This paper presents a simple model to analyze the effect of geographically localized spillovers on the internationalization decision of firms. It is shown that, once spatially bounded externalities are taken into account, the standard predictions on the nature and direction of foreign direct investment (FDI) flows may be reversed. We highlight three effects. First, an FDI-en-hancing effect: the presence of spillovers increases the profitability of the FDI strategy when the competitive gap between firms is narrow. Second, a dissipation effect: firms may refrain from investing abroad for fear of diffusion of their firm-specific assets. Third, a sourcing effect: the presence of spillovers may induce a firm to invest abroad, even in the absence of exporting costs.