing (321); paper manufacturing (322); printing and
printing support activities (323); petroleum and coal prod-
ucts manufacturing (324); chemical manufacturing (325);
plastics and rubber products manufacturing (326); nonme-
11
tallic mineral product manufacturing (327); primary metal
manufacturing (331); fabricated metal product manufac-
turing (332); machinery manufacturing (333); computer
and electronic product manufacturing (334); electrical
equipment, appliance, and component manufacturing
(335); transportation equipment manufacturing (336); fur-
niture manufacturing (337); and miscellaneous durable
goods manufacturing (339). Note that the textile product
mills sector (314) is not represented in the final sample.
2
“Acronyms BRIC out all over.” The Economist, September
18, 2008. http://www.economist.com/specialreports/dis-
playstory.cfm?story_id=12080703.
3
The 2006 MSCI list of emerging markets used for this
study was retrieved as of August 20, 2008 at http://www.
mscibarra.com/products/indices/equity. The International
Monetary Fund (IMF) used the MSCI Emerging Market
Equity Index to define emerging markets in its 2006 Glo-
bal Financial Stability Report-Market Developments and
Issues (http://www.imf.org/external/pubs/ft/gfsr/2006/
02/index.htm). The US Federal Reserve System also used
the MSCI list to identify emerging markets in its study of
the 2007–2009 financial crisis (http://www.federalreserve.
gov/pubs/ifdp/2010/1006/ifdp1006.pdf).
4
GVKEY information can be found at http://www.library.
hbs.edu/helpsheets/wrdscompustat.html; see more details
at http://wrds.wharton.upenn.edu
5
The 3-digit NAICS industry is used for PPI calculations.
Industry PPIs are obtained from US Department of
Labor’s Bureau of Labor Statistics (http://www.bls.gov/
PPI/).
6
We thank the Senior Editor for suggestions on the nested
random coefficients model.
7
Random intercepts at the firm level are not reported but
available upon request.
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