Week 5

Disruptive innovation in multinational enterprises

Birton J. Cowden and Hadi S. Alhorr Saint Louis University, St Louis, Missouri, USA

Abstract

Purpose – This paper aims to address the link between the internationalization of the MNC and its location choices and the discovery of disruptive innovations among the dispersed network of subsidiaries.

Design/methodology/approach – A recent categorization of innovation suggests that not all innovations can be treated the same. Distinguishing between the various innovation typologies, this paper focuses on disruptive innovation within an international context. Many researchers have found that large incumbent firms tend to have issues with developing disruptive innovation, and are often disrupted by new entrants. However, there are cases of MNEs being successful with disruptive innovation and this paper sets out to theoretically explain where MNEs find ideas for disruption to aid in the incumbent’s curse. Specifically, this paper asks, where do disruptive innovations originate in a MNE?

Findings – Using a transaction cost approach and resource-based view, along with other seminal pieces in international business, it is proposed that disruptive ideas start in subsidiaries. It further proposes the characteristics of these subsidiaries that should increase the likelihood of discovering disruption.

Originality/value – This paper not only expands the boundary conditions of disruptive innovation, but also expands on the “where” question for knowledge acquisition and long-term performance in MNEs.

Keywords Disruptive innovation, FSAs-CSAs, Innovation in MNEs, Subsidiary roles

Paper type Conceptual paper

Introduction

In many ways innovation is the single most important building block of competitive advantage . . . giving a company something unique that its competitors lack (Hill and Jones, 1998, p. 89).

Recently, research on innovation strategy of multinational enterprises (MNEs) has come into focus, specifically on how a MNE creates centers of excellence (Forsgren et al., 2000), cross-subsidies innovations worldwide (Birkinshaw et al., 2005) and ultimately achieves simultaneous global coordination and local responsiveness (Cantwell and Janne, 1999). Scholars from various realms of mainstream management have predominantly focused on the efficacies of incremental innovation, offering contributions about innovation and its relationship to firm performance (Cohen, 2010), the firm structure (Pierce and Delbecq, 1977), and internal characteristics and capabilities (Damanpour, 1991).While this focal premise on innovation and strategic choices has received empirical and theoretical support, the existing literature has not given adequate attention to the various typologies of innovation and the extent to which different types of innovations impact organizational strategic choices.

The current issue and full text archive of this journal is available at

www.emeraldinsight.com/1525-383X.htm

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Received 25 May 2013 Revised 24 June 2013 Accepted 9 August 2013

Multinational Business Review Vol. 21 No. 4, 2013 pp. 358-371 q Emerald Group Publishing Limited 1525-383X DOI 10.1108/MBR-05-2013-0027

In fact, the existing literature on innovation suggests that innovation lies on a spectrum with disruptive innovations on one side of the spectrum and sustaining innovations on the other. Disruptive innovations are simple adaptations to existing technologies that appeal to customers who were not attracted to previous products. From a market standpoint, this is considered a low-end encroachment (Schmidt and Druehl, 2008), where a firm targets a higher volume of customers by providing a cheaper, no-frills version of existing solutions. An example of this disruptive innovation from a MNE is General Electric’s portable ultrasound machine that was developed out of a need to better attract lower income markets (Zeschky et al., 2011). Conversely, sustaining innovations are incremental improvements on existing technology that allows the firm to move up the market in order to sell higher margin products to its best customers (Christensen, 1997). One can think about these innovations as a firm’s next generation product that comes out periodically. Due to the nature of disruptive innovation, many have observed that incumbents tend to not pursue disruptive ideas because of organizational inertia, path dependencies, resource dependencies of their existing progress of moving up the market to higher-end, more profitable customers (Barnes, 1984; Christensen and Raynor, 2003; Godkin and Allcorn, 2004), and their unwillingness to cannibalize themselves (Chandy and Tellis, 1998).

Additionally, the general management literature on innovation has primarily focused on sustaining innovations. Disruptive innovation has received very little attention in the field of strategy, and more specifically within the realm of international and cross-cultural studies (Cowden and Kalliny, 2013). Past research on disruptive innovation has predominantly focused on industry effects, innovative trends during times of uncertainty, and managerial behaviors towards disruptive innovation (Bower and Christensen, 1995; Christensen, 1997; Christensen and Raynor, 2003; Leifer et al., 2001). While the existing literature on disruptive innovation offers valuable insights towards understanding the various facets of disruptive innovation and its managerial implications, the main drawback is the focus on domestic firms with the firm as a single node.

Overall, disruptive innovations seem to be an uphill battle for MNEs. When taken from a view of the many nodes within a MNE, a deeper understanding of where firms pursue such endeavors is still lacking, which has led to companies still being reluctant to pursue a disruptive strategy (Hamel, 2000). This paper fills these gaps by theoretically explaining where disruption should come from in MNEs, and asks where does disruptive innovation originate in MNEs?

Christensen and Raynor (2003) argue that incumbent firms have three options to proactively pursue disruptive innovation. They can:

(1) change the processes and values of the current organization;

(2) create an independent organization; or

(3) acquire a different organization.

However, this initial analysis does not account for MNEs and their network of subsidiaries. This paper argues that disruptive innovation comes from the internal network of a MNE, specifically a subsidiary. It will further be proposed that certain characteristics of a subsidiary make it more likely to discover disruptive innovation.

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To make these arguments, this paper will rely on a transaction cost approach (Buckley and Casson, 1976; Rugman, 1981; Williamson, 1975) and the resource-based view (Barney, 1991; Dierickx and Cool, 1989; Teece et al., 1997; Wernerfelt, 1984). More specifically, this paper will follow Rugman and Verbeke’s (1992, 2001) understanding of MNE activities through the combination of firm-specific advantages (FSAs) and country-specific advantages (CSAs). FSAs are a firm’s unique resources, knowledge, and capabilities that the firm owns in order to gain a competitive advantage. FSAs can either be location-bound (LB-FSAs) or non-location bound (NLB-FSAs). CSAs are the unique benefits a firm receives by being located in a specific location, through either the home or host country. By understanding a firm’s FSAs and CSAs, many aspects of the firm’s behavior can be better understood (Rugman and Verbeke, 2007). This paper will argue that it is also robust enough to understand where MNEs discover disruptive innovations.

Within an international context, pursuing disruptive innovation poses an even more interesting question pertaining to the realm of strategic choices that a MNE implements to achieve its global excellence. Cantwell (2009) sees conflicting trends between firms keeping R&D centralized and having R&D in various subsidiaries. With the accelerating growth of internationalization, multinationals are experiencing greater competitive pressure to establish new markets and protect old ones. The ability and process to create any useful innovation is a dynamic capability that allows these multinational firms to sustain their competitive position in the global arena (Teece et al., 1997). However, studies on innovation have shown that not all innovation will prove long-term competitive success (Chandy and Tellis, 1998). As such, focusing on disruptive innovations has many positive implications.

Hence, building on the existing literature that discusses the pressures for MNEs to either act globally or locally, this paper contributes to the existing literature on innovations and strategic choices by offering a theoretical framework to determine where knowledge advantages can be gained within the MNE. These different strategies also play a major role in how a firm can innovate, specifically with disruption in mind. The last part of the paper offers implications and suggestions for future research on this topic.

Literature review Disruptive innovation and competitive advantage of the MNE The failure to disruptively innovate tends to be a major downfall for existing firms, as disruptive innovations are overwhelmingly introduced by new entrants who subsequently start a new market with new complementary inputs; additionally, it has been shown that incumbent firms typically win sustaining innovation battles (Christensen and Raynor, 2003). As stated above, the nature of disruptive innovation is for a low-end encroachment on the market, which is neglected and hard to predict as profitable. Christensen (1997) draws on resource dependency theory (Pfeffer and Salancik, 1978) to interpret the reason why some firms fail to introduce disruptive innovation, stating that outside actors set the boundaries of how the firm acts or reacts to certain circumstance as many stakeholders do not promote nor see the benefit for them to focus on something unproven.

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From inside the MNE, existing time, money, and effort has driven success, creating path dependency (Sydow et al., 2009). This path dependency creates organizational inertia, creating resistance to movement in new directions (Godkin and Allcorn, 2004). It becomes extremely difficult for managers to move backwards in the market to go after the less profitable customers, which could cannibalize their existing market share (Chandy and Tellis, 1998). Alternatively, sustaining innovations tend to be on the same trajectory of the existing path, with more data, and thus, more predictability of the short-term performance the firm can expect.

Although difficult, firms still seek out disruptive innovation as it is shown to be very beneficial for long-term competitive success (Christensen and Raynor, 2003). Yet, there are still many questions about this type of innovation and the characteristics of the firm that introduces them. As stated above, large incumbents are the ones that tend to get disrupted. This paper argues that geographically dispersed subsidiaries could serve as very beneficial resources to discover and exploit disruptive innovations.

Disruptive innovation and the MNE network Birkinshaw et al. (2007) focus on how to create new networks for discontinuous innovation, e.g. idea networks, corporate venturing networks, lead user groups, cross-industry alliances, and communities of practice, supplier networks, and open innovation networks. All of these networks require a deep reliance on external players. Connect and develop (Huston and Sakkab, 2006) is a similar concept in which the firm reaches out to various networks for solutions to pre-defined problems. In fact, existing studies suggest that the new frontier for innovation is to create experiences through networks of external partners and customer communities (Prahalad and Ramaswamy, 2003).

However, this does not appear true for disruptive innovations due to their nature. This is best understood by taking a transaction cost perspective. Barriers that increase transaction costs include bounded rationality and opportunism (Williamson, 1975). Like managers, customers also use heuristics (Petty et al., 1983; Tversky and Kahneman, 1973) and have bounded rationality, making it much more difficult for them to think of new products that do not exist. Researchers (Christensen and Raynor, 2003; Trott, 2001) believe that market research and customer feedback will not lead to disruptive innovation, as customers only focus on how to make what they already have better. MNE reliance on market research or feedback from existing customers would lead to an incremental change or sustaining innovation.

Thus, knowledge of the MNE’s existing customer base will likely not generate a cheaper, lower-frills product. Conversely, potential new customers will rarely ask for something that they do not know exists or seek out a product to complete a task that they can already do now without that product. Therefore, a supply side of external knowledge and ideas for disruption is innately limited.

Additionally, the nature of disruptive innovation allows for rampant opportunism of external players to capitalize on the disruptive technology themselves. As stated above, a disruptive innovation requires simpler technology and lower market entry, which is why new entrants are more prone to developing them as they do not require the size and expertise of a larger incumbent. Similarly, the reliance on an open network will increase the opportunism for another party to implement the idea at a quicker rate

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than the MNE, and thus, disruptive innovation suffers from a public good issue (Rugman, 1981).

Thus, internalization theory (Buckley and Casson, 1976; Coase, 1937; McManus, 1972; Rugman, 1981) suggests that internal instead of external markets are needed to capitalize on disruptive innovations for MNEs so firms can achieve their objectives more efficiently and effectively by using internal resources rather than external markets that typically have higher transaction costs. Further, scholars link internalization to knowledge and information flows (Teece, 1981). Costs will be associated with the acquisition and absorption of the knowledge that needs to be brought into the firm. Costs will also be accrued by the policing of external players to ensure that they do not unfairly act out of self-interest (Rugman, 1986). All of this increases uncertainty and requires a more in-depth process of transferring tacit knowledge (Pisano, 1990). The learning potential for the firm may provide the firm with a dynamic capability in disruptive discovery and implementation (Teece et al., 1997). Thus, excess reliance on external actors may reduce the learning potential and related dynamic capabilities.

P1. For MNEs that pursue disruptive innovations, more disruptive innovation will be discovered through the firm’s internal network rather than through open networks.

Where in the internal network? From an internal network perspective, the next step is to ask whether disruptive innovation comes from the center (parent initiative) or from a subsidiary. Prahalad (1976) and Doz (1980) describe the internal and external conflicts a firm faces when deciding between the strategies of global standardization for low-cost advantages and local responsiveness for differentiation advantages. Simultaneously, Doz et al. (1981) suggest that managers, depending on the context, use several decision – making processes for choosing one of these conflicting international orientations.

The global integration – local responsiveness (I-R) framework is formalized by Prahalad and Doz (1987), where they describe the difference between global business and global competition and how firms can compete with the two extreme pressures. The I-R framework has been utilized to map industries and determine overall strategies of MNEs, similar to Porter’s (1980) five forces. As the framework evolved, it is now seen that global and local forces both exist for every firm (Bartlett, 1983). Almost every decision a firm makes can be broken down into this framework by applying the same item across the entire reach of the firm or applying different ones based on the context of each location.

A third piece that was not originally part of the I-R framework is learning and innovation. Hedlund (1986) conceptualized that the MNE’s main focus is not to make decisions, but to innovate and learn. He proposes that the firm has the resources and incentives to have its internal network experiment and accumulate knowledge to progress innovation. Innovation and learning has taken a priority over the other pressures, so much so that Kogut and Zander (1992) argue that the firm’s ability to transfer knowledge is the reason why it exists. Cantwell (1989) states that technological accumulation for a firm is more important than capital accumulation. Bartlett and Ghoshal (1989, p. 147) describe transnational innovation as the process of using

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“linkages among dispersed units of the organization to leverage existing resources and capabilities, irrespective of location, to exploit any new opportunity that arises anywhere in the company”. This innovation can then be globally integrated or only applied to certain locations that are appropriate to satisfy local needs.

Organizational structures and managerial systems naturally arise based on the pressures between global integration and local responsiveness. Bartlett and Ghoshal (1989) provide four managerial systems MNEs could follow to optimize a firm’s assets, subsidiaries, and diffusion of knowledge: a multinational firm, an international firm, a global firm, or a transnational firm. Global and multinational firms are still the prominent strategies used by most MNEs today. While no firm will fit neatly into any one of the four categories, most align with either a global strategy or a multinational strategy (Leong and Tan, 1993).

From a theoretical standpoint, these frameworks can be explained using transaction cost theory (Rugman and Verbeke, 1992) or RBV (Rugman, 1996) by identifying the combination of FSAs and CSAs. Focusing on RBV, FSAs should be valuable, rare, inimitable, and non-substitutable (Barney, 1991). One very important FSA for a firm is knowledge of the market in which they operate (Eriksson et al., 1997; Gupta and Govindarajan, 1991; Kogut and Zander, 1992; Wiklund and Shepherd, 2003). With superior knowledge of the market, better decisions can be made, leading to better performance. In reference to disruptive innovation, the ability to be disruptive is highly dependent on a firm’s knowledge of the market, as it depends on knowing the current supply and demand for filling a need within a given market.

Research has shown that international diversity leads to the acquisition of new knowledge (Hitt et al., 1997), which leads to more innovation (Miller, 1996). Technological developments differ by location, and thus, allow a MNE to be technologically diverse (Cantwell and Janne, 1999). Pittaway et al. (2004) conclude that diverse perspectives, knowledge bases, behaviors, and thoughts are needed for complex and radical innovation processes. It has also been demonstrated that MNEs prefer to develop core technologies at home and develop other technologies abroad (Cantwell and Santaagelo, 1999). Thus, from a knowledge-based view, the initial discovery of disruption will most likely stem from a firm’s LB-FSAs due to the need of local responsiveness to best understand the idiosyncrasies of the market when operating in a host country. Bjerre and Sharma (2003) find that a majority of the knowledge in a MNE sits with the local subsidiaries. Shane (2000) concludes that opportunity searches are hard to do from the center because of the subsidiary’s prior knowledge. This theoretically implies that disruptive innovations must come from a subsidiary rather than the parent (Rugman and Verbeke, 2001), as it is up to the subsidiary to take advantage of local opportunities (Birkinshaw et al., 2005).

P2. For MNEs that pursue disruptive innovations, more disruptive innovations will be discovered in subsidiaries than in the parent.

Subsidiary focus Another implication of disruptive innovation being a combination of LB-FSAs in host countries is the determination of the subsidiary’s initiative. An initiative is “an entrepreneurial process, beginning with the identification of an opportunity and culminating in the commitment of resources to that opportunity” (Birkinshaw, 1997,

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p. 207). From a dynamic capabilities view, “more decentralized organizations with greater local autonomy are less likely to be blindsided by market and technological developments” (Teece, 2007, p. 1323). For a subsidiary to take on an initiative, it is assumed that the subsidiary has a significant level of autonomy from the parent, has access to resources, and a certain level of absorptive capacity to recognize an opportunity (Zahra and George, 2002). Given these assumptions, it is argued that disruptive innovation in a subsidiary stems from an initiative, but what type?

Four types of subsidiary market initiatives have been identified: global, local, internal, and global-internal hybrid (Birkinshaw, 1997). A subsidiary with a global market initiative utilizes NLB-FSAs to take on general global market solutions. With an internal market initiative, a subsidiary works on solutions that aid in the exchanges between nodes within the MNE. This can be for a specific node or for all nodes, depicting the global-internal hybrid. A subsidiary with a local market initiative utilizes LB-FSAs to take on specific needs in a defined market. Taken from the logic above, a subsidiary that pursues disruptive innovation must capitalize on its LB-FSAs to understand the need of the local market and effectively implement disruptive innovation. Thus, it is argued that more disruptive innovations are discovered due to local market initiatives of subsidiaries that have the resources and abilities to respond to local needs.

P3. For MNEs that pursue disruptive innovations, more disruptive innovations will be discovered in subsidiaries that pursue local market initiatives.

Subsidiary physical location Up until now, we have focused on the FSAs in the host country. CSAs also play a role in understanding where disruptive discoveries occur within a MNE. As stated above, targeting disruption can be thought of in classic micro-economic terms. Put simply, the firm encroaches the lower end of the market to attract higher demand from a larger base of customers whose needs were being unmet. Because of this unique attribute that makes up a disruptive innovation, it has previously been implied that disruptive innovation could be a means for MNEs to enter and operate in countries that consist of the bottom-of-the-pyramid (BOP) (Hart and Christensen, 2002), which represents the lowest-income individuals in the world, totaling about 4 billion people (Prahalad and Hammond, 2002). However, many MNEs have not pursued this strategy, most likely due to the lack of markets and formal institutions (Meyer, 2001; North, 1990; Tonoyan et al., 2010). Additionally, it has been shown that firms must rely on many third parties to complete transactions in the BOP (London and Hart, 2004). Thus, from the logic of our first proposition, subsidiaries located in the BOP may not be the most successful in discovering disruptive innovation.

More pointedly, we adopt the logic that being located in a country or region with a high supply of low-income individuals aids in the quantity of demand for disruptive innovation, but adds other CSAs that remove the transaction cost for the MNE. Again, innovating in the BOP adds transaction costs to the firm from the lack of property rights and a free market. The definition of an emerging economy is a country with “a rapid pace of economic development, and governmental policies favoring economic liberalization and the adoption of a free-market system” (Hoskisson et al., 2000, p. 249). Emerging economies provide a more structured market and set of rules than the BOP,

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but also provide many more low-income individuals than developed nations. Additionally, from a labor supply aspect, emerging economies can provide a workforce that intimately knows the markets and also has the skills and ability to create a disruptive innovation due to enhanced education systems than the BOP (Hoskisson et al., 2000; Khanna and Palepu, 2010). Therefore, the CSAs of a knowledgeable workforce with local ties, a supply of low-income customers, favorable institutions, and a migration to a free market provides an optimization with the FSAs mentioned above for a MNE to discover disruptive innovation.

P4. For subsidiaries that pursue local market initiatives, more disruptive innovation will be discovered in those located in emerging markets.

Discussion and implications While previous studies (Christensen, 1997; Christensen and Raynor, 2003) on disruptive innovations have laid the foundation to explain the “what” and “why” for disruptive innovations, this paper contributes to such literature by addressing the fundamental question of “where” for firms in an international setting. Specifically, this paper addresses the link between the internationalization of the MNC and its location choices and the discovery of disruptive innovations among the dispersed network of subsidiaries. Large incumbent firms find it difficult to pursue disruptive innovations and tend to get disrupted by new entrants. By addressing the “where” question, we can begin to set a framework for understanding this type of innovation.

This paper offers a theoretical linkage that makes the pursuit of such innovative opportunities a core element embedded in the MNE’s international operations. Linking transaction cost economics/internalization theory set forth by Rugman (1981) and Dunning (1988) with the concept of disruptive innovation, this paper suggests that disruptive innovation in MNEs can be understood through FSAs, CSAs, and internalization advantages. Hence, this paper offers that disruptive innovation fits neatly into the realm of international business and can be partly explained using the literature that forms the foundation of the field. Second, and subsequently, this approach shines light on a new stream of research that is needed in international business, and perhaps, provides the groundwork on how to begin filling this gap. While this might not be “the” question that sustains the international business research agenda, it does indicate a contradiction to Buckley’s (2002) view that the international business research agenda is out of steam.

The main theoretical premise of the paper suggests the existence of a strong relationship between the nature of disruptive innovation discovery and the structure and nature of the MNE’s internal network. Building on the existing literature on disruptive innovations (Bower and Christensen, 1995; Christensen, 1997; Christensen and Raynor, 2003; Leifer et al., 2001) offers a linkage between the firm’s structure and internal network and the process of disruptive innovation creation. We suggest that the research framework offered here bridges the gap between the way MNEs compete on a global or regional platform with a complex network of subsidiaries (a phenomena that has traditionally been a subject of interest among international managers), and the process of creating disruptive innovations. In this sense, the paper extends international innovation and knowledge management research by examining the

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firm-subsidiary level variables that have a direct effect on disruptively innovative activities. Additionally, this paper provides a bridge for future work to integrate intrapreneurship and international business (Antoncic and Hisrich, 2001; Stopford and Baden-Fuller, 1994).

This research has several implications. Most obvious, of course, are the implications for managers of international organizations seeking to develop innovations that are considered disruptive in nature. Indeed, the propositions of this paper might serve as a meaningful argument against those corporate stakeholders that tend to argue against decentralizing innovation to subsidiaries, especially in emerging markets.

This paper also implies that disruptive innovations will most likely not come from a grand initiative of the MNE that involves a lot of resources. As argued above, disruption comes in a very small scale to create a solution for one market by utilizing LB-FSAs. This does not mean, however, that disruption cannot be diffused to other areas of the MNE. While the discovery may take form from LB-FSAs, we concur with others (Birkinshaw, 1997; Rugman and Verbeke, 2001) that it is in the best interest of the firm for the disruptive innovation to be transformed into a NLB-FSA to implement in other potential markets or become a subsidiary-specific advantage (resources and capabilities that the subsidiary can exploit globally without interaction with headquarters or other subsidiaries) (Rugman and Verbeke, 2001). In fact, the innovation will probably not reach true disruptive innovation status by practitioners until the innovation is diffused to multiple markets. Arguably, because of the simplistic nature of disruptive innovation, the diffusion to other markets should not be difficult for the MNE to achieve.

Perhaps a subtle but profound implication from this paper is that we indirectly argue that a multinational strategy will prove to be more beneficial over time than a global strategy, based on our proposed FSA-CSA configuration as displayed by Rugman and Verbeke (1992). That is, if disruptive innovation has shown positive effects for long-term performance and survival, and, as this paper argues, a multinational strategy is best to pursue disruption, then a multinational strategy will prove best for long-term success. The obvious caveat is that a multinational strategy is necessary but not sufficient. A MNE must also be proactive in its pursuits of disruptive innovation and promote this type of thinking in each subsidiary. This logic directly aligns with the work of Nohria and Ghoshal (1994), which shows that MNEs govern through differentiated fit and shared values to achieve optimal performance.

Future studies can take this further to identify the relationship between headquarters and subsidiaries during the pursuit of disruption. What are the main functions of the subsidiaries and which strategy are they pursuing? Is there an optimal structure for discovering disruptive innovation? What other aspects of location matter (culture, economic systems, education, technological advancement, etc.)? Is there a regional dimension to disruptive innovation that determines the subsidiary location (Arregle et al., 2009)? Should the pursuit of disruptive innovation be evaluated as a unique determinant of FDI? Can disruption be acquired? What ownership and managerial controls are most successful in discovering disruption? Do strategic groups play a part in this process (Peng et al., 2004)?

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Conclusion Innovation is a key determinant of a MNE’s success, and some believe it is the most important. There are many works on MNE innovation, but very few actually look at innovation at a more detailed level. Different categories of innovation are typically handled differently inside the firm, and should be considered different on the scholastic side. Through the perspective of the appreciative theory (Nelson and Winter, 1982), international innovation studies should add the complexities of disruptive innovation and allow for its contextual specificities. This will allow scholars to examine more variations of firm success or failure through innovation. More importantly, determining the effects of the different types of innovation will enhance current knowledge for business managers and will reduce the barriers set by uncertainty, which may lead to more instances of successful disruptive innovation and how the process can be repeated successfully.

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Corresponding author Birton J. Cowden can be contacted at: [email protected]

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