Theories of the Multinational Enterprise, Volume 16: Diversity, Complexity and Relevance

CONTENTS LIST OF CONTRIBUTORS vii PREFACE Michael A. Hitt and Joseph L. C. Cheng ix PART I: THEORY OF THE METANATION...

Author: Michael Hitt | Michael Hitt | Joseph Cheng

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CONTENTS LIST OF CONTRIBUTORS

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PREFACE Michael A. Hitt and Joseph L. C. Cheng

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PART I: THEORY OF THE METANATIONAL FIRM TOWARD A MANAGERIAL THEORY OF THE MNC Yves L. Doz

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MAKING SENSE OF THE METANATIONAL: DOES THE FIRM REALLY KNOW WHAT IT KNOWS? Julian Birkinshaw and Niklas Arvidsson

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YVES DOZ AND INTERNATIONAL MANAGEMENT Andrew C. Inkpen

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STRATEGIC MANAGEMENT AND THE ROLE OF THE MNC IN A POST-INDUSTRIAL WORLD MARKET Stephen Tallman

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PART II: EVOLVING THEORIES OF THE MNE NATIONAL CONTEXT AND THE METANATIONAL PERSPECTIVE IN INTERNATIONAL STRATEGY Mona Makhija and Oded Shenkar

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THE THEORY OF THE MULTINATIONAL FIRM Robert Grosse

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PART III: DIVERSE THEORETICAL PERSPECTIVES ON THE MNE THE METANATIONAL FIRM IN CONTEXT: COMPETITION IN KNOWLEDGE-DRIVEN INDUSTRIES Thomas P. Murtha

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A FRAMEWORK FOR UNDERSTANDING INTERNATIONAL DIVERSIFICATION BY BUSINESS GROUPS FROM EMERGING ECONOMIES Robert E. Hoskisson, Heechun Kim, Robert E. White and Laszlo Tihanyi

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THE INTERNATIONALIZATION OF NEW VENTURES: A RISK MANAGEMENT MODEL Benjamin M. Oviatt, Rodney C. Shrader and Patricia P. McDougall

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DISTANCE MATTERS: LIABILITY OF FOREIGNNESS, INSTITUTIONAL DISTANCE AND OWNERSHIP STRATEGY Lorraine Eden and Stewart R. Miller

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EXPLORING THE LIMITATIONS OF THE KNOWLEDGE PROJECTION MODEL IN MNCS: THE IMPACT OF EXPATRIATE MANAGERS ON SUBSIDIARY SURVIVAL Philippe Very, Louis Hébert and Paul W. Beamish

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LIST OF CONTRIBUTORS Niklas Arvidsson

Service Management Group SMG AB, Sweden

Paul W. Beamish

The University of Western Ontario, Canada

Julian Birkinshaw

London Business School, UK

Joseph L. C. Cheng

University of Illinois at Urbana-Champaign, USA

Yves L. Doz

INSEAD, France

Lorraine Eden

Texas A&M University, USA

Robert Grosse

Thunderbird, USA

Louis Hébert

HEC Montreal, Canada

Michael A. Hitt

Texas A&M University, USA

Robert E. Hoskisson

Arizona State University, USA

Andrew C. Inkpen

Thunderbird, USA

Heechun Kim


Mona Makhija

Ohio State University, USA

Patricia P. McDougall

Indiana University, USA

Stewart R. Miller

University of Texas, USA

Thomas P. Murtha

University of Minnesota, USA

Benjamin M. Oviatt

Georgia State University, USA

Oded Shenkar

Ohio State University, USA

Rodney C. Shrader

University of Illinois at Chicago, USA vii

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Stephen Tallman

University of Utah, USA

Laszlo Tihanyi

University of Oklahoma, USA

Philippe Very

EDHEC, France

Robert E. White


PREFACE The early research on multinational enterprises usually relied on traditional economic theory or relatively simple, but powerful, theories developed in the field of international business. They were developed to help us understand why firms entered international markets (e.g. Dunning’s eclectic theory). However, as the field of international management (and international business) has developed further, with more scholars from adjacent disciplines conducting research on issues of importance to international markets and multinational firms, newer, more diverse and complex theoretical perspectives have been developed and diffused. The purpose of this volume is to explore some of these important and newer theoretical perspectives. For example, herein, we examine the recent theoretical work on the metanational that emphasizes knowledge-sharing among subsidiaries on a global basis. We also explore theoretical issues related to international entrepreneurship, a new, important, and growing perspective in the field of international management. Additionally, we include work focused on the liabilities of foreignness and other critical issues in the management of multinational enterprises. As such, we believe that this volume provides a basis for future research on the multinational enterprise, and we hope that the work contained herein serves as a catalyst for such research using the different theoretical perspectives examined herein. In this volume, we specifically highlight the research of Professor Yves Doz as the recipient of the AIM-IMD Distinguished Scholar Award for 2003. Representing the last of a five-year commitment, the AIM editors in consultation with the Executive Council of the International Management Division of the Academy of Management selected Professor Doz for this major award, in recognition of his outstanding contributions to the study of international management. As a part of the tribute to his work and in a further examination of his recent research on the metanational, Professor Doz provides the opening chapter of this volume. Additionally, we invited three leading international management scholars to provide commentary on Professor Doz’s recent work and contributions to the field. As the recipient of the 2003 AIM-IMD Distinguished Scholar Award, we congratulate Professor Yves L. Doz. Professor Doz is the Timken Chaired Professor of Global Technology and Innovation and Professor of Business Policy at ix

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INSEAD. Professor Doz received his doctoral degree from Harvard University and is also a graduate of the Ecole des Hautes Etudes Commerciales (France). He has previously taught at the Stanford Graduate School of Business, Harvard Business School, the Helsinki School of Economics, and the Aoyama Gakuin University in Tokyo. Professor Doz has been on the faculty at INSEAD for a number of years, and during that time, he has also held several leadership positions. From 1987 to 1994, he led the management of technology and innovation program at INSEAD. This was a multidisciplinary effort that involved 20 faculty members and researchers over these years. He has served as the Associate Dean for Research and Development (1990–1995) and the Dean of Executive Education (1999–2002) at INSEAD. Professor Doz has been interested in, and conducted research on, strategy used in multinational enterprises throughout his career. His research has been published in a number of articles in top scholarly journals and in several major books. These books include Government Control and Multinational Management (1979), Strategic Management in Multinational Companies (1986), The Multinational Mission: Balancing Local Demands and Global Vision (1987), Alliance Advantage (1998), and, most recently, From Global to Metanational: How Companies Win in the Knowledge Economy (2001). Professor Doz has received a number of awards for his scholarly research and contributions, the most recent of which is the distinguished scholar award noted above. Additionally, Professor Doz is a fellow in the Academy of International Business and is in line to serve as chair of the 2005 annual conference for this organization. Professor Doz is a well-published and highly respected scholar who has made important contributions to the field of international management. We are delighted to highlight his research and contributions in this volume. The present volume involves a series of invited papers focused partly on Professor Doz’s recent work and on other newer and important theoretical perspectives on the multinational enterprise. These works are authored by a number of top scholars in the field from North America and Europe. The intent of this volume is to highlight and emphasize the new and diverse theoretical foci in this field and serve as a catalyst to the increasingly important research designed to help us understand and build a theory of the multinational firm. The book is divided into three parts, with the first focused on the new and visible theory of the metanational firm by Yves Doz and comments on this work and Yves Doz’s broader contributions to the field by three top scholars in the international management field. The second part contains two works that serve as a transition point emphasizing the evolving nature of theory on the multinational firm in international management research. The third part contains

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five papers that present diverse yet highly important theoretical perspectives on the multinational enterprise. We commend this research to you and hope that it plants a seed from which future excellent research in the field of international management will be based. Michael A. Hitt and Joseph L.C. Cheng Series Co-editors

TOWARD A MANAGERIAL THEORY OF THE MNC Yves L. Doz INTRODUCTION This introductory chapter presents a personal perspective on the challenges of building a managerial theory of the multinational corporation (MNC). By managerial theory, I mean a practice theory (Van de Ven & Johnson, in press); i.e. a theory that draws upon discipline-based knowledge to show how more general abstract conceptual analysis can be brought to bear on specific real-life managerial problems (Simon, 1996). Developing such a managerial theory is fraught with challenges and pitfalls. Such a theory has to provide a conceptual link between academic disciplines (traditional science or at least academic research) and practical knowledge (learning from action). Each follows very different theory building rules (Christensen et al., 2002; Cook & Brown, 1999;Van de Ven & Johnson, in press), and yet a managerial theory needs to incorporate both. It needs to be useful in the context of an evolving phenomenon: Today’s global companies neither carry the same activities nor draw their legitimacy or competitive advantage from the same sources as yesterday’s multinationals. A theory that attempts to bring theoretical disciplines to bear on practice also needs to be multidisciplinary and eclectic. Thus, there are three challenges addressed in this chapter. First, a managerial theory needs to be broad-gauged, not only relying on academic disciplines, but also analysing and explaining the actions and behaviours of managers in context, i.e. both in the organizational and structural context within which they operate in their companies (Bower, 1970) and in the broader economic, political, and technical context, which gives rise to, and justifies the existence Theories of the Multinational Enterprise: Diversity, Complexity and Relevance Advances in International Management, Volume 16, 3–30 Copyright © 2004 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 0747-7929/doi:10.1016/S0747-7929(04)16001-0

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of, the MNC as an institution for the governance of cross-border exchanges. A prerequisite is to build such a theory, seeing the traditional international business “schools” of transaction-cost economics and of management process as complementary contributions, rather than opposing perspectives. Second, a management theory of the MNC needs to be able to capture an evolving phenomenon, and thus to be rooted in its history. The MNC arose as an organizational phenomenon in response to specific historical circumstances. Here, we are researching a phenomenon of real-world importance and of some complexity, and a phenomenon that keeps evolving over time. As transaction governance forms and technologies keep changing, so do the specs of MNC efficiency and effectiveness: They are called to perform different functions and offered different opportunities in the world economy. This means that our research agenda, as scholars of the MNC phenomenon, keeps evolving and needs to track or, better, intercept a moving target. Today, the move from operational efficiency to innovative effectiveness as a key source of competitive advantage and the growing role of knowledge, in particular complex, geographically distributed and locally rooted knowledge, as a strategic resource central to innovation capabilities pose new challenges to MNC managers and researchers alike (Doz et al., 2001). This “moving target” nature of the phenomenon raises various challenges for theory building. Do we need to anticipate the phenomenon? Do we need to develop a dynamic theory that will have resilience? Should we create a theory of change and evolution? Should we, like business historians, merely document and analyse its unfolding past? Or perhaps, as journalist do, should we chronicle the current developments and, at best, collect the facts that future scholars will analyse? The latter two alternatives are not academically attractive, the former are perhaps not feasible. Third, like the economic theory of the MNC built by Dunning (1981, 1988, 1993) a managerial theory needs to be eclectic, to borrow models, tools, prisms, and conceptualizations from several underlying disciplines and to integrate them effectively (Doz & Prahalad, 1991). This in turn means that our work will perhaps never have the simplicity or the elegance of more abstract theory building; here, we are developing a practice theory, not an abstract academic model. Although this inevitably makes our research more difficult, and the theorizing we can strive for more complex and less elegant than research in the context of a single discipline, multiple disciplines need to be drawn on to further our understanding of this phenomenon.

THE CHALLENGE OF BUILDING A BROAD THEORY Research on the management of multinational corporations (MNC) has proceeded essentially along two distinct tracks that are, in principle, complementary but, in

Toward a Managerial Theory of the MNC

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reality, often quasi-antagonistic. Economists have placed a long tradition of MNC research in transaction-costs economics (Coase, 1937; Williamson, 1975), explaining the development of MNCs and identifying the challenges their governance poses as a consequence of market failure in the global resources MNCs arbitrage, such as knowledge, and in the type of goods they produce, such as differentiated engineered products and branded consumer goods (Buckley & Casson, 1976; Caves, 1982; Hymer, 1960/1976). Essentially, they adopt a functionalist “outsidein” perspective, where managerial action and drive are only incidental, and where MNCs grow, and succeed or fail, as a function of the need for them in the world economy. Some MNCs will succeed, and others will fail, but at an aggregate level, the economic role they need to play will be fulfilled. Management scholars, often more phenomenon-driven than discipline-based in their approach, and often preoccupied with explaining and influencing the strategy and performance of single firms, rather than with economic aggregates, have developed a second track, with origins in a resource-based, firm-specific, and management-led, drive for growth (Penrose, 1959; Wilkins, 1970, 1974) rather than in market failure. In this perspective, management entrepreneurship seeks markets, discovers value-creating arbitrage opportunities, and mobilizes firm-specific resources and capabilities to exploit them. This is essentially an “inside-out” perspective, where the manager is centre stage. An obvious but useful practical starting point for the first track is simply to acknowledge that the management of the MNC must reflect the value-creating role MNCs need to play in the global economy as an institutional form. In other words, managers must enable their firms to perform their economic role efficiently. Historically, in this research tradition, MNCs have been seen as means to compensate for market failure in the process of economic globalization, starting with the colonial trading companies (which were mechanisms to share risks between private entrepreneurs and governments). In their wake, MNCs emerged to access scarce materials (and internalize and control their trade), to find new customers (and control distribution and intellectual property rights, particularly for branded and engineered goods), and to take advantage of lower-cost labour, energy, and capital, and control their use and international leverage. In seeking resources and markets, MNCs projected home-based innovations and technology, as well as marketing and operating process skills (e.g. manufacturing, logistics, etc.) to new markets and environments, following a product life-cycle model, and a step-by-step internationalization logic (Johanson & Vahlne, 1977; Vernon, 1966). According to this view, common ownership and an integrated hierarchy provide a better mean to access materials and other production factors and to find and serve customers, and even more so, a better means than markets to deploy globally innovations and capabilities first developed in the home base (Kogut & Zander,

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1993). Transaction costs and agency problems were in principle addressed by the MNC as an institutional form. MNCs internalize activities and transactions they can govern more effectively than markets would (Caves, 1982). From a management perspective, this approach sets the minimum performance specs of the MNC, to exist as a superior alternative to other institutional arrangement, and thus indirectly sets an agenda, and performance thresholds, for managerial action. It also points to the need for organizational arrangements and processes to address agency problems effectively within the firm, and the potential difficulty of doing so (Moran & Ghoshal, 1999; Nahapiet & Ghoshal, 1998). The second track, largely independent, and occasionally deliberately purporting to be “different” from the first, stems mainly from the grounded, inductive work of management scholars, finding its source and initial inspiration in business history (Wilkins, 1970, 1974) and grounded observation of MNC managers. Without necessarily knowing it, these researchers were building a practice theory. They often belonged more to a European scholarly tradition, mostly with Nordic roots.1 Because their focus was on the MNC as a historical phenomenon, as observed by researchers carrying out fieldwork in corporations and reported by their managers, with their disciplinary basis often quite distinct from economics (e.g. history, sociology, institutional theory, organizational theory, ethnography) and their methods not always compatible with quantitative empirical econometric analysis, the work of these management researchers evolved largely independent from the economic perspective. Although, in actuality, and with the benefit of hindsight, the work from this series of management scholars now appears cumulative, taxonomic and language differences slowed its progress and led to a proliferation of seemingly different, but in fact rather similar, conceptualizations often purporting to explain the same realities. Although their contributions are richly nuanced and interestingly differentiated, these managerial researchers concentrated for the most part on three key related issues: (1) Once the firm has spread internationally, how should it combine the efficiency of cross-border integration of activities (vs. the simplicity of stand-alone autonomous local operations) and the effectiveness of responding to differences among national markets and public policy contexts by differentiating its offerings and activities (vs. the simplicity of uniformity), leading to the integration/responsiveness (I/R) framework and its derivatives (Bartlett & Ghoshal, 1986, 1989; Doz, 1979, 1986; Porter & Fuller, 1986; Prahalad, 1975; Roth & Morrison, 1992)?2 (2) What blend of management systems, structures and processes would allow the MNC to perform better than markets in managing the resource exchanges


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called for by the combination of integration efficiency and responsiveness effectiveness, and thus justify internalization (Bartlett & Ghoshal, 1989; Hedlund, 1986), and how narrowly cut and finely tuned can such a combination be to individual businesses, locations, market segments, functions, etc. without becoming unmanageable? (3) How can the balance of I/R capabilities be purposively changed in response to market liberalization and convergence, technological changes, new competitors, and other external demands, in particular when that change goes against the natural evolution of an organization and needs to be finely adjusted between functions in a business and between businesses in a diversified MNC (Doz & Prahalad, 1981; Prahalad, 1975; Prahalad & Doz, 1987)? Of course, in the same way as it had several prescient antecedents (e.g. Perlmutter, 1969), many further developments characterize the evolution of the managerial research tradition on the MNC (e.g. Asakawa, 1996, 2001; Malnight, 1995, 2001). Two of these further developments are particularly noteworthy, because they triggered a reframing of the research agenda. First, Bartlett and Ghoshal explicitly brought a third dimension to the I/R framework: innovation and/or learning. Although the critical role that local knowledge could play in conferring influence and power to local subsidiary executives in their relationship to corporate headquarters and other subsidiaries had been recognized earlier (e.g. Doz, 1979), the responsiveness argument had largely been seen as a need to adapt to differences, not as an opportunity to learn and innovate from differences. Yet, although Bartlett and Ghoshal point to the “transnational solution,” they do not really explain how it would work in practice beyond differentiated roles and relationships among national subsidiaries and managers aligned to various dimensions of a matrix organization in a MNC network (Ghoshal & Bartlett, 1990). In articulating the challenge of distributed knowledge creation as turning the MNC into an almost recomposable system, and outlining a dozen prerequisites for such a system to innovate successfully, Hedlund (1996) took this argument significantly further. Second, while early perspectives had been largely architectural “top down” conceptualizations of MNC structures and processes, Birkinshaw focused on the key importance of subsidiary initiatives and entrepreneurship in making the opportunity to learn from differences a reality (Birkinshaw, 1996; Birkinshaw & Hood, 1998). While Hedlund emphasized integrative mechanisms, Birkinshaw emphasized the key role of subsidiary-driven differentiation. Both, however, still rely on existing subsidiaries as the founts of differentiated, innovative knowledge. Bridges between the managerial and the economic perspective have been relatively few, several prominent examples being provided by Dunning (1981, 1993), Ghoshal (1987), Rugman and Verbeke (1998, 2003a), and Vernon (1966), and

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have typically gone only part of the way. Most researchers used one tradition or the other as a position from which to frame issues pertaining more squarely to the other. Essentially, though, and despite its structuring role in the international business academic community, the economic vs. managerial distinction is practically a false dichotomy. The economic perspective sets the specs for managerial action: The MNC has to be superior, more efficient, and more value-creating (including the discovery and exploitation of new opportunities) than alternative, mostly market-based, governance forms for the leverage and arbitrage of resources across borders. How, and with what success corporate leaders and managers then endeavour to meet these specs is the purview of a managerial theory, or perhaps more exactly a theory of the management of the MNC. But a complete theory would require both. Purposive strategic management action cannot be understood outside its broader context, and in the absence of efficiency and effectiveness criteria, lest research confine itself to purpose-free description and analysis, a rather pointless exercise. At the same time, ignoring the impact of management choices and of how successfully they are implemented would lead to economic models that would not sustain managerial implications. If we accept that a managerial theory has to incorporate variables on which managers can act (Donaldson, 2002) and needs to lead to prescriptive conclusions on which managers can take enlightened action (Christensen & Raynor, 2003), the economic and managerial traditions become the two sides of the same coin. The real difference between economists and management scholars lies elsewhere; i.e. in how the scope of a good theory is defined. Essentially, economists define the scope of the theory more narrowly than management scholars. Their primary focus is on how extrinsic forces, such as geography, technological change, demographics, and politics, among others, give rise to and explain the existence of the MNC and its boundaries. Questions about modes of market entry and other contours of firm boundaries take them into managerial territory (e.g. Hennart, 1982), but the research questions they ask are seldom about management processes and managers’ actions. Some management scholars, in their most extreme pronouncements,3 argue that agitating alternative models and provocative hypotheses – true or false – in front of managers gives them food for thought and jolts them out of their routine action and conventional wisdom. The action they may take on the basis of this newly stimulated and broadened cognition is their purview, and sole responsibility. Both miss the fertile ground for managerial theory building. Describing and inductively building theories from the observation of management action and behaviour, and then deductively testing their accuracy and boundary conditions, are key missing links between the economic theory of the MNC and managerial

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Fig. 1. A Full Managerial Theory.


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prescriptions (Christensen et al., 2002). In fact, this has to be the heart of a managerial theory, not just a theory built on statistical correlations and econometric analysis, but a theory built on in-depth understanding of the phenomenon. Figure 1 shows the scope of a managerial theory of the MNC. Obviously, entry points remain different among researchers, and most contributions can address only part of the total scope. Yet, integrative managerial frameworks are also needed. The “I/R” grid, simple as it is, has demonstrated enduring power as an integrative way to map key managerial challenges faced by MNCs. It is not only that it captures key trade-offs,4 but also, and perhaps more, that it spans levels of analysis and covers the scope of an integrative managerial theory shown on Fig. 1. The I/R grid applies from the level of national economies and industries, at the most aggregate level, to the mental maps and cognitive schemes individual managers hold at the most disaggregated (Murtha et al., 1998). It also provides both an integrative normative tool and a way to derive prescriptions for individual businesses and companies.

THE CHALLENGE OF BUILDING A DYNAMIC THEORY The role of the MNC in the global economy has kept evolving, as its role of conduit for leveraging strategic assets for which external markets are difficult to create and establish has changed. Strategically, this can be seen as a “race” between the increase in the efficiency of markets (including relational contracting and alliances) for a given strategic asset – such as a knowledge asset, say TQM – and the advantage of the MNC as a conduit for arbitraging and leveraging that asset across locations. As the knowledge matures and becomes codified and explicit, and as specialized providers develop, the effectiveness and efficiency of the MNC compared with alternative arrangements declines, leaving a lesser role for integrated hierarchies and allowing a greater role for markets. Similarly, “commoditized” assets cease to confer a competitive advantage to the MNC and lead to outsourcing to companies such as contract manufacturers or designers, which do not have the same profitable opportunities as the MNC but may have a superior efficiency and better skills for these particular tasks by pooling the needs of various MNCs. In other words, what MNC managers manage keeps shifting over time as a function of what the MNC can arbitrage best across locations, among a range of strategic assets that keeps evolving. In other words, the strategic agenda of MNC management keeps changing. External demands and constraints on MNCs also keep changing. Recent decades have seen a partial withdrawal of the state as a constraint, as liberal states and supranational organizations such as the EU, NAFTA, and the WTO have


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prevailed. This has allowed a whole range of formerly state-controlled industries, from electrical equipment to media and communication, or banks, to become more globally integrated. However, in a partly globalized world (a reality rediscovered by Ghemawat, 2003, after Vernon, 1971 and others), new agents occupied the space vacated by the states. Globalization has opened a much greater opportunity for global customers to strike a global supply agreement for MNCs and limit the extent of price discrimination they can exercise, at least toward major customers in developed countries. On a number of dimensions, NGOs have become a very significant force to reckon with, substituting for weakened states in developed countries (e.g. for environmental protection) and for failed states in poor countries (e.g. for trade in “blood” diamonds). The power of NGOs, and the range of constraints they impose on MNCs, keeps shifting and, more than most states’ policies, is only revealed through action. This is difficult, therefore, to anticipate for MNC managers, and so any managerial theory of the MNC has to be a dynamic theory, a theory of pluralistic change and evolution. Multiple forces affect the evolution of MNCs, with different actors, different resources, and different objectives. Further, different strategic assets, originating in different places, raise different management challenges for MNC executives. Some strategic assets, such as funds, are highly mobile but also very volatile. Complex knowledge, at the other end of the spectrum as a strategic asset, is entirely different: locally embedded, sticky, collective, tacit, and needing to be used, not to decay. These differences make it both easier to manage (e.g. it has positive externalities) and more difficult (e.g. it is not fungible and is locally sticky). Resource allocation heuristics drawn from the experience of one type of strategic assets will falter when applied to new ones. In a perhaps even more challenging way, the nature of some strategic resources also shifts over time: Today’s young executives may not have the same appetite for prolonged expatriation and nomadic lives as their parents. A world where wars are waged against ill-defined terrorist organizations which strike anywhere without warning or rules of engagement may further increase the difficulty of traditional expatriation patterns. This may have profound implications for the organization and management of MNCs. Finally, the continued existence of the MNC as an institutional form is contingent upon the discovery, by MNC managers, of new strategic assets for which the MNC, as an institutional form, enjoys an arbitraging advantage. The continued development of MNCs, therefore, is a co-evolutionary result of the interaction of their discovery of new strategic assets and of new management tools and processes to harness and arbitrage them effectively. First, the international leverage of firmspecific assets created at home, such as new products and processes, innovative service concepts and business models, and the projection onto overseas markets

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and operations of the knowledge their deployment required were the key elements of the management agenda. Later, as MNCs started to integrate regionally or globally, the management of distributed but interdependent operations became the focus of attention. In the 1980s and 1990s, the deployment of new management disciplines, access to large new emerging markets, and the efficient streamlining of sourcing networks and supply chains globally were at the forefront of management agendas. Innovating from dispersed sources of complex knowledge is part of today’s agenda.

Organizing for Deployment: The Logic of Projection Projection takes knowledge created “at home” in the country of origin of the MNC and leverages it internationally to gain advantage in foreign markets. The simplest form of projection is replication. Most MNCs have expanded globally first as replicators. Perhaps the most basic replication vehicle is exports: extending the sales network, via distributors and other agents, to sell domestic products globally. Products used in export markets embody home-base knowledge and allow users to capture its value. For instance, Japanese quality, and the huge knowledge base that underpins it, is embodied in the pickup trucks that ply the African bush, but very little of the underlying knowledge is shared with Africa. In service businesses, which do require local activities, localized product creation, replication through franchising, and cloning, a business recipe has obviously been prevalent (Szulanski & Winter, 2001). Manufacturing locally with standardized plants and processes, as do many Japanese MNCs, or the introduction of home-base marketing and sales practices to new markets, as Xerox did with leasing and per-copy pricing for copiers, are more elaborate aspects of a projection strategy. Knowledge is embedded in systems and procedures, and in some cases in physical assets, such as machinery. In a projection strategy, knowledge flows are selective and one-way. Headquarters transfer knowledge to foreign operations on a “need to know” (for local replication) basis and package that knowledge in a way that makes it as immune to local contextual variations as possible. This is typically achieved by both making the knowledge as explicit and context-neutral as possible, and making the knowledge package comprehensive and complete, minimizing the interfaces, in particular those that cannot be specified ex ante, between the transferred knowledge and its recipient context (Doz et al., 2003a, b). Global functional forms of organization have been historically most effective vehicles for successful knowledge projection because they focus on specialized knowledge and extend beyond borders. This, however, puts the international


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managers in a dependency position on headquarters, in particular since the activities most likely to be extended abroad, and the projected knowledge they embody, are often those where the headquarters’ influence is strongest, such as sales and manufacturing. “Recipes” imported from the home country of the MNC are usually to be followed faithfully, with no departure from the procedural script. This is perhaps best illustrated by the Intel strategic motto: “copy exactly.” Whilst this may suit Intel well (after all, one may not want to tinker with a semiconductor “fab,” given its billion dollar investment cost and how complex and difficult its operating processes are), other companies where blind replication may not be optimal obviously suffer from it. For instance, Unilever discovered only fortuitously, and then exploited, a large market for low-end detergents in emerging countries. The unexpected entry of a local detergent-maker, Nirma, in India, which created a low-end market from which it grew into a strong and dangerous competitor, triggered a response from Hindustan Lever, Unilever’s local subsidiary. This was followed serendipitously by a young Brazilian manager, who learned about the experience in India during his secondment to Pakistan. Back home, against the advice of market researchers who claimed that there could not be a low-end detergent market segment, he nonetheless decided to emulate the Indian product in Brazil. His product became a major success. Unilever’s success in this case unfortunately is more the exception than the rule, even for Unilever. Put differently, the logic of projection and replication blinds most companies to opportunities that do not emulate activities at home, in markets that do not mirror the home market’s conditions. The logic of projection thus rests on three key deployment and control mechanisms: (1) knowledge replication; (2) resource dependency (on innovation and knowledge developed in the home base of the MNC); (3) normative isomorphism to the home country’s operations (Westney, 1993). Supportive mechanisms may be used, such as relying on expatriate managers who will adhere faithfully to corporate procedures, partly because they do not know any better, or different, and partly because they see their future up the corporate ladder back at headquarters. Even where it made the most sense, as for semiconductors, in the long run projection becomes a self-defeating approach, likely to fall a victim of its own success. It loses energy with the maturing of an industry and of its technological and marketing skills (the contributions from headquarters becoming less valuable) with entry of the MNC to markets whose characteristics depart from the home base, as it spreads widely around the globe, with innovation being driven more by

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customer needs than by technology breakthroughs, and with the growth of local capabilities in its subsidiaries. Local customer and government demands may also take the company increasingly further from the businesses where its home base is strongest, e.g. Philips moving into telecom and defence electronics in the U.K., Germany, and France, far from its lighting and consumer-products roots. Subsidiary managers are sometimes all too willing to respond to these demands, not just because they may open profitable business opportunities, but also because they offer an escape from what they sometimes perceive as a stifling dependence on headquarters. Historically, political fragmentation forces have also been at play, for instance with antitrust consent decrees in the U.S. imposing competition among subsidiaries of an MNC (e.g. Timken; see Pruitt, 1998), or even with wars forcing its units to be independent (like Philips’ U.S. holdings being grouped in an independent trust, to escape confiscation as enemy property once the Netherlands had been invaded by Germany in World War II). As the value of central knowledge provided through projection declines, exit or adjustments may become necessary. Some companies’ strategies planned for a timely exit from the start, such as Corning (before its recent exclusive focus on optical telecom). Corning became internationalized mainly through joint ventures with local companies, with Corning providing innovative technologies, local partners providing market access, local plants and investments, and application/market development insights. As a given industry matures, and as Corning’s technologies become less valuable to the partner, Corning exits, usually by selling its share of the joint venture to the local partner, recognizing that the value of the knowledge assets projected on the joint operations declines. Adjustments to a projection strategy that has run its course, in markets and technologies that have matured, call for a shift in the competitive logic of the MNC from home-country innovativeness to system-wide efficiency, usually obtained through a strategy of global or regional integration.

Organizing for Efficiency: Overcoming Fragmentation Historically, most traditional MNCs, did not respond rapidly to the weakening of the projection logic. Over time, they evolved from projection to the autonomy and independent national responsiveness of individual subsidiaries, weakening their competitive position as industries globalized and new competitors came in (Hamel & Prahalad, 1986). Inaction was partly the result of external conditions, with country units in a relatively fragmented world making sense until recent efforts at regional integration and global trade liberalization. Inaction was also the result


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of internal inertia and of the extreme difficulties of overcoming fragmentation once it had set in (Doz, 1979). This led, over time, to a growing autonomy of local subsidiaries, which adjusted increasingly on their own to the peculiarities of their own markets, sometimes over-emphasizing them in their desire to convince headquarters of the need for adjustment to local conditions. When local contexts happened to be munificent as markets, and thus to allow good subsidiary performance which earned credibility at head office; when they happened to be lead-locations (in the sense of being harbingers of future global changes and sources of new market and technical learning); and when the subsidiary manager happened to be entrepreneurial and committed to the development of his subsidiary, subsidiaries took the initiative to overcome fragmentation on their own and grew into a source of innovation for the whole MNC (Birkinshaw, 2000). Despite its underlying strategic value, and often top-management support, this was usually achieved only against the grudging opposition of headquarter staff, and usually succeeded only because the local subsidiary happened to make very valuable and timely contributions, i.e. offers that could not be refused. Fuji-Xerox in Japan, Hewlett-Packard’s Singapore subsidiary, and Intel-Israel provide fascinating examples of that process (Doz et al., in press). Yet, such successful subsidiary entrepreneurship is the exception rather than the rule. The shift to a strategy of efficiency through integration is usually initiated late, in response to a performance decline or, at best, in anticipation of a crisis, given weakening strategic positions, even if financial performance still appears satisfactory. The reasons why the shift from multidomestic fragmentation to global integration and efficiency is so extremely difficult have been recognized years ago (Doz & Prahalad, 1981), and so have been the pitfalls facing a change process (Prahalad & Doz, 1987). Radical reorganization, e.g. from geographic to product (or business unit) structures, has also been recognized as difficult, and potentially dangerous, leading to over centralization, the fragmentation of international expertise, and a frequent retreat from international markets (Davidson & Haspeslagh, 1982). Although many MNCs disbanded their international divisions early, in an attempt to internationalize domestic operations (Stopford & Wells, 1972), the resulting lack of a strong voice, and of a focal point for internationalization expertise triggered retrenchment and rationalization, and stifled further international expansion. This is partly because the relevant knowledge is distributed, and imprisoned or left dormant and tacit, in the various national subsidiaries, as the customer knowledge usually resides there. Replacing a geographic organization with a global business unit structure destroys this local knowledge and replaces it with “out of context” global knowledge, held centrally in business unit headquarters, but of limited relevance to local markets and of no credibility to subsidiary managers. Rather

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than fostering efficiency, restructuring into global units, or even into a matrix organization, thus sometimes leads to infighting, higher costs, and increased fragmentation. The discomfort and lack of familiarity of central executives with the actual condition of international markets leads to further retrenchment. Successful transitions have been characterized by a patient “re-weaving” of the organizational fabric, rather than by radical structural reorganization. Typically, this called first for breaking monolithic organizations into smaller more focused units, which are easier to change: product lines, industry markets, and functions within countries. Second, some degree of multidimensionality was introduced through less formal arrangements than matrix organizations, such as communities of practice and various ad hoc integration tools, around project management, quality deployment disciplines, and common platforms (Doz, 2005) providing for a “matrix in the mind” (Bartlett & Ghoshal, 1990) without the full range of organizational tensions sometimes faced by managers implementing a full matrix management process. This, in turn, has led MNC managers to a shift in focus from structural to process solutions, a change identified (in a “mirrored” way by considering the evolution of the content of the research of MNC management scholars) by Martinez and Jarillo (1989). This shift to a process orientation on the part of MNC managers was later confirmed, at least in selected multinationals, by various clinical studies (Dalsace & Doz, 2001; Malnight, 1995). Yet, by moving toward progressively smaller units of adjustment, and increasingly fine-grained mechanisms (e.g. shifting from business unit-level adjustment through organizational structures to market segment-level adjustments through rearranging business processes, to individual task- and interface-level adjustments through redefining individual managerial roles), the process emphasis can go only so far before it leads to a differentiation-integration challenge of such magnitude as to make the management task impossible. Shifting perspective from issue to issue, meeting to meeting, and task to task taxes the cognitive and emotional capabilities of managers. This challenge had led scholars of the MNC to pay increasing attention to forms of collective regulation that do not require common management, but rely on mutual adjustment within an architecture not only of management processes but also of values and common identities. Drawing on Simon’s view of almost decomposable systems, Hedlund’s concept of a “holographic” organization (Hedlund, 1986) provided the starting point for this line of thinking. His conceptualization of MNCs as “nearly recomposable systems” developed it further (Hedlund, 1996). More recently, this polycentric self-structuring perspective received additional momentum from the vogue of complexity theory applied to management (considering organizations as complex adaptive systems) and from the growing body of research on the structure and sociology of networks (e.g. Nohria & Ghoshal, 1997) and on the importance of social capital in organizations (Kostova & Roth, 2003).


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Yet, in the process view, the combination of a focus on efficiency through global integration and of network-based conceptualizations has often led to a somewhat restrictive view of both knowledge and innovation. The ambiguity about the third dimension of the I/R framework, sometimes presented as innovation sometimes as learning, has added to the restriction because learning and innovation are actually quite different: Learning is typically incremental, achieved through repeated practice, and based on existing knowledge. Therefore, approaches such as “best practice” identification and sharing, and knowledge-management tools and processes work for incremental learning. This vogue of best practices has led to another toxic side-effect: a naive emphasis on explicitation, codification, and the reduction in knowledge to information in a drive to make knowledge more mobile and more amenable to the use of IT-based “knowledge management” tools (Doz, 2004). Innovation is a different story. It does not stem easily from continuous learning, but requires radical departures from the existing knowledge and perspectives embedded in the operating organization. The knowledge it requires lies not in the organization, but outside, in new markets where the company is not yet present, in innovative labs, with trendsetting but not always very credible, ex ante, customer groups (Doz et al., 2001). The way in which new and disparate knowledge elements are to be combined is not known ex ante; the underlying knowledge architecture of the opportunity must be discovered and reflected in the structure of the innovative project and, ultimately, in that of the new product, service, or application, and of its value proposition and activity system. The potential value of such genuinely polycentric, distributed, networked approaches to true innovation, as distinct from continuous improvement, has become more evident as we have witnessed companies placing increasing emphasis not on operating efficiency (by now a qualifying but not a winning capability, i.e. necessary but not sufficient), but on innovative effectiveness, and doing this in a new context of growing knowledge dispersion. This calls for internalizing knowledge flows. Knowledge markets are hard to organize for several reasons. If the knowledge is explicit, it retains its value only as long as it has not been shared, calling for ex ante contracting. If the knowledge is not explicit, its transfer is difficult, and the recipient will not trust its own ability to use the knowledge. In both cases, markets for knowledge fail.

Organizing for Global Innovation: The Metanational Leaders of MNCs came to realize that innovative capabilities are the next competitive differentiator at the same time as knowledge sources, and their innovative potential, became increasingly dispersed around the world.5 In some

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industries, such as flat panel displays, early successful entry has been possible only to entities and alliances that combined sources from multiple continents (Murtha, this volume; Murtha et al., 2001). What MNCs now seek, or ought to be seeking, is dispersed knowledge that can fuel their innovation capabilities. Such knowledge is not only dispersed, but also locally specific and locally rooted, because of the localized nature of knowledge creation – the “S” (for socialization) of collective tacit knowledge created in Nonaka’s model (Nonaka, 1991; Nonaka & Takeuchi, 1995) – and because of its context-dependent nature (Brannen et al., in press; Kostova & Roth, 2002; Szulanski, 1996). The locally embedded nature of knowledge creation and the difficulty in sharing context-dependent knowledge at a distance strongly suggest co-location of innovation teams; hence, this a first challenge when knowledge is dispersed. Indeed, either as an accepted assumption of the innovation process or as a normative recommendation, nearly all the research work on innovation outside the international business field is based on a co-location assumption. Second, because innovations were usually achieved through co-located processes, mostly at home or in a few dispersed centres of excellence (a polycentric organization, but one still for knowledge projection), knowledge flows were essentially one-way: centre to periphery, to “support” the diffusion of innovations within the MNC network. Most management researchers still consider knowledge-sharing as knowledge projection from the centre, and theorize it implicitly or explicitly, as one-way knowledge diffusion.6 Perhaps, because they are still vastly more frequent, perhaps given the nature of the firms studied (e.g. innovative Swedish MNCs), or perhaps because researchers implicitly assume the traditional model of internationalization, the bulk of this work assumes knowledge projection (Buckley & Casson, 1976; Kogut & Zander, 1992, 1993; Kostova, 1999; Kostova & Roth, 2002). Refreshing exceptions are provided by Cantwell and Janne (1999), Frost (2001), Frost and Zhou (2003), and (on strategy innovations) Regner (2003). With growing knowledge dispersion, the issue of reversing the knowledge flow, and bringing together dispersed inputs into the innovation process became particularly relevant. The importance and difficulty of the challenge were recognized earlier, as it became clear that the source of advantage – what MNCs actually contribute to globalization that markets still cannot – is an efficient and effective form of multiplex knowledge sharing (Conner & Prahalad, 1996; Ghoshal, 1987; Kogut & Zander, 1993; Rugman & Verbeke, 2003b; Teece, 1977; Vernon, 1979). In the course of our recent research (Doz et al., 2001, 2003a, b), we identified, and conceptualized an “ideal-type” company, as a prototype of a global innovator, which we called the metanational company. In broad overview terms, and stated


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in a style that provides an example of how a practice theory could be written, it comprises the following:7 The Company’s “Sensing” Network In order to rise to the challenge of increased knowledge dispersion, a company needs to extend its capabilities in identifying new sources of relevant technologies, competencies, and understanding about leading-edge customers, beyond locations where it already has subsidiaries. This means learning how to sense and process this complex knowledge into a form that the corporation can use efficiently. But identifying and accessing knowledge that rivals have already mastered will only bring competitive parity. Building new sources of competitive advantage requires a sensing network that can identify innovative technologies or emerging customer needs that competitors have overlooked – a network that pre-empts global sources of new knowledge. The prevailing logic of sensing is discovery and reconnaissance. Sensing involves the following: the capacity to identify a sensing need – a goal, even if broadly defined, is essential to move from aimless exploration to purposeful reconnaissance work; the capability to prospect the world for sources of relevant knowledge, unearthing new pockets of knowledge ahead of competitors; the capacity to access new knowledge once its location is identified – not a trivial task when the required knowledge is complex or when it needs to be pried loose from a tightly knit local club. A company’s sensing network may comprise: alliances with lead customers, suppliers, other partners, or even competitors who can provide access to new market or technical knowledge; targeted acquisitions to access specialist know-how; links with venture capital funds to intercept promising new technologies or ideas at an early stage; cooperation with universities or research institutes in various parts of the world; “roving reporters” charged with identifying and assessing out pockets of emerging technologies or new customer applications; existing subsidiaries and sites as they generate new knowledge in the course of adapting products and services to local markets. Magnets to Mobilize Dispersed and Fragmented Knowledge It is clearly not enough for a company to amass a rich hoard of knowledge from around the world. Stopping there may render a company exceptionally

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well informed, but impotent. Leaders in the knowledge economy will be those companies that can not only access this dispersed knowledge, but also mobilize it to create innovative products, services, processes and business models, and then leverage these innovations across the world’s markets through a large-scale, efficient network of operations. This requires the construction of a set of structures (which may be virtual, temporary, or both) to translate new knowledge into innovative products or specific market opportunities. These new structures (evidence suggests that existing operating units and systems will seldom do the job) need to mobilize knowledge that is scattered in pockets around the corporation and use it to pioneer new products and services, sometimes with the help of lead customers. We call these structures “magnets.” Their prevailing logic is one of entrepreneurship and mobilization. They may take the form of a project to develop a new solution for a lead customer, to design a global product or service platform, or of a network of units staffed by people dedicated to mobilizing and leveraging knowledge scattered around the world. Whatever their organizational form, these magnets attract dispersed, potentially relevant knowledge and use it to create innovative products, services, or processes, and they then facilitate the transfer of these innovations into the network of day-to-day operations. Infrastructures and Processes to Leverage Innovations Once a new product, service, or business model has been pioneered, its profit potential must be realized. This means scaling up the supply chain, improving efficiencies, making incremental improvements, and engineering local adaptations. Most multinationals are already proficient in this arena where the logic is efficiency, flexibility, and financial discipline. The evolution of MNC management challenges, from projecting home-base advantage to fostering global innovation, highlights a fundamental challenge for scholars researching MNCs. With the exception of broad integrative models that are both taxonomies and conceptual structures that can accommodate multiple levels of analysis and shifts in the importance of various factors (e.g. Dunning’s “OLI” model, perhaps the “I/R grid”), and of discipline-based models applied to the MNC among other things (e.g. transaction-cost economics, neo-institutionalism), none of which is a managerial theory of the MNC, our contributions to developing such a theory must recognize that both the specs set for MNCs by external demands and opportunities and the managerial agendas of their leaders keep changing. A consequence of this reality of MNC management being a moving target is that research work from one period will almost inevitably look dated in future periods, unless integrated in a dynamic theory, or carefully considered by scholars


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as part of the historical evolution of the international management field. This raises several difficult issues for researchers. First, the dynamic nature of the MNC phenomenon confronts them with a trade-off between building a practice theory that attempts to lead practice, i.e. to research emerging managerial agenda or even try to anticipate them, or to lag practice, i.e. to study existing management behaviours but at the risk of constantly finding the leading edge of managerial agendas running ahead of their research.

Finding The Right Balance Between Conceptual Intercepting and Empirical Reporting The fact that the MNC management agenda keeps shifting yields a dilemma for academic research. Typical empirical, positivistic, work will normally be lagging reality and will relegate scholars to the position of chroniclers and ex post theorizers. In other words, as scholars, we will document, analyse, and propose to explain history. This may still be useful to lagging firms that follow (late) a conventional path, perhaps not a road to greatness. The relevance of such work to executives in leading companies will almost necessarily thus be limited. Relevant work does not need to collect, categorize, and conceptualize widely practised (average) management structures, processes, and skills, but should “intercept” emerging management agendas (from the discovery of new strategic assets and seizing up the management challenges they raise). Such an exercise is obviously dangerous. First, one needs to develop a new theory and identify leading practices. Research data and evidence are used to stimulate and test one’s own thinking (e.g. with additional cases testing findings from prior cases; see Eisenhardt, 1989). Data may be presented to support and illustrate a point of view and theoretical construct, with the particular examples being presented not to allow inductive derivation of the construct but to provide an illustrative interpretation (Ghoshal & Bartlett, 1990, 1994). Research writing is open to the criticism of being ideological – of presenting a distorted and self-serving depiction of reality – and of being empirically flimsy.

Finding an Appropriate Level of Conceptualization A possible reconciliation of these tensions is to develop both mid-level theories of great relevance, but perhaps for a limited period, and higher-level, more abstract, but more enduring aggregative theories. Focusing on areas and issues that are perennial at the conceptual level, even if they appear in a different guise over time,

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may help minimize the risk of theoretical obsolescence. Through our cursory review of the history of the MNC phenomenon, a few enduring issues stand out: (1) Building advantage on intangible assets: MNCs may have an advantage over markets in arbitraging and deploying intangible assets, such as brands, leaky and sticky technologies for which exact property rights are hard to specify, complex knowledge, and relationships for which social capital matters. (2) Co-strategizing with external parties, such as host and home governments, strategic partners, NGOs, and global customers, calling for a partly competitive partly collaborative negotiated strategy-making process. (3) Responding to multiple forces pulling in different directions, making simple strategies and unidimensional structures unrealistic over-simplifications. This calls for complex structures and flexible management processes allowing variable configurations of resource access, combination and deployment. (4) Maximizing both differentiation and integration in strategy, subunit roles and management processes. (5) Striving for both efficiency and effectiveness and reconciling creative and operative processes that place conflicting demands on managers and integration processes (e.g. the processes of sensing, mobilizing and deploying in metanational companies). Over a decade ago, C. K. Prahalad and I had outlined a series of “demands” a theory of the MNC would have to take into account (Doz & Prahalad, 1991). That list was not so different from the points made above, denoting either true enduring issues or, perhaps, constancy in error on my part! The list was as follows: (1) (2) (3) (4) (5) (6) (7)

structural indeterminacy; internal differentiation; integrative optimization; information intensity; latent linkages (leaving room for emergent patterns of interaction); network organizations and “fuzzy” boundaries; learning and continuity.

By lifting the specification of a theory of MNC management from the specifics of the multinational context to a slightly more abstract set of specifications, it is possible to build a theory of adaptive organizations that will fit the MNC and be more enduring and general than a theory that stays too close to the phenomenon. Put differently, the issue of obsolescence can be subsumed under a choice of appropriate level of conceptualization. What has perhaps been lacking in research on the management of the MNC is this “meso” level of theorization so essential to developing a practice theory. In that effort, one can err both ways. To take what in


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retrospect looks like a missed opportunity, the research C. K. Prahalad and I did on the processes of change between integration and responsiveness in the late 1970s could at that time have been the basis of a more general theory-building effort on the process of strategic change and redirection, but we failed to see the wider applicability of our findings until much later (Doz & Thanheiser, 1993; Prahalad & Doz, 2000). Conversely, management-process researchers have sometimes been criticized for building a very general theory on the basis of a single, perhaps not so fully researched case study, presented as if it were a grounded inductive theoretical development. In our current research, Santos, Williamson, and I are trying to extend our initial “meso” model of a metanational company both toward a finer-grained, more detailed practice theory of how to build and lead such a company (Doz et al., in press), and toward a broader theoretical development of the relationship between the spread of metanational companies and regional development.

THE CHALLENGE OF MULTIDISCIPLINARITY In 1991, we stressed the need for a multidisciplinary approach in developing a managerial theory of the diversified multinational (Doz & Prahalad, 1991). In particular, we suggested that the pluralistic and evolving nature of the MNC made richly detailed power and politics models from the European school of organizational sociology a good starting point for building a practice theory. At the same time, as stressed in earlier sections, economic models of imperfect globalization and competition in a “semi-globalized” world are key to developing an understanding of the broader economic roles to be performed by MNCs. As Ghemawat (2003) notes, what makes the MNC phenomenon particularly relevant, in terms of research, and MNCs interesting and original organizational forms, is such incomplete or imperfect globalization. Organizational economics models, drawing primarily on transaction cost and agency theories, are also essential in setting the performance specs of the MNC as a form of transaction governance and in pointing to both the challenges it faces and the capabilities it needs in providing efficient and effective governance. Other theories, such as institutional theories, also shed light on the management and leadership issues of MNCs. Multidisciplinarity creates several further challenges for the researcher. First, it adds to the broad gauge challenge described in the first section of this chapter. Not only is the territory that one may articulate in a practice theory particularly vast, from underlying driving forces of the MNC phenomenon to the managerial prescriptions, but also travelling that territory calls for theoretical transformations. These are of at least three types.

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First, and perhaps most simply, different theories, each with its set of concepts and categories and its own language, are required. They cannot just be juxtaposed, nor integrated into a “grand” theory, but defining their interfaces and interactions, and the translation of each into the others’ language and concepts, still poses very real challenges. In other words, different theories illuminate different facets of the MNC management tasks and obviously frame them differently. But not to avoid the syndrome of the blind men touching the elephant, and describing it as a rope, a tree, etc., researchers still need to understand how the different ways in which theories shed light on the phenomenon complement one another. Second, when applied to MNCs, different theories purport to explain different facets of the phenomenon and to address different questions. What is a central question in a theory may well be a rather insignificant and uninteresting “residual” in another. Almost inescapably, a managerial theory is more complex, both in its explanations and in the empirical research to develop or falsify it, than more abstract, more general theories. For most researchers, this leads to the famous “Occam’s razor” question: Why not a more parsimonious theory? Answering this question has its own dangers: Before one gets into a managerial theory, one exhausts oneself in the “approach march” painstakingly refuting simpler (usually economic) explanations. This challenge may be compounded by the difficulty in observing and conceptualizing some management processes. As in mountain climbing in theory building the going gets rougher as one proceeds.8 As the simpler, more parsimonious explanations are incomplete, the researchers have to turn to more complex explanations. This may lead to a “damned if you do, damned if you don’t” paradox. The approach march is needed to convince scholars from various disciplines that a managerial theory is needed, and yet it is difficult to develop or even apply such a theory.9 Third, inductive conceptualization and deductive logical theory building are both required. This calls for multiple and heterogeneous research designs. Again, as stressed earlier, researchers in the economics tradition and researchers in the managerial tradition have emphasized different, but complementary, approaches to theory building. Yet, the current convergence around knowledge, the management of distributed innovation and the organization of global R&D, among researchers from various disciplines is encouraging.

CONCLUSION In this chapter, I have attempted to provide an integrative view of the research challenges and opportunities posed by the existence of MNCs as economic agents and organizational forms for scholars who attempt to develop a practice theory


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of the phenomenon. Both the challenges and opportunities stem from the same factors: the intrinsic expanse of empirical and conceptual territory that a practice theory of a complex phenomenon needs to cover, the required heterogeneity of the disciplines one needs to bring to bear on the phenomenon, compounded by the elusive nature of some processes, such as competence accumulation, and by the fact that what MNCs actually do keeps shifting over time.

NOTES 1. In particular, streams of doctoral dissertations in Sweden and Finland. 2. Many more researchers have contributed to what has become known as the I/R line of research, the purpose of this paper is not to do a full literature review, and for the sake of space only a few of the key works are mentioned and cited here. 3. E.g., Sumantra Ghoshal’s Distinguished Scholar Award acceptance speech of the Academy of Management’s International Division and of Advances in International Management, in Washington, in 2001. 4. I am indebted to Jose Santos for pointing out, very usefully, that much of the use of the I/R grid, as well as its initial formulation, implicitly emphasize a “primitive” choice between integration and responsiveness. The initial formulation may reflect the integration of strategic and process issues, in particular a framing of the trade-off as an expression of relative power between country executives and global business or function managers. This reflects a misunderstanding of the richness of the conceptual map, an attempt to oversimplify rather than grasp the true trade offs on each dimension: uniformity vs. differentiation of offerings and local operations on the responsiveness axis, autonomy of self-contained units vs. strategic coordination and operational integration of interdependent operations on the integration axis. The existence of two separate trade-offs justifies the two orthogonal dimensions and the way the grid is sometimes more thoughtfully used. The ability to combine differentiation of offerings and integration of operations becomes a firm-specific organizational capability. More successful firms achieve a higher level of both integration and responsiveness than less successful firms. 5. It is important to note that many MNCs actually grew and developed in periods of nearly absolute dominance of their home base in the particular technologies and skills they relied on, be they German chemical companies two centuries ago, British consumer good companies a century ago, American machinery companies just after WW II or Japanese consumer electronic companies a few decades ago, and ICT companies from Silicon Valley more recently. 6. Interestingly, perhaps they are less influenced by the actual practices of mangers in MNCs, researchers from the economics tradition have more readily embraced the importance and burgeoning reality of knowledge dispersion and global innovation. See for instance Cantwell (1992) and Pearce (1999). 7. This section is adapted from Doz et al. (2002). 8. For example, among many similar instances, I recall vividly a seminar presentation by a leading scholar who studied the success of minimills in the steel industry and spent the bulk of the session refuting traditional economic and competitive strategy

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explanations as not fully accounting for the phenomenon, only to come, frustratingly, in the last few minutes of the session, and paragraphs of his paper, to suggest that hard to observe firm-specific differences in organizational learning and innovating capabilities were the true cause of performance differentials and that management actions could influence these. 9. Another researcher, explaining the failure of managers to divest from an industry threatened by technological substitution through a network embeddedness “ties that bind” argument, had to convince the economists that simpler and logical strategic and financial explanations did not justify the delays observed in capacity reduction and the sociologists that the managers’ network ties were strong enough to blind them to the threat of disruptive technologies and make a timely adaptive response impossible, a tall order on both sides.

ACKNOWLEDGMENTS The author gratefully acknowledges the contribution of Jose Santos and Peter Williamson (co-authors of From Global to Metanational: How Companies Win in the Knowledge Economy, HBS Press, 2001) to the argument developed in this paper. The author is also deeply indebted to C. K. Prahalad for having been a friend, an intellectual stimulant, a co-researcher, and a frequent co-author over many years.

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MAKING SENSE OF THE METANATIONAL: DOES THE FIRM REALLY KNOW WHAT IT KNOWS? Julian Birkinshaw and Niklas Arvidsson The multinational corporation (MNC) has long been an exciting arena in which to conduct business research. MNCs are highly complex organizations; they are continuously evolving; and they provide researchers with the opportunity to integrate separate strands of theory from multiple disciplines, including economics, sociology, and economic geography. Yves Doz, in whose honour this paper is written, has been at the forefront of research on MNCs since the mid-1970s. And unlike many others who have stuck doggedly to one position, or who have changed the foci of their research, Yves has been clever, adapting his thinking as MNCs evolve. In the late 1970s, he worked closely with C. K. Prahalad on the formulation of the Integration-Responsive grid as a means of conceptualizing the environmental pressures that MNCs face (Doz, 1976). This work was published in a series of journal articles (Doz et al., 1981; Prahalad & Doz, 1981) and a landmark book, The Multinational Mission (Prahalad & Doz, 1987). In the 1990s, the research agenda shifted towards understanding the organizational theory perspectives regarding MNCs; Yves was also at the forefront of this change (Doz & Prahalad, 1991). More recently, working with Peter Williamson and Joe Santos, Yves has pushed the boundaries again by linking issues of MNC competitiveness with the recent research on knowledge and learning (Doz, Williamson & Santos, 2001). The metanational, to which they refer, is the latest concept of what the MNC is, or ought to be.

Theories of the Multinational Enterprise: Diversity, Complexity and Relevance Advances in International Management, Volume 16, 31–41 Copyright © 2004 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 0747-7929/doi:10.1016/S0747-7929(04)16002-2

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Herein, we seek to shed some further light on the metanational concept. While the concept of the metanational is highly alluring, there are questions about how it works in practice. While the metanational represents the state of the art in academic thinking, there is a gap between what companies are actually doing in this domain and what we as academics ascribe to them. The analysis of the metanational is presented in four main parts. The first part provides an overview of the ideas of the metanational. The second and third parts describe a research study that examines several important issues regarding knowledge transfer and learning in MNCs. The fourth part integrates the conceptual and empirical issues and offers conclusions.

THE METANATIONAL: ACCESSING AND LEVERAGING GLOBAL KNOWLEDGE An assumption underlying the concept of the metanational is that the necessary knowledge, ideas, and assets for creating new business opportunities are spread across the world. Most firms, even those that are multinational in scope, are not highly effective at accessing or making use of globally dispersed knowledge because they are deeply embedded in their home market, and their overseas subsidiaries (for the most part) act on the orders of their parent company rather than taking autonomous action. Doz et al. (2001) argue that MNCs need to change this traditional organizational logic and structure themselves to facilitate effective interaction between the pockets of knowledge and capabilities dispersed globally. They propose a three-stage model: sensing (tapping into new opportunities and new technologies), mobilizing (creating “magnets” to obtain the necessary resources to act on the opportunities that have been identified), and integrating (leveraging the new business activity through the existing corporate infrastructure). This model builds on a number of prior studies, including Ghoshal’s (1986) sense-response-implementation framework and Hansen’s (1999) search-transfer problem. The problem with this framework, as Hansen (1999) has pointed out, is that it is extraordinarily difficult to manage the whole process effectively. Sensing per se is relatively easy to do but is costly. Likewise, integrating is relatively straightforward if it is deemed to be a strategic imperative. The challenge comes in trying to do both simultaneously. For example, during the early 1990s, Volkswagen’s U.S. business had sensed a number of important changes in the North American marketplace, but their intelligence briefings were ignored at the Wolfsburg headquarters in Germany. The integrating activities were, in essence, decoupled from the sensing activities. Indeed, it took five difficult years of

Making Sense of the Metanational

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lobbying before even simple changes such as proper cupholders were installed in the Golf/Jetta model. The purpose of magnets is essentially to bridge the gap between sensing and integrating. It is not enough to create an operation that senses new opportunities in the local market; the operation also must make use of, or apply, that knowledge in such a way that it can then be integrated with the activities of the rest of the corporation. So, in Volkswagen, the U.S. subsidiary should have not only identified new market trends, but also been given the authority to prototype and pilot the product ideas that emerged from their scanning activity. (This is what ultimately happened in the design of the New Beetle. The initial design work for it was done in California and the subsequent engineering and development were carried out in Germany.) The idea of building magnets to mobilize new sources of knowledge is attractive in theory but remains difficult to do in practice. Xerox’ Palo Alto Research Centre represents an early example of such a unit, but it was always isolated from the main power base of the company. As another example, during the early 1990s, Ericsson invested in a number of “cyberlabs” in Silicon Valley, New York, and elsewhere to act as magnets, but they also became detached and never realized their potential. There seem to be two main reasons why such operations are difficult to manage. First, magnets are boundary-spanners by nature, and as such they have trouble balancing both sides of the boundary evenly. Some “go native” and become deeply embedded in the local community that they lose their influence with headquarters. Others are seen as instruments of HQ and never build the level of embeddedness or respect they need in the local community to do their job. It is difficult, perhaps impossible, to be considered an insider in both the local and corporate networks. The second problem facing magnet units is that the level of awareness or knowledge-sharing across the MNC appears to be very low, and this makes it very difficult for the sophisticated mechanisms to work, as described by Doz et al. (2001). Indeed, there is a more general concern here, namely that the processes for knowledge transfer and sharing assume a reasonable level of knowledge about where useful ideas and “best practices” reside in the organization. If the MNC is “holographic” (Hedlund, 1986, 1993), and information about the whole is stored in every part, then knowledge transfer and other sophisticated techniques can be usefully employed. But in the absence of such shared awareness, the organization is likely to transfer mediocre practices (rather than best practices), or a fragment of the MNC’s knowledge base. In sum, while the metanational model is conceptually attractive and has (justifiably) attracted a great deal of interest, a question remains as to whether MNCs have developed the sophistication in knowledge-sharing needed to

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implement Doz et al.’s (2001) ideas. These questions and concerns motivated an empirical investigation of firm-level knowledge-sharing, which will be discussed next.

RESEARCH EVIDENCE: DOES THE MNC REALLY KNOW WHAT IT KNOWS? This section presents some results from a study undertaken by Niklas Arvidsson as part of his doctoral thesis (Arvidsson, 1999). While the primary focus of the research was to make sense of knowledge flows and capabilities of subsidiaries, the research design also allowed us to explore the patterns of knowledge flow of the firm. Indeed, many prior studies have examined internal knowledge flows at the level of the dyad or the subsidiary node (e.g. Gupta & Govindarajan, 2000; Hansen, 1999; Szulanski, 1996), but this is the first study, to our knowledge, that has attempted to quantify firm-level knowledge flows. Six large Swedish businesses agreed to take part in the research. In each one, we identified the top 30–40 sales and marketing subsidiaries globally. A questionnaire was sent to the general manager of each subsidiary requesting information about its market position, marketing capabilities, knowledge flows from and to other units, patterns of communication with other parts of the network, and so on. In addition – and this was critical to the design – we asked HQ managers to make their own assessments of the capabilities and performance of these foreign subsidiaries. In total, we received valid questionnaire responses from all the HQ managers and from 160 subsidiary managers across the six businesses (see Table 1). Because of the lack of prior research, we focused our efforts on developing measures of firm-level knowledge-sharing. In the context of Yves Doz’s work on the metanational, this is an important construct, because it has significant implications for the identification of appropriate locations for scanning and mobilizing Table 1. Sample Firms.

Alfa Laval Agri Ericsson handsets Pharmacia-Upjohn Sandvik Coromant Sandvik Steel Volvo Cars

Annual Revenues

Product/Industry

$1.1 billion $3.2 billion $7.2 billion $1.3 billion $1.3 billion $11.8 billion

Milking machines Mobile handsets Ethical drug selling Drill bits for machine tools Speciality steel Automobiles

Number of Subsidiaries Sampled 31 27 18 29 27 21


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activities, and for the effective sharing of practices between subsidiaries. It also allows us to quantify our answer to the question: Does the MNC know what it claims to know? The research allowed us to create three measures of firm-level knowledgesharing. Each measure on its own has its limitations, but collectively, the measures provide a relatively complete picture of the extent to which knowledge about each individual subsidiary unit is shared across the entire network. The three measures are as follows: (1) Level of knowledge flow across the MNC: This is a process, rather than an outcome, variable. The measure focuses on the frequency with which information about new products, processes or practices is shared across the subsidiaries in the MNC network. (2) Subsidiary-HQ agreement on subsidiary capabilities: This measure reflects the level of agreement between the subsidiary managers’ self-ratings on a number of outcomes and the ratings of their bosses at HQ. For each firm, we rank the subsidiary self-ratings and the HQ manager’s ratings, and examine the correlation between the two sets of numbers. (3) Awareness of peer-subsidiary capabilities: This measure focuses on the extent to which subsidiary managers are able to identify the peer subsidiaries with the strongest capabilities in specific areas. Tables 2–4 list the scores for each business on these three measures. The businesses are also ranked for each measure, where “1st” is the business with Table 2. Average Subsidiary Ratings for Knowledge Flows Aggregated to Firm Level.


Average Absolute Inflow Level

Average Absolute Outflow Level

Knowledge-Flow Ranking

3.0 2.4 2.3 2.8 2.7 2.6

2.6 2.1 2.1 2.1 2.2 2.1

1st 5th 6th 2nd 2nd 4th

Note: Inflow ratings are the means of answers to questions: How often do the following flows occur? (a) new products or services transferred from HQ to local company; (b) new “best practices” transferred from HQ to local company; (c) new products or services transferred from other local companies; (d) new “best practices transferred from other local companies, where 1 = never, 2 = less than once a year, 3 = one or twice a year, 4 = around 3–6 times per year, 5 = more than 6 times per year. Outflow ratings are the exact reverse.

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Table 3. Level of Convergence Between Subsidiary Self-Ratings and HQ/Peer Ratings. Level of Convergence Between HQ and Subsidiary Capability Ratings


Correlationa

Ranking

0.45 0.44 0.01 0.42 0.10 0.32

1st 2nd 6th 3rd 5th 4th

a Spearman

rank-order correlation between subsidiary’s self-rating of capability and HQ rating of subsidiary capability.

the greatest level of knowledge-sharing, and “6th” is the business with the least. Three important insights emerge from this analysis. First, the overall level of knowledge-sharing can be characterized as low. The second measure (subsidiary-HQ agreement on subsidiary capabilities) indicates a remarkably low correlation between HQ and subsidiary ratings overall, from a correlation of essentially zero in the Pharmacia-Upjohn case to a high of 0.45. The third measure (awareness of peer-subsidiary capabilities) indicates that between 30 and 63% of respondents in each company did not know enough about their peer subsidiaries to identify which ones were good at specific activities. The first measure (level of knowledge flow across the MNC) indicates that the average frequency of product, process, or practice flows is about once a month. Table 4. Level of Knowledge About High-Performing Units in Other Parts of the Firm.


One/Two Best Units (%)

All Units Equal (%)

Don’t Know (%)

Ranking

58 25 29 35 32 51

8 27 9 20 32 19

34 47 63 45 35 30

1st 6th 5th 3rd 4th 2nd

Note: The questionnaire asked subsidiary managers to identify the highest-performing one or two units for a number of specific capabilities. They were also given the option of stating that “all units perform equally well” in this capability or “don’t know.” The ranking is based on the percentage of respondents who believed they could identify the one or two best-performing units (even though we cannot prove that their assessment is accurate).


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Second, the rankings are consistent across the three measures. For example, Alfa Laval Agri ranks highest on all three measures, while Pharmacia-Upjohn is last or second from last in all three. This provides some reassurance that the three measures are all tapping into the same meta-construct. It also makes it possible to develop hypotheses as to why some businesses consistently score higher on these measures than others (see below). Third, knowledge-sharing may be difficult, but it is not impossible. While the overall scores here appear low, there are also several positive areas. For example, Alfa Laval Agri’s score on measure three suggests that 58% of subsidiary managers are able to identify the one or two best-performing units for a given capability,1 a fairly impressive number given that these subsidiaries are located all over the world.

WHY DO SOME FIRMS SHARE KNOWLEDGE BETTER THAN OTHERS? Having developed these measures, and identified consistent differences in knowledge-sharing across businesses, we desired to understand why some businesses share knowledge more effectively than others. We conducted interviews in each company and collected additional data about the nature of the businesses and the industries in which they were competing. The result of this analysis was a set of provisional hypotheses linking industry- and firm-level factors to the level of knowledge-sharing in the MNC, as follows (see also Fig. 1).

Business Size and Scope The businesses with more effective knowledge-sharing (Alfa Laval Agri and the two Sandvik divisions) were typically smaller. This is not surprising, because it is easier for a smaller or more focused business to keep track of what is going on, and to bring the subsidiary managers together for discussions than a large one.

Number and Size of Acquisitions The primary reason that Pharmacia-Upjohn rated so poorly was that the company was the product of a recent (two years earlier) merger between Pharmacia and Upjohn. Some foreign subsidiaries were dominated by ex-Pharmacia people; some had predominantly Upjohn people; and some had both. These outcomes resulted

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Fig. 1. A Firm-Level Framework for Knowledge-Sharing in MNCs.

in a poor understanding of what peer subsidiaries were doing. At a more generic level, the Pharmacia-Upjohn case highlighted the disruptive effect of mergers and acquisitions on the knowledge base of the business. Clearly, acquisitions represent an opportunity to bring in new knowledge, but they also create (at least temporarily) a considerable amount of confusion as to where the valuable knowledge resides. Complexity of Strategic Agenda The relatively poor knowledge-sharing within both Ericsson and PharmaciaUpjohn appeared to be related to the complexity of the strategic agendas the businesses were facing. Both were operating in fast-moving, high-technology environments; Ericsson was attempting to service the phenomenal growth in demand for handsets; and Pharmacia-Upjohn was trying to manage its post-merger integration process. Therefore, knowledge-sharing was not high on the agenda of either firm because other strategic imperatives were deemed more important. In some of the more focused businesses (Sandvik Steel, Alfa Laval Agri), in contrast, the strategic agenda was clear and well established, and knowledge-sharing consequently received greater attention. Industry Growth and Environmental Turbulence While the previous points were expressed as business-level issues, different arguments focused on industry-level contingencies may be developed. Thus, the higher growth the industry and the more turbulent the business environment, the


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more complex the strategic agenda of the business will be, and the less attention is likely to be given to knowledge-sharing. (At this stage, of course, it is impossible to distinguish between whether the industry or business-level factors are more important.)

Business Investments in Knowledge-Sharing The final set of factors involves the various internal structures and systems that are put in place to enable the knowledge-sharing between units. This includes such things as formal meetings of subsidiary managers, personnel transfers, knowledge databases, incentive systems, and communication media. Alfa Laval Agri, for example, held quarterly meetings for all its subsidiary managers and required its managers to share performance data on multiple dimensions so that each subsidiary manager could compare their unit against its peers. Conceptually, this set of factors can be seen as the actions and/or investments made by business managers to increase knowledge-sharing, whereas all the preceding points referred to existing attributes of the business or industry. The implication is that investments in knowledge-sharing need to be greater in cases where the business is large, complex, and operating in a turbulent environment. Interestingly, as we shall discuss below, this is not common, however. In sum, this exploratory research allows us to develop hypotheses that explain the different levels of knowledge-sharing in MNCs. The results are far from conclusive, and there is a need for further theoretical development and more comprehensive empirical testing. Nonetheless, as a first step in understanding firm-level knowledge-sharing, the study provides us with some important insights. We have discovered that knowledge-sharing was generally low, and that there were a number of often good reasons why this was the case. In the final part, we examine the broader implications for MNC management and for the metanational.

DISCUSSION AND CONCLUSIONS The key point from the research is that mechanisms for knowledge transfer and sharing were typically perceived in these firms as promoting efficiency – as a means of gaining incremental cost savings, and, to some degree, revenue enhancements, through the transfer of practices between operating units. While this approach is valid, it underplays the potential value of greater knowledge-sharing in the MNC. Furthermore, such an approach does not support the metanational concept suggesting that knowledge-sharing is concerned with developing and exploiting radical new ideas wherever in the world they emerge.

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Of course, we did not focus our research on external sensing and market intelligence. But as argued earlier, external sensing should not occur in isolation. Rather, it should be closely linked to the mobilizing and integrating activities of the firm in order for the information that is “sensed” to be used. For example, it would not matter whether Ericsson’s handset business had high-quality sensing capabilities at the time of our data collection, because they lacked the complementary capabilities of mobilization and integration. The model proposed by Doz et al. (2001) essentially is less valuable if one or more of the elements are missing. This takes us back to the statement made at the beginning of the paper, that there is a considerable gap between what firms are doing in the area of knowledge management and what academics are suggesting that they should do. Simply put, academics are advising firms on the importance of more sophisticated mechanisms for sensing and managing knowledge, but the executives in these firms argue that, “yes we know they are important, but they are not as important as other strategic imperatives on which we are currently working.” In short, MNCs lack capabilities in knowledge-sharing and also do not perceive it to be a priority. It is beyond the scope of this work to resolve the problem, but we can offer some recommendations to move forward. First, it is important to emphasize that firms do not invest in learning networks unless there is a proven need. So, unless Ericsson or Pharmacia & Upjohn believe that they are endangering their livelihood, they are unlikely to invest in knowledge-sharing activities. Instead, they will focus on what they perceive to be the more critical issues they face (e.g. managing growth, coping with new technologies, integrating acquisitions) and focus on the processes of sensing, mobilizing, and integrating knowledge later. Second, and following from the first point, it is important to find compelling evidence that the metanational processes really matter, because only then will MNCs dedicate the necessary resources and time to them. For example, one of the reasons Nokia came to dominate the mobile-handsets business in the late 1990s was its superior understanding of consumer needs, which in turn can be traced back to the sensing and mobilizing capabilities it established in leading-edge markets. Motorola, Ericsson, and others failed to establish these capabilities and continued to market their handsets as consumer electronics products rather than fashion accessories. The value to Nokia in this case was unambiguous, but unfortunately, similarly robust examples are uncommon (though Doz et al., 2001 discuss a number of other cases). We believe there is a need for more systematic and detailed research in this area. The metanational model provides an interesting set of hypotheses that are in need of further empirical testing. It would be interesting to the academic community to establish whether these hypotheses are supported. But it would also be of value


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to the MNCs if research demonstrated that sensing, mobilizing, and integrating activities had a positive and enduring effect on a firm’s competitiveness.

NOTE 1. It is possible to speculate that this answer means the respondents were more decisive or opinionated than their counterparts in other businesses. However, on further analysis, it was clear that they typically identified the same one or two units in each case, and that their answers were different for different capabilities. This provides some reassurance that the data were valid.

REFERENCES Arvidsson, N. (1999). The ignorant multinational: The role of perception gaps in knowledge management. Stockholm: Institute of International Business. Doz, Y. L. (1976). National policies and multinational management. Unpublished doctoral dissertation, Harvard Business School. Doz, Y. L., Bartlett, C. A., & Prahalad, C. K. (1981). Global competitive pressures and host country demands: Managing tensions in MNCs. California Management Review, 23(3), 63–75. Doz, Y. L., & Prahalad, C. K. (1991). Managing DMNCs: A search for a new paradigm. Strategic Management Journal, 12, 145–164. Doz, Y. L., Williamson, P., & Santos, J. (2001). From global to metanational: How companies win in the knowledge economy. Boston: Harvard Business School Press. Ghoshal, S. (1986). The innovative multinational: A differentiated network of organizational roles and management processes. Unpublished doctoral dissertation, Harvard Business School. Gupta, A., & Govindarajan, V. (2000). Knowledge flows within multinational corporations. Strategic Management Journal, 21(4), 473–496. Hansen, M. (1999). The search-transfer problem: The role of weak ties in sharing knowledge across organizational sub-units. Administrative Science Quarterly, 44, 82–111. Hedlund, G. (1986). The hyper-modern MNC – a heterarchy? Human Resource Management, 25(1). Hedlund, G. (1993). Assumptions of hierarchy and heterarchy, with applications to the management of the multinational corporation. In: S. Ghoshal & D. E. Westney (Eds), Organization Theory and the Multinational Corporation. New York: St. Martin’s Press. Prahalad, C. K., & Doz, Y. L. (1981, Summer). An approach to strategic control in MNCs. Sloan Management Review, 23(3), 5–13. Prahalad, C. K., & Doz, Y. L. (1987). The multinational mission. New York: Free Press. Szulanski, G. (1996). Exploring internal stickiness: Impediments to the transfer of best practises within the firm [Special issue]. Strategic Management Journal, 17, 27–44.

YVES DOZ AND INTERNATIONAL MANAGEMENT Andrew C. Inkpen Over the past two and half decades, Yves Doz has studied strategic decision-making and resource commitment processes in complex multinational organizations (MNCs). He has also examined strategic alliances, the management of technology and innovation, corporate renewal, and mobilization processes. In tapping into the processes of international firms, Yves’ research has yielded important findings in international management and strategy. In his wide-ranging body of work, Yves has achieved a balance between the dual constituencies of academe and practice and has established a reputation for careful, provocative, and innovative thinking. In this paper I will examine Yves Doz’s contributions to international management. I will first discuss some characteristics of his research. I will then offer some comments on his current research on the metanational model, which he discusses in an article in this volume. Finally, I will make some comments on Yves’ contribution to our understanding of international strategic alliances.

STRATEGIC MANAGEMENT IN MULTINATIONAL COMPANIES My first exposure to Yves Doz’s work was his book Strategic Management in Multinational Companies (Doz, 1986). In 1988, I was in the first year of my Ph.D. program and was deep inside research methods, statistics, and special fields Theories of the Multinational Enterprise: Diversity, Complexity and Relevance Advances in International Management, Volume 16, 43–52 Copyright © 2004 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 0747-7929/doi:10.1016/S0747-7929(04)16003-4

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courses. I received an unsolicited copy of Yves’ book from the publisher. I was not familiar with his work and compared with much of the “normal science/positivist” research I was reading, this book was significantly different. In the introduction, Yves wrote that he “tried to avoid theoretical abstractions and the complex language that provides only the trappings of objectivity and not the essence of it” (Doz, 1986, p. 10). He also said that for students of the MNC, his objective was to “integrate several theories into a managerial understanding of the multinational company.” These statements are at the heart of Yves’ research and his approach to empirical study: The work is accessible, interesting, relevant, and, most importantly from a scholarship perspective, firmly anchored in theory. The Strategic Management book emphasizes that to truly understand the choices between national responsiveness and global integration, researchers must incorporate an analysis of organizational capabilities and constraints. While many of the specific industry discussions are now dated, the in-depth analyses of managerial processes remain highly relevant. In addition, for students and managers of MNC management, Strategic Management continues to provide a useful discussion of concepts like host government bargaining power and administrative mechanisms that can be used to implement strategy. Yves Doz’s subsequent book with C. K. Prahalad, The Multinational Mission (Doz & Prahalad, 1987), continued this discussion with a more explicit focus on the integration-responsiveness framework.

THE NATURE OF YVES DOZ’S RESEARCH Some additional characteristics of Yves Doz’s research are worth mentioning because these characteristics provide the foundation for understanding his international management research themes and his impact. In discussing scholarly research, and more specifically organizational research, Daft (1983) argued that research should tell a story. Daft wrote, “Research is storytelling. . . . Storytelling means explaining what the data mean, using data to explain how organizations work. . . . The research craft is enhanced by respect for error and surprise, storytelling, research poetry, emotion, common sense, firsthand learning, and research colleagues” (pp. 541, 544). Daft also emphasized that to truly understand organizations, researchers must have direct contact with them. Much of Yves Doz’s research deals with diversified MNCs (DMNCs), a very complex organizational phenomenon. Is it possible to really understand the decision-making processes and resource allocation practices of diversified MNC without obtaining first-hand knowledge from the managers in these organizations? I doubt it, which is probably why we know so little about them, i.e. they are very difficult to study.

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Moreover, it is an unfortunate reality that important research streams that begin with intensive case research often fail to generate sufficient follow-up research because first-hand access is not sought or is unavailable. That said, one can hope that Yves Doz’s latest research will generate thoughtful empirical inquiry that challenges and advances his propositions about MNC knowledge flows and competitive advantage. Yves tells stories and weaves together theoretical foundations, real-world examples, and empirical analysis. Yves, I suspect, would be the first to agree that his research is not “normal science.” Although the issue of managerial relevance has been a much debated topic within the business academy, Yves’ research demonstrates a realized strategy of informing scholars and practitioners. The danger in such an approach is the stuck-in-the middle problem: The research is perceived as theoretically and empirically weak by the academic community and uninteresting to practitioners. Since Yves’ work is heavily cited by academics, one must discount criticism that is not rigorous. On the practitioner side, Yves’ continued ability to gain access at the senior levels of large MNCs is a testimony to the relevance of his work. Another important characteristic of Yves’ research is that he does not deal with what have been called toy problems. Toy problems, as Michael Jensen (1982) described them, are simple models of complex phenomena that have the appearance of being a toy rather than a real business phenomenon. In most research areas, a great deal of work has to be done in a new area of analysis before the depth and the major variables for the problem can be defined. Unfortunately, management researchers, often operating under the impression that mathematics means being rigorous, tend to jump into statistical analyses at too early a stage in a research area’s development. The result, all too often, is elegant research on toy problems that have little connection to the real underlying phenomenon. The management processes of DMNCs, the focus of much of Yves’ research, are probably the most complex for-profit organizational structures. DMNCs are difficult to study because of what Doz and Prahalad (1991, p. 146) called the “combined consequences of multidimensionality and heterogeneity,” which lead to theoretical challenges such as structural indeterminacy, information intensity, and fuzzy boundaries within the DMNC and between DMNC stakeholders. Yves, in his research into the workings of DMNCs, does not deal with toy problems: He explores big, meaty, real-world phenomena that have meaning for managers, policy-makers, educators, and other researchers. Finally, Yves’ research into managerial process has generated important insights into how MNC decisions are made and resources allocated. His work has provided valuable insights into what leaders and managers actually do and how complex organizations work.

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THE EVOLVING MNC The characteristics discussed above can be seen in Yves Doz’s latest work on the metanational. In this work, Doz and colleagues (Doz et al., 2001) argue that the MNC is facing two distinct challenges: one, a move from operational efficiency to innovative effectiveness as a key source of competitive advantage, and two, the growing role of knowledge as a strategic resource central to innovation capabilities. To deal with these challenges, they draw on case research to identify the characteristics of a new type of MNC which they call a metanational. The metanational is characterized by the following: prospecting for, and accessing untapped pockets of, knowledge, technology, and emerging consumer trends from around the world; leveraging knowledge locally trapped in a multinational’s subsidiaries; mobilizing the newfound knowledge to generate innovations, profits, and shareholder value. Doz, in this volume, argues that projection strategies, with their selective and one-way knowledge flows, have run their course. He calls for a shift in the competitive logic of the MNC from home-country innovativeness to system-wide efficiency. Doz et al. (2001) provide detailed examples of companies such as STMicroelectronics, ARM, Acer, Nokia, Shiseido, and PolyGram that “sense and mobilize knowledge from around the world.” The arguments are persuasive and intriguing. However, from the international management scholars’ perspective, several questions come to mind. First, are the examples conveniently selected, or do they really represent a new wave of MNCs? There is no question that to become a world leader in mobile telephones, Nokia had to operate much differently than competitors such as Motorola that have enormous domestic markets and a legacy of competition in various electronics sectors. If Nokia’s unique circumstances were the antecedents of their innovative management structure and processes, how applicable is the Nokia model to other MNCs? Alternatively, the Nokia model may represent an innovative approach that can be replicated by other firms that are “born in the wrong locations.” If the alternative is true, a new wave of MNCs may make inroads into the traditional dominance of triad firms. Second, is the projection model really obsolete and is there a demonstrated need for a new theory of MNCs? The Japanese automakers, and especially Toyota, have always used a projection model and are currently replicating this model, with requisite national responsiveness, in their European expansion strategies. Wal-Mart, the world’s largest retailer, also has what would have to be called a projection strategy (which may explain its notable lack of success in Germany).


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Perhaps what is really happening is an adaptation of the projection model in an environment where there is now a much greater understanding of the value of knowledge that resides in dispersed areas of the MNC. While the knowledge management area may suffer from a lack of theoretical integration, the past decade has seen a rise in the emphasis on understanding and managing the pockets of knowledge that exist in MNCs. Quite simply, firms are getting better at managing knowledge, which means that the firms presented as metanationals may soon be faced with a wave of competitors that have successfully grafted better knowledge management practices onto a traditional projection model.

The Role of Knowledge Flows While I have raised several questions about the metanational as a valid concept, a valuable contribution of the research is that it brings into sharp focus the role of knowledge and, in particular, the importance of knowledge-sharing and knowledge transfer. The notions of reversing the MNC knowledge flow and creating magnets to attract dispersed, potentially relevant knowledge are fascinating and reflect some novel thinking. That said, the connection between knowledge flows and performance has been around a while. A growing body of research indicates that organizations able to transfer knowledge effectively from one organizational unit to another are more productive than organizations that are less capable at knowledge transfer (e.g. Argote et al., 1990; Baum & Ingram, 1998; Hansen, 2002). In addition, the notion of the MNC as a global learning organization is not, in and of itself, a new idea. Other researchers have made similar arguments (e.g. Govindarajan & Gupta, 2001). The argument that MNCs should seek out knowledge from distant parts of their corporate empire will generate little disagreement among scholars or managers. The problem is that few firms seem to understand how to do it or even why it should be done. Moreover, Doz pays limited attention to the practical realities of why few firms are unable to move beyond the knowledge projection model. Drawing on my own research on alliances and knowledge transfer (which comprises one aspect of what Doz calls a firm’s sensing network), I will suggest four reasons why MNCs are not very good at taking advantage of their knowledge reservoirs. I would also suggest that these are hypotheses about why the metanational is, at present, more of an idealized state than a rapidly emerging MNC development (and I challenge my international management colleagues to prove me wrong with some empirical evidence). First, many firms do not really understand the value of the knowledge that resides in their various subsidiaries and affiliate companies. Moreover, a common expectation is that the valuable knowledge will be visible and easily transferable.

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When firms truly understand what they know, they usually realize that the most valuable knowledge is deeply embedded in an overall philosophy of doing business and tied to the culture and values of the organization. Once a firm, or a manager, realizes that knowledge is more complex than expected, there is a tendency to conclude that the learning and knowledge transfer efforts are simply too difficult and not worth a major investment in knowledge management. Second, top management’s role in organizational knowledge management should be one of catalyst and architect. While multiple advocates are important, there must be at least one strong champion of knowledge management in a leadership position. The leader’s role is especially important in initiating linkages between headquarters and subsidiary strategies. Unfortunately, managers and leaders often do not appreciate the deeper meaning of the differences in skills between the various subsidiaries and discount the learning opportunities. More than a decade ago, in the alliance context, Hamel et al. (1989) suggested that leaders are often obsessed with alliance ownership and structural issues while discounting learning opportunities. Third, to take advantage of the knowledge opportunities, it is not sufficient to merely expose individuals to new knowledge; the intensity of efforts applied to the learning is also critical. Unfortunately, many companies are unwilling to incur the expense of setting up knowledge management systems. Given the sometimes haphazard and idiosyncratic nature of knowledge management, firms may view resources committed to knowledge as extravagant, wasteful, and not directly associated with organizational performance. Finally, the classic problem of “not invented here” can derail an MNC’s attempts to manage knowledge flow. Headquarters’ managers are often threatened by the learning occurring in their subsidiaries and by the managers assigned to the subsidiaries. The result is that headquarters managers will be motivated to discount the value of the learning potential and make statements such as, “What they do in the subsidiary does not apply here. The subsidiary is in a different business.” Also, the headquarters may have difficulty accepting the subsidiary as a legitimate teacher or source of innovative ideas.

The Metanational and Knowledge Transfer The challenge for MNCs is to break down the barriers to knowledge flows and create an environment where an integrated global network can really be created. Doz and colleagues have found some examples of firms that have succeeded in doing this and have given MNC researchers a rich agenda for future research. Their recent work has helped address the question of why knowledge sharing and


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transfer are so important to MNCs. Indeed, one of the issues that has held back the whole area of knowledge management is the absence of an overarching strategic rationale for why knowledge sharing is valuable. The metanational work, albeit still in its infancy, is heading in the right direction. As Doz suggests in this volume, Bartlett and Ghoshal (1989) incorporated learning in their discussion of the integration-responsiveness framework. However, they did not explain how learning would enhance the competitiveness of the MNC. Others who have addressed the question of MNC knowledge transfer have typically focused on the transfer of best practices between organizational units (e.g. Szulanski, 1996). While this work is valuable, the transfer of best practices is not the same as learning and innovation. The best practice may have originated from some innovative thinking; its transfer rarely will. That knowledge is dispersed and locally embedded is well understood by managers in the distant affiliates of MNCs but typically less understood, or at least less appreciated, by those at the center. The key issues are how this knowledge can be mobilized and how it coalesces into innovations. Doz and colleagues use the concept of magnets to describe the vehicle that can aid in the knowledge mobilization. The research challenge is to develop a detailed understanding of how MNCs access, mobilize, and leverage the global knowledge pool. Knowledge is not created and transferred in discrete packages, which is a complexity that Doz and colleagues have not yet addressed. Knowledge is always part of a broader spectrum and knowledge base. When MNCs transfer knowledge from one location to another, there will be other pockets of knowledge that may directly or indirectly influence the transfer process. Over time, knowledge flow networks will evolve. How is the network influenced over time? How do different contexts in various subunits affect knowledge flows? These questions await further study. Moreover, as the field moves forward, and research on knowledge and the MNC develops, we must ensure that prior work in the area of learning and knowledge management is not ignored. Nelson and Winter (1982) and Teece (1977) laid the critical foundation for understanding knowledge transfer across international organizational units. Teece (1977) focused on implicit or unembodied forms of knowledge, mainly technological know-how, and suggested that international technology transfer enables the firm to accumulate a stock of knowledge that is applicable across borders. The primary variables studied were the level and the determinants of the costs involved in transfers. Nelson and Winter (1982) examined organizational routines replication and determined that possessing the routine’s template enables improved replication within the organization rather than across organizations. Kogut and Zander (1993) examined the characteristics of knowledge that inhibit its transfer and thus influence a firm’s decision about internalizing the knowledge transfer. If the technology transferred is codifiable and teachable,

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the firm does not possess a relative advantage in transferring it and thus will not transfer it. Research Questions and the Metanational The metanational research provides a foundation for some important research questions. First, how many other firms have the characteristics of the metanational, such as sensing and mobilizing dispersed knowledge? Can the characteristics be linked with performance? Second, there is a need to develop the concept of knowledge in much finer detail. The broad categories of explicit and tacit are not specific or useful enough to form the foundation for a new theory. There is a real need for a more finely grained understanding of knowledge types and how the different knowledge types can be transferred, shared, and replicated. Third, there is a need to explore the roles that various parts of the firm network play in supporting innovation. Fourth, how is the knowledge actually transferred? Doz suggests that new structures must be developed to enable magnets to attract dispersed, potentially relevant knowledge. How are the structures created, and which structures are most effective? Fifth, the metanational concept must be better integrated with work that has already been done on knowledge transfer, such as in the alliance area. Sixth, it has been said that MNCs have a learning disability. I identified several reasons earlier as to why I believe MNCs struggle to capitalize on learning opportunities. A deeper understanding of the barriers to MNC knowledge transfer is sorely needed. Finally, what is the role of the MNC center in developing a company’s sensing network of alliances, acquisitions, universities, and so on?

YVES DOZ’S CONTRIBUTION TO INTERNATIONAL ALLIANCE MANAGEMENT In addition to his work on MNC management, Yves Doz has been a leading researcher in the strategic alliance area. Like his work on MNCs, Yves has dealt primarily with process-oriented questions. His work on learning and alliances, which began with Hamel et al. (1989), is closely connected to the metanational ideas, since alliances form one of the possible nodes in a firm’s sensing network. Doz’s (1996) study on evolutionary processes in alliances is one of the most important pieces of process research in the alliance area. This paper discusses the evolution of alliances and partner relationships. Using a case research approach, the study identifies the initial conditions that shape alliances and examines how initial conditions evolve as the partners interact and learn about each other. The initial alliance conditions include the definition of the collaborative task and objectives, design of the partner interface and governance systems, and


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identification of expectations about the performance of the alliance and of one’s partner. Once the alliance is formed, and if the initial conditions support continued collaboration (as opposed to termination), the movement toward deeper cooperation involves a willingness by the partner firms to make irreversible commitments to the alliance such as learning about the partner. This study addressed an important managerial issue: What happens when firms form alliances with little knowledge of their partners and how they operate? Doz (1996) argued that learning processes are central to the evolution of an alliance, and that learning and adjustment by the partners are key determinants of alliance longevity and the avoidance of premature dissolution. This proposition about the relationship between learning and alliance performance challenges much of the work in the alliance area that deals with concepts such as partner control, firm experience, and bargaining power. If firms can learn to be better partners, and in doing so learn about their partners, the result will be more structured approaches to dealing with the inherent uncertainty and ambiguity that exist in most strategic alliances. Unfortunately, this proposition remains largely untested, and the alliance field has not followed up on the Doz (1996) study in a significant way. There are several reasons for the lack of follow-up work, with the primary reason being the challenges and costs of doing this type of research, which Doz (1996, p. 80) called “unavoidably onerous.” The strategic alliance book by Yves Doz and Gary Hamel (Doz & Hamel, 1998) is also highly representative of the research characteristics discussed earlier. The book is targeted at practitioners but unlike many practitioner-oriented books, there is a solid theoretical foundation. The book is full of questions, ideas, and provocative statements, all grounded in real companies and experiences. More importantly, there is a wealth of research questions that provide a broad agenda for strategic alliance researchers.

CONCLUSION In closing, perhaps the best way to describe Yves Doz is that he is full of ideas, questions, propositions, and theories about international management. When you listen to Yves give a presentation, you get a torrent of ideas, which, as we all know, are the most valuable capital in the research business. A few years ago, I served on a workshop panel with Yves. As he was speaking, I was taking notes and trying feverishly to keep up with the flow of interesting ideas and examples. Eventually, I gave up and just listened. You may disagree with the ideas and even argue that some are, to use Yves’ own words, empirically flimsy. However, Yves has chosen the quite risky path, in so far as mainstream academic research goes, of “intercepting

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emerging management agendas.” In doing so, Yves has pushed the frontiers of MNC research and most recently has developed the idea of the metanational. Are the metanational ideas valid? They are certainly interesting, provocative, and a reservoir for future research. Tests of their validity await what hopefully will be further study in this important research area.

REFERENCES Argote, L., Beckman, S. L., & Epple, D. (1990). The persistence and transfer of learning in industrial settings. Management Science, 36, 140–154. Baum, J. A. C., & Ingram, P. (1998). Survival-enhancing learning in the Manhattan hotel industry, 1898–1980. Management Science, 44, 996–1016. Bartlett, C. A., & Ghoshal, S. (1989). Managing across borders: The transnational solution. Boston: Harvard Business School Press. Daft, R. L. (1983). Learning the craft of organizational research. Academy of Management Review, 8, 539–546. Doz, Y. L. (1986). Strategic management in multinational companies. Oxford: Pergamon. Doz, Y. L. (1996). The evolution of cooperation in strategic alliances: Initial conditions or learning processes? [Summer special issue]. Strategic Management Journal, 17, 55–84. Doz, Y. L., & Hamel, G. (1998). Alliance advantage: The art of creating value through partnering. Boston: Harvard Business School Press. Doz, Y. L., & Prahalad, C. K. (1987). The multinational mission: Balancing local demand and global vision. New York: Free Press. Doz, Y. L., & Prahalad, C. K. (1991). Managing DMNCs: A search for a new paradigm. Strategic Management Journal, 12, 145–164. Doz, Y. L., Williamson, P., & Santos, J. (2001). The metanational. Boston: Harvard Business School Press. Govindarajan, V., & Gupta, A. K. (2001). The quest for global dominance: Transforming global presence into global competitive advantage. San Francisco: Jossey-Bass. Hamel, G., Doz, Y. L., & Prahalad, C. K. (1989). Collaborate with your competitors – and win. Harvard Business Review, 67(1), 133–139. Hansen, M. T. (2002). Knowledge networks: Explaining effective knowledge-sharing in multiunit companies. Organization Science, 13, 232–248. Jensen, M. C. (1982). Corporate financial reporting: A methodological review of empirical research: Comment. Paper presented at the 1982 Annual Accounting Research Conference, The University of Chicago, April 29–30. Kogut, B., & Zander, U. (1993). Knowledge of the firm and the evolutionary theory of the multinational corporation. Journal of International Business Studies, 24, 625–645. Nelson, R., & Winter, S. (1982). An evolutionary theory of economic change. Cambridge: Belknap Press. Szulanski, G. (1996). Exploring internal stickiness: Impediments to the transfer of best practice within the firm [Special issue]. Strategic Management Journal, 17, 27–43. Teece, D. J. (1977). Technology transfer by multinational firms: The resource cost of transferring technological know-how. The Economic Journal, 87, 242–261.

STRATEGIC MANAGEMENT AND THE ROLE OF THE MNC IN A POST-INDUSTRIAL WORLD MARKET Stephen Tallman International business (IB) and strategic management indeed have very different roots but consistently have been moving closer together over the last 30 years or so. I agree with Professor Doz that IB traces its ancestry to international trade theory, and strategic management arose from the observation, case study, and best practice approaches of business-policy studies. However, micro-economic and organizational theories have been brought to bear on both IB and strategy, such that both now have strong (and similar) theoretical models. At the same time, both lines of inquiry have moved away from markets and industries to firms and business units as appropriate levels of study. Today, theoretical models in strategic management and in “global strategy,” as the relevant part of IB has come to be called, are much the same, and scholars from both disciplines are focusing on multinational companies for empirical studies. This confluence of interests has developed as the importance of knowledge – innovation, learning, protection, leverage, and exploitation of information – to firm performance has gained great recognition, if not primacy. This situation makes Yves Doz’s paper in this volume most timely and appropriate, but also makes the need for a variety of approaches to the evolution of global strategies, MNCs, and IB studies ever more apparent. This paper is a critique of the contributions made by Professor Doz and an analysis of his proposals in his “Managerial Theory of the MNC,” but it is also intended to provide alternative ideas about the relationship between strategic management and international business.


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THE SCHOLAR Before I comment on the substance of the paper offered by Professor Yves Doz in this issue, I believe that a few comments on the author are appropriate, since this issue celebrates him as a distinguished scholar in international management. The importance of Yves to the development of international strategic management is evident in his discussion of the evolution of the theory of the MNC. The study of the interaction of international economics and management studies that has resulted in modern concepts of the multinational corporation is, to a significant degree, the consequence of his own work. The paper offered in this volume is a natural development from his stream of work and in many ways reflects the patterns that have made Professor Doz such an important scholar. As a management scholar, he is embedded in the tradition that he calls the phenomenon-driven approach to the MNC, and the distinct characteristic of most of his work is its grounding in the real world of organizations. However, the models with which he is most associated also display solid theoretical bases, removing them from the realm of small sample, case-based, observational empiricism, and providing the resonance for other studies that have made them classic. As one example, the Integration–Responsiveness model (Doz et al., 1981) is closely tied to observation of the strategies used by firms in different industries to pursue international markets. However, it also incorporates Industrial Organization theory to establish how the Structure-Conduct-Performance paradigm plays out in the international realm. More recently, Yves developed with others the idea of the diversified multinational corporation (Doz & Prahalad, 1991) as a way to describe and categorize the growing number of firms that pursued diversification in both their product offerings and their choices of geographical markets. In analyzing these complex organizations, though, he specifically uses ideas from theories of diversification strategy, organizational learning, networking, evolution, and adaptation. Thus, he provides rich descriptions but also permits scholars of organizational sociology or economics to build on his examples. The tie of theory keeps his work in the mainstream of model building rather than the backwater of managerial case studies. In a similar fashion, the “managerial theory” introduced here builds on his previous work on the metanational firm (Doz et al., 2001), which derived from the idea of the DMNC, and incorporates ideas from theories of co-evolution, network learning, and innovation in addition to observations about the changing roles of subsidiaries and MNC headquarters. Yves’ frameworks have moved from the industry level to the level of the firm as a structured organization to that of the activity or actions of the firm, all based on observations of changing phenomena, and all set in established and cutting-edge theoretical models. It is this characteristic

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bridging between theory and observation, strategic management and international business, abstract and practical that makes the work of Professor Doz unique and uniquely valuable, and establishes him as a truly distinguished scholar of international management.

THE ARTICLE Professor Doz starts by describing the intersection of international economics and strategic management as the basis for this paper (and really all of his work, as established above and by Birkinshaw & Arvidsson, 2004) and as the dynamic that has moved the study of international and global strategy forward. He follows by considering the conventional approach to the process of internationalization and then considering the same process from the specific perspective of knowledge and innovation. He finishes by presenting his model of the metanational corporation as a “response” to the changing global marketplace and by suggesting further extensions of that model. I will attempt to look at each section from a slightly different perspective and finally offer critical comments on the overall thrust of the paper.

INTRODUCTION: THE THEORETICAL HISTORY OF THE MNC Professor Doz focuses on the economic track as descriptive of the development of a theoretically driven model of the MNC, moving from international trade theory through product life-cycle models to internalization and transaction-cost economics. These models offer progressively more detailed models of the MNC as a solution to market failures for the international distribution of goods and services. His second track is that work emerging from strategic management scholars that is grounded in observation and case studies – a track that would encompass much of his own work with Prahalad and much of the work of Bartlett and Ghoshal (1989) on the transnational form. He mentions that this second track is tied to various disciplines but focuses on its “real world” aspect, as opposed to the theoretical basis of the “economics track.” I believe that Professor Doz’s work has been very important to the development of global strategy and the MNC as areas of study, and I believe that the basis for its importance is its role in bringing strategic management together with international business studies, but I would suggest that strategic management has been an important source of theoretical concepts as well as grounded model-building. An interesting aspect of this approach is that it highlights the

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parallel development of international management and business strategy, despite their previously limited connections (see Fig. 1). What contact there has been between the study of the MNC and the study of strategic management has been in large part due to the efforts of Professor Doz and his collaborators and colleagues, in addition to a few other scholars attempting to straddle the worlds of strategy and international business. The study of the MNC emerged from international trade theory, according to most analyses, with Hymer’s dissertation (1960/1976). This work observed that the patterns of international trade and investment proposed in macroeconomic models did not actually dominate real markets and proposed what has been called the strategic behavior model of foreign investment (Kogut, 1988). This model is grounded in Industrial Organization theory, a theory that was under development at the same time as an explanation for industry differences in performance and became the basis for the Structure-Conduct-Performance model of business strategy, arguably the first real theoretical foundation for that field. This model bridged the gap between neo-classical price theory and the sort of grounded observational case research that characterized early business strategy research by explaining why efficient markets did not work and providing a theoretically grounded basis to connect the specific strategic choices of firms to subsequent performance. The influence of IO on the emergence of business policy as a discipline is apparent in the early work of Porter (1980), and its influence on the emergence of international strategy is apparent in the work of Doz (1976), Prahalad (1975), Stopford and Wells (1972), Vernon (1966), and the dominance of the Integration–Responsiveness model. We can see, for instance, that Doz (1986) describes firm strategies as responses to the interacting demands of governments and industry characteristics. This work peaked with Bartlett and Ghoshal (1989), who introduced the concept of learning or knowledge exchange across borders to the model of the MNC, bringing a new theoretical dimension to an industry-oriented model. Even as the IO model dominated both business strategy and international management, a second economic model was building momentum. The transaction-cost model of the firm introduced by Ronald Coase (1937) led to books by Buckley and Casson (1976) about MNCs as efficient solutions to international market failure and by Williamson (1975) about the multidivisional firm as a solution to market failure in general, due to bounded rationality and opportunistic human nature. In both cases, the intellectual rigor of transactional analysis, combined with the observation that industry membership did not fully explain performance differences, led to these models of the firm (or MNC) largely supplanting IO models in both strategy (Teece, 1982) and international business (Dunning, 1977; Rugman, 1979; Teece, 1985) research. The emergence of organizational economics coincided with developing interest by strategy researchers in organization theory models


Fig. 1. The (Economics-Based) Theoretical Development of Global and Strategic Management.

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from other social science disciplines to refocus the emerging discipline on the firm and its activities (transactions), rather than the industry, as the key to strategy analysis. As Doz (1997) puts it, attention shifted to the MNC as an institution, and international business became international management. Again, Professor Doz’s work on the DMNC applied these new concepts to the study of the MNC. Doz and Prahalad (1991) list seven organizational level theories that they see as important to the ongoing study of managing DMNCs: transaction-cost and agency theories from organizational economics; and population ecology, institutional theory, contingency theory, power dependence, and organizational learning from organization theory. By applying these theories to their own tradition of casebased research, Doz and Prahalad make a strong case for the need for mid-range, process-oriented theory which brings in new ideas from the developing fields of strategic management and organization theory to begin to understand the MNC as an organization, rather than as a response to macro-level market conditions. From the combination of industry-level studies of sustained imperfect competition and firm-level foci on transactional efficiency and organizational theory emerged yet another approach to competitive advantage and business strategy. Resource-based strategy (Barney, 1991; Wernerfelt, 1984) and its progeny (capabilities or competency-based strategy, knowledge-based strategy) continued to focus on the firm but looked to the unique assets, skills, and know-how of the individual firm to explain differential economic success rather than focusing solely on exchange efficiency. This model, as propounded by Barney (1991) and many others (Grant, 1991; Peteraf, 1993), has come to dominate strategy. It has likewise been applied to the analysis of the MNC and its strategic roles by various authors working at the boundaries of international business and strategic management (Collis, 1991; Tallman, 1992). While the IO and TC economics approaches to business strategy and to international organizations and management developed largely independently, despite their common theoretical heritage, the growing integration of strategy and international business over the last decade or so has resulted in direct application of these new strategic management frameworks to the analysis of the MNC and global strategy. The concepts of the metanational and of the “managerial model” proposed in this paper apply resource-based, and particularly knowledge-based, strategy ideas to the MNC. As Professor Doz says, this paper applies the ideas of innovative effectiveness and of geographically tied knowledge to the development of firmlevel capabilities in place of a focus on operational efficiency. Resource-based models have been applied to MNCs since at least Collis (1991) and Tallman (1991) in a special issue of Strategic Management Journal addressing Global Strategy. More recently, knowledge-based models (Kogut & Zander, 1993) and capability-based models (Tallman & Fladmoe-Lindquist, 2002) have been used


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to explore the organizations, strategies, and sources of competitive advantage of MNCs, as have evolutionary and co-evolutionary constructs (Kogut, 1997). Doz integrates various current ideas about the firm as a co-evolutionary system with its environment and as a mechanism for developing and transmitting knowledge in the analysis of the MNC. In this way, he continues the tradition of applying strategic-management concepts to international business, as well as that of bringing the case-analysis tradition of strategy to the effort to understand MNCs. While most of these concepts have been developed by others, Professor Doz provides a more comprehensive and integrated model than most.

GLOBAL STRATEGY AND THE MULTINATIONAL CORPORATION The second section of the body of Professor Doz’s paper reviews the functional roles played by MNCs, both from a historical perspective on empirical modeling and as a timewise sequence of evolving strategies (Tallman & Yip, 2001). Thus, the focus of most early studies of MNC activity looked at foreign direct investment as a replacement for trade or licensing in “projecting” the advantages of the MNC into foreign markets (Caves, 1971; Dunning, 1977; Stopford & Wells, 1972). Interestingly, this is the stage of global strategy and organization that is most relevant to both strategic behavior and transaction-cost analysis approaches – the specific trade-off of internal for external markets – but is probably the least important aspect of the MNC in the post-industrial age. While specialized knowledge was historically an advantage of multinationals over local firms in developing markets, and still is in many fields, the intensive competition among MNCs and the importance of innovation in knowledge-based competition make the focus on size and market power of strategic behavior models generally outdated. Internalization models largely focused on knowledge-intensive industries, but also largely assume that knowledge is incorporated in goods, which are either exported from the center or produced locally as determined by the MNC headquarters. As presented in Tallman and Yip (2001) and in various models of internationalization, MNCs tend to become fragmented presences in a variety of markets as they invest in local subsidiaries to supplement and then replace trade. What has been the most important aspect of global strategy arises in response to this fragmentation, as MNCs begin to integrate across the various subsidiaries to improve efficiency in applying their corporate assets and capabilities. This process was presented until recently as a matter of reducing the costs of operations below those of local competitors and as something to be accomplished by structural change. The choice of consolidation over fragmentation is largely the domain

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of the Integration–Responsiveness model that is the focus of Yves’ early work (Prahalad & Doz, 1987). In keeping with models of the MNC as a learning or knowledge-driven organization (Tallman & Fladmoe-Lindquist, 2002), Doz points to a couple of key issues that bring this model into the information age. First, integration is much more about the consolidation of organizational knowledge, i.e. organizational learning, than about cost minimization for trade in goods. Second, new processes, or organizational capabilities, for encouraging innovation and learning are much more important to successful integration than is the choice of formal organization structure. Companies can be organized around local competencies and markets, but still use information technology and learning strategies to integrate their intellectual value adding processes globally. Network models of the MNC (Ghoshal & Nohria, 1989) reflect patterns of information exchange, but not the reporting relationships of an actual organization chart.

ORGANIZATIONAL LEARNING IN THE MNC The next two sections of the paper focus on innovation and learning in MNCs. In the first section, Doz describes the benefits of dispersed operations to innovation. If subsidiaries are located in a variety of contexts, they will tend to develop new and different ways of operating and generate more innovation, a finding associated strongly with the work of Julian Birkinshaw and various co-authors (e.g. Birkinshaw & Hood, 2000). The successful MNC must “reverse the flow” of knowledge from project out of the center to collection and packaging knowledge from the periphery for dispersion throughout the MNC. He points out that this is neither easy nor natural but requires top-management intervention to make it happen. Doz then proposes, in the next section, that his model of the metanational corporation can answer the needs of the MNC in knowledge-intensive environments. The metanational specializes in operating in global markets rather than in transferring knowledge from one locale to another. Doz suggests that capabilities must be built in sensing new knowledge through empowered subsidiaries, alliances, and technical personnel; in mobilizing newly detected knowledge throughout the firm by establishing “magnet structures”; and in leveraging innovations in multiple markets. This is essentially an organizational learning model. Zahra and George (2002) describe four steps in organizational learning, which could be applied to the MNC as follows: acquire knowledge through innovation, acquisition, or alliance; assimilate knowledge by transferring it across boundaries; adapt knowledge to local conditions by recombining it with local skills; and apply knowledge by targeting local customers with tailored products. Doz has placed a similar learning model into a more grounded, more pragmatic perspective


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but is largely working to apply a set of concepts that is well developed in the literature. This model suggests that the MNC acts to detect, mobilize, arbitrage, and leverage innovative knowledge in a faster and more efficient manner than its competitors. Important to this capability is the ability to communicate directly from subsidiary unit to subsidiary unit without moving knowledge through the center. Doz speaks of reversing the flow of knowledge from center to subsidiary to subsidiary to center. Rather, the network organization proposed by Ghoshal and others (Ghoshal & Nohria, 1989) models direct communications between subordinate units within the firm and places the HQ in the role of coordinator rather than controller of the dispersed firm. Doz might consider the center, in information-age terms, as the “webmaster” of the MNC. In this metaphor, the HQ sets up the architecture of the firm’s knowledge acquisition, transmittal, and integration, and ensures (or at least attempts to ensure) the uniform application and adaptation of this architecture, while not directly supervising the acquisition, assimilation, adaptation, or application of any specific components of the MNC’s stock of knowledge. It is this combination of structure and decentralization that appears to be best able to generate organizational (as opposed to unit-level) innovation (Hedlund & Ridderstrale, 1993).

THE MANAGERIAL MODEL Professor Doz closes with a discussion about turning the metanational model into a dynamic approach to a constantly changing world. As he says, once a piece of knowledge matures and becomes more explicit, more accepted, and better understood around the world, the MNC loses any advantage as an arbitrageur of the knowledge – the market becomes dominant. He is essentially calling for a co-evolutionary model of the MNC in the global marketplace (Kogut, 1997). The world develops, the influence of various entities evolves, selection pressures change over time, and the MNC must evolve and adapt or die. At the same time, the microprocesses of organizational strategy, structure, and systems continue to develop (networks of alliances, information technology, economic value added analysis, and so on), and the MNC must also adapt to these new concepts or fall behind its competitors. As a point of interest, even as Yves points to the decline of the nation-state and the rise of supranational organizations and NGOs, the latest news is of the collapse of the Cancun round of WTO talks and the political and increasingly economic estrangement between the U.S. and the European Union. It appears that nations and regional political associations of nations may be more resilient than globalists have assumed.

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The concept of the MNC as an arbitrageur of information and knowledge is not original to this paper. It was, for instance, the topic of a debate between John Dunning and Michael Porter at the 1997 Academy of Management in Boston. The metanational model is more comprehensive and complete than most efforts to describe the firm in the knowledge economy but still leaves questions and concerns, as outlined in this volume by Birkinshaw and Arvidsson (2003). I believe that the greatest question, though, is whether conceptual model building is in large part outracing practice. Alan Rugman (Rugman & D’Cruz, 2000) makes the case frequently that few markets, industries, or firms are global; despite decades of scholarly work on the implications of globalization, most international competition is regional. The Transnational Enterprise (Bartlett & Ghoshal, 1989) is seen as an idealization based on extrapolation of trends beyond reasonable bounds. In this same vein, we might ask how many firms are really approaching the metanational ideal. Some MNCs are actively attempting to source knowledge internationally, some are trying to mobilize new ideas among their component parts, and some are trying hard to leverage across markets. How many are doing all of these well, or even effectively? Birkinshaw and Arvidsson (2003) find that the magnets are weak – what might we realistically expect in the case of the rest of the organizational learning process? The weakness of small-sample observation and extrapolation is that complex models built from a detailed analysis of a few path-breaking, innovative firms may never apply to the majority. Is the MNC as a knowledge arbitrageur in a network of outsourced production and marketing “really real,” or is it an extrapolation of events in a small set of elite firms that will never become a dominant trend? Only time will tell, but the question remains, “How many firms can make a living by neither making nor selling, but by trading between producers and marketers?” It worked in U.S. energy markets for a short time, but once a few competitors entered the market, even Enron was reduced to market manipulation, political influence, and criminal activities for its short remaining life. How many metanationals can survive the pressures to make a profit on marketized knowledge? Doz ties the paper together as he returns to his historical analysis to demonstrate how much the environments and the capabilities of MNCs have co-evolved in the last two or three decades. He recognizes that these rapid changes can make descriptions and prescriptions from earlier eras seem quaint, simplistic, and irrelevant. He again makes the case that the small-sample, case-based empiricism of the strategic-management school can keep researchers of the MNC current with their evolving phenomenon as opposed to the retrospective nature of large databases and statistical analysis. He only alludes to theory, but I would say that scholarly abstract model building can keep pace with organizational evolution only if it has a strong theoretical core – the other critical borrowing from strategic


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management studies. Without the sort of adaptable firm-level models of the MNC provided by such theoretical constructs as transaction-cost economics or the resource-based and knowledge-based views of the firm, we would be astounded by every new idea coming from organizations. With theory, we have tools to begin to collect, categorize, and conceptualize the meanings of these innovations – even before we begin the cycle of statistical analysis. The strength of Yves Doz’s work has been its blend of observing the real world and applying current theory to understand what is seen. Without the theoretical component, Yves would have an extraordinary collection of cases. With it, he is deservedly recognized as a distinguished scholar.

REFERENCES Barney, J. B. (1991). Firm resources and sustained competitive advantage. Journal of Management, 17, 99–120. Bartlett, C. A., & Ghoshal, S. (1989). Managing across borders: The transnational solution. Boston: Harvard Business School Press. Birkinshaw, J., & Arvidsson, N. (2004). Making sense of the metanational: Does the firm really know what it knows? This volume. Birkinshaw, J., & Hood, N. (2000). Characteristics of foreign subsidiaries in industry clusters. Journal of International Business Studies, 31, 141–154. Buckley, P. J., & Casson, M. C. (1976). The future of the multinational enterprise. London: MacMillan. Caves, R. E. (1971). Industrial corporations: The industrial economics of foreign investment. Economica, 41, 176–193. Coase, R. (1937). The nature of the firm. Economica, 4, 386–405. Collis, D. J. (1991). A resource-based analysis of global competition: The case of the bearings industry [Special issue]. Strategic Management Journal, 12, 49–68. Doz, Y. L. (1976). National policies and multinational management. Unpublished doctoral dissertation, Harvard Business School. Doz, Y. L. (1986). Government policies and global industries. In: M. E. Porter (Ed.), Competition in Global Industries (pp. 225–266). Boston: Harvard Business School Press. Doz, Y. L., Bartlett, C. A., & Prahalad, C. K. (1981). Global competitive pressures and host country demands: Managing tensions in MNCs. California Management Review, 23(3), 63–75. Doz, Y. L., & Prahalad, C. K. (1991). Managing DMNCs: A search for a new paradigm. Strategic Management Journal, 12, 145–164. Doz, Y. L., Williamson, P., & Santos, J. (2001). The metanational. Boston: Harvard Business School Press. Dunning, J. H. (1977). Trade, location of economic activity, and the MNE: A search for an eclectic approach. In: B. Ohlin, P. O. Hesselborn & P. M. Wijkman (Eds), The International Allocation of Economic Activity (pp. 395–418). London: Macmillan. Ghoshal, S., & Nohria, N. (1989). Internal differentiation within multinational corporations. Strategic Management Journal, 10, 323–337. Grant, R. M. (1991). The resource-based theory of competitive advantage: Implications for strategy formulation. California Management Review, 33, 114–135.

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Hedlund, G., & Ridderstrale, J. (1993). Toward the N-Form Corporation: Exploitation and creation in the MNC. Institute of international Business, Stockholm School of Economics, RP 92/15. Hymer, S. H. (1976). The international operations of national firms: A study of direct foreign investment. Cambridge, MA: MIT Press. (Original work published 1960.) Kogut, B. (1988). Joint ventures: Theoretical and empirical perspectives. Strategic Management Journal, 9, 3319–3322. Kogut, B. (1997). The evolutionary theory of the multinational corporation: Within- and across-country options. In: B. Toyne & D. Nigh (Eds), International Business: An Emerging Vision (pp. 470–488). Columbia: University of South Carolina Press. Kogut, B., & Zander, U. (1993). Knowledge of the firm and the evolutionary theory of the multinational corporation. Journal of International Business Studies, 24, 625–645. Peteraf, M. A. (1993). The cornerstones of competitive advantage: A resource-based view. Strategic Management Journal, 14(3), 179–191. Porter, M. E. (1980). Competitive strategy: Techniques for analyzing industries and competitors. New York: Free Press. Prahalad, C. K. (1975). The strategic process in a multinational corporation. DBA dissertation, Harvard Business School. Prahalad, C. K., & Doz, Y. (1987). The multinational mission: Balancing local demands and global vision. New York: Free Press. Rugman, A. M. (1979). International diversification and the multinational enterprise. Lexington, MA: Lexington Books. Rugman, A. M., & D’Cruz, J. (2000). Multinationals as flagship firms: Regional business networks. Oxford: Oxford University Press. Stopford, J., & Wells, L. (1972). Managing the multinational organization of the firm and overlap of subsidiaries. New York: Basic Books. Tallman, S., & Fladmoe-Lindquist, K. (2002). Internationalization, globalization, and capability-based strategy. California Management Review, 45, 116–135. Tallman, S. B. (1991). Strategic management models and resource-based strategies among MNEs in a host market [Special issue]. Strategic Management Journal, 12, 69–82. Tallman, S. B. (1992). A strategic management perspective on host country structures of multinational enterprises. Journal of Management, 18, 455–471. Tallman, S. B., & Yip, G. S. (2001). Strategy and the multinational enterprise. In: A. Rugman & T. Brewer (Eds), The Oxford Handbook of International Business (pp. 317–348). Oxford: Oxford University Press. Teece, D. J. (1982). Towards an economic theory of the multiproduct firm. Journal of Economic Behavior and Organization, 3, 39–64. Teece, D. J. (1985). Multinational enterprise, internal governance and economic organization. American Economic Review, 75, 233–238. Vernon, R. (1966). International investment and international trade in the product cycle. Quarterly Journal of Economics, 80(2), 190–207. Wernerfelt, B. (1984). A resource-based view of the firm. Strategic Management Journal, 5, 171–180. Zahra, S., & George, G. (2002). Absorptive capacity: A review, reconceptualization, and extension. Academy of Management Review, 27, 185–203.

NATIONAL CONTEXT AND THE METANATIONAL PERSPECTIVE IN INTERNATIONAL STRATEGY Mona Makhija and Oded Shenkar In their recent book, From Global to Metanational, Yves Doz, Jose Santos and Peter Williamson (2001) argue that in today’s evolving competitive environment, the fundamental pillar of success for a firm’s international strategy is its ability to manage knowledge. This idea rests on three foundations: (1) a firm’s ability to achieve competitive advantage relies primarily on knowledge-based assets rather than more tangible assets; (2) the knowledge required by the firm is dispersed around the globe and, indeed, will be scattered across even the most inconspicuous of locations; and (3) distances are less important than ever, as the cost of accessing “commodities” such as capital, goods, and information is falling to such a low point that they no longer constitute a barrier to international competition. These are, without a doubt, important ideas that resonate in today’s knowledgeintensive world. There is enough intuitive sense, and perhaps an element of truth in each, that makes them difficult to question. Indeed, the pivotal position of knowledge has been recognized in the international strategy literature over the last two decades (Cheng & Bolon, 1993; Gupta & Govindarajan, 1991; Hitt et al., 1997; Johanson & Valhne, 1977). In 1987, Prahalad and Doz posited that the global presence of the multinational firm required the management of knowledge inherent in an integrated global network of production and markets. Porter, in his 1986 volume on global industries, stressed that the critical basis for competing in highly global industries was the knowledge associated with coordinating

Theories of the Multinational Enterprise: Diversity, Complexity and Relevance Advances in International Management, Volume 16, 67–82 Copyright © 2004 Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 0747-7929/doi:10.1016/S0747-7929(04)16005-8

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dispersed operations. Later in 1989, Bartlett and Ghoshal proposed that success in the new competitive environment required a transnational strategy, which allowed for both local responsiveness and global integration. In rephrasing a balance that has been touted by generations of management and international business researchers before them, the authors added that a two-way flow of knowledge across subsidiaries and headquarters was essential for its achievement. In light of the considerable emphasis on knowledge in prior work, it is appropriate to ask what is different in the new “metanational” perspective espoused by Doz and colleagues. Scholars may question the uniqueness of its contribution because the firm’s knowledge has been identified as a primary source of competitive advantage in both strategic management and international business research. Three ideas raised in this book may qualify as novel, however. They pertain to the costs and benefits associated with the national context in developing a firm’s capability set, the value-creating activities underlying the firm’s competitive advantage, and the role of innovation in international strategy. We describe each below. The role of national context in the metanational approach contrasts with prior perspectives. This approach suggests that firms no longer need to be organizationally embedded in diverse national contexts via a complex web of subsidiaries and can instead leverage alliances, procurement agreements, and other relationships to greater effectiveness. Such arrangements are said to provide a more organic arrangement, allowing the firm adaptation to technological and competitive market changes without being encumbered by heavy financial and operational requirements. A second related departure from past literature is the de-emphasis of organization-related knowledge and the dispersion of value-added activities, which had been of primary concern in the work of Bartlett and Ghoshal (1989), Porter (1986), and Prahalad and Doz (1987). Doz and his colleagues believe that this is no longer a key for achieving global competitive advantage, since such activities are so commonplace today that they no longer differentiate companies. They cite falling trade and investment barriers that have opened access to low-cost sources of production, the global dispersion of production and management techniques, and the proliferation of information technologies facilitating control of complex and far flung operations. If the ability to manage their operations and to address national differences is no longer important, what, then, is the source of firms’ competitive advantage today? Doz and his colleagues place the primary emphasis on a firm’s ability to innovate. Innovation capability appears to be the key driving force behind the metanational strategy, providing form to their notions on knowledge. The critical capabilities that underlie this strategy are all associated with the management of innovation: (1) the ability to sense, or identify, new sources of relevant technologies,

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competencies and knowledge about customers; (2) the ability to infuse dispersed knowledge into useful products and services; and (3) the organizational aptitude to accomplish these activities in an efficient and flexible manner. Taken together, these three differences stem from one fundamental idea that underlies the metanational perspective, namely that managing national context is not as critical as it may have been in the past and that its role and relevance stems primarily from (and, some might say, is reduced to) the identification and acquisition of knowledge. Such a view of national context represents a fundamental departure from the extant international business literature. This paper sets out, therefore, to examine the assumptions relating to the role of the national context in the metanational perspective. In the sections below, we compare the three core ideas of the metanational perspective that relate to the national context against the existing theoretical perspectives in international strategy.

THE ROLE OF THE NATIONAL CONTEXT IN FORMING COMPETITIVE ADVANTAGE Firms competing in national contexts other than their own suffer from “the liability of foreignness” (Zaheer, 1995). This liability stems from their lack of in-depth knowledge relating to economic, cultural, social, and political factors that influence the operating environment in these countries. Without such knowledge, firms will incur greater risks than local firms who have detailed understanding of these factors, or other firms with more experience in such environments, thereby putting them at a competitive disadvantage. To compensate, firms expanding internationally need to develop, leverage, and deploy capabilities that provide them with advantages unavailable to their local competitors. For this reason, national context has been the foundation on which past theoretical treatments of the MNE rested, greatly influencing the formulation of international strategy. Take, for instance, the 1970s-era Uppsala model of internationalization, which held that firms gradually commit to higher involvement in markets that are incrementally higher in psychic distance. The Uppsala formula assumes that the costs and risks of entering overseas markets are nontrivial, and lack of knowledge on foreign markets raises the probability of failure. All else being equal, firms will choose to enter those markets first in which their overall risks are lower, which are markets that are culturally, geographically or developmentally similar to their own. Similarity of country contexts increases the probability that a firm will be able to successfully replicate practices and routines in which its competitive advantage and industry knowledge are embedded. The costs associated with adapting product and operational requirements to this environment will likewise

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be lower. Equally important, the firm is less likely to commit costly mistakes by misreading a foreign environment with which it is unfamiliar. In the same vein, Vernon’s (1966) international product life cycle indicates that products are first adopted in markets that are similar to the market of origin. National context also plays a key role in Dunning’s (1980) eclectic theory, which stresses that countries vary in attributes that matter to MNEs. Firms adapt their operations in these countries, adjusting ownership and governance (e.g. wholly owned or partially owned subsidiaries) accordingly. All three perspectives share, explicitly or implicitly, an assumption that national environments affect firms’ costs and risks. Taking this notion further, Porter, in his 1990 book, The Competitive Advantage of Nations, argues that not only are the differences in national context between the home and host country important, but the national context in which firms are born plays a critical role in their ability to develop a global competitive advantage. In this view, the national environment comprises several important characteristics that facilitate development of the firm’s capabilities. Below we outline these national characteristics and compare their implications with those stemming from the metanational perspective. One national characteristic suggested by Porter (1990) stems from the availability of key production factors. Access to vital resources and capabilities in the home environment reduces the costs of producing the product, conferring a critical advantage. While some vital resources must be locally available, Porter stresses that not all requisite resources need be. Rather, the lack of some resources combined with the availability of others will impel firms to innovate, giving them another source of competitive advantage. A second factor is home rivalry. If the home market is the arena of intense competition, firms will learn to “fight hard” and go the extra mile to secure customers. This ability, born out of necessity in the home market, will translate into a competitive advantage in international market vis-à-vis firms who did not have to develop such capabilities. A third factor has to do with home-market customers. The more demanding the domestic consumer, the harder firms will have to work in order to gain their business. Such demand can be due to better education, in-depth understanding of the technology associated with the product, or significant cost or quality imperatives for consumers with unique needs. For example, the ability to gain market share in a low-income country requires the ability to control production and distribution costs, an ability which can ultimately be leveraged in overseas competition. Similarly, unique requirements such as conservation knowledge originating from expensive or unreliable electric power, miniaturization capabilities developed in areas of high population density, or product agility perfected in adverse climates require firms to innovate and incorporate product features that can translate into competitive advantage globally. Porter also notes that the presence


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of excellent support industries benefits firms by facilitating their ability to produce and deliver their own product; national clusters are created in which resources, skills, and demand are beneficially interwoven. For example, the proximity of an efficient and innovative plastics industry allows automotive firms to work with plastic manufacturers so that component parts better meet their requirements. In all, the combination of domestically anchored factors creates an environment that not only contains critical product knowledge but also provides incentives for achieving industry excellence. The presence of such factors creates an impetus for early development of the industry, giving local firms a head start in competition and erecting barriers to new entrants. Firms in other nations that cannot benefit from the presence of such factors will not be able to move down the learning curve as fast and are less likely to be as competitive. Thus, in Porter’s perspective, the national context plays a vital competency-building role that will ultimately drive innovation, conferring a honed ability with which to address global competition. Critically, the capabilities associated with national context are likely to benefit firms even, and perhaps especially, when facing a set of competitors abroad whose nascence is in a markedly different environment. Consistent with prior perspectives, the firm utilizes superior capabilities developed at home to compete with overseas firms. In stark contrast to this positivist perspective, Doz and Colleagues assert that the role of national context is no longer so important; rather, that national origin may actually be detrimental to the firm’s ability to innovate. The rationale is that the importance of the national environment is rooted in the cost associated with distance, and with such costs rapidly falling due to transport and communication advances, the ability to take a homegrown formula and successfully project it into new markets around the world no longer distinguishes one competitor from another. Unimpeded information flows and easy access to production factors allows for easy imitation and reduces the benefits of homegrown formulas. With the product life cycle shortened, any remaining local edge will not yield much rent. Hence, neither global efficiency nor home characteristics or local adaptation are retained as distinctive sources of advantage for the firm. Because of these changes in the competitive environment, firms need to become more innovative than ever. While local knowledge may be a useful generator of innovation, Doz cautions that reliance on such knowledge creates hazards. Technological convergence across industries, knowledge dispersion through offshore sourcing, technology transfer and increasing technological complexity combine to increase the requisite range of knowledge for maintaining a competitive edge and its diversity. It is unlikely that one national context will be adequate for deriving all the knowledge required for innovation. With innovation sources spread throughout the globe, firms risk being locked into a locally

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available but less promising idea. A firm’s geographic roots are hence no longer an important driver of innovation and can be limiting, causing myopic behavior.

BORN IN THE . . . WRONG PLACE? To support their point, Doz and colleagues reflect on the increased evidence of innovations taking place outside of “traditional” home markets, sometimes revolutionizing the industry. They ask: Would you pick Finland as your home base from which to storm the international market for mobile telephones? Would you select Switzerland as your launching pad to break into the international market for guided missile systems? Would you choose Japan as the location from which to compete with Steinway in the global market for pianos?

Competitors such as Nokia and Yamaha appear to break the mold, but do they really? A close examination of these two cases would reveal a different story, one that might actually reaffirm the value of the national context. Nokia had its start under another name in 1865 as a forest industry firm which merged at the end of the century with a Finish rubber firm, and later with a local cable company. Its national origin was important, since, in the company’s own account, it taught it to operate under constant threat. This was typical of Finland’s geopolitical position as a vulnerable neighbor to a powerful and expansionist Russia. The ability to operate under such threat became quite useful for a firm that would find itself later in the highly volatile and competitive telecommunications sector. In the 1980s, Nokia acquired a series of related firms in Finland, Sweden, Germany, France, and Germany. Finland remained its operational center, but it could now benefit from geographic and cultural proximity to Scandinavian markets as well as from access to the European Union markets. Similarly, while Japan may seem an unlikely location for piano manufacturing, Japanese prowess in electronics propelled Yamaha into electronic keyboards and pianos, ultimately transitioning into traditional pianos. In addition, Japanese expertise in complex assembly permitted Yamaha to introduce a quality massproduced piano at competitive prices, undercutting Steinway’s craft assembly techniques. In this way, Yamaha is an example of a company that was able to leverage its national base towards entry into global markets. Note that this was highly reminiscent of the way Steinway itself upstaged its European competitors a century earlier, when it incorporated into its own production process standardized elements, something in which U.S. industry excelled. That these firms are still making use of a national advantage anchored in their locale does not preclude the entry of new competitors, who in their turn take


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advantage of national characteristics that are not static but rather come into play at a certain time phase. Although the auto industry was born in the U.S. and Western Europe, Japanese, and later, Korean firms were able to leverage their own unique capabilities to compete internationally in this industry, taking advantage of conditions unavailable to others (e.g. miniaturization skills applicable in the building of small cars, which came into higher demand because of the oil crisis). Similarly, China has become the world’s most popular location for the low cost production of toys, an industry that was fairly unknown to this location only a decade earlier, partially by building enough agglomeration (most of China’s toy manufacturing is concentrated in one area in southern China). Leveraging its cheap labor and emerging market, China is now a competitor to Steinway and Yamahas in pianos and increasingly to Nokia in cell phones. Likewise, India is leveraging its long-time advantages of English-speaking labor and low-cost location to become a major source of telecommunications-based services for Western firms. This industry is completely new for India yet makes sense in light of its national attributes. Thus, the advantage embedded in national origin may be evolving, but this certainly does not mean that it becomes irrelevant. For instance, the location advantages of Germany and Japan allowed them to maintain competitiveness in auto production despite their steep wage cost structure, and their ability to extend this advantage via offshore production only serves to solidify the importance of their original location. Another example provided by Doz and his colleagues is a comparison of U.S.-based Intel and France-based ST. The authors note that national context such as that of the U.S. can still be rich enough to provide adequate competitive advantage for a company like Intel. Since Intel is able to benefit from U.S.-based advantages, it has less need to develop a structure for accessing internationally dispersed knowledge. In contrast, because ST of France did not have access to the same national endowments, it had to be more innovative in overcoming these deficiencies, presumably by looking outside its home market. If anything, however, this example confirms the importance of the national context of the home country. Further, when it comes to R&D, Intel not only accesses knowledge in foreign locations but has set up overseas development centers, in locations such as Israel and India. Because of the nature of its product, however, its manufacturing processes around the globe are highly standardized. The combination seems like a classical case of a firm seeking to simultaneously leverage global scale and local advantages. Finally, and equally problematic for the Doz thesis, is the reality of uneven global distribution of innovation. The U.S. has maintained a huge surplus in technology flows for decades and continues to lead in the development of new technologies. Tiny Israel produces more NASDAQ registered firms than France

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and Spain combined. China, despite enormous foreign investment inflows, still has relatively little to show for in terms of new knowledge creation. Knowledge may indeed be found anywhere on the planet, but the probability of it being generated varies dramatically, as does the probability of being found and utilized. Indeed, the ability to identify, decipher, and apply knowledge obtained from a variety of locales is itself anchored in a home environment which defines key portions of the firm’s absorptive capacity.

LOCATION OF VALUE-CREATING ACTIVITIES IN FORMING COMPETITIVE ADVANTAGE Doz’s earlier book, The Multinational Mission, presents an integrationresponsiveness grid which reiterates a longstanding convention in international business that globalization and localization are the chief opposing forces to be addressed by a firm’s international strategy. This work, like others before and after it, notes that particular global conditions create a need for worldwide integration of important value-added activities relating to procurement, production, and marketing. These conditions stem from factors such as competitors that impose strong cost and innovation pressures, the need to leverage high investment costs across multiple products and markets, and the benefits of exploiting economies of scale and experience by building large plants to serve multiple markets. Even though these notions may have been associated first with manufacturing, it is evident that they generalize across industries, including those that involve technologyintensive activities or services, where labor-intensive activities associated with accounting, consumer relations (i.e. call centers), pharmaceutical testing, as well as research and development, are outsourced to developing countries where labor costs are lower. Also adopting the notion of the integration-responsiveness grid, in The Transnational Solution Bartlett and Ghoshal (1989) describe how a transnational strategy allows firms to coordinate dispersed value-added activities across the globe, and at the same time, deliver locally appropriate products to specific markets. To survive in an internationally competitive industry, a company must have global-scale, international resource access and a worldwide market position. These features allow the MNE to extract cost advantage from the ability to arbitrage input costs across the globe, benefit from worldwide scale economies, and slide down the experience curve. Benefits notwithstanding, the complexity of this endeavor is enormous. The accomplishment of these conflicting imperatives requires skillful management of knowledge within the organization, in a manner that ensures both efficiency and


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innovation. A traditional global strategy involves the establishment of regional subsidiaries within a tightly coordinated network under the MNE’s ownership and governance. This coordination is accomplished by a massive two-way flow of information and knowledge throughout the organization, which ensures that activities throughout the globe are carefully integrated (Bartlett & Ghoshal, 1989). The ability to manage knowledge is hence a fundamental success factor for the MNE. The knowledge of subsidiaries is to be continually shared, with headquarters as well as with other subsidiaries. Headquarters not only receives this knowledge but also provides feedback and disseminates its own. This continuous flow of knowledge among all parts of the organization is a critical feature of the transnational firm. Subsidiaries and headquarters are partners in this process of production and dissemination of knowledge. In contrast, Doz and colleagues argue that the ability to produce, whether goods or services, is now “commodity-like.” Production knowledge is so completely mobile that these features no longer distinguish companies. Companies that do not have production knowledge, perhaps because they were “born in the wrong place,” can just as easily scan the world for locations with the necessary capabilities in production, marketing, and distribution. Their concern is to assemble, rather than develop, the operating capabilities needed to leverage innovations globally. Therefore, these capabilities may come from sites within their own network or from outside partners. The firm operates as a global supply chain assembled from capabilities drawn from different sites around the world. Importantly, while knowledge pays a central role, firm ownership is not consequential in the metanational strategy. Instead, partnerships with other firms reduce the need to manage production activities. While the management of knowledge is indeed critical to an international strategy, it is nonetheless not at all clear that organizing and coordinating the production function can now take a back seat. The procurement of inputs and components, the identification of the best locations, structuring investments in a manner that minimize political and economic risks, applying technology to the production process, and training workers in new production techniques, are all, ultimately, critical to the ability of the firm to deliver a superior product or service. As suggested by Dunning and Buckley, among others, the decision to control operations depends on the extent to which the requisite capability is present, proprietary and easily conveyed. Firms can and do differentiate themselves in how they manage the value-creating process. This can stem from variations in the organization of the production function, the type of technologies employed, the manner of motivating employees, and the tolerance of production risks. Superior ways of organizing operations can add critical value, over and above the capability of the firm to innovate.

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The ability to manage a dispersed web of worldwide suppliers is not necessarily more important than the ability to manage one’s own operations, as implied in the metanational perspective. The alliance literature indicates clearly that cooperative arrangements are more complex than stand-alone operations, enormously prone to failure, and often more expensive to run than single-ownership subsidiaries. When it comes to knowledge, not only are alliances problematic in terms of dissemination, but they represent a remarkable risk of knowledge leakage and loss of competencies, often to direct competitors. The more integrated the alliance is with the core operations of its parent, the greater the potential damage from uncompensated knowledge flows and from an unintended dissolution. The notion that alliance capabilities can be acquired (e.g. Barkema et al., 1997; Kale et al., 2002) and that, if properly developed and deployed, they can become a source of competitive advantage (Ireland et al., 2002) does not imply that an alliance arrangement, in and of itself, is superior to full ownership. Knowing how to structure and run a large MNE involves its own set of capabilities, and the successful firm would try to develop both to increase its range of strategic options. Along this range, a major reason for establishing alliances with a local partner is the unfamiliarity of a foreign investor with the local environment, which again reminds us of the relevance of national context. Indeed, even in locations like Hong Kong, where there are no regulations forcing an alliance with a local partner or special incentives to do so, such alliances far outnumber alliances with other foreign partners which could provide knowledge but not that of the local environment. Again, national context matters in multidimensional ways. As Makino and Inkpen (2003) note, the national origin of the MNE may limit its ability to search and identify learning opportunities. An alliance strategy can be useful in this regard, but so can other strategies, such as establishing a wholly owned development center in a promising knowledge source or within an agglomerated cluster. An alliance can extend a firm’s absorptive capacity by leveraging the inter-organizational level (Van den Bosch et al., 2003), but there is also the question of where such knowledge will be stored (Salk & Simonin, 2003) as well as the material risk that in the end, the capacity will reside in the partner, which is often a competitor. Adopting an alliance network without control of core knowledge may result in the MNE eroding valuable knowledge assets rather than adding to them.

INNOVATION, THE ULTIMATE DRIVER OF COMPETITIVE ADVANTAGE In the final analysis, according to Doz and his colleagues, it is the firm’s innovative capability that is the ultimate driver of competitive advantage. This advantage is


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based on identifying, accessing, and utilizing pockets of specialist knowledge drawn from around the world. They argue that the future belongs to the firm that is finely tuned to sense, mobilize, and leverage such knowledge dispersed around the world. These capabilities will open the door to new and powerful sources of value creation and competitive advantage that traditional multinationals are unable to harness. The central role played by knowledge and innovation in the future of international strategy has much intuitive appeal. Indeed, as we noted in the introduction to this commentary, others have already identified innovation as a defining feature of international strategy (Cheng & Bolon, 1993). A firm’s ability to develop new products and processes allows it to better address the needs of diverse overseas customers, and to appropriate the benefits of its innovations more advantageously than by simply selling or licensing its technology. In a perspective quite reminiscent of that articulated by Doz and his colleagues, Bartlett and Ghoshal in 1989 wrote that: A firm’s ability to innovate is rapidly becoming the primary source of competitive success. Although worldwide companies once gained competitive advantage by exploiting global scale economies or arbitraging imperfections in the world’s labor, materials, or capital markets, such advantages have eroded over time. . . . The new winners are the companies that are sensitive to market or technological trends no matter where they occur, creatively responsive to worldwide opportunities and threats, and able to exploit their new ideas and products globally in a rapid and efficient manner (Bartlett & Ghoshal, 1989, pp. 131–132).

Although the importance of innovation is clearly seen in these words by Bartlett and Ghoshal, their perspective of how firms leverage their innovative capacity for competitive advantage differs from that of Doz and colleagues in a number of ways. First, they surmise that the international competitive field is populated by a handful of large international firms, which, despite their diverse national origins, are comparable in size and geographical reach. Smaller national companies pose little threat. In contrast, the strong emphasis on innovation as the source of competitive edge in Doz’s perspective suggests that the competitive threat can come from anywhere, not just large MNEs. In fact, the threat may be even more likely from small players that are primarily national in the early stages of their internationalization. It is established that small firms tend to be more innovative than their larger competitors. When combined with their strategic and operational flexibility, this innovation ability presents a formidable challenge to larger, more entrenched firms that are slow to respond to new technological developments or market movements. A second difference between the perspectives of Bartlett and Ghoshal and that of Doz and his colleagues is the critical role of subsidiaries in the innovation process. According to Doz and colleagues, the existence of subsidiaries translates into

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an entrenched organizational structure that reduces the flexibility of the firm and its ability to innovate. In contrast, Bartlett and Ghoshal note that internationally dispersed subsidiaries are among the strongest advantages of the transnational firm. These subsidiaries are reflections of the national context in which they are embedded and, not less importantly, enjoy a level of local legitimacy. Each of these subsidiaries serves as the local “eyes and ears” of the firm, allowing it to pick up on highly subtle and nationally embedded knowledge that would otherwise go unnoticed. This includes the actions and intentions of their national counterparts which alliances, often formed between competitors, are much less likely to provide. At the same time, subsidiaries are sensitive to the needs of their environment and, by combining firm resources and capabilities with local knowledge, can be a source of innovative capability. Alliances, which only partially overlap the parent firm, may be unable to combine the MNE and the local resources in a way that will offer real synergy on knowledge creation as well as in other domains. This argument may point to another important concern over the metanational perspective. While they espouse the importance of identifying idiosyncratic knowledge dispersed throughout unusual locations around the world, which resonates clearly with the ability to innovate, the viability of their methods for doing so is not as clear. They suggest that the organization must establish a set of organizational structures which collect and meld dispersed pieces of knowledge into innovative business models, product and service designs, or processes and systems. These structures, which they refer to as “magnets,” may be temporary or permanent, depending on the nature of the innovation, and may take the form of project teams that are sensitized to specific needs and innovations. Project teams or any other temporary element of coordination operate within the context of a formal structure, which serves to coordinate the efforts of these teams and helps to disperse and integrate the knowledge gained from them throughout the organization. There is little discussion of such structures which would serve as the main means of strategy implementation and are discussed in depth in the organization design and international business literature. Recent evidence suggests that MNEs are moving once again towards structures that emphasize the national or regional context, in the form of matrix-based and mixed structures with strong geographical elements. For many MNEs, then, national context still matters, and its importance may be growing rather than diminishing. It is important to note that nationally embedded knowledge that may be leveraged for competitive advantage is likely to be obscure as well as highly tacit or “sticky.” How likely is it that a firm will continuously be able to identify such knowledge without deep roots in national contexts, which allow it to identify and extricate it from its surroundings? Anything less would allow competing firms to also identify and access relevant knowledge. Since potentially relevant


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knowledge is idiosyncratically dispersed, it would be difficult for firm members to have the depth of contextual understanding required to recognize opportunities for innovation. In addition, the national context in which a firm operates is an important “teacher” or filter through which other knowledge can be evaluated. This context sensitizes us to the utility of specific types of knowledge. Finally, while innovation is clearly an important driver of competitive advantage, it should not be mistaken to operate separately from other aspects of the firm’s operations. Innovation figures throughout the firm’s value-adding abilities and the firm will benefit from significant innovations that result from new technologies and revamp entire product lines. However, most innovations are small and incremental, and take place on an ongoing basis without much fanfare. Innovations are therefore highly path-dependent and are based on prior accumulated knowledge and experience. The accumulated significance of this path-dependent development should not be discounted.

NATIONAL CONTEXT: THE CRITICAL LINK In sum, the metanational perspective serves a useful purpose, that of calling attention to the critical role of knowledge, flexibility, and innovation in the international strategy of the firm. However, a consideration of the critical features of the national environment that facilitates or hampers knowledge flows, enhances or impedes flexibility, and improves or detracts from innovation would benefit this thesis immensely. Identification and incorporation of the multifaceted influences of such environments will greatly enrich the insights derived from it. That the national context influences the ability of the firm to achieve its goals is well documented in the literature, and there is little evidence that this is changing any time soon. Even those who discount the role of the national unit acknowledge that we are nowhere close to achieving a type of globalization in which managing across environments does not pose challenges. According to Rugman and D’Cruz (2000) and Rugman and Girod (2003), there is considerable evidence that even the largest MNEs continue to concentrate most of their productive activity in countries within the triad region that are similar to their own, with only back-end resource acquisition as the primary reason for globalizing the value chain. To move forward, we suggest a more detailed consideration of two variables that we believe are particularly key ingredients of the international business environment: national diversity and bridging capability. The first concept refers to the extent of differences between the national environments in which the MNE operates or is strategically motivated to do so. The second concept refers to the abilitiy of the MNE to select, understand, extract, and deploy resources and

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capabilities (including, but not limited to, those related to knowledge) within and across the national contexts which are relevant for its survival and prosperity. The configuration of these two variables for any given MNE is unique, evolving, and a determinant of competitive advantage. National diversity reflects national idiosyncrasies associated with environmental features, including resource endowments. The latter include naturally endowed resources such as raw materials and geography, refined resources associated with skills and infrastructure, and knowledge-related resources, such as the stock of knowledge associated with science and technology. National diversity is anchored in a unique combination of cultural, political, economic, social, and institutional attributes. The continuous use and apparent comeback of geographic structures among MNEs serve as a reminder that national peculiarities retain their importance and that in terms of information-processing capabilities, they are as important as industry variations.1 The interaction between industry and locale is embedded within a firm’s structure and processes. In addition to an enhanced ability to recognize opportunities in this environment, this interaction results in unique knowledge structures that can help firms recombine and further develop new types of knowledge, constituting a potential competitive advantage. The challenge for the MNE is to utilize the right mixture of national idiosyncrasies and leverage these bundles of advantages across national boundaries over the long run. While national diversity stems from the idiosyncrasies or uniqueness of each locale in which the MNE operates, bridging capability refers to the ability to traverse national distance, to understand these idiosyncrasies and bridge the differences across nations. The term “distance” has two assumptions behind it. First, differences among locales tend to persist and, though evolving, will largely remain in some form in the foreseeable future. Second, the MNE has a need to build a common platform, a bridge across which resources can be exchanged and leveraged, from which it will derive its global competitive advantage. National distance incorporates a number of different sources of “distance,” each of which requires a different set of integrative mechanisms. Of these, the importance of geographic distance is obvious, because physical proximity still has advantages over and above other forms of communication such as e-mail and telecommunications. It is ironic in this respect that the development of high technologies which have spawned ideas as “distance does not matter any more” also generated the idea of agglomeration or clusters, which in essence suggests just the opposite. Distance is not only geographic, however. It also stems from cultural, economic, political, social, and institutional differences. While these factors also create national idiosyncrasies, their role in national distance highlights the requirement of different logistic solutions for bringing together diverse resources and opportunities.


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It is the MNE’s capabilities in global communication, coordination, and integration which underlie its ability to bridge diverse bases of national comparative advantage into a firm’s competitive advantage. This means that distance should not be conceived as a bilateral construct as is presently assessed. Rather, it should be thought of as a multilateral system of multiple landscapes around which the MNE must navigate in its search for opportunities, whether stemming from knowledge or other resources, and which must be bridged to create scale and synergetic advantages if the MNE is to operate as more than a collection of locally dispersed units. Much of the innovation potential of the firm is dependent on this capability to create an effective network within its various locales as much as a network of alliances with outsiders. In conclusion, our approach is different from that of Doz in that it puts a premium on the local environment as a key ingredient. Not only does it not decline in importance as a result of globalization, but it actually becomes more important. This is based on the observation that many group features tend to be accentuated under interaction and a threat of homogeneity, as well as on empirical observations showing, for instance, the much lower value returned to acquirers in cross-border vs. domestic transactions. It is not simply that we agree with Bartlett and Ghoshal’s framework over that of Doz and colleagues. While we appreciate their notions of “integration” and “localization,” which are ideas that have stood the tests of time over decades, we focus more on the actual mix of environmental variables in each national context that gives rise to a firm’s unique blend of competitive advantage. In particular, we incorporate distance as a key concept and hence the bridging of such distance as the key challenge to the MNE in balancing “globalization and localization” (the less fanciful but classic designation in international business). Like these authors, we too see knowledge as a key resource and the ability to leverage it a key competitive advantage. Unlike them, however, we see such knowledge as closely tied to the national context in which it emerged and the challenge of knowledge transfer as one of “translating” knowledge from one locality to another. Nation still matters and, in a knowledge-intensive age, perhaps more than ever. National dispersion still matters, and so does the organization which is set to implement a global strategy. This may not sound as elegantly parsimonious as some earlier frameworks but is probably a more accurate representation of the complex world in which we live.

NOTE 1. For an example see advertising giant WPP’s recent retreat from global marketing and its appointment of country managers in key locations. White, Erin, “One size doesn’t fit all,” the Wall Street Journal, October 1, 2003, B1.

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REFERENCES Barkema, H. G., Shenkar, O., Vermeulen, F., & Bell, J. H. (1997). Working abroad, working with others: How firms learn to operate international joint ventures. Academy of Management Journal, 40(2), 426–442. Bartlett, C., & Ghoshal, S. (1989). Managing across borders: The transnational solution. Boston: Harvard Business School Press. Cheng, J., & Bolon, D. (1993). The management of multinational R&D: A neglected topic in international business research. The Journal of International Business Studies, 24, 1–18. Doz, Y., Santos, J., & Williamson, P. (2001). From global to metanational: How companies win in the knowledge economy. Boston: Harvard Business School Press. Dunning, J. (1980). Towards an eclectic theory of international production: Some empirical tests. Journal of International Business Studies, 18, 179–202. Gupta, A., & Govindarajan, V. (1991). Knowledge flows and the structure of control within multinational corporations. Academy of Management Review, 16, 768–792. Hitt, M. A., Hoskisson, R., & Kim, H. (1997). International diversification: Effects on innovation and firm performance in product diversified firms. Academy of Management Journal, 40, 767–798. Ireland, R. D., Hitt, M. A., & Vaidyanath, D. (2002). Alliance management as a source of competitive advantage. Journal of Management, 28(3), 413–446. Johanson, J., & Valhne, J. (1977). The internationalization process of the firm: A model of knowledge development and increasing foreign commitments. Journal of International Business Studies, 8, 23–32. Kale, P., Dyer, J. H., & Singh, H. (2002). Alliance capability, stock market response, and long term alliance success: The role of the alliance function. Strategic Management Journal, 23, 747–767. Makino, S., & Inkpen, A. C. (2003). Knowledge seeking FDI and learning across borders. In: M. Easterby-Smith & M. A. Lyles (Eds), The Blackwell Handbook of Organizational Learning and Knowledge Management. Malden, MA: Blackwell. Porter, M. (Ed.) (1986). Competition in global industries. Boston: Harvard Business School Press. Porter, M. (1990). The competitive advantage of nations. New York: Free Press. Prahalad, C. K., & Doz, Y. (1987). The multinational mission: Balancing local demands and global vision. New York: Free Press. Salk, J. E., & Simonin, B. (2003). Beyond alliances: Towards a meta-theory of collaborative learning. In: M. Esterby-Smith & M. A. Lyles (Eds), The Blackwell Handbook of Organizational Learning and Knowledge Management. Malden, MA: Blackwell. Van den Bosch, F. A. J., Van Wijk, R., & Volberda, H. W. (2003). Absorptive capacity: Antecedents, models and outcomes. In: M. Esterby-Smith & M. A. Lyles (Eds), The Blackwell Handbook of Organizational Learning and Knowledge Management. Malden, MA: Blackwell. Vernon, R. (1966). International investment and international trade in the product cycle. Quarterly Journal of Economics, 80, 190–208. Zaheer, S. (1995). Overcoming the liability of foreignness. Academy of Management Journal, 38(2), 341–363.

THE THEORY OF THE MULTINATIONAL FIRM Robert Grosse This paper sketches a view of the multinational enterprise (MNE) based on the evolving literature of the past three decades. It suggests that a multifaceted view, similar in spirit to the perspective of Dunning (1977), offers the most useful approach to understanding the activities of MNEs. Before presenting this view, the state of development of our thinking about MNEs is discussed, and the main theoretical views currently applied to this phenomenon are reviewed.

THE MNE AS AN OCTOPUS The traditional view of the multinational firm, from the early analyses in the 1960s and early 1970s, is one of a large industrial company with operations in multiple countries and a centralized chain of command. By definition, a multinational firm has activities in more than two countries. Although this simple definition is not widely used, it is a reasonable baseline from which to begin thinking about such firms. If the firm has sales operations in multiple countries, production in multiple countries, or some other permutation of international business activities physically present in multiple countries, then it is multinational. Other definitions include Vernon’s statement that multinationals are firms “with a parent company that controls a large cluster of corporations of various nationalities” that “have access to a common pool of human and financial resources and seem responsive to elements of a common strategy” (Vernon, 1966, p. 4); or

Theories of the Multinational Enterprise: Diversity, Complexity and Relevance Advances in International Management, Volume 16, 83–97 Copyright © 2004 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 0747-7929/doi:10.1016/S0747-7929(04)16006-X

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Fig. 1. General Motors MNE.

Dunning’s statement that “We define MNEs as companies which undertake productive activities outside the country in which they are incorporated” (Dunning, 1977, p. 400). These views might be categorized as seeing the multinational enterprise as an octopus, as shown in Fig. 1, with tentacles reaching out across national borders to pull business activities into the body of the organization. The focus was on ownership, and control of affiliates through that means (as well as through other methods such as personnel assignments and training, export and import linkages, and others). The example presented here is General Motors, which over time has acquired companies throughout the world and established its own Greenfield investments in many countries. The acquisitions of Adam Opel in Germany (1929) and Isuzu in Japan (1971), as well as the more recent purchases of major ownership in Saab in Sweden (1989) and partial ownership of Fiat in Italy are good examples of this strategy. The investments to set up manufacturing in Indonesia (1993) and to acquire Daewoo (a former joint venture partner) in Korea are additional items shown in the figure. The key point is that General Motors is internalizing production in different countries through these owned affiliates, along with serving the markets in those countries (and often in neighboring countries). As early as 1983, GM was able to see the benefits of learning from a rival, as shown through the NUMMI joint-venture set up in California to produce cars jointly with Toyota.

The Theory of the Multinational Firm

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Note again that the thrust of the MNE under the traditional definitions is an organism whose tentacles control activities that extend across national boundaries – and perhaps most importantly that the organism is one entity, rather than a set of cooperating entities. This perspective has changed in recent years, as multinational firms have become engaged in increasing numbers of strategic alliances for product distribution, R&D, manufacturing, and just about every aspect of corporate activity. In the early 21st century, it is clearly important to look at multinationals as including service-sector firms, since this sector constitutes by far the largest part of most economies, and large firms such as McDonald’s, Sheraton, Citigroup, McKinsey, and McCann-Erickson do rival traditional manufacturers such as Ford, Dow Chemical, and Nestlé in their size, scope, and importance worldwide. These service firms still may operate as octopuses, but they are producing intangibles rather than physical products for their sales to clients. The analyses of the 1960s and 1970s tended to look at multinationals as a response to economic opening in the industrial countries after World War II. That is, multinational firms were a phenomenon that developed to take advantage of the fact that governments, especially in Western Europe, opened their frontiers to foreign-owned companies. Prior to that time, although a handful of multinational firms existed, the regulatory barriers to overseas expansion were often severe, leading companies to use exports or contracting out to local firms rather than foreign direct investment and thus owned production in other countries. (Cf. Wilkins, 1974, who details the activities of a considerable number of MNEs from World War I through to the 1960s.)

THE MNE AS THE WIZARD OF OZ In the early 21st century, it may be most useful to view the MNE as a coordinator of a global network of business activities, some owned and some contracted, some operated independently and some operated in alliance with other firms. This perspective reflects the very clear reality that strategic alliances are a fundamental part of international business and that multinational firms must use them as part of their overall strategies, given limited company resources and the need to react quickly to changing technological, competitive, and regulatory environments. Instead of a single, centrally controlled body, the multinational has become more of a set of relationships between affiliates and allies. This reality requires a different set of capabilities and a different perspective to manage successfully, in contrast to the second half of the 20th century, when the single-body (octopus) model was a better fit to that earlier reality.

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The image that might best convey this reality is the Wizard of Oz, a little person behind a curtain pulling levers and speaking with a magnified voice. S/he does not have as much power as it might seem, but as long as that fact can be hidden, the Wizard can keep the global organization obeying commands. The image is misleading in the sense that the coordinator of a global network of affiliates and allies has to be much more than a puller of levers. The new multinational enterprise must have managers adept at coaxing along recalcitrant alliance partners, motivating employees in far-flung locations, and otherwise dealing with inter-personal and inter-organizational issues that are far from the considerations of the traditional theory. Time Warner, the company that owns the Wizard of Oz movie rights, is a good example of the 21st-century MNE. The company is a media conglomerate, with major holdings in publishing (Time Magazine; Time-Warner books), movies (Warner Brothers), television (Turner Broadcasting), Internet service (AOL) and music (Warner Music Group), as well as other businesses (such as HBO). The company has strategic alliances with the Cisneros Group in Latin America, where they jointly operate AOL Latin America; with the Australian company, Village Roadshow, with whom they operate thousands of movie theaters in Australia, Japan, and other Asian countries; and with Sony in Brazil and several Central European countries, where they jointly operate the HBO business. Some of these activities are noted in Fig. 2, with key affiliates in the U.K. and Canada, and major alliances based in Venezuela (Cisneros), Australia (Village Roadshow), and Brazil (Sony). In sum, the MNE today, whether in manufacturing or in services, often has a wide range of activities in different countries, from wholly owned subsidiaries, to contract production to joint ventures in capital-intensive businesses. The theory of the multinational has migrated to reflect this reality, with models of the MNE as a network of affiliates (Bartlett & Ghoshal, 1987; Birkinshaw & Hood, 1998; Toyne, 1989) as one response. Another direction of research on multinationals is the emphasis placed on strategic alliances as vehicles for company activities, from research and development, to joint marketing agreements, to co-production. This line of reasoning focuses on the need of multinational managers to function as coordinators of these alliances, rather than as direct controllers of all business activities of the firm. And the fairly recently identified (sociology-based) Institutional Theory (Powell & Dimaggio, 1991; Scott & Meyer, 1994) puts yet more emphasis on the people side of the strategies of firms in general and applied to multinationals in particular. The goals of the firm have not changed: It is still essential to produce satisfactory returns to shareholders while meeting the demands of other stakeholders such as governments, employees, customers, and others affected by the firm’s activities


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Fig. 2.

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(Post et al., 2002). What has changed is our ability to analyze the multinational firm from a broader perspective than one solely based on economic factors, or just on strategic factors. The more detailed understanding that we possess today comes from the inclusion of company, country, industry, and environmental factors into the analysis – something that earlier analysts failed to accomplish, largely due to a lack of tools and lack of information on the issues of interest.

EXISTING THEORIES OF THE MNE Vernon’s International Product Cycle The first theory that focused specifically on the multinational firm was Raymond Vernon’s international product cycle (Vernon, 1966). In an attempt to explain the pattern of U.S. international trade that was highlighted by the Leontief paradox (U.S. exports were more labor-intensive than capital-intensive), Vernon joined several other researchers in suggesting explanations (e.g. Hufbauer, 1965; Keesing, 1967) that emphasized technology as a key factor of production. Vernon also emphasized market conditions (such as consumers’ purchasing power) that were and are typically ignored in economic analyses (with the notable exception of Burenstam-Liner, 1961). His explanation for the pattern of U.S. exports showed the logic for why U.S. firms would innovate new (high-tech) products in the U.S. market and export them overseas. This production of new products would be laborintensive in the need for scientists and engineers to develop the products, hence offering an explanation of why U.S. exports tended to be labor-intensive. And also new products would tend to be introduced in the high-income U.S. market by any innovator, so that the demand side of the equation equally favored U.S. production. Vernon moved beyond the export issue by continuing his argument to point out that as products became more mature, they would logically be produced closer to the foreign markets where demand for them was growing, and ultimately they would be produced in low-cost locations such as emerging markets with very low-cost labor, when technology became standardized and more easily available. Since U.S. firms could be the ones to set up production overseas, not just local firms in those other countries, Vernon’s concept provided a rationale for the creation and expansion of multinational companies. Dunning’s Eclectic Theory – OLI Dunning’s eclectic theory (Dunning, 1977) followed Vernon’s international product cycle as a theory specifically devoted to explaining activities of multinational


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enterprises. Dunning took more of a traditional economic perspective in focusing on supply-side factors such as production costs and transaction costs, rather than on market/demand conditions. He started by looking at capabilities of firms that would enable them to compete successfully in an imperfectly competitive or oligopolistic world. These capabilities, which he called ownership advantages, included the kinds of strengths noted by Joe Bain (1956) in analyzing domestic U.S. competition and subsequently by Michael Porter (1985) under the heading of competitive advantages. They include such things as proprietary technology, superior marketing skills, economies of scale in production, superior management skills, and other firm-specific capabilities. He next added in from location theory the idea that national differences in costs and regulation would lead to company choices as to whether to serve markets from local production or imports, thus focusing on country-specific location advantages. This is largely a cost-based perspective in the economics literature, though Dunning expands it to include government regulation that may limit market access (e.g. through tariffs and quotas), thus presenting a broader country-specific logic for choosing to produce locally or import into target markets. Finally, he used the concept of internalization to motivate the company decisions on exporting or producing locally to profit from foreign markets. The choice of whether to carry out a business function within the firm (internalize it) or to contract out to a third party to provide the function (e.g. manufacturing, distribution, advertising, or after-sale service) is equivalent to the traditional economics decision to integrate a business vertically or horizontally. When considered in the cross-border context, internalization relates to the choice among exporting, licensing (or other contracting out), or investing to produce a product or service. Dunning’s and Vernon’s views are the only theories in common use today that are specific to multinational enterprise. A number of other theoretical perspectives have been brought to bear on multinational firms, though focusing primarily on domestic competition. These include Porter’s competitive advantage theory, Barney and others’ resource-based view, Prahalad and Hamel’s idea of core competencies, Williamson and others’ new institutional economics, and various authors’ institutional theory ideas that emphasize intra- and inter-organizational relations. Porter’s competitive advantage theory identifies a range of competitive strengths that firms may develop in the value-added chain, from preferential access to inputs, to superior capabilities in production, to better after-sale service to clients. Any of the stages of the production process are subject to market imperfections or company-specific differentiation, such that an advantage may be derived relative to competitor firms. Porter presented an excellent tool for thinking about company

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strategy, though without any particular emphasis on cross-border activities. His ideas have been extended to include competitive advantages that arise in MNEs such as the ability to switch production among locations to take advantage of changes in input costs; the ability to learn from business in one country and apply those lessons to competing more successfully in other countries; the ability to arbitrage tax jurisdictions; and the ability to reduce risks by operating in a portfolio of countries, among other international advantages. The resource-based view (Barney, 1986, 1991; Wernerfelt, 1984) builds an idea of firm-specific advantages in parallel with that of Porter, focusing on those attributes of firms that are valuable, rare, difficult to imitate, and not substitutable, and thus can lead to sustained competitive advantage. The resources can be tangible or intangible, and they specifically include management skills, scientific knowledge, and organizational processes. Just as with Porter’s view, there is nothing inherently international about this view, other than the fact that some resources can pertain to multinationality (such as the ability to serve a portfolio of markets and to obtain inputs from a portfolio of suppliers in different countries). Prahalad and Hamel (1990) created a perspective that built on the idea of competitive advantage, arguing that firms can build competitiveness based on their capabilities to carry out business functions better than their rivals. This idea of core competencies fits easily into a domestic context, but it also extends readily to explain competition among firms at the international or global level. The fact that one firm has multicountry operations when its rivals do not can provide that firm with a core competency in international distribution, or in international sourcing of production inputs, as well as potentially a competitive advantage in having a lower risk through diversification of its activities across relatively uncorrelated markets. Williamson’s development of transaction-cost economics, and the broader perspective of New Institutional Economics, offers yet another point of view that readily suits analysis of the MNE. This view is not international in and of itself, but the application to cross-border business is straightforward. Williamson has focused on the question of whether markets or firms (hierarchies) serve better in various contexts to deal with transactions costs. The MNE, for example, serves well in situations where barriers exist to cross-border availability of information and where substantial risk of opportunistic behavior by suppliers or customers exists. Moving activity such as production and distribution within the firm, rather than contracting out to independent firms, may resolve those problems, particularly at the international level where more than one legal jurisdiction is involved. Buckley and Casson (1976) and Rugman (1980) have responded to the transaction-cost issue by developing the idea of internalization. This concept is far from international, given that it refers simply to the “make-vs.-buy” decision, or to the idea of vertical and horizontal company integration. However, these


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authors have applied internalization as a mechanism to explain multinational enterprise decisions for foreign-market entry and more generally for choosing how to serve target markets. The internalization concept is a powerful motivating force that can be used in considering how firms should leverage their resources or core competencies. Another view of the firm focuses specifically on institutional aspects of its activities, particularly relations with external stakeholders such as governments and pressure groups. One line of institutional theory has its roots in sociology, emphasizing the behavior of the firm as mirroring societal norms and traditions. This view of the firm as part of a broader institutional context (DiMaggio & Powell, 1991; Hall & Taylor, 1996; Oliver, 1991) emphasizes the limits of rational maximizing behavior in the light of pressures from other institutional participants. This perspective opens the analysis to consider organizational behaviors (e.g. follow-the-leader behavior between firms; cultural differences deriving from differences between societies of origin of MNEs) from a sociological point of view. A second line of institutional theory comes from political science (March & Olsen, 1984) and emphasizes the hierarchy of relationships from governments to companies to individuals. This point of view opens the analysis to consider such things as the bargaining relationship between governments and companies, and the need for the firm to respond to demands of pro-labor and pro-environment groups, among others. This institutional theory is particularly useful in trying to explain multinational enterprise activities that occur in response to government policies as well as MNE activities that attempt to influence government policies. Note that this perspective is quite different from the new institutional economics, since the former focuses largely on transaction costs, and this latter perspective emphasizes relations between firms and non-company organizations in the environment where the firm operates.

A Multidimensional View: MNEs Aim at Multiple Goals Under Uncertainty A multidimensional perspective that may be used to further develop the theory of the multinational firm can be drawn from ideas that originate in economics and institutional theory. That is, a view that draws on industrial organization ideas from economics and on managerial strategy ideas from organizational theory can be used to build on the key theoretical advances since the original theories of multinational company behavior that can be traced to Vernon’s international product cycle (1966) and Dunning’s eclectic theory (1977). The perspective

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offered here is itself eclectic, drawing on inputs from economics and organizational theory, just as Dunning’s theory linked economics (location theory) and business strategy (competitive advantages and internalization). Additionally, the present view is dynamic, relying on the idea of repeated re-evaluation or re-contracting as the mechanism for making the theory’s lessons change as the conditions change in the environment and inside the firm.1 In this view, the multinational firm is a multicountry organization that pursues the goal of increasing value to shareholders and responding to concerns/pressures of other stakeholders. It operates in a complex world of competitive and sometimes collaborative rivals, suppliers, customers, labor groups, environmental pressure groups, and other outside influences. The firm repeatedly reconsiders its scope through the mechanism of internalization and particularly includes strategic alliances as a form of solution to this problem (viz., the make-vs.-buy decision). The cultural base of the company plays an important role in the choice of limits that are defined on the firm’s activities, from geographic locations to types of product or service to make and sell, to the kinds and numbers of employees to employ. This reasoning lays out the basis for competitiveness of multinational firms as deriving from their firm-specific capabilities (Dunning’s ownership advantages; Porter’s competitive advantages; Barney’s firm-specific resources). These capabilities include proprietary knowledge about how to make products, how to distribute more effectively than rivals, and how to deal with clients more successfully than competitors. Underemphasized from the economics perspective are capabilities that enable the firm to achieve higher revenues than rivals, i.e. that enable the firm to achieve greater success on the demand side, rather than focusing only on cost-reducing capabilities. These include such capabilities as superior marketing skills and more extensive/effective distribution channels. Second, the ability of the firm to succeed in domestic and international competition requires management of institutional relationships such as the ability to deal successfully with government regulators, with environmental pressure groups, with labor groups, and with other stakeholders in places where the firm has activities. The whole range of concerns about relations with non-business stakeholders are generally ignored, or held as external to the firm’s ability to manage, or otherwise marginalized in much of business and economic analysis. One of the key insights of Institutional Theory is that institutions such as governments are critical players in the firm’s “environment,” and that management of these relationships is a potential source of competitive advantage. In fact, it is this dimension that isolates those features that are peculiar to international, as contrasted with domestic, business, e.g. dealing with more than one national government, multiple currencies, and the liabilities of foreignness.


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The concept of internalization, which economists label (vertical and horizontal) economic integration, is a powerful glue to fix the firm’s capabilities to specific decisions such as acquiring a supplier or establishing production overseas. This concept was developed in the MNE context by Buckley and Casson (1976), and as part of Dunning’s eclectic theory (1977), as well as by Rugman (1980) and Grosse (1981). It has largely focused on supply-side issues, particularly on cost reduction, but the concept is readily extended to consider market issues such as product quality, customer preferences (e.g. for locally produced goods and services), and barriers to market entry. Thus, the multinational enterprise is conceived as a more complex entity than in earlier analyses, mainly because our tools and our understanding of these firms have advanced to the point where it is possible to add these complexities without losing analytical focus and policy/strategy relevance. Table 1 suggests the features that characterize multinational firms and the issues that can be explored by using these characteristics. The intent of this illustration is to place attention on the key questions that are being raised about MNEs and their activities in the early 21st century, and to Table 1. A 3-D Theory of the Multinational Enterprise. Characteristics Resources Proprietary technology/knowledge Marketing skills Access to distribution channels Ability to bring knowledge from one country into use in others Institutional characteristics Human resource management Government relations management Dealing with outside pressure groups Political differences between countries Economic differences between countries Cultural differences Internalization mechanisms Acquire other firms Invest in new ventures Contract out Form joint venture Form other alliances

International Research Questions

Reasons for FDI and other entry modes Reasons for greater success in international business activities (profits, market share, lower costs, etc.)

Reasons for different behavior across countries Choice of country(ies) for FDI, other activities Reasons for different characteristics and performance by firms from different countries Impact of currencies on business decisions and performance Reasons for different behaviors across cultures Choices among exports, FDI, various alliance forms Management of international networks of affiliates and allied firms

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demonstrate how a differentiated view of the firm enables analysis to explore these questions. Notice that the structure of the perspective resembles the eclectic theory in having three parts, but that the second part (institutional characteristics) greatly exceeds the economics-based location factors that Dunning uses. At the same time, it should be noted that the second dimension contains those features that are peculiar to international, as opposed to domestic, business – specifically differences between countries such as laws and governments, currencies, and (arguably) cultures. By dividing the terrain in this way, it can be seen that the important issues related to multinationals are ones to do with cross-country differences in behavior or performance. That is, the theory of the MNE focuses on those aspects of firms that, for some reason, differ across nations – or ones that relate to multinationality itself. The fundamental building blocks of competitive advantage and institutional behavior, which are uninational concepts, are used to explore issues that are specific to the international context. Even so, with the domestic or uninational conceptual tools, the tendency is to ignore cross-border issues, so that MNE theory almost requires a new mindset to bring in the cultural, economic, and legal differences (among others) that are relevant at this level. This is a huge issue and one that may be inadequately recognized. Most of the analysis of multinational firms focuses on their activities as large companies, rather than as activities that cross national borders. While Porter’s competitive advantage model, or the internalization concept, has much to offer for understanding company behavior, neither is particularly adept at explaining multinational activity. Whether that specific emphasis is appropriate or not is a separate question. The context of interest in our analysis is the multinational firm, and thus the questions of central concern are those that relate to the cross-border aspects of these companies. The 3-D theory of the MNE can give a much more fine-grained understanding of decisions such as “Where in the world should we put that plant?” (Stobaugh, 1968). The early analyses of the foreign investment location decision tended to focus on economic factors such as country market size, costs of various inputs, and risks. This new perspective allows for focus on additional factors such as cultural differences, corporate learning from overseas experiences, and bargaining between companies and governments. The 3-D theory of the MNE can attack questions such as, “why do firms use joint ventures more extensively in emerging markets than in industrial countries?”, using explanatory concepts from cost and risk reduction, to response to government demands, to the use of a local ally to mitigate the liabilities of foreignness. Initial efforts to answer this question focused on company competitive advantages such as technology, size, and access to markets and on country characteristics such as a small market size and protectionist policies. With


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the new theory, it is possible to explore both cultural and economic differences, and questions of institutional theory as well as business strategy. Also, in the context of alliances, the 3-D MNE theory can help to explore the concern with “trust,” seeking to understand how firms can build trust with alliance partners and foster trustworthy behavior (rather than opportunistic behavior). The issue of trust has been analyzed extensively in the recent management literature; what is needed is a focus on the particularly international aspects of the issue, such as cultural differences and differences in government-company relations across countries. Probably the most difficult questions to consider with the traditional models/ theories of multinational enterprise are those to do with human behavior, from managing people to negotiating agreements with governments. The theory suggested here explicitly involves Institutional Theory as a source of ideas and constructs for the measurement of such phenomena and the design of corporate responses. How can a multinational firm negotiate optimal treatment from a host-country government? Through use of a bargaining model that identifies goals and stakes for government and firm, producing a path for the firm to follow to obtain desired regulatory treatment. How can a multinational firm make the most of its people skills, when people from very different cultures make up the firm’s human resources? Through use of a cross-cultural management model that may come from the institutional theory literature. These examples suggest the broader capability of this 3-D MNE theory. Another issue that may be explored fruitfully with the 3-D MNE theory is the question of the appropriate level of analysis of business phenomena. Recent literature in management and in international business has considered the idea of looking at firms as part of inter-company networks such as supply chains or Asian keiretsu and chaebols. These networks could be used as an appropriate level of analysis of company behavior, since there are extensive inter-dependencies between and among firms in the networks, and the networks very often cross national borders. A final concern that is particularly useful to examine through the 3-D MNE theory is business activity in emerging markets. From entry and operation of foreign MNEs to develop of local, emerging-market MNEs, the new theory offers conceptual bases that were not previously available. Firms from emerging markets that succeed in international markets are not following the same paths that were followed by industrial-country MNEs. The emerging market firms often succeed first in other emerging markets, and they often succeed regionally rather than globally. These phenomena are better explained with a perspective that takes into account the cultural and environmental differences between emerging and industrial countries.

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NOTE 1. This view may be seen as overly ambitious, along the lines of efforts to create a “general; theory of social science” (e.g. Parsons et al., 2001). While that extreme certainly exists as a goal for some social scientists, the aim here is much more modest.

REFERENCES Bain, J. (1956). Barriers to new competition. Cambridge, MA: Harvard University Press. Barney, J. (1986). Strategic factor markets: Expectations, luck and the theory of business strategy. Management Science, 32, 1512–1524. Barney, J. (1991). Firm resources and sustained competitive advantage. Journal of Management, 17, 99–120. Bartlett, C., & Ghoshal, S. (1987). Managing across borders: New strategic requirements. Sloan Management Review (Summer), 7–17. Birkinshaw, J., & Hood, N. (1998). Multinational subsidiary evolution: Capability and change in foreign-owned subsidiary companies. Academy of Management Review, 23, 773–795. Buckley, P., & Casson, M. (1976). The future of multinational enterprise. New York: Holmes & Meier. Burenstam-Liner, S. (1961). An essay on trade and transformation. Uppsala: Almquist & Wicksells. DiMaggio, P., & Powell, W. (1991). The new institutionalism in organizational analysis. Chicago: University of Chicago Press. Dunning, J. (1977). Trade, location of economic activity and the MNE: A search for an eclectic approach. In: B. Ohlin (Ed.), The International Allocation of Economic Activity (pp. 395–418). New York: Holmes & Meier. Grosse, R. (1981). The theory of foreign direct investment. Essays #3 in International Business (pp. 1–51). Columbia: University of South Carolina. Hall, P., & Taylor, R. (1996). Political science and the three new institutionalisms. Political Studies, 44, 936–957. Hufbauer, G. C. (1965). Synthetic materials and the theory of international trade. London: Duckworth. Keesing, D. (1967). Outward-looking policies and economic development. The Economic Journal (June), 303–319. March, J. G., & Olsen, J. P. (1984). The new institutionalism: Organizational factors in political life. American Political Science Review, 78, 738–749. Oliver, C. (1991). Strategic responses to institutional processes. Academy of Management Review, 16(1), 145–179. Parsons, T., Shils, E. A., & Smelser, N. J. (2001). Toward a general theory of action: Theoretical foundations for the social sciences. New York: Transaction. Porter, M. (1985). Competitive advantage. New York: Basic Books. Post, J., Preston, L., & Sachs, S. (2002). Redefining the corporation. Stanford, CA: Stanford University Press. Rugman, A. (1980). Internalization as a general theory of foreign direct investment. Weltwirtschaftliches Archiv, 116, 365–379. Scott, W. R., & Meyer, J. W. (1994). Institutional environments and organizations. Thousand Oaks, CA: Sage.


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Toyne, B. (1989). International exchange: A foundation for theory building in international business. Journal of International Business Studies, 20(1), 1–17. Vernon, R. (1966). International trade and international investment in the product cycle. Quarterly Journal of Economics, 80, 190–207. Wernerfelt, B. (1984). A resource-based view of the firm. Strategic Management Journal, 5(2), 171–180. Wilkins, M. (1974). The maturing of multinational enterprise. Cambridge, MA: Harvard University Press.

THE METANATIONAL FIRM IN CONTEXT: COMPETITION IN KNOWLEDGE-DRIVEN INDUSTRIES Thomas P. Murtha ABSTRACT The increasing pace of global competition has recast the balance between multinational corporations’ (MNCs’) needs to protect the knowledge that underlies their competitive advantages and their needs to continually create new knowledge. This essay will discuss MNCs’ knowledge-seeking strategies as industry-level phenomena. I will argue that knowledge-seeking strategies demand a concept of industries both as arenas for competition and as global knowledge networks within which firms collaborate to innovate. Contemporary MNCs face challenges to function not only as self-contained production systems that internationalize in the search for efficiency and markets, but also as open systems globally seeking knowledge and innovations. Metanational strategies and organizations represent a new response to these challenges. I present empirical evidence of distinctive metanational industry opportunities and organizational responses from the emergence of the global flat panel display industry. The essay concludes with a framework that outlines the characteristics of a global knowledge-driven generic strategy as an alternative and synthesis of generic product-driven strategies of cost-leadership and differentiation.


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Despite diverse disciplinary foundations and focal units of analysis, multiple theories of the multinational firm have co-existed around a common theme since the mid-1960s. This theme pertains to knowledge as a source of competitive advantage, whether in its embodiment as technology, its creation as innovation, or the strategic management processes that renew and sustain its value. At the same time, tension has existed between the search for parsimonious general theory and complex, process-oriented, phenomenological approaches. General theorists have tried to build a time-robust framework to explain the existence, structure, and operations of multinational corporations (MNCs). Process and phenomenological researchers have focused on the rapid co-evolution of multinational corporations with the world economy, and the shifting competitive challenges that managers face as a consequence (Doz & Prahalad, 1991). This essay will discuss competition in global, knowledge-driven industries. I will draw on both traditions of research on MNCs, without making any effort to reconcile them, critique them, or suggest how one might subsume or colonize the other. Unlike Rugman and Verbeke (2003), I do not perceive a widening intellectual schism between the two, but rather, a functional distinction based on units of analysis and methodological approaches. General theorists have tended to adopt a deductive approach with firms and industries as their focal units of analysis. Process researchers have tended to adopt an inductive approach with individual managers and firms as units of analysis. While general theorists have attempted to establish fundamental conditions and a stable vocabulary to explain the MNC as a capitalist economic institution, process researchers have concerned themselves with normative, middle-range theories of change. Constructs have evolved along with the MNC phenomenon and process researchers’ understanding of it. The idea of the metanational firm (Doz, Santos & Williamson, 2001) represents the most recent evolution. Any framework for understanding competition in knowledge-driven industries necessarily cuts across research traditions because all three levels of analysis – individual, firm, and industry – must be spanned to build such a framework. Knowledge-driven competition involves innovation, which I think of as a function of knowledge creation. Knowledge creation begins with individuals (Nonaka & Takeuchi, 1995). Firms innovate by combining the knowledge of many individuals into mutual understandings that transform product and service offerings. In theory, multinational firms exist to internalize the innovation process and the potential rents to be gained from it by transferring knowledge within organizational boundaries (Buckley & Casson, 2002, 2003; Hennart, 1982; Rugman, 1981). In this way, MNCs exploit competitive advantages gained from innovations across multiple national markets, while guarding against the risk that proprietary knowledge that pertains to these advantages will diffuse into the hands of competitors

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or potential competitors. Historically, these advantages have generally arisen from home-based R&D (Vernon, 1971) combined with market strategies honed under conditions of vigorous domestic rivalry within a firm’s industry (see Porter, 1990).

KNOWLEDGE AND THE MNC Conceptions of MNCs’ competitive raisons de’être have more recently grown to encompass cross-national knowledge creation as well as transfer and exploitation (Doz et al., 2001; Kogut & Zander, 1993). This poses requirements for new thinking on the parts of both academics and managers, while confronting the latter group with major operational challenges as well. First, as the pace of technological change has accelerated, MNCs no longer have the luxury of cultivating homegrown responses to every innovation by rivals. Nor can they count on finding the resources necessary to participate in every new and emerging industry at home as U.S. firms, in particular, have often assumed should be possible. As Kogut (1991) was among the earliest to forecast, knowledge resources have proven more difficult to separate from national context than many models of MNC strategy might have predicted (see also Ghemawat, 2003; Rugman & Verbeke, 2003). Staying abreast of requirements for continuous innovation requires MNCs to use their organizational capabilities to sense, source, and build on new knowledge streams when and where they first arise, whether at home or elsewhere in the world. This, in turn, demands that incentives be aligned to inspire affiliates to undertake decentralized initiatives, while operating in concert with MNCs’ global organizations. Second, sensing and utilizing knowledge in context requires openness and exchange within local business and technology environments. It has long been understood that innovation processes involve individuals employed by networks of firms that include focal companies, their suppliers, their customers, and, at times, their competitors (Van de Ven & Garud, 1989; von Hippel, 1988). As knowledge-driven competition has intensified throughout the post-World-War II period, the imperative for cooperation among firms to innovate has intensified as well. The kinds of knowledge that theorists historically have considered advantageous for MNCs to internalize often flow openly among unaffiliated individuals and firms linked together in global industry knowledge networks (Giarratani & Murtha, 2003). Some of the firms linked together in these networks do not qualify as MNCs in the traditional sense of the word. That is, they do not own and coordinate affiliated operations in multiple countries; rather, they are entrepreneurial enterprises, often relatively small, that exploit knowledge-based

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advantages in global partnerships without necessarily establishing operations outside their home countries (Kulkki & Doz, 2003). These developments have profoundly altered global industry structures. The dominant business model in personal computer manufacturing, for example, envisions unit assembly to customers’ orders, using components and software sourced from myriad suppliers around the world. In principle, the entire supply chain can consist of unaffiliated specialist firms, coordinated by a company like Dell, which leverages market knowledge, product design, and logistics competencies to control the final customer interface (see Curry & Kenney, 1999; Fields, 2003). This stands in contrast to the high degree of vertical integration that firms in manufacturing industries typically undertook during most of the 20th century to place critical value chain activities – including logistics, R&D, production and marketing – under unified ownership. But this phenomenon, which observers refer to as deverticalization or vertical disaggregation, is not in itself new. Its PC industry origins had already faded more than 25 years into the past when the present volume of Advances in International Management was published. By the early 21st century, however, the forces driving vertical disaggregation were well established as critical factors in the creation of new industries and in the innovation processes driving the evolution of most existing industries. “Fabless” semiconductor design and marketing firms appeared around the world, along with foundry companies – mainly in Asia – that were contracted to carry out manufacturing process development and chip fabrication for multiple clients (Linden et al., 2004; Mathews & Cho, 2000). Total manufacturing service providers, such as Flextronics, performed the gamut of factory-based activities for lengthy client lists of firms that often acted as rivals in R&D and final goods markets (Sturgeon, 2002). High-technology manufacturers that have historically self-manufactured many of the capital goods installed in their plants turned to specialized global equipment producers such as Applied Materials (Murtha et al., 2001; Stowsky, 1989; Young, 1994), a trend that has accelerated. These equipment producers have found, in turn, that their value-adding activities increasingly consist of knowledge-based services. Rather than building goods in their own factories, they may field teams of employees to construct equipment at client sites from globally sourced components delivered there. These producers then field other on-site teams to bring new equipment and entire plants online, train clients’ operator forces, and participate in ongoing manufacturing process development. As an exemplar of a global trend, the services component (as opposed to production) in U.S. manufacturing has increased from 32 to 48% of employment since 1993, due mainly to increasing customer needs for specialized engineering and market adaptation of suppliers’ core offerings, both before and after sales (Ansberry, 2003). Critical knowledge work has thereby both


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loosened and tightened its ties to geography, as teams of engineers travel among customer sites, offering creative solutions to fundamentally location-bound problems. At the same time, virtual connectivity allows business processes that firms have traditionally reserved as internal activities in their home countries – such as product design, financial accounting or laboratories that analyze test results – increasingly to be operated anywhere in the world, potentially by outside contractors. “Offshoring” is the popular term that has emerged to describe allocations of activities within firms to affiliates abroad. The term “outsourcing” pertains to contracting for activities with unaffiliated parties.

SEEKING EFFICIENCY, MARKETS, AND KNOWLEDGE Several structural explanations can account for these phenomena. Costs of R&D, new manufacturing facilities, and professional staff in many industries have continued to grow. With inexorable downward pressures on all costs, firms have searched for novel approaches to allocate value chain activities across countries (see Kenney & Florida, 2004, for a number of industry examples). Theories of multinational strategy have explained MNCs’ international value chain configurations as outcomes of both efficiency- and market-seeking strategies (Behrman, 1972; Dunning, 1993, pp. 56–63). No doubt, cost savings have motivated many MNCs’ decisions to locate activities, including knowledge work in developing areas, as Microsoft, for example, has done by continuing to expand its Bangalore campus. It is also likely that MNCs that increase their local presence and interdependence with domestic firms enhance their local market positions. Increasing capital requirements for new facilities have also motivated firms to outsource more activities. This enables risk-sharing, but also increases a focal firm’s dependence on other firms that act as its customers and suppliers at home and abroad (Murtha, 1991, 1993). Firms differ within industries in the ways they allocate value chain activities between internal and external sources. Theories of multinational strategy have explained these differences as managers’ decisions about which activities constitute the innovative core of the firm, and which complementary assets should or should not be contracted out in order to most profitably sustain the advantages that emerge from innovation. The latter decisions are based on judgments about the processes by which firms’ innovation advantages and complementary assets co-specialize over time to create interdependence among the firm, prospective suppliers, and customers. If the profits from a firm’s innovation advantage depend on the services of specialized complementary assets it does not own, while the asset owners have alternative,

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equally attractive relationship opportunities, a dependent hostage situation results. Under the circumstances, the complementary asset holders can claim a disproportionate share of the firm’s innovation rents as ransom. The firm may also stand to lose its advantage to second movers that own the complementary assets or enjoy superior access to them (Teece, 1986, 1987; Williamson, 1983). Academic and business media observers have recently suggested that a new trend toward offshoring of firms’ knowledge-based activities has materialized, accompanied by a trend toward outsourcing in the same categories of work (Dossani & Kenney, 2003; Engardio et al., 2003). At first glance, such an outsourcing trend seems consistent with the perspectives described above, if: (1) the activities are not vital to the client firm’s innovations or knowledge-creation processes; or (2) if vital, are not specialized, but could be obtained from other sources; or (3) in general, if cost savings outweighed any risk of holdup. Many outsourcing instances appear to meet these conditions. As such, they would represent tactical decisions, mainly in support of cost-driven strategies. Viewing such transactions in isolation from their industry contexts, however, provides an incomplete, potentially misleading picture, particularly in cases that involve MNCs. Viewed in industry context, many apparently short-run, cost-driven outsourcing as well as offshoring decisions prove to have far-reaching strategic relevance for firms. But this relevance has more often than not been overlooked because international strategy research views MNCs primarily as self-contained production networks that internationalized in search of efficiency and markets, rather than as open systems seeking knowledge and innovation. In the same spirit, strategists view industries primarily as arenas of competition, rather than as knowledge networks within which firms often collaborate to innovate. The realities lie somewhere in the middle. Contemporary MNCs face imperatives to seek efficiency, markets, and knowledge, which sets up a tension between the needs to constantly drive down costs and to continually innovate to meet rapidly evolving market requirements. Contemporary global industries embody a tension between knowledge creation and knowledge diffusion. In order to maintain high rates of innovation, firms must manage cooperation around common issues, such as standards, that require mutual disclosure; collaborate with suppliers and customers that maintain parallel relationships with their rivals; and often collaborate directly with rivals to perform activities that contribute to their competitive positions vis-à-vis each other in downstream markets. Firms collaborate, in part, to mutually leverage gains from specialization, by accessing partners’ deep knowledge of particular components, technologies, and services that together comprise their industry supply chains. Yet, co-specialization arises as an inevitable byproduct of the cooperation process (Doz & Hamel, 1998). Firms


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gain relationship-specific knowledge of each other’s advantages and needs. They may also create new, jointly held knowledge in the form of product innovations, process solutions and ways of doing business (Murtha et al., 2001). These developments would appear, on the surface, to pose a crisis to MNC theory. Inevitably, MNCs come to share vital knowledge that pertains to their competitive advantages with other firms. They also share many of the processes that create new knowledge that renews and sustains their competitive advantages. Co-specialization carries the potential for continuing dilemmas, as firms spar to gain the upper hand in the apportionment of rents in relationships through implied threats to withdraw cooperation. These circumstances seem to describe the very set of problems that MNCs, theoretically, evolved to resolve. Viewing MNCs and their knowledge networks at the industry level of analysis can help us to see more readily how such strategies conform, fail to conform, or suggest new evolutionary stages to theories of the MNC. I will draw heavily on the relatively recent history of several MNCs involved in the flat-panel display (FPD) industry to provide empirical context for my argument.

Creating the High-Volume, Large-Format FPD Industry In 2003, the $40 billion worldwide market value of FPDs was expected to permanently surpass the value of traditional cathode-ray tubes (CRT), which will continue to decline in the future (DisplaySearch, 2003). The crossover was driven by the unexpectedly rapid penetration in mass consumer markets of flat, wall-hangable home televisions. Science fiction has offered audiences the fantasy of such an image engine since before 1897, when Karl Braun invented the CRT. But flat TV technologies did not offer any near-term possibility of rivaling the CRT for more than 90 years following Braun’s invention. Then, in 1988, Sharp and a joint research team of IBM and Toshiba scientists separately demonstrated 14-inch thin-film transistor liquid crystal displays (TFT LCDs) in Japan. These first large-format displays were built on basic science and R&D from the U.S., Scotland, Switzerland and Germany, as well as a long history of incremental advances to manufacture larger screens for increasingly sophisticated applications in Japan. These advances progressed from 1973 when Sharp and Seiko Suwa, respectively, introduced the first electronic calculator screens and watch screens, through early “pocket” TVs, color pocket TVs, personal digital assistants, slightly larger portable color TVs, and video-camera viewfinders. Prior to 1986, when Sharp and IBM/Toshiba initiated their projects, the largest color TFTs incorporated in products measured three inches diagonally. Murtha et al. (2001) provided a detailed history of FPD technology and industry evolution.

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The companies that demonstrated the first large-format TFT LCDs initially differed in their conceptions of which customers and final goods markets could provide the basis for commercialization. Notebook computers did not supplant TVs as the most-favored initial application until 1989. In any case, the capabilities of manufacturing large-format FPDs at high volume did not follow quickly on the heels of the prototypes. The first high-volume plants, built in Japan between 1988 and late 1990–1991, faced daunting difficulties with production yields, due to particle-contamination issues in the semiconductor-like fabrication process. Yields at first fell short of 6%, resulting in extremely high costs of usable goods. The ability to lower costs sufficiently to support high-volume market applications seemed far off, indeed. In additional to process technology barriers, the early producers faced difficulties from an unexpected quarter: U.S. domestic politics. In July 1990, a group of small U.S. firms experimenting with large-format FPD production filed an anti-dumping petition with the U.S. International Trade Commission (ITC) against firms starting up large-format production in Japan. In August 1991, the ITC found in favor of the claimants and imposed duties (which proved short-lived) on FPDs originating from Japan (Murtha et al., 1996). Observers in U.S. media, academe, and government gained a lasting impression that the emergence of the high-volume, large-format FPD industry in Japan signaled a competitive catastrophe for the U.S. TFT LCDs, in the views of many critics, represented yet another instance in a long history of U.S. technologies commercialized by Japanese companies rather than by U.S. companies at home. From the mid-1990s to the end of the decade, R&D subsidy programs operated through a number of government agencies, including the Defense Advanced Research Projects Agency (DARPA), to encourage intra-industry collaboration within the U.S. to develop domestic production capabilities. By 2001, none of the FPD manufacturers and potential manufacturers that had relied on these programs had succeeded in establishing significant capacity. Most had left the industry. The controversy over U.S. national competitiveness in FPDs has continued to fog perceptions regarding the fundamentally global origins of the high-volume industry. The entire decade of the 1990s passed before the value of production in Japan fell below 50% of the global market. U.S.-based production never approached 5%. Yet, U.S. MNCs played vital, profitable roles. IBM and Toshiba’s joint research project led the two companies to establish a strategic alliance for display production, the 50/50 equity joint venture, Display Technologies, Inc. (DTI). Although Sharp established a prototypical plant to build 8.4-inch TFTs in 1987, DTI’s 10.4-inch TFT LCDs, which started coming off its first line in spring 1991, sparked the first “hit” notebook computer, the IBM ThinkPad 700C. DTI led in


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the global market share of the largest display sizes from 1996 to 1998. It remained a major source until the principals divided its assets in 2001. Other U.S. MNCs made contributions in equipment and materials that helped define the manufacturing paradigm for the new technology. Corning has long dominated in glass substrates for TFTs, at one time holding as much as 80% of the world market. Corning discovered TFT LCD technology in the early 1980s, when several large Japanese electronics firms began to order a type of glass the company had previously made available principally to biology and medical labs as a medium for microscope viewing. At first, it adapted an existing U.S. plant to supply the paper-thin glass sheets that comprise the fronts and backs of TFTs. Continuing advances in its proprietary fusion glass processes, plus plants erected in Japan, The Republic of Korea, and Taiwan – some through strategic alliances – have kept Corning in the market forefront. Applied Materials, through its subsidiary AKT, has dominated the market for chemical vapor deposition (CVD) equipment. CVD coats profoundly thin layers of chemicals and metals on glass substrates as part of the procedure that creates the millions of transistors that drive the image pixels on large TFT LCDs. CVD equipment represents one of the most sizable investments required to establish a TFT production line. By one estimate, Applied Materials’ share of the funds invested in each new manufacturing facility (known as “fabs”) during the 1990s accounted for 10% of all expenditures. (Fabs have ranged from about $130 million for the first generation of high-volume equipment to more than $2 billion in 2003.) Applied leveraged competencies developed in its semiconductor equipment manufacturing business to create a CVD solution that drastically reduced particle contamination. With the introduction of its first product, AKT helped push factory yields past a barrier of less than 60% achieved by 1993 to 80–90% in the years thereafter. The strategies of U.S. MNCs that contributed to the early emergence of the FPD industry shared several common elements. First, IBM, AKT, and Corning each established a new business to participate in the industry. Second, each company established the global headquarters for its new business in Japan. Third, the companies did not limit themselves to U.S. domestic customers and research partners, but actively cultivated networks in Japan, and later, elsewhere in Asia. These factors starkly contrast with the strategies of U.S. firms that engaged in government-subsidized R&D consortia which, until 1998, only other U.S. firms could join. The division of the U.S. FPD community into two camps – those that established relationships in Japan and those that retained a domestic orientation – presented a natural experiment that reveals much about how contemporary MNE theory developments and their normative implications correspond to contemporary

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industry practice. The successful companies leveraged core competencies extant in their global networks with pre-existing organizational capabilities in Japan to establish metanational learning and knowledge-creation partnerships. IBM Japan (IBMJ) led IBM’s partnering effort with Toshiba and served as a conduit of existing knowledge, expertise, and basic research from its local organization and IBM units elsewhere, particularly the Thomas Watson Laboratory in Yorktown Heights, New York. IBMJ combined these resources with Toshiba’s manufacturing expertise, which it developed to produce small-area TFT LCDs. Applied Materials Japan worked to coordinate U.S. and local expertise with Sharp, Toshiba, and eventually DTI to develop AKT’s first TFT CVD tool. This tool supplanted first-generation technology based on a manufacturing process for solar-power cells, for which particle-generated flaws matter little to performance. Satoshi Furuyama was a local Corning salesman who followed a paper trail of orders from corporate electronics laboratories in Japan, for thin glass products that had no obvious application in their industries. In doing so, he discovered the nascent TFT industry. Furuyama brought the new technology to the attention of colleagues at headquarters in Corning, New York. After commissioning a market research report, Corning transferred Furuyama to New York to cultivate an export business for the glass. At the same time, with top management encouragement, he wrote a highly speculative business plan for investing in the new industry. Corning Japan KK was formed on the basis of the plan, to co-develop, manufacture, and supply substrate solutions to the global industry. Furuyama returned to Japan as its first president. Companies that chose U.S.-centric strategies included entrepreneurial ventures as well as corporate giants such as AT&T, Xerox, and Guardian Industries. The companies that intended to enter FPD fabrication adopted low-volume, niche production strategies, aimed at markets such as weaponry, avionics, and medical imaging. Low-volume markets, however, could not absorb sufficient quantities to drive fabs down the production learning curve. Many U.S. equipment and materials suppliers received government matching funds to co-develop manufacturing process solutions with these U.S. producers. But the low-volume production environment caught them in the same trap as their customers. When some of them made efforts to compete in Japan and, later, other Asian markets, they were stymied by their lack of high-volume production experience. Potential customers in Asia often admired the technical elegance of the solutions offered, “suitable for NASA,” as one commented. But the economics of production were such that successful manufacturers could not risk taking proven high-volume equipment and materials off-line to test alternative solutions. By restricting themselves to domestic development partners, rather


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than investing in an open, global knowledge-creation process, the U.S.-centric firms weakened themselves. Throughout the 1990s, they continued to fall farther behind developments in the global industry. The idea of industries as global knowledge networks helps explain the roles of IBM, Corning, Applied Materials, Toshiba, and Sharp, all large MNCs, as lead innovators in FPD industry emergence. Toshiba and Sharp found themselves at home, but not alone. Japan emerged as the global center of the new industry: an incremental development that followed more than 20 years of manufacturingprocess improvements that permitted display sizes to gradually increase. Sharp played a pivotal role from the beginning, when it commercialized the first LCD calculator. Yet firms’ late–1980s decisions to jump from producing 3-inch displays to much larger sizes created a discontinuity in the development trajectory of TFT LCD manufacturing process technology. Although IBM, Corning, and Applied Materials were “born in the wrong place,” as Doz et al. (2001) might have suggested, each of these firms owned resources that proved critical to inventing the large-format TFT, closing the process technology gap, or both. Collaboration among the members of an international community of firms with organizational capabilities in Japan was essential to industry emergence. But was the metanational approach to strategy and organization essential to success for firms from outside of Japan? Could IBM, for example, have established its alliance with Toshiba and constructed the first DTI fab in the U.S.? Why did Applied Materials and Corning establish global headquarters for their FPD-related businesses in Japan? In fact, many factors that IBM weighed in deliberations over where to locate a first TFT LCD fab registered neutral or favored the U.S. over Japan. Favorable factors included costs of land, labor, critical resources such as water, and proximity to potential large customers, including IBM’s PC Division, Dell, and Compaq. Cost-of-capital for bank financing set Japan at a slight advantage, but in principal, the venture could have arbitraged those rates in international markets. U.S. government R&D funds might have been available, although perhaps not for a joint venture with a foreign firm. The nature and speed of the knowledge-creation processes that drove industry emergence, however, favored Japanese locations. Several observable indicators track these processes fairly explicitly. In general, FPD product R&D progresses in close linkage with manufacturing process technology development. Companies often (but not always) make public announcements of product technology breakthroughs, generally by demonstrating ever-larger FPD prototypes with improved visual characteristics. Prototype announcements can prove unreliable as guides to firm or industry progress, however, because they may precede

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high-volume manufacturing solutions, if any, after one year or more. Almost three years passed after the IBM/Toshiba and Sharp 14-inch TFT LCD announcements before their new, high-volume fabs produced more than test batches. Two other indicators track the nature and speed of FPD industry knowledge creation more reliably and directly in real time. The first reflects the successive generations of equipment and materials that comprise the most advanced fabrication solutions in given time periods. In order to enlarge substrate surface processing capabilities, new generations must encompass advances across the entire set of equipment and materials. Substrate dimensions function as a summary parameter to characterize generations, standing in for a host of distinctive technology challenges. The Generation 1 plants that Sharp and DTI opened in 1991 processed 300–320 mm by 400 mm substrates. Each substrate could potentially yield two to four FPDs, depending on the requirements dictated by the final product application designs that incorporated the screens (for example, notebook computers). Between 1991 and 2003, companies introduced six main equipment and materials generations, with a number of proprietary dimensional variants and fractional generations that offered slight increases in substrate area (e.g. Gen 2.5, 3.5, etc.). Progress slowed during the Asian Financial Crisis of 1997–1999. Nonetheless, one company’s analysts suggested that the rate of change in FPD technology, as indicated by substrate-area increases between 1990 and 2000, exceeded the rate of change in semiconductor technology during the equivalent stage in its development by a multiple of 18 (Law, 2000). Another way of looking at such data suggests that TFT LCD-makers achieved at least five generational changes in half the time the semiconductor industry endured the same number of transitions.1 The second indicator pertains to the elapsed time between starting up new FPD lines and bringing them to commercial yields of 80% or more. The earliest highvolume, large-format lines proved extremely difficult to “wake up” (an industry term for starting up a new line). Fewer than one in 10 TFT LCDs passed muster for use in final products. Finding acceptable units was, as one manager described it, “like picking through the garbage” (Snyder, 1994, A1). In Generation 2, the new AKT–1600 offered a CVD process technology solution that enabled crucial reductions in particle contamination. But this was one of many problems that engineers and operators needed to master repeatedly to wake up new fab lines, particularly in generational transitions. Even so, for Generation 3, conventional wisdom held that 6 months were required to achieve commercial yields on new lines, while materials spoilage costs equaled the investment in land, plant, and equipment. As the latter investments averaged $500 million, the overall expense of starting up a new fab already exceeded $1 billion in 1996. In principle, it takes more time for the first company that orders new-generation equipment to bring up a new line than its competitors should require for successive


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startups of the same generation. Over time, the first new-generation lines have, on average, required progressively less time to bring up to yield, and second movers gained the advantage of purchasing a proven tool set. The averages, however, can mask differences among companies in this regard. Instances have arisen in which first and/or subsequent movers have stumbled and fallen behind rivals, due to factors such as errors in deployment of experienced personnel and failed process experiments. These differences distinguish companies in industry competition for two reasons. First, delays can raise the costs associated with wasted materials and costly underutilization of capital equipment. Second, delays mean lost sales during the early, most profitable phases of new-generation life cycles, the period when the first fabs have reached commercial yields, but supplies remain tight because followers still lag. However, managers at one leading company suggested in late 2003 that they delayed or skipped entry into some new generations, as a way of denying competitors the benefits of their contributions to tool and process development. Fixed costs for TFT LCD plant and equipment have continued to climb throughout industry history. (Although alternative technologies have at times promised lower capital costs and operating expenses, none have as yet overtaken TFTs as lower cost or technically superior in leading-edge applications.) At the same time, each new generation has enabled companies to produce larger FPDs, in higher volumes, at lower costs. Existing markets and new applications such as desktop monitors and home TV continue to demand ever-larger screens. As a consequence, generational transitions also pressure companies to adapt older lines to produce fewer, larger panels from smaller substrates, at higher costs than can be achieved with the fully optimized new lines. Companies that wished to enter or remain in the industry had no alternative but to implement learning and knowledge-creation strategies to master continuous advances in both product and process technology. The rapid pace of technology advance also dictated a need for speed. Companies that fell behind the leading edge of generational transition suffered high costs relative to frontrunners, combined with diminished production capacity, when retooled at the highest-demand screen sizes. The next section will show how speed interacted with practical requirements of the knowledge-creation process to reward metanational strategizing for companies from outside of Japan.

THE SHIFTING BALANCE BETWEEN TACIT, VERBAL, AND CODIFIED KNOWLEDGE By the mid-1980s, the high proportion of knowledge-creating activities taking place in Japan around LCDs had already significantly and positively influenced the probabilities that the next innovations would take place there. The accelerating

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pace of industry evolution amplified the role of social interaction among industry people in information exchange, learning, and knowledge-creation processes. The increasing importance of social interaction, in turn, increased the value to companies of locating their FPD-related businesses close to one another in Japan. The importance of face-to-face contact among people and the accompanying benefits of proximity among industry members grew out of three dynamics of knowledge creation at individual, team, company, and industry levels of analysis. These dynamics concerned: (1) the rate, form and proportion of tacit knowledge that individuals converted into explicit knowledge – verbal or codified – that could be shared within groups of engineers, operators and managers; (2) the rate and primary language of company and industry knowledge articulation and codification; and (3) the volume and unpredictability of industry information flows. I discuss the underlying logic for each of these dynamics below. First, as individuals and groups accumulated new knowledge more rapidly, time-pressure diseconomies (Dierickx & Kool, 1989) increased the proportion that remained tacit or verbal relative to that which became codified. All knowledge includes tacit elements – vital components of individuals’ understanding that evade explicit representation (Polanyi, 1962, 1983). Murtha et al. (2001) and Zollo and Winter (2002) drew a distinction within explicit knowledge between verbalization (articulation) and codification. Both portrayed this distinction as one of degree. Zollo and Winter based their distinction on the greater investment in explicitness implied by codification, particularly as formal, written documentation. Murtha and colleagues emphasized the investments in distinctive organizational processes required to create and transmit tacit or verbal knowledge. Team, company, or industry knowledge-creation processes can incorporate tacit and verbal dimensions, if organized so that individuals interact directly. Groups may learn by doing, learn by discussing, arrive at non-explicit shared understandings, or carry knowledge forward in time as verbal tradition. Nonaka and Takeuchi (1995) explained how social interaction can help to convert elements of individuals’ tacit knowledge to explicit forms through verbalization, codification, and ultimately embodiment as product innovations. Yet, conversion necessarily remains incomplete, so that some proportion of knowledge always remains tacit or verbal. This incompleteness contributes greatly to the reasons why knowledge embodied in product technologies, process technologies, as well as organizational practices incur social as well as physical costs to transfer (Teece, 1977), not to mention outright barriers (Szulanski, 1996). The difficulties increase when prospective transfers must cross international boundaries (Kogut, 1991, 1993; Zander & Kogut, 1995). The history of FPD industry emergence suggests that conditions of rapid industry evolution retard the knowledge-conversion process, such that effective


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organizations must act and build on given knowledge while a relatively higher proportion remains in the tacit and verbal domains. Under conditions of rapid evolutionary change, individuals may rush communications, resort to shorthand forms of expression, rely more heavily on personal intuition, and miss connections with others. They may spend more time taking personal action and less time reflecting on how to interpersonally share, leverage, and increase knowledge. Creative processes come under stress when participants resort to shorthand or routine communications (Weick, 1995, p. 73), such as e-mail. Consequently, the importance of direct interpersonal connections increases for sustaining knowledge-creation processes. As FPD industry evolution accelerated, individuals and groups carried forward an increasing proportion of vital knowledge for companies’ progress. Companies found that generational transitions required them to reassign substantial numbers of experienced managers, engineers, and operators from older manufacturing lines to the new ones. Yet, older lines also required experienced personnel to keep running at full yield and to train their cohorts’ replacements. As the time between generational changes decreased, some companies adopted new generations before they had fully started up predecessor lines. This detracted from yields on the existing lines and retarded progress in waking up the new generation. Other companies skipped generations, in part because they could not redeploy experienced staff to awaken new lines without degrading productivity on the old ones. Second, as the pace of company and industry knowledge accumulation intensified, the codified proportion decreased, while the translation of Japanese materials into English or other languages lagged by at least one year. Many materials were written in Japanese, including manufacturing-equipment manuals, scientific papers, patents, and the best current business media. R&D results, process evolution, product needs, market opportunities, business outcomes, and technical standards discussions raced ahead. Systems to record and track them lagged. The codification gap intensified a pre-existing need for broad personal intracompany and intercompany contacts. Collegial competition characterized cross-company relationships among members of the international technical community, business managers in Japan, and senior international managers. At the same time, information gathered by trade associations and government agencies diminished in comprehensiveness and fell more rapidly out of date. Companies outside Japan sometimes solved technical problems for which open-market solutions already existed. Telecommunications, teleconferences, and e-mail helped to span the codification gap and language barrier, but these remote communication forms alone proved insufficient. Non-Japanese participants found live, one-on-one contacts and group discussions with Japanese participants essential. Over time, the calendar of technical

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conferences, trade shows, and industry economics conferences grew, bringing many participants from around the world together in Japan and, increasingly, other locales. As interest in the industry grew around the world, these venues grew increasingly multilingual. English functioned more often as a common tongue for many participants. But in the earliest days of the industry, understanding developments in Japan required an active corporate presence and rich, ongoing relationships among counterparts. Strategic alliances and intimate collaborations among affiliates, customers and suppliers in Japan played important roles in successful industry entry by several non-Japanese MNCs, including IBM, Applied Materials, and Corning. Pre-existing organizational capabilities in Japan provided these U.S. companies with prospective advantages over other non-Japanese MNCs that might also have owned the technological competencies to enter the industry. As Hymer (1960/1976) theorized and Srilata Zaheer (1995) showed empirically, MNCs’ affiliates face inherent disadvantages relative to local firms, or a “liability of foreignness” that arises from such factors as culture, knowledge of the local environment, and legitimacy. Her study with Mosakowski (Zaheer & Mosakowski, 1997) also demonstrated that for relatively long-established affiliates, this liability diminishes until it disappears, placing them on an equivalent standing with domestically owned firms. Evidence suggests that at least two, and probably all, of these companies had long enjoyed such a status (Morgan & Morgan, 1991). The metanational element in these U.S. MNCs’ strategic successes in FPDs did not arise from this “quasi-local” status, however, but from how they used the capabilities it conferred to participate, with Japanese firms, in industry knowledge creation. I address this in more general terms below, under “The metanational challenge . . .” The third dynamic concerned the volume and randomness of information flows. Random events critically influence the evolution of new businesses and industries, particularly early in their histories (Arthur, 1994, 1996). The unexpected arrival on Satoshi Furuyama’s Tokyo desk of orders from electronics companies for thin-glass products (described earlier in the essay) triggered the knowledge-creation process that eventually led Corning to start its substrate business, including the research program that established, and maintained, its industry leadership. The orders acquired meaning beyond price and quantity because Corning had assigned the right people in the right place at the right time to notice it, interpret it, learn from it and leverage it with other information. The event coincided with discussions within the company about engaging affiliates outside the U.S. in more initiatives. The company was prepared to implement new strategy processes to transform information into knowledge about affiliate opportunities, and provide incentives, responsibility, and authority to translate


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knowledge into action. Yet, the stimulus to bring these plans into action was essentially random.

TECHNOLOGY GENERATIONS AND KNOWLEDGE CREATION AT THE INDUSTRY LEVEL OF ANALYSIS Figure 1 reframes the argument using a knowledge spiral, as pioneered by Nonaka and Takeuchi (1995). Although they proposed the spiral to address individual, group, and company level processes, I have adapted it to illustrate industrylevel knowledge creation. In FPD industry evolution, as with any technology, new knowledge increasingly formed the basis of newer knowledge. Each of the four quadrants in the figure represents a phase in a transition from one generational knowledge-creation cycle to another. The spiral charts progress within and among phases. These ideas generalize to any technology for which generations (or releases) mark distinctive evolutionary stages, including semiconductors, mobile telecommunications, and software. The new-generation spiral begins as current generation R&D winds down (Quadrant I). FPD products, manufacturing equipment, and input materials embody current generation knowledge. This knowledge has also been codified in patents, equipment manuals, and process recipes. Knowledge embodiment and

Fig. 1. Evolutionary Spiral: Cross-Generational Knowledge Formation at the Industry Level of Analysis, Inspired by Nonaka and Takeuchi (1995) and Adapted from Murtha et al. (2001, p. 143).

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codification processes, however, are not exhaustive. Vital elements continue to accumulate (sublimation) and remain uncodified in the form of tacit and verbal knowledge that researchers, engineers, operators, and business managers can carry forward to start up a new generation (QII). Some of this knowledge will short-circuit the spiral and enter codification as next-generation documentation or embodiment in new-generation products (QIV). Most of it will go to jump-start (exponentiate) next-generation knowledge creation (QIII), as experienced individuals join new participants to accomplish the generational shift. The availability of experienced individuals constrains the process. Experience may be hired from a firm’s existing workforce, from other industry firms, or from a pool of free agents or consultants. Progress into QIII emerges out of routine current-generation operations, sparked by scientists’ imaginations and managers’ visions of new-generation possibilities. These individuals form the core of groups that experiment with next-generation products, manufacturing equipment, processes, and business models. They develop their initial thinking as individuals. This knowledge remains tacit at first. These tacit foundations afford the basis for new tacit, verbal, and codified knowledge in both individual and group processes. Individuals from different companies meet in informal networks. Next-generation progress forms a principal theme at professional meetings, where industry people make presentations on technical, business, and strategic issues. Individuals form teams to create papers, proposals, and business plans that circulate within and outside their companies as inputs to supply agreements, sales contracts, equipment development processes, and technical standards discussions. Lead individuals push teams for results, including prototypes, as first steps to embody new-generation knowledge (QIV). Pressure mounts to move as rapidly as possible to codify knowledge in manuals and process recipes, embody it in production facilities, and ramp up to economic scale before competitors do. Yet, some proportion of the knowledge carried through the transition remains tacit and some verbal. Circumstances of rapid industry evolution require companies to strike a balance between codification and putting knowledge directly to work in tacit and verbal forms. Codification requires time and other investments (Zollo & Winter, 2002). It also sets the stage for technology diffusion (see Boisot, 1998). Once the first company achieves commercial yields, the future generation rapidly ages to become the current generation. With increasing codification, it becomes a generation of the past that may serve as a classroom for learning by new entrants, but not as a platform for competing at the industry’s leading edge. Accelerating the pace of industry evolution transforms the role of uncodified knowledge in magnitude, character, and scope. As such, it amplifies the function of direct social interaction among people in learning and knowledge-creation processes. As the overall quantity of knowledge in the field increases, the proportion


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codified at any given moment decreases. Successive industry generations incorporate increasingly recent tacit and verbal knowledge from prior generations to create the knowledge basis of new developments. Geographic proximity and community membership sustain these interactions at inter- and intra-company levels. The need for speed creates a proximity premium not only for primary producers, but also for equipment and materials suppliers that collaborate with them to enable generational transitions. Rapid innovation cycles counterbalance companies’ interests in closely holding knowledge that pertains to current generation product-based advantages. This creates a major motivation for strategic alliances and close relationships with suppliers. As many observers have shown in other contexts, such arrangements allow companies to leverage each other’s specialized knowledge and complementary assets (see, for example, Cohen & Levinthal, 1990; Contractor & Lorange, 1988; Doz & Hamel, 1998; Dussauge & Garrette, 1999; Hagedoorn, 1993; Hitt et al., 2000; Yoshino & Rangan, 1995). Close customer connections, supplier relations, and alliances can serve as probes (Brown & Eisenhardt, 1998) that provide rapid market feedback and windows on future opportunities. These relationships involve significant sharing of firm-specific knowledge, even at tacit levels where people- and group-embeddedness would otherwise greatly attenuate hazards of imitation (Lane & Lubatkin, 1998; Mowery et al., 1996). Despite the risks of enhancing competitors’ positions (Hamel, 1991; Hamel et al., 1989; Reich & Mankin, 1986), these disclosures are rational, in so far as companies seek to lead generational transitions, rather than to sustain inherently unsustainable advantages built on previous generations. Competition is knowledge-based, not product-market-based. This is the context in which the metanational perspective on global strategy and organization applies.

THE METANATIONAL CHALLENGE: FREEING AFFILIATES FOR CREATIVITY AND GLOBAL LEADERSHIP FPD industry history empirically illustrates how some international managers have evolved in their attitudes toward relationships between global and local phenomena to arrive at a new mindset (Murtha et al., 2001; see also Murtha et al., 1998). This mindset encompasses capabilities to understand global organizational potential in metanational terms. This new, metanational mindset frees managers from hierarchical assumptions about headquarters/affiliate relations that have remained implicit in the most advanced global learning and network MNC strategies. On its surface, the need for advancement in managerial thinking to encompass metanational strategizing may not seem obvious. Many MNCs maintain

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world-class organizational capabilities in multiple countries, but most continue to rely exclusively on home-based platforms to create new knowledge. Many MNCs maintain foreign R&D operations that adapt existing products to local markets and keep an eye on competitors’ technologies. But these operations rarely lead in establishing new global markets. Concerns arise that if affiliates gain the technological initiative, they may also gain autonomy to pursue their own interests at the expense of corporate interests (Prahalad & Doz, 1981; Rugman & Verbeke, 2003). Models of heterarchic, multifocal and integrated network organizations (Hedlund, 1986; Prahalad & Doz, 1987; Bartlett & Ghoshal, 1989, respectively) have emphasized the potential contributions to firms’ strategies of global interaffiliate learning and diffusion, within the MNC, of locally derived affiliate innovations (Ghoshal & Bartlett, 1988). Metanational prescriptions superficially resemble the routinized affiliate autonomy represented by such important organizational innovations as global production mandates, worldwide functional oversight responsibilities, best practice sharing, center-of-excellence status or expanded R&D assignments. But these approaches, put into practice, can easily reduce to decentralized authorities knit together by centrally orchestrated hierarchies of routines. The metanational distinction lies in a recognition of affiliates’ potential for leading non-routine, integrative actions that include global knowledge-creation, global responses to competitive opportunities and establishment of new businesses in new global industries. Knowledge creation may be defined as an ongoing process that forms a necessary condition for innovations. Innovations represent discrete outcomes, such as new technologies or products, that may be diffused or adopted. The challenge lies not so much in cultivating local autonomy for innovation as in finding ways for affiliates to leverage an MNC’s worldwide resources, necessarily distributed across multiple locales, in knowledge-creation processes that have global potential. Resource attraction matters as much as innovation diffusion. On this basis alone, strategies for global adoption of local innovations incompletely embrace the idea of global knowledge creation. Metanational thinking also enlarges the corporate vision of MNCs’ global learning networks to encompass interaction with customers, suppliers, and competitors at the industry and inter-industry level of analysis. It expands the resources for innovation beyond MNCs’ local technology environments and global learning networks to encompass industries as global knowledge networks. Global knowledge-driven competition demands a more holistic, less entropic, less home-country-centric conception of corporate interest than theories of the MNC have heretofore envisioned. New industry opportunities require companies to maintain all of their global capabilities at readiness because location can confer early advantages. Beyond initial phases of industry emergence, the speed of


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technological advance may challenge companies to master one product generation before another comes along. MNCs avoid overlooking opportunities by encouraging affiliates to propose new industry initiatives. This does not mean releasing affiliates to pursue projects at cross-purposes with the corporation as a whole. Rather, the global context offers the highest potential environment for several practices that empirical research has shown to mediate speed of decision-making with overall firm performance in extremely dynamic environments. These include decentralization (Eisenhardt & Bourgeois, 1988), ongoing consideration of rich information streams from diverse operational sources, developing multiple, simultaneous alternatives, and institutionalizing multitiered consultation processes (Eisenhardt, 1989). On a practical level, it means preparing affiliates to leverage proximity to leading-edge phenomena, country-specific capabilities, corporate knowledge, and other affiliates’ capabilities from around the world, including deep senior managerial expertise tested in diverse settings. Deformalization and slack resources (Rugman & Verbeke, 2003, p. 133) do not reside at the center of these practices, but rather, an insistence on disciplined, globally informed strategy processes that fully utilize, expand, and reconfigure firms’ resources, as necessary. Competition in knowledge-driven industries amplifies the challenge of knowledge creation in addition to the other strategic problems of internationalization that companies increasingly faced in the 1970s, 1980s, and 1990s. These problems can be broadly characterized from process theories of international management as balancing complex interactions among strategic values that include global integration, national responsiveness, intrafirm coordination, and learning (Prahalad & Doz, 1987; Bartlett & Ghoshal, 1989; Murtha, Lenway & Bagozzi, 1998). It is consistent with these perspectives to suggest that companies historically internationalized to exploit firm-specific capabilities by leveraging their value-chain activities across geographic locations to create cost advantages, differentiation advantages, or both (Kogut, 1985; Porter, 1985, 1986). As the pace of competition and technology evolution increased, companies also leveraged their activities with the capabilities of alliance partners, suppliers, and customers to gain benefits of collaboration (Doz & Hamel, 1998). Competing in knowledge-driven industries requires MNCs to do more than leverage value chain activities within their companies, across geographic space, and among allied organizations. Knowledge-driven competition challenges MNCs to leverage their competencies across time, technologies, and technology generations as well (Murtha et al., 2001, p. 147). The essence of knowledge-driven strategy synthesizes traditional product-driven generic global strategies of cost leadership and product differentiation (Porter, 1986) with a new, dynamic value proposition: speed. This idea resonates with recent work by

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Table 1. Principle Attributes of a Knowledge-Driven Competitive Orientation Compared to Generic Product Positioning Strategies of Cost Leadership and Differentiation (Adapted from Murtha et al., 2001, pp. 9 and 148). Attribute

Competitive Orientation Differentiation

Knowledge-Driven

Value proposition

Cost leadership

Uniqueness

Speed

Competitive advantage

Products and processes

Products and services

Competencies, functionalities and solutions

Internationalization: R&D process

Efficiency-seeking: Central R&D creates standardized global products

Market-seeking: Local R&D adapts global products for local markets

Knowledge-seeking

Internationalization: new business development process

Global leadership from home country

Affiliates choose opportunities from central repertoire

Affiliates and center lead and leverage each other globally

Sustaining knowledge-based advantages

Protect, exploit; extend

Protect, exploit, adapt

Create, share, transcend: drive for next generation

International integration

Vertical supply autonomy; selective alliances and purchase contracts to redress scale disadvantages

Captive suppliers of critical value chain activities; selective alliances and purchase contracts to redress competence gaps

Alliance, supplier and merchant relationships for key activities to learn, enhance speed to market, and secure location advantages

Intrafirm network

Center-outward

Center-outward and inward

Multiplex

Globalization

Project, protect home national positions

Project, adapt home national positions

Leverage multiple national strengths

Nationality

Dominance

Co-option

Collaboration

THOMAS P. MURTHA

Cost-Driven


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Nonaka and Toyama (2002, 2003), which offers a knowledge-based strategy agenda to create synthesis between product-positioning and resource-based strategy theories, and work by Eisenhardt and Martin (2000), who hold that high-velocity markets represent a limiting case of the resource-based view of the firm. The concluding sections of this essay contrast attributes of Porter’s two product-driven generic strategies of cost leadership and differentiation with those of a metanational, knowledge-based strategic orientation. Table 1 summarizes this argument, which I then discuss in detail with brief reference to FPD industry history as considered above.

Speed as Value Companies compete by creating and sustaining firm-specific core competencies. Hamel and Prahalad defined core competence as “a bundle of skills and technologies that enables a company to deliver a particular benefit to customers” (1994, p. 199). Companies create value in cost-driven strategies by producing their products and services at low cost relative to competitors. Differentiation strategies rely on a value proposition of perceived or actual product/service uniqueness. Companies may, for example, create a line of related products, each specialized to meet the needs of different market segments. They may establish brand names associated with particular product attributes, such as exceptional quality. As long as customers do not perceive competitors’ offerings as direct substitutes, they may willingly pay premium prices for products they find specially suited to their needs. Innovators face a finite window of high profitability for any new product: the time period before imitators arrive on the scene, and price competition sets in. Knowledge-driven competition reduces the time the window remains open. Speed adds value to the extent that it allows a company to stay ahead of competitors by delivering a stream of new products at decreasing cost. Rapid product innovation props open the profitability window as old products lose fashion, draw imitators and fall subject to price competition. Rapid process innovation couples product advances with advances in manufacturing efficiency that decrease costs. As the large-format, high-volume FPD industry emerged, the most profitable companies simultaneously expanded the frontiers of product and process innovation by leading rapid increases in substrate sizes, throughput and manufacturing yields. As discussed in relation to Fig. 1, companies that dealt most effectively with these challenges handled generational evolution as a continual knowledge-creation process rather than as a set of discrete stages in industry development. As Eisenhardt and Brown have also shown (1998; see also Brown & Eisenhardt,

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1998), superior-performing companies in fast-paced competitive environments focus on leading, not following, transitions and maintain a consistent rhythm of change accordingly.

Knowledge-Based Competitive Advantages Knowledge-driven competition requires companies to look beyond products, production processes and services to consider core competencies and functionalities as sources of competitive advantage. The core competence view of strategy conceptually liberates capabilities from embeddedness in existing products and organizational units and casts light on opportunities to recombine them for future markets. Functionality-thinking similarly liberates user benefits from end-product and service embodiments, which encourages flexibility in creating new solutions for customer needs. Eisenhardt and Martin (2000) have made similar points in arguing that in extremely dynamic markets, long-term competitive advantage lies in resource configuration, which I interpret as a continuous process. The early 1970s FPD industry exemplified these distinctions. Sharp and Seiko Suwa invested in knowledge-creation processes for LCDs, delivering light, portable, visual functionalities that established new markets for affordable hand-held calculators and digital watches. These successes led to notebook screens and flat desktop computer monitors, for which no concepts existed at the time. Some U.S. companies pursued LCD technology with the objective of leaping directly to large, wall-hanging TVs. When these efforts failed to rapidly bear fruit, the companies starved, interrupted, or cancelled their FPD research programs. None of these companies remain in the TV industry today, and none have the competencies to enter it.

R&D Internationalization and New Business Development Process The knowledge-seeking motive for firms’ internationalization processes merits a distinctive classification in Behrman’s durable taxonomy (1972; see also Dunning, 1993, pp. 56–63). Efficiency-seeking, market-seeking, and naturalresource-seeking motives have longstanding acceptance in the vocabulary of international business, to which Dunning added the idea of strategic asset-seeking. Kuemmerle (1997) and Wesson (1993) have written of technology or home-base R&D augmentation as motives for establishing facilities abroad. Kuemmerle (p. 63) defined home-base augmentation as “absorbing knowledge from the local


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scientific community, creating new knowledge, and transferring it to the company’s central R&D site.” The metanational idea calls for an even more expansive research frame to encompass diverse country bases for R&D internationalization, new business creation, business leadership and even global strategic renewal within individual MNCs. This is what I mean by “knowledge-seeking” as a distinctive classification. Efficiency- and market-seeking motivations applied to R&D internationalization and new business development bear close relationships to cost- and differentiationdriven competitive orientations. Both orientations favor retaining critical aspects of these activities in MNCs’ home countries. Cost-driven strategies centralize R&D to leverage technology platforms across product divisions, gain economies of scope in creating standardized products for global markets, and improve on scale advantages by supporting cost-saving manufacturing process improvements. Home-based managers lead product and new business development on a global basis. Differentiation strategies tend to concentrate power at home to control new core technologies and product applications. New business development leadership also resides in the home country. Affiliates generally rely on the MNC’s global product portfolio as the font of new business ideas. MNCs in some industries, such as packaged goods, may allow affiliates some discretion, though limited, to establish distinctive local brands. Some companies establish R&D in advantageous institutional contexts that offer, for example, distinguished research universities, generous government programs, public/private consortia, and labor markets abundant in educated, experienced people (Kuemmerle, 1997; Murmann, 2003; Nelson, 1993). But the existence of such centers does not assure a global knowledge-creation process. These units often operate with a branch laboratory mentality, scanning for technology and adapting MNCs’ products to local preferences. Even if senior managers view affiliates as augmenters of home-base advantages, they rarely view them as originators of new global businesses. MNCs that implement knowledge-driven strategies structure their organizations to establish global innovation capabilities in multiple R&D centers in different countries. Global new business creation in knowledge-driven competition demands active, peer-based relationships among R&D, corporate, and business leadership within and across countries, as witnessed by the AKT, IBM, and Corning cases. This means that headquarters and affiliates share responsibility, as well as accountability, to identify new business opportunities that have global potential. Without such accountability sharing, many new industry opportunities that emerge outside of an MNC’s home country will fade or balloon in entry cost before strategists notice them. New business development leadership will not necessarily locate to conform to pre-existing geographic value chain configurations,

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headquarters locations, or R&D laboratory hierarchies. By identifying a new global business opportunity in a timely fashion, an affiliate gains a presumptive leadership opportunity, particularly if it is located in a country that leads the industry’s technical and market evolution. Successful affiliate leadership requires leveraging country-specific advantages, the MNC’s core competencies, and other affiliates’ knowledge. Decentralization of initiative also retards the organizational politicization and consequent slowdown of strategic decision-making that accompany centralization (Eisenhardt & Bourgeois, 1988).

Processes to Sustain Knowledge-Based Advantages Internalization prescriptions for sustaining cost-driven and differentiation advantages call for MNCs to closely control the critical generative processes of knowledge creation to avoid diffusing ideas to outsiders. In many MNCs, this orientation applies not only to relationships with competitors, suppliers, and customers but also to affiliates. Cost-driven strategies embody competitive advantages in standardized global products. Manufacturing process capabilities represent core knowledge assets, because they can drive costs down to sustain profit streams from innovations. Consequently, cost-driven strategies tend to locate responsibility for both product and process development at home,2 and assign downstream activities with intrinsically local characteristics, such as sales and marketing, to affiliates. Affiliates may also do manufacturing that does not require core technology transfers, such as intermediate or final goods assembly. As MNCs expand, some affiliates may gain regional production mandates or global responsibility to source key (usually locally abundant) inputs. But they remain peripheral to the knowledge-creation processes that sustain MNCs’ long-term competitive advantages. National preferences that define significant product differentiation prospects enlarge affiliates’ opportunities to help create and sustain MNCs’ knowledgebased advantages. Many contribute by adapting core technologies, products and services through line extensions, improvements, or other alterations to suit national tastes. Adaptive innovations may have global potential, or appeal to market segments in other countries with similar needs or tastes. MNCs face a challenge to design processes that amplify these contributions’ potential outside of the countries where they originate. Typically, this translates into globalizing affiliates’ innovations from the center, through worldwide product-management teams based at home. Centralized approaches to sustaining knowledge-based advantages contrast with affiliate-based, metanational approaches. In rapidly evolving markets, the need


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for speed counterbalances the idea that MNCs should babysit new technologies at home. Furthermore, in extremely dynamic environments, specific advantages prove unsustainable. Firms may sustain high performance by creating a series of temporary advantages (D’Aveni, 1994; Eisenhardt & Martin, 2000; Eisenhardt & Santos, 2002). Given the fleeting nature of such advantages, technology innovations require prompt attention from global management, but continuing, locally based development that leverages the country-specific resources in the geographic context that gave rise to them. Knowledge-driven MNCs sustain their advantages when they rapidly transcend current products and create their successors, as the lead FPD producers did, even when manufacturing process evolution required the resolution of significant uncertainties. Imitators lose traction when lead companies render their products and manufacturing processes obsolete.

International Integration MNCs have dominated international goods trade since at least the mid-1970s (see Vernon, 1998, p. 13 for exemplary evidence) by managing internal flows of firmspecific resources – particularly knowledge – among integrated global networks of owned affiliates. Cross-national integration creates global intrafirm production and trading networks. Ownership of activities that directly employ firm-specific knowledge reduces risks that the knowledge basis of core technologies or other proprietary advantages will leak to trading partners. But MNCs face increasing requirements to invest in shared innovation processes with alliance partners, customers and suppliers. Consequently, knowledge, rather than its embodiment in goods, accounts for ever-larger proportions of international trade. Vertically integrated MNCs vary in the degree to which they concentrate or disperse their value chain activities across countries (Porter, 1986). MNCs that pursue simple global strategies centralize most of their value chain activities in one or a few countries and transfer final goods to marketing affiliates around the world. Toyota, for example, performed virtually all of its design and manufacturing activities in Japan until the early 1980s. MNCs may also implement vertical integration in a more decentralized way by assigning global mandates for specific activities, or complete value chains for specific products to many affiliates. Affiliates can transship parts and products among themselves to assemble complete product lines in every country. Globally integrated strategies and organization structures have historically biased MNCs’ decision processes toward self-supply. Cost-driven strategies selectively employ purchase agreements or alliances to compensate for scale diseconomies or gaps in market knowledge. These relationships may serve as learning

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opportunities to prepare for acquisitions or greenfield investments (Lee, 1991). Demands for responsiveness can tilt differentiators’ incentives toward vertical structures that build market credibility through customer proximity, distributing production as widely as efficiently possible among countries. Horizontally integrated MNCs mirror home-country organizational structures, but allow affiliates scope for local differentiation by virtue of operating complete value chains in most markets. MNCs that pursue differentiation strategies within the same industry often differ in their integration patterns, as they seek to own and control the activities that embody their unique advantages. Dell, for example, leverages logistics competence and outsources all of its notebook computer components, while Samsung chose to build and integrate a display competence in support of its notebook business. Conventionally, MNCs that pursue differentiation strategies enter long-term purchase agreements or alliances either to bridge competence gaps or to acquire inputs that do not shape their advantages relative to others. All notebook producers, for example, purchase microprocessors from chipmakers such as Intel and AMD. FPD development histories at Sharp, IBM, Toshiba, and the DTI alliance illustrate more flexible, metanational approaches to integration than conventional global strategies envision. All of these companies developed the FPD market by engaging in merchant sales of their most advanced displays to achieve scale economies, more rapid learning and cash flows to fund R&D. IBM and Toshiba also sourced displays from producers other than DTI, to stay in touch with market and technology advances. In addition to the benefits realized by IBM and Toshiba, these practices advanced equipment and materials technologies and their suppliers more rapidly than would otherwise have been the case. More than one senior manager remarked during my fieldwork in 2003 that these advances spread the high costs of research and development, and developed the FPD industry’s knowledge base when single firms could not have afforded the risks. Both were necessary to enable the industry to emerge.

Metanational Networks, Nationality, and Globalization The metanational idea suggests that MNCs of the future will need to compete and learn in the most dynamic possible industry settings: the world regions where their industries are evolving most rapidly. These regions expose MNCs to the toughest possible rivals and provide critical relationship contexts for knowledge creation.


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In addition to relatively well-defined relationships that encompass the most knowledgeable allies, suppliers and customers, less-structured professional, social, and institutional networks offer rich, current information and unwritten knowledge about technologies and industries. Many of the world’s MNCs built their success by competing globally with home-created, home-based advantages. They embodied their advantages in products and technologies projected outward from headquarters to affiliates around the world. In the simplest global strategies, affiliates interacted with headquarters, but rarely, if ever, with each other. In more complex strategies, headquarters mediated interactions among affiliates, for example, to share information on best managerial practice. But the sources of competitive advantage remained home-based. Managing an MNC’s evolution from a home-based cost- or differentiationdriven strategy to a metanational, knowledge-driven strategy acknowledges a fundamental shift in the nature of markets brought on by the spread of high technology and digitalization. This shift affects all industries, not just those commonly classified as high tech. Products morph beyond companies’ traditional competencies, as digital cameras have done for many photography-industry participants. Digital convergence creates new interdependencies, such as those among computing, wireless telephony, video, and Internet access, and erodes industry boundaries such as those among utilities, entertainment and telecommunications (Hitt et al., 1998). New industries have grown up around components, such as FPDs, that some managers continue to regard as generic commodities. Developments in FPDs – such as flexible plastic substrates – may transform the competitive landscape for such traditional industries as paper. These changes occur rapidly. They alter the set of relevant technologies, customers, suppliers, partners, allies, and competitors that an MNC must understand and face. In order to leverage home-based advantages and create new advantages in the face of these changes, most MNCs will need to fundamentally alter their affiliates’ roles. They will also need to forge new ties to new partners in new places. While cost- and differentiation-driven strategies project competitive advantage, knowledge-driven strategies also assemble competitive advantage by discovering, combining, and recombining both home- and affiliate-based resources. Knowledge-strategy implementation depends on developing an organization structure that operates with multiple centers of authority and responsibility to manage multilateral flows of knowledge, people, funding and technology among affiliates in all countries. These flows, combined with strong ties to alliance partners, customers, and suppliers, play critical roles in internationally leveraging the distributed competencies that form the competitive strength of the knowledge-driven MNC.

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CONCLUSION: METANATIONAL ADVANTAGE AND THE FUTURE The increasing pace of global competition has recast the balance between MNCs’ needs to protect the knowledge that underlies their competitive advantages and the need to continually create new knowledge. MNCs have historically built the foundations of competitive advantage at home and competed internationally by projecting that advantage outward into the world. In future industry environments, MNCs will build the foundations of competitive advantage in multiple countries, wherever knowledge is evolving most rapidly. This essay has argued and shown empirically that the creation of the high-volume, large-format FPD industry represents a harbinger of this new reality. Plenty of opportunity remains to develop new theories, or adapt old ones, to acknowledge and explain these phenomena. The FPD industry concentrated in Japan as it emerged because technology knowledge accumulated more rapidly there than anywhere else in the world. The pace of industry change, the role of uncodified knowledge embedded in individuals and groups, and the foreignness of the environment to most Western firms meant that much of the early knowledge that accumulated did not travel easily. U.S. MNCs needed an established presence in Japan to participate in the industrywide learning process. Both U.S. and Japanese companies benefited from this co-location. Yet Japanese location by itself did not constitute a sufficient condition for either Japanese or non-Japanese firms to succeed during the period of industry emergence. Companies also needed to participate in global knowledge-creation regimes in which suppliers, customers, and alliance partners could freely interact. As Jennifer Spencer (2003) showed in another, quantitative study associated with the research program that produced this essay, global openness in knowledgesharing translated directly into innovation performance, measured as the value of firms’ FPD industry patent portfolios. Non-Japanese companies also needed processes to provide their Japanese affiliates with authority as well as responsibility to create, develop, and globally lead new FPD businesses. Without such processes, industry knowledge accumulation would have quickly, permanently outrun them, as it did in the many cases of U.S. companies that failed to recognize the need to participate in knowledge creation abroad. This distinction among U.S. FPD industry participants, with its clear implications for both performance and survival, offers powerful empirical evidence in support of the metanational idea. As international trade in knowledge-based goods and services continues to expand, a sense of unease has grown among U.S. observers considering the scope of adaptation that this fundamental change may impose on firms and national


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economies (Engardio et al., 2003). The metanational experience in FPDs and other industries (Doz et al., 2001) draws attention to the opportunities that the knowledge-based economy offers in the same context of rapid change. These opportunities extend not only to giant MNCs with far-flung global networks, as some have suggested (see Herbert, 2003), but also to enterprises of all sizes, including the small ones that have formed a backbone of inventiveness and job creation in most capitalist economies. The ranks of global enterprises will change to include increasing numbers of more specialized firms, and greater variation in firms’ sizes. More global enterprises will originate and base their businesses outside of the triad countries. In this environment, some current MNCs may deverticalize, transforming themselves into a number of smaller companies. Most will continue to increase in size, and some will migrate their competencies to new businesses. Others will disappear. My current research suggests that the continuing inventiveness of large, medium, and small enterprises alike will depend on access to global industry knowledge networks that link them to the best ideas from the best suppliers, customers, and partners, MNCs or otherwise, regardless of location (Giarratani & Murtha, 2003). In my view, this is an area of understanding for which the metanational research program holds great promise.

NOTES 1. This represents a conservative interpretation. The outcomes of such analyses depend critically on how many generations the analyst judges to have passed. This is in part an issue of industry politics, as companies may claim territory by referring to their own incremental changes as generation changes, or by discounting the generational claims of others. 2. This may also hold true for differentiation strategies in industries such as chemicals, semiconductors, pharmaceuticals and flat panel displays. In these industries, process design and improvements help erect barriers against imitation by affecting product performance and attributes.

ACKNOWLEDGMENTS The author is grateful to Stefanie Ann Lenway, Yves L. Doz, and Michael A. Hitt for critical consultations that helped to shape this paper, and to the Alfred P. Sloan Foundation Industry Studies Program for project grants that funded the research. Jeffrey A. Hart’s important, earlier contributions to ongoing research on the flatpanel display industry are also gratefully acknowledged. Any errors remain the responsibility of the author.

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A FRAMEWORK FOR UNDERSTANDING INTERNATIONAL DIVERSIFICATION BY BUSINESS GROUPS FROM EMERGING ECONOMIES Robert E. Hoskisson, Heechun Kim, Robert E. White and Laszlo Tihanyi ABSTRACT Prior research on international diversification has focused primarily on multinational enterprises (MNEs) from developed economies, such as the U.S. and other developed nations. As an increasing number of MNEs are now located in emerging economies, new theoretical frameworks are needed to better understand the motivations of these MNEs to diversify internationally. This paper contributes to the theory development of MNEs by examining the characteristics of international diversification by business groups from emerging economies. Using the resource-based view (RBV) of the firm and organizational learning theory, we suggest that the international diversification motives of business groups from emerging economies vary by host country context. Business groups from emerging economies are more likely to enter developed economies (rather than other emerging economies) when their primary aim is exploring new resources and capabilities, and more Theories of the Multinational Enterprise: Diversity, Complexity and Relevance Advances in International Management, Volume 16, 137–163 Copyright © 2004 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 0747-7929/doi:10.1016/S0747-7929(04)16008-3

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likely to enter other emerging economies (rather than developed economies) when their primary aim is to exploit existing group resources and capabilities. We also suggest that these motives influence business-group performance. We identify two important moderators of these relationships: product diversification and social capital. Because of the importance of the business-group organizational form in emerging economies, understanding business-group international diversification may lead to improved MNE theory.

Much of the previous research addressing international diversification has focused on multinational enterprises (MNEs) originating from developed economies, particularly the U.S., Western Europe, and Japan. This is somewhat understandable, given that world trade and foreign direct investment (FDI) were exclusively by MNEs of these nations at the time when early theories of international diversification were formulated. Although most of the FDI still comes from MNEs in develop economies, a growing percentage of the world’s FDI originates from MNEs in emerging economies, such as South Korea, China, and Brazil. In fact, emerging economies accounted for 12% of the world’s outward FDI stock in 2002. The amount of outward FDI stock by emerging country MNEs has grown from $65 billion in 1980 to $849 billion in 2002 (UNCTAD, 2003). The most important emerging economies for outward FDI stock today are located in South-East Asia: the investments of MNEs originated from this region are almost twice the size of the investments of Japanese MNEs in 2002. But while firms from emerging economies are, like their competitors from developed economies, increasingly international in scope, MNEs in emerging economies may have different competencies than their counterparts in developed economies. The competencies of these MNEs were developed in institutional environments with a lower environmental munificence, generally characterized by a lack of strong market institutions, shortages of raw materials and qualified personnel, poor access to needed technology inputs, and poor protection of property rights (La Porta et al., 1998; Wan & Hoskisson, 2003). To overcome the problems associated with relatively poor local institutional environments, many firms in emerging economies are organized into large diversified business groups. These business groups facilitate the allocation of product, capital, and human resources in the absence of well-developed market institutions (Khanna & Palepu, 1997, 2000a, b). Business groups tend to dominate many emerging economies and, more recently, make important contributions to their home economies by successfully diversifying their operations internationally. For example, Savia De C. V. and Grupo Carso De C. V., two Mexican business groups, garnered 88% and 43%, respectively, of

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their total revenue in 2000 from international sales. Likewise, Berjaya Group, from Malaysia, brought in 46% of its fiscal year 2000 sales from outside the borders of its home country (UNCTAD, 2002). Other groups, such as Korea’s Samsung, are quickly becoming well-known players in a variety of global industries. Yet, despite the increasing international presence of business groups (e.g. Lieberthal & Lieberthal, 2003; Zeng & Williamson, 2003), little attention has been given to their international expansion. The study of business groups’ international diversification is even more interesting when the groups are rooted in underdeveloped institutional environments, such as those from emerging economies (Yiu et al., 2003). The purpose of this paper is to fill this gap by developing a framework of international diversification by business groups from emerging economies. We develop our international diversification framework using the perspectives of the resource-based view (RBV) of the firm (e.g. Hitt et al., 1997; Peng, 2001; Tallman, 1991) and organizational learning theory (e.g. Hitt et al., 2000; Vermeulen & Barkema, 2001). From the light of the RBV and organizational learning theory, a business group’s international diversification can be seen as either capitalizing on existing resources and capabilities (i.e. international exploitation) or gaining and developing new resources and capabilities embedded in host-country environments (i.e. international exploration). International exploitation activities by business groups from emerging economies are more likely to take place in similar emerging economies than in developed economies for a number of reasons, including the relatively stronger ability of emerging economy business groups (vis-à-vis developed economy MNEs) to operate in less munificent environments. Because developed economies are more likely than emerging economies to possess larger resource bases and higher levels of technological expertise (Wan & Hoskisson, 2003), the international exploration activities of emerging economy business groups will tend to take place in developed economies rather than in emerging economies. As illustrated in Fig. 1, the varying motives of emerging economy business groups in entering developed vs. emerging economies may have important implications for performance. Furthermore, as shown in Fig. 1, we expect the product diversification by business groups to moderate the relationship between their international diversification and performance. Additionally, social capital, an important determinant in the formation of business groups (Granovetter, 1994), is expected to moderate the relationship between business groups’ international diversification and performance (see Fig. 1). Social capital is expected to facilitate the management and exploitation of existing resources (Blyler & Coff, 2003) and thus benefit exploitation. However, strong social relationships among group member firms may constrain the diversity and openness internally that may be necessary to absorb new ideas in the organization (Florida et al., 2002). As a

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Fig. 1. Research Framework.

result, social capital may not allow the diversity necessary to create new resources and capabilities from an emphasis on exploration. This paper is organized as follows: First, we provide an overview of the resource-based view of the firm and organizational learning, and discuss the two major motives of firms’ international diversification, international exploitation and exploration. We then examine the characteristics of business groups in emerging economies. Building on this background, we next develop a number of propositions related to international diversification by business groups from emerging economies. We conclude by discussing theoretical and practical implications of our framework and suggesting directions for future research.

THEORETICAL BACKGROUND Resources, Learning, and International Diversification The RBV of the firm (Barney, 1991; Penrose, 1959; Wernerfelt, 1984) proposes that a firm’s success is dependent on the resources it controls. Based on the assumptions of resource heterogeneity and resource immobility, RBV holds that firms with resources that are valuable, rare, inimitable, and nonsubstitutable may exploit them to achieve sustained competitive advantage and superior returns (Barney, 1997).


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In the context of international diversification, Fladmoe-Lindquist and Tallman (1994) argued that MNEs would act differently from one another due to differences in their unique resources originating from home country institutional characteristics such as physical infrastructure, competition, comparative factor advantage, and financial institutions. Hitt et al. (1997) also make use of RBV logic in arguing that MNEs use “internal resources and capabilities to exploit market imperfection existing across global regions and countries” (1997, p. 769). According to Peng, the RBV extends international diversification arguments emphasizing firmspecific advantages by “specifying the nature of . . . resources and capabilities” (2001, p. 810). Organizational learning appears to be complementary to the RBV of international diversification in that MNEs not only must utilize firm-specific resources and capabilities, but also must learn and develop new resources and capabilities. Focusing on the learning side, Penner-Hahn (1998) showed that MNEs sought sequential foreign investments in R&D activities to acquire new knowledge in the biotechnology industry. Tallman and Fladmoe-Lindquist (2002) add that MNEs in the global marketplace can sustain their competitive advantage by both exploiting their current capabilities and developing or learning new capabilities. Along this line, Luo (2000, 2002) pointed out that MNEs gain competitive advantages by combining capability exploitation and building; the former is concerned with the extent to which MNEs exploit rent-generating resources, while the latter is concerned with continuously reinvesting in building new resources. Furthermore, Vermeulen and Barkema (2001) found that acquisitions into foreign countries play a crucial role in broadening a firm’s knowledge base, decreasing inertia, and responding to rapidly changing environments. In a study of partner selection in international strategic alliances, Hitt and colleagues (2000) emphasize the effectiveness of the organizational learning perspective. Their study found that, compared to firms from developed markets, firms from emerging economies place greater emphasis on allying with developed market firms that have significant technological capabilities. Similarly, Makhija (2003) found that Czech firms undergoing privatization had a stronger market share if they had learned to develop competitive capabilities. An important aspect of learning is the ability a firm has to develop new knowledge and capabilities. Indeed, organizational learning is enriched by absorptive capacity. Absorptive capacity is the ability to expand and extend that which is already known and to transform that knowledge to produce new organizational capabilities (Cohen & Levinthal, 1990; Lane & Lubatkin, 1998; Zahra & George, 2002). Absorptive capacity is likely to increase the strategic flexibility of firms from emerging economies which helps to deal with increased environmental change as privatization occurs (Uhlenbruck et al., 2003a, b).

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Integrating RBV and organizational learning arguments is especially useful when international diversification is examined more closely, i.e. by considering its different processes, such as international exploitation and exploration. The distinction between exploitation and exploration originated with March (1991). March argued that “the essence of exploitation is the refinement and extension of existing competences, technologies, and paradigms . . . The essence of exploration is experimentation with new alternatives” (1991, p. 85). Thus, exploitation includes refinement, production, efficiency, and implementation, while exploration includes search, risk-taking, flexibility, and innovation. As such, returns from exploitation are “positive, proximate, and predictable,” while those from exploration are “uncertain, distant, and often negative” (March, 1991, p. 85). The ability to engage in international exploitation and exploration might be influenced by organizational attributes. The attributes of the business-group organization in general should be relevant for exploitation and exploration in the international environment. Next, we provide an overview of business groups with special attention to emerging economy business groups.

BUSINESS GROUPS IN EMERGING ECONOMIES Business groups, such as chaebol in Korea, grupos in Latin America, and qiye jituan in China, are defined as “a set of firms which, though legally independent, are bound together by a constellation of formal and informal ties and are accustomed to taking coordinated action” (Khanna & Rivkin, 2001, pp. 47–48). Such business groups play an important role in many national economies (Leff, 1978). For example, the 30 largest Korean business groups accounted for about 40% of Korea’s economy in 1996 (Chang & Hong, 2000). The characteristics of business groups are reflected in three streams of extant theories (see Table 1 for details). Transaction-cost economics (TCE) conceptualizes business groups as responses to market imperfections and underdeveloped institutions such as capital, labor, and product markets (e.g. Chang & Choi, 1988; Leff, 1978). According to TCE, business groups serve as functional substitutes for market failures by internalizing intermediate products and services through product diversification (Khanna & Palepu, 2000b; Khanna & Rivkin, 2001). For example, Chang and Choi (1988) found that Korean business groups with a multidivisional structure gained superior performance because such a structure led to a reduction in transaction costs stemming from market imperfections. Also relying on TCE, Khanna and Palepu (2000a) found a curvilinear relationship between firm performance and the extent of unrelated group diversification in Chilean business groups.

Authors

Theoretical Framework

Research Question

Countries

Data

Chang and Choi (1988)

Transaction-cost economics

South Korea

63 group-affiliated firms and 119 independent non-affiliated firms

Khanna and Palepu (2000a)


Chile

34 group affiliates and 80 unaffiliated firms

Khanna and Palepu (2000b)


India

Khanna and Rivkin (2001)


The effect of fit between diversification and resulting structure on performance for group-affiliated firms relative to independent non-affiliated firms Relationship between diversification and nature of external markets The performance of affiliates of diversified Indian business groups relative to unaffiliated firms The effects of group affiliation on firm profitability

655 group affiliates and 654 focused firms unaffiliated with any business group 809 business groups

Keister (1998)

Economic sociology Resource-based view

Guillen (2000)

Chang and Hong (2000)

Resource-based view

9 emerging economies: Argentina, Brazil, Columbia, India, Indonesia, South Korea, Mexico, Spain, and Taiwan South Korea

40 largest business groups and their 535 member firms 90 business groups (top 10 business groups from each country) 317 business groups

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Business-group structure and firm performance The rise of business groups in emerging economies in terms of the resource-based view (RBV) of the firm Impact of resource heterogeneity and cross-subsidization on performance of Korean business groups

14 emerging economies: Argentina, Brazil, Chile, India, Indonesia, Israel, Mexico, Peru, the Philippines, South Africa, South Korea, Taiwan, Thailand, and Turkey China


Table 1. Selected Research on Business Groups in Emerging Economies.

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A second approach, rooted in economic sociology, emphasizes social solidarity in business groups (Granovetter, 1994). Group-affiliated firms are generally “linked by relations of interpersonal trust, on the basis of a similar personal, ethnic, or communal background” (Leff, 1978, p. 663). In this context, a businessgroup head has a high degree of power over group-affiliated firms and is seldom challenged (Steers et al., 1989). Bolstering the importance of social capital in business groups, Keister (1998) found that firms in Chinese business groups with nonhierarchical organizational structures showed better performance than those in hierarchical groups. The author points out that business-group structure can have a positive effect on performance when monitoring and contractual arrangements are informal. In addition, the presence of interlocking directorates and finance firms in Chinese business groups improved performance and productivity (i.e. output per worker) of group-affiliated firms. The third approach to research on business groups relies on the resource-based view of the firm (Chang & Hong, 2000; Guillen, 2000; Hoskisson et al., 2000). Guillen (2000) argued that business groups in emerging economies resulted from repeated industry entry by entrepreneurs and firms who received special favors from governments and were allowed to gain access to resources necessary to enter a new industry. Owing to protectionist government policies and established relationships with the government, local business groups were able to establish high entry barriers and face lower threats of entry from entrepreneurial and foreign firms (Guillen, 2000). These relationship-based capabilities helped business-group member firms to reduce the effects of regulatory and competitive changes (Hoskisson et al., 2004). As noted earlier, the RBV is a useful perspective in the context of international diversification because business groups from emerging economies may have group-specific resources and capabilities to exploit in other countries. However, the RBV fails to consider how new resources and capabilities are developed or learned (Teece et al., 1997; Uhlenbruck et al., 2003b), an integral element of the international diversification process. Thus, a combined perspective of the RBV and organizational learning theory may help better understand the international diversification of business groups from emerging economies.

PROPOSITIONS International Exploration vs. Exploitation Across Host Countries The RBV emphasizes the utilization of existing resources and capabilities when firms enter other countries (Hitt et al., 1997). To gain a competitive advantage


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in host countries, business groups should possess several strategic resources relative to their local competitors (Chang, 1995). Furthermore, business groups’ resource bundles should be compatible with the characteristics of a given market (Tallman, 1991). Although similar arguments are used by Hymer (1960/1976) and others, we argue that the resources employed may be different than those from developed economies. For example, although business groups may have group-specific resources and capabilities, they can face difficulties in creating competitive advantage in developed economies (Hu, 1995). Indigenous firms in developed economies generally have richer and stronger resources and capabilities than do emerging economy business groups because the former develop their resources and capabilities in more munificent environments with advanced market institutions (Fladmoe-Lindquist & Tallman, 1994; Wan & Hoskisson, 2003). As such, indigenous firms in developed economies are more likely than business groups to possess strategic resources. To improve their competitiveness in developed economies, emerging economy business groups are likely to need to develop new resources and capabilities. One way to do this is to seek abilities that may only be more fully developed in developed economies. As such, business groups from emerging economies may also follow a strategy that allows them to develop such capabilities by acquiring or partnering with firms in developed economies. This approach may be similar to Cantwell’s (1992) suggestion; he noted that technology acquisitions in the international context allow development of new technological capabilities when such acquisitions are in host country environments that are qualitatively different from their home country environments. The development of new resources and capabilities is more likely in developed countries that have large and high-quality knowledge bases than in emerging economies (Kuemmerle, 1999). Because the knowledge and technology bases present in developed economies are more abundant than those in emerging economies, business groups are more likely to find resources and technological, managerial, and other types of capabilities that are necessary to renew their competencies and create new competitive advantages in developed economies (Hitt et al., 2000). For example, when the Korean business group, Samsung, was seeking to gain advanced technology in memory chips, it launched a large R&D facility in Silicon Valley. The expertise gained there was subsequently transferred back to Korea, where it has been used ever since to the group’s benefit (Dawar & Frost, 1999). However, other emerging economies, because of their less munificent environments (Wan & Hoskisson, 2003), present a lesser opportunity for business groups to develop new resources and capabilities. Nevertheless, business groups in these economies can have a competitive advantage because of their existing resources and capabilities. Group-specific resources and capabilities developed

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in their home (emerging economy) environment may easily lead to a competitive advantage in other environments with underdeveloped institutions (Hu, 1995). For example, the Grupo de Empresas Farmaceuticas Sidus, an Argentine business group, successfully diversified into Latin America, Asia, Eastern Europe, and Africa in deploying its research capabilities in treating Third World diseases such as Chagas’ disease, cholera, malaria, and dengue fever. Because of the relative paucity of these medical conditions in developed economies and the difficulties in dealing with local medical administrations in emerging economies, MNEs from developed economies have not aggressively pursued this product market (Carrera & Quiroga, 2003). Such exploitation activities by business groups from emerging economies are more likely to take place in emerging economies than in developed economies. Hitt and colleagues argue that, “the types of resources firms seek to leverage and the capabilities they need to learn will vary with their market context (emerging or developed)” (2000, p. 450). We develop a similar argument in the context of emerging economy business groups. While we acknowledge that the reason for international diversification into any given country is likely to contain both exploration and exploitation motivations, it is likely that the relative emphasis given to exploration as opposed to exploitation will be associated with the target host country’s relative development level. Figure 2 summarizes our theoretical model of international diversification by emerging economy business groups. Of the four cells depicted in Fig. 2, we expect emerging economy business groups to emphasize Cell 2 over Cell 1 and Cell 4 over Cell 3.

Fig. 2. International Diversification and Performance Configuration of Business Groups Across Host Countries.


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Proposition 1. Compared to emerging economies, international diversification focused on exploration by business groups from emerging economies will be higher in developed economies. Proposition 2. Compared to developed economies, international diversification focused on exploitation by business groups from emerging economies will be higher in emerging economies.

International Diversification and Business-Group Performance The match between the motivation for international diversification (exploration vs. exploitation) and the target country’s level of economic development is expected to influence firm performance. In this section, we first compare R1 (performance in Cell 1) with R2 (performance in Cell 2), both focusing on exploration activities; then, we compare R3 (performance in Cell 3) with R4 (performance in Cell 4), both focusing on exploitation activities. Our framework does not directly examine either the linearity or the curvilinearity of the relationship between international diversification and performance. Meanwhile, it goes beyond prior research in that it divides international diversification (i.e. international exploration vs. exploitation) by host countries (i.e. developed vs. emerging economies) and then examines the relationship between international diversification and performance according to host countries. In this paper, we are concerned with relative performance according to different types of international diversification and host-country environment. International exploration provides business groups from emerging economies with an opportunity to renew their competitive advantages and enhance performance (Birkinshaw et al., 1998; Frost et al., 2002; Rugman & Verbeke, 2001), although returns from exploration are typically distant in time (March, 1991). These expected returns from exploration may vary with host-country environment. The size of the host-country knowledge base, local production factors, and institutions all affect the ability of business groups to develop new capabilities and improve performance (Kuemmerle, 1999; Wan & Hoskisson, 2003). Returns from international exploration are hard to measure because exploration often serves as an antecedent to exploitation that actually raises financial performance (Koza & Lewin, 1998; Rowley et al., 2000; Rothaermel & Deeds, 2002). However, many organizational learning models do include non-financial constructs (such as the development of knowledge stocks, building a firm’s knowledge, or its resource portfolio) which are amenable to measuring learning and which in turn have been related back to organizational outcomes (Cohen & Levinthal, 1990). Drawing on this literature, we utilize the concept of potential absorptive capacity

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as an indicator for performance created by international exploration. Zahra and George (2002) defined potential absorptive capacity as a firm’s capability to acquire and assimilate new resources and capabilities. Thus, the higher the potential absorptive capacity, the more likely a firm is able to enhance its performance. While Van Wijk et al. (2001) found that a firm’s propensity to extend its knowledge base is positively related to the breadth and depth of knowledge exposure, Zahra and George (2002) emphasized the importance of external sources of new resources and capabilities. Given that a business group’s foreign subsidiaries are embedded in host-country environments, they become exposed to “external knowledge networks” of customers, local suppliers, and competitors. This will likely increase potential absorptive capacity and thus the business group’s learning and performance (Andersson et al., 2002; Yli-Renko et al., 2001). Regarding these external knowledge networks, business groups are more likely to experience higher levels of potential absorptive capacity in developed economies than in emerging economies for at least two reasons. First, developed economies have more munificent factors and institutions, through which external knowledge networks create new resources and capabilities, than do emerging economies (Khanna & Palepu, 1997; Wan & Hoskisson, 2003). Business groups from emerging economies are more likely to be motivated to enter developed economies to develop new resources and capabilities as well as benefit from knowledge spillovers from other firms in developed economies (Almeida, 1996; Porter, 1998; Shan & Song, 1997). Second, the specialized resources and capabilities of emerging economy business groups are likely to be more similar to the resources and capabilities of other firms in emerging economies than that of firms in developed economies. The relative similarity of resources and capabilities among firms in emerging economies hinders business groups from gaining new resources and capabilities and from substantially enhancing potential absorptive capacity in emerging economies relative to developed economies (Cohen & Levinthal, 1990; Lane & Lubatkin, 1998). However, the relatively richer external knowledge networks in developed economies may help business groups gain higher levels of potential absorptive capacity and subsequent performance. Accordingly, we propose: Proposition 3. Compared to emerging economies, international diversification focused on exploration in developed economies will be related to higher business-group performance (R 2 > R 1 ). Now, we turn our attention to international exploitation (i.e. R3 and R4 of Fig. 2). Performance arising from international exploitation is expected to vary with the extent to which resources and capabilities are transferable and applicable to a given host country. Generally, the gap in terms of expertise, skills, and


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competencies between firms from developed economies and business groups from emerging economies tends to be quite large. Accordingly, based on their existing resources and capabilities, business groups may have difficulty efficiently competing with firms from developed economies (Hitt et al., 2000). This situation may be exacerbated when developed economies are the target host countries of international expansion. In developed economies, business groups may encounter considerable competition, since many resource-endowed firms have already established their market positions, and customers are very demanding (Aulakh et al., 2000). Thus, group-specific resources and capabilities of emerging economy business groups may not be sufficient to compensate for the competitiveness of indigenous competitors and manage the differences in factors and institutions. In emerging economies, business groups are more likely to be able to manage institutional and factor differences and thus have stronger competitiveness, as opposed to foreign competitors from developed economies.1 For example, Lee and Beamish (1995) found that Korean firms faced a lower local knowledge gap in emerging economies, since they were familiar with a similar type of economic situation and institutional context. Consistent with this view, Dawar and Frost (1999) and Ghemawat (2001) argued that firms from emerging economies can transfer assets developed in their home markets to countries where market conditions are very similar to theirs. Pananond and Zeithaml (1998) provided evidence that the Charoen Pokphand Group, Thailand’s largest multinational business group, was able successfully to exploit its resources and capabilities in emerging economies of Indonesia, Hong Kong, Singapore, Taiwan, and China. Diversifying internationally in this way provides business groups from emerging economies a greater opportunity to realize economies of scale and scope in emerging economies than in developed economies. Although firms from developed economies may have superior resources and capabilities to those of business groups from emerging economies, the former may face more difficulties than the latter in transferring their resources and capabilities to emerging economies (Hu, 1995). For example, while firms from emerging economies often do not have to make significant changes to their business models when they enter other emerging economies, firms from developed economies are often required to change their business models upon their entry into emerging economies because local customers in emerging economies have different product preferences due in part to custom or income levels (Prahalad & Lieberthal, 1998). However, changing business models to adapt to conditions in emerging economies may also challenge firms from developed economies by attenuating their global identity (Dawar & Frost, 1999; Prahalad & Lieberthal, 1998). In addition to the problem of attenuation of identity, firms from developed economies may face higher levels of task uncertainty in emerging economies. As

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a result, they must increase their capacity to process environmental information, which increases firm costs (Galbraith, 1974). In this situation, as business groups become increasingly familiar with, and learn to more efficiently manage, their operations in emerging economies, the benefits from international diversification for business groups may be higher than their transaction and coordination costs than for firms from developed economies (Geringer et al., 2000). Drawing on the aforementioned arguments, we suggest the following proposition: Proposition 4. Compared to developed economies, international diversification focused on exploitation in emerging economies will be related to higher business-group performance (R 4 > R 3 ).

The Moderating Effect of Product Diversification As discussed earlier, business groups in general rely heavily on product diversification to gain competitive advantages (Chang & Choi, 1988; Khanna & Palepu, 2000a, b; Khanna & Rivkin, 2001). Thus, we expect product diversification to moderate the relationship between international diversification and group performance (Geringer et al., 2000; Hitt et al., 1997; Tallman & Li, 1996). We noted earlier that international exploration is aimed at developing new resources and capabilities that may eventually enhance potential absorptive capacity. Given that a country’s production factors and institutions play a critical role in a firm’s new knowledge acquisition, business groups may have a better chance of acquiring new resources and capabilities in developed economies than in emerging economies and thus are more likely to enhance potential absorptive capacity in developed economies than in emerging economies. However, enhancing potential absorptive capacity may become increasingly challenging as business groups compete in an increasing number of different product markets in both developed and emerging economies. For example, business groups are often required to develop different routines and practices that fit with different product markets. Furthermore, high levels of product diversification may attenuate the ability of business groups to develop new resources and capabilities because information-processing demands become so high that top management may not be able to cope with product breadth in an appropriate manner (Hitt et al., 1997). Thus, all these elements may combine to depress business-group performance, but this depressive effect of product diversification on business-group performance may be stronger in developed economies than in emerging economies because there tends to be a more complex market environment in developed economies than in emerging economies. Business groups, therefore, are more likely to be


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pressured to enhance potential absorptive capacity in diverse product markets in developed economies than in emerging economies owing to the intensity and rate of competition. Product diversification is more likely to mitigate the ability of business groups to recognize and assess new resources and capabilities, and to acquire and assimilate them in developed economies than in emerging economies. Thus, Proposition 5. Product diversification will negatively moderate the relationship between international diversification focused on exploration and business-group performance (R1 and R2 ), such that the negative effect will be higher in developed economies than in emerging economies. In international diversification focused on exploitation, product diversification may help improve business-group performance regardless of host-country environments. Some studies suggest that product diversification in geographically diverse markets leads to poorer performance (Franko, 1989; Tallman & Li, 1996). This may be because firms with product diversification may be less likely to extend their core competencies and use strategic resources. However, such product diversification may help business groups achieve potential synergies by exploiting their interdependencies (Hitt et al., 1997). In a study of Korean business groups, Chang and Hong (2000) found that, despite their unrelated product diversification, group-level tangible and intangible resource sharing led to higher performance. Thus, product diversification of business groups in geographically diverse markets not only helps business groups achieve economies of scale and scope (Hitt et al., 1997; Tallman & Li, 1996) but reduces the potentially negative effect of product diversification through resource-sharing, or joint exploitation of existing resources (Chang & Hong, 2000; Khanna & Rivkin, 2001). However, this positive effect of product diversification on the relationship between business-group performance and international diversification focused on exploitation may vary with the uniqueness of existing resources and capabilities in host-country environments. Because of the generally higher level of competition in developed economies, the rarity of a business group’s resources and capabilities is more likely to be higher in emerging economies than in developed economies. Thus, Proposition 6. Product diversification will positively moderate the relationship between international diversification focused on exploitation and businessgroup performance (R3 and R4 ) such that the positive effect will be higher in emerging economies than in developed economies. The second moderator of business-group international diversification and performance is social capital. Social capital, defined here as features of organizations, including social networks, trust, norms, relationship strength, and shared language,

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that facilitate action and cooperation (e.g. Portes, 1998), plays an important role in business groups. Indeed, Granovetter (1994) argues that business groups are distinguished from stand-alone firms by their level of social internal solidarity and social structure. Our focus here comes primarily from the sociology literature focusing on social capital, which is internal to the business group. Previous research in the management literature has suggested that social capital has important implications for the performance of firms embedded in external networks as well (e.g. Kalnins & Chung, 2002). Nahapiet and Ghoshal (1998) have argued that a firm’s social capital can be a source of sustained competitive advantage under the RBV framework. One reason for this is that social capital often enables resource management, aiding in the integration and recombination of existing resources (Blyler & Coff, 2003). One of the most important resources that social capital helps to manage is information. Koka and Prescott (2002) suggest that social capital can yield benefits in terms of increased richness and increased volume of information flow through the organization. Such information can often allow firms to identify market opportunities in which existing firm resources can be exploited. Thus, by facilitating the ability to gain access to information and resources, social capital can serve as a type of “grease” which allows an organization to run smoothly (Prusak, 2001). Empirical evidence supports this claim. In a study of a large multiunit firm, Tsai and Ghoshal (1998) found that two dimensions of social capital – social interaction and trust – were related to the level of interunit resource exchange and value creation. Given that social capital better facilitates exploitation in less competitive environments than in more competitive environments (Rowley et al., 2000), the positive effect of social capital on the relationship between business-group performance and international diversification focused on exploitation is expected to be higher in emerging economies than in developed economies. Thus, Proposition 7. Social capital will positively moderate the relationship between international diversification focused on exploitation and business-group performance (R3 and R4 ) such that the positive effect will be higher in emerging economies than in developed economies. While social capital has been found to have many positive effects on organizations, it has also been found to play a somewhat dysfunctional role at times (Koka & Prescott, 2002; Nahapiet & Ghoshal, 1998). While social capital plays an important role in providing access to important internal information, there is evidence that it may constrain the diversity and openness internally that may be necessary to absorb new ideas into the organization. As Florida, Cushing, and Gates state, “relationships can get so strong that the community becomes complacent and


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insulated from outside information and challenges” (2002, p. 20). This tendency can be manifested in a tendency to exclude outsiders and restrict autonomy (Portes, 1998). Nahapiet and Ghoshal confirm this point in their analysis of external networks: “[O]rganizations high in social capital may become ossified through their relatively restricted access to diverse sources of ideas and information” (1998, p. 260). Thus, while social capital can facilitate internal information flow allowing the reconfiguration and deployment (i.e. the exploitation) of existing resources to meet market demands, it can also inhibit learning by fostering an inward-focused organization. Given that firms need to focus more heavily on exploration in more competitive environments than in less competitive environments (Lant et al., 1992), social capital, which impedes the ability of business groups to acquire new resources and capabilities, is more likely to affect business-group performance negatively in developed economies than in emerging economies. Thus, Proposition 8. Social capital will negatively moderate the relationship between international diversification focused on exploration and business-group performance (R1 and R2 ) such that the negative effect will be higher in developed economies than in emerging economies.

DISCUSSION AND CONCLUSIONS Drawing on the resource-based view of the firm and organizational learning theory, we have addressed the issues of: (1) how business groups from emerging economies would pursue international diversification strategies; (2) what the performance implications of international diversification strategies would be; and (3) the effects on performance of two moderators: product diversification and social capital. With regard to the first issue, we have argued that business groups from emerging economies are likely to place a relatively high emphasis on international exploration in developed economies as opposed to emerging economies. Business groups do so to gain new market, technical, and other types of resources, and capabilities, which can then be utilized in their operations worldwide. However, business groups are more likely to be able to exploit the resources and capabilities that they have amassed in emerging economies compared to developed economies. Regarding the second issue, we have proposed that, compared to emerging economies, international exploration by emerging economy business groups in developed economies will be related to higher business-group performance. However, compared to developed economies, international exploitation by these

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business groups in emerging economies is expected to be related to higher business-group performance. With regard to the third issue, we have attempted to follow Peng’s (2001) recommendation that further research should “look at whether international diversification, independently and/or in association with product diversification, adds value” (Peng, 2001, p. 811). Likewise, we have sought to foster understanding with regard to the condition under which possessing social capital will likely improve the situation of a business group as it pursues international diversification. In so doing, we have suggested that the moderating effects of product diversification depend on motivation of international diversification (i.e. exploitation vs. exploration) and host-country environment (i.e. emerging vs. developed economies). Furthermore, we argued that social capital positively moderates the relationship between international diversification and businessgroup performance when business groups focus heavily on exploitation, while it negatively moderates the relationship between international diversification and business-group performance when business groups focus heavily on exploration.

Implications for Extant Theories Although MNEs from emerging economies are becoming increasingly important players in the global economy, little effort has generally been directed at enhancing our understanding of these organizations (Wells, 1998). We use the RBV and organizational learning theory to develop a framework regarding rationales (exploitation and exploration) behind international diversification by emerging economy business groups. Recently, some scholars (e.g. Hitt et al., 2000; Uhlenbruck et al., 2003b) have attempted to synthesize these two theoretical perspectives in various contexts such as international joint ventures and organizational transformation in transition economies. Our effort enriches this line of inquiry by analyzing the international diversification of business groups from emerging economies. Furthermore, we argue that home-country environment can play an important role for firms from emerging economies in formulating international diversification strategies.

Implications for Practice In addition to these theoretical implications, the paper lends itself to practical implications. First, firms from emerging economies may benefit from exploitation-related activities in other emerging economies. In some sense, this


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seems counter-intuitive, since markets in developed economies typically are more attractive owing to a higher cumulative purchasing power. However, while there are exceptions, most firms from emerging economies are not equipped to compete head to head with firms from developed economies vying for the same market space. Thus, by entering other emerging economies that are at a similar or lower level of economic development, firms from emerging economies enjoy operating in a terrain that they understand better than competitors from developed economies. However, firms from emerging economies still possess sufficiently advanced technology and capabilities to gain a competitive advantage and achieve high returns in other emerging economies (e.g. Carrera & Quiroga, 2003; Dawar & Frost, 1999). For example, Huawei Technologies, a telecommunicationsequipment manufacturer from China, has achieved growing success by focusing on emerging economies in Russia, Asia, and the Middle East, working below the scrutiny of American and European competitors (Buckley, 2003). A second implication of our framework, given our expectation that international diversification focused on exploration in developed economies rather than in emerging economies will be related to higher business-group performance, is that firms from emerging economies may want to concentrate their involvement in developed economies toward R&D and other financial and intangible capability development functions (Hitt et al., 2000). Thus, firms from emerging economies may want to seek partnerships with firms from developed economies in those developed economies. This suggestion expands on the work of Wan and Hoskisson (2003), who propose that firms from emerging economies should look to such partnerships in their home countries through inbound international diversification partnerships with firms from developed countries. However, research by Horne and Hsu (2003) suggests that firms from emerging economies that work with original equipment manufacturers (OEMs) primarily from developed economies, may find that “relying on learning from the key buyer to move up the value ladder may be a false promise.” Thus, as the next section suggests, more research is needed regarding international strategies of firms from emerging market economies.

Future Research In light of our model, it would be interesting to investigate the sequential process of international diversification across host countries. In this paper, we assume that exploration precedes exploitation, regardless of host-country environment. However, van Hoesel (1999) found that Korean and Taiwanese firms followed the Uppsala economists’ stages model of internationalization (e.g. Johanson & Vahlne, 1977); namely, international exploitation in emerging economies preceded

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international exploration in developed economies. Business groups from emerging economies may also pursue international exploration to seek new resources and capabilities in developed economies and then make their commitment to international exploitation in emerging economies. In addition, even when firms seek to exploit firm-specific resources and capabilities in other emerging economies, they may first need to explore new local knowledge rather than to exploit firm-specific resources and capabilities directly (Luo, 2000). In this paper, we have not paid special attention to the sequence of internationalization of business groups across host countries, but the literature would certainly be enriched by an in-depth investigation of this topic. Whether the primary strategic emphasis is on exploration or exploitation, it is also important for firms engaging in international diversification to choose the appropriate entry mode to implement such a strategy (Harzing, 2002). The literature on international entry is primarily concerned with three entry modes: joint ventures, acquisitions, and greenfield investments. Joint ventures are frequently used to acquire a partner’s knowledge such as managerial techniques, technological expertise, marketing expertise, product development expertise, and manufacturing processes (Hamel, 1991; Huber, 1991; Lane et al., 2001). When a firm attempts to enter resource-rich countries, joint ventures with indigenous firms allow the firm to access resources and capabilities usually controlled by these indigenous firms (Chen & Hennart, 2002) in order to facilitate business operations. Given that developed economy firms rarely consider the technological capabilities of potential alliance partners (Hitt et al., 2000), business groups from emerging economies may be able to access such joint ventures and add significantly to their existing knowledge base. Thus, joint ventures are expected to be a relatively preferred entry method into developed economies for the purpose of exploration. While entry into developed economies via joint venture offers substantial benefits, this sort of entry into emerging economies poses serious risks. Because joint ventures often take the form of collaboration with present or future competitors, business groups may find it difficult to maintain their resources and capabilities relative to their competitors because of the frequent necessity of sharing knowledge with partners (Hamel, 1991). Thus, entry via joint venture into emerging economies for exploitation purposes might be problematic. The second major entry vehicle is acquisitions. Acquisitions can be useful when a firm is attempting to gain new knowledge that is distant from the existing knowledge of the firm, although it may not be easy to assimilate and integrate tacit knowledge of acquired firms (Nonaka, 1994). Vermeulen and Barkema (2001) have argued that acquisitions help firms to enrich their knowledge base. Especially when new knowledge is associated with the firm’s core businesses, acquisitions are often more appropriate than other types of entry modes (Hagedoorn &


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Duysters, 2002). However, it may be difficult for firms from emerging economies to pursue acquisitions, especially if they are from countries with illiquid capital markets. Thus, in an exploration, or learning, context, acquisitions may be a useful entry vehicle for emerging economy business groups, but there may also be difficulties involved in pursuing this mode of entry. The third major entry mode, greenfield investment, has been found to help a firm exploit firm-specific advantages (Barkema & Vermeulen, 1998; Hennart & Park, 1993). Chang and Rosenzweig (2001) have argued that when a firm attempts to exploit home-base competitive advantages, greenfield investment is a more efficient entry mode than joint ventures and/or acquisitions. However, because repeated greenfield investments tend to reduce variety in the firm’s knowledge base (Vermeulen & Barkema, 2001), greenfield investments are unlikely to be useful in facilitating an exploration (learning) motive. Further investigation may reveal the appropriateness of different entry vehicles for the success of business groups from emerging economies pursuing international exploration and exploitation activities. In addition to the sequence of entry and entry mode, it would also be interesting to explore the influence of the liability of foreignness (Zaheer, 1995) on the relationships we have posited in this paper. While the complexity of our model did not permit its consideration here, it may have important implications that need to be considered. The liability of foreignness firms may face will vary with cultural distance, even between emerging economies (Thomas & Eden, 2003). For example, compared with German MNEs, Korean business groups that enter Chinese markets will be less likely to face the liability of foreignness owing to a lower cultural distance. However, Korean business groups would be more likely than German MNEs to face the liability of foreignness when they enter Hungary because of large cultural distance, even though China and Hungary both belong to the category of emerging economies. Future research is needed to examine how the combined effects of the liability of foreignness and cultural distance affect the extent to which firms can exploit firm-specific resources and capabilities in seeking to realize improved firm performance. Finally, we suggest empirical testing of our formal propositions. Data availability would likely be a significant issue in such an effort, particularly given the need for intra-organizational data to isolate the contribution to overall firm performance of a range of subsidiaries across different host-country environments. Regarding subsidiary performance data, the researcher may be able to use a managerial assessment of performance, given sufficient construct validity (Dess & Robinson, 1984). For example, Delios and Beamish (2001) asked subsidiary managers to classify their unit’s performance according to three categories: loss, break even, and gain. Along this line, the researcher may be able to ask the parent firm’s managers to evaluate subsidiary performance across developed and emerging economies.

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In addition, central to this kind of research is the measurement of the concepts of exploitation and exploration. For example, when firms perform processoriented R&D, this can be viewed as exploitation. However, when they perform product-oriented R&D, this can be viewed as exploration (Rowley et al., 2000). In the context of international diversification, the researcher may be able to measure these concepts using a survey questionnaire. For example, to measure exploitation activities, one can ask the extent to which a firm undertakes such activities as: (1) adapting existing products to local demand; (2) gaining access to low-cost labor; and (3) improving current returns. However, to measure exploration activities, one can query the extent to which the firm seeks to: (1) gain access to technological knowledge; (2) develop new products; and (3) improve future returns. Such empirical testing would do much to establish the validity of our arguments presented herein.

NOTE 1. There are other factors that could impact the ability of a business group to successfully enter a foreign market, e.g. the liability of foreignness (Zaheer, 1995) or cultural distance (Kogut & Singh, 1988). These other sources of variance are outside the scope of this paper.

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THE INTERNATIONALIZATION OF NEW VENTURES: A RISK MANAGEMENT MODEL Benjamin M. Oviatt, Rodney C. Shrader and Patricia P. McDougall ABSTRACT Yves Doz, Jose Santos, and Peter Williamson’s (2001) book about metanational processes emphasizes entrepreneurial behavior and briefly considers what they call metanational upstarts. We extend their exploration in this article through our focus on the rapid internationalization of new ventures. We present a multilevel model of new venture internationalization that highlights the importance of managing risk. The model specifies relationships between the general environment and venture entrepreneurs that are mediated by industry conditions, and relationships between industry conditions and the venture that are mediated by the decisions and actions of entrepreneurs. Complex interactions and simultaneous relationships are described among the entrepreneurs, the venture, and venture internationalization. At the foundation of the metanational corporation (Doz et al., 2001) is international entrepreneurship. Yves Doz and his colleagues describe the metanational process as: (1) sensing and acquiring new knowledge faster than competitors; (2)


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mobilizing capabilities to take advantage of creative opportunities through acts of entrepreneurial insight; and (3) operationalizing innovations more efficiently than competitors. The process is literally depicted on maps of the world. Their book, From Global to Metanational, appears to be the culmination of a gradual movement by many international management scholars from a focus on international organizational processes, structures, and strategy to a focus on entrepreneurial behavior in the international arena. The definition of international entrepreneurship has evolved over several years and recently was defined as, “the discovery, enactment, evaluation, and exploitation of opportunities – across national borders – to create future goods and services” (Oviatt & McDougall, in press). The academic discipline has two branches. One branch focuses on the cross-border behaviors of entrepreneurial actors (i.e. organizations, groups, and individuals), and the other branch compares entrepreneurial behavior among nations. Academic interest in international entrepreneurship is significant and widely distributed. Many journals headquartered in various parts of the world regularly publish articles about international entrepreneurship. Special issues and forums on the topic have been published in Academy of Management Journal and Entrepreneurship Theory and Practice. The Journal of International Business Studies has an editorial area on international entrepreneurship. Various academic meetings on the subject take place each year and attract scholars from multiple continents. The Journal of International Entrepreneurship has recently emerged. Doz et al. (2001) have highlighted the importance of spotting creative ideas in many locations around the world and turning those ideas into innovative new products and services that have global appeal. Since the topic of international entrepreneurship includes two quite distinct branches – one that focuses on cross-border entrepreneurial behavior and one that compares entrepreneurial behavior among nations – no single theory, model, or framework is likely to describe the topic entirely. Doz et al. (2001) present a model for metanational innovation that may be viewed as a prescriptive model for successful cross-border entrepreneurial behavior. Although Zahra and George (2002) say they present an integrated model of international entrepreneurship, they also only consider cross-border entrepreneurship. Madsen and Servais (1997) note that the internationalization processes of established firms will be different than that of new ventures. Oviatt and McDougall (1994) are explicit in their efforts to describe only the necessary and sufficient elements of sustainable international new ventures. Bell et al. (2003) provide a model of small-firm internationalization that highlights varying firm trajectories from incremental to instant internationalization. Like those scholars, we describe here a model of cross-border entrepreneurial behavior, and we leave the comparative branch of international

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entrepreneurship to other scholars (e.g. Busenitz et al., 2000; Mitchell et al., 2000; Reynolds et al., 2002). Our model has a focus that distinguishes it from the models highlighted above. While Doz et al. (2001) described examples of new ventures that employ metanational processes – what they called “metanational upstarts” – the research questions that motivated them and their primary focus was on the activities of large established multinational corporations. Similarly, Zahra and George (2002) emphasize corporate entrepreneurship and build on their considerable and valuable experience in that arena. Bell et al. (2003) build on their own deep knowledge and interest in small firms. Like Madsen and Servais (1997) and Oviatt and McDougall (1994), we build on our understanding of new venture internationalization. Small firms, those with fewer than 500 employees, accounted for 97% of growth in the number of exporters in the U.S. during the mid-1990s (Department of Commerce, 1999), and the recently accelerated nature of internationalization among new ventures is given importance by the interest of many governments around the world (OECD, 1997). Uniquely, we highlight the management of risk as a centerpiece of our model because it is worth exploring how firms typically evolving under the uncertainties of both newness and relatively small size (Stinchcombe, 1965), simultaneously, manage the additional risk of internationalization.

RISK IN ENTREPRENEURSHIP AND INTERNATIONAL BUSINESS Oviatt and McDougall (1999) emphasized that technological change is the foundation for accelerated internationalization among entrepreneurial firms. They detailed the pervasive effects of innovations in communication, computation, production, biological, and transportation technologies. They then described four building blocks laid on that foundation – the political economy, industry conditions, firm effects, and the management team – that greatly influence how international entrepreneurial behavior is manifested and evolves. A series of empirical studies have shown that these forces do indeed distinguish international new ventures from domestic new ventures (McDougall et al., 2003), affect the relationship between collaboration and performance among high-technology new ventures that internationalized relatively quickly (Shrader, 2001), and explain how foreign market risks are managed by new ventures and their managers (Shrader et al., 2000). That issue of risk management is especially salient in the current context. Venture founders and managers do not simply accept unfavorable risks to which their firms might be exposed (Shapira, 1995). They take action when confronted

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with threats (Miller, 1992; Shrader et al., 2000), and their actions are intended to produce the highest and most reliable possible firm performance. No assumption is made here that venture entrepreneurs are economically rational profit maximizers, but it is assumed that they prefer superior performance, or more firm growth and profits to less. One possible way of achieving more of both, when their firm has a competitive advantage in technology, for example, is to begin or to expand sales in foreign markets. Yet, conducting international business is inherently risky (Cosset & Roy, 1991; Ghoshal, 1987; McCabe, 1990; Roth, 1992) and requires a significant tolerance for risk (McCabe, 1990). Furthermore, risk has a major influence in decisions regarding internationalization (Miller, 1992; Roth, 1992). Although the amount of risk varies depending on what activities are internationalized and where and how they are internationalized, some risk is involved in any international activity (Cosset & Roy, 1991). Profits and/or assets may be lost as a result of changes in political, legal, economic, and social factors in the foreign markets where the firm competes (Boyacigiller, 1990; Ghoshal, 1987). Risks of conducting international business also result from venturing into unknown territory where lack of market expertise may result in wasted resources. Even a cursory review highlights the importance of risk within the international business literature, which is filled with studies of foreign exchange and political risk. Entrepreneurship scholars also explicitly recognize that the founding of a new venture requires the assumption and management of risk (Brockhaus, 1980; Gartner, 1985; Laitenen, 1992; Shane, 2003; Simon & Houghton, 2003; Vesper, 1990). The primary risks to new ventures are the liabilities of newness (Stinchcombe, 1965) and the high failure rate faced by new ventures (Laitenen, 1992). These risks involve the potential loss of resources invested in the venture, as well as the potential opportunity costs of not employing those resources elsewhere. In addition, entrepreneurs face the risk of the emotional losses resulting from the failure of a new business. It is clear that both the internationalization of a business and starting a new venture are inherently risky. It may be concluded, therefore, that starting an international new venture represents a particularly risky undertaking. The very efforts in which international entrepreneurs engage to increase their firms’ performance are constrained by the risks of loss that those efforts naturally entail. Thus, it seems appropriate that a model of new venture internationalization behaviors and outcomes be, at its essence, a risk-management model. There are a variety of forces that managers may use to leverage firm performance and risk, as demonstrated in the academic international business literature (e.g. Miller, 1992), the entrepreneurship literature (e.g. Oviatt & McDougall, 1999; Shane, 2003; Zahra & George, 2002), and strategic management literature (e.g. Baird & Thomas, 1985; Palmer & Wiseman, 1999). Our model of risk


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management in the internationalization of new ventures is founded on Miller’s (1992, 1998) concept of integrated risk management.

A RISK-MANAGEMENT MODEL OF NEW VENTURE INTERNATIONALIZATION Miller’s (1992) integrated model highlighted the importance of managing three groups of uncertainties in international business. Those groups were: (1) general environmental uncertainties; (2) industry uncertainties; and (3) firm-specific uncertainties. These groups are similar to the foundation and building blocks of accelerated internationalization identified above and discussed by Oviatt and McDougall (1999) and to the categories of strategic risk-taking variables identified by Baird and Thomas (1985). It seems wise to build on such time-tested convergence. There are, however, important differences between our model and the others. First, as can be seen in Fig. 1, our risk-management model highlights venture internationalization. We believe our model is a specific application of the other more general models. Describing how the risks of international operations can be managed is the raison d’être of Miller (1992), but his model applies to international firms in general, while our model is focused on new ventures. Baird and Thomas (1985) acknowledge that the characteristics of a problem or issue under consideration (e.g. reversibility, probably of loss) affect risk-taking. We simply made the issue specific by identifying it as venture internationalization. A second issue that distinguishes our model is that we make venture performance an explicit consideration. Although the issue is implied in both the other models, they focus on risk-taking (Baird & Thomas, 1985) and risk-management behaviors (Miller, 1992). The most important distinction is that we specify a largely mediated model of risk management in new venture internationalization. As shown in Fig. 1, we believe general environmental influences are mediated by industry conditions. Venture entrepreneurs, in turn, mediate the influence of industry conditions on the venture and on venture internationalization. The first mediation – by industry conditions – is consistent with Baird and Thomas’s (1985) speculation that the influence of the general environment on firm risk is felt through industry conditions. The second mediation – by venture entrepreneurs – is consistent with findings by Palmer and Wiseman (1999), which showed that industry uncertainties had their effects on organizational risk primarily through the actions of organizational managers. The dominant influence of the venture entrepreneurs in Fig. 1 is consistent with past analyses of international new ventures (Madsen & Servais,

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Fig. 1. Risk-Management Model of New Venture Internationalization.


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1997; McDougall et al., 1994) and with new ventures in general (Shane, 2003). The influence of a single founder or, more frequently, a small group of entrepreneurs at the top of a new venture is usually profound, especially given the relatively informal structure and less established routines typical of a new venture. In summary, we believe that our mediated model of risk management in new venture internationalization builds on past scholarship but is unique in its specification and comprehensiveness. Some of the same environmental influences, industrial conditions, and organizational factors are depicted in other models as direct effects (e.g. Madsen & Servais, 1997) or more interactive than mediating (e.g. Zahra & George, 2002). The need for empirical study about such issues is obvious, and we hope that the explicit specification of this model will encourage empirical examination of the issue. In the sections that follow, each part of the model in Fig. 1 is considered, beginning on the left with the most general influence of the environment.

General Environment The general environment has several aspects. By carefully choosing the countries in which they operate, venture entrepreneurs have the advantage of being able to partially select the political, governmental, economic, social, governmental, economic, and natural risks that affect them. Entrepreneurs of domestic ventures do not have the same ability. Consistent with our model, such decisions are influenced by the industry in which the venture competes. Nevertheless, the general environment can have pervasive and often manageable effects. Weak economies on multiple continents, as occurred in the early part of the 21st century, make industry conditions risky for many sectors of business, but especially for fragile new ventures. Worldwide economic downturns also make it more difficult for venture entrepreneurs to make risk-reducing trade-offs among choices about what country to enter, the amount of revenue and assets that the venture has exposed to foreign risk, and the foreign entry modes employed because all may be adversely affected. However, as we propose above, the forces of the general environment on a venture are believed to be mediated by industry conditions, and even in a general recession, some industry sectors still thrive. Of course, the risks of internationalization are decreased during periods of widespread economic growth. This may be especially important for opportunity-seeking entrepreneurs (Kaish & Gilad, 1991). Therefore, Proposition 1. The influence of the general environment on venture entrepreneurs is mediated by industry conditions.

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Industry Conditions Industries distinguished by technological intensity and rapid technological change often present significant opportunities (Oviatt & McDougall, 1999). Opportunities may be discovered within technological changes, or they may be enacted and effectuated by the unique perceptions and actions of entrepreneurs (Oviatt & McDougall, in press; Sarasvarthy, 2001; Shane, 2000). Such knowledge-based industries are more likely than other industries to produce products with characteristics and uses that are relatively homogeneous in many countries because they are less influenced by cultural differences. Firms in such industries are more likely to have globally integrated production and internationally coordinated competitive strategies. Furthermore, product life cycles in such industries may be relatively short and innovations rapid (e.g. software). Those conditions create niche opportunities for new ventures but also require rapid action before windows of opportunity close (Coviello & Munro, 1995). Such industry conditions are obviously risky. Nonetheless, the empirical evidence is that small firms, which are often new ventures, produce more innovations per employee than large established ones (Acs & Audretsch, 1990) and frequently lead innovation even in industries where large firms dominate (Acs & Audretsch, 1988). There are other industrial conditions that both push and pull new ventures to internationalize (Oviatt & McDougall, 1995, 1997). Technological innovations such as the Internet enable small firms and new ventures with limited resources to internationalize, whereas previously, they could not afford to do so (Knight & Cavusgil, 1996). Where domestic competition is intense, new ventures may be pushed toward rapid internationalization to escape it (OECD, 1997). When globally integrated industries are growing rapidly, such as information technology in the latter part of the 1990s, internationalization is increasingly attractive to the entrepreneurs in a new venture. The potential for reversal, however, makes it risky. Yet, risk-taking is common when the attention of decision-makers is directed toward opportunities (March & Shapira, 1987; Simon & Houghton, 2003). The key to determining venture behavior, then, is to consider whether industry conditions are discovered or enacted in ways that lead entrepreneurs to exploit opportunities. Therefore, Proposition 2. The influence of industry conditions on venture internationalization risk is mediated by venture entrepreneurs. Venture Entrepreneurs Miller’s (1992) model of integrated risk management in international business depicted managers as only one aspect of firm-specific uncertainty, and his


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discussion focused on agency issues. Perhaps that was appropriate in the context of the large, established, and diversified multinational corporation that he had in mind, but in new ventures, a founder, a team of founders, or a small number of owner-managers often dominate decisions, and issues beyond agency become salient (Madsen & Servais, 1997; McDougall et al., 1994). Personal characteristics, psychological traits, and network relationships influence how entrepreneurs interpret industry conditions. Those interpretations bias all the decisions they make about their ventures, including the way the risks of internationalization are managed. The literature on these influences is voluminous (Aldrich, 1999; Shane, 2003). Therefore, only a limited number of issues that are most salient for our purposes will be highlighted here. Personal Characteristics The characteristics highlighted below are experience, education, and age. All are believed to have significant effects on how risks are managed. Experience. The prior experiences of entrepreneurs and managers may compensate or substitute for lack of experience by the organization itself (Bell et al., 2003; Cooper & Dunkelberg, 1986). Moreover, the self-confidence bred by experience has been found to have a strong positive influence on risk-taking (Baird & Thomas, 1985; Kahneman & Lovallo, 1993; March & Shapira, 1987). Relevant experience may reduce the perceived complexity, ambiguity, and probability of loss inherent in a situation. Experienced entrepreneurs may underestimate actual risks involved, overestimate their own abilities, and consequently take what may appear to be foolish risks (Busenitz & Barney, 1997; March & Shapira, 1987; Simon & Houghton, 2003; Sitkin & Pablo, 1992). However, managers’ abilities to influence, control, or manage risk are often underestimated by observers (Shapira, 1995). International work experience provides knowledge of foreign markets and plays an important role in widening the sphere of perceived opportunities (Brush, 1992; Knight & Cavusgil, 1996; McDougall et al., 1994; Murray, 1996; Ray, 1989). Thus, a strong relationship exists between international experience among venture officers and the extent of the venture’s international operations (Bloodgood et al., 1996; Reuber & Fischer, 1997). International experience among managers reduces the uncertainty of operating internationally (Sambharya, 1996). Research has shown that alertness to new business opportunities is influenced by previous industry experience (Ronstadt, 1988) because that experience provides the framework for processing information. For this reason, entrepreneurs generally find themselves producing the same goods and services as their previous employers and/or targeting the same customers (Aldrich, 1999; Cooper

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& Dunkelberg, 1986). Such facts suggest that entrepreneurs are able to absorb knowledge and are most alert to opportunities within the bounds of their industry experience. Furthermore, perhaps entrepreneurs who are comfortable with industry norms feel more in control and, therefore, less at risk, and are more willing to take on the risks of rapid internationalization in their industry. Or perhaps such people are prescient observers of nascent industry trends toward greater internationalization. Marketing and technical experience has been shown to be one of the most important factors in the successful internationalization of new ventures (Jolly et al., 1992), and lack of marketing expertise was found to be a significant obstacle to the internationalization of small firms (Brush, 1992). Entrepreneurs with stronger marketing and technical skills appear less preoccupied with developing these basic skills and find it easier to adapt the skills they already have for international markets. Entrepreneurs with prior start-up experience are more efficient about decisionmaking in a new venture (Cooper, 1970), and they do better in terms of sales and profits than entrepreneurs in their first businesses (Lamont, 1972). The lessons learned in forming prior ventures are likely to be included in routines for starting subsequent new businesses. The more experience entrepreneurs have with prior start-ups, the more confidence they have that they can manage the risks associated with starting a new venture (Shane, 2003), and thus the more willing they are to accept the risks of internationalization. Education and age. In addition to experience, two additional personal characteristics, education level and age, are believed to have a significant influence on entrepreneurial risk-taking. Although the relationship between education level and risk-taking in the psychology literature is unclear (MacCrimmon & Wehrung, 1990), within the management literature, findings have been consistently positive (Bantel & Jackson, 1989; Lafuente & Salas, 1989). Moreover, the likelihood of starting a new venture is positively related to the level of entrepreneur education (Birley & Norburn, 1987; Shane, 2003). Thus, while education level may not influence individual risk-taking, it may influence individuals to engage in organizational risk-taking. An educated entrepreneur’s higher information processing capacity, greater tolerance for ambiguity, and receptivity to innovation (Wiersema & Bantel, 1992) may permit them to deal better with the complexities of internationalization (Simpson & Kujawa, 1974). The literature makes a strong case that there is a negative relationship between age and risk-taking (Bantel & Jackson, 1989; MacCrimmon & Wehrung, 1990). As individuals age, they may become conservative and more realistic about their


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abilities (Baird & Thomas, 1985; Kahneman & Lovallo, 1993). Therefore, older entrepreneurs may pursue less aggressive venture strategies and may be less willing to become involved in the complexities of managing a new venture in an international arena. Psychological Traits Experience, education, and age are characteristics that one acquires. Psychological traits are cognitive biases that are relatively innate in an individual. Two related traits that appear likely to affect how venture entrepreneurs enact the industry conditions affecting them are risk-taking propensity and overconfidence. Risk-taking propensity. While there have been many studies of this issue in entrepreneurs, disagreement about conclusions remains. Brockhaus (1980), in a frequently cited and well-regarded study, found that risk-taking propensities were similar in entrepreneurs and managers. However, a recent meta-analysis of a dozen studies found that entrepreneurs had a greater tendency to take risks than managers (Stewart & Roth, 2001). Shane’s (2003) review of several studies draws a similar conclusion. Shapira (1995) points out that risk-taking is generally depicted by academics as something akin to a gamble that, once accepted, cannot be altered, while managers and entrepreneurs believe they can influence or manage the uncertainties of business as they play out over time. In other words, risks are rarely simply accepted. Whatever the case, entrepreneurs who have a relatively high propensity to take risks are more likely than others to enter the inherently risky international arena in their industries. Overconfidence. Those entrepreneurs who believe that industry uncertainties can be influenced and managed sometimes overestimate their abilities. A variety of studies indicate that entrepreneurs tend to be overconfident (Busenitz & Barney, 1997; Shane, 2003; Simon & Houghton, 2003). As far as we know, there are no studies of the relationship between psychological biases, such as overconfidence, and entrepreneurs’ willingness to take their firms international. However, it seems logical that entrepreneurs who have a propensity for risk-taking and are overconfident in their ability to manage those risks over time are more likely than most to view positively the international opportunities in their industry. Network Relationships Entrepreneurs’ personal network relationships are essential for the very existence of their ventures (Aldrich, 1999). Networks enable them to tap the resources they need for a viable firm without owning all those resources. Social networks can

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even compensate for an entrepreneur’s lack of knowledge, such as marketing knowledge about a particular target population (Coviello & Munro, 1995). It is clear that entrepreneurs operating in the international arena depend significantly on an extended social network to take their ventures international (Coviello & Munro, 1997). Thus, social networks provide a vital mechanism for managing industry risk and the risks of internationalization. The amount of risk that can be managed depends on the character of the entrepreneur’s network (Aldrich, 1999). The networks of entrepreneurs who most successfully manage the risks of internationalization are likely to be relatively large simply because more diverse locations are being managed than in a domestic business. Most successful entrepreneurs require a small number of “strong ties” involving close friendship, support, and advice. The number is small because no one can successfully maintain a large number of intense relationships. Therefore, there are likely to be fewer than 20, perhaps around 10, strong ties. An international network will depend on many more “weak ties” that provide vital business-like connections to essential firm resources and capabilities. Those weak ties will be relatively diverse in terms of the types of resources those ties influence because actions are being taken in multiple cultures. A few “network brokers” who provide a bridge into the networks of foreign countries will be present, especially at the initiation of international efforts. As the entrepreneurs embed themselves directly into those foreign networks, brokers become less important and “contact ties” that provide spot-market business are likely to be increasingly encountered. In summary, entrepreneurs exert a powerful and long lasting influence on the ventures they start (Burton, 2001), and a variety of slowly acquired personal characteristics, relatively innate psychological traits, and constantly evolving social networks exert a powerful influence over entrepreneurs’ decisions and actions. Relevant experience may reduce the industry and international risks perceived by venture entrepreneurs and increase their belief that the risks can be managed. Young age, a high level of education, a positive risk-taking propensity, and overconfidence appear to have similar effects. Social networks provide information and social status, and serve as the dynamic force in this mix. These are complex issues which have been frequently studied, and a considerable amount has been written about these issues. However, in this broad multilevel analysis, we believe it is most appropriate to emphasize the following, Proposition 3. The interaction of personal characteristics, psychological traits, and social networks through which industry conditions are interpreted is the most powerful influence on entrepreneurs’ decisions and actions concerning the new venture, its internationalization, and its risks.


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The Venture The decisions and actions of entrepreneurs result in certain venture conditions, resources, strategies, and governance structures. Each of those demonstrates the content of decisions made by the venture entrepreneurs and the risks they are taking. Size, Financial Strength, and Organizational Slack Firm age, size, financial strength, and organizational slack were all issues identified by Baird and Thomas (1985) as organizational characteristics that affect risk. Our model focuses on new ventures, which are already assumed to be riskier than established firms. Although many new ventures are quite small, some grow quickly and become large enough to go public. Relatively large new ventures, especially those that are publicly held, tend to have a greater financial strength in the form of cash, equity, and borrowing power. Some ventures have slack resources, such as unused borrowing power that permits them to withstand problems like the failure of a large customer to pay in a timely fashion. Size, financial strength, and slack all indicate a venture’s ability to withstand significant unexpected problems, which means that the venture is at less risk of failure. Resources Size, financial strength, and slack are usually tangible resources. While such resources are certainly valuable, competitive advantage is more often provided by intangible resources, such as a reputation for high-quality products and services, and by human resources with unique and inimitable skills and knowledge (Barney, 1991). Indeed, successful international new ventures have been shown empirically to emphasize high quality and customer service (McDougall et al., 2003). Such advantages sometimes depend on tacit knowledge and a socially complex culture among a team of people that is valuable and difficult to copy. Strategy and Innovation Viable ventures conducting business in foreign countries overcome the natural edge enjoyed by indigenous firms and seek competitive advantage by transferring unique, valuable, and movable resources that they control, such as private knowledge, across national boundaries to combine them with less movable resources, such as raw materials and people (Oviatt & McDougall, 1994). Knowledge may be an especially valuable resource because it can sometimes be moved with low marginal costs. However, the value of knowledge is made uncertain by its degree of geographic stickiness, by its tacit nature, and by competitors’ ability to appropriate that knowledge for themselves (Doz et al., 2001).

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Doz et al. (2001) emphasize the importance of proactive efforts to discover new knowledge resources and to mobilize those resources into valuable innovations that address needs in a variety of countries. They say explicitly that such a strategy is important for the success of both established multinational corporations and new ventures. Thus, knowledge resources and technological innovations are often observed to be foundations for new venture strategies. Moreover, many international new ventures seem to emphasize the uniqueness of their outputs rather than their low-cost structure of production (McDougall et al., 1994). Thus, they appear to employ a generic strategy of differentiation. The risks of differentiation are, of course, potential for high costs which buyers are unwilling to pay, changing buyer demands, and successful imitation by competitors (Porter, 1980). Governance In order to decrease the risks to which they are exposed, investors typically hold diversified portfolios of shares from many companies. A corollary is that the shares of a publicly held firm are usually widely diffused among many owners. With risks diversified, investors prefer firms to adopt risky strategies, such as aggressive market entries and early internationalization, with the expectation that while some firms will perform poorly, others will more than make up for that with superior performance. However, much of the wealth of top-level managers is usually not diversified but tied to the specific firm that they manage through the present value of their expected salaries, ownership of shares, and options for shares (Beatty & Zajac, 1994). The wealth of new venture entrepreneurs is especially concentrated in their firms because they often go into significant personal debt to start a firm and own a large percentage of the venture. Even in public or venture-capital-backed private firms, entrepreneurs often retain significant ownership. Their concentrated personal wealth may inhibit entrepreneurs’ willingness to take risks, such as internationalization, ceteris paribus. However, venture capitalists and other outsiders who have an ownership stake may act to encourage venture risk-taking. That is often done by having a representative on the venture board of directors, and if that representative has significant international experience, the venture is more likely to engage foreign markets (Carpenter et al., 2003). Proposition 4. The interaction of venture size, financial strength, slack, resources, strategy, innovation, and governance determines the level of risk inherent in a new venture. Venture Internationalization As indicated by Fig. 1, the way in which a new venture internationalizes is the result of interaction among the decisions of the venture entrepreneurs and the


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history and path dependence of the venture itself. Even the youngest and most flexible venture with the most powerful of entrepreneurs still has some degree of inertia in its characteristics, strategy, and governance. Several decisions and actions concerning internationalization take place roughly simultaneously. One is the venture’s degree of dependence on foreign markets for inputs and sales revenue, or degree of exposure (Miller, 1998). Exposure may range from zero, when a purely domestic venture derives no sales or inputs from foreign countries, to nearly 100%, in the case of an import/export business. Greater international exposure represents greater risk because in its attempt to profit from the sale of its outputs, a venture is exposed to increased uncertainties about such things as foreign government action, exchange rate fluctuation, logistical complexities, communication difficulties, and other problems. Doz et al. (2001) highlight the advantages of operating in a number of countries. It provides opportunities to discover new knowledge, to profit from innovation in multiple countries, and to create the most efficient operations to serve them. The ability to flexibly shift resources provides huge advantages and may lower the risk for the company as a whole. Some countries are riskier than others, however. And venture entrepreneurs often have significant discretion to choose the countries in which they operate. Countries vary in the characteristics that determine the political and economic risks of conducting business. In addition, cultural differences and geographic distance increase the uncertainty of doing business in a foreign country. However, even if entry into a country is judged risky, that risk may be accepted if the expected return is high enough to compensate for the risk. Strong market potential, as indicated by market size, wealth, growth, and education level, provide an opportunity for new ventures to achieve such returns. Doz et al. (2001) emphasize the importance of speed in overcoming threats from international competitors. Autio et al. (2000) emphasize the value of internationalizing early in the life of a new venture. They call it the “learning advantage of newness,” because they believe young firms with fewer established routines are able to synthesize new ideas from a variety of locations more rapidly than older firms that may be inhibited by outmoded procedures. Yet every international commercial exchange is complicated by the encounter with unfamiliar laws, culture, language, and people. Thus, speedy internationalization, while potentially valuable, increases the risk of making errors. Decisions must also be made about foreign entry modes: exporting, licensing, franchising, joint venturing, and fully owned foreign direct investment. The order in which these entry modes are listed roughly indicates increasing involvement and commitment of resources and, therefore, greater exposure. Because a venture may sell several different products or services in a variety of locations, multiple operating modes are likely to be simultaneously employed in a single venture.

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Scholars debate whether various aspects of exposure, country risk, speed of internationalization, and foreign entry mode represent a single dimension or several separate dimensions of internationalization (Ramaswamy et al., 1996; Sullivan, 1994, 1996). However, it is most realistic to view them as separate but simultaneously determined (Miller, 1992). Entrepreneurs have significant discretion in managing each dimension, but a decision about one affects the risks of all others. Moreover, to the degree that venture strategy is well established, choices about these international dimensions may be circumscribed. Thus, entrepreneurs make trade-offs among the dimensions to control the venture’s overall level of international risk (Shrader et al., 2000). For example, ventures entering high-risk countries may elect not to be highly dependent on them (e.g. low sales objectives), and entry modes may be employed that require only minor commitments of resources (e.g. licensing). Proposition 5. The pattern of venture internationalization and the overall degree of international risk are simultaneously determined by the degree of exposure, the number of countries entered, the country conditions, the speed of entry, and the entry-mode choices. Proposition 6. The interaction of venture entrepreneurs’ decisions and conditions established in the venture itself influence all the dimensions of venture internationalization.

Venture Performance Overall, venture performance is determined by a combination of venture strategy and venture internationalization, which themselves result from the venture entrepreneurs’ decisions and actions. Performance is, of course, judged from many points of view. Thus, many metrics are employed, and disparate judgments may occur. Conventional metrics at the firm level are profitability, sales growth, and investor returns. The entrepreneurs and other owners obviously hope those metrics will be as high as possible. However, it has been argued, and some empirical support has been found, that these measures of firm performance vary in a complex way with the degree of internationalization (Lu & Beamish, 2001). That is, as a new venture begins internationalization, its financial performance declines due to the liabilities of foreignness until it is operating in three to five countries, at which point its performance increases as the profitable growth opportunities and other advantages of foreign direct investment kick in. However, as the number of countries increases greatly, and the firm becomes an established multinational corporation, at some point financial performance


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decreases again perhaps because of the managerial complexities of operating in so many environments. At the country level, Doz et al. (2001) emphasize the benefits of knowledge transfer and innovative products and services provided by what they call metanational upstarts that are competing in multiple countries from the outset. Governments and their citizens expect jobs for workers, advanced technology, increased productivity, economic growth, wealth, and improved lifestyles. Risk may be measured by the probably of failure to achieve any of these things and by the variability of these metrics over time.

Learning from Performance The dashed line in Fig. 1 from the Venture Performance block to the Venture Entrepreneurs block represents feedback from performance in the form of learning by entrepreneurs. Over time, venture entrepreneurs observe and interact as their international efforts succeed and fail, and their observations affect their experience, their networks, and their decisions about future venture actions, including future international efforts. The dashed line in Fig. 1 from the Venture Performance block to The Venture block represents feedback from performance in the form of changes in size, financial strength, slack, resources, and abilities to successfully innovate. Together, these two dashed lines emanating from Venture Performance may create dynamic capabilities for ventures (Teece et al., 1997). Or if learning does not occur, and resources are squandered, capabilities may be destroyed, and venture survival is threatened. The other dashed lines in Fig. 1 represent how The Venture can affect Industry Conditions and how they, in turn, can affect the General Environment. Technological innovations in one venture may bring about technological changes in whole industries, as is periodically seen in the pharmaceutical industry. As industries change, health and social conditions in whole countries can be affected. Thus, the model represented in Fig. 1 contains a mediated feedback loop.

CONCLUSION Professor Doz and his colleagues (2001) describe how multinational corporations may evolve to metanational corporations and how metanational upstarts are born. Their focus is on the former while the model described in this article focuses on the latter. Our model also highlights venture risk and is more abstract and formal, while they stress managerial application. Nonetheless, we believe our risk

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management model of new venture internationalization is consistent with Doz et al.’s (2001) emphasis on entrepreneurial processes. They detail the process by which valuable new knowledge in disparate locations is discovered and acquired and how entrepreneurial insight enables the creation of innovative products for an international economy. Thus, scholarship in international business has converged with scholarship in entrepreneurship.

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DISTANCE MATTERS: LIABILITY OF FOREIGNNESS, INSTITUTIONAL DISTANCE AND OWNERSHIP STRATEGY Lorraine Eden and Stewart R. Miller ABSTRACT The costs of doing business abroad (CDBA) is a well-known concept in the international business literature, measuring the disadvantages or additional costs borne by multinational enterprises (MNEs) that are not borne by local firms in a host country. Recently, international management scholars have introduced a second concept, liability of foreignness (LOF). There is confusion in the two literatures as to the relationship between CBDA and LOF, as evidenced in a recent special issue on liability of foreignness (Journal of International Management, 2002). We argue that LOF stresses the social costs of doing business abroad, whereas CDBA includes both economic and social costs. The social costs arise from the unfamiliarity, relational, and discriminatory hazards that foreign firms face over and above those faced by local firms in the host country. Because the economic costs are well understood and can be anticipated, LOF becomes the core strategic issue for MNE managers. We argue that the key driver behind LOF is the institutional distance (cognitive, normative, and regulatory) between the home and host countries, and explore the ways in which institutional distance can affect LOF. We operationalize our arguments by showing how Theories of the Multinational Enterprise: Diversity, Complexity and Relevance Advances in International Management, Volume 16, 187–221 Copyright © 2004 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 0747-7929/doi:10.1016/S0747-7929(04)16010-1

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institutional distance and liability of foreignness can provide an alternative explanation for the MNE’s ownership strategy when going abroad. [N]ational firms are likely to have advantages over foreigners . . . National firms have the general advantage of better information about their country: its economy, its language, its law, and its politics. To a foreigner, the cost of acquiring this information may be considerable. But note that it is a fixed cost . . . Of a more permanent nature is the barrier to international operations arising from discrimination by government, by consumers, and by suppliers. It is not the general treatment that is important: this affects the domestic firms as well as the foreign firms, but it does not give one firm an advantage over another. What is important is the fact that in given countries, foreigners and nationals may receive very different treatment. (Hymer, 1960/1976, pp. 34–35)

Stephen Hymer (1960/1976) was the first scholar to theorize that firms experienced costs of doing business abroad (CDBA) that were not experienced by local firms. He argued that CDBA should be measured by the advantages national firms have in their home markets relative to foreign-owned firms. Since Hymer’s 1960 dissertation, researchers have focused on the types of firm-specific advantages that multinational enterprises (MNEs) need to offset these costs. CDBA has received less attention, serving primarily to motivate research on MNE advantages (Buckley & Casson, 1976; Caves, 1982; Dunning, 1977; Hennart, 1982; Rugman, 1981). Recently, international management scholars have begun to “open the black box” of the costs of doing business abroad (Eden & Miller, 2001), arguing that MNEs face a liability of foreignness in host countries (Kostova & Zaheer, 1999; Zaheer, 1995; Zaheer & Mosakowski, 1997). Zaheer defined liability of foreignness as “the costs of doing business abroad that result in a competitive disadvantage for an MNE subunit . . . broadly defined as all additional costs a firm operating in a market overseas incurs that a local firm would not incur” (1995, pp. 342–343). Zaheer’s liability of foreignness list parallels Hymer’s CDBA. Both authors focus on additional costs not incurred by local firms in the host country; Hymer speaks of “the stigma of being foreign” (1960/1976, p. 35), and Zaheer (1995) uses the two terms interchangeably. Are the two concepts interchangeable, or are they different? A recent special issue of the Journal of Management (Vol. 8, No. 3, 2002) suggests there is still confusion about the two concepts. Luo and Mezias (2002, p. 218), in their introduction to the special issue, see the two concepts as the same, arguing that CDBA was a “precursor to LOF,” but the definitions and use of the two concepts vary from paper to paper. Zaheer (2002, p. 350), in her commentary on the volume, explicitly asks, “Are they [CDBA and LOF] synonymous? Are the liabilities of foreignness a subset of the costs of doing business abroad? Or are they an overarching concept within which the costs of doing business abroad fall?” She answers by noting first that in her early work on LOF, she saw them as the same, but now sees them as different. CDBA is an economic concept consisting primarily of market-driven costs

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related to geographic distance; whereas LOF is a sociological concept consisting primarily of structural/relational and legitimacy costs. She concludes with a call for a deeper “understanding of foreignness, and its ramifications” (2002, p. 357). Our objective herein is to answer Zaheer’s call for a deeper understanding of liability of foreignness and its ramifications through an explicit and careful deconstruction of the relationship between CDBA and LOF. Our view of the relationship is close to, but not the same as, Zaheer’s; that is, we see LOF as the key component of CDBA. LOF stresses the social costs of doing business abroad. These social costs arise from the unfamiliarity, relational, and discriminatory hazards that foreign firms face and domestic firms do not; such costs are inherently due to uncertainty and are likely to persist over time. We argue that the key driver behind LOF is the institutional distance (cognitive, normative, and regulatory) between the home and host countries. CDBA, however, is a broader concept that includes LOF but also includes economic activity-based (production, marketing, distribution) costs related to geographic distance. Since these economic costs related to value-adding activities by the MNE can be anticipated and measured, and may well be finite, the core issue for MNE managers remains liability of foreignness. We therefore focus the rest of the paper on LOF. We decompose LOF into three types of hazards (unfamiliarity, relational, and discriminatory hazards) and show how the three pillars of institutional distance (regulatory, normative, and cognitive) can affect each hazard. We operationalize our arguments by showing how institutional distance and liability of foreignness can provide an alternative explanation for the MNE’s ownership strategy, that is, the optimal percentage of equity held by the MNE in its foreign operations (where 0% represents exporting and 100% a wholly owned subsidiary), with or without a local partner. The rest of this work is organized into five parts. The following section briefly reviews key theoretical contributions to the literature on the costs of doing business abroad and liability of foreignness. The third section offers a new deconstruction of the relationship between CDBA and LOF. The fourth section explores the three pillars of institutional distance as drivers of LOF. The fifth section examines some implications for the MNE’s ownership strategy. Finally, the sixth section provides conclusions.

LITERATURE REVIEW The Costs of Doing Business Abroad The theoretical concept of the costs of doing business abroad was first developed in Hymer’s (1960/1976) dissertation. Building on earlier work on the barriers to entry

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to new firms, Hymer argued that multinational firms, because they were foreign, faced barriers to entry in a host-country market. MNEs, therefore, needed their own firm-specific advantages to overcome the “home-court” advantages of local firms.1 Hymer identified four types of foreign firm disadvantages (or domestic firm advantages) that could generate CDBA. First, foreign firms would have less information than domestic firms about the host country and needed to incur start-up costs of acquiring this information. Second, foreign firms could receive differential and worse treatment from the host-country government, buyers, and suppliers compared to domestic firms. Hymer expected this discriminatory treatment to persist over time, even after the firm established operations in the host country. Third, the firm’s home government could also generate differential treatment, for example, by prohibiting the firm (both the parent and its foreign affiliates) from engaging in certain activities or by levying more onerous taxes than local firms faced in the host country. Lastly, foreign firms would face foreign exchange risks because receipts and payments of foreign currencies were not synchronized, which local firms would not face.2 Hymer’s CDBA were over and above the costs faced by domestic firms in the host country. The costs were assumed to be mostly fixed (i.e. non-varying with output); they would decrease over time (but remain positive) the longer the MNE was in the host country. For the same revenue stream, this meant that the MNE would earn smaller profits than an equivalent domestic firm. This is illustrated in Fig. 1, in which the costs of doing business abroad are shown by the MNE’s average cost curve lying above that of local firms.3 Local firms earn profits shown

Fig. 1. Costs of Doing Business Abroad.

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by the shaded rectangle P0 bcd, whereas the MNE’s profits are only P0 bef; thus, the costs of doing business abroad are the rectangle of forgone profits, fecd. The MNE therefore needed a firm-specific advantage that either raised revenues (e.g. product patents, brand names) or lowered costs (e.g. economies of scale and scope) or both, to offset CDBA. Hymer’s argument was widely accepted,4 and international business research in the 1970s and 1980s focused not on CDBA, but on understanding firm-specific advantages. The costs of doing business abroad languished as a research area.

Liability of Foreignness Writing 20 years after Hymer, Doz (1980, p. 27) was perhaps the first to realize that the costs of doing business abroad involved two conflicting pressures on the MNE. The “economic imperative” pushed MNEs to integrate and rationalize their operations across countries, while the “political imperative” pushed MNE subsidiaries to tailor their operations to host-country demands. In responding to these conflicting pressures, Doz argued that MNEs could adopt a “worldwide integration strategy” or “national responsiveness” strategy, or could satisfice by choosing an in-between “administrative coordination” strategy. This integration-responsiveness matrix was subsequently developed in Bartlett and Ghoshal (1989), Doz and Prahalad (1984), and Prahalad and Doz (1987). Viewing the MNE as a network provided a new way to conceptualize CDBA through the integration-responsiveness lens. Ghoshal and Bartlett (1990) argued that in host countries with strong relational ties between suppliers, manufacturers, customers, and government (within-density pressures), MNE subunits would face intense pressures for isomorphism with their local environments. These pressures could cause conflicts in terms of internal legitimacy within the MNE network (across-density pressures). Furthermore, different firm-specific characteristics could be “explained in terms of selected attributes of the external network” in which the MNE subunit is embedded, underscoring differences across host-country environments (1990, p. 610).5 In a similar vein, Rosenzweig and Singh (1991) examined the costs associated with conflicting pressures to conform to the institutional demands of host countries yet also to coordinate closely with other MNE subsidiaries. Empirical work on the costs of doing business abroad started with Zaheer’s (1995) empirical study of the exit patterns of trading rooms of U.S. and Japanese banks. Treating CDBA and LOF as interchangeable, she organized LOF into four categories that paralleled Hymer (1960/1976): costs due to spatial distance (travel, transport, coordination), unfamiliarity with the local environment, differential treatment by the host country, and costs imposed by the home-country environment.

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Combining the global integration-national responsiveness matrix developed by Doz (1980) with an institutional perspective of the MNE (Rosenzweig & Singh, 1991), she argued that MNEs could reduce LOF by either transferring firm-specific advantages from their parents or mimicking the organizational practices of local firms. Zaheer (1995) found that firm-specific advantages were preferable to local isomorphism in terms of reducing exits. Zaheer and Mosakowski (1997) expanded this analysis to the exit patterns of all currency-trading rooms worldwide over a 20-year period. They found that exit patterns for MNEs were similar to those for domestic firms during the first 2 years and after 16 years of entry; in the middle period MNE exit rates were higher, suggesting that LOF exists but falls with in-country experience and eventually disappears. They concluded that LOF arose “mainly from the foreign firm not being sufficiently embedded in the information networks in the country of location” (1997, p. 445).6 Kostova and Zaheer (1999) applied institutional theory to the theory of the multinational enterprise, arguing that MNEs were rewarded for isomorphism with the local environment, receiving increased legitimacy, resources, and survival capabilities, whereas a failure to conform adversely affected their legitimacy. They suggested that host-country institutions lacked information about the MNE and would therefore use stereotypes and impose different criteria to judge MNEs. Moreover, MNEs faced different legitimacy standards compared to domestic firms, and in many instances, they were expected to do more than domestic firms with respect to “building their reputation and goodwill, in supporting local communities, and so on” (1999, p. 74). The costs involved in establishing and maintaining legitimacy placed foreign-owned firms at a competitive disadvantage. When operating in multiple countries, the challenges facing MNEs increased as complexities rose in the legitimating environment, organization, and process of legitimization. Recent empirical work has tested whether LOF is reflected in poorer performance by MNE subunits (Miller & Parkhe, 2002; Miller & Richards, 2002), high exit rates (Hennart et al., 2002), and increased lawsuits (Mezias, 2002b), compared to local firms. The studies find clear evidence that LOF reduces MNE performance and increases firm exits. However, Mezias (2002a), in his careful research design, points out the difficulties of appropriately testing the links between LOF and firm performance. In addition to work on LOF and firm performance, some researchers have focused on firm strategies to reduce the liability of foreignness. Buckley (1983, p. 48) noted that local knowledge should give domestic firms advantages, but relative only to first-time foreign investors, not to long-established multinationals. Gray argued that:

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[T]he disadvantage of being foreign wanes with the duration of being established in the host country and is largely eliminated by foreign direct investment (FDI) through acquisition. The Hymer postulate is still relevant for some young firms with ownership advantages that allow them to compete in niche markets, but for the well-established TNCs that now dominate international production in well-defined industries and product lines, it is no longer relevant (1996, pp. 51–52).

Zaheer and Mosakowski (1997, p. 458) agree that Hymer’s postulate presents a “rather static picture of both the costs of doing business abroad and of MNE competitive advantage, and is perhaps most useful at understanding the MNE at a point in time, such as at market entry.” Zaheer (2002, p. 353) notes that LOF is “inherently a dynamic concept” and that as the MNE subunit becomes more of an insider in the host country, LOF should fall and perhaps disappear. Petersen and Pedersen (2002), based on a survey of 494 MNEs from Sweden, Denmark, and New Zealand, show that managerial discretion is directly related to unfamiliarity hazards of LOF. MNEs with a global integration strategy (Doz, 1980; Prahalad & Doz, 1987) that discouraged local learning and adaptation remained unfamiliar with the local environment years after entry. Eden and Miller (2001) argued that mode-of-entry selection into the host country could be a way to reduce LOF; for example, selecting a local joint venture partner would reduce unfamiliarity costs and discriminatory treatment by the local government. Luo et al. (2002) argued that MNE strategies to cope with LOF should be separated into offensive strategies (local networking, resource commitment, legitimacy improvement, and input localization) and defensive strategies (contract protection, parental control, parental service, and output standardization). They examined the effects of local networking and contract protection on production and marketing costs and sales revenues of 92 MNEs in China. Their results showed that contracts reduced costs while local networking raised revenues; together, both reduced LOF and raised MNE profitability in the host country. Eden and Molot (2002) offer support for the effects of offensive and defensive strategies. In their case study of foreign MNEs in the Canadian automotive industry, the authors showed how first movers (the U.S. assemblers) used their firm-specific advantages and relation-building strategies to become insiders, effectively eliminating LOF. Their insider status was used to obstruct the entry and worsen the MNE-state bargains of latecomers (Japanese transplants). And, most recently, Nachum (2003) shows that firm-specific advantages and multinationality enabled foreign firms to outperform local firms in the London financial services industry. In 2002, Luo and Mezias guest-edited a special issue of the Journal of International Management on the liability of foreignness. LOF definitions varied across the papers in the volume. Luo and Mezias (2002, p. 218) argued that CDBA was a “precursor to LOF,” seeing the concepts as identical. Sethi and Guisinger

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(2002, p. 223), however, expanded LOF to encompass more than CDBA by including “the aggregated effect of the firm’s interaction with all elements of the international business environment.” In a “middle of the road” approach, Calhoun (2002, p. 305) agreed that LOF could be defined as “all additional costs to a firm related to operating in a distant location” (that is, as CDBA), but argued that these costs should be categorized into two groups. One set of costs is related to geographic distance; these costs can be anticipated and are finite. The second set of costs, Calhoun argued, is related to uncertainty and persists over time. These costs are at “the heart of every discussion of liability of foreignness.” Reading between the lines, LOF is therefore a subset of CDBA. Zaheer, in her commentary on the papers, raised the issue of whether CDBA and LOF were identical concepts. Contrary to her earlier work, she argued that the concepts were not the same; CDBA came from an economic approach to MNE theory, whereas LOF was grounded in socio-institutional analysis. “[W]hile the costs of doing business abroad focus on market-driven economic costs, I see the liability of foreignness as focusing on the more social costs of access and acceptance” (2002, p. 352). LOF, for Zaheer, involves costs associated with the firm’s network linkages (or lack thereof) in the host country and institutional distance between the home and host countries. Our view lies between that of Calhoun (2002) and Zaheer (2002); that is, we see LOF as the key component of CDBA. LOF stresses the social costs of doing business abroad, whereas CDBA includes both economic and social costs. These social costs arise from the unfamiliarity, relational, and discriminatory hazards that foreign firms face and domestic firms do not; such costs are inherently due to uncertainty and are likely to persist over time. We argue that the key driver behind LOF is the institutional distance (cognitive, normative, and regulatory) between the home and host countries. CDBA, however, is a broader concept that includes LOF but also includes economic activity-based (production, marketing, distribution) costs related to geographic distance. Since these economic costs related to value-adding activities by the MNE can be anticipated and measured, and may well be finite, the core issue for MNE managers remains liability of foreignness. We explore these arguments below.

DECONSTRUCTING THE COSTS OF DOING BUSINESS ABROAD In this section, we develop a new perspective on the costs of doing business abroad, one that incorporates liability of foreignness as its key component, but also includes economic-based costs. Our definition remains true to Hymer (1960/1976): CBDA

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measures all the additional costs faced by a home-country firm connected with its market-based (selling and/or buying) activities in a foreign country, relative to the costs faced by a local firm engaged in similar activities. These activities could be as minimal as exporting into a host-country market (where the local firm also sells in the host market) to the extensive activities involved in extraction and processing raw materials (where the local firm also extracts and processes).7 To phrase this more broadly: What are the “additional costs incurred by foreign firms in dealing with the same set of issues local firms deal with?” (Zaheer, 2002, p. 355). Drawing on our review of the CDBA and LOF literatures, we separate CDBA costs into two major categories: economic market-based activity costs and liability of foreignness.

Activity-Based Costs When a firm goes abroad, its value-adding activities in the host country can range from minimal to extensive. Consider exporting, for example. Assuming that manufacturing costs are the same in both countries (for simplicity), exporting involves higher freight, insurance, communication, and foreign exchange costs and trade barriers (tariffs, entry, and license fees) that are not faced by a local firm in the host country. If the MNE replaces exports with a local manufacturing plant in the host country, some of the distance-related costs are lower, but there are one-time costs of adapting the MNE’s technology and production methods to the host country and the additional costs of training local workers to use the MNE’s technology. Zaheer (2002, p. 351) refers to these costs as “market-driven costs”; this term, however, suggests that the motivation for entry is market-seeking. There are other motivations for going abroad including natural resource-seeking or knowledge-seeking where the value-adding activities may involve extraction and foreign purchases for export to the home country, rather than sales in the host country. The new literature on metanationals (Doz et al., 2001) argues that the core activity for MNEs in the 21st century is the sensing of knowledge in host countries, mobilizing the knowledge into innovative products and processes, and operationalizing their production and delivery throughout the MNE network. This suggests that knowledge-seeking activities, rather than market-seeking activities, are fundamental drivers of competitiveness. To cover the range of motivations for going abroad, we refer to economic costs as activity-based costs; these include transportation and communications costs, trade barriers, and costs associated with foreign exchange transactions. These costs are overwhelmingly economic and driven by geographic distance. As

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Calhoun (2002) argues, they can be anticipated and quantified. They have also become less important with the new information technologies and globalization in the 21st century.

Liability of Foreignness The second and, we argue, more important component of CBDA is liability of foreignness – being a “stranger in a strange land.” Following Zaheer (2002), we argue that LOF can be broken down into three hazards that affect foreign firms disproportionately to local firms in the host country. Unfamiliarity Hazards Unfamiliarity costs reflect the lack of knowledge of, or experience in, the host country, which places the foreign firm at a disadvantage compared to local firms. As Caves (1971, p. 5) argued: The foreign enterprise must pay dearly for what the native either has acquired at no cost to the firm (because it was part of the entrepreneur’s general education) or can acquire more cheaply (because, as it were, the native knows where to look).

Zaheer provided a good example of such information asymmetry and its likely impact on the competitiveness of host-country and foreign-owned firms: “German banks in Germany might have a better feel for whether the Bundesbank is going to lower Deutsche Mark interest rates within the next 24 hours than might British banks located in Germany” (1995, p. 344). This liability of foreignness is related not to the age of the MNE, but rather to the longevity of its experience in the host country. Short tenure in the host country causes unfamiliarity hazards, which are measured by the additional costs that the MNE must incur to achieve the same level of host-market knowledge as a local firm.8 Information can be earned by local production, investment in marketing, previous experiences in similar countries, taking on a local joint venture partner, and so on. Caves (1971, p. 13) argued that the additional costs of gathering information were fixed; that is, “they do not vary proportionately with the amount of resources that the firm might stake abroad.” Unfamiliarity hazards are therefore the type of additional costs shown in Fig. 1; they shift the foreign firm’s average cost curve upwards but do not change production levels. These costs of building market knowledge should disappear over time; however, Peterson and Pedersen (2002) show that they can persist in the long run if MNE managers follow a standardized global strategy and do not proactively engage in local learning.

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Discrimination Hazards The second component of liability of foreignness is the discriminatory treatment inflicted on the foreign firm relative to local firms in the host country. Discriminatory treatment can arise from differential treatment by the home or host governments, consumers, or the general public in the host country. These costs may reflect political hazards (Henisz & Williamson, 1999) or consumer ethnocentricity in the host country (Balabanis et al., 2001; Sumner, 1906). Discriminatory costs therefore focus on the challenges of obtaining external legitimacy. We contend that liability of foreignness is a two-way mirror: foreignness needs to be viewed both from the MNE’s perspective of the host country (outside-inside) and from the host country’s perspective of the MNE (inside-outside). Kostova and Zaheer (1999) asserted that liability of foreignness was based on the host-country’s unfamiliarity with the foreign firm (an inside-outside approach), resulting in stereotypes and higher standards being imposed on foreign firms.9 The MNE subunit’s lack of embeddedness in the host country relative to local firms led to discriminatory treatment by host-country stakeholders. Even if the MNE affiliate were guaranteed full national treatment under host-country laws, informal discriminatory treatment could occur if the affiliate were perceived and treated as an outsider.10 Relational Hazards All firms incur costs of organization (Masten et al., 1991), whether in the form of internal organization costs (intrafirm transactions) or external organization costs (external market transactions). Both sets of costs are expected to be higher for the firm operating in foreign countries; as Caves notes (1971, p. 6): “alien status always imposes some penalty on managerial effectiveness.” Anderson and Gatignon (1986) argued that MNEs faced a greater uncertainty than domestic firms, in terms of both external uncertainty (due to the unpredictability of foreign environments) and internal uncertainty (due to the difficulties of managing employees at a distance and from different cultures). These uncertainties create relational hazards in the form of higher administrative costs of managing the relationships between parties involved in doing business abroad (Buckley & Casson, 1998; Henisz & Williamson, 1999). From the perspective of intra-organizational relations, administrative (or, alternatively, governance) costs must be incurred in managing operations at a distance. Supervision and management of employees is a more difficult and opportunistic behavior (shirking) that is more likely as geographic distance increases (Hennart, 2001). MNEs face conflicting lines of authority and have multiple sources of value when operating in multiple countries (Sundaram & Black, 1992). Hitt et al. (1997, p. 773) argue that international diversification brings both benefits and costs. The

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costs (which they call “internal governance costs”) are generated by the increased transaction costs and managerial information-processing demands of managing high complex internationally diversified firms. Calhoun (2002) suggests that governance costs also rise with cultural distance because managerial motivations and goals vary across cultures. Parent firms’ routines are also likely to have a tacit component that is difficult to transfer to MNE subunits (Kostova, 1999; Kostova & Roth, 2002). Let us call these costs intra-organizational relational hazards, or intra-relational hazards for short. From the perspective of inter-organizational relations, additional costs of negotiating, monitoring, and dispute settlement are incurred with arm’s length modes (exports, licensing), whereas costs of trust building must be incurred with cooperative modes (joint ventures and alliances). Trust is a valuable contributor to many forms of exchange, reducing transaction costs in more uncertain environments (Doney et al., 1998). These costs are assumed to be ongoing, but decrease over time if the partners develop a trust-based relationship. Trust facilitates long-term relationships between firms (e.g. Ring & Van De Ven, 1992) and is critical to strategic alliance success (e.g. Gulati, 1995; Madhok, 1995). Moreover, interfirm cooperation lowers costs by reducing the incentive for opportunism and the need to protect against it by one or more of the involved parties (Hagen & Choe, 1998). We call these costs inter-organizational relational hazards, or inter-relational hazards for short. A distinction is required between inter-relational hazards and discriminatory hazards. Inter-relational hazards are firm-to-firm costs that affect external and quasi-external, cross-border internal and external transactions within the MNE’s buyer-supplier network. Discriminatory hazards affect the MNE’s relations with host-country stakeholders (the host-country government, consumers, and other firms). One set of hazards could influence the other; for example, discriminatory treatment by a host government might encourage a domestic licensee or joint-venture partner to become more opportunistic in its dealings with the multinational, so that political hazards encourage inter-organizational relational hazards (Henisz & Williamson, 1999). Nevertheless, we do see these costs as distinct from one another, which is consistent with the separation of public and private expropriation hazards in Delios and Henisz (2000). In summary, we have argued that the costs of doing business abroad can be split into two groups: economic market-based costs and liability of foreignness. The former costs can be anticipated and measured, and have decreased with globalization. LOF – the unfamiliarity, discriminatory, and relational hazards that create the added costs of being foreign – is the major barrier faced when firms enter host countries. We argue that a key driver behind these hazards is institutional distance between the home and host countries, to which we now turn.

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INSTITUTIONAL DISTANCE AND THE LIABILITY OF FOREIGNNESS Institutions are “the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interaction” (North, 1990, p. 3). Scott (1995, p. 33) elaborates on this definition by defining institutions as “cognitive, normative, and regulative structures and activities that provide stability and meaning to social behavior.” One of the underpinnings of institutional theory is that organizations are influenced by “common understandings of what is appropriate and, fundamentally, meaningful behavior” (Zucker, 1983, p. 105). Organizations are embedded in a broader institutional environment, and institutional theory underscores the ability of institutions to influence organizations to conform to practices, policies, and structures that are consistent with institutional preferences (Meyer & Rowan, 1977). In highly institutionalized environments, the structure of firms is strongly influenced by coercive isomorphism (formal pressure from other organizations), mimetic isomorphism (imitation of structures by other organizations in response to pressures), and normative isomorphism (conformance to normative standards established by external institutions) (DiMaggio & Powell, 1983). Thus, according to this school of thought, organizations subjected to the same environmental conditions are expected to have the similar structures. Many scholars have recognized the importance of national boundaries in the study of the organization and environment. In an early work, Lawrence and Lorsch (1967) addressed, to a limited degree, the challenges faced by MNEs, recognizing the importance of national boundaries in organizational environments. Meyer and Rowan (1977) indicated that there was variance across countries in their institutional environments. In the international domain, MNE researchers have adapted this “environmentally deterministic” perspective by positing that each foreign subsidiary of a MNE operates in a unique task environment, which constrains and influences the subunit’s activities (Rosenzweig & Singh, 1991; Westney, 1993). Kostova and Zaheer (1999) employed institutional theory to examine organizational legitimacy of MNEs, arguing that firms are rewarded for isomorphism with increased legitimacy, resources, and survival capabilities, whereas a failure to conform adversely affected MNE legitimacy. Their framework focused on the cognitive aspects of the liability of foreignness, arguing that the host-country environment lacked information about the MNE. As a result, the host country’s legitimating institutions used stereotypes and imposed different criteria to judge MNEs, which in turn served as targets for the host-country special-interest groups. They contended that “the host country legitimating environment typically has less information with which to judge an MNE entrant, thus could result in delays in legitimization, in continuing suspicion toward the MNE, and in scrutiny of the

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MNE to a much greater extent than that of domestic firms” (1999, p. 73). Moreover, MNEs could face different legitimacy standards compared to domestic firms and in many instances, they were expected to do more than domestic firms with respect to “building their reputation and goodwill, in supporting local communities, and so on” (1999, p. 74). The fact that institutions matter and differ between countries suggests the importance of a theoretical link between institutional distance and MNE strategies. Building on Scott’s definition, Kostova (1996) defined institutional distance between two countries as the degree of difference/similarity between the regulatory, cognitive, and normative institutions of two countries. Institutional distance has been used to explain MNE behavior in terms of building organizational legitimacy in host countries (Kostova & Zaheer, 1999), the transfer of organizational practices from the parent to its subsidiaries (Kostova, 1999; Kostova & Roth, 2002), and location decisions and mode-of-entry strategies (Xu & Shenkar, 2002). The larger the institutional distance between home and host countries, the greater the pressures on the MNE for local responsiveness (Doz, 1980; Prahalad & Doz, 1987), but the more difficulty the MNE has building external legitimacy (Kostova & Zaheer, 1999). At the same time, as institutional distance increases, practicing a global integration strategy becomes more problematic because transferring strategic routines between the parent firm and its subsidiaries becomes more difficult (Kostova & Roth, 2002). Thus, as institutional distance increases, the conflicting pressures for local responsiveness and global integration become stronger (Doz, 1980; Prahalad & Doz, 1987). Institutional distance can be different for each institutional “pillar”: regulatory, normative, and cognitive. The regulatory pillar deals with the “setting, monitoring and enforcing of rules” (Xu & Shenkar, 2002, p. 610), and it reflects “existing laws and rules in a particular national environment which promote certain types of behaviors and restrict others” (Kostova, 1997, p. 180). The regulatory pillar therefore sets out prescriptive (“may”) and proscriptive (“may not”) behaviors, and applies rewards and sanctions for compliance with these pre/proscriptions. The regulatory pillar in host countries is perhaps the easiest for foreign firms to observe, understand, and correctly interpret because regulatory institutions are codified and formalized in rules and procedures. Regulatory institutions create coercive isomorphism pressures for adoption of social patterns (Kostova & Roth, 2002, p. 217). In terms of multinational strategies, host-country regulatory institutions create pressures for local responsiveness to which MNE subunits must conform to achieve external legitimacy. Such pressures come at the cost of global integration (Doz, 1980; Prahalad & Doz, 1987). The normative institutional pillar consists of “social norms, values, beliefs, and assumptions about human nature and human behavior that are socially shared and

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are carried by individuals” (Kostova, 1997, p. 180). The normative pillar is “rooted in societal beliefs and norms” and “prescribes desirable goals and the appropriate means of attaining them” (Xu & Shenkar, 2002, p. 610). The normative pillar specifies how things should or should not be done, reflecting the values and norms of society. Such informal prescriptions and proscriptions are often culturally driven, tacit understandings that are opaque to outsiders. Public sector corruption is an example of an informal normative institution (Calhoun, 2002; El Said & McDonald, 2002). Normative institutions are tacit, “deep structures” of a country that are difficult to sense and interpret, particularly by outsiders (Kostova & Zaheer, 1999). Higher normative institutional distance should therefore be positively related to liability of foreignness, creating normative isomorphic pressures to conform to host-country practices. The cognitive institutional pillar affects the “schemas, frames, and inferential sets, which people use when selecting and interpreting information . . . it reflects the cognitive structures and social knowledge shared by the people in a given country” (Kostova, 1997, p. 180). Cognitive institutions affect “the way people notice, characterize, and interpret stimuli from the environment” (Kostova, 1999, p. 314) in terms of national symbols, stereotypes, key sectors, and so on. As cognitive institutional distance rises, liability of foreignness increases for MNEs, heightening the pressures for national responsiveness by conforming to host-country practices. We interpret the difference between the regulatory and normative pillars as follows: while the regulatory pillar defines what organizations and individuals “may or may not do” (where “may” implies permission), the normative pillar defines what they “should or should not do.” The cognitive pillar defines what “is or is not true” and what “can or cannot be done” (where “can” implies ability). Thus, the three institutional pillars are akin to three verb tenses: may/may not (regulatory), should/should not (normative) and can/cannot (cognitive). Institutional distance can explain the dual pressures faced by the MNE for global integration and local responsiveness (Xu & Shenkar, 2002). First, consider the pressures for local responsiveness. Kostova and Zaheer (1999) argued that the cognitive pillar lies between the regulatory and normative pillars in terms of tacitness, and that liability of foreignness is more affected by cognitive and normative institutions than by the regulatory institutions. In all three cases, institutional distance increases liability of foreignness and the need for local responsiveness to host-country institutions, creating pressures for local isomorphism. Regulatory institutional distance creates pressures for coercive isomorphism, normative for normative isomorphism, and cognitive for mimetic isomorphism (Kostova & Roth, 2002, p. 217). Second, consider the pressures for global integration. Normative institutional distance is probably more important than either regulatory or cognitive in

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explaining the difficulties of transferring MNE practices from the parent firm to its subunits (or vice versa; Kostova, 1999; Xu & Shenkar, 2002). MNEs should be reluctant to transfer practices that are illegal in the host country (regulatory distance) or where the local employees would have obvious difficulties learning the practice (cognitive distance). However, because of its tacitness, normative distance suggests that MNE practices could appear to be transferable at low cost, whereas, in fact, different cultural assumptions and value systems mean that normative distance is much higher than it appears. Thus, the greater the normative distance between the home and host countries, the greater the difficulty faced by the MNE in implementing and maintaining a global strategy (Xu & Shenkar, 2002).

INSTITUTIONAL DISTANCE, LIABILITY OF FOREIGNNESS, AND OWNERSHIP STRATEGY We now integrate these theoretical strands explained above and explore the linkages between institutional distance, the costs of doing business abroad (more particularly, the liability of foreignness), and the MNE’s ownership strategy. Peng (2002, p. 251) argues that an institution-based view of business strategy can explain “why strategies of firms from different countries and regions differ.” We focus our analysis on one of the most important of the MNE’s strategies, the mode of entry decision, which we operationalize as the percentage of equity ownership held by the MNE (where 0% represents exporting and 100% a greenfield, wholly owned subsidiary), with or without a local partner. Perhaps the most comprehensive work linking the economic costs of doing business abroad to the firm’s mode of entry decision is Buckley and Casson (1998). They outlined four types of CDBA (although they did not use the term): (1) a net cost of home production relative to foreign production; (2) a one-time cost of learning about the foreign market; (3) transaction costs if the mode of entry is arm’s length (costs of monitoring, dispute settlement, opportunistic behavior, etc.) or cooperative (trust-building costs); and (4) a one-time net cost of adapting a foreign production facility to the firm’s technology if foreign production involves a local firm. Using basic assumptions regarding these costs and holding the host-country environment constant, Buckley and Casson predicted the most likely modes of entry and analyzed how cost changes could affect the entry choice. Their analysis, however, is primarily a microeconomic approach to the costs of doing business abroad, with less attention paid to socio-institutional factors that affect liability of foreignness considerations. Some work has been done using an institutional approach to the firm’s mode of entry decision. Davis et al. (2000) argue that, in order to achieve legitimacy

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in the host country, the MNE must conform to host-country institutional norms. Local adaptation pressures made it difficult for the MNE subunit to achieve parent isomorphism. Thus, tensions between local responsiveness and global integration affect the MNE’s mode of entry decision. Based on surveys of U.S.-based firms in the pulp and paper industry, the authors found that wholly owned subsidiaries have a higher parent isomorphism than other entry modes, whereas exporters have a higher host-country isomorphism. When external and internal pressures were both low, the firms used mixed entry modes. The degree to which countries rely on formal or informal institutions can also affect market entry strategies. El Said and McDonald (2002) hypothesize that OECD countries have impersonal exchange systems with strong third-party enforcement mechanisms (regulatory institutions); transition and emerging market economies, however, tend to have weak formal institutions and therefore rely more heavily on informal institutional enforcement procedures (e.g. networks, trust, hostages). Where informal constraints were more important than formal constraints, the authors hypothesized that firms were more likely to take a local partner (equity joint venture or subcontracts to intermediaries), and their interviews with foreign managers in Jordan supported this hypothesis. Most recently, Xu and Shenkar (2002) applied the concept of institutional distance and its three pillars to the MNE’s location and mode-of-entry strategies. In terms of mode of entry, they argue that the higher institutional distance, in general, the lower the preferred level of equity control and commitment because of the twin difficulties of obtaining external legitimacy in the host country and transferring managerial practices to the MNE subunit. To this point, we have not addressed the linkages between institutional distance and the MNE’s choice between acquisition and greenfield investment. Studies have concluded that MNEs tend to prefer greenfield investments over acquiring local firms when institutional differences between countries are pronounced (e.g. Kogut & Singh, 1988) because acquisitions accentuate these differences (Barkema & Vermeulen, 1997). For example, when normative institutional distance is high, it is more difficult to transfer organizational practices to an acquired local subsidiary, especially when the practices of local firms are institutionalized in the host-country environment. In contrast, local employees in a greenfield subsidiary should be more receptive to adopting the MNE parent’s practices. Moreover, when the cognitive institutional distance is high, acquisitions are viewed as “takeovers” and a “blow to national sovereignty” from the local market’s perspective (Xu & Shenkar, 2002, p. 613), discouraging acquisition in favor of greenfield entry. When the institutional distance is low, both acquisition and greenfield investment become more attractive (Xu & Shenkar, 2002). The choice, in such situations, therefore turns on other factors. For example, Zejan (1990) found that when

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market growth was high, foreign firms prefer greenfield investment. In addition, industry concentration has been shown to increase the likelihood of greenfield investment (Hennart & Park, 1993; Shaver, 1998).11

Institutional Distance and Ownership Strategy We turn now to integrating these ideas into a model linking institutional distance, liability of foreignness and the MNE’s ownership strategy. We start from the premise that, holding revenues constant, the multinational enterprise should select the ownership strategy (i.e. the percentage of equity ownership) that minimizes the additional costs of doing business abroad; that is, the sum of activity-based costs, unfamiliarity hazards, discriminatory hazards, and intraand inter-relational hazards. As we argued above, economic activity-based costs are affected primarily by geographic distance and choice of production location. They can be measured and anticipated. Therefore, it is the costs associated with avoiding unfamiliarity, discriminatory, and relational hazards that principally drive the MNE’s ownership strategy. These costs are the components of liability of foreignness. We have argued above that LOF is driven by institutional distance; thus, LOF mediates the relationship between institutional distance and the MNE’s ownership strategy. The greater the institutional distance, the greater the liability of foreignness and the more likely the MNE is to select an intermediate ownership strategy.12 Our model of these relationships is illustrated in Fig. 2, and these relationships are explored below. We start with a basic proposition linking overall institutional distance, through its effects on liability of foreignness, to the MNE’s ownership strategy. Xu and

Fig. 2. Institutional Distance, Costs of Doing Business Abroad, and Ownership Strategy.

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Shenkar (2002) argue that the higher institutional distance, the lower the preferred level of equity because of the difficulties of obtaining external legitimacy in the host country and transferring managerial practices to the MNE subunit. MNEs that enter distant markets typically choose lower levels of commitment and resources (Anderson & Gatignon, 1986), preferring joint ventures to wholly owned subsidiaries as an entry mode. Where perceived institutional distance is higher, MNEs favor entry modes with low resource commitments (Hill et al., 1990). Therefore, Proposition 1. As institutional distance increases between the home and host countries, the MNE is more likely to choose a low ownership strategy, ceteris paribus.

Regulatory Distance and Ownership Strategy Regulatory distance measures the difference between home and host countries in terms of the setting, monitoring and enforcement of rules. Within developed countries, regulatory frameworks have become more homogeneous due to globalization pressures, regional integration schemes, and international institutions such as the World Trade Organization and the OECD. Even in developing countries, the ability of governments to force capricious, unilateral policy changes on MNEs has been substantially curtailed by the web of bilateral investment and double tax treaties, membership in international organizations, and structural adjustment constraints imposed by the World Bank and International Monetary Fund (Ramamurti, 2001). In addition, almost all national policy changes affecting MNEs since 1990 have been liberalizing (UNCTAD, 2003). Only in key sectors where local cognitive symbolism is high (e.g. petroleum in Mexico) are there still regulations restricting foreign equity ownership. However, government regulations can also indirectly affect ownership strategy. For example, lack of intellectual property rights protection heightens interrelational hazards of opportunistic behavior by local partners, thereby discouraging intermediate equity modes in favor of either exporting or wholly owned subsidiaries (Xu & Shenkar, 2002). Missing property rights also encourage corruption in the form of counterfeiting and intellectual piracy. MNEs are therefore more likely to choose either arm’s length contracts or 100% equity ownership (where there is no regulatory ceiling on equity share) to protect their property rights. Therefore, Proposition 2. As regulatory institutional distance rises between the home and host countries, the MNE is likely to avoid intermediate ownership strategies in favor of either a low (contractual) ownership or high (100%) ownership, except where high ownership is prohibited by host-country regulations, ceteris paribus.

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Normative Distance and Ownership Strategy Normative institutional distance reduces the MNE parent’s ability to transfer practices effectively to the MNE subunit, which raises the intra-relational costs of managing operations at a distance. In addition, normative institutional distance reduces the ability of a foreign entrant to understand host-country institutional guidelines (Kostova & Zaheer, 1999), and so unfamiliarity hazards should be higher across all modes of entry. Normative distance increases the challenges for the MNE subunit to establish and maintain external legitimacy, thus increasing the probability of discriminatory treatment (Kostova & Zaheer, 1999). Therefore, we expect unfamiliarity, discriminatory, and inter- and intra-relational hazards all to increase with normative institutional distance. These hazards favor lower equity modes, in particular, sharing equity with a local partner. Proposition 3. As normative institutional distance rises between the home and host countries, the MNE is more likely to choose an intermediate ownership strategy, ceteris paribus.

Cognitive Distance and Ownership Strategy Cognitive institutions represent “the way people notice, characterize, and interpret stimuli from the environment” in terms of national symbols and stereotypes (Kostova, 1999, p. 314). Cognitive institutional distance facing the MNE should therefore come primarily in the form of national symbols and stereotypes. Kostova and Zaheer (1999) suggested that foreign firms could incur stereotyping by host-country institutions due to their unfamiliarity with outsiders. Cognitive institutions are affected by the way domestic firms and consumers interact and how they view foreigners. We provide four examples. Consumer Ethnocentrism We argue that the degree of stereotyping by host-country institutions should depend on the level of ethnocentrism in the host country (Balabanis et al., 2001). Ethnocentrism reflects an unfavorable perception of outsiders and favorable perception of insiders (Sumner, 1906). Balabanis et al. (2001, p. 60) suggested that the consequences of this bias range from maintaining and forming stereotypes to “genetic superiority.” We infer that high levels of ethnocentrism result in stronger, more intense stereotyping against outsiders or favoritism of insiders. We contend that higher levels of ethnocentrism are associated with higher discriminatory hazards for all

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modes of entry. As a result, the MNE should be more likely to want a local partner in order to attenuate anti-foreign sentiments. As ethnocentrism increases in the host country, inter-relational hazards may also increase because of challenges associated with establishing trust with local entities (Williams, 2001). The issue for the MNE is to find a suitable local partner that does not share this ethnocentrism, but still engenders the respect and support of other locals. For MNEs that choose to operate in countries with high consumer ethnocentrism, more than likely, the firm will need to use an exporting strategy for a foreign subsidiary rather than a local market strategy. In this scenario, we anticipate that the benefits of having a local partner should offset the greater relational hazard. The size of the MNE may be important here. Firm size provides advantages such as financial strength, market power, and a strong reputation that should lower discriminatory hazards and encourage the MNE to opt for a wholly owned subsidiary. With size, however, comes increased visibility and a higher probability of being targeted by special interest groups, making it more difficult for the MNE to maintain external legitimacy (Kostova & Zaheer, 1999). In high ethnocentric countries, the likelihood of consumer reaction increases, raising the liability of foreignness and the need for a local partner. Therefore: Proposition 4. The higher the level of consumer ethnocentrism in the host country, the greater the cognitive institutional distance and the more likely the MNE is to choose an intermediate ownership strategy, ceteris paribus. Country-of-Origin Effects In some environments, being perceived as foreign may be an advantage, not a disadvantage (Bilkey & Nes, 1982; Nagashima, 1977). French wine and Swiss watches are common examples of products that have country-of-origin advantages. These advantages may disappear if the MNE sets up a joint venture and moves production to the host country. For example, Miller (a U.S. beer producer) had the rights to distribute Lowenbrau in the U.S. Because demand outstripped supply, Miller renegotiated its contract with Lowenbrau and began to brew the beer in Texas. However, sales decreased once production shifted to the U.S. because the beer lost its image as a premium import from Germany (Griffin & Pustay, 1999). In such cases, licensing is preferable to a joint venture because it avoids local production (retaining the cachet of foreignness) while assisting with transfer of local-market knowledge to the MNE (reducing unfamiliarity and discriminatory hazards). Therefore: Proposition 5. Where country-of-origin effects are strong and viewed positively by host-country consumers, the MNE benefits from foreignness; thus, the

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greater the cognitive institutional distance based on country-of-origin, the more likely the MNE is to use a low ownership strategy, ceteris paribus. Social Embeddedness of Local Firms We argue that embedded social networks of firms in host countries increase the cognitive institutional distance for foreign firms. Social embeddedness reflects the degree to which economic transactions take place through social relationships and networks of relationships that use social and non-commercial criteria to govern business dealings (Marsden, 1981). The importance of “in-group” association that leads to differences in the treatment and perception of outsiders relative to insiders is fundamental to this perspective (Tajfel & Billig, 1974). Research suggests that embeddedness becomes more of an issue for foreigners that enter relationship-driven markets (Bhappu, 2000; Uzzi, 1997). Bower (1987) concluded that Japanese firms forged strong ties that led to high entry barriers. Similarly, Granovetter (1973) found that tight relationship linkages between host-country insiders led to exclusion of organizations that were unable to establish comparable ties. High embeddedness of local firms increases the distinction between insiders and outsiders, raising cognitive institutional distance, and increasing discriminatory hazards. Local embeddedness can also be a barrier to the sharing of information, increasing unfamiliarity hazards for foreign firms. Thus, external legitimacy is likely to be problematic for an MNE subunit unless it has a local partner; however, building trust with firms that are already embedded in another set of relationships should also be difficult. Therefore: Proposition 6a. The higher the social embeddedness of local firms, the greater the cognitive institutional distance and the more likely the MNE is to choose an intermediate ownership strategy, ceteris paribus. Scholars have suggested that trust in cross-border business relationships is especially prevalent in Oriental cultures, which tend to exhibit a high collectivism and long-term orientation that, in turn, is integrated into managerial decision-making and affects the country’s business environment (Hofstede, 1980). As a result, social embedded ties between organizations are quite common (Egelhoff, 1984; Ouchi, 1980). These ties, which are based on “strong mutual monitoring and sanctioning” (Yamagishi, 1988, p. 217), or what some scholars have deemed deterrent-based trust (Gulati, 1995), reduce costs and risk, facilitate communication, ensure trust and reliability (e.g. Gerlach, 1992), and consequently reduce the need for control. Researchers have concluded that the Japanese interorganizational system can be transplanted effectively to other countries (Hagen & Choe, 1998; Nishiguchi,

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1994). An MNE accustomed to building trust in business relationships at home is inclined to better understand information sharing and operate more effectively abroad. Empirical studies have concluded that firms with home-country socially embedded ties are inclined to use less equity ownership in different host-country environments (Sohn, 1994). Therefore: Proposition 6b. If local firms in both the home and host countries exhibit a high local social embeddedness, the MNE is more likely to choose a lower ownership strategy compared to the case where only host-country firms exhibit high social embeddedness, ceteris paribus. Proportion of Foreign to Local Firms The mix of foreign to local firms in the host country can also affect cognitive institutional distance. Anderson and Gatignon argued that the presence of foreign MNEs encouraged local workers to “obtain a business education abroad, which in turn, can reduce problems associated with sociocultural distance and reduce the level of ethnocentrism in the host country” (1986, p. 200). As the number of foreign firms in a host country increases, the host country has more information by which to evaluate new entrants so unfamiliarity and discriminatory hazards, from the host-country perspective, should be lower. Zaheer and Mosakowski (1997) found that as the balance of foreign to local trading rooms increased in a host country, the liability of foreignness declined, and the longevity of both domestic and foreign firms increased. This suggests that the MNE should be willing to take on a higher equity mode the greater the ratio of foreign to local firms in the host country. However, as the proportion of foreign to domestic firms rises in a politically salient industry (e.g. petroleum, autos, banking), further entry can cause a backlash against foreign firms because of the perceived violation of national symbols. This backlash is likely to harm new entrants the most because of their lack of external legitimacy. Thus, the relationship between the ratio of foreign to local firms and cognitive institutional distance may be U-shaped, falling initially as early entrants ease the way for latecomers, but eventually rising as host-country residents become concerned about the proportion of national assets held by outsiders. Therefore: Proposition 7. As the proportion of foreign to domestic firms rises in the host country, cognitive institutional distance decreases, making the MNE more likely to choose a high ownership strategy; however, this effect is weaker for nationally sensitive industries and weakens (and could reverse) as the percentage of foreign to domestic firms continues to increase, ceteris paribus.

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Mixed-Distance Effects on Ownership Strategy Some phenomena include more than one type of institutional distance and therefore should have more complex effects on the MNE’s ownership strategy. We propose two examples: cultural distance and corruption distance. Cultural distance primarily involved normative and cognitive institutional distance (informal constraints). Corruption distance, however, involves regulatory and normative distance; that is, a mix of formal and informal constraints. We discuss each briefly below. Cultural (Cognitive and Normative) Distance Cultural distance is closely related to the two institutional pillars: normative and cognitive. Culture has a cognitive aspect, “the collective programming of the mind that distinguishes the members of one category of people from those of another category” (Hofstede & Bond, 1988, p. 6). Culture also has a normative aspect because society’s values and attitudes are part of a culture’s characteristics. Cultural distance can therefore be closely proxied by an increase in normative and cognitive institutional distance. As cultural distance increases, we expect the primary effect to be increased unfamiliarity, in terms of the MNE’s knowledge of the host country and vice versa. Discriminatory hazards may also rise, but we anticipate that the primary impact of cultural distance will be to heighten unfamiliarity hazards, therefore increasing the need for a partner that understands the local environment. If the tacit component of the normative and cognitive pillars is low (that is, cognitive frames and social values can be learned), unfamiliarity hazards should decrease with time and, once the MNE has incurred the one-time costs of learning about the host-country environment from its partner, we expect the MNE to acquire the local partner. Thus, an equity joint venture should be the preferred – but short-term – ownership strategy when the cultural distance is high. In the long term, the MNE should prefer to acquire the local partner’s share of the equity joint venture. Barkema et al. (1996) pointed out that equity joint ventures incur doublelayered acculturation, requiring adaptation not only to the local environment but also to the culture of the partner. They suggested that culture distance should make alliances shorter-lived. However, empirical evidence suggests that they are preferred to wholly owned subsidiaries for entering countries that are culturally distant (Barkema & Vermeulen, 1997; Kogut & Singh, 1988). We can resolve this paradox once we recognize that cultural distance raises unfamiliarity hazards, which typically are temporary. Thus, an equity alliance with a local partner is an optimal, but short-run, solution to increased cultural distance. There are, however, exceptions. Kostova and Zaheer (1999) argue that the normative pillar is more tacit in nature than the cognitive pillar. This suggests that

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where cultural distance is primarily driven by differences in normative systems, unfamiliarity hazards do not necessarily diminish with experience in the host country so that a local partner may continue to have value for the MNE. However, where cultural distance is primarily driven by differences in cognitive institutions, joint ventures will be short-lived. Therefore: Proposition 8a. Where cultural distance is driven primarily by differences in cognitive institutions between the home and host countries, the greater the cultural distance, the more likely the MNE is to choose an intermediate ownership strategy; however, this choice is expected to be short term in nature with the MNE later acquiring the local partner’s share, ceteris paribus. Proposition 8b. Where cultural distance is driven primarily by differences in normative institutions between the home and host countries, the greater the cultural distance, the more likely the MNE is to choose an intermediate ownership strategy, in the short- and long term, ceteris paribus. Our analysis runs contrary to Xu and Shenkar (2002, p. 2002) who argue that “the inconsistent results reported for cultural distance’s impact on foreign investment launch, entry mode and performance show that it may be too narrow a construct to capture the decisions of firm-level actors.” If cultural distance is a mixture of normative and cognitive distance, the inconsistent results may be caused by the reverse effect, that cultural distance is too broad a construct, not too narrow. As our argument shows, ownership strategy depends on whether cultural distance is primarily driven by normative or cognitive institutional distance. Corruption (Regulatory and Normative) Distance Public sector corruption is another example of how institutional distance can affect liability of foreignness and the MNE’s entry-mode choice. Rodriguez et al. (in press) and Doh et al. (2003) argue that corruption has two key characteristics. The first characteristic, pervasiveness, is the probability of a firm’s encountering corruption in its interactions with government officials and policy-makers. In a country with highly pervasive corruption (China, Mexico, or Nigeria, for example), bribery extortion is regular, predictable, effective and akin to a tax. There are few regulatory institutions to deter corruption, and corrupt behavior pervades societal norms and values (Calhoun, 2002). The second characteristic, arbitrariness, is the degree of ambiguity or uncertainty associated with corrupt transactions, which makes them less transparent and less predictable in terms of payments and outcomes. In a country with highly arbitrary corruption (Hungary, Malaysia, or Namibia, for example), firms face enormous uncertainties and complexities, in terms of the incidence, predictability, and outcomes of corruption.

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In many transition and emerging market economies, corruption is both pervasive and arbitrary, as, for example, in India, Indonesia, or Russia. Firms are likely to comply with pervasive corruption, Oliver argues, because “[w]hen institutional rules or norms are broadly diffused and supported, organizations will be predicted to acquiesce to the pressures because their social validity is largely unquestioned” (1991, p. 169). Pervasive corruption is an informal institutional constraint where bribery is socially acceptable. In order to achieve organizational legitimacy in the host country, the MNE must comply with the state’s pressures to pay bribes and is likely to do so unless the home country prohibits such practices by its MNEs and their subsidiaries. The Foreign Corrupt Practices Act in the U.S. has severely restricted the ability of U.S. multinationals to pay bribes to corrupt foreign governments. However, until their governments signed the new OECD Anti-Bribery Convention, U.K. and German MNEs were free to pay bribes and, in fact, could deduct them as a cost of doing business abroad against their home-country income tax. In terms of the mode-of-entry decision, Rodriguez et al. (in press) argue that pervasive corruption does not encourage taking on a local partner because a local partner can neither reduce the required bribes nor increase the MNE subunit’s external legitimacy. Once the MNE overcomes the short-term unfamiliarity hazards of operating in a pervasively corrupt economy, the authors argue that bribe payments become routine and anticipated; as a result, the MNE can choose a wholly owned subsidiary for an entry mode without adversely affecting external legitimacy. Only where arbitrariness of corruption is high does a local partner become valuable as a method for reducing the unpredictability of corruption. As both dimensions of corruption increase, the MNE should rely more heavily on local firms for insider knowledge and legitimacy. The exception to this case occurs where home regulations prohibit offering bribes. In such situations, Rodriguez et al. (in press) argue that MNEs are more likely to use low equity modes or arm’s length intermediaries in the host country to avoid home-country penalties. We define corruption distance as the difference in the pervasiveness and arbitrariness of public-sector corruption between the home and host countries. Corruption distance could be high on either pervasive or arbitrary dimensions or both. In terms of the pervasiveness dimension, corruption distance depends on differences in both normative institutions and regulatory institutions. Pervasive corruption is based on strong informal institutions where societal norms and values have a high tacit component. In addition, regulatory institutions to monitor and punish corruption should be weak or missing in pervasively corrupt societies. Offsetting the weak regulatory institutions in host countries is the fact that home country regulations against bribery in host countries were also missing for most countries,

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other than the U.S., until recently.13 This suggests that pervasive corruption is driven more by differences in the normative than the regulatory institutional pillar for MNEs from most countries. In this case, the tacitness of pervasive corruption does not dissipate with longevity in the host country, and the value of taking on a local partner to reduce unfamiliarity and discriminatory hazards increases. This case was not considered by Rodriguez et al. (in press). We therefore modify their result as follows: Proposition 9a. Where pervasive corruption distance is driven primarily by differences in regulatory institutions, the higher the pervasive corruption distance, the more likely the MNE is to choose a high ownership strategy, except where high ownership is prohibited by host-country regulations, ceteris paribus. Proposition 9b. Where pervasive corruption distance is driven primarily by differences in normative institutions between the host and home countries, the higher the pervasive corruption distance, the more likely the MNE is to choose an intermediate ownership strategy, ceteris paribus. Where corruption distance is high on the arbitrariness dimension, the tacitness and opacity of corruption reflect a high degree of uncertainty and unpredictability. In such cases, belonging to a local supplier-buyer network can be an important buffer against random, arbitrary treatment by government officials and other firms. Relation-based contracting with groups or networks that have shared values and informal enforcement mechanisms can shield firms from arbitrary corruption (El Said & McDonald, 2002). In transition economies with weak or missing regulatory institutions, relation-based contracting can overcome institutional uncertainties (Peng, 2003). This suggests the MNE has a strong need for a local partner to penetrate local networks and lessen the risk of random, discriminatory treatment from arbitrary corruption, but at the same time, inter-organizational relational hazards should also be high. Despite these inter-relational hazards, a local partner should be the preferred ownership strategy when local embeddedness is high. Moreover, where embeddedness of local networks is an ongoing phenomenon, the MNE should be less inclined to acquire its local partner for fear of increased discriminatory hazards following the acquisition. Therefore, Proposition 10. The higher the arbitrary corruption distance between home and host countries, the more likely the MNE is to choose an intermediate ownership strategy, in the short- and long term, ceteris paribus.

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DISCUSSION AND CONCLUSION The concept of the costs of doing business abroad (CDBA) is well known in the international business literature, measuring the disadvantages or additional costs borne by multinational enterprises that are not borne by host-country local firms. Recently, international management scholars introduced a second concept, liability of foreignness (LOF). There has been confusion in the two literatures about the relationship between CBDA and LOF, as evidenced in a recent special issue on liability of foreignness (Journal of International Management, 2002). In this paper, we have tried to sort out the differences by arguing that LOF stresses the social costs of doing business abroad, whereas CDBA includes both economic and social costs. These social costs arise from the unfamiliarity, relational, and discriminatory hazards that foreign firms encounter over and above those faced by local firms in the host country. CDBA, however, is a broader concept that includes LOF but also includes economic activity-based costs related to geographic distance. Because these market-related costs are well understood, finite, and can be anticipated, LOF becomes the core strategic issue for MNE managers. We argued that the key driver behind LOF was institutional distance and its three pillars (cognitive, normative, and regulatory) between the home and host countries. We explored the ways in which institutional distance could affect liability of foreignness. We then operationalized our arguments by showing how institutional distance and liability of foreignness could provide an alternative explanation for the MNE’s ownership strategy. Our paper contributes to the growing literature on institutional distance, liability of foreignness, and strategies of multinational enterprises. We carefully explored the differences between the costs of doing business abroad and the liability of foreignness, arguing that LOF was the core (but not the only) component of CDBA. We showed how the three institutional pillars (regulatory, normative, and cognitive) could be conceptualized as forms of institutional distance and explored the impact of each type of distance on the liability of foreignness and the MNE’s ownership strategy choice. We also examined two mixed forms of institutional distance: cultural distance (which, we argued, could be broken down into normative and cognitive institutional distance) and corruption distance (which could be broken down into regulatory and normative institutional distance). We linked our analysis to the pressures for global integration and local responsiveness in the international strategy literature. Our analysis supports the argument that liability of foreignness is driven mostly by normative and cognitive institutional distance and that, because of their tacitness, MNEs may continue to need local partners to achieve external legitimacy in host countries. We explored some implications of our analysis for MNEs entering transition and emerging market economies.

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At this stage of theory development, it may be premature to discuss the managerial consequences of our model. Nevertheless, we highlight a few issues. First, in this conceptual framework, we assumed that an MNE can achieve external legitimacy, at some cost. However, MNE managers need to recognize that in some institutional environments, outsiders can approach, but may never achieve, legitimacy in the environment. Francis (1991) argued that being isomorphic did not necessarily translate into gaining acceptance. Adapting to local practices could be based on the faulty assumption that “what works for locals will work for foreigners,” a perspective destined to fail if local residents view foreigners as outsiders, regardless of their behavior. The same differentiation holds true for foreign firms operating in the host country. They may gain some degree of legitimacy but never achieve insider status. Second, access to local knowledge is an important reason why MNEs choose a local equity partner over a wholly owned subsidiary. It is important to note that the rate of knowledge acquisition is in the firm’s control and is a necessary condition to shift from a joint venture to a wholly owned subsidiary (Inkpen & Beamish, 1997; Petersen & Pedersen, 2002). Another issue is that there can be substantial variation across countries with respect to institutional distance between home and host countries. Our hypotheses tend to reflect the ownership strategies of MNEs from industrialized countries. For example, market structures in OECD countries have impersonal exchange systems and strong third-party enforcement mechanisms (laws, courts, regulatory agencies), and therefore have strong, formalized institutional structures. Transition economies and many emerging market economies, however, with missing or weak formal regulatory institutions, rely on informal institutions to facilitate exchange (El Said & McDonald, 2002; Hoskisson et al., 2000; Peng, 2002). In this paper, we have focused on institutional distance in an absolute value sense, ignoring whether the home or host country has stronger institutions and how this might affect liability of foreignness and the MNE’s ownership strategy. We leave this to future research. Lastly, our research should be extended to empirical analysis. The propositions developed in this paper are testable. Entry-mode choice can be captured with a dichotomous variable, or by percentage of equity ownership. Measures for the three institutional pillars can be constructed. Shimp and Sharma (1987) have developed scales to measure consumer ethnocentrism. Chao’s (1993) questionnaire can be used to measure country-of-origin effects. Embeddedness of local firms can be operationalized by adapting Dodwell Marketing Consultants’ (1994) indicator of “tie strength” in Japanese industrial groups or a Herfindahl index, which Baker (1994) showed can be used to measure the mix of different types of ties in a firm’s network. Rodriguez et al. (in press) set out a framework for measuring pervasive and arbitrary corruption, from which corruption distance could be calculated.

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In conclusion, we have deconstructed and reconstructed the twin concepts of the costs of doing business abroad and liability of foreignness. We hope that international business and international management scholars will find our framework and propositions useful in their own research on the multinational enterprise.

NOTES 1. The CDBA concept, therefore, was a foil for the real subject matter of the dissertation: the monopolistic advantages of MNEs relative to national firms. 2. Hennart noted that, “operation in a foreign country will usually entail higher costs, everything else being equal, than operation at home” (1982, p. 2). MNEs incur costs associated with travel, long-distance communication, time lost in communicating decisions and information, and foreign exchange. In addition, firms incur costs associated with unfamiliarity with host country consumer tastes, legal and institutional frameworks of business, and local business customs. 3. If the MNE’s average cost curve were above point b in Fig. 1, the firm would incur losses, which would deter entry or hasten exit. If part of CBDA were on a per-unit basis, both the marginal and average cost curves would shift upwards, causing the profit-maximizing output level to fall in addition to the reduction in profits. 4. For example, writing in the late 1970s, Buckley and Casson’s list of the costs of doing business abroad is similar to Hymer’s: increased communication costs within the MNE network, higher resource costs when economies of scale differed between stages of production, political discrimination costs (e.g. host governments favored local firms or threatened expropriation), and pure governance costs (associated with organizing internal markets across countries and dealing with multiple plants and multicurrency accounting) (Buckley & Casson, 1976, pp. 42–22). 5. Recent work by Zaheer (2000) supported this argument, suggesting that the interorganizational network can be a source of competitive advantage for some MNEs. 6. Embeddedness refers to as the degree to which economic transactions take place through social relationships and networks of relationships that use social and noncommercial criteria to govern business dealings (Marsden, 1981). 7. Note that in some cases there may be no local firm engaged in the same activities as the MNE; in such cases, CDBA measures the additional costs over and those that would be incurred by a hypothetical local firm engaged in the same market-based activities. 8. We refrain from using the term liability of newness (Stinchcombe, 1965), which is related to the age of the MNE, rather to the longevity of its experience in the host country. 9. Kostova and Zaheer referred to the MNE’s outside-inside perspective in the context of spillover effects, indicating that “the subsidiary lacks knowledge about the institutional environment . . . and, thus, is limited in its ability to achieve legitimacy” (1999, p. 76). However, they did not make this link to liability of foreignness. 10. National treatment means that foreign investments and investors receive the same treatment inside a country as do local investors and investments. Chapter 11 of the North American Free Trade Agreement (NAFTA), for example, guarantees national treatment to investors and investments within North America.

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11. Since our paper focuses on institutional distance, we leave the effects of market growth and industry concentration on the MNE’s ownership strategy for later work. 12. We assume an intermediate ownership strategy (e.g., an equity joint venture) always involves a local partner, not a foreign partner. 13. For example, in terms of investing in China in the 1980s and early 1990s, corruption distance would have been higher for U.S. MNEs than for German and U.K. MNEs, all other things being equal, because the U.S. was the only country enforcing anti-bribery regulations.

ACKNOWLEDGMENTS This paper has benefited from helpful comments and discussions with many individuals, particularly Albert Cannella, Tamer Cavusgil, Pervez Ghauri, Michael Hitt, Tatiana Kostova, Gareth Jones, Gerry McNamara, Antoine Monteils, Metin Sengul, Klaus Uhlenbruck, Tieying Yu, Srilata Zaheer, and Asghar Zardkoohi. We would like to thank these individuals, while retaining full responsibility for any errors or omissions.

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EXPLORING THE LIMITATIONS OF THE KNOWLEDGE PROJECTION MODEL IN MNCS: THE IMPACT OF EXPATRIATE MANAGERS ON SUBSIDIARY SURVIVAL Philippe Very, Louis Hébert and Paul W. Beamish ABSTRACT Few studies have explored how multinational firms (MNCs) use their experience when expanding abroad. According to the “knowledge projection” model of the MNC, appropriately disseminating industry experience, country experience and mode experience can a priori increase the chances of success of new subsidiaries. However, with inconsistent findings, prior research is of limited assistance in understanding this relationship. We argue that this situation can be explained by a focus on firm’s potential for experience accumulation, rather than on the actual transfer of experience. Deploying expatriate managers enable MNCs to apply organizational experience in foreign markets. It should also have an impact on foreign subsidiary’s chances of success and survival. Therefore, this paper examines how the use of expatriates to transfer experience can affect subsidiary survival.

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Our findings suggest that to enhance the chance of survival of a new subsidiary in a foreign market, the use of expatriates should be contingent on experience specificity, knowledge complexity, and perceptions of context similarities. Findings also question whether an extensive use of expatriate managers from Japanese firms is an effective method to transfer any type of complex experience from headquarters to subsidiaries. In other words, expatriation can no longer be systematically considered as an efficient mechanism for diffusing core experience throughout the “knowledge projection” MNC. In their recent book “From Global to Metanational,” Doz et al. (2001) argue that the rise of the global knowledge economy poses new challenges for the multinational firm (MNC). Traditionally, several MNCs have developed by leveraging and projecting their home-based competitive advantage into foreign markets. In this projection model, as MNCs enter into a new geographic market, they transfer elements of their knowledge base developed and accumulated in their home market. The expansion into new markets, through wholly owned investments, alliances, or acquisitions, also provides MNCs with the opportunity to develop their knowledge base. For instance, the more a firm acquires, the more it accumulates knowledge about this entry mode. When entering a new business, whether related or unrelated, the firm has the possibility of increasing its knowledge of various sectors. When multiplying subsidiaries or simply maintaining a subsidiary in the same country, it can enhance its knowledge of this country. Thus, MNCs have multiple avenues for accumulating a broad set of knowledge and experiences. Typically, these experiences are of a complex and tacit nature, and cannot be totally codified. The efficient diffusion of this knowledge and experiences across national boundaries is well known to represent a difficult task (Delios & Beamish, 2001; Kogut & Zander, 1993). Because of their complex and tacit nature, MNCs systematically consider sending expatriates for diffusing their knowledge and experiences toward their subsidiaries. The deployment of expatriates is indeed seen as a key mechanism for transferring a firm’s unique knowledge base in new markets (Bouquet et al., 2004; Doz et al., 2001). However, the relationship between the transfer of experience, through expatriates or other mechanisms, and the survival or performance of foreign subsidiaries remains poorly understood. Results are frequently inconsistent, and the question “Should we be sending expatriates” remains with no clear answer. In our opinion, there are four main reasons for this situation: (1) Researchers have generally studied knowledge accumulation, and not knowledge transfer. In other words, transfer or learning mechanisms have rarely

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been studied. Researchers have essentially used an experience accumulation proxy to test linkages between knowledge and performance. (2) The particular role of expatriate managers in ensuring efficient knowledge transfer and subsidiary survival has received limited attention. Doz et al. (2001) describe the dominant model of knowledge transfer in MNCs as the “co-location/projection model”: the firm projects knowledge from a co-location to its subsidiaries. Co-location refers to the headquarters or a unit where experts are co-located and produce knowledge together. When transferring knowledge by projection, MNCs frequently rely upon people as knowledge carriers. They are expatriate technicians and managers for projecting complex and tacit knowledge. (3) Past research has mostly focused on one type of experience: the experience with the host country, the organizational mode used, or the industry targeted. However, when expanding abroad, a variety of experiences are likely considered in a simultaneous manner to come down to the proper course of actions. Examples include the entry mode and the effective level of expatriate staffing in a new subsidiary. For instance, in the case of staffing, the lack of country experience can incite an experienced acquirer to rely on local managers. At the same time, it might be tempting to send expatriates for applying its acquisition expertise. In such a case, the decision to send expatriates seems to present both advantages and disadvantages from an experience point of view. (4) Past research has rarely considered the three main modes of entry available to firms: wholly owned subsidiaries (WOS), international joint ventures (IJVs), and acquisitions. Most studies have tended to focus on a specific entry mode, such as WOS or IJVs, or on comparing WOS and IJVs, with little or no attention to acquisitions. In turn, the acquisition literature also tended to neglect alternative entry modes. In short, the objective of our research is to analyze, from a knowledge-transfer perspective, the relationship between the use of expatriates and subsidiary survival. We considered expatriates as carriers of MNC experience, combined diverse types of experience, and took into account context conditions that could make knowledge transfer easy or difficult. A review of the literature led us to design a set of hypotheses that were then tested on a sample of subsidiaries from Japanese multinationals that can be considered as clear examples of the knowledge projection model. The findings helped us discuss conditions under which expatriation is likely to be efficient. Finally, we conclude with the potential competitive limitations of the projection model of MNCs.

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EXPATRIATES AS COMPLEX KNOWLEDGE CARRIERS Multinational corporations rely on expatriates for staffing critical managerial functions abroad (Harvey, 1996, 1999). Expatriates are preferred to local executives for various reasons. Their technical/business expertise, political understanding of the headquarters organization, and ability to transfer the domestic corporate culture to the foreign operation help to insure communication clarity between headquarters and the subsidiary, and to exercise effective social control over the subsidiary (Black et al., 1992; Dowling et al., 1998; Edstrom & Galbraith, 1977; Harvey, 1996; Martinez & Quelch, 1996; Vaughen, 1998). Consequently, the decision to send expatriates emerges in response to perceived functional needs of control, coordination, and know-how transfer within firms (Torbiorn, 1994). In addition, researchers found that an expatriation policy is costly and that expatriate managers face difficulties emanating from cross-cultural management assignments (Birdseye & Hall, 1995; Black et al., 1991; Harvey, 1996). From a knowledge perspective, the controlling function is not sufficient for justifying the cost of expatriation. MNCs should send expatriates when this action is likely to improve the competitiveness of the firm. Doz et al. (2001) describe the model of knowledge transfer in MNCs that has been prevailing since the 1990s: a combination of physical co-location and projection. Physical co-location means that the employees who accumulate critical knowledge and drive innovation are gathered at the same site; projection means broadcasting knowledge from the co-location to its subsidiaries. Sometimes, local adaptation is added, but most of the creation of knowledge comes from co-location (often in the home country). When transferring knowledge by projection, MNCs frequently rely upon people as knowledge carriers. They send technicians and managers abroad for projecting complex knowledge. Doz et al. (2001) outline four categories of knowledge: Simple knowledge: This is easily codified (like a patent) and can be understood by seeing and studying, rather like taking a picture. Such knowledge can be transferred using manuals and procedures. Experiential knowledge: This is not fully codified or articulated, and requires learning through experience and practice. Examples are individual skills, simple organizational routines, and unwritten industry norms. This knowledge can be easily diffused in foreign countries. Distance learning methods can help disseminate it abroad. Endemic knowledge: This is partially codified, but to understand it, one needs to be cognizant of the context in which the knowledge is embedded. Typical


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examples include vision statements and management processes. Because of its embeddedness, this knowledge is more difficult to transfer to new countries. Existential knowledge: This is the most complex type of knowledge; This type of knowledge is of a cognitive nature; it is imprinted in the mind of the expert. The experience of an acquisition process or the firm’s administrative heritage is included in this category. Existential knowledge requires a long period of shared experience : one grasps it by feeling and living it. Within the “co-location/projection model,” for endemic and existential knowledge to be transferred, skilled expatriates need to be sent to subsidiaries. Therefore, expatriation is justified when benefits expected from knowledge transfer surpass the cost of expatriation and when transfer can only be people-based. Researchers have extensively studied the role of expatriates, trends in the expatriation policy, how to retain and repatriate these managers, as well as expatriate staffing practices. Yet, little attention has been devoted to determining when it would be appropriate to send employees abroad. In this attempt to analyze the relationship between expatriation and success, we focused on a specific strategic move, internationalization, and explored the conditions under which expatriation is likely to enhance the chances of new subsidiary survival.

EXPATRIATION IN THE CONTEXT OF AN INTERNATIONALIZATION STRATEGY The internationalization strategy is an important context for studying performance in expatriation policies. Upon entering a foreign market, an MNC can transfer diverse knowledge that could be advantageous for the new subsidiary: its experience in the industry and competitive strategies; its experience with the country, if it has already operated therein; and its experience with the entry mode – a wholly owned, jointly owned, or acquired subsidiary. In order to understand the contribution of this variety of experiences, we first analyzed knowledge accumulated under the form of industry experience and country experience, which we label “context experience,” as well as their relationship to subsidiary survival. We then introduced the firm’s experience with the entry mode in the framework and built hypotheses from research findings on this theme. Subsequently, consistent with Doz et al.’s (2001) arguments, we investigated knowledge complexity and its influence on the relationship between experience and subsidiary survival. Finally, we analyzed how perceptions of country similarities, which could persuade MNCs to send expatriates to psychically close countries, affect the relationship between expatriation and survival.

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PRIOR CONTEXT EXPERIENCE AND SUBSIDIARY SURVIVAL Context experience refers to the MNC’s experience with the subsidiary industry and the subsidiary country of operations. Let us now review these two types of experience. Industry Experience and Subsidiary Survival Following Rumelt’s (1974) early works, a considerable amount of research in the 1980s examined the degree of relatedness to explain the performance of the firm in a new business. Relatedness represents the potential of the firm to use, in the new business, the experience it accumulated in its core business. However, this important research stream yielded mostly inconsistent and contradictory results, a situation that could be explained by the different measures used for assessing relatedness (Markides & Williamson, 1994; Ramanujam & Varadarajan, 1989). In studying relatedness, researchers have generally measured the potential for transferring industry experience instead of the actual transfer of experience. They measured the proximity between businesses rather than their genuine relatedness. In other words, most studies focused on the capacity of the firm to use its industry experience rather than on the actual transfer of experience. The dissemination of industry knowledge across organizational boundaries is in itself a challenging task. Because of its inherent complexity and tacit nature, its transfer is likely to rely on people-based mechanisms and in particular on expatriate managers with the required industry capabilities (Delios & Björkman, 2000). Bettis and Prahalad (1986) concluded that the dominant logic of general management possessed by a top-manager was highly tacit. Therefore, it was difficult to reproduce and to apply in a different industrial setting. Bresman et al. (1999) examined the transfer of R&D knowledge in acquisitions and identified two different patterns. Technological know-how, a more tacit form of knowledge, was found to be transferred best through intensive communication, frequent visits and meetings, and when the acquisition was fully integrated. In turn, codified knowledge, like patents, could be transferred more easily and did not require strong in-person or group interactions. The transfer of tacit knowledge also required more time. According to the authors, the emergence of a single integrated social community following a merger tended to further facilitate the transfer of tacit knowledge. In sum, effective diffusion of tacit knowledge such as industry experience is likely to depend on the transfer of individuals.


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Consequently, considering the complexity and tacitness of industry knowledge, its transfer may well require expatriate managers with the relevant industry capabilities. The effective dissemination of such knowledge by expatriates is also likely to have an impact on the subsidiary performance and chances of survival. When an MNC is investing in its core industry abroad or in an industry in which it has considerable experience, the use of expatriate industrial experts could help to formulate a subsidiary competitive strategy. The likelihood of survival of the unit is likely to increase with the transfer. In contrast, if the firm has little knowledge of the industry, it should rely on outside experts or acquired firm executives to enhance the likelihood of subsidiary survival. We can formulate our first hypothesis as follows: H1.1. The greater the MNC’s prior industry experience, the more expatriates increase the chances of subsidiary survival. Country Experience and Subsidiary Survival Upon entering new countries, firms face several obstacles to success, the so-called “liabilities of foreignness” (Zaheer, 1995). They have to learn how to deal with local institutions, local customer needs, and a different socio-political and legal context; in other words, they have to develop locally based capabilities and knowledge to overcome their disadvantages compared to local firms. Expatriate managers confront a similar challenge upon arrival in a new country; they also have to learn about their new environment. Acquiring such locally based capabilities typically takes time and can be achieved by accumulating local experience (Johanson & Vahlne, 1977). Being experience-based, host-country local knowledge has a tacit and existential nature. Learning about foreign markets has received considerable attention in recent years in the internationalization literature (see Lord & Ranft, 2000). Researchers have studied whether the process of internationalization is influenced by prior knowledge accumulated by the MNC about a targeted country, particularly when the entry mode is an acquisition. Barkema and Vermeulen (1998), Johanson and Vahlne (1977), Kedia and Bhagat (1988), and Li (1995) found that local experience facilitates further investments in a particular country. Barkema and Vermeulen (1998) observed a linkage between local experience and the choice to acquire in that country. When a buyer has an established subsidiary or operation, local staff can provide assistance in finding local targets and in analyzing, negotiating, and managing an acquisition. On the contrary, issues of information, negotiation, and integration are more likely to be problematic when the acquisition

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is a first entry into a country. In the specific case of acquisition, some studies have failed to find any support for the relationship between local experience and acquisition success (Hennart & Park, 1993; Kogut & Singh, 1988). Because of the equivocal nature of this research, it is unclear whether local experience influences the survival of foreign subsidiaries. Similar to industry experience, researchers have generally used measures of experience accumulation, e.g. the number of years of residence in a country or the number of existing local subsidiaries, rather than measures of experience transfer. Focusing on knowledge, its transfer across borders and organizational boundaries, and the use of expatriate managers for this purpose could shed some light on the importance of local knowledge for subsidiary survival. As country knowledge is complex, actually transferring the firm experience requires expatriate managers with the relevant country skills. The MNC’s country knowledge could affect the relationship between expatriate staffing and subsidiary survival. At first glance, prior country knowledge per se does not justify sending expatriates: local managers have the required experience and should be cheaper. This is why other motivations for expatriations are needed; according to the “projection/co-location” model, country experience should be helpful in adapting some central knowledge to local conditions. Country experience is likely to enhance chances of subsidiary survival when combined with other types of knowledge transferred by the expatriates. For instance, industry experience should be diffused more efficiently by someone understanding local economic rules, management styles, and culture. Similarly, experience with the entry mode should be used, taking into account local rules and sociocultural context. In sum, a multinational company should use its expatriates possessing host country experience for diffusing its core knowledge in this specific country. These expatriates will be able to adapt this core knowledge to country specificities. Hence the following hypothesis: H1.2. The greater the MNC’s prior experience in the host country, the more expatriates increase the chances of subsidiary survival. Entry-Mode Experience and Subsidiary Survival MNCs expanding abroad choose how to enter a specific country, among possibilities offered by local laws. In the absence of foreign ownership restrictions, they can proceed with a greenfield wholly owned subsidiary, a joint venture with a local partner or the acquisition of a local firm. Experience with one entry mode could be useful a priori when the firm decides to use this mode again for further expansion. Such knowledge is inherently complex: creating a new foreign subsidiary involves dealing simultaneously with numerous dimensions:


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financial investments, resource allocation, recruitment, laws and tax system, local administrative requirements, etc. Part of this experience that is common to any greenfield investment can certainly be codified in manuals, but the overall process of firm creation and entrepreneurship remains embedded in the sociocultural context of the country. Since national culture has been defined as “the software of the mind” (Hofstede, 1980), establishing a subsidiary requires an adaptation, not only to formal rules, but also to local mental schemes and management styles which are inherently of a tacit nature (Athanassiou & Nigh, 2000). Establishing a joint venture or conducting an acquisition arguably adds complexity to the process of experience accumulation. Building experience must take into account not only country specificities, but also firm specificities. Typically, each transaction is unique. Partners and targets are seldom similar to former allied and acquired firms. Transactions pursue diverse strategic objectives and are built upon different sources of value creation. Very (1999) found that big acquirers often used codified manuals for conducting the pre-merger phase, while relying on mentors – experienced colleagues – to help to manage the integration and capitalize on past experience. Thus, the management of an acquisition or joint venture can be considered as existential knowledge, even more than the process of greenfield subsidiary creation. Researchers have extensively studied how firms select an entry mode as well as the linkage between mode experience and entry-mode performance. We review findings for each of the three modes.

Greenfield Wholly Owned Investment (WOS) Japanese firms have shown a tendency to establish greenfield investments in foreign markets (Cho & Padmanabhan, 1995; Wilson, 1980). They replicate units and factories of the Japanese parents to transfer Japanese savoir faire to the foreign markets. According to Barkema and Vermeulen (1998) and Hofstede (1991), MNCs generally establish WOS in foreign countries by sending over expatriates. These managers are responsible for selecting and hiring employees from the local population (Hofstede, 1991), and they gradually build up the business (Simmonds, 1990; Teece, 1982). Greenfield investments take longer than acquisitions or alliances to yield returns (Biggadike, 1979). Consequently, we expect that expatriates with greenfield wholly owned subsidiary experience will be able to shorten the time needed to make a new foreign investment profitable. However, because of excessive routinization, rigidity, and replication of internal processes, the experience with greenfields has been shown to negatively influence the probability of survival of subsequent greenfield investments (Vermeulen

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& Barkema, 2001). The replication of practices and mental schemes tends to narrow the firm’s knowledge base and to oversimplify the management of the new subsidiary. The experienced MNC will not react to unexpected or new issues emerging from the local context. Vermeulen and Barkema (2001) tested finergrained implications of this theory. They found that the probability of subsidiary survival was even lower when former WOS were made in the same product or geographical market. The authors concluded that replication and exploitation of existing knowledge tend to promote considerable rigidity and simplicity. These findings suggest that two variables need to be introduced in the relationship between expatriate staffing and the survival of WOS: industry experience and country experience. The specificity of the experience (experience with WOS in a particular country or in a particular industry) is likely to be associated with the success of subsequent similar strategic moves. However, two contradictory hypotheses emanate from prior research: expatriates should increase the chances of survival if they transfer the “right” experience, or they should decrease the chances of survival if they simply replicate practices developed in similar contexts. In combination, these conclusions lead us to propose two hypotheses. The first hypothesis reflects the experience view. Specific experience refers to experience with WOS in the host country or in the industry segment of the new subsidiary. Both dimensions will be empirically tested. The second hypothesis reflects the replication view: H2.1a. The greater the MNC’s prior specific experience with WOS, the more expatriates increase the chances of new wholly owned subsidiary survival. H2.1b. The greater the MNC’s prior specific experience with WOS, the more expatriates decrease the chances of subsidiary survival.

Acquisitions Research on acquisition experience suggested that limiting our investigation to the overall experience of acquisition could be misleading. Some types of experiences could be superposed and could exhibit a compounding effect. Acquisition experience in a specific industry or country could have a unique value for a following transaction in the same industry or country. Haleblian and Finkelstein (1999)’s research is well known for proposing a U-shaped relationship between acquisition experience and financial market performance. They suggested that inexperienced acquirers tend to inappropriately generalize to future deals what they learned from their first acquisition, regardless of the similarity or dissimilarity between the first


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and subsequent acquisitions. More experienced buyers appropriately discriminated between future acquisitions based on similarities with past transactions. For these researchers, transactions were considered as similar if the acquired firms operated in the same industry. Hayward (1999) did not fully support such a conclusion. His findings rather suggested that a firm’s focal acquisition performance was related to past acquisitions that were not completely similar or dissimilar to the focal deal in terms of industry. This discussion leads us to propose that the more specific the acquisition experience, the more useful it is for managing a new acquisition. The experience associated with an earlier acquisition in a specific industry is likely to be extremely valuable for a following transaction in the same industry. The individuals involved in earlier transactions in the same industry could bring their experience to effectively integrate a newly acquired firm in the same industry. A similar rationale can be applied to the acquisition experience in a specific country. Experience from prior transaction is likely to benefit the integration of the new acquisition in the same country. Thus, relying on expatriate to transfer such specific experience should enhance the chances of subsidiary survival. Indeed, when entering a new and unknown country and therefore in the absence of local acquisition experience, acquirers often choose to rely upon target executives (Very & Schweiger, 2001). The interests toward the transfer of such specific knowledge could be further explained by considering the adaptation process firms undertake when diversifying geographically. In fact, following entry in a new country, firms have to develop new capabilities. They also have to adapt existing capabilities in order to meet the unique competitive and societal requirements of the host-country environment. In this regard, host-country experience may help in adapting some centrally located knowledge and business practices to local conditions. For instance, Schoenberg (2001) explained the acquirers’ failure to achieve the forecast synergies by their inability to adapt core functional knowledge to local business and cultural conditions. In sum, we propose that beyond mere general acquisition experience, transfer of acquisition experience in a specific country and specific industry is likely to have a positive impact on the integration of a new acquisition in the same country or industry. In particular, the use of expatriate managers in such circumstances should increase the chances of subsidiary survival. The following hypothesis can be formulated: H2.2. The greater the MNC’s prior specific experience with acquisitions, the more expatriates increase the chances of new acquisition survival. Specific experience refers to experience with local acquisitions or experience with acquisitions in the acquired firm’s industry.

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International Joint Ventures (IJVs) The creation of an IJV with a local partner is perceived as a platform for acquiring local complementary assets (Inkpen & Beamish, 1997), thus enabling foreign firms to cope with their liability of foreignness (Zaheer, 1995). Despite their competitive and strategic benefits, IJVs often encounter performance problems (Geringer & Hébert, 1991). By their inherent nature, the presence of two or more parents represents a potentially significant source of complexity, often making these ventures difficult and laborious to manage as well as prone to failure (Killing, 1983). Developing the capabilities to effectively manage these shared equity and decision-making arrangements has significant importance for achieving strategic objectives in international arenas (Doz & Hamel, 1999). In particular, considerable attention has been devoted to the development and importance of IJV experience. Prior work has suggested that experience with this entry mode may enable firms to develop capabilities for managing IJVs more effectively (Barkema et al., 1997). IJV experience has been associated with several benefits and advantages. Alliance-experienced firms have been suggested to be more effective in establishing relationships characterized by trust and cooperation, both key success factors of alliances (Ireland et al., 2002). They develop specific capabilities for coping with cultural differences, goal incongruence, and risks of opportunistic behaviors (Barkema et al., 1997; Beamish & Banks, 1987; Doz & Hamel, 1999). Some may even develop a so-called “collaborative advantage” (Kanter, 1994). They also create organizational units dedicated to the management of their strategic alliances (Dyer et al., 2001). Firms have been shown to actively seek partners with greater IJV experience, since they are expected to be more effective in transferring knowledge and expertise (Hitt et al., 2000; Nooteboom, 1999). There is also some strong evidence that IJV experience represents a significant determinant of both IJV survival and profitability (Delios & Beamish, 2001). However, Barkema et al. (1997) suggested that benefits from IJV experience varied extensively across firms. Experience with domestic JVs proved to be a stepping stone for effectively managing IJVs. Yet, IJV experience in itself was a poor predictor of IJV performance, thereby raising the question of the transferability of such experience across the firm. The development of new capabilities was most salient when firms where involved in majority-owned and 50/50 IJVs rather than minority-owned IJVs (Barkema et al., 1996). Experience with IJVs may also matter most for performance when firms can rely on IJV experience in a specific country (Makino & Delios, 1996). Merely relying on general IJV experience may not be sufficient for performance. IJVs allow the development of capabilities that may not be perfectly transferable


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to other contexts. For example, differences in the creation and management dynamics between IJVs in developed countries and those in developing countries are well documented (Beamish, 1988). Significant differences do exist in the capabilities sought and in the partner selection criteria used by developed-country firms compared to emerging country ones (Hitt et al., 2000). Therefore, as in the case for acquisitions, experience with IJVs in a specific industry or country may prove to be effective in adapting centrally developed practices and knowledge to the specific local or industry conditions. Still, most studies adopted an experience accumulation rather than formally investigating the use of expatriate managers as vehicles for transferring IJV-specific knowledge. In this regard, the simple presence of expatriates can lead to culture clashes and conflicts, which may hamper the performance of IJVs (Konopaske et al., 2002). Such results do not question the effectiveness of expatriates for dissemination experience and knowledge. They may underline the cost associated with the use of expatriate managers in the absence of relevant experience to be transferred (Makino & Delios, 1996). Building from Kogut and Zander (1993), Makino and Delios (1996) suggested that in the absence of effective transfer of specific IJV experience, firms may not be able to manage with the inherent complexity of these organizations. Therefore, we propose the following hypothesis: H2.3. The greater the MNC’s prior specific experience with JVs, the more expatriates increase the chances of new JV survival. Here also, specific experience refers to experience either with local IJVs, or with IJVs in the subsidiary’s industry. Context Complexity, Transfer of Experience, and Subsidiary Survival The preceding hypotheses were derived from past research specifically dealing with the diverse types of experience that the MNC can accumulate and use to increase its chances of survival when expanding abroad. The literature on industry and country experience allows us to introduce context complexity into the expatriation-survival framework. Research has indeed suggested that transferring knowledge requires different mechanisms. And transfer mechanisms depend upon knowledge complexity. Delios and Beamish (2001) studied the relationship between survival and knowledge complexity, using the firm’s extent of intangible assets as a proxy of knowledge complexity. Working on a sample of foreign subsidiaries of Japanese MNCs, they found that the greater the intangible assets, the greater the likelihood of subsidiary survival. Delios and Björkman (2000)’s findings indicated that expatriates play a significant knowledge transfer role in marketing and technology-intensive industries, but with varying importance across countries

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(more important in China than in the USA). In fact, the more complex the knowledge, the more people-based its transfer needs to be (Doz et al., 2001). In the case of market entry, the decision to send expatriates should depend upon knowledge complexity. When the firm has endemic or existential knowledge, the temptation to send expatriates is great, because subsidiary competitiveness could be enhanced by its appropriation of a unique knowledge. This is particularly true for firms organized according to the “co-location/projection” model. This perspective complements Delios and Beamish’s (2001) hypothesis by including the role of expatriates for the transfer of complex knowledge: H3. The more complex the industry knowledge, the more expatriates increase the chances of subsidiary survival. Perceived Country Similarities As Doz et al. (2001) explained, knowledge complexity incites companies to send expatriates for the purpose of diffusing knowledge. Yet, complex knowledge does not cross borders easily. The quality of the expatriate’s knowledge decreases abroad because this knowledge is embedded in its original context of creation. Not only does the expatriate with no country experience work in a new context that they cannot fully comprehend, but part of their knowledge can be inappropriate or misleading. Unfortunately, firms organized according to the “co-location/projection” model can ignore such difficulties or mistakes because they are naturally tempted to develop their expatriation policy in nearby countries. Early theorists of internationalization indeed argued that firms tend to enter psychically close countries where their current knowledge is perceived as being applicable to the new market (Johanson & Vahlne, 1977). Psychic distance encompasses cultural, structural, and language differences (Nordström & Vahlne, 1994). Building from this theory, Evans and Mavondo (2002) and O’Grady and Lane (1996) have found that foreign direct investments are no more profitable when they are made in psychically close countries. They refer to a “psychic distance paradox.” This paradox says that operations in psychically close countries may result in failure, because the perception of similarity with the home country prevents the managers from taking care of the subtle but critical differences that exist between the countries. The easier it is perceived, the more dangerous it could be. These findings lead us to propose that MNCs will tend to send expatriates in psychically close countries. However, this staffing decision is risky for the subsidiaries in these countries. Consequently, psychic distance should moderate the relationship between expatriation and subsidiary survival in the following manner:


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H4. The shorter the psychic distance between home and host countries, the more expatriates decrease the chances of subsidiary survival.

METHODOLOGY We chose to test our hypotheses using foreign subsidiaries of Japanese companies, since past research has shown that in the 1980s and 1990s, these MNCs presented the characteristics of firms following the “co-location/projection” model. Japanese companies reproduce clones of home-based operations in the foreign country (Cho & Padmadabhan, 1995; Wilson, 1980). Some studies have singled out specific expatriation policies of Japanese MNCs when compared to MNCs from other countries. Japanese firms are more likely to use expatriates as managing directors (Harzing, 2001) or as “president” and “key director” (Peterson et al., 1996, 2000). Japanese expatriates stay a longer time in their foreign subsidiary when compared to their U.S. or Western counterparts (Tung, 1981, 1982, 1988). While developed country MNCs in the 1990s tended to reduce their number of expatriates to reduce costs, Japanese firms maintained their expatriation staffing intact (Peterson et al., 1996, 2000). Japanese MNCs also use very few third-country expatriates (Peterson et al., 1996). Thus, their main choice when expanding abroad is to send Japanese staff or to rely on local managers.

Sample and Data Sources This study used data available in Kaigai Shinshutsu Kiyou Souran (“Japanese Overseas Investments”), an annual publication of Toyo Keizei Inc., which provides extensive subsidiary-level information on the overseas activities of Japanese MNCs. Toyo Keizei Inc. has compiled this information (since 1970) by sending a questionnaire to major listed and non-listed Japanese firms, and supplementing survey information, where required, with data collected through press releases, annual reports, and telephone interviews. The data set has been found to provide reliable data for the study of Japanese FDI (Beamish et al., 1997). The 1997 version contained information on 22,214 subsidiaries – representing more than 5000 public and private firms – established in more than 100 countries. Our data set included Japanese MNCs having entered North America, South America, Europe, Asia, Africa, Oceania, and the Middle East before 1992 through a greenfield wholly owned subsidiary (a subsidiary in which one partner possesses more than 95% of its equity), an IJV (a subsidiary in which one partner possesses at least 5% of its equity) or an acquisition (a partial or full takeover of a domestic

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firm). To be included in our data set, firms had to report total and Japanese employment data. A total of 7433 entries were identified: 3784 WOS, 3293 IJVs, and 356 acquisitions. This distribution reflected the Japanese firms’ emphasis on greenfield and IJV as entry modes, and their reluctance to use mergers and acquisitions.

Variables All data used in the study were obtained from Toyo Keizei’s Kaigai Shinshutsu Kiyou Souran, including the mode of entry (greenfield WOS, IJV and acquisition) and the number of Japanese expatriates (as a percentage of total employment). The dependent variable for this study is survival. A subsidiary might be expected to remain in operation as long as it represents the most efficient organization mode, in terms of transaction costs (Inkpen & Beamish, 1997). Empirical evidence suggests that survival correlates positively with financial and satisfaction measures of performance (Geringer & Hébert, 1991). The achievement of a parent’s objectives can also be thwarted by premature, unintended dissolution of a subsidiary. Operationally, we define survival as the continued presence of a subsidiary in its host market, and failure is an exit. The dependent variable for all models was the subsidiary’s survival status by the end of 1996. Exits were coded as one, and surviving subsidiaries were coded as zero. The duration of the subsidiary, to its time of exit or to the year 1997, was computed by the number of years from foundation to exit, or to 1997. Knowledge complexity was measured with two variables. The first was R&D intensity, an indicator of a firm’s possession of proprietary technological knowledge, which has been used frequently in earlier research (Hennart, 1991; Kim & Hwang, 1992; Kogut & Singh, 1988). The second was advertising intensity, an indicator of the brand equity and the goodwill of the firm in general (Hennart, 1991). They were, respectively, R&D expenditures and advertising expenditures as a percentage of firm sales. They were calculated as five-year averages (1992–1996) and were divided by industry R&D and advertising intensity to derive normalized intensity terms. R&D intensity and advertising intensity are expected to correlate positively with asset specificity. Psychic distance was determined from the cultural distance between Japan and the host country in which the subsidiary was situated and by the investment risk and openness to FDI of the host country. The cultural distance measure was computed from Hofstede (1980) measures using the methodology outlined in Kogut and Singh (1988). Host-country risk was a variable derived from indices

Variable 1. % Expatriate 2. R&D intensity 3. Advertising intensity 4. Cultural distance 5. Country risk 6. FDI openness 7. Host country exp. 8. Mode exp. 9. Industry exp. 10. WOS/industry exp. 11. WOS/country exp. 12. IJV/industry exp. 13. IJV/country exp. 14. Acq./industry exp. 15. Acq/country exp. 16. Subsidiary age 17. Survival

Mean

Std. Dev.

9.837 19.179 1.579 1.305 0.008 0.011 2.976 0.999 −0.490 0.692 −0.208 0.845 −0.629 113.051 2.124 551.360 0.084 64.875 0.003 0.373 0.004 0.337 0.007 29.930 6.569 61.987 0.005 3.257 0.001 6.838 9.504 7.971 0.16 0.369

1

2

3

4

5

1.00 −0.02 −0.02 −0.01 −0.11 0.20 −0.06 −0.41 0.27 0.20 0.18 0.34 0.48 0.01 −0.25 −0.03 −0.21

1.00 0.16 −0.01 −0.03 −0.04 −0.10 −0.12 0.03 0.10 −0.02 −0.03 −0.08 0.06 −0.02 0.03 −0.09

1.00 −0.03 −0.05 0.03 −0.16 −0.23 −0.03 0.04 0.01 −0.00 −0.19 −0.02 −0.09 0.02 −0.08

1.00 0.29 −0.07 −0.06 0.05 0.03 −0.02 −0.11 0.04 −0.04 0.19 −0.01 −0.12 −0.07

1.00 −0.07 −0.14 0.12 0.10 −0.08 −0.37 0.08 −0.11 0.04 −0.09 −0.14 −0.11

Note: Correlations > 0.03 significant at p < 0.05.

6

7

8

9

10

11

12

13

14

15

16

1.00 0.03 1.00 −0.05 0.54 1.00 −0.03 0.13 0.29 1.00 0.17 0.02 0.01 0.30 1.00 0.37 0.16 0.05 0.05 0.29 1.00 −0.03 0.13 0.33 0.83 0.10 0.01 1.00 0.07 0.10 0.64 0.14 0.01 0.08 0.17 1.00 −0.08 0.15 0.41 0.34 0.00 0.00 0.00 0.00 1.00 −0.06 0.59 0.59 0.04 0.00 0.00 0.00 0.00 0.16 1.00 0.13 −0.18 −0.28 −0.18 −0.03 −0.06 −0.22 −0.19 −0.09 −0.11 1.00 0.03 0.08 0.01 −0.12 −0.20 −0.04 −0.12 0.03 −0.05 −0.01 −0.01


Table 1. Descriptive Statistics.

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published in Euromoney in 1996. For openness to FDI, data on local ownership restrictions were obtained from the World Competitiveness Report, 1996, using an item that reported on the openness of 47 countries to foreign equity participation. We expect measures of cultural distance and country risk to be positively correlated with psychic distance and FDI openness to be negatively related. We measured host country, mode and industry experience using a firm’s FDI history. Host-country experience is the number of years in which a firm operated a subsidiary in a particular host country; industry experience is the number of years in which a firm operated a subsidiary in a particular industry; and mode experience is the number of years in which a firm operated a particular entry mode. Similar measures were used for mode-specific experience. For instance, WOS/industry experience is the number of years in which a firm operated a WOS in a specific industry. Such measures were used for all entry modes and for both industry and host country, for a total of six variables. For all survival analyses, we used Cox’s proportional hazard model. In order to correct for problems of censored data and aging effects, we used the Cox regression procedure included in SPSS 10.1, which incorporates the age distribution directly into the estimation. Furthermore, analyses were conducted with centered and non-centered variables, and no significant differences in the results were observed. The results presented here include centered variables, and descriptive statistics are listed in Table 1.

RESULTS The results from all analyses are listed in Tables 2 and 3. The base model presents survival analysis using all exogenous variables but without interaction terms. Several variables were found to have a significant effect on the likelihood of subsidiary survival, including R&D intensity, FDI openness, and country risk. Among experience variables, both mode and industry experience were significant, while the proportion of expatriates also exhibited a significant and positive effect on survival. Hypotheses 1.1 and 1.2 proposed that the relationship between the use of expatriate managers and subsidiary survival will be moderated by the MNC’s experience. In the Model 1 column, the moderating effect of industry knowledge was significant and negative, consistent with our hypothesis. However, the interaction term for host-country experience and expatriates was not significant and not in the expected direction. The proportion of expatriate managers and mode experience had a significant negative and positive effect on subsidiary termination, respectively. Typically, the variables that had been found to have significant effects

Variable R&D intensity Advertising intensity FDI openness Cultural distance Country risk Host country experience Mode experience Industry experience % Expatriate managers

Base Model

Model 1 (H1.1–H1.2) −0.082***

−0.064*

(13.563) −3.030 (1.491) 0.108** (11.553) −0.036 (2.384) −0.337*** (61.912) 0.000 (2.279) 0.001*** (170.117) −0.002* (6.663) −1.110*** (316.089)

(13.742) −2.848 (1.317) 0.101** (9.927) −0.039# (2.819) −0.323*** (56.502) 0.000 (0.461) 0.001*** (150.842) −0.001 (2.025) −1.042*** (224.074)

(4.512) 5.266# (2.936) 0.092 (2.035) −0.032 (0.794) −0.160 (1.938) −0.001 (1.689) 0.002*** (85.686) −0.280 (1.442) −0.822*** (120.445) −0.462*** (18.251) 0.568*** (37.244)

WOS/industry experience WOS/country experience IJV/industry experience IJV/country experience Acquisition/industry experience

Model 2 (H2.1)

−0.081***

0.001 (0.971) 0.000 (0.008) −0.011** (6.822)

Model 3 (H2.2) −0.214 (0.002) −2.214 (0.052) −0.715# (3.240) −0.343# (2.965) −0.799** (8.454) 0.001 (0.192) −0.017 (0.531) 0.08 (1.737) −0.292 (0.046)

Model 4 (H2.3) −0.052 (2.236) −13.976** (8.049) 0.151** (10.979) 0.003 (0.005) −0.251*** (17.570) −0.002# (2.894) 0.001*** (45.460) −0.004# (2.851) −1.670*** (100.974)


Table 2. Survival Models for Japanese Subsidiaries.

0.010* (4.208) 0.005# (2.732)

241

−0.065 (0.150)

242

Table 2. (Continued ) Variable

Base Model

Model 1 (H1.1–H1.2)

Model 2 (H2.1)

Acquisition/country experience

Model 3 (H2.2) 0.017 (0.292)

Interaction terms Host-country experience × % Expatriate

−0.001 (0.302) 0.000 (0.000) −0.011* (4.461) 0.106 (0.385) −0.023 (0.023)

Mode experience × % Expatriate Industry experience × % Expatriate WOS/industry experience × % Expatriate WOS/country experience × % Expatriate

0.109** (8.210) 0.444* (6.458) −0.449* (4.013)

JV/industry experience × % Expatriate

Acquisition/industry exp. × % Expatriate

26611.47 1448.9***

26438.97 1474.9***

12762.284 1142.6***

875.215 81.0***

9145.358 537.3***


−0.307 (0.019) −1.340** (8.846)

Acquisition/country exp. × % Expatriate

Note: Numbers in parentheses are Wald statistics. ∗ p < 0.05 two-tailed tests. ∗∗ p < 0.01 two-tailed tests. ∗∗∗ p < 0.001 two-tailed tests. # p < 0.10 two-tailed tests.

0.006** (9.812) 0.001* (5.035) −0.004 (0.084)

−0.016 (0.509) −0.013** (7.055)

JV/country experience × % Expatriate

−2 Log likelihood Model ␹2

Model 4 (H2.3)

Variable R&D intensity Advertising intensity FDI openness Cultural distance Country risk Host country experience Mode experience Industry experience % Expatriate managers Interaction terms Host country experience × % Expatriate Mode experience × % Expatriate Industry experience × % Expatriate

Base Model

Model 5

Model 6

−0.081***

−0.035*

−0.052#

(13.563) −3.030 (1.491) 0.108** (11.553) −0.036 (2.384) −0.337*** (61.912) 0.000 (2.279) 0.001*** (170.117) −0.002* (6.663) −1.110*** (316.089)

(4.078) −0.799 (0.116) 0.058* (4.301) −0.030 (1.642) −0.318*** (64.112) 0.003*** (36.053) 0.001*** (176.59) −0.003** (12.008) −1.128*** (329.04)

(3.789) −0.581 (0.061) 0.057* (4.087) −0.030 (1.694) −0.314*** (61.690) 0.002*** (26.384) 0.001*** (154.35) −0.002* (4.137) −1.321*** (130.07) 0.002*** (29.548) 0.000 (0.519) −0.012** (8.706)

Model 7 (H3–H4) −0.057* (6.214) −1.359 (0.272) 0.056# (2.829) −0.035 (1.991) −0.209*** (22.197) 0.000 (1.480) 0.001*** (149.264) −0.001 (2.068) −1.532*** (34.277)


Table 3. Survival Models for Japanese Subsidiaries.

243

244

Table 3. (Continued ) Variable

Base Model

Mode exp. × Host country experience Mode exp. × Industry experience

Model 5

Model 6

0.000*** (30.657) 0.000 (0.013)

0.000*** (29.548) 0.000 (0.379) 0.000* (5.341) 0.000* (4.213)

Mode exp. × Host coun. exp. × % Expat. Mode exp. × Ind. exp. × % Expatraite Advertising intensity × % Expatriate

−8.649 (1.691) −0.149** (8.626) −0.898*** (35.580) 0.009 (0.25) 0.394*** (19.395)

R&D intensity × % Expatriate Country risk × % Expatriate Cultural distance × % Expatriate FDI openness × % Expatriate

Note: Numbers in parentheses are Wald statistics. ∗ p < 0.05 two-tailed tests. ∗∗ p < 0.01 two-tailed tests. ∗∗∗ p < 0.001 two-tailed tests. # p < 0.10 two-tailed tests.

26611.47 1448.9***

26791.31 1029.7***

26819.6 1137.3***

26271.835 1481.1***


−2 Log likelihood Model ␹2

Model 7 (H3–H4)


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in the base model remained significant. Still, Hypothesis 1.1 was supported, while H1.2 was not. Hypotheses 2.1, 2.2, and 2.3 address the relative importance of country- and industry-specific experience for the expatriate – subsidiary survival relationship using different entry modes (see Table 2). As discussed earlier, we would expect the effectiveness of expatriate managers in transferring experience to vary across different entry modes. The WOS model (Model 2 in Table 2) suggests that a variety of experience variables influence WOS survival. In particular, the presence of prior WOS experience in the targeted industry increased the chances of survival. In contrast, mode experience (here, general WOS experience) and specific WOS experience in the targeted country both reduced the chances of survival. With the exception of the industry experience-expatriate interaction term, no interaction terms were significant at p < 0.05. Thus, neither H2.1a nor H2.1b was supported. In the acquisition model (Model 3), none of the direct effects of the proportion of expatriate managers and of the experience variables, including the acquisition experience in the targeted country and industry, were significant. Experience did not appear to influence directly the survival or termination of the acquired subsidiary. However, several interaction terms were significant. In the presence of extensive industry experience and specific acquisition experience in the targeted country, a greater reliance on expatriate managers significantly reduced the likelihood of termination, as suggested by the negative coefficients observed. The interaction term for specific acquisition in the targeted industry was not significant, however. Consequently, Hypothesis 2.2 was partly supported empirically. In turn, the interaction terms for host-country experience and mode experience were positive and significant. While no hypotheses had been formulated for these variables, these results suggested that the use of expatriates increased termination risks with greater local and mode experience. Finally, in IJVs (Model 4), mode experience and IJV experience in the targeted industry were both found to increase significantly the chances of termination. Also, with considerable host-country experience, mode experience, and IJV experience in the targeted country, the use of more expatriate managers also significantly increased the chances of termination. Such results contradicted Hypothesis 2.3. To examine further this group of hypotheses related to mode-specific experience, we use an interaction term where mode experience was combined with host-country experience and with industry experience. This approach would allow us to test our hypotheses in all modes, rather than mode by mode. The results are presented in Table 3, under model 5. The two three-way interaction terms combining mode experience, host-country experience, and expatriates, on the one hand, and mode experience, industry experience, and expatriates, on the other

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hand, yielded significant and positive coefficients. Even though the coefficients were small, they suggest that in the presence of extensive mode experience in a country or in an industry, the use of expatriate managers increases the chances of termination. This empirical evidence again contradicts our second hypothesis. Hypothesis 3 proposed that with the complexity of industry knowledge, the use of expatriates increased the chances of survival (see Table 3). The negative coefficient on the expatriate–R&D intensity interaction terms supports this hypothesis (see Model 8). Yet, the term involving advertising intensity was in the expected direction but not significant. Similar partial support was obtained for the psychic distance Hypothesis (H4). As predicted, the use of expatriate in the presence of increasing country risk and FDI openness had respectively, a negative and positive effect on subsidiary termination (see Model 8). The results for the cultural distance–expatriate interaction term were not significant. In other words, in an uncertain environment characterized by high country risks and low openness to FDI, expatriate managers increase the change in subsidiary survival. H4 was partially supported.

DISCUSSION This paper explored the role of knowledge transfer through expatriation in the survival of the foreign subsidiary in MNCs. Prior research argued that intangible assets and experience enable foreign firms to overcome their knowledge disadvantage compared to local firms and therefore would secure the survival of their foreign subsidiaries. In this important research stream, the accumulation of knowledge assets is one fundamental factor. Our paper contributes to this literature by examining not only the accumulation of knowledge but also the transfer of such knowledge towards subsidiaries. Recent work suggests that it is this ability to disseminate knowledge within their organizational network that represents MNCs’ main source of value creation. The paper has focused on the use of expatriate managers for transferring complex knowledge within the MNC, thus contributing to the expatriate literature by taking account of their role in knowledge transfer and the stability of foreign subsidiaries.

Expatriate Managers and Knowledge Transfer In our study, empirical evidence supported the proposition that expatriate managers influence the stability of the foreign subsidiary. Overall, the commitment of expatriate management was found to have a positive effect on the chances of


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survival of a wholly owned, jointly owned, or acquired foreign subsidiary. The use of expatriate managers could indeed reflect a commitment of the parent firm toward the success and development of the subsidiary. In a WOS investment, expatriates can ensure the proper implementation of the company’s systems, processes, and practices. In an acquisition, the goal may be one of effectively integrating the new subsidiary. In an IJV, expatriates can be used as a control mechanism and for both transferring and protecting the MNC’s proprietary and intangible assets. In short, such results could be interpreted as validating the use of the knowledge projection model observed in traditional MNCs. Our analyses also support the impact of intangible and experience-based assets on subsidiary stability. Consistent with Delios and Beamish (2001), the presence of firm-specific intangible assets such as R&D assets appeared to increase the chances of subsidiary survival. The second dimension of intangible assets, advertising intensity, was not found to have any significant effect. Our results may imply that marketing expertise, high advertising expenses, and the associated brand recognition are less fungible than technology capabilities. In fact, marketing capabilities can be very location-specific (Anand & Delios, 2002). When entering a new market, foreign firms typically rely on their technological assets to overcome marketing disadvantages (Hamel et al., 1989), rather than to exploit marketingbased advantages. Japanese firms are even known to replace their domestically developed brand names with locally adapted ones (Hennart, 1991). Therefore, the MNC’s technological capabilities have a greater impact on the outcome of foreign investment. The role of organizational experience varied depending on the type of experience. In particular, the accumulation of host country and mode experience is typically correlated with subsidiary termination. There may be several explanations for this. First, it may be that beyond a certain experience level, firms should not be using “expensive” expatriates to such an extent. As firms acquire experience with managing an entry mode (WOS, IJV or acquisition), they develop the ability to better assess performance and to terminate subsidiaries when required. Our results might also be explained by the composition of our sample, which included a large proportion of IJVs. Host-country experience relates to the external benefits of accumulating operating experience and the development of the external capabilities of the firms (Cyert et al., 1993). With experience, firms develop a better understanding of their environment, market, and customers; they acquire local knowledge. Inkpen and Beamish (1997) suggested that the foreign partner’s ability to acquire knowledge about the local environment might alter the relative bargaining power of the partners. Such changes may reduce the foreign partner’s dependency on the IJV, destabilize it, and ultimately result in its termination. Accumulating host-country experience may reduce the competitive

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disadvantage of foreign firms but may also reduce their need for a local partner. Indeed, the impact of host-country experience was more significant in IJVs than in other modes. In turn, a foreign market entry in an activity in which a firm has extensive industry experience typically enhanced the chances of subsidiary survival. Consistent with Li (1995), firms which stay in businesses in which they have experience or in their core business are more likely to see their ventures survive. In turn, foreign investments in businesses where the firm has little experience (or, in other words, was diversifying when expanding geographically) involve greater risks. Analyses of mode-specific experience provided some further evidence of the role of host country and industry experience. WOS or IJV experience in the subsidiary’s industry (an element of industry experience) typically increased the chances of survival. In turn, WOS and IJV experience in the subsidiary’s host country (an element of host-country experience) increased the chances of termination. The results regarding expatriates, organizational experience, and intangible assets lead us to address the role of expatriates as complex knowledge carriers. In particular, our results suggest that the possession of intangible and experiencebased assets is not sufficient to explain subsidiary survival. In the presence of such assets, relying extensively on expatriate managers increased the likelihood of survival. In addition, the use of expatriates appeared to be an effective mechanism for dealing with the host-country environment uncertainty resulting from extensive psychic distance. In environments characterized by considerable cultural distance and limited openness to foreign investments, expatriates emerged as a stabilizing force in foreign subsidiaries. Such results were especially evident in WOS and IJVs where the transfer of firm-specific assets would be expected to be critical for the success of market entry. Overall, such results would support the knowledge projection model in MNCs. However, results related to the importance of expatriates in transferring organizational experience and increasing the chances of survival lead us to question the robustness of this contention. Globally, reliance on expatriates was found to enhance the chances of survival only in the presence of industry experience. In other words, the transfer of industry-specific knowledge through expatriates would increase the chances of success in foreign entry. Similarly, expatriate managers may be efficient knowledge carriers when firms have mode-specific experience in a country. When a firm had the opportunity to proceed with an IJV or an acquisition in a given country before, the use of expatriates appeared to affect positively survival. This also means that a new subsidiary has a greater chance of survival when a firm has applied the same entry mode before and uses this experience appropriately. Local mode experience does matter in this regard.


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Still, the combination of experience and expatriate management was found to have negative or limited impact on subsidiary survival in several situations. For instance, in the presence of host-country experience, the use of expatriates has either a positive or negligible impact on survival overall and in all entry modes.

Limitations of the “Co-Location/Projection” Model Our study may serve to highlight some limitations of the “co-location/projection” model. The transfer of headquarter-centralized experience through home-country expatriates may have a negative effect on the stability of a foreign subsidiary. Expatriates can be used for a variety of reasons as we know, from control mechanism to knowledge diffusion. Still, their use consumes resources. They represent an important organizational resource commitment, in their development and their utilization. Resorting to expatriates is also risky, as a large proportion of mandates result in failure or early repatriation. Except for industry experience and prior local experience with the mode, expatriates do not seem to carry other types of experience with any significant degree of efficiency. This finding raises a question about the efficiency of the “co-location/projection” model. Sending experts abroad to broadcast headquarters experience appears economically useful only for very specific types of experience. But, at the same time, expatriation in itself globally increases the chances of subsidiary survival. An explanation can be given to this apparent paradox. Japanese MNCs may be sending expatriates abroad for control purposes more than for knowledge purposes. Individual managerial qualities and the ability to diffuse organizational practices and procedures may be seen by these MNCs as more important than the capacity to transfer country or entry-mode experience. Carlos Ghosn, CEO of Renault-Nissan, selected French managers to accompany him in Japan. His choice was primarily based on personal qualities; while experience was considered as something beneficial, it could not be substituted for personal qualities (Emerson, 2001). If these assumptions were corroborated, it would mean that the “co-location/projection” model is neither used to broadcast knowledge nor grounded in MNCs’ practices. Therefore, the relevance of this model to explain MNC competitiveness is not yet proved. Further research is needed on this proposition. We recommend not only to test the same assumptions on different populations of MNCs, but also to take into account the limitations of our study. This study focused on the use of home-country expatriates and did not include third-country expatriates, a rising phenomenon in international business, even if it is not current practice in Japan. Furthermore, a more fine-grained design could be useful for measuring knowledge complexity.

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In our framework, we show that, in general, the diverse types of experiences are of endemic or existential nature, and consequently that transfer should be people-based. More precise measurement could help in evaluating experience complexity and could consider both codification and expatriation as transfer mechanisms. Such improvements would reveal whether alternative learning mechanisms are substituted for expatriation to diffuse knowledge. In addition, one limitation of our research resides in the use of survival as the sole performance measure. Future studies could use performance measures other than survival to explore the robustness of our findings to alternate measures of performance. The limitations associated with survival are especially evident for IJVs. It is indeed possible that terminated IJVs had been replaced by other organizational modes.

CONCLUSION In this research, we deployed a knowledge-based perspective to identify conditions in which expatriate staffing is likely to increase the chances of survival for Japanese MNCs foreign subsidiaries. Our findings suggest that the knowledge lens, certainly among other considerations, helps in deciding whether to send experts abroad but also raises questions about the efficiency of the “co-location/projection” MNC model. We studied Japanese MNCs practices because these firms land to adopt this co-location/projection model. While our choice can be considered as logical, it is worth noting that an alternative model is nowadays applied by some cuttingedge firms. According to Doz et al. (2001), the traditional conception of knowledge transfer cannot provide any competitive advantage in industries where multiple MNCs compete worldwide. They describe the “metanational” firm as a possible response to this new context. The “metanational” company has acknowledged that skills, capabilities, and innovation can be found anywhere, in or around any subsidiary of the group. Such a company does not differentiate units in term of “centers” and “periphery.” Any unit can become an innovator whose knowledge would benefit the other units. If this “metanational” perspective is largely adopted by firms in the future, our knowledge framework will need to be revised. Instead of analyzing expatriate staffing, researchers will have to investigate the transfer of skilled employees between any unit of the group, not just expatriation or impatriation. The survival of a new subsidiary will not be solely linked to transfer of headquarter experience, but could be associated with experience coming from another subsidiary. Further, HR policies may become increasingly complex when the company seeks to optimize the diffusion of experience and innovation from anywhere to everywhere.


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As far as endemic or existential knowledge is concerned, HR managers will have to organize numerous transfers of experts between units, shorter or longer periods of time. Organizing assignments is likely to become a very complex task. Exploring inherent new practices and their relevance for the competitiveness and long-term performance of the MNC is surely one of the most appealing future research routes to emerge from our study.

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