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GLOBAL STRATEGY THIRD EDIT ION

Mike W. Peng, PhD

Jindal Chair of Global Strategy

Jindal School of Management

University of Texas at Dallas

Chair, Global Strategy Interest Group (2008)

Strategic Management Society

Fellow, Academy of International Business (since 2012)

Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

GLOBAL STRATEGY THIRD EDIT ION

Mike W. Peng, PhD

Jindal Chair of Global Strategy

Jindal School of Management

University of Texas at Dallas

Chair, Global Strategy Interest Group (2008)

Strategic Management Society

Fellow, Academy of International Business (since 2012)

Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States

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Global Strategy, 3rd Edition

Mike W. Peng

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ABOUT THE AUTHOR

Mike W. Peng is the Jindal Chair of Global Strategy at the Jindal School of Management, University of Texas at Dallas, a National Science Foundation CAREER Award winner, and a Fellow of the Academy of International Business. He is also Executive Director of the Center for Global Business, which he founded. At UT Dallas, he has been the number one contributor to the 45 top journals tracked by Financial Times, which has ranked UT Dallas as a top 20 school in research worldwide and its MBA and EMBA programs increasingly in the top tier.

Professor Peng holds a bachelor’s degree from Winona State University, Minnesota, and a PhD degree from the University of Washington, Seattle. Between 2005 and 2011, he was the first Provost’s Distinguished Professor at UT Dallas, a chair position that was created to attract him to join the faculty. He had previously been an associate professor (with tenure) at the Ohio State University. Prior to that he had served on the faculty at the Chinese University of Hong Kong and University of Hawaii. He has taught in five states in the United States (Hawaii, Ohio, Tennessee, Texas, and Washington) as well as China, Hong Kong, and Vietnam. He has also held visiting or courtesy appointments in Australia, Britain, China, Denmark, Hong Kong, and the United States.

Professor Peng is one of the most prolific and most influential scholars in global strategy. During the decade 1996–2006, he was among the top seven contributors to the Journal of International Business Studies. His research is also among some of the most widely cited—both the United Nations and the World Bank have cited his work. A Journal of Management article found him to be among the top 65 most widely cited management scholars, and an Academy of Management Perspectives study found him to be the fourth most influential management scholar both inside and outside of academia (measured by academic citations and non-edu Google webpages) among professors who obtained their PhD since 1991. Overall, Professor Peng has published over 100 articles in

VII Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

leading journals, over 30 pieces in non-refereed outlets, and five books. Since the launch of Global Strategy’s second edition, he has published not only in top global strategy journals, such as the Academy of Management Journal, Journal of International Business Studies, and Strategic Management Journal, but also in leading outlets in operations (Journal of Operations Management), entrepreneurship (Journal of Business Venturing and Entrepreneurship Theory and Practice), and human resources (International Journal of Human Resource Management).

Professor Peng’s market-leading textbooks, Global Strategy, Global Business, and GLOBAL, are studied in over 30 countries and have been translated into Chinese, Spanish, and Portuguese. A European adaptation, International Business (with Klaus Meyer), has been successfully launched.

Professor Peng is active in leadership positions. He has served on the editorial boards of AMJ, AMR, JIBS, JMS, JWB, and SMJ, and guest-edited a special issue for the JMS. At the Strategic Management Society (SMS), he was elected to be the Global Strategy Interest Group Chair (2008). He also co-chaired the SMS Special Conference on China in Shanghai (2007). At the Academy of International Business (AIB), he was co-chair of the AIB/JIBS Frontiers Conference in San Diego (2006), guest-edited a JIBS special issue (2010), chaired the Emerging and Transition Economies track for the Nagoya conference (2011), and chaired the Richard Farmer Best Dissertation Award Committee for the Washington conference (2012). He was recently elected to be a Fellow of AIB. He served one term as Editor-in-Chief of the Asia Pacific Journal of Management. During his editorial tenure, he managed the doubling of submission numbers and the successful bid to enter the Social Sciences Citation Index (SSCI), which reported APJM’s first citation impact to be 3.36 and rated it as the top 18 among 140 management journals for 2010.

Professor Peng is also an active consultant, trainer, and keynote speaker. He has provided on-the-job training to over 300 professors. He has consulted and been a keynote speaker for multinational enterprises (such as AstraZeneca, Berlitz, KOSTA, Nationwide, SAFRAN, and Texas Instruments), nonprofit organizations (such as Greater Dallas Asian American Chamber of Commerce and World Affairs Council of Dallas-Fort Worth), educational and funding organizations (such as Harvard University Kennedy School of Government, National Science Foundation, Social Sciences and Humanities Research Council of Canada, and the University of Memphis), and national and international organizations (such as the US-China Business Council, US Navy, and World Bank).

Professor Peng has attracted close to $1 million in external funding. His honors include a National Science Foundation CAREER Grant, a US Small Business Administration Best Paper Award, a (lifetime) Distinguished Scholar Award from the Southwestern Academy of Management, and a (lifetime) Scholarly Contribution Award from the International Association for Chinese Management Research. He has been quoted in The Economist, Newsweek, Dallas Morning News, Smart Business Dallas, Atlanta Journal-Constitution, The Exporter Magazine, The World Journal, Business Times (Singapore), Sing Tao Daily (Vancouver), and Brasil Econômico (São Paulo), as well as on Voice of America.

VIII ABOUT THE AUTHOR

BRIEF CONTENTS

About the Author vii Preface xxiii

PART 1 FOUNDATIONS OF GLOBAL STRATEGY 1 1 Strategizing Around the Globe 2

Opening Case: The Global Strategy of Global Strategy 3 Closing Case: Emerging Markets: Microsoft’s Evolving China Strategy 27

2 Managing Industry Competition 32 Opening Case: Emerging Markets: Competing in the Indian Retail Industry 33

Closing Case: Emerging Markets: High Fashion Fights Recession 57

3 Leveraging Resources and Capabilities 62 Opening Case: IBM at 100 63 Closing Case: Emerging Markets: From Copycats to Innovators 85

4 Emphasizing Institutions, Cultures, and Ethics 92 Opening Case: Cut Salaries or Cut Jobs? 93 Closing Case: Facebook Violates Privacy 119

PART 2 BUSINESS-LEVEL STRATEGIES 125 5 Growing and Internationalizing the Entrepreneurial Firm 126

Opening Case: Emerging Markets: Amazon.com of Russia 127 Closing Case: Emerging Markets: Microfinance: Macro Success or Global Mess? 149

6 Entering Foreign Markets 154 Opening Case: Enter the United States by Bus 155 Closing Case: Emerging Markets: Pearl River Goes Abroad 182

7 Making Strategic Alliances and Networks Work 188 Opening Case: Emerging Markets: Yum! Brands Teams Up with Sinopec 189

Closing Case: Emerging Markets: BP, AAR, and TNK-BP 215

8 Managing Global Competitive Dynamics 222 Opening Case: Patent Wars and Shark Attacks 223 Closing Case: Emerging Markets: HTC Fights Apple 253

IX Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

PART 3 CORPORATE-LEVEL STRATEGIES 257 9 Diversifying, Acquiring, and Restructuring 258

Opening Case: Emerging Markets: Corporate Diversification Strategy in South Korean Business Groups 259

Closing Case: Emerging Markets: Emerging Acquirers from China and India 288

10 Strategizing, Structuring, and Learning Around the World 294 Opening Case: Emerging Markets: Samsung’s Global Strategy Group 295 Closing Case: A Subsidiary Initiative at Bayer MaterialScience North America 321

11 Governing the Corporation Around the World 326 Opening Case: High Drama at Hewlett-Packard (HP) 327 Closing Case: Emerging Markets: The Private Equity Challenge 353

12 Strategizing with Corporate Social Responsibility 360 Opening Case: Launching the Nissan Leaf: The World’s First Electric

Car 361 Closing Case: Whole Foods’ John Mackey on Conscious Capitalism 385

Integrative Cases 389

IC 1 3i Group’s Private Equity Investment in China’s Little Sheep 391 IC 2 TeliaSonera: A Nordic Investor in Eurasia 404 IC 3 The Indian Business Process Offshoring Industry 409 IC 4 Wynn Macau: Gambling on the Edge of China 412 IC 5 Ryanair 418 IC 6 SolarWorld USA 424 IC 7 SnowSports Interactive: A Global Start-up’s Challenges 431 IC 8 Wikimart: Building a Russian Version of Amazon 436 IC 9 Texas Instruments in South Korea: An Educational Opportunity 440 IC 10 Jobek do Brasil’s Joint Venture Challenges 448 IC 11 The Antitrust Case on the AT&T–T-Mobile Merger 456 IC 12 Ocean Park Fights Hong Kong Disneyland 460 IC 13 Nomura’s Integration of Lehman Brothers’ Assets in Asia and

Europe 462 IC 14 Baosteel Europe 465 IC 15 Bank of America’s Corporate Social Responsibility and the Occupy

Wall Street Movement 471

Glossary 477 Index of Organizations 491 Index of Names 499 Index of Subjects 517

X BRIEF CONTENTS

CONTENTS

About the Author vii Preface xxiii

PART 1 FOUNDATIONS OF GLOBAL STRATEGY 1 CH A P T E R 1

Strategizing Around the Globe 2

Opening Case: The Global Strategy of Global Strategy 3 A Global Global-Strategy Book 4

Emerging Markets 1.1—Foxconn 6 Emerging Markets 1.2—GE’s Reverse Innovation from the Base of the Pyramid 8

Why Study Global Strategy? 9 What Is Strategy? 10

Origin 10 Plan versus Action 10 Strategy as Theory 11 Strategy in Action 1.1—German and French Military Strategy, 1914 12

Fundamental Questions in Strategy 15 Why Do Firms Differ? 15 How Do Firms Behave? 16 What Determines the Scope of the Firm? 17 What Determines the Success and Failure of Firms Around the Globe? 18

What Is Global Strategy? 19 What Is Globalization? 20

Three Views on Globalization 20 The Pendulum View on Globalization 21 Semiglobalization 22

Global Strategy and the Globalization Debate 23 Organization of the Book 24 Chapter Summary 25 Key Terms 26 Critical Discussion Questions 26 Topics for Expanded Projects 26 Closing Case: Emerging Markets: Microsoft’s Evolving China Strategy 27 Notes 29

XI Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

CHA P T E R 2

Managing Industry Competition 32

Opening Case: Emerging Markets: Competing in the Indian Retail Industry 33 Defining Industry Competition 34 The Five Forces Framework 35

From Economics to Strategy 35 Intensity of Rivalry among Competitors 35 Threat of Potential Entry 38 Strategy in Action 2.1—The Cruise Industry: Too Many Love Boats 39 Bargaining Power of Suppliers 41 Bargaining Power of Buyers 41 Threat of Substitutes 42 Lessons from the Five Forces Framework 43 Strategy in Action 2.2—From Cardinal Foods to Cardinal Health 44

Three Generic Strategies 45 Cost Leadership 45 Strategy in Action 2.3—Ryanair: The Continuous Search for Low Cost 46 Differentiation 47 Focus 47 Lessons from the Three Generic Strategies 48

Debates and Extensions 48 Clear versus Blurred Boundaries of Industry 48 Threats versus Opportunities 49 Five Forces versus a Sixth Force 50 Stuck in the Middle versus All Rounder 50 Industry Rivalry versus Strategic Groups 51 Integration versus Outsourcing 52 Industry-Specific versus Firm-Specific and Institution-Specific Determinants of Performance 54 Making Sense of the Debates 54

The Savvy Strategist 54 Chapter Summary 55 Key Terms 56 Critical Discussion Questions 56 Topics for Expanded Projects 57 Closing Case: Emerging Markets: High Fashion Fights Recession 57 Notes 59

CHA P T E R 3

Leveraging Resources and Capabilities 62

Opening Case: IBM at 100 63 Understanding Resources and Capabilities 64

Emerging Markets 3.1—The Ordinary Heroes of the Taj 66

XII CONTENTS

Resources, Capabilities, and the Value Chain 67 From SWOT to VRIO 71

The Question of Value 71 The Question of Rarity 72 The Question of Imitability 72 Strategy in Action 3.1—ANA: Refreshing the Parts Other Airlines Can’t Reach 73 The Question of Organization 74 Emerging Markets 3.2—Strategic Ambidexterity in Emerging Economies 75

Debates and Extensions 76 Firm-Specific versus Industry-Specific Determinants of Performance 76 Static Resources versus Dynamic Capabilities 77 Offshoring versus Non-Offshoring 79 Domestic Resources versus International (Cross-Border) Capabilities 81

The Savvy Stategist 82 Chapter Summary 83 Key Terms 84 Critical Discussion Questions 84 Topics for Expanded Projects 84 Closing Case: Emerging Markets: From Copycats to Innovators 85 Notes 87

CH A P T E R 4

Emphasizing Institutions, Cultures, and Ethics 92

Opening Case: Cut Salaries or Cut Jobs? 93 Understanding Institutions 94

Definitions 94 What Do Institutions Do? 95 Emerging Markets 4.1—Managing Uncertainty in Pakistan 96 Emerging Markets 4.2—Binding International Commercial Arbitration 97 How Do Institutions Reduce Uncertainty? 98

An Institution-Based View of Business Strategy 100 Overview 100 Two Core Propositions 102 Emerging Markets 4.3—The Institution-Based Motivation Behind Emerging Multinationals 103

The Strategic Role of Cultures 105 The Definition of Culture 105 The Five Dimensions of Culture 105 Cultures and Strategic Choices 107

The Strategic Role of Ethics 108 The Definition and Impact of Ethics 108 Managing Ethics Overseas 109 Ethics and Corruption 110

C ON T E N T S X I I I

A Strategic Response Framework for Ethical Challenges 111 Debates and Extensions 113

Opportunism versus Individualism/Collectivism 113 Cultural Distance versus Institutional Distance 114 Bad Apples versus Bad Barrels 115

The Savvy Strategist 115 Chapter Summary 117 Key Terms 117 Critical Discussion Questions 118 Topics for Expanded Projects 118 Closing Case: Facebook Violates Privacy 119 Notes 120

PART 2 BUSINESS-LEVEL STRATEGIES 125 CHA P T E R 5

Growing and Internationalizing the Entrepreneurial Firm 126

Opening Case: Emerging Markets: Amazon.com of Russia 127 Entrepreneurship and Entrepreneurial Firms 128 A Comprehensive Model of Entrepreneurship 129

Industry-Based Considerations 130 Resource-Based Considerations 130 Strategy in Action 5.1—Profiting from the Dirtiest Job Online 131 Strategy in Action 5.2—Private Military Companies 132 Institution-Based Considerations 133

Five Entrepreneurial Strategies 134 Growth 134 Innovation 134 Emerging Markets 5.1—Israel: The Start-Up Nation 135 Network 136 Financing and Governance 136 Harvest and Exit 138

Internationalizing the Entrepreneurial Firm 140 Transaction Costs and Entrepreneurial Opportunities 140 International Strategies for Entering Foreign Markets 141 International Strategies for Staying in Domestic Markets 141

Debates and Extensions 142 Traits versus Institutions 142 Slow Internationalizers versus Born Global Start-ups 143 Anti-Failure Biases versus Entrepreneur-Friendly Bankruptcy Laws 144

The Savvy Entrepreneur 146 Chapter Summary 147 Key Terms 147 Critical Discussion Questions 148

XIV CONTENTS

Topics for Expanded Projects 148 Closing Case: Emerging Markets: Microfinance: Macro Success or Global Mess? 149 Notes 150

CH A P T E R 6

Entering Foreign Markets 154

Opening Case: Enter the United States by Bus 155 Overcoming the Liability of Foreignness 156

Emerging Markets 6.1—Russian Firms Spread Their Wings 157 Understanding the Propensity to Internationalize 158 A Comprehensive Model of Foreign Market Entries 159

Industry-Based Considerations 160 Resource-Based Considerations 160 Institution-Based Considerations 161

Where to Enter? 163 Location-Specific Advantages and Strategic Goals 163 Emerging Markets 6.2—Dubai Airport Connects the World 164 Cultural/Institutional Distances and Foreign Entry Locations 166 Emerging Markets 6.3—Emerging Multinationals from South Africa 167

When to Enter? 168 How to Enter? 170

Scale of Entry: Commitment and Experience 170 Modes of Entry: The First Step on Equity versus Non-equity Modes 170 Modes of Entry: The Second Step on Making Actual Selections 174

Debates and Extensions 176 Liability versus Asset of Foreignness 177 Global versus Regional Geographic Diversification 177 Old-line versus Emerging Multinationals: OLI versus LLL 178

The Savvy Strategist 179 Chapter Summary 180 Key Terms 181 Critical Discussion Questions 181 Topics for Expanded Projects 182 Closing Case: Emerging Markets: Pearl River Goes Abroad 182 Notes 183

CH A P T E R 7

Making Strategic Alliances and Networks Work 188

Opening Case: Emerging Markets: Yum! Brands Teams Up with Sinopec 189 Defining Strategic Alliances and Networks 190

C O N T E N T S XV

A Comprehensive Model of Strategic Alliances and Networks 191 Strategy in Action 7.1—The Tug of War Over Japan Airlines 192 Industry-Based Considerations 193 Resource-Based Considerations 195 Emerging Markets 7.1—A Local Partner’s Perspective: “BP Has Been Treating Russians as Subjects” 197 Institution-Based Considerations 198

Formation 200 Stage One: To Cooperate or Not to Cooperate? 200 Stage Two: Contract or Equity? 200 Stage Three: Positioning the Relationship 202

Evolution 203 Combating Opportunism 203 Evolving from Strong Ties to Weak Ties 203 From Corporate Marriage to Divorce 205

Performance 206 The Performance of Strategic Alliances and Networks 206 The Performance of Parent Firms 207

Debates and Extensions 208 Majority JVs as Control Mechanisms versus Minority JVs as Real Options 208 Alliances versus Acquisitions 209 Emerging Markets 7.2—Embraer’s Alliances and Acquisitions 209 Acquiring versus Not Acquiring Alliance Partners 211

The Savvy Strategist 211 Chapter Summary 213 Key Terms 214 Critical Discussion Questions 214 Topics for Expanded Projects 214 Closing Case: Emerging Markets: BP, AAR, and TNK-BP 215 Notes 217

CHA P T E R 8

Managing Global Competitive Dynamics 222

Opening Case: Patent Wars and Shark Attacks 223 Strategy as Action 224 Industry-based Considerations 225

Collusion and Prisoners’ Dilemma 225 Industry Characteristics and Collusion vis-à-vis Competition 229 Emerging Markets 8.1—Is a Diamond (Cartel) Forever? 228

Resource-based Considerations 231 Value 231 Rarity 232 Imitability 232 Organization 232

XVI CONTENTS

Resource Similarity 232 Strategy in Action 8.1—A Fox in the Hen House 234 Fighting Low-Cost Rivals 235

Institution-based Considerations 236 Formal Institutions Governing Domestic Competition: A Focus on Antitrust 236 Formal Institutions Governing International Competition: A Focus on Antidumping 238 Emerging Markets 8.2—From Trade Wars to Antitrust Wars 239

Attack and Counterattack 241 Three Main Types of Attack 241 Awareness, Motivation, and Capability 242

Cooperation and Signaling 245 Local Firms versus Multinational Enterprises 245 Debates and Extensions 247

Strategy versus IO Economics and Antitrust Policy 247 Competition versus Antidumping 249

The Savvy Strategist 249 Chapter Summary 251 Key Terms 252 Critical Discussion Questions 252 Topics for Expanded Projects 252 Closing Case: Emerging Markets: HTC Fights Apple 253 Notes 255

PART 3 CORPORATE-LEVEL STRATEGIES 257 CH A P T E R 9

Diversifying, Acquiring, and Restructuring 258

Opening Case: Emerging Markets: Corporate Diversification Strategy in South Korean Business Groups 259 Product Diversification 261

Product-Related Diversification 261 Product-Unrelated Diversification 261 Product Diversification and Firm Performance 262

Geographic Diversification 263 Limited versus Extensive International Scope 263 Geographic Diversification and Firm Performance 264

Combining Product and Geographic Diversification 265 A Comprehensive Model of Diversification 266

Industry-Based Considerations 266 Strategy in Action 9.1—The Evolution of Danisco’s Corporate Strategy 267 Resource-Based Considerations 269

C ON T E N T S XV I I

Strategy in Action 9.2—Can HondaJet Fly High? 270 Institution-Based Considerations 272 The Evolution of the Scope of the Firm 273

Acquisitions 276 Setting the Terms Straight 276 Motives for Mergers and Acquisitions 277 Emerging Markets 9.1—Brazil’s Whopper Deal 278 Performance of Mergers and Acquisitions 280

Restructuring 282 Setting the Terms Straight 282 Motives for Restructuring 282

Debates and Extensions 283 Product Relatedness versus Other Forms of Relatedness 283 Acquisitions versus Alliances 284

The Savvy Strategist 284 Chapter Summary 285 Key Terms 286 Critical Discussion Questions 287 Topics for Expanded Projects 287 Closing Case: Emerging Markets: Emerging Acquirers from China and India 288 Notes 290

CHA P T E R 10

Strategizing, Structuring, and Learning Around the World 294

Opening Case: Emerging Markets: Samsung’s Global Strategy Group 295 Multinational Strategies and Structures 296

Pressures for Cost Reduction and Local Responsiveness 296 Four Strategic Choices 297 Emerging Markets 10.1—Citroën Designs Cars in Shanghai 300 Four Organizational Structures 300 The Reciprocal Relationship between Multinational Strategy and Structure 304

A Comprehensive Model of Multinational Strategy, Structure, and Learning 304

Industry-Based Considerations 304 Resource-Based Considerations 306 Institution-Based Considerations 307 Strategy in Action 10.1—Moving Headquarters Overseas 308

Worldwide Learning, Innovation, and Knowledge Management 310 Knowledge Management 310 Knowledge Management in Four Types of Multinational Enterprises 311 Globalizing Research and Development (R&D) 312 Problems and Solutions in Knowledge Management 313

XVIII CONTENTS

Debates and Extensions 314 One Multionational versus Many National Companies 315 Corporate Controls versus Subsidiary Initiatives 315 Strategy in Action 10.2—Centralized and Decentralized Strategic Planning at the Oil Majors 316 Customer-Focused Dimensions versus Integration, Responsiveness, and Learning 317

The Savvy Strategist 318 Chapter Summary 319 Key Terms 319 Critical Discussion Questions 320 Topics for Expanded Projects 320 Closing Case: A Subsidiary Initiative at Bayer MaterialScience North America 321 Notes 322

CH A P T E R 11

Governing the Corporation Around the World 326

Opening Case: High Drama at Hewlett-Packard (HP) 327 Owners 328

Concentrated versus Diffused Ownership 328 Family Ownership 329 State Ownership 329

Managers 330 Principal–Agent Conflicts 330 Principal–Principal Conflicts 331 Strategy in Action 11.1—The Murdochs versus Minority Shareholders 331

Board of Directors 333 Board Composition 334 Leadership Structure 334 Board Interlocks 334 The Role of Boards of Directors 335 Directing Strategically 335

Governance Mechanisms as a Package 336 Internal (Voice-Based) Governance Mechanisms 337 External (Exit-Based) Governance Mechanisms 337 Internal Mechanisms + External Mechanisms = Governance Package 338

A Global Perspective 339 A Comprehensive Model of Corporate Governance 340

Industry-Based Considerations 340 Resource-Based Considerations 342 Institution-Based Considerations 342

C O N T E N T S X IX

Debates and Extensions 344 Opportunistic Agents versus Managerial Stewards 345 Global Convergence versus Divergence 345 State Ownership versus Private Ownership 346 Emerging Markets 11.1—Welcoming Versus Restricting Sovereign Wealth Fund Investments 349

The Savvy Strategist 350 Chapter Summary 351 Key Terms 352 Critical Discussion Questions 352 Topics for Expanded Projects 353 Closing Case: Emerging Markets: The Private Equity Challenge 353 Notes 355

CHA P T E R 12

Strategizing with Corporate Social Responsibility 360

Opening Case: Launching the Nissan Leaf: The World’s First Electric Car 361 A Stakeholder View of the Firm 364

A Big Picture Perspective 364 Primary and Secondary Stakeholder Groups 364 A Fundamental Debate 365 Strategy in Action 12.1—Michael Porter on Creating Shared Value 367

A Comprehensive Model of Corporate Social Responsibility 368 Industry-Based Considerations 370 Resource-Based Considerations 372 Institution-Based Considerations 373

Debates and Extensions 378 Domestic versus Overseas Social Responsibility 378 Active versus Inactive CSR Engagement Overseas 379 Race to the Bottom (“Pollution Haven”) versus Race to the Top 380

The Savvy Strategist 380 Emerging Markets 12.1—Dow Chemical Company in China 381

Chapter Summary 383 Key Terms 383 Critical Discussion Questions 383 Topics for Expanded Projects 384 Closing Case: Whole Foods’ John Mackey on Conscious Capitalism 385 Notes 386

XX CONTENTS

Integrative Cases 389

IC 1 3i Group’s Private Equity Investment in China’s Little Sheep (Lily Fang, INSEAD, and Roger Leeds, Johns Hopkins University, School of Advanced International Studies) 391

IC 2 TeliaSonera: A Nordic Investor in Eurasia (Canan Mutlu, University of Texas at Dallas) 404

IC 3 The Indian Business Process Offshoring Industry (Debmalya Mukherjee, University of Akron) 409

IC 4 Wynn Macau: Gambling on the Edge of China (Javier C. Cuervo, University of Macau) 412

IC 5 Ryanair (Charles M. Byles, Virginia Commonwealth University) 418

IC 6 SolarWorld USA (David Darling and Fabia Bourda, University of Texas at Dallas) 424

IC 7 SnowSports Interactive: A Global Start-up’s Challenges (Marilyn L. Taylor, University of Missouri at Kansas City, Xiaohua Yang, University of San Francisco, and Diaswati (Asti) Mardiasmo, Queensland University of Technology) 431

IC 8 Wikimart: Building a Russian Version of Amazon (Daniel J. McCarthy and Sheila M. Puffer, Northeastern University) 436

IC 9 Texas Instruments in South Korea: An Educational Opportunity (Kris Baker, Harold Burman, Andrew Cyders, and Ben Wilson, University of Texas at Dallas, and Yanmin Wu, Texas Instruments) 440

IC 10 Jobek do Brasil’s Joint Venture Challenges (Dirk Michael Boehe, Insper Institute of Education and Research, and Luciano Barin Cruz, HEC Montréal) 448

IC 11 The Antitrust Case on the AT&T–T-Mobile Merger (Mike W. Peng, University of Texas at Dallas) 456

IC 12 Ocean Park Fights Hong Kong Disneyland (Michael N. Young, Hong Kong Baptist University) 460

IC 13 Nomura’s Integration of Lehman Brothers’ Assets in Asia and Europe (Mike W. Peng, University of Texas at Dallas) 462

IC 14 Baosteel Europe (Bernd Michael Linke, Friedrich Schiller University of Jena, Germany, and Andreas Klossek, Technical University of Freiberg, Germany) 465

C O N T E N T S XX I

IC 15 Bank of America’s Corporate Social Responsibility and the Occupy Wall Street Movement (Cathy Benjamin, Vivian Brown, James Buchanon, Grace Crane, and Michele Harkins, University of Texas at Dallas) 471

Glossary 477 Index of Organizations 491 Index of Names 499 Index of Subjects 517

XXII CONTENTS

PREFACE

It has been a decade since I began work on the first edition of Global Strategy. While thepractice of global strategy has clearly become more important, the research and teach- ing of global strategy have also scaled new heights. Two landmark events important to the global strategy community in the past decade are (1) the founding of a dedicated Global Strategy Interest Group (GSIG) within the Strategic Management Society (SMS) and (2) the launch of the Global Strategy Journal (GSJ). I have actively supported these two initiatives, by serving as the first elected officer of GSIG (culminating in my service as the GSIG Chair) and by serving as an inaugural member of GSJ’s editorial review board. I believe that the widespread adoption of Global Strategy’s first two editions has enhanced the legitimacy of the global strategy field, widened its influence, and helped push the launch of these two exciting initiatives.

Starting from 2002, my goal has been to set a new standard for strategic management and international business textbooks in general and global strategy textbooks in particular. Global Strategy serves the needs of three types of undergraduate or MBA courses: (1) global or international strategy courses, (2) strategic management courses (especially those taught by internationally oriented instructors), and (3) international business courses (especially those taught by strategically oriented instructors). Based on the enthusiastic support from students and professors in Angola, Australia, Austria, Brazil, Britain, Canada, Chile, China, Finland, France, Denmark, Germany, Hong Kong, India, Ireland, Macau, Malaysia, Mexico, the Netherlands, Netherlands Antilles, New Zealand, Norway, Portugal, Romania, Singapore, South Korea, Spain, Sweden, Switzerland, Taiwan, Thailand, and the United States, the first two editions achieved unprecedented success and largely accomplished my goal. In addition to English, Global Strategy is also available in Chinese, Spanish, and Portuguese. In short, Global Strategy is global.

The third edition aspires to do even better. It continues the market-winning framework centered on the “strategy tripod” pioneered in the first edition and has been thoroughly updated to capture the rapidly moving research and events in the past several years. Its most strategic features include (1) a broadened definition of “global strategy,” (2) a comprehensive and innovative coverage, (3) an evidence-based, in-depth, and consistent explanation of cutting-edge research, and (4) an interesting and accessible way to engage students.

A Broadened Definition of “Global Strategy” In this book, “global strategy” is defined not as a particular multinational enterprise (MNE) strategy, but as “strategy around the globe.” While emphasizing international strategy, we do not exclusively focus on it. Just like “international business” is about “business” (in addition to being “international”), “global strategy” is most fundamentally about “strategy” before being “global.” Most global strategy and international business

XXIII Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

textbooks take the perspective of the foreign entrant, typically the MNE, often dealing with issues such as how to enter foreign markets and how to look for local partners. Important as these issues are, they only cover one side of international business—namely, the foreign side. The other side, naturally, is how domestic firms strategize by competing against each other and dealing with foreign entrants. Failing to understand the “other side,” at best, captures only one side of the coin.

A Comprehensive and Innovative Coverage With a broadened definition of “global strategy,” this book covers the strategies of both large MNEs and smaller entrepreneurial firms, both foreign entrants and domestic firms, and both firms from developed economies and from emerging economies. As a result, this text offers the most comprehensive and innovative coverage of global strategy topics available on the market. In short, it is the world’s first global, global-strategy book. Its unique features include:

• A chapter on institutions, cultures, and ethics (Chapter 4) and a focus on the emerging institution-based view of strategy (in addition to the traditional industry-based and resource-based views) throughout the book.

• A chapter on entrepreneurship (Chapter 5), especially its internationalization aspects.

• A chapter on global competitive dynamics (Chapter 8), including substantial discussions on cartel, antitrust, and antidumping issues typically ignored by other textbooks.

• A chapter on both product and geographic diversification (Chapter 9), the first time these crucial aspects of corporate strategies appear in the same textbook chapter.

• A chapter on corporate governance around the world (Chapter 11), the first time both the principal-agent and principal-principal conflicts are given equal “air time.”

• A chapter on corporate social responsibility (Chapter 12), an increasingly important area of interest.

• A geographically comprehensive coverage, not only covering firms from the developed economies of the Triad (North America, Western Europe, and Japan) but also those from emerging economies of the world (with a focus on BRIC—Brazil, Russia, India, and China)

• A consistent theme on ethics, which is not only highlighted in Chapters 4 and 12 but also throughout all chapters in the form of Ethical Dilemma features and ethics-based Critical Discussion Questions

An Evidence-Based, In-Depth, and Consistent Explanation The breadth of the field poses a challenge to textbook authors. My respect and admiration for the diversity of the field have increased tremendously over the past decade. To provide an evidence-based, in-depth explanation, I have leveraged the latest research (including my own forthcoming and ongoing work).1 Specifically, every article published in the past

1 All my articles are listed at www.mikepeng.com and www.utdallas.edu/~mikepeng. Go to “Journal Articles.”

XXIV PREFACE

ten years in leading journals has been consulted. Consequently, the Notes after each chapter are lengthy and comprehensive. While not every publication is cited, I am confident that I have left no major streams of research untouched. Readers—especially contributors to the literature—should feel free to check the Name Index to verify this claim. (Unfortunately, a number of older references have to be deleted to make room for more recent research.)

Given the breadth of the field, it is easy to lose focus. To combat this tendency, I have endeavored to provide a consistent set of frameworks in all chapters. This is done in three ways. First, I have focused on the four most fundamental questions in strategic manage- ment.2 These are: (1) Why do firms differ? (2) How do firms behave? (3) What deter- mines the scope of the firm? and (4) What determines the success and failure of firms around the globe? A particular emphasis is on the fourth question on firm performance, which has also been argued to be the leading question guiding global strategy and international business research.3

Another way to combat the tendency to lose the sight of the “forest” while scrutinizing various “trees” (or even “branches”) is to consistently draw on the strategy tripod—the three leading perspectives on strategy, namely, industry-based, resource-based, and insti- tution-based views. An innovative feature is the development of the institution-based view. In every chapter, these three views are integrated to develop a comprehensive model. This provides a great deal of continuity in the learning process.

Finally, I have written a beefy “Debates and Extensions” section for every chapter. Virtually all textbooks uncritically present knowledge “as is” and ignore the fact that the field is alive with numerous debates. Because debates drive practice and research ahead, it is imperative that students be exposed to various cutting-edge debates.

An Interesting and Accessible Way To Engage Students If you fear this book must be very boring because it draws so heavily on current research, you are wrong. I have used a clear, engaging, conversational style to tell the “story.” Relative to rival books, my chapters are generally more lively and shorter. Some reviewers commented that reading Global Strategy is like reading a “good magazine.”

I have woven a large number of interesting anecdotes into the text. In addition to examples from the business world, “outside-the-box” examples range from ancient Chi- nese military writings to the Roman Empire’s import quotas, from quotes from Anna Karenina to mutually assured destruction (MAD) strategy during the Cold War.

So what? Many textbooks leave students to struggle with this question at the end of every chapter. In Global Strategy, every chapter ends with a section on “The Savvy Strategist” with one teachable table/slide on “Strategic Implications for Action” from a practical standpoint. No other competing textbook is so savvy and so relevant.

Students and professors especially enjoyed the wide-ranging and globally relevant cases in previous editions. In the third edition, I have worked hard to bring together a new (and I believe more attractive) set of case materials. The third edition has been blessed by a

2 R. Rumelt, D. Teece, & D. Schendel (eds.), 1994, Fundamental Issues in Strategy: A Research Agenda, Boston: Harvard Business School Press. 3 M. W. Peng, 2004, Identifying the big question in international business research, Journal of International Business Studies, 35(2): 99–108.

P R E F A C E XXV

global community of case contributors who are based in Australia, Brazil, Canada, China, Germany, India, Singapore, and the United States. Many are experts who are located in or are from the countries in which the cases take place. For example, we now have an Australia case written by an Australia-based author (see Integrative Case on SnowSports Interactive), a Brazil case penned by a Brazil-based author (see Integrative Case on Jobek do Brasil), two Macau and Hong Kong, China, cases contributed by Macau-based and Hong Kong-based authors (see Integrative Cases on Wynn Macau and Ocean Park fights Hong Kong Disneyland), and a Texas Instruments (TI) case coauthored by a TI executive (see Integrative Case on TI in South Korea). This edition also features a Russia case contributed by the world’s top two leading experts on Russian management (see Inte- grative Case on Wikimart). The end result is an unparalleled, diverse collection of case materials that will significantly enhance the teaching and learning of global strategy around the world.

What’s New in the Third Edition? Most strategically, the third edition has (1) enhanced the executive voice by drawing more heavily from CEOs and other strategic leaders and (2) dedicated more space to emerging economies.

First, if Global Strategy aims to train a new generation of global strategists, we need to coach them to think, act, and talk like CEOs. While I have taught a few CEO classes in executive education with Global Strategy, most students using the book—even the highest- level Executive MBA (EMBA) students—have not assumed that kind of executive respon- sibilities. To facilitate strategic thinking, the third edition has featured more extensive quotes and perspectives from CEOs and other strategic leaders. These are longer and more visibly prominent break-out quotes—not merely single quotes typically embedded (or “buried”) in paragraphs. In Chapter 1 alone, you will enjoy such insightful quotes from (1) Facebook’s founder, chairman, and CEO, (2) GE’s chairman and CEO, (3) Microsoft’s CEO of Greater China, and (4) P&G’s chairman and CEO. In later chapters, the following leaders will share their thoughts with you:

Bayer North America’s CEO Carlyle Group’s co-founder and managing

director Dow Chemical’s CEO GE’s former chairman and CEO IBM’s CEO LG’s chairman TNK-BP’s chairman and CEO

US Secretary of Justice (representing the Department of Justice’s challenge of AT&T’s proposedmergerwithT-Mobile)

US Secretary of Treasury (on the US-China Strategic and Economic Dialogue)

Whole Foods’ co-founder and CEO

Second, this edition builds on Global Strategy’s previous strengths by more promi- nently highlighting global strategy challenges in and out of emerging economies. This is both a reflection of the global realities in which emerging economies have played a more important role and a reflection of my own strong research interest in emerging econo- mies. Specifically, in the third edition, (1) a new Emerging Markets in-chapter feature is launched in every chapter, and (2) more than half of the longer Integrative Cases are now

XXVI PREFACE

devoted to competition in and out of emerging economies (including one case on Brazil, two on Russia, one on India, and five on China).

Of course, in addition to these new features, every chapter has been thoroughly updated. Of the 15 Integrative Cases, 14 (93%) are new to this edition. Of the 60 in- chapter features (each chapter has an Opening Case, a Closing Case, and three boxes), 54 (90%) are new.

Overall, the third edition of Global Strategy has packed rigor with relevance, timeliness with excitement, and the strategic with the practical. To see how this book, itself a global product, competes around the world, check out the Chapter 1 Opening Case.

Support Materials A full set of support materials is available for adopting instructors on the accompanying Instructor Resource CD, ensuring that instructors have the tools they need to plan, teach, and assess their course. These resources include:

• Instructor’s Manual—This comprehensive manual provides chapter outlines, lecture notes, and sample responses to end-of-chapter questions, providing a complete set of teaching tools to save instructors time in preparing for class and to maximize student success within the class. The Instructor’s Manual also includes notes to accompany the Integrative Cases from the text.

• Testbank—The robust Global Strategy testbank contains a wide range of questions with varying degrees of difficulty in true/false, multiple-choice, and short answer/essay formats. All questions have been tagged to the text’s learning objectives and according to AASCB standards to ensure students are meeting necessary criteria for course success. Instructors can use the included ExamView® software package to view, choose, and edit their test questions according to their specific course requirements.

• PowerPoint® Slides—Each chapter includes a complete set of PowerPoint slides designed to present relevant chapter material in a way that will allow more visual learners to firmly grasp key concepts.

Acknowledgment As Global Strategy launches its third edition, I first want to thank all the customers— professors, instructors, and students around the world who have made the book’s success possible. As my (non-book-related) research not only progresses but also accelerates while I work on the book, I also want to thank my over 90 coauthors around the world for being in action together with me on the research front.

At UT Dallas, I thank my colleagues Dan Bochsler, Larry Chasteen, Tev Dalgic, Van Dam, Greg Dess, Dave Ford, Richard Harrison, Maria Hasenhuttl, Charlie Hazzard, Marilyn Kaplan, Seung-Hyun Lee, Elizabeth Lim, John Lin, Livia Markóczy, Joe Picken, Roberto Ragozzino, Orlando Richard, Jane Salk, Mary Vice, Eric Tsang, and Habte Woldu, as well as the supportive leadership team—Hasan Pirkul (dean), Varghese Jacob (associate dean), and Greg Dess (area coordinator). I also thank my two PhD students, Brian Pinkham (now at Texas Christian University) and Steve Sauerwald, for their research assistance. One PhD student (Canan Mutlu), four MBA students (Kris Baker,

P R E F A C E XXV I I

Harold Burman, Andrew Cyders, and Ben Wilson), and seven EMBA students (Cathy Benjamin, Fabia Bourda, Vivian Brown, James Buchanon, Grace Crane, David Darling, and Michele Harkins) authored excellent case materials.

At South-Western Cengage Learning, I thank the “Peng team” that not only publishes Global Strategy but also Global Business and GLOBAL. Our Global Strategy team includes Erin Joyner, Publisher; Michele Rhoades, Senior Acquisitions Editor; Josh Wells, Associate Development Editor; Jonathan Monahan, Market Development Manager; Rob Ellington, Media Editor; and Tammy Grega, Editorial Assistant.

In the academic community, I would like to thank the reviewers:

Charles M. Byles (Virginia Commonwealth University)

Sara B. Kimmel (Belhaven College) Ted W. Legatski (Texas Christian

University)

Jun Li (University of New Hampshire) Carol Sanchez (Grand Valley State

University)

In addition, I thank many colleagues who provided informal feedback to me on the book. Over the last decade I have been blessed by such feedback from hundreds of colleagues from around the world. Space constraints here force me to only acknowledge colleagues who wrote me since the second edition, since colleagues who wrote me earlier were thanked in earlier editions. (If you wrote me but I failed to mention your name here, my apologies—blame this on the volume of such emails.)

M. Ambashankar (Gupta College of Management, India)

Hari Bapuji (University of Manitoba, Canada)

Balbir Bhasin (University of Arkansas at Fort Smith, USA)

Murali Chari (Rensselaer Polytechnic Institute, USA)

Tee Yin Chaw (Management and Science University, Malaysia)

Joyce Falkenberg (Norwegian School of Economics and Business Administration, Norway)

Todd Fitzgerald (Saint Joseph’s University, USA)

Myles Gartland (Rockhurst University, USA) Dennis Garvis (Washington and Lee

University, USA) John Gerace (Chestnut Hill College, USA) Mike Geringer (Ohio University, USA) Maria Hasenhuttl (University of Texas

at Dallas, USA) Katalin Haynes (Texas A&M University,

USA)

Stephanie Hurt (Meredith College, USA)

Anisul Islam (University of Houston, USA)

Basil Janavaras (Minnesota State University, USA)

Marshall Shibing Jiang (Brock University, Canada)

Ferry Jie (University of Technology, Sydney, Australia)

Ben Kedia (University of Memphis, USA) Aldas Kriauciunas (Purdue University,

USA) Sumit Kundu (Florida International

University, USA) Somnath Lahiri (Illinois State University,

USA) Seung-Hyun Lee (University of Texas at

Dallas, USA) David Liu (George Fox University, USA) Anoop Madhok (York University, Canada) Mike Poulton (Dickinson College, USA) David Pritchard (Rochester Institute of

Technology, USA)

XXVIII PREFACE

Pradeep Kanta Ray (University of New South Wales, Australia)

David Reid (Seattle University, USA) Al Rosenbloom (Dominican University, USA)

Anne Smith (University of Tennessee, USA) Clyde Stoltenberg (Wichita State University, USA)

Steve Strombeck (Azusa Pacific University, USA)

Jose Vargas-Hernandez (Universidad de Guadalajara, Mexico)

Loren Vickery (Western Oregon University, USA)

George White (Old Dominion University, USA)

En Xie (Xi’an Jiaotong University, China) Gracy Yang (University of Sydney,

Australia) Haibin Yang (City University of Hong

Kong, China) Richard Young (Minnesota State

University, USA) Wu Zhan (University of Sydney, Australia)

I also want to thank six very special colleagues: Sun Wei and Lui Xinmei (Xi’an Jiaotong University) in China, Joaquim Carlos Racy (Pontifícia Universidade Católica de São Paulo) and George Bedinelli Rossi (Universidade de São Paulo) in Brazil, and Mercedes Munoz (Tecnológico de Monterrey) and Octavio Nava (Universidad del Valle de Mexico) in Mexico. They loved the book so much that they were willing to endure the pain of translating the first and second editions into Chinese, Portuguese, and Spanish. Their hard work has enabled Global Strategy to reach wider audiences globally, living up to its self-proclaimed tagline as a “global, global-strategy book.”

In this edition, 30 colleagues—including one executive from Texas Instruments— graciously contributed cases:

Kris Baker (University of Texas at Dallas, USA)

Cathy Benjamin (University of Texas at Dallas, USA)

Dirk Michael Boehe (Insper Institute of Education and Research, Brazil)

Fabia Bourda (University of Texas at Dallas, USA)

Vivian Brown (University of Texas at Dallas, USA)

James Buchanon (University of Texas at Dallas, USA)

Harold Burman (University of Texas at Dallas, USA)

Charles Byles (Virginia Commonwealth University, USA)

Luciano Barin Cruz (HEC Montreal, Canada)

Grace He Crane (University of Texas at Dallas, USA)

Javier Cuervo (University of Macau, China)

Andrew Cyders (University of Texas at Dallas, USA)

David Darling (University of Texas at Dallas, USA)

Rohit Deshpande (Harvard Business School, USA)

Lily Fang (INSEAD, Singapore) Michele Harkins (University of Texas at

Dallas, USA) Andreas Klossek (Technical University of

Freiberg, Germany) Roger Leeds (Johns Hopkins University,

USA) Bernd Michael (Friedrich Schiller

University of Jena, Germany) Daniel McCarthy (Northeastern

University, USA) Diaswati (Asti) Mardiasmo (Queensland

University of Technology, Australia) Debmalya Mukherjee (University of

Akron, USA)

P R E F A C E XX IX

Canan Mutlu (University of Texas at Dallas, USA)

Sheila Puffer (Northeastern University, USA) Anjali Raina (HBS India Research Center,

India) Marilyn Taylor (University of Missouri at

Kansas City, USA)

Ben Wilson (University of Texas at Dallas, USA)

Yanmin Wu (Texas Instruments, USA) Xiaohua Yang (University of San

Francisco, USA) Michael Young (Hong Kong Baptist

University, China)—two cases

In addition, the work of the following global dignitaries was reprinted to grace the pages of our book:

Mikhail Fridman (chairman and CEO of TNK-BP and founder of Alfa Group, Russia)

John Mackey (co-founder and CEO of Whole Foods)

Michael Porter (strategy guru at Harvard Business School)

Last, but no means least, I thank my wife Agnes, my daughter Grace, and my son James—to whom this book is dedicated. I have named Agnes CEO, CFO, CIO, CTO, and CPO for our family, the last of which is coined by me, which stands for “chief parenting officer.” Ten years ago Grace was a newborn and James was still waiting for his turn to show up in the world. Now my ten-year-old Grace, already a voracious reader and writer, can help me edit, and my eight-year-old James can assist me to enter grades. Grace is writing and editing her 17th short story called My Magic Life, and James is very interested in creating Lego models. For now, Grace wants to be a lawyer and James a banker. As a third-generation professor in my family, I can’t help but wonder whether one (or both) of them will become a fourth-generation professor. To all of you, my thanks and my love.

MWP December 1, 2012

XXX PREFACE

P A R T1 FOUNDATIONS OFGLOBAL STRATEGY

1 Strategizing Around the Globe

2 Managing Industry Competition

3 Leveraging Resources and Capabilities

4 Emphasizing Institutions, Culture, and Ethics

CHAPTER1

STRATEGIZING AROUND THE GLOBE

KNOWLEDGE OBJECT IVES

After studying this chapter, you should be able to

1. Offer a basic critique of the traditional, narrowly defined “global strategy”

2. Articulate the rationale behind studying global strategy

3. Define what is strategy and what is global strategy

4. Outline the four fundamental questions in strategy

5. Participate in the debate on globalization with a reasonably balanced view and a keen awareness of your likely bias

ot o/ A le xe y St io p

2 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

OPENING CASE

The Global Strategy of Global Strategy

Launched in 2005, Global Strategy has been used by business schools in over 30 countries and is now available in Chinese, Spanish, and Portuguese in addition to English. Global Strategy has also spawned two related books: Glo- bal Business (a more comprehensive, traditional textbook in international business) and GLOBAL (a more compact, innovative paperback). Everybody knows global competi- tion is tough. How do Global Strategy and its sister books compete around the world? In other words, what is the nature of the global strategy of Global Strategy?

Global Strategy and its sister books are published by South-Western Cengage Learning, which is a division of Cen- gage Learning. Cengage Learning serves students, teachers, and libraries in the secondary and higher education markets, as well as government agencies and corporations. While the copyright page of this book indicates an address in Mason, Ohio (a suburb of Cincinnati), note that this is the address for the specific division: South-Western. The corporate headquar- ters of Cengage Learning is in Stamford, Connecticut. Cen- gage Learning is a global company, which is owned by Apax Partners of the UK and OMERS Capital Partners of Canada, two private equity groups. Overall, the global nature of Cen- gage Learning permeates the organization: it is UK- and Canadian-owned and US-headquartered. With annual sales of over $2 billion, Cengage Learning has approximately 5,800 employees worldwide across 35 countries.

In business and economics textbooks, South-Western Cengage Learning vies for number one in the world in terms of market share with McGraw-Hill Irwin and Pearson Prentice Hall, the other two members of the Big Three in this industry. While competition historically focused on the United States and other English-speaking countries, it is now worldwide. Global Strategy targets courses in strategic management and international business. While there is no shortage of textbooks in these two areas, Global Strategy broke new ground by being the first to specifically address their intersection. Thanks to enthusiastic students and pro- fessors in Angola, Australia, Austria, Brazil, Britain, Canada, Chile, China, Finland, France, Denmark, Germany, Hong Kong, India, Ireland, Japan, Macau, Malaysia, Mexico, the Netherlands, Netherlands Antilles, New Zealand, Norway,

Portugal, Romania, Singapore, South Korea, Spain, Swe- den, Taiwan, Thailand, and the United States, Global Strat- egy achieved unprecedented success.

While competition is primarily among the Big Three, Glo- bal Strategy has also attracted new entrants—competing textbooks published by smaller, historically more specialized academic publishers such as Cambridge, Oxford, and Wiley that are interested in breaking into the mainstream textbook market. In addition to new entrants, the publishing industry has also been experiencing another challenge: the digital revolution. E-books have emerged as a viable substitute to the printed version. Amazon now sells more Kindle versions than printed versions of books. To keep up with this movement, the Kindle version of Global Strategy has been available since the second edition.

Although competition, in theory, is global, in practice Cengage Learning needs to win one local market after another—literally, one course taught by one instructor in one school in one country. Obviously, no instructor tea- ches globally, and no student studies globally. Teaching and learning remain very local. For the company as a

M ap

Re so ur ce s

3 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

A Global Global-Strategy Book How do firms, such as Cengage Learning, McGraw-Hill, and Pearson, compete around the globe? In the publishing industry in each country, how do various foreign entrants and local firms interact, compete, and/or sometimes collaborate? What determines their success and failure? Since strategy is about competing and winning, this book on global strategy will help current and would-be strategists answer these and other important questions. Setting an example by itself, the book you are reading is a real global product that leverages its strengths, engages rivals, and competes around the world (see Opening Case).

However, this book does not focus on a particular form of international (cross-border) strategy, which is characterized by the production and distribution of standardized products and services on a worldwide basis. For over two decades, this strategy, com- monly referred to as “global strategy” for lack of a better term, has often been advocated by traditional global-strategy books.1 However, there is now a great deal of rumbling and soul-searching among managers frustrated by the inability of their “world car,” “world drink,” or “world commercial” to conquer the world.

whole, the motto is: “Think global, act local.” The hard truth is: Global Strategy does not have a “global strategy” (!). While this statement is provocative, what it really means is that Global Strategy does not have a grand strategic plan around the globe. What defines its strategy is a relentless process to be in touch with the rapidly evolving market and an unwavering commitment to aspire to meet and exceed customer expectations around the world. In other words, Cengage Learning embraces a “strategy as action” perspective, as opposed to a “strategy as plan” perspective. Every step of the way, Cengage Learning literally learns, tests the market, engages custo- mers, and aspires to improve in the next edition. For instance, the Portuguese edition has been developed by two professors in Brazil, who are not mere translators but “revisers” who enhance the local flavor. In the third edi- tion, Global Strategy builds on the already strong coverage of emerging economies in the two previous editions and introduces a new feature on emerging markets in every chapter. This edition has also expanded coverage on the previously under-covered regions such as Latin America and Africa, thus making Global Strategy more global.

Finally, to successfully compete around the globe, a good understanding of the rules of the game is a must. In some countries, foreign publishers are free to publish whatever they please. In other countries, foreign publishers are not allowed to publish anything at all. For example, Brazil allows

Cengage Learning to set up a wholly owned subsidiary that can publish the Portuguese version. However, China does not allow foreign publishers to publish books on their own. Therefore, Cengage Learning licensed the translation of Global Strategy to a leading Chinese publisher: Posts and Telecom Press. Further, Chinese rules dictate that all books published in China—regardless of foreign or domestic origin—have to pass political censorship. A thorough under- standing of these rules is crucial. Experienced editors at Posts and Telecom Press advised that the title be changed to Global Business Strategy (Quanqiu Qiye Zhanlue), to avoid potential confusion in the eyes of the political censors that this might be a book about “global military strategy.” Such important but subtle local knowledge helped avoid misun- derstandings and troubles down the road, and helped a global company to successfully turn a page locally.

Sources: Based on (1) author’s interviews with Cengage Learning executives in Brazil, China, and the United States; (2) Economist, 2010, The future of publishing, April 3: 65–66; (3) M. W. Peng, 2009,Global Strategy, 2nd ed., Cincinnati: South-Western Cengage Learning; (4)M.W. Peng, 2007,Quanqiu Qiye Zhanlue, translated by W. Sun & X. Lui, Beijing, China: Posts & Telecom Press; (5) M. W. Peng, 2008, Estratégia Global, translated by J. C. Racy & G. B. Rossi, São Paulo, Brazil: Cengage Learning; (6) M. W. Peng, 2010, Estrategia Global, segunda edición, translated by A. Alcérreca &M. Muñoz, Mexico City, Mexico: Cengage Learning.

(Continued)

OPENING CASE

4 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

In reality, multinational enterprises (MNEs), defined as firms that engage in foreign direct investment (FDI) by directly controlling and managing value-adding activities in other countries,2 often have to adapt their strategies, products, and services for local markets. For example, the Opening Case clearly shows that in the publishing industry, one size does not fit all. In the automobile industry, there is no “world car.” Cars popular in one region are often rejected by customers elsewhere. The Volkswagen Golf and the Ford Mondeo (marketed as the Contour in the United States), which have dominated Europe, have little visibility in the streets of Asia and North America. The so-called “world drink,” Coke Classic, actually tastes different around the world (with varying sugar content). The Coca-Cola Company’s effort in pushing for a set of “world commercials” centered on the polar bear cartoon character presumably appealing to some worldwide values and inter- ests has been undermined by uncooperative TV viewers around the world. Viewers in warmer weather countries had a hard time relating to the furry polar bear. In response, Coca-Cola switched to more costly but more effective country-specific advertisements. For instance, the Indian subsidiary launched an advertising campaign that equated Coke with “thanda,” the Hindi word for “cold.” The German subsidiary developed a series of commercials that showed a “hidden” kind of eroticism (!).3

It is evident that the narrow notion of “global strategy” in vogue over the past two decades (in other words, the “one-size-fits-all” strategy), while useful for some firms in certain industries, is often incomplete and unbalanced.4 This is reflected in at least three manifestations:

• Too often, the quest for worldwide cost reduction, consolidation, and restructuring in the name of “global strategy” has sacrificed local responsiveness and global learning. The results have been unsatisfactory in many cases and disastrous in others. Many MNEs have now pulled back from such a strategy. MTV has switched from standardized (American) English-language programming to a variety of local languages. With over 5,000 branches in 79 countries, HSBC is one of the world’s largest and most global banks. Yet, instead of highlighting its “global” power, HSBC brags about being “the world’s local bank.”

• Almost by definition, the narrow notion of “global strategy” focuses on how to compete internationally, especially on how global rivals, such as Coca-Cola and Pepsi, Toyota and Honda, and Boeing and Airbus, meet each other in one country after another. As a result, the issue of how domestic companies compete with each other and with foreign entrants seems to be ignored. Does anyone know the nationalities and industries of the following companies: Cemex, Embraer, Foxconn, Huawei, and Tata? Based in Mexico, Brazil, Taiwan, China, and India, these five firms are world-class competitors in, respectively, cement, aerospace, electronics manufacturing, telecommunications equipment, and cars. They represent some of the top MNEs from emerging economies. If such firms are outside your strategic radar screen, then perhaps the radar has too many blind spots (see Emerging Markets 1.1).

• The current brand of “global strategy” seems relevant only for MNEs from developed economies, primarily North America, Europe, and Japan—commonly referred to as the Triad—to compete in other developed economies, where income levels and consumer preferences may be similar. Emerging economies (or emerging markets), a term that has gradually replaced the term developing economies since the 1990s, now command half of the worldwide FDI inflow and nearly half of the global gross domestic product

multinational enterprise (MNE)

A firm that engages in for- eign direct investment (FDI) by directly controlling and managing value-adding activities in other countries.

foreign direct investment (FDI)

A firm’s direct investment in production and/or ser- vice activities abroad.

Triad

Three primary regions of developed economies: North America, Europe, and Japan.

emerging economies (emerging markets)

A label that describes fast- growing developing economies since the 1990s.

C h a p t e r 1 S t r a t e g i z i n g A r o u n d t h e G l o b e 5

E T H I C A L D I L E M M AEMERGING MARKETS 1.1

Foxconn

Until 2010, the vast majority of the endusers of Apple iPhones and iPads, Hewlett-Packard laptops, Amazon Kindles, and Microsoft Xboxes around the world had no clue about the firm that manufactured their beloved gadgets. The firm is Foxconn, which is headquartered in Taipei, Taiwan. Foxconn’s shares (under the name of Hon Hai) are not only listed in Taipei (TWSE: 2317), but also in Hong Kong (SEHK: 2038), London (LSE: HHPD), and NASDAQ (HNHPF). With $110 billion in annual revenue, Foxconn is the global leader in contract manufacturing services. In other words, everybody has heard that leading electronics firms such as Cisco, Dell, Ericsson, Intel, Motorola, Nintendo, Nokia, and Sony—in addition to those named in the first three lines of this box above—have outsourced a large chunk of their manufacturing to “low-cost producers.” But to whom? Only a small number of people know the answer: Foxconn has been scooping up a tremendous number of outsourcing orders.

Starting in 1975 in Taipei with a meager $7,500, Foxconn was founded by Taiwanese entrepreneur Terry Gou, who still serves as its chairman. As Foxconn becomes a giant, of course, industry insiders know and respect it. But outside the industry Foxconn lives in relative obscurity. It is likely to be the largest firm many people around the world have never heard of. Just how big is Foxconn? Worldwide, it has 1.3 million employees. In China alone, it employs over 920,000 workers (300,000 on one factory campus in Shenzhen). To put these mind- boggling numbers in perspective, its worldwide headcount is as large as the entire US military, and its headcount in China is three times the size of the Taiwanese military. In addition to China, Foxconn has factories in 12 countries: Australia, Brazil, the Czech Republic, India, Japan, Mexico, the Netherlands, Poland, Russia, Slovakia, Singapore, and the United States. Foxconn is the largest private employer and the largest exporter in China and the second largest exporter in the Czech Republic.

In 2010, Foxconn stumbled into the media spotlight, not because of its accomplishments, but because a dozen

employees in Shenzhen, China, committed suicide in a span of several months, most of them by jumping from high-rise Foxconn dormitories. Here comes one of the biggest paradoxes associated with such an emerging multinational. What are Foxconn’s secrets for being so successful? Just like 100 years ago when Henry Ford created the mass assembly line by standardizing each worker’s job, Foxconn has pioneered a business model that it calls e-enabled Components, Modules, Moves, and Services (eCMMS) that can help its clients save a ton of money. But why were there so many worker suicides that shocked the world? The business model is certainly a culprit. Working at Foxconn demands a great deal of concentration and repetition that breed enormous stress. Bloomberg Businessweek described Gou as “a ruthless taskmaster.” Although the media and corporate social responsibility gurus criticize Foxconn for treating workers like machines and exploiting cheap labor, there is no evidence that Foxconn has mistreated or abused employees. In fact, in China, labor watchdogs actually give Foxconn credit for exceeding the norms, by paying workers (relatively) higher salaries, on time, and for overtime. In both 2005 and 2006, it was among the Best Employers in China, according to a ChinaHR.com poll. In response to the suicides, Foxconn increased Shenzhen factory workers’ pay by 30% to $176 a month in 2010. Such raises cut earnings per share by about 5% in 2010 and by 12% in 2011. As a result, Gou recently scaled back his annual growth target from 30% to 15%. Despite the setback, this intriguing (and until recently largely hidden) emerging multinational continues to deserve your attention, especially the next time you turn on your iPad.

Sources: Based on (1) Bloomberg Businessweek, 2010, Chairman Gou, September 13: 58–69; (2) Bloomberg Businessweek, 2011, How to beat the high cost of happy workers, May 9: 39–40; (3) www.foxconn.com.

6 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

(GDP) measured at purchasing power parity.5 Brazil, Russia, India, and China—now known as BRIC in the new jargon—command more attention. BRICS (that is: BRIC + South Africa) has become a newer buzzword. Many local firms rise to the challenge, not only effectively competing at home but also launching offensives abroad.6 Overall, more than a quarter of the worldwide FDI outflows are now generated by these emerging multinationals from emerging economies.

As a result, modifying (or even abandoning) the traditional “global strategy” has increasingly been entertained.7 Figure 1.1 illustrates the global economy as a pyramid. The top consists of about one billion people with annual per capita income greater than $20,000. These are mostly people in the Triad and a small percentage of rich people in the rest of the world. Another billion people, making $2,000 to $20,000 a year, make up the second tier. The vast majority of humanity—about five billion people—make less than $2,000 a year and comprise the base of the pyramid (BOP), which has been ignored by traditional “global strategy.” Many MNEs from developed economies believed that there was no money to be made in BOP markets. Recent developments in the global economy have shaken this erroneous belief. General Motors (GM) now sells more cars in China than in the United States, and China has surpassed the United States as the world’s largest car market. If MNEs from developed economies do not pay serious attention to BOP markets in emerging economies, local competitors such as India’s Tata Motors and China’s Geely will (see Emerging Markets 1.2). From the bottom (BOP) up, these new competitors increasingly go after the second and top tier markets overseas, creating serious competitive challenges to MNEs from developed economies.

FIGURE 1.1 The Global Economic Pyramid

Per capita GDP > $20,000 Approximately one billion people

Per capita GDP $2,000–$20,000 Approximately one billion people

Per capita GDP < $2,000 Approximately five billion people

Top Tier

Second Tier

Base of the Pyramid

Sources: Adapted from (1) C. K. Prahalad & S. Hart, 2002, The fortune at the bottom of the pyramid, Strategy+Business, 26: 54–67; (2) S. Hart, 2005, Capitalism at the Crossroads (p. 111), Philadelphia: Wharton School Publishing.

BRIC

Brazil, Russia, India, and China.

BRICS

Brazil, Russia, India, China, and South Africa

base of the pyramid (BOP)

The vast majority of humanity, about five billion people, who make less than $2,000 a year.

C h a p t e r 1 S t r a t e g i z i n g A r o u n d t h e G l o b e 7

EMERGING MARKETS 1.2

GE’s Reverse Innovation from the Base of the Pyramid

Mulitnationals such as General Electric (GE) historically innovate new products in developed economies and then localize these products by tweaking and simplifying them for customers in emerging economies. Unfortunately, a lot of these expensive products meant for well-off customers at the top of the global economic pyramid flop at the base of the pyramid. This is not only because of the products’ price tag, but also due to the lack of consideration for the specific needs and wants of local customers. Being the exact opposite, reverse innovation turns innovative products created for emerging economies into low-cost offerings for developed economies.

Take a look at GE’s conventional ultrasound machines, originally developed in the United States and Japan and sold for $100,000 and up (as much as $350,000). In China, these expensive, bulky devices sold poorly because not every sophisticated hospital imaging center could afford them. GE’s team in China realized that more than 80% of China’s population relies on rural hospitals or clinics that are poorly funded. Conventional ultrasound machines are simply out of reach for these facilities. Patients thus have to travel to urban hospitals to access ultrasound. However, transportation to urban hospitals, especially for the sick and the pregnant, is challenging. Since most Chinese patients could not come to the ultrasound machines, the machines have to go to the patients. Scaling down its existing bulky, expensive, and complex ultrasound machines was not going to serve that demand. GE realized that it needed a revolutionary product—a compact, portable ultrasound machine. In 2002, GE in China launched its first compact ultrasound, which combined a regular laptop computer with sophisticated software. The machine sold for only $30,000. In 2008, GE introduced a newmodel that sold for $15,000, less than 15% of the price tag of its high-end conventional ultrasound models. While portable ultrasounds have naturally become a hit in China, especially in rural clinics, they have also generated dramatic growth throughout the world, including developed economies. These machines combine a new dimension previously unavailable to ultrasound machines—portability— with an unbeatable price in developed economies where

containing health care cost is increasingly paramount. Before the global recession hit, portable ultrasounds by 2008 were a $278 million global product line for GE, growing at 50% to 60% annually. Even in the midst of a severe global recession, this product line has been growing 25% annually in China.

GE’s experience in developing portable ultrasound machines in China is not alone. For rural India, it has pioneered a $1,000 handheld electrocardiogram (ECG) device that brings down the cost by a margin of 60% to 80%. In the Czech Republic, GE developed an aircraft engine for small planes that slashes its cost by half. This allows GE to challenge Pratt & Whitney’s dominance of the small turboprop market in developed economies.

Why is GE so enthusiastic about reverse innovation? GE’s chairman and CEO Jeffrey Immelt wrote in a Harvard Business Review article:

To be honest, the company is also embracing reverse innovation for defensive reasons. If GE doesn’t come up with innovations in poor countries and take them global, new competitors from the developing world—like Mindray, Suzlon, Goldwind, and Haier—will… GE has tremendous respect for traditional rivals like Siemens, Philips, and Rolls-Royce. But it knows how to compete with them; they will never destroy GE. By introducing products that create a new price-performance paradigm, however, the emerging giants very well could. Reverse innovation isn’t optional; it’s oxygen.

Sources: Based on (1) Economist, 2011, Frugal healing, January 22: 73–74: (2) Economist, 2011, Life should be cheap, January 22: 16; (3) V. Govindarajan & R. Ramamurti, 2011, Reverse innovation, emerging markets, and global strategy, Global Strategy Journal, 1: 191–205; (4) J. Immelt, V. Govindarajan, & C. Trimble, 2009, How GE is disrupting itself, Harvard Business Review,October: 56–65; (5) C. K. Prahalad & R.Mashelkar, 2010, Innovation’s holy grail, Harvard Business Review, July: 132–141; (6) Wall Street Journal, 2011, Medicine on the move, March 28.

8 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

Overall, this book can be considered as part of this broad movement in search of a better understanding of how to effectively strategize and compete around the globe, not being merely about “global strategy” per se. This book differentiates itself from existing global-strategy books by providing a more balanced coverage, not only in terms of the traditional “global strategy” and “non-global strategy,” but also in terms of both MNEs’ and local firms’ perspectives. In addition to developed economies, this book also devotes extensive space to competitive battles waged in and out of emerging economies. In every chapter, at least one box deals with “emerging markets” that refer to competition within emerging economies or multinationals emerging from these economies that enhance your understanding of this new breed of global competitors. No other global-strategy book does this. In a nutshell, this is truly a global global- strategy book.

Why Study Global Strategy? Strategy courses in general—and global strategy courses in particular—are typically the most valued courses in a business school.8 Why study global strategy? Three compelling reasons emerge. First, the most sought-after and highest-paid business school graduates (both MBAs and undergraduates) are typically strategy consultants with global expertise. You can be one of them. Outside the consulting industry, if you aspire to join the top ranks of large firms, expertise in global strategy is often a prerequisite. While eventually international experience may be required to become an expatriate (expat) manager, knowledge of and interest in global strategy during your education will eventually make you a more ideal candidate to be selected.9 So, don’t forget to add a line on your resume that you have studied this strategically important course.

Second, even for graduates at large companies with no interest in working for the consulting industry and no aspiration to compete for top jobs, as well as those indivi- duals who work at small firms or are self-employed, you may find yourself dealing with foreign-owned suppliers and buyers, competing with foreign-invested firms in your home market, and perhaps even selling and investing overseas. Or alternatively, you may find yourself working for a foreign-owned corporation, your previously domestic employer acquired by a foreign player, or your unit ordered to shut down for global consolidation. Approximately 80 million people worldwide, including six million Americans, one million British, and 18 million Chinese, are directly employed by foreign-owned firms. For example, in Africa, the largest private sector employer is Coca-Cola, with 65,000 employees. In the UK, the largest private sector employer is Tata with 45,000 employees. Understanding how strategic decisions are made may facilitate your own career in such organizations. If there is a strategic rationale to downsize your unit, you would want to be able to figure this out as soon as possible and be the first to post your resume online, instead of being the first to receive a pink slip. In other words, you want to be more strategic. After all, it is your career that is at stake. Don’t be the last in the know!

Overall, in this age of globalization, “how do you keep from being Bangalored? Or Shanghaied?”10 (That is, have your job outsourced to India or China.) To do this, you must first understand what strategy is, which is discussed next.

reverse innovation

Low-cost innovation from emerging economies that has potential in developed economies.

C h a p t e r 1 S t r a t e g i z i n g A r o u n d t h e G l o b e 9

What Is Strategy? Origin Derived from the ancient Greek word strategos, the word “strategy” originally referred to the “art of the general” or “generalship.” Strategy has very strong military roots.11 The oldest book on strategy, The Art ofWar, dates back to around 500 BC. It was authored by Sun Tzu, a Chinese military strategist.12 Sun Tzu’s most famous teaching is “Know yourself, know your opponents; encounter a hundred battles, win a hundred victories.” The application of the principles of military strategy to business competition, known as strategic management (or strategy in short), is a more recent phenomenon developed since the 1960s.13

Plan versus Action Because business strategy is a relatively young field (despite the long roots of military strategy), what defines strategy has been a subject of intense debate.14 Three schools of thought have emerged (Table 1.1). The first “strategy as plan” school is the oldest. Drawing on the work of Carl von Clausewitz, a Prussian (German) military strategist of the 19th century,15 this school suggests that strategy is embodied in the same explicit rigorous formal planning as in the military.

TABLE 1.1 What Is Strategy?

Strategy as plan & “Concerned with drafting the plan of war and shaping the individual campaigns and, within these, deciding on the

individual engagements” (von Clausewitz, 1976)1

& “A set of concrete plans to help the organization accomplish its goal” (Oster, 1994)2

Strategy as action & “The art of distributing and applying military means to fulfill the ends of policy” (Liddel Hart, 1967)3

& “A pattern in a stream of actions or decisions” (Mintzberg, 1978)4

& “The creation of a unique and valuable position, involving a different set of activities … making trade-offs in competing … creating fit among a company’s activities” (Porter, 1996)5

Strategy as integration & “The determination of the basic long-term goals and objectives of an enterprise, and the adoption of courses of action and

the allocation of resources necessary for carrying out these goals” (Chandler, 1962)6

& “The major intended and emergent initiatives undertaken by general managers on behalf of owners, involving utilization of resources to enhance the performance of firms in their external environments” (Nag, Hambrick, and Chen, 2007)7

& “The analyses, decisions, and actions an organization undertakes in order to create and sustain competitive advantages” (Dess, Lumpkin, and Eisner, 2008)8

Sources: Based on (1) C. von Clausewitz, 1976, On War, vol. 1 (p. 177), London: Kegan Paul; (2) S. Oster, 1994, Modern Competitive Analysis, 2nd ed. (p. 4), New York: Oxford University Press; (3) B. Liddell Hart, 1967, Strategy, 2nd rev. ed. (p. 321), New York: Meridian; (4) H. Mintzberg, 1978, Patterns in strategy formulation (p. 934), Management Science, 24: 934–948; (5) M. Porter, 1996, What is strategy? (pp. 68, 70, 75), Harvard Business Review, 74: 61–78; (6) A. Chandler, 1962, Strategy and Structure (p. 13), Cambridge, MA: MIT Press; (7) R. Nag, D. Hambrick, & M. Chen, 2007, What is strategic management, really? Strategic Management Journal, 28: 935–955; (8) G. Dess, G. T. Lumpkin, & A. Eisner, 2008, Strategic Management, 4th ed. (p. 8), Chicago: McGraw-Hill Irwin.

strategic management

A way of managing the firm from a strategic, “big picture” perspective.

strategy

A firm’s theory about how to compete successfully.

strategy as plan

A perspective that suggests that strategy is most fun- damentally embodied in explicit, rigorous formal planning as in the military.

10 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

However, the planning school has been challenged by the likes of Liddell Hart, a British military strategist of the early 20th century, who argued that the key to strategy is a set of flexible goal-oriented actions.16 Hart favored an indirect approach, which seeks rapid flexible actions to avoid clashing with opponents head-on. Within the field of business strategy, this “strategy as action” school has been advocated by Henry Mintzberg, a Canadian scholar. Mintzberg posited that in addition to the intended strategy that the planning school emphasizes, there can be an emergent strategy that is not the result of “top down” planning but rather the outcome of a stream of smaller decisions from the “bottom up.”17 For example, Mark Zuckerberg, Facebook’s founder, shared with a journalist in an interview:

We build things quickly and ship them. We get feedback. We iterate, we iterate, we iterate. We have these great signs around: “Done is better than perfect.”18

Each of these two schools of thought has merits and drawbacks. Strategy in Action 1.1 compares and contrasts them by drawing on real strategies used by the German and French militaries in 1914. The Opening Case suggests that the very book you are reading now comes from a multinational publisher that embraces the “strategy as action” school.

Strategy as Theory Although the debate between the planning school and action school is difficult to resolve, many managers and scholars have realized that, in reality, the essence of strategy is likely to be a combination of both planned deliberate actions and unplanned emergent activities, thus leading to a “strategy as integration” school. First advocated by Alfred Chandler,19

an American business historian, this more balanced “strategy as integration” school of thought has been adopted in many textbooks and is the perspective we embrace here. Following Peter Drucker, an Austrian-American management guru, we extend the “strat- egy as integration” school by defining strategy as a firm’s theory about how to compete successfully. In other words, if we have to define strategy with one word, our choice is neither plan nor action—it is theory.

According to Drucker, “a valid theory that is clear, consistent, and focused is extra- ordinarily powerful.”20 Table 1.2 outlines the four advantages associated with our “strat- egy as theory” definition. First, it capitalizes on the insights of both planning and action schools. This is because a firm’s theory of how to compete will simply remain an idea until it has been translated into action. Thus, formulating a theory (advocated by the planning school as strategy formulation) is merely a first step; implementing it through a series of actions (noted by the action school as strategy implementation) is a necessary second part. Although the cartoon in Figure 1.2 humorously portrays these two activities as separate endeavors, in reality, good strategists do both. Graphically shown in Figure 1.3, a strategy entails a firm’s assessment at point A of its own strengths (S) and weaknesses (W), its desired performance levels at point B, and the opportunities (O) and threats (T) in the environment.21 Such a SWOT analysis resonates very well with Sun Tzu’s teaching on the importance of knowing “yourself” and “your opponents.” After such an assess- ment, the firm formulates its theory on how to best connect points A and B. In other words, the broad arrow becomes its intended strategy. However, given so many uncer- tainties, not all intended strategies may prove successful, and some may become unrea- lized strategies. On the other hand, other unintended actions may become emergent

strategy as action

A perspective that suggests that strategy is most fun- damentally reflected by firms’ pattern of actions.

intended strategy

A strategy that is deliber- ately planned for.

emergent strategy

A strategy based on the outcome of a stream of smaller decisions from the “bottom up.”

strategy as integration

A perspective that suggests that strategy is neither solely about plan nor action and that strategy integrates elements of both schools of thought.

strategy formulation

The crafting of a firm’s strategy.

strategy implementation

The actions undertaken to carry out a firm’s strategy.

SWOT analysis

A strategic analysis of a firm’s internal strengths (S) and weaknesses (W) and the opportunities (O) and threats (T) in the environment.

C h a p t e r 1 S t r a t e g i z i n g A r o u n d t h e G l o b e 11

strategies with a thrust toward point B. Overall, this definition of strategy enables us to retain the elegance of the planning school with its more orthodox logical approach, and to entertain the flexibility of the action school with its more dynamic experimental character.

TABLE 1.2 Four Advantages of the “Strategy as Theory” Definition

& Integrating both planning and action schools & Leveraging the concept of “theory,” which serves two purposes (explanation and prediction) & Requiring replications and experimentations & Understanding the difficulty of strategic change

STRATEGY IN ACTION 1.1

German and French Military Strategy, 1914

Although Germany and France are now the best of friends within the European Union (EU), they had fought for hundreds of years (the last war in which they butted heads was World War II). Prior to the commencement of hostilities that led to World War I in August 1914, both sides had planned for a major clash.

Known as the Schlieffen Plan, the German plan was meticulous. Focusing on the right wing, German forces would smash through Belgium. Every day’s schedule of march was fixed in advance: Brussels would be taken by the 19th day, the French frontier crossed on the 22nd, and Paris conquered and a decisive victory attained by the 39th. Heeding Carl von Clausewitz’s warning that military plans that left room for the unexpected could result in disaster, the Germans with infinite care had endeavored to plan for every contingency except one—flexibility.

Known as Plan 17, the French plan was a radical contrast to the German plan. Humiliated in the 1870 Franco–Prussian War, during which France lost two provinces (Alsace and Lorraine), the French were determined to regain their lost territories. However, the French had a smaller population and thus a smaller army. Since the French army could not match the German army man for man, the French military emphasized the individual initiatives, actions, and bravery (known as élan vital, the all-conquering will). A total of five sentences from Plan 17 was all that was shown to the generals who would

lead a million soldiers into battle. As a strategy exercise, we can speculate that Sentence 1 would be “Target Berlin,” Sentence 2 “Recover Alsace and Lorraine,” and the last sentence “Good luck!” Now, fill in the blanks for the two other sentences—it won’t be too hard.

Sources: Based on (1) B. Tuchman, 1962, The Guns of August, New York: Macmillan; (2) US Military Academy, 2008, Map: Northwest Europe 1914, Department of History, www.dean.usma.edu.

M ap

Re so ur ce s

ga ge

Le ar ni ng

12 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

Second, this new definition rests on a simple but powerful idea, the concept of “theory.” The word “theory” often frightens students and managers because it implies an image of “abstract” and “impractical.” But it shouldn’t.22 A theory is merely a statement describing relationships between a set of phenomena. At its core, a theory serves two powerful purposes: to explain the past and to predict the future.23 If a theory is too complicated, nobody can understand, test, or use it. For example, the theory of gravity explains why some Foxconn employees committing suicide were successful by jumping from a high-rise (see Emerging Markets 1.1). It also predicts that should you (hypothe- tically) harbor such a dangerous tendency, you will be equally successful by doing the same. Likewise, Wal-Mart’s theory, “everyday low prices,” captures the essence of all the activities performed by its two million employees in 8,500 stores in 15 countries. This theory explains why Wal-Mart has been successful in the past. After all, who doesn’t like “everyday low prices”? It also predicts that Wal-Mart will continue to do well by focusing on low prices.

Third, a theory proven successful in one context during one time period does not necessarily mean it will be successful elsewhere.24 As a result, a hallmark of theory building and development is replication—repeated testing of theory under a variety of conditions to establish its applicable boundaries. In natural sciences, this is known as continuous experimentation. For instance, after several decades of experiments in outer space, we now know that the theory of gravity is earth bound and that it does not apply in outer space. This seems to be the essence of business strategy.25 Firms successful in one

FIGURE 1.2 Strategy Formulation and Strategy Implementation

Source: Harvard Business Review, October 2011 (p. 40).

replication

Repeated testing of theory under a variety of condi- tions to establish its applicable boundaries.

C h a p t e r 1 S t r a t e g i z i n g A r o u n d t h e G l o b e 13

product or country market—that is, having proven the merit of their theory once— constantly seek to expand into newer markets and replicate their previous success. In new markets, firms sometimes succeed and other times fail. As a result, these firms are able to gradually establish the limits of their particular theory about how to compete successfully. For instance, Wal-Mart’s theory failed in both Germany and South Korea, and the retail giant had to pull out from those markets recently.

Finally, the “strategy as theory” perspective helps us understand why it is often difficult to change strategy.26 Imagine how hard it is to change an established theory. The reason that certain theories are widely accepted is because of their past success. However, past success does not guarantee future success. Although scientists are sup- posed to be objective, they are also human. Many scientists may be unwilling to concede the failure of their favorite theories even in the face of repeatedly failed tests. Think about how much resistance from the scientific establishment that Galileo, Copernicus, and Einstein had to face initially. The same holds true for strategists. Bosses were promoted to current positions because of their past success in developing and imple- menting “old” theories. National heritage, organizational politics, and personal career considerations may prevent many bosses from admitting the evident failure of an existing strategy. Yet, the history of scientific progress suggests that although difficult, it is possible to change established theories. If enough failures in testing are reported and enough researchers raise doubts about certain theories, their views, which may be marginalized initially, gradually drive out failed theories and introduce better ones. The painful process of strategic change in many firms such as Microsoft is similar (see the Closing Case). Usually a group of managers, backed by performance data, challenge the current strategy. They propose a new theory on how to compete more effectively, which initially is often marginalized by top management. But eventually, the momentum of the new theory may outweigh the resistance of the old strategy, thus leading to some strategic change. For example, Wal-Mart recently changed its strategy from “everyday low prices” to “save money, live better” in order to soften its undesirable image as a ruthless cost cutter.

FIGURE 1.3 The Essence of Strategy

Pe rf

or m

an ce

Time

Where are we?

Point A Unrealized

strategy

Point B

Emergent strategy

Intende d strate

Where must we be?

ga ge

Le ar ni ng

14 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

Overall, strategy is not a rulebook, a blueprint, or a set of programmed instructions. Rather, it is a firm’s theory about how to compete successfully, a unifying theme that gives coherence to its various actions. Just as military strategies and generals have to be studied simultaneously, an understanding of business strategies around the globe would be incomplete without an appreciation of the role top managers play as strategists. Although mid-level and lower-level managers need to understand strategy, they typically lack the perspective and confidence to craft and execute a firm-level strategy. A top management team (TMT) led by the chief executive officer (CEO) must exercise leadership by making strategic choices. Since the directions and operations of a firm typically are a reflection of its top managers, their personal preferences based on their own culture, background, and experience may affect firm strategy.27 Therefore, although this book focuses on firm strategies, it is also about strategists who lead their firms. By definition, strategic work is different from non-strategic (tactical) work. Drawing on the wisdom of A. G. Lafley, chairman and CEO of Procter & Gamble (P&G) between 2000 and 2009, Table 1.3 outlines the nature of the highest level of strategic work that only the CEO can do.

Fundamental Questions in Strategy Although strategy around the globe is a vast area, we will focus our attention only on the most fundamental issues, which act to define a field and to orient the attention of students, practitioners, and scholars in a certain direction. Specifically, we will address the following four fundamental questions:28

• Why do firms differ?

• How do firms behave?

• What determines the scope of the firm?

• What determines the success and failure of firms around the globe?

Why Do Firms Differ? In every modern economy, firms, just like individuals, differ. This question thus seems obvious and hardly generates any debate. However, much of our knowledge about “the firm” is from research on firms in the United States and to a lesser extent the United Kingdom, both of which are embedded in what is known as Anglo-American capitalism.

TABLE 1.3 Strategic Work Only the CEO Can Do

& Identify the meaningful outside and link it with the internal organization & Define what business the firm is in (and not in) & Balance present and future & Shape values and standards

Source: Adapted from A. G. Lafley, 2009, What only the CEO can do, Harvard Business Review, May: 54–62. Lafley was chairman and CEO of P&G, 2000–2009.

top management team (TMT)

The team consisting of the highest level of executives of a firm led by the CEO.

C h a p t e r 1 S t r a t e g i z i n g A r o u n d t h e G l o b e 15

A smaller literature deals with other Western countries such as Germany, France, and Italy, collectively known as continental European capitalism. While some differences between Anglo-American and continental European firms have been reported (such as a shorter and a longer investment horizon, respectively),29 the contrast between these Western firms and their Japanese counterparts is more striking.30 For example, instead of using costly acquisitions typically found in the West, Japanese firms extensively employ a network form of supplier management, giving rise to the term keiretsu (interfirm net- work).31 The word keiretsu is now frequently used in English-language publications without the explanation given in the parentheses—an educated reader of BusinessWeek, Economist, or Wall Street Journal is presumed to already understand it.

More recently, as the strategy radar screen scans the business landscape in emerging economies, more puzzles emerge. For example, it is long established that economic growth can hardly occur in poorly regulated economies. Yet given China’s strong economic growth and its underdeveloped formal institutional structures (such as a lack of effective courts), how can China achieve rapid rates of economic growth? Among many answers to this intriguing puzzle, a partial answer suggests that interpersonal networks and relationships (guanxi), cultivated by managers, may serve as informal substitutes for formal institutional support. In other words, interpersonal relationships among managers are translated into an interfirm strategy of relying on networks and alliances to grow the firm, which, in the aggregate, contributes to the growth of the economy.32 As a result, the word guanxi has now become the most famous Chinese business word to appear in English-language media, again often without the explanation provided in parentheses. Similarly, the Korean word chaebol (large business group) and the Russian word blat (relationships) have also entered the English vocabulary. Behind each of these deceptively simple words lie some fundamental differences on how to compete around the world.33

How Do Firms Behave? This question focuses on what determines firms’ theories about how to compete. Figure 1.4 identifies three leading perspectives that collectively lead to a strategy tripod.34 The industry-based view suggests that the strategic task is mainly to examine the compe- titive forces affecting an industry, and to stake out a position that is less vulnerable relative to these five forces. While the industry-based view primarily focuses on the external opportunities and threats (the O and T in a SWOT analysis), the resource- based view largely concentrates on the internal strengths and weaknesses (S and W) of the firm. This view posits that it is firm-specific capabilities that differentiate successful firms from failing ones.

Recently, an institution-based view has emerged to account for differences in firm strategy.35 This view argues that in addition to industry-level and firm-level conditions, firms also need to take into account the influences of formal and informal rules of the game. A better understanding of the formal and informal rules of the game explains a great deal behind Microsoft’s strategic changes in China (see the Closing Case).

Collectively viewed as a strategy tripod, these three views form the backbone of the first part of this book, Foundations of Global Strategy (Chapters 2, 3, and 4). They shed considerable light on the question “How do firms behave?”36

strategy tripod

A framework that suggests that strategy as a discipline has three “legs” or key perspectives: industry- based, resource-based, and institution-based views.

16 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

What Determines the Scope of the Firm? This question first focuses on the growth of the firm. Most firms seem to have a lingering love affair with growth. The motivation to grow is fueled by the excitement associated with such growth. For publicly listed firms, without growth, the share price will not grow. However, there is a limit beyond which further growth may backfire. Then downsizing, downscoping, and withdrawals are often necessary. In other words, answers to the question, “What determines the scope of the firm?” pertain not only to the growth of the firm, but also to the contraction of the firm.

In developed economies, a conglomeration strategy featuring unrelated product diversification, which was in vogue in the 1960s and the 1970s, was found to destroy value and was largely discredited by the 1980s and the 1990s. Witness how many firms are still trying to divest and downsize in the West. However, this strategy seems to be alive and well in many emerging economies. Although puzzled Western media and consultants often suggest that conglomerates destroy value and should be dismantled in emerging economies, empirical evidence suggests otherwise. Recent research in emerging economies reports that some (but not all) units affiliated with conglomerates may enjoy higher profitability than independent firms, pointing out some discernible performance benefits associated with conglomeration.37 One reason behind such a contrast lies in the institutional differences between developed and emerging economies. Viewed through an institutional lens, conglomeration may make sense (at least to some extent) in emerging economies because this strategy and its relatively positive link with perfor- mance may be a function of the level of institutional (under)development in these countries.38

In addition to product scope, careful deliberation of the geographic scope is impor- tant.39 On the one hand, for companies aspiring to become global leaders, a strong position in each of the three Triad markets is often necessary. Expanding market position in key emerging economies, such as BRIC, may also be desirable. But on the other hand, it is not realistic that all companies can, or should, “go global.” Given the recent hype to “go global,” many companies may have entered too many countries too quickly and may be subsequently forced to withdraw.

FIGURE 1.4 The Strategy Tripod: Three Leading Perspectives on Strategy

Strategy Performance

Industry-based competition

Firm-specific resources and capabilities

Institutional conditions and transitions

ga ge

Le ar ni ng

C h a p t e r 1 S t r a t e g i z i n g A r o u n d t h e G l o b e 17

What Determines the Success and Failure of Firms Around

the Globe? This focus on performance, more than anything else, defines the field of strategic manage- ment and international business.40 We are not only interested in acquiring and leveraging competitive advantage, but also in sustaining such advantages over time and across regions. All three major perspectives that form the strategy tripod ultimately seek to answer this question.

The industry-based view posits that the degree of competitiveness in an industry largely determines firm performance. Shown in the Opening Case, the structure of the college textbook publishing industry, such as stable brands and high entry barriers, explains a great deal behind the dominance of the top three incumbents in business and economics college textbook publishing around the world.

The resource-based view suggests that firm-specific capabilities drive performance differences. Within the same industry, while some firms win, others struggle. Winning firms such as South-Western Cengage Learning tend to have valuable, unique, and hard- to-imitate capabilities, such as having a “Mr. Global” born in China to author Global Strategy, which will inherently have a more global flavor. Rival publishers have a hard time competing with Global Strategy, because a majority of other textbook authors were born in the United States and, despite their best efforts to globalize their work, will naturally exhibit a US-centric tendency.

The institution-based view argues that institutional forces also provide an answer to differences in firm performance. As illustrated by our Opening Case, firms must “think global” and “act local” simultaneously. Firms that do not do their “homework” by getting to know the various formal and informal rules of the game in overseas markets are unlikely to emerge as winners in the global marketplace.

Overall, although there are many debates among the different schools of thought, the true determinants of firm performance probably involve a combination of these three- pronged forces (see Figure 1.4).41 While these three views present relatively straightfor- ward answers, the reality of global competition often makes these answers more complex and murky. If you survey ten managers from ten countries on what performance exactly is, you may get ten different answers. Long-term or short-term performance?42 Financial returns or market shares? Profits maximized for shareholders or benefits maximized for stakeholders (individuals and organizations that are affected by a firm’s actions and thus have a stake in how a firm is managed)? Without consensus on the performance measures, it is difficult to find an easy, uncontroversial answer. Instead of focusing on a single financial or economic bottom line, some firms adopt a triple bottom line, which consists of economic, social, and environmental dimensions (see Chapter 12). Another solution is to adopt a balanced scorecard, which is a performance evaluation method from the customer, internal, innovation and learning, and financial perspectives. Outlined in Table 1.4, the balanced scorecard can be thought of as the dials in a flight cockpit. To fly an aircraft, pilots simultaneously need a lot of information, such as air speed, altitude, and bearing. To manage a firm, strategists have similar needs. But pilots and strategists also cannot afford information overload—too much information. The balanced scorecard summarizes and channels a large volume of information to a relatively small number of crucial dimensions.

stakeholder

Any group or individual who can affect or is affected by the achieve- ment of the organization’s objectives.

triple bottom line

A performance yardstick consisting of economic, social, and environmental performance.

balanced scorecard

A performance evaluation method from the customer, internal, innovation and learning, and financial per- spectives.

information overload

Too much information to process.

18 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

In summary, these four questions represent some of the most fundamental puzzles in strategy. While other questions can be raised, they all relate in one way or another to these four. Thus, answering these four questions will be the primary focus of this book and will be addressed in every chapter.

What Is Global Strategy? “Global strategy” has at least two meanings. First, as noted earlier, the traditional and narrowly defined notion of “global strategy” refers to a particular theory on how to compete and is centered on offering standardized products and services on a worldwide basis.43 This strategy obviously is only relevant for large Triad-based MNEs active in many countries. Smaller firms in developed economies and most firms in emerging economies operating in only one or a few countries may find little use for this definition.

Second, “global strategy” can also refer to “strategy with a comprehensive worldwide perspective.”44 It essentially means any strategy outside one’s home country. Americans seem especially fond of using the word “global” this way, which essentially becomes the same as “international.” For example, Wal-Mart’s first foray outside the United States in 1991 was widely hailed as evidence that Wal-Mart had “gone global.” In fact, Wal-Mart had only expanded into Mexico at that time. While this was an admirable first step for Wal-Mart, the action was similar to Singapore firms doing business in Malaysia or German companies investing in Austria. To many internationally active Asian and European firms, there is nothing significantly “global” about these activities in neighbor- ing countries. So why is there the hype about the word “global,” especially among Americans? Historically, the vast US domestic markets made it unnecessary for many firms to seek overseas markets. As a result, when many US companies do venture abroad, even in countries as close as Mexico, they are likely to be fascinated about their “discovery of global markets.” Since everyone seems to want a more exciting “global” strategy rather than a plain-vanilla “international” one, calling non-US (or non-domestic) markets “global” markets becomes a cliché.

So what do we mean by “global strategy” in this book? Neither of the preceding definitions will do. Here, global strategy is defined as strategy of firms around the globe—essentially various firms’ theories about how to compete successfully. Seeking to break out of the US-centric straightjacket, this book deals with both the strategy of MNEs (some of which may fit into the traditional narrow global strategy definition)

TABLE 1.4 Performance Goals and Measures from the Balanced Scorecard

& From a customer perspective: How do customers see us? & From an internal business perspectives: What must we excel at? & From an innovation and learning perspective: Can we continue to improve and create value? & From a financial perspective: How do we look to shareholders?

Source: Adapted from R. Kaplan & D. Norton, 2005, The balanced scorecard: Measures that drive performance, Harvard Business Review, July: 172–180.

global strategy

(1) Strategy of firms around the globe. (2) A particular form of international strategy, characterized by the production and distribution of standardized products and services on a worldwide basis.

C h a p t e r 1 S t r a t e g i z i n g A r o u n d t h e G l o b e 19

and the strategy of smaller firms (some of which may have an international presence, while others may be purely domestic). These firms compete in both developed and emerging economies. We do not exclusively concentrate on firms doing business abroad, which is the traditional domain of global-strategy books. To the extent that international business involves two sides—namely, domestic firms and foreign entrants—an exclusive focus on foreign entrants only covers one side and, thus, paints a partial picture. The strategy of domestic firms is equally important. As a result, a truly global global-strategy book needs to provide a balanced coverage. Like our publisher in the Opening Case, our motto is: Think global, act local.45 This is the challenge we will take on throughout this book.

What Is Globalization? Globalization, generally speaking, is the close integration of countries and peoples of the world. This abstract five-syllable word is now frequently heard and debated. Those who approve of globalization count its contributions to include greater economic growth and standards of living, increased technology sharing, and more extensive cultural integration. Critics argue that globalization causes the global recession, undermines wages in rich countries, exploits workers in poor countries, and gives MNEs too much power. This section (1) outlines three views on globalization, (2) recommends the pendulum view, and (3) introduces the idea of semiglobalization.

Three Views on Globalization Depending on what sources you read, globalization could be

• A new force sweeping through the world in recent times

• A long-run historical evolution since the dawn of human history

• A pendulum that swings from one extreme to another from time to time

An understanding of these views helps put the debate about globalization in perspec- tive. First, opponents suggest that it is a new phenomenon beginning in the late 20th century, driven by recent technological innovations and a Western ideology focused on exploiting and dominating the world through MNEs. The arguments against globalization focus on an ideal world free of environmental stress, social injustice, and sweatshop labor but present few clear alternatives to the present economic order. Advocates and anti- globalization protesters often argue that globalization needs to be slowed down, if not stopped.

A second view contends that globalization has always been part of human history. Historians debate whether globalization started 2,000 or 8,000 years ago. MNEs existed for more than two millennia, with their earliest traces discovered in Phoenician, Assyrian, and Roman times.46 International competition from low-cost countries is nothing new. In the first century AD, the Roman emperor Tiberius was so concerned about the massive quantity of low-cost Chinese silk imports that he imposed the world’s first known import quota of textiles.47 In a nutshell, globalization is nothing new and will always exist.

globalization

The close integration of countries and peoples of the world.

20 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

A third view suggests that globalization is the “closer integration of the countries and peoples of the world which has been brought about by the enormous reduction of the costs of transportation and communication and the breaking down of artificial barriers to the flows of goods, services, capital, knowledge, and (to a lesser extent) people across borders.”48 Globalization is neither recent nor one-directional. It is, more accurately, a process similar to the swing of a pendulum.

The Pendulum View on Globalization The pendulum view probably makes the most sense because it can help us understand the ups and downs of globalization. The current era of globalization originated in the aftermath of World War II, when major Western countries committed to global trade and investment. However, between the 1950s and the 1970s, this view was not widely shared. Communist countries, such as the former Soviet Union and China, sought to develop self-sufficiency. Many non-communist developing countries such as Brazil, India, and Mexico focused on protecting domestic industries. But refusing to partici- pate in global trade and investment ended up breeding uncompetitive industries. In contrast, four developing economies in Asia—namely, Hong Kong, Singapore, South Korea, and Taiwan—earned their stripes as the “Four Tigers” by participating in the global economy. They became the only economies once recognized as less developed (low-income) by the World Bank to have subsequently achieved developed (high- income) status.

Inspired by the Four Tigers, more countries and regions—such as China in the late 1970s, Latin America in the mid 1980s, Central and Eastern Europe in the late 1980s, and India in the 1990s—realized that joining the global economy was a must. As these countries started to emerge as new players in the global economy, they became known as “emerging economies.” As a result, globalization rapidly accelerated in the 1990s.

The pendulum view suggests, however, that globalization is unable to keep going in one direction. Rapid globalization in the 1990s saw some significant backlash. First, the rapid growth of globalization led to the historically inaccurate view that globalization is new. Second, it created fear among many people in developed economies that they would lose jobs. Emerging economies not only seem to attract many low-end manufacturing jobs away from developed economies, but also increasingly appear to threaten some high-end jobs. Finally, some factions in emerging economies complained against the onslaught of MNEs, alleging that MNEs not only destroy local companies, but also local cultures, values, and the environment.

While small-scale acts of vandalizing McDonald’s restaurants are reported in several countries, the December 1999 anti-globalization protests in Seattle and the September 2001 terrorist attacks in New York and Washington are undoubtedly the most visible and most extreme acts of anti-globalization forces at work. As a result, international travel was curtailed, and global trade and investment flows slowed in the early 2000s. Then in the mid-2000s, worldwide GDP, cross-border trade, and per capita GDP all soared to historically high levels. But starting in 2008, the world was engulfed in a global economic crisis now known as the Great Recession. This recession has been characterized by a painful financial meltdown and numerous government bailouts. Rightly or wrongly, many people have blamed globalization for the recent crisis.

C h a p t e r 1 S t r a t e g i z i n g A r o u n d t h e G l o b e 21

After unprecedented intervention throughout developed economies whose govern- ments ended up being the largest shareholders of many banks, there is growing confidence that the global economy has now turned the corner and that the global recession is now ending. However, economic recovery is likely to be slow in developed economies, whereas emerging economies have rebounded faster.49

The recession reminds all firms and managers of the importance of risk management— the identification and assessment of risks and the preparation to minimize the impact of high-risk, unfortunate events.50 As a technique to prepare and plan for multiple scenarios, scenario planning is now used by many firms around the world.51 As far as the direction of globalization is concerned, the recovery may see more protectionist measures because various governments’ stimulus packages and job creation schemes emphasize policies to “hire locals” and “buy national” (such as the “buy American” policy in the United States and the promotion of “indigenous innovation” in China). In short, the pendulum is swinging back.

Like the proverbial elephant, globalization is seen by everyone and rarely compre- hended. The suddenness and ferocity of the recent economic crisis surprised everybody, ranging from central bankers to academic experts. Remember, all of us felt sorry when we read the story of a bunch of blind men trying to figure out the shape and form of the elephant. We really shouldn’t. Although we are not blind, our task is more challenging than the blind men with a standing animal. Our beast—globalization—does not stand still and is often moving, back and forth (!). Yet, we try to live with it, avoid being crushed by it, and even profit from it. Overall, relative to the other two views, the view of globaliza- tion as a pendulum is more balanced and more realistic. In other words, globalization has both rosy and dark sides, and it changes over time.

Semiglobalization Despite the hype, globalization is not complete. Do we really live in a globalized world? Is doing business abroad just as easy as at home? Obviously not. Most measures of market integration, such as trade and FDI, have recently scaled new heights but still fall far short of becoming a single, globally integrated market. In other words, what we have may be labeled semiglobalization, which is more complex than extremes of total isolation and total globalization. Semiglobalization suggests that barriers to market integration at borders are high, but not high enough to completely insulate countries from each other.52

Semiglobalization calls for more than one way of strategizing business around the globe. Total isolation on a nation-state basis would suggest localization—a strategy of treating each country as a unique market. So an MNE marketing products to 100 countries will need to come up with 100 versions of local cars or drinks. This approach is clearly too costly. Total globalization, on the other hand, would lead to standardization, or a strategy of treating the entire world as one market. The MNE in our previous example can just market one version of “world car” or “world drink.” The world obviously is not that simple. Between total isolation and total globalization, semiglobalization has no single right strategy, resulting in a wide variety of strategic experimentations and changes (see the Closing Case). Overall, (semi)globalization is neither to be opposed as a menace nor to be celebrated as a panacea; it is to be engaged.

risk management

The identification and assessment of risks and the preparation to minimize the impact of high-risk, unfortunate events.

scenario planning

A technique to prepare and plan for multiple scenarios (either high or low risk).

semiglobalization

A perspective that suggests that barriers to market integration at borders are high but not high enough to completely insulate countries from each other.

22 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

Global Strategy and the Globalization Debate Anti-globalization protests in Seattle (1999). 9/11 terrorist attacks (2001) and the resultant War on Terror (still ongoing). Enron (2001). Global financial crisis (2008) and the Great Recession afterwards. The euro crisis (since 2010). Earthquake in Japan (2011). Occupy Wall Street (2011). These and many other challenges confronting strategists around the globe in the 21st century are enormous. This book is designed to help you make informed strategic choices in this complex and rapidly moving world.

A fundamental reason that many executives, policymakers, and scholars were caught off guard by the anti-globalization protests, the terrorist attacks, and the Occupy Wall Street movement is that they have failed to heed Sun Tzu’s most famous maxim: “Know yourself, know your opponents.” To know yourself calls for a thorough understanding of not only your strengths, but also your limitations. Many individuals fail to understand their limitations or simply choose to ignore them. Although relative to the general public, executives, policymakers, and scholars tend to be better educated and more cosmopolitan, they are likely to be biased—just like everybody else. Most of them, in both developed and emerging economies in the last two decades, are biased toward acknowledging the benefits of globalization.

Although it has long been known that globalization carries both benefits and costs, many executives, policymakers, and scholars have failed to take into sufficient account the social, political, and environmental costs associated with globalization. However, that these elites share certain perspectives on globalization does not mean that most other members of society share the same views. Unfortunately, many elites mistakenly assume that the rest of the world either is, or should be, more like “us.” To the extent that powerful economic and political institutions are largely controlled by these elites, it is not surprising that some powerless and voiceless anti-globalization groups end up resorting to unconventional tactics, such as mass protests, to make their point.

Many of the opponents of globalization are nongovernmental organizations (NGOs) such as environmentalists, human rights activists, and consumer groups. Ignoring them will be a grave failure in due diligence when doing business around the globe. Instead of viewing NGOs as opponents, many firms view them as partners. NGOs do raise a valid point when they insist that firms, especially MNEs, should have a broader concern for the various stakeholders affected by the MNEs’ actions around the world.53

It is certainly interesting and perhaps alarming to note that as would-be business leaders who will shape the global economy in the future, current business school students already exhibit values and beliefs in favor of globalization similar to those held by executives, policymakers, and scholars and different from those held by the general public. Shown in Table 1.5, US business students have significantly more positive (almost one-sided) views toward globalization than the general public. While these data are based on US business students, my teaching and lectures around the world suggest that most business students around the world—regardless of their nationality—seem to share such positive views. This is not surprising. Both self-selection to study business and socialization within the curriculum, in which free trade is widely regarded as positive, may lead to certain attitudes in favor of globalization. Consequently, business students tend to focus more on the economic gains of globalization and be less concerned with its darker sides.

nongovernmental organization (NGO)

Organization advocating causes such as the environment, human rights, and consumer rights that are not affiliated with government.

C h a p t e r 1 S t r a t e g i z i n g A r o u n d t h e G l o b e 23

Current and would-be business leaders need to be aware of their own biases embodied in such one-sided views toward globalization. Since business schools aspire to train future business leaders by indoctrinating students with the dominant values managers hold, these results suggest that business schools may have largely succeeded in this mission. However, to the extent that current managers (and professors) have strategic blind spots, these findings are potentially alarming. They reveal that students already share these blind spots. Despite possible self-selection in choosing to major in business, there is no denying that student values are shaped, at least in part, by the educational experience provided by business schools. Knowing such limitations, professors and students need to work espe- cially hard to break out of this mental straitjacket.

In order to combat the widespread tendency to have one-sided, rosy views, a significant portion of this book is devoted to the numerous debates that surround globalization.54 Debates are systematically introduced in every chapter to provoke more critical thinking and discus- sion. Virtually all textbooks uncritically present knowledge “as is.” The reality is that our field has no shortage of debates.55 It is imperative that you be exposed to cutting-edge debates and encouraged to form your own views.56 In addition, ethics is emphasized throughout the book. A featured Ethical Dilemma can be found in every chapter. Two whole chapters are devoted to ethics, norms, and cultures (Chapter 3) and corporate social responsibility (Chapter 14).

Organization of the Book This book has three parts. The first part concerns foundations. Following this chapter, Chapters 2, 3, and 4 introduce the strategy tripod, consisting of the three leading perspectives on strategy: industry-based, resource-based, and institution-based views. Students will be systematically trained to use this tripod to analyze a variety of strategy problems. The second part covers business-level strategies. In contrast to most global- strategy books that focus on large MNEs, we start with the internationalization of small entrepreneurial firms (Chapter 5), followed by ways to enter foreign markets (Chapter 6),

TABLE 1.5 Views on Globalization: American General Public versus Business Students

PERCENTAGE ANSWERING “GOOD” FOR THE QUESTION: OVERALL, DO YOU THINK GLOBALIZATION IS GOOD OR BAD FOR

GENERAL PUBLIC1

(N = 1,024)

BUSINESS STUDENTS (AVERAGE AGE 22)2

(N = 494)

US consumers like you 68% 96%

US companies 63% 77%

The US economy 64% 88%

Strengthening poor countries’ economies 75% 82%

Sources: Based on (1) A. Bernstein, 2000, Backlash against globalization, BusinessWeek, April 24: 43; (2) M. W. Peng & H. Shin, 2008, How do future business leaders view globalization? Thunderbird International Business Review (p. 179), 50 (3): 175–182. All differences are statistically significant.

24 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

to leverage alliances and networks (Chapter 7), and to manage global competitive dynamics (Chapter 8). Finally, the third part deals with corporate-level strategies. Chapter 9 on diversifying, acquiring, and restructuring starts this part, followed by strategies to structure, learn, and innovate (Chapter 10), to govern the corporation around the world (Chapter 11), and to profit from corporate social responsibility (Chapter 12).

A unique organizing principle is a consistent focus on the strategy tripod and on the four fundamental questions regarding strategy in all chapters. Following this chapter, every chapter has a substantial “Debates and Extensions” section, which is followed by “The Savvy Strategist” section culminating a one-slide “Strategic Implications for Action” to drive home the important take-aways.

CHAPTER SUMMARY

1. Offer a basic critique of the traditional, narrowly defined “global strategy” • The traditional and narrowly defined notion of “global strategy” is characterized by the production and distribution of standardized products and services on a worldwide basis—in short, a “one size fits all” approach. This strategy has often backfired in practice.

• As a global global-strategy book, this book provides a more balanced coverage, not only in terms of the traditional “global strategy” and “non-global strategy,” but also in terms of both MNEs’ and local firms’ perspectives. Moreover, this book has devoted extensive space to emerging economies.

2. Articulate the rationale behind studying global strategy • To better compete in the corporate world that will appreciate expertise in global strategy.

3. Define what is strategy and what is global strategy • There is a debate between two schools of thought: “strategy as plan” and “strategy as action.” This book, together with other leading textbooks, instead follows the “strategy as integration” school.

• In this book, strategy is defined as a firm’s theory about how to compete successfully, while global strategy is defined as strategy of firms around the globe.

4. Outline the four fundamental questions in strategy • The four fundamental questions are: (1) Why do firms differ? (2) How do firms behave? (3) What determines the scope of the firm? (4) What determines the success and failure of firms around the globe?

• The three leading perspectives guiding our exploration are industry-based, resource- based, and institution-based views, which collectively form a strategy tripod.

5. Participate in the debate on globalization with a reasonably balanced view and a keen awareness of your likely bias • Some view globalization as a recent phenomenon, while others believe that it has been evolving since the dawn of human history.

• We suggest that globalization is best viewed as a process similar to the swing of a pendulum. • Strategists need to know themselves (including their own biases) and know their opponents.

C h a p t e r 1 S t r a t e g i z i n g A r o u n d t h e G l o b e 25

KEY TERMS

Balanced scorecard p. 18

Base of the pyramid (BOP) p. 7

BRIC p. 7

BRICS p. 7

Emergent strategy p. 11

Emerging economies (emerging markets) p. 5

Foreign direct investment (FDI) p. 5

Global strategy p. 19

Globalization p. 20

Information overload p. 18

Intended strategy p. 11

Multinational enterprise (MNE) p. 5

Nongovernmental organization (NGO) p. 23

Replication p. 13

Reverse innovation p. 9

Risk management p. 22

Scenario planning p. 22

Semiglobalization p. 22

Stakeholder p. 18

Strategic management p. 10

Strategy p. 10

Strategy as action p. 11

Strategy as integration p. 11

Strategy as plan p. 10

Strategy formulation p. 11

Strategy implementation p. 11

Strategy tripod p. 16

SWOT analysis p. 11

Top management team (TMT) p. 15

Triad p. 5

Triple bottom line p. 18

CRITICAL DISCUSSION QUESTIONS

1. A skeptical classmate says: “Global strategy is relevant for top executives such as CEOs in large companies. I am just a lowly student who will struggle to gain an entry-level job, probably in a small company. Why should I care about it?” How do you convince her that she should care about global strategy?

2. ON ETHICS: Some argue that globalization benefits citizens of rich countries. Others argue that globalization benefits citizens of poor countries. What are the ethical dilemmas here? What do you think?

3. ON ETHICS: Critics argue that MNEs, through FDI, allegedly both exploit the poor in poor countries and take jobs away from rich countries. If you were the CEO of an MNE from a developed economy or from an emerging economy, how would you defend your firm?

TOPICS FOR EXPANDED PROJECTS

1. The 2008 global financial crisis and the Great Recession since then have been devastating. However, not all industries and not all firms have suffered. Some may have profited from these events. Write a short paper describing how some industries and firms may have profited from the crisis and the recession.

26 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

2. As the CEO of an MNE from an emerging economy, use the strategy tripod to analyze what the leading challenges for your firm’s internationalization will be. Present your analysis in the form of a short paper or visual presentation.

3. ON ETHICS: What are some of the darker sides (in other words, costs) associated with globalization? How can strategists make sure that the benefits of their various actions outweigh their drawbacks (such as job losses in developed economies and environmental damage in emerging economies)? Working individually or in teams, write a short paper describing at least three examples.

E T H I C A L D I L E M M ACLOSING CASE

Emerging Markets: Microsoft’s Evolving China Strategy

Microsoft’s first decade in China was disastrous. It estab- lished a representative office in 1992 and then set up a wholly owned subsidiary, Microsoft (China), in 1995. The firm quickly realized that it didn’t have a market share problem—everybody was using Windows. The problem was how to translate that market share into revenue, since everybody seemingly used pirated versions. Microsoft’s solution? Sue violators in Chinese courts. But Microsoft lost such lawsuits regularly. Alarmed, the Chinese govern- ment openly promoted the free open-source Linux operat- ing systems. For security reasons, the Chinese government was afraid that Microsoft’s software might contain spy- ware for the US government. Internally, Microsoft’s execu- tives often disagreed with this confrontational strategy. Its country managers came and went—five in a five-year period. Two of them later wrote books criticizing this strategy. These books revealed that Microsoft’s antipiracy policy was excessively heavy-handed. Their authors’ efforts to educate their bosses in headquarters in Redmond, Washington (a Seattle suburb), were deeply frustrated.

Fast forward to 2007. President Hu Jintao visited Micro- soft and paid Bill Gates a visit at his house as a dinner guest. “You are a friend to the Chinese people, and I am a friend of Microsoft,” Hu told Gates. “Every morning I go to my office and use your software.” Starting in the mid-2000s, the Chinese government required all government agencies to use legal software and all PC manufacturers to load legal software before selling to consumers. Prior to these

requirements, Lenovo, the leading domestic PC maker, had only shipped about 10% of its PCs that way. Many foreign (and some US) PC makers in China sold numerous machines “naked,” implicitly inviting their customers to use cheap illegal software. From a disastrous start, Microsoft today is in a sweet spot in China. So, what happened?

In a nutshell, Microsoft radically changed its China strategy in its second decade in the country. In China, it became the “un-Microsoft”: pricing at rock bottom instead of insisting on one very high “global price,” aban- doning the confrontational, litigious approach in defense of its intellectual property rights (IPR), and closely

M ap

Re so ur ce s

C h a p t e r 1 S t r a t e g i z i n g A r o u n d t h e G l o b e 27

partnering with the government as opposed to fighting it (as it was doing back home when it was sued by the US government).

To be sure, the strategic changes were gradual. In 1998, Gates sent Craig Mundie, who headed the firm’s public policy group, to Beijing. Mundie urged for strategic changes. He brought 25 of Microsoft’s 100 vice presidents for a week-long “China Immersion Tour.” Also in 1998, in part as a gesture of goodwill, Microsoft set up a research center in Beijing, which emerged to become the premier employer for top-notch software talent in China.

Within Microsoft, debates raged. Given the size of the country, changing the China strategy would inevitably lead to changing the global strategy, which was centered on a globally “one-size-fits-all” set of pricing (such as $560 for the Windows and Office toolset as in the United States). The heart of the question was: “Does Microsoft need China?” As late as in 2004, its CFO John Connors argued “No” publicly. Connors was not alone. On the face of it, nobody needed China less than Microsoft, which became a dynamo without significant China sales. However, in the long run, China’s support of Linux could pose dangers to Microsoft. This was because a public infrastructure for a software industry built around Linux could generate an alternative ecosystem with more low-cost rivals that break free from dependence on Windows. By the early 2000s, concerned about this competitive threat, Gates increasingly realized that if the Chinese consumer were going to use pirated software, he would rather prefer it to be Microsoft’s.

In 2003, Tim Chen, a superstar China manager at Motorola, was hired as Corporate Vice President and CEO of Greater China Region for Microsoft. Led by Chen, Microsoft quit suing people and tolerated piracy. Instead, it worked with the National Development Reform Com- mission to build a software industry, with the Ministry of Information Industry to jointly fund labs, and with the Ministry of Education to finance computer classrooms in rural areas. Overall, it elevated its R&D presence, trained thousands of professionals, and invested close to $100 million in local firms. In response to Chinese government concerns about the alleged US government spyware embedded in Microsoft’s software, in 2003 the firm offered China (and 59 other countries) the fundamental source code for Windows and the right to substitute cer- tain portions with local adaptation—something Microsoft had never done before. Only after such sustained and

multidimensional efforts did the Chinese government bless Microsoft’s business by requiring that only legal software be used by government offices and be loaded by PC makers. Although Microsoft never disclosed how deep the discount it offered to the Chinese government, a legal package of Windows and Office could be bought for $3 (!). In Chen’s own words:

With all this work, we start changing the perception that Microsoft is the company coming just to do antipiracy and sue people. We changed the company’s image. We’re the company that has the long-term vision. If a foreign company’s strategy matches with the government’s development agenda, the government will support you, even if they don’t like you.

Microsoft now has its own five-year plan to match the Chinese government’s. But not all is rosy when working closely with the Chinese government. Problems have erupted on two fronts. First, Microsoft continues to be frustrated by the lack of sufficient progress on IPR. While not disclosing country-specific sales numbers, CEO Steve Balmer complained in an interview in 2010 that thanks to IPR problems, “China is a less interesting market to us than India … than Indonesia.” Second, Microsoft has been cri- ticized by free speech and human rights activists for its “cozy” relationship with the Chinese government. While largely unscrutinized by the media, the Chinese version of Microsoft MSN has long filtered certain words such as “democracy” and “freedom.” In 2010 Google butted heads with the Chinese government and openly called for Microsoft (and other high-tech firms) to join its efforts. Microsoft refused. Instead, Microsoft took advantage of Google’s trouble. It set up an alliance with Google’s num- ber one rival in China, Baidu, to provide English-language search results for Baidu from its Bing search engine. Such search results, of course, would be subject to political censorship. In 2011, anyone in China searching “jasmine,” in either Chinese (on Baidu) or English (on Baidu and routed through Bing), would find this term to be unsearchable—thanks to the Jasmine Revolution (otherwise known as the Arab Spring).

Sources: Based on (1) CFO, 2004, Does Microsoft need China? August 10, www.cfo.com; (2) Fortune, 2007, How Microsoft conquered China, July 23: 84–90; (3) Guardian, 2010, We’re staying in China, March 25, www.guardian.co.uk;

28 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

NOTES

(4) Guardian, 2011, Microsoft strikes deal with China’s biggest search engine Baidu, July 4, www.guardian.co.uk; (5) Microsoft, 2006, Microsoft in China, www.microsoft.com; (6) South China Morning Post, 2010, Beijing flexes its economic muscle, July 27: B8.

C A S E D I S C U S S I O N Q U E S T I O N S

1. From an industry-based view, why does Microsoft feel threatened by Linux in China and globally?

2. From a resource-based view, what valuable and unique resources and capabilities does Microsoft have in the eyes of the Chinese users and the government?

3. From an institution-based view, what are the major lessons from Microsoft’s strategic changes?

4. From a “strategy as theory” perspective, why is it hard to change strategy? How are strategic changes made?

5. ON ETHICS: As a Microsoft spokesperson, how do you respond to free speech and human rights critics?

[Journal acronyms] AMJ – Academy of Management Journal; AMP – Academy of Management Perspectives; AMR – Academy of Management Review; APJM – Asia Pacific Journal of Management; BW – BusinessWeek (before 2010) or Bloomberg Businessweek (since 2010); ETP – Entrepreneurship Theory and Practice; GSJ – Global Strategy Journal; HBR – Harvard Business Review; IJMR – International Journal of Management Reviews; JEL – Journal of Economic Literature; JEP – Journal of Economic Perspec- tives; JF – Journal of Finance; JIBS – Journal of International Business Studies; JIM – Journal of International Manage- ment; JM – Journal of Management; JMS – Journal of Management Studies; JWB – Journal of World Business; MBR –Multinational Business Review;MIR –Management International Review; OSt – Organization Studies; SMJ – Strategic Management Journal

1. V. Govindarajan & A. Gupta, 2001, The Quest for Global Dominance, San Francisco: Jossey-Bass; S. Tall- man, 2009, Global Strategy, West Sussex, UK: Wiley; G. Yip, 2003, Total Global Strategy II, Upper Saddle River, NJ: Pearson Prentice Hall.

2. J. Dunning, 1993, Multinational Enterprises and the Global Economy (p. 30), Reading, MA: Addison- Wesley. Other terms are multinational corporation (MNC) and transnational corporation (TNC), which are often used interchangeably with MNE. To avoid confusion, we will use MNE throughout this book.

3. K. Macharzina, 2001, The end of pure global strategies? (p. 106), MIR, 41: 105–108.

4. P. Ghemawat, 2007, Redefining Global Strategy, Boston: Harvard Business School Press.

5. M. W. Peng, 2013, GLOBAL 2 (p. 6), Cincinnati: South-Western Cengage Learning.

6. J. Mathews, 2006, Dragon multinationals as new fea- tures of globalization in the 21st century, APJM, 23: 5–27; M. W. Peng, 2012, The global strategy of emer- ging multinationals from China, GSJ, 2: 97–107; S. Sun, M. W. Peng, R. Ben, & D. Yan, 2012, A comparative ownership advantage framework for cross-border M&As, JWB, 47: 4–16.

7. “Transnational” and “metanational” have been pro- posed to extend the traditional notion of “global strat- egy.” See C. Bartlett & S. Ghoshal, 1989, Managing Across Borders, Boston: Harvard Business School Press; Y. Doz, J. Santos, & P. Williamson, 2001, From Global to Metanational, Boston: Harvard Business School Press. A more radical idea is to abandon “global strategy.” See A. Rugman, 2005, The Regional Mul- tinationals, Cambridge, UK: Cambridge University Press.

8. R. Barker, 2010, No, management is not a profession (p. 58), HBR, July: 52–60.

9. Expatriate managers often command significant pre- mium in compensation. In US firms, their average total compensation package is $250,000–300,000. See M. W. Peng, 2011, Global Business, 2nd ed., Cincin- nati: South-Western Cengage Learning.

10. BW, 2007, The changing talent game (p. 68), August 20: 68–71.

11. A. Carmeli & G. Markman, 2011, Capture, govern- ance, and resilience: Strategy implications from the history of Rome, SMJ, 32: 322–341.

12. Sun Tzu, 1963, The Art of War, translation by S. Griffith, Oxford: Oxford University Press.

13. I. Ansoff, 1965, Corporate Strategy, New York: McGraw-Hill; D. Schendel & C. Hofer, 1979, Strategic Management, Boston: Little, Brown. D. Hambrick &

C h a p t e r 1 S t r a t e g i z i n g A r o u n d t h e G l o b e 29

M. Chen, 2008, New academic fields as admittance- seeking social movements, AMR, 33: 32–54.

14. D. Collis & M. Rukstad, 2008, Can you say what your strategy is? HBR, April: 82–90; M. de Rond & R. Thietart, 2007, Choice, chance, and inevitability in strategy, SMJ, 28: 535–551.

15. K. Von Clausewitz, 1976,OnWar, London: Kegan Paul. 16. B. Liddell Hart, 1967, Strategy, New York: Meridian. 17. H. Mintzberg, 1994, The Rise and Fall of Strategic

Planning, New York: Free Press. See also J. Bower & C. Gilbert, 2007, How managers’ everyday decisions create or destroy your company’s strategy, HBR, February: 72–79.

18. BW, 2011, Charlie Rose talks to Mark Zuckerberg, November 14: 50.

19. A. Chandler, 1962, Strategy and Structure, Cambridge, MA: MIT Press.

20. P. Drucker, 1994, The theory of the business (p. 96), HBR, September–October: 95–105.

21. S. Julian & J. Ofori-Dankwa, 2008, Toward an inte- grative cartography of two strategic issue diagnosis frameworks, SMJ, 29: 93–114.

22. C. Christensen & M. Raynor, 2003, Why hard-nosed executives should care about management theory, HBR, September: 67–74.

23. R. Wiltbank, N. Dew, S. Read, & S. Sarasvathy, 2006, What to do next? SMJ, 27: 981–998.

24. J. Camillus, 2008, Strategy as a wicked problem, HBR, May: 99–106.

25. E. Anderson & D. Simester, 2011, A step-by-step guide to smart business experiments, HBR, March: 98–105; J. Donahoe, 2011, How eBay developed a culture of experimentation, HBR, March: 93–97; G. Gavetti & J. Rivkin, 2005, How strategists really think, HBR, April: 54–63; C. Zook & J. Allen, 2011, The great repeatable business model, HBR, November: 107–114.

26. A. Pettigrew, R. Woodman, & K. Cameron, 2001, Studying organizational change and development, AMJ, 44: 697–713; T. Reay, K. Golden-Biddle, & K. Germann, 2006, Legitimizing a new role, AMJ, 49: 977–998.

27. D. Hambrick & P. Mason, 1984, Upper echelons, AMR, 9: 193–206; M. Porter, J. Lorsch, & N. Nohria, 2004, Seven surprises for new CEOs, HBR, October: 62–72.

28. R. Rumelt, D. Schendel, & D. Teece (eds.), 1994, Fundamental Issues in Strategy (p. 564), Boston: Harvard Business School Press.

29. C. Carr, 2005, Are German, Japanese, and Anglo- Saxon strategic decision styles still divergent in the context of globalization? JMS, 42: 1155–1188.

30. M. Carney, E. Gedajlovic, & X. Yang, 2009, Varieties of Asian capitalism, APJM, 26: 361–380.

31. M. W. Peng, S. Lee, & J. Tan, 2001, The keiretsu in Asia, JIM, 7: 253–276.

32. M. W. Peng & Y. Luo, 2000, Managerial ties and firm performance in a transition economy, AMJ, 43: 486– 501; H. Yang, S. Sun, Z. Lin, & M. W. Peng, 2011, Behind M&As in China and the United States, APJM, 28: 239–255.

33. N. Bloom, C. Genakos, R. Sadun, & J. Van Reenen, 2012, Management practices across firms and coun- tries, AMP, February, 12–33; N. Bloom & J. Van Reenen, 2010, Why do management practices differ across firms and countries? JEP, 24: 203–224; C. Crossland & D. Hambrick, 2011, Differences in managerial discretion across countries, SMJ, 32: 797– 819; G. Jackson & R. Deeg, 2008, Comparing capital- isms, JIBS, 39: 540–561; C. Luk, O. Yau, L. Sin, A. Tse, R. Chow, & J. Lee, 2008, The effects of social capital and organizational innovativeness in different institu- tional contexts, JIBS, 39: 589–612; R. Whitley, 2006, Understanding differences, OSt, 27: 1153–1177.

34. M. W. Peng, S. Sun, B. Pinkham, & H. Chen, 2009, The institution-based view as the third leg for a strat- egy tripod, AMP, 23: 63–81.

35. M. W. Peng, D. Wang, & Y. Jiang, 2008, An institu- tion-based view of international business strategy, JIBS, 39: 920–936.

36. K. Meyer, S. Estrin, S. Bhaumik, & M. W. Peng, 2009, Institutions, resources, and entry strategies in emerging economies, SMJ. 30: 61–80.

37. M. Carney, E. Gedajlovic, P. Heugens, M. Van Essen, & J. Van Oosterhout, 2011, Business group affiliation, performance, context, and strategy, AMJ, 54: 437–460; T. Khanna & Y. Yafeh, 2007, Business groups in emerging markets, JEL, 45: 331–372; K. B. Lee, M. W. Peng, & K. Lee, 2008, From diversification premium to diversification discount during institu- tional transitions, JWB, 43: 47–65; D. Yiu, Y. Lu, G. Bruton, & R. Hoskisson, 2007, Business groups, JMS, 44: 1551–1579.

38. M. W. Peng, S. Lee, & D. Wang, 2005, What deter- mines the scope of the firm over time? AMR, 30: 622–633.

39. G. Qian, T. Khoury, M. W. Peng, & Z. Qian, 2010, The performance implications of intra- and inter-regional

30 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

geographic diversification, SMJ, 31: 1018–1030; M. Wiersema & H. Bowen, 2011, The relationship between international diversification and firm performance, GSJ, 1: 152–170; S. Zaheer & L. Nachum, 2011, Sense of place, GSJ, 1: 96–108.

40. M. W. Peng, 2004, Identifying the big question in international business research, JIBS, 25: 99–108

41. K. Brouthers, L. Brouthers, & S. Werner, 2008, Resource-based advantage in an international context, JM, 34: 189–217; C. Chan, T. Isobe, & S. Makino, 2008, Which country matters? SMJ, 29: 1179–1205; G. Gao, J. Murray, M. Kotabe, & J. Lu, 2010, A “strategy tripod” perspective on export behaviors, JIBS, 41: 377–396; Y. Yamakawa, M. W. Peng, & D. Deeds, 2008, What drives new ventures to inter- nationalize from emerging to developed economies? ETP, 32: 59–82; X. Yang, Y. Jiang, R. Kang, & Y. Ke, 2009, A comparative analysis of the internationalization of Chinese and Japanese firms, APJM, 26: 141–162.

42. D. Marginson & L. Macaulay, 2008, Exploring the debate on short-termism, SMJ, 29: 273–292.

43. T. Levitt, 1983, The globalization of markets, HBR, May: 92–102.

44. S. Tallman & T. Pedersen, 2011, The launch of Global Strategy Journal, GSJ, 1: 1–5.

45. B. Greenwald & J. Kahn, 2005, All strategy is local, HBR, September: 95–105.

46. K. Moore &D. Lewis, 2009, The Origins of Globaliza- tion, New York: Routledge.

47. D. Yergin & J. Stanislaw, 2002, The Commanding Heights (p. 385), New York: Simon & Schuster.

48. J. Stiglitz, 2002, Globalization and Its Discontents (p. 9), New York: Norton.

49. M. W. Peng, R. Bhagat, & S. Chang, 2010, Asia and global business, JIBS, 41: 373–376.

50. R. Simons, 2010, Stress test your strategy, HBR, November: 93–100; P. Mackay & S. Moeller, 2007, The value of corporate risk management, JF, 62: 1379–1419; N. Taleb, D. Goldstein, & M. Spitznagel, 2009, The six mistakes executives make in risk man- agement, HBR, October: 78–81.

51. S. Lee & M. Makhija, 2009, The effect of domestic uncertainty on the real options value of international investments, JIBS, 40: 405–420.

52. P. Ghemawat, 2003, Semiglobalization and interna- tional business strategy, JIBS, 34: 138–152.

53. J. Boddewyn & J. Doh, 2011, Global strategy and the collaboration of MNEs, NGOs, and governments for the provisioning of collective goods in emerging mar- kets, GSJ, 1: 345–361; T. Devinney, 2011, Social responsibility, global strategy, and the multinational enterprise, GSJ, 1: 329–344.

54. M. W. Peng, S. Sun, & D. Blevins, 2011, The social responsibility of international business scholars, MBR, 19: 106–119; D. Rodrik, 2011, The Globalization Para- dox, New York: Norton.

55. J. Barney, 2005, Should strategic management research engage public policy debates? AMJ, 48: 945–948; D. Hambrick, 2005, Venturing outside the monastery, AMJ, 48: 961–962.

56. M. W. Peng & E. Pleggenkuhle-Miles, 2009, Current debates in global strategy, IJMR, 11: 51–68.

C h a p t e r 1 S t r a t e g i z i n g A r o u n d t h e G l o b e 31

CHAPTER2

MANAGING INDUSTRY COMPETITION

KNOWLEDGE OBJECT IVES

After studying this chapter, you should be able to

1. Define industry competition

2. Analyze an industry using the five forces framework

3. Articulate the three generic strategies

4. Understand the seven leading debates concerning the industry-based view

5. Draw strategic implications for action

ot o/ A le xe y St io p

32 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

E T H I C A L D I L E M M A

OPENING CASE

Emerging Markets: Competing in the Indian Retail Industry

India has the world’s highest density of retail outlets. It has more than 15 million outlets, compared with 900,000 in the United States, whose market (by revenue) is 13 times big- ger. At present, 95% of retail sales in India are made in tiny independent mom-and-pop shops, mostly smaller than 500 square feet (46 square meters). In Indian jargon, this is known, quite accurately, as the “unorganized” sector. The “organized” sector refers to more modern supermarkets and chain stores. The organized sector commands only 5% of the country’s $435 billion retail sales. In India, the retail industry is the largest provider of jobs after agriculture, accounting for 6%–7% of jobs and 10% of GDP.

Given the two distinct groups of outlets, competition primarily takes place within the unorganized sector and within the organized sector. Customers tend to be price sensitive and purchase in small quantities. The mom-and- pop shops are too small to negotiate good deals with middleman companies such as wholesalers. But the major- ity of Indians shop at mom-and-pop shops—often because of a lack of choice. Organized outlets simply do not exist in many rural areas. Because of the scarcity of outlets, com- petition among supermarkets is relatively tranquil. How- ever, it is heating up. Reliance Group, one of India’s largest conglomerates, is now making huge waves by investing $5.5 billion to build 1,000 hypermarkets and 2,000 super- markets to blanket the country in the next five years.

With a booming economy, a fast-growing middle class, and fragmented local competitors, this industry is the world’s biggest untapped retail market. Not surpris- ingly, foreign giants such as Wal-Mart, Carrefour, Metro, and Tesco are knocking at the door trying to expand the organized sector. However, here is a catch: The door is still officially closed to foreign direct investment (FDI) in this industry. Since the post-1991 opening to FDI has brought India to the global spotlight, investing in India has become one of the top items on the corporate to-do list in many multinationals. Yet, there are industry-specific restrictions, and the retail industry is conspicuous in being one of the last four still officially closed to FDI—the other three are the more sensitive atomic energy, gambling, and agriculture.

Given the Indian government’s and the public’s general appreciation of the contributions made by FDI, the retail industry, according to an Economist editorial in 2011, is now “the most glaring example of the need for foreign investment.” One of the leading arguments is that super- efficient retail operations will enhance efficiency through- out the entire supply chain. At present, about a third of fruits and vegetables spoils while in transit, a catastrophe in a country where so many go hungry. In countries with more modern retail systems, less than a tenth is lost.

For years, a side door has been open to FDI. Until 2011, foreign firms could take up to 51% equity in single-brand shops that sell their own products, such as Nike, Nokia, and Starbucks. Foreign firms could also set up wholesale and sourcing subsidiaries that supply local mass retail part- ners. In 2006, Australia’s Woolworths started to supply Croma stores owned by Tata Group. In 2010, Wal-Mart teamed with Bharti by operating nine Best Price joint- venture wholesale stores. But until November 2011, FDI in multi-brand stores (such as supermarkets) had been banned.

To attract more FDI, the government in November 2011 announced that foreign firms could now own 51% of multi-brand retailers (up from zero) and foreign firms’ stake in single-brand retailers could now reach 100% (up from 51%). The reforms would be very limited—only to be implemented in 53 cities with population of more than one million. Consumers would benefit from increased competition. The shares of listed local retailers soared, on speculation that they might be bought out by foreign firms. Farmers would gain from greater investment in the supply chain. Currently farmers have little bargaining power. They sell to a wholesale market, which dictates prices. The wholesaler then sells the produce to another middleman, which further passes the produce to a distri- butor. By the time food reaches the consumer, it will have been marked up three to four times, but nearly all of that goes to various middlemen, not farmers. Easy profits pro- vide little incentive for middlemen to enhance efficiency and invest in modern supply chain (such as cold storage), and food spoils along the way. To attract farmers, foreign

33 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

Why is the Indian retail industry turning from relative peace and tran-quility to more heated competition? Why are foreign firms interested inentering? What are the responses of existing players (incumbents) such as unorganized shops, organized supermarkets, and middleman companies? How do farmers and consumers react? Finally, are there any substitutes for retail shopping? This chapter addresses these and other strategic questions. We accom- plish this by introducing the industry-based view, which is one of the three leading perspectives on strategy. (The other two, resource-based and institution-based views, will be covered in Chapters 3 and 4, respectively.)

As noted in Chapter 1, a basic strategy tool is SWOT analysis, dealing with internal strengths (S), weaknesses (W), environmental opportunities (O), and threats (T). The focus of this chapter is O and T from the industry environment (S and W will be discussed later). We start by defining industry competition. Then, the five forces framework will be introduced, followed by a discussion of three generic strategies. Finally, we spell out seven leading debates.

Defining Industry Competition An industry is a group of firms producing products (goods and/or services) that are similar to each other. The traditional understanding is based on Adam Smith’s (1776) model of perfect competition, in which price is set by the invisible hand known as the “market,” where all firms are price takers and entries and exits are relatively easy. However, such perfect competition is rarely observed in the real world. Consequently, since the late 1930s, a more realistic branch of economics, called industrial organization (IO) economics (or industrial economics), has emerged. Its primary contribution is

(Continued)

OPENING CASE

retailers would have to offer higher prices. Wal-Mart set itself a target of increasing farmer income by 20% over five years. Cost-conscious foreign retailers would then invest in modern supply chain to minimize food spoilage.

A huge political brawl erupted after the announce- ment. Many shopkeepers, supported by middlemen, pro- tested against the alleged onslaught of multinationals and cited the controversial “Wal-Mart effect” being debated in the United States and elsewhere. Interested in shop- keepers’ votes, the government thus faced a dilemma. In December 2011, a mere two weeks after the announce- ment of the retail reforms, a humiliated government announced that it would suspend the reforms that would

bring lower prices for consumers and better prices for farmers. The incumbents won the day. However, the reforms were “suspended,” not “cancelled.” So stay tuned for the evolution of this industry.

Sources: Based on (1) Associated Press, 2011, India backtracks on plan to let in foreign retail, December 7; (2) Economist, 2011, Fling wide the gates, April 16: 16; (3) Economist, 2011, Let Walmart in, December 3: 20; (4) Economist, 2011, Send for the supermarketers, April 16: 67–68; (5) Economist, 2011, The supermarket’s last frontier, December 3: 75–76; (6) Times, 2011, Why India should stop fearing Walmart, November 28: http://globalspin.blogs.time.com.

industry

A group of firms producing products (goods and/or services) that are similar to each other.

perfect competition

A competitive situation in which price is set by the “market,” all firms are price takers, and entries and exits are relatively easy.

industrial organization (IO) economics

A branch of economics that seeks to better understand how firms in an industry compete and then how to regulate them.

34 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

a structure-conduct-performance (SCP) model. Structure refers to the structural attributes of an industry (such as the costs of entry/exit). Conduct is firm actions (such as product differentiation). Performance is the result of firm conduct in response to industry structure, which can be classified as (1) average (normal), (2) below-average, and (3) above-average. The model suggests that industry structure determines firm conduct (or strategy), which, in turn, determines firm performance.1

However, the goal of IO economics is not to help firms compete; instead, it is to help policymakers better understand how firms compete in order to properly regulate them. In terms of the number of firms in one industry, there is a continuum ranging from thousands of small firms in perfect competition to only one firm in a monopoly. In between, there may be an oligopoly with only a few players or a duopoly with two competitors. The numerous small firms can only hope to earn average returns at best, whereas the monopolist may earn above-average returns. Economists and policymakers are usually alarmed by above-average returns, which they label “excess profits.” Monopoly is usually outlawed and oligopoly scrutinized.

Such an intense focus on above-average firm performance is shared by IO economics and strategy. However, IO economists and policymakers are concerned with the minimiza- tion rather than the maximization of above-average profits. The name of the game, from the perspective of strategists in charge of the profit-maximizing firm, is exactly the opposite—to try to earn above-average returns (of course, within legal and ethical boundaries). Therefore, strategists have turned the SCP model upside down, by drawing on its insights to help firms perform better.2 This transformation comprises the heart of this chapter.

The Five Forces Framework The industry-based view of strategy is underpinned by the five forces framework, first advocated by Michael Porter (a Harvard strategy professor who is an IO economist by training) and later extended and strengthened by numerous others. This section intro- duces this framework.

From Economics to Strategy In 1980, Porter “translated” and extended the SCP model for strategy audiences.3 The result is the well-known five forces framework, which forms the backbone of the industry-based view of strategy. Shown in Figure 2.1, these five forces are (1) the intensity of rivalry among competitors, (2) the threat of potential entry, (3) the bargain- ing power of suppliers, (4) the bargaining power of buyers, and (5) the threat of substitutes. A key proposition is that firm performance critically depends on the degree of competitiveness of these five forces within an industry. The stronger and more competitive these forces are, the less likely the focal firm will be able to earn above- average returns, and vice versa (Table 2.1).

Intensity of Rivalry among Competitors Actions indicative of a high degree of rivalry include (1) frequent price wars, (2) prolifera- tion of new products, (3) intense advertising campaigns, and (4) high-cost competitive

structure-conduct- performance (SCP) model

An industrial organization economics model that sug- gests industry structure determines firm conduct (strategy), which in turn determines firm perfor- mance.

structure

Structural attributes of an industry such as the costs of entry/exit.

conduct

Firm actions such as pro- duct differentiation.

performance

The result of firm conduct.

monopoly

A situation whereby only one firm provides the goods and/or services for an industry.

oligopoly

A situation whereby a few firms control an industry.

duopoly

A special case of oligopoly that has only two players.

five forces framework

A framework governing the competitiveness of an industry proposed by Michael Porter. The five forces are (1) the intensity of rivalry among competi- tors, (2) the threat of potential entry, (3) the bargaining power of sup- pliers, (4) the bargaining power of buyers, and (5) the threat of substitutes.

C h a p t e r 2 Ma n a g i n g I n d u s t r y C o m p e t i t i o n 35

actions and reactions (such as honoring all competitors’ coupons). Such intense rivalry threatens firms by reducing profits. The key question is: What conditions have led to it?

At least six sets of conditions emerge (Table 2.1). First, the number of competitors is crucial. The more concentrated an industry is, the fewer competitors there will be, and the more likely those competitors will recognize their mutual interdependence and thus restrain their rivalry. For instance, in the automobile industry, the few luxury car competitors such as Ferrari, Lamborghini, and Rolls-Royce historically do not engage in intense competitive actions (such as deep discounts) typically found among mass market competitors.

Second, competitors of similar size, market influence, and product offerings often vigorously compete with each other. This is especially true for firms unable to differentiate their products, such as airlines. How many airlines have flown into the skies of bank- ruptcy lately? In contrast, the presence of a dominant player lessens rivalry because it can set industrywide prices and discipline behaviors deviating too much from the prices norm. De Beers in the diamond industry is one such example.

Third, in industries whose products are “big tickets” and purchased infrequently (such as mattresses and motorcycles), it may be difficult to establish dominance—the market leader has a very large market share. The upshot is more intense rivalry. In contrast, it may be relatively easier for leading firms to dominate in “staple goods” industries with low-price,

FIGURE 2.1 The Five Forces Framework

Industry competitiveness

Rivalry among competitors

Threat of substitutes

Bargaining power of buyers

Bargaining power of suppliers

Threat of entrants

dominance

A situation whereby the market leader has a very large market share.

ga ge

Le ar ni ng

36 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

more frequently purchased products (such as beers and facial tissues) (see Table 2.2). This is because consumers for “staple goods” are not likely to spend much time to do research on their purchase decisions and find it convenient to stick with well-known brands. On the other hand, consumers for “big ticket” items are more interested in searching for a good deal every time they buy, and may not automatically rely on the reputation of leading firms. For instance, how often do you buy a car? Chances are that the next time you buy a car, you would do some research again. Therefore, the current producer that sold you a car several years ago runs the risk of losing you as a customer.

Fourth, in some industries, new capacity must be added in large increments, thus fueling intense rivalry.4 If the route between two seaports is currently served by two cruise lines (each with one ship of equal size), any existing company’s (or new entrant’s) new addition of merely one ship will increase the capacity by 50%. Thus, the two existing cruise lines are often compelled to cut prices (see Strategy in Action 2.1). Industries such as hotels, petrochemicals, semiconductors, and steel often periodically experience over- capacity, leading to price-cutting as a primary coping mechanism.5

Fifth, slow industry growth or decline makes competitors more desperate, often unleashing actions not used previously. In the life-and-death fight to remain viable after

TABLE 2.1 Threats of the Five Forces

FIVE FORCES THREATS INDICATIVE OF STRONG COMPETITIVE FORCES THAT CAN DEPRESS INDUSTRY PROFITABILITY

Rivalry among competitors

& A large number of competing firms & Rivals are similar in size, influence, and product offerings & High-price low-frequency purchases & Capacity is added in large increments & Industry slow growth or decline & High exit costs

Threat of potential entry

& Little scale-based advantages (economies of scale) & Little non-scale-based advantages & Inadequate product proliferation & Insufficient product differentiation & Little fear of retaliation due to the focal firm’s lack of excess capacity & No government policy banning or discouraging entry

Bargaining power of suppliers

& A small number of suppliers & Suppliers provide unique differentiated products & Focal firm is not an important customer of suppliers & Suppliers are willing and able to vertically integrate forward

Bargaining power of buyers

& A small number of buyers & Products provide little cost savings or quality-of-life enhancement & Buyers purchase standard undifferentiated products from focal firm & Buyers are willing and able to vertically integrate backward

Threat of substitutes & Substitutes are superior to existing products in quality and function & Switching costs to use substitutes are low

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the 2008 economic crisis, many luxury goods makers had to resort to discounting—a practice they typically avoided before (see the Closing Case).

Finally, industries experiencing high exit costs are likely to see firms continue to operate at a loss. Specialized equipment and facilities that are of little or no alternative use, or that cannot be sold off, pose as exit barriers. In addition, emotional, personal, and career costs, especially on the part of executives admitting failure, may be high. In Japan and Germany, managers may be legally prosecuted if their firms file for bankruptcy.6

Thus, it is not surprising that these executives will try everything before admitting failure and taking their firms to exit the industry.

Overall, if there are only a small number of rivals led by a few dominant firms, new capacity is added incrementally, industry growth is strong, and exit costs are reasonable, the degree of rivalry is likely to be moderate and industry profits more stable. Conditions opposite from those may unleash intense rivalry. Chapter 8 will discuss more details of interfirm rivalry.

Threat of Potential Entry In addition to keeping an eye on existing rivals, established firms in an industry, which are called incumbents, also have a vested interest in keeping potential new entrants out.7 New entrants are motivated to enter an industry because of the lucrative above-average returns some incumbents earn.8 For example, the Amazon Kindle’s success has attracted Barnes and Noble to launch its Nook.

Incumbents’ primary weapons are entry barriers, which refer to industry structures increasing the costs of entry. For instance, Airbus’s new A380 burned $12 billion and

TABLE 2.2 Big Tickets versus Staple Goods

PRODUCT US MARKET LEADER LEADER’S MARKET

SHARE LEADER’S SHARE AMONG

TOP-4 FIRMS

Big tickets: High-price less-frequently purchased products

Athletic footwear Reebok 25% 40%

Automobile General Motors 35% 46%

Mattresses Sealy 25% 46%

Motorcycles Honda 33% 42%

Refrigerators General Electric 34% 38%

Staple goods: Low-price more-frequently purchased products

Beer Anheuser Busch (Budweiser) 44% 52%

Facial tissues Kimberly-Clark (Kleenex) 47% 56%

Laundry detergents Procter & Gamble 53% 59%

Light bulbs General Electric 59% 62%

Processed cheese Kraft 54% 71%

Source: Adapted from J. Shamsie, 2003, The context of dominance: An industry-driven framework for exploiting reputation (pp. 214–215), Strategic Management Journal, 24: 199–215.

incumbents

Current members of an industry that compete against each other.

entry barriers

The industry structures that increase the costs of entry.

38 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

Boeing’s new 787 consumed $10 billion before their maiden flights. Facing such sky-high entry barriers, all potential entrants, including those backed by the Japanese and Korean governments, have quit. The key question is: What conditions have created such high entry barriers?

Shown in Table 2.1, at least six structural attributes are associated with high entry barriers. The first is whether incumbents enjoy scale-based advantages. The key concept is economies of scale, which refer to reductions in per unit costs by increasing the scale of production and distribution. For example, Wal-Mart thrives on using its enormous economies of scale in distribution to spread logistics and overhead cost over a large number of outlets, which results in lower prices. In India, it is such economies of scale that the unorganized shop owners are afraid of if Wal-Mart were allowed to enter (see the Opening Case).

STRATEGY IN ACTION 2.1

The Cruise Industry: Too Many Love Boats

The cruise industry is the second life of the ocean liner industry. Eclipsed by jets, the last ocean liners stopped service in the 1980s. The modern cruise industry started in the 1960s, when Norwegian and Carnival cruise lines were founded and dedicated to vacation cruises—not to transportation. In 1977, ABC started its weekly Love Boat television series that became a decade-long unpaid commercial for the fledgling industry. The cruise liner was portrayed as a blend of fun and romance. The cruise industry gradually gained popularity, slowly at first but at an increased rate since the 1980s. Initially the industry was serviced by redundant ocean liners. By the 1990s, purpose- built mega ships increasingly entered service. Every year since 2001, nine or more new cruise ships hit the waves, centered around the key markets in the Caribbean, Alaska, Mexico, and Europe. Most of these mega ships were 100,000 tons or greater—larger than the largest, Nimitz- class aircraft carrier. The new ones keep getting bigger. The world’s largest are Royal Caribbean’s Oasis of the Seas and Allure of the Seas, each at 225,000 tons with 2,700 cabins and room for 5,400 passengers. Mega ships are more profitable because they enable cruise lines to spread fixed costs across more customers.

Despite the glamour, captains of this industry know that they need a steel stomach to navigate the waters infested by love boats—indeed, too many of them.

Between 1966 and 2008, 88 firms entered the US market but 77 either dropped out or dropped dead. Competition among the survivors now focuses on who can fill an armada of bigger, fancier vessels. In 2000, the US market was served by 111 ships with a capacity of 165,381 lower berths. By 2010, there were 60% more ships and 86% more berths (because of the introduction of larger ships). During the same decade, crises ranged from “9/11” to the recession. To lure passengers, firms slashed prices, eliminated fuel surcharges, repositioned ships from exotic ports to locations that did not require extensive air travel, and launched short (one-day or one-weekend) cruises. In 2010, while the industry carried 15 million passengers (10 million in the United States), an annual increase of 10%, occupancy was still not where it was before the recession. To fill the huge love boats, the key is to reach out to the 80% of Americans who have never taken a cruise.

Sources: Based on (1) the author’s interviews; (2) BusinessWeek, 2004, Carnival: Plenty of ports in a storm, November 15: 76–78; (3) BusinessWeek, 2009, To cruise lines, too many love boats, November 24: 100–102; (4) D. Sull, 2010, Turbulent times and golden opportunities, Business Strategy Review, Spring: 34–39.

scale-based advantages

Advantages derived from economies of scale (the more a firm produces some products, the lower the unit costs become).

economies of scale

Reduction in per unit costs by increasing the scale of production.

C h a p t e r 2 Ma n a g i n g I n d u s t r y C o m p e t i t i o n 39

Another set of advantages that incumbents may enjoy is independent of scale— non-scale-based advantages. For example, proprietary technology (such as patents) is helpful. Entrants have to “invent around,” the outcome of which is costly and uncertain. Entrants can also directly copy proprietary technology, which may trigger lawsuits by incumbents for patent violations. Another source of such advantages is know-how, the intricate knowledge of how to make products and serve customers that takes years, sometimes decades, to accumulate. It is often difficult for new entrants to duplicate such know-how.

In addition to scale-based and non-scale-based low-cost advantages, another entry barrier is product proliferation, which refers to efforts to fill product space in a manner that leaves little “unmet demand” for potential entrants.9 For example, South-Western Cengage Learning, our multibillion dollar multinational publisher (see Chapter 1 Opening Case), has teamed with your author (whose nickname is “Mr. Global”) to not only publish this market-leading text, Global Strategy, but also Global Business and GLOBAL around the world. European students can enjoy a European adaptation titled International Business (coauthored with Klaus Meyer). For non-English readers who are dying to arm themselves with the wisdom contained in Global Strategy, there are Quanqiu Qiye Zhanlue (the Chinese translation), Estrategia Global (the Spanish translation), and Estra- tégia Global (the Portuguese translation) (see Chapter 1 Opening Case).

Also important is product differentiation, which refers to the uniqueness of the incumbents’ products that customers value. Its two underlying sources are (1) brand identification and (2) customer loyalty. Incumbents, often through intense advertising, would like customers to identify their brands with some unique attributes. BMW brags about its cars being the “ultimate driving machines.” Champagne makers in the French region of Champagne argue that competing products made elsewhere are not really worthy of the name Champagne.

A second source of product differentiation is customer loyalty, especially when switch- ing costs for new products are substantial. Many high-tech industries are characterized by network externalities, whereby the value a user derives from a product increases with the number (or the network) of other users of the same product.10 These industries have a “winner take all” property, whereby winners (incumbents) whose technology standard is embraced by the market (such as Microsoft Word, Excel, and PowerPoint) are essentially locking out potential entrants. In other words, these industries have an interesting “increasing returns” characteristic, as opposed to “diminishing returns” taught in basic economics.

Another entry barrier is possible retaliation by incumbents. Incumbents often maintain some excess capacity, designed to punish new entrants. To think slightly outside the box, perhaps the best example is the armed forces. They cost taxpayers huge sums of money and clearly represent excess capacity in peace time. But they exist for one reason—to deter foreign invasion (or “punish new entrants”). No country has ever unilaterally disbanded its armed forces, and the worst punishment for defeated countries (such as Germany and Japan in 1945 and Iraq in 2003) is to have their military dismantled. In general, the more credible and predictable the retaliation, the more likely new entrants may be deterred. Coca-Cola has been known to retaliate by slashing prices if any competitor (other than Pepsi) crosses the threshold of 10% share in any market. As a result, potential entrants often think twice before proceeding.

non-scale-based advantages

Low-cost advantages that are not derived from the economies of scale.

product proliferation

Efforts to fill product space in a manner that leaves little “unmet demand” for potential entrants.

product differentiation

The uniqueness of products that customers value.

network externalities

The value a user derives from a product increases with the number (or the network) of other users of the same product.

excess capacity

Additional production capacity currently underuti- lized or not utilized.

40 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

Finally, government policy banning or discouraging entries can serve as another entry barrier. For example, the US government does not allow foreign entrants to invest in the defense industry and only allows up to 25% equity injection from foreign carriers in the airline industry. The Indian government bans large-scale entry by foreign retailers such as Wal-Mart (see the Opening Case). In almost every case, the lowering of government- imposed entry barriers leads to a proliferation of new entrants, threatening the profit margins of incumbents. This, of course, is exactly why Indian retail incumbents lobby so hard to prevent the onslaught of foreign entrants.

Overall, if incumbents can leverage scale-based and/or non-scale-based advantages, offer numerous products, provide sufficient differentiation, maintain a credible threat of retaliation, and/or enjoy regulatory protection, the threat of potential entry becomes weak. Thus, incumbents can enjoy higher profits.

Bargaining Power of Suppliers Suppliers are organizations that provide inputs, such as materials, services, and man- power, to firms in the focal industry. The bargaining power of suppliers refers to their ability to raise prices and/or reduce the quality of goods and services. Four conditions may lead to suppliers’ strong bargaining power (Table 2.1). First, if the supplier industry is dominated by a few firms, they may gain an upper hand. To make a point, energy giant Gazprom slowed gas deliveries to Ukraine due to price disputes, leaving customers shivering in winter cold—three times in three years (2007, 2008, and 2009).

Second, the bargaining power of suppliers can become substantial if they provide unique, differentiated products with few or no substitutes. For instance, as a supplier of mission-critical software for most personal computers (PCs), Microsoft is able to extract significant price hikes from PC makers such as Dell, HP, and Lenovo whenever its Windows unleashes a new version.

Third, suppliers enjoy strong bargaining power if the focal firm is not an important customer. Boeing and Airbus are not too concerned with losing the business of small airlines, which may only purchase 1–2 aircraft at a time. Consequently, they often refuse to lower prices. But they are intensely concerned about losing large airlines, such as American, Japan, and Singapore Airlines. Thus, lower prices are often offered.

Finally, suppliers may enhance their bargaining power if they are willing and able to enter the focal industry by forward integration.11 In other words, suppliers may threaten to become both suppliers and rivals. For example, in addition to supplying phones to tradi- tional telecom retail stores, Apple has established a number of Apple Stores in major cities.

In summary, powerful suppliers can squeeze profitability out of firms in the focal industry. Firms in the focal industry, thus, have an incentive to strengthen their own bargaining power by reducing their dependence on certain suppliers. For example, Wal-Mart has implemented a policy of not having any supplier account for more than 3% of its purchases.

Bargaining Power of Buyers From the perspective of buyers (individual or corporate), firms in the focal industry are essentially suppliers. Therefore, our previous discussion on suppliers is relevant here (Table 2.1). Four conditions lead to the strong bargaining power of buyers. First, a small

bargaining power of suppliers

The ability of suppliers to raise prices and/or reduce the quality of goods and services.

forward integration

Acquiring and owning downstream assets.

bargaining power of buyers

The ability of buyers to reduce prices and/or enhance the quality of goods and services.

C h a p t e r 2 Ma n a g i n g I n d u s t r y C o m p e t i t i o n 41

number of buyers leads to strong bargaining power. For example, hundreds of automobile component suppliers try to sell to a small number of automakers, such as BMW, Ford, and Honda. These buyers frequently extract price concessions and quality improvements by playing off suppliers against each other. When these automakers invest abroad, they often encourage or coerce suppliers to invest with them and demand that supplier factories be sited next to the assembly plants—at suppliers’ own expenses. Not surprisingly, many suppliers comply.12 This is how Toyota cloned Toyota City in Guangzhou, China, whose main Toyota- owned factory is surrounded by 30 supplier factories.

Second, buyers may enhance their bargaining power if products of an industry do not clearly produce cost savings or enhance the quality of life for buyers. For example, repeated and frequent upgrades in software packages are causing a buyer fatigue. Heads of information technology (IT) departments are increasingly suspicious of whether the costly new “gadgets” are really able to help their companies save money. The upshot is that reluctant buyers can either refuse to buy or extract significant discounts.

Third, buyers may have strong bargaining power if they purchase standard, undiffer- entiated commodity products from suppliers. Although automobile components suppliers as a group possess less bargaining power relative to automakers, suppliers are not equally powerless. There are usually several tiers. The top tier suppliers are the most crucial, often supplying nonstandard, differentiated key components such as electric systems, steering wheels, and car seats. The bottom tier consists of suppliers making standard, undiffer- entiated commodity products such as seat belt buckles, cup holders, or simply nuts and bolts. Not surprisingly, top tier suppliers possess more bargaining power than bottom tier suppliers.

Finally, like suppliers, buyers may enhance their bargaining power by entering the focal industry through backward integration. Buyers such as COSTCO, Tesco, and Marks & Spencer now directly compete with their own suppliers such as Procter & Gamble (P&G) and Johnson & Johnson by procuring private label (also known as store brand) pro- ducts.13 Private label products, such as Kirkland (for COSTCO), Kroger, and Safeway brands, compete side by side with national brands on the shelf space. At present, store brand products command approximately 40% of grocery sales in Spain, 35% in the Netherlands, 30% in Britain, 25% in France, and 20% in the United States.14 Only leading brand producers such as Frito-Lay (potato chips) can resist the demand made by the powerful stores to make private label goods for the stores. Many mediocre brand producers, when facing the choice of producing private label goods for the stores or being kicked out of shelf space (because their products are replaceable), surrender to the strong bargaining powers of stores.

In summary, powerful or desperate buyers may enhance their bargaining power. Buyers’ bargaining power may be minimized if firms can sell to numerous buyers, identify clear value added, provide differentiated products, and enhance entry barriers.

Threat of Substitutes Substitutes are products of different industries that satisfy customer needs currently met by the focal industry. For instance, while Pepsi is not a substitute for Coke (Pepsi is a rival in the same industry), tea, coffee, juice, and water are—that is, they are still beverages but are in a different product category. Two areas of substitutes are particularly threatening (Table 2.1).

backward integration

Acquiring and owning upstream assets.

substitutes

Products of different industries that satisfy customer needs currently met by the focal industry.

42 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

First, if substitutes are superior to existing products in quality and function, they may rapidly emerge to attract a large number of customers. For example, music downloads (both legal and illegal kinds) are now rapidly eating into CD sales. Online media has pushed print newspapers to the brink of extinction in many cities. Smartphones (such as iPhone) and tablets (such as iPad) are now substituting some PCs.

Second, substitutes may pose significant threats if switching costs are low. For example, consumers incur virtually no costs when switching from sugar to a sugar substitute like Nutrasweet. Both are readily available in restaurants and grocery stores. On the other hand, no substitutes exist for large passenger jets, especially for transoceanic transporta- tion. The only other way to go to Hawaii or New Zealand seems to be swimming (!). As a result, Boeing and Airbus can charge higher prices than would be the case if there were substitutes for their products.

Overall, the possible threat of substitutes requires firms to vigilantly scan the larger environment, as opposed to the narrowly defined focal industry. Enhancing customer value (such as price, quality, utility, and location) may reduce the attractiveness of substitutes.

Lessons from the Five Forces Framework Taken together, the five forces framework offers three significant lessons (Table 2.3):

• The framework reinforces the important point that not all industries are equal in terms of their potential profitability. The upshot is that when firms have the luxury to choose (such as diversified companies contemplating entry to new industries or entrepreneurial start-ups scanning new opportunities—see Strategy in Action 2.2), they will be better off if they choose an industry whose five forces are weak. Michael Dell confessed that he probably would have avoided the PC industry had he known how competitive the industry would become.

• The task is to assess the opportunities (O) and threats (T) underlying each competitive force affecting an industry, and then estimate the likely profit potential of the industry.15

• The challenge, according to Porter, is “to stake out a position that is less vulnerable to attack from head-to-head opponents, whether established or new, and less vulnerable to erosion from the direction of buyers, suppliers, and substitutes.”16 In other words, the key is to position your firm well within an industry and defend its position. Consequently, the five forces framework also becomes known as the industry positioning school.

Although the thrust of this framework was put forward over 30 years ago, it has continued to assert strong influence on strategy practice and research today. While it has been debated and modified (introduced later), its core features remain remarkably insightful.

TABLE 2.3 Lessons from the Five Forces Framework

& Not all industries are equal in terms of potential profitability.

& The task for strategists is to assess the opportunities (O) and threats (T) underlying each of the five competitive forces affecting an industry.

& The challenge is to stake out a position that is strong and defensible relative to the five forces.

industry positioning

Ways to position a firm within an industry in order to minimize the threats presented by the five forces.

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STRATEGY IN ACTION 2.2

From Cardinal Foods to Cardinal Health

Headquartered in Dublin, Ohio (a suburb of Columbus), Cardinal Health is one of the largest and most successful US firms that many of you probably have never heard of. Cardinal Health is a $99 billion giant that was ranked 19 on the Fortune 500 list (by sales) in 2011—yes, it was number 19, not a typo for 190. Named a “stealth empire” by Fortune, Cardinal Health produces significantly larger revenues than some of the seemingly more visible health care companies both on the pharmaceutical side (such as Pfizer) and the retail side (such as Walgreens). Cardinal Health today provides products and services to 90% of US hospitals. Every day more than 50,000 deliveries are made to 40,000 hospitals, pharmacies, and other points of care. If you have health care needs in the United States, chances are you have been a Cardinal Health customer without even knowing it.

How Cardinal Health chose to focus on health care is an amazing story of the power of the five forces framework. In 1971, the firm was founded by 26-year-old Robert Walter, who earned anMBA fromHarvard in the same year. The firm was named Cardinal Foods, which had nothing to do with health care. Walter’s father had been a food broker, so Walter knew a little about the food wholesale distribution business. But after peddling ketchup for a few years, it occurred to Walter that Cardinal Foods would never be a big fish in the crowded and competitive food business. Walter then put on his MBA hat and did a classic five forces analysis, scanning various industries. His findings?

• The drug distribution industry had 354 small, indepen- dently owned distributors, but only three large, publicly listed firms. In other words, competition was primarily local and not severe. Entry barriers were low. Time was ripe for consolidation.

• Buyers (patients) had little bargaining power. Med- icine, when prescribed by a doctor, could not be

substituted—unlike, say, butter. Suppliers (drug- makers) had to rely on drug distributors to get their products to the far corners of the country.

• The drug business was growing faster than the econ- omy, thus presenting more growth opportunities.

Fueled by this powerful insight, Cardinal Foods entered drug distribution by becoming Cardinal Distribution (covering both foods and drugs) in 1980. Finally, the firm, having already sold off its food wholesale business in 1988, renamed itself Cardinal Health in 1994. The rest was history.

Sources: Based on (1) the author’s interviews; (2) Fortune, 2011, Fortune 500 list; (3) M. W. Peng, 2009, Global Strategy, 2nd ed. (pp. 457–458). Cincinnati: South-Western Cengage Learning.

Detroit

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44 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

Three Generic Strategies Having identified the five forces underlying industry competition, the next challenge is how to make strategic choices. Porter suggested three generic strategies, (1) cost leader- ship, (2) differentiation, and (3) focus, all of which are intended to strengthen the focal firm’s position relative to the five competitive forces (see Table 2.4).17

Cost Leadership Recall that our definition of strategy (see Chapter 1) is a firm’s theory about how to compete successfully. A cost leadership strategy suggests that a firm’s theory about how to compete successfully centers on low costs and prices. Offering the same value of a product at a lower price—in other words, better value—tends to attract many customers. A cost leader often positions its products to target “average” customers for the mass market with little differentiation. The key functional areas center on efficiency in manufacturing, services, and logistics. The hallmark of this strategy is a high-volume low-margin approach.

A cost leader, such as Wal-Mart, can minimize the threats from the five forces. First, it is able to charge lower prices and make better profits compared with higher-cost rivals. Second, its low-cost advantage is a significant entry barrier. Third, the cost leader typically buys a large volume from suppliers, whose bargaining power is reduced. Even Wal-Mart’s largest supplier, P&G, is afraid of Wal-Mart’s size. In response, P&G acquired Gillette to enhance its size and, hence, its bargaining power. Fourth, the cost leader would be less negatively affected if strong suppliers increase prices or powerful buyers force prices down. Finally, the cost leader challenges substitutes to not only outcompete the utility of its products but also its prices, a very difficult proposition. Thus, a true cost leader is relatively safe from these threats.

However, a cost leadership strategy has at least two drawbacks. First, there is always the danger of being outcompeted on costs. This forces the leader to continuously search for lower costs. A case in point is Ryanair’s continuous quest for lower cost (but still safe and on time) air travel (see Strategy in Action 2.3). Second, in the relentless drive to cut costs, a cost leader may cut corners that upset customers. Toyota’s recalls were caused by its efforts to cut short test procedures when developing software that controlled acceleration. The damage to its reputation was enormous.

Overall, a cost leadership strategy is pursued by most firms, which find little alternative basis for distinction. However, a number of other firms have decided to be different by embracing the second generic strategy discussed next (see the Closing Case).

TABLE 2.4 Three Generic Competitive Strategies

PRODUCT DIFFERENTIATION MARKET SEGMENTATION KEY FUNCTIONAL AREAS

Cost leadership Low (mainly by price) Low (mass market) Manufacturing, services, and logistics

Differentiation High (mainly by uniqueness) High (many market segments) R&D, marketing, and sales

Focus Extremely high Low (one or a few segments) R&D, marketing, and sales

generic strategies

Strategies intended to strengthen the focal firm’s position relative to the five competitive forces, includ- ing (1) cost leadership, (2) differentiation, and (3) focus.

cost leadership

A competitive strategy that centers on competing on low cost and prices.

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STRATEGY IN ACTION 2.3

Ryanair: The Continuous Search for Low Cost

Ryanair is the undisputed king of low cost airlines in Europe. Founded in Dublin, Ireland, in 1985, Ryanair has defied gravity. The past decade since 2001 was devastated by “9/11” attacks, SARS epidemics, the Great Recession, and (in Europe) the complete grounding of air travel due to an Icelandic volcanic eruption (2010). All US legacy airlines flew into the skies of bankruptcy. Most European airlines were struggling. Over the past decade, the global airline industry collectively lost $50 billion. Yet Ryanair turned healthy profits in nine out of the ten years.

What are Ryanair’s secrets? Plenty. Like its role model Southwest, Ryanair specializes in short-haul flights using a single type of aircraft, the Boeing 737. Flying point to point allows it to quickly turn around flights. It gets 50% more flying hours per day out of its aircraft than its hub-and- spoke rivals. Ryanair has also rented out overhead storage and seatbacks to advertisers. In-flight food and drinks? Forget it. Baggage fees? Of course. Instead of flying between main airports, Ryanair flies between secondary airports far away from the central city. For example, British Airways (BA) charges $400 for a flight between London (Heathrow) and Munich, Germany, which includes free baggage, food, and drinks. Ryanair only charges $221 between London Stansted (one hour away from central London) and Memmingen (two hours away from Munich proper). Ryanair passengers would cough up another $40 for baggage, food, and drinks. Adding ground transportation from London to Heathrow and from Munich airport to city proper, BA passengers pay $441 for a three-hour journey. In contrast, Ryanair passengers pay $311 (30% savings) for a four-hour trip.

In addition to competing with legacy airlines such as BA, Ryanair also fights with fellow no-frills airlines such as easyJet and Air Berlin. As a result, Ryanair continuously searches for new ways to lower cost. Some of these outside-the-box ideas voiced by its outspoken CEO Michael O’Leary have created huge controversies. For

example, O’Leary announced that Ryanair would charge passengers €1 for a trip to use the restroom, and that he was considering offering standing cabins (like a bus) to pack in more passengers. He also suggested that only one pilot would be needed to fly the aircraft. Finally, he argued that the average passenger did not “deserve” the baggage service treatment, which was a high-cost system built during an era when air travel was rare and passengers were affluent. Elsewhere in today’s passengers’ life, they did not get that kind of treatment. Therefore, today’s passengers need to carry their own bags—or pay extra.

“Everytime he opens his mouth,” said the head of a nonprofit passenger advocacy group, “he insults the dignity of the flying public.” O’Leary has worked hard to be known as the most unpleasant man in Ireland. Ryanair is infamous for its customer service, which some describe as “minimalist” and others say as “hell.” Wheelchairs are charged extra. Complaints must be sent by fax—no emails please. A major newspaper, Guardian, has created reader competitions dedicated to publicizing Ryanair horror stories.

Enjoying all that publicity, O’Leary has dismissed the notion of bad publicity. He is proud of making provocative (and some say obnoxious) statements about how to further shave a penny from the already minimum cost of no-frills flights. Although passengers have voted Ryanair the “least liked” airline in customer surveys, they continue to flock to its flights. In 2010, Ryanair became the first European airline to fly more than seven million passengers in one month.

Sources: Based on (1) Bloomberg Businessweek, 2010, The duke of discomfort, September 6: 58–61; (2) C. Byles, 2014, Ryanair, in M. W. Peng, Global Strategy, 3rd ed., Cincinnati: South-Western Cengage Learning (in this book as an Integrative Case); (3) A. Ruddock, 2007, Michael O’Leary: A Life in Full Flight, London: Penguin; (4) Wall Street Journal, 2009, A lavatory levy, June 3: C16.

46 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

Differentiation A differentiation strategy focuses on how to deliver products that customers perceive to be valuable and different (Table 2.4). While cost leaders serve “typical” customers, differentiators target customers in smaller, well-defined segments who are willing to pay premium prices. The key is a low-volume high-margin approach. The ability to charge higher prices enables differentiators to outperform competitors unable to do so. A Lexus car is not significantly more expensive to produce than a Chrysler car, yet customers always pay more to get a Lexus. To attract customers willing to pay premiums, differ- entiated products must have some truly (or perceived) unique attributes, such as quality, sophistication, prestige, and luxury. The challenge is to identify these attributes and deliver value centered on them for each market segment. Therefore, in addition to maintaining a strong lineup for its 3-, 5-, and 7-series, BMW is now filling in the “gaps” by adding the new 1- and 6-series as well as sport utility vehicles (SUVs). For differ- entiators, research and development (R&D) is an important functional area that experi- ments with new features. Another key function is marketing and sales, focusing on both capturing customers’ psychological desires that lure them to buy and satisfying their needs after the sales through excellent services (see the Closing Case).

According to the five forces framework, the less a differentiator resembles its rivals, the more protected its products are. For instance, Disney theme parks advertise the unique experience associated with Disney movie characters. Lingerie queen Victoria’s Secret emphasizes her—I mean “its”—seductive secret. Menswear king Ermenegildo Zegna hints at the power and the elegance associated with its style. The bargaining power of suppliers is relatively less of a problem because differentiators may be better able to pass on some (but not unlimited) price increases to customers than cost leaders can. Similarly, the bargaining power of buyers is less problematic because differentiators tend to enjoy relatively strong brand loyalty.

On the other hand, a differentiation strategy has two drawbacks. First, the differentia- tor may have difficulty sustaining the basis of differentiation in the long run. There is always the danger that customers may decide that the price differential between the differentiator’s and cost leader’s products is not worth paying for. Second, the differen- tiator has to confront relentless efforts of imitation. As the overall quality of the industry goes up, brand loyalty in favor of the leading differentiators may decline. For example, the previously high-flying Starbucks has an increasingly hard time differentiating itself. As McDonald’s raises its coffee quality and enhances its store image (especially through its newer and hipper McCafé), McDonald’s has been able to eat some of Starbucks’ lunch (or drink Starbucks’ coffee!). In the Great Recession, Starbucks seems to have lost its shine while offerings at McDonald’s have become especially valued.

Focus A focus strategy serves the needs of a particular segment or niche of an industry (Table 2.1). The segment can be defined by (1) geographical market, (2) type of customer, or (3) product line. While the breadth of the focus is a matter of degree, focused firms usually serve the needs of a segment so unique that broad-based competitors choose not to serve it. In the coffee industry, while Starbucks is a differentiated player, single-origin coffeemakers such as Discovery, Intelligentsia, and Stumptown deploy a focus strategy by only sourcing

differentiation

A strategy that focuses on how to deliver products that customers perceive as valuable and different.

focus

A strategy that serves the needs of a particular segment or niche of an industry.

C h a p t e r 2 Ma n a g i n g I n d u s t r y C o m p e t i t i o n 47

premium coffee from a single high-quality region (such as certain farms or villages in Ethiopia, the birthplace of coffee).18 Compared with Starbucks that mixes coffee from different parts of Ethiopia for its “Ethiopia Sidamo Blend,” single-origin coffeemakers are more discriminating and more selective. (In comparison, cost leader Kraft Foods simply labels one of its Maxwell House coffees “South Pacific Blend,” without even mentioning any particular farm or even country—conceding that it mixes a lot of low-cost coffee beans from various places.)

Although it sounds like a tongue twister, a specialized differentiator (such as Bentley) is basically more differentiated than the large differentiator (such as BMW). This approach may be successful when a focused firm possesses intimate knowledge about a particular segment. The logic of how a traditional differentiator can dominate the five forces, discussed before, applies here, the only exception being a much smaller and narrower, but sharper, focus. The two drawbacks, namely, the difficulty to sustain such expensive differentiation and the challenge of defending against ambitious imitation, also apply here.

Lessons from the Three Generic Strategies Recall from Chapter 1 that strategy is about making choices—what to do and what not to do. The essence of the three generic strategic choices is whether to perform activities differently or to perform different activities relative to competitors.19 Two lessons emerge. First, cost and differentiation are two fundamental strategic dimensions. The key is to choose one dimension and focus on it consistently. Second, companies that are stuck in the middle—that is, neither having the lowest cost nor sufficient differentia- tion (or focus)—may be indicative of having either no or a drifting strategy. Their performance may suffer as a consequence. However, the second point is subject to debate, as outlined next.

Debates and Extensions Although the industry-based view is a powerful strategic tool, it is not without contro- versies. A new generation of strategists needs to understand some of these debates and thus avoid uncritical acceptance of the traditional view. This section introduces seven leading debates: (1) clear versus blurred boundaries of industry, (2) threats versus opportunities, (3) five forces versus a sixth force, (4) stuck in the middle versus all rounder, (5) industry rivalry versus strategic groups, (6) integration versus outsourcing, and (7) industry-specific versus firm-specific and institution-specific determinants of firm performance.

Clear versus Blurred Boundaries of Industry The heart of the industry-based view is the identification of a clearly defined industry. However, this concept of an industry may become increasingly elusive. For example, consider the boundaries of the television broadcasting industry. The emergence of cable, satellite, telecommunications, and online technologies has blurred the industry’s boundaries. A television in the future may be able to control

48 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

household security systems, play interactive games, and place online orders—essentially blending with the functions of a PC. To jockey for advantageous positions in preparation for such a future, there have been a large number of mergers and alliances among television, telecommunications, cable, software, and movie companies in recent years. In other words, the competitors of ABC not only include CBS, NBC, CNN, and Fox, but also AT&T, SkyTV, Microsoft, Apple, YouTube (owned by Google), Sony, and others. So what exactly is this “industry”? Such fuzzy industry boundaries are not alone in television broadcasting. Try to figure out the boundaries of mobile communication or (worse) cloud computing—isn’t it mind-boggling to try to define the boundaries of “cloud”? (see Table 2.5). A new concept is to view all the players involved as an “ecosystem.”20

However, it will be challenging to specify the boundaries of such an ecosystem, thus making it extremely difficult to clearly identify the five forces.

Threats versus Opportunities Even assuming that industry boundaries can be clearly identified, the assumption that all five forces are (at least potential) threats seems too simplistic. This view has been challenged in two areas. First, strategic alliances are on the rise, and even competitors are increasingly exploring opportunities to collaborate. GM and Toyota manufacture cars together. The CEOs of Cisco and Huawei shook hands and discussed collaboration, after Cisco sued Huawei and both firms reached a settlement. In other words, if these rivals do not love each other, they do not hate each other either. Compared with the traditional black-and-white view, this more complicated and realistic view requires a more sophis- ticated understanding of today’s competition and collaboration (see Chapters 7 and 8 for more details).

Second, even if firms do not directly collaborate with competitors, intense rivalry within an industry, long considered a “no-no,” may become an opportunity instead of a threat. In the IT industry, a number of ambitious firms from India, Israel, and South Korea, instead of staying at home and enjoying the relative tranquility as suggested by the five forces framework, have come to Silicon Valley to seek out the most competitive environment. Their rationale is that only by being closer to where the action is can they hope to become globally competitive.21 In other words, the new strategic motto seems to be: “Love thy competitors! They make you stronger.” Overall, it seems that the five forces model may have overemphasized the threat (T) in SWOT analysis. A more balanced view needs to highlight both O and T.

TABLE 2.5 Players “Up in the Cloud” (and Their Unofficial Nicknames)

INCUMBENTS NEW ENTRANTS ARMS DEALERS

IBM (The eminence) Amazon (The instigator) Dell (The gear head)

HP (The question mark) Google (The needler) Cisco (The plumber)

VMware (The optimizer) Microsoft (The late bloomer)

Source: Based on figure in Bloomberg Businessweek, 2011, The power of the cloud (pp. 58–59), March 7: 53–59. The unofficial nicknames were given by the magazine.

C h a p t e r 2 Ma n a g i n g I n d u s t r y C o m p e t i t i o n 49

Five Forces versus a Sixth Force The five forces Porter identified in the 1980s are not necessarily exhaustive. In 1990, Porter added related and supporting industries as an important force that affects the competitiveness of an industry.22 This is endorsed by Andrew Grove, the former CEO of Intel, who coined the term complementors.23 Basically, complementors are firms that sell products that add value to the products of a focal industry. The complementors to the PC industry are firms that produce software applications. When complementors produce exciting products (such as new games), the demand for PCs grows, and vice versa. Therefore, it may be helpful to add complementors as a possible sixth force.24 However, complementors do not have to be in high-tech industries. For example, sports games directly boost beer sales, which, in turn, fund a lot of commercials aired during sports games. A case can be made that sports and beers are complementors.

Stuck in the Middle versus All Rounder A key proposition in the industry-based view is that firms must choose either cost leadership or differentiation. Pursuing both may make firms “stuck in the middle” with poor performance prospects.25 Borders bookstores seemed to be stuck in the middle. Relative to Barnes and Nobles, Borders offered a wider selection. But its selection was nowhere close to the much wider selection offered by Amazon’s online list. Crushed by a high cost structure (thanks to the larger inventory cost relative to Barnes and Nobles’) and insufficient differentiation (relative to Amazon), Borders closed shops and was liquidated in 2011.26

However, some highly successful firms such as Singapore Airlines stand out as both cost leaders and differentiators. Widely regarded as the world’s premium carrier, Singa- pore Airlines has won the World’s Best Airline Award from Condé Nast Traveler 21 out of the 22 times it has been awarded. As a differentiator, Singapore Airlines always buys newer aircraft. It is the launch (first) customer for the new double-decker Airbus A380. It also replaces aircraft more frequently. On average, its fleet is six years old versus an industry average of 13 years old. Customers are willing to pay more for seats on newer aircraft. New aircraft are more fuel efficient and need less repair and maintenance, resulting in lower cost. Singapore Airlines is also renowned for its legendary service. Its cabin crews are trained to interact with American, Chinese, and Japanese passengers differently. However, Singapore Airlines does not pay premium salary. Its wage is average by Singapore standards, which are relatively low by global standards. As a result, its labor costs are about 16% of total costs, whereas United Airlines’ are 23%, British Airways’ 28%, and American Airlines’ 31%. In short, Singapore Airlines is both a world-class differ- entiator and a cost leader.27

As a result, a debate has emerged. First, critics argue that holding technology constant, for firms already operating at the maximum efficiency scale, further cost savings are not possible and differentiation is a must.28 The king of cost leadership, Wal-Mart, has sought to become more differentiated by experimenting with a more “earth friendly” store in McKinney, Texas; with upscale offerings in Plano, Texas; and with in-store health clinics in Dallas area stores.

Second, critics suggest that technology may not be constant. The idea that differ- entiators cannot be cost competitive is influenced by manufacturing technology in the

complementor

A firm that sells products that add value to the pro- ducts of a focal industry.

50 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

1970s, whereas more recently, flexible manufacturing technology has enabled firms to produce differentiated products at a low cost (usually on a smaller batch basis than the large batch typically produced by cost leaders). Thus, the name of the game may become mass customization, pursuing cost leadership and differentiation simultaneously.

A review of 17 studies finds that instead of being underdogs, some (but not all) firms “stuck in the middle” may have potential to be “all-rounders,” being both cost competitive and differentiated.29 While not conclusive, these findings do raise questions and enrich the substance of the debate.

Industry Rivalry versus Strategic Groups While the five forces framework focuses on the industry level, how meaningful it is depends on how an “industry” is defined. In a broadly defined industry, such as the Indian retail industry, obviously not every firm is competing against each other. However, some groups of firms within a broad industry do compete against each other, such as the competition among mom-and-pop shops in the unorganized sector and the rivalry among supermarkets in the organized sector in India (see the Opening Case). Likewise, in the automobile industry, we can identify the mass market, luxury, and ultra-luxury groups (Figure 2.2). These different groups of firms are thus known as strategic groups. It is argued that strategy within one group tends to be similar: Within the automobile industry, the mass market group pursues a cost leadership strategy, the luxury group a differentia- tion strategy, and the ultra-luxury group a focus strategy. Members within a strategic group tend to have similar performance.30

While this intuitive idea seems uncontroversial, a debate has erupted on two issues. First, how stable are strategic groups?31 In other words, how easy or difficult is it for firms to change from one strategic group to another? In the automobile industry, strong incentives exist for firms in the mass market group to charge into the luxury group. Can they do it? The launch of Lexus, Acura, and Infiniti by Toyota, Honda,

FIGURE 2.2 Three Strategic Groups in the Global Automobile Industry

C os

t/ pr

ic e

Prestige

Chrysler, Ford, GM, Honda, Hyundai, Nissan,

Renault, Toyota, Volkswagen

Mass Market

Acura, BMW, Lexus, Mercedes, Porsche

Bentley, Ferrari, Lamborghini

Luxury

Ultra-Luxury

flexible manufacturing technology

Modern manufacturing technology that enables firms to produce differen- tiated products at low costs (usually on a smaller batch basis than the large batch typically produced by cost leaders).

mass customization

Mass produced but customized products.

strategic groups

Groups of firms within a broad industry.

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and Nissan, respectively, suggests that despite the challenges, it is possible. However, Mazda entertained the idea of launching its own luxury brand but decided to quit. The root cause is mobility barriers, which are within-industry differences that inhibit the movement between strategic groups. Clearly, Mazda was not confident about its ability to overcome mobility barriers. Recently, Hyundai has fought a similar uphill battle by attempting to go upmarket. Will Hyundai succeed or fail?

A second issue centers on the data that classify strategic group memberships. Since strategic group analysis usually requires large quantities of objective data,32 how useful is it when there is a paucity of data, especially when entering new markets such as emerging economies? Research suggests that while objective data are hard to find, subjective measures tapping into executives’ cognitive inclusion and exclusion of certain firms as competitors may provide more reliable clues.33 This is because executives, when confronting the complexity and chaos of industry competition, are likely to use some simplifying schemes to better organize their strategic understanding around some identifiable reference points.34 In the Chinese electronics industry, executives use ownership type, a simple and easily identifiable reference point, to mentally organize strategic groups.35 In other words, state-owned enter- prises tend to compete with each other, private-owned firms watch each other closely, and foreign entrants view other foreign entrants as a strategic group (Table 2.6). Interviews with these executives find that members within the same self-identified strategic group benchmark intensely against each other, but care less about what is going on in other groups.

Overall, strategic groups have become a useful but somewhat controversial middle ground between industry-level and firm-level analyses. Regardless of whether “real” strategic groups exist, if the idea of strategic groups helps managers simplify the complex- ity they confront when analyzing an industry, then the strategic group concept seems to have some value.

Integration versus Outsourcing How to determine the scope of a firm is one of the four most fundamental questions in strategy.36 As noted earlier, the industry-based view advises the focal firm to consider integrating backward (to compete with suppliers) or forward (to compete with buyers)—or at least threaten to do so. This strategy is especially recommended when market uncertainty is high, coordination with suppliers/buyers requires tight control, and the number of suppliers/buyers is small.37 (What if they hold us up, if we don’t buy them out?) However,

TABLE 2.6 Strategic Groups and Ownership Types in the Chinese Electronics Industry

STRATEGIC GROUP DEFENDER ANALYZER REACTOR

Ownership type State ownership Mixed Unstable

Customer base Stable Mixed Changing

Growth strategy Cautious Mixed Aggressive

Managers Older, more conservative Mixed Younger, more aggressive

Source: Adapted from M. W. Peng, J. Tan, & T. Tong, 2004, Ownership types and strategic groups in an emerging economy (p. 1110), Journal of Management Studies, 41 (7): 1105–1129.

mobility barrier

Within-industry differences that inhibit the movement between strategic groups.

52 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

this strategy is very expensive because it takes huge sums of capital to acquire independent suppliers/buyers and most acquisitions end up in failure (see Chapter 9).

In the past two decades, a great debate has erupted challenging the wisdom of integration. Critics make two points. First, they argue that under conditions of uncer- tainty, less integration is advisable. When demand is uncertain, a focal firm with no internal supplier units can simply reduce output by discontinuing or not renewing supply contracts, whereas a firm stuck with its own internal supplier units may keep producing simply to keep these supplier units employed. In other words, integration reduces strategic flexibility.38 Second, internal suppliers, which had to work hard for contracts if they were independent suppliers, may lose high-powered market incentives simply because their business is now taken care of by the “family.”39 Over time, internal suppliers may become less competitive relative to outside suppliers. The focal firm thus faces a dilemma: To go with outside suppliers will keep internal suppliers idle, but to choose internal suppliers will sacrifice cost and quality. In the past two decades, integration has gradually gone out of fashion and outsourcing (turning over an activity to an outside supplier) is in vogue.

The outsourcing movement has been influenced by the Japanese challenge in the 1980s and the 1990s. Given that the five forces framework is a product of prevailing Western strategic practices of the 1970s, the Japanese way of managing suppliers, through what is called a keiretsu (interfirm network), seems radically different. In the 1990s, while GM had 700,000 employees, Toyota only had 65,000. A lot of activities performed by GM, such as those in internal supplier units, are undertaken by Toyota’s keiretsu member firms using non-Toyota employees.

At the same time, Toyota has far fewer suppliers than GM. They tend to be “cherry picked,” trusted members of the keiretsu. Instead of treating suppliers as adversaries, Toyota treats its suppliers (mostly first-tier ones) as partners by codeveloping proprietary technology with them, relying on them to deliver directly to the assembly line just in time, and helping them when they are in financial difficulty. However, Toyota does not only rely on trust and goodwill. To minimize the potential loss of high-powered market incentive on the part of keiretsu members, a dual sourcing strategy—namely, splitting the contract between a keiretsu member and a nonmember (often a local company when Toyota moves abroad)—is often practiced.40 This makes sure that both the internal (keiretsu) and external suppliers are motivated to do their best.

Healthy relationships with suppliers may have direct benefits.41 Overall, similar to the idea discussed earlier that rivalry may represent opportunities instead of threats, solid value-adding relationships with suppliers (and buyers and other partners) are now widely regarded as a source of competitive advantage and are implemented by many non- Japanese firms around the world.42

However, this is not the end of the debate. In a curious turn of events, while many US firms have become more “Japanese-like,” Japanese firms are increasingly under pressure to become more “American-like” (!). This is because some outsourced activities, crucial to the core business, should not have been outsourced; otherwise, the firm risks becoming a “hollow corporation.”43 Supplier relations that are too close may introduce rigidities, resulting in a loss of much-needed flexibility.44 In Japan, some previously rock-solid buyer–supplier links have started to fray. There is now less willingness to help troubled suppliers improve. Even keiretsu members, previously discouraged (if not outright for- bidden) to seek contracts outside the network, are now encouraged to look for work

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elsewhere, because it is believed that the benefits of learning from dealing with other customers may eventually accrue to the lead firm (such as Toyota).45 Overall, the rise and fall of these two perspectives in the past two decades suggest very careful analysis is needed when making decisions on the optimal scope of the firm.46

Industry-Specific versus Firm-Specific and Institution-Specific

Determinants of Performance The industry-based view argues that firm performance is most fundamentally determined by industry-specific attributes.47 This view has recently been challenged, from two direc- tions. The first is the resource-based view. Although the five forces framework suggests that particular industries (such as airlines) are highly unattractive, certain firms, such as Southwest, Ryanair, and Singapore Airlines, are highly successful. What is going on? A short answer is that there must be firm-specific resources and capabilities that contribute to the winning firms’ performance.

A second challenge comes from the critique that the industry-based view “ignores industry history and institutions.”48 Porter’s work, first published in 1980, may have carried some hidden, taken-for-granted assumptions underpinning the way competition was structured in the United States in the 1970s. As “rules of the game” in a society, institutions obviously affect firm strategies. For example, cost leadership as a strategy is banned by law in the Japanese bookselling industry. All bookstores have to sell new books at the same price without discount. Thus, Amazon, whose primary weapon was low price, had a hard time elbowing its way into Japan. Clearly, strategists need to understand how institutions affect competition. This view has become known as the institution-based view. Overall, these two views complement the industry-based view,49 and we will introduce them in Chapters 3 and 4.

Making Sense of the Debates The seven debates suggest that the industry-based view—and in fact the strategy field as a whole—is alive, exciting, and yet unsettling. All these debates direct their attention to Porter’s work, which has become an incumbent in the field.50 When describing his work, Porter deliberately chose the word “framework” rather than the more formal “model.” In his own words, “frameworks identify the relevant variables and the questions that the user must answer in order to develop conclusions tailored to a particular industry and company.”51 In this sense, Porter’s frameworks have succeeded in identifying variables and raising questions, while not necessarily providing definitive answers. Although the degree of contentiousness among these debates is not the same, it is evident that the last word has not been written on any of them.

The Savvy Strategist The savvy strategist can draw at least three important implications for action (Table 2.7). (1) You need to understand your industry inside and out by focusing on the five forces.52

The industry-based view provides a systematic foundation for industry analysis and competitor analysis, upon which more detailed examination, introduced in later chapters,

54 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

can be added. (2) Be aware that additional forces, some of which are discussed in the “Debates and Extensions” section, may influence the competitive dynamics of your industry. The five forces framework should be a start, but not the end of your strategic analysis. (3) Realize that industry is not destiny. While the industry-based view is a powerful framework to understand the behavior and performance of the “average” firm, you need to be aware that certain firms may do well in a structurally unattractive industry. As a strategist, your job is to lead your firm to become a high-flying outlier despite the pull of gravity of some unattractive attributes of your industry.

In conclusion, we suggest that the industry-based view directly answers the four fundamental questions discussed in Chapter 1. First, why do firms differ? The industry- based view suggests that the five forces in different industries lead to diversity in firm behavior. The answer to the second question, How do firms behave? boils down to how they maximize opportunities and minimize threats presented by the five forces. Third, what determines the scope of the firm? A traditional answer is to examine the relative bargaining power of the focal firm relative to that of suppliers and buyers. Integration would result in an expanded scope of the firm. However, more recent work suggests caution. Firms are advised to leverage opportunities of outsourcing, remain focused on core activities, and be willing to collaborate not only with suppliers and buyers but also possibly their competitors. Finally, what determines the international success and failure of firms? The answer, again, is that industry-specific conditions must have played an important role in determining firm performance around the world.

CHAPTER SUMMARY

1. Define industry competition • An industry is a group of firms producing similar goods and/or services. • The industry-based view of strategy grows out of industrial organization (IO) economics, which helps policymakers better understand how firms compete so policymakers can properly regulate them.

• Pioneered by Michael Porter, the five forces framework forms the backbone of the industry-based view of strategy, which draws on the insights of IO economics to help firms better compete.

2. Analyze an industry using the five forces framework • The stronger and more competitive the five forces are, the less likely that firms in an industry are able to earn above-average returns, and vice versa.

• The five forces are: (1) rivalry within an industry, (2) threat of potential entry, (3) bargaining power of suppliers, (4) bargaining power of buyers, and (5) threat of substitutes.

TABLE 2.7 Strategic Implications for Action

& Establish an intimate understanding of your industry by focusing on the five forces.

& Be aware that additional forces may influence the competitive dynamics of your industry.

& Realize that industry is not destiny. Certain firms may do well in a structurally unattractive industry.

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3. Articulate the three generic strategies • The three generic strategies are: (1) cost leadership, (2) differentiation, and (3) focus.

4. Understand the seven leading debates concerning the industry-based view • These debates are: (1) clear versus blurred boundaries of industry, (2) threats versus opportunities, (3) five forces versus a sixth force, (4) stuck in the middle versus all rounder, (5) integration versus outsourcing, (6) industry rivalry versus strategic groups, and (7) industry-specific versus firm-specific and institution-specific determinants of firm performance.

5. Draw strategic implications for action • Establish an intimate understanding of your industry by focusing on the five forces. • Be aware that additional forces may influence the competitive dynamics of your industry.

• Realize that industry is not destiny. Certain firms may do well in an unattractive industry.

KEY TERMS

Backward integration p. 42

Bargaining power of buyers p. 41

Bargaining power of suppliers p. 41

Complementor p. 50

Conduct p. 35

Cost leadership p. 45

Differentiation p. 47

Dominance p. 36

Duopoly p. 35

Economies of scale p. 39

Entry barrier p. 38

Excess capacity p. 40

Five forces framework p. 35

Flexible manufacturing technology p. 51

Focus p. 47

Forward integration p. 41

Generic strategies p. 45

Incumbents p. 38

Industrial organization (IO) economics p. 34

Industry p. 34

Industry positioning p. 43

Mass customization p. 51

Mobility barrier p. 52

Monopoly p. 35

Network externalities p. 40

Non-scale-based advantages p. 40

Oligopoly p. 35

Perfect competition p. 34

Performance p. 35

Product differentiation p. 40

Product proliferation p. 40

Scale-based advantages p. 39

Strategic group p. 51

Structure p. 35

Structure-conduct-performance (SCP) model p. 35

Substitutes p. 42

CRITICAL DISCUSSION QUESTIONS

1. Why do price wars often erupt in certain industries (such as the automobile industry), but less frequently in other industries (such as the diamond industry)? What can firms do to discourage price wars or be better prepared for price wars?

56 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

2. Compare and contrast the five forces affecting the airline industry, the fast food industry, the beauty products industry, and the pharmaceutical industry (1) on a worldwide basis and (2) in your country. Which industry holds more promise for earning higher returns? Why?

3. ON ETHICS: As a manager, is it ethical to threaten your suppliers? Your buyers?

TOPICS FOR EXPANDED PROJECTS

1. Conduct a five forces analysis of the business school industry or the higher education industry. Identify the strategic group to which your institution belongs. Then write a short paper, using this analysis to explain why your institution is doing well (or poorly) in the competition for better students, professors, donors, and ultimately rankings.

2. ON ETHICS: “Excessive profits” coming out of monopoly, duopoly, or any kind of strong market power are often targets for government investigation and prosecution (for exam- ple, Microsoft was charged by both US and EU competition authorities). Yet, strategists openly pursue above-average profits, which are argued to be “fair profits.” Do you see an ethical dilemma here? Working in pairs, with one person performing the role of an antitrust official and the other acting as a firm strategist (such as Bill Gates), write two statements, each with a rebuttal, to support both sides of the argument.

3. ON ETHICS: A powerful new entrant is likely to drive a lot of smaller incumbent firms out of business and their employees out of work. In the Opening Case, this is the heart of the debate on whether the Indian retail industry should be open to FDI. As a manager at Wal-Mart interested in entering India, how do you respond to the political uproar against such entry? As an Indian government official, how do you introduce the new policy to allow such entry to an angry crowd of mom-and-pop shopkeepers? Write a short paper to explain your answers.

CLOSING CASE

Emerging Markets: High Fashion Fights Recession

Pumping out fancy clothing, handbags, jewelry, perfumes, and watches, the high end of the fashion industry— otherwise known as the luxury goods industry—had a challenging time in the Great Recession. In 2008, banks were falling left and right, unemployment rates sky high, and consumer confidence at an all time low. In 2009, total

luxury goods industry sales fell by 20%. How did the industry cope?

Of the five forces, the threat of substitutes was relatively insignificant. Potential new entrants were not dying to enter when incumbents were struggling. Suppliers such as leather tanneries were hit hard by cancelled or scaled-down orders

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from auto companies, shoemakers, and furniture firms. Suppliers thus were eager to work with any order that luxury goods firms could lavish on them. As a result, mana- ging industry competition boiled down to how to manage rivalry among competitors and manage customers.

The high-end fashion industry was dominated by the Big Three: LVMH (with more than 50 brands such as Louis Vuitton handbags, Moët Hennessy liquor, Christian Dior cosmetics, TAG Heuer watches, and Bulgari jewlery), Gucci Group (with nine brands such as Gucci handbags, Yves Saint Laurent clothing, and Sergio Rossi shoes), and Bur- berry (famous for raincoats and handbags). Next were a number of more specialized players such as king of mens- wear Ermenegildo Zegna and queen of womenswear Christian Lacroix. Virtually all firms in this industry pursued a differentiation strategy and a smaller number of them engage in a focus strategy. By definition, high fashion means high prices. An informal code of conduct (or norm) permeates the industry: no discount, no coupons, no price wars please—in theory at least. Discounting, so frequently used in the low-end fashion industry, is generally viewed as dangerous and poisonous, not only to the occasional firm that unleashes it, but also to the image and margin of the whole world of high fashion. But here is the catch: How do firms survive the Great Recession when such nasty tactics are not advised?

In desperation, many firms cut prices—but quietly. At Tiffany jewelry stores, sales people advised customers about diamond ring price reductions, but otherwise there was no publicity. Gucci and Richemont (with brands such as Cartier jewelry, Vacheron Constantin watches, and Alfred Dunhill menswear) offloaded their excess inventory to discount websites. Coach launched a lower-priced line branded Poppy as a fighter brand without cheapening the image of the Coach brand. During the month prior to Christmas in 2008, American department stores such as Macy’s and Saks Fifth Avenue offered some savage price slashing of up to 80% of some luxury goods. The only firm that stood rock solid was the industry leader LVMH, which claimed that it never puts its products on sales at a discount. When the going gets tough, it destroys stock instead. In contrast to many luxury goods firms that rely on department stores, LVMH owns its retail shops, thus allowing it to completely control the fate and price of its own products.

The bloodbath in the Great Recession forced the weaker players such as Christian Lacroix and Escada to file for

bankruptcy. But it made stronger players such as LVMH even more formidable. They benefitted from an established pattern in high fashion: the flight to quality. In other words, when people have less money, they spend it on the best. Shoppers go for fewer, more classic items, such as one Burberry raincoat (as opposed to two designer dresses) and one Kelly bag by Hermès (rather than three bags by less prestigious brands). For this reason, LVMH, according to its proud president, “always gains market share in crises.” LVMH’s sales grew from $24 billion in 2008 to $29 billion in 2011, with profit margins at a healthy 40% or so—twice as high as some of its weaker rivals.

In addition to managing interfirm rivalry, how to man- age the fickle and capricious customers was tricky. Although the seriously rich were not affected by the Great Recession, their number remained small. Most luxury goods firms had been relying on the “aspirational” customers to fund their growth. As the recession became worse, many middle-class customers in economically depressed, developed economies began to hunt for value instead of triviality and showing off. Japan had been the number one market for luxury goods for years and most Japanese women reportedly owned at least one Louis Vuitton product. But sales were falling since 2005 and dropped sharply since 2008. Young Japanese women seemed more individualistic than their mothers, and often hauled home lesser-known (and cheaper) brands.

Emerging markets, especially China, offered luxury goods firms the best hope while the rest of the world was bleak. Since 2008, while global sales declined, Chi- nese consumption (both at home and traveling) had been growing between 20% and 30%. In 2009, China sur- passed the United States to become the world’s second- largest market. In 2011, China rocketed ahead of Japan for the first time as the world’s champion consumer of luxury goods—splashing $12.6 billion to command a 28% global market share. Everybody that was somebody in high fashion had been elbowing its way into China, which appears like the New World to old European brands. Interestingly, several years ago it was the Japa- nese ladies who did the heavy lifting for the top line of luxury goods firms; now it is the Chinese dudes who (are more likely than Chinese women to) eagerly open their wallets to indulge themselves with luxurious trappings. Beyond China, luxury goods firms eagerly chased custom- ers in Brazil, India, Poland, Russia, and Saudi Arabia.

58 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

NOTES

Where did LVMH open one of its newest stores? Ulan Bator, Mongolia.

Sources: Based on (1) BusinessWeek, 2009, Coach’s new bag, June 29: 41–43; (2) BusinessWeek, 2009, When discounting can be dangerous, August 3: 49; (3) Economist, 2009, LVMH in the recession, September 19: 79–81; (4) Economist, 2010, Fashionably alive, November 13: 76; (5) Economist, 2010, Luxury goods in Poland, June 19: 72; (6) Economist, 2011, The glossy posse, October 1: 67; (7) J. Li, 2010, Luxury Brands Management, Beijing: Peking University Press.

C A S E D I S C U S S I O N Q U E S T I O N S

1. Using the five forces framework, how would you characterize the competition in the luxury goods industry?

2. How much bargaining power did consumers as buyers have during the Great Recession?

3. Why was discounting looked down upon by industry peers, all of which were differentiated or focus competitors?

4. What would be the likely challenges in emerging markets for luxury goods firms?

[Journal acronyms] AME – Academy of Management Executive; AMP – Academy of Management Perspectives; AMJ – Academy of Management Journal; AMR – Academy of Management Review; APJM – Asia Pacific Journal of Management; BW – BusinessWeek (before 2010) or Bloom- berg Businessweek (since 2010); ETP – Entrepreneurship Theory and Practice; HBR – Harvard Business Review; JBR – Journal of Business Research; JEP – Journal of Economic Perspectives; JIBS – Journal of International Business Studies; JIM – Journal of International Manage- ment; JMS – Journal of Management Studies; LRP – Long Range Planning; OSc – Organization Science; QJE – Quarterly Journal of Economics; SMJ – Strategic Manage- ment Journal

1. L. Einav & J. Levin, 2010, Empirical industrial organi- zation, JEP, 24: 145–162.

2. M. Porter, 1981, The contribution of industrial organi- zation to strategic management, AMR, 6: 609–620; C. Zott & R. Amit, 2008, The fit between product market strategy and business model, SMJ, 29: 1–26.

3. M. Porter, 1980, Competitive Strategy, New York: Free Press.

4. D. Simon, 2005, Incumbent pricing responses to entry, SMJ, 26: 1229–1248.

5. J. Henderson & K. Cool, 2003, Learning to time capa- city expansions, SMJ, 24: 393–413; H. Tan & J. Math- ews, 2010, Identification and analysis of industry cycles, JBR, 63: 454–462.

6. S. Lee, M. W. Peng, & J. Barney, 2007, Bankruptcy law and entrepreneurship development, AMR, 32: 257–272.

7. D. Lavie, 2006, Capability reconfiguration, AMR, 31: 153–174.

8. G. Dowell, 2006, Product line strategies of new entrants in an established industry, SMJ, 27: 959–979; D. Souder & J. M. Shaver, 2010, Constraints and incentives for making long horizon corporate invest- ments, SMJ, 31: 1316–1336.

9. A. Mainkar, M. Lubatkin, & W. Schulze, 2006, Toward a product-proliferation theory of entry bar- riers, AMR, 31: 1062–1075.

10. T. Eisenmann, G. Parker, & M. Van Alstyne, 2011, Platform envelopment, SMJ, 32: 1270–1285; M. Schilling, 2002, Technology success and failure in winner-take-all markets, AMJ, 45: 398–461; P. Soh, 2010, Network pat- terns and competitive advantage before the emergence of a dominant design, SMJ, 31: 438–461.

11. R. Gulati, P. Lawrence, & P. Puranam, 2005, Adapta- tion in vertical relationships, SMJ, 26: 415–440.

12. M. W. Peng, S. Lee, & J. Tan, 2001, The keiretsu in Asia, JIM, 7: 253–276.

13. S. Chen, 2010, Transaction cost implication of private branding and empirical evidence, SMJ, 31: 371–389.

14. BW, 2011, Even better than the real thing, November 28: 25–26; Economist, 2010, Basket cases, October 16: 79.

15. I. McCarthy, T. Lawrence, B. Wixted, & B. Gordon, 2010, A multidimensional conceptualization of environ- mental velocity, AMR, 35: 604–626.

16. M. Porter, 1998, On Competition (p. 38), Boston: Harvard Business School Press.

17. M. Porter, 1985, Competitive Advantage, New York: Free Press.

C h a p t e r 2 Ma n a g i n g I n d u s t r y C o m p e t i t i o n 59

18. BW, 2011, A pot of trouble brews in the coffee world, September 8: 13–14.

19. M. Porter, 1996, What is strategy? HBR, 74 (6): 61–78. 20. D. Teece, 2007, Explicating dynamic capabilities, SMJ,

28: 1319–1350. 21. Y. Yamakawa, M. W. Peng, & D. Deeds, 2008, What

drives new ventures to internationalize from emerging to developed economies? ETP, 32: 59–82.

22. M. Porter, 1990, The Competitive Advantage of Nations, New York: Free Press.

23. A. Grove, 1996, Only the Paranoid Survive, New York: Doubleday.

24. D. Yoffie & M. Kwak, 2006, With friends like these, HBR, September: 89–98.

25. R. Huckman & D. Zinner, 2008, Does focus improve operational performance? SMJ, 29: 178–193; S. Thornhill & R. White, 2007, Strategic purity, SMJ, 28: 553–561.

26. BW, 2011, The end of Borders is not the end of books, November 14: 94–97.

27. L. Heracleous & J. Wirtz, 2010, Singapore Airlines’ balancing act, HBR, July: 145–149.

28. C. Hill, 1988, Differentiation versus low cost or differ- entiation and low cost, AMR, 13: 401–412.

29. C. Campbell-Hunt, 2000, What have we learned about generic competitive strategy? SMJ, 21: 127–154.

30. W. DeSarbo, R. Grewal, & R. Wang, 2009, Dynamic strategic groups, SMJ, 30: 1420–1439; G. Leask & D. Parker, 2007, Strategic groups, competitive groups, and performance within the UK pharmaceutical industry, SMJ, 28: 723–745; F. Mas-Ruiz & F. Ruiz- Moreno, 2011, Rivalry within strategic groups and consequences for performance, SMJ, 32: 1286–1308; J. Short, D. Ketchen, T. Palmer, & G. T. Hult, 2007, Firm, strategic group, and industry influences on per- formance, SMJ, 28: 147–167.

31. D. Dranove, M. Peteraf, & M. Shanley, 1998, Do strategic groups exist? SMJ, 19: 1029–1044

32. R. Hamilton, E. Eskin, & M. Michaels, 1998, Assessing competitors, LRP, 31: 406–417; J. D. Osborne, C. Stub- bart, & A. Ramaprasad, 2001, Strategic groups and competitive enactment, SMJ, 22: 435–454.

33. D. Johnson & D. Hoopes, 2003, Managerial cognition, sunk costs, and the evolution of industry structure, SMJ, 24: 1057–1068; B. Kabanoff & S. Brown, 2008, Knowledge structures of prospectors, analyzers, and defenders, SMJ, 29: 149–171; J. Kuilman& J. Li, 2009, Grades of member- ship and legitimacy spillovers, AMJ, 52: 229–245.

34. G. McNamara, R. Luce, & G. Tompson, 2002, Exam- ining the effect of complexity in strategic group knowledge structures on firm performance, SMJ, 23: 151–170.

35. M. W. Peng, J. Tan, & T. Tong, 2004, Ownership types and strategic groups in an emerging economy, JMS, 41: 1105–1129.

36. A. Afuah, 2003, Redefining firm boundaries in the face of the Internet, AMR, 28: 34–53; M. Jacobides, 2005, Industry change through vertical disintegration, AMJ, 48: 465–498.

37. O. Williamson, 1985, The Economic Institutions of Capitalism, New York: Free Press.

38. S. Nadkarni & V. Narayanan, 2007, Strategic schemas, strategic flexibility, and firm performance, SMJ, 28: 243–270; G. Pacheco-de-Almeida, J. Henderson, & K. Cool, 2008, Resolving the commitment versus flex- ibility trade-off, AMJ, 51: 517–538.

39. A. Vining, 2003, Internal market failure, JMS, 40: 431–457; W. Egelhoff & E. Frese, 2009, Understand- ing managers’ preferences for internal markets versus business planning, JIM, 15: 77–91.

40. J. Liker & T. Choi, 2004, Building deep supplier rela- tionships, HBR, December: 104–113.

41. D. Griffith & M. Myers, 2005, The performance impli- cations of strategic fit of relational norm governance strategies in global supply chain relationships, JIBS, 36: 254–269.

42. J. Dyer & H. Singh, 1998, The relational view, AMR, 23: 660–679.

43. J. Barthelemy, 2003, The seven deadly sins of out- sourcing, AME, 17 (2): 87–98.

44. M. Kotabe, X. Martin, & H. Domoto, 2003, Gaining from vertical partnerships, SMJ, 24: 293–316.

45. C. Ahmadjian & J. Lincoln, 2001, Keiretsu, govern- ance, and learning, OSc, 12: 683–701; R. Lamming, 2000, Japanese supply chain relationships in recession, LRP, 33: 757–778; J. McGuire & S. Dow, 2009, Japa- nese keiretsu, APJM, 26: 333–351.

46. C. de Fontenay & J. Gans, 2008, A bargaining perspective on strategic outsourcing and supply com- petition, SMJ, 29: 819–839; M. Leiblein, J. Reuer, & F. Dalsace, 2002, Do make or buy decisions matter? SMJ, 23: 817–833.

47. A. McGahan & M. Porter, 1997, How much does industry matter, really? SMJ, 18: 15–30.

48. S. Oster, 1994, Modern Competitive Analysis, 2nd ed. (p. 46), New York: Oxford University Press.

60 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

49. J. Bou & A. Satorra, 2007, The persistence of abnor- mal returns at industry and firm levels, SMJ, 28: 707–722; A. van Witteloostujin & C. Boone, 2006, A resource-based theory of market structure and organizational form, AMR, 31: 409–426.

50. C. Decker & T. Mellewigt, 2007, Thirty years after Micahel E. Porter, AMP, 21: 41–55.

51. M. Porter, 1994, Toward a dynamic theory of strategy, in R. Rumelt, D. Schendel, & D. Teece (eds.), Funda- mental Issues in Strategy (p. 427), Boston: Harvard Business School Press.

52. X. Lecocq & B. Demil, 2006, Strategizing industry structure, SMJ, 27: 891–898; A. McGahan, 2004, How industries change, HBR, October: 87–94.

C h a p t e r 2 Ma n a g i n g I n d u s t r y C o m p e t i t i o n 61

CHAPTER3

LEVERAGING RESOURCES AND CAPABILITIES

KNOWLEDGE OBJECT IVES

After studying this chapter, you should be able to

1. Explain what firm resources and capabilities are

2. Undertake a basic SWOT analysis along the value chain

3. Decide whether to keep an activity in-house or outsource it

4. Analyze the value, rarity, imitability, and organizational (VRIO) aspects of resources and capabilities

5. Participate in four leading debates concerning the resource-based view

6. Draw strategic implications for action

ot o/ A le xe y St io p

62 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

OPENING CASE

IBM at 100

International Business Machines (popularly known as IBM and more affectionately as Big Blue) celebrated its 100th anniversary in 2011. IBM is a multinational infor- mation technology (IT) corporation headquartered in Armonk, New York. It manufactures and sells computer hardware and software and offers consulting services in areas ranging from mainframe computers to nanotech- nology. IBM is renowned for its innovations. It holds more patents than any other US firm and currently has nine research laboratories worldwide. Its employees have garnered five Nobel Prizes, nine National Medals of Technology, and five National Medals of Science. Its inventions include the automated teller machine (ATM), the floppy disk, the hard disk drive, the magnetic stripe card, the relational database, the Universal Product Code (UPC), the SABRE airline reservation system, DRAM, and Watson artificial intelligence. At present, it employs more than 425,000 employees (often referred to as IBMers) in over 200 countries. In 2010, its sales reached $100 billion, making it the 18th largest corporation in the United States and 31st largest in the world (by sales). Despite the Great Recession, IBM remained highly profitable—ranked 7th most profitable company in the United States. As of September 2011, IBM was the second-largest publicly traded technology company in the world by market capitalization (behind Apple). Other kudos for 2011 included the number one company for leaders (Fortune), number two best global brand (Inter- brand), number one green company worldwide (News- week), 12th most admired company (Fortune), and 18th most innovative company (Fast Company).

In the past century, countless companies came and went. A few countries also appeared and then disappeared—think of the former Soviet Union, Yugoslavia, and Czechoslovakia. “Why is IBM still alive and thriving after so long, in an industry characterized perhaps more than any other by innovation and change?” asked the Economist. This ques- tion is not just academic. Far younger IT giants, such as Dell, Nokia, and Sony, are dying to know the answer in order to prevent their own life span from being much shorter than IBM’s.

IBM pioneered in the industry that we now call the IT industry. The intensity of competition in this fast-moving industry is legendary. In essence, this industry can be characterized as never-ending efforts to create “plat- forms.” First came tabulating machines. Then main- frames. These were followed by “distributed” systems, progressing from mini-computers to personal computers (PCs) and then to servers. Now computing clouds and mobile devices are the rage. There has been no short- age of ambitious new entrants. Many of them have flamed out while IBM marches on. Customers in perso- nal and business segments have different needs, and it is hard to please them all. Suppliers of components and services often have a nasty tendency to enter the foray and become direct competitors—think of Acer and Lenovo, which ate IBM’s lunch in PCs. Entrepreneurs and incumbents constantly dream up new products and services to substitute what Big Blue has to offer. Michael Dell publicly confessed that had he known how intensely competitive the IT industry had become, he would not have entered this industry.

In such a tough neighborhood, IBM’s life is not all smooth sailing. In 1969, during the heydays of its dom- inance in mainframes, it became the first IT company to be labeled an “evil empire” by antitrust authorities (before the more recently alleged “evil empire,” Microsoft, was born). (The US government eventually dropped the case in 1982.) In the 1990s, it narrowly escaped from bankruptcy. IBM has undergone numerous rounds of organizational restructuring since its inception, acquiring companies such as PricewaterhouseCoopers (2002) and selling off busi- nesses such as the printer division Lexmark (1991) and the PC division (2004).

Tons of ink has been spilled on IBM’s long history. What are the secrets behind its longevity and success? An innovative culture. A commitment to customer rela- tionships. A willingness to change. A strong leadership team. A multinational presence—it now has 60,000 employees in India and its corporate procurement head- quarters is based in China. Many more factors can be nominated. But what exactly is it? Answers to this crucial

63 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

Why is IBM able to stand out in a very crowded and competitiveindustry? How has IBM consistently delivered value to customers inthe past century? Why do most of its rivals fail to match IBM’s lon- gevity? The answer is that there must be certain resources and capabilities specific to IBM that are not shared by rivals. This insight has been developed into a resource-based view, which has emerged as one of the three leading perspectives on strategy.1

While the industry-based view focuses on how “average” firms within one industry compete, the resource-based view sheds considerable light on how indi- vidual firms (such as IBM) differ from each other within one industry. In SWOT analysis, the industry-based view deals with the external O and T, and the resource-based view concentrates on the internal S and W.2 A key question is: How can high-flyers such as IBM defy gravity and sustain competitive advantage?3 In this chapter, we first define resources and capabilities, and then discuss the value chain analysis. Afterward, we focus on value (V), rarity (R), imitability (I), and organization (O) through a VRIO framework. Debates and extensions follow.

Understanding Resources and Capabilities A basic proposition of the resource-based view is that a firm consists of a bundle of productive resources and capabilities.4 Resources are defined as “the tangible and intan- gible assets a firm uses to choose and implement its strategies.”5 There is some debate regarding the definition of capabilities. Some argue that capabilities are a firm’s capacity to dynamically deploy resources. They suggest a crucial distinction between resources and capabilities, and advocate a “dynamic capabilities” view.6

While scholars may debate the fine distinctions between resources and capabilities, these distinctions are likely to become blurred in practice.7 For example, is IBM’s long history a resource or capability? How about its multinational presence? How about its willingness to jettison low-margin businesses? For current and would-be strategists, the key is to understand how these attributes help improve firm performance, as opposed to

(Continued)

OPENING CASE

question are not only important to IBMers and their com- petitors, but also to executives in other industries as well as interested students, scholars, and reporters around the world. The Economist opined that IBM “is unlikely to reach its limits soon.” Stay tuned on how far IBM can go in its next 100 years

Sources: Based on (1) Bloomberg Businessweek, 2011, Can this IBMer keep Big Blue’s edge? October 31: 31–32; (2) Economist, 2007, IBM and globalization, April 7: 67–69; (3) Eco- nomist, 2011, 1100100 and counting, June 11: 67–69; (4) Economist, 2011, IBM v. Carnegie Corporation, June 11: 64–66.

resource-based view

A leading perspective of strategy that suggests that differences in firm performance are most fundamentally driven by differences in firm resources and capabilities.

resource

The tangible and intangible assets a firm uses to choose and implement its strategies.

64 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

figuring out whether they should be labeled as resources or capabilities. Therefore, in this book, we will use the terms “resources” and “capabilities” interchangeably and often in parallel. In other words, capabilities are defined here the same way as resources.

All firms, including the smallest ones, possess a variety of resources and capabilities. How do we meaningfully classify such diversity? A useful way is to separate them into two categories: tangible and intangible ones (Table 3.1). Tangible resources and capabilities are assets that are observable and more easily quantified. They can be broadly divided into three categories:

• Financial resources and capabilities. Examples include firms’ abilities to tap into capital markets.

• Physical resources and capabilities. For instance, while many people attribute the success of Amazon to its online savvy (which makes sense), a crucial reason Amazon has emerged as the largest bookseller is because it has built some of the largest physical, brick-and- mortar book warehouses in key locations.

• Technological resources and capabilities.8 IBM is renowned for such technological prowess.

Intangible resources and capabilities, by definition, are harder to observe and more difficult (or sometimes impossible) to quantify (see Table 3.1). Yet, it is widely acknowl- edged that they must be “there,” because no firm is likely to generate competitive advantage by solely relying on tangible resources and capabilities alone.9 Examples of intangible assets include:

• Human resources and capabilities. Emerging Markets 3.1 illustrates how extraordinary human resources (HR) can be crucial assets during crisis.

• Innovation resources and capabilities. Some firms are renowned for innovations. For instance, Apple is famous for its cool gadgets.

• Reputation resources and capabilities. Reputation can be regarded as an outcome of a competitive process in which firms signal their attributes to constituents.10 IBM, despite some setbacks, can leverage its reputation and march from strength to strength, while many of its less reputable rivals struggle.

It is important to note that all resources and capabilities discussed here are merely examples; they do not represent an exhaustive list. As firms forge ahead, discovery and leveraging of new resources and capabilities are likely.

TABLE 3.1 Examples of Resources and Capabilities

TANGIBLE INTANGIBLE

Financial Human

Physical Innovation

Technological Reputation

capability

The tangible and intangible assets a firm uses to choose and implement its strategies.

tangible resources and capabilities

Observable and more easily quantified resources and capabilities.

intangible resources and capabilities

Hard-to-observe and difficult-to-codify resources and capabilities.

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C h a p t e r 3 L e v e r a g i n g R e s o u r c e s a n d C a p a b i l i t i e s 65

EMERGING MARKETS 3.1

The Ordinary Heroes of the Taj

On November 26, 2008, Unilever hosted a dinner at the Taj Mahal Palace Hotel in Mumbai. Unilever’s directors, senior executives, and their spouses were bidding farewell to a departing CEO and welcoming a new CEO. About 35 Taj employees, led by a 24-year-old banquet manager, Mallika Jagad, were assigned to manage the event in a second-floor banquet room. Around 9:30 PM, as they served the main course, they heard what they thought were fireworks at a nearby wedding. In reality, these were the first gunshots from terrorists who were storming the Taj.

The staff quickly realized something was wrong. Jagad had the doors locked and the lights turned off. She asked everyone to lie down quietly under tables and refrain from using cell phones. She insisted that husbands and wives separate to reduce the risk to families. The group stayed there all night, listening to the terrorists rampaging through the hotel, hurling grenades, firing automatic weapons, and tearing the palace apart. According to the guests, the Taj staff kept calm, and constantly went around offering water and asking people if they needed anything else. Early the next morning, a fire started in the hallway outside, forcing the group to try to climb out the windows. A fire crew spotted them and, with its ladders, helped the trapped people escape quickly. The staff evacuated the guests first, and no casualties resulted.

Elsewhere in the hotel, the upscale Japanese restaurant Wasabi was busy by 9:30 PM. A warning call from a hotel operator alerted the staff that terrorists had entered the building and were heading toward the restaurants. Thomas Varghese, the 48-year-old senior waiter, immediately instructed his 50-odd guests to crouch under tables, and he directed employees to form a human cordon around them. Four hours later, security forces asked Varghese if he could get the guests out of the hotel. He decided to use a spiral staircase near the restaurant to evacuate the customers first and then the staff. The 30-year Taj veteran insisted that he would

be the last man to leave, but he never did get out. The terrorists gunned him down as he exited.

When Karambir Singh Kang, the Taj’s general manager, heard about the attacks, he immediately left the conference he was attending off-site. He took charge at the Taj the moment he arrived, supervising the evacuation of guests and coordinating the efforts of firefighters amid the chaos. His wife and two young children were in a sixth-floor suite, where the general manager traditionally lives. When he realized that the terrorists were on the upper floors, he tried to get to his family. It was impossible. By midnight the sixth floor was in flames, and there was no hope of anyone’s surviving. Kang led the rescue efforts until noon the next day. Only then did he call his parents to tell them that the terrorists had killed his wife and children. His father, a retired general, told him, “Son, do your duty, do not desert your

M ap

Re so ur ce s

66 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

Resources, Capabilities, and the Value Chain If a firm is a bundle of resources and capabilities, how do they come together to add value? A value chain analysis allows us to answer this question. Shown in Panel A of Figure 3.1, most goods and services are produced through a chain of vertical activities (from upstream to downstream) that add value—in short, a value chain. The value chain typically consists of two areas: primary activities and support activities.11

Each activity requires a number of resources and capabilities. Value chain analysis forces managers to think about firm resources and capabilities at a very micro, activity- based level.12 Given that no firm is likely to be good at all primary and support activities,

FIGURE 3.1 The Value Chain

Primary activities

INPUT

Research and development

Components

Final assembly

Marketing

OUTPUT

Support activities

Infrastructure

Logistics

Human resource

Panel A. An Example of a Value Chain with Firm Boundaries

Primary activities

INPUT

Research and development

Components

Final assembly

Marketing

OUTPUT

Support activities

Infrastructure

Logistics

Human resources

Panel B. An Example of a Value Chain with Some Outsourcing

Note: Dotted lines represent firm boundaries.

post.” Kang replied, “If the hotel goes down, I will be the last man out.”

During the onslaught on the Taj, 31 people died and 28 were hurt, but the hotel received only praise the day after. Its guests were overwhelmed by employees’ dedication to duty, their desire to protect guests with little regard to their own personal safety, and their quick thinking. As many as 11 Taj employees—a third of the hotel’s casualties—laid down their lives while helping between 1,200 and 1,500 guests escape.

At some level, that isn’t surprising. One of the world’s top hotels, the Taj is ranked number 20 by Condé Nast

Traveler. The hotel is known for the highest levels of quality, its ability to go many extra miles to delight customers, and its staff of highly trained employees. It is a well-oiled machine, where every employee knows his or her job, has encyclopedic knowledge about regular guests, and is comfortable taking orders. Even so, the Taj employees gave customer service a whole new meaning during the terrorist strike.

Source: Excerpted from R. Deshpandé & A. Raina, 2011, The ordinary heroes of the Taj, Harvard Business Review, December: 119–123.

value chain

Goods and services produced through a chain of vertical activities that add value.

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C h a p t e r 3 L e v e r a g i n g R e s o u r c e s a n d C a p a b i l i t i e s 67

the key is to examine whether the firm has resources and capabilities to perform a particular activity in a manner superior to competitors—a process known as benchmarking in SWOT analysis. If managers find that their firm’s particular activity is unsatisfactory, a decision model (shown in Figure 3.2) can remedy the situation. In the first stage, managers ask: “Do we really need to perform this activity in-house?” Figure 3.3 introduces a framework to take a hard look at this question, whose answer boils down to (1) whether an activity is industry-specific or common across industries, and (2) whether this activity is proprietary (firm-specific) or not. The answer is “No” when the activity is found in Cell 2 in Figure 3.3 with a great deal of commonality across industries and little need for keeping it proprietary—known in the recent jargon as a high degree of commoditization. The answer may also be “No” if the activity is in Cell 1 in Figure 3.3, which is industry-specific but also with a high level of commoditization. Then, the firm may want to outsource this activity, sell the unit involved, or lease the unit’s services to other firms (see Figure 3.2). This is because operating multiple stages of uncompetitive activities in the value chain may be cumbersome and costly.

Think about steel, definitely a crucial component for automobiles. But the question for automakers is: “Do we need to make steel by ourselves?” The requirements for steel are common across end-user industries—that is, the steel for automakers is essentially the same for construction, defense, and other steel-consuming end users (ignoring minor technical differences for the sake of our discussion). For automakers, while it is imperative

FIGURE 3.2 A Decision Model in a Value Chain Analysis

Do we really need to perform this activity

in-house?

Yes

Outsource, sell the unit, or lease its services

to other firms

Do we have the resources and

capabilities that add value in a way better

than rivals do?

Keep doing it and improving it

Access resources and capabilities

through strategic alliances

Acquire necessary resources and

capabilities in-house

benchmarking

Examination as to whether a firm has resources and capabilities to perform a particular activity in a manner superior to competitors.

commoditization

A process of market competition through which unique products that command high prices and high margins generally lose their ability to do so— these products thus become “commodities.”

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68 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

to keep the auto making activity (especially engine and final assembly) proprietary (Cell 3 in Figure 3.3), there is no need to keep steel making in-house. Therefore, although many automakers such as Ford and GM historically were involved in steel making, none of them does it now. In other words, steel making is outsourced and steel commoditized. In a similar fashion, Ford and GM no longer make glass, seats, and tires as they did before.

Outsourcing is defined as turning over an organizational activity to an outside supplier that will perform it on behalf of the focal firm.13 For example, many consumer products companies (such as Nike), which possess strong capabilities in upstream activities (such as design) and downstream activities (such as marketing), have outsourced manufacturing to suppliers in low-cost countries. A total of 80% of the value of Boeing’s new 787 Dreamli- ner is provided by outside suppliers. This compares with 51% for existing Boeing air- craft.14 Recently, not only is manufacturing often outsourced, a number of service activities, such as IT, HR, and logistics, are also outsourced. The driving force is that many firms, which used to view certain activities as a very special part of their industries (such as airline reservations and bank call centers), now believe that these activities have relatively generic attributes that can be shared across industries. Of course, this changing mentality is fueled by the rise of service providers, such as IBM and Infosys in IT, Manpower in HR, Foxconn in contract manufacturing, and DHL in logistics. These specialist firms argue that such activities can be broken off from the various client firms (just as steel making was broken off from automakers decades ago) and leveraged to serve multiple clients with greater economies of scale.15 Such outsourcing enables client firms to become “leaner and meaner” organizations, which can better focus on their core activities (see Figure 3.1 Panel B).

If the answer to the question, “Do we really need to perform this activity in-house?” is “Yes” (Cell 3 in Figure 3.3), but the firm’s current resources and capabilities are not up to the task, then there are two choices (see Figure 3.2). First, the firm may want to acquire

FIGURE 3.3 In-House versus Outsource

Industry specific

Common across industries

H ig

h co

m m

od iti

za tio

n Pr

op ri

et ar

y (fi

rm -s

pe ci

fic )

C o m

m o d it iz

at io

n v

er su

s p ro

p ri

et ar

y n at

u re

o f th

e ac

ti vi

Industry specificity

Cell 1 Outsource

Cell 3 In-House

Cell 2 Outsource

Cell 4 ???

Note: At present, no clear guidelines exist for cell 4, where firms either choose to perform activities in-house or outsource.

outsourcing

Turning over all or part of an activity to an outside supplier to improve the performance of the focal firm.

ga ge

Le ar ni ng

C h a p t e r 3 L e v e r a g i n g R e s o u r c e s a n d C a p a b i l i t i e s 69

and develop capabilities in-house so that it can perform this particular activity better.16

Second, if a firm does not have enough skills to develop these capabilities in-house, it may want to access them through alliances.

Conspicuously lacking in both Figures 3.2 and 3.3 is the geographic dimension—domestic versus foreign locations.17 Because the two terms “outsourcing” and “offshoring” have emerged rather recently, there is a great deal of confusion, especially among some journalists, who often casually equate them as the same. So to minimize confusion, we go from two terms to four terms in Figure 3.4, based on locations and modes (in-house versus outsource):18

• Offshoring—international/foreign outsourcing

• Onshoring—domestic outsourcing

• Captive sourcing—setting up subsidiaries to perform in-house work in foreign locations

• Domestic in-house activity

Outsourcing—especially offshoring—has no shortage of controversies and debates (see the Debates and Extensions section). Despite this set of new labels, we need to be aware that “captive sourcing” is conceptually identical to foreign direct investment (FDI), which is nothing new in the world of global strategy (see Chapters 1 and 6 for details). We also need to be aware that “offshoring” and “onshoring” are simply international and domestic variants of outsourcing, respectively. While offshoring low-cost IT work to India, the Philippines, and other emerging economies has been widely practiced, inter- estingly, eastern Germany; northern France; and the Appalachian, Great Plains, and southern regions of the United States have emerged as new hotbeds for onshoring.19

In job-starved regions such as Michigan, high-quality IT workers may accept wages 35% lower than at headquarters in Silicon Valley.

FIGURE 3.4 Location, Location, Location

Mode of activity

Cell 1 Captive

sourcing/FDI

Cell 2 Offshoring

L o ca

ti o n o

f ac

ti vi

Foreign location

Cell 3 Domestic in-house

Cell 4 Onshoring Domestic location

In-house Outsourcing

Note: “Captive sourcing” is a new term that is conceptually identical to foreign direct investment (FDI), a term widely used in global strategy.

offshoring

International/foreign outsourcing.

onshoring

Outsourcing to a domestic firm.

captive sourcing

Setting up subsidiaries to perform in-house work in foreign location. Conceptually identical to foreign direct investment (FDI).

ga ge

Le ar ni ng

70 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

One interesting lesson we can take away from Figure 3.4 is that even for a single firm, value-adding activities may be geographically dispersed around the world, taking advantage of the best locations and modes to perform certain activities. For instance, a Dell laptop may be designed in the United States (domestic in-house activity), its components may be produced in Taiwan (offshoring) as well as the United States (onshoring), and its final assembly may be in China (captive sourcing/FDI). When customers call for help, the call center may be in India, Ireland, Jamaica, or the Philippines, manned by an outside service provider—Dell may have outsourced the service activities through offshoring.

Overall, a value chain analysis engages managers to ascertain a firm’s strengths and weaknesses on an activity-by-activity basis, relative to rivals, in a SWOT analysis. The recent proliferation of new labels is intimidating, causing some gurus to claim that “21st century offshoring really is different.”20 In reality, it is not. Under the skin of the new vocabulary, we still see the time-honored SWOT analysis at work. The next section introduces a framework on how to do this.

From SWOT to VRIO Recent progress in the resource-based view has gone beyond the traditional SWOT analysis. The new work focuses on the value (V), rarity (R), imitability (I), and organiza- tional (O) aspects of resources and capabilities, leading to a VRIO framework.21 Summar- ized in Table 3.2, addressing these four important questions has a number of ramifications for competitive advantage.

The Question of Value Do firm resources and capabilities add value? The preceding value chain analysis suggests that this is the most fundamental question to start with.22 Only value-adding resources can lead to competitive advantage, whereas non-value-adding capabilities may lead to competitive disadvantage. With changes in the competitive landscape, previous value- adding resources and capabilities may become obsolete. The evolution of IBM is a case in

TABLE 3.2 The VRIO Framework: Is a Resource or Capability…

VALUABLE? RARE? COSTLY TO IMITATE?

EXPLOITED BY ORGANIZATION?

COMPETITIVE IMPLICATIONS

FIRM PERFORMANCE

No — — No Competitive disadvantage Below average

Yes No — Yes Competitive parity Average

Yes Yes No Yes Temporary competitive advantage

Above average

Yes Yes Yes Yes Sustained competitive advantage

Consistently above average

Sources: Adapted from (1) J. Barney, 2002, Gaining and Sustaining Competitive Advantage, 2nd ed. (p. 173), Upper Saddle River, NJ: Prentice Hall; (2) R. Hoskisson, M. Hitt, & R. D. Ireland, 2004, Competing for Advantage (p. 118), Cincinnati: South-Western Cengage Learning.

VRIO framework

A resource-based framework that focuses on the value (V), rarity (R), imitability (I), and organizational (O) aspects of resources and capabilities.

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point. IBM historically excelled in making hardware, including tabulating machines in the 1930s, mainframes in the 1960s, and PCs in the 1980s. However, as competition for hardware heated up, IBM’s capabilities in hardware not only added little value, but also increasingly stood in the way for it to move into new areas. Since the 1990s, under two new CEOs, IBM has been transformed into focusing on more lucrative software and services, where it has developed new value-adding capabilities, aiming to become an on- demand computing service provider for corporations. As part of this new strategy, IBM purchased PricewaterhouseCoopers (PwC), a leading technology consulting firm, in 2002 and sold its PC division to China’s Lenovo in 2004 (see the Opening Case).

The relationship between valuable resources and capabilities and firm performance is straightforward. Instead of becoming strengths, non-value-adding resources and capabil- ities, such as IBM’s historical expertise in hardware, may become weaknesses. If firms are unable to get rid of non-value-adding assets, they are likely to suffer below-average performance.23 In the worst case, they may become extinct, a fate IBM narrowly skirted during the early 1990s. According to IBM’s new CEO Ginni Rometty:

Whatever business you’re in, it’s going to commoditize over time, so you have to keep moving it to a higher value and change.24

The Question of Rarity Simply possessing valuable resources and capabilities may not be enough. The next question asks: How rare are valuable resources and capabilities?25 At best, valuable but common resources and capabilities will lead to competitive parity but not an advantage. Consider the identical aircraft made by Boeing and Airbus used by numerous airlines. They are certainly valuable, yet it is difficult to derive competitive advantage from these aircraft alone. Airlines have to work hard on how to use these same aircraft differently (see Strategy in Action 3.1).

Only valuable and rare resources and capabilities have the potential to provide some temporary competitive advantage. Overall, the question of rarity is a reminder of the cliché: If everyone has it, you can’t make money from it. For example, the quality of the American Big Three automakers is now comparable with the best Asian and European rivals. However, even in their home country, the Big Three’s quality improvements have not translated into stronger sales. Embarrassingly, in 2009 both GM and Chrysler, despite the decent quality of their cars, had to declare bankruptcy and be bailed out by the US government (and in the case of GM, also by the Canadian government). The point is simple: Flawless high quality is now expected among car buyers, is no longer rare, and thus provides no advantage.

The Question of Imitability Valuable and rare resources and capabilities can be a source of competitive advantage only if competitors have a difficult time imitating them (see the Closing Case). While it is relatively easier to imitate a firm’s tangible resources (such as plants), it is a lot more challenging and often impossible to imitate intangible capabilities (such as tacit knowl- edge, superior motivation, and managerial talents).26

Imitation is difficult. Why? In two words: causal ambiguity, which refers to the difficulty of identifying the causal determinants of successful firm performance.27 What exactly has

causal ambiguity

The difficulty of identifying the causal determinants of successful firm performance.

72 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

caused IBM to be such an enduring and continuously relevant company (see the Opening Case)? IBM has no shortage of competitors and imitators. Rumors about IBM’s end erupt periodically (and almost became true at least once in the 1990s). Yet, IBM has always been able to turn around by discarding businesses that it once dominated (think of PCs) and constructing a new portfolio of products and services that add value. In 2011, its service businesses had 32% margins, and its software businesses enjoyed 88% margins.28

A natural question is: How does IBM do it? Usually a number of resources and capabilities will be nominated, such as an innovative culture, a commitment to customer relationships, a willingness to change, a strong leadership team, and a multinational presence. While all of these resources and capabilities are plausible, what exactly is it? This truly is a million (or billion) dollar question, because knowing the answer to this question is not only intriguing to scholars and students, it can also be hugely profitable for IBM’s rivals. Unfortunately, outsiders usually have a hard time understanding what a firm does inside its boundaries. We can try, as many rivals have, to identify IBM’s recipe for success by drawing up a long list of possible reasons, labeled as “resources and capabil- ities” in our classroom discussion. But in the final analysis, as outsiders we are not sure.29

What is even more fascinating for scholars and students and more frustrating for rivals is that often managers of a focal firm such as IBM do not know exactly what contributes to their firm’s success. When interviewed, they can usually generate a long list of what they do well, such as a strong organizational culture, a relentless drive, and many other

STRATEGY IN ACTION 3.1

ANA: Refreshing the Parts Other Airlines Can’t Reach

Launched in 2011, the new Boeing 787 Dreamliner is the first plane to introduce a game-changing technology— lightweight plastic composites. As a result, this midsize long-haul jet is regarded as a technological wonder that is 20% more fuel efficient and 30% less costly to maintain than similar-sized planes. Not surprisingly, airlines around the world love it. In the seven years (2004–2011) before the 787 entered service, it became the fastest selling airliner in history, winning over 800 orders. Its launch customer is All Nippon Airways (ANA), Japan’s number one airline, which has ordered 55.

The Dreamliner will certainly be valuable to the first airline to fly it. However, its novelty will soon disappear, as more than 800 planes will follow ANA’s first 55 to enter service. In other words, the Dreamliner is valuable, not necessarily rare, and relatively easy to imitate—Boeing is happy to produce for any airline that is willing to cough up

$170 million for a copy. What is ANA’s response to hold onto its competitive advantage associated with the 787? It plans to install bidet-toilets as standard in its fleet of Dreamliners, in a bid to attract more fastidious passengers from Japan where the washlet is commonplace. Approxi- mately 70% of Japanese households have a bidet. In July 2007, when the Dreamliner was first unveiled at Boeing’s plant in Everett, Washington, ANA chief executive Mineo Yamamoto proudly announced at the ceremony that the bidet-toilets onboard the 787 will be a key source of differentiation by “refreshing the parts other airlines can- not reach.”

Sources: Based on (1) Bloomberg Businessweek, 2011, ANA: First in class, businessweek.com/adsections, (2) South China Morning Post, 2007, Boeing unveils new, green 787 jetliner, July 10: A8; (3) All Nippon Airways, 2012, www.ana.co.jp/787.

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attributes. To make matters worse, different managers of the same firm may have a different list. When probed as to which resource or capability is “it,” they usually suggest that it is all of the above in combination. This is probably one of the most interesting and paradoxical aspects of the resource-based view: If insiders have a hard time figuring out what unambiguously contributes to their firm’s performance, it is not surprising that outsiders’ efforts in understanding and imitating these capabilities are usually flawed and often fail.30

Overall, valuable and rare but imitable resources and capabilities may give firms some temporary competitive advantage, leading to above-average performance for some period of time. However, such advantage is not likely to be sustainable. Shown by the example of IBM, only valuable, rare, and hard-to-imitate resources and capabilities may potentially lead to sustained competitive advantage.

The Question of Organization Even valuable, rare, and hard-to-imitate resources and capabilities may not give a firm a sustained competitive advantage if it is not properly organized. Although movie stars represent some of the most valuable, rare, and hard-to-imitate as well as highest-paid resources, most movies flop. More generally, the question of organization asks: How can a firm (such as a movie studio) be organized to develop and leverage the full potential of its resources and capabilities?

Numerous components within a firm are relevant to the question of organization.31 In a movie studio, these components include talents in “smelling” good ideas, photography crews, musicians, singers, makeup artists, animation specialists, and managers on the business side. These components are often called complementary assets,32 because by themselves they are difficult to generate box office hits. For the favorite movie you saw most recently, do you still remember the names of its makeup artists? Of course, not—you probably only remember the stars. However, stars alone cannot generate hit movies, either. It is the combination of star resources and complementary assets that create hit movies. “It may be that not just a few resources and capabilities enable a firm to gain a competitive advantage but that literally thousands of these organizational attributes, bundled together, generate such advantage.”33 Emerging Markets 3.2 illustrates how ambidexterity to manage both market forces and government forces simultaneously—as a bundle of complementary resources—is key to navigate the competitive waters in emerging economies. In other words, to attain competitive advantage, market-based and nonmarket-based (political) capabilities need to complement each other. Otherwise, strong market performers, such as Ford in Brazil and Tata in India, may nevertheless hit a wall when messing up government relations (see Emerging Markets 3.2).

Another idea is social complexity, which refers to the socially complex ways of organizing typical of many firms. Many multinationals consist of thousands of people scattered in many different countries. How they overcome cultural differences and are organized as one corporate entity and achieve corporate goals is profoundly complex. Oftentimes, it is their invisible relationships that add value.34 Such organizationally embedded capabilities are thus very difficult for rivals to imitate. This emphasis on social complexity refutes what is half-jokingly called the “Lego” view of the firm, in which a firm can be assembled (and dissembled) from modules of technology and people (a la Lego toy

complementary assets

Numerous noncore assets that complement and support the value-adding activities of core assets.

ambidexterity

Ability to use one’s both hands equally well. In management jargon, this term has been used to describe capabilities to simultaneously deal with paradoxes (such as exploration versus exploitation).

social complexity

The socially complex ways of organizing typical of many firms.

74 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

blocks). By treating employees as identical and replaceable blocks, the “Lego” view fails to realize that social capital associated with complex relationships and knowledge permeat- ing many firms can be a source of competitive advantage.

EMERGING MARKETS 3.2

Strategic Ambidexterity in Emerging Economies

“Ambidexterity” literally means the ability to use one’s both hands equally well. In management jargon, this metaphor has often been used to theorize about organizational capabilities to simultaneously deal with paradoxes, such as the need to explore new but uncertain innovations versus the necessity to exploit existing efficiency in production. In the context of emerging economies, strategic ambidexterity is defined as firms’ dynamic capabilities to simultaneously manage influences from both governments and markets. Since market competition has intensified, firms obviously have to enhance their market-based capabilities. However, more influence of market forces does not necessarily mean less influence of government forces. Instead of shying away from government forces, firms are advised to embrace them.

In the Brazilian state of Rio Grande do Sul, the elec- tion success of a leftist PT Party (Workers Party) created a problem for Dell. Dell had signed a $100 million invest- ment deal with the previous state government that was more friendly to multinationals. Dell obtained a lucrative incentive package consisting of a 75% tax reduction for 12 years and a $16 million loan at a favorable rate. During the election campaign, the PT Party candidate, who would eventually win and become the new governor, attacked such “excessive” concessions granted to Dell (and also to Ford in a similar deal). Once the new governor was in power, Ford chose to go to another Brazilian state.

Sensing that the new governor was criticized for job losses associated with Ford’s departure, Dell seized the opportunity by reaching out to renegotiate with the new governor. Dell argued that unlike Ford, Dell’s operations would not pollute the environment; instead, Dell would facilitate access to the Internet—a precondition for a more just and egalitarian social order promoted by the new

governor. Not wanting to lose another major investor, the new governor in the end agreed to let Dell keep its lucrative incentive package intact. The only condition was that Dell needed to donate some computers to poor regions in the state, a condition to which Dell readily agreed.

The need to pay attention to political winds is not only relevant to foreign firms such as Dell in Brazil, it is also important to domestic firms. Case in point: The Tata Nano, the much-hyped, cheapest car that presumably would allow many Indians to become first-time car owners and create thousands of jobs, could not be made in its originally planned factory in the Indian state of West Bengal. Thousands of farmers who lost their land used to build the Nano factory protested. Pressure from angry politicians forced Tata to abandon the plan and start another plant in another state, Gujarat, at a great cost. The fact that such an influential and otherwise-respected firm can mess up its political relationships domestically underscores the importance of managing political calculations as part of the capabilities in strategic ambidexterity in emerging economies. At winning firms such as Dell, market capabilities complement political savvy. At frustrated firms such as Tata, market capabilities are pulled back by political struggles.

Sources: Based on (1) BusinessWeek, 2008, Farmers vs. factories, September 8: 30; (2) F. Hermelo & R. Vassolo, 2010, Institutional development and hypercompetition in emerging economies, Strategic Management Journal, 31: 1457–1473; (3) Y. Li, M. W. Peng, & C. Macaulay, 2012, Managing strategic ambidexterity during institutional transitions, working paper, University of Texas at Dallas; (4) R. Nelson, 2007, Dell’s dilemma in Brazil, in H. Merchant (ed.), Competing in Emerging Markets, London: Routledge.

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Overall, only valuable, rare, and hard-to-imitate capabilities that are organization- ally embedded and exploited can possibly lead to sustained competitive advantage and persistently above-average performance. Because capabilities cannot be evaluated in isolation, the VRIO framework presents four interconnected and increasingly difficult hurdles for them to become a source of sustainable competitive advantage (Table 3.2). In other words, these four aspects come together as one “package.” Illustrated in Figure 3.5, the VRIO framework urges every firm to search for a strategic sweet spot where it adds value by meeting customer needs in a way that rivals cannot.

Debates and Extensions Like the industry-based view outlined in Chapter 2, the resource-based view has its fair share of controversies and debates. Here, we introduce four leading debates: (1) firm-specific versus industry-specific determinants of performance, (2) static resources versus dynamic capabilities, (3) offshoring versus non-offshoring, and (4) domestic resources versus inter- national capabilities.

Firm-Specific versus Industry-Specific Determinants

of Performance At the heart of the resource-based view is the proposition that firm performance is most fundamentally determined by firm-specific resources and capabilities, whereas the indus- try-based view argues that firm performance is ultimately a function of industry-specific attributes. The industry-based view points out persistently different average profit rates of different industries, such as pharmaceutical versus grocery industries. The resource-based view, on the other hand, has documented persistently different performance levels among firms within the same industry, such as IBM and Apple in IT and Southwest and Ryanair

FIGURE 3.5 Strategic Sweet Spot

Competitors’ Offerings

Customers’ Needs

Company’s Capabilities

SWEET SPOT

Source: D. Collis & M. Rukstad, 2008, Can you say what your strategy is? (p. 89), Harvard Business Review, April: 82–90.

strategic ambidexterity

Firms’ dynamic capabilities to simultaneously manage influences from both governments and markets.

76 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

in airlines versus other competitors. A number of studies find industry-specific effects to be more significant.35 However, many studies are supportive of the resource-based view— firm-specific capabilities are stronger determinants of firm performance than industry- specific effects.36

While the debate goes on, it is important to caution against an interest in declaring one side to be “winning.”37 There are two reasons for such caution— methodological and practical. First, while industry-based studies have used more observable proxies such as entry barriers and concentration ratios, resource-based studies have to confront the challenge of how to measure unobservable firm-specific capabilities, such as organizational learning, knowledge management, and manage- rial talents. While resource-based scholars have created many innovative measures to “get at” these capabilities, these measures at best are “observable consequences of unobservable resources” and can be subject to methodological criticisms.38 Critics contend that the resource-based view follows the logic that “show me a success story and I will show you a core competence [resource] (or show me a failure and I will show you a missing competence).”39 Resource-based theorists readily admit that “the source of sustainable competitive advantage is likely to be found in different places at different points in time in different industries.”40 While such reasoning can insightfully explain what happened in the past, it is difficult to predict what will happen in the future. For instance, are we going to do better than rivals if we match, say, their equipment?

Second and perhaps more important, there is a good practical reason to believe that it is the combination of both industry-specific and firm-specific attributes that collectively drive firm performance. They have in fact been argued to be the two sides of the same “coin” of strategic analysis from the very beginning of the development of the resource- based view.41 It seems to make better sense when viewing both perspectives as comple- mentary to each other. In other words, blending these two insightful frameworks may generate more insight.

Static Resources versus Dynamic Capabilities Another debate stems from the relatively static nature of the resource-based logic, which essentially suggests “Let’s identify S and W in a SWOT analysis and go from there.” Such a snapshot of the competitive situation may be adequate for slow-moving industries (such as meat packing), but it may be less satisfactory for dynamically fast-moving industries (such as IT). Critics, therefore, posit that the resource-based view needs to be strength- ened by a heavier emphasis on dynamic capabilities.

More recently, as we advance into a “knowledge economy,” many scholars argue for a “knowledge-based” view of the firm.42 Tacit knowledge, probably the most valuable, unique, hard-to-imitate, and organizationally complex resource, may represent the ulti- mate dynamic capability a firm can have.43 Such invisible assets range from knowledge about customers through years (and sometimes decades) of interaction to knowledge about product development processes and political connections.

Focusing on knowledge-based dynamic capabilities, recent research suggests some interesting, counter-intuitive findings. Summarized in Table 3.3, while the hallmark for resources in relatively slow-moving industries (such as hotels and railways) is complexity

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that is difficult to observe and results in causal ambiguity, capabilities in very dynamic high-velocity industries (such as IT) take on a different character. They are “simple (not complicated), experiential (not analytic), and iterative (not linear).”44 In other words, while traditional resource-based analysis urges firms to rigorously analyze their strengths and weaknesses and then plot some linear application of their resources (“learning before doing”), firms in high-velocity industries have to engage in “learning by doing.” The imperative for strategic flexibility calls for simple (as opposed to complicated) routines, which help managers stay focused on broadly important issues without locking them into specific details or the use of inappropriate past experience (see the quote from Facebook’s founder Mark Zuckerberg in Chapter 1 on p. 11).

Not all fast-moving industries are high-tech ones. As the pace of competition accel- erates, more industries, including many traditional low-tech ones, are becoming fast moving—for example, think of the luxury goods industry (see Chapter 2 Closing Case). The end result is hypercompetition, whose hallmark is a shortened window during which a firm may command competitive advantage.45 In hypercompetition, firms undertake dynamic maneuvering intended to unleash a series of small, unpredictable, but powerful actions to erode rivals’ competitive advantage.

Overall, recent research suggests that the current resource-based view may have over- emphasized the role of leveraging existing resources and capabilities and underempha- sized the role of developing new ones. The assumption that a firm is a tightly bundled collection of resources may break down in high-velocity environments, whereby resources are added, recombined, and dropped with regularity.46 In such a world of hypercompeti- tion whereby sustainable competitive advantage may be unrealistic, a series of short-term unpredictable advantage seems to be the best a firm can hope for.

TABLE 3.3 Dynamic Capabilities in Slow-Moving and Fast-Moving Industries

SLOW-MOVING INDUSTRIES

FAST-MOVING (HIGH-VELOCITY) INDUSTRIES

Market environment Stable industry structure, defined boundaries, clear business models, identifiable players, linear and predictable change

Ambiguous industry structure, blurred boundaries, fluid business models, ambiguous and shifting players, nonlinear and unpredictable change

Attributes of dynamic capabilities

Complex, detailed, analytic routines that rely extensively on existing knowledge (“learning before doing”)

Simple, experiential routines that rely on newly created knowledge specific to the situation (“learning by doing”)

Focus Leverage existing resources and capabilities Develop new resources and capabilities

Execution Linear Iterative

Organization A tightly bundled collection of resources with relative stability

A loosely bundled collection of resources, which are frequently added, recombined, and dropped

Outcome Predictable Unpredictable

Strategic goal Sustainable competitive advantage (hopefully for the long term)

A series of short-term (temporal) competitive advantage

Sources: Adapted from (1) K. Eisenhardt & J. Martin, 2000, Dynamic capabilities: What are they? Strategic Management Journal, 21: 1105–1121; (2) G. Pisano, 1994, Knowledge, integration, and the locus of learning, Strategic Management Journal, 15: 85–100.

hypercompetition

A way of competition cen- tered on dynamic maneu- vering intended to unleash a series of small, unpre- dictable, but powerful actions to erode the rival’s competitive advantage.

78 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

Offshoring versus Non-Offshoring Offshoring—or, more specifically, international outsourcing—has emerged as a leading corporate movement. Outsourcing low-end manufacturing is now widely practiced. But increased outsourcing of more high-end services, particularly IT services and all sorts of business process outsourcing (BPO), is controversial. Because digitization and commodi- tization of service work are enabled only by the very recent rise of the Internet and the reduction of international communication costs, their long-term impact is not known. Thus, it is debatable whether such offshoring proves to be a long-term benefit or hindrance to Western firms and economies.47

Proponents argue that offshoring creates enormous value for firms and economies. Western firms are able to tap into low-cost yet high-quality labor, translating into significant cost savings. Firms can also focus on their core capabilities, which may add more value than dealing with non-core (and often uncompetitive) activities. In turn, offshoring service providers, such as Infosys and Wipro, develop their core competencies in IT/BPO. McKinsey reported that for every dollar spent by US firms’ offshoring to India, US firms save 58 cents (see Table 3.4). Overall, $1.46 of new wealth is created, of which the US economy captures $1.13. India captures the other 33 cents. While acknowledging that some US employees may lose their jobs, proponents suggest that on balance, offshoring is a win-win solution for both US and Indian firms and economies.

Critics make three points on strategic, economic, and political grounds. Strategically, if “even core functions like engineering, R&D, manufacturing, and marketing can—and often should—be moved outside,”48 what is left of the firm? US firms have gone down this path before—in manufacturing—with disastrous results. In the 1960s, Radio Corporation of America (RCA) invented the color TV and then outsourced its production to Japan, a low-cost country at that time. Fast-forward to the 2000s and the United States no longer has any US-owned color TV producers. What is the nationality of the RCA brand? French firm Thomson sold it to Chinese firm TCL in 2003. So RCA is now a Chinese brand. Overall, critics argue that offshoring nurtures rivals. Why are Indian IT/BPO firms now emerging as strong rivals? It is in part because they built up their capabilities doing work for IBM and EDS in the 1990s, particularly by working to help the IT industry prevent the “millennium bug” (or “Y2K”) problem.

TABLE 3.4 Benefit of $1 US Spending on Offshoring to India

BENEFIT TO THE UNITED STATES $ BENEFIT TO INDIA $

Savings accruing to US investors/customers 0.58 Labor 0.10

Exports of US goods/services to providers in India 0.05 Profits retained in India 0.10

Profit transfer by US-owned operations in India back to the US 0.04 Suppliers 0.09

Net direct benefit retained in the United States 0.67 Central government taxes 0.03

Value from US labor reemployed 0.46 State government taxes 0.01

Net benefit to the United States 1.13 Net benefit to India 0.33

Source: Based on text in D. Farrell, 2005, Offshoring: Value creation through economic change, Journal of Management Studies, 42: 675–683. Farrell is director of the McKinsey Global Institute, and she refers to a McKinsey study.

business process outsourcing (BPO)

Outsourcing of business processes such as loan origination, credit card processing, and call center operations.

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In manufacturing, many Asian firms, which used to be original equipment manu- facturers (OEMs) executing design blueprints provided by Western firms, now want to have a piece of the action in design by becoming original design manufacturers (ODMs) (see Figure 3.6). Having mastered low-cost and high-quality manufacturing, Asian firms such as BenQ, Flextronics, Foxconn, HTC, and Huawei are indeed capable of capturing some design function from Western firms such as Dell, HP, Kodak, and Nokia. Therefore, increasing outsourcing of design work by Western firms may accelerate their own long-run demise. A number of Asian OEMs, now quickly becoming ODMs, have openly announced that their real ambition is to become original brand manufacturers (OBMs). Thus, according to critics of offshoring, isn’t the writing already on the wall?

Economically, critics question whether developed economies, on the whole, actually gain more. While shareholders and corporate highflyers embrace offshoring, it increas- ingly results in job losses in high-end areas such as design, R&D, and IT/BPO. While white-collar individuals who lose jobs will naturally hate it, the net impact on developed economies may still be negative.

Finally, critics make the political argument that many large Western firms are unethical and are interested only in the cheapest and most exploitable labor. Not only is work commoditized, people are degraded as tradable commodities that can be jettisoned. As a result, large firms that outsource work to emerging economies are often accused of destroying jobs at home, ignoring corporate social responsibility,

FIGURE 3.6 From Original Equipment Manufacturer (OEM) to Original Design Manufacturer (ODM)

Primary activitiesPrimary activities

INPUT

Research and development

Components

Final assembly

Marketing

OUTPUT

INPUT

Research and development

Components

Final assembly

Marketing

OUTPUT

An example of OEM An example of ODM

Note: Dotted lines represent firm boundaries. A further extension is to become an original brand manufacture (OBM), which would incorporate brand ownership and management in the marketing area. For graphic simplicity, it is not shown here.

original equipment manufacturer (OEM)

A firm that executes design blueprints provided by other firms and manufactures such products.

original design manufacturer (ODM)

A firm that both designs and manufactures products.

original brand manufacturer (OBM)

A firm that designs, manufactures, and markets branded products.

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violating customer privacy (for example, by sending medical records, tax returns, and credit card numbers to be processed overseas), and in some cases undermining national security. Not surprisingly, the debate often becomes emotional and explosive when such accusations are made.

For firms in developed economies, where this debate primarily takes place, the choice is not really offshoring versus non-offshoring, but where to draw the line on offshoring. There is relatively little debate in emerging economies because they clearly stand to gain from offshoring. Taking a page from the Indian playbook, the Philippines, with numerous English-speaking professionals, is trying to eat some of India’s lunch. Northeast China, where Japanese is widely taught, is positioning itself as an ideal location for call centers for Japan. Central and Eastern Europe gravitates toward serving Western Europe. Central and South American countries want to grab call center contracts for the large Hispanic market in the United States.

Domestic Resources versus International

(Cross-Border) Capabilities Do firms that are successful domestically have what it takes to win internationally? If you ask managers at The Limited Brands, their answer would be “No.” The Limited Brands is the number one US fashion retailer, which has a successful retail empire of 4,000 stores throughout the country with brands such as The Limited, Victoria’s Secret, and Bath & Body Works. Yet, it has refused to go abroad—not even Canada. On the other hand, the ubiquitous retail outlets of Zara, LVMH, Gucci, and United Colors of Benetton in major cities around the world suggest that their answer would be “Yes!”

Some domestically successful firms continue to succeed overseas. For example, IKEA has become a global cult brand. The new generation in Russia is known simply as the IKEA Generation. However, many other domestically formidable firms are burned badly overseas. Wal-Mart withdrew from Germany and South Korea. Wal- Mart’s leading global rival, France’s Carrefour, had to exit the Czech Republic, Japan, Mexico, and Slovakia. Starbucks’ bitter brew has also failed to turn into sweet profits overseas.

Are domestic resources and cross-border capabilities essentially the same? The answer can be either “Yes” or “No.”49 This debate is an extension of the larger debate on whether international business is different from domestic business. Answering “Yes” to this question is an excellent argument for having stand-alone international business courses (and for having a global strategy textbook like this one). Answering “No” to this question argues that “international business” fundamentally is about “business,” which is well covered by strategy, finance, and other courses (most text- books in these areas have at least one chapter on international topics). This question is obviously very important for companies and business schools. However, there is no right or wrong answer. It is important to emphasize the advice: think global, act local. In practice, this means that despite grand global strategic designs, companies have to concretely win one local market (country) after another (see Chapter 1 Opening Case).

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The Savvy Strategist The savvy strategist can draw at least three important implications for action (Table 3.5). First, there is nothing very novel in the proposition that firms “compete on resources and capabilities.” The subtlety comes when managers attempt to distinguish resources and capabilities that are valuable, rare, hard to imitate, and organizationally embedded from those that do not share these attributes. In other words, the VRIO framework can greatly aid the time-honored SWOT analysis, especially the S and W parts. Because managers cannot pay attention to every capability, they must have some sense of what really matters. A common mistake that managers often make when evaluating their firms’ capabilities is failing to assess them relative to rivals’, thus resulting in a mixed bag of both good and mediocre capabilities. The VRIO framework helps managers make deci- sions on what capabilities to focus on in-house and what to outsource. Capabilities not meeting the VRIO criteria need to be jettisoned or outsourced.

Second, relentless imitation or benchmarking, while important, is not likely to be a successful strategy.50 By the time Elvis Presley died in 1977, there were a little over 100 Elvis impersonators. After his death, the number skyrocketed.51 But obviously none of these imitators achieved any fame remotely close to the star status attained by the King of Rock ‘n’ Roll. Imitators have a tendency to mimic the most visible, the most obvious, and, conse- quently, the least important practices of winning firms (and musicians). At best, follower firms that meticulously replicate every resource possessed by winning firms can hope to attain competitive parity. Firms so well endowed with resources to imitate others may be better off by developing their own unique and innovative capabilities (see the Closing Case).

Third, a competitive advantage that is sustained does not imply that it will last forever, which is not realistic in today’s global competition. In fact, competitive advantage has become shorter in duration.52 All a firm can hope for is a competitive advantage that can be sustained for as long as possible. Over time, all advantages erode.53 The Opening Case noted that each of IBM’s product-related advantages associated with tabulating machines, mainframes, and PCs was sustained for a period of time. But eventually, these advantages disappeared. The lesson for all firms, including current market leaders, is to develop strategic foresight—“over-the-horizon radar” is a good metaphor. Such strategic foresight enables firms to anticipate future needs and move early to identify and develop resources and capabilities for future competition.

Finally, how does the resource-based view answer the four fundamental questions in strategy? The idea that each firm is a unique bundle of resources and capabilities directly addresses the first question: Why do firms differ? The answer to the second question— How do firms behave?—boils down to how they take advantage of their strengths embodied in resources and capabilities and overcome their weaknesses. Third, what

TABLE 3.5 Strategic Implications for Action

& Managers need to build firm strengths based on the VRIO framework. & Relentless imitation or benchmarking, while important, is not likely to be a successful strategy. & Managers need to build up resources and capabilities for future competition.

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determines the scope of the firm? The value chain analysis suggests that the scope of the firm is determined by how a firm performs different value-adding activities relative to rivals. Lastly, what determines firms’ international success and failure? Are winning firms lucky or are they smart? The answer, again, boils down to firm-specific resources and capabilities. Although luck certainly helps, it is difficult to believe that IBM’s 100-year life span is entirely blessed by luck alone (see the Opening Case).

CHAPTER SUMMARY

1. Explain what firm resources and capabilities are • “Resources” and “capabilities” are tangible and intangible assets a firm uses to choose and implement its strategies.

2. Undertake a basic SWOT analysis along the value chain • A value chain consists of a stream of activities from upstream to downstream that add value.

• A SWOT analysis engages managers to ascertain a firm’s strengths and weaknesses on an activity-by-activity basis relative to rivals.

3. Decide whether to keep an activity in-house or outsource it • Outsourcing is defined as turning over all or part of an organizational activity to an outside supplier.

• An activity with a high degree of industry commonality and a high degree of commoditization can be outsourced, and an industry-specific and firm-specific (proprietary) activity is better performed in-house.

• On any given activity, the four choices for managers in terms of modes and locations are (1) offshoring, (2) onshoring, (3) captive sourcing/FDI, and (4) domestic in-house activity.

4. Analyze the value, rarity, imitability, and organizational (VRIO) aspects of resources and capabilities • A VRIO framework suggests that only resources and capabilities that are valuable, rare, inimitable, and organizationally embedded will generate sustainable competitive advantage.

5. Participate in four leading debates concerning the resource-based view • (1) Firm-specific versus industry-specific determinants of performance, (2) static resources versus dynamic capabilities, (3) offshoring versus non-offshoring, and (4) domestic resources versus international capabilities.

6. Draw strategic implications for action • Managers need to build firm strengths based on the VRIO framework. • Relentless imitation or benchmarking, while important, is not likely to be a successful strategy.

• Managers need to build up resources and capabilities for future competition.

C h a p t e r 3 L e v e r a g i n g R e s o u r c e s a n d C a p a b i l i t i e s 83

KEY TERMS

Ambidexterity p. 74

Benchmarking p. 68

Business process outsourcing (BPO) p. 79

Capability p. 65

Captive sourcing p. 70

Causal ambiguity p. 72

Commoditization p. 68

Complementary assets p. 74

Hypercompetition p. 78

Intangible resources and capabilities p. 65

Offshoring p. 70

Onshoring p. 70

Original brand manufacturer (OBM) p. 80

Original design manufacturer (ODM) p. 80

Original equipment manufacturer (OEM) p. 80

Outsourcing p. 69

Resource p. 64

Resource-based view p. 64

Social complexity p. 74

Strategic ambidexterity p. 76

Tangible resources and capabilities p. 65

Value chain p. 67

VRIO framework p. 71

CRITICAL DISCUSSION QUESTIONS

1. Pick any pair of rivals (such as Boeing/Airbus and Cisco/Huawei), and explain why one outperforms another.

2. ON ETHICS: Ethical dilemmas associated with offshoring are plenty. Pick one of these dilemmas and make a case to either defend your firm’s offshoring activities or argue against such activities (assuming you are employed at a firm headquartered in a developed economy).

3. ON ETHICS: Since firms read information posted on competitors’ websites, is it ethical to provide false information on resources and capabilities on corporate websites? Do the benefits outweigh the costs?

TOPICS FOR EXPANDED PROJECTS

1. Conduct a VRIO analysis by ranking your school in terms of the following six dimensions relative to the top three rival schools. If you were the dean with a limited budget, where would you invest precious financial resources to make your school number one among its rivals?

YOUR SCHOOL COMPETITOR 1 COMPETITOR 2 COMPETITOR 3

Perceived reputation

Faculty strength

Student quality

Administrative efficiency

Information systems

Building maintenance

84 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

2. The Opening Case introduces IBM’s 100-year history. Find another firm in any industry and any country that has also survived 100 years. In a short paper, compare and contrast the “secrets” behind the longevity of these two firms.

3. ON ETHICS: Illustrated in Strategy in Action 3.2, strategic ambidexterity in emerging economies requires foreign and domestic firms to be not only strong on market competi- tion, but also strong on building relationships with governments. Many governments in emerging economies are known for being corrupt and bureaucratic. Write a short paper to describe some of the ethical dilemmas involved in building good relationships with such governments. Working in small groups, share and discuss your findings.

E T H I C A L D I L E M M ACLOSING CASE

Emerging Markets: From Copycats to Innovators

The rise of emerging multinationals from emerging economies—think of Acer, BYD, Cemex, Embraer, Fox- conn, Geely, Goldwind, HTC, Lenovo, Mahindra, Suzlon, and Tata—has created tremendous buzz, fear, and disdain around the world. The fear comes from multinationals based in developed economies that are afraid of the dis- ruption brought by this new breed of global competitors. The disdain stems from the characterization of these new multinationals as mere copycats that are good at imitating and bad at innovating.

Although multinationals from developed economies imitate each other all the time, their favorite bragging line is their focus on innovation. In contrast, firms from emerging economies openly confess that they are more interested in learning, which is to say that they are not ashamed of being copycats. In the West, a copycat is defined as one that closely imitates (and even mimics) another, and being a copycat is indicative of a lack of creativity. However, throughout emerging economies, being a copycat is indicative of a conscientious student who intimately learns from the master’s every move. For firms in emerging economies, their masters have been good teachers in teaching basic moves. In search for low-cost solutions, Western firms have brought their

original equipment manufacturers (OEM) up to speed —that was how Acer and Lenovo started. In the scram- ble prior to 2000 to fix the “millennium bug” (other- wise known as the “Y2K” problem), Western IT giants taught Indian firms such as TCS, Infosys, and Wipro a bag of tricks. About a decade ago, the conventional wisdom among Western firms was that firms in emer- ging economies would indeed become formidable low- cost providers of basic products and services, but as long as they remained behind in the innovation game, they would remain permanently behind leading Western firms. However, such conventional wisdom is now increasingly challenged.

Western firms’ emphasis on innovation is consistent with traditional theory, which suggests that a firm’s world-class competitive advantage stems from the inno- vations that it owns—the jargon is “ownership advan- tage.” Owning such innovations allows the GEs, the Siemens, and the Hondas from the Triad to invest globally to teach the rest of the world how to make the stuff. However, a new breed of emerging multinationals has become active global competitors in the absence of such world-class capabilities. For example, in semiconductor wafer factories, Chinese technologies are at least two

C h a p t e r 3 L e v e r a g i n g R e s o u r c e s a n d C a p a b i l i t i e s 85

generations behind those of Japan, South Korea, Taiwan, and the United States. In internal-combustion engines, Chinese automakers are still 10 to 20 years behind global leaders. While Indian firms made great progress in IT/BPO, India’s lackluster infrastructure seems to under- mine the development of more advanced manufacturing and logistics industries.

So what are the core capabilities of the emerging multinationals? While debates rage, one school of thought points to their learning abilities. Learning is prob- ably the most unusual aspect among many emerging multinationals. Instead of the “I-will-tell-you-what-to- do” mentality typical of old-line MNEs from developed economies, many emerging multinationals openly profess that they go abroad to learn. Tata expressed a strong interest in learning how to compete in developed econo- mies with high-end products by acquiring Jaguar and Land Rover. Lenovo aspired to learn how to globalize its organization by purchasing IBM’s PC division. Geely endeavored to learn to enhance automotive safety and branding capabilities by taking over Volvo.

If you have watched any kung-fu movie (the most recent is Kung-Fu Panda), you will remember that a new champion cannot merely be an excellent student—at some point, the student will have to be a master himself by innovating some fancy moves. These moves are not likely to create head-to-head competition against existing mas- ters. Rather, these innovators are likely to leverage their intimate knowledge of the needs and wants of customers in lower-income markets and package it with their learn- ing from world-class competitors. Shown in Table 3.6, the

results may be some “game-changing” or “paradigm- changing” innovations that decisively push advantage to the side of some (while certainly not all) emerging multinationals.

While scholars have long suggested that innovations do not necessarily have to be “high-tech,” the hype about “innovation” centers around cutting-edge pro- ducts and services—many executives and firms day- dream about becoming the next Apple. Emerging multinationals tend to focus on “mid-tech” industries and thrive on their capabilities that unleash novel “affordability innovations.” For old-line multinationals that traditionally develop high-tech and high-price inno- vations in developed economies and then manage to let these innovations “trickle down,” the learning race now focuses on developing new products and services in emerging economies—known as “reverse innovations.” GE’s efforts to develop portable ultrasounds and ECG machines in China and India, respectively, represent some successful examples of these new experiments, which are necessitated by the emergence of innovative new multinationals that even the mighty GE has to take seriously (see Emerging Markets 1.2).

Sources: Based on (1) R. Chittoor, M. Sarkar, S. Ray, & P. Aulakh, 2009, Third World copycats to emerging multinationals, Organization Science, 20: 187–205; (2) V. Govindarajan & R. Ramamurti, 2011, Reverse innovation, emerging markets, and global strategy, Global Strategy Journal, 1: 191–205; (3) Y. Luo, J. Sun, & S. Wang, 2011, Emerging economy copycats, Academy of

TABLE 3.6 New Innovations from Emerging Multinationals

AREAS OF INNOVATION EXAMPLES

Dramatic cost and price reductions that open the vast potential of base-of-the-pyramid markets.

The Tata Nano car, priced at about $2,500, is the world’s cheapest mass-produced car.

Leapfrog to latest technologies due to their lack of financial and psychological attachments to legacy technologies.

China’s BYD, a battery maker, has little legacy investments in the internal-combustion engine. It is now a leading player in developing electric cars.

Frugal innovations that may have a ready market among poor people in developed economies.

Microfinance, pioneered in Bangladesh, not only revolutionizes entrepreneurial financing in the developing world, but works for the inner-city poor in developed economies.

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NOTES

Management Perspectives, May: 37–56; (4) J. Mathews, 2006, Dragon multinationals as new features of globaliza- tion in the 21st century, Asia Pacific Journal of Manage- ment, 23: 5–27; (5) M. W. Peng, 2012, The global strategy of emerging multinationals from China, Global Strategy Journal, 2: 97–107; (6) M. W. Peng, R. Bhagat, & S. Chang, 2010, Asia and global business, Journal of Inter- national Business Studies, 41: 373–376; (7) O. Shenkar, 2010, Copycats, Boston: Harvard Business School Press; (8) S. Sun, M. W. Peng, B. Ren, & D. Yan, 2012, A compara- tive ownership advantage framework for cross-border M&As, Journal of World Business, 47: 4–16.

C A S E D I S C U S S I O N Q U E S T I O N S

1. What are the core resources and capabilities of emerging multinationals from emerging economies?

2. What are the core resources and capabilities of most multinationals from developed economies?

3. ON ETHICS: Some of the copycat strategies embraced by emerging multinationals have violated the intellectual property rights of their rivals in developed economies. As a new CEO of an emerging multinational brought from the outside, you have just discovered this issue at your new employer. What are you going to do about it?

[Journal acronyms] AMJ – Academy of Management Journal; AMR – Academy of Management Review; BW – BusinessWeek (before 2010) or Bloomberg Businessweek (since 2010); HBR – Harvard Business Review; JIBS – Journal of International Business Studies; JIM – Journal of International Management; JM – Journal of Manage- ment; JMS – Journal of Management Studies; JWB – Journal of World Business; MIR – Management Interna- tional Review; OSc – Organization Science; SMJ – Strategic Management Journal

1. J. Barney, 1991, Firm resources and sustained compe- titive advantage, JM, 17: 99–120; M. W. Peng, 2001, The resource-based view and international business, JM, 27: 803–829.

2. A. Cuervo-Cazurra & L. Dau, 2002, Promarket reforms and firm profitability in developing countries, AMJ, 52: 1348–1368; D. Sirmon, M. Hitt, J. Arregle, & J. Camp- bell, 2010, The dynamic interplay of capability strengths and weaknesses, SMJ, 31: 1386–1409.

3. S. Newbert, 2002, Empirical research on the resource- based view of the firm, SMJ, 28: 121–146; D. Sirmon, M. Hitt, & R. D. Ireland, 2007, Managing firm resources in dynamic environments to create value, AMR, 32: 273–292.

4. A. Goerzen & P. Beamish, 2002, The Penrose effect, MIR, 47: 221–239; J. Steen & P. Liesch, 2007, A note on Penrosian growth, resource bundles, and the

Uppsala model of internationalization, MIR, 47: 193–206.

5. J. Barney, 2001, Is the resource-based view a useful perspective for strategic management research? (p. 54), AMR, 26: 41–56.

6. G. Schreyogg &M. Kliesch-Eberl, 2002, How dynamic can organizational capabilities be?SMJ, 28: 913–933;D. Sirmon & M. Hitt, 2009, Contingencies within dynamic man- agerial capabilities, SMJ, 30: 1375–1394; D. Teece, 2007, Explicating dynamic capabilities, SMJ, 28: 1319–1350.

7. C. Helfat & S. Winter, 2011, Untangling dynamic and operational capabilities, SMJ, 32: 1243–1250.

8. E. Danneels, 2002, The process of technological com- petence leveraging, SMJ, 28: 511–533; A. Phene, K. Fladmoe-Lindquist, & L. Marsh, 2006, Breakthrough innovations in the US biotechnology industry, SMJ, 27: 369–388.

9. A. Carmeli & A. Tishler, 2004, The relationships between intangible organizational elements and orga- nizational performance, SMJ, 25: 1257–1278.

10. G. Davies, R. Chun & M. Kamins, 2010, Reputation gaps and the performance of service organizations, SMJ, 31: 530–546; N. Gardberg & C. Fombrun, 2002, Corporate citizenship, AMR, 31: 329–346; M. Rhee, 2009, Does reputation contribute to reducing organi- zational errors? JMS, 46: 676–702; V. Rindova, T. Pollock, & M. Hayward, 2006, Celebrity firms, AMR, 31: 50–71.

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11. M. Porter, 1985, Competitive Advantage, New York: Free Press.

12. A. Parmigiani, 2002, Why do firms both make and buy? SMJ, 28: 285–311; M. W. Peng, Y. Zhou, & A. York, 2006, Behind make or buy decisions in export strategy, JWB, 41: 289–300.

13. S. Beugelsdijk, T. Pedersen, & B. Petersen, 2009, Is there a trend toward global value chain specialization? JIM, 15: 126–141; K. Coucke & L. Sleuwaegen, 2002, Offshoring as a survival strategy, JIBS, 39: 1261–1277; J. Hatonen & T. Eriksson, 2009, 30+ years of research and practice of outsourcing, JIM, 15: 142–155; P. Jensen, 2009, A learning perspective on the offshoring of advanced services, JIM, 15: 181–193; J. Kedia & D. Mukherjee, 2009, Understanding offshoring, JWB, 44: 250–261; K. Kumar, P. van Fenema, & M. von Gli- now, 2009, Offshoring and the global distribution of work, JIBS, 40: 642–667; S. Mudambi & S. Tallman, 2010, Make, buy, or ally? JMS, 47: 1434–1456; G. Trautmann, L. Bals, & E. Hartmann, 2009, Global sourcing in integrated network structures, JIM, 15: 194–208; C. Weigelt & M. Sarkar, 2012, Performance implications of outsourcing for technological innova- tions, SMJ, 33: 189–216.

14. BW, 2006, The 787 encounters turbulence, June 19: 38–40.

15. S. Lahiri, B. Kedia, & D. Mukherjee, 2012, The impact of management capability on the resource-perfor- mance linkage, JWB, 47: 145–155; R. Mudambi & M. Venzin, 2012, The strategic nexus of offshoring and outsourcing decisions, JMS, 47: 1510–1533; H. Safizadeh, J. Field, & L. Ritzman, 2008, Sourcing practices and boundaries of the firm in the financial services industry, SMJ, 29: 79–91.

16. D. Gregorio, M. Musteen, & D. Thomas, 2002, Off- shore outsourcing as a source of international compe- titiveness of SMEs, JIBS, 40: 969–988; D. Griffith, N. Harmancioglu, & C. Droge, 2009, Governance deci- sions for the offshore outsourcing of new product development in technology intensive markets, JWB, 44: 217–224; C. Grimpe & U. Kaiser, 2010, Balancing internal and external knowledge acquisition, JMS, 47: 1483–1509; M. Kenney, S. Massini, & T. Murtha, 2009, Offshoring administrative and technical work, JIBS, 40: 887–900; A. Lewin, S. Massini, & C. Peeters, 2009, Why are companies offshoring innovation? JIBS, 40: 901–925; Y. Li, Z. Wei, & Y. Liu, 2010 Strategic orientation, knowledge acquisition and firm performance, JMS, 47: 1457–1482.

17. J. Doh, K. Bunyaratavej, & E. Hahn, 2009, Separable but not equal, JIBS, 40: 926–943; J. Hatonen, 2009, Making the locational choice, JIM, 15: 61–76; R. Liu, D. Fails, & B. Scholnick, 2011, Why are different services outsourced to different countries? JIBS, 42: 558–571; M. Demirbag & K. Glaister, 2010, Factors determining offshore location choice for R&D pro- jects, JMS, 47: 1534–1560; S. Zaheer, A. Lamin, & M. Subramani, 2009, Cluster capabilities or ethnic ties? JIBS, 40: 944–968.

18. F. Contractor, V. Kuma, S. Kundu, & T. Pedersen, 2010, Reconceptualizing the firm in a world of out- sourcing and offshoring, JMS, 47: 1417–1433.

19. A. Pande, 2011, How to make onshoring work, HBR, March: 30.

20. D. Levy, 2005, Offshoring in the new global political economy (p. 687), JMS, 42: 685–693.

21. J. Barney, 2002, Gaining and Sustaining Competitive Advantage (pp. 159–174), Upper Saddle River, NJ: Prentice Hall.

22. R. Adner & R. Kapoor, 2010, Value creation innova- tion ecosystems, SMJ, 31: 306–333; F. Bridoux, R. Coeurderoy, & R. Durand, 2011, Heterogenous motives and the collective creation of value, AMR, 36: 711–730; A. Capaldo, 2007, Network structure and innovation, SMJ, 28: 585–608; O. Chatain & P. Zemsky, 2011, Value creation and value capture with frictions, SMJ, 32: 1206–1231; J. Grahovac & D. Miller, 2009, Competitive advantage and perfor- mance, SMJ, 30: 1192–1212; T. Holcomb, M. Holmes, & B. Connelly, 2009, Making the most of what you have, SMJ, 30: 457–485; M. Kunc & J. Morecroft, 2010, Managerial decision making and firm perfor- mance under a resource-based paradigm, SMJ, 31: 1164–1182; V. La, P. Patterson, & C. Styles, 2009, Client-perceived performance and value in profes- sional B2B services, JIBS, 40: 274–300; M. Leiblein & T. Madsen, 2009, Unbundling competitive heteroge- neity, SMJ, 30: 711–735; M. Sun & E. Tse, 2009, The resource-based view of competitive advantage in two- sided markets, JMS, 46: 45–64.

23. D. Sirmon, S. Gove, & M. Hitt, 2008, Resource man- agement in dyadic competitive rivalry, AMJ, 51: 919–935.

24. BW, 2011, Can this IBMer keep Big Blue’s edge? October 31: 31–32.

25. F. Aime, S. Johnson, J. Ridge, & A. Hill, 2010, The routine may be stable but the advantage is not, SMJ, 31: 75–87; D. Tzabbar, 2009, When does scientist

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recruitment affect technological repositioning? AMJ, 52: 873–896.

26. G. Ray, J. Barney, & W. Muhanna, 2004, Capabilities, business processes, and competitive advantage, SMJ, 25: 23–37.

27. A. King, 2007, Disentangling interfirm and intrafirm casual ambiguity, AMR, 32: 156–178; T. Powell, D. Lovallo, & C. Caringal, 2006, Causal ambiguity, man- agement perception, and firm performance, AMR, 31: 175–196.

28. BW, 2011, Can this IBMer keep Big Blue’s edge? 29. S. Jonsson & P. Regner, 2009, Normative barriers to

imitation, SMJ, 30: 517–536; M. Lieberman & S. Asaba, 2006, Why do firms imitate each other? AMR, 31: 366–385; F. Polidoro & P. Toh, 2011, Let- ting rivals come close or warding them off? AMJ, 54: 369–392.

30. A. Lado, N. Boyd, P. Wright & M. Kroll, 2006, Para- dox and theorizing within the resource-based view, AMR, 31: 115–131.

31. M. Chari, S. Devaraj, & P. David, 2007, International diversification and firm performance, JWB, 42: 184–197; S. Ethiraj, N. Ramasubbu, & M. Krishnan, 2012, Does complexity deter customer-focus? SMJ, 33: 137–161; M. Gruber, F. Heinemann, M. Brettel, & S. Hungeling, 2010, Configurations of resources and capabilities and their performance implica- tions, SMJ, 31: 1337–1356; M. Kotabe, R. Parente, & J. Murray, 2007, Antecedents and outcomes of modular production in the Brazilian automobile industry, JIBS, 38: 84–106; R. Ployhart, C. Van Iddekinge, & W. Mackenzie, 2011, Acquiring and developing human capital in service contexts, AMJ, 54: 353–368; R. Sinha & C. Noble, 2008, The adoption of radical manufacturing technologies and firm survival, SMJ, 29: 943–962; K. Srikanth & P. Puranam, 2011, Integrating distributed work, SMJ, 32: 849–875.

32. T. Chi & A. Seth, 2009, A dynamic model of the choice of mode for exploiting complementary capabil- ities, JIBS, 40: 365–387; A. Hess & F. Rothaermel, 2011, When are assets complementary? SMJ, 32: 895–909; N. Stieglitz & K Heine, 2007, Innovations and the role of complementarities in a strategic theory of the firm, SMJ, 28: 1–15.

33. J. Barney, 1997, Gaining and Sustaining Competitive Advantage (p. 155), Reading, MA: Addison-Wesley; J. Jansen, F. Van den Bosch, & H. Volberda, 2005, Managerial potential and related absorptive capacity, AMJ, 48: 999–1015.

34. T. Kostova & K. Roth, 2003, Social capital in multi- national corporations and a micro-macro model of its formation, AMR, 28: 297–317; P. Moran, 2005, Structural vs. relational embeddedness, SMJ, 26: 1129–1151.

35. N. Balasubramanian & M. Lieberman, 2010, Industry learning environments and the heterogeneity of firm performance, SMJ, 31: 390–412; M. Lenox, S. Rockart, & A. Lewin, 2010, Does interdependency affect firm and industry profitability? SMJ, 31: 121–139.

36. J. Hough, 2006, Business segment performance redux, SMJ, 27: 45–61; Y. Spanos, G. Zaralis, & S. Lioukas, 2004, Strategy and industry effects on profitability, SMJ, 25: 139–165.

37. G. McNamara, F. Aime, & P. Vaaler, 2005, Is perfor- mance driven by industry- or firm-specific factors? SMJ, 26: 1075–1081; Y. Tang & F. Liou, 2010, Does firm performance reveal its own causes? SMJ, 31: 39–57.

38. P. Godfrey & C. Hill, 1995, The problem of unobser- vables in strategic management research (p. 530), SMJ, 16: 519–533.

39. O. Williamson, 1999, Strategy research (p. 1093), SMJ, 20: 1087–1108.

40. D. Collis, 1994, How valuable are organizational cap- abilities (p. 151), SMJ, 15: 143–152.

41. B. Wernerfelt, 1984, A resource-based view of the firm (p. 171), SMJ, 5: 171–180.

42. T. Reus, A. Ranft, B. Lamont, & G. Adams, 2009, An interpretive systems view of knowledge investments, AMR, 34: 382–400; A. von Nordenflycht, 2010, What is a professional service firm? AMR, 35: 155–174.

43. S. Berman, J. Down, & C. Hill, 2002, Tacit knowledge as a source of competitive advantage in the National Basketball Association, AMJ, 45: 13–32.

44. K. Eisenhardt & J. Martin, 2000, Dynamic capabilities: What are they? (p. 1113), SMJ, 21: 1105–1121.

45. R. D’Aveni, 1994, Hypercompetition, New York: Free Press. See also E. Chen, R. Katila, R. McDonald, & K. Eisenhardt, 2010, Life in the fast lane, SMJ, 31: 1527–1547; C. Lee, N. Venkatraman, H. Tanriverdi, & B. Iyer, 2010, Complementarity-based hyper- competition in the software industry, SMJ, 31: 1431–1457,

46. T. Moliterno & M. Wiersema, 2007, Firm perfor- mance, rent appropriation, and the strategic resource divestment capability, SMJ, 28: 1065–1087; J. Shamsie, X. Martin, & D. Miller, 2009, In with the old, in with the new, SMJ, 30: 1440–1452.

C h a p t e r 3 L e v e r a g i n g R e s o u r c e s a n d C a p a b i l i t i e s 89

47. R. Javalgi, A. Dixit, & R. Scherer, 2009, Outsourcing to emerging markets, JIM, 15: 156–168; M. Reitzig & S. Wagner, 2010, The hidden cost of outsourcing, SMJ, 31: 1183–1201; S. Swan & B. Allred, 2009, Does “the China Option” influence subsidiary technology sourcing strategy? JIM, 15: 169–180.

48. M. Gottfredson, R. Puryear, & S. Phillips, 2005, Stra- tegic sourcing (p. 132), HBR, February: 132–139.

49. J. Boddewyn, B. Toyne, & Z. Martinez, 2004, The meanings of “international management,” MIR, 44: 195–212.

50. K. Kim & W. Tsai, 2012, Social comparison among competing firms, SMJ, 33: 115–136.

51. D. Burrus, 2011, Flash Foresight (p. 11), New York: HarperCollins.

52. M. Chari & P. David, 2012, Sustaining superior per- formance in an emerging economy, SMJ, 33: 217–229; R. D’Aveni, G. Dagnino, & K. Smith, 2010, The age of temporary advantage, SMJ, 31: 1371–1385.

53. G. Pacheco-de-Almeida, 2010, Erosion, time compres- sion, and self-displacement of leaders in hypercompe- titive environments, SMJ, 31: 1498–1526.

90 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

CHAPTER4

EMPHASIZING INSTITUTIONS, CULTURES, AND ETHICS

KNOWLEDGE OBJECT IVES

After studying this chapter, you should be able to

1. Explain the concept of institutions

2. Understand the two primary ways of exchange transactions that reduce uncertainty

3. Articulate the two propositions underpinning an institution-based view of strategy

4. Appreciate the strategic role of cultures

5. Identify the strategic role of ethics culminating in a strategic response framework

6. Participate in three leading debates concerning institutions, cultures, and ethics

7. Draw strategic implications for action

ot o/ A le xe y St io p

92 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

E T H I C A L D I L E M M A

OPENING CASE

Cut Salaries or Cut Jobs?

As a Japanese expatriate, you are the CEO of Yamakawa Corporation’s US subsidiary. You scratch your head as you face a difficult decision: Cut salaries across the board or cut jobs when confronting a horrific economic downturn with major losses? Headquarters in Osaka has advised that earnings at home are bad, and that you cannot expect headquarters to bail out your operations. Too bad, US government bailouts are only good for US-owned firms and are thus irrelevant for your unit, which is 100% owned by the Japanese parent company.

As a person brought up in a collectivistic culture, you instinctively feel compelled to suggest an across-the- board pay cut for all 1,000 employees in the United States. You feel an ethical obligation to protect the people working for you, but of course you also feel a grave responsibility to ensure the survival of your business. Personally, as the highest-paid US-based employee, you are willing to take the highest percen- tage of a pay cut (you are thinking of 30%). If imple- mented, this plan would call for other executives, who are mostly Americans, to take a 20%–25% pay cut, mid-level managers and professionals a 15%–20% pay cut, and all the rank-and-file employees a 10%–15% pay cut. Indeed, in your previous experience at Yama- kawa in Japan, you did this with positive results among all affected Japanese employees. This time, most execu- tive colleagues in Japan are doing the same. However, since you are now managing US operations, headquar- ters in Osaka, being more globally minded and sensitive, does not want to impose any uniform solutions around the world and asks you to make the call.

A conscientious executive, you have studied all the books on rules, cultures, norms, and ethics—in both Japa- nese and English—that you can find in preparing for this tough decision. You understand that the formal laws in the United States present few barriers to lay-offs. You have seen frequent announcements in the US media about reduction in force (RIF), which is a euphemism for mass

layoffs. You have also noticed that in the recent recession, even “bona-fide” US firms such as AMD, FedEx, HP, and the New York Times have trimmed the base pay for all employees. If there is a time to change the norm and move toward more across-the-board pay cuts in an effort to preserve jobs and avoid RIF, this may be it, according to some US executives quoted in the media.

At the same time, you have also read that some experts note that across-the-board pay cuts are anathema to a performance culture enshrined in the United States. “The last thing you want is for your A players—or people in key strategic positions delivering the most value—to leave because you have mismanaged your compensation sys- tem,” according to Mark Huselid, a Rutgers University professor. You have also read in a Harvard Business Review survey that despite the worst recession, 20% of high- potential players in US firms voluntarily jumped ship between 2008 and 2009, in search of greener pastures elsewhere. Naturally, you worry that should you decide to implement the across-the-board pay cuts, you may lose a lot of American star performers and end up with a bunch of mediocre players who cannot go elsewhere—and you may be stuck with them for a long time even after the economy recovers.

After spending two days reading all the materials you have gathered, you still do not have a clear picture. Instead, you have a big headache. You scratch your head again: How should you proceed?

Sources: This case is fictitious. It was inspired by (1) M. Brannen, 2008, Global talent management and learning for the future, AIB Insights, 8: 8–12; (2) BusinessWeek, 2009, Cutting salaries instead of jobs, June 8: 46–48; (3) BusinessWeek, 2009, Pay cuts made palatable, May 4: 67; (4) N. Carter & C. Silva, 2009, High potentials in the downturn: Sharing the pain? Harvard Business Review, September: 25; (5) Wall Street Journal, 2011, Even hints of layoffs decay morale, September 19, online.wsj.com.

93 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

How are strategic decisions, such as those associated with cutting salariesor jobs in a recession, made? It is evident that the industry-based andresource-based views introduced in the previous two chapters, while certainly insightful, are not enough to answer such a high-stakes question. To a large degree, firm strategies are enabled and constrained by institutions, popularly known as “the rules of the game” in a society. Different countries have different formal rules regarding the termination of employees. Beyond formal rules, there are informal rules governing these practices. When coping with a recession, in many collectivistic countries such as Japan, across-the- board pay cuts tend to be the norm. In many individualistic countries such as the United States, mass layoffs are often the norm. There are different perfor- mance outcomes of these strategic decisions. While across-the-board pay cuts facilitate employee loyalty, they may undermine the morale of star performers. Although mass layoffs keep the star performers, practically everybody else at the firm lives in fear. A workforce living in fear is not likely to show initiative and creativity. Overall, how firms play the game and win (or lose), at least in part, depends on how the rules are made and enforced. Popularized since the 1990s, this institution-based view, covering institutions, cultures, and ethics, has emerged as one of the three leading perspectives on strategy.1 This chapter first introduces the institution-based view. Then we discuss the strategic role of cultures and ethics, followed by a strategic response framework. Debates and implications follow.

Understanding Institutions Definitions Building on the “rules of the game” metaphor, Douglass North, a Nobel laureate in economics, more formally defines institutions as “the humanly devised constraints that structure human interaction.”2 An institutional framework is made up of formal and informal institutions governing individual and firm behavior. These institutions are supported by three “pillars” identified by Richard Scott, a leading sociologist. They are (1) regulatory, (2) normative, and (3) cognitive pillars.3

Shown in Table 4.1, formal institutions include laws, regulations, and rules. Their primary supportive pillar, the regulatory pillar, is the coercive power of governments. For example, while many individuals and companies may pay taxes out of their patriotic duty, a larger number of them pay taxes in fear of the coercive power of the government if they are caught not paying taxes.

On the other hand, informal institutions include norms, cultures, and ethics. The two main supportive pillars are normative and cognitive. The normative pillar refers to how the values, beliefs, and actions of other relevant players—collectively known as norms—influence the behavior of focal individuals and firms.4 The recent norms

institution-based view

A leading perspective of strategy that argues that in addition to industry- and firm-level conditions, firms also need to take into account wider influences from sources such as the state and society when crafting strategy.

institution

Humanly devised constraints that structure human interaction— informally known as the “rules of the game.”

institutional framework

A framework of formal and informal institutions governing individual and firm behavior.

formal institutions

Institutions represented by laws, regulations, and rules.

regulatory pillar

How formal rules, laws, and regulations influence the behavior of individuals and firms.

informal institutions

Institutions represented by norms, cultures, and ethics.

normative pillar

How the values, beliefs, and norms of other relevant players influence the behavior of individuals and firms.

norm

The prevailing practice of relevant players that affect the focal individuals and firms.

94 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

centered on rushing to invest in China and India have prompted many Western firms to imitate each other without a clear understanding of how to make such moves work. Cautious managers resisting such “herding” are often confronted by board members and investors: “Why are we not in China and India?” In other words, “Why don’t you follow the norm?”

Also supporting informal institutions, the cognitive pillar refers to the internalized, taken-for-granted values and beliefs that guide individual and firm behavior.5 For exam- ple, what triggered whistle blowers to report Enron’s wrongdoing was their belief in what was right and wrong. While most employees may not feel comfortable with organizational wrongdoing, the norm is to avoid “rocking the boat.” Essentially, whistle blowers choose to follow their internalized personal beliefs on what is right by overcoming the norm that encourages silence.

What Do Institutions Do? While institutions do many things, their key role, in two words, is to reduce uncertainty.6 By signaling which conduct is legitimate and which is not, institutions constrain the range of acceptable actions. In short, institutions reduce uncertainty, which can be potentially devas- tating.7 Political uncertainty such as terrorist attacks and ethnic riots may render long-range planning obsolete (see Emerging Markets 1.1). Political deadlocks in Washington have made the US government “less stable, less effective, and less predictable,” which led Standard & Poor’s to downgrade its triple A crediting rating to AA+.8 Economic uncertainty such as failure to carry out contractual obligations may result in economic losses. During the Great Recession of 2008–2009, a number of firms, such as Dow Chemical and Trump Holdings, argued that the “unprecedented economic crisis” should let them off the hook.9 Force majeure is a long-standing legal doctrine that excuses firms from living up to the terms of a deal in the event of natural disasters or other calamities. But is the economic crisis “force majeure”? If the argument prevails, critics contend, then every debtor in a country suffering economic crisis can avoid paying debts. While these arguments are debated in court battles, a great deal of economic uncertainty looms on the horizon.

Uncertainty surrounding economic transactions can lead to transaction costs, which are defined as the costs associated with economic transactions—or more broadly, the costs of doing business. Nobel laureate Oliver Williamson refers to frictions in mechanical

TABLE 4.1 Dimensions of Institutions

DEGREE OF FORMALITY EXAMPLES SUPPORTIVE PILLARS

Formal institutions & Laws & Regulations & Rules

& Regulatory (coercive)

Informal institutions & Norms & Cultures & Ethics

& Normative & Cognitive

cognitive pillar

The internalized, taken-for- granted values and beliefs that guide individual and firm behavior.

transaction costs

Costs associated with economic transaction—or more broadly, costs of doing business.

ga ge

Le ar ni ng

C h a p t e r 4 E m p h a s i z i n g I n s t i t u t i o n s , C u l t u r e s , a n d E t h i c s 95

systems: “Do the gears mesh, are the parts lubricated, is there needless slippage or other loss of energy?” He goes on to suggest that transaction costs can be regarded as “the economic counterpart of frictions: Do the parties to exchange operate harmoniously, or are there frequent misunderstandings and conflicts?”10

EMERGING MARKETS 4.1

Managing Uncertainty in Pakistan

Mahummad Azhar Ali, factory manager for National Foods in Karachi, Pakistan, has a set work routine. At dawn he calls his production managers, who live in different parts of this sprawling city of 18 million on the Arabian sea, to find out whether outbreaks of violence have rendered any area dangerous.

If conditions seem especially risky, Ali slips two wallets into his pocket—one real and the other filled with expired credit cards and loose change, ready to hand over if bandits hold him up. He has been held up once. He checks to make sure he isn’t riding in the same car as the day before, usually shunning his company-provided Toyota Corolla (a favorite vehicle for Pakistan’s upper-middle class) for his own less conspicuous Suzuki Cultus hatchback.

Finally, Ali and his driver head out to meet the 15 buses that have picked up employees at different collection points. Once all the buses have assembled at the rendezvous, Ali heads the convoy 50 kilometers from the city center to National Foods’ main plant. When the convoy arrives at 7:45 AM, after a 90-minute ride, the workers line up outside a boundary wall topped with barbed wire and go through a body search as guards armed with shot guns look on. Ali monitors the security check on closed-circuit television from his office. The workday is about to begin. He has been up for more than three hours.

“Anyone else in my position in another country would have half the work I do,” says Ali, 49, who has worked at the company, Pakistan’s largest maker of spices and pickles, for over 25 years. “If I didn’t have to spend so much time figuring all this out, I would be looking at ways to enhance productivity.”

Companies across Pakistan’s industrial heartland are struggling to cope with rising insecurity, incessant power outages, and government corruption and inefficiency.

Pakistan has lost 35,000 civilians in terrorist attacks since 2006. The war on the Taliban has cost $68 billion in destroyed infrastructure, higher security costs, lost foreign investment, and more.

Some companies still manage to grow. At publicly traded National Foods, sales rose 23% to 7.4 million rupees ($81 million) in the fiscal year ended June 30, 2011. In the company’s first year, in 1970, revenue was only 5,000 rupees. “Back then, it was a one-room operation where red chili, coriander, and turmeric were manually ground,” says Shakaib Arif, chief operating officer. “Now we make 60 million packets a year with 2,000 employees.”

Political violence is not National Foods’ worst problem. “The biggest problem by far is energy,” says Arif, 38. Demand for electricity in Pakistan is three times the supply. President Asif Ali Zardari is trying to attract independent power producers to Pakistan and has big plans to build hydroelectric plants. Companies cannot wait. “We have created a mix of power we get from the grid, and what we can generate using our gas and diesel generators,” Ali says. “It costs three times as much to produce the power through generators.”

The country’s lack of security takes its toll. “Every time I stop at a light, I look around me and think a gunman is about to come,” says Arif, who drives in a small car when visiting the Karachi factory. “I’ve already been held up three or four times.” Ali, the factory manager, has his own way of handling the tension. “When I get into the car in the morning I close my eyes and rest. I don’t want to know if any gunman is coming. I let my driver take all the stress.”

Source: Excerpted from Bloomberg Businessweek, 2011, Convoys and patdowns: A day at the office in Pakistan, July 25: 11–13.

96 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

An important source of transaction costs is opportunism, defined as self-interest seeking with guile. Examples include misleading, cheating, and confusing other parties in transactions that will increase transaction costs. In order to reduce such transaction costs, institutional frameworks increase certainty by spelling out the rules of the game so that violations (such as failure to fulfill a contract) can be mitigated with relative ease (such as through formal arbitration—see Emerging Markets 4.2).

EMERGING MARKETS 4.2

Binding International Commercial Arbitration

Avoiding countries with a weak rule of law is typically advised by textbooks. Yet recent textbooks have also called for firms to invest aggressively in emerging economies, and emerging economies are widely known for their weak rule of law. In Brazil, a limitless number of appeals can be undertaken and the oldest active court case dates back to 1911. In Russia, numerous Russian managers and a small number of foreign managers are in jail, thanks to corrupt prosecutors, police, and courts. In India, there is a shortage of judges—just 11 for every million people, compared with 51 in Britain and 107 in the United States. The number of cases pending before India’s courts exceeds 30 million. In China, even when foreign firms win intellectual property cases against domestic firms, many court rulings are simply not enforced.

Prior to the recent interest in investing in emerging economies, which country’s law would govern the contracts had always been a headache for international investors. Between a host country and a home country, the foreign entrant is understandably afraid of using the host country law—in fear of the local firm’s “home court advantage.” This fear is magnified in an emerging economy known for its lack of effective rule of law. On the other hand, using the law of the home country of the foreign entrant may not be allowed by the host country of the investment. Are there any institutional mechanisms that can facilitate international investments while addressing the legitimate concerns of both parties?

In response, binding international commercial arbitration (BICA) has emerged as a solution to this seemingly intractable

problem. BICA is a process whereby two transacting firms agree a priori to come before a neutral third party (arbitrator) should a dispute arise. As an alternative dispute resolution system, BICA is a means to resolve disputes without entering the domestic court system (in either the home or host country)—thereby creating a neutral middle ground between firms. As a result, BICA has been increasingly used.

For example, why has China been able to attract so much foreign direct investment (FDI) in the past three decades? In addition to the usual suspects such as low cost labor and sizable domestic market, an institution- based rationale, which is typically ignored by reports on China-bound FDI, is that Chinese authorities have actively promoted the use of BICA to alleviate foreign entrants’ understandable fear of China’s lack of effective rule of law. Specifically, BICA by Stockholm Chamber of Commerce (SCC, a major international arbitration organization) is especially recommended by the Chinese authorities. A case in point: During 2007 and 2009, when Danone and Wahaha engaged in a series of disputes, it was BICA before the SCC that forced both firms to reach a settlement.

Source: This case was based on (1) Economist, 2006, India: The long arms of the law, July 1: 40; (2) Economist, 2009, Brazil: The self-harming state, November 14: 14–15; (3) Economist, 2011, Putin’s Russia, December 10: 27–30; (4) B. C. Pinkham&M.W. Peng, 2012, Arbitration and cross-border transaction costs, working paper, University of Texas at Dallas.

opportunism

Self-interest seeking with guile.

C h a p t e r 4 E m p h a s i z i n g I n s t i t u t i o n s , C u l t u r e s , a n d E t h i c s 97

Without stable institutional frameworks, transaction costs may become prohibitively high, to the extent that certain transactions simply would not take place. In the absence of credible institutional frameworks that protect investors, investors may choose to put their money abroad. Rich Russians often choose to purchase a soccer club in London or a seaside villa in Cyprus instead of investing in Russia—in other words, the transaction costs for doing business in Russia may be too high.

How Do Institutions Reduce Uncertainty? Throughout the world, two primary kinds of institutions—informal and formal—reduce uncertainty.11 Often called relational contracting, the first kind of economic transaction is known as an informal, relationship-based, personalized exchange. In many parts of the world, there is no need to write an IOU note when you borrow money from your friends. Insisting on such a note, either by you or, worse, by your friends, may be regarded as an insulting lack of trust. While you are committed to paying your friends back, they also believe you will—thus, your transaction is governed by informal norms and cognitive beliefs based on what friendship is about. In case you opportunistically take the money and run, your reputation will be ruined and you will not only lose these friends but also, through their word of mouth, lose other friends who may have been willing to loan you money in the future.

However, in addition to the benefits of friendship, there are costs—remember how much time you have spent with friends and how many gifts you have given them? Plotted graphically (Figure 4.1), initially, at time T1, the costs to engage in relational contracting are high (at point A) and the benefits low (at point B), because parties need to build strong social networks through a time- and resource-consuming process to check each other out (such as going to school together). If relationships stand the test of time, then benefits may outweigh costs. Over time, when the scale and scope of informal transactions

FIGURE 4.1 Informal, Relationship-Based, Personalized Exchange

C os

ts /b

en efi

Time

T1 T2 T3 T4

Costs

Benefits

Costs

Benefits

B E

Source: M. W. Peng (2003), Institutional transitions and strategic choices (p. 279), Academy of Management Review, 28 (2): 275–296.

relational contracting

Contracting based on informal relationships (see also informal, relationship-based, personalized exchange).

informal, relationship- based, personalized exchange

A way of economic exchange based on informal relationships among transaction parties. Also known as relational contracting.

98 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

expand, the costs per transaction move down (from A to C and then E) and benefits move up (from B to C and then D), because the threat of opportunism is limited by the extent to which informal sanctions may be imposed against opportunists if necessary. There is little demand for costly formal third-party enforcement (such as an IOU note scrutinized by lawyers and notarized by governments). Thus, between T2 and T3, you and your friends— and the economy collectively—are likely to benefit from relational contracting.12

Past time T3, however, the costs of such a mode may gradually outweigh its benefits, because “the greater the variety and numbers of exchange, the more complex the kinds of agreements that have to be made, and so the more difficult it is to do so” informally.13

Specifically, there is a limit as to the number and strength of network ties an individual or firm can possess. In other words, how many good friends can each person (or firm) have? Regardless of how many “Facebook friends” you have, nobody can claim to have 100 real good friends. When the informal enforcement regime is weak, trust can be easily exploited and abused. What are you going to do if your (so-called) friends who borrow money from you refuse to pay you back or simply disappear? As a result, the limit of relational contracting is likely to be reached at time T3. Past T4, the costs are likely to gradually outweigh the benefits.

Often termed arm’s-length transaction, the second institutional mode to govern rela- tionships is a formal, rule-based, impersonal exchange with third-party enforcement. As the economy expands, the scale and scope of transactions rise (you want to borrow more money to start up a firm and there are many entrepreneurs like you), calling for the emergence of third-party enforcement through formal market-supporting institutions. Shown in Figure 4.2, the initial costs per transaction are high, because of the high costs of formal institutions. Credit bureaus, courts, jails, police, and lawyers are expensive.

FIGURE 4.2 Formal, Rule-Based, Impersonal Exchange

C os

ts /b

en efi

Time

T1 T2

Benefits

Costs

Source: M. W. Peng (2003), Institutional transitions and strategic choices (p. 280), Academy of Management Review, 28 (2): 275–296.

arm’s-length transactions

Transactions in which parties keep a distance (see also formal, rule- based, impersonal exchange).

formal, rule-based, impersonal exchange

A way of economic exchange based on formal transactions in which parties keep a distance (see also arm’s-length transactions).

C h a p t e r 4 E m p h a s i z i n g I n s t i t u t i o n s , C u l t u r e s , a n d E t h i c s 99

Small villages usually cannot afford (and do not need) them. Over time, however, third- party enforcement is likely to facilitate the widening of markets, because unfamiliar parties, people who are not your friends and who would have been deterred to transact with you before, are now confident enough to trade with you (and others). In other words, with an adequate formal institutional framework, you (or your firm) can now borrow from local banks, out-of-state banks, or even foreign banks. Thus, formal market-supporting institutions facilitate more new entries (such as all the new start-ups you and your fellow entrepreneurs can found and all the banks that provide financing) by lowering transaction costs. Consequently, firms are able to grow and economies to expand.

There is no presumption that formal institutions are inherently better than informal ones, because in many situations the demand for formal institutions is not evident. Both forms complement each other. Relational contracting has an advantage when the size of the economy is limited—imagine a small village where everybody knows each other. Its disadvantage is that it may cause firms to stick with established relationships rather than working with new untried players, thus creating barriers to entry. As transaction complex- ity rises, informal dealings within the group may become difficult—imagine a city or national economy whereby it would be too difficult to impose informal sanctions against opportunists. Arm’s-length transactions, on the other hand, help overcome these barriers, by bringing together formerly distant groups (firms, communities, and even countries) to enjoy the gains from complicated long-distance trade. These rule-based transactions thus become increasingly attractive as more new players enter the game. A global economy simply cannot operate on informal institutions alone.

Overall, interactions between institutions and firms that reduce transaction costs shape economic activity. In addition, institutions are not static.14 Institutional transitions, defined as “fundamental and comprehensive changes introduced to the formal and informal rules of the game that affect organizations as players,”15 are widespread in the world, especially in emerging economies (see Chapter 1). It is evident that managers making strategic choices during such transitions must take into account the nature of institutional frameworks and their transitions, a perspective introduced next.

An Institution-Based View of Business Strategy Overview Historically, much of the strategy literature, as exemplified by the industry-based and resource-based views, does not discuss the specific relationship between strategic choices and institutional frameworks. To be sure, the influence of the “environment” has been noted. However, much existing work has a “task environment” view that focuses on economic variables such as market demand and technological change.

A case in point is Porter’s “diamond” model (Figure 4.3) that argues that competitive advantage of different industries in different nations depends on four factors.16 According to this model, first, firm strategy, structure, and rivalry within one country are essentially the same industry-based view covered in Chapter 2. Second, factor endowments refer to the natural and human resource repertoires. Third, related and supporting industries

Institutional transitions

Fundamental and comprehensive changes introduced to the formal and informal rules of the game that affect organizations as players.

firm strategy, structure, and rivalry

How industry structure and firm strategy interact to affect interfirm rivalry.

factor endowments

The endowments of production factors such as land, water, and people in one country.

related and supporting industries

Industries that are related to and/or support the focal industry.

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provide the foundation upon which key industries can excel. Switzerland’s global excel- lence in pharmaceuticals goes hand in hand with its dye industry. Finally, tough domestic demand propels firms to scale new heights to satisfy such demand. Why is the American movie industry so competitive worldwide? One reason is that American moviegoers demand the very best. Endeavoring to satisfy such a tough domestic crowd, movie studios unleash High School Musical 2 and 3 after High School Musical and Spiderman 2 and 3 after Spiderman—each time packing more excitement to go beyond the previous produc- tion. Overall, the combination of these four factors explains what is behind the compe- titive advantage of certain globally leading industries.

Interesting as the “diamond” model is, it has been criticized for ignoring histories and institutions, such as what is behind firm rivalry.17 Among strategists, Porter is not alone. Given that most research focuses on market economies, a market-based institutional framework has been taken for granted—in fact, no other strategy textbook has devoted a full chapter to institutions like this one.

Such an omission is unfortunate, because strategic choices, such as those made by the Japanese CEO in the US subsidiary (see the Opening Case), are obviously selected within and constrained by institutional frameworks. Today, this insight becomes more important as more firms do business abroad, especially in emerging economies. The striking institutional differences between developed and emerging economies have propelled the institution-based view to the forefront of strategy discussions.18 Shown in Figure 4.4, the

FIGURE 4.3 The Porter Diamond: Determinants of National Competitive Advantage

Firm strategy, structure, and

rivalry

Domestic demand

conditions

Related and supporting industries

Country factor

endowments

domestic demand

Demand for products and services within a domestic economy.

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institution-based view focuses on the dynamic interaction between institutions and firms, and considers strategic choices as the outcome of such interaction. Specifically, strategic choices are not only driven by industry structure and firm-specific resources and cap- abilities emphasized by traditional strategic thinking, but are also a reflection of the formal and informal constraints of a particular institutional framework.19

Overall, it is increasingly acknowledged that institutions are more than background conditions. Instead, “institutions directly determine what arrows a firm has in its quiver as it struggles to formulate and implement strategy and to create competitive advantage.”20

At present, the idea that “institutions matter” is no longer novel or controversial. What needs to be better understood is how they matter.21

Two Core Propositions The institution-based view suggests two core propositions on how institutions matter (Table 4.2). First, managers and firms rationally make strategic choices within institu- tional constraints.22 Emerging Markets 4.3 illustrates that one of the main institution- based reasons for emerging multinationals from BRIC to invest overseas is to avoid the bureaucratic, unfriendly, and in some cases predatory policies of their domestic

FIGURE 4.4 Institutions, Firms, and Strategic Choices

Firms

Strategic Choices

Institutions Dynamic

Interaction

informal constraints

Formal and Industry conditions and firm-specific

resources and capabilities

Sources: Adapted from (1) M. W. Peng, 2000, Business Strategies in Transition Economies (p. 45), Thousand Oaks, CA: Sage; (2) M. W. Peng, 2002, Towards an institution-based view of business strategy (p. 253), Asia Pacific Journal of Management, 19 (2): 251–267.

TABLE 4.2 Two Core Propositions of the Institution-Based View

Proposition 1 Managers and firms rationally pursue their interests and make choices within the formal and informal constraints in a given institutional framework.

Proposition 2 While formal and informal institutions combine to govern firm behavior, in situations where formal constraints are unclear or fail, informal constraints will play a larger role in reducing uncertainty and providing constancy to managers and firms.

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EMERGING MARKETS 4.3

The Institution-Based Motivation Behind Emerging Multinationals

The outward foreign direct investment (OFDI) made by multinationals from emerging economies, especially those from China, has grabbed sensational headlines, such as “China buys the world” (Fortune, October 26, 2009) and “Buying up the world” (Economist, November 11, 2010). The unmistakable tone is that due to the strengths of the Chinese economy, these new multinationals are likely to become strong global contenders and some may become “threats”—resulting in another Economist cover story: “America’s fear of China” (May 19, 2007). Further digging by scholars reveals that such media sensations are not substantiated by facts on the ground. Two points can be made. First, even among emerging economies, China is not the largest generator of OFDI. So what emerging economy has the largest OFDI stock? Not Brazil, not India. Surprise—it is Russia (!). Yet, since 1991, no Western media has ever bothered to report any “Russia threat,” despite Russia’s much larger OFDI stock (2.1% of world total) versus China’s (1.5% of world total). Overall, total Chinese OFDI stock is only 6% of the US OFDI stock. If Chinese multinationals could indeed “buy up” the world with such a tiny sum, then do your own math: US firms would have bought up the world 16 times. The upshot? China’s OFDI, while emerging and increasing, certainly does not deserve the media hoopla that does not make a lot of sense.

Second, the actual data reveal that a lot of OFDI made by the emerging multinationals not only from China, but also from Brazil, Russia, and India is a reflection of the institutional weaknesses of these economies. A look at the geographic distributions of such OFDI tells why. The number one country receiving Russia’s OFDI is tiny Cyprus. Brazil’s multinationals love to invest in the British Virgin Islands (BVI). India’s OFDI has flooded Mauritius. A full two-thirds of China’s OFDI has gone to Hong Kong, and the second largest recipient of China’s OFDI is the BVI. How can these relatively small economies known as tax havens absorb so much OFDI from BRIC? The answer: They do not. A substantial chunk of such OFDI is re-invested back to BRIC—this is known as capital round-tripping. The number one foreign investors (by stock) in Brazil, Russia,

India, and China are the BVI, Cyprus, Mauritius, and Hong Kong, respectively. In China, the BVI has the second largest FDI stock. In other words, instead of using the money overseas to “threaten” host economies, a substantial chunk of such money goes back home to BRIC. The “real” OFDI that is used to acquire local outfits, build factories, and compete with local rivals is much smaller than the total OFDI dollar numbers suggest. Why would managers and firms in BRIC go through such arduous trouble to engage in capital round-tripping? A short answer is that their domestic institutions to protect private property and facilitate investments are weak. In Brazil and India, bureaucratic regulations and heavy taxations on domestic earnings have created incentives for firms to invest overseas. In Russia and China, in addition to the above, managers and firms worry about political instability, which may result in the expropriation of their assets. Chinese regulations are more friendly to foreign investors than to domestic firms, especially domestic private firms. In response, a large number of managers and firms in Russia and China have made a rational decision by turning their operations at home into “subsidiaries” of foreign firms registered in the likes of Cyprus and the BVI. Overall, applying some critical thinking

M ap

Re so ur ce s

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governments. Why would managers from these firms embrace the challenges of going global while they could have been relatively comfortable and stayed home—after all, their home economies have been growing a lot faster than the rest of the world? The answer has to be that these managers have made a rational decision because the institution-based hassles at home outweigh the challenges overseas.

In another example, hundreds of firms and thousands of individuals around the world are involved with counterfeiting. Close to 10% of all world trade is reportedly in counter- feits. Remember that this is not slavery and that everyone involved has voluntarily entered this business. However, no high school graduate anywhere in the world, when filling out a form to determine what would be a desirable career to pursue after graduation, has ever declared an interest in joining counterfeiting. So what happened? Why are so many individuals and firms involved? The key is to realize that managers and entrepreneurs who make such a strategic choice are not amoral monsters but just ordinary people. They have made a rational decision (from their standpoint at least) given an institutional environment of weak intellectual protection and the availability of moderately capable manufacturing and distribution skills. Of course, to suggest that a strategy of counter- feiting may be rational does not deny the fact that it is unethical and illegal. However, without an understanding of its institutional basis, it is difficult to devise effective countermeasures.

Obviously, nobody has perfect rationality—possessing all the knowledge under all circumstances. So Proposition 1 specifically deals with bounded rationality, which refers to the necessity of making rational decisions in the absence of complete information.23

Without prior experience, managers from emerging multinationals from BRIC getting their feet wet overseas and individuals getting involved in counterfeiting do not know exactly what they are getting into. So emerging multinationals often burn cash overseas and counterfeiters sometimes land in jail, which are examples of these decision makers’ bounded rationality.

The second proposition is that while formal and informal institutions combine to govern firm behavior, in situations where formal constraints fail, informal constraints will play a larger role in reducing uncertainty and providing constancy to managers and firms. For example, when the formal institutional regime collapsed with the disappearance of the former Soviet Union, it was largely the informal constraints, based on personal relation- ships and connections (called blat in Russian) among managers and officials, that have facilitated the growth of many entrepreneurial firms.24

Many observers have the impression that relying on informal connections is a strategy only relevant to firms in emerging economies and that firms in developed economies only

skills and probing deeper into institution-based reasoning behind OFDI from emerging economies is so much better and more insightful than blindly believing in the media hoopla.

Sources: Based on (1) Economist, 2011, Trouble islands, October 15: 68–69; (2) J. Hines, 2010, Treasure islands, Journal of Economic Perspectives, 24: 103–126; (3) A. Kuznetsov, 2011,

Outward FDI from Russia and its policy context, update 2011, Columbia FDI Profiles, August 2; (4) M. W. Peng, 2012, Why foreign direct investments from China are not a threat,Harvard Business Review, February (blogs.hbr.org); (5) M. W. Peng, S. Sun, & D. Blevins, 2011, The social responsibility of international business scholars, Multinational Business Review, 19: 106–119; (6) United Nations, 2011, World Investment Report 2011, New York: UNCTAD.

bounded rationality

The necessity of making rational decisions in the absence of complete information.

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pursue “market-based” strategies. This is far from the truth. Even in developed economies, formal rules only make up a small (although important) part of institutional constraints, and informal constraints are pervasive. Just as firms compete in product markets, firms also fiercely compete in the political marketplace characterized by informal ties.25 The best-connected firms can reap huge benefits. For every dollar on lobbying spent by US defense firms, they reap $28, on average, in earmarks from Uncle Sam, and more than 20 firms grab $100 or more.26 Such enviable return on investment (ROI) compares favorably to capital expenditure (where $1 spent brings in $17 in revenues) or direct marketing (where $1 spent barely generates $5 in sales). Basically, if a firm cannot be a cost, differentiation, or focus leader, it may still beat the competition on other grounds— namely, the nonmarket political environment featuring informal relationships.27 To use the resource-based language, political assets may be very valuable, rare, and hard to imitate. Note that lobbying is not necessarily “corruption”—just a demonstration of certain firms’ mastery of the rules of the game.

The Strategic Role of Cultures The Definition of Culture Although hundreds of definitions of culture have appeared, we will use the one proposed by the world’s foremost cross-cultural expert, Geert Hofstede, a Dutch professor. He defines culture as “the collective programming of the mind which distinguishes the members of one group or category of people from another.”28 Although most international business text- books and trade books talk about culture (often presenting numerous details such as how to present business cards in Japan and how to drink vodka in Russia), virtually all strategy books ignore culture because culture is regarded as “too soft.” Such a belief is narrow- minded in today’s global economy. Here we will focus on the strategic role of culture.

Before proceeding, it is important to make two points to minimize confusion. First, although it is customary to talk about American culture or Brazilian culture, there is no strict one-to-one correspondence between cultures and nation-states. Within the United States, there are numerous sub-cultures such as the Asian American and African Amer- ican cultures. The same is true for multiethnic countries such as Belgium, Brazil, China, India, Indonesia, Russia, South Africa, and Switzerland. Second, there are many layers of culture, such as regional, ethnic, and religious cultures. Within a firm, one will find a specific organizational culture (such as the Toyota culture). Having acknowledged the validity of these two points, we will follow Hofstede by using the term “culture” when discussing national culture—unless otherwise noted. While this is a matter of expediency, it is also a reflection of the institutional realities of the world, which consists of over 200 nation-states imposing different institutional frameworks.

The Five Dimensions of Culture While many ways exist to identify dimensions of culture, the work of Hofstede has become by far the most influential. He and his colleagues have proposed five dimensions (Figure 4.5). First, power distance is the extent to which less powerful members within a country expect and accept that power is distributed unequally. For example, in high power distance Brazil, the richest 10% of the population receives approximately 50% of the

culture

The collective programming of the mind that distinguishes the members of one group or category of people from another.

power distance

The degree of social inequality.

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national income and everybody accepts this as “the way it is.” In low power distance Sweden, the richest 10% only gets 22% of the national income. In the United States, subordinates often address their bosses on a first-name basis, a reflection of a relatively low power distance. While this boss, Mary or Joe, still has the power to fire you, the distance appears to be shorter than if you have to address this person as Mrs. Y or Dr. Z. In low power distance American universities, all faculty members, including the lowest-ranked assistant professors, are commonly addressed as “Professor A.” In high power distance British universities, only full professors are allowed to be called “Professor B.” Everybody else is called “Dr. C” or “Ms. D” (if D does not have a PhD). German universities are perhaps more extreme: Full professors with PhDs need to be honored as “Prof. Dr. X.”

Second, individualism refers to the perspective that the identity of an individual is fundamentally his or her own, whereas collectivism refers to the idea that the identity of an individual is primarily based on the identity of his or her collective group (such as family, village, or company). In individualistic societies, ties between individuals are relatively loose and individual achievement and freedom are highly valued. In contrast, in collectivist societies, ties between individuals are relatively close and collective accom- plishments are often sought after. This difference in part explains why mass layoffs are widely used in the United States, whereas across-the-board pay cuts are frequently undertaken in Japan (see the Opening Case).

Third, the masculinity versus femininity dimension refers to sex role differentiation. In every traditional society, men tend to have occupations that reward assertiveness, such as

FIGURE 4.5 Examples of Hofstede Dimensions of Culture

65 118

To determine the cultural characteristics of a country, compare the number and vertical distance (higher means more) of that country on a particular cultural dimension (labeled on the right side of the exhibit) with those of other countries. For example, with a score of 80, Japan has the second highest long-term orientation. It is exceeded only by China, which has a score of 118. By contrast, with a score of 0, Pakistan has the weakest long-term orientation.

95 74

48 33

31 40

Brazil China Germany Japan Pakistan Russia Singapore Sweden USA

Long-term Orientation

Uncertainty Avoidance

Masculinity

Individualism

Power Distance

individualism

The perspective that the identity of an individual is most fundamentally based on his or her own individual attributes (rather than the attributes of a group).

collectivism

The perspective that the identity of an individual is most fundamentally based on the identity of his or her collective group (such as family, village, or company).

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politicians, soldiers, and executives. Women, on the other hand, usually work in caring professions such as teachers and nurses in addition to being homemakers. High mascu- linity societies (led by Japan) continue to maintain such a sharp role differentiation along gender lines. In low masculinity societies (led by Sweden), women increasingly become politicians, scientists, and soldiers, and men frequently assume the role of nurses, teachers, and househusbands.29

Fourth, uncertainty avoidance refers to the extent to which members in different cultures accept ambiguous situations and tolerate uncertainty. Members of high uncer- tainty avoidance cultures (led by Greece) place a premium on job security, career patterns, and retirement benefits. They also tend to resist change, which, by definition, is uncertain. Low uncertainty avoidance cultures (led by Singapore) are characterized by a greater willingness to take risk and less resistance to change.

Finally, long-term orientation emphasizes perseverance and savings for future better- ment. China, which has the world’s longest continuous written history of approximately 5,000 years and the highest contemporary savings rate, leads the pack. On the other hand, members of short-term orientation societies (led by Pakistan) prefer quick results and instant gratification.

Overall, Hofstede’s dimensions are interesting and informative. They are also largely supported by subsequent work.30 It is important to note that Hofstede’s dimensions are not perfect and have attracted some criticisms.31 However, it is fair to suggest that these dimensions represent a starting point for us in trying to figure out the role of culture in global business.

Cultures and Strategic Choices A great deal of strategic choices is consistent with Hofstede’s cultural dimensions. For example, solicitation of subordinate feedback and participation, widely practiced in low power distance Western countries, is regarded as a sign of weak leadership and low integrity in high power distance countries.32

Individualism and collectivism also affect strategic choices. Because entrepreneurs are usually willing to take more risk, individualistic societies tend to foster relatively higher levels of entrepreneurship, whereas collectivism may result in relatively lower levels of entrepreneurship.

Likewise, masculinity and femininity have strategic implications. The stereotypical manager in masculine societies is “assertive, decisive, and ‘aggressive’ (only in masculine societies does this word carry a positive connotation),” whereas the stylized manager in feminine societies is “less visible, intuitive rather than decisive, and accustomed to seeking consensus.”33 At the economy level, masculine countries (such as Japan) may have an advantage in mass manufacturing that focuses on efficiency and speed. Feminine coun- tries (such as Denmark) may have an advantage in small-scale customized manufacturing.

Uncertainty avoidance also has a bearing on strategic behavior. Managers in low uncertainty avoidance countries (such as Great Britain) rely more on experience and training, whereas managers in high uncertainty avoidance countries (such as China) rely more on rules and procedures.

In addition, cultures with a long-term orientation are likely to nurture firms with long horizons. Japanese and Korean firms are known to be willing to forego short-term profits and focus more on market share, which, in the long term, may translate into financial gains. In comparison, Western firms focus on relatively short-term profits.

masculinity

A relatively strong form of societal-level sex role dif- ferentiation whereby men tend to have occupations that reward assertiveness and women tend to work in caring professions.

femininity

A relatively weak form of societal-level sex role dif- ferentiation whereby more women occupy positions that reward assertiveness and more men work in caring professions.

uncertainty avoidance

The extent to which members in different cultures accept ambiguous situations and tolerate uncertainty.

long-term orientation

A perspective that emphasizes perseverance and savings for future betterment.

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Overall, there is strong evidence pointing out the strategic importance of culture.34

Sensitivity to cultural differences can not only help strategists better understand what is going on in other parts of the world, but can also avoid strategic blunders (see Table 4.3 for examples). In addition, while “what is different” cross-culturally can be interesting, it can also be unethical and illegal—all depending on the institutional frameworks in which firms are embedded. Thus, it is imperative that current and would-be strategists be aware of the importance of business ethics, as introduced next.

The Strategic Role of Ethics The Definition and Impact of Ethics Ethics refers to the norms, principles, and standards of conduct governing individual and firm behavior. Ethics is not only an important part of informal institutions, but is also deeply reflected in formal laws and regulations. Recent corporate scandals have pushed ethics to the forefront of global strategy discussions, with numerous firms introducing a code of conduct—a set of guide- lines for making ethical decisions. There is a debate on what motivates firms to become ethical.

• A negative view suggests that some firms may simply jump onto the ethics “bandwagon” under social pressures to appear more legitimate without necessarily becoming more ethical.

• A positive view maintains that some (although not all) firms may be self-motivated to “do it right” regardless of social pressures.

• An instrumental view believes that good ethics may represent a useful instrument to help make good profits.

TABLE 4.3 Some Cross-Cultural Blunders

& Electrolux, a major European home appliance maker, advertised its powerful vacuum machines in the United States using the slogan “Nothing sucks like an Electrolux!”

& A Japanese subsidiary CEO in New York, at a staff meeting consisting of all American employees, informed everyone of the firm’s grave financial losses and passed on a request from headquarters in Japan that everyone redouble efforts. The staff immediately redoubled their efforts—by sending their resumes out to other employers.

& In Malaysia, an American expatriate was introduced to an important potential client he thought was named “Roger.” He proceeded to call this person “Rog.” Unfortunately, this person was a “Rajah,” which is an important title of nobility in high power distance Malaysia. Upset, the Rajah walked away from the deal.

& In the United States, some Brazilian and Japanese expatriates treated American secretaries as personal servants, insisting that they serve coffee.

& Shortly after arrival in the US subsidiary, a British expatriate angered minority employees by firing several black middle managers (including the head of the affirmative action program). He was later sued by these employees.

Sources: Based on text in (1) P. Dowling & D. Welch, 2005, International Human Resource Management, 4th ed., Cincinnati: South-Western Cengage Learning; (2) M. Gannon, 2008, Paradoxes of Culture and Globalization, Thousand Oaks, CA: Sage; (3) D. Ricks, 1999, Blunders in International Business, 3rd ed., Oxford, UK: Blackwell.

ethics

The norms, principles, and standards of conduct governing individual and firm behavior.

code of conduct (code of ethics)

Written policies and standards for corporate conduct and ethics.

108 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

All sides of the debate, however, agree that it is increasingly clear that ethics can make or break a firm. Firms with an ethical, trustworthy reputation will not only earn kudos, but may gain significant competitive advantage by attracting more investors, customers, and employees. Perhaps the best way to appreciate the strategic value of ethics is to examine what happens after some crisis. As a “reservoir of goodwill,” the value of an ethical reputation can be magnified during crisis. After the November 26, 2008, terrorist attacks on the Taj Mahal Palace Hotel in Mumbai that killed 31 people (including 20 guests), the hotel received only praise. Why? The surviving guests were overwhelmed by employees’ dedication to duty and their desire to protect guests in the face of terrorist attacks. Eleven employees laid down their lives while helping between 1,200 and 1,500 guests safely escape (see Emerging Markets 3.1). Paradoxically, catastrophes may allow more ethical firms such as the Taj that are renowned for their integrity and customer service to shine. The upshot seems to be that ethics pays (see Figure 4.6).

Managing Ethics Overseas Managing ethics overseas is challenging, because what is ethical in one country may be unethical elsewhere.35 Think about the headache that the Japanese expatriate experienced in our Opening Case. Facing such differences, how can managers prepare themselves?

FIGURE 4.6 Integrity Can Command a Premium

Source: Reprinted with permission from Nick Hobart.

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Two schools of thought exist.36 First, ethical relativism refers to an extension of the cliché, “When in Rome, do as the Romans do.” If women in Muslim countries are discriminated against, so what? Likewise, if industry rivals in China can fix prices, who cares? Isn’t that what “Romans” do in “Rome”? Second, ethical imperialism refers to the absolute belief that “There is only one set of Ethics (with the big E), and we have it.” Americans are especially renowned for believing that their ethical values should be applied universally. For example, since sexual discrimination and price fixing are wrong in the United States, they must be wrong every- where else. In practice, however, neither of these schools of thought is realistic. At the extreme, ethical relativism would have to accept any local practice, whereas ethical imperi- alism may cause resentment and backlash among locals.

Three “middle-of-the-road” guiding principles have been proposed by Thomas Donaldson, a business ethicist (Table 4.4). First, respect for human dignity and basic rights (such as those concerning health, safety, and the needs for education instead of working at a young age) should determine the absolute minimal ethical thresholds for all operations around the world.

Second, respect for local traditions suggests cultural sensitivity. If gifts are banned, foreign firms can forget about doing business in China and Japan. While hiring employ- ees’ children and relatives instead of more qualified applicants is illegal according to US equal opportunity laws, Indian companies routinely practice such nepotism, which would strengthen employee loyalty. What should US companies setting up subsidiaries in India do? Donaldson advises that such nepotism is not necessarily wrong—at least in India.

Finally, respect for institutional context calls for a careful understanding of local institutions. Codes of conduct banning bribery are not very useful unless accompanied by guidelines for the scale of appropriate gift giving/receiving. Citigroup allows employees to accept noncash gifts whose nominal value is less than $100. The Economist lets its journalists accept any noncash gift that can be consumed in a single day—thus, a bottle of wine is acceptable but a case of wine is not. Overall, these three principles, although far from perfect, can help managers improve the quality of their decisions.

Ethics and Corruption Ethics helps to combat corruption, often defined as the abuse of public power for private benefits usually in the form of bribery (in cash or in kind).37 Corruption distorts the basis for competition that should be based on products and services, thus causing misallocation of resources and slowing economic development.38 Some evidence reveals that corruption

TABLE 4.4 Managing Ethics Overseas: Three “Middle-of-the-Road” Approaches

& Respect for human dignity and basic rights & Respect for local traditions & Respect for institutional context

Sources: Based on text in (1) T. Donaldson, 1996, Values in tension: Ethics away from home, Harvard Business Review, September-October: 4–11; (2) J. Weiss, 2006, Business Ethics, 4th ed., Cincinnati: South-Western Cengage Learning.

ethical relativism

The relative thinking that ethical standards vary significantly around the world and that there are no universally agreed upon ethical and unethical behaviors.

ethical imperialism

The imperialistic thinking that one’s own ethical standards should be applied universally around the world.

corruption

The abuse of public power for private benefit usually in the form of bribery.

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discourages foreign direct investment (FDI).39 If the level of corruption in Singapore (very low) increases to the level in Mexico (in the middle range), it reportedly would have the same negative effect on FDI inflows as raising the tax rate by 50%.40

However, there are exceptions. China is an obvious case, where corruption is often reported. Another exception seems to be Indonesia, whose former president Suharto was known as “Mr. Ten Percent,” which refers to the well-known (and transparent!) amount of bribes foreign firms were expected to pay him or members of his family. Why are these two countries popular FDI destinations? Two reasons emerge. First, the vast potential of these two economies may outweigh the drawbacks of corruption. Second, overseas Chinese (mainly from Hong Kong and Taiwan) and Japanese firms are leading investors in mainland China and Indonesia, respectively. While Hong Kong, Taiwan, and Japan may be relatively “cleaner,” they are not among the “cleanest” countries. It is possible that “acquiring skills in managing corruption [at home] helps develop a certain competitive advantage [in managing corruption overseas].”41

If that is indeed the case, it is not surprising that many US firms complain that they are unfairly restricted by the Foreign Corrupt Practices Act (FCPA), a law enacted in 1977 that bans bribery to foreign officials. They also point out that overseas bribery expenses were often tax-deductible (!) in many EU countries such as Austria, France, Germany, and the Netherlands—at least until the late 1990s. However, even with the FCPA, there is no evidence that US firms are inherently more ethical than others. The FCPA itself was triggered by investigations in the 1970s of many corrupt US firms. Even the FCPA makes exceptions for small “grease” payments to get goods through customs abroad. Most alarmingly, a World Bank study reports that despite over two decades of FCPA enforce- ment, US firms actually “exhibit systematically higher levels of corruption” than other OECD firms (original italics).42

Overall, the FCPA can be regarded as an institutional weapon in the fight against corruption.43 Recall that every institution has three supportive pillars: regulatory, norma- tive, and cognitive (Table 4.1). Despite the FCPA’s formal regulatory “teeth,” for a long time, there was neither a normative pillar nor a cognitive pillar. The norms among other OECD firms used to be to pay bribes first and get a tax deduction later (!)—a clear sign of ethical relativism. Only in 1997 did the OECD Convention on Combating Bribery of Foreign Public Officials commit all 30 member countries (essentially all developed economies) to criminalize bribery. It went into force in 1999. A more ambitious campaign is the UN Convention against Corruption, signed by 106 countries in 2003 and activated in 2005. If every country criminalizes bribery and every investor resists corruption, their combined power will eradicate it. However, this will not happen unless FCPA-type legislation is institutionalized and enforced in every country.

A Strategic Response Framework for Ethical Challenges At its core, the institution-based view focuses on how certain strategic choices, under institutional influences, are diffused from a few firms to many.44 In other words, the attention is on how certain practices (such as from paying bribes to refusing to pay) become institutionalized. Such forces of institutionalization are driven by a combination

Foreign Corrupt Practices Act (FCPA)

A US law enacted in 1977 that bans bribery of foreign officials.

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of regulatory, normative, and cognitive pillars. How firms strategically respond to ethical challenges, thus, leads to a strategic response framework. It features four strategic choices: (1) reactive, (2) defensive, (3) accommodative, and (4) proactive strategies (Table 4.5).

A reactive strategy is passive. Even when problems arise, firms do not feel compelled to act, and denying is usually the first line of defense. The need to take necessary action is neither internalized through cognitive beliefs, nor becoming any norm in practice. That only leaves formal regulatory pressures to compel firms to act. For example, Ford marketed the Pinto car in the early 1970s, knowing that its gas tank had a fatal design flaw that could make the car susceptible to exploding in rear-end collisions. Citing high costs, Ford decided not to add an $11 per car improvement. Sure enough, accidents happened and people were killed and burned in Pintos. Still, for several years Ford refused to recall the Pinto, and more lives were lost. Only in 1978, under intense formal pressures from the government and court cases and informal pressures from the media and consumer groups, did Ford belatedly recall all 1.5 million Pintos.45

A defensive strategy focuses on regulatory compliance. In the absence of regulatory pressures, firms often fight informal pressures coming from the media and activists. In the 1990s, Nike was criticized for running “sweatshops,” while these incidents took place in its contractors’ factories in Indonesia and Vietnam. Although Nike did not own these factories, its initial statement, “We don’t make shoes,” failed to convey any ethical responsibility. Only when several senators began to suggest legislative solutions did Nike become more serious. Similarly, Facebook defended its behavior when the Federal Trade Commission found that it engaged in unethical (and potentially illegal) conduct (see the Closing Case).

An accommodative strategy features emerging organizational norms to accept respon- sibility and a set of increasingly internalized cognitive beliefs and values toward making certain changes. These normative and cognitive values may be shared by a number of firms, thus leading to new industry norms. In other words, it becomes legitimate to accept a higher level of ethical and moral responsibility beyond what is minimally required legally. In this fashion, Nike became more accommodative toward the late 1990s.

In another example, in 2000, when Ford Explorer vehicles equipped with Firestone tires had a large number of fatal rollover accidents, Ford evidently took the painful lesson from its Pinto fire fiasco in the 1970s. It aggressively initiated a speedy recall, launched a

TABLE 4.5 Strategic Responses to Ethical Challenges

STRATEGIC RESPONSES STRATEGIC BEHAVIORS EXAMPLES IN THE TEXT

Reactive Deny responsibility; do less than required Ford Pinto fire (the 1970s)

Defensive Admit responsibility but fight it; do the least that is required

Nike (the 1990s), Facebook (2011)

Accommodative Accept responsibility; do all that is required Ford Explorer rollovers (the 2000s)

Proactive Anticipate responsibility; do more than is required BMW (the 1990s)

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media campaign featuring its CEO, and discontinued the 100-year-old relationship with Firestone. While critics argue that Ford’s accommodative strategy was to place blame squarely on Firestone, the institution-based view (especially Proposition 1) suggests that such highly rational actions are to be expected. Even if Ford’s public relations campaign was only “window dressing,” publicizing a set of ethical criteria opens doors for scrutiny by concerned stakeholders. It is fair to argue that Ford became a better corporate citizen in 2000 than what it was in 1975.

Finally, proactive firms anticipate institutional changes and do more than is required. For example, BMW anticipated its emerging responsibility associated with the German govern- ment’s proposed “take-back” policy, requiring automakers to design cars whose components can be taken back by the same manufacturers for recycling. BMW not only designed easier- to-disassemble cars, but also signed up the few high-quality dismantler firms as part of an exclusive recycling infrastructure. Further, BMW actively participated in public discussions and succeeded in establishing its approach as the German national standard for automobile disassembly. Other automakers were thus required to follow BMW’s lead. However, they had to fight over smaller lower-quality dismantlers or develop in-house dismantling infrastruc- ture from scratch.46 Through such a proactive strategy, BMWhas facilitated the emergence of new environmentally friendly norms in both car design and recycling. In brief, proactive firms go beyond the current regulatory requirements to do the “right thing.” While there is probably an element of “window dressing,” the fact that proactive firms are going beyond the current regulatory requirements is indicative of the normative and cognitive beliefs held by many managers on the importance of doing the “right thing.”

Debates and Extensions Similar to the industry-based and resource-based views, the institution-based view has also attracted some significant debates. This section focuses on: (1) opportunism versus individualism/collectivism, (2) cultural distance versus institutional distance, and (3) “bad apples” versus “bad barrels.”

Opportunism versus Individualism/Collectivism47

Opportunism is a major source of uncertainty, and transaction cost theorists maintain that institutions emerge to combat opportunism. However, critics argue that emphasizing oppor- tunism as “human nature” may backfire in practice.48 If a firm assumes that employees will steal and thus places surveillance cameras everywhere, then employees who otherwise would not steal may feel alienated enough to do exactly that. If firm A insists on specifying minute details in an alliance contract in order to prevent firm B from behaving opportunistically in the future, A is likely to be regarded by B as being not trustworthy and being opportunistic now. This is especially the case if B is from a collectivist society. Thus, attempts to combat opportunism may beget opportunism.

Transaction cost theorists acknowledge that opportunists are a minority in any popu- lation. However, theorists contend that because of the difficulty to identify such a minority of opportunists before they cause any damage, it is imperative to place safeguards that, unfortunately, treat everybody as a potential opportunist. For example, thanks to the work of only 19 terrorists, millions of air travelers around the world since September 11,

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2001, now have to go through heightened security. Everybody hates it, but nobody argues that it is unnecessary. This debate, therefore, seems deadlocked.

One cultural dimension, individualism/collectivism, may hold the key to an improved understanding of opportunism. A common stereotype is that players from collectivist societies (such as China) are more collaborative and trustworthy, and that those from individualist societies (such as the United States) are more competitive and opportunistic.49 However, this superficial understanding is not necessarily the case. Collectivists are more collaborative only when dealing with in-group members— individuals and firms regarded as a part of their own collective. The flip side is that collectivists discriminate more harshly against out-group members—individuals and firms not regarded as a part of “us.” On the other hand, individualists, who believe that every person (firm) is on his/her (its) own, make less distinction between in-group and out-group. Therefore, while individualists may indeed be more opportunistic than collectivists when dealing with in-group members (this fits the stereotype), collectivists may be more opportunistic when dealing with out-group members. Thus, on balance, the average Chinese is not inherently more trustworthy than the average American. The Chinese motto regarding out-group members is: “Watch out for strangers. They will screw you!”

This helps explain why the United States, the leading individualist country, is among societies with a higher level of spontaneous trust, whereas there is greater interpersonal and interfirm distrust in the large society in China than in the United States.50 This also explains why it is important to establish guanxi for individuals and firms in China; otherwise, life can be very challenging in a sea of strangers.

While this insight is not likely to help improve airport security screening, it can help managers and firms better deal with each other. Only through repeated social interactions can collectivists assess whether to accept newcomers as in-group mem- bers. If foreigners who, by definition, are from an out-group refuse to show any interest in joining the in-group, then it is fair to take advantage of them. For instance, don’t refuse the friendly offer of coffee from a Saudi businessman. Most of us do not realize that “Feel free to say no when offered food or drink” reflects the cultural underpinning of individualism, and folks in collectivist societies do not view this as an option (unless one wants to offend the host). This misunderstanding, in part, explains why many cross-culturally naïve Western managers often cry out loud for being taken advantage of in collectivist societies—they are simply being treated as “deserving” out-group members.

Cultural Distance versus Institutional Distance Given cross-cultural differences and conflicts, it is not surprising that, for instance, Japanese–US joint ventures are shorter lived than Japanese–Japanese joint ventures.51

Basically, when disputes and misunderstandings arise, it is difficult to ascertain whether the other side is deliberately being opportunistic or is simply being (culturally) different. Firms in general may prefer to do business with culturally close countries because of the shorter cultural distance.

However, critics make four arguments.52 First, they point out a number of findings inconsistent with the cultural distance hypothesis.53 For example, one study reports

in-group

Individuals and firms regarded as part of “us.”

out-group

Individuals and firms not regarded as part of “us.”

cultural distance

The difference between two cultures along some identifiable dimensions.

114 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

that joint ventures between Chinese and Western firms outperform those between Chinese and Asian firms.54 Second, critics contend that given the complexity of foreign entry decisions, cultural distance, while important, is but one of many factors to consider. For instance, relative to national culture, organizational culture may be equally important.55

Finally, some argue that perhaps cultural distance can be complemented (but not replaced) by the institutional distance concept, which is “the extent of similarity or dissimilarity between the regulatory, normative, and cognitive institutions of two countries.”56 For example, the cultural distance between Canada and China is virtually as huge as the cultural distance between Canada and Hong Kong (where 98% of the population is ethnic Chinese). However, the institutional distance between Canada and Hong Kong is much shorter: Both use common law, speak English as an official language, and share a common heritage of being former British colonies. Therefore, before entering mainland China, Canadian firms may have a preference to enter Hong Kong first. Overall, this emerging idea on institutional distance is gathering some momentum, as scholars start to look beyond the cultural dimensions and investigate the intricacies of other institutional differences around the world.

Bad Apples versus Bad Barrels This debate focuses on the root cause of unethical business behavior. One argument suggests that people may have ethical or unethical predispositions before joining firms. Another side of the debate argues that while there are indeed some opportu- nistic “bad apples,” many times people commit unethical behavior not because they are “bad apples” but because they are spoiled by “bad barrels.” Some firms not only condone but may even expect unethical behavior. For example, Siemens has recently been criticized for breeding a “bad barrel” and paid record fines to German, US, and other authorities for engaging in thousands of illegal acts of bribing officials around the world.

The debate on “bad apples” versus “bad barrels” is an extension of the broader debate on “nature versus nurture.” Are we who we are because of our genes (nature) or our environments (nurture)? Most studies report that human behavior is the result of both nature and nurture. Although individuals and firms (staffed by people) do have some ethical or unethical predispositions that influence their behavior, the institutional environment (such as organizational norms and national institutions) can also have a profound impact. In a nutshell, even “good apples” may turn bad in “bad barrels.”

The Savvy Strategist Strategy is about choices. When seeking to understand how these choices are made, practitioners and scholars usually “round up the usual suspects”—namely, industry structures and firm-specific capabilities. While these views are very insightful, they usually

institutional distance

The extent of similarity or dissimilarity between the regulatory, normative, and cognitive institutions of two countries.

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do not pay adequate attention to the underlying context. A contribution of the institution- based view is to emphasize the importance of institutions, cultures, and ethics as the bedrock propelling or constraining strategic choices. Overall, if strategy is about the “big picture,” then the institution-based view reminds current and would-be strategists not to forget the “bigger picture.”

The savvy strategist draws at least three important implications for action (Table 4.6). First, when entering a new country, do your homework by having a thorough understanding of the formal and informal institutions governing firm behavior. While you don’t necessarily have to do “as the Romans do” when in “Rome,” you need to understand why Romans do things in a certain way.57 In countries that emphasize informal relational exchanges, insisting on formalizing the contract right away may backfire.

Second, strengthen cross-cultural intelligence by building awareness, expanding knowl- edge, and leveraging skills.58 In cross-cultural encounters, while you may not share (or may disagree) with the values held by others, you will need to at least obtain a roadmap of the informal institutions governing their behavior. Of course, culture is not everything. It is advisable not to read too much into culture, which is one of many variables affecting global strategy. But it is imprudent to ignore culture.

Third and finally, integrate ethical decision making as part of the core strategy processes of the firm—faking it does not last very long. The best managers expect norms to shift over time by constantly deciphering the changes in the informal “rules of the game” and by taking advantage of new opportunities—how BMW managers proactively shaped the automobile recycling norms serves as a case in point. Failing to understand and adapt to the changing norms by “sticking one’s neck out” in an insensitive and unethical way may lead to unsatisfactory or disastrous results, as Facebook found out (see the Closing Case).

We conclude this chapter by revisiting the four fundamental questions. First, why do firms differ? The institution-based view points out the institutional frameworks that shape firm differences. Second, how do firms behave? The answer also boils down to institutional differences. Third, what determines the scope of the firm? Chapter 9 will have more details on how institutions have shaped the scope of the firm. Finally, what determines the international success and failure of firms? The institution-based view argues that firm performance is, at least in part, determined by the institutional frameworks governing strategic choices.

TABLE 4.6 Strategic Implications for Action

& When entering a new country, do your homework by having a thorough understanding of the formal and informal institutions governing firm behavior.

& Strengthen cross-cultural intelligence by building awareness, expanding knowledge, and leveraging skills.

& Integrate ethical decision making as part of the core strategy processes of the firm—faking it does not last very long.

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CHAPTER SUMMARY

1. Explain the concept of institutions • Commonly known as “the rules of the game,” institutions have formal and informal components, each with different supportive pillars (the regulatory, normative, and cognitive pillars).

2. Understand the two primary ways of exchange transactions that reduce uncertainty • Institutions reduce uncertainty in two primary ways: (1) informal relationship-based personalized exchanges (known as relational contracting), and (2) formal rule-based impersonal exchanges with third-party enforcement (known as arm’s-length transaction).

3. Articulate the two propositions underpinning an institution-based view of strategy • Proposition 1: Managers and firms rationally pursue their interests and make strategic choices within formal and informal institutional constraints.

• Proposition 2: In situations where formal constraints fail, informal constraints will play a larger role.

4. Appreciate the strategic role of cultures • According to Hofstede, national culture has five dimensions: (1) power distance, (2) individualism/collectivism, (3) masculinity/femininity, (4) uncertainty avoidance, and (5) long-term orientation. Each has some significant bearing on strategic choices.

5. Identify the strategic role of ethics culminating in a strategic response framework • When managing overseas, two schools of thought are (1) ethical relativism and (2) ethical imperialism.

• Three “middle-of-the-road” principles focus on respect for (1) human dignity and basic rights, (2) local traditions, and (3) institutional context.

• When confronting ethical challenges, a strategic framework suggests four strategic choices: (1) reactive, (2) defensive, (3) accommodative, and (4) proactive strategies.

6. Participate in three leading debates on institutions, cultures, and ethics • (1) Opportunism versus individualism/collectivism, (2) cultural distance versus institutional distance, and (3) “bad apples” versus “bad barrels.”

7. Draw strategic implications for action • When entering a new country, do your homework. • Strengthen cross-cultural intelligence. • Integrate ethical decision making as part of the core strategy processes of the firm.

KEY TERMS

Arm’s-length transactions p. 99

Bounded rationality p. 104

Code of conduct (code of ethics) p. 108

Cognitive pillar p. 95

Collectivism p. 106

Corruption p. 110

Cultural distance p. 114

Culture p. 105

Domestic demand p. 101

Ethical imperialism p. 110

Ethical relativism p. 110

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Ethics p. 108

Factor endowments p. 100

Femininity p. 107

Firm strategy, structure, and rivalry p. 100

Foreign Corrupt Practices Act (FCPA) p. 111

Formal institutions p. 94

Formal, rule-based, impersonal exchange p. 99

In-group p. 114

Individualism p. 106

Informal institutions p. 94

Informal, relationship-based, personalized exchange p. 98

Institution p. 94

Institution-based view p. 94

Institutional distance p. 115

Institutional framework p. 94

Institutional transitions p. 100

Long-term orientation p. 107

Masculinity p. 107

Norm p. 94

Normative pillar p. 94

Opportunism p. 97

Out-group p. 114

Power distance p. 105

Regulatory pillar p. 94

Related and supporting industries p. 100

Relational contracting p. 98

Transaction cost p. 95

Uncertainty avoidance p. 107

CRITICAL DISCUSSION QUESTIONS

1. How does the institution-based view complement and differ from the industry-based and resource-based views? Why has the institution-based view become a third leg in the strategy tripod?

2. Find one example of institutional transitions from developed economies and one example from emerging economies. What are their similarities and differences?

3. ON ETHICS: Assuming you work for a New Zealand company exporting a container of kiwis to Haiti. The customs official informs you that there is a delay in clearing your container and it may last a month. However, if you are willing to pay an expediting fee of US$200, he will try to make it happen in one day. What are you going to do?

TOPICS FOR EXPANDED PROJECTS

1. If you were the CEO of National Foods in Pakistan, how would you manage uncertainty other than those outlined in Emerging Markets 4.1? If you were the CEO of a foreign electricity utility company looking for opportunities around the world, would President Zardari’s call for FDI in the power sector attract you to consider investing in Pakistan? Write a short paper to explain your answers.

2. Some argue that guanxi (relationships and connections) is a unique Chinese-only phe- nomenon embedded in the Chinese culture. As evidence, they point out that the word guanxi has now entered the English language and is often used in mainstream media (such

118 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

as the Wall Street Journal) without explanations provided in brackets. Others disagree, arguing that every culture has a word or two describing what the Chinese call guanxi, such as blat in Russia, guan he in Vietnam, and “old boys’ network” in the English-speaking world. They suggest that the intensive use of guanxi in China (and elsewhere) is a reflection of the lack of formal institutional frameworks. Write a short paper to explain which side of the debate you would join and why.

3. ON ETHICS: Why has the FCPA not ended corruption in global business? Working in groups of three or four, research the FCPA, its implementation, and enforcement. Present your findings in a short paper or visual presentation.

E T H I C A L D I L E M M ACLOSING CASE

Facebook Violates Privacy

Facebook has been playing with fire and has got its fingers burned, again. On November 29, 2011, the US Federal Trade Commission (FTC) announced that it had reached a draft settlement with the giant social network over allegations that it had misled people about its use of their personal data.

The details of the settlement made clear that Facebook, which boasts over 800 million users, betrayed its users’ trust. It is also notable because it appears to be part of a broader attempt by the FTC to craft a new privacy frame- work to deal with the swift rise of social networks in the world.

The regulator’s findings come at a sensitive time for Facebook, which is preparing for an initial public offering next year that could value it at around $100 billion. To clear the way for its blockbuster floatation, the firm first needs to resolve its privacy tussles with regulators in Amer- ica and Europe. Hence its willingness to negotiate the settlement unveiled this week, which should be finalized at the end of December 2011 after a period for public comment.

Announcing the agreement, the FTC said it had found a number of cases where Facebook had made claims that were “unfair and deceptive, and violated federal law.” For instance, Facebook passed on personally identifiable infor- mation to advertisers, even though it said it would not do

so. And it failed to keep a promise to make photos and videos on deactivated and deleted accounts inaccessible.

The settlement does not constitute an admission by Face- book that it has broken the law. But the regulator’s findings are deeply embarrassing for the firm nevertheless. In a blog post published the same day, Mark Zuckerberg, Facebook’s boss, tried to play down the impact of the deal. First he claimed that “a small number of high-profile mistakes”were overshadowing the social network’s “good history” on priv- acy. Then he confessed that it could still do better and said he had hired two new “chief privacy officers.”

The FTC is not relying on Facebook to police itself. Among other things, the firm will now have to seek con- sumers’ approval before it changes the way it shares their data. And it has agreed to an independent privacy audit every two years for the next 20 years. Jeff Chester of the Center for Digital Democracy reckons that it will make it somewhat easier for privacy activists to hold the social network to account.

There is a clear pattern here. In separate cases over the past couple of years the FTC had insisted that Twitter and Google accept regular external audits, too, after each firm was accused of violating its customers’ privacy. The intent seems to be to create a regulatory regime that is tighter than the status quo, but one that

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NOTES

still gives social networks plenty of room to innovate. The audits can be used to tweak the framework in the light of new developments.

Some observers reckon web firms have agreed to all this in the hope that it will deflect a push for more onerous privacy legislation in America. But outrage over Facebook’s behavior could spur Congress into action anyway. And it will certainly not be lost on regulators in Europe who are scrutinizing the social network’s privacy record too. Mr. Zuckerberg’s latest mea culpa (admission of error and formal apology) is unlikely to be his last.

Source: Economist, 2011, Facebook and privacy: Sorry, friends, December 3: 79.

C A S E D I S C U S S I O N Q U E S T I O N S

1. ON ETHICS: Supporters of Facebook argue that Facebook’s contributions to mankind—think of its positive role behind the Arab Spring of 2011—outweigh its ethical imperfections. Overly harsh regulations will suffocate its capacity to innovate. Do you agree or disagree?

2. ON ETHICS: Critics of Facebook argue that its business model is built on violating user privacy. Without selling sensitive personal information to advertisers, how can it make money? Therefore, Facebook must be on a tight regulatory leash. Do you agree or disagree?

3. ON ETHICS: Are some of Facebook employees “bad apples” or is Facebook a “bad barrel”?

[Journal acronyms] AME – Academy of Management Executive; AMJ – Academy of Management Journal; AMP – Academy of Management Perspectives; AMR – Academy of Management Review; APJM – Asia Pacific Journal of Management; BW – BusinessWeek (before 2010) or Bloomberg Businessweek (since 2010); HBR – Harvard Business Review; JBV – Journal of Business Venturing; JIBS – Journal of International Business Studies; JIM – Journal of International Management; JM – Journal of Management; JMS – Journal of Management Studies; JWB – Journal of World Business; MIR – Management International Review; RES – Review of Economics and Statistics; SMJ – Strategic Management Journal.

1. M. W. Peng, S. Sun, B. Pinkham, & H. Chen, 2009, The institution-based view as a third leg for a strategy tripod, AMP, 23: 63–81; M. W. Peng, D. Wang, & Y. Jiang, 2008, An institution-based view of international business strategy, JIBS, 39: 920–936.

2. D. North, 1990, Institutions, Institutional Change, and Economic Performance (p. 3), New York: Norton.

3. W. R. Scott, 1995, Institutions and Organizations, Thousand Oaks, CA: Sage.

4. D. Philippe & R. Durand, 2011, The impact of norm- conforming behaviors on firm reputation, SMJ, 32: 969–993.

5. S. Hannah, B. Avolio, & D. May, 2011, Moral matura- tion and moral conation, AMR, 36: 663–685; S. Nadkarni & P. Barr, 2008, Environmental context, managerial cognition, and strategic action, SMJ, 29: 1395–1427; B. Tyler & D. Gnyawali, 2009, Managerial collective cognitions, JMS, 46: 93–126.

6. M. W. Peng, 2000, Business Strategies in Transition Economies (pp. 42–44), Thousand Oaks, CA: Sage.

7. O. Branzai & S. Abdelnour, 2010, Another day, another dollar, JIBS, 41: 804–825; M. Czinkota, G. Knight, P. Liesch, & J. Steen, 2010, Terrorism and international business, JIBS, 41: 826–843; H. de Soto, 2011, The destruction of economic facts, BW, May 2: 60–63; T. Khoury & M. W. Peng, 2011, Does institutional reform of intellectual property rights lead to more inbound FDI? JWB, 46: 337–345; S. Lee, Y. Yamakawa, M. W. Peng, & J. Barney, 2011, How do bankruptcy laws affect entrepreneurship development around the world? JBV, 28: 505–520.

8. Economist, 2011, Looking for someone to blame, August 13: 25–26.

9. BW, 2009, The financial crisis excuse, February 23: 32. 10. O. Williamson, 1985, The Economic Institutions of

Capitalism (pp. 1–2), New York: Free Press. 11. J. Zhou & M. W. Peng, 2010, Relational exchanges

versus arm’s-length transactions during institutional transitions, APJM, 27: 355–370.

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12. M. W. Peng, 2003, Institutional transitions and stra- tegic choices, AMR, 28: 275–296. See also S. Li, 1999, The benefits and costs of relation-based governance, working paper, Hong Kong: City University of Hong Kong.

13. North, 1990, Institutions (p. 34). 14. S. Puffer & D. McCarthy, 2007, Can Russia’s state-

managed, network capitalism be competitive? JWB, 42: 1–13.

15. Peng, 2003, Institutional transitions and strategic choices (p. 275). See also E. George, P. Chattopad- hyay, S. Sitkin, & J. Barden, 2006, Cognitive under- pinning of institutional persistence and change, AMR, 31: 347–365.

16. M. Porter, 1990, Competitive Advantage of Nations, New York: Free Press; B. Snowdon & G. Stonehouse, 2006, Competitiveness in a globalized world, JIBS, 37: 163–175.

17. H. Davies & P. Ellis, 2001, Porter’s Competitive Advantage of Nations, JMS, 37: 1189–1215; A. Grif- fiths & R. Zammuto, 2005, Institutional governance systems and variations in national competitive advan- tage, AMR, 30: 823–842; P. Minford, 2006, Competi- tiveness in a globalized world: A commentary, JIBS, 37: 176–178.

18. A. Cuervo-Cazurra & L. Dau, 2009, Promarket reforms and firm profitability in developing countries, AMJ, 52: 1348–1368; G. McDermott, R. Corredoira, & G. Kruse, 2009, Public-private institutions as catalysts of upgrading in emerging market societies, AMJ, 52: 1270–1296; M. Wright, I. Filatotchev, R. Hoskisson, & M. W. Peng, 2005, Strategy research in emerging economies, JMS, 42: 1–33.

19. M. Carney, E. Gedajlovic, & X. Yang, 2009, Varieties of Asian capitalism, APJM, 26: 361–380; M. Witt & G. Redding, 2008, Culture, meaning, and institutions, JIBS, 40: 859–885.

20. P. Ingram & B. Silverman, 2002, Introduction (p. 20, added italics), in P. Ingram & B. Silverman (eds.), The new institutionalism in strategic management: 1–30. Amsterdam: Elsevier.

21. A. Chacar, W. Newburry, & B. Vissa, 2010, Bringing institutions into performance persistence research, JIBS, 41: 1119–1140; R. Coeurderoy & G. Murray, 2008, Reg- ulatory environments and the location decision, JIBS, 39: 670–687; K. Huang & F. Murray, 2009, Does patent strategy shape the long-run supply of public knowledge? AMJ, 52: 1193–1221; S. Julian, J. Ofori-Dankwa, & R. Justis, 2008, Understanding strategic responses to

interest group pressures, SMJ, 29: 963–984; T. Kochan, M. Guillen, L. Hunter, & S. O’Mahony, 2008, Public policy and management research, AMJ, 52: 1088–1100; T. Kostova, K. Roth, & M. T. Dacin, 2008, Institutional theory in the study of multinational corporations, AMR, 33: 994–1006; B. Lee, 2009, The infrastructure of collec- tive action and policy content diffusion in the organic food industry, AMJ, 52: 1247–1269; C. Marquis & Z. Huang, 2009, The contingent nature of public policy and the growth of US commercial banking, AMJ, 52: 1222–1246; K. Pajunen, 2008, Institutions and flows of foreign direct investment, JIBS, 39: 652–669; T. Tong, T. Alessandri, J. Reuer, & A. Chintakananda, 2008, How much does country matter? JIBS, 39: 387–405.

22. S. Elbanna & J. Child, 2007, The influence of decision, environmental, and firm characteristics on the rationality of strategic decision-making, JMS, 44: 561–590; M. Peteraf & R. Reed, 2007, Managerial discretion and internal alignment under regulatory constraints and change, SMJ, 28: 1089–1112; C. Stevens & J. Cooper, 2010, A behavioral theory of governments’ ability to make credible commitments to firms, APJM, 27: 587–610.

23. D. Ariely, 2009, The end of rational economics, HBR, July: 78–84; P. Rosenzweig, 2010, Robert S. McNamara and the evolution of modern management, HBR, December: 87–93.

24. M. W. Peng, 2001, How entrepreneurs create wealth in transition economies, AME, 15: 95–108.

25. L. Capron & O. Chatain, 2008, Competitors’ resource- oriented strategies, AMR, 33: 97–121; G. Holburn & R. Bergh, 2008, Making friends in hostile environments, AMR, 33: 521–540; S. Lux, T. Crook, & D. Woehr, 2011, Mixing business with politics, JM, 37: 223–247; C. Oliver & I. Holzinger, 2008, The effectiveness of strategic political management, AMR, 33: 496–520.

26. BW, 2007, Inside the hidden world of earmarks, September 17: 56–59.

27. BW, 2011, Pssst … wanna buy a law? December 5: 66–72; R. Lester, A. Hillman, A. Zardkoohi, & B. Cannella, 2008, Former government officials as out- side directors, AMJ, 51: 999–1013; H. Li & Y. Zhang, 2007, The role of managers’ political networking and functional experience in new venture performance, SMJ, 28: 791–804; J. Pearce, J. De Castro, & M. Guillen, 2008, Influencing politics and political systems, AMR, 33: 493–495; P. Ring, G. Bigley, T. D’Aunno, & T. Khanna, 2005, perspectives on how governments matter, AMR, 30: 308–320.

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28. G. Hofstede, 1997, Cultures and Organizations: Soft- ware of the Mind (p. 5), New York: McGraw-Hill; G. Hofstede, 2007, Asian management in the 21st cen- tury, APJM, 24: 421–428.

29. BW, 2012, Behind every great woman: The perfect husband, January 9: 54–59.

30. B. Kirkman, K. Lowe, & C. Gibson, 2006, A quarter century of Culture’s Consequences, JIBS, 37: 285–320; K. Leung, R. Bhagat, N. Buchan, M. Erez, & C. Gib- son, 2005, Culture and international business, JIBS, 36: 357–378; L. Tang & P. Koveos, 2008, A framework to update Hofstede’s cultural value indices, JIBS, 39: 1045–1063.

31. T. Fang, 2010, Asian management research needs more self-confidence, APJM, 27: 155–170; R. House, P. Hanges, M. Javidan, P. Dorfman, & V. Gupta, 2004, Culture, Leadership, and Organizations, Thousand Oaks, CA: Sage; R. Maseland & A. van Hoom, 2009, Explaining the negative correlation between values and practices, JIBS, 40: 527–532; R. Tung & A. Ver- beke, 2010, Beyond Hofstede and GLOBE, JIBS, 41: 1259–1274.

32. G. Hirst, P. Budhwar, B. Cooper, M. West, C. Long, C. Xu, & H. Shipton, 2008, Cross-cultural variations in climate for autonomy, stress, and organizational pro- ductivity relationships, JIBS, 39: 1343–1358.

33. Hofstede, 1997, Cultures and Organizations (p. 94). 34. A. Bhardwaj, J. Dietz, & P. Beamish, 2007, Host

country cultural influences on foreign direct invest- ment, MIR, 47: 29–50; K. Lee, G. Yang, & J. Graham, 2006, Tension and trust in international business negotiations, JIBS, 37: 623–641; J. Salk & M. Brannen, 2000, National culture, networks, and individual influence in a multinational management team, AMJ, 43: 191–202.

35. D. McCarthy & S. Puffer, 2008, Interpreting the ethi- cality of corporate governance decisions in Russia, AMR, 33: 11–31; A. Spicer, T. Dunfee, & W. Bailey, 2004, Does national context matter in ethical decision making? AMJ, 47: 610–620.

36. This section draws heavily from T. Donaldson, 1996, Values in tension, HBR, September–October: 4–11.

37. K. Martin, J. Cullen, J. Johnson, & K. Parboteeah, 2007, Deciding to bribe, AMJ, 50: 1401–1422.

38. C. Robertson & A. Watson, 2004, Corruption and change, SMJ, 25: 385–396; S. Lee & K. Oh, 2007, Corruption in Asia, APJM, 24: 97–114; S. Lee & S. Hong, 2012, Corruption and subsidiary profitability,

APJM (in press); J. H. Zhao, S. Kim, & J. Du, 2003, The impact of corruption and transparency on foreign direct investment, MIR, 43: 41–62; J. Zhou & M. W. Peng, 2012, Does bribery help or hurt firm growth around the world? APJM (in press).

39. S. Globerman & D. Shapiro, 2003, Governance infra- structure and US foreign direct investment, JIBS, 34: 19–39.

40. S. Wei, 2000, How taxing is corruption on interna- tional investors? RES, 82: 1–11.

41. M. Habib & L. Zurawicki, 2002, Corruption and for- eign direct investment (p. 295), JIBS, 33: 291–307.

42. J. Hellman, G. Jones, & D. Kaufmann, 2002, Far from home: Do foreign investors import higher stan- dards of governance in transition economies (p. 20), Working paper, Washington: World Bank (www. worldbank.org).

43. A. Cuervo-Cazzura, 2008, The effectiveness of laws against bribery abroad, JIBS, 39: 634–651; C. Kwok & S. Tadesse, 2006, The MNC as an agent of change for host-country institutions, JIBS, 37: 767–785.

44. J. Clougherty & M. Grajek, 2008, The impact of ISO 9000 diffusion on trade and FDI, JIBS, 39: 613–633; H. Greve, 2011, Fast and expensive, SMJ, 32: 949–968; K. Weber, G. Davis, & M. Lounsbury, 2009, Policy as myth and ceremony? AMJ, 52: 1319–1347.

45. L. Trevino & K. Nelson, 2004, Managing Business Ethics, 3rd ed. (p. 13), New York: Wiley.

46. S. Hart, 2005, Capitalism at the Crossroads, Philadel- phia, PA: Wharton School Publishing.

47. This section draws heavily from C. Chen, M. W. Peng, & P. Saparito, 2002, Individualism, collectivism, and opportunism, JM, 28: 567–583.

48. S. Ghoshal & P. Moran, 1996, Bad for practice, AMR, 21: 13–47.

49. J. Cullen, K. P. Parboteeah, & M. Hoegl, 2004, Cross- national differences in managers’ willingness to justify ethically suspect behaviors, AMJ, 47: 411–421.

50. F. Fukuyama, 1995, Trust, New York: Free Press; G. Redding, 1993, The Spirit of Chinese Capitalism, New York: Gruyter.

51. J. Hennart & M. Zeng, 2002, Cross-cultural differ- ences and joint venture longevity, JIBS, 33: 699–716.

52. Y. Luo & O. Shenkar, 2011, Toward a perspective of cultural friction in international business, JIM, 17: 1–14; J. Salk, 2012, Changing IB scholarship via rheto- ric or bloody knuckles, JIBS, 43: 28–40; K. Singh, 2007, The limited relevance of culture to strategy, APJM, 24: 421–428; O. Shenkar, 2012, Beyond

122 PART 1 FOUNDATIONS OF GLOBAL STRATEGY

cultural distance, JIBS, 43: 12–17; O. Shenkar, Y. Luo, & O. Yoheskel, 2008, From “distance” to “friction,” AMR, 33: 905–923; S. Zaheer, M. Schomaker, & L. Nachum, 2012, Distance without direction, JIBS, 43: 18–27.

53. O. Shenkar, 2012, Cultural distance revisited, JIBS, 43: 1–11. See also S. Lee, O. Shenkar, & J. Li, 2008, Culture distance, investment flow, and control in cross-border cooperation, JIBS, 29: 1117–1125; L. Tihanyi, D. Griffith, & C. Russell, 2005, The effect of cultural distance on entry mode choice, international diversification, and MNE performance, JIBS, 36: 270–283.

54. J. Li, K. Lam, & G. Qian, 2001, Does culture affect behavior and performance of firms? JIBS, 32: 115–131.

55. V. Pothukuchi, F. Damanpour, J. Choi, C. Chen, & S. Park, 2002, National and organizational culture differ- ences and international joint venture performance, JIBS, 33: 243–265.

56. D. Xu & O. Shenkar, 2002, Institutional distance and the multinational enterprise (p. 608), AMR, 27: 608–618. See also H. Berry, M. Guillen, & N. Zhou, 2010, An institutional approach to cross-national dis- tance, JIBS, 41: 1460–1480; D. Dow & A. Karunaratna, 2006, Developing a multidimensional instrument to measure psychic distance stimuli, JIBS, 37: 578–602; L. Hakanson & B. Ambos, 2010, The antecedents of psychic distance, JIM, 16: 195–210.

57. R. Orr & W. R. Scott, 2008, Institutional exceptions on global projects, JIBS, 39: 562–588.

58. J. Johnson, T. Lenartowicz, & S. Apud, 2006, Cross-cultural competence in international busi- ness, JIBS, 37: 525–543; A. Tsui, S. Nifadkar, & A. Ou, 2007, Cross-national, cross-cultural organi- zational behavior research, JM, 33: 426–478; N. Yagi & J. Kleinberg, 2011, Boundary work, JIBS, 42: 629–653.

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P A R T2 BUSINESS-LEVELSTRATEGIES

5 Growing and Internationalizing the Entrepreneurial Firm

6 Entering Foreign Markets

7 Making Strategic Alliances and Networks Work

8 Managing Global Competitive Dynamics

CHAPTER5

GROWING AND INTERNATIONALIZING THE ENTREPRENEURIAL FIRM

KNOWLEDGE OBJECT IVES

After studying this chapter, you should be able to

1. Define entrepreneurship, entrepreneurs, and entrepreneurial firms

2. Articulate a comprehensive model of entrepreneurship

3. Identify five strategies that characterize a growing entrepreneurial firm

4. Differentiate international strategies that enter foreign markets and that stay in domestic markets

5. Participate in three leading debates concerning entrepreneurship

6. Draw strategic implications for action

ot o/ A le xe y St io p

126 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

OPENING CASE

Emerging Markets: Amazon.com of Russia

Ozon.ru is frequently called the Amazon.com of Russia. But the differences between theMoscow-based start-up and the US e-commerce giant are more revealing than the similari- ties. There is no equivalent of FedEx or UPS that covers all of Russia, so Ozon must run its own fleet of hundreds of delivery trucks, which have to get as far as Khabarovsk, nearly 4,000 miles (6,400 kilometers) away on the Chinese border. Most Russians eschew credit cards, so customers typically pay delivery staff in cash. Many of Ozon’s customers are also wary of placing orders online, so more than 10% of its transaction occur over the phone. “We do look at Ama- zon, but we always try to adapt what they are doing to the Russian market,” says Maelle Gavet, Ozen’s chief executive officer. “Copy and paste never works here.”

On September 8, 2011, the company announced it was raising $100 million from a consortium of investors includ- ing the Baring Vostok Private Equity Fund and Rakuten, the largest e-commerce company in Japan. Ozon, which has more than 1,100 employees based mostly in Moscow and at an 8,000-square-foot shipping center in Tver, located centrally between Moscow and St. Petersburg, plans to use the money to improve its website and build data centers to compensate for the country’s sluggish net- work infrastructure. “They have delivered millions of packages over the last few years,” says Giueppe Zocco, a partner at venture capital firm Index Ventures, which has backed Ozon since 2007 and invested in the last round. “It’s a well-oiled machine and poised to keep growing.”

The Ozon funding caps an eventful year for the Russian Internet. In November 2010, Mail.ru, the operator of various Russia social network sites and an investor in Facebook, raised $912 million on the London Stock Exchange. Yandex, a Russian search engine, followed in May 2011 with an official public offering on NASDAQ that raised $1.3 billion. As in China, investors are attracted primarily by the sheer size of the opportunity. There are 67 million Internet users in Russia, out of a population of 147 million, and the country’s Internet audience is among the fastest-growing in Europe.

Ozon was born nearly 14 years ago, when a St. Petersburg software company called Reksoft saw an Amazon press

release and decided to import the business model to Russia. The fledgling effort caught the attention of Baring Vostok, whichmoved the company toMoscow and eventually tapped Swiss-born Bernard Lukey, a former marketing executive at Yandex, to run it. Lukey raised capital, expanded the com- pany’s revenues fivefold, built a state-of-the-art distribution center, and added a profitable online travel arm. Two years ago he started preparations to step aside to return to his native country (he is still Ozon’s president).

That cleared the way for the 33-year-old French-born Gavet. She speaks French, Russian, and English, and is a six-year veteran of the consumer retail practice for Boston Consulting Group. She began taking over Lukey’s responsi- bilities in early 2011 and has quickly made several changes. Ozon had experimented with selling a Kindle-like e-reader called the Ozon Galaxy, but Gavet suspended the effort and is now focused on selling e-books, video games, and other digital content for smartphones and mobile devices. She is also trying to expand Ozon’s live, 24/7 customer support operation, because Russians often demand to speak to peo- ple over the phone. One of her goals: getting the Ozon customer support staff to be polite. “Russians are not a very friendly people,” Gavet says. “It’s hard to get them to speak nicely to the customers. It’s just not in their culture.”

M ap

Re so ur ce s

127 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

How do entrepreneurial firms such as Ozon grow? What are the challengesand constraints they face? This chapter deals with these important ques-tions. This is different from many strategy textbooks, which only focus on large firms. To the extent that every large firm started small and that some (although not all) of today’s small and medium-sized enterprises (SMEs) may become tomorrow’s multinational enterprises (MNEs), current and would-be strategists will not gain a complete picture of the strategic landscape if they only focus on large firms. SMEs are firms with fewer than 500 employees in the United States and with fewer than 250 employees in the European Union (Ozon is no longer an SME). Most students will join SMEs for employment. Some readers of this book will also start up their own SMEs, thus further necessitating our attention on these numerous “Davids” instead of on the smaller number of “Goliaths.”

This chapter will first define entrepreneurship. Next, we outline a compre- hensive model of entrepreneurship informed by the three leading perspectives on strategy. Then, we introduce six major entrepreneurial strategies. As before, debates and extensions follow.

Entrepreneurship and Entrepreneurial Firms Although entrepreneurship is often associated with smaller and younger firms, there is no rule banning larger and older firms from being “entrepreneurial.” So what exactly is entrepreneurship? Recent research suggests that firm size and age are not defining character- istics of entrepreneurship. Instead, entrepreneurship is defined as “the identification and exploitation of previously unexplored opportunities.”1 Specifically, it is concerned with “the sources of opportunities; the processes of discovery, evaluation, and exploitation of oppor- tunities; and the set of individuals who discover, evaluate, and exploit them.”2 These individuals, thus, are entrepreneurs. French in origin, the word “entrepreneurs” traditionally means intermediaries connecting others. Today, the word mostly refers to founders and owners of new businesses or managers of existing firms. Consequently, international entre- preneurship is defined as “a combination of innovative, proactive, and risk-seeking behavior that crosses national borders and is intended to create wealth in organizations.”3

Although SMEs are not the exclusive domain of entrepreneurship, the convention that many people use is to associate entrepreneurship with SMEs, because, on average, SMEs tend

Another challenge for Ozon is finding qualified staff. Good engineers in Russia are scarce and expensive. A web programmer inMoscow demands a higher salary than in San Francisco, Gavet says, which has her joking that perhaps the company should consider outsourcing to the US. If she can solve that problem and get Russians to keep buying online, she may just catch the eye of the man who inspired Ozon,

Jeffrey Bezos. In 2004, Amazon acquired a start-up called Joyo in China—another country with byzantine customs, massive terrain, and a poor shipping infrastructure.

Source: Bloomberg Businessweek, 2011, Amazon.com on the Volga, September 19: 43–44.

(Continued)

OPENING CASE

small and medium-sized enterprise (SME)

A firm with fewer than 500 employees in the United States or with fewer than 250 employees in the European Union.

entrepreneurship

The identification and exploitation of previously unexplored opportunities.

entrepreneur

An individual who identifies and explores previously unexplored opportunities.

international entrepreneurship

A combination of innova- tive, proactive, and risk- seeking behavior that crosses national borders and is intended to create wealth in organizations.

128 PART 2 BUSINESS-LEVEL STRATEGIES

to be more entrepreneurial than large firms. To minimize confusion, the remainder of this chapter will follow that convention, although it is not totally accurate. In other words, while we acknowledge that some managers at large firms can be very entrepreneurial, we will limit the use of the term “entrepreneurs” to owners, founders, and managers of SMEs. Further, we will use the term “entrepreneurial firms” when referring to SMEs.

SMEs are important. Worldwide, they account for over 95% of the number of firms, create approximately 50% of total value added, and generate 60%–90% of employment (depending on the country).4 Obviously, entrepreneurship has both rewarding and pun- ishing aspects.5 Many entrepreneurs will try; many SMEs will fail.6 Only a small number of entrepreneurs and SMEs will succeed.

A Comprehensive Model of Entrepreneurship The strategy tripod consisting of the three leading perspectives on strategy—namely, the industry-based, resource-based, and institution-based views—sheds considerable light on the entrepreneurship phenomenon. This leads to a comprehensive model illustrated in Figure 5.1.

FIGURE 5.1 A Comprehensive Model of Entrepreneurship

Entrepreneurs and entrepreneurial

start-up firms

considerations Industry-based

• Interfirm rivalry • Entry barriers • Bargaining power of suppliers • Bargaining power of buyers • Substitute products/services

Resource-based considerations

• Value • Rarity • Imitability • Organization

Institution-based considerations

• Formal institutional constraints (such as laws and regulations) • Informal institutional constraints (such as cultural values and norms)

ga ge

Le ar ni ng

C h a p t e r 5 G r o w i n g a n d I n t e r n a t i o n a l i z i n g t h e E n t r e p r e n e u r i a l F i r m 129

Industry-Based Considerations The industry-based view, exemplified by the Porter five forces framework first introduced in Chapter 2, emphasizes (1) interfirm rivalry, (2) entry barriers, (3) bargaining power of suppliers, (4) bargaining power of buyers, and (5) threats of substitute products. First, the intensity of interfirm rivalry has a direct impact on the probability that a new start-up will be able to make it.7 The fewer the number of incumbent firms, the more likely they will form some sort of collusion to prevent newcomers from gaining market shares. In a worst-case scenario, a monopoly incumbent, such as Microsoft, may become so dominant that it may potentially stifle new innovation brought about by SMEs—this was the key reason why Microsoft was prosecuted by the US and EU antitrust authorities.

Entry barriers impact entrepreneurship. It is not surprising that new firm entries cluster around low entry-barrier industries, such as restaurants. Conversely, capital-intensive indus- tries hinder the chances of entrepreneurial success. For example, at present no entrepreneurs in their right mind would bet their money on competing against Boeing or Airbus.

When the bargaining power of suppliers becomes too large, entrepreneurial solutions can reduce such bargaining power. For instance, Microsoft is the monopoly supplier of operating systems to a majority of personal computer (PC) makers in the world, which feel uncomfortable about being compelled to purchase Microsoft products. As a result, LINUX has become more popular as an emerging alternative.

Similarly, entrepreneurs who can reduce the bargaining power of buyers may also find a niche for themselves. For example, a small number of national chain (“brick and mortar”) bookstores used to represent the only major outlets through which hundreds of publishers could sell their books. Entrepreneurial Internet bookstores, such as Amazon in the United States and Ozon in Russia (see the Opening Case), have provided more outlets for publishers, thereby reducing the bargaining power of traditional bookstores as buyers.

Substitute products/services mayoffer great opportunities for entrepreneurs. If entrepreneurs can bring in substitute products that can redefine the game, they can effectively chip away someof the competitive advantages held by incumbents. For example, e-mails and online payments, pioneered by entrepreneurial firms, are now substituting a large portion of faxes, express mails, and paper check printing and processing, whose incumbents are powerless to fight back.

Obviously, entrepreneurs need to carefully understand the nature of the industries they intend to join. However, even when the industry is conducive for entries, there is no guarantee that entrepreneurs will be successful. Firm-specific (and often entrepreneur- specific) resources and capabilities are also important.

Resource-Based Considerations The resource-based view, first introduced in Chapter 3, sheds considerable light on entrepreneurship, with a focus on its value, rarity, imitability, and organizational (VRIO) aspects (see Figure 5.1). First, entrepreneurial resources must create value.8 For instance, by offering cheap fares, convenient schedules, and Wi-Fi and a power port on every seat, Megabus offers superb value to travelers for medium-haul trips that are too far for a leisurely drive but too close to justify the expenses and the increasing hassle to fly (see Chapter 6 Opening Case). On medium-haul routes, Megabus is rapidly changing the way Americans—especially the young—travel, so much so that it may help kill plans for the new high-speed rail, which after all may not offer that much value.

130 PART 2 BUSINESS-LEVEL STRATEGIES

Second, resources must be rare. As the cliché goes, “If everybody has it, you can’t make money from it.” The best-performing entrepreneurs tend to have the rarest knowledge and deeper insights about business opportunities. For instance, in the 1980s, a small-fry entrepreneur in China, Zong Qinghou, peddled school supplies and ice cream from a bicycle-drawn cart. He noticed that, spoiled by their parents and grandparents, Chinese kids, products of the “one child policy,” preferred junk food over more nutritious food. These “little emperors” could benefit from nutritional supplements that supply needed vitamins and minerals. But all the numerous nutri- tional supplements marketed in China at that time targeted adults, claiming to boost their longevity and sexual potency. Armed by this powerful insight, Zong started up Wahaha that pioneered the category of children’s nutritional supplements.9 Wahaha has now grown to become China’s number one beverages company, and Zong one of the richest men in China.

Third, resources must be inimitable. For instance, in the ocean of e-commerce com- panies, the abilities to do the “dirtiest job on the Internet” as online moderators are very hard to imitate. That is why firms such as eModeration and ICUC Moderation can charge up to $50,000 a month to clean up comments and tweets for established organizations (see Strategy in Action 5.1).

STRATEGY IN ACTION 5.1

Profiting from the Dirtiest Job Online

The Internet has enabled some of the most noble human spirit in collaboration to shine—think of Wikipedia. However, the Internet has also unleashed some of the most nasty, disgusting, and hurtful expressions to be used as weapons of choice. In online communities, discussion boards, and social media, the lethal combination of anonymity and opinion have often resulted in discussions going out of control, cussing and swearing increasingly dominating the air. Although such uncivil comments represent less than 10% of online comments, they often command disproportionate attention, resulting in headaches, embarrassments, and disasters for established companies, nonprofits, and government agencies. Such uncivil comments have also presented wonderful opportunities for a new breed of entrepreneurs known as moderators (or “mods”).

Moderators delete uncivil comments, scold people behind them (such as “We don’t call each other a–holes”), and in the case of repeat offenders ban their accounts from airing their profanity. Working at home (or during vacation), moderators can make between $40,000 to $80,000

annually. But they need to be prepared to daily exposure to extreme racism and bigotry, images of pedophilia, and other undesirable expressions. Such clean-up is arguably the dirtiest job on the Internet. “Sometimes you feel like you need to spend two hours in the shower because it is so disgusting,” said Keith Bilous, founder of the Winnipeg, Canada-based ICUC Moderation.

Employing over 200 moderators, ICUC Moderation has emerged as a global leader with $10 million revenue. Its clients include Calvin Klein, Chevron, Intel, Molson, National Public Radio, Scotiabank, Starbucks, and Virgin Group, as well as the Government of Canada. London-based eModeration is another leader, which has 160 moderators with $7 million revenue. Its clients include BBC, the Economist, ESPN, HSBC, Lego,MTV, Oprah, and Sony Ericsson. In 2010, Nestlé’s public relations (PR) department attempted to deal with criticisms from Greenpeace on Nestlé’s Facebook page, which was not professionally moderated. It turned out to be a PR disaster. The experience, judgment, and expertise of moderators would have contained such fire before it exploded.

C h a p t e r 5 G r o w i n g a n d I n t e r n a t i o n a l i z i n g t h e E n t r e p r e n e u r i a l F i r m 131

Fourth, entrepreneurial resources must be organizationally embedded.10 For example, as long as wars are fought, there have been mercenaries for hire. But only in recent times have private military companies (PMCs) become a global industry, thanks to the superb organizational capabilities of entrepreneurial firms such as Blackwater (now known as Xe) (see Strategy in Action 5.2).

Many firms such as New York Times moderate their own websites. But the trend is to increasingly outsource such work to professional online content and community moderation service providers such as ICUC Moderation and eModeration, which typically charges $30 to $40 an hour. However, competition is rapidly becoming global,

with Indian and Philippine service providers offering deals to clients at $5 an hour.

Sources: Based on (1) Bloomberg Businessweek, 2011, The dirtiest job on the Internet, December 5: 95–97; (2) www. emoderation.com; (3) www.icucmoderation.com.

E T H I C A L D I L E M M ASTRATEGY IN ACTION 5.2

Private Military Companies

Private military companies (PMCs) form a $100 billion global industry. Although often stereotyped as “mercenaries,” modern PMCs are professional firms that offer valuable, unique, and hard-to-imitate organizational capabilities in environments that most individuals, firms, and governments, as well as national militaries, would prefer to avoid. Entrepreneurs thrive on chaos. To PMCs, the war in Iraq and Afghanistan has been a pot of gold. As US forces and allies withdraw, PMCs rush in. In Afghanistan, in 2009, PMCs were the largest military force (130,000 personnel), outnumbering both the Afghan National Army (100,000 personnel) and the US (national) forces (64,000 personnel). In Iraq, in 2009, PMCs were the second largest military contingent (about 113,000 personnel) after the US (national) forces (130,000 personnel). Long after the official withdrawal of the US (national) military in Iraq in 2011, PMCs will remain active in the country. The State Department alone will employ 5,000 PMC personnel in Iraq. Although not every EMC directly engages in the battlefield, this line of work is certainly dangerous. PMCs reported 1,800 dead and 40,000 wounded in Iraq and Afghanistan by 2009.

An ethical challenge confronting PMCs is how to responsively deploy their lethal capabilities while getting the job done. In 2007, a furious US Congress held hearings on Blackwater, which, according to the Iraqi government, allegedly killed 17 innocent civilians in Baghdad. Blackwater’s

staunchest defenders tended to be US officials protected by its private soldiers. US officials preferred PMCs because PMC personnel were regarded as more highly trained than (national) military guards. Blackwater’s founder, Erik Prince, told the Congressional committee that “no individual protected by Blackwater has ever been killed or seriously injured,” while 30 of its private soldiers died on the job. After the hearing, Blackwater was banned from operating in Iraq. In 2009, Blackwater rebranded itself as Xe Services LLC (pronounced zee).

Continuously looking for new entrepreneurial opportunities, some PMCs have recently branched into maritime security services, thanks to Somali pirates who attack ships off the coast of Africa. Most recently, what country has commanded a lot of attention from PMCs? Libya.

Sources: Basedon (1)BloombergBusinessweek, 2011,Aswarwinds down in Libya, enter the consultants, September 26: 17–18; (2) Bloomberg Businessweek, 2011, For sale, cheap, December 19: 32–35; (3) Economist, 2007, Blackwater in hot water, October 13: 51; (4) T. Hammes, 2010, Private contractors in conflict zones, Strategic Forum of National Defense University, 260: 1–15; (5) M.W. Peng, 2014, Privatemilitary companies, inM.W. Peng,Global Business, 3rded.,Cincinnati: South-WesternCengageLearning; (6) M. Schwartz, 2009,Department of Defense Contractors in Iraq and Afghanistan,Washington, DC: Congressional Research Service.

132 PART 2 BUSINESS-LEVEL STRATEGIES

Institution-Based Considerations

First introduced in Chapter 4, both formal and informal institutional constraints, as rules of the game, affect entrepreneurship (see Figure 5.1). Although entrepreneurship is thriving around the globe in general, its development is uneven. Whether entrepreneur- ship is facilitated or retarded significantly depends on formal institutions governing how entrepreneurs start up new firms.11 A World Bank survey, Doing Business, reports some striking differences in government regulations concerning how easy it is to start up new entrepreneurial firms in terms of registration, licensing, and incorporation (Figure 5.2). A relatively straightforward (or even “mundane”) task of connecting electricity to a newly built commercial building illustrates such tremendous differences. In general, govern- ments in developed economies impose fewer procedures (an average of 4.6 procedures for OECD high-income countries) and a lower total cost (free in Japan and 5.1% of per capita GDP in Germany). On the other hand, entrepreneurs have to put up with harsher hurdles in poor countries. In a class of its own, Burundi imposes a total cost of 430 times of its per capita GDP for entrepreneurs to obtain electricity. Sierra Leone leads the world in requiring entrepreneurs to spend 441 days to obtain electricity. Overall, it is not surprising that the more entrepreneur-friendly these formal institutional requirements are, the more flourishing entrepreneurship is, and the more developed the economies become—and vice versa. As a result, more countries are now reforming their formal institutions in order to become more entrepreneur-friendly.

FIGURE 5.2 Average Ranking on the Ease of Doing Business

0 20

OECD (high income)

Eastern Europe & Central Asia

East Asia & Pacific

Middle East & North Africa

Latin America & Caribbean

South Asia

Sub-Saharan Africa

40 60 80 100 120 140 160

Ranking: 1−183 out of 183 countries surveyed, the lower the better

Source: Data extracted from World Bank, 2010, Doing Business 2010 (database at www.doingbusiness.org).

C h a p t e r 5 G r o w i n g a n d I n t e r n a t i o n a l i z i n g t h e E n t r e p r e n e u r i a l F i r m 133

In addition to formal institutions, informal institutions such as cultural values and norms also affect entrepreneurship.12 For example, because entrepreneurs necessarily take more risk, individualistic and low uncertainty avoidance societies tend to foster relatively more entrepreneurs, whereas collectivistic and high uncertainty avoidance societies may result in relatively fewer entrepreneurs. Among developed economies, Japan has the lowest rate of start-ups, one-third of America’s rate and half of Europe’s.13 In another example, Russians make heavy use of social networks online, averaging 9.8 hours per month—more than double the world average. While spending that much time online makes sense during the long and cold Russian winter, another important reason is the long-held Russian tradition of relying more on informal information networks for daily life. These informal norms help nurture social network entrepreneurs such as Russia’s Vkontakte and attract foreign entrants such as Facebook.14 Overall, the institution-based view suggests that both formal and informal institutions matter. Later sections will discuss how they matter.

Five Entrepreneurial Strategies This section discusses five entrepreneurial strategies: (1) growth, (2) innovation, (3) network, (4) financing/governance, and (5) harvest/exit. A sixth one, internationali- zation, is covered in the next section.

Growth For many entrepreneurs, the excitement associated with growing a new company is the very thing that attracts them in the first place.15 Recall from the resource-based view that a firm can be conceptualized as a bundle of resources and capabilities. The growth of an entrepreneurial firm can thus be viewed as an attempt to more fully use currently under- utilized resources and capabilities. An entrepreneurial firm can leverage its vision, drive, and leadership in order to grow, even though it may be shorter on resources such as financial capital than a larger firm would be.

Innovation Innovation is at the heart of an entrepreneurial mindset.16 Israeli SMEs, for example, are known for their formidable innovation capabilities (see Emerging Markets 5.1). Well- known examples include firewalls (Checkpoint) and ICQ instant messaging software (Mirabilis) as well as the Pentium chip (developed by Intel’s subsidiary in Israel).17

An innovation strategy is a specialized form of differentiation strategy (see Chapter 2). It offers three advantages. First, it allows a potentially more sustainable basis for compe- titive advantage. Firms first to introduce new goods or services are likely to earn (quasi) “monopoly profits” until competitors emerge. If entrepreneurial firms come up with “disruptive technologies,” then they may redefine the rules of competition, thus wiping out the advantages of incumbents.18

Second, innovation should be regarded broadly. Not only are technological break- throughs innovations, less novel but still substantially new ways of doing business are also

134 PART 2 BUSINESS-LEVEL STRATEGIES

innovations. Most start-ups reproduce existing organizational routines, but recombine them to create some novel product/service offerings, such as FedEx’s (re)combination of existing air and ground assets to create a new market.

Entrepreneurial firms are uniquely ready for innovation. Owners, managers, and employees at entrepreneurial firms tend to be more innovative and risk taking than those at large firms. In fact, many SMEs are founded by former employees of large firms who were frustrated by their inability to translate innovative ideas into realities at the large firms. A group of programmers at IBM’s German affiliate proposed to IBM that standard programming solutions could be profitably sold to clients. After their ideas were turned down, they left and founded SAP, now the number one player in the thriving enterprise resource planning (ERP) market. Innovators at large firms also have limited ability to personally profit from their innovations because property rights usually belong to the corporation. In contrast, innovators at entrepreneurial firms are better able to reap the financial gains associated with innovation, thus fueling their motivation to charge ahead.

EMERGING MARKETS 5.1

Israel: The Start-Up Nation

The young must shout if they want to be heard. In a stone hanger in the old port of Jaffa, 30 entrepreneurs have five minutes each to present their start-up companies to a panel of digital luminaries and an audience that includes potential investors. Not everyone in the room is ready to shut up and listen, so the hopefuls must battle against the din. Feng-GUI explains how, by simulating human vision, it can tell advertisers and designers which areas of a web page are most likely to grab people’s attention. CopyV promises to send large files quickly and securely. With Fooducate, “a dietician in your pocket,” on your smartphone, you can scan bar codes in the supermarket and find out what’s really going into your trolley.

Israel’s legions of young technology firms clamor for attention and money. Rapid-pitch events like this one, at DLD Tel Aviv, a two-day conference in November, are common. More than 300 firms applied for a slot at DLD; 100 turned up; the lucky 30 were chosen by raffle. Yossi Vardi, a technology entrepreneur who has invested in 75 start-ups since 1996, says that he receives between three and eight approaches every day.

Dan Senor and Saul Singer called Israel The Start-Up Nation in a book of that name in 2009. The label has stuck

because it fits. Everybody and his brother-in-law seems to be starting a company—with old schoolmates or army colleagues, in a spare room or the parental home. Starting a business is easier than ever, thanks to advances in information technology. Budding designers of smartphone apps can rent space when they need it on a remote server rather than buying huge amounts of computing power. “The Internet has democratized the right to innovate,” says Mr. Vardi.

Israelis innovate because they have to. The land is arid, so they excel at water and agricultural technology. They have little oil, so they furrow their brows to find alternatives. They are surrounded by enemies, so their military technology is superb and creates lucrative spin- offs, especially in communications. The relationships forged during military service foster frenetic networking in civilian life. A flood of immigrants in the 1990s gave national brainpower a mighty boost. The results are the envy of almost everyone outside Silicon Valley.

Source: Excerpted from Economist, 2012, What next for the start-up nation? January 21: 69–70. © The Economist.

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Network A network strategy refers to intentionally constructing and tapping into relationships, connections, and ties that individuals and organizations have.19 There are two kinds of networks: personal and organizational. Both are important. Prior to and during the founding phase of the entrepreneurial firm, these two networks overlap significantly. In other words, entrepreneurs’ personal networks are essentially the same as the firm’s organizational networks.20 The essence of entrepreneurship can be regarded as a process to “translate” personal networks into value-adding organizational networks. Three attributes—namely, urgency, intensity, and impact—distinguish entrepreneurial networking.

First, entrepreneurial firms have a high degree of urgency to develop and leverage networks. They confront a liability of newness, defined as the inherent disadvantage that entrepreneurial firms experience as new entrants. In the absence of a track record (many start-ups only have an idea), start-ups do not inspire confidence and lack legitimacy in the eyes of suppliers, customers, financiers, and other stakeholders. Therefore, start-ups urgently need to draw upon entrepreneurs’ social networks to overcome the liability of newness. Convincing more legitimate and well-established individuals (as co-founders, management team members, investors, or board directors) and organizations (as alliance partners, sponsors, or customers) to lend a helping hand can boost the legitimacy of start-ups. In other words, legitimacy, an intangible but highly important resource, can be transferred.21

A second characteristic that distinguishes entrepreneurial networking is its intensity. Network relationships can be classified as strong ties and weak ties. Strong ties are more durable, reliable, and trustworthy relationships, whereas weak ties are less durable, reliable, and trustworthy. Efforts to cultivate, develop, and maintain strong ties are usually more intense than weak ties. Entrepreneurs often rely on strong ties—typically 5–20 individuals—for advice, assistance, and support. Over time, the preference for strong ties may change, and the benefits of weak ties may emerge (see the next section).

Finally, because of the small firm size, the contributions of entrepreneurs’ personal networks tend to have a stronger impact on firm performance.22 In comparison, the impact of similar networks cultivated by managers at large firms may be less pronounced because of these firms’ sheer size. Moreover, being private owners, entrepreneurs can directly pocket the profits if their firms perform well, thereby motivating them to make these networks work.

Overall, there is strong evidence that networks, both personal and organizational, represent significant resources and opportunities and that successful networking may lead to successful entrepreneurial performance. The most advantageous positions are those well connected to a number of players who are otherwise not connected—in other words, more centrally located network positions are helpful. Armed with useful ties and contacts, entrepreneurs, therefore, can literally become “persons who add value by brokering the connection between others.”23 Remember, this indeed is the original mean- ing of the word entrepreneurs.

Financing and Governance All start-ups need to raise capital.24 Here is a quiz (also a joke): Of the “4F” sources of entrepreneurial financing, the first three Fs are founders, family, and friends, but what is

liability of newness

The inherent disadvantage that entrepreneurial firms experience as new entrants.

strong ties

More durable, reliable, and trustworthy relationships cultivated over a long period of time.

weak ties

Relationships that are characterized by infrequent interaction and low intimacy.

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the other F source? The answer is… fools (!). While this is a joke, it strikes a chord in the entrepreneurial world: Given the well-known failure risks of start-ups (a majority of them will fail), why would anybody other than fools be willing to invest in start- ups? In reality, most outside, strategic investors, who can be angels (wealthy indivi- dual investors), venture capitalists (VCs), banks, foreign entrants, and government agencies, are not fools. They often examine business plans, require a strong manage- ment team, and scrutinize financial reviews and analysis. They also demand some assurance (such as collateral) indicating that entrepreneurs will not simply “take the money and run.” Entrepreneurs need to develop relationships with these outside investors, some of which are weak ties. Turning weak-tie contacts into willing investors is always challenging.25

While dealing with strong-tie contacts can be quite informal (based on handshake deals or simple contracts), working with weak-tie contacts may be more formal. In the absence of a long history of interaction, weak-tie investors such as angels and VCs often demand a more formal governance structure to safeguard their investment, through a significant percentage of equity (such as 20%–40%), a corresponding number of seats on the board of directors, and a set of formal rules and policies.26 In extreme cases, when business is not going well, VCs may exercise their formal voting power and dismiss the founder CEO. Entrepreneurs, therefore, have to make tradeoffs given the need for larger- scale financing and the necessity to cede a significant portion of ownership and control rights of their “dream” firms.

Given the well-known hazards associated with start-up risks, anything that entrepre- neurs can do to improve their odds would be helpful. The odds for survival during the crucial early years are significantly correlated with firm size—the larger, the better (Table 5.1). The upshot is that the faster start-ups can reach a certain size, the more likely they will survive the first few years in the face of the liability of newness. Since it takes a significant amount of capital to reach a large size, entrepreneurs often make the choice of accepting more outside investment and agreeing to give up some ownership and control rights.27

TABLE 5.1 One-Year and Four-Year Survival Rates by Firm Size

FIRM SIZE (EMPLOYEES)

CHANCES OF SURVIVING AFTER 1 YEAR

FIRM SIZE (EMPLOYEES)

CHANCES OF SURVIVING AFTER 4 YEARS

0–9 78% 0–19 50%

10–19 86% 20–49 67%

20–99 95% 50–99 67%

100–249 95% 100–499 70%

250+ 100%

Source: Adapted from J. Timmons, 1999, New Venture Creation (p. 33), Boston: Irwin McGraw-Hill, based on US data.

venture capitalist (VC)

An investor who invests capital in early-stage, high-potential start-ups.

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Internationally, the extent to which entrepreneurs draw on resources of family and friends vis-à-vis formal outside investors (such as VCs) is different. Global Entrepreneur- ship Monitor reported that Sweden, South Africa, Belgium, and the United States lead the world in VC investment as a percentage of GDP.28 In contrast, Greece and China have the lowest level of VC investment. On the other hand, China leads the world with the highest level of informal investment from family and friends as a percentage of GDP. In comparison, Brazil and Hungary, on the other hand, have the lowest level of informal investment. While there is a lot of noise in such worldwide data, the case of China (second lowest in VC investment and highest in informal investment) is easy to explain: China’s lack of formal market-supporting institutions, such as VCs and credit-reporting agencies, requires a high level of informal investment for Chinese entrepreneurs and new ventures, particularly during a time of entrepreneurial boom.29

A highly innovative solution, called microfinance, has emerged in response to the lack of financing for entrepreneurial opportunities in many countries. Microfinance involves lending small sums ($50–$300) used to start small businesses with the intention of ultimately lifting the entrepreneurs out of poverty. Starting in the 1970s in countries such as Bangladesh and India, microfinance has now become a global movement and has become controversial lately (see the Closing Case).

Harvest and Exit Outlined in Table 5.2, entrepreneurial harvest and exit can take a number of routes. First, selling an equity stake to outside strategic investors (discussed earlier) can substantially increase the value of the firm and therefore offer an excellent harvest option. However, entrepreneurs must be willing to give up some ownership and control rights.

Second, selling the firm to other private owners or companies may be done with a painful discount if the business is failing, or it may carry a happy premium if the business is booming.30 Selling the firm is typically one of the most significant and emotionally charged events entrepreneurs confront. It is important to note that “selling out” does not necessarily mean failure. Many entrepreneurs deliberately build up businesses in antici- pation of being acquired by larger corporations and profiting handsomely.

Third, when a business is not doing well, merging with another company is another alternative. The drawbacks are that the firm may lose its independence and that some entrepreneurs may have to personally exit the firm to leave room for executives from another company. It is obvious that a lackluster entrepreneurial firm is not in a great position to bargain for a good deal. However, if properly structured and negotiated, a merger will allow entrepreneurs to reap the rewards for which they have worked so hard.

TABLE 5.2 Routes of Entrepreneurial Harvest and Exit

& Selling an equity stake & Selling the business & Merging with another firm & Considering an initial public offering (IPO) & Declaring bankruptcy

microfinance

A practice to provide microloans ($50–$300) to start small businesses with the intention of ultimately lifting the entrepreneurs out of poverty.

ga ge

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Fourth, entrepreneurs can take their firms through an initial public offering (IPO), which is the goal of many entrepreneurs. An IPO has several advantages and disadvantages (Table 5.3). Among the advantages, first and foremost is financial stability, in that the firm no longer has to constantly “beg” for money. For entrepre- neurs themselves, an IPO can potentially result in financial windfalls. For the firm, stock options can be issued as incentives to motivate, attract, and retain capable employees. The IPO is also a great signal indicating that the firm has “made it.” Such an enhanced reputation enables it to raise more capital to facilitate future growth such as acquisitions.

On the other hand, an IPO carries a number of nontrivial disadvantages. The firm is being subject to the rational and irrational exuberance (and also pessimism) of the financial market. After the IPO, founding entrepreneurs may gradually lose their majority control. The firm, legally speaking, is no longer “theirs.” Instead, founding entrepreneurs have the new fiduciary duty to look after the interests of outside shareholders. As a result, certain constraints restrict entrepreneurs’ freedom of action. They are being scrutinized by securities authorities, shareholders, and the media, which often force firms to focus on the short term. There is also a loss of privacy, as information about personal wealth, shareholding, and compensation must be disclosed. In a worst case, the founder can be ousted by new management—a humiliation Apple co-founder Steve Jobs suffered in 1985. Because of these concerns, some entrepreneurs, such as Ingvar Kamprad, founder of the Swedish furniture chain IKEA, and Tadao Yoshida, founder of the Japanese zipper giant YKK, have refused to go public.31

Finally, while taking the firm through an IPO is the most triumphant way of harvest, many entrepreneurial firms that are failing do not have such a luxury. The only viable exit is often to declare bankruptcy (see the Debates and Extensions section for some details).

Overall, a number of harvest and exit options are available to entrepreneurs. For instance, they are encouraged to think about the exit plan early in the business cycle and aim at maximizing the gains from the fruits of their labor. Otherwise, they may end up having to eventually declare bankruptcy and face the consequences—definitely not something they planned on.

TABLE 5.3 Advantages and Disadvantages of an Initial Public Offering (IPO)

ADVANTAGES DISADVANTAGES

& Improved financial condition & Access to more capital & Diversification of shareholder base & Ability to cash out & Management and employee incentives & Enhanced corporate reputation & Greater opportunity for future acquisitions

& Subject to the whims of financial market & Forced to focus on the short term & Loss of entrepreneurial control & New fiduciary responsibilities for shareholders & Loss of privacy & Limits on management’s freedom of action & Demands of periodic reporting

initial public offering (IPO)

The first round of public trading of company stock.

ga ge

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Internationalizing the Entrepreneurial Firm There is a myth that only large MNEs do business abroad and that SMEs mostly operate domestically. This myth, based on historical stereotypes, is being increasingly challenged as more SMEs go international.32 Further, some start-ups attempt to do business abroad from inception. These are often called born global firms (or international new ventures).33

This section examines how entrepreneurial firms internationalize.

Transaction Costs and Entrepreneurial Opportunities Compared with domestic transaction costs (the costs of doing business), international transaction costs are qualitatively higher. Some costs are high due to numerous innocent differences in formal institutions and informal norms (see Chapter 4). Other costs, however, may be due to a high level of deliberate opportunism that is hard to detect and remedy. For example, when a small manufacturer in Texas with $5 million annual revenues receives an unsolicited order of $1 million from an unknown buyer in Alaska, most likely the Texas firm will fill the order and allow the Alaska buyer to pay within 30 or 60 days after receiving the goods—a typical practice among domestic transactions in the United States. But what if this order comes from an unknown buyer (importer in this case) in Azerbaijan? If the Texas firm ships the goods but foreign payment does not arrive on time (after 30, 60, or even more days), it is difficult to assess whether firms in Azerbaijan simply do not have the norm of punctual payment or that particular importer is being deliberately opportunistic. If the latter is indeed the case, suing the importer in a court in Azerbaijan where Azeri is the official language may be so costly that it is not an option for a small US exporter.

Maybe the Azerbaijani importer is an honest and capable firm with every intention and ability to pay. But because the Texas firm may not be able to ascertain, prior to the transaction, that the Azerbaijani side will pay upon receiving the goods, the Texas firmmay simply say “No, thanks!” Conceptually, this is an example of transaction costs being so high that many firms may choose not to pursue international opportunities. Therefore, entrepreneurial opportunities exist to lower transaction costs and bring distant groups of people, firms, and countries together. Table 5.4 shows that while entrepreneurial firms can internationalize by entering foreign markets, they can also add an international dimension without actually going abroad. Next, we discuss how an SME can undertake some of these strategies.

TABLE 5.4 Internationalization Strategies for Entrepreneurial Firms

ENTERING FOREIGN MARKETS STAYING IN DOMESTIC MARKETS

& Direct exports & Franchising/licensing & Foreign direct investment (through greenfield

wholly owned subsidiaries, strategic alliances, and/or foreign acquisitions)

& Indirect exports (through domestic export intermediaries)

& Supplier of foreign firms & Franchisee/licensee of foreign brands & Alliance partner of foreign direct investors & Harvest and exit (through sell-off to foreign

entrants)

born global firm (international new venture)

A start-up company that attempts to do business abroad from inception.

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International Strategies for Entering Foreign Markets SMEs can enter foreign markets through three broad modes: (1) direct exports, (2) licensing/franchising, and (3) foreign direct investment (FDI) (see Chapter 6 for more details). First, direct exports entail the sale of products made by entrepreneurial firms in their home country to customers in other countries. This strategy is attractive because entrepreneurial firms are able to reach foreign customers directly. When domestic markets experience some downturns, sales abroad may compensate for such drops. However, a major drawback is that SMEs may not have enough resources to turn overseas opportunities into profits.

A second way to enter international markets is through licensing and/or franchising. Usually used in manufacturing industries, licensing refers to Firm A’s agreement to give Firm B the rights to use A’s proprietary technology (such as a patent) or trademark (such as a corporate logo) for a royalty fee paid to A by B. Assume (hypothetically) that a US exporter cannot keep up with demand in Turkey. It may consider granting a Turkish firm the license to use its technology and trademark for a fee. Franchising is essentially the same idea, except it is typically used in service industries such as fast food. A great advantage is that SME licensors and franchisors can expand abroad while risking rela- tively little of their own capital. Foreign firms interested in becoming licensees or franchisees have to put their own capital up front. For example, a McDonald’s franchise now costs the franchisee approximately $1 million. But licensors and franchisors also take a risk because they may suffer a loss of control over how their technology and brand names are used. If a (hypothetical) McDonald’s licensee in Finland produces sub-standard products that damage the brand and refuses to improve quality, McDonald’s has two difficult choices: (1) sue its licensee in an unfamiliar Finnish court or (2) discontinue the relationship. Either choice is complicated and costly.

A third entry mode is FDI, which may involve greenfield wholly owned subsidiaries (see Chapter 6), strategic alliances with foreign partners (see Chapter 7), and acquisi- tions of foreign firms (see Chapter 9). By planting some roots abroad, a firm becomes more committed to serving foreign markets. It is physically and psychologically closer to foreign customers. Relative to licensing and franchising, a firm is better able to control how its proprietary technology is used. However, FDI has a major drawback: its cost and complexity. It requires both a nontrivial sum of capital and a significant managerial commitment.

While many entrepreneurial firms have aggressively gone abroad, it is probably true that a majority of SMEs will be unable to do so; they already have enough headaches struggling with the domestic market. However, as discussed next, some SMEs can still internationalize by staying at home.

International Strategies for Staying in Domestic Markets Table 5.4 also shows a number of strategies for entrepreneurial SMEs to internationalize without leaving their home country. The five main strategies are (1) export indirectly, (2) become suppliers for foreign firms, (3) become licensees or franchisees of foreign brands, (4) become alliance partners of foreign direct investors, and (5) harvest and exit through sell-offs.

direct exports

Directly selling products made in the home country to customers in other countries.

licensing

Firm A’s agreement to give Firm B the rights to use A’s proprietary technology (such as a patent) or trademark (such as a corporate logo) for a royalty fee paid to A by B. This term is typically used in manufacturing industries.

franchising

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First, whereas direct exports may be lucrative, many SMEs simply do not have the resources to handle such work. But they can still reach overseas customers through indirect exports, which involve exporting through domestic-based export intermediaries. Export intermediaries perform an important middleman function by linking domestic sellers and overseas buyers who otherwise would not have been connected.34 Being entrepreneurs themselves, export intermediaries facilitate the internationalization of many SMEs.35

A second strategy is to become a supplier for a foreign firm that is doing business in the domestic market. For example, when Subway opened restaurants in Northern Ireland, it secured a contract for chilled part-bake bread with a domestic bakery. This relationship was so successful that the firm now supplies Subway franchisees throughout Europe. SME suppliers thus may be able to internationalize by piggybacking on the larger foreign entrants.

Third, an entrepreneurial firm may consider becoming licensee or franchisee of a foreign brand. Foreign licensors and franchisors provide training and technology transfer—for a fee, of course. Consequently, an SME can learn a great deal about how to operate at world-class standards. Further, if enough learning has been accomplished, it is possible to discontinue the relationship and to reap greater entrepreneurial profits. In Thailand, Minor Group, which had held the Pizza Hut franchise for 20 years, broke away from the relationship. Then its new venture, The Pizza Company, became the market leader in Thailand.36

A fourth strategy is to become an alliance partner of a foreign direct investor.37 Facing an onslaught of aggressive MNEs, many entrepreneurial firms may not be able to successfully defend their market positions. Then it makes great sense to follow the old adage, “If you can’t beat them, join them!” While dancing with the giants is tricky, it is better than being crushed by them.

Finally, as a harvest and exit strategy, entrepreneurs may sell an equity stake or the entire firm to foreign entrants.38 An American couple, originally from Seattle, built a Starbucks-like coffee chain in Britain called Seattle Coffee. When Starbucks entered Britain, the couple sold the chain of 60 stores to Starbucks for a hefty $84 million. In light of the high failure rates of start-ups (see the next section), being acquired by foreign entrants may help preserve the business in the long run.

Debates and Extensions The entrepreneurial boom throughout the world has attracted significant controversies and debates. This section introduces three leading debates: (1) traits versus institutions, (2) slow versus rapid internationalization, and (3) anti-failure biases versus entrepreneur- friendly bankruptcy laws.

Traits versus Institutions This is probably the oldest debate on entrepreneurship. It focuses on the question: What motivates entrepreneurs to establish new firms, while most others are simply content to work for bosses? The “traits” school of thought argues that it is personal traits that matter. Compared with non-entrepreneurs, entrepreneurs seem more likely to possess a stronger desire for achievement and are more willing to take risks and tolerate ambiguities. Overall,

indirect exports

Exporting indirectly through domestic-based export intermediaries.

export intermediary

A firm that performs an important middleman function by linking domes- tic sellers and foreign buyers that otherwise would not have been connected.

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entrepreneurship inevitably deviates from the norm to work for others, and this deviation may be in the “blood” of entrepreneurs.39 For instance, serial entrepreneurs are people who start, grow, and sell several businesses throughout their career. One example is David Neeleman, who as a serial entrepreneur has founded four airlines in three countries (Morris Air and JetBlue in the United States, WestJet in Canada, and Azul in Brazil).40

Critics, however, argue that some of these traits, such as a strong achievement orienta- tion, are not necessarily limited to entrepreneurs, but instead are characteristic of many successful individuals. The diversity among entrepreneurs makes any attempt to develop a standard psychological or personality profile futile. Critics suggest what matters is institu- tions—namely, the environments that set formal and informal rules of the game. Consider the ethnic Chinese, who have exhibited a high degree of entrepreneurship throughout Southeast Asia. As a minority group (usually less than 10% of the population in countries such as Indonesia and Thailand), ethnic Chinese control 70%–80% of the wealth in the region. Yet, in mainland China, for three decades (the 1950s to the 1970s), there had been virtually no entrepreneurship, thanks to harsh communist policies. Over the past three decades, however, as government policies became relatively more entrepreneur-friendly, the institutional transitions have opened the floodgates of entrepreneurship in China.41

A high-profile case documents how institutions constrain or enable entrepreneurship. In 2005, Chinese Internet start-up Baidu listed on NASDAQ and its shares surged 354% on the same day (from $27 to $154), scoring the biggest one-day stock surge in US capital markets since 2000. While there might be some “irrational exuberance” among US investors chasing “China’s Google,” it is evident that they did not discriminate against Baidu. The sad reality for Baidu is that, at home, it was blatantly discriminated against by the Chinese securities authorities. As a private start-up, it was not allowed to list its stock on China’s stock exchanges—only state-owned firms need apply. Essentially, Baidu was pushed out of China to list in the United States, whose entrepreneur-friendly institutional frameworks, such as NASDAQ regulations, are able to facilitate more entrepreneurial success.42 In a nutshell, it is not what is in people’s “blood” that makes or breaks entrepreneurship—it is institutions that encourage or constrain entrepreneurship.

Beyond the macro societal-level institutions, more micro institutions also matter. Family background and educational attainment have been found to correlate with entrepreneurship. Children of wealthy parents, especially those who own businesses, are more likely to start their own firms. So are people who are better educated. Taken together, informal norms governing one’s socioeconomic group, in terms of whether starting a new firm is legitimate or not, assert some powerful impact on the propen- sity to create new ventures. Overall, this debate is an extension of the broader debate on “nature versus nurture.” Most scholars now agree that entrepreneurship is the result of both nature and nurture.

Slow Internationalizers versus Born Global Start-ups Two components should be considered here: (1) Can SMEs internationalize faster than what has been suggested by traditional stage models (models that portray SME internationalization as a slow, stage-by-stage process)? (2) Should they rapidly interna- tionalize? The dust has largely settled on the first component: it is possible for some (but not all) SMEs to make very rapid progress in internationalization. Consider Logitech, now

serial entrepreneur

An entrepreneur who starts, grows, and sells several businesses throughout his/her career.

stage model

Model that suggests firms internationalize by going through predictable stages from simple steps to complex operations.

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a global leader in computer peripherals. It was established by entrepreneurs from Switzer- land and the United States, where the firm set up dual headquarters. Research and development (R&D) and manufacturing were initially split between these two countries and then quickly spread to Ireland and Taiwan through FDI. Its first commercial contract was with a Japanese company. Logitech is not alone among such born global firms.

What is currently being debated is the second component.43 On the one hand, advocates argue that every industry has become “global” and that entrepreneurial firms need to rapidly go after these opportunities.44 On the other hand, stage models suggest that firms need to enter culturally and institutionally close markets first, spend enough time there to accumulate overseas experience, and then gradually move from more primitive modes such as exports to more sophisticated strategies such as FDI in distant markets. Consistent with stage models, Sweden’s IKEA waited 20 years (1943–1963) before entering a neighboring country, Norway. Only more recently has it accelerated its internationalization. Stage models caution that inexperienced swimmers may drown in unfamiliar foreign waters.

A key issue, therefore, is whether it is better for entrepreneurs to start the interna- tionalization process soon after founding (as born global firms do) or to postpone until the firm has accumulated significant resources (as IKEA did). One view supports rapid internationalization. Specifically, firms following the prescription of stage models, when eventually internationalizing, must overcome substantial inertia because of their domestic orientation.45 In contrast, firms that internationalize earlier need to overcome fewer of these barriers. Therefore, SMEs without an established domestic orientation (such as Logitech discussed earlier) may outperform their rivals that wait longer to internation- alize.46 In other words, contrary to the inherent disadvantages in internationalization associated with SMEs as suggested by stage models, there may be “inherent advantages” of being small while venturing abroad.

On the other hand, some scholars argue that “the born-global view, although appeal- ing, is a dangerous half-truth.” They maintain that “You must first be successful at home, then move outward in a manner that anticipates and genuinely accommodates local differences.”47 In other words, the teachings of stage models are still relevant. Conse- quently, indiscriminate advice to “go global” may not be warranted.48

Anti-Failure Biases versus Entrepreneur-Friendly

Bankruptcy Laws49

Corporate bankruptcies have climbed to new heights in the Great Recession (note “bankruptcy” here refers only to corporate bankruptcy; we do not consider personal bank- ruptcy). Firms ranging from huge ones such as General Motors to tiny entrepreneurial outfits have dropped out left and right around the world. Since bankruptcies do not sound too good or inspiring, is there anything that we—the government, financial institutions, consumers, or the society at large—can do to prevent widespread bankruptcies?

Efforts to rescue failing firms from bankruptcies stem from an “anti-failure” bias widely shared among entrepreneurs, scholars, journalists, and government officials. Although a majority of entrepreneurial firms fail, this “anti-failure” bias leads to strong interest in entrepreneurial success (remember how many times Google and Facebook were written up by the press?), and to scant attention devoted to the vast

144 PART 2 BUSINESS-LEVEL STRATEGIES

majority of entrepreneurial firms that end up in failure and bankruptcy. However, one perspective suggests that bankruptcies, which are undoubtedly painful to individ- ual entrepreneurs and employees, may be good for the society. Consequently, bank- ruptcy laws need to be reformed to become more entrepreneur-friendly by making it easier for entrepreneurs to declare bankruptcies and to move on. Consequently, financial, human, and physical resources stuck with failed firms can be redeployed in a socially optimal way.

A leading debate is how to treat failed entrepreneurs who file for bankruptcy. Do we let them walk away from debt or punish them? Historically, entrepreneur-friendliness and bankruptcy laws are like an “oxymoron,” because bankruptcy laws are usually harsh and even cruel. The very term “bankruptcy” is derived from a harsh practice: In medieval Italy, if bankrupt entrepreneurs did not pay their debt, debtors would destroy the trading bench (booth) of the bankrupt—the Italian word for broken bench, “banca rotta,” has evolved into the English word “bankruptcy.” The pound of flesh demanded by the creditor in Shakespeare’s The Merchant of Venice is only a slight exaggeration. The world’s first bankruptcy law, passed in England in 1542, considered a bankrupt individual a criminal and penalties ranged from incarceration to death sentence.

Recently, many governments have realized that entrepreneur-friendly bankruptcy laws can not only lower exit barriers, but also lower entry barriers. Although we are confident that many start-ups will fail, at present it is impossible to predict which ones will go under. Thus, from an institution-based standpoint, if entrepreneurship is to be encouraged, there is a need to ease the pain associated with bankruptcy by means such as allowing entrepreneurs to walk away from debt, a legal right that bankrupt US entrepreneurs appreciate. In contrast, until the recent bankruptcy law reforms, bankrupt German entrepreneurs might remain liable for unpaid debt for up to 30 years. Further, German and Japanese managers of bankrupt firms can also be liable for criminal penalties. Numerous bankrupt Japanese entrepreneurs have com- mitted suicide. As rules of the “end game,” harsh bankruptcy laws thus become grave exit barriers. They can also be significant entry barriers, as fewer would-be entrepre- neurs may decide to launch their ventures.

At a societal level, if many would-be entrepreneurs abandon their ideas in fear of failure, there will not be a thriving entrepreneurial sector. Given the risks and uncer- tainties, it is not surprising that many entrepreneurs do not make it the first time. However, if they are given second, third, or more chances, some of them will succeed. Approximately 50% of US entrepreneurs who filed bankruptcy resumed a new venture in four years. This high level of entrepreneurialism is, in part, driven by the relatively entrepreneur-friendly bankruptcy laws in the United States (such as the provision of Chapter 11 bankruptcy reorganization, instead of straight liquidation). On the other hand, a society that severely punishes failed entrepreneurs (such as forcing financially insolvent firms to liquidate) is not likely to foster widespread entrepreneurship. Overall, worldwide evidence from 29 countries—involving both developed and emerging economies—has identified a strong linkage between entrepreneur-friendly bankruptcy laws and new firm entries.50

Institutionally, there is an urgent need to remove some of our anti-failure bias and design entrepreneur-friendly bankruptcy policies so that failed entrepreneurs are given more chances. At a societal level, entrepreneurial failures may be beneficial, since it is

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through a large number of entrepreneurial experimentations—although many will fail— that winning solutions will emerge and that economies will develop. In short, the boom in busts is not necessarily bad.51

The Savvy Entrepreneur Entrepreneurs and their firms are quintessential engines of the “creative destruction” process underpinning global capitalism first described by Joseph Schumpeter. All three leading perspectives can shed considerable light on entrepreneurship. The industry- based view suggests that entrepreneurial firms tend to choose industries with lower entry barriers. The resource-based view posits that it is largely intangible resources such as vision, drive, and willingness to take risk that have been fueling entrepreneurship. Finally, the institution-based view argues that the larger institutional frameworks explain a great deal about what is behind the differences in entrepreneurial and economic development around the world.

Consequently, the savvy entrepreneur can draw at least four important implications for action (Table 5.5). (1) Establish an intimate understanding of your industry to identify gaps and opportunities, or, alternatively, to avoid or exit from it if the threats are too strong. (2) Leverage entrepreneurial resources and capabilities, such as entrepreneurial drive, innova- tive capabilities, and network ties. (3) Push for more entrepreneur-friendly formal institu- tions, such as rules governing how to set up new firms (Figure 5.2) and how to go through bankruptcy. Entrepreneurs also need to cultivate strong informal norms granting legitimacy to start-ups. Talking to high school and college students, taking on internships, and providing seed money as angels for new ventures are some of the actions that entrepreneurs can undertake. (4) When internationalizing, be bold but not too bold.52 Being bold does not mean being reckless. One specific insight from this chapter is that it is possible to inter- nationalize without venturing abroad. There are a variety of international strategies that enable entrepreneurial firms to stay in domestic markets. When the entrepreneurial firm is not ready to take on higher risk abroad, this more limited involvement may be appropriate.

We conclude this chapter by revisiting the four fundamental questions. Because start-ups are an embodiment of the personal characteristics of their founders, why firms differ (Question 1) and how they behave (Question 2) can be found in how entrepreneurs differ from non-entrepreneurs. What determines the scope of the firm (Question 3) boils down to how successful entrepreneurs can expand their businesses. Finally, what determines the international success and failure of firms (Question 4) depends on whether entrepreneurs can select the right industry, leverage their capabilities, and take advantage of formal and informal institutional resources—both at home and abroad.53

TABLE 5.5 Strategic Implications for Action

& Establish an intimate understanding of your industry to identify gaps and opportunities. & Leverage entrepreneurial resources and capabilities. & Push for institutions that facilitate entrepreneurship development—both formal and informal. & When internationalizing, be bold, but not too bold.

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CHAPTER SUMMARY

1. Define entrepreneurship, entrepreneurs, and entrepreneurial firms • Entrepreneurship is the identification and exploration of previously unexplored opportunities. • Entrepreneurs may be founders and owners of new businesses or managers of existing firms. • Entrepreneurial firms in this chapter are defined as SMEs.

2. Articulate a comprehensive model of entrepreneurship • Five forces of an industry shape entrepreneurship associated with this industry. • Resources and capabilities largely determine entrepreneurial success and failure. • Institutions enable and constrain entrepreneurship around the world.

3. Identify five strategies that characterize a growing entrepreneurial firm • (1) Growth, (2) innovation, (3) network, (4) financing/governance, and (5) harvest/exit.

4. Differentiate international strategies that enter foreign markets and that stay in domestic markets • Entrepreneurial firms can internationalize by entering foreign markets, through entry modes such as (1) direct exports, (2) licensing/franchising, and (3) FDI.

• Entrepreneurial firms can also internationalize without venturing abroad, by (1) exporting indirectly, (2) supplying foreign firms, (3) becoming licensees/franchisees of foreign firms, (4) joining foreign entrants as alliance partners, and (5) harvesting and exiting through sell-offs to foreign entrants.

5. Participate in three leading debates concerning entrepreneurship • (1) Traits versus institutions, (2) slow versus rapid internationalization, and (3) anti-failure biases versus entrepreneur-friendly bankruptcy laws.

6. Draw strategic implications for action • Establish an intimate understanding of your industry to identify gaps and opportunities. • Leverage entrepreneurial resources and capabilities. • Push for institutions that facilitate entrepreneurship development. • When internationalizing, be bold, but not too bold.

KEY TERMS

Born global firm (international new venture) p. 140

Direct export p. 141

Entrepreneur p. 128

Entrepreneurship p. 128

Export intermediary p. 142

Franchising p. 141

Indirect export p. 142

Initial public offering (IPO) p. 139

International entrepreneurship p. 128

Liability of newness p. 136

Licensing p. 141

Microfinance p. 138

Serial entrepreneur p. 143

Small and medium-sized enterprise (SME) p. 128

Stage model p. 143

Strong ties p. 136

Venture capitalist (VC) p. 137

Weak ties p. 136

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CRITICAL DISCUSSION QUESTIONS

1. Why is entrepreneurship most often associated with SMEs, as opposed to larger firms?

2. Given that most entrepreneurial start-ups fail, why do entrepreneurs found so many new firms? Why are (most) governments interested in promoting more start-ups?

3. ON ETHICS: Your former high school buddy invites you to join a start-up that specializes in making counterfeit products. She offers you the job of CEO and 10% of the equity of the firm. The chances of getting caught are slim. You are currently unemployed. How would you respond to her proposition?

TOPICS FOR EXPANDED PROJECTS

1. Some suggest that foreign markets are graveyards for entrepreneurial firms to overextend themselves. Others argue that foreign markets represent the future for SMEs. If you were the owner of a small, reasonably profitable firm, would you consider expanding overseas? Why or why not? Write a short paper to state your case.

2. ON ETHICS: Everything is the same as in Critical Discussion Question 3, except the “counterfeit” products involved are the more affordable generic drugs to combat HIV/ AIDS. Providing these drugs at a lower cost would potentially help millions of patients worldwide who cannot afford the high-priced patented drugs. How would you respond? Write a short paper to explain your answer.

3. ON ETHICS: Some argue that entrepreneur-friendly bankruptcy laws, which may allow entrepreneurs to walk away from their debt, are unethical because they increase the cost of financing for everybody. Review the arguments in the Debates and Extensions section. Working in small groups, discuss the arguments and then decide whether you support or do not support more entrepreneur-friendly bankruptcy laws. Present your answers in a short paper or a visual presentation.

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E T H I C A L D I L E M M ACLOSING CASE

Emerging Markets: Microfinance, Macro Success or Global Mess?

Teach a man to fish, and he’ll eat for a lifetime. However, here is a catch: In many poor developing countries, numer- ous eager fishermen—also known as entrepreneurs— cannot afford a fishing pole. In 1976, Muhammad Yunus, a young economics professor who received his PhD from Vanderbilt University, lent $27 out of his own pocket to a group of poor craftsmen in his native Bangladesh. He also helped found a village-based enterprise called the Gra- meen Project. It never occurred to Yunus that he would inspire a global movement for entrepreneurial financing, much less that 30 years later, in 2006 he and the Grameen Bank he founded would be awarded the Nobel Peace Prize.

Used to buy everything from milk cows to mobile phones (to be used as pay phones by the entire village), microloans (typically $50–$300) can make a huge differ- ence. The poor tend to have neither assets (necessary for collateral) nor credit history, making traditional loans risky. The innovative, simple solution is to lend to women. On average, women are more likely to use their earnings to support family needs than men, who may be more likely to indulge in drinking, gambling, or drugs. A more sophisti- cated solution is to organize the women in a village into a collective and lend money to the collective but not to individuals. Overall, 84% of microloan recipients are women. While annual interest rates average a hefty 35%, they are still far below the rates charged by local loan sharks. By 2011, more than 7,000 microfinance institutions (MFIs) had served 120 million borrowers around the world.

However, as microfinance grows from periphery to mainstream, not all is rosy. Two ferocious debates have erupted recently. The first debate deals with how to view the initial public offerings (IPOs) of MFIs (see Table 5.6). The “successful” IPOs of several MFIs have attracted criti- cisms that these MFIs and their new shareholders, most of whom are rich investors from North America and Europe, have enriched themselves at the expense of very poor people at the base of the pyramid. In short, the rich have literally profited from the poor. Is that right?

Second, with the onslaught of the 2008–2009 global crisis, default rates have skyrocketed. Several competitive MFIs may have dumped several microfinance loans to the same uneducated clients. In a microfinance boom, some lending practices have increasingly become compe- titive and reckless, similar to subprime lending in the West before the financial crisis. Should crops or ventures fail, clients thus face crushing debt loads. Recovery methods from MFIs sometimes involve intimidation. The Indian gov- ernment had a list of 85 MFI “victims,” who committed suicide. In response, policymakers in some parts of India capped the interest rate at 24%, and called default bor- rowers to refuse to pay up. Thus, in some parts of India, nearly 80% of borrowers were in default. Because of the high costs of making and collecting payments on millions of tiny loans, MFIs’ margins are razor-thin. Such massive defaults quickly pushed some MFIs to go under, and the Indian government reluctantly spent $221 million to bail them out in 2010. Sheikh Hasina, Bangladesh’s prime

TABLE 5.6 Initial Public Offerings of Microfinance Institutions

MFI COUNTRY CAPITAL RAISED YEAR

Bank Rakyat Indonesia $480 million 2003

Equity Bank Kenya $88 million 2006

Banco Compartamos Mexico $467 million 2007

SKS Microfinance India $1.5 billion 2010

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NOTES

minister, charged MFIs with “sucking blood from the poor” and treating the people of Bangladesh as “guinea pigs.” She launched an investigation into Grameen Bank’s allegedly questionable operations. Although as managing director of Grameen Bank, Yunus was even- tually cleared of wrongdoing, microfinance—and its mis- sionary pioneer—has suffered from a crisis of faith.

Sources: Based on (1) Bloomberg Businessweek, 2010, An IPO for India’s top lender to the poor, May 10: 16–17; (2) Bloom- berg Businessweek, 2010, In a microfinance boom, echoes of subprime, June 21: 50–51; (3) G. Bruton, S. Khavul, & H. Chavez, 2011, Microlending in emerging economies, Journal of International Business Studies, 42: 718–739; (4) Economist, 2010, Leave well alone, November 20: 16; (5) Economist, 2010, Under water, December 11: 56; (6) Economist, 2011, Saint under siege, January 8: 75; (7) Newsweek, 2010, The

micromess, December 20: 10; (8) B. Pinkham & P. Nair, 2011, Microfinance: Going global … and global public? case study, University of Texas at Dallas.

C A S E D I S C U S S I O N Q U E S T I O N S

1. Why was Yunus awarded the Nobel Peace Prize (as opposed to the Nobel Economics Prize)?

2. ON ETHICS: As an investor in a developed economy, do you have any problem investing in MFIs?

3. ON ETHICS: As CEO of a leading MFI in Kenya, Indonesia, or Mexico, you have been invited by your country’s leading newspaper to write an opinion piece in defense of MFIs. This defense is prompted by the Indian government bailouts of MFIs and the Bangladesh government investigation of Grameen Bank. How would you proceed?

[Journal acronyms] AME – Academy of Management Executive; AMJ – Academy of Management Journal; AMP – Academy of Management Perspectives; AMR – Academy of Management Review; APJM – Asia Pacific Journal of Management; ASQ – Administrative Science Quarterly; BW – BusinessWeek (before 2010) or Bloomberg Businessweek (since 2010); ETP – Entrepre- neurship Theory and Practice; FEER – Far Eastern Economic Review; HBR – Harvard Business Review; JBV – Journal of Business Venturing; JIBS – Journal of International Business Studies; JMS – Journal of Management Studies; JWB – Journal of World Business; MS – Management Science; SEJ – Strategic Entrepre- neurship Journal; SMJ – Strategic Management Journal; SMR – MIT Sloan Management Review

1. M. Hitt, R. D. Ireland, S. M. Camp, & D. Sexton, 2001, Strategic entrepreneurship (p. 480), SMJ, 22: 479–491. See also M. Hitt, R. D. Ireland, D. Sirmon, & C. Trahms, 2011, Strategic entrepreneurship, AMP, May: 57–75; R. Hoskisson, J. Covin, H. Vol- berda, & R. Johnson, 2011, Revitalizing entrepre- neurship, JMS, 48: 1141–1168; J. McMullen & D. Shepherd, 2006, Entrepreneurial action and the role of uncertainty in the theory of the entrepreneur, AMR, 31: 132–152; S. Venkataraman, S. Sarasvathy,

N. Dew, & W. Forster, 2012, Reflections on the 2010 AMR Decade Award: Whither the promise? AMR, 37: 21–33.

2. S. Shane & S. Venkataraman, 2000, The promise of entrepreneurship as a field of research (p. 218), AMR, 25: 217–226.

3. P. McDougall & B. Oviatt, 2000, International entre- preneurship (p. 903), AMJ, 43: 902–906. See also T. Baker, E. Gedajlovic, & M. Lubatkin, 2005, A frame- work for comparing entrepreneurship processes across nations, JIBS, 36: 492–504; Y. Chandra & N. Coviello, 2010, Broadening the concept of international entre- preneurship, JWB, 45: 228–236; D. Cumming, H. Sapienza, D. Siegel, & M. Wright, 2009, International entrepreneurship, SEJ, 3: 283–296.

4. Z. Acs & C. Armington, 2006, Entrepreneurship, Geo- graphy, and American Economic Growth, New York: Cambridge University Press.

5. M. Hayward, D. Shepherd, & D. Griffin, 2006, A hubris theory of entrepreneurship, MS, 52: 160–172; V. Lau, M. Shaffer, & K. Au, 2007, Entrepreneurial career success from a Chinese perspective, JIBS, 38: 126–146; R. Lowe & A. Ziedonis, 2006, Overoptimism and the performance of entrepreneurial firms, MS, 52: 173–186.

150 PART 2 BUSINESS-LEVEL STRATEGIES

6. R. Mudambi & S. Zahra, 2007, The survival of inter- national new ventures, JIBS, 38: 333–352.

7. S. Bradley, H. Aldrich, D. Shepherd, & J. Wiklund, 2011, Resources, environmental change, and survival, SMJ, 32: 486–509; T. Fan, 2010, De novo venture strategy, SMJ, 31: 19–38; P. Geroski, J. Mata, & P. Portugal, 2010, Founding conditions and the survival of new firms, SMJ, 31: 510–529.

8. A. Arikan & A. McGrahan, 2010, The development of capabilities in new firms, SMJ, 31: 1–18; A. Arora & A. Nandkumar, 2012, Insecure advantage? SMJ, 33: 231–251; B. Campbell, M. Ganco, A. Franco, & R. Agarwal, 2012, Who leaves, where to, and why worry? SMJ, 33: 65–87; A. Chatterji, 2009, Spawned with a silver spoon? SMJ, 30: 185–206; G. Knight & D. Kim, 2009, International business competence and the contemporary firm, JIBS, 40: 255–273; D. Lepak, K. Smith, & M. S. Taylor, 2007, Value creation and value capture, AMR, 32: 180–194; H. Park & H. K. Steensma, 2012, When does corporate venture capital add value for new ventures? SMJ, 33: 1–22.

9. D. Sull, 2005, Strategy as active waiting (p. 125), HBR, September: 121–129.

10. G. George, 2005, Slack resources and the performance of privately held firms, AMJ, 48: 661–676; R. Katila & S. Shane, 2005, When does lack of resources make new firms innovative? AMJ, 48: 814–829.

11. S. Anokhin & J. Wincent, 2012, Start-up rates and innovation, JIBS, 43: 41–60; H. Bowen & D. De Clercq, 2008, Institutional context and the allocation of entre- preneurial efforts, JIBS, 39: 747–767; J. Capelleras, K. Mole, F. Freene, & D. Storey, 2008, Do more heavily regulated economies have poorer performing new ventures? JIBS, 39: 688–704; J. Levie & E. Autio, 2011, Regulatory burden, rule of law, and entry of strategic entrepreneurs, JMS, 48: 1392–1419; T. Man- olova, R. Eunni, & B. Gyoshev, 2008, Institutional environments for entrepreneurship, ETP, January: 203–218.

12. D. Kim, E. Morse, R. Mitchell, & K. Seawright, 2010, Institutional environment and entrepreneurial cogni- tions, ETP, 34: 491–516.

13. Economist, 2011, Son also rises, November 27: 71–72. 14. BW, 2011, In Russia, Facebook is more than a social

network, January 3: 32–33. 15. M. Cardon, J. Wincent, J. Singh, & M. Drnovsek,

2009, The nature and experience of entrepreneurial passion, AMR, 34: 511–532; J. Clarke, 2011, Revitaliz- ing entrepreneurship, JMS, 48: 1365–1391; V. Rin- dova, D. Barry, & D. Ketchen, 2009, Entrepreneuring

as emancipation, AMR, 34: 477–491; D. Souder, Z. Simsek, & S. Johnson, 2012, The differing effects of agent and founder CEOs on the firm’s market expansion, SMJ, 33: 23–41.

16. G. Dess & G. T. Lumpkin, 2005, The role of entre- preneurial orientation in stimulating effective corpo- rate entrepreneurship, AME, 19: 147–156; J. Dyer, H. Gregerson, & C. Christensen, 2008, Entrepreneur behaviors, opportunity recognition, and the origins of innovative ventures, SEJ, 2: 317–338; I. Filatotchev & J. Piesse, 2009, R&D, internationalization, and growth of newly listed firms, JIBS, 40: 1260–1276; A. Gaur, D. Mukherjee, S. Gaur, & F. Schmid, 2011, Environmental and firm-level influences on inter- organizational trust and SME performance, JMS, 48: 1752–1781; B. George, 2011, Entrepreneurial orienta- tion, JMS, 48: 1291–1313; E. Golovko & G. Valentini, 2011, Exploring the complementarity between inno- vation and export for SMEs’ growth, JIBS, 42: 362–380; S. Kotha, 2010, Spillovers, spill-ins, and strategic entrepreneurship, SEJ, 4: 284–306; F. Santos & K. Eisenhardt, 2009, Constructing markets and shaping boundaries, AMJ, 52: 643–671; M. Terziovski, 2010, Innovative practice and its performance impli- cations in SMEs in the manufacturing sector, SMJ, 31: 892–902.

17. Economist, 2009, Lands of opportunity, March 14: 16–17; Economist, 2011, Beyond the start-up nation, January 1: 60.

18. C. Christensen, 1997, The Innovator’s Dilemma, Bos- ton: Harvard Business School Press.

19. D. Gregorio, M. Musteen, & D. Thomas, 2008, Inter- national new ventures, JWB, 43: 186–196; S. Jack, 2010, Approaches to studying networks, JBV, 25: 120–137; R. Ma, Y. Huang, & O. Shenkar, 2011, Social networks and opportunity recognition, SMJ, 32: 1183–1205; D. Sullivan & M. Marvel, 2011, Knowl- edge acquisition, network reliance, and early-stage technology venture outcomes, JMS, 48: 1169–1193; B. Vissa, 2011, A matching theory of entrepreneurs’ tie formation intentions and initiation of economic exchange, AMJ, 54: 137–158; L. Zhou, B. Barnes, & Y. Lu, 2010, Entrepreneurial proclivity, capability upgrading, and performance advantage of newness among international new ventures, JIBS, 41: 882–905.

20. M. Colombo, L. Grilli, S. Murtinu, L. Piscitello, & E. Piva, 2009, Effects of international R&D alliances in performance of high-tech start-ups, SEJ, 3: 346–368; T. Manolova, I. Manev, & B. Gyoshev, 2010, In good company, JWB, 45: 257–265; M. Musteen, J. Francis,

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& D. Datta, 2010, The influence of international net- works on internationalization speed and performance, JWB, 45: 197–205; S. Prashantham & C. Dhanaraj, 2010, The dynamic influence of social capital on the international growth of new ventures, JMS, 47: 965–994; L. Riddle, G. Hrivnak, & T. Nielsen, 2010, Transnational diaspora entrepreneurship in emerging markets, JIM, 16: 398–411; P. Sonderegger & F. Taube, 2010, Cluster life cycle and diaspora effects, JIM, 16: 383–397; J. Yu, B. Gilbert, & B. Oviatt, 2011, Effects of alliances, time, and network cohesion on the initiation of foreign sales by new ventures, SMJ, 32: 424–446.

21. G. Chen, D. Hambrick, & T. Pollock, 2008, Puttin’ on the Ritz, AMJ, 51: 954–975.

22. M. W. Peng & Y. Luo, 2000, Managerial ties and firm performance in a transition economy, AMJ, 43: 486–501.

23. R. Burt, 1997, The contingent value of social capital (p. 342), ASQ, 42: 339–365.

24. P. Vaaler, 2011, Immigrant remittances and the ven- ture investment environment of developing countries, JIBS, 42: 1121–1149.

25. T. Dalziel, R. White, & J. Arthurs, 2011, Principal costs in initial public offerings, JMS, 48: 1346–1364; A. Zacharakis, J. McMullen, & D. Shepherd, 2007, Venture capitalists’ decision policies across three countries, JIBS, 38: 691–708.

26. G. Bruton, I. Filatotchev, S. Chahine, & M. Wright, 2010, Governance, ownership structure, and perfor- mance of IPO firms, SMJ, 31: 491–509; B. Walters, M. Kroll, & P. Wright, 2010, The impact of TMT board member control and environment on post- IPO performance, AMJ, 53: 572–595.

27. D. Hope, D. Thomas, & D. Vyas, 2011, Financial credibility, ownership, and financing constraints in private firms, JIBS, 42: 935–951.

28. M. Minniti, W. Bygrave, & E. Autio, 2006, Global Entre- preneurshipMonitor 2006,Wellesley,MA:BabsonCollege.

29. D. Ahlstrom, G. Bruton, & K. Yeh, 2007, Venture capital in China: Past, present, future, APJM, 24: 247–268; K. Au & H. Kwan, 2009, Start-up capital and Chinese entrepre- neurs, ETP, 33: 889–908; M. Wright, 2007, Venture capi- tal in China: A view from Europe, APJM, 24: 269–282.

30. M. Graebner & K. Eisenhardt, 2004, The seller’s side of the story, ASQ, 49: 366–403.

31. R. Larsson, K. Brousseau, M. Driver, M. Holmqvist, & V. Tarnovskaya, 2003, International growth through cooperation (p. 15), AME, 17: 7–21.

32. C. Bingham, 2009, Oscillating improvisation, SEJ, 3: 321–345; S. Fernhaber, B. Gilbert, & P. McDougall,

2008, International entrepreneurship and geographic location, JIBS, 39: 267–290; M. Giarratana & S. Tor- risi, 2010, Foreign entry and survival in a knowledge- intensive market, SEJ, 4: 85–104.

33. N. Hashai, 2011, Sequencing the expansion of geo- graphic scope and foreign operations by “born global” firms, JIBS, 42: 995–1015.

34. M. W. Peng, 1998, Behind the Success and Failure of US Export Intermediaries, Westport, CT: Quorum.

35. M. W. Peng & A. York, 2001, Behind intermediary performance in export trade, JIBS, 32: 327–346.

36. FEER, 2002, Pepperoni power, November 14: 59–60. 37. V. Aggarwal & D. Hsu, 2009, Modes of cooperative

R&D commercialization by start-ups, SMJ, 30: 835–864; P. Ozcan & K. Eisenhardt, 2009, Origin of alliance portfolios, AMJ, 52: 246–279.

38. M. Graebner, 2009, Caveat venditor, AMJ, 52: 435–472. 39. G. Cassar, 2010, Are individuals entering self-

employment overly optimistic? SMJ, 31: 822–840; D. Gregoire, A. Corbett, & J. McMullen, 2011, The cognitive perspective in entrepreneurship, JMS, 48: 1443–1477.

40. BW, 2010, Getting over the JetBlues, February 15: 52–54. 41. D. Ahlstrom, S. Chen, & K. Yeh, 2010, Managing in

ethnic Chinese communities, APJM, 27: 341–354; J. Lu & Z. Tao, 2010, Determinants of entrepreneurial activities in China, JBV, 25: 261–273; M. W. Peng, 2001, How entrepreneurs create wealth in transition economies, AME, 15: 95–108.

42. Y. Yamakawa, M. W. Peng, & D. Deeds, 2008, What drives new ventures to internationalize from emerging to developed economies?, ETP, 32: 59–82.

43. S. Loane, J. Bell, & R. McNaughton, 2007, A cross- national study on the impact of management teams on the rapid internationalization of small firms, JWB, 42: 489–504; H. Sapienza, E. Autio, G. George, & S. Zahra, 2006, A capabilities perspective on the effects of early internationalization on firm survival and growth, AMR, 31: 914–933.

44. V. Govindarajan & A. Gupta, 2001, The Quest for Global Dominance, San Francisco: Jossey-Bass.

45. S. Nadkarni, P. Herrmann, & P. Perez, 2011, Domes- tic mindset and early international performance, SMJ, 32: 510–531.

46. J. Mathews & I. Zander, 2007, The international entrepreneurial dynamics of accelerated internation- alization, JIBS, 38: 387–403.

47. S. Rangan & R. Adner, 2001, Profits and the Internet (pp. 49–50), SMR, summer: 44–53.

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48. L. Lopez, S. Kundu, & L. Ciravegna, 2009, Born global or born regional? JIBS, 40: 1228–1238.

49. This section draws heavily from S. Lee, M. W. Peng, & J. Barney, 2007, Bankruptcy law and entrepreneurship development, AMR, 32: 257–272; M. W. Peng, Y. Yamakawa, & S. Lee, 2010, Bankruptcy laws and entrepreneur-friendliness, ETP, 34: 517–530.

50. S. Lee, Y. Yamakawa, M. W. Peng, & J. Barney, 2011, How do bankruptcy laws affect entrepreneurship development around the world? JBV, 28: 505–520.

51. A. Knott & H. Posen, 2005, Is failure good? SMJ, 26: 617–641.

52. M. W. Peng, C. Hill, & D. Wang, 2000, Schumpeter- ian dynamics versus Williamsonian considerations, JMS, 37: 167–184.

53. D. Ahlstrom & G, Bruton, 2010, Rapid institutional shifts and the co-evolution of entrepreneurial firms in transition economies, ETP, 34: 531–554; G. Bruton, D. Ahlstrom, & H. Li, 2010, Institutional theory and entrepreneurship, ETP, 34: 421–440; C. Moore, R. G. Bell, & I. Filatotchev, 2010, Institutions and foreign IPO firms, ETP, 34: 469–490; R. Nasra & M. T. Dacin, 2010, Institutional arrangements and international entrepreneurship, ETP, 34: 583–609; S. Puffer, D. McCarthy, & M. Boisot, 2010, Entrepreneurship in Russia and China, ETP, 34: 441–467; J. Webb, G. Kistruck, R. D. Ireland, & D. Ketchen, 2010, The entre- preneurship process in base of the pyramid markets, ETP, 34: 555–581; S. Zahra & M. Wright, 2011, Entre- preneurship’s next act, AMP, November: 67–83.

C h a p t e r 5 G r o w i n g a n d I n t e r n a t i o n a l i z i n g t h e E n t r e p r e n e u r i a l F i r m 153

CHAPTER6

ENTERING FOREIGN MARKETS

KNOWLEDGE OBJECT IVES

After studying this chapter, you should be able to

1. Understand the necessity to overcome the liability of foreignness

2. Articulate a comprehensive model of foreign market entries

3. Match the quest for location-specific advantages with strategic goals (where to enter)

4. Compare and contrast first-mover and late-mover advantages (when to enter)

5. Follow a decision model that outlines specific steps for foreign market entries (how to enter)

6. Participate in three leading debates concerning foreign market entries

7. Draw strategic implications for action

ot o/ A le xe y St io p

154 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

OPENING CASE

Enter the United States by Bus

If you are a college student studying in the Midwest or Northeast parts of the United States, you may have heard of (or taken a ride on) Megabus. Its website announces that it is “the first, low-cost, express bus service to offer city-to-city travel for as low as $1 via the Internet.” Currently serving 50 US cities from five hubs (Chicago, New York, Philadelphia, Pittsburgh, and Washington, DC), Megabus, according to Bloomberg Businessweek, “has fundamentally changed the way Americans— especially the young—travel.”

A generation ago, Greyhound was a national icon for intercity travel. Unfortunately, as Americans fell more in love with cars and the cost of airfares dropped further, intercity bus ridership steadily decreased. Further, as inner cities, where the bus depots (terminals) were situated, decayed, bus travel became the travel mode of last resort. In 1990, Greyhound filed for Chapter 11 bankruptcy.

Yet, the demand for medium-distance trips ideal for intercity bus travel did not go away. For some of the most traveled routes (such as between Chicago and Detroit and between New York and DC), the distance is too far for a leisurely drive but too close to justify the expense (and increasingly the hassle) of air travel. While Greyhound has been in decline, small, entrepreneurial bus operators, known as the “Chinatown buses,” emerged. They started by shuttling passengers (primarily recent Chinese immi- grants) between Chinatowns in New York and Boston. Such niche operators quickly grabbed the attention of many college students. Despite four decades of decline, overall US intercity bus ridership spiked in 2006, the year when Megabus entered.

Although Megabus is a brand-new, no-frills entrant into the US market, it is backed by the full strength of the second-largest transport firm in the UK, Stagecoach Group, which employs 18,000 people there. Founded in 1980 and headquartered in Perth, Scotland, Stagecoach not only operates buses, but also trains, trams, and ferries throughout the UK, moving 2.5 million people every day. It is listed on the London Stock Exchange, where it is a member of the FTSE 250. Megabus is a brand of Stage- coach’s wholly owned US subsidiary, Coach USA.

Stagecoach is not a stranger to international forays, having previously operated in Hong Kong, Kenya, Malawi, New Zealand, Portugal, and Sweden. However, these operations turned out to be lackluster and were all sold. For now, the sole international market it focuses on is North America (Megabus entered Canada in 2008).

Although Megabus is clearly a late mover in North America, its future looks bright. So what allows Megabus to turn a declining national trend of bus ridership around? At least four features stand out. First, tickets are super cheap, starting at $1 (!). Megabus uses a yield manage- ment system, typically used by airlines, which offers early passengers dirt-cheap deals and late passengers progres- sively higher prices. Although only one or two passengers per trip can get the $1 deal, even the “higher” prices are very competitive. In routes where it competes with Amtrak (the railway), Megabus costs about a tenth of Amtrak. All tickets have to be booked online. This not only eliminates the expenses of maintaining ticket booths, but also attracts a more educated demographic group.

Second, instead of using depots, Megabus follows the Chinatown buses by using curbside stops (like regular city bus stops) to board and disembark passengers. Interestingly, dumping the depot model not only saves a lot of money, but also makes Megabus more attractive, because passengers do not have to spend time in the typically poorly maintained (and sometimes filthy and unsafe) bus depots.

Third, all Megabus coaches are equipped with Wi-Fi and power outlets, allowing the time on board to be more productive (or more fun). These features, which are some- times not available even when flying first class, have made travel by bus totally cool to the online-savvy younger crowd. Among surveyed passengers, 37% said that Wi-Fi and power outlets were central to their decision to travel by Megabus.

Finally, as gas prices and environmental consciousness rise, bus travel offers an unbeatable “green” advantage. At eight cents per mile, a bus is four times more fuel- efficient than a car. US curbside carriers, led by Megabus, have already reduced fuel consumption by 11 million gal- lons a year, equivalent to taking 24,000 cars off the road.

155 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

How do firms such as Stagecoach Group enter foreign markets? Why dothey enter certain countries but not others? Why was Stagecoach ableto transform a lackluster travel mode to one that attracts a younger and more educated crowd? These are some of the key questions driving this chapter. Entering foreign markets is crucial for global strategy.1 Focusing on the necessity to overcome the liability of foreignness, this chapter develops a comprehensive model based on the strategy tripod—namely, industry-based, resource-based, and institution-based views.2 Then we focus on three crucial dimensions: where, when, and how—known as the 2W1H dimensions. Debates and extensions follow.

Overcoming the Liability of Foreignness Why is it so challenging to enter and succeed in overseas markets? This is primarily because of the liability of foreignness, which is the inherent disadvantage foreign firms experience in host countries because of their non-native status.3 Such a liability is manifested in at least two ways. First, numerous differences in formal and informal institutions govern the rules of the game in different countries. While local firms are already well versed in these rules, foreign firms have to learn the rules quickly. For example, European firms that have subsidiaries operating in the United States are busy learning the new “Buy American” rules in US stimulus packages that would qualify them as “US firms.”4 Many governments ban foreigners from owning assets in certain strategic sectors. Governments in Central and Eastern Europe are concerned about investments from Russia (see Emerging Markets 6.1).

Second, although customers in this age of globalization supposedly no longer discrimi- nate against foreign firms, the reality is that foreign firms are often still discriminated against, sometimes formally and other times informally. For example, activists in India accused both Coca-Cola and PepsiCo of having products that contained higher-than- permitted levels of pesticides but did not test any Indian-branded soft drinks, even though pesticide residues are present in virtually all groundwater in India. Although both Coca-Cola and PepsiCo denied these charges, their sales suffered.

While politicians like to talk about the “bright future” of high-speed rail and $10 billion has been budgeted to jump-start the new rail projects, not a single mile of high-speed rail tracks has been laid as of this writing. At the same time, Megabus has been charging ahead and carrying more than 13 million passengers since its entry, while requiring zero additional investment in infrastruc- ture. Texas, Florida, and California are some of the markets it may enter soon. Given the cost and political headache to

build new high-speed rail, Bloomberg Businessweek speculated: “The Megabus approach works so well, it may scuttle plans for high-speed rail.”

Sources: Based on (1) Bloomberg Businessweek, 2011, How to keep the world moving, December 5: 80–86; (2) Bloomberg Businessweek, 2011, The Megabus effect, April 11: 62–67; (2) Magabus, 2012, www.megabus.com; (3) Stagecoach Group, 2012, www.stagecoachgroup.com.

(Continued)

OPENING CASE

liability of foreignness

The inherent disadvantage foreign firms experience in host countries because of their nonnative status.

156 PART 2 BUSINESS-LEVEL STRATEGIES

Against such significant odds, how do foreign firms crack new markets? The answer: to deploy overwhelming resources and capabilities so that after offsetting the liability of foreignness, there is still significant competitive advantage. For example, recently the Chinese government seemed to be more assertive and more interested in promoting “indigenous innovation,” and GE’s CEO openly complained to the press—typically regarded as a bad political move by experienced China hands.5 Yet, two weeks after airing such high-profile complaints, GE still won a major contract to equip China’s all-new, 200-seat C919 jetliner with its advanced engines.6 Evidently, GE’s overwhelming capabilities in advanced engines were able to overcome its political incorrectness—an example of liability of foreignness.

E T H I C A L D I L E M M AEMERGING MARKETS 6.1

Russian Firms Spread Their Wings

After the fall of the Berlin Wall in 1989, Russia suffered a decade of turmoil. Since 1999, the Russian economy staged a spectacular comeback, largely thanks to consistently high prices of its main export items, oil and gas. The 2008–2009 global crisis created another setback. But with the Middle East up in flames since 2011 (think of Libya), the more stable oil and gas production from Russia bodes well for the country’s economic performance.

Accumulation of earnings and lucrative oppor- tunities abroad have turned a series of Russian firms into multinational enterprises (MNEs), spreading their wings around the globe. Russian firms active in foreign direct investment (FDI) can be found in three categories: (1) One group targets acquisition targets in Western Europe and North America to access technological innovations and advanced management know-how. (2) Another group focuses on the “near abroad”—the Commonwealth of Independent States (CIS), whose member countries were all formerly part of the Soviet Union. (3) A third group channels funds through offshore financial centers such as Cyprus and the British Virgin Islands and reinvests back in Russia—a process known as capital round-tripping. Experts estimate that about 10% of the Russian outward FDI is involved in round-tripping, leaving the other 90% to be real FDI.

Thanks to the liability of foreignness, Russian FDI abroad is not without controversies. Host country governments and the media often voice concern that Russian MNEs, especially large energy companies, may represent the “long arm of the Kremlin.” The political hard line recently taken by the Russian government (such as the war with Georgia and the decision to cut off gas supply to Ukraine) heightens such concerns, especially in sensitive Central and Eastern European countries such as Hungary, Lithuania, and Poland. Russian MNEs claim that their FDI is solely driven by profit motives. However, host country governments face the dilemma of how to accommodate the legitimate economic interests of Russia MNEs, harness the FDI dollars they bring, and limit the potential damage when dealing with the bears (or eagles) from Russia. In Central and Eastern Europe, this dilemma has intensified after the Great Recession, when traditionally active MNEs from Germany and Austria were pulling back while Russian firms possessed fat checkbooks ready to invest.

Sources: Based on (1) Bloomberg Businessweek, 2011, The Russians are buying, and buying, September 19: 17–18; (2) A. Panibratov & K. Kalotay, 2009, Russia outward FDI and its policy context, Columbia FDI Profiles, No. 1, www.vcc. columbia.edu; (3) United Nations, 2011, World Investment Report 2010, New York: UN.

C h a p t e r 6 E n t e r i n g F o r e i g n M a r k e t s 157

Understanding the Propensity to Internationalize Despite recent preaching by some gurus that every firm should go abroad, the reality is that not every firm is ready for it. Prematurely venturing overseas may be detrimental to overall firm performance, especially for smaller firms whose margin for error is very small. Then, what motivates some firms to go abroad, while others are happy to stay at home?

At the risk of oversimplification, we can identify two underlying factors: (1) size of the firm and (2) size of the domestic market, which lead to a 2×2 framework (Figure 6.1). In Cell 1, large firms in a small domestic market are likely to be very enthusiastic inter- nationalizers, because they can quickly exhaust opportunities in a small country. Consider Nestlé of Switzerland. Given Switzerland’s small population (7 million), the demand for Nestlé’s food products is rather limited. As a result, a majority of Nestlé’s sales and employees are outside of Switzerland.

In Cell 2, many small firms in a small domestic market are labeled “follower inter- nationalizers,” because they often follow their larger counterparts such as Nestlé to go abroad as suppliers. Even small firms that do not directly supply large firms may similarly venture abroad, because of the inherently limited size of the domestic market. A con- siderable number of small firms from small countries such as Austria, Denmark, Finland, New Zealand, Singapore, and Taiwan are active overseas.

In Cell 3, large firms in a large domestic market are labeled “slow internationalizers,” because their overseas activities are usually (but not always) slower than those of enthu- siastic internationalizers in Cell 1. For example, Wal-Mart’s pace of internationalization is slower when compared with its two global rivals based in relatively smaller countries, Carrefour of France and Metro of Germany.

FIGURE 6.1 Firm Size, Domestic Market Size, and Propensity to Internationalize

(Cell 1) Enthusiastic

internationalizer

(Cell 2) Follower

internationalizer Market Domestic Small

Market Domestic Large(Cell 4)

Occasional internationalizer

Size of the Domestic Market

Size of the Firm

(Cell 3) Slow

internationalizer

Large Firm Small Firm

ga ge

Le ar ni ng

158 PART 2 BUSINESS-LEVEL STRATEGIES

Finally, in Cell 4, most small firms in a large domestic market confront a “double whammy” on the road to internationalization, both because of their relatively poor resource base and the large size of their domestic market. Many small firms in the United States do not feel compelled to go abroad. Overall, small firms in a large domestic market can be labeled “occasional internationalizers” (if they have any international business at all). One joke is that if the United States were divided into 50 independent countries, then the number of US multinational enterprises (MNEs) would skyrocket.7

A Comprehensive Model of Foreign Market Entries Assuming the decision to internationalize is a “go,” strategists must make a series of decisions regarding the location, timing, and mode of entry, collectively known as the where, when, and how (“2W1H”) aspects, respectively.8 Underlying each decision is a set of strategic considerations drawn from the three leading perspectives in the strategy tripod, which form a comprehensive model (Figure 6.2).

FIGURE 6.2 A Comprehensive Model of Foreign Market Entries

Industry-based considerations on the degree of competitiveness

• Rivalry among firms • Entry barriers/scale economies • Bargaining power of suppliers • Bargaining power of buyers • Substitute products/services

Resource-based considerations on firm-specific assets

• Value • Rarity • Imitability • Organization

Institution-based considerations on country risks

• Regulatory risks • Trade barriers • Currency risks • Cultural distances • Institutional norms

Foreign entry decisions

Where/When/How

ga ge

Le ar ni ng

C h a p t e r 6 E n t e r i n g F o r e i g n M a r k e t s 159

Industry-Based Considerations Industry-based considerations are primarily drawn from the five forces framework first introduced in Chapter 2. First, rivalry among established firms may prompt certain moves. Firms, especially those in oligopolistic industries, often match each other in foreign entries. If Komatsu and FedEx enter a new country—let’s say Afghanistan— Caterpillar and DHL, respectively, probably would feel compelled to follow. Sometimes, firms may enter foreign markets to retaliate. For example, Texas Instruments (TI) entered Japan not to make money but to lose money. The reason was that TI faced the low-price Japanese challenge in many markets, whereas rivals such as NEC and Toshiba were able to charge high prices in Japan and use domestic profits to cross-subsidize their overseas expansion. By entering Japan and slashing prices there, TI retaliated by incurring a loss. This forced the Japanese firms to defend their profit sanctuary at home, whereby they had more to lose.

Second, the higher the entry barriers, the more intense firms will be in attempting to compete abroad. A strong presence overseas in itself can be seen as a major entry barrier. By tapping into wider and bigger markets, international sales can increase scale economies and deter entry. It would be mind-boggling to imagine how high the costs of Boeing and Airbus aircraft would be in the absence of international sales.

Third, the bargaining power of suppliers may prompt certain foreign market entries, often called backward vertical integration because they involve multiple stages of the value chain. Many extractive industries feature extensive backward integration (such as bauxite mining), in order to provide a steady supply of raw materials to late stage production (such as aluminum smelting). Since natural resources are not always found in politically stable countries, many firms have no choice but to enter politically uncertain countries, such as Libya and Venezuela. Why do these Western MNEs go through such troubles to secure oil supplies? Evidently, the costs of such troubles are still less than the costs of having to deal with strong unfriendly suppliers such as OPEC.

Fourth, the bargaining power of buyers may lead to certain foreign market entries, often called forward vertical integration.9 For example, instead of working with retail chains that as buyers often extract significant price concessions, Apple has established a series of Apple stores in major cities worldwide.

Finally, the market potential of substitute products may encourage firms to bring them abroad. A generation ago, Kodak and Fuji comfortably led the film industry. Their products were substituted by digital camera makers such as Canon. Then cell phone makers such as Nokia and Samsung incorporated the camera function within their devices, which substituted a lot of single-purpose digital cameras. In every round, produ- cers of substitute products had tremendous incentive to hawk their wares globally.

Overall, how an industry is structured and how its five forces are played out signifi- cantly affect foreign entry decisions. Next, we examine the influence of resource-based considerations.

Resource-Based Considerations The VRIO framework introduced in Chapter 3 sheds considerable light on entry decisions (Figure 6.2).10 First, the value of firm-specific resources and capabilities plays a key role behind decisions to internationalize.11 It is often the superb value of firm-specific assets

160 PART 2 BUSINESS-LEVEL STRATEGIES

that allows foreign entrants such as Stagecoach to overcome the liability of foreignness (see the Opening Case).

Second, the rarity of firm-specific assets encourages firms that possess them to leverage such assets overseas. Patents, brands, and trademarks legally protect the rarity of certain product features. It is not surprising that patented and branded products, such as cars and DVDs, are often aggressively marketed overseas. However, here is a paradox: Given the uneven protection of intellectual property rights, the more countries these products are sold in (becoming less rare), the more likely counterfeits will pop up somewhere around the globe. The question of rarity, therefore, directly leads to the next issue of imitability.

Third, if firms are concerned that their imitable assets may be expropriated in certain countries, they may choose not to enter. In other words, the transaction costs may be too high. This is primarily because of dissemination risks, defined as the risks associated with the unauthorized imitation and diffusion of firm-specific assets.12 The worst nightmare is to have nurtured a competitor.

Finally, the organization of firm-specific resources and capabilities as a bundle favors firms with strong complementary assets integrated as a system and encourages them to utilize these assets overseas.13 Many MNEs are organized in a way that protects them against entry and favors them as entrants into other markets—consider the near total vertical integration at ExxonMobil and BP.

In summary, the resource-based view suggests an important set of underlying considera- tions underpinning entry decisions. In the case of imitability and dissemination risk, it is obvious that these issues are related to property rights protection, which leads to our next topic.

Institution-Based Considerations Since Chapter 4 has already illustrated a number of informal institutional differences such as cultural differences, here we focus on the formal institutional constraints confronting foreign entrants: (1) regulatory risks, (2) trade barriers, and (3) currency risks (Figure 6.2).

Regulatory risks are defined as those risks associated with unfavorable government policies (see Emerging Markets 6.1). Some governments may demand that foreign entrants share technology with local firms, essentially increasing the dissemination risk. Even as a WTO member, the Chinese government has continued its historical practice of only approving joint ventures for foreign automakers and banned their attempt to set up wholly owned subsidiaries. The government’s openly proclaimed goal has been to “encourage” local automakers to learn from their foreign partners.

A well-known regulatory risk is the obsolescing bargain, referring to a deal struck by an MNE and a host government, which changes the requirements after the entry of the MNE. It typically unfolds in three rounds:

• In Round One, the MNE and the government negotiate a deal. The MNE usually is not willing to enter in the absence of some reasonable government assurance of property rights, earnings, and even some incentives (such as tax holidays).

• In Round Two, the MNE enters and, if all goes well, earns profits that may become visible.

dissemination risks

The risks associated with the unauthorized diffusion of firm-specific assets.

regulatory risks

Risks associated with unfavorable government regulations.

obsolescing bargain

A deal struck by an MNE and a host government, which change the require- ments after the entry of the MNE.

C h a p t e r 6 E n t e r i n g F o r e i g n M a r k e t s 161

• In Round Three, the government, often pressured by domestic political groups, may demand renegotiations of the deal that seems to yield “excessive” profits to the foreign firm (which, of course, regards these as “fair” and “normal” profits). The previous deal, therefore, becomes obsolete.

The government’s tactics include removing incentives, demanding higher taxes, and even confiscating foreign assets—in other words, expropriation. The Indian government in the 1970s demanded that Coca-Cola share its secret formula, something that the MNE did not even share with the US government. At this time, the MNE has already invested substantial sums of resources (called sunk costs) and often has to accommodate some new demands; otherwise, it may face expropriation or exit at a huge loss (as Coca-Cola did in India). Coca-Cola’s experience in India, unfortunately, was not alone. Many governments in Africa, Asia, and Latin America in the 1950s, 1960s, and 1970s expropriated MNE assets through nationalization by turning them over to state-owned enterprises (SOEs).

Recently, some decisive changes have occurred around the world in favor of foreign entries (see Chapter 1). Many governments realize that nationalization of foreign MNE assets does not necessarily maximize their national interests. While expropriation drives MNEs away, SOEs are often unable to run the operations as effectively as did MNEs, and most SOEs end up losing money and destroying value. Therefore, the global trend since the 1980s and 1990s has been privatization, which, being the opposite of nationalization, turns state-owned assets into private firms (see Chapter 11). Interestingly, many private bidders of SOEs are MNEs. Understandably, MNEs often push for the transparency and predictability in host-government decision making before committing to new deals. Coca- Cola, for example, agreed to return to India in the 1990s with an explicit commitment from the government that its secret formula would be untouchable.

Overall, there is global competition among host governments (especially those in the developing world) to transform their relationship with MNEs from a confrontational to cooperative one. While regulatory risks, especially those associated with expropriation, have decreased significantly around the world, individual countries still vary considerably, thus calling for very careful analysis of such risks. As recently as 2012, Argentina expropriated the assets of a Spanish MNE, Repsol.

Trade barriers include (1) tariff and nontariff barriers, (2) local content requirements, and (3) restrictions on certain entry modes. Tariff barriers, taxes levied on imports, are government-imposed entry barriers. Nontariff barriers are more subtle. For example, the Japanese customs inspectors, in the name of detecting unwanted bacteria from abroad, often insist on cutting every tulip bulb exported from the Netherlands vertically down the middle. The Dutch argument that their tulips have been safely exported to just about every other country in the world has not been persuasive. These barriers effectively encourage foreign entrants to produce locally and discourage them from exporting.

However, even after foreign entrants set up factories locally, they can still export completely knocked down (CKD) kits to be assembled in host countries. Such factories are nicknamed “screw driver plants”—only screw drivers plus local labor would be needed. In response, many governments have imposed local content requirements, mandating that a “domestically produced” product can still be subject to tariff and nontariff barriers unless a certain fraction of its value (such as 51% in the United States)

expropriation

Confiscation of foreign assets invested in one country.

sunk costs

Irrevocable costs incurred and investments made.

trade barriers

Barriers blocking international trade.

tariff barriers

Taxes levied on imports.

nontariff barriers

Trade and investment barriers that do not entail tariffs.

local content requirements

Government requirements that certain products be subject to higher import tariffs and taxes unless a given percentage of their value is produced domestically.

162 PART 2 BUSINESS-LEVEL STRATEGIES

is truly produced domestically. The Brazilian government, for example, imposed a 70% local content requirement for all the equipment ordered by Petrobras.

Certain entry modes also have restrictions. Many countries limit or even ban wholly owned subsidiaries of MNEs. For example, in the United States, foreign airlines are not allowed to operate wholly owned subsidiaries or acquire US airlines. In Russia, foreign firms are not allowed to operate wholly owned subsidiaries in the strategically important oil and gas industry.

Currency risks stem from unfavorable movements of the currencies to which firms are exposed. For instance, if the Chinese yuan appreciates (as demanded by the US govern- ment), domestic and foreign firms producing there may lose a significant chunk of their low-cost advantage. Since a majority of Wal-Mart products are made in China (mostly by non-Chinese-owned producers), a 30% appreciation of the yuan (all else being equal) may result in a 30% cost increase on a lot of Wal-Mart products. Therefore, Wal-Mart and its US-owned suppliers that produce in China face severe currency risks if the yuan appreciates.

In response, firms can engage in currency hedging or strategic hedging. Currency hedging protects firms from exposure to foreign exchange fluctuations. However, this is risky in the case of wrong bets of currency movements. Strategic hedging means spread- ing out activities in a number of countries in different currency zones in order to offset the currency losses in certain regions through gains in other regions. It was one of the key motivations behind Toyota’s decision to set up a new factory in France, instead of expanding its existing British operations (which would have cost less in the short run)— France is in the euro zone that the British refused to join.

In addition to formal institutional constraints, firms also need to develop a sophis- ticated understanding of numerous informal aspects such as cultural distances and institutional norms. Since Chapter 4 has already discussed these issues at length, we will not repeat them here other than to stress their importance. We will, however, revisit some of them in the next section.

Overall, the value of the core proposition of the institution-based view, “Institutions matter,” is magnified in foreign entry decisions.14 Rushing abroad without a solid under- standing of institutional differences can be hazardous and even disastrous.

Where to Enter? Like real estate, the motto for international business is “Location, location, location.” In fact, such a spatial perspective (that is, doing business outside of one’s home country) is a defining feature of international business.15 Two sets of considerations drive the location of foreign entries: (1) strategic goals and (2) cultural and institutional distances. Each is discussed next.

Location-Specific Advantages and Strategic Goals Favorable locations in certain countries may give firms operating there location-specific advantages. Certain locations simply possess geographical features that are difficult for others to match. For example, Dubai is an ideal stopping point for air traffic between Europe and Asia and between Africa and Asia. Emirates Airlines has been blessed by being based in Dubai (see Emerging Markets 6.2).

currency risks

Risks stemming from exposure to unfavorable movements of the currencies.

currency hedging

A transaction that protects traders and investors from exposure to the fluctua- tions of the spot rate.

strategic hedging

Spreading out activities in a number of countries in different currency zones to offset any currency losses in one region through gains in other regions.

location-specific advantages

Advantages associated with operating in a specific location.

C h a p t e r 6 E n t e r i n g F o r e i g n M a r k e t s 163

Beyond geographic advantages, location-specific advantages also arise from the clus- tering of economic activities in certain locations, usually referred to as agglomeration. The basic idea dates back at least to Alfred Marshall, a British economist who first published it in 1890. Essentially, location-specific advantages stem from (1) knowledge spillovers among closely located firms that attempt to hire individuals from competitors, (2) industry demand that creates a skilled labor force whose members may work for different firms without having to move out of the region, and (3) industry demand that facilitates a pool of specialized suppliers and buyers to also locate in the region.16 For

EMERGING MARKETS 6.2

Dubai Airport Connects the World

As a part of the United Arab Emirates, Dubai has emerged as the undisputed financial, business, and shopping center in the Middle East. Dubai International Airport (DXB) not only positions itself as the aviation center of the region, but also aspires to become the aviation center of the world. Geographically, Dubai is indeed the center of the world known as the natural “pinch point” by experts. It is the ideal stopping point for air traffic between Europe and Asia and between Africa and Asia. Two billion people live within four hours of flying time from Dubai, and four billion can be reached within seven hours. Connecting 220 destinations across six continents with 130 airlines, DXB already handles approximately over 40 million passengers a year. New expansion will allow DXB to serve 60 million passengers a year in the near future. Since Dubai’s own population is fewer than 4 million (most are expatriates), the majority of the passengers are connecting passengers who are not from or going to Dubai. DXB’s expansion will have to rely on customers from the rest of the world. Will they come?

DXB’s hometown carrier, Emirates Airlines, is betting that connecting passengers will come. Launched in 1985, Emirates is known as a “super-connecting” airline because the majority of its customers are connecting passengers. One of the world’s most powerful carriers, Emirates has an all wide-body fleet of 138 planes and 140 more on firm order (including 50 Airbus A380s). From Dubai, Emirates flies to over 100 cities in over 60 countries. Emirates is the largest customer of the ultra-long-range Boeing 777 and one of the largest users of the A380.

With these capable jets, any two cities in the world can be linked with just one stop via Dubai. Emirates thus has been directly challenging traditional long-haul carriers such as British Airways (BA) and Lufthansa. Emirates has launched services connecting Dubai with secondary (but still very sizable) cities, such as Manchester, Hamburg, and Kolkata. These cities are neglected by BA, Lufthansa, and Air India, respectively, which focus on their own hubs. Passengers flying, for example, from Hamburg to Sydney may not care whether they change planes at Frankfurt or Dubai, especially when Emirates flies newer and quieter planes, offers cheaper tickets, and provides nicer amenities at DXB.

Starting in 1950, DXB has been experiencing an astonishing annual growth rate of 15%. Today it is already the world’s third-busiest international passenger airport (after London Heathrow and Hong Kong) and the seventh-busiest cargo airport. Yet it will be replaced by an even larger airport, Dubai World Central-Al Maktoum International (DWC), which partially opened in 2010 (with one runway and with cargo flights only). When completed, the new DWC will be the largest airport in the world, with five parallel runways and an annual passenger capacity of 160 million (!).

Sources: Based on (1) Aviation News, 2011, Dubai Inter- national Airport, December: 34–39; (2) Bloomberg Business- week, 2010, Emirates wins with big planes and low costs, July 5: 18–19; (3) Economist, 2010, Rulers of the new silk road, June 5: 75–77; (4) Economist, 2010, Super-duper-connectors from the Gulf, June 5: 21.

agglomeration

Clustering economic activities in certain locations.

164 PART 2 BUSINESS-LEVEL STRATEGIES

example, due to agglomeration, Dallas has the world’s heaviest concentration of telecom companies. US firms such as AT&T, HP, Raytheon, TI, and Verizon cluster there. Numerous leading foreign telecom firms such as Alcatel-Lucent, Ericsson, Fujitsu, Huawei, Siemens, and STMicroelectronics have also converged in this region.

Given that different locations offer different benefits, it is imperative that a firm match its strategic goals with potential locations. The four strategic goals are shown in Table 6.1.

• Natural resource seeking firms have to go to particular foreign locations where those resources are found. For example, the Middle East, Russia, and Venezuela are all rich in oil. Even when the Venezuelan government became more hostile, Western oil firms had to put up with it.

• Market seeking firms go to countries that have a strong demand for their products and services. For example, China is now the largest car market in the world, and practically all the automakers in the world are now elbowing into this fast-growing market. General Motors (GM) has emerged as the leader. It now sells more cars in China than in the United States.

• Efficiency seeking firms often single out the most efficient locations featuring a combination of scale economies and low-cost factors. It is the search for efficiency that induced numerous MNEs to enter China. China now manufactures two-thirds of the world’s photocopiers, shoes, toys, and microwave ovens; one-half of the DVD players, digital cameras, and textiles; one-third of the desktop computers; and one-quarter of the mobile phones, television sets, and steel. Shanghai alone reportedly has a cluster of over 400 of the Fortune Global 500 firms. Approximately one-quarter of all foreign direct investment (FDI) in China has been absorbed by Shanghai.17 It is important to note that China does not present the absolutely lowest labor costs in the world, and Shanghai is the highest cost city in China. However, Shanghai’s attractiveness lies in its ability to enhance efficiency for foreign entrants by lowering total costs.

• Innovation seeking firms target countries and regions renowned for world-class innovations, such as Silicon Valley and Bangalore (in IT), Dallas (in telecom), and Russia (in aerospace).18 (See Chapter 10 for details.)

TABLE 6.1 Matching Strategic Goals with Locations

STRATEGIC GOALS LOCATION-SPECIFIC ADVANTAGES EXAMPLES IN THE TEXT

Natural resource seeking

Possession of natural resources and related transport and communication infrastructure

Oil in the Middle East, Russia, and Venezuela

Market seeking Abundance of strong market demand and customers willing to pay

GM in China

Efficiency seeking Economies of scale and abundance of low-cost factors

Manufacturing in China (especially in Shanghai)

Innovation seeking Abundance of innovative individuals, firms, and universities

IT in Silicon Valley and Bangalore; telecom in Dallas; aerospace in Russia

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It is important to note that location-specific advantages may grow, change, and/or decline, prompting firms to relocate. If policy makers fail to maintain the institutional attractiveness (for example, by raising taxes) and if companies overcrowd and bid up factor costs such as land and talents, some firms may move out of certain locations previously considered advantageous. For example, BMW and Mercedes had proudly projected a 100% “Made in Germany” image until the early 1990s. Now both firms produce in a variety of countries such as Brazil, China, Mexico, South Africa, the United States, and Vietnam and instead boast “Made by BMW” and “Made by Mercedes.” Both the relative decline of Germany’s location-specific advantages and the rise of other countries’ advantages prompted Mercedes and BMW to do this.

Cultural/Institutional Distances and Foreign Entry Locations In addition to strategic goals, another set of considerations centers on cultural/institutional distances (see also Chapter 4). Cultural distance is the difference between two cultures along some identifiable dimensions (such as individualism).19 Considering culture as an informal part of institutional frameworks governing a particular country, institutional distance is “the extent of similarity or dissimilarity between the regulatory, normative, and cognitive institutions of two countries.”20 Many Western consumer products firms, such as L’Oreal, have shied away from Saudi Arabia citing its stricter rules of personal behavior—in essence, its cultural and institutional distance being too large.

Two schools of thought have emerged. The first is associated with stage models, arguing that firms will enter culturally similar countries during their first stage of internationalization, and that they may gain more confidence to enter culturally distant countries in later stages.21 This idea is intuitively appealing: It makes sense for Belgium firms to first enter France, taking advantage of common cultural, language, and historical ties.22 Business between countries that share a language on average is three times greater than between countries without a common language. Firms from common-law countries (English-speaking countries and Britain’s former colonies) are more likely to be interested in other common-law countries. Colony–colonizer links (such as Britain’s ties with the Commonwealth and Spain’s with Latin America) boost trade significantly. In general, MNEs from emerging economies perform better in other developing countries, presumably because of their closer institutional distance and similar stages of economic development.23 There is some evidence documenting certain performance benefits of competing in culturally and institutionally adjacent countries.24

Citing numerous counter-examples, a second school of thought argues that considera- tions of strategic goals such as market and efficiency are more important than cultural/ institutional considerations.25 For instance, natural resource seeking firms have compel- ling reasons to enter culturally and institutionally distant countries (such as Papua New Guinea for bauxite and Zambia for copper). On Sakhalin Island, a remote, oil-rich part of the Russian Far East, Western oil firms have to live with Russia’s strong-arm tactics to grab more shares and profits that are described as “thuggish ways” by the Economist.26

Because Western oil firms have few alternatives elsewhere, cultural, institutional, and geographic distance in this case does not seem relevant—they simply have to be there and let the Russians dictate the terms. Overall, in the complex calculus underpinning entry decisions, locations represent but one of several important sets of considerations (see Emerging Markets 6.3). As shown next, entry timing and modes are also crucial.

166 PART 2 BUSINESS-LEVEL STRATEGIES

EMERGING MARKETS 6.3

Emerging Multinationals from South Africa

Since apartheid was removed in 1994, South Africa has brewed a series of multinationals that are increasingly active abroad. While most readers of this book probably have heard about SABMiller (beers) and De Beers (diamonds), how many of you have heard of Didata, MTN, Old Mutual, SAB, SASOL, and Standard Bank? If you have not heard of them, watch out as they may soon come to a city near you (if they have not already arrived).

Naturally, South African firms started by entering sub- Saharan African countries. In fact, South Africa is the number one foreign investor in sub-Saharan Africa. South African Breweries (SAB) first pioneered the concept of the pan-African beer market, and then went on to become the global titan known as SABMiller after acquiring Miller Beer of the United States in 2002. As an early mover in cellular (mobile) phones, telecom provider MTN was one of a handful companies to defy conventional wisdom and prove that Africa could be a huge market for mobile services. Retailers such as Massmart, Shoprite, and Game are bringing Western-style shopping to Malawi, Mozambique, Nigeria, Uganda, and others. Standard Bank has charged into 16 African countries that previously often lacked even basic financial services. “Africa is the next China,” one South African businessman noted. South African firms have every intention of enjoying first-mover advantages there.

After a short time cutting their teeth in Africa, many South African firms spread their wings beyond the shores of Africa. In the early 1990s, SABmoved into China and Central and Eastern Europe, establishing strong positions in major emerging economies ahead of global rivals. Since becoming SABMiller, it has further globalized. It is now the second- largest brewer in South America. Old Mutual, South Africa’s biggest financial services firm, bought Sweden’s oldest insurance house in 2005. Dimension Data (Didata), an IT firm, competes in over 30 countries. SASOL, a chemicals and energy firm, operates in over 20 countries.

What explains such a surge of internationalization from South Africa? From an industry-based view, South African multinationals tend to specialize in industries where growth in Africa and elsewhere is strong. From a resource-based

standpoint, since South Africa represents 10% of Africa’s population but 45% of its GDP, winning firms in South Africa not surprisingly have a competitive edge in other less competitive African countries. Capabilities that serve African customers well can then be leveraged to more effectively compete in more distant emerging economies elsewhere. From an institution-based view, the lifting of anti-apartheid sanctions by other countries and the generally open trade and investment environment worldwide have made such global expansion possible. As Africa is at last enjoying peace and (relatively) decent government, trade barriers have been reduced. Intra-Africa trade has gone from 6% to 13% of the total volume in a decade. “South Africans do well when they go elsewhere,” noted another expert, “because they’re not afraid, having done well in the most difficult continent on earth.”

Sources: Based on (1) S. Burgess, 2003, Within-country diversity: Is it key to South Africa’s prosperity in a changing world? International Journal of Advertising, 22: 157–182; (2) BusinessWeek, 2008, Africa’s dynamo, December 15: 51–56; (3) Economist, 2006, Going global, July 15: 59–60; (4) Economist, 2009, Africa’s new Big Man, April 18: 11; (5) Economist, 2011, The sun shines bright, December 3: 15.

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When to Enter? Entry timing refers to whether there are compelling reasons to be an early or late entrant in a particular country. Some firms look for first-mover advantages, defined as the benefits that accrue to firms that enter the market first and that later entrants do not enjoy.27 Speaking of the power of first-mover advantages, “Xerox,” “FedEx,” and “Google” have now become verbs such as “Google it.” In many African countries, “Colgate” is the generic term for toothpaste. Unilever, a late mover, is disappointed to find out that its African customers call its own toothpaste “the red Colgate” (!). Table 6.2 outlines such advantages.

• First movers may gain advantage through proprietary technology. Think about Apple’s iPod, iPad, and iPhone.

• First movers may also make preemptive investments. A number of Japanese MNEs have cherry picked leading local suppliers and distributors in Southeast Asia as new members of the expanded keiretsu networks (alliances of Japanese businesses with interlocking business relationships and shareholdings) and have blocked access to the suppliers and distributors by late entrants from the West.28

• First movers may erect significant entry barriers for late entrants, such as high switching costs due to brand loyalty. Buyers of expensive equipment are likely to stick with the same producers for components, training, and services for a long time. That is why American,

TABLE 6.2 First-Mover Advantages and Late-Mover Advantages

FIRST-MOVER ADVANTAGES EXAMPLES IN THE TEXT

LATE-MOVER ADVANTAGES EXAMPLES IN THE TEXT

Proprietary, technological leadership

Apple’s iPod, iPad, and iPhone

Opportunity to free ride on first mover investments

Ericsson won big contracts in Saudi Arabia, free riding on Cisco’s efforts

Preemption of scarce resources

Japanese MNEs in Southeast Asia

Resolution of technological and market uncertainties

GM and Toyota have patience to wait until the Nissan Leaf resolves uncertainties about the electric car

Establishment of entry barriers for late entrants

Poland’s F-16 fighter jet contract

First mover’s difficulty to adapt to market changes

Greyhound is stuck with the bus depots, whereas Megabus simply uses curbside stops

Avoidance of clash with dominant firms at home

Sony, Honda, and Epson went to the US market ahead of their Japanese rivals

Relationships with key stakeholders such as governments

Citigroup, JP Morgan Chase, and Metallurgical Corporation of China entered Afghanistan

first-mover advantages

The advantages that first movers enjoy and later movers do not.

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British, French, German, and Russian aerospace firms competed intensely for Poland’s first post–Cold War order of fighters—America’s F-16 eventually won.

• Intense domestic competition may drive some non-dominant firms abroad to avoid clashing with dominant firms head-on in their home market. Matsushita, Toyota, and NEC were the market leaders in Japan, but Sony, Honda, and Epson all entered the United States in their respective industries ahead of the leading firms.

• First movers may build precious relationships with key stakeholders such as customers and governments. For example, Citigroup, JP Morgan Chase, and Metallurgical Corporation of China have entered Afghanistan, earning a good deal of goodwill from the Afghan government that is interested in wooing more FDI.29

The potential advantages of first movers may be counter-balanced by various disad- vantages, which result in late-mover advantages (also listed in Table 6.2). Numerous first-mover firms—such as EMI in CT scanners and Netscape in Internet browsers—have lost market dominance in the long run. It is such late-mover firms as GE and Microsoft (Explorer), respectively, that win. Specifically, late-mover advantages are manifested in three ways.

• Late movers can free ride on first movers’ pioneering investments. In Saudi Arabia, Cisco invested millions of dollars to rub shoulders of dignitaries, including the king, in order to help officials grasp the promise of the Internet in fueling economic development, only to lose out to late movers such as Ericsson that offered lower-cost solutions. For instance, the brand-new King Abdullah Economic City awarded an $84 million citywide telecom project to Ericsson whose bid was more than 20% lower than Cisco’s—in part because Ericsson did not have to offer basic education and did not have to entertain that much. “We’re very proud to have won against a company that did as much advance work as Cisco did,” an elated Ericsson executive noted.30

• First movers face greater technological and market uncertainties. Nissan, for example, has launched the world’s first all-electric car, the Leaf, which can run without a single drop of gasoline. However, there are tremendous uncertainties. After some of these uncertainties are removed, late movers such as GM and Toyota will join the game with their own electric cars.

• As incumbents, first movers may be locked into a given set of fixed assets or reluctant to cannibalize existing product lines in favor of new ones. Late movers may be able to take advantage of the inflexibility of first movers by leapfrogging them. Although Greyhound, the incumbent in intercity bus service in the United States, is financially struggling, it cannot get rid of the expensive bus depots in inner cities that are often poorly maintained and dreadful. Megabus, the new entrant from Britain, simply has not bothered to build and maintain a single bus depot. Instead, Megabus uses curbside stops (like regular city bus stops), which have made travel by bus more appealing to a large number of passengers (see the Opening Case).

Overall, evidence points out both first-mover advantages and late-mover advantages. Unfortunately, a mountain of research is still unable to conclusively recommend a

late-mover advantages

Advantages associated with being a later mover (also known as first-mover disadvantages).

C h a p t e r 6 E n t e r i n g F o r e i g n M a r k e t s 169

particular entry timing strategy.31 Although first movers may have an opportunity to win, their pioneering status is not a guarantee of success. For example, among the three first movers into the Chinese automobile industry in the early 1980s, Volks- wagen captured significant advantages, Chrysler had very moderate success, and Peugeot failed and had to exit. Although many of the late movers that entered in the late 1990s are struggling, GM, Honda, and Hyundai gained significant market shares. It is obvious that entry timing cannot be viewed in isolation and entry timing per se is not the sole determinant of success and failure of foreign entries. It is through interaction with other strategic variables that entry timing has an impact on performance.

How to Enter? This section first focuses on large-scale versus small-scale entries. Then, it introduces a decision model. The first step is to determine whether to pursue equity or non-equity modes of entry. Finally, we outline the pros and cons of various equity and non-equity modes.

Scale of Entry: Commitment and Experience One key dimension in foreign entry decisions is the scale of entry, which refers to the amount of resources committed to entering a foreign market. The benefits of large-scale entries are a demonstration of strategic commitment to certain markets. This both helps assure local customers and suppliers (“We are here for the long haul!”) and deters potential entrants. The drawbacks are (1) limited strategic flexibility elsewhere and (2) huge losses if these large-scale “bets” turn out to be wrong.

Small-scale entries are less costly. They focus on “learning by doing” while limiting the downside risk.32 For example, to enter the market of Islamic finance whereby no interest can be charged (per teaching of the Koran), Citibank set up the subsidiary Citibank Islamic Bank, HSBC established Amanah, and UBS launched Noriba. They were all designed to experiment with different interpretations of the Koran on how to make money while not committing religious sins. It is simply not possible to acquire such an ability outside the Islamic world. Overall, the longer foreign firms stay in host countries, the less liability of foreignness they experience. The drawbacks of small-scale entries are a lack of strong commitment, which may lead to difficulties in building market share and in capturing first-mover advantages.

Modes of Entry: The First Step on Equity versus

Non-equity Modes Among numerous modes of entry, managers are unlikely to consider all of them simulta- neously. Given the complexity of entry decisions, it is imperative that managers prioritize, by considering only a few manageable key variables first and then contemplating other variables later. Therefore, a decision model (shown in Figure 6.3 and explained in Table 6.3) is helpful.33

scale of entry

The amount of resources committed to foreign mar- ket entry.

170 PART 2 BUSINESS-LEVEL STRATEGIES

In the first step, considerations for small-scale versus large-scale entries usually boil down to the equity (ownership) issue. Non-equity modes (exports and contractual agree- ments) tend to reflect relatively smaller commitments to overseas markets, whereas equity modes (joint ventures and wholly owned subsidiaries) are indicative of relatively larger and harder-to-reverse commitments. Equity modes call for the establishment of indepen- dent organizations overseas (partially or wholly owned), while non-equity modes do not require such independent establishments.

The distinction between equity and non-equity modes is not trivial. In fact, it is what defines an MNE: An MNE enters foreign markets via equity modes through FDI. A firm that merely exports/imports with no FDI is usually not regarded as an MNE. Why would a firm, say, an oil importer, want to become an MNE by directly investing in the oil- producing country, instead of relying on the market mechanism by purchasing oil from an exporter in that country?

FIGURE 6.3 The Choice of Entry Modes: A Decision Model

Choice of entry modes

Non-equity modes

Exports

Direct exports

Indirect exports

Others

Minority JVs

50/50 JVs

Majority JVs

Greenfields

Acquisitions

Others

Licensing/ franchising

Turnkey projects

R&D contracts

Co-marketing

Contractual agreements

Joint ventures (JVs)

Wholly owned subsidiaries (WOS)

Equity (FDI) modes

Strategic alliances (within dotted area)

Source: Adapted from Y. Pan & D. Tse, 2000, The hierarchical model of market entry modes (p. 538), Journal of International Business Studies, 31: 535–554. The dotted area labeled “strategic alliances,” including both non-equity modes (contractual agreements) and equity modes (JVs), is added by the present author. See Chapter 7 for more details on strategic alliances.

non-equity modes

Modes of foreign market entries that do not involve the use of equity.

equity modes

Modes of foreign market entry that involve the use of equity.

C h a p t e r 6 E n t e r i n g F o r e i g n M a r k e t s 171

TABLE 6.3 Modes of Entry: Advantages and Disadvantages

ENTRY MODES (EXAMPLES IN THE TEXT) ADVANTAGES DISADVANTAGES

1. Non-equity modes: Exports

Direct exports (Pearl River piano exports to over 80 countries)

& Economies of scale in production concentrated in home country

& Better control over distribution

& High transportation costs for bulky products & Marketing distance from customers & Trade barriers and protectionism

Indirect exports (commodities trade in textiles and meats)

& Concentration of resources on production

& No need to directly handle export processes

& Less control over distribution (relative to direct exports)

& Inability to learn how to operate overseas

2. Non-equity modes: Contractual agreements

Licensing/franchising (Pizza Hut in Thailand)

& Low development costs & Low risk in overseas expansion

& Little control over technology and marketing & May create competitors & Inability to engage in global coordination

Turnkey projects (a German, Italian, and Iranian consor- tium on a BOT project in Iran)

& Ability to earn returns from process technology in countries where FDI is restricted

& May create efficient competitors & Lack of long-term presence

R&D contracts (IT work in India and aerospace research in Russia)

& Ability to tap into the best locations for certain innovations at low costs

& Difficult to negotiate and enforce contracts & May nurture innovative competitors & May lose core innovation capabilities

Co-marketing (McDonald’s works with movie studios and toymakers; airline alliances)

& Ability to reach more customers & Limited coordination

3. Equity modes: Partially owned subsidiaries

Joint ventures (Shanghai Volkswagen)

& Sharing costs, risks, and profits & Access to partners’ knowledge and

assets & Politically acceptable

& Divergent goals and interests of partners & Limited equity and operational control & Difficult to coordinate globally

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Relative to a non-MNE, an MNE has three principal advantages: ownership (O), location (L), and internalization (I). Since we already discussed location earlier, we focus on ownership and internalization here. By owning assets in both oil-importing and producing countries, the MNE is better able to coordinate cross-border activities, such as delivering crude oil to the oil refinery in the importing country right at the moment its processing capacity becomes available (just-in-time), instead of letting crude oil sit in expensive ships or storage tanks for a long time. This advantage is therefore called ownership advantage.

Another advantage stems from the removal of the market relationship between an importer and an exporter, which may suffer from high transaction costs. Using the market, deals have to be negotiated, prices agreed upon, and deliveries verified, all of which entail significant costs. What is more costly is the possibility of opportunism on both sides. For instance, the oil importer may refuse to accept a shipment after its arrival, citing unsatisfactory quality, but the real reason could be the importer’s inability to sell refined oil downstream (people may drive less due to high oil prices). The exporter is thus forced to find a new buyer for a boatload of crude oil on a last-minute “fire sale” basis. On the other hand, the oil exporter may demand higher-than-agreed-upon prices, citing a variety of reasons ranging from inflation to natural disasters. The importer thus has to either (1) pay more or (2) refuse to pay and suffer from the huge costs of keeping expensive refinery facilities idle. These transaction costs increase international market inefficiencies and imperfections. By replacing such a market relationship with a single organization spanning both countries (a process called internalization, basically transforming external markets with in-house links), the MNE thus reduces cross- border transaction costs and increases efficiencies. This advantage is called internaliza- tion advantage.

Relative to a non-MNE, an MNE that operates in certain desirable locations enjoys a combination of ownership (O), location (L), and internalization (I) advantages (Figure 6.4). These are collectively labeled as the OLI advantages by John Dunning, a leading MNE

TABLE 6.3 (Continued)

ENTRY MODES (EXAMPLES IN THE TEXT) ADVANTAGES DISADVANTAGES

4. Equity modes: Wholly owned subsidiaries

Greenfield operations (PRPG America; Japanese auto transplants in the United States)

& Complete equity and operational control & Protection of know-how & Ability to coordinate globally

& Potential political problems and risks & High development costs & Add new capacity to industry & Slow entry speed (relative to acquisitions)

Acquisitions (Pearl River’s acquisition of Ritmüller)

& Same as greenfield (above) & Do not add new capacity & Fast entry speed

& Same as greenfield (above), except adding new capacity and slow speed

& Post-acquisition integration problems

ownership advantage

Advantage associated with directly owning assets overseas, which is one of the three key advantages of being a multinational enterprise (the other two are location and internali- zation advantages).

internalization

The process of replacing a market relationship with a single multinational orga- nization spanning both countries.

internalization advantage

The advantage associated with internalization, which is one of the three key advantages of being a multinational enterprise (the other two are owner- ship and location advan- tages).

OLI advantages

Ownership, location, and internalization advantages, which are typically asso- ciated with MNEs.

C h a p t e r 6 E n t e r i n g F o r e i g n M a r k e t s 173

scholar.34 Overall, the first step in entry mode considerations is extremely critical. A strategic decision must be made in terms of whether to undertake FDI and become an MNE by selecting equity modes.

Modes of Entry: The Second Step on Making

Actual Selections During the second step, managers consider variables within each group of non-equity and equity modes. If the decision is to export, then the next consideration is direct exports or indirect exports. Direct exports are the most basic mode of entry, capitalizing on econo- mies of scale in production concentrated in the home country and providing better control over distribution. Pearl River, for example, exports its pianos from China to over 80 countries (see the Closing Case). This strategy essentially treats foreign demand as an extension of domestic demand, and the firm is geared toward designing and producing first and foremost for the domestic market. While direct exports may work if the export volume is small, they are not optimal when the firm has a large number of foreign buyers. Marketing 101 suggests that the firm needs to be closer, both physically and psychologi- cally, to its customers, prompting the firm to consider more intimate overseas involve- ment such as FDI. In addition, direct exports may provoke protectionism, potentially triggering antidumping actions (see Chapter 8).

Another export strategy is indirect exports—namely, exporting through domestically based export intermediaries. This strategy not only enjoys the economies of scale similar to direct exports but is also relatively worry free. A significant amount of export trade in commodities such as textiles and meats, which compete primarily on price, is indirect through intermediaries.35 Indirect exports have some drawbacks. For example, third parties such as export trading companies may not share the same objectives as exporters. Exporters choose intermediaries primarily because of information asymmetries concerning foreign markets.36 Intermediaries with international contacts and knowledge essentially make a living by taking advantage of such information asymmetries. They are not interested in reducing such asymmetries. Intermediaries, for example, may repackage the products under

FIGURE 6.4 The OLI Advantages Associated with Being an MNE through FDI

FDI/MNE

Ownership advantages

Location advantages

Internalization advantages

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their own brand and insist on monopolizing the communication with overseas customers. If the exporter is interested in knowing more about how its products perform overseas, indirect exports would not provide such knowledge.

The next group of non-equity entry modes involves the following types of contractual agreement: (1) licensing or franchising, (2) turnkey projects, (3) research and develop- ment contracts, and (4) co-marketing. In licensing/franchising agreements, the licensor/ franchisor sells the rights to intellectual property such as patents and know-how to the licensee/franchisee for a royalty fee. The licensor/franchisor, thus, does not have to bear the full costs and risks associated with foreign expansion. On the other hand, the licensor/ franchisor does not have tight control over production and marketing.37 Pizza Hut, for example, was disappointed when its franchisee in Thailand discontinued the relationship and launched a competing pizza restaurant to eat Pizza Hut’s lunch.

In turnkey projects, clients pay contractors to design and construct new facilities and train personnel. At project completion, contractors hand clients the proverbial key to facilities ready for operations, hence the term “turnkey.” This mode allows firms to earn returns from process technology (such as construction) in countries where FDI is restricted. The drawbacks, however, are twofold. First, if foreign clients are competitors, turnkey projects may boost their competitiveness. Second, turnkey projects do not allow for a long-term presence after the key is handed to clients. To obtain a longer-term presence, build-operate-transfer agreements are now often used, instead of the traditional build-transfer type of turnkey projects. A build-operate-transfer (BOT) agreement is a non-equity mode of entry used to build a longer-term presence by building and then operating a facility for a period of time before transferring operations to a domestic agency or firm. For example, a consortium of German, Italian, and Iranian firms obtained a large-scale BOT power-generation project in Iran. After completion of the construction, the consortium will operate the project for 20 years before transferring it to the Iranian government.

Research and development (R&D) contracts refer to outsourcing agreements in R&D between firms. Firm A agrees to perform certain R&D work for Firm B. Firms thereby tap into the best locations for certain innovations at relatively low costs, such as aerospace research in Russia. However, three drawbacks may emerge. First, given the uncertain and multidimensional nature of R&D, these contracts are often difficult to negotiate and enforce. While delivery time and costs are relatively easy to negotiate, quality is often hard to assess. Second, such contracts may cultivate competitors. A number of Indian IT firms, nurtured by such work, are now on a global offensive to take on their Western rivals. Finally, firms that rely on outsiders to perform a lot of R&D may lose some of their core R&D capabilities in the long run.

Co-marketing refers to efforts among a number of firms to jointly market their products and services. Toy makers and movie studios often collaborate in co-marketing campaigns with fast-food chains such as McDonald’s to package toys based on movie characters in kids’ meals. Airline alliances such as One World and Star Alliance engage in extensive co-marketing through code sharing. The advantage is the ability to reach more customers. The drawback centers on limited control and coordination.

Next are equity modes, all of which entail some FDI and transform the firm to an MNE. A joint venture (JV) is a corporate child, a new entity jointly created and owned by two or more parent companies. It has three principal forms: Minority JV (less than 50%

turnkey projects

Projects in which clients pay contractors to design and construct new facilities and train personnel.

build-operate-transfer (BOT) agreement

A special kind of turnkey project in which contrac- tors first build facilities, then operate them for a period of time, and then transfer them back to clients.

research and development (R&D) contracts

Outsourcing agreements in R&D between firms (that is, Firm A agrees to perform certain R&D work for Firm B).

co-marketing

Agreements among a number of firms to jointly market their products and services.

joint venture (JV)

A “corporate child” that is a new entity given birth and jointly owned by two or more parent companies.

C h a p t e r 6 E n t e r i n g F o r e i g n M a r k e t s 175

equity), 50/50 JV (equal equity), and majority JV (more than 50% equity). JVs, such as Shanghai Volkswagen, have three advantages. First, an MNE shares costs, risks, and profits with a local partner, so the MNE possesses a certain degree of control but limits risk exposure. Second, the MNE gains access to knowledge about the host country; the local firm, in turn, benefits from the MNE’s technology, capital, and management. Third, JVs may be politically more acceptable in host countries.

In terms of disadvantages, JVs often involve partners from different backgrounds and with different goals, so conflicts are natural. Furthermore, effective equity and operational control may be difficult to achieve since everything has to be negotiated—in some cases, fought over. Finally, the nature of the JV does not give an MNE the tight control over a foreign subsidiary that it may need for global coordination. Overall, all sorts of non-equity- based contractual agreements and equity-based JVs can be broadly considered as strategic alliances (within the dotted area in Figure 6.3). Chapter 7 will discuss them in detail.

The last entry mode is to establish a wholly owned subsidiary (WOS), defined as a subsidiary located in a foreign country that is entirely owned by the parent multinational. There are two primary means to set up a WOS.38 One is to establish greenfield operations, building new factories and offices from scratch (on a proverbial piece of “green field” formerly used for agricultural purposes). For example, PRPG America, Ltd., is a wholly owned greenfield subsidiary of Pearl River Piano Group of China (see the Closing Case). There are three advantages. First, a greenfield WOS gives an MNE complete equity and management control, thus eliminating the headaches associated with JVs. Second, this undivided control leads to better protection of proprietary technology. Third, a WOS allows for centrally coordinated global actions. Sometimes, a subsidiary (such as TI’s in Japan, discussed earlier) will be ordered to lose money. Local licensees/ franchisees or JV partners are unlikely to accept such a subservient role to lose money (!).

In terms of drawbacks, a greenfield WOS tends to be expensive and risky, not only financially but also politically. Its conspicuous foreignness may become a target for nationalistic sentiments. Another drawback is that greenfield operations add new capacity to an industry, which will make a competitive industry more crowded. For example, think of all the Japanese automobile plants built in the United States, which have severely squeezed the market share of US automakers. Finally, greenfield operations suffer from a slow entry speed of at least one to several years (relative to acquisitions).

The other way to establish a WOS is an acquisition. Pearl River’s acquisition of Ritmüller is a case in point (see the Closing Case). Acquisition shares all the benefits of greenfield WOS but enjoys two additional advantages: (1) adding no new capacity and (2) faster entry speed. In terms of drawbacks, acquisition shares all of the disadvantages of greenfield WOS except adding new capacity and slow entry speed. But acquisition has a unique disadvantage: post-acquisition integration problems (see Chapter 9 for details).

Debates and Extensions This chapter has already covered some crucial debates, such as first-mover versus late- mover advantages. Here we discuss three heated recent debates: (1) liability versus asset of foreignness, (2) global versus regional geographic diversification, and (3) old-line versus emerging multinationals.

wholly owned subsidiary (WOS)

Subsidiary located in a for- eign country that is entirely owned by the MNE.

greenfield operation

Building factories and offices from scratch (on a proverbial piece of “green- field” formerly used for agricultural purposes).

176 PART 2 BUSINESS-LEVEL STRATEGIES

Liability versus Asset of Foreignness In terms of the “liability of foreignness,” one contrasting view argues that under certain circumstances, being foreign can be an asset (that is, a competitive advantage).39 German cars are viewed as of higher quality in the United States and Japan. In China, consumers discriminate against made-in-China luxury goods. Although these made-in-China luxury goods sport Western brands, they are viewed as inferior to made-in-France handbags and made-in-Switzerland watches (see Chapter 2 Closing Case). American cigarettes are “cool” among smokers in Central and Eastern Europe. Anything Korean—ranging from handsets and TV shows to kimchi (pickled cabbage)-flavored instant noodles—is considered hip in Southeast Asia. Conceptually, this is known as the country-of-origin effect, which refers to the positive or negative perception of firms and products from a certain country. Pearl River’s promotion of the Ritmüller brand, which highlights its German origin, suggests that the negative country-of-origin effect can be (at least partially) overcome (see the Closing Case). Pearl River is not alone in this regard. Here is a quiz: What is Häagen-Dazs ice cream’s country of origin? My students typically say: Germany, Belgium, Switzerland, and other European countries. Sorry, all wrong. Häagen-Dazs is American and has always been (!).

Whether foreignness is indeed an asset or a liability remains tricky. Tokyo Disneyland became wildly popular in Japan, because it played up its American image. But Paris Disneyland received relentless negative press coverage in France, because it insisted on its wholesome American look. To play it safe, Hong Kong Disneyland endeavored to strike the elusive balance between American image and Chinese flavor. All eyes are now on the forthcoming Shanghai Disneyland in terms of such balance.

Over time, the country-of-origin effect may shift. A number of UK firms used to proudly sport names such as British Telecom and British Petroleum. Recently, they have shied away from being “British” and rebranded themselves simply as BT and BP. In Britain, these changes are collectively known as the “B phenomenon.” These costly rebranding campaigns are not casual changes. They reflect less confidence in Britain’s positive country-of-origin effect. Recently, BAE Systems, formerly British Aerospace, has complained that its British origin is pulling its legs in its largest market, the US defense market. Only US citizens are allowed to know the details of its most sensitive US contracts, and even its British CEO cannot know such details. This is untenable now that two-fifths of its sales are in the United States. Thus, BAE Systems is seriously considering becoming “American.” However, in an interesting twist, an “Americanized” BAE Systems may encounter liability of foreignness in Britain.40 Not surprisingly, the “B phenomenon” is controversial in Britain. One lesson we can draw is that foreignness can either be a liability or an asset, and that changes are possible. One solution is to blur the country of origin. For example, Gucci positions itself as a firm with Italian roots that has a Dutch address (where it is registered) and sells French fashion.

Global versus Regional Geographic Diversification In this age of globalization, debate continues on the optimal geographic scope for MNEs.41

Despite the widely held belief that MNEs are expanding “globally,” Alan Rugman and colleagues report that, surprisingly, even among the largest Fortune Global 500 MNEs, few are truly “global.”42 Using some reasonable criteria (at least 20% of sales in each of the three regions of the Triad consisting of Asia, Europe, and North America but less than 50% in any one region), only nine MNEs are found to be really “global” (Table 6.4).

country-of-origin effect

The positive or negative perception of firms and products from a certain country.

C h a p t e r 6 E n t e r i n g F o r e i g n M a r k e t s 177

Should most MNEs further “globalize”? There are two answers. First, most MNEs know what they are doing, and their current geographic scope is the maximum they can manage. Some of them may have already over-diversified and will need to downscope. Second, these data only capture a snapshot (in the 2000s) and some MNEs may become more “globalized” over time. However, more recent data do not show major changes.43 While the debate goes on, it has at least taught us one important reason: Be careful when using the word “global.” Themajority of the largest MNEs are not necessarily very “global” in their geographic scope.

Old-line versus Emerging Multinationals: OLI versus LLL MNEs presumably possess OLI advantages. The OLI framework is based on the experi- ence of MNEs headquartered in developed economies that typically possess high-caliber technology and management know-how. However, emerging multinationals, such as those from China (see the Closing Case), Russia (Emerging Markets 6.1), and South Africa (Emerging Markets 6.3), are challenging some of this conventional wisdom.44

While these emerging multinationals, like their old-line counterparts, hunt for lucrative locations and internalize transactions—conforming to the L and I parts of the OLI framework—they typically do not own better proprietary technology, and their manage- ment capabilities are usually not world class. In other words, the O part is largely missing. How can we make sense of these emerging multinationals?

One interesting new framework is the “linkage, leverage, and learning” (LLL) framework advocated by John Mathews.45 Linkage refers to emerging MNEs’ ability to identify and bridge gaps. Pearl River has identified the gap between what its pianos can actually offer and what price it can command given the negative country-of-origin effect associated with Chinese products. Pearl River’s answer has been two-pronged: (1) develop the economies of scale to bring down the unit cost of pianos while maintaining a high standard for quality, and (2) acquire and revive the Ritmüller brand to reduce some of the negative country-of-origin effect. Thus, Pearl River links China and Germany to propel its global push (see the Closing Case).

Leverage refers to emerging multinationals’ ability to take advantage of their unique resources and capabilities, which are typically based on a deep understanding of customer needs and wants. For example, Naver enjoys a 76% market share for Internet searches in South Korea. It intends to leverage its deep understanding of Asian languages and cultures by charging into Japan. In the long run, it also has ambition to launch other culturally specific search engines, such as “Naver Korean-American” and “Naver

TABLE 6.4 There Are Only Nine “Global” Multinational Enterprises (MNEs) Measured by Sales

1 2 3 4 5 6 7 8 9

IBM Sony Philips Nokia Intel Canon Coca-Cola Flextronics LVMH

Sources: Adapted from A. Rugman & A. Verbeke, 2004, A perspective on regional and global strategies of multinational enterprises (pp. 8–10), Journal of International Business Studies, 35: 3–18. “Global”MNEs have at least 20% of sales in each of the three regions of the Triad (Asia, Europe, and North America), but less than 50% in any one region.

178 PART 2 BUSINESS-LEVEL STRATEGIES

Chinese-American.” On a global scale, Naver’s skills obviously pale in comparison with Google’s capabilities. But in certain markets such as South Korea, emerging multinationals such as Naver have been beating Google.

Learning probably is the most unusual aspect among the motives behind the internatio- nalization push of many emerging multinationals.46 Instead of the “I-will-tell-you-what-to- do” mentality typical of old-line MNEs from developed economies, many MNEs from emerging economies openly profess that they go abroad to learn. Skills they need to absorb range from basic English skills to high-level executive skills in transparent governance, market planning, and management of diverse multicultural workforces.

Of course, there is a great deal of overlap between OLI and LLL frameworks. So the debate boils down to whether the differences are fundamental, which would justify a new theory such as LLL advantages, or just a matter of degree, in which case OLI would be just fine to accommodate the new MNEs. Given the rapidly moving progress of these emer- ging multinationals, one thing for certain is that our learning and debate about them will not stop anytime soon.47

The Savvy Strategist Foreign market entries are crucial in global strategy. Without these first steps, firms will remain domestic players. The challenges associated with internationalization are daunting, the complexities enormous, and the stakes high. Consequently, the savvy strategist can draw four implications for action (Table 6.5). First, from an industry-based view, you need to thoroughly understand the dynamism underlying the industry in a foreign market you are looking into. For example, in the early 2000s, a number of European financial services firms such as ABN Amro, HSBC, and ING Group spent billions of dollars to enter the United States through a series of acquisitions. They failed to realize the forthcoming collapse of this industry engulfed in the Great Recession. As a result, they suffered tremendous losses.

Second, from a resource-based view, you and your firm need to develop overwhelming capabilities to offset the liability of foreignness. A case in point is the rise of Pearl River illustrated in the Closing Case.

Third, from an institution-based view, you need to understand the rules of the game, both formal and informal, governing competition in foreign markets. Failure to under- stand these rules can be costly. In the 2000s, managers at Dubai Ports World (DP World) and China National Offshore Oil Corporation (CNOOC) misread the xenophobic US sentiments against foreign acquisitions, which could be regarded as informal norms. As a result, their acquisition attempts were torpedoed politically.

TABLE 6.5 Strategic Implications for Action

& Grasp the dynamism underlying the industry in a host country that you are looking into. & Develop overwhelming resources and capabilities to offset the liability of foreignness. & Understand the rules of the game—both formal and informal—governing competition in

foreign markets. & Match efforts in market entry and geographic diversification with strategic goals.

LLL advantages

Linkage, leverage, and learning advantages, which are typically associated with MNEs from emerging economies.

ga ge

Le ar ni ng

C h a p t e r 6 E n t e r i n g F o r e i g n M a r k e t s 179

Finally, the savvy strategist matches entries with strategic goals. If the goal is to deter rivals in their home markets by slashing prices there (as TI did when entering Japan), then be prepared to fight a nasty price war and lose money. If the goal is to generate decent returns, then withdrawing from some tough nuts to crack may be necessary (as Wal-Mart withdrew from Germany).

In conclusion, this chapter sheds considerable light on the four fundamental questions. Why firms differ in their propensity to internationalize (Question 1) boils down to the size of the firm and that of the domestic market. How firms behave (Question 2) depends on how considerations for industry competition, firm capabilities, and institutional differences influence market entry decisions. What determines the scope of the firm (Question 3)—in this case, the scope of its international involvement—fundamentally depends on how to acquire and leverage the three-pronged OLI advantages. Firms committed to owning some assets overseas through equity modes of entry and, thus, to becomingMNEs are likely to have a broader scope overseas than those unwilling to do so. Finally, entry strategies obviously have something to do with the international success and failure of firms (Question 4).48

However, appropriate entry strategies, while certainly important, are only a beginning.49 It takes a lot more to succeed overseas, as we will discuss in later chapters.

CHAPTER SUMMARY

1. Understand the necessity to overcome the liability of foreignness • When entering foreign markets, firms confront a liability of foreignness. • The propensity to internationalize differs among firms of different sizes and different home market sizes.

2. Articulate a comprehensive model of foreign market entries • The industry-based view suggests that industry dynamism in a host country cannot be ignored.

• The resource-based view calls for the development of capabilities along the VRIO dimensions.

• The institution-based view focuses on institutional constraints that foreign entrants must confront.

3. Match the quest for location-specific advantages with strategic goals (where to enter) • Where to enter depends on certain foreign countries’ location-specific advantages and firms’ strategic goals, such as seeking (1) natural resources, (2) market, (3) efficiency, and (4) innovation.

4. Compare and contrast first-mover and late-mover advantages (when to enter) • Each has pros and cons, and there is no conclusive evidence pointing to one direction.

5. Follow a decisionmodel that guides specific steps for foreignmarket entries (how to enter) • How to enter depends on the scale of entry: Large-scale versus small-scale entries. • A decision model first focuses on the equity (ownership) issue. • The second step makes the actual selection, such as exports, contractual agreements, JVs, and WOS.

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6. Participate in three leading debates on foreign market entries • (1) Liability versus asset of foreignness, (2) global versus regional geographic diversification, and (3) old-line versus emerging multinationals.

7. Draw strategic implications for action • Grasp the dynamism underlying the industry in a host country that you are looking into. • Develop overwhelming resources and capabilities to offset the liability of foreignness. • Understand the rules of the game governing competition in foreign markets. • Match efforts in market entry and geographic diversification with strategic goals.

KEY TERMS

Agglomeration p. 164

Build-operate-transfer (BOT) agreement p. 175

Co-marketing p. 175

Country-of-origin effect p. 177

Currency hedging p. 163

Currency risk p. 163

Dissemination risk p. 161

Equity mode p. 171

Expropriation p. 162

First-mover advantage p. 168

Greenfield operation p. 176

Internalization p. 173

Internalization advantage p. 173

Joint venture (JV) p. 175

Late-mover advantage p. 169

Liability of foreignness p. 156

LLL advantages p. 179

Local content requirement p. 162

Location-specific advantage p. 163

Non-equity mode p. 171

Nontariff barrier p. 162

Obsolescing bargain p. 161

OLI advantages p. 173

Ownership advantage p. 173

Regulatory risk p. 161

Research and development (R&D) contract p. 175

Scale of entry p. 170

Strategic hedging p. 163

Sunk cost p. 162

Tariff barrier p. 162

Trade barrier p. 162

Turnkey project p. 175

Wholly owned subsidiary (WOS) p. 176

CRITICAL DISCUSSION QUESTIONS

1. Pick an industry in which firms from your country are internationally active. What are the top five most favorite foreign markets for firms in this industry? Why?

2. From institution-based and resource-based views, identify the liability of foreignness confronting MNEs from emerging economies interested in expanding overseas. How can such firms overcome them?

3. ON ETHICS: Entering foreign markets, by definition, means not investing in a firm’s home country. What are the ethical dilemmas here? What are your recommendations as (1) MNE executives, (2) labor union leaders of your domestic (home country) labor forces, (3) host country officials, and (4) home country officials?

C h a p t e r 6 E n t e r i n g F o r e i g n M a r k e t s 181

TOPICS FOR EXPANDED PROJECTS

1. During the 1990s, many North American, European, and Asian MNEs set up operations in Mexico, tapping into its location-specific advantages such as (1) proximity to the world’s largest economy, (2) market-opening policies associated with NAFTA member- ship, and (3) abundant, low-cost, and high-quality labor. None of these has changed much. Write a short paper explaining whether you think Mexico does or does not enjoy such advantages as it approaches the 30th anniversary of NAFTA.

2. ON ETHICS: Foreign entrants are often criticized for destroying local firms and cultures. Working in pairs, write a script for an interview between a local TV reporter and the CEO of a leading foreign entrant in a host country discussing this issue.

3. ON ETHICS: As CEO of a social media firm (such as Facebook), you have been informed that your firm’s service will be discontinued in the host country because it allegedly incites social unrest. (Egypt really did that in 2011 and the UK threatened to do that in 2010). Working in small groups, research this situation and write a press release to explain your firm’s response.

CLOSING CASE

Emerging Markets: Pearl River Goes Abroad

To many readers of this book, Pearl River is likely to be the world’s largest piano maker you have never heard of. It is also the fastest-growing piano maker in North America, with the largest dealer network in Canada and the United States (over 300 dealers). Its website proudly announces that Pearl River is “the world’s best selling piano.” Although some of you may say, “Sorry, I don’t play piano, so I don’t know anything about leading piano brands,” you most likely have heard about Yamaha and Steinway. Therefore, your excuse for not knowing Pearl River would collapse.

The problem is both yours and Pearl River’s. Given the relatively low prestige associated with made-in-China goods, you probably would not associate a fine musical instrument such as a piano with a Chinese firm. Pearl River Piano Group (PRPG) is China’s largest piano maker and has

recently dethroned Japan’s Yamaha to become the world champion by volume. Despite PRPG’s outstanding capabil- ities, it is difficult for one firm to change the negative country-of-origin image associated with made-in-China goods.

PRPG was founded in 1956 in Guangzhou, China, where the Pearl River flows by. Pearl River (the company) in fact exported its very first piano to Hong Kong, yet its center of gravity has remained in China. Pianos have become more affordable with rising incomes. The one- child policy has made families willing to invest in their only child’s education. As a result, the Chinese now buy half of the pianos produced in the world.

If you think life will be easy for the leading firm in the largest market in the world, you are wrong. In fact, life is increasingly hard for PRPG. Rising demand has attracted

182 PART 2 BUSINESS-LEVEL STRATEGIES

NOTES

numerous new entrants, many of which compete at the low end in China. These over 140 competitors have pushed PRPG’s domestic market share from 70% at its peak a decade ago to about 25% now—although it is still the market leader.

Savage domestic competition has pushed PRPG to increasingly look for overseas opportunities. It now exports to over 80 countries. In North America, PRPG started in the late 1980s by relying on US-based importers. Making its first-ever FDI, it set up a US-based sales subsidiary, PRPG America, Ltd., in Ontario, California, in 1999. Acknowl- edging the importance of the US market and the limited international caliber of his own managerial rank, PRPG’s CEO, Tong Zhi Cheng, attracted Al Rich, an American with long experience in the piano industry, to head the subsidi- ary. In two years, the greenfield subsidiary succeeded in getting Pearl River pianos into about one-third of the specialized US retail dealers. In ten years, the Pearl River brand became the undisputed leader in the low end of the upright piano market in North America. Efforts to pene- trate the high-end market, however, were still frustrated.

Despite the enviable progress made by PRPG itself in general and by its US subsidiary in particular, the Pearl River brand suffers from all the usual trappings associated with Chinese brands. “We are very cognizant that our pricing provides a strong incentive to buy,” Rich noted in a media interview, “but $6,000 is still a lot of money.” In an auda- cious move to overcome buyers’ reservations about purchas- ing a high-end Chinese product, PRPG made its second major FDI move in 2000, by acquiring Ritmüller of Germany.

Ritmüller was founded in 1795 by Wilhelm Ritmüller, during the lifetimes of composers Beethoven and Haydn. It was one of the first pianomakers in Germany and one of the

most prominent in the world. Unfortunately, during the post-WWII era, Ritmüller’s style of small-scale, handicraft- based pianomaking had a hard time surviving the disruptive, mass-production technologies unleashed by Yamaha and more recently by Pearl River. Prior to being acquired by Pearl River, Ritmüller had ended up being inactive. Today, Ritmül- ler has entered a new era in its proud history and has operated a factory in Germany with full capacity. The entire product line has been re-engineered to reflect a new com- mitment to a classic heritage and standards of excellence. PRPG has commissioned international master piano designers to marry German precision craftsmanship with the latest piano making technology.

Sources: Based on (1) Beijing Review, 2009, The return of the king, May 21, www.bjreview.com; (2) Funding Universe, 2009, Guangzhou Pearl River Piano Group Ltd., www. fundinguniverse.com; (3) Y. Lu, 2009, Pearl River Piano Group’s international strategy, in M. W. Peng, Global Strategy, 2nd ed. (pp. 437–440), Cincinnati: South-Western Cengage Learning; (4) Pearl River Piano Group, 2012, www.pearlriver piano.com; (5) Pearl River USA, 2012, www.pearlriverusa.com.

C A S E D I S C U S S I O N Q U E S T I O N S

1. Drawing on the industry-based, resource-based, and institution- based views, explain how Pearl River, from its humble roots, became China’s and the world’s largest piano producer.

2. Why did Pearl River’s top management believe that the firm must engage in significant internationalization (beyond the direct export strategy)?

3. Why did Pearl River use different entry modes when entering different markets?

[Journal acronyms] AMJ – Academy of Management Journal; AMR – Academy of Management Review; APJM – Asia Pacific Journal of Management; BJM – British Journal of Management; BW – BusinessWeek (before 2010) or Bloomberg Businessweek (since 2010); CME – Construction Management and Economics; EJIM – European Journal of International Manage- ment; GSJ – Global Strategy Journal; HBR – Harvard

Business Review; IBR – International Business Review; JIBS – Journal of International Business Studies; JIM – Journal of International Management; JM – Journal of Management; JMS – Journal of Manage- ment Studies; JWB – Journal of World Business; MIR – Management International Review; SCMP – South China Morning Post; SMJ – Strategic Manage- ment Journal

C h a p t e r 6 E n t e r i n g F o r e i g n M a r k e t s 183

1. K. Meyer, S. Estrin, S. Bhaumik, & M. W. Peng, 2009, Institutions, resources, and entry strategies in emer- ging economies, SMJ, 30: 61–80.

2. G. Gao, J. Murray, M. Kotabe, & J. Lu, 2010, A strategy tripod perspective on export behaviors, JIBS, 41: 377–396; Y. Xie, H. Zhao, Q. Xie, & M. Arnold, 2012, On the determinants of post-entry strategic positioning of foreign firms in a host market: A strat- egy tripod perspective, IBR (in press).

3. A. Cuervo-Carurra, M. Maloney, & S. Manrakhan, 2007, Causes of the difficulties in internationalization, JIBS, 38: 709–725; B. Elango, 2009, Minimizing effects of “liability of foreignness”, JWB, 44: 51–62; J. Johan- son & J. Vahlne, 2009, The Uppsala internationaliza- tion process model revisited, JIBS, 40: 1411–1431; H. Yildiz & C. Fey, 2012, The liability of foreignness reconsidered, IBR (in press).

4. BW, 2009, Europe’s rush to grab US stimulus cash, May 4: 52.

5. SCMP, 2010, GE’s problem with China, July 6: B14. 6. SCMP, 2010, GE boards China’s jumbo jet program,

July 13: B4. 7. J. Hennart, 2007, The theoretical rationales for a multi-

nationality-performance relationship,MIR, 47: 423–452. 8. T. Hutzschenreuter, T. Pederson, & H. Volberda,

2007, The role of path dependency and managerial intentionality, JIBS, 38: 1055–1068; D. Paul & P. Wooster, 2008, Strategic investments by US firms in transition economies, JIBS, 39: 249–266.

9. T. Shervani, G. Frazier, & G. Challagalla, 2007, The moderating influence of firm market power on the transaction cost economics model, SMJ, 28: 635–652.

10. A. Kirca et al., 2011, Firm-specific assets, multination- ality, and financial performance, AMJ, 84: 47–72; M. W. Peng, 2001, The resource-based view and international business, JM, 27: 803–829.

11. H. Berry, 2006, Shareholder valuation of foreign investment and expansion, SMJ, 27: 1123–1140; S. Lee & M. Makhija, 2009, Flexibility in internationali- zation, SMJ, 30: 537–555.

12. X. Tian, 2010, Managing FDI technology spillovers, JWB, 45: 276–284.

13. W. Lin, K. Cheng, & Y. Liu, 2009, Organizational slack and firm’s internationalization, JWB, 44: 397–406; N. Malhotra & C. Hinings, 2010, An orga- nizational model for understanding internationaliza- tion process, JIBS, 41: 300–349.

14. C. Chan & S. Makino, 2007, Legitimacy and multi- level institutional environments, JIBS, 38: 621–638;

M. Demirbag, K. Glaister, & E. Tatoglu, 2007, Institu- tional and transaction cost influence on MNEs’ own- ership strategies of their affiliates, JWB, 42: 418–434; J. Li, J. Yang, & D. Yue, 2007, Identity, community, and audience, AMJ, 50: 175–190; C. Oh & J. Oetzel, 2011, Multinationals’ response to major disasters, SMJ, 32: 658–681; J. Shaner & M. Maznevski, 2011, The relationship between networks, institutional development, and performance in foreign invest- ments, SMJ, 32: 556–568; A. Slangen & S. Beugelsdijk, 2010, The impact of institutional hazards on foreign multinational activity, JIBS, 41: 980–995.

15. J. Dunning, 2009, Location and the MNE: A neglected factor? JIBS, 40: 5–19. See also R. Belderbos, W. Olffen, & J. Zou, 2011, Generic and specific social learning mechanisms in foreign entry location choice, SMJ, 32: 1309–1330; J. Cantwell, 2009, Location and the MNE, JIBS, 40: 35–41; R. Flores & R. Aguilera, 2007, Globalization and location choice, JIBS, 38: 1187–1210; E. Garcia-Canal & M. Guillen, 2008, Risk and the strategy of foreign location choice in regulated industries, SMJ, 29: 1097–1115; S. Zaheer & L. Nachum, 2011, Sense of place, GSJ, 1: 96–108.

16. A. Arikan & M. Schilling, 2011, Structure and govern- ance in industrial districts, JMS, 48: 772–803; S. Bell, P. Tracey, & J. Heide, 2009, The organization of regional clusters, AMR, 34: 623–642; S. Manning, J. Ricart, M. Rique, & A. Lewin, 2010, from blind spots to hotspots, JIM, 16: 369–382; B. McCann & G. Vroom, 2010, Pricing response to entry and agglomeration effects, SMJ, 31: 284–305.

17. BW, 2007, Shanghai rising, February 19: 51–55. 18. W. Chung & S. Yeaple, 2008, International knowledge

sourcing, SMJ, 29: 1207–1224. 19. S. Lee, O. Shenkar, & J. Li, 2008, Cultural distance,

investment flow, and control in cross-border coopera- tion, SMJ, 29: 1117–1125; R. Parente, B. Choi, A. Slangen, & S. Ketkar, 2010, Distribution system choice in a service industry, JIM, 16: 275–287.

20. D. Xu&O. Shenkar, 2002, Institutional distance and the multinational enterprise (p. 608), AMR, 27: 608–618. See also M. Cho & V. Kumar, 2010, The impact of institutional distance on the international diversity- performance relationship, JWB, 45: 93–103; G. Delmestri & F. Wezel, 2011, Breaking the wave, JIBS, 42: 828–852.

21. H. Barkema & R. Drogendijk, 2007, Internationalizing in small, incremental or larger steps? JIBS, 38: 1132–1148.

22. S. Makino & E. Tsang, 2011, Historical ties and foreign direct investment, JIBS, 42: 545–557.

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23. E. Tsang & P. Yip, 2007, Economic distance and survival of foreign direct investments, AMJ, 50: 1156–1168.

24. M. Myers, C. Droge, & M. Cheung, 2007, The fit of home to foreign market environment, JWB, 42: 170–183.

25. J. Steen & P. Liesch, 2007, A note on Penrosian growth, resource bundles, and the Uppsala model of internationalization, MIR, 47: 193–206.

26. Economist, 2006, Don’t mess with Russia, December 16: 11.

27. A. Delios, A. Gaur, & S. Makino, 2008, The timing of international expansion, JMS, 45: 169–195; J. G. Frynas, K. Mellahi, & G. Pigman, 2006, First mover advantages in international business and firm-specific political resources, SMJ, 27: 321–345.

28. M. W. Peng, S. Lee, & J. Tan, 2001, The keiretsu in Asia, JIM, 7: 253–276.

29. BW, 2011, Land of war and opportunity, January 10: 46–54.

30. BW, 2008, Cisco’s brave new world (p. 68), November 24: 56–68.

31. S. Dobrev & A. Gotsopoulos, 2010, Legitimacy vacuum, structural imprinting, and the first mover disadvantage, AMJ, 53: 1153–1174; J. Gomez & J. Maicas, 2011, Do switching costs mediate the relationship between entry timing and performance? SMJ, 32: 1251–1269; G. Lee, 2008, Relevance of organizational capabilities and its dynamics, SMJ, 29: 1257–1280; M. Semadeni & B. Anderson, 2010, The follower’s dilemma, AMJ, 53: 1175–1193; F. Suarez & G. Lanzolla, 2005, The half- truth of first-mover advantage, HBR, April: 121–128; J. Woo, R. Reed, S. Shin, & D. Lemak, 2009, Strategic choice and performance in late movers, JMS, 46: 308–335.

32. G. Gao & Y. Pan, 2010, The pace of MNEs’ sequential entries, JIBS, 41: 1572–1580; L. Lages, S. Jap, & D. Griffith, 2008, The role of past performance in export ventures, JIBS, 39: 304–325; P. Li & K. Meyer, 2009, Contextualizing experience effects in interna- tional business, JWB, 44: 370–382; A. Nadolska & H. Barkema, 2007, Learning to internationalize, JIBS, 38: 1170–1187; L. Qian & A. Delios, 2008, Interna- tionalization and experience, JIBS, 39: 231–248; J. Xia, K. Boal, & A. Delios, 2009, When experience meets national institutional environmental change, SMJ, 30: 1286–1309.

33. G. Benito, B. Petersen, & L. Welch, 2009, Towards more realistic conceptualizations of foreign operation modes, JIBS, 40: 1455–1470; Y. Pan & D. Tse, 2000,

The hierarchical model of market entry modes, JIBS, 31: 535–554.

34. J. Dunning, 1993, Multinational Enterprises and the Global Economy, Reading, MA: Addison-Wesley. See also L. Brouthers, S. Mukhopadhyay, T. Wilkinson, & K. Brouthers, 2009, International market selection and subsidiary performance, JWB, 44: 262–273; J. Galan & J. Gonzalez-Benito, 2006, Distinctive determinant fac- tors of Spanish foreign direct investment in Latin America, JWB, 41: 171–189; K. Ito & E. Rose, 2010, The implicit return on domestic and international sales, JIBS, 41: 1074–1089.

35. M. W. Peng, Y. Zhou, & A. York, 2006, Behind make or buy decisions in export strategy, JWB, 41: 289–300.

36. A. Chintakananda, A. York, H. O’Neill, & M. W. Peng, 2009, Structuring dyadic relationships between export producers and intermediaries, EJIM, 3: 302–327.

37. A. Akremi, K. Mignonac, & R. Perrigot, 2011, Oppor- tunistic behaviors in franchise chains, SMJ, 32: 930–948; P. Aulakh, M. Jiang, & Y. Pan, 2010, Inter- national technology licensing, JIBS, 41: 587–605; J. Barthelemy, 2008, Opportunism, knowledge, and the performance of franchise chains, SMJ, 29: 1451–1463.

38. A. Slangen, 2011, A communication-based theory of the choice between greenfield and acquisition entry, JMS, 48: 1699–1726.

39. D. Kronborg & S. Thomsen, 2009, Foreign ownership and long-term survival, SMJ, 30: 207–219.

40. Economist, 2006, BAE Systems: Changing places, October 28: 66–67.

41. E. Banalieva & K. Eddleston, 2011, Home-region focus and performance of family firms, JIBS, 42: 1060–1072; L. Cardinal, C. C. Miller, & L. Palich, 2011, Breaking the cycle of iteration, GSJ, 1: 175–186; J. Cuervo & L. Pheng, 2004, Global perfor- mance measures for transnational construction cor- porations, CME, 22: 851–860; J. Dunning, J. Fujita, & N. Yakova, 2007, Some macro-data on the regionali- zation/globalization debate, JIBS, 38: 177–199; J. Hennart, 2011, A theoretical assessment of the empirical literature on the impact of multinationality on performance, GSJ, 1: 135–151; T. Osegowitsch & A. Sammartino, 2008, Reassessing (home-) regionali- zation, JIBS, 39: 184–196; G. Qian, T. Khoury, M. W. Peng, & Z. Qian, 2010, The performance implications of intra- and inter-regional geographic diversification, SMJ, 31: 1018–1030; M. Wiersema & H. Bowen, 2011, The relationship between international diversification and firm performance, GSJ, 1: 152–170.

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42. S. Collinson & A. Rugman, 2007, The regional char- acter of Asian multinational enterprises, APJM, 24: 429–446; A. Rugman & A. Verbeke, 2004, A perspec- tive on regional and global strategies of multinational enterprises, JIBS, 35: 3–18.

43. A. Rugman & C. Oh, 2012, Why the home region matters, BJM (in press).

44. M. W. Peng, 2012, The global strategy of emerging multinationals from China, GSJ, 2: 97–107.

45. J. Mathews, 2006, Dragon multinationals: Emerging players in 21st century globalization, APJM, 23: 5–27.

46. Y. Luo & R. Tung, 2007, International expansion of emerging market enterprises, JIBS, 38: 481–498.

47. M. W. Peng, R. Bhagat, & S. Chang, 2010, Asia and global business, JIBS, 41: 373–376.

48. M. Chari, S. Devaraj, & P. David, 2007, Interna- tional diversification and firm performance, JWB,

42: 184–197; F. Contractor, V. Kumar, & S. Kundu, 2007, Nature of the relationship between interna- tional expansion and performance, JWB, 42: 401–417.

49. S. Chang & J. Rhee, 2011, Rapid FDI expansion and firm performance, JIBS, 42: 979–994; W. Hejazi & E. Santor, 2010, Foreign asset risk exposure, DOI, and performance, JIBS, 41: 845–860; S. Li & S. Tallman, 2011, MNC strategies, exogenous shocks, and perfor- mance outcomes, SMJ, 32: 1119–1127; T. Pedersen & J. M. Shaver, 2011, Internationalization revisited, GSJ, 1: 263–274; J. Puck, D. Holtbrugge, & A. Mohr, 2009, Beyond entry mode choice, JIBS, 40: 388–404; J. M. Shaver, 2011, The benefits of geographic sales diversification, SMJ, 32: 1046–1060; D. Tan, 2009, Foreign market entry strategies and post-entry growth, JIBS, 40: 1046–1063.

186 PART 2 BUSINESS-LEVEL STRATEGIES

CHAPTER7

MAKING STRATEGIC ALLIANCES AND NETWORKS WORK

LEARN ING OBJECT IVES

After studying this chapter, you should be able to

1. Define strategic alliances and networks

2. Articulate a comprehensive model of strategic alliances and networks

3. Understand the decision processes behind the formation of alliances and networks

4. Gain insights into the evolution of alliances and networks

5. Identify the drivers behind the performance of alliances and networks

6. Participate in three leading debates concerning alliances and networks

7. Draw strategic implications for action

ot o/ A le xe y St io p

188 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

OPENING CASE

Emerging Markets: Yum! Brands Teams Up with Sinopec

Gas stations do everything they can to avoid heat and fire. But in 2011 competition in gas stations operated by China Petroleum and Chemical Corporation (known as Sinopec) was heating up. It was triggered by a strategic alliance agreement signed between Sinopec and Yum! Brands, the number one fast food chain in China with about 3,500 Kentucky Fried Chicken (KFC) and 560 Pizza Hut restau- rants in 650 Chinese cities. The agreement announced that KFC and Pizza Hut restaurants would open inside Sinopec’s gas stations. By revenue, Sinopec is the largest firm in China and the fifth largest in the world (with $273 billion sales in 2011). It operates over 30,000 gas stations throughout China. As car ownership takes off in China, the growth potential for both Sinopec and for Yum! Brands seems enormous.

Both companies expect this important cooperation to have a significant and far-reaching impact on the development and strategic growth of their businesses. Through the complementary advantages of both companies, the combination of the strengths will offer better service for customers, promote both brands, generate more economic returns, and improve their capabilities for sustainable development.

This sounds like a quote from the press release from Sinopec and Yum! Brands—except, it is not (!). This is actually a quote from a strategic alliance announcement between Sinopec and Yum! Brands’ archrival, McDonald’s, which was signed in 2007. In their homeland, McDonald’s beat Yum! Brands, and KFC was struggling. But in China, McDonalds’ 1,000 restaurants were no match to the much larger number and wider spread of KFC, Pizza Hut, and their Chinese cousin East Dawning, a new chain restaurant brand that only sells Chinese fast food. In an effort to catch up, McDonald’s set up an alliance with Sinopec.

As a result, Yum! Brands was a late mover in teaming up with Sinopec. Because the deal between Sinopec and McDonald’s was a 20-year deal, Yum! Brands restaurants

could not displace McDonald’s at Sinopec gas stations. Yum! Brands could operate either in new stations not having McDonald’s or in established stations alongside McDonald’s. In response to such “polygamy,” McDonald’s announced that it was the first “spouse,” with all the rights and privileges to pick high-priority locations. Empha- sizing “healthy competition,” Yum! Brands highlighted its advantages in two ways: (1) Its multiple restaurant brands could cater to different demographic groups, and (2) its supply chain was far more widespread, thus enabling it to team with Sinopec to reach the far corners of inland China.

As the king of fast food in China, Yum! Brands has not only constantly faced smaller local competitors, but also increasingly confronted capable multinational rivals eager to eat its lunch. In addition to McDonald’s, these included Asian chains, such as Dicos, owned by Taiwanese com- pany Ting Hsin International Group; Yoshinoya, owned by Japanese firm Yoshinoya Holdings; and Yonghe King and Hongzhuangyuan, both owned by Manila-based Jollibee, a powerful regional chain that beats both McDonald’s and Yum! in the Philippines.

It was such intense competitive pressure that drove Yum! Brands into Sinopec gas stations. As a late entrant into this tricky three-way relationship, Yum! Brands will have to wait to see whether the Sinopec alliance can deliver the growth it seems to promise. Stay tuned for the evolution of this intriguing relationship.

Sources: Based on (1) 21st Century Business Insights, 2011, KFC and McDonald’s fight over Chinese gas stations, December 16: 60–61; (2) Bloomberg, 2011, McDonald’s no match for KFC in China as colonels rules fast food, January 26, www.bloomberg.com; (3) China Daily, 2011, Yum! Brands signs deal with Sinopec, November 23, www.chinadaily.com.cn; (4) Sinopec, 2007, The first “drive-through” restaurant and gas station complex is opened collaboratively by Sinopec and McDonald’s, January 19, english.sinopec.com.

189 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

Why do both Yum! Brands and McDonald’s establish strategic allianceswith Sinopec? How do they navigate the complexities of such a trickythree-way relationship? Will these alliances become successful or end up in divorce? These are some of the key questions driving this chapter. As globalization intensifies, “the least attractive way to try to win on a global basis,” according to GE’s former chairman and CEO Jack Welch, “is to think you can take on the world all by yourself.”1 Proliferation of strategic alliances and networks can now be seen in just about every industry and every country, yet 30%–70% of all alliances and networks fail, thus necessitating our attention to the causes of their failures.

This chapter will first define strategic alliances and networks, followed by a comprehensive model drawing upon the strategy tripod. Then, we discuss the formation, evolution, and performance of alliances and networks, followed by debates and extensions.

Defining Strategic Alliances and Networks Strategic alliances are voluntary agreements of cooperation between firms.2 As noted in Chapter 6, the dotted area in Figure 6.3 consisting of non-equity-based contractual agreements and equity-based joint ventures (JVs) can all be broadly considered strategic alliances. Figure 7.1 illustrates this further, visualizing alliances as a compromise between pure market transactions and mergers and acquisitions (M&As). Contractual (non-equity-based) alliances include co-marketing, research and development (R&D) contracts, turnkey projects, strategic suppliers, strategic distributors, and licensing/ franchising. Equity-based alliances include strategic investment (one partner invests in another), cross-shareholding (both partners invest in each other), and JV. A JV is one form of equity-based alliance. It involves the establishment of a new legally independent entity (in other words, a new firm) whose equity is provided by two (or more) partners (see the Closing Case).

Strategic networks are strategic alliances formed by multiple firms to compete against other such groups and against traditional single firms.3 For example, the airline industry has three multipartner alliances—Star Alliance (consisting of United Airlines, Lufthansa, Air Canada, SAS, and others), SkyTeam (Delta Airlines, Air France-KLM, Korean Air, and others), and Oneworld (American Airlines, British Airways, Cathay Pacific, Qantas, Japan Airlines, and others). These strategic networks are sometimes called constellations. Shown in Strategy in Action 7.1, such multilateral strategic networks are inherently more complex than single alliance relationships between two firms.4 Overall, we will use the terms “strategic alliances” and “strategic networks” to refer to cooperative interfirm relationships.

strategic alliance

A voluntary agreement of cooperation between firms

contractual (non-equity- based) alliance

A strategic alliance that is based on contracts and does not involve the shar- ing of ownership

equity-based alliance

A strategic alliance that involves the use of equity.

strategic investment

One partner invests in another as a strategic investor.

cross-shareholding

Both partners invest in each other to become cross-shareholders.

strategic network

A strategic alliance formed by multiple firms to com- pete against other such groups and against tradi- tional single firms (also known as a constellation).

constellation

A multipartner strategic alliance (also known as strategic network).

190 PART 2 BUSINESS-LEVEL STRATEGIES

A Comprehensive Model of Strategic Alliances and Networks Despite the diversity of cooperative interfirm relationships, underlying each decision to engage in alliances and networks is a set of strategic considerations drawn from the strategy tripod discussed earlier. These considerations lead to a comprehensive model (Figure 7.2).

FIGURE 7.1 The Variety of Strategic Alliances

Market transactions

Co-marketing

Turnkey project

Strategic supplier

Strategic distributor

Licensing/ franchising

Strategic investment

Cross- shareholding

Equity-based alliances

Joint venture

R&D contract

Mergers and

acquisitions (M&As)

Contractual (non-equity-based)

alliances

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C h a p t e r 7 Ma k i n g S t r a t e g i c A l l i a n c e s a n d N e t w o r k s W o r k 191

STRATEGY IN ACTION 7.1

The Tug of War Over Japan Airlines

Since 2000, the skies of the world have been dominated by three global airline alliances: Oneworld (American Airlines [AA], British Airways, Cathay Pacific, Qantas, Japan Airlines [JAL], and others); SkyTeam (Delta, Air France-KLM, Korean Air, and others); and Star Alliance (United, Lufthansa, Air Canada, SAS, and others). While the high drama of switching alliance memberships did take place for smaller airlines, the tug of war between Oneworld (led by AA) and SkyTeam (led by Delta) to fight over JAL’s loyalty was probably the most dramatic.

The largest Asian carrier by revenue, JAL had been battered by a severe drop in passenger traffic in the aftermath of the 2008 global crisis, huge pension obligations, an aging fleet, and dozens of unprofitable routes. JAL filed for bankruptcy under the Corporate Rehabilitation Law (the Japanese equivalent of a US Chapter 11 bankruptcy filing) in January 2010, and its shares were delisted in February 2010. Positioning as “white knights,” Delta and its SkyTeam partners proposed that they be strategic investors in JAL and put $1 billion on the table—the catch was that JAL would need to defect from its existing Oneworld alliance relationship. Why were Delta and its partners trying to get involved with an airline that appeared to head for a crash landing?

Although saddled with debt, JAL was attractive because of its strong position in the Asia Pacific, whose air traffic growth would far outpace the rest of the world. Japanese government officials were pushing JAL to accept Delta’s (and SkyTeam’s) offer, primarily because SkyTeam was a larger (and thus financially less risky) alliance. In 2010, SkyTeam flew 384 million passengers, while Oneworld flew 333 million (including JAL’s 53 million). In response, AA and its Oneworld partners coughed up $1.4

billion to rescue the desperate JAL. While highlighting the $500 million JAL had benefitted annually from its Oneworld alliance, AA pointed out that of the $1 billion Delta and its partners offered, a sizable chunk would be used to pay for the financial penalty for leaving Oneworld. Therefore, the bang for the buck was actually much less than $1 billion. After intense negotiations, JAL announced that it would stay loyal to AA and Oneworld. “The biggest reason for our decision to strengthen our alliance with American is to avoid inconvenience to our customers as much as we can,” announced a JAL executive. Although the $1.4 billion that AA and its partners offered was never mentioned in the announcement, everybody knew that money talks.

M ap

Re so ur ce s

192 PART 2 BUSINESS-LEVEL STRATEGIES

Industry-Based Considerations According to the traditional industry-based view, firms are independent players interested in maximizing their own performance. In reality, most firms in any industry are embedded in a number of competitive and/or collaborative relationships, thus

Thanks in part to the cash injection from AA and its partners, JAL emerged from bankruptcy protection in March 2011. Unfortunately, in part because of such lavish expenditure, AA itself entered Chapter 11 bankruptcy reorganization in November 2011. There were no reports about JAL coming to AA’s rescue.

Sources: Based on (1) CBC News, 2010, Japan Airlines chooses American over Delta, February 9, www.cbc.ca; (2) Financial Times, 2010, Tokyo rejects external funding for JAL, January 10, cachef.ft.com; (3) New York Times, 2009, Dueling alliances make aid offers to Japan Airlines, November 18, www.nytimes.com.

FIGURE 7.2 A Comprehensive Model of Strategic Alliances and Networks

Industry-based considerations

• Collaboration among rivals (horizontal alliances) • Entry barriers scaled by alliances • Upstream/downstream vertical alliances with suppliers/buyers • Alliances and networks to provide substitute products/services

Resource-based considerations

• Value-added must outweigh costs • Rarity of relational capabilities and desirable partners • Imitability of firm-specific and relationship-specific capabilities • Organization of alliance activities at the firm and relationship levels

Institution-based considerations

• Formal regulatory pillar (antitrust concerns and entry requirements) • Informal normative pillar (the social pressures to find partners) • Informal cognitive pillar (the internalized beliefs in the value of collaboration)

Strategic alliances and networks

Formation/Evolution/ Performance

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C h a p t e r 7 Ma k i n g S t r a t e g i c A l l i a n c e s a n d N e t w o r k s W o r k 193

necessitating considerations of their alliance and network ties if we are going to realisti- cally understand the dynamics of the five forces.5

First, because rivalry reduces profits, many competitors collaborate by forming strate- gic alliances (often called horizontal alliances).6 For example, BMW and Mercedes are collaborating on green car technology. Pfizer and GSK have pooled HIV/AIDS assets to create ViiV Healthcare, a specialized company focusing on HIV/AIDS drugs. This does not suggest that these pairs of rivals (BMW/Mercedes and Pfizer/GSK) are no longer competing; they still are, in most cases. What is interesting is that they have decided to collaborate on a limited basis.

Second, while high entry barriers may deter individual firms, firms may form strategic alliances to scale these walls. For instance, both Coca-Cola and Nestlé were interested in entering the hot canned drinks market (such as hot coffee and tea) in Japan. However, domestic players led by Suntory built formidable entry barriers and neither Coca-Cola nor Nestlé, despite their global experience, had any expertise in this particular segment largely unknown outside of Japan. Although Suntory was better than Coca-Cola at soluble coffee and tea and had a larger distribution network than Nestlé, Suntory was unable to match the combined strengths of these two giants once they formed an alliance. Overall, combining forces allows for lower cost and lower risk entries into new markets for partner firms.

Third, although suppliers in the five forces framework are traditionally regarded as a threat, that is not necessarily the case. As introduced in Chapter 2, it is possible to establish strategic alliances with suppliers (often called upstream vertical alliances), as exemplified by the Japanese keiretsu networks. In essence, strategic supply alliances transform the relationship from an adversarial one centered on hard bargaining to a collaborative one featuring knowledge sharing and mutual assistance. Instead of dealing with a large number of suppliers that are awarded contracts on a frequent short-term basis (such as 2.3 years, the average length of US auto supply contracts in the 1990s), strategic supply alliances rely on a smaller number of key suppliers that are awarded longer-term contracts (such as 8 years, the average length of Japanese auto supply contracts in the 1990s).7 This helps align the interests of the focal firm with those of suppliers, which, in turn, are more willing to make specialized investments to produce better components. This is not to say that bargaining power becomes irrelevant. Instead, buyer firms increase their dependence on a smaller number of strategic suppliers, whose bargaining power may, in turn, increase. However, collaboration softens some rough edges of bargaining power by transforming a zero-sum game into a win-win proposition.

Fourth, similarly, instead of treating buyers and distributors as a possible threat, establishing strategic distribution alliances (also called downstream vertical alliances) may bind the focal firm and buyers and distributors together. For example, numerous hotels, publishers, airlines, and car rental companies find that alliances with leading Internet distributors such as Amazon, Expedia, Priceline, and Travelocity enable them to reach more customers.

Finally, the market potential of substitute products may encourage firms to form strategic alliances and networks to materialize the commercial potential of these new products. For instance, smartphones developed by the Android alliance centered on Google and its partners such as HTC and Samsung have now substituted some personal computers (PC).

horizontal alliance

A strategic alliance formed by competitors.

upstream vertical alliance

A strategic alliance with firms on the supply side (upstream).

downstream vertical alliance

A strategic alliance with firms in distribution (downstream).

194 PART 2 BUSINESS-LEVEL STRATEGIES

Resource-Based Considerations The resource-based view, embodied in the VRIO framework, sheds considerable light on strategic alliances and networks (Figure 7.2).8

VALUE. Alliances must create value.9 The three global airline alliance networks create value by reducing 18%–28% of the ticket costs booked on two-stage flights compared with separate flights on the same route if these airlines were not allied.10 Table 7.1 identifies three broad categories of value creation in terms of how advantages outweigh disadvantages. First, alliances may reduce costs, risks, and uncertainties.11

As Google rises to preeminence, Microsoft for its Bing search engine has set up alliances with Baidu, Facebook, Firefox/Mozilla, Nokia, RIM, and Yahoo!. Second, alliances allow firms such as McDonald’s, Yum! Brands, and Sinopec to tap into complementary assets of partners and facilitate learning (see the Opening Case).12 In another case, when Renault entered Turkey via a JV, its Turkish partner that held 49% of the JV was Oyak (Turkish Armed Forces Pension Fund).13 What complementary resources would Oyak bring to this JV that manufactured cars? In addition to capital, political connections in a country where the military enjoyed a good deal of prestige were clearly helpful.

Finally, an important advantage of alliances lies in their value as real options.14

Conceptually, an option is the right, but not the obligation, to take some action in the future. Technically, a financial option is an investment instrument permitting its holder, having paid for a small fraction of an asset (often known as a deposit), the right to increase investment to eventually acquire it if necessary. A real option is an investment in real operations as opposed to financial capital.15 A real options view has two propositions:

• In the first phase, an investor makes a relatively small, initial investment to buy an option, which leads to the right to future investment without being obligated to do so.

• The investor holds the option until a decision point arrives in the second phase, and then decides between exercising the option or abandoning it.

TABLE 7.1 Strategic Alliances and Networks: Advantages and Disadvantages

ADVANTAGES DISADVANTAGES

& Reduce costs, risks, and uncertainties & Gain access to complementary assets & Opportunities to learn from partners & Possibilities to use alliances and networks as

real options

& Possibilities of choosing the wrong partners & Costs of negotiation and coordination & Possibilities of partner opportunism & Risks of helping nurture competitors

(learning race)

real option

An option investment in real operations as opposed to financial capital.

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For firms interested in eventually acquiring other companies but not sure about such moves, working together in alliances thus affords an insider view to evaluate the capabil- ities of partners. This is similar to trying on new shoes to see if they fit before buying them.16 Since acquisitions are not only costly but also very likely to fail, alliances permit firms to sequentially increase their investment should they decide to pursue acquisitions. On the other hand, after working together as partners, if firms find that acquisitions are not a good idea, there is no obligation to pursue them. Overall, alliances have emerged as great instruments of real options because of their flexibility to sequentially scale up or scale down the investment.

On the other hand, alliances have a number of nontrivial drawbacks. First, there is always a possibility of being stuck with the wrong partner(s).17 Firms are advised to choose a prospective mate with caution. The mate should be sufficiently differentiated to provide some complementary (non-overlapping) capabilities.18 Just like many individuals who have a hard time figuring out the true colors of their spouses before they get married, many firms find it difficult to evaluate the true intentions and capabilities of their prospective partners until it is too late.

A second disadvantage is potential partner opportunism. While opportunism is likely in any kind of economic relationship, the alliance setting may provide especially strong incentives for some (but not all) partners to be opportunistic. Cooperative relationships always entail some elements of trust, which may be easily abused.19 For example, BP’s JV partners in Russia alleged that BP treated them not as equal partners, but as lowly subjects (see Emerging Markets 7.1 and the Closing Case).

Finally, alliances, especially those between rivals, can be dangerous, because they may help competitors. By opening “doors” to outsiders, alliances make it easier to observe and imitate firm-specific capabilities. In alliances between competitors, there is a potential “learning race” in which partners aim to outrun each other by learning the “tricks” from the other side as fast as possible.

RARITY. The second component in the VRIO framework has two dimensions: (1) capability rarity and (2) partner rarity. First, the capabilities to successfully manage interfirm relationships—often called relational (or collaborative) capabilities—may be rare. Managers involved in alliances require relationship skills rarely covered in the traditional business school curriculum that emphasizes competition as opposed to collaboration.20 To truly derive benefits from alliances, managers need to foster trust with partners, while at the same time being on guard against opportunism.21

As much as alliances represent a strategic and economic arrangement, they also constitute a social, psychological, and emotional phenomenon: words such as “courtship,” “marriage,” and “divorce” often surface. Given that the interests of partner firms do not fully overlap and are often in conflict, managers involved in alliances live a precarious existence, trying to represent the interests of their respective firms while attempting to make the complex relationship work. Given the general shortage of good relationship skills in the human population (remember: 50% of marriages in the United States fail), it is not surprising that sound relational capabilities to successfully manage alliances are in short supply.

A second aspect of rarity is partner rarity, defined as the difficulty to locate partners with certain desirable attributes. This stems from two sources: (1) industry structure and

learning race

A race in which alliance partners aim to outrun each other by learning the “tricks” from the other side as fast as possible.

relational (collaborative) capabilities

The capabilities to successfully manage interfirm relationships.

partner rarity

The difficulty to locate partners with certain desirable attributes.

196 PART 2 BUSINESS-LEVEL STRATEGIES

(2) network position. First, from an industry structure standpoint, in many oligopolistic industries, the number of available players as potential partners is limited. In some emerging economies whereby only a few local firms may be worthy partners, latecomers may find that potential partners have already been “cherry picked” by rivals. In the Chinese automobile industry (where wholly owned subsidiaries [WOS] are not allowed), Ford, as a late mover, ended up allying with second-tier partners in China and suffered from mediocre performance.

Second, from a network position perspective, firms located in the center of interfirm networks may have access to better and more opportunities (such as information, access, capital, goods, and services) and consequently may accumulate more power and influ- ence.22 The upshot is that firms with a high degree of network centrality—defined as the extent to which the position occupied by a firm is pivotal with respect to others in the interfirm network—are likely to bemore attractive partners. Unfortunately, such firms are rare, and they are often very choosy in the kind of relationships they enter. Cisco, Citigroup, and Carrefour, for example, routinely turn down alliance proposals coming from all over the globe.

IMITABLILITY. The issue of imitability pertains to two levels: (1) firm level and (2) alliance level. First, as noted earlier, one firm’s resources and capabilities may be imitated by partners. For instance, in the late 1980s, McDonald’s set up a JV with the Moscow Municipality Government that helped it enter Russia. However, during the 1990s, the Moscow mayor set up a rival fast food chain, The Bistro. The Bistro tried to eat McDonald’s’ lunch by replicating numerous products and practices. There was very little that McDonald’s could do, because nobody sues the mayor in Moscow and hopes to win.

Another imitability issue refers to the trust and understanding among partners in successful alliances. Firms without such “chemistry” may have a hard time imitating such

E T H I C A L D I L E M M AEMERGING MARKETS 7.1

A Local Partner’s Perspective: “BP Has Been Treating Russians as Subjects”

The following are excerpts from an article published in London’s Financial Times on July 7, 2008, by Mikhail Fridman, chairman of the board of TNK-BP and founder of Alfa Group, which owns 25% of TNK-BP.

• We see a long-term future for the joint venture and have no intention of selling out of a business with great prospects.

• We want to build TNK-BP into a great international oil business.

• But we can only do this if BP treats us as its partners, not its subjects.

Source: M. Fridman, 2008, BP has been treating Russians as subjects, Financial Times, July 7: 11. © Financial Times

network centrality

The extent to which a firm’s position is pivotal with respect to others in the interfirm network.

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activities. CFM International, a JV set up by GE and Snecma to produce jet engines in France, has successfully operated for over 30 years. Rivals would have a hard time imitating such a successful relationship.

ORGANIZATION. Similarly, the organizational issues affect two levels: (1) firm level and (2) alliance/network level. First, at the firm level, how firms are organized to benefit from alliances and networks is an important issue.23 When the number of such relationships is small, many firms adopt a trial-and-error approach. Not surprisingly, “misses” are often frequent. What is problematic is that even for the successful “hits,” this ad hoc approach does not allow for systematic learning from these experiences. This obviously is a hazardous way of organizing for large MNEs engaging in numerous alliances and networks around the globe. In response, many firms have been developing a dedicated alliance function (parallel with traditional functions such as finance and marketing), often headed by a vice president or director with his/her own staff and resources. Such a dedicated function acts as a focal point for leveraging lessons from prior and ongoing relationships. HP has developed a 300-page decision-making manual on alliances, including 60 different tools and templates (such as alliance contracts, metrics, and checklists). It also organizes a two-day course three times a year to disseminate such learning about alliances to its managers worldwide.

At the alliance/network level, some alliance relationships are organized in a way that makes it difficult for others to replicate. There is much truth behind Tolstoy’s opening statement in Anna Karenina: “All happy families are like one another; each unhappy family is unhappy in its own way.” Given the difficulty for individuals in unhappy marriages to improve their relationship (despite an army of professional marriage counselors, social workers, friends, and family members), it is not surprising that firms in unsuccessful alliances (for whatever reason) often find it exceedingly challenging, if not impossible, to organize and manage their interfirm relationships better.

Institution-Based Considerations

FORMAL INSTITUTIONS SUPPORTED BY A REGULATORY PILLAR. Strategic alliances and networks function within formal legal and regulatory frameworks.24 The impact of these formal institutions can be found along two dimensions: (1) antitrust concerns and (2) entry mode requirements. First, many firms establish alliances with competitors. Cooperation between competitors is usually suspected of at least some tacit collusion by antitrust authorities (see Chapter 8). However, because integration within alliances is usually not as tight as acquisitions (which would eliminate one competitor), antitrust authorities are more likely to approve alliances as opposed to acquisitions.25 For instance, the proposed merger between American Airlines and British Airways was blocked by both US and UK antitrust authorities. However, they have been allowed to form an alliance that has eventually grown to

198 PART 2 BUSINESS-LEVEL STRATEGIES

become the multipartner Oneworld. In another example, the proposed merger between AT&T and T-Mobile (a WOS of Deutsche Telekom in the United States) was torpedoed by the US antitrust authorities. But the US government blessed AT&T and T-Mobile’s collaboration in roaming.

Second, formal requirements on market entry modes affect alliances and networks. In many countries, governments discourage or simply ban acquisitions to establish WOS, thereby leaving some sort of alliances with local firms to be the only entry choice for FDI. For instance, the Indian government dictates the maximum ceiling of foreign firms’ equity position in the retail sector to be 51%, forcing foreign entrants to set up alliances such as JVs with local firms. For example, Wal-Mart formed a 50/50 JV with Bharti—Bharti Wal- Mart Private Limited.

Recently, two characteristics have arisen concerning formal government policies on entry mode requirements. First is the general trend toward more liberal policies. Many governments (such as those in Mexico and South Korea) that historically only approved JVs have now allowed WOS as an entry mode. As a result, there is now a noticeable decline of JVs and a corresponding rise of acquisitions in emerging economies.26 A second characteristic is that many governments still impose consider- able requirements, especially when foreign firms acquire domestic assets. Only JVs are permitted in the strategically important Chinese automobile assembly industry and the Russian oil industry (see the Closing Case), thus eliminating acquisitions as a choice. US regulations only permit up to 25% of the equity of any US airline to be held by foreign carriers, and EU regulations limit non-EU ownership to 49% of EU-based airlines.

INFORMAL INSTITUTIONS SUPPORTED BY NORMATIVE AND COGNITIVE PILLARS. The first set of informal institutions centers on collective norms, supported by a normative pillar. A core idea of the institution-based view is that because firms act to enhance or protect their legitimacy, copying other reputable organizations—even without knowing the direct performance benefits of doing so— may be a low-cost way to gain legitimacy. Therefore, when competitors have a variety of alliances, jumping on the alliance “bandwagon” may be perceived as a cool way to join the norm as opposed to ignoring industry trends.27 In other words, informal but powerful normative pressures from the business press, investment community, and board deliberations probably drove late-mover firms such as Ford to ally with relatively obscure partners in China (discussed earlier) as opposed to having no partner and hence no presence there. For the same reason unmarried adults tend to experience some social pressure to get married, firms insisting on “going alone,” especially when they experience performance problems, often confront similar pressures and criticisms from peers, analysts, investors, and the media. The flipside of such a behavior is that many firms rush into interfirm relationships without adequate due diligence (investigation prior to signing contracts) and then get burned.

A second set of informal institutions stresses the cognitive pillar, which centers on the internalized taken-for-granted values and beliefs that guide firm behavior. BAE Systems (formerly British Aerospace) announced in the 1990s that all its future aircraft

due diligence

Investigation prior to signing contracts

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development programs would involve alliances, evidently believing that an alliance strat- egy was the right thing to do.

Overall, both of the two core propositions that underpin the institution-based view (first introduced in Chapter 4) are applicable. The first proposition—individuals and firms rationally pursue their interests and make strategic choices within institutional constraints—is illustrated by the constraining and enabling power of the formal regulatory pillar, the informal but powerful normative pillar, and the internalized but evident cognitive pillar. The second proposition—when formal constraints fail, informal constraints may play a larger role—is also evident. Similar to the institutions governing human marriages, formal regulations and contracts can only govern a small (although important) portion of alliance/network behavior, and the success and fail- ure of such relationships, to a large degree, depend on the day-in-day-out interaction between partners influenced by informal norms and cognitions. This point will be expanded in more detail in the next three sections on the formation, evolution, and performance of strategic alliances and networks.

Formation How are alliances formed? Figure 7.3 illustrates a three-stage model to address this question.28

Stage One: To Cooperate or Not to Cooperate? In Stage One, a firm must decide if growth can be achieved strictly through market transactions, acquisitions, or alliances.29 To grow by pure market transactions, the firm has to confront competitive challenges independently. This is highly demanding, even for resource-rich multinationals. As noted earlier in the chapter, acquisitions have some unique drawbacks, leading many managers to conclude that alliances are the way to go. For example, Dallas-based Sabre Travel Network has used alliances to enter Australia, Bahrain, India, Israel, Japan, and Singapore.

Stage Two: Contract or Equity? In Stage Two, a firm must decide whether to take a contract or an equity approach. As noted in Chapter 6, the choice between contract and equity is crucial. Table 7.2 identifies four driving forces. The first driving force is shared capabilities. The more tacit (that is, hard to describe and codify) the capabilities, the greater the preference for equity involvement. Although not the only way, the most effective way to learn complex processes is through learning by doing. A good example of this is learning to cook by actually cooking and not by simply reading cookbooks. Many business processes are the same way. A firm that wants to produce cars will find that the codified knowledge in books or reports is not enough. Much tacit knowledge can only be acquired via learning by doing, preferably with experts as alliance partners.

learning by doing

A way of learning not by reading books but by engaging in hands-on activities.

200 PART 2 BUSINESS-LEVEL STRATEGIES

A second driving force is the importance of direct monitoring and control. Equity relationships allow firms to have some direct control over joint activities on a continuing basis, whereas contractual relationships usually do not. In general, firms that fear their intellectual property may be expropriated prefer equity alliances (and a higher level of equity).

A third driver is real options thinking. Some firms prefer to first establish contractual relationships, which can be viewed as real options (or stepping stones) for possible upgrading into equity alliances should the interactions turn out to be mutually satisfactory.

Finally, the choice between contract and equity also boils down to institutional con- straints. As noted earlier, some governments eager to help domestic firms climb the technology ladder either require or encourage the formation of JVs between foreign and domestic firms. The Chinese auto industry is a case in point.

FIGURE 7.3 Alliance Formation

STAGE I

To cooperate or not to

cooperate?

STAGE II

Contract or equity?

STAGE III

Specifying the relationship

Equity

Strategic investment

Cross-shareholding

Joint venture

Contract

Co-marketing

Market transactions

Mergers and acquisitions

Pursue cooperative interfirm relationships

R&D contracts

Turnkey project

Strategic supplier/distributor

Licensing/franchising

Source: Adapted from S. Tallman & O. Shenkar, 1994, A managerial decision model of international cooperative venture formation (p. 101), Journal of International Business Studies, 25(1): 91–113.

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Stage Three: Positioning the Relationship Although the formation of strategic alliances has historically been assumed to be between two partners, the proliferation of interfirm relationships suggests that such thinking needs to be expanded. Given that each firm is likely to have multiple interfirm relationships, it is important to manage them as a corporate portfolio (or network) (see Table 7.3). The combination of several individually “optimal” rela- tionships may not create an optimal relationship portfolio for the entire firm, in light of some tricky alliances with competitors.30 In a world of multilateral intrigues, one step down the alliance path, which may open some doors, may foreclose other opportunities. In other words, “my friend’s enemy is my enemy, and my enemy’s enemy is my friend.” Thus, to prevent an “alliance gridlock,” carefully assessing the impact of each individual relationship prior to its formation on the firm’s other relationships becomes increasingly important (see the Opening Case and the Closing Case).

TABLE 7.2 Equity-Based versus Non-Equity-Based Strategic Alliances and Networks

DRIVING FORCES EQUITY-BASED ALLIANCES/NETWORKS

NON-EQUITY-BASED ALLIANCES/NETWORKS

Nature of shared resources (degree of tacitness and complexity)

High Low

Importance of direct organizational monitoring and control

High Low

Potential as real options High (for possible upgrading to M&As) High (for possible upgrading to equity-based relationships)

Influence of formal institutions High (when required or encouraged by regulations)

High (when required or encouraged by regulations)

TABLE 7.3 Cisco’s Top Strategic Alliance Partners

Platform companies HP, IBM, Intel, EMC, Microsoft, SAP

Telecom solutions companies Fujitsu, Italtel, Motorola, Nokia, Nokia Siemens Networks

Services companies Accenture, Bearing Point, Capgemini, EDS, Wipro

Source: www.cisco.com

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Evolution All relationships evolve—some grow, others fail.31 This section deals with three aspects: (1) combating opportunism, (2) evolving from strong ties to weak ties, and (3) going through a divorce.

Combating Opportunism The threat of opportunism looms large on the horizon. Most firms want to make their relationship work, but also want to protect themselves in case the other side is opportu- nistic (see the Closing Case).32 While it is difficult to completely eliminate opportunism, it is possible to minimize its threat by (1) walling off critical capabilities or (2) swapping critical capabilities through credible commitments.

First, both sides can contractually agree to wall off critical skills and technologies not meant to be shared. For example, GE and Snecma cooperated to build jet engines, yet GE was not willing to share its proprietary technology fully with Snecma. GE thus presented sealed “black box” components (the inside of which Snecma had no access to), while permitting Snecma access to final assembly. This type of relationship, in human marriage terms, is like couples whose premarital assets are protected by pre- nuptial agreements. As long as both sides are willing to live with these deals, these relationships can prosper.

The second approach, swapping skills and technologies, is the exact opposite of the first approach. Both sides not only agree not to hold critical skills and technologies back, but also make credible commitments to hold each other as a “hostage.”33 Motorola, for instance, licensed its microprocessor technology to Toshiba, which, in turn, licensed its memory chip technology to Motorola. Setting up a reciprocal relationship may increase the incentives for both partners to cooperate.

In human marriage terms, mutual “hostage taking” is similar to the following commit- ment: “Honey, I will love you forever. If I betray you, feel free to kill me. But if you dare to betray me, I’ll cut your head off!” To think slightly outside the box, the precarious peace during the Cold War can be regarded as a case of mutual “hostage taking” that worked. Because both the United States and Soviet Union held each other as a “hostage,” nobody dared to launch a first nuclear strike. As long as the victim of the first strike had only one nuclear ballistic missile submarine left (such as the American Ohio class or the Soviet Typhoon class), this single submarine would have enough retaliatory firepower to wipe the top 20 US or Soviet cities off the surface of earth, an outcome that neither of the two superpowers found acceptable (see the movie The Hunt for Red October). The Cold War did not turn hot in part because of such a “mutually assured destruction” (MAD) strategy—a real military jargon.

Evolving from Strong Ties to Weak Ties First introduced in Chapter 5, strong ties are more durable, reliable, and trustworthy relationships cultivated over a long period of time. Strong ties have two advantages:

• Strong ties are associated with the exchange of finer-grained and higher-quality information.

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• Strong ties serve as an informal social-control mechanism that is an alternative to formal contracts and thus act to combat opportunism. It is not surprising that many strategic alliances and networks are initially built upon strong ties among individuals and firms.

Defined as relationships characterized by infrequent interaction and low intimacy, weak ties, paradoxically, are likely to provide more opportunities. Weak ties enjoy two advantages:

• Weak ties are less costly (requiring less time, energy, and money) to maintain.

• Weak ties excel at connecting with distant others possessing unique and novel information for strategic actions—often regarded as the strength of weak ties. This may be especially critical as firms search for new knowledge for cutting-edge technologies and practices.

In the same way that individuals tend to have a combination of a small number of good friends (strong ties) and a large number of acquaintances (weak ties), firms at any given point in time are likely to have a combination of strong ties and weak ties in their interfirm relationships. Both strong and weak ties are beneficial, but under different conditions. One of the conditions influencing the types of advantages that firms require is the degree to which their strategies are designed to exploit current resources (such as existing connections) or explore new opportunities (such as future technologies).

Of particular interest to us is the distinction between “exploitation” and “exploration” noted by James March, a leading organization theorist. Exploitation refers to “such things as refinement, choice, production, efficiency, selection, and execution,” whereas exploration includes “things captured by terms such as search, variation, risk taking, experimentation, play, flexibility, discovery, and innovation.”34 While both kinds of strategic activities are important and often occur simultaneously, there is a trade-off between the two because of the limited resources firms possess.35 Thus, an emphasis on either set of the ties is often necessary during a particular period. In environments conducive for exploitation, strong ties may be more beneficial. Conversely, in environ- ments suitable for exploration, weak ties may be preferred.

Many strong ties evolve to become weak ties. Examples from two contexts illustrate these dynamics. First, a new start-up often first concentrates on dense strong ties because it seeks to exploit the current external networks of the founding entrepreneur(s) to ensure its survival. In the next phase, having largely exploited (and exhausted) the initial set of opportunities, the firm needs to search for new opportunities. Therefore, it shifts to exploration in order to seek new opportunities, thus calling for more weak ties with greater diversity. Amazon’s changing alliance portfolio is indicative of such evolution. Initially, Amazon established strong ties with a few key publishing and distributing firms. As Amazon expanded to cover new products (toys and CDs) and new business models (auctions), it formed numerous weak ties with a variety of large suppliers, small mer- chants, and auction houses.

A second example is a JV formed by two partners. Over time as the initial set of opportunities are exploited and exhausted by the JV, partners, as they embark on new searches, may prefer to establish some weak-ties-based relationships with a diverse set of players. In other words, the strong ties within the JV may become too limiting. However, original partners will naturally become upset. In a human marriage, it is easy to appreciate

exploitation

Actions captured by terms such as refinement, choice, production, efficiency, selection, and execution.

exploration

Actions captured by terms such as search, variation, risk taking, experimenta- tion, play, flexibility, dis- covery, and innovation.

204 PART 2 BUSINESS-LEVEL STRATEGIES

the fury of one spouse when the other spouse is exploring other relationships (although only weak ties!). In the case of the BP-AAR dispute over TNK-BP, AAR was upset by the “extramarital” relationship that BP developed with Rosneft in a new alliance (see the Closing Case).

From Corporate Marriage to Divorce36

Alliances are often described as corporate marriages and, when terminated, as corporate divorces. Figure 7.4 portrays an alliance dissolution model. To apply the metaphor of divorce, we focus on the two-partner alliance. Following the convention in research on human divorce, the party who begins the process of ending the alliance is labeled the initiator, while the other party is termed the partner—for lack of a better word. We will draw on our Closing Case to explain this process.

The first phase is initiation. The process begins when the initiator starts feeling uncomfortable with the alliance (for whatever reason). Wavering begins as a quiet, unilateral process by the initiator, which seemed to be AAR in this case. After repeated requests to modify BP’s behavior failed, AAR began to escalate its demands. At this point, its display of discontent became bolder. Initially, BP, the partner, may simply not “get it.” The initiator’s “sudden” dissatisfaction may confuse the partner. Thus, initiation tends to escalate.

FIGURE 7.4 Alliance Dissolution

Initiation Reconciliation

Going public Mediation by third parties

Uncoupling Last minute salvage

Aftermath Go alone

New relationship

Source: Adapted from M. W. Peng & O. Shenkar, 2002, Joint venture dissolution as corporate divorce (p. 95), Academy of Management Executive, 16(2): 92–105.

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The second phase is going public. The party that breaks the news first has a first-mover advantage. By presenting a socially acceptable reason in favor of its cause, this party is able to win sympathy from key stakeholders, such as parent company executives, investors, and journalists. Not surprisingly, the initiator is likely to go public first. Alternatively, the partner may pre-empt by blaming the initiator and establishing the righteousness of its position—this was exactly what BP did. Eventually, both AAR and BP were eager to publicly air their grievances (see Emerging Markets 7.1).

The third phase is uncoupling. Like human divorce, alliance dissolution can be friendly or hostile. In uncontested divorces, both sides attribute the separation more on, say, a change in circumstances. For example, Eli Lilly and Ranbaxy phased out their JV in India and remained friendly with each other. In contrast, contested divorces involve a party that accuses another. The worst scenario is “death by a thousand cuts” inflicted by one party at every turn. A case in point is the numerous lawsuits and arbitrations filed in many countries (such as the British Virgin Islands, China, France, Italy, and the United States) by Danone and Wahaha accusing each other of wrongdoing.

The last phase is aftermath. Like most divorced individuals, most (but not all) “divorced” firms are likely to search for new partners. Understandably, the new alliance is often negotiated more extensively.37 One Italian executive reportedly signed each of the 2,000 pages (!) of an alliance contract.38 However, excessive formalization may signal a lack of trust—in the same way that prenuptials may scare away some prospective human marriage partners.

Figure 7.4 illustrates that for every phase of the dissolution process, there is a way out. In the case of the BP-AAR dispute over TNK-BP, while both sides went public to accuse each other, they managed to stay “married” and did not dissolve their important alliance relationship (see the Closing Case).

Performance Performance is a central focus for strategic alliances and networks.39 This section discusses (1) the performance of alliances and networks and (2) the performance of parent firms.

The Performance of Strategic Alliances and Networks Although managers naturally focus on alliance performance, opinions vary on how to measure it.40 Table 7.4 shows that a combination of objective measures (such as profit and market share) and subjective measures (such as managerial satisfaction) can be used. Figure 7.5 illustrates four factors that may influence alliance performance: (1) equity, (2) learning and experience, (3) nationality, and (4) relational capabilities.

First, the level of equity may be crucial in how an alliance performs. A greater equity stake may mean that a firm is more committed, which is likely to result in higher performance. Second, whether firms have successfully learned from partners is important when assessing alliance performance. Since learning is abstract, experience is often used as a proxy because it is relatively easy to measure.41 While experience certainly helps, its impact on performance is not linear. There is a limit beyond which further increase in experience may not enhance performance.42 Third, nationality may affect performance. For the same reason that marriages where both parties have similar backgrounds are more

206 PART 2 BUSINESS-LEVEL STRATEGIES

stable, dissimilarities in national culture may create strains in alliances. Not surprisingly, international alliances tend to have more problems than domestic ones (see the Closing Case). Finally, alliance performance may fundamentally boil down to soft, difficult-to- measure relational capabilities. The art of relational capabilities, which are firm specific and difficult to codify and transfer, may make or break alliances.

However, none of these factors asserts an unambiguous, direct impact on perfor- mance.43 Research has found that they may have some correlations with performance. It would be naïve to think that any of these single factors would guarantee success. It is their combination that jointly increases the odds for the success of strategic alliances.

The Performance of Parent Firms Do parent firms benefit from strategic alliances and networks?44 This goes back to the value-added aspect of these relationships (discussed earlier). Compared with the relative

TABLE 7.4 Alliance- and Network-Related Performance Measures

ALLIANCE/NETWORK LEVEL PARENT FIRM LEVEL

Objective & Financial performance (e.g., profitability) & Product market performance (e.g., market

share) & Stability and longevity

Subjective & Level of top management satisfaction

Objective & Financial performance (e.g., profitability) & Product market performance (e.g., market

share) & Stock market reaction

Subjective & Assessment of goal attainment

FIGURE 7.5 What Is Behind Alliance Performance?

Equity

Learning and experience

Nationality

Strategic alliance performance

Relational capabilities

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lack of consensus on alliance/network performance, there has been some convergence on the benchmarks of firm performance (such as profitability, product market share, and stock market reaction), in addition to the more subjective measure of goal attainment as perceived by management (see Table 7.4).

A number of studies report that a higher level of collaboration and shared technology is associated with better profitability and product market share for parent firms.45

Another group of studies focus on stock market reactions by treating each decision to enter or exit a relationship as an “event.” If the event window is short enough (several days prior to and after the event), it is possible to view the “abnormal” stock returns as directly caused by that particular event. A number of such event studies indeed find that stock markets respond favorably to alliance activities, but only under certain circum- stances, such as (1) complementarities of resources, (2) previous alliance experience, and (3) ability to manage host country political risks.46 Overall, it is evident that strategic alliances and networks can create value for their parent firms, although how to make that happen remains a challenge.

Debates and Extensions The rise of alliances and networks has generated a number of debates. Three of them are introduced here: (1) majority JVs as control mechanisms versus minority JVs as real options, (2) alliances versus acquisitions, and (3) acquiring versus not acquiring alliance partners.

Majority JVs as Control Mechanisms versus Minority JVs as

Real Options A long-standing debate focuses on the appropriate level of equity in JVs. While the logic of having a higher level of equity control in majority JVs is straightforward, its actual imple- mentation is often problematic. Asserting one party’s control rights, even when justified based on a majority equity position and stronger bargaining power, may irritate the other party. This is especially likely in international JVs in emerging economies, whereby local partners often resent the dominance of Western MNEs (see Emerging Markets 7.1). Some authors advocate a 50/50 share of management control even when the MNE has majority equity.47 However, a 50/50 JV has its own headaches (see the Closing Case).

In addition to the usual benefits associated with being a minority partner in JVs (such as low cost and less demand on managerial resources and attention), an additional benefit alluded to earlier is exercising real options. In general, the more uncertain the conditions, the higher the value of real options. In highly uncertain but potentially promising industries and countries, M&As or majority JVs may be inadvisable, because the cost of failure may be tremendous. Therefore, minority JVs are recommended toehold invest- ments, seen as possible stepping stones for future scaling up—if necessary—while not exposing partners too heavily to the risks involved.

Since the real options thinking is relatively new, its applicability is still being debated. While the real options logic is straightforward, its practice—when applied to acquisitions of JVs—is messy. This is because most JV contracts do not specify a previously agreed

208 PART 2 BUSINESS-LEVEL STRATEGIES

upon price for one party to acquire the other’s assets. Most contracts only give the rights of first refusal to the parties, which agree to negotiate in “good faith.” It is understandable that “neither party will be willing to buy the JV for more than or sell the JV for less than its own expectation of the venture’s wealth generating potential.”48 As a result, how to reach an agreement on a “fair” price is tricky.

Alliances versus Acquisitions An alternative to alliances is M&As (see Chapter 9). Many firms seem to pursue M&As and alliances in isolation. While many large MNEs have an M&A function and some have set up an alliance function (discussed earlier), few firms have established a combined “mergers, acquisitions, and alliance” function. In practice, it may be advisable to explicitly consider alliances vis-à-vis acquisitions within a single decision framework.49

See Emerging Markets 7.2 for an example.

EMERGING MARKETS 7.2

Embraer’s Alliances and Acquisitions

Embraer is a Brazilian manufacturer of small commercial and military aircraft. It was established in 1960 as a state-owned enterprise. It was privatized in 1994 with 60% of shares owned by private Brazilian interests (though the government retains a controlling “golden share”). It invested overseas prior to privatization (the United States in 1979, Europe in 1988) primarily to offer sales and technical support to customers in developed markets. However, after 1994—and especially in 1999—it entered into a series of strategic alliances with European groups such as EADS and Thales (France) in order to gain technology (and to reduce risk by pooling resources). Later it made acquisitions to ensure brand recognition in specialist aerospace markets. In 2004, it established a manufacturing affiliate in China (in which it owns a 51% stake), which assembles final aircraft for the Chinese and regional market. With 90% of its global sales overseas, Embraer can be regarded as one of Brazil’s (indeed Latin America’s) few truly global players.

Source: Excerpts from United Nations, 2006, World Investment Report 2006: FDI from Developing and

Transition Economies (p. 159), New York and Geneva: United Nations/UN Conference on Trade and Development (UNCTAD). © United Nations, 2006.

M ap

Re so ur ce s

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Shown in Table 7.5, alliances, which tend to be loosely coordinated among partners, do not work well in a setting that requires a high degree of interdepen- dence. Such a setting would call for acquisitions. Alliances work well when the ratio of soft to hard assets is relatively high (such as a heavy concentration of tacit knowledge), whereas acquisitions may be preferred when such a ratio is low. Alliances create value primarily by combining complementary resources, whereas acquisitions derive most of their value by eliminating redundant resources. Finally, consistent with real options thinking, alliances are more suitable under conditions of uncertainty, and acquisitions are more preferred when the level of uncertainty is low.50

While these rules are not exactly “rocket science,” “few companies are disciplined to adhere to them.”51 Consider the 50/50 JV between Coca-Cola (Coke) and Procter and Gamble (P&G) that combined their fruit drink businesses (such as Coke’s Minute Maid and P&G’s Sunny Delight) in 2001. The goal was to combine Coke’s distribu- tion system with P&G’s R&D capabilities in consumer products. However, the stock market sent a mixed signal in response, pushing P&G’s stock 2% higher and Coke’s 6% lower on the day of the announcement. For three reasons, Coke probably could have done better by simply acquiring P&G’s fruit drink business. First, a higher degree of integration would be necessary to derive the proposed synergies. Second, because Coke’s distribution assets were relatively easy-to-value hard assets, while P&G’s R&D capabilities were hard-to-value soft assets, the risk was higher for Coke. Finally, little uncertainty existed regarding the popularity of fruit drinks, so investors found it difficult to understand why Coke would share 50% of this fast-growing business with P&G, a laggard in the industry. Not surprisingly, the JV was quickly terminated within six months.

On the other hand, many M&As (such as DaimlerChrysler) would have probably been better off had the firms pursued alliances, at least initially. Overall, acquisitions may be overused as a first step to access resources in another firm, whereas alliances, guided by a real options logic, can provide a great deal of flexibility to scale up or scale down investments.

TABLE 7.5 Alliances versus Acquisitions

ALLIANCES ACQUISITIONS

Resource interdependence Low High

Ratio of soft to hard assets High Low

Source of value creation Combining complementary resources

Eliminating redundant resources

Level of uncertainty High Low

Source: Based on text in J. Dyer, P. Kale, & H. Singh, 2003, Do you know when to ally or acquire? Choosing between acquisitions and alliances, Working paper, Brigham Young University.

210 PART 2 BUSINESS-LEVEL STRATEGIES

Acquiring versus Not Acquiring Alliance Partners As noted earlier, alliance partners with a high degree of network centrality benefit from being centrally located in a network of players. One debate deals with whether such centrally located firms should acquire other more peripheral (less centrally located) and typically smaller alliance partners in the network. Recent comparative research involving US and Chinese firms reveals interesting contrasts. In the United States, centrally located firms in an alliance network seem to enjoy the benefits of high centrality and are not eager to acquire alliance partners—this finding is consistent with the predictions made from standard network theory.52 However, in China, centrally located firms, to derive benefits from their high centrality, seem to more aggressively and more quickly acquire partners— this finding is opposite to standard predictions.53

Why are there such differences? Researchers speculate that due to the dynamic, fast- moving institutional transitions unfolding in China, any competitive advantage asso- ciated with high centrality is likely to erode very rapidly, prompting centrally located firms to quickly acquire alliance partners. In the United States, the pace of competitive dynamics is not as fast-moving, thus enabling some centrally located firms to enjoy the benefits and not having to acquire alliance partners.54 In other words, if the real options logic is in play, it is played out over a longer period of time in the United States than in China.

In addition to Chinese firms, firms from other emerging economies such as Brazil and India also seem to have little patience and have often been found to indulge on a “buying binge” in acquiring alliance partners overseas. Used to their dynamic and fast-moving domestic competition, firms from emerging economies may be interested in aggressively and quickly acquiring partner firms overseas—out of fear that any competitive advantage associated with the acquisition moves may erode rapidly if they do not act quickly.55

Whether rapidly acquiring alliance partners results in better parent firm performance remains to be seen. Two lessons out of this debate are: (1) Alliance partner firms in developed economies need to get used to the more “rapid fire” acquisitions initiated by firms in emerging economies, and (2) firms from developed economies need to speed up their partner acquisition process when competing in emerging economies.56

The Savvy Strategist Traditionally firm strategy is, by definition, about how a single firm strategizes and competes. Instead of concentrating on competition only, a new generation of strategists needs to be savvy at both competition and cooperation—in other words, “co-opetition.”57

For example, Google’s CEO Eric Schmidt responded to a reporter who asked (in 2010, before Apple’s CEO Steve Jobs passed away): “You no longer serve on the Apple board. It is said Steve Jobs got very upset with you, his friend. I didn’t go into the search business, he said. Why are you going into the phone business?”

Apple is a company we both partner and compete with. We do a search deal with them, recently extended, and we’re doing all sorts of things in maps and things like that. So the sum of all this is that two large corporations, both of which are important, both of which I care a lot about, will remain pretty close. But Android was around earlier than iPhone.58

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The savvy strategist draws three important implications for action (Table 7.6). First, improving relational (collaborative) capabilities is crucial for the success of strategic alliances and networks. Given that excellent relational skills are rare among the population in general (think of the high divorce rates) and that the business school curriculum often emphasizes competition at the expense of collaboration, you need to work extra hard to be good at collaboration. The do’s and don’ts in Table 7.7 will provide a useful start.

Second, you need to understand the rules of the game governing alliances and net- works—both formal and informal—around the world. Formal rules dictating alliances to be the preferred mode of entry and banning WOS would make it necessary to embark on an alliance strategy, as Eli Lilly did when entering India in the 1990s. Over time, such rules have been relaxed and WOS allowed, thus enabling some reconsideration of Eli Lilly’s JV strategy. Informal norms and values are also important. In the absence of a legal mandate for alliances, the norms for entering emerging economies used to be in favor of alliances (see the Opening and Closing Cases). However, the recent trend has moved toward phasing out alliances and establishing stronger controls over subsidiaries in emerging economies.

TABLE 7.6 Strategic Implications for Action

& Improve relational (collaborative) capabilities crucial for the success of strategic alliances and networks. & Understand and master the rules of the game governing alliances and networks around the world. & Carefully weigh the pros and cons of alliances vis-à-vis those of acquisitions.

TABLE 7.7 Improving the Odds for Alliance Success

AREAS DO’S AND DON’TS

Contract versus “chemistry”

No contract can cover all elements of the relationship. Relying on a detailed contract does not guarantee a successful relationship. It may indicate a lack of trust.

Warning signs Identify symptoms of frequent criticism, defensiveness (always blaming others for problems), and stonewalling (withdrawal during a fight).

Invest in the relationship

Like married individuals working hard to invigorate their ties, alliances require continuous nurturing. Once a party starts to waver, it is difficult to turn back the dissolution process.

Conflict resolution mechanisms

“Good” married couples also fight. Their secret weapon is to find mechanisms to avoid unwarranted escalation of conflicts. Managers need to handle conflicts— inevitable in any alliance—in a credible, responsible, and controlled fashion.

Source: Based on text in M. W. Peng & O. Shenkar, 2002, Joint venture dissolution as corporate divorce (pp. 101–102), Academy of Management Executive, 16 (2): 92–105.

ga ge

Le ar ni ng

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Third, you need to carefully weigh the pros and cons associated with alliances and acquisitions. Diving into alliances (or acquisitions) without considering the other option may be counterproductive, as Coca-Cola found out after it established a JV with P&G on fruit drinks. Considering alliances vis-à-vis acquisitions within an integrated decision framework may be necessary.

Overall, this chapter sheds considerable light on the four fundamental questions in strategy. The answers to Questions 1 (Why firms differ?) and 2 (How firms behave?) boil down to how different industry-based, resource-based, and institution-based con- siderations drive alliance and network actions. What determines the scope of the firm (Question 3)—or more specifically, the scope of the alliance in this context—can be found in the strategic goals behind these relationships. Some alliances may have a wide scope in anticipation of an eventual merger (such as the Renault–Nissan alliance), while other alliances may have a limited scope, keeping the partners fiercely competitive in other aspects (such as the GM–Toyota JV). Finally, the international success and failure of strategic alliances and networks (Question 4) are fundamentally determined by how firms develop, possess, and leverage “soft” relational capabilities when managing their interfirm relationships, in addition to “hard” assets such as technology and capital. In conclusion, there is no doubt that strategic alliances and networks are difficult to manage. But managing is hardly ever simple, whether managing external relationships or internal units.

CHAPTER SUMMARY

1. Define strategic alliances and networks • Strategic alliances are voluntary agreements of cooperation between firms. • Strategic networks are strategic alliances formed by multiple firms.

2. Articulate a comprehensive model of strategic alliances and networks • Industry-based, resource-based, and institution-based considerations form the backbone of a comprehensive model of strategic alliances and networks.

3. Understand the decision processes behind the formation of alliances and networks • Principal phases of alliance and network formation include (1) deciding whether to cooperate or not, (2) determining whether to pursue contractual or equity modes, and (3) positioning the particular relationship.

4. Gain insights into the evolution of alliances and networks • Three aspects of evolution highlighted are (1) combating opportunism, (2) evolving from strong ties to weak ties, and (3) turning from corporate marriages to divorces.

5. Identify the drivers behind the performance of alliances and networks • At the alliance/network level, (1) equity, (2) learning and experience, (3) nationality, and (4) rational capabilities are found to affect alliance and network performance.

6. Participate in three leading debates concerning alliances and networks • (1) Majority JVs as control mechanisms versus minority JVs as real options, (2) alliances versus acquisitions, and (3) acquiring versus not acquiring alliance partners.

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7. Draw strategic implications of action • Improve relational (collaborative) capabilities. • Understand and master the rules of the game governing alliances and networks around the world.

• Carefully weigh the pros and cons of alliances vis-à-vis those of acquisitions.

KEY TERMS

Constellation p. 190

Contractual (non-equity- based) alliance p. 190

Cross-shareholding p. 190

Downstream vertical alliance p. 194

Due diligence p. 199

Equity-based alliance p. 190

Exploitation p. 204

Exploration p. 204

Horizontal alliance p. 194

Learning by doing p. 200

Learning race p. 196

Network centrality p. 197

Partner rarity p. 196

Real option p. 195

Relational (collaborative) capability p. 196

Strategic alliance p. 190

Strategic investment p. 190

Strategic network p. 190

Upstream vertical alliance p. 194

CRITICAL DISCUSSION QUESTIONS

1. Pick any recent announcement of the formation of an international alliance. Predict its likely success or failure.

2. ON ETHICS: During the courtship and negotiation stages, managers often emphasize “equal partnerships” and do not reveal (and try to hide) their true intentions. What are the ethical dilemmas here?

3. ON ETHICS: Some argue that engaging in a “learning race” is unethical. Others believe that a “learning race” is part and parcel of alliance relationships, especially those with competitors. What do you think?

TOPICS FOR EXPANDED PROJECTS

1. Some argue that at a 30%–70% failure rate (depending on different studies), strategic alliances and networks have a strikingly high failure rate and that firms need to scale down their alliance and network activities. Others suggest that this failure rate is not particularly higher than the failure rate of new entrepreneurial start-ups, internal corporate ventures, new products launched by single companies, and M&As. Therefore, such a failure rate is not of grave concern. Write a short paper describing how you would join this debate.

214 PART 2 BUSINESS-LEVEL STRATEGIES

2. Working in pairs, find the longest-running alliance relationship your research can find. Present its secrets for such longevity in a short paper or visual presentation.

3. What are the similarities and differences between human marriages and interfirm alli- ances? How can the lessons behind the success and failure of human marriages enhance the odds of alliance success? State your answers in a short paper.

E T H I C A L D I L E M M ACLOSING CASE

Emerging Markets: BP, AAR, and TNK-BP (also see Emerging Markets 7.1)

TNK-BP is a joint venture (JV) company that is 50% owned by BP and 50% owned by the AAR consortium, which represents three major Russian business groups: Alfa, Access, and Renova. Founded in 2003, TNK-BP is a major oil company in its own right. It is Russia’s third largest oil producer and among the ten largest private oil companies in the world. Producing about 1.9 million barrels of oil per day, TNK-BP provides about 25% of BP’s oil production and 40% of its reserves. It pays about $2 billion dividends each year to BP. Such a cash cow with huge reserves would seem to be—in the words of Bloomberg Business- week—a “godsend.” Unfortunately, TNK-BP has turned out to be an unending saga of headaches, conflicts, and intrigue between BP and its three Russian oligarch part- ners: Mikhail Fridman (founder of Alfa Group and chair- man of the board of TNK-BP), Len Blavatnik (founder of Access Industries), and Viktor Vekselberg (founder of Renova Group). Two episodes stand out.

Episode I

In 2008, the Russian partners publicly aired two grie- vances. First, TNK-BP relied on too many BP’s expatriate (expat) consultants, whose fees were a “rip off”—extra dividends to BP but excessive costs to TNK-BP. Second, and more importantly, the Russians wanted TNK-BP to pursue opportunities outside of Russia and Ukraine, but BP insisted on fencing TNK-BP within Russia and Ukraine to prevent TNK-BP from becoming a global competitor. A memo from the American CEO of TNK-BP at that time,

Bob Dudley, barred managers from entertaining deals in countries blacklisted by the US State Department, such as Cuba, Iran, and Syria. “TNK-BP is an independent Russian company,” noted Fridman, “and should be subject to Russian laws,” which would bless deals in these countries. In fact, given its Russian background, TNK-BP might be particularly well-suited to exploit opportunities in these “rogue” countries labeled by the US government. The board room dispute quickly spilled out to grab media headlines. The Russian partners claimed that TNK-BP should be free to grow into an independent, global oil company (at least the JV agreement did not ban this).

Rapid-fire developments took place in 2008. In January, the visas of BP’s 148 expats working at TNK-BP were declared invalid. In March, the Moscow offices of both BP and TNK-BP were raided by police. Shortly after, a TNK-BP manager was arrested for alleged espionage. In April, a little-known minority shareholder filed a court case blocking BP’s expats from working at TNK-BP. In June, the high drama on who was in charge in this 50/50 JV reached a bizarre climax. In a Moscow hearing with Russian immi- gration officials regarding the proper number of visas for TNK-BP’s foreign workers, two delegations showed up, both claiming to represent TNK-BP (!). Tim Summers, TNK-BP’s chief operating officer and a BP representative, claimed that visas for 150 foreign workers would be needed. But Vekselberg, a director and 12.5% shareholder of TNK-BP, said that only 71 visas would be necessary. Officials supported Vekselberg’s case and thus forced some expat employees to leave Russia almost immediately for good.

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BP framed the dispute as oligarchs’ time-honored prac- tice to grab control of companies by political pressures and argued that the outcome would be a test of the rule of law in Russia. BP also implied that the Russian government might be behind the oligarchs’ aggressive moves. In an article published in Financial Times on July 7, 2008, Fridman dismissed political motivations and characterized the dis- pute as “a traditional, commercial dispute about different ambitions of the strategic development of the business” (see Emerging Markets 7.1). Accusing BP of being opportu- nistic, Fridman wrote that BP treated TNK-BP as if it had been a wholly owned subsidiary instead of a JV. BP allegedly treated Russians as “subjects,” as opposed to shareholders of equal rights. The article noted that BP cared more about its oil reserves than costs or profits. The punch line? Dud- ley’s ouster as TNK-BP’s CEO. Under such tremendous pres- sures, Dudley had to quickly flee the country. A Russian court even barred him from performing his job for two years for allegedly violating local labor laws. In September 2008, Fridman, in addition to his position as chairman of the board, became interim CEO of TNK-BP.

In the end, while the Russians needed BP’s expertise, BP also needed to access TNK-BP’s crude in Siberia, which was far easier and safer to get at than the complicated and unsafe deep water drilling in places such as the Gulf of Mexico. In April 2010, the devastating oil spill took place. In July 2010, Dudley—although disgraced in Russia—was pro- moted to become the new BP CEO. As the new CEO, Dudley quickly flew to Moscow and became more accom- modating to the Russian partners. With a changed attitude, BP now agreed that TNK-BP could expand abroad. In Octo- ber 2010, BP sold assets worth $1.8 billion in Venezuela and Vietnam to TNK-BP—a milestone for TNK-BP that finally broke out of Russia and Ukraine. As a Russian company, TNK-BP might indeed be better positioned to do well in “tricky” countries such as Venezuela and Vietnam. To BP, these sales raised immediate cash to help defray the cleanup and compensation costs in the Gulf of Mexico, and it did not have to sell to competitors. Overall, Episode I seemed to have a (relatively) happy ending.

Episode II

Only a couple of months after the ending of Episode I, Episode II began. In January 2011, BP announced a new

$16 billion strategic alliance with Russia’s state-owned Rosneft. Creating the first cross-shareholding alliance between international and Russian oil companies, the deal would enable BP to own 9.5% of Rosneft’s shares and Rosneft to own 5% of BP’s shares. Both sides would jointly explore a new offshore oil field on the Russian Arctic continental shelf in the Kara Sea. Rosneft is Russia’s sec- ond largest oil company, which produces 2.4 million bar- rels of oil a day (behind Gazprom but ahead of TNK-BP). This new alliance had the full support of the Russian government—after all, Rosneft’s chairman of the board Igor Sechin was the sitting Deputy Prime Minister. All seemed well . . . but here was the catch: The Russian part- ners at TNK-BP jumped out and sought to block the deal. Their argument was that per the TNK-BP JV agreement, BP could only pursue further business in Russia through the JV. In other words, AAR’s rights of first refusal were vio- lated. In simple terms, “if you want to marry a new wife,” a furious Fridman argued, “you have to divorce the old one first.” The Russian government was mad about BP too. “I met with BP’s head and he did not say a word about it,” said (then) Prime Minister Vladmir Putin. Basi- cally, BP had lied to Rosneft that it had no third-party obligations. According to the Economist,

At the least, it seems a woeful misjudgment on BP’s part. The company says it had no idea that its deal with Rosneft would result in such a legal tussle, so it felt no need to mention the terms of its shareholder agreement with TNK-BP to its new Russian partners. Perhaps Mr. Dudley gambled that getting into bed with Rosneft would silence TNK-BP.

Such a gamble backfired badly. AAR initiated legal challenges by initiating arbitration proceedings to block BP’s deal with Rosneft.* In March 2011 a Swedish arbitra- tion tribunal supported AAR and dealt a blow to the Rosneft deal, which became known as “Ros-nyet.” In May 2011, BP admitted failure and reaffirmed that it remained fully committed to TNK-BP as its “primary busi- ness vehicle in Russia”—which, in human marriage terms,

*Arbitration is a private form of dispute resolution that bypasses the court systems of the host country and the home country. In this case, parties to the TNK-BP JV agreed when they signed the contract that neither Russian law nor British law would govern the contractual relationship. Instead they agreed to use arbitration done in a third, neutral country (Sweden in this case) to resolve their disputes.

216 PART 2 BUSINESS-LEVEL STRATEGIES

NOTES

sounded like acknowledging AAR as its legally married spouse after being caught for indulging in an extramarital affair.

However, BP’s headache did not end. In September 2011, its frustrated other partner Rosneft struck a new strategic alliance deal with Exxon Mobil. They would jointly explore the same icy blocks of the Arctic Kara Sea that slipped from BP’s hand. Things then got worse. The very next day, BP’s Moscow offices were raided by police again. Having managed to alienate both the Russian government and Rosneft—just imagine Kremlin’s fury after the collapse of the deal—on the one hand and AAR on the other hand, “BP appears to have little protection against being pushed around in Russia,” noted the Economist. In October 2011, a severely weakened BP agreed to let Fridman to formally serve as CEO, thus enabling him and AAR partners to essentially run the show at TNK-BP.

Despite the ordeals, challenges, and hard feelings, both BP and AAR remained committed to the success of TNK-BP. One has to be totally naïve to believe that they would live “happily ever after.” So stay tuned for Episode III…

Sources: Based on (1) BusinessWeek, 2008, BP: Roughed up in Russia, June 16: 69; (2) Bloomberg Businessweek, 2010, How BP learned to dance with the Russian bear, September 27: 19–20; (3) BP, 2010, BP to sell Venezuela and Vietnam businesses to TNK-BP, October 18, www.bp.com; (4) BP,

2011, BP and AAR agree on new management structure for TNK-BP, October 21, www.bp.com; (5) BP, 2011, BP and AAR reaffirm commitment to growth and success of TNK-BP, May 17, www.bp.com; (6) BP, 2011, BP remains committed to partner with Russia, March 24, www.bp.com; (7) BP, 2011, Rosneft and BP form global and Arctic strategic alliance, January 14, www.bp.com; (8) Economist, 2008, At war with itself, July 5: 74; (9) Economist, 2008, Crude tactics, June 7: 74–75; (10) Economist, 2011, Dudley do-wrong, April 2: 60; (11) Economist, 2011, Exxonerated, September 3: 64; (12) M. Fridman, 2008, BP has been treating Russians as subjects, Financial Times, July 7: 11.

C A S E D I S C U S S I O N Q U E S T I O N S

1. From an industry-based view, explain why alliances are a frequent mode of entry for the oil industry in Russia.

2. From a resource-based view, what are the complementary resources and capabilities both sides brought to TNK-BP?

3. From an institution-based view, what are the formal and informal rules of the game governing this industry in Russia?

4. ON ETHICS: As an ethics consultant to BP, how would you advise it during both episodes of the conflicts with AAR?

5. ON ETHICS: If you were an arbitrator in Stockholm, Sweden, which side would you support in both episodes?

[Journal acronyms] AME – Academy of Management Executive; AMJ – Academy of Management Journal; AMP – Academy of Management Perspectives; AMR – Academy of Management Review; APJM – Asia Pacific Journal of Management; BW – BusinessWeek (before 2010) or Bloomberg Businessweek (since 2010); GSJ – Global Strategy Journal; HBR – Harvard Business Review; JIBS – Journal of International Business Studies; JIM – Journal of International Management; JM – Journal of Management; JMS – Journal of Management Studies; JWB – Journal of World Business; MS – Management Science; OSc – Organization Science; SMJ – Strategic Management Journal

1. Cited in J. Reuer, 2004, Introduction (p. 2), in J. Reuer (ed.), Strategic Alliances, New York: Oxford University Press.

2. P. Beamish & N. Lupton, 2009, Managing JVs, AMP, May, 75–94; P. Kale & H. Singh, 2009, Managing strategic alliances, AMP, August: 45–62.

3. T. Das & B. Teng, 2002, Alliance constellations, AMR, 27: 445–456; S. Nambisan & M. Sawhney, 2011, Orchestration processes in network-centric innovation, AMP, August: 40–56.

4. S. Lazzarini, 2007, The impact of membership in com- peting alliance constellations, SMJ, 28: 345–367.

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5. X. Yin &M. Shanley, 2008, Industry determinants of the “merger versus alliance” decision, AMR, 33: 473–491.

6. B. Garrette, X. Castaner, & P. Dussauge, 2009, Horizontal alliances as an alternative to autonomous production, SMJ, 30: 885–894.

7. J. Dyer, 1997, Effective interfirm collaboration, SMJ, 18: 543–556.

8. L. Mesquita, J. Anand, & T. Brush, 2008, Comparing the resource-based and relational views, SMJ, 29: 913–941; M. Schreiner, P. Kale, & D. Corsten, 2009, What really is alliance management capability and how does it impact alliance outcomes and success? SMJ, 30: 1395–1419.

9. J. Adegbesan & M. Higgins, 2010, The intra-alliance division of value created through collaboration, SMJ, 32: 187–211; R. Agarwal, R. Croson, & J. Mahoney, 2010, The role of incentives and communication in strategic alliances, SMJ, 31: 413–437; R. Z. Ainuddin, P. Beamish, J. Hulland, & M. Rouse, 2007, Resource attributes and firm performance in IJVs, JWB, 42: 47–60; F. Castellucci & G. Ertug, 2010, What’s in it for them? AMJ, 53: 149–166; E. Fang & S. Zou, 2009, Antecedents and consequences of marketing dynamic capabilities in IJVs, JIBS, 40: 742–761; A. Joshi & A. Nerkar, 2011, When do strategic alliances inhibit innovation by firms? SMJ, 32: 1139–1160; M. Srivas- tava & D. Gnyawali, 2011, When do relational resources matter? AMJ, 54: 797–810.

10. Economist, 2003, Open skies and flights of fancy (p. 67), October 4: 65–67.

11. S. Ang, 2008, Competitive intensity and collaboration, SMJ, 29: 1057–1075; R. Sampson, 2007, R&D alliances and firm performance, AMJ, 50: 364–386.

12. B. Bourdeau, J. Cronin, & C. Voorhees, 2007, Model- ing service alliances, SMJ, 28: 609–622; H. Mitsuhashi & H. Greve, 2009, A matching theory of alliance formation and organizational success, AMJ, 52: 975–995; A. Tiwana & M. Keil, 2007, Does peripheral knowledge complement control? SMJ, 28: 623–634.

13. M. Koza, S. Tallman, & A. Ataay, 2011, The strategic assembly of global firms (p. 38), GSJ, 1: 27–46.

14. A. Chintakananda & D. McIntyre, 2012, Market entry in the presence of network effects, JM (in press); I. Cuypers & X. Martin, 2010, What makes and what does not make a real option? JIBS, 41: 47–69.

15. B. Kogut, 1991, JVs and the option to expand and acquire, MS, 37: 19–33; T. Tong, J. Reuer, & M. W. Peng, 2008, International joint ventures and the value of growth options, AMJ, 51: 1014–1029.

16. M. McCarter, J. Mahoney, & G. Northcraft, 2011, Testing the waters, AMR, 36: 621–640.

17. L. Hsieh, S. Rodrigues, & J. Child, 2010, Risk percep- tion and post-formation governance in IJVs in Taiwan, JIM, 16: 288–303; M. Meuleman, A. Lockett, S. Manigart, & M. Wright, 2010, Partner selection deci- sions in interfirm collaborations, JMS, 47: 995–1018.

18. M. Jensen & A. Roy, 2008, Staging exchange partner choices, AMJ, 51: 495–516; D. Li, L. Eden, M. Hitt, & R. D. Ireland, 2008, Friends, acquaintances, or stran- gers? AMJ, 51: 315–334; X. Luo & L. Deng, 2009, Do birds of a feather flock higher? JMS, 46: 1005–1030; F. Rothaermel & W. Boeker, 2008, Old technology meets new technology, SMJ, 29: 47–77; R. Shah & V. Swaminathan, 2008, Factors influencing partner selection in strategic alliances, SMJ, 29: 471–494.

19. A. Arino & P. Ring, 2010, The role of fairness in alliance formation, SMJ, 31: 1054–1087.

20. D. Zoogah & M. W. Peng, 2011, What determines the performance of strategic alliance managers? APJM, 28: 483–508.

21. C. Jiang, R. Chua, M. Kotabe, & J. Murray, 2011, Effects of cultural ethnicity, firm size, and firm age on senior executives’ trust in their overseas business partners, JIBS, 42: 1150–1173; Y. Luo, 2009, Are we on the same page? JWB, 44: 383–396; L. Mesquita, 2007, Starting over when the bickering never ends, AMR, 32: 72–91; F. Molina-Morales & M. Martinez- Fernandez, 2009, Too much love in the neighborhood can hurt, SMJ, 30: 1013–1023; A. Phene & S. Tallman, 2012, Complexity, context, and governance in bio- technology alliances, JIBS, 43: 61–83.

22. G. Ahuja, F. Polidoro, & W. Mitchell, 2009, Structural homophily or social asymmetry? SMJ, 30: 941–958; B. Koka & J. Prescott, 2008, Designing alliance networks, SMJ, 29: 639–661; C. Phelps, 2010, A longi- tudinal study of the influence of alliance network struc- ture and composition on firm exploratory innovation, AMJ, 53: 890–913; H. Yang, Z. Lin, & Y. Lin, 2010, A multilevel framework of firm boundaries, SMJ, 31: 237–261; A. Zaheer, R. Gozubuyuk, & H. Milanov, 2010, It’s the connections, AMP, February: 62–76.

23. V. Aggarwal, N. Siggelkow, & H. Singh, 2011, Gov- erning collaborative activity, SMJ, 32: 705–730.

24. D. Chen, Y. Paik, & S. Park, 2010, Host-country policies and MNE management control in IJVs, JIBS, 41: 526–537; W. Shi, S. Sun, & M. W. Peng, 2013, Sub-national institutional contingencies, network positions, and IJV partner selection, JMS (in press).

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25. Federal Trade Commission, 2000, Antitrust Guidelines for Collaborations among Competitors, Washington: FTC; T. Tong & J. Reuer, 2010, Competitive conse- quences of interfirm collaboration, JIBS, 41: 1056–1073.

26. M. W. Peng, 2006, Making M&As fly in China, HBR, March: 26–27. See also H. K. Steensma, L. Tihanyi, M. Lyles, & C. Dhanaraj, 2005, The evolving value of foreign partnerships in transitioning economies, AMJ, 48: 213–235; J. Xia, J. Tan, & D. Tan, 2008, Mimetic entry and bandwagon effect, SMJ, 29: 195–217.

27. M. T. Dacin, C. Oliver, & J. Roy, 2007, The legitimacy of strategic alliances, SMJ, 28: 169–187.

28. This section draws heavily from S. Tallman & O. Shen- kar, 1994, A managerial decision model of international cooperative venture formation, JIBS, 25: 91–113.

29. G. Lee & M. Lieberman, 2010, Acquisition versus internal development, SMJ, 31: 140–158.

30. W. Hoffmann, 2007, Strategies for managing a port- folio of alliances, SMJ, 28: 827–856; D. Lavie, C. Lechner, & H. Singh, 2007, The performance implica- tions of timing of entry and involvement in multi- partner alliances, AMJ, 50: 578–604; J. Reuer & R. Ragozzino, 2006, Agency hazards and alliance portfo- lios, SMJ, 27: 27–43.

31. S. Makino, C. Chan, T. Isobe, & P. Beamish, 2007, Intended and unintended termination of IJVs, SMJ, 28: 1113–1132; H. Ness, 2009, Governance, negotiations, and alliance dynamics, JMS, 46: 451–480; H. K. Steensma, J. Barden, C. Dhanaraj, M. Lyles, & L. Tihanyi, 2008, The evolution and internalization of IJVs in a transitioning economy, JIBS, 39: 491–507.

32. S. White & S. Lui, 2005, Distinguishing costs of coop- eration and control in alliances, SMJ, 26: 913–932.

33. Y. Zhang & N. Rajagopalan, 2002, Inter-partner cred- ible threat in IJVs, JIBS, 33: 457–478.

34. J. March, 1991, Exploration and exploitation in orga- nizational learning (p. 71), OSc, 2: 71–87.

35. D. Lavie & L. Rosenkopf, 2006, Balancing exploration and exploitation in alliance formation, AMJ, 49: 797–818.

36. This section draws heavily from M. W. Peng & O. Shenkar, 2002, JV dissolution as corporate divorce, AME, 16: 92–105. See also H. Greve, J. Baum, H. Mitsuhashi, & T. Rowley, 2010, Built to last but falling apart, AMJ, 53: 302–322.

37. D. Faems, M. Janssens, A. Madhok, & B. Looy, 2008, Toward an integrative perspective on alliance

governance, AMJ, 51: 1053–1078; N. Pangarkar, 2009, Do firms learn from alliance terminations? JMS, 46: 982–1004; J. Reuer & A. Arino, 2007, Strate- gic alliance contracts, SMJ, 28: 313–330.

38. A. Arino & J. Reuer, 2002, Designing and renegotiat- ing strategic alliance contracts (p. 44), AME, 18: 37–48.

39. A. Goerzen, 2007, Alliance networks and firm perfor- mance, SMJ, 28: 487–509.

40. R. Kaplan, D. Norton, & B. Rugelsjoen, 2010, Managing alliances with the balanced scorecard, HBR, January: 114–120; J. Li, C. Zhou, & E. Zajac, 2009, Control, collaboration, and productivity, SMJ, 30: 865–884; J. Lu & D. Xu, 2006, Growth and survival of IJVs, JM, 32: 426–448; A. Shipilov, 2006, Network strategy and performance of Canadian investment banks, AMJ, 49: 590–604.

41. M. Cheung, M. Myers, & J. Mentzer, 2011, The value of relational learning in global buyer-supplier exchanges, SMJ, 32: 1061–1082; F. Evangelista & L. Hau, 2009, Organizational context and knowledge acquisition in IJVs, JWB, 44: 63–73; E. Fang & S. Zou, 2010, The effects of absorptive and joint learning on the instability of IJVs in emerging economies, JIBS, 41: 906–924; R. Gulati, D. Lavie, & H. Singh, 2009, The nature of partnering experience and the gains from alliances, SMJ, 30: 1213–1233; P. Kale & H. Singh, 2007, Building firm capabilities through learning, SMJ, 28: 981–1000; J. Lai, S. Chang, & S. Chen, 2010, Is experience valuable in international strategic alliances? JIM, 16: 247–261; C. Liu, P. Ghauri, & R. Sinkovics, 2010, Understanding the impact of rela- tional capital and organizational learning on alliance outcomes, JWB, 45: 237–249; M. Lyles & J. Salk, 2007, Knowledge acquisition from foreign parents in IJVs, JIBS, 38: 3–18; K. Meyer, 2007, Contextualizing orga- nizational learning, JIBS, 38: 27–37; B. Nielsen & S. Nielsen, 2009, Learning and innovation in interna- tional strategic alliances, JMS, 46: 1031–1058; S. Tall- man & A. Chacar, 2011, Communities, alliances, networks, and knowledge in multinational firms, JIM, 17: 201–210; G. Vasudeva & J. Anand, 2011, Unpacking absorptive capacity, AMJ, 54: 611–623; M. Zollo & J. Reuer, 2010, Experience spillovers across corporate development activities, OSc, 21: 1195–1212.

42. Y. Luo & M. W. Peng, 1999, Learning to compete in a transition economy, JIBS, 30: 269–296.

43. A. Gaur & J. Lu, 2007, Ownership strategies and survival of foreign subsidiaries, JM, 33: 84–110; A.

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Madhok, 2006, How much does ownership really matter? JIBS, 37: 4–11; J. Xia, 2011, Mutual depen- dence, partner substitutability, and repeated partner- ship, SMJ, 32: 229–253.

44. D. Lavie, 2007, Alliance portfolios and firm perfor- mance, SMJ, 28: 1187–1212.

45. A. Afuah, 2000, How much do your co-opetitors’ capabilities matter in the face of technological change?, SMJ, 21: 387–404; J. Baum, T. Calabrese, & B. Silverman, 2000, Don’t go it alone, SMJ, 21: 267–294.

46. M. Kunar, 2010, Are JVs positive sum games? SMJ, 32: 32–54; S. Yeniyurt, J. Townsend, S. T. Cavusgil, & P. Ghauri, 2009, Mimetic and experiential effects in international marketing alliance formations of US pharmaceutical firms, JIBS, 40: 301–320.

47. C. Choi & P. Beamish, 2004, Split management con- trol and IJV performance, JIBS, 35: 201–215; H. K. Steensma & M. Lyles, 2000, Explaining IJV survival in a transition economy, SMJ, 21: 831–851.

48. T. Chi, 2000, Option to acquire or divest a JV, SMJ (p. 671), 21: 665–687.

49. L. Wang & E. Zajac, 2007, Alliance or acquisition? SMJ, 28: 1291–1317.

50. K. Brouthers & D. Dikova, 2010, Acquisitions and real options, JMS, 47: 1048–1070.

51. J. Dyer, P. Kale, & H. Singh, 2004, When to ally and when to acquire, HBR (p. 113), July–August: 109–115.

52. R. Burt, 1992, Structural Holes, Cambridge, MA: Har- vard University Press; H. Yang, Z. Lin, & M. W. Peng, 2011, Behind acquisitions of alliance partners, AMJ, 54: 1069–1080.

53. Z. Lin, M. W. Peng, H. Yang, & S. Sun, 2009, How do networks and learning drive M&As? SMJ, 30: 1113–1132.

54. H. Yang, S. Sun, Z. Lin, & M. W. Peng, 2011, Behind M&As in China and the United States, APJM, 28: 239–255.

55. S. Sun, M. W. Peng, B. Ren, & D. Yan, 2012, A comparative ownership advantage framework for cross-border M&As, JWB, 47: 4–16.

56. M. W. Peng, 2012, The global strategy of emerging multinationals from China, GSJ, 2: 97–107.

57. A. Brandenburger & B. Nablebuff, 1996, Co-opetition, New York: Doubleday.

58. BW, 2010, Charlie Rose talks to Eric Schmidt, September 27: 39.

220 PART 2 BUSINESS-LEVEL STRATEGIES

CHAPTER8

MANAGING GLOBAL COMPETITIVE DYNAMICS

KNOWLEDGE OBJECT IVES

After studying this chapter, you should be able to

1. Articulate the “strategy as action” perspective

2. Understand the industry conditions conducive for cooperation and collusion

3. Explain how resources and capabilities influence competitive dynamics

4. Outline how antitrust and antidumping laws affect domestic and international competition

5. Identify the drivers for attacks, counterattacks, and signaling

6. Discuss how local firms fight multinational enterprises (MNEs)

7. Participate in two leading debates concerning competitive dynamics

8. Draw strategic implications for action

ot o/ A le xe y St io p

222 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

E T H I C A L D I L E M M A

OPENING CASE

Patent Wars and Shark Attacks

The number of worldwide patent applications has shot up from about 800,000 a year in the 1980s to close to 2 million a year in the 2000s. The number of patent lawsuits has also skyrocketed. In the hotly contested mobile arena, Apple sued Samsung, Nokia, and HTC for patent viola- tions. In retaliation, Samsung, Nokia, and HTC counter- sued Apple, also for patent violations. Kodak also sued Apple as well as Blackberry’s maker, Research In Motion (RIM). Oracle and Xerox sued Google. Hardly a week goes by without a new lawsuit in “patent wars.”

In many rapidly developing but patent-choked indus- tries, inadvertently tripping over someone else’s patents is a real danger. The open secret, according to the Econo- mist, is that “everyone infringes everyone else’s patents in some way.” This creates an incentive for firms to engage in an “arms race” in filing and hoarding patents. In patent wars, patents are both defensive and offensive weapons.

Contrary to popular thinking, many patents are not truly novel and nonobvious. BusinessWeek opined that the United States is now “awash in a sea of junk patents. Some are just plain silly, such as a patent for ‘a method of exercising and entertaining cats’ (basically teasing them with a laser pointer).” Such “massive overpatenting,” according to critics, has resulted in a “patent epidemic.” Escalation of patenting obviously costs firms a lot of money: on average, one patent costs half a million dollars. But firms are rational. Strategically patenting a portfolio of inventions around some core technologies allows them to gain an upper hand in patent lawsuits and negotiations. Patent lawsuits are becoming very predictable. Firm A sues Firm B for patent infringement. B digs through its own patent portfolio and discovers that some of its own patents are infringed by A. So B countersues A. To avoid costly and mutually destructive exchange of endless patent lawsuits, both typically reach cross-licensing deals that, after exchanging small sums of money, give each other the rights to the patents.

But here is a catch: to be a party to such exchange, a firm needs to have a sufficiently large hoard of patents. As

a young firm, Google, prior to 2011, only had applied for or received 307 mobile-related patents. As a result, Google was vulnerable when compared with RIM’s 3,134 mobile- related patents, Nokia’s 2,655, and Microsoft’s 2,594. That was a key reason behind Google’s colossal $12.5 billion purchase of Motorola Mobility, a handset maker that was losing money. But Google was not primarily interested in the handset business; instead, it was buying Motorola’s rich hoard of over 1,000 mobile-related patents.

Among large firms clashing in emerging industries such as mobile devices, patent fights are normal or even (somewhat) predictable. What are less predictable but no less damaging are attacks by patent “sharks” (or “trolls”). Trolls are patent-holding individuals or (often small) firms that legally challenge manufacturers for patent infringement in order to receive damage awards for the illegitimate use of trolls’ patents. While sharks and trolls are colorful labels, the jargon for them is “non-operating entities” (NOEs). In contrast to all the “operating entities” named in the first four paragraphs above, NOEs, by definition, had neither capability nor intention to commercialize their patents. Traditionally, most NOEs would license their patents to manufac- turers that would pay a licensing fee. But many of today’s trolls hope to be infringed and do everything they can to keep patents as invisible as possible (the jargon is to be a “submarine”) until the patents are illegitimately used by manufacturers. Trolls then pounce in surprise attacks demanding compensation exceeding what they would reasonably expect from real licensing fees up front. In 1990, individual inventor Jerome Lemelson sued toymaker Mattel for infringing a coupling technology used in toy trucks. Although the court determined that Mattel inadvertently (not willfully) infringed Lemelson’s patent, the court nevertheless awarded him $24 million— that was a lot of toy trucks (!). Most experts agreed that if Lemelson and Mattel had negotiated up front, Lemelson would not have been able to extract a licen- sing fee close to this astronomical sum. Cases of this kind have motivated a lot of trolls, eventually opening

223 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

Whydo firms take certain actions such as patent lawsuits? Once one side initiatesan action, how does the other respond? These are some of the strategicquestions we address in this chapter, which focuses on such competitive dynamics—actions and responses undertaken by competing firms.1 Since one firm’s actions are rarely unnoticed by rivals, the initiating firm would naturally like to predict rivals’ responses before making its own move.2 This process is called competitor analysis, advocated a long time ago by ancient Chinese strategist Sun Tzu’s teaching to not only know “yourself” but also “your opponents.”

Recall that Chapter 1 introduced the “strategy as plan” and “strategy as action” schools. As military officers have long known, a good plan never survives the first contact with the enemy because the enemy does not act according to our plan (!). Thus, strategy’s defining feature is action, not planning. This chapter first highlights the “strategy as action” perspective, followed by a comprehensive model. Then, attack, counterattack, and signal- ing are outlined, with one interesting extension on how local firms fight multinational enterprises (MNEs) in emerging economies. Debates and extensions follow.

Strategy as Action The heart of this chapter is the “strategy as action” perspective (Figure 8.1). It suggests that the essence of strategy is interaction, which is actions and reactions that lead to competitive advantage. Firms, like militaries, often compete aggressively. Note the military tone of terms such as “attacks,” “counterattacks,” and “price wars.”3 General Motors (GM) runs a war game among its top 60 executives. Six teams with 10 executives each play GM’s major rivals trying to crush GM.4

So, business is war—or is it? It is obvious that military principles cannot be completely applied, because the marketplace, after all, is not a battlefield whose motto is “Kill or be killed.”

the floodgates for the “troll business.” Although ethi- cally dubious, such a strategy is not only profitable but also perfectly legal.

Executives at “operating entities” (manufacturers), especially high-tech ones, are well advised to prepare for shark attacks. Beefing up patent law expertise is crucial. One joke in high-tech industries is that firms must spend most of their R&D budgets on patent lawyers. Devoting more resources to monitor patents is another obvious solution. However, this solution will not be perfect, because given the mushrooming volume of patents, patent monitoring costs have increased massively. The overall risk of simply neglect- ing prior art has risen. On the other hand, most of the troll patents are relatively marginal and can be invented

around. This further adds more incentive to have a number of alternative patents in a firm’s portfolio—just in case.

Sources: Based on (1) Bloomberg Businessweek, 2011, Android’s dominance is patent pending, August 8: 36–37; (2) BusinessWeek, 2006, The patent epidemic, January 9: 60–62; (3) Economist, 2005, Patent sense, October 22: 5; (4) Economist, 2010, The great patent battle, October 23: 75–76; (5) Economist, 2011, Inventive warfare, August 20: 57–58; (6) Economist, 2011, Patent applications, November 19: 105; (7) M. Reitzig, J. Hendel, & C. Heath, 2007, On sharks, trolls, and their patent prey, Research Policy, 36: 134–154; (8) R. Ziedonis, 2004, Don’t fence me in, Management Science, 50: 804–820.

(Continued)

OPENING CASE

competitive dynamics

Actions and responses undertaken by competing firms.

competitor analysis

The process of anticipating rivals’ actions in order to both revise a firm’s plan and prepare to deal with rivals’ responses.

224 PART 2 BUSINESS-LEVEL STRATEGIES

If fighting to the death destroys the “pie,” there will be nothing left. In business, it is possible to compete and win without killing the opposition. In a nutshell, business is simultaneously war and peace. Alternatively, most competitive dynamics concepts can also be explained in terms of sports analogies, such as “offense” and “defense.”

While militaries fight over territories, waters, and air spaces, firms compete in markets along product dimensions and geographic dimensions. Multimarket competition occurs when firms engage the same rivals in multiple markets.5 Because a multimarket compe- titor can respond to an attack not only in the attacked market but also in other markets in which both firms meet, its challenger has to think twice before launching an attack. In other words, while firms “act local,” they have to “think global.” Because firms recognize their rivals’ ability to retaliate in multiple markets, such multimarket competition may result in reduction of competitive intensity among rivals, an outcome known as mutual forbearance,6 which we will discuss in more detail next.

Overall, the strategy tripod sheds considerable light on competitive dynamics, leading to a comprehensive model (Figure 8.2). The next three sections discuss the three “legs” for the tripod.

Industry-based Considerations Collusion and Prisoners’ Dilemma Industry-based considerations focus on the very first of the Porter five forces, rivalry among competitors in an industry (see Chapter 2). Most firms in an industry, if given a choice, would probably prefer a reduced level of competition. “People of the same trade seldom meet together, even for merriment and diversion,” wrote Adam Smith in The Wealth of Nations (1776), “but their conversation often ends in a conspiracy against the public.” In modern jargon, this means that competing firms in an industry may have an incentive to engage in collusion, defined as collective attempts to reduce competition.

FIGURE 8.1 Strategy as Action

interaction Competitive

Response

Competitive advantage and performance

Action

Source: C. M. Grimm & K. G. Smith, 1997, Strategy as Action: Industry Rivalry and Coordination (p. 62), Cincinnati: South-Western Thomson (now Cengage Learning).

multimarket competition

Firms engage the same rivals in multiple markets.

mutual forbearance

Multimarket firms respect their rivals’ spheres of influence in certain markets and their rivals reciprocate, leading to tacit collusion.

collusion

Collective attempts between competing firms to reduce competition.

C h a p t e r 8 Ma n a g i n g G l o b a l C o m p e t i t i v e D y n a m i c s 225

Because managers (and students) generally do not like to discuss “collusion,” another “C” word, coordination, is now frequently used in preference over collusion.7 However, given the legal battles centered on collusion, managers (and students) cannot shy away from it; instead they need to confront the legal definitions and debates about collusion, which can be tacit or explicit. Firms engage in tacit collusion when they indirectly coordinate actions by signaling their intention to reduce output and maintain pricing above competitive levels. Explicit collusion exists when firms directly negotiate output and pricing and divide markets. Explicit collusion leads to a cartel—an output-fixing and price-fixing entity involving multiple competitors. A cartel is also known as a trust, whose members have to trust each other in honoring agreements. Since the Sherman Act of 1890, cartels have often been labeled “anticompetitive” and outlawed by antitrust laws in many countries.

In addition to antitrust laws, collusion often suffers from a prisoners’ dilemma, which underpins game theory. The term “prisoners’ dilemma” derives from a simple game in which two prisoners suspected of a major joint crime (such as burglary) are separately interrogated and told that if either one confesses, the confessor will get a one-year

FIGURE 8.2 A Comprehensive Model of Global Competitive Dynamics

Industry-based considerations

• Concentration • Industry price leader • Product homogeneity • Entry barriers • Market commonality with rivals

Resource-based considerations

• Valuable abilities to attack, deter, and retaliate • Rarity of certain assets • Imitability of competitive actions • Organizational skills for actions • Resource similarity with rivals

Institution-based considerations

• Domestic competition: Primarily competition/antitrust policy • International competition: Primarily trade/antidumping policy

Competitive dynamics

Attack/Counterattack/ Cooperation

tacit collusion

Firms indirectly coordinate actions to reduce competi- tion by signaling to others their intention to reduce output and maintain pri- cing above competitive levels.

explicit collusion

Firms directly negotiate output, fix pricing, and divide markets.

cartel

An entity that engages in output- and price-fixing, involving multiple competi- tors. Also known as a trust.

antitrust laws

Laws that attempt to curtail anticompetitive business practices such as cartels and trusts.

prisoners’ dilemma

In game theory, a type of game in which the outcome depends on two parties deciding whether to cooperate or to defect.

game theory

A theory that focuses on competitive and coopera- tive interaction (such as in a prisoners’ dilemma situation).

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226 PART 2 BUSINESS-LEVEL STRATEGIES

sentence while the other will go to jail for ten years. Since the police do not have strong incriminating evidence for the more serious burglary charges, if neither confesses, both will be convicted of a lesser charge (such as trespassing) and each jailed for two years. If both confess, both will go to jail for ten years. At a first glance, the solution to this problem seems clear enough. The maximum joint payoff would be for neither of them to confess. However, even if both parties agree not to confess before they are arrested, there are still tremendous incentives to confess.

Translated to an airline setting, Figure 8.3 illustrates the payoff structure for both airlines A and B in a given market—let’s say—between Sydney, Australia, and Auckland, New Zealand. Assuming a total of 200 passengers, Cell 1 represents the most ideal outcome for both airlines to maintain the price at $500; each gets 100 passengers and makes $50,000—the “industry” revenue reaches $100,000. In Cell 2, if B maintains its price at $500 while A drops it to $300, B is likely to lose all customers. Assuming perfectly transparent pricing information on the Internet, who would want to pay $500 when you can get a ticket for $300? Thus, A may make $60,000 on 200 passengers and B gets nobody. In Cell 3, the situation is reversed. In both Cells 2 and 3, although the industry decreases revenue by 40%, the price dropper increases its revenue by 20%. Thus, both A and B have strong incentives to reduce price and hope for the other side to become a “sucker.” However, neither likes to be a “sucker.” Thus, both A and B may want to chop prices, as in Cell 4, whereby each still gets 100 passengers. But both firms as well as the industry end up with a 40% reduction of revenue. A key insight of game theory is that even if A and B have a prior agreement to fix the price at $500, both still have strong incentives to cheat, thus pulling the industry to Cell 4 in which both are clearly worse off.8

FIGURE 8.3 A Prisoners’ Dilemma for Airlines and Payoff Structure (assuming a total of 200 passengers)

(Cell 1) A: $50,000 B: $50,000

Action 1 A keeps

price at $500

Action 1 B keeps

price at $500

Action 2 A drops

price to $300

Action 2 B drops

price to $300

(Cell 2) A: $60,000

B: 0

(Cell 4) A: $30,000 B: $30,000

Airline A

Airline B

(Cell 3) A: 0

B: $60,000

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C h a p t e r 8 Ma n a g i n g G l o b a l C o m p e t i t i v e D y n a m i c s 227

Industry Characteristics and Collusion vis-à-vis Competition Given the benefits of collusion and incentives to cheat, what industries are conducive for collusion vis-à-vis competition? Five factors emerge (Table 8.1). The first relevant factor is the number of firms or—more technically—the concentration ratio, defined as the percentage of total industry sales accounted for by the top four, eight, or 20 firms. In general, the higher the concentration, the easier it is to organize collusion. Because the top four concentration in mobile wireless telecommunications services in the United States accounted for more than 90% of market share, the antitrust authorities blocked the second largest firm AT&T’s merger with the fourth largest firm T-Mobile. Specifically, the US Department of Justice argued:

The substantial increase in concentration that would result from this merger, and the reduction in the number of nationwide providers from four to three, likely will lead to lessened competition due to an enhanced risk of anticompetitive coordination. Certain aspects of mobile wireless communications services markets, including transparent pricing, little buyer-side market power, and high barriers to entry and expansion, make them particularly conductive to coordination.9

Second, the existence of a price leader—a firm that has a dominant market share and sets “acceptable” prices and margins in the industry—helps maintain order and stability needed for tacit collusion. The price leader can signal to the entire industry, with its own pricing behavior, when it is appropriate to raise or reduce prices without jeopardizing the overall industry structure. The price leader also possesses the capacity to punish, defined as sufficient resources to deter and combat defection. To combat cheating, the most frequently used punishment entails undercutting the defector by flooding the market with deep discounts, thus making the defection fruitless. Such punishment is very costly because it will bring significant financial losses in the short run. However, if small-scale cheating is not dealt with, defection may become endemic. Thus, the price leader needs to have both the willingness and the capability to carry out punishments and bear the costs (see Emerging Markets 8.1). On the other hand, an industry without an acknowledged price leader is likely to be more chaotic. Prior to the 1980s, GM played the price leader role, announcing in advance the percentage of price increases and expecting Ford and Chrysler to follow (which they often did). Should the latter two have stepped “out of bounds,” GM would have punished them. However, more recently, when Asian and

TABLE 8.1 Industry Characteristics and Possibility of Collusion vis-à-vis Competition

COLLUSION POSSIBLE COLLUSION DIFFICULT (COMPETITION LIKELY)

& Few firms (high concentration) & Existence of an industry price leader & Homogeneous products & High entry barriers & High market commonality (mutual

forbearance)

& Many firms (low concentration) & No industry price leader & Heterogeneous products & Low entry barriers & Lack of market commonality (no mutual

forbearance)

concentration ratio

The percentage of total industry sales accounted for by the top four, eight, or 20 firms.

price leader

A firm that has a dominant market share and sets “acceptable” prices and margins in the industry.

capacity to punish

Having sufficient resources to deter and combat defection.

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E T H I C A L D I L E M M AEMERGING MARKETS 8.1

Is a Diamond (Cartel) Forever?

The longest-running cartel in the modern world is the international diamond cartel headed by De Beers of South Africa. The cartel system underpinning the $64 billion a year industry is, according to the Economist, “curious and anomalous—no other market exists, nor would anything similar be tolerated in a serious industry.”

A key reason diamonds were so expensive was because of the deeply ingrained perception of scarcity. If there was an oversupply, prices could plummet. Cecil Rhodes, an English tycoon who founded the De Beers Mines in South Africa in 1875, sought to solve this problem by focusing on two areas. First, Rhodes realized that supply from South Africa, the only significant producer in the world at that time, should be limited. Second, because producers (diggers) had little control over the quality and quantity of their output, they preferred to deal with an indiscriminate buyer willing to purchase both spectacular and mediocre stones. Since most output would be mediocre stones, producers preferred to remove any uncertainty and to be able to sell all of their output. On the other hand, buyers (merchants) preferred to secure a steady supply of stones (both high and low ends). Rhodes’s solution was to create an ongoing agreement between a single producer and a single buyer in which supply was kept low and prices high.

Putting his idea in action, Rhodes bought out all the major South African mines in the 1890s and formed a diamond merchants’ association in the country, called the Diamond Syndicate, to which he would sell his output. In such “single-channel marketing,” all members of the Syndicate pledged to buy diamonds from Rhodes and sell them in specific quantities and prices. With such an explicit scheme of quantity- and price-fixing, the diamond cartel was born.

Most cartels collapse due to organizational and incentive problems. The longevity of the De Beers cartel, now running for more than 100 years, is very unusual. At least three attributes contribute to its longevity. First, the industry has an extraordinarily high concentration. In

Rhodes’s day, De Beers controlled all of South African (and hence virtually worldwide) production. Today, De Beers still controls approximately 40% of the world’s rough diamond production, and its London-based wholly owned subsidiary Diamond Trading Company (DTC) sorts, values, and sells about 70% of the world’s rough diamonds by value.

Second, De Beers is the undisputed price leader. Ten times a year, sales of rough diamonds (called “sights”) are managed by the DTC to an exclusive group of cherry picked “sightholders” from cities such as Antwerp, Johannesburg, Mumbai, New York, and Tel Aviv. Sightholders inform the DTC of their preferences, and the DTC then matches them with inventory. During each sight, the DTC offers each sightholder a preselected parcel. The buyer either takes it or leaves it—no bargaining is permitted. Buyers usually take the parcel. If buyers repeatedly decline to take the parcel, they will not be invited again. This tactic allows De Beers to control, down to the carat, exactly what and how many stones enter the market and at what price. To maintain the exclusivity of the sightholders, their number has reduced from about 350 in the 1970s to less than 100 in the 2000s.

Third, De Beers possesses both the willingness and the capability to enforce cartel arrangements. As in all cartels, the incentives to cheat are tremendous: Both producers and buyers are interested in cutting De Beers out of the process. As a price leader with a significant capacity to punish, De Beers’s reactions are typically swift and powerful. In 1981, President Mobutu Seko of Zaire (now the Democratic Republic of Congo) announced that his country would break away from De Beers by directly marketing its diamonds. Although only 3% of De Beers’ sales were lost, its world order would be at stake if such actions went unpunished. Consequently, De Beers drew on its stockpiles to flood the market, driving the price of Zairian industrial diamonds from $3 per carat to $1.8 and wiping out any gains the Zairians hoped to grab. While incurring disproportional losses, De Beers made its point and Zaire crawled back on its knees.

C h a p t e r 8 Ma n a g i n g G l o b a l C o m p e t i t i v e D y n a m i c s 229

European challengers have refused to follow GM’s lead, GM has no longer been willing and able to play this role. Thus, the industry has become much more competitive and chaotic. From the Big Three, the US auto industry is now mostly populated by the Magnificent Seven (the other four are Toyota, Honda, Nissan, and Hyundai/Kia).10

Third, an industry with homogeneous products, in which rivals are forced to compete on price (rather than differentiation), is likely to lead to collusion.11 Because price competition is often “cut throat,” firms may have stronger incentives to collude. Since the 1990s, many firms in commodity industries around the globe, such as shipping and vitamins, have been convicted of price fixing.

Fourth, an industry with high entry barriers for new entrants (such as shipbuilding) is more likely to facilitate collusion than an industry with low entry barriers (such as restaurants). New entrants are likely to ignore the existing industry norms by introducing less homogeneous products with newer technologies (in other words, “disruptive technologies”).12 As “mavericks,” new entrants “can be thought of as loose cannons in otherwise placid and calm industries.”13

Incumbents have collective interest in resisting such new entrants.

In another example, many sightholders in Tel Aviv began to hoard diamonds purchased from the DTC in the 1970s, hoping to combat Israel’s rampant inflation. The disappearance of a substantial amount of diamonds from global circulation tightened supply, leading to skyrocketing prices and encouraging merchants elsewhere also to hoard and profit. While De Beers actually benefited from such higher prices in the short run, it realized that in the long run such an uncontrolled speculative bubble would burst. In response, De Beers purged one third of sightholders and kicked out the most aggressive Israeli speculators. Cut off from their supplies, speculative merchants were forced to draw down their stockpiles, thus restoring prices to normal levels.

Finally, De Beers faces one major institutional headache. The US government argued that De Beers was in clear violation of US antitrust laws and unsuccessfully tried to prosecute it in 1945, 1974, and 1994. De Beers managed to stay beyond the extraterritorial reach of US laws since it had no legal presence and no (direct) sales in the US. All its diamonds were sold in London, with sightholders then exporting them to the US, which is legal. However, with 50% of the retail diamond buyers in the US, these legal actions had prevented De Beers executives from being able to visit their buyers and retailers in the US in fear of being arrested. In 2008, De Beers settled the US charges for a total of $295 million and agreed to operate in accordance with competition laws around the world. A question thus looms large on the

horizon for De Beers executives and antitrust officials: Has the longest-running cartel really come to an end? This truly is a billion-dollar question.

Sources: Based on (1) Chicago Tribune, 2008, Diamond refunds are a consumer’s best friend, January 21, www. chicagotribune.com; (2) A. Cockburn, 2002, Diamonds: The real story, National Geographic, March: 2–35; (3) Economist, 2004, The cartel isn’t forever, July 17: 60–62; (4) Economist, 2011, Betting on De Beers, November 12: 73; (5) D. Spa, 1994, The Cooperative Edge: The Internal Politics of International Cartels, Ithaca, NY: Cornell University Press; (6) www.debeersgroup.com.

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Finally, market commonality, defined as the degree of overlap between two competi- tors’markets, also has a significant bearing on the intensity of rivalry.14 Multimarket firms may respect rivals’ spheres of influence in certain markets, and their rivals may recipro- cate, leading to tacit collusion. To make that happen, firms need to establish multimarket contact by following each other to enter new markets.15 Thus, when Carlsberg enters a new country, Heineken will not be far behind.

Mutual forbearance, due to a high degree of market commonality, primarily stems from two factors: (1) deterrence and (2) familiarity.16 Deterrence is important because a high degree of market commonality suggests that if a firm attacks in one market, its rivals may engage in cross-market retaliation, leading to a costly all-out war nobody can afford. Familiarity is the extent to which tacit collusion is enhanced by a firm’s awareness of the actions, intentions, and capabilities of rivals.17 Repeated interactions lead to such familiarity, resulting in more mutual respect. In the words of GE CEO Jeff Imelt:

GE has tremendous respect for traditional rivals like Siemens, Philips, and Rolls-Royce. But it knows how to compete with them; they will never destroy GE. By introducing products that create a new price-performance paradigm, however, the emerging giants [such as Mindry, Suzlon, Goldwind, and Haier] very well could.18

Overall, the industry-based view, underpinned by industrial organization (IO) economics (see Chapter 2), has generated a voluminous body of insights on competitive dynamics. IO economics has been influential in antitrust policy. For example, concen- tration ratios used to be mechanically applied by US antitrust authorities. For many years (until 1982), if an industry’s top-four firm concentration ratio exceeded 20%, it would automatically trigger an antitrust investigation. However, since the 1980s, such a mechanical approach has been abandoned, in part because “cartels have formed in markets that bear few of the suggested structural criteria and have floundered in some of the supposedly ideal markets.”19 Evidently, industry-based considerations, while certainly insightful, are unable to tell the complete story, thus calling for contribu- tions from resource-based and institution-based views, as outlined in the next two sections.

Resource-based Considerations A number of resource-based imperatives, informed by the VRIO framework first out- lined in Chapter 4, drive decisions and actions associated with competitive dynamics (see Figure 8.2).

Value Firm resources must create value when engaging rivals.20 One way to add value is patenting. Firms are rapidly expanding their scale and scope of patenting (see the Open- ing Case). Also, the ability to attack in multiple markets—of the sort Gillette (now part of P&G) possessed when launching its Sensor razors in 23 countries simultaneously—throws rivals off balance, thus adding value. Likewise, the ability to rapidly respond to challenges also adds value.21 Another example is a dominant position in key markets (such as flights

market commonality

The degree to which two competitors’ markets overlap.

cross-market retaliation

Retaliation in other mar- kets when one market is attacked by rivals.

C h a p t e r 8 Ma n a g i n g G l o b a l C o m p e t i t i v e D y n a m i c s 231

in and out of Dallas/Fort Worth for American Airlines). Such a strong sphere of influence poses credible threats to rivals, which understand that the firm will defend its core markets vigorously.

Rarity Either by nature or nurture (or both), certain assets are very rare, thus generating significant advantage. Singapore Airlines, in addition to claiming one of the best locations connecting Europe and Asia as its home base, has often been rated as the world’s best airline. This combination of both geographic advantage and man-made reputation advantage is rare, thus allowing Singapore Airlines to always charge higher prices and equip itself with newer and better equipment. It is the first airline in the world to fly the all-new A380.

Imitability Most rivals watch each other and probably have a fairly comprehensive (although not necessarily accurate) picture of how their rivals compete. However, the next hurdle lies in how to imitate successful rivals. Slow-moving firms often find it difficult to do so. Many major airlines have sought to imitate discount carriers such as Southwest and Ryanair but have failed repeatedly.

Organization Some firms are better organized for competitive actions, such as stealth attacks and answering challenges “tit-for-tat.”22 An intense “warrior-like” culture not only requires top management commitment, but also employee involvement down to the “soldiers in the trenches.” It is such a self-styled “wolf” culture that has propelled Huawei to become Cisco’s leading challenger. It is difficult for slow-moving firms to suddenly wake up and become more aggressive.23

On the other hand, more centrally coordinated firms may be better mutual for- bearers than firms whose units are loosely controlled. For an MNE competing with rivals across many countries, a mutual forbearance strategy requires some units, out of respect for rivals’ sphere of influence, to sacrifice their maximum market gains by withholding some efforts. Of course, such coordination helps other units with domi- nant market positions to maximize performance, thus helping the MNE as a whole. Successfully carrying out such mutual forbearance calls for organizational reward systems (such as those concerning bonuses and promotions) that encourage coopera- tion between units. Conversely, if a firm has competitive reward systems (for example, bonuses linked to unit performance), unit managers may be unwilling to give up market gains for the greater benefits of the whole firm, thus undermining mutual forbearance.24

Resource Similarity Resource similarity is defined as “the extent to which a given competitor possesses strategic endowment comparable, in terms of both type and amount, to those of the focal firm.”25 Firms with a high degree of resource similarity are likely to have similar competitive actions. For instance, Apple and IBM used to have a lot of resource similarity

resource similarity

The extent to which a given competitor possesses strategic endowments comparable to those of the focal firm.

232 PART 2 BUSINESS-LEVEL STRATEGIES

in the 1990s, so they fought a lot. Why did they not fight a lot recently? One reason is that their level of resource similarity decreased.

If we put together resource similarity and market commonality (discussed earlier), we can yield a framework of competitor analysis for any pair of rivals (Figure 8.4). In Cell 4, because two firms have a high degree of resource similarity but a low degree of market commonality (little mutual forbearance), the intensity of rivalry is likely to be the highest. Conversely, in Cell 1, since both firms have little resource similarity but a high degree of market commonality, the intensity of their rivalry may be the lowest. Cells 2 and 3 present an intermediate level of competition.

For example, the high-flying Starbucks and the down-to-earth McDonald’s used to have little resource similarity. Both had high market commonality—in the United States, both blanketed the country with chain stores. In other words, they were in Cell 1 with the lowest intensity of rivalry. However, recently, McDonald’s aspired to go “up market” and offered products such as iced coffee designed to eat some of Starbucks’ lunch (or drink some of Starbuck’s coffee). Due to profit pressures, Starbucks seemed to go “down market” by offering cheaper drinks and instant coffee. We can say that their resource similarity has increased. Given that they still maintain high market commonality, their rivalry has migrated to Cell 2, whose intensity of rivalry is higher than that in Cell 1. To further illustrate, Strategy in Action 8.1 describes how Fox’s entry into the US broad- casting industry intensified the rivalry. Overall, conscientious mapping along the dimen- sions outlined in Figure 8.4 can help managers sharpen their analytical focus, allocate resources in proportion to the degree of threat each rival presents, and avoid nasty surprises.

FIGURE 8.4 A Framework for Competitor Analysis between a Pair of Rivals

(Cell 1) Intensity of rivalry

Lowest Second lowest

Second highest Highest

Low

High

Low

(Cell 2) Intensity of rivalry

(Cell 4) Intensity of rivalry

Resource Similarity

(Cell 3) Intensity of rivalry

Market Commonality

Sources: Adapted from (1) M. Chen, 1996, Competitor analysis and interfirm rivalry: Toward a theoretical integration (p. 108), Academy of Management Review, 21: 100–134; (2) J. Gimeno & C. Y. Woo, 1996, Hypercompetition in a multimarket environment: The role of strategic similarity and multimarket contact in competitive de-escalation (p. 338), Organization Science, 7: 322–341.

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STRATEGY IN ACTION 8.1

A Fox in the Hen House

Prior to 1996, the US TV broadcasting industry could be viewed as a relatively tranquil “hen house.” The Big Three networks (ABC, NBC, and CBS) dominated mainstream programming and CNN ran its 24-hour news show. Like hens sharing a house, there was some rivalry. But there were well-understood rules of engagement, such as not raiding each other’s affiliate stations. Overall, competition was gentlemanly.

However, the 1996 arrival of Fox News Channel, a subsidiary of Rupert Murdoch’s News Corporation, has transformed the industry. First, Fox violated industry norms by raiding Big Three affiliate stations. Fox convinced some affiliates to switch and become Fox stations. In some markets, affiliate defections gave Fox overnight success at the expense of one of the Big Three. Second, Fox paid up to $11 per subscriber to cable operators. This violated another norm where cable operators only paid stations carriage fees for programming. Having outfoxed the Big Three, Fox turned its guns to CNN. When it bought CNN, Time Warner was required by an antitrust consent to carry a second news channel in addition to CNN. Time Warner chose MSNBC instead of Fox; Fox sued Time Warner. The media war became dirty: CNN owner Ted Turner publicly compared Murdoch to Hitler while Murdoch’s New York Post questioned Turner’s sanity. Perhaps controversy was exactly what Fox wanted. Critics repeatedly accused Fox of promoting a conservative (allegedly Republican) point of view. Viewers did not care. By 2006, Fox was the most watched news channel in the United States, reaching 96% of US households.

Using Figure 8.4, we can suggest that the pre-1996 industry was in Cell 2. The intensity of rivalry was the second lowest because the Big Three and CNN had high market commonality (all focusing on the US) and high resource similarity (TV programming). However, Fox’s entry has transformed the game. News Corporation is a global player that was historically headquartered in

Australia but is now headquartered and listed in New York. In addition to its Australian roots, News Corporation has a major presence in Asia, Canada, and Europe. Its first US acquisition took place in 1973, and Murdoch became an American citizen in 1985 to satisfy a requirement that only US citizens could own American TV stations. In other words, while Fox shares high resource similarity with the Big Three and CNN, it has low market similarity with the Big Three because they have little non-US presence. The upshot? The industry is now in Cell 4 with the highest intensity of rivalry. Fox can beat up the Big Three because it has little fear of retaliation against its non-US markets. The Big Three thus pay a heavy price for their US-centric mentality. Being more international, CNN is in a better position to fight Fox. In 1997, Turner and Murdoch settled, with Time Warner agreeing to carry Fox and News Corporation giving Time Warner access to News Corporation’s satellites in Asia and Europe. In other words, they have established some mutual forbearance.

Sources: Based on (1) BusinessWeek, August 21/28, 2006: 82; (2) www.newscorp.com.

M ap

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234 PART 2 BUSINESS-LEVEL STRATEGIES

Fighting Low-Cost Rivals A leading challenge for incumbents is how to deal with low-cost rivals.26 By the 1990s, Dell, Southwest Airlines, and Wal-Mart showed their low-cost teeth. Now, low-cost rivals pop up around the world, such as Israel’s Teva in generic drugs, China’s Huawei and ZTE in telecom equipment, and Taiwan’s HTC in smartphones (see the Closing Case). For incumbents, ignoring them will be dangerous, but do incumbents have the necessary capabilities to fight low-cost rivals?

Figure 8.5 suggests a framework for responding to low-cost rivals. It shows that incumbents need to resist the urge to initiate price wars in an effort to drive out low- cost rivals. From an institution-based view, predatory pricing may be illegal in many countries (see next section). From a resource-based view, in a race to the bottom, incumbents usually lose, because low-cost rivals have much better capabilities in the

FIGURE 8.5 How to Fight a Low-Cost Rival

Will this low-cost rival take away any of my present or future

customers?

Are sufficient numbers of

consumers willing to pay more for the benefits I offer?

If I set up a low- cost business, will it generate synergies with my existing

business?

Learn to live with a smaller company. If possible, merge

with or take over rivals.

Switch to selling solutions or

transform your company into

a low-cost player.

Watch, but don’t take on the new rival.

Intensify differentiation by offering more benefits. Over time, restructure your company to reduce the

price of the benefits you offer.

Attack your low-cost rival by setting up a low-cost business.

Don’t launch a price war. Increase the differentiation of your products by using a combination of tactics.

YESYES

YES

NO NO

Source: Adapted from N. Kumar, 2006, Strategies to fight low-cost rivals, Harvard Business Review (p. 107), December: 104–112.

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low-cost game. K-Mart not only failed to beat Wal-Mart on price, but also dragged itself into bankruptcy. Similarly, American Airlines dueled its cross-town rival Southwest (both are headquartered in the Dallas/Forth Worth area, but in different airports). In the end, Southwest soared but American crash-landed into bankruptcy. One piece of advice for incumbents is to enhance differentiation and convince customers to pay for such benefits (see Chapter 2). Apple designs cool gadgets. Target charges a small premium above Wal- Mart prices, as opposed to trying to beat Wal-Mart prices.

However, when differentiation fails and incumbents are forced to go down market, they need to take a hard look at the O aspect from a VRIO standpoint: Do they have the necessary organizational capabilities to compete against low-cost rivals? Incumbents tend to have the delusion that based on their experience, they can easily replicate low-cost opera- tions. In the 1990s, most major airlines launched no-frills operations, such as BA’s Go, Continental Lite, Delta Express, KLM’s Buzz, SAS’s Snowflake, and United’s Shuttle. Since then, all of them have failed, indicating both a lack of organizational capabilities and a lack of ability to learn “new tricks.” In the Great Recession, Coach launched a “fighter brand” Poppy with lower prices for handbags and accessories while maintaining the high prices of its Coach line. Does Coach have what it takes to make Poppy bloom? Stay tuned.

Eventually, while incumbents may (hopefully) transform themselves to become suc- cessful low-cost players, they may also switch to selling solutions. For example, IBM switched from selling hardware, whose markets are eroded by low-cost rivals, to selling high-end solutions. The leading piano maker Steinway now focuses on the “experience” and sells a large number of pianos made by its low-cost rival, Pearl River from China, which has formidable manufacturing firepower but limited branding capabilities.

Institution-based Considerations In a nutshell, the institution-based view advises managers to be well versed in the “rules of the game” governing domestic and international competition. Surprisingly, existing strat- egy textbooks often have relatively little (or sometimes no) coverage on the institutions governing competitive dynamics. This is unfortunate because a lack of understanding of these institutions may land otherwise successful firms (such as Microsoft) in deep trouble. In a nutshell, the institution-based view argues that free markets are not necessarily free. This section shows why this is the case.

Formal Institutions Governing Domestic Competition:

A Focus on Antitrust Formal institutions governing domestic competition are broadly guided by competition policy, which “determines the institutional mix of competition and cooperation that gives rise to the market system.”27 Of particular relevance to us is one branch called antitrust policy, which is designed to combat monopolies and cartels. Competition and antitrust policy seeks to balance efficiency and fairness. While efficiency is relatively easy to understand, it is often hard to agree on what is fair. In the United States, fairness means equal opportunities for incumbents and new entrants. It is “unfair” for incumbents to fix prices and raise entry barriers to shut out new entrants. However, in Japan, fairness means the opposite—that is, incumbents that have

competition policy

Policy governing the rules of the game in competition, which determine the institutional mix of competition and cooperation that gives rise to the market system.

antitrust policy

Competition policy designed to combat mono- polies, cartels, and trusts.

236 PART 2 BUSINESS-LEVEL STRATEGIES

invested in and nurtured an industry for a long time deserve to be protected from new entrants. What Americans approvingly describe as “market dynamism” is negatively labeled by Japanese as “market turbulence.” The Japanese ideal is “orderly competition,” which may be labeled “collusion” by Americans. Overall, the American antitrust policy is pro-competition and pro-consumer, while the Japanese approach is pro-incumbent and pro-producer. It is difficult to argue who is right or wrong here, but we need to be aware of such crucial differences.

As examples, Table 8.2 outlines the three major US antitrust laws and five landmark cases. Competition and antitrust policy focuses on (1) collusive price setting and (2) predatory pricing. Collusive price setting refers to price setting by monopolists or collu- sion parties at a level higher than the competitive level. For example, the global vitamin cartel convicted in the 2000s artificially jacked up prices by 30% to 40%.

TABLE 8.2 Major Antitrust Laws and Landmark Cases in the United States

MAJOR ANTITRUST LAWS LANDMARK CASES

Sherman Act of 1890 & It is illegal to monopolize or attempt to

monopolize an industry. & “Every person who shall monopolize, or

attempt to monopolize, or combine or conspire with any person or persons, to monopolize any part of the trade or commerce among the several states, or with foreign nations, shall be deemed guilty of a misdemeanor.”

& Explicit collusion is clearly illegal. & Tacit collusion is in a gray area, although

the spirit of the law is against it.

Clayton Act of 1914 & Created the Federal Trade Commission

(FTC) to regulate the behavior of business firms

& Empowered the FTC to prevent firms from engaging in harmful business practices

Hart-Scott-Rodino (HSR) Act of 1976 & Empowered the Department of Justice (DOJ)

to require firms to submit internal documents.

& Empowered state attorneys general (AGs) to initiate triple-damage suits.

Standard Oil (1911) & Had a US market share exceeding 85%. & Found guilty of monopolization. & Dissolved into several smaller firms.

Aluminum Company of America (ALCOA) (1945) & Had 90% of the US aluminum ingot market. & Found guilty of monopolization. & Ordered to subsidize rivals’ entry and sold plants.

IBM (1969–1982) & Had 70% US computer market share. & Sued by DOJ for monopolization. & Case dropped by the Reagan Administration.

AT&T (1974–1982) & A legal “natural monopoly” since the 1900s. & Still sued by DOJ for monopolization, in particular

its efforts to block new entrants. & Ordered to break up.

Microsoft (1990–2001) & MS-DOS and Windows had an 85%

market share. & Sued by DOJ, FTC, and 22 state AGs for

monopolization and illegal product bundling. & Settled in 1994, ordered to split into two in 2000,

judgment to split the firm reversed on appeal in 2001.

collusive price setting

Monopolists or collusion parties setting prices at a level higher than the com- petitive level.

ga ge

Le ar ni ng

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Another area of concern is predatory pricing, which is defined as (1) setting prices below cost and (2) intending to raise prices after eliminating rivals to cover its losses in the long run (“an attempt to monopolize”). This is an area of significant contention. First, it is not clear what exactly constitutes “cost.” Second, even when firms are found to be selling below cost, US courts have ruled that if rivals are too numerous to eliminate, one firm cannot recoup the losses incurred by charging low prices by later jacking up prices, so its pricing cannot be labeled “predatory.” This seems to be the case in most industries. These two legal tests have made it extremely difficult to win a (domestic) predation case in the United States.28

A third area of concern is extraterritoriality, namely, the reach of one country’s laws to other countries. US courts have taken it upon themselves to unilaterally punish non-US cartels (some of which may be legal elsewhere). One example is the diamond cartel led by De Beers (see Emerging Markets 8.1). Recently, the EU evidently has taken a page from the US antitrust playbook. It threatened to veto the merger between Boeing and McDonnell Douglas, successfully torpedoed the proposed merger between GE and Honeywell, and heavily fined Microsoft and Intel (Emerging Markets 8.2). Without a doubt, in the age of globalization, extraterritorial applications of domestic competition/antitrust laws create tension among governments and firms.29

Since the Reagan era, US antitrust enforcement has generally become more permissive. It is not an accident that strategic alliances among competitors have proliferated since the 1980s (see Chapter 7). However, despite improved clarity and permissiveness, the legal standards are still ambiguous. For example, in 1996, Boeing was allowed to acquire McDonnell Douglass, creating a real monopoly in commercial aircraft (at least domestically). However, in 2011, AT&T was not allowed to take over T-Mobile, even though the combined nation- wide market share of the two firms would barely exceed 40%. Given such fluctuating and inconsistent application of antitrust laws within one country, it is easy to understand the unpredictability and the frustration associated with the international application of antitrust laws in different countries. In the absence of international harmonization of antitrust policy, it is crucial that firms be aware of these ambiguities when planning their actions, especially when operating under the jurisdiction of multiple governments (see Emerging Markets 8.2).

Formal Institutions Governing International Competition:

A Focus on Antidumping In the same spirit of predatory pricing, dumping is defined as (1) an exporter selling below cost abroad and (2) planning to raise prices after eliminating local rivals. While domestic predation is usually labeled “anticompetitive,” cross-border dumping is often emotionally accused of being “unfair.”

Consider the following two scenarios. First, a steel producer in Indiana enters a new market in Texas, where it offers prices lower than those in Indiana, resulting in a 10% market share in Texas. Texas firms have two choices. The first one is to initiate a lawsuit against the Indiana firm for “predatory pricing.” However, it is difficult to prove (1) that the Indiana firm is selling below cost and (2) that its pricing is an “attempt to monopolize.” Under US antitrust laws, a predation case like this will have no chance of succeeding. In other words, domestic competition/antitrust laws offer no hope for protection. Thus, Texas firms are most likely to opt for their second option—to retaliate in kind by offering lower prices to customers in Indiana, benefitting consumers in both Texas and Indiana.

predatory pricing

(1) Setting prices below costs in the short run to destroy rivals and (2) intending to raise prices to cover losses in the long run after eliminating rivals.

extraterritoriality

The reach of one country’s laws to other countries.

dumping

An exporter selling below cost abroad and planning to raise prices after eliminating local rivals.

238 PART 2 BUSINESS-LEVEL STRATEGIES

E T H I C A L D I L E M M AEMERGING MARKETS 8.2

From Trade Wars to Antitrust Wars

In the 21st century, trade wars are often threatened but seldom fought. However, a new style of trade wars centered on protectionism is on the rise. These new trade wars are increasingly known as antitrust wars, because antitrust policy, which historically focuses on domestic competition, has been used to score international points.

In 2001, the EU antitrust authorities vetoed the proposed merger of two US-based firms, GE and Honeywell. In 2009, the EU fined Intel a record $1.45 billion for alleged anticompetitive conduct against its smaller US-based rival, AMD. In 2004, the EU fined Microsoft $660 million for bundling its own Media Player with Windows and thus excluding market access for RealNetworks, a US-based rival. In 2009, the EU prosecuted Microsoft for tying Windows with its own web browser, Internet Explorer, and stifling competition from other browsers— exactly the same alleged crime pursued by US authorities a decade ago. The only viable US competitor from the earlier US case against Microsoft, Netscape, had essentially vanished by 2009, accounting for less than 1% of browser usage. This time, the EU case against Microsoft was triggered by a complaint from Opera Software, an Oslo, Norway-based browser maker. In comparison with Explorer’s 86% global browser market share in 1999, the 2009 case came at a time when Microsoft’s dominance in browsers was weakened. In 2009, Explorer only had 68% of the global market, and its nearest competitor, Firefox (developed by US-based Mozilla), enjoyed 20%. In Europe, Microsoft was even weaker, with Explorer accounting for only 60% of the market, followed by Opera’s 5% and Firefox’s 3%. Overall, the EU antitrust authorities appear to more vigorously pursue leading US firms, suggesting a potential protectionist undertone.

Not to be outdone, the fledgling Chinese antitrust authorities entered the foray by starting to enforce China’s new Antimonopoly Law in 2008. Mergers of

firms not headquartered in China, as long as their combined China turnover reached $120 million in the previous year, had to be cleared by Chinese authorities. For example, the merger between Belgium-based InBev and US-based Anheuser-Busch was approved by the Chinese authorities, subject to some conditions. What was controversial was the very first decision to stop an acquisition announced in 2009: the proposed acquisition of China’s leading fruit juice maker Huiyuan by Coca-Cola. At $2.4 billion, the price was 50 times Huiyuan’s expected earnings in 2008 and a 200% premium to Huiyuan’s share price. Huiyuan’s delighted owners agreed to sell. The only party blocking the transaction was the Chinese Ministry of Commerce. The Ministry cited the adverse impact on small and medium-sized domestic juice makers as a major reason—in other words, protectionism. Beyond the antitrust merit of this individual case, there is a possibility that the Chinese authorities used it to signal displeasure to the United States, which recently disallowed high-profile Chinese acquisitions in the United States. Such signals may be mixed. In 2011, Yum! Brands’ acquisition of an iconic national chain restaurant, Little Sheep Hot Pot, did receive approval from the Chinese antitrust authorities. Yum! Brands thus could add Little Sheep to its successful restaurants such as Kentucky Fried Chicken (KFC) and Pizza Hut in China.

Sources: Based on (1) M. Bachrack, 2009, Merger control under China’s Antimonopoly Law, China Business Review, July: 18–21; (2) J. Clougherty, 2005, Antitrust holdup source, cross-national institutional variation, and corporate political strategy implications for domestic mergers in a global context, Strategic Management Journal, 26: 769–790; (3) Wall Street Journal, 2009, EU hits Microsoft with new antitrust charges, January 17; (4) Wall Street Journal, 2011, Yum’s proposed Little Sheep takeover approved, November 8, online.wsj.com.

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Now in the second scenario, the “invading” firm is not from Indiana but India. Holding everything else constant, Texas firms can argue that the Indian firm is dumping. Under US antidumping laws, Texas producers “would almost certainly obtain legal relief on the very same facts that would not support an antitrust claim, let alone antitrust relief.”30 Note that imposing antidumping duties on Indian imports reduces the incentive for Texas firms to counter attack by entering India, resulting in higher prices in both Texas and India, where consumers are hurt. These two hypothetical scenarios are highly realistic. An OECD study in Australia, Canada, the EU, and the US reports that 90% of the practices found to be unfairly dumping in these countries would never have been questioned under their own antitrust laws if used between domestic firms.31 In a nutshell, foreign firms are discriminated against by the formal rules of the game.

Discrimination is also evident in the actual antidumping investigation. A case is usually filed by a domestic firm with the relevant government authorities. In the United States, the authorities are the International Trade Administration (a unit of the Depart- ment of Commerce) and International Trade Commission (an independent government agency). These government agencies then send lengthy questionnaires to the foreign firms accused of dumping and request comprehensive, proprietary data on their cost and pricing, in English, using US generally accepted accounting principles (GAAP), within 30–45 days. Many foreign defendants fail to provide such data on time because they are not familiar with US GAAP. The investigation can have one of the four following outcomes:

• If no data are forthcoming from abroad, the estimated data provided by the accusing firm become the evidence, and the accusing firm can easily win.

• If foreign firms do provide data, the accusing firm can still argue that these unfair foreigners have lied—“There is no way their costs can be so low!” In the case of Louisiana versus Chinese crawfish suppliers, the authenticity of the $9 per week salary made by Chinese workers was a major point of contention.

• Even if the low cost data are verified, US (and EU) antidumping laws allow the complainant to argue that these data are not “fair.” In the case of China, the argument goes, its cost data reflect huge distortions due to government intervention because China is still a “nonmarket” economy. Wages may be low, but workers may also be provided with low-cost housing and government-subsidized benefits. Thus the crawfish case boiled down to how much it would cost hypothetically to raise crawfish in a market economy. In this particular case, Spain was mysteriously chosen. Because Spanish costs were about the same as Louisiana costs, despite vehement objections, the Chinese were found guilty of dumping in America by selling below Spanish costs. Thus, 110% to 123% import duties were levied on Chinese crawfish.

• The fourth possible outcome is that the defendant wins the case. But this is rare and happens in only 5% of the antidumping cases in the United States.

One study found that simply filing an antidumping petition (regardless of the out- come) may result in a nontrivial 1% increase in the stock price for US listed firms

antidumping laws

Laws that punish foreign companies that engage in dumping in a domestic market.

240 PART 2 BUSINESS-LEVEL STRATEGIES

(an average of $46 million increase in market value).32 Evidently, Wall Street knows that Uncle Sam favors US firms. Globally, this means that governments usually protect their domestic firms in antidumping investigations. Not surprisingly, antidumping cases have proliferated throughout the world. It is ironic that the rising tide of globalization in the past two decades has been accompanied by the rising proliferation of antidumping cases, which are allowed by the World Trade Organization (WTO). The institution-based message to firms defending home markets is clear: Get to know your country’s antidumping laws. The institution-based message to firms interested in doing business abroad is also clear: Your degree of freedom in overseas pricing is significantly less than that in domestic pricing. In summary, let’s drop the “F” word (free) in “free market” competition.

Overall, institutional conditions such as the availability of antidumping protection are not just the “background.” They directly determine what weapons a firm has in its arsenal to wage competitive battles. Next, we outline two main action items.

Attack and Counterattack In the form of price cuts, advertising campaigns, market entries, and new product introductions, an attack is defined as an initial set of actions to gain a competitive advantage, and a counterattack is a set of actions in response to an attack (see Figure 8.6). This section focuses on: (1) What are the main kinds of attacks? (2) What kinds of attacks are more likely to be successful?

Three Main Types of Attack The three main types of attack are (1) thrust, (2) feint, and (3) gambit.33 Shown in Figure 8.7, thrust is the classic frontal attack with brute forces. A case in point is the smartphone war. In 2008, HTC launched the world’s first smartphone powered by Google’s Android operating system. Such a thrust made HTC in 2011 become the largest smartphone vendor in the United States with a 25% market share, ahead of Apple iPhone’s 20% and Blackberry’s 9% (see the Closing Case).

A feint, in basketball, is one player’s effort to fool his/her defender, pretending he/ she would go one way but instead charging ahead another way. Shown in Figure 8.8, in competitive dynamics, a feint is a firm’s attack on a focal arena important to a competitor but one that is not the attacker’s true target area.34 The feint is followed by the attacker’s commitment of resources to its actual target area. Consider the “Marlboro war” between Philip Morris and R. J. Reynolds (RJR). In the early 1990s, both firms’ traditional focal market, the United States, experienced a 15% decline over the previous decade. Both were interested in Central and Eastern Europe (CEE), which grew rapidly. Philip Morris executed a feint in the United States by dropping 20% off the price on its flagship brand, Marlboro, on one day (April 2, 1993, which became known as the “Marlboro Friday”). Confronting this ferocious move, RJR diverted substantial resources earmarked for CEE to defend its US market. Philip Morris thus rapidly established its dominance in CEE.

attack

An initial set of actions to gain competitive advantage.

counterattack

A set of actions in response to attacks.

thrust

The classic frontal attack with brute force.

feint

A firm’s attack on a focal arena important to a competitor, but not the attacker’s true target area.

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A gambit, in chess, is a move that sacrifices a low-value piece in order to capture a high-value piece. The competitive equivalent is to withdraw from a low-value market to attract rivals to divert resources into it in order to capture a high-value market (Figure 8.9). For example, Gillette and Bic competed in both razors and lighters. Gillette was stronger in razors and Bic was stronger in lighters. Gillette withdrew entirely from lighters and devoted its attention to razors. Bic accepted the gambit and diverted razor resources to lighters. The gambit can be regarded as an exchange of the spheres of influence between Gillette and Bic, each with a stronger position in one market.

Awareness, Motivation, and Capability Obviously, unopposed attacks are more likely to be successful. Thus, attackers need to understand the three drivers for counterattacks: (1) awareness, (2) motivation, and (3) capabilities.35

FIGURE 8.6 It’s War!

Source: Bloomberg Businessweek, 2011, Year in review (p. 65), December 23.

gambit

A firm’s withdrawal from a low-value market to attract rival firms to divert resources into the low- value market so that the original withdrawing firm can capture a high-value market.

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FIGURE 8.7 Thrust

Target X

B engaged in A’s target market X

A massively attacks target market X

First round

Target X

B withdraws from target X

A’s sphere of influence in target X is enhanced

Second round

Source: Adapted from R. G. McGrath, M. Chen, & I. C. MacMillan, 1998, Multimarket maneuvering in uncertain spheres of influence: Resource diversion strategies (p. 729), Academy of Management Review, 23: 724–740.

FIGURE 8.8 Feint

Focal Y

A attacks focal market Y salient to B

Target X

B engaged in A’s target market X

First round Second round

A’s sphere of influence in target X is enhanced

Focal Y

Target X

B redeploys from target X to defend focal market Y

Source: Adapted from R. G. McGrath, M. Chen, & I. C. MacMillan, 1998, Multimarket maneuvering in uncertain spheres of influence: Resource diversion strategies (p. 731), Academy of Management Review, 23: 724–740.

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• If an attack is so subtle that rivals are not aware of it, the attacker’s objectives are likely to be attained. One interesting idea is the “blue ocean strategy” that avoids attacking core markets defended by rivals.36 A thrust on rivals’ core markets is very likely to result in a bloody price war—in other words, a “red ocean.” In the 1990s, Netscape drew tremendous publicity by labeling Microsoft the “Death Star” (of the movie Star Wars fame) and predicting that the Internet would make Windows obsolete. Such a challenge helped make Netscape Microsoft’s number-one enemy, leading to the demise of Netscape (or its drowning in the “red ocean”).

• Motivation is also crucial. If the attacked market is of marginal value, managers may decide not to counterattack. Consider how China’s Haier entered the US white goods market. Although Haier dominates its home country with a broad range of products, it chose to enter the US market in a most non-threatening segment: mini-bars (compact refrigerators) for hotels and dorms. Does anyone remember the brand of the mini-bar in the last hotel room where you stayed? Evidently, not only did you fail to pay attention to that brand, but incumbents such as GE and Whirlpool also dismissed this segment as peripheral and low margin. In other words, they were not motivated to counterattack. Thanks in part to the incumbents’ lack of motivation to counterattack, Haier now commands a 50% US market share in compact refrigerators and has built a factory in South Carolina to go after more lucrative product lines.

• Even if an attack is identified and a firm is motivated to respond, it requires strong capabilities to carry out counterattacks—as discussed in our earlier section on resources.

FIGURE 8.9 Gambit

Focal Y

A withdraws from focal market Y salient to B

Target X

B engaged in A’s target market X

First round Second round

A’s sphere of influence in target X is enhanced

Focal Y

Target X

B redeploys from target market X to enhance sphere of influence

in focal market Y

Source: Adapted from R. G. McGrath, M. Chen, & I. C. MacMillan, 1998, Multimarket maneuvering in uncertain spheres of influence: Resource diversion strategies (p. 733), Academy of Management Review, 23: 724–740.

blue ocean strategy

A strategy that focuses on developing new markets (or “blue ocean”) and avoids attacking core markets defended by rivals, which is likely to result in a bloody price war (or “red ocean”).

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Cooperation and Signaling Some firms choose to compete, and others choose to cooperate. How do firms signal their intention to cooperate in order to reduce competitive intensity? Short of illegally talking directly to rivals, firms have to resort to signaling—that is, “While you can’t talk to your competitors on pricing, you can always wink at them.” We outline four means of such winking:

• Firms may enter new markets, not necessarily to challenge incumbents but to seek mutual forbearance by establishing multimarket contact. Thus, MNEs often chase each other, entering one country after another. Airlines that meet in many routes are often less aggressive than airlines that meet in one or a few routes.

• Firms can send an open signal for a truce. As GM faced grave financial difficulties in 2005, Toyota’s chairman told the media twice that Toyota would “help GM” by raising Toyota prices in the United States. Toyota’s signal could not have been more unambiguous, short of talking directly to GM, which would have been illegal.

• Sometimes firms can send a signal to rivals by enlisting the help of governments. Although it is illegal to hold direct negotiations with rivals on what constitutes “fair” pricing, holding such discussions is legal under the auspices of government investigations. Thus, filing an antidumping petition or suing a rival does not necessarily indicate a totally hostile intent but rather a signal to talk. When Cisco sued Huawei, they were able to legally discuss a number of strategic issues during settlement negotiations, which were mediated by US and Chinese governments. In the end, Cisco dropped its case against Huawei after both firms negotiated a settlement.

• Firms can organize strategic alliances with rivals for cost reduction. Although price fixing is illegal, reducing cost by 10% through an alliance, which is legal, has the same impact on the financial bottom line as collusively raising price by 10%.

Overall, because of the sensitive nature of interfirm cooperation designed to reduce competition, we do not know a lot about it. However, to the extent that business is both war and peace, strategists need to pay as much attention to making peace with rivals as fighting wars against them.

Local Firms versus Multinational Enterprises While managers, students, and journalists are often fascinated by MNE rivalries such as between Coca-Cola and Pepsi, GM and Toyota, and SAP and Oracle, much less is known about how local firms cope with MNE attacks. Given the broad choices of competing and/ or cooperating, local firms can adopt one of four strategic postures, depending on (1) the industry conditions and (2) the nature of competitive assets. Shown in Figure 8.10, these factors suggest four strategic actions.37

Cell 3 shows how in some industries, the pressures to globalize are relatively low and local firms’ strengths lie in a deep understanding of local markets. In this case, local assets where MNEs are weak are leveraged in a defender strategy. For example, facing an

defender

A strategy that leverages local assets in areas in which MNEs are weak.

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onslaught from MNE cosmetics firms, a number of local Israeli firms turned to focus on products suited to the Middle Eastern climate and managed to defend their turf. Ahava has been particularly successful, partly because of its highly unique components extracted from the Dead Sea that MNEs cannot find elsewhere. In other words, while local firms such as Ahava cede some markets (such as mainstream cosmetics) to MNEs, they build strongholds in narrower but deeper product markets (such as the “Dead Sea mud”). In other words, this is an example of gambit.

Cell 4 shows industries where pressures for globalization are relatively low and local firms may possess some skills that are transferable overseas, thus leading to an extender strategy. This strategy centers on leveraging home-grown competencies abroad. For example, Asian Paints controls 40% of the house paint market in India. Asian Paints developed strong capabilities tailored to this environment, characterized by thousands of small retailers serving numerous poor consumers who only want small quantities of paint that can be diluted to save money. Such capabilities are not only a winning formula in India but also in much of the developing world. In contrast, MNEs, whose business model typically centers on affluent customers in developed economies, have had a hard time coming up with profitable low-end products.

Cell 1 depicts local firms that compete in industries with high pressures for globaliza- tion. Thus, a dodger strategy is necessary. This is largely centered on cooperating through joint ventures (JVs) with MNEs and sell-offs to MNEs. In the Chinese automobile industry, all major domestic automakers have entered JVs with MNEs. In the Czech Republic, the government sold Skoda to Volkswagen. In essence, to the extent that local

FIGURE 8.10 How Local Firms in Emerging Economies Respond to Multinationals

(Cell 1) Dodger

High

Transferable abroad

Low

Contender (Cell 2)

(Cell 3) Defender Extender

(Cell 4)

Customized to home markets

Competitive Assets

Industry

to Globalize Pressures

Source: Adapted from N. Dawar & T. Frost, 1999, Competing with giants: Survival strategies for local companies in emerging markets (p. 122), Harvard Business Review, March–April: 119–129.

extender

A strategy that centers on leveraging homegrown competencies abroad by expanding into similar markets.

dodger

A strategy that centers on cooperating through joint ventures with MNEs and/or sell-offs to MNEs.

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firms are unable to successfully compete head-on against MNEs, cooperation becomes necessary. In other words, if you can’t beat them, join them!

Finally, in Cell 2, some local firms, through a contender strategy, engage in rapid learning and then expand overseas. A number of Chinese mobile phone makers such as TCL and Bird rapidly caught up with global heavyweights such as Motorola and Nokia. Domestic firms in China now command more than 50% market share. Following their success at home, TCL and Bird have now entered foreign markets.

Particularly in emerging economies, how domestic firms respond is crucial for man- agers. For example, in China, despite initial dominance, MNEs do not always stay on top. In numerous industries (such as sportswear, cellular phone, personal computer, and home appliance), many MNEs have found themselves losing market share to domestic firms. While weak domestic players are washed out, some of the stronger domestic firms not only succeed in the competitive domestic environment, but now challenge MNEs over- seas. In the process, they become a new breed of MNEs themselves. The upshot is that when facing the onslaught of MNEs, local firms are not necessarily “sitting ducks.”

Debates and Extensions Numerous debates revolve around this sensitive area. We outline two of the most significant ones: (1) strategy versus IO economics and antitrust policy, and (2) competi- tion versus antidumping.

Strategy versus IO Economics and Antitrust Policy Managers deploy strategy to lead their firms to win in the marketplace. But antitrust officials, influenced by IO economics, sometimes get in the way by accusing firms (such as Microsoft) of being “anticompetitive.” Most business school students do not study anti- trust policy. After they graduate and become managers, they do not care about it. Antitrust officials, on the other hand, tend to study economics and law but not business. A background in economics and law, however, does not give antitrust officials an intimate understanding of how firm-level competition and/or cooperation unfolds, which is some- thing that a business school education provides. These officials often believe that in the absence of government intervention (specifically, antitrust action), competitive advantage of large firms is likely to last forever and monopoly will prevail. Managers know better: Given rapid technological changes, ambitious new entrants, and strong global competi- tion, no competitive advantage lasts forever even in the absence of government interven- tion (see Chapter 3).38 It is possible that none of the antitrust officials has ever studied a strategy textbook like this one. But officials who have a static view of the sustainability of competitive advantage end up deciding and enforcing the rules governing competition. Such a disconnect naturally breeds mutual suspicion and frustration on both sides. Business school students and managers will be better off if they arm themselves with knowledge about antitrust concerns and engage in intelligent conversations and debates with officials and policy makers.

Why were large and successful firms such as AT&T, IBM, and Microsoft (Table 8.2) accused of engaging in illegal “anticompetitive” conduct for the very same conduct that

contender

A strategy that centers on rapid learning and then expanding overseas.

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made them successful in the first place? Google is now widely rumored to be the next antitrust target. Because the United States has the world’s oldest antitrust frameworks (dating back to the 1890 Sherman Act), the US debate is the most watched in the world and so is the focus here. Rather than adopting a US-centric approach, here we treat the US debate as a case study that may have global ramifications.

On behalf of managers, strategy and management scholars have made four argu- ments.39 First, antitrust laws were often created in response to the old realities of mostly domestic competition—the year 1890 for the Sherman Act is not a typo for 1990. However, the largely global competition today means that a large dominant firm in one country (think of Boeing) does not automatically translate into a dangerous monopoly. The existence of foreign rivals (such as Airbus) forces the large domestic incumbent to be more competitive.

Second, the very actions accused to be “anticompetitive” may actually be highly “competitive” or “hypercompetitive.” In the 1990s, the hypercompetitive Microsoft was charged with “anticompetitive” behavior. Its alleged crime? Not voluntarily helping its competitors. It is puzzling why Microsoft should have voluntarily helped its competitors. Just imagine: If your manager asked you to voluntarily help your firm’s competitors, would you just do it or think that your manager was out of his or her mind?

Third, US antitrust laws create strategic confusion.40 Because the intention to destroy your firm’s rivals is the smoking gun of antitrust cases, managers are forced to use milder language. Don’t say or write a memo that says “We want to beat our competitors!” Otherwise, managers could end up in court. In contrast, non-US firms often use war-like language: Komatsu is famous for “Encircling Caterpillar!” and Honda for “Annihilate, crush, and destroy Yamaha!” The inability to talk straight creates confusion among lower- level managers and employees in US firms. A confused firm is not likely to be aggressive.

Finally, US antitrust laws may be unfair because these laws discriminate against US firms. In 1983, if GM and Ford were to propose to jointly manufacture cars, antitrust officials would have turned them down, citing an (obvious!) intent to collude. The jargon is per se (in and of itself) violation of antitrust laws. Ironically, starting in 1983, GM was allowed to jointly make cars with Toyota. Now 30 years later, Toyota is a leading automaker in the United States. The upshot? American antitrust laws have helped Toyota but not Ford or GM. One country’s (or region’s) antitrust laws may be used against other countries’ firms. For example, the EU antitrust authorities have been very harsh on US firms: stopping the merger between GE and Honeywell and severely fining Microsoft and Intel. While these actions provoked protests from the American side, they are at least understandable from a protectionist standpoint (see Emerging Markets 8.2). What is difficult to understand is why US firms are sometimes discriminated against by their own government. The most recent case in point: In 2011, AT&T was forced to abandon its merger with T-Mobile, a wholly owned subsidiary of Deutsche Telekom (DT), and was forced to pay a $3 billion (!) breakup fee to T-Mobile. A US firm was thus forced by the US government to subsidize a foreign firm, which did not even want to compete in the United States anymore.

Far from being theoretical, this institution-based debate has far-reaching ramifications for the future of global competition. Business students and future managers should pay attention to this debate and be prepared to engage in it. As managers rise to assume more strategic, C-level positions (such as CEO, CFO, and CIO), the importance of knowledge about this debate rises.

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Competition versus Antidumping Two arguments exist against the practice of imposing antidumping restrictions on foreign firms. First, because dumping centers on selling “below cost,” it is often difficult (if not impossible) to prove the case given the ambiguity concerning “cost.” The second argu- ment is that if foreign firms are indeed selling below cost, so what? This is simply a (hyper)competitive action. When entering a new market, virtually all firms lose money on Day 1 (and often in Year 1). Until some point when the firm breaks even, it will lose money because it sells below cost. Domestically, cases abound of such dumping, which are perfectly legal. We all receive numerous coupons in the mail offering free or cheap goods. Coupon items are frequently sold (or given away) below cost. Do consumers complain about such good deals? Probably not. “If the foreigners are kind enough (or dumb enough) to sell their goods to our country below cost, why should we complain?”41

A classic response is: What if, through “unfair” dumping, foreign rivals drive out local firms and then jack up prices? Given the competitive nature of most industries, it is often difficult to eliminate all rivals and then recoup losses by charging higher monopoly prices. The fear of foreign monopoly is often exaggerated by special interest groups who benefit at the expense of consumers in the entire country. Joseph Stiglitz, a Nobel laureate in economics, wrote that antidumping duties “are simply naked protectionism” and one country’s “fair trade laws” are often known elsewhere as “unfair trade laws.”42

One solution is to phase out antidumping laws and use the same standards against domestic predatory pricing. Such a waiver of antidumping charges has been in place between Australia and New Zealand, between Canada and the United States, and within the EU. Thus, a Canadian firm, essentially treated as a US firm, can be accused of predatory pricing but cannot be accused of dumping in the United States. Since antidumping is about “us versus them,” such harmonization represents essentially an expanded notion of “us.” However, domestically, as noted earlier, a predation case is very difficult to make. In such a way, competition can be fostered, aggressiveness rewarded, and “dumping” legalized.

The Savvy Strategist If capitalism, according to Joseph Schumpeter, is about “creative destruction,” then the “strategy as action” perspective highlights how such power of creative destruction is unleashed in the marketplace. Consequently, three implications for action emerge for the savvy strategist (Table 8.3). First, you need to thoroughly understand the nature of your industry that may facilitate competition and/or cooperation. Consider music, software, and film industries, where digital piracy is accelerating thanks to broadband Internet connec- tions and peer-to-peer networks. Table 8.4 advises incumbents (copyright holders) to view pirates as competitors and new entrants. Thus, lower cost and enhanced differentiation, derived from the industry-based view, may prove effective in fighting digital piracy.

Second, you and your firm need to strengthen capabilities to compete and/or cooperate more effectively. In attacks and counterattacks, subtlety, frequency, complexity, and unpredictability are helpful. In cooperation, market similarity and mutual forbearance may be better. As Sun Tzu advised, you not only need to “know yourself,” but also “know your opponents” by developing skills and instincts in competitor analysis and thinking like your opponents.

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Third, you need to understand the rules of the game governing competition around the world. Aggressive language such as “Let’s beat competitors” may not be allowed in countries such as the United States. Remember, an email, like a diamond, is “forever,” and “deleted” emails are still stored on a server and can be recovered. However, carefully crafted ambitions such as Wal-Mart’s “We want to be number one in grocery business” are legal, because such wording (at least on paper) shows no illegal intention to destroy rivals. Too bad 31 US supermarket chains declared bankruptcy since Wal-Mart charged into groceries in the 1990s—just a tragic coincidence (!).43

The necessity to understand the rules of the game is crucial when venturing abroad. What is legal domestically may be illegal elsewhere. Many Chinese managers are surprised that their low-cost strategy is labeled “illegal” dumping in the very countries advocating “free market” competition. In reality, “free markets” are not free. However, managers well-versed in the rules of the game may launch subtle attacks without incurring the wrath of antidumping officials. Imports commanding less than 3% market share in a 12-month period are regarded by US antidumping laws as “negligible imports” not worthy of investigation.44 Thus, foreign firms not crossing such a “red line” would be safe. As an exporter, would you like to maintain a steady 3% US market share every year over ten years or a dramatic 30% upsurge in Year 1, which would attract antidumping actions preventing further growth in Year 2 and beyond?

In terms of the four fundamental questions, why firms differ (Question 1) and how firms behave (Question 2) boil down to how the strategy tripod influences competitive

TABLE 8.4 Strategic Responses to Digital Piracy

& Not only compete but also cooperate with pirates by adopting a permissive stance, especially when there are strong network effects and the copyright holder is competing with rivals to get its offering established as a standard.

& Provide free samples, instead of having pirates serve the demand for samples whose quality may be questionable.

& Exercise cost leadership by lowering the price of the legal good in order to deter entry by pirates. & Enhance differentiation by offering something extra to consumers who pay full price for the legal good. & Change the incentives of buyers of pirate products (such as music companies’ support for Apple’s

iTune services). & Influence the norms associated with digital piracy by legally challenging and punishing major offenders.

Source: Based on text in C. Hill, 2007, Digital piracy: Causes, consequences, and strategic responses, Asia Pacific Journal of Management, 24: 9–25. For related research, see D. Bryce, J. Dyer, & N. Hatch, 2011, Competing against free, Harvard Business Review, June: 104–111.

TABLE 8.3 Strategic Implications for Action

& Thoroughly understand the nature of your industry that may facilitate competition and/or cooperation. & Strengthen resources and capabilities that more effectively compete and/or cooperate. & Understand the rules of the game governing domestic and international competition around the world.

ga ge

Le ar ni ng

250 PART 2 BUSINESS-LEVEL STRATEGIES

dynamics. What determines the scope of the firm (Question 3) is driven, in part, by an interest in establishing mutual forbearance with multimarket rivals—in other words, “the best defense is a good offense.” Finally, what determines the international success and failure of firms (Question 4), to a large extent, depends on how firms carry out their competitive and cooperative actions. Overall, given that business is simultaneously war and peace, a winning formula, as in war and chess, is “Look ahead, reason back.”

CHAPTER SUMMARY

1. Articulate the “strategy as action” perspective • Underpinning the “strategy as action” perspective, competitive dynamics refers to actions and responses undertaken by competing firms.

2. Understand the industry conditions conducive for cooperation and collusion • Such industries tend to have (1) a small number of rivals, (2) a price leader, (3) homog- enous products, (4) high entry barriers, and (5) high market commonality (mutual forbearance).

3. Explain how resources and capabilities influence competitive dynamics • Resource similarity and market commonality can yield a powerful framework for competitor analysis.

4. Outline how formal institutions affect domestic and international competition • Domestically, antitrust laws focus on collusion and predatory pricing. • Internationally, antidumping laws discriminate against foreign firms and protect domestic firms.

5. Identify the drivers for attacks, counterattacks, and signaling • The three main types of attacks are (1) thrust, (2) feint, and (3) gambit. Counterattacks are driven by (1) awareness, (2) motivation, and (3) capability.

• Without talking directly to competitors, firms can signal to rivals through various means.

6. Discuss how local firms fight MNEs • When confronting MNEs, local firms can choose a variety of strategic choices: (1) defender, (2) extender, (3) dodger, and (4) contender. They may not be as weak as many people believe.

7. Participate in two leading debates concerning competitive dynamics • (1) Strategy versus IO economics and antitrust policy, and (2) competition versus antidumping.

8. Draw strategic implications for action • Thoroughly understand the nature of your industry that may facilitate competition or cooperation.

• Strengthen resources and capabilities to compete and/or cooperate more effectively. • Understand the rules of the game governing domestic and international competition around the world.

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KEY TERMS

Antidumping laws p. 240

Antitrust laws p. 226

Antitrust policy p. 236

Attack p. 241

Blue ocean strategy p. 244

Capacity to punish p. 228

Cartel (trust) p. 226

Collusion p. 225

Collusive price setting p. 237

Competition policy p. 236

Competitive dynamics p. 224

Competitor analysis p. 224

Concentration ratio p. 228

Contender p. 247

Counterattack p. 241

Cross-market retaliation p. 231

Defender p. 245

Dodger p. 246

Dumping p. 238

Explicit collusion p. 226

Extender p. 246

Extraterritoriality p. 238

Feint p. 241

Gambit p. 242

Game theory p. 226

Market commonality p. 231

Multimarket competition p. 225

Mutual forbearance p. 225

Predatory pricing p. 238

Price leader p. 228

Prisoners’ dilemma p. 226

Resource similarity p. 232

Tacit collusion p. 226

Thrust p. 241

CRITICAL DISCUSSION QUESTIONS

1. ON ETHICS: As a CEO, you feel the price war in your industry is killing profits for all firms. However, you have been warned by corporate lawyers not to openly discuss pricing with rivals, whom you know personally (you went to school with them). How would you signal your intentions?

2. ON ETHICS: As a CEO, you are concerned that your firm and the industry in your country are being devastated by foreign imports. Trade lawyers suggest that you file an antidumping case against leading foreign rivals and assure you a win. Would you file an antidumping case or not? Why?

3. ON ETHICS: As part of a feint attack, your firm (firm A) announces that in the next year, it intends to enter country X where the competitor (firm B) is very strong. Your firm’s real intention is to march into country Y where B is very weak. There is actually no plan to enter X. However, in the process of intentionally trying to “fool” B, customers, suppliers, investors, and the media are also being inadvertently misled. What are the ethical dilemmas here? Do the pros of this action outweigh its cons?

TOPICS FOR EXPANDED PROJECTS

1. Find some competitive moves made by some emerging multinationals from emerging economies. How do the two frameworks in Figures 8.4 and 8.10 help you understand these moves?

252 PART 2 BUSINESS-LEVEL STRATEGIES

2. If your country has competition/antitrust laws, find a landmark case, and explain whether you support the plaintiff or the defendant. If your country does not have competition/ antitrust laws, explain why.

3. ON ETHICS: As a party not directly involved in the (second) United States v. AT&T case (in 2011, during which the US government blocked AT&T’s proposed merger of T-Mobile), such as a manager at another firm or a student, what do you think is right about antitrust policy? What is wrong about antitrust policy? Why?

CLOSING CASE

Emerging Markets: HTC Fights Apple

Everybody has heard of Apple and its iPhone, which set the smartphone market on fire when it first appeared in 2007. Fast forward to 2012: Which company had the highest smartphone market share in the United States? Not Apple (20% market share), not Samsung (20%), and not Blackberry (9%). The winner was HTC, which com- manded a 25% market share. “Apple iPhone’s market share was lower than what?” some of you may ask.

Founded in Taiwan in 1997, HTC was an “unlikely leader” in the smartphone world infested by global heavyweights, according to Bloomberg Businessweek. Founded as High Tech Computer, the firm followed the well-known Taiwanese outsourcing formula of designing and manufacturing gadgets for other compa- nies without a brand name of its own. The plain-vanilla original name (which the firm no longer uses) was as low-profile as a corporate name could be. The firm toiled for a long time in obscurity as an original design manufacturer (ODM), quietly designing and making high-end smartphones for leading Western mobile operators such as Verizon and Orange. HTC’s first big contract came when Microsoft asked it to make smart- phones. HTC quickly became the world’s top producer of Windows phones. It set up its US headquarters in Bellevue, Washington, a Seattle suburb where Microsoft was headquartered. Like many contract manufacturers,

HTC worried that a brandless firm would permanently remain a low-margin manufacturer of commodity pro- ducts. What was worse was that the already razor-thin margin would be squeezed even further as clients shopped for lower-cost producers (read: China). The solution was usually to launch a firm’s own brand to command higher margins and more respect—in other words, to become an original brand manufacturer (OBM) just like Apple. However, Taiwanese (and Asian) firms attempting to overcome this hurdle usually had to face a “double whammy:” (1) a lack of capabilities in innovation and branding and (2) the loss of clients, which did not want to do business with an emerging rival. Such a “double whammy” forced many manufac- turers to remain on the low-cost treadmill. How did HTC overcome the challenge?

Three things stand out. First, as emphasized by Cher Wang, HTC’s chairwoman, in media interviews, HTC never did original equipment manufacturing (OEM). From the start, it had always been an ODM—emphasizing the “design” function that was lacking among most OEM manufacturers (such as Foxconn or Hon Hai, the largest Taiwanese OEM). The difference was nontrivial: HTC had developed world-class design and innovation capabilities. It began designing some of the world’s first touch screen and wireless handheld devices as early as in 1998.

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Second, HTC was very skillful in collaborating with larger firms. Such successful collaborations—in combina- tion with its design prowess—led to a series of enviable first-mover accomplishments in this rapidly developing industry. These accomplishments included creating the world’s first touch screen smartphones as the Treo for Palm and the iPAQ for Compaq (2000); the first Microsoft-powered smartphone (2002) and the first Microsoft 3G smartphone (2005); the world’s first smartphone powered by Google’s Android operating system, which was promoted as a free, open-source system (2008); and the first 4G-capable phone in the United States (2010).

Third, unlike many Asian firms that had a hard time globalizing their operations due to language barriers and cultural constraints, HTC was a “born global” firm. Emails and documents were in English from day one. CEO Peter Chou, according to the Economist, sounded more like a Silicon Valley management guru than a typical Asian corpo- rate patriarch. “Instead of telling them what to do, I want people to have the freedom to explore their talent,” Chou said. Such an open culture made HTC a more attractive employer forWestern talents. In 2006, HTC attracted Horace Luke, a rising star at Microsoft. He had been the creative director of Windows Mobile. At HTC, Luke created an inno- vation infrastructure of fast-moving development teams. Some of these teams were based in Seattle. In 2011, HTC also opened a research and development (R&D) office in Durham, North Carolina. Chou also proudly noted in a 2010 interview that at the topmanagement level, more than half of the CEO’s direct reports were not Taiwanese.

Sticking its neck out as a new OBM, HTC started to develop its own brand in 2006. By 2008 when its first Android phone was marketed, it was branded as “HTC.” As Google built an ecosystem based on Android to wage its battle with Apple, HTC as Google’s leading Android partner gained tremendous visibility. Since then, HTC took off. In 2011, it displaced Acer and was ranked number one among Taiwan’s global brands by Interbrand, which listed its brand as number 98 in the world. In 2011, it was named “Device Manufacturer of the Year” by the Mobile World Congress. Also, its market value surpassed that of Nokia to become the third largest smartphone maker in the world (by market value), behind only Apple and Sam- sung. When asked about Apple in interviews, Chou acknowledged that despite HTC smartphones’ attractive features, they would not attract crowds with “midnight

madness” outside Apple stores to lay their hands on the new gadgets. “HTC is HTC,” asserted Chou. “I don’t care about the iPhone. I don’t even look at it.”

Apple, on the other hand, took HTC’s challenge very seriously. In addition to vigorously competing on the pro- duct dimension, Apple sued HTC for 20 counts of patent violations in 2010. This was part of a broader Apple strat- egy to slow the ascendance of Android phones, which were not only made by HTC but also by Samsung and Motorola. Led by HTC, Android phones rocketed from less than 3% market share in 2009 to 48% in 2011. In addi- tion to HTC, Apple also sued Samsung, Motorola, as well as Google itself. In response, HTC sued Apple for infring- ing on five of HTC’s patents and sought to ban Apple products imported into the United States from manufac- turing facilities in Asia.

As HTC’s fight with Apple spilled over from product markets to courts, HTC, the clear underdog, claimed that it had sufficient patents to deal with Apple. “Patent lawsuits are normal,” Wang answered the media. “Chinese firms have seldom used this strategic weapon. So we are setting an example.” Likewise, Chou said, “if HTC can do a good job and set an example in innovation, we can inspire other companies to try the same.”

Sources: Based on (1) 21st Century Business Insights, 2011, HTC: Can being itself allow it to surpass Apple? October 1: 58–59; (2) Bloomberg Businessweek, 2010, A former no-name from Taiwan builds a global brand, November 1: 37–38; (3) Bloomberg Businessweek, 2011, Android’s dominance is patent pending, August 8: 36–37; (4) Economist, 2009, Upwardly mobile, July 11: 68; (5) Economist, 2011, Android alert, July 23: 64; (6) Interbrand, 2011, Taiwan top 20 global brands 2011, www.brandingtaiwan.com.

C A S E D I S C U S S I O N Q U E S T I O N S

1. From a resource-based view, what are HTC’s unique resources and capabilities?

2. From an institution-based view, what are the lessons you can draw from the patent lawsuits between HTC and Apple?

3. What are the lessons that ambitious firms in Asia and other emerging economies can draw when they aspire to upgrade their capabilities, become more innovative, and command more respect as OBMs?

254 PART 2 BUSINESS-LEVEL STRATEGIES

NOTES [Journal acronyms] AMJ – Academy of Management Journal; AMR – Academy of Management Review; BW – BusinessWeek (before 2010) or Bloomberg Businessweek (since 2010); HBR – Harvard Business Review; JEP – Journal of Economic Perspectives; JIBS – Journal of International Business Studies; JM – Journal of Manage- ment; JMS – Journal of Management Studies; JWB – Journal of World Business; SMJ – Strategic Management Journal

1. D. Ketchen, C. Snow, & V. Hoover, 2004, Research on competitive dynamics, JM, 30: 779–804.

2. L. Capron & O. Chatain, 2008, Competitors’ resource- oriented strategies, AMR, 33: 97–121; K. Coyne & J. Horn, 2009, Predicting your competitor’s reaction, HBR, April: 90–97; W. Tsai, K. Su, & M. Chen, 2011, Seeing through the eyes of a rival, AMJ, 54: 761–778.

3. V. Rindova, M. Becerra, & I. Contardo, 2004, Enacting competitive wars, AMR, 29: 670–686.

4. BW, 2011, Dan Akerson is not a car guy, August 29: 56–60.

5. J. Anand, L. Mesquita, & R. Vassolo, 2009, The dynamics of multimarket competition in exploration and exploita- tion activities, AMJ, 52: 802–821; H. Greve, 2008, Multi- market contact and sales growth, SMJ, 29: 229–249; Z. Guedri & J. McGurie, 2011, Multimarket competi- tion, mobility barriers, and firm performance, JMS, 48: 857–890; G. Markman, P. Gianiodis, & A. Buchholtz, 2009, Factor-market rivalry, AMR, 34: 423–441; J. Prince & D. Simon, 2009, Multimarket contact and service quality, AMJ, 52: 336–354.

6. T. Yu, M. Subramanian, & A. Cannella, 2009, Rivalry deterrence in international markets, AMJ, 52: 127–147.

7. J. Baker, 1999, Developments in antitrust economics, JEP, 13: 181–194.

8. S. Brenner, 2011, Self-disclosure at international car- tels, JIBS, 42: 221–234; Y. Zhang & J. Gimeno, 2010, Earnings pressure and competitive behavior, AMJ, 53: 743–768.

9. United States et al. v. AT&T Inc. et al., 2011, Second amended complaint (p. 17), September 30, Washington, DC: US District Court for the District of Columbia.

10. Economist, 2011, From Big Three to Magnificent Seven, January 15: 67–68.

11. M. Semadeni, 2006, Minding your distance, SMJ, 27: 169–187.

12. M. Benner, 2007, The incumbent discount, AMR, 32: 703–720; C. Hill & F. Rothaermel, 2003, The performance of incumbent firms in the face of radical technological innovation, AMR, 28: 257–274.

13. J. Barney, 2002, Gaining and Sustaining Competitive Advantage (p. 359), Upper Saddle River, NJ: Prentice Hall.

14. M. Chen, 1996, Competitor analysis and interfirm rivalry (p. 106), AMR, 21: 100–134.

15. E. Rose & K. Ito, 2008, Competitive interactions, JIBS, 39: 864–879.

16. G. Clarkson & P. Toh, 2010, “Keep out” signs, SMJ, 31: 1202–1225.

17. G. Kilduff, H. Elfenbein, & B. Staw, 2010, The psy- chology of rivalry, AMJ, 53: 943–969; R. S. Livengood & R. Reger, 2010, That’s our turf! AMR, 35: 48–66.

18. J. Immelt, V. Govindarajan, & C. Trimble, 2009, How GE is disrupting itself, HBR, October: 56–65.

19. D. Spar, 1994, The Cooperative Edge: The Internal Politics of International Cartels (p. 5), Ithaca, NY: Cornell UP.

20. D. Sirmon, S. Gove, & M. Hitt, 2009, Resource man- agement in dynamic competitive rivalry, AMJ, 51: 919–935.

21. J. R. Baum & S. Wally, 2003, Strategic decision speed and firm performance, SMJ, 24: 1107–1129; H. Ndo- for, D. Sirmon, & X. He, 2011, Firm resources, com- petitive actions, and performance, SMJ, 32: 640–657.

22. R. Agarwal, M. Ganco, & R. Ziedonis, 2009, Reputa- tions for toughness in patent enforcement, SMJ, 30: 1349–1374; M. Chen, H. Lin, & J. Michel, 2010, Navi- gating in a hypercompetitive environment, SMJ, 31: 1410–1430; G. Vroom & J. Gimeno, 2007, Ownership form, managerial incentives, and the intensity of riv- alry, AMJ, 50: 901–922.

23. J. Boyd & R. Bresser, 2008, Performance implications of delayed competitive responses, SMJ, 29: 1077–1096; B. Connelly, L. Tihanyi, S. T. Certo, & M. Hitt, 2010, Marching to the beat of different drummers, AMJ, 53: 723–742; V. Rindova, W. Ferrier, & R. Wiltbank, 2010, Value from gestalt, SMJ, 31: 1474–1497.

24. B. Golden & H. Ma, 2003, Mutual forbearance, AMR, 28: 479–493; A. Kalnins, 2004, Divisional multimarket

C h a p t e r 8 Ma n a g i n g G l o b a l C o m p e t i t i v e D y n a m i c s 255

contact within and between multiunit organizations, AMJ, 47: 117–128.

25. Chen, 1996, Competitor analysis and interfirm rivalry (p. 107). See also W. Desarbo, R. Grewal, & J. Wind, 2006, Who competes with whom? SMJ, 27: 101–129; L. Fuentelsaz & J. Gomez, 2006, Multipoint competi- tion, strategic similarity, and entry into geographic markets, SMJ, 27: 477–499.

26. N. Kumar, 2006, Strategies to fight low-cost rivals, HBR, December: 104–112.

27. E. Graham & D. Richardson, 1997, Issue overview (p. 5), in E. Graham & D. Richardson (eds.), Global Competition Policy, Washington: Institute for Interna- tional Economics.

28. Economist, 2009, The unkindest cuts, August 22: 68. 29. J. Clougherty, 2005, Antitrust holdup source, cross-

national institutional variation, and corporate political strategy implications for domestic mergers in a global context, SMJ, 26: 769–790.

30. R. Lipstein, 1997, Using antitrust principles to reform antidumping law (p. 408, original italics), in E. Graham & D. Richardson (eds.), Global Competi- tion Policy, Washington: Institute for International Economics.

31. OECD, 1996, Trade and Competition: Frictions After the Uruguay Round (p. 18), Paris: OECD.

32. S. Marsh, 1998, Creating barriers for foreign compe- titors, SMJ, 19: 25–37.

33. R. McGrath, M. Chen, & I. MacMillan, 1998, Multi- market maneuvering in uncertain spheres of influ- ence, AMR, 23: 724–740.

34. G. Stalk, 2006, Curveball: Strategies to fool the com- petition, HBR, September: 115–122.

35. M. Chen, K. Su, & W. Tsai, 2007, Competitive tension, AMJ, 50: 101–118; T. Yu & A. Cannella, 2007, Rivalry between multinational enterprises, AMJ, 50: 665–686.

36. W. C. Kim & R. Mauborgne, 2005, Blue Ocean Strategy, Boston: Harvard Business School Press.

37. N. Dawar & T. Frost, 1999, Competing with giants, HBR, March: 119–129.

38. R. D’Aveni, G. Dagnino, & K. Smith, 2010. The age of temporary advantage, SMJ, 31: 1371–1385.

39. R. D’Aveni, 1994, Hypercompetition, New York: Free Press.

40. E. Rockefeller, 2007, The Antitrust Religion, Washington, DC: Cato Institute.

41. R. Griffin & M. Pustay, 2003, International Business, 3rd ed. (p. 241), Upper Saddle River, NJ: Prentice Hall.

42. J. Stglitz, 2002, Globalization and Its Discontent (pp. 172–173), New York: Norton.

43. C. Fishman, 2006, The Wal-Mart Effect, New York: Penguin.

44. M. Czinkota & M. Kotabe, 1997, A marketing perspective of the US International Trade Commission’s antidumping actions (p. 183), JWB, 32: 169–187.

256 PART 2 BUSINESS-LEVEL STRATEGIES

P A R T3 CORPORATE-LEVELSTRATEGIES

9 Diversifying, Acquiring, and Restructuring

10 Strategizing, Structuring, and Learning Around the World

11 Governing the Corporation Around the World

12 Strategizing with Corporate Social Responsibility

CHAPTER9

DIVERSIFYING, ACQUIRING, AND RESTRUCTURING

KNOWLEDGE OBJECT IVES

After studying this chapter, you should be able to

1. Define product diversification and geographic diversification

2. Articulate a comprehensive model of diversification

3. Gain insights into the motives and performance of acquisitions

4. Enhance your understanding of restructuring

5. Participate in two leading debates concerning diversification, acquisitions, and restructuring

6. Draw strategic implications for action

ot o/ A le xe y St io p

258 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

OPENING CASE

Emerging Markets: Corporate Diversification Strategy in South Korean Business Groups

Large conglomerates (business groups), such as Samsung, Hyundai, and LG, are called chaebol in South Korea (hereafter Korea). They dominate the economy, contri- buting approximately 40% of GDP as of 1996. In 1996, Samsung had 80 subsidiaries, Hyundai 57, LG 49, and Daewoo 30—scattered in different industries such as automobiles, chemicals, construction, electronics, finan- cial services, insurance, semiconductors, shipbuilding, and steel. Why and how did chaebol, all from humble roots in focused industries, grow to become such sprawl- ing conglomerates? The chairman of LG shared an intri- guing story:

My father and I started a cosmetic cream factory in the late 1940s. At that time, no company could supply us with plastic caps of adequate quality for cream jars, so we had to start a plastic business. Plastic caps alone were not sufficient to run the plastic molding plant, so we added combs, toothbrushes, and soap boxes. This plastics business also led us to manufacture electric fan blades and telephone cases, which in turn led us to manufacture electrical and electronic products and telecommunications equipment. The plastics business also took us into oil refining, which needed a tanker shipping company. The oil refining company alone was paying an insurance premium amounting to more than half the total revenue of the then largest insurance company in Korea. Thus, an insurance company was started.

What the story does not reveal is the visible hand of the Korean government, which channeled financial resources to fund chaebol’s growth. In the meantime, the govern- ment protected domestic markets from foreign competi- tion. However, the cozy protected environment did not last forever. Because Korea’s eagerness to join the OECD prior to its accession in 1996 resulted in external pressures to open the economy, the government gradually removed import restrictions. In addition, capital markets became more open and vibrant. At the same time, labor costs rose sharply. Internationally, chaebol products were often stuck

in the middle between high-end Japanese offerings and low-cost Chinese merchandise.

Confronting such rising environment turbulence by the 1990s, chaebol as a group increased their corporate scope. The average number of affiliates of the top 30 chaebol grew from 17 per group in 1987 to 22 in 1996, a 30% increase. In the process, they took on a high level of debt. Banks were happy to provide loans, believing that chaebol were “too big to fail.” The debt/equity ratio ended up being, on average, 617% for the top 30 chaebols. In some extreme cases, New Core’s debt/equity ratio was 1,225%, Halla’s was 2,066%, and Jinro’s was 3,765%.

Unfortunately, by the time the Asian economic crisis of 1997 struck, chaebol took an enormous beating. Their excessive borrowing and reckless growth were sharply criticized. Of the 30 top chaebol in 1996, close to half of them went through bankruptcy proceedings or bank- sponsored restructuring programs. Daewoo, ranked num- ber four in 1996, was literally broken up. All surviving chaebol sold businesses and substantially reduced their scope.

In retrospect, signs of chaebol’s troubles had been like writing on the wall before the crisis. There was indeed a time chaebol carried a diversification premium, with affili- ates outcompeting comparable independent firms (about 10% higher sales during 1984–1987). However, rising environmental turbulence coupled with growing firm size proved to be a lethal combination. By 1994–1996, there was a diversification discount, with chaebol member firms selling at 5% less than comparable independent firms. Finally, the better developed external capital markets further eroded the chaebol advantage to operate an inter- nal capital market.

Prior to 1997, chaebol were often applauded as the champions of Korea’s economic development and a worthy model for other developing economies to emulate. Since 1997, chaebol were often blamed for the country’s economic crisis. Korean and Western media called for the dismantling of chaebol. Both positions seemed extreme.

259 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

Why did Samsung and other chaebol groups pursue a conglomerationstrategy? Why did reducing their corporate scope after the 1997 Asianeconomic crisis result in better performance, which enabled them to better cope with the 2008 global economic crisis? What can firms do to improve their odds for successfully diversifying, acquiring, and restructuring? These are some of the key questions driving this chapter.

Starting from this chapter, Part III (Chapters 9, 10, 11, and 12) focuses on corporate-level strategy (or, in short, corporate strategy), which is how a firm creates value through the configuration and coordination of its multimarket activities. In comparison, Part II (Chapters 5, 6, 7, and 8) has dealt with business-level strategy, defined as ways to build competitive advantage in an identifiable market. While

Chaebol probably were neither “paragons” nor “para- sites.” Their roles changed. Chaebol as conglomerates did add value during earlier days, but past some point of inflection, their drawbacks started to outweigh their ben- efits. After the 2008 global crisis, while Korea’s exports slid, chaebol’s exports gobbled up market share from glo- bal competitors. So chaebol again were regarded as saviors in Korea. Perhaps one of chaebol’s proudest moment came on April 3, 2010, when the Economist apologized: “Chaebol are certainly due an apology from those, including this newspaper [the Economist], who thought they would be too unwieldy for modern business.”

Recent corporate diversification strategy in chaebol demonstrates both change and continuity. Change is evidenced by the reduced corporate scope and reduced debt loads. Before 1997, Samsung was a mediocre player in many industries. After 1997, Samsung emerged as a world-class leader in LCD screens and mobile phones—one of the key reasons was the reduced corporate scope to focus on these areas of excellence. However, the continued pursuit of a con- glomeration (product-unrelated diversification) strategy also seems evident. In recent years, an emboldened Samsung announced a grand scheme of placing a whopping $20 billion in five product-unrelated indus- tries in which it had relatively little presence: solar

panels, energy-saving LED lighting, medical devices, bio- tech drugs, and batteries for electric cars. Despite their lack of obvious product relatedness, Samsung argued that these industries share two things in common: (1) they were about to take off, and (2) they could benefit from a splurge of capital that could scale up manufac- turing and thus lower costs—essentially repeating the game that Samsung successfully played in DRAM, LCD, and mobile phones. While Samsung, which contributed 20% of Korea’s GDP and 13% of its exports as of 2010, is a shining example, it is not alone. Perhaps, undertaking such a “fast follower” and “scale builder” strategy, supported by stable family ownership and patience, is chaebol’s core competence.

Sources: Based on (1) S. Choe & T. Roehl, 2007, What to shed and what to keep, Long Range Planning, 40: 465–487; (2) Economist, 2010, Return of the overload, April 3: 71–73; (3) Economist, 2010, The chaebol conundrum, April 3: 14–15; (4) Economist, 2011, Asia’s new model company, October 1: 14; (5) H. Kim, R. Hoskisson, L. Tihanyi, & J. Hong, 2004, The evolution and restructuring of diversified business groups in emerging markets, Asia Pacific Journal of Management, 21: 25–48; (6) K. B. Lee, M. W. Peng, & K. Lee, 2008, From diversification premium to diversification discount during institutional transitions, Journal of World Business, 43: 47–65.

(Continued)

OPENING CASE

corporate-level strategy (corporate strategy)

Strategy about how a firm creates value through the configuration and coordination of its multimarket activities.

business-level strategy

Strategy that builds competitive advantage in a discrete and identifiable market.

260 PART 3 CORPORATE-LEVEL STRATEGIES

business-level strategy is very important, for larger, multimarket firms, corporate- level strategy is equally or perhaps more important.1 In other words, an under- standing of corporate-level strategy helps us see the “forest,” whereas business-level strategy focuses on “trees.”

In this chapter, we focus on a key aspect of corporate strategy, diversification, which is adding new businesses to the firm that are distinct from its existing operations. Diversification is probably the single most researched, discussed, and debated topic in corporate strategy.2 It can be accomplished along two dimensions. The first is product diversification—through entries into different industries. The second is geographic diversification—through entries into different countries. Although market entries can entail greenfield investments (see Chapter 6) and strategic alliances (see Chapter 7), our focus here is on mergers and acquisitions (M&As) and restructuring.

We will first introduce product diversification and geographic diversifica- tion. Then, we will develop a comprehensive model, drawing on the strategy tripod. Acquisitions and restructuring are examined next, followed by debates and extensions.

Product Diversification Most firms start as small businesses focusing on a single product or service with little diversification—known as a single business strategy. Over time, a product diversification strategy, with two broad categories (related and unrelated), may be embarked upon.

Product-Related Diversification Product-related diversification refers to entries into new product markets and/or activities that are related to a firm’s existing markets and/or activities.3 The emphasis is on operational synergy (also known as scale economies or economies of scale), defined as increases in competitiveness beyond what can be achieved by engaging in two product markets and/or activities separately. In other words, firms benefit from declining unit costs by leveraging product relatedness—that is, 2 + 2 = 5. The sources of operational synergy can be (1) technologies (such as common platforms), (2) marketing (such as common brands), and (3) manufacturing (such as common logistics).

Product-Unrelated Diversification Product-unrelated diversification refers to entries into industries that have no obvious product-related connections to the firm’s current lines of business.4

Product-unrelated diversifiers (such as Samsung in the Opening Case) are

Product-unrelated diversification

Entries into industries that have no obvious product-related connections to the firm’s current lines of business.

diversification

Adding new businesses to the firm that are distinct from its existing operations.

product diversification

Entries into new product markets and/or business activities that are related to a firm’s existing markets and/or activities.

geographic diversification

Entries into new geographic markets.

single business strategy

A strategy that focuses on a single product or service with little diversification.

Product-related diversification

Entries into new product markets and/or business activities that are related to a firm’s existing markets and/or activities.

operational synergy

Synergy derived by having shared activities, personnel, and technologies.

scale economies (economies of scale)

Reductions in per unit costs by increasing the scale of production.

C h a p t e r 9 D i v e r s i f y i n g , A c q u i r i n g , a n d R e s t r u c t u r i n g 261

called conglomerates, and their strategy is known as conglomeration. Instead of operational synergy, conglomerates focus on financial synergy (also known as scope economies or economies of scope)—namely, increases in competitiveness for each individual unit financially controlled by the corporate headquarters beyond what can be achieved by each unit competing independently as stand-alone firms.

The mechanism to obtain financial synergy is different from operational synergy. The key role of corporate headquarters is to identify and fund profitable investment oppor- tunities, such as the five new industries that Samsung Group has entered recently (see the Opening Case). In other words, a conglomerate serves as an internal capital market that channels financial resources to high-potential high-growth areas.5 Given there are active external capital markets that try to do the same, a key issue is whether units affiliated with conglomerates in various industries (such as GE’s aircraft engine division) outperform their stand-alone independent competitors in respective industries (such as Snecma). Stated differently, at issue is whether corporate headquarters can do a better job in identifying and taking advantage of profitable opportunities than external capital markets. If conglomerate units beat stand-alone rivals (which is something most GE units con- sistently do), then there is a diversification premium (or conglomerate advantage)—in other words, product-unrelated diversification adds value.6 Otherwise, there can be a diversification discount (or conglomerate disadvantage), when conglomerate units are better off by competing as standalone entities (see the Opening Case).

Product Diversification and Firm Performance Hundreds of studies, mostly conducted in the West, suggest that, on average (although not always), performance may increase as firms shift from single business strategies to product-related diversification, but performance may decrease as firms change from product-related to product-unrelated diversification—in other words, the linkage seems to be an inverted U shape (Figure 9.1).7 Essentially “putting all your eggs in one basket,” a single business strategy can be potentially risky and vulnerable. “Putting your eggs in different baskets,” product-unrelated diversification may reduce risk, but its successful execution requires strong organizational capabilities that many firms lack (discussed later). Consequently, product-related diversification, essentially “putting your eggs in similar baskets,” has emerged as a balanced way to both reduce risk and leverage synergy since the 1970s.

However, important caveats exist. Not all product-related diversifiers outperform unrelated diversifiers. In an age of “core competence,” the continuous existence and prosperity of the likes of GE, Siemens, and Virgin Group suggest that for a small group of highly capable firms, conglomeration may still add value in developed economies. Moreover, in emerging economies, a conglomeration strategy seems to be persisting, with some units (such as those affiliated with South Korea’s Samsung Group, India’s Tata Group, and Turkey’s Koc Group) outperforming stand-alone competitors (see the Opening Case).8 The reason many conglomerates fail is not because this strategy is inherently unsound, but because firms fail to implement it. Conglomeration calls for corporate managers to impose a strict financial discipline on constituent units and hold unit managers accountable—of the sort GE’s former chairman and CEO, Jack Welch, famously imposed on all divisions, “Either become

conglomerate

Product-unrelated diversifier.

conglomeration

A strategy of product- unrelated diversification.

financial synergy

The increase in competitiveness for each individual unit that is financially controlled by the corporate headquarters beyond what can be achieved by each unit competing independently as standalone firms.

scope economies (economies of scope)

Reduction in per unit costs and increases in competitiveness by enlarging the scope of the firm.

internal capital market

A term used to describe the internal management mechanisms of a product- unrelated diversified firm (conglomerate) that operate as a capital market inside the firm.

diversification premium

Increased levels of performance because of association with a product- diversified firm (also known as conglomerate advantage).

diversification discount

Reduced levels of performance because of association with a product- diversified firm (also known as conglomerate discount).

262 PART 3 CORPORATE-LEVEL STRATEGIES

the world’s top one or two in your industry, or expect your unit to be sold.” However, most corporate managers are not so “ruthless,” and they may tolerate poor perfor- mance of some units, which can be subsidized by better units.9 By robbing the better units to aid the poor ones, corporate managers in essence practice “socialism.” Over time, better units may lose their incentive to do well, and eventually corporate performance suffers.

Geographic Diversification Although geographic diversification can be done within one country (expanding from one city, state, or province to another), in this chapter we focus on international diversifica- tion, namely, the number and diversity of countries in which a firm competes (see also Chapter 6).

Limited versus Extensive International Scope Two broad categories of geographic diversification can be identified. The first is limited international scope, such as US firms focusing on NAFTA markets and Spanish firms concentrating on Latin America. The emphasis is on geographically and culturally adjacent countries in order to reduce the liability of foreignness (see Chapters 4 and 6 for details). The second category is extensive international scope, maintaining a substan- tial presence beyond geographically and culturally neighboring countries. For example, the largest market for Yum! Brands (which operates KFC and Pizza Hut restaurants) is China. While neighboring countries are not necessarily “easy” markets, success in distant countries (such as Yum! Brands’ success in China) obviously calls for a stronger set of advantages to compensate for the liability of foreignness there.

FIGURE 9.1 Product Diversification and Firm Performance

Single business

Product-related diversification

Product-unrelated diversification

Level of product diversification

Pe rf

or m

an ce

Source: Adapted from R. E. Hoskisson, M. A. Hitt, R. D. Ireland, & J. S. Harrison, 2008, Competing for Advantage, 2nd ed. (p. 214), Cincinnati: South-Western Cengage Learning.

international diversification

The number and diversity of countries in which a firm competes.

C h a p t e r 9 D i v e r s i f y i n g , A c q u i r i n g , a n d R e s t r u c t u r i n g 263

Geographic Diversification and Firm Performance In this age of globalization, we frequently hear the calls for greater geographic diversifica- tion: All firms need to go “global,” non-international firms need to start venturing abroad, and firms with a little international presence should widen their geographic scope. The ramifications for firms failing to heed such calls presumably are grave. However, the evidence is not fully supportive of this popular view. As captured by the S curve in Figure 9.2, two findings emerge. First, at a low level of internationalization, there is a U-shaped relationship between geographic scope and firm performance, which suggests an initially negative effect of international expansion on performance before the positive returns are realized. This stems from the well-known hazard of liability of foreignness (see Chapter 6). Second, at moderate to high levels of internationalization, there is an inverted U shape, implying a positive relationship between geographic scope and firm performance— but only to a certain extent, beyond which further expansion is again detrimental. In other words, the conventional wisdom—“the more global, the better”—is actually misleading.

Not all firms have been sufficiently involved overseas to experience the ups and downs captured by the S curve in Figure 9.2. Many studies report a U-shaped relationship, because they only sample firms in the early to intermediate stages of internationaliza- tion.10 Small, inexperienced firms are often vulnerable during the initial phase of overseas expansion. On the other hand, many other studies document an inverted U shape, because their samples are biased for larger firms with moderate to high levels of diversi- fication.11 Many large multinational enterprises (MNEs) have a “flag planting” mentality, bragging about the number of countries in which they have a presence. However, their performance, beyond a certain limit, often suffers, thus necessitating some withdrawals. Wal-Mart, for example, had to withdraw from Germany and South Korea.

FIGURE 9.2 Geographic Diversification and Firm Performance: An S Curve

Limited Intermediate Extensive Level of geographic diversification

Pe rf

or m

an ce

Source: Adapted from (1) F. Contractor, S. K. Kundu, & C.-C. Hsu, 2003, A three stage theory of international expansion: The link between multinationality and performance in the service sector (p. 7), Journal of International Business Studies, 34: 5–18; (2) J. Lu & P. Beamish, 2004, Inter- national diversification and firm performance: The S-curve hypothesis (p. 600), Academy of Management Journal, 47: 598–609.

264 PART 3 CORPORATE-LEVEL STRATEGIES

Given this complexity, it is hardly surprising that there is a great debate about geographic diversification.12 Shown in Figure 9.2, there indeed is an intermediate range within which firm performance increases with geographic scope, leading some studies that sample firms in this range to conclude that “there is value in internationalization itself because geographic scope is found to be related to higher firm profitability.”13

However, other studies, which sample firms with a high level of geographic scope, caution that “multinational diversification is apparently less valuable in practice than in theory.”14 Consequently, the recent consensus emerging out of the debate is to not only acknowledge the validity of both perspectives, but also to specify conditions under which each perspective (geographic diversification helps or hurts firm performance) is likely to hold.15

Combining Product and Geographic Diversification Although most studies focus on a single dimension of diversification (product or geographic) that is already very complex, in practice, most firms (except single-business firms with no interest to internationalize) have to entertain both dimensions of diversi- fication simultaneously.16 Figure 9.3 illustrates the four possible combinations. Firms in Cell 3 are anchored replicators, because they focus on product-related diversification and a limited geographic scope. They seek to replicate a set of activities in related industries in a small number of countries anchored by the home country.

Firms in Cell 1 can be called multinational replicators because they engage in product- related diversification on the one hand and far-flung multinational expansion on the other

FIGURE 9.3 Combining Product and Geographic Diversification

(Cell 1) Multinational

replicator conglomerate

Extensive

Unrelated

Limited

(Cell 2) Far-flung

(Cell 4) Classic

Product Scope

(Cell 3) Anchored

Geographic Scope

anchored replicator

A firm that seeks to replicate a set of activities in related industries in a small number of countries anchored by the home country.

multinational replicator

A firm that engages in product-related diversification on the one hand and far-flung multinational expansion on the other hand.

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hand. Most automakers such as Volkswagen, Renault, and Nissan have pursued this combination.

Firms in Cell 2 can be labeled as far-flung conglomerates because they pursue both product-unrelated diversification and extensive geographic diversification. MNEs such as Bombardier, GE, Mitsui, Samsung, Siemens, and Vivendi Universal serve as cases in point.

Finally, in Cell 4 we find classic conglomerates, firms that engage in product- unrelated diversification within a small set of countries centered on the home country. Current examples include India’s Tata Group, Turkey’s Koc Group, and China’s Hope Group.

Overall, migrating from one cell to another, although difficult, is possible. For instance, most of the current multinational replicators (Cell 1) can trace their roots as anchored replicators (Cell 3). One interesting migratory pattern in the past two decades is that many classic conglomerates, such as Denmark’s Danisco (see Strategy in Action 9.1), Finland’s Nokia, and South Korea’s Samsung, which formerly domi- nated multiple unrelated industries in their home countries, have reduced their product scope but significantly expanded their geographic scope—in other words, migrating from Cell 4 to Cell 1.17 In broad strategic terms, this means that the costs for doing business abroad have declined and that the costs for managing conglom- eration have risen. In other words:

Further, asserting that firms in a particular cell will outperform those in other cells is naïve if not foolhardy. In every cell, we can find both highly successful and highly unsuccessful firms. Next, we explore why this is the case.

A Comprehensive Model of Diversification Why do firms diversify? The strategy tripod suggests a comprehensive model of diversi- fication (Figure 9.4) to answer this complex and important question.

Industry-Based Considerations A straightforward motivation for diversification is the growth opportunities in an indus- try. If an industry has substantial growth opportunities (such as biotechnology), most incumbents have an incentive to engage in product-related and/or international diversi- fication. However, if it is a “sunset” industry (think of typewriters), many incumbents may exit and pursue opportunities elsewhere.

In addition to growth opportunities, the structural attractiveness of an industry, captured by the five forces framework, also has a significant bearing on diversification. Intense interfirm rivalry may motivate firms to diversify. PepsiCo diversified into sports drinks. When demand for carbonated beverages, such as Mountain Dew, flattened out

Costs in Cell 4 (managing conglomeration while mostly staying at home) >

Costs in Cell 1 (doing business extensively abroad but maintaining product relatedness in

diversification)

far-flung conglomerate

A conglomerate firm that pursues both extensive product-unrelated diversification and extensive geographic diversification.

classic conglomerate

A firm that engages in product-unrelated diversification within a small set of countries centered on the home country.

266 PART 3 CORPORATE-LEVEL STRATEGIES

STRATEGY IN ACTION 9.1

The Evolution of Danisco’s Corporate Strategy

When, in 2009, Danisco announced the completion of the sale of its sugar division to its German competitor Nordzucker, many Danes were rubbing their eyes. For them, the name “Danisco” was synonymous with “sugar.” What was Danisco doing now? The answer: Danisco had been undergoing a steady transformation over 20 years.

After the transformation, Danisco was positioned as a specialized supplier of food ingredients based on natural raw materials. Its customers included global food giants such as Unilever, Kraft, Danone, and Nestlé, as well as regional and local players in all major economies. Danisco specialized in ingredients that alter the properties of processed foods such as yogurt, ice cream, sauces, and bread. For example, it was involved in the creation of Magnum ice cream, which was successfully marketed by major brand manufacturers around the world.

How did Danisco become a global leader in this niche? It was created in 1989 by a merger of three companies, the oldest of which was Danish Sugar dating back to 1872. The merger was hoped to keep traditional businesses in Danish hands and enhance their viability. The new company was a diversified conglomerate operating mainly in Denmark and other parts of Northern and Western Europe. In the first annual report (1989/1990), the corporate strategy was stated as “to be a first-class supplier to the international food industry on the global market and be a supplier of high quality foods and branded goods on selected European markets.” Over the years, the foods, food ingredients, and packaging businesses were grown, while businesses in the machine building segment were sold.

In the sugar sector, Danisco first consolidated its dominant position in Denmark. It then grew by acquisitions around the Baltic Sea in Sweden, (East) Germany, Poland, and Lithuania. The sugar market was shaped by EU regulation that aimed to protect sugar beet farmers, but that also constrained the intensity of competition and limited the scope for aggressive growth.

Liberalization of this market had long been anticipated, and it finally came into effect in 2009.

In 1999, Danisco announced a new strategy focusing solely on food ingredients and acquired Finnish ingredients manufacturer Cultor OY to cement this strategic shift. At the same time, Danisco began to sell its businesses in branded foods and food packaging including iconic Danish brands such as Aalborg Snaps. Two divisions thus remained: Danisco Ingredients focused on emulsifiers, stabilizers, flavors, and enzymes, and Danisco Sugar dominated Northern European sugar markets. The internationalization of sales rapidly increased, with sales outside Denmark rising from 69% in 1995 to 88% in 2004—and over 95% after the sale of the sugar division in 2009. In 2009, Danisco generated €1.7 billion revenue, of which 38% came from Europe, 40% from the Americas, and 17% from the Asia Pacific. Danisco employed 6,800 people in 17 countries, in part to serve local markets (such as China) and in part to process natural ingredients only found in specific locations (such as Chile). Expansion in Europe, North America, and Australia occurred mainly through acquisitions, while business in emerging economies grew to a large extent by greenfield projects.

The sale of the sugar division in 2009 was thus the logical consequence of the two-decade-long evolutionary process of Danisco’s corporate strategy. The synergies between the sugar and ingredients sectors had diminished, while liberalization of the EU sugar regime led to the expectation of changing competitive dynamics in the sector. In response, Danisco migrated from Cell 4 to Cell 1 in Figure 9.3 with a reduced product scope and much more extensive geographic scope globally. In 2011, Danisco itself was acquired by DuPont.

Source: Adapted from M. W. Peng & K. Meyer, 2011, International Business (pp. 422–423), London: Cengage Learning EMEA.

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(at least in the United States), PepsiCo’s considerable distribution capabilities could find some synergy by adding the newly acquired Gatorade products.

Second, high entry barriers facilitate certain kinds of firms to diversify. For example, most of the industries that Samsung successfully competed in—LCD and mobile phones—are characterized by high entry barriers. The five new industries that Samsung has aggressively entered—solar panels, LED lighting, medical devices, bio- tech drugs, and batteries for electric cars—share the same characteristics (see the Opening Case). The choices are not random. Samsung has deliberately targeted such high capital intensity industries that would scare away a lot of potential entrants due to high entry barriers.

The bargaining power of suppliers and buyers may prompt firms to broaden their scope by acquiring suppliers upstream and/or buyers downstream. For example, Coca-Cola recently acquired its leading bottlers.

FIGURE 9.4 A Comprehensive Model of Diversification

Industry-based considerations

• Industry growth opportunities • Interfirm rivalry • Entry barriers • Power of suppliers and buyers • Threat of substitutes • Possible conglomeration

Resource-based considerations

• Value (risk reduction and core competencies) • Rarity • Imitability • Organization (different for related or unrelated diversifiers)

Institution-based considerations

• Formal institutions constrain or enable diversification • Lack of formal institutions promotes conglomeration • Informal norms and cognitions (managerial motives)

Diversification strategies

Product/Geographic

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The threat of substitutes also has a bearing on diversification. Kodak and Fuji have been threatened by Canon, Samsung, and HP, which diversified into digital cameras—a substitute for film. None of these electronics firms had been regarded as a rival by Kodak and Fuji until recently.

In summary, the industry-based view, by definition, has largely focused on product- related diversification with an industry focus (often in combination with geographic diversification). Next, we introduce resource-based and institution-based considerations to enrich this discussion.

Resource-Based Considerations Shown in Figure 9.4, the resource-based view—outlined by the VRIO framework—has a set of complementary considerations underpinning diversification strategies.

VALUE. Does diversification create value? The answer is “Yes,” but only under certain conditions.18 Compared with non-diversified single-business firms, diversified firms are able to spread risk. Even for over-diversified firms that have to restructure, no one is returning to a single business with no diversification. The most optimal point tends to be some moderate level of diversification.

Beyond risk reduction, diversification can create value by leveraging certain core competencies, resources, and capabilities. Honda is renowned for its product-related diversification by leveraging its core competence in internal combustion engines. It not only competes in automobiles and motorcycles, but also in boat engines and lawnmowers. HondaJet represents its most recent efforts (see Strategy in Action 9.2).

RARITY. For diversification to add value, firms must have unique skills to execute such a strategy. In 2004, an executive team at China’s Lenovo planned to acquire IBM’s PC division—a significant move in geographic diversification. The team confronted Lenovo’s suspicious board, which raised a crucial question: If a venerable American technology company had failed to profit from the PC business, did Lenovo have what it took to do better when managing such a complex global business? The answer was actually “No.” The board only gave its blessing to the plan when the acquisition team agreed to not only acquire the business, but also to recruit top American executives.

IMITABILITY. While many firms undertake acquisitions, a much smaller number of them have mastered the art of post-acquisition integration.19 Consequently, firms that excel in integration possess hard-to-imitate capabilities. At Northrop, integrating acquired businesses has progressed to a “science.” Each must conform to a carefully orchestrated plan listing nearly 400 items, from how to issue press releases to which accounting software to use. Unlike its bigger defense rivals such as Boeing and Raytheon, Northrop thus far has not stumbled with any of the acquisitions.

ORGANIZATION. Fundamentally, whether diversification adds value boils down to how firms are organized to take advantage of the benefits while minimizing the

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costs.20 Since Chapter 10 will be devoted to organizational issues in geographic diversification, here we focus on product diversification. Given the recent popularity of product-related diversification, many people believe that product-unrelated diversification is an inherently value-destroying strategy. However, this is not true. With proper organization, product-unrelated diversification can add value.

Shown in Table 9.1, product-related diversifiers need to foster a centralized organizational structure with a cooperative culture. The key is to explore operational linkages among various units, and some units may need to be pulled back to coordinate with other units. For example, to maximize corporate profits, Disney’s movie division producing the movie High School Musical (and its sequels High School Musical 2 and 3) had to wait before launching the movie until its merchan- dise divisions were ready to hawk related merchandise such as books, DVDs, video games, on-stage musicals, ice-skating shows, Valentines’ day cards, blankets, and pillow covers. If movie managers’ bonuses were linked to the annual box-office receipts, they would obviously be eager to release the movie. But if bonuses were

STRATEGY IN ACTION 9.2

Can HondaJet Fly High?

Honda is renowned for leveraging its core competence in internal combustion engines, by not only competing in automobiles and motorcycles but also in boat engines and lawn mowers. And now Honda is taking to the skies. Are you ready for a HondaJet?

Having taken its first maiden flight in 2003, HondaJet is now being introduced to the business jet (corporate aviation) market. Michimasa Fujino, president and CEO of Honda Aircraft Company, Inc., reports that the company will be delivering several aircraft to early customers in 2013, increasing production throughout 2014, and reaching full production capacity—approximately 70 to 100 small jets annually—in 2015.

Currently, however, the HondaJet is still undergoing extensive testing in the process of FAA and EASA certification. These tests are especially important given that Honda is incorporating a number of technological innovations in aviation design. Perhaps the most notable of these is Honda’s over-the-wing engine-mount con- figuration, which Honda claims dramatically improves performance and fuel efficiency by reducing aerodynamic drag. The new design, which gives the HondaJet a

distinctive appearance, also reduces noise and increases both cabin and cargo capacity. Another innovation is the “next generation” glass flight deck, which Honda describes as “the most advanced available in any light business jet.”

Honda Aircraft Company, a wholly owned subsidiary of American Honda Motors Inc., was founded in 2006. At Honda Aircraft’s world headquarters campus in Piedmont Triad International Airport, Greensboro, North Carolina (near the birthplace of aviation where the Wright brothers took their first flight), state-of-the-art R&D and manufacturing work is being performed. In a nutshell, the question now is: “How high can HondaJet fly?”

Sources: Based on (1) K. Arcieri, 2012, Mass production of HondaJet expected later this year, The Business Journal, May 14, http://www.bizjournals.com/triad/news/2012/05/14/honda- aircraft-co-to-begin-mass.html (accessed August 14, 2012); (2) R. Goyer, 2012, Honda jet makes progress, Flying Magazine, May 15, http://www.flyingmag.com/aircraft/jets/ honda-jet-makes-progress (accessed August 14, 2012); (3) http:// hondajet.honda.com (accessed February 29, 2012).

270 PART 3 CORPORATE-LEVEL STRATEGIES

linked with overall corporate profits, then movie managers would be happy to assist and coordinate with their merchandise colleagues and would not mind waiting for a while. Consequently, corporate headquarters should not evaluate division performance solely based on strict financial targets (such as sales). The principal control mechan- ism is strategic control (or behavior control), based on largely subjective criteria to monitor and evaluate units’ contributions with rich communication between corpo- rate and divisional managers.

However, the best way to organize conglomerates is exactly the opposite. The emphasis is on financial control (or output control), based on largely objective criteria (such as return on investment) to monitor and evaluate units’ performance. Because most corpo- rate managers have experience in only one industry (or a few) and none realistically can be an expert in the wide variety of unrelated industries represented in a conglomerate, corporate headquarters is forced to focus on financial control, which does not require a lot of rich industry-specific knowledge. Otherwise, corporate managers will experience a tremendous information overload (too much information to process). Consequently, the appropriate organizational structure is decentralization with substantial divisional autonomy—in other words, structurally separate units. To keep divisional managers focused on financial performance, their compensation should be directly linked with quantifiable unit performance. Thus, the relationship among various divisions is compe- titive, each trying to attract a larger share of corporate investments. Such competition within an internal capital market is similar to stand-alone firms competing for more funds from the external capital market. The Virgin Group, for example, considers itself as “a branded venture capital firm” whose portfolio includes airlines, railways, beverages, and music. The corporate headquarters supplies a common brand (Virgin) and leaves divi- sional managers “alone” as long as they deliver sound performance.

Overall, the key to adding value through either product-related or product-unrelated diversification is the appropriate match between diversification strategy and organizational

TABLE 9.1 Product-Related versus Product-Unrelated Diversification

PRODUCT-RELATED DIVERSIFICATION

PRODUCT-UNRELATED DIVERSIFICATION

Synergy Operational synergy Financial synergy

Economies Economies of scale Economies of scope

Control emphasis Strategic (behavior) control Financial (output) control

Organizational structure Centralization Decentralization

Organizational culture Cooperative Competitive

Information processing Intensive rich communication Less intensive communication

strategic control (behavior control)

Controlling subsidiary/unit operations based on whether they engage in desirable strategic behavior (such as cooperation).

financial control (output control)

Controlling subsidiary/unit operations strictly based on whether they meet financial/output criteria.

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structure and control. Conglomerates often fail when corporate managers impose a more centralized structure undermining lower-level autonomy.

Institution-Based Considerations Given that it is a combination of formal and informal institutions that drives firm strategies such as diversification, we examine each set of institutions in turn.

FORMAL INSTITUTIONS. Formal institutions affect diversification strategies.21 The rise of conglomerates in the 1950s and the 1960s in developed economies was inadvertently promoted by formal constraints designed to curtail product-related diversification. In the United States, the post-1950 antitrust authorities viewed product-related diversification (especially mergers), designed to enhance firms’ market power within an industry, as “anticompetitive” and challenged them. Thus, firms seeking growth were forced to look beyond their industry, triggering a great wave of conglomeration. By the 1980s, the US government changed its mind and no longer critically scrutinized related mergers within the same industry. It is not a coincidence that the movement to dismantle conglomerates and focus on core competencies has taken off since the 1980s.

Similarly, the popularity of conglomeration in emerging economies is often under- pinned by their governments’ protectionist policies. Conglomerates (often called business groups in emerging economies) can leverage connections with governments by obtaining licenses, arranging financing (often from state-owned or state-controlled banks), and securing technology. As long as protectionist policies prevent significant foreign entries, conglomerates can dominate domestic economies. However, when governments start to dismantle protectionist policies, competitive pressures from foreign multinationals (as well as domestic non-diversified rivals) may intensify. These changes may force conglomerates to improve performance by reducing their scope (see the Opening Case).22

Likewise, the significant rise of geographic diversification undertaken by numerous firms can be attributed, at least in part, to the gradual opening of many economies initiated by formal marketing-supporting and market-opening policy changes.

INFORMAL INSTITUTIONS. Informal institutions can be found along normative and cognitive dimensions. Normatively, managers often seek to behave in ways that will not cause them to be noticed as different and consequently singled out for criticism by shareholders, board directors, and the media. Therefore, when the norm is to engage in conglomeration, more managers may simply follow such a norm. Poorly performing firms are especially under such normative pressures. While early movers in conglomeration (such as GE) may indeed have special skills and insights to make such a complex strategy work, many late movers probably do not have these capabilities and simply jump on the “bandwagon” when facing poor performance. Over time, this explains—at least partially—the massive disappointment with conglomeration in developed economies.

Another informal driver for conglomeration is the cognitive dimension—namely, the internalized beliefs that guide managerial behavior.23 Managers may have motives to

business group

A term to describe a conglomerate, which is often used in emerging economies.

272 PART 3 CORPORATE-LEVEL STRATEGIES

advance their personal interests that are not necessarily aligned with the interests of the firm and its shareholders.24 These are called managerial motives for diversification, such as (1) reduction of managers’ employment risk and (2) pursuit of power, prestige, and income. Because single-business firms are vulnerable to economy-wide ups and downs (such as recessions), managers’ jobs and careers may be at risk. Thus, managers may have an interest to diversify their firms in order to reduce their own employment risk. In addition, since power, prestige, and income are typically associated with a larger firm size, some managers may have self-interested incentives to overdiversify their firms, resulting in value destruction. Such excessive diversification is known as empire building (see Chapter 11).

In summary, the institution-based view suggests that formal and informal institutional conditions directly shape diversification strategy. Taken together, the industry-based, resource-based, and institution-based views collectively explain how the scope of the firm evolves around the world.

The Evolution of the Scope of the Firm25

At its core, diversification is essentially driven by economic benefits and bureaucratic costs. Economic benefits are the various forms of synergy (operational or financial) discussed earlier. Bureaucratic costs are the additional costs associated with a larger, more diversified organization, such as more headcounts and more complicated information systems. Overall, it is the difference between the benefits and costs that leads to certain diversification strategies. Since the economic benefits of the last unit of growth (such as the last acquisition) can be defined as marginal economic benefits (MEB) and the addi- tional bureaucratic costs incurred as marginal bureaucratic costs (MBC), the scope of the firm is thus determined by a comparison between MEB and MBC. Shown in Figure 9.5, the optimal scope is at point A, where the appropriate level of diversification should be D1. If the level of diversification is D2, some economic benefits can be gained by moving up to D1. Conversely, if a firm overdiversifies to D3, reducing the scope to D1 becomes necessary. Thus, how the scope of the firm evolves over time can be analyzed by focusing on MEB and MBC.26

In the United States (Figure 9.6), between the 1950s and 1970s, if we hold MBC constant (an assumption relaxed later), the MEB curve shifted upward, resulting in an expanded scope of the firm on average (moving from D1 to D2). This is because (1) growth opportunities within the same industry through product-related diversification, especially for large firms, were blocked by formal institutions such as antitrust policies, (2) the emergence of organizational capabilities to derive financial synergy from conglomeration, and (3) the diffusion of these actions through imitation, leading to an informal but visible norm among managers that such product-unrelated growth was legitimate. During that time, external capital markets, which were less sophisticated, were supportive, believing that conglomerates had an advantage in allocating capital.

However, by the early 1980s, significant transitions occurred along industry, resource, and institutional dimensions. First, M&As within the same industry were no longer critically scrutinized by the government, making it unnecessary to focus on unrelated diversification in different industries. Second, a resource-based analysis suggests that given the VRIO hurdles, it would be extremely challenging—though not impossible—to

economic benefits

Benefits brought by the various forms of synergy in the context of diversification.

bureaucratic costs

The additional costs associated with a larger, more diversified organization.

marginal economic benefits (MEB)

The economic benefits of the last unit of growth (such as the last acquisition).

marginal bureaucratic costs (MBC)

The bureaucratic costs of the last unit of organizational expansion (such as the last subsidiary established).

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FIGURE 9.6 The Evolution of the Scope of the Firm in the United States: 1950–1970 and 1970–1990

D1 D3 D2 Level of diversification

Marginal bureaucratic costs (MBCUS1990)

Marginal economic benefits (MEBUS1970)

Marginal economic benefits (MEBUS1950)

Marginal bureaucratic costs (MBCUS1950 and 1970)

C os

ts /b

en efi

Source: M. W. Peng, S.-H. Lee, & D. Wang, 2005, What determines the scope of the firm over time? A focus on institutional relatedness (p. 627), Academy of Management Review, 30: 622–633.

FIGURE 9.5 What Determines the Scope of the Firm?

Level of diversification

D2 D1 D3

Marginal bureaucratic costs (MBC)

Marginal economic benefits (MEB)

C os

ts /b

en efi

Source: Adapted from G. Jones & C. Hill, 1988, Transaction cost analysis of strategy-structure choices (p. 166), Strategic Management Journal, 9: 159–172.

274 PART 3 CORPORATE-LEVEL STRATEGIES

derive competitive advantage from conglomeration (discussed earlier). In other words, with an expanded scope of the firm, MBC also increased, often outpacing the increase in MEB (Figure 9.6). Many firms overdiversified and destroyed value. Consequently, a dramatic reversal in US investor sentiment occurred toward conglomeration: Positive in the 1960s, neutral in the 1970s, and negative in the 1980s. Parallel to these developments, external capital markets became better developed with more analysts and more transpar- ent and real-time reporting, all of which allowed for more efficient channeling of financial resources to high-potential firms. As a result, the conglomerate advantage serving as an internal capital market became less attractive. Finally, informal norms and cognitions changed, as managers increasingly became more disciplined and focused on shareholder value maximization and believed that reducing the scope of the firm was the “right” thing to do. All these combined to push the appropriate scope of the firm from D2 to D3 in Figure 9.6 by the 1990s.

Globally, an interesting extension is to understand the puzzle of why conglomeration, which has been recently discredited in developed economies, not only is in vogue but also in some (but not all) cases adds value in emerging economies. Figure 9.7 shows how conglom- erates in emerging economies may add value at a higher level of diversification, whereby firms in developed economies are not able to. This analysis relies on two crucial and reasonable assumptions. The first is that at a given level of diversification, MEBEmergingEcon > MEBDevelopedEcon. This is primarily because underdeveloped external capital markets in emer- ging economies make conglomerates as internal capital markets more attractive.

FIGURE 9.7 The Optimal Scope of the Firm: Developed versus Emerging Economies at the Same Time

D1 D3 D2 Level of diversification

Marginal bureaucratic costs (MBCDevelopedEcon)

Marginal economic benefits (MEBEmergingEcon)

Marginal economic benefits (MEBDevelopedEcon)

Marginal bureaucratic costs (MBCEmergingEcon)

A B

C os

ts /b

en efi

Source: M. W. Peng, S.-H. Lee, & D. Wang, 2005, What determines the scope of the firm over time? A focus on institutional relatedness (p. 628), Academy of Management Review, 30: 622–633.

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A second assumption is that at a given level of diversification, MBCEmergingEcon < MBCDevelopedEcon. In emerging economies, because of the weaknesses of formal institu- tions, informal constraints rise to play a larger role in regulating economic exchanges (see Chapter 4). Most conglomerates in these countries are family firms whose managers rely more on informal personal (and often family) relationships to get things done. Relative to firms in developed economies, firms in emerging economies typically feature a lower level of bureaucratization, formalization, and professionalization, which may result in lower bureaucratic costs.

Consequently, for any scope between D1 and D2 (such as D3) in Figure 9.7, firms in developed economies at point C need to be downscoped toward point A (D1), whereas there is still room to gain for firms in emerging economies at point E, which can move up to point B (D2). However, bear in mind that conglomerates in emerging economies confront the same problem that plagues those in developed economies: The wider the scope, the harder it is for corporate headquarters to coordinate, control, and invest properly in different units. It seems evident that for conglomerates in emerging econo- mies, there is also a point beyond which further diversification may backfire. As shown in the Opening Case on South Korean conglomerates, the conglomerate advantage is especially likely to be eroded when external capital markets in emerging economies become better developed. Thus, some reduction of the corporate scope will be a must.

Overall, industry dynamics, resource repertoires, and institutional conditions are not static, nor are diversification strategies. The next two sections describe two primary means for expanding and contracting the scope of the firm—through acquisitions and restruc- turing, respectively.

Acquisitions Setting the Terms Straight Although the term “mergers and acquisitions” (M&As) is often used, in reality, acquisi- tions dominate the scene. An acquisition is transfer of the control of assets, operations, and management from one firm (target) to another (acquirer), the former becoming a unit of the latter. A merger is the combination of assets, operations, and management of two firms to establish a new legal entity. Only approximately 3% of cross-border M&As are mergers. Even many so-called “mergers of equals” turn out to be one firm taking over another (such as DaimlerChrysler). Because the number of “real” mergers is very low, for practical purposes, we can use the two terms “M&As” and “acquisitions” interchangeably. Specifically, we focus on cross-border (international) M&As, whose various types are illustrated by Figure 9.8. Cross-border activities represent approximately 30% of all M&As, and M&As represent the largest proportion (about 70%) of FDI flows.

There are three primary categories of M&As: (1) horizontal, (2) vertical, and (3) con- glomerate. Horizontal M&As refer to deals involving competing firms in the same industry (such as Nomura’s acquisition of Lehman Brothers’ assets).27 Approximately 70% of the cross-border M&As are horizontal. Vertical M&As, another form of product-related diversification, are deals that allow the focal firms to acquire (upstream) suppliers and/ or (downstream) buyers (such as Coca-Cola’s acquisition of its bottler Coca-Cola Enter- prises).28 About 10% of cross-border M&As are vertical ones. Conglomerate M&As are

merger and acquisition (M&A)

Merging with or acquiring other firms.

acquisition

The transfer of control of assets, operations, and management from one firm (target) to another (acquirer); the former becomes a unit of the latter.

merger

The combination of assets, operations, and management of two firms to establish a new legal entity.

horizontal M&A

An M&A deal involving competing firms in the same industry.

vertical M&A

An M&A deal involving suppliers (upstream) and/or buyers (downstream).

conglomerate M&A

An M&A deal involving firms in product-unrelated industries.

276 PART 3 CORPORATE-LEVEL STRATEGIES

transactions involving firms in product-unrelated industries (such as 3G Capital’s acqui- sition of Burger King—see Emerging Markets 9.1). Roughly 20% of cross-border M&As are conglomerate deals.

The terms of M&As can be friendly or hostile. In friendly M&As, the board and management of a target firm agree to the transaction. Hostile M&As (also known as hostile takeovers) are undertaken against the wishes of the target firm’s board and management, who reject M&A offers. In the United States, hostile M&As are more frequent, reaching 14% of all deals in the 1980s (although the number went down to 4% in the 1990s). Internationally, hostile M&As are very rare, accounting for less than 0.2% of all deals and less than 5% of total value. The $19 billion hostile takeover of Cadbury by Kraft in 2010 was a high-profile example of hostile cross-border M&A.

Motives for Mergers and Acquisitions What drives M&A? Table 9.2 shows three drivers: (1) synergistic, (2) hubris, and (3) managerial motives, which can be illustrated by the three leading perspectives.

FIGURE 9.8 The Variety of Cross-Border Mergers and Acquisitions

Cross-border M&As

Mergers (about 3% of all M&As)

Consolidation (equal mergers)

Statutory merger (only one

firm survives)

Acquisitions (about 97% of

all M&A)

Acquisition of a foreign

affiliate

Acquisition of a local

firm

Acquisition of a private local firm

Privatization (acquisition of a

public enterprise)

friendly M&A

An M&A deal in which the board and management of a target firm agree to the transaction (although they may initially resist).

hostile M&A (hostile takeover)

An M&A deal undertaken against the wishes of target firm’s board and management, who reject the M&A offer.

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In terms of synergistic motives, the most frequently mentioned industry-based rationale is to enhance and consolidate market power.29 For example, the merger of United and Continental created the world’s largest airline.

From a resource-based view, the most important synergistic rationale is to leverage superior resources.30 Shown in the Closing Case, Indian firms’ cross-border acquisitions have primarily targeted high-tech and computer services in order to leverage their superior resources in these industries. Finally, another motive is to gain access to complementary resources, as evidenced by Nomura’s interest in Lehman Brothers’ worldwide client base.31

In terms of synergistic motives, from an institution-based view, acquisitions are often a response to formal institutional constraints and transitions in search of synergy.32 It is not a coincidence that the number of cross-border M&As has skyrocketed in the past two decades. This is the same period during which trade and investment barriers have gone down and FDI has risen.

EMERGING MARKETS 9.1

Brazil’s Whopper Deal

In 2010, 3G Capital of Brazil, a private equity firm, acquired the Miami-headquartered fast food chain Burger King for $3.3 billion. 3G Capital was supported by three well-known Brazilian investors: Jorge Paulo Lemann, Carlos Alberto Sicupira, and Marcel Telles. Lemann founded one of Brazil’s most successful investment banks, Banco de Investimentos Garantia, in the 1970s. Sicupira started in the 1980s at that bank and then grew a single Rio de Janeiro store into Lojas Americanas, one of Brazil’s biggest retail chains. In the 1980s, Telles, with Lemann and Sicupira, gained control of a Brazilian brewery that they grew into AmBev, which merged with Belgium’s InBev and acquired America’s Anheuser-Busch.

In 2011, Alex Behring, a 3G Capital managing partner, became Burger King’s chairman and CEO. Behring worked at GP Investmentos, a private equity firm that Sicupira founded. As a result, Brazilians quietly control and manage both Anheuser-Busch and Burger King, two iconic American brands.

As domestic competition in Brazil intensified, it became tougher for Brazilian companies to grow through M&As locally. Therefore, they eyed overseas markets with a great deal of interest. Brazilian companies active in overseas M&As include Gerdau (which picked up

Ameristeel); JBS-Friboi (which bought Pilgrim’s Pride); Petrobras (which took over the Pasadena refinery and Cascade Field); WEG (which acquired Voltran and Zest Group); and Vale (which invested in White Plains and Fosfertil).

Burger King’s new management team must revitalize the 12,000-store, 75-country chain that was a distant number two to McDonald’s. This would not be easy. Franchisees resisted the expensive face-lift recommended by Burger King. In an effort to boost sales, some stores in Virginia and Maryland started deliveries. The Latin American connection could help too. Burger King’s supply chain could benefit by procuring more meat and grain in South America. Also, the fast food chain could expand across the continent. In the two years after the 3G takeover, Burger King increased the number of restaurants it operated in Latin America by 6%, to about 1,200.

Sources: Based on (1) Bloomberg Businessweek, 2010, An expensive face-lift on Burger King’s menu, October 11: 21–22; (2) Bloomberg Businessweek, 2012, Burger King: A home delivery program, January 23: 26; (3) F. Luzio, 2010, Brazil’s Whopper deal, Harvard Business Review, September 13: blogs.hbr.org.

278 PART 3 CORPORATE-LEVEL STRATEGIES

While all the synergistic motives, in theory, add value, hubris and managerial motives reduce value. Hubris refers to managers’ overconfidence in their capabilities. Managers of acquiring firms make two very strong statements. The first is that “We can manage your assets better than you [target firm managers] can!” This was essentially what Brazilian executives at 3G Capital who took over Burger King told the former management team (see Emerging Markets 9.1). The second statement is even bolder, because acquirers of publicly listed firms always have to pay an acquisition premium (an above-the-market price to acquire another firm).33 Acquirers of US firms on average pay a 20% to 30% premium, and acquirers of EU firms pay a slightly lower premium (about 18%).34 This is essentially saying: “We are smarter than the market!” To the extent that the capital market is (relatively) efficient and that the market price of target firms reflects their intrinsic value, there is simply no hope to profit from such acquisitions. Even when we assume the capital market to be inefficient, it is still apparent that when the premium is too high, acquiring firms must have overpaid. This is especially true when multiple firms bid for the same target, the winning acquirer may suffer from the “winner’s curse” from auctions—that is, the winner has overpaid. From an institution-based view, many managers join the acquisition “bandwagon” after some first-mover firms start doing deals in an industry. The fact that M&As come in “waves” speaks volumes about such a herd behavior.35 Eager to catch up, many late movers in such “waves”may rush in, prompted by a “Wow! Get it!” mentality. Not surprisingly, many deals go bust.

While the hubris motives suggest that managers may unknowingly overpay for targets, managerial motives posit that for self-interested reasons, some managers may have knowingly overpaid the acquisition premium for target firms.36 Driven by such norms and cognitions, some managers may have deliberately overdiversified their firms through M&As (see Chapter 11 for details).

Overall, synergistic motives add value, and hubris and managerial motives destroy value. They may simultaneously coexist. The Closing Case uses emerging multinationals as a new breed of cross-border acquirers to illustrate these dynamics. Next, we discuss the performance of M&As.

TABLE 9.2 Motives behind Mergers and Acquisitions

INDUSTRY-BASED ISSUES RESOURCE-BASED ISSUES INSTITUTION-BASED ISSUES

Synergistic motives

& Enhance and consolidate market power

& Overcome entry barriers & Reduce risk & Leverage scope economies

& Leverage superior managerial capabilities

& Access to complementary resources

& Learning and developing new skills

& Respond to formal institutional constraints and transitions

& Take advantage of market openings and globalization

Hubris motives

& Managers’ overconfidence in their capabilities

& Herd behavior—following norms and chasing fads of M&As

Managerial motives

& Self-interested actions such as empire-building guided by informal norms and cognitions

hubris

Managers’ overconfidence in their capabilities.

acquisition premium

The difference between the acquisition price and the market value of target firms.

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Performance of Mergers and Acquisitions Despite the popularity of M&As, their performance record is rather sobering.37 As many as 70% of M&As reportedly fail. On average, acquiring firms’ performance does not improve after acquisitions and is often negatively affected.38 Target firms, after being acquired, often perform worse than when they were independent standalone firms.39 The only identifiable group of winners is shareholders of target firms, who may experience, on average, a 24% increase in their stock value during the period of the transaction (thanks to the acquisition premium). Shareholders of acquiring firms experience a 4% loss of their stock value during the same period. The combined wealth of shareholders of both acquiring and target firms is marginally positive, less than 2%.40 While these findings are mostly from three decades of M&A data in the United States (where half of the global M&As take place and most of the M&A research is done), they probably also apply to cross-border acquisitions.

Why do many acquisitions fail? Problems can be identified in both pre- and post- acquisition phases (Table 9.3). During the pre-acquisition phase, because of executive hubris and/or managerial motives, acquiring firms may overpay targets—in other words, they fall into a “synergy trap.” For example, in 1998, when Chrysler was profitable, Daimler-Benz paid $40 billion, a 40% premium over its market value, to acquire it. Given that Chrysler’s expected performance was already built into its existing share price, at a zero premium, Daimler-Benz’s willingness to pay for such a high premium was indicative of (1) strong managerial capabilities to derive synergy, (2) high levels of hubris, (3) sig- nificant managerial self-interests, or (4) all of the above. As it turned out, by the time Chrysler was sold in 2007, it only fetched $7.4 billion, destroying four-fifths of the value. In 2010, Microsoft paid $8.5 billion for Skype, which was 400 times greater than Skype’s income. Although practically every reader of this book has heard about Skype, Skype has remained an iconic but underachieving Internet firm—how many people have paid money to Skype each other? Not surprisingly, this acquisition, Microsoft’s biggest, raised a lot of eyebrows.

TABLE 9.3 Symptoms of Merger and Acquisition Failures

PROBLEMS FOR ALL M&As PARTICULAR PROBLEMS FOR CROSS-BORDER M&As

Pre-acquisition: Overpayment for targets

& Managers overestimate their ability to create value

& Inadequate pre-acquisition screening & Poor strategic fit

& Lack of familiarity with foreign cultures, institutions, and business systems

& Inadequate number of worthy targets & Nationalistic concerns against foreign takeovers

(political and media levels)

Post-acquisition: Failure in integration

& Poor organizational fit & Failure to address multiple stakeholder

groups’ concerns

& Clashes of organizational cultures compounded by clashes of national cultures

& Nationalistic concerns against foreign takeovers (firm and employee levels)

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Another primary pre-acquisition problem is inadequate screening and failure to achieve strategic fit, which is the effective matching of complementary strategic capabil- ities.41 For example, Bank of America, in a hurry to make a deal, spent only 48 hours in September 2008 before agreeing to acquire Merrill Lynch for $50 billion. Not surprisingly, failure to do adequate homework—technically, due diligence (investigation prior to sign- ing contracts)—led to numerous problems centered on the lack of strategic fit. Conse- quently, this acquisition was labeled by the Wall Street Journal as “a deal from hell.”42

Acquiring international assets can be even more problematic because institutional and cultural distances can be even larger, and nationalistic concerns over foreign acquisitions may erupt (see the Closing Case). When Japanese firms acquired Rockefeller Center and movie studios in the 1980s and the 1990s, the US media reacted with indignation. In the 2000s, when DP World from the United Arab Emirates and CNOOC from China attempted to acquire US assets, they had to back off due to political backlash.

Numerous integration problems may surface during the post-acquisition phase.43

Defined as similarity in cultures, systems, and structures, organizational fit is just as important as strategic fit. Many acquiring firms do not analyze organizational fit with targets. For example, when Nomura decided to acquire Lehman Brothers’ assets in Asia and Europe in a lightning 24 hours, no consideration was given on the total lack of organizational fit between a hard-charging New York investment bank and a conservative, seniority-based Japanese firm still practicing lifetime employment. Firms may also fail to address the concerns of multiple stakeholders, including job losses and diminished power (see Figure 9.9). Most firms focus on task issues such as

FIGURE 9.9 Stakeholder Concerns During Mergers and Acquisitions

Internal conflicts: fractious management groups, key staff leave

Synergies difficult to attain

Unrealistic euphoria

When do lay-offs begin?

What should I tell my customers?

Who is setting my priorities

and objectives?

Optimistic view of return on investment?

Will synergy benefits be

downscaled?

Will efficiency & short-term

revenues fall?

Expected to do M&A + day jobs at the same time

Concern over job security

Overwhelmed by scale and scope

Service quality dips, relationship

suffers So what?

No one is listening to me. Do I still matter?

Middle management

Front-line employees

Customers

Top management

Investors

strategic fit

The complementarity of partner firms’ “hard” skills and resources, such as technology, capital, and distribution channels.

organizational fit

The complementarity of partner firms’ “soft” organizational traits, such as goals, experiences, and behaviors, that facilitate cooperation.

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standardizing reporting and pay inadequate attention to people issues, which typically results in low morale and high turnover.

In cross-border M&As, integration difficulties may be much worse because clashes of organizational cultures are compounded by clashes of national cul- tures.44 Due to cultural differences, Chinese acquirers such as Geely often have a hard time integrating Western firms such as Volvo (see the Closing Case). But even when both sides are from the West, cultural conflicts may still erupt. When Four Seasons acquired a hotel in Paris, the simple American request that employ- ees smile at customers was resisted by French employees and laughed at by the local media as “la culture Mickey Mouse.” After Alcatel acquired Lucent, the situation, in the words of Bloomberg Businessweek, became “almost comically dysfunctional.”45 At an all-hands gathering at an Alcatel-Lucent European facility, employees threw fruits and vegetables at executives announcing another round of restructuring.

Although acquisitions are often the largest capital expenditures most firms ever make, they frequently are the worst planned and executed activities of all.46 Unfortunately, while merging firms are sorting out the mess, rivals are likely to launch aggressive attacks. When Daimler struggled first with the chaos associated with the marriage with Chrysler and then was engulfed in the divorce with Chrysler, BMW overtook Mercedes-Benz to become the world’s number-one luxury carmaker. Adding all of the above together, it is hardly surprising that most M&As fail.

Restructuring Setting the Terms Straight Although the term “restructuring” normally refers to adjustments to firm size and scope through either diversification (expansion or entry), divestiture (contraction or exit), or both,47 its most common definition is reduction of firm size and scope—we will adopt this more frequently used definition here. There is a historical reason behind this one-sided use of the word “restructuring.” By the 1980s and the 1990s when this word surfaced in our vocabulary, many firms suffered from overdiversification and became interested in reducing size and scope. Using this definition, there are two primary ways of restructur- ing: (1) downsizing (reducing the number of employees through lay-offs, early retire- ments, and outsourcing) and (2) downscoping (reducing the scope of the firm through divestitures and spin-offs). The flipside of downscoping is refocusing, namely, narrowing the scope of the firm to focus on a few areas (see Strategy in Action 9.1).

Motives for Restructuring We can draw on the industry-based, resource-based, and institution-based views to understand the motives for restructuring.48 From an industry-based view, restructuring is often triggered by a rising level of competition within an industry. Given that a primary motivation for M&As is to eliminate redundant assets, industries experiencing a high level of M&As (such as automobiles and banking) not surprisingly often unleash major restructuring efforts.

restructuring

(1) Adjusting firm size and scope through either diversification (expansion or entry), divestiture (contraction or exit), or both. (2) Reducing firm size and scope.

downsizing

Reducing the number of employees through lay-offs, early retirements, and outsourcing.

downscoping

Reducing the scope of the firm through divestitures and spin-offs.

refocusing

Narrowing the scope of the firm to focus on a few areas.

282 PART 3 CORPORATE-LEVEL STRATEGIES

The resource-based view suggests that while restructuring may bring some benefits, significant costs also arise (such as organizational chaos, anxiety, and low morale). When most rivals restructure, these activities may not generate sustainable value, are not rare, and cause organizational problems. In short, it is “not possible for firms to ‘save’ or ‘shrink’ their way to prosperity.”49

From an institution-based perspective, by the 1980s and the 1990s, firms in developed economies increasingly felt pressure from capital markets to restructure. Managers increasingly accepted restructuring to be a part of legitimate business undertaking.50

However, strong institutional pressures against restructuring also exist. In the United States, restructuring, job losses, and outsourcing have been controversial issues in every recent presidential election. In Germany, all “redundancies” must, by law, be negotiated by workers’ councils (unions), whose members understandably are not keen to vote themselves out of jobs. In Asia, restructuring has been slow. Overall, corporate restructur- ing is not widely embraced around the world.51

Debates and Extensions The two leading debates discussed here are: (1) product relatedness versus other forms of relatedness and (2) acquisitions versus alliances.

Product Relatedness versus Other Forms of Relatedness What exactly is relatedness? While the idea of product relatedness is seemingly straight- forward (see Strategy in Action 9.2 on HondaJet), it has attracted at least three significant points of contention. First, how to actually measure product relatedness remains deba- table.52 Starbucks now sells music CDs in its coffee shops. Are coffee and music related? The answer would be both “yes” and “no,” depending on how you measure relatedness. Amazon not only sells books, but also hawks apparel, furniture, movies, power tools, TVs, and dozens of other product categories. Are these products “related”? From a production standpoint, they certainly are not. But from a distribution/shopping standpoint, a com- pelling case can be made that these products are related. One interesting quiz is: How do we characterize Sony’s product relatedness? Most of us think of Sony as a manufacturer of electronics hardware (such as TV) and software (such as games) as well as a producer of entertainment content (such as movies and music). However, since all of the above make little or lose money in recent years, what has sustained Sony is its seldom-reported and (almost totally) unrelated business in life insurance. So a sarcastic answer to the question, “What is Sony?” can be that Sony is a life insurer that makes TVs as a hobby (!).53

Second, beyond measurement issues, an important school of thought, known as the “dominant logic” school, argues that it is not the visible product linkages that can only count as product relatedness. Rather, it is a set of common underlying dominant logic that connects various businesses in a diversified firm.54 Consider Britain’s easyGroup, which operates easyJet (airline), easyCinema, and easyInternetcafe, among others. Underneath its conglomerate skin, a dominant logic is to actively manage supply and demand. Early and/or non-peak-hour customers get cheap deals (such as 20 cents a movie), and late and/ or peak-hour customers pay a lot more. Charges at the Internet cafés rise as the seats fill

dominant logic

A common underlying theme that connects various businesses in a diversified firm.

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up. While many firms (such as airlines) practice such “yield management,” none has been so aggressive as the easyGroup. Thus, instead of treating the easyGroup as an “unrelated conglomerate,” perhaps we may label it a “related yield management firm.”

Finally, from an institution-based view, some “product-unrelated” conglomerates may be linked by institutional relatedness, defined as “a firm’s informal linkages with dominant institutions in the environment that confer resources and legitimacy.”55 For example, sound informal relationships with government agencies, in countries (usually emerging econo- mies) where such agencies control crucial resources such as licensing, financing, and labor pools, would encourage firms to leverage such relationships by entering multiple industries. In emerging economies, solid connections with banks—a crucial financial institution—may help raise financing to enter multiple industries, whereas stand-alone entrepreneurial start- ups without such connections often have a hard time securing financing. This idea helps explain why in developed economies, e-commerce is dominated by new start-ups (such as Amazon and eBay), whereas in emerging economies it is dominated by new units of old-line conglomerates (such as Hong Kong’s Wharf and Singapore’s Sembcorp). It seems that despite the Western advice to downscope, some conglomerates in emerging economies have recently expanded their scope by entering new industries such as solar panels (see the Opening Case). In other words, a firm, which is classified as a “product-unrelated” conglomerate, may actually enjoy a great deal of institutional relatedness.

Acquisitions versus Alliances Despite the proliferation of acquisitions, their lackluster performance has led to a debate regarding whether they have been overused. Strategic alliances are an alternative to acquisitions (see Chapter 7). However, many firms seem to have plunged straight into “merger mania.” Even when many firms pursue both M&As and alliances, they are often undertaken in isolation.56 While many large MNEs have an M&A function and some have set up an alliance function, few firms have established a combined “mergers, acquisitions, and alliance” function. In practice, it may be advisable to explicitly compare and contrast acquisitions vis-à-vis alliances. Compared with acquisitions, alliances, despite their own problems, cost less and allow for opportunities to learn from working with each other before engaging in full-blown acquisitions. Many poor acquisitions (such as Daimler- Chrysler) would probably have been better off had firms pursued alliances first.

The Savvy Strategist Guided by the three leading perspectives that underpin the strategy tripod, the savvy strategist draws three important implications for action (Table 9.4). First, understand the nature of your industry that may call for diversification, acquisitions, and restructuring. In some “sunset” industries, diversifying out of them is a must. In new hot-growth industries and countries, new entrants often feel compelled to acquire in order to ensure a timely presence (see the Closing Case).

Second, you and your firm need to develop capabilities that facilitate successful acquisi- tions and restructuring, by following the suggestions outlined in Table 9.5. These would include do not overpay for targets and focus on both strategic and organizational fit.

institutional relatedness

A firm’s informal linkages with dominant institutions in the environment that confer resources and legitimacy.

284 PART 3 CORPORATE-LEVEL STRATEGIES

Finally, you need to master the rules of the game governing acquisitions around the world. In 2001, GE and Honeywell proposed to merge and cleared US antitrust scrutiny. Yet, they failed to anticipate the power of the EU antitrust authorities to torpedo the deal.57 These two otherwise highly capable firms should have done more “home work”— known in the jargon as due diligence—on the institutional side. More recently, many Chinese firms failed to complete the overseas M&A deals that they announced, because they did not understand the institutional intricacies of navigating in host countries (see the Closing Case).

In terms of the four most fundamental questions, this chapter directly answers Question 3: What determines the scope of the firm? Industry conditions, resource repertoire, and institutional frameworks shape corporate scope. In addition, why firms differ (Question 1) and how firms behave (Question 2) boil down to why and how they choose different diversification strategies. Finally, what determines the international success and failure of firms (Question 4)? The answer lies in whether they can successfully overcome the challenges associated with diversification, acquisitions, and restructuring.

CHAPTER SUMMARY

1. Define product diversification and geographic diversification • Product-related diversification focuses on operational synergy and scale economies. • Product-unrelated diversification (conglomeration) stresses financial synergy and scope economies.

• Geographically diversified firms can have a limited or extensive international scope. • Most firms pursue product and geographic diversification simultaneously.

TABLE 9.4 Strategic Implications for Action

& Understand the nature of your industry that may call for diversification, acquisitions, and restructuring. & Develop capabilities that facilitate successful acquisitions and restructuring. & Master the rules of the game governing acquisitions and restructuring around the world.

TABLE 9.5 Improving the Odds for Acquisition Success

AREAS DO’S AND DON’TS

Pre-acquisition & Do not overpay for targets and avoid a bidding war when premiums are too high. & Engage in thorough due diligence concerning both strategic fit and organizational fit.

Post-acquisition & Address the concerns of multiple stakeholders and try to keep the best talents. & Be prepared to deal with roadblocks thrown out by people whose jobs and

power may be jeopardized.

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2. Articulate a comprehensive model of diversification • The strategy tripod suggests industry-based, resource-based, and institution-based factors for diversification.

3. Gain insights into the motives and performance of acquisitions • Most M&As are acquisitions. • M&As are driven by (1) synergistic, (2) hubris, and/or (3) managerial motivations.

4. Enhance your understanding of restructuring • Restructuring involves downsizing, downscoping, and refocusing.

5. Participate in two leading debates concerning diversification, acquisitions, and restructuring • (1) Product relatedness versus other forms of relatedness and (2) acquisitions versus alliances.

6. Draw strategic implications for action • Understand the nature of your industry that may call for diversification, acquisitions, and restructuring.

• Develop capabilities that facilitate successful acquisitions and restructuring. • Master the rules of the game governing acquisitions and restructuring around the world.

KEY TERMS

Acquisition p. 276

Acquisition premium p. 279

Anchored replicator p. 265

Bureaucratic cost p. 273

Business group p. 272

Business-level strategy p. 260

Classic conglomerate p. 266

Conglomerate p. 262

Conglomerate M&A p. 276

Conglomeration p. 262

Corporate-level strategy (corporate strategy) p. 260

Diversification p. 261

Diversification discount p. 262

Diversification premium p. 262

Dominant logic p. 283

Downscoping p. 282

Downsizing p. 282

Economic benefit p. 273

Far-flung conglomerate p. 266

Financial control (output control) p. 271

Financial synergy p. 262

Friendly M&A p. 277

Geographic diversification p. 261

Horizontal M&A p. 276

Hostile M&A (hostile takeover) p. 277

Hubris p. 279

Institutional relatedness p. 284

Internal capital market p. 262

International diversification p. 263

Marginal bureaucratic cost (MBC) p. 273

Marginal economic benefit (MEB) p. 273

Merger p. 276

Merger and acquisition (M&A) p. 276

Multinational replicator p. 265

Operational synergy p. 261

Organizational fit p. 281

Product diversification p. 261

Product-related diversification p. 261

Product-unrelated diversification p. 261

Refocusing p. 282

Restructuring p. 282

Scale economies (economies of scale) p. 261

Scope economies (economies of scope) p. 262

Single business strategy p. 261

286 PART 3 CORPORATE-LEVEL STRATEGIES

Strategic control (behavior control) p. 271

Strategic fit p. 281

Vertical M&A p. 276

CRITICAL DISCUSSION QUESTIONS

1. M&As are a rare event for most firms. How can they enhance their capabilities for M&As?

2. ON ETHICS: As a CEO leading an acquisition of a foreign firm (think of Anheuser-Busch or Cadbury), you are interviewed by a reporter from the host country. The reporter asks: “A lot of people in our country are mad about this foreign takeover of our iconic company. How would you alleviate their concerns?”

3. ON ETHICS: CEOs’ pay is typically linked to the size of the firms they lead. Therefore, some argue that CEOs have an inherent bias in favor of undertaking M&As using share- holders’money while enriching CEOs’ personally. Do you agree or disagree with this view? Explain.

TOPICS FOR EXPANDED PROJECTS

1. Some argue that shareholders can diversify their stockholdings and that there is no need for corporate diversification to reduce risk. The upshot is that any excess earnings (known as “free cash flows”), instead of being used to acquire other firms, should be returned to shareholders as dividends and that firms should pursue more focused strategies. Write a short paper explaining why you agree or disagree with this statement.

2. Unrelated product diversification (conglomeration) is widely discredited in developed economies. However, in some cases it still seems to add value in emerging economies (see the Opening Case). Is this interest in conglomeration likely to hold or decrease in emerging economies over time? Why? Explain your answers in a short paper.

3. ON ETHICS: As members of the executive team of a firm, you are trying to decide whether to acquire a foreign firm. The size of your firm will double after this acquisition and it will become the largest in your industry. On the one hand, you are excited about the opportunity to be a leading captain of industry and the associated power, prestige, and income (you expect your income to double next year). On the other hand, you have just read this chapter and are troubled by the 70% M&A failure rate. Working in small groups of three or four, develop a strategy for success. Present your strategy in a short paper or visual presentation.

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E T H I C A L D I L E M M ACLOSING CASE

Emerging Markets: Emerging Acquirers from China and India

Multinational enterprises (MNEs) from emerging econo- mies, especially from China and India, have emerged as a new breed of acquirers around the world. Causing “oohs” and “ahhs,” they have grabbed media headlines and caused controversies. Anecdotes aside, are the patterns of these new global acquirers similar? How do they differ? Only recently has rigorous academic research been con- ducted to allow for systematic comparison (Table 9.6).

Overall, China’s stock of outward foreign direct investment (OFDI) (1.5% of the worldwide total) is about three times India’s (0.5%). A visible similarity is that both Chinese and Indian MNEs seem to primarily use M&As as their primary mode of OFDI. Throughout the 2000s, Chinese firms spent $130 billion to engage in M&As overseas, whereas Indian firms made M&A deals worth $60 billion.

From an industry-based view, it is clear that MNEs from China and India have targeted industries to support and strengthen their own most competitive industries at home. Given China’s prowess in manufacturing industries at home, Chinese firms’ overseas M&As have primarily

targeted energy, minerals, and mining—crucial supply industries that feed their manufacturing operations. Indian MNEs’ world-class leadership position in high-tech and software services is reflected in their interest in acquiring firms in these industries.

The geographic spread of these MNEs is indicative of the level of their capabilities. Chinese firms have undertaken most of their deals in Asia, with Hong Kong being their most favorable location. In other words, the geographic distribution of Chinese M&As is not global; rather, it is quite regional. This reflects a relative lack of capabilities to engage in managerial challenges in regions distant from China, especially in more developed economies. Indian MNEs have primarily made deals in Europe, with the United Kingdom as the leading target country. For example, acquisitions made by Tata Motors (Jaguar and Land Rover) and Tata Steel (Corus Group) propelled Tata Group to become the number one private-sector employer in the UK. Overall, Indian firms display a more global spread in their M&As, and a higher level of confidence and sophistication in making deals in developed economies.

TABLE 9.6 Comparing Cross-Border M&As Undertaken by Chinese and Indian MNEs

M&AS UNDERTAKEN BY CHINESE MNES

M&AS UNDERTAKEN BY INDIAN MNES

Top target industries Energy, minerals, and mining High-tech and software services

Top target countries Hong Kong United Kingdom

Top target regions Asia Europe

Top acquiring companies involved State-owned enterprises Private business groups

% of successfully closed deals 47% 67%

Source: Extracted from S. Sun, M. W. Peng, B. Ren, & D. Yan, 2012, A comparative ownership advantage framework for cross-border M&As: The rise of Chinese and Indian MNEs, Journal of World Business, 47(1): 4–16.

288 PART 3 CORPORATE-LEVEL STRATEGIES

From an institution-based view, the contrasts between the leading Chinese and Indian acquirers are significant. The primary M&A players from China are state-owned enterprises (SOEs), which have their own advantages (such as strong support from the Chinese government) and trappings (such as resentment and suspicion from host country governments). The movers and shakers of over- seas M&As from India are private business groups, which generally are not viewed with strong suspicion. The limited evidence suggests that M&As by Indian firms tend to create value for their shareholders. On the other hand, M&As by Chinese firms tend to destroy value for their shareholders—indicative of potential hubris and manage- rial motives evidenced by empire building and agency problems.

Announcing high-profile deals is one thing, but com- pleting them is another matter. Chinese MNEs have par- ticularly poor records in completing the overseas acquisi- tion deals they announce. Only less than half (47%) of the acquisitions announced by Chinese MNEs were com- pleted, which compares unfavorably to Indian MNEs’ 67% completion rate. Chinese MNEs’ lack of ability and experience in due diligence and financing is one reason, but another reason is the political backlash and resis- tance they encounter, especially in developed econo- mies. The 2005 failure of CNOOC’s bid for Unocal in the United States and the 2009 failure of Chinalco’s bid for Rio Tinto’s assets in Australia are but two high-profile examples.

Even assuming successful completion, integration is a leading challenge during the post-acquisition phase. Both Chinese and Indian firms seem to suffer from these challenges. Tata, for example, was famously clawed by Jaguar. In general, acquirers from China and India have often taken the “high road” to acquisitions, in which acquirers deliberately allow acquired target companies to retain autonomy, keep the top management intact, and then gradually encourage interaction between the two sides. In contrast, the “low road” to acquisitions would be for acquirers to act quickly to impose their systems and rules on acquired target companies. Although the “high road” sounds noble, this is a

reflection of these acquirers’ lack of international man- agement experience and capabilities.

Sources: Based on (1) Y. Chen & M. Young, 2010, Cross- border M&As by Chinese listed companies, Asia Pacific Journal of Management, 27: 523–539; (2) L. Cui & F. Jiang, 2010, Behind ownership decision of Chinese outward FDI, Asia Pacific Journal of Management, 27: 751–774; (3) P. Deng, 2009, Why do Chinese firms tend to acquire strategic assets in international expansion? Journal of World Business, 44: 74–84; (4) S. Gubbi, P. Aulakh, S. Ray, M. Sarkar, & R. Chittoor, 2010, Do international acquisitions by emerging economy firms create shareholder value? Journal of International Business Studies, 41: 397–418; (5) M. W. Peng, 2012, The global strategy of emerging multinationals from China, Global Strategy Journal, 2: 97–107; (6) M. W. Peng, 2012, Why China’s investments aren’t a threat, Harvard Business Review, February: blogs.hbr.org; (7) H. Rui & G. Yip, 2008, Foreign acquisitions by Chinese firms, Journal of World Business, 43: 213–226; (8) S. Sun, M. W. Peng, B. Ren, & D. Yan, 2012, A comparative ownership advantage framework for cross-border M&As: The rise of Chinese and Indian MNEs, Journal of World Business, 47(1): 4–16.

C A S E D I S C U S S I O N Q U E S T I O N S

1. Why have M&As emerged as the primary mode of foreign market entry for Chinese and Indian MNEs?

2. Drawing on industry-based, resource-based, and institution- based views, outline the similarities and differences between Chinese and Indian multinational acquirers.

3. ON ETHICS: As CEO of a firm from either China or India engaging in a high-profile acquisition overseas, shareholders at home are criticizing you of “squandering” their money, and target firm management and unions—as well as host country government and the media—are resisting. Should you proceed with the acquisition or consider abandoning the deal? If you are considering abandoning the deal, under what conditions would you abandon it?

C h a p t e r 9 D i v e r s i f y i n g , A c q u i r i n g , a n d R e s t r u c t u r i n g 289

NOTES

[Journal acronyms] AME – Academy of Management Executive; AMJ – Academy of Management Journal; AMP – Academy of Management Perspectives; AMR – Academy of Management Review; APJM – Asia Pacific Journal of Management; BW – BusinessWeek (before 2010) or Bloomberg Businessweek (since 2010); EJ –Economic Journal; JEP – Journal of Economic Perspec- tives; JIBS – Journal of International Business Studies; JM – Journal of Management; JMS – Journal of Manage- ment Studies; JWB – Journal of World Business; MIR – Management International Review; OSc – Organization Science; SMJ – Strategic Management Journal; WSJ – Wall Street Journal.

1. E. Bowman & C. Helfat, 2001, Does corporate strategy matter? SMJ, 22: 1–23.

2. M. Nippa, U. Pidun, & H. Rubner, 2011, Corporate portfolio management, AMP, November: 50–66.

3. M. Benner & M. Tripsas, 2012, The influence of prior industry affiliation on framing in nascent industries, SMJ, 33: 277–302; J. Eggers, 2012, All experience is not created equal, SMJ, 33: 315–335; H. Tanriverdi & C. Lee, 2008, Within-industry diversification and firm performance in the presence of network externalities, AMJ, 51: 381–397.

4. D. Miller, M. Fern, & L. Cardinal, 2007, The use of knowledge for technological innovation within diversi- fied firms, AMJ, 50: 308–326.

5. J. Shackman, 2007, Corporate diversification, vertical integration, and internal capital markets, MIR, 47: 479–504.

6. K. B. Lee, M. W. Peng, & K. Lee, 2008, From diversi- fication premium to diversification discount during institutional transitions, JWB, 43: 47–65.

7. P. Chen, C. Williams, & R. Agarwal, 2012, Growing pains, SMJ, 33: 252–276.

8. M. Carney, E. Gedajlovic, P. Heugens, M. Van Essen, & J. Van Oosterhout, 2011, Business group affiliation, performance, context, and strategy, AMJ, 54: 437–460; B. Kedia, D. Mukherjee, & S. Lahiri, 2006, Indian busi- ness groups, APJM, 23: 559–577; M. Li, K. Ramas- wamy, & B. Petitt, 2006, Business groups and market failures, APJM, 24: 439–452; Y. Lu & J. Yao, 2006, Impact of state ownership and control mechanisms

on the performance of group affiliated companies in China, APJM, 23: 485–504; M. W. Peng & A. Delios, 2006, What determines the scope of the firm over time and around the world? APJM, 24: 385–405.

9. D. Lange, S. Boivie, & A. Henderson, 2009, The par- enting paradox, AMJ, 52: 179–198.

10. N. Capar & M. Kotabe, 2003, The relationship between international diversification and performance in service firms, JIBS, 34: 345–355.

11. L. Gomes & K. Ramaswamy, 1999, An empirical examination of the form of the relationship between multinationality and performance, JIBS, 30: 173–188.

12. M. Chari, S. Devaraj, & P. David, 2007, International diversification and firm performance, JWB, 42: 184–197; Y. Fang, M. Wade, A. Delios, & P. Beamish, 2007, International diversification, subsidiary perfor- mance, and the mobility of knowledge resources, SMJ, 28: 1053–1064; A. Gande, C. Schenzler, & L. Senbert, 2009, Valuation effects of global diversification, JIBS, 40: 1515–1532; M. Hitt, L. Tihanyi, T. Miller, & B. Connelly, 2006, International diversification, JM, 32: 831–867.

13. A. Delios & P. Beamish, 1999, Geographic scope, product diversification, and the corporate perfor- mance of Japanese firms (p. 724), SMJ, 20: 711–727.

14. J. M. Geringer, S. Tallman, & D. Olsen, 2000, Product and international diversification among Japanese mul- tinational firms (p. 76), SMJ, 21: 51–80.

15. G. Qian, T. Khoury, M. W. Peng, & Z. Qian, 2010, The performance implications of intra- and inter- regional geographic diversification, SMJ, 31: 1018–1030.

16. A. Goerzen & S. Makino, 2007, Multinational cor- poration internationalization in the service sector, JIBS, 38: 1149–1169; M. Wiersema & H. Bowen, 2008, Corporate diversification, SMJ, 29: 115–132.

17. K. Meyer, 2006, Global focusing, JMS, 43: 1109–1144. 18. J. Bercovitz & W. Mitchell, 2007, When is more

better? SMJ, 28: 61–79; L. Capron & J. Shen, 2007, Acquisitions of private vs. public firms, SMJ, 28: 891–911; E. Doving & P. Gooderham, 2008, Dynamic capabilities as antecedents of the scope of related

290 PART 3 CORPORATE-LEVEL STRATEGIES

diversification, SMJ, 29: 841–857; S. Karim, 2006, Modularity in organizational structure, SMJ, 27: 799–823; K. Ellis, T. Reus, B. Lamont, & A. Ranft, 2011, Transfer effects in large acquisitions, AMJ, 54: 1261–1276; J. Macher & C. Boerner, 2006, Experience and scale and scope economies, SMJ, 27: 845–865; K. Uhlenbruck, M. Hitt, & M. Semadeni, 2006, Market value effects of acquisitions involving Internet firms, SMJ, 27: 899–913.

19. J. Kim & S. Finkelstein, 2009, The effects of strategic and market complementarity on acquisition perfor- mance, SMJ, 30: 617–646.

20. K. Ellis, T. Reus, & B. Lamont, 2009, The effects of procedural and informational justice in the integra- tion of related acquisitions, SMJ, 30: 137–161.

21. C. Moschieri & J. Campa, 2009, The European M&A industry, AMP, November: 71–87.

22. M. Dieleman, 2009, Shock imprinting, APJM, 27: 481–502.

23. C. Marquis & M. Lounsbury, 2007, Vive la resistance, AMJ, 50: 799–820.

24. E. Matta & P. Beamish, 2008, The accentuated CEO career horizon problem, SMJ, 29: 683–700; P. Parvinen & H. Tikkanen, 2007, Incentive asymmetries in the M&A process, JMS, 44: 759–786.

25. This section draws heavily from M. W. Peng, S. Lee, & D. Wang, 2005, What determines the scope of the firm over time? A focus on institutional relatedness, AMR, 30: 622–633.

26. G. Jones & C. Hill, 1988, Transaction cost analysis of strategy-structure choices, SMJ, 9: 159–172. See also E. Rawley, 2010, Diversification, coordination costs, and organizational rigidity, SMJ, 31: 873–891; Y. Zhou, 2010, Synergy, coordination costs, and diver- sification choices, SMJ, 32: 624–639.

27. J. Clougherty & T. Duso, 2009, The impact of hor- izontal mergers on rival, JMS, 46: 1365–1395.

28. M. Jacobides, 2008, How capability differences, trans- action costs, and learning curves interact to shape vertical scope, OSc, 19: 306–326.

29. M. Chari & K. Chang, 2009, Determinants of the share of equity sought in cross-border acquisitions, JIBS, 40: 1277–1297; D. Iyer & K. Miller, 2008, Per- formance feedback, slack, and the timing of acquisi- tions, AMJ, 51: 808–822.

30. S. Chen, 2008, The motives for international acquisi- tions, JIBS, 39: 454–471; P. Puranam & K. Srikanth, 2007, What they know vs. what they do, SMJ, 28: 805–825.

31. H. Yang, Z. Lin, & M. W. Peng, 2011, Behind acquisi- tions of alliance partners, AMJ, 54: 1069–1080.

32. Z. Lin, M. W. Peng, H. Yang, & S. Sun, 2009, How do networks and learning drive M&As? SMJ, 30: 1113–1132; H. Yang, S. Sun, Z. Lin, & M. W. Peng, 2011, Behind M&As in China and the United States, APJM, 28: 239–255.

33. H. Krishnan, M. Hitt, & D. Park, 2007, Acquisition premiums, subsequent workforce reductions, and post-acquisition performance, JMS, 44: 709–732; T. Laamanen, 2007, On the role of acquisition premium in acquisition research, SMJ, 28: 1359–1369.

34. C. Moschieri & J. Campa, 2009, The European M&A industry (p. 82), AMP, November: 71–87.

35. G. McNamara, J. Heleblian, & B. Dykes, 2008, The performance implications of participating in an acqui- sition wave, AMJ, 51: 113–130.

36. M. Goranova, T. Alessandri, P. Brandes, & R. Dhar- wadkar, 2007, Managerial ownership and corporate diversification, SMJ, 28: 211–225.

37. T. Laamanen & T. Keil, 2008, Performance of serial acquirers, SMJ, 29: 663–672; D. Siegel & K. Simons, 2010, Assessing the effects of M&As on firm perfor- mance, SMJ, 31: 903–916; G. Valentini, 2012, Measur- ing the effect of M&A on patenting quantity and quality, SMJ, 33: 336-346; M. Zollo & D. Meier, 2008, What is M&A performance? AMP, August: 55–77.

38. D. King, D. Dalton, C. Daily, & J. Covin, 2004, Meta- analyses of post-acquisition performance, SMJ, 25: 187–200.

39. R. Kapoor & K. Lim, 2007, The impact of acquisitions on the productivity of inventors at semiconductor firms, AMJ, 50: 1133–1155.

40. G. Andrade, M. Mitchell, & E. Stafford, 2001, New evidence and perspectives on mergers, JEP, 15: 103–120.

41. C. Meyer & E. Altenborg, 2008, Incompatible strate- gies in international mergers, JIBS, 39: 508–525.

42. WSJ, 2009, Bank of America-Merrill Lynch: A $50 billion deal from hell, January 22: blogs.wsj.com.

43. J. Allatta & H. Singh, 2011, Evolving communication patterns in response to an acquisition event, SMJ, 32: 1099–1118; M. Brannen & M. Peterson, 2009, Mer- ging without alienating, JIBS, 40: 468–489; R. Chakra- barti, S. Gupta-Mukherjee, & N. Jayaraman, 2009, Mars-Venus marriages, JIBS, 40: 216–236; G. Stahl & A. Voigt, 2008, Do cultural differences matter in M&As? OSc, 19: 160–176.

C h a p t e r 9 D i v e r s i f y i n g , A c q u i r i n g , a n d R e s t r u c t u r i n g 291

44. T. Reus & B. Lamont, 2009, The double-edged sword of cultural distance in international acquisitions, JIBS, 40: 1298–1316; R. Sarala & E. Vaara, 2010, Cultural differences, convergence, and crossvergence as expla- nations of knowledge transfer in international acqui- sitions, JIBS, 41: 1365–1390.

45. BW, 2011, Hi-yah! Alcatel-Lucent chops away at years of failure (p. 29), May 2: 29–31.

46. M. Cording, P. Christmann, & D. King, 2010, Redu- cing causal ambiguity in acquisition integration, AMJ, 51: 744–767.

47. H. Barkema & M. Schijven, 2008, Toward unlocking the full potential of acquisitions, AMJ, 51: 696–722; D. Bergh, R. Johnson, & R. DeWitt, 2008, Restructuring through spin-off or sell-off, SMJ, 29: 133–148; H. Berry, 2009, Why do firms divest? OSc, 21: 380–398; T. Numagami, M. Karube, & T. Kato, 2010, Organiza- tional deadweight, AMP, November: 25–37.

48. D. Bergh & E. Lim, 2008, Learning how to restructure, SMJ, 29: 593–616.

49. W. Cascio, 2002, Strategies for responsible restruc- turing (p. 81), AME, 16: 80–91. See also J. Guthrie

& D. Datta, 2008, Dumb and dumber, OSc, 19: 108–123.

50. K. Shimizu, 2007, Prospect theory, behavioral theory, and the threat-rigidity hypothesis, AMJ, 50: 1495–1514.

51. E. G. Love & M. Kraatz, 2009, Character, conformity, or the bottom line? AMJ, 52: 314–335.

52. A. Pehrsson, 2006, Business relatedness and perfor- mance, SMJ, 27: 265–282.

53. BW, 2011, Sony needs a hit (p. 77), November 21: 72–77.

54. C. K. Prahalad & R. Bettis, 1986, The dominant logic, SMJ, 7: 485–501. See also D. Ng, 2007, A modern resource-based approach to unrelated diversification, JMS, 44: 1481–1502.

55. Peng, Lee, & Wang, 2005, What determines the scope of the firm over time? (p. 623).

56. X. Yin & M. Shanley, 2008, Industry determinants of the “merger versus alliance” decision, AMR, 33: 473–491.

57. N. Aktas, E. Bodt, & R. Roll, 2007, Is European M&A regulation protectionist?, EJ, 117: 1096–1121.

292 PART 3 CORPORATE-LEVEL STRATEGIES

CHAPTER10

STRATEGIZING, STRUCTURING, AND LEARNING AROUND THE WORLD

LEARN ING OBJECT IVES

After studying this chapter, you should be able to

1. Understand the four basic configurations of multinational strategies and structures

2. Articulate a comprehensive model of multinational strategy, structure, and learning

3. Outline the challenges associated with learning, innovation, and knowledge management

4. Participate in three leading debates concerning multinational strategy, structure, and learning

5. Draw strategic implications for action

ot o/ A le xe y St io p

294 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

OPENING CASE

Emerging Markets: Samsung’s Global Strategy Group

Founded in 1938, Samsung Group is South Korea’s leading conglomerate. It has 270,000 employees in 470 units in 67 countries, with $227 billion in annual revenues. The flagship company within Samsung Group is Samsung Electronics Corporation (SEC). With $136 billion revenues in 2010 (more than Apple and Sony combined), SEC is the largest electro- nics firm in the world. In addition to SEC, other major Sam- sung Group companies include Samsung Life Insurance (the 13th largest life insurer in the world), Samsung C&T Corpora- tion (one of the world’s largest developers of skyscrapers and solar/wind power plants), and Samsung Heavy Industries (the world’s largest shipbuilder). Samsung’s performance has been impressive. Despite the Great Recession, SEC’s profits have been higher than those of its five largest Japanese rivals (Sony, Panasonic, Toshiba, Hitachi, and Sharp) combined. In 2010, SEC achieved record profits of $14 billion, compared with $12 billion profits for Intel and less than $1 billion profits for Panasonic as well as $3.2 billion losses for Sony.

Clearly, Samsung has done something right. However, it has not been easy. To increasingly compete outside Korea, Samsung needs to attract more non-Korean talents. But given its traditionally rigid hierarchical structure and the language barrier, its efforts to attract and retain non-Korean talents had often been disappointing. In response, Samsung Group headquarters in 1997 set up a unique internal con- sulting unit, the Global Strategy Group, which reports directly to the CEO. Members of the Global Strategy Group are non-Korean MBA graduates from top Western business schools who have worked for leading multinationals such as Goldman Sachs, Intel, and McKinsey. They are required to spend two years in Seoul and study basic Korean. The group’s mission, according to its website, is to “(1) develop a pool of global managers, (2) enhance Samsung’s business performance, and (3) globalize Samsung.”

Global Strategy teams work on various internal strategy projects for different Samsung companies. Each team has a project leader, which gives the individual an opportunity to take on a leadership role in a high-level consulting project much earlier than a typical consulting career provides. Each team has one to two global strategists. It also has a project coordinator, who is a senior Korean manager acting as a

liaison between the team and the management of the (inter- nal) client company. On average, projects last three months and typically involve some overseas travel. Starting with 20 global strategists in the class of 1997, nearly 400 projects have been completed in 15 years. These projects help global strategists form informal ties and expose them to the orga- nizational culture. After two years, global strategists would “graduate” and be assigned to Samsung subsidiaries, many of which are in their home countries.

Despite good-faith efforts by both Korean and non-Korean sides, the success of the Global Strategy Group is anything but assured. Overall, cultural integration is a toughnut to crack. Of the 208 non-Korean MBAs who joined the group since its inception, 135were still with Samsung as of 2011. Themost successful ones are thosewho have taken the greatest pains to fit into the Korean culture, such as eating kimchi and drinking Koreanwine at dinner parties. Before the establishment of the Global Strategy Group, not a single non-Korean MBA lasted more than three years at SEC.With theGlobal StrategyGroup as a cohort group, one-third of the non-Korean MBAs in the first class of 1997 were still with SEC three years later (in 2000). Over the next decade, the reten- tion ratewent up to two-thirds. Three experts notedhowthenon- Korean members of the Global Strategy Group have slowly but surely globalized Samsung’s corporate DNA:

M ap

Re so ur ce s

295 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

How can multinational enterprises (MNEs) such as Samsung strategicallymanage growth around the world? How can they learn country tastes,global trends, and market transitions that may call for structural changes? How can they attract and retain global talents and improve the odds for better innovation? These are some of the key questions driving this chapter. Our focus here is on relatively large MNEs. We start by discussing the crucial relationship between four strategies and four structures. Next, a comprehensive model drawing from the strategy tripod sheds light on these issues. Then, we discuss worldwide learning, innovation, and knowledge management. Debates and extensions follow.

Multinational Strategies and Structures This section first introduces an integration-responsiveness framework centered on the pressures for cost reductions and local responsiveness. We then outline the four strategic choices and the four corresponding organizational structures that MNEs typically adopt.

Pressures for Cost Reduction and Local Responsiveness MNEs confront primarily two sets of pressures: cost reduction and local responsiveness. These two sets of pressures are captured in the integration-responsiveness framework, which allows managers to deal with the pressures for both global integration and local responsiveness. Cost pressures often call for global integration, while local responsiveness pushes MNEs to adapt locally. In both domestic and international competition, pressures to reduce costs are almost universal. What is unique in international competition is the pressure for local responsiveness, which means reacting to different consumer preferences and host-country demands. Consumer preferences vary tremendously around the world. For example, McDonald’s beef-based hamburgers would obviously find few customers in India, a land where cows are held sacred by the Hindu majority. Thus, changing McDonald’s menu is a must in India. Host-country demands and expectations add to the pressures for local responsiveness. Throughout Europe, Canadian firm Bombardier

The effects of these employees on the organization have been something like that of a steady trickle of water on stone. As more people from the Global Strategy Group are assigned to SEC, their Korean colleagues have had to change their work styles and mind-sets to accommodate Westernized practices, slowly and steadily making the environment more friendly to ideas from abroad. Today, SEC goes out of

its way to ask the Global Strategy group for more newly hired employees.

Sources: Based on (1) S. Chang, 2008, Sony vs. Samsung, Singapore: Wiley; (2) T. Khanna, J. Song, & K. Lee, 2011, The paradox of Samsung’s rise, Harvard Business Review, July: 142– 147; (3) SamsungGlobal StrategyGroup, 2012, gsg.samsung.com.

(Continued)

OPENING CASE

integration- responsiveness framework

A framework of MNE management on how to simultaneously deal with two sets of pressures for global integration and local responsiveness.

local responsiveness

The necessity to be responsive to different cus- tomer preferences around the world.

296 PART 3 CORPORATE-LEVEL STRATEGIES

manufactures an Austrian version of rail-cars in Austria, a Belgian version in Belgium, and so on. Bombardier believes that such local responsiveness, although not required, is essential for making sales to railway operators in Europe, which tend to be state owned.

Taken together, being locally responsive certainly makes local customers and govern- ments happy but unfortunately increases costs. Given the universal interest in lowering cost, a natural tendency is to downplay or ignore the different needs and wants of various local markets and instead market a global version of products and services. The move- ment to globalize offerings can be traced to a 1983 article by Theodore Levitt: “The Globalization of Markets.”1 Levitt argued that worldwide consumer tastes are converging. As evidence, Levitt pointed to the worldwide success of Coke Classic, Levi Strauss jeans, and Sony color TV. Levitt predicted that such convergence would characterize most product markets in the future.

Levitt’s idea has often been the intellectual force propelling many MNEs to globally integrate their offerings while minimizing local adaptation. Ford experimented with “world car” designs. MTV pushed ahead with the belief that viewers would flock to global (essentially American) programming. Unfortunately, most of these experiments are not successful. Ford found that consumer tastes ranged widely around the globe. MTV eventually realized that there is no “global song.” In a nutshell, one size does not fit all.2

This leads us to look at how MNEs can pay attention to both dimensions: cost reduction and local responsiveness.

Four Strategic Choices Based on the integration-responsiveness framework, Figure 10.1 plots the four strategic choices: (1) home replication, (2) localization, (3) global standardization, and (4) transna- tional. Each strategy has a set of pros and cons outlined in Table 10.1. (Their correspond- ing structures are discussed in the next section.)

Home replication strategy, often known as international (or export) strategy, duplicates home country–based competencies in foreign countries. Such competencies include production scales, distribution efficiencies, and brand power. In manufacturing, this is usually manifested in an export strategy. In services, this is often done through licensing and franchising. This strategy is relatively easy to implement and usually the first one adopted when firms venture abroad.

On the disadvantage side, home replication strategy often lacks local responsiveness because it focuses on the home country. This strategy makes sense when the majority of a firm’s customers are domestic. However, when a firm aspires to broaden its international scope, failing to be mindful of foreign customers’ needs and wants may alienate them. For example, when Wal-Mart entered Brazil, the stores had exactly the same inventory as its US stores, including a large number of American footballs. Considering that Brazil is the land of soccer that has won the World Cup five times, more wins than any other country, nobody (except a few homesick American expatriates in their spare time) plays American football there.

Localization strategy is an extension of the home replication strategy.3 Localization (multidomestic) strategy focuses on a number of foreign countries/regions, each of which is regarded as a stand-alone local (domestic) market worthy of significant attention and adaptation. While sacrificing global efficiencies, this strategy is effective when differences

home replication strategy

A strategy that emphasizes the international replication of home country–based competencies such as production scales, distribution efficiencies, and brand power.

localization (multi-domestic) strategy

An MNE strategy that focuses on a number of foreign countries/regions, each of which is regarded as a standalone local (domestic) market worthy of significant attention and adaptation.

C h a p t e r 1 0 S t r a t e g i z i n g , S t r u c t u r i n g , a n d L e a r n i n g A r o u n d t h e W o r l d 297

FIGURE 10.1 Multinational Strategies and Structures: The Integration- Responsive Framework

Pressures for local responsiveness Low High

Global product division

Global standardization strategy

Global matrix Transnational strategy

International division

Home replication strategy

Geographic area Localization strategy

H ig

h Lo

w P re

ss u re

s fo

r co

st r

ed u ct

io n s

Note: In some other textbooks, “home replication” may be referred to as “international” or “export” strategy, “localization” as “multidomestic” strategy, and “global standardization” as “global” strategy. Some of these labels are confusing, because one can argue that all four strategies here are “international” or “global,” thus resulting in some confusion if we label one of these strategies as “international” and another as “global.” The present set of labels is more descriptive and less confusing.

TABLE 10.1 Four Strategic Choices for Multinational Enterprises

ADVANTAGES DISADVANTAGES

Home replication & Leverages home country-based advantages

& Relatively easy to implement

& Lack of local responsiveness & May result in foreign customer

alienation

Localization & Maximizes local responsiveness & High costs due to duplication of efforts in multiple countries

& Too much local autonomy

Global standardization

& Leverages low-cost advantages & Lack of local responsiveness & Too much centralized control

Transnational & Cost efficient while being locally responsive

& Engages in global learning and diffusion of innovations

& Organizationally complex & Difficult to implement

ga ge

Le ar ni ng

ga ge

Le ar ni ng

298 PART 3 CORPORATE-LEVEL STRATEGIES

among national and regional markets are clear and pressures for cost reductions are low. For example, Disney has attempted to localize some of its offerings in its five theme parks in Anaheim, California; Orlando, Florida; Hong Kong; Paris; and Tokyo. Its newest Disneyland in Shanghai, which will open in 2015, will feature traditional Disney rides and those based on Chinese culture. It will drop a standard feature common in all Disney parks: Main Street USA.4

In terms of disadvantages, localization strategy has high costs due to duplication of efforts in multiple countries. The costs of producing such a variety of programming for MTV are obviously greater than the costs of producing one set of programming. As a result, this strategy is only appropriate in industries where the pressures for cost reduc- tions are not significant. Another potential drawback is too much local autonomy, which happens when each subsidiary regards its country as so unique that it is difficult to introduce corporate-wide changes. In the 1980s, Unilever had 17 country subsidiaries in Europe. It took four years to persuade all 17 subsidiaries to introduce a single new detergent across Europe.

As the opposite of localization strategy, global standardization strategy is sometimes referred to simply as global strategy. Its hallmark is the development and distribution of standardized products worldwide in order to reap the maximum benefits from low-cost advantages. While both home replication and global standardization strategies minimize local responsiveness, a crucial difference is that an MNE pursuing a global standardization strategy is not limited to its major operations at home. In a number of countries, the MNE may designate centers of excellence, defined as subsidiaries explicitly recognized as a source of important capabilities, with the intention that these capabilities be leveraged by and/or disseminated to other subsidiaries. Centers of excellence are often given a world- wide (or global) mandate—a charter to be responsible for one MNE function throughout the world. HP’s Singapore subsidiary has a worldwide mandate to develop, produce, and market all of HP’s handheld products.

In terms of disadvantages, a global standardization strategy obviously sacrifices local responsiveness. This strategy makes great sense in industries where pressures for cost reductions are paramount and pressures for local responsiveness are relatively minor (particularly commodity industries such as tires). However, as noted earlier, in indus- tries ranging from automobiles to consumer products, a one-size-fits-all strategy may be inappropriate. Consequently, arguments such as “all industries are becoming global” and “all firms need to pursue a global (standardization) strategy” are potentially mis- leading.

Transnational strategy aims to capture the best of both worlds by endeavoring to be both cost efficient and locally responsive. In addition to cost efficiency and local respon- siveness, a third hallmark of this strategy is global learning and diffusion of innovations. Traditionally, the diffusion of innovations in MNEs is a one-way flow from the home country to various host countries—the label “home replication” says it all (!). Under- pinning the traditional one-way flow is the assumption that the home country is the best location for generating innovations. However, given that innovations are inherently risky and uncertain, there is no guarantee that the home country will generate the highest- quality innovations.

MNEs that engage in a transnational strategy promote global learning and diffusion of innovations in multiple ways. Innovations not only flow from the home country to host

global standardization strategy

An MNE strategy that relies on the development and distribution of standardized products worldwide to reap the maximum benefits from low-cost advantages.

center of excellences

MNE subsidiaries explicitly recognized as a source of important capabilities, with the intention that these capabilities be leveraged by and/or disseminated to other subsidiaries.

worldwide (global) mandate

The charter to be responsi- ble for one MNE function throughout the world.

transnational strategy

An MNE strategy that endeavors to be cost effi- cient, locally responsive, and learning driven simul- taneously.

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countries (which is the traditional flow), but also flow from host countries to the home country and flow among subsidiaries in multiple host countries. Citroën not only designs cars in France, but also in China. On a worldwide basis, it intends to produce and market luxury cars such as the Metropolis designed in Shanghai (see Emerging Markets 10.1).

On the disadvantage side, a transnational strategy is organizationally complex and difficult to implement. The large amount of knowledge sharing and coordination may slow down decision making. Trying to achieve cost efficiencies, local responsiveness, and global learning simultaneously places contradictory demands on MNEs (to be discussed in the next section).

Overall, it is important to note that given the various pros and cons, there is no optimal strategy. The new trend in favor of a transnational strategy needs to be qualified with an understanding of its significant organizational challenges. This point leads to our next topic.

Four Organizational Structures Figure 10.1 also shows four organizational structures that are appropriate for each of the strategic choices: (1) international division, (2) geographic area, (3) global product divi- sion, and (4) global matrix.

International division is typically used when firms initially expand abroad, often engaging in a home replication strategy. Figure 10.2 shows Starbucks’ international division in addition to its four US-centric divisions. Although this structure is intuitively appealing, it often leads to two problems. First, foreign subsidiary managers, whose input

EMERGING MARKETS 10.1

Citroën Designs Cars in Shanghai

For a long time, automakers have been jockeying for position in China, which has recently become the world’s largest producer country and buyer country of cars. Obviously automakers have done a great deal in exporting cars to China and producing them locally. But designing cars in China? Not only for the domestic market but also for the world? Unveiled at Auto China 2010, the Citroën Metropolis luxury concept car, designed in Shanghai, has shown how central Chinese tastes now are to global automakers.

Sleek, low, and wide, the Metropolis is a bold statement to signal Citroën’s aim to recapture the innovation and individuality embodied in some of its most successful cars in the 20th century. But instead of

being designed in France, the Metropolis was designed in the firm’s global design studio in Shanghai. Citroën hinted that the Metropolis would become the flagship of the new DS luxury model series. While the production model would not be as avant-garde as the bold concept car, the production model would retain much of the elegant style. Citroën indicated that this car was designed in China for the world. “Our strategy for Citroën is to have the same car for Europe and China,” said Citroën’s design director.

Sources: Based on (1) Citroën, 2010, Metropolis: A concept car for China, www.citroen.com; (2) Silkroad, 2011, Design direction, July: 30.

international division

An organizational structure typically set up when firms initially expand abroad, often engaging in a home replication strategy.

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is channeled through the international division, are not given sufficient voice relative to the heads of domestic divisions. Second, by design, the international division serves as a silo whose activities are not coordinated with the rest of the firm, which is focusing on domestic activities. Consequently, many firms phase out this structure after their initial stage of overseas expansion.

Geographic area structure organizes the MNE according to different geographic areas (countries and regions). It is appropriate for a localization strategy. Figure 10.3 illustrates such a structure for Avon. A geographic area can be a country or a region, led by a country (or regional) manager. Each area is largely stand-alone. In contrast to the limited voice of subsidiary managers in the international division structure, country (and regional) managers carry a great deal of weight in a geographic area structure. Interestingly and paradoxically, both the strengths and weaknesses of this structure lie in its local responsiveness. While being locally responsive can be a virtue, it also encourages the fragmentation of the MNE into fiefdoms.

FIGURE 10.3 Geographic Area Structure at Avon Products

Avon Western

Europe, Middle East, & Africa

Avon Central & Eastern Europe

Avon Asia Pacific

Avon Latin

America

Avon North

America

Headquarters

Source: Adapted from avoncompany.com. Headquartered in New York, Avon Products, Inc. is the company behind numerous “Avon ladies” around the world.

FIGURE 10.2 International Division Structure at Starbucks

Starbucks Coffee

US Division

Starbucks Coffee

International Division

Partner Resources Division

Consumer Products Division

Supply Chain and Coffee Operations Division

Headquarters

Sources: Adapted from (1) www.cogmap.com and (2) www.starbucks.com. Headquartered in Seattle, Starbucks is a leading international coffee and coffeehouse company.

geographic area structure

An organizational structure that organizes the MNE according to different countries and regions and is the most appropriate structure for a multido- mestic strategy.

country (regional) manager

The business leader in charge of a specific country (or region) for an MNE.

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Global product division structure, which is the opposite of the geographic area struc- ture, supports the global standardization strategy by assigning global responsibilities to each product division. Figure 10.4 shows an example from the European Aeronautic Defense and Space Company (EADS), whose most famous unit is Airbus. This structure treats each product division as a stand-alone entity with full worldwide responsibilities. This structure is highly responsive to pressures for cost efficiencies, because it allows for consolidation on a worldwide (or at least regional) basis and reduces inefficient duplication in multiple countries. For example, Unilever reduced the number of soap-producing factories in Europe from ten to two after adopting this structure. Recently, because of the popularity of the global standardization strategy (noted earlier), the global product division structure is on the rise. Its main drawback is that local responsiveness suffers, as Ford discovered when it phased out the geographic area structure.

A global matrix alleviates the disadvantages associated with both geographic area and global product division structures, especially for MNEs adopting a transnational strategy. Shown in Figure 10.5, its hallmark is the coordination of responsibilities between product divisions and geographic areas. In this hypothetical example, the country manager in charge of Japan—in short, the Japan manager—reports to Product Division 1 and Asia Division, both of which have equal power.

In theory this structure supports the goals of the transnational strategy, but in practice it is often difficult to deliver. The reason is simple: While managers (such as the Japan manager in Figure 10.5) usually find dealing with one boss headache enough, they do not appreciate having two bosses who are often in conflict (!). For example, Product Division 1 may decide that Japan is too tough a nut to crack and that there are more promising markets elsewhere, thus ordering the Japan manager to curtail her investment and channel resources elsewhere. This makes sense because Product Division 1 cares about its global market position and is not wedded to any particular country. However, Asia Division, which is evaluated by how well it does in Asia, begs to differ. Asia Division argues that it cannot afford to be a laggard in Japan if it expects to be a leading player in Asia. Therefore, Asia Division demands that the

FIGURE 10.4 Global Product Division Structure at European Aeronautic Defense and Space Company (EADS)

Space Division

Defense and Security Systems Division

Aeronautics (Helicopter)

Division

Military Transport Aircraft Division

Airbus Division

Headquarters

Source: Adapted from www.eads.com. Headquartered in Munich, Germany, and Paris, France, EADS is the largest commercial aircraft maker and the largest defense contractor in Europe.

global product division

An organizational structure that assigns global responsibilities to each product division.

global matrix

An organizational structure often used to alleviate the disadvantages associated with both geographic area and global product division structures, especially for MNEs adopting a transnational strategy.

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Japan manager increase her investment in the country. Facing these conflicting demands, the Japan manager, who prefers to be politically correct, does not want to make any move before consulting corporate headquarters. Eventually, headquarters may provide a resolution. But crucial time may be lost in the process, and important windows of opportunity for competitive actions may be missed.

Despite its merits on paper, the matrix structure may add layers of management, slow down decision speed, and increase costs while not showing significant performance improvement. There is no conclusive evidence for the superiority of the matrix structure. The following quote from the CEO of Dow Chemical, an early adopter of the matrix structure, is sobering:

We were an organization that was matrixed and depended on teamwork, but there was no one in charge. When things went well, we didn’t know whom to reward; and when things went poorly, we didn’t know whom to blame. So we created a global product division structure, and cut out layers of management. There used to be 11 layers of management between me and the lowest level employees, now there are five.5

Overall, the positioning of the four structures in Figure 10.1 is not random. They develop from the relatively simple international division through either geographic area or global product division structures and may finally reach the more complex global matrix stage. Not every MNE experiences all of these structural stages, and the movement is not necessarily in one direction. For example, the matrix structure’s poster child, the Swedish-Swiss conglomerate ABB, recently withdrew from this structure.

FIGURE 10.5 A Hypothetical Global Matrix Structure

Product Division 1

Asia Europe

Headquarters

Product Division 2

Japan manager here belongs to Asia Division

and Product Division 1

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The Reciprocal Relationship between Multinational Strategy

and Structure In one word, the relationship between strategy and structure is reciprocal. Three ideas stand out:

• Strategy usually drives structure.6 The fit between strategy and structure, as exemplified by the pairs in each of the four cells in Figure 10.1, is crucial.7 A misfit, such as combining a global standardization strategy with a geographic area structure, may have grave consequences.

• The relationship is not one-way. As much as strategy drives structure, structure also drives strategy. The unworkable matrix structure has called into question the wisdom of the transnational strategy.

• Neither strategies nor structures are static. It is often necessary to change strategy, structure, or both. In an effort to move toward a global standardization strategy, many MNEs have adopted a global product division structure while de-emphasizing the role of country headquarters. However, unique challenges in certain countries, especially China, have now pushed some MNEs to revive the country headquarters, such as the China headquarters, so that it can coordinate numerous activities within a large, complex, and important host country.8 A further experimentation is to have an emerging economies division, which is not dedicated to any single country but dedicated to pursuing opportunities in a series of emerging economies ranging from Brazil to Saudi Arabia. Cisco pioneered this structure, which has been followed by rivals such as IBM.9

A Comprehensive Model of Multinational Strategy, Structure, and Learning Having outlined the basic strategy/structure configurations, let us introduce a compre- hensive model that, as before, draws on the strategy tripod (see Figure 10.6).

Industry-Based Considerations Why are MNEs structured differently? Why do they emphasize different forms of learning and innovation? For example, industrial-products firms (such as semiconductors) tend to adopt global product divisions, and consumer-goods companies (such as cosmetics) often rely on geographic area divisions. Industrial-products firms typically emphasize techno- logical innovations, whereas consumer-goods companies place premiums on learning consumer trends and generating repackaged and recombined products as marketing innovations (such as Heinz’s marketing of green ketchup that appeals to children). A short answer is that the different nature of their industries provides a clue. Industrial- products firms value technological knowledge that is not location-specific (such as how to most efficiently make semiconductor chips). Consumer-goods industries, on the other hand, require deep knowledge about consumer tastes that is location-specific (such as what kinds of potato chips consumers in Hungary or Honduras would prefer).10

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In addition, the five forces framework again sheds considerable light on the issue at hand. Within a given industry, as competitors increasingly match each other in cost efficiencies and local responsiveness, their rivalry naturally focuses on learning and innovation.11 This is especially the case in oligopolistic industries (such as automobiles and cosmetics) (see Chapter 8).

Entry barriers also shape MNE strategy, structure, and learning. Why do many MNEs phase out the multidomestic strategy and geographic area division structure by consoli- dating production in a small number of world-scale facilities? One underlying motivation is that smaller suboptimal-scale production facilities, scattered in a variety of countries, are not effective deterrents against potential entrants. Massive, world-scale facilities in strategic locations can serve as more formidable deterrents. For example, Foxconn built a world-scale factory complex employing 300,000 workers in Shenzhen, China.

FIGURE 10.6 A Comprehensive Model of Multinational Strategy, Structure, and Learning

Industry-based considerations

• Nature of industry • Interfirm rivalry on integration, responsiveness, and learning • Entry barriers • Power of suppliers and buyers • Threat of substitutes

Multinational strategy, structure,

and learning

Institution-based considerations

• Formal/informal institutions governing MNEs and home/host country environments • Formal/informal institutions on MNE governance

external

internal

Resource-based considerations

• Value • Rarity • Imitability • Organization

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The bargaining power of suppliers and buyers also has a bearing. When buyer firms move internationally, they increasingly demand integrated offerings from their suppliers—that is, the ability to buy the same supplies at the same price and quality in every country in which they operate. Components suppliers are thus often forced—or at least encouraged (!)—to internationalize. Otherwise, suppliers run the risk of losing a substantial chunk of business. Not surprisingly, as Volkswagen invested in Brazil, all of its top suppliers set up factories in adjacent areas at their own expenses.

The threat of substitute products has a direct bearing on learning and innovation. R&D often generates innovative substitutes. 3M’s Post-It notes, for example, can partially substitute for glue and tape. Smartphones and mobile devices are now substituting some personal computers.

Resource-Based Considerations Shown in Figure 10.6, the resource-based view—exemplified by the value, rarity, imitability, and organization (VRIO) framework—adds a number of insights. First, when looking at structural changes, it is critical to consider whether a new structure (such as a matrix) adds concrete value. The value of innovation must also be considered. A vast majority of innovations simply fail to reach market, and most new products that do reach market end up being financial failures. The difference between an innovator and a profitable innovator is that the latter not only has plenty of good ideas but also lots of complementary assets (such as appropriate organiza- tional structures and marketing muscles) to add value to innovation. Philips, for example, is a great innovator. It invented rotary shavers, video cassettes, and CDs. Still, its ability to profit from these innovations lags behind that of Sony, Matsushita, and Samsung.

A second question is rarity. Certain strategies or structures may be in vogue at a given point in time. So, for example, when a company’s rivals all move toward a global standardization strategy, this strategy cannot be a source of differentiation. To improve global coordination, many MNEs spend millions of dollars to equip them- selves with enterprise resource planning (ERP) packages provided by SAP and Oracle. However, such packages are designed to be implemented widely and appeal to a broad range of firms, thus providing no firm-specific advantage for any adopting firm.

Even when capabilities are valuable and rare, they have to pass a third hurdle— imitability. Formal structures are easier to observe and imitate than informal structures. This is one of the reasons why the informal, flexible matrix is in vogue now. It “is less a structural classification than a broad organizational concept or philosophy, manifested in organizational capability and management mentality.”12 Obviously imitating an intangible mentality is much harder than imitating a tangible structure.

The last hurdle is organization—namely, how MNEs are organized, both formally and informally, around the world.13 One elusive but important concept is organizational culture. Recall from Chapter 4 that culture is defined by Hofstede as “the collective programming of the mind which distinguishes the members of one group or category of people from another.” We can extend this concept to define organizational culture as the collective programming of the mind that distinguishes members of one organization

organizational culture

The collective programming of the mind that distinguishes members of one organization from another.

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from another. Huawei, for example, is known to have a distinctive “wolf” culture, which centers on “continuous hunting” and “relentless pursuit” with highly motivated employ- ees who routinely work over time and sleep in their offices. Although rivals can imitate everything Huawei does technologically, their biggest hurdle lies in their lack of ability to wrap their arms around Huawei’s “wolf” culture.

Institution-Based Considerations MNEs face two sets of the rules of the game: Formal and informal institutions governing (1) external relationships and (2) internal relationships. Each is discussed in turn.

Externally, MNEs are subject to the formal institutional frameworks erected by various home-country and host-country governments. In order to protect domestic employment, the British government taxes the foreign earnings of British MNEs at a higher rate than their domestic earnings. In another example, home-country governments may discourage or ban MNE operations abroad for political reasons. After the Cold War ended, US defense firms such as Boeing and Lockheed Martin were eager to set up R&D subsidiaries in Russia, whose rocket scientists were some of the best (and certainly cheapest!) in the world. The US government warned these firms, however, not to perform any mission- critical R&D there.

Host-country governments, on the other hand, often attract, encourage, or coerce MNEs into undertaking activities that they otherwise would not. For example, basic manufacturing generates low-paying jobs, does not provide sufficient technology spill- overs, and carries little prestige. Advanced manufacturing, R&D, and regional head- quarters, on the other hand, generate better and higher-paying jobs, provide more technology spillovers, and lead to better prestige. Therefore, host-country governments (such as those in China, Hungary, and Singapore) often use a combination of carrots (such as tax incentives and free infrastructure upgrades) and sticks (such as threats to block market access) to attract MNE investments in higher value-added areas (see Strategy in Action 10.1).

In addition to formal institutions, MNEs also confront a series of informal institu- tions governing their relationships with home countries (see Strategy in Action 10.1). In the United States, few laws ban MNEs from aggressively setting up overseas subsidiaries, although the issue is a hot button in public debate and is always subject to changes in political policy. Therefore, managers contemplating such moves must consider the informal but vocal backlash against such activities due to the associated losses in domestic jobs.

Dealing with host countries also involves numerous informal institutions. Airbus spends 40% of its procurement budget with US suppliers in 40 states. While there is no formal requirement for Airbus to farm out supply contracts, its sourcing is guided by the informal norm of reciprocity: If one country’s suppliers are involved with Airbus, airlines based in that country are more likely to buy Airbus aircraft.

Institutional factors affecting MNEs are not only external. How MNEs are governed internally is also determined by various formal and informal rules of the game. Formally, organizational charts, such as those in Figures 10.2 to 10.5, specify the scope of responsibilities for various parties. Most MNEs have systems of evaluation, reward, and punishment in place based on these formal rules.

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E T H I C A L D I L E M M ASTRATEGY IN ACTION 10.1

Moving Headquarters Overseas

A number ofMNEs havemoved headquarters (HQ) overseas. In general, there are two levels of HQ: business unit HQ and corporate HQ. At the business unit level, examples are numerous. In 2004, Nokia moved its corporate finance HQ from Helsinki, Finland, to New York. In 2006, IBM’s global procurement office moved from New York to Shenzhen, China. In 2009, Nomura transferred its investment banking HQ from Tokyo to London. Examples for corporate HQ relocations are fewer, but they tend to be of higher profile. In 1992, HSBC moved corporate HQ from Hong Kong to London. Similarly, Anglo American, Old Mutual, and SAB (later to become SABMiller after acquiring Miller Beer) moved from South Africa to London. In 2004, News Corporation moved corporate HQ from Melbourne, Australia, to New York. In 2005, Lenovo set up corporate HQ in Raleigh, North Carolina, home of IBM’s former PC division that Lenovo acquired. The question is: Why?

If you have moved from one house to another in the same city, you can easily appreciate the logistical challenges (and nightmares!) associated with relocating HQ overseas. A simple answer is that the benefits must significantly outweigh the drawbacks. At the business unit level, the answer is straightforward: the “center of gravity” of the activities of a business unit may pull its HQ toward a host country.

At the corporate level, there are at least five strategic rationales. First, a leading symbolic value is the unambiguous statement to various stakeholders that the firm is a global player. News Corporation’s new corporate HQ in New York is indicative of its global status, as opposed to being a relatively parochial firm from “down under.” Lenovo’s coming of age is no doubt underpinned by the establishment of its worldwide HQ in the United States.

Second, there may be significant efficiency gains. If the new corporate HQ is in a major financial center such as New York or London, the MNE can have more efficient and more frequent communication with institutional

shareholders, financial analysts, and investment banks. The MNE also increases its visibility in a financial market, resulting in a broader shareholder base and greater market capitalization. Three leading (former) South African firms, Anglo American, Old Mutual, and SABMiller, have now joined FTSE 100—the top 100 UK firms by capitalization.

Third, firms may benefit from their visible commitment to the laws of the new host country. They can also benefit from the higher-quality legal and regulatory regime they now operate under. These benefits are especially crucial for firms from emerging economies where local rules are not world-class. A lack of confidence about South Africa’s political stability drove Anglo American, Old Mutual, and SABMiller to London. By coming to London, HSBC likewise deviated from its Hong Kong roots at a time when the political future of Hong Kong was uncertain.

Fourth, moving corporate HQ to a new country clearly indicates a commitment to that country. In addition to political motivation, HSBC’s move to London signaled its determination to become a more global player, instead of being a regional player centered on Asia. HSBC indeed carried out this more global strategy since the 1990s. However, in an interesting twist of events, HSBC’s CEO relocated back to Hong Kong in 2010. Technically, HSBC’s corporate HQ is still in London, and its chairman remains in London. However, the symbolism of the CEO’s return to Hong Kong is clear. As China becomes more economically powerful, HSBC is interested in demonstrating its commitment to that part of the world, which was where HSBC started (HSBC was set up in Hong Kong in 1865 as Hongkong and Shanghai Banking Corporation).

Finally, by moving (or threatening to move) HQ, firms enhance their bargaining power vis-à-vis that of their (original) home-country governments. Tetra Pak’s 1981 move of its corporate HQ to Switzerland was driven primarily by the owners’ tax disputes with the Swedish government. A few years ago, Seagate Technology,

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What the formal organizational charts do not reveal are the informal rules of the game, such as organizational norms, values, and networks. The nationality of the head of foreign subsidiaries is an example. Given the lack of formal regulations, MNEs essentially can have three choices:

• a home-country national as the head of a subsidiary (such as an American for a subsidiary of a US-headquartered MNE in India)

• a host-country national (such as an Indian for the same subsidiary)

• a third-country national (such as an Australian for the same subsidiary above)

MNEs from different countries have different norms when making these appoint- ments. Most Japanese MNEs follow an informal rule: Heads of foreign subsidiaries, at least initially, need to be Japanese nationals. In comparison, European MNEs are more likely to appoint host-country and third-country nationals to lead subsidiaries. As a group, US MNEs are somewhere between Japanese and European practices. These staffing

formerly registered in Silicon Valley, changed its incorporation to Cayman Islands in search of lower taxes. More US firms may follow such a move. Having already paid overseas taxes, US MNEs naturally resented Obama administration’s proposal to extract from them $109 billion additional US taxes. “Doesn’t the Obama administration recognize that most big US companies are multinationals that happen to be headquartered in the United States?” asked Duncan Niederauer, CEO of NYSE Euronext in a BusinessWeek interview. Likewise, as three of Britain’s large banks—Barclays, HSBC, and Standard Chartered, the three best-run ones that didn’t need bailouts—now face higher taxes and more government intervention, they too have threatened to move their HQ out of London. The message is clear: If the home-country government treats us harshly, we will pack our bags.

The last point, of course, is where the ethical and social responsibility controversies erupt. According to the Economist, Italy “regularly goes into hysteria over whether Fiat will stay.” After Fiat’s acquisition of Chrysler in 2009, whether the combined group’s HQ would be in Turin or Detroit became an emotionally charged debate (Fiat’s HQ eventually stayed in Turin). Although the absolute number of jobs lost is not great, these are high-quality (and high- paying) jobs that every government would prefer to see. For that reason, different cities in China, such as Beijing and Shanghai, offered very lucrative packages to attract regional HQ. For MNEs’ home country, if a sufficient

number of HQ move overseas, there is a serious ramification that other high-quality service providers, such as lawyers, bankers, and accountants, will follow them. In response, proposals are floating to offer tax incentives for these “foot-loose” MNEs to keep HQ at home. However, critics question why these wealthy MNEs (and executives) need to be subsidized (or bribed), while many other sectors and individuals are struggling.

Sources: Based on (1) G. Benito, R. Lunnan, & S. Tomassen, 2011, Distant encounters of the third kind: Multinational companies locating divisional headquarters abroad, Journal of Management Studies, 48: 373–394; (2) J. Birkinshaw, P. Braunerhjelm, U. Holm, & S. Terjesen, 2006, Why do some multinational corporations relocate their headquarters overseas? Strategic Management Journal, 27: 681–700; (3) BusinessWeek, 2009, NYSE chief Duncan Niederauer on Obama and business, 8 June: 15–16; (4) China Business Review, 2009, The race for regional headquarters takes off, November: 56–59; (5) Economist, 2010, Las Vegas leaving, December 4: 71; (6) Economist, 2011, HSBC: Gulliver’s travels, April 16: 75–77; (7) IBM, 2006, IBM Procurement headquarters moves to Shenzhen, China, May 22, www-03. ibm.com; (8) T. Laamanen, T. Simula, & S. Torstila, 2012, Cross-border relocations of headquarters in Europe, Journal of International Business Studies, 43: 187–210; (9) Wall Street Journal, 2009, HSBC re-emphasizes its “H,” September 26, www.wsj.com.

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approaches may reflect strategic differences. Home-country nationals, especially long-time employees of the same MNE at home, are more likely to have developed a better under- standing of the informal workings of the firm and to be better socialized into its dominant norms and values. Consequently, the Japanese propensity to appoint home-country nationals is conducive to their preferred global standardization strategy, which values globally coordinated and controlled actions. Conversely, the European comfort in appointing host-country and third-country nationals is indicative of European MNEs’ (traditional) preference for a localization strategy.

Beyond the nationality of subsidiary heads, the nationality of top executives at the highest level (such as chairman, CEO, and board members) seems to follow another informal rule: They are almost always home-country nationals. To the extent that top executives are ambassadors of the firm and that the MNE’s country of origin is a source of differentiation (for example, a German MNE is often perceived to be different from an Italian MNE), home-country nationals would seem to be the most natural candidates for top positions.

In the eyes of stakeholders such as employees and governments around the world, however, a top echelon consisting of largely one nationality does not bode well for an MNE aspiring to globalize everything it does. Some critics even argue that this “glass ceiling” reflects “corporate imperialism.”14 Consequently, such leading MNEs as BP, Coca-Cola, Electrolux, GSK, Lenovo, Nissan, Nokia, PepsiCo, and Sony have appointed foreign-born executives to top posts. Such foreign-born bosses bring sub- stantial diversity to the organization, which may be a plus. However, such diversity puts an enormous burden on these non-native top executives to clearly articulate the values and exhibit behaviors expected of senior managers of an MNE associated with a particular country. In 2010, Hewlett-Packard (HP) appointed Léo Apotheker, a native of Germany, to be its CEO. Unfortunately, HP lost $30 billion in market capitalization during his short tenure (less than 11 months), thanks to his numerous change initiatives. He was quickly fired in 2011. Since then, the old rule is back: HP is again led by an American executive.

Overall, while formal internal rules on how the MNE is governed may reflect con- scientious strategic choices, informal internal rules are often taken for granted and deeply embedded in administrative heritages, thus making them difficult to change.

Worldwide Learning, Innovation, and Knowledge Management Knowledge Management Underpinning the recent emphasis on worldwide learning and innovation is the emer- ging interest in knowledge management.15 Knowledge management can be defined as the structures, processes, and systems that actively develop, leverage, and transfer knowledge.

Many managers regard knowledge management as simply information management. Taken to an extreme, “such a perspective can result in a profoundly mistaken belief that the installation of sophisticated information technology (IT) infrastructure is the be-all

knowledge management

The structures, processes, and systems that actively develop, leverage, and transfer knowledge.

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and end-all of knowledge management.”16 Knowledge management depends not only on IT but also on informal social relationships within the MNE.17 There are two categories of knowledge: (1) explicit knowledge and (2) tacit knowledge. Explicit knowledge is codifi- able—it can be written down and transferred with little loss of richness. Virtually all of the knowledge captured, stored, and transmitted by IT is explicit. Tacit knowledge is non- codifiable, and its acquisition and transfer require hands-on practice. For example, read- ing a driver’s manual (a ton of explicit knowledge) without any road practice does not make you a good driver. Tacit knowledge is evidently more important and harder to transfer and learn; it can only be acquired through learning by doing (driving in this case). Consequently, from a resource-based view, explicit knowledge captured by IT may be strategically less important. What counts is the hard-to-codify and hard-to-transfer tacit knowledge.18

Knowledge Management in Four Types of Multinational

Enterprises Differences in knowledge management among four types of MNEs in Figure 10.1 funda- mentally stem from the interdependence (1) between the headquarters and subsidiaries and (2) among various subsidiaries, as outlined in Table 10.2.19 In MNEs pursuing a

TABLE 10.2 Knowledge Management in Four Types of Multinational Enterprises

STRATEGY HOME REPLICATION LOCALIZATION GLOBAL STANDARDIZATION TRANSNATIONAL

Interdependence Moderate Low Moderate High

Role of foreign subsidiaries

Adapting and leveraging parent company competencies

Sensing and exploiting local opportunities

Implementing parent company initiatives

Differentiated contributions by subsidiaries to integrate worldwide operations

Development and diffusion of knowledge

Knowledge developed at the center and transferred to subsidiaries

Knowledge developed and retained within each subsidiary

Knowledge mostly developed and retained at the center and key locations

Knowledge developed jointly and shared worldwide

Flow of knowledge

Extensive flow of knowledge and people from headquarters to subsidiaries

Limited flow of knowledge and people in both directions (to and from the center)

Extensive flow of knowledge and people from center and key locations to subsidiaries

Extensive flow of knowledge and people in multiple directions

Sources: Adapted from (1) C. Bartlett & S. Ghoshal, 1989, Managing Across Borders: The Transnational Solution (p. 65), Boston: Harvard Business School Press; (2) T. Kostova & K. Roth, 2003, Social capital in multinational corporations and a micro-macro model of its formation (p. 299), Academy of Management Review, 28 (2): 297–317.

explicit knowledge

Knowledge that is codifiable (that is, it can be written down and transferred without losing much of its richness).

tacit knowledge

Knowledge that is not codifiable (that is, hard to be written down and transmitted without losing much of its richness).

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home replication strategy, such interdependence is moderate and the role of subsidi- aries is largely to adapt and leverage parent company competencies. Thus, knowledge on new products and technologies is mostly developed at the center and flown to subsidiaries, representing the traditional one-way flow. Starbucks, for example, insists on replicating its US coffee shop concept around the world, down to the elusive “atmosphere.”

When MNEs adopt a localization strategy, the interdependence is low. Knowledge management centers on developing insights that can best serve local markets. Ford of Europe used to develop cars for Europe, with a limited flow of knowledge to and from headquarters. In MNEs pursuing a global standardization strategy, on the other hand, the interdependence is increased. Knowledge is developed and retained at the headquarters and a few centers of excellence. Consequently, knowledge and people typically flow from headquarters and these centers to other subsidiaries. For example, Yokogawa Hewlett-Packard, HP’s subsidiary in Japan, won a coveted Japanese Dem- ing Award for quality. The subsidiary was then charged with transferring such knowledge to the rest of HP, which resulted in a tenfold improvement in corporate- wide quality in ten years.

A hallmark of transnational MNEs is a high degree of interdependence and extensive and bi-directional flows of knowledge. For example, Kikkoman first devel- oped teriyaki sauce specifically for the US market as a barbecue glaze. It was then marketed to Japan and the rest of the world. Similarly, Häagen-Dazs developed a popular ice cream in Argentina that was based on a locally popular caramelized milk dessert. The company then took the new flavor and sold it as “dulce de leche” throughout the United States and Europe. Within one year, it became the second most popular Häagen-Dazs ice cream (next only to vanilla). Particularly fundamental to transnational MNEs is knowledge flows among dispersed subsidiaries. Instead of a top-down hierarchy, the MNE thus can be conceptualized as an integrated network of subsidiaries. Each subsidiary not only develops locally relevant knowledge but also aspires to contribute knowledge to benefit the MNE as a whole (see Emerging Markets 10.1).

Globalizing Research and Development (R&D) R&D represents a crucial arena for knowledge management. Relative to production and marketing, only more recently has R&D emerged as an important function to be inter- nationalized—often known as innovation-seeking investment.20 The intensification of competition for innovation drives the globalization of R&D. Such R&D provides a vehicle to access a foreign country’s local talents and expertise.21 Recall earlier discussions in Chapter 6 on the importance of agglomeration of high-caliber innovative firms within a country. For foreign firms, a most effective way to access such a cluster is to be there through foreign direct investment (FDI)—as Shiseido did in France by setting up a perfume lab there.

From a resource-based standpoint, a fundamental basis for competitive advantage is innovation-based firm heterogeneity (being different).22 Decentralized R&D per- formed by different locations and teams around the world virtually guarantees that there will be persistent heterogeneity in the solutions generated.23 GSK, for example,

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has aggressively spun off R&D units, because it realizes that adding more researchers in centralized R&D units does not necessarily enhance global learning and innova- tion.24 GE’s China units have developed low-cost, portable ultrasound machines at a fraction of the cost of existing machines developed in the United States. GE has not only been selling the developed-in-China machines throughout emerging economies, but has also brought them back to the United States and other developed economies, which also benefit tremendously from such low-cost machines (see Emerging Markets 1.2).

Problems and Solutions in Knowledge Management Institutionally, how MNEs employ the formal and informal rules of the game has a significant bearing behind the success or failure of knowledge management.25 Shown in Table 10.3, a number of informal “rules” can become problems in knowledge manage- ment. In knowledge acquisition, many MNEs prefer to invent everything internally. However, for large firms, R&D actually offers diminishing returns.26 Consequently, a new model, open innovation, is emerging.27 Open innovation is “the use of purposive inflows and outflows of knowledge to accelerate internal innovation and expand the markets for external use of innovation.”28 It relies on more collaborative research among various internal units, external firms, and university labs. Firms that skillfully share research often outperform those that fail to do so.29

In knowledge retention, the usual problems of employee turnover are compounded when such employees are key R&D personnel, whose departure will lead to knowledge leakage.30 In knowledge outflow, there is the “How does it help me?” syndrome. Speci- fically, managers of the source subsidiary may view the outbound sharing of knowledge as a diversion of scarce time and resources. Further, some managers may believe that “knowledge is power”—monopolizing certain knowledge may be viewed as the currency to acquire and retain power within the MNE.31

TABLE 10.3 Problems in Knowledge Management

ELEMENTS OF KNOWLEDGE MANAGEMENT COMMON PROBLEMS

Knowledge acquisition Failure to share and integrate external knowledge

Knowledge retention Employee turnover and knowledge leakage

Knowledge outflow “How does it help me?” syndrome and “knowledge is power” mentality

Knowledge transmission Inappropriate channels

Knowledge inflow “Not invented here” syndrome and absorptive capacity

Source: Adapted from A. Gupta & V. Govindarajan, 2004, Global Strategy and Organization (p. 109), New York: Wiley.

open innovation

The use of purposive inflows and outflows of knowledge to accelerate internal innovation and expand the markets for external use of innovation.

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Even when certain subsidiaries are willing to share knowledge, inappropriate transmission channels may still torpedo effective sharing.32 It is tempting to establish global virtual teams, which do not meet face to face, to transfer knowledge. Unfortu- nately, such teams often have to confront tremendous communication and relation- ship barriers.33 Videoconferences can hardly show body language, and Skype often breaks down. Thus, face-to-face meetings—of the sort Samsung’s Global Strategy teams often hold (see the Opening Case)—are often still necessary. Finally, for two reasons recipient subsidiaries may block successful knowledge inflows. First, the “not invented here” syndrome creates a resistance to ideas from other units. Second, recipients may have limited absorptive capacity—the “ability to recognize the value of new information, assimilate it, and apply it.”34

As solutions to combat these problems, headquarters can manipulate the formal “rules of the game,” such as (1) tying bonuses to measurable knowledge outflows and inflows,35 (2) using high-powered corporate-based or unit-based incentives (as opposed to individual-based and single-subsidiary-based incentives), and (3) investing in codify- ing tacit knowledge (such as the codification of the Toyota Way). However, these formal policies fundamentally boil down to the very challenging (if not impossible) task of how to accurately measure inflows and outflows of tacit knowledge. The nature of tacit knowledge simply resists such formal bureaucratic practices. Consequently, MNEs often have to rely on a great deal of informal integrating mechanisms, such as (1) facilitating management and R&D personnel networks among various subsidiaries through joint teamwork, training, and conferences, and (2) promoting strong organizational (that is, MNE-specific) cultures and shared values and norms for cooperation among subsidi- aries. Shown in the Opening Case, Samsung’s Global Strategy Group has facilitated the establishment of such networks between Korean and non-Korean executives and fos- tered the sharing of the Samsung culture, by having Global Strategy teams to work on a variety of internal strategy consulting projects interacting with various Samsung sub- sidiaries in a two-year period.

Instead of using traditional formal command-and-control structures that are often inef- fective, knowledge management is best facilitated by informal social capital, which refers to the informal benefits individuals and organizations derive from their social structures and networks.36 Because of the existence of social capital, individuals are more likely to go out of their way to help friends and acquaintances. Consequently, managers of the China subsidiary are more likely to help managers of the Chile subsidiary with needed knowledge if they know each other and have some social relationship. Otherwise, managers of the China subsidiary may not be as enthusiastic to provide such help if the call for help comes from managers of the Canada subsidiary, with whom there is no social relationship. Overall, the micro informal interpersonal relationships among managers of various units may greatly facilitate macro inter-subsidiary cooperation among various units—in short, a micro-macro link.37

Debates and Extensions The question of how to manage complex MNEs has led to numerous debates, some of which have been discussed earlier (such as the debate on the matrix structure). Here we outline three of the leading debates not previously discussed: (1) one

global virtual teams

Teams whose members are physically dispersed in multiple locations in the world. They cooperate on a virtual basis.

absorptive capacity

The ability to absorb new knowledge by recognizing the value of new informa- tion, assimilating it, and applying it.

social capital

The informal benefits individuals and organiza- tions derive from their social structures and networks.

micro-macro link

The link between micro, informal interpersonal relationships among managers of various units and macro, interorganiza- tional cooperation among various units.

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multinational versus many national companies, (2) corporate controls versus sub- sidiary initiatives, and (3) customer-focused dimensions versus integration, respon- siveness, and learning.

One Multinational versus Many National Companies We often treat each MNE as one firm. However, from an institution-based view, one can argue that a multinational enterprise may be a total fiction that does not exist. Legally, incorporation is only possible under national law. In other words, every so-called MNE is essentially a bunch of national companies (subsidiaries) registered in various countries. A generation ago, such firms were often labeled “multi-national companies” with a hyphen. Although some pundits argue that globalization is undermining the power of national governments, little evidence suggests that the modern nation-state system, in existence since the 1648 Treaty of Westphalia, is retreating.

This debate is not just academic hair-splitting fighting over a hyphen. It is very relevant and stakes are high. One case in point concerns taxation. Google Ireland is not a branch of the US-based Google Corporation. Google Ireland is a separate, legally independent corporation registered in Ireland. Although Google Corporation intentionally lets Google Ireland earn a lot of profits, the Internal Revenue Service (IRS) cannot tax a dime Google Ireland makes unless it sends back (repatriates) the profits to Google Corporation. Google Corporation does not have just one subsidiary. It has lots around the world. Overall, 54% of Google’s profits are parked overseas and are not taxable by the IRS. Google is not alone. The list of leading US firms that have left a majority of their profits overseas includes Chevron, Cisco, Citigroup, ExxonMobil, GE, HP, IBM, Johnson & Johnson, Microsoft, P&G, PepsiCo, and Pfizer.38 These firms claim that they are willing to bring the profits back home to invest and create jobs as long as Congress grants them a tax holiday. Running huge budget deficits, Congress is understandably reluctant.

Another case in point is brought by Indian firm Satyam’s scandal. Satyam was listed on the New York Stock Exchange (NYSE), and PricewaterhouseCooper (PwC) endorsed Satyam’s books even through $1 billion cash did not exist at all. While such sloppy auditing was done by PwC India, some Satyam shareholders sued PwC International Limited headquartered in New York. But PwC International spokesman argued in inter- views that “there is no such a thing as a global firm because we are a membership organization.”39 That is to say: PwC India, registered in India, is a legally independent firm whose conduct has nothing to do with other nationally registered firms such as PwC International or PwC Hong Kong. In court battles, whether the argument that PwC International is not responsible for PwC India’s misconduct can repel the allegations remains to be seen.

Corporate Controls versus Subsidiary Initiatives One of the leading debates on how to manage large firms is centralization versus decentralization (see Strategy in Action 10.2). Within an MNE, the debate boils down to central controls versus subsidiary initiatives. A starting point is that subsidiaries are not necessarily at the receiving end of commands from headquarters. When headquarters promote certain practices (such as quality circles or ethics training), some subsidiaries

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STRATEGY IN ACTION 10.2

Centralized and Decentralized Strategic Planning at the Oil Majors

According to some critics, strategic planning is in crisis. Historically top down, bureaucratic, and formalized, strategic planning seems unable to keep up with the turbulent world of modern competition. Many corporate planning departments have been downsized, and critics predict the demise of strategic planning. However, at the world’s major oil companies known as the Oil Majors (some of which were formerly known as the Seven Sisters a century ago), such as BP, Chevron, Elf, ENI, ExxonMobil, Shell, and Texaco, such a demise seems unlikely as strategic planning continues to play an important although transformed role.

Usually ranked among the world’s largest MNEs, the Oil Majors have complex operations spanning the globe. The uncertainty of their markets and the large capital requirements call for careful planning. As a result, the Oil Majors were among the first group of firms that pioneered the creation of corporate planning departments in the 1960s, and have been leading-edge practitioners of centralized strategic planning.

Since the 1970s, the competitive environment has experienced a great deal of turmoil, because of the Oil Shocks of 1973–74 and 1979–80, tensions in the Middle East, and wars and chaos in major oil-producing countries such as Iraq, Nigeria, Russia, and Venezuela—the most recent case in point: Libya (2011). Thanks to the tremendous fluctuation, the accuracy of crude oil price predictions declines. Thus, the danger of relying on these forecasts becomes apparent.

In response to the heightened uncertainty, strategic planning at the Oil Majors has been transformed in three significant ways. First, forecasting is reduced, whereas scenario planning, based on multiple scenarios with numerous “reference prices,” is increasingly used. Planning horizons are shortened from 10–15 years to five years or less. Second, planning is less formal with less emphasis on written documentation and more on open discussions. At Exxon- Mobil, annual planning meetings between divisional and corporate heads have been cut from 3–4 days to a half-day.

Third and perhaps most significantly, all Oil Majors have decentralized their decision making. A more turbulent

environment has pushed decision making increasingly down to the subsidiary and divisional level. It is believed that such lower level decision making allows for better, speedier responses to fast-changing circumstances in many different countries. Capital expenditure limits above which subsidiary and divisional managers need corporate approval have all risen—for instance, to $50 million at ExxonMobil and $150 million at BP. On the other hand, subsidiary and divisional managers are increasingly held accountable for performance targets. An inevitable corollary of these changes is that subsidiary and divisional managers must be free to select strategies capable of delivering the required performance. As a result, since the 1990s, strategy formulation has taken place, for the most part, outside of the corporate strategic planning systems. Strategic decisions are now typically “bottom up,” proposed and made by subsidiary and divisional managers, and are subsequently incorporated into corporate strategic plans.

Overall, there indeed has been some reduction in corporate planning staff since the 1990s. For example, at Shell, the staff has been reduced from 48 to 17. However, the prediction that the planning staff may become an endangered species is premature, because now almost all major subsidiaries and divisions have planning units. The subsidiary and divisional planning staff routinely outnumbers the corporate planning staff—for instance, 416 versus 72 at ENI. Overall, at the Oil Majors, strategic planning has become more decentralized, less corporate staff driven, and more informal, while plans themselves become shorter term, more goal focused, and less specific.

Sources: Based on (1) R. Grant, 2003, Strategic planning in a turbulent environment, Strategic Management Journal, 24: 491–517; (2) H. Mintzberg, 1994, The Rise and Fall of Strategic Planning, New York: Free Press; (3) M. W. Peng, 2012, Managing political risk in the Middle East (p. 31), Global, Cincinnati: South-Western Cengage Learning; (4) D. Simpson, 1998, Why most strategic planning is a waste of time and what you can do about it, Long Range Planning, 31: 476–480.

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may be in full compliance, others may pay lip service to them, and still others may simply refuse to adopt them, citing local differences.40

In addition to reacting to headquarters’ demands differently, some subsidiaries may actively pursue their own subsidiary-level strategies and agendas.41 These activities are known as subsidiary initiatives, defined as the proactive and deliberate pursuit of new opportunities by a subsidiary. Advocates argue that such initiatives may inject a much-needed spirit of entrepreneurship throughout the larger bureaucratic MNE (see the Closing Case).

However, from the perspective of corporate headquarters, it is hard to distinguish between good-faith subsidiary initiative and opportunistic “empire-building.”42 A lot is at stake when determining which subsidiary initiatives are supported.43 Subsidiaries whose initiatives fail to receive support may see their roles marginalized and, in the worst case, their facilities closed. Subsidiary managers are often host-country nationals, who would naturally prefer to strengthen their subsidiary. However, these tendencies, although very understandable, are not necessarily consistent with the MNE’s corporate-wide goals. These tendencies, if not checked and controlled, can surely lead to chaos. According to the title of an influential article authored by Andy Grove, former chairman and CEO of Intel, the challenge for corporate management is:

Let chaos reign, then rein in chaos—repeatedly.44

Customer-Focused Dimensions versus Integration,

Responsiveness, and Learning As discussed earlier, juggling the three dimensions of integration, responsiveness, and learning has often made the global matrix structure so complex it is unworkable. How- ever, instead of simplifying, many MNEs have added new dimensions. Often, new customer-focused dimensions of structure are placed on top of an existing structure, resulting in a four- or five-dimension matrix.45

Of the two primary customer-focused dimensions, the first is a global account structure to supply customers (often other MNEs) in a coordinated and consistent way across various countries.46 Most original equipment manufacturers (OEMs)—namely, contract manufacturers that produce goods not carrying their own brands (such as the makers of Nike shoes and Microsoft Xbox)—use this structure. For example, Singapore’s Flextronics, one of the world’s largest OEMs, has dedicated global accounts for Dell, Palm, and Sony Ericsson. The second customer-focused dimension is the oft-used solutions- based structure. For instance, as a “customer solution” provider, IBM will sell whatever combination of hardware, software, and services that customers prefer, whether that means selling IBM products or rivals’ offerings.

The typical starting point is to put in place temporary solutions rather than create new layers or units. However, this ad hoc approach can quickly get out of control, resulting in subsidiary managers’ additional duties of reporting to three or four “informal bosses” (acting as global account managers) on top of their “day jobs.” Eventually, new formal structures may be called for, resulting in more bureaucracy.

So what is the solution when confronting the value-added potential of customer- focused dimensions and their associated complexity and cost? One solution is to simplify. For instance, ABB, when facing performance problems, transformed its sprawling “Byzantine” matrix structure to a mere two product divisions.

subsidiary initiative

The proactive and deliberate pursuit of new business opportunities by an MNE’s subsidiary to expand its scope of responsibility.

global account structure

A customer-focused structure that supplies customers (often other MNEs) in a coordinated and consistent way across various countries.

solutions-based structure

An MNE organizational structure that caters to the needs of providing solutions for customers’ problems.

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The Savvy Strategist MNEs are the ultimate large, complex, and geographically dispersed business organizations. To manage effectively, four clear implications emerge for the savvy strategist (Table 10.4). First, understand the nature and evolution of your industry in order to come up with the right strategy-structure configurations. When the Japanese automobile industry was primar- ily exporting, Honda adopted a home replication strategy supported by an international division. However, as the industry evolved to becomemore geographically dispersed in terms of production and innovation, Honda’s strategy and structure had to adapt to keep up.

Second, managers need to develop learning and innovation capabilities to leverage multinational presence.47 A winning formula is “think global, act local.”48 Failing to do so may be costly. Between 1999 and 2000, many Ford Explorer SUVs accidentally rolled over and killed many people in the United States. Most of these accidents were caused by faulty tires made by Japan’s Bridgestone and its US subsidiary Firestone. Before the number of US accidents skyrocketed, an alarming number of accidents had already taken place in warmer-weather countries such as Brazil and Saudi Arabia, and local managers dutifully reported them to headquarters in Japan and the United States. Unfortunately, these reports were dismissed by higher-ups as “driver error” or “road conditions.” Bridgestone (and Firestone) thus failed to leverage its multinational presence as an asset—it should have learned from these reports and proactively probed into the potential for similar accidents in cooler-weather countries (tires depreciate faster in warmer weather).

Third, mastering the external rules of the game governing MNEs and home/host country environments becomes a must. In 2000, Philips took advantage of home-country rules concerning antidumping (see Chapter 8) by suing Chinese firms for dumping in the EU. However, after Philips upset the host-country government, its sales in China, its second largest market after the United States, immediately dropped by 10% (from $5.5 billion in 2000 to $5 billion in 2001). Getting the message, Philips tried to repair the damage. In 2003 Philips’ board held its first meeting outside of Amsterdam in Beijing and visited Chinese officials. It also moved its Asia headquarters from Hong Kong to Shanghai and set up R&D units in Xian.

Finally, managers need to understand and be prepared to change the internal rules of the game governing MNE management. Different strategies and structures call for different internal rules of the game. Some facilitate and others constrain MNE actions. It is impossible for a home replication firm to entertain having a foreigner as its CEO. Yet, as an MNE becomes more global in its operations, its managerial outlook needs to be broadened as well (see the Opening Case).

TABLE 10.4 Strategic Implications for Action

& Understand the evolution of your industry to come up with the right strategy-structure configurations. & Develop learning and innovation capabilities to leverage multinational presence as an asset—“think

global, act local.” & Master the external rules of the game governing MNEs and home/host country environments. & Be prepared to change the internal rules of the game governing MNE management.

ga ge

Le ar ni ng

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CHAPTER SUMMARY

1. Understand the four basic configurations of multinational strategies and structures • Governing multinational strategy and structure is an integration-responsiveness framework.

• There are four strategy/structure pairs: (1) home replication strategy/international division structure, (2) localization strategy/geographic area structure, (3) global standardization strategy/global product division structure, and (4) transnational strategy/ global matrix structure.

2. Articulate a comprehensive model of multinational strategy, structure, and learning • Industry-based considerations drive a number of decisions affecting strategy, structure, and learning.

• Management of MNE strategy, structure, and learning needs to take into account its VRIO. • MNEs are governed by external and internal rules of the game around the world.

3. Outline the challenges associated with learning, innovation, and knowledge management • Knowledge management primarily focuses on tacit knowledge. • Globalization of R&D calls for capabilities to combat a number of problems associated with knowledge creation, retention, outflow, transmission, and inflow.

4. Participate in three leading debates on multinational structure, learning, and innovation • (1) One multinational versus many national companies, (2) corporate controls versus subsidiary initiatives, and (3) customer-focused dimensions versus integration, responsiveness, and learning.

5. Draw strategic implications for action • Understand the evolution of your industry to come up with the right strategy-structure configurations.

• Develop learning and innovation capabilities around the world—“think global, act local.” • Master the external rules of the game from home/host country environments. • Be prepared to change the internal rules of the game governing MNEs.

KEY TERMS

Absorptive capacity p. 314

Center of excellence p. 299

Country (regional) manager p. 301

Explicit knowledge p. 301

Geographic area structure p. 301

Global account structure p. 317

Global matrix p. 302

Global product division p. 302

Global standardization strategy p. 299

Global virtual team p. 314

Home replication strategy p. 297

Integration-responsiveness framework p. 296

International division p. 300

Knowledgemanagement p. 310

Local responsiveness p. 296

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Localization (multi-domestic) strategy p. 297

Micro-macro link p. 314

Open innovation p. 313

Organizational culture p. 306

Social capital p. 314

Solutions-based structure p. 317

Subsidiary initiative p. 317

Tacit knowledge p. 311

Transnational strategy p. 299

Worldwide (global) mandate p. 299

CRITICAL DISCUSSION QUESTIONS

1. In this age of globalization, some gurus argue that all industries are becoming global and that all firms need to adopt a global standardization strategy. Do you agree? Why or why not?

2. From time to time, a manager may be faced with the need to change the internal rules of the game within his/her MNE. What skills and capabilities may be useful in achieving this?

3. ON ETHICS: If you were a CEO or a business unit head, under what conditions would you consider moving your headquarters overseas? (see Strategy in Action 10.1)

TOPICS FOR EXPANDED PROJECTS

1. ON ETHICS: You are the head of the best-performing subsidiary in an MNE. Because bonuses are tied to subsidiary performance, your bonus is the highest among managers of all subsidiaries. Now headquarters is organizing managers from other subsidiaries to visit and learn from your subsidiary. You worry that if your subsidiary is no longer the star unit when other subsidiaries’ performance catches up, your bonus will go down. What are you going to do? State your answer in a one-page paper.

2. ON ETHICS: You are a corporate R&D manager at Boeing and are thinking about transferring some R&D work to China, India, and Russia, where the work performed by a $70,000 US engineer reportedly can be done by an engineer in one of these countries for less than $7,000. However, US engineers at Boeing have staged protests against such moves. US politicians are similarly vocal concerning job losses and national security hazards. Write a short paper describing how you’ve decided to proceed and why.

3. ON ETHICS: Working in pairs or small groups, research and review a high-profile case of an MNE moving its headquarters out of your country and the media and political outcry surrounding this move (see Strategy in Action 10.1). Determine whether you are for or against the firm’s move, and present your research in a short paper or visual presentation.

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CLOSING CASE

A Subsidiary Initiative at Bayer MaterialScience North America

Bayer Group is a $50 billion chemical and health care giant based in Germany. Its three main product divisions are Bayer MaterialScience (BMS), Bayer CropScience, and Bayer HealthCare. In this matrix organization, each of these product divisions has country/regional subsidiaries in major markets. Between 2004 and 2011, the CEO for Bayer MaterialScience North America (BMS NA) was Greg Babe. Contributing 25% of BMS’ global revenues, BMS NA delivered highly respected performance. It had strong sales growth in 2005 ($3.5 billion, increasing from $2.7 billion in 2004), and suffered a modest flattening in 2006 ($3.3 billion). However, in early 2007, BMS made a radical decision: to dismantle BMS NA—in other words, to shut down the North America regional headquarters in Pitts- burgh. Allegedly undermining cost competitiveness, the regional structure was viewed as too bloated.

Shocked, Babe asked for time to propose another solution. In his own words: “The stakes couldn’t have been higher: not only the future of my position but the credibility of the entire regional operation was in ques- tion.” Cost cutting was nothing unusual in this cyclical industry, and the norm was usually to shave off a certain percentage of overhead (such as 10%). A month into the analysis, Babe and his team had an “aha” moment. The cost structure, they realized, should be dictated by how they grew the business, not by an arbitrary target. With that insight, they looked at the overall picture from a strategic growth lens rather than a tactical cost reduction lens. They set two specific goals: (1) to grow at 1% to 2% above GDP and (2) to save 25% on selling, general, and administrative (SG&A) costs. To deliver that, Babe needed to completely re- shape his unit but also needed additional investment of $70 million.

In late 2007, when Babe presented to BMS’s global leadership team, everyone expected him to come up with a cost-cutting exercise. Instead, he presented a subsidiary growth initiative. BMS’s global leadership team challenged

key concepts of the proposal, many of which deviated from Bayer’s global norms. For example, transportation was historically deemed by Bayer as a core competence. Babe proposed to outsource it, which would allow custo- mers to give a 12 (rather than 72) hours’ notice for ship- ping. Overall, Babe promised to turn BMS NA into a lean growth engine. In the end, the bold proposal paid off. Babe left the meeting with $70 million in hand. In his own words:

I was excited, but also scared to death, because delivering on it was by no means going to be easy. It would require laying off hundreds of employees and retraining more than 1,000 others, outsourcing many operations, rolling out new IT systems, and modifying our product offerings, all within 18 months—not much time for a project of that scale.

To make the matters worse, the chemical industry soon entered a severe downturn worldwide, and BMS suffered eight consecutive quarters of declining sales starting in 2008. In such a bleak environment, BMS NA’s efforts became more strategically important. By early 2009, BMS NA delivered on everything Babe had promised: it reduced SG&A costs by 25% ($100 million)

Pittsburgh

M ap

Re so ur ce s

C h a p t e r 1 0 S t r a t e g i z i n g , S t r u c t u r i n g , a n d L e a r n i n g A r o u n d t h e W o r l d 321

NOTES

and head count by 30%. It actually overdelivered: only $60 million of the $70 million allotted for growth was spent. By 2010, BMS NA’s sales turned around and enjoyed double-digit quarterly growth (2010 sales went up to $2.7 billion from the bottom of $2.1 billion in 2009). What was more valuable was that some of the reorganized processes (such as outsourcing transporta- tion), so foreign at the time to BMS, now became implemented by BMS around the world. Overall, by endorsing the regional subsidiary’s initiative, BMS’s glo- bal leadership team took some significant risk. But in the end, the payoff was handsome.

Sources: Based on (1) Bayer AG, 2012, www.bayerus.com; (2) G. Babe, 2011, The CEO of Bayer Corp. on creating a lean growth engine, Harvard Business Review, July: 41–45.

Case Discussion Questions

1. While Bayer has a matrix structure, it has maintained some flavor of a geographic area structure. What are the advantages and disadvantages of a geographic area structure as seen in this case?

2. What are the advantages and disadvantages of a matrix structure as seen in this case?

3. ON ETHICS: While this is a successful case of subsidiary initiative, from a corporate or division headquarters’ standpoint, it is often difficult to ascertain whether the subsidiary is making good-faith efforts acting in the best interest of the MNE or the subsidiary managers such as Babe are primarily promoting their own self-interest, such as protecting their own jobs. How can headquarters differentiate good-faith efforts from more opportunistic maneuvers?

[Journal acronyms] AME – Academy of Management Executive; AMJ – Academy of Management Journal; AMP – Academy of Management Perspectives; AMR – Academy of Management Review; APJM – Asia Pacific Journal of Management; ASQ – Administrative Science Quarterly; BW – BusinessWeek (before 2010) or Bloom- berg Businessweek (since 2010); HBR – Harvard Business Review; JIBS – Journal of International Business Studies; JIM – Journal of International Management; JMS – Journal of Man- agement Studies; JWB – Journal of World Business;MIR – Management International Review; OSc – Organization Science; SMJ – Strategic Management Journal

1. T. Levitt, 1983, The globalization of markets, HBR, May: 92–102.

2. A. Rugman, 2001, The End of Globalization, New York: AMACOM.

3. J. Arregle, P. Beamish, & L. Hebert, 2009, The regional dimension of MNEs’ foreign subsidiary localization, JIBS, 40: 86–107; C. Asmussen, 2009, Local, regional, or global? JIBS, 40: 1192–1205; B. Greenwald & J. Kahn, 2005, All strategy is local, HBR, September: 95–104.

4. BW, 2011, Disney gets a second chance in China, April 18: 21–22.

5. R. Hodgetts, 1999, Dow Chemical CEO William Stav- ropoulos on structure, AME, 13: 30.

6. A. Chandler, 1962, Strategy and Structure, Cambridge, MA: MIT Press. See also W. C. Kim & R. Mauborgne, 2009, How strategy shapes structure, HBR, September: 73–80; J. Galan & M. Sanchez-Bueno, 2009, The con- tinuing validity of the strategy-structure nexus, SMJ, 30: 1234–1243.

7. J. Garbe & N. Richter, 2009, Causal analysis of the internationalization and performance relationship based on neural networks, JIM, 15: 413–431; J. Wolf & W. Egelhoff, 2002, A reexamination and extension of international strategy-structure theory, SMJ, 23: 181–189.

8. X. Ma & A. Delios, 2010, Home-country headquarters and an MNE’s subsequent within-country diversifica- tion, JIBS, 41: 517–525.

9. BW, 2008, Cisco’s brave new world, November 24: 56–66.

10. C. Bouquet, A. Morrison, & J. Birkinshaw, 2009, International attention and MNE performance, JIBS, 40: 108–131; T. Chi, P. Nystrom, & P. Kircher, 2004, Knowledge-based resources as determinants of MNC structure, JIM, 10: 219–238.

11. E. Morgan & F. Fai, 2007, Innovation, competition, and change in IB, MIR, 47: 631–638.

322 PART 3 CORPORATE-LEVEL STRATEGIES

12. C. Bartlett & S. Ghoshal, 1989, Managing Across Bor- ders (p. 209), Boston: Harvard Business School Press.

13. L. Nachum & S. Song, 2011, The MNE as a portfolio, JIBS, 42: 381–405.

14. C. K. Prahalad & K. Lieberthal, 1998, The end of corporate imperialism, HBR, August: 68–79.

15. Y. Lu, E. Tsang, & M. W. Peng, 2008, Knowledge management and innovation strategy in the Asia Paci- fic, APJM, 25: 361–374. See also N. Driffield, J. Love, & S. Menghinello, 2010, The MNE as a source of international knowledge flows, JIBS, 41: 350–359; N. Foss, K. Husted, & S. Michailova, 2010, Governing knowledge sharing in organizations, JMS, 47: 455–482; A. Fransson, L. Hakanson, & P. Liesch, 2011, The underdetermined knowledge-based theory of the MNC, JIBS, 42: 427–435; J. Martin & K. Eisenhardt, 2010, Rewiring, AMJ, 53: 265–301; H. Yang, C. Phelps, & H. K. Steensma, 2010, Learning from what others have learned from you, AMJ, 53: 371–389; J. Zhang & C. Baden-Fuller, 2010, The influence of technological knowledge base and organizational structure on tech- nology collaboration, JMS, 47: 679–704.

16. A. Gupta & V. Govindarajan, 2004, Global Strategy and Organization (p. 104), New York: Wiley.

17. P. Gooderham, D. Minbaeva, & T. Pedersen, 2011, Governance mechanisms for the promotion of social capital for knowledge transfer in MNCs, JMS, 48: 123–150.

18. S. Berman, J. Down, & C. Hill, 2002, Tacit knowledge as a source of competitive advantage, AMJ, 45: 13–31.

19. M. Kotabe, D. Dunlap-Hinkler, R. Parente, & H. Mis- hra, 2007, Determinants of cross-national knowledge transfer and its effect on firm innovation, JIBS, 38: 259–282.

20. K. Asakawa & A. Som, 2008, Internationalizing R&D in China and India, APJM, 25: 375–394; P. Criscuolo & R. Narula, 2007, Using multi-hub structures for inter- national R&D,MIR, 47: 639–660; D. Hillier, J. Pindado, V. de Queiroz, & C. Torre, 2011, The impact of coun- try-level corporate governance on research and devel- opment, JIBS, 42: 76–98; N. Lahiri, 2010, Geographic distribution of R&D activity, AMJ, 53: 1194–1209; A. Minin & M. Bianchi, 2011, Safe nests in global nets, JIBS, 42: 910–934; M. Nieto & A. Rodriguez, 2011, Offshoring of R&D, JIBS, 42: 345–361.

21. M. W. Peng & D. Wang, 2000, Innovation capability and foreign direct investment, MIR, 40: 79–83; J. Penner-Hahn & J. M. Shaver, 2005, Does interna- tional R&D increase patent output?, SMJ, 26: 121–140.

22. G. Vegt, E. Vliert, & X. Huang, 2005, Location-level links between diversity and innovative climate depend on national power distance, AMJ, 48: 1171–1182.

23. F. Sanna-Randaccio & R. Veugelers, 2007, Multina- tional knowledge spillovers with decentralized R&D, JIBS, 38: 47–63; T. Schmidt & W. Sofka, 2009, Lia- bility of foreignness as a barrier to knowledge spil- lovers, JIM, 15: 460–474.

24. A. Witty, 2011, Research and develop (p. 140), The World in 2011, London: The Economist Group. Witty is CEO of GSK.

25. This section draws heavily from Gupta & Govindarajan, 2004, Global Strategy and Organization.

26. H. Greve, 2003, A behavioral theory of R&D expen- ditures and innovations, AMJ, 46: 685–702.

27. P. Bierly, F. Damanpour, & M. Santoro, 2009, The application of external knowledge, JMS, 46: 481–508; H. Hoang & F. Rothaermel, 2010, Leveraging internal and external experience, SMJ, 31: 734–758; U. Lichtenthaler, 2011, Open innovation, AMP, February: 75–92.

28. H. Chesbrough, W. Vanhaverbeke, & J. West (eds.), 2006, Open Innovation (p. 1), Oxford, UK: Oxford University Press.

29. J. Spencer, 2003, Firms’ knowledge-sharing strategies in the global innovation system, SMJ, 24: 217–233; K. Laursen & A. Salter, 2006. Open for innovation, SMJ, 27: 131–150.

30. Q. Yang & C. Jiang, 2007, Location advantages and subsidiaries’ R&D activities, APJM, 24: 341–358.

31. R. Mudambi & P. Navarra, 2004, Is knowledge power? JIBS, 35: 385–406; R. Teigland & M. Wasko, 2009, Knowledge transfer in MNCs, JIM, 15: 15–31.

32. T. Ambos & B. Ambos, 2009, The impact of distance on knowledge transfer effectiveness in MNCs, JIM, 15: 1–14; A. Dinur, R. Hamilton, & A. Inkpen, 2009, Critical context and international intrafirm best-practice trans- fers, JIM, 15: 432–446; M. Esterby-Smith, M. Lyles, & E. Tsang, 2008, Inter-organizational knowledge transfer, JMS, 45: 677–690; D. Gnyawali, M. Singal, & S. Mu, 2009, Knowledge ties among subsidiaries in MNCs, JIM, 15: 387–400; J. Hong & T. Nguyen, 2009, Knowledge embeddedness and the transfer mechan- isms in MNCs, JWB, 44: 347–356; L. F. Monteiro, N. Arvidsson, & J. Birkinshaw, 2008, Knowledge flows within MNCs, OSc, 19: 90–107; G. Szulanski & R. Jensen, 2006, Presumptive adaptation and the effective- ness of knowledge transfer, SMJ, 27: 937–957.

C h a p t e r 1 0 S t r a t e g i z i n g , S t r u c t u r i n g , a n d L e a r n i n g A r o u n d t h e W o r l d 323

33. M. Haas, 2010, The double-edged swords of auton- omy and external knowledge, AMJ, 53: 989–1008; Z. Sharp, 2010, From unilateral transfer to bilateral transition, JIM, 16: 304–313; M. Zellmer-Bruhn & C. Gibson, 2006, Multinational organization context, AMJ, 49: 501–518.

34. W. Cohen & D. Levinthal, 1990, Absorptive capacity, ASQ, 35: 128–152. See also A. Cuervo-Cazurra & C. A. Un, 2010, Why some firms never invest in formal R&D, SMJ, 31: 759–779; J. Hong, R. Snell, & M. Easterby-Smith, 2006, Cross-cultural influences on organizational learning in MNCs, JIM, 12: 408–429; J. Jansen, F. Bosch, & H. Volberda, 2005, Managing potential and realized absorptive capacity, AMJ, 48: 999–1015; P. Lane, B. Koka, & S. Pathak, 2006, The reification of absorptive capacity, AMR, 31: 833–863; L. Perez-Nordtvedt, E. Babakus, & B. Kedia, 2010, Learning from international business affiliates, JIM, 16: 262–274; G. Todorova & B. Durisin, 2007, Absorptive capacity, AMR, 32: 774–786.

35. C. Fey & P. Furu, 2008, Top management incentive compensation and knowledge sharing in MNEs, SMJ, 29: 1301–1323.

36. A. Inkpen & E. Tsang, 2005, Social capital, networks, and knowledge transfer, AMR, 30: 146–165; N. Noorderhaven & A. Harzing, 2009, Knowledge-shar- ing and social interaction within MNEs, JIBS, 40: 715–741.

37. M. W. Peng & Y. Luo, 2000, Managerial ties and firm performance in a transition economy, AMJ, 43: 486–501. See also M. Mors, 2010, Innovation in a global consulting firm, SMJ, 31: 841–872; M. Reinholt, T. Pedersen, & N. Foss, 2011, Why a central network position isn’t enough, AMJ, 54: 1277–1297.

38. BW, 2011, Profits on overseas holiday, March 21: 64–69. 39. BW, 2009, For accounting giants, nowhere to hide?

February 16: 56–57. 40. F. Ciabuschi, M. Forsgren, & O. Martin, 2011,

Rationality versus ignorance, JIBS, 42: 958–970. 41. A. Bjorkman & R. Piekkari, 2009, Language and

foreign subsidiary control, JIM, 15: 105–117; C.

Garcia-Pont, I. Canales, & F. Noboa, 2009, Subsidiary strategy, JMS, 46: 182–214.

42. T. Ambos, U. Andersson, & J. Birkinshaw, 2010, What are the consequences of initiative-taking in multina- tional subsidiaries? JIBS, 41: 1099–1118; C. Bouquet & J. Birkinshaw, 2008, Weight versus voice, AMJ, 51: 577–601; F. Ciabuschi, H. Dellestrand, & O. Martin, 2011, Internal embeddedness, headquarters involve- ment, and innovation importance in MNEs, JMS, 48: 1612–1638; A. Delios, D. Xu, & P. Beamish, 2008, Within-country product diversification and foreign subsidiary performance, JIBS, 39: 706–724; D. Vora, T. Kostova, & K. Roth, 2007, Roles of subsidiary managers in MNCs, MIR, 47: 595–620.

43. J. Balogun, P. Jarzabkowski, & E. Vaara, 2011, Selling, resistence, and reconciliation, JIBS, 42: 765–786; H. Dellestrand, 2011, Subsidiary embeddedness as a determinat of divisional headquarters involvement in innovation transfer processes, JIM, 17: 229–242; C. Dorrenbacher & J. Gammelgaard, 2010, MNCs, inter-organizational networks, and subsidiary charter removals, JWB, 45: 206–216; A. Phene & P. Almeida, 2008, Innovation in multinational subsidiaries, JIBS, 39: 901–919; P. Scott, P. Gibbons, & J. Coughlan, 2010, Developing subsidiary contribution to the MNC- subsidiary entrepreneurship and strategy creativity, JIM, 16: 328–339; A. Schotter & P. Beamish, 2011, Performance effects of MNC headquarters-subsidiary conflict and the role of boundary spanners, JIM, 17: 243–259; C. Williams, 2009, Subsidiary-level determi- nants of global initiatives in MNCs, JIM, 15: 92–104.

44. R. Burgelman & A. Grove, 2007, Let chaos reign, then rein in chaos—repeatedly, SMJ, 28: 965–979.

45. S. Segal-Horn & A. Dean, 2009, Delivering “effortless” experience across borders, JWB, 44: 41–50.

46. L. Shi, C. White, S. Zou, & S. T. Cavusgil, 2010, Global account management strategies, JIBS, 41: 620–638.

47. P. Ghemawat, 2011, The cosmopolitan corporation, HBR, May: 92–99.

48. S. Gould & A. Grein, 2009, Think glocally, act glocally, JIBS, 40: 237–254.

324 PART 3 CORPORATE-LEVEL STRATEGIES

CHAPTER11

GOVERNING THE CORPORATION AROUND THE WORLD

KNOWLEDGE OBJECT IVES

After studying this chapter, you should be able to

1. Differentiate various ownership patterns around the world

2. Articulate the role ofmanagers in bothprincipal–agent andprincipal–principal conflicts

3. Explain the role of the board of directors

4. Identify voice-based and exit-based governance mechanisms and their combination as a package

5. Acquire a global perspective onhowgovernancemechanisms vary around theworld

6. Elaborate on a comprehensive model of corporate governance

7. Participate in three leading debates concerning corporate governance

8. Draw strategic implications for action

ot o/ A le xe y St io p

326 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

E T H I C A L D I L E M M A

OPENING CASE

High Drama at Hewlett-Packard (HP)

In the late 1990s, something strange happened to HP—the equivalent of a deranged hairy-bellied scientist getting hold of the company’s DNA and adding a dangerous dose of Hollywood flakiness. The HP story suddenly acquired some unexpected new ingredients: a board room coup (Carly Fiorina was brought in as the first female chief executive of a Dow-30 company but was tossed out after the com- pany lost half its value); a corporate spying scandal (Patricia Dunn, the company’s chairwoman, was also binned after it emerged that she had used a private security firm to spy on board members and journalists); and obscene pay packets (Ms. Fiorina was paid more than $20 million to leave).

The company did its best to rid itself of its new Hollywood DNA by appointing Mark Hurd—a nerdy-looking numbers guy—as chief executive in 2005. But on August 6, 2010, the news broke that Mr. Hurd had more than numbers on his mind. Two more improbable characters entered the HP story. One was Jodi Fisher, a former softcore-porn and B-movie actress who had helped at corporate events for HP. The other was Gloria Allred, a Los Angeles lawyer who had previously locked horns with O. J. Simpson, Britney Spears, and Tiger Woods. Mr. Hurd resigned amid stories of sexual harassment and iffy expense reports—and HP saw $10 billion wiped off its stock market value.

Where does this psychodrama leave the Silicon Valley giant? Pretty much where it was a week ago, said senior figures. Marc Andreessen, a member of the board, said that “HP is not about any one person.” Cathie Lesjak, the company’s interim chief executive, argued that, although “Mark was a strong leader,” he “didn’t drive our initiative. The company drove that.” But if Mr. Hurd was “only one person” and the company was what mattered, why did HP

pay him $30 million in 2009? And why was it reportedly considering paying him $100 million to stay on for another three years?

The problem for HP is that Mr. Hurd deserved his money more than most other chief executives. The com- pany’s share price doubled on his watch. HP sped past IBM to become the world’s largest information technology (IT) company by revenues. It also became the first IT company to have sales of more than $100 billion. Mr. Hurd restored HP to its former glory as the world’s biggest maker of personal computers. He prepared the ground for further growth by putting together a succession of multibillion- dollar deals, snapping up Electronic Data Systems (EDS), 3Com, and Palm. And he did all this while squeezing costs.

HP is now struggling to fill not one but two top posi- tions: Mr. Hurd doubled as chief executive and chairman (despite pointed warnings from corporate reformers). His abrupt departure also leaves HP grappling with innumerable questions. Why exactly is Mr. Hurd leaving? Ms. Fisher says that the two never had sex and that her complaint against him—about which she remains tight-lipped—was settled without a lawsuit. The board’s charge sheet on Mr. Hurd focuses on dodgy expense claims. It is all rather confusing. If his ethical lapses were serious, then why is he being given a golden parachute of $12.2 million? And if they weren’t serious, then why is the company getting rid of a star chief executive? Larry Ellison, Oracle’s chief executive, calls it “the worst personnel decision since the idiots on the Apple board fired Steve Jobs many years ago.”

Source: Excerpted from Economist, 2010, The curse of HP, August 14: 54.

HP’s high drama did not end after Mark Hurd’s resignation in August 2010.In November 2010, its board hired Léo Apotheker, former chief executiveofficer (CEO) of SAP, as HP’s new CEO. But in September 2011 the board fired him after HP lost $30 billion in market capitalization during his short tenure.

chief executive officer (CEO)

The top executive in charge of the strategy and operations of a firm.

327 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

For Apotheker’s less than 11 months of service, he walked away with $13 million: severance payment of $7.2 million, HP shares worth $3.4 million, and a perfor- mance bonus of $2.4 million. In September 2011, Meg Whitman, an HP board member and eBay’s former CEO, was named HP’s newest CEO—the fourth CEO since 2005 and the seventh since 1999.

While HP’s high drama is an extreme case, it raises a series of questions affecting many firms: What is the most optimal way to govern corporations so that investors will reap returns? What is the proper role of the board of directors? How should CEOs be properly motivated and compensated? These are some of the key questions addressed in this chapter, which focuses on how to govern the corporation around the world. Corporate governance is “the relationship among various participants in determining the direction and performance of corporations.”1

The primary participants in corporate governance are (1) owners, (2) managers, and (3) board of directors (Figure 11.1). This chapter first discusses the primary partici- pants. Next, we cover internal and external governance mechanisms from a global perspective, followed by a comprehensive model drawn from the strategy tripod. Debates and extensions follow.

Owners Owners provide capital, bear risks, and own the firm.2 Three broad patterns exist: (1) concentrated versus diffused ownership, (2) family ownership, and (3) state ownership.

Concentrated versus Diffused Ownership Founders usually start up firms and completely own and control them. This is referred to as concentrated ownership and control. However, at some point, if the firm aspires to grow and needs more capital, the owners’ desire to keep the firm in family hands will have

FIGURE 11.1 The Primary Participants in Corporate Governance

Managers

Board of Directors

Owners

corporate governance

The relationship among various participants in determining the direction and performance of corporations.

concentrated ownership and control

Ownership and control rights concentrated in the hands of owners.

ga ge

Le ar ni ng

328 PART 3 CORPORATE-LEVEL STRATEGIES

to accommodate the arrival of other shareholders. Approximately 80% of listed US firms and 90% of listed UK firms are now characterized by diffused ownership, with numerous small shareholders but none with a dominant level of control.3 In such firms, there is a separation of ownership and control, in that ownership is dispersed among many small shareholders and control is largely concentrated in the hands of salaried professional managers who own little (or no) equity. In short, this refers to separation of ownership (by dispersed shareholders) and day-to-day control (by managers).

If majority or dominant owners (such as founders) do not personally run the firm, they are naturally interested in keeping a close eye on how the firm is run. However, dispersed owners, each with a small stake, have neither incentives nor resources to do so. Most small shareholders do not bother to show up at annual shareholder meetings. They prefer to free ride and hope that other shareholders will properly monitor and discipline managers. If small shareholders are not happy, they will simply sell the stock and invest elsewhere. However, if all shareholders behave in this manner, then no shareholder would care and managers would end up acquiring significant de facto control power.

The rise of institutional investors, such as professionally managed mutual funds and pension pools, has significantly changed this picture.4 Institutional investors have both incentives and resources to closely monitor and control managerial actions. However, the increased size of institutional holdings limits the ability of institutional investors to dump the stock. This is because when one’s stake is large enough, selling out depresses the share price and harms the seller.

While the image of widely held corporations is a reasonably accurate description of most modern large US and UK firms, it is not the case in other parts of the world. Outside the Anglo-American world, there is relatively little separation of ownership and control. Most large firms are typically owned and controlled by families or the state.5 Next, we turn our attention to such firms.

Family Ownership The vast majority of large firms throughout continental Europe, Asia, Latin America, and Africa feature concentrated family ownership and control. On the positive side, family ownership and control may provide better incentives for the firm to focus on long-term performance. It may also minimize the conflicts between owners and professional man- agers typically encountered in widely owned firms. However, on the negative side, family ownership and control may lead to the selection of less qualified managers (who happen to be the sons, daughters, and relatives of founders), the destruction of value because of family conflicts, and the expropriation of minority shareholders (discussed later). At present, there is no conclusive evidence on the positive or negative role of family own- ership and control on the performance of large firms.6

State Ownership Other than families, the state is another major owner of firms around the world. Since the 1980s, many countries—ranging from Britain to Brazil to Belarus—realized that their state-owned enterprises (SOEs) often perform poorly. SOEs typically suffer from an incentive problem. Although in theory all citizens (including employees) are owners, in

diffused ownership

An ownership pattern involving numerous small shareholders, none of whom has a dominant level of control.

separation of ownership and control

The dispersal of ownership among many small shareholders, with control of the firm largely concentrated in the hands of salaried, professional managers who own little or no equity.

state-owned enterprise (SOE)

A firm owned and controlled by the state (government).

C h a p t e r 1 1 G o v e r n i n g t h e C o r p o r a t i o n A r o u n d t h e W o r l d 329

practice, they have neither the rights to enjoy dividends generated from SOEs (as shareholders would) nor the rights to transfer or sell “their” property. SOEs are de facto owned and controlled by government agencies far removed from ordinary citizens and employees. Thus, there is little motivation for SOE managers and employees to improve performance, which they can hardly benefit from personally. In a most cynical fashion, SOE employees in the former Soviet Union summed it up well: “They pretend to pay us and we pretend to work.” A wave of privatization hit the world since the 1980s. However, SOEs staged a spectacular comeback recently. In 2008, many governments in developed economies nationalized major firms ranging from General Motors (GM, which reads “Government Motors”) to Royal Bank of Scotland (RBS) in order to prevent massive bankruptcies and job losses.

Managers Managers, especially executives on the top management team (TMT) led by the CEO, represent another important group of players in corporate governance.

Principal–Agent Conflicts The relationship between shareholders and professional managers is a relationship between principals and agents—in short, an agency relationship. Principals are persons (such as owners) delegating authority, and agents are persons (such as managers) to whom authority is delegated. Agency theory suggests a simple yet profound proposition: To the extent that the interests of principals and agents do not completely overlap, there will inherently be principal–agent conflicts. These conflicts result in agency costs, including (1) the principals’ costs of monitoring and controlling the agents and (2) the agents’ costs of bonding (signaling their trustworthiness).7 In a corporate setting, when shareholders (principals) are interested in maximizing the long-term value of their stock, managers (agents) may be more interested in maximizing their own power, income, and perks.

Manifestations of agency problems include excessive executive compensation, on-the-job consumption (such as corporate jets), low-risk short-term investments (such as maximizing current earnings while cutting long-term R&D), and empire-building (such as value- destroying acquisitions). Consider executive compensation. In 1980, the average US CEO earned approximately 40 times what the average worker earned. Today, the ratio is 400 times. Despite some performance improvement, it seems difficult to argue that the average firm CEO improved performance 10 times faster than her workers since 1980 and thus deserved the salary of 400 workers today. In other words, one can “smell” some agency costs.

Directly measuring agency costs, however, is difficult. In two most innovative (and hair- raising) studies to directly measure agency costs, scholars find that some sudden CEO deaths (plane crashes or heart attacks) are accompanied by an increase in share prices of their firms.8 These CEOs reduced agency costs that shareholders had to shoulder by dropping dead (!). Conversely, we could imagine how much value these CEOs destroyed when they had been alive. The capital market, sadly, was pleased with such human tragedies.

The primary reason agency problems persist is because of information asymmetries between principals and agents—that is, agents such as managers almost always know more about the property they manage than principals do. While it is possible to reduce

agency relationship

The relationship between principals and agents.

principals

Persons (such as owners) who delegate authority.

agents

Persons (such as managers) to whom authority is delegated.

agency theory

The theory about principal–agent relationships (or agency relationships in short).

principal–agent conflicts

Conflicts of interests between principals (such as shareholders) and agents (such as professional managers).

agency costs

The costs associated with principal–agent relation- ships. They are the sum of (1) the principals’ costs of monitoring and controlling agents and (2) the agents’ costs of bonding.

information asymmetries

Asymmetric distribution of information between two sides.

330 PART 3 CORPORATE-LEVEL STRATEGIES

information asymmetries through governance mechanisms, it is not realistic to completely eliminate agency problems.

Principal–Principal Conflicts Since concentrated ownership and control by families is the norm in many parts of the world, different kinds of conflicts are at play. One of the leading indicators of concen- trated family ownership and control is the appointment of family members as board chairman, CEO, and other TMT members. In East Asia, approximately 57% of the corporations have board chairmen and CEOs from the controlling families.9 In conti- nental Europe, the number is 68%.10 The families are able to do so, because they are controlling (although not necessarily majority) shareholders. For example, at News Corporation, neither the board nor angry shareholders can get rid of the Murdochs, who are controlling shareholders (Strategy in Action 11.1).

E T H I C A L D I L E M M ASTRATEGY IN ACTION 11.1

The Murdochs versus Minority Shareholders

Founded in Adelaide, Australia, News Corporation (in short, News Corp.) is now headquartered in New York and listed on NASDAQ with secondary listings on the Australian Securities Exchange. While the unethical conduct of its British tabloid operations rocked the world in 2011, this was not the first time News Corp., which enjoys reporting controversies of others, stirred up controversies itself. A consistent theme of controversies is how Rupert Murdoch and his family as controlling shareholders treat minority shareholders.

Exhibit A: In 2003, the 30-year-old James Murdoch became CEO of BSkyB, Europe’s largest satellite broadcaster, in the face of loud minority shareholder resistance. The reason? James’ father Rupert controlled 35% of BSkyB equity and controlled the board.

Exhibit B: In 2007, Rupert Murdoch pursued a pet project by paying a rich $5.6 billion price to buy Dow Jones, publisher of the Wall Street Journal—against the wishes of numerous minority shareholders and the advice of Peter Chernin, News Corp. president and a non-family member. The upshot? After four months, News Corp. wrote down its value by $2.8 billion, and in 2009, Chernin left.

Exhibit C: In 2011, in a related transaction News Corp. announced that it would pay $673 million to buy Shine

Group, a London-based media studio owned by Rupert’s daughter Elisabeth Murdoch. While Shine produced some hit shows such as NBC’s The Office and The Biggest Loser, minority shareholders alleged that News Corp. overpaid for Shine with 13.1 times Shine’s $45.6 million in earnings before interest, taxes, depreciation, and amortization (EBITDA). In contrast, Apollo Global Management, a leading private equity firm, paid $510 million to purchase American Idol owner CKx, a deal valued at 8.5 times CKx’s $60.23 million in EBITDA. Frustrated minority shareholders such as Amalgamated Bank and other pension funds filed a lawsuit in Delaware (where News Corp. is registered) to block the sale. The complaint alleged that:

Murdoch did not even pretend there was a valid strategic purpose for News Corp. to buy Shine … The transaction is a naked and selfish endeavor by Murdoch to further infuse the upper ranks of News Corp. with his offspring.

Sources: Based on (1) Bloomberg Businessweek, 2011, Will the scandal tame Murdoch? July 25: 18–20; (2) Economist, 2011, How to lose friends and alienate people, July 16: 25–27; (3) Economist, 2011, Last of the moguls, July 23: 9.

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The Murdoch case is a classic example of the conflicts in family-owned and family- controlled firms. Instead of between principals (shareholders) and agents (professional managers), the primary conflicts are between two classes of principals: controlling shareholders and minority shareholders—in other words, principal–principal conflicts11

(Figure 11.2 and Table 11.1). Family managers such as the Murdochs, who represent (or are) controlling shareholders, may advance family interests at the expense of minority shareholders. Controlling shareholders’ dominant position as both principals and agents (managers) may allow them to override traditional governance mechanisms designed to curtail principal–agent conflicts such as the board of directors.

A manifestation of principal–principal conflicts is that family managers may have the potential to engage in expropriation of minority shareholders, defined as activities that enrich

FIGURE 11.2 Principal–Agent Conflicts and Principal–Principal Conflicts

Professional managers

Family managers

Controlling shareholders

Minority shareholders

Principal-agent conflicts

Principal-principal conflicts

Family managers are appointed by controlling shareholders

Source: Adapted from M. Young, M. W. Peng, D. Ahlstrom, G. Bruton, & Y. Jiang, 2008, Corporate governance in emerging economies: A review of the principal-principal perspective (p. 200), Journal of Management Studies, 45: 196–220.

principal–principal conflicts

Conflicts of interests between two classes of principals: controlling shareholders and minority shareholders.

expropriation

Activities that enrich the controlling shareholders at the expense of minority shareholders.

332 PART 3 CORPORATE-LEVEL STRATEGIES

controlling shareholders at the expense of minority shareholders. For example, man- agers from the controlling family may simply divert resources from the firm for personal or family use. This activity is vividly nicknamed “tunneling”—digging a tunnel to sneak resources out.12 While such “tunneling” (often known as “corporate theft”) is illegal, expropriation can be legally done through related transactions, whereby con- trolling owners buy firm assets from another firm they own at above-market prices or spin off the most profitable part of a public firm and merge it with another private firm of theirs (see Strategy in Action 11.1).

Overall, while corporate governance practice and research traditionally focus on how to control professional managers because of the separation of ownership and control in a majority of US and UK firms, how to govern family managers in firms with concentrated ownership and control is of equal or probably higher importance around the world (including in certain US and UK firms, such as News Corporation).

Board of Directors As an intermediary between owners and managers, the board of directors oversees and ratifies strategic decisions and evaluates, rewards, and if necessary penalizes top managers.

TABLE 11.1 Principal–Agent versus Principal–Principal Conflicts

PRINCIPAL–AGENT CONFLICTS PRINCIPAL–PRINCIPAL CONFLICTS

Ownership pattern

Dispersed—shareholders holding 5% of equity are regarded as “blockholders.”

Dominant—often greater than 50% of equity is controlled by the largest shareholders.

Manifestations Strategies that benefit entrenched managers at the expense of shareholders (such as shirking, excessive compensation, and empire building).

Strategies that benefit controlling shareholders at the expense of minority shareholders (such as minority shareholder expropriation and cronyism).

Institutional protection of minority shareholders

Formal constraints (such as courts) are more protective of shareholder rights. Informal norms adhere to shareholder wealth maximization.

Formal institutional protection is often lacking. Informal norms are typically in favor of controlling shareholders.

Market for corporate control

Active, at least in principle as the “governance mechanism of last resort.”

Inactive even in principle. Concentrated ownership thwarts notions of takeover.

tunneling

Activities of managers from the controlling family of a corporation to divert resources from the firm for personal or family use.

related transaction

Controlling owners sell firm assets to another firm they own at below-market prices or spin off the most profitable part of a public firm and merge it with another of their private firms.

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Board Composition Otherwise known as the insider/outsider mix, board composition has recently attracted significant attention. Inside directors are top executives of the firm. The trend around the world is to introduce more outside (independent) directors, defined as non-management members of the board. Often ideally labeled “independent directors,” outside directors are presumably more independent and can better safeguard shareholder interests.

Although there is a widely held belief in favor of a higher proportion of outside directors, academic research has failed to empirically establish a link between the out- sider/insider ratio and firm performance.13 Even “stellar” firms with a majority of outside directors on the board (on average 74% of outside directors at Enron, Global Crossing, and Tyco before their scandals erupted) can still be plagued by governance problems. In the world’s largest financial services firms, the more outside directors on their boards, the worse their stock returns during the 2008 crisis.14

It is possible that some of these outside directors are affiliated directors who may have family, business, and/or professional relationships with the firm or firm management. In other words, such affiliated outside directors are not necessarily “independent.”

Leadership Structure Whether the board is led by a separate chairman or by the CEO who doubles as a chairman—a situation known as CEO duality—is also important. From an agency theory standpoint, if the board is to supervise agents such as the CEO, it seems imperative that the board be chaired by a separate individual. Otherwise, how can the CEO be evaluated by the body that he/she chairs? In other words, can a schoolboy grade his own papers? However, a corporation led by two top leaders (a board chairman and a CEO) may lack a unity of command and experience top-level conflicts. As a powerful executive, a CEO obviously does not appreciate being constantly second-guessed by a board chairman. Not surprisingly, there is significant divergence across countries. For instance, while a majority of the large UK firms separate the two top jobs, many large US firms combine them. A practical difficulty often cited by US boards is that it is very hard to recruit a capable CEO without the board chairman title.

Academic research is inconclusive on whether CEO duality (or non-duality) is more effective.15 However, pressures have arisen around the world for firms to split the two jobs to at least show that they are serious about controlling the CEO. In 2010, only 12% of the new CEOs around the world were also appointed as chairmen. In 2002, the percentage was 48%. Even in US firms that typically favor CEO duality, Standard & Poor’s 500 firms practicing CEO duality fell from 78% in 2002 to 59% in 2010.16

Board Interlocks Directors tend to be economic and social elites who share a sense of camaraderie and reciprocity.17 When one person affiliated with one firm sits on the board of another firm, an interlocking directorate has been created. Firms often establish relationships through such board appointments. For instance, outside directors from financial institutions often facilitate financing. Outside directors experienced in acquisitions may help the focal firms engage in these practices.

inside director

A director serving on a corporate board who is also a full-time manager of the company.

outside (independent) director

A non-management member of the board.

CEO duality

The CEO doubles as chairman of the board.

interlocking directorate

Two or more firms share one director on their boards.

334 PART 3 CORPORATE-LEVEL STRATEGIES

In the United States, Frank Carlucci, a former Secretary of Defense and chair- man of the Carlyle Group (a leading private equity firm), served on 20 boards (!) at one time. In Hong Kong, the most heavily connected director, David Li, chairman of the Bank of East Asia, sat on nine boards.18 Critics argue that such directors are unlikely to effectively monitor management. In fact, one of the boards David Li served on was Enron’s. In the post-Enron environment, such unusual practices are increasingly rare.

The Role of Boards of Directors In a nutshell, boards of directors perform (1) control, (2) service, and (3) resource acquisition functions. Boards’ effectiveness in serving the control function stems from their independence, deterrence, and norms. Specifically:

• The ability to effectively control managers boils down to how independent directors are. Outside directors who are personally friendly and loyal to the CEO are unlikely to challenge managerial decisions. Exactly for this reason, CEOs often nominate family members, personal friends, and other passive directors.19

• There is a lack of deterrence on the part of directors should they fail to protect shareholder interests. Courts usually will not second-guess board decisions in the absence of bad faith or insider dealing.

• When challenging management, directors have few norms to draw on. Directors who “stick their necks out” by confronting the CEO in meetings tend to be frozen out of board deliberations.

In addition to control, another important function of the board is service—primarily advising the CEO.20 Finally, another crucial board function is resource acquisition for the focal firm, often through interlocking directorates.21

Overall, until recently, many boards of directors simply “rubber stamped” (approve without scrutiny) managerial actions. Prior to the 1997 economic crisis, many South Korean boards did not bother to hold meetings and board decisions were literally “rubber stamped”—not even by directors themselves, but by corporate secretaries who stamped the seals of all the directors, which were kept in the corporate office. However, change is in the air throughout the world. In South Korea, board meetings are now regularly held and seals are personally stamped by the directors themselves.22

Directing Strategically If boards are to function effectively, being a director is one of the most demanding jobs, calling for an active “nose in but hands off” approach. Given the comprehensive functions of control, service, and resource acquisition and the limited time and resources directors have, directors must strategically prioritize.23 How they do this differs significantly around the world. In US and UK firms, the traditional focus, which stems from their separation of ownership and control, is on the boards’ control function. While the service function is still important, the resource

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acquisition role, although important in practice, tends to be criticized by policy- makers, activists, and the media, who often regard activities such as interlocking directorates as “collusive.” Consequently, recent US regulations, especially the Sar- banes-Oxley (SOX) Act of 2002, emphasize the control function almost to the exclusion of the resource acquisition function. For example, Apple acquired certain resources from Google to power its iPhones, and Google’s CEO Eric Schmidt used to serve on Apple’s board. However, recently, as the competition between Apple and Google (which launched its own Android phone) heated up, Schmidt had to give up his Apple board membership.

Since outside directors are not likely to have enough firsthand knowledge about the firm, they are thus forced to focus on financial performance targets and numbers—known as financial control (see Table 11.2). Financial control may encourage CEOs to focus on the short term, at the expense of long-term share- holder interests (such as maximizing current earnings by reducing R&D). There- fore, inside directors, who are executives, can bring firsthand knowledge to board deliberations, allowing for a more sophisticated understanding of some managerial actions (such as investing in the future while not maximizing current earnings). A board informed by such inside views is able to exercise strategic control, basing its judgment beyond a mere examination of financial numbers. It seems that a healthy board requires both kinds of control, thus calling for a balanced composition of insiders and outsiders.

Governance Mechanisms as a Package Governance mechanisms can be classified as internal and external ones—otherwise known as voice-based and exit-based mechanisms, respectively. Voice-based mechan- isms refer to shareholders’ willingness to work with managers, usually through the board, by “voicing” their concerns. Exit-based mechanisms indicate that shareholders

TABLE 11.2 Outside Directors versus Inside Directors

PROS CONS

Outside directors & Presumably more independent from management (especially the CEO).

& More capable of monitoring and controlling managers.

& Good at financial control.

& Independence may be illusionary. & “Affiliated” outside directors may

have family or professional relationships with the firm or management.

& Not good at strategic control.

Inside directors & Have firsthand knowledge about the firm.

& Good at strategic control.

& Non-CEO inside directors (executives) may not be able to control and challenge the CEO.

voice-based mechanisms

Corporate governance mechanisms that focus on shareholders’ willingness to work with managers, usually through the board of directors, by “voicing” their concerns.

exit-based mechanisms

Corporate governance mechanisms that focus on exit, indicating that share- holders no longer have patience and are willing to “exit” by selling their shares.

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no longer have patience and are willing to “exit” by selling their shares. This section outlines these mechanisms.

Internal (Voice-Based) Governance Mechanisms The two internal governance mechanisms typically employed by boards can be character- ized as (1) “carrots” and (2) “sticks.” In order to better motivate managers, increasing executive compensation as “carrots” is often a must. Stock options that help align the interests of managers and shareholders have become increasingly popular.24 The under- lying idea is pay for performance, which seeks to link executive compensation with firm performance.25 While in principle this idea is sound, in practice it has a number of drawbacks. If accounting-based measures (such as return on sales) are used, managers are often able to manipulate numbers to make them look better. If market-based measures (such as stock prices) are adopted, stock prices obviously are subject to too many forces beyond managers’ control. Consequently, the pay-for-performance link in executive compensation is usually not very strong.26

In general, boards are likely to use “carrots” before considering “sticks.” However, when facing continued performance failures, boards may have to dismiss the CEO.27

Among the world’s largest 2,500 listed firms, CEO tenure has decreased from 8.1 years in 2000 to 6.3 years in 2012. In 2010, 12% of these firms changed CEOs.28 In brief, boards seem to be more “trigger-happy” recently. Case in point: Léo Apotheker served seven months as CEO of SAP and then ten months as CEO of HP (see the Opening Case).

Because top managers must shoulder substantial firm-specific employment risk (a fired CEO such as Apotheker is extremely unlikely to run another publicly traded company), they naturally demand more generous compensation—a premium on the order of 30% or more—before taking on new CEO jobs. This in part explains the rapidly rising levels of executive compensation.29

External (Exit-Based) Governance Mechanisms There are three external governance mechanisms: (1) market for product competition, (2) market for corporate control, and (3) market for private equity. Product market competition is a powerful force compelling managers to maximize profits and, in turn, shareholder value. However, from a corporate governance perspective, product market competition complements the market for corporate control and the market for private equity, each of which is outlined next.

THE MARKET FOR CORPORATE CONTROL. This is the main external governance mechanism, otherwise known as the takeover market or the mergers and acquisitions (M&A) market (see Chapter 9). It is essentially an arena where different management teams contest for the control rights of corporate assets. As an external governance mechanism, the market for corporate control serves as a disciplining mechanism of last resort when internal governance mechanisms fail. The underlying logic is spelled out by agency theory, which suggests that when managers engage in self-interested actions and internal governance mechanisms fail, firm stock will be undervalued by investors. Under these circumstances, other management teams, which recognize an opportunity

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to create new value, bid for the rights to manage the firm (see Chapter 9). How effective is the market for corporate control? Three findings emerge:

• On average, shareholders of target firms earn sizable acquisition premiums.

• Shareholders of acquiring firms experience slight but insignificant losses.

• A substantially higher level of top management turnover occurs following M&As.

In summary, while internal mechanisms aim at “fine-tuning,” the market for corporate control enables the “wholesale” removal of entrenched managers. As a radical approach, the market for corporate control has its own limitations. It is very costly to wage such financial battles, because acquirers must pay an acquisition premium. In addition, a large number of M&As are driven by acquirers’ sheer hubris or empire building, and the long-term profit- ability of post-merger firms is not particularly impressive30 (see Chapter 9). Nevertheless, the net impact, at least in the short run, seems to be positive, because the threat of takeovers does limit managers’ divergence from shareholder wealth maximization—as recently reported in Japan.31

THE MARKET FOR PRIVATE EQUITY. Instead of being taken over, a large number of publicly listed firms have gone private by tapping into private equity—equity capital invested in private (non-public) companies (see the Closing Case). Private equity is primarily invested through leveraged buyouts (LBOs). In an LBO, private investors, often in partnership with incumbent managers, issue bonds and use the cash raised to buy the firm’s stock—in essence replacing shareholders with bondholders and transforming the firm from a public to a private entity. As another external governance mechanism, private equity utilizes the bond market, as opposed to the stock market, to discipline managers. LBO-based private equity transactions are associated with three major changes in corporate governance:

• LBOs change the incentives of managers by providing them with substantial equity stakes.

• The high amount of debt imposes strong financial discipline.

• LBO sponsors closely monitor the firms they have invested in.

Overall, evidence suggests that private equity results in relatively small job losses (about 1%–2%) and improves efficiency by about 2%, at least in the short run.32 The picture is less clear regarding the long run, because LBOs may have forced managers to reduce investments in long-term R&D. However, more recent research reports (1) that private equity-backed firms have more focused patents that generate better economic returns and (2) that such firms do not suffer from a reduction of R&D in the long run.33

Internal Mechanisms + External Mechanisms = Governance

Package Taken together, the internal and external mechanisms can be considered a “package.”34

Michael Jensen, a leading agency theorist, argues that in the United States, failures of internal governance mechanisms in the 1970s activated the market for corporate control

private equity

Equity capital invested in private (non-public) companies.

leveraged buyout (LBO)

A means by which private investors, often in partnership with incumbent managers, issue bonds and use the cash raised to buy the firm’s stock.

338 PART 3 CORPORATE-LEVEL STRATEGIES

in the 1980s. Managers initially resisted. However, over time, many firms that are not takeover targets or that have successfully defended themselves against such attempts end up restructuring and downsizing—doing exactly what “raiders” would have done had these firms been taken over. In other words, the strengthened external mechanisms force firms to improve their internal mechanisms.

Overall, since the 1980s, American managers have become much more focused on stock prices, resulting in a new term, “shareholder capitalism,” which has been spreading around the world. In Europe, executive stock options become popular and M&As more frequent. In Russia, some traces of modern corporate governance have emerged.35

A Global Perspective Illustrated in Figure 11.3, different corporate ownership and control patterns around the world lead to a different mix of internal and external mechanisms. The most familiar type is Cell 4, exemplified by most large US and UK firms. While external governance mechanisms (M&As and private equity) are active, internal mechanisms are relatively weak due to the separation of ownership and control that gives managers significant de facto control power.

The opposite can be found in Cell 1, namely, firms in continental Europe and Japan where the market for corporate control is relatively inactive (although there is more activity recently). Consequently, the primary governance mechanisms remain concen- trated ownership and control.

FIGURE 11.3 A Global Perspective on Internal and External Governance Mechanisms

(Cell 1) Germany

Japan Strong

Strong

Weak

(Cell 2) Canada

(Cell 3) State-owned enterprises

(Cell 4) United States

United Kingdom

Weak

External governance mechanisms

Internal

mechanisms governance

Source: Cells 1, 2, and 4 are adapted from E. R. Gedajlovic & D. M. Shapiro, 1998, Management and ownership effects: Evidence from five countries (p. 539), Strategic Management Journal, 19: 533–553. The label of Cell 3 is suggested by the present author.

shareholder capitalism

A view of capitalism that suggests that the most fundamental purpose for firms to exist is to serve the economic interests of shareholders (also known as capitalists).

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Overall, the Anglo-American and continental European-Japanese (otherwise known as German-Japanese) systems represent the two primary corporate governance families in the world, with a variety of labels (see Table 11.3). Given that both the United States and the United Kingdom as a group and continental Europe and Japan as another group are highly developed successful economies, it is difficult and probably not meaningful to argue whether the Anglo-American or German-Japanese system is better.

Some other systems do not easily fit into such a dichotomous world. Placed in Cell 2, Canada has both a relatively active market for corporate control and a large number of firms with concentrated ownership and control—over 380 of the 400 largest Canadian firms are controlled by a single shareholder. Canadian managers thus face powerful internal and external constraints.

Finally, SOEs (of all nationalities) are typically in a position of both weak external and internal governance mechanisms (Cell 3). Externally, the market for corporate control does not exist. Internally, managers are supervised by officials who act as de facto “owners” with little control.

Overall, firms around the world are governed by a combination of internal and external mechanisms. For firms in Cells 1, 2, and 4, there is some partial substitution between internal and external mechanisms (for example, weak boards may be partially substituted by a strong market for corporate control).

A Comprehensive Model of Corporate Governance Figure 11.4 shows a comprehensive model drawn from the strategy tripod. This section discusses these three views in turn.

Industry-Based Considerations The nature of industry sometimes questions certain widely accepted conventional wisdom regarding (1) outside directors, (2) insider ownership, and (3) CEO duality.36 Having more outside directors on the board is often regarded as a performance-enhancing

TABLE 11.3 Two Primary Families of Corporate Governance Systems

CORPORATIONS IN THE UNITED STATES AND THE UNITED KINGDOM

CORPORATIONS IN CONTINENTAL EUROPE AND JAPAN

Anglo-American corporate governance models German-Japanese corporate governance models

Market-oriented high-tension systems Bank-oriented network-based systems

Rely mostly on exit-based external mechanisms Rely mostly on voice-based internal mechanisms

Shareholder capitalism Stakeholder capitalism

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practice. However, such thinking ignores industry differences. In industries characterized by a rapid pace of innovation requiring significant R&D investments (such as IT), outside directors often have a negative impact on firm performance.37 This is because the necessity for directors to have intimate knowledge about these industries requires more strategic control. Inexperienced outside directors often focus on financial control— inappropriate in these industries.

Another example is the widely noted link between inside management ownership and firm performance. Research finds that for firms in low-growth stable industries, there is no such relationship.38 Only in relatively high-growth turbulent industries has this relationship been found. While increased insider ownership is designed to encourage managers to take more risks, opportunities to profitably take such risks probably are more likely in high-growth turbulent industries.

A third example is the often-criticized practice of CEO duality. In industries experi- encing great turbulence, the presence of a single leader may allow a faster and more unified response to changing events. These benefits may outweigh the potential agency costs brought by such duality.

Overall, governance practices need to create a fit with the nature of the industry in which firms are competing. This cautions against universal prescriptions of certain “best” practices.

FIGURE 11.4 A Comprehensive Model of Corporate Governance

Industry-based considerations

• Outside directors • Inside ownership • CEO duality

Resource-based considerations

• Value • Rarity • Imitability • Organizational capabilities

Corporate governance

Institution-based considerations

• Formal frameworks • Informal frameworks

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Resource-Based Considerations From a corporate governance standpoint, some of the most valuable, rare, and hard-to- imitate firm-specific resources (the first three in the VRIO framework) are the skills and abilities of top managers and directors—often regarded as managerial human capital.39

Some of these capabilities are highly unique, such as international experiences. Executives without such firsthand experience are often handicapped when they try to expand over- seas. In addition, the social networks of these executives, often through board interlocks, are highly unique and likely to add value.40 Also, top managerial talents are hard-to- imitate—unless they are hired away by rival firms.

In another example, the ability to successfully list on a high-profile exchange such as the New York Stock Exchange (NYSE) and London Stock Exchange (LSE) is valuable, rare, and hard to imitate. In 1997, the valuations of foreign firms listed in New York were 17% higher than their domestic counterparts in the same country that were either unable or unwilling to list abroad.41 Now, despite hurdles such as SOX, the select few that are able to list in New York are rewarded more handsomely: Their valuations are now 37% higher than comparable groups of domestic firms in the same country.42 London-listed foreign firms do not enjoy such high valuations.43 This is classic resource-based logic at work: Precisely because it is much more challenging to list in New York in the SOX era, the small number of foreign firms that are able to do this are truly exceptional. Thus, they deserve much higher valuations.

The last crucial component in the VRIO framework is O: organizational. It is within an organizational setting (in TMTs and boards) that managers and directors function.44

Overall, the few people at the top of an organization can make a world of difference— Steve Jobs at Apple was a great example. Governance mechanisms need to properly motivate and discipline them to make sure they make a positive impact.

Institution-Based Considerations

FORMAL INSTITUTIONAL FRAMEWORKS. A fundamental difference is between the separation of ownership and control in (most) Anglo-American firms and the concentration of ownership and control in the rest of the world. Why is there such a difference? While explanations abound, a leading answer is an institution-based one. In brief, better formal legal protection of shareholder rights, especially those held by minority shareholders, in the United States and the United Kingdom encourages founding families to dilute their equity to attract minority shareholders and delegate day-to-day management to professional managers. Given reasonable investor protection, founding families themselves (such as the Rockefellers) may, over time, feel comfortable becoming minority shareholders of the firms they founded. On the other hand, when formal legal and regulatory institutions are dysfunctional, founding families must run their firms directly. In the absence of investor protection, inviting outside professional managers may invite abuse and theft.

Strong evidence exists to point out that the weaker the formal legal and regulatory institutions protecting shareholders, the more concentrated ownership and control rights become—in other words, there is some substitution between the two. Common-law countries generally have the strongest legal protection of investors and the lowest con- centration of corporate ownership.45 Among common-law countries, such ownership

managerial human capital

The skills and abilities acquired by top managers.

342 PART 3 CORPORATE-LEVEL STRATEGIES

concentration is higher for firms in emerging economies (such as Hong Kong, India, and Israel) than developed economies (such as Australia, Canada, Ireland, and New Zealand). In short, concentrated ownership and control is an answer to potentially rampant principal–agent conflicts in the absence of sufficient legal protection of shareholder rights.

However, what is good for controlling shareholders is not necessarily good for minority shareholders and for an economy. As noted earlier, the minimization of principal–agent conflicts through concentration of ownership and control, unfortunately, introduces more principal–principal conflicts (see Strategy in Action 11.1). Consequently, many potential minority shareholders may refuse to invest. “How to avoid being expropriated as a minority shareholder?” one popular saying suggests, “Don’t be one!” If minority share- holders are informed enough to be aware of these possibilities and still decide to invest, they are likely to discount the shares floated by family owners. For example, thanks to the “Murdoch discount,” News Corporation’s stock performance has trailed behind that of its rivals such as Time Warner, Walt Disney, and Viacom (see Strategy in Action 11.1). Overall, such principal–principal conflicts can result in lower valuations, fewer publicly traded firms, inactive and smaller capital markets, and, in turn, lower levels of economic development in general.

Given that almost every country desires vibrant capital markets and economic devel- opment, it seems puzzling why strong investor protection is not universally embraced. It is important to note that at its core, corporate governance ultimately is a choice about political governance. For largely historical reasons, most countries have made hard-to- reverse political choices. For example, the German practice of “codetermination” (employees control 50% of the votes on supervisory boards) is an outcome of political decisions made by postwar German governments.46 If German firms had US/UK-style dispersed ownership and still allowed employees to control 50% of the votes on super- visory boards, these firms would end up becoming employee-dominated firms. Thus, concentrated ownership and control become a natural response.

Changing political choices, though not impossible, will encounter significant resistance, especially from incumbents (such as German labor unions or Asian families) who benefit from the present system. Some of the leading business families not only have great connections with the government, sometimes they are the government. Two recent prime ministers of Italy and Thailand—Silvio Berlusconi and Thaksin Shinawatra, respectively— came from leading business families and were the richest men in these countries.

Only when extraordinary events erupt would some politicians muster sufficient poli- tical will to initiate major corporate governance reforms.47 The spectacular corporate scandals in the United States (such as Enron) are an example of such extraordinary events prompting more serious political reforms such as SOX. The 2008 financial crisis resulted in the enactment of the Dodd-Frank Act in 2010, which for the first time allows share- holders to cast proxy votes on executive compensation—in short, “say on pay.”

INFORMAL INSTITUTIONAL FRAMEWORKS. In the past two decades around the world, why and how have informal norms and values concerning corporate governance changed to such a great extent?48 From the United States and the United Kingdom, the idea of shareholder capitalism is rapidly spreading. At least three sources of these changes can be identified: (1) the rise of capitalism, (2) the impact of globalization, and (3) the global diffusion of “best practices.”

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First, recent changes in corporate governance around the world are part of the greater political, economic, and social movement embracing capitalism. The triumph of capital- ism naturally boils down to the triumph of capitalists (otherwise known as shareholders). However, “free markets” are not necessarily free. Even some of the most developed countries have experienced significant governance failures, calling for a sharper focus on shareholder value.

Second, at least three aspects of recent globalization have a bearing on corporate governance.

• Thanks to more trade and investment, firms with different governance norms increasingly come into contact and expose their differences. Being aware of alternatives, shareholders as well as managers and policymakers are no longer easily persuaded that “our way” is the best way of corporate governance.49

• Foreign portfolio investment (FPI)—foreigners purchasing stocks and bonds—has scaled new heights. These investors naturally demand better shareholder protection before committing their funds.

• The global thirst for capital has prompted many firms to pay attention to corporate governance. Foreign firms that list their stock in New York and London have to be in compliance with US and UK listing requirements.

Third, the changing norms and values are also directly promoted by the global diffusion of “best practices” in the form of corporate governance codes.50 A lot of codes are advisory and not legally binding. However, strong pressures exist for firms to “voluntarily” adopt these codes. For example, in Russia, although adopting the 2002 Code of Corporate Conduct is voluntary, firms not adopting it have to publicly explain why, essentially naming and shaming themselves.

In addition, the Organization for Economic Cooperation and Development (OECD) has spearheaded efforts to globally diffuse “best practices” through the OECD Principles of Corporate Governance (1999). The Principles are non-binding even for the 34 OECD member countries. Nevertheless, the global norms seem to be moving toward the Principles. For example, China and Taiwan, both non-OECD members, have recently taken a page from the Principles and allowed for class action lawsuits brought by shareholders.

Slowly but surely, change is in the air. But such change is not necessarily in one direction. The ferociousness of the 2008 global financial crisis has caused tremendous resentment toward fat executive pay packages, income inequality, and the financial services industry in general. Movements such as Occupy Wall Street and Occupy London are a tangible indication of the changing informal sentiments as the swing of the pendulum (see Chapter 1), which has triggered or intensified formal regulatory changes.

Debates and Extensions This section discusses three major debates: (1) opportunistic agents versus managerial stewards, (2) global convergence versus divergence, and (3) state ownership versus private ownership.

foreign portfolio investment (FPI)

Foreigners’ purchase of stocks and bonds in one country.

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Opportunistic Agents versus Managerial Stewards Agency theory assumes managers to be agents who may engage in self-serving opportu- nistic activities if left to their own devices. However, critics contend that most managers are likely to be honest and trustworthy. Managerial mistakes may be due to a lack of competence, information, or luck, and not necessarily due to self-serving motives. Thus, it may be unfair to characterize all managers as opportunistic agents. Although very influential, agency theory has been criticized as an “anti-management theory of manage- ment.”51 A “pro-management” theory, stewardship theory has emerged recently. It suggests that most managers can be viewed as owners’ stewards. Safeguarding share- holders’ interests and advancing organizational goals will maximize (most) managers’ own utility functions.

If all principals view all managers as self-serving agents with control mechanisms to put managers on a “tight leash,” some managers, who initially view themselves as stewards, may be so frustrated that they end up engaging in the very self-serving behavior agency theory seeks to minimize. In other words, as a self-fulfilling prophecy, agency theory may induce such behavior.

Global Convergence versus Divergence Another leading debate is whether corporate governance is converging or diverging globally. Convergence advocates argue that globalization unleashes a “survival-of-the- fittest” process by which firms will be forced to adopt globally best (essentially Anglo- American) practices. Global investors are willing to pay a premium for stock in firms with Anglo-American-style governance, prompting other firms to follow.

One interesting phenomenon often cited by convergence advocates is cross-listing, namely, listing shares on foreign stock exchanges. Cross-listing is primarily driven by the desire to tap into larger pools of capital. Foreign firms thus must comply with US and UK securities laws and adopt Anglo-American governance norms. For instance, Japanese firms listed in New York and London, compared with those listed at home, are more concerned about shareholder value. A US or UK listing can be viewed as a signal of the firm’s commitment to strengthen shareholder value, resulting in higher valuations.

Critics contend that governance practices will continue to diverge throughout the world.52 For example, promoting more concentrated ownership and control is often recommended as a solution to combat principal–agent conflicts in US and UK firms. However, making the same recommendation to reform firms in the rest of the world may be counterproductive or even disastrous.53 The main problem there is that controlling shareholders typically already have too much ownership and control. Finally, some US and UK practices differ significantly. In addition to the split on CEO duality (the UK against, the US for) discussed earlier, none of the US anti-takeover defenses (such as “poison pills”) is legal in the UK.

In the case of cross-listed firms, divergence advocates make two points. First, despite some convergence on paper (such as having more outside directors), cross-listed foreign firms do not necessarily adopt US governance norms before or after listing. Second, despite the popular belief that US and UK securities laws would apply to cross-listed foreign firms, in practice, these laws have rarely been effectively enforced against foreign firms’ “tunneling.”54

stewardship theory

A theory that suggests that managers should be regarded as stewards of owners’ interests.

cross-listing

Firms list their shares on foreign stock exchanges.

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At present, complete divergence is probably unrealistic, especially for large firms in search of capital from global investors. Complete convergence also seems unlikely. What is more likely is “cross-vergence,” balancing the expectations of global investors and those of local stakeholders.55

State Ownership versus Private Ownership56

Private ownership is good. State ownership is bad. Although crude, these two statements fairly accurately capture the intellectual and political reasoning behind three decades of privatization around the world between 1980 and 2008. Table 11.4 summarizes the key differences between private ownership and state ownership. Obviously, both forms of ownership have their own pros and cons. So the debate boils down to which form of ownership is better—whether the pros outweigh the cons.

The debate on private versus state ownership underpins much of the global economic evolution in the 20th century. The Great Depression (1929–1933) was seen as a failure of capitalism and led numerous elites in developing countries and a nontrivial number of scholars in developed economies to favor the Soviet-style socialism centered on state

TABLE 11.4 Private Ownership versus State Ownership

PRIVATE OWNERSHIP STATE OWNERSHIP

Objective of the firm Maximize profits for private owners who are capitalists (and maximize shareholder value for shareholders if the firm is publicly listed).

Optimal balance for a “fair” deal for all stakeholders. Maximizing profits is not the sole objective of the firm. Protecting jobs and minimizing social unrest are legitimate goals.

Establishment of the firm Entry is determined by entrepreneurs, owners, and investors.

Entry is determined by government officials.

Financing of the firm Financing is from private sources (and public shareholders if the firm is publicly traded).

Financing is from state sources (such as direct subsidiaries or banks owned or controlled by governments).

Liquidation of the firm Exit is forced by competition. A firm has to declare bankruptcy or be acquired if it becomes financially insolvent.

Exit is determined by government officials. Firms deemed “too big to fail” may be supported by taxpayer dollars indefinitely.

Appointment and dismissal of management

Management appointments are made by owners and investors largely based on merit.

Management appointments are made by government officials who may also use noneconomic criteria.

Compensation of management

Managers’ compensation is determined by competitive market forces. Managers tend to be paid more under private ownership.

Managers’ compensation is determined politically with some consideration given to a sense of fairness and legitimacy in the eyes of the public. Managers tend to be paid less under state ownership.

Sources: Based on (1) M. W. Peng, 2000, Business Strategies in Transition Economies (p. 19), Thousand Oaks, CA: Sage; (2) M. W. Peng, G. Bruton, & C. Stan, 2012, Theories of the (state-owned) firm, working paper, University of Texas at Dallas.

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ownership. As a result, the postwar decades saw an increase in state ownership and a decline in private ownership. State ownership was not only extensive throughout the former Eastern bloc (the former Soviet Union, Central and Eastern Europe, China, and Vietnam), but was also widely embraced throughout developed economies in Western Europe. By the early 1980s, close to half of the GDP in major Western European countries such as Britain, France, and Italy was contributed by SOEs.

Experience throughout the former Eastern bloc and Western Europe indicated that SOEs typically suffer from a lack of accountability and a lack of economic efficiency. SOEs were known to feature relatively equal pay between managers and the rank and file. Since extra work did not translate into extra pay, employees had little incentive to improve the quality and efficiency of their work.

As Britain’s prime minister, Margaret Thatcher privatized a majority of British SOEs in the 1980s. Very soon, SOEs throughout Central and Eastern Europe followed suit. After the Soviet Union collapsed, the new Russian government unleashed some of the most aggressive privatization schemes in the 1990s. Eventually, the privatization movement became global, reaching Brazil, India, China, Vietnam, and most countries in Africa. In no small part, such a global movement was championed by the Washington Consensus, spearheaded by two Washington-based international organizations: the International Monetary Fund (IMF) and the World Bank. A core value of the Washington Consensus is the unquestioned belief in the superiority of private ownership over state ownership. The widespread privatization movement suggested that the Washington Consensus had clearly won the day—or so it seemed.

But in 2008, the pendulum suddenly swung back (see Chapter 1). During the unpre- cedented recession, major governments in developed economies, led by the US govern- ment, bailed out numerous failing private firms using public funds, effectively turning them into SOEs. As a result, all the arguments in favor of private ownership and “free market” capitalism collapsed. Since SOEs had such a dreadful reputation (essentially a “dirty word”), the US government has refused to acknowledge that it has SOEs. Instead, the US government refers to them as “government-sponsored enterprises” (GSEs).

Conceptually, what are the differences between SOEs and GSEs? Hardly any! The right column in Table 11.4 is based on research on the “classical” SOEs in pre-reform China and Russia published more than a decade ago. This column also accurately summarizes what is happening in developed economies featuring GSEs now. For example, protecting jobs is one of the stated goals behind bailouts. Entry and exit are determined by govern- ment officials, and some firms that have been clearly run to the ground, such as AIG, GM, and RBS, are deemed “too big to fail” and are bailed out with taxpayer dollars. The US government forced the exit of GM’s former chairman and CEO and is now directly involved in the appointment and compensation of executives at GM and other GSEs.

One crucial concern is that despite noble goals to rescue the economy, protect jobs, and fight recession, government bailouts serve to heighten moral hazard—recklessness when people and organizations (including firms and governments) do not have to face the full consequences of their actions.57 In other words, capitalism without the risk of failure becomes socialism. It is long known that managers in SOEs face a “soft budget constraint” in that they can always dip into state coffers to cover their losses. When managers in private firms make risky decisions that turn sour, but their firms do not go under—thanks to generous bailouts—they are likely to embrace more risk in the future.

Washington Consensus

A view centered on the unquestioned belief in the superiority of private own- ership over state ownership in economic policy making, which is often spearheaded by two Washington-based international organizations: the International Monetary Fund and the World Bank.

moral hazard

Recklessness when people and organizations (includ- ing firms and governments) do not have to face the full consequences of their actions.

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Although the worst fear about the recession is now over, debates continue to rage. In the ashes of the Washington Consensus emerged a Beijing Consensus, which centers on state ownership and government intervention. Anchored by SOEs, China over the past 30 years has grown its GDP by 9.5% a year and its international trade volume by 18% a year. SOEs represent 80% of China’s stock market capitalization. But China is not alone. In Russia, the figure is 62%, and in Brazil 38%.58 Overall, nine of the top 15 largest IPOs since 2006 are SOEs (Table 11.5). For policymakers in developed economies, an important dimension of this debate is about how to view the incoming investments from state- owned entities such as sovereign wealth funds (SWFs) from emerging economies (see Emerging Markets 11.1).

TABLE 11.5 State-Owned Enterprises Represent Nine of the 15 Largest IPOs since 2005

COMPANY INDUSTRY YEAR VALUE ($ BILLION)

Agricultural Bank of China (SOE) Finance 2010 22.1

Industrial & Commercial Bank of China (SOE) Finance 2006 21.9

AIA (Hong Kong) Insurance 2010 20.5

Visa (United States) Finance 2008 19.7

General Motors (United States) (SOE) Automotive 2010 18.1

Bank of China (SOE) Finance 2006 11.2

Dai-ichi Life Insurance (Japan) Insurance 2010 11.1

Rosneft (Russia) (SOE) Oil & gas 2006 10.7

Glencore International (Switzerland) Mining 2011 10.0

China Construction Bank (SOE) Finance 2005 9.2

Electricité de France (SOE) Utility & energy 2005 9.0

VTB Group (Russia) (SOE) Finance 2007 8.0

Banco Santander Brasil Finance 2009 7.5

China State Construction Engineering Corporation (SOE)

Construction 2009 7.3

Iberdrola Renovables (Spain) Utility & energy 2007 6.6

Source: Adapted from Economist, 2012, New masters of universe (p. 8), Special Report: State Capitalism, January 21: 8.

Beijing Consensus

A view that questions Washington Consensus’ belief in the superiority of private ownership over state ownership in eco- nomic policy making, which is often associated with the position held by the Chinese government.

sovereign wealth fund (SWF)

A state-owned investment fund composed of financial assets such as stocks, bonds, real estate, or other financial instruments funded by foreign exchange assets.

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E T H I C A L D I L E M M AEMERGING MARKETS 11.1

Welcoming versus Restricting Sovereign Wealth Fund Investments

A sovereign wealth fund (SWF) is a state-owned investment fund composed of financial assets such as stocks, bonds, real estate, or other financial instruments funded by foreign exchange assets. Investment funds that we now call SWFs were first created in 1953 by Kuwait. Both the United States and Canada have had their own SWFs (at least at the state and provincial level, such as the Alaska Permanent Fund and Alberta Heritage Fund).

In the recent crisis, SWFs came to the rescue. They now represent approximately 10% of global investment flows. For example, in 2007, the Abu Dhabi Investment Authority injected $7.5 billion (4.9% of equity) into Citigroup. In 2008, China Investment Corporation (CIC) invested $5 billion for a 10% equity stake in Morgan Stanley. While most SWFs make relatively passive investments, some have become more active, direct investors as they hold larger stakes in recipients.

Such large-scale investments have ignited the debate on SWFs. On the one hand, SWFs have brought much-needed cash to rescue desperate Western firms. On the other hand, concerns are raised by host countries, which are typically developed economies. A primary concern is national security in that SWFs may be politically (as opposed to commercially) motivated. Another concern is SWFs’ inadequate transparency. Governments in several developed economies, in fear of the “threats” from SWFs, have been erecting anti- SWF measures to defend their companies.

Foreign investment certainly has both benefits and costs to host countries. However, in the absence of any evidence that the costs outweigh benefits, the rush to erect anti-SWF barriers is indicative of protectionist (or, some may argue, even racist) sentiments. For executives at hard-pressed Western firms, it would not seem sensible to ask for government bailouts on the one hand and to reject cash from SWFs on the other hand. Most SWF investment is essentially free cash with little strings attached. For example, CIC, which now holds 10% of Morgan Stanley equity, did not demand a board seat or a management role. For Western policymakers, it makes little sense to spend taxpayers’ dollars to bail out failed

firms, run huge budget deficits, and then turn away SWFs. Commenting on inbound Chinese investment in the United States (including SWF investment), leading scholars Steve Globerman and Daniel Shapiro note:

It seems feckless on the part of US policymakers to stigmatize Chinese investment in the United States based upon imprecise and likely exaggerated estimates of the relevant costs and risks of that investment.

At least some US policymakers agree. In the September/October 2008 issue of Foreign Affairs, then- Secretary of the Treasury Henry Paulson commented:

These concerns [on Chinese investment] are misplaced … the United States would do well to encourage such investment from anywhere in the world—including China— because it represents a vote of confidence in the US economy and it promotes growth, jobs, and productivity in the United States.

Lastly, thanks to the financial crisis in 2008–2009, recent SWF investment in developed economies suffered major losses. Such a “double whammy”—both the political backlash and the economic losses—has severely discouraged SWFs. As a result, the recession put a premium on maintaining a welcoming climate. As part of the efforts to foster such a climate in times of great political and economic anxiety, both US and Chinese governments confirmed the following in the US-China Strategic and Economic Dialogue (S&ED) on July 28, 2009:

The United States confirms that the Committee on Foreign Investment in the United States (CFIUS) process ensures the consistent and fair treatment of all foreign investment without prejudice to the place of origin. The United States welcomes sovereign wealth fund investment, including that from China. China stresses that investment decisions by its state-owned investment firms will be based solely on commercial grounds.

Beyond bilateral negotiations such as the US-China S&ED, in September 2008, major SWFs of the world at a

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The Savvy Strategist In the corporate governance arena, the savvy strategist capitalizes on three strategic implications for action (Table 11.6). First, understand the nature of principal–agent and principal–principal conflicts to create better governance mechanisms. For example, the rise of private equity is a direct response to principal–agent conflicts typically found in publicly listed firms (see the Closing Case). Amazingly, private equity typically makes the same managers, managing the same assets, perform much more effectively. In terms of mechanisms to alleviate principal–principal conflicts, one practice is to introduce a second controlling (dominant) shareholder that may monitor and constrain the action of the first controlling shareholder.59

Second, savvy strategists need to develop firm-specific capabilities to differentiate on governance dimensions. In India, the leading IT firm Infosys has emerged as an exemplar.60 It is the first Indian firm to follow US generally accepted accounting principles (GAAP), the first to offer stock options to all employees, and one of the first to introduce outside directors. Since its listings in Mumbai in 1993 and NAS- DAQ in 1999, it has gone far beyond disclosure requirements mandated by both Indian and US standards. On NASDAQ, Infosys voluntarily behaves like a US domestic issuer, rather than subjecting itself to the less stringent standards of a foreign issuer.

Third, savvy strategists need to understand the rules and anticipate changes.61 In the first year that shareholders were granted a “say on pay” in US firms (2011), median pay for CEOs at Standard & Poor’s 500 firms jumped 35% to $8.4 million.62 While

summit in Santiago, Chile, agreed to a voluntary code of conduct known as the Santiago Principles. These principles are designed to alleviate some of the concerns for host countries of SWF investment and to enhance the transparency of such investment. These principles represent an important milestone of SWFs’ evolution.

Sources: Based on (1) V. Fotak & W. Megginson, 2009, Are SWFs welcome now? Columbia FDI Perspectives, No. 9, July 21, www.vcc.columbia.edu; (2) S. Globerman & D. Shapiro,

2009, Economic and strategic considerations surrounding Chinese FDI in the United States (p. 180), Asia Pacific Journal of Management, 26: 163–183; (3) H. Paulson, 2008, The right way to engage China, Foreign Affairs, September/ October, www.foreignaffairs.org; (4) Sovereign Wealth Fund Institute, 2012, About sovereign wealth fund, www. swfinstitute.org; (5) United Nations (UN), 2010, World Investment Report 2010 (p. xviii), New York and Geneva: UN; (6) US Department of the Treasury, 2009, The First US-China Strategic and Economic Dialogue Economic Track Joint Fact Sheet, July 28, Washington.

TABLE 11.6 Strategic Implications for Action

& Understand the nature of principal–agent and principal–principal conflicts to create better governance mechanisms.

& Develop firm-specific capabilities to differentiate a firm on corporate governance dimensions. & Master the rules affecting corporate governance and anticipate changes.

ga ge

Le ar ni ng

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shareholders only rejected executive pay at less than 2% of public firms, this practice of significantly increasing CEO compensation seemed to deviate from the spirit—if not the letter—of the Dodd-Frank Act that unleashed “say on pay.” As a result, more tightening of the rules can be expected down the road.

Overall, a better understanding of corporate governance can help us answer the four fundamental questions in strategy. First, why do firms differ? Firms differ in corporate governance because of the different nature of industries, different abilities to motivate and discipline managers, and different institutional frameworks. Second, how do firms behave? Given that most corporations throughout the world have similar basic compo- nents of corporate governance (owners, managers, and boards), the primary sources of differences stems from how these components relate and interact with each other to set the direction of the corporate ship. Third, what determines the scope of the firm? From a corporate governance standpoint, a wide scope may be indicative of managers’ empire- building and risk reduction. Finally, what determines the success and failure of firms around the globe? Although research is still inconclusive, there is reason to believe—in the aggregate and in the long run—that better governed firms will be rewarded with a lower cost of capital and consequently better firm performance.63

CHAPTER SUMMARY

1. Differentiate various ownership patterns (concentrated/diffused, family, and state ownership) • In the US and UK, firms with separation of ownership and control dominate. • Elsewhere, firms with concentrated ownership and control in the hands of families or governments are predominant.

2. Articulate the role of managers in both principal–agent and principal–principal conflicts • In firms with separation of ownership and control, the primary conflicts are principal– agent conflicts.

• In firms with concentrated ownership, principal–principal conflicts prevail.

3. Explain the role of the board of directors • The board of directors performs (1) control, (2) service, and (3) resource acquisition functions.

• Around the world, boards differ in composition, leadership structure, and interlocks.

4. Identify voice-based and exit-based governance mechanisms and their combination as a package • Internal voice-based mechanisms and external exit-based mechanisms combine as a package to determine corporate governance effectiveness.

• The market for corporate control and the market for private equity are two primary external mechanisms.

5. Acquire a global perspective on how governance mechanisms vary around the world • Different combinations of internal and external governance mechanisms lead to four main groups.

• Privatization around the world represents efforts to enhance governance effectiveness.

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6. Elaborate on a comprehensive model of corporate governance • Industry-based, institution-based, and resource-based views shed considerable light on governance issues.

7. Participate in three leading debates concerning corporate governance • (1) Opportunistic agents versus managerial stewards, (2) global convergence versus divergence, and (3) state ownership versus private ownership.

8. Draw strategic implications for action • Understand the nature of principal–agent and principal–principal conflicts. • Develop firm-specific capabilities to differentiate on corporate governance dimensions. • Master the rules affecting corporate governance and anticipate changes.

KEY TERMS

Agency cost p. 330

Agency relationship p. 330

Agency theory p. 330

Agent p. 330

Beijing Consensus p. 348

CEO duality p. 334

Chief executive officer (CEO) p. 327

Concentrated ownership and control p. 328

Corporate governance p. 328

Cross-listing p. 345

Diffused ownership p. 329

Exit-based mechanism p. 336

Expropriation p. 332

Foreign portfolio investment (FPI) p. 344

Information asymmetries p. 330

Inside director p. 334

Interlocking directorate p. 334

Leveraged buyout (LBO) p. 338

Managerial human capital p. 342

Moral hazard p. 347

Outside (independent) director p. 334

Principal p. 330

Principal–agent conflict p. 330

Principal–principal conflict p. 332

Private equity p. 338

Related transaction p. 333

Separation of ownership and control p. 329

Shareholder capitalism p. 339

Sovereign wealth fund (SWF) p. 348

State-owned enterprise (SOE) p. 329

Stewardship theory p. 345

Tunneling p. 333

Voice-based mechanism p. 336

Washington Consensus p. 347

CRITICAL DISCUSSION QUESTIONS

1. Some argue that the Anglo-American-style separation of ownership and control is an inevitable outcome in corporate governance. Others contend that this is one variant (among several) on how large firms can be effectively governed and that it is not necessarily the most efficient form. What do you think?

2. Recent corporate governance reforms in various countries urge (and often require) firms to add more outside directors to their boards and separate the jobs of board chairman and CEO. Yet, academic research has not been able to conclusively support the merits of both practices. Why?

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3. ON ETHICS: You are 30 years old and obtained your MBA from a top business school two years ago. You are being promoted to be CEO of a multibillion-dollar firm that is publicly listed in your country. There is loud minority shareholder resistance to your appointment because you are too young. Too bad, your father and your family are the controlling shareholders and you get the job. What are you going to say at your first press conference as CEO, knowing that there will be some tough questions from reporters?

TOPICS FOR EXPANDED PROJECTS

1. Given that you can choose where to register and list your firm anywhere in the world, which country’s securities and corporate governance laws would you prefer? Working in small groups, research and compare at least five possible locations, and then make a final selection. Present your research findings, selection criteria, and explanation of final choice in a short paper or visual presentation.

2. How do you side in the debate on state ownership versus private ownership? State your position in a short paper.

3. ON ETHICS: As a chairman/CEO, you are choosing between two candidates for one outside director position on your board. One is another CEO, a long-time friend whose board you have served on for many years. The other is a known shareholder activist whose tag line is “No need to make fat cats fatter.” Placing him on the board will earn you kudos among analysts and journalists for inviting a leading critic to scrutinize your work. However, he may try to prove his theory that CEOs are overpaid. Who would you choose? Explain your rationale for your choice in a short paper.

E T H I C A L D I L E M M ACLOSING CASE

Emerging Markets: The Private Equity Challenge

Private equity is one of the hottest and most controversial buzzwords in corporate governance. Private equity firms often take an underperforming publicly listed company off the stock exchange, add some heavy dose of debt, throw in sweet “carrots” to incumbent managers, and trim all the “fat” (typically through layoffs). Private equity firms get paid by (1) the fees and (2) the profits reaped when they take the private firms public again through a new IPO.

Private equity first emerged in the 1980s, with a stream of deals peaked by Kohlberg Kravis Robert’s (KKR) $25

billion takeover of RJR Nabisco in 1988—then the highest price paid for a public firm. While KKR disciplined dead- wood managers who destroyed shareholder value, it received a ton of bad press, cemented in a best-selling book Barbarians at the Gate that portrayed KKR as a greedy and barbarous raider.

After the RJR Nabisco deal, the private equity industry stagnated during the 1990s. However, in the 2000s, private equity scaled new heights. In 1991, just 57 private equity firms existed. In 2007, close to 700 chased deals. Private

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equity deals now routinely represent 25% of all mergers and acquisitions (M&As) in the world (and 35% in the United States). Since 2005, Europe has had more actions (measured by deal values) than the United States. In 2007, Cerberus, a private equity firm, purchased Chrysler from DaimlerChrysler for $7.4 billion. APAX Partners spent $7.75 billion to buy Thomson Learning—the publisher of this book—from The Thomson Corporation listed in New York and Toronto. However, private equity suffered a tre- mendous setback since 2008. Many deals struck in the easy credit environment of 2006–2007 collapsed, resulting in severe losses. In a record-breaking $43 billion deal in 2007, Texas Pacific Group (now known as TPG Capital) and KKR jointly took over Dallas-based utility TXU, which is now called Energy Future Holdings. However, by 2011, KKR valued its investment at only ten cents on the dollar.

Private equity has always been controversial. Pro- ponents argue that private equity is a response to the corporate governance deficiency of the public firm. Private equity excels in four ways:

• Private owners, unlike dispersed individual shareholders, care deeply about the return on investment. Private equity firms always send experts to sit on the board and are hands-on in managing.

• A high level of debt imposes strong financial discipline to minimize waste.

• Private equity turns managers from agents to principals with substantial equity (typically 5% equity for the CEO and 16% for the whole top management team). Private equity firms pay managers more generously, but also punish failure more heavily. Managers’ compensation at firms under private ownership, according to leading expert Michael Jensen, is 20 times more sensitive to performance than at firms listed publicly. On average, private equity makes the samemanagers, managing the same assets, perform much more effectively. On average there is a 2% boost in productivity and efficiency.

• Finally, privacy is fabulous. For managers, no more short- term burden to “meet the numbers” for Wall Street, no more burdensome paperwork from regulators (an especially crushing load thanks to SOX), and better yet, no more disclosure in excruciating detail of their pay (an inevitable invitation to be labeled “fat cats”). Top

managers under private ownership are indeed fatter cats. It is not surprising that more managers prefer a quieter but far more lucrative life. In 1997, over 7,000 firms were listed on US stock exchanges. In 2012, thanks to private equity only over 4,000 bothered to be listed.

All of the above, according to critics, are exactly what is wrong with private equity. Other than “barbarians,” private equity has also been labeled “asset strippers” and “locusts.” As high executive compensation at public firms has already become a huge controversy, private equity has further increased the income inequality between the high financiers and top managers as one group and the rest of us as another group. Private equity has rapidly proliferated around the world. Some of the fuss reflects the shock in countries suddenly facing the full rigor of Anglo-American private equity. In Germany, some politicians labeled foreign private equity groups as “locusts who feast on German firms for profit before spitting them out.” In South Korea, Lone Star Funds of Dallas was initially hailed in 2003 as a brave outsider willing to save troubled Korean firms. How- ever, in 2006, when Lone Star tried to cash out by selling its 51% equity of Korea Exchange Bank, unions took to the street to protest and prosecutors issued a warrant to arrest its co-founder for alleged financial manipulation.

To be sure, private equity results in job cuts (about 1%–2% of the jobs at the firms that were taken over were lost). But the same would happen if targets were acquired by public firms. In other words, private equity buyers are no more barbaric than public firms. In terms of financial returns, private equity investors earn slightly more than the Standard and Poor’s (S&P) 500 before the fees are charged. However, after the fees are charged, private equity performs slightly below S&P. In other words, outside investors would do as well or better with their money in an S&P index fund. In summary, while private equity is under attack for destroying jobs, its real problem is that returns to investors are low.

Private equity is inherently global. As the homeland of private equity is now engulfed in economic recession and widespread resentment (think of Occupy Wall Street), the outlook is grim. Is private equity “Monsters, Inc.?” asked an Economist editorial. Thus, private equity firms have increasingly targeted emerging economies, especially China, for future growth. The following quote is from a

354 PART 3 CORPORATE-LEVEL STRATEGIES

NOTES

speech in 2010 given by David Rubenstein, co-founder and managing director of one of the largest private equity firms, Carlyle Group:

When I’m in Washington, DC, people are barraging me, saying that I’m not paying enough taxes, I’m not worried enough about labor concerns. I’ve got labor unions protesting me. I’ve got everybody telling me that I didn’t do something right. In China, people wantmy autograph. In China, private equity professionals are like rock stars. Because China has taken the view that private equity is a value-adding technique and a value-added resource, they encourage it… Honestly, I tell people… the center of capitalism is Beijing, and the center of non-capitalism is Washington, DC. Now obviously, that’s an exaggeration to make a point, but there’s no doubt that in China, what private equity people do is very much welcomed and not criticized.

Sources: Based on (1) Bloomberg Businessweek, 2011, The people vs. private equity, November 28: 90–93; (2) Bloomberg Businessweek, 2012, You’re so Bain, January 16: 6–8; (3) G. Bruton, I. Filatotchev, S. Chahine, & M. Wright, 2010, Governance, ownership structure, and performance of IPO firms: The impact of different types of private equity investors and institutional environments, Strategic Management Jour- nal, 31: 491–509; (4) D. Cumming & U. Walz, 2010, Private

equity returns and disclosure around the world, Journal of International Business Studies, 41: 727–754; (5) Economist, 2012, Bain or blessing? January 28: 73–74; (6) Economist, 2012, Monsters, Inc.? January 28: 10–11; (7) M. Jensen, 1989, Eclipse of the public corporation, Harvard Business Review, September: 61–74; (8) S. Kaplan & P. Stromberg, 2009, Leveraged buyouts and private equity, Journal of Eco- nomic Perspectives, 23: 121–146; (9) L. Phalippou, 2009, Beware of venturing into private equity, Journal of Economic Perspectives, 23: 147–166; (10) Wharton Private Equity Review, 2010, The Storm Clouds Begin to Clear (p. 19), Wharton School.

C A S E D I S C U S S I O N Q U E S T I O N S

1. If you were a private equity specialist, what kind of target firms would you look for?

2. If you were CEO of a publicly traded firm and were approached by a private equity firm, how would you proceed?

3. If you were a Chinese regulator, how concerned should you be after you have learned about the criticisms against private equity in the United States, Germany, South Korea, and elsewhere?

[Journal acronyms] AER – American Economic Review; AMJ – Academy of Management Journal; AMP – Academy of Management Perspectives; AMR – Academy of Management Review; APJM – Asia Pacific Journal of Management; BW – BusinessWeek (before 2010) or Bloomberg Businessweek (since 2010); CG – Corporate Governance; JAE – Journal of Accounting and Economics; JEP – Journal of Economic Perspectives; JF – Journal of Finance; JFE – Journal of Fin- ancial Economics; JIBS – Journal of International Business Studies; JMS – Journal of Management Studies; JWB – Journal of World Business; MOR – Management and Organization Review; OSc – Organization Science; OSt – Organization Studies; RES – Review of Economics and Statis- tics; RFS – Review of Financial Studies; SMJ – Strategic Management Journal

1. R. Monks & N. Minow, 2001, Corporate Governance (p. 1), Oxford, UK: Blackwell. See also M. Benz & B. Frey, 2007. Corporate governance, AMR, 32: 92–104; S.Globerman,M.W.Peng, &D. Shapiro, 2011, Corporate governance and Asian companies, APJM, 28: 1–14.

2. B. Connelly, R. Hoskisson, L. Tihanyi, & S. T. Certo, 2010, Ownership as a form of corporate governance, JMS, 47: 1561–1589.

3. R. Stulz, 2005, The limits of financial globalization (p. 1618), JF, 60: 1595–1638.

4. K. Schnatterly, K. Shaw, & W. Jennings, 2008, Informa- tion advantages of large institutional owners, SMJ, 29: 219–227.

5. R. La Porta, F. Lopez-de-Silanes, & A. Shleifer, 1999, Corporate ownership around the world, JF, 54: 471–517.

C h a p t e r 1 1 G o v e r n i n g t h e C o r p o r a t i o n A r o u n d t h e W o r l d 355

6. Y. Jiang & M. W. Peng, 2011, Are family ownership and control in large firms good, bad, or irrelevant? APJM, 28: 15–39; M. W. Peng & Y. Jiang, 2010, Institutions behind family ownership and control in large firms, JMS, 47: 253–273; W. Schulze & E. Gedaj- lovic, 2010, Whither family business? JMS, 47: 191–204.

7. M. Jensen & W. Meckling, 1976, Theory of the firm, JFE, 3: 305–360.

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9. S. Claessens, S. Djankov, & L. Lang, 2000, The separa- tion of ownership and control in East Asian corpora- tions, JFE, 58: 81–112.

10. M. Faccio & L. Lang, 2002, The ultimate ownership of Western European corporations, JFE, 65: 365–395.

11. M. Young, M. W. Peng, D. Ahlstrom, G. Bruton, & Y. Jiang, 2008, Corporate governance in emerging economies, JMS, 45: 196–220.

12. S. Johnson, R. La Porta, F. Lopez-de-Silanes, & A. Shleifer, 2000, Tunneling, AER, 90: 22–27.

13. D. Dalton, C. Daily, A. Ellstrands, & J. Johnson, 1998, Meta-analytic reviews of board composition, leader- ship structure, and financial performance, SMJ, 19: 269–290; M. Kroll, B. Walters, & S. Le, 2007, The impact of board composition and top management team ownership structure on post-IPO performance in young entrepreneurial firms, AMJ, 50: 1198–1216; M. W. Peng, T. Buck, & I. Filatotchev, 2003, Do out- side directors and new managers help improve firm performance? JWB, 38: 348–360.

14. D. Erkins, M. Hung, & P. Matos, 2012, Corporate governance in the 2007–2008 financial crisis, working paper, University of Southern California.

15. V. Chen, J. Li, & D. Shapiro, 2011, Are OECD- prescribed “good corporate practices” really good in an emerging economy? APJM, 28: 115–138; M. W. Peng, S. Zhang, & X. Li, 2007, CEO duality and firm performance during China’s institutional transitions, MOR, 3: 205–225.

16. Economist, 2012, The shackled boss, January 21: 76. 17. M. Geletkanycz & B. Boyd, 2011, CEO outside direc-

torships and firm performance, AMJ, 54: 335–352. 18. K. Au, M. W. Peng, & D. Wang, 2000, Interlocking

directorates, firm strategies, and performance in Hong Kong (p. 32), APJM, 17: 29–47.

19. J. Tang, M. Crossan, & W. G. Rowe, 2011, Dominant CEO, deviant strategy, and extreme performance, JMS, 48: 1479–1502; J. Westphal & I. Stern, 2007, Flattery will get you everywhere, AMJ, 50: 267–288.

20. A. Gore, S. Matsunaga, & P. E. Yeung, 2011, The role of technical expertise in firm governance structure, SMJ, 32: 771–786; M. Kroll, B. Walters, & P. Wright, 2008, Board vigilance, director experience, and corpo- rate outcomes, SMJ, 29: 363–382; M. McDonald, J. Westphal, & M. Graebner, 2008, What do they know? SMJ, 29: 1155–1177.

21. M. W. Peng, 2004, Outside directors and firm perfor- mance during institutional transitions, SMJ, 25: 453–471.

22. A. Chizema & J. Kim, 2010, Outside directors on Korean boards, JMS, 47: 109–129.

23. R. Adams, A. Licht, & L. Sagiv, 2011, Shareholders and stakeholders, SMJ, 32: 1331–1355; S. Graffin, M. Carpenter, & S. Boivie, 2011, What’s all that (strategic) noise? SMJ, 32: 748–770.

24. C. Devers, R. Wiseman, & R. M. Holmes, 2007, The effects of endowment and loss aversion in managerial stock option valuation, AMJ, 50: 191–208; M. Gora- nova, T. Alessandri, P. Brandes, & R. Dharwadkar, 2007, Managerial ownership and corporate diversifi- cation, SMJ, 28: 211–225; W. G. Sanders & A. Tuschke, 2007, The adoption of institutionally con- tested organizational practices, AMJ, 50: 33–56.

25. C. Cadsby, F. Song, & F. Tapon, 2007, Sorting and incentive effects of pay for performance, AMJ, 50: 387–405; T. Cho & W. Shen, 2007, Changes in execu- tive compensation following an environmental shift, SMJ, 28: 747–754; M. Larraza-Kintana, R. Wiseman, L. Gomez-Mejia, & T. Welbourne, 2007, Disentan- gling compensation and employment risks using the behavioral agency model, SMJ, 28: 1001–1019.

26. L. Bebchuk & J. Fried, 2004, Pay without Performance, Cambridge, MA: Harvard University Press; J. Wade, J. Porac, T. Pollock, & S. Graffin, 2006, The burden of celebrity, AMJ, 49: 643–660; X. Zhang, K. Bartol, K. Smith, M. Pfarrer, & D. Khanin, 2008, CEOs on the edge, AMJ, 51: 241–258.

27. A. Cowen & J. Marcel, 2011, Damaged goods, AMJ, 54: 509–527; M. Wiersema & Y. Zhang, 2011, CEO dismissal, SMJ, 32: 1161–1182.

28. Economist, 2012, The shackled boss, January 21: 76. 29. R. Hoskisson, M. Castleton, & M. Withers, 2009,

Complementarity in monitoring and bonding, AMP, May: 57–74.

356 PART 3 CORPORATE-LEVEL STRATEGIES

30. V. Bodolica & M. Spraggon, 2009, The implementa- tion of special attributes of CEO compensation con- tracts around M&A transactions, SMJ, 30: 985–1011; N. Hiller & D. Hambrick, 2007, Conceptualizing executive hubris, SMJ, 26: 297–319; R. Masulis, C. Wang, & F. Xie, 2007, Corporate governance and acquirer returns, JF, 62: 1851–1889.

31. M. Nakamura, 2011, Adoption and policy implica- tions of Japan’s new corporate governance practices after the reform, APJM, 28: 187–213; T. Yoshikawa & J. McGuire, 2008, Change and continuity in Japanese corporate governance, APJM, 25: 5–24.

32. S. Kaplan & P. Stromberg, 2009, Leveraged buyouts and private equity, JEP, 23: 147–166; L. Phalippou, 2009, Beware of venturing into private equity, JEP, 23: 147–166; P. Phan & C. Hill, 1995, Organizational restructuring and economic performance in leveraged buyouts, AMJ, 38: 704–739.

33. J. Lerner, P. Stromberg, & M. Sorensen, 2008, Private equity and long-run investment, in J. Lerner & A. Gurung (eds.), The Global Economic Impact of Private Equity Report 2008 (pp. 27–42), Geneva, Switzerland: World Economic Forum.

34. R. Aguilera, I. Filatotchev, H. Gospel, & G. Jackson, 2008, An organizational approach to comparative cor- porate governance, OSc, 19: 475–492; B. Boyd, K. Haynes, & F. Zona, 2011, Dimensions of CEO-board relations, JMS, 48: 1892–1923; G. Dowell, M. Shackell, & N. Stuart, 2011, Boards, CEOs, and surviving a financial crisis, SMJ, 32: 1025–1045; B. Hermalin, 2005, Trends in corporate governance, JF, 60: 2351–2384.

35. D. McCarthy & S. Puffer, 2008, Interpreting the ethi- cality of corporate governance decisions in Russia, AMR, 33: 11–31.

36. A. Henderson, D. Miller, & D. Hambrick, 2006, How quickly do CEOs become obsolete? SMJ, 27: 447–460.

37. Y. Kor & V. Misangyi, 2008, Outside directors’ industry-specific experience and firms’ liability of foreignness, SMJ, 29: 1345–1355.

38. M. Li & R. Simerly, 1998, The moderating effect of environmental dynamism on the ownership- performance relationship, SMJ, 19: 169–179.

39. S. Kaplan, 2008, Cognition, capabilities, and incen- tives, AMJ, 51: 672–695; J. Tian, J. Haleblian, & N. Rajagopalan, 2011, The effects of board human and social capital on investor reactions to new CEO selection, SMJ, 32: 731–747; J. Westphal & M. Clement, 2008, Sociopolitical dynamics in relations between top managers and security analysts, AMJ, 51: 873–897.

40. A. Alexiev, J. Jansen, F. Van den Bosch, & H. Volberda, 2010, Top management team advice seeking and exploratory innovation, JMS, 47: 1343–1364.

41. C. Doidge, A. Karolyi, & R. Stulz, 2004, Why are foreign firms listed in the US worth more? JFE, 71: 205–238.

42. A. Karolyi, 2010, Corporate governance, agency problems, and international cross-listings, working paper, Cornell University.

43. C. Doidge, A. Karolyi, & R. Stulz, 2009, Has New York become less competitive than London in global markets? JFE, 91: 253–277; N. Fernandes, U. Lel, & D. Miller, 2010, Escape from New York, JFE, 95: 129–147.

44. S. Boivie, D. Lange, M. McDonald, & J. Westphal, 2011, Me or we, AMJ, 54: 551–576; J. He & Z. Huang, 2011, Board informal hierarchy and firm financial performance, AMJ, 54: 1119–1139; A. Mackey, 2008, The effect of CEOs on firm performance, SMJ, 29: 1357–1367; S. Nadkarni & P. Herrmann, 2010, CEO personality, strategic flexibility, and firm performance, AMJ, 53: 1050–1073; A. Raes, M. Heijltjes, U. Glunk, & R. Roe, 2011, The interface of the top management team and middle managers, AMR, 36: 102–126; Z. Simsek, 2007, CEO tenure and organizational perfor- mance, SMJ, 28: 653–662; C. Tuggle, K. Schnatterly, & R. Johnson, 2010, Attention patterns in the board- room, AMJ, 53: 550–571; Y. Zhang & M. Wiersema, 2009, Stock market reaction to CEO certification, SMJ, 30: 693–710.

45. A. Bris & C. Cabolis, 2008, The value of investor protection, RFS, 21: 605–648; C. Doidge, A. Karolyi, & R. Stulz, 2007, Why do countries matter so much for corporate governance? JFE, 86: 1–39.

46. T. Buck & A. Shahrim, 2005, The translation of cor- porate governance changes across national cultures, JIBS, 36: 42–61.

47. G. Davis, 2009, The rise and fall of finance and the end of the society of organizations, AMP, August: 27–44.

48. S. Estrin & M. Prevezer, 2011, The role of informal institutions in corporate governance, APJM, 28: 41–67.

49. P. David, T. Yoshikawa, M. Chari, & A. Rasheed, 2006, Strategic investments in Japanese corporations, SMJ, 27: 591–600.

50. R. Aguilera & A. Cuervo-Cazurra, 2009, Codes of good governance, CG, 17: 376–387; I. Haxhi & H. van Ees, 2010, Explaining diversity in the world- wide diffusion of codes of good governance, JIBS, 41: 710–726.

C h a p t e r 1 1 G o v e r n i n g t h e C o r p o r a t i o n A r o u n d t h e W o r l d 357

51. L. Donaldson, 1995, American Anti-management The- ories of Management, Cambridge, UK: Cambridge University Press.

52. M. Lubatkin, P. Lane, S. Collin, & P. Very, 2005, Origins of corporate governance in the USA, Sweden, and France, OSt, 26: 867–888; Y. Shi, M. Magnan, & J. Kim, 2012, Do countries matter for voluntary disclosure? JIBS, 43: 143–165.

53. M. van Essen, J. van Oosterhout, & P. Heugens, 2012, Competition and cooperation in corporate govern- ance, OSc (in press).

54. J. Siegel, 2003, Can foreign firms bond themselves effectively by renting US securities laws? JFE, 75: 319–359.

55. A. Chizema & Y. Shinozawa, 2012, The “company with committees,” JMS, 49: 77–101; C. Crossland & D. Hambrick, 2007, How national systems differ in their constraints on corporate executives, SMJ, 28: 767–789; T. Khanna, J. Kogan, & K. Palepu, 2006, Globalization and similarities in corporate governance, RES, 88: 69–90; C. Kwok & S. Tadesse, 2006, National culture and financial systems, JIBS, 37: 227–247.

56. State ownership is also often referred to as “public ownership.” However, since a lot of privately owned firms are publicly listed and traded (which can cause confusion), I have decided to use “state ownership” here to minimize confusion.

57. P. Bernstein, 2009, The moral hazard economy, HBR, July–August: 101–102.

58. Economist, 2012, The rise of state capitalism, January 21: 11.

59. Y. Jiang & M. W. Peng, 2011, Principal-principal conflicts during crisis, APJM, 28: 683–695.

60. T. Khanna & K. Palepu, 2004, Globalization and convergence in corporate governance, JIBS, 35: 484–507.

61. R. G. Bell, I. Filatotchev, & A. Rasheed, 2012, The liability of foreignness in capital markets, JIBS, 43: 107–122; L. Capron & M. Guillen, 2009, National corporate governance institutions and post-acquisition target reorganization, SMJ, 30: 803–833; J. Kang & J. Kim, 2010, Do foreign investors exhibit a corporate governance disadvantage? JIBS, 41: 1415–1438; A. Pe’er & O. Gottschalg, 2011, Red and blue, SMJ, 32: 1356–1367; H. Zou & M. Adams, 2008, Corporate ownership, equity risk, and returns in the People’s Republic of China, JIBS, 39: 1149–1168.

62. BW, 2011, After much hoopla, investor “say on pay” is a bust, June 20: 23–24.

63. O. Gottschalg & M. Zollo, 2007, Interest alignment and competitive advantage, AMR, 32: 418–437; J. Ho, A. Wu, & S. Xu, 2011, Corporate governance and returns on information technology investment, SMJ, 32: 595–623.

358 PART 3 CORPORATE-LEVEL STRATEGIES

CHAPTER12

STRATEGIZING WITH CORPORATE SOCIAL RESPONSIBILITY

KNOWLEDGE OBJECT IVES

After studying this chapter, you should be able to

1. Articulate what a stakeholder view of the firm is

2. Develop a comprehensive model of corporate social responsibility

3. Participate in three leading debates concerning corporate social responsibility

4. Draw strategic implications for action

ot o/ A le xe y St io p

360 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

OPENING CASE

Launching the Nissan Leaf: The World’s First Electric Car

An electric car that does not burn a single drop of gasoline— technically called an “electric vehicle” (EV)—is the “dream car” of many environmentalists. Known as a “plug-in” vehicle, an EV is totally based on battery power, has no tailpipe, and thus has zero emission. It would be more revolutionary than Toyota’s hybrid Prius, which drives on battery power before its gasoline engine kicks in and recharges the battery.

The million-dollar question is: Are car buyers ready for the EV? The environmental benefits are clear, yet the tech- nological, social, psychological, and economic forces work- ing against the EV are formidable. Technologically, the most advanced EV can only run between 60 and 100 miles (between 96 and 160 kilometers) per charge. It takes about seven hours to fully charge. The EV is clearly not as con- venient as the conventional car. Socially, the EV, like the Prius, may be a hit in a niche market, but it is questionable whether the EV can penetrate the mainstream. Psychologi- cally, since public charging stations are few and far between (and nonexistent in many communities), drivers will experi- ence “range anxiety”—will the EV run out of battery before it reaches the next charging station? Finally, the economics of the EV is not too enticing. Hybrids such as the Prius cost about $4,000 more than a comparable conventional car. The EV is likely to cost $10,000 to $20,000 more. Owners preferably will also need a special charger installed at home, which would cost another $2,000. Simply plugging into the standard household power outlet is advised for emergency charging only; the local utility circuit may collapse if so much electricity is suddenly sucked out by an EV.

Against such significant odds, Nissan in December 2010 launched a mid-size five-door hatchback, the Leaf, which is the world’s first mass-produced EV. The world’s very first customer, in San Francisco, drove home the Leaf on December 11, 2010. The first delivery in Japan took place at Kanagawa Prefecture on December 22, 2010. Portugal, Ireland, and the UK are the first European markets the Leaf entered. While Americans may be shocked by the $32,780 list price, the Leaf in the United States is the least expensive globally (see Table 12.1). Elsewhere, the EV costs between

$44,600 to $49,800 (!). Even adding all the incentives dished out by governments, the Leaf is still not a cheap car. So what did Nissan do to prepare the launch of this pioneering car?

At least three areas of Nissan’s preparation stand out. First, from an institution-based view, Nissan has a sharp awareness of the emerging regulatory requirements that would necessitate the EV. While the car industry fought the tightening of emission standards for years, the 2007 Energy Independence and Security Act raised fuel econ- omy averages of all cars made by any single automaker to 35 miles per gallon by 2020, a 40% improvement over current levels. Instead of shying away from the EV, having a zero-emission car like the Leaf has become a smart way to balance out the fuel-thirsty gas guzzlers such as SUVs. All of a sudden, most automakers are rushing to develop the EV, but none—not even Prius’ maker, Toyota—can beat Nissan in the race to introduce the first EV.

Second, from a resource-based view, Nissan has accu- mulated significant capabilities in the crucial lithium-ion

TABLE 12.1 The Nissan Leaf’s Prices and Launch Times in the First Five Markets

LIST PRICE (US$)

NET PRICE AFTER INCENTIVES (US$)

MARKET LAUNCH

United States

$32,780 $25,000 December 2010

Japan $44,600 $35,500 December 2010

Portugal $45,500 $39,325 January 2011

Ireland $45,100 $39,000 February 2011

United Kingdom

$49,800 $38,400 March 2011

ga ge

Le ar ni ng

361 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

battery technology. As early as in 1997, it introduced its first prototype EV. In 1999, when Renault took over Nissan and Carlos Ghosn became in charge, Nissan was dangerously close to bankruptcy. In the gut-wrenching restructuring initiated by Ghosn, 60% of the R&D pro- jects were slashed. Yet, the costly and uncertain battery project was kept and nurtured, which ultimately led to the Leaf.

Third, to ensure a successful launch, Nissan embraced a stakeholder approach by meticulously working with a vari- ety of stakeholders, such as government officials, utilities, activists, and customers, in highly innovative ways. In 2008, Nissan set up a Zero Emission Mobility Team, whose members were not only executives from sales and market- ing, but also from government affairs, product planning, and communications. In the United States, the team focused on seven environmentally progressive states: Ari- zona, California, Hawaii, Oregon, Tennessee, Texas, and Washington (state). By limiting the launch to just seven states, Nissan can achieve a critical mass of charging sta- tions. The team visited government officials to urge them to offer more incentives to buyers and utilities to encou- rage them to install public charging stations, and worked to streamline the permitting and installation process for home chargers. The team also called on the utilities to get ready and made presentations at utility conferences, which was something automakers had never done before. The Nissan team also reached out to activists. It invited a total of 1,400 people in 307 cities in 27 states to participate in focus group meetings. Leading activists were invited to Yokohama, Japan, where the Leaf was being built, to test drive the EV.

The moment of truth came in April 2010, when Nissan invited interested buyers to pre-order by putting down a refundable $99 fee. Within the first 24 hours, Nissan received 6,000 (!) reservations. By September, Nissan no longer accepted any more reservations for the remainder of 2010. Customers had to wait four to seven months. It seemed that Nissan would have no problem selling the first 50,000 Leafs produced in its Yokohama factory. Production will ramp up, involving its Smyrna, Tennessee, plant in 2012 and its Sunder- land, UK, plant in 2013.

Officially ranked as the most fuel efficient vehicle (99 miles per gallon gasoline equivalent) in the United States, the Leaf costs about 2 cents per mile to drive, far more economical than the 13 cents per mile for an average conventional car. While the Chevy Volt and the Toyota Prius Plug-In will enter the foray soon, they remain hybrids. As the only full EV, the Leaf has enjoyed a great deal of attention and grabbed numerous awards, such as the 2010 Green Car Vision Award, 2011 European Car of the Year, 2011 World Car of the Year, 2011 Eco-Friendly Car of the Year, and 2012 Car of the Year Japan. While the Leaf earns a lot of kudos for its contributions to a cleaner envi- ronment, from a competitive standpoint, Nissan is especially pleased that so much of the “green car” conversation now revolves around the Leaf, instead of the Prius.

Sources: Based on (1) Bloomberg Businessweek, 2011, Charged for battle, January 3: 49–56; (2) Bloomberg Businessweek, 2010, Green cars still need training wheels, December 6: 37–38; (3) Economist, 2012, The World in 2012 (p. 134), London: The Economist Newspaper Group; (4) www. 2011nissanleaf.net; (5) www.nissanusa.com.

(Continued)

OPENING CASE

M ap

Re so ur ce s

362 PART 3 CORPORATE-LEVEL STRATEGIES

Why is an EV the “dream car” for many environmentalists? Why domany automakers not bother to offer it? Why does Nissan, the first firmthat has mass-produced an EV, earn so many kudos? The simple answer is that Nissan’s decision to take the risk to develop the first EV is indicative of Nissan’s interest in corporate social responsibility (CSR), which refers to “con- sideration of, and response to, issues beyond the narrow economic, technical, and legal requirements of the firm to accomplish social benefits along with the traditional economic gains which the firm seeks.”1 Historically, CSR issues have been on the back burner for many managers, but these issues are increasingly being brought to the forefront of corporate agendas. While this chapter is positioned as the last in this book, by no means do we suggest that CSR is the least important topic. Instead, we believe that this chapter is one of the best ways to integrate previous chapters drawing on the strategy tripod.2 The comprehensive nature of CSR is evident in our Opening Case.

At the heart of CSR is the concept of stakeholder, which is “any group or individual who can affect or is affected by the achievement of the organization’s objectives.”3 Shown in Figure 12.1, while shareholders certainly are an important group of stakeholders, other stakeholders include managers, non-managerial employ- ees (hereafter “employees”), suppliers, customers, communities, governments, and social and environmental groups. Since Chapter 11 has already dealt with share- holders at length, this chapter focuses on non-shareholder stakeholders, which we term

FIGURE 12.1 A Stakeholder View of the Firm

THE FIRM Managers

Employees

Shareholders

Customers

Social groupsGovernments

Communities

Suppliers

Environmental groups

Source: Adapted from T. Donaldson & L. Preston, 1995, The stakeholder theory of the corporation: Concepts, evidence, and implications (p. 69), Academy of Management Review, 20: 65–91.

corporate social responsibility (CSR)

The social responsibility of corporations. It pertains to consideration of, and response to, issues beyond the narrow economic, technical, and legal requirements of the firm to accomplish social benefits along with the traditional economic gains that the firm seeks.

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“stakeholders” here for compositional simplicity. A leading debate on CSR is whether managers’ efforts to promote the interests of these stakeholders are at odds with their fiduciary duty (required by law) to safeguard shareholder interests.4 To the extent that firms are not social agencies and that their primary function is to serve as economic enterprises, it is certainly true that firms should not (and are unable to) take on all the social problems of the world. Yet on the other hand, failing to heed to certain CSR imperatives may be self-defeating in the long run. Therefore, the key is how to strategize with CSR.

The remainder of this chapter introduces a stakeholder view of the firm and discusses a comprehensive model of CSR drawn from the strategy tripod. Debates and extensions then follow.

A Stakeholder View of the Firm A Big Picture Perspective A stakeholder view of the firm, with a quest for global sustainability, represents a “big picture.” A key goal for CSR is global sustainability, which is defined as the ability “to meet the needs of the present without compromising the ability of future generations to meet their needs.”5 It not only refers to a sustainable social and natural environment, but also sustainable capitalism (see the Closing Case).6 Globally, at least three sets of drivers are related to the urgency of sustainability:

• Rising levels of population, poverty, and inequity associated with globalization call for new solutions. The repeated protests staged around the world are but tips of an iceberg of such sentiments.

• Compared with the relatively eroded power of national governments in the wake of globalization, nongovernmental organizations (NGOs) and other civil society stakeholders have increasingly assumed the role of monitor and in some cases enforcer of social and environmental standards.7

• Industrialization has created irreversible effects on the environment.8 Global warming, pollution, soil erosion, and deforestation have become problems demanding solutions.9

Drivers underpinning global sustainability are complex and multidimensional. For multinational enterprises (MNEs) with operations spanning the globe, their CSR areas seem mind-boggling. This bewilderingly complex “big picture” forces managers to prioritize.10 To be able to do that, primary and secondary stakeholders must be identified.

Primary and Secondary Stakeholder Groups Primary stakeholder groups are constituents the firm relies on for its continuous survival and prosperity. Shareholders, managers, employees, suppliers, customers—together with governments and communities whose laws and regulations must be obeyed and to whom taxes and other obligations may be due—are typically considered primary stakeholders.

global sustainability

The ability to meet the needs of the present with- out compromising the abil- ity of future generations to meet their needs.

primary stakeholder groups

Constituents on which the firm relies for its continu- ous survival and prosperity.

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Secondary stakeholder groups are defined as “those who influence or affect, or are influenced or affected by, the corporation, but they are not engaged in transactions with the corporation and are not essential for its survival.”11 Environmental groups (such as Greenpeace) often take it upon themselves to fight pollution. Fair labor practice groups (such as Fair Labor Association) frequently challenge firms that allegedly fail to provide decent labor conditions for employees. While the firm does not depend on secondary stakeholder groups for its survival, such groups may have the potential to cause significant embarrassment and damage—think of Nike in the 1990s.

A key proposition of the stakeholder view of the firm is that instead of only pursuing the economic bottom line, such as profits and shareholder returns, firms should pursue a more balanced set, called the triple bottom line. First introduced in Chapter 1, the triple bottom line consists of economic, social, and environmental performance.12 To the extent that some competing demands obviously exist, it seems evident that the CSR proposition represents a dilemma. In fact, it has provoked a fundamental debate, which is introduced next.

A Fundamental Debate The CSR debate centers on the nature of the firm in society. Why does the firm exist? Most people would intuitively answer: “To make money.” Milton Friedman, a former University of Chicago economist and Nobel laureate, eloquently argued: “The business of business is business.”13 The idea that the firm is an economic enterprise seems uncontroversial. At issue is whether the firm is only an economic enterprise. Although Friedman passed away in 2006, his ideas continue to be influential.14

One side of the debate argues that “the social responsibility of business is to increase its profits,” which is the title of Friedman’s influential article mentioned earlier that was published in 1970. This free market school of thought draws upon Adam Smith’s idea that pursuit of economic self-interest (within legal and ethical bounds) leads to efficient markets. Free market advocates believe that the first and foremost stakeholder group is shareholders, whose interests managers have a fiduciary duty to look after. To the extent that the hallmark of our economic system remains capitalism, the providers of capital— namely, capitalists or shareholders—deserve a commanding height in managerial atten- tion. Since the 1980s, a term that explicitly places shareholders as the single most important stakeholder group, shareholder capitalism, has become increasingly influential around the world (see Chapter 11).

Free market advocates argue that if firms attempt to attain social goals, such as providing employment and social welfare, managers will lose their focus on profit maximization (and its derivative, shareholder value maximization). Consequently, firms may lose their char- acter as capitalistic enterprises and become socialist organizations. This perception of socialist organization is not a pure argumentative point, but an accurate characterization of numerous state-owned enterprises (SOEs) throughout the pre-reform Soviet Union, Central and Eastern Europe, and China, as well as other developing countries in Africa, Asia, and Latin America. Privatization, in essence, is to remove the social function of these firms and restore their economic focus through private ownership (see Chapter 11). Overall, the free market school is influential around the world. It has also provided much of the intellectual underpinning for globalization spearheaded by MNEs.

secondary stakeholder groups

Stakeholders who influence or affect, or are influenced or affected by, the cor- poration, but they are not engaged in transactions with the corporation and are not essential for its survival.

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It is against such a formidable and influential school of thought that the CSR move- ment has emerged. CSR advocates argue that a free market system that takes the pursuit of self-interest and profit as its guiding light—although in theory constrained by rules, contracts, and property rights—may in practice fail to constrain itself, thus often breeding greed, excesses, and abuses. Firms and managers, if left to their own devices, may choose self-interest over public interest. The financial meltdown in 2008–2009 is often fingered as a case in point. While not denying that shareholders are important stakeholders, CSR advocates argue that all stakeholders have an equal right to bargain for a “fair deal.” Given stakeholders’ often conflicting demands, the very purpose of the firm, instead of being a profit-maximizing entity, is argued to serve as a vehicle for coordinating their interests. Of course, a very thorny issue in the debate is whether all stakeholders indeed have an equal right and how to manage their (sometimes inevitable) conflicts.15

Starting in the 1970s as a peripheral voice in an ocean of free market believers, the CSR school of thought has slowly but surely made progress in becoming a more central part of strategy discussions.16 Strategy guru Michael Porter has been vehemently advocating the importance of creating shared value, “which involves creating economic value in a way that also creates value for society by addressing its needs and challenges” (see Strategy in Action 12.1). The CSR school has two driving forces. First, even as free markets march around the world, the gap between the haves and have-nots has widened. Although many emerging economies have been growing by leaps and bounds, the per capita income gap between developed economies and much of the developing world has widened.17 While 2% of the world’s children living in America enjoy 50% of the world’s toys, one-quarter of the children in Bangladesh and Nigeria are in their countries’ work force. Even within developed economies such as the United States, the income gap between the upper and lower echelons of society has widened. In 1980, the average American CEO was paid 40 times more than the average worker. The ratio is now above 400. Although American society accepts a greater income inequality than many others do, aggregate data of such widening inequality, which both inform and numb, often serve as a stimulus for reforming the “leaner and meaner” capitalism. Participants in the Occupy Wall Street movement in 2011 argued that the 1% have gained at the expense of the 99%.18 However, the response from free market advocates is that to the extent there is competition, there will always be both winners and losers. What CSR critics describe as “greed” is often translated as “incentive” in the vocabulary of free market advocates.

A second reason behind the rise of the CSR movement seems to be waves of disasters and scandals.19 In 1989, the oil tanker Exxon Valdez spilled a tanker-load of oil in the pristine waters of Alaska. In 2002, scandals of Enron, WorldCom, Royal Ahold, and Parmalat rocked the world. In 2009, excessive amounts of Wall Street bonuses distributed by financial services firms receiving government bailout funds were criticized of being socially insensitive and irresponsible. In 2010, BP made a huge mess in the Gulf of Mexico. In 2011, a Japanese earthquake triggered the meltdown of the Fukushima nuclear power station. Not surprisingly, new disasters and scandals often propel CSR to the forefront of public policy and management discussions.

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E T H I C A L D I L E M M ASTRATEGY IN ACTION 12.1

Michael Porter on Creating Shared Value

The capitalist system is under siege. In recent years business increasingly has been viewed as a major cause of social, environmental, and economic problems. Companies are widely perceived to be prospering at the expense of the broader community.

Even worse, the more business has begun to embrace CSR, the more it has been blamed for society’s failures. The legitimacy of business has fallen to levels not seen in recent history. This diminished trust in business leads political leaders to set policies that undermine competitiveness and sap economic growth. Business is caught in a vicious circle.

A big part of the problem lies with companies themselves, which remain trapped in an outdated approach to value creation that has emerged over the past few decades. They continue to view value creation narrowly, optimizing short-term financial performance in a bubble while missing the most important customer needs and ignoring the broader influences that determine their long-term success. How else could companies overlook the well-being of customers, the depletion of natural resources vital to their businesses, the viability of key suppliers, or the economic distress of the communities in which they produce and sell? How else could companies think that simply shifting activities to locations with even lower wages was a sustainable “solution” to competitive challenge? Government and civil society have often exacerbated the problem by attempting to address social weaknesses at the expense of business. The presumed trade-offs between economic efficiency and social progress have been institutionalized in decades of policy choices.

Companies must take the lead in bringing business and society back together. The recognition is there among sophisticated business and thought leaders, and promising elements of a new model are emerging. Yet we still lack an overall framework for guiding these efforts, and most companies remain stuck in a “CSR”

mind-set in which societal issues are at the periphery, not the core.

The solution lies in the principles of shared value, which involves creating economic value in a way that also creates value for society by addressing its needs and challenges. Businesses must reconnect company success with social progress. Shared value is not CSR, philanthropy, or even sustainability, but a new way to achieve economic success. It is not on the margin of what companies do but at the center. We believe that it can give rise to the next major transformation of business thinking.

A growing number of companies known for their hard-nosed approach to business—such as GE, Google, IBM, Intel, Johnson & Johnson, Nestlé, Unilever, and Wal-Mart—have already embarked on important efforts to create shared value by reconceiving the intersection between society and corporate performance. Yet our recognition of the transformative power of shared value is still in its genesis. Realizing it will require leaders and managers to develop new skills and knowledge—such as a far deeper appreciation of societal needs, a greater understanding of the true bases of company productivity, and the ability to collaborate across profit/nonprofit boundaries. Government must learn how to regulate in ways that enable shared value rather than work against it.

Capitalism is an unparalleled vehicle for meeting human needs, improving efficiency, creating jobs, and building wealth. But a narrow conception of capitalism has prevented business from harnessing its full potential to meet society’s broader challenges. The opportunities have been there all along but have been overlooked. Businesses acting as businesses, not as charitable donors, are the most powerful force for addressing the pressing issues we face. The moment for a new conception of capitalism is now; society’s needs are large and growing, while customers, employees, and a new generation of young people are asking business to step up.

The purpose of the corporation must be redefined as creating shared value, not just profit per se. This

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Overall, managers as a stakeholder group are unique in that they are the only group that is positioned at the center of all these relationships.20 It is important to understand how they make decisions concerning CSR, as illustrated next.

A Comprehensive Model of Corporate Social Responsibility While some people do not view CSR as an integral part of strategy, a comprehensive model of CSR drawn from the strategy tripod (Figure 12.2) shows that the three tradi- tional perspectives on strategy can shed considerable light on CSR with relatively little adaptation and extension. This section articulates why this is the case.

Industry-Based Considerations The industry-based view, exemplified by the five forces framework, can be extended to help understand the emerging competition on CSR.

RIVALRY AMONG COMPETITORS. The more concentrated an industry is, the more likely competitors will recognize their mutual interdependence based on old ways of doing business that are not up to the higher CSR standards (see Chapter 8). Under such circumstances, it is easier for incumbents to resist CSR pressures. For example, when facing mounting pressures to reduce emission levels, the automobile industry lobbied politicians, challenged the science of global climatic change, and pointed to the high costs of reducing emissions—until some first-mover firms deviated from such norms in order to score competitive points with game-changing new products such as the Nissan Leaf (see the Opening Case).

THREAT OF POTENTIAL ENTRY. How can incumbents raise entry barriers to deter potential entrants? Experience accumulated from being first movers in pollution control technologies can create entry barriers that favor incumbents. The two major types of pollution control technologies have their differences. The first is for more proactive pollution prevention. Like defects, pollution typically reveals flaws in product design or production. Pollution prevention technologies reduce or eliminate pollutants by using cleaner alternatives, often resulting in superior products (such as the Nissan Leaf in the Opening Case). The second pollution control area is more reactive, “end-of-pipe” pollution reduction, often added as a final step to capture pollutants prior to their

will drive the next wave of innovation and pro- ductivity growth in the global economy. It will also reshape capitalism and its relationship to society. Perhaps most important of all, learning how to create shared value is our best chance to legitimate business again.

Source: Excerpts from M. E. Porter & M. R. Kramer, 2011, Creating shared value, Harvard Business Review, January– February: 62–77. Michael Porter is a professor at Harvard Business School, and Mark Kramer is managing director of FSG, a global social impact consulting firm that he co- founded with Porter.

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discharge. Their effectiveness is not equal. The technologies likely to give incumbents the most effective entry barrier are in the area of proactive pollution prevention.

BARGAINING POWER OF SUPPLIERS. If socially and environmentally conscious suppliers provide unique differentiated products with few or no substitutes, their bargaining power is likely to be substantial. For example, Coca-Cola is the sole provider of Coke syrup to its bottlers around the world, most of which are independently owned by franchisees. Coca-Cola is thus able to assert its bargaining power by requiring that all its bottlers certify that their social and environmental practices are responsible. Coca-Cola also encourages its bottlers to support social programs, such as financing start-up kiosks in South Africa and Vietnam, donating free drinks to earthquake victims in China and Japan, and promoting reading among school children in 42 countries, including the United States.

BARGAINING POWER OF BUYERS. By leveraging their bargaining power, individual and corporate buyers interested in CSR may extract substantial concessions from the focal

FIGURE 12.2 A Comprehensive Model of Corporate Social Responsibility

Industry-based considerations

• Rivalry among competitors • Threat of potential entry • Bargaining power of suppliers • Bargaining power of buyers • Threat of substitutes

Resource-based considerations

• Value • Rarity • Imitability • Organizational capabilities

Institution-based considerations

• Reactive strategy • Defensive strategy • Accommodative strategy • Proactive strategy

Scale and scope of corporate social

responsibility activities

ga ge

Le ar ni ng

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firm. An example of the power of individual consumers is the controversy regarding Shell’s 1995 decision to sink an oil platform in the North Sea. It led to strong protests organized by Greenpeace in Germany, which caused an 11% drop in Shell gas station sales in one month. Such pressures forced Shell to reverse its decision and dismantle the oil platform on shore at great cost.

An example of how corporate buyers extract concessions is the recent efforts made by Nike, which acted in response to criticisms for its failure to eradicate “sweatshops” throughout its supply chain. Although Nike does not own its supplier factories, Nike is able to enact a worldwide monitoring program for all supplier factories, using both internal and third-party auditors. For “clean” contractors that have never engaged in “sweatshop” practices, this simply adds a ton of work such as documentation and hosting of auditors as well as extra costs. For “sweatshop” operators, this requires some fundamental and costly change to the way they do business. Not surprisingly both groups initially resisted Nike’s efforts. Nevertheless, Nike has been able to “just do it” by throwing its weight around.

Finally, buyers can increase bargaining power when they are in great difficulties. Dying HIV/AIDS patients in Africa, Asia, and Latin America, backed by their governments and CSR groups, often demand that pharmaceutical firms headquartered in rich developed economies (1) donate free drugs, (2) lower drug prices, and (3) release patents to allow for local manufacturing of cheaper generic versions of the same drugs. While pharmaceutical firms have resisted these attempts, they may eventually give in.

THREAT OF SUBSTITUTES. If substitutes are superior to existing products and costs are reasonable, they may attract more customers. For example, wind power, which is much more environmentally friendly than fossil-fuel sources of power (such as oil and coal) and safer than nuclear power, may have great potential. It is true that at present, wind power requires heavy government subsidies in order to become commercially viable. However, its future is likely to be promising, given the increasing depletion of fossil fuel, the skyrocketing oil prices, and the growing awareness of the risks associated with conventional technologies (such as the risk of terrorism at nuclear power plants). Overall, the possible threat of substitutes requires firms to vigilantly scan the larger environment, instead of narrowly focusing on the focal industry.

TURNING THREATS TO OPPORTUNITIES. Taken together, the five forces framework suggests two lessons. First, it reinforces the important point that not all industries are equal in terms of their exposure to CSR challenges. Energy- and materials-intensive industries (such as chemicals) are more vulnerable to environmental scrutiny. Labor- intensive industries (such as apparel) are more likely to be challenged on fair labor practice grounds. However, despite varying degrees of exposure, no industry may be completely immune from CSR. Table 12.2 shows the widening list of industries challenged by environmentalists, one of the core CSR groups, over the past four decades.

Given the increasingly inescapable responsibility to be good corporate citizens, the second lesson is that industries and firms may want to selectively but proactively turn some of these threats into opportunities. For example, instead of treating NGOs as threats, Dow Chemical, Home Depot, Lowe’s, and Unilever work with them. Many managers

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TABLE 12.2 Industries Challenged by Environmentalists

1960s 1970s 1980s 1990s

Coal mining and pollution Detergents Mining Pesticides Water (dams)

Aerosols Airports Asbestos Automobiles Biotechnology Chemicals Coal mining and pollution Deep sea fishing Detergents Heavy trucks Metals Nuclear power Oil tankers Packaging Passenger jets Pesticides Pulp mills Tobacco Toxic waste Transport Water Whaling

Aerosols Agriculture Airports Animal testing Automobiles Biotechnology Chemicals Coal mining and pollution Computers Deep sea fishing Detergents Fertilizers Forestry Incineration Insurance Landfill Nuclear power Oil tankers Onshore oil and gas Packaging Paints Pesticides Plastics Pulp and paper Refrigeration Supermarkets Tobacco Toxic waste Tropical hardwoods Tuna fishing Water Whaling

Aerosols Agriculture Air conditioning Airlines and airports Animal testing Armaments Automobiles Banking Biotechnology Catering Chemicals Coal mining and pollution Computers Detergents Dry cleaning Electricity supply Electrical equipment Fashion Fertilizers Fish farming Fishing Forestry Incineration Insurance Landfill Meat processing Mining Motorways Nuclear power Office supplies Oil tankers Onshore oil and gas Packaging Paints Pesticides Plastics Property Pulp and paper Refrigeration Shipping Supermarkets Textiles Tobacco Tourism Toxic waste Transport Tropical hardwoods Tires Water

Sources: Adapted from J. Elkington, 1994, Towards the sustainable corporation: Win-win-win business strategies for sustainable development (p. 95), California Management Review, winter: 90–100.

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traditionally treat CSR as a nuisance, involving heavy regulation, added costs, and unwelcome liability. Such an attitude may underestimate strategic business opportunities associated with CSR. The most proactive managers and the companies they lead (such as Nissan in the Opening Case, Whole Foods in the Closing Case, and Dow Chemical in Emerging Markets 12.1) are far-sighted enough to embrace CSR challenges through selective but preemptive investments and sustained engagement—in essence, making their CSR activities a source of differentiation, as opposed to an additional item of cost.

Resource-Based Considerations CSR-related resources can include tangible technologies and processes as well as intangible skills and attitudes.21 The VRIO framework can shed considerable light on CSR.

VALUE. Do CSR-related resources and capabilities add value? This is the litmus test for CSR work (see Strategy in Action 12.1). Many large firms, especially MNEs, can apply their tremendous financial, technological, and human resources toward a variety of CSR causes. For example, firms can choose to appease environmental groups by purchasing energy only from power plants utilizing green sources, such as wind-generated power. Or firms can respond to human rights groups by not doing business in or with countries accused of human rights violations. These activities can be categorized as social issue participation, which refers to a firm’s participation in social causes not directly related to the management of its primary stakeholders. Research suggests that these activities may actually reduce shareholder value.22 Overall, although social issue participation may create some remote social and environmental value, it does not satisfy the economic leg of the triple bottom line, so these abilities do not qualify as value-adding firm resources.

RARITY. CSR-related resources are not always rare. Remember that even a valuable resource is not likely to provide a significant advantage if competitors also possess it. For example, both Home Depot and Lowe’s have NGOs such as the Forest Stewardship Council certify that suppliers in Brazil, Indonesia, and Malaysia use only material from renewable forests. These complex processes require strong management capabilities such as negotiating with local suppliers, undertaking internal verification, coordinating with NGOs for external verification, and disseminating such information to stakeholders. Such capabilities are valuable. But since both competitors possess capabilities to manage these processes, they are common (but not rare) resources.

IMITABILITY. Although valuable and rare resources may provide some competitive advantage, the advantage will only be temporary if competitors can imitate it. Resources must be not only valuable and rare but also hard to imitate in order to give firms a sustainable (not merely temporary) competitive advantage. At some firms, CSR-related capabilities are deeply embedded in idiosyncratic managerial and employee skills, attitudes, and interpretations. The socially complex way of channeling their energy and conviction toward CSR at Whole Foods, led by John Mackey, a guru on conscious capitalism, cannot be easily imitated (see the Closing Case).

social issue participation

Firms’ participation in social causes not directly related to managing pri- mary stakeholders.

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ORGANIZATION. Does the firm have organizational capabilities to do a good job on CSR? Is the firm organized to exploit the full potential of CSR? Numerous components within a firm, such as formal management control systems and informal relationships between managers and employees, may be relevant. These components are often called complementary assets (see Chapter 3), because, by themselves, they typically do not generate advantage. However, complementary assets, when combined with valuable, rare, and hard-to-imitate capabilities, may enable a firm to fully utilize its CSR potential.

For example, assume that Firm A is able to overcome the three hurdles mentioned above (V, R, I) by achieving a comprehensive understanding of some competitors’ best practices in pollution prevention. Although Firm A has every intention to implement such best practices, chances are that they may not work unless Firm A also possesses a number of complementary assets. Process-focused best practices of pollution prevention are not in isolation and are often difficult to separate from a firm’s other activities. These best practices require a number of complementary assets, such as a continuous emphasis on process innovation and a dedicated workforce. These complementary assets are not developed as part of new environmental strategies; rather, they are grown from more general business strategies, such as differentiation. If such complementary assets are already in place, they can be leveraged in the new pursuit of best environmental practices. Otherwise, single-minded imitation is not likely to be effective.

THE CSR-ECONOMIC PERFORMANCE PUZZLE. The resource-based view helps solve a major puzzle in the CSR debate: the CSR-economic performance puzzle. The puzzle—a source of frustration to CSR advocates—is why there is no conclusive evidence on a direct, positive link between CSR and economic performance such as profits and shareholder returns. Although some studies do indeed report a positive relationship,23 others find a negative relationship24 or no relationship.25 Viewed together, “CSR does not hurt [economic] performance, but there is no concrete support to believe that it leads to supranormal [economic] returns.”26 While there can be a number of explanations for this intriguing mess, a resource-based explanation suggests that because of the capability constraints discussed above, many firms are not cut out for a CSR-intensive (differentiation) strategy.27 Since all studies have some sampling bias (no study is perfect), studies that over-sample firms not yet ready for a high level of CSR activities are likely to report a negative relationship between CSR and economic performance. Likewise, studies that over-sample firms ready for CSR may find a positive relationship. Also, studies with more balanced (more random) samples may fail to find any statistically significant relationship. In summary, since each firm is different (a basic assumption of the resource- based view), not every firm’s economic performance is likely to benefit from CSR.

Institution-Based Considerations The institution-based view sheds considerable light on the gradual diffusion of the CSR movement and the strategic responses of firms.28 At the most fundamental level, regula- tory pressures underpin formal institutions, whereas normative and cognitive pressures support informal institutions.29 The strategic response framework consists of (1) reactive,

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(2) defensive, (3) accommodative, and (4) proactive strategies, as first introduced in Chapter 4 (see Table 4.5). This framework can be extended to explore how firms make CSR decisions, as illustrated in Table 12.3.

A reactive strategy is indicated by relatively little or no support by top management of CSR causes. Firms do not feel compelled to act in the absence of disasters and outcries. Even when problems arise, denial is usually the first line of defense. Put another way, the need to accept some CSR is neither internalized through cognitive beliefs nor does it result in any norms in practice. That leaves only formal regulatory pressures to compel firms to comply. For example, in the United States, food and drug safety standards that we take for granted today were fought by food and drug companies in the first half of the 20th century. The basic idea that food and drugs should be tested before being sold to customers and patients was bitterly contested even as unsafe foods and drugs killed thousands of people. As a result, the Food and Drug Administration (FDA) was progres- sively granted more powers. This era is not necessarily over. Today, many dietary supplement makers, whose products are beyond the FDA’s regulatory reach, continue to sell untested supplements and deny responsibility.

A defensive strategy focuses on regulatory compliance. Top management involvement is piecemeal at best, and the general attitude is that CSR is an added cost or nuisance. Firms admit responsibility but often fight it. After the establishment of the Environmental Protection Agency (EPA) in 1970, the US chemical industry resisted the EPA’s intrusion (see Table 12.3). The regulatory requirements were at significant odds with the norms and cognitive beliefs held by the industry at that time.

TABLE 12.3 The US Chemical Industry Responds to Environmental Pressures

PHASE STRATEGIC RESPONSE

REPRESENTATIVE STATEMENTS FROM THE INDUSTRY’S TRADE JOURNAL, CHEMICAL WEEK

1962–70 Reactive Denied the severity of environmental problems and argued that these problems could be solved independently through the industry’s technological prowess.

1971–82 Defensive “Congress seems determined to add one more regulation to the already 27 health and safety regulations we must answer to. This will make the EPA [Environmental Protection Agency] a chemical czar. No agency in a democracy should have that authority” (1975).

1983–88 Accommodative “The EPA has been criticized for going too slow … Still, we think that it is doing a good job” (1982). “Critics expect an overnight fix. The EPA deserves credit for its pace and accomplishments” (1982).

1989–present Proactive “Green line equals bottom line—The Clean Air Act (CAA) equals efficiency. Everything you hear about the ‘costs’ of complying with the CAA is probably wrong … Wiser competitors will rush to exploit the Green Revolution” (1990).

Sources: Extracted from text from A. Hoffman, 1999, Institutional evolution and change: Environmentalism and the US chemical industry, Academy of Management Journal, 42: 351–371. Hoffman’s last phase ended in 1993; its extension to the present is done by the present author.

reactive strategy

A strategy that is passive about corporate social responsibility. Firms do not act in the absence of dis- asters and outcries. When problems arise, denial is usually the first line of defense.

defensive strategy

A strategy that is defensive in nature. Firms admit responsibility, but often fight it.

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How do various institutional pressures change firm behavior? In the absence of informal normative and cognitive beliefs, formal regulatory pressures are the only feasible way to push firms ahead. A key insight of the institution-based view is that indivi- duals and organizations make rational choices given the right kind of incentives. For example, one efficient way to control pollution is to make polluters pay some “green” taxes—ranging from gasoline retail taxes to landfill charges. But how demanding these regulatory pressures should be remains controversial. One side of the debate argues that tough environmental regulation may lead to higher costs and reduced competi- tiveness, especially when competing with foreign rivals not subject to such demanding regulations. Others argue, however, that “green” taxes simply force firms to pay real costs that they otherwise place on others. If a firm pollutes, it is imposing a cost on the surrounding community that must either live with the pollution or pay to clean it up. By imposing a pollution tax that roughly equals the cost to the community, the firm has to account for pollution as a real cost. Economists refer to this as “inter- nalizing an externality.”

CSR advocates, endorsed by former vice president and Nobel laureate Al Gore, further argue that stringent environmental regulation may force firms to innovate, however reluctantly, thus benefiting the competitiveness of both the industry and country.30 For example, a Japanese law set standards to make products easier to disassemble. Although Hitachi initially resisted the law, it responded by redesigning products to simplify disassembly. The company reduced the parts in its washing machines by 16% and in vacuum cleaners by 30%. The products became not only easier to disassemble but also easier and cheaper to assemble in the first place, thus providing Hitachi with a significant cost advantage.

The accommodative strategy is characterized by some support from top managers, who may increasingly view CSR as a worthwhile endeavor. Since formal regulations may be in place and informal social and environmental pressures may be increasing, a number of firms themselves may be concerned about CSR, leading to the emergence of some new industry norms. Further, new managers who are passionate about or sympathetic toward CSR causes may join the organization, or some traditional man- agers may change their outlook, leading to increasingly strong cognitive beliefs that CSR is the right thing to do. In other words, from both normative and cognitive standpoints, it becomes legitimate or a matter of social obligation to accept responsi- bility and do all that is required.31 For example, in the US chemical industry, such a transformation probably took place in the early 1980s (see Table 12.3). More recently, Burger King, Kraft, Nestlé, and Unilever were pressured by Greenpeace to be concerned about the deforestation practices undertaken by their major palm oil supplier Sinar Mas in Indonesia. Eventually, the food giants accommodated Greenpeace’s demands and dumped Sinar Mars as a supplier, leading to a new industry norm that is more earth- friendly.32

Adopting a code of conduct is a tangible indication of a firm’s willingness to accept CSR. A code of conduct (sometimes called a code of ethics) is a set of written policies and standards outlining the proper practices for a firm. The global diffusion of codes of conduct is subject to intense debate. First, some argue that firms adopting these codes may not necessarily be sincere. This negative view suggests that an apparent interest in CSR may simply be window dressing. Some firms feel compelled

accommodative strategy

A strategy that tries to accommodate corporate social responsibility considerations into decision making.

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to appear sensitive to CSR, following what others are doing, but have not truly and genuinely internalized CSR concerns.33 For example, in 2009, BP implemented a new safety-oriented operating management system.34 But after the 2010 oil spill, it became apparent that this system had not been seriously implemented, and the result was a huge catastrophe. Second, an instrumental view suggests that CSR activities simply represent a useful instrument to make good profits.35 Firms are not necessarily becoming more ethical. For example, after the 2010 oil spill, BP reshuffled manage- ment and created a new worldwide safety division. The instrumental view would argue that these actions did not really mean that BP became more ethical. Finally, a positive view believes that (at least some) firms and managers may be self-motivated to do it right regardless of social pressures.36 Codes of conduct tangibly express values that organizational members view as central and enduring.

The institution-based view suggests that all three perspectives are probably valid. This is to be expected given how institutional pressures work to instill value. Regardless of actual motive, the fact that firms are practicing CSR is indicative of the rising legitimacy of CSR on the management agenda.37 Even firms that adopt a code of conduct simply as window dressing open doors for more scrutiny by concerned stakeholders because they have publicized a set of CSR criteria against which they can be judged. Such pressures are likely to transform the firms internally into more self-motivated, better corporate citizens. Thus, it probably is fair to say that Nike is a more responsible corporate citizen in 2014 than it was in 1994.

From a CSR perspective, the best firms embrace a proactive strategy when engaging in CSR, constantly anticipating responsibility and endeavoring to do more than is required.38

Top management at a proactive firm not only supports and champions CSR activities, but also views CSR as a source of differentiation that permeates throughout the corporate DNA. For example, Whole Foods’ co-founder and co-CEO John Mackey commented (see the Closing Case for details):

When people are really happy in their jobs, they provide much higher degrees of service to the customers. Happy team members result in happy customers. Happy customers do more business with you. They become advocates for your enterprise, which results in happy investors. That is a win, win, win, win strategy. You can expand it to include your suppliers and the communities where you do business, which are tied in to this prosperity circle.

Similarly, Starbucks since 2001 has voluntarily published an annual report on CSR, which embodies its founder, chairman, and CEO Howard Schultz’s vision that “we must balance our responsibility to create value for shareholders with a social conscience.”39

Proactive firms often engage in three areas of activity. First, some firms such as Swiss Re and Duke Energy actively participate in regional, national, and international policy and standards discussions.40 To the extent that policy and standards discussions today may become regulations in the future, it seems better to get involved early and (hopefully) steer the course toward a favorable direction. Otherwise—as the saying goes—if you’re not at the table, you’re on the menu. For example, Duke Energy operates 20 coal-fired power plants in five states. It is the third largest US emitter of CO2 and the 12th largest in the world. But its CEO Jim Rogers has proactively worked with green technology producers, activists, and politicians to engage in policy and legislative discussions. These are not

proactive strategy

A strategy that focuses on proactive engagement in corporate social responsibility.

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merely defensive moves to protect his firm and the power utility industry. Unlike his industry peers, Rogers has been “bitten by the climate bug” and is genuinely interested in reducing greenhouse gas emissions.41

Second, proactive firms often build alliances with stakeholder groups. For example, many firms collaborate with NGOs.42 Because of the historical tension and distrust, these “sleeping-with-the-enemy” alliances are not easy to handle. The key lies in identifying relatively short-term, manageable projects of mutual interests. For instance, Starbucks collaborated with Conservation International to help reduce deforestation practices.

Third, proactive firms often engage in voluntary activities that go beyond what is required by regulations.43 While examples of industry-specific self-regulation abound, an area of intense global interest is the pursuit of the International Standards Organization (ISO) 14001 certification of the environment management system (EMS). Headquartered in Switzerland, the ISO is an influential NGO consisting of national standards bodies in 111 countries. Launched in 1996, the ISO 14001 EMS has become the gold standard for CSR- conscious firms. Although not required by law, many MNEs, such as Ford and IBM, have adopted ISO 14001 standards in all their facilities worldwide. Firms such as Toyota, Siemens, and General Motors have demanded that all of their top-tier suppliers be ISO 14001 certified.

From an institutional perspective, these proactive activities are indicative of the normative and cognitive beliefs held by many managers on the importance of doing the right thing.44 While there is probably a certain element of window dressing and a quest for better profits, it is obvious that these efforts provide some tangible social and environmental benefits.

MAKING STRATEGIC CHOICES. The typology of (1) reactive, (2) defensive, (3) accommodative, and (4) proactive strategies is an interesting menu provided for different firms to choose from. At present, the number of proactive firms is still a minority. While many firms are compelled to do something, a lot of CSR activities probably are still window dressing. Only sustained pressures along regulatory, normative, and cognitive dimensions may push and pull more firms to do more. After publicizing its corporate-wide CSR plan for one year, British retailer Marks & Spencer (M&S) reported interesting data on the distribution of its consumers and employees along these four dimensions (Table 12.4). Since

TABLE 12.4 Distribution of Marks & Spencer’s Consumers and Employees

CONCEPTUAL CATEGORY M&S’S LABEL

PERCENTAGE OF CONSUMERS

PERCENTAGE OF EMPLOYEES

Reactive “Not my problem” 24% 1%

Defensive “What’s the point” 38% 21%

Accommodative “If it’s easy” 27% 54%

Proactive “Green crusaders” 11% 24%

Source: Based on text in Marks & Spencer, 2008, Plan A: Year 1 Review (p. 16), January 15, plana. marksandspencer.com.

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CSR cannot be embarked upon in a vacuum, a firm’s particular strategy needs to have some alignment with the CSR propensity of its consumers, employees, and other stakeholders. In other words, it is not realistic to implement a proactive strategy when the firm has numerous reactive employees and consumers.

Debates and Extensions Without exaggeration, the entire subject of CSR is about debates. It is not far-fetched to suggest that there is a big debate between this chapter (focusing on stakeholder capital- ism) and Chapter 11 (focusing on shareholder capitalism). Here, we discuss three recent, previously unexplored debates particularly relevant for international operations: (1) domestic versus overseas social responsibility, (2) active versus inactive CSR engagement overseas, and (3) race to the bottom (“pollution haven”) versus race to the top.

Domestic versus Overseas Social Responsibility Given that corporate resources are limited, devoting resources to overseas CSR often means fewer resources left to devote to domestic CSR. Consider two primary stakeholder groups: domestic employees and communities. Expanding overseas, especially toward emerging economies, may not only increase corporate profits and shareholder returns, but also provide employment to host countries and develop these economies at the “base of the pyramid,” all of which have noble CSR dimensions (see Chapter 1). However, this is often done at the expense of domestic employees and communities. One can vividly appreciate the devastation of job losses on such employees and communities by watching the 1998 movie The Full Monty. The movie takes place in Sheffield, England, the former steel capital of Europe and the world. In the movie, the local economy has been so decimated by plant closures that laid-off steel mill workers eventually take up an “alternative” line of work (male strip dancing). To prevent such a possible fate, in the 2000s, DaimlerChrysler’s German unions had to scrap a 3% pay raise and endure an 11% increase in work hours (from 35 to 39 hours) with no extra pay in exchange for promises that 6,000 jobs would be kept in Germany for eight years—otherwise, their jobs would go to the Czech Republic, Poland, and South Africa. However, such labor deals will probably only slow down, not stop, the outgoing tide of jobs from developed economies. The wage differentials are just too great.45

To the extent that few (or no) laid-off German employees would move to the neighboring Czech Republic and Poland to seek work (and forget about moving to China, India, or South Africa), most of them end up being social welfare recipients in Germany. Thus, one may argue that MNEs shirk their CSR by increasing the social burdens of their home countries. Executives making these decisions are often criticized by the media, unions, and politicians. However, from a corporate governance perspec- tive, especially the “shareholder capitalism” variant, MNEs are doing nothing wrong by maximizing shareholder returns (see Chapter 11).

Although framed in a domestic versus overseas context, the heart of this debate boils down to a fundamental point that frustrates CSR advocates: In a capitalist society, it is

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shareholders (otherwise known as capitalists) who matter at the end of the day. According to Jack Welch, GE’s former chairman and CEO:

Unions, politicians, activists—companies face a Babel of interests. But there’s only one owner. A company is for its shareholders. They own it. They control it. That’s the way it is, and the way it should be.46

When firms have enough resources, it would be nice to take care of domestic employ- ees and communities. However, when confronted with relentless pressures for cost cutting and restructuring, managers have to prioritize. Given the lack of a clear solution, this politically explosive debate is likely to heat up in the years to come.

Active versus Inactive CSR Engagement Overseas Active CSR engagement is now increasingly expected of MNEs.47 MNEs that fail to do so are often criticized by NGOs. In the 1990s, Shell was harshly criticized for “not lifting a finger” when the Nigerian government brutally cracked down on rebels in the Ogoni region where Shell operated. In 2009 Shell settled a long-running case brought by Ogoni activists with $15.5 million.48 However, such well-intentioned calls for greater CSR engagement are in direct conflict with a long-standing principle governing the relation- ship between MNEs and host countries: non-intervention in local affairs.

The non-intervention principle originated from concerns that MNEs may engage in political activities against the national interests of the host country. Chile in the 1970s serves as a case in point. After the democratically elected socialist President Salvador Allende had threatened to expropriate the assets of MNEs, ITT (a US-based MNE), allegedly in connection with the Central Intelligence Agency (CIA), promoted a coup that killed President Allende. Consequently, the idea that MNEs should not interfere in the domestic political affairs of the host country has been enshrined in a number of codes of MNE conduct sponsored by international organizations such as the United Nations (UN).

However, CSR advocates have been emboldened by some MNEs’ actions during the apartheid era in South Africa, when local laws required racial segregation of the work- force. While many MNEs withdrew, those that remained (such as BP) challenged the apartheid system by desegregating their employees and thus undermining the govern- ment’s base of power. Emboldened by the successful removal of the apartheid regime in South Africa in 1994, CSR advocates have unleashed a new campaign, stressing the necessity for MNEs to engage in actions that often constitute political activity, in parti- cular in the human rights area. Shell, after its widely criticized (lack of) action in Nigeria, has explicitly endorsed the UN Declaration on Human Rights and supported the exercise of such rights “within the legitimate role of business.”

But what exactly is the “legitimate role” of CSR initiatives in host countries? In almost every country, there are local laws and norms that some foreign MNEs may find objection- able. In Estonia, ethnic Russians are being discriminated against. In many Arab countries, women do not have the same legal rights as men. In the United States, a number of groups (ranging from Native Americans to homosexuals) claim to be discriminated against. At the heart of this debate is whether foreign MNEs should spearhead efforts to remove some of these discriminatory practices or should remain politically neutral by conforming to current host country laws and norms. This obviously is a nontrivial challenge.

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Race to the Bottom (“Pollution Haven”) versus Race to the Top One side of this debate argues that because of heavier environmental regulation in developed economies, MNEs may have an incentive to shift pollution-intensive produc- tion to developing countries with lower environmental standards. To attract investment, developing countries may enter a “race to the bottom” by lowering (or at least not tightening) environmental standards and some may become “pollution havens.”

The other side argues that globalization does not necessarily have negative effects on the environment in developing countries to the extent suggested by the “pollution haven” hypothesis. This is largely due to many MNEs’ voluntary adherence to environmental standards higher than those required by host countries.49 Most MNEs reportedly outper- form local firms in environmental management. The underlying motivations behind MNEs’ voluntary “green practices” can be attributed to (1) worldwide CSR pressures in general, (2) CSR demands made by customers in developed economies, and (3) require- ments of MNE headquarters for worldwide compliance of higher CSR standards (such as ISO 14001). Although it is difficult to suggest that the “race to the bottom” does not exist, MNEs as a group do not necessarily add to the environmental burden in developing countries.50 Some MNEs, such as Dow, may facilitate the diffusion of better environ- mental technologies to these countries (see Emerging Markets 12.1).

The Savvy Strategist Concerning CSR, the strategy tripod suggests three clear implications for action (Table 12.5). First, the industry-based view points out that while managers in certain industries may have stronger CSR challenges, savvy managers in all industries need to be prepared to confront these challenges. Given the increasingly inescapable responsibility to be good corporate citizens, managers may want to integrate CSR as part of the core activities of the firm—instead of “faking it” and making cosmetic changes. Many man- agers traditionally treat CSR as a nuisance, involving regulation, added costs, and liability. Such an attitude may underestimate potential business opportunities associated with CSR. Table 12.6 outlines some suggestions made by Porter (see Strategy in Action 12.1), and the Closing Case illustrates an exemplary firm.

Second, savvy managers need to pick CSR battles carefully. The resource-based view suggests an important lesson, which is captured by Sun Tzu’s timeless teaching: “Know yourself, know your opponents.” While your opponents may engage in high-profile CSR activities that allow them to earn bragging rights while contributing to their triple bottom line, blindly imitating these practices, while not knowing enough about “yourself” (you as a manager and the firm/unit you lead), may lead to some disappointment. Instead of

TABLE 12.5 Strategic Implications for Action

& Integrate CSR as part of the core activities and processes of the firm—faking it doesn’t last very long. & Understand the rules of the game, anticipate changes, and seek to shape and influence such changes. & Pick your CSR battles carefully—don’t blindly imitate other firms’ CSR activities.

ga ge

Le ar ni ng

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always chasing the newest best practices, firms are advised to select CSR practices that fit with their existing resources, capabilities, and especially complementary assets.

Third, savvy managers need to understand the formal and informal rules of the game, anticipate changes, and seek to shape such changes. Although the US government refused to ratify the 1997 Kyoto Protocol and only signed the nonbinding 2009 Copenhagen Accord, many US firms (such as Duke Energy) voluntarily participate in CSR activities not (yet) mandated by law, in anticipation of more stringent environmental requirements down the road.

EMERGING MARKETS 12.1

Dow Chemical Company in China

Dow Chemical Company is a leading US-based MNE that has a presence in more than 175 countries. Dow has paid considerable attention to CSR. Since 1999, it has advocated the Guiding Principles of Responsible Care, a voluntary initiative within the chemical industry to safely handle its products from inception to ultimate disposal.

China naturally has become an increasingly important market for Dow. However, beyond Dow’s immediate market reach, the general deterioration of the environment in China, an unfortunate byproduct of the strong economic growth, is visible and getting worse. For example, on a “sunny” day, pedestrians in Beijing have a hard time seeing through the smog to actually see the sun. As a result, China’s leadership is putting increasing focus on environmental sustainability as a key national policy.

Aspiring to serve as a multinational role model fully aligned with Dow’s own CSR commitment and with the government’s concern to reduce pollution, Dow partnered with the State Environmental Protection Administration (SEPA) of China to launch a SEPA-Dow National Cleaner Production Pilot Project in 2005. Dow agreed to contribute $750,000 over the first three years. Cleaner Production is the continuous application of an integrated preventive environmental strategy to processes, products, and services to increase efficiency and reduce risks and possible damage to humans and the environment. The Pilot Project has focused on training local environmental protection agencies and officials as well as managers at

small and medium-sized enterprises (SMEs), a category of firms in China that, on average, tend to be less professional and more reckless in environmental management.

In the Pilot Project’s first year, 19 SMEs in the chemical, dyeing, electronics, brewery, and food industries participated. The Project generated a combined reduction of waste water by 3.3 million cubic meters, of exhaust gas emissions by 554 tons, and of solid waste by 487 tons. This resulted in 538 cleaner production measures and an annual economic profit of approximately $130,000 for the 19 participating firms. Overall, these achievements, in Dow’s own words, “confirm Dow’s belief that Cleaner Production not only reduces waste in the production processes, it also increases the efficiency of energy resources and ultimately improves competitiveness of enterprises.” Further, Dow intends to diffuse such “best practices” in China and beyond.

Sources: Based on (1) China Business Review, 2007, Dow partners with China’s SEPA, May–June: 17; (2) Dow, 2006, SEPA-Dow Cleaner Production National Pilot Project achieves strong start and outstanding results, news.dow.com; (3) E. Economy & K. Lieberthal, 2007, Scorched earth: Will environmental risk in China overwhelm its opportunities, Harvard Business Review, June: 88–96; (4) M. W. Peng, 2011, Global Business, 2nd ed. (p. 568), Cincinnati: South- Western Cengage Learning.

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For current and would-be strategists, this chapter has clearly shown that from a CSR perspective, we can revisit the four fundamental questions. First, why do firms differ in CSR activities? Firm differences can be found in (1) industry structures, (2) resource repertoire, and (3) formal and informal institutional pressures. Second, how do firms behave in the CSR arena? Some are reactive and defensive, others are accommodative, and still others are proactive. Third, what determines a firm’s CSR scope? While industry structures, resource bases, and formal institutional pressures are likely to ensure some minimal involvement, firms with a broad range of CSR engagements are likely to be characterized by a large percentage of managers and employees who intrinsically feel the need to “do it right” (see Table 12.4). In other words, it fundamentally boils down to differences in informal normative and cognitive beliefs held by managers and employees. Finally, what determines the success and failure of firms around the world? No doubt, CSR will increasingly become an important part of the answer. The best performing firms are likely to be those that can integrate CSR activities into the core economic functions of the firm while addressing social and environmental concerns.

The globally ambiguous and different CSR standards, norms, and expectations make many managers uncomfortable. Many managers continue to relegate CSR to the “back burner.” However, this does not seem to be the right attitude for current and would-be strategists who are studying this book—that is, you. It is important to note that we live in a dangerous period of global capitalism. In the post–Great Recession and post–Occupy Wall Street world, managers, as a unique group of stakeholders, have an important and challenging responsibility to safeguard and advance capitalism (see Strategy in Action 12.1 and the Closing Case). From a CSR standpoint, this means building more humane, more inclusive, and fairer firms that not only generate wealth and develop economies, but also respond to changing societal expectations concerning the social and environmental role of the firm around the world.51

TABLE 12.6 From Corporate Social Responsibility to Creating Shared Value

(RELATIVELY ISOLATED) CORPORATE SOCIAL RESPONSIBILITY

CREATING SOCIAL VALUE (VIA ECONOMIC VALUE CREATION)

Value: Doing good Value: Economic and societal benefits relative to cost

Citizenship, philanthropy, and sustainability Joint company and community value creation

Discretionary or in response to external pressure Integral to competing

Separate from profit maximization Integral to profit maximization

Agenda is determined by personal preferences Agenda is company specific and internally generated

Impact limited by corporate footprint and CSR budget

Realigns the entire company budget

Source: Adapted fromM. E. Porter &M. R. Kramer, 2011, Creating shared value (p. 76),Harvard Business Review, January–February: 62–77. For details, see Strategy in Action 12.1 for an excerpt of this article.

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CHAPTER SUMMARY

1. Articulate what a stakeholder view of the firm is • A stakeholder view of the firm urges companies to pursue a more balanced triple bottom line, consisting of economic, social, and environmental performance.

• Despite the fierce defense of the free market school, especially its shareholder capitalism variant, the CSR movement has now become a more central part of strategy discussions around the globe.

2. Develop a comprehensive model of CSR • The industry-based view argues that the nature of different industries drives different CSR strategies.

• The resource-based view posits that not all CSR activities satisfy the VRIO requirements. • The institution-based view suggests that when confronting CSR pressures, firms may employ (1) reactive, (2) defensive, (3) accommodative, and (4) proactive strategies.

3. Participate in three leading debates concerning CSR • (1) Domestic versus overseas social responsibility, (2) active versus inactive CSR engagement overseas, and (3) race to the bottom versus race to the top.

4. Draw strategic implications for action • Integrate CSR as part of the core activities and processes of the firm. • Pick your CSR battles carefully—don’t blindly imitate other firms’ CSR activities. • Understand the rules of the game, anticipate changes, and seek to influence such changes.

KEY TERMS

Accommodative strategy p. 375

Corporate social responsibility (CSR) p. 363

Defensive strategy p. 374

Global sustainability p. 364

Primary stakeholder groups p. 364

Proactive strategy p. 376

Reactive strategy p. 374

Secondary stakeholder groups p. 365

Social issue participation p. 372

CRITICAL DISCUSSION QUESTIONS

1. ON ETHICS: Between the two opposing views (CSR does not create value versus CSR can create value), which view do you support? Why?

2. ON ETHICS: Your CPA firm is organizing a one-day-long CSR activity using company time, such as cleaning up a dirty road or picking up trash on the beach. A colleague tells you: “This is so stupid. I already have so much unfinished work. Now to take a whole day away from work? Come on! I don’t mind CSR. If the company is serious about CSR, why

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don’t they donate one day of my earnings, which I am sure will be more than the value I can generate by cleaning up the road or picking up trash? With that money, they can just hire someone to do a better job than I would.” What are you going to say to her? (Your colleague makes $73,000 a year and on a per-day basis she makes $200.)

3. ON ETHICS: As CEO of a leading bank in Wall Street or the City of London, you have decided to directly meet participants in the Occupy Wall Street movement or the Occupy London movement, respectively. What will you say?

TOPICS FOR EXPANDED PROJECTS

1. ON ETHICS: In the landmark Dodge v. Ford case in 1919, the Michigan State Supreme Court determined whether Henry Ford could withhold dividends from the Dodge brothers (and other shareholders of the Ford Motor Company) to engage in what today would be called CSR activities. With a resounding “No,” the court opined that “A business organi- zation is organized and carried on primarily for the profits of the stockholders.” If the court in your country were to decide on this case this year (or in 2019), what do you think would be the likely outcome?

2. ON ETHICS: Some argue that investing in emerging economies greatly facilitates eco- nomic development at the base of the global economic pyramid. Others contend that moving jobs to low-cost countries not only abandons CSR for domestic employees and communities in developed economies, but also exploits the poor in these countries and destroys the environment. If you were (1) CEO of an MNE headquartered in a developed economy, (2) the leader of a labor union in the home country of the MNE mentioned here that is losing a lot of jobs, or (3) the leader of an environmental NGO in the low-cost country in which the MNE invests, how would you participate in this debate?

3. ON ETHICS: Hypothetically, your MNE is the largest foreign investor in (1) Vietnam where religious leaders are being prosecuted or (2) Estonia where ethnic Russian citizens are being discriminated against by law. As the country manager there, you are being pressured by NGOs of all stripes to help the oppressed groups in these countries. But you also understand that the host government could be upset if your firm is found to engage in local political activities deemed inappropriate. These activities, which you personally find distasteful, are not directly related to your operations. How would you proceed?

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E T H I C A L D I L E M M ACLOSING CASE

Whole Foods’ John Mackey on Conscious Capitalism

After dropping out of the University of Texas at Austin, John Mackey co-founded Safer Way Natural Foods store in Austin in 1978. In 1980, Safer Way merged with a competitor to become Whole Foods, one of the country’s first natural foods supermarkets. Thirty years and 15 acquisitions later, Whole Foods dominates natural foods retailing and has become an iconic brand in the United States. It is expanding in the United Kingdom as well. Its purchasing standards and priorities shape agricultural practices around the world. The outspoken Mackey, who is a self-styled guru on conscious capitalism, was interviewed by Harvard Business Review:

What is conscious capitalism?

First, you have to understand the basic principles that help capitalism flourish. One is property rights. You need the ability to trade your property, and to trade it to pretty much whoever you want. Another is the rule of law—laws and regulations that are well understood so that you can factor them into your business decisions. The rule of law has to be applied equally to everyone. For example, if Whole Foods goes into a city and is told our cheese has to be refrigerated, it’s fundamentally unjust if that rule isn’t applied to our competitors as well—which, I might add, does sometimes happen in New York City. You also need to have conscious businesses—that is, businesses that become conscious of their higher purpose, which is not just about maximizing profits and shareholder value.

Second, you have to recognize the stakeholder model: Customers, employees, investors, suppliers, larger commu- nities, and the environment are all interdependent. You oper- ate the business in such a way that it’s not a zero-sum game.

Third, you need what we call conscious leadership. You could also call it servant leadership. Leaders identify their own flourishing with the flourishing of the organization. They’re trying to serve the organization and its purpose.

Fourth, you have to create a conscious culture—a culture that allows the organization to fulfill its higher

purpose, implements the stakeholder model, and enables conscious leadership to flourish.

So, what are the core principles of Whole Foods, and where do they come from?

I think business enterprises are like any other commu- nities. They can aspire to the highest values that have inspired humans throughout time. You can use different value mod- els, but I like Plato’s the good, the true, and the beautiful. Add the heroic to that—meaning changing and improving the world and standing up for what you believe is true and right and good. I think Whole Foods’s highest purpose is a heroic one: to try to change and improve our world. That is what animates me personally. That is what animates the company. I resisted that purpose for a long time, by the way. I actually thought we were in some variant of service— that was really about fulfilling the good. The team members consistently told me I was wrong, that we had a different purpose. It was this more heroic purpose.

In terms of the age-old debate about whether companies exist for the shareholders or for something else, is there one group? Is it customers? Is it employees? Or is it purpose?

That gets back to the second principle of conscious capitalism—the stakeholder model. I think it’s deep in human nature to think in terms of the zero sum. If one stakeholder is winning, someone else must be losing. It comes from sports, where there is one winner and lots of losers, and this idea of a fixed pie, where if someone is getting a bigger share, someone else has to be getting a smaller piece, and what’s needed for social justice is to make sure people get equal pieces. But a conscious busi- ness recognizes that you can have an expanding pie, and potentially everyone can get a larger piece.

I’ll give youa simple example:management’s job atWhole Foods is to make sure that we hire good people, that they are well trained, and that they flourish in the workplace, because we found thatwhenpeople are really happy in their jobs, they provide much higher degrees of service to the customers. Happy team members result in happy customers. Happy customers do more business with you. They become advo- cates for your enterprise, which results in happy investors.

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NOTES

That is a win, win, win, win strategy. You can expand it to include your suppliers and the communities where you do business, which are tied in to this prosperity circle. A meta- phor I like is the spiral, which tends to move upward but doesn’t move in a straight line.

HBR’s pages are full of discussions about how sustainability is becoming a competitive advantage. Do you believe that?

I do think sustainability is a way to compete. I don’t think it’s the most important way. I see it as more of a niche. It reflects the consciousness of your customers, and the truth is that most customers don’t care about it. Most customers at the end of the day care mostly about price. That conscious- ness is still dominant out there. But there is a growing con- sciousness about things like environmental sustainability and animal welfare. When we started out, 30 years ago, organic was a niche, and most people didn’t know what it was. But I would say that partly because of Whole Foods’ success, organic is now very much in the national consciousness.

More recently, Whole Foods has gotten behind the emphasis on local agriculture and has helped to popularize it. Wal-Mart is beginning to pay attention to this also, so in a lot of ways Whole Foods is helping to evolve the agricultural system in the United States.

Source: Excerpts from J. Mackey, 2011, What is it that only I can do? Harvard Business Review, January: 119–123.

C A S E D I S C U S S I O N Q U E S T I O N S

1. What are Whole Foods’ firm-specific resources and capabilities that underpin its success?

2. From an institution-based view, how would you characterize Whole Foods’ strategy featuring its “heroic” purpose to “try to change and improve our world”?

3. Why does Mackey acknowledge that most customers don’t care about consciousness, and yet he and his firm emphasize so much of it?

[Journal acronyms] AMJ – Academy of Management Journal; AMP – Academy of Management Perspectives; AMR – Academy of Management Review; APJM – Asia Pacific Journal of Management; BSR – Business and Society Review; BW – BusinessWeek (before 2010) or Bloomberg Businessweek (since 2010); HBR – Harvard Business Review; JBE – Journal of Business Ethics; JIBS – Journal of International Business Studies; JIM – Journal of International Management; JMS – Journal of Management Studies; JWB – Journal of World Business; NYTM – New York Times Magazine; OSt – Organization Studies; SMJ – Strategic Management Journal; WSJ – Wall Street Journal.

1. K. Davis, 1973, The case for and against business assumption of social responsibilities (p. 312), AMJ, 16: 312–322. See also R. Aguilera, R. Rupp, C. Wil- liams, & J. Ganapathi, 2007, Putting the S back in CSR, AMR, 32: 836–863; P. Cappelli, H. Singh, J. Singh, & M. Useem, 2010, The India way, AMP, May: 624; J. Campbell, L. Eden, & S. Miller, 2012, Multinationals and CSR in host countries, JIBS, 43: 84106; C. Egri & D. Ralston, 2008, Corporate responsibility, JIM, 14: 319–339; D. Matten & J. Moon, 2008, “Implicit” and “explicit” CSR, AMR, 33: 404–424.

2. Y. He, Z. Tian, & Y. Chen, 2007, Performance implica- tions of nonmarket strategy in China, APJM, 24: 151–169; K. O’Shaughnessy, E. Gedajlovic, & P. Rein- moeller, 2007, The influence of firm, industry, and network on the corporate social performance of Japanese firms, APJM, 24: 283–304; A. Scherer & G. Palazzo, 2011, The new political role of business in a globalized world, JMS, 48: 899–931.

3. E. Freeman, 1984, Strategic Management: A Stakeholder Approach (p. 46), Boston: Pitman. See also M. Barnett, 2007, Stakeholder influence capacity and the variability of financial returns to CSR, AMR, 32: 794–816; S. Brickson, 2007, Organizational identity orientation, AMR, 32: 864– 888; D. Crilly, 2011, Predicting stakeholder orientation in the MNE, JIBS, 42: 694–717; T. Jensen & J. Sandstrom, 2011, Stakeholder theory and globalization, OSt, 32: 473– 488; A. Kacperczyk, 2009, With greater power comes greater responsibility? SMJ, 30: 261–285.

4. P. David, M. Bloom, & A. Hillman, 2007, Investor activism, managerial responsiveness, and corporate social performance, SMJ, 28: 91–100; J. Harrison, D. Bosse, & R. Phillips, 2010, Managing for stake- holders, stakeholder utility functions, and competitive advantage, SMJ, 31: 58–74.

386 PART 3 CORPORATE-LEVEL STRATEGIES

5. World Commission on Environment and Develop- ment, 1987, Our Common Future (p. 8), Oxford: Oxford University Press.

6. S. Hart, 2005, Capitalism at the Crossroads, Phila- delphia: Wharton School Publishing; R. Rajan, 2010, Fault Lines, Princeton, NJ: Princeton Univer- sity Press.

7. J. Doh & T. Guay, 2006, CSR, public policy, and NGO activism in Europe and the United States, JMS, 43: 47–73.

8. P. Romilly, 2007, Business and climate change risk, JIBS, 38: 474–480.

9. C. Seelos & J. Mair, 2007, Profitable business models and market creation in the context of deep poverty, AMP, November: 49–63; A. Scherer & G. Palazzo, 2007, Toward a political conception of corporate responsibility, AMR, 32: 1096–1120.

10. B. Husted & D. Allen, 2006, CSR in the MNE, JIBS, 37: 838–849.

11. M. Clarkson, 1995, A stakeholder framework for ana- lyzing and evaluating corporate social performance (p. 107), AMR, 20: 92–117. See also F. den Hond & F. de Bakker, 2007, Ideologically motivated activism, AMR, 32: 901–924; C. Marquis, M. Glynn, & G. Davis, 2007, Community isomorphism and corporate social action, AMR, 32: 925–945; S. Waddock, 2008, Build- ing a new institutional infrastructure for corporate responsibility, AMP, August: 87–109.

12. T. Donaldson & L. Preston, 1995, The stakeholder theory of the corporation, AMR, 20: 65–91; J. Elking- ton, 1997, Cannibals with Forks: The Triple Bottom Line of 21st Century Business, New York: Wiley.

13. M. Friedman, 1970, The social responsibility of busi- ness is to increase its profits, NYTM, September 13: 32–33.

14. D. Ahlstrom, 2010, Innovation and growth, AMP, August: 11–24; A Karnani, 2010, The case against corporate social responsibility, WSJ, August 23.

15. A. Delios, 2010, How can organizations be competi- tive but dare to care? AMP, August: 25–36.

16. A. Mackey, T. Mackey, & J. Barney, 2007, CSR and firm performance, AMR, 32: 817–835.

17. G. Bruton, 2010, Business and the world’s poorest billion, AMP, August: 6–10.

18. Economist, 2011, Rage against the machine, October 22: 13.

19. Y. Mishina, B. Dykes, E. Block, & T. Pollock, 2010, Why “good” firms do bad things, AMJ, 53: 701–722; A. Muller & R. Kraussl, 2011, Doing good deeds in

times of need, SMJ, 32: 911–929; C. Oh & J. Oetzel, 2011, Multinationals’ response to major disasters, SMJ, 32: 658–681.

20. K. Basu & G. Palazzo, 2008, Corporate social respon- sibility, AMR, 33: 122–136.

21. A. Kolk & J. Pinkse, 2008, A perspective on MNEs and climate change, JIBS, 39: 1359–1378.

22. A. Hillman & G. Keim, 2001, Shareholder value, stake- holder management, and social issues, SMJ, 22: 125–139.

23. R. Chan, 2010, Corporate environmentalism pursuit by foreign firms competing in China, JWB, 45: 80–92; Y. Eiadat, A. Kelly, F. Roche, & H. Eyadat, 2008, Green and competitive? JWB, 43: 131–145; P. God- frey, C. Merrill, & J. Hansen, 2009, The relationship between CSR and shareholder value, SMJ, 30: 425–445; B. Lev, C. Petrovits, & S. Radhakrishnan, 2010, Is doing good good for you? SMJ, 31: 182–200; S. Ramchander, R. Schwebach, & K. Staking, 2012, The informational relevance of CSR, SMJ, 33: 303–314; M. Sharfman & C. Fernando, 2008, Envir- onmental risk management and the cost of capital, SMJ, 29: 569–592; H. Wang & C. Qian, 2011, Corpo- rate philanthropy and corporate financial perfor- mance, AMJ, 54: 1159–1181.

24. S. Ambec & P. Lanoie, 2008, Does it pay to be green? AMP, November: 45–62; D. Vogel, 2005, The low value of virtue, HBR, June: 26.

25. S. Brammer & A. Millington, 2008, Does it pay to be different? SMJ, 29: 1325–1343; J. Surroca, J. Tribo, & S. Waddock, 2010, Corporate responsibility and financial performance, SMJ, 31: 463–490.

26. T. Devinney, 2009, Is the socially responsible corpora- tion a myth? AMP, May: 53.

27. J. Choi & H. Wang, 2009, Stakeholder relations and the persistence of corporate financial performance, SMJ, 30: 895–907; C. Hull & S. Rothenberg, 2008, Firm performance, SMJ, 29: 781–789.

28. J. Campbell, 2007, Why would corporations behave in socially responsible ways? AMR, 32: 946–967; J. Murillo-Luna, C. Garces-Ayerbe, & P. Rivera- Torres, 2008, Why do patterns of environmental response differ? SMJ, 29: 1225–1240; A. Terlaak, 2007, Order without law? AMR, 32: 968–985; D. Waldman et al., 2006, Cultural and leadership predictions of CSR values of top management, JIBS, 37: 823–837.

29. B. Gifford, A. Kestler, & S. Anand, 2010, Building local legitimacy into CSR, JWB, 45: 304–311.

C h a p t e r 1 2 S t r a t e g i z i n g w i t h C o r p o r a t e S o c i a l R e s p o n s i b i l i t y 387

30. A. Gore, 2006, An Inconvenient Truth, Emmaus, PA: Rodale Press.

31. A. Muller & A. Kolk, 2010, Extrinsic and intrinsic drivers of corporate social performance, JMS, 47: 1–26.

32. Economist, 2010, The other oil spill, June 26: 71–73. 33. J. Janney & S. Gove, 2011, Reputation and CSR aber-

rations, trends, and hypocrisy, JMS, 48: 1562–1584. 34. BW, 2010, Nine questions (and provisional answers)

about the spill, June 14: 62. 35. D. Siegel, 2009, Green management matters only if it

yields more green, AMP, August: 5–16. 36. A. Marcus & A. Fremeth, 2009, Green management

matters regardless, AMP, August: 17–26. 37. V. Hoffmann, T. Trautmann, & J. Hemprecht, 2009,

Regulatory uncertainty, JMS, 46: 1227–1253. 38. N. Darnall, I. Henriques, & P. Sadorsky, 2010, Adopt-

ing proactive environmental strategy, JMS, 47: 1072–1094.

39. Starbucks Global Responsibility Report 2010, 2011, Message from Howard Schultz, www.starbucks.com.

40. G. Unruh & R. Ettenson, 2010, Winning in the green frenzy, HBR, November: 110–116.

41. BW, 2010, The smooth-talking king of coal—and climate change, June 7: 65.

42. A. King, 2007, Cooperation between corporations and environmental groups, AMR, 32: 889–900; A. Kour- ula, 2010, Corporate engagement with NGOs in dif- ferent institutional contexts, JWB, 45: 395–404; J. Nebus & C. Rufin, 2010, Extending the bargaining power model, JIBS, 41: 996–1015.

43. M. Barnett & A. King, 2008, Good fences make good neighbors, AMJ, 51: 1150–1170; M. Delmas &

M. Montes-Sancho, 2010, Voluntary agreements to improve environmental quality, SMJ, 31: 575–601.

44. B. Arya & G. Zhang, 2009, Institutional reforms and investor reactions to CSR announcements, JMS, 46: 1089–1112; M. Delmas & M. Toffel, 2008, Organi- zational responses to environmental demands, SMJ, 29: 1027–1055; E. Reid & M. Toffel, 2009, Respond- ing to public and private politics, SMJ, 30: 1157–1178; E. Wong, M. Ormiston, & P. Tetlock, 2011, The effects of top management team integrative complexity and decentralized decision making on corporate social performance, AMJ, 54: 1207–1228.

45. BW, 2004, European workers’ losing battle (p. 41), August 9: 41.

46. J. Welch & S. Welch, 2006, Whose company is it anyway? BW, October 9: 122.

47. S. Brammer, S. Pavelin, & L. Porter, 2009, Corporate charitable giving, MNCs, and countries of concern, JMS, 46: 575–596; B. Scholtens, 2009, CSR in the international banking industry, JBE, 86: 159–175.

48. Economist, 2009, Spilling forever, June 13: 51. 49. P. Christmann & G. Taylor, 2006, Firm self-regulation

through international certifiable standards, JIBS, 37: 863–878.

50. P. Madsen, 2009, Does corporate investment drive a “race to the bottom” in environmental protection? AMJ, 52: 1297–1318.

51. R. Bies, J. Bartunek, T. Fort, & M. Zald, 2007, Cor- porations as social change agents, AMR, 32: 788–793; N. Gardberg & C. Fombrun, 2006, Corporate citizen- ship, AMR, 31: 329–346; T. Hemphill, 2004, Corpo- rate citizenship, BSR, 109: 339–361.

388 PART 3 CORPORATE-LEVEL STRATEGIES

INTEGRATIVE

CASES

INTEGRATIVE CASE 1

3i Group’s Private Equity Investment in China’s Little Sheep1

How and why was an unlikely yet productive relationship forged between a large, well-established global private equity firm and a rapidly growing Chinese restaurant chain?

Lily Fang, INSEAD Roger Leeds, Johns Hopkins University, School of Advanced International Studies

“Many people grow a company like raising a pig. The pig gets fat, you kill it and make money. I grow my company like raising a son. The average life of a restaurant is less than three years in China. I want Little Sheep to last a century.”

—Zhang Gang, Founder, Little Sheep Catering Chain Co.

“Helping a great business to realize its potential takes a lot more than just capital. It is ultimately about the people, thus your relationship with the management team and the sort of support you can provide, such as introductions to key industry expertise and relevant operational best practice, is very important.”

—Anna Cheung, 3i Partner, China

3i Group PLC 3i Group plc is one of the oldest private equity firms in the world, with a track record dating back to 1945 when the British government and a consortium of banks founded two organizations—the Industrial and Commercial Finance Corporation (ICFC) and the Finance Corporation for Industry (FCI)—to bridge

the financing gap afflicting small and medium-sized enterprises (SMEs) in the aftermath of World War II.2

In 1975, these two corporations merged, and in 1983, the combined entity was renamed 3i—“investors in industry.” In 1994, 3i was listed on the London Stock Exchange, becoming the first large private equity fund to go public and have access to perma- nent capital. 3i invests in a wide variety of businesses through its five lines: buyouts, growth capital, venture capital, infrastructure, and quoted private equity (see Exhibit 1).

Expanding its geographic footprint beyond the UK and Europe, 3i today has offices in 14 countries across Europe, Asia, and the US and has made investments in more than 30 countries. The firm opened its first Asia office in Singapore in 1997, followed by a second office in Hong Kong four years later and offices in Shanghai, Mumbai, and Beijing subsequently. During fiscal year 2006, 16% of the group’s new investments were in Asia. Alongside the geographic shift, 3i’s investment strategy has also evolved, with an emphasis on making fewer, larger, and more sector-focused investments. In Asia, the group’s average investment size has been about $40 million to $50 million, and sectors in focus included consumer-related goods and services, healthcare, and energy.

These changes in investment strategy were consis- tent with a decision to become more actively involved

1 This case was written by Lily Fang (INSEAD) and Roger Leeds (SAIS, Johns Hopkins University). It was originally published in 2008 as “3i Group plc and Little Sheep” by the World Economic Forum USA, Inc., as part of Globalization of Alternative Investments Working Papers, Volume 1 The Global Economic Impact of Private Equity Report 2008 (http://www3.weforum.org/docs/WEF_IV_PrivateEquity_Report_2008.pdf). The authors express their appreciation for the research and editing support provided by Brian DeLacey. © World Economic Forum, Lily Fang, and Roger Leeds. Reprinted with permission. 2 The perceived funding gap—the “Macmillan gap”—was scrutinized back in 1929 in a report by a committee under the chairmanship of Lord Macmillan. The founding of ICFC, predecessor of 3i, was closely linked to one suggestion in the Macmillan Report.

391 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

in its portfolio companies, returning to the firm’s ori- ginal modus operandi as an “investor in industry.” To better serve its portfolio companies, 3i developed two unique programs: People Program and Business Development Practice. People Program is a highly sophisticated approach to cultivating relationships internationally with seasoned executives and industry experts whom 3i regularly calls upon to assist the deal team at various stages of the investment pro- cess, from due diligence to post-investment opera- tional support. While many private equity groups rely upon industry experts, 3i’s People Program is unique in its scale and 20-year history of building an enviable rolodex. Chris Rowlands, 3i’s managing director for Asia, explained: “At 3i, this is not a nice-to-have, or an afterthought. This is at the heart of our investment model.”

The second distinctive 3i program, the Business Development Practice, is a dedicated resource to help 3i’s portfolio companies expand their operations inter- nationally. Initially this grew out of a demand from European firms wanting to gain entry to Asia, but the team is increasingly working with Asian firms seeking to tap into the European and US markets, and Row- lands believes it “is not only a service for our portfolio companies, but we believe it directly increases our investment value as well.”

Entrepreneurial Beginnings of Inner Mongolia Little Sheep Catering Chain Co., Ltd. In 1999, an entrepreneur called Zhang Gang founded Little Sheep Catering Chain Co. in Inner Mongolia, one of the most remote and underdeveloped corners of the world. One of the five autonomous regions in China, Inner Mongolia’s economy was primarily agrarian and until the 1990s had ranked among the country’s poor- est regions. But this began to change dramatically with the economic reform programs initiated by Deng Xiaoping in the 1980s. The combination of a reform- minded regional government and rich natural resources provided strong impetus for Inner Mongo- lia’s economic growth. By 2006, Inner Mongolia had been transformed into one of the wealthiest regions in terms of GDP per capita.3

Although with no formal business education, Zhang (ethnic Han Chinese) was an opportunistic and intui- tive businessman long before he founded Little Sheep. A short stint as a factory worker in Baotou Steel Fac- tory at an early age led Zhang to conclude that a career as a worker in a state-owned factory would be “very repressive.” He then ventured into clothes retailing while still a teenager and, by the early 1990s, had accumulated enough capital to enter the cell phone

EXHIBIT 1 Summary Information on 3i’s Business Lines

Note: Figures in millions £

Buyouts Growth Capital

Venture Capital Infrastructure

Quoted Public Equity Total

3i’s own capital 1,281 1,460 741 469 20 3,971

Third-party funds 2,129 227 15 385 0 2,756

TOTAL 3,410 1,687 756 854 20 6,727

Source: 3i Annual Report 2007; http://www3.weforum.org/docs/WEF_IV_PrivateEquity_Report_2008.pdf.

3 In 2006, Inner Mongolia’s GDP per capita ranked number ten among Chinese regions, behind only nine wealthy coastal provinces (GDP per capita ranking data from wikipedia.com, November 2007).

392 INTEGRATIVE CASE 1 3i Group ’s P r iva te Equ i t y Inves tment in Ch ina ’s L i t t l e Sheep

business, eventually rising to become the sole distribu- tor of cell phone equipment in Inner Mongolia.

Zhang initially thought about entering the food business as a hobby. He focused on a popular dish in Northern China called “hot pot”—a pot of boiling soup that sits atop a small, table-top stove to which diners add thinly sliced meat and vegetables. Traditionally, the cooked food is then dipped in flavored sauces. Zhang wanted to improve the soup base so that there would be no need to dip the cooked food in sauces—he wanted to create a healthier and more naturally flavored hot pot. After many trials and tastings, he finally settled on a unique recipe containing over 60 spices and herbs. Only then did he begin thinking about it as a business. “It made sense—I always wanted to have a basic busi- ness, selling something simple that people wanted,” he recalled.

Zhang named his venture Little Sheep because locally raised lamb is a staple in the Mongolian diet and thinly sliced lamb would be the specialty in his new restaurant. He opened the first Little Sheep restaurant in Baotou, a large city in Inner Mongolia on August 8, 1999, and it was an instant success. By the second day, long lines of customers lined up outside the restaurant, an unprecedented phenomenon in a city where people were unaccustomed to waiting in line for supper. Based on this early success, Zhang managed to open two additional restaurants in Baotou within two months, with an equally enthusiastic customer response.

The Trademark Battle As Zhang witnessed the surprising popularity of Little Sheep, his business intuition immediately set in. Once word spread about the phenomenal early success of the restaurants, he knew others would try to replicate his business model and even use the Little Sheep name, undermining the brand value. As early as October 1999, just as he was opening his second and third restaurants, Zhang submitted his first application to the National Trademark Office, the official government agency in charge of intellectual property matters. This proved to be the start of a battle that would drag on for nearly seven years, until Little Sheep was finally awarded trademark protection in June 2006. Ironically, it took Little Sheep longer to be granted trademark protection in China than in several overseas markets.

Reflecting on this drawn-out experience with the government authorities, Zhang lamented that this was his “single biggest headache” during the entire history of the firm. Not only would this have an unexpected impact on Little Sheep’s growth strategy, it also would sow the seeds in Zhang’s mind to bring Little Sheep to the public market.

Rapid Growth and Strategic Re-orientation The extraordinary success of the first three restaurants spurred Zhang to expand with lightening speed throughout the country. By the end of 2002, just over three years after opening the doors to his first restau- rant in Baotou, the company had established a nation- wide chain of more than 500 restaurants. Ironically, the lack of trademark protection was as much a driver of rapid expansion as the founder’s ambition and entre- preneurial talent. “I didn’t have the luxury to wait. I had to move fast to grab market. Otherwise, anyone could start a Little Sheep and we had no legal recourse to fight back,” Zhang explained.

But this success came at a high cost, and by the end of 2002, the company was suffering from serious growing pains. While the rapid expansion had been primarily driven by an aggressive franchise strategy, the company’s thin management ranks resulted in very weak oversight of the franchisees. The problems were aggravated when media reports began to appear claiming substandard quality and service in certain Little Sheep franchise stores, inevitably damaging the brand.

At the end of 2002, Zhang faced a critical decision: Should the company curtail growth and scale back the franchises until the management team could be strengthened, even though this would result in the immediate loss of substantial franchise fees? More- over, Zhang would risk alienating a growing roster of franchise applicants who were waiting to capitalize on the brand and open Little Sheep restaurants. Resisting the temptation to maximize short-term profit, Zhang decided to temporarily halt the award- ing of new franchises in the following year. In addi- tion, he initiated efforts to more closely monitor the performance of the existing franchises and designated

INTEGRATIVE CASE 1 3i Group ’s Pr i va te Equ i t y Inves tment in Ch ina ’s L i t t l e Sheep 393

one of his long-time lieutenants, Zhang Zhan Hai, to be in charge of the task.

Management’s Goal Gradually, Zhang’s decision to scale back the expansion began to pay off. In 2004, the company strengthened its management ranks significantly by hiring as senior vice president of finance, industry veteran Lu Wen Bing, former vice president of Meng Niu (Mongolian Cow), a well-known Inner Mongolia–based dairy company. Lu brought much-needed financial discipline and internal control to the company, and by 2005, Little Sheep’s performance had clearly rebounded as the company collected a number of prestigious regional and national business awards, including the Little Sheep brand being ranked 95th by the World Brand Lab among “The 500 Most Valuable Chinese Brands.” According to Ministry of Commerce statistics, the company had the second largest market share among China’s restaurants chains, behind only the fast-food giant KFC. (See Exhibit 2 for a major-events time line in Little Sheep’s corporate history up to the 3i investment and Exhibit 3 for the company’s footprint in China at the end of 2005, just before the 3i investment.)

Notwithstanding this renewed success, Zhang recognized that sustaining the company’s growth would require not only financial resources but, more importantly, additional industry expertise. Like many Chinese entrepreneurs, Zhang came to believe that the ultimate validation for Little Sheep’s success would be a public listing, preferably on an overseas exchange.4 This would give the company a diversi- fied source of capital as well as brand recognition and subject it to market discipline. His preference for an overseas listing was rooted in his concern about the lax listing standards on the domestic Chi- nese exchanges. But to prepare for an initial public offering (IPO), he believed that the company needed to attract not only additional capital, but also a partner with the capability to provide much-needed industry knowledge and expertise. “What we lacked were high level professionals from the food and beverage industry who could help take Little Sheep

to the next, higher level…We needed a partner that could help us prepare for an IPO outside China,” explained Zhang.

Origin of 3i’s Private Equity Deal with Little Sheep Little Sheep’s extraordinary growth and brand name recognition attracted many willing investors, includ- ing such prestigious investment banks as Morgan Stanley and Goldman Sachs. At 3i, Little Sheep was spotted by an associate director, Daizong Wang, a Wharton MBA who had recently joined the group after a four-year stint with Goldman Sachs in Hong Kong. As 3i’s investment strategy in Asia was becoming more sector focused, Wang was assigned to study the food and beverage sector, which had been growing at a rate twice as fast as China’s GDP for over 15 years. As the Chinese economy began to shift toward more consumption-led growth, Wang believed that consumer-related sectors such as restaurants would offer tremendous upside (see Exhibit 4).

Wang also noticed that even though the sector was experiencing rapid growth, prior to 2005, there had been no private equity investments due to the lack of scale in typical restaurant businesses. Unfazed, he began to analyze the market share rankings of restau- rant chains in China to screen for investment targets. Little Sheep ranked second, occupying 6.2% of the entire restaurant and catering market, behind KFC.5

Intrigued by Little Sheep’s ability to achieve scale unlike most other restaurants, Wang realized that the key was the simplicity of Little Sheep’s business model: “The Chinese restaurant business is fragmented because it is difficult to standardize. In most restau- rants the largest cost component is the chef, but it is difficult to achieve consistency. Little Sheep is different because customers cook their own food in the hot pot, which eliminates the need for a chef. This do-it-yourself style of dining and the ease of standardization made this business capable of scale.” In fact, these chara- cteristics made hot pot restaurants a significant sub- sector of the total restaurant industry, accounting

4 At the time, the Chinese A-share market was closed for new public listing. 5 According to Euromonitor, Little Sheep had a higher, 9.9% market share among China’s full-service restaurant chains, excluding fast food.

394 INTEGRATIVE CASE 1 3i Group ’s P r iva te Equ i t y Inves tment in Ch ina ’s L i t t l e Sheep

for more than 20% of all consumer spending on res- taurants, with Little Sheep the clear market leader with one-third of total hot-pot revenue (see Exhibit 5).

Based on this analysis, Daizong Wang concluded, “From the very beginning, I wanted to invest in this business.”

EXHIBIT 2 Major Events in Little Sheep’s Corporate History

DATE EVENT

August 1999 Little Sheep opens first restaurant

October 1999 Little Sheep becomes a chain with two more restaurants opened

May 2001 Subsidiary company in Shanghai established

January 2002 Little Sheep sets up subsidiary companies in Beijing and Shenzhen

August 2002 Little Sheep receives both the China national “Green Food” certification and ISO 9001 certification

January 2003 Research and development (R&D) facility for seasonings established by Little Sheep

January 2004 Subsidiary company in Hong Kong established

May 2004 First Hong Kong Little Sheep restaurant opened

November 2004 Little Sheep becomes the only restaurant to break into the “China Top 500 Businesses” list at #451; the company is also awarded the Chinese “Prestigious Brand” label

May 2005 The “Inner Mongolia Top 50 Private Business” list ranks Little Sheep at #2

August 2005 Little Sheep ranks #95 on the “China Top 500 Most Valuable Brands” list, with an estimated value of 5.5 billion RMB; on the “China Top 500 Service Business” list, Little Sheep ranks #1 among food companies and #160 overall

September 2005 Little Sheep ranks #2 on the “China Top 100 Food Businesses” list

October 2005 Little Sheep establishes its first overseas direct-ownership restaurant in Toronto, Canada

December 2005 The company enters the “China Food and Beverages Top 10 Quality” list and the “China Top 500 Quality” list

May 2006 Little Sheep is awarded a spot on “Inner Mongolia's Most Respected 50 Businesses” list

June 2006 Little Sheep receives its official trademark

Source: Compiled from company documents; http://www3.weforum.org/docs/WEF_IV_PrivateEquity_Report_2008.pdf.

INTEGRATIVE CASE 1 3i Group ’s Pr i va te Equ i t y Inves tment in Ch ina ’s L i t t l e Sheep 395

His next step, in August 2005, was to cold-call Little Sheep’s senior vice president of finance, Lu Wen Bing. After making his pitch to Lu, whom Wang found “surprisingly open minded [about private equity],” he was invited to a formal meeting in Baotou, Little Sheep’s headquarters. Reflecting on the initial exchange, Wang said: “At a time when few in China understood the difference between private equity and investment banking, Lu was very sophisticated and ahead of the curve.” It turned out that earlier in his career, Lu had worked on the senior management team of Meng Niu when it received a widely publicized investment from Morgan Stanley and CDH, a well- known Chinese private equity fund. Based on this pre- vious experience, he was predisposed to working with a private equity investor.

Winning the Mandate After the initial meeting in August, 3i engaged in a four-month competition with other private equity suitors, including Goldman Sachs and Morgan Stan- ley, before finally being awarded the Little Sheep mandate. During this period, Anna Cheung, a 3i partner based in Hong Kong, was assigned as the senior member on the team working with Wang to secure the mandate. The investment team flew to Baotou frequently, getting to know Little Sheep’s senior management team and explaining 3i’s invest- ment philosophy. At the same time, the team spoke with a number of research analysts covering the Hong Kong and Chinese restaurant sector to learn more about the sector and shared its findings with Little Sheep senior management. The team also

EXHIBIT 3 Little Sheep’s Footprint in China (as of the end of 2005)

Source: Company documents; http://www3.weforum.org/docs/WEF_IV_PrivateEquity_Report_2008.pdf.

396 INTEGRATIVE CASE 1 3i Group ’s P r iva te Equ i t y Inves tment in Ch ina ’s L i t t l e Sheep

tapped into 3i’s network of industry experts (via 3i’s People Program) and identified Nish Kankiwala, former president of Burger King International, as a

suitable advisor for Little Sheep. As the top executive at one of the world’s largest fast-food restaurant chains, Kankiwala would bring a wealth of sorely

EXHIBIT 4 Growth Statistics for the Chinese Restaurant Industry

0 2001 2002 2003

Years

R M

B b

2004 2005

400

800

1200

Revenue of China’s restaurant industry (2001–2005)

CAGR = 19.4%

Source: Company documents; http://www3.weforum.org/docs/WEF_IV_PrivateEquity_Report_2008.pdf.

EXHIBIT 5 Hot Pot Restaurant as a Sub-sector of the Dining Industry

100% = 822.0 [bn RMB]

16%–22%

Non-hot pot

Hot pot

Chinese food volume in 2005 Comments

• Data from China Restaurants in Chain Statistics Yearbook • Hot pot market share is growing – 14.7% in 2003 – 21.2% in 2004

• A telephone survey conducted by Roland Berger found on average hot pot dining represents 15%–20% of overall restaurant spending

Hot pot's market share of the restaurant industry is estimated to be 16% to 22% of the Chinese food industry on a growing basis.

Source: Company documents; http://www3.weforum.org/docs/WEF_IV_PrivateEquity_Report_2008.pdf.

INTEGRATIVE CASE 1 3i Group ’s Pr i va te Equ i t y Inves tment in Ch ina ’s L i t t l e Sheep 397

needed knowledge about the franchise business. At the request of the 3i team, Kankiwala flew to Beijing and spent a number of days meeting with Little Sheep’s entire senior management team, learning the ups and downs of the company’s performance and discussing the relevance of his own experience to Little Sheep’s future strategy. This was the first time that Little Sheep managers had direct access to a world-class expert with a deep understanding of their business, and they were impressed by 3i’s commitment and ready access to this caliber of expertise.

But the specter of Goldman Sachs continued to lurk in the background. Wang heard that his former Gold- man colleagues were visiting Little Sheep in Baotou in late 2005, so he immediately flew there and was “pre- pared to sit there until we signed the term sheet.” His persistence paid off, and four months after Wang’s August cold call, 3i signed a term sheet with Little Sheep, agreeing to a $25 million equity investment for a minority stake in the company. (Prax Capital, a private equity fund focused on Chinese investments, invested $5 million as a co-investor.) The transaction closed six months later in June 2006, and 3i’s real value-add to the company began to take shape.

Forming a Strategic Blueprint During the six-month period between the signing of the mandate in late 2005 and the final closing in June 2006, 3i worked closely with Little Sheep management to clarify a number of strategic questions that the company needed to address, and an agreement was reached to engage Roland Berger, a strategy consulting company, to provide fact-based analysis as a basis for resolving some of the most pressing issues.

Based on extensive data collection and analysis, the consultants made a number of specific recommen- dations, such as optimal store size and location in different sub-markets6 and how the company should overhaul its existing franchises (as described in the next section). These findings and recommendations became the basis of a blueprint that outlined a step-by-step effort to professionalize and improve the company’s operations. When the analysis and recommendations

were presented to the Little Sheep board, the response was highly favorable.

Mapping Strategy to Operations: The 180-Day Plan Aided by the strategic insights gained from Roland Berger’s report, 3i’s Wang drafted a “180-day plan,” a detailed work plan of tasks that the company needed to address in the ensuing six months, including specific financial, legal, operational, and HR issues (see Exhibit 6). After discussing the plan with the management and obtaining full commitment to executing it, its progress was then continuously tracked and updated. 3i partner Anna Cheung explained: “The 180-day plan helped to provide structure and a time frame that gave all parties involved a goal to work towards.”

This detailed level of post-investment involvement is standard for all 3i investments, and it confirmed for the Little Sheep management team that 3i was willing and able to provide the non-financial benefits that it had been seeking from its private equity investor.

Strengthening the Management Team and the Board Both 3i and Little Sheep understood clearly that a critical task for the company prior to a public listing was strengthening the management team and board struc- ture. Little Sheep’s management team had a high level of integrity and drive but lacked depth: the entire top management team consisted of founder and CEO, Zhang, a senior vice president of finance, and three regional vice presidents (see Exhibit 7). Even more significantly, as Wang remarked, “the company lacked systems such as centralized operation management, new store develop- ment and marketing teams which were crucial for the company to continue to grow in a coordinated man- ner.” Through the years, the company had been carried forward almost entirely by a small team of managers united and motivated by the founder’s sheer personal strength and charm. “The founder, Mr Zhang, is an inspirational person,” remarked Cheung. As one of Zhang’s lieutenants would confirm, Zhang was “the heart

6 For example, Roland Berger found that the optimal store sizes for tier-1, tier-2, and tier-3 cites were 1200 m2, 600 m2, and 300 m2, respectively, and that the reason for most under-performing stores (profitability < 5% of sales) was due to a wrong store location.

398 INTEGRATIVE CASE 1 3i Group ’s P r iva te Equ i t y Inves tment in Ch ina ’s L i t t l e Sheep

EXHIBIT 6 Highlights from the “180-Day Plan”

# ISSUES TIMING ACTION / OUTPUT

I. Legal

…

g. Lease agreement

Within 6 months - Renew lease agreements by 31 July 2006 - Revise certain lease agreements (identified in legal due diligence) by 31 July 2006 - …

… -

i. Other permits and certificates

Within 12 months - Obtain compliance with fire safety and environmental protection within 12 months

II. Financial

a. Internal System Within 3 months— report and recommendations; within 12 months— adoption of recommendations

- … - Engage a leading accounting firm to examine systems, processes, and controls

to ensure speedy and accurate information flow - Recommendations for improvements to be presented at first Board meeting

post-completion. Satisfactory system in place in 12 months - …

…

III. Business and Operations

…

c. New site selection

By 31 September 2006 - Standardize and formalize location assessment process - Set up a dedicated team responsible for new site selection for the whole group - Establish a set of criteria such as those in the Roland Berger report - …

…

e. Store-level operational improvement

Assign responsibilities and agree on action plan within 3 months

- Refine operations manual - Step up staff training and communications - Enhance internal audit and increase frequency of store checks - Implement KPI benchmark at city/provincial, regional, and national levels

… -

Source: Company documents; http://www3.weforum.org/docs/WEF_IV_PrivateEquity_Report_2008.pdf.

INTEGRATIVE CASE 1 3i Group ’s Pr i va te Equ i t y Inves tment in Ch ina ’s L i t t l e Sheep 399

and soul” of the business. But there was a pressing need to recruit additional professional managers, install man- agement information systems, and revamp the structure and responsibilities of the board.

In this regard, 3i was instrumental in helping Little Sheep gradually put a strong team and a governance system in place. Once 3i made the investment, Cheung and Wang both joined the board as non-executive directors. 3i also recruited two additional independent directors with strong industry experience: Nish Kanki- wala, the former president of Burger King International who played a part in the deal initiation process, and Yuka Yeung, CEO of the KFC franchise in Hong Kong. Both individuals had extensive experience in the food industry and were exactly the type of high-level indus- try people that Little Sheep had been looking for.

Instead of viewing these new directors as outsiders, however, Little Sheep’s top management enthusiasti- cally welcomed them as partners capable of adding considerable value to the company. When 3i proposed four board meetings per year, Little Sheep came back and asked for more. “Little Sheep is the only company I have worked with that has asked for more board meet- ings… Zhang is an extraordinary entrepreneur, but he was very humble and eager to learn. This is one of the most impressive things about the company,” Cheung commented.

The newly constituted board immediately began to focus on adding depth to the management team. Up to this point, Zhang had served as both the board chair- man and CEO and had tended to delegate much of routine management to members of his senior manage- ment team. One of the first 3i recommendations was to recruit a full-time CEO dedicated to overseeing day-to- day management of the business. “We practically insisted on it,” recalled Wang. In addition, based on 3i’s recommendation, the board agreed to create new positions for a COO and a CFO, but emblematic of China’s thin supply of professional managers, it would take more than a year to recruit the right candidates. (See Exhibit 8 for Little Sheep’s organization chart as of October 2007.)

Creating a Standards Committee Until these three new senior executives could be recruited, an interim management solution was needed. 3i proposed—and the board agreed—to create a Stan- dards Committee consisting of Little Sheep’s existing management team, plus Wang. The committee’s pur- pose was to serve as interim CEO, focusing especially on enhancing the communication and coordination among the three regional operations until a proper headquarters could be set up. For the first three months between June and September 2006, the committee met bi-weekly to

EXHIBIT 7 Little Sheep’s Management Team before 3i’s Investment

Vice President of Shenzhen Region

Senior Vice President of Finance

Mr. Lu Wen Bing, Ex-Meng Niu executive

Vice President of Beijing Region

Vice President of Shanghai Region

Board Chairman/CEO Mr. Zhang Gang,

Founder of Little Sheep

Source: http://www3.weforum.org/docs/WEF_IV_PrivateEquity_Report_2008.pdf.

400 INTEGRATIVE CASE 1 3i Group ’s P r iva te Equ i t y Inves tment in Ch ina ’s L i t t l e Sheep

discuss detailed operational matters and make decisions to be carried out by the three regional VPs. Gradually, as internal communication improved and key headquarters functions were established, the Standard Committee evolved to become a series of monthly meetings focused more on long-term strategic issues, such as new-store developments, marketing, and budgeting. Finally, in November 2007, with the establishment of Little Sheep’s new national operation headquarters in Shanghai, the committee was formally dissolved.

Creating and Executing a New Franchise Strategy Although Little Sheep had taken the initiative to halt the awarding of new franchises in 2003, the existing sprawling network of over 500 franchises was not sys- tematically addressed prior to 3i’s involvement. Symp- tomatic of the problem was the fact that management had actually lost count of the exact number of stores in the Little Sheep network. Cleaning up the existing franchise system and designing a new franchise strategy thus became a top priority for the newly constituted board. Based on the insights from the Roland Berger

report, the board came to the conclusion that the new strategy should focus on quality rather than quantity and that the franchise system should become more centrally managed. Not only was this consistent with protecting and strengthening the Little Sheep brand, it was also made feasible by the strengthened manage- ment and headquarters capabilities. The following three-phased overhaul of the franchise system was agreed on and carried out:

• Phase 1: Cleaning up the existing franchise system. A systematic effort was taken to visit and catalogue every franchise in the country. These visits generated store-by-store information that was fed into a database created to track critical performance indicators and served as a basis for making decisions about the future status of each franchise. More than 200 franchises that had clearly violated the franchise agreement or did not meet Little Sheep’s quality standards were closed. Others that were performing reasonably well had their franchise agreements renewed, and the best-performing stores were bought back by Little Sheep to become directly owned as part of the new, more centralized strategy. This task was complete by the end of 2006.

EXHIBIT 8 Little Sheep’s Management Team after 3i’s Investment

General Manager of

Shenzhen Region

Chief Operating Officer

Mr. Yuka Yeung

Chief Financial Officer

Mr. Daizong Wang

Vice President for

Corporate Office

Vice President Beijing Region

Franchise Business

General Manager of

Shanghai Region

Board Chairman Mr. Zhang Gang,

Founder of Little Sheep

Chief Executive Off icer Mr. Lu Wen Bing

Source: http://www3.weforum.org/docs/WEF_IV_PrivateEquity_Report_2008.pdf.

INTEGRATIVE CASE 1 3i Group ’s Pr i va te Equ i t y Inves tment in Ch ina ’s L i t t l e Sheep 401

• Phase 2: Enhancing training and support to remaining franchise stores. Phase 2 involved stepping up the training for all franchise personnel through an elaborate new program consisting of various stages of training at headquarters, on site, and during regular national and regional franchisee meetings. In addition, headquarters staff members continued to provide on-site training during their regular store visits.

• Phase 3: Developing new franchise stores. The final phase in the new franchise strategy was to proactively develop new stores and grow the franchise fee base. In contrast to the traditional, passive expansion method of responding when potential franchisees called, Little Sheep’s new, active approach began with research into the local business environment, which then led to a choice of locations. The company then actively sought out restaurant operators with good reputations to run the franchise stores.

In little more than a year, this new proactive strategy transformed the profile of Little Sheep’s franchise sys- tem. The company moved from having 40 directly owned stores to over 500 franchises before the 3i investment to a more balanced mix of 101 to 260 by late 2007. Even with a dramatically decreased total store count, these fundamental changes resulted in year-on-year revenue growth of close to 40%, double the industry average of about 20%.

Shelving the International Expansion Plan Prior to 3i’s investment, Little Sheep had an ambitious plan for international expansion. With successful res- taurants already operating in Toronto and Hong Kong, management was eager to accelerate the pace of over- seas growth and establish the Little Sheep brand name globally. Each regional VP was designated to lead expansion efforts in different overseas regions—North America, North Asia, and South East Asia—even though they were already stretched thin managing their domestic operations.

Little Sheep’s overseas ambitions were quite common among the new generation of Chinese private enter- prises. On this issue, however, 3i and Little Sheep man- agement had different views. Even though 3i was well placed to provide introductions and on-the-ground

support for an overseas expansion, it strongly recom- mended that Little Sheep initially focus on strength- ening domestic operations rather than rushing into overseas expansion. “Given the vast and yet untapped opportunities in China’s restaurant industry, it is stra- tegically important for Little Sheep to leverage the leading market share and brand name it has already established to secure a dominant market position at home before expanding its operations overseas,” Cheung explained.

Although management initially resisted this 3i recommendation, Zhang later conceded that this was a sensible approach. Looking back on the incident, one of the independent directors viewed the outcome as one more example of the company’s fundamental strength: “They [Little Sheep management] are open-minded, and very willing to listen,” remarked Yuka Yeung, “which is really remarkable. It is a learning company.”

Early Results From the time of 3i’s investment in mid-2006 until the end of 2007, Little Sheep opened 37 new stores and achieved year-on-year revenue growth of 40%, far in excess of the 15%–20% average growth in China’s food sector. The strong revenue growth was also fueled by the evolution of Little Sheep from a pure restaurant business into a more diversified food and beverages group with two meat processing facilities, a packaged-seasoning plant, a logistics company, and a number of regional subsidiary com- panies. Little Sheep also completed its search for new senior executive talent: Daizong Wang validated his confidence in Little Sheep by resigning from 3i in October 2007 to become Little Sheep’s new CFO, and Yuka Yeung, one of the independent directors and the former CEO of KFC’s Hong Kong franchise, became the new COO.

Conclusions At first glance, the pairing of 3i, a global private equity group with almost no track record in China, and a restaurant chain with origins in remote Inner Mongolia might seem like an odd and unlikely match. But the story of their relationship conforms to many of the fundamental characteristics of successful private equity transactions, especially in emerging markets. First, the

402 INTEGRATIVE CASE 1 3i Group ’s P r iva te Equ i t y Inves tment in Ch ina ’s L i t t l e Sheep

initial driver that allowed 3i to win the mandate after an intense contest with better-known competitors was chemistry, or the ability to make the founder comfor- table with its industry expertise, commitment to the company, and approach to post-investment value crea- tion. Money was secondary. Second, Little Sheep’s founder had the foresight and self-confidence to recog- nize the value of accepting an active investor into his company. Even though he had never heard of 3i before meeting Daizong Wang, he and his senior management team exhibited an openness and eagerness to learn from outsiders, which is not always the case, especially with closely held family-run firms in emerging markets. Third, this is a textbook case of the positive results that stem from closely aligned interests between a private equity investor and the management of a portfolio company. From the beginning, the 3i team was excep- tionally hands on, working closely with the company’s senior management team on a continuous basis to make significant changes in the company, always with an eye to building value and moving closer to the day when Little Sheep would be positioned to successfully execute an IPO. The combination of these three factors go far to explain the ingredients required for successful private equity transactions in emerging markets—or anywhere.

C A S E D I S C U S S I O N Q U E S T I O N S

1. From an industry-based view, identify some of the competitive forces affecting the Chinese restaurant industry.

2. What are the key factors that explain the success of Little Sheep? What are the main obstacles associated with its continued growth?

3. From a resource-based view, explain the non- financial benefits that 3i can bring to Little Sheep. In other words, why did 3i win the competition against other private equity suitors such as Goldman Sachs and Morgan Stanley?

4. Compare and contrast the similarities and differences between the typical mid-size private equity investments in the West and such investments in China (as captured by this case). If you were a manager working for a Western private equity firm (such as 3i), what lessons would you draw from this case?

5. If you were an entrepreneur at a firm in China (such as Little Sheep) or in emerging economies in general, what lessons would you draw from this case?

INTEGRATIVE CASE 1 3i Group ’s Pr i va te Equ i t y Inves tment in Ch ina ’s L i t t l e Sheep 403

INTEGRATIVE CASE 2

TeliaSonera: A Nordic Investor in Eurasia1

How did TeliaSonera grow from being a local telecom provider in the Nordic region to a trend-setting international player in Eurasia markets?

Canan Mutlu, University of Texas at Dallas

Today, climbers can have 3G access on Mount Everest to brag about their experience on top of the world. How- ever, not many people know that it is a Nordic company providing this service in such an alien environment. The company is TeliaSonera, which provides telecommunica- tions (hereafter “telecom”) services in a wide geographic area from Nordic countries to Nepal that includes the emerging and highly valued Eurasia markets. TeliaSonera is the fifth largest telecom operator in Europe and has operations in Azerbaijan, Belarus, Denmark, Estonia, Finland, Georgia, Kazakhstan, Latvia, Lithuania, Mol- dova, Nepal, Norway, Russia, Spain, Sweden, Tajikistan, Turkey, Ukraine, and Uzbekistan.

As a Swedish-Finnish company, TeliaSonera launched the world’s first 4G network. Spanning from the Nordic and Baltic countries to the Himalayas, TeliaSonera serves more than 150 million customers in total. Listed on NASDAQ OMX Stockholm and NASDAQ OMX Helsinki, TeliaSonera had net sales of around US$15.9 billion and EBITDA of US$5.6 billion, and enjoyed a market value of US$31 billion as of April 2010. How did TeliaSonera grow from being a local telecom provider in the Nordic region to a trend-setting international player in Eurasia markets (see Exhibit 1)?

Merger of Telia & Sonera TeliaSonera emerged as a company after the merger of Telia of Sweden and Sonera of Finland in 2002. Telia’s history goes back to the early 1900s, when the Swedish government established a state-owned monopoly tele- phone company in the name of Royal Telegraph Ser- vice, which became Televerket in 1953. How could a

state-owned monopoly evolve into a modern, private, and competitive company?

The rules of the game began to change for the telecom industry toward the end of the 20th century. First, accelerated technologies in the form of cordless and mobile phones forced Televerket to re-evaluate its organizational capabilities. Second, new private players started to enter the Swedish telecom market. Third, the fall of the Berlin Wall in 1989 presented new invest- ment opportunities in Eastern Europe markets. With an urge to modernize the company and respond to these opportunities and challenges, Televerket was privatized and removed from the national budget in 1984. After investing in several Eastern Europe coun- tries, Televerket converted into Telia AB in 1993, a private and competitive company that operated both in Sweden and Europe’s liberalized telecom market.

Finland was governed by Russia between 1809 and 1917, and its telegraph operations had been part of the Russian state telegraph system since 1855. However, as Finland declared independence in 1917, the country’s tele- phone system went under the control of private parties, unlike the early state monopoly of Sweden. However, the government still controlled the expansion of telecom sys- tems in rural and international areas. In 1921, about 850 private telecom companies united into a federation, which was named Finnet later in 1996. Eventually, the Finnish telecom market had two major players, one state-owned and one private. The telephone part of the state-owned company turned into a commercial company in 1994 in the name of Telecom Finland. Introduced in the stock exchange in 1998, the company’s name changed to Sonera.

1 This case was written by Canan Mutlu (University of Texas at Dallas) under the supervision of Professor Mike Peng. © Canan Mutlu. Reprinted with permission.

404 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

The fall of the Berlin Wall in 1989 and the EU’s new telecom policies presented both challenges and opportu- nities. Financial restrictions and the necessity to face new opportunities with a stronger cooperation led Telia of Sweden and Sonera of Finland to merge in 2002. In the Baltic countries, Telia and Sonera joined forces to build fixed and mobile networks. They were on the scene even before the collapse of the former Soviet Union in the early 1990s. Telia already had experience operating mobile companies in various countries in Asia, Africa, Latin America, and Europe. The most significant aspect of this collective power was displayed in its Eurasia expansion.

Eurasia Expansion Distinguishing its markets as mature and growth mar- kets, TeliaSonera identified its operations under three business areas: mobility services, broadband services, and Eurasia (see Exhibit 2). Mature markets especially consisted of the Northern Europe countries, where cus- tomers demand value-added services that can best be used with smartphones. The leading growth market, Eurasia, was named as its growth engine by TeliaSonera.

TeliaSonera developed aggressive goals for its Eurasia operations: (1) double-digit revenue growth, (2) defend- ing the EBITDA margin, (3) taking a leading position in mobile data, and (4) increasing ownership in core hold- ings. What are the underlying reasons that led to the successful expansion of TeliaSonera in these challenging yet attractive markets? TeliaSonera’s operations in Eur- asia, where the institutional frameworks are either in transition from planned to market economy or relatively weak compared to Europe, can be examined under the lens of the strategy tripod in terms of the resource-based, institution-based, and industry-based views.

First, TeliaSonera leveraged its decades of telecom expertise developed in Nordic countries in the developing countries of Eurasia region. The technical know-how and deep customer understanding of the company as unique resources enabled operations in difficult areas to be smoother and less problematic. TeliaSonera utilized its know-how specifically in infrastructure investments in the region. The highly technological and better quality network investments provided TeliaSonera a leading edge in the region compared to local competitors. This high

EXHIBIT 1 TeliaSonera’s Eurasia Operations

COUNTRY POPULATION GDP GROWTH

BRAND NAME

TELIASONERA OWNERSHIP

MARKET POSITION

SUBSCRIPTION RATE

MARKET SHARE

Azerbaijan 9 million 2.8% Azercell 51.3% 1 4 million 55%

Georgia 4.4 million 5.5% Geocell 100.0% 1 2 million 44%

Kazakhstan 16.5 million 5.9% Kcell 51% 1 9 million 50%

Moldova 3.6 million 4.5% Moldcell 100% 2 907,000 32%

Nepal 28.5 million 4.5% Ncell 80.0% 2 4.1 million 42%

Russia 141.9 million 4.8% MegaFon 43.8% 2 57 million 26%

Tajikistan 7.1 million 5.8% Tcell 60% 1 1.7 million 36%

Turkey 73.7 million 4.6% Turkcell 38% 1 34 million 55%

Uzbekistan 27.8 million 7% Ucell 94% 2 7 million 32%

Source: TeliaSonera website, http://www.teliasonera.com.

INTEGRATIVE CASE 2 Te l iaSonera : A Nord ic Inves tor in Euras ia 405

investment cost turned into a larger and more satisfied customer base, upgrading TeliaSonera into the leading positions in most countries. Moreover, the technology expertise reflected in infrastructure investments expedited the government relations and related bureaucratic issues.

Second, TeliaSonera faced certain challenges due to weak institutional settings, especially in former Soviet Union countries in Eurasia. Although each country is in a different phase of transition to market economy, the economic, legal, and regulatory systems are still highly bureaucratic and risky. The ambiguity in the institutional frameworks brings additional risks for businesses, signifi- cantly increasing the costs of investments. The telecom industry has further liabilities in terms of infrastructure spending and related fix costs. TeliaSonera’s success in its Eurasia expansion lay in utilization of strong business and government ties that were developed in decades throughout the company’s history in the region.

Third, the market conditions in Eurasia countries pre- sent many opportunities for technology companies. In contrast to developed European countries, fixed networks are not as developed, which in turn makes these countries rely more on mobile networks. This in fact means a jump into a higher technology for consumers. Moreover, mobile network penetration is lower in Eurasia than in TeliaSonera’s mature markets, offering a great deal of potential for TeliaSonera’s mobile operations. There are fewer competitors, which enables higher margins to be reaped. Moreover, many Eurasia markets welcome for- eign direct investments (FDI) as a source of economic development. Thesemarket conditions not only increased

the attractiveness of the region forTeliaSonera but also the likelihood of future investments.

Another significant aspect of market conditions is a larger and younger population that is the number one customer group of new technologies and telecom services in Eurasia countries. This provided a huge sales oppor- tunity for TeliaSonera’s telecom services in the region. For example, although it is below the level of developed economies, the use of mobile data services showed an increasing trend and constituted a big share in total revenues in Eurasia markets (see Exhibit 3). Moreover, improved macroeconomic situations and growing econo- mies led to strong subscription intake, which increased revenues by 16% in 2010. By further leveraging its cap- abilities, TeliaSonera set its target to become the number one player in Eurasia and neighboring region, which has a population of more than 380 million.

Alliances and Acquisitions in Eurasia How could a Nordic company with roots in highly developed markets in Europe expand in such politically risky and institutionally ambiguous settings? Savvy use of alliances and acquisitions in Eurasia appeared to be a key. Itself the result of a merger between Telia of Sweden and Sonera of Finland in 2002, TeliaSonera certainly understood the importance of alliances and acquisitions. Its alliances and acquisitions throughout Eurasia resulted in enviable performance in many host countries, often commanding either the number one or number two positions (see Exhibit 1).

EXHIBIT 2 TeliaSonera’s Business Areas

MOBILITY SERVICES

Mobile communication services. The business area is composed of mobile operations in Sweden, Finland, Norway, Denmark, Lithuania, Latvia, Estonia, and Spain.

BROADBAND SERVICES

Communication and entertainment services to corporate and individual customers. The business area is composed of operations in Sweden, Finland, Norway, Denmark, Lithuania, Latvia, Estonia, and international carrier operations.

EURASIA TeliaSonera is the biggest telecom investor in Eurasia. The business area is composed of mobile operations in Kazakhstan, Azerbaijan, Uzbekistan, Tajikistan, Georgia, Moldova, and Nepal. The business area is also responsible for developing TeliaSonera’s shareholding in Russian MegaFon and Turkish Turkcell.

Source: TeliaSonera website, http://www.teliasonera.com.

406 INTEGRATIVE CASE 2 Te l iaSonera : A Nord ic Inves tor in Euras ia

Nepal is an interesting case study for TeliaSonera`s challenges in Eurasia. After TeliaSonera’s acquisition of 80% equity of Nepalese youth brand MeroMobile in 2008, the start-up company, which was now called Ncell, grew into a GSM leader in the whole country. However, the road to success had serious difficulties. There was an ongoing political and security crisis involving terrorist attacks and union strikes, which negatively affected multi- nationals. TeliaSonera contributed to the efforts to over- come such host country difficulties by offering world-class technologies to this country traditionally suffering from poor telecommunications and also by generating local jobs and employment opportunities. The base stations (cell transmission towers) increased from 300 to 1500 in three years. As a result, the percentage of the population covered by mobile TeliaSonera networks increased from 44% to 80%. Another significant contributor was the use of local employees. Other than employing 25 expatriates, Ncell created 500 solid jobs for locals in a variety of positions.

TeliaSonera’s operations in Eurasia aimed to be the trendsetter in these highly dynamic and low penetra- tion markets. For example, its alliance with a local player, Kcell (in which TeliaSonera held a 51% share), was the first company to launch GPRS technologies that provided Kazakhstan people the opportunity to access Mobile Internet, WAP, and MMS services. Kcell owed its reputation to providing the best net- work coverage and also distribution systems in the whole country. In addition, the young and dynamic population generated a promising customer base for mobile data services, which already made 8% of total Kcell revenues.

New Branding Strategy Operating in such a broad geographic area, TeliaSonera refined its branding strategy to identify its operations under one brand image in 2009. Eighteen brands of TeliaSonera from Nordics to Nepal began to use the

EXHIBIT 3 TeliaSonera’s Mobile Data Potential and Revenues

Denmark Ncell 3% Tcell 3% Geocell 3% Moldcell 4% Azercell 6% Ucell 6% Kcell 8%

Penetration

Mobile Broadband Market Maturity Stages Mobile Data as Percent of Total Revenues

NorwayUS

Finland Netherlands SpainIreland

Italy Greece

Lithuania UAE

Croatia

Bahrain

Russia Romania

Time

Poland Turkey

Kazakhstan Latvia

Moldova Georgia

Uzbekistan India

AzerbaijanTajikistan Nepal

Source: TeliaSonera website, http://www.teliasonera.com.

INTEGRATIVE CASE 2 Te l iaSonera : A Nord ic Inves tor in Euras ia 407

same brand image to convey the customers the message of unity under a strong, multinational brand. At the same time, the local brand names were not altered. Lars Nyberg, CEO and president of TeliaSonera, explained:

Our strength lies in the combination of two features: leading and local. We are one of Europe’s leading operators with international strength and reach. At the same time, we have strong local brands and operate very close to our customers on each market. Therefore, it is natural to keep the name of the strong local brands but adding a unifying visual brand symbol. This strategy also clearly differentiates us from our competitors.

The most interesting aspect of this change was that the new branding strategy was first tested in the Eurasia markets in Kcell (Kazakhstan), Geocell (Georgia), Ncell (Nepal), Tcell (Tajikistan), Azercell (Azerbaijan), Moldcell (Moldova), and lastly in Ucell (Uzbekistan) as seen in Exhibit 4. The new brand identity united the local companies under the same umbrella and turned out to be a success in the region that led the companies to protect their leading market positions. Defined as “the next step on our journey to unify the company” by Lars Nyberg, the new branding strategy took off from Eurasia and spread to the Nordic and Baltic region. This harmonization in branding enabled TeliaSonera to further spread and better defend its extensive telecommunication technology in risky but high opportunity markets.

Sources: Based on publicly available information and press releases of TeliaSonera. The following sources were primarily helpful: (1) TeliaSonera CEO’s speech Annual General Shareholders Meeting April 6, 2011; (2) TeliaSonera Annual Report 2010; (3) TeliaSonera Investor Day, 2011.

C A S E D I S C U S S I O N Q U E S T I O N S

1. How would you characterize the competitive intensity and attractiveness of the telecom industry in Eurasia by using Porter`s Five Forces?

2. Many multinational companies fail in their expansion in emerging economies. What are the main capabilities and resources that drive TeliaSonera`s successful growth in Eurasian markets?

3. Given the institutional differences between European and Eurasian markets, what are the main challenges faced by TeliaSonera in its international expansion strategy? Which strategies enable TeliaSonera to minimize the risks of these challenges?

4. How does TeliaSonera differentiate itself from its competitors in Eurasian markets?

EXHIBIT 4 TeliaSonera’s Eurasian Brands

Megafon

Kcell

Azercell

Turkcell

Geocell

Moldcell

Tcell

Ncell

Ucell

408 INTEGRATIVE CASE 2 Te l iaSonera : A Nord ic Inves tor in Euras ia

INTEGRATIVE CASE 3

The Indian Business Process Offshoring Industry1

How has the Indian BPO industry evolved? What are its recent trends after the global recession?

Debmalya Mukherjee, University of Akron

The global business process offshoring (BPO) industry is estimated at more than $50 billion in 2012. India accounts for more than 30% of the worldwide BPO market and remains the world’s most attractive desti- nation for BPO services delivery. Recent estimates sug- gest that the BPO sector in India directly and indirectly employs over 4.5 million people, with 50% of these employees younger than 25 years.

Industry Evolution BPO as a strategic device gained popularity among companies in developed economies chiefly due to its cost attractiveness. In addition, a vast pool of English- speaking graduates who can perform the BPO activ- ities at a fraction of the cost in developed economies makes India a popular destination for companies worldwide. The BPO industry has evolved dramati- cally in the past two decades. It first gained impetus in the early 1990s when Western companies, driven by increasing cost pressures, started to offshore routine information technology (IT) activities such as testing, simple coding, and data entry to countries such as India, China, and the Philippines. The next wave of offshoring involved business processes that are more knowledge intensive than low-complexity IT activities. As offshoring service providers scaled up their opera- tions and became more specialized, an increasing number of multinationals began to offshore more knowledge-intensive IT and BPO functions including R&D, product design, analytical research, and engi- neering services.

Genpact, Aegis, Tata Consultancy Service (TCS), WNS Global services, Wipro BPO, Infosys BPO, Mphasis, HCl

Technologies, and Sparsh are some of the key players in this fiercely competitive and increasingly growing industry. Their clients include most Fortune 500 companies. Two retail giants, the UK-based Tesco and the US-based Home Depot, have been outsourcing pro- jects to Indian third-party service providers, including TCS and Infosys, apart from Tesco’s and Home Depot’s own captive centers. Tesco, for instance, saves over $100 million every year by outsourcing some of its IT projects to India and primarily drives projects from its own cap- tive center in Bangalore.

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409 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

BPO providers such as TCS BPO, Wipro, Genpact, Infosys, and WNS are global players capable of offer- ing a diversified portfolio of services and also posses- sing the capabilities to deliver globally. TCS, one of Target’s BPO partners, supports the retailer’s opera- tions from its delivery centers in Uruguay and Chile, in addition to India. TCS recently bagged a multi-year BPO deal of $2.2 billion from the UK-based Friends Life, a provider of pensions, investments, and insur- ance. Small and mid-sized players offering a more focused portfolio of services represent over 60% of the market.

Interestingly, a recent trend for client firms has been to divest their non-core captive centers to the top BPO players in exchange for better outsourcing rates and long-term contracts. In 2008, Citibank sold its Indian back-office business to TCS for $505 million and Citi Technology Services sold its own in-house captive cen- ter for $127 million to Wipro. These transactions were coupled with the assurance of $3 billion in business for TCS and Wipro. In a win-win situation, Citigroup benefited from freed-up financial resources that had been tied to its non-core business. The close partner- ships with firms in developed economies have helped the Indian BPO companies to scale up their service offerings. The industry players have invested heavily to reinforce their relationship management with the client firms and develop capabilities to serve newer industries (such as healthcare) and also across the full range of the product development value chain. In 2011, the engineering design and products devel- opment segments grew by 13.6% to generate reve- nues of $9 billion.

The Impact of the Global Recession The global recession and the careful spending of North American and European companies have also impacted the dynamics of the Indian BPO industry in at least two ways. First, several BPO providers have started addressing newer and mostly untapped markets in Europe, Asia, and Latin America. Wipro, for instance, has expanded its existing operations in Germany by setting up centers in six German cities. Infosys is also expanding its European operations. TCS has recently set up a global delivery center in Buenos Aires, Argentina. In an effort to better serve

the US market, the former GE spin-off Genpact acquired Headstrong, a Virginia-based consulting and IT services company with a specialized focus in financial services, for $550 million. In 2011, Gen- pact also acquired EmPower Research, a New York- based integrated media and business research com- pany that has strong capabilities in social media research and measurement with office locations in New York, Bangalore, Cincinnati, New Jersey, San Francisco, and London.

Second, huge opportunities for growth lie in the domestic market itself. Infosys entered the domestic market in 2008. It has entered into a partnership with Airtel and is actively trying to grab big govern- ment projects as the Indian economy continues to grow despite the global recession. Recently, Infosys concluded a $45.3 million deal to help Indian Rail- ways, the largest railway network in the world, to build an integrated coach management system. Indian IT firms are also increasing their focus on the domestic market to enhance their skill sets. More opportunities exist in the utilities industries, includ- ing power, oil, gas, and water distribution projects. Handling such big projects may also help these pro- viders develop capabilities that can be successfully exploited in other emerging markets.

Sources: Based on (1) BusinessWeek, 2009, Indian outsourcing companies: Look for new markets, October 12: http://www. businessweek.com/globalbiz/content/oct2009/gb20091012_ 021104.htm; (2) IndiaTechOnline, 2011, India BPO still rules: Nasscom, October: http://indiatechonline.com/nasscom-bpo- summit-2011-543.php; (3) B. Kedia & D. Mukherjee, 2009, Understanding offshoring: A research framework based on disintegration, location, and externalization advantages, Journal of World Business, 44: 250–261; (4) S. Lahiri, B. Kedia, & D. Mukherjee, 2012, The impact of management capability on the resource-performance linkage: Examining Indian outsourcing providers, Journal of World Business, 47: 145–155; (5) www. nasscom.in.

C A S E D I S C U S S I O N Q U E S T I O N S

1. How would you characterize the competition in the Indian BPO industry?

410 INTEGRATIVE CASE 3 The Ind ian Bus iness P rocess Of f shor ing Indus t ry

2. What unique resources and capabilities help Indian BPO firms to compete globally and also enter new markets?

3. What formal and informal institutions may accelerate or constrain the growth of the Indian BPO industry?

4. ON ETHICS: As CEO of any of the leading Indian BPO providers, how do you answer a US reporter who asks: “Many Americans believe outsourcing IT/ BPO work has destroyed a lot of US jobs. What do you think?”

INTEGRATIVE CASE 3 The Ind ian Bus iness Process Of f shor ing Indust ry 411

INTEGRATIVE CASE 4

Wynn Macau: Gambling on the Edge of China1

Las Vegas-based Wynn Resorts entered Macau in 2002. How did it emerge to become the leader in Macau’s gaming industry in ten years? What are its future challenges?

Javier C. Cuervo, University of Macau

The liberalization of the gaming industry in Macau, a Special Administrative Region (SAR) of the People’s Republic of China, attracted eager bidders to operate casinos in the former Portuguese enclave. In 2001, the year before the casinomonopoly of Stanley Ho’s S.T.D.M. ended in Macau, gross gaming revenues (GGR) were US$2.3 billion. By 2011, GGR increased to US$33.5 billion. Macau’s 29.7 square kilometer area attracted a record-breaking 28 million visitors in 2011—a big leap from the 10 million visitors in 2001.

In January 2012, visitor arrivals increased by 18.6% year on year, with those coming from mainland China representing 60.7% of the total of 2,461,640 visitors.

Visitors from other major markets came from Hong Kong (26%), Taiwan (3.5%), South Korea (1.9%), Japan (1.3%), and Southeast Asia.

The GGR pie is now shared by six players: (1) Sociedade de Jogos deMacau, S. A. (“SJM”)—a subsidiary of S.T.D.M.; (2) Galaxy Casino, S.A. (“Galaxy”); (3) Wynn Resorts (Macau), S.A. (“Wynn”); (4) VenetianMacau S.A. (“Vene- tian”); (5) MGM Grand Paradise, S.A. (“MGM”); and (6) Melco PBL Jogos (Macau), S.A. (“Melco”). There were 34 casinos operated by the six players in Macau by year-end 2011 (Exhibit 1). In 2011, the Wynn Macau casino was reported by Macau Business to be the most productive single casino property with gross gaming revenues at US

EXHIBIT 1 Number of Casinos in Macau

PLAYERS 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

SJM 11 11 13 15 17 18 19 20 20 20

Galaxy — — 1 1 5 5 5 5 5 6

Venetian — — 1 1 1 2 3 3 3 3

Wynn — — — — 1 1 1 1 1 1

Melco — — — — — 1 2 3 3 3

MGM — — — — — 1 1 1 1 1

TOTAL 11 11 15 17 24 28 31 33 33 34

Source: Direcção de Inspecção e Coordenação de Jogos (DICJ) or Gaming Inspection and Coordination Bureau, 2012, Information, http://www.dicj.gov.mo/web/en/information/index.html, accessed on February 24, 2012.

1 This case was written to provide material for class discussion and learning. The author does not intend to illustrate either effective or ineffective handling of a managerial situation. The views in this case are those of the author alone and do not represent those of the University of Macau. The author thanks Mr. Richie Chiu for research assistance and Prof. Mike Peng for his support. © Javier C. Cuervo. Reprinted with permission.

412 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

$4.375 billion. How did Wynn emerge as the industry leader in ten years? What are its future challenges?

The Stage for Competition The arena where competition takes place in Macau’s gaming market has to be viewed in perspective. Macau is the only jurisdiction within China where casinos are legal. Equally important are the entry requirements of mainland Chinese citizens who visit Macau. Before July 2003, mainland Chinese citizens were allowed to visit Macau only on a group tour visa or on business. With the introduction of the Individual Visit Scheme (IVS) in July 2003, the number of mainland tourists visiting Macau was given a boost. Added to this are factors such as the Chinese penchant for games of fortune, the rise of the Chinese currency relative to the pataca (the Macau currency), and the increasing number of wealthier Chinese, all of which create opportunities for Macau’s privileged position.

Supply-side dynamics of gaming operations in Macau are initially determined by institutional factors, such as by Law no. 16/2001 and Administrative Regulation no. 26/2001. The concession contracts by the Macau SAR government for the operation of casinos were signed in March 2002 with SJM and in June 2002 with Galaxy and Wynn. Following the issuance of a sub-concession con- tract in December 2002 by Galaxy with the Venetian, SJM also signed a sub-concession contract with MGM in April 2005, whileWynn signed a sub-concession contract with Melco in September 2006. These concession con- tracts are for a 20-year period, after which they are subject to renewal—or the government may award a concession to a new casino operator.

The other limiting factor in competition is the number of gaming tables that casinos are allowed to provide—a main source of gaming revenues. Gaming tables have significantly increased from 339 in 2002 to 5,302 in 2011 (see Exhibit 2). A cap has been set by the Macau SAR government at 5,500 gaming tables until 2013 and thereafter to be increased between 3% to 5% annually. The table cap signals the need to develop further the contribution of the non-gaming revenues in Macau, which is currently trivial, compared to Las Vegas where only 26% of revenues are based on gaming.

The importance of gaming tables is described by McCartney (2010, pp. 176–177): “In 2008, 835 of the

casino tables were VIP tables, generating around 70% of casino revenues. Historically, the majority of gaming revenues are from casino tables (or VIP tables), and mostly from the game of baccarat. These are through junket operators who receive commission payments.” More recently, the VIPs are estimated to have contrib- uted 72% of Macau’s gaming revenues in 2010.

It has been reported by a source to Macau Business that two out of every five gaming tables are VIP tables. Moreover, the same source also noted the following market share of VIP tables as of the end of September 2011: SJM (28%), Venetian (17%), Melco (17%), Galaxy (16%), Wynn (13%), and MGM (9%).

Legalized in 2010, junket operators play an impor- tant role in securing gaming revenues for VIP tables in Macau’s casinos. They serve as middlemen who lend high-rollers money to play at the VIP tables and are paid 40% of the casinos’ take in return. The junket operators commit a minimum amount of rolling chip purchases set by the casino with which they are asso- ciated and then enter into agreements with their

EXHIBIT 2 Number of Gaming Tables and Slot Machines

YEAR GAMING TABLES SLOT MACHINES

2002 339 808

2003 424 814

2004 1,092 2,254

2005 1,388 3,421

2006 2,762 6,546

2007 4,375 13,267

2008 4,017 11,856

2009 4,770 14,363

2010 4,791 14,050

2011 5,302 16,056

Source: Direcção de Inspecção e Coordenação de Jogos (DICJ) or Gaming Inspection and Coordination Bureau, 2012, Information, http://www.dicj.gov.mo/web/en/ information/index.html, accessed on February 24, 2012.

INTEGRATIVE CASE 4 Wynn Macau : Gambl ing on the Edge of Ch ina 413

representatives, who make the credit checks on the high-rollers and bring them in to play at the VIP gaming tables. The government has imposed an agreed VIP commission cap to avert any commission war among the casinos.

The dynamics of competition take place in various locations within Macau SAR. These include the Macau peninsula of 9.3 square kilometers, which is geographically contiguous south of mainland China and where the border gate and the old ferry terminal are located. South of the Macau peninsula and connected by three bridges is the 6.8 square kilometers of Taipa, where the international airport and the new ferry terminal are located. Finally, the south- ern tip of Macau SAR is Coloane, which is 7.6 square kilometers. The swamp land that was reclaimed between Coloane and Taipa was termed Cotai by combining the first syllables of these two words—an estimated area of 6 square kilometers. The land in Cotai is where future expansion is being eyed by the incumbents to up the ante in competition.

The casino properties of the six players are located throughout Macau SAR. SJM has 16 properties in the Macau peninsula and four properties in Taipa. Galaxy has six properties with four in the Macau peninsula, one in Taipa, and the largest land bank in Cotai. Venetian has one property in Macau and two properties in Cotai. Wynn has one casino property in the Macau peninsula. Melco has two properties in Taipa and one in Cotai. MGM has a single casino property on the waterfront of the Macau peninsula. Based on a recent Standard Char- tered report on Macau’s gaming industry published at year-end 2011, the six players’ performance metrics are presented in Exhibit 3.

Wynn Is Winning Based on the metrics of performance, the most productive and profitable single property casino sector player isWynn. This was analyzed in the same Standard Chartered report: “The key to Wynn’s success is the high yield it generates in its mass, VIP, slots and non-gaming businesses. In the

EXHIBIT 3 Performance Metrics on Macau’s Six Gaming Concessionaires and Sub-concessioners

PLAYER/METRIC VENETIAN MELCO MGM SJM WYNN GALAXY TOTAL

VIP tables Dec 2011E 213 341 193 586 286 498 2,117

Mass tables Dec 2011E 909 314 226 1,153 212 452 3,266

Slot handles Dec 2011E 3,515 3,068 1,142 4,147 943 1,254 14,069

Mass market net win (HK $m) Dec 2011E

14,660 6,512 4,595 21,360 6,207 5,656 58,990

VIP net win (HK$m) Dec 2011E 22,335 30,201 21,239 53,349 28,114 35,402 190,641

Slot net win (HK$m) Dec 2011E 2,928 2,048 1,534 1,461 2,278 878 11,127

Total GGR (HK$m) Dec 2011E 39,923 38,761 27,368 76,170 36,600 41,936 260,758

Adjusted EBITDA (HK$m) Dec 2011E 11,770 6,131 4,919 6,984 8,014 5,443 43,261

Adjusted EBITDA margin (% of net revenues)

31.5 20.4 24.5 12.0 27.1 21.8 23.9

Net debt/(cash) HK$m 30 June 2011 11,913 9,997 1,173 -14,161 -4,446 4,996 n.a.

Retail GFA (sq ft) Dec 2011E 1,216,900 175,000 0 0 49,200 0 1,441,100

Hotel keys Dec 2011E 3,439 1,616 587 1,097 1,004 2,522 10,265

Source: Standard Chartered Bank Ltd., 2011, Macau Gaming, December 6, Figure 25, p. 14. “E” refers to estimates.

414 INTEGRATIVE CASE 4 Wynn Macau: Gambl ing on the Edge of China

gaming segment, Wynn’s fair share ratio (gross gaming revenue market share divided by table count market share) is the highest of any operator or property in 2011.” The profitability performance of Wynn is even more out- standing when considering its relatively lower number of gaming tables, retail space, and hotel rooms—compared with the Venetian, for example. Finally, Wynn Macau has a strong balance sheet position of HK$4 billion net cash (i.e., total debt—cash and cash equivalent) in June 2011. What were the underlying factors or reasons behind Wynn’s successful performance in Macau?

In 2005, BusinessWeek reported that Wynn’s “timing couldn’t be better” in working out detailed plans to plug into the booming Chinese market in Macau. Indeed, as Macau Business pointed out, “Even before opening its doors, Wynn Macau was three-quarters paid for, thanks to the sale of its sub-concession… More than that, it elevated Stanley Ho’s second son, Lawrence, the Melco chairman, to gaming business stardom.”

Wynn Macau, Limited, is traded on the Main Board of the Hong Kong Stock Exchange and is a subsidiary of Nevada-based and S&P 500/NASDAQ-100 listed Wynn Resorts, Limited. Wynn Macau broke ground in June 2004, and the first phase was completed in September 2006. The approximate cost of the first phase of the property development in Macau (including the expansion completed in December 2007) was US$1.1 billion featur- ing 380 gaming tables, 1,270 slot machines in 205,000 square feet of casino space, and 46,000 square feet of retail space. Wynn Macau is successfully positioned to cater to the upper end of the market.

With the benefit of hindsight or prudence—a year before the financial crisis took its toll on the US economy and US- based casinos—Stephen A. Wynn, chairman and CEO of Wynn Macau, Limited, commented that “management recognizes and will continue to monitor the effect on our business of the dramatic expansion in supply represented by the openings of the Venetian Cotai in August and theMGM Grand Paradise in November. In light of this uncertainty in the marketplace, we have elected to open only a portion of our Wynn Macau expansion in the third quarter of 2007 and to opportunistically provide the additional supply avail- able in the remainder of the expansion.”

WynnMacau approved to pay dividends on December 3, 2010, and considered paying recurring dividends to shareholders of the company. Moreover, Wynn Macau

has also contributed social dividends through the preser- vation and appreciation of Chinese art through generous donations of Buccleuch vases displayed at the Wynn Macau hotel lobby and Chinese vases that Wynn pur- chased for US$12.8 million at Christie’s London auction for the future Cotai property. Mr. Wynn proudly said, “I am delighted to announce that we are returning an extra- ordinary collection of porcelain vases from the Qing Dynasty to the People’s Republic of China.”

In November 2008, Wynn Macau won two prestigious Mobile Five-Star ranking awards and is the only hotel in Macau to do so, reinforcing its leadership role in the transformation of Macau into an international travel and leisure destination for the most discerning guests.

The Cotai Challenge The Venetian is the largest multi-use integrated resort in Macau with a first-mover advantage in the Cotai area. Its dominant presence in the area will be further strength- ened when in March 2012 the first phase of Sands Cotai Central opens with approximately 600 five-star Conrad rooms/suites, 1,200 four-star Holiday Inn rooms/suites, and 300,000 square feet of meeting space, retail outlets, and gaming space. The third quarter of 2012 will also bring in 2,000 Sheraton-branded rooms and more space for entertainment, retail, and meeting facilities.

The Venetian is positioned to take the leading position in the non-gaming segment in Macau as 30% of its hotel guests are families and business travelers. Its announced strategy is “to develop Cotai and to leverage our integrated resort business model to create Asia’s premier gaming, leisure and convention destination. Our ultimate plans for Cotai include five interconnected integrated resorts, which leverage a wide range of branded hotel and resort offerings to attract different segments of the market. When complete, we expect our Cotai Strip development to con- tain over 20,000 hotel rooms, approximately 1.6 million square feet of MICE space, over 2.0 million square feet of retail malls, six theaters and other amenities.”

Another major player in Cotai is Galaxy, which has the largest confirmed land bank in the area and is posi- tioned as an integrated “Asian Centric Resort” with world-class hospitality and global standard for the Asian market. Galaxy is the recipient of two prestigious inter- national awards at the International Gaming Awards ceremony held in London: the Casino Operator of the

INTEGRATIVE CASE 4 Wynn Macau : Gambl ing on the Edge of Ch ina 415

Year Australia/Asia award and the World’s Best Casino/ Integrated Resort of the Year award. The Galaxy has delivered 12 consecutive quarters of EBITDA growth as of the third quarter 2011 and a solid balance sheet with cash on hand of HK$7.0 billion as of September 30, 2011.

Melco’s City of Dreams in Cotai is another integrated urban casino resort, which recently won the Best Cus- tomer Experience of the Year Award from International Gaming Awards (IGA) 2012, announced at the ceremony held in London on January 23, 2012. The award recog- nized City of Dreams’ outstanding customer service and unique world-class entertainment experience, such as the successful spectacular “The House of Dancing Water,” a Franco Dragone Entertainment Group creation.

Proud of the achievements, Mr. Lawrence Ho, co-chair- man and CEO of Melco Crown Entertainment Limited, commented: “I am pleased to report our results for the fourth quarter of 2011, completing a remarkable year for the Company where we delivered full year net revenue and EBITDA growth of 45% and 88%, respectively, demon- strating strong top line growth together with impressive operating leverage. Our strong results in the fourth quarter of 2011 further demonstrate our ability to build on the meaningful improvements made earlier in the year, while at the same time executing on a range of strategically important milestones.” Long-term growth and increased presence for Melco were given a boost with the successful acquisition of a 60% interest in the Studio City project in the Cotai area. The Studio City project is 32 acres with an expected gross floor area of 465,000 square meters and is aimed at delivering a unique, entertainment-driven experi- ence through innovative attractions in Macau.

As competition heats up in Macau, a “wait-and-see” or “patience may be the path to victory” attitude may be called for by Wynn, MGM, and SJM as they seek the Macau SAR government’s approval of their Cotai land applications. Moreover, further expansion by some players in Cotai (such as Sands) will certainly bring pressures in recruitment given Macau’s tight labor market. The unemployment rate in Macau was 2.2% in the period October–December 2011.

Given the Cotai Challenge, the future will tell what opportunities the casino operators will face, how they will deal with such opportunities, what obstacles they will encounter, and, most importantly, how they will address these challenges.

Sources: Based on (1) P. Azevedo, 2004, Nice bet, Wynn, www. macaubusiness.com, Issue 8, accessed on December 29, 2011; (2) Direcção dos Serviços de Estatística e Censos (DSEC) or Statistics and Census Service, Macau SAR Government, 2012a, http://www.dsec.gov.mo/Statistic.aspx, accessed on February 24, 2012; (3) DSEC, 2012b, Employment survey for November 2011–January 2012, February 7, http://www.dsec. gov.mo/Statistic/LabourAndEmployment/EmploymentSurvey/ Employment Survey2011M11.aspx, accessed on February 29, 2012; (4) Direcção de Inspecção e Coordenação de Jogos (DICJ) or Gaming Inspection and Coordination Bureau, 2012, Information, http://www.dicj.gov.mo/web/en/information/ index.html, accessed on February 24, 2012; (5) Economist, 2009, Gambling in Macau, June 6: 64; (6) Economist, 2011, A window on China, December 10: 61–62; (7) Galaxy Entertainment Group Limited, 2010a, Galaxy Entertainment Group won top awards at International Gaming Awards, http:// www.galaxyentertainment.com/en/ir-release.html?view= investorrelation, accessed on February 22, 2012; (8) Galaxy Entertainment Group Limited, 2010b, Selected unaudited 2011 third quarter financial data, October 20, http://www.galaxy entertainment.com/en/financial-reports.html?view=investor relation, accessed on February 22, 2012; (9) A. Lages, 2010, Gaming table cap to remain unchanged, Macau Daily Times online, November 15; (10) N. Lam & I. Scott (Eds.), 2011, Gaming, Governance and Public Policy in Macao (pp. 225–241), Hong Kong University Press and University of Macau Press; (11) L. Leitão, 2012, Very important promoters, Macau Busi- ness, February: 75–76; (12) Macau Business, 2011a, Wynn Macau buys Chinese vases for Cotai property, July 8, www. macaubusiness.com, accessed on December 29, 2011; (13) MacauBusiness, 2011b, Buccleuch vases arrive at Wynn Macau, October 28, www.macaubusiness.com, accessed on December 29, 2011; (14) Macau Business, 2012, The money spinners, February: 67; (15) Macau Daily Times, 2012, Sands new recruitment campaign pressures SMEs, February 27, http://www. macaudailytimes.com.mo/macau/34035-Sands-new-recruitment- campaign-pressures-SMEs.html, accessed on February 29, 2012; (16) G. McCartney, 2010, Stanley Ho Hung-sun: The “King of Gambling,” in R. Butler & R. Russel (Eds.), Giants of Tourism, Cambridge, MA: CABI Publishing; (17) Melco Crown Enter- tainment Limited, 2012a, City of Dreams garnered Best Cus- tomer Experience of the Year Award from International Gaming Awards 2012, January 26, http://www.melco-crown.com/eng/ ir_pr.php, accessed on February 22, 2012; (18) Melco Crown Entertainment Limited, 2012b, Melco Crown Entertainment

416 INTEGRATIVE CASE 4 Wynn Macau: Gambl ing on the Edge of China

announces unaudited Fourth Quarter 2011 earnings, February 9, http://www.melco-crown.com/eng/ir_pr.php, accessed on February 22, 2012; (19) Melco Crown Entertainment Limited, 2012c, Melco Crown Entertainment: Your winning hand, http:// www.melco-crown.com/eng/bg.php, accessed on February 29, 2012; (20) Melco Crown Entertainment Limited, 2012d, Our properties: The Studio City Project, http://www.melco-crown. com/eng/tsc.php, accessed on February 29, 2012; (21) C. Palmeri, 2005, The revenge of SteveWynn, BusinessWeek, April 11: 74–75; (22) Sands China Ltd., 2010a, 2010 Annual Report, http://www. sandschinaltd.com/sands/en/financial_information/, accessed on February 29, 2012; (23) Sands China Ltd., 2010b, 2011 Interim Report, http://www.sandschinaltd.com/sands/en/financial_ information/, accessed on February 29, 2012; (24) Sands China Ltd., 2010c, The company, http://www.sandschinaltd.com/ sands/en/company/, accessed on February 29, 2012; (25) Stan- dard Chartered Bank Ltd., 2011, Macau Gaming, 6 December; (26) University of Macau, 2010, About Responsible Gambling, The Institute for the Study of Commercial Gaming, http://www. umac.mo/iscg/Events/RG_symposium/rg_home.html, accessed on February 29, 2012; (27) Wynn Resorts, Limited, 2006, Wynn Resorts, Limited reports third quarter results, November 7; (28) Wynn Resorts, Limited, 2007, Wynn Resorts, Limited announces equity repurchase program, June 7; (29) Wynn Resorts, Limited, 2008a, Wynn Resorts, Limited reports fourth quarter results, February 12; (30) Wynn Resorts, Limited, 2008b, Wynn Macau celebrates Five-Star Awards from Mobil Travel Guide, November 10; (31) Wynn Resorts, Limited, 2010, Wynn Resorts, Limited reports third quarter results, November 2.

C A S E D I S C U S S I O N Q U E S T I O N S

1. How would you characterize competition in the gaming industry in Macau?

2. From the institution-based view, what institutional developments have facilitated the development of this industry?

3. What resources and capabilities were behind the performance of Wynn Macau?

4. Retrieve and analyze recent information concerning Wynn’s operations in Macau. Are there any recent developments that may significantly affect Wynn’s future performance? How does the updated assessment of performance differ from your assessment of Wynn’s performance answered in Question 3? What factors may be able to explain the change in its recent performance?

5. ON ETHICS: Responsible gaming is promoted by various stakeholders in various gambling capitals of the world, such as Macau. The government in your city or country is soliciting views from stakeholders on the issues concerning the introduction of gambling. Discuss the various stakeholders’ positions that will most likely be presented to the government, and debate the pros and cons of introducing gambling in your city or country. What conclusions can you make about gambling and its impact on society?

INTEGRATIVE CASE 4 Wynn Macau : Gambl ing on the Edge of Ch ina 417

INTEGRATIVE CASE 5

Ryanair1

From industry-based, resource-based, and institution-based views, how can we understand the drivers behind Ryanair’s success? From an ethical standpoint, is CEO Michael O’Leary a loose cannon or an astute strategist?

Charles M. Byles, Virginia Commonwealth University

Always in the news and not shy of adverse publicity, Ryanair has been soaring in profits for the past few years. In November 2011, CEO Michael O’Leary announced a 20% increase in profits that in his words was “a testament to the strength of Ryanair’s lowest fare/lowest cost model.” Ryanair did not start with this model, however. Founded in 1985 with its headquar- ters in Dublin, Ireland, Ryanair began flights between Ireland and the UK and later launched services on the lucrative Dublin-London route after challenging the British Airways-Aer Lingus duopoly. But its initial foray into the airline business was not profitable. As a result of severe financial losses in 1990, Ryanair changed its strategy, adopting the Southwest Airlines business model and becoming the pioneer of low fares in Europe. The next two decades showed growth from 745,000 passengers in 1990 to 73.5 million in 2010. Based on passengers carried, the airline is now Europe’s largest low-cost carrier and second larg- est airline.

Resources and Strategy While Ryanair competes primarily on low cost, it also differentiates (through certain aspects of customer ser- vice) and raises revenues on non-ticket items (through ancillary services) as a means of offsetting the lower fares. Although successful, this strategy has been con- troversial. The airline has been accused of concealing its ancillary fees and offering customer services that are only available for a fee. How does Ryanair deliver on its low-cost strategy? Five value chain activities are key to its low-cost advantage: (1) operations, (2) human

resource management, (3) customer service, (4) use of the Internet, and (5) ancillary revenues.

Operations Use of a single model of aircraft (the Boeing 737-800) is the primary method of cost control because it allows minimization of training and maintenance costs, efficient management of spare parts inventory, and more flexible scheduling of flight crews. The popularity of the 737 model also means that flight crews are more readily available for hire. Finally, because Ryanair purchases a large number of aircraft from Boeing, it can negotiate price concessions.

Other cost savers are the use of secondary and regional airports that offer competitive prices, the use of outdoor boarding stairs instead of jetways, having all passengers check in on the Internet, and the introduc- tion of a checked bag fee, which reduces the number of bags carried by passengers (hence reducing handling costs and the number of check-in desks). Airports are chosen because of their low fees rather than for market reasons. Some agreements with secondary and regional airports base the airline’s fees on traffic volume.

The short-haul flights operate without the costs of meals, movies, and other in-flight services expected by passengers on longer flights. While the distance of the secondary airport from the main cities and the charge for checked baggage are inconvenient, a benefit is more frequent on-time arrivals, quicker turnarounds (fewer bags to check), and more frequent on-time departures because these airports are less congested. Quicker turn- arounds and more frequent on-time departures are also

1 © Charles M. Byles. Reprinted with permission. As of February 2012, the exchange rates were approximately €1 = £0.83 = US$1.32.

418 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

enhanced because the airline offers neither connecting flights nor the transfer of baggage to other flights, whether operated by Ryanair or not.

Human Resource Management The productivity-based incentive system is another activ- ity contributing to greater ancillary revenues and effi- ciency. Flight attendants receive commissions for onboard sales and, along with pilots, payments based on the number of hours or sectors flown. For the 2010 fiscal year, productivity-based incentives accounted for approximately 39% of a typical flight attendant’s total earnings and 37% of a typical pilot’s total compensation. The cost of customer service is reduced by outsourcing ticketing and other services at airports. For these services, Ryanair has been successful in negotiating fixed-price multi-year contracts.

Customer Service Although Ryanair has a reputation for poor customer service, the airline states that customer service is an important aspect of its strategy. Ryanair’s stated approach to customer service is the deliberate reduction of services in some areas (e.g., free checked bags, meals, flights to major airports) while raising it in others (e.g., on-time departures and arrivals, fewer lost bags). Its December 2011 customer service statistics (pub- lished on the Ryanair website) state that 89% of flights arrived on time, complaints were less than one per 1,000 passengers, and mislaid bag claims were fewer than one per 2,000 passengers.

The airline believes that customers prefer fewer ser- vices plus extra fees as needed for meals and other items in exchange for low fares. The Air Transport Users’ Council, however, claims that in 2009, easyJet and Ryanair had the most complaints of any major European airlines. Cancellations, missing bags, and denied boardings were top complaints. In a recent Bloomberg Businessweek article titled “Ryanair’s O’Leary: The Duke of Discomfort,” even CEO O’Leary suggests that customer service is poor:

In exchange for cheap fares, he [O’Leary] says, passengers will put up with just about anything. On Ryanair, that can include high luggage fees; relentless in-flight sales pitches for smokeless

cigarettes and scratch-off lottery games; minimal customer service; bad, expensive food; cramped seats; and flights to secondary city airports that are sometimes hours from the actual city.

In the same article, O’Leary criticizes competitors for treating budget travelers with a level of courtesy that they do not receive elsewhere nor expect when traveling. O’Leary believes that customers will endure discomfort and indignity as long as they get to their destination cheaply and with their suitcases.

Ancillary Revenues Ancillary revenues (revenues beyond the sale of a ticket and including sales of related items such as hotel reser- vations or car rental, as well as charges for food, checked baggage, priority boarding, and other items) allow the airline to make up income lost through lower ticket prices. Ryanair has been particularly creative in coming up with new means of generating ancillary rev- enues. For example, in 2009, the company announced the sale of smokeless cigarettes to ensure that passengers get their “fix” of nicotine without lighting up.

The company’s website contains offers for car hire, travel insurance, hotels, airport transfer, credit cards, hostels and bed and breakfasts, cruise holidays, villas and apartments, campsite holidays, and others. Ancillary revenues are also generated by charging fees for priority boarding, reserved seats, airport boarding card reissue, checked baggage, excess baggage, infant equipment, sports equipment, musical instruments, and many others. One controversial fee is the boarding pass reissue fee (charging €40/£40 for a passenger who fails to print out his boarding pass) that has been ruled illegal by a judge in Barcelona, Spain. Without the charge, Ryanair argues that it would have to employ numerous handling agents to issue boarding passes for passengers who forget to print them.

The Irish Examiner newspaper reported that Ryan- air’s ancillary revenues for 2009 were €663 million, more than any European airline, and in the top five ranking of airlines around the world (the top three are United, American, and Delta). For the half-year ended September 30, 2011, ancillary revenues increased by 15% to €486.5 million, faster than the increase in pas- senger volume.

INTEGRATIVE CASE 5 Ryana i r 419

Use of the Internet: Booking, Check-in, and Boarding Passengers must book and pay for fares on the Ryan- air website or through the call center. An adminis- trative fee applies to all bookings made through the call center and also to web bookings made without using Ryanair’s free payment method (MasterCard Prepaid Debit Card). Flights are booked one-way only, and tickets may be changed for a fee but cannot be cancelled. Passengers must check in online starting 15 days before the flight and up to 4 hours before departure time. An online check-in fee applies to all tickets booked (€6/£6 for flights booked online and €12/£12 for those made via the call center or at the airport). After checking in, the boarding pass must be printed and presented at boarding. No changes can be made to passenger name(s), flight dates, times, or route once the check-in is completed. Seating is not assigned unless “Reserved Seating” has been pur- chased (on the website) or where passengers have indicated that they need special assistance. Passengers who have purchased “Priority Boarding” (also from the website) may board before others provided they arrive at the gate no later than 30 minutes before boarding. Refunds are possible only in the event of a flight cancellation or the death of an immediate family member (within 14 days of the travel date).

Loose Cannon or Astute Strategist CEO Michael O’Leary has served as a director since November 1988, deputy chief executive from 1991 to 1994, and CEO since January 1, 1994. In 1991, he went to Dallas to meet Southwest executives and took the lessons back to Ryanair. While O’Leary embraced a few central aspects of Southwest’s model (e.g., a single air- craft model, secondary airports), he went much further with the constant drive to keep costs down. In partic- ular, the extensive use of ancillary fees to balance the low ticket prices became a trademark of Ryanair and now forms a core element of its low-cost strategy.

Known for his aggressiveness, outrageous public statements, and insults to almost any group or indi- vidual who gets in the way of Ryanair—including cus- tomers who complain about poor service—O’Leary has been accused of making outlandish suggestions (for

example, to have standing passengers on aircraft or to replace one of the pilots with a computer) to gain publicity. One recent proposal is to remove two of the three toilets on each aircraft in order to add six seats.

O’Leary referred to the decision to close Scottish airspace in May 2011 because of the volcano eruption in Iceland as “bureaucratic incompetence.” To demon- strate that there was no safety threat to aircraft and the designation of it as a “red zone” by the UK’s Civil Aviation Office was flawed, Ryanair deliberately flew an aircraft (without passengers) through that closed airspace.

Despite giving the impression of being a loose can- non, however, industry experts say O’Leary is an astute strategist who has created a singular focus on cost control that competitors have been unable to imitate. He leads by example—staying in budget motels, having no smartphone, and flying on Ryanair. His office is sparse and the company headquarters in Dublin is a drab 15,000-square-foot building.

Operating and Financial Performance For the half-year ended September 30, 2011, total oper- ating expenses increased 26% to €2.06 billion as a result of increased fuel prices, an increased level of activity, and costs associated with the growth of the airline. Fuel remains the main cost (€907.0 million or 44%), but airport and handling charges are also signif- icant (€316.3 million or 15%), as well as route charges (€271.5 million or 13%) and staff costs (€222.5 million or 11%). Fuel costs increased by 37%, while route charges increased by 22% and airport and handling charges increased by 18%. Ryanair aggressively tries to hold costs in check through fuel hedging and nego- tiation with airports over their charges. Adjusted profit after taxes increased 20% to €543.5 million compared with €451.9 million in the previous half-year. The increase was primarily due to increases in fares and strong ancillary revenues of €486.5 million, an increase of 15% over the previous year.

Government Regulation Ryanair owes much of its success to the liberalization of air transportation in Europe, starting first with air transportation between Ireland and the UK. In 1992, the Council of Ministers of the EU adopted measures to

420 INTEGRATIVE CASE 5 Ryana i r

liberalize air transportation. EU carriers were allowed to set fares provided they created access to routes throughout the EU. A licensing procedure was also established. Beginning in April 1997, EU carriers have generally been able to provide service on domestic routes within any EU member state outside the home country in which the airline is based. Ryanair is subject to both Irish and EU regulation.

The Irish Department of Transportation (DOT) is responsible for implementation of EU and Irish legisla- tion and international standards relating to air trans- portation. Of importance to Ryanair, in 2005, the DOT enacted legislation in response to EU legislation requir- ing compensation and assistance to passengers in the event of denied boarding, flight cancellation, and long delays (EU 261).

Ryanair views the EU 261 regulations as “unfair and discriminatory” because they require airlines to pay compensation to passengers as well as cover other costs in circumstances beyond the control of the airline such as air traffic control strikes or failure by airports to clear snow from runways. Ryanair argues that compen- sation in such circumstances be limited to the ticket price paid as is required for train, coach, and ferry operations. (The regulation itself states that airlines are not responsible for passenger compensation for events beyond the airline’s control.) In the case of denied boarding, cancellation, or a long delay (which is deemed the same as a cancellation), short-haul air- lines such as Ryanair would be required to pay €250 per passenger (for inconvenience to that passenger). Airlines are also required to reroute or refund the ticket and may be required to provide meals, accommoda- tion, and other amenities to passengers.

Questionable Practices Ryanair has been accused of a number of questionable practices, particularly the use of controversial or mis- leading advertisements. Several complaints have been filed against Ryanair with the Advertising Standards Authority (ASA), the UK’s independent regulator of advertising. BBC News reported that, in 2008, Ryanair faced an ASA probe asserting that it made exaggerated claims about the availability of flights at advertised prices that did not include taxes and fees.

Even Ryanair acknowledges its controversial advertise- ments by a statement on its website that it engages in “punchy advertising that sometimes gets us in trouble.” In 2011, the ASA criticized a Ryanair advertisement featuring a bikini-clad woman promoting trips to a “place in the sun.” The ASA argued that some of these places had as little as three hours of sunshine per day. Many of these advertisements appear to violate Ryan- air’s own policy against “misrepresentation of the facts” (part of the airline’s published ethics code).

Industry and Competition The European airline industry is highly competitive with a number of low-fare (e.g., easyJet, Air Berlin, and Germanwings), traditional (e.g., British Airways, Lufthansa, and Air France), and charter airlines (e.g., Monarch Airlines and Titan Airways). Charter flights are offered by low-fare as well as traditional airlines, and some charter airlines (e.g., Monarch) offer sched- uled services. Airlines compete on fares, time and frequency of services, service quality (e.g., number of on-time departures and arrivals, frequency of lost baggage, and frequency of involuntary denied board- ings), amenities such as frequent flyer programs, and reputation. Ryanair believes that state-owned compe- titors have advantages because of subsidies and other state aid provided to them. In addition, the EU-US Open Skies Agreement that took effect in 2008 allows US carriers to offer services in the intra-EU market that result in increased competition. The increasing consolidation in the industry (for example, the recent acquisition of BMI by International Airlines Group, the parent company of the merged British Airways and Iberia) poses additional threats for Ryanair as these airlines control large percentages of short-haul slots at major airports.

Although Ryanair boasts having the lowest fares, a survey in May 2011 by The Telegraph showed how the cost of a flight on a low-cost carrier can escalate when all fees are added, making prices on a traditional carrier such as British Airways more competitive. The survey was of return flights for a family of four from London to Madrid traveling on the same dates in August with two checked bags, golf clubs, and a cot (baby crib) and paying with a debit card. The base fares were: Ryanair

INTEGRATIVE CASE 5 Ryana i r 421

£271.92; easyJet £275.92; and British Airways £476.20. While Ryanair had the lowest fare, the costs went up substantially once all fees were added. To Ryanair’s ticket cost would be added an online check-in fee (£48), luggage fees (£80 plus £80 for golf clubs and £20 for the travel cot), administration fees (£48), and the new delay/ cancellation fee (£16) for a total cost of £563.92, the highest of the three carriers. While this survey represents a snapshot of a particular trip and may not be applic- able to all trips, it makes the point that Ryanair is not always the cheapest way to travel; passengers must con- sider the added fees before making the ticket purchase. To the extent that passengers become more familiar with the complex Ryanair fee structure, Ryanair may be placed at a disadvantage compared to low-fare and traditional airlines as illustrated in this survey.

Airlines also face competition from substitutes such as high-speed rail systems and sea transportation (which in Ryanair’s case would be more relevant to travel between the UK, Ireland, and continental Europe, as well as travel to Morocco). Finally, the industry faces cost pressure from monopoly suppliers such as airports and air traffic control services as well as revenue pres- sures from buyers with low switching costs.

Future Risks and a Bold Idea Ryanair’s recent financial performance shows growth, profitability, and strong returns to shareholders. CEO O’Leary attributes this success to the company’s strat- egy. But the company also faces risks of cost increases from suppliers (primarily fuel) and regulatory agencies that may impose additional costs associated with envi- ronmental, safety, and security measures. Fuel prices are expected to rise in 2012. Increasing legislation, in parti- cular EU 261, could have continuing adverse effects on Ryanair. One new piece of legislation that took effect in January 2012 is the European Union’s emissions trading scheme. Under this requirement, airlines must pay for the carbon dioxide they emit. Estimates are that airlines are likely to pay about €1.4 billion for carbon permits in 2012, rising to €7 billion by 2020. A certain number of permits will be issued free to each airline, but they will have to buy permits on the open market for emission beyond the allowed amount.

Could other airlines successfully imitate Ryanair’s strategy much as it imitated Southwest’s strategy?

Should Ryanair raise the competitive stakes? One bold strategic idea is to offer free flights in perpetuity (the airline already has some free flights) given Ryanair’s remarkable success with ancillary revenues. Ken Fisher, founder of Fisher Investments (and a Ryanair share- holder), told CNBC in an interview, “You get on the plane; they sell you stuff; the stuff they sell you is what pays for you going.” Is this idea a realistic possibility? The most recent financial data show that while ancil- lary revenues had record growth in the previous six months, they make up only 18% of total operating revenues. Ryanair would have to generate significantly large increases in revenues to cover its expenses and generate a profit, especially given the cost increases cited earlier.

Sources: Based on (1) Airlines to spend estimated €1.4bn on carbon permits in 2012, The Guardian, January 3, 2012; (2) Ancillary charges account for 20% of Ryanair income, Belfast Telegraph, September 11, 2012; (3) Annual Report, Ryanair Holdings PLC, (Form 20F filed with US Securities and Exchange Commission), July 20, 2010; (4) Careers: Working for Ryanair, Ryanair website, 2011; (5) S. P. Chan, Monarch to compete with Ryanair and easyJet as it steers away from package holidays, The Telegraph, June 1, 2011; (6) Child free flights from October 2011, Ryanair News, April 1, 2011 (website); (7) easyJet and Ryanair top complaints league, guardian.co.uk, 12 March, 2010; (8) N. Emerson, Ryanair challenges Spanish court over boarding passes, BBC News, 21 January, 2011; (9) N. Erlich, Bullish on Ryanair’s free flights: Investor, CNBC Stock Blog, 19 April, 2011; (10) F. Gillette, Ryanair’s O’Leary: The Duke of Discomfort, Bloomberg Businessweek, September 2, 2010; (11) N. Hennessy, Baggage, credit card charges driving Ryanair’s €663 million ancillary revenue haul, Irish Examiner.com, July 23, 2010; (12) History of Ryanair, Ryanair website, 2011; (13) M. Leroux & A. Schaefer, Ryanair fights to reduce passenger luggage, The Times, February25, 2009; (14) S. Lyall,Noapologies from theboss of a no- frills airline, The New York Times, August 1, 2009; (15) R. Massey, Cross your legs and prepare for takeoff: Ryanair reveals plan to have just one toilet on each plane to make room for more seats, Mail Online, 13 October, 2011; (16) M. Maier, A radical fix for airlines: Make flying free, CNNMoney, March 31, 2006; (17) D. Milmo, Ryanair to charge for seat reservations, guardian.co.uk, April 19, 2011; (18) Ryanair faces probe over adverts, BBC News, September 4, 2008; (19) Ryanair flies plane through Icelandic volcano ash cloud, The Telegraph, May 24, 2011; (20) Ryanair half

422 INTEGRATIVE CASE 5 Ryana i r

year profits rise 20% to €544m, traffic grows 12%, full year guidance raised 10% to €440m, half year results 2012, Ryanair website; (21) Ryanair No 1 customer service stats—December 2011, Ryanair News, January 18, 2012 (website); (22) Ryanair’s bikini advert banned by ASA, BBC News, 27 April, 2011; (23) Ryanair’s Michael O’Leary: Outrageous success story, Travel Sentry, August 2, 2009; (24) Ryanair to allow passengers to ‘smoke’ on board, Ryanair News, September 20, 2009 (website); (25) Ryanairwill complywithunfair EU261 regulations,RyanairNews, April 22, 2010 (website).

C A S E D I S C U S S I O N Q U E S T I O N S

1. From an industry-based view, assess the strength of the five forces and determine the extent to which Ryanair is positioned against those forces.

2. From a resource-based view, what explains Ryanair’s success?

3. From an institution-based view, assess the opportunities and threats presented by the current and future institutional environment (both formal and informal). How should Ryanair respond?

4. What is your evaluation of the proposal that Ryanair offer free flights in perpetuity? Draw on the three views in your answer.

5. ON ETHICS: Evaluate Ryanair’s ethical (or unethical) behavior, especially in light of the questionable practices discussed in the case. What changes, if any, would you recommend to CEO Michael O’Leary?

INTEGRATIVE CASE 5 Ryana i r 423

INTEGRATIVE CASE 6

SolarWorld USA1

SolarWorld USA, a subsidiary of Germany’s SolarWorld AG, is the largest US-based manufacturer of solar products. In the face of intense Chinese competition, SolarWorld USA’s revenue has declined and margins are in free fall. How can it survive?

David Darling, University of Texas at Dallas Fabia Bourda, University of Texas at Dallas

Gordon Brinser, president of SolarWorld USA (a sub- sidiary of Germany’s SolarWorldAG), reviewed the quarterly financial statements from his office in Hills- boro, Oregon. It was a bright, sunny afternoon in June 2011. Although the clear sunny day was perfect for the production of electricity from the solar panels his company produced, the financial reports provided a stormy forecast. Brinser had just come back to his office from the quarterly business meeting with his top management team, and the results were troubling. The sales forecasts showed declining sales, deteriorat- ing gross margin, and a rapid reduction in market share. He desperately needed to find a way to reverse this downward trend in sales volume and to increase sales margins in the face of serious market competition.

Particularly troubling was the pressure from Chinese solar panel makers. These low-cost suppliers came from relative obscurity and were now the dominant players globally. Thousands of US jobs, hundreds of millions of dollars, and the future of SolarWorld were at stake. As Brinser intently studied the financial documents, he recounted how rapidly the situation had changed in the solar panel industry.

Just three short years before, riding the waves of poli- tical support, recent financial success, and anticipating bright growth prospects in North America, SolarWorld had dramatically increased its US investment. The future had seemed bright due to the dramatic growth in the sales

forecasts and SolarWorld’s leading market share position. With the sun setting, knowing that he had to face share- holders and reporters with the quarterly financial report tomorrow, Brinser began to write down the strategic options and plans for SolarWorld. In the back of his mind, he was wondering: “How can SolarWorld survive in a world of intense Chinese competition?”

SolarWorld History From the austere beginnings as Solar Technology Inter- national in 1975, SolarWorld AG emerged in 1998 to enter Germany’s rapidly increasing solar market. The dramatic growth of the German solar industry was dri- ven by the German government through wide-ranging

M ap

R es

o u rc es

1 This case was written by David Darling and Fabia Bourda (University of Texas at Dallas EMBA 2012) under the supervision of Professor Mike Peng. The purpose of the case is to serve as a basis for class discussion rather than to illustrate the effective or ineffective handling of an administrative situation. The views expressed are those of the authors (in their private capacity as EMBA students) and do not necessarily reflect those of the individuals and organizations mentioned. © David Darling and Fabia Bourda. Reprinted with permission.

424 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

regulations and initiatives like the “100,000 Roofs Initia- tive.” The programs included regulated wholesale and retail pricing of electricity and significant incentives for manufacturers and large-scale solar power production facility operators.

On this foundation, SolarWorld built a business whose principal activities include research, develop- ment, production, and marketing of products for solar power generation as well as the installation of complete solar power stations. The company is fully vertically integrated, combining all aspects of the solar product cycle from the raw material silicon to turnkey solar power plants, as well as the develop- ment of proprietary solar systems and power solu- tions. Controlling all the stages of the product design and production cycle allows the company to uphold high quality and environmental standards through- out the process.

The SolarWorld group of companies operates in Germany, Europe, Asia, the US, and other countries. It is also involved in the planning, construction, and operation of wind energy and solar energy parks as well as other power stations based on renewable energies.

In 2008, SolarWorld purchased a 480,000-square- foot production facility in Hillsboro, Oregon, and added 1,000 employees, making it the largest US-based solar manufacturer as well as one of the largest in the world. Just like the expansion in Germany a decade earlier, this US expansion was also largely driven and supported by government initiatives. These included regulations, tax incentives, low-interest loans, and multiple other federal programs. The Obama admin- istration’s green initiatives and “Buy American” pro- grams were consistent with the desire to expand the US demand for solar products and to create US jobs.

Corporate Financial Performance SolarWorld is struggling with serious financial problems. Shown in Exhibit 1, revenue has decreased by 21% between 2Q2010 and 2Q2011. In addition, the declining gross margin due to sales price erosion has resulted in a 66% decrease in consolidated net income. Investors and creditors rely heavily on the quarterly performance reports in making their investment decisions. The com- pany’s stock price, also shown in Exhibit 1, has been

taking a beating based upon earnings rumors. These new financial results, to be released tomorrow, will further erode the stock price. In addition to these pressures, many of the subsidized loans and tax incentives are based upon revenue performance targets and sustained employment commitments for the US employees. Therefore, cost cutting through US production or job reductions is not an option.

Solar Technology Solar energy is a 100% renewable form of energy that is generated by radiant sunlight. It is a secondary energy source categorized alongside wind, ocean wave power, hydroelectricity, and biomass. Only a very small amount of total electrical power in the world is gener- ated using solar energy.

Solar technologies are broadly characterized as either passive solar or active solar depending on the way they capture, convert, and distribute the solar energy. Active solar technology includes the use of photovoltaic panels and is the primary product of SolarWorld. The core objective of solar panels is to efficiently capture the photons of sunlight and convert them into useable electrical power.

US Solar Power Utilization The United States has multiple sources of fuel energy for the production of electricity. Coal is the predominant fuel used, and the US has large coal reserves. Coal is followed by nuclear power and then natural gas. The average retail price paid for electri- city in the US in 2010 was $0.1046 per kilowatt- hour. The reasonable price for electricity in the US provides very little incentive for producers or con- sumers to quickly move to alternative forms of energy.

Renewable energy makes up 8% of the total power production and consumption in the US with photovol- taic generation supplying 1% of the total renewable energy. The primary reason for the small percentage of utilization is the high comparative cost of solar power and the capital investment required. Actual per- formance and financial data proved difficult to obtain from public sources, so as part of this case research, a quotation for a roof-mounted photovoltaic system was

INTEGRATIVE CASE 6 So la rWor ld USA 425

sourced from a national provider of solar energy solu- tions. The system included 224 240-watt solar modules and a non-penetrating ballasted roof mounting struc- ture. The DC power produced would be fed through

one 50kW, 480-volt inverter and connected to the main building power. Solar performance as well as federal and state utility tax incentive information was also provided with the quotation. The results are provided

EXHIBIT 1 SolarWorld AG Financial Data

Revenue EBITDA EBIT Consolidated Net Income

2Q 2010 $529,581 $109,685 $80,051 $40,794

2Q 2011 $417,857 $93,562 $55,663 $13,689

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000 T

h o u sa

n d s

o f D

o lla

(000's)

Stock Charts for SolarWorld AG (SRWRF)

SolarWorld

SRWRF:US Open 12.87 High 12.87 Low 12.8315 Close 12.8315

NovOctSepMayAprMarDec 2011 Feb 06/24/2011

Sources: SolarWorld.com (currency conversion done November 15, 2011); Bloomberg.com.

426 INTEGRATIVE CASE 6 So la rWor ld USA

in Exhibit 2, which illustrates that with more than 60% of the capital cost paid for by federal and state incentives, the system still requires 15 to 20 years to achieve a simple payback. The internal rate of return is very low, ranging from 2% to 4% based upon a 25- year expected life of the system.

US Solar Energy Trade In 2010, the United States remained a significant net exporter of solar energy products. The total net exports were $1.9 billion. The US solar energy pro- ducts segment maintained a net positive trade bal- ance of $247 million to $540 million with China. The largest single export product is polysilicon at $2.5 billion, and it is used in the production of photovoltaic cells abroad. The largest solar energy imported product was photovoltaic modules. Addi- tional information is available in Exhibit 3.

SolarWorld Products In addition to polysilicon and other industrial products in support of photovoltaic technology manufacturing for power generation, SolarWorld makes Sunmodule

and Sunkits® solar products for the US consumer market.

Sunmodule TM

solar panels are designed andmanufactured to the highest standards of quality, guaranteed performance, and durability. Sunkits® are custom-designed complete solar electric systems. A new and innovative solar car- port is also offered. These products are supported by a 25-year linear electrical output performance guarantee and 10-year product workmanship warranty. The mono-crystalline and poly-crystalline products from SolarWorld come in a variety of sizes, making them suitable for all applications—from a residential rooftop to a large-scale facility.

International Market Conditions China is currently the largest solar energy–related trad- ing partner with the United States. At this time, the US maintains a net positive trade balance with China. The US provides capital equipment and raw materials, and China sells back the completed solar modules. The dynamics are rapidly changing, however, as China begins to flex its economic muscle. Chinese companies have led the way toward reducing the price of solar modules by nearly 50% in 2009, and the economic battle is raging.

Much like the US government, the Chinese govern- ment sees a dramatic opportunity in the growth of solar energy products. However, China has a significant institutional advantage: It has tens of billions of dollars to invest. In 2010 alone, the Chinese Development Bank provided $30 billion in low-cost loans to the top five solar module producers. The magnitude of this capital infusion has some people in the solar industry calling it “predatory financing.”

The stage is currently being set for a charge by US solar companies against Chinese firms for the dump- ing of solar modules on the US and world markets. Chinese firms are often the focus of US antidumping accusations, but these accusations also occur between many countries. The typical claim is that the foreign company is using an unfair advantage or government

EXHIBIT 2 Solar Photovoltaic Project Proposal

Fujitsu—Photovoltaic Proposal 2011 • Proposed 54 kW DC system • Roof mounting on light framing • 50 kW, 480 VAC inverter • No batteries • Connected to main service

Photovoltaic Solution: 54 KW, no batteries

Return on Investment

System Costs $309,120 Federal Incentives – 92,736 Utility Incentives – 94,080 Net Initial Investment $122,304

Yearly 78,948 kWh at 78,948 kWh at Production $0.08/kWh $0.08/kWh Yearly Profit $6,316 $7,895 Simple Payback 19.4 years 15.5 years

IRR 2% 4%

Source: Fujitsu Network Communications, Facilities Department, Dallas.

INTEGRATIVE CASE 6 So la rWor ld USA 427

funding to engage in dumping in order to benefit in the foreign market and drive out the domestic com- petition.

SolarWorld’s Resources and Capabilities SolarWorld has several significant resources that are available to help combat their sagging performance. It is a fully vertically integrated provider, which creates a long and resilient value chain. This can be demon- strated using value (V), rarity (R), imitability (I), and organization (O)—or the VRIO framework.

Multiple opportunities for additional focus and revenue generation are available. For example, new tech- nology development and fully integrated solutions are opportunities to enhance value. Value can also be exploited through bundling of products and services, such as SolarWorld’s dual-purpose solar carport.

As solar modules are becoming commoditized, SolarWorld continues to have other strong product segments that provide advantages in the area of rarity including polysilicon production. Polysilicon is a very

specialized product and requires considerable time and capital to establish a production facility.

A primary area of concern is imitability. The Chi- nese are close on the heels of SolarWorld, and China has demonstrated the financial capability and the stay- ing power to keep driving the industry.

Finally, organizational structure and experienced management resources are also tremendous assets to SolarWorld due to its long history in the solar industry and the experience gained from operations through multiple business cycles.

Institutional Considerations The dominant threat posed by the influx of Chinese solar modules is best evaluated from the institution- based view. Institutions played a key role in the original founding of SolarWorld and its early success in Germany, as well as the expansion and success in the US from 2008 to present.

The entire US solar power industry is largely funded and propelled by federal and state support and receives enthusiastic public support from multiple

EXHIBIT 3 US Solar Imports and Exports

Imports from Selected Country to the United States (in millions of dollars)

Exports from the United States to Selected Country (in millions of dollars)

China: 1,431 Mexico: 480 Japan: 322 Taiwan: 264 Germany: 215 Austria: 24 Canada: 22 Korea: 20 Italy: 12

∗Some estimates provided as a range due to corporate confidentiality policies.

All Other: 194 Undisclosed∗: 695

China: 1,671–1,963 Germany: 865 Japan: 609 Norway: 258 Canada: 223 Italy: 126 France: 74 Spain: 23 All Other: 912 Undisclosed∗: 561–853

$1,934M

$5,614M $3,679M

NET EXPORTS

TOTAL IMPORTS

TOTAL EXPORTS

Source: GTM Research.

428 INTEGRATIVE CASE 6 So la rWor ld USA

constituencies. These provide an excellent strategic advantage for SolarWorld. The institutional frame- work in the US is a dominant market force. In a recent research study on the American Jobs Creation Act of 2004, government action provided companies that lobbied for these laws a return of $220 for every $1 invested in lobbying for its passage. These same forces were at work in the Economic Recovery Bill of 2009 in which $100 billion was invested in clean energy and environmental projects.

Lastly, SolarWorld has an advantage due to the US antidumping laws and the sentiment among constitu- ents and lawmakers that favor US-produced solar products.

Business Decision Over the previous three years, the US government during the Obama presidency has provided an excel- lent opportunity for green energy providers. With billions of tax dollars invested in green energy initia- tives in the past three years, the US solar power industry received a huge upward boost. These funds were invested in research, development, and federally guaranteed low-interest business loans. They provided federal funding for procuring renewal energy sources including solar panels for use in state and federal properties.

During this same time period of dramatic federal investment, however, another dramatic change was occurring. According to SustainableBusiness.com, the US global market share of solar modules had decreased from 50% to about 6%. Even more surprising, the Chinese had captured more than 50% of the global market, and the importation of Chinese panels into the US grew by more than 300%.

In the face of the challenging market conditions and intense market competition particularly from Chinese manufacturers, SolarWorld is determined to create a strategy to adapt. As Brinser reviewed his notes, he began to formulate a strategy based upon the firm’s resources and capabilities as he wondered: “Which strategy should I pursue, and is it possible for Solar- World to survive?”

Sources: Based on (1) US Energy Information Administration, 2010 Annual Review (n.d.), retrieved November 16, 2011,

http://www.eia.gov/forecasts/aeo/sector_electric_power.cfm; (2) US Energy Information Administration, 2011, Average Retail Prices, October 19, retrieved November 16, 2011, http://38.96.246.204/totalenergy/data/annual/showtext.cfm? t=ptb0810; (3) K. Bradsher, 2011, China charges protection- ism in call for solar panel tariffs, New York Times, October 21, retrieved November 6, 2011, http://www.nytimes.com/ 2011/10/22/business/global/china-warns-of-bad-effects-if-us- turns-protectionist.html?pagewanted=all; (4) K. Bradsher, 2009, China racing ahead of US in the drive to go solar, New York Times, August 24, retrieved November 6, 2011, http:// www.nytimes.com/2009/08/25/business/energy-environment/ 25solar.html; (5) K. Bradsher, 2011, Chinese trade case has clear targets, not obvious goals, New York Times, October 20, retrieved November 6, 2011, http://www.nytimes.com/2011/ 10/21/business/chinese-solar-trade-case-has-clear-targets- not-obvious-goals.html?pagewanted=all; (6) A. Carey, 2010, Obama’s green initiatives lobbied for by the same people who profit from them, Daily Caller, August 26, retrieved November 16, 2011, http://dailycaller.com/2010/08/26/obamas-green- initiatives-lobbied-for-by-the-same-people-who-profit-from- them/; (7) Coalition for American Solar Manufacturing, 2011, Fact Sheet, November 6, retrieved November 6, 2011, http:// www.americansolarmanufacturing.org/; (8) R. Gaertner, 2001, Germany embraces the sun,Wired, July 9, retrieved November 16, 2011, http://www.wired.com/science/discoveries/news/ 2001/07/45056?currentPage=all; (9) A. Giegerich, 2011, Salem, Hillsboro got in “the zone” for solar jobs, Sustainable Business Oregon, May 23, retrieved November 16, 2011, http:// sustainablebusinessoregon.com/articles/2011/05/salem- hillsboro-got-in-the-zone-for.html; (10) S. Lacey, 2011, How China dominates solar power, Guardian, September 12, retrieved November 6, 2011, http://www.guardian.co. uk/environment/2011/sep/12/how-china-dominates-solar- power; (11) M. W. Peng, 2009, Global Strategy, 2nd ed., Mason, OH: South-Western Cengage Learning; (12) S. Alexander, 2009, Measuring rates of return for lobbying expenditures, SSRN, retrieved November 16, 2011, http:// ssrn.com/abstract=1375082; (13) B. Stuart, 2010, Solar- World to Create 350 Jobs, retrieved November 16, 2011, from http://www.pv-magazine.com/news/details/beitrag/ solarworld-to-create-350-jobs-_100000110/; (14) Sustainable Business.com News, 2011, US solar companies call for stiff tariffs on Chinese solar imports, October 20, retrieved November 16, 2011, www.sustainablebusiness.com/index.cfm/go/news.display/ id/23056.

INTEGRATIVE CASE 6 So la rWor ld USA 429

C A S E D I S C U S S I O N Q U E S T I O N S

1. How would you characterize the competition in this industry?

2. What resources and capabilities underpin Solar- World’s competitive advantage? Why is such advantage eroding?

3. From an institution-based view, why do antidumping tariffs emerge as a weapon of choice?

4. What is Brinser going to tell shareholders and reporters tomorrow?

5. Predict the likely response from Chinese rivals after SolarWorld files antidumping charges against them.

430 INTEGRATIVE CASE 6 So la rWor ld USA

INTEGRATIVE CASE 7

SnowSports Interactive: A Global Start-up’s Challenges1

SnowSports Interactive executives confronted a number of challenges: Could they attract investors who could share their dream? Which countries could they spread their wings to? How should they spread their wings, i.e., what global strategy should they implement? Could a Brisbane, Australia-based start-up expand globally? If so, how?

Marilyn L. Taylor, University of Missouri at Kansas City Xiaohua Yang, University of San Francisco Diaswati (Asti) Mardiasmo, Queensland University of Technology

“The best trick this season won’t be done on skis or a board, it will be worn.” SnowSports Interactive (here- after, SSI) executives felt that phrase appropriately described the new technology they were planning to introduce to the world of skiing in the winter of 2006– 2007. However, in late June 2006, the company con- fronted a number of challenges. What, they wondered, did they need to do to maximize the potential for their company?

History of the Company SSI was born over a beer at a conference in Melbourne, Australia, in January 2004. Company founders Steve Kenny and Shubber Ali quickly envisioned their initial product as a skier tracker system. During 2004, Kenny completed an analysis of the global ski industry. He identified key gaps in the market and the combina- tion of technologies available to fill them. In May 2005, SSI was legally born with Kenny as CEO and Ali as Chairman.

The company’s core intellectual property combined the latest positioning, wireless, and identification tech- nologies with proprietary tracking and analysis soft- ware. In simple English, SSI technology could locate people and assets at any ski resort in the world where the company’s technology was installed.

The company was located in Brisbane, Australia, and became an i.Lab member in November 2005. The i.Lab was part of the Queensland Government’s new State- wide Technology Incubation Strategy. Location in the i.Lab provided the company with the opportunity to work with some of the leading business minds in Queensland and Australia. Nurturing, mentoring, and resources from i.Lab helped the company reach the next stage/level.

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1 The case was developed based on face-to-face interviews with the company executives and publicly available sources. The authors wish to express thanks to the SSI executives and other associates who continue to contribute to the ongoing development of this case study. © Marilyn L. Taylor, Xiaohua Yang, and Diaswati (Asti) Mardiasmo. Reprinted with permission.

431 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

The Product/Services From 2004 through spring 2006, SSI associates concen- trated on product design and technology development. The company called its initial product, a small light- weight tag worn by skiers and snowboarders, the Flaik. The Flaik device included multiple technologies, including Global Positioning System (GPS) units to continuously monitor the position and time of users and GSM Communications units to transmit position and time data to a Network Operating Centre.

In March 2006, SSI and Mt. Buller Alpine Resort agreed to a beta test of SSI technology. Located near Melbourne, the Mt. Buller Alpine Resort was the fourth largest among Australia’s five major ski resorts. SSI provided both tracking technology and the firm’s wire- less Internet service called whispar™ at Mt. Buller. The partners used a significant proportion of available funds to install the wireless system. SSI established an on site office for company personnel who dealt directly with customers and observed first-hand how the tech- nology operated on the slopes. The system came into operation on June 9, 2006, and the beta test ran suc- cessfully during the 2006 season. Sales of the whispar system increased daily during the first month of opera- tion and continued a favorable growth pattern.

SSI executives wanted to dramatically enhance the experience of skiers, snowboarders, and downhill sli- ders worldwide. The company had developed extensive intellectual property combining the latest in GPS, Wi- Fi, and RFID technologies with proprietary tracking and analysis software. When asked what the company’s competitive advantage was, an SSI representative responded, “The SSI advantage is simple. We provide a simple, compelling user experience through the inte- gration of the latest technology with unique, proprie- tary applications and services, all in a sleek package with a simple user interface.”

The Flaik would be another accessory offering for the skier. Accessories, apparel, and apparel accessories were a must on the slopes. Among items that had been popular in recent years were anti-outerwear, urban influences for edgy looks, hip in the city, hip on the slopes, denim in snowboard pants, synthetic leather pants, prints like zebra, military fatigues, great fitting clothes for women, pockets with CD players, and ava- lanche devices in garments for the backcountry.

The Industry The snow sports industry was composed of many facets including manufacturing, retailing, resort development, and tourism. The industry’s success was dependent on often-fickle Mother Nature—i.e., on whether the season had sufficient snow. The snow season was different on the five populated continents, and SSI would need to adapt its business model accordingly.

Snow depth was considered very important in the skiing industry as it determined whether a ski resort stayed open or not, the amount of operational days within a season, and the number of lifts operating within the season. The industry reported that the 2003–2004 ski season was the third best season ever in terms of skier visits, despite persistent negative factors such as a slowly rebounding international economy, a jobless recovery in many sectors of the economy, high gas prices, muted consumer confidence levels, and international tensions.

The snow sports industry was primarily known for its downhill and cross-country skiing and snowboard- ing. In the US, the demand for alpine ski lessons had increased, with a 1.1% increase between 2002–2003 (17,935 lessons) and 2003–2004 (18,135 lessons). The number of snowboard lessons had a smaller increase of 0.2% (from 6,101 in 2002–2003 to 6,113 in 2003–2004).

A new sport that had become recently popular was New School—a youth movement about music, festivals, and action sports. The movement was a fusion of snowboarding, skiing, skateboarding, bike stunt riding, motocross, and surfing. It was “hot” with 12- to 16- year-olds. Another sport that had become popular was Telemark Skiing, where downhill skiers “floated” down the mountain with their heels un-attached. Telemark skiers mostly accessed the backcountry, as it offered freedom and untouched powder for advanced skiers who wanted to push their limits.

The industry had created many innovative products and experienced significant gains in women’s and chil- dren’s equipment and apparel stores. The industry recognized that it relied heavily on affluent but aging baby boomers. However, the industry was also market- ing itself to GEN Y, a group defined as those born immediately after GEN X. GEN Y included people in their early to mid-20s, teenagers, and children over the age of five. The term GEN Y was most popular in the

432 INTEGRATIVE CASE 7 SnowSpor t s In te rac t i ve : A Globa l S ta r t -up ’s Cha l l enges

US, but its use had gone far beyond the US to refer to the youth throughout the anglophone world. The GEN Y age group was more diverse than previous “genera- tions.” For example, 40% of 16- to 24-year-olds were not Caucasian.

In the US, the snow sports industry was governed by SnowSports Industries America (SIA). SIA was a national, not-for-profit, member-owned trade associa- tion of competing snow sports companies. Its member- ship was open to product manufacturers, distributors, suppliers, and retail shops. Service providers, including web designers, could be involved through limited mem- berships. SIA was known for its comprehensive report on the global skiing market.

The industry also included manufacturers, impor- ters, distributors, and retail suppliers of equipment, apparel, and accessories. Some of these companies were divisions of major corporations listed on the New York Stock Exchange. Others were small, independent com- panies. The greatest strength of the independent com- panies lay in their ability to innovate in design of new products, which were constantly giving skiers and riders fresh reasons to hit the slopes.

In the US alone, there were 8,500 retailers and other companies offering winter sports products for sale, rent, use as promotions, or use for professional pur- poses. Of that number, about 2,000 were specialty and chain stores that sold apparel or accessories related to winter sports but not what would be called a “ski/ snowboard shop.”

The consumer profile of the snow sports industry had continued to exhibit stability on many visitor char- acteristics and a gradual shift on others. Among the most prominent shifts were the continued aging of the visitor base and a related increase in experience in snow sports. There were also signs of gradual increase in participation by children in the 10–14 and 15–17 age groups, first-timers and beginners, and different ethnicities.

At that time, SSI’s main competitors for the Flaik included NASTAR, Slope Tracker, Suunto, and NAV- MAN. SSI identified its competitive advantage in real- time remote monitoring, the ability to locate friends, and safety applications. SSI’s potential competition came from two main streams, namely, recreational GPS receiver and sports tool manufacturers and

recreational snow sports analysis service providers. However, SSI executives felt they were differentiating themselves as a company that would provide customers a low-cost, easy-to-use service with functionality that far outstripped that provided by existing manufacturers and service providers.

The Financial Situation One of the challenges SSI as a global start-up continued to face in mid-2006 was how to finance growth and capitalize on its current greenfield opportunity pre- sented by the lack of dedicated ski tracking companies. SSI was initially funded by Kenny and Ali. The two founders then relied on a round of financing provided by “three Fs” (family, friends, and fools). In mid-2006, SSI was in the process of placing a round for US$1.5 million at US$3.50 a share (i.e., a company valuation of US$6.06 million). The company had recruited Mike Wallas, CEO of Enterprise Growth Solutions, to secure this round from a combination of high net worth individuals, investment groups, and venture capitalists. The company had also secured government funding through Commercialising Emerging Technologies (COMET) and was preparing grant applications for Commercial Ready, the Queensland Innovation Start- up Scheme, and the (Australian) Federal Government’s Export Market Development Grant.

Most experts identify financial issues as among glo- bal start-ups’ major challenges. SSI executives agreed. The company’s five-year profit and loss forecast is presented in Exhibit 1.

The Company Strategy SSI identified five potential revenue sources in its busi- ness model. These sources were: ski school applications, user applications, resort management applications, sponsorship and advertising, and wireless Internet.

A tentative global strategy SSI had adopted to raise funds involved creating partnerships with ski resorts. SSI executives envisioned approaching target markets for expressions of interest. Each partnership would involve creating a limited liability company with a ski resort company. The limited liability company would be operated by a combination of the existing SSI Australian team and a local team. SSI executives

INTEGRATIVE CASE 7 SnowSpor t s In te rac t i ve : A Globa l S ta r t -up ’s Cha l lenges 433

identified the benefits offered to the resort itself as well as to the users of the system, including:

n Improved efficiency of ski school operations resulting in increased utilization of resort assets, including the ski runs, and thus increased revenue.

n Increased safety for ski school participants.

n Improved peace of mind for participants who could locate current positions of friends and family anywhere on the mountain—an aspect deemed to be especially useful to parents in trying to keep track of children, ski schools instructors tracking the whereabouts of their students, or the ski patrol trying to locate missing skiers.

n Enhanced skier experiences on the slopes by keeping score of performance statistics and enabling the skier to compare rankings with friends, family, and competitors.

n Extension of the skiing experience beyond the slopes by creating an online memory of their time on the mountain to share at a later date.

As an SSI partner, each resort would have two options for the infrastructure deployment. The infra- structure would support the range of applications that SSI would provide to the resort operators and guests. The options were: (1) resort purchasing infrastructure

that included a three-year life span with license and services contract charges yearly, or (2) resort leasing infrastructure for three years with the license and ser- vices contract charged yearly.

The partnership agreement called for SSI to provide a user-friendly process for customers through three elements: (1) integrating Flaik into existing point-of- sale systems in order to simplify the rental process for users, (2) providing upselling of data to parents of ski school participants, and (3) providing optimal place- ment locations for interactive kiosks in congregation areas such as lodges for customers to use across the resort.

Revenue sharing opportunities between SSI and its resort partners included the upselling of performance data to parents of ski school participants, provision of wireless access to customers using the whispar service, and rental of Flaik devices to non-ski school partici- pants during the first phase of deployment.

The infrastructure and supporting technologies uti- lized by SSI were sourced from leading technology providers around the world and, where necessary, adapted to the alpine environmental conditions. SSI’s current ecosystem of network partners included: Wire- less Tech Group, CMD, Power Converter Technolo- gies, Strix Systems Inc, MassMedia Studios, and Abuzz Technologies.

EXHIBIT 1 SSI Five-Year Profit and Loss Forecast

$10,000,000

2006–2007

Revenue Total Expenses Operating Profit/(Loss) Before Tax

2007–2008 2008–2009 2009–2010 2010–2011

$20,000,000

$30,000,000

$40,000,000

$50,000,000

$60,000,000

Source: Snowsports Interactive, 2006.

434 INTEGRATIVE CASE 7 SnowSpor t s In te rac t i ve : A Globa l S ta r t -up ’s Cha l l enges

SSI believed that its primary competitive advantages lay in continual innovation through an evergreen research and development (ERD) program, which would allow SSI to update the functionality, flexibility, and interactivity of its front-end user software on a seasonal basis and its hardware every 12 to 18 months. The com- pany planned to protect its intellectual property through a variety of means including patents, trademarks, and copyrights, as well as trade secrets of its designs and circuit layouts. The company also planned to use and enforce confidential non-disclosure agreements.

SSI identified the company’s business activities as subject to relatively high risk factors, risks that were related to its business activities and were also of a general business nature. SSI executives fully acknowl- edged that the company’s risks were higher than those generally faced by other companies. These risks included: limited operating history and forecasted losses, intellectual property, national and international regulations, specific country laws, dependence on third-party suppliers, schedule delays, seasonal market fluctuations, and competition. To manage such risks, SSI managers prepared a risk management plan detail- ing both preventive and contingency actions.

A Global Market for SSI? SSI executives recognized that signing the agreement with Mt. Buller was “just baby steps” on a long road; the only way to grow the business was to expand into international markets given the seasonality of the ski industry. The company’s executives had identified several countries as targetmarkets including theUS,Canada, Japan, European countries, China, and New Zealand.

In-house market research suggested that the North American market was the most promising, owing in part to the abundance of information SSI had been able

to acquire on it. Although there was more limited information on other target market countries, the executives aimed to spend time investigating them to identify and aggressively address areas with snow ski- ing activities. As Kenny put it in June 2006:

We currently have one location, i.e., Mt. Buller. And, we need to be in more resorts in Australia but there are only five major ski resorts and four minor ones here in this country. The most lucrative market, of course, is the USA where there are 493 ski resorts. We could focus on Japan, but that takes a different protocol and we would have to redesign our technology. However, we have had inquiries from Japan and there are a couple of people associated with Hoikkaido resorts. We need to think this through.

Sources: Based on (1) authors’ interviews; (2) SnowSports Interactive, 2006, SnowSports Interactive Information Mem- orandum, Brisbane, Australia; (3) SnowSports Interactive, 2006, Resort Visitor Statistics, Brisbane, Australia.

C A S E D I S C U S S I O N Q U E S T I O N S

1. Assess the company as a potential investor. Use a thorough SWOT analysis as a basis for your assess- ment. Utilize the RBV and VIRO analytical tools to assess SSI’s core competences.

2. What are the major risks the company faces as it implements

a. its domestic market strategy? b. a “born global” strategy?

3. What advice do you have for SSI founders for future international expansion? Which market(s) should SSI expand into first?

INTEGRATIVE CASE 7 SnowSpor t s In te rac t i ve : A Globa l S ta r t -up ’s Cha l lenges 435

INTEGRATIVE CASE 8

Wikimart: Building a Russian Version of Amazon1

How does a Russian Internet start-up grow? How does it line up financing? How promising are its prospects?

Daniel J. McCarthy, Northeastern University Sheila M. Puffer, Northeastern University

Wikimart was founded in 2008 by Stanford MBA stu- dents Maxim Faldin and Kamil Kurmakayev as an online marketplace for Russia and Russian-speaking countries. Its focus was a B2C platform for Russian retailers who listed goods at no charge but initially paid a minimum 3% fee to Wikimart on each transaction, later reduced to 1.5%. Wikimart also provided services to these retailers including order fulfillment, account- ing and legal support, and e-commerce marketing tools. The company’s objective was to become a dominant e-commerce marketplace in Russia and other countries of the former Soviet Union.

Time Line of Financing and Growth In the first half of 2009, financing of $700,000 was secured from a number of sophisticated angel investors, including Michael van Swaaij who had invested in Skype and eBay Europe; Mark Zaleski and Robert Dighero who had invested in QXL Ricardo; Alec Oxen- ford, founder of OLX, DineroMail.com, and DeRemate; Jose Marin, founder of DeRemate; and Kerim Baran, founder of Yonja.com. By mid-2009, Wikimart’s web- site was attracting 5,000 daily visitors and had more than 1,000 online merchants offering over 370,000 products.

In early 2010, Series A financing was secured from Tiger Global Management, a successful US-based private equity investor specializing in technology start-ups, often in emerging economies. The deal raised

$5 million for Wikimart and resulted in 50% ownership for Tiger, according to a filing with the US Securities and Exchange Commission. In August 2010, Wikimart secured Series B financing of $7 million, again from Tiger Global.

By mid-2010, the company website had 2,000 online merchants generating $1.5 million in monthly revenues for Wikimart that by 2011 had increased to 2,500 merchants and $3 million in monthly revenues. Of course, online sales were a significant order of magni- tude larger. Company revenues would have been greater if the order completion rates could have been

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1 This case was written by Daniel J. McCarthy (McKim d’Amore Distinguished Professor of Global Management and Innovation, Northeastern University) and Sheila M. Puffer (University Distinguished Professor and Cherry Family Senior Fellow of International Business, Northeastern University). The authors would like to acknowledge the excellent research assistance provided by Northeastern University College of Business student Maxim Russkikh. © Daniel J. McCarthy and Sheila M. Puffer. Reprinted with permission.

436 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

improved beyond the 68% level prevailing in 2011. Achieving such an increase, however, would remain a major challenge to implementing the company’s strat- egy as retailers often had insufficient inventories to fulfill customer orders.

By March 2011, the company had signed up 2,200 retailers that listed more than 528,000 products through Wikimart’s website. The company reported that the site was attracting 2 million visitors per month, although one of the founders stated that the number could be as large as 3 million. Among the products prominent on its website were home goods and appliances, consumer electronics, wine and tobacco, and virtually any product that could be found on Amazon’s website, with the best-selling categories being clothing, sporting goods, and children’s pro- ducts. The vast majority of the products were familiar, internationally known brands.

Why Tiger? One of Wikimart’s founders, Kurmakayev, explained in 2011 why the company had chosen Tiger Global from among various potential core investors: “We chose Tiger because they did not impose their views and did not seek to participate in the business management, but are ready for the long-term partnership.” Other poten- tial core investors included Accel Partners, a firm based primarily in the US, with offices in Palo Alto, CA, and New York, that had invested in companies like Groupon and Veritas. Accel also had offices in London, China, and India. Another potential core investor was Index Ventures, a US investor with successful invest- ments in technology start-ups like Skype and Dropbox. It seemed that all of these investment firms might have been looking for the next Google, the hugely successful Internet giant cofounded a decade earlier by Russian- born University of Maryland and Stanford University graduate Sergei Brin.

Business Model Wikimart’s business model centered around creating an Amazon-like online retail platform and business model in the Russian-speaking countries of the former Soviet Union. Similar models had been developed in Korea by Gmarket and in Japan by Rakuten Ichiba. The

company’s business model offered free space online to merchants while collecting a minimum of 1.5% of each transaction once sales began.

Company Strategy and Organization The company’s strategy included reaching a younger, tech-savvy segment of customers in the Russian-speak- ing world. The company was headquartered in Mos- cow, and merchants selling on its site delivered goods only within Russia as of early 2011. One of the partners stressed that Wikimart’s objective was to continue developing the Russian market even after it moved to new markets. The company planned to expand overall services to other Russian-speaking countries of the former Soviet Union such as Ukraine and Kazakstan. The partner reasoned that Russia was the tenth largest European country in terms of GDP but had even greater promise in terms of Internet users. Although Wikimart seemed to have vast potential, the company had not turned a profit by early 2012. However, the founders believed that 2013 could be a profitable year. With an objective of eventually attaining 20% to 30% share of the fast-growing online retail market, company executives saw the possibility of annual revenues reach- ing as high as $15 billion by 2018.

The two founders initially assumed separate respon- sibilities, with Kurmakayev being in charge of main- taining relations with retailers and developing the com- pany’s technology and Faldin being responsible for sales, marketing, and business development. As the company grew, the founders recognized early that they had to change to a more corporate-like structure. Fal- din became CEO responsible for the operational aspects of the business, such as developing metrics and achieving goals. Kurmakayev took on a strategic role incorporating forecasting and budgeting, as well as developing the company’s competitive strategy.

One of the founders claimed that a significant percentage of company costs stemmed from intensive development efforts. Wikimart, although an online retail business, was basically a technology company. The vast majority of the 260 employees in 2011 were programmers who wrote software code to support the company’s online business. They were guided in their development work with Silicon Valley expertise pro- vided by their investors and consultants.

INTEGRATIVE CASE 8 Wik imar t : Bu i ld ing a Russ ian Vers ion of Amazon 437

Russia’s Internet Industry and Wikimart’s Competition The overall Russian e-commerce market was estimated at $7 billion to $9 billion in 2011, a substantial increase over the $6 billion in 2010, growth that attracted many competitors. Exponential future growth, with forecasts of 40% annually, saw estimates of up to a $50 billion market by 2018. Such forecasts added luster to the already attractive Russian online retail market. Wiki- mart’s largest competitor was Ozon.ru, the oldest e-commerce giant of the Russian Internet. Sites like Groupon and KupiVip offering group discounts on products and services were also substantial competi- tors, and both had attracted relatively large investments from US firms. The order fulfillment challenge for Wikimart noted earlier was due to retailers relying on relatively poor IT technologies. One of Wikimart’s founders noted that the online retail industry in Russia required huge investments in IT and supply chain. In 2012, only 1.5% of all Russian retail purchases took place online, but the founders believed that the number would grow to 10% to 20% within five to 10 years.

Some Russian companies, such as mail.ru, had already become powerful Internet players within Russia. That firm’s parent, the mail.ru Group, was formerly known as Digital Sky Technologies and was an early-stage investor in Facebook, owning 5%–10% of that company by 2011 according to various reports. It had invested $200 million in 2009 and an additional $500 million in 2011. This is another example of the globalization of private investments; this time, however, the participants were a Russian investment group taking a stake in a US online venture. Mail.ru itself was an extremely successful publicly traded Internet company. Other successful Russian online companies included Vkontakte and Rambler. Vkontakte was a private company that offered social network services and was notable for design and functionality that mimicked Facebook. As of February 2012, Vkontakte reportedly had 116.6 million user accounts and was the fourth most pop- ular Russian Internet website. Rambler was a search engine that offered Web 2.0 services such as e-mail aggregation and e-commerce, with its main compe- titors being mail.ru and Yandex. Yandex had a

reported 64% market share of the Russian search provider space and was the fifth largest search engine worldwide with 1.7% of global searches as of September 2011. The company had enjoyed a decade of success before going public in 2011 on NASDAQ in the US. Its IPO raised $1.3 billion, and its stock price soon traded up by 55%. The price of $1.3 billion valued the company at about $8 billion.

Wikimart’s Future Analysts noted that start-ups like Wikimart had become attractive for strategic investors as the Inter- net expansion in Russia accelerated. In 2012, the number of Internet users in Russia was not large but was expected to grow by approximately 10% per year. Some analysts expected that if Wikimart continued to increase revenues and profits, it could soon be targeted by strategic investors such as Ama- zon or eBay. Having US investors like Tiger Global that were very familiar with the Russian Internet market could help attract others, including strategic investors who might invest funds with the intention of acquiring Wikimart at some point. Wikimart’s founders and other major shareholders, such as Tiger Global, might eventually have to decide between selling the company to a strategic investor or continuing to maintain control while growing the company to its full potential. As is typical in such cases, timing would be a key factor.

Sources: Based on (1) DST smenila nazvanie (DST changes its name), 2010, http://www.vedomosti.ru/companies/news/ 1103680/dst_smenila_nazvanie; (2) A. Hesseldahl, 2012. Zuckerberg is the billion-share man: Who owns what, who makes what in the Facebook IPO, AllThingsD, February 1, http://allthingsd.com/20120201/facebooks-ipo-filing-who-owns- what-who-makes-what/; (3) Forbes, 2011, My stroim Amazon in Russia (We are building Amazon in Russia), July 20, http://www. forbes.ru/tehno-opinion/internet-i-telekommunikatsii/70954- my-stroim-amazon-v-rossii; (4) RT, 2011, Tiger Global ups the ante on Wikimart, March 2, http://rt.com/business; (5) http://bloomberg.com/news/2011-05-24/yandex-jumps-after- raising-1-3-billion-in-biggest-technology-ipo-of-the-year.html; (6) http://en.wikipedia.org/wiki/Yandex.

438 INTEGRATIVE CASE 8 Wikimar t : Bu i ld ing a Russ ian Vers ion of Amazon

C A S E D I S C U S S I O N Q U E S T I O N S

1. From an industry-based view, given the frag- mented, rapidly growing nature of online retail space in the Russian-speaking world, how would you characterize the competition in this industry?

2. Why was Wikimart able to secure financing during its early stages of growth? Put differently, if you were an angel investor or private equity

investor, what special qualities of Wikimart would attract you?

3. While Wikimart’s objective is to become a dominant e-commerce marketplace in Russia and other countries of the former Soviet Union, given the existing com- petition (such as Ozon.ru), is such ambition realistic?

4. What are some of the viable exit strategies for the two founders?

INTEGRATIVE CASE 8 Wik imar t : Bu i ld ing a Russ ian Vers ion of Amazon 439

INTEGRATIVE CASE 9

Texas Instruments in South Korea: An Educational Opportunity1

The South Korean Ministry of Education (MOE) recently announced plans to spend $2 billion providing tablet PCs with digital textbooks to a vast majority of students in South Korea by 2015. How can Texas Instruments’ Education Technology division tap into these opportunities? What are the challenges?

Kris Baker, University of Texas at Dallas Harold Burman, University of Texas at Dallas Andrew Cyders, University of Texas at Dallas Ben Wilson, University of Texas at Dallas Yanmin Wu, Texas Instruments

With an average of fewer than eight students per PC in 2007, the Korean education system already boasts one of the most technologically enabled student bodies in the world, and this initiative will advance its cutting- edge use of computers in the classroom even further. This effort, in conjunction with the ongoing digital textbook initiative undertaken by the MOE in 2007, will push the Korean education system to the forefront of industrialized nations and presents a huge opportu- nity for educational device suppliers.

Based in Dallas, Texas Instruments (TI) has long been a leader in producing and marketing education solutions for students and teachers. TI offers both hardware solutions (including calculators, scientific instruments, and docking stations) and software solu- tions (including teacher–student interface programs, math and science modules, and class interconnectivity applications), providing a multitude of value-add prod- ucts for educators and students alike. Given TI’s

prominent position in the education marketplace and its broad product portfolio, the Korean market repre- sents an intriguing prospect for future business.

The questions for TI are quite simple: What oppor- tunities does the Korean tablet initiative provide for TI?

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1 This case was written by Kris Baker, Harold Burman, Andrew Cyders, and Ben Wilson (University of Texas at Dallas MBA 2011) and Yanmin Wu (Texas Instruments) under the supervision of Professor Mike Peng. The team thanks Ashwin Joshi for his collaboration. The purpose of the case is to serve as a basis for class discussion rather than to illustrate the effective or ineffective handling of an administrative situation. The views expressed are those of the authors (in their private capacity) and do not necessarily reflect those of the individuals and organizations mentioned. © Kris Baker, Harold Burman, Andy Cyders, Ben Wilson, and Yanmin Wu. Reprinted with permission. 2 Socyberty.com, 2010, Koreans substitute books with PC tablets.

440 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

How can TI effectively communicate the value of its education solutions to its Korean constituents? Perhaps most importantly, how can TI ensure that its products have all of the attributes necessary to meet the needs of the Korean education system?

Textbooks: From Paper to Pixels The ubiquitous paper textbook is an item that most modern students know quite well. The multi-billion dollar industry boasts a number of large international players including Cengage Learning (publisher of this textbook), McGraw-Hill, and Pearson Education. While such textbooks are deeply ingrained in tradi- tional classroom instruction, recent studies into the feasibility of digital textbooks and the massive increase in personal computing access have pushed both educa- tors and textbook publishers to examine the future of the industry, which appears to be digital.3 The combi- nation of interactivity, reduced marginal cost, and per- sonalized content have positioned digital textbooks at the precipice of worldwide adoption, and many educa- tional institutions worldwide are beginning to incorpo- rate digital textbooks into their curriculum.

Removing the textbook from the written page offers a number of significant benefits to both students and teachers. Far beyond basic PDF versions of traditional text, modern digital textbooks apply technology to enrich the student experience, including audio, video, and interactive features like quizzes and note-sharing tools. Digital textbooks complement the multimedia and interactive functions with links to references such as articles, primary sources, workbooks, and diction- aries. Furthermore, they allow students the conveni- ence of accessing the textbook on the same computer that they use to complete their homework assignments. Digital textbooks also offer significant benefits to educators, as they allow teachers to monitor student activity, identify areas of improvement, and facilitate interaction between students. Exhibit 1 illustrates the benefits of digital textbooks.

Many textbook publishers are also beginning to identify the massive opportunity that digital textbooks provide. Margins for digital textbooks are quite high. Although they are typically priced lower than print versions, they avoid the production cost of paper textbooks, which currently eats up a large portion of publishers’ margins. “Printing and distribution of tra- ditional books account for more than 20 percent of the cost of the book.”4 With commodity prices expected to continue rising, that share stands to grow. Publishers may also benefit from a larger customer base since digital textbooks can be easily divided and sold in portions. Further, additional revenue streams are pre- sented to publishers through both licensing of books (allowing customers to use the content for a limited period of time) and dissemination of content update patches (a process with minimal distribution costs due to the digital nature of the content).

While publishers certainly face challenges in adapt- ing and developing content for digital textbooks, the most compelling reason to enter this market is quite simple: increasing demand. The recent rise of tablet PCs and digital media devices, such as Amazon’s Kindle and Apple’s iPad, has led to an explosion in the electronic book market. The digital textbook market has been slow to catch on, representing “only 2.8 percent of total US textbook sales in 2010,”5 but is already experiencing large growth, with expected US sales of $267.3 million in 2011—up 44.3% from the year before.6 However, with students increasingly turning to personal computing for help both inside and outside of the classroom, sales are expected to grow considerably in the near term, “[doubling] over the next four years to $1.5 billion by 2015, [and accounting] for 25 percent market share.”7 Publishers can expect to face stiff competition as software pro- grammers, device manufacturers, and content devel- opers push for a piece of this market. With global trends mirroring the US market, competition will only intensify.

3 C. Schuetze, 2011, Textbooks finally take a big leap to digital, New York Times, November. 4 B. Coombs, 2011, Tablets make digital textbooks cool on campus, USA Today, June 17, http://www.usatoday.com/tech/news/2011-06-17- digital-textbooks_n.htm. 5 N. Rachlin, 2011, Digital textbooks slow to catch on, New York Times. 6 C. Schuetze, 2011, Textbooks finally take a big leap to digital, New York Times, November. 7 Coombs, 2011, Tablets make digital textbooks cool on campus, USA Today.

INTEGRATIVE CASE 9 Texas Ins t ruments in South Korea: An Educat iona l Oppor tun i ty 441

South Korea: Modernizing Education As a nation with limited natural resources but high population density and a rising standard of living, the Korean government has long recognized the impor- tance of maintaining a well-educated, technologically enabled workforce. To this end, the Korean govern- ment has taken a number of measures, from facilitating the fastest residential broadband network in the world8

to investing heavily in applying information and com- munications technology (ICT) in Korean classrooms. Additionally, the Korean culture highly values educa- tion, seeing it as a measure of both social status and economic differentiation. While Americans may view secondary education as an investment, “in Korea, high school students and their parents sustain a con- stant demand for higher education, even following

significant declines in both the relative lifetime earn- ings advantages for college graduates and the expected rate of return on higher education.”9

The combination of economic incentive and cultural demand for access to quality education has led the Korean government to devote significant resources to improving education nationwide. Responding to recent studies showing that traditional methods of lecture- and text-based learning are not adequately preparing students for careers in a “multitasking, multifaceted, technology-driven, diverse, and vibrant world,”10 the Korean Ministry of Education, Science and Technology (MEST) initiated the Digital Textbook project in 2007. With a goal of studying the benefits and challenges associated with implementing digital textbooks in Korean classrooms, the project began with 5th and 6th

EXHIBIT 1 The Benefits of Digital Textbooks

Resource Management Function

Learning Management Function

Learning Assistance Function

Teaching and Learning Functions

Interactive Function

• Hyperlink • Management of study progress and schedule • Assessment and management of grades • E-portfolio• Correct data

• Suggest a teaching and learning method • Assessment

• Learner • Learner and textbook • Learner and learner • Learner and teacher

• Draft and edit documents • Graphics, composition • Navigate and view pages • Various dictionaries

• Motivation • Propose learning contents • Present learning data

• Data search and index • Link with outside resources

Source: Adapted from Korea Education & Research Information Service, 2007, Research on the Standardization of Digital Textbooks, Seoul.

8 J. Sutter, 2010, Why Internet connections are fastest in South Korea, CNN.com, March 31, http://articles.cnn.com/2010-03-31/tech/broadband. south.korea_1_broadband-plan-south-korea-broadband-internet/2?_s=PM:TECH. 9 D. Kim, 2002, Expectations from education, Journal of Higher Education Policy and Management, 24(2), p. 2. 10 D. Kim, 2002, Expectations from education, p. 2.

442 INTEGRATIVE CASE 9 Texas Ins t ruments in South Korea : An Educat iona l Oppor tun i ty

graders in a test group of 20 schools, later expanded to 100 schools.11

The conclusions drawn from this pilot program were striking. First, students showed significant improvement in “interest, comprehension, satisfaction, and self-efficacy as well as in their level of academic achievement after using differentiated instruction with digital textbooks.”12 Second, low-achievement students in test groups showed marked improvement over con- trol groups using printed textbooks. While results var- ied by region, socioeconomic status, and family status, test groups responded favorably overall.13 Third, and perhaps most importantly, teachers responded ex- tremely well to the implementation of digital textbooks. Teachers spent less time preparing instructional props to align with printed textbooks, allowing them to focus on “designing and developing instructional strategies” and “concentrate on providing more significant instructional feedback than simply checking home- work.”14

Despite these clear benefits, the study went on to identify a number of potential challenges in the imple- mentation of digital textbooks in Korean classrooms. A lack of clear design parameters led to complex textbook packages that were “difficult to develop and main- tain,”15 and integration of the multitude of additional features was costly and time consuming. Without sig- nificant upfront training and experience with the digi- tal textbooks, teachers struggled to smoothly integrate them into the classroom environment. Further, while digital textbooks were shown to be effective for teach- ing mathematics, teachers still felt that additional effort was needed to align the digital textbooks used in the study with specific academic subjects. “For instance, science classes often require various lab- oratory activities; however, digital textbooks cannot

support them.”16 After reviewing the results of this study, the Korean MOE and MEST viewed these challenges as temporary gaps in quality that will be overcome as publishers collaborate with software deve- lopers to improve content delivery. Expanding the study each year following the pilot in 2007, the Korean gov- ernment has recently announced plans to provide tablet PCs with digital textbooks for each student in K–12 education and is set to implement this plan in 2015.

TI: A Pioneer in Education Founded in 1930, TI is a manufacturing, design, and sales leader that produces a variety of products including com- munications equipment, computing hardware, industrial supplies, consumer electronics, automotive components, and education solutions (see Exhibit 2).17 With 2010 net income of $3.2 billion on roughly $14 billion in revenue, TI is one of the largest and most profitable manufacturers in the United States. TI also has a significant global presence. In 2010, over 88% of its revenue was generated outside the US (see Exhibit 3).18

To students in the United States, TI’s most visible products are its lineup of calculators and other educa- tion solutions, which come from the TI Education Technology (TI ET or Ed Tech) division and generate 3% of TI’s overall revenue.19 TI ET offers a multitude of hardware products and software applications to help improve learning in the classroom. Assuming the MOE will continue to source tablets from LG as it did during the pilot tests,20 there may not be a market for TI’s lower-level graphing calculators. Therefore, the follow- ing discussion will examine attributes of the high-end hardware and software applications most applicable to the Korean market: the Nspire calculator product line and the software/online content products offered by TI to educators.

11 J. Kim & H. Jung, 2010, South Korean Digital Textbook Project, Taylor & Francis Group, LLC, p. 6. 12 Kim & Jung, 2010, South Korean Digital Textbook Project, p. 11. 13 Kim & Jung, 2010, South Korean Digital Textbook Project, p. 12. 14 Kim & Jung, 2010, South Korean Digital Textbook Project, p. 12. 15 Kim & Jung, 2010, South Korean Digital Textbook Project, p. 13. 16 Kim & Jung, 2010, South Korean Digital Textbook Project, p. 14. 17 TI Form 10-K, http://investor.ti.com/sec.cfm?DocType=Annual&Year=2011, Edgar Online, 2011, p. 4. 18 TI Form 10-K, Edgar Online, 2011, p. 59. 19 TI Form 10-K, Edgar Online, 2011, p. 4. 20 T. Kim, 2009, Digital textbook plan hits snag, Korea Times, November 12.

INTEGRATIVE CASE 9 Texas Ins t ruments in South Korea: An Educat iona l Oppor tun i ty 443

EXHIBIT 2 Texas Instruments Product Portfolio

END MARKET APPLICATIONS TI PRODUCTS

Communications (42% of product revenue)

Phones and infrastructure equipment Mobile connectivity solutions (including wireless LAN, global positioning systems, Bluetooth®, NFC) Video conferencing

Analog, Embedded Processing, Wireless, Other

Computing (22% of product revenue)

Printers Hard disk drives Monitors and projectors Notebooks, netbooks, desktop computers and servers Tablet computers

Analog, Embedded Processing, Wireless, Other

Industrial (14% of product revenue)

Digital power controls: Switch mode power supplies Uninterruptible power supplies

Motor controls: Heating/ventilation/air conditioning Industrial control motor drives Power tools Printers/copiers

Security: Biometrics (fingerprint identification and authentication) Intelligent sensing (smoking and glass-breakage detection) Video analytics (surveillance)

Smart metering Test and measurement Point of service/portable data terminals

Analog, Embedded Processing, Other

Consumer Electronics (11% of product revenue)

Digital cameras, gaming and audio/visual equipment Portable and car audio Home appliances Personal navigation devices eBook readers

Analog, Embedded Processing, Wireless, Other

Automotive (8% of product revenue)

Body systems Chassis systems Driver information/telemetrics Entertainment Powertrain Safety systems Security systems

Analog, Embedded Processing, Other

Education (3% of product revenue)

Handheld graphing and scientific calculators Educational software

Others

Source: Texas Instruments 2010 Annual Report, http://investor.ti.com/sec.cfm?DocType=Annual&Year=2011.

444 INTEGRATIVE CASE 9 Texas Ins t ruments in South Korea : An Educat iona l Oppor tun i ty

TI Nspire Nspire is TI’s premium educational package and con- sists of a combination of powerful graphing

calculators, sophisticated software, and a network interface that allows students and teachers to be linked wirelessly. The calculators come in four

EXHIBIT 3 Texas Instruments Revenue by Region and Product Segment ($ Million) Revenue by Region

US ASIA EUROPE JAPAN REST OF WORLD TOTAL

Revenue

2010 $ 1,539 $ 8,903 $ 1,760 $ 1,366 $ 398 $ 13,966

2009 1,140 6,575 1,408 976 328 10,427

2008 1,551 7,387 1,875 1,268 420 12,501

Property, plant and equipment, net

2010 $ 1,694 $ 1,575 $ 139 $ 249 $ 23 $ 3,680

2009 1,727 1,013 161 244 13 3,158

2008 1,785 988 200 314 17 3,304

Revenue by Product Segment

ANALOG EMBEDDED PROCESSING WIRELESS OTHER TOTAL

Revenue

2010 $ 5,979 $ 2,073 $ 2,978 $ 2,936 $ 13,966

2009 4,202 1,471 2,626 2,128 10,427

2008 4,789 1,631 3,451 2,630 12,501

Operating profit

2010 $ 1,876 $ 491 $ 683 $ 1,464 $ 4,514

2009 770 194 315 712 1,991

2008 1,074 268 323 772 2,437

Source: Texas Instruments 2010 Annual Report, http://investor.ti.com/sec.cfm?DocType=Annual&Year=2011.

INTEGRATIVE CASE 9 Texas Ins t ruments in South Korea: An Educat iona l Oppor tun i ty 445

product types: CX, CX-CAS, Nspire Handheld, and CAS Handheld, all of which contain standard software modules with a variety of hardware and software upgrades focused primarily on science and math edu- cation. Standard software modules include basic scientific calculator functions, lists and spreadsheets, data analysis and statistics, geometry modules, and document viewing software.

The Nspire product line also has two additional software features that are particularly relevant for class- room use: Vernier DataQuest and the Question appli- cation. DataQuest allows Nspire devices to interface with external sensors that conduct readings on motion, temperature, PH, light, and gas pressure, and automa- tically produces a graphical or table readout on the calculator screen, allowing for easy scientific experi- mentation. As an additional benefit, the USB interface of the DataQuest equipment makes it compatible with most other hardware available on the market today. The Question application allows teachers to ask sub- ject-specific questions tailored to a student’s level of proficiency and embed those questions within the cal- culator for the student to answer.

There are a number of additional product attributes that make Nspire a premier selection for classroom instructors in the United States. Most important are the Nspire Teacher and Student Software packages that can be purchased in addition to the calculator units. The Teacher Software allows instructors to browse ready-made lessons, customize documents using the PublishView application, manage lessons digitally, and transmit interactive lessons to the students’ devices using the TI Smartview emulator. The Student Software packages contain “all the same functionality as TI- Nspire handhelds,”21 but also allow students to begin assignments on their Nspire units and then transfer the files to their personal computers for completion at home.

The Nspire solution also offers connectivity solu- tions that enrich the student experience, fostering class- room interaction and monitoring of individual activity by the instructor. The Nspire Navigator system pro- vides adaptors that enable wireless communication between the Nspire units and a central router, and the

Navigator for Network Computers solution allows schools to operate the Nspire modules through their existing computer platform. Features of Navigator include Screen Capture, which allows instructors to monitor their students’ activity in real time; Live Pre- senter, which transmits the image on one student’s screen to the whole class; and Quick Poll, which allows the teacher to ask the entire student group a question through their devices and collect responses. The Nspire solution also comes with a docking station that charges the devices and simultaneously allows the teacher to transfer student files to the instructor’s computer.

Software and Content In addition to the comprehensive hardware and soft- ware package offered by Nspire, TI has worked to develop additional education solutions that are not reliant on its hardware components. These include software modules that run on existing networks, such as the network-enabled version of Navigator men- tioned above, and educational content including fully developed lessons, activity modules, explanatory videos, and exams and quizzes. Examining TI’s soft- ware products in further detail identifies a number of potential opportunities for expansion within the Korean market.

As mentioned in the previous section, two of the most easily transferrable solutions offered by TI are the Math Nspire and Science Nspire software packages. These products not only offer students the aforementioned benefits, but also provide subject-specific guidance for instructors tasked with teaching the material. As part of these packages, video tutorials and professional develop- ment webinars give teachers the tools and knowledge to best deliver the content, providing teachers with a rewarding way to develop their skill as educators.

Additional software and supplementary online content, such as the Activities Exchange and TI-Math. com, deliver a superior level of service to teachers implementing these solutions. Activities Exchange is an online database of free math and science lessons that teachers can browse and download for use in their classrooms. TI-Math.com is a subscription-based service that sends subject-specific lessons directly to

21 Texas Instruments Education Product Catalog, 2010, p. 7.

446 INTEGRATIVE CASE 9 Texas Ins t ruments in South Korea : An Educat iona l Oppor tun i ty

teachers’ computers, allowing teachers to shift their preparation time from content development to content integration and delivery. Through workshops such as TI-MathForward and Teacher Leader Cadre, TI works with teachers to develop their proficiency in using TI products and provides feedback on how to integrate those tools into their lessons. Lastly, and perhaps most importantly, TI works with textbook publishers to inte- grate its hardware, software, and digital content with the textbook in order to enrich the student experience.

Conclusion Both within Korea and globally, the digital textbook market represents a significant opportunity for TI. As publishers, students, schools, and teachers continue to develop this market, companies that have lengthy experience integrating educational software with tech- nology interfaces have a significant advantage over tablet manufacturers that attempt to develop proprie- tary educational software on an in-house basis. As text- books go digital, TI’s brand identity, reputation for quality, and integration-ready software platform facil- itate a much smoother transition than firms attempting

to develop education software from scratch. TI’s his- tory of hardware enablement allows it to differentiate its software from competitors offering mere simula- tions of fully interactive programs. Furthermore, TI’s existing solutions are primarily targeted at math and science. These two subjects can be particularly enriched by the use of digital textbooks and tablets, positioning TI even further ahead of the competition. Much like a classroom, there is a learning process associated with entering new markets and developing new applications for existing products, and much like its customers, TI will truly be taking its own education digital.

C A S E D I S C U S S I O N Q U E S T I O N S

1. What opportunities does the Korean tablet initiative provide for TI?

2. How can TI effectively communicate the value of its education solutions to its Korean constituents?

3. How can TI ensure that its products have all of the attributes necessary to meet the needs of the Korean education system?

INTEGRATIVE CASE 9 Texas Ins t ruments in South Korea: An Educat iona l Oppor tun i ty 447

INTEGRATIVE CASE 10

Jobek do Brasil’s Joint Venture Challenges1

Jobek do Brasil’s joint venture with a US partner, Hatteras Hammocks, is in trouble. The environmentally conscious Jobek do Brasil insists on using certified (sustainable) wood to make hammocks, but Hatteras has demanded uncertified wood products at more competitive prices. The troubled relationship has been compounded by the global economic crisis, which has reduced customers’ willingness to pay a premium for socially and environmentally responsible products. Will the joint venture survive?

Dirk Michael Boehe, Insper Institute of Education and Research, Brazil Luciano Barin Cruz, HEC Montréal, Canada

Barny Köpf had just returned from Spoga, the interna- tional trade fair for outdoor equipment and furniture held in Germany. Despite the global economic crisis, the results achieved at the fair were very positive for his company, Jobek, a Brazil-based multinational manufac- turer of leisure furniture and hammocks. However, Barny must resolve some issues before he can relax and enjoy the magical sunset from the patio of his beach house in Iguape, located 50 kilometers from the city of Fortaleza on Brazil’s Northeast Coast. The main issue is what to do with the international joint venture (IJV) forged seven years ago with the US company Hatteras Hammocks. The IJV, which began with the sale of a 49.5% interest in his company, was causing him to lose sleep. Jobek had always maintained a focus on environmental protection. The wood used to make its hammocks came from certified sources, a fact that the company had always used as a competitive advan- tage. The owners of Hatteras, however, had never been concerned with environmental matters. Historically, their clients were large chains such as Wal-Mart, and the focus was low prices.

What worried Barny was the fact that Jobek had adopted a strategy to enter international markets that

had little or nothing in common with Hatteras’ strat- egy. This difference had become apparent over the years of the partnership, which led to the initial terms

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1 This case study is solely for the purpose of classroom discussion and does not propose to render an opinion on managerial effectiveness or ineffectiveness or serve as a primary source of data. © 2012 Insper Institute of Education and Research. Reprinted with permission. No part of this case study may be reproduced or transmitted by any electronic or mechanical means, including photocopying, recording, or any storage system, without the express written consent of Insper Institute of Education and Research. Infractions are punishable under articles 102, 104, 106, and 107 of Brazilian Federal Law 9610 of February 19, 1998. For a Portuguese version, please email [email protected].

448 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

of the IJV agreement not being fully observed. If the IJV agreement had been complied with to the letter, Hatteras would not be buying from China, but from Jobek. At the same time, the contract for the exclusive distribution of Jobek products in the US market by Hatteras prevented Barny from selling to other US retailers and distributors he had met at the last trade fair. An ideal move would be to terminate the partner- ship, but how? Barny quickly dialed the number of his brother, Josef, the co-owner of Jobek.

The Hammock and Leisure Furniture Industry In Brazil, production is concentrated in a few centers of small-scale manufacturers located in the Northeast, especially in the state of Ceará. In Latin America, there are several such centers in Mexico and Colom- bia. In Asia, especially in India and China, there are various producers of diversified outdoor leisure furni- ture products, including sun umbrellas, tables, chairs, swing chairs, hammocks, and other textile products for the export market. In developed economies (such as Europe and the United States), companies have emerged with strong brands. They often outsource production to or operate manufacturing plants in developing countries.

It is worth noting that in recent years the sector has been undergoing change on a global scale. In the 1970s and the 1980s, developed economies were responsible for most of production, as well as exports of the final product. As of 1980, however, emerging economies began to play a more important role due to their cheaper labor and raw materials. As a result, companies in developed economies began to specialize in design, product development, distribution, and sales, handing over production to producers in emerging economies. In this process, the importance of agencies that verify product quality and conformity began to increase.

Social and Environmental Certifications Preoccupation over the environment and sustainability has become increasingly apparent in the media and in public policies. Companies have come under increasing pressure to adopt the path of sustainability. However, a

new problem arises. What does being responsible mean, and how does it add value to a company that uses sustainability as a competitive advantage? It is well known that the cost of being environmentally respon- sible can be extremely high and that consumers around the world respond to sustainability concerns in differ- ent ways.

As a result, more certifications have been created to support a reliable sustainability and social responsibil- ity seal. They include the well-known ISO series, inter- national reporting standards (such as the Global Reporting Initiative [GRI]), and certifications in speci- fic areas and sectors (such as those granted by the Forest Stewardship Council [FSC]). The FSC is an international and independent NGO, and its seal is the most widely recognized by other international NGOs (including the WWF, Greenpeace, and Friends of the Earth) and by the consumer market. The FSC fosters responsible forest management, aiming to pre- serve the forests’ main economic, environmental, and social characteristics.

The FSC provides two types of certification: Forest Management certifies organizations or agents that manage the forest in a sustainable manner in accor- dance with international standards and technical, eco- nomic, environmental, and social requirements. The main Chain of Custody Certificate requirement is the traceability of raw material from the forest(s) in ques- tion (in every stage of production, from extraction to the final product sold to the customer). Jobek possesses the FSC Chain of Custody Certificate, granted after an audit to ensure that only certified wood was used in its products. The certification is valid for five years, during which time the firm is subject to annual inspections to ensure compliance.

Despite the FSC’s initiatives to reduce certification costs, it is still up to the contracting company to pay for the annual audits and inspections, in addition to an annual fee whose precise amount is determined by the size of the operation to be certified. Nevertheless, sustainability certificates are increasingly valued by consumers, especially in developed countries. Conse- quently, obtaining the FSC seal is an attractive option for Jobek do Brasil in that it adds value to its prod- ucts through the green seal and a guarantee of high quality.

INTEGRATIVE CASE 10 Jobek do Bras i l ’s Jo in t Ventu re Cha l lenges 449

History of Jobek do Brasil At the end of the 1980s, Jobek’s founders, two German brothers named Barny and Josef Köpf, put their enter- prising idea into practice. Barny recalls:

In 1989, we started with the traditional Latin hammock, as we call it here: the hammock of Brazil and Mexico, hammocks without a rope, without a wooden framework. And so we started to import 400 hammocks as a test (from Ceará, Brazil, to Germany). We had no idea how it was going to work out but […] our neighbors liked them, since we started selling them straight from our garage […] Later we added support, accessories, etc.

Today Jobek is a multinational manufacturer of hammocks and leisure furniture based in two countries. The first base was established in 1992 in Schwan- gau, Germany, where Barny and Josef Köpf were

born. The second was founded in 2000 in Maraca- naú, in the metropolitan region of Fortaleza, Ceará, in Brazil. Today they run the Maracanaú facility, which is also where the products are manufactured. The German headquarters is in charge of quality management and product sales. In Brazil, Jobek has 250 employees in the high season and 80 in the low season. The German facility has a staff of 25. Between 2005 and 2007, Jobek’s annual export rev- enue averaged more than US$5 million. In 2008, however, it was less. Export profitability varies between 1% and 10% of revenue. Germany is the main export destination, followed by France and Spain (see Exhibit 1).

Product Design Due to growing competition for mass-produced, low- added-value products, Jobek do Brasil has been

EXHIBIT 1 Jobek’s Key Markets

COUNTRY 2005 2006 2007 2008 2009

Germany 47% 47% 45% 47% 66%

Canada 7% 5% 5% 5% 5%

US 5% 10% 3%

France 30% 30% 28% 32% 17%

Switzerland 1% 1% 1%

Spain 10% 10% 9% 10% 7%

Other 5% 2% 2% 3% 5%

TOTAL EXPORTS 100% 100% 100% 100% 100%

DOMESTIC MARKET (BRAZIL)

% of Total Produced 1% 1% 2% 3% 5%

Source: Jobek

450 INTEGRATIVE CASE 10 Jobek do Bras i l ’s Jo in t Ventu re Cha l lenges

focusing more on the premium niche. Some ham- mocks with accessories sell for more than €1,500 (US$2,000) each, thanks to innovative and exclusive design, rapid renewal of the product range, and possession of FSC certification, international safety certification (GS), and quality certification (ISO). In addition, some of the products’ attributes are beneficial for health. Hatteras Hammocks supplies a synthetic yarn called DuraCord exclusively to Jobek do Brasil, replacing the old cotton-based yarn. In addition to being cheaper than cotton, DuraCord is more resistant and durable while maintaining cotton’s soft texture. Jobek usually protects its more innovative products by patenting them. According to the quality and purchasing manager at the south German facility, the company is concerned with the continuous devel- opment of new products and is constantly striving to stay ahead of its competitors: “We are always two years ahead of the Asians because we’re continuously coming up with new products.”

Jobek’s global value chain formed in the past few years encompasses suppliers in Brazil and China, pro- duction in Brazil, and distributors in Canada, the United States, and several countries in Europe, among others.

The Adoption of the FSC Certification Standard and the Supply of Certified Wood Although the FSC seal is only one certification among many, its name, brand, and reputation have become established in several markets, and it is the most widely recognized and respected in Europe. In order to pro- mote the seal, the FSC attends trade shows and also communicates its proposal through television and magazines. Given the characteristics of the hammock production sector and the growing tendency of seeking environmental and social certifications, companies need to ensure the sustainability of the global value chain within which they operate in order to maintain the global and general consistency of their differentia- tion based on social and environmental responsibility. However, this is no easy task. Although Jobek do Brasil has been attempting to do precisely this, its JV with Hatteras Hammocks has raised certain issues that merit some reflection.

Certified wood suppliers are few in number and in a position to impose payment conditions almost unilat- erally. In 2008, the FSC’s representatives in Brazil admitted that “there is a problem of wood supply and, at the moment, certified forests have stopped increasing.” While Jobek do Brazil’s distributors and retailers can make use of a 180-day credit line, the company has to pay for its certified wood in cash. Barny comments on the reasons for this imbalance:

Like everything else, there are two sides to the story. The bad side is [that] today we are dependent on FSC suppliers, which is very difficult, since we are not the only ones seeking FSC-certified wood. The Chinese, the Vietnamese, the entire world is after this wood. Unfortunately, Brazil’s rules put us at a disadvantage. When it arrives here, from the interior of Pará (Brazil), our wood is already loaded with taxes, and freight is also very expensive. The Chinese go there, to Belém (Brazil) or Curitiba (Brazil), pay for their wood for export and get it tax-free. For us, buying wood is very complicated, not to mention frustrating. We currently have only one FSC supplier. One! We are in the hands of a single supplier.

Due to growing demand for certified wood, Jobek’s quality and purchasing manager in Germany and Jobek do Brasil’s export manager admit that the com- pany has had to turn down orders. In fact, it has been suffering legal problems due to the bottlenecks in the supply of certified wood to a major German retail chain.

Jobek has been trying to obtain alternative suppliers, in addition to certification from Brazilian agencies. However, this new certification has limited potential, since it is much less well-known than the FSC’s, which hinders the penetration of international markets.

Jobek’s owners visit their suppliers regularly in order to verify the quality of the wood and the volume produced, which has helped increase the company’s credibility with its international distributors and clients. The wood certification auditor firm considers Jobek even as a pioneer in its sector.

INTEGRATIVE CASE 10 Jobek do Bras i l ’s Jo in t Ventu re Cha l lenges 451

International Marketing The success of Jobek’s international hammock sales depends heavily on public awareness of the company’s FSC certification. Barny points out that Brazilian prod- ucts with a dubious ecological pedigree cannot take part in trade fairs in Europe, given that Europe keeps a very close eye on what is happening in the Amazon region. “If you sell an uncertified product, there’s a good chance you’ll have Greenpeace protesting in front of your store and no one wants that.”

In this sense, the FSC’s disclosure efforts are already producing results worldwide. Jobek’s Cana- dian distributor believes that consumers are changing and that the green seal constitutes a definite advantage for the product. “Previously, it was the sellers who used to tell clients about the certification, but today it’s the customers who are demanding the FSC seal.” However, Jobek’s US distributor believes that certified wood products have no market there, since both retail- ers and customers regard price as the most important factor in purchasing decisions. As a result, Hatteras Hammocks began to demand uncertified wood prod- ucts at more competitive prices. A Hatteras repre- sentative leaves us with no doubt regarding his opinion of certified wood:

Personally, I think it’s a great idea and everyone should support it. The problem is that the people who go to Walmart or stores of that type are not willing to pay more. It’s all or nothing. You can’t have a company that’s competitive just because it’s sustainable if there’s no market for it. The thing is that everyone wants to be environmentally correct, but they don’t realize the cost and they’re not willing to pay for it.

Obviously, the emphasis on FSC certification is not enough in itself to promote Jobek’s product abroad. The product is closely associated with the Latin Amer- ican culture—think of the lifestyle of Latin American people, life in tropical regions, and beaches sur- rounded by palm trees. Because many people in the Northern hemisphere envy such a lifestyle, it makes perfect sense to exploit these concepts when promot- ing the product internationally. According to Barny, this is part of the strategy:

We associated Brazilian culture with the product, which I personally think is very important, and I used this strategy in Europe and at the trade fair. I said: in Brazil the culture is hammocks, the culture is coffee. What comes from Brazil? Fruit, caipirinha, exuberance—a hammock can’t come from India or China. And we used this as a marketing tool; we put it on the packaging. These products are the most expensive line we have, they use a lot of wood, 100% certified wood of course. The packaging with the coffee sack stamp […] was a great success.

Production and Distribution In June 2000, following investments of R$3.5 million (US$2 million), Jobek do Brasil Indústria Têxtil opened a 6,900-square-meter factory in Maracanaú, which pro- duces the entire line of hammocks, hanging chairs, and accessories. After peaking in 2004, when the facility turned out 500,000 items, production plunged in 2008 and 2009 due to dwindling US demand and the global economic crisis. As a result, Jobek reduced its direct workforce to around 80 in the low season and out- sourced part of production.

Until 2008, Jobek exported almost its entire output. It is the sector leader in Europe, with a market share of around 80%, but competition from Asia has begun to threaten its performance. Currently, it exports to more than 40 countries: more than three-quarters of produc- tion goes to Europe, while 15% goes to the US and 5% to Asia. Only 1% of output is sold in Brazil itself, mostly in the south and southeast. Exports exceed 200,000 hammocks per year.

The International Joint Venture with Hatteras Walter R. Perkins, Jr., the founder and current CEO of Hatteras, acquired Pawleys Island and became the world’s largest hammock producer. Pawleys Island Ham- mocks was the oldest hammock manufacturer in the United States, which had been handcrafting cotton ham- mocks since its founding in 1889. Pawleys Island Rope Hammock stood for high-quality material, mixing com- fort and art. One of Hatteras’ competitive advantages is the DuraCord yarn that was specially created for it.

452 INTEGRATIVE CASE 10 Jobek do Bras i l ’s Jo in t Ventu re Cha l lenges

In view of the stronger competition, Jobek sought to increase its strength by forming a JV. The partnership with Hatteras started in a curious way, as Barny explains:

At the beginning of 2001 and 2002, we began to take part in trade fairs in the US, in Chicago, and apparently Hatteras had heard about us. They came to our stand, talked […]. In 2002, we began selling to Walmart and Sam’s, and Hatteras folks were seriously upset, because someone had broken their monopoly and they lost a major client.

Hatteras’ response caught Barny and his brother by surprise:

Hatteras’ CEO told me he thought we should talk instead of becoming competitors. Then they invited me to come to Greenville, in North Carolina, so I did, and we were really interested in establishing a partnership with them, with production in Brazil, and so were they. The two biggest companies in the US and Europe were going to get together. To create more! Two times two doesn’t make four, it makes five. That was the idea. In 2002 and 2003, the dollar was exceptionally strong, almost four reais (Brazilian currency), so it was cheap for them to produce here (in Brazil). At the time, we had very little working capital, so we decided: “let’s sell 49.5% of Jobek to them.” And they promised to transfer all their production to Brazil, expand the factory here, the infrastructure, everything. We drew up the agreement, sold 49.5% to them and began to build a larger factory.

In addition to building the new factory, the JV agreement also established that Hatteras would have the exclusive right to distribute Jobek’s products in the United States, while Jobek would distribute Hat- teras and Pawleys Island brand products in Europe. Jobek products would be sold in the United States under the Jobek do Brasil name, aiming to associate Brazil’s image with the Latin hammock made of fabric, thus differentiating it from the typical American hammocks. The Americans were visibly committed to the new venture. The son of Hatteras’ founder, Walter Perkins III, spent four weeks in Maracanaú to help

implement the basis for Hatteras hammock production, whose process is completely different from that used for the production of Jobek hammocks. In fact, the JV got off to an excellent start. The Americans trained the Brazilian workers, who learned extremely quickly. For the Americans, who already had busi- ness ties with Chinese suppliers, Brazil was also ideal from the logistics point of view. Proximity with the US shortened sea transport significantly: from 35 days from China to only 12 days from Pecém, Ceará, to Norfolk, Virginia.

However, much to Barny and Josef’s surprise, in the course of the JV, Jobek’s annual US sales plunged from US$3 million to just US$100,000. Initially, Jobek employees did not realize what was happening. Barny recalls: “We weren’t aware of it. Since they sold through a distributor, we never got the correct figure. Unfortu- nately, that was a mistake.” The experience left Jobek’s owners with a bitter taste because they were expecting to double the company’s revenue through the partner- ship. After all, they had changed the company’s entire infrastructure in Maracanaú and reserved “2,500 square meters of the factory just for them.”

But in 2003, the exchange rate started to worsen, moving from 3.6 Brazilian Reais per US$ in January 2003 to 1.75 Brazilian Reais per US$ in January 2008 (see Exhibit 2). It did not take long for Brazil-based production of hammocks to lose its allure for Hatteras, which ordered more products from India and China. In hindsight, Barny remarks:

They cut down on their orders and their idea was always to produce as little as possible—it wasn’t to sell our products in the US—and we began to realize that. Theywere not bad partners in the beginning.When you are a partner with almost 50%, when things become difficult, I expect you to remain a partner because the company is yours. Three years ago I called them and we had a meeting: “You have to place the orders or we’re going to have to change the infrastructure here…” “No, but the orders are coming…”And they continued acting like that […] they had come through the door but had never really entered.

The situation got so bad that Hatteras has not placed a single order since May 2008. Barny concludes: “We

INTEGRATIVE CASE 10 Jobek do Bras i l ’s Jo in t Ventu re Cha l lenges 453

have the infrastructure, their things are completely idle here and we no longer communicate with Hatteras.” On the other hand, European sales of Hatteras products through Jobek’s distribution channels were not very significant, either. Analyzing the Hatteras JV in hind- sight, Barny observes:

I think it was a big cultural problem. I’m German, they are Americans, and we are in Brazil. As a German, I see everything from a long-term perspective. Like this warehouse, which was built to last a lifetime. I think it’s a very different culture. And I saw a little of the difference between idealism and capitalism. I understood that it was no longer working with the Americans, not with that exchange rate. But maybe we could have come up with an alternative for another product line, adding more value. With a cheaper product I can’t produce more due to labor and infrastructure costs; I have to manufacture a product with greater added value or I have to rationalize more […]

The Crisis and Future Challenges The impasse in the Hatteras–Jobek partnership was compounded by the global economic crisis, which affected people’s willingness to pay a premium for socially and environmentally responsible products, in turn penalizing those companies committed to such products. As a result, many certified wood suppliers (such as Precious Wood in Belém, Brazil) have gone out of business. Others (such as El Dorado) are in the process of doing so. “How can we honor our commit- ments to our clients abroad?” Barny wonders, “We only have a few orders, but we still have to fill a container with FSC-certified wood products by the end of the season.” As if that were not enough, the crisis also affected the other side of the global value chain: “On December 22, 2008, our largest French distributor, Interproduct, went under,” Barny recalls.

It is Hatteras that is keeping Jobek’s owners awake at night. Barny and Josef both know that they would have been able to easily weather the crisis if they had not formed a JV with the Americans and expanded the

EXHIBIT 2 Exchange Rate Real (R$)/US$

0.80

1.20

1.60

R ea

l ( R

$) /U

2.00

2.40

2.80

3.20

3.60

4.00

Jan. ‘95 Jan. ‘96 Jan. ‘97 Jan. ‘98 Jan. ‘99 Jan. ‘00 Jan. ‘01 Jan. ‘02 Jan. ‘03 Jan. ‘04 Jan. ‘05 Jan. ‘06 Jan. ‘07 Jan. ‘08

Source: Data from Board of Governors of the Federal Reserve System

454 INTEGRATIVE CASE 10 Jobek do Bras i l ’s Jo in t Ventu re Cha l lenges

company’s infrastructure. “High fliers have the most to lose; now we have no working capital. In addition to being stuck for capital, there is also the agreement giving Hatteras the exclusive right to distribute Jobek’s products in the US. If it were not for that, we could capitalize on our advantages with sustainable prod- ucts,” Barny declares. A possible change in US envi- ronmental policy could help Jobek. “Last night, the new American president Obama said on TV that the US economy would have to grow with […] renewable energy. In this case we are two steps ahead of Hatteras, who will be our competitor because they never cared about the issue.”

At that moment, Barny remembers everything he learned from the Americans when they were in the factory in Maracanaú: “from products to how they estimated the costs. Nevertheless, it wouldn’t make any sense to compete with the same prod- ucts. The products that Hatteras buys from China are cheaper. It would be smarter to compete with design, quality, innovation, with products that are not yet sold in the US. And we learned a lot from the Americans. If it weren’t for this exclusivity agreement […] they wanted to sell us their share, but since we don’t have enough working capital, how can we pay them?” Barny questions, “Working capital is hard to come by because of the global crisis. They offered to sell their 49.5% for the same

price they paid when they entered the partnership. That’s absurd,” he exclaims, outraged. “Because in the meantime they caused us a huge loss due to the lack of orders. So, how am I going to buy at the same price? You come in with no risk and you get out with no risk? Perfect, isn’t it?”

Sources: Based on (1) authors’ interviews; (2) L. Barin Cruz & D. M. Boehe, 2008, CSR in the global market place: Towards sustainable global value chains, Management Decision, 46(1): 1187–1209; (3) Forst Stewardship Council, http://www.fsc.org; (4) Internal documents provided by Jobek GmbH, http://www.jobek.com.br.

C A S E D I S C U S S I O N Q U E S T I O N S

1. How would you evaluate the IJV between Jobek and Hatteras?

2. What was the international market strategy of Jobek? And of Hatteras?

3. What are the differences between the concepts of corporate social responsibility used by Hatteras and Jobek?

4. Based on your evaluation, what should Jobek do?

5. Describe Jobek’s current competitive environment. What changes do you foresee in the future? How do you think they will influence Jobek?

INTEGRATIVE CASE 10 Jobek do Bras i l ’s Jo in t Ventu re Cha l lenges 455

INTEGRATIVE CASE 11

The Antitrust Case on the AT&T–T-Mobile Merger1

In 2011, the second largest US mobile wireless carrier, AT&T (with a 25% market share), proposed to merge with the fourth largest carrier, T-Mobile, which had a 15% market share and was a wholly owned subsidiary of Deutsche Telekom. Antitrust authorities blocked this merger. Why?

Mike W. Peng, University of Texas at Dallas

The Merger In March 2011, Dallas-based AT&T announced that it reached an agreement with Deutsche Telekom (DT) to purchase DT’s wholly owned US subsidiary, T-Mobile USA, for $39 billion. The top-four concentration in mobile wireless telecommunications services in the United States accounted for more than 90% of market share. Of the Big Four, the second-ranked AT&T had about 25% market share, and the fourth-ranked T- Mobile had 15%. The largest player was Verizon (31%), and the third was Sprint Nextel (20%). Although some small carriers competed in certain regions, no carriers other than the Big Four competed nationally. After the proposed merger, the combined AT&T/T-Mobile would become the nation’s largest wireless carrier, commanding over 40% of market share with 132 million customers and $72 billion in revenues. The scale and scope of the merger would require reg- ulatory approval. AT&T indicated its willingness to sell off certain assets if necessary and planned to complete the merger in one year.

AT&T argued that the merger would allow AT&T to expand 4G LTE broadband to another 55 million Americans, reaching a total of 97% of the population and especially benefitting rural areas currently without broadband coverage. Because T-Mobile was losing money and suffered from its poor economies of scale, it (and its parent company DT) had been unable to upgrade its networks and invest in 4G broadband. While AT&T was booming and adding customers, T- Mobile was losing customers—it was the only major

carrier that did not offer the iPhone. But T-Mobile possessed some hard-to-substitute resources: spectrum. Spectrum was finite resources auctioned by the Federal Communications Commission (FCC). Exhausting its own spectrum, AT&T could benefit from tapping into T-Mobile’s underutilized spectrum. Accelerating 4G wireless deployment would not only generate new jobs due to AT&T’s own investment, but also stimulate broader job creation and civil engagement due to better access to more affordable and more widespread wire- less broadband services.

A variety of labor, environmental, and business groups supported the merger. These groups pointed to AT&T’s record and commitments to labor and environmental standards and appreciated the invest- ment and the jobs the merger would bring. Also, civil rights groups applauded the additional boost in civil engagement that could be facilitated by more wide- spread broadband. Governors of 26 states wrote letters to support the merger.

However, other diverse groups were opposed to this merger. Not surprisingly, Verizon and Sprint did not like this deal because it would make them weaker. Sprint would become a distant third, so clearly it would not appreciate the outcome. Verizon would lose its top position, but it would still be a strong player in a new duopoly. Internet companies did not like the merger either, because it would leave them with fewer service providers to negotiate with for getting their content and applications to customers. The Computer and Communication Industry Association, which included eBay, Google, Microsoft, and Yahoo as its members,

1 This research was supported by the O. P. Jindal Chair at the Jindal School of Management, University of Texas at Dallas. All views and errors are those of the author. © Mike W. Peng. Reprinted with permission.

456 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

was opposed to the merger. Consumer groups argued that the merger would raise prices and stifle innovation by consolidating so much of the wireless industry in one firm.

On the core issue of whether increasing AT&T’s market power would hurt consumers, AT&T pointed out that the average inflation-adjusted price for wireless services in the United States fell by 50% from 1999 to 2009, according to the Government Account- ing Office. AT&T also argued that in many local markets AT&T would still be competing with four or more rivals, so taking T-Mobile (which was losing customers anyway) out of the mix would not dent competition. If AT&T could not acquire T-Mobile (which had sizable infrastructure such as cellular towers and significant spectrum), then AT&T might be forced to build its own infrastructure, which would be an unnecessarily costly undertaking and social waste, especially in crowded urban areas such as San Francisco. But even if AT&T went head to head with infrastructure building, it would still suffer from a shortage of spectrum, while T-Mobile, at the same time, could not fully utilize its spectrum—clearly a waste of finite resources.

The Antitrust Case In August 2011, the US Department of Justice (DOJ) filed a lawsuit alleging that this merger would reduce competition and violate antitrust law. DOJ alleged that the “anticompetitive harm” of this merger would include:

(a) actual and potential competition between AT&T and T-Mobile will be eliminated; (b) competition in general likely will be lessened substantially; (c) prices are likely to be higher than they otherwise would; (d) the quality and quantity of services are likely to be less than they otherwise would due to reduced incentives to invest in capacity and technology improvements; and (e) innovation and product variety likely will be reduced.

In particular, given T-Mobile’s positioning as a self- styled “Disruptive Pricing” provider, “AT&T’s acquisi- tion of T-Mobile,” alleged DOJ, “would eliminate the important price, quality, product variety, and innovation

competition that an independent T-Mobile brings to the marketplace.” In addition, DOJ argued:

In conclusion, DOJ argued that the proposed merger would violate Section 7 of the Clayton Act and that it should be stopped. In the lawsuit, DOJ also sued T-Mobile and DT as co-defendants. On behalf of the US government, DOJ was the sole plaintiff in its first complaint filed on August 31, 2011. In its first amended complaint filed on September 16, DOJ was joined by the states of New York, Washington, California, Illinois, Massachusetts, Ohio, and Pennsylvania as co-plaintiffs. In its second amended complaint filed on September 30, Puerto Rico joined as a co-plaintiff. The case was officially the United States et al. v. AT&T Inc. et al.

AT&T was not a stranger to antitrust lawsuits. Today’s AT&T is the direct result of the first United States v. AT&T antitrust lawsuit. Because of its mono- poly in long-distance (land-line) telephone, the original AT&T (“Ma Bell”) was forced by DOJ to break up into seven regional Bell operating companies (known as “Baby Bells”) in 1983. Between 1983 and 2005, today’s AT&T was one of these Baby Bells—named South- western Bell Corporation between 1983 and 1995 and shortened to SBC between 1995 and 2005. Due to its successful market performance, SBC emerged as a lead- ing offspring of the original AT&T (Verizon was another leading offspring). In 2005, SBC spent $16 billion to purchase its former parent company, AT&T Corporation—a Baby Bell acquiring Ma Bell. Quitting the SBC name, the merged entity named itself AT&T Inc. and took on the iconic AT&T branding (including its logo and its stock ticker “T,” which simply stands for “telephone”). Before the filing of the second United States v. AT&T case, the Economist asked: “Could the

INTEGRATIVE CASE 11 The Ant i t rus t Case on the AT&T–T-Mob i le Merge r 457

bid for T-Mobile be a sign that monopoly Ma is trying to return from her grave?”

The Outcome In November 2011, the FCC issued its opinion and joined DOJ in opposing the merger. In December 2011 (before the antitrust case went on trial), AT&T gave up the merger and DOJ dismissed the case. A triumphant DOJ announced:

Consumers won today… Had AT&T acquired T- Mobile, consumers in the wireless market place would have faced higher prices and reduced innovation. We sued to protect consumers who rely on competition in this important industry. With the parties’ abandonment, we achieved that result.

A frustrated AT&T noted in its press release:

[Dallas, Texas, December 19, 2011] AT&T Inc. (NYSE: T) said today that after a thorough review of options it has agreed with Deutsche Telekom AG to end its bid to acquire T-Mobile USA, which began in March of this year.

The actions by the Federal Communications Commission and the Department of Justice to block this transaction do not change the realities of the US wireless industry. It is one of the most fiercely competitive industries in the world, with a mounting need for more spectrum that has not diminished and must be addressed immediately. The AT&T and T-Mobile USA combination would have offered an interim solution to this spectrum shortage. In the absence of such steps, customers will be harmed and needed investment will be stifled

“AT&T will continue to be aggressive in leading the mobile Internet revolution,” said Randall Stephenson, AT&T chairman and CEO. “Over the past four years we have invested more in our networks than any other US company. As a result, today we deliver best-in-class mobile broadband speeds—connecting smartphones, tablets, and emerging devices at a record pace—and we are well underway with our nationwide 4G LTE deployment.

“To meet the needs of our customers, we will continue to invest,” Stephenson said. “However,

adding capacity to meet these needs will require policymakers to do two things. First, in the near term, they should allow the free markets to work so that additional spectrum is available to meet the immediate needs of the US wireless industry, including expeditiously approving our acquisition of unused Qualcomm spectrum currently pending before the FCC. Second, policymakers should enact legislation to meet our nation’s longer-term spectrum needs.

“The mobile Internet is a dynamic industry that can be a critical driver in restoring American economic growth and job creation, but only if companies are allowed to react quickly to customer needs and market forces,” Stephenson said.

The fine print in the deal included DOJ’s blessing of AT&T and T-Mobile’s collaboration in roaming. The more significant (or, if you will, the more bizarre) outcome was that as per AT&T’s original deal with DT, in the event of merger failure, AT&T would pay T-Mobile $3 billion as a break-up fee and give T-Mobile $1 billion worth of AT&T-held wireless spectrum. In short, the US government reduced the competitiveness of a US firm by forcing a US firm to subsidize the wholly owned subsidiary of a foreign firm.

In the name of preserving (domestic) competition, the US government preserved a (foreign) competitor. “The problem is,” noted one expert at Slate, “T-Mobile doesn’t want to be a competitor anymore. Its parent company DT wants out of the US market.” As the weakest among the Big Four, T-Mobile only added 89,000 new customers between 2009 and 2011, while the industry took in 33 million new customers. By essentially giving up since March 2011, T-Mobile lost 467,000 lucrative contract customers during the merger process. By focusing on its terms of exit, T-Mobile turned its attention away from network upgrades and improvements. DOJ and FCC cannot force T-Mobile to be in business, just like no one can force customers to sign up for plans they do not want. By breathing a new lease on life into T-Mobile, that was exactly what DOJ and FCC did: forcing T-Mobile to be in business against its (and its parent company’s) own wishes. The same expert at Slate continued:

458 INTEGRATIVE CASE 11 The Ant i t rus t Case on the AT&T–T-Mobi le Merger

Sure, companies like T-Mobile and Sprint can offer cheaper plans, but the success of Verizon and AT&T shows price is not our primary concern when it comes to wireless service. We want shiny smartphones and big, powerful, reliable networks … Rather than stifle competition, the merger would have intensified the war between the two giants, AT&T and Verizon. And for those people for whom price is paramount, there would remain not only Sprint, but a slew of smaller, regional providers like Leap and MetroPCS.

Sources: Based on (1) the author’s interviews, 2011; (2) AT&T, 2011, AT&T ends bid to add network capacity through T-Mobile USA purchase, December 19, www.att.com; (3) AT&T, 2011, AT&T statement on Department of Justice action, August 31, www.att.com; (4) Bloomberg Businessweek, 2011, Behind AT&T’s epic lobbying failure, December 12: 40–42; (5) Bloomberg Businessweek, 2011, For wireless giants, reception may get spotty, July 18: 35–36; (6) CBS News, 2011, What the AT&T-T-Mobile breakup means for you, December 20, www.cbsnews.com; (7) Economist, 2011, An audacious merger with a poor reception, March 26: 71–72; (8) Economist, 2011, Tripped at the altar, September 3: 62; (9) W. Oremus, 2011, Truth, justice, and terrible mobile service, Slate, December 21, www.slate.com; (10) United States of America v. AT&T, T-Mobile USA, Inc., and Deutsche Telekom AG, 2011, Complaint, Case 1:11-cv-01560, August 31, Washington, DC: US District Court for the District of Columbia; (11) United States of America et al.

v. AT&T Inc. et al., 2011, Amended complaint, Civil Action No. 11-01560 (ESH), September 16, Washington, DC: US District Court for the District of Columbia; (12) United States of America et al. v. AT&T Inc. et al., 2011, Second amended complaint, Civil Action No. 11-01560 (ESH), September 30, Washington, DC: US District Court for the District of Columbia; (13) United States of America et al. v. AT&T Inc. et al., 2011, Stipulation of dismissal, Civil Action No. 11-01560 (ESH), December 20, Washington, DC: US District Court for the District of Columbia; (14) Wall Street Journal, 2012, T-Mobile will focus on network quality in wake of deal failure, January 11, online.wsj.com.

C A S E D I S C U S S I O N Q U E S T I O N S

1. Defend AT&T’s position as its CEO.

2. Defend this merger as T-Mobile’s or Deutsche Telekom’s CEO (both firms were co-defendants in this case).

3. Provide an expert testimonial as Verizon’s or Sprint Nextel’s CEO.

4. Challenge AT&T’s position as an antitrust lawyer working for the government.

5. ON ETHICS: As a party not directly involved in the case (such as a manager at another firm not in this industry or a student), what do you think is right about antitrust policy? What is wrong about antitrust policy? Why?

INTEGRATIVE CASE 11 The Ant i t rus t Case on the AT&T–T-Mob i le Merge r 459

INTEGRATIVE CASE 12

Ocean Park Fights Hong Kong Disneyland1

Before and immediately after Hong Kong Disneyland’s opening in 2005, many people believed that Hong Kong’s homegrown amusement park, Ocean Park, might not be able to survive. Would Ocean Park become a “sitting duck” when Donald Duck came?

Michael N. Young, Hong Kong Baptist University

The Arrival of Hong Kong Disneyland The arrival of Hong Kong Disneyland in 2005 had caused many pundits to predict the demise of Hong Kong’s homegrown amusement park, Ocean Park. Sev- eral of Disney’s characters, such as Mickey Mouse, Donald Duck, and Winnie the Pooh, were household names all over the world. With its legendary “Imagineer- ing,” Disney was cranking out new animated characters that debuted in movies, making them well known by the time visitors encountered them in Disney parks.

In comparison, few people outside of Hong Kong had even heard of Ocean Park. Founded in 1977, Ocean Park had been the only amusement park in town. The lack of competition did not push it to strengthen its brand image, symbolized by its Seahorse logo. The nonsmiling seahorse was far from warm and cuddly to the impres- sionable younger customers—it was hard for children to imagine snuggling with a seahorse. “You could say that we had no brand image at all at that time,” conceded one manager. Hearing that Disney would be coming, Ocean Park introduced a sea lion named Whiskers as its new mascot. Whiskers was bigger and cuter with a big smile, triggering a much warmer and easily approachable feel- ing to customers. Soon after Whiskers was introduced, he became a household name in Hong Kong, particularly with children and families. In addition to stronger brand building, Ocean Park also geared up to prepare for Dis- ney’s onslaught by installing new attractions, upgrading existing rides, and enhancing interactive activities with animals (including Hong Kong’s only pandas). Yet the dazzling commencement ceremony of Hong Kong

Disneyland made Ocean Park look relatively tired and dated by comparison.

Most local people were sympathetic to Ocean Park, as it seemed like a classic David versus Goliath compe- tition. Ocean Park, the clear underdog, had become a fixture of Hong Kong’s cultural heritage. Disneyland, playing the part of Goliath, represented the quintessen- tial multinational giant set out to destroy the local icon. But the fact was that despite some improvement, Ocean Park was beginning to look and feel tired and shabby, and its attractions paled when compared with the glitz and glamour of Disney. Would Ocean Park be able to survive? In other words, when Donald Duck came, would Ocean Park become a “sitting duck”?

Leveraging Ocean Park’s Strengths While Ocean Park did have thrill rides, its primary focus was on nature and wildlife with many animal-related

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activities. Its Ocean Theater staged dolphin and sea lion shows. Its world-class Atoll Reef, Shark Aquarium, Bird Aviary, and Pacific Pier gave visitors opportunities to view wild animals and beautiful scenery up close—a rarity in urban Hong Kong. In addition, Ocean Park had distinct Chinese characteristics that reflected its roots in Hong Kong.

“The only way we can survive is to make our park world class,” stated Allan Zeman, Ocean Park’s Board Chairman. Early on, Ocean Park made a clear decision that it would not try to beat Disneyland at its own game. Zeman stated: “We do not want to try to ‘out-Disney’ Disney.” The result was an ambitious $700 million mas- ter plan, including schemes for a new roller coaster that would be operating by 2012, a subzero Ice Palace, and a 7.6-million-liter aquarium with an underwater restau- rant. An extra 33 animal species would be brought in, and the number of rides was doubled to 70. Ocean Park hoped to position itself as a world-class marine-based attraction with real animals in this ambitious overhaul. The park would further strengthen its core competencies in “real” nature rather in contrast to Disney’s strengths in cartoon characters, castles, virtual reality, and fantasy. It was hoped that Ocean Park could differentiate itself more clearly from Disneyland. However, the huge $700 million investment would put a severe financial burden onOcean Park as half of the investment would come from bank loans. Ocean Park’s profit in 2005 was only $15 million. Despite the high cost of the redevelopment plan, manage- ment kept Ocean Park’s admission fee at 30% lower than Disney’s: $36 versus $51 for adults in 2011.

To boost attendance of local visitors, Ocean Park introduced an annual pass with unlimited admissions for an entire year. It hoped that annual pass holders might also bring along other visitors. Besides the new pricing campaign, seasonal holiday themes were another field of battle between Ocean Park and Hong Kong Dis- neyland. This battle highlighted the different approaches taken by East and West. For instance, for Halloween 2009, a creative campaign was laid out. While Hong Kong Disneyland was fashioning a sinister, dark world, like the one in Hollywood blockbusters, Ocean Park tapped into the local psyche, derived from old tales like the madness at the high street police station and

the long-haired girl who was said to haunt a university laboratory. There was a clear contrast between Ocean Park that played the Hong Kong card and Disneyland that deployed strong Western elements.

Turning a Threat into an Opportunity By 2010, Ocean Park had not only overcome Dis- ney’s challenges, but had even managed to turn a threat into an opportunity. Far from being the death knell as predicted by many analysts, Disney’s arrival in Hong Kong had been a boon for Ocean Park. Disney’s opening spurred Ocean Park into action with a dramatic turnaround. In 2010, Ocean Park achieved the highest recorded attendance (5.1 million) in its history, surpassing Disneyland’s 5 million visitors. Some commentators suggested that Ocean Park was a bigger benefactor from Disneyland than was Disney itself. The opening of Disneyland had rejuvenated local interest in amusement parks. Furthermore, Hong Kong Disneyland increased the number of tourists from China and Southeast Asia to Hong Kong—particularly families interested in amusement parks. In addition to seeing Disney, it was natural for them to want to see Ocean Park. As a result, Ocean Park enjoyed increasing profits, while Hong Kong Disneyland struggled—with missing attendance goals and doubtful profitability.

C A S E D I S C U S S I O N Q U E S T I O N S

1. How was Ocean Park able to turn a threat into an opportunity?

2. Ocean Park made the decision not to compete head to head with Disneyland. Will this strategy always work when local companies face multinational giants? Explain.

3. How can Ocean Park further capitalize on Disneyland’s presence? (Hint: Check out how other parks surrounding Disney, such as Sea World and Universal Studios, survive and thrive in Anaheim, California, and Orlando, Florida.)

4. How can Hong Kong Disneyland turn around its lackluster performance?

INTEGRATIVE CASE 12 Ocean Park F igh ts Hong Kong Disney land 461

INTEGRATIVE CASE 13

Nomura’s Integration of Lehman Brothers’ Assets in Asia and Europe1

Is there strategic fit between Nomura and Lehman? Is there organizational fit? Does Nomura have what it takes to successfully integrate these two companies with contrasting management styles?

Mike W. Peng, University of Texas at Dallas

The Opportunity of a Lifetime In September 2008, Lehman Brothers went bankrupt. Britain’s Barclay Capital bought Lehman’s North America operations for $3.75 billion. Lehman’s assets in Asia and Europe were purchased by Nomura for the bargain-base- ment price of $200 million. Founded in 1925, Nomura is the oldest and largest securities brokerage and investment banking firm in Japan. Although Nomura had operated in 30 countries prior to the Lehman deal in 2008, it had always been known as a significant but still primarily regional (Asian) player in the big league of the financial services industry. In addition to Lehman, the list of elite investment banking firms in early 2008 would include Goldman Sachs, Morgan Stanley, Bear Stearns, JP Morgan, and Citigroup of the United States; Credit Suisse and UBS of Switzerland; and Deutsche Bank of Germany. No one would include Nomura in this group. Nomura viewed itself primarily as an Asian version of Merrill Lynch.

The tumultuous 2008 left Bear Stearns dead first, Lehman second, and all of the firms in the big league named above in deep financial trouble. To Nomura, this became the opportunity of a lifetime. Within a lightning 24 hours, CEO Kenichi Watanabe decided to acquire Lehman’s remnants in Asia and Europe. Some of the Lehman assets were dirt cheap. For exam- ple, its French investment banking operations were sold to Nomura for only one euro (that is, €1!). Overall, by cherry-picking Lehman’s Asia and Europe opera- tions and adding 8,000 employees who tripled Nomura’s size outside Japan, Nomura transformed

itself into a global heavyweight overnight. The question was: Does Nomura have what it takes to make this acquisition a success?

Integration Challenges The answer was a decisive “No!” from Nomura’s inves- tors, who drove its shares down by 70% by 2012. Since the purchase price seemed reasonable and there was little evidence that Nomura overpaid, the biggest challenge was postacquisition integration, merging a hard-charging New York investment bank with a

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hierarchical Japanese firm that still largely practices lifetime employment.

Clearly, Lehman’s most valuable, rare, and hard-to- imitate assets are its talents. To ensure that Nomura retained most of the ex-Lehman talents, Nomura set aside a compensation pool of $1 billion (five times the acquisition price) and guaranteed all ex-Lehman employees who chose to stay with Nomura not only their jobs, but also their 2007 pay level (including bonuses) for three years. About 95% of them accepted Nomura’s offer. Given the ferociousness of the financial meltdown in 2008–2009 (which, if you remember, was triggered by Lehman’s collapse), many employees at other firms that were not bankrupt lost their jobs. The fact that Nomura guaranteed both jobs and pay levels was widely appreciated by ex-Lehman employees who otherwise would have been devastated.

Instead, acquiring Lehman introduced significant stress to Nomura’s long-held traditions. A leading chal- lenge was pay level. Most senior executives at Lehman made on average $1 million in 2007. On average, Nomura employees only received half the pay of their Lehman counterparts. Not surprisingly, guaranteeing ex- Lehman employees at such an astronomical pay level (viewed from a Nomura perspective) created a major problem among Nomura’s Japanese employees. In response, Nomura in 2009 offered its employees in Japan higher pay and bonuses that would start to approach the level ex-Lehman employees were commanding, in exchange for less job security—in other words, they could be fired more easily if they underperformed. So far, about 2,000 Japanese employees accepted the offer, which would link pay to individual and departmental performance rather the firm as a whole.

Another challenge was the personnel rotation system. Like many leading Japanese firms, Nomura periodically rotated managers to different positions. For example, Yoshihiro Fukuta, who served as head of Nomura International Hong Kong Ltd. in 2008, was rotated back to Tokyo as head of the Internal Audit Division in 2009. While these practices produced well- rounded generalist managers, they generated a rigid hierarchy: a manager in a later cohort year, no matter how superb his (always a male) performance was, was unlikely to supervise a manager in an earlier cohort year. These Nomura practices directly clashed with

Western norms: (1) work was increasingly done by specialists who developed deep expertise and (2) super stars were typically on a fast track rocketing ahead. Although the personnel rotation system largely did not apply to Nomura’s overseas employees, it resulted in a top echelon that consisted entirely of Japanese executives who went through the rotations. In an effort to globalize, Nomura’s top echelon needed to attract diverse talents, especially those from Lehman. Could the rotation system accommodate the arrival of ex-Lehman employees who had neither experience with nor stomach for it?

Postacquisition Performance Four years after the acquisition, the performance was disappointing. In 2009, Nomura moved its investment banking headquarters to London to demonstrate its commitment to break into the top tier. In 2011, in Europe, Nomura was No. 13 in underwriting equities and No. 15 in advising on mergers. In Asia outside of Japan and in the United States, it was a distant No. 24 and No. 22, respectively, in underwriting equity offer- ings. Its dominance in Japan was indeed strengthened by the Lehman deal. Nomura’s market share in advis- ing Japanese acquirers that made deals overseas shot up from 10% in 2007 to 25% in 2011.

Integration continued to be Nomura’s number-one headache. Outside Japan, the deal turned out to be a “reverse” takeover with gaijin (foreigners) running most of the show. Nomura undertook a campaign to expunge the long shadows of the Lehman hangover. Both symbolically and comically, mentioning the “L” word (such as “This is how we did it at Lehman”) during senior executive meetings in London would cost executives £5 every time—they had to toss the money into a box as a penalty. In 2012, Jesse Bhattal, who was the former Asia Pacific CEO of Lehman, the deputy president of the Nomura group, and the CEO of Nomura’s investment banking group (the highest ranked non-Japanese executive at Nomura), resigned amid heavy losses. Bhattal failed to see eye to eye with the board and was frustrated by his inability to undertake much-needed cost cutting. His departure was regarded as “the culmination of a clash with Nomura’s old guard,” according to Bloomberg. The dark clouds over Nomura thickened…

INTEGRATIVE CASE 13 Nomura ’s In tegra t ion of Lehman Brothers ’ Asse ts in As ia and Europe 463

Sources: Based on (1) Bloomberg, 2012, Nomura reeling from Lehman hangover, February 28, www.bloomberg. com; (2) BusinessWeek, 2009, Nomura is starting to flex its Lehman muscles, September 28; (3) E. Choi, H. Leung, J. Chan, S. Tse, & W. Chu, 2009, How can Nomura be a true global financial company? Case study, University of Hong Kong; (4) Economist, 2009, Numura’s integration of Lehman, July 11; (5) A. Huo, E. Liu, R. Gampa, & R. Liew, 2009, Nomura’s bet on Lehman, case study, University of Hong Kong; (6) Reuters, 2012, Ex-Lehman’s Bhattal quits Nomura amid deep losses, January 10: www.reuters.com.

C A S E D I S C U S S I O N Q U E S T I O N S

1. What is the strategic fit between Nomura and Lehman?

2. Is there any organizational fit? How can the gaps between the cultures of these two firms be bridged?

3. How does Nomura alleviate the concerns of multiple stakeholders?

4. How would you predict the effectiveness of Nomura’s transformation after this acquisition?

464 INTEGRATIVE CASE 13 Nomura ’s In tegrat ion of Lehman Brothe rs ’ Assets in As ia and Europe

INTEGRATIVE CASE 14

Baosteel Europe1

How does a leading Chinese steelmaker manage its European headquarters in Germany?

Bernd Michael Linke, Friedrich Schiller University of Jena, Germany Andreas Klossek, Technical University of Freiberg, Germany

The Making of a Global Corporation The name “Baosteel” combines Baoshan, a district in Shanghai, China, and the English word “steel.” “Baosteel” stands for a Chinese company with global outreach. However, experts in Asia think that there is an additional twist at play, as is often the case with company names in this region. In Chinese, “bao” also signifies “valuable” or “precious,” and a literal transla- tion of Baosteel may be “premium steel”—certainly something to which the company aspires.

Baosteel’s home market is staggering. On the demand side, the market reflects the sheer and insati- able needs of the largest and most successful emerging economy in the world. However, on the supply side, it is fragmented unlike any other market in the world. Currently, the Chinese steel market is divided by 260 steelmakers of various sizes, and some sources say this number could be greater than 1,000. While some of these firms are profitable, most are not. Thus, it is not surprising that the Chinese government is urging them to turn themselves into large steelmaking corporations following the lead of Baosteel.

Baosteel Group was founded in Shanghai in 1978 under the name of Baoshan Iron and Steel Complex. Skipping some of the historical details, it suffices to say that the current-day corporation is the result of a large merger between Shanghai Metallurgical Holding Group Corporation and Shanghai Meishan Group Co., Ltd., carried out in 1998 on the basis of a government

decree. With continued growth, the most recent acqui- sition took place in April 2008, when Baosteel acquired the Bayi Steel Group in the province of Xinjiang.

Baosteel Group is a holding company consisting of five divisions: (1) financial, (2) steel trading, (3) equip- ment and spare parts engineering, (4) steel products, and (5) Shanghai headquarters office (administrative and service). The company produces and sells steel primarily to carmakers, shipbuilders, electronics and household appliances makers, oil drilling and pipeline companies, and construction companies. Baosteel has further diversified into areas such as financial services, trading, and logistics services. In sum, the company’s operational philosophy is to continue to “diversify trading functions and operation products” while “gra- dually expanding non-Baosteel trading business.”2

In comparison to international rivals, Baosteel dis- plays a high degree of diversification. However, this is typical for many large Asian firms. Baosteel is a wholly owned state-owned enterprise (SOE). The largest busi- ness unit, Baoshan Iron and Steel Co., Ltd. (Baosteel Co., Ltd.), has been listed on the Shanghai Stock Exchange since 2000. Currently, 78% of the shares are held by Baosteel Group and thus ultimately by the Chinese government.

In recent years, the turnover of Baosteel has risen annually by 10%, from $19.5 billion in 2004 to $26.3 billion in 2007. During the same period, steel produc- tion has risen from 21.4 million to 28.6 million tons.

1 This case was written by Bernd Michael Linke (Friedrich Schiller University of Jena, Germany) and Andreas Klossek (Technical University of Freiberg, Germany). It was first published in the authors’ study Chinese Companies in Germany: Chances and Challenges, which was sponsored by Bertelsmann Foundation and Deloitte (the full study can be accessed at http://www.bertelsmann-stiftung.de/cps/rde/xbcr/SID-12ED87F3- 5090242B/bst_engl/xcms_bst_dms_27517_27534_2.pdf). The authors would like to thank both for granting the permission to reprint this case. © Bertelsmann Foundation. Reprinted with permission. Case discussion questions were added by Mike Peng. 2 Baosteel, 2009, Address by the President, Accessed November 11, 2009, www.baosteel.eu.

465 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

Baosteel, which currently employs 122,780 workers, is China’s largest producer of steel. It has worked on prestigious and complex building projects such as the principal venue of the 2008 Summer Olympic Games (the national stadium nicknamed “Bird’s Nest” in Beij- ing), the headquarters of CCTV state television in Beijing, and the terminals of international airports in Beijing and Shanghai. In international terms, the com- pany is also one of the largest corporations of its kind. Since 2006, Baosteel has been in fifth place in the global steelmaker category. In 2004, Baosteel was the first Chinese manufacturing company to be included in the Fortune 500 list at 372—by 2008, it had climbed to 259. Baosteel aims to become one of the three largest steel producers in the world as soon as possible and is well on its way to achieving this goal.

Strategic Positioning and Global Activities Many experts believe that Baosteel’s goal is attainable. Its accomplishments, which the Western media tradi- tionally would not have thought possible in the case of a Chinese SOE, speak for themselves. Over the course of the most recent merger, the workforce was cut 43% from 176,000 to 122,780. Baosteel believes that its future success is no longer going to be based on cheap labor, but instead on automated production. The main plant in Shanghai is considered to be one of the most modern and most efficient manufacturing sites for steel products in the world. At Baosteel, the new manage- ment focus is visible in many areas. For example, the “Six Sigma” quality management system was success- fully introduced in 2005. Further, Baosteel engages in strategic planning and has an integrated management system designed to regulate and assign responsibilities, executive order powers, and communication channels between business entities.

Corporate social responsibility (CSR) has also become increasingly important in recent years. Baosteel is ahead of this social trend, embracing CSR and bank- rolling numerous social projects as early as in 1990. For example, the establishment of Baosteel Education Fund

is one of the most visible education awards nationwide. Its foundation has set up 38 Hope elementary schools3

and provides support for sustainability and environ- mental projects. To further substantiate its dedication to CSR, Baosteel is the first Chinese company to pub- lish annual sustainability reports, which have appeared since 2005. Moreover, in 2006, the management announced a new slogan and goal centered around CSR. The slogan, “Green Baosteel, our common home,” is aligned with its goal of turning Baosteel into the cleanest and most sustainable steelmaker in the world.

The preconditions for turning the company into a global player are in place. First, Baosteel, since its founding, has never been a typical Chinese SOE. Sec- ond, it dates back only to 1978, which coincides with the exact point at which the Chinese economic reforms got off the ground. Thus, unlike many SOEs, it was not burdened with the legacy of the Chinese communist past. Finally, it has been shaped by the cosmopolitan tradition of Shanghai, which is reflected in the long- lasting relationships and numerous joint ventures that the Baosteel Group holds with other global players.

Baosteel is prepared to confront the future and recognizes the enormous challenges it will bring. Spe- cial market segments in China have, for some time, seen higher growth rates and much higher demand levels than in other emerging markets such as India and Russia. To some extent, they have even caught up with those of industrialized countries such as the Uni- ted States. The latest OECD research suggests that this trend is visible in every segment of the Chinese steel market and is projected to become more pronounced. At the same time, exports continue to grow despite the gigantic demand in China. In 2004, Chinese steel exports exceeded imports for the first time in history.

Endeavoring to meet the high demand at home, more than 90% of Baosteel’s turnover is in China. Additionally, to enhance its negotiating position in the competition for scarcer natural resources, it is plan- ning further mergers and acquisitions at home and abroad, both horizontally and vertically (upstream and downstream) across the value chain. The current consolidation of the Chinese steel market and open

3 In Chinese jargon, Hope schools refer to schools set up in poor rural areas where children would not have been educated had these schools not been set up. These schools are known to offer “hope.”

466 INTEGRATIVE CASE 14 Baostee l Europe

access to international markets are making this strategy of acquiring new plants and integrating important mining sites possible. For example, currently, Baosteel imports 80% of the iron ore it needs. However, as early as in 2001, the company took a 50% share in the Brazilian iron ore mine Água Limpa, and in 2003, it acquired shares in Hamersley Iron, an Australian sub- sidiary of Rio Tinto. These equity positions are exam- ples of Baosteel’s vertical movement on the value chain. Moreover, loose partnerships and numerous meetings with other steel giants in Asia, such as Nippon Steel in Japan and Posco in Korea, nurture rumors that a mer- ger may emerge.

Of decisive importance for the Baosteel Group’s strategic planning are not only the economic goals, but also the acquisition of international management experience. As such, internationalization efforts, such as those detailed in the remainder of the case with a focus on Baosteel Europe, are crucial.

Setting Up a Subsidiary in Hamburg, Germany Baosteel has been conducting business in Germany for a long time, though its activities have changed signifi- cantly over the years. In the beginning, it was impos- sible to think about selling steel products; rather, its main task was to supply Chinese companies with vital replacement parts sourced in Germany for domestic production. This changed in 1993, when senior management decided to expand and founded Baosteel Europe GmbH with $6.64 million. Baosteel selected Germany for a very specific reason: the local courts provide European customers and suppliers with more legal protection than if business were to be conducted in Hong Kong or China. In other words, using the institution-based view, Baosteel considered the “rules of the game” regarding the legal infrastructure and enforce- ment across countries and made its location decision.

After deciding to locate in Germany, Baosteel also evaluated a number of German cities. Its decision to locate the business in the Hamburg metropolis was based on both economical motives (such as direct

access to shipping routes) and cultural aspects. For example, Ye Meng, the current President of Baosteel Europe, states, “Hamburg and China can look back on a long history of partnership. There really are quite a lot of Chinese companies and trading entities here. The parent of Baosteel Europe GmbH comes from Ham- burg’s sister city, Shanghai, which is also a port city. Both from a cultural perspective and for geographical reasons Hamburg in our opinion provides us with favorable conditions for the development of our com- pany.” Additionally, the workforce, technology, and infrastructure in Germany are known to be world class. Further, Meng believes that earning the trust of German clients and selling “Made in Germany” steel parts in China have benefited the company greatly.4

Indeed, Baosteel Europe’s business has been boom- ing. In the past three years, turnover increased to $732 million. This means that Baosteel Europe is among the largest Chinese companies in Germany. While making a profit, Baosteel Europe is certainly not resting on its laurels. Not only is Baosteel Europe strategizing to increase its share of the global market, it is also seek- ing to expand in Germany and Europe with new products and innovations. As such, the Hamburg sub- sidiary is due for expansion with new specialists recruited. Under Meng, the structure of Baosteel Europe GmbH has changed considerably in the past few years. For example, in 2004, there were 30 Baosteel employees in Germany, and today there are 55—with additional employees in other offices throughout Europe, the Middle East, and Shanghai. The finance department and the Shanghai office are responsible for the internal organization of what happens in Ham- burg. Looking after customers and suppliers is the task of each business area (i.e., steel trading, spare parts and equipment, and metal products). Recently, the new business department has been given the mandate of expanding into new business areas. In order to manage a variety of tasks, the company employs indi- viduals from a number of countries. In Hamburg, Chinese expatriates work side by side with Germans. In other subsidiaries in Europe, employees from the various host countries are in the majority. Taken

4 “Hamburg provides Chinese company with link to Germany, Europe, and the world,” accessed November 12, 2009, http://www.gtai.com/ homepage/info-service/publications/our-publications/germany-investment-magazine/vol-2008/vol-032008/foreign-direct-investment1/.

INTEGRATIVE CASE 14 Baostee l Eu rope 467

together, it is apparent that Baosteel is a transnational company with a global outlook.

Business Areas of the Baosteel Subsidiary in Germany Procurement, which was of considerable importance at the start of Baosteel’s activities in Germany, continues to play an important role today. The transactions involved are complicated and interculturally demanding, requir- ing good coordination. The procurement process is set in motion by a firm in a given location—for example, a Chinese steelmaker in a province that needs spare parts obtainable only from Europe. This requirement is relayed to the Baosteel head office in Shanghai, which subsequently transmits an inquiry to Baosteel Europe. The inquiry is received by a Chinese or German employee in Hamburg, who then places an order with a local (German) supplier. After the spare parts arrive, another Chinese or German Baosteel employee arranges for them to be sent to China. Inquiry, order processing, and transport are dealt with in Chinese, German, and English, meaning that employees of both nations transact on many tasks together and must engage in an ongoing dialogue. Thus, at the Hamburg location, business success absolutely depends on Sino- German cooperation, which is based on years of experience and mutual understanding. A Chinese department head supervises four tandems, each con- sisting of a Chinese and a German employee, who know each other and work together in a coordinated manner.

Steel trading, however, has a fundamentally different procurement process, wherein ten Chinese co-workers— most of whom are engineers—work under the direction of the internationally experienced deputy managing director, Guo Zheng. The working language is Chinese, and in keeping with international business practices, English is used when communicating with the “outside” world. In steel trading, the German market plays a subordinate role. Sales orders are sent via Hamburg, where the contracts are concluded, to the whole of Europe and the rest of the world. The majority of customers value Baosteel’s quality, reliability, punctual delivery, and service. Although price is important in certain countries, Baosteel does not position itself

in the lower price segment, preferring to have a price level akin to that of ThyssenKrupp and ArcelorMittal. In order to increase its market share in Europe, Baosteel is pinning its hopes on premium quality and customer orientation. The turnover volume, currently about 500,000 to 600,000 tons annually, is still a very small percentage of the total output.

The new business department is also managed by a Chinese expatriate with international experience. “New” refers both to new regions (such as the Middle East, Eastern Europe, and Africa) and to new activities (such as investments in sectors other than the steel industry). The current planning phase involves conducting feasibility studies (with the help of external expertise) and studying market entry methods.

Corporate Culture and Work Atmosphere In recent years, Baosteel’s senior management has come to realize the importance of a common corporate culture—for both Chinese and foreign employees. In 2004, Baosteel implemented a program that stresses “good faith” and “synergy” as basic values and empha- sizes the significance of culture as the basis of all economic action. It has been said that “Baosteel’s cul- ture is the soul of management, while Baosteel’s man- agement is the vehicle of culture.” The executives at Baosteel Europe emphasize words such as “integrity,” “teamwork,” and “loyalty,” and are thus transferring to all employees the essence and level of their cooperation with the head office in Shanghai. To stress the high opinion and importance of the local workforce, all German employees of Baosteel Europe were invited to stay in Shanghai for a week. There they were shown the organization of the head office, met their counterparts with whom they often telephoned or exchanged emails, and experienced Chinese hospitality—along with grati- tude for their achievement and loyalty to the company. The German employees have also been included in the Chinese bonus system in order to encourage their participation in the success of the company.

At the biannual meeting involving all Baosteel Europe employees, management reports at length about the success and goals of the parent company

468 INTEGRATIVE CASE 14 Baostee l Europe

and the Hamburg subsidiary, hoping to foster a com- munity spirit. The German employees were also pleas- antly surprised that the Chinese executives clearly try to respect German habits and customs by not expecting German employees to stay in the office until late in the evening, as is often the case with Chinese expatriates. Baosteel has come to understand and acknowledge that despite different work habits, in the end, the efficiency is the same.

The German employees are also particularly appre- ciative of the respect with which Chinese superiors treat their subordinates. The experience of working together on a daily basis means that German employees at Baosteel certainly do not share the typically negative picture of China that is often painted by the media. Instead, most have developed a far more positive pic- ture of China.

Apart from the good atmosphere in the workplace, employees have additional motivations. Specifically, a large and expanding company is synonymous with safe jobs. This is especially true for Chinese companies, where protection against dismissal is based on the Chinese and Confucian belief that one has a duty to look after the well-being of others. The high one-off bonuses for special accomplishments confirm the appreciative attitude of the senior management. There- fore, employee turnover is quite low in comparison with other companies within this industry.

To advance within Baosteel, it is necessary to occupy a position of responsibility at the head office. As such, it is important for individuals to possess not only professional qualifications, but also have the ability to speak fluent Chinese. Thus, many German employees who do not speak Chinese find it extremely difficult to reach the senior management level at Baosteel Europe. Overall, while challenges remain, Baosteel has over- come many of the cultural differences by taking time to understand those differences and finding ways to embed both the German and Chinese cultures within its organizational culture.

Human Resource Management (HRM) In China, Baosteel enjoys a good reputation for its excellent compensation and career opportunities. To maintain its reputation and recruit top talent, Baosteel implements a very thorough recruiting process.

Candidates for its comprehensive examination proce- dure are selected from a large number of applicants— all of whom are university graduates. Unlike most companies in East Asia, Baosteel rarely recruits candi- dates jumping ship from other employers or at job fairs. However, once candidates are selected, the suc- cessful applicants are introduced to and trained in Baosteel’s corporate culture, which is a customary prac- tice in Chinese firms. If the candidate does well over the course of the year, the company may cover the cost of further education—for example, a one-year higher education program at home or abroad. After this, the individual is likely to be promoted within the company and employed as a senior executive, alternating between China and other countries. Interestingly, until recently it had been considered a welcome opportunity for Chinese employees to be offered the opportunity to work abroad for a number of years, since it coincided with good pay and enhanced qualifications. However, because income and career opportunities have devel- oped enormously within China in recent years, many consider this same “opportunity” or assignment to be a burden, especially since the quality of life in Shanghai is now higher than that in many Western cities.

In other words, Chinese expatriates now experience the same types of burdens as expatriates from devel- oped countries, such as separation from their family or problems with their children’s schools overseas. Although Baosteel takes into account these reservations and offers its Chinese expatriates numerous incentives such as increased compensation and job guarantees for spouses, the willingness to work in other countries is declining. However, for individuals trying to climb the career ladder, successful stints abroad considerably facilitate access to the senior management level and to executive posts in the subsidiaries and at the head office.

More recently, Baoteel has expanded the scope of its HRM, becoming more strategic in nature. In addition to regular assessments, the skills of its employees are continually being enhanced by means of systematic training. Further, preparatory country-specific or cul- ture-specific instruction for foreign assignments is now available, as are returnees’ programs. Finally, the men- toring system is well organized and highly valued. Talented young executives are watched over and given

INTEGRATIVE CASE 14 Baostee l Eu rope 469

advice by mentors appointed to look after and guide them. As mentors rise in the company hierarchy, it will eventually lead to advancement for their “mentees,” who may also receive recommendations for employ- ment elsewhere. This network system not only leads to good professional work, but is indispensable if one wishes to advance to a decision-making position.

Baosteel Europe Paves the Way for Integration and Expansion For Baosteel, numerous economic and cultural aspects were of decisive importance when it chose Hamburg as its European location. Endeavoring for a win-win out- come, Baosteel Europe has developed a great relation- ship with the Hamburg city government, especially with its departments involved in economic development. Baosteel continuously manages this relationship by staying in touch with the media and having company representatives participate in and sponsor public events. Interestingly, Baosteel has also incorporated its German- oriented practices of external representation back in China, demonstrating its dedication to learning from global best practices. Baosteel has also begun to develop ideas regarding networking strategies with other Chinese organizations in Germany geared toward the joint promotion of their interests and maintained loose part- nerships with two other large Chinese corporations also located in Hamburg—COSCO and Bank of China.

Baosteel Europe is said to exemplify the “large Chinese corporation abroad,” and it occupies a front- runner role in two senses—being both a “test case” and a “model.”5 Many Chinese companies still find it difficult to be internationally competitive, and there is often a discrepancy between an impressive success story told at home and the hesitant progress overseas that may be marred by setbacks. This could change quickly if “pilot projects,” such as the internationalization of Baosteel, are a success and the senior management of other companies draws the right conclusions. How- ever, it is not only the views within an industry that are of importance. Chinese companies, especially those with international ambitions, must assume that they are being

watched intently by the public both at home and abroad and must behave in a responsible manner.

After a rough start, Baosteel has made significant progress in recent years. Admittedly, the situation has been rather auspicious for the steel industry. An essen- tial basis for further expansion in the international sector is a systematic development of HR beginning with recruiting and leading to career planning and further education. Baosteel aims to use the talents of both German and third-country specialists and to form inter- national leadership teams that will be in a position to meet the challenges of international management. Further, in the case of international customer–supplier relationships, it is important to preempt cross-cultural conflicts by increasing the level of intercultural compe- tence and strengthening an overarching corporate culture.

Baosteel is well on its way to mastering these chal- lenges, having already united a variety of very different companies in Shanghai and developing a distinct corpo- rate culture among its employees. When discussing Baosteel’s “hard skills,” the former chairwoman Qihua Xie once coined the slogan “quality, not quantity.” The same can just as well be applied to Baosteel’s “soft skills.” Overall, the Baosteel Group is an exemplary company from which other Chinese companies can learn.

C A S E D I S C U S S I O N Q U E S T I O N S

1. What location-specific advantages did Hamburg, Germany, provide Baosteel? Evaluate other European locations that might offer similar advantages.

2. How did Baosteel manage its entry into Europe? What factors have enhanced its success?

3. How did Baosteel Europe overcome the challenges of managing a subsidiary?

4. What are the lessons on how to manage human resources in a subsidiary that we can draw based on Baosteel Europe’s experience in Germany?

5. Why does Baosteel devote considerable resources to corporate social responsibility?

5 Handelsblatt no. 43, March 1, 2007.

470 INTEGRATIVE CASE 14 Baostee l Europe

INTEGRATIVE CASE 15

Bank of America’s Corporate Social Responsibility and the Occupy Wall Street Movement1

Although Bank of America invested $268.8 billion in CSR-related activities in 2010, it was a leading target for the Occupy Wall Street protestors in 2011. In the middle of the Occupy Wall Street movement, two executives were trying to figure out how to formulate CSR plans for 2012.

Cathy Benjamin, University of Texas at Dallas Vivian Brown, University of Texas at Dallas James Buchanon, University of Texas at Dallas Grace Crane, University of Texas at Dallas Michele Harkins, University of Texas at Dallas

“What do these people want from us?” Mary Turner, Global Strategy and Marketing Executive for Bank of America, looked outside her fourth floor window as Occupy Wall Street protesters marched on the sidewalk in front of the bank in October 2011. Anne was preparing to meet with Mark Smith, Global Corporate Social Responsibility (CSR) and Consumer Policy Executive, to discuss their recommendations to the board regarding 2012 CSR plans.

Public outcry demanded more and more from the bank, as it was repeatedly blamed for causing the 2008 mortgage crisis. Occupy Wall Street protesters marched with signs stating “We are the 99%” as a reminder of the distribution of wealth between the wealthiest 1% and the remainder of the population. Wealth distribution had become a growing and heated debate in 2011. The week before, a group of protestors had briefly taken over a Los Angeles branch demanding that Bank of America help resolve state budget deficits. The bank was forced to call in police to protect its customers, employees, and prop- erty. Trash recovered from a foreclosed home was dumped on the lawn of some bank executives.

Consumers were being encouraged to close accounts at big banks and open accounts at credit unions. Protestors seemed to believe that corporate greed was the root cause

M ap

R es

o u rc es

1 This case was written by Cathy Benjamin, Vivian Brown, James Buchanon, Grace Crane, and Michele Harkins (University of Texas at Dallas EMBA 2012) under the supervision of Professor Mike Peng. The purpose of the case is to serve as a basis for class discussion rather than to illustrate the effective or ineffective handling of an administrative situation. The views expressed are those of the authors (in their private capacity as EMBA students) and do not necessarily reflect those of the individuals and organizations mentioned. © Cathy Benjamin, Vivian Brown, James Buchanon, Grace Crane, and Michele Harkins. Reprinted with permission. Case discussion questions were added by Mike Peng.

471 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

of America’s financial crisis. This public outcry for the banks to be more socially responsible was threaten- ing their ability to do business.

Bank of America’s CSR Activities Bank of America considered itself to be a socially respon- sible company. Its 2010 CSR activities included invest- ments of $268.8 billion (see Exhibit 1), including:

• $168.5 billion in community development (see Exhibit 2)

• $92 billion in small and medium-sized businesses

• $4.1 billion spent with thousands of small, medium, and diverse suppliers

• $4 billion in environmental business initiatives

• $207.9 million in philanthropy (see Exhibit 3)

• 1.3 million employee volunteer hours

Despite the challenging economic environment, the bank launched its Emergency Safety Net Strategy. The program was designed to meet pressing community needs stemming from the poor economy. It provided direct funding to enable health and human service nonprofit organizations to continue delivering health care, job training, childcare programs, shelter, hunger relief, and other services to help stabilize the commu- nities it served. At a time of government cutbacks and failing service providers, the bank continued to support education and youth development, community devel- opment and neighborhood preservation, health and human services, and arts and culture.

EXHIBIT 1 Bank of America 2010 CSR Highlights

BIG GOALS FOR 2010 ACHIEVEMENTS IN 2010

Invest and lend $1.5 trillion in community development projects by 2019.

Invested $168.5 billion in community development, increasing total investment since 2009 to $336.7 billion.

Increase loans to small and medium-sized businesses by $5 billion in 2010.

Increased lending to more than $92 billion to small and medium-sized businesses, $10.5 billion more than in 2009.

Spend $10 billion with small, medium-sized, and diverse suppliers by 2015.

Spent $4.1 billion with thousands of small, medium-sized and diverse suppliers, including $2.3 billion with diverse suppliers alone.

Invest $20 billion in environmentally friendly businesses by 2017.

Invested nearly $4 billion toward environmental business initiative in 2010, reaching the $11.6 billion mark on three-year-old initiative to address climate change through lending, investing products and services, and operations.

Reduce total greenhouse gas emissions by 9% between 2004 and 2009.

Surpassed goal to achive an overall emissions reduction of 18% within the legacy Bank of America portfolio between 2004 and 2010; reduced Scope 1 and 2 emissions by 8 percent in 2010 alone.

Invest $2 billion through philanthropy by 2019, including at least $200 million in 2010.

Invested $207.9 million in philanthropy in 2010.

Volunteer one million employee hours of service in 2010.

Volunteered nearly 1.3 million hours of employee service.

Source: Bank of America, Opportunity in Motion Corporate Responsibility Report 2010, http://webmedia.bankofamerica.com/ aheadbankofamerica/v4/video_files/CSR/Bank%20of%20America%202010%20Corporate%20Social%20Responsibility%20 Report.pdf

472 INTEGRATIVE CASE 15 Bank of Amer i ca ’s Corporate Soc ia l Respons ib i l i t y and the Occupy Wal l S t ree t Movement

EXHIBIT 2 Bank of America 2010 Community Development Efforts

0 20 40 60 80

Total = $168.5 billion

100%

Consumer

Economic Development

Small Business

Affordable Housing $151.2 billion (90%)

$11.3 billion (7%)

$3.0 billion (2%)

EXHIBIT 3 Bank of America 2010 Philanthropic Investments

0 5 10 15 20 25 30%

Total = $207.9 million

Arts & Culture

Community Development & Neighborhood Preservation

Education

Environmental

Health & Human Services

Associate Directed Giving

Other

$54,818,793 (26%)

$43,737,458 (21%)

$40,174,577 (19%)

$32,472,681 (16%)

$29,961,849 (14%)

$5,839,500 (3%)

$935,001 (1%)

INTEGRATIVE CASE 15 Bank of Amer i ca ’s Corpora te Soc ia l Respons ib i l i t y and the Occupy Wal l S t ree t Movement 473

Turner doubted that the protesters were aware of the sacrifice the bank was making at a time when she believed it should focus more on its bottom line. She knew it would be tough to convince Smith to cut back on corporate giving. But the bank was under scrutiny at every turn. Every morning when she turned on MSNBC, she dreaded the moment the bank’s name would be mentioned. A new story about the bank and its robo-signing practices was on the front page of the Mortgage Servicing News on her desk. She glanced at the articles in her inbox—Bloomberg, American Banker, ABA Banking Journal, Wall Street Journal, and New York Times. She began to wonder if Bank of America had a reserved spot on the front page of every financial news vehicle. She reached for her BlackBerry and shook her head as she read the latest tweet about how many homeowners the bank had forced to be homeless. She had recently shut down her LinkedIn and Facebook accounts due the flood of negative com- ments she was receiving. Since she agreed to the inter- view on Good Morning America, she had begun to receive personal messages. “Aren’t banks in the busi- ness to make a profit for their shareholders?” she wondered out loud as Smith stuck his head in her door.

History Bank of America is one of the largest financial institu- tions in the world with offices in more than 40 coun- tries. Its Global Capital Markets and Global Corporate & Investment Banking divisions work to structure and underwrite capital raising transactions in the debt and equity markets. In the United States, the bank serves individual consumers, small- and middle-market busi- nesses, and large corporations. Its services include banking, investing, asset management, and other prod- ucts and services, including consumer mortgage lend- ing and servicing.

In July 2008, Bank of America acquired Country- wide Financial and became the largest mortgage lender and consumer bank in the US, making it the lender in one of every four US home loans. In 2007, Country- wide and its CEO, Angelo Mozilo, came under scrutiny for the large number of defaults and foreclosures of subprime loans. Although several other mortgage lend- ers were also under scrutiny, Countrywide was the nation’s largest lender and carried with it a history of

predatory lending practices. Starting in the 1990s, the company borrowed from Wall Street, quickly closed the loans, and sold them on the secondary market. Although originally a profitable situation for both sides, the increased number of mortgage defaults created a breakdown of this cycle. By 2007, the threat of bank- ruptcy as a result of predatory lending practices was looming, and Mozilo agreed to the Bank of America buyout. Mozilo’s exit package was approximately $72 million, even though he was under investigation for his accelerated sale of stock from 2006 to 2007.

The 2008 subprime mortgage crisis was triggered when over 20% of these high-risk borrowers defaulted on primarily adjustable-rate mortgages. By the end of 2007, Americans had also increased their debt to per- sonal income ratio to over 120%, home prices declined, mortgage-backed securities lost their value, foreclosures increased, banks tightened credit, interest rates increased, and banks were forced to foreclose on homes. In October 2008, Congress passed the Troubled Asset Relief Program (TARP) designed to allow banks and other mortgage financers to regain stability and to resume consumer lending. Bank of America was deemed “too big to fail” and received $45 billion in TARP funds, which it repaid in December 2009.

2010 CSR Report: Conflict Between Social and Financial Responsibility Bank of America released its 2010 CSR Report in early 2011 amid controversy as to how the bank should repay the public for the legacy Countrywide issues. The report emphasized the bank’s commitment to its core values and operating principles and its continued struggles in the mortgage arena. The company was not shy about discussing how it would clean up its legacy issues and outlined its mortgage retention solutions, including home loan modifications, customer assistance programs, and improved clarity in the lending process. The report indicated that 76% of foreclosed borrowers had not made a mortgage payment for at least one year. Through its self-identified audit practices, the bank evaluated the integrity of its foreclosure practices and responded with additional staffing, controls, and quality checks.

Bank of America committed to prepare for and participate in upcoming mortgage industry reforms,

474 INTEGRATIVE CASE 15 Bank of Amer i ca ’s Corporate Soc ia l Respons ib i l i t y and the Occupy Wal l S t ree t Movement

to introduce a new loan modification program, to dis- patch a dedicated mortgage servicing team, and to deploy the newly formed Legacy Asset Servicing divi- sion with a dedicated staff and executive leadership. The bank supports employee volunteerism by granting two volunteer hours per week per employee during business hours. Philanthropy is supported by up to $5,000 in matching funds for employee donations to non-profit organizations.

Turner believed in the bank’s approach to CSR. However, she had to convince Smith, and the board, that the economic downturn demanded that the bank sharpen its focus on its shareholders. She began her discussion with Smith by reminding him of the losses the bank had suffered since the Countrywide purchase. The midyear report indicated the bank’s $6.78 billion loss in net income, excluding goodwill impairment charge. Although the bank had realized a slight reduc- tion in nonperforming loans, leases, and foreclosed properties, 2011 financial reports indicated the bank had a need to reduce debt and increase capital.

Last year, Moody’s, Standard & Poor’s, and Fitch had each downgraded the bank’s credit rating. In June 2011, Moody’s placed the bank on review for an addi- tional downgrade. These agencies reminded the bank of the systemic damage legacy issues have on the econ- omy. Slow US job growth, supply chain impacts due to the Japanese natural disaster, concern over the European financial crisis, inflation pressures in China, and the US federal debt issues contributed to an environment that reduced the public’s confidence in Bank of America.

In 2011, the Financial Accounting Standards Board (FASB) introduced new guidelines affecting loan mod- ifications, repurchase agreements, fair value measure- ment principles, and the presentation of comprehen- sive income. In June, BAC Home Loans Servicing and certain Countrywide affiliates entered a $8.6 billion settlement agreement. Bank of New York Mellon acted as trustee to resolve outstanding and potential claims regarding warranty breaches and other historical loan servicing claims associated with legacy Countrywide activities. Bank of America was under investigation by the Department of Justice for alleged irregularities in foreclosure practices, including compliance with FHA HUD requirements. Regulatory reform resulting from

the 2010 Financial Reform Act threatened to increase the cost of doing business. FDIC deposit insurance assessments of large and complex financial institutions threatened the bank’s cash reserves. Scrutiny by the Consumer Financial Protection Bureau, BASEL II capi- tal requirement rules, and changes to Market Risk Rules continued to threaten the financial services industry. Other threats to the bank’s solvency included new rules surrounding how non-sufficient fund fees, overdraft charges, and ATM fees could be charged.

The Dilemma Bank of America Faced for 2012 CSR Plan Smith was well aware of the state of the economy, including the state of the financial services environ- ment. He understood all of the threats to the solvency of the bank and was clear on the potential impact to the communities in which it served. Turner was delivering a haunting speech that made him seriously rethink his 2012 CSR plans. He began to wonder if the bank could afford its current commitments. He had always vowed to treat the bank’s funds as if they were his own. However, he had already reduced his personal financial commitments by 25% over the past two years. He continued his philanthropic giving, but reduced it to health and human services, reasoning that necessities such as food and shelter were most important during this financial downturn. He received disappointing calls and letters from the arts and cultural organiza- tions to which he traditionally donated. A few of his friends at the country club tried to persuade him that he had no reason to feel personally responsible for the mortgage crisis. Even his family taunted him after he announced he would be reducing spending. Perhaps it was time for the bank to do likewise.

Smith listened intently as Turner detailed the state of the bank. Although she agreed that corporate giving promoted the company’s brand, she could not ignore the need for deeper financial cuts. In September, the bank announced that it would reduce its 288,000 work- force by 30,000 over the next few years, citing attrition and freezes of job opening as the primary manner of reduction. However, by early October, layoffs were occurring throughout the company. Was the bank in a worse shape than Turner realized?

INTEGRATIVE CASE 15 Bank of Amer i ca ’s Corpora te Soc ia l Respons ib i l i t y and the Occupy Wal l S t ree t Movement 475

Smith thought about the upcoming meeting with the board and realized that he had no options. The bank could no longer afford to continue its level of giving. Something had to change quickly in order to meet stakeholder demands. But how could Bank of America change its CSR strategy without further dam- aging the brand? Already, Wells Fargo was being criti- cized for reducing its commitment to green building. Citigroup was battling the SEC over mortgage fraud charges. Goldman Sachs paid millions last year in an SEC settlement related to subprime loans.

Bank of America was looking for more cash. The CEO, Brian Moynihan, announced in early 2011 the bank was looking to improve its fortress balance sheet amid questions on whether the bank had sufficient capital to sustain itself through the economic down- turn. Rumors were surfacing around the bank’s likelihood of further reducing its holdings in China Construction Bank. Since becoming CEO in 2010, Moynihan had already sold a Canadian credit-card portfolio, an insurance unit, and a private bank. The week before, the bank agreed to sell its stake in the Pizza Hut franchisee, including its debt, for $755 million to Olympus Partners. The deal would result in a net gain of over $375 million for the bank.

Smith realized that shareholder value should be the most immediate concern of the bank. He was suddenly exhausted as he looked over his list of corporate com- mitments. Slowly he pulled out his highlighter and started a lengthy review that would take him and Turner the next four hours to complete.

Sources: Based on (1) Bank of America and Countrywide, June 2010, retrieved October 15, 2011, from RealtyTrac: http://www.realtytrac.com/foreclosure/reo/bank-of-america-

countrywide-foreclosure.html; (2) Bank of America Finishes TARP Repayment, December 10, 2009, retrieved October 29, 2011, from DealBook: http://dealbook.nytimes.com/2009/12/ 10/bank-of-america-finishes-tarp-repayment/; (3) Bank of America Investor Relations, September 13, 2011, retrieved November 5, 2011, from Bank of America: http://investor. bankofamerica.com/phoenix.zhtml?c=71595&p=irol-reports other; (4) Bank of America Investor Relations, September 13, 2011, retrieved November 7, 2011, from Bank of America Investor Fact Book - Midyear 2011: http://investor.bankof america.com/phoenix.zhtml?c=71595&p=irol-reportsother; (5) Bank of America Releases First Corporate Social Responsibility Report, July 12, 2011, retrieved October 15, 2011, from Bank of America, Inside Our Company: http:// ahead.bankofamerica.com/featured/bank-of-america-releases- corporate-social-responsibility-report/; (6) Bank of America (n.d.), retrieved from http://investor.bankofamerica.com/ phoenix.zhtml?c=71595&p=irol-reportsother; (7) Wall Street Journal, BofA Hunts for More Cash, November 8, 2011, retrieved November 8, 2011, http://online.wsj.com/article/ SB10001424052970204190704577023890083609800.html? KEYWORDS=pizza+hut.

C A S E D I S C U S S I O N Q U E S T I O N S

1. ON ETHICS: Despite such significant contributions to CSR causes, why is Bank of America so resented, not only by the Occupy Wall Street crowd but also by large segments of the general public?

2. ON ETHICS: Did or should Bank of America communicate to the Occupy Wall Street crowd about its CSR work?

3. ON ETHICS: What should Turner and Smith recommend to the board?

476 INTEGRATIVE CASE 15 Bank of Amer i ca ’s Corporate Soc ia l Respons ib i l i t y and the Occupy Wal l S t ree t Movement

GLOSSARY

A absorptive capacity The ability to absorb new knowl- edge by recognizing the value of new information, assimilating it, and applying it.

accommodative strategy A strategy that tries to accommodate corporate social responsibility considera- tions into decision making.

acquisition The transfer of control of assets, opera- tions, and management from one firm (target) to another (acquirer); the former becomes a unit of the latter.

acquisition premium The difference between the acquisition price and the market value of target firms.

agency costs The costs associated with principal– agent relationships. They are the sum of (1) the prin- cipals’ costs of monitoring and controlling agents and (2) the agents’ costs of bonding.

agency relationship The relationship between princi- pals and agents.

agency theory The theory about principal–agent rela- tionships (or agency relationships in short).

agents Persons (such as managers) to whom author- ity is delegated.

agglomeration Clustering economic activities in cer- tain locations.

ambidexterity Ability to use one’s both hands equally well. In management jargon, this term has been used to describe capabilities to simultaneously deal with para- doxes (such as exploration versus exploitation).

anchored replicator A firm that seeks to replicate a set of activities in related industries in a small number of countries anchored by the home country.

antidumping laws Laws that punish foreign compa- nies that engage in dumping in a domestic market.

antitrust laws Laws that attempt to curtail anti- competitive business practices such as cartels and trusts.

antitrust policy Competition policy designed to com- bat monopolies, cartels, and trusts.

arm’s-length transactions Transactions in which parties keep a distance (see also formal, rule-based, impersonal exchange).

attack An initial set of actions to gain competitive advantage.

B backward integration Acquiring and owning up- stream assets.

balanced scorecard A performance evaluation method from the customer, internal, innovation and learning, and financial perspectives.

bargaining power of buyers The ability of buyers to reduce prices and/or enhance the quality of goods and services.

bargaining power of suppliers The ability of suppliers to raise prices and/or reduce the quality of goods and services.

base of the pyramid (BOP) The vast majority of humanity, about five billion people, who make less than $2,000 a year.

Beijing Consensus A view that questions Washington Consensus’ belief in the superiority of private ownership over state ownership in economic policy making, which is often associated with the position held by the Chinese government.

benchmarking Examination as to whether a firm has resources and capabilities to perform a particular activity in a manner superior to competitors.

477 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

blue ocean strategy A strategy that focuses on devel- oping new markets (or “blue ocean”) and avoids attack- ing core markets defended by rivals, which is likely to result in a bloody price war (or “red ocean”).

born global firm (international new venture) A start-up company that attempts to do business abroad from inception.

bounded rationality The necessity of making rational decisions in the absence of complete information

BRIC Brazil, Russia, India, and China.

BRICS Brazil, Russia, India, China, and South Africa

build-operate-transfer (BOT) agreement A special kind of turnkey project in which contractors first build facilities, operate them for a period of time, and then transfer them back to clients.

bureaucratic costs The additional costs associated with a larger, more diversified organization.

business group A term to describe a conglomerate, which is often used in emerging economies.

business process outsourcing (BPO) Outsourcing of business processes such as loan origination, credit card processing, and call center operations.

business-level strategy Strategy that builds competi- tive advantage in a discrete and identifiable market.

C capability The tangible and intangible assets a firm uses to choose and implement its strategies.

capacity to punish Having sufficient resources to deter and combat defection.

captive sourcing Setting up subsidiaries to perform in-house work in foreign location. Conceptually iden- tical to foreign direct investment (FDI).

cartel An entity that engages in output- and price- fixing, involving multiple competitors. Also known as a trust.

causal ambiguity The difficulty of identifying the causal determinants of successful firm performance.

center of excellences MNE subsidiaries explicitly recognized as a source of important capabilities, with the intention that these capabilities be leveraged by and/or disseminated to other subsidiaries.

CEO duality The CEO doubles as chairman of the board.

chief executive officer (CEO) The top executive in charge of the strategy and operations of a firm.

classic conglomerate A firm that engages in product- unrelated diversification within a small set of countries centered on the home country.

co-marketing Agreements among a number of firms to jointly market their products and services.

code of conduct (code of ethics) Written policies and standards for corporate conduct and ethics.

cognitive pillar The internalized, taken-for-granted values and beliefs that guide individual and firm behavior.

collectivism The perspective that the identity of an individual is most fundamentally based on the identity of his or her collective group (such as family, village, or company).

collusion Collective attempts between competing firms to reduce competition.

collusive price setting Monopolists or collusion par- ties setting prices at a level higher than the competitive level.

commoditization A process of market competition through which unique products that command high prices and high margins generally lose their ability to do so—these products thus become “commodities.”

competition policy Policy governing the rules of the game in competition, which determine the institutional mix of competition and cooperation that gives rise to the market system.

competitive dynamics Actions and responses under- taken by competing firms.

competitor analysis The process of anticipating riv- als’ actions in order to both revise a firm’s plan and prepare to deal with rivals’ responses.

478 GLOSSARY

complementary assets Numerous noncore assets that complement and support the value-adding activities of core assets.

complementor A firm that sells products that add value to the products of a focal industry.

concentrated ownership and control Ownership and control rights concentrated in the hands of owners.

concentration ratio The percentage of total industry sales accounted for by the top four, eight, or 20 firms.

conduct Firm actions such as product differentiation.

conglomerate Product-unrelated diversifier.

conglomerate M&A An M&A deal involving firms in product-unrelated industries.

conglomeration A strategy of product-unrelated diversification.

constellation A multipartner strategic alliance (also known as strategic network).

contender A strategy that centers on rapid learning and then expanding overseas.

contractual (non-equity-based) alliance A strategic alliance that is based on contracts and does not involve the sharing of ownership

corporate governance The relationship among var- ious participants in determining the direction and performance of corporations.

corporate social responsibility (CSR) The social responsibility of corporations. It pertains to consideration of, and response to, issues beyond the narrow economic, technical, and legal requirements of the firm to accom- plish social benefits along with the traditional economic gains that the firm seeks.

corporate-level strategy (corporate strategy) Strategy about how a firm creates value through the configura- tion and coordination of its multimarket activities.

corruption The abuse of public power for private benefit usually in the form of bribery.

cost leadership A competitive strategy that centers on competing on low cost and prices.

counterattack A set of actions in response to attacks.

country (regional) manager The business leader in charge of a specific country (or region) for an MNE.

country-of-origin effect The positive or negative perception of firms and products from a certain country.

cross-listing Firms list their shares on foreign stock exchanges.

cross-market retaliation Retaliation in other markets when one market is attacked by rivals.

cross-shareholding Both partners invest in each other to become cross-shareholders.

cultural distance The difference between two cultures along some identifiable dimensions.

culture The collective programming of the mind that distinguishes the members of one group or category of people from another.

currency hedging A transaction that protects traders and investors from exposure to the fluctuations of the spot rate.

currency risks Risks stemming from exposure to unfavorable movements of the currencies.

D defender A strategy that leverages local assets in areas in which MNEs are weak.

defensive strategy A strategy that is defensive in nature. Firms admit responsibility, but often fight it.

differentiation A strategy that focuses on how to deliver products that customers perceive as valuable and different.

diffused ownership An ownership pattern involving numerous small shareholders, none of whom has a dominant level of control.

direct exports Directly selling products made in the home country to customers in other countries.

dissemination risks The risks associated with the unauthorized diffusion of firm-specific assets.

GLOSSARY 479

diversification Adding new businesses to the firm that are distinct from its existing operations.

diversification discount Reduced levels of perfor- mance because of association with a product-diversified firm (also known as conglomerate discount).

diversification premium Increased levels of perfor- mance because of association with a product-diversified firm (also known as conglomerate advantage).

dodger A strategy that centers on cooperating through joint ventures with MNEs and/or sell-offs to MNEs.

domestic demand Demand for products and services within a domestic economy.

dominance A situation whereby the market leader has a very large market share.

dominant logic A common underlying theme that connects various businesses in a diversified firm.

downscoping Reducing the scope of the firm through divestitures and spin-offs.

downsizing Reducing the number of employees through lay-offs, early retirements, and outsourcing.

downstream vertical alliance A strategic alliance with firms in distribution (downstream).

due diligence Investigation prior to signing contracts

dumping An exporter selling below cost abroad and planning to raise prices after eliminating local rivals.

duopoly A special case of oligopoly that has only two players.

E economic benefits Benefits brought by the various forms of synergy in the context of diversification.

economies of scale Reduction in per unit costs by increasing the scale of production.

emergent strategy A strategy based on the outcome of a stream of smaller decisions from the “bottom up.”

emerging economies (emerging markets) A label that describes fast-growing developing economies since the 1990s.

entrepreneur An individualwho identifies and explores previously unexplored opportunities.

entrepreneurship The identification and exploitation of previously unexplored opportunities.

entry barriers The industry structures that increase the costs of entry.

equity modes Modes of foreign market entry that involve the use of equity.

equity-based alliance A strategic alliance that involves the use of equity.

ethical imperialism The imperialistic thinking that one’s own ethical standards should be applied univer- sally around the world.

ethical relativism The relative thinking that ethical standards vary significantly around the world and that there are no universally agreed upon ethical and une- thical behaviors.

ethics The norms, principles, and standards of conduct governing individual and firm behavior.

excess capacity Additional production capacity cur- rently underutilized or not utilized.

exit-based mechanisms Corporate governance mechan- isms that focus on exit, indicating that shareholders no longer have patience and are willing to “exit” by selling their shares.

explicit collusion Firms directly negotiate output, fix pricing, and divide markets.

explicit knowledge Knowledge that is codifiable (that is, it can be written down and transferred without losing much of its richness).

exploitation Actions captured by terms such as refinement, choice, production, efficiency, selection, and execution.

exploration Actions captured by terms such as search, variation, risk taking, experimentation, play, flexibility, discovery, and innovation.

export intermediary A firm that performs an important middleman function by linking domestic sellers and for- eign buyers that otherwise would not have been connected.

480 GLOSSARY

expropriation (1) of foreign assets: Activities that enrich the controlling shareholders at the expense of minority shareholders. (2) of minority shareholders: Confiscation of foreign assets invested in one country.

extender A strategy that centers on leveraging home- grown competencies abroad by expanding into similar markets.

extraterritoriality The reach of one country’s laws to other countries.

F factor endowments The endowments of production factors such as land, water, and people in one country.

far-flung conglomerate A conglomerate firm that pursues both extensive product-unrelated diversification and extensive geographic diversification.

feint A firm’s attack on a focal arena important to a competitor, but not the attacker’s true target area.

femininity A relatively weak form of societal-level sex role differentiation whereby more women occupy positions that reward assertiveness and more men work in caring professions.

financial control (output control) Controlling subsidiary/unit operations strictly based on whether they meet financial/output criteria.

financial synergy The increase in competitiveness for each individual unit that is financially controlled by the corporate headquarters beyond what can be achieved by each unit competing independently as standalone firms.

firm strategy, structure, and rivalry How industry structure and firm strategy interact to affect interfirm rivalry.

first-mover advantages The advantages that first movers enjoy and later movers do not.

five forces framework A framework governing the competitiveness of an industry proposed by Michael Porter. The five forces are (1) the intensity of rivalry among competitors, (2) the threat of potential entry, (3) the bargaining power of suppliers, (4) the bargain- ing power of buyers, and (5) the threat of substitutes.

flexible manufacturing technology Modern manufac- turing technology that enables firms to produce differenti- ated products at low costs (usually on a smaller batch basis than the large batch typically produced by cost leaders).

focus A strategy that serves the needs of a particular segment or niche of an industry.

Foreign Corrupt Practices Act (FCPA) A US law enacted in 1977 that bans bribery of foreign officials.

foreign direct investment (FDI) A firm’s direct invest- ment in production and/or service activities abroad.

foreign portfolio investment (FPI) Foreigners’ pur- chase of stocks and bonds in one country.

formal institutions Institutions represented by laws, regulations, and rules.

formal, rule-based, impersonal exchange A way of eco- nomic exchange based on formal transactions in which parties keep a distance (see also arm’s-length transactions).

forward integration Acquiring and owning down- stream assets.

franchising Firm A’s agreement to give Firm B the rights to use A’s proprietary technology (such as a patent) or trademark (such as a corporate logo) for a royalty fee paid to A by B. This term is typically used in service industries.

friendly M&A An M&A deal in which the board and management of a target firm agree to the transaction (although they may initially resist).

G gambit A firm’s withdrawal from a low-value market to attract rival firms to divert resources into the low- value market so that the original withdrawing firm can capture a high-value market.

game theory A theory that focuses on competitive and cooperative interaction (such as in a prisoners’ dilemma situation).

generic strategies Strategies intended to strengthen the focal firm’s position relative to the five competitive forces, including (1) cost leadership, (2) differentiation, and (3) focus.

GLOSSARY 481

geographic area structure An organizational structure that organizes the MNE according to different countries and regions and is the most appropriate structure for a multidomestic strategy.

geographic diversification Entries into new geo- graphic markets.

global account structure A customer-focused struc- ture that supplies customers (often other MNEs) in a coordinated and consistent way across various countries.

global matrix An organizational structure often used to alleviate the disadvantages associated with both geo- graphic area and global product division structures, especially for MNEs adopting a transnational strategy.

global product division An organizational structure that assigns global responsibilities to each product division.

global standardization strategy An MNE strategy that relies on the development and distribution of standardized products worldwide to reap the maximum benefits from low-cost advantages.

global strategy (1) Strategy of firms around the globe. (2) A particular form of international strategy, charac- terized by the production and distribution of standard- ized products and services on a worldwide basis.

global sustainability The ability to meet the needs of the present without compromising the ability of future generations to meet their needs.

global virtual teams Teams whose members are phys- ically dispersed in multiple locations in the world. They cooperate on a virtual basis.

globalization The close integration of countries and peoples of the world.

greenfield operation Building factories and offices from scratch (on a proverbial piece of “greenfield” formerly used for agricultural purposes).

H home replication strategy A strategy that emphasizes the international replication of home country–based competencies such as production scales, distribution efficiencies, and brand power.

horizontal alliance A strategic alliance formed by competitors.

horizontal M&A An M&A deal involving competing firms in the same industry.

hostile M&A (hostile takeover) An M&A deal undertaken against the wishes of target firm’s board and management, who reject the M&A offer.

hubris Managers’ overconfidence in their capabilities.

hypercompetition A way of competition centered on dynamic maneuvering intended to unleash a series of small, unpredictable, but powerful actions to erode the rivals’ competitive advantage.

I in-group Individuals and firms regarded as part of “us.”

incumbents Current members of an industry that compete against each other.

indirect exports Exporting indirectly through domestic- based export intermediaries.

individualism The perspective that the identity of an individual is most fundamentally based on his or her own individual attributes (rather than the attributes of a group).

industrial organization (IO) economics A branch of economics that seeks to better understand how firms in an industry compete and then how to regulate them.

industry A group of firms producing products (goods and/or services) that are similar to each other.

industry positioning Ways to position a firm within an industry in order to minimize the threats presented by the five forces.

informal institutions Institutions represented by norms, cultures, and ethics.

informal, relationship-based, personalized exchange A way of economic exchange based on informal relation- ships among transaction parties. Also known as relational contracting.

482 GLOSSARY

information asymmetries Asymmetric distribution of information between two sides.

information overload Too much information to process.

initial public offering (IPO) The first round of pub- lic trading of company stock.

inside director A director serving on a corporate board who is also a full-time manager of the company.

institution Humanly devised constraints that struc- ture human interaction—informally known as the “rules of the game.”

institution-based view A leading perspective of strat- egy that argues that in addition to industry- and firm- level conditions, firms also need to take into account wider influences from sources such as the state and society when crafting strategy.

institutional distance The extent of similarity or dis- similarity between the regulatory, normative, and cog- nitive institutions of two countries.

institutional framework A framework of formal and informal institutions governing individual and firm behavior.

institutional relatedness A firm’s informal linkages with dominant institutions in the environment that confer resources and legitimacy.

institutional transitions Fundamental and compre- hensive changes introduced to the formal and informal rules of the game that affect organizations as players.

intangible resources and capabilities Hard-to-observe and difficult-to-codify resources and capabilities.

integration-responsiveness framework A framework of MNE management on how to simultaneously deal with two sets of pressures for global integration and local responsiveness.

intended strategy A strategy that is deliberately plan- ned for.

interlocking directorate Two or more firms share one director on their boards.

internal capital market A term used to describe the internal management mechanisms of a product-unrelated

diversified firm (conglomerate) that operate as a capital market inside the firm.

internalization The process of replacing a market relationship with a single multinational organization spanning both countries.

internalization advantage The advantage associated with internalization, which is one of the three key advantages of being a multinational enterprise (the other two are ownership and location advantages).

international diversification The number and diver- sity of countries in which a firm competes.

international division An organizational structure typically set up when firms initially expand abroad, often engaging in a home replication strategy.

international entrepreneurship A combination of innovative, proactive, and risk-seeking behavior that crosses national borders and is intended to create wealth in organizations.

J joint venture (JV) A “corporate child” that is a new entity given birth and jointly owned by two or more parent companies.

K knowledge management The structures, processes, and systems that actively develop, leverage, and transfer knowledge.

L late-mover advantages Advantages associated with being a later mover (also known as first-mover disadvantages).

learning by doing A way of learning not by reading books but by engaging in hands-on activities.

learning race A race in which alliance partners aim to outrun each other by learning the “tricks” from the other side as fast as possible.

leveraged buyout (LBO) A means by which private investors, often in partnership with incumbent man- agers, issue bonds and use the cash raised to buy the firm’s stock.

GLOSSARY 483

liability of foreignness The inherent disadvantage foreign firms experience in host countries because of their nonnative status.

liability of newness The inherent disadvantage that entrepreneurial firms experience as new entrants.

licensing Firm A’s agreement to give Firm B the rights to use A’s proprietary technology (such as a patent) or trademark (such as a corporate logo) for a royalty fee paid to A by B. This term is typically used in manufacturing industries.

LLL advantages Linkage, leverage, and learning advan- tages, which are typically associated with MNEs from emerging economies.

local content requirements Government requirements that certain products be subject to higher import tariffs and taxes unless a given percentage of their value is pro- duced domestically.

local responsiveness The necessity to be responsive to different customer preferences around the world.

localization (multi-domestic) strategy An MNE strategy that focuses on a number of foreign countries/ regions, each of which is regarded as a standalone local (domestic) market worthy of significant attention and adaptation.

location-specific advantages Advantages associated with operating in a specific location.

long-term orientation A perspective that emphasizes perseverance and savings for future betterment.

M managerial human capital The skills and abilities acquired by top managers.

marginal bureaucratic costs (MBC) The bureau- cratic costs of the last unit of organizational expansion (such as the last subsidiary established).

marginal economic benefits (MEB) The economic benefits of the last unit of growth (such as the last acquisition).

market commonality The degree to which two com- petitors’ markets overlap.

masculinity A relatively strong form of societal-level sex role differentiation whereby men tend to have occupations that reward assertiveness and women tend to work in caring professions.

mass customization Mass produced but customized products.

merger The combination of assets, operations, and management of two firms to establish a new legal entity.

merger and acquisition (M&A) Merging with or acquiring other firms.

micro-macro link The link between micro, informal interpersonal relationships among managers of various units and macro, interorganizational cooperation among various units.

microfinance A practice to provide microloans ($50–$300) to start small businesses with the intention of ultimately lifting the entrepreneurs out of poverty.

mobility barrier Within-industry differences that inhibit the movement between strategic groups.

monopoly A situation whereby only one firm pro- vides the goods and/or services for an industry.

moral hazard Recklessness when people and organi- zations (including firms and governments) do not have to face the full consequences of their actions.

multimarket competition Firms engage the same rivals in multiple markets.

multinational enterprise (MNE) A firm that engages in foreign direct investment (FDI) by directly controlling and managing value-adding activities in other countries.

multinational replicator A firm that engages in product-related diversification on the one hand and far-flung multinational expansion on the other hand.

mutual forbearance Multimarket firms respect their rivals’ spheres of influence in certain markets and their rivals reciprocate, leading to tacit collusion.

N network centrality The extent to which a firm’s position is pivotal with respect to others in the interfirm network.

484 GLOSSARY

network externalities The value a user derives from a product increases with the number (or the network) of other users of the same product.

non-equity modes Modes of foreign market entries that do not involve the use of equity.

non-scale-based advantages Low-cost advantages that are not derived from the economies of scale.

nongovernmental organization (NGO) Organization advocating causes such as the environment, human rights, and consumer rights that are not affiliated with government.

nontariff barriers Trade and investment barriers that do not entail tariffs.

norm The prevailing practice of relevant players that affect the focal individuals and firms.

normative pillar How the values, beliefs, and norms of other relevant players influence the behavior of indi- viduals and firms.

O obsolescing bargain A deal struck by an MNE and a host government, which change the requirements after the entry of the MNE.

offshoring International/foreign outsourcing.

OLI advantages Ownership, location, and internali- zation advantages, which are typically associated with MNEs.

oligopoly A situation whereby a few firms control an industry.

onshoring Outsourcing to a domestic firm.

open innovation The use of purposive inflows and outflows of knowledge to accelerate internal innovation and expand the markets for external use of innovation.

operational synergy Synergy derived by having shared activities, personnel, and technologies.

opportunism Self-interest seeking with guile.

organizational culture The collective programming of the mind that distinguishes members of one organi- zation from another.

organizational fit The complementarity of partner firms’ “soft” organizational traits, such as goals, experi- ences, and behaviors, that facilitate cooperation.

original brand manufacturer (OBM) A firm that designs, manufactures, and markets branded products.

original design manufacturer (ODM) A firm that both designs and manufactures products.

original equipment manufacturer (OEM) A firm that executes design blueprints provided by other firms and manufactures such products.

out-group Individuals and firms not regarded as part of “us.”

outside (independent) director A non-management member of the board.

outsourcing Turning over all or part of an activity to an outside supplier to improve the performance of the focal firm.

ownership advantage Advantage associated with directly owning assets overseas, which is one of the three key advantages of being a multinational enter- prise (the other two are location and internalization advantages).

P partner rarity The difficulty to locate partners with certain desirable attributes.

perfect competition A competitive situation in which price is set by the “market,” all firms are price takers, and entries and exits are relatively easy.

performance The result of firm conduct.

power distance The degree of social inequality.

predatory pricing (1) Setting prices below costs in the short run to destroy rivals and (2) intending to raise prices to cover losses in the long run after eliminating rivals.

price leader A firm that has a dominant market share and sets “acceptable” prices and margins in the industry.

primary stakeholder groups Constituents on which the firm relies for its continuous survival and prosperity.

GLOSSARY 485

principals Persons (such as owners) who delegate authority.

principal–agent conflicts Conflicts of interests between principals (such as shareholders) and agents (such as professional managers).

principal–principal conflicts Conflicts of interests between two classes of principals: controlling share- holders and minority shareholders.

prisoners’ dilemma In game theory, a type of game in which the outcome depends on two parties deciding whether to cooperate or to defect.

private equity Equity capital invested in private (non- public) companies.

proactive strategy A strategy that focuses on proactive engagement in corporate social responsibility.

product differentiation The uniqueness of products that customers value.

product diversification Entries into new product markets and/or business activities that are related to a firm’s existing markets and/or activities.

product proliferation Efforts to fill product space in a manner that leaves little “unmet demand” for potential entrants.

product-related diversification Entries into new prod- uct markets and/or business activities that are related to a firm’s existing markets and/or activities.

product-unrelated diversification Entries into indus- tries that have no obvious product-related connections to the firm’s current lines of business.

R reactive strategy A strategy that is passive about cor- porate social responsibility. Firms do not act in the absence of disasters and outcries. When problems arise, denial is usually the first line of defense.

real option An option investment in real operations as opposed to financial capital.

refocusing Narrowing the scope of the firm to focus on a few areas.

regulatory pillar How formal rules, laws, and regula- tions influence the behavior of individuals and firms.

regulatory risks Risks associated with unfavorable government regulations.

related and supporting industries Industries that are related to and/or support the focal industry.

related transaction Controlling owners sell firm assets to another firm they own at below-market prices or spin off the most profitable part of a public firm and merge it with another of their private firms.

relational (collaborative) capabilities The capabilities to successfully manage interfirm relationships.

relational contracting Contracting based on informal relationships (see also informal, relationship-based, personalized exchange).

replication Repeated testing of theory under a variety of conditions to establish its applicable boundaries.

research and development (R&D) contracts Outsourcing agreements in R&D between firms (that is, Firm A agrees to perform certain R&D work for Firm B).

resource The tangible and intangible assets a firm uses to choose and implement its strategies.

resource similarity The extent to which a given com- petitor possesses strategic endowments comparable to those of the focal firm.

resource-based view A leading perspective of strategy that suggests that differences in firm performance are most fundamentally driven by differences in firm resources and capabilities.

restructuring (1) Adjusting firm size and scope through either diversification (expansion or entry), divestiture (contraction or exit), or both. (2) Reducing firm size and scope.

reverse innovation Low-cost innovation from emerging economies that has potential in developed economies.

risk management The identification and assessment of risks and the preparation to minimize the impact of high-risk, unfortunate events.

486 GLOSSARY

S scale economies (economies of scale) Reductions in per unit costs by increasing the scale of production.

scale of entry The amount of resources committed to foreign market entry.

scale-based advantages Advantages derived from economies of scale (the more a firm produces some products, the lower the unit costs become).

scenario planning A technique to prepare and plan for multiple scenarios (either high or low risk).

scope economies (economies of scope) Reduction in per unit costs and increases in competitiveness by en- larging the scope of the firm.

secondary stakeholder groups Stakeholders who influ- ence or affect, or are influenced or affected by, the cor- poration, but they are not engaged in transactions with the corporation and are not essential for its survival.

semiglobalization A perspective that suggests that barriers to market integration at borders are high but not high enough to completely insulate countries from each other.

separation of ownership and control The dispersal of ownership among many small shareholders, with control of the firm largely concentrated in the hands of salaried, professional managers who own little or no equity.

serial entrepreneur Anentrepreneurwho starts, grows, and sells several businesses throughout his/her career.

shareholder capitalism A view of capitalism that suggests that the most fundamental purpose for firms to exist is to serve the economic interests of shareholders (also known as capitalists).

single business strategy A strategy that focuses on a single product or service with little diversification.

small and medium-sized enterprise (SME) A firm with fewer than 500 employees in the United States or with fewer than 250 employees in the European Union.

social capital The informal benefits individuals and organizations derive from their social structures and networks.

social complexity The socially complex ways of orga- nizing typical of many firms.

social issue participation Firms’ participation in social causes not directly related to managing primary stakeholders.

solutions-based structure An MNE organizational structure that caters to the needs of providing solutions for customers’ problems.

sovereign wealth fund (SWF) A state-owned invest- ment fund composed of financial assets such as stocks, bonds, real estate, or other financial instruments fund- ed by foreign exchange assets.

stage model Model that suggests firms internationalize by going through predictable stages from simple steps to complex operations.

stakeholder Any group or individual who can affect or is affected by the achievement of the organization’s objectives.

state-owned enterprise (SOE) A firm owned and controlled by the state (government).

stewardship theory A theory that suggests that man- agers should be regarded as stewards of owners’ interests.

strategic alliance A voluntary agreement of coopera- tion between firms

strategic ambidexterity Firms’ dynamic capabilities to simultaneously manage influences from both gov- ernments and markets.

strategic control (behavior control) Controlling sub- sidiary/unit operations based on whether they engage in desirable strategic behavior (such as cooperation).

strategic fit The complementarity of partner firms’ “hard” skills and resources, such as technology, capital, and distribution channels.

strategic groups Groups of firms within a broad industry.

strategic hedging Spreading out activities in a num- ber of countries in different currency zones to offset any currency losses in one region through gains in other regions.

GLOSSARY 487

strategic investment One partner invests in another as a strategic investor.

strategic management A way of managing the firm from a strategic, “big picture” perspective.

strategic network A strategic alliance formed by multiple firms to compete against other such groups and against traditional single firms (also known as a constellation).

strategy A firm’s theory about how to compete successfully.

strategy as action A perspective that suggests that strategy is most fundamentally reflected by firms’ pat- tern of actions.

strategy as integration A perspective that suggests that strategy is neither solely about plan nor action and that strategy integrates elements of both schools of thought.

strategy as plan A perspective that suggests that strategy is most fundamentally embodied in explicit, rigorous formal planning as in the military.

strategy formulation The crafting of a firm’s strategy.

strategy implementation The actions undertaken to carry out a firm’s strategy.

strategy tripod A framework that suggests that strategy as a discipline has three “legs” or key perspectives: industry-based, resource-based, and institution-based views.

strong ties More durable, reliable, and trustworthy relationships cultivated over a long period of time.

structure Structural attributes of an industry such as the costs of entry/exit.

structure-conduct-performance (SCP) model An industrial organization economics model that suggests that industry structure determines firm conduct (strat- egy), which in turn determines firm performance.

subsidiary initiative The proactive and deliberate pursuit of new business opportunities by an MNE’s subsidiary to expand its scope of responsibility.

substitutes Products of different industries that satisfy customer needs currently met by the focal industry.

sunk costs Irrevocable costs incurred and invest- ments made.

SWOT analysis A strategic analysis of a firm’s internal strengths (S) and weaknesses (W) and the opportunities (O) and threats (T) in the environment.

T tacit collusion Firms indirectly coordinate actions to reduce competition by signaling to others their intention to reduce output and maintain pricing above competi- tive levels.

tacit knowledge Knowledge that is not codifiable (that is, hard to be written down and transmitted without losing much of its richness).

tangible resources and capabilities Observable and more easily quantified resources and capabilities.

tariff barriers Taxes levied on imports.

thrust The classic frontal attack with brute force.

top management team (TMT) The team consisting of the highest level of executives of a firm led by the CEO.

trade barriers Barriers blocking international trade.

transaction costs Costs associated with economic transaction—or more broadly, costs of doing business.

transnational strategy An MNE strategy that en- deavors to be cost efficient, locally responsive, and learning driven simultaneously.

Triad Three primary regions of developed economies: North America, Europe, and Japan.

triple bottom line A performance yardstick consisting of economic, social, and environmental performance.

tunneling Activities of managers from the control- ling family of a corporation to divert resources from the firm for personal or family use.

turnkey projects Projects in which clients pay con- tractors to design and construct new facilities and train personnel.

488 GLOSSARY

U uncertainty avoidance The extent to which members in different cultures accept ambiguous situations and tolerate uncertainty.

upstream vertical alliance A strategic alliance with firms on the supply side (upstream).

V value chain Goods and services produced through a chain of vertical activities that add value.

venture capitalist (VC) An investor who invests capital in early-stage, high-potential start-ups.

vertical M&A An M&A deal involving suppliers (upstream) and/or buyers (downstream).

voice-based mechanisms Corporate governance mechanisms that focus on shareholders’ willingness to work with managers, usually through the board of directors, by “voicing” their concerns.

VRIO framework A resource-based framework that focuses on the value (V), rarity (R), imitability (I), and organizational (O) aspects of resources and capabilities.

W Washington Consensus A view centered on the unquestioned belief in the superiority of private ownership over state ownership in economic policy making, which is often spearheaded by two Washing- ton-based international organizations: the International Monetary Fund and the World Bank.

weak ties Relationships that are characterized by infrequent interaction and low intimacy.

wholly owned subsidiary (WOS) Subsidiary located in a foreign country that is entirely owned by the MNE.

worldwide (global) mandate The charter to be respon- sible for one MNE function throughout the world.

GLOSSARY 489

INDEX OF ORGANIZATIONS

3Com, 327 3G Capital, 278 3i, 235, 401 3i Group PLC, 391–403 3M, 306

A AAR, 205, 206, 215–217 ABB, 303 ABC, 39, 49, 234 ABN Amro, 179 Abuzz Technologies, 434 Accel Partners, 437 Accenture, 202 Access, 215 Acer, 63, 85 ADM, 239 Aegis, 409 Aer Lingus, 418 Agricultural Bank of China, 348 Água Limpa, 467 Ahava, 246 AIG, 347 Air Berlin, 421 Air Canada, 190, 192 Air France-KLM, 190, 192, 421 Air India, 164 Airbus, 5, 38, 41, 43, 50, 72, 130, 164, 302, 307 Alaska Permanent Fund, 235, 349 Alberta Heritage Fund, 349 Alcatel, 282 Alcatel-Lucent, 165, 282 Alfa Group, 197, 215 All Nippon Airways (ANA), 73 Aluminum Company of America (ALCOA), 237 Amalgamated Bank, 332 Amanah, 170 Amazon, 3, 6, 38, 49, 50, 54, 127, 194, 204, 284, 436–438, 441 AmBev, 278 American Airlines (AA), 190, 192, 198–199, 232, 236 American Honda Motors Inc., 269 Ameristeel, 278 Amtrak, 156 Android alliance, 194 Anglo American, 308 Anheuser Busch (Budweiser), 38, 239, 278 Apax Partners, 3

APAX Partners, 354 Apollo Global Management, 332 Apple, 6, 41, 49, 63, 76, 139, 160, 168, 211, 223, 232, 236, 241, 250,

253–254, 327, 336, 342, 441 ArcelorMittal, 468 Asian Paints, 246 AT&T, 49, 165, 199, 228, 237,

247–248, 456–459 AT&T/T-Mobile, 456–459 Australian Securities Exchange, 332 Avon Products, 301 Azul, 143

B BAE Systems, 177, 199 Baidu, 28, 143, 195 Bain, 355 Banco de Investimentos Garantia, 278 Banco Santander Brasil, 348 Bank of America, 281 Bank of China, 348, 470 Baosteel Europe, 465–470 Baosteel Europe GmbH, 467 Baosteel Group, 465, 466, 467 Baotou Steel Factory, 392 Barclays, 309 Baring Vostok Private Equity Fund, 127 Barnes and Noble, 38, 50 Bath & Body Works, 80 Bayer Group, 321 Bayer MaterialScience, 321, 322 Bayi Steel Group, 465 BBC, 131 Bear Stearns, 462 Bearing Point, 202 BenQ, 80 Bentley, 48 Best Price, 33 Bharti, 33, 199 Bic, 242 Bing, 28 Bird, 247 Blackwater, 132. See also Xe Services LLC BMI, 421 BMW, 40, 42, 47, 112–113, 116, 166, 194, 282 Boashan Iron and Steel Complex, 465 Boeing, 5, 39, 41, 43, 69, 72, 73, 130, 164, 238, 269, 307

491 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

Bombardier, 266, 297 Borders, 50 Boston Consulting Group, 127 BP, 161, 196, 197, 205, 206, 215–217, 310, 316, 366, 376, 379 Bridgestone, 318 British Aerospace, 177 British Airways (BA), 46, 50, 164, 190, 192, 198–199, 236, 418,

421–422 British Petroleum (BP), 177 British Telecom (BT), 177 BSkyB, 332 Burberry, 58 Burger King, 277, 278, 375, 398, 400 BYD, 85

C Cadbury, 277 Calvin Klein, 131 Cambridge, 4 Canon, 160, 178, 269 Capgemini, 202 Cardinal Distribution, 44 Cardinal Foods, 44 Cardinal Health, 44 Carlesberg, 231 Carlyle Group, 335, 355 Carnival cruise line, 39 Carrefour, 33, 80, 158, 197 Cascade Field, 278 Caterpillar, 160 Cathay Pacific, 190, 192 CBS, 234 CDH, 396 Cemex, 5, 85 Cengage Learning, 3, 4, 441 CFM International, 198 Checkpoint, 134 Chevrolet, 362 Chevron, 131, 315, 316 China Dow Chemical, 382 China Construction Bank, 348 China Investment Corporation (CIC), 349 China National Offshore Oil Corporation (CNOOC), 179 China Petroleum and Chemical Corporation. See Sinopec China State Construction Engineering Corporation, 348 Christian Lacroix, 58 Chrysler, 72, 170, 228, 280, 282, 354 Cisco, 6, 49, 169, 197, 202, 232, 245, 303, 315 Citi Technology Services, 410 Citibank, 410 Citibank Islamic Bank, 170 Citigroup, 110, 168, 169, 197, 315, 349, 462 Citroën, 300 CKx, 332

CMD, 434 CNN, 49, 234 CNOOC, 281 Coach, 58, 236 Coach USA, 155 Coca-Cola Company, 5, 9, 40, 42, 156, 162, 178, 194, 210, 213, 239,

245, 268, 276, 297, 310, 369 Colgate, 168 Commercial Ready, 433 Compaq, 254 Condé Nast Traveler, 67 Conrad, 415 Continental Airlines, 278 Continental Lite, 236 COSCO, 470 COSTCO, 42 Credit Suisse, 462 Croma, 33 Cultor OY, 267

D Daewoo, 259 Dai-ichi Life Insurance, 348 Daimler-Benz, 280 DaimlerChrysler, 210, 276, 284, 354, 378 Danisco, 266, 267 Danish Sugar, 267 Danone, 206, 267 DataQuest, 445–446 De Beers, 36, 167, 229, 238 Dell, 6, 41, 49, 63, 71, 75, 80, 235, 317 Delta, 190, 192, 236 DeRemate, 436 Deutsche Bank, 462 Deutsche Telekom, 199, 248, 456–459 DHL, 69, 160 Diamond Syndicate, 229 Diamond Trading Company (DTC), 229 Dicos, 189 Didata, 167 Digital Sky Technologies, 438 DineroMail.com, 436 Discovery, 47 Disney, 47, 269, 299, 460–461 Disneyland, 460–461 Dow Chemical, 95, 303, 370, 372, 381 Dow Jones, 332 DP World, 281 Dropbox, 437 Dubai International Airport (DXB), 164 Dubai Ports World (DP World), 179 Dubai World Central-Al Maktoum

International (DWC), 164 Duke Energy, 376, 381

492 INDEX OF ORGANIZAT IONS

E EADS, 209 East Dawning, 189 easyCinema, 283 easyGroup, 283 easyInternetcafe, 283 easyJet, 283, 421, 422 eBay, 284, 327, 438, 456 eBay Europe, 436 EDS, 202 El Dorado, 454 Electricité de France, 348 Electrolux, 108, 310 Electronic Data Systems (EDS), 327 Elf, 316 Eli Lily, 206, 212 Embraer, 5, 85, 209 EMC, 202 EMI, 169 Emirates Airlines, 163 eModeration, 131, 132 EmPower Research, 410 Energy Future Holdings, 354 ENI, 316 Enron, 95, 334, 335, 343, 369 Enterprise Growth Solutions, 433 Epson, 168, 169 Ericsson, 6, 165, 168, 169 Ermenegildo Zegna, 47, 58 Escada, 58 ESPN, 131 Expedia, 194 ExxonMobil, 161, 315, 316

F Facebook, 11, 99, 112, 119–120, 127, 131, 134, 144, 195, 438 FedEx, 127, 135, 160, 168 Ferrari, 36 Fiat, 309 Finnet, 404–408 Firefox/Mozilla, 195 Firestone Tires, 112–113 Fisher Investments, 422 Flextronics, 80, 178 Ford, 42, 69, 112, 197, 199, 228, 248, 318, 377 Fox, 49 Fox News Channel, 234 Foxconn, 5–7, 13, 69, 80, 85, 253 Friends Life, 410 Frito-Lay, 42 Fuji, 160, 269 Fujitsu, 165, 202

G Galaxy Casino, 412, 413, 414, 415 Game, 167 Gazprom, 41 GE, 7–8 Geely, 7, 85, 282 General Electric (GE), 7–9, 38, 85–86, 157, 169, 198, 203, 231,

238–239, 244, 262, 266, 269, 272, 285, 313, 315, 367, 410 General Motors (GM), 7, 38, 49, 53, 69, 72, 144, 165, 168, 170, 213,

228, 230, 245, 248, 330, 347, 348, 377 Genpact, 409, 410 Geocell, 408 Gerdau, 278 Germanwings, 421 Gillette, 231, 242 Glencore International, 348 Global Crossing, 334 Goldman Sachs, 295, 394, 398, 462 Goldwind, 85 Google, 28, 49, 119, 143, 144, 168, 179

194, 195, 211, 223, 248, 254, 315, 336 367, 437, 456

GP Investmentos, 278 Grameen Bank, 149–150 Greyhound, 155, 168, 169 Groupon, 437, 438 GSK, 194, 310, 312–313 Gucci Group, 58, 80, 177

H Häagen-Dazs, 177, 312 Haier, 244 Hamersley Iron, 467 Hatteras Hammocks, 448–455 HCl Technologies, 409 Headstrong, 410 Heinekin, 231 Heinz, 304 Hewlett-Packard (HP), 41, 49, 80, 198, 202, 269, 310, 315, 327, 337 Hitachi, 295, 376 Holiday Inn, 415 Home Depot, 370, 372, 409 Honda, 5, 38, 51, 85, 168–170, 230, 269, 318 Honda Aircraft Company, 269 HondaJet, 269, 283 Honeywell, 238, 239, 285 Hong Kong Disneyland, 460–461 Hongkong and Shanghai Banking Corporation. See HSBC Hongzhuangyuan, 189 HonHai, 253 Hope Group, 266 HP. See Hewlett Packard (HP) HSBC, 5, 131, 170, 179, 308, 309

INDEX OF ORGANIZATIONS 493

HTC, 80, 85, 194, 223, 241, 253–254 Huawei, 5, 49, 80, 165, 232, 235, 245, 307 Huiyuan, 239 Hyundai, 52, 170, 259 Hyundai/Kia, 230

I Iberdrola Renovables, 348 Iberia, 421 IBM, 49, 63–64, 69, 72–73, 76, 82, 86, 135, 178, 202, 237, 247, 269,

303, 308, 315, 327, 367, 377 ICUC Moderation, 131, 132 IKEA, 80, 139, 144 InBev, 239, 278 Index Ventures, 127, 437 Industrial & Commercial Bank of China, 348 Infosys, 69, 79, 350, 409, 410 Infosys BPO, 409 ING Group, 179 Intel, 6, 131, 134, 178, 202, 238, 295, 317, 367 Intelligentsia, 47 International Airlines Group, 421 International Monetary Fund (IMF), 347 Italtel, 202

J Japan Airlines (JAL), 190, 192 JBS-Friboi, 278 JetBlue, 143 Jobek do Brasil, 448–455 Johnson & Johnson, 42, 315, 367 Jolibee, 189 Joyo, 127 JP Morgan, 462 JP Morgan Chase, 168, 169

K K-Mart, 236 Kcell, 407, 408 Kentucky Fried Chicken (KFC), 189, 239, 263, 394, 400 Kimberly-Clark (Kleenex), 38 KLM, 236 Koc Group, 262, 266 Kodak, 80, 160, 269 Komatsu, 160 Korea Exchange Bank, 354 Korean Air, 190, 192 Kraft, 38 Kraft Foods, 48, 267, 277, 375 Kroger, 42 KupiVip, 438

L Lamborghini, 36 Lego, 131

Lehman Brothers, 276, 278, 462–463 Lenovo, 41, 63, 72, 85, 269, 308 Lexmark, 63 LG, 259, 443 Limited Brands, 80 LINUX, 28, 130 Little Sheep Catering

Chain Co., 391–403 Little Sheep Hot Pot, 239, 393 Lockheed Martin, 307 Logitech, 144 Lojas Americanas, 278 London Heathrow Airport, 164 Lone Star Funds, 354 L’Oreal, 166 Lowe’s, 370, 372 Lucent, 282 Lufthansa, 164, 190, 192, 421 LVMH, 58, 59, 80, 178

M Macy’s, 58 Magnum, 267 Mahindra, 85 Mail.ru, 127 mail.ru Group, 438 Manpower, 69 Marks & Spencer, 42, 377 Massmart, 167 MassMedia Studios, 434 Matsushita, 169, 306 Mattel, 223 Maxwell House, 48 Mazda, 52 McDonald’s, 21, 47, 141, 172, 175, 189–190, 195, 197, 233, 278, 296 McDonnell Douglas, 238 McGraw-Hill Irwin, 3, 4, 441 McKinsey, 295 Megabus, 130, 155–156, 168, 169 Melco PBL Jogos, 412, 413, 416 Meng Niu (Mongolian Cow), 394, 396 Mercedes-Benz, 166, 194, 282 MeroMobile, 407 Merrill Lynch, 281, 462 Metro, 33, 158 Mettalurgical Corporation of China, 168, 169 MGM Grand Paradise, 412, 413, 416 Microsoft, 14, 16, 27–28, 28, 40, 41, 49, 63, 130, 169, 195, 202, 232,

236–239, 244, 247, 254, 280, 315, 317, 456 Miller Beer, 167 Minor Group, 142 Mirabilis, 134 Mitsui, 266 Moldcell, 408 Molson, 131

494 INDEX OF ORGANIZAT IONS

Monarch Airlines, 421 Morgan Stanley, 349, 394, 396, 462 Morris Air, 143 Motorola, 6, 202, 203, 247 Mozilla, 239 Mphasis, 409 MTN, 167 MTV, 5, 131, 297

N NASDAQ, 332 NASTAR, 433 National Foods, 96 National Public Radio, 131 Naver, 178 NAVMAN, 433 NBC, 49, 234, 332 Ncell, 407, 408 NEC, 160, 169 Nestlé, 131, 158, 194, 267, 367, 377 Netscape, 169, 239 New Core, 259 New York Post, 234 News Corporation, 234, 332, 333, 342 Nike, 33, 69, 112, 317, 365, 370, 376 Nintendo, 6 Nippon Steel, 467 Nissan, 52, 169, 230, 266, 310, 361–362, 363, 368, 372 Nokia, 6, 33, 63, 80, 160, 178, 195, 202, 223, 247,

266, 308, 310 Nokia Siemens Networks, 202 Nomura, 276, 278, 281, 308, 462–463 Nordzucker, 267 Noriba, 170 Northrop, 269 Norwegian Cruise Line, 39 Nspire, 443, 445–446 Nutrasweet, 43 NYSE Euronext, 309

O Ocean Park, 460–461 Old Mutual, 167, 308 OLX, 436 OMERS Capital Partners, 3 Oneworld, 175, 190, 192, 198–199 Opera Software, 239 Oprah, 131 Oracle, 223, 245, 306, 327 Oxford University Press, 4 Oyak (Turkish Armed Forces Pension Fund), 195 Ozon, 127–128 Ozon.ru, 438

P Palm, 327 Panasonic, 295 Paris Disneyland, 177 Parmalat, 369 Pawleys Island Hammocks, 452 Pearl River, 172, 174, 176, 177, 178, 182, 236 Pearl River Piano Group (PRPG), 182–183 Pearson Education, 441 Pearson Prentice Hall, 4 PepsiCo, 5, 42, 245, 266, 268, 310, 315 Petrobras, 163, 278 Peugeot, 170 Pfizer, 44, 194, 315 Philip Morris, 241 Philips, 178, 318 Pilgrim’s Pride, 278 Pizza Hut, 142, 172, 175, 189, 239, 263 Posco, 467 Power Converter Technologies, 434 Prax Capital, 398 Precious Wood, 454 Priceline, 194 PricewaterhouseCoopers (PwC), 63, 72, 315 Proctor & Gamble (P & G), 15, 42, 45, 210, 213, 231, 315

Q Qantas, 190, 192 QXL Ricardo, 436

R Rakuten, 127 Rambler, 438 Ranbaxy, 206 Raytheon, 165, 269 RCA, 79 RealNetworks, 239 Reebok, 38 Reksoft, 127 Reliance Group, 33 Renault, 195, 213, 266, 362 Renova, 215 Research in Motion (RIM), 195, 223 Richemont, 58 Ritmuller, 173, 176, 177, 178, 183 R.J. Reynolds, 241 RJR Nabisco, 353 Rolls Royce, 36 Rosneft, 205, 216–217, 348 Royal Ahold, 369 Royal Bank of Scotland (RBS), 330 Royal Caribbean, 39 Royal Telegraph Service, 404 Ryanair, 45, 46, 54, 76, 232, 418–422

INDEX OF ORGANIZATIONS 495

S SAB, 308 SABMiller, 167, 308 SABRE, 63 Sabre Travel Network, 200 Safer Way Natural Foods. See Whole Foods Safeway, 42 Samsung, 160, 194, 223, 253–254, 259, 261–262, 266, 268–269, 306,

314 Samsung C&T Corporation, 295 Samsung Electronics Corporation (SEC), 295 Samsung Group, 295 Samsung Heavy Industries, 295 Samsung Life Insurance, 295 Sands Cotai Central, 415 SAP, 135, 202, 245, 306, 327, 337 SAS, 190, 192, 236 SASOL, 167 Satyam, 315 Scotiabank, 131 Seagate Technology, 308–309 Sealy, 38 Seattle Coffee, 142 Sembcorp, 284 Shanghai Disneyland, 177 Shanghai Meishan Group Co., Ltd., 465 Shanghai Metallurgical Holding Group Corporation, 465 Shanghai Volkswagon, 172 Sharp, 295 Shell, 316, 370, 379 Shine Group, 332 Shoprite, 167 Siemens, 85, 165, 262, 266, 377 Sinar Mas, 375 Singapore Airlines, 50, 54, 232 Sinopec, 189, 190, 195 Skoda, 246 Skype, 280, 314, 436, 437 SkyTeam, 190, 192 SkyTV, 49 Slope Tracker, 433 Snecma, 203 SnowSports Industries America (SIA), 433 SnowSports Interactive (SSI), 431, 431–435 Sociedade de Jogos de Macau (SJM), 412, 413, 414, 416 SolarWorld AG, 424–430 SolarWorld USA, 424–430 Sonera, 404 Sony, 6, 49, 63, 168–169, 178, 283, 295, 306, 310 Sony Ericsson, 131, 317 South African Breweries (SAB), 167 South-Western Cengage Learning, 3, 18, 40 Southwest Airlines, 46, 54, 76, 232, 235, 236, 418, 420, 422 Southwestern Bell Corporation (SBC), 457 Sparsh, 409

Sprint, 456 Stagecoach Group, 155–156, 161 Standard & Poor, 95, 334, 350, 354 Standard Bank, 167 Standard Chartered, 309 Standard Oil, 237 Star Alliance, 175, 190, 192 Starbucks, 33, 47, 48, 80, 131, 142, 233, 283, 300, 312, 376, 377 Steinway, 182, 236 STMicroelectronics, 165 Strix Systems Inc, 434 Stumptown, 47 Subway, 142 Suntory, 194 Suunto, 433 Suzlon, 85 Swiss Re, 376

T T-Mobile, 199, 238, 456–459 Taj Mahal Palace Hotel, 66, 66–67, 108 Target, 236, 410 Tata, 5 Tata Consultancy Service (TCS), 409 Tata Group, 33, 266 Tata Motors, 7, 9, 85, 262, 285 Tata Nano, 75 Tata Setel (Corus Group), 285 Tcell, 408 TCL, 247 TCS, 409, 410 TCS BPO, 410 Televerket, 404 Telia, 404 TeliaSonera, 404–408 Tesco, 33, 42, 409 Tetra Pak, 308 Texaco, 316 Texas Instruments (TI), 160, 165, 440–447 Texas Pacific Group (TPG Capital), 354 Thales, 209 The Bistro, 197 The Economist, 131 The New York Times, 132 The Pizza Company, 142 Thomson Corporation, 354 Thomson Learning, 354 ThyssenKrupp, 468 Tiffany, 58 Tiger Global Management, 436, 437, 438 Time Warner, 234, 342 Ting Hsin International Group, 189 Titan Airways, 421 TNK-BP, 196, 197, 205, 206, 215–217 Tokyo Disneyland, 177

496 INDEX OF ORGANIZAT IONS

Toshiba, 160, 295 Toyota, 5, 42, 45, 49, 51, 53–54, 163, 168–169, 213, 230, 245, 248, 314,

361–362, 377 Travelocity, 194 Trump Holdings, 95 Twitter, 119 TXU, 354 Tyco, 334

U UBS, 170, 462 Unilever, 66, 168, 267, 299, 367, 370, 375 United Airlines, 50, 190, 192, 236, 278 United Colors of Benetton, 80 UPS, 127

V Vale, 278 Venetian Macau, 412, 413 Veritas, 437 Verizon, 165, 253, 456 Viacom, 342 Victoria’s Secret, 47, 80 ViiV Healthcare, 194 Virgin Group, 131, 262, 270 Visa, 348 Vivendi Universal, 266 Vkontakte, 134, 438 VMware, 49 Volkswagon, 5, 246, 266 Voltran, 278 Volvo, 282

W Wahaha, 131, 206 Walgreens, 44 Wall Street Journal, 332 Walmart, 13, 14, 19, 33, 39, 41, 45, 50, 80, 158, 163, 199, 235–236, 250, 264,

297, 367, 386, 448

WEG, 278 WestJet, 143 Wharf, 284 Whirlpool, 244 Whole Foods, 372, 376, 385–386 Wikimart, 436–438 Wikipedia, 131 Wipro, 79, 202, 410 Wipro BPO, 409 Wireless Tech Group, 434 WNS Global Services, 409, 410 Woolworths, 33 WorldCom, 369 Wynn Macau, 412–417 Wynn Resorts, 412, 413, 414, 416

X Xe Services LLC, 132 Xerox, 168

Y Yahoo!, 195, 456 Yamaha, 182, 183 Yamakawa Corp., 91 Yandex, 127, 438 YKK, 139 Yokogawa Hewlett-Packard (HP), 312 Yonghe King, 189 Yonja.com, 436 Yoshinoya, 189 Yoshinoya Holdings, 189 YouTube, 49 Yum! Brands, 189, 190, 195, 239, 263

Z Zara, 80 Zest Group, 278 ZTE, 235

INDEX OF ORGANIZATIONS 497

INDEX OF NAMES

A Abdelnour, S., 120 Acs, Z., 150 Adams, G., 89 Adams, M., 358 Adams, R., 356 Adegbesan, J., 218 Adner, R., 88, 152 Afuah, A., 60, 220 Agarwal, R., 151, 218, 255, 290 Aggarwal, V., 152, 218 Aguilera, R., 184, 357, 386 Ahlstrom, D., 152–153, 332–333, 356, 387 Ahmadjian, C., 60 Ahuja, G., 218 Aime, F., 88, 89 Ainuddin, R. Z., 218 Akerson, Dan, 255 Akremi, A., 185 Aktas, N., 292 Aldrich, H., 151 Alessandri, T., 121, 291, 356 Alexiev, A., 357 Ali, Mahummad Azhar, 96 Ali, Shubber, 431 Allata, J., 291 Allen, D., 387 Allen, J., 30 Allende, Salvador, 379 Allred, B., 90 Allred, Gloria, 327 Almeida, P., 324 Altenborg, E., 291 Ambec, S., 387 Ambos, B., 123, 323 Ambos, T., 323–324 Amit, R., 59 Anand, J., 218, 219, 255 Anand, S., 387 Anderson, B., 185 Anderson, E., 30 Andersson, U., 324 Andrade, G., 291 Andreessen, Marc, 327 Ang, S., 218 Anokhin, S., 151 Ansoff, I., 29 Apotheker, Léo, 310, 327–328, 337

Apud, S., 123 Ariely, D., 121 Arikan, A., 151, 184 Arino, A., 218, 219 Armington, C., 150 Arnold, M., 184 Arora, A., 151 Arregle, J., 87, 322 Arthurs, J., 152 Arvidson, N., 323 Arya, B., 388 Asaba, S., 89 Asakawa, K., 323 Asmussen, C., 322 Ataay, A., 218 Au, K., 150, 152, 356 Aulakh, P., 86, 185, 289 Autio, E., 151, 152 Avolio, B., 120

B Babakus, E., 324 Babe, Greg, 321, 322 Bachrack, M., 239 Baden-Fuller, C., 323 Baker, J., 255 Baker, Kris, 440–447 Baker, T., 150 Balasubramanian, N., 89 Balogun, J., 324 Bals, L., 88 Banalieva, E., 185 Baran, Kerim, 436 Barden, J., 121, 219 Barkema, H., 184, 185, 292 Barker, R., 29 Barnes, B., 151 Barnett, M., 386, 388 Barney, J., 31, 59, 71, 87–89, 153

255, 387 Barr, P., 120 Barry, D., 151 Barthelemy, J., 60, 185 Bartlett, C., 29, 311, 323 Bartol, K., 356 Bartunek, J., 388 Basu, K., 387 Baum, J., 219, 220

499 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

Baum, J. R., 255 Beamish, P., 87, 122, 217, 218, 219, 220, 264, 290–291, 322, 324 Bebchuk, L., 356 Becerra, M., 255 Beethoven, 183 Behring, Alex, 278 Belderbos, R., 184 Bell, J., 152 Bell, R. G., 153, 358 Bell, S., 184 Ben, R., 29 Benito, G., 185, 309 Benjamin, Cathy., 471–476 Benner, M., 255, 290 Benz, M., 355 Bercovitz, J., 290 Berger, Roland, 398 Bergh, D., 292 Bergh, R., 121 Berlusconi, Silvio, 343 Berman, S., 89, 323 Bernstein, A., 24 Bernstein, P., 358 Berry, H., 123, 184, 292 Bettis, R., 292 Beugelsdijk, S., 88, 184 Bezos, Jeffrey, 127 Bhagat, R., 31, 87, 122 Bhardwaj, A., 122 Bhattal, Jesse, 462 Bhaumik, S., 30, 184 Bianchi, M., 323 Bierly, P., 323 Bies, R., 388 Bigley, G., 121 Bilous, Keith, 131 Bing, Lu Wen, 394, 396 Bingham, C., 152 Birkinshaw, J., 309, 322, 323, 324 Bjorkman, A., 324 Blavatnik, Len, 215 Blevins, D., 31, 104 Block, E., 387 Bloom, M., 386 Bloom, N., 30 Boal, K., 185 Boddewyn, J., 31, 90 Bodolica, V., 357 Bodt, E., 292 Boehe, Dirk Michael, 448–455 Boeker, W., 218 Boerner, C., 291 Boiset, M., 153 Boivie, S., 290, 356, 357 Boone, C., 61

Bosch, F., 324 Bosse, D., 386 Bou, J., 61 Bouquet, C., 322, 324 Bourda, Fabia, 424–430 Bourdeau, B., 218 Bowen, H., 31, 151, 185, 290 Bower, J., 30 Bowman, E., 290 Boyd, B., 356, 357 Boyd, J., 255 Boyd, N., 89 Bradley, S., 151 Brammer, S., 387, 388 Brandenburger, A., 220 Brandes, P., 291, 356 Brannen, M., 91, 122, 291 Branzai, O., 120 Braunerhjelm, P., 309 Brenner, S., 255 Bresser, R., 255 Brettel, M., 89 Brickson, S., 386 Bridoux, F., 88 Brin, Sergei, 437 Brinser, Gordon, 424 Bris, A., 357 Brousseau, K., 152 Brouthers, K., 31 Brouthers, L., 31, 185, 220 Brown, S., 60 Brown, Vivian, 471–476 Brush, T., 218 Bruton, G., 30, 150, 152–153, 332–333, 346, 355–356, 387 Bryce, D., 250 Buchan, N., 122 Buchanon, James, 471–476 Buchholtz, A., 255 Buck, T., 356, 357 Budhwar, P., 122 Bunyaratavej, K., 88 Burgelman, R., 324 Burgess, S., 167 Burman, Harold, 440–447 Burrus, D., 90 Burt, R., 152, 220 Bygrave, W., 152 Byles, C., 46 Byles, Charles M., 418–422

C Cabolis, C., 357 Cadsby, C., 356 Cainkota, M., 120 Calabrese, T., 220

500 INDEX OF NAMES

Cameron, K., 30 Camillus, J., 30 Camp, S. M., 150 Campa, J., 291 Campbell, B., 151 Campbell-Hunt, C., 60 Campbell, J., 87, 386, 387 Canales, I., 324 Cannella, A., 255, 256 Cannella, B., 121 Cantwell, J., 184 Capaldo, A., 88 Capar, N., 290 Capelleras, J., 151 Cappelli, P., 386 Capron, L., 121, 255, 290, 358 Cardinal, L., 185, 290 Cardon, M., 151 Caringal, C., 89 Carlucci, Frank, 335 Carmeli, A., 29, 87 Carney, M., 30, 121, 290 Carpenter, M., 356 Carr, C., 30 Carter, N., 91 Cascio, W., 292 Cassar, G., 152 Castaner, X., 218 Castellucci, F., 218 Castleton, M., 356 Cavusgil, S. T., 220, 324 Certo, S. T., 255, 355 Chacar, A., 121, 219 Chachine, S., 152 Chahine, S., 355 Chakrabarti, R., 291 Challagalla, G., 184 Chan, C., 31, 184, 219 Chan, J., 464 Chan, R., 387 Chandler, Alfred, 11, 30, 322 Chandra, Y., 150 Chang, K., 291 Chang, S., 31, 87, 219, 296 Chari, M., 89, 90, 290, 291, 357 Chatain, O., 88, 121, 255 Chatterji, A., 151 Chattopadhyay, P., 121 Chavez, H., 150 Chen, C., 122, 123 Chen, D., 218 Chen, E., 89 Chen, G., 152 Chen, H., 30 Chen, M., 30, 243–244, 255, 256, 289

Chen, P., 290 Chen, S., 59, 152, 219, 233, 291 Chen, Tim, 28 Chen, V., 356 Chen, Y., 386 Cheng, K., 184 Chernin, Peter, 332 Chesbrough, H., 323 Chester, Jeff, 119 Cheung, Anna, 391, 396, 400 Cheung, M., 185, 219 Chi, T., 89, 220, 322 Child, J., 121, 218 Chintakananda, A., 121, 185, 218 Chittour, R., 86, 289 Chizema, A., 356, 358 Cho, M., 184 Cho, T., 356 Choe, S., 260 Choi, B., 184 Choi, C., 220 Choi, E., 464 Choi, J., 123, 387 Choi, T., 60 Chou, Peter, 254 Chow, R., 30 Christensen, C., 30, 151 Christmann, P., 292, 388 Chu, W., 464 Chua, R., 218 Chun, H., 120 Chun, R., 87 Chung, W., 184 Ciabuschi, F., 324 Ciravegna, L., 153 Claessens, S., 356 Clarke, J., 151 Clarkson, G., 255 Clarkson, M., 387 Clement, M., 357 Clougherty, J., 122, 239, 256, 291 Cockburn, A., 230 Coeurderoy, R., 88, 121 Cohen, W., 324 Collin, S., 358 Collis, D., 30, 76, 89 Colombo, M., 151 Combs, J., 356 Connelly, B., 88, 255, 290, 355 Connors, John, 28 Contardo, I., 255 Contractor, F., 88, 264 Cool, K., 59, 60 Cooper, B., 122 Cooper, J., 121

INDEX OF NAMES 501

Copernicus, 14 Corbett, A., 152 Cording, M., 292 Corredoira, R., 121 Corsten, D., 218 Coucke, K., 88 Coughlan, J., 324 Coviello, N., 150 Covin, J., 150, 291 Cowen, A., 356 Coyne, K., 255 Crane, Grace, 471–476 Crilly, D., 386 Criscuolo, P., 323 Cronin, J., 218 Crook, T., 121 Crosen, R., 218 Crossan, M., 356 Crossland, C., 30 Cruz, Luciano Barin, 448–455 Cuervo-Cazurra, A., 87, 121, 122, 184, 324, 357 Cuervo, J., 185 Cuervo, Javier C., 412–417 Cui, L., 289 Cullen, J., 122 Cumming, D., 150, 355 Cuypers, I., 218 Cyders, Andrew, 440–447 Czinkota, M., 256

D Dacin, M. T., 121, 153, 219 Dagnino, G., 90, 256 Daily, C., 291, 356 Dalsace, F., 60 Dalton, D., 291, 356 Dalziel, T., 152 Damanpour, F., 123, 323 Danneels, E., 87 Darling, David, 424–430 Darnall, N., 388 Das, T., 217 Datta, D., 152, 292 Dau, L., 87, 121 D’Aunno, T., 121 D’Aveni, R., 89, 90, 256 David, P., 89, 90, 290, 357, 386 Davies, G., 87 Davies, H., 121 Davis, G., 122, 357, 387 Davis, K., 386 Dawar, N., 246, 256 de Bakker, F., 387 De Castro, J., 121 De Clercq, D., 151

de Fontenay, C., 60 de Quieroz, V., 323 de Rond, M., 30 de Soto, H., 120 Dean, A., 324 Decker, C., 61 Deeds, D., 31, 60, 152 Deeg, R., 30 Delios, A., 185, 290, 322, 324, 387 Dell, Michael, 43, 63 Dellestrand, H., 324 Delmas, M., 388 Delmestri, G., 184 Demil, B., 61 Demirbag, M., 88, 184 den Hond, F., 387 Deng, P., 289 Desarbo, W., 60, 256 Deshpandé, R., 67 Dess, G., 151 Devaraj, S., 290 Devarjai, S., 89 Devers, C., 356 Devinney, T., 31, 387 Dew, N., 30, 150 DeWitt, R., 292 Dhanaraj, C., 152, 219 Dharwadkar, R., 291, 356 Dieleman, M., 291 Dietz, J., 122 Dighero, Robert, 436 Dikova, D., 220 Dinur, A., 323 Dixit, A., 90 Djankov, S., 356 Dobrev, S., 185 Doh, J., 31, 88, 387 Doidge, C., 357 Domoto, H., 60 Donahue, M., 356 Donaldson, L., 358 Donaldson, T., 363 Donaldson, Thomas, 110, 122, 387 Dorfman, P., 122 Dorrenbacher, C., 324 Doving, E., 290 Dow, D., 123 Dow, S., 60 Dowell, G., 59, 357 Dowling, P., 108 Down, J., 89, 323 Doz, Y., 29 Dranove, D., 60 Driffield, N., 323 Driver, M., 152

502 INDEX OF NAMES

Drnovsek, M., 151 Droge, C., 88, 185 Drogendijk, R., 184 Drucker, Peter, 11, 30 Du, J., 122 Dudley, Robert, 215, 216 Dunlap-Hinkler, D., 323 Dunn, Patricia, 327 Dunning, J., 29 Dunning, John, 173, 184, 185 Durand, R., 88, 120 Durisin, B., 324 Duso, T., 291 Dussuage, P., 218 Dyer, J., 60, 151, 210, 218, 220 Dykes, B., 291, 387

E Easterby-Smith, M., 324 Economy, E., 381 Eddleston, K., 185 Eden, L., 218, 386 Egelhoff, W., 60, 322 Eggers, J., 290 Egri, C., 386 Eiadat, Y., 387 Einav, L., 59 Einstein, 14 Eisenhardt, K., 78, 89, 151, 152, 323 Eisenmann, T., 59 Elango, B., 184 Elbanna, S., 121 Elfenbein, H., 255 Elkington, J., 371, 387 Ellis, K., 291 Ellis, P., 121 Ellison, Larry, 327 Ellstrands, A., 356 Erez, M., 122 Eriksson, T., 88 Erkins, D., 356 Ertug, G., 218 Eskin, E., 60 Esterby-Smith, M., 323 Estrin, S., 30, 184, 357 Ethiraj, S., 89 Ettenson, R., 388 Eunni, R., 151 Evangelista, F., 219 Eyadat, H., 387

F Faccio, M., 356 Faems, D., 219 Fai, F., 322

Fails, D., 88 Faldin, Maxim, 436, 437 Falllieres, M., 399 Fang, E., 218, 219 Fang, Lily, 391–403 Fang, T., 122 Fang, Y., 290 Farrell, D., 79 Fern, M., 290 Fernando, C., 387 Fernhaber, S., 152 Ferrier, W., 255 Fey, C., 184, 324 Field, J., 88 Filatotchev, I., 121, 151–153, 355, 356, 357, 358 Finkelstein, S., 291 Fiorina, Carly, 327 Fisher, Jodi, 327 Fisher, Ken, 422 Fishman, C., 256 Fladmoe-Lindquist, K., 87 Flores, R., 184 Fombrun, C., 87, 388 Ford, Henry, 6 Forsgren, M., 324 Forster, W., 150 Fort, T., 388 Foss, N., 323, 324 Fotak, F., 350 Francis, J., 151 Franco, A., 151 Fransson, A., 323 Frazier, G., 184 Freeman, E., 386 Freene, F., 151 Fremeth, A., 388 Frese, E., 60 Frey, B., 355 Fridman, Mikhail, 197, 215–217 Fried, J., 356 Friedman, Milton, 365, 387 Frost, T., 246, 256 Frynas, J. G., 185 Fuentelsaz, L., 256 Fujita, J., 185 Fukata, Yoshihiro, 462 Fukuyama, F., 122 Furu, P., 324

G Galan, J., 185, 322 Galileo, 14 Gammelgaard, J., 324 Gampa, R., 464 Ganapathi, J., 386

INDEX OF NAMES 503

Ganco, M., 151, 255 Gande, A., 290 Gang, Zhang, 391, 392, 393, 394, 400 Gannon, M., 108 Gans, J., 60 Gao, G., 31, 185 Garbe, J., 322 Garces-Ayerbe, C., 387 Garcia-Canal, E., 184 Garcia-Pont, C., 324 Gardberg, N., 87, 388 Garrette, B., 218 Garung, A., 357 Gates, Bill, 27, 28 Gau, G., 184 Gaur, A., 151, 185 Gaur, S., 151 Gavet, Maelle, 127–128 Gavetti, G., 30 Gedajlovic, E., 30, 121, 150, 290, 338, 356, 386 Geletaknycz, M., 356 Genakos, C., 30 George, B., 151 George, E., 121 George, G., 151, 152 Geringer, J. M., 290 Germann, K., 30 Geroski, P., 151 Ghauri, P., 220 Ghemawat, P., 29, 31, 324 Ghoshal, S., 29, 122, 311, 323 Ghosn, Carlos, 362 Ghuari, P., 219 Gianiodis, P., 255 Giarratana, M., 152 Gibbons, P., 324 Gibson, C., 122, 324 Gifford, B., 387 Gilbert, B., 152 Gilbert, C., 30 Gimeno, J., 233, 255 Glaister, K., 88, 184 Globerman, S., 122 Globerman, Steve, 349, 350, 355 Glunk, U., 357 Glynn, M., 387 Gnyawali, D., 120, 218, 323 Godfrey, P., 89, 387 Goerzen, A., 87, 219, 290 Golden, B., 255 Golden-Biddle, K., 30 Goldstein, D., 31 Golovko, E., 151 Gomes, L., 290 Gomez, J., 185, 256

Gomez-Mejia, L., 356 Gonzalez-Benito, J., 185 Gooderham, P., 290, 323 Goranova, M., 291, 356 Gordon, B., 59 Gore, A., 356, 375, 388 Gospel, H., 357 Gotsopoulos, A., 185 Gottfredson, M., 90 Gottschlag, O., 358 Gou, 6 Gould, S., 324 Gove, S., 88, 255, 388 Govindarajan, V., 29, 86, 152, 255, 313, 323 Gozubuyuk, R., 218 Graebner, M., 152, 356 Graffin, S., 356 Graham, E., 256 Graham, J., 122 Grahovac, J., 88 Grajek, M., 122 Grant, R., 316 Greenwald, B., 31, 322 Gregerson, H., 151 Gregorio, D., 88, 151, 152 Grein, A., 324 Greve, H., 122, 218, 219, 255, 323 Grewal, R., 60, 256 Griffin, D., 150 Griffith, D., 60, 88, 123, 185 Griffiths, A., 121 Grilli, L., 151 Grimm, C. M., 225 Grimpe, C., 88 Grove, Andrew, 50, 60, 316, 324 Gruber, M., 89 Guar, A., 220 Guay, T., 387 Gubbi, S., 289 Guedri, Z., 255 Guillen, M., 121, 123, 184, 358 Gulati, R., 59, 219 Gupta, A., 29, 152, 313, 323 Gupta-Mukherjee, S., 291 Gupta, V., 122 Guthrie, J., 292 Gyoshev, B., 151

H Haas, M., 324 Habib, M., 122 Hahn, E., 88 Hakanson, L., 123, 323 Haleblian, J., 357 Hambrick, D., 30, 31, 152, 357

504 INDEX OF NAMES

Hamilton, R., 60, 323 Hammes, T., 132 Hanges, P., 122 Hannah, S., 120 Hansen, J., 387 Harkins, Michele, 471–476 Harmancioglu, N., 88 Harrison, J., 386 Harrison, J. S., 263 Hart, B. Liddell, 30 Hart, Liddell, 11 Hart, S., 122, 387 Hartmann, E., 88 Harzing, A., 324 Hashai, N., 152 Hatch, N., 250 Hatonen, J., 88 Hau, L., 219 Haxhi, I., 357 Hayden, 183 Haynes, K., 357 Hayward, M., 87, 150 He, J., 357 He, X., 255 He, Y., 386 Heath, C., 224 Hebert, L., 322 Heide, J., 184 Heijltjes, M., 357 Heine, K., 89 Heinemann, F., 89 Heleblian, J., 291 Helfat, C., 87, 290 Hellman, J., 122 Hemphill, T., 388 Hemprecht, J., 388 Hendel, J., 224 Henderson, A., 290, 357 Henderson, J., 59, 60 Hennart, J., 122, 184, 185 Henriques, I., 388 Heracleous, L., 60 Hermalin, B., 357 Hermelo, F., 75 Herrmann, P., 152, 357 Hess, A., 89 Heugens, P., 30, 290, 358 Higgins, M., 218 Hill, A., 88 Hill, C., 60, 89, 153, 250, 255, 291

323, 357 Hiller, N., 357 Hillier, D., 323 Hillman, A., 121, 386, 387 Hines, J., 104

Hinings, C., 184 Hirst, G., 122 Hitt, M., 71, 87, 88, 150, 218, 255, 263, 290, 291 Ho, J., 358 Ho, Lawrence, 416 Ho, Stanley, 412 Hoang, H., 323 Hodgetts, R., 322 Hoegl, M., 122 Hoffman, A., 374 Hoffman, W., 219 Hoffmann, V., 388 Hofstede, Geert, 105, 106, 107, 122, 306 Holburn, G., 121 Holcomb, T., 88 Holm, U., 309 Holmes, M., 88 Holmes, R. M., 356 Holmqvist, M., 152 Holzinger, I., 121 Hong, J., 260, 323, 324 Hong, S., 122 Hoopes, D., 60 Hoover, V., 255 Hope, D., 152 Horn, J., 255 Hoskisson, R., 30, 71, 121, 150, 260, 263, 355–356 Hough, J., 89 House, R., 122 Hrivnak, G., 152 Hsieh, L., 218 Hsu, C.-C., 264 Hsu, D., 152 Huang, K., 121 Huang, X., 323 Huang, Y., 151 Huang, Z., 121, 357 Huckman, R., 60 Hull, C., 387 Hulland, J., 218 Hult, G. T., 60 Hung, M., 356 Hungeling, S., 89 Hunter, L., 121 Huo, A., 464 Hurd, Mark, 327 Huselid, Mark, 91 Husted, B., 387 Husted, K., 323 Hutzschenreuter, T., 184

I Imelt, Jeff, 231 Immelt, Jeffrey, 8, 255 Ingram, P., 121

INDEX OF NAMES 505

Inkpen, A., 323, 324 Ireland, R. D., 71, 87, 150, 153, 218, 263 Isobe, T., 31, 219 Ito, K., 185, 255 Iyer, B., 89, 291

J Jack, S., 151 Jackson, G., 30, 357 Jacobides, M., 60, 291 Jagad, Mallika, 66 Janney, J., 388 Jansen, J., 89, 324, 357 Janssens, M., 219 Jap, S., 185 Jarzabkowski, P., 324 Javagli, R., 90 Javidan, M., 122 Jayaraman, N., 291 Jennings, W., 355 Jensen, M., 218, 356 Jensen, Michael, 354 Jensen, P., 88 Jensen, R., 323, 337–338 Jensen, T., 386 Jiang, C., 218, 323 Jiang, F., 289 Jiang, M., 185 Jiang, Y., 30–31, 120, 332–333, 356, 358 Jintao, Hu, 27 Jobs, Steve, 139, 211, 327, 342 Johanson, J., 184 Johnson, D., 60 Johnson, J., 122, 123, 356 Johnson, R., 150, 292, 357 Johnson, S., 88, 151, 356 Johnson, W., 356 Jones, G., 122, 291 Jonsson, S., 89 Joshi, A., 218 Julian, S., 30, 121 Justis, R., 121

K Kabanoff, B., 60 Kacperczyk, 386 Kahn, J., 31, 322 Kaiser, U., 88 Kale, P., 210, 217, 218, 219, 220 Kalnins, A., 255 Kalotay, K., 157 Kamins, M., 87 Kamprad, Ingvar, 139 Kang, J., 358 Kang, Karambir Singh, 66–67

Kang, R., 31 Kankiwala, Nish, 398, 400 Kaplan, R., 19, 219 Kaplan, S., 355, 357 Kapoor, R., 88, 291 Karim, S., 291 Karnani, A., 387 Karolyi, A., 357 Karube, M., 292 Karunaratna, A., 123 Katila, R., 89, 151 Kato, T., 292 Kaufmann, D., 122 Ke, Y., 31 Kedia, B., 88, 290, 324, 410 Kedia, J., 88 Keil, M., 218 Keil, T., 291 Keim, G., 387 Kelly, A., 387 Kenney, M., 88 Kenny, Steve, 431, 435 Kestler, A., 387 Ketchen, D., 60, 151, 153, 255, 356 Ketkar, S., 184 Khanin, D., 356 Khanna, T., 30, 121, 296, 358 Khavul, S., 150 Khoury, T., 30, 120, 185, 290 Kilduff, G., 255 Kim, D., 151 Kim, H., 260 Kim, J., 291, 356, 358 Kim, K., 90 Kim, S., 122 Kim, W. C., 256, 322 King, A., 89, 388 King, D., 291, 292 Kirca, A., 184 Kircher, P., 322 Kirkman, B., 122 Kistruck, G., 153 Kleinberg, J., 123 Kliesch-Eberl, M., 87 Klossek, Andreas, 465–470 Knight, G., 120, 151 Knott, A., 153 Kochan, T., 121 Kogan, J., 358 Kogut, B., 218 Koka, B., 218, 324 Kolk, A., 388 Köpf, Barny, 448, 450, 452 Köpf, Josef, 450 Kor, Y., 357

506 INDEX OF NAMES

Kostova, T., 89, 121, 311, 324 Kotabe, M., 31, 60, 89, 184, 218, 256, 290, 323 Kotha, S., 151 Kourula, A., 388 Koveos, P., 122 Koza, M., 218 Kraatz, M., 292 Kramer, M. R., 368, 382 Kraussl, R., 387 Krishnan, H., 291 Krishnan, M., 89 Kroll, M., 89, 152, 356 Kronborg, D., 185 Kruse, G., 121 Kuilman, J., 60 Kuma, V., 88 Kumar, K., 88 Kumar, N., 235, 256 Kumar, V., 184 Kunar, M., 220 Kunc, M., 88 Kundu, S., 88, 153, 264 Kurmakayev, Kamil, 436, 437 Kuznetsov, A., 104 Kwak, M., 60 Kwan, H., 152 Kwok, C., 122, 358

L La, V., 88 La Porta, R., 355, 356 Laamanen, T., 291, 309 Lado, A., 89 Lafley, A. G., 15 Lages, L., 185 Lahiri, S., 88, 290, 323 Lai, J., 219 Lam, K., 123 Lamin, A., 88 Lamont, B., 89, 291, 292 Lane, P., 324, 358 Lang, L., 356 Lange, D., 290, 357 Lanoie, P., 387 Lanzolla, G., 185 Larraza-Kintana, M., 356 Larsson, R., 152 Lau, V., 150 Laursen, K., 323 Lavie, D., 59, 219, 220 Lawrence, P., 59 Lawrence, T., 59 Lazzarini, S., 217 Le, S., 356 Leask, G., 60

Lechner, C., 219 Lecocq, X., 61 Lee, B., 121 Lee, C., 89, 290 Lee, G., 185, 219 Lee, J., 30 Lee, K., 30, 122, 260, 290, 296 Lee, K. B., 30, 260, 290 Lee, S., 30–31, 59, 121–123, 153, 184–185, 274–275, 291–292 Leeds, Roger, 391–403 Leiblein, M., 60, 88 Lemak, D., 185 Lemann, Jorge Paulo, 278 Lemelson, Jerome, 223 Lenartowicz, T., 123 Lenox, M., 89 Lepak, D., 151 Lerner, J., 357 Lester, R., 121 Leung, H., 464 Leung, K., 122 Lev, B., 387 Levie, J., 151 Levinthal, D., 324 Levitt, T., 31, 297, 322 Levy, D., 88 Lewin, A., 88, 89, 184 Lewis, D., 31 Li, D., 218 Li, David, 335 Li, H., 121, 153 Li, J., 60, 123, 184, 219, 356 Li, M., 290, 357 Li, P., 185 Li, Y., 75, 88 Licht, A., 356 Lichtenthaler, U., 323 Lieberman, M., 89, 219 Lieberthal, K., 323, 381 Liesch, P., 87, 120, 185, 323 Liew, R., 464 Liker, J., 60 Lim, E., 292 Lim, K., 291 Lin, H., 255 Lin, W., 184 Lin, Y., 218 Lin, Z., 30, 218, 220, 291 Lincoln, J., 60 Linke, Bernd Michael, 465–470 Liou, F., 89 Lioukas, S., 89 Lipstein, R., 256 Liu, C., 219 Liu, E., 464

INDEX OF NAMES 507

Liu, R., 88 Liu, Y., 88, 184 Livengood, R. S., 255 Loane, S., 152 Lockett, A., 218 Long, C., 122 Looy, B., 219 Lopez-de-Silanes, F., 355, 356 Lopez, L., 153 Lorsch, J., 30 Lounsbury, M., 122, 291 Lovallo, D., 89 Love, E. G., 292 Love, J., 323 Lowe, K., 122 Lowe, R., 150 Lu, J., 31, 152, 184, 219, 264 Lu, Y., 30, 151, 183, 290, 323 Lubatkin, M., 59, 150, 358 Luce, R., 60 Lui, S., 219 Luk, C., 30 Luke, Horace, 254 Lukey, Bernard, 127 Lumpkin, G. T., 151 Luo, Y., 30, 86, 122–123, 152

218, 219, 324 Lupton, N., 217 Lux, S., 121 Lyles, M., 219, 220, 323

M Ma, H., 255 Ma, R., 151 Ma, X., 322 Macaulay, C., 75 Macaulay, L., 31 Macharzina, K., 29 Macher, J., 291 Mackay, P., 31 Mackenzie, W., 89 Mackey, A., 387 Mackey, John, 372, 376, 385, 386 Mackey, T., 387 MacMillan, I. C., 243–244, 256 Madhok, A., 219–220 Madsen, P., 388 Madsen, T., 88 Magee, R., 356 Magnan, M., 358 Mahoney, J., 218 Maicas, J., 185 Mainkar, A., 59 Mair, J., 387 Makhija, M., 31, 184

Makino, S., 31, 184, 185, 219, 290 Malhotra, N., 184 Maloney, M., 184 Manev, I., 151 Manigart, S., 218 Manning, S., 184 Manolova, T., 151 Manrakhan, S., 184 Marcel, J., 356 March, James, 203, 219 Marcus, A., 388 Mardiasmo, Diaswati, 431–435 Marginson, D., 31 Marin, Jose, 436 Markman, G., 29, 255 Marquis, C., 121, 291, 387 Marsh, L., 87 Marsh, S., 256 Martin, J., 78, 89, 323 Martin, K., 122 Martin, O., 324 Martin, X., 60, 89, 218 Martinez-Fernandez, M., 218 Martinez, Z., 90 Marvel, M., 151 Mas-Ruiz, F., 60 Maseland, R., 122 Mason, P., 30 Massini, S., 88 Masulis, R., 357 Mata, J., 151 Mathews, J., 29, 59, 87, 152 Mathews, John, 178 Matos, P., 356 Matsunaga, S., 356 Matta, E., 291 Matten, D., 386 Mauborgne, R., 256, 322 May, D., 120 Maznevski, M., 184 McCann, B., 184 McCarter, M., 218 McCarthy, D., 121, 122, 153, 357 McCarthy, Daniel J., 436–438 McCarthy, I., 59 McDermott, G., 121 McDonald, M., 356, 357 McDonald, R., 89 McDougall, P., 150, 152 McGahan, A., 60, 61 McGrahan, A., 151 McGrath, R. G., 243–244, 256 McGuire, J., 60, 255, 357 McIntyre, D., 218 McKinsey, 79

508 INDEX OF NAMES

McMullen, J., 150, 152 McNamara, G., 60, 89, 291 McNaughton, R., 152 Meckling, W., 356 Megginson, W., 350 Meier, D., 291 Mellahi, K., 185 Mellewigt, T., 61 Menghinello, S., 323 Mentzer, J., 219 Merrill, C., 387 Mesquita, L., 218, 255 Meuleman, M., 218 Meyer, C., 291 Meyer, K., 30 Meyer, Klaus, 40, 184, 185, 219, 267, 290 Michaels, M., 60 Michailova, S., 323 Michel, J., 255 Mignonac, K., 185 Milanov, H., 218 Miller, C. C., 185 Miller, D., 88, 89, 290, 357 Miller, K., 291 Miller, S., 386 Miller, T., 290 Millington, A., 387 Minbaeva, D., 323 Minford, P., 121 Minin, A., 323 Minniti, M., 152 Minnow, N., 355 Mintzberg, H., 30, 316 Mishina, Y., 387 Mishra, H., 323 Missangyi, V., 357 Mitchell, M., 291 Mitchell, R., 151 Mitchell, W., 218, 290 Mitsuhashi, H., 218, 219 Moeller, S., 31 Mole, K., 151 Molina-Morales, F., 218 Moliterno, T., 89 Monks, R., 355 Monteiro, L. F., 323 Montes-Sancho, M., 388 Moon, J., 386 Moore, C., 153 Moore, K., 31 Moran, P., 89, 122 Morecroft, J., 88 Morgan, E., 322 Morrison, A., 322 Mors, M., 324

Morse, E., 151 Moschieri, C., 291 Mu, S., 323 Mudambi, R., 88, 151, 323 Mudambi, S., 88 Muhanna, W., 89 Mukherjee, D., 88, 151, 290 Mukherjee, Debmayla, 409–410 Mukhopadhyay, S., 185 Muller, A., 387 Mundie, Craig, 28 Murdoch, Elisabeth, 332 Murdoch, James, 331–332 Murdoch, Rupert, 234, 331–332, 342 Murillo-Luna, J., 387 Murray, F., 121 Murray, G., 121 Murray, J., 31, 89, 184, 218 Murtha, T., 88 Murtinu, S., 151 Musteen, M., 88, 151 Mutlu, Canan, 404–408 Myers, M., 60, 185, 219

N Nablebuff, B., 220 Nachum, L., 31, 123, 184, 323 Nadkarni, S., 60, 120, 152, 357 Nadolska, A., 185 Nagarajan, N., 356 Nakamura, M., 357 Nambisan, S., 217 Nandkumar, A., 151 Narayanan, V., 60 Narula, R., 323 Nasra, R., 153 Navarra, P., 323 Ndofor, H., 255 Nebus, J., 388 Neeleman, David, 143 Nelson, K., 122 Nelson, R., 75 Nerkar, A., 218 Ness, H., 219 Newbert, S., 87 Newburry, W., 121 Newman, H., 356 Ng, D., 292 Nguyen, T., 323 Niederauer, Duncan, 309 Nielsen, B., 219 Nielsen, S., 219 Nielsen, T., 152 Nieto, M., 323 Nifadkar, S., 123

INDEX OF NAMES 509

Noble, C., 89 Noboa, F., 324 Nohria, N., 30 Noorderhaven, N., 324 North, Douglass, 94, 120, 121 Northcraft, G., 218 Norton, D., 19, 219 Numagami, T., 292 Nyberg, Lars, 408 Nystrom, P., 322

O Obama, Barack, 309, 424–430 Oetzel, J., 184, 387 Ofori-Dankwa, J., 30, 121 Oh, C., 184, 387 Oh, K., 122 O’Leary, Michael, 46, 418–422 Olffen, W., 184 Oliver, C., 121, 219 Olsen, D., 290 O’Mahony, S., 121 O’Neill, H., 185 Ormiston, M., 388 Orr, R., 123 Osborne, J. D., 60 Osegowitsch, T., 185 O’Shaughnessy, K., 386 Oster, S., 60 Ou, A., 123 Oviatt, B., 150, 152 Oxenford, Alec, 436 Ozcan, P., 152

P Pacheco-de-Almeida, G., 60, 90 Paik, Y., 218 Pajunen, K., 121 Palazzo, G., 386, 387 Palepu, K., 358 Palich, L., 185 Palmer, T., 60 Pan, Y., 185 Pande, A., 88 Pangarkar, N., 219 Panibratov, A., 157 Parboteeah, K., 122 Parente, R., 89, 184, 323 Park, D., 291 Park, H., 151, 219 Park, S., 123, 218 Parker, D., 60 Parker, G., 59 Parmigiani, A., 88 Parvinen, P., 291

Pathak, S., 324 Patterson, P., 88 Paul, D., 184 Paulson, Henry, 349, 350 Pavelin, S., 388 Pearce, J., 121 Pedersen, T., 31, 88, 184, 323, 324 Peeters, C., 88 Pehrsson, A., 292 Peng, M. W., 24, 29–31, 44, 46, 52, 59–60, 75, 87–88, 97–99, 102, 104,

120–122, 132, 152–153, 184–185, 205, 212, 218, 219, 220, 260, 267, 274–275, 289–292, 316, 323–324, 332–333, 346, 355–356, 358, 381, 456–459, 462–463

Peng, W., 59 Penner-Hahn, J., 323 Perez-Nordtvedt, L., 324 Perez, P., 152 Perkins, Walter R., 452 Perrigot, R., 185 Perryman, A., 356 Peteraf, M., 60, 121 Petersen, B., 88, 185 Petersen, M., 291 Petitt, B., 290 Petrovits, C., 387 Pettigrew, A., 30 Pfarrer, M., 356 Phalippou, L., 355 Phan, P., 357 Phelps, C., 218, 323 Phene, A., 87, 218, 324 Pheng, L., 185 Philippe, D., 120 Philips, S., 90 Phillips, R., 386 Piekkari, R., 324 Piesse, J., 151 Pigman, G., 185 Pindado, J., 323 Pinkham, B., 30, 120 Pinkham, C., 97 Pinkse, J., 387 Pisano, G., 78 Piscitello, L., 151 Piva, E., 151 Ployhart, R., 89 Pluggenkuhle-Miles, E., 31 Polidoro, F., 89, 218 Pollock, T., 87, 152, 356, 387 Porac, J., 356 Porter, L., 388 Porter, M., 30 Porter, Michael, 35, 43, 50, 54, 59–61, 88, 99–100, 121, 130, 366, 367,

368, 380, 382 Portugal, P., 151

510 INDEX OF NAMES

Posen, H., 153 Pothukuchi, V., 123 Powell, T., 89 Prahalad, C. K., 292, 323 Prashantham, S., 152 Prescott, J., 218 Presley, Elvis, 82 Preston, L., 363, 387 Prevezer, M., 357 Prince, Erik, 132 Prince, J., 255 Puffer, S., 121, 122, 153, 357 Puffer, Shiela M., 436–438 Puranam, P., 59, 89, 291 Puryear, R., 90

Q Qian, C., 387 Qian, G., 30, 123, 185, 290 Qian, L., 185 Qian, Z., 30, 185, 290 Qinghou, Zong, 131

R Radhakrishnan, S., 387 Raes, A., 357 Ragozzino, R., 219 Raina, A., 67 Rajagopalan, N., 219, 357 Rajan, R., 387 Ralston, D., 386 Ramamurti, R., 86 Ramaprasad, A., 60 Ramasubba, N., 89 Ramaswamy, K., 290 Ramchander, S., 387 Ranft, A., 89, 291 Rangan, S., 152 Rasheed, A., 357, 358 Rawley, E., 291 Ray, G., 89 Ray, S., 86, 289 Raynor, M., 30 Read, S., 30 Reay, T., 30 Redding, G., 121, 122 Reed, R., 121, 185 Reger, R., 255 Regner, P., 89 Reid, E., 388 Reinmoeller, P., 386 Reitzig, M., 90, 224 Ren, B., 87, 220, 289 Reuer, J., 60, 121, 217, 218, 219

Reus, T., 89, 291–292 Rhodes, Cecil, 229 Ricart, J., 184 Rich, Al, 183 Richardson, D., 256 Richter, N., 322 Ricks, D., 108 Riddle, L., 152 Ridge, J., 88 Rindova, V., 87, 151, 255 Ring, P., 121, 218 Rique, M., 184 Ritmuller, Willhelm, 183 Ritzman, L., 88 Rivera-Torres, P., 387 Rivkin, J., 30 Robert, Kohlberg Kravis (KKR), 353, 354 Robertson, C., 122 Roche, F., 387 Rockart, S., 89 Rockefeller, E., 256 Rockefellers, 342 Rodkin, D., 31 Rodrigues, S., 218 Rodriguez, A., 323 Roe, R., 357 Roehl, T., 260 Rogers, Jim, 376–377 Roll, R., 292 Rometty, Ginni, 72 Romilly, P., 387 Rose, Charlie, 30, 220 Rose, E., 185, 255 Rosenkopf, L., 219 Rosenzweig, P., 121 Roth, K., 89, 121, 311, 324 Rothaermel, F., 89, 218, 255, 323 Rothenberg, S., 387 Rouse, M., 218 Rowe, W. G., 356 Rowlands, Chris, 392 Rowley, T., 219 Roy, A., 218 Roy, J., 219 Rubenstein, David, 355 Ruckstad, M., 30 Ruddock, A., 46 Rufin, C., 388 Rugelsjoen, B., 219 Rugman, A., 29 Rugman, Alan, 177, 322 Rui, H., 289 Ruiz-Moreno, F., 60 Rukstad, M., 76

INDEX OF NAMES 511

Rumelt, R., 30, 61 Rupp, R., 386 Russell, C., 123

S Sadorsky, P., 388 Sadun, R., 30 Safizadeh, H., 88 Sagiv, L., 356 Salk, J., 122, 219 Salter, A., 323 Sammartino, A., 185 Sampson, R., 218 Sanchez-Bueno, M., 322 Sanders, W. G., 356 Sandstrom, J., 386 Sanna-Randaccio, F., 323 Santoro, M., 323 Santos, F., 151 Santos, J., 29 Saparito, P., 122 Sapienza, H., 150, 152 Sarala, R., 292 Sarasvathy, S., 150 Saravathy, S., 30 Sarkar, M., 86, 88, 289 Satorra, A., 61 Sawhney, M., 217 Schendel, D., 30, 61 Schenzler, C., 290 Scherer, A., 386, 387 Scherer, R., 90 Schijven, M., 292 Schilling, M., 184 Schmid, F., 151 Schmidt, Eric, 211, 220, 336 Schmidt, T., 323 Schnatterly, K., 355, 357 Scholnick, B., 88 Scholtens, B., 388 Schomaker, M., 123 Schotter, A., 324 Schreiner, M., 218 Schreyogg, G., 87 Schultz, Howard, 376, 388 Schulze, W., 356 Schumpeter, Joseph, 146 Schwartz, M., 132 Schwebach, R., 387 Scott, P., 324 Scott, Richard, 94 Scott, W. R., 120, 123 Seawright, K., 151 Seelos, C., 387 Segal-Horn, S., 324

Seko, Mobuto, 229 Semadeni, M., 185, 255, 291 Senbert, L., 290 Senor, Dan, 135 Seth, A., 89 Shackell, M., 357 Shackman, J., 290 Shaffer, M., 150 Shah, R., 218 Shahrim, A., 357 Shakespeare, William, 145 Shamsie, J., 38 Shane, S., 150, 151 Shaner, J., 184 Shanley, M., 60, 218, 292 Shapiro, D., 122 Shapiro, D. M., 338 Shapiro, Daniel, 349, 350, 355, 356 Sharfman, M., 387 Sharp, Z., 324 Shaver, J. M., 59, 323 Shaw, K., 355 Shen, J., 290 Shen, W., 356 Shenkar, O., 87, 122–123, 151, 184, 201, 205, 212, 219 Shepherd, D., 150–152 Shervani, T., 184 Shi, L., 324 Shi, W., 218 Shi, Y., 358 Shimizu, K., 292 Shin, H., 24 Shin, S., 185 Shinawatra, Thaksin, 343 Shinozawa, Y., 358 Shipilov, A., 219 Shipton, H., 122 Shleifer, A., 355, 356 Short, J., 60 Shulze, W., 59 Sicupira, Carlos Alberto, 278 Siegel, D., 150, 291, 388 Siegel, J., 358 Siggelkow, N., 218 Silva, C., 91 Silverman, B., 121, 220 Simerly, R., 357 Simester, D., 30 Simon, D., 59, 255 Simons, K., 291 Simons, R., 31 Simpson, D., 316 Simpson, O. J., 327 Simsek, Z., 151, 357 Simula, T., 309

512 INDEX OF NAMES

Sin, L., 30 Singal, M., 323 Singer, Saul, 135 Singh, H., 60, 210, 217, 218, 219, 220, 291, 386 Singh, J., 151, 386 Singh, K., 122 Sinha, R., 89 Sinkovics, R., 219 Sirmon, D., 87, 88, 150, 255 Sitkin, S., 121 Slangen, A., 184, 185 Sleuwaegen, L., 88 Smith, Adam, 34, 225, 365 Smith, K., 90, 151, 256, 356 Smith, K. G., 225 Snell, R., 324 Snow, C., 255 Sofka, W., 323 Som, A., 323 Sonderegger, P., 152 Song, F., 356 Song, J., 296 Song, S., 323 Sorensen, M., 357 Souder, D., 59, 151 Spanos, Y., 89 Spar, D., 255 Spears, Britney, 327 Spencer, J., 323 Spitznagel, M., 31 Spraggon, M., 357 Srikanth, K., 89, 291 Srivastava, M., 218 Stafford, E., 291 Stahl, G., 291 Staking, K., 387 Stalk, G., 256 Stan, C., 346 Stanislaw, J., 31 Staw, B., 255 Steen, J., 87, 120, 185 Steensma, H. K., 151, 219, 220, 323 Stephenson, Randall, 458 Stern, I., 356 Stevenes, C., 121 Stglitz, J., 256 Stieglitz, N., 89 Stiglitz, J., 31 Stiglitz, Joseph, 249 Storey, D., 151 Stromberg, P., 355, 357 Stuart, N., 357 Stubbart, C., 60 Stulz, R., 355, 357 Styles, C., 88

Su, K., 255, 256 Suarez, F., 185 Subramani, M., 88 Subramanian, M., 255 Suharto, 110 Sull, D., 151 Sullivan, D., 151 Summers, Tim, 215 Sun, J., 86 Sun, M., 88 Sun, S., 29–31, 104, 120, 218, 220, 289, 291 Surroca, J., 387 Swaminathan, V., 218 Swan, S., 90 Szulanski, G., 323

T Tadesse, S., 122, 358 Taleb, N., 31 Tallman, S., 29, 31, 88, 201,

218, 219, 290 Tan, D., 219 Tan, H., 59 Tan, J., 30, 52, 59, 60, 185, 219 Tang, J., 356 Tang, L., 122 Tang, Y., 89 Tanriverdi, H., 89, 290 Tao, Z., 152 Tapon, F., 356 Tarnovskaya, V., 152 Tatoglu, E., 184 Taube, F., 152 Taylor, G., 388 Taylor, M. S., 151 Taylor, Marilyn, 431–435 Teece, D., 30, 60, 61, 87 Telles, Marcel, 278 Teng, B., 217 Terjesen, S., 309 Terlaak, A., 387 Terziovski, M., 151 Tetlock, P., 388 Teva, 235 Thatcher, Margaret, 347 Thietart, R., 30 Thomas, D., 88, 151, 152 Thomsen, S., 185 Thornhill, S., 60 Tian, J., 357 Tian, X., 184 Tian, Z., 386 Tiberius, 20 Tiegland, R., 323 Tihanyi, L., 123, 219, 255, 260, 290, 355

INDEX OF NAMES 513

Tikkanen, H., 291 Timmons, J., 137 Tishler, A., 87 Tiwana, A., 218 Todorova, G., 324 Toffel, M., 388 Toh, P., 89, 255 Tomassen, S., 309 Tompson, G., 60 Tong, T., 52, 60, 121, 218, 219 Torre, C., 323 Torrisi, S., 152 Torsila, S., 309 Townsend, J., 220 Toyne, B., 90 Tracey, P., 184 Trahms, C., 150 Trautmann, G., 88 Trautmann, T., 388 Trevino, L., 122 Tribo, J., 387 Trimble, C., 255 Tripsas, M., 290 Tsai, W., 90, 255, 256 Tsang, E., 184, 185, 323, 324 Tse, A., 30 Tse, D., 185 Tse, E., 88 Tse, S., 464 Tsui, A., 123 Tuchman, B., 12 Tuggle, C., 357 Tung, R., 122 Turner, Ted, 234 Tuschke, A., 356 Tyler, B., 120 Tzabbar, D., 88 Tzu, Sun, 10, 11, 23, 29, 224

249, 380

U Uhlenbruck, K., 291 Un, C. A., 324 Unruh, G., 388 Useem, M., 386

V Vaaler, P., 89, 152 Vaara, E., 292, 324 Vahlne, J., 184 Valentini, G., 151, 291 Van Alstyne, M., 59 Van den Bosch, F., 89, 357 van Ees, H., 357 Van Essen, M., 30, 290, 358

van Fenema, P., 88 van Hoom, A., 122 Van Iddekinge, C., 89 Van Oosterhout, J., 30, 290, 358 Van Reenen, J., 30 van Swaaij, Michael, 436 Van Witteloostujin, A., 61 Vanhaverbeke, W., 323 Vardi, Yossi, 135 Varghese, Thomas, 66 Vassolo, R., 75, 255 Vasudeva, G., 219 Vegt, G., 323 Vekselberg, Viktor, 215 Venkataraman, S., 150 Venkatraman, N., 89 Venzin, M., 88 Verbeke, A., 122 Very, P., 358 Veugelers, R., 323 Vining, A., 60 Vissa, B., 121, 151 Vliert, E., 323 Vogel, D., 387 Voigt, A., 291 Volberda, H., 89, 150, 184, 324, 357 Von Clausewitz, Carl, 10, 12, 30 von Glinow, M., 88 Von Nordenflycht, A., 89 Voorhees, C., 218 Vora, D., 324 Vroom, G., 184, 255 Vyas, D., 152

W Waddock, S., 387 Wade, J., 356 Wade, M., 290 Wagner, S., 90 Waldman, D., 387 Wallas, Mike, 433 Wally, S., 255 Walter, Robert, 44 Walters, B., 152, 356 Walz, U., 355 Wang, C., 357 Wang, Cher, 253 Wang, D., 30, 120, 153, 274–275, 291–292, 323, 356 Wang, Daizong, 394, 396, 401, 403 Wang, H., 387 Wang, L., 220 Wang, R., 60 Wang, S., 86 Wasko, M., 323

514 INDEX OF NAMES

Watanabe, Kenichi, 462 Watson, A., 122 Webb, J., 153 Weber, K., 122 Wei, S., 122 Wei, Z., 88 Weigelt, C., 88 Weiss, J., 110 Welbourne, T., 356 Welch, D., 108 Welch, Jack, 190, 262–263, 380, 388 Welch, L., 185 Welch, S., 388 Werner, S., 31 Wernerfelt, B., 89 West, J., 323 West, M., 122 Westphal, J., 356, 357 Wezel, F., 184 White, C., 324 White, R., 60, 152 White, S., 219 Whitley, R., 30 Whitman, Meg, 327 Wiersema, M., 31, 89, 185, 290

356, 357 Wiklund, J., 151 Wilkinson, T., 185 Williams, C., 290, 324, 386 Williamson, O., 60, 89, 95, 120 Williamson, P., 29 Wilson, Ben, 440–447 Wiltbank, R., 30, 255 Wincent, J., 151 Wind, J., 256 Winter, S., 87 Wirtz, J., 60 Wiseman, R., 356 Withers, M., 356 Witt, M., 121 Witty, A., 323 Wixted, B., 59 Woehr, D., 121 Wolf, J., 322 Wong, E., 388 Woo, C. Y., 233 Woo, J., 185 Woodman, R., 30 Woods, Tiger, 327 Wooster, P., 184 Wright, M., 121, 150, 152, 153

218, 355 Wright, P., 89, 152, 356 Wu, A., 358 Wu, Yanmin, 440–447

X Xia, J., 185, 220 Xiaoping, Deng, 392 Xie, F., 357 Xie, Q., 184 Xie, Qihua, 470 Xie, Y., 184 Xu, C., 122 Xu, D., 123, 184, 219, 324 Xu, S., 358

Y Yafeh, Y., 30 Yagi, N., 123 Yakova, N., 185 Yamakawa, Y., 31, 60, 152, 153 Yamamoto, Mineo, 73 Yan, D., 29, 87, 220, 289 Yang, G., 122 Yang, H., 30, 218, 220, 291, 323 Yang, J., 184 Yang, Q., 323 Yang, X., 30, 31, 121 Yang, Xiaohua, 431–435 Yao, J., 290 Yau, O., 30 Yeaple, S., 184 Yeh, K., 152 Yeniyurt, S., 220 Yergin, D., 31 Yeung, P. E., 356 Yeung, Yuka, 400, 401 Yildiz, H., 184 Yin, X., 218, 292 Yip, G., 29, 289 Yip, P., 185 Yiu, D., 30 Yoffie, D., 60 Yoheskel, O., 123 York, A., 88, 152, 185 Yoshida, Tadao, 139 Yoshikawa, T., 357 Young, M., 289, 332, 333, 356 Young, Michael N., 460–461 Yu, J., 152 Yu, T., 255, 256 Yue, D., 184 Yunus, Muhammad, 149, 150

Z Zacharakis, A., 152 Zaheer, S., 31, 88, 123, 184, 218 Zahra, S., 151, 152, 153

INDEX OF NAMES 515

Zajac, E., 219, 220 Zald, M., 388 Zammuto, R., 121 Zander, I., 152 Zaralis, G., 89 Zardari, Asif Ali, 96 Zardkoohi, A., 121 Zellmer-Bruhn, M., 324 Zeman, Allan, 461 Zemsky, P., 88 Zeng, M., 122 Zhang, G., 388 Zhang, J., 323 Zhang, S., 356 Zhang, X., 356 Zhang, Y., 121, 219, 356, 357 Zhao, H., 184 Zhao, J. H., 122 Zheng, Guo, 468

Zhou, C., 219 Zhou, J., 121, 122, 185 Zhou, L., 151 Zhou, N., 123 Zhou, Y., 88, 291 Ziedonis, A., 150, 224 Ziedonis, R., 255 Zinner, D., 60 Zocco, Giueppe, 127 Zollo, M., 219, 220, 291, 358 Zona, F., 357 Zoogah, D., 218 Zook, C., 30 Zott, C., 59 Zou, H., 358 Zou, J., 184 Zou, S., 218, 219, 324 Zuckerberg, Mark, 30, 78, 119–120 Zurawicki, L., 122

516 INDEX OF NAMES

INDEX OF SUBJECTS

2W1H foreign market entry model how, 170–176 when, 168–170 where, 163–166

5 forces framework, 35–37, 130 bargaining power of buyers, 41–42 bargaining power of suppliers, 41 foreign market entries and, 160 intensity of rivalry among competitors, 35–38 threat of potential entry, 38–41 threat of substitutes, 42–43

A Absorptive capacity, 314 Abu Dhabi Investment Authority, 349 Accommodative strategies, 112, 375 Acquisition premiums, 279 Acquisitions, 276. See also Diversification, acquisition and

restructuring versus alliances, 284 establishing WOSs, 176 versus market transactions, 200

Active CSR engagement overseas, 379 Afghan National Army, 132 Afghanistan, 132 Africa, 167

diamond industry, 229 trade and, 167

Agency costs, 330 Agency relationships, 330 Agency theory, 330 Agglomeration, 164 Air Transport Users Council, 419 Airline industry, 46, 73, 191, 226, 235, 418–422 Alliance dissolution, 205, 215–217 Alliance formation, 200–202, 207, 404–408 Alliances. See Strategic alliances and networks American Jobs Creation Act of 2004, 429 Anchored replicators, 265 Anglo-American capitalism, 15–16 Anglo-American governance systems, 345 Anna Karenina (Tolstoy), 198 Anti-failure bias, 144–146 Antidumping, 237–241, 249 Antiglobalization protests, 21, 23 Antitrust issues, 226, 236, 239, 456–459 Arab Spring, 28 Arm’s-length transaction, 99 The Art of War (Sun Tzu), 10

Attack on hotel in Mumbai, 66–67 Attacks, 241–242 Australia, 6, 33, 433 snow-sports industry, 431–435 Statewide Technology Incubation Strategy, 431

Austria, 111 Automobile industry bailout of, 72 electric cars, 361–362 mass market cars, 51 strategic groups, 51

B Backward integration, 42 Balanced scorecard, 18 Bankruptcy, 145 Baosteel Education Fund, 466 Barbarians at the Gate, 353 Barclay Capital, 462 Bargaining power of buyers, 41–42, 130 of suppliers, 41, 130

Base of the pyramid (BOP), 7–8 Behavior controls, 271 Beijing Consensus, 348 Belgium, 12 Benchmarking, 68 Berlin Wall, fall of, 404, 405 Best practices, 343 Beyer CropScience, 321 Big ticket items, 38 Binding international commercial arbitration

(BICA), 97 Blue ocean strategy, 244 Blurred boundaries, 48–49 Boards of directors, 398, 400 composition of, 334 directing strategically, 335–336 interlocks, 334–335 leadership structure, 334 role of, 335

Born global firms, 140, 435 BOT (build-operate-transfer)

agreements, 175 Bounded rationality, 104 Branding, 408 Brazil, 5–6, 97, 105, 278, 448–455, 467 airline industry, 209–210

517 Copyright 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).

BRIC, 7, 17, 102–103 politics of, 75

bribes, 111 BRIC (Brazil, Russia, India, China), 7, 17, 102–103 Britain, 42, 97 Build-operate-transfer (BOT) agreement, 175 Bureaucratic costs, 273 Burundi, 133 Business groups, 259–260, 272 Business-level strategies, 260 for competitive dynamics

attacks and counterattacks, 241–244 comprehensive model for, 225–241 cooperation and signaling, 245 debates and extensions for, 247–249 implications for action, 249–251 local firms versus multinational enterprises, 245–247 strategy as action concept, 224–225

for entrepreneurial firm growth and internationalization comprehensive model for, 129–132 debates and extensions for, 142–146 entrepreneurial firms and, 128–129 financing and governance, 136–137 growth, 134 harvest and exit, 138–139 implications for action, 146 innovation, 134–135 internationalization, 140–142 network, 136

for foreign market entries 2W1H model, 163–176 comprehensive model for, 159–163 debates and extensions for, 177–179 implications for action, 179–180 liability of foreignness, 156–157 propensity to internationalize, 158–159

for strategic alliances and networks comprehensive model for, 191–200 debates and extensions for, 208–211 defined, 190 evolution of, 200–206 formation of, 200–203 implications for action, 211–213 performance of, 206–208

Business process outsourcing (BPO), 79, 409–410 Business unit HQ, 308 “Buy American” policy, 21 Buyers, bargaining power, 41–42, 130

C Canada, 131 Capabilities. See Resource capabilities and leverage Capacity to punish concept, 228 Capitalism, 367, 382

Captive sourcing, 70 Cartels, 226, 229–230 Causal ambiguity, 73 Center for Digital Democracy, 119 Centers of excellence, 299 Central Intelligence Agency, 379 CEO duality, 334 CEOs (chief executive officer), 327, 400 Chapter 11 bankruptcy, 146, 155, 191, 192 Chief executive officers (CEOs), 327, 400 China, 16, 20–21, 97, 103, 110, 157, 288, 381, 412

Antimonopoly Law (2008), 239 automobile industry, 7–8, 86, 170, 199, 300 BRIC, 7, 17, 102–103 computer industry, 27–28 corporate social responsibility (CSR), 466 electronics industry, 7–8, 52 global strategy in, 5–6 human rights in, 28 luxury goods industry, 58 mergers and acquisitions (M&As), 189–190, 199 mobile phones, 247 multinational enterprises (MNEs) and, 288, 349 outward foreign direct investment (OFDI), 103 piano companies, 182 restaurant industry, 189, 391–403 solar power industry, 424–430 state-owned enterprises (SOEs), 347, 466 steel industry, 465–470 textbook industry, 16

“Chinatown buses,” 155 Classic conglomerates, 266 Clayton Act (1914), 237, 457 Clear boundaries, 48–49 Co-marketing, 175, 191 Code of Corporate Conduct 2002, 344 Codes

of conduct, 108, 344, 375–376 of corporate governance, 344

Cognitive pillars, 95, 199–200 Collaborative capabilities, 196 Collectivism, 91, 92, 106 Collusion, 225–226, 228, 237 Commercialising Emerging Technologies (COMET), 433 Committee on Foreign Investment in the United

States (CFIUS), 349 Commoditization, 68 Commonwealth of Independent States (CIS), 157 Competition management, 413, 421, 424–430

vs. antidumping, 238–240 vs. collusion, 225–226 debates and extensions for, 49 clear vs. blurred boundaries of industry, 48–49 five forces vs. a sixth force, 50 industry rivalry vs. strategic groups, 48–49, 51

518 INDEX OF SUBJECTS

industry-specific vs. firm-specific and institution-specific determinants of performance, 54

integration vs. outsourcing, 52–54 stuck in the middle vs. all rounder, 50–51 threats vs. opportunities, 49

five forces framework, 35–37 bargaining power of buyers, 41–42 bargaining power of suppliers, 41 intensity of rivalry among competitors, 35–38 lessons from, 43, 43T threat of potential entry, 38–41 threat of substitutes, 42–43

generic strategies, 45–48 cost leadership, 45 differentiation, 47 focus, 47–48 lessons from, 48

Competition policy, 236 Competitive dynamics management

attacks and counterattacks, 241–244 comprehensive model for industry-based considerations, 225–231 institution-based considerations, 236–241 resource-based considerations, 231–236

cooperation and signaling, 245 debates and extensions for competition versus antidumping, 249 strategy versus IO economics and antitrust policy, 247–248

defined, 224 implications for action, 249–251 local firms versus multinational enterprises, 245–247, 460–461 strategy as action, 224–225

Competitor analysis, 224, 233 Competitor rivalry, 35–36, 368 Complementary assets, 74 Complementors, 50 Computer and Communication Industry Association, 456 Concentrated ownership, 328 Concentration ratios, 228 Conduct codes, 35, 344 Conglomerates and conglomeration, 259–260, 262, 276–277 Conscious capitalism, 372, 385–386 Conscious leadership, 385 Constellations, 190 Contender strategies, 247 Contractual agreements, 172, 175 Contractual alliances, 190, 191 Cooperation and signaling, 245 Copenhagen Accord, 381 Corporate culture, 468 Corporate divorce, 205, 215–217 Corporate governance (CG), 400

boards of directors composition of, 334 directing strategically, 335–336

interlocks, 334–335 leadership structure, 334 role of, 335

comprehensive model for industry-based considerations, 340–341 institution-based considerations, 342–344 resource-based considerations, 342

debates and extensions for convergence versus divergence, 345–346 opportunistic agents versus managerial stewards, 345 overview, 344 state ownership versus private ownership, 346–348

defined, 328 governance

combination of mechanisms, 338–339 external mechanisms, 337–338 global perspective on, 339–340 internal mechanisms, 337 overview, 336–337

implications for action, 350–351 managers

principle-agent conflicts, 330–331 principle-principle conflicts, 331–332, 331–333

ownership concentrated versus diffused ownership, 328–329 family ownership, 329 state ownership, 329–330

private equity, 338 privatization, 346–347

Corporate headquarters (HQ), 308–309 Corporate-level strategies, 260 for corporate governance

boards of directors, 334–336 comprehensive model for, 340–344 debates and extensions for, 345–358 governance, 336–340 implications for action, 350–351 managers, 330–332 ownership, 328–330 private equity, 338 privatization, 346–347

for corporate social responsibility comprehensive model for, 368–378 debates and extensions for, 378–380 implications for action, 380–382 stakeholders and, 364–368

for diversification, acquisition, and restructuring, 284–285 combinatorial diversification, 265–266 comprehensive model for, 269–273 debates and extensions for, 283–284 evolution of, 273 geographic diversification, 263–265 implications for action, 284–285 motives for, 277–279 performance of, 280–282

INDEX OF SUBJECTS 519

product diversification, 261–263 terminology, 273, 282

for multinational strategies and structures comprehensive model for, 304–307 cost reduction and local responsiveness, 296–297 debates and extensions for, 314–318 implications for action, 318 knowledge management, 310–314 organizational structures, 300–303 reciprocal relationship between strategy and structure, 304 research & development (R&D), 312–313 strategic choices, 297–300

Corporate marriage, 201, 207 Corporate Rehabilitation Law, 191 Corporate social responsibility (CSR), 448–455, 466 comprehensive model for

industry-based considerations, 368–372 institution-based considerations, 373–378 resource-based considerations, 372–373

debates and extensions for active versus inactive CSR engagement overseas, 379 domestic versus overseas social responsibility, 378–379 pollution haven debate, 380

economic performance puzzle, 373 implications for action, 380–382 stakeholders and

big picture perspective, 363 debate, 365–369 primary stakeholder groups, 364 secondary stakeholder groups, 365

Corruption, 110 Cost leadership, 45 Counterattacks, 241–244 Country managers, 301 Country-of-origin effect, 177 Cross-border M&As, 277, 282, 288–289 Cross-cultural blunders, 108T Cross-listing, 345 Cross-market retaliation, 231 Cross-shareholding, 190, 191 Cruise industry, 39 CSR. See Corporate social responsibility (CSR) Cultural distance, 114–115, 166–167 Cultural emphases. See Institutional, cultural, and ethical emphases Currency hedging, 163 Currency risks, 163 Czech Republic, 6, 8

D Debates and extensions, 48–54 for business-level strategies

competitive dynamics management, 247–249 entrepreneurial firm growth and internationalization, 142–146 foreign market entries, 177–179 strategic alliances and networks, 208–211

for corporate-level strategies corporate governance, 344–348 corporate social responsibility, 378–380 diversification, acquisition, and restructuring, 283–284

for foundation-level strategies industry competition management, 48–54 institutional, ethical, and cultural emphases, 113–116 resource capabilities and leverage, 76–81

for multinational strategies and structures multinational strategies and structures, 315–318

Decision model, 68, 170–171 Defender strategies, 245 Defensive strategies, 112, 374 Diamond industry, 229–230 “Diamond model” by M. Porter, 100 Differentiation, 47 Diffused ownership, 329 Digital piracy, 250 Digital textbooks, 440–447 Direct exports, 141, 172, 174 Dissemination risks, 161 Distance, cultural vs. institutional, 114–115 Diversification, acquisition and restructuring, 258, 261, 282

combining product and geographic, 265–266 comprehensive model for industry-based considerations, 266–269 institution-based considerations, 272–273 resource-based considerations, 269–272

debates and extensions for acquisitions versus alliances, 284 product relatedness versus other forms, 283–284

evolution of, 273 geographic diversification firm performance and, 264–265 limited versus extensive international scope, 263

implications for action, 284–285 motives for, 277–279, 282–283 performance of, 280–282 product diversification firm performance and, 262–263 product-related, 261 product-unrelated, 261–262

terminology, 276–277, 282 Diversification discount, 262 Diversification premium, 262 Dodd-Frank Act of 2010, 343 Dodger strategies, 246 Doing Business (World Bank Survey), 133 Domestic demands, 101 Domestic in-house activity, 69, 70 Domestic markets, 158–159 Dominance, 36 Dominant logic, 283 Downscoping, 282 Downsizing, 282

520 INDEX OF SUBJECTS

Downstream vertical alliances, 194 Dubai, 163, 164 Due diligence, 199 Dumping, 238 Duopolies, 35 Dynamic capabilities, 78

E E-commerce, 436–438 EBITDA (earnings before interest, taxes, depreciation, and

amortization), 332, 405, 416 Economic benefits, 273 Economic Recovery Bill of 2009, 429 Economies of scale, 39, 261 Economies of scope, 262 The Economist, 16, 33, 110 Educational software, 445–446 Educational technology, 440–447 Efficiency seeking firms, 165 Electric vehicle (EV), 361–362, 363 Electronic books (e-books), 38, 440–447 Emergent strategy, 11 Emerging economies, 5–11, 27–28, 32–34, 66, 75, 97, 403, 404–408

China, 58 India, 57–59 piracy, 85

Emerging markets. See Emerging economies

Energy Independence and Security Act (2007), 361 Entering foreign markets. See Foreign market entries Enterprise resource planning (ERP), 135 Entrepreneur-friendly bankruptcy laws, 144–146 Entrepreneurial firm growth and internationalization, 126–153

comprehensive model for, 129f industry-based considerations, 130 institution-based considerations, 133–134 resource-based considerations, 130–132

debates and extensions for anti-failure biases vs. entrepreneur-friendly bankruptcy laws,

144–146 slow internationalizers vs. born global start-ups, 143–144 traits vs. institutions, 142–143

entrepreneurial firms, 128–129 five strategies financing and governance, 136–137 growth, 134 harvest and exit, 138–139 innovation, 134–135 network, 136

implications for action, 146 internationalization strategies for entering foreign

markets, 141 strategies for staying in domestic markets, 141–142 transaction costs, 140

Entry barriers, 38, 130 Environmentalist challenges, 371 Environment management system

(EMS), 377 Environmental Protection Agency

(EPA), 374 Equity-based alliances, 190, 191, 202 Equity modes, 170–174 Ethical emphases. See Institutional, cultural, and ethical emphases Ethical imperialism, 110 Ethical relativism, 110 EU-US Open Skies Agreement, 421 Eurasia, 404–408 Eurasian markets telecom industry, 408

Europe Eurozone, 163

European Aeronautic Defense and Space Company (EADS), 302 European Union (EU), 5, 16, 128 euro crisis, 23

Evergreen Research and Development (ERD) program, 435 Excess capacity, 40 Exit-based governance mechanisms, 336 Explicit collusion, 226 Explicit knowledge, 311 Exploitation, 204 Exploration, 204 Export intermediaries, 142 Exports, 172, 174 Expropriation, 162, 331 Extender strategies, 246 Extensions. See Debates and extensions External governance mechanisms, 338 Extraterritoriality, 238 Exxon Valdez, 366

F Factor endowments, 100 Fair Labor Association, 365 Family ownership, 331, 332 Far-flung conglomerate, 266 Fashion industry, 57–59 Fast-moving industries, 78 FCPA (Foreign Corrupt Practices Act), 111 FDA (Food and Drug Administration), 374 (FDI) foreign direct investment, 5 Federal Communications Commission (FCC), 456, 458 Federal Trade Commission, 112 Feints, 241, 243f Femininity, 106–107 Feng-GUI, 135 Finance Corporation for Industry (FCI), 391 Financial control, 271, 336 Financial resources and capabilities, 65

INDEX OF SUBJECTS 521

Financial synergy, 262 Finland telecom industry, 404–408

Firm-specific determinants of performance, 54

Firm strategy, structure, and rivalry, 100 Firms, 15–18 behavior of, 16–17 scope of, 17 strategic choices, 102 success and failure of, 18 why differ, 15–16

First-mover advantages, 168 Five dimensions of culture, 104 Five forces framework, 35–43, 50, 130 bargaining power of buyers, 41–42 bargaining power of suppliers, 41 foreign market entries and, 160 intensity of rivalry among competitors, 35–38 threat of potential entry, 38–41 threat of substitutes, 42–43

Flexible manufacturing technology, 51 Focus, 47–48 Food and Drug Administration (FDA), 374 Forbearance, mutual, 225 Foreign Corrupt Practices Act (FCPA), 111 Foreign direct investment (FDI), 5, 33, 70, 97, 103, 141, 157, 174, 406 Foreign market entries, 154–185 2W1H aspects

how, 170–176 when, 168–170 where, 163–166

comprehensive model for industry-based considerations, 160 institution-based considerations, 161–163 overview, 159 resource-based considerations, 160–161

debates and extensions global vs. regional geographic diversification, 177–178 liability vs. asset of foreignness, 177 old-line vs. emerging multinationals (OLI vs. LLL), 178–179

implications for action, 179–180 liability of foreignness, 156–157 propensity to internationalize, 158–159 strategic goals and, 165

Foreign portfolio investment (FPI), 344 Foreignness liability concept, 156 Forest Stewardship Council (FSC), 372, 449, 451, 452 Formal institutions, 94 competitive dynamics management, 236–241 corporate governance, 342–343 corporate social responsibility, 373 diversification, 272 foreign market entries, 166

multinational strategies and structures, 307

strategic alliances and networks, 198–199 Formal, rule-based, impersonal

exchanges, 99 Fortune 500, 44 Forward integration, 41 Foundation, 54 Foundation-level strategies. See also Five forces framework

fundamental topics for 21st century, 23–24 firms, 15–18 global nature of, 4–9 global strategy, 19–20 globalization, 20–21 strategy issues, 9, 9–14

for industry competition management debates and extensions, 48–54 defined, 34–35 generic strategies, 45–48 implications for action, 54–55

for institutional, cultural, and ethical emphases corruption and, 110, 110–111 debates and extensions for, 113–115 defined, 94 five dimensions of, 105–107 implications for action, 115–116 managing overseas, 93, 109 reduction of uncertainty, 98–100 role of, 95 strategic choices and, 104–105, 107–108, 111–112 strategic response framework for, 111–113 view of business strategy, 100–101

for resource capabilities and leverage debates and extensions for, 76–81 implications for action, 81–83 understanding, 64–65 value chain and, 67–71 VRIO framework, 71–76

Four Tigers, 21 FPI (foreign portfolio investment), 344 France, 12, 16, 42, 111 Franchising, 141, 175, 191 Franco-Prussian War, 12 Fukushima nuclear power station, 366 The Full Monty, 378

G GAAP (generally accepted accounting principles), 240 Gambits, 242, 244f Game theory, 226 Gaming industry, 412–417 Generally accepted accounting principles (GAAP), 240 Generic strategies, 45–48

cost leadership, 45

522 INDEX OF SUBJECTS

differentiation, 47 focus, 47–48 lessons from, 48

Geographic area structures, 301 Geographic diversification, 261, 263–265 Germany, 12, 14, 16, 40, 111, 467

bankruptcy in, 38, 145 solar technology industry, 424–430

Global account structures, 317 Global activities, 466 Global mandate, 299 Global matrix, 302–303 Global Positioning System (GPS), 432 Global product division, 302 Global recession, 410 Global Reporting Initiative (GRI), 449 Global standardization strategy, 298–299, 311 Global start-ups, 431–435 Global strategies, 3, 5, 9, 19, 435

business-level strategies for competitive dynamics, 224–230 for entrepreneurial firm growth and internationalization, 126–147 for strategic alliances and networks, 190–213

corporate-level strategies for corporate governance, 324–348 for corporate social responsibility, 363–382 for diversification, acquisition, and restructuring, 265–284

corporate-level strategies (corporate strategy) for multinational strategies and structures, 296–318

for foreign market entries, 159–179 foundation-level strategies fundamental topics for, 4–24 for industry competition management, 32–61 for institutional, cultural, and ethical emphases, 94–116 for resource capabilities and leverage, 64–83

Global Strategy Group, 295 Global sustainability, 364 Global virtual teams, 314 Globalization, 20

in the 21st century, 23–24 debate about, 23 overview, 20–21 pendulum view on, 20–21 semiglobalization, 22 views of, 24T

Golden parachute, 327 Government sponsored enterprises (GSEs), 347 Grameen Project, 149 Great Depression, 346 Great Recession, 21, 46, 47, 57–58, 63, 95, 144, 157, 179, 295, 382 Greece, 197 Green energy, 429 Greenfield operations, 173, 176, 182–183 Greenpeace, 365, 370, 375, 449 Growth strategies, 134

H Hammock and leisure furniture industry, 449 Hart-Scott-Rodino (HSR) Act of 1976, 237 Harvest strategies, 138–139 Hawaii, 43 Headquarters (HQ), 308–309 Health care industry, 44 Hedging, 163 High School Musical, 100, 269 High-volume low-margin approach, 45 HIV/AIDS drugs, 192, 370 Hofstede dimensions of cultures, 104–106 Home replication strategies, 297–298, 311 Hong Kong, 6, 21 Disneyland in, 460–461

Hope schools, 466 Horizontal alliances, 194 Horizontal M&As, 276 Hostile M&A’s, 277 HQ (Headquarters), 308–309 HSR (Hart-Scott-Rodino) Act of 1976, 237 Hubris, 279 Human resource management (HRM), 65, 419, 469 The Hunt for Red October, 203 Hypercompetition, 78

I ICQ instant messaging software, 134 i.Lab, 431 Imitability competitive dynamics management, 232 corporate social responsibility, 372 diversification, 269 foreign market entries and, 161 multinational strategies and structures, 306 resource capabilities and leverage, 72–74 strategic alliances and networks, 197–198

Imperialism, ethical, 110 Implications for action, 54–55 for business-level strategies

strategic alliances and networks, 211–213 competitive dynamics management, 224–225 for corporate-level strategies

corporate governance, 350–351 diversification, acquisition, and restructuring, 284–285 multinational strategies and structures, 318

entrepreneurial firm growth and internationalization, 146 foreign market entries and, 179–180 for foundation-level strategies

industry competition management, 54–55 resource capabilities and leverage, 81–83

for institutional, cultural, and ethical emphases, 115–116 In-group members, 114 In-house production, 69 Inactive CSR engagement overseas, 379

INDEX OF SUBJECTS 523

Incumbents, 38, 54 Independent directors, 334 India, 5–7, 86, 103, 288 automobile market in, 7 BRIC, 7, 17, 102–103 business acquisitions in, 288–289 business process offshoring (BPO) industry, 409–410 multinational enterprises (MNEs) and, 288 offshoring to, 79 retail industry in, 32–34, 41

Indirect exports, 142, 174 Individualism, 106 Indonesia, 110 Industrial and Commercial Finance Corporation (ICFC), 391 Industrial organization (IO) economics, 34, 247–248 Industry, 34 Industry-based considerations for business-level strategies

competitive dynamics management, 225–231 entrepreneurial firm growth and internationalization, 130 foreign market entries, 160 strategic alliances and networks, 193–194

for corporate-level strategies corporate governance, 340–341 corporate social responsibility, 368–372 diversification, acquisition and restructuring, 266–269 multinational strategies and structures, 304–306

Industry-based view, 49 debates and extensions for

five forces vs. a sixth force, 50 industry-specific vs. firm-specific and institution-specific determinants of performance, 54

integration vs. outsourcing, 52–54 stuck in the middle vs. all rounder, 50–51 threats vs. opportunities, 49

Industry competition management, 32–61, 48–49 debates and extensions for, 49

clear vs. blurred boundaries of industry, 48–49 five forces vs. a sixth force, 50 industry rivalry vs. strategic groups, 51 industry-specific vs. firm-specific and institution-specific determinants of performance, 54

integration vs. outsourcing, 52–54 stuck in the middle vs. all rounder, 50–51 threats vs. opportunities, 49

generic strategies, 45, 45–48 cost leadership, 45 differentiation, 47

focus, 47–48 lessons from, 48

Industry positioning, 43 Industry rivalry, 51 Industry-specific determinants of performance, 54 Industry-specific restrictions, 33 Informal institutions, 94

corporate governance, 343–344 corporate social responsibility, 373 diversification, acquisition and restructuring, 272–273 entrepreneurial firm growth and internationalization, 130 institutional, ethical, and cultural emphases, 93 multinational strategies and structures, 307 strategic alliances and networks, 199–200

Informal, relationship-based, personalized exchange, 98, 98f Information asymmetries, 330 Information overload, 18 Initial public offerings (IPOs), 139, 394 Inner Mongolia, 392 Innovation, 85, 86 Innovation entrepreneurship strategies, 134–135 Innovation resources and capabilities, 65 Innovation seeking firms, 165 Inside directors, 334, 335 Insourcing, 70 Institution-based considerations, 418–422, 428–429

for business-level strategies competitive dynamics management, 236–241 entrepreneurial firm growth and internationalization,

133–134 foreign market entries, 161–163 strategic alliances and networks, 199–200

for corporate-level strategies corporate governance, 342–344 corporate social responsibility, 368–372 diversification, acquisition and restructuring, 272–273 multinational strategies and structures, 307, 309–310

Institution-based views, 94, 102f Institution-specific determinants of performance, 54 Institutional, cultural, and ethical emphases

corruption and, 110, 110–111 debates and extensions for cultural distance vs. institutional distance, 114–115 opportunism vs. individualism/collectivism, 113–114 origin of unethical business

behavior, 115 defined, 94 five dimensions of, 105–107 implications for action, 115–116 institution-based views core propositions of, 102, 104–105 overview, 100–101

managing overseas, 109, 110 reduction of uncertainty, 98–100 role of, 95

524 INDEX OF SUBJECTS

strategic choices and, 104–105, 107–108 strategic response framework for, 111–113

Institutional distance, 115, 165 Institutional framework, 94 Institutional relatedness, 284 Institutional transactions, 100 Institutions, 94

dimensions of, 95T reduction of uncertainty, 98–100 strategic choices, 102 vs. traits, 142–143

Intangible resources and capabilities, 65 Integration, 52–54, 462 Integration-responsiveness framework, 296, 298 Intellectual property rights (IPR), 27, 161, 392, 431, 435 Intended strategies, 11 Intercity bus travel, 154–155 Interfirm rivalry, 130 Interlocking directorates, 334–335 Internal capital markets, 262 Internal governance mechanisms, 338 Internalization, 173 Internalization advantage, 173 International diversification, 263 International division structure, 300–301 International entrepreneurship, 128 International Gaming Awards (IGA), 416 International joint venture (IJV), 448–455, 452 International marketing, 452 International safety certification (GS), 451 International Standards Organization (ISO), 377 Internationalization. See Entrepreneurial firm growth and

internationalization Internet, 131, 420, 436–438 Intra-African trade, 167 IO (industrial organization) economics, 34, 247–248 IPOs (initial public offerings), 139, 149 IPR (intellectual property rights), 27, 161 Iraq, 40, 132 Irish Department of

Transportation (DOT), 421 Islamic finance, 170 ISO (International Standards

Organization), 377 Israel, 134, 135 IT industry, 63, 70, 409 Italy, 16 ITT, 379

J Japan, 5–6, 16, 39, 40, 53, 105, 462

airline industry, 73, 191 automobile industry, 193 bankruptcy in, 38, 145 bookselling industry in, 54

collectivism, 92 earthquake in, 23, 366, 369 internet commerce in, 127 layoffs and, 91 luxury goods industry, 58

Jasmine Revolution, 28 Joint ventures (JVs), 171, 175, 190, 191

246, 448–455

K keiretsu, 16, 53, 168, 193 Knowledge management, 310–311 Korea, 16, 39 Korean Ministry of Education, Science and Technology (MEST), 443 Kung Fu Panda, 86 Kyoto Protocol (2007), 381

L Late-mover advantages, 168–169 Latin America, 21 Learning. See Multinational strategies and structures Learning by doing, 200 Learning race view, 196 Leveraged buyouts (LBOs), 338 Licensing, 141, 175, 191 Linkage, leverage, and learning (LLL) framework, 178, 179 Local content requirements, 162 Local firms, 245–247, 460–461 Local responsiveness, 296 Localization strategies, 297–298, 311 Location-specific advantages

and goals, 163–166 London Stock Exchange, 127 Long-term orientation, 107 Love Boat (ABC), 39 Low-cost rivals, 46, 234–236, 253–254 Low-volume high-margin approach, 47 Luxury automobiles, 51 Luxury goods industry, 57–59

M M&As. See Mergers and acquisitions (M&As) Macau, 412–417 Managerial human capital, 342 Managerial stewards, 345 Marginal bureaucratic costs (MBCs), 273 Marginal economic benefits (MEBs), 273 Market commonalities, 231 Market seeking firms, 165 Masculinity, 106–107 Mass customization, 51 MBCs (marginal bureaucratic costs), 273 MEBs (marginal economic benefits), 273 Merchant of Venice (Shakespeare), 145

INDEX OF SUBJECTS 525

Mergers and acquisitions (M&As), 191, 276, 337–338, 354, 404–408, 465–470

in China, 288–289 defined, 277 mobile phone industry, 456–459 performance of, 280–283, 464

Mexico, 6, 19 Micro-macro link, 314 Microfinance, 138, 149–150 Microfinance institutions (MFIs), 149 Middle-of-the-road approaches, 110 Military strategy, 12 Minority shareholders, 331, 332, 342–343 MNEs. See Multinational enterprises (MNEs) Mobile phone industry, 456–459 Mobility barriers, 52 Modes of entry, 170–176 Monopolies, 35 Moral hazard, 347 Moscow Municipality Government, 198 Multi-brand stores, 33 Multidomestic strategies, 297–298, 311 Multimarket competition, 225 Multinational enterprises (MNEs), 9, 21, 85, 86T, 103–104, 157, 174,

264, 288–289, 379, 380, 404–408 defined, 5 emerging, 85–86 geographic diversification by sales, 178 versus local firms, 245–247, 460–461 outward foreign direct investment (OFDI), 103

Multinational replicators, 265 Multinational strategies and structures comprehensive model for

industry-based considerations, 304–306 institution-based considerations, 307, 309–310 resource-based considerations, 306–307

cost reduction and local responsiveness, 296–297 debates and extensions for

corporate controls versus subsidiary initiatives, 315–316 integration, responsiveness, and learning, 317–318 one multinational versus many national companies, 315 overview, 314–315

implications for action, 318 knowledge management, 310–312, 313–314 organizational structures, 300–303 reciprocal relationship between strategy and

structure, 304 research & development (R&D), 312–313 strategic choices, 297–300

Music industry, 43 Mutual forbearance, 225

N NAFTA markets, 263 NASDAQ, 6, 127, 143, 350, 404, 438

National Medal of Science, 63 National Medals of Technology, 63 Natural resource seeking firms, 165 Nepal, 407 Netherlands, 6, 42, 111 Network centrality, 197 Network externalities, 40 Networks. See Strategic alliances and networks New York Stock Exchange, 315, 342, 433 New Zealand, 43 Newness liability concept, 136 NGOs (nongovernmental organizations), 23, 370, 372, 377, 379 Non-equity based alliances, 190, 191, 202T Non-equity modes, 171 Non-operating entities (NOEs), 223 Non-scale-based advantages, 40 Non-shareholder stakeholders, 363 Nongovernmental organizations (NGOs), 23, 370, 372, 377, 379 Nontariff barriers, 162 Normative pillars, 94, 199–200

O Obsolescing bargain, 161 Occupy London, 344 Occupy Wall Street, 23, 344, 354, 366, 382 OECD (Organization for Economic Cooperation and Development),

111, 259, 344 OEMs (original equipment

manufacturers), 80 OFDI, 103 Offshoring, 70, 79, 409–410 Oil Majors, 316 Oil Shocks of 1973-74 and 1979-80, 316 OLI (ownership-location-internalization) advantages, 173–174 Oligopolies, 35 Online media, 43 Online moderators, 131 Onshoring, 70 OPEC, 160 Open innovation, 313 Operational synergy, 261 Opportunism, 97, 196, 203 Organization

competitive dynamics management, 232 corporate social responsibility, 373 diversification, 269 multinational strategies and structures, 306 resource capabilities and leverage, 74–76 strategic alliances and networks, 198

Organization for Economic Cooperation and Development (OECD), 344

Organizational culture, 306–307 Organizational fit, 281, 462–463 Origin of strategy, 10 Original brand manufacturers (OBMs), 80

526 INDEX OF SUBJECTS

Original design manufacturers (ODMs), 80 Original equipment manufacturers (OEMs), 80 Out-group, 114 Output control, 271, 336 Outside directors, 334, 335 Outsourcing, 6, 9, 69–70, 175

defined, 69 versus integration, 52–54

Outward foreign direct investment (OFDI), 103, 104 Ownership, 52 Ownership advantage, 173 Ownership-location-internalization (OLI) advantages, 173–174

P Pakistan, 95, 96, 107 Partner opportunism, 196 Partner rarity, 196 Patenting, 223–224, 253–254, 435 Pendulum view on globalization, 21 Pentium chip, 134 Perfect competition, 34 Performance, 19, 35, 207, 414–415, 420 Pharmaceutical industry, 44 Physical resources and capabilities, 65 Piano companies, 182 Piracy, digital, 250 PMCs (private military companies), 132–133 Poland, 168–169 Political deadlocks, 95 Politics, 75 Pollution, 368–369, 373, 375, 380, 381 Porter diamond model, 100, 101 Power distance, 104 Predatory pricing, 238 Price leaders, 228 Primary stakeholder groups, 364 Principals, 330 Principle-agent conflicts, 330 Principle-principle conflicts, 331 Prisoner’s dilemma, 225–227 Privacy issues, 119–120 Private equity, 338, 346, 353–355, 391–403, 436 Proactive strategies, 112, 376 Product differentiation, 40 Product diversification, 261

combining with geographic diversification, 265–266 defined, 261 firm performance and, 262–263 product-related, 261 product-unrelated, 261–262

Product proliferation, 40 Product-related diversification, 261 Product-related versus unrelated diversification, 261–262 Proprietary technology, 40 PRPG America, 173

Public opinion of globalization, 23–24 Pyramid, base of the (BOP), 7, 7–8

Q Quality certification (ISO), 451

R Race to the bottom debate, 380 Races, learning, 194 Rarity competitive dynamics management, 232 corporate social responsibility, 372 diversification, 269 multinational strategies and structures, 306 resource capabilities and leverage, 72 strategic alliances and networks, 196–197

Reactive strategies, 112, 374 Real options, 195 Rebranding, 177 Reduction of uncertainty, 95 Refocusing, 282 Regional geographic diversification, 177–178 Regional managers, 301 Regulatory pillars, 94, 198–199 Regulatory risks, 161 Related and supporting industries, 100 Related transactions, 333 Relational capabilities, 196 Relational contracting, 98 Relationships. See Strategic alliances and networks Relativism, ethical, 110 Renewable energy, 425 Replication, 13 Reputation resources and capabilities, 65 Research and development (R&D), 47 Research and development (R&D)

contracts, 175, 191 Resource-based considerations, 418–422 for business-level strategies

competitive dynamics management, 231–236 entrepreneurial firm growth and internationalization, 130–132 foreign market entries, 160–161 strategic alliances and networks, 194–195, 197–198

for corporate-level strategies corporate governance, 342 corporate social responsibility, 372–373 diversification, acquisition and restructuring, 269–272 multinational strategies and structures, 306–307

Resource-based view, 64 Resource capabilities and leverage debates and extensions for

domestic resources vs. international (cross-border) capabilities, 81

firm-specific vs. industry-specific determinants of performance, 76–77

INDEX OF SUBJECTS 527

offshoring vs. non-offshoring, 79, 79–81 static resources vs. dynamic capabilities, 77–78

implications for action, 81–83 understanding, 64–65 value chain and, 67–71 VRIO framework

imitability, 72–74 organization, 74–76 rarity, 72 value, 71–72

Resource similarity, 231–232 Resources, 64 Restaurant industry, 391–403 Restructuring. See Diversification, acquisition and restructuring Reverse innovation, 7–9 RFID technologies, 432 Risk management, 22, 435 Rule of law, 97 Russia, 6, 16, 97–98, 103, 198 BRIC, 7, 17, 102–103 Code of Corporate Conduct 2002, 344 internet commerce in, 127–128, 436–438 oil industry, 199 state-owned enterprises (SOEs), 347

S Santiago Principles, 350 Sarbanes-Oxley (SOX) Act of 2002, 336, 342–343, 354 SARS epidemic, 46 Scale-based advantages, 39 Scale economies, 261 Scale of foreign market entries, 170–171 Scenario planning, 22 Schlieffen Plan, 12 Scope economies, 262 Secondary stakeholder groups, 365 Semiglobalization, 22 SEPA-Dow National Cleaner Production Pilot, 381 Separation of ownership and control, 329 September 2001 terrorist attacks, 21, 113–114 Serial entrepreneurs, 143 Servant leadership, 386 Sex role differentiation, 105–106 Shanghai Stock Exchange, 465 Shareholder capitalism, 339, 343, 365 Shareholders, 332 Sherman Act of 1890, 226, 237, 248 Sierra Leone, 133 Singapore, 6, 21 Single business strategies, 261 “Six Sigma” quality management system, 466 Ski resorts, 431 Slovakia, 6 Slow-moving industries, 78 Small and medium-sized enterprises (SMEs), 128, 135, 142

Smartphones, 43, 253–254 SMEs (small and medium-sized enterprises), 135, 142 Snow sports industry, 431–435 Social complexity, 74 Social issue participation, 372 Social networking, 119–120 SOEs (state-owned enterprises), 162, 289, 329–330, 346–348 Solar power industry, 428 Solar technology industry, 424–430 Solar Technology International, 425 Solutions-based structures, 317 South Africa, 7, 167

diamond industry, 229 emerging multinationals from, 167 internationalization of firms from, 167

South Korea, 14, 21, 259–260, 440–447 digital tablets, 440, 445–446 modernizing education, 443–444

South Korean Ministry of Education (MOE), 440, 443 Sovereign wealth funds (SWFs), 348, 349 Soviet Union (former), 21

collapse of, 405. See also Russia SOX (Sarbanes-Oxley) Act of 2002, 336, 342–343, 354 Spain, 42 Spiderman, 100 Stage models, 144 Stakeholders, 18 Start-up business, 431–435, 436–438 The Start-Up Nation (Senor and Singer), 135 State Environmental Protection Administration

(SEPA) of China, 381 State-owned enterprises (SOEs), 162, 289, 329–330, 346–348, 465,

466 Steel industry, 465–470 Stewardship theory, 345 Stockholm Chamber of Commerce (SCC), 97 Strategic alliances and networks, 190

comprehensive model for industry-based considerations, 192–194 institution-based considerations, 198–199 resource-based considerations, 195–198

debates and extensions for acquiring vs. not acquiring alliance partners, 211 alliances vs. acquisitions, 209–210 majority vs. minority JVs, 208–209

defined, 190–191 evolution of combating opportunism, 203 from corporate marriage to divorce, 189, 205–206, 212 overview, 200 from strong ties to weak ties, 203–205

formation of contract or equity, 200–202 market transactions vs. acquisitions, 200 positioning relationships, 202–203

528 INDEX OF SUBJECTS

implications for action, 211–213 performance of overview, 206–207 parent firms, 207–208

Strategic ambidexterity, 75 Strategic choices, 102, 107 Strategic control, 271 Strategic fit, 281, 462–463 Strategic groups, 51, 52 Strategic implications for action. See Implications for action Strategic investment, 190, 191 Strategic management, 10 Strategic networks, 190 Strategic planning, 316, 398, 399 Strategic positioning, 466 Strategic response framework, 111–112 Strategies, 10. See also names of specific strategies

fundamental questions in, 15 localization, 297–298, 311 overview, 14f tripod of, 11, 16, 16f versus IO economics and antitrust policy, 247–248

Strategy as action school, 11, 225f Strategy as integration school, 11 Strategy as plan school, 10 Strategy as theory, 11, 12 Strategy formulation, 11 Strategy implementation, 11 Strong ties, 136 Structure-conduct-performance

(SCP) model, 35 Sub-Saharan Africa, 167 Subsidiaries, 424–430, 467, 468

partially owned, 172 wholly owned, 173

Subsidiary initiatives, 316, 317, 321–322 Substitutes, 42, 130, 422

threat of, 42–43, 57 Suicides, 6 Sunk costs, 162 Suppliers, bargaining power of, 41 Survival rates, start-up businesses, 137 Sustainable capitalism, 364 Sweden, 406 Switzerland, 158 SWOT analysis, 11, 34, 64 Synergy

financial, 262 operational, 261

T Tablet PCs, 440–447 Tacit collusion, 226 Tacit knowledge, 311

Taiwan, 5, 6, 21 Tangible resources and capabilities, 65 Tariff barriers, 162 Technological resources and capabilities, 65 Technology start-ups, 436, 437 Telecom industry, 404–408 Television broadcasting industry, 234 Terrorism, 21, 66–67, 113–114 Textbook publishing industry, 4, 16, 440 Threats (T) of potential entry, 38 of substitutes, 42–43 turning to opportunities, 49, 460–461

Thrusts, 241, 243f Top management teams (TMTs), 15, 330–331, 398, 400, 401 Trade barriers, 162 Traits, 142–143 Transaction costs, 95 Transnational strategy, 298, 299–300, 311 Treaty of Westphalia, 315 Triad, 5 Triple bottom line, 18 Tunneling, 333 Turnkey projects, 175, 191

U Ultra-luxury car market, 51 UN Declaration on Human Rights, 379 Uncertainty, 95, 98–100, 107 Unethical business behavior, 110 United Arab Emirates, 164 United Kingdom, 9, 15 United Nations, 379 United States, 6, 8, 15, 42, 97, 105 antitrust laws, 456–459 antitrust laws in, 230, 237 automobile market in, 7 bankruptcy in, 191 chemical industry, 374, 375 Congress, 132 Department of Commerce, 240 Department of Justice, 228 environmental policies, 455 Federal Trade Commission (FTC), 119 intercity bus travel in, 155–156 International Trade Administration, 240 International Trade Commission, 240 snow-sports industry, 433 solar power industry, 425, 427, 428 State Department, 132, 215 television broadcasting industry, 234

United States et al. v. AT&T Inc. et al., 457, 458 Universal Product Code (UPC), 63 Upstream vertical alliances, 193

INDEX OF SUBJECTS 529

US-China Strategic and Economic Dialogue (S&ED), 349 US Department of Justice (DOJ), 457, 458 US Securities and Exchange Commission, 436

V Value, 130 competitive dynamics management, 231–232 corporate social responsibility, 371, 372, 376, 382 creating shared, 367 diversification, 269 foreign market entries, 160 multinational strategies and structures, 306 resource capabilities and leverage, 71–72 strategic alliances and networks, 195–196

Value chains, 67–71, 467 Venture capitalists (VCs), 137 Vertical M&As, 276 Voice-based mechanisms, 336 VRIO framework, 71, 71f, 76, 82, 130, 342 competitive dynamics management, 231–232 corporate social responsibility, 372–373 diversification, acquisition and restructuring, 269, 269–272 foreign market entries, 160–161

multinational strategies and structures, 306

resource capabilities and leverage, 71–76 strategic alliances and networks, 194–198

VTB Group, 348

W “Wal-Mart effect,” 34 Wall Street Journal, 16 Washington Consensus, 347, 348 Watson artificial intelligence, 63 Weak ties, 136 Wealth of Nations (Smith), 225 Wholly owned subsidiary (WOS), 176, 456–459 Wi-Fi, 432 World Bank, 21, 133, 347 World War I, 12 World War II, 21 Worldwide mandate, 299

Y Y2K problem, 85

530 INDEX OF SUBJECTS

About the Author��
Brief Contents
Contents��
Preface��
Part 1: Foundations of Global Strategy��

Ch 1: Strategizing around the Globe

Knowledge Objectives
Opening Case: The Global Strategy of Global Strategy��
A Global Global-Strategy Book��
Why Study Global Strategy?��
What is Strategy?��
Fundamental Questions in Strategy��
What is Global Strategy?��
What is Globalization?��
Global Strategy and the Globalization Debate��
Organization of the Book��
Chapter Summary��
Key Terms��
Critical Discussion Questions��
Topics for Expanded Projects��
Closing Case: Emerging Markets: Microsoft's Evolving China Strategy
Notes��

Ch 2: Managing Industry Competition��

Knowledge Objectives
Opening Case: Emerging Markets: Competing in the Indian Retail Industry��
Defining Industry Competition��
The Five Forces Framework��
Three Generic Strategies��
Debates and Extensions��
The Savvy Strategist��
Chapter Summary��
Key Terms��
Critical Discussion Questions��
Topics for Expanded Projects��
Closing Case: Emerging Markets: High Fashion Fights Recession��
Notes��

Ch 3: Leveraging Resources and Capabilities��

Knowledge Objectives
Opening Case: IBM at 100��
Understanding Resources and Capabilities��
Resources, Capabilities, and the Value Chain��
From SWOT to VRIO��
Debates and Extensions��
The Savvy Stategist��
Chapter Summary��
Key Terms��
Critical Discussion Questions��
Topics for Expanded Projects��
Closing Case: Emerging Markets: From Copycats to Innovators
Notes��

Ch 4: Emphasizing Institutions, Cultures, and Ethics��

Knowledge Objectives
Opening Case: Cut Salaries or Cut Jobs?��
Understanding Institutions��
An Institution-Based View of Business Strategy��
The Strategic Role of Cultures��
The Strategic Role of Ethics��
A Strategic Response Framework for Ethical Challenges��
Debates and Extensions��
The Savvy Strategist��
Chapter Summary��
Key Terms��
Critical Discussion Questions��
Topics for Expanded Projects��
Closing Case: Facebook Violates Privacy��
Notes��

Part 2: Business-Level Strategies��

Ch 5: Growing and Internationalizing the Entrepreneurial Firm��

Knowledge Objectives
Opening Case: Emerging Markets: Amazon.com of Russia��
Entrepreneurship and Entrepreneurial Firms��
A Comprehensive Model of Entrepreneurship��
Five Entrepreneurial Strategies��
Internationalizing the Entrepreneurial Firm��
Debates and Extensions��
The Savvy Entrepreneur��
Chapter Summary��
Key Terms��
Critical Discussion Questions��
Topics for Expanded Projects��
Closing Case: Emerging Markets: Microfinance, Macro Success or Global Mess?
Notes��

Ch 6: Entering Foreign Markets��

Knowledge Objectives
Opening Case: Enter the United States by Bus��
Overcoming the Liability of Foreignness��
Understanding the Propensity to Internationalize��
A Comprehensive Model of Foreign Market Entries��
Where to Enter?��
When to Enter?��
How to Enter?��
Debates and Extensions��
The Savvy Strategist��
Chapter Summary��
Key Terms��
Critical Discussion Questions��
Topics for Expanded Projects��
Closing Case: Emerging Markets: Pearl River Goes Abroad��
Notes��

Ch 7: Making Strategic Alliances and Networks Work��

Learning Objectives
Opening Case: Emerging Markets: Yum! Brands Teams Up with Sinopec��
Defining Strategic Alliances and Networks��
A Comprehensive Model of Strategic Alliances and Networks��
Formation��
Evolution��
Performance��
Debates and Extensions��
The Savvy Strategist��
Chapter Summary��
Key Terms��
Critical Discussion Questions��
Topics for Expanded Projects��
Closing Case: Emerging Markets: BP, AAR, and TNK-BP��
Notes��

Ch 8: Managing Global Competitive Dynamics��

Knowledge Objectives
Opening Case: Patent Wars and Shark Attacks��
Strategy as Action��
Industry-Based Considerations
Resource-Based Considerations
Institution-Based Considerations
Attack and Counterattack��
Cooperation and Signaling��
Local Firms versus Multinational Enterprises��
Debates and Extensions��
The Savvy Strategist��
Chapter Summary��
Key Terms��
Critical Discussion Questions��
Topics for Expanded Projects��
Closing Case: Emerging Markets: HTC Fights Apple��
Notes��

Part 3: Corporate-Level Strategies��

Ch 9: Diversifying, Acquiring, and Restructuring��

Knowledge Objectives
Opening Case: Emerging Markets: Corporate Diversification Strategy in South Korean Business Groups��
Product Diversification��
Geographic Diversification��
Combining Product and Geographic Diversification��
A Comprehensive Model of Diversification��
Acquisitions��
Restructuring��
Debates and Extensions��
The Savvy Strategist��
Chapter Summary��
Key Terms��
Critical Discussion Questions��
Topics for Expanded Projects��
Closing Case: Emerging Markets: Emerging Acquirers from China and India��
Notes��

Ch 10: Strategizing, Structuring, and Learning around the World

Learning Objectives
Opening Case: Emerging Markets: Samsung's Global Strategy Group��
Multinational Strategies and Structures��
A Comprehensive Model of Multinational Strategy, Structure, and Learning��
Worldwide Learning, Innovation, and Knowledge Management��
Debates and Extensions��
The Savvy Strategist��
Chapter Summary��
Key Terms��
Critical Discussion Questions��
Topics for Expanded Projects��
Closing Case: A Subsidiary Initiative at Bayer MaterialScience North America��
Notes��

Ch 11: Governing the Corporation around the World

Knowledge Objectives
Opening Case: High Drama at Hewlett-Packard (HP)��
Owners��
Managers��
Board of Directors��
Governance Mechanisms as a Package��
A Global Perspective��
A Comprehensive Model of Corporate Governance��
Debates and Extensions��
The Savvy Strategist��
Chapter Summary��
Key Terms��
Critical Discussion Questions��
Topics for Expanded Projects��
Closing Case: Emerging Markets: The Private Equity Challenge��
Notes��

Ch 12: Strategizing with Corporate Social Responsibility��

Knowledge Objectives
Opening Case: Launching the Nissan Leaf: The World's First Electric Car��
A Stakeholder View of the Firm��
A Comprehensive Model of Corporate Social Responsibility��
Debates and Extensions��
The Savvy Strategist��
Chapter Summary��
Key Terms��
Critical Discussion Questions��
Topics for Expanded Projects��
Closing Case: Whole Foods' John Mackey on Conscious Capitalism��
Notes��

Integrative Cases

Integrative Case 1: 3i Group's Private Equity Investment in China's Little Sheep

3i Group PLC
Entrepreneurial Beginnings of Inner Mongolia Little Sheep Catering Chain Co., Ltd.
The Trademark Battle
Rapid Growth and Strategic Re-orientation
Management's Goal
Origin of 3i's Private Equity Deal with Little Sheep
Winning the Mandate
Forming a Strategic Blueprint
Mapping Strategy to Operations: The 180-Day Plan
Strengthening the Management Team and the Board
Creating a Standards Committee
Creating and Executing a New Franchise Strategy
Shelving the International Expansion Plan
Early Results
Conclusions
Case Discussion Questions

Integrative Case 2: TeliaSonera: A Nordic Investor in Eurasia

Merger of Telia & Sonera
Eurasia Expansion
Alliances and Acquisitions in Eurasia
New Branding Strategy
Case Discussion Questions

Integrative Case 3: The Indian Business Process Offshoring Industry

Industry Evolution
The Impact of the Global Recession
Case Discussion Questions

Integrative Case 4: Wynn Macau: Gambling on the Edge of China

The Stage for Competition
Wynn Is Winning
The Cotai Challenge
Case Discussion Questions

Integrative Case 5: Ryanair

Resources and Strategy
Operations
Human Resource Management
Customer Service
Ancillary Revenues
Use of the Internet: Booking, Check-in, and Boarding
Loose Cannon or Astute Strategist
Operating and Financial Performance
Government Regulation
Questionable Practices
Industry and Competition
Future Risks and a Bold Idea
Case Discussion Questions

Integrative Case 6: SolarWorld USA

SolarWorld History
Corporate Financial Performance
Solar Technology
US Solar Power Utilization
US Solar Energy Trade
SolarWorld Products
International Market Conditions
SolarWorld's Resources and Capabilities
Institutional Considerations
Business Decision
Case Discussion Questions

Integrative Case 7: SnowSports Interactive: A Global Start-up's Challenges

History of the Company
The Product/Services
The Industry
The Financial Situation
The Company Strategy
A Global Market for SSI?
Case Discussion Questions

Integrative Case 8: Wikimart: Building a Russian Version of Amazon

Time Line of Financing and Growth
Why Tiger?
Business Model
Company Strategy and Organization
Russia's Internet Industry and Wikimart's Competition
Wikimart's Future
Case Discussion Questions

Integrative Case 9: Texas Instruments in South Korea: An Educational Opportunity

Textbooks: From Paper to Pixels
South Korea: Modernizing Education
TI: A Pioneer in Education
TI Nspire
Software and Content
Conclusion
Case Discussion Questions

Integrative Case 10: Jobek Do Brasil's Joint Venture Challenges

The Hammock and Leisure Furniture Industry
Social and Environmental Certifications
History of Jobek do Brasil
Product Design
The Adoption of the FSC Certification Standard and the Supply of Certified Wood
International Marketing
Production and Distribution
The International Joint Venture with Hatteras
The Crisis and Future Challenges
Case Discussion Questions

Integrative Case 11: The Antitrust Case on the AT&T - T-Mobile Merger

The Merger
The Antitrust Case
The Outcome
Case Discussion Questions

Integrative Case 12: Ocean Park Fights Hong Kong Disneyland

The Arrival of Hong Kong Disneyland
Leveraging Ocean Park's Strengths
Turning a Threat into an Opportunity
Case Discussion Questions

Integrative Case 13: Nomura's Integration of Lehman Brothers' Assets in Asia and Europe

The Opportunity of a Lifetime
Integration Challenges
Postacquisition Performance
Case Discussion Questions

Integrative Case 14: Baosteel Europe

The Making of a Global Corporation
Strategic Positioning and Global Activities
Setting up a Subsidiary in Hamburg, Germany
Business Areas of the Baosteel Subsidiary in Germany
Corporate Culture and Work Atmosphere
Human Resource Management (HRM)
Baosteel Europe Paves the Way for Integration and Expansion
Case Discussion Questions

Integrative Case 15: Bank of America's Corporate Social Responsibility and the Occupy Wall Street Movement

Bank of America's CSR Activities
History
2010 CSR Report: Conflict between Social and Financial Responsibility
The Dilemma Bank of America Faced for 2012 CSR Plan
Case Discussion Questions

Glossary��
Index of Organizations��
Index of Names��
Index of Subjects��

<< /ASCII85EncodePages false /AllowTransparency false /AutoPositionEPSFiles true /AutoRotatePages /None /Binding /Left /CalGrayProfile () /CalRGBProfile (sRGB IEC61966-2.1) /CalCMYKProfile (U.S. Web Coated \050SWOP\051 v2) /sRGBProfile (sRGB IEC61966-2.1) /CannotEmbedFontPolicy /Warning /CompatibilityLevel 1.7 /CompressObjects /Off /CompressPages true /ConvertImagesToIndexed true /PassThroughJPEGImages false /CreateJobTicket false /DefaultRenderingIntent /Default /DetectBlends true /DetectCurves 0.1000 /ColorConversionStrategy /LeaveColorUnchanged /DoThumbnails false /EmbedAllFonts true /EmbedOpenType false /ParseICCProfilesInComments true /EmbedJobOptions true /DSCReportingLevel 0 /EmitDSCWarnings false /EndPage -1 /ImageMemory 524288 /LockDistillerParams true /MaxSubsetPct 1 /Optimize false /OPM 1 /ParseDSCComments true /ParseDSCCommentsForDocInfo true /PreserveCopyPage true /PreserveDICMYKValues true /PreserveEPSInfo true /PreserveFlatness false /PreserveHalftoneInfo false /PreserveOPIComments false /PreserveOverprintSettings true /StartPage 1 /SubsetFonts false /TransferFunctionInfo /Preserve /UCRandBGInfo /Preserve /UsePrologue false /ColorSettingsFile () /AlwaysEmbed [ true ] /NeverEmbed [ true ] /AntiAliasColorImages false /CropColorImages false /ColorImageMinResolution 200 /ColorImageMinResolutionPolicy /OK /DownsampleColorImages true /ColorImageDownsampleType /Bicubic /ColorImageResolution 600 /ColorImageDepth -1 /ColorImageMinDownsampleDepth 1 /ColorImageDownsampleThreshold 1.00000 /EncodeColorImages true /ColorImageFilter /DCTEncode /AutoFilterColorImages false /ColorImageAutoFilterStrategy /JPEG /ColorACSImageDict << /QFactor 0.15 /HSamples [1 1 1 1] /VSamples [1 1 1 1] >> /ColorImageDict << /QFactor 0.15 /HSamples [1 1 1 1] /VSamples [1 1 1 1] >> /JPEG2000ColorACSImageDict << /TileWidth 256 /TileHeight 256 /Quality 30 >> /JPEG2000ColorImageDict << /TileWidth 256 /TileHeight 256 /Quality 30 >> /AntiAliasGrayImages false /CropGrayImages false /GrayImageMinResolution 200 /GrayImageMinResolutionPolicy /OK /DownsampleGrayImages true /GrayImageDownsampleType /Bicubic /GrayImageResolution 600 /GrayImageDepth -1 /GrayImageMinDownsampleDepth 2 /GrayImageDownsampleThreshold 1.00000 /EncodeGrayImages true /GrayImageFilter /DCTEncode /AutoFilterGrayImages false /GrayImageAutoFilterStrategy /JPEG /GrayACSImageDict << /QFactor 0.15 /HSamples [1 1 1 1] /VSamples [1 1 1 1] >> /GrayImageDict << /QFactor 0.15 /HSamples [1 1 1 1] /VSamples [1 1 1 1] >> /JPEG2000GrayACSImageDict << /TileWidth 256 /TileHeight 256 /Quality 30 >> /JPEG2000GrayImageDict << /TileWidth 256 /TileHeight 256 /Quality 30 >> /AntiAliasMonoImages false /CropMonoImages false /MonoImageMinResolution 595 /MonoImageMinResolutionPolicy /OK /DownsampleMonoImages false /MonoImageDownsampleType /Average /MonoImageResolution 1200 /MonoImageDepth -1 /MonoImageDownsampleThreshold 1.50000 /EncodeMonoImages true /MonoImageFilter /CCITTFaxEncode /MonoImageDict << /K -1 >> /AllowPSXObjects true /CheckCompliance [ /None ] /PDFX1aCheck false /PDFX3Check false /PDFXCompliantPDFOnly false /PDFXNoTrimBoxError true /PDFXTrimBoxToMediaBoxOffset [ 0.00000 0.00000 0.00000 0.00000 ] /PDFXSetBleedBoxToMediaBox true /PDFXBleedBoxToTrimBoxOffset [ 0.00000 0.00000 0.00000 0.00000 ] /PDFXOutputIntentProfile (U.S. Web Coated \050SWOP\051 v2) /PDFXOutputConditionIdentifier (CGATS TR 001) /PDFXOutputCondition () /PDFXRegistryName (http://www.color.org) /PDFXTrapped /False /CreateJDFFile false /Description << /ENU (Use these settings to create press-ready Adobe PDF documents for Cengage Learning books using Distiller 8.0.x. The resulting PDF will be compatible with Acrobat 8 $PDF 1.7$ per CL File Preparation and Certification Task Force) >> /Namespace [ (Adobe) (Common) (1.0) ] /OtherNamespaces [ << /AsReaderSpreads false /CropImagesToFrames true /ErrorControl /WarnAndContinue /FlattenerIgnoreSpreadOverrides false /IncludeGuidesGrids false /IncludeNonPrinting false /IncludeSlug false /Namespace [ (Adobe) (InDesign) (4.0) ] /OmitPlacedBitmaps false /OmitPlacedEPS false /OmitPlacedPDF false /SimulateOverprint /Legacy >> << /AllowImageBreaks true /AllowTableBreaks true /ExpandPage false /HonorBaseURL true /HonorRolloverEffect false /IgnoreHTMLPageBreaks false /IncludeHeaderFooter false /MarginOffset [ 0 0 0 0 ] /MetadataAuthor () /MetadataKeywords () /MetadataSubject () /MetadataTitle () /MetricPageSize [ 0 0 ] /MetricUnit /inch /MobileCompatible 0 /Namespace [ (Adobe) (GoLive) (8.0) ] /OpenZoomToHTMLFontSize false /PageOrientation /Portrait /RemoveBackground false /ShrinkContent true /TreatColorsAs /MainMonitorColors /UseEmbeddedProfiles false /UseHTMLTitleAsMetadata true >> << /AddBleedMarks false /AddColorBars false /AddCropMarks true /AddPageInfo true /AddRegMarks false /BleedOffset [ 18 18 18 18 ] /ConvertColors /NoConversion /DestinationProfileName (U.S. Web Coated $SWOP$ v2) /DestinationProfileSelector /UseName /Downsample16BitImages true /FlattenerPreset << /PresetSelector /MediumResolution >> /FormElements true /GenerateStructure false /IncludeBookmarks false /IncludeHyperlinks false /IncludeInteractive false /IncludeLayers false /IncludeProfiles false /MarksOffset 18 /MarksWeight 0.250000 /MultimediaHandling /UseObjectSettings /Namespace [ (Adobe) (CreativeSuite) (2.0) ] /PDFXOutputIntentProfileSelector /UseName /PageMarksFile /RomanDefault /PreserveEditing true /UntaggedCMYKHandling /LeaveUntagged /UntaggedRGBHandling /LeaveUntagged /UseDocumentBleed false >> ] /SyntheticBoldness 1.000000 >> setdistillerparams << /HWResolution [2400 2400] /PageSize [612.000 792.000] >> setpagedevice