Multinationals and Emerging Economies: The Quest for Innovation and Sustainability

Multinationals and Emerging Economies INNOVATION, CO-OPERATION and DEVELOPMENT Series Editors: Wilfred Dolfsma, Profe...

Author: Wilfred Dolfsma | Geert Duysters | Ionara Costa

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Multinationals and Emerging Economies

INNOVATION, CO-OPERATION and DEVELOPMENT Series Editors: Wilfred Dolfsma, Professor of Innovation, University of Groningen, the Netherlands and Geert Duysters, Professorial Fellow, UNUMERIT Maastricht University, the Netherlands In recent years two connected realizations have dawned upon scholars studying economic development: innovation is indispensible for development and, crucially, successful innovation depends upon co-operation. Monographs and edited volumes in this series will explore this theme theoretically and empirically, studying the developed world as well as emerging and developing economies. This is the first series to bring together a range of different perspectives that explore different aspects of innovation, co-operation and development. Containing cutting-edge research with a multi-disciplinary approach, the books in this series will be of great interest to scholars, practitioners and policymakers working in these fields.

Multinationals and Emerging Economies The Quest for Innovation and Sustainability

Edited by

Wilfred Dolfsma Professor, University of Groningen, The Netherlands, and corresponding editor of the Review of Social Economy

Geert Duysters Scientific Director, Maastricht University India Institute, Professorial Fellow, UNU-MERIT and Professor of Innovation Management, Eindhoven University of Technology, The Netherlands

Ionara Costa UNU-MERIT, Maastricht University, The Netherlands

INNOVATION, CO-OPERATION AND DEVELOPMENT

Edward Elgar Cheltenham, UK • Northampton, MA, USA

© Wilfred Dolfsma, Geert Duysters and Ionara Costa 2009 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA

A catalogue record for this book is available from the British Library Library of Congress Control Number: 2009928600

ISBN 978 1 84844 008 1 Printed and bound by MPG Books Group, UK

Contents List of figures, tables and boxes List of contributors List of abbreviations Preface

vii ix xi xiv

Introduction Ionara Costa, Wilfred Dolfsma and Geert Duysters 1

Multinationals are multicultural units: some indications from a cross-cultural study Nantawan Noi Kwanjai and J. Friso den Hertog

1

6

2

The innovativeness of foreign firms in China Branka Urem, Ludovico Alcorta and Tongliang An

23

3

New Europe’s promise for life sciences Sergey Filippov and Kálmán Kalotay

41

4

Facing the trial of internationalizing clinical research to developing countries: evidence from Mexico Fernando Santiago-Rodríguez

58

Intermezzo I. Do multinationals matter for emerging markets, or vice versa? 75 Rajneesh Narula 5

6

Strategic motivations for international alliances: the Chinese perspective Tina Saebi and Qinqin Dong

78

Cross-border investment and economic integration: the case of Guangdong Province and Hong Kong SAR Naubahar Sharif and Can Huang

92

v

vi

7

8

Multinationals and emerging economies

The ‘making of’ national giants: the international expansion of oil companies from Brazil and China Flavia Carvalho and Andrea Goldstein

111

Beyond the emission market: Kyoto and the internationalization of firms from the waste industry Asel Doranova, Geert-Jan Eenhoorn and Ionara Costa

127

Intermezzo II. Emerging knowledge economies Jojo Jacob and Luc Soete

144

9

Changing configuration of alternative energy systems Radhika Perrot

149

10

Serving low-income markets: rethinking multinational corporations’ strategies Shuan SadreGhazi and Geert Duysters

Index

166

183

Figures, tables and boxes FIGURE Figure 6.1

Foreign direct investment in Guangdong, 1985–2006

94

TABLES Table 2.1

Table 2.2

Table A.2.1 Table 4.1 Table 4.2 Table 6.1

Table 7.1 Table 10.1

Innovations of high novelty by nationality of firm ownership, propensity indicators (% of number of firms) Innovations of high novelty by nationality of firm ownership, intensity indicators (% of number of firms) Descriptive statistics Distribution of clinical trials by main countries and regions, 1948–2008 Mexico: main causes of death, 2000–2005 Average annual TFP growth rate of state-owned, collective, shareholding, and foreign enterprises in Guangdong Province (percentage), 1997–2006 Chinese and Brazilian oil companies at a glance BOP population and income

32

33 40 63 65

102 116 169

BOXES Box 5.l Box 6.1 Box 10.1 Box 10.2

Chinese strategic motives to enter international alliances Formation of variables for TFP calculation Overcoming the low purchasing power barrier Understanding and accommodating expected functions vii

85 99 174 175

viii

Box 10.3 Box 10.4 Box 10.5


Marketing in remote locations Educating users and overcoming lack of awareness Effect of low-income market characteristics on multinationals’ activities

176 177 179

Contributors Tongliang An, Nanjing University, Jiangsu, China Ludovico Alcorta, Director, Research and Statistic Branch; Programme Coordination and Field Operations Division – UNIDO Flavia Carvalho, PhD Candidate, United Nations University – MERIT Ionara Costa, Researcher, United Nations University – MERIT Wilfred Dolfsma, Professor of Innovation, University of Groningen, the Netherlands Qinqin Dong, PhD Candidate, Wuhan University of Technology, China Asel Doranova, PhD Candidate, United Nations University – MERIT Geert Duysters, Professorial Fellow, United Nations University – MERIT Geert-Jan Eenhoorn, Manager, Carbon Assets, Energy and Climate Strategy – Ecofys Sergey Filippov, PhD Candidate, United Nations University – MERIT Andrea Goldstein, Senior Economist, OECD Development Centre J. Friso den Hertog, Professor, United Nations University – MERIT and Maastricht University Can Huang, Researcher, United Nations University – MERIT Jojo Jacob, Researcher, United Nations University – MERIT Kálmán Kalotay, Economic Affairs Officer, UNCTAD Nantawan Noi Kwanjai, PhD Candidate, United Nations University – MERIT Rajneesh Narula, Professor of International Business Regulation, University of Reading, UK Radhika Perrot, PhD Candidate, United Nations University – MERIT Shuan SadreGhazi, PhD Candidate, United Nations University – MERIT ix

x


Tina Saebi, PhD Candidate, United Nations University – MERIT Fernando Santiago-Rodríguez, PhD Candidate, United Nations University – MERIT Naubahar Sharif, Assistant Professor, Division of Social Science, The Hong Kong University of Science and Technology Luc Soete, Director, United Nations University – MERIT Branka Urem, PhD Candidate, United Nations University – MERIT

Abbreviations AMIIF AN ARCO BMIS BO BP CANIFARMA CARB CCINSHAE CDM CEE CEO CER CFCs CIS CIT CNG CNOOC CNP CNPC CO2 COFEPRIS CRO CSN CVCC CVRD EPA EU FDA FDI

Asociación Mexicana de Industrias de Investigación Farmacéutica (Mexico) Agência Nacional do Petróleo (Brazil) Atlanta Richfield Oil Company Bioresearch Monitoring Information System Base of the pyramid British Petroleum Cámara Nacional de la Industria Farmacéutica (Mexico) California Air Resources Board Comisión Coordinadora de Institutos Nacionales de Salud y Hospitales de Alta Especialidad (Mexico) clean development mechanism Central and Eastern Europe chief executive officer certified emission reduction chlorofluorocarbons community innovation survey Commission on Innovation and Technology (Hong Kong) compressed natural gas China National Offshore Oil Company Conselho Nacional do Petróleo (Brazil) China National Petroleum Corporation carbon dioxide Comisión Federal para la Protección contra Riesgos Sanitarios (Mexico) contract research organization Companhia Siderúrgica Nacional (Brazil) compound vortex controlled combustion Companhia Vale do Rio Doce (Brazil) Environment Protection of America European Union Federal Drug Administration (US) foreign direct investment xi

xii

GCP GDP GHG GLP HAWT HKD HKSAR HRM IC ICH ICT IEA IMF IMSS IND INEGI INPI IOCB IPM IRB ISSSTE ISWA IT ITF JI KW LNG M&As MD MNC MW N2O NCEs NGO NHI NIH NLM NOCs NREL


good clinical practices gross domestic product greenhouse gas good laboratory practices horizontal-axis wind turbine Hong Kong dollars Hong Kong Special Administrative Region human resource management internal combustion International Conference on Harmonization information and communication technologies International Energy Agency International Monetary Fund Instituto Mexicano del Seguro Social (Mexico) investigational new drug Instituto Nacional de Estadística, Geografía e Informática (Mexico) Instituto Nacional de Propriedade Industrial (Brazil) Institute of Organic Chemistry and Biochemistry (Czech Republic) integrated pest management Institutional Review Board Instituto de Seguridad y Servicios Sociales para los Trabajadores del Estado (Mexico) International Solid Waste Association information technologies Innovation and Technology Fund (Hong Kong) joint implementation kilowatts liquefied natural gas mergers and acquisitions managing director multinational corporation megawatts nitrous oxide new chemical entities non-governmental organization National Health Institutes (Mexico) National Institutes of Health (US) National Library of Medicine national oil companies National Renewable Energy Laboratory

Abbreviations

OECD OEM OLI OLS OPEC PPP PROÁLCOOL PURPA R&D SINAIS Sinopec SS TCSDD TFP UFRJ UN UNCTAD UNDP UNEP UNFCCC UNICAMP US USD USPTO UTC VAWT VP WRI WTO ZEV

xiii

Organisation for Economic Co-operation and Development original equipment manufacturing ownership, location and internalization ordinary least square Organization of the Petroleum Exporting Countries purchasing power parity Brazilian Program of Alcohol Public Utilities Regulatory Policy Act (US) research and development Sistema Nacional de Información en Salud (Mexico) China Petroleum and Chemical Corporation (China) Secretaría de Salud (Mexico) Tufts Center for the Study of Drug Development total factor productivity Federal University of Rio de Janeiro United Nations United Nations Conference on Trade and Development United Nations Development Programme United Nations Environment Programme United Nations Framework Convention on Climate Change State University of Campinas United States US dollars United States Patent and Trademark Office United Technologies Corporation vertical-axis wind turbine vice president World Resources Institute World Trade Organization zero emissions vehicles

Preface This volume emerged from the ongoing research meetings at UNUMERIT (United Nations University – Maastricht Economic Research and training center for Innovation and Technology). Revolving around the themes of innovation, global business strategies and host country development, these meetings culminated in a workshop in November of 2007 on the theme summarized by the title of this volume. Junior scholars at the cutting edge of research on the role of multinationals for development, innovation and their combined impact on sustainability together with scholars who in the recent past have and will in the future continue to have a defining role joined together to discuss. Many of these contributions have found a place in this volume in some way, but some have not although they have contributed to the meetings and thus to the volume, and so, Ivan Kulis, Rajesh Kumar, Sarianne Lundan, Anabel Marin and Lynn Mytelka deserve a special word of thanks.

xiv

Introduction Ionara Costa, Wilfred Dolfsma and Geert Duysters MULTINATIONALS For long periods of time, in both policy as well as scholarly circles, multinational corporations were approached with quite a bit of suspicion, especially in relation to the effects of their behaviour for developing countries. With their quintessential reach into many different countries, multinationals can tap into a broad set of resources. As a consequence, their intentions were questioned, their workings were deemed inherently hurtful to developing countries, and especially to the very poor living there, and they were believed to offer goods and services that hurt rather than benefit the interests of consumers in the countries hosting their subsidiaries. Whether or not these claims ever held water, and despite the fact that some still believe these claims hold true, the situation seems to have changed in recent times. Especially in recent years, the contribution of multinational enterprises is not just noticeable through international production activities or in the impact of their activities on such macroeconomic variables as financial flows and trade. Multinationals are now seen as being potentially able to contribute to the economic as well as technological development, particularly of those developing and emerging economies. The explanations for such a dramatic change are to be found in the transformations of the world economy over the last 20 years or so, in the evolution of the multinationals themselves, and in how these two movements interact with one another. Innovation is one of the main, if not the most, important sources of unique resources or assets that shape the competitive advantages of multinational corporations ‒ their so-called firm-specific or ownership advantages. Notwithstanding the crucial role of the institutional and systemic conditions under which the innovation process takes place at country level, firms are the main locus of innovation (Nelson and Winter, 1982). Yet, it is possible to exploit, sustain and improve the firm-specific advantages that propel multinationals’ expansion worldwide. Although the size of multinationals may mean that not all information and knowledge 1

2


is optimally shared within each of them, their formal and hierarchical structure does tend to promote specialization. A divisional set-up ensures that individuals and groups within multinationals may be more likely to interact and exchange relevant information than they would have been on opposite sides of organizational boundaries. Multinationals have been able to develop a deep and extensive knowledge base. The expansion of multinational firms far beyond the borders of their original home markets, as global actors par excellence, is partly driven by the creation and diffusion of technological knowledge within firm boundaries. Innovating at the global level, yet local in the sense of staying within the firm. Some multinationals have rearranged their R&D activities, offshoring these activities primarily, so far, to adapt products developed in the central R&D Lab to local market conditions. The knowledge and other resources multinationals can draw on may include those that can assist in making sure that any economic or technological development they contribute to is sustainable as well. As key players of the global innovation process multinationals are active in defining the global frontier of technological knowledge. As the main creators of (industrial) technologies, multinationals represent an important channel for the diffusion of technologies and innovations across national borders. The importance attached to innovation as driver of sustainable growth has been central in turn in a number of countries’ economic policies to multinationals. Countries and firms ‒ multinationals or otherwise ‒ have pursued innovation as their engine for their sustainable growth. This quest for both innovation and sustainability can be assumed as the central link between multinationals and national economies. Sometimes the two goals may not be compatible, but sometimes they may. Particularly relevant in this regard is the link between multinationals and the so-called emerging economies.

EMERGING ECONOMIES Having foreign multinationals within the national border, or having local firms that ally with multinationals, is a familiar experience to countries worldwide. In relation, the rapidly growing economies of Asia, eastern parts of Europe and Latin America have drawn quite a bit of attention. Emerging economies have seen in innovation a way to catch up with the world’s most advanced countries. Much is expected of them for their inhabitants as well as for the world economy as a whole. They may, for instance, reduce the extent to which a stable economic situation globally is dependent on just one or a few economies. They may be sources of technological development and economic growth and they may alleviate poverty and inequality.

Introduction

3

As such countries become more important, however, use of the term ‘emerging economies’ may begin to feel inappropriate. In absolute terms, for instance, the Chinese economy is among the largest economies already, albeit not in terms of income per capita. Capitalization of some Chinese companies ranks them among the biggest ones in the world too ‒ this cannot be attributed only to idiosyncrasies of Chinese capital markets or Initial Public Offering policies and related financial markets regulation faced by those firms. Examples include PetroChina, Lenovo and Sinopec in China, Arcelor-Mittal, Mahindra & Mahindra and Tata from India, Vale, Petrobras and Embraer from Brazil, and CEMEX, Grupo Alfa and Grupo Bimbo from Mexico. A similar problem of definition arose when Japan rose to economic prowess. While assimilating one country under the umbrella of ‘western’ countries and economies, doing so for whole swathes of them would make the term ultimately meaningless. Using the arguments to include Japan in the G8, for instance, will no longer do without making the institution unwieldy. It raises the issue of how to structure a governance model to take care of supra-national affairs (The Economist, 2008). Multinationals are bound to play an important role in this.Increasing interdependencies of countries and economies across the globe is not only evident from an economic and technological perspective; social and ethical responsibilities cannot be ducked by multinationals. This holds for how clinical trials are undertaken, for how dire poverty in the bottom of the pyramid is to be tackled. Some, indeed quite a few, multinationals are aware of this and are actively involved. Some see such considerations as a fringe phenomenon, perceiving it as something that they are required to do in order to show some kind of corporate (social and environmental) responsibility. Others are more centrally involved and, thus, seek to make a profit, at least at some point, in developing and emerging economies while minding the social and ethical considerations faced. While Albert Hirschman (1982) hinted at the effects of market on society being civilizing, destructive, or feeble as a theoretical question, we suggest that the answer is very much dependent on empirical circumstances and choices by actors involved. Multinationals and national governments play an important role here.

INNOVATION AND SUSTAINABILITY The quest for innovation and sustainability is at the heart of concerns among different groups of actors in the current globalization era (Freeman,

4


2003). Policymakers, business community, scholars and so forth recognize innovation as the crucial driver of competitiveness and economic development. Innovation may both clash with and encourage the sustainability of the economic processes in an environmental and social sense ‒ partly depending on the institutional context in an emerging economy. Innovation has been defined from different perspectives. In essence, it is understood as a change resulting from the creation of new technological knowledge and its introduction into the market. Stricto sensu, innovation represents a change in relation to the world market, and a true novelty at the edge of the world technological frontier (Kim and Nelson, 2000; Bell and Albu, 1999). The developmental impacts of an innovation depend on the level of novelty and originality of the (technological) change it implies to the market and to the knowledge frontier, and on the systemic environment under which it takes places. The ability of countries and their institutions and organizations, firms particularly, to introduce innovations into the global market in a sustained manner is at the core of the matter in explaining the gap between developed and developing economies. Hence, innovation is the key element for the catching up of countries lagging behind in the global economy. Sustainability refers to a cumulative and persistent trajectory of growth, at economic level ‒ the economic sustainability or at firm level ‒ the business sustainability; an inclusive growth trajectory that yields benefits to people at different levels of social position, both within countries and worldwide ‒ the social sustainability; and a growth trajectory that recovers and preserves the natural environment, and is well balanced in terms of exploitation of natural resources ‒ the environmental sustainability. In all of these senses, sustainability can be linked to the cumulative and path dependent nature of the innovation process (Nelson and Winter, 1982). If developing economies, the emerging one in particular, are to catch up with the developed ones, they are to reach a sustainable innovation process, economically, socially and environmentally. Multinationals are due to play a part in it.

THIS VOLUME This volume sheds new light on these connections, bringing together insights from business studies and economics. It provides novel and profound analyses of how multinational corporations and emerging economies are related to one another, and how this relationship is implicated in the dynamics of the global economy. It combines the perspectives of both firms and countries; it addresses multinationals from developed as well as emerging economies; and deals with sustainability in an environmental

Introduction

5

and a social sense as well as keeps an eye for the strategic choices that multinationals face. Moreover, it combines concise theoretical discussion with empirical analyses of unique data, quantitative as well as qualitative. The chapters have all been discussed extensively in a series of regular seminars involving the editors and the authors of the chapters, as well as during a one-day workshop at UNU-MERIT in November of 2007. By having a firm basis in empirical knowledge and analyses, chapters in this volume offer valuable insights on the multifaceted role multinationals have to play in the economic development of emerging countries. Two intermezzi, authored by internationally well-known scholars who are experts in the field, provide the kind of backdrop and critical note that readers might find valuable.

REFERENCES Bell, M. and M. Albu (1999), ‘Knowledge systems and technological dynamism in industrial clusters in developing countries’, World Development, 27(9),1715‒34. Freeman, C. (2003), ‘A Schumpeterian renaissance?’, SPRU electronic working paper series no. 102. Hirschman, A.O. (1982), ‘Rival interpretations of market society: civilizing, destructive, or feeble?’, Journal of Economic Literature, 20,1463‒84. Kim, L. and R. Nelson (eds) (2000), Technology, Learning and Innovation: Experiences of Newly Industrializing Economies, Cambridge: Cambridge University Press. Nelson, R.R. and S. Winter, S. (1982), An Evolutionary Theory of Economic Change, Cambridge, MA: Harvard University Press. The Economist (2008), ‘What a way to run the world’, July 3.

1.

Multinationals are multicultural units: some indications from a crosscultural study Nantawan Noi Kwanjai and J. Friso den Hertog

INTRODUCTION Academic and policy discourse on multinational corporations has been prolific in both economic and management communities with substantial interdisciplinary influences, notably of the former on the latter. A side effect of the dominance of economic thinking in the discourse on multinationals is a sore lack of attention on one fundamental element of multinational corporations, namely culture. Culture, although not entirely ignored in economics, has never been given a rigorous attention (DiMaggio, 1990; Fernández, 2008; Guiso et al., 2006). Treatment of culture in economics, in brief, is still in elementary state. For this, management thinking may return the favour and inject an inspiring influence. This chapter makes a case for the value of looking at culture and multinationals from a management and organizational perspective because it is one that could direct greater attention towards culture as a significant factor in future investigation on multinational corporations. This is because multinationals are fundamentally multicultural units in more ways than one, as we attempt to illustrate in this chapter. Culture permeates many aspects of a multinational and to ignore, put aside, or downplay its role may render our understanding of multinational corporations inexcusably simplistic and critically incomplete. This chapter is based on selected materials from a qualitative study of culture and learning in organizations and management that was informed primarily by the interpretative paradigm of inquiry (Kwanjai, forthcoming). The study investigated four selected subsidiaries of Dutch multinationals located in Thailand using evidences collected through observations and open-ended interviews. All evidences were analysed under grounded theory procedure (Corbin and Strauss, 1990; Glaser and Strauss, 1967; Locke, 2001; Strauss and Corbin, 1998). A grounded theory of cultural 6

Multinationals are multicultural units

7

intelligence, by the name of ‘cross-cultural intelligence amid intricate cultural webs’ became the key outcome of the study. The chapter begins with two cultural riddles from one of the cases in the study ‒ the Dutch multinational ADT1 ‒ as a backdrop for subsequent discussions. Following the riddles is an abridged version of the key finding of the study ‒ the aforementioned grounded theory of cross-cultural intelligence. Then the two riddles are revisited, this time to illustrate how the proposed theory could illuminate an understanding of their covert meanings vis-à-vis culture and learning in multinationals. Last, we reinstate how our study and its theoretical and empirical findings can elucidate the central thesis that multinationals are essentially multicultural units.

CULTURAL RIDDLES OF DEADLINE AND MISTAKE Deadline: dead or alive? Take the routine case of setting up a delivery schedule, for example. Khun2 Joeri, ADT’s VP of sales and marketing, always presented himself to the Thai subsidiary as their biggest customer. In a typical Dutch tradition, Khun Joeri believed that he only needed to make his wishes clear and then there should be no question about the delivery to fulfil those wishes. As a production manager/HRM, Khun Maleewan was directly responsible for scheduling the resources, physical as well as human, so that production could be done to meet delivery requirements, vis-à-vis quantity, quality and time. ADT itself served a client-base that was very demanding and competed in a computerized technology market, which changed so rapidly that stockpiling was not a viable solution. Put simply, the clients wanted the right products, at the right time, with the right quality. What this meant to Khun Joeri was that once a commitment was made for a delivery, it had to be delivered as and when committed. Delivery schedule for Khun Joeri was thus a deadline with the emphasis on dead. Khun Maleewan knew this of course and always tried to set a production schedule so that it matched with Khun Joeri’s expectation. For the Thai subsidiary, however, that commitment could be no more than a delivery schedule ‒ as an intended date of completion, or a point of reference. Khun Pim, the manager director (MD) of the Thai subsidiary, on his part, could only trust that Khun Maleewan and her team would try their very best to keep to that point of reference.

8


Unfortunately, things did not often go as scheduled and the delivery dates had to be rescheduled ‒ sometimes more than once. At the Thai subsidiary, this was a matter of working harder to meet the new point of reference. However, for Khun Joeri this could spell disaster. He needed to deal with anxious or, more often than not, disgruntled customers worldwide. He might even need to take costly action to keep the deadline alive, such as having the shipment delivered by expensive air cargo across continents instead of cheaper sea freight. This dented the profit margin and did not reflect well on sales and marketing. As it was, Khun Joeri and Khun Kees, the ADT’s CEO, faced pressure from the clients everywhere and everyday to deliver on schedule. How could this pressure be felt just as acutely at the Thai subsidiary, so that delivery schedule would translate into delivery deadline to them? Khun Pim had experienced that kind of pressure before, so he knew how it felt. Yet, everyday, he also witnessed how hard his staff tried to do their job and he learned that putting pressure on the staff was not really the Thai way of getting results. At the same time, Khun Maleewan also felt the pressure. She knew full well that when Khun Joeri, who was as blunt as blunt could be, said he wanted things delivered, it must be delivered and she tried her best to keep to the estimates. Still, she could only push the factory so far. The production was these people’s jobs, yes, but it was not their lives. She knew that in Thailand people worked to live, not vice versa. She wished the schedules could be a tad more flexible as reference points, rather than the deadlines that the Dutch made them out to be. How could everyone be served and pleased at the same time? How could the delivery deadline and schedule be synchronized? Mistake: three strikes and you’re out? Murphy’s Law governed the ADT’s Thai subsidiary once in a while, that was to be expected. Nobody at ADT had the unrealistic expectation that mistakes would not be made. Still, mistakes could bring complications that were beyond their simple direct consequences. The question was how should one deal with mistakes? ADT had a strict policy that the sales and marketing department must be the only focal point of all communications with clients. This code of conduct was the key to keep ADT’s tactical and strategic responses to the market as solidified and competitive as possible. Khun Joeri took this to be not only his main responsibility but also his crucial marketing tactic. He did not really mind dealing with the clients’ concerns. It did not matter where in the company the concerns were related to, be it design and development, production, or after sales support. To deal with


9

clients’ requests and complaints was after all part of Khun Joeri’s job. The information he got from such dealings could be used to improve future operation. In some cases, he could even use the situations to leverage his negotiation with the clients. If a client had any issue with ADT’s products or services, Khun Joeri and his team were there to deal with it. All in a day’s work. However, the clients sometimes did not really care to observe the ADT internal code of conduct, like in the case of a Singaporean client who took it upon himself to approach the ADT’s Thai subsidiary directly regarding his dissatisfaction with a particular shipment. To the client, this was the shortest route to having his concern addressed. The Thai staff at the factory who received the complaint were very embarrassed and anxious. They knew that they should tell the client to go to Khun Joeri but they suspected that the client was reluctant to do so for a combination of reasons. The client was in Asia and it was more convenient to contact the Thai subsidiary than the Dutch office. All that the client wanted was a direct, instant response he could get with a face-to-face meeting or simple phone call, without having to bother with time-zone difference or delayed e-mail communication. Moreover, most local clients preferred to deal with their local counterparts. To most Asians, it could be quite uncomfortable to approach, and deal with, the Dutch who were too far away and often too direct for them to cope with. To the Thai staff, it was their obligation to please the client and rectify the shameful situation that arose out of their domain. They did not even feel comfortable to refer the problem to Khun Pim, the MD. In the end, they tried their best to satisfy the client’s request exactly as asked. After all, such direct dealings were not uncommon in most Thai business operations. Why involve sales and marketing in the Netherlands when it was actually the Thai subsidiary’s fault? All’s well that ends well. Until Khun Joeri found out what happened. This made his job incredibly difficult. The Thai subsidiary was thus given a clear warning ‒ a written announcement from the top boss, Khun Kees, the CEO, who was not happy about the incident. ‘Please next time, if and when the factory get any request from a client, whoever that is, refer the customer to sales and marketing and do nothing else whatsoever until you hear from your biggest customer ‒ VP of sales and marketing.’ End of Act One. Act Two: a similar request from another local Asian client was addressed to the Thai subsidiary. This was followed again by a similar arrangement between the client and the Thai staff. Another very stern warning was issued and made clear to all parties. This time it was specifically stated that whoever disobeyed this policy again would be simply asked to take leave. Three strikes and you are out. End of Act Two.

10


Khun Pim did not want for Act Three to ever come about; he would feel greatly uncomfortable if he had to fire any of his Thai staff. He knew it was a common practice back in the Netherlands for such a reprimand to be issued and take effect. Yet he felt ill at ease seeing that stern treatment applied to the Thai staff, which he now considered his people. Although he realized that they had repeatedly violated an important code of conduct, he also believed that they were trying their best with the best intentions and might not take the reprimand as it was intended by headquarters. Something needed to be done to ensure that the best intention would equate the best practice. Intriguing questions remained. How could the best intention result in such unintended tension? Why was it that, for the same incident, the Thais focused purely on the mistake at the production line as a shame to be rectified with honour while the Dutch were more concerned with the guilty disciplinary violation and its consequences? How could the best intention be aligned with the best practice? What exactly was the mistake and was it a shame or guilt? Before we attempt to decipher these two cultural riddles, a roadmap to the analysis must first be drawn.

CULTURAL INTELLIGENCE Culture is a concept that defies a universal definition. Numerous conceptualizations of culture span several decades and disciplines since its inauguration in anthropology in the 1960s (Adler, 2002; Boyacigiller et al., 2004; Geertz, 1993; Groseschl and Doherty, 2000; Hofstede, 2001; House et al., 2004; Inglehart et al., 2004; Kroeber and Kluckhohn, 1963; Leung and Bond, 2004; Sackmann, 1991; Schneider and Barsoux, 2003; Schwartz and Sagiv, 1995; Trompenaars and Hampden-Turner, 1998). The conceptualization of culture in our grounded theory resonates with what has been previously put forward by Geertz (1993) and stands as yet one more variant for the meaning of culture. What emerged as the locus of culture in our theorizing are the sense-making process and the meanings that are the results of that process. Culture, under this locus, is thus a web of shared meanings that underlies two basic processes in social interaction: 1) cognitive process, which comprises sense-making and interpretation of all that a person encounters, be that material objects, social behaviours, or mental concepts, and 2) behavioural process, which comprises action, inaction and interaction, based on meanings given to the objects of that action, inaction or interaction. To wit, culture is a shared way of being and sense making that is unique to a distinct group of people and can distinguish that group from others.


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A cultural onion model The cultural onion model is a widely accepted conceptualization of the internal dynamics of culture (Adler, 2002; Hofstede, 2001; Schneider and Barsoux, 2003). Although there are as many variations of the cultural onion as there are cultural theorists, all variants of the model, including ours, share the following fundamental implications. Culture manifests itself in diverse ways, shapes and forms, ranging from the most visible to the least fathomable. These many diverse manifestations of culture can be likened to the many layers of an onion. The outer layers are the more easily seen and comprehended components of culture, such as material objects, costumes, verbal and non-verbal languages, or architecture. The inner layers are the less visible facets, such as institutions or cognitive attributes. Most theorists would go on to state that these layers are all related to one another in a particular fashion. The most frequently theorised relation, again ours included, is that the inner layers are the ones that influence the outer layers, and the innermost, namely the cultural core, bears significant illumination to all cultural influences. For our conceptualization, the cultural core is theorised to encompass the core meanings of self, others, the environment, and the relationship among these elements. Cross-cultural intelligence amid intricate cultural webs A grounded theory of cross-cultural intelligence amid intricate cultural webs3 is a theory of how a cultural unit (such as a person, group, organization, nation and so on) operates in a cross-cultural platform and as such could aid in analysis of cross-cultural phenomena. The key property of any cultural unit is its cultural identity, which comprises dynamic webs of cultures. A cultural unit, even an individual, usually belongs to or is made up of multiple cultures. The property of a cultural unit can thus be depicted as a cluster of many cultural onions. Most, if not all, cultural units will have many overlapping and oftentimes conflicting cultural layers from many cultural onions, thereby forming webs of cultures. When a cultural unit operates in a cross-cultural platform, it then must function also amidst other webs of cultures. By definition, cross-cultural platform itself is also a cultural unit, with its own webs of cultures in force since cross-cultural platform designates a social condition that comprises people from at least two distinct cultures. As such, any real world crosscultural interaction is intractably complex, because it invariably involves a multitude of competing meanings that are constantly in flux. To cope in such an intractably, non-deterministic situation, a cultural unit has

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to exercise what we theorized as cross-cultural intelligence ‒ the ability to manoeuvre the cultural webs effectively. The metaphorical concept of webs of cultures in brief signifies how any cultural unit is inherently multicultural by its very nature.

UNDERSTANDING THE CULTURAL RIDDLES OF DEADLINE AND MISTAKE: ADT AS A CULTURAL UNIT The study and its theorizing centred on what actually transpired. Hence, the very central unit of analysis was ADT’s Thai subsidiary, which was fundamentally a unique set of intricate cultural webs in itself, with multitude of competing meanings. For this study, it was the crossing of two distinct cultural units of the same level ‒ national, that was the primary crosscultural context: the crossing of Dutch and Thai cultures. This particular crossing of cultures thus became the exact spot where the theoretical lens zoomed in to expound upon. This section explores the underlying webs of meanings in these two cultures and identifies the potential competing meanings when the two cultures come into contact with each other. Core meanings: Dutch and Thai Analysis of the evidences in our study yielded a set of possible core meanings in the Dutch and Thai culture. Even at cursory glance, the contending nature of the two sets of meanings is interestingly evident. Not only do the two sets of meanings differ, they differ in quite a contrasting fashion. This is the first signal that the undercurrent of the two contrasting national cultures has a high potential to exert consequential influences, because it provides a rich ground for competing meanings. The following are elaborations on this observation. The meaning of ‘self’ First is the meaning of self, or in other words, the meaning of one’s existence. In Dutch culture, this is primarily defined by the individual him or herself, meaning you are what you make of yourself. Not surprisingly, the Netherlands scored very high in Hofstede’s individualism index ‒ with an index of 80 and a rank at the top 4‒5, on a par with Canada and only surpassed by the US, Australia and Great Britain (Hofstede, 2001:500). Yet, the Dutch’s view of self has its unique quality, in line with what has been theorized to be a major common Dutch trait: egalitarianism (van der Horst, 1996). As van der Horst inferred, the Dutch version of


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egalitarianism had its particular flavour, ‘[i]t advocates cultural individuality but not personal egoism’ (van der Horst, 1996:57). For the Dutch, the meaning of oneself is first and foremost a responsibility before it can turn into a right or privilege. You are responsible for your own significance but that does not mean that you are the only one that matters. Everybody is subject to this one responsibility and that is what makes for equality. You have to earn your meaning, in the Dutch eyes; you are not simply born deserving it. To repeat, you are what you make of yourself. The Thais, by contrast, tend to define the meaning of themselves based primarily on how they think other people view their existence. It is not that they do not take their own ideas of themselves into account, they do, but only after and in relation to what they deem to be the ideas other people have of them. Not surprisingly, Thailand scored in the opposite direction to the Netherlands in Hofstede’s individualism index ‒ an index of 20 and ranked towards the bottom half at 39‒41. Many analyses of Thai culture unanimously classified it as a collectivist society, where collective thinking exerts decisive forces on individuals (Atmiyanandana and Lawler, 2004; Holmes and Tangtongtavy, 1997; Komin, 1991; Mulder, 2000; Redmond, 2002). Komin’s (1991) interpretation of the Thai egoorientation described exactly how the Thai ego was shaped in a collectively oriented way, because by ‘ego oriented’ she meant highly conscious of selfimage. As such, for the Thais, self or ego is what is out there in the open, defined and revealed by how others treat and define you. In a nutshell, you are what people make of you. Holmes and Tangtongtavy (1997) gave an insightful view of how Thais would behave based on other people’s views. They theorized on the exact nature of others that Thais take into account under the framework of ‘the three circles of Thailand’ (Holmes and Tangtongtavy, 1997:39‒44), which classified the three spheres of social circles. From the most intimate one ‒ the family circle, to the not intimate but important one ‒ the cautious circle, to the negligible one ‒ the selfish circle. They elaborated on how Thais would behave differently when operating in each of these circles. Their observation sheds interesting light on how Thais define the meaning of themselves. How a typical Thai takes into account what other people think of him or herself, depends very much on which of these circles those others belong to. How a family member, which also includes someone you consider as virtually your family, thinks of you is meaningful but can be taken for granted. Those from the cautious circle, however, are ones whose notion of you must be cautiously cultivated and harvested. These are the people you interact with on a social or formal basis, at work, social functions, and so on. How the views of these others would contribute to the meaning of your existence, in turn, depends on who they are to you.

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How your boss sees you, contributes substantially to who you are at work and how you work. If he or she thinks well of you, then you are significant in your work function. The same can be said of your teachers, friends, colleagues and so on. Finally, the negligible others are those from the selfish circle, the circle where you can totally define your own ego without paying much attention to the views of these insignificant others. These are people who have no material or lasting influences on your life, and as such, what they make of you has no influence on the meaning of your existence in the Thais’ view. The meaning of ‘others’ The meaning of others in the Dutch and Thai cultures are logically related to the meaning of self. Generally, how the Dutch and Thais give meanings to others is a kind of mirror image of how they give meaning to themselves, although the process has its own slant and emphasis. The Dutch define the meaning of others by their conduct in a situation and in relation to what contributions their actions make to the situation. In a way, this is also rooted in the egalitarian spirit of the Dutch culture ‒ each person is judged based on how he or she is and acts, individually. It also relates very much to the Dutch utilitarianism as identified by van der Horst (1996). For the Dutch, those who contribute positively to a situation are people whose existence bears valuable meaning. The opposite is of course true when their acts contribute negatively to a situation. Thus, the Dutch judge people based on what they do and the contributions that they make. The Thais, on the other hand, are first and foremost concerned with what role a person has and how he or she fulfils that role. The meaning of other people is first defined by looking at who they are in a situation. The role of each person in a situation has to be established first, before one knows how to address and interact with each individual one meets. There is, however, more than a simple rule of hierarchy in the Thai webs of meanings. Again, the framework of the three circles of Thailand provides an elucidation. The Thais see meanings in others, first and foremost, based on which circle those others belong to. Within each circle, there are a set of roles, each of which has its own specific rank, status, behaviour, contribution and so on, or in brief, the total meaning of a person in that role. What role a person takes in a particular situation is then based on a combination of diverse factors ‒ initial birth condition, age, gender, education, social status, achievement, responsibility, task and so forth. Once roles are established in a situation, Thais would then see others based on how they fulfil their particular roles. Certain expectations of character and behaviour are always associated with each role. In general,


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the higher in rank a role is, the more superior quality is expected. Role definition is then set against role fulfilling and, when the two do not correlate in a person, the meaning of that person diminishes significantly. In the work place, for example, a boss is expected to be superior in all aspects of character and behaviour. He or she is supposed to know best, act kindly but decisively, make good decisions, lead with confidence, take responsibility, be morally and ethically sound and so forth. If a boss does not fulfil these expectations, a Thai subordinate tends to think less of him or her. A subordinate, by comparison, has a different set of expectations to fulfil. In general, a subordinate does not need to know best but must follow orders well and be loyal to the boss without a speck of doubt. Loyalty usually implies defending the boss’s honour, or face, as if it were one’s own. The meaning of ‘environment’ The Dutch and the Thais look at the environment, again, in a starkly contending way. For the Dutch, the environment is simply a given whose value must be explored and exploited. By explore we mean a practical survey to evaluate the situation and by exploit we mean to make the best possible use of what is given. This applies to all aspects of environment. Thus to the Dutch, natural environment serves a functional purpose and must be managed to the best of its potential. The famous Dutch dykes and other ingenious ways to make use of land and water are testimonials to this spirit and often used to characterise the Dutch utilitarian view of their physical environment (Hampden-Turner and Trompenaars, 1993; van der Horst, 1996). The Dutch treat abstract environment in the same fashion. Time and space are truly scarce resources to the Dutch, they serve functional purposes and must be managed and used efficiently. Punctuality is a virtue in Dutch culture because time is precious and must be well observed. The deadline episode at ADT is a classic illustration of how the Dutch view time and how that view can cross with the meaning of time in other cultures, as will be duly elaborated on. The Thais, by contrast, take environment as a gift, to be thankful for and revered. Natural environment is deemed sacred and animate; there are gods for all various natural artefacts ‒ rivers, mountains, valleys, forests, rain, drought, the sun, moon, stars, sky and so on. Countless rituals are associated with how Thais look at natural environments not as physical objects but animated entities. Abstract environment is regarded by Thais in a similar fashion. Time is regarded as a part of life, it is a mere point of reference and its meaning is relative. As Klausner observed: ‘the Thai are adverse to being slaves to the clock’ (Klausner, 1993:334). Time, in other words, is part of what transpires and not a dictate of them. In fact, Thais tend to regard haste as something that could lead to undesirable results,

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such as mistakes and accidents. No wonder, at ADT, deadlines for Thai employees were neither definite nor critical; they were mainly points of reference. As for space, Thais regard this as part of nature and so their view of space is similar to how they view natural environment. The Thai concept of space is very similar to the Chinese concept of feng shui even though they do not subscribe to meticulous practices as do the Chinese. Interpreting the cultural riddles The above set of potentially contending core meanings in the Dutch and Thai cultures gives rise to great possibilities that the two cultures will give meanings to many concepts, entities or acts, not just in different manners but more so in a divergent fashion and hence most likely to bear significant force in the crossing of the two cultures. It must be mentioned that the term ‘significant force’ emphasizes only the issue of strength and does not carry with it any judgemental insinuation. It suggests simply that the starkly contending meanings have a great potential to define the nature of the crossing of these two cultures, but does not claim to predict any specific property of that nature ‒ good or bad, positive or negative. Opposites can attract as well as repel and that is exactly the case with cross-cultural cultural contention. Deadline: dead or alive? The riddle on delivery schedule versus delivery deadline is a web of contending meanings at many levels. At the very core are the contending meanings of time. For the Dutch, time is precious and schedule is a sacred contract; for the Thais, time should not be allowed to dictate but only to provide a point of reference. As such, for the Dutch, particularly Khun Joeri, the VP of sales and marketing, the delivery timetable was a guarantee of commitment. It designated what he guaranteed to deliver to customers, which equated to what the production line guaranteed to deliver to him. It was a deadline, meaning failure to fulfil this commitment would result in a fatal consequence. In Thai culture, as time is usually seen as something one should take command of and not be subject to, Thais tend not take appointment time too seriously. It is only a point of reference, something that you set up so you have an idea of your target. Not meeting an appointment means no more than that either the target is wrongly set or something else happens that has not been included in the estimation. That means a new target can be set and life goes on, no fatality needed. The deadline episode also illustrates influences of a few other contending meanings: valuation, lifestyle, work and play and privacy. For brevity’s sake, these manifestations are not elaborated further.


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Mistake: guilt or shame? The episode concerning mistakes at ADT provides a good illustration of how the Thais and the Dutch see mistakes so differently in many aspects. Fundamentally, it illustrates how the different ways the Dutch and Thais give meaning to themselves could influence their views of a mistake. For Thai employees, the company and their bosses are almost ‘family’ and the mistake was seen as a loss of face to the outer immediate cautious circle, the client, whom they needed to be most careful with. Their reasoning could be as follows: The customers must always think well of you and your boss, else you would lose your face and your business. How the bosses thought of you and how you acted in this case was an internal affair that could or should be easily resolved in near-family relations. Thus, it was more important to take quick action to remedy the customer’s negative view. Moreover, this interpretation also brings out the complexity of intricate webs of cultures since it illustrates how there can be no deterministic rule of when a particular cultural force will be the trigger of a particular action. In this case, the force of the familial role as part of the company was stronger than the force of the role as an obedient employee, because Thais are most concerned with face when dealing with the cautious circle. The boss was almost part of the family circle, whose collective face was pre-eminent to any violation of internal agreement. Then, there were at least two other aspects to the meaning of mistake: what a mistake signifies versus what is identified as a mistake. The Thais tend to look at mistakes with apprehension. This has to do with the abhorrence of losing face. To most typical Thais, it is very important to be perceived well by the two important circles of others in the community, particularly the cautious circle; and to be perceived well is achieved mostly by fronting respectable, flawless appearances, reinforced by the eagerness to please others. In reverse, anything that signifies a weakness, failure or inferiority is to be avoided, covered up, or readily rectified. Mistake signifies negative quality and is a cause for shame. While Thais are shameful of mistakes, the Dutch tend to take it simply as a sign of inefficiency or incorrect choice. To a typical Dutch, one learns from one’s mistake and moves on. As such, to make the same mistake repeatedly in the Dutch eyes is a sign of either inexcusable ignorance or misguided stubbornness. The above interpretation may explain partly why the Thai staff acted the way that they did when confronted with a client’s complaint and why the Dutch were not amused at the repeated violation of the company policy. It may also explain why there was a mismatch of identification of what exactly the mistake was. The Thai staff felt responsible for having delivered bad products and at the same time, when confronted by the client, they identified themselves as part of the company. They must have

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felt doubly shameful: at having produced bad products and embarrassed on behalf of the company. While the Thais looked externally, the Dutch were more concerned with the internal implication of the mistake. Khun Kees and Khun Joeri were much less concerned with the defect in shipment than with the outright violation of the company’s key policy. To them, as executives, the consequences of the production mistake were at operational level, while violation of code of conduct struck at company’s strategic and tactical cord. The incident thus illustrated a rather tangled web of mismatched meanings of mistake. So what? It must be emphasized that the above analyses are but our interpretations of the story. We do not claim to deliver the impossible task of having a complete or absolute understanding of it. Our intention is to illustrate how the webs of meanings based on cultural interpretation could give a plausible explanation to what can influence people to act the way they do in real world cross-cultural encounters. Also, it is not our intention to prescribe a cultural deterministic view that culture is the only force in social phenomena. We intend to only point out only that culture is one of the significant forces. What is important is not to see culture everywhere, but rather to see it where it matters. That is when cross-cultural intelligence comes into play. So far, we may have given an impression that the complexity of webs of cultures are beyond comprehension and solution or resolution. That is far from the case. We intentionally did not go beyond deciphering the possible competing meanings in the case. We did not conclude which meaning was most appropriate, because, as our study has revealed, such a conclusion is highly situational and the key to finding a solution or resolution to the complexity of cross-cultural condition and its multitudes of competing meanings lies in an understanding and practice of cross-cultural intelligence.

CULTURE AND MULTINATIONAL CORPORATIONS Under the view of the proposed grounded theory on cross-cultural intelligence, it can be argued that multinationals are multicultural units. By its definition, multinational corporations are cultural units made up of more than one culture, that is, more than one national culture, for starters. In most cases, there is more than one national cultural force within multinationals, since they must function in a variety of cultural webs of international markets, employ employees from a variety of countries,


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work with supply-chains from diverse nations, and so on and so forth. Moreover, national culture is but one possible web within multinational corporations. As the concept of webs of cultures would suggest, multinational corporations, viewed from our proposed theory, are complex webs of cultures operating in yet other webs of cultures. It should not be difficult to imagine the many possible levels and layers of cultures ‒ clique, team, department, profession and so on, that must be spinning their webs within one single multinational corporation. This is our simple assertion of a very complex issue that carries one key implication: a multitude of cultural forces and their competing meanings form a potential influencing factor underlying multinational corporations. What happen with and within multinationals are essentially a form of cross-cultural interface in more ways than one. As such, a genuine understanding of the dynamics of these cultural forces, their competing meanings, and the cross-cultural interactions that they may be driving must be one of the indispensable insights needed in the study of multinational corporations. To date, as observed in the introduction, this has yet not been the case in the economic discourse of multinationals. It is hoped that the work on cross-cultural management, where culture has received a more rigorous attention during the past half century, together with the implications of the proposed theory, would inspire some in the economic community to put culture at a prominent place in economic investigation of multinational corporations. A set of elementary observations on how this could develop serves as our conclusion.

CONCLUSIONS As culture has received relatively little attention in economic study of multinational corporations, the first challenge is to concentrate the effort on driving home the significance of culture in research on multinationals. A conviction that multinationals are multicultural units with complex webs of cultures as their cultural identity as well as their operating context may be one instrument in such effort. Theoretically, economics could benefit from the advances in the conceptualization of culture accomplished by the management community and make a jump start in further delving into relating culture to economic issues in multinationals. The question of how cultural dimensions relate to the many economic aspects of a multinational, such as growth, profit, mode of entry, or innovation, could be investigated based on the success of many management studies that relate culture to management topics. Last, and probably most importantly, economic study of multinational corporations

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could benefit from the crucial lesson learned in the management community regarding culture, namely, that this is one theme of research that demands diversity of views, methods, and cultures (Boyacigiller et al., 2004; Usunier, 1998). As such, it may be crucial for the economic community to include in their study of culture and multinationals paradigms of inquiry and methodologies that are not the mainstream in economics. For example, non-positivist perspective and qualitative approach should be encouraged, a prospect that admittedly may not be easily accomplished given the established inclination in economic study. That may yet be the ultimate challenge for economic research that seeks to investigate culture and multinationals.

NOTES 1. For anonymity, company and character names were replaced with fictitious ones. The stories, however, were based on real incidents and factual details were kept as accurate as possible. 2. To give local flavour to the narration, all characters are addressed in Thai style as it was in real life, with the Thai Khun, which is equivalent to Mr or Mrs in English, followed by the first name, except when first introduced. Character job titles follow what they were in real life. 3. The concept of cross-cultural intelligence (with the emphasis on cross) as developed in our theory bears a subtle, yet significant, distinction and relationship to a recently established concept of cultural intelligence (Ng and Earley, 2006; Thomas and Inkson, 2003; Triandis, 2006). Broadly speaking, the former is a specific subset of the latter. See Kwanjai and den Hertog (2008) for further details on this issue.

REFERENCES Adler, N.J. (2002), International Dimensions of Organizational Behavior, 4th edn, Cincinnati, OH: South-Western. Atmiyanandana, V. and J. Lawler (2004), ‘Introduction: culture and management in Thailand’, in M. Warner and P. Joynt (eds), Culture and Management in Asia, London: Routledge, pp.229‒48. Boyacigiller, N.A., M.J. Kleinberg, M.E. Phillips and S.A. Sackmann (2004), ‘Conceptualizing culture: elucidating the streams of research in international cross-cultural management’, in B.J. Punnett and O. Shenkar (eds), Handbook for International Management Research, 2nd edn, Ann Arbor, MI: The University of Michigan Press, pp.99‒167. Corbin, J. and A.L. Strauss (1990), ‘Grounded theory research: procedures, canons, and evaluative criteria’, Qualitative Sociology, 13(1), 3‒21. DiMaggio, P.J. (1990), ‘Cultural aspects of economic organization and behavior’, in R. Friedland and A.F. Robertson (eds), Beyond the Marketplace: Rethinking Economy and Society, Chicago, IL: Aldine Publishing Company, pp.113‒36.


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Fernández, R. (2008), ‘Culture and economics’, in S. Durlauf and L. Blume (Eds), The New Palgrave Dictionary of Economics, 2nd edn, Basingstoke: Palgrave Macmillan. Geertz, C. (1993), The Interpretation of Cultures: Selected Essays, London: Fontana Press. Glaser, B.G. and A.L. Strauss (1967), The Discovery of Grounded Theory, Chicago, IL: Aldine Publishing Company. Groseschl, S. and L. Doherty (2000), ‘Conceptualising culture’, Cross Cultural Management, 7(4), 12‒17. Guiso, L., P. Sapienza and L. Zingales (2006), ‘Does culture affect economic outcomes?’, Journal of Economic Perspectives, 20, 23‒48. Hampden-Turner, C. and F. Trompenaars (1993), ‘Self-constructed lands: the Dutch as God’s apprentice’, in C. Hampden-Turner and F. Trompenaars (eds), The Seven Cultures of Capitalism: Value Systems for Creating Wealth in the US, Britain, Japan, Germany, France, Sweden and the Netherlands, London: Doubleday, pp.261‒92. Hofstede, G. (2001), Culture’s Consequences: Comparing Values, Behaviors, Institutions, and Organizations Across Nations, 2nd edn, London: Sage Publications. Holmes, H. and S. Tangtongtavy (1997), Working with the Thais, Bangkok: White Lotus. House, B.R.J., P.J. Hanges, M. Javidan, P.W. Dorfman and V. Gupta (eds) (2004), Culture, Leadership, and Organizations: The Globe Study of 62 Societies, London: Sage Publications. Inglehart, R.,M. Basanez, J. Diez-Medrano, L. Halman and R. Luijkx (eds) (2004), Human Beliefs and Values: A Cross-cultural Sourcebook Based on the 19992002 Values Surveys, Buenos Aires, Argentina: Siglo Veintuno Editores. Klausner, W.J. (1993), Reflections on Thai Culture, 4th edn, Bangkok: Siam Society. Komin, S. (1991), Psychology of the Thai People: Values and Behavioral Patterns, Bangkok: National Institute of Development Administration (NIDA). Kroeber, A.L. and C. Kluckhohn (1963), Culture: A Critical Review af Concepts and Definitions, new edn, New York: Random House. Kwanjai, N.N. and J.F. den Hertog (2008), ‘Cultural intelligence: a qualitative angle’, Paper presented at the 24th European Group for Organizational Studies (EGOS) Colloquium, Amsterdam. Kwanjai, N.N. (forthcoming), Cross-cultural Intelligence Amidst intricate cultures webs: A Tale of the unDutchables in the Land of 1001 Smiles, Maastricht, the Netherlands: Maastricht University, forthcoming. Leung, K. and M.H. Bond (2004), ‘Social axioms: a model of social beliefs in multi-cultural perspective’, in M.P. Zanna (ed.), Advances in Experimental Social Psychology, vol.36, San Diego, CA: Elsevier Academic Press, pp.119‒97. Locke, K. (2001), Grounded Theory in Management Research, London: Sage Publications. Mulder, N. (2000), Inside Thai Society: Religion, Everyday Life, Change, Chiang Mai, Thailand: Silkworm Books. Ng, K.-Y. and P.C. Earley (2006), ‘Culture + intelligence: old constructs, new frontiers’, Group Organization Management, 31(1), 4‒19. Redmond, M. (2002), Wandering into Thai Culture, Bangkok: Redmondian Insight Enterprises.

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Sackmann, S.A. (1991), Cultural Knowledge in Organizations: Exploring the Collective Mind, Newbury Park, CA: Sage Publications. Schneider, S.C. and J.-L. Barsoux (2003), Managing Across Cultures, 2nd edn, New York: Prentice Hall. Schwartz, S.H. and L. Sagiv (1995), ‘Identifying culture-specifics in the content and structure of values’, Journal of Cross-Cultural Psychology, 26, 92‒116. Strauss, A.L. and J. Corbin (1998), Basics of Qualitative Research: Techniques and Procedures for Developing Grounded Theory, 2nd edn, Thousand Oaks, CA: Sage Publications. Thomas, D.C. and K. Inkson (2003), Cultural Intelligence: People Skills for Global Business, San Francisco, CA: Berrett-Koehler Publishers. Triandis, H.C. (2006), ‘Cultural intelligence in organizations’, Group Organization Management, 31(1), 20‒26. Trompenaars, F. and C. Hampden-Turner (1998), Riding the Waves of Culture: Understanding Diversity in Global Business, 2nd edn, New York: McGraw-Hill. Usunier, J.-C. (1998), International and Cross-cultural Management Research, London: Sage Publications. van der Horst, H. (1996), The Low Sky: Understanding the Dutch, Schiedam, the Netherlands: Scriptum Books.

2.

The innovativeness of foreign firms in China Branka Urem, Ludovico Alcorta and Tongliang An

INTRODUCTION While the traditional literature on the role of multinationals in innovation in host countries has emphasized the significance of multinationals in international technology transfer, the emphasis of recent literature has been on the increasing role of multinationals in the generation of innovations in host countries. Consistent with these developments it seems important to raise the issue of the impact of foreign ownership on the novelty of innovations in host countries. The research on the novelty of innovations in relationship to the nationality of ownership is recent and relatively limited. Existing studies typically make a distinction between two levels of novelty, innovations new to the firm and innovations new to the market, consistent with the distinctions suggested by the Oslo Manual (OECD, 2005) and adopted in the European Community Innovation Survey (CIS). The focus is typically on the impact of foreign ownership on innovations new to the market, as a high level of novelty, and on propensity indicators. In the case of developed countries, there are several studies based on CIS data, but evidence on the impact of foreign ownership is mixed. Sadowsky and Sadowsky-Rasters (2006) report a positive impact among firms in the Netherlands that include both innovators and non-innovators but, among innovators only, they find no impact or a negative impact when controlling for sources of innovation. Dachs et al. (2007), in a group of five small European countries, detect a positive impact of at least one category of foreign firms (grouped by the home-country corporate governance into three categories) in three countries (Denmark, Finland and Sweden) and no impact on the introduction of new to the market innovations in two (Austria and Norway). Disaggregating the effect associated with foreign firms, Frenz and IettoGillies (2007) find positive impact of high multinationality on the introduction of new to the market innovations in the UK, but no impact of 23

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corporate-group, multinational and foreign-multinational membership. With regard to (advanced) developing countries there is limited evidence, with the exception of a study on Brazil, which finds that foreign firms have a higher propensity to introduce product innovation new to the market than domestic firms (Kannebley et al., 2005). This chapter is also focused on the relationship between the nationality of ownership of firms and innovations of high novelty, but with an approach that differs from the literature in three ways. First, while existing studies focus only on direct effects of foreign ownership on propensity of innovations of high novelty, building on the literature on the internationalization of R&D by multinationals this study also examines a moderating impact of R&D on the relationship. Up to now, studies on the impact of foreign ownership on innovation in host countries have considered the direct effects of R&D only, despite the role of R&D in the generation of innovations in multinational subsidiaries. Second, unlike other studies that are based on a single indicator of innovation of high novelty ‒ propensity, here the analysis is based on two indicators ‒ propensity and intensity. The propensity indicator (measuring whether firms have introduced innovation) rates an ability to introduce innovations on the market. In contrast, the intensity indicator (calculated as a share of innovation sales in total sales) measures the degree of the commercial success of introduced innovations and, thus, represents a direct measure of the innovation output. While the propensity indicator shows whether a firm is an innovator, the intensity indicator measures the volume of sales generated by introduced innovations, that is the extent of economic benefits of innovative activities (Arundel et al., 1998). However, the intensity indicator has been neglected in prior studies on the impact of foreign ownership on innovation in host countries. Third, the relationship between the nationality of ownership of firms and innovation novelty is examined in context of advanced developing countries. While these countries attract not only an increasing share of foreign direct investments, but also an increasing proportion of foreign R&D investments (UNCTAD, 2005), studies on effects of foreign ownership on innovation novelty have primarily been oriented on developed countries (with exception of Kannebley et al., 2005). The empirical analysis is based on data from China, which represents a suitable research context for two main reasons. First, in the last decades China has achieved remarkable progress in building innovation capabilities in the enterprise sector, despite this its patent performance remains low both relative to its share in R&D as well as in comparison to foreign firms (OECD, 2007). Second, up until recently foreign multinationals have been primarily establishing low cost manufacturing operations, but China currently has the highest inward foreign direct investments on R&D in the

Innovativeness of foreign firms in China

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world (European Commission, 2004). These conditions provide a suitable setting to examine the relationship between foreign ownership and innovations of high novelty and to assess the moderating effect of R&D internationalization on propensity of innovations of high novelty. The remainder of the chapter is organized as follows. The first section provides a conceptual background and develops hypotheses about the relationship between foreign ownership and propensity and intensity of innovations of high novelty. The next section describes the innovation survey data used, the variables and the method of analysis. The results are presented in the third section. The last section contains discussion of empirical findings and main conclusions.

MULTINATIONALS AND INNOVATION IN HOST COUNTRIES Building on eclectic theory of international production (Dunning, 1993, 1988), two issues are considered particularly important in the understanding of the role of multinationals in innovations in host countries. On one side, the international exploitation and generation of innovations by multinationals, associated with their ownership advantages and, on the other side, the locational aspect associated with the context of advanced developing host countries. Regarding the role of multinationals in the generation and transfer of innovations and implications for the novelty of innovations of their subsidiaries located in advanced developing host countries, a starting point is a conceptual distinction between international exploitation of home developed innovations and international generation of innovations (following Archibugi and Michie, 1995). Internal (intra-firm) international technology transfer processes are considered associated with pre-existing ownership advantages on the basis of which multinational firms exploit innovations developed in home countries through international production as postulated by the traditional theories (Caves, 1982; Vernon, 1966; Dunning, 1993). Multinationals have generally been seen as the most efficient institutional form for the transfer of technological knowledge across national borders due to either the transaction costs-based arguments about imperfect markets in the intangible assets (Teece, 1981), or the knowledge-based arguments about characteristics of the tacit technological knowledge (Kogut and Zander, 1993). In traditional approaches, overseas subsidiaries are mainly seen as more passive recipients of the parent technology. The argument is that both development and first commercial application of new products and processes take place in home countries of

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multinationals, while overseas subsidiaries primarily engage in production activities (Vernon, 1966). Consistent with recent trends of increasing internationalization of generation of innovations by multinationals, overseas subsidiaries seem increasingly likely to also engage in the development of improved or new products and processes. It has been argued that the generation of innovations in multinationals’ subsidiaries in host countries can be driven by two motives. The asset exploitation (Dunning and Narula, 1995) or home-base exploiting (Kuemmerle, 1999a) motive is associated with generation of innovations in response to local conditions either by adapting the parent innovation or by creating new innovations for the local market. In addition, the asset-seeking (Dunning and Narula, 1995) or home-base augmenting (Kuemmerle, 1999a) motive for the internationalization of innovation drives generation of innovations for the global market. The nature of the motives for international generation of innovations by multinationals imply that their overseas subsidiaries are unlikely to remain passive recipients of the technology transfer from the parent, but are likely to also engage in innovation generation, especially as they become further established in their host economies. Multinationals’ subsidiaries recombine learning with the knowledge from their home countries through the evolutionary process of knowledge accumulation in the host economy (Kogut and Zander, 1993). The increasing involvement of overseas subsidiaries in the process of innovation generation is associated with the creation of a variety of innovation networks within multinationals (Zander, 1999), in which, in addition to traditional parent-subsidiary technology flows, reverse flows from subsidiaries to parent, as well as technology flows among subsidiaries are gaining importance. When considering the impact of foreign ownership on the innovation of high novelty in host countries, the locational conditions have to be considered also. The empirical evidence on recent trends of international generation of innovation by multinationals reveals that overseas R&D investments are primarily located in developed countries but have also recently been increasing in advanced developing economies, particularly in South East Asia and China (UNCTAD, 2005). Since in the generation of innovations overseas subsidiaries rely not only on access to the knowledge of the parent, but also on sources of innovation in the host environment (Cantwell and Santangelo, 1999), availability of complementary local scientific and technological capabilities is an important locational factor for multinationals’ overseas R&D activities. More specifically, asset exploiting foreign R&D investments seem to be primarily attracted to countries with large markets and asset augmenting R&D to countries with a strong science base (Kuemmerle, 1999b). While advanced developing


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countries may have started to build specialized innovation capabilities for the generation of innovations in certain firms and sectors (Leydesdorff and Zhou, 2005; Mahmood and Singh, 2003), in these countries innovations of lower novelty still predominate. Hypotheses In studies of the impact of foreign ownership on innovation in host countries, it is typically argued that foreign-owned firms will be more innovative than domestically-owned firms because of existing ownership advantages. Since Hymer (1976), it has been widely accepted that due to the advantages of domestic firms in their own national environment, the multinationals’ ownership advantages represent a precondition for the entry into production in foreign countries. The international production is based on an intra-firm transfer of technology developed in the home countries. According to the transaction cost-based theory transfer of technological knowledge is internalised within multinationals because of transactional difficulties in the market for technological knowledge (Teece, 1981). The knowledge-based theory argues that multinationals internally transfer technological knowledge that cannot be more efficiently obtained by either international inter-firm technology transfer or by imitation (Kogut and Zander, 1993). Given the technology gap between home countries and host advanced developing countries these arguments imply a higher level of innovation novelty of multinational subsidiaries on the basis of exploitation of innovations generated in home countries. Consistent with these arguments it is hypothesized: Hypothesis 1a. Foreign firms will have higher propensity of innovations of high novelty than domestic firms. An inherent aspect of the international generation of innovations by multinationals is the internationalization of R&D. Studies on R&D internationalization suggests that there are both centripetal as well as centrifugal forces influencing the location of R&D by multinationals in home versus host countries (Hirschey and Caves, 1981). The main centralizing forces include the protection of firm-specific technology, home-market conditions as a basis for firm-specific technological advantages, economies of scale in R&D and minimization of costs of coordination and control (Granstrand et al., 1992). Decentralizing forces include both demandoriented factors, such as an adaptation of products and processes to local conditions and government regulations, as well as supply-oriented factors, including scientific infrastructure, cost of R&D and R&D subsidies

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(Granstrand et al., 1992). Regarding multinationals’ R&D investments in developing countries it has been argued that they are primarily driven by the availability of local science and technology resources and their lower costs (Reddy, 1997). The dual motives for the overseas location of R&D activities (Kuemmerle, 1999a; Dunning and Narula, 1995) suggest that the internationalization of R&D by multinationals is a precondition for the generation of innovations in host countries. A higher propensity of innovations of high novelty in foreign subsidiaries is not expected because of the existing ownership advantages ‒ that is innovation exploitation. Therefore, it is hypothesized: Hypothesis 1b. Foreign firms with formal R&D will have higher propensity of innovations of high novelty than domestic firms. It has been argued that the successful commercialization of introduced innovations depends on access to capabilities or assets complementary to innovation capabilities, typically those in manufacturing and marketing (Teece, 1988). Ownership advantages of foreign multinational subsidiaries over domestic firms typically include not only technology related advantages, but a variety of other intangible and complementary asset advantages, for example in relation to input sourcing, marketing, finance, management, knowledge of international markets and so on (Dunning, 1993). While multinational subsidiaries resemble independent firms, it is the access to assets of their parents that distinguishes them from independent firms (Penrose, 1956). This implies access to capabilities and resources of the corporation that are likely to be superior to those accessible by local firms. Therefore, multinational subsidiaries are more likely to have access to the relevant complementary assets needed to successfully commercialize introduced innovations than domestic firms are. This is especially likely in the case of host developing and transition economies because of the gap in their capabilities and resources in relation to multinationals’ home countries (Hitt et al., 2000). Thus, it is hypothesized: Hypothesis 2: Foreign firms will have higher intensity of innovations of high novelty than domestic firms.

DATA AND METHOD The empirical analysis is based on data from Jiangsu province of China. Jiangsu, located on the East coast, is one of the most developed provinces, and has the characteristics of an advanced developing economy


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of relevance for this study. First, it has significant domestic innovation capabilities, ranked third by its share of R&D in China (OECD, 2007). Next, it has considerable inflow of foreign direct investments, the second largest after Guandong (Invest in China, 2006), with important presence of foreign R&D too (23 per cent share of industrial R&D) (OECD, 2007). Lastly, within the innovation system of the province, foreign multinational subsidiaries and small and medium size enterprises are more important than state-owned enterprises or public research organizations (OECD, 2007). The data are from an innovation survey conducted in 2003 by Ludovico Alcorta and Tongliang An. Since the official business register of firms in Jiangsu province was not available, the sampling frame was based on telephone directories of the capitals of 13 municipal counties of Jiangsu. In contrast to typical official Chinese surveys, it includes firms of all sizes (from ten or more employees). Firms were randomly sampled from a population of urban manufacturing firms. The sample was restricted to one fifth of the estimated population of 12,000 firms. The data collection started with a postal survey, with follow-up visits to non-responding firms, resulting in a response rate of 15 per cent. The innovation survey was single-respondent, subject-based and consistent with the Oslo Manual (OECD, 1996), with several modifications. Our survey covered both incremental and significant innovations, included sales-based output measurement of product innovations of all levels of novelty; and covered innovations for one year ‒ 2002.1 Analysis is restricted to those innovating firms that introduced product innovations (defined as the commercial adoption of a new product) and reported product innovation sales and the associated levels of innovation novelty, resulting in a sample of 174 firms. It is assumed here that innovation novelty distinctions based on the Oslo manual provide a basis for the categorization of innovations by novelty that is relevant when considering the role of multinationals in the transfer and generation of innovations in host economies, in other words across national borders. Apart from new to the firm innovations, as the lowest level of novelty (considered in other classifications in the literature as well), the Oslo manual distinguishes, on the basis of geographical criteria, new to the region (in case of large countries), new to the country and new to the world innovations, in increasing order of novelty. Consistent with the Oslo manual, our innovation survey distinguished between first to the firm, first to Jiangsu, first to China and first to the world innovations. For the purpose of this study the first to China and first to the world innovations are considered as innovations of high novelty. Thus, innovations of high novelty as defined here are at least new to the host country.2

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Product innovation novelty is analysed on the basis of two indicators, innovation propensity and innovation intensity. The innovation propensity variable is dichotomous with value one if the firm reported sales of innovations of high novelty and value zero if the firm did not report sales of innovations of high novelty. Reporting sales of innovations of high novelty is interpreted as their successful introduction. The innovation intensity is measured by the ratio of sales of product innovations of high novelty in the total sales. The innovation intensity variable is defined as dichotomous with value one if a firm has a share of sales of innovations of high novelty in total sales above mean and value zero if the share is below the mean, which is calculated for the pooled sample of foreign and domestic firms. The independent variable, the nationality of ownership, is dichotomous with value one if the firm is foreign-owned and value zero if it is domestically-owned. Foreign firms are defined as firms in majority foreign ownership and in majority Hong Kong, Macao and Taiwan (that is overseas Chinese) ownership. This definition is consistent with the ownership categories of foreign invested enterprises and Hong Kong, Macao and Taiwan invested enterprises in the Chinese official statistics. The moderator variable, formal R&D, is measured as a dichotomous variable with value one if the firm has an R&D department and value zero if it does not. In case of foreign firms, it indicates whether a decentralization of R&D to the subsidiaries of foreign multinationals located in Jiangsu has taken place. Consistent with the innovation literature it is controlled for the influence of size and industry. The size variable is defined as a dichotomous variable, with value one if firms are large-and-medium (that is, have 300 or more employees), and zero if they are small (Lundin et al., 2006). The influence of industry is controlled by a dichotomous variable sector. It is based on a categorization of sectors by Robson et al. (1988), which distinguishes between core sectors that are highly innovative and primarily characterised by product innovations, secondary sectors that are less innovative and have similar levels of both product and process innovations and the sector others that are low innovative. The core and secondary sectors are considered here as high innovative, and the sector others as low innovative. The variable sector has value one if the firm is from the high innovative sector and value zero if it is from the low innovative sector. Following Robson et al.’s classification, the high innovative sector includes chemicals, plastics, metal products, non-electrical machinery, electrical machinery and vehicles, and the low innovative sector food, textile, wood and non-metal industries and other manufacturing. The analysis of the relationship between foreign ownership and innovation of high novelty is based on testing of the difference between


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domestic and foreign firms. The analysis includes bivariate analysis of a direct relationship, three variable analyses of contingency relationship and the effect of control factors. All tests are based on Chi-square nonparametric tests. Descriptive statistics is presented in Table A.2.1 in the Appendix.

INNOVATIVENESS OF FOREIGN FIRMS IN JIANGSU Propensity of innovations of high novelty Results of the Chi-square non-parametric tests for independent, moderator and control variables for the propensity of high novelty innovations are presented in Table 2.1. Foreign firms are expected to have a higher propensity of innovations of high novelty in Hypothesis 1a. In contrast, Hypothesis 1b predicts that foreign firms will have a higher propensity of innovations of high novelty contingent on the presence of formal R&D. While the propensity of innovations of high novelty was higher among foreign firms than among domestic ones, the Chi-square test shows that the difference is not statistically significant. Thus, the evidence does not support Hypothesis 1a. Contrary to our expectation, the findings reveal that the propensity of innovations of high novelty among foreign firms is higher both in the subgroup of firms with formal R&D as well as in the subgroup of firms without formal R&D, but the Chi-square test shows that the difference is not statistically significant in either subgroup of firms. Thus, the relationship between foreign ownership and propensity of innovations of high novelty does not appear to be moderated by the presence of formal R&D. Hypothesis 1b is therefore not supported either. It appears that the successful market introduction of innovations of high novelty is not associated with foreign firms either directly or indirectly, through the relationship contingent on the R&D internationalization. The results for one of the control variables are also interesting. The relationship between foreign ownership and the propensity of innovations of high novelty appears to be contingent on the sector. In the high innovative sector, the propensity of innovations of high novelty among foreign firms is marginally lower than among domestic firms and the Chi-square test shows that the difference is not statistically significant. However, in the low innovative sector, the Chi-square test shows that the propensity of innovations of high novelty is statistically significantly higher among foreign firms than among domestic firms.

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Table 2.1

Innovations of high novelty by nationality of firm ownership, propensity indicators (% of number of firmsa) Innovations of high novelty

Nationality of ownership

Chi-Square Test

Domestic Foreign Significant?b

Without controls

Control for R&D With separate R&D dpt.

Introduced Not introduced

75.5 24.5 100.0

86.7 13.3 100.0

No

Introduced Not introduced

82.9 17.1 100.0 65.6 34.4 100.0

85.7 14.3 100.0 88.9 11.1 100.0

No

82.6 17.4 100.0 62.7 37.3 100.0

81.8 18.2 100.0 100.0 0.0 100.0

No

76.3 23.8 100.0 75.0 25.0 100.0

92.3 7.7 100.0 72.7 27.3 100.0

No

Without separate R&D dpt. Introduced Not introduced Control for main sector of activity High innovative

Low innovative

Control for firm sizec Large and medium

Small

Introduced Not introduced Introduced Not introduced

Introduced Not introduced Introduced Not introduced

No

Yes**

No

Notes: (a) Number of observations is 174, unless otherwise stated. (b) Whether the difference between foreign and domestic firms is statistically significant: * at 10 %, ** at 5 %, *** at 1 %. (c) Number of observations is 152. Source:

Jiangsu survey.

Intensity of innovations of high novelty Results of the Chi-square non-parametric tests for independent and control variables for the intensity of high novelty innovations are reported in Table 2.2. Hypothesis 2 predicts that foreign firms will have


Table 2.2

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Innovations of high novelty by nationality of firm ownership, intensity indicators (% of number of firmsa) Innovations of high novelty

Nationality of ownership

Chi-Square Test

Domestic Foreign Significant?b

Without controls

Control for R&D With separate R&D dpt.

Without separate R&D dpt.

Control for main sector of activity High innovative

Low innovative

Control for firm sizec Large and medium

Small

Above mean Below mean

27.3 72.7 100.0

63.3 36.7 100.0

Yes***


32.9 67.1 100.0 19.7 80.3 100.0

61.9 38.1 100.0 66.7 33.3 100.0

Yes**

31.5 68.5 100.0 19.6 80.4 100.0

63.6 36.4 100.0 62.5 37.5 100.0

Yes***

27.5 72.5 100.0 22.9 77.1 100.0

53.8 46.2 100.0 54.5 45.5 100.0

Yes*


Above mean Below mean Above mean Below mean

Above mean Below mean Above mean Below mean

Yes***

Yes**

Yes**

Notes: (a) Number of observations is 174, unless otherwise stated. (b) Whether the difference between foreign and domestic firms is statistically significant: * at 10 %, ** at 5 %, *** at 1 %. (c) Number of observations is 152. Source:

Jiangsu survey.

a higher intensity of innovations of high novelty than domestic firms will. Consistent with expectations, the Chi-square test suggests that statistically foreign firms have significantly higher intensity of sales of innovations of high novelty.3 This evidence supports the proposition that

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foreign firms are more intensive than domestic firms in innovations of a high novelty level. Foreign firms seem to have higher commercial success from introduced innovations of high novelty than domestic firms do.

DISCUSSION AND CONCLUSIONS The objective of this study was to examine the relationship between foreign ownership and innovations of high novelty in the context of an advanced developing country ‒ China. Two dimensions of innovation novelty were considered, innovation propensity and innovation intensity. The results have provided support for one of the three formulated hypotheses. The direct Hypotheses 1a predicted that foreign firms will have a higher propensity of product innovations of high novelty than domestic firms while, in contrast, the contingency Hypotheses 1b predicted that only foreign firms with formal R&D will have a higher propensity of innovations of high novelty than domestic firms. The results did not support the direct hypothesis. This is not consistent with a single prior study, which found a positive impact of foreign ownership on the introduction of new to the market innovations in Brazil (Kannebley et al., 2005). However, the finding is not surprising in light of the arguments for the alternative contingency hypothesis, which suggest that foreign firms are not likely to have a higher propensity of innovations of high novelty on the basis of the exploitation of existing innovations generated in home countries. Yet, no support was found for the hypothesized moderating impact of the propensity of formal R&D on the relationship between foreign ownership and the propensity of innovations of high novelty either. Thus, it seems that the proportion of firms that introduce innovations of high novelty is not higher among foreign firms than among domestic firms, not even when the internationalization of R&D is taken into account. While unexpected, this finding seems consistent with multinationals’ overseas R&D activities that are primarily driven by asset exploitation motive. It is congruent with preceding studies on China that have reported that the initially high number of R&D units were established because of regulatory requirements (Walsh, 2003) and that the majority of R&D units aimed at adaptive innovations for the local market (von Zedtwitz, 2004). Moreover, the finding appears consistent with the empirical evidence on the role of locational factors, which suggests that in countries with relatively large markets and weak science based foreign R&D is primarily oriented towards exploitation of existing innovations (Kuemmerle, 1999b). Hypothesis 2 predicted the higher intensity of product innovations of


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high novelty of foreign firms in comparison to domestic ones and was supported by the results. This seems to show that foreign firms generate a higher proportion of sales from introduced innovations of high novelty than domestic firms do. In other words, foreign and domestic firms do not seem to create similar commercial output from innovations of high novelty. The implication is that economic benefits obtained by the market introduction of high novelty innovations are higher in foreign than in domestic firms. This is consistent with the argument that foreign multinational subsidiaries have ownership advantages over domestic firms in intangible and other assets complementary to technological assets. The results seem also consistent with the evidence that firms from advanced developing countries have relatively weaker resource endowments than firms from developed countries. For example, empirical evidence suggests that firms from emerging market economies during partner selection place more emphasis on partner’s financial, technological and intangible assets and willingness to share expertise than firms from developed economies (Hitt et al., 2000). Similarly, the evidence suggests that international partnering by Chinese firms is primarily motivated by learning, in particular with regard to marketing expertise and managerial skills (Luo, 2002). The findings of the study contribute to the literature in three ways. First, the results suggest that the relationship between foreign ownership and propensity of innovations of high novelty in advanced developing host countries might be more complex than is typically assumed. The evidence does not seem to provide support for the argument that there is a positive direct relationship based on existing ownership advantages. A more complex contingency relationship was also examined, consistent with the arguments that a relationship between foreign ownership and propensity of innovations of high novelty is moderated by the creation of ownership advantages through internationalization of R&D, yet the evidence does not seem to support this argument either. Second, this is a rare attempt to examine a relationship between the foreign ownership and the intensity of innovations of high novelty. The results seem to support the argument about a positive direct relationship based on the existing ownership advantages in complementary assets. Third, the findings on the relationship between foreign ownership and propensity and intensity of innovations of high novelty taken together seem to suggest that different resources and capabilities of multinationals are associated with the two dimensions of the innovation novelty. The important implication of these findings is that the current focus in the literature on the single indicator, propensity of innovations of high novelty, represents a limitation. The finding suggests two important policy implications for China, and other advanced developing and transition economies. First, the lower

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degree of commercial success of innovations of high novelty of domestic firms relative to foreign firms suggests relatively weak capabilities for commercialization of innovations among Chinese firms. This seems to imply that access to relevant complementary assets is likely to depend on further increasing partnering with foreign firms. While the Chinese government has so far supported international alliances primarily because of access to advanced technologies, it appears that support for alliance with non-technological motives may also be justified. Second, while in relation to the presence of foreign firms the emphasis is often on technological spillovers, foreign firms also seem likely to provide an opportunity for non-technological spillovers, as an important source of learning about complementary capabilities, especially management, financial and marketing skills, which seems to be weak in the majority of firms from advanced developing and transition economies. In this sense, the findings seem to provide partial support for the current policy of attracting foreign direct investments, in particular that of foreign R&D and high-tech investments in China. A further shift in foreign direct investments away from low cost manufacturing operations is likely to contribute to the positive impact of foreign firms on the propensity of innovations of high novelty too. Certain caveats concerning this research should be mentioned. First, the study is focused on urban enterprises only. Since rural firms (that is private firms in rural areas) are less innovative than urban firms in Jiangsu (Sun and Wang, 2004:28), the evidence presented here is likely to overestimate the innovation level of firms in this province. Including rural firms in the analysis in further research might be fruitful. Lastly, the data on innovation refer to one year only. While the weakness of a single year is that it may be atypical for the relevant period, the decision to focus on a year rather than on a three-year period, as suggested by the Oslo manual and commonly adopted in innovation surveys, was primarily made to increase the recall by respondents and make answering the relevant questions easier, thus increasing the response rate. An implication is that the empirical results should be considered primarily as indicative. Further research should aim to cover a common three-year period. The study shares a weakness with other studies of innovation novelty based on a broad concept of innovation and a dual categorization of innovation novelty. The concept of high novelty applied here includes two levels defined by the geographical criteria of novelty (innovations new to the country and innovations new to the world) and this aggregation is likely to affect the results. For example, a result of no apparent difference in the propensity of innovations of high novelty could be obtained in an extreme case in which domestic firms would only introduce innovation that were new to the country while foreign firms would only introduce


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innovations that were new to the world. Therefore, the aggregation-based results presented should be interpreted with caution. While in this study the emphasis is primarily on the relationship between foreign ownership and two indicators of a given (high) level of innovation novelty, further research should pursue the issue of the relationship between foreign ownership and propensity of different individual levels of novelty (which we also follow up on in another study). Furthermore, to our knowledge, this is the first study that considers the moderating impact of R&D internationalization on the relationship between foreign ownership and innovations of high novelty. Since the moderator variable measured the presence of formal R&D, rather than its nature, there is an opportunity for further research into the moderating role of the motivation and composition of R&D activities in the relationship between foreign ownership and propensity of innovations of high novelty.

NOTES 1. For a full description of the main results of the survey, see Alcorta et al. (2008). 2. In contrast to the novelty levels considered here, other studies on the relationship between the nationality of ownership and innovation novelty are based on CIS, which makes a distinction between innovations new to the firm and innovations new to the firm’s market. Regarding the comparability of the novelty levels used here and the CIS distinctions, following Mohnen and Therrien (2001), it is taken that all innovations that are new beyond the firm (that is except new to the firm innovations) correspond to new to the market innovations (as nearest concepts). This implies that the concept of high novelty adopted here is narrower than the concept equivalent to the new to the market innovations as used in the studies based on CIS data. 3. The tests on the median-based definition of the innovation intensity variable have resulted in the same findings, except for small firms, where no statistically significant results were found.

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Caves, R.E. (1982), Multinational Enterprise and Economic Analysis, Cambridge: Cambridge University Press. Dachs, B., B. Ebersberger and H. Lööf (2007), ‘The innovative performance of foreign-owned enterprises in small open economies’, Journal of Technology Transfer, accessed at: http://www.springerlink.com/content/bq484t8tq16t1211/. Dunning, J.H. (1988), ‘The eclectic paradigm of international production: a restatement and some possible extensions’, Journal of International Business Studies, 19(1), 1‒31. Dunning, J.H. (1993), Multinational Enterprises and the Global Economy, Wokingham, and Reading, MA: Addison-Wesley. Dunning, J.H. and R. Narula (1995), ‘The R&D activities of foreign firms in the United States’, International Studies of Management and Organization, 25(1‒2), 39‒73. European Commission (2004), ‘Annual policy trends report for SE Asian countries’, European trend chart on innovation, Innovation/SMEs Programme, accessed on 2 September 2007 at http://trendchart.cordis.lu/reports/documents/ SEAsia_revised%20SPA%20app%20LKP%20HL.doc. Frenz, M. and G. Ietto-Gillies (2007), ‘Does multinationality affect the propensity to innovate? An analysis of the third UK community innovation survey’, International Review of Applied Economics, 21(1), 99‒117. Granstrand, O., L. Håkanson and S. Sjölander (1992), ‘Introduction and overview’, in O. Granstrand, L. Håkanson and S. Sjölander (eds), Technology Management and International Business: Internationalization of R&D and Technology, Chichester: John Wiley & Sons, pp.1‒18. Hirschey, R.C. and E. Caves (1981), ‘Research and transfer of technology by multinational enterprises’, Oxford Bulletin of Economics and Statistics, 43(2), 115‒30. Hitt, M.A., M.T. Dacin, E. Levitas J.L. Arregle and A. Borza (2000), ‘Partner selection in emerging and developed market contexts: resource-based and organizational learning perspectives’, Academy of Management Journal, 43(3), 449‒67. Hymer, S. (1976), The International Operations of National Firms: A Study of Direct Investment, originally presented as the author’s thesis, MIT, 1960, Cambridge, MA and London: The MIT Press. Invest in China (2006), ‘FDI Statistics Categorized by provinces’, accessed 2 September 2007 at http://www.fdi.gov.cn/pub/FDI_EN/Statistics/Home%20 News/t20060906_61680.htm. Kannebley Jr., S., G.S. Porto and E. Toldo Pazello (2005), ‘Characteristics of Brazilian innovative firms: an empirical analysis based on PINTEC ‒ industrial research on technological innovation’, Research Policy, 34, 872‒93. Kleinknecht, A., K. van Monfort and E. Brouwer (2002), ‘The non-trivial choice between innovation indicators’, Economics of Innovation and New Technology, 11(2), 109‒21. Kogut, B. and U. Zander (1993), ‘Knowledge of the firm and the evolutionary theory of the multinational corporation’, Journal of International Business Studies, 4, 625‒45. Kuemmerle, W. (1999a), ‘Foreign direct investment in industrial research in the pharmaceutical and electronic industries: results from a survey of multinational firms’, Research Policy, 28, 179‒93. Kuemmerle, W. (1999b), ‘The drivers of foreign direct investment into research and development: an empirical investigation’, Journal of International Business Studies, 30(1), 1‒24.


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Leydesdorff, L. and P. Zhou (2005), ‘Are contributions of China and Korea upsetting the world system of science?’, Scientometrics, 63(3), 617‒30. Lundin, N., F. Sjöholm and J. Qian (2006), ‘The role of small firms in China’s technology development’, Stockholm School of Economics, European Institute of Japanese Studies Working Paper 227, accessed 2 September 2007 at http:// www.hhs.se/eijs. Luo, Y. (2002), ‘Partnering with foreign businesses: perspectives from Chinese firms’, Journal of Business Research, 55, 481‒93. Mahmood, I.P. and J. Singh (2003), ‘Technological dynamism in Asia’, Research Policy, 32, 1031‒54. Mohnen, P. and P. Therrien (2001), ‘How innovative are Canadian firms compared to some European firms? A comparative look at innovation surveys’, MERIT-Infonomics Research Memorandum series 2001‒033. Organisation for Economic Co-operation and Development (OECD) (1996), Oslo Manual: Proposed Guidelines for Collecting and Interpreting Technological Innovation Data, 2nd edn, Paris: OECD. OECD (2005), Oslo Manual: Guidelines for Collecting and Interpreting Innovation Data, 3rd edition, accessed at http://www.oecd.org. OECD (2007), OECD Reviews of Innovation Policy: China, synthesis report by OECD in collaboration with the Ministry of Science and Technology, China, accessed on 2 September 2007 at http://www.oecd.org/dataoecd/54/20/39177453.pdf. Penrose, E. (1956), ‘Foreign investment and the growth of the firm’, The Economic Journal, 66(262), 220‒35. Reddy, P. (1997), ‘New trends in globalization of corporate R&D and implications for innovation capability in host countries: a survey from India’, World Development, 25(11), 1821‒37. Robson, M., J. Townsend and K. Pavitt (1988), ‘Sectoral patterns of production and use of innovations in the UK: 1945‒1983’, Research Policy, 17, 1‒14. Sadowsky, B.M. and G. Sadowsky-Rasters (2006), ‘On the innovativeness of foreign affiliates: evidence from companies in The Netherlands’, Research Policy, 35, 447‒62. Sun, Y. and H. Wang (2004), ‘Does Internet access matter for rural industry? A case study of Jiangsu, China’, Journal of Rural Studies, 21, 247‒58. Teece, D.J. (1981), ‘The market for know-how and the efficient international transfer of technology’, Annals of the American Academy of Political and Social Science, 458, 81‒96. Teece, D.J. (1988), ‘Profiting from technological innovation: Implications for integration, collaboration, licensing and public policy’, in M.L. Tushman and W.L. Moore (eds), Readings in the Management of Innovation, 2nd edition, Ballinger. UNCTAD (2005), ‘Transnational corporations and the internationalization of R&D’, World Investment Report, New York and Geneva: United Nations. Vernon, R. (1966), ‘International investment and international trade in the product cycle’, Quarterly Journal of Economics, 80(2), 190‒207. von Zedtwitz, M. (2004), ‘Managing foreign R&D laboratories in China’, R&D Management, 34(4),439‒52. Walsh, K. (2003), ‘Foreign high-tech R&D in China: risks, rewards, and implications for U.S.‒China relations’, The Henry L. Stimson Center, accessed 2 September, 2007 at www.stimson.org/techtransfer/pdf/FinalReport.pdf. Zander, I. (1999), ‘How do you mean “global”? An empirical investigation of innovation networks in the multinational corporation’, Research Policy, 28, 195‒213.

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APPENDIX Table A.2.1

Descriptive statisticsa (% of number of firms)

Dichotomous variables

Nationality of ownership Propensity of innovations of high novelty Introduced Not introduced Intensity of innovations of high novelty Above mean Below mean Mean of continuous data Standard deviation of continuous data Separate R&D dpt. Yes No Main sector of activity High innovative Low innovative Firm sizeb Large-and-medium Small

Nationality of ownership Domestic

Foreign

82.70

17.30

75.50 24.50

86.70 13.30

27.30 72.70 0.30 0.34

63.30 36.70 0.66 0.40

57.30 42.70

70.00 30.00

64.30 35.70

73.30 26.70

62.50 37.50

54.20 45.80

Notes: (a) Number of observations is 173, unless otherwise stated. (b) Number of observations is 152. Source:

Jiangsu survey.

3.

New Europe’s promise for life sciences Sergey Filippov and Kálmán Kalotay

INTRODUCTION The life science industry has a significant impact on the health of the population and the wealth of nations and has attracted a lot of attention recently. Growth in the life sciences is fuelled primarily by the disruptive and creative nature of biotechnology. It is similar to the changes provoked by the technological revolution that information and communication technologies (ICT) provoked in the recent past. There are profound differences though. Because governmental regulations did not play a crucial role for ICT, the major players in the sector were start-up firms and small and medium-sized enterprises in general, in the life sciences sector the situation is different (Luukkonen and Palmberg, 2007). The sector falls under a tight control by national medicine regulatory bodies. Moreover, it is characterized by high upfront R&D investment and long development times. Thus, in most cases only multinational companies possessing enough capital and facilities and able to comply with regulations can operate in the sector; and small companies tailor their strategies to cooperate with multinationals. Not only in the life sciences, but in most other industries too, multinationals are playing an ever increasing role in global economy in terms of production of goods and delivery of services as well as research and development (R&D) activities. Already in the mid-1990s, multinationals accounted for a large share in the R&D expenditures of the Triad economies ‒ US, Western Europe and Japan (Gassmann and von Zedtwitz, 1999). In 2002, the 700 largest R&D spending firms of the world ‒ of which at least 98 per cent were multinationals accounted for 69 per cent of world’s business R&D expenditures (UNCTAD, 2005). Traditionally, multinationals retained their R&D activities at their headquarters, unlike other largely internationalized functions. A recent trend, however, is the internationalization of R&D (Granstrand et al., 1993; Kuemmerle, 1997; 1999), stimulated by various factors, such as changing technologies and shorter product life cycles. Multinationals feel the pressure to invest more 41

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in R&D to succeed in the global market. This imperative, coupled with a shortage of skilled labour (and its rising cost) in their home bases, lead multinationals to adopt global R&D strategies. The superiority of the Triad as a location for R&D is challenged by emerging economies. Although the bulk of overseas R&D activities of multinationals are still taking place in developed economies, recently R&D expenditures have grown fast in emerging economies (UNCTAD, 2005). Therefore, the internationalization of corporate R&D, coupled by dynamic growth in non-Triad regions, has changed the global landscape for R&D. Countries of Central and Eastern Europe (CEE), the new member states of the European Union (EU), are emerging as prospective locations for foreign investors too, and not only for manufacturing, but also for higher-value added corporate activities, such as R&D. Historically, the science and technology systems of CEE countries were well developed. Presently they attempt to strengthen their R&D capacities by various measures, including attracting foreign investments in R&D. It is estimated that business enterprise R&D in the ten new EU members rose from USD 688 million in 1991 to USD 1452 million in 2003 (UNCTAD, 2005:287). Following these developments, the focus of this chapter is placed on the intersection of the sectoral view on the life sciences, with a special interest in foreign direct investment (FDI) in R&D. We analyse multinational subsidiaries in the Czech life sciences sector. A large body of academic literature provides theoretical foundation for this analysis. The literature on multinationals’ entry mode into a host economy is well established, based on the pioneering studies by Stopford and Wells (1972) and Wind and Perlmutter (1977). Root (1994) argues that the choice of market entry mode is one of the most critical strategic decisions for multinationals. Entry into a host market ultimately leads to establishment of a subsidiary. Studies on multinational subsidiaries are a relatively new strand of the international business literature that has burgeoned considerably over the recent decennia (Paterson and Brock, 2002), with the subsidiary evolution as a core research issue (Birkinshaw, 1996; Birkinshaw and Hood, 1998). While insights from the international business literature on subsidiaries are helpful for the present study, the chapter seeks to contribute to other research areas, namely the academic literature on transformations in the CEE region and EU enlargement. Notwithstanding the abundance of literature on the economic transition (Campos and Coricelli, 2002; Knell, 1992, 1996; Scholtès, 1996) and the role of FDI in transition (Estrin et al., 1997; Meyer, 1998), studies investigating knowledge-based activities in CEE economies remain scant (Piech and Radosevic, 2006). Developments

New Europe’s promise for life sciences

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of life sciences sector (and biotechnology in particular) in CEE remain largely an under researched topic, at best represented by studies on clinical trials (Babic and Kucerova, 2003; Natorff, 1998; Pal, 1997). Despite seemingly widespread interest in the implication of the 2004 EU enlargement, focus of many economic studies is still placed on old member states, EU-15. Despite some exceptions (Damborský et al., 2006; Sansom, 1999), most studies in life sciences tend to focus on EU-15 (Mangematin, 2004; Reiss et al., 2004). The chapter is an explorative study that seeks to fill this gap in the literature by employing qualitative analysis and investigating operations of several multinationals in the life sciences in the Czech Republic, one of the regional leaders. Focusing on only one country allows us to have a deeper and more detailed look, yet since many features of the Czech life sciences sector are common to other countries in the CEE region, the study is relevant for them too. The chapter is organized as follows. The first section sets the stage by providing insights into the life sciences sector. The second section presents a qualitative analysis of strategies and operations of subsidiaries in the life sciences sector of the Czech Republic. The last section concludes and provides policy implications.

THE LIFE SCIENCES SECTOR, MULTINATIONALS AND THE CEE COUNTRIES Life sciences are a global innovative industry, widely regarded as one of the most promising frontier technologies for the coming decades. It has recently attracted increasing attention as an important tool that has transformed the route for new drug discoveries and deliveries and can, in general, improve the quality of life. Life sciences may be broadly defined as including the scientific discipline of life and of living organisms. The term is used as a collective name for the pharmaceutical and biotechnology industries as well as medical technologies, clustered together due to their interdependence and the fuzzy borders between them. The interdependence between pharmaceuticals and biotechnology emerged in the second half of the 1970s when several pharmaceutical multinationals started partnering with biotechnological start-ups to gain knowledge (Roijakkers and Hagedoorn, 2006). Most biotechnology companies are small, they account for the bulk of innovative activity and their business model is based on the commercialization of university research that may lead to major scientific and technological changes. In most cases, this commercialization mainly depends on the involvement of large multinational

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companies (Kenney, 1986; Powell, 1996; McKelvey, 1996). By now, collaboration in R&D between pharmaceutical multinationals and biotechnology companies has increased dramatically (Roijakkers and Hagedoorn, 2006). Moreover, pharmaceutical multinationals not only engage in partnering with biotechnology start-ups, but they also acquire them, as a way to withstand competitive pressure from generic drugs companies. Different typologies have been designed to study the R&D-intensity of industries (UNCTAD, 2005:108). According to the UK Department of Trade and Industry, pharmaceuticals and health is the first and the most R&D-intensive group, with R&D-intensity defined as direct R&D expenditures as a percentage of production (gross output) (DTI, 2006). It consists of pharmaceuticals and biotechnology (R&D-intensity: 14.9 per cent) and health care equipment and services (R&D-intensity: 6.4 per cent). Moreover, at the global level, the pharmaceutical sector is characterized by the growth of R&D expenditures which is induced by a number of factors, such as ageing of the population in developed countries and market growth in developing ones. As for the biotechnology, it is a relatively young area, but it has shown an impressive and effective development over the past few years, pushing the boundaries of conventional medicine into the fields of genomics, molecular biology, biomedicine, bio-informatics and so forth. The high level of R&D-intensity of the life sciences sector implies that linkages between multinational R&D activities (including research and clinical trial) and host-country science and research systems are very important. In other words, strong links between public sector and industry are crucial for the commercialization of products (Meyer-Krahmer and Reger, 1999). The life sciences sector is heavily concentrated on the leading spots of the Triad, with the US taking the lead and surpassing Europe in the amount of R&D investment and production. The global life sciences sector is set to grow which, in turn, forces multinationals to search for new cost-effective locations to remain competitive. Life sciences in CEE Owing to the increasing demand for innovative drugs and an increasing patient base, CEE economies have good potential. The geographical proximity to advanced Western European markets is a key advantage. Moreover, the CEE economies have a reasonable environment for knowledge-based activities of multinational companies and development of life sciences industry in particular, owing to a relatively strong scientific and technological base and a critical mass of skilled human resources.


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The 2004 accession to the EU is a major factor in the development of the sector in the region. Joining the European common market implies that a product developed and manufactured in any member state can be sold across the Union. Apart from the classic benefits of regional economic integration for multinationals in terms of enlarged market, the Union is set to play a decisive role in promoting knowledge-based economy and in the life sciences specifically. For example, in January 2002, the European Commission adopted a Strategy for Europe on Life Sciences and Biotechnology, which proposes a comprehensive roadmap of policy orientations and an action plan up to 2010. Many governments in the region have realized the potential of the sector, hence designed and implemented respective public policies (BioPolis Report, 2007). In the process of transition, the sector was largely neglected and governments in the region have only recently declared the sector a priority. The biggest challenge inherited from the past is the separation between academic research and industry; not all CEE countries have made progress in this area (BioPolis Report, 2007). The pharmaceutical market in the CEE countries is relatively small in comparison to Western Europe or the US. In 2006, it was estimated at USD 9.2 billion and it is expected to reach around USD 14 billion by 2010, still being around 5 per cent of global pharmaceuticals (Miriyam, 2007). Although domestic pharmaceutical and biotechnology companies are active in the life sciences sector in CEE countries, it is characterized by the strong presence of subsidiaries of multinational companies, which have been a driving force behind the growth in the sector. Foreign direct investments in the CEE life sciences Academic literature has extensively investigated drivers of FDI and has distinguished four main motives (Dunning, 1993). Three of them (marketseeking, efficiency-seeking, strategic asset-seeking) help explain investment behaviour of multinationals in the CEE life sciences sector. Market-seeking FDI implies that a multinational company establishes subsidiaries to serve host country markets. In the CEE region, rapid economic growth and a largely under-served population have motivated market-seeking FDI. Increased demand from both public and private healthcare is to lead to growth in sales of both branded and generic drugs, although generics dominate over the brands due to lower purchasing power than in the West. Moreover, since the CEE economies became part the EU, non-EU investors are attracted by the magnitude of the single European market. Efficiency-seeking FDI is carried out with the purposes of restructuring

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existing production through rationalization and locating some parts of the value chain in places that provide lower costs. In the CEE countries, efficiency-seeking FDI is attracted by the low cost of manufacturing and, primarily, low cost of labour. Additionally, the search for cost-effective locations is driven by the increasing R&D costs that pharmaceutical and biotechnology multinationals have to bear. This search for cost-effective destinations for R&D corresponds to the type of the asset-seeking FDI, investments in strategic assets, such as human capital and technology. The CEE countries have a strong technological legacy that attracts FDI. Multinationals are attracted by the presence of universities and research institutes involved in life sciences. Although, performance of the CEE countries in terms of attracting FDI in path-breaking research is very moderate, since the mid-1990s they have emerged as advantageous locations for clinical trials. The decisive factors are the availability of homogeneous, drug-naive patient base, high treatment compliance rates of patients and high ratio of doctors per capita of population. As the clinical trials must comply with the EU regulations, more multinational pharmaceutical companies are focusing on the new EU member states, which offer excellent location for such development activities (Babic and Kucerova, 2003; Natorff, 1998; Pal, 1997). The quantity of research conducted in these countries is increasing. The three largest new EU member states ‒ Czech Republic, Hungary and Poland ‒ host up to 1000 studies annually. New EU member states have lower clinical development costs and less regulation as opposed to traditional locations in Western Europe. The governments of new EU member states have incorporated the European legislation into national law before the accession to the Union, including Directive 65/65/EEC, the first and fundamental pharmaceutical framework directive in the EU, and Directive 2001/20/EC on the clinical trials. Undoubtedly, the CEE region is not a homogeneous block. BioPolis Report (2007) groups new EU member states in three clusters based on the degree of advances in the life sciences. Cluster I includes the countries closing the gap with the EU-27 ‒ Czech Republic, Estonia, Hungary and Slovenia. Cluster II consists of countries making progress ‒ Poland and Slovakia. Finally, cluster III unites weak performers ‒ Bulgaria, Latvia, Lithuania and Romania. Foreign direct investments in the Czech life sciences Czech Republic, belonging to cluster I, emerged as a dynamic economy. During the transformation period, the country has greatly benefited from a large amount of FDI, having recorded one of the highest FDI stock per


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capita in the region. The FDI inflow has been stimulated by the introduction of a transparent system of investment incentives in 1998. CzechInvest, the Czech national investment promotion agency, has identified nine key investment areas, including life sciences and medical devices and R&D. Within R&D, six priority areas are defined, including molecular biology, biomedicine and biotechnologies, as well as development of new materials meant to advance life sciences. Pharmaceutical companies investing in production activities in the Czech Republic are eligible for corporate tax relief for up to ten years, job creation grants, training and retraining grants and site support. Subsidies to business activity and training and retraining are available for technology centres and applied R&D. Essentially, three main groups of players can be identified in the Czech life sciences sector. These are research institutes and universities, domestic companies and subsidiaries of foreign multinational companies. According to the Czech Biotech Report (2007), at the beginning of 2007, there were 57 biotechnology companies and 308 biotechnology research entities in the country. A substantial number of the Czech biotech companies cooperate closely with big pharmaceutical players in the Czech market, operating as either a supplier base of pharmaceutical substances or conducting subsequent research and contractual work. US and European pharmaceutical multinationals dominate the sector and their products are exported to other European markets and to the rest of the world. In such a knowledge-intensive sector as life sciences, research institutes play a crucial role. The Czech Republic possesses a network of research institutes spread across the country. It is no coincidence that biotechnology clusters have emerged in university cities. For instance, Brno, the second largest city in the Czech Republic, is becoming a hub of biotech companies. Most of the research institutes in the area of life sciences belong either to universities, to the Ministry of Health or the Academy of Sciences of the Czech Republic. The Academy of Sciences is the national centre of non-university basic and applied research. It unites 53 institutes engaging in research in the natural, technical and social sciences and the humanities. There are three biomedical institutes of the Czech Academy of Sciences ‒ Institute of Experimental Medicine, Institute of Physiology and Institute of Microbiology. University professors and PhD researchers become increasingly involved in research projects with industries. For instance, the University of Veterinary and Pharmaceutical Sciences in Brno is engaged in partnerships with companies such as Zentiva and Spofa. The International Clinical Research Centre is planned to become an important player in the sectoral innovation system of the Czech life sciences. This clinical-research-educational centre, established in 2006 in

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Brno, is a result of collaboration between Czech scientists and the Mayo Clinic, a US non-profit university hospital. The International Clinical Research Centre can be a platform for strengthening EU-US collaboration in medical research and education. The project is valued at USD 100 million and around 250 researchers are employed. The technology parks provide infrastructure suitable for growth within the industry. Several institutions perform the clinical testing of drugs in the Czech Republic. The State Institute for Drug Control in Prague is the highest authority supervising clinical trials. The company I.Q.A. founded as a spin-off from the Research Institute of Pharmacy and Biochemistry is engaged in the preclinical and clinical testing of drugs. Other companies doing all phases of clinical trial are Zak-Pharma services (Brno), Cepha (Prague), Clinst (Prague), Pharm Test (Hradec Králové).

MULTINATIONAL COMPANIES IN THE CZECH LIFE SCIENCES Major US and European multinationals are important players in the Czech economy and in the life sciences sector in particular. According to the OcoMonitor database, from 2003 till August 2007 alone, the Czech Republic recorded a total of four new investment projects in this sector, representing 17 per cent of the CEE total (of 23 cases), compared to 9 per cent for Poland, 17 per cent for Russia and 22 per cent for Hungary. The list of investors present in the Czech Republic include such names as Lonza (Switzerland), Arrow International (US), Amgen (US), Eisai (Japan), Molnlycke Health Care (Sweden), Covance (US), Olympus (Japan), Paul Hartmann (Germany), Synthon (The Netherlands), Johnson & Johnson (US). Moreover, many medical producers are present; inter alia B Braun Medical (Germany), Carl Zeiss (Germany), Axel Johnson International (Sweden), Philips Medical Systems (The Netherlands) and Thermo LabSystems Corporation (USA). Multinational companies may enter a market through a variety of forms, such as green-field development, strategic alliances, joint ventures and takeovers (Root, 1994). In the present analysis, we focus on two main modes of entry ‒ greenfield and acquisition. Greenfield FDI denotes investment projects entailing establishment of an entire new unity in a foreign country, while acquisition FDI implies taking over an existing local unit in a foreign country. Acquisitions have become a key mode of global FDI since the late 1980s (UNCTAD, 2000, 2006). This is explained by the fact that the acquisition of local firms by foreign multinationals enable quick entry and facilitate access to resources


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and networks available in the host country. In many cases, an acquired firm possesses technological capabilities that can be either downsized or integrated into the corporate network of the acquirer multinational. For the host country, the main difference between a greenfield FDI project and an acquisition one lies in the immediate of short-term effects, such as capital formation and employment generation, since in the long run the impact on the host country can be difficult to distinguish (UNCTAD, 2000, 2006). Takeovers in the Czech life sciences In CEE countries as a whole, the cases of acquisition were widespread during the transition period, especially linked to the privatization of stateowned organizations. The Czech life sciences were not an exception. Galena, originally a state-owned company with 120 years of history and a leader in the Czech pharmaceutical industry, was acquired by the Ivax Corporation, headquartered in Miami, in 1994. After the deal, Galena had its R&D department dedicated to biotechnology retained and remained embedded in the Czech innovation system. In 1999, Lachema, then privately owned but originally a state-owned enterprise privatized in 1991, was acquired by the Croatian pharmaceutical company Pliva, becoming Pliva-Lachema. At the end of the same year, Pliva-Lachema was taken over by the US company Barr Pharmaceuticals. The stateowned Radioisotope Research and Application Institute based in Prague was acquired in 1992 by the French company Immunotech. The focus of the resulting subsidiary company was on R&D and production of diagnostic kits for medical use. Since 1995, following a sequence of global deals, Immunotech Czech Republic is a subsidiary of the US company Beckman-Coulter, a leading producer of biomedical testing instrument systems. Although the privatization process ended mostly by the 2000s, acquisition has remained a popular mode of FDI into the Czech life sciences. In 2003 the Dutch company Zentiva, which main shareholder is another multinational, the French Sanofi-Aventis, acquired the Czech company Léčiva. Léčiva was a state-owned firm until 1998, when the majority of its share was acquired by Warburg Pincus, a world-leading private capital fund. In 2002, Baxter Corporation, a global provider of medical products and services bought a site and unfinished building from Sevac, a state-owned enterprise, initially established as the Institute of Sera and Vaccines. Since then, Baxter has invested around almost USD 56 million to develop its Czech subsidiary, which now has around 200 employees.

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Acquisition of stand-alone R&D units, such as research institutes in a host economy is a very specific mode of entry, characteristic of CEE countries. In the centrally planned economic system, the organizational structure for research, development and innovation was highly fragmented. There was a traditional separation between a network of branch R&D, project design and product design organization on one side, and a network of enterprises on the other (Hanson and Pavitt, 1987). This fragmentation was an obstacle for innovation, but could be managed by the central planning agencies. With the demise of the command economy, this traditional fragmentation led to unpredictable developments. Demand for R&D from manufacturing companies significantly decreased and many research institutes found themselves on the verge of bankruptcy. In the light of these developments, the decision made by the Czech government in the 1990s to privatize some research institutes was not surprising. It meant that state-owned research institutes were available for acquisition, not only for domestic, but for foreign investors, too. Acquisition of state-owned research institutes represents a typical case of asset-seeking FDI, attracted by strategic assets available in a host economy. As early as in 1991, the Research Institute for Biofactors and Veterinary Drugs began co-operation with the Lonza Group, a Swiss chemical and biotechnology company, which is one of the world’s leading suppliers to the pharmaceutical, healthcare and life science industries. In 1992, Lonza acquired the institute, which became its Czech subsidiary named Lonza Biotec. A noteworthy observation is that Lonza entered the Czech market through acquisition of the most advanced corporate function, R&D. Later, Lonza Biotec progressed to more downstream functions as it started production of L-Carnitin. In 2002, Lonza began considerably expanding its Czech facilities, and in 2004, Lonza Biotec incorporated more downstream processing capacities. In 2006, Lonza Biotec’s R&D capabilities were strengthened by the opening in Kouřim of a new R&D centre, worth of USD 18 million and employing 50 people. It could have been assumed that the potential for asset-seeking FDI in the Czech life sciences sector has been fully exhausted after privatization of state-owned research institutes in the 1990s. Nowadays, it is private national R&D firms that remain the target of foreign multinational pharmaceuticals. For example, in August 2007, the US-based international clinical trial company Medpace announced acquisition of Monax, a 500-employee Czech contract research organization. It is indicative that with this deal, Medpace aims to strengthen its presence in Europe, in addition to its existing offices in Belgium, Germany and the Netherlands.


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Greenfield and partnership In the case of greenfield investments, a host country should be able to outcompete alternative locations short-listed by a multinational company in terms of package of investment incentives, provision of infrastructure and facilitation of entry. Laminar Medica is illustrative in this respect. It is headquartered in Tring, UK, and specializes in design, test, manufacture and validation of transport systems for healthcare facilities. In 2003, Laminar Medica started looking for a new location in CEE to match the demand of an expanding consumer base, while taking into account the lower costs of prospective locations. It considered the Czech Republic, Poland and, to a lesser extent, Hungary and Austria, but finally chose the Czech Republic thanks to its favourable conditions and the investment incentives offered by the Czech government. Hence, in 2005 Laminar Medica established its production subsidiary in the Czech Republic as a greenfield investment project. Another greenfield investment project, amounting to USD 21.9 million and creating 58 new jobs was implemented by the US company Covance in 2006 with the opening of a clinical development office in Prague. This new office supports Covance’s clinical trial operations in the Czech Republic and Slovakia. It would complement the network of existing clinical development offices, inter alia, in Warsaw and Budapest. It is worth noting that many foreign multinational companies established partnerships with domestic firms or research institutes before entering the Czech economy through an acquisition or a greenfield investment. An illustration of a joint venture between a domestic and a foreign-owned company leading to a greenfield investment is given by the pharmaceutical company Ferring. In 1993, this Swiss multinational entered in a joint venture with the then state-owned Léčiva. In 1997, Ferring started construction of its own subsidiary in the Czech Republic, which was completed in 1999. The Ferring whole-owned subsidiary is named Ferring Léčiva, which kept manufacturing contracts with Léčiva, which was already privatized by that time. The entry of the US multinational biopharmaceutical company Gilead Sciences in the Czech Republic resulted of its partnership with a Czech research institute. In 1991, Gilead Sciences entered into license agreement with the Institute of Organic Chemistry and Biochemistry (IOCB) of the Czech Academy of Sciences. In 1992, the development of small molecule antiviral therapeutics was ushered in with the licensing of nucleotide compounds discovered by the IOCB and a research institute in Belgium. In July 2006, Gilead Sciences announced a donation to IOCB in order to establish a Gilead Sciences Research Centre. Gilead pledged to provide USD 1.1

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million annually to IOCB for an initial five-year period in order to fund IOCB’s ongoing research activities and its Centre’s future operations. The Gilead Sciences Research Centre will consist of selected research groups led by scientists from IOCB. Another agreement signed between these two parties stipulates that Gilead would provide patent services to IOCB. Multinationals’ Czech subsidiaries Overall, the multinationals that entered the Czech market in the 1990s and invested in the development of their subsidiaries, are now key local players. Several examples of global multinational companies entering the Czech life sciences sector with different motivations and strategies provide rich food for thought. The establishment of a subsidiary without any R&D capacities corresponds to market- or efficiency-seeking FDI. In such cases, a multinational establishes a subsidiary producing goods and products already manufactured in the corporate network elsewhere. In the case of pharmaceuticals, the costs of setting up a completely new production facility are higher giving all the required certification of the manufacturing processes. In an acquisition, a multinational would buy a firm possessing manufacturing capacities and gain immediate access to the market. Both modes of entry can be beneficial for the host economy since the acquisition of existing firms integrates these manufacturing facilities into the global corporate network, and in a greenfield investment the country receives capital inflows and new jobs are created. Subsidiaries combining manufacturing and R&D capacities may unite market-, efficiency‒and/or resource-seeking FDI. When this type of subsidiary results from greenfield investments the benefit for the host economy in terms of capital inflows, job creation and strengthening of the knowledge base can be maximized, making this the most desirable type of FDI. In the cases of acquisition, the impacts for the host economy are more difficult to be evaluated. When an acquired domestic firm becomes part of the global corporate network of the acquirer multinational, its production capacities are likely to be retained, however it is questionable whether its R&D facilities will be preserved and integrated into the global network of the new owner. A somewhat less frequent case is the entry to the host economy in the form of stand-alone R&D unit, which results from the trend of corporate R&D internationalization. It is typically an asset-seeking FDI. Investment promotion agencies of many countries specifically target and compete for a tiny share of the best FDI, that is, FDI in R&D. However, attraction of R&D-related FDI is not an end in itself, integration of the R&D subsidiary into the host innovation system is a key challenge.


53

An even more specific case is the acquisition of stand-alone R&D facility, as illustrated by the acquisition of state-owned research institutes by multinational companies in the process of privatization in the 1990s. The argument supporting such deals was that the privatization of the science and technology sector would solve the problems inherent to the socialist economy. The claim was that although the state was losing control over R&D capabilities, particularly when the acquirer was a foreign multinational, the research institutes would became effectively integrated into the global economy. Moreover, the issue of ownership would not be relevant, as the R&D facilities remained physically present in country. Yet, there were opponents to such deals who considered the loss of national control over R&D capabilities as the biggest disadvantage of the acquisition of research institutes by foreign multinationals. Since the control is transferred to the headquarters of a multinational company, the state remains powerless and a multinational company can downsize or even close down these R&D facilities.

CONCLUSIONS AND POLICY IMPLICATIONS The life sciences sector emerged as a prospective area, being the twentyfirst century gold rush. On one hand, traditional pharmaceutical multinationals explore new opportunities in the biotechnology worldwide and seek to reinforce their positions in the global market. On the other hand, national governments try to jump on the bandwagon and try to develop the life sciences industry of their countries as they are afraid to be left out of what is perceived as a source for high-end economic development. Giving the fact that the life sciences sector (and pharmaceuticals in particular) is highly globalized, promoting and targeting FDI has become a natural way to develop this industry. However, unlike the gold rush in California, which was driven by resource-seeking motives, the biotech gold rush is driven by asset-seeking motives, meaning that life sciences multinationals invest in locations that offer a pool of educated labour force, unique knowledge and expertise. Several CEE countries, new EU member states and Czech Republic in particular, emerge as such locations. The Czech Republic offers investment incentives for FDI projects in the life sciences too, but the real motivation for multinationals to enter the market is based on a different rationale. The country had a strong science foundation in pharmaceuticals and natural sciences in the past. Successful privatization of its pharmaceuticals industry provided a boost in the development of the life sciences sector in the country. Hence, it is not surprising that acquisition of state-owned enterprises was the most common way

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for multinationals to enter the Czech life sciences industry. Moreover, acquisition of state-owned research institutes is an interesting case per se. Presently, as the mass privatization ended, multinational acquire private R&D companies. However, multinationals’ R&D activities in the Czech life sciences have been limited to clinical trials and not encompassed groundbreaking research. The developments in the Czech life sciences sector should be regarded through the country’s membership in the EU, as it belongs to the 27-member block that fosters common market and enforces harmonious regulatory environment. However, some reservation about EU membership should be expressed. This competitive advantage is eroded as more countries join the bloc. In this way, the current study, although focusing on only one country is relevant for several other new EU member states. Previous studies on public policies to promote pharmaceutical sector suggest that policy shaping the local network and stimulating a demanding competitive environment is more effective than protecting the local market and de-linking it from the global market (Thomas, 1994). Most CEE countries, and Czech Republic in particular, indeed chose the first course, trying to make domestic firms stronger and to attract new investors and stimulate the evolution of multinational subsidiaries already in place (Costa and Filippov, 2007). The chapter points to the fact that the sourcing of knowledge by multinational companies is taking place not only through formal acquisition of domestic firms or research institutes, but more importantly, through partnership, strategic alliances between foreign and locally-owned players. This co-operation should be further promoted for the benefits of both sides. Moreover, policies should stimulate universities and research institutes to understand market issues and engage more in demand-driven research.

NOTE 1. The profiles of subsidiaries discussed in the paper are obtained from the official CzechInvest website unless otherwise is specified.

REFERENCES Babic, D. and I. Kucerova (2003), ‘Benchmarking clinical trials practices in Central and Eastern Europe’, Applied Clinical Trials, 12(5), 56‒58. BioPolis Report (2007), ‘Inventory and analysis of national public policies that


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stimulate biotechnology research, its exploitation and commercialisation by industry in Europe in the period 2002‒2005, TNO Innovation Policy Group, Netherlands, Fraunhofer ISI, Germany, and SPRU, UK, accessed at http:// ec.europa.eu/research/biosecurity/pdf/biopolisfinalreport_en.pdf. Birkinshaw, J. (1996), ‘How multinational subsidiary mandates are gained and lost’, Journal of International Business Studies, 27(3), 467‒95. Birkinshaw, J. and N. Hood (1998), ‘Multinational subsidiary evolution: capability and charter change in foreign-owned subsidiary companies’, Academy of Management Review, 23(4), 773‒95. Campos, N. and F. Coricelli (2002), ‘Growth in transition: what we know, what we don’t, and what we should’, Journal of Economic Literature, 40(3), 793‒836. Costa, I. and S. Filippov (2007), ‘A new nexus between foreign direct investment, industrial and innovation policies’, United Nations University-MERIT working paper 2007‒030. Czech Biotech Report (2007), Brno: South Moravian Innovation Centre, information about the report accessed at www.gate2biotech.com/Czechbiotech-report-1/. Damborský, J., Z. Prokop and M. Kostka (2006), ‘Perspectives: biotechnology in Czech Republic, the past and the future’, Biotechnology Journal, 1(5), 487‒90. Department of Trade and Industry (DTI) (2006), The R&D Scoreboard 2006, The Top 800 UK and 1250 Global Companies by R&D Investment, London: DTI & Company Report. Dunning, J. (1993), Multinational Enterprises and the Global Economy, Wokingham: Addison-Wesley. Economist Intelligence Unit (2007), Industry Forecast: Healthcare and Pharmaceuticals. Czech Republic, London: EIU Press. Estrin, S., K. Hughes and S. Todd (1997), Foreign Direct Investment in Central and Eastern Europe: Multinationals in Transition, London: Pinter. Gassmann, O. and M. von Zedtwitz (1999), ‘New concepts and trends in international R&D organisation’, Research Policy, 28(3), 231‒50. Granstrand, O., L. Hakanson and S. Sjolander (1993), ‘Internationalisation of R&D: a survey of some recent research’, Research Policy, 22(5‒6), 413‒30. Hanson, Ph. and K. Pavitt (1987), ‘The comparative economics of research and development in East and West: a survey’, Fundamentals of Pure and Applied Economics, 25. Kenney, M. (1986), ‘Schumpeterian innovation and entrepreneurs in capitalism: a case study of the US biotechnology industry’, Research Policy, 15(1), 21‒31. Knell, M. (1992), Socialist Economies in Transition: Appraisals of the Market Mechanisms, Northampton, MA, USA, Cheltenham and UK: Edward Elgar. Knell, M. (1996), Economics of Transition: Structural Adjustments and Growth Prospects in Eastern Europe, Cheltenham UK and Brookfield, US: Edward Elgar. Kuemmerle, W. (1997), ‘Building effective R&D capabilities abroad’, Harvard Business Review, 75(2), 61‒70. Kuemmerle, W. (1999), ‘Foreign direct investment in industrial research in the pharmaceutical and electronic industries ‒ results from a survey of multinational firms’, Research Policy, 28(2‒3), 179‒193. Luukkonen, T. and C. Palmberg (2007), ‘Living up to the expectations set by ICT? The case of biotechnology commercialisation in Finland’, Technology Analysis and Strategic Management, 19(3), 329‒49.

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Mangematin, V. (2004), ‘From sectoral to horizontal public policies: the evolution of support for biotechnology in Europe, 1994‒2001’, Science and Public Policy, 31(5), 397‒406. McKelvey, M. (1996), Evolutionary Innovations. The Business of Biotechnology, Oxford: Oxford University Press. Meyer, K.E. (ed.) (1998), Direct Investment in Economies in Transition, Cheltenham UK and Lyme, US: Edward Elgar. Meyer-Krahmer, F. and G. Reger (1999), ‘New perspectives on the innovation strategies of multinational enterprises: lessons for technology policy in Europe’, Research Policy, 28(7), 751‒76. Miriyam, S. (2007), ‘Central and Eastern Europe pharmaceutical industry: an overview’, Frost & Sullivan, Pharmalicensing, accessed 1 September 2007 at http://pharmalicensing.com/articles/disp/1169475631_45b4c82f37694. Natorff, B. (1998), ‘Clinical trials in Central/Eastern Europe: industry viewpoint’, Drug Information Association Journal, 32, 129‒33. Pal, D. (1997), ‘Recent changes in clinical trial authorization in Eastern Europe’, Drug Information Association Journal, 31, 151‒55. Paterson, S.L. and D.M. Brock (2002), ‘The development of subsidiarymanagement research: review and theoretical analysis’, International Business Review, 11(2), 139‒63. Piech, K. and S. Radosevic (eds) (2006), The Knowledge-based Economy in Central and Eastern Europe: Countries and Industries in a Process of Change, Basingstoke: Palgrave Macmillan. Powell, W. (1996), ‘Inter-organizational collaboration in the biotechnology industry’, Journal of Institutional and Theoretical Economics, 152, 197‒215. Reiss, Th., S. Hinze and I. Lacasa (2004), ‘Performance of European member states in biotechnology’, Science and Public Policy, 31(5), 344‒58. Roijakkers, N. and J. Hagedoorn (2006), ‘Inter-Firm R&D partnering in pharmaceutical biotechnology since 1975: trends, patterns, and networks’, Research Policy, 35, 431‒46. Root, F. (1994), Entry Strategies for International Markets, London: Lexington Books. Sansom, C. (1999), ‘European biotechnology turns East’, Nature Biotechnology, 17, 437‒39. Scholtès, Ph. (1996), Industrial Economics for Countries in Transition: Evidence from Eastern Europe and Asia Pacific, Cheltenham UK and Brookfield, US: Edward Elgar. Stopford, J. and L. Wells (1972), Managing the MNE: Organization of the Firm and Ownership of the Subsidiaries, New York: Basic Books. Thomas, L. (1994), ‘Implicit industrial policy: the triumph of Britain and the failure of France in global pharmaceuticals, Industrial and Corporate Change, 3(2), 451‒89. UNCTAD (2000), World Investment Report, New York and Geneva: United Nations. UNCTAD (2005), ‘Transnational corporations and the internationalization of R&D’, in World Investment Report, New York and Geneva: United Nations. UNCTAD (2006), ‘FDI from developing and transition economies’, in World Investment Report, New York and Geneva: United Nations. Wind, Y. and H. Perlmutter (1977), ‘On the identification of frontier issues in international marketing’, Columbia Journal of World Business, 12, 131‒139.


Websites and databases CzechInvest: www.czechinvest.org Gate2biotech: www.gate2biotech.com OcoMonitor: www.ocomonitor.com

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4.

Facing the trial of internationalizing clinical research to developing countries: evidence from Mexico Fernando Santiago-Rodríguez

INTRODUCTION Recent years witness trends towards outsourcing and internationalization of clinical research by multinational pharmaceutical firms. Increasingly clinical trials are run at numerous sites around the world. Several developing countries are emerging as relevant investigative sites. Although India and China appear as preferred destinations, good prospects to participate are also available for other advanced developing economies, such as Brazil, South Africa and, as discussed here, Mexico. In addition to large domestic markets, such countries have consolidated major regional manufacturing and export bases for foreign-owned subsidiaries as well as for some domestic firms. Moreover, these emerging economies feature some country specific conditions shaping their attractiveness as investigative sites. This chapter analyses recent developments in the markets for clinical trials in developing countries. It leans on the Mexican case to illustrate some factors driving the dynamics and attractiveness of such countries as investigative sites. It also points to some challenges developing countries face to adjust and modernize their local regulatory environment governing clinical trials. The chapter brings together scholarly literature on internationalization of R&D by multinationals and on ethical implications and regulations of clinical trials. The analysis in this chapter builds on both primary and secondary data sources. Primary data were gathered through semi-structured interviews carried out in Mexico between February and August 2007. Informants included representatives from foreign-owned multinational subsidiaries and Mexican pharmaceutical firms as well as representatives from the main local trade organizations in this industry, CANIFARMA and AMIIF. The chapter also benefits from interviews with representatives from the Mexican regulatory agency, the COFEPRIS, and the coordinating body 58

Internationalizing clinical research

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of the public health and research centres hosting most clinical research protocols in Mexico, the CCINSHAE. The statistical data used in the chapter are from two main sources. ClinicalTrials.gov, an online database with information about the number, distribution and some general characteristics of clinical trials carried out in the US and other 153 countries. This is one of the two most authorized publicly available sources of information about clinical trials in the world.1 Registration of trials in this dataset may be a pre-requisite for eventual publication of research results in the specialized medical literature (De Angelis et al., 2005). Additional data were obtained from the 11 January 2008 version of the Bioresearch Monitoring Information System (BMIS), which provides information submitted to the US Federal Drug Administration (FDA) about clinical investigators, contract research organizations and institutional review boards involved in conducting investigational new drug studies with human investigational drugs. The chapter is organized as follow. The first section characterizes clinical trials within the broader innovatory process in the pharmaceutical industry including some determinants of their internationalization and location to developing countries. The second section looks at some regulatory challenges in relation to clinical trials in Mexico. The third section concludes the chapter.

CLINICAL TRIALS: INNOVATION AND MARKETS The innovation process in the pharmaceutical industry comprises four major stages (Achilladelis and Antonakis, 2001; Hara, 2003; McKelvey and Orsenigo, 2002; Styhre and Sundgren, 2003). The first stage encompasses discovery or basic research leading to identification of new molecular targets, new chemical entities, and pre-clinical studies. The second stage refers to development or clinical research comprising activities pre- and post-marketing of new drugs. The third stage involves regulatory processes of evaluation and eventual approval or rejection of development and marketing of pharmaceutical products. The last stage concerns manufacturing, marketing and product life cycle support. The length and sequencing of each stage depends on legal, ethical, scientific and economic factors (Gaudillière, 2004; Jungmittag, 2000). In general, 10 to 15 years are required to pass through all four stages and bring a new drug into the market. The largest share of this time involves clinical trials. In addition, clinical trials account for a third or more of the USD 800‒900 million estimated as the investment required in the entire process of pharmaceutical innovation (Boggs et al., 1999; Maiti and Raghavendra, 2007).

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Clinical research involves epidemic studies, life-style modifications, prognostic studies, health records and tests of non-pharmacology related therapies. However, clinical research on new drugs is the most abundant. In a broad sense, new drug-related clinical trials can be defined as tests to certify efficacy, safety, overall socio-economic and technical viability of prospective new drugs or medical devices. Clinical trials of a new drug are split in four phases, each of which differs in complexity regarding technical knowledge, infrastructure, number and profiles of people involved, regulatory requirements and so on. Phase I constitutes first-time administration of new chemical entities in humans, firstly on healthy volunteers. Then, during Phase II the drug is administered to a small sample of volunteers featuring the target medical condition. These two first phases inform research questions, definition of analytical conditions and end-points2 for the subsequent more lengthy and massive studies in Phase III (Zivin, 2000). Phase IV consist of post-marketing studies informing about longterm effects of the new drug, while exploring opportunities to develop improved or new applications for existing products, extending their life cycle. Speed, coordination, efficiency, accuracy and minimizing costs of trials are critical to reduce time-to-market, increase profits and enhance product quality. Each day saved in the process, particularly in Phase III, brings substantial gains in expected revenues. On this regard, the outsourcing and ultimate internationalization of clinical trials has been an increasingly common strategy adopted by pharmaceutical firms. What drives internationalization of clinical research? The characteristics of pharmaceutical innovation allied with rapid technological change, fierce competition and development of pockets of scientific and technological excellence throughout the world compels multinationals to continuously adjust and reorganize their R&D activities worldwide (Gassmann and von Zedtwitz, 1999). In general, the scholarly literature on R&D internationalization points to many factors related to science and technology and R&D costs that may drive multinationals to concentrate and/or spread out their innovation activities (Cantwell and Kosmopoulou, 2001; Gassmann and von Zedtwitz, 1999; Patel and Vega, 1999; Reddy, 1997; von Zedtwitz and Gassmann, 2002). Studies on R&D internationalization have distinctly observed trends or patterns of R&D internationalization depending on the aspects they address, such as R&D-specific or external factors, motives, host location characteristics, inter-temporal characteristics and degree of cooperation between individual R&D units (Gassmann and von Zedtwitz, 1999; Kuemmerle, 1999; Reddy, 1997; von Zedtwitz and Gassmann, 2002).


61

It is not our intention to review all those factors here. It suffices to say that those patterns entail distinct interactions, conditions to participate and more importantly, different influences on the structure and performance of regional, sectoral and national systems of innovation of hosting location (Archibugi and Pietrobelli, 2002; Chen, 2006; Dunning, 1994; Le Bas and Sierra, 2002; Milstien et al., 2007; Reddy, 1997). The characteristics of the host countries, industries and firms matter when identifying particular patterns of R&D internationalization. Yet, it is problematic to set clear-cut distinctions between these dimensions, particularly between countries and industries (Dunning, 1994; Kuemmerle, 1999; von Zedtwitz and Gassmann, 2002). Clearly however, multinationals can split research (R) and at a larger extent, development (D), across geographical locations (von Zedtwitz and Gassmann, 2002). In such a way, multinationals may tap on scientific and technical capabilities and other country-specific characteristics in relevant markets while protecting, enhancing or complementing the core knowledge developed at corporate level (Kuemmerle, 1999; Le Bas and Sierra, 2002; Patel and Vega, 1999). Host countries may serve different roles for multinationals: they can be a place to exploit knowledge and innovation produced at key locations within the corporation, mainly at home or be part of complex global innovation generating networks (Dias and Bresciani, 2006; Reddy, 1997). The pharmaceutical industry is very illustrative of this process. It is one of the more globalized industries and tends to show a more ample tendency to outsourcing and offshoring research and development activities (Kuemmerle, 1999; von Zedtwitz and Gassmann, 2002). Relevant for the purpose of this chapter is the tendency of increasing internationalization of the R&D activities related to clinical trials. This tendency has benefited from regulatory changes taking place in relevant markets. For instance, the US allows the inclusion of data from clinical trials performed abroad in any application of new drug to the FDA (FDA, 2001; PhRMA, 2006b). In such cases, a company may benefit from the flexibility in terms of choosing clinical trials locations, such as reducing the related costs. Maiti and Raghavendra (2007), for example report savings of 30 to 50 per cent in India for comparable clinical trials carried out in Europe or the US. Other advantages of internationalizing clinical trials are related to the countries hosting such activities, particularly when they represent relevant potential market themselves. For instance, a pharmaceutical company would benefit from proximity and access to local organizations, notably drug regulatory authorities, in terms of shaping demand for their products and/ or benefiting a subsidiary already in place in the host country, if that is the case (Kuemmerle, 1999). Many aspects are taken into account when comes to select a country,

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or particular site, to host the clinical research for a new drug. Relatively strong regulatory environments, swift evaluation and approval of research protocols, reduced time for drug registration and marketing authorizations are among the factors that make a country attractive for hosting clinical trials (DiMasi, 2001; Piachaud, 2002). The capacity of host countries to comply with tough international standards on good clinical practices (GCP) and good laboratory practices (GLP) respectively,3 is required to ensure quality and integrity of data and more importantly, to safeguard wellbeing of study subjects. Moreover, the number, quality and cost of investigators and study subjects is critical (Zivin, 2000). The global clinical trial market and the internationalization to developing countries There has been an expansion of clinical trials in developing countries (Maiti and Raghavendra, 2007). This movement is partially explained by some general features of those countries, such as heterogeneous and growing populations, high prevalence of targeted diseases and lower research costs ‒ even for similar labour force quality and research conditions relative to developed countries. The size of the global market for clinical trials is difficult to define; estimates of annual investment in this area vary widely according to different sources: in 2006, the range was between USD 10 to 40 billion (Lamtech Institute, 2007; LeadDiscovery, 2006). In this chapter, we look at the distribution of trials among investigative sites throughout the world. To do so, we rely on data about trials carried out in the US and another 153 countries, registered by the US Federal Drug Administration (FDA) ‒ NIH-NLM. We aggregated the data in order to distinguish between developed and developing regions, following classifications by the World Bank, the IMF and the OECD (Table 4.1). By the end of February 2008, about 51 987 protocols had been or were being carried out in the world since 1948. Considering that many of these trials are performed in multiple sites at once, the actual number may add up to 75 900.4 Global clinical trial activities record a tenfold increase since the year 2000, with a strong dynamism in those performed outside the US. Notably, whereas participant developing countries rose from 34 to 93 in less than a decade, their share practically doubled over the same period. A similar situation occurs with transition economies. A breakdown by main developing country region shows that Latin America has the largest share. Yet, driven by India and China, East and Southeast Asia show the strongest dynamism. In their respective regions, Brazil, South Africa and Mexico have a significant weight as investigative sites.


Table 4.1

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Distribution of clinical trials by main countries and regions, 1948–2008 1948–2000 2001–2008 2008a 1948–2000 2001–2008 2008a

Region b

Per cent share of trials

World Developing Transition Developed Region Africa South Africa Latin America Brazil Mexico East, Southeast Asia and Pacific Chinac India Europe Middle East North Asia Developed US Europe Japan

6590 69274 75900 6.4 12.7 12.1 1.0 3.6 3.4 92.6 83.7 84.5 Per cent by main region 1.2 1.9 1.9 0.9 1.0 0.9 4.8 5.3 5.2 0.2 1.1 1.0 0.0 1.0 0.9 0.3 4.9 4.5 0.1 0.0 0.9 0.1 0.0 2.0 64.1 18.7 0.1

2.6 0.9 2.5 0.3 0.3 1.5 37.5 30.3 1.1

2.4 0.8 2.3 0.3 0.3 1.6 39.8 29.3 1.0

Participating countries 72 34 9 29 7 – 13 – – 9 – – 10 3 1 29 – 18 –

137 93 15 29 By region 37 – 24 – – 19 – – 11 11 6 29 – 18 –

137 93 15 29 37 – 24 – – 19 – – 11 11 6 29 – 18 –

Notes: (a) February, 28. (b) Absolute numbers. (c) Includes Taiwan and Hong Kong. Otherwise, the share would go down to 0.0, 0.9 and 0.9, for each respective period. Our regional classification differs from that used in the original source. We rearranged following World Bank, IMF and OECD classifications. Source:

Author with information from NIH-NLM.

Availability of qualified human resources is critical for the adequate performance of any system of innovation. On the same lines, growing clinical trial activities would be hindered without the corresponding development of a pool of specialized personnel. A positive response from developing countries would be the rise in the number of applications for clinical investigators to the FDA. Since 1997, the number of applications of clinical investigators from the five countries mentioned above has grown at an average 13.5 per cent a year. In 2007, applicants from these

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five countries represented 6.9 per cent of the total. However, since many of such applications would actually refer to the same single individual, the dearth of well-trained and experienced personnel remains a major shortcoming in developing countries. Concerns of future shortages of qualified people would be on the rise as current difficulties to find well-trained and experienced personnel are compounded by rather slow responses from local education systems (Singh, 2007).

CLINICAL RESEARCH IN MEXICO Mexico is the world’s ninth largest pharmaceutical market in the world and the second in Latin America. According to the IMS (2006), strong dynamism reflects in the growth rates of 6 to 8 per cent per annum in retail sales in the private drug market growing. Mexico is a relevant manufacturing and export base to tender Latin America and, at a lesser extent, the US, Europe and Asia. With regard to clinical trials, there is growing local activity as pharmaceutical related trials rose from 285 protocols in 2000 to 1360 protocols in 2007 (COFEPRIS, 2007). Data from Mexico-based trials would support the registration of new products in the US and other relevant markets. An illustrative example comes from one of the interviews we carried out. The local personnel of a Mexican subsidiary of a European pharmaceutical firm developed a multivitamin product for people with diabetes. However, as locally performed trials suggested the product would also have positive effects on some post-operation side effects for cardiovascular disease, the company’s headquarters decided to test for an eventual new application of the product by performing clinical trials at a more global scale. How can we explain this? A number of country specific factors may be at stake. According to the World Bank, Mexico is the 11th most populated country in the world. Estimates for 2007 by the Sistema Nacional de Información en Salud (SINAIS) set a total population at 108.6 million, with about 43 million (nearly 39 per cent) aged 19 years or less. This is a potential market for paediatric products, offering opportunities to exploit well-reputed and specialized research infrastructure in the area (Castellanos and Chiprut, 2002; Lamtech Institute, 2007). Moreover, according to information from the National Institute of Statistics, Geography and Informatics (INEGI), about 37.6 per cent of the Mexican population agglomerates in Mexico City, her two largest neighbouring states ‒ Estado de Mexico and Puebla, and in the industrial states of Jalisco and Nuevo León. This agglomeration of the population coincides with concentration of some of the country’s largest public


Table 4.2

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Mexico: main causes of death, 2000–2005a

Item

2000

2005

Diabetes mellitus Ischemic and related heart diseases Cirrhosis and other chronic affections of the liver Brain vascular diseases Malign tumours Lung obstructive chronic disease Diseases related to prenatal period Acute low respiratory infections Hypertension Nefresie and related Malnutrition HIV/AIDS Gastrointestinal infections

10.7 10.1 5.8 5.8 5.5 3.7 4.5 3.3 2.2 2.3 2.0 1.0 1.2

13.6 10.8 5.6 5.5 5.3 4.1 3.3 3.0 2.6 2.3 1.7 0.9 0.9

Note: Source:

(a) Percentage of total dead ratios per 100,000 inhabitants. SINAIS (2009).

health premises, many of the most modern health related education and research facilities, and the location of the majority of local and foreign pharmaceutical firms in the country (Dussel, 1999). Local demographics and epidemics lead to a mix of diseases characteristic of developing countries but also of more developed ones (Table 4.2). Urbanization, augmented life-expectancy at birth and improved sanitary conditions imply that although poverty related diseases such as gastrointestinal and respiratory infections or malnutrition, are now in check or slightly decreasing, they persist in being among the main causes of death, particularly among children and in highly impoverished regions (SS, 2005). In contrast, chronic illnesses and those associated with metabolism and age have gained prevalence. Nowadays, life-style diseases such as diabetes and ischemia account for nearly a quarter of death rates per 100 000 people in Mexico; the country is expected to host one of the largest diabetic populations by 2025 (Kuri et al., 2001). Shrinking birth rates, from 34.7/1000 in 1980 to 18.6/1000 in 2007, accompany a smooth demographic transition with the share of elderly people (65 or more years old) increasing from 4.3 per cent to 5.5 per cent over the same period (Calderón, 2007). This raises expectations of growing, multiple and longer lasting future drug intakes (Kuri et al., 2001; SS, 2005). At least, compared to other Latin American countries, Mexico has a strong public healthcare system that, next to large population coverage,

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hosts some of the country’s more advanced health research capabilities (SS, 2005). According to INEGI (2008), the Instituto Mexicano del Seguro Social (IMSS) and the Instituto de Seguridad y Servicios Sociales para los Trabajadores del Estado (ISSSTE) are the largest public medical care organizations with about 61 million affiliates. Other relevant public organizations include the national health institutes featuring ample capacity to perform clinical and some basic research, together with highly specialized health-assistance and training across 12 different therapeutic areas. Complementing the sector are a number of public hospitals and universities throughout the country. Linking to these public organizations saves firms the need to create the specialized centres that are required by the Mexican authorities to perform clinical trials. More importantly, they grant access to huge and captive populations under standardized research conditions. The institutional environment underpinning clinical trials This second section of the chapter enquires about the extent to which developing countries may be able to promote orderly developments in their local markets for clinical trials. Available literature suggests such goal is reliant on the countries’ ability to adopt proactive policy stances towards the operation of multinational firms (Archibugi and Pietrobelli, 2003; Chen, 2007; Dunning, 1994). Following Dunning (1994), influences from public policy on multinationals’ innovation activities may be either direct ‒ through funding and regulating of R&D activities; or indirect by influencing the overall environment in which firms undertake innovation. Regarding the latter, the current debate on the ethical implications associated with clinical trials hints at, among others, two interrelated areas relevant for policy intervention. While the first area is related to characteristics of the regulatory environment, the second refers to the structure and functioning of mechanisms responsible to evaluate and monitor clinical trials (Castellanos and Chiprut, 2002; Drews, 2000; Zivin, 2000; Fleck, 2004; Kermani, 2006; Lombera, 2006; Maiti and Raghavendra, 2007; PhRMA, 2006a; Valdez-Martinez et al., 2006). These areas highlight some minimum conditions increasing the likelihood that local performance of clinical trials meets international standards about protection of study subjects,5 while promoting adequate interactions between local agents and multinational firms. Regulatory issues Relative strength and compliance with regulatory frameworks and internationally accepted standards condition the attractiveness of investigative


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sites. In Mexico, the regulatory authority is the Comisión Federal para la Protección contra Riesgos Sanitarios (COFEPRIS). Created in 2001 COFEPRIS institutionalized efforts to integrate and simplify, and homogenize, within a single government organization, regulation on sanitary and related risks. Items under scrutiny include pharmaceutical products but also basic sanitation, environmental risks, publicity on health, food and related products and so on (Enríquez, 2006). COFEPRIS is responsible to approve and monitor clinical trials according to tight legal, safety, technical, ethical and other requirements set in current legislations. The agency however, is only able to partially fulfil the task; gaps persist in monitoring work in progress. This is an issue of equal concern in India, where despite improved regulation of the industry, weak enforcement remains an issue (Singh, 2007). Regulatory agencies in both countries suffer from a dearth of well-trained and experienced personnel, financial resources and infrastructure to carry out monitoring. In Mexico, according to information we gathered through interviews, poor remunerations and salaries compound the picture. Mexican officers would lack full awareness and hands-on experience of conducting clinical trials; learning processes would run parallel to actual performance of supervisory duties. Accordingly, COFEPRIS often has to lean on experts from hospitals, research centres, universities and the industry itself to conform supervisory and monitoring teams. Authorities would avoid conflicts of interest or inappropriate behaviour by requesting blind evaluations, leaving the actual decision-making to ethics committees. The extent that this practice rules out conflicts of interest and other problems calls for further study as major shortcomings remain in the operation of such committees. In any case, disappointment with an agency expected to stand as tall as the FDA but that instead, remains poorly empowered and financially endowed is clear. The governance of trials features shortcomings which are prone to hold back their adequate development in the future (Enríquez, 2006; Lamtech Institute, 2007). Pending in the agenda is the modernization of the regulatory framework, notably in relation to research. The current framework rests on the Ley General de Salud (General Health Act), and the associated Reglamento de la Ley General de Salud en material de Investigación (Bill on Health Research), dating back to 1984 and 1987 respectively (SS, 1984 and 1987). These documents specify the steps and conditions necessary to perform clinical trials in Mexico. However, both of them were conceived when such activities were relatively limited in number in the country. Consequently, current guidelines are rather general and less strict compared to the current industry standard practices, such as the International Conference on Harmonization (ICH); and somehow inadequate to tackle

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challenges resulting from an expanding market (Lamtech Institute, 2007). Generality refers to the need to harmonise research, clinical and laboratory procedures throughout the country as well. Initiatives are thus taken for a Mexican Norm on Clinical Research, so that procedures may meet the highest standards agreed upon by all relevant parties. Perhaps more progress is required in this department. COFEPRIS has strengthened and increased transparency of the regulation on clinical trials. Steps towards improving the regulatory framework in Mexico include the recent creation of a permanent pharmacovigilance program and enactment of a Mexican norm on the matter (Becerril, 2006). Pharmacovigilance in Mexico is divided into two stages: (1) early pharmacovigilance, mandatory by law, it requires watching for any sanitary risk arising during the first two years of commercialization of a new drug; and (2) intensive pharmacovigilance that considers specific tests of particular features of a drug after commercialization, therefore requiring more active stances by firms. Requests for specific studies are expected to give an early warning of any sanitary risks associated with trials and consumption of pharmaceutical products. In addition, and mirroring similar experiences in India,6 the Mexican pharmacovigilance norm induces firms and research organizations to agree on who takes responsibility to notify COFEPRIS of any major sanitary risk occurring during clinical trials either at home or abroad (Lamtech Institute, 2007). The last important aspect relates to dissemination of detailed and accurate information about clinical trials, this is critical to inform potential volunteer study subjects about the pros and cons of taking part in a given study; such is the essence of informed consent (PhRma, 2006a). In Mexico, lack of data or at least readily available access to it, is regrettable especially considering that strong regulatory agencies may induce firms to provide some minimum information about their activities.7 Better understanding of market dynamics would begin by solving this basic but critical statistical gap. COFEPRIS is developing an ad hoc database containing all research protocols in the country; the concrete impact of the initiative is yet to be seen. Ethics committees According to internationally accepted standards, performance of clinical trials is contingent on approval and close monitoring by ad hoc, independent bodies known as ethics committees or institutional review boards (IRBs).8 In Mexico, conformation and operation of IRBs, particularly within large organizations, follows paradigms set by the FDA9 (Castellanos and Chiprut, 2002). However, practical evidence is rather


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mixed about compliance with accepted principles of operation. In line with Valdez-Martinez et al.’s (2006) study on the functioning IRBs at IMSS ‒ the most important locus for clinical trials in Mexico, we found problems derived from the dearth of people with sufficient knowledge and experience to integrate the committees. Responsibility to evaluate protocols ethically would often fall onto a key person ‒ the dean of the teaching program or the service head at the host organization, for example. To the extent that such characters may frequently act as principal researchers ‒ those responsible to lead the research teams conducting a trial in those host organizations, the risks of potential conflicts of interests, insufficient transparency and objectivity in decision-making seems high. This is relevant as COFEPRIS’ lack of resources and expertise undermines its capacity to ensure that protocols are evaluated and carried out according to proper ethical and other relevant standards. Enforcement of existing legislation is a challenge. Deficient conformation of IRBs would slow evaluation of new protocol applications too. Waiting times depend on the institution, type and number of protocols. Bureaucratic procedures, lack of coordination, duplication of responsibilities and even contradictory decisions taken, particularly within large organizations, complicate operation of IRBs. Although approval times would mirror that of developed countries in general, it may take up to three months for IRBs to emit their judgement (Castellanos and Chiprut, 2002). Speeding up the evaluation processes, including ethical evaluations, import licences for investigational drugs, customs paperwork and logistics and so on, is critical for a timely performance of trials (Lamb and Setley, 2005). Overall waiting times for regulatory approval in Mexico may add-up up to nine months. Similar processes may take about three months in most Western European countries (BMI, 2006). Times for regulatory approval in Mexico would be more competitive however, compared to China where this may take up to one year (Lamb and Setley, 2005). Industry’s proposals for the creation of ad hoc independent evaluation committees to compensate for the absence of IRBs in some Mexican organizations, financed by the industry and actively involving regulatory authorities are currently under debate. The process seems to progress rather slowly, though.

CONCLUDING REMARKS This chapter explored recent developments in the market for clinical trials in Mexico and other developing countries. Hence, we illustrated a series of country specific characteristics underpinning the attractiveness of those countries as host locations for clinical trials: demographic,

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commercial, regulatory and R&D related factors became intertwined. The chapter also addressed some regulatory and related ethical challenges facing developing countries such as Mexico. A relevant conclusion is that a number of ethical and welfare considerations call for a more proactive stance from developing countries vis-à-vis the activities of multinational firms. More specifically, they need to address important bottlenecks characterizing the overall institutional and regulatory environments underpinning the local conduction of clinical research. Weak enforcement of inadequate and out of date regulations, alternatively slow or incomplete processes of reform and modernization of such frameworks supports concerns about the extent that potential benefits may outperform the inherent risks faced by local populations participating in clinical trials. Creation of ad hoc regulatory agencies is insufficient if they are not properly endowed and empowered. Tapping on local healthcare providers and health related education and research organizations with experience of conducting clinical trials sponsored by multinational firms would assist to improve the structure and coordinating powers of regulatory agencies. It may also contribute to ensure adequate flows of qualified and experienced labour force to meet demands from rising clinical trial activities. Strong regulatory agencies in turn, seem instrumental to shape and operate research systems meeting internationally accepted ethical and related standards. At a more basic level, a stronger commitment of regulatory agencies to gather and make information about trials taking place in their circumscription publicaly available would help in improving our understanding of factors related to the socioeconomic factors driving internationalization of clinical trials and their corresponding implications on developing countries.

NOTES 1. The second source is the International Standard Randomized Controlled Trials Number (ISRCTN). We preferred ClinicalTrials.gov because of its more user-friendly features to browse and locate trials. In addition, several of the records quoted by the ISRCTN were obtained precisely from the former dataset. 2. End-points are ‘unambiguous results that indicate exactly what the treatment can do’, they signal changes in a patient’s condition ranging from healing to reductions in the progression of disease or whether death rates have fallen (Zivin, 2000:73). 3. Adoption of GCPs in the post-World War II period responded to the need to protect integrity of subjects participating in clinical trials; key practices include informed consent and observance of ethical aspects of tests in humans. GLPs in turn, refer to systems of management controls conditioning work in laboratories and research organizations ensuring quality, consistency, validity and reliability of test data. (FDA) 4. Double counting, particularly in breakdowns by region is evident in the source (NIHNLM).


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5. Until recently India banned the performance of clinical trials within its territory before similar trials had being carried out elsewhere already (Kermani, 2006). 6. According to Maiti and Raghavendra (2007), amendments made in 2005 to the Schedule Y of Drugs and Cosmetic Act 1945 in India, made reporting duties ‘clearer and unambiguous’ for firms. 7. We requested COFEPRIS official data about the market for clinical trials in Mexico. COFEPRIS’ response was that such detailed information is nonexistent. 8. Following US paradigms, ‘institutional review board/independent ethics committees (IRB/IEC)’ are a group of people formally designated to approve, monitor and review biomedical and behavioural research involving humans with the aim to protect the rights and welfare of study subjects (FDA, 2007). 9. Ideally, a minimum of five persons should integrate the Committee, with at least one independent from the host organization and one a member of the civil society in a nonscientific area (usually from a religious community or minority group)

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Kuri, P., M. Vargas, M. Zárate, and P. Juárez(2001), ‘La diabetes en México’, Investigación y Desarrollo, 6, accessed at www.invdes.com.mx/anteriores/ junio2001/htm/diabetes.html. Lamb, M. and D. Setley (2005), ‘Clinical trial logistics: the trial of emerging markets’, Clinical Trial Services, 5, accessed 27 January 2009 at www.zlmzgroup.com/papers/clinicalservices.aspx. Lamtech Institute (2007). Inauguración del diplomado en formación de monitores clínicos, training programme presented at the Hotel Presidente Intercontinental Polanco, Mexico City. Le Bas, C. and C. Sierra (2002) ‘Location versus home country advantages’ in R&D activities: some further results on multinationals’ locational strategies’, Research Policy, 31(4), 589‒609. LeadDiscovery (2006), The Clinical Trials Market 2006, London: Lead Discovery. Lombera, M. (2006), ‘La COFEPRIS: su papel en la regulación y aprobación para la Investigación en seres humanos’, Coloquio Comités Hospitalarios de Bioética y Comités de Ética en Investigación, Colegio de Ingenieros Civiles de México, accessed at http://cnb-mexico.org/docs/p_cofepris.ppt. Maiti, R. and M. Raghavendra (2007), ‘Clinical trials in India’, Pharmacological Research, 56(1), 1‒10. Marks, L. and E. Power (2002), ‘Using technology to address recruitment issues in the clinical trial process’, Trends in Biotechnology, 20(3),106‒109. McKelvey, M. and L. Orsenigo (2002), ‘Pharmaceuticals as a sectoral innovation system’, paper presented at DRUID Academy Winter 2002 PhD Conference. Milstien B., P. Gaulé and M. Kaddar (2007), ‘Access to vaccine technologies in developing countries: Brazil and India’, Vaccine, 25(44),7610‒19. Patel, P. and M. Vega (1999), ‘Patterns of internationalisation of corporate technology: location vs. home country advantages’, Research Policy, 28(2/3):145‒55. PhRma (2006a) ‘Principles on conduct of clinical trials and communication of clinical trial results’, accessed 27 January 2009 at www.jirb.org.fw/DB/File/ Download/phrma-principles_on_comduc.pdf. PhRma (2006b) ‘Research and development’, accessed 27 January 2009 at www. phrma.org/index.php?option=com_content&task=view&id=382&itemid=118. Piachaud, B. (2002), ‘Outsourcing in the pharmaceutical manufacturing process: an examination of the CRO experience’, Technovation, 22(2), 81‒90. Reichert, J. (2003), ‘Trends in Development and approval times for new therapeutics in the United States’, Nature Reviews Drug Discovery, 2,695‒702. Reddy, P. (1997), ‘New trends in globalization of corporate R&D and implications for innovation capability in host countries: a survey from India’, World Development, 25(1), 1821‒37. Sistema National de Informacioń en Salud (SINAI) (2009), ‘Estadisticas per tama: mortalidad informaćion 2000‒2005, Cuadro S’, accessed 27 January at http:// sinais.salud.gob.mx/mortalidad/index.html. Schüklenk, U. (2000), ‘Protecting the vulnerable: testing times for clinical research ethics’, Social Science and Medicine, 51(6), 969‒77. Sharma, D. (2004), ‘Feature: India pressed to relax rules on clinical trials. Drug companies claim changes are essential, but critics fear Indian patients will become guinea pigs’, TheLancet, 363(9569), 1233. Singh, S. (2007), ‘Indian pharma enters the global arena’, Cell, 128(5)(March), 811‒14.

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Secretaria de Salud (SS) (1984), ‘Ley general de salud’, Diario Oficial de la Federación, México: SS. SS (1987), ‘Reglamento de la Ley general de salud en materia de investigación para la salud’, Diario Oficial de la Federación, México: SS. SS (2005), Hacia una Política Farmacéutica Integral para México, Mexico: Secretaría de Salud. Styhre, A. and M. Sundgren (2003) ‘“Management is evil”: management control, technoscience and saudade in pharmaceutical research’, Leadership & Organization Development Journal, 24 (8), 436‒446 TCSDD (2007), Outlook 2007, Boston, MA: Tufts Center for the Study of Drug Development. The Lancet (2007), ‘Editorial: strengthening clinical research in India’ The Lancet, 369, (9418), 1528‒9. Valdez-Martinez, E., B. Turnbull, J. Garduño-Espinoza and J. Porter (2006), ‘Descriptive ethics: a quality study of local research ethics committees in Mexico’, Developing World Bioethics, 6(2), 95‒105. van Brunt, J. (1999), ‘I want you for clinical trials’, Signals Magazine online accessed 27 January,2009 at www.signalsmag.com/signalsmag.nsf657b06742b5 748e8882565c6201/5389193e02f6924b882567c20059349d?Open Document. von Zedtwitz, M. and O. Gassmann (2002), ‘Market versus technology drive in R&D internationalization: four different patterns of managing research and development’,. Research Policy, 31(4), 569‒88. Zivin, J.A. (2000), ‘Understanding clinical trials’, Scientific American, April, 69‒75.

Websites AMIIF Asociación Mexicana de Industrias de Investigación Farmacéutica http:// www.amiif.org.mx/sprensa/sprensa.htm BMIS Bioresearch Monitoring Information System http://www.fda.gov/Cder/foi/ special/bmis/index.htm CANIFARMA Cámara Nacional de la Industria Farmacéutica, http://www.canifarma.org.mx/ CCINSHAE Comisión Coordinadora de Institutos Nacionales de Salud y Hospitales de Alta Especialidad, http://www.salud.gob.mx/unidades/cgins/ acerca.html IMSS, Instituto Mexicano del Seguro Social, http://www.imss.gob.mx/imss ISSSTE, Instituto de Seguridad y Servicios Sociales para los Trabajadores del Estado. http://www.issste.gob.mx/ NIH-NLM Clinical trials.gov. http://clinicaltrials.gov/ct2/home SINAIS, Sistema Nacional de Información en Salud, Secretaria de Salud http:// www.salud.gob.mx/apps/htdocs/estadisticas/mortalidad/mortalidad.htm World Bank, World Development Indicators available at: http://web.worldbank. org/WBSITE/EXTERNAL/DATASTATISTICS/0,,contentMDK:21298138~ pagePK:64133150~piPK:64133175~theSitePK:239419,00.html

Intermezzo I. Do multinationals matter for emerging markets, or vice versa? Rajneesh Narula It is undeniably the case that the subject of multinationals in emerging markets has become a diverse subject. A volume such as this indicates that much has changed in development studies over the last two decades and, from my point of view, this change has been almost completely positive. The study of multinationals has clearly evolved from a niche area to the mainstream of the social sciences and I am delighted to see international institutions, as well as politicians and policy makers at all levels, earnestly discussing how to engage (positively) with the multinational firm. The richness and diversity of perspectives that multinationals and emerging markets are nowadays analysed from is well-illustrated by the chapters in this book and, indeed, by the first four contributions that precede this comment. The variety of the subject matter and the myriad perspectives from which the activities of multinational firms is examined confirms for me that post-modernism is alive and well within academia. Diversity is refreshing, not least because diversity is indicative of vigour, and in a Darwinian sense, the means by which progress is made. The first four chapters of this book alone have addressed the outsourcing of clinical trials, the challenges of cross-cultural management and the innovativeness of multinational firms, covering countries as diverse as Thailand, the Czech Republic, Mexico and China, to name but a few. As recently as two decades ago, multinationals were regarded with considerable suspicion. At one extreme, they were largely regarded as a symbol of continued social, political and economic control by the industrialized world over the developing countries, a new form of neoimperialism. Now the reverse is the case. Multinational activity is considered to be largely a force for positive change and a means to promote economic progress (Lall and Narula, 2004). I wonder, however, if the pendulum has swung too far in the other direction. On the other hand, I am also concerned that while the studies 75

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themselves weave a rich tapestry, an underlying assumption of many of these studies ‒ both here and elsewhere in this burgeoning literature ‒ is almost unitary and single minded, so much so that it is taken for granted. The questionable assumption is this: multinationals are essential in promoting economic growth and technological change at the national level. I do not exaggerate when I say that many studies seem to assume that multinationals are a sine qua non for development (Narula and Portelli, 2007). The definition of the multinational firm and the mechanisms by which it can exert influence on its host and home countries have been steadily expanded to encompass such a large canvas that the some studies are in danger of confirming a tautology. How useful are the activities of multinationals in promoting economic development, in and of themselves? Certainly, a note of caution needs to be raised. Studies of the net benefits of multinational activity are ‒ when taken together ‒ ambiguous regarding the extent to which multinationals affect host economies significantly. Where they do indicate that this is the case, this often reflects improvements in the domestic political, sociological and economic milieu as much as the presence of multinationals. This might suggest ‒ and this is not a large conjecture on my part ‒ that multinational activity is concatenated with host country growth, rather than being responsible for such growth and change. In other words, multinational activity may represent a placebo effect, indicative of improving domestic activity rather than being the most important cause of it. The results of Chapter 2 by Urem et al. would seem to be suggestive of such results, as do several other chapters that follow. This is not to say that multinational activity is to be discouraged nor am I denigrating the value of work that does not examine the evolution of the domestic milieu and its relationship with the multinational. There are few economies which are primarily domestic in nature, dominated largely by domestic firms and whose knowledge base is not largely integrated with foreign knowledge sources and firms (Narula, 2003). Globalization has caused considerable interdependencies of markets for knowledge, resources and capital, and these cross-border flows are very much the new reality. The implications of these developments and the challenges that they create for cross-border management are not fully understood, as Chapter 1 by Kwanjai and den Hertog would indicate and, indeed, Chapter 5 by Saebi and Dong. The immeasurable complexity of reality and its ever-changing nature does not permit us easy answers, or even questions that remain the same. Having said that, all enquiry adds incrementally to knowledge, and the contributions included here move us forward.

Intermezzo I

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REFERENCES Lall, S. and R. Narula (2004), ‘FDI and its role in economic development: do we need a new agenda?’, European Journal of Development Research, 16, 447‒64. Narula, R. (2003), Globalisation and Technology, Cambridge: Polity Press. Narula, R. and B. Portelli (2007), ‘Foreign direct investment and economic development: opportunities and limitations from a developing country perspective’. in L. Piscitello and G. Santangelo (eds), Do Multinationals Feed Local Development and Growth?, Amsterdam: Elsevier.

5.

Strategic motivations for international alliances: the Chinese perspective Tina Saebi and Qinqin Dong

INTRODUCTION Quite aware of the potential benefits of securing a competitive position in the 1.3 billion-consumer market of China, an increasing number of multinationals from the Triad countries ‒ Western Europe, US and Japan ‒ are establishing alliances with local Chinese companies. Chinese alliance partners can offer instant access to established customer and supplier bases as well as to the complex Chinese distribution system. Triad partners can further benefit from their local partners’ contacts, experience and credibility hence gathering valuable opportunities for strategic learning (Jagersma, 2005). However, given that alliances with local Chinese firms have become an important value-creating strategy for many Triad multinational companies, it is striking how poor the performance of many alliances remain. In general, one major cited reason for alliance failure is the incompatibility of alliance partners’ objectives. Failing to establish and communicate compatible objectives can lead to insuperable problems for the process and outcome of the alliance (Dacin et al., 1997). Particularly, divergences in alliance motives can lead to conflict situations, giving that alliance partners hold different expectations about the goals of the alliance. Especially in cross-border settings, alliance partners are likely to differ in terms of strategic intentions and alliance objectives (Dacin et al., 1997; Demirbag et al., 1995; Slocum and Lei, 1993; Tallman and Shenkar, 1990; Yan and Gray, 1994). Therefore, it is imperative to investigate the strategic motives of potential alliance partners in order to avoid premature and unfruitful termination of alliances. In this regard, the common underlying strategic motives of Triad multinationals to enter into alliances with Chinese companies have been wellresearched (Beamish, 1988; Glaister and Wang, 1993). However, with a few notable exceptions, little is known about the underlying motives of Chinese companies to enter into alliances with Triad partners (Dong and Glaister, 78

Strategic motivations for international alliances

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2006; Hitt et al., 2004; Luo, 1997; 2002). Surprisingly, despite the enormous increase in the number of Sino-Triad alliances, the subject of strategic motives of Chinese alliance partners has received scant attention in the scholarly literature. To meet the challenge this poses in extant international alliance literature, this chapter investigates the key drivers of international alliance formation from the perspective of Chinese companies. Particularly, this chapter aims to answer the questions of how and why strategic motives of Chinese alliance partners differ from their Triad counterparts. By answering these questions this chapter addresses a main deficiency in the international alliance literature that has so far given little attention to the perspective of local companies domiciled in emerging economies (Hitt et al., 2004; Luo, 2002; Yan and Gray, 1994). We intentionally depart from previous research in this field by providing a comprehensive analysis of the strategic motives of local companies based upon an extensive literature review of original Chinese research. We choose to focus on primarily Chinese academic literature because it is reasonable to assume that Chinese companies are less reluctant to provide information on their alliance motives to Chinese scholars than to foreign researchers. Furthermore, Chinese scholars are often closely networked with Chinese companies and have a profound knowledge of the culture and ways of doing business in China. Hence, we assume that Chinese studies are better able to provide us with unique insights into the Chinese view on strategic alliance motives. In order to validate our findings and fully grasp the underlying motivations of international alliance formation we have also conducted interviews with eight leading Chinese alliance companies. The chapter is organized as follows. The first section reviews the merits and challenges of establishing alliances in general, highlighting the importance of partner motives compatibility in cross-national settings. The second section provides an overview of the main motives of Triad multinationals to enter China via alliances. The third section presents our results on the main strategic motives of Chinese companies to enter into alliances with Triad companies. This is followed by an extensive discussion on why underlying strategic motives of Chinese and Triad alliance partners differs. We conclude with the main findings and managerial implications for both Chinese and Triad alliance partners.

STRATEGIC MOTIVATIONS AND COMPATIBILITY OF ALLIANCE PARTNERS Strategic alliances are increasingly vital to a company’s competitive survival (Das and Teng, 2000; Doz and Hamel, 1998; Gomes-Casseres,

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1996; Yoshino and Rangan, 1995, Combs and Ketchen, 1999; Ireland, et al., 2002). The surge in alliance activity can be observed particularly in knowledge-based industries; where the increasing costs of R&D in combination with a shortening of product and technology life cycles observed have made it almost impossible for companies to develop technologies on a stand-alone basis (Teece, 1987; Borys and Jemison, 1989; Erramilli and Rao, 1990; Hamel, 1991, Eisenhard and Schoonhoven, 1996; Combs and Ketchen, 1999; Das and Teng, 2000). As a single company has rarely the full range of knowledge or expertise, companies use strategic alliances increasingly to perform activities together that neither could perform alone. However, the potential synergy effects of alliances can be actualized rarely; failure rates up to 70 per cent come as no surprise to many practitioners (Bleeke and Ernst, 1993; Park and Ungson, 2001). As Dacin et al., (1997) emphasize, the incompatibility of alliance partners is found to be among the most important reasons for alliance failure. Diverging alliance motives among partners lead to conflict situations, hindering the successful implementation of an alliance. Especially in cross-border settings, alliance partners are likely to differ in terms of strategic intentions and alliance objectives (Slocum and Lei 1993; Dacin et al., 1997; Demirbag et al., 1995; Tallman and Shenkar, 1990; Yan and Gray, 1994). Particularly, considerable heterogeneity in institutional environments and asymmetry in resources and capabilities among alliance partners are expected to affect the strategic alliance motives of firms (Peng and Heath, 1996; Hitt et al., 2000). This is especially important where differences in culture, infrastructure, economic development and government policies increase the complexity of the context in which alliances are embedded (Slocum and Lei, 1993). The cultural heritage of a nation has been suggested to strongly influence the strategic orientations of company executives, resulting in different managerial ideologies that eventually affect the strategic decision processes within organizations (Hitt et al., 1997). Further, differences in levels of economic development are found to impact the alliance motives of respective companies, where firms from developed economies predominantly seek local partners for market access, political connections and to fulfil local government’s requirements for foreign direct investments. Conversely, firms from developing economies are found to seek access to technology, export opportunities and to gain international alliance experience. Following this logic, Beamish (1988) concludes that partners may differ significantly by economic development levels with respect to alliance motives and expected benefits. In the same line, Hitt et al. (1997:7) suggest that ‘differences in


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government support and foreign investment policies can influence the alliance process’. While it is unlikely that alliance partners may have complete agreement on alliance objectives and expected benefits, a careful selection of alliance partners can increase the likelihood of at least complementary alliance motives. As Dacin et al. (1997:4) stress, ‘the need to understand both partners’ similarities and differences in alliance objectives and strategic intentions is paramount in ensuring the success of alliances’.

MAJOR DRIVERS OF SINO-TRIAD ALLIANCES: THE TRIAD PERSPECTIVE Extant literature on Sino-Triad alliances has examined the strategic motives of Triad alliance companies in China extensively; indicating that the main motives of Triad multinationals to enter into alliances with Chinese partners include faster entry into the Chinese market (Beamish, 1988), facilitation of international expansion (Glaister and Wang, 1993), conformation to host government policy, as well as low cost sourcing. Particularly, access to the Chinese market is considered the most importance alliance drivers for Triad companies. As the Chinese market is expanding an increasing number of consumers are gaining purchasing power. To tap into this market, Triad companies have long been required to establish joint ventures with local Chinese firms. However, since China entered the WTO in 2001, foreign companies are no longer required to partner with local firms in order to invest in most high-tech industries. Nevertheless, Triad companies still opt for alliances, as to get key access to rising industries as well as to established customer, supplier and distribution networks in the country (Jagersma, 2002). The merits of allying with Chinese firms lies in the ability of the latter to provide country-specific knowledge, contacts with regulatory authorities and management of the local labour force (Inkpen and Beamish, 1997). In particular, alliances where technology constitutes an important component, Triad firms are able to leverage resources and capabilities from local partners and adapt products to the local Chinese market (Wu and Callahan, 2005). Especially, in comparison to setting up wholly-owned foreign subsidiaries in China, allying with local firms offers the superior advantage of maintaining flexibility in an unfamiliar and turbulent business environment. Chinese alliance companies often have complementary skills, resources and more easy access to Chinese markets and distribution systems, reducing the initial start up investment required by Triad companies. Further, as the government retains great influence in the Chinese market, allying with

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local partners that have strong government relationships enables Triad companies to overcome barriers in the local markets. This is particularly true in IT sectors where the Chinese government plays a dominant role in determining technical standards (Wu and Callahan, 2005). Hence, a key motive of Triad companies to form alliances with Chinese firms is to build favourable relationships with (state-owned) organizations that have influence on these technical standards. In comparison to wholly-owned subsidiaries, alliances with local Chinese firms facilitate the access to external complementary skills and resources while retaining flexibility for the Triad counterpart.

METHODOLOGY AND DATA: CHINESE SOURCES AND ALLIANCE PORTFOLIO To provide a comprehensive analysis of Chinese alliance motives this chapter draws on both primary and secondary Chinese sources. A thorough literature review on Chinese written alliance studies has been carried out, complemented by structured interview with eight Chinese alliance companies. All eight companies were selected on the presence of international alliance experience. To ensure a balanced mix, we interviewed local companies of different size and industries. The experts, native planning or general managers were selected on the basis of their established reputation in the field of alliances and ability to sufficiently contribute to the goal of the interviews. To facilitate the interviews, a questionnaire was designed in Chinese and presented to the interviewees. The interviews lasted between 30‒60 minutes and contained questions about company demographics (size, location and sales volumes) and strategic motives to enter international alliances. Strategic alliances were defined to include strategic supplier relationships, minority stakes, joint ventures, crosslicensing arrangements, joint marketing agreements and research consortia. We excluded mergers, acquisitions, internal alliances, franchising, simple licensing and non-strategic supplier relationships from our definition. Specifically, our questions did not target individual alliances, but respondents had to consider the entire alliance portfolio when answering the questions. Shifting the level of analysis from individual alliances to the alliance portfolio of companies is more likely to generate a comprehensive overview of the company’s alliance activities and experience. As the average alliance portfolio of firms in our dataset consisted of 13 alliances, the total dataset refers to 104 alliances. Only 25 per cent of the companies in our sample had formed more than 20 alliances over the last five years. While the percentage of international alliances constitutes a relatively


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small share of the entire alliance portfolio of the companies in our sample, the total dataset nevertheless refers to 32 international alliances. In line with earlier studies, the number of alliances that a firm has formed can be used as a proxy for alliance experience (Kale et al., 2002; Duysters and Heimeriks, 2007). With an average of four international alliances, we can reasonably assume that the responding companies have some basic experience with international alliance partners. The responding companies were selected from a variety of industries: 50 per cent of companies in our sample operate in the automobile industry, while the remaining companies are in the pharmaceutical, software, telecommunication and construction industries. The majority of companies (75 per cent) in our sample are large, with an employee base greater than 1000 people. Only 25 per cent are small sized companies with a maximum employee base of 500 people. Of the companies that we interviewed 50 per cent are located in the Wuhan province; the remaining ones are based in Liuzhou (Guangxi province) and Neimenggu. Regarding the Chinese alliance literature, we present here the main findings of an extensive review. He should be noted that, all sources we reviewed agreed on the major motives of international alliance formation for Chinese firms.

MAJOR DRIVERS OF SINO-TRIAD ALLIANCES: THE CHINESE PERSPECTIVE Chinese studies report that the key objective of Chinese companies entering international alliances is to gain access to international markets (Gu, 2003; Liu, 2005; TiKan, 2003). In particular, Chinese studies report that especially after the entry of China to WTO in 2003, local Chinese firms have increasingly pursued alliance with international partners (Liu, 2005; TiKan, 2003). Chinese companies report that allying with Triad partners allow them to rely on their partners’ established distribution and marketing channels in order to enter foreign markets (Chen and Wang, 2002; Liu, 2005). Similarly, Chinese partners aspire to learn from their Triad partners about the dynamics and requirements of foreign markets Another important strategic motive for Chinese companies is to gain access to advanced technologies of the Triad partners (Chen and Wang, 2002; Liang, 2005; Lin and Guo, 2005; Liu, 2005; TiKan, 2003; Wang, 2007; Zhou and Zhu, 2006). Particularly, in high-tech industries, the formation of international alliances is considered a necessary strategy. Investigating the competitive capability of local companies in high-tech industries, Lin and Guo (2005) find that the average life span of local small and medium-sized companies

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amounts only to 2.5 years. In order to overcome the outdated technology base that causes the premature exit of many local companies, Lin and Guo (2005) urge the necessity to form alliances with international partners that possess advanced technologies. Interestingly, Chinese studies like to refer to the alliance between Changhong (a Chinese TV manufacturer) and the Japanese firm Panasonic, where the Chinese partner successfully gained access to and imitated its partner’s technology and became a close competitor in the following years (Zhou and Zhu, 2006). Further, Chinese companies consider allying with Triad firms as a viable cost-effective strategy to acquire not only advanced technologies but also to benefit from technological and R&D capabilities of their Triad partners (Fan, 2003). Therefore technology-related learning constitutes a major international alliance formation motive for Chinese companies (Chen and Wang, 2002; Liang, 2005, Zhou and Zhu, 2006). Moreover, Chinese studies find that the managerial capabilities and decision-making processes of local Chinese companies are not sufficiently developed in order to effectively compete in an international environment (TiKan, 2003). Particularly, Luo (1999) finds that many firms in China have inferior organizational and managerial capabilities than their counterparts in advanced industrialized countries. Hence, by allying with Triad companies, Chinese firms aspire to acquire the advanced managerial know-how from their Triad counterparts. In sum, for Chinese companies, access to complementary resources, both tangible and intangible, presents a key alliance formation driver (Liu, 2005). It is interesting to note that Chinese studies report that local companies increasingly value intangible resources, such as reputational capital or market experience, more strongly than partners’ capital (Wang et al., 2003). Seeking complementary intangible resources has thus become an important motive of international alliance formation for Chinese companies.

DISCUSSION ON THE DIFFERENCES Our interviews strongly indicate that learning-driven motives, technology- and management-related, constitute the most important drivers for international alliance formation for Chinese companies. Similarly, gaining access to international markets is another key alliance motive. Access to capital was a less important motive for the responding firms. The main motivations that arise from these interviews are described in Box 5.1. Main finding 1: Access to international markets is a very important alliance driver for Chinese companies


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BOX 5.1 CHINESE STRATEGIC MOTIVES TO ENTER INTERNATIONAL ALLIANCES Chinese alliance motives:

Western alliance motives

Access to international market Access to technology Access to management skills Access to complementary resources

Access to Chinese market Securing government relationships

Source:

Author’s own elaboration.

At first, Chinese and Triad companies appear not to differ significantly; Chinese studies report that the key objective of Chinese companies entering international alliances is to gain access to international markets (Liu, 2005; Ge et al., 2003; TiKan, 2003). Chinese companies are not fully equipped in terms of technological and managerial know-how in order to effectively compete in international markets (Peng, 2000), and hence aim to avoid direct competition at all cost. Therefore, by allying with Triad companies, Chinese firms aspire to acquire necessary capabilities and knowledge without the need to face Triad competitors directly. Main finding 2: Access to partner’s technology and technological capabilities is an important alliance formation driver for Chinese companies One of the main deficiencies of local Chinese companies is a lack in advanced technologies and technological capabilities (Hitt et al., 2004). This significant technology gap is dividing China from the developed market economies and consequently hinders local Chinese firms from competing effectively in product technologies with firms from developed countries (Svetlicic and Rojec, 1994). Particularly, Chinese companies cannot develop or offer new and sophisticated products in sufficient quantity and quality to be competitive with firms from other countries (Hitt et al., 2004). As a result, Chinese firms seek access to new technology in order to develop products that can be competitive (Gillespie and Teegen, 1995). As the access to advanced technologies is often only attainable by means of foreign alliances (Oliver, 1997) the Chinese government soon realized the merits of international alliances as a vehicle to overcome deficiencies in innovation and product development (Shenkar, 1990). Hence, with preferential treatment policy, lower income taxes and favourable financing terms,

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the Chinese government has ever so encouraged its local firms to ally with foreign partners possessing advanced technologies in order to improve their technological capabilities and eventually increase their competitiveness in global markets (Keister, 1998; Luo, 2002; Shenkar and Li, 1999). As a result, one of the main concerns of local Chinese companies is to gain access to current technology (Chen and Wang, 2002; Liang, 2005; Yu et al., 2004; Wang et al., 2003; Zhou and Zhu, 2006; Fan, 2003). Consequently, Chinese companies are likely to stress the access to advanced technologies as a main alliance motive. In contrast, Triad alliance firms usually have relatively sophisticated technologies that provide firm-specific technological advantages and there rarely emphasize the technological capabilities of local partners to be key drivers for alliance formation. Main finding 3: Access to partners’ managerial capabilities is an important alliance formation driver for Chinese companies In our interviews, we found that access to advanced management skills is a very important motive to engage in strategic alliances with Triad partners. As many Chinese firms are formerly state-owned enterprises that have been recently privatized, managers generally have little experience with managing market-oriented and decentralized businesses (Lau, 1998; McDonald, 1993). Management capabilities and decision-making processes are often not well developed in local Chinese firms, as they have had little exposure to modern management concepts, techniques and processes (Hitt et al., 2000; Lyles and Baird, 1994; Shama, 1993). Hence, the need to compete in market-oriented economies with more managerially-sophisticated competitors forces Chinese firms to seek Triad partners with strong managerial capabilities. While Triad alliance partners would surely prefer a Chinese partner who has effective managerial capabilities, Triad companies generally have the capability to compensate for the local partners’ deficiency in this area (Hitt et al., 2004). Main finding 4: Access to partners’ intangible assets is more important than tangible resources for Chinese companies Chinese literature reports that Chinese companies increasingly consider intangible assets to be more significant than tangible assets of partner firms (Wang et al., 2003). Initial emphasis on tangible assets such as partners’ capital can be explained by the poorly developed financial and capital market of China, where capital had been only attainable at a high cost (Hitt et al., 2000; Svetlicic and Rojec, 1994). Hence, by allying with Triad companies, Chinese companies could circumvent the capital market


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problem in the country. As long as the financial and capital markets are not fully developed, and the economy remains unstable, attaining partners’ capital is likely to remain an important objective of Chinese alliance companies. However, a more recent driving force for Chinese companies to pursue alliances with Triad partners is to develop reputational capital. As an increasing share of Chinese consumers grows an affinity for name brands, thereby declining inferior and counterfeit products, Chinese firms prefer to ally with foreign firms having well-known products (Luo, 2002). As Hitt et al., (2004:176) observe, ‘legitimacy afforded by a firm with a strong global reputation enhances the Chinese partner’s ability to compete in global markets, thereby allowing it to earn needed hard currency and achieve growth’. Consequently, Chinese companies are more likely to select Triad partners with strong positive reputations to reduce the perceived risk in the market. The opposite is not true. Intangible resources such as reputation and legitimacy are more critical to the Chinese partner as they enhance their access to other resources such as a customer base, financial resources, and possible future alliance partners.

CONCLUSIONS AND IMPLICATION With a few notable exceptions, extant Triad literature on Sino-Triad alliances has so far failed to acknowledge the importance of investigating the strategic motives of Chinese alliance companies and has subsequently treated them as passive partners (Dong and Glaister, 2006; Hitt et al., 2004; Luo, 1997). In this chapter, we therefore tried to fill this void by investigating the key drivers of international alliance formation from the perspective of Chinese companies. Our results indicate that initial deficiencies in the Chinese institutional environment have shaped the strategic motives of local companies: accesses to international markets, technological and managerial competences are the most important motives for Chinese companies to enter into alliances with Triad companies. We have further discussed how alliance motives differ among Triad and Chinese companies. Apart from some protected sectors where joint venture is a requirement, Triad companies are free to choose their entry mode into the Chinese market. While local alliance partners may provide local knowledge and distribution systems, Triad partners are not completely dependent on their Chinese partner. Once a basic level of local knowledge is gained and necessary local ties are established, Triad partners can venture on by themselves. However, in the case of Chinese companies, allying with Triad companies presents a far more urgent strategy.

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For example if Triad firms realize that access to technology and knowledge is one of the main reasons for their Chinese counterparts to partner with them, they can design a knowledge diffusion strategy that enables knowledge transfer of those knowledge assets that can be shared and that prevents unwanted knowledge spillovers to their Chinese partners. The reluctance of Triad companies to share technology and knowledge with their Chinese counterparts is very clearly reported in the Chinese literature (Zhou and Zhu, 2006). This finding is confirmed in our interviews. Understanding these differences is a necessity for both Triad and Chinese partners. Acknowledging these differences allows both partner firms to overcome initial differences in expectations, as they re-adjust their alliance strategies to fit their own and their partners’ alliance motives.

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multi-corporation’, Journal of Anhui University of Technology, Social Sciences, 20(5), 43‒7 (in Chinese). Wang, X. (2007), ‘A study on the choice of international market entry mode for China enterprise’, (in Chinese), master’s degree thesis. Wu, J. and J. Callahan (2005), ‘Motive, form and function of international R&D alliances: evidence form the Chinese IT industry’, Journal of High Technology Management Research, 16,173‒91. Yan, A.M. and B. Gray (1994), ‘Bargaining power, management control, and performance in United States-China joint ventures: a comparative case-study’, Academy of Management Journal, 37(6), 1478‒517. Yoshino, M.Y. and U.S. Rangan, (1995), Strategic Alliances: An Entrepreneurial Approach to Globalization, Boston, MA: Harvard Business School Press. Yu, J., X. Fang and X. Han (2004), ‘Mechanism study on enterprise alliance for telecommunication standard competition’, Science Research Management, 25(1), 129‒32 (in Chinese). Yuan, K.K. (2001), ‘Upgrading strategic alliances between Chinese firm and foreign enterprise’, Journal of Chongqing Institute of Commerce, 2, 31‒3 (in Chinese). Zhou, H. and Y. Zhu (2006), ‘Research on management strategy of technical control in multinational corporation’s joint venture in China’, Journal of Zhengzhou Institute of Aeronautical Industry Management, 6 (in Chinese).

6.

Cross-border investment and economic integration: the case of Guangdong Province and Hong Kong SAR Naubahar Sharif and Can Huang

INTRODUCTION Globalization ‒ the integration of national economies into a global system ‒ entails, in part, the transfer of manufacturing sectors from the developed world to developing countries. As Feenstra (1998) indicates, measured by the merchandise trade relative to value added, the world is much more integrated than in the past. However, this ongoing global integration of industrial and trade activities brings with it the disintegration of production or business processes whereby, to increase profits, multinationals seek to outsource or directly invest either domestically or abroad. The overseas relocation of manufacturing and services spurs controversy and debate, not only in the advanced countries from which the manufacturing sectors move but also in the developing countries that receive them via foreign direct investment (FDI). Leaders of advanced countries face political opposition to the unemployment that results from the offshoring activities of their home-based multinationals (Rodrik, 1997; Schultze, 2004). For their part, observers in FDI-recipient countries are concerned about the potentially negative effects of the domination of the manufacturing sector by foreign-owned companies. Local firms in recipient countries must weather fierce competition from their foreign counterparts and face difficulties in upgrading their technological competence from the low end of the global value chain. Motivated by intense debate about these issues, this chapter undertakes a comparative study of the performance of local and foreign competitors’ manufacturing firms in one such FDI-recipient region ‒ Guangdong Province, China ‒ and analyses the policy implications of the comparison for the advanced, FDI-outflow region ‒ Hong Kong Special Administrative Region (HKSAR). 92

Cross-border investment and economic integration

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In this chapter, we centre our analysis on the productivity performance of Guangdong’s local and foreign-funded manufacturing sectors. By highlighting changes in productivity that vary with changes in manufacturing firm ownership, we reveal that domestic firms have been catching up with their foreign counterparts, including Hong Kong-based firms, though foreign firms have successfully strengthened their dominating position in Guangdong’s manufacturing industry. Informed by the history of Hong Kong’s manufacturing industry, we discuss strategic options for undertaking future industry and innovation policy coordination between Guangdong and Hong Kong from an HKSAR-perspective.

THE ECONOMIC TIES BETWEEN HONG KONG AND GUANGDONG AND THE INDUSTRY DYNAMICS IN GUANGDONG Among developing countries, China has indisputably attracted the most FDI over the past two decades. Around one-third of FDI to China in the period of 1985 and 2003 went to Guangdong Province (Figure 6.1). Guangdong was able to attract 30 per cent of China’s total FDI, because of its geographical and cultural proximity to Hong Kong, Macau and Taiwan, all three of which have invested heavily in China over the past 25 years. In 1985, 90 per cent of the FDI flows into Guangdong were invested by entrepreneurs from Hong Kong. The ratio fluctuated in the second half of the 1980s and decreased steadily after the mid-1990s, but in 2006, approximately 47 per cent of FDI in Guangdong still came from Hong Kong. During the period 1979‒2001, cumulative FDI from Hong Kong in Guangdong amounted to USD 79 billion, accounting for 71 per cent of total cumulative FDI flows into Guangdong (Federation of Hong Kong Industries, 2003). Nearly 70 per cent of the FDI into China or Guangdong has been devoted to the manufacturing sectors, securing China’s current position as a world manufacturing centre. From Hong Kong’s perspective, Guangdong is the most important investment destination in Mainland China. Since the mid-1990s, Hong Kong-based entrepreneurs have allocated as much as half of their total investments in China to Guangdong (Figure 6.1). Along with the transfer of manufacturing sectors to Mainland China, economic activities in Hong Kong have been reconfigured extensively. Indeed, since the opening of China, Hong Kong has transformed itself from an industrial city into a centre of manufacturing-related service activities (Chan, 2002; Tao and Wong, 2002). China-related trade and investment have generated a significant proportion of Hong Kong’s income. Sun and Wong (2000) estimate

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Multinationals and emerging economies 100 90

Percentage

80 70 60 50 40 30

19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 20 05

20

Ratio of actually-used FDI from Hong Kong to FDI from Hong Kong, Macau and Taiwan in Guangdong Ratio of FDI from Hong Kong to total FDI in Guangdong Ratio of FDI in Guangdong to FDI in China Ratio of FDI in manufacturing sector to total FDI in Guangdong Ratio of Hong Kong FDI in Guangdong to Hong Kong FDI in China

Note: (a) When calculating the ‘Ratio of Hong Kong FDI in Guangdong to Hong Kong FDI in China’ for the period of 1994–1997, the authors adopt the FDI data, which include data reflecting foreign loans and foreign non-direct investment. Source: Guangdong Statistical Yearbook and China Statistical Yearbook.

Figure 6.1 Foreign direct investment in Guangdong, 1985–2006a

that the ratio of Hong Kong’s China-related trade and investment to its gross domestic product (GDP) reached 24.4 per cent in 1996. Many scholars attempting to understand the extent of Hong Kong’s economic interdependence with Guangdong, have thus far either analysed Hong Kong’s economic transition in the context of manufacturing crossproduction in Guangdong (Eng, 1997; Hollows, 1999; Kwong, et al., 2000) or focused on the two regions’ economic integration from a Hong Kong perspective (Tuan and Ng, 1995; 2004). Few studies have examined the changing nature of economic ties between Hong Kong and Guangdong as a function of industry dynamics in Guangdong, especially studies that discuss policy measures. Yeung’s (2001; 2002) articles are exceptions in linking industrial development in Guangdong to the Hong Kong factor, but they consist almost entirely of qualitative analyses. We argue that the closer ties being forged between Hong Kong and southern China over the last three decades, particularly following the handover of Hong Kong from Britain to the People’s Republic of China in 1997, call for a study of Guangdong’s industry dynamics that not only contextualizes the nature of its economic and technological ties with HKSAR but also does so with a view towards policy measures in one of the two regions. The process through which southern China has opened up to global economic and cultural contacts (featuring Special Economic Zones) catalysed


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the transformation of Hong Kong’s and Guangdong’s industry sectors. The most striking change in Hong Kong’s economy since the opening-up process was that, as the role of manufacturing decreased, the role of the services sector increased. At its peak in the mid-1980s, the manufacturing sector in Hong Kong employed 41.7 per cent of the active labour force, but by 1995, it employed only 15.3 per cent (Berger and Lester, 1997:9). The contribution made by manufacturing to Hong Kong’s GDP dropped from 23.6 per cent in 1980 to just 4.6 per cent in 2002; concurrently, the contribution made by services rose from 67.3 per cent to 87.4 per cent. By shifting parts of their operations to China, Hong Kong industrialists vastly increased the scope of their companies. It is estimated that by 1997 Hong Kong manufacturing companies employed some five million people in their subsidiaries in Hong Kong and China ‒ over five times the labour force they employed in Hong Kong at the peak of manufacturing in the territory in 1984 (Berger and Lester, 1997:10). By the end of 2001, according to the Federation of Hong Kong Industries (2003) the figure was estimated to have surpassed 11 million people. By 2003, manufacturing production services accounted for around 50 per cent of Hong Kong’s GDP. Approximately 1.5 million jobs involving over 40 per cent of Hong Kong’s labour force were related to Hong Kong companies’ manufacturing activities in Guangdong (Federation of Hong Kong Industries, 2003). Hong Kong has therefore entered, particularly in the years following 1997, a period of warming economic, political, social and cultural ties with Mainland China. Nowadays, Hong Kong companies, or investors operating out of Hong Kong employ at least 14 to 15 million people and own 60,000 factories in Guangdong Province. Thus, the migration of production units to Guangdong in many ways has represented growth rather than decline in Hong Kong’s engagement in manufacturing; yet for political reasons such growth was categorized as outside the territory, even if it was from a historical perspective a reintegration into Guangdong markets. The effects on the service industries have also brought economic benefits, as most of the migration spurred further growth and increased sophistication in producer business services (Tao and Wong, 2002). In establishing and upgrading these networks, Hong Kong firms have exploited their traditional strategies of imitation and followership while emphasizing the development of organizational know-how rather than formal R&D for new product development. Several surveys of firms from Hong Kong’s electronics sector have for example found that 60 to 70 per cent of such firms have succeeded by copying or modifying other products instead of initiating independent product design (Yu and Robertson, 2000). In fact, the bulk of R&D expenditure by private firms in Hong Kong

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is devoted to redesigning and improving products as well as to making them easier and cheaper to produce. In other words, process innovation has often taken precedence over product innovation in Hong Kong industries. By learning extensively from their original equipment manufacturing (OEM) contacts overseas, Hong Kong firms have been instrumental in setting up and improving production facilities in Guangdong ‒ transferring innovative production technology and management organization rather than product innovations. These changing conditions underscore both the historical and contemporary importance and interdependence of Hong Kong and Guangdong Province. Yet an important question arises here: what is the nature of the change that has been occurring in manufacturing in Hong Kong and Guangdong? In particular, how have locally and foreign-invested firms, including those based in Hong Kong with subsidiaries in Guangdong, performed? What are the policy implications of these developments? Our approach to answering these questions centres on total factor productivity (TFP) and labour productivity growth in manufacturing in Guangdong Province.

TECHNOLOGICAL CATCHING-UP OF GUANGDONG: TOTAL FACTOR PRODUCTIVITY AND LABOUR PRODUCTIVITY The industry-level dataset used in this chapter is taken from various issues of the Guangdong Statistical Yearbook. It covers 27 two-digit manufacturing sectors in the period spanning 1997‒2006.1 It embraces four ownership groups: the three domestic ownership groups (state-owned enterprises, collective enterprises and shareholding enterprises) and one foreign ownership group (foreign enterprises).2 In 1997, Hong Kong FDI accounted for 72 per cent of total foreign FDI in Guangdong. Although the ratio declined steadily thereafter as a result of increasing investment inflows from the rest of the world, the share was still over 50 per cent in 2004. Among the foreign direct investment in Guangdong, 70 per cent was in manufacturing sectors across the observation period of 1997‒2006. Since there are no disaggregated data available for Hong Kong-invested firms and only aggregated data for foreign firms in general, we do not aim to precisely measure the performance of the Hong Kong-invested firms vis-à-vis that of Guangdong domestic firms in this section.3 Instead, we reveal the dynamics of manufacturing firms with different ownership status in Guangdong province, highlighting the productivity improvement occurring in the domestically owned firms.


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Industrial output dynamics and labour productivity in Guangdong Breaking down the industrial gross output value of Guangdong manufacturing firms, we find that from 1997 to 2006 the share in industry gross output taken by foreign-owned subsidiaries increased in 17 out of the total 27 manufacturing sectors. State-owned companies expanded their shares in six sectors. The share taken by shareholding enterprises grew in 24 sectors; in contrast, the share taken by collectively owned firms declined in all but one sector. The growth in shares of output in manufacturing sectors taken by shareholding companies, as well as the decrease in shares taken by state-owned enterprises, stems mainly from the ownership reform that was taking place during our observation period, over the course of which many state-owned companies were transformed into shareholding companies and were publicly listed on stock exchanges. In 2006, foreign-owned subsidiaries produced more than 60 per cent of the total industrial output in 14 sectors, further securing their predominant sectoral positions in Guangdong’s economy. Even though foreign subsidiaries surpassed their domestic counterparts in Guangdong in terms of output growth, domestic enterprises gained in labour productivity, calculated as value added divided by labour input. In 1997, foreign subsidiaries featured higher labour productivity than domestic firms in 20 out of 27 sectors. In many of those sectors, foreign firms’ labour productivity in 1997 was two to three times that of local enterprises. However, it is worth noting that within ten years domestic companies had gained the lead in 16 out of 27 sectors. From 1997 to 2006, pressured by fierce competition from foreign-owned subsidiaries, domestic companies shrank in size while simultaneously achieving higher labour productivity growth rates and regaining the advantage in over half of Guangdong’s manufacturing sectors. Total factor productivity in Guangdong Li (1999) utilizes the translogarithmic production function to analyse a panel of state factories in Guangdong province for the period 1980‒7. His research, based on firm-level data, reveals the rapid TFP growth that Guangdong manufacturing firms achieved during the period in question. Following Li (1999), we adopt the following translog function as a framework for calculating TFP growth in Guangdong manufacturing sectors:4 q 5 exp c a0 1 aklnk 1 allnl 1 att 1 1 bkt ( lnk) t 1

1 b (lnk) 2 1 bkl (lnk) (lnl) 2 kk

1 1 bll ( lnl) 2 1 blt ( lnl) t 1 bttt2 d 2 2

(1)

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Where: ● ● ● ●

q is the deflated value added; k is the deflated capital input; l is the labour input; t is the time-trend variable.

Under the assumption of constant returns to scale, the parameters of Function (1) satisfy the following conditions: ak 1 al 5 1 and bkk 1 bkl 5 bll 1 bkl 5 bkt 1 blt 5 0

(2)

With reference to Jefferson et al.’s (1992; 1996) variable deflation methodology, which is designed particularly for Chinese industrial statistics data, we utilize the price deflators for gross industrial output reported in the Chinese Statistical Yearbook to obtain the deflated variable of value added.5 The variable of capital input is deflated by the price indices of fixed-asset investment. The details pertaining to our variable deflation are elaborated in Box 6.1. The ordinary least square (OLS) estimation of Function (1), with standard deviation in parentheses, is as follows: q 5 exp [ 0.022(0.093) 1 0.53(0.056) lnk 1 0.36(0.059) lnl 1 0.15(0.025)t 1 0.20(0.011) (lnk) 2 2 0.0025(0.023) (lnk) (lnl) 2 0.027(0.054) (lnk) t 2 0.010(0.013) (lnl) 2 2 0.010(0.0058) (lnl) t 2 0.0044(0.0021)t2 ] ,

(3)

With: ● ● ●

adjusted R-square = 0.913 F(9,1092) = 1279.8 N=1102

With the estimated coefficients of Equation (1) and Equations6 (4)‒(8), we obtain the TFP growth of state-owned, collective, shareholding and foreign manufacturing sectors in the period of 1997‒2006. Table 6.1 reveals the average annual TFP growth rates for enterprises falling into the four above-mentioned ownership groups. In 25 out of 27 manufacturing sectors, at least one domestic ownership group achieved faster TFP growth than did foreign firms (marked in bold text in Table


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BOX 6.1 FORMATION OF VARIABLES FOR TFP CALCULATIONa Variables entered in the function (6)

Variables directly or calculated from the statistical yearbook

Deflator or calculation equation

Deflator data description

Deflated Industrial value value added added (100 million RMB at current price)

Deflator of value added = ex-factory price indices of industrial products (2000 price as 1)

1997–2000

2001–2006

Data cover only 15 industry sectors. The general indices for all sectors are adopted for the industry sectors that lack of data.

Data cover 37 two-digit industry sectors

Deflated gross industrial output value

Gross industrial output value (100 million RMB at current price) The data for three ownership groups i.e. state-owned collective and foreign enterprises are collected separately

Deflator of gross industrial output value = ex-factory price indices of industrial products (2000 price as 1)

1997–2000

2001–2006

Data cover only 15 industry sectors. The general indices for all sectors are adopted for the industry sectors that lack of data

Data cover 37 two-digit industry sectors

Average balance of net value of fixed assets for production

Average balance of next value of fixed assets for production = (1) average balance of

100 Variables entered in the function (6)

Multinationals and emerging economies Variables directly or calculated from the statistical yearbook



net value of fixed assets * (2) ratio of fixed assets for production to total fixed assets Deflated capital input

(1) Average balance of net value of fixed assets (100 million RMB at current price)

(2) Ratio of fixed assets for production to total fixed assets

Labour input Annual average number of

Deflator of average balance of net value of fixed assets = price indices of investment of fixed assets (2000 price as 1)

Ratio of fixed assets for production to total fixed assets = fixed assets for production (100 million RMB without depreciation) / total fixed assets (100 million RMB without depreciation)

Data are available for the period of 1997–2006

1997–2000 and 2004– 2006

2001–2003

Not available. The mean of the data in the period of 2001–2003 is adopted for this period

Panel data cover three ownership groups, i.e., stateowned, collective, and foreign enterprises and 37 two-digit industry sectors. The capital deflator of stateowned enterprise is also applied to shareholding enterprise

Cross-border investment and economic integration Variables entered in the function (6)

Variables directly or calculated from the statistical yearbook



Deflator of intermediate input = purchasing price indices of raw materials fuels and power (2000 price as 1)

1997–2000

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employed persons (10,000 persons) Deflated Intermediate intermediate input = gross input industrial output value – valueadded of industry + value-added tax

2001–2006

Data cover Data cover 37 only 9 industry two-digit industry sectors. sectors The general indices for all sectors are adopted for the industry sectors that lack data

Note: (a) All variables and price deflators are taken from various issues of the Guangdong Statistical Yearbook except for Fixed Assets for Production and Total Fixed Assets, which are taken from various issues of China Industry Economy Statistical Yearbook. Sources:

Guangdong Statistical Yearbook; China Industry Economy Statistical Yearbook.

6.1). In several sectors ‒ garments, paper, chemical products, pharmaceutical products, ferrous metals smelting, nonferrous metals, special mechanical products, transportation equipment and instruments and office machinery ‒ all three domestic ownership groups achieved superior levels of TFP growth as compared with foreign subsidiaries. The above analysis of TFP growth based on assumptions typical of neo-classical economic theory confirms the result obtained by theory-free labour productivity that productivity grew more rapidly in Guangdong domestic firms than in their foreign counterparts in the observation period of 1997‒2006. Guangdong domestic firms caught up technologically in comparison with their foreign counterparts, although foreign-owned subsidiaries further secured their dominant position in manufacturing sectors in Guangdong.

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Table 6.1


Average annual TFPa growth rate of state-owned, collective, shareholding, and foreign enterprises in Guangdong Province (percentage), 1997–2006

Sectors Agri-food processing Food Beverage Textile Garments Leather Wood processing Furniture Paper Printing Educational and sports products Petroleum products Chemical products Pharmaceutical products Chemical fiber Rubber Plastics Nonmetal mineral products Ferrous metals smelting Nonferrous metals smelting Metal products General mechanical products Special mechanical products Transportation equipment Electrical equipment Telecommunication and computer Instruments and office machinery

State-Owned Collective Shareholding Foreign Enterprises Enterprises Enterprises Enterprises 15.30 8.28 12.50 12.51 21.30 18.55 24.25 7.87 4.94 11.11 4.97

20.88 12.49 3.70 12.84 11.33 9.29 5.38 17.56 6.90 6.32 12.32

9.77 8.22 19.50 5.12 9.49 28.83 29.64 11.16 11.66 13.83 8.73

3.15 10.63 11.39 7.75 6.21 18.57 7.16 9.63 4.79 7.93 6.94

9.65 10.62 8.77 20.07 7.34 4.71 14.07

N.A. 8.19 12.24 18.11 3.93 6.98 9.00

22.39 11.98 11.49 14.82 3.76 4.48 15.28

10.03 4.49 5.28 14.98 6.33 9.02 12.66

10.04 10.52

17.21 18.54

9.10 35.02

6.80 9.61

11.19 11.14

10.52 9.30

9.18 11.57

9.81 9.01

18.94

8.72

7.32

6.60

27.11

13.96

16.16

12.02

21.10 14.25

5.48 6.36

2.96 22.82

13.72 8.44

17.30

22.04

26.61

12.07

Note: (a) The TFP growth rates of state-owned, collective, or shareholding firms that are higher than those of foreign firms are marked in italic text.


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We therefore find ourselves needing to explain apparently paradoxical results: (1) domestic firms in Guangdong have been catching up with foreign firms in the province; but (2) foreign firms have increased their output share in Guangdong’s manufacturing sectors. We suggest two complementary explanations. First, from 1997 through 2006, Guangdong firms did not catch up with foreign firms at a conspicuously rapid pace. In 11 out of 27 sectors, these firms demonstrated inferior labour productivity compared with that of foreign subsidiaries in 2006. In 17 out of 27 sectors, at least one domestic ownership group had not caught up in terms of TFP growth. While the catching up in productivity of Guangdong domestic firms might have provided them with a favourable market position in the future, this catching-up was not robust enough over our observation period to reverse the trend that saw foreign firms expanding their businesses in Guangdong. The second factor that resolves the apparent paradox is that, since the Chinese economy has begun opening up, many multinationals have been attracted by low manufacturing costs and moved production activities to China. A large number of such foreign subsidiaries located in China are concentrated in the processing business, particularly in producing and exporting labour-intensive products (Huang, 2003). They source the raw materials from within China or import critical components, hire local workers for processing and assembly and then export the final products to overseas markets.7 Lemoine and Unal-Kesenci (2004) and Fung (2005) confirm that the recent expansion of China’s exports in machinery, electrical equipment and so on, is attributable to the processing trade. According to a report by the Chinese Ministry of Commerce, processing trade exports accounted for 55 per cent of China’s total exports in 2004 (Xinhua Net, 2004). Indeed, as the first province in China to welcome foreign investment, Guangdong has attracted a large number of overseas investors, principally from Hong Kong, to establish processing businesses in its territory. According to the Guangdong Statistical Yearbook (2007), 74.9 per cent of Guangdong’s exports were due to the processing trade in 1995, a ratio that has decreased but still remained as high as 65.6 per cent in 2006. In 2006, 76.5 per cent of exports from foreign subsidiaries located in Guangdong were classified in the category of processing and assembling with import materials whereas only 11.1 per cent of such exports were recorded under general trade. Foreign firms that were engaged in the processing business and targeted overseas markets would not compete directly with those domestic firms in Guangdong that focused on the domestic market. The expansion of foreign manufacturing subsidiaries in Guangdong was not strongly influenced by the catching-up in productivity of domestic firms

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as it depended, in part, on overseas demand and multinationals’ own strategies. By this logic, the progress of domestic firms in terms of productivity growth should have little direct impact on the activity of foreign subsidiaries, at least in the short run.

FROM LOW-COST CROSS-BORDER PRODUCTION TO INNOVATION-BASED COMPETITIVENESS Hong Kong’s manufacturing in history: low-tech and low-cost Our finding that domestic manufacturing firms in Guangdong achieved steady productivity gains in the period of 1997‒2006 contrasts with the overall decrease of TFP among Hong Kong’s manufacturing companies in the period of 1984‒1993, as revealed by Kwong et al. (2000). The salient features of the history of manufacturing development in Hong Kong should serve as a point of departure in discussing such a sharp contrast between the development trajectories of the manufacturing industries on the two sides of the border. From the early beginnings of manufacturing in Hong Kong, a period of development that began in the 1950s and carried into the 1970s, technological sophistication played almost no role in establishing Hong Kong’s industries. In fact, the roots of Hong Kong’s manufacturing sector can be associated with the opportunistic exploitation of a geographic land space by Mainland Chinese immigrants, particularly textile barons from Shanghai, who transferred start-up capital and managerial expertise to the colony (Wong, 1988; Hollows, 1999). These Shanghai industrialists concentrated on low-cost manufacturing in the labour-intensive textile and clothing industries and turned to the British trading houses in Hong Kong, which had established links with international export markets (Tsui-Auch, 1998:9). Over time, however, as Hong Kong’s manufacturers faced limits to low-cost manufacturing, they found an escape route for their manufacturing activities in the opening up of China from 1979 onwards. This period of opening up enticed many of Hong Kong’s manufacturers to move their operations north of Hong Kong’s border so that they could exploit even cheaper land and labour resources for their production activities. Unlike their counterparts in other newly industrialized East Asian economies, Hong Kong’s entrepreneurs could use their linguistic and cultural familiarity to easily leverage the abundant labour and land resources in Guangdong to their advantage. In this way, they were able to offset the disadvantage of heightened labour costs without undertaking the more


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ambitious strategy of moving up the global value chain. Enjoying the cost advantage of cross-border production in Guangdong, Hong Kong’s manufacturing firms did not pursue technological sophistication, as did their counterparts in other Asian tigers. Automated processes and R&D activities were limited (Eng, 1997). Similarly, in the early 1980s, Hong Kong was not recognized as a major source of advanced technology in Mainland China. The technology transferred through Hong Kong’s FDI outflow was likely to be either low-level or quite standardized (Kamath, 1990). The idea that the growth and profitability of Hong Kong’s manufacturing companies was based on lowering their factor input costs is supported by scholars in the field. For example, by conducting an empirical analysis similar to ours Kwong et al. (2000) find that, during the period of 1984‒1993, Hong Kong’s manufacturing sector demonstrated an overall decrease in TFP, although such a technological decline did not mean lower profitability. It was during this period that Hong Kong’s firms engaged in a frenzy of manufacturing facility relocation to Guangdong. Because the unfinished products shipped at low prices from Guangdong’s manufacturing units, Hong Kong’s firms could enjoy high profitability even as technology declined. Hence Kwong et al. conclude that Hong Kong has grown mainly by utilizing the Mainland’s cheaper resources, instead of through technological advancement. They also argue that technology upgrading might have seemed too daunting a task for Hong Kong’s manufacturing firms as compared to moving the production base to Guangdong in order to maintain a competitive edge in global markets. Tuan and Ng (1995) conducted a survey in the course of investigating cross-border investment activity on the part of Hong Kong-invested firms in Guangdong province. They find that Hong Kong firms moved their manufacturing base to Guangdong mainly because of Guangdong’s cheap labour costs, low rents and geographical proximity, which complement the arguments of Kwong et al. A higher return on investment, a shorter payback period and factor-cost savings are strongly associated with the cross-border operation of Hong Kong’s manufacturing firms. Existing studies therefore already provide historical and empirical evidence that helps explain our findings related to productivity growth in Guangdong’s manufacturing sectors as well as the potential impact of Hong Kong-based firms. Hong Kong’s moves towards value added manufacturing and leveraging in Guangdong Partly because of their acknowledgement of the developments described above and partly because of the Asian Financial Crisis of 1997, Hong Kong began to reconsider the future of its economic growth engine. This

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was in light of the marginalized role of manufacturing in the territory, its decreasing importance as a trading hub and the scarcity of opportunities for reducing factor input costs. A Commission on Innovation and Technology (CIT) based its vision of Hong Kong’s new role explicitly on science, technology and innovation (CIT, 1999). Since the publication of the Commission’s two reports (CIT, 1998; 1999), Hong Kong has launched a number of policy measures designed to help its move into a new strategic posture that no longer relies primarily on lowering factor costs to achieve and maintain its competitive advantage. Most notable among these measures was the establishment of the Innovation and Technology Fund (ITF) in 1999 with HKD 5 billion, earmarked to provide funding support to projects that contribute to innovation and technology upgrading in industry, as well as to projects essential to the upgrading and development of new industries. The main purpose of the ITF was to counter what scholars such as Kwong et al. (2000) and Tuan and Ng (1995) were advocating: increasing competitiveness through higher value added goods and services. In evaluating measures designed to build competitiveness through innovation and technology, it is difficult not to acknowledge how late the policies have been in coming to fruition. Not until 1999 did Hong Kong develop any kind of formal, coordinated technology policy and not until late 2004 or early 2005 did it formally recognize the importance of the Mainland and the relationship between the two systems. Against any comparison benchmark ‒ that of OECD countries, Asian Tiger economies, or countries of a similar size, Hong Kong falls short in being among the last to recognize the value of technology and the benefits of increasing competitiveness through innovation. As such, the results of Hong Kong’s new technology measures are yet to be seen; in particular, the desire to ‘leverage the Mainland’ is only just now taking shape. However, we can say with some confidence that Hong Kong’s policy focus is at least facing in the right direction.

CONCLUSION In this chapter, we compare the performance of local and foreign competitors’ manufacturing firms in one FDI-recipient region ‒ Guangdong Province, China ‒ and analyse the policy implications of the comparison for one advanced, FDI-outflow region ‒ Hong Kong Special Administrative Region. We characterize the context in which mutual economic interdependence between Guangdong and Hong Kong has been growing and indicate that in 1997‒2006 Guangdong’s domestic manufacturing firms


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were catching up with their foreign-funded counterparts in productivity ‒ dominated by Hong Kong-based companies. Our findings suggests that domestic manufacturing firms in Guangdong achieved steady productivity gains in the period of 1997‒2006, standing in contrast against the overall decrease in TFP of Hong Kong’s manufacturing companies as illustrated in the literature for the period of 1984‒1993. To carry our understanding of the sharp contrast in development trajectories that characterizes manufacturing on the two sides of the Guangdong‒Hong Kong border into the future, we must inform our research and discussion with a grasp of salient features of the history of manufacturing development in Hong Kong.

NOTES 1. In various issues of the Guangdong Statistical Yearbook, in addition to data on the 27 manufacturing sectors, data on tobacco, coal mining, petroleum and natural gas extraction, ferrous metal mining, nonferrous metal mining, non-metal minerals mining, electricity supply, gas supply and water supply are also consistently reported. However, private and foreign capital were denied entry in most of these industry sectors in our observation period; we therefore do not include these sectors in the analysis of this chapter. Moreover, in various issues of Guangdong Statistical Yearbook, besides the data on state-owned, collective, shareholding, and foreign enterprises, the data on employee shareholding cooperative enterprises are reported as well. However, due to their minuscule economic scale we do not include them in the analysis. 2. The ownership status of a firm that operates in China is determined according to Chinese legislative regulations that apply when the firm registers with agencies of the Administration for Industry and Commerce. In general, a firm is classified as a foreignfunded firm only if the foreign equity stake is at or above 25 per cent. More detailed discussion of the classification of foreign-funded firms in China can be found in Huang (2003:4 and 35). 3. By using an econometric methodology prevalent in spillover literature and incorporating additional detailed data, Huang and Sharif (2005) separated the Hong Kong-invested firms from general foreign firms in Guangdong industry sectors and rigorously estimated the impact of the Hong Kong-invested firms on Guangdong domestic firms. 4. When obtained through the growth accounting method, total factor productivity (TFP) is traditionally utilized to explain technological change at the firm, industry, and country levels. Young’s paper (1995) on East Asia’s fast-growing economies (including Hong Kong’s) and Krugman’s (1994) subsequent interpretation are based on TFP. Their results have however received much criticism from scholars such as Chen (1997), Felipe (1999), Nelson and Pack (1999), Rodrigo (2000) and Felipe and McCombie (2003). Critics argue that several assumptions underlying Young’s TFP growth accounting methodology, such as that technological progress is exogenous, disembodied, and Hickneutral, are too far removed from reality. They call for policy attention to entrepreneurship, innovation, and learning in a country’s effort to catch up technologically and economically. 5. According to the China Statistical Yearbook (2004:572), Industrial Value Added = Gross Industrial Output Value minus Intermediate Input plus Value Added Tax (VAT). Since there is no specific value added deflator published in the China Statistical Yearbook, we adopt the Ex-Factory Price Indices of Industrial Products as our value added deflator. This methodology s differs from the one adopted by Jefferson et al. (1992 and 1996), who estimate the production function as Gross Industrial Output Value = Capital Input plus

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Labour Input plus Intermediate Input; and do not include value added into their production function. 6. The TFP growth across discrete time periods is: TFPt21,t 5 (lnqt 2 lnqt21) 2 ak (lnkt 2 lnkt21) 2 bl (lnlt 2 lnlt21)

(4)

where ak and bl denote the elasticity of output with respect to capital and labour input, respectively, and: ak 5 (ak,t 1 ak,t21) /2

(5)

bk 5 (bk,l 1 bk,l21) /2.

(6)

According to the definitions of ak and bl and the assumption of constant returns to scale, we obtain ak,t and bl,t through the following functions: 0lnq ak,l 5 5 ak 1 bkk (lnkt) 1 bkl (lnlt) 1 bktt (7) 0lnk bl,t 5 1 2 ak,t

(8)

7. In Chinese foreign trade statistics, this type of processing of imports and exports is recorded in the categories of processing and assembling with customer materials, processing and assembling with import materials, and compensation trade, which are separate from general trade. In line with this classification standard, firms that are engaged in processing trade are classified as foreign firms.

REFERENCES Berger, S. and R.K. Lester (1997), Made by Hong Kong, Hong Kong: Oxford University Press. Chan, R. (2002), ‘Towards strategic planning and regional sustainability: Hong Kong in the Pearl River Delta region’, Sustainable Development, 10, 122‒30. Chen, E.K.Y. (1997), ‘The total factor productivity debate: determinants of economic growth in East Asia’, Asian Pacific Economic Literature, 11(1), 18‒38. China Statistical Yearbook (2004), China Statistical Yearbook, Beijing: China Statistics Press. Commission of Innovation and Technology (CIT) (1998), Commission on Innovation and Technology First Report, Hong Kong: CIT. CIT (1999), Commission on Innovation and Technology Second Report, Hong Kong: CIT. Eng, I. (1997), ‘Flexible production in late industrialization: the case of Hong Kong’, Economic Geography, 73(1), 26‒43. Federation of Hong Kong Industries (2003), Made in PRD: The Changing Face of Hong Kong Manufacturers, Hong Kong: Federation of Hong Kong Industries. Feenstra, R.C. (1998), ‘Integration of trade and disintegration of production in the global economy’, Journal of Economic Perspective, 12(4), 31‒50. Felipe, J. (1999), ‘Total factor productivity growth in East Asia: a critical survey’, Journal of Development Studies, 35(4), 1‒41.


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Felipe, J. and J.S.L. McCombie (2003), ‘Some methodological problems with the neoclassical analysis of the East Asian miracle’, Cambridge Journal of Economics, 27(5), 695‒721. Fung, K. (2005), ‘Trade and investment among China, the United States, and the Asia-Pacific economies’, an invited testimony to the US Congressional Commission on China as an Emerging Regional and Technological Power: Implications for US Economic and Security Interests, hearing before the US-China Economic and Security Review Commission, 108th Congress, 2nd Session, US, Washington, DC: Government Printing Office, p. 30‒6, accessed at www.uscc.gov/hearings/2004hearings/transcripts/04_02_12.pdf. Guangdong Statistical Yearbook (various issues), Guangdong Statistical Yearbook, Beijing: China Statistics Press. Huang, Y.S. (2003), Selling China, Foreign Direct Investment During the Reform Era, Cambridge: Cambridge University Press. Huang, C. and N. Sharif (2005), ‘Manufacturing dynamics and technological catching-up: the case of Guangdong Province and Hong Kong SAR’, unpublished. Hollows, J. (1999), ‘Historical trajectories of innovation and competitiveness: Hong Kong firms and their China linkages’, Creativity and Innovation Management, 8(1), 57‒63. Jefferson, G.H., T.G. Rawski and Y.X. Zheng (1992), ‘Growth, efficiency, and convergence in China’s state and collective industry’, Economic Development and Cultural Change, 40(2), 239‒66. Jefferson, G.H., T.G. Rawski and Y.X. Zheng (1996), ‘Chinese industrial productivity: trends, measurement issues, and recent developments’, Journal of Comparative Economics, 23, 146‒80. Kamath, S.J. (1990), ‘Foreign direct investment in a centrally planned developing economy: the Chinese case’, Economic Development and Cultural Change, 39(1), 107‒30. Krugman, P. (1994), ‘The myth of Asia’s miracle’, Foreign Affairs, 73(6), 62‒78. Kwong, K., L. Lau and T. Lin (2000), ‘The impact of relocation on the total factor productivity of Hong Kong manufacturing’, Pacific Economic Review, 5(2), 171‒99. Lemoine, F. and D. Unal-Kesenci (2004), ‘Assembly trade and technology transfer: the case of China’, World Development, 32(5), 829‒50. Li, H.G. (1999), ‘State factories in transition: openness, competition, and productivity’, Journal of Development Economics, 58, 429‒62. Nelson, R. and H. Pack (1999), ‘The Asian miracle and modern growth theory’, The Economic Journal, 109, 416‒36. Rodrigo, C.G. (2000), ‘East Asia’s growth: technology or accumulation?’, Contemporary Economic Policy, 18(2), 215‒27. Rodrik, D. (1997), Has Globalization Gone Too Far?, Washington, DC: Institute for International Economics. Schultze, C.L. (2004), ‘Offshoring, import competition, and the jobless recovery’, The Brookings Institution Policy Brief, 137, accessed at www.brookings.edu/~/ media/Files/rc/papers/2004/0622business_schultze/20040622.pdf. Sun, Y. and K. Wong (2000), ‘Growth of Hong Kong before and after its reversion to China: the China factor’, Pacific Economic Review, 5(2), 201‒28. Tao, Z. and R. Wong (2002), ‘Hong Kong: from an industrialized city to a centre of manufacturing-related services’, Urban Studies, 39(12), 2345‒58.

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Tsui-Auch, L. (1998), ‘Has the Hong Kong model worked? Industrial policy in retrospect and prospect’, Development and Change, 29, 55‒79. Tuan, C. and L.F. Ng (1995), ‘Hong Kong’s outward investment and regional economic integration with Guangdong: process and implications’, Journal of Asian Economics, 6(3), 385‒405. Tuan, C. and L.F. Ng (2004), ‘FDI and industrial restructuring in post-WTO greater PRD: implications on regional growth in China’, The World Economy, 27(10), 1609‒30. Wong, S. (1988), Emigrant Entrepreneurs: Shanghai Industrialists in Hong Kong, Hong Kong and New York: Oxford University Press. Xinhua Net (2004), ‘China’s export and import structure experienced substantial change, China is marching to a strong trade nation’ (in Chinese), accessed at http://news.xinhuanet.com/fortune/2004-12/12/content_2324527.html. Yeung, G. (2001), ‘Foreign direct investment and investment environment in Dongguan Municipality of Southern China’, Journal of Contemporary China, 10(26), 125‒54. Yeung, G. (2002), ‘WTO accession, the changing competitiveness of foreignfinanced firms and regional development in Guangdong of Southern China’, Regional Studies, 36(6), 627‒42. Young, A. (1995), ‘The tyranny of numbers: confronting the statistical realities of the East Asian growth experience’, Quarterly Journal of Economics, 110(3), 641‒80. Yu, T. and P.L. Robertson (2000), ‘Technological capabilities and the strategies of small manufacturing firms: the case of Hong Kong’, in N.J. Foss and P.L. Robertson (ed.), Resources, Technology, and Strategy, London and New York: Routledge.

7.

The ‘making of’ national giants: the international expansion of oil companies from Brazil and China Flavia Carvalho and Andrea Goldstein

INTRODUCTION This chapter analyses the international expansion of oil firms from two of the largest emerging economies, Brazil and China. With high growth rates (especially in China, to a lesser extent in Brazil) and rising FDI outflows, Brazil and China are both interesting illustrations of the internationalization of firms from the emerging world. Moreover, the oil sector itself is interesting due to its strategic importance for most countries nowadays, especially the high-growth ones. The oil industry has traditionally been at the vanguard of globalization and it remains one of the largest and most internationalized businesses worldwide. The sector is continuously expanding; according to UNCTAD (2007), oil and gas drilling operations have doubled since 2002. For over a century, a few giant companies, mostly from developed economies, dominated this market. The high involvement of the state is another distinguishing feature of the oil industry. In the second half of the twentieth century, developing economies created their own national oil companies (NOCs) in order to secure their access to one of the main fuels of economic development. NOCs first targeted domestic reserves and then started to internationalize, becoming multinationals at surprisingly fast rates, thus also attracting the attention of international business scholars. In particular, the impressive expansion of Chinese state oil companies has been attributed to geo-strategic motivations, while the competitiveness of Petrobras, the Brazilian oil company has been seen as the by-product of a long-term effort to build distinctive resources and capabilities. In this chapter, we analyse the emergence and evolution of oil firms from China and Brazil, in order to understand the determinants of their foreign investments, as well as their main competitive advantages. We found them to be diverse due to: aspects inherent to the oil sector, the timing of their 111

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internationalization strategies, the characteristics of the two countries and the role of governments in this process. Moreover, technology and innovation have played quite a different role in the strategy of corporate expansion of Chinese and Brazilian national oil companies. The chapter is organized as follows. The first section introduces aspects specific to the oil industry and presents the Brazilian and Chinese cases. The second section discusses the role of innovation and technology. The third section deals with the role of the state and the last section provides some concluding remarks.

FOREIGN DIRECT INVESTMENTS IN THE OIL SECTOR: BRAZIL AND CHINA Oil is a unique commodity in terms of strategic importance ‒ it is the main source of energy and an essential input to industrial production. It is also strategic because of a remarkable North-South divide: more than 80 per cent of world oil production takes place in developing countries, while OECD countries consume around 54 per cent of the total produced (Aykut and Goldstein, 2008). The industry has traditionally shown an oligopolistic structure, driven by its technical characteristics: a) very high investment requirements and corresponding scale economies in operation; b) risky investments due to the uncertainty regarding exploration prospects (Furtado and Muller, 1993). In terms of ownership, private firms dominated until the 1960s: independence in a number of producing countries, the emergence of the Organization of the Petroleum Exporting Countries (OPEC) and the increasing political and strategic importance of oil (along with its raising prices) led to a wave of nationalization, shifting the bargaining scenario (UNCTAD, 2007). Nowadays, in developing countries oil companies are mostly state-owned, whereas in most developed countries they are privately held (especially in the major consuming countries). Among the 50 top oil companies, 34 are state-owned, out of which 20 have 100 per cent state ownership (UNCTAD, 2007). A group of emerging economies’ NOCs is referred to as the new Seven Sisters: Saudi Aramco (Saudi Arabia), Gazprom (Russia), CNPC (China), NIOC (Iran), Petróleos de Venezuela (Venezuela), Petrobras (Brazil) and Petronas (Malaysia). Firms have reacted to these features and to the instability of oil prices through vertical integration, which makes them relatively less dependent on the vagaries of individual markets and by-products. International investments in the oil sector comprise most of the FDI motivations identified in the international business literature: they can be resource-seeking,

The ‘making of ’ national giants

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market-seeking, or strategic-asset-seeking. In general, resource-seeking investments occur in the upstream segments of the oil industrial chain, in other words in exploration and extraction; market-seeking investments are concentrated in the downstream segment (retailing). Strategic assetseeking deals are gaining in importance as several oil companies aim to enhance competitiveness by acquiring important know-how and/or technology through cross-border mergers and acquisitions. Foreign investments can therefore be quite diverse in their objectives, according to the strategic goals of firms and countries. Oil companies from Brazil: Petrobras in frank international expansion President Getulio Vargas established Petrobras (Petróleo Brasileiro) in October 1953, afterwards Law 2004 established the government’s monopoly in all segments and activities of the Brazilian oil sector. The new stateowned company was allowed to undertake oil sector activities in Brazil on behalf of the Union and inherited all the assets of the National Oil Council (Conselho Nacional do Petróleo, CNP). In 2006, 53 years later, Petrobras’ net revenues surpassed USD 77 billion, while its net profits were around USD 2 billion. It is the largest Brazilian company in terms of market value and revenues (Exame, 2007), while in terms of market capitalization it was the world’s sixth largest energy company in 2007 (PFC Energy, 2008). Petrobras is also one of the top multinationals from Brazil with external revenues of over USD 5 billion (Chevarria, 2006). The foundation of Petrobras, along with other state-owned enterprises in basic industries (such as Vale in iron ore and CSN in steel), was one of the cornerstones of the import substitution industrialization strategy carried out in Brazil, with the aim of reducing its external dependence in basic inputs. The 1970s oil crises, however, showed that Brazil’s energy policy had failed to make it independent from foreign oil sources. In this context, Petrobras increased its strategic importance and focused on the development of specific technological capabilities for prospecting oil in deep waters (due to this particular location of most Brazilian reserves) and the search for alternative energy sources. Petrobras’ international expansion started in 1972, with the creation of the Braspetro Petrobras International. At the time, oil imports covered more than 80 per cent of domestic demand and Petrobras’ international branch had as its main purpose to guarantee supply security (Chevarria, 2006). The first investments were made in Latin America, particularly in Colombia’s Caribbean Sea, where oil was extracted from deep waters in 1972. Petrobras then expanded towards other areas where similar exploration conditions existed ‒ in Angola, Africa (1979), taking advantage of the

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fact that Brazil had been the first country to recognize the new government after independence; and in the Gulf of Mexico, where currently Petrobras owns more than 300 deepwater blocs. Nowadays, Petrobras is directly present in 27 countries, holds more than 100 production licences and owns 16 refineries, in Brazil, Argentina and the US. Petrobras’ overseas refining capacity has gone from zero barrels in 2000 to 126.2 thousand barrels of oil per day in 2007 (Petrobras, 2008). Its refining capacity is concentrated in the Southern Cone of America, one of its strategic areas of action. In fact, Argentina has become the second most important market for Petrobras. Petrobras’ investments in Argentina aim the establishment of synergies (scale and scope economies) with its operations in Brazil (Chevarria, 2006; Dalla Costa and Pessali, 2007). According to its 2008‒12 strategic plans, Petrobras expects to realize overseas investments of around USD 15 billion in both exploration and production, along with the expansion of ethanol production and an enhanced international expansion. This reflects a consistent internationalization path. In 2005, Petrobras invested over USD 3 billion in overseas projects (Petrobras, 2006). The opening of the domestic market has also put pressure on Petrobras’ management to internationalize. Until 1997, Petrobras had the monopoly of exploration in the Brazilian territory. However, technological and investment pressures convinced the Cardoso government (as many others around the world) to establish a competitive environment for oil exploration (Aykut and Goldstein, 2008). The role of government has been reshaped, from production and promotion of the sector to regulation and surveillance. Since then, around 50 new companies from the oil sector have established operations in Brazil (Estado de São Paulo, 2007). Nine concession rounds have been conducted and 71 concessionaires (35 of which foreign investors) are currently operating in Brazil.1 Petrobras’ production has doubled since 1996, to reach 1.8 million barrels of oil per day (Estado de São Paulo, 2007). Chinese national oil corporations While the first known use of the term for oil ‒ shiyou ‒ occurred during the Song Dynasty (Kambara and Howe 2007), the rationalization of the oil and gas industry started later in China than in Brazil: it was not before the 1980s that the first national oil company ‒ China National Offshore Oil Corporation (CNOOC), was set up in China. Chinese oil companies have gone through an extensive process of restructuring, in order to reshape ownership structures, to instil market mechanisms into state-owned firms and to make them more similar to integrated international oil companies elsewhere.2


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State-owned enterprises dominate the Chinese oil and gas industry. In 1998 most state-owned assets were grouped into the China National Petroleum Corporation (CNPC) and the China Petroleum and Chemical Corporation (Sinopec), resulting in the creation of vertically integrated firms. The former is responsible for most upstream activities, concentrated in the North of China; the latter deals with downstream activities, concentrated in Southern regions (Houser, 2008). CNOOC is the other major state sector firm, which handles offshore exploration and production and accounts for roughly 15 per cent of domestic production. Despite such a relatively short history as a quasi-market industry, the oil sector is one of the most internationalized in the Chinese economy. Even though the first outflow of FDI only took place recently, in 1992 (Chorell and Nisson, 2006), by 2003 the oil sector was already the second most important overseas investor (behind IT, computer and software industry) and accounted for 18 per cent of Chinese outward FDI stock (China Ministry of Commerce, 2004, in Giroud, 2005). Among the top ten Chinese multinationals (in terms of foreign revenues) three are in the oil business (Giroud, 2005). The Chinese oil companies have rapidly gained in size and can now be compared to global giants such as Exxon Mobil, Shell and BP. In terms of oil output, for instance, CPNC and its affiliate PetroChina are close to the world’s leading companies, with oil production of 822.9 million barrels and gas production of 1119.5 billion cubic feet in 2005 (OGJ, 2006), compared with the production of BP of 935.1 million barrels for oil and 3074 billion cubic feet for gas, respectively. In terms of market capitalization, PetroChina reached the top of the energy company’s ranking in 2007, while Sinopec is ranked fifth in the list. Chinese firms led the sector’s share price growth of 2007 (PFC Energy, 2008).

TECHNOLOGICAL ACCUMULATION AND INTERNATIONAL EXPANSION It is important to highlight that, since their emergence, multinationals from developing countries are considered a different specimen in the ecology of world business (Goldstein, 2007). While traditional foreign direct investments from advanced economies could be explained mostly in terms of access to superior technology and competitive resources, those from the developing world tend to depend on government support. This does not mean that technology has had no role in the internationalization of firms from emerging economies ‒ it simply has assumed different ones. In an early phase, some companies benefited from special

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Table 7.1

Chinese and Brazilian oil companies at a glance

Indicator R&D expenditures (USD millions, 2006) Patents USPTO (since 1976) Production (million BOE, 2005) Foreign production (percentage) Position in Top Oil Companies Ranking Sources:

Petrobras

PetroChina/ CNPC

CNOOC

Sinopec

399.74

396.64

49.86

278.46

187

5

749.6

1119.6

8.8

16.8

17

5

1 211

88 316.6

21.8

15.4

38

30

DTI (2006), OGJ (2006), UNCTAD (2007), USPTO (2007).

technological assets developed to adapt to the specific circumstances in their home markets, such as small production runs and low-quality infrastructure, adapted technologies. The experience of Petrobras, however, tells a different story. Table 7.1 summarizes the position that both Chinese firms and Petrobras hold in terms of technological achievements. R&D and production numbers show the remarkable achievements of both countries, and point out the impressive catching up by Chinese oil companies. Technology, new markets and new segments: Petrobras investing deep Fast-paced technological alignment with leading oil firms and the development of its own technology for deepwater extraction have been the cornerstones of Petrobras’ international expansion since the 1970s. Petrobras managed to go beyond localized technological change to develop a stateof-the-art set of techniques to explore specific features of Brazilian oil reserves. Thanks to intensive R&D efforts, the accumulation of technological capabilities by Petrobras evolved from an initial set of incremental innovations from imported technologies to the development of its own set of techniques (Neto and Dalla Costa, 2006). The possession of such know-how is central to foreign expansion giving it its tacit character and consequently making it difficult to be codified and disseminated. Throughout its history, Petrobras accumulated strong capabilities in deepwater extraction, for which it has received several industry awards, such as the ‘Distinguished Achievement’ from the Offshore Technology


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Conference in 1992 and in 2001 (Dalla Costa and Pessali, 2008). Petrobras technological accumulation derived from the fact that oil reserves in Brazil are in deep and ultra-deepwaters,3 which demands special extracting expertise. Petrobras made extensive investments in R&D in order to develop its own technology, evolving from importer of third parties’ technologies to the owner of its own technologies. The strategy has produced its benefits: while in 1987 only 1.7 per cent of production came from the sea, in 2000 this amounted to 55 per cent (Bruni, 2002). Petrobras has created several research centres, some of them acting in cooperation with renowned Brazilian universities, such as the Federal University of Rio de Janeiro (UFRJ) and the State University of Campinas (Unicamp).4 The universities are important providers of highquality human resources to Petrobras ‒ around 40 per cent have a college degree, and around 4 per cent have a post-graduation degree (Petrobras, 2008). The outcomes of Petrobras’ technology and innovation strategy have been quite impressive. It is the fifth-largest world oil company in terms of R&D expenditures and also the leading innovative firm in Brazil, with USD 399 million invested in R&D activities in 20065 (Petrobras, 2006; DTI, 2006). In terms of R&D, the outputs are similarly impressive. Petrobras is the Brazilian company with most patent applications and with more patents granted in the US Patents Office (USPTO). Until 2005, Petrobras also held the largest number of patents from the Brazilian Patents Office (INPI): 222 in the period 1990‒2001. In 2006, it was surpassed by Unicamp, but remains the leader in the business sector. On average, Petrobras files 80 patent claims per year and has already filed more than 1000 patents. The uncertainty of deepwater prospection makes it necessary to invest huge sums in the development of appropriate technologies. On this regard, the association of Petrobras with other oil firms in the early 1980s, for developing new technologies was quite peculiar (Furtado and Freitas, 2000). The goal of these arrangements was not to passively absorb external knowledge, but rather to build the basis for developing new technologies, with Petrobras playing an active role in the development process. As a respected technological leader in its specific extraction techniques, Petrobras is now in the position to attract bigger international oil companies as partners in more recent technological endeavours.6 In addition, Petrobras is currently a world reference for alternative energy sources, such as ethanol. Here again, foreign oil companies are interested in creating partnerships with Petrobras and in investing in R&D in Brazil. The recent movements towards foreign markets have a strong orientation to expand business along the industry chain and conquer new

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markets. This is consistent with Petrobras’ goal to become an integrated company in the energy sector as a whole ‒ explaining why Petrobras has diversified its investments towards other segments of the market. The acquisition of refineries in the USA has the objective of developing new distribution channels for Petrobras branded fuel. Petrobras is searching for large profits from refining its excess capacity and operating in the downstream segment.7 In addition, the ethanol business shows a strong potential for Petrobras’s international expansion. With an expected export capacity of 500 thousand cubic feet of ethanol for the year 2008, Petrobras aims to grow its capacity in 45.5 per cent a year, reaching exports of 4.8 billion cubic feet by 2012. In addition to expanding exports from Brazilian operations, Petrobras has plans to invest in research and ethanol production in some African countries. In Mozambique, a memorandum has already been signed with the local government, and Angola is another prospective partner. The national relevance of Petrobras technology has taken a new dimension since the announcement that Brazil has become self-sufficient in oil supply, in April 2006, after the opening of another platform for deepwater exploration at the Bay of Campos. Nevertheless, it was the discovery of the biggest deepwater oil field off the Southeastern coast in November 2007 that has the potential to transform Brazil into a global energy powerhouse. Petrobras reckons that this field named as Tupi holds some five to eight billion barrels of crude oil and natural gas, making it the biggest in the world since a discovery in Kazakhstan in 2000. In the next five years, it is conceivable that Brazil could move ahead of Mexico and Canada in total oil reserves, becoming third only to Venezuela and the United States in the energy pecking order of the Americas. To coax the oil from Tupi field, Petrobras’ engineers will have to drill up to 4800 meters below the sea floor through salt and rocks, in water depths of up to 3000 meters, an undertaking that is at the frontier of the industry’s technological ability. In summary, Petrobras’ story shows the crucial importance of accumulating technological capabilities to establish leading international position. As Dantas and Bell (2006:9) stress, Petrobras’s capabilities ‘[. . .] evolved from those of an imitative technology-user to those of a leading player at the international innovation frontier’. Strategic intent was the key. Moreover, a change in the Brazilian regulatory scenario for oil investments has fostered Petrobras’ further internationalization strategy, in order to strengthen its competitive position. The investments in the Gulfs of Mexico and Guinea, areas where only companies at the frontier of deep-shore exploration can operate, provide evidence of the sophistication of Petrobras offshore technologies (Chevarria, 2006).


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Technology and Chinese firms: the quick catching up The role of technology in the expansion of Chinese oil firms has been quite different from Petrobras’ expansion. CNPC, PetroChina, CNOOC and Sinopec are relatively young, if compared to Petrobras and the big oil companies. Moreover, they still lag behind the global giants in developing world-class technologies. However, the Chinese NOCs have recently caught up with some of the oil majors in several categories and are sparing no efforts to fill the gap completely. In 2006, PetroChina was ranked the sixth world oil company in terms of R&D performance (DTI, 2006). Its performance in terms of patents granted at the USPTO is also impressive (Table 7.1). The combined R&D efforts of the major Chinese oil firms in 2000 was about 1‒2 fifths of that spent by the three world biggest oil companies ‒ Total, ExxonMobil and Shell. In 2006, PetroChina and CNOOC together spent one third of the amount spent by the leading three companies. However, their combined patents’ production is still only a fraction of that of their Triad competitors (Nolan and Zhang, 2002). Furthermore, despite all efforts, Chinese oil firms still face great obstacles in purchasing the R&D embedded in the products of specialist suppliers to the oil and petrochemical industry. Chinese firms still need to bridge several technological gaps. Extracting and treatment equipments are either imported or only assembled in China, without domestic production. Key electronic instruments and software for exploration and production are imported as well. In spite of holding a refining capacity comparable to the world oil majors, the Chinese NOCs suffer from poor technological capabilities and high refining costs (China Petroleum, 1999; Chorell and Nisson, 2006). Facing these constrains, most Chinese investments abroad seek technologies that China needs to access oil reserves to satisfy its rocketing demand ‒ China consumes around 9 per cent of world oil and has only 1 per cent of the world’s proven reserves (Houser, 2008). China’s oil output has remained relatively stable over the last five years and securing an oil supply will be a major challenge for China in coming years. China’s willingness to own world-class energy companies, combined with the scarcity of domestic reserves, leaves no other choice for Chinese oil companies than seeking reserves overseas (Houser, 2008). PetroChina’s accelerating investments in exploration has so far only served to replace previous production rather than expand its oil reserve base. PetroChina’s domestic oil portfolio looks increasingly mature; meeting government’s security-of-supply objectives will therefore become more onerous in future years, further stimulating overseas expansion efforts.

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PetroChina has invested in 30 countries, and produces in a third of these locations. The specific characteristics of Chinese crude oil reserves (sweet and light) have directed PetroChina’s initial investments to similar reserves, in order to use existing facilities for refining (Houser, 2008). Locations such as Sudan, Iran and Syria were chosen both because of the weaker competition from big oil firms and the fact that in these countries extraction complies with Chinese capabilities. As refining capabilities expanded in China, the same occurred with their sources of oil overseas. The focus of CNPC’s strategy has been towards areas of high aboveground risk and mature assets, therefore avoiding head on competition with international oil companies. Its stated mission is to become a globally competitive multinational. In particular, much debate has focused on the extent to which CNPC’s overseas expansion has been driven by the Chinese government’s strategic goal of securing energy supply or by CNPC’s desire to develop itself into a global energy player (Chorell and Nisson, 2006). Overseas expansion, although headline grabbing, has been on a relatively modest scale and CNPC’s portfolio remains dominated by conventional onshore oil production in China. In fact, CNPC has acted in a way consistent with corporate development aims, rather than simple resource capture. The problem stands in slow decision-making and a riskaverse outlook, which may have been factors in its apparently conservative development moves. In addition, if CNPC is to become a true international competitor it must move to fill the strategic gaps in its portfolio. Areas in which CNPC is currently entirely absent include deepwater exploration, major international gas (including liquefied natural gas, LNG) and unconventional oil. CNPC is also severely underweight compared to the major oil companies in offshore areas and high impact international exploration. This signalizes the need of further investments to improve capabilities, on top of all. In contrast to oil, the prospects for Chinese gas production are much more promising. Several joint ventures have been carried out over recent years in order to improve capabilities and production in this segment. Such partnerships reinforce the strategy used by China to catch up and gain market and resource access, deepening its international presence. In short, on foreign markets Chinese oil firms are searching higher capabilities and resources, and in these terms the role of technology in the internationalization process is very different from the case of Petrobras. In terms of its own technological capabilities, Chinese firms still have a lot to evolve and learn from their foreign counterparts, especially if China wants to explore its reserves of oil sand ‒ whose technologies are still to be mastered in order to make it affordable (Chorell and Nisson, 2006).


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THE ROLE OF GOVERNMENTS The Brazilian government’s intent to turn Petrobras into a strong, technologically advanced player in the domestic (and later global) oil industry, capable of keeping Brazil immune from the imbalances originated from international oil crises, has been a key constant in Petrobras’s history. In this sense, the developmentalist government has played a central role in the development of Petrobras’ competitive advantages. The rationale is rather simple: Brazil has deepwater oil reserves that require specific exploration technologies, which were largely absent off-the-shelf and could not be transferred at arms’ length. This kind of circumstance provided the ultimate technological push to Petrobras’s pursuit of its own techniques. On the other hand, insofar as the internationalization of Petrobras is concerned, there is very little evidence of a government push or of any stimulus or support. It is only recently that the government has started considering the internationalization of productive activities of Brazilian firms as a way to boost export performance and improve the country’s overall competitiveness. Until recently, the predominant vision associated foreign investment by domestic companies with the crowding out of capital, investments and employment, and therefore saw the phenomenon as very harmful to the Brazilian economy. The evidence now is that in Brazil (as elsewhere) internationalized, multinational firms perform better, possess better technologies and human resources and achieve better export profitability due to these advantages (De Negri et al., 2005). As a result some programs and policies have been introduced in order to foster further international insertion of Brazilian firms (Iglesias and Veiga, 2002; Prochnik et al., 2005; Alem and Cavalcanti, 2007; Almeida, 2007). The trajectory of Chinese investments has been quite different on this regard as well. China was making its first steps towards a market economy when Brazil and other developing economies were already engaged in a first wave of outward direct investments. Under the Chinese open door policy, established in 1979, outward investments started to be stimulated, but always with government surveillance. In fact, until 2003 Chinese private firms were forbidden from investing abroad (Buckley et al., 2007). Nowadays, the Chinese government’s acts are the key driver of the go global strategy, either facilitating investment processes or providing the necessary financial support for Chinese overseas investments (Child and Rodrigues, 2005). The direct participation of the state is another aspect of the government’s push to internationalization: in 2003, 43 per cent of Chinese investors abroad were state firms (Chinese Ministry of Commerce, 2004 in Giroud, 2005). This places Chinese multinationals in a privileged

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position in terms of access to capital and technology and has steered political controversy in other nations. The extensive presence of the Chinese government in investments reveals that political motivations have as important a role as economic ones (Cai, 1999). Chinese state-owned enterprises support the authorities’ long-term strategy to reinsert China in the global economy ‒ as part of a greater plan to accomplish successfully the economic transition. Securing energy and other natural resources, along with strong international positioning for Chinese firms ‒ the national champions, are key motivations behind the Chinese government’s encouragement of outward direct investments.

CONCLUDING REMARKS This chapter looked at a specific industry with an advanced level of internationalization ‒ oil. Our purpose was to understand the role of governments and technology in the internationalization strategy of oil companies from two emerging countries, Brazil and China. We found that the determinants of the internationalization of the Brazilian Petrobras and of the Chinese oil companies, CNPC/PetroChina, CNOOC and Sinopec have relied on different resources and assets and followed different objectives. The case study reveals important aspects related to the policies pursued by emerging economies to support the internationalization of their firms and the ‘making of’ national giants. The success of Petrobras in its internationalization and growth strategy is striking, although it unfortunately represents an exception and does not reflect a national trend. Petrobras achieved its success due to a deep commitment to technological development, favoured by a series of political, economic and geographic circumstances. Petrobras was one of the leading companies in the first wave of multinationals from developing countries and succeeded to develop technological assets beyond the scope of localized technological change. Unfortunately, the case is an isolated one in the Brazilian economy and is not part of a national plan towards internationalization and the strengthening of the domestic industry by means of outward direct investments. Until recently, no deliberate policies have been carried out to promote stronger foreign insertion of Brazilian firms in the global economy and recent initiatives are moving very slowly. The rise of Chinese oil companies, on the other hand, is more recent. In a competitive sector already dominated by giant players, their expansion has been facilitated by the government’s strong political will to achieve fast-paced global insertion of the Chinese economy (Dunning et al., 1997;


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Fleury, 2006). Strategic asset-seeking is the key motivation for Chinese firms to expand overseas (in the oil sector, but also in general terms) and technology, rather than being the asset that is deployed, is a key goal they are searching everywhere ‒ via foreign acquisitions and strategic alliances established with big players. An important conclusion highlighted in this chapter is that governments can play a decisive role in the process of internationalization of national firms. They can either foster technological development within their countries, which leads to stronger competitive assets to operate abroad, or use subsidies to stimulate the foreign venture of firms so that they can leverage key assets not available in the domestic environment. We have also illustrated the changing role of technology in the evolution of emerging economies’ multinationals and the increasing role of asset-seeking investments undertaken by some emerging countries, like China. The subject of the internationalization of firms from emerging economies has a wide set of issues that need to be further investigated. This chapter sought to start the discussion by highlighting the role of multinationals ‒ in this case those of developing nations ‒ in the process of sustainable technological upgrading and economic development, which is the broad subject of this book.

NOTES 1. The list of concessionaires is available at the Brazilian Ministry of Energy’s website: http://www.brasil-rounds.gov.br/geral/ATIV_lista_de_concessionarios_R9.asp. 2. CNPC separated out most of its high quality assets into a subsidiary called PetroChina and carried out its IPO of a 15 per cent interest on both the Hong Kong and New York stock exchanges in April 2000. Sinopec also offered a 15 per cent stake in its October 2000 IPO on the Hong Kong and New York stock exchanges. In February 2001, CNOOC held its IPO of a 27.5 per cent stake after an earlier attempt in September 1999 was cancelled. Major multinationals seeking China market entry were the largest subscribers: BP bought 20 per cent of PetroChina’s offered shares, 57 per cent of Sinopec’s shares were bought by ExxonMobil, BP, and Shell, and Shell purchased 20 per cent of CNOOC listed shares. 3. Deep-shore extraction refers to reserves up to 1000 meters; ultra-deep extraction refers to reserves with depth above 1000 meters. 4. Cenpes, Petrobras’ most important research centre, is located within the UFRJ. It has been in operation since 1966, employs 1800 people (many of them holding PhD degrees) and plays a key role in Petrobras’ corporate growth strategy. Cepetro is a research and training centre jointly ran with Unicamp, in which campus it is located. In 2006, Cepetro received USD 5.1 million from Petrobras for research projects. 5. Corresponding to BRR 645 millions as announced in Petrobras’ website. 6. Companies which associate with Petrobras for technological purposes are Repsol-YPF, ExxonMobil, Shell, Chevron, Statoil and Total (Petrobras, 2008). 7. Petrobras’ interest in expanding in the downstream sector was the main reason for the acquisition of 50 per cent of the Pasadena Refinery in Texas, in September 2006.

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Dunning, J., R. van Hoesel and R. Narula (1997), ‘Explaining the “new” wave of outward FDI from developing countries: the case of Taiwan and Korea’, MERIT Research Memoranda, 9. Estado de São Paulo (2007), ‘Dez anos após o fim do monopólio, a Petrobras está forte como nunca’, Estado de São Paulo, Caderno Economia, 5 August. Exame (2007), ‘Melhores e Maiores 2007’, Revista Exame, Editora Abril. Fleury, A. (2006), ‘China e Brasil na economia global: competências e estratégias empresariais’, mimeo, IEA, Brazil. Furtado, A. and A.G. de Freitas (2000), ‘The catch-up strategy of Petrobras through cooperative R&D’, Journal of Technology Transfer, 25(1), 23‒36. Furtado, A. and N. Muller (1993), ‘Competitividade da indústria de extração e refino de petróleo’, Estudo da Competitividade da Economia Brasileira, mimeo, MCT/FINEP/PADCT, Campinas accessed at http://200.130.9.7/publi/Compet/ Default.htm. Giroud, A. (2005), ‘Chinese outward foreign direct investment’, UNCTAD Expert Meeting on Enhancing the Productive Capacity of Developing Country Firms Through Internationalization, 5‒7 December, Geneva. Goldstein, A. (2007), Multinational companies from Emerging Economies: Composition, Conceptualization and Direction in the Global Economy, Basingstoke: Palgrave. Houser, T. (2008), ‘The roots of Chinese oil investments abroad’, Research Note Asia Policy, 5, 141‒66. Iglesias, R. and P.M. Veiga (2002), ‘Promoção de exportações via internacionalização das firmas de capital brasileiro’, in Pinheiro, Markwald and Pereira (eds), O Desafio das Exportações, Rio de Janeiro: BNDES. Kambara, T. and C. Howe (2007), China and the Global Energy Crisis, Cheltenham, UK and Northampton, MA, USA: Edward Elgar. Kumar, K. and M. McLeod (eds), (1981), Multinationals from Developing Countries, Lanham, MD: Lexington Books. Kumar, K. (1982), ‘Third world multinationals: a growing force in international relations’, International Studies Quarterly, 26(3),397‒424. Lall, S. (ed.), (1983), The New Multinationals: The Spread of Third World Enterprises, Chichester: John Wiley and Sons. Matthews, J. (2006), ‘Dragon multinationals: new players in 21st century globalization’, Asia Pacific Journal of Management, 23, 5‒27. Matthews, J. (2002), Dragon Multinationals: A New Model for Global Growth, Oxford: Oxford University Press. Neto, J.B.O. and A. Dalla Costa (2006), ‘A Petrobras e a exploração de petróleo offshore no Brasil: um approach evolucionário’, IE-UFPR Texto para Discussão, 20. Nolan, P. and J. Zhang (2002), ‘The challenge of globalization for large firms’, UNCTAD Discussion Papers, 162. OGJ (2006), ‘Leading oil and gas companies outside the US’, Oil and Gas Journal, 104(33), 4 September. Petrobras (2002), ‘Discussion of international strategy’, Petrobras conference call webcast with Petrobras’ International Director Jorge Marques de Toledo Camargo, transcript accessed at http://www2.petrobras.com.br/ri/port/ ApresentacoesEventos/ConfTelefonicas/pdf/webcast_int_090102.PDF Petrobras (multiple years), Year report, accessed at www.petrobras.com.br. PFC Energy (2008), ‘Energy 50: the definitive annual ranking of the world’s largest listed energy firms’, accessed at http://www.pfcenergy.com/pfc50.aspx.

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Prochnik, V., L.A. Esteves and F. Freitas, (2007), ‘Internationalization and firm heterogeneity in Brazilian industry’, UNU MERIT MEIDE Conference, Maastricht. Ricupero, R. and A. Barreto (2007), ‘A importância do investimento direto estrangeiro do Brasil no exterior para o desenvolvimento socioeconômico do país’, in Almeida (ed.), Internacionalização de Empresas Brasileiras: Perspectivas e Riscos, Sao Paulo: Editora Campus. Sauvant, K. (2005), ‘New sources of FDI ‒ the BRICs: outward FDI from Brazil, Russia, India and China’, Journal of World Investment and Trade, 6(5), 639‒709. Teixeira, A. (2006), ‘A internacionalizacao de empresas brasileiras e o papel do estado’, XVIII Fórum Nacional ‒ Por que o Brasil não é um país de alto crescimento? Tolentino, P.E. (2000), Multinational Corporations: Emergence and Evolution, London: Routledge, pp. 93‒122. UNCTAD (2007), ‘Transnational corporations, extractive industries and development’, in World Investment Report, New York and Geneva: United Nations, accessed at www.unctad.org/wir. UNCTAD (2006), ‘FDI from developing and transition economies’, in World Investment Report, New York and Geneva: United Nations, accessed at www. unctad.org/wir. UNCTAD (2005), ‘Firms in developing countries rapidly expanding foreign investment, transnational activities’, in UNCTAD Press Release, 30 May. UNCTAD (2004), ‘Outward FDI from Brazil: poised to take off?’, in UNCTAD Occasional Note, 7 December. UNCTAD (2003), ‘China; an emerging FDI outward investor’, UNCTAD E-brief, available at: http://www.unctad.org Vernon, R. (1966), ‘International investment and international trade in the product life cycle’, The Quarterly Journal of Economics, 80(2), 190‒207. Vernon, R. (1979), ‘The product cycle hypothesis in a new international environment’, Oxford Bulletin of Economics and Statistics, 41(4), 255‒67. Vilella, A. (1983), ‘Multinationals from Brazil’, in S. Lall (ed.), The New Multinationals, Chichester: John Wiley and Sons. Wells, L.J. Jr (1983), Third World Multinationals, Cambridge, MA: MIT Press.

Websites CNOOC: www.cnooc.com.cn CNPC: www.cnpc.com.cn Sinopec: www.sinopec.com.cn Petrobras: www.petrobras.com.br USPTO: www.uspto.org

8.

Beyond the emission market: Kyoto and the internationalization of firms from the waste industry Asel Doranova, Geert-Jan Eenhoorn and Ionara Costa

INTRODUCTION The Kyoto Protocol is generally recognized for its paramount aim to reduce the global level of greenhouse gas (GHG) emissions and for the global emission market it has created. The market-based approach is a key aspect of the Protocol and follows recent trends from the environmental policy domain to engage the private sector in the achievement of public goals. The Kyoto’s emission market is pivoted on the splitting of the signatory countries into two groups: developing countries with no emission limits; and developed countries, the so-called Annex I countries with bound targets to reduce their GHG emissions. Within the latter, the national emission-reducing targets are allocated to local entities, business firms mainly, according to the level of GHG emissions their activities generate. Three flexibility mechanisms put the Kyoto emission market into motion: the Clean Development Mechanism (CDM), the Joint Implementation (JI), and the Emissions Trading. Together these marketbased mechanisms allow flexibility to countries and business firms in meeting their reduction targets, based on credits of GHG emission reduction ‒ the Certified Emission Reduction (CER). CERs can be generated by CDM and JI projects hosted by respectively developing and transition economies and be used to offset an actor’s own emission liabilities, or negotiated in the global emissions market. In principle, CDM and JI projects have to involve the deployment of technologies leading to the reduction or avoidance of GHG emissions in the host country. Business firms often based on developed economies own the bulk of such technologies. The possibility of obtaining CERs is assumed the key incentive 127

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for these firms to deploy their technologies and expertise in CDM and JI projects. This chapter argues that the motivations of firms with no emission liabilities to participate as technology providers in CDM and JI projects go beyond the revenues they can obtain from selling the emission credits earned from such projects. Instead, their motivations are based on opportunities for exploiting their technologies and expertise and (further) expanding their business internationally, particularly towards untapped markets located in developing and transition economies. The rationale of this argument is three fold. First, as a rule the core business of such firms is directly associated with the environment, inasmuch as their firm-specific advantages are based on environmentally-friendly technologies and expertise. Secondly, given the imperfect nature of the markets in which those firms operate, their emergence and sustainable growth, as well as the generation and diffusion of relevant technologies and expertise are intrinsically associated with government policy intervention. Thirdly, looking at the previous aspects we might argue that the expansion of firms in such green markets is geographically bounded. The objective of the chapter is to substantiate this argument by analysing the participation in CDM and JI projects by three business firms from the Dutch waste management industry, more specifically from the segment of solid waste. The selection of Dutch firms from this segment for the case studies was due to two main reasons. First, waste handling and disposal represent an important technological area in terms of CDM and JI: it accounts for 20.9 per cent of all CDM projects registered (UNFCCC) and around 9 per cent in terms of JI (UNEP/RISOE, 2008). Second, the development and consolidation of the waste management industry has taken place within developed economies, resulting from the adoption of market-enabling policy instruments as an alternative to the traditional command-and-control policies. The Netherlands is a benchmark case of how government policies have been crucial in creating and enabling the business environment for this sector. The chapter is organized as follows. The first section focuses on the role of market-based policy instruments in stimulating the development of firms and technologies in environmentally friendly sectors and discusses the role of the Kyoto Protocol as market enabler. The second section addresses the role of government policies and the development and structure of the waste production chain. Then, the third section turns to the Dutch waste management industry and the fourth section presents the analyses of the case studies. The last section concludes the analysis and suggests issues for further research.

Beyond the emission market

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MARKET ENABLING POLICIES, THE KYOTO PROTOCOL AND FIRMS’ EXPANSION The use of market-based instruments strategically combined with strict environmental regulations and political support have pushed the development of clean technologies and adoption of practices that minimize or avoid, among others, GHG emissions, even before the introduction of the Kyoto Protocol (Jaffe and Palmers, 1996; Kemp, 2006; Newel, 1997). Since the 1980s, the traditional command-and-control approach to environmental policies has been challenged by the emergence of alternative policy instruments based on market incentives and flexibility, such as producers’ and polluters’ charges and tradable emission permits (Stavins, 1998; Voß, 2007). The adoption of this market-based approach, mainly by developed economies, has led to the appearance and consolidation of business firms specialized in various environmental technologies. Among examples are renewable energy, energy efficiency, soil remediation, waste treatment and so forth. The core business of firms from such green markets is directly associated with the environment, inasmuch as their competitive advantages are based on environmentally-friendly technologies and expertise. This is in contrast to the case of firms from pollution-intensive industries, where the adoption of environmentally sound business practices are mainly to comply with environmental regulations; and green competences are not part of firms’ core competitive advantages (Rugman and Verbeke, 1998). Another important characteristic of green industries is the imperfect nature of their markets. Hence, the emergence and sustainable growth of business firms, as well as the generation and diffusion of relevant technologies and expertise are intrinsically associated with government policy incentives (Jaffe and Palmers, 1996; Newell, 1997). However, the crucial role played by government policies in creating market incentives to propel environmentally-based industries, combined with the localized nature of environmental issues may lead to geographical bounds to firms’ growth. Hence, the exploitation of firm-specific advantages and market expansion of green firms may be limited to the geographical reach of their government policies, and the characteristics of their original environment. Regional, international and multilateral policies can help to overcome such local boundaries to the expansion of firms from green industries. The European Union’s environmental policies are emblematic examples on this regard. In this line, it can be argued that the Kyoto Protocol can also be considered as playing the role of market-enabler; opening market opportunity to the expansion of green firms.

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Kyoto and firms’ international expansion The Kyoto Protocol aims to mobilize business firms to apply their resources, technologies and expertise for the avoidance and reduction of GHG emissions. For this purpose, it applies market-based instruments at the multilateral level, creating the economic incentives for engaging business firms in the international effort to control GHG emissions. The direct and active participation of the business sector is crucial for the functioning of the Kyoto Protocol. There are two reasons for this: First, a substantial part of the national emissions targets is of the responsibility of local business companies, which are expected to seek the most cost-effective and credible GHG emission reduction strategies to meet their emissions targets. Second, business firms based in developed countries control the lion’s share of the technologies and expertise expected to be transferred to developing and transition economies via CDM and JI projects, respectively. Business firms with and without emissions reduction targets can participate in CDM and JI projects. Further, this participation can be either direct (for example as project developers, technology providers, equipment suppliers, consultants and environmental auditors) or indirect (for example as emissions buyers, brokers, banks and some other intermediary parties). The majority of studies on the participation of business companies in the Kyoto Protocol’s mechanisms are related to the emissions market itself. The most studied cases are those of large companies from developed countries with emissions reduction targets, particularly of their strategies for emissions reduction (Hamilton and Kenber, 2006; Kolk and Pinkse, 2005). However, the very fact is that these companies are not always directly involved in the design and implementation of CDM and JI projects and tend to be mainly buyers of CERs in the emissions trading market, motivated by the need to offset their own emissions liabilities. To the best of our knowledge, there is no comprehensive study dealing with business companies that do not have emission reduction targets to meet and yet have been directly involved in the technical implementation of CDM and JI projects, due to their knowledge and expertise on emissions reducing or avoiding technologies. It seems reasonable to assume that the Protocol, by means of its flexibility mechanisms represents opportunities for firms to exploit their technologies and expertise and (further) expanding their business internationally, particularly towards untapped markets located in developing and transition economies.


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GOVERNMENT POLICIES AND THE WASTE MANAGEMENT INDUSTRY’S PRODUCTION CHAIN The waste management industry offers many examples of successful implementation of market-based policy instruments, specially in Western Europe and of how the state and the business sector can work together to address negative externalities, meeting both public and private interests. Furthermore, the technologies and expertise associated with this industry represent an important area under the Kyoto Protocol. They involve the capture or avoidance of methane, a GHG 21 times stronger than carbon gas generated from the decomposition of organic waste. Waste, in its nature, does not seem to have much economic attractiveness. The traditional, and most usual, way of dealing with waste is to dump it in areas referred to as landfills. However, the disposal of waste in landfills leads to many negative externalities, such as ground water pollution, fire and explosion hazard, odour, soil pollution and so forth, representing a threat to both the environment and human health. The problems associated with landfills increases with the volume of waste. With the rapid economic and population growth, increasing welfare and consumption, the volume of waste is ever growing (Cointreau, 2007; The Economist, 2007). The 1990s represents a hallmark in government policies on solid waste with the first examples of adoption of market-based instruments, notably in the United States and Western Europe. The use of market-based approaches to address the negative externalities generated by waste, and indeed to reduce the amount of waste at first place, has fostered the development of an entire production chain and its related technologies that can be referred to as the waste management industry. Nowadays, the waste management industry is consolidated in many developed countries, and comprises many technologies and schemes for collecting, sorting, treating, reusing and recycling various materials. Inputs: turning waste into a commodity The core input in the waste management industry is waste itself. Thus, the very first step in the waste production chain involves its collection and transportation. A related activity refers to the separation of waste according to its composition, such as organic waste, plastic, glass, metal, paper and so forth. A basic step is the separation of the organic waste at the household level. The sorting of non-organic waste can be either combined with collection or performed as an individual step, depending on the collection scheme adopted. The quality of the

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inputs, associated with aspects such as the levels of moisture or hazardous waste, depends on how well collection and sorting schemes are designed and implemented. As in any other industry, it will affect all the following stages of the waste treatment and recycling production chain. Government policies at different levels ‒ municipal, national or regional have been crucial in ensuring the availability and quality of waste inputs. Market-based instruments such as pollution charges, payas-you-throw schemes, landfill fees and bans have been frequently used with the purpose of making waste disposal in landfill more expensive than alternative treatment and recycling; hence creating opportunities and ensuring the supply of inputs for different segments of the waste management industry. Processing: turning waste commodities into valuable goods There is a broad range of alternatives to treat and recycle waste, differentiated according to types of materials. The basic distinction is between organic waste, recyclable waste (for example, glass, metals, paper and so forth) and non-recyclable waste. It is largely accepted that biological treatment is by far a much better option to deal with organic waste than the traditional landfilling. By means of processes such as aerobic decomposition, commonly known as composting and anaerobic decomposition organic waste can be turned into amendment for agriculture and gardening, avoiding the generation of methane (Eenhoorn, 2007). Many countries have banned the disposal of organic waste (among other materials) in landfills, but the fact is that the dumping of waste in landfills is still in practice in most of the countries all over the world. Although, it is important noticing that there are differences in terms of regulations and standards imposed on landfills and that the operation of landfills has become a sophisticated engineering and managing activity. For instances, techniques to capture and convert into energy the methane generated by landfilled organic material, also known as waste-to-energy, have been developed and widely diffused among developed economies. In the case of recyclable waste, the processes are as many are the materials composing it. For instances, glass and metals can be re-melted indefinitely and initiate a new life cycle as raw materials for many industries; paper can be turned into pulp and than used to produce new paper (The Economist, 2007). As for the non-recyclable waste, the two main alternatives are landfilling and incineration, with the latter being preferable to landfilling particularly when it involves energy recovery (Kemp, 2006; Parto et al., 2006). In fact, the incineration of nonrecyclable waste, the so-called waste-to-energy, represents an increasingly important source of renewable energy.


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Outputs: energy and recycled materials The output stage of the waste management chain refers to the diverse range of products from the waste treatment and recycling processes. While it is obvious that the output of the recycling of paper, plastic, glass and metal are the same materials; the outputs from the treatment of organic waste and non-recyclable waste diverges from its original composition, including high quality compost, organic fertilisers, biogas, heat and power. The prices of waste outputs serve as an economic viability factor for the entire waste management scheme. It is important that recycled raw materials and products can compete against virgin raw materials and other products (Eenhoorn, 2007). In this regard, policy instruments that secure market demand and prices ensuring economic return are crucial for the success of the entire waste management industry. Examples of such supportive instruments are the guaranteed procurement of electricity generated from landfill and incinerators and the reduction of the market price of recycled materials via tax exemption. The waste players The large variety of ways of processing and treating solid waste implies the existence of different players. Hopstaken (2007) identifies three main groups of waste firms, according to their business concepts: multi-utility firms that encompass activities from sectors as diverse as waste, energy, transport and water; vertically integrated firms that cover different stages of the waste production chain, from collection, recycling and treatment; and niche player firms focussed on technology, concept, region or segment. This group includes, for example, firms specialized in the recycling of specific materials such as plastics, paper and metals. Producers of equipment and machines, such as sorting machines can also be included in this group. In terms of capital, the composition between public and privately owned firms varies from country to country, and according to the stages of the waste production chain. Waste management industry: a national or international business? The characteristics of the waste management industry differ from country to country, and even among regions or municipalities within the same countries. The policy approach adopted at different government levels is crucial in defining the contours and dynamics of this market. Together with the local nature of waste generation, the central role of government policies implies that the advantages of waste firms tend to be locally

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bounded. In other words, in the absence of enabling conditions somewhere else, waste firms tend to have their expansion limited to their local markets. One of the international aspects of this industry is the movement and trade of waste material across borders. There have been some examples of developed countries, or municipalities within these countries, exporting recyclable waste materials to recycling firms overseas, or simply for landfill dumping. Nowadays, China is the largest market for recyclable raw materials (The Economist, 2007). From the perspective of local waste firms, the export of inputs, that is waste, may not be positive to their business. The movement of waste for landfill dumping in foreign countries, or in different provinces within the same countries, is also a common practice that involves many controversial issues (Parto et al., 2006). This practice has been restricted as many countries and provinces in both the United States and Europe introduce landfill bans. In terms of firms’ international expansion, a process of increasing the internationalization of the waste management industry has been observed over the last decennia or so (Hopstaken, 2007; SenterNovem, 2006). Regional or international regulations and standards, such as those defined by the NAFTA or the European Union represent an important driving force of this process. For example, the requirements for Eastern European countries to meet the EU standards regarding local waste management practices have opened up opportunities for waste firms from Western Europe to operate and provide services in this region, enlarging the geographical scope of their market. In fact, the internationalization of the waste management industry would be better regarded as regionalization, as it has been mainly observed within regions, the European Union in particular. Europe is still the stronghold of the largest European waste firms, with a consolidated position in Western Europe and increasing participation in East Europe. This process is associated with a strong concentration observed in this industry (Hall, 2007). A small number of large waste management firms account for a large share of the European waste market. The two largest European waste firms are the French multi-utility Veolia/Onyx and SUEZ/SITA (Hall, 2007; Hopstaken, 2007). These two France-based firms retain a significant leading position ahead of their counterparts and are about twice the size of the third and fourth largest European waste firms, respectively German Remondis/Retherman and the Spanish FCC (Hall, 2007; Hopstaken, 2007). These two firms, in turn, are two or three times larger than the following group of firms composed by Biffa (UK), Urbaser and Cespa/Ferrovial (Spain), Alba (Germany) and the recently merged AVR/van Gansewinkel1 (originally Dutch firms they are currently


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owned by the private equity funds KKR (US) and CVC (Europe)) (Hall, 2007; Hopstaken, 2007). It is worth noticing that all the big players in the European waste industry are based in Europe, with non-participation of non-European firms, with the only exception to the KKR private equity fund. Waste firms from the United States, for instance, have concentrated their activities within their home country, a movement explained by the huge size of the North American waste market. By 2001, the two largest US waste firms, Allied Waste and Waste Management Inc. had withdrawn from Europe and from the rest of the world (Davies, 2001). It is intuitive that the limits for the expansion of waste firms are closely related to the access to sources of waste, the industry raw material. The generation of waste can be affected by efforts to avoid it in the first place, but the primary factor affecting the availability of waste inputs is population size. Hence, the access to the untapped potential market in developing and transition economies is recognized as an opportunity for waste firms, specially for the small and medium ones, to exploit their technological expertise and to growth. Indeed, the case of technologies associated with the capture of and energy recovery from landfill is emblematic. In countries where complete landfill ban is already in place, as in the Netherlands, firms’ advantages in landfill gas tend to lose value in a not so far future.

THE WASTE MANAGEMENT INDUSTRY IN THE NETHERLANDS The Dutch waste management industry is one of the most advanced in the world. Recycling, reuse and incineration cover around 97 per cent of the total 60 million tonnes of municipal waste generated in the Netherlands (Gerlagh, 2007). Only 3 per cent of the solid waste generated in the country goes to landfills, while 84 per cent is recovered and 13 per cent incinerated (Bartelings et al., 2005; Gerlagh, 2007; Hopstaken, 2007). The number of operating landfill sites in the Netherlands fell from 1000 in 1976; to 39 in 2004 and to 22 in 2007 (Gerlagh, 2007). These figures are followed by reduction of related negative externalities. For instance, the emissions of methane from landfills decreased by 18 per cent during the 1990s (Environmental Expert, 1998; SenterNovem, 2006). Concomitantly to the decrease of landfilling, the capacity for incineration with energy recovery, that is waste-to-energy, has been increasing in the Netherlands (Gerlagh, 2007). The Dutch waste market is estimated at around EUR 5.35 billion when considering the total turnover from the inputs, treatment, recycling and outputs stages (Bartelings et al., 2005; Hopstaken, 2007). In line with

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trends in the European waste market, there has been a movement towards concentration, vertical integration and increasing of firms’ size (Davies, 2001; Gerlagh, 2007; Hall, 2007; Hopstaken, 2007; van Bezooijen, 2007; Parto et al., 2006; SenterNovem, 2006). The top five waste firms operating in the Netherlands ‒ the AVR/VG, the French SUEZ/SITA, the Dutch public multi-utility Essent and the UK-headquartered Shanks ‒ account for 40 per cent of the Dutch waste management market (Hopstaken, 2007; van Bezooijen, 2007). The implementation of the waste management in the Netherlands is supported by institutional and organizational arrangements and involves public and private parties (Eenhoorn, 2007). The main task of governments is to design, implement and enforce adequate anti-dumping regulations. For example, a landfill ban for different materials is combined with a high landfill tax of EUR 115 per ton, the highest in the European Union (SenterNovem, 2006). The municipal governments are responsible for ensuring proper waste collection, either by contracting private companies to collect and transport the waste to treatment plants or by establishing their own companies. Moreover, incentive schemes encouraging sorting activities at household level have been widely and successfully applied. The multi-stream collection schemes adopted in the Netherlands have achieved very high waste separation results at the household level. The participation of private business firms in the treatment and recycling of waste is very significant in the Netherlands. According to the Vereniging Afvalbedrijven, the association of Dutch waste management companies, over 40 companies located in different regions involved in the various waste processing activities as well as a large number of small firms involved in niche activities such as disassembling cars, electronics and other equipment. According to Hopstaken (2007), the top 6‒15 waste firms account for 15 per cent of the Dutch market,2 while the top 16‒25 waste firms account for another 6 per cent and the remaining smaller waste firms contributed to 40 per cent of the market revenue. On the output side, a market for recycled products has been quickly maturing in the country. For a few types of waste recycling products, the market demand has been created through direct public involvement. An example of state-induced-demand comes from construction and demolition waste. By requiring public biddings for road construction to use mainly recycled construction and demolition waste instead of virgin materials from riverbeds or quarries, a large and steady market was created. Nowadays close to 100 per cent of waste from construction and demolition is recycled in the Netherlands (Eenhoorn, 2007). In sum, the well functioning of the waste management industry in the Netherlands is the result of proper addressing of the input, processing and


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output stages and a clear definition of the responsibilities of public and private parties. The government ensures availability and quality of the input through the institutionalization of waste collection and separation and creates a market for recycled products. In other words, government intervention creates an enabling business environment, allowing business firms to overcome market failures and to grow in a sustainable way. This synergy of state policy and business interests has created a favourable soil for the Dutch waste management and recycling companies to develop resources and expertise defining their firm-specific advantages.

EXPANSION OF DUTCH WASTE FIRMS UNDER THE KYOTO This section analyses the participation of three firms from the Dutch waste management industry as providers of technologies and expertise in CDM and/or JI projects. The analysis focuses on motivations, form of participation and future strategies in relation to CDM and JI projects. The cases are analysed against the conceptual framework of market enabling governmental policies and the international expansion of firms possessing unique resources and capabilities. The selection of firms for this study was based on the CDM documentation available at the website of the United Nations Framework Convention on Climate Change (UNFCCC). Initially, five Dutch companies involved in waste management projects were identified, Biogas Technology Group; Arcadis; Van der Wiel/Ecair, VAR/WWR and Grontmij. The latter three agreed to participate in this study.3 The analysis is based on in-depth interviews with these firms carried out in September and October 2007. It has also benefited from an interview with a representative of the SenterNovem, an agency of the Dutch Ministry of Economic Affairs that promotes the environmental and innovation policies. Moreover, given this is an under researched area, anecdotal evidences have been also considered, as well as additional and updated information from the firms’ websites. Van der Wiel Holding BV ‒ VdW/Ecair Van der Wiel Holding BV is a medium-sized privately owned firm, with 320 employees and a turnover of around EUR 85 million. It has been working for half a century in the areas of transport, infrastructure and environment. Landfill gas recovery and methane capture is one of its areas of expertise. VdW directly implement or provide consultancy for projects of biogas, landfill gas and CO2 reduction.

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VdW’s international activities have been significantly enlarged by the Kyoto Protocol’s mechanisms. Previously to CDM and JI, VdW was involved in three projects outside the Netherlands, in Poland, Belgium and Iran. CDM and JI projects are considered by the VdW as important channels for the further exploitation of its core advantages on landfill methane capture and energy conversion (waste-to-energy). VdW participation in CDM and JI is through its subsidiary Ecair. In terms of JI, Ecair has one project in Romania, two projects in Poland and eight projects in Slovakia. As for CDM, VdW/Ecair has three projects in Brazil, one in Argentina and two in Malaysia. The first largest CDM by VdW/Ecair is the Bandeirantes landfill project in Brazil, which has generated over eight million tonnes worth of CERs. The pattern followed by VdW/Ecair suggests that once it enters a certain country or a region with CDM or JI project, it starts to consolidate its local presence by looking vigorously for further possibilities for new projects in the same country or the region. Further strategic plans defined by VdW/ Ecair, includes targeting at least 14 new countries, in addition to those where the company has already projects, among them, Mexico, Chile, China, Thailand, Vietnam, Indonesia, the Baltic states, Czech Republic, Hungary and Bulgaria. Veluwse Afval Recycling BV ‒ VAR/World Wide Recycling ‒ WWR VAR BV is an integrated waste firm, with expertise in landfill management, recycling of construction and demolition waste, sorting activities and composting. It employs 148 people and has an annual turnover of around EUR 50 million (VAR, 2006). In order to expand VAR’s activities towards developing economies, its founder, Jan Boone established the World Wide Recycling BV in 2004. WWR’s mission is to implement and operate VAR’s technologies in countries around the world, by adapting it to meet specific local circumstances. Along with landfill projects, World Wide Recycling has taken a very active part in composting projects and in fact became a pioneer in developing and getting approval for organic composting-related methodology for calculating emission credits.4 Moreover, WWR is supporting the World Bank with registering composting projects under CDM in the Middle East and Asia. It is worth mentioning that previous to CDM and JI, VAR’s international activities were based on composting projects in Ireland, Belgium, France and Russia. VAR/WWR’s first two CDM projects are under implementation in Bangladesh and represent an important experience to VAR/WWR. First, Bangladesh is one of the least developed economies in the world and is


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normally not very attractive for investors. Second, the effective functioning of the projects has been ensured by a partnership with the Bangladeshi NGO Waste Concern Consultants (WCC) and extensive efforts on the promotion of collaboration with local municipalities. VAR/WWR is designing three JI projects in Eastern Europe and few CDM projects in Asia and Latin America, particularly in Brazil, where it has a subsidiary company. Grontmij Grontmij is a multinational firm headquartered in the Netherlands, with units in five other European countries: Belgium, Denmark, United Kingdom, Sweden and Ireland. It employs 6337 people and has net revenue of around EUR 390 million (Grontmij, 2006).Western Europe is the source of 90 per cent of its revenue, 70 per cent being from the Netherlands alone. Grontmij is a consultancy and engineering firm in the areas of building, transportation, environment, energy, water and other industries. Waste management is one of the areas composing its environment division. Its expertise in this area is related mainly to waste water purification and soil remediation, with few activities related to solid waste. Grontmij has a broad international experience and has been working for around 15 years in many European countries, such as Hungary, Poland, Czech Republic, Romania, Bulgaria, Croatia and Turkey. Furthermore, it is one of the few companies with very early experience with GHG emission cutting projects. In 1994‒1997 under the so caller ‘Activities Implemented Jointly’, which was a pilot program for CDM and JI schemes, Grontmij successfully implemented two projects on landfill gas capture in Russia. Nevertheless, Grontmij has not been directly involved in CDM and JI projects currently. It had two CDM projects but withdrew from further participation before the technical implementation stage started. This decision was due to potential risks in terms of profit performance related to changes in the regulations in the host countries. Yet, Grontmij has been indirectly involved in CDM and JI by providing technical consultancy services on technologies related to biogas, biomass, energy efficiency, wind, waste to energy, digestion and combined heat and power production and distribution. Moreover, it offers services to project owners and investors in carbon resources, for instance in terms of the approval and registration of projects by international and national authorities. Grontmij acknowledges that there are business opportunities related to CDM and JI projects, but it does not consider them a priority area at this

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moment. Grontmij has based its expansion on its diversified portfolio and already consolidated international experience. Functions, parties and business model Ecair and WWR participate in all stages of the project cycle, starting from feasibility assessment and basic design to final installation, startingup of the facilities and monitoring. Moreover, both companies ensured initial financial investments. In all their projects, other companies have been involved either as equal partners or on a short-contract basis. Local counterparts are important elements for the success of the projects. In general, the day-to-day operation of the facilities after the installation is due to be done by local partners trained by Ecair and WWR. Furthermore, the establishment of dialog with local municipal agencies in order to ensure their legal (and if possible technical) support has been important in all projects analysed. In fact, the participation of local governments is crucial for the longterm sustainability and escalation of the projects and for the development of the entire waste management cycle, for example waste collection and input, management of the landfill sites and so forth. The waste sector in developing countries tends to lack regulatory incentive and legal enforcement mechanisms in all stages of the waste production chain. The case of waste-to-energy is illustrative. Often, the methane captured in CDM and JI landfill projects is simply flared without energy recovery. In general, national power grid prevailing in developing countries does not favour the market for small-scale energy producers. The barriers can be related to both technical and economic aspects. Power distributors in many developing countries, usually state-owned or monopoly companies, often have no procedures to connect small-scale power units and purchase their electricity. Furthermore, the low purchasing prices do not cover the cost of small-scale electricity production. There are some exceptions, where local factors can play a positive role to the viability of the projects. For instance, in the case of WWR’s composting projects in Bangladesh, the revenues from compost are important. Compared to in the Netherlands, compost has a higher demand and price in the Bangladeshi market. Nevertheless, the feasibility of the business models adopted in these pioneering CDM and JI projects is mainly ensured by the Kyoto’s emission credits. Both VdW/Ecair and VAR/WWR are very keen to expand their CDM and JI businesses. All the three companies interviewed are rather optimistic about the post Kyoto perspective, after 2012.


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CONCLUDING REMARKS This chapter took up the challenge to shed light on an under researched issue, the participation of firms without GHG emission liabilities as technology providers in CDM and JI projects, the flexibility mechanisms of the Kyoto Protocol. It argues that the motivation for those firms to engaging in CDM and JI projects is based on market stimuli beyond those related to the emission market itself. Their motivations are largely associated with search for new markets where their technological resources and expertise can be exploited. The cases studied in this chapter suggest that the Kyoto’s mechanisms compensate, to some extent, for the weakness of underdeveloped waste management sectors in developing and transition economies. By ensuring revenues from emission credits, CDM and JI reduce market imperfections associated with the waste industry and hence the viability of the investments. As a result, the Kyoto Protocol stimulates investments and plays a similar role as the one played by government policy in the developed countries. The multilaterally ensured market created by the Kyoto Protocol has represented an important factor for the international expansion of small and medium business firms from the Dutch waste management industry. By engaging in CDM and JI project these firms are able to access new sources of inputs, exploit their technological expertise, establish their brand names in the host countries and identify local partners, paving their way to future international ventures, related or not to the Kyoto Protocol. In other words, CDM and JI projects may have a multiplying effect and serve as a reasonable way for business companies from the waste management industry to enter and to try new markets in developing and transition economies. This can be considered as an indication that the motivations of firms with no emission liabilities to provider technology and expertise for CDM and JI projects are strongly associated with the possibility to entering untapped potential markets, with the emissions revenues being a feasibility factor. As usual, some caveats should be mentioned. First, a broader study encompassing waste management firms from other countries would help to make a stronger case for the argument put forward in this chapter. Second, the extension of this analysis to other green industries would be insightful. Last but not least, the Kyoto Protocol is still a new institution, inasmuch as not many CDM and JI projects have been concluded so far. Studies covering a longer time spam, including for instance scenarios for the post-Kyoto activities of green firms in the emerging economies would be welcoming.

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NOTES 1. AVR, the largest waste firm in the Netherlands was acquired by KKR/CVC in January 2006 from the Municipality of Rotterdam; while van Gansewinkel, the third in the Dutch market in 2006 and originally privately owned, was bought in January 2007 (Hall, 2007). 2. Within this group is VAR, which is one of the firms analysed in this chapter. 3. The selection was made in July 2007. Information on participants in JI projects are not available in the UNFCCC website. 4. See ‘Avoided emissions from organic waste through alternative waste treatment processes ‒ AM0025’, available at: http://cdm.unfccc.int/methodologies/PAmethodologies/ approved.html. Giving its experience, WWR is providing consulting for the World Bank on methodological issues of CDM projects in waste management.

REFERENCES Bartelings, H., P. van Beukering, O. Kuik, V. Linderhof and F. Oosterhuis (2005), Effectiveness of Landfill Taxation, The Netherlands: Institute for Environmental Studies, IVM. van Bezooijen, G. (2007), ‘A short introduction to policy, approach and practice of waste management in the Netherlands’, paper presented at the ISWA-NVRD World Congress, Amsterdam, accessed at www.nvrd.nl/nvrd/proceedings/ proceedings.asp. Cointreau, S. (2007), ‘The growing complexities and challenges of solid waste management in developing countries’, The World Bank paper presented at the ISWA-NVRD World Congress, Amsterdam, accessed at www.nvrd.nl/nvrd/ proceedings/proceedings.asp. Davies, S. (2001), ‘Mergers and acquisitions in the European waste management industry 2000‒2001’, report for the waste meeting of trade union representatives of the European Federation of Public Service Unions (EPSU), February, accessed at: www.epsu.org. Eenhoorn, G.J. (2007), ‘World Wide Recycling: a waste recycling business model that works in emerging markets’, paper presented at the ISWA-NVRD World Congress, Amsterdam, accessed at www.nvrd.nl/nvrd/proceedings/proceedings.asp. Environmental Expert (1998), ‘Waste in the Netherlands’, The Netherlands: Ministry of Housing, Spatial Planning, and the Environment, accessed at www. environmental-expert.com. Gerlagh, T. (2007), ‘More energy from waste, the Dutch way’, SenterNovem, paper presented at the ISWA-NVRD World Congress, Amsterdam, accessed at www.nvrd.nl/nvrd/proceedings/proceedings.asp. Grontmij (2006), ‘Key figures 2006’, accessed 25 March 2008 at www.grontmij. com. Hall, D. (2007), ‘Waste management companies in Europe 2007’, a report commissioned by the European Federation of Public Service Unions (EPSU), accessed at www.epsu.org. Hamilton, K. and M. Kenber (2006), Business views on International Climate and Energy Policy, London: UKBCSE and The Climate Group, accessed at www. bcse.org.uk.


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Hopstaken, F. (2007), ‘Dutch and European waste market review, background and innovation’, Fact Management Consultancy, paper presented at the ISWANVRD World Congress, Amsterdam, accessed at www.nvrd.nl/nvrd/proceedings/proceedings.asp. Jaffe, A.B. and K. Palmers (1996), ‘Environmental regulation and innovation: a panel data study’, NBER Working Paper no. 5545, Cambridge, MA. Kemp, R. (2007), ‘An example of a managed transition: the transformation of the waste management subsystem in the Netherlands’, in M. LehmannWaffenschmidt (ed.), Innovations Towards Sustainability: Conditions and Consequences, Heidelberg and New York: Physica-Verlag, pp. 87‒94. Kolk, A. and J. Pinkse (2005), ‘Business responses to climate change: identifying emergent strategies’, California Management Review, 47(3), 6‒20 Newell, R.G. (1997), ‘Environmental policy and technological change: the effects of economic incentives and direct regulation on energy-saving innovation’, PhD thesis, Harvard University, Cambridge, MA. Parto, S., D. Loorbach, A. Lansink and R. Kemp (2007), ‘Transitions and institutional change: the case of the Dutch waste subsystem’, In S. Parto and B. Herbert-Copley (eds), Industrial Innovation and Environmental Regulation: Developing Workable Solutions, UNU-Press. Rugman, A.M. and A. Verbeke (1998), ‘Corporate strategies and environmental regulations: an organizing framework’, Strategic Management Journal, 19, 363‒75. SenterNovem (2006), ‘The Dutch waste profile: 1990‒2005’. Waste Managment Department, accessed at www.senternovem.nl. Stavins, R.N. (1998), ‘Market-based environmental policies’, Resources for the Future discussion paper 98‒26. The Economist (2007), ‘The truth about recycling’, 7 June, accessed at www. economist.com/science/tq/displaystory.cfm?story_id=9249262. UNEP/RISOE (2008), ‘JI projects’, accessed 25 March at http://cdmpipeline.org/ ji-projects.htm#2. VAR (2006), ‘Jaarverslag ‒ Annual Report’, accessed 25 March 2008 at www.var. nl. Voß, J.P. (2007), ‘Innovation processes in governance: the development of “emissions trading” as a new policy instrument’, Science and Public Policy, 34(5), 329‒43.

Web sites ECAIR: www.ecair.nl Vereniging Afvalbedrijven: www.verenigingafvalbedrijven.nl VDW: www.vanderwiel.nl VAR: www.var.nl UNFCCC: http://unfccc.int/2860.php Grontmij: www.grontmij.com

Intermezzo II. economies

Emerging knowledge

Jojo Jacob and Luc Soete The last two decades have witnessed the breaking away of a number of less developed countries from decades of poor economic performance to emerge and exert significant influence on the global economic landscape. Their appearance on the world-stage has coincided with a shift towards domestic economic liberalization and openness to trade and foreign investment ‒ all of which have brought them closer to the rest of the world, albeit at different rates. The rapid rise of these economies has attracted a lot of interest in academia, business, media and policy circles, mainly for two reasons: First, the speed of the economic transformation in many countries, such as China and India, has been unprecedented; and second, underlying this transformation has been an equally impressive transformation of domestic enterprises. Long thrived in a domestic market cut off from foreign competition, many of these firms have shown themselves to withstand foreign competition domestically and, perhaps more significantly, they have taken competition to the doorsteps of foreign firms through internationalizing their operations. The growth momentum has sustained and in many cases accelerated, even after the world has moved into a stricter intellectual property regime with the establishment of the world trade organization (WTO) in 1995. In the past such a strict regime would have disfavoured emerging economies, lagging behind in knowledge development, but in a number of different ways this has not happened. The reality of growth is now a much more complex and often context specific one that warrants in-depth analyses at various levels ‒ country, industry and firm level; development can be different from the one-dimensional, uni-directional ‘integration into the world economy’ that mainstream economic explanations for the fast-paced growth of countries have provided. This is important from the point of view of garnering insights for policy makers in countries that have so far been excluded from the current wave of industrialization. In this context the four preceding chapters assume great significance. Chapters 5 and 6 focus on China, the largest of the 144

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emerging economies, Chapter 7 compares internationalization of oil firms from China and Brazil and Chapter 8 explores the role of international treaties, such as the Kyoto protocol, in filling the institutional voids that inhibit the development of environment-centred industries in less developed countries. The opening up of the Chinese economy in 1979 presented local firms with an opportunity to technologically catch up with foreign firms, as well as to explore foreign markets. In this regard establishing alliances with foreign firms has been an important first step. From the point of view of foreign firms, alliances with Chinese firms helped them extend their operations to the Chinese market. Until China’s accession to WTO in 2001, foreign firms wishing to operate in China were required to enter into joint venture partnerships with local firms. While Sino-foreign alliances might therefore appear as marriages of necessity, than of choice, evidence points to an expansion of such alliances within China during the 2000s (e.g. Duysters et al., 2008). This suggests that both types of firms, but especially Chinese firms whose international aspirations hinge significantly on such partnerships, bring vital complimentary assets to the alliance relationship. Despite their apparent significance, alliances are often short-lived, especially those in high-technology industries. Explanations for this based on environmental (cultural, economic, political and legal) diversity have been found to be wanting. A major cause of alliancefailures seems to be the differences in the strategic objectives of alliance partners (Shenkar, 1990). Studies undertaken by Chinese scholars have uncovered these important differences ‒ due to Chinese companies apparently being more candid about their objectives for alliances when speaking with Chinese researchers than with non-Chinese researchers. In Chapter 5, Saebi and Dong conduct a review of the Chinese literature in this area and back that evidence up with their own interviews with Chinese firms. Their study brings out the strategic motivations driving Chinese firms to undertake alliances with foreign firms. They observe significant differences in the objectives of Chinese and foreign alliancepartners. Understanding such differences is of great value to all partners because that would help them take steps to accommodate at least some of the major strategic motivations of the other partners and thus help keep the partnership going. Another less understood aspect in relation to China pertains to Hong Kong-(mainland) China economic relationship. In regard to China’s rapid economic transformation Hong Kong’s contribution is often highlighted ‒ as a source of investment, supplier of expert manpower and so on. Chapter 6 by Sharif and Huang sheds light on the contribution of China’s Guangdong Province in the economic transformation of Hong

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Kong into a service powerhouse. Guangdong received about one third of China’s inward FDI during 1985‒2003 and Hong Kong accounted for about 70 per cent of Guangdong’s cumulative FDI stock during 1979‒2001. Since the mid 1990s nearly half of Hong Kong’s FDI has gone into Guangdong, and the output share of foreign firms (which are dominated by Hong Kongese firms) in Guangdong has increased substantially during this period (accounting in 2006 for over 60 per cent of total output in most 2-digit industries). Nevertheless, during 1997‒2006 Chinese firms in Guangdong have caught up with, and in many industries surpassed, the productivity performance of foreign firms. An explanation for this apparent paradox is that Hong Kong firms export the bulk of their final output and do not compete directly with Chinese firms in Guangdong. From the outset of China’s economic reforms since 1979 Hong Kong began transplanting its low-cost manufacturing to China, particularly Guangdong, and by the mid-1990s achieved its transition to a service-sector-oriented economy (Imai, 2001). This transition, and the role played by Guangdong in it, seems to provide some answers to the question as to why Hong Kong did not move up the value chain in manufacturing, like other East Asian ‘tiger’ economies, such as Korea or Taiwan. At the same time, it also raises question about the sustainability of the tradable-services sector of Hong Kong connected to Guangdong. Finally, the spectacular growth performance of Chinese firms, who in recent years appear to have outsmarted their Hong Kong counterparts in Guangdong, calls for more research. Perhaps the subject that has raised the greatest interest in relation to emerging economies in recent years is the rise of multinationals from these economies. However, this remains a poorly understood area. The frameworks developed to explain the growth of Western multinationals are not adequate to explain the growth of emerging multinationals today. Such an approach ends up comparing the strategies of late-stage multinationals from developed countries with early-stage multinationals from less developed countries (Ramamurti, forthcoming). It is therefore important to gain insights from careful case studies that compare the strategies for, as well as the circumstance of, growth of multinationals from less developed countries themselves. Chapter 6 by Carvalho and Goldstein is an important contribution in this respect. It examines multinationals from Brazil and China operating in the oil industry. These firms are not only amongst the top corporations in their home countries, they are also amongst the biggest corporations in their industry. They share common characteristics, such as being set up as state-owned enterprises to alleviate oil shortages in their home countries. There are major differences between them as well. While the Brazilian firm Petrobras was set up back in 1953, the first

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Chinese oil company was only established in 1982. Petrobras is a world leader not just in terms of its size but also in terms of technology ‒ having also developed its own niche technology in deep-sea drilling, and turning into a world reference on alternative energy, such as ethanol. Chinese oil firms despite their huge size, rely heavily on foreign technologies. While foreign firms line up to partner with Petrobras Chinese firms find it challenging to bridge their technological gap with industry leaders. Carvalho and Goldstein unpack the growth trajectories of Petrobras and Chinese oil firms taking into account, among other things, local specificities (e.g. resource endowments) that appear to have a bearing on the speed of and the motives (e.g. resource seeking vs. market seeking vs. strategic asset seeking) for internationalization. Chapter 8 by Doranova, Eenhoorn and Costa points out what international treaties can do to overcome, what they call, market imperfections that stand in the way of the emergence and development of new industries (e.g. waste management) in less developed countries. These industries require a support structure in the form of regulations governing, for example in the case of solid-waste management, proper collection and sorting schemes of waste inputs, and land fill fees (to induce recycling). Since the early 1990s developed nations have been developing such support structures which have resulted in the emergence of firms whose core business is environment-related. Thus the environmental challenges paused by industrialization have been turned into economic opportunities. What are the prospects of similar developments in less developed countries? Not only do less developed countries have weak support structures, they do not possess the necessary technologies (which require a support structure to emerge in the first place and are being developed in advanced economies). Doranova, Eenhoorn and Costa show how Kyoto protocol has generated market incentives for Dutch MNCs specializing in waste management to enter less developed countries. Certified Emission Reduction, popularly known as carbon credits, is central to the Kyoto protocol. It has motivated these MNCs to deploy their technologies in less developed countries even in situations where their final output (e.g. captured methane) does not find a ready market. However, the study also suggests that entering less developed countries has its challenges, which require adaptation of business strategies in tune with domestic circumstances. Since environment-based industries require support from local firms (e.g. in the collection of waste) multinationals’ activities in these industries have the potential of triggering local business interest (as well as transfer of expertise). This is good for not only the environment, but also the subsequent emergence of indigenous capabilities and industries.

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REFERENCES Duysters, G., M. Cloodt, W. Schoenmakers and J. Jacob (2008), ‘Internationalisation efforts of Chinese and Indian companies: an empirical perspective’, mimeo, UNU-Merit, Maastricht, Netherlands. Imai, H. (2001), ‘Structural transformation and economic growth in Hong Kong: another look at Young’s Hong Kong thesis’, Journal of Comparative Economics, 29, 366‒82. Ramamurti, R. (forthcoming), ‘What have we learned about emerging market MNEs?’, in R. Ramamurti and J.V. Singh (eds) Emerging Multinationals from Emerging Markets, Cambridge University Press. Shenkar, O. (1990), ‘International joint ventures’ problems in China: risks and remedies’, Long Range Planning, 23(3), 82‒90

9.

Changing configuration of alternative energy systems Radhika Perrot

INTRODUCTION The objective of this chapter is to look at how, over the years since the first oil price shock of the 1970s, firms, the government and technologies interacted with each other in both developed countries as well as in emerging economies. Each actor reacted to changes in the other and, as a result of these interactions, changes were observed in the market of alternative energy technologies. With recent surging oil prices and mounting pressures to reduce toxic gaseous emissions, both governments and firms interact with each other to move towards alternative energy solutions. Firms respond to policy measures implemented by the government, while the government on the other hand ensures that their policies stimulate innovation. We will, in part, look at the role played by firms and governments from emerging economies and how through their interaction they are indeed driving the direction of growth of these alternative energy technologies. Alternative energy technologies so discussed here include energy technologies that optimize energy consumption, cleaner energy technologies that reduce the amount of toxic gaseous emissions and renewable energy that sources energy from renewable sources like solar, hydro and wind. It will include renewable energy (energy from all natural sources like wind, solar, water and so forth) and other alternative or cleaner forms of energy like hydrogen and bio-fuels. The formidable task is now on the government to transform the existing fossil fuel energy system into a more sustainable form that consumes less energy or that which sources energy from clean and renewable energy technologies. Now whether it is possible to transform the existing system to one of cleaner and greener technological systems will depend on the economic and technical opportunities of new alternative technologies and how firms react to them. While policies promoting the use of these new technologies tend to make new technologies attractive to private investors, regulatory changes tend to lead the direction of change by changing the economic conditions of technologies. Firms respond to these market 149

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opportunities induced by policies and incentives by developing and diffusing these new technologies and eventually creating new market conditions for alternative energy technologies. Firms will play an important role in bringing about desired changes that will likely transform the energy system. The desired changes are efforts that seek to develop and use energy systems that are improved, made efficient and cost effective, in addition to being sustainable. It is through technological innovations that designs are improved, costs and technologies are made more efficient and firms bring about necessary changes that will help in the evolution of the current system into a newer one. Firms bring about technological innovations through strategies, which give firm access to technologies, knowledge, faster access to markets and helps them share the high costs and uncertainties of new technologies, typical of alternative energy technologies. The chapter is organized as follows. The first section looks at the historical and market context of firms and their external environment, observes the changing configuration of the market, the development of technologies and the type, innovation strategies and cross-sector participation of firms. It has been observed that policies and firms in emerging economies only appeared in the third and the final period (mid-1990s‒2000s). The second section offers explanations for the inter-connection between firm strategies, government regulations and technological innovations in general and what the driving changes are in the configuration, even in emerging economies. The final section is the conclusion drawn from the evidence of how firms reacted to policies and technologies, even among firms in emerging economies, although an early part of the technologically-driven changes first came from firms and governments in countries like the US, Japan and Denmark among others.

HISTORICAL ORIGINS The history of the alternative energy market can be analysed as an evolutionary process of adaptation involving selective pressures, uncertainties, institutional changes and external shocks. This historical analysis will elicit how the strategies of firms are intertwined with government policies and the nature of technologies. The beginning of the analysis is traced starting from the 1970s up to the 2000s and is divided into three major epochs. The first period, roughly between the 1970s and mid-1980s, was one in which the first major oil crisis struck and, coupled with air pollution concerns, the government directed considerable effort towards the development of alternative energy technologies like solar, wind, hydro-power, geothermal.

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In this period, particular emphasis was given to solar cell production for terrestrial-use and wind power development. The second period, roughly between mid-1980‒1990, was characterized by a dwindling of interests in alternatives as oil prices had stabilized and, more often than not, lobbying by firms was successful in reducing regulatory emission criteria. The third is the period between the mid-1990s‒2000s, characterized by serious climate change and energy security concerns, including the biggest oil price shock in recent times, that has spiralled energy prices without signs of stabilizing. These factors have forced economies to re-strategize their energy consumption patterns seeking alternatives in non-fossil energy like renewable and energy efficient technologies like CNG and co-generation processes. Beginnings: 1970s to mid-1980s In the first period between the 1970s and early 1980s, in response to the first oil price shock, countries like Japan sought substitutes in alternative energy technologies and in optimizing energy consumption through energy efficient technologies. Alternative energy technologies that were primarily explored during the 1970s were geo-thermal, biomass, hydropower (IEA, 2005) and solar and wind in addition to alternatives to produce oil and gas through coal gasification and liquefaction techniques. Coupled with energy security concerns and economic recessions the publication Limits to Growth, by the Club of Rome in 1972, drew considerable public attention to the predicament of scarce resource depletion like fossil fuels. During the same time, air pollution concerns were taken seriously, especially in the United States after the city of Los Angeles was found to be the most pollutive city. Several studies then documented the harmful effects of toxic air pollutants released mainly by industries and vehicles on human health alongside reports of the occurrence of acid rains in several regions. The above-mentioned factor led to changes in energy polices and/or to the introduction of entirely new policies that sought to develop alternative energy technologies. Japan, a country solely dependent on oil imports, responded to the 1970 crisis by initiating a Sunshine Project in the year 1974. The purpose of the project was to develop new and alternative energy technologies like solar, wind and coal gasification and liquefaction. An Alternative Energy Act was enacted in 1980 that raised electricity and coal taxes whose revenues were used to develop renewable and alternative energy technologies. In response to air pollution concerns, the Environmental Agency of Japan pushed for a legislation in 1972, similar to the Muskie Act in the US, that forced automobile companies like Toyota, Honda and Nissan to comply with emission reduction regulations through technological innovations (Yarime et al., 2008).

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Honda first began complying with in-house technological development of a new engine type called the CVCC for its motorcycles. Although it complied with all the required emissions standards, it later abandoned its production. Instead, Nissan and Toyota developed a new type of catalyst, called a three-way catalyst, rather than changing the structure of the IC engines for their whole range of vehicles. During the same time, the US government responded to the oil crisis of the 1970s by introducing federal and state tax credits for renewable energy and energy efficient users and, in 1978, it passed the Public Utilities Regulatory Policy Act (PURPA) to encourage efficient use of electric utility resources. PURPA created a market for non-utilities, as it required utilities to buy power from independent companies that could produce power for less than what it would have cost for the utility to generate the power, called the avoided cost. It established a Solar Energy Laboratory in 1978 to further research in solar energy technologies. Today it is the nation’s largest research centre in renewable energy technologies called the NREL. The US Federal Wind Energy Program was initiated to encourage research in wind technologies entirely through federal tax credit. In response to air pollution concerns, the Environment Protection of America (EPA) enforced the Clean Air Act in 1970, an amendment to the Muskie Act, a very stringent regulation, required the auto industry to reduce the amount of emissions of CO2, hydrocarbons and N2O to one-tenth. US automakers were successful in opposing the Clean Air Act in 1970, which according to them was unrealistic and technically impossible at that time to achieve and so, finally, in 1974 the mandatory emission requirements were reduced. The automakers eased regulations for their own benefit by avoiding investments in new and sustainable technologies and resorted to catalytic converters instead, that did not require any change to the IC engine. In the US solar industry, few small start-ups, spin-offs from solar US government research labs and space application programs, entered the PV production industry for terrestrial use. Solar Power Corporation, Solarex Corporation, Spire Corporation, Solec International and Solar Technology International were the few start-ups established in the early 1970s. In addition to small firms, there was interest among large oil and gas firms in developing solar cells. In 1979, ARCO Solar built the biggest solar cells and photovoltaic systems production plant through its own internal research and development efforts while British Petroleum (BP) started it own solar cell production unit in 1973. In response to the oil crisis, federal research and development activities also resulted in the design, fabrication and testing of 13 different small wind turbine designs (ranging from 1 KW to 40 KW), five large (100 KW‒3.2 MW) horizontal-axis turbine (HAWT) designs and several


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vertical axis (VAWT) designs ranging from 5‒500 KW (Murphy, 2004). Many wind turbine manufacturers were attracted to the conducive wind policy environment of California. The National Energy Act of 1978 and the California Acts provided a 15 per cent federal energy tax credit and a 25 per cent California energy tax credit for investment in renewable energy sources. In addition to these tax incentives, California utilities, acting in compliance with PURPA, offered attractive rates for the purchase of power from independent electricity producers, further encouraging the development of wind systems (Cox et al., 1991). Danish firms had an advantage in the US market, with its long history in wind turbine design and development of the improved three-blades Gedser mills. Their wind turbines were officially endorsed most reliable as compared to other windmill manufacturers of that time. In 1979, the government of Denmark offered an investment subsidy for up to 30 per cent of the cost of wind turbines, biogas digesters and solar panels that spurted interested among investors especially in the wind industry. Interests were shown by three groups mainly: private and individual owners of turbines who set-up a turbine in their back-yard or invested in shares in cooperatives and power companies were forced to comply with new regulations when the Parliament legislated a purchasing price of 85 per cent of the retail price of electricity. Most started the development of wind turbines but most were not commercially successful except for that of SEAS, which helped finance the Gedser three-blade design (c) diversification of agricultural equipment firms like Vestas, Nordex, Nordtank, Bonus and Micon into wind turbine manufacturing. The companies are in the top-15 list of manufacturers today. In addition, by 1986, the Danish wind turbine manufacturers had 50 per cent of the US market share. Therefore, this period saw four distinct firm characteristics respond to the external environment of oil price shocks and policy support at that time: ● ● ● ●

Independent solar PV start-ups Large electronics and semiconductor firms Oil and gas firms Agricultural equipment firms

Downside: mid-1980s ‒ mid-1990s Soon after, in the mid-1980s, when oil prices stabilized, interest in alternatives fell. In the late 1980s, Japanese firms Hitachi, Toshiba and NEC withdrew from PV business. For these firms growing markets of semiconductors and computers were much more important than the unpromising future market of PV according to Kimura and Suzuki (2006). During this

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period, the mandatory requirements of the Clean Air Act of 1970 coupled with the energy crisis plunged American automobile manufacturers into a deep depression. They asserted that the necessary technology to comply with the regulation did not exist and the use of catalytic convertors was instead suggested. Car consumers were turning to Japanese and European cars that consumed less oil. So the Federal government then relented and eased air pollution standards and automobile manufacturers inserted catalytic convertors into the exhaust pipe of vehicles. Such were the makeshift solutions or end-of-pipe solutions towards which development led during this period. Emission norms, product standards and bans and in some cases charges and subsidies were insufficient measures that led to the development and use of cleaning technology such as end-of-pipe instead of ‘clean’ technology or cleaner production processes (Kemp and Soete, 1992). The concept of the selection environment explains why developments along the internal combustion (IC) engine trajectory were not easily abandoned by the US automobile manufacturers. According to Kemp (1994), moving to a new trajectory, will require new skills, education and training and, hence, drop-in innovations are easily adopted. It also explains why there are developments directed towards finding CFC substitutes rather finding an alternative to the whole refrigeration technology of today. An incentives program in the form of capital grants for installation of wind turbines was established in the late 1970s, but was abolished in 1989. Moreover, when the California wind program ended in 1985‒1986, a large number of the 20-odd manufacturers went bankrupt, having few alternative markets for their products. Incentives that were provided to home producers of solar and wind energy under the US Energy Tax Act in response to the oil crisis of the 1970s were phased out in the mid-1980s as a result of new policies to leave energy conservation and renewable energy decisions up to market conditions (gosolar.com). It has been documented that between 1974‒1981 the wind energy program in the US had been most efficient and successful as it built 13 small systems and four large wind turbine designs were developed and tested. Nevertheless, in the years between 1981‒1988 despite millions of federal tax credits ‒ only four new wind turbine designs were developed in the United States (Murphy, 2004). Upside: mid-1990s‒2000s A series of intergovernmental conferences focusing on climate change began in the late 1980s, and went on into the early 1990s, in response to a growing scientific understanding of climate change. The UN called for the start of treaty negotiations wherein a Convention was started to build


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a framework on climate change. The impact on climate change caused by human activities like deforestation and pollution was brought to public attention with much controversy, but the issues and concerns behind the cause were more widely debated than ever before. The concerns and issues related to the environmental impact of growth and technological advance have suddenly re-emerged in a context very different from that of the mid-1970s [. . .] the evidence on the environmental damage in terms of air, water and soil pollution is by far more overwhelming [. . .] and public perception of the environmental problems is far more acute. (Kemp and Soete, 1992:454)

Such conferences urged several Western European countries to adopt national targets of greenhouse gases emission reduction, for example, the former Western Germany’s 1987 target to reduce 30 per cent of its emission by 2005 and France and Australia to reduce 20 per cent by 2005 (Kimura and Suzuki, 2006). In the 1990s, Japanese regulatory barriers against the deployment of distributed power generators were removed and simple procedures for grid-connection was called for so as to expand renewable energy deployment. The original target to supply 1.6 per cent of the total energy demand from alternative energy in 1990 was raised up to 5 per cent in 1990 and 7 per cent in 1995. There was a strong commitment by the Japanese government to introduce PV stimulated private investments (Watanabe, 1999). Japanese firms like Kyocera, Sanyo and Sharp that continued PV developed despite the downside in the late 1980s had by the late 1990s become top-ranking PV producers. In 1991, the US government broadened research areas to include renewable and energy efficient other than solar. It renamed the Solar Energy Research Institute to National Renewable Energy Laboratory to advance several renewable energy technologies. In the 1990s, the Bush Administration encouraged and resumed the funding of the under-funded wind energy sector. The management of the federal wind program was shifted to NREL. The California Air Resources Board (CARB) enacted the Low Emissions Vehicle Regulation in 1990, which required seven large automobile manufacturers, including Japanese cars, to include a small percentage of their sales as zero emissions vehicles (ZEV). The targets for the introduction of ZEVs were set at 2 per cent after 1998, 5 per cent after 2001 and 10 per cent after 2003. There were several technological developments by Japanese carmakers in response to the regulations implemented by the Environment Agency of Japan and those set by CARB for ZEVs. According to Yarime et al. (2008), the number of patents filed by Toyota, Nissan, Honda, Mazda, Mitsubishi

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and Fuji Heavy Industry in electric vehicles increased in early 1990s but it declined sharply in the 2000s. Electric vehicle technologies had technical glitches in battery performance and cruising range and were therefore abandoned. Besides, Japanese carmakers began to file for fuel cell vehicle patents in the middle of 1990s, the number increased sharply in the 2000s, reflecting the changes in regulations influencing the research focus in the auto industry. The Californian Fuel Cell Partnership was started in 1998 that began development of fuel cell vehicles between CARB, automobile manufacturers (DaimlerChrystler, Ford, GM, Honda, Nissan, Toyota, Volkswagen and Hyundai), oil companies (Shell Hydrogen, BP, ChevronTexaco, Exxon Mobil) and fuel cell producers (Ballard and UTC). Partnerships of this form has the advantage of developing fuel cells through shared costs and uncertainties and a faster move towards standards creation for early stage-technologies. It was in this period that governments from emerging economics like China and India started responding to their huge energy security needs. The energy demand needs of these countries had been increasing partly to their fast growing economies and partly to their fast growing population. In fact, developing countries already contribute 74 per cent of the increase in global primary energy use. And China and India alone account for 45 per cent of the increase. The energy needs of both these countries are expected to quadruple by 2030 and which could most likely create a supply crunch as early as 2015. So the challenge is on these emerging economies to reduce their energy needs, without harming their economic growth and development. So a solution out would be for governments to devise policy mechanisms that promote alternative energy technologies in these economies. Renewable policy interventions in countries like India and China has given economic and technical opportunities to local firms to rise and develop these technologies. So starting from the mid-1990s, many new wind development firms sprung up in India and China in response to their policy environment. The Eighth Five-Year Plan of India, in the 1990s, gave tax exemptions to imports of wind turbines and a tax holiday for five years for those who developed and manufactured renewable energy technologies. In a short time, the conducive policy environment in India drove Suzlon to emerge as one of the fifth largest wind manufacturers in the world and strategically compete against technologically advanced and competent firms from Germany and Spain. Initially a compact-disc manufacturer, Moser Baer, has emerged as one of the world’s largest solar PV manufacturers. Renewable energy policies and incentives, coupled with changes in the semiconductor polices of India, Moser Baer had been able exploiting its existing expertise in laser


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technology to manufacture solar PV for the Indian solar market. Through acquisitions of various firms in the US and Europe, the firm is acquiring new technologies and expanding its market. Like India, China had put its policies for renewable energy in place since the mid-1990s. In 1994, it issued a regulation that required power companies to give priority to wind-generated electricity. In 1999, the government set a new rule for wind power pricing at a level that became lucrative for investors and which at the same time did not dis-advantage consumers. Because of these policies, the wind capacity in China grew from 4MW to 567 MW in 2003. Today there are more than 40 wind farms operating in mainland China. The Ninth Five-Year Plan (1996‒2000) of China required that any wind-turbine equipment purchased for wind must contain 40 per cent of locally made components. And according to NREL, to capitalize on this, many Chinese companies formed joint-ventures with international companies and thus acquired the necessary technological competencies. Also during the same five-year period, the government funded research to develop technologies for 600KW turbines, and which actually helped built a prototype. On its basis, many professional component manufacturers then began producing key components like blades, gearboxes and generators around the 600KW turbines. In the biofuels industry, most advancements and interests first came from Brazil. Although small efforts were made in biofuels in the 1930s, the actual implementation took off in the 1970s, soon after the first major oil embargo. Low price of sugar in the international market coupled with strong political pressure from sugar cane producers, Brazil implemented the Brazilian Program of Alcohol (PROÁLCOOL) (Teixera et al., 2008). In the mid-1980s, with oil prices stabilizing, interest in biofuels cooled off and many technological advances made during this period were discrete and not harmonized. However, the industry received much buoyancy in the 1990s, when international oil prices rose and climate change and pollution policies became mandatory particularly in Europe. A bio-diesel program was mandated. The mid-1990‒2000s are witnessing several and more diversified characteristic of firms enter the alternative energy market, as opposed to that witnessed in the 1970s: ● ● ● ● ●

Large electronics and semiconductor Oil and gas firms Automobile manufacturers Agricultural export firms Biotechnology firms

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New start-ups in solar, wind, bio fuels Flat screen manufacturers Laser CD manufacturers Glass manufacturers

EXPLANATION FOR THE CHANGING CONFIGURATION SINCE THE 1970s The factors that are causing the energy market to change over time are understood when one observes the interrelation and interplay between firms, technology and the government. Therefore, in essence, the explanation for the changing configuration is given to a) the nature of the technologies b) the nature of competition between firms c) and the nature of government support and incentives. The nature of the technologies The nature of technologies allows for the inclusion and combination of different science-based technologies like nanotechnology, laser and optical fiber technology and genetics. The combinatorial nature of the technology is characteristic of new wave technologies, which has three defining features: their science base, patent activity and system embeddedness (Mytelka, 2004). We observed the combinatorial nature of technologies in the convergence between IT and telecommunications and between pharmaceuticals and biotechnology in the late 1980s and early 1990s. The extent to which these technologies can be cross-applied or applied in other areas depends on the technical and economic opportunities or on the technological paradigm (Dosi, 1982) or scientific paradigm (Khun, 1962) so defined by the parameters of science. In fact, it is the nature of technologies themselves that will determine the range within which products and processes can adjust to the changing economic conditions (Kemp and Soete, 1992) and adjust to the changing nature of technologies themselves. Each technology emerged within the paradigm of the earlier mechanically base and now are beginning to incorporate nano-level technologies, and new wave technologies are developed through a combination of several distinct trajectories with significantly different scientific roots (Mytelka, 2004). The combinatorial nature of technologies requires both a wide range of different knowledge inputs and a strong science and engineering base. Hence, the establishment of a dominant design in such new wave technologies depends upon innovations from across sectors. The combinatorial nature of technologies is


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seeing a cross-sectoral participation of firms with different expertise and knowledge base as exemplified in the examples above: solar cell production, bio-fuels and hydrogen fuels. The solar cell technology is developing along its own technological trajectory but whose advancement and movement is strongly integrated with the development path of the semiconductors and optical laser trajectories. The combinatorial nature of technologies and their integration into the products and processes of other technological systems opens the way for larger firms to play a more prominent role in shaping the technological trajectory and the speed with which new technologies are incorporated into the production processes than in the past (Mytelka, 2004). Large firms like Shell, Royal Dutch and BP are being transformed into energy companies and their presence in the renewable energy market will mark the evolution of alternative energy technological systems because of their enormous size, huge investment abilities and vested interests. The path of the microprocessors, laser, audio/visual and more recently the application of biotechnology in pharmaceutical has been shaped by only a handful of large firms like Sharp, Moser Baer and Du Pont. Thus, in brief we see that the nature of competition between them is leading to an increase in the cross-sectoral participation of firms and in the engagement of large established firms from other sectors. The nature of competition and market entry Firms in this industry have adopted various innovative strategies to extract value from new technologies and maintain their competitive advantage. The sudden need to change in response to rising oil prices and climate change concerns, have forced firms to reconsider the organization and management of their internal research and development and their strategies of capturing knowledge, technologies and products from external innovators. The way in which this industry is evolving especially in terms of the nature of technologies involved is also changing the way firms are strategizing in response. Rapid development of alternative energy technologies and the combinational nature of the technologies has created and shaped inter-firm relationships between pure-play alternative energy, established oil and gas firms, large agricultural and electrical firm and new and small entrants. So the changing nature of the technologies is seeing a corresponding change in the strategies of firms ‒ it is giving rise to a different type of strategy which is not only that of internal research and development but that of external activities with other firms that maybe upstream input firms, downstream users and infrastructure and other kinds of firms that constitute a new energy system.

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So along with these new changes and new requirements came changes in the traditional way of market competition among firms based on price and product differentiation. The need to reduce investment costs so as to quickly achieve an optimal production size and research and development is leading firms to strategic partnering of two kinds: a) competition through the creation of consortiums amongst a group of rival firms b) two-way partnerships with a focus on knowledge production and sharing rather than a one-way transfer of technology. Both these modes of knowledge-based competition are resorted to as a means to reduce production costs and technological risks. These modes of competition are affecting market competition as they act as ‘entry barriers’ to new entrants and have given firms, particularly large firms, access to new technologies and markets. In fact modes of competition of this nature determine the speed with which a dominant design emerges, costs are reduced and systemic constraints are removed (Delapierre and Mytelka, 1998). The research and development intensive nature of the new technologies is forcing firms to share the initial high costs of research and product development and thus reduce uncertainty. The creation of consortiums or group alliances is a form of new competition that is speeding up the process of innovation and shaping the development path of a trajectory rather than resort to internal research and development is associated with high costs, market risks and uncertainties. An example of such a consortium is the California Fuel Cell Partnership, which is a technical collaboration of 31 members like automobile manufacturers, energy providers, government agencies and fuel cell system firms that jointly develop and commercialize hydrogen fuel cell vehicles. Members are Ballard Power Systems, Daimler Chrysler, Ford Motor Company, BP, Shell Hydrogen and Chevron Texaco that formed the partnership in 1999. For a long time, internal research and development was considered to be the only source of knowledge for innovation (Mowery, 1983 and Griliches, 1979 in Arora and Gamberdella, 1990). Up to the 1970s, most technological innovations introduced by large firms were from in-house research and development investments but in the past two decades, firms were unable to internalize all their resources to produce and commercialize technologies (Arora and Gamberdella, 1990). Now firms develop technological know-how through their competitors, suppliers and other organizations through contractual arrangements like licences, research and development agreements and joint ventures (Pisano, 1990). The ability to exploit external knowledge becomes critical to firm innovation (Chesborough, 2003; Cohen and Levinthal, 1990; Teece et al., 1997; von Hippel, 1982). Firms thus became aware of the necessity to cooperate with other firms and organizations in order to obtain expertise which otherwise


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cannot be generated in-house. Cooperation with other firms in the form of alliances and joint ventures broadens a firms’ strategic option especially in a time of technological uncertainty as in the alternative energy industry. Firms that are trying to keep up with rapid and costly technological progress engage in partnerships (Dussauge, 1992). Especially in high tech industries, high costs of research and development, steep learning curves and shortening of product and technology life cycles urge firms to share development costs and thus reduce lead times for their innovative products (Duysters, 2001). Empirically, it has been shown that high tech firms that cooperate with others tend to be more innovative than firms that do not (Kotabe and Swan, 1995). Also considering the uncertainties about the profitability and stability of these new emerging technologies, it makes sense for private investors to share the initial costs of risk venturing like costly and time-consuming basic research. Thus in brief we see that the nature of competition and nature of entry coupled with the nature of technologies is leading to a) knowledge-based modes of competition and b) rise of alliances and joint ventures. Nature of government support and incentives Wider and intensive research support from governments is making technologies attractive for private firms because the market by itself will not generate a move from the dominant and inferior technology in which it is locked-in as exemplified in the example of Cowan and Gunby (1996) of the difficulty of farmers to switch to a better IPM system from a dominant and inferior chemical spraying method of pest control. The market is locked into a comfort zone of localized learning, uncertainty and unpredictable pay-offs associated with new technologies. In addition, the existence of interrelated technological trajectories or systems (Rosenberg, 1990) or the embeddedness of the combinatorial nature of the technologies (Mytelka, 2004) is making the switch to a new technology even more difficult. New technologies face major barriers because the positive externalities involved develops over time and are prevented from doing so by the existing dominant technological trajectory (Kemp and Soete, 1992). Government subsidies and incentives can help direct resources away from these dominant and less superior technologies. There has been an increase in government spending in alternative energy technologies in terms of research funding and infrastructure building and in the availability of subsidies like tax incentives and feed-in tariffs and of stringent regulations that support utilities that make use of renewable energy through on-grid connections. However, with such uncertainties about the stability and profitability of these new markets private investors

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are unwilling to take risks. Here the role of the government becomes important to mitigate the investment risks by providing production incentives and research subsidies as well as being involved in accelerating the development of new renewable technologies until the market becomes stable for firms to make profits. So to share the initial risks associated with research and development investments and to gain a first mover advantage, many firms are found to collaborate with other firms, research organizations and governments to develop these technologies. Because of the nature of technologies and their system embeddedness, the role of government funding and policy support are important constituents in transforming the current fossil fuel based energy system to one towards cleaner and greener forms of energy source.

CONCLUSIONS We saw that over the years the configuration of the alternative energy market has been changing, to include more and more firms, the types of firms have changed and the number of technologies considered has increased manifold. The expertise and experience of the firms entering this market are playing a major role in advancing these new energy technologies. We have also seen that many firms in emerging countries are playing a major role in both developing and diffusing these technologies. With such a diverse knowledge base it becomes increasingly important, particularly by policy makers, to recognize ways in which knowledge is appropriated in this market, particularly in emerging economies where there is a huge need for energy. In the period between 1970s and 1980s, we saw firms respond to policy changes and make technological changes, namely by resorting to end-of-pipe solutions and catalytic converters, rather than actually innovate in new and clean energy technologies. But soon with changes in the nature of technologies, like the advent of biotechnology, nanotechnologies and the systemic nature of information technology, the way in which firms responded changed. In fact, the complexity of the nature of technologies has opened up possibilities for firms, particularly large ones with financial, organizational and knowledge edge over smaller firms from across sectors to become involved in the alternative energy market. Their sheer ability and strategic efforts have allowed them to easily integrate new external capabilities and compete in the alternative energy market despite several uncertainties and risks. As for smaller firms, it was possible to integrate their research and technological capability with larger firms, so as to share the initial high development costs and market uncertainties. The way in which firms are competing to innovate and responding to policies, and the


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way in which the nature of technologies determine the way firms should innovate and the way policies are designed, allows us to see the interplay between firms, technologies and policies. Considerations of the interplay between these three processes are in fact important determinants of the process of innovation, and particularly for firms in emerging economies, where energy needs are fast increasing.

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10.

Serving low-income markets: rethinking multinational corporations’ strategies Shuan SadreGhazi and Geert Duysters

INTRODUCTION There is an ongoing debate in the academic literature about the role and impact of multinational corporations in developing countries. Some of the views are very sceptical and consider multinationals’ activities in developing countries as a new way of exploitation (Porritt, 2005:253), while others view multinational corporations as giant engines of economic growth that can become the new wellsprings of prosperity to developing economies (Hart, 2005; Prahalad, 2005). Alongside these discussions, we see an ongoing trend in which many multinationals try to build a positive image by engaging in philanthropic and corporate social responsibility projects. Recently, a new debate is emerging about market-based approaches to addressing low-income markets in developing countries and the main motivations that drive these approaches. These approaches are diverse and can range from poverty alleviation to pure profit driven attempts. Highlighting the characteristics of low-income markets, this chapter analyses challenges and opportunities that multinational corporations face in entering them. Higher-income markets have been the most attractive marketplace for large corporations, despite their smaller population in a global comparison to low-income markets. Consequently, a large share of the world population with low-income levels has been ignored as an attractive market by both multinationals and large domestic companies. It is not the size of the market that made them relatively unattractive. The general lack of purchasing power from these markets and infrastructure issues were commonly considered as major problems that made it very unattractive for companies to invest heavily in them. However, the fact is that more than two thirds of the world’s population resides in the lower-income tier of the world economic pyramid (also known as the Base/Bottom of the Pyramid ‒ BOP). Despite the fact that the size of these markets is much 166

Serving low-income markets

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larger than the markets at the top of the economic pyramid, there are still very few products and services developed particularly to satisfy the needs of the users in the base of the pyramid. It is widely argued that a large share of the world population, those who live in the low-income communities of developing countries, are not adequately included in the global economy and have limited access to products, markets and opportunities to develop themselves (Hammond et al., 2007; Prahalad, 2005). Similarly, their lack of resources discourages companies from providing the basic goods and services that would empower them and would improve their lives. Those who encourage market-based approaches argue that finding appropriate ways to satisfy the unmet needs of low-income communities can bring enhanced opportunities for these communities, in terms of access to better products as well as in terms of employment. On the other hand, businesses firms can benefit from the opportunities that have the potential to foster their long-term growth (Grayson and Hodges, 2004; Hammond et al. 2007; Hart, 2005; Prahalad, 2005; Rangan et al., 2007; UNDP, 2007). Although the importance of international aid for serving unmet needs is not ruled out, aid and philanthropy approaches face some limitations in terms of scale and sustainability. Furthermore, donors and non-profit organizations are also seeking more effective approaches to their aid efforts and some look for alternative ways to help out underserved communities, for instance by joining forces with the private sector (Brugmann and Prahalad, 2007). Because of the limited economic opportunities, so far low-income communities have often been unable to contribute to or benefit from growing market economies. Furthermore, even when such opportunities do occur, the poor are generally unable to take advantage of these opportunities because they often lack good health, education and credit. If market-based approaches are going to contribute to their development and make a difference, there is a need for a deeper understanding about the characteristics of these communities and their dynamics.

WHAT IS IN THE BASE OF THE PYRAMID? Recently the idea of market approach to address low-income communities, known as the bottom or base of the pyramid, has gathered increased momentum, both in theory and practice. Early works have focused on articulating the logic for pursuing business strategies aimed at low-income communities (Hammond and Prahalad, 2004; Hart and Christensen, 2002; Hart and Milstein, 1999).

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The phrase and concept of the ‘bottom of the pyramid’ originates from the work of C.K. Prahalad and S. Hart and in their seminal 2002 article ‘The fortune at the bottom of the pyramid’: This is a time for multinational corporations to look at globalization strategies through a new lens of inclusive capitalism. For companies with the resources and persistence to compete at the bottom of the world economic pyramid, the prospective rewards include growth, profits, and incalculable contributions to humankind. Countries that still do not have the modern infrastructure or products to meet basic human needs are an ideal testing ground for developing environmentally sustainable technologies and products for the entire world (Prahalad and Hart, 2002:1).

In the base of the pyramid approach, the global population is divided into segments based on purchasing power parity. There is still no consensus about the proper way to define base of the pyramid population. Different authors on low-income markets have articulated different PPP lines ‒ ranging from USD 1500‒USD 3000 per annum to USD 1 ‒ USD 2 per day, depending on the way they define low-income and bottom of the income pyramid (Hammond et al. 2007; Prahalad, 2005; Prahalad and Hart, 2002). This inconsistency in measuring the base of the income pyramid has received some criticism (Karnani, 2007). More recently, the World Resource Institute (Hammond et al., 2007) conducted a study to analyse the size and aggregate purchasing of the base of the pyramid (Table 10.1). Although there have been some attempts by multinational corporations to serve those in extreme and moderate poverty (for instance, P&G’s lowcost water purification devices and Philips’ energy efficient wood stoves), the majority of initiatives fit the conditions of lower middle-income and upper low-income customers. In line with such an approach, that does not yet include those in extreme poverty; some use the label ‘the next billion’ rather than talking about the whole base of the pyramid. There seems to be a growing consensus that the potential of serving the whole base of the pyramid community has not been fulfilled and that most attention of global corporations is on serving lower middle and upper low-income customers. Market-based approach to serving low-income communities Markets are not the only solution to the problems of low-income communities, but market-based approaches have some benefits that, if properly addressed, have the potential to contribute to both human development and business growth (UNDP, 2007). Proponents of market inclusion argue that consumers in low-income communities can enjoy a better life


Table 10.1

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BOP population and income1 BOP share of BOP income BOP share of BOP population total population (PPP, 2005 total income (%) USD) (%) (millions)

Africa Asia Eastern Europe Latin America and Carribbean Total Note: Source:

1

486 2858 254 360

95.1 83.4 63.8 69.9

3958

429 000 3 470 000 458 000 509 000

70.5 41.7 36 28.2

4 866 000

Calculated based on selected representative countries. Adapted form World Resources Institute (2007).

if the business community offers them the ability to fulfil their basic needs for nutrition, health, education, housing and sanitation. A market-based approach starts from the idea that having a low income does not eliminate market processes: almost all poor households trade cash or labour to meet their basic needs. A market-based approach to lowincome markets considers local people as both consumers and agents that can be part of the business process, for example as producers, distributors, promoters and so forth. Such an approach can lead to creative solutions that can make markets more efficient and competitive and thus more beneficial for the people who live in low-income communities (UNDP, 2007). It is not always evident that large corporations have real advantages over small, local organizations. Multinational corporations may never be able to beat the cost or responsiveness of local entrepreneurs. In fact, empowering local entrepreneurs and enterprises seems to be a key to developing solutions for poor communities. Still, there are some reasons why multinationals can play a role in serving low-income markets. Prahalad and Hart (2002) point to three capabilities of multinationals that give them the potential to play a positive role in addressing low-income markets: resources, leverage and bridging. Resources Building a complex commercial infrastructure for the base of the pyramid is a resource-intensive activity. Developing products and services for the base of the pyramid requires significant research. Furthermore, distribution channels and communication networks are costly to develop and maintain. Not many local entrepreneurs have the managerial or technological resources to create such an infrastructure.

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Leverage Multinationals can serve as agents that transfer knowledge from one market to another and scale-up solutions. Although practices and products have to be customized to serve local needs, multinationals, with their global knowledge base, have an advantage that is not easily accessible to local entrepreneurs. Bridging Multinationals can facilitate building the commercial infrastructure and providing access to knowledge and financial resources. They can act as catalysts to cooperate with non-government organizations (NGOs), communities, local governments, entrepreneurs and multilateral organizations in their attempts to bring development to underserved communities. Because of the size and specific nature of the base of the pyramid, the scale and sustainability of the solutions seem to be of paramount importance in such a market-based approach. A single sector approach, focusing on either government, aid agencies, non-profits or the private sector, is not likely to achieve the goal of serving the large scale of underserved communities alone. Therefore, a partnership among various sectors seems necessary to unlock and share the full potential. The private sector can potentially act as an integrator of the various sectors and make a positive contribution in development by taking an orchestration role in development initiatives. The strength of the private sector can potentially aid local entrepreneurs, firms and communities in getting involved in innovation and investment, and help them to create jobs. The flows of income and the creative energy that they are able to generate may facilitate productive capacity and may provide a basis for mutual long-term development. Opportunities in low-income markets The opportunities associated with low-income markets are becoming gradually more apparent to multinational corporations (London and Hart, 2004). The majority of the population in these markets is primarily in the large but informal economies that are not counted in official statistics. It has been estimated that the informal sector around the world includes more than USD 9 trillion in unregistered assets. This amount is close to the total value of all companies listed on the main stock exchanges of the 20 most developed countries (de Soto, 2000:35). In addition to assets, the value of economic transactions in the informal markets might be even higher than what is recorded in the formal economic sectors in developing countries (Henderson, 1999). It is also argued that by getting engaged in base of the pyramid markets, multinationals can learn about


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important capabilities, practices and innovations that they might transfer to their higher-income markets (Hart and Christensen, 2002; Christensen et al., 2006). A report by the World Resources Institute (Hammond et al., 2007) indicates that the Asian base of the pyramid market has the largest size, with 2.86 billion people and a total income of USD 3.47 trillion. It constitutes 83 per cent of the region’s total population and 42 per cent of its aggregate purchasing power. Eastern Europe’s USD 458 billion base of the pyramid market includes 254 million people, 64 per cent of the region’s population, with 36 per cent of aggregate purchasing power. In Latin America, the base of the pyramid market of USD 509 billion includes 360 million people, representing 70 per cent of the region’s population but only 28 per cent of aggregate purchasing power, a smaller share than in other developing regions. In Africa, the base of the pyramid market is USD 429 billion, but it represents 71 per cent of aggregate purchasing power in this region. The African BOP includes 486 million people, 95 per cent of the region’s surveyed population. The World Resources Institute’s report also characterizes the base of the pyramid markets by sector (Hammond et al., 2007). This report suggests that the BOP markets range from relatively small sectors ‒ such as water (USD 20 billion) and information and communication technologies (USD 51 billion), to medium-scale sectors ‒ such as health (USD 158 billion), transportation (USD 179 billion), housing (USD 332 billion) and energy (USD 433 billion), to very large sectors ‒ such as the food market (USD 2895 billion). These low-income markets have different levels of sophistication and risk. Some regions might face more challenges than others might and those at the very bottom of the pyramid in extreme poverty might not directly benefit from the solutions offered to other low-income communities. Still, the aggregate market potential is higher than what can be expected from the conventional multinational corporations’ advanced markets.

MULTINATIONALS’ ACTIVITIES IN DEVELOPING COUNTRIES Private sector firms are continually searching for new business opportunities. The growth of developed world markets is showing signs of slow down while shareholders and investors typically demanding double digit returns. Few organizations are likely to enjoy such level of growth in the long term. Furthermore, with the arrival of new competitors and new technologies, these already saturated markets are becoming more and more competitive

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(Hart and Christensen, 2002). Consequently, many firms try to broaden their opportunities by seeking new markets to increase revenues and to find new sources of supply to reduce costs. This has led to a greater attention to the markets in developing countries that are further down the economic pyramid (Dawar and Chattopadhyay, 2002; Prahalad and Lieberthal, 1998). Although these initiatives are aimed to serve the lowincome communities, they are different from corporate social responsibility and philanthropic activities of multinational in the developing world and are expected to translate into economic returns for the company. From a historical perspective, at times operations of multinational corporations have faced hostility and resentment in developing countries. This is partly rooted in colonial domination times and clashes with host countries’ national interests (Caves, 2007:253). However, this hostility, which was dominant during 1970s, has largely faded and an increasing number of countries in the developing world are actively encouraging foreign direct investment. Since mid-1990s, foreign direct investment through multinational corporations has become the main source of foreign capital for developing countries (Ramamurti, 2004). Typically, the operations of multinationals in developing countries fall into three main categories: export of natural resources; export of manufactured goods and supplying the host market (Caves, 2007:254). Although the first two categories have a longer history, the idea of serving local markets of developing countries has picked up additional steam during the 1990s. Many multinationals rushed into the larger developing countries first, eagerly trying to fill the demands of the (potential) billions of new consumers. In fact, the companies only addressed a tiny share of highincome consumers in emerging markets who have global preferences and purchasing power similar to advanced markets. It has been suggested that it did not suffice to take a global approach to developing markets. Recently, some companies are beginning to realize that they must delve deeper into the local consumer base in order to deliver on the promise of tapping into the billion-consumer markets. However, this calls for a shift in emphasis from fitting the available products and practices to a new approach that acknowledges the realities of the low-income communities. Products and programs transplanted from advanced markets into emerging markets only appeal to the affluent elite, which in emerging markets are no more than 5 per cent of the population (Dawar and Chattopadhyay, 2002). It is argued that one of the reasons why the so-called pro-poor innovations, formerly known as appropriate technologies, did not manage to diffuse in underserved communities is associated with the so-called scalability issue. Non-profit organizations that usually promote such innovations do not have the required resources to scale-up their solutions. In view


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of the lack of a mass-market, the prospects of economies of scale would not yield enough profit to attract business actors. It was increasingly realized that delving deeper into the consumer base to establish mass-market positions would be the way to create the economies of scale necessary to justify production for low-income markets. This requires a specific understanding of the distinct conditions of low-income markets, which are significantly different from mainstream markets of multinational corporations.

UNDERSTANDING THE CHARACTERISTICS OF LOW-INCOME MARKETS The first step in addressing the low-income markets in the developing world is to understand existing markets and their associated challenges and opportunities. In this part of the chapter, we highlight the most important characteristics of low-income markets and provide examples where companies have tried to overcome the limitations of such markets. Low disposable income The most eminent characteristic of the communities at the base of the pyramid is their lower level of disposable income. This issue has other consequences that further complicate the use of multinationals’ mainstream business models in such a context. The problem of low disposable income manifests itself in two main ways (1) low purchasing power and (2) lack of access to credit. The majority of the low-income communities have fluctuating daily rather than constant monthly income, which makes it difficult for them to have high one-off payments to buy goods and services. In higher-income regions, consumers have the choice of getting access to credit and buying expensive items. However, banks usually do not provide such credits to those who do not have a constant monthly income. As a result, in many low-income communities people have to pay very high interest rates to the informal moneylenders to overcome the credibility problem. Often low-income communities even have to pay a higher price for many of their basic goods and services ‒ a phenomenon called poverty penalty. High-income consumers spend a much smaller percentage of their resources on basic necessities of life, leaving them enough money to purchase life enhancing items. While in most low-income markets at least 50 per cent of the income is spent just on food. Individuals’ limited access to or use of formal banking services pervades many emerging markets. In China and India, for instance, just one-third

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of the population has access to the formal banking sector. Recently, however, some microfinance institutions have made initiatives in overcoming such a financial exclusion. Some non-financial industries are also employing specific business models in order to adapt to the conditions of low-income markets (Box 10.1).

BOX 10.1

OVERCOMING THE LOW PURCHASING POWER BARRIER

Casas Bahia, a retail chain in Brazil, tried to target the lowincome market in Brazil by overcoming the credit problem in such markets. For example, 70 per cent of its customers don’t have a formal or consistent income. By providing a passbook scheme Casas Bahia enabled those without formal financial credit to make small instalment payments for the goods. The salespeople also educated consumers to buy according to their budget. They benefited from addressing a large customer base while the lowincome communities got the chance to buy appliances that they could not afford to buy without having credit. Source:

Prahalad (2005).

Low-purchasing power is a well-known issue in developing studies. Since the purchasing power is far less than the top of the pyramid market, price reduction strategies that are common in high-income markets and serve as a promotion strategy might not fit low-income markets. Some companies have actively used innovative business models to overcome the price issue. A model based on shared access is one of the most well known models. Instead of charging the individual user for a good or service, this model provides the option of sharing the cost amongst the user community. For instance, instead of charging individual households for water services, Manila Water Company provides local communities the option of having collective installation for 3‒4 households or a bulk of 40‒50. This allows low-income communities to use the water service while sharing the costs among themselves to make it affordable for all. Furthermore, low purchasing power customers may expect different functions from a product than the traditional high purchasing power customers. It is therefore important to identify the required functionalities instead of focusing on the product. For example, Unilever in India realized that in rural areas soaps are also used for washing hair, so they tried


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to make a body soap that contained healthy ingredients for the hair as well. Their 2-in-1 soap subsequently gained a large market share in rural areas. In another case, a Chinese appliance manufacturer assigned a dedicated R&D team in order to understand the expectations of the rural user and accommodate them in their product (Box 10.2).

BOX 10.2

UNDERSTANDING AND ACCOMMODATING EXPECTED FUNCTIONS

In the mid-1990s Haier Group, a leading home appliance manufacturer in China, found out that many rural consumers used their washing machines not only to launder clothes, but to do other tasks such as washing vegetables. Haier dedicated an R&D team to incorporate this matter. They modified the product by installing wider pipes that would not clog with vegetable peels. They also added instructions on the modified washers, with easy to understand directions on how to clean potatoes and other vegetables using the machine. They continued getting feedback from observing their rural customers and developed a modified washing machine to make cheese from milk. Strategies like these increased the acceptability of washing machines and helped Haier to gain a high market share in the competitive market of home appliances. Source:

Paine and Crewford (1998).

Dispersed locations Compared to the tip of the pyramid, the base of the pyramid represents a more diverse cultural variety and geography. In the majority of lowincome markets, the availability of logistics infrastructure cannot be taken for granted. That makes delivery, distribution and service of products more difficult. In addition, limited access to media makes common ways of media advertisement less effective. In order to access and educate consumers at low-income markets, a variety of approaches are needed: from simple method of billboards on walls and truck-mounted demonstrations to the use of local communities for spreading the word by way of mouth advertising (Box 10.3). Currently there are more than three billion mobile phone users and

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BOX 10.3

MARKETING IN REMOTE LOCATIONS

Realizing the limitations of traditional marketing methods in lowincome markets, Smart, a mobile company in Philippines, promoted a kind of viral marketing by using local entrepreneurs. It proved an effective marketing strategy that popularized Smart’s service and raised awareness about the service in a social way through friends, family and members of the entrepreneurs’ local community. In addition, the entrepreneurs adopted the advertising method to the local conditions by putting advertising stickers on the local transportation, such as carts. Source:

Anderson and Billou (2007).

obviously not all of them are rich. It is interesting to see how mobile usage has diffused among the rural communities and to see how new technologies can help people who could not utilize an older technology (that is, fixed line telephones) leapfrog and use a more sophisticated device which offers more value. As the use of mobile phones became much more common in low-income countries, the number of services based on mobile communication is growing and they are used widely. Lower skill and knowledge It is generally known that higher user-friendliness of a product leads to higher acceptance rates of that product. There have been many cases where a new product that has been widely acclaimed by its producers has failed to diffuse in the market because consumers find the product very complicated to use. Sometimes engineers in R&D departments get too much involved in the technical aspects that they tend to undermine the usability aspects. It is important to take into account the context in which the product is going to be used. Although this is not unique to a certain type of market, it seems to have vital implications in the base of the pyramid. A considerable share of the low-income population is illiterate, almost one fifth of adults around the world are functionally illiterate. In addition, they have less experience working with technology-intensive products or devices that require some level of prior skill or knowledge to operate. Hence, it is important to redesign the user interface and product functions in order to make it acceptable and easy to use for those who lack the skill or knowledge to use the product. To serve such customers, some companies


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are working on simplified interfaces where minimum prior knowledge is required to use and operate the device. Using speech-controlled devices that send and receive voice commands is another suitable approach for certain types of products and services. Educating the end-user is another way to overcome the problem. In the event of a lack of traditional channels for educating users some companies have teamed up with NGOs and local groups to do this task. For instance, CEMEX, a leading global building solutions company based in Mexico, offered not only affordable housing solutions through tailored business models, but also established a local network of trusted distributors to provide quality material and education on how to build houses. Others, like Nokia have created a consumer education program in low-income markets (Box 10.4).

BOX 10.4

EDUCATING USERS AND OVERCOMING LACK OF AWARENESS

In India, where lack of awareness and skill was considered as a major barrier for marketing products, Nokia started a consumer education program called ‘Connect’. The idea of this program was to educate consumers about the different facets of mobile technology. Nokia planned to make it simple for consumers to use the different features and applications available on its phones. As part of the Connect program, Nokia educated users about functionalities such as SMS and Bluetooth. Despite many features in handsets, there is still a general lack of awareness among users. By providing them a user-friendly guide, Nokia’s ‘Connect’ initiative helped consumers across the country to improve their mobile experience. Source: Nokia India, Press Release, 27 January 2006, available at: http://www. india-cellular.com/Press-Releases/Nokia-27-1-06.html

Other challenges of low-income markets In addition to the afore-mentioned issues, low-income markets have other characteristics that challenge the business practices developed in advanced markets. Many countries in low-income markets face political instability, volatile exchange rates and an underdeveloped physical infrastructure that makes business even more difficult.

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Much of the physical infrastructure conditions that are taken for granted in advanced markets are not available or are rather weak in low-income markets. Fluctuating electricity and a hostile environment (for instance, heat and moisture) require specific changes in product design, especially considering the fact that access to repair facilities is more difficult in such markets. The low degree of penetration of information and communication services together with limited transportation and logistics put some major restrictions on the use of usual distribution models. Furthermore, institutional factors pose another challenge; instable political system, different institutional structure, weak legal enforcement and intellectual property issues pose new rules of the game, which many multinational companies are not familiar with. The wide and scattered nature of low-income markets also requires extensive distribution networks that are viable at low volumes and low prices. The creation of such networks in low-income markets requires new partnerships and alliances that are not common in advanced markets. Partnerships of companies with financial institutions, NGOs and other international organizations and their involvement in multistakeholder development projects are already taking place. Yet, there is not much knowledge about the appropriate ways to create those networks effectively.

THE IMPACT OF LOW-INCOME MARKET CHARACTERISTICS ON MULTINATIONALS’ STRATEGY When entering new markets, companies have to leverage their resources and develop certain capabilities to be able to operate in the new environment. As discussed above, low-income markets have specific features which most of the multinational companies are unfamiliar with. Box 10.5 summarizes the main characteristics of low-income markets and the way in which core activities of multinationals in terms of R&D, production and distribution/promotion have to be adapted in order to meet the challenges of those specific markets. As to overcome the problem of low-purchasing power, some companies have put more attention on the improvement of the price-performance ratio and have started to focus on functionality in terms of offering a product that simply does the job without extra bells and whistles. In terms of production, considering the abundance of labour in low-income markets, creating conditions for employing local labour in production can rise their income (hence their consumption power) while reducing the unit


BOX 10.5

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EFFECT OF LOW-INCOME MARKET CHARACTERISTICS ON MULTINATIONALS’ ACTIVITIES R&D

Production

Distribution/ promotion

Low purchasing power

Focusing on functionality, improving price/ performance

Smaller packages/ sachets, using local producers and local labour

Combining financial services with the product, collective payment option

Dispersed locations

Developing scaleable solutions, using local entrepreneurs

Partnering with local producers, modular design

Partnering with civil communities and NGOs

Lower skill/ knowledge

Acknowledging endogenous solutions, proper user interface

Robust production to work in hostile environments

Customer education programs, viral marketing

Weak Building local Build local infrastructure, research laboratories, production etc turning infrastructure capacity constraints to sources for innovation Source:

Creating dedicated distribution network, adapting to existing means of transport

Authors’ own elaboration based on literature review.

costs. For products like consumer goods, the low disposable income has been tackled by offering smaller packages of the good; while in terms of promoting the product, some companies have embedded financial services in their product offering to overcome the credit problem of these markets. To facilitate R&D for dispersed locations, some companies have identified local entrepreneurs that act as local researchers with a better sense of local conditions. Setting up production units or partnering with local producers has been another solution to scale up operations. Moreover, since the main challenge in terms of distribution is the fact that often distribution channels are not available, a solution has been found in identifying and using local options and in some cases by setting up a dedicated distribution network. Furthermore, a number of companies have started to work with local communities or NGOs.

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In order to make products acceptable and usable for the large number of less skilled customers in low-income markets, research has taken place by some companies aiming to identify the solutions that communities have already developed based on their culture, beliefs and endogenous knowledge. Instead of pushing a new proprietary product into the market, such locally-based approaches help to design products with which consumers are familiar. It makes it easier for consumers to adapt when they make the shift to use the product. Since lack of education is another issue in such markets, some firms have tried to use specific user interfaces for their products and services that acknowledges this fact. Instead of using usual advertisement and marketing methods, some companies set up teams that go into the communities and offer education and awareness about the benefits and use of the products. However, the effectiveness and appropriate ways for such awareness programs needs to be studied further. In most cases, companies are engaged in activities that they have not done before, something that is quite different from their conventional business models in mainstream markets. By using creative solutions, they have tried to respond to the limitations of low-income markets and turn the challenges to opportunities. It is interesting to see how companies try to understand the requirements and needs of this different context. In most of the solutions, multinationals have engaged in new partnerships, for example with local producers, suppliers and NGOs.

CONCLUSION AND IMPLICATIONS In line with the ongoing debate about the specific role of companies in low-income markets, the base of the pyramid literature argues that once companies figure out how to serve low-income consumers in developing countries profitably, everyone might benefit: the underserved communities gain access to products and services that the private sector is best positioned to deliver, while companies benefit from tapping into vast new markets. On top of that, when core sectors of the economy ‒ such as banking, electricity and telecommunications ‒ progress, they might transform consumers into producers, thereby enhancing economic development (Beshouri, 2006). Nevertheless, there seems to be a long road ahead to eventually reach this goal. Multinational corporations have a long history of dramatic failures in low-income markets. Practicing business as usual in low-income markets has proven to be a recipe for failure. Therefore, in this chapter we argue that corporate strategies need to be redefined when it comes to addressing low-income markets. Various limitations and constraints of


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low-income markets require firms to think of creative new ways in order to benefit from the so-far untapped high-growth markets. A new approach is needed in which an understanding of social embeddings and the local context are key to offering what might be called appropriate innovation. Establishing new partnerships and networks for serving low-income markets is another piece of puzzle. Many companies are pursuing ways to increase social impact in their profit-making business mandates (Brugmann and Prahalad, 2007). Some NGOs, on the other hand, are joining forces with the private sector to foster socio-economic development. The intention is to share competencies, networks, infrastructure and know-how required to operate in low-income markets. Such partnerships are new for both sides and hence both sides face difficulties in adapting to it. Capacity for partnerships with many different stakeholders (governments, NGOs, social organizations, banks and so forth), with diverse ways of working and interests is a challenging task that has yet to be addressed. Overall, we can claim that low-income markets provide companies with many new business opportunities. However, the specific characteristics of these markets increasingly challenge existing practices of multinational corporations. Successful companies have therefore embraced a completely new way of organizing themselves for low-income markets based on embracing local practices, local innovation, local distribution systems and local production/sales systems. In order to access these local resources, collaboration with both the local community as well as with NGOs seems to be crucial for corporate success and base of the pyramid development.

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Washington, DC: World Resources Institute (WRI) and the International Finance Corporation (IFC), accessed at www.wri.org/thenext4billion . Hammond, A. and C.K. Prahalad (2004), ‘Selling to the poor’, Foreign Policy, 142(30). Henderson, H. (1999), Beyond Globalization: Shopping a Sustainable Global Economy, London: Kumarian Press. Hart, S.L. (2005), Capitalism at the Crossroads: The Unlimited Business Opportunities in Solving the World’s most Difficult Problems, Upper Saddle River, NJ: Wharton School Publishing. Hart, S.L. and C.M. Christensen (2002), ‘The great leap: driving innovation from the base of the pyramid’, Sloan Management Review, 44(1), 51‒6. Hart, S.L. and M.B. Milstein (1999), ‘Global sustainability and the creative destruction of industries’, Sloan Management Review, 41(1), 23‒33. Henderson, H. (1999), Beyond Globalisation: Shaping a Sustainable Global Economy, London: Kumarian Press. Von Hippel, E. (2005), Democratizing Innovation, Cambridge, MA: MIT Press. Karnani, A. (2007), ‘The mirage of marketing to the bottom of the pyramid: how the private sector can help alleviate poverty’, California Management Review, 49(4), 90‒111. London, T. and S.L. Hart (2004), ‘Reinventing strategies for emerging markets: beyond the transnational model’, Journal of International Business Studies, 35(5), 350‒70. Paine, S. and R.J. Crawford (1998), ‘The Haier Group A’, Harvard Business School case study 398101, Harvard Business School Publishing. Porritt, J. (2005), Capitalism as if the World Matters, London and Sterling, VA: Earthscan. Prahalad, C.K. (2005), The Fortune at the Bottom of the Pyramid Eradicating Poverty Through Profits, Upper Saddle River, NJ: Wharton School Publications. Prahalad, C.K and S.L. Hart (2002), ‘The fortune at the bottom of the pyramid’, Strategy+Business, 26, 54‒67. Prahalad, C.K. and K. Lieberthal (1998), ‘The end of corporate imperialism’, Harvard Business Review, 76(4), 68‒79. Ramamurti, R. (2004) ‘Developing countries and MNEs: extending and enriching the research agenda’, Journal of International Business Studies, 35(4), 277‒83. Rangan, V.K. (2007), Business Solutions for the Global Poor: Creating Social and Economic Value, San Francisco, CA: Jossey-Bass. Sabharwal Ahmad, P., M, Egorman and P. Werhane (2004), ‘Case study: Hindustan Lever Limited and marketing to the poorest of the poor’, International Journal of Entrepreneurship and Innovation Management, 4(5), 495‒511. de Soto, H. (2000), The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, New York: Basic Books. United Nations Development Programme (UNDP) (2007), Growing Inclusive Markets, New York: UNDP.

Index Academy of Sciences, Czech Republic 47 acquisition FDI 48‒9 Czech life sciences 49‒50 Alternative Energy Act, Japan 151 alternative energy systems 149‒63 firm strategies 159‒61 government support 161‒2 market developments 150‒58 reasons for market changes 158‒62 asset exploitation motive for innovation 26 asset-seeking FDI, CEE life sciences sector 46 asset-seeking motive for innovation 26 Base of the Pyramid 166‒7, 167‒71 Baxter Corporation 49 Beamish, P.W. 80 Bell, M. 118 biofuels industry 157 Bottom of the Pyramid 166‒7, 167‒71 Brazil biofuels industry 157 government role in oil industry 121 oil industry 113‒14, 116‒18, 121, 122, 146‒7 bridging, multinationals and lowincome markets 170 California Fuel Cell Partnership 160 cars, alternative fuel technology 155‒6 Casas Bahia 174 Central and Eastern European (CEE) countries, life science industry 42‒54 Czech Republic 46‒54 FDI 45‒8 Certified Emission Reduction (CER) 127

China energy needs and alternative technologies 156‒7 FDI from Hong Kong 92‒107 government role in oil industry 121‒2 innovativeness of foreign firms 24‒5, 28‒37, 31‒4 motivations for international alliances 78‒88, 145 oil industry 114‒15, 119‒20, 121‒2, 122‒3, 146‒7 circles of Thailand 13‒14 Clean Air Act 152 Clean Development Mechanism (CDM) 127 climate change conferences 154‒5 clinical research Czech Republic 47‒8 in developing countries 58‒70 Mexico 64‒9 CNPC (China National Petroleum Corporation) 115, 120 COFEPRIS 67 competition, alternative energy industry 159‒61 consortiums, alternative energy industry 160 cooperation, alternative energy industry 160‒61 Cowan, R. 161 Crawford, R.J. 175 cross-border investment see FDI cross-cultural intelligence 11‒12 cultural intelligence 10‒12 cultural onion model 11 cultural units 11 cultural webs 11‒12 culture and multinationals 6‒20 attitudes to deadlines 7‒8, 16 attitudes to mistakes 8‒10, 17‒18

183

184


culture, definition 10 Czech Republic, life sciences sector FDI 46‒8 greenfield investments 51 multinational companies 48‒53 partnerships 51‒2 takeovers 49‒50 Dachs, B. 23 Dacin, M.T. 80, 81 Dantas, E. 118 deadlines, cultural differences 7‒8, 16 Denmark, alternative energy firms 153 developing countries clinical trials 58‒70 low income markets 166‒81 and multinationals 171‒3 dispersed locations, low-income markets 175‒6 disposable income, low income markets 173‒5 Dutch culture and deadlines 7‒8, 16 and mistakes 8‒10, 17‒18 view of ‘environment’ 15 view of ‘others’ 14 view of ‘self’ 12‒13 Ecair 138, 140 education and low-income markets 176‒7 efficiency-seeking FDI, CEE life sciences sector 45‒6 egalitarianism as Dutch trait 12‒13 emerging economies 2‒3 energy industry see alternative energy systems; oil industry environment, cultural interpretations 15‒16 ethics committees and clinical trials, Mexico 68‒9 European Union accession, effects on life sciences, CEE countries 45 waste management industry 134‒5 FDI (foreign direct investment) CEE life sciences sector 45‒6 Czech life sciences 46‒8

Guangdong 93, 96, 146 oil sector 112‒15 Feenstra, R.C. 92 Ferring-Léčiva 51 foreign direct investment see FDI foreign ownership and innovation 23‒37 Frenz, M. 23 Fung, K. 103 Galena 49 Gilead Sciences 51‒2 government policies and waste management industry 131‒5 government role alternative energy industry 161‒2 oil industry 121‒2 greenfield FDI 48‒9 Czech Republic 51 Grontmij 139‒40 Guandong 92‒107 economic relations with Hong Kong 93‒6, 145‒6 Hong Kong FDI 93, 96, 146 labour productivity 97 technological catching-up through FDI 96‒103 total factor productivity 97‒103 Gunby, P. 161 Guo, W.X. 83‒4 Haier Group 175 Hart, S.L 168 healthcare system, Mexico 65‒6 Hirschman, A.O. 3 Hitt, M.A. 80‒81 Hofstede individualism index 12, 13 Holmes, H. 13 Hong Kong 92‒6, 104‒7 economic relations with Guangdong 93‒6, 145‒6 FDI in Guangdong 93, 96, 146 history of manufacturing development 104‒6 Hopstaken, F. 133 human resources and clinical trial market 63‒4 Ietto-Gillies, G. 23 Immunotech Czech Republic 49

Index incentives, alternative energy industry 154 India, energy needs and alternative technologies 156‒7 individualism index 12, 13 industrial output dynamics, Guangdong 97 infrastructure and low-income markets 178 innovation 3‒4 impact of foreign ownership 23‒37 China 28‒37 measurement 29‒31 and multinationals 1‒2, 25‒8 innovation intensity 24, 30 innovation novelty 29‒30 and foreign ownership 30‒31 intensity 32‒4, 34‒5 propensity 24, 30, 31, 34 innovation process, pharmaceutical industry 59‒60 innovation propensity 24, 30 Innovation and Technology Fund (ITF), Hong Kong 106 intangible assets motive for Sino-Triad alliances 86‒7 intensity indicator of innovation 24, 30 intensity of innovations of high novelty 32‒4, 34‒5 International Clinical Research Centre, Czech Republic 47‒8 internationalization of clinical research 60‒64 drivers of 60‒62 internationalization of R&D 27‒8 internationalization, waste management industry 133‒5 and Kyoto Protocol 130 Japan alternative energy developments 151‒2 alternative fuel vehicles 155‒6 Jiangsu Province, China 28‒37 innovation and foreign firms 31‒4 Joint Implementation (Kyoto Protocol) 127 Kemp, R. 154, 155 Klausner, W.J. 15

185

knowledge-based competition, alternative energy industry 160 knowledge-based theory and knowledge transfer 27 Komin, S. 13 Kwong, K. 104, 105, 106 Kyoto Protocol and waste industry 127‒41 and Dutch waste firms 137‒40, 147 and firms’ international expansion 130 labour productivity, Guangdong 97 Lachema 49 Laminar Medica 51 Léčiva 49, 51 Lemoine, F. 103 leverage Hong Kong 105‒6 multinationals and low-income markets 170 Li, H.G. 97 life science industry 41‒54 CEE countries 44‒5 Czech Republic 46‒54 FDI 45‒8 Lin, X.L. 83‒4 locational conditions and impact of innovation 26‒7 Lonza 50 low-income markets 166‒81 characteristics 173‒8 market opportunities 170‒71 and multinationals’ strategy 178‒80 Luo, Y.D. 84 Maiti, R. 61 managerial capability motive for SinoTriad alliances 86 manufacturing development, Hong Kong 104‒5 market access as motive for Sino-Triad alliances 84‒5 market size, low-income markets 170‒71 market-based approaches to lowincome markets 168‒70 market-based instruments and waste management firms 129‒30

186


market-seeking FDI, CEE life sciences sector 45 Mexico, clinical research 64‒9 mistakes, cultural differences in attitudes 8‒10, 17‒18 Moser Baer 156‒7 motivations, Sino-Triad alliances 78‒88 Chinese perspectives 82‒7 Triad perspectives 81‒2, 84‒7 multinationals 1‒2 Czech life sciences sector 48‒53 in developing countries 171‒3 and innovation in host countries 25‒37 and low-income markets 178‒80 as multicultural units 18‒19 R&D expenditure 41‒2 National Renewable Energy Laboratory (NREL) 155 Netherlands culture see Dutch culture waste firms and Kyoto Protocol 137‒40 waste management industry 135‒7 Ng, L.F. 105, 106 Nokia, consumer education program 177 oil industry 111‒23 Brazil 113‒14, 116‒18 China 114‒15, 119‒20 FDI 112‒15 role of governments 121‒2 others, cultural interpretations 14‒15 outputs, waste management industry 133 Paine, S. 175 partnerships alternative energy industry 161 life sciences sector, Czech Republic 51‒2 Petrobras (Petróleo Brasileiro) 113‒14, 116‒18 PetroChina 119‒20 pharmaceutical industry and biotechnology companies 43‒4 innovation process 59‒60 see also clinical research

Pliva-Lachema 49 Prahalad, C.K. 168, 174 private firms, waste management industry 136 product innovation novelty 29‒30 pro-poor innovations 172‒3 propensity indicator of innovation 24, 30, 31, 34 public healthcare system, Mexico 65‒6 Public Utilities Regulatory Policy Act, US 152 purchasing power, low-income markets 174 R&D see research and development Raghavendra, M. 61 regulatory issues and clinical trials, Mexico 66‒8 reputational capital as motive for SinoTriad alliances 87 research and development (R&D) CEE countries 42 Chinese oil firms 119 expenditure, multinationals 41‒2 life sciences sector 43‒4 Czech Republic 46‒53 research and development unit acquisition as FDI 50, 53 research institutes, Czech Republic 47 acquisition 50 Robson, M. 30 Root, F. 42 Sadowsky, B.M. 23 Sadowsky-Rasters, G. 23 scalability, pro-poor innovations 172‒3 self, cultural interpretations 12‒14 Sino-Triad alliances 78‒88 skill levels, low-income markets 176‒7 social circles, Thailand 13‒14 Soete, L. 155 Solar Energy Laboratory, US 152 solar industry, US 152 strategic motivations for international alliances 78‒88 Sun, Y. 93‒4 sustainability 4

Index takeovers, Czech life sciences 49‒50 Tangtongtavy, S. 13 technological access as motive for Sino-Triad alliances 85‒6 technological accumulation, oil firms 115‒20 Thai culture and deadlines 7‒8, 16 and mistakes 8‒10, 17‒18 three circles of Thailand 13‒14 view of ‘environment’ 15‒16 view of ‘others’ 14‒15 view of ‘self’ 13‒14 total factor productivity, Guangdong 97‒103 transaction cost-based theory and knowledge transfer 27 Triad multinationals alliances with Chinese partners 78‒88 Tuan, C. 105

Valdez-Martinez, E. 69 value added manufacturing, Hong Kong 105‒6 van der Horst, H. 12‒13 Van der Wiel Holding BV 137‒8 Veluwse Afval Recycling BV 138‒9

Unal-Kesenci, D. 103 United States, alternative energy developments 152‒3, 155

Yeung, G. 94

187

waste as commodity 131‒2 waste industry 127‒41 government policies 131‒5 internationalization 133‒5 Kyoto Protocol and firms’ international expansion 130 Netherlands 135‒40 internationalization 137‒40 waste processing 132 waste-to-energy 140 webs of culture 11‒12 wind energy 152‒3, 156, 157 Wong, K. 93‒4 World Wide Recycling BV 138‒9, 140

Zentiva 49

Multinationals and Emerging Economies: The Quest for Innovation and Sustainability

Intellectual Property, Innovation and Management in Emerging Economies

Technological Innovation and Third World Multinationals

Indicator Systems for Sustainable Innovation (Sustainability and Innovation)

Innovations Towards Sustainability: Conditions and Consequences (Sustainability and Innovation)

Growth and Development in Emerging Economies

Knowledge Economies: Organization, location and innovation

Taxation of Financial Intermediation: Theory and Practice for Emerging Economies

Taxation of Financial Intermediation. Theory and Practice for Emerging Economies

From Agglomeration to Innovation: Upgrading Industrial Clusters in Emerging Economies

Technological Innovation for Sustainability - DoCEIS 2011

The Strategic Development of Multinationals: Subsidiaries and Innovation

The Strategic Development of Multinationals: Subsidiaries and Innovation

Media Piracy in Emerging Economies

Media Piracy in Emerging Economies

Cyber Law and Cyber Security in Developing and Emerging Economies

Innovation for Sustainable Electricity Systems: Exploring the Dynamics of Energy Transitions (Sustainability and Innovation)

New Frontiers in Environmental and Social Labeling (Sustainability and Innovation)

Multinationals and global capitalism

Multinationals and Development

Multinationals, Clusters and Innovation: Does Public Policy Matter?

Innovation in Environmental Policy?: Integrating the Environment for Sustainability

Innovation in Environmental Policy?: Integrating the Environment for Sustainability

Agricultural Policies in Emerging Economies 2009: Monitoring and Evaluation

Science and Innovation for Development

E-procurement in Emerging Economies: Theory and Cases

Skills for Innovation and Research

Income and Influence: Social Policy in Emerging Market Economies

Monetary Policies and Inflation Targeting in Emerging Economies

Trade and Competition, from Doha to Cancun (Emerging Economies Transition)

Multinationals and Emerging Economies: The Quest for Innovation and Sustainability

Intellectual Property, Innovation and Management in Emerging Economies

Technological Innovation and Third World Multinationals

Indicator Systems for Sustainable Innovation (Sustainability and Innovation)

Innovations Towards Sustainability: Conditions and Consequences (Sustainability and Innovation)

Growth and Development in Emerging Economies

Knowledge Economies: Organization, location and innovation

Taxation of Financial Intermediation: Theory and Practice for Emerging Economies

Taxation of Financial Intermediation. Theory and Practice for Emerging Economies

From Agglomeration to Innovation: Upgrading Industrial Clusters in Emerging Economies

Technological Innovation for Sustainability - DoCEIS 2011

The Strategic Development of Multinationals: Subsidiaries and Innovation

The Strategic Development of Multinationals: Subsidiaries and Innovation

Media Piracy in Emerging Economies

Media Piracy in Emerging Economies

Cyber Law and Cyber Security in Developing and Emerging Economies

Innovation for Sustainable Electricity Systems: Exploring the Dynamics of Energy Transitions (Sustainability and Innovation)

New Frontiers in Environmental and Social Labeling (Sustainability and Innovation)

Multinationals and global capitalism

Multinationals and Development

Multinationals, Clusters and Innovation: Does Public Policy Matter?

Innovation in Environmental Policy?: Integrating the Environment for Sustainability

Innovation in Environmental Policy?: Integrating the Environment for Sustainability

Agricultural Policies in Emerging Economies 2009: Monitoring and Evaluation

Science and Innovation for Development

E-procurement in Emerging Economies: Theory and Cases

Skills for Innovation and Research

Income and Influence: Social Policy in Emerging Market Economies

Monetary Policies and Inflation Targeting in Emerging Economies

Trade and Competition, from Doha to Cancun (Emerging Economies Transition)

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