Case Study

Mike W. Peng, PhD Jindal Chair of Global Strategy

University of Texas at Dallas

Chair, Global Strategy Interest Group, Strategic Management Society (2008)

Decade Award Winner, Journal of International Business Studies (2015) The Only Global Strategy Textbook Author Listed in

The World’s Most Influential Scientific Minds (2015)

Global Strategy FOURTH EDITION

Australia • Brazil • Mexico • Singapore • United Kingdom • United States

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Global Strategy, Fourth Edition Mike W. Peng

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WCN: 02-300

To Agnes, Grace, and James

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Brief Contents Preface xviii

About the Author xxv

PART 1 FOUNDATIONS OF GLOBAL STRATEGY 1

1 STRATEGIZING AROUND THE GLOBE 2 OPENING CASE:

Emerging Markets: Samsung’s Global Strategy Group 3

CLOSING CASES:

Emerging Markets: Microsoft’s Evolving China Strategy 23

Emerging Markets: Samsung’s Global Strategy Group 25

The Global Strategy of Global Strategy 27

2 MANAGING INDUSTRY COMPETITION 32 OPENING CASE:

Emerging Markets: Competing in the Indian Airline Industry 33

CLOSING CASES:

Emerging Markets: Competing in the Indian Airline Industry 53

Emerging Markets: Competing in the Indian Retail Industry 54

Emerging Markets: High Fashion Fights Recession 56

3 LEVERAGING RESOURCES AND CAPABILITIES 60 OPENING CASE:

Enhancing Value, Rarity, and Inimitability at Burberry 61

CLOSING CASES:

Emerging Markets: From Copycats to Innovators 78

Enhancing Value, Rarity, and Inimitability at Burberry 80

IBM at 100 81

iv

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4 EMPHASIZING INSTITUTIONS, CULTURES, AND ETHICS 86 OPENING CASE:

Emerging Markets: One Rock Formation, Two Countries 87

CLOSING CASE:

Emerging Markets: One Rock Formation, Two Countries 106

PART 2 BUSINESS-LEVEL STRATEGIES 111

5 GROWING AND INTERNATIONALIZING THE ENTREPRENEURIAL FIRM 112 OPENING CASE:

Emerging Markets: The Rise of Alibaba 113

CLOSING CASES:

Emerging Markets: Amazon.com of Russia 130

Emerging Markets: Microfinance, Macro Success or Global Mess? 131

Emerging Markets: The Rise of Alibaba 133

6 ENTERING FOREIGN MARKETS 138 OPENING CASE:

Emerging Markets: SABMiller in Nigeria 139

CLOSING CASES:

Emerging Markets: Pearl River Goes Abroad 160

Emerging Markets: SABMiller in Nigeria 162

Enter the United States by Bus 163

7 MAKING STRATEGIC ALLIANCES AND NETWORKS WORK 168 OPENING CASE:

Emerging Markets: Etihad Airways’ Alliance Network 169

CLOSING CASES:

Emerging Markets: BP, AAR, and TNK-BP (also see Emerging Markets 7.1) 188

Emerging Markets: Etihad Airways’ Alliance Network 191

8 MANAGING GLOBAL COMPETITIVE DYNAMICS 196 OPENING CASE:

Emerging Markets: Emirates Airlines Fights Legacy Airlines 197

CLOSING CASES:

Emerging Markets: Emirates Airlines Fights Legacy Airlines 220

Emerging Markets: HTC Fights Apple 222

Brief Contents v

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PART 3 CORPORATE-LEVEL STRATEGIES 227

9 DIVERSIFYING AND MANAGING ACQUISITIONS GLOBALLY 228 OPENING CASE:

Emerging Markets: Emerging Acquirers from China and India 229

CLOSING CASE:

Emerging Markets: Emerging Acquirers from China and India 251

10 STRATEGIZING, STRUCTURING, AND LEARNING AROUND THE WORLD 258 OPENING CASE:

Emerging Markets: GE Innovates from the Base of the Pyramid 259

CLOSING CASES:

A Subsidiary Initiative at Bayer MaterialScience North America 277

Emerging Markets: GE Innovates from the Base of the Pyramid 279

11 GOVERNING THE CORPORATION AROUND THE WORLD 284 OPENING CASE:

Global Competition in How to Best Govern Large Firms 285

CLOSING CASES:

Emerging Markets: The Private Equity Challenge 306

Emerging Markets: GE Innovates from the Base of the Pyramid 309

12 STRATEGIZING WITH CORPORATE SOCIAL RESPONSIBILITY 316 OPENING CASE:

Emerging Markets: The Ebola Challenge 317

CLOSING CASES:

Emerging Markets: The Ebola Challenge 335

Launching the Nissan Leaf: The World’s First Electric Car 337

Glossary 343

Index 355

vi Brief Contents

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Contents Preface xviii

About the Author xxv

PART 1 FOUNDATIONS OF GLOBAL STRATEGY 1

1 STRATEGIZING AROUND THE GLOBE 2 OPENING CASE:

Emerging Markets: Samsung’s Global Strategy Group 3

A GLOBAL GLOBAL-STRATEGY BOOK 4

WHY STUDY GLOBAL STRATEGY? 7

WHAT IS STRATEGY? 7

Origin 7

Plan versus Action 8

Strategy as Theory 9

FUNDAMENTAL QUESTIONS IN STRATEGY 13

Why Do Firms Differ? 13

How Do Firms Behave? 14

What Determines the Scope of the Firm? 16

What Determines the Success and Failure of Firms Around the Globe? 16

WHAT IS GLOBAL STRATEGY? 17

WHAT IS GLOBALIZATION? 18

Three Views on Globalization 18

The Pendulum View on Globalization 18

Semiglobalization 20

GLOBAL STRATEGY AND THE GLOBALIZATION DEBATE 20

ORGANIZATION OF THE BOOK 22

vii

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CHAPTER SUMMARY 22

CRITICAL DISCUSSION QUESTIONS 23

TOPICS FOR EXPANDED PROJECTS 23

CLOSING CASES:

Emerging Markets: Microsoft’s Evolving China Strategy 23

Emerging Markets: Samsung’s Global Strategy Group 25

The Global Strategy of Global Strategy 27

NOTES 28

2 MANAGING INDUSTRY COMPETITION 32 OPENING CASE:

Emerging Markets: Competing in the Indian Airline 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 37

Bargaining Power of Suppliers 39

Bargaining Power of Buyers 39

Threat of Substitutes 40

Lessons from the Five Forces Framework 41

THREE GENERIC STRATEGIES 41

Cost Leadership 42

Differentiation 42

Focus 44

Lessons from the Three Generic Strategies 44

DEBATES AND EXTENSIONS 44

Clear versus Blurred Boundaries of Industry 44

Threats versus Opportunities 46

Five Forces versus a Sixth Force 46

Stuck in the Middle versus All-Rounder 46

Industry Rivalry versus Strategic Groups 47

Integration versus Outsourcing 49

Industry-Specific versus Firm-Specific and Institution-Specific Determinants of Performance 50

Making Sense of the Debates 50

viii Contents

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THE SAVVY STRATEGIST 51

CHAPTER SUMMARY 51

CRITICAL DISCUSSION QUESTIONS 52

TOPICS FOR EXPANDED PROJECTS 52

CLOSING CASES:

Emerging Markets: Competing in the Indian Airline Industry 53

Emerging Markets: Competing in the Indian Retail Industry 54

Emerging Markets: High Fashion Fights Recession 56

NOTES 58

3 LEVERAGING RESOURCES AND CAPABILITIES 60 OPENING CASE:

Enhancing Value, Rarity, and Inimitability at Burberry 61

UNDERSTANDING RESOURCES AND CAPABILITIES 62

RESOURCES, CAPABILITIES, AND THE VALUE CHAIN 63

FROM SWOT TO VRIO 67

The Question of Value 67

The Question of Rarity 68

The Question of Imitability 68

The Question of Organization 69

DEBATES AND EXTENSIONS 70

Firm-Specific versus Industry-Specific Determinants of Performance 71

Static Resources versus Dynamic Capabilities 72

Offshoring versus Non-Offshoring 73

Domestic Resources versus International (Cross-Border) Capabilities 75

THE SAVVY STATEGIST 75

CHAPTER SUMMARY 76

CRITICAL DISCUSSION QUESTIONS 77

TOPICS FOR EXPANDED PROJECTS 77

CLOSING CASES:

Emerging Markets: From Copycats to Innovators 78

Enhancing Value, Rarity, and Inimitability at Burberry 80

IBM at 100 81

NOTES 82

Contents ix

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4 EMPHASIZING INSTITUTIONS, CULTURES, AND ETHICS 86 OPENING CASE:

Emerging Markets: One Rock Formation, Two Countries 87

UNDERSTANDING INSTITUTIONS 88

Definitions 88

What Do Institutions Do? 89

How Do Institutions Reduce Uncertainty? 90

AN INSTITUTION-BASED VIEW OF BUSINESS STRATEGY 92

Overview 92

Two Core Propositions 94

THE STRATEGIC ROLE OF CULTURE 95

The Definition of Culture 95

The Five Dimensions of Culture 95

Cultures and Strategic Choices 97

THE STRATEGIC ROLE OF ETHICS 97

The Definition and Impact of Ethics 97

Managing Ethics Overseas 98

Ethics and Corruption 99

A STRATEGIC RESPONSE FRAMEWORK FOR ETHICAL CHALLENGES 100

DEBATES AND EXTENSIONS 102

Opportunism versus Individualism/Collectivism 102

Cultural Distance versus Institutional Distance 103

THE SAVVY STRATEGIST 103

CHAPTER SUMMARY 104

CRITICAL DISCUSSION QUESTIONS 105

TOPICS FOR EXPANDED PROJECTS 105

CLOSING CASE:

Emerging Markets: One Rock Formation, Two Countries 106

NOTES 107

PART 2 BUSINESS-LEVEL STRATEGIES 111

5 GROWING AND INTERNATIONALIZING THE ENTREPRENEURIAL FIRM 112 OPENING CASE:

Emerging Markets: The Rise of Alibaba 113

ENTREPRENEURSHIP AND ENTREPRENEURIAL FIRMS 114

x Contents

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A COMPREHENSIVE MODEL OF ENTREPRENEURSHIP 115

Industry-Based Considerations 115

Resource-Based Considerations 116

Institution-Based Considerations 117

FIVE ENTREPRENEURIAL STRATEGIES 118

Growth 118

Innovation 118

Network 119

Financing and Governance 120

Harvest and Exit 121

INTERNATIONALIZING THE ENTREPRENEURIAL FIRM 123

Transaction Costs and Entrepreneurial Opportunities 123

International Strategies for Entering Foreign Markets 123

International Strategies for Staying in Domestic Markets 124

DEBATES AND EXTENSIONS 125

Traits versus Institutions 125

Slow Internationalizers versus Born Global Start-ups 126

Anti-Failure Biases versus Entrepreneur-Friendly Bankruptcy Laws 127

THE SAVVY ENTREPRENEUR 128

CHAPTER SUMMARY 129

CRITICAL DISCUSSION QUESTIONS 129

TOPICS FOR EXPANDED PROJECTS 130

CLOSING CASES:

Emerging Markets: Amazon.com of Russia 130

Emerging Markets: Microfinance, Macro Success or Global Mess? 131

Emerging Markets: The Rise of Alibaba 133

NOTES 134

6 ENTERING FOREIGN MARKETS 138 OPENING CASE:

Emerging Markets: SABMiller in Nigeria 139

OVERCOMING THE LIABILITY OF FOREIGNNESS 140

UNDERSTANDING THE PROPENSITY TO INTERNATIONALIZE 141

A COMPREHENSIVE MODEL OF FOREIGN MARKET ENTRIES 142

Industry-Based Considerations 143

Contents xi

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Resource-Based Considerations 143

Institution-Based Considerations 144

WHERE TO ENTER? 146

Location-Specific Advantages and Strategic Goals 146

Cultural/Institutional Distances and Foreign Entry Locations 148

WHEN TO ENTER? 148

HOW TO ENTER? 150

Scale of Entry: Commitment and Experience 150

Modes of Entry: The First Step on Equity versus Non-Equity Modes 151

Modes of Entry: The Second Step on Making Actual Selections 153

DEBATES AND EXTENSIONS 156

Liability versus Asset of Foreignness 156

Global versus Regional Geographic Diversification 156

Old-Line versus Emerging Multinationals: OLI versus LLL 157

THE SAVVY STRATEGIST 158

CHAPTER SUMMARY 159

CRITICAL DISCUSSION QUESTIONS 160

TOPICS FOR EXTENDED PROJECTS 160

CLOSING CASES:

Emerging Markets: Pearl River Goes Abroad 160

Emerging Markets: SABMiller in Nigeria 162

Enter the United States by Bus 163

NOTES 164

7 MAKING STRATEGIC ALLIANCES AND NETWORKS WORK 168 OPENING CASE:

Emerging Markets: Etihad Airways’ Alliance Network 169

DEFINING STRATEGIC ALLIANCES AND NETWORKS 170

A COMPREHENSIVE MODEL OF STRATEGIC ALLIANCES AND NETWORKS 171

Industry-Based Considerations 172

Resource-Based Considerations 173

Institution-Based Considerations 175

FORMATION 177

Stage One: To Cooperate or Not to Cooperate? 177

Stage Two: Contract or Equity? 177

Stage Three: Positioning the Relationship 178

xii Contents

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EVOLUTION 179

Combating Opportunism 179

Evolving from Strong Ties to Weak Ties 179

From Corporate Marriage to Divorce 181

PERFORMANCE 182

The Performance of Strategic Alliances and Networks 182

The Performance of Parent Firms 183

DEBATES AND EXTENSIONS 183

Majority JVs as Control Mechanisms versus Minority JVs as Real Options 184

Alliances versus Acquisitions 184

Acquiring versus Not Acquiring Alliance Partners 185

THE SAVVY STRATEGIST 186

CHAPTER SUMMARY 187

CRITICAL DISCUSSION QUESTIONS 188

TOPICS FOR EXPANDED PROJECTS 188

CLOSING CASES:

Emerging Markets: BP, AAR, and TNK-BP (also see Emerging Markets 7.1) 188

Emerging Markets: Etihad Airways’ Alliance Network 191

NOTES 192

8 MANAGING GLOBAL COMPETITIVE DYNAMICS 196 OPENING CASE:

Emerging Markets: Emirates Airlines Fights Legacy Airlines 197

STRATEGY AS ACTION 198

INDUSTRY-BASED CONSIDERATIONS 199

Collusion and Prisoners’ Dilemma 199

Industry Characteristics and Collusion vis-à-vis Competition 201

RESOURCE-BASED CONSIDERATIONS 203

Value 203

Rarity 203

Imitability 204

Organization 204

Resource Similarity 204

Fighting Low-Cost Rivals 205

INSTITUTION-BASED CONSIDERATIONS 207

Formal Institutions Governing Domestic Competition: A Focus on Antitrust 207

Formal Institutions Governing International Competition: A Focus on Antidumping 209

Contents xiii

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ATTACK AND COUNTERATTACK 210

Three Main Types of Attack 210

Awareness, Motivation, and Capability 212

COOPERATION AND SIGNALING 213

LOCAL FIRMS VERSUS MULTINATIONAL ENTERPRISES 213

DEBATES AND EXTENSIONS 215

Strategy versus IO Economics and Antitrust Policy 215

Competition versus Antidumping 216

THE SAVVY STRATEGIST 218

CHAPTER SUMMARY 219

CRITICAL DISCUSSION QUESTIONS 220

TOPICS FOR EXTENDED PROJECTS 220

CLOSING CASES:

Emerging Markets: Emirates Airlines Fights Legacy Airlines 220

Emerging Markets: HTC Fights Apple 222

NOTES 224

PART 3 CORPORATE-LEVEL STRATEGIES 227

9 DIVERSIFYING AND MANAGING ACQUISITIONS GLOBALLY 228 OPENING CASE:

Emerging Markets: Emerging Acquirers from China and India 229

PRODUCT DIVERSIFICATION 231

Product-Related Diversification 231

Product-Unrelated Diversification 231

Product Diversification and Firm Performance 232

GEOGRAPHIC DIVERSIFICATION 233

Limited versus Extensive International Scope 233

Geographic Diversification and Firm Performance 233

COMBINING PRODUCT AND GEOGRAPHIC DIVERSIFICATION 235

A COMPREHENSIVE MODEL OF DIVERSIFICATION 236

Industry-Based Considerations 236

Resource-Based Considerations 237

Institution-Based Considerations 239

The Evolution of the Scope of the Firm 240

xiv Contents

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ACQUISITIONS 243

Setting the Terms Straight 243

Motives for Mergers and Acquisitions 244

Performance of Mergers and Acquisitions 245

Restructuring 248

DEBATES AND EXTENSIONS 248

Product Relatedness versus Other Forms of Relatedness 248

Acquisitions versus Alliances 249

THE SAVVY STRATEGIST 249

CHAPTER SUMMARY 250

CRITICAL DISCUSSION QUESTIONS 251

TOPICS FOR EXPANDED PROJECTS 251

CLOSING CASE:

Emerging Markets: Emerging Acquirers from China and India 251

NOTES 254

10 STRATEGIZING, STRUCTURING, AND LEARNING AROUND THE WORLD 258 OPENING CASE:

Emerging Markets: GE Innovates from the Base of the Pyramid 259

MULTINATIONAL STRATEGIES AND STRUCTURES 260

Pressures for Cost Reduction and Local Responsiveness 260

Four Strategic Choices 261

Four Organizational Structures 264

The Reciprocal Relationship between Multinational Strategy and Structure 266

A COMPREHENSIVE MODEL OF MULTINATIONAL STRATEGY, STRUCTURE, AND LEARNING 267

Industry-Based Considerations 267

Resource-Based Considerations 268

Institution-Based Considerations 269

WORLDWIDE LEARNING, INNOVATION, AND KNOWLEDGE MANAGEMENT 271

Knowledge Management 271

Knowledge Management in Four Types of Multinational Enterprises 271

Globalizing Research and Development (R&D) 272

Problems and Solutions in Knowledge Management 273

DEBATES AND EXTENSIONS 274

Corporate Controls versus Subsidiary Initiatives 274

Customer-Focused Dimensions versus Integration, Responsiveness, and Learning 275

THE SAVVY STRATEGIST 275

Contents xv

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CHAPTER SUMMARY 276

CRITICAL DISCUSSION QUESTIONS 277

TOPICS FOR EXPANDED PROJECTS 277

CLOSING CASES:

A Subsidiary Initiative at Bayer MaterialScience North America 277

Emerging Markets: GE Innovates from the Base of the Pyramid 279

NOTES 280

11 GOVERNING THE CORPORATION AROUND THE WORLD 284 OPENING CASE:

Global Competition in How to Best Govern Large Firms 285

OWNERS 287

Concentrated versus Diffused Ownership 287

Family Ownership 288

State Ownership 288

MANAGERS 288

Principal–Agent Conflicts 289

Principal–Principal Conflicts 289

BOARD OF DIRECTORS 291

Board Composition 291

Leadership Structure 292

Board Interlocks 292

The Role of Boards of Directors 292

Directing Strategically 293

GOVERNANCE MECHANISMS AS A PACKAGE 294

Internal (Voice-Based) Governance Mechanisms 294

External (Exit-Based) Governance Mechanisms 294

Internal Mechanisms + External Mechanisms = Governance Package 295

A GLOBAL PERSPECTIVE 296

A COMPREHENSIVE MODEL OF CORPORATE GOVERNANCE 297

Industry-Based Considerations 297

Resource-Based Considerations 298

Institution-Based Considerations 299

DEBATES AND EXTENSIONS 301

Opportunistic Agents versus Managerial Stewards 301

Global Convergence versus Divergence 301

State Ownership versus Private Ownership 302

xvi Contents

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THE SAVVY STRATEGIST 304

CHAPTER SUMMARY 305

CRITICAL DISCUSSION QUESTIONS 306

TOPICS FOR EXPANDED PROJECTS 306

CLOSING CASES:

Emerging Markets: The Private Equity Challenge 306

Emerging Markets: GE Innovates from the Base of the Pyramid 309

NOTES 311

12 STRATEGIZING WITH CORPORATE SOCIAL RESPONSIBILITY 316 OPENING CASE:

Emerging Markets: The Ebola Challenge 317

A STAKEHOLDER VIEW OF THE FIRM 319

A Big Picture Perspective 319

Primary and Secondary Stakeholder Groups 320

A Fundamental Debate 320

A COMPREHENSIVE MODEL OF CORPORATE SOCIAL RESPONSIBILITY 322

Industry-Based Considerations 322

Resource-Based Considerations 324

Institution-Based Considerations 327

DEBATES AND EXTENSIONS 330

Domestic versus Overseas Social Responsibility 330

Active versus Inactive CSR Engagement Overseas 331

Race to the Bottom (“Pollution Haven”) versus Race to the Top 332

THE SAVVY STRATEGIST 332

CHAPTER SUMMARY 334

CRITICAL DISCUSSION QUESTIONS 334

TOPICS FOR EXPANDED PROJECTS 335

CLOSING CASES:

Emerging Markets: The Ebola Challenge 335

Launching the Nissan Leaf: The World’s First Electric Car 337

NOTES 339

Glossary 343

Index 355

Contents xvii

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Preface The first three editions of Global Strategy aspired to set a new standard for (1) global or international strategy courses, (2) strategic management courses, and (3) international business courses at the undergraduate and MBA levels. They have been widely used in Angola, Australia, Austria, Brazil, Britain, Canada, Chile, China, Denmark, Egypt, Finland, France, Germany, Hong Kong, India, Indonesia, Ireland, Israel, Lithuania, Macau, Malaysia, Mexico, the Netherlands, Netherlands Antilles, New Zealand, Norway, Peru, Philippines, Portugal, Puerto Rico, Romania, Russia, Singapore, Slovenia, South Africa, South Korea, Spain, Sweden, Switzerland, Taiwan, Thailand, and the United States. Based on the enthusiastic support from more than 30 countries, the first three editions achieved unprecedented success. Available in Chinese, Portuguese, and Spanish, Global Strategy is global.

For the first time, going completely digital, the fourth edition endeavors to accomplish even more. It continues the market-winning framework centered on the “strategy tripod” and has been thoroughly updated to capture the rapidly moving research and events. 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 inter- esting and accessible way to engage students.

A BROADENED DEFINITION OF “GLOBAL STRATEGY” In this text, “global strategy” is defined not as a particular multinational enterprise (MNE) strategy, but rather as “strategy around the globe.” While emphasizing inter- national strategy, we do not exclusively focus on international strategy. Just like “international business” is about “business” (in addition to being “international”), so “global strategy” is most fundamentally about “strategy” before being “global.” Most global strategy and international business textbooks take the perspective of the for- eign entrant, typically the MNE, often dealing with issues such as how to enter for- eign markets and how to look for local partners. Important as these issues are, they only cover one side of global strategy—namely, the foreign side. The other side, nat- urally, 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.

xviii

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A COMPREHENSIVE AND INNOVATIVE COVERAGE With a broadened definition of “global strategy,” this text covers the strategies of both large MNEs and smaller entrepreneurial firms, both foreign entrants and domestic firms, and firms from both developed economies and from emerging econ- omies. 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 text.

Its unique features include: Chapter 4 (on institutions, cultures, and ethics cen- tered on the emerging institution-based view of strategy), Chapter 5 (on entre- preneurship and small firm internationalization), Chapter 8 (on global competitive dynamics), Chapter 9 (on both product and geographic diversification—the first time these crucial aspects of corporate strategies appear in the same textbook chap- ter), and Chapter 11 (on corporate governance—the first time both the principal– agent and principal–principal conflicts are given equal “air time”).

Global Strategy offers a geographically comprehensive coverage, not only cover- ing 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 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 admi- ration 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 lat- est research. Personally, I have accelerated my own research, publishing a total of 30 articles after I finished the third edition.1 Some of these recent articles appear in top- tier outlets in global strategy, such as the Academy of Management Journal (2012), Journal of International Business Studies (2014 and 2016), Journal of Management Studies (2012, 2013, and 2015), Journal of World Business (2012, 2014, 2015, and 2016), and Strategic Management Journal (2013, 2015, and 2016). Writing Global Strategy has also enabled me to broaden the scope of my research, publishing recently in top tier journals in operations (Journal of Operations Management), ethics (Journal of Business Ethics), entrepreneurship (Journal of Business Ventur- ing and Entrepreneurship Theory and Practice), human resources (International Journal of Human Resource Management), and history (Journal of Management History). In addition to my own work, I have also drawn on the latest research of numerous colleagues. The end result is the unparalleled, most comprehensive set of evidence-based insights on the market. While citing every article is not possible, I am confident that I have left no major streams of research untouched. (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 management.2 These are: (1) Why do firms differ? (2) How do firms behave? (3) What determines the scope of the firm? (4) What determines the success

1All my articles are listed at www.mikepeng.com and www.utdallas.edu/~mikepeng. Go to “Journal Articles.” 2R. Rumelt, D. Teece, & D. Schendel (eds.), 1994, Fundamental Issues in Strategy: A Research Agenda, Boston: Harvard Business School Press.

Preface xix

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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 scru- tinizing 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 institution-based views. An innovative feature is the develop- ment of the institution-based view.4 In every chapter, these three views are inte- grated to develop a comprehensive model.5 This provides a great deal of continuity in the learning process.

Finally, I have written a beefy “Debates and Extensions” section for every chap- ter. 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 text must be boring because it draws so heavily on latest research, you are wrong. I have used a clear and engaging conversational style to tell the “story.” Relative to rival texts, my chapters are shorter and livelier. Some earlier users commented that reading Global Strategy is like reading a “good magazine.” A large number of interesting anecdotes have been woven into the text. Non-traditional (“outside-the-box”) examples range from ancient Chinese military writings to mutu- ally assured destruction (MAD) strategy during the Cold War, from Tolstoy’s Anna Karenina to the Ebola challenge.

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.

WHAT’S NEW IN THE FOURTH EDITION? Most strategically, the fourth edition has (1) significantly expanded the case offerings, (2) launched a new Business Insights feature, (3) enhanced the executive voice by drawing more heavily from CEOs and other strategic leaders, and (4) drawn directly on the author’s consulting experience.

The fourth edition has dramatically expanded case offerings by (1) presenting 10 new Integrative Cases and (2) making available 16 popular and still timely Integrative Cases from earlier editions. Students and instructors especially enjoyed the wide- ranging and globally relevant cases in previous editions. The fourth edition is blessed

3M. W. Peng, 2004, Identifying the big question in international business research, Journal of Interna- tional Business Studies, 35(2): 99–108. 4M. W. Peng, S. Sun, B. Pinkham, & H. Chen, 2009, The institution-based view as a third leg for a strat- egy tripod, Academy of Management Perspectives, 23(3): 99–108; M. W. Peng, D. Wang, & Y. Jiang, 2008, An institution-based view of international business strategy: A focus on emerging economies, Journal of International Business Studies, 39(5): 920–936. 5K. Meyer, S. Estrin, S. Bhaumik, & M. W. Peng, 2009, Institutions, resources, and entry strategies in emerging economies, Strategic Management Journal, 30(1): 61–80; Y. Yamakawa, M. W. Peng, & D. Deeds, 2008, What drives new ventures to internationalize from emerging to developed economies? Entrepreneurship Theory and Practice, 32(1): 59–82; D. Zoogah, M. W. Peng, & H. Woldu, 2015, Institu- tions, resources, and organizational effectiveness in Africa, Academy of Management Perspectives, 29(1): 7–31.

xx Preface

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with 10 new Integrative Cases, dealing with companies headquartered in Australia, Austria, Brazil, Canada, China, Jamaica, Japan, and the United States. Beyond these new Integrative Cases, for the first time we are making 16 Integrative Cases from the previous editions available in digital format. This solves one of the leading headaches associated with launching a new edition. I know numerous instructors have their favorite cases from earlier editions. But to inject newness into a new edition, a vast majority of old cases would have to be jettisoned. No traditional textbook has that kind of space to print old cases. Going digital completely liberates Global Strategy from these constraints. Except those cases that seem too dated, I have carefully selected Integrative Cases from previous editions. Overall, users of the fourth edition can enjoy 26 Integrative Cases (10 new þ 16 old ones)—this represents a 73% increase from the 15 Integrative Cases offered in the third edition. The end result is an unparalleled, diverse collection of cases that will significantly enhance the teach- ing and learning of global strategy around the world.

In the fourth edition, we are also launching a new Business Insights (Global Strat- egy Insights) section that is completely online. Instead of inserting boxes and closing cases in the chapters, I have selected 36 Business Insights features (three per chap- ter) that draw on the global media (most of which is from my favorite magazine, the Economist). A series of open-ended and multiple-choice questions are available. As well, faculty will be able to add current articles from Business Insights to keep the examples current and relevant to issues that are happening contemporaneously.

If Global Strategy aspires 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 clas- ses in executive education with Global Strategy, most students using the text—even the highest-level Executive MBA (EMBA) students—have not assumed that kind of executive responsibilities. To facilitate strategic thinking, the fourth edition has fea- tured more extensive quotes and perspectives from the following CEOs and other strategic leaders:

Alibaba’s founder and CEO Jack Ma (Chapter 5) Dow Chemical’s CEO William Stavropoulos (Chapter 10) GE’s chairman and CEO Jeff Immelt (Chapters 8 and 10) GE’s chairman and CEO Jack Welch (Chapter 12) Google’s CEO Eric Schmidt (Chapter 7) IBM’s CEO Ginni Rometty (Chapter 3) P&G’s chairman and CEO A. G. Lafley (Chapter 1)

Ryannair’s CEO Michael O’Leary (Chapter 7) US Attorney General (representing the Department of Justice’s challenge of AT&T’s proposed merger with T-Mobile—Chapter 8) World Health Organization’s Director-General Margaret Chan (Chapter 12) Whole Foods’ co-founder and CEO John Mackey (Chapter 12)

Finally, I have directly drawn on my recent consulting experience to inject new insights. Chapter 1 describes my consulting engagements with MTR Corporation, in which I pushed its executives to condense a strategy mission from 23 words to a short and sweet eight words (see Table 1.3). Chapter 3 illustrates a strategic sweet spot for UK manufacturing, which I developed for a major consulting engage- ment I completed for the UK Government Office for Science as part of its two-year Future of Manufacturing project (see Figure 3.6). Table 4.5 (“Texas Instruments Guidelines on Gifts in China,” which is in the public domain) is shared with me by a consulting client at TI. Overall, I am confident that students can directly benefit from such new insights gained from my consulting engagements with multinationals and governments.

Overall, the fourth edition of Global Strategy has packed rigor with relevance, timeliness with excitement, and the strategic with the practical. Enjoy the all-new completely digital experience!

Preface xxi

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MINDTAP Online resources are transforming many aspects of everyday life, and learning is not immune to the impact of technology. Rather than simply taking the pages of Global Strategy and placing them online, we have reimagined the content to fully utilize the engagement and interactivity that the medium allows.

MindTap is a digital learning solution that helps instructors engage and trans- form today’s students into critical thinkers. Through paths of dynamic assignments and applications that you can personalize, real-time course analytics, and an accessi- ble reader, MindTap helps you turn apathy into engagement:

• Critical Thinking—Engaging, chapter-specific content is arranged in a singular Learning Path designed to elevate thinking.

• Personalization—Customize the Learning Path by integrating outside content like videos, articles, and more.

• Analytics—Easily monitor student progress, time on task, and outcomes with real-time reporting.

In addition, MindTap integrates other powerful tools to help enhance your course:

• YouSeeU facilitates group projects and a variety of other assignments through digital video and collaboration tools.

• Business Insights provides a rich online database and research tool. • We have provided a pre- and post-course assessment that measures Global Liter-

acy that provides both students and instructors with feedback on the general awareness of global social, cultural, political, and economic awareness. In addi- tion, having this data can also provide valuable data to support assurance of learning reporting for accreditation purposes. We thank the efforts of Anne Mägi of the University of Illinois-Chicago for her work on these assessments.

• Additional media and text cases that are not found in the chapters, assessment, and much more!

For more information on using MindTap in your course, consult the instructor resources or visit www.cengage.com/mindtap.

SUPPORT MATERIALS A full set of support materials is available for adopting instructors, 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.

• Test bank—The robust Global Strategy test bank contains a wide range of ques- tions 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 Cognero® software package to view, choose, and edit their test questions according to their specific course requirements. The test bank is also available in a format compatible with most Learning Management Systems.

xxii Preface

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• 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.

ACKNOWLEDGMENTS As Global Strategy celebrates the launch of its fourth edition, I first want to thank all the customers—instructors and students around the world who have made the book’s success possible. A big thanks goes to nine 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; Enrique Benjamín and Franklin Fincowski (Universidad Nacional Autónoma del de México), Mercedes Muñoz (Tecnológico de Monterrey Campus Santa Fe y Estado de México), Octavio Nava (Universidad del Valle de Mexico), and Claudia Gutiérrez Rojas (Tecnológico de Monterrey Cam- pus Estado de México) in Mexico. They loved the book so much that they were willing to endure the pain of translating it into Chinese, Portuguese, and Spanish. Their hard work has made Global Strategy more global.

At the Jindal School at UT Dallas, I appreciate Naveen Jindal’s general support to fund the Jindal Chair. I thank my colleagues Shawn Carraher, Larry Chasteen, Emily Choi, Tev Dalgic, Greg Dess, Dave Ford, Richard Harrison, Maria Hasenhuttl, Charlie Hazzard, Tom Henderson, Jeff Hicks, Shalonda Hill, Seung-Hyun Lee, Sheen Levin, John Lin, Livia Markóczy, Toyah Miller, Joe Picken, Orlando Richard, Jane Salk, Rajiv Shah, Eric Tsang, Habte Woldu, and Jun Xia—as well as Hasan Pirkul (dean) and Varghese Jacob (associate dean). I also thank my PhD students (Sergey Lebedev, Canan Mutlu, and Cristina Vlas) for their assistance. One colleague (Maria Hasenhuttl), two former PhD students (Sunny Li Sun [University of Missouri at Kansas City] and Erin Pleggenkulhe-Miles [University of Nebraska at Omaha]), and a former EMBA student (Steven Lange) contributed excellent case materials.

At Cengage Learning, I thank the “Peng team” that not only publishes Global Strategy, but also Global Business: Erin Joyner, VP & GM; Jason Fremder, Product Director; Mike Roche, Senior Product Manager; John Sarantakis, Content Developer; Emily Horowitz, Marketing Manager, and Kim Kusnerak, Senior Content Project Manager.

In addition, I thank many colleagues and students who provided informal feed- back to me on the text. It is especially gratifying to receive unsolicited correspon- dence from students. Space constraints force me to only acknowledge those who wrote me since the third edition, since those 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.)

Majed Al-Dhelee (Kyung Hee University, South Korea) M. Ambashankar (Gupta College of Management, India) Siah Hwee Ang (Victoria University of Wellington, New Zealand) 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)

Limin Chen (Wuhan University, China) Glen Damro (UMIT University, Australia) Joyce Falkenberg (Norwegian School of Economics and Business Administration, Norway) Todd Fitzgerald (Sanit Joseph’s University, USA) Dennis Garvis (Washington and Lee University, USA) John Gerace (Chestnut Hill College, USA) Mike Geringer (Ohio University, USA)

Preface xxiii

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Katalin Haynes (Texas A&M University, USA) Thomas Henderson (University of Texas at Dallas) Jorge Heredia (Universidad del Pacífico, Peru) Stephanie Hurt (Meredith College, USA) Basil Janavaras (Minnesota State University, USA) Jungkwon Kim (Hanyang University, South Korea) Marshall Shibing Jiang (Brock University, Canada) Ferry Jie (University of Technology Sydney, Australia) Ben Kedia (University of Memphis, USA) Aldas Kriauciunas (Purdue University, USA) Seung-Hyun Lee (University of Texas at Dallas, USA) David Liu (George Fox University, USA) Rajiv Mehta (New Jersey Institute of Technology, USA) Paul Miesing (State University of New York at Albany, USA) Phillip Nell (Vienna University of Economics and Business, Austria) David Pritchard (Rochester Institute of Technology, USA)

Pradeep Kanta Ray (University of New South Wales, Australia) David Reid (Seattle University, USA) Pamela Resurreccion (De La Salle University, Philippines) Al Rosenbloom (Dominican University, USA) Daniel Rottig (Florida Gulf Coast University, USA) Steve Strombeck (Azusa Pacific University, USA) Hao Tan (University of Newcastle, Australia) Paula Tomsett (I-Shou University, Taiwan) Jose Vargas-Hernandez (Universidad de Guadalajara, Mexico) Krishna Venkitachalam (Stockholm University, Sweden) Loren Vickery (Western Oregon University, USA) George White (University of Michigan at Flint, USA) Richard Young (Minnesota State University, USA) Wu Zhan (University of Sydney, Australia) Man Zhang (Bowling Green State University, USA)

In this edition, 11 colleagues—including one executive from China—graciously contributed new Integrative Case (authors of older Integrative Cases made avail- able in the fourth edition were acknowledged in earlier editions):

Charles Byles (Virginia Commonwealth University, USA) Zhu Chen (SIA Energy, China) Maria Hasenhuttl (University of Texas at Dallas, USA) Armand Gilinsky (Sonoma State University, USA)—two cases Steven Lange (University of Texas at Dallas, USA) Raymond Lopez (Pace University, USA) —two cases

Klaus Meyer (China Europe International Business School, China) Canan Mutlu (Kennesaw State University, USA) Erin Pleggenkuhle-Miles (University of Nebraska at Omaha, USA) Sunny Li Sun (University of Missouri at Kansas City, USA) Yanli Zhang (Montclair State University, USA)

Last, but no means least, I thank my wife Agnes, my daughter Grace, and my son James—to whom this textbook is dedicated. When the first edition was con- ceived, Grace was one month old and James was waiting for his turn to show up in the world. Now my 13-year-old Grace is already a voracious reader and a prolific writer of young-adult novels, and my 11-year-old James can beat me in chess. Both are competitive swimmers and world travelers, having been to more than 30 coun- tries. 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.

xxiv Preface

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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. He is also a National Science Foundation (NSF) CAREER Award winner and a Fellow of the Academy of International Business (AIB). At UT Dallas, he has been the number-one contributor to the list of 45 top journals tracked by Financial Times, which consis- tently ranks UT Dallas as a top 20 school in research worldwide.

Professor Peng holds a bachelor’s degree from Winona State University, Minnesota, and a PhD degree from the University of Washington, Seattle. He had pre- viously served on the faculty at the Ohio State Univer- sity, University of Hawaii, and Chinese University of

Hong Kong. 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, Canada, China, Denmark, Hong Kong, and the United States, and lectured around the world.

Professor Peng is one of the most prolific and most influential scholars in global strategy. Both the United Nations and the World Bank have cited his work. In 2015, he received the Journal of International Business Studies Decade Award. A Jour- nal of Management article found him to be among the top 65 most widely cited man- agement scholars, and an Academy of Management Perspectives study reported that he is the fourth most influential management scholar among professors who obtained their PhD since 1991. Overall, Professor Peng has published more than 120 articles in leading journals, more than 30 pieces in non-refereed outlets, and five books. Since the launch of Global Strategy’s third edition, he has not only published in top global strategy journals such as the Academy of Management Journal, Jour- nal of International Business Studies, Journal of Management Studies, and Strate- gic Management Journal, but also in leading outlets in entrepreneurship (Entrepreneurship Theory and Practice), ethics (Journal of Business Ethics), human resources (International Journal of Human Resource Management), and history (Journal of Management History). Used in more than 30 countries, Profes- sor Peng’s best-selling textbooks, Global Strategy, Global Business, and GLOBAL, are global market leaders that have been translated into Chinese, Portuguese, and Spanish.

Truly global in scope, Professor Peng’s research has investigated firm strategies in Africa, Asia Pacific, Central and Eastern Europe, and North America. He is best

xxv

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known for his development of the institution-based view of strategy and his insights about the rise of emerging economies such as China in global business. With more than 20,000 Google citations and an H-index of 60, he is listed among The World’s Most Influential Scientific Minds (compiled by Thomson Reuters based on citations covering 21 fields)—in the field of economics and business, he is one of the only 95 world-class scholars listed and the only global strategy textbook author listed.

Professor Peng is active in leadership positions. He has served on the editorial boards of the AMJ, AMP, 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 in Shanghai (2007) and in Sydney (2014). At AIB, he co-chaired the AIB/ JIBS Frontiers Conference in San Diego (2006), guest-edited a JIBS special issue (2010), chaired a track for the Nagoya conference (2011), and chaired the Richard Farmer Best Dissertation Award Committee for the Washington conference (2012). He served one term as Editor-in-Chief of the Asia Pacific Journal of Management (2007–2009). He managed the successful bid to enter the Social Sciences Citation Index (SSCI), which reported APJM’s first citation impact to be 3.4 and rated it as the top 18 among 140 management journals for 2010. In recognition of his contribu- tions, APJM has named its best paper award the Mike Peng Best Paper Award. Currently he is a Consulting Editor at the Journal of World Business.

Professor Peng is also an active consultant, trainer, and keynote speaker. He has provided on-the-job training to more than 400 professors. He has consulted and been a keynote speaker for multinational enterprises (such as AstraZeneca, Berlitz, Nationwide, SAFRAN, and Texas Instruments), educational and funding organiza- tions (such as Canada Research Chair, Harvard Kennedy School of Government, National Science Foundation of the United States, and Natural Science Foundation of China), and national and international organizations (such as the UK Government Office for Science, US-China Business Council, US Navy, and World Bank).

Professor Peng has received numerous honors, including an NSF CAREER Grant ($423,000), a US Small Business Administration Best Paper Award, a (lifetime) Scholarly Contribution Award from the International Association for Chinese Man- agement Research (IACMR), and a Best Paper Award named after him. He has been quoted by The Economist, Newsweek, US News and World Report, Yahoo Finance, Dallas Morning News, Smart Business Dallas, Atlanta Journal-Constitution, The

Exporter Magazine, The World Journal, Business Times (Singapore), CEO-CIO (Beijing), Sing Tao Daily (Vancouver), and Brasil Econômico (São Paulo), as well as on the Voice of America.

xxvi About the Author

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PART 1 Foundations of Global Strategy

• Chapter 1 Strategizing Around the Globe

• Chapter 2 Managing Industry Competition

• Chapter 3 Leveraging Resources and Capabilities

• Chapter 4 Emphasizing Institutions, Cultures, and Ethics

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CHAPTER

1 KEY TERMS

multinational enterprises (MNEs)

foreign direct investment (FDI)

Brazil, Russia, India, and China (BRIC)

Triad “emerging economies”

(or “emerging markets”)

base of the pyramid (BoP) reverse innovation (or

frugal innovation) strategic management strategy

strategy as plan strategy as action intended strategy emergent strategy strategy as integration strategy formulation strategy implementation SWOT analysis replication top management team (TMT)

chief executive officer (CEO)

strategy tripod

stakeholders triple bottom line balanced scorecard information overload Global strategy Globalization risk management scenario planning semiglobalization nongovernmental

organizations (NGOs)

KNOWLEDGE OBJECTIVES 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

2

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Strategizing Around the Globe

OPENING CASE Emerging Markets: Samsung’s Global Strategy Group

Founded in 1938, Samsung Group is South Korea’s leading conglomerate. It has 420,000 employ- ees in 510 units in 80 countries, with US$327 billion in annual revenues in 2014. The flagship com- pany within Samsung Group is Samsung Electronics Corporation (SEC). With US$226 billion revenues in 2014, SEC is the largest electronics firm in the world. In addition to SEC, other major Samsung Group companies include Samsung Life Insurance (the 13th-largest life insurer in the world), Samsung C&T Corporation (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 of 2008–2009, SEC’s profits have been higher than those of its five largest Japanese rivals (Sony, Panasonic, Toshiba, Hitachi, and Sharp) combined.

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 tradition- ally 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 consulting unit, the Global Strategy Group, which reports directly to the CEO. Mem- bers of the Global Strategy Group are non-Korean MBA graduates of 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 perfor- mance, and (3) globalize Samsung.” By 2013, Samsung’s global strategists have come from 18 countries, with 19 native languages, six years of average work experience, and an average age of 30 years.

Global Strategy teams work on various internal strategy projects for different Samsung compa- nies. Each team has a project leader, which gives the individual an opportunity to take on a leader- ship 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 (internal) client company. On average, projects last three months and typically involve some overseas travel. Starting with 20 global strategists in the class of 1997, more than 400 projects have been completed. These pro- jects help global strategists form informal ties and expose them to the organizational culture. After two years, global strategists would “graduate” and be assigned to Samsung subsidiaries, many of which are in their home countries.

3

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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 tough nut to crack. Of the 208 non-Korean MBAs who joined the group since its inception, 135 were still with Samsung as of 2011. The most successful ones are those who have taken the greatest pains to fit into the Korean culture, such as eating kimchi and drinking Korean wine 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 the Global Strategy Group 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 retention rate went up to two-thirds. Three experts noted how the non-Korean members of the Global Strategy Group have slowly, but surely, globalized Samsung’s corporate DNA:

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 mindsets to accommodate Westernized practices, slowly and steadily making the envi- ronment 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) Samsung Global Strategy Group, 2015, gsg.samsung.com

A GLOBAL GLOBAL-STRATEGY BOOK How do firms such as Samsung compete around the globe? 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. However, this book does not focus on a particular form of inter- national (cross-border) strategy, which is characterized by the production and distri- bution of standardized products and services on a worldwide basis. For more than three decades, this strategy, commonly referred to as “global strategy” for lack of a better term, has often been advocated by traditional global-strategy books.1 How- ever, there is now a great deal of rumbling and soul-searching among managers frus- trated by the inability of their “world car,” “world drink,” or “world commercial” to conquer the world.

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. The Opening Case clearly shows that Samsung must tap into the pool of non-Korean talents in its quest to globalize its operations. This often entails drawing on the experience and expertise of managers coming from the very coun- tries that Samsung is interested in entering. Samsung is aware that whatever works in Korea may or may not work elsewhere. In short, 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 are popular in 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). Coca-Cola’s effort in pushing for a set of “world commercials” centered on the polar bear cartoon character presumably appealing to some worldwide values and interests 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

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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 three decades (in other words, the “one-size-fits-all” strategy), while useful for some firms in certain industries, is often incomplete and unbalanced. This is reflected in at least three manifestations:

• Too often, the quest for worldwide cost reduction, consolidation, and restructur- ing in the name of “global strategy” has sacrificed local responsiveness and global learning. The results have been unsatisfactory in many cases and disas- trous 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 more than 5,000 branches in 80 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, Samsung and Sony, 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: Embraer, Gazprom, Reliance, and Xiaomi? Best known for its regional jets, Brazil’s Embraer is the world’s third-largest aerospace producer (behind Boeing and Air- bus). Russia’s Gazprom is the world’s largest natural gas producer and Europe’s largest natural gas supplier. India’s Reliance (among its many lines of business) operates the country’s largest retail operations and has successfully elbowed the all-mighty Wal-Mart out of India. China’s Xiaomi has dethroned Samsung and Apple to become the smartphone market share leader in both China and India. Based in Brazil, Russia, India, and China (BRIC), these four firms represent some of the top MNEs from emerging economies.4 If such firms are outside your strategic radar screen, then perhaps your radar has too many blind spots.

• The current brand of “global strategy” seems relevant only for MNEs from devel- oped 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 are similar. Since the 1990s, the term “emerging economies” (or “emerging markets”) has gradually replaced the term “developing econ- omies” since the 1990s. Led by BRIC, emerging economies command 48% of world trade, attract 60% of FDI inflows, and generate 40% FDI outflows. Overall, emerg- ing economies contribute approximately 50% of the global gross domestic product (GDP).5 In 1990, they accounted for less than a third of a much smaller world GDP. Although their growth rates may slow down, emerging economies as a group are destined to grow both their absolute GDP and their percentage of world GDP. Many local firms in emerging economies rise to the challenge, not only effectively competing at home but also launching offensives abroad.6

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 pyra- mid. The top consists of about one billion people with annual per capita income greater than US$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 US$2,000 to US$20,000 a year, make up the second tier. The vast majority of humanity—about five billion people—make less than US$2,000 a year and comprise the base of the pyra- mid (BoP), which has been ignored by traditional “global strategy.” Many MNEs from

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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. Gen- eral 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 econ- omies, then local competitors such as India’s Tata Motors and China’s Geely will. From BoP markets, these new competitors increasingly go after the second-tier and top-tier markets overseas, creating serious competitive challenges to MNEs from developed economies.

One interesting recent development is reverse innovation (or frugal innovation)—an innovation that is adopted first in emerging economies and then diffused around the world.8 Traditionally, innovations are generated by Triad-based multinationals with the needs and wants of rich customers at the top of the pyramid in mind. When such multinationals entered lower-income economies, they tended to simplify prod- uct features and lower prices. In other words, the innovation flow is top down. How- ever, as Deere & Company found out in India, its large-horsepower tractors designed for American farmers were a poor fit for the very different needs and wants of Indian farmers. Despite Deere’s efforts to simplify the product and reduce the price, the price was still too high in India. Instead, Mahindra & Mahindra brought its widely popular small-horsepower tractors that were developed in India to the United States, and carved out a growing niche that eventually propelled it to become the world’s largest tractor maker by units sold.9 In response, Deere abandoned its US tractor designs and “went native” in India, by launching a local design team charged with developing something from scratch—with the needs and wants of farmers in India (or, more broadly, in emerging economies) in mind. The result was a 35-horsepower tractor that was competitive not only with Mahindra & Mahindra in India, but also in the United States and elsewhere. In both cases, the origin of new innovations is from the BoP. The flow of innovation is bottom up—in other words, reverse innovation.

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.

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The US$100 Xiaomi smartphone is another good example. Relative to a US$600 Apple iPhone or a US$500 Samsung Galaxy, a Xiaomi phone is merely good enough. It is 3G-capable, and has a solid processor, a passable camera, as well as barely decent but expandable memory (8 GB), which can be expanded to 64 GB with cheap SD cards. But its performance is certainly more than 20% of an Apple or a Sam- sung. To customers in the BoP and beyond, Xiaomi’s reverse innovation thus delivers tremendous value relative to its price. Customers in China and India have used their hard-earned cash to vote Xiaomi into the first place in both countries, enabling Xiaomi to rocket ahead of Samsung and Apple in these two most populous markets.

Overall, this book is part of the broad movement in search of a better under- standing of how to effectively strategize and compete around the globe, not being merely about “global strategy” per se. It differentiates itself from existing global- strategy books by providing a more balanced coverage, not only in terms of the tra- ditional “global strategy” and “non-global strategy,” but also in terms of both MNEs’ and local firms’ perspectives. This book also devotes extensive space to competitive battles waged in and out of emerging economies. This will help enhance your under- standing of a new breed of global competitors.10 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.11 Why study global strategy? The most sought-after and highest-paid business school graduates (both MBAs and undergrad- uates) 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. So, don’t forget to add a line on your resume that you have studied this strategically important course.

Even for graduates at large companies with no interest in working for the con- sulting 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 Group with 50,000 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 want to be able to figure this out as soon as pos- sible 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!

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.12 The oldest book on strategy, The Art of War, dates back to around 500 BC.

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It was authored by Sun Tzu, a Chinese military strategist.13 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.14

Plan versus Action Because business strategy is a relatively young field (despite the long roots of mili- tary strategy), what defines strategy has been a subject of intense debate.15 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,16 this school suggests that strategy is embodied in the same explicit rigorous formal planning as in the military.

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 strat- egy is a set of flexible goal-oriented actions.17 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

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 adop-

tion 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 sus- tain 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.

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smaller decisions from the “bottom up.”18 Facebook is a good example. Its founder Mark Zuckerberg 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.” 19

Each of these two schools of thought has merits and drawbacks. In August 1914, both Germany and France confronted the same strategic problem: how to win a war. The Germans embraced the “strategy as plan” school with a meticulous Schlieffen Plan. Every day’s schedule of march was fixed: Brussels would be taken by the 19th day, the French-Belgium border crossed on the 22nd, and Paris conquered and vic- tory achieved by the 39th. The Germans planned for everything except flexibility. In short, there was no Plan B. Arguing that no plan would survive the first contact with the enemy, the French practiced the “strategy as action” school. Known as Plan 17, the French plan was a radical contrast to the German plan. A total of five sentences was all that was shared with the generals who would lead a million sol- diers into battle. Sentence one was “Target Berlin.” Sentence two was “Recover Alsace and Larraine” (the two provinces that the French had lost to the Germans in a previous war). The last sentence was “Good luck!” In the end, both plans failed mis- erably, with appalling casualties but no victories to show. A crucial lessen is that a winning strategy must have a combination of both schools of thought, leveraging their advantages while minimizing their weaknesses.

Strategy as Theory 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 emer- gent activities, thus leading to a “strategy as integration” school. First advocated by Alfred Chandler,20 an American business historian, this more balanced “strategy as integration” school of thought has been adopted in many textbooks and is the per- spective we embrace here. Following Peter Drucker, an Austrian-American manage- ment guru, we extend the “strategy 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, it is neither plan nor action—it is theory.

According to Drucker, “a valid theory that is clear, consistent, and focused is extraordinarily powerful.”21 Table 1.2 outlines the four advantages associated with our 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 plan- ning 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 activ- ities as separate endeavors, in reality good strategists do both.

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.22 Such a SWOT analysis resonates

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

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very well with Sun Tzu’s teaching on the importance of knowing “yourself” and “your opponents.” After such an assessment, the firm formulates its theory on how to best connect points A and B. In other words, the broad arrow becomes its intended strat- egy. However, given so many uncertainties, not all intended strategies may prove successful, and some may become unrealized strategies. On the other hand, other unintended actions may become emergent 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.

FIGURE 1.2 Strategy Formulation and Strategy Implementation.

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

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

gy

Where must we be?

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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.23 A theory is merely a statement on relationships between two phenomena. At its core, a theory serves two powerful purposes: to explain the past and to predict the future. For example, the theory of gravity explains why many people committing suicide were successful by jumping from high-rise buildings or tall cliffs. It also predicts that should individuals (hypothetically) harbor such a dangerous tendency, they will be equally successful by doing the same. Each firm has a unique theory (way) of doing business.24 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”? The theory 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 period does not necessarily mean it will be successful elsewhere or in other periods.25 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 nat- ural sciences, this is known as continuous experimentation. For instance, after several decades of experiments in outer space, we now know that objects dropped by astronauts inside a spacecraft would not fall. Instead, they float. In other words, replication helps us understand that the theory of gravity is earth bound and that it does not apply in outer space. Such replication seems to be the essence of business strategy. Firms successful in one 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.26 In new mar- kets, 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 com- pete successfully. For instance, Wal-Mart’s theory failed in Germany, India, and South Korea, and the retail giant had to pull out from those markets recently. Just as knowing the limits of the theory of gravity helps the scientific community, so knowing the limits of a business theory, although painful to managers involved, is beneficial to the firm.

Finally, the “strategy as theory” perspective helps us understand why it is often difficult to change strategy. Imagine how hard it is to change an established theory. The reason that a certain theory is widely accepted is because of its past success. But past success does not guarantee future success. Although scientists are supposed to be objective, they are also human. Many scientists may be unwill- ing 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 have been promoted to current positions because of their past success in developing and implementing “old” theories. National heritage, organizational politics, and personal career considerations may prevent many bosses from admitting the failure of an existing strategy. Yet, the history of scien- tific 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, then their views, which may be peripheral initially, gradually drive out failed theories and introduce better ones. The painful process of strategic change in many firms is similar. Usually a group of younger 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 out- weigh the resistance of the old strategy, thus leading to some strategic change. For example, Wal-Mart recently changed its strategy from “everyday low prices”

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to “save money, live better,” in order to soften its undesirable image as a ruthless cost cutter associated with “everyday low prices.”

Overall, strategy is not a rulebook, a blueprint, or a set of programmed instruc- tions. Rather, it is a firm’s theory about how to compete successfully, a unifying theme that gives coherence to its various actions. Strategy is about articulating and communicating. If a theory is to be understood, it needs to be communicated in a powerful but easy-to-remember way. If it has too many words, managers and employees will not be able to remember it. Then there is no way they can relate what they do day in and day out to strategy. For this reason, this book’s definition of strategy goes above and beyond the dozens of words stemming from each of the pre- vious definitions (see Table 1.1). We leverage the power of just one word—theory.

One of the first questions I often raise when engaging executives in training and consulting is: “What is your company’s strategy?” One of the most typical answers I get is: “What do you mean? Vision? Mission statement?” Most of them are clueless about “strategy.” Then after overcoming the initial confusion and after going to their companies’ websites, they usually give me dozens (and sometimes hundreds!) of words. “Can you recite these words and tell your subordinates what these words are, without using Google?” I would ask. They, of course, cannot. Regardless of the labels used such as “vision” or “mission statement,” any strategy statement that is hard to remember is by definition hard to communicate and thus hard to understand. A successful strategy needs to be short but to the point, com- municating the uniqueness of a particular theory of doing business—think of Wal-Mart’s “everyday low prices” and “save money, live better.” Table 1.3 illustrates my efforts to push executives at MTR Corporation to condense their (relatively) well-crafted “mission” from 23 words to only eight words—a two-thirds (!) reduction—in order to more effectively articulate and communicate its strategy to internal and external stakeholders.

Just as military strategies and generals must be studied simultaneously, so 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 must 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 strategic leadership by making strategic choices.27 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.28 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

TABLE 1.3 Articulating Strategy for MTR Corporation.

Official Mission Articulation We will:

• Strengthen our Hong Kong corporate citizen reputation • Grow and enhance our Hong Kong core businesses • Accelerate our success in the Mainland and internationally

We will:

• Strengthen reputation • Grow in Hong Kong • Go global

SOURCES: MTR Corporation is a publicly listed company headquartered in Hong Kong. In Hong Kong, it builds and oper- ates transit railways that carry five million passengers every weekday. It also develops residential and commercial real estate property. In addition to Hong Kong, it operates in six cities worldwide (Beijing, Hangzhou, and Shenzhen in China; London, UK; Melbourne, Australia; and Stockholm, Sweden). Globally, it carries 1.36 billion passengers every year. “Offi- cial Mission” is adapted from MTR Corporation, 2015, Vision, mission, values, www.mtr.com.hk [accessed February 1, 2015]. “Articulation” is from the author’s discussions with MTR executives, July 2013 and July 2014.

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2000 and 2009, Table 1.4 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 define a field and orient the attention of stu- dents, practitioners, and scholars in a certain direction. Specifically, we will address the following four fundamental questions:29

• 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. The question of why firms differ, 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 Britain, both of which are embedded in what is known as Anglo-American capitalism. A smaller literature deals with other Western countries, such as Germany, France, and Italy, collectively known as continental European cap- italism. While some differences between Anglo-American and continental European firms have been reported (such as a shorter and a longer investment horizon, respec- tively), the contrast between these Western firms and their Japanese counterparts is more striking. 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 network).30 The word keiretsu is now fre- quently used in English-language publications without the explanation given in the parentheses—an educated reader of BusinessWeek, Economist, or Wall Street Jour- nal 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, contri- butes to the growth of the economy.31 As a result, the word guanxi has now become the most famous Chinese business word to appear in English-language media, again

TABLE 1.4 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.

Chapter 1 • Strategizing Around the Globe 13

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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.32

More systematically, Figure 1.4 shows the diversity of management practices around the world. The quality of management practices seems to correlate with the level of economic development. Figure 1.5 illustrates the distribution of firms in terms of management quality in Brazil, Britain, China, Greece, India, Portugal, and the United States. Why do firms differ, thus, remains an intriguing question in strategy.33

How Do Firms Behave? This question focuses on what determines firms’ theories on how to compete.34

Figure 1.6 identifies three leading perspectives that collectively lead to a strategy tripod.35 The industry-based view suggests that the strategic task is mainly to examine the competitive forces affecting an industry, and to stake out a position that is less vulnerable relative to these 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 differ- entiate successful firms from failing ones.

Recently, an institution-based view has emerged to account for differences in firm strategy.36 This view argues that in addition to industry-level and firm-level

FIGURE 1.4 Management Quality Varies around the World.

USA Japan

Germany Sweden Canada

Australia UK

Italy France

New Zealand Mexico Poland Ireland

Portugal Chile

Argentina Greece

Brazil China India

2.6 2.8 3 Average management practice scores,

from 1 (worst practice) to 5 (best practice)

3.2 3.4

SOURCE: Adapted from N. Bloom, C. Genakos, R. Sadun, & J. Van Reenen, 2012, Management practices across firms and countries (p. 18), Academy of Management Perspectives, February: 12–33. Averages taken across all firms within each country. A total of 9,079 observations. Firms were randomly sampled from the population of all manufacturing firms with 100 to 5,000 employees. The median firm is privately owned, has approximately 350 employees, and operates two pro- duction plants.

14 Part 1 • Foundations of Global Strategy

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conditions, firms also must take into account the influences of formal and informal rules of the game.37 A better understanding of the formal and informal rules of the game explains a great deal behind the success and failure of numerous firms around the world.

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?”38 For the sec- ond and third parts of the book, we will repeatedly draw on the strategy tripod with these three views to tackle a variety of strategy problems, such as competitive

FIGURE 1.5 The Distribution of Firms: The US and the UK Has Few Badly Managed Firms, and Brazil, China, Greece, India, and Portugal Have a Tail of Badly Managed Firms.

0

.2

.4

.6

.8

0 1 2

UK India Greece and Portugal

USA Brazil China Bars are the histogram of firms in each country

Line is the smoothed US density, shown for comparison to the US

F ra

c ti

o n

o f

F ir

m s

3

Firm management scores, from 1 (worst practice) to 5 (best practice)

4 5 1 2 3 4 5 1 2 3 4 5

.2

.4

.6

.8

SOURCE: Adapted from N. Bloom, C. Genakos, R. Sadun, & J. Van Reenen, 2012, Management practices across firms and countries (p. 20). Academy of Management Perspectives, February: 12–33. A total of 4,930 observations. See footnote to Figure 1.4 for details of the survey.

FIGURE 1.6 The Strategy Tripod: Three Leading Perspectives on Strategy.

Strategy Performance

Industry-based competition

Firm-specific resources and capabilities

Institutional conditions and transitions

Chapter 1 • Strategizing Around the Globe 15

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dynamics, strategic alliances, corporate diversification, corporate governance, and corporate social responsibility.

What Determines the Scope of the Firm? This question first focuses on the growth of the firm. Most firms seem to have a lin- gering love affair with growth. The motivation to grow is fueled by the excitement associated with such growth. 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 product-unrelated 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 (see the Opening Case). 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 inde- pendent firms, pointing out some discernible performance benefits associated with conglomeration.39 One reason behind such a contrast lies in the institutional differ- ences between developed and emerging economies. Viewed through an institutional lens, conglomeration may make sense (at least to some extent) in emerging econo- mies because this strategy and its relatively positive link with performance may be a function of the level of institutional (under)development in these countries.40

In addition to product scope, careful deliberation of the geographic scope is important.41 For firms 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. However, it is not realis- tic 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.

What Determines the Success and Failure of Firms Around the Globe? This focus on firm performance, more than anything else, defines the field of strate- gic management and international business.42 We are not only interested in acquir- ing and leveraging competitive advantage, but also in sustaining such advantages over time and across regions. All three major perspectives that form the strategy tri- pod ultimately seek to answer this crucial performance question.43

What is firm performance? There is no consensus. If you survey ten managers from ten countries on what performance exactly is, you may get ten different answers.44 Long-term or short-term performance?45 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 to the question on what drives firm performance. Instead of focusing on a single financial or economic bottom line, some firms adopt a triple bottom line, which consists of economic, social, and envi- ronmental dimensions (see Chapter 12).

One solution is to adopt a balanced scorecard, which is a performance evaluation method from the customer, internal, innovation and learning, and financial perspec- tives. Outlined in Table 1.5, the balanced scorecard can be thought of as the dials in a

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flight cockpit. To fly an aircraft, pilots simultaneously require a lot of information, such as air speed, altitude, and bearing. To manage a firm, strategists have similar needs. But pilots and strategists cannot afford information overload—too much informa- tion. The balanced scorecard summarizes and channels a large volume of informa- tion to a relatively small number of crucial dimensions.

In summary, these four questions represent some of the most fundamental puz- zles 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.46 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 world- wide perspective.”47 It essentially means any strategy outside one’s home country. Americans seem especially fond of using the word “global” this way, which essen- tially becomes the same as “international.” For example, Wal-Mart’s first foray out- side 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 entering Austria. To many internationally active Asian and European firms, there is nothing significantly “global” about these activities in neighboring 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? We use neither of the pre- ceding definitions. Global strategy is simply defined as strategy of firms around the globe—essentially firms’ theories about how to compete successfully. We deal with both the strategy of MNEs (some of which may fit into the traditional narrow global strategy definition) 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

TABLE 1.5 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.

Chapter 1 • Strategizing Around the Globe 17

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firms doing business abroad, which is the traditional domain of global-strategy books. To the extent that international business involves two sides—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 impor- tant. A truly global global-strategy book needs to provide a balanced coverage. 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 eco- nomic growth, higher standards of living, increased technology sharing, and more extensive cultural integration. Critics argue that globalization undermines wages in rich countries, exploits workers in poor countries, grants MNEs too much power, destroys the environment, and promotes inequality. So, what exactly is globaliza- tion? This section outlines three views on globalization, recommends the pendulum view, and introduces the idea of semiglobalization.

Three Views on Globalization Depending on what sources you read, globalization can 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 per- spective. First, opponents of globalization 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 environmental stress, social injustice, and sweatshop labor, but present few clearly worked-out alternatives to the present economic order.

A second view contends that globalization has always been part and parcel of human history. Historians debate whether it started 2,000 or 8,000 years ago. The earliest traces of MNEs have been discovered in Assyrian, Phoenician, and Roman times.48 International competition from low-cost countries is nothing new. In the first century A.D., 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.49 Today’s most successful MNEs do not come close to wielding the historical clout of some MNEs, such as the East India Company during colonial times. In a nutshell, globalization is nothing new and will always exist.

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 artifi- cial barriers to the flows of goods, services, capital, knowledge, and (to a lesser extent) people across borders.”50 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 under- stand the ups and downs of globalization. The current era of globalization originated in the aftermath of World War II, when major Western countries committed

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themselves to global trade and investment. However, between the 1950s and the 1970s, this view was not widely shared. Communist countries, such as China and the Soviet Union, sought to develop self-sufficiency. Many non-communist devel- oping countries, such as Brazil, India, and Mexico, focused on fostering and protect- ing domestic industries. But refusing to participate in global trade and investment ended up breeding uncompetitive industries. In contrast, four developing economies in Asia—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 become collectively known as “emerging economies.” As a result, globalization rap- idly accelerated.

However, globalization, like a pendulum, is unable to keep going in one direc- tion. Rapid globalization in the 1990s and the 2000s 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 econ- omies that they would lose jobs. Emerging economies not only seem to attract many low-end manufacturing jobs away from developed economies, but they also increas- ingly appear to threaten some high-end service jobs. Finally, some factions in emerg- ing economies complained against the onslaught of MNEs, alleging that they destroy local companies as well as local cultures, values, and environments.

The December 1999 anti-globalization protests in Seattle and the September 2001 terrorist attacks in New York and Washington have been undoubtedly some of 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, however, worldwide GDP, cross- border trade, and per capita GDP all soared to historically high levels. It was during that period that BRIC became a buzzword.

Unfortunately, the party suddenly ended in 2008. The 2008–2009 global eco- nomic crisis was unlike anything the world had seen since the Great Depression (1929–1933). The crisis showed, for better or worse, how interconnected the global economy has become. Deteriorating housing markets in the United States, fueled by unsustainable subprime lending practices, led to massive government bailouts of failed firms. The crisis quickly spread around the world, forcing numerous govern- ments to bail out their own troubled banks. Global output, trade, and investment plummeted, while unemployment skyrocketed. The 2008–2009 crisis became known as the Great Recession. Many people blamed globalization for the Great Recession.

After unprecedented government intervention in developed economies, confi- dence was growing that the global economy had turned the corner.51 However, start- ing in 2010, the Greek debt crisis and then the broader PIGS debt crisis (“PIGS” refers to Portugal, Ireland or Italy, Greece, and Spain) erupted. The already slow recovery in Europe thus became slower, and unemployment hovered at very high levels.

The Great Recession reminds all firms and managers of the importance of risk management—the identification and assessment of risks and the preparation to mini- mize the impact of high-risk, unfortunate events.52 As a technique to prepare and plan for multiple scenarios (either high risk or low risk), scenario planning is now extensively used around the world.53 The recovery has seen more protectionist mea- sures, since the stimulus packages and job creation schemes of various governments often emphasize “buy national” (such as “buy American”) and “hire locals.” In short, the pendulum is swinging back.

Chapter 1 • Strategizing Around the Globe 19

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Like the proverbial elephant, globalization is seen by everyone yet rarely compre- hended. The sudden ferocity of the 2008–2009 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 who study a standing animal. Our beast—globalization—does not stand still and often rapidly moves, back and forth (!). Yet, we try to live with it, avoid being crushed by it, and even attempt to profit from it. Overall, relative to the other two views, the view of globalization 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? Are selling and investing 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 pointing to 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 insu- late countries from each other completely.54

Semiglobalization calls for more than one way of strategizing around the globe. Total isolation on a nation-state basis would suggest localization—a strategy of treat- ing each country as a unique market. An MNE marketing products to 100 countries will need to come up with 100 versions. This strategy is clearly too costly. Total glob- alization, on the other hand, would lead to standardization—the traditional “global strategy” of treating the entire world as one market (as discussed earlier). The MNE can just market one version of “world car” or “world drink.” But 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 experimentations. Overall, (semi)globalization is neither to be opposed as a menace nor to be celebrated as a panacea; it is to be engaged.

GLOBAL STRATEGY AND THE GLOBALIZATION DEBATE Anti-globalization protests in Seattle (1999). 9/11 terrorist attacks (2001). Enron (2001). The Great Recession (2008–2009). The euro crisis (since 2010). Earthquake in Japan (2011). Occupy Wall Street (2011). Confrontation between the West and Russia (2014). Ebola (2014). ISIS (2014). Assassination of French cartoonists (2015). Aging society. Global warming. These and many other challenges confronting strategists around the globe 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 thor- ough understanding of not only your strengths, but also your limitations. Many indi- viduals fail to understand their limitations or simply choose to ignore them. Although relative to the general public, executives, policymakers, and scholars tend to be bet- ter educated and more cosmopolitan, they are likely to be biased—just like every- body 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

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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.” It is not surprising that some powerless and voiceless anti-globalization groups end up resorting to unconventional tactics, such as mass protests, to voice their frustration and 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 con- cern for the various stakeholders affected by the MNEs’ actions around the world.55

It is certainly interesting, and perhaps alarming, to note that as would-be busi- ness leaders, 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 1.6, US business students have significantly more positive (almost one-sided) views toward globaliza- tion than does the general public. While these data are based on US students, my teaching and lectures around the world suggest that most business students around the world—regardless of nationality—seem to share such positive views. This is not surprising. Both self-selection to study business and socialization within the curricu- lum 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 con- cerned with its darker sides.

Current and would-be business leaders must 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 held by managers, 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 must work especially hard to break out of this mental straitjacket.

To combat the widespread tendency to have one-sided, rosy views, a significant portion of this book is devoted to the numerous debates surrounding globalization.56

Debates and extensions are systematically introduced in every chapter to provoke more critical thinking and discussion. Our field has no shortage of debates.57

TABLE 1.6 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 ¼ 1,024)

Business students (average age 22)2

(N ¼ 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.

Chapter 1 • Strategizing Around the Globe 21

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It is imperative that you be exposed to cutting-edge debates and form your own views. In addition, ethics is emphasized throughout the book. At the end of every chapter, a series of On ETHICS questions engage students. Two whole chapters are devoted to ethics, norms, and cultures (Chapter 3) and corporate social respon- sibility (Chapter 12).

ORGANIZATION OF THE BOOK Global Strategy 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 con- trast to most global-strategy books that focus on large MNEs, we start with small entrepreneurial firms (Chapter 5), followed by ways to enter foreign markets (Chap- ter 6), to leverage alliances and networks (Chapter 7), and to manage global competi- tive dynamics (Chapter 8). Finally, the third part deals with corporate-level strategies. Chapter 9 on diversification and acquisitions 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 in 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 character- ized by the production and distribution of standardized products and ser- vices 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 cover- age, 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?, and (4) What determines the success and failure of firms around the globe?

22 Part 1 • Foundations of Global Strategy

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

5. Participate in the debate on globalization

• 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.

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. Why have some industries and some firms profited from the crisis and the recession?

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.

3. ON ETHICS: What are some of the darker sides associated with globalization? How can strategists make sure that the benefits of their various actions outweigh their drawbacks?

CLOSING CASE 1.1

Emerging Markets: Microsoft’s Evolving China Strategy Microsoft’s first decade in China was disastrous. It established 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 Win- dows. 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 government openly pro- moted the free open-source Linux operating systems. For security reasons, the Chinese government was afraid that Microsoft’s software might contain spy-ware for the US gov- ernment. Internally, Microsoft’s executives often disagreed with this confrontational strat- egy. Its country managers came and went—five in a five-year period. Two of them later

Chapter 1 • Strategizing Around the Globe 23

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wrote books criticizing this strategy. These books revealed that Microsoft’s antipiracy pol- icy was excessively heavy-handed. Their authors’ efforts to educate their bosses in head- quarters in Redmond, Washington (a Seattle suburb), were deeply frustrated.

Fast forward to 2007. President Hu Jintao visited Microsoft 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,” abandoning the confrontational, litigious approach in defense of its intellectual property rights (IPR), and closely 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 Commission 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 certain 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 com- ing 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.

24 Part 1 • Foundations of Global Strategy

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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 criticized 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 alli- ance with Google’s number 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 Chi- nese (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: 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; 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.

Questions 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 Micro-

soft 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?

CLOSING CASE 1.2

Emerging Markets: Samsung’s Global Strategy Group Founded in 1938, Samsung Group is South Korea’s leading conglomerate. It has 420,000 employees in 510 units in 80 countries, with US$327 billion in annual revenues in 2014. The flagship company within Samsung Group is Samsung Electronics Corporation (SEC). With US$226 billion revenues in 2014, SEC is the largest electronics firm in the world. In addition to SEC, other major Samsung Group companies include Samsung Life Insurance (the 13th-largest life insurer in the world), Samsung C&T Corporation (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 of 2008–2009, SEC’s profits have been higher than those of its five largest Japanese rivals: Sony, Panasonic, Toshiba, Hitachi, and Sharp combined.

Chapter 1 • Strategizing Around the Globe 25

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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, Sam- sung Group headquarters in 1997 set up a unique internal consulting unit, the Global Strategy Group, which reports directly to the CEO. Members of the Global Strategy Group are non-Korean MBA graduates of 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.” By 2013, Samsung’s global strategists have come from 18 countries, with 19 native languages, six years of average work experience, and an average age of 30 years.

Global Strategy teams work on various internal strategy projects for different Sam- sung companies. Each team has a project leader, which gives the individual an opportu- nity 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 (internal) client company. On average, projects last three months and typically involve some overseas travel. Starting with 20 global strate- gists in the class of 1997, more than 400 projects have been completed. These projects help global strategists form informal ties and expose them to the organizational 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 tough nut to crack. Of the 208 non-Korean MBAs who joined the group since its inception, 135 were still with Samsung as of 2011. The most successful ones are those who have taken the greatest pains to fit into the Korean culture, such as eating kimchi and drinking Korean wine 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 the Global Strategy Group 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 retention rate went up to two- thirds. Three experts noted how the non-Korean members of the Global Strategy Group have slowly, but surely, globalized Samsung’s corporate DNA:

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 mindsets to accommodate Westernized practices, slowly and steadily making the envi- ronment 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: 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. Samsung Global Strategy Group, 2015, gsg.samsung.com.

Questions 1. How do firms such as Samsung compete around the globe? 2. What determines their success and failure?

26 Part 1 • Foundations of Global Strategy

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CLOSING CASE 1.3

The Global Strategy of Global Strategy Launched in 2005, Global Strategy has been used by business schools in over 30 coun- tries and is now available in Chinese, Spanish, and Portuguese in addition to English. Global Strategy has also spawned two related books: Global Business (a more compre- hensive, traditional textbook in international business) and GLOBAL (a more compact, innovative paperback). Everybody knows global competition 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 Cengage 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 headquarters of Cengage Learning is in Stamford, Connecticut. Cengage 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 Cengage 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 and Pearson, 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 professors 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, Sweden, Taiwan, Thailand, and the United States, Global Strategy achieved unprecedented success.

While competition is primarily among the Big Three, Global Strategy has also attracted new entrants—competing textbooks published by smaller, historically more specialized academic publishers such as Cambridge, Oxford, and Wiley that are inter- ested 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 teaches globally, and no student studies globally. Teaching and learning remain very local. For the company as a 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 Strat- egy 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 customers, 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 edition,

Chapter 1 • Strategizing Around the Globe 27

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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 for- eign 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 understand- ing 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 mis- understandings and troubles down the road, and helped a global company to success- fully turn a page locally.

Sources: 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.

Questions 1. How do firms, such as Cengage Learning, McGraw-Hill, and Pearson, compete around the

globe? 2. In the publishing industry in each country, how do various foreign entrants and local firms inter-

act, compete, and/or sometimes collaborate? 3. What determines their success and failure?

NOTES [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; 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; MBR–Multinational Business Review; MIR– Management International Review; OSc–Organization Science; SMJ–Strategic Management Journal; SO–Strategic Organization

28 Part 1 • Foundations of Global Strategy

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1. V. Govindarajan & A. Gupta, 2001, The Quest for Global Dominance, San Francisco: Jossey-Bass; S. Tallman, 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. R. Hoskisson, M. Wright, I. Filtotchev, & M. W. Peng, 2013, Emerging multinationals

from mid-range economies, JMS, 50: 1295–1321; M. W. Peng, 2012, The global strategy of emerging multinationals from China, GSJ, 2: 97–107.

5. United Nations, 2014, World Investment Report 2014 (p. ix), New York and Geneva: UN.

6. A. Cuervo-Cazurra & M. Genc, 2011, Obligating, pressuring, and supporting dimensions of the environment and the non-market advantages of developing-country multinational companies, JMS, 48: 441–455; L. Cui & F. Jiang, 2010, Behind ownership decision of Chinese outward FDI, APJM, 27: 751–774; P. Gammeltoft, H. Barnard, & A. Madhok, 2010, Emerging multinationals, emerging theory, JIM, 16: 95–101; S. Lebedev, M. W. Peng, E. Xie, & C. Stevens, 2015, Mergers and acquisitions in and out of emerging economies, JWB (in press); S. Sun, M. W. Peng, R. Ben, & D. Yan, 2012, A comparative ownership advantage framework for cross-border M&As, JWB, 47: 4–16; S. Sun, M. W. Peng, R. Lee, & W. Tan, 2015, Institutional open access at home and outward internationalization, JWB, 50: 234–246.

7. “Transnational” and “metanational” have been proposed to extend the traditional notion of “global strategy.” 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 Multinationals, Cambridge, UK: Cambridge University Press.

8. V. Govindarajan & C. Trimble, 2012, Reverse Innovation (p. 4), Boston: Harvard Business Review Press. See also S. Bradley, J. McMullen, K. Artz, & E. Smimiyu, 2012, Capital is not enough, JMS, 49: 684–717; Economist, 2015, Cheap and cheerful, January 24: 60.

9. Economist, 2013, Mahindra & Mahindra: SUVival of the fittest, November 2: 67–68. 10. A. E. Bass & S. Chakrabarty, 2014, Resource security, JIBS, 45: 961–979; P. Choudhury

& T. Khanna, 2014, Toward resource independence, JIBS, 45: 943–960; A. Cuervo- Cazurra, A. Inkpen, A. Musacchio, & K. Ramaswamy, 2014, Governments as owners, JIBS, 45: 919–942; J. Duanmu, 2014, State-owned MNCs and host country expropriation risk, JIBS, 45: 1044–1060; K. Meyer, Y. Ding, J. Li, & H. Zhang, 2014, Overcoming trust, JIBS, 45: 1005–1028; Y. Pan, L. Teng, A. Supapol, X. Lu, D. Huang, & Z. Wang, 2014, Firms’ FDI ownership, JIBS, 45: 1029–1043.

11. R. Barker, 2010, No, management is not a profession (p. 58), HBR, July: 52–60. 12. D. Ahlstrom, D. Lamond, & Z. Ding, 2009, Reexamining some management lessons

from military history, APJM, 26: 617–642; A. Carmeli & G. Markman, 2011, Capture, governance, and resilience: Strategy implications from the history of Rome, SMJ, 32: 322–341; L. Freedman, 2013, Strategy: A History, New York: Oxford University Press.

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

14. I. Ansoff, 1965, Corporate Strategy, New York: McGraw-Hill; D. Schendel & C. Hofer, 1979, Strategic Management, Boston: Little, Brown; D. Hambrick & M. Chen, 2008, New academic fields as admittance-seeking social movements, AMR, 33: 32–54.

15. D. Collis & M. Rukstad, 2008, Can you say what your strategy is? HBR, April: 82–90; S. Paroutis & L. Heracleous, 2013, Discourse revisited, SMJ, 34: 935–956.

16. K. Von Clausewitz, 1976, On War, London: Kegan Paul. 17. B. Liddell Hart, 1967, Strategy, New York: Meridian. 18. H. Mintzberg, 1994, The Rise and Fall of Strategic Planning, New York: Free Press. 19. BW, 2011, Charlie Rose talks to Mark Zuckerberg, November 14: 50. 20. A. Chandler, 1962, Strategy and Structure, Cambridge, MA: MIT Press. 21. P. Drucker, 1994, The theory of the business (p. 96), HBR, September: 95–105. See also

T. Zenger, 2013, What is the theory of your firm? HBR, June: 73–78.

Chapter 1 • Strategizing Around the Globe 29

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22. S. Julian & J. Ofori-Dankwa, 2008, Toward an integrative cartography of two strategic issue diagnosis frameworks, SMJ, 29: 93–114. For an application, see M. Chand & R. Tung, 2014, The aging of the world’s population and its effects on global business, AMP, 28: 409–429.

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

24. T. Zenger, 2013, Strategy: The uniqueness challenge, HBR, November: 52–58. 25. J. Camillus, 2008, Strategy as a wicked problem, HBR, May: 99–106. 26. 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; C. Zook & J. Allen, 2011, The great repeatable business model, HBR, November: 107–114.

27. R. Charan, 2013, You can’t be a wimp, HBR, November: 72–78; P. Rosenzweig, 2013, What makes strategic decisions different, HBR, November: 89–93.

28. D. Hambrick & P. Mason, 1984, Upper echelons, AMR, 9: 193–206; A. Pentland, 2013, Beyond the echo chamber, HBR, November: 80–86; M. Porter, J. Lorsch, & N. Nohria, 2004, Seven surprises for new CEOs, HBR, October: 62–72.

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

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

32. M. Carney, E. Gedajlovic, & X. Yang, 2009, Varieties of Asian capitalism, APJM, 26: 361–380; C. Crossland & D. Hambrick, 2011, Differences in managerial discretion across countries, SMJ, 32: 797–819; G. Jackson & R. Deeg, 2008, Comparing capitalisms, JIBS, 39: 540–561; M. Li, L. Cui, & J. Lu, 2014, Varieties of state capitalism, JIBS, 45: 980–1004; C. Luk, O. Yau, L. Sin, A. Tse, R. Chow, & J. Lee, 2008, The effects of social capital and organizational innovativeness in different institutional contexts, JIBS, 39: 589–612.

33. Y. Luo, J. Sun, & S. Wang, 2011, Comparative strategic management, JIM, 17: 190–200. 34. M. Baer, K. Dirks, & J. Nickerson, 2013, Microfoundations of strategic problem

formulation, SMJ, 34: 197–214; J. Barney & T. Felin, 2013, What are microfoundations? AMP, 27: 138–155; N. Foss & S. Lindenberg, 2013, Microfoundations for strategy, AMP, 27: 85–102; H. Greve, 2013, Microfoundations of management, AMP, 27: 103–119; A. Van de Ven & A. Lifschitz, 2013, Rational and reasonable microfoundations of markets and institutions, AMP, 27: 156–172; S. Winter, 2013, Habit, deliberation, and action, AMP, 27: 120–137.

35. M. W. Peng, S. Sun, B. Pinkham, & H. Chen, 2009, The institution-based view as the third leg for a strategy tripod, AMP, 23: 63–81. See also 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 internationalize from emerging to developed economies? ETP, 32: 59–82.

36. M. W. Peng, D. Wang, & Y. Jiang, 2008, An institution-based view of international business strategy, JIBS, 39: 920–936. See also M. Ahn & A. York, 2011, Resource-based and institution-based approaches to biotechnology industry development in Malaysia, APJM, 28: 257–275; G. Ahuja & S. Yayavaram, 2011, Explaining influence rents, OSc, 22: 1631–1652; L. Dau, 2012, Pro-market reforms and developing country multinational corporations, GSJ, 2: 262–276; T. Khoury & M. W. Peng, 2011, Does institutional reform of intellectual property rights lead to more FDI? JWB, 46: 337–345; H. Kim, H. Kim, & R. Hoskisson, 2010, Does market-oriented institutional change in an emerging economy make business group-affiliated multinationals perform better? JIBS, 41: 1141–1160; W. Ritchie & S. Melnyk, 2011, The impact of emerging institutional norms on adoption timing decisions, SMJ, 32: 860–870; G. Shinkle & A. Kriauciunas, 2012, The impact of current and founding institutions on strength of competitive aspirations in transition economies, SMJ, 33: 448–458.

37. C. Stevens, E. Xie, & M. W. Peng, 2015, Toward a legitimacy-based view of political risk, SMJ (in press); D. Zoogah, M. W. Peng, & H. Woldu, 2015, Institutions, resources, and organizational effectiveness in Africa, AMP, 29: 7–31.

30 Part 1 • Foundations of Global Strategy

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38. K. Meyer, S. Estrin, S. Bhaumik, & M. W. Peng, 2009, Institutions, resources, and entry strategies in emerging economies, SMJ. 30: 61–80; K. Meyer & M. W. Peng, 2005, Probing theoretically into Central and Eastern Europe, JIBS, 35: 600–621.

39. 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 institutional transitions, JWB, 43: 47–65.

40. Y. Li, M. W. Peng, & C. Macaulay, 2013, Market-political ambidexterity during institutional transitions, SO, 11: 205–213; M. W. Peng, S. Lee, & D. Wang, 2005, What determines the scope of the firm over time? AMR, 30: 622–633.

41. G. Qian, T. Khoury, M. W. Peng, & Z. Qian, 2010, The performance implications of intra- and inter-regional geographic diversification, SMJ, 31: 1018–1030; S. Zaheer & L. Nachum, 2011, Sense of place, GSJ, 1: 96–108.

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

43. 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; X. Yang, Y. Jiang, R. Kang, & Y. Ke, 2009, A comparative analysis of the internationalization of Chinese and Japanese firms, APJM, 26: 141–162.

44. C. Chen, M. Delmas, & M. Lieberman, 2015, Production frontier methodologies and efficiency as a performance measure in strategic management research, SMJ, 36: 19–36.

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

46. T. Levitt, 1983, The globalization of markets, HBR, May: 92–102. 47. S. Tallman & T. Pedersen, 2011, The launch of Global Strategy Journal, GSJ, 1: 1–5. 48. K. Moore & D. Lewis, 2009, The Origins of Globalization, New York: Routledge. 49. D. Yergin & J. Stanislaw, 2002, The Commanding Heights (p. 385), New York: Simon &

Schuster. 50. J. Stiglitz, 2002, Globalization and Its Discontents (p. 9), New York: Norton. 51. M. W. Peng, R. Bhagat, & S. Chang, 2010, Asia and global business, JIBS, 41: 373–376. 52. L. Purda, 2008, Risk perception and the financial system, JIBS, 39: 1178–1196; M.

Sharfman & C. Fernando, 2008, Environment risk management and the cost of capital, SMJ, 29: 569–592.

53. H. Courtney, D. Lovallo, & C. Clarke, 2013, Deciding how to decide, HBR, November: 63–70; S. Lee & M. Makhija, 2009, The effect of domestic uncertainty on the real options value of international investments, JIBS, 40: 405–420.

54. P. Ghemawat, 2003, Semiglobalization and international business strategy, JIBS, 34: 138–152.

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

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

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

Chapter 1 • Strategizing Around the Globe 31

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CHAPTER

2 KEY TERMS

industry perfect competition industrial organization (IO)

economics (or industrial economics)

structure- conduct-performance (SCP) model

Structure Conduct Performance monopoly oligopoly duopoly five forces framework dominance

incumbents entry barriers scale-based advantages economies of scale non-scale-based advantages

product proliferation product differentiation network externalities excess capacity bargaining power of suppliers

forward integration bargaining power of buyers

backward integration Substitutes industry positioning generic strategies cost leadership differentiation focus complementors flexible manufacturing

technology mass customization additive manufacturing

(or 3D printing) strategic groups mobility barriers

KNOWLEDGE OBJECTIVES 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

32

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Managing Industry Competition

OPENING CASE Emerging Markets: Competing in the Indian Airline

Industry

As China’s domestic airline market becomes the second-largest in the world (behind the United States), a great deal of attention is now paid to India’s domestic airline market, which is destined to grow. The annual number of passengers is estimated to more than double from about 70 million in 2014 to 160 million by 2020. In addition to the state-owned Air India (which has an 18% domestic market share), a number of privately owned discount (budget or low-cost) airlines have joined the foray. Led by the current market share leader IndiGo (over 30% market share), discount airlines include Jet Airways (21%), SpiceJet (18%), GoAir (9%), and other smaller rivals.

While the growth prospects are bright, here is a catch: money seems nowhere to be made. According to Bloomberg Businessweek, India is “one of the world’s toughest aviation markets, with high state taxes making jet fuel the costliest in Asia.” Discount airlines elsewhere can cut costs by outsourcing security, baggage handling, and maintenance. Not in India, where all airlines have to keep such functions in-house. Intense dogfights for market share have resulted in some new entrants offering base fares unsustainably low—sometimes as low as two cents (US) per flight. On average, whenever a passenger takes off, the industry as a whole loses US$22. That is a staggering US$10 billion in losses over the past seven years.

The airline industry in general, according to Richard Branson, founder of Virgin Atlantic Airways (which flies internationally to New Delhi and Mumbai but does not compete domestically in India), is notorious for turning billionaires into millionaires. While his comment was made without India on his mind, it turned out to be extraordinarily insightful for India as well. In 2012, Kingfisher Airlines, which was owned by a liquor baron who made a ton of money selling Kingfisher Beers and which at one time was the country’s second-largest airline, was too broke to fly. In 2014, long-time market share leader Jet Airways was bailed out by Abu Dhabi-based Etihad Airways, who took a 24% stake. SpiceJet, owned by another billionaire, trimmed its fleet and was desperately trying to find a “white knight” to rescue it. A seemingly bottomless money pit, Air India lives off government bail- outs. Its latest bailout was dished out in 2012, and it will not complete a turnaround until 2021. Of the entire industry, IndiGo, which dethroned Jet Airways to become the market share leader in 2012, is the only airline that manages to be profitable—but barely.

Despite the financial hemorrhage, airlines generally remain optimistic in the long run. The reason is simple: As incomes rise, people fly more. In addition, India’s sizable territory, many dis- persed business centers, and terrible rail and road infrastructure make it ideal to fly. An alternative to a 90-minute flight can be a grueling 18 hours on a crowded train or more than a day on bumpy

33

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slow roads. In 2014, IndiGo, literally in one go, ordered 250 new Airbus A320, which was the single- largest order Airbus ever received in its 45-year history—not bad for a young airline that only commenced operations in 2006.

While domestic airlines struggle, some international airlines salivate for a share of the spoils. The Indian government announced in 2012 that it would approve foreign direct investment (FDI) in this industry as long as foreign carriers would not exceed 49% of the shares of domestic airlines. In 2014, AirAsia India, a joint venture (JV) between Malaysia’s AirAsia (one of Asia’s most successful airlines, which commenced operations in 1996) and India’s Tata Group, was launched. Its inaugural flight, from Bangalore to Goa, cost only US$16 and was sold out in minutes. Deliberately avoiding the crowded New Delhi–Mumbai route, AirAsia India aimed to serve millions of South Indians who normally travel by rail. In 2015, another new entrant, Vistara, a JV between Singapore Airlines and Tata Group (the same JV partner for AirAsia India), took to the skies. To avoid bloody price wars, Vistara positioned itself following its parent, the renowned Singapore Airlines known for its high- touch, premium service aimed at passengers who are willing to cough up more. Vistara’s inaugural New Delhi–Mumbai flight cost US$229, which was almost triple the US$80 fare Air India charged. These two JVs also marked Tata Group’s return to the airline industry after 60 years. A pioneer in civil aviation in India, Tata Group indeed started the airline that was later nationalized to become Air India. Given Richard Branson’s famous description about the brutal nature of the airline industry, whether new entrants such as AirAsia India and Vistara would defy gravity and soar to new altitudes remains to be seen.

SOURCES: Based on (1) Bloomberg Businessweek, 2015, India’s discount airlines get an upscale rival, January 8: 22–23; (2) Economist, 2012, AirAsia: Spreading its wings, September 29: 68–69; (3) Economist, 2013, Open skies, bottomless pits, March 23: 72; (4) Economist, 2014, In short-haul for the long run, November 29: 58–59.

Why is it so hard for firms in the Indian airline industry to make money? Why are new entrants still interested in joining the foray? How do passengers and airplane makers react? Finally, are there any substitutes for flying? This chapter addresses these and other strategic questions. We accomplish 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. Conse- quently, since the late 1930s, a more realistic branch of economics, called industrial organization (IO) economics (or industrial economics), has emerged. Its primary contribution is 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 prod- uct 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

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(3) above-average. The model suggests that industry structure determines firm con- duct (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 eco- nomics and strategy. However, IO economists and policymakers are concerned with the minimization 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 econo- mist by training) and later extended and strengthened by numerous others. This sec- tion introduces 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 bar- gaining 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) pro- liferation of new products, (3) intense advertising campaigns, and (4) high-cost com- petitive actions and reactions (such as honoring all competitors’ coupons). Such intense rivalry threatens firms by reducing profits.4 The key question is: What condi- tions have led to it?

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

Chapter 2 • Managing Industry Competition 35

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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 (see the Opening Case). How many air- lines have flown into the skies of bankruptcy lately? In contrast, the presence of a dominant player lessens rivalry because it can set industry-wide prices and discipline behaviors deviating too much from the price norm. De Beers in the diamond industry is one such example.

Third, in industries whose products are “big tickets” and purchased infrequently (such as cars, 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” indus- tries with low-price, more frequently purchased products (such as beers and facial tis- sues).5 This is because consumers for “staple goods” are not likely to spend much time doing 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. 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. 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. Industries such as hotels, petrochemicals, semiconductors, and steel often periodically experience overcapacity, leading to price-cutting as a primary coping mechanism.6

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

36 Part 1 • Foundations of Global Strategy

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

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 alterna- tive use, or that cannot be sold off, pose as exit barriers. In addition, emotional, per- sonal, 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.7 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.8 New entrants are motivated to enter an industry because of the lucra- tive above-average returns some incumbents earn.9 For example, the Amazon Kindle’s success attracted Barnes and Noble to launch its Nook.

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

Chapter 2 • Managing Industry Competition 37

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Incumbents’ primary weapons are entry barriers, which refer to industry structures increasing the costs of entry. For instance, Airbus’s new A380 burned US$12 billion and Boeing’s new 787 consumed US$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.

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 uncer- tain. Entrants can also directly copy proprietary technology, which may trigger law- suits 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.10 For example, Cengage Learning, our multibillion dollar multinational publisher, 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 Estratégia Global (the Portuguese translation).

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 attri- butes. 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 switching costs for new products are substantial. Many high-tech industries are char- acterized 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.11

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 out- side 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 coun- try 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

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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.

Finally, government policy banning or discouraging entries can serve as another entry barrier. For example, the US government only allows up to 25% equity injection from foreign carriers in the airline industry. The Indian government only allows up to 49% foreign ownership in any airline (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.

Overall, if incumbents can leverage scale-based and/or non-scale-based advan- tages, offer numerous products, provide significant differentiation, maintain a credi- ble 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 condi- tions 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. While hundreds of airlines around the world struggle to make a profit (in India, for example, only one airline IndiGo is profitable—see the Opening Case), they have to rely on only two suppliers: Boeing and Airbus. Not surprisingly, Boing and Airbus enjoy a great deal of bargaining power.

Second, the bargaining power of suppliers can become substantial if they pro- vide 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 impor- tant customer. Boeing and Airbus are not too concerned with losing the business of small airlines, which may only purchase one or two 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 to these airlines.

Finally, suppliers may enhance their bargaining power if they are willing and able to enter the focal industry by forward integration. In other words, suppliers may threaten to become both suppliers and rivals. For example, in addition to supplying phones to traditional 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. Thus, firms in the focal industry 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 (individual or corporate) buyers, 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 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

Chapter 2 • Managing Industry Competition 39

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BMW, Ford, and Honda. These buyers frequently extract price concessions and qual- ity improvements by playing off suppliers against each other. When these auto- makers 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 suppli- ers’ 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 buyer fatigue. Heads of information technology (IT) departments are increasingly suspi- cious 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, undifferentiated commodity products from suppliers. Although automobile compo- nents suppliers as a group possess less bargaining power relative to automakers, suppliers are not equally powerless. There are usually several tiers. The top-tier sup- pliers are the most crucial, often supplying nonstandard, differentiated key compo- nents, such as electric systems, steering wheels, and car seats. The bottom-tier suppliers make standard, undifferentiated commodity products, such as seat belt buckles, cup holders, or simply nuts and bolts. Not surprisingly, automakers possess more bargaining power when dealing with bottom-tier suppliers.

Finally, like suppliers, buyers may enhance their bargaining power by entering the focal industry through backward integration. Buyers such as Costco, Marks & Spen- cer, and Tesco 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) products.13 Private label products, such as Kirkland (for Costco), Kro- ger, and Safeway brands, compete side by side with national brands on the shelf space. 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 medio- cre 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 power 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, 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 par- ticularly threatening (Table 2.1). First, if substitutes are superior to existing products in quality and function, they may rapidly emerge to attract a large number of custo- mers. For example, music downloads (both legal and illegal kinds) are now rapidly eating into CD sales. Online media has pushed many print-based newspapers to the brink of extinction. 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

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sugar substitute such as Nutrasweet. Both are readily available in restaurants and grocery stores. On the other hand, no substitutes exist for large passenger jets, especially for transoceanic transportation. 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) of existing products may reduce the attractiveness of substitutes.

Lessons from the Five Forces Framework Taken together, the five forces framework offers three significant lessons (Table 2.2):

• 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 lux- ury to choose (such as diversified companies contemplating entry to new indus- tries or entrepreneurial start-ups scanning new opportunities), 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 com- petitive 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 vulner- able 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 more than 35 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.

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 leadership, (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 2.3).17

TABLE 2.2 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.

Chapter 2 • Managing Industry Competition 41

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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” custo- mers 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 substi- tutes to not only outcompete the utility of its products, but also its prices—a very diffi- cult 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 continu- ously search for lower costs. Otherwise, it may no longer be a cost leader. A case in point is Southwest Airlines, the legendary, Dallas-based discount carrier that has been the role model for numerous budget airlines around the world, such as Ryanair in Ireland, AirAsia in Malaysia, and IndiGo in India (see the Opening Case). While Southwest has become the fourth-largest airline in the United States, it is no longer the cost leader.18 At 8.25 cents, Southwest’s per-mile cost to fly one passenger (tech- nically known as available seat mile) is still below that of its three larger rivals (Delta: 8.98 cents, United: 8.81, and American: 8.55). But the true cost leaders in the US airline industry are now the ultra-budget Spirit Airlines (5.95 cents) and Allegiant Travel (5.66), which pack more seats onto planes by not letting seats recline (Figure 2.2).

Second, in the relentless drive to cut costs, a cost leader may cut corners that upset customers. Toyota’s recent 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.

Differentiation A differentiation strategy focuses on how to deliver products that customers perceive to be valuable and different (Table 2.3). While cost leaders serve “typical” customers,

TABLE 2.3 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

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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, differentiated 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 vehi- cles (SUVs). For differentiators, research and development (R&D) is an important functional area that experiments 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 post-purchase needs through excellent services.

According to the five forces framework, the less a differentiator resembles its riv- als, 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 (which really should be “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 strong brand loyalty.

On the other hand, a differentiation strategy has two drawbacks. First, the differ- entiator 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. In India’s nasty skies where flyers are used to discounts and all (except one) airlines struggle with losses, whether new entrant Vistara (a JV between Singapore Airlines and Tata Group), which positions itself as a differentiator, can fly high remains to be

FIGURE 2.2 Cost per Mile to Fly One Passenger (Available Seat Mile in US$ Cents).

9

10

8

7

6

5

4

3

2

1

0

De lta

Un ite

d

Am er

ica n

So ut

hw es

t

Je tB

lue Sp

iri t

All eg

ian t

SOURCE: Extracted from data in Bloomberg Businessweek, 2014, Southwest hangs up its low-cost jersey (p. 27), Septem- ber 11: 27–28.

Chapter 2 • Managing Industry Competition 43

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seen (see the Opening Case). Second, the differentiator 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. Since the Great Recession, the previ- ously 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 eating some of Starbucks’ lunch (or drinking Starbucks’ coffee!).

Focus A focus strategy serves the needs of a particular segment or niche of an industry (Table 2.3). 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 usu- ally serve the needs of a segment so unique that broad-based competitors choose not to serve. 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 premium coffee from a single high-quality region (such as certain farms or villages in Ethiopia, the birthplace of coffee).19 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 compari- son, 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 Bent- ley) is basically more differentiated than a 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 smal- ler and narrower, but sharper, focus. The two drawbacks—namely, (1) the difficulty to sustain such expensive differentiation and (2) 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.20

Two lessons emerge. First, cost and differentiation are two fundamental strategic dimensions. The key is to choose one dimension and focus on it consistently. Sec- ond, companies that are stuck in the middle—that is, neither having the lowest cost nor sufficient differentiation (or focus)—may be indicative of having either no or a drifting strategy. Their performance may suffer as a consequence. However, the sec- ond 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 con- troversies. A new generation of strategists must understand some of these debates and thus avoid uncritical acceptance of the traditional view. This section introduces seven leading debates.

Clear versus Blurred Boundaries of Industry The heart of the industry-based view is the identification of a clearly defined indus- try. However, this concept of an industry may become increasingly elusive. For example, consider the boundaries of the television broadcasting industry.

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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 household security systems, play interactive games, and place online orders—essen- tially 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 alli- ances among television, telecommunications, cable, software, and movie companies in recent years. In other words, the competitors of ABC not only include CBS, CNN, Fox, and NBC, but also Apple, AT&T, Microsoft, SkyTV, Sony, YouTube (owned by Google), and others. So what exactly is this “industry”? Such fuzzy industry bound- aries are not alone in television broadcasting (see Figure 2.3). 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 2.4). A new concept

TABLE 2.4 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.

FIGURE 2.3 What Are the Boundaries of These Industries?

SOURCE: Bloomberg Businessweek, 2011, Year in review (p. 65), December 23.

Chapter 2 • Managing Industry Competition 45

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is to view all the players involved as an “ecosystem.”21 However, it will be challeng- ing to specify the boundaries of such an ecosystem, thus making it extremely diffi- cult 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 dis- cussed 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 sophisticated understanding of today’s competi- tion 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.22 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.

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.23 This is endorsed by Andrew Grove, the former CEO of Intel, who coined the term complementors.24 Basically, complementors are firms that sell products that add value to the products of a focal industry. The com- plementors to PC and smartphone industries are firms that produce software appli- cations. When complementors produce exciting products (such as games), the demand for PCs and smartphones grows, and vice versa. Therefore, it may be helpful to add complementors as a possible sixth force. However, complementors do not have to be high-tech. For example, sports directly boost beer sales, which, in turn, fund a lot of commercials aired during 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.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. Crushed by a high cost structure (thanks to the larger inventory cost relative to Barnes and Noble) 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 car- rier, Singapore Airlines has won the World’s Best Airline Award from Condé Nast

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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 will- ing 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 differentia- tor 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 1970s, whereas more recently, flexible manufacturing technology has enabled some 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.

The recent emergence of additive manufacturing (or 3D printing) has made such mass customization possible. Ask any factory to make you a single pencil or shovel to your own design specification. The factory would charge you at least thousands of dollars, because it would have to make a mold, buy components, and assemble them into the finished product. To do all of the above for a single pencil or shovel would be extremely expensive. Pencils and shovels only become affordable to you because their factories produce thousands of them—thanks to economies of scale. However, economies of scale for the new additive manufacturing (or 3D printing) are almost zero.29 The software can be endlessly adjusted and the cost to set up the 3D printer is the same regardless of whether it produces (or prints) one thing or many copies. Thus, from rapid prototyping, additive manufacturing has already been widely used to produce individually tailored dental crowns, hearing aids, and artificial limbs in a differentiated and cost-competitive way.

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.30 Note that all of these studies were published before the proliferation of additive manufacturing. According to the Economist, additive manufacturing represents a wave in the Third Industrial Revolution (the first two began, respectively, in Britain in the late 18th century and in America in the early 20th century).31 It is possible that in the Third Industrial Revolution, more firms will emerge as both cost leaders and differentiators.

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, obviously not every firm is competing against each other. However, some groups of firms within a broad industry do compete against each other. In the automobile industry, we can iden- tify three groups: mass market, luxury, and ultra-luxury (Figure 2.4). These different

Chapter 2 • Managing Industry Competition 47

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groups of firms are thus known as strategic groups. Within the automobile industry, strat- egy within one group tends to be similar: the mass market group pursues a cost leader- ship strategy, the luxury group a differentiation strategy, and the ultra-luxury group a focus strategy. Members within a strategic group tend to have similar performance.32

While this intuitive idea seems uncontroversial, a debate has erupted on two issues. First, how stable are strategic groups? In other words, how easy or difficult is it for firms to change from one strategic group to another? In the automobile indus- try, strong incentives exist for firms in the mass market group to charge into the lux- ury group. Can they do it? The 1990s launch of Lexus, Acura, and Infiniti by Toyota, Honda, 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 simi- lar 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, 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 compe- tition, are likely to use some simplifying schemes to better organize their strategic understanding around some identifiable reference points. In the Chinese electronics industry, executives use ownership type, a simple and easily identifiable reference point, to mentally organize strategic groups.34 In other words, state-owned enterprises 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 2.5). Inter- views with these executives find that members within the same self-identified strate- gic group intensely benchmark against each other, but care less about what is going on in other groups.

Overall, strategic groups have become a useful but somewhat controversial mid- dle ground between industry-level and firm-level analyses. The concept of strategic

FIGURE 2.4 Three Strategic Groups in the Global Automobile Industry.

C os

t/ pr

ic e

Prestige

Chrysler, Fait, Ford, GM, Honda, Hyundai, Mazda, Nissan, Renault, Toyota,

Volkswagen

Mass Market

Acura, BMW, Lexus, Mercedes, Porsche

Bentley, Ferrari, Lamborghini

Luxury

Ultra-Luxury

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groups adds some value by helping managers simplify the complexity they confront when analyzing an industry.

Integration versus Outsourcing How to determine the scope of a firm is one of the four most fundamental questions in strategy.35 As noted earlier, the industry-based view advises the focal firm to con- sider 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.36 (What if they hold us up, if we don’t buy them out?) However, 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).37

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, inte- gration reduces strategic flexibility.38 Second, internal suppliers, which had to work hard for contracts if they were independent suppliers, may lose high-powered mar- ket 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 suppli- ers. The focal firm thus faces a dilemma: Going with outside suppliers will keep inter- nal suppliers idle, but choosing 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 activ- ities 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. Toyota’s suppliers tend to be “cherry picked,” trusted members of the keiretsu. Instead of treating sup- pliers as adversaries, Toyota treats suppliers (mostly first-tier ones) as partners by co-developing 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 diffi- culty. 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,

TABLE 2.5 Strategic Groups and Ownership Types in the Chinese Electronics Industry.

Strategic Group Defender Analyzer Prospector Ownership type State ownership Foreign ownership Private ownership 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 econ- omy (p. 1110), Journal of Management Studies, 41 (7): 1105–1129.

Chapter 2 • Managing Industry Competition 49

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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. 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. 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. They have been imple- mented by many non-Japanese firms around the world.

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 out- sourced activities, crucial to the core business, should not have been outsourced. Otherwise, the firm risks becoming a “hollow corporation.” Supplier relations that are too close may introduce rigidities, resulting in a loss of much-needed flexibility. 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 forbidden) to seek contracts outside the net- work, are now encouraged to look for work elsewhere, because the benefits of learn- ing from dealing with other customers may eventually accrue to the lead firm (such as Toyota).40 Overall, the rise and fall of these two perspectives in the past two dec- ades suggest very careful analysis is needed when making decisions on the optimal scope of the firm.41

Industry-Specific versus Firm-Specific and Institution-Specific Determinants of Performance The industry-based view argues that firm performance is most fundamentally deter- mined by industry-specific attributes. This view has recently been challenged from two directions.42 The first is the resource-based view. Although the five forces frame- work suggests that particular industries (such as airlines) are highly unattractive (see the Opening Case), 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.”43 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 must 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 must understand how institutions affect competition. This view has become known as the institution-based view. Overall, these two views comple- ment the industry-based view, 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.44 When describing his work, Porter deliberately chose the word “framework” rather than the more formal “model.” In his own words, “frameworks identify the relevant vari- ables and the questions that the user must answer in order to develop conclusions tailored to a particular industry and company.”45 In this sense, Porter’s frameworks

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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 2.6). (1) You need to understand your industry inside and out by focusing on the five forces.46 The industry-based view provides a systematic foundation for industry analysis and competitor analysis, to which more detailed examination, introduced in later chapters, can be added. (2) Be aware that additional forces, some of which are discussed in the “Debates and Extensions” section, may influ- ence 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—think of Zara in fashion retail and IndiGo in airlines (see the Opening Case). Your job is to lead your firm to become a high-flying outlier, despite the pull of gravity of some unat- tractive attributes of your industry.

In conclusion, we suggest that the industry-based view can directly answer the four fundamental questions discussed in Chapter 1. First, why do firms differ? The five forces in different industries lead to tremendous 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 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 with 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.

TABLE 2.6 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.

Chapter 2 • Managing Industry Competition 51

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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.

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

• (1) Clear versus blurred boundaries of industry, (2) threats versus opportu- nities, (3) five forces versus a sixth force, (4) stuck in the middle versus all- rounder, (5) integration versus outsourcing, (6) industry rivalry versus stra- tegic 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 unattrac-

tive industry.

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?

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 edu-

cation industry. Identify the strategic group to which your institution belongs. Then write a 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 pros- ecution (for example, 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 incum- bent firms out of business and their employees out of work. As CEO of a

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multinational visiting a small country that your firm would like to enter, you face protestors organized by small firms. You are going to be interviewed by a local journalist, who has given you a list of questions ahead of the interview. One of the questions is: How can we be sure that the entry of your firm is beneficial to our economy? How do you answer this question?

CLOSING CASE 2.1

Emerging Markets: Competing in the Indian Airline Industry As China’s domestic airline market becomes the second-largest in the world (behind the United States), a great deal of attention is now paid to India’s domestic airline market, which is destined to grow. The annual number of passengers is estimated to more than double from about 70 million in 2014 to 160 million by 2020. In addition to the state- owned Air India (which has an 18% domestic market share), a number of privately owned discount (budget or low-cost) airlines have joined the foray. Led by the current market share leader IndiGo (over 30% market share), discount airlines include Jet Airways (21%), SpiceJet (18%), GoAir (9%), and other smaller rivals.

While the growth prospects are bright, here is a catch: money seems nowhere to be made. According to Bloomberg Businessweek, India is “one of the world’s toughest avia- tion markets, with high state taxes making jet fuel the costliest in Asia.” Discount airlines elsewhere can cut costs by outsourcing security, baggage handling, and maintenance. Not in India, where all airlines have to keep such functions in-house. Intense dogfights for market share have resulted in some new entrants offering base fares unsustainably low—sometimes as low as two cents (US) per flight. On average, whenever a passenger takes off, the industry as a whole loses US$22. That is a staggering US$10 billion in losses over the past seven years.

The airline industry in general, according to Richard Branson, founder of Virgin Atlantic Airways (which flies internationally to New Delhi and Mumbai but does not com- pete domestically in India), is notorious for turning billionaires into millionaires. While his comment was made without India on his mind, it turned out to be extraordinarily insightful for India as well. In 2012, Kingfisher Airlines, which was owned by a liquor baron who made a ton of money selling Kingfisher Beers and which at one time was the country’s second-largest airline, was too broke to fly. In 2014, long-time market share leader Jet Airways was bailed out by Abu Dhabi-based Etihad Airways, who took a 24% stake. SpiceJet, owned by another billionaire, trimmed its fleet and was desperately trying to find a “white knight” to rescue it. A seemingly bottomless money pit, Air India lives off government bailouts. Its latest bailout was dished out in 2012, and it will not complete a turnaround until 2021. Of the entire industry, IndiGo, which dethroned Jet Airways to become the market share leader in 2012, is the only airline that manages to be profitable—but barely.

Despite the financial hemorrhage, airlines generally remain optimistic in the long run. The reason is simple: As incomes rise, people fly more. In addition, India’s sizable terri- tory, many dispersed business centers, and terrible rail and road infrastructure make it ideal to fly. An alternative to a 90-minute flight can be a grueling 18 hours on a crowded train or more than a day on bumpy slow roads. In 2014, IndiGo, literally in one go, ordered 250 new Airbus A320, which was the single-largest order Airbus ever received in its 45-year history—not bad for a young airline that only commenced operations in 2006.

While domestic airlines struggle, some international airlines salivate for a share of the spoils. The Indian government announced in 2012 that it would approve foreign direct investment (FDI) in this industry as long as foreign carriers would not exceed 49% of the shares of domestic airlines. In 2014, AirAsia India, a joint venture (JV) between Malaysia’s AirAsia (one of Asia’s most successful airlines, which commenced operations in 1996) and India’s Tata Group, was launched. Its inaugural flight, from Bangalore to Goa, cost only

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US$16 and was sold out in minutes. Deliberately avoiding the crowded New Delhi–Mumbai route, AirAsia India aimed to serve millions of South Indians who normally travel by rail. In 2015, another new entrant, Vistara, a JV between Singapore Airlines and Tata Group (the same JV partner for AirAsia India), took to the skies. To avoid bloody price wars, Vistara positioned itself following its parent, the renowned Singapore Airlines known for its high- touch, premium service aimed at passengers who are willing to cough up more. Vistara’s inaugural New Delhi–Mumbai flight cost US$229, which was almost triple the US$80 fare Air India charged. These two JVs also marked Tata Group’s return to the airline industry after 60 years. A pioneer in civil aviation in India, Tata Group indeed started the airline that was later nationalized to become Air India. Given Richard Branson’s famous description about the brutal nature of the airline industry, whether new entrants such as AirAsia India and Vistara would defy gravity and soar to new altitudes remains to be seen.

Sources: 1. Bloomberg Businessweek, 2015, India’s discount airlines get an upscale rival, January 8:

22–23; 2. Economist, 2012, AirAsia: Spreading its wings, September 29: 68–69; 3. Economist, 2013, Open skies, bottomless pits, March 23: 72; 4. Economist, 2014, In short-haul for the long run, November 29: 58–59.

Questions 1. Why is it so hard for firms in the Indian airline industry to make money? 2. Why are new entrants still interested in joining the foray? 3. How do passengers and airplane makers react? 4. Finally, are there any substitutes for flying?

CLOSING CASE 2.2

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 majority 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, competition among supermar- kets is relatively tranquil. However, 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 hyper- markets and 2,000 supermarkets to blanket the country in the next five years.

With a booming economy, a fast-growing middle class, and fragmented local compe- titors, this industry is the world’s biggest untapped retail market. Not surprisingly, foreign giants such as Wal-Mart, Carrefour, Metro, and Tesco are knocking at the door trying to

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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 restric- tions, 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 contribu- tions 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 argu- ments is that super-efficient retail operations will enhance efficiency throughout 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 sup- ply local mass retail partners. 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 distributor. 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 provide little incen- tive 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 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 announcement. Many shopkeepers, supported by middlemen, protested against the alleged onslaught of multinationals and cited the con- troversial “Wal-Mart effect” being debated in the United States and elsewhere. Interested in shopkeepers’ votes, the government thus faced a dilemma. In December 2011, a mere two weeks after the announcement 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: 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.

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Questions 1. Why is the Indian retail industry turning from relative peace and tranquility to more heated

competition? 2. Why are foreign firms interested in entering? 3. What are the responses of existing players (incumbents) such as unorganized shops, organized

supermarkets, and middleman companies? 4. How do farmers and consumers react? 5. Finally, are there any substitutes for retail shopping?

CLOSING CASE 2.3

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 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, managing 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 Burberry (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 Chris- tian 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 Con- stantin watches, and Alfred Dunhill menswear) offloaded their excess inventory to dis- count 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.

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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. Shop- pers 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 manage the fickle and capricious customers was tricky. Although the seriously rich were not affected by the Great Reces- sion, 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 mar- ket 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, Chinese con- sumption (both at home and traveling) had been growing between 20% and 30%. In 2009, China surpassed 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 con- sumer 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 Japanese 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 customers in Brazil, India, Poland, Russia, and Saudi Arabia. Where did LVMH open one of its newest stores? Ulan Bator, Mongolia.

Sources: 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.

Questions 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?

Chapter 2 • Managing Industry Competition 57

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NOTES

[Journal acronyms] 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 Bloomberg Businessweek (since 2010); ETP–Entrepreneurship Theory and Practice; GSJ– Global Strategy Journal; HBR–Harvard Business Review; JBR–Journal of Busi- ness Research; JEP–Journal of Economic Perspectives; JIBS–Journal of Interna- tional Business Studies; JIM–Journal of International Management; JMS– Journal of Management Studies; JWB–Journal of World Business; SMJ–Strategic Management Journal

1. L. Einav & J. Levin, 2010, Empirical industrial organization, JEP, 24: 145–162. 2. M. Porter, 1981, The contribution of industrial organization 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. J. Zhou, L. Booth, & B. Chang, 2013, Import competition and disappearing dividends,

JIBS, 44: 138–154. 5. J. Shamsie, 2003, The context of dominance, SMJ, 24: 199–215. 6. H. Tan & J. Mathews, 2010, Identification and analysis of industry cycles, JBR, 63:

454–462. 7. S. Lee, M. W. Peng, & J. Barney, 2007, Bankruptcy law and entrepreneurship

development, AMR, 32: 257–272. 8. L. Jiang, J. Tan, & M. Thursby, 2010, Incumbent firm invention in emerging fields, SMJ,

32: 55–75; A. Konig, N. Kammerlander, & A. Enders, 2013, The family innovator’s dilemma, AMR, 38: 418–441; R. Seamans, 2013, Threat of entry, asymmetric information, and entry, SMJ, 34: 426–444.

9. M. Benner & M. Tripsas, 2012, The influence of prior industry affiliation on framing in nascent industries, SMJ, 33: 277–302; G. Markman & T. Waldron, 2014, Small entrants and large incumbents, AMP, 28: 179–197; L. Mulotte, P. Dussauge, & W. Mitchell, 2013, Does pre-entry licensing undermine the performance of subsequent independent activities? SMJ, 34: 358–372; F. Polidoro, 2013, The competitive implications of certifications, AMJ, 56: 597–627; D. Souder & J. M. Shaver, 2010, Constraints and incentives for making long horizon corporate investments, SMJ, 31: 1316–1336; F. Zhu & M. Iansiti, 2012, Entry into platform-based markets, SMJ, 33: 88–106.

10. A. Barroso & M. Giarratana, 2013, Product proliferation strategies and firm performance, SMJ, 34: 1435–1452.

11. A. Afuah, 2013, Are network effects really all about size? SMJ, 34: 257–273; C. Cennamo & J. Santalo, 2013, Platform competition, SMJ, 34: 1331–1350; T. Eisenmann, G. Parker, & M. Van Alstyne, 2011, Platform envelopment, SMJ, 32: 1270–1285; P. Soh, 2010, Network patterns and competitive advantage before the emergence of a dominant design, SMJ, 31: 438–461.

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: 21. 15. I. McCarthy, T. Lawrence, B. Wixted, & B. Gordon, 2010, A multidimensional

conceptualization of environmental 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. 18. BW, 2014, Southwest hangs up its low-cost jersey, September 11: 27–28. 19. BW, 2011, A pot of trouble brews in the coffee world, September 8: 13–14. 20. M. Porter, 1996, What is strategy? HBR, November: 61–78. See also R. Makadok &

D. Ross, 2013, Taking industry structuring seriously, SMJ, 34: 509–532. 21. R. Kapoor & J. Lee, 2013, Coordinating and competing in ecosystems, SMJ, 34:

274–296; D. Teece, 2007, Explicating dynamic capabilities, SMJ, 28: 1319–1350.

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22. Y. Yamakawa, M. W. Peng, & D. Deeds, 2008, What drives new ventures to internationalize from emerging to developed economies? ETP, 32: 59–82.

23. M. Porter, 1990, The Competitive Advantage of Nations, New York: Free Press. 24. A. Grove, 1996, Only the Paranoid Survive, New York: Doubleday. 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 differentiation and low cost, AMR, 13:

401–412. 29. Economist, 2012, Additive manufacturing: Solid print, April 21: www.economist.com. 30. C. Campbell-Hunt, 2000, What have we learned about generic competitive strategy?

SMJ, 21: 127–154. 31. Economist, 2012, A third Industrial Revolution, April 21: www.economist.com. 32. W. De Sarbo, 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.

33. B. Kabanoff & S. Brown, 2008, Knowledge structures of prospectors, analyzers, and defenders, SMJ, 29: 149–171; J. Kuilman & J. Li, 2009, Grades of membership and legitimacy spillovers, AMJ, 52: 229–245.

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

35. M. W. Peng, S. Lee, & D. Wang, 2005, What determines the scope of the firm over time? AMR, 30: 622–633; M. W. Peng & W. Su, 2014, Cross-listing and the scope of the firm, JWB, 49: 42–50.

36. O. Williamson, 1985, The Economic Institutions of Capitalism, New York: Free Press. 37. M. Ceccagnoli & L. Jiang, 2013, The cost of integrating external technologies, SMJ, 34:

404–425. 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 flexibility trade-off, AMJ, 51: 517–538.

39. W. Egelhoff & E. Frese, 2009, Understanding managers’ preferences for internal markets versus business planning, JIM, 15: 77–91.

40. K. Aoki & T. Lennerfors, 2013, The new, improved keiretsu, HBR, September: 109–113; J. McGuire & S. Dow, 2009, Japanese keiretsu, APJM, 26: 333–351.

41. C. de Fontenay & J. Gans, 2008, A bargaining perspective on strategic outsourcing and supply competition, SMJ, 29: 819–839.

42. J. Bou & A. Satorra, 2007, The persistence of abnormal returns at industry and firm levels, SMJ, 28: 707–722; A. Fortune & W. Mitchell, 2012, Unpacking firm exit at the firm and industry levels, SMJ, 33: 794–819; E. Karniouchina, S. Carson, J. Short, & D. Ketchen, 2013, Extending the firm vs. industry debate, SMJ, 34: 1010–1018; J. Short, D. Ketchen, T. Palmer, & G. T. Hult, 2007, Firm, strategic group, and industry influences on performance, SMJ, 28: 147–167.

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

44. C. Decker & T. Mellewigt, 2007, Thirty years after Michael E. Porter, AMP, 21: 41–55. 45. M. Porter, 1994, Toward a dynamic theory of strategy, in R. Rumelt, D. Schendel, &

D. Teece (eds), Fundamental Issues in Strategy (p. 427), Boston: Harvard Business School Press.

46. E. Hirsh & K. Rangan, 2013, The grass isn’t greener, HBR, January: 21–22; M. Jacobides & A. Kudina, 2013, How industry architectures shape firm success when expanding in emerging economies, GSJ, 3: 150–170.

Chapter 2 • Managing Industry Competition 59

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CHAPTER

3 KEY TERMS

resource-based view Resources capabilities value chain benchmarking commoditization Outsourcing Offshoring Onshoring

Captive sourcing VRIO framework causal ambiguity complementary assets ambidexterity social complexity hypercompetition business process outsourcing (BPO)

original equipment manufacturers (OEMs)

original design manufacturers (ODMs)

original brand manufacturers (OBMs)

reshoring

KNOWLEDGE OBJECTIVES 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

60

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Leveraging Resources and Capabilities

OPENING CASE Enhancing Value, Rarity, and Inimitability at Burberry

Asked to name an iconic British luxury brand, most people would probably nominate Burberry. Founded in 1856, Burberry grew to become a leading global fashion house with US$5.2 billion reve- nue in 2012. Most famous for its trench coats worn by soldiers in the trenches during World War I, Burberry became such a part of British culture that it earned a royal warrant as an official supplier to the royal family.

However, by the mid-2000s, Burberry had lost its focus. It had 23 licensees in a variety of pro- ducts and locations around the world, each doing something different, ranging from dog cover-ups and leashes to kilts. In luxury, ubiquity by definition is the killer of exclusivity. Among numerous Bur- berry products, outerwear exemplified by the “boring old trench coat” only represented 20% of its global revenue. While luxury sales were growing globally, Burberry seemed to be losing out, with a lackluster growth rate of only 2% per year by 2006. Each of Burberry’s two leading global rivals (LVMH and Gucci) had more than ten times Burberry’s revenue and much higher growth. How could Burberry, which had become a “David,” grow against such “Goliaths”?

In 2006, with the arrival of new CEO Angela Ahrendts, significant soul searching took place at Burberry. Focusing on value, rarity, and inimitability of Burberry’s resources and capabilities, the firm realized that its greatest assets lay in its Britishness, more specifically its trench coat roots— hence, the highest value it could deliver. Further, such a focus on Britain’s positive country- of-origin image would be rare in a world largely populated by French and Italian luxury brands. It would also be difficult (or sometimes impossible) to imitate if this heritage were emphasized and strengthened.

With this powerful insight, Burberry adopted a new strategy centered on the iconic trench coat— its first social media platform was named www.artofthetrench.com. Before the transformation, Burberry sold just a few styles of trench coats and almost all were beige with the signature check lining. Now with centralized and consistent design (a significant intangible capability), it sells more than 300 products in a wide variety of styles and colors related to trench coats. By 2012, 60% of its revenue came from apparel, and outerwear made up more than half of that. Many of its stylish trench coats are priced over US$1,000. Further, instead of outsourcing, Burberry has concentrated its trench coat production at the Castleford factory in the north of England, adding more than 1,000 jobs in the UK in the last two years alone (of a global labor force of 9,000). In summary, a Burberry trench coat designed and manufactured in the UK is valuable, rare, and impossible to imitate by rivals.

The upshot? Burberry has been rewarded handsomely by the market. In five years (2007–2012), its revenue and operating income doubled. In 2011, Interbrand named it the fourth

61

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fastest-growing global brand (behind Apple, Google, and Amazon) and the fastest-growing luxury brand. So impressed was Apple that in 2013 it poached Ahrendts, who quit Burberry and became Apple’s senior vice president in charge of retail and online operations.

SOURCES: Based on (1) A. Ahrendts, 2013, Burberry’s CEO on turning an aging British icon into a global luxury brand, Harvard Business Review, January: 39–42; (2) Daily Mail, 2013, Burberry share price plummets after CEO Angela Ahrents quits fashion house to take key role at Apple, October 13: www.dailymail.co.uk; (3) M. W. Peng, 2014, High fashion fights recession, in M. W. Peng, Global Strategy, 3rd ed. (57–59), Cincinnati: Cengage Learning; (4) M. W. Peng & K. Meyer, 2013, Winning the future markets for UK manufacturing output (p. 30), Future of Manufacturing Project Evidence Paper 25, London: UK Government Office for Science; (5) www.artofthetrench.com; (6) www.burberry.com.

Why is Burberry able to turn around? Why does it choose to focus on the value, rarity, and inimitability of its core products centered on outerwear, as opposed to the proliferation of unrelated products? The answer is that there must be certain resources and capabilities specific to Burberry 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 individual firms (such as Burberry) 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 Burberry defy gravity and sustain competitive advantage? 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.3 Resources are defined as “the tangible and intan- gible assets a firm uses to choose and implement its strategies.”4 There is some debate regarding the definition of capabilities. Some argue that capabilities are a firm’s capac- ity to dynamically deploy resources. They suggest a crucial distinction between resources and capabilities, and advocate a “dynamic capabilities” view.5

While scholars may debate the fine distinctions between resources and capabili- ties, these distinctions are likely to become blurred in practice.6 For example, is Bur- berry’s long history a resource or capability? How about its multinational presence? How about its willingness to jettison unrelated businesses such as dog cover-ups? For current and would-be strategists, the key is to understand how these attributes help improve firm performance, as opposed to figuring out whether they should be labeled as resources or capabilities. Therefore, 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 capabil- ities. 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

62 Part 1 • Foundations of Global Strategy

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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. Boeing and Airbus jets fly high due to such resources and capabilities.

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 acknowledged that they must be “there,” because no firm is likely to generate com- petitive advantage by solely relying on tangible resources and capabilities alone. Examples of intangible assets include:

• Human resources and capabilities. Extraordinary human resources (HR) can be crucial assets propelling a firm to new heights, while mediocre HR can be a drag.

• Innovation resources and capabilities. Some firms such as Apple are renowned for innovations.

• Reputation resources and capabilities. Reputation can be regarded as an out- come of a competitive process in which firms signal their attributes to constitu- ents.7 IBM, despite some setbacks, can leverage its reputation and march from strength to strength, while many of its less reputable rivals struggle.

Note that all resources and capabilities discussed here are merely examples. They do not represent an exhaustive list. Firms will forge ahead to discover and leverage new resources and capabilities.

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 activi- ties (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.8

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.9 Given that no firm is likely to be good at all primary and support activities, the key is to examine whether the firm has resources and capabilities to per- form 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

TABLE 3.1 Examples of Resources and Capabilities.

Tangible Intangible Financial Human Physical Innovation Technological Reputation

Chapter 3 • Leveraging Resources and Capabilities 63

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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 cum- bersome and costly.

Think about steel, definitely a crucial component for automobiles. But the ques- tion 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 auto- makers, while it is imperative 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 histor- ically 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 sup- plier that will perform it on behalf of the focal firm.10 For example, many consumer products companies (such as Apple and 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 Dreamliner is provided by outside suppliers. This com- pares with 51% for existing Boeing aircraft.11 Recently, not only is manufacturing often outsourced, but 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, Fox- conn 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 mak- ing was broken off from automakers decades ago) and leveraged to serve multiple clients with greater economies of scale.12 Such outsourcing enables client firms to

FIGURE 3.1 The Value Chain.

Infrastructure

Logistics

Human resource

Infrastructure

Logistics

Human resources

INPUT

Research and development

Components

Final assembly

Marketing

OUTPUT

INPUT

Research and development

Components

Final assembly

Marketing

OUTPUT

Primary activities Support activities

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

Primary activities Support activities

NOTE: Dotted lines represent firm boundaries.

64 Part 1 • Foundations of Global Strategy

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FIGURE 3.2 A Decision Model in a Value Chain Analysis.

Do we really need to perform this activity

in-house?

No

Yes

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

No

Access resources and capabilities

through strategic alliances

Acquire necessary resources and

capabilities in-house

FIGURE 3.3 In-House versus Outsource.

C o m

m o d

it iz

a ti

o n

v e rs

u s p

ro p

ri e ta

ry

n a tu

re o

f th

e a

c ti

v it

y

Industry specificity

Cell 1 Outsource

Cell 3 In-House

Cell 2 Outsource

Cell 4 ???

Industry specific

Common across industries

Pr op

rie ta

ry (fi

rm -s

pe ci

fic )

Hi gh

co m

m od

iti za

tio n

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

Chapter 3 • Leveraging Resources and Capabilities 65

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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 capabili- ties are not up to the task, then there are two choices (see Figure 3.2). First, the firm may want to acquire and develop capabilities in-house so that it can better perform this particular activity.13 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.14 Because the two terms “outsourcing” and “off- shoring” 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):15

• 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 “onshor- ing” 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, interestingly, eastern Germany; northern France; and the Appalachian, Great Plains, and southern regions of the United States have emerged as new hotbeds for onshoring.16 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 c a ti

o n

o f

a c ti

v it

y

Cell 3 Domestic

in-house

Cell 4 Onshoring

In-house Outsourcing

Domestic location

Foreign location

NOTE: “Captive sourcing” is a new term, which is conceptually identical to foreign direct investment (FDI), a term widely used in global strategy.

66 Part 1 • Foundations of Global Strategy

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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, tak- ing 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 out- sourced 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 analy- sis. The recent proliferation of new labels is intimidating, causing some gurus to claim that “21st-century offshoring really is different.”17 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 new framework.

FROM SWOT TO VRIO18 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 orga- nizational (O) aspects of resources and capabilities, leading to a VRIO framework. Sum- marized 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.19 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 point. IBM historically excelled in making hard- ware, 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, IBM has been more focused on lucrative soft- ware 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, a leading technology con- sulting firm, and sold its PC division to Lenovo.

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.

Chapter 3 • Leveraging Resources and Capabilities 67

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The relationship between valuable resources and capabilities and firm per- formance is straightforward. Instead of becoming strengths, non-value-adding resources and capabilities, 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.20 In the worst case, they may become extinct, a fate IBM narrowly skirted during the early 1990s. According to IBM’s 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. 21

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?22 At best, valuable but common resources and capabilities will lead to competitive parity but not to 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.

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 qual- ity of the American Big Three automakers is now comparable with that of 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 the Canadian government). The point is simple: Flawless high quality is now expected among car buyers, is no longer rare, and thus provides little advantage. At best, it provides competitive parity.

The Question of Imitability Valuable and rare resources and capabilities can be a source of competitive advan- tage only if competitors have a difficult time imitating them. While it is relatively eas- ier 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 knowledge, superior motivation, and managerial talents).

Imitation is difficult. Why? In two words: causal ambiguity, which refers to the diffi- culty of identifying the causal determinants of successful firm performance. What exactly has caused Burberry to be such an enduring and continuously relevant luxury goods company (see the Opening Case)? Burberry has no shortage of competitors and imitators. Its performance has not always been enviable. Yet, in the past 160 years Bur- berry has always been able to turn around by finding new paths to growth (sometimes by returning to roots, as evidenced by its most recent turnaround).

A natural question is: How does Burberry do it? Usually a number of resources and capabilities will be nominated, such as a commitment to customer relationships, a willingness to change, a strong leadership team, and a multinational presence. While all of these 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, but it can also be hugely profitable for Burberry’s rivals. Unfor- tunately, outsiders usually have a hard time understanding what a firm does inside its boundaries. We can try, as many rivals have, to identify Burberry’s recipe for success by drawing up a long list of possible reasons, labeled as “resources and capabilities” in our classroom discussion. But in the end, as outsiders we are not sure.23

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What is even more fascinating for scholars and students, and more frustrating for rivals, is that, often, managers of a focal firm such as Apple do not know exactly what contributes to their firm’s success. When interviewed, they can usually gener- ate a long list of what they do well, such as a strong organizational culture, a relent- less drive, and many other attributes. To make matters worse, different managers of the same firm may have a different list. When probed as to which resource or capa- bility is “it,” they usually suggest that it is all of the above in combination. After Apple made a record-breaking US$18 billion profit in the fourth quarter of 2014 (never before had so much money been made by a single firm in three months), its CEO Tim Cook told the media that it was “hard to comprehend.”24 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, then it is not surprising that outsider efforts in understanding and imitating these capabilities are usually flawed and often fail.

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 Burberry, 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.25 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 organiza- tion asks: How can a firm (such as a movie studio) be organized to develop and lever- age the full potential of its resources and capabilities?

Numerous components within a firm are relevant to the question of organiza- tion.26 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,27 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 names of the stars. However, stars alone cannot generate hit movies. 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, gen- erate such advantage.”28

Known as the ability to use one’s two hands equally well, ambidexterity in the strat- egy and management literature describes capabilities to simultaneously deal with paradoxes. For example, in emerging economies, ambidexterity to manage both mar- ket forces and government forces simultaneously—as a bundle of complementary resources—is key to navigate the competitive waters.29 In other words, to attain competitive advantage, market-based and nonmarket-based (political) capabilities need to complement each other. This is not only important for foreign firms, but is also crucial for 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 fac- tory in the Indian state of West Bengal. Thousands of farmers who lost their land used to build the Nano factory protested. Political pressure 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 relations domestically underscores the importance of ambidexterity as capabilities to manage

Chapter 3 • Leveraging Resources and Capabilities 69

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both market-based and nonmarket-based relationships. Otherwise, strong market performers, such as Tata in India, may nevertheless hit a wall when messing up gov- ernment relations.

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.30 Such organi- zationally 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 (à la Lego toy blocks). By treating employees as identical and replaceable blocks, the “Lego” view fails to realize that social capital associated with complex relationships and knowledge permeating many firms can be a source of competitive advantage.

Overall, only valuable, rare, and hard-to-imitate capabilities that are organiza- tionally embedded and exploited can lead to sustained competitive advantage and persistently above-average performance.31 Because capabilities cannot be evaluated in isolation, the VRIO framework presents four interconnected and increasingly diffi- cult hurdles (Table 3.2). In other words, these four aspects come together as one “package.” Shown 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. Figure 3.6 draws on your author’s recent consulting work for the UK government on how to enhance the export competitiveness of UK manufacturing.

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 international capabilities.

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. ©

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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 industry-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 Apple in IT and Ryanair in airlines versus other competitors. Findings are mixed. Some studies find industry-specific effects to be more significant, and other studies are supportive of the resource-based view—firm-specific capabilities are stronger deter- minants of firm performance than industry-specific effects.32

While the debate goes on, it is important to caution against an interest in declaring one side to be “winning.”33 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 con- front the challenge of how to measure unobservable firm-specific capabilities, such as organizational learning, knowledge management, and managerial 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.34 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).”35 Resource-based theorists readily admit that “the source of sustain- able competitive advantage is likely to be found in different places at different points in time in different industries.”36 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

FIGURE 3.6 UK Manufacturing: The Search for Strategic Sweet Spot.

Export customers’ demand

UK rivals’ capabilities

UK manufacturers’ offerings

SWEET SPOT

SOURCE: M. W. Peng & K. Meyer, 2013, Winning the future markets for UK manufacturing output (p. 30), Future of Manufacturing Project Evidence Paper 25, London: UK Government Office for Science. The full report is in the public domain at www.bis.gov.uk/foresight. © Crown copyright.

Chapter 3 • Leveraging Resources and Capabilities 71

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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 develop- ment of the resource-based view.37 It seems to make better sense when viewing both perspectives as complementary to each other.

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 dynami- cally fast-moving industries (such as IT). Critics, therefore, posit that the resource- based view needs to be strengthened 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.38 Tacit knowledge, probably the most valu- able, unique, hard-to-imitate, and organizationally complex resource, may represent the ultimate dynamic capability a firm can have.39 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 hall- mark for resources in relatively slow-moving industries (such as hotels and railways) is complexity 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).”40 In other words, while traditional resource-based analysis urges firms to rigorously analyze their strengths and weaknesses and then plot some linear applica- tion 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.

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 bound- aries, 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.

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Not all fast-moving industries are high-tech ones. As the pace of competition accelerates, more industries, including many traditional low-tech ones, are becoming fast moving. The end result is hypercompetition, whose hallmark is a shortened window during which a firm may command competitive advantage.41 In hypercompetition, firms undertake dynamic maneuvering intended to unleash a series of small, unpre- dictable, but powerful actions to erode rivals’ competitive advantage.

Overall, recent research suggests that the current resource-based view may have overemphasized the role of leveraging existing resources and capabilities and underem- phasized the role of developing new ones. The assumption that a firm is a tightly bun- dled collection of resources may break down in high-velocity environments, whereby resources are added, recombined, and dropped with regularity.42 In such a world, a series of short-term unpredictable advantage seems to be the best a firm can hope for.

Offshoring versus Non-Offshoring Offshoring—or, more specifically, international (offshore) outsourcing—has emerged as a leading corporate movement in the 21st century.43 Whether such off- shoring proves to be a long-term benefit or hindrance to Western firms and econo- mies is debatable.

Proponents argue that offshoring creates enormous value for firms and econo- mies.44 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 noncore (and often uncompetitive) activities. In turn, off- shoring service providers, such as Infosys and Wipro, develop their core competen- cies in business process outsourcing (BPO). A McKinsey study reports that for every dollar spent by US firms’ offshoring in India, $1.46 of new wealth is created, of which the US economy captures $1.13, through cost savings and increased exports to India, which buys Made-in-USA equipment, software, and services (see Table 3.4). India captures the other 33 cents through profits, wages, and taxes.45 While acknowledg- ing that some US employees may regrettably lose their jobs, offshoring proponents suggest that, on balance, offshoring is a win–win solution for both US and Indian firms and economies. In other words, offshoring can be conceptualized as the latest incarnation of international trade (in tradable services), which theoretically will bring mutual gains to both countries.

Critics of offshoring make three points on strategic, economic, and political grounds. Strategically, according to some outsourcing gurus, if “even core functions like engineering, R&D, manufacturing, and marketing can—and often should—be moved outside,”46 what is left of the firm? In manufacturing, US firms have gone down this path before, with disastrous results. In the 1960s, Radio Corporation of America (RCA) invented the color TV and then outsourced its production to Japan,

TABLE 3.4 Benefit of US$1 US Spending on Offshoring to India.

Benefit to the United States US$ Benefit to India US$ 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.

Chapter 3 • Leveraging Resources and Capabilities 73

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a low-cost country at that time. Fast-forward to 2010: the United States no longer has any US-owned color TV producers left. The nationality of RCA itself, after being bought and sold several times, is now Chinese (France’s Thomson sold RCA to Chi- na’s TCL in 2003). Critics argue that offshoring nurtures rivals. Why are Indian IT/ BPO firms now emerging as strong global rivals to Western firms such as IBM? It is in part because they built up their capabilities doing work for IBM in the 1990s to fix the “millennium bug” (Y2K) problem.

In manufacturing, many Asian firms, which used to be original equipment manufac- turers (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 3.7). Having mastered low-cost and high-quality manufacturing, Asian firms such as Asus, BenQ, Compal, Flextronics, Hon Hai/Foxconn, 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 (such as Taiwan’s Acer), 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 contend that they are not sure whether developed econo- mies, on the whole, actually gain more. While shareholders and corporate high-flyers embrace offshoring (see Chapter 1), offshoring increasingly results in job losses in high-end areas such as design, R&D, and IT/BPO. Finally, critics make the political argument that many large US firms claim that they are global companies and, conse- quently, that they should neither represent nor be bound by American values any more. According to this view, all that these firms are interested in is the cheapest and most exploitable labor. Not only is work commoditized, but people (such as IT programmers) are also degraded as tradable commodities that can be jettisoned. As a result, large firms that outsource work to emerging economies are often accused of

FIGURE 3.7 From Original Equipment Manufacturer (OEM) to Original Design Manufacturer (ODM).

An example of OEM An example of ODM

INPUT

Research and development

Components

Final assembly

Marketing

OUTPUT

INPUT

Research and development

Components

Final assembly

Marketing

OUTPUT

Primary activities Primary activities

NOTE: Dotted lines represent firm boundaries. A further extension is to become an original brand manufacturer (OBM), which would incorporate brand ownership and management in the marketing area.

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being unethical, destroying jobs at home, ignoring corporate social responsibility, 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 explo- sive when such accusations are made. More recently as the cost of producing in China rises because of rising labor cost and unreliable quality, some Western firms have brought work back to their home countries—a process known as reshoring.

This debate primarily takes place in developed economies. There is little debate in emerging economies because they stand to gain from such 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 Japa- nese 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 firms 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? Some domestically successful firms continue to succeed overseas. IKEA has found that its Scandinavian-style furniture, combined with do-it-yourself flat packaging, is popular around the globe. Thus, IKEA has become a global cult brand. The young generation in Russia is now known as the “IKEA Generation.”

However, many other firms that are formidable domestically are burned badly overseas. Wal-Mart withdrew from Germany, India, and South Korea. Similarly, its leading global rival, Carrefour, had to exit the Czech Republic, Japan, Mexico, and South Korea. In electronics, Best Buy found it was the “worst buy” in China and had to quit the country. Similarly, Media Markt of Germany had to leave China in tears.

Are domestic resources and cross-border capabilities essentially the same? The answer can be either “Yes” or “No.” This debate is an extension of the larger debate on whether international business is different from domestic business. However, there is no right or wrong answer.

THE SAVVY STATEGIST 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 dis- tinguish 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, espe- cially the S and W parts. Because managers cannot pay attention to every capabil- ity, 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 their capabilities relative to those of their rivals, thus resulting in a mixed bag of both good and mediocre capabilities. The VRIO framework helps managers make decisions on what capabilities to focus on in-house and what to outsource.

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.

Chapter 3 • Leveraging Resources and Capabilities 75

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Second, relentless imitation or benchmarking, while important, is not likely to be a successful strategy.47 By the time Elvis Presley died in 1977, there were a little more than 100 Elvis impersonators. After his death, the number skyrocketed.48 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, consequently, the least important practices of winning firms (and rock stars). 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.

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.49 All a firm can hope for is a competi- tive advantage that can be sustained for as long as possible. Over time, all advan- tages erode.50 For example, 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. Even IBM’s newer focus on software and servers is challenges by cloud computing heavyweights such as Amazon.51 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 develop resources and capabilities for future competition.52

Finally, how does the resource-based view answer the four fundamental ques- tions in strategy? The idea that each firm is a unique bundle of resources and capabil- ities 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 resources and capabilities and overcome their weaknesses. Third, what 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 rel- ative 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 Burberry’s lifespan of close to 160 years (see the Opening Case) is entirely blessed by luck alone.53

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 down-

stream 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 activ-

ity 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.

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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 sus- tainable 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.

CRITICAL DISCUSSION QUESTIONS 1. Pick any pair of rivals (such as Boeing/Airbus and Apple/Samsung), 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 activ- ities or argue against such activities (assuming you are employed at a firm head- quartered in a developed economy).

3. ON ETHICS: Since managers read information posted on competitors’ web- sites, 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

2. The Opening Case introduces Burberry, which is 160 years old in 2016. Find another firm in any industry and any country that has also survived more than 100 years. Find the “secrets” behind the longevity of this firm.

3. ON ETHICS: Highly successful firms ranging from Standard Oil in the 1910s to Microsoft in the 1990s have been accused by the government and many critics for engaging in “unfair” competition to “crush competitors.” As CEO of one of the successful firms that is being sued by the government for engaging in such behavior, how do you defend your firm from a resource-based view?

Chapter 3 • Leveraging Resources and Capabilities 77

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CLOSING CASE 3.1

Emerging Markets: From Copycats to Innovators The rise of emerging multinationals from emerging economies—think of Acer, BYD, Cemex, Embraer, Foxconn, Geely, Goldwind, HTC, Lenovo, Mahindra, Suzlon, and Tata—has cre- ated tremendous buzz, fear, and disdain around the world. The fear comes from multina- tionals based in developed economies that are afraid of the disruption brought by this new breed of global competitors. The disdain stems from the characterization of these new mul- tinationals 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 man- ufacturers (OEM) up to speed—that was how Acer and Lenovo started. In the scramble prior to 2000 to fix the “millennium bug” (otherwise known as the “Y2K” problem), West- ern 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 emerging 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 innovations that it owns—the jargon is “ownership advantage.” 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 genera- tions 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 undermine 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 probably 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 econo- mies, many emerging multinationals openly profess that they go abroad to learn. Tata expressed a strong interest in learning how to compete in developed economies 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 masters. 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 learning 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.

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While scholars have long suggested that innovations do not necessarily have to be “high-tech,” the hype about “innovation” centers around cutting-edge products and services—many executives and firms daydream about becoming the next Apple. Emerg- ing 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 innovations 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, respec- tively, represent some successful examples of these new experiments, which are neces- sitated by the emergence of innovative new multinationals that even the mighty GE has to take seriously (see Emerging Markets 1.2).

Sources: 1. R. Chittoor, M. Sarkar, S. Ray, & P. Aulakh, 2009, Third World copycats to emerging multina-

tionals, 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 Management Per-

spectives, May: 37–56; 4. J. Mathews, 2006, Dragon multinationals as new features of globalization in the 21st century,

Asia Pacific Journal of Management, 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 International

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 comparative ownership advantage framework

for cross-border M&As, Journal of World Business, 47: 4–16.

Questions 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?

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 revolutio- nizes entrepreneurial financing in the developing world, but works for the inner-city poor in developed economies.

Chapter 3 • Leveraging Resources and Capabilities 79

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CLOSING CASE 3.2

Enhancing Value, Rarity, and Inimitability at Burberry Asked to name an iconic British luxury brand, most people would probably nominate Burberry. Founded in 1856, Burberry grew to become a leading global fashion house with US$5.2 billion revenue in 2012. Most famous for its trench coats worn by soldiers in the trenches during World War I, Burberry became such a part of British culture that it earned a royal warrant as an official supplier to the royal family.

However, by the mid-2000s, Burberry had lost its focus. It had 23 licensees in a vari- ety of products and locations around the world, each doing something different, ranging from dog cover-ups and leashes to kilts. In luxury, ubiquity by definition is the killer of exclusivity. Among numerous Burberry products, outerwear exemplified by the “boring old trench coat” only represented 20% of its global revenue. While luxury sales were growing globally, Burberry seemed to be losing out, with a lackluster growth rate of only 2% per year by 2006. Each of Burberry’s two leading global rivals (LVMH and Gucci) had more than ten times Burberry’s revenue and much higher growth. How could Burberry, which had become a “David,” grow against such “Goliaths”?

In 2006, with the arrival of new CEO Angela Ahrendts, significant soul searching took place at Burberry. Focusing on value, rarity, and inimitability of Burberry’s resources and capabilities, the firm realized that its greatest assets lay in its Britishness, more specifi- cally its trench coat roots—hence, the highest value it could deliver. Further, such a focus on Britain’s positive country-of-origin image would be rare in a world largely populated by French and Italian luxury brands. It would also be difficult (or sometimes impossible) to imitate if this heritage were emphasized and strengthened.

With this powerful insight, Burberry adopted a new strategy centered on the iconic trench coat—its first social media platform was named www.artofthetrench.com. Before the transformation, Burberry sold just a few styles of trench coats and almost all were beige with the signature check lining. Now with centralized and consistent design (a sig- nificant intangible capability), it sells more than 300 products in a wide variety of styles and colors related to trench coats. By 2012, 60% of its revenue came from apparel, and outerwear made up more than half of that. Many of its stylish trench coats are priced over US$1,000. Further, instead of outsourcing, Burberry has concentrated its trench coat pro- duction at the Castleford factory in the north of England, adding more than 1,000 jobs in the UK in the last two years alone (of a global labor force of 9,000). In summary, a Burberry trench coat designed and manufactured in the UK is valuable, rare, and impos- sible to imitate by rivals.

The upshot? Burberry has been rewarded handsomely by the market. In five years (2007–2012), its revenue and operating income doubled. In 2011, Interbrand named it the fourth fastest-growing global brand (behind Apple, Google, and Amazon) and the fastest- growing luxury brand. So impressed was Apple that in 2013 it poached Ahrendts, who quit Burberry and became Apple’s senior vice president in charge of retail and online operations.

Sources 1. A. Ahrendts, 2013, Burberry’s CEO on turning an aging British icon into a global luxury brand,

Harvard Business Review, January: 39–42; 2. Daily Mail, 2013, Burberry share price plummets after CEO Angela Ahrents quits fashion house

to take key role at Apple, October 13: www.dailymail.co.uk; 3. M. W. Peng, 2014, High fashion fights recession, in M. W. Peng, Global Strategy, 3rd ed.

(57–59), Cincinnati: Cengage Learning; 4. M. W. Peng & K. Meyer, 2013, Winning the future markets for UK manufacturing output (p. 30),

Future of Manufacturing Project Evidence Paper 25, London: UK Government Office for Science; 5. www.artofthetrench.com; 6. www.burberry.com.

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Questions 1. Why is Burberry able to turn around? 2. Why does it choose to focus on the value, rarity, and inimitability of its core products centered

on outerwear, as opposed to the proliferation of unrelated products?

CLOSING CASE 3.3

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 information tech- nology (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 nanotechnology. IBM is renowned for its innovations. It holds more patents than any other US firm and currently has nine research laboratories world- wide. 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 data- base, 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, mak- ing 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 (Newsweek), 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 character- ized perhaps more than any other by innovation and change?” asked the Economist. This question 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 com- petition in this fast-moving industry is legendary. In essence, this industry can be charac- terized as never-ending efforts to create “platforms.” First came tabulating machines. Then mainframes. 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 shortage of ambitious new entrants. Many of them have flamed out while IBM marches on. Customers in personal and busi- ness segments have different needs, and it is hard to please them all. Suppliers of com- ponents 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 dominance 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

Chapter 3 • Leveraging Resources and Capabilities 81

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1990s, it narrowly escaped from bankruptcy. IBM has undergone numerous rounds of organizational restructuring since its inception, acquiring companies such as Pricewater- house Coopers (2002) and selling off businesses 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 relationships. A willingness to change. A strong leadership team. A multinational presence—it now has 60,000 employees in India and its corporate procurement headquarters is based in China. Many more factors can be nominated. But what exactly is it? Answers to this crucial ques- tion are not only important to IBMers and their competitors, 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: 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. Economist, 2011, 1100100 and counting, June 11: 67–69; 4. Economist, 2011, IBM v. Carnegie Corporation, June 11: 64–66.

Questions 1. Why is IBM able to stand out in a very crowded and competitive industry? 2. How has IBM consistently delivered value to customers in the past century? 3. Why do most of its rivals fail to match IBM’s longevity?

NOTES

[Journal acronyms] AMJ—Academy of Management Journal; AMP—Academy of Management Perspectives; AMR—Academy of Management Review; BW—Busi- nessWeek (before 2010) or Bloomberg Businessweek (since 2010); CMR—Califor- nia Management Review; GSJ—Global Strategy Journal; HBR—Harvard Business Review; JEP—Journal of Economic Perspectives; 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; SMJ—Strategic Management Journal; SO—Strategic Organization

1. J. Barney, 1991, Firm resources and sustained competitive 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, 2009, Promarket reforms and firm profitability in developing countries, AMJ, 52: 1348–1368; D. Sirmon, M. Hitt, J. Arregle, & J. Campbell, 2010, The dynamic interplay of capability strengths and weaknesses, SMJ, 31: 1386–1409.

3. M. W. Peng & P. Heath, 1996, The growth of the firm in planned economies in transition, AMR, 21: 492–528. See also W. Egelhoff & E. Frese, 2009, Understanding managers’ preferences for internal markets versus business planning, JIM, 15: 77–91; H. Greve, 2008, A behavioral theory of firm growth, AMJ, 51: 476–494; M. Huesch, 2013, Are there always synergies between productive resources and resource deployment capabilities? SMJ, 34: 1288–1313; T. Reus, A. Ranft, B. Lamont, & G. Adams, 2009, An interpretive systems view of knowledge investments, AMR, 34: 382–400; S. Sonenshein, 2014, How organization foster the creative use of resources, AMJ, 57: 814–848.

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4. J. Barney, 2001, Is the resource-based view a useful perspective for strategic management research? (p. 54), AMR, 26: 41–56.

5. D. Teece, 2007, Explicating dynamic capabilities, SMJ, 28: 1319–1350; D. Teece, 2014, The foundations of enterprise performance, AMP, 28: 328–352. See also J. Denrell, C. Fang, & Z. Zhao, 2013, Inferring superior capabilities from sustained superior performance, SMJ, 34: 182–196; G. Di Stefano, M. Peteraf, & G. Verona, 2014, The organizational drivetrain, AMP, 28: 307–327; S. Kahl, 2014, Association, jurisdictional battles, and the development of dual-purpose capabilities, AMP, 28: 381–394; A. Kleinbaum & T. Stuart, 2014, Network responsiveness, AMP, 28: 353–367; Y. Kor & A. Mesko, 2013, Dynamic managerial capabilities, SMJ, 34: 233–244; G. Lee, 2008, Relevance of organizational capabilities and its dynamics, SMJ, 29: 1257–1280; O. Schilke, 2014, Second-order dynamic capabilities, AMP, 28: 368–380; D. Sirmon & M. Hitt, 2009, Contingencies within dynamic managerial capabilities, SMJ, 30: 1375–1394.

6. C. Helfat & S. Winter, 2011, Untangling dynamic and operational capabilities, SMJ, 32: 1243–1250.

7. G. Davies, R. Chun & M. Kamins, 2010, Reputation gaps and the performance of service organizations, SMJ, 31: 530–546; Y. Mishina, E. Block, & M. Mannor, 2012, The path dependence of organizational reputation, SMJ, 33: 459–477; M. Rhee, 2009, Does reputation contribute to reducing organizational errors? JMS, 46: 676–702.

8. M. Porter, 1985, Competitive Advantage, New York: Free Press. 9. M. W. Peng, Y. Zhou, & A. York, 2006, Behind make or buy decisions in export

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chain specialization? JIM, 15: 126–141; K. Coucke & L. Sleuwaegen, 2008, 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; K. Kumar, P. van Fenema, & M. von Glinow, 2009, Offshoring and the global distribution of work, JIBS, 40: 642–667; Q. Li, P. Maggitti, K. Smith, P. Tesluk, & R. Katila, 2013, Top management attention to innovation, AMJ, 56: 893–916; S. Mudambi & S. Tallman, 2010, Make, buy, or ally? JMS, 47: 1434–1456; P. Puranam, R. Gulati, & S. Bhattacharya, 2013, How much to make and how much to buy? SMJ, 34: 1145–1161; G. Trautmann, L. Bals, & E. Hartmann, 2009, Global sourcing in integrated network structures, JIM, 15: 194–208; V. Van de Vranke, 2013, Balancing your technology-sourcing portfolio, SMJ, 34: 610–621; C. Weigelt & M. Sarkar, 2012, Performance implications of outsourcing for technological innovations, SMJ, 33: 189–216.

11. S. Kotha & K. Srikanth, 2013, Managing a global partnership model, GSJ, 3: 41–66. 12. S. Lahiri, B. Kedia, & D. Mukherjee, 2012, The impact of management capability on the

resource-performance linkage, JWB, 47: 145–155; R. Mudambi & M. Venzin, 2010, 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; C. Weigelt, 2013, Leveraging supplier capabilities, SMJ, 34: 1–21.

13. D. Gregorio, M. Musteen, & D. Thomas, 2009, Offshore outsourcing as a source of international competitiveness of SMEs, JIBS, 40: 969–988; D. Griffith, N. Harmancioglu, & C. Droge, 2009, Governance decisions 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; M. Sartor & P. Beamish, 2014, Offshoring innovation to emerging markets, JIBS, 45: 1072–1095.

14. 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 projects, JMS, 47: 1534–1560; S. Zaheer, A. Lamin, & M. Subramani, 2009, Cluster capabilities or ethnic ties? JIBS, 40: 944–968.

Chapter 3 • Leveraging Resources and Capabilities 83

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15. F. Contractor, V. Kuma, S. Kundu, & T. Pedersen, 2010, Reconceptualizing the firm in a world of outsourcing and offshoring, JMS, 47: 1417–1433.

16. A. Pande, 2011, How to make onshoring work, HBR, March: 30. 17. D. Levy, 2005, Offshoring in the new global political economy (p. 687), JMS, 42:

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F. Bridoux, R. Coeurderoy, & R. Durand, 2011, Heterogenous motives and the collective creation of value, AMR, 36: 711–730; O. Chatain & P. Zemsky, 2011, Value creation and value capture with frictions, SMJ, 32: 1206–1231; J. Grahovac & D. Miller, 2009, Competitive advantage and performance, 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 performance under a resource-based paradigm, SMJ, 31: 1164–1182; V. La, P. Patterson, & C. Styles, 2009, Client-perceived performance and value in professional B2B services, JIBS, 40: 274–300; M. Leiblein & T. Madsen, 2009, Unbundling competitive heterogeneity, SMJ, 30: 711–735; J. Macher & C. Boerner, 2012, Technological development at the boundaries of the firm, SMJ, 33: 1016–1036; M. Sun & E. Tse, 2009, The resource-based view of competitive advantage in two-sided markets, JMS, 46: 45–64; K. Zhou & C. Li, 2012, How knowledge affects radical innovation, SMJ, 33: 1090–1102.

20. J. Schmidt & T. Keil, 2013, What makes a resource valuable? AMR, 38: 206–228; D. Sirmon, S. Gove, & M. Hitt, 2008, Resource management in dyadic competitive rivalry, AMJ, 51: 919–935.

21. BW, 2011, Can this IBMer keep Big Blue’s edge? October 31: 31–32. 22. F. Aime, S. Johnson, J. Ridge, & A. Hill, 2010, The routine may be stable but the

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23. R. Casadesus-Masanell & F. Zhu, 2013, Business model innovation and competitive imitation, SMJ, 34: 464–482; S. Jonsson & P. Regner, 2009, Normative barriers to imitation, SMJ, 30: 517–536; F. Polidoro & P. Toh, 2011, Letting rivals come close or warding them off? AMJ, 54: 369–392; H. Posen, J. Lee, & S. Yi, 2013, The power of imperfect imitation, SMJ, 34: 149–164.

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26. G. Carnabuci & E. Operti, 2013, Where do firms’ recombinant capabilities come from? SMJ, 34: 1591–1613; 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 implications, SMJ, 31: 1337–1356; 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.

27. T. Chi & A. Seth, 2009, A dynamic model of the choice of mode for exploiting complementary capabilities, JIBS, 40: 365–387; A. Hess & F. Rothaermel, 2011, When are assets complementary? SMJ, 32: 895–909.

28. J. Barney, 1997, Gaining and Sustaining Competitive Advantage (p. 155), Reading, MA: Addison-Wesley.

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29. Y. Li, M. W. Peng, & C. Macaulay, 2012, Market-political ambidexterity during institutional transitions, SO, 11: 205–213; M. W. Peng, S. Sun, & L. Markoczy, 2015, Human capital and CEO compensation during institutional transitions, JMS, 52: 117–147.

30. A. Chatterji & A. Patro, 2014, Dynamic capabilities and managing human capital, AMP, 28: 395–408; E. Mollick, 2012, People and process, suits and innovators, SMJ, 33: 1001–1015.

31. G. Ray, L. Xue, & J. Barney, 2013, Impact of information technology capital on firm scope and performance, AMJ, 56: 1125–1147.

32. 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.

33. Y. Tang & F. Liou, 2010, Does firm performance reveal its own causes? SMJ, 31: 39–57. 34. P. Godfrey & C. Hill, 1995, The problem of unobservables in strategic management

research (p. 530), SMJ, 16: 519–533. 35. O. Williamson, 1999, Strategy research (p. 1093), SMJ, 20: 1087–1108. 36. D. Collis, 1994, How valuable are organizational capabilities (p. 151), SMJ, 15: 143–152. 37. B. Wernerfelt, 1984, A resource-based view of the firm (p. 171), SMJ, 5: 171–180. 38. 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.

39. S. Berman, J. Down, & C. Hill, 2002, Tacit knowledge as a source of competitive advantage in the National Basketball Association, AMJ, 45: 13–32.

40. K. Eisenhardt & J. Martin, 2000, Dynamic capabilities: What are they? (p. 1113), SMJ, 21: 1105–1121.

41. 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 hypercompetition in the software industry, SMJ, 31: 1431–1457,

42. J. Shamsie, X. Martin, & D. Miller, 2009, In with the old, in with the new, SMJ, 30: 1440–1452.

43. F. Ceci & A. Prencipe, 2013, Does distance hinder coordination? JIM, 19: 324–332; J. Chen, R. McQueen, & P. Sun, 2013, Knowledge transfer and knowledge building at offshored technical support centers, JIM, 19: 362–376; S. Houseman, C. Kurz, P. Lengermann, & B. Mandel, 2011, Offshoring bias in US manufacturing, JEP, 25: 111–132; P. Jensen, M. Larsen, & T. Pedersen, 2013, The organizational design of offshoring, JIM, 19: 315–323; R. Raman, D. Chadee, B. Roxas, & S. Michailova, 2013, Effects of partnership quality, talent management, and global mindset on performance of offshore IT service providers in India, JIM, 19: 333–346; A. Soderberg, S. Krishna, & P. Bjorn, 2013, Global software development, JIM, 19: 347–361.

44. D. Mukherjee, A. Gaur, & A. Dutta, 2013, Creating value through offshore outsourcing, JIM, 19: 377–389.

45. D. Farrell, 2005, Offshoring, JMS, 42: 675–683. 46. M. Gottfredson, R. Puryear, & S. Phillips, 2005, Strategic sourcing (p. 132), HBR,

February: 132–139. 47. K. Kim & W. Tsai, 2012, Social comparison among competing firms, SMJ, 33: 115–136. 48. D. Burrus, 2011, Flash Foresight (p. 11), New York: HarperCollins. 49. M. Chari & P. David, 2012, Sustaining superior performance 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; D. Souder & P. Bromiley, 2012, Explaining temporal orientation, SMJ, 33: 550–569.

50. G. Pacheco-de-Almeida, 2010, Erosion, time compression, and self-displacement of leaders in hypercompetitive environments, SMJ, 31: 1498–1526.

51. BW, 2014, It’s not us, it’s you: Why customers re breaking up with IBM, May 26: 58–63. 52. S. Rockart & N. Dutt, 2015, The rate and potential of capability development

trajectories, SMJ, 36: 53–75. 53. A. Henderson, M. Raynor, & M. Ahmed, 2012, How long must a firm be great to rule

out chance? SMJ, 33: 387–406.

Chapter 3 • Leveraging Resources and Capabilities 85

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CHAPTER

4 KEY TERMS institution-based view institutions institutional framework formal institutions regulatory pillar informal institutions normative pillar norms cognitive pillar transaction costs opportunism relational contracting informal, relationship-

based, personalized exchange

arm’s-length transaction

formal, rule-based, impersonal exchange with third-party enforcement

Institutional transitions firm strategy, structure, and

rivalry factor endowments related and supporting

industries domestic demand bounded rationality culture Power distance Individualism collectivism

masculinity femininity Uncertainty avoidance Long-term orientation Ethics code of conduct ethical relativism ethical imperialism corruption Foreign Corrupt Practices

Act (FCPA) in-group out-group cultural distance institutional distance

KNOWLEDGE OBJECTIVES 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 two leading debates concerning institutions, cultures, and ethics 7. Draw strategic implications for action

86

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Emphasizing Institutions, Cultures, and Ethics

OPENING CASE Emerging Markets: One Rock Formation, Two Countries

North Mexico shares a great deal of similarities with south Texas. They include landscape, weather, people, food, culture … and rock formation beneath the land. South Texas has hit the jackpot of sitting on top of Eagle Ford shale, whose rock formation contains significant shale gas deposits. Fueled by hydraulic fracturing—in short, “fracking”—thousands of shale wells have bubbled up throughout Texas. However, the entrepreneurial boom of fracking does not seem to spill over the border. As of May 2014, fewer than 25 shale wells have stood up in all of Mexico. Why has the same rock formation not generated the same entrepreneurial boom in Mexico?

The answer is institution based. Oil is big business. But Mexicans have a stubborn attachment to smallness in business. Mexico has a higher percentage of small firms with ten or fewer employ- ees as a share of all firms (95.5%) than other Latin American countries (80%–90% in Argentina, Brazil, and Chile). Known as the Peter Pan syndrome, many firms prefer to stay small than to grow, in an effort to minimize tax and regulatory intrusion. Overall, only 8% of bank loans in Mexico go to small and medium-sized enterprises (SMEs). Of about five million SMEs, only 900,000 are sufficiently formal to be creditworthy. Bank loans they obtain carry much higher interest rate than the interest rate for large firms.

Another reason behind the silence of fracking in Mexico is a lack of incentives. In Texas—as well as the rest of the United States—rights to what is discovered under one’s farm or ranch belong to the private owner, whereas in Mexico the government owns what is under your farm or ranch. In other words, private land ownership in Mexico literally only covers the land, but not anything under- neath it. As a result, there is hardly any incentive for any Mexican farmer or rancher to be curious about what lies beneath his or her land.

SOURCES: Based on (1) Economist, 2014, Electronic arm-twisting, May 17: 68; (2) Economist, 2014, On shaky ground, May 3: 32; (3) Economist, 2014, The Peter Pan syndrome, May 17: 63–64.

How are strategic decisions, such as drilling or not drilling for oil and shale gas, made? Why are Americans on one side of the US–Mexican border so eager to engage in fracking, while Mexicans on the other side are not so interested? It is evident that the industry-based and resource-based views introduced in the previous two chapters, while certainly insightful, are not enough to answer such high-stakes questions. To a large degree, firm strategies are enabled and constrained by institutions, popularly known as “the rules of the game” in a

87

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society. 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 firms may pay taxes out of their patriotic duty, a larger number of them pay taxes in fear of the coercive power of the govern- ment 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 cen- tered 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 we 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 example, 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 shut up and 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.

How do these three forms of supportive pillars combine to shape individual and firm behavior? Let us use two examples—one at the individual level and another at

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

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the firm level. First, speed limit formally defines how fast drivers can go. However, many drivers adjust their speed depending on the speed of other vehicles—a form of normative pillar. When some drivers are ticketed by police because they drive above the legal speed limit, they protest: “We are barely keeping up with traffic!” This state- ment indicates that they do not have a clear cognitive pillar regarding what is the right speed (never mind the posted speed limit signs); they often let other drivers define what is the right speed. Second, in 2008, a year during which Wall Street had to be bailed out by trillions of taxpayer dollars, Wall Street executives paid them- selves US$18 billion in bonuses. The resulting public outcry was understandable. However, by paying themselves so handsomely, these executives did not commit any crime. Therefore, the regulatory pillar had little teeth. Rather, this was a case of major clashes between normative pillar and cognitive pillar held by these executives. In the minds of these executives supported by their own cognitive pillar, they deserved such bonuses. What they failed to read was the normative pressure coming from an angry public.

What Do Institutions Do? While institutions do many things, their key role, in two words, is to reduce uncer- tainty.6 By signaling which conduct is legitimate and which is not, institutions con- strain the range of acceptable actions. In short, institutions reduce uncertainty, which can be potentially devastating.7 Political uncertainty such as terrorist attacks and ethnic riots may render long-range planning obsolete. Political deadlocks in Washington have made the US government “less stable, less effective, and less predictable,” which led Standard & Poor’s to downgrade its AAA 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 their contractual obligations 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 fric- tions in mechanical 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

An important source of transaction costs is opportunism, defined as self-interest seeking with guile. Examples include misleading, cheating, and confusing other par- ties in transactions that will increase transaction costs. In order to reduce such trans- action 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).

Without stable institutional frameworks, transaction costs may become pro- hibitively 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.

Chapter 4 • Emphasizing Institutions, Cultures, and Ethics 89

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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 about 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 be 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 out each other (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 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 ben- efits, 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

FIGURE 4.1 Informal Relationship-Based Personalized Exchange.

C os

ts /b

en efi

ts

Time

T1 T2 T3 T4

Costs

Benefits

Costs

Benefits

A

B E

D

FC

SOURCE: M. W. Peng, 2003, Institutional transitions and strategic choices (p. 279), Academy of Management Review, 28 (2): 275–296.

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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 law- yers are expensive. 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, by lowering transaction costs, 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). Consequently, firms are able to grow and economies to expand.

There is no guarantee 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 rela- tionships rather than working with new untried players, thus creating barriers to entry. As transaction complexity rises, informal dealings within the group may

FIGURE 4.2 Formal, Rule-Based, Impersonal Exchange.

C os

ts /b

en efi

ts

Time

T1 T2

Benefits

Costs

A

B

C

SOURCE: M. W. Peng, 2003, Institutional transitions and strategic choices (p. 280), Academy of Management Review, 28 (2): 275–296.

Chapter 4 • Emphasizing Institutions, Cultures, and Ethics 91

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become difficult—imagine a city or national economy whereby it would be too diffi- cult 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 compli- cated 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 evi- dent that managers making strategic choices during such transitions must take into account the nature of institutional frameworks and their transitions, a perspective introduced next.16

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 stra- tegic choices and institutional frameworks. To be sure, the influence of the “envi- ronment” has been noted. However, much existing work has a “task environment” view that focuses on economic variables such as market demand and technologi- cal change.

A case in point is Michael Porter’s “diamond” model (Figure 4.3) that argues that competitive advantage of different industries in different nations depends on four factors.17 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 provide the foundation upon which key industries can excel. Switzerland’s global excellence 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 Hunger Games 3 after Hunger Games 1 and 2 and Transformers 4 after Transformers 1, 2, and 3—each time pack- ing more excitement to go beyond the previous production. Overall, the combination of these four factors explains what is behind the competitive 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. Among strategists, Porter is not alone. Given that most research focuses on market economies, a market-based insti- tutional 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 are obviously selected within and constrained by institutional frameworks (see the Opening Case). 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 institution- based view focuses on the dynamic interaction between institutions and firms, and considers strategic choices as the outcome of such interaction. Specifically, strategic

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choices are not only driven by industry structure and firm-specific resources and capabilities emphasized by traditional strategic thinking, but are also a reflection of the formal and informal constraints of a particular institutional framework (see the Opening Case).19

Overall, it is increasingly acknowledged that institutions are more than back- ground conditions. Instead, “institutions directly determine what arrows a firm has

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

SOURCE: M. Porter, 1990, The competitive advantage of nations (p. 77), Harvard Business Review, March–April. © 1990 by Harvard Business School Publishing; all rights reserved.

FIGURE 4.4 Institutions, Firms, and Strategic Choices.

Firms

Strategic Choices

Institutions Dynamic

Interaction

Formal and informal

constraints

Industry conditions and firm-specific

resources and capabilities

Chapter 4 • Emphasizing Institutions, Cultures, and Ethics 93

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in its quiver as it struggles to formulate and implement strategy and to create com- petitive 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 mat- ter (Table 4.2). First, managers and firms rationally make strategic choices within institutional constraints.22 For example, hundreds of firms and thousands of indivi- duals around the world are involved with counterfeiting. Close to 10% of all world trade is reportedly in counterfeits.23 Remember that this is not slavery and 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 desir- able career to pursue after graduation, has ever declared an interest in joining coun- terfeiting. 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 deci- sion (from their standpoint at least), given an institutional environment of weak intellectual protection and the availability of moderately capable manufacturing and distribution skills.24 Of course, to suggest that a strategy of counterfeiting 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. Proposition 1 specifically deals with bounded rationality, which refers to the necessity of making rational decisions in the absence of complete information.25

Without prior experience, managers from emerging multinationals 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 their bounded rationality.

The second proposition is that while formal and informal institutions combine to govern firm behavior, in situations where formal constraints fail, informal con- straints 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 con- straints, based on personal relationships and connections (called blat in Russian) among managers and officials that have facilitated the growth of many entrepreneur- ial firms.

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 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 com- pete in product markets, so firms also fiercely compete in the political marketplace

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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characterized by informal ties.26 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.27 Such envi- able 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.28 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’ mas- tery of the rules of the game.

THE STRATEGIC ROLE OF CULTURE The Definition of Culture Although hundreds of definitions of culture have appeared, we will use the one pro- posed by the world’s foremost cross-cultural expert, Geert Hofstede, a Dutch profes- sor. He defines culture as “the collective programming of the mind which distinguishes the members of one group or category of people from another.”29

Although most international business textbooks 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 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 the American culture, there is no strict one-to-one correspondence between cultures and nation-states. Many sub-cultures exists in multiethnic countries such as Australia, Belgium, Brazil, Britain, Canada, China, India, Indonesia, Russia, South Africa, Switzerland, and the United States. Second, there are many layers of culture, such as regional, ethnic, and religious cul- tures. Within a firm, one will find a specific organizational culture (such as the IKEA culture). Having acknowledged the validity of these two points, we will follow Hof- stede 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 more than 200 nation-states imposing differ- ent institutional frameworks.

The Five Dimensions of Culture While many ways exist to identify dimensions of culture, Hofstede’s work has become by far the most influential. He and his colleagues have proposed five dimen- sions (Figure 4.5). 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 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, whom you call 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 uni- versities, 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

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“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.”

Individualism refers to the perspective that the identity of an individual is funda- mentally 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 con- trast, in collectivist societies, ties between individuals are relatively close and collec- tive accomplishments are often sought after. This difference in part explains when confronting economic downturns, why mass layoffs are widely used in the United States, whereas across-the-board pay cuts are frequently undertaken in Japan.

The masculinity versus femininity dimension refers to sex role differentiation. In every traditional society, men tend to have occupations that reward assertiveness, such as politicians, soldiers, and executives. Women, on the other hand, usually work in caring professions, such as teachers and nurses, in addition to being home- makers. High masculinity 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, executives, scientists, and soldiers, and men frequently assume the role of nurses, teachers, and househusbands.30

Uncertainty avoidance refers to the extent to which members in different cultures accept ambiguous situations and tolerate uncertainty. Members of high uncertainty 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.

FIGURE 4.5 Examples of Hofstede Dimensions of Culture.

Brazil China Germany Japan Pakistan Russia Singapore Sweden USA

Long-term Orientation

Uncertainty Avoidance

Masculinity

Individualism

Power Distance

118

60

50

20 67

66

65

31

80

92

95

46 14

50

70

0

90

40

50

20

48

8

48 33

29

8

71

10

80

35 54 55

95 74

31

65

76

49

38

69 40

91

62

46

29

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.

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Long-term orientation emphasizes perseverance and savings for future betterment. 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.31 It is important to note that Hofstede’s dimensions are not perfect and have attracted some criticisms.32 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 choice is consistent with Hofstede’s cultural dimensions. For example, solicitation of subordinate feedback and participation, widely prac- ticed in low power distance Western countries, is regarded as a sign of weak leader- ship and low integrity in high power distance countries.

Individualism and collectivism also affect strategic choices. Because entrepre- neurs are usually willing to take more risk, individualistic societies tend to foster rel- atively higher levels of entrepreneurship, whereas collectivism may result in relatively lower levels of entrepreneurship.

Likewise, the stereotypical manager in high masculinity societies is “assertive, decisive, and ‘aggressive’ (only in masculine societies does this word carry a positive connotation),” whereas the stylized manager in high femininity societies is “less visi- ble, intuitive rather than decisive, and accustomed to seeking consensus.”33

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 (such as quarterly) profits.

Overall, there is strong evidence pointing out the strategic importance of culture. 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). In addition, while “what is different” cross-culturally can be interest- ing, it can also be unethical and illegal—all depending on the institutional frame- works 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.34 Recent corporate scandals have pushed ethics to the forefront of global strategy discussions, with numerous firms introducing a code of conduct—a set of guidelines 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 neces- sarily becoming more ethical.

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• 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 instru- ment to help make good profits.

Perhaps the best way to appreciate the strategic value of ethics is to examine what happens after a crisis. As a “reservoir of goodwill,” the value of an ethical repu- tation can be magnified during crisis. After the 2008 terrorist attacks on the Taj Mahal Palace Hotel in Mumbai, India, 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 terror- ist attacks. Eleven employees laid down their lives while helping between 1,200 and 1,500 guests safely escape. Paradoxically, catastrophes may allow more ethical firms such as the Taj that are renowned for their integrity and customer service to shine.35

The upshot seems to be that ethics pays.

Managing Ethics Overseas Managing ethics overseas is challenging, because what is ethical in one country may be unethical elsewhere.36 Facing such differences, how can managers cope?

Two schools of thought exist.37 First, ethical relativism refers to an extension of the cliché, “When in Rome, do as the Romans do.” If women in Muslim countries are dis- criminated against, so what? Likewise, if industry rivals in Mexico 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 everywhere else. In prac- tice, however, neither of these schools of thought is realistic. At the extreme, ethical relativism would have to accept any local practice, whereas ethical imperialism 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

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 employ- ees, 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.

• 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: 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.

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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 hir- ing employees’ 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 set- ting up subsidiaries in India do? Donaldson advises that such nepotism is not neces- sarily 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 accompa- nied by guidelines for the scale of appropriate gift giving/receiving (see Table 4.5). Citigroup allows employees to accept noncash gifts whose nominal value is less than US$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 pri- vate benefits usually in the form of bribery (in cash or in kind).38 Corruption distorts the basis for competition that should be based on products and services, thus caus- ing misallocation of resources and slowing economic development.39 Therefore, cor- ruption discourages foreign direct investment (FDI). If the level of corruption in Singapore (very low) increases to the level in Mexico (in the midrange worldwide), it reportedly would have the same negative effect on FDI inflows as raising the tax rate by 50%.40

In the global fight against corruption, the US Congress enacted the Foreign Cor- rupt Practices Act (FCPA) in 1977, banning bribery to foreign officials. Many US firms complain that the act has unfairly restricted them. They also point out that over- seas bribery expenses were often tax-deductible (!) in many EU countries, such as Austria, France, Germany, and the Netherlands—at least until the late 1990s. How- ever, 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” pay- ments to get goods through customs abroad. Most alarmingly, a World Bank study reports that despite more than two decades of FCPA enforcement, US firms actu- ally “exhibit systematically higher levels of corruption” than do other OECD firms (original italics).41

Overall, the FCPA can be regarded as an institutional weapon in the fight against corruption.42 Recall that every institution has three supportive pillars: regulatory, normative, 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

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: Cengage Learning.

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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 firm resists corruption, then their combined power will eradicate it. How- ever, 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.43 In other words, the attention is on how certain practices (such as from paying bribes to refus- ing to pay) become institutionalized. Such forces of institutionalization are driven by a combination 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 4.6).

A reactive strategy is passive. Even when problems arise, firms do not feel com- pelled to act, and denying is usually the first line of defense. The need to take neces- sary action is neither internalized through cognitive beliefs, nor becomes any norm in practice. That only leaves formal regulatory pressures to compel firms to act.

TABLE 4.5 Texas Instruments (TI) Guidelines on Gifts in China.

• These China-specific Guidelines are based on TI’s Global Standard Guidelines, taking into consideration China’s local business climates, legal requirements, customs, and cultures as appropriate. Employees of TI entities in China (“TIers”) should comply with both these China- specific Guidelines and Global Standard Guidelines. In any event of conflict, the stricter standard will apply.

• Acceptable gifts include calendars, coffee cups, appointment books, notepads, small pocket calculators, and ball point pens.

• Gifts with excessive value refer to those that are worth more than RMB 200 yuan (approximately US$32), and need approval from Asia Finance Director.

• If you are not sure when you can accept or offer any gift, the following two Quick Tests are recommended:

a. “Reciprocity” Test. Ask this question: Based on your knowledge of TI’s policy and culture, would TI under similar circumstances allow you to provide a TI business partner a gift of an equivalent nature? If the answer is no, then politely refuse the offer.

b. “Raise Eyebrow” or “Embarrassments” Test. Ask those questions: Would you “raise eye- brows” or feel uncomfortable in giving or receiving the gift in the presence of others in a work area? Would you feel comfortable in openly displaying the gift you are offering or receiving? Would you feel embarrassed if it were seen by other TI business partners or by your colleagues/supervisor?

• No cash or cash equivalent gift cards may be given. Gift cards that are redeemable only for a specific item (and not cash) with a fixed RMB value, such as a Moon Cake card,* are permitted as long as the gift is otherwise consistent with these Guidelines.

*Moon Cake is a special dessert for the Mid-Autumn Festival, which is a major holiday for family reunion in September.

SOURCE: Adapted from Texas Instruments, Comprehensive Guidelines on Gifts, Entertainment, and Travel in China (2014).

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For example, as early as in 2005, General Motors (GM) had been aware that the igni- tion switch of some of its cars could accidentally shut off the engine. Yet, it refused to take any actions and proceeded to produce and sell the cars for a decade. Sure enough, accidents happened and people were killed and injured due to the faulty switches. Only when victims’ families sued and congressional pressures increased did GM belatedly recall millions of cars in 2014.

A defensive strategy focuses on regulatory compliance. In the absence of regula- tory pressures, firms often fight informal pressures coming from the media and acti- vists. In the early 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.

An accommodative strategy features emerging organizational norms to accept responsibility and a set of increasingly internalized cognitive beliefs and values toward making certain changes. In other words, it becomes legitimate to accept a higher level of ethical and moral responsibility beyond what is minimally required legally. For 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. In the 1970s Ford marketed the Pinto car, being aware of a design flaw that could make the car sus- ceptible to exploding in real-end collisions. Similar to GM’s recent scandal, Ford had not recalled the Pinto until congressional, consumer, and media pres- sures heated up. In 2000, Ford aggressively initiated a speedy recall, launched a 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 would open 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 government’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 establish- ing 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.44 Through such a proactive strategy, BMW has facilitated the emergence of new environmentally friendly norms.

TABLE 4.6 Strategic Responses to Ethical Challenges.

Strategic Responses Strategic Behaviors Examples in the Text Reactive Deny responsibility; do less than required GM (the 2000s) Defensive Admit responsibility but fight it; do the least that is required Nike (the 1990s) Accommodative Accept responsibility; do all that is required Ford (the 2000s) Proactive Anticipate responsibility; do more than is required BMW (the 1990s)

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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 and (2) cultural distance versus institutional distance.

Opportunism versus Individualism/Collectivism45

Opportunism is a major source of uncertainty, and transaction cost theorists main- tain that institutions emerge to combat opportunism. However, critics argue that emphasizing opportunism as “human nature” may backfire in practice. 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 espe- cially the case if B is from a collectivist society. Thus, attempts to combat opportun- ism may beget opportunism.

Transaction cost theorists acknowledge that opportunists are a minority in any population. 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, 2001, now have to go through heightened security. Every- body 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.46 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.”47 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 individual- ists 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. This can be seen at the street level. In China, drivers do not yield to pedestrians and often get mad by pressing the horn when pedestrians cross the street in front of their cars. In the United States, drivers often yield to pedestrians and wave to let them cross the street first. To drivers, pedestrians by definition are out-group members. As collectivists, the same Chinese drivers who are rude to pedestrians often demonstrate impeccable courtesy when dealing with their own in-group members. As individualists, the American drivers show little distinction when dealing with in-group and out-group members (pedestrians).

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!” Or, “Watch out for cars when crossing the street. They will smash you!” This helps explain why the United States, the leading individualist country, is among societies with a higher level of spontaneous trust,

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whereas there is greater interpersonal and interfirm distrust in the large society in China than in the United States.48 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 inter- est in joining the in-group, then it is fair to take advantage of them. This 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 (JVs) are shorter lived than are Japanese–Japanese JVs. Basically, when disputes and misunderstandings arise, it is difficult to ascertain whether the other side is deliberately being opportunistic or is simply being (cultur- ally) different. Firms in general may prefer to do business with culturally close coun- tries because of the shorter cultural distance.

However, critics make four arguments.49 First, they point out a number of find- ings inconsistent with the cultural distance hypothesis.50 Second, critics contend that given the complexity of foreign entry decisions, cultural distance, while impor- tant, is but one of many factors to consider. For instance, relative to national culture, organizational culture may be equally important.

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.”51 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 Brit- ish 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 cul- tural dimensions and investigate the intricacies of other institutional differences around the world.

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 insightful, they usu- ally 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 4.7). First, when entering a new country, do your homework by having a thorough understanding of the formal and informal institutions governing firm

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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. In coun- tries that emphasize informal relational exchanges, insisting on formalizing the contract right away may backfire.

Second, strengthen cross-cultural intelligence by building awareness, expand- ing knowledge, and leveraging skills.52 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. The best managers expect norms to shift over time by con- stantly deciphering the changes in the informal “rules of the game” and by taking advantage of new opportunities—how BMW managers proactively shaped the auto- mobile recycling norms serves as a case in point.

We conclude this chapter by revisiting the four fundamental questions. First, why do firms differ? The institution-based view points out the institutional frame- works 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.

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 contract- ing) 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 con-

straints will play a larger role.

TABLE 4.7 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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4. Appreciate the strategic role of cultures • According to Hofstede, national culture has five dimensions: (1) power dis-

tance, (2) individualism/collectivism, (3) masculinity/femininity, (4) uncer- tainty 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 dig-

nity 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 two leading debates on institutions, cultures, and ethics. • (1) Opportunism versus individualism/collectivism and (2) cultural distance

versus institutional distance. 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.

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 con- tainer 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?

4. ON ETHICS: One of the selling points of social media firms such as YouTube is that anybody is free to post anything. They have now become dissemination outlets and recruiting tools for some terrorist organizations that otherwise would not find low-cost ways to disseminate their hatred and recruit new members on a worldwide basis. Should social media firms do something about it? If so, how?

TOPICS FOR EXPANDED PROJECTS 1. Some argue that guanxi (relationships and connections) is a unique Chinese-

only phenomenon 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 as the Wall Street Journal) without explana- tions provided in brackets. Others disagree, arguing that every culture has a

Chapter 4 • Emphasizing Institutions, Cultures, and Ethics 105

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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.

2. 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.

3. ON ETHICS: As CEO of Chiquita, you are eager to promote CSR efforts, such as complying with the Social Accountability 8000 (SA8000) labor rights standard and Rain Forest environmental standard. However, you are frustrated that retai- lors and consumers have not rewarded such behavior. Should Chiquita scale back some of these CSR-driven activities?

CLOSING CASE 4.1

Emerging Markets: One Rock Formation, Two Countries North Mexico shares a great deal of similarities with south Texas. They include landscape, weather, people, food, culture … and rock formation beneath the land. South Texas has hit the jackpot of sitting on top of Eagle Ford shale, whose rock formation contains signifi- cant shale gas deposits. Fueled by hydraulic fracturing—in short, “fracking”—thousands of shale wells have bubbled up throughout Texas. However, the entrepreneurial boom of fracking does not seem to spill over the border. As of May 2014, fewer than 25 shale wells have stood up in all of Mexico. Why has the same rock formation not generated the same entrepreneurial boom in Mexico?

The answer is institution-based. Oil is big business. But Mexicans have a stubborn attachment to smallness in business. Mexico has a higher percentage of small firms with ten or fewer employees as a share of all firms (95.5%) than other Latin American countries (80%–90% in Argentina, Brazil, and Chile). Known as the Peter Pan syndrome, many firms prefer to stay small than to grow, in an effort to minimize tax and regulatory intrusion. Overall, only 8% of bank loans in Mexico go to small and medium-sized enterprises (SMEs). Of about five million SMEs, only 900,000 are sufficiently formal to be creditworthy. Bank loans they obtain carry much higher interest rate than the interest rate for large firms.

Another reason behind the silence of fracking in Mexico is a lack of incentives. In Texas—as well as the rest of the United States—rights to what is discovered under one’s farm or ranch belong to the private owner, whereas in Mexico the government owns what is under your farm or ranch. In other words, private land ownership in Mexico literally only covers the land, but not anything underneath it. As a result, there is hardly any incentive for any Mexican farmer or rancher to be curious about what lies beneath his or her land.

Sources 1. Economist, 2014, Electronic arm-twisting, May 17: 68; 2. Economist, 2014, On shaky ground, May 3: 32; 3. Economist, 2014, The Peter Pan syndrome, May 17: 63–64.

Questions 1. How are strategic decisions, such as drilling or not drilling for oil and shale gas, made? 2. Why are Americans on one side of the US–Mexican border so eager to engage in fracking, while

Mexicans on the other side are not so interested?

106 Part 1 • Foundations of Global Strategy

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NOTES

[Journal acronyms] AMJ–Academy of Management Journal; AMLE–Academy of Management Learning & Education; AMP–Academy of Management Perspectives; AMR–Academy of Management Review; APJM–Asia Pacific Journal of Manage- ment; BH–Business Horizons; 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 Management; JMS–Journal of Management Studies; JWB–Journal of World Business; RES–Review of Economics and Statistics; SMJ–Strategic Man- agement Journal; SO–Strategic Organization

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 maturation and moral conation, AMR, 36:

663–685. 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; T. Khoury & M. W. Peng, 2011, Does institutional reform of intellectual property rights lead to more inbound FDI? JWB, 46: 337–345; L. Weber & K. Mayer, 2014, Transaction cost economics and the cognitive perspective, AMR, 39: 344–363.

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.

12. M. W. Peng, 2003, Institutional transitions and strategic choices, AMR, 28: 275–296. See also S. Li, 1999, The benefits and costs of relation-based governance, working paper, City University of Hong Kong.

13. North, 1990, Institutions (p. 34). 14. M. Clemente & T. Roulet, 2015, Public opinion as a source of deinstitutionalization, AMR,

40: 96–114; B. Gray, J. Rurdy, & S. Ansari, 2015, From interactions to institutions, AMR, 40: 115–143; W. Ocasio, J. Loewenstein, & A. Nigam, 2015, How streams of communication reproduce and change institutional logics, AMR, 40: 28–48; 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). 16. K. Meyer & M. W. Peng, 2005, Probing theoretically into Central and Eastern Europe,

JIBS, 36: 600–621. 17. M. Porter, 1990, Competitive Advantage of Nations, New York: Free Press. 18. R. Corredoira & G. McDermott, 2014, Adaptation, bridging, and firm upgrading, JIBS,

45: 699–672; A. Cuervo-Cazurra & L. Dau, 2009, Promarket reforms and firm profitability in developing countries, AMJ, 52: 1348–1368; L. Dau, 2013, Learning across geographic space, JIBS, 44: 235–262; R. Hoskisson, M. Wright, I. Filatotchev, & M. W. Peng, 2013, Emerging multinationals from mid-range economies, JMS, 50: 1295–1321; G. McDermott, R. Corredoira, & G. Kruse, 2009, Public-private institutions as catalysts of upgrading in emerging market societies, AMJ, 52: 1270–1296.

19. M. Carney, E. Gedajlovic, & X. Yang, 2009, Varieties of Asian capitalism, APJM, 26: 361–380; S. Lazzarini, 2015, Strategizing by the government, SMJ, 36: 97–112; M. Witt & G. Redding, 2008, Culture, meaning, and institutions, JIBS, 40: 859–885.

Chapter 4 • Emphasizing Institutions, Cultures, and Ethics 107

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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. M. Abdi & P. Aulakh, 2012, Do country-level institutional frameworks and interfirm governance arrangements substitute or complement in international business relationships? JIBS, 43: 477–497; A. Chacar, W. Newburry, & B. Vissa, 2010, Bringing institutions into performance persistence research, JIBS, 41: 1119–1140; T. Kostova, K. Roth, & M. T. Dacin, 2008, Institutional theory in the study of multinational corporations, AMR, 33: 994–1006; K. Meyer & H. Thein, 2014, Business under adverse home country institutions, JWB, 49: 156–171; R. Salomon & Z. Wu, 2012, Institutional distance and local isomorphism strategy, JIBS, 43: 343–367; G. Shinkle & A. Kriauciunas, 2010, Institutions, size, and age in transition economies, JIBS, 41: 267–286.

22. C. Stevens & J. Cooper, 2010, A behavioral theory of governments’ ability to make credible commitments to firms, APJM, 27: 587–610.

23. P. Chaudhry & A. Zimmerman, 2009, The Economics of Counterfeit Trade, Heidelberg, Germany: Springer.

24. M. W. Peng, 2013, An institution-based view of IPR protection, BH, 56: 135–139. 25. 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.

26. M. Hadani & D. Schuler, 2013, In search of El Dorado, SMJ, 34: 165–181; 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.

27. BW, 2007, Inside the hidden world of earmarks, September 17: 56–59. 28. BW, 2011, Pssst … wanna buy a law? December 5: 66–72; Y. Li, M. W. Peng, & C.

Macaulay, 2013, Market-political ambidexterity during institutional transitions, SO, 11: 205–213.

29. G. Hofstede, 1997, Cultures and Organizations: Software of the Mind (p. 5), New York: McGraw-Hill; G. Hofstede, 2007, Asian management in the 21st century, APJM, 24: 421–428.

30. BW, 2012, Behind every great woman: The perfect husband, January 9: 54–59. 31. B. Kirkman, K. Lowe, & C. Gibson, 2006, A quarter century of Culture’s Consequences,

JIBS, 37: 285–320; L. Tang & P. Koveos, 2008, A framework to update Hofstede’s cultural value indices, JIBS, 39: 1045–1063.

32. 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. Verbeke, 2010, Beyond Hofstede and GLOBE, JIBS, 41: 1259–1274.

33. Hofstede, 1997, Cultures and Organizations (p. 94). 34. M. Bazerman, 2014, Becoming a first-class notice, HBR, July: 116–119; D. Welsh &

L. Ordonez, 2014, Conscience without cognition, AMJ, 57: 723–742. 35. R. Deshpande & A. Raina, 2011, The ordinary heroes of the Taj, HBR, December:

119–123. 36. D. McCarthy & S. Puffer, 2008, Interpreting the ethicality of corporate governance

decisions in Russia, AMR, 33: 11–31. 37. This section draws heavily from T. Donaldson, 1996, Values in tension, HBR,

September–October: 4–11. 38. I. Montiel, B. Husted, & P. Christmann, 2012, Using private management standard

certification to reduce information asymmetries in corrupt environments, SMJ, 33: 1103–13; J. Spencer & C. Gomez 2011, MNEs and corruption, SMJ, 32: 280–300.

39. S. Lee & S. Hong, 2012, Corruption and subsidiary profitability, APJM, 29: 949–964; S. Lee & D. Weng, 2013, Does bribery in the home country promote or dampen firm exports? SMJ, 34: 1472–1487; J. Zhou & M. W. Peng, 2012, Does bribery help or hurt firm growth around the world? APJM, 29: 907–921.

40. S. Wei, 2000, How taxing is corruption on international investors? RES, 82: 1–11.

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41. J. Hellman, G. Jones, & D. Kaufmann, 2002, Far from home: Do foreign investors import higher standards of governance in transition economies (p. 20), Working paper, Washington: World Bank (www.worldbank.org).

42. A. Cuervo-Cazzura, 2008, The effectiveness of laws against bribery abroad, JIBS, 39: 634–651.

43. 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.

44. S. Hart, 2005, Capitalism at the Crossroads, Philadelphia: Wharton School Publishing. 45. This section draws heavily from C. Chen, M. W. Peng, & P. Saparito, 2002,

Individualism, collectivism, and opportunism, JM, 28: 567–583. 46. J. Cullen, K. P. Parboteeah, & M. Hoegl, 2004, Cross-national differences in managers’

willingness to justify ethically suspect behaviors, AMJ, 47: 411–421. 47. M. Muethel & M. Bond, 2013, National context and individual employees’ trust of the

out-group, JIBS, 2013: 312–333. 48. F. Fukuyama, 1995, Trust, New York: Free Press; G. Redding, 1993, The Spirit of

Chinese Capitalism, New York: Gruyter. 49. 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 rhetoric or bloody knuckles, JIBS, 43: 28–40; O. Shenkar, Y. Luo, & O. Yoheskel, 2008, From “distance” to “friction,” AMR, 33: 905–923.

50. O. Shenkar, 2012, Cultural distance revisited, JIBS, 43: 1–11; S. Zaheer, M. Shomaker, & L. Nachum, 2012, Distance without direction, JIBS, 43: 18–27.

51. 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 distance, JIBS, 41: 1460–1480; L. Hakanson & B. Ambos, 2010, The antecedents of psychic distance, JIM, 16: 195–210.

52. G. Lucke, T. Kostova, & K. Roth, 2014, Multiculturalism from a cognitive perspective, JIBS, 45: 169–190; M. Mendenhall, A. Arnardottir, G. Oddou, & L. Burke, 2013, Developing cross-cultural competencies in management education via cognitive- behavior therapy, AMLE, 12: 436–451; A. Molinsky, 2013, The psychological processes of cultural retooling, AMJ, 56: 683–710; S. B. Szkudlarek, J. McNett, L. Romani, & H. Lane, 2013, The past, present, and future of cross-cultural management education, AMLE, 12: 477–493; N. Yagi & J. Kleinberg, 2011, Boundary work, JIBS, 42: 629–653.

Chapter 4 • Emphasizing Institutions, Cultures, and Ethics 109

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PART 2 Business-Level Strategies

• Chapter 5 Growing and Internationalizing the Entrepreneurial Firm

• Chapter 6 Entering Foreign Markets

• Chapter 7 Making Strategic Alliances and Networks Work

• Chapter 8 Managing Global Competitive Dynamics

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CHAPTER

5 KEY TERMS

small and medium-sized enterprises (SMEs)

entrepreneurship entrepreneurs international

entrepreneurship liability of newness Strong ties

weak ties venture capitalists (VCs) microfinance initial public offering (IPO) born global firms (or international new ventures)

direct exports

licensing Franchising indirect exports Export intermediaries serial entrepreneurs stage models

KNOWLEDGE OBJECTIVES 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 those that

stay in domestic markets 5. Participate in three leading debates concerning entrepreneurship 6. Draw strategic implications for action

112

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Growing and Internationalizing the Entrepreneurial Firm

OPENING CASE Emerging Markets: The Rise of Alibaba

Founded in 1999 by a former English teacher Jack Ma, Alibaba has risen to become the largest e-commerce firm not only in China, but also in the world—the value of goods sold on its platforms (US$170 billion in 2013) are more than Amazon and eBay combined. Alibaba started as a business- to-business (B2B) portal connecting overseas buyers and small Chinese manufacturers. Inspired by eBay, Alibaba next launched Taobao, a consumer-to-consumer (C2C) portal that now features nearly one billion products and is the one of the 20 most-visited websites worldwide. Finally, with Tmall, Alibaba offers an Amazon-like business-to-consumer (B2C) portal that assists global brands such as Levi’s and Disney reach the middle class in China.

The rise of Alibaba has been breathtaking. As China becomes the largest e-commerce market (already bigger than the United States), Alibaba controls four-fifths of all e-commerce in China. In 2013, on Single’s Day (November 11, a marketing invention created to encourage singles to “be nice” to themselves), Alibaba sold more than US$5.7 billion in merchandise. Preparing to initiate an initial public offering (IPO) in New York, Alibaba was predicted by the Economist to have the potential “to be among the world’s most valuable companies.” On September 19, 2014, Alibaba’s IPO on the New York Stock Exchange was indeed the world’s largest, raising US$25 billion.

Behind the rise of Alibaba is a story of focus and innovation. “eBay may be a shark in the ocean,” Ma once said, “but I am a crocodile in the Yangtze river. If we fight in the ocean, I lose; but if we fight in the river, I win.” The Crocodile of Yangtze, as Ma became known, has largely focused on China to avoid head-on competition with eBays of the world elsewhere. In China, eBay has been forced to retreat. In a low-trust society such as China, where people generally shy away from buying from strangers online and where people hesitate to use credit cards, Alibaba has pio- neered an Alipay system. This is a novel online-payments system that relies on escrow (releasing money to sellers only once their buyers are happy with the goods received). This not only facilitates transactions for Alibaba as well as its buyers and sellers, but also helps build trust at the societal level. Alifinance, Alibaba’s financing arm, has become a big microlender to small firms, which are typically underserved by China’s state-owned banks. Alifinance now plans to lend to individuals as well. Alibaba is also delivering insurance online. Perhaps its biggest treasure lies in its vast amount of data about the creditworthiness of millions of China’s middle class and of thousands of firms that do business via Alibaba—clearly a Big Data gold mine.

From an institution-based standpoint, the fact that Alibaba as a privately owned firm can grow to such an enormous size is remarkable about the Chinese government’s tolerance of e-commerce. Ironically, the US government placed Alibaba on the list of “notorious markets,” because counterfeits could be bought and sold on its websites. Alibaba has endeavored to remove fakes from its

113

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websites, and its recent removal from the US government’s list of “notorious markets” is indicative of its hard work. However, Western managers of genuine items on Tmall continue to complain that cheap fakes can still be found on Taobao. Evidently, the fight is still on.

Formidable as Alibaba is, it is not without challenges. Its business model grows on PC-based e-commerce. Recently as China becomes the world’s largest market for smartphones, it is fast moving to mobile commerce—at a speed faster than any other major economy. The upshot? According to Alibaba’s own prospectus, “we face a number of challenges to successfully monetiz- ing our mobile user traffic.” In other words, Alibaba is but one of several contenders. Until fairly recently, Alibaba and two other Internet giants in China largely minded their own business as the “three kingdoms,” referring to an historical era during which China was divided three ways. While Alibaba dominated e-commerce, Baidu was king of search engines, and Tencent made a killing on online games. The truce among the “three kingdoms” seems to have ended with the arrival of mobile commerce, as all three rush to establish dominance in this new market frontier. Famous for elbowing out Google, Baidu is listed on NASDAQ and is Microsoft’s partner in China. In addition to online games, Tencent is more famous for its WeChat social messaging app, which is widely popular. There is no guarantee Alibaba will win in this contest.

In addition to fighting it out in China, the Crocodile of the Yangtze has also been eyeing the wider global ocean. Some 12% of Alibaba’s sales are already overseas. Its most attractive overseas markets are likely to be low-trust, underbanked emerging economies in Asia, Africa, and Latin Amer- ica. But sharks such as eBay and Amazon will not be easy to fight with. Looking forward, whether Alibaba deserves to be one of the world’s most valuable companies will depend on how it can defend its e-commerce dominance at home in the mobile era and how it can grow its business abroad.

SOURCES: Based on (1) Bloomberg Businessweek, 2013, Alibaba plays defense against Tencent, August 26: 38–40; (2) Economist, 2013, Tencent’s worth, September 21: 66–68; (3) Economist, 2013, The Alibaba phenomenon, March 23: 15; (4) Economist, 2013, The world’s greatest bazaar, March 23: 27–30; (5) Economist, 2014, From bazaar to bonanza, May 10: 63–65; (6) Economist, 2014, After the float, September 6: 66–67; (7) South China Morning Post, 2014, Alibaba expected to be approved for IPO, July 12: B4.

How do entrepreneurial firms such as Alibaba grow? How do they enter international markets? What are the challenges and constraints they face? This chapter deals with these important questions. 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 global 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 (other countries may have different definitions—Alibaba obviously is no longer an SME). Most students will join SMEs for employment. Some 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

114 Part 2 • Business-Level Strategies

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defining characteristics 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 opportunities; 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.3 Today, the word mostly refers to founders and owners of new businesses or managers of existing firms. Consequently, international entrepreneurship is defined as “a combination of innovative, proactive, and risk- seeking behavior that crosses national borders and is intended to create wealth in organizations.”4

Although SMEs are not the exclusive domain of entrepreneurship, the conven- tion that many people use is to associate entrepreneurship with SMEs, because, on average, SMEs tend to be more entrepreneurial than large firms. To minimize confu- sion, 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 “entrepre- neurs” 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 more than 95% of the num- ber of firms, create approximately 50% of total value added, and generate 60%– 90% of employment (depending on the country). Many entrepreneurs will try; many SMEs will fail. 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 consider- able light on the entrepreneurship phenomenon.5 This leads to a comprehensive model illustrated in Figure 5.1.

Industry-Based Considerations The industry-based view, exemplified by the Porter five forces framework first intro- duced in Chapter 2, emphasizes (1) interfirm rivalry, (2) entry barriers, (3) bargain- ing 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 prob- ability that a new start-up will be able to make it.6 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, an 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 industries hinder the chances of entrepreneurial success. For exam- ple, at present no entrepreneurs in their right mind would bet their money on com- peting against Boeing or Airbus.

When the bargaining power of suppliers becomes too large, entrepreneurial solutions can reduce such bargaining power. For instance, Coca-Cola is the monop- oly supplier of Coke syrups, leveraging enormous bargaining power around the world. As a result, numerous beverages companies have been founded to chip away Coca-Cola’s bargaining power one drink at a time.

Chapter 5 • Growing and Internationalizing the Entrepreneurial Firm 115

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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 book- stores, such as Amazon in the United States and Ozon in Russia, have provided more outlets for publishers, thereby reducing the bargaining power of traditional book- stores as buyers.

Substitute products/services may offer great opportunities for entrepreneurs. If entrepreneurs can bring in substitute products that can redefine the game, they can effectively chip away some of the competitive advantages held by incumbents. For example, e-commerce firms such as Alibaba are now eating the lunch of many tradi- tional retailors (see the Opening Case).

Obviously, entrepreneurs must 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

FIGURE 5.1 A Comprehensive Model of Entrepreneurship.

Interfirm rivalry Entry barriers Bargaining power of suppliers Bargaining power of buyers Substitute products/services

Value Rarity Imitability Organization

Formal institutional constraints (such as laws and regulations) Informal institutional constraints (such as cultural values and norms)

Industry-based

considerations

Resource-based

considerations

Institution-based

considerations

Entrepreneurs

and entrepreneurial

start-up firms

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(VRIO) aspects (see Figure 5.1). First, entrepreneurial resources must create value.7

For instance, by offering cheap fares, convenient schedules, 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 increas- ing hassle to fly. 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.

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 rar- est knowledge and deeper insights about business opportunities. Math geniuses are few and far between, but the ability to turn a passion for math into profit is truly rare. Google’s two founders are such rare geniuses.

Third, resources must be inimitable. For instance, in the ocean of e-commerce companies, the abilities to do the “dirtiest job on the Internet” as online moderators are very hard to imitate. After being exposed to, and then cleaning up, the nastiest and most undesirable racism and bigotry on a daily basis, sometimes online modera- tors “feel you need to spend two hours in the shower just because it is so disgusting.”8 But then that is why firms such as eModeration and ICUC Moderation can charge a lot of money to clean up comments and tweets for established organizations.

Fourth, entrepreneurial resources must be organizationally embedded.9 For example, as long as wars are fought, there have been mercenaries for hire. But only in recent times have private military companies become a global industry, thanks to the superb organizational capabilities of entrepreneurial firms such as Blackwater (rebranded first as Xe and now known as Academi).

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 entrepreneur- ship is thriving around the globe in general, its development is uneven. Whether entrepreneurship is facilitated or retarded significantly depends on formal institu- tions governing how entrepreneurs start up new firms.10 A World Bank survey, Doing Business, reports some striking differences in government regulations con- cerning 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 “mun- dane”) task of connecting electricity to a newly built commercial building illustrates tremendous differences. In general, governments 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.

In addition to formal institutions, informal institutions such as cultural values and norms also affect entrepreneurship.11 For example, because entrepreneurs nec- essarily 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.12 In another example, Russians make heavy use of social networks

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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 win- ter, 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.13 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, internation- alization, is covered in the next section.

Growth For many entrepreneurs, such as Jack Ma, the excitement associated with growing a new company, such as Alibaba, is the very thing that attracts them in the first place (see the Opening Case).14 Recall from the resource-based view that a firm can be conceptualized as a bundle of resources and capabilities. The growth of an entrepre- neurial firm can thus be viewed as an attempt to more fully use currently under- utilized resources and capabilities. An entrepreneurial firm can leverage its (intangi- ble) vision and drive in order to grow, even though it may be short on (tangible) resources such as financial capital.

Innovation Innovation is at the heart of an entrepreneurial mindset.15 Innovation can range from low-tech ones such as Huy Fong’s humble Sriracha hot sauce that has fired up

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).

118 Part 2 • Business-Level Strategies

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American food to high-tech ones such as Alibaba’s Taobao that can handle millions of online transactions daily (see the Opening Case).

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 competitive 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 com- petition, thus wiping out the advantages of incumbents.16

Second, innovation should be regarded broadly. Not only are technological breakthroughs innovations, but less novel though still substantially new ways of doing business are also innovations. Most start-ups reproduce existing organiza- tional 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 inno- vation, thus fueling their motivation to charge ahead.

Network A network strategy refers to intentionally constructing and tapping into relation- ships, connections, and ties that individuals and organizations have.17 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 essen- tially the same as the firm’s organizational networks.18 The essence of entre- preneurship can be regarded as a process to “translate” personal networks into value-adding organizational networks. Three attributes—namely, urgency, inten- sity, and impact—distinguish entrepreneurial networking.

First, entrepreneurial firms have a high degree of urgency to develop and lever- age 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, start-ups do not inspire confidence and lack legitimacy in the eyes of suppli- ers, customers, financiers, and other stakeholders. Thus, start-ups urgently need to draw on entrepreneurs’ social networks to overcome the liability of newness. Convincing more 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.

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 those for weak ties. Entrepreneurs often rely on strong ties—typically 5–20 individuals—for advice, assistance, and support.

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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’ per- sonal networks tend to have a stronger impact on firm performance.19 In compari- son, the impact of similar networks cultivated by managers at large firms may be less pronounced because of the sheer size of these firms. 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 organiza- tional, represent significant resources and opportunities and that successful networking may lead to successful entrepreneurial performance. The most advanta- geous positions are those well connected to a number of players who are otherwise not connected—in other words, more centrally located network positions are help- ful. Armed with useful ties and contacts, entrepreneurs, therefore, can literally become “persons who add value by brokering the connection between others.”20

Remember, this indeed is the original meaning of the word “entrepreneurs.”

Financing and Governance All start-ups need capital.21 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 the other F source? The answer is … fools (!).22 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 individual investors), venture capitalists (VCs), banks, foreign entrants, and government agencies, are not fools. They often examine business plans, require a strong management team, and scrutinize financial statements. 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.23

While dealing with strong-tie contacts can be quite informal (based on hand- shake deals or simple contracts), working with weak-tie contacts may be more for- mal. 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 invest- ment, 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.24 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 trade- offs 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 entre- preneurs 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 bet- ter (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.25

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 Entre- preneurship Monitor reported that Sweden, South Africa, Belgium, and the United States lead the world in VC investment as a percentage of GDP.26 In contrast, Greece and China have the lowest level of VC investment. On the other hand, China leads the

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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 invest- ment for Chinese entrepreneurs and new ventures, particularly during a time of entrepreneurial boom.27

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 (US$50–US$300) to start small businesses with the intention of ultimately lifting the entrepreneurs out of poverty. Starting in Bangla- desh in the 1970s by Muhammad Yunus, microfinance has now become a global movement.28 Yunus won a Nobel Peace Prize in 2006.

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. Selling the firm is typically one of the most significant and emo- tionally charged events that entrepreneurs confront. It is important to note that “sell- ing out” does not necessarily mean failure. Many entrepreneurs deliberately build up businesses in anticipation of being acquired by larger corporations and profiting handsomely.

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.

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

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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 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 struc- tured and negotiated, a merger will allow entrepreneurs to reap the rewards for which they have worked so hard.

Fourth, entrepreneurs can take their firms through an initial public offering (IPO), which is the goal of many entrepreneurs (see the Opening Case). 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 must constantly “beg” for money. For entrepreneurs 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 pri- vacy, 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 behemoth IKEA), Tadao Yoshida (founder of the Japanese zipper king YKK), and Ren Zhengfei (founder of the Chinese telecom equipment giant Huawei) have refused to go public.

Finally, while taking the firm through an IPO is the most triumphant way of har- vest, many entrepreneurial firms that are failing do not have such a luxury. The only viable exit is often to declare bankruptcy.

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

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INTERNATIONALIZING THE ENTREPRENEURIAL FIRM There is a myth that only large MNEs do business abroad and that SMEs mostly oper- ate domestically. This myth, based on historical stereotypes, is being increasingly challenged as more SMEs go international.29 Further, some start-ups attempt to do business abroad from inception. These are often called born global firms (or international new ventures).30 This section examines how entrepreneurial firms internationalize.

Transaction Costs and Entrepreneurial Opportunities Compared with domestic transaction costs (the costs of doing business), interna- tional transaction costs are qualitatively higher. Some costs are high due to numer- ous innocent differences in formal institutions and informal norms (see Chapter 4). Other costs, however, may be due to a high level of potential opportunism that is hard to detect and remedy. For example, when a small manufacturer in Texas with US$5 million annual revenues receives an unsolicited order of US$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 Algeria? 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 Algeria 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 Algeria, where Arabic is the official language, may be so costly that it is not an option for a small US exporter.

Maybe the Algerian importer is an honest and capable firm with every intention and ability to pay. But because the Texas firm cannot ascertain, prior to the transac- tion, that the Algerian side will pay upon receiving the goods, the Texas firm may 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. There- fore, entrepreneurial opportunities exist to lower transaction costs and bring distant groups of people, firms, and countries together.31 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.

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).32

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)

Chapter 5 • Growing and Internationalizing the Entrepreneurial Firm 123

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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 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 trade- mark (such as a corporate logo) for a royalty fee paid to A by B. Assume (hypotheti- cally) 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, 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 relatively little of their own capital. Foreign firms inter- ested in becoming licensees or franchisees have to put their own capital up front. For example, a McDonald’s franchise now costs the franchisee approximately US$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: sue its licensee in an unfamiliar Finnish court, or discontinue the relationship. Either choice is complicated and costly.

A third entry mode is FDI, which may involve greenfield wholly owned subsidiar- ies (see Chapter 6), strategic alliances with foreign partners (see Chapter 7), and acquisitions of foreign firms (see Chapter 9). By planting some roots abroad, a firm becomes more committed to serving foreign markets. It is physically and psycholog- ically 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 two major drawbacks: 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 head- aches 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 internation- alize without leaving their home country. The five main strategies are (1) export indi- rectly, (2) become suppliers for foreign firms, (3) become licensees or franchisees of foreign brands, (4) become alliance partners of foreign direct investors, and (5) har- vest and exit through sell-offs.

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 link- ing domestic sellers and overseas buyers who otherwise would not have been connected. Being entrepreneurs themselves, export intermediaries facilitate the internationalization of many SMEs.33

A second strategy is to become a supplier for a foreign firm that enters a domes- tic market. For example, when Subway went to Northern Ireland, it secured a con- tract 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.

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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 fran- chise for 20 years, broke away from the relationship. Then its new venture, The Pizza Company, became the market leader in Thailand.34

A fourth strategy is to become an alliance partner of a foreign direct investor.35

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.36 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 US$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 controver- sies and debates. This section introduces two leading debates: traits versus institu- tions, and slow versus rapid internationalization.

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, entrepreneurship inevitably deviates from the norm to work for others, and this deviation may be in the “blood” of entrepre- neurs.37 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 most recently Azul in Brazil).38

Critics, however, argue that some of these traits, such as a strong achievement orientation, are not necessarily limited to entrepreneurs, but instead are characteris- tic of many successful individuals. The diversity among entrepreneurs makes any attempt to develop a standard psychological or personality profile futile. Critics sug- gest what matters is institutions—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. More recently, however, as government policies became relatively more entrepreneur friendly, the institutional transitions have opened the floodgates of entrepreneurship in China.39

In Europe, a leading debate focuses on why so few Europeans are interested in entrepreneurship. Global Entrepreneur Monitor has reported that in Europe, an alarm- ingly small percentage of individuals are involved in “early stage entrepreneurship,”

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representing 2.3% of Italy’s adult population, 4.2% of Germany’s, and 5.8% of France’s. These numbers compare very unfavorably with 7.6% in the United States, 14% in China, and 17% of in Brazil.40 The lack of a risk-taking entrepreneurial culture is one reason. But another reason is a series of formal, institution-based barriers that scare away a lot of would-be entrepreneurs. Europe’s personal bankruptcy laws are notoriously unfriendly to bankrupt entrepreneurs. In France, they are responsible for their debts for nine years after the bankruptcy. In Germany, six years. In the United States, failed entrepreneurs can walk away from their debts in less than a year.

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 busi- nesses, are more likely to start their own firms. So are people who are better edu- cated. 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 propensity 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 internationalize? 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 a global leader in computer peripherals. It was established by entrepre- neurs from Switzerland and the United States, where the firm set up dual headquar- ters. 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.41

What is currently being debated is the second component. On the one hand, advocates argue that every industry has become “global” and that entrepreneurial firms must rapidly pursue these opportunities.42 On the other hand, stage models suggest that firms must 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 inexpe- rienced swimmers may drown in unfamiliar foreign waters.

A key issue, therefore, is whether it is better for entrepreneurs to start the inter- nationalization process soon after founding (as Logitech did) 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.43 In contrast, firms that internationalize earlier need to overcome fewer of these barriers. Therefore, SMEs without an established domestic orientation (such as Logitech) may outperform their rivals that wait longer to inter- nationalize. In other words, contrary to the inherent disadvantages in internationali- zation associated with SMEs as suggested by stage models, there may be “inherent advantages” of being small while venturing abroad.

On the other hand, some authors 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

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local differences.”44 In other words, the teachings of stage models are still relevant. Consequently, indiscriminate advice to “go global” may not be warranted.45

Anti-Failure Biases versus Entrepreneur-Friendly Bankruptcy Laws46

Corporate bankruptcies have climbed to new heights in the Great Recession (note “bankruptcy” here refers only to corporate bankruptcy; we do not consider personal bankruptcy). Firms ranging from huge ones such as General Motors to tiny entrepre- neurial 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 wide- spread 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 Alibaba, Facebook, and Google were written up by the press?), and to scant attention devoted to the vast majority of entrepreneurial firms that end up in failure and bankruptcy. However, one perspective suggests that bankruptcies, which are undoubtedly painful to individual entrepreneurs and employees, may be good for the society. Consequently, bankruptcy laws must 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 individ- ual a criminal, and penalties ranged from incarceration to death sentence.

Recently, many governments have realized that entrepreneur-friendly bank- ruptcy 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 entre- preneurship 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 entre- preneurs have committed 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 entrepreneurs 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 suc- ceed. 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).

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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.47

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 benefi- cial, since it is 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.48

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 institutional frame- works 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 implica- tions for action (Table 5.5):

1. Establish an intimate understanding of your industry to identify gaps and oppor- tunities, or, alternatively, to avoid or exit from it if the threats are too strong.

2. Leverage entrepreneurial resources and capabilities, such as entrepreneurial drive, innovative capabilities, and network ties.

3. Push for more entrepreneur-friendly formal institutions, 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, by talking to high school and college students, taking on internships, and providing seed money as angels for new ventures.

4. When internationalizing, be bold but not too bold.49

Being bold does not mean being reckless. One specific insight from this chapter is that it is possible to internationalize without venturing abroad. When the entrepre- neurial firm is not ready to take on higher risk abroad, the more limited international involvement at home 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

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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businesses. Finally, what determines the international success and failure of firms (Question 4) depends on whether entrepreneurs can select the right industry, lever- age their capabilities, and take advantage of formal and informal institutional resources—both at home and abroad.50

CHAPTER SUMMARY 1. Define entrepreneurship, entrepreneurs, and entrepreneurial firms

• Entrepreneurship is the identification and exploration of previously unex- plored 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 those 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 two leading debates concerning entrepreneurship • (1) Traits versus institutions and (2) slow versus rapid internationalization.

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.

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 cur- rently unemployed. How would you respond to her proposition?

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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 poten- tially help millions of patients worldwide who cannot afford the high-priced pat- ented 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 Debate. Will you support or not support more entrepreneur-friendly bankruptcy laws? Present your answers in a short paper or a visual presentation.

CLOSING CASE 5.1

Emerging Markets: Amazon.com of Russia Ozon.ru is frequently called the Amazon.com of Russia. But the differences between the Moscow-based start-up and the US e-commerce giant are more revealing than the simi- larities. 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 Amazon, 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 including 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 network infra- structure. “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 coun- try’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, which moved the

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company to Moscow and eventually tapped Swiss-born Bernard Lukey, a former market- ing executive at Yandex, to run it. Lukey raised capital, expanded the company’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 responsibilities 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 people 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.”

Another challenge for Ozon is finding qualified staff. Good engineers in Russia are scarce and expensive. A web programmer in Moscow demands a higher salary than in San Francisco, Gavet says, which has her joking that perhaps the company should con- sider 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: 1. Bloomberg Businessweek, 2011, Amazon.com on the Volga, September 19: 43–44.

Questions 1. How do entrepreneurial firms such as Ozon grow? 2. What are the challenges and constraints they face?

CLOSING CASE 5.2

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, numerous 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 enter- prise called the Grameen Project. It never occurred to Yunus that he would inspire a global movement for entrepreneurial financing, less than 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 difference. The poor tend to have neither assets (necessary for collateral) nor credit history, making tradi- tional 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 sophisticated solu- tion 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

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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 criticisms 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 competitive 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 government had a list of 85 MFI “victims,” who committed suicide. In response, pol- icymakers in some parts of India capped the interest rate at 24%, and called default borrowers 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 mil- lions 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 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 question- able operations. Although as managing director of Grameen Bank, Yunus was eventu- ally cleared of wrongdoing, microfinance—and its missionary pioneer—has suffered from a crisis of faith.

Sources: 1. Bloomberg Businessweek, 2010, An IPO for India’s top lender to the poor, May 10: 16–17; 2. Bloomberg 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 Inter-

national 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, Micro-

finance: Going global … and global public? case study, University of Texas at Dallas.

Questions 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?

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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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 investiga- tion of Grameen Bank. How would you proceed?

CLOSING CASE 5.3

Emerging Markets: The Rise of Alibaba Founded in 1999 by a former English teacher Jack Ma, Alibaba has risen to become the largest e-commerce firm not only in China, but also in the world—the value of goods sold on its platforms (US$170 billion in 2013) are more than Amazon and eBay combined. Alibaba started as a business-to-business (B2B) portal connecting overseas buyers and small Chinese manufacturers. Inspired by eBay, Alibaba next launched Taobao, a consumer-to-consumer (C2C) portal that now features nearly one billion products and is the one of the 20 most-visited websites worldwide. Finally, with Tmall, Alibaba offers an Amazon-like business-to-consumer (B2C) portal that assists global brands such as Levi’s and Disney reach the middle class in China.

The rise of Alibaba has been breathtaking. As China becomes the largest e-commerce market (already bigger than the United States), Alibaba controls four-fifths of all e-commerce in China. In 2013, on Single’s Day (November 11, a marketing inven- tion created to encourage singles to “be nice” to themselves), Alibaba sold more than US$5.7 billion in merchandise. Preparing to initiate an initial public offering (IPO) in New York, Alibaba was predicted by the Economist to have the potential “to be among the world’s most valuable companies.” On September 19, 2014, Alibaba’s IPO on the New York Stock Exchange was indeed the world’s largest, raising US$25 billion.

Behind the rise of Alibaba is a story of focus and innovation. “eBay may be a shark in the ocean,” Ma once said, “but I am a crocodile in the Yangtze river. If we fight in the ocean, I lose; but if we fight in the river, I win.” The Crocodile of Yangtze, as Ma became known, has largely focused on China to avoid head-on competition with eBays of the world elsewhere. In China, eBay has been forced to retreat. In a low-trust society such as China, where people generally shy away from buying from strangers online and where people hesitate to use credit cards, Alibaba has pioneered an Alipay system. This is a novel online-payments system that relies on escrow (releasing money to sellers only once their buyers are happy with the goods received). This not only facilitates transactions for Alibaba as well as its buyers and sellers, but also helps build trust at the societal level. Alifinance, Alibaba’s financing arm, has become a big microlender to small firms, which are typically underserved by China’s state-owned banks. Alifinance now plans to lend to individuals as well. Alibaba is also delivering insurance online. Perhaps its biggest treasure lies in its vast amount of data about the creditworthiness of millions of China’s middle class and of thousands of firms that do business via Alibaba—clearly a Big Data gold mine.

From an institution-based standpoint, the fact that Alibaba as a privately owned firm can grow to such an enormous size is remarkable about the Chinese government’s toler- ance of e-commerce. Ironically, the US government placed Alibaba on the list of “notori- ous markets,” because counterfeits could be bought and sold on its websites. Alibaba has endeavored to remove fakes from its websites, and its recent removal from the US gov- ernment’s list of “notorious markets” is indicative of its hard work. However, Western managers of genuine items on Tmall continue to complain that cheap fakes can still be found on Taobao. Evidently, the fight is still on.

Formidable as Alibaba is, it is not without challenges. Its business model grows on PC-based e-commerce. Recently as China becomes the world’s largest market for smart- phones, it is fast moving to mobile commerce—at a speed faster than any other major economy. The upshot? According to Alibaba’s own prospectus, “we face a number of

Chapter 5 • Growing and Internationalizing the Entrepreneurial Firm 133

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challenges to successfully monetizing our mobile user traffic.” In other words, Alibaba is but one of several contenders. Until fairly recently, Alibaba and two other Internet giants in China largely minded their own business as the “three kingdoms,” referring to an historical era during which China was divided three ways. While Alibaba dominated e-commerce, Baidu was king of search engines, and Tencent made a killing on online games. The truce among the “three kingdoms” seems to have ended with the arrival of mobile commerce, as all three rush to establish dominance in this new market frontier. Famous for elbowing out Google, Baidu is listed on NASDAQ and is Microsoft’s partner in China. In addition to online games, Tencent is more famous for its WeChat social messag- ing app, which is widely popular. There is no guarantee Alibaba will win in this contest.

In addition to fighting it out in China, the Crocodile of the Yangtze has also been eye- ing the wider global ocean. Some 12% of Alibaba’s sales are already overseas. Its most attractive overseas markets are likely to be low-trust, underbanked emerging economies in Asia, Africa, and Latin America. But sharks such as eBay and Amazon will not be easy to fight with. Looking forward, whether Alibaba deserves to be one of the world’s most valu- able companies will depend on how it can defend its e-commerce dominance at home in the mobile era and how it can grow its business abroad.

Sources: 1. Bloomberg Businessweek, 2013, Alibaba plays defense against Tencent, August 26: 38–40; 2. Economist, 2013, Tencent’s worth, September 21: 66–68; 3. Economist, 2013, The Alibaba phenomenon, March 23: 15; 4. Economist, 2013, The world’s greatest bazaar, March 23: 27–30; 5. Economist, 2014, From bazaar to bonanza, May 10: 63–65; 6. Economist, 2014, After the float, September 6: 66–67; 7. South China Morning Post, 2014, Alibaba expected to be approved for IPO, July 12: B4.

Questions 1. How do entrepreneurial firms such as Alibaba grow? 2. How do they enter international markets? 3. What are the challenges and constraints they face?

NOTES

[Journal acronyms] 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); B&S–Busi- ness and Society; ETP–Entrepreneurship Theory and Practice; FEER–Far East- ern Economic Review; HBR–Harvard Business Review; JBV–Journal of Business Venturing; JIBS–Journal of International Business Studies; JMS–Jour- nal of Management Studies; JWB–Journal of World Business; OSc–Organization Science; SEJ–Strategic Entrepreneurship Journal; SMJ–Strategic Management Journal; SMR–MIT Sloan Management Review

1. M. Hitt, R. D. Ireland, S. M. Camp, & D. Sexton, 2001, Strategic entrepreneurship, 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. Volberda, & R. Johnson, 2011, Revitalizing entrepreneurship, JMS, 48: 1141–1168; S. Venkataraman, S. Sarasvathy, N. Dew, & W. Forster, 2012, Reflections on the 2010 AMR Decade Award: Whither the promise? AMR, 37: 21–33.

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2. S. Shane & S. Venkataraman, 2000, The promise of entrepreneurship as a field of research, AMR, 25: 217–226.

3. M. W. Peng, S. Lee, & S. Hong, 2014, Entrepreneurs as intermediaries, JWB, 49: 21–31. 4. P. McDougall & B. Oviatt, 2000, International entrepreneurship, AMJ, 43: 902–906. See

also Y. Chandra & N. Coviello, 2010, Broadening the concept of international entrepreneurship, JWB, 45: 228–236; D. Cumming, H. Sapienza, D. Siegel, & M. Wright, 2009, International entrepreneurship, SEJ, 3: 283–296.

5. Y. Yamakawa, M. W. Peng, & D. Deeds, 2008, What drives new ventures to internationalize from emerging to developed economies? ETP, 32: 59–82.

6. 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.

7. 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; D. Hsu & R. Zienonis, 2013, Resources as dual sources of advantage, SMJ, 34: 761–781; M. Keyhani, M. Levesque, & A. Madhok, 2015, Toward a theory of entrepreneurial rents, SMJ, 36: 76–96; H. Park & H. K. Steensma, 2012, When does corporate venture capital add value for new ventures? SMJ, 33: 1–22; S. Sui & M. Baum, 2014, Internationalization strategy, firm resources, and the survival of SMEs in the export market, JIBS, 45: 821–841.

8. BW, 2011, The dirtiest job on the Internet, December 5: 95–97. 9. J. Lerner, 2013, Corporate venturing, HBR, October: 86–94; J. Sorensen & M. Fassiotto,

2011, Organizations as fonts of entrepreneurship, OSc, 22: 1322–1331. 10. S. Anokhin & J. Wincent, 2012, Start-up rates and innovation, JIBS, 43: 41–60;

T. Khoury & A. Prasad, 2015, Entrepreneurship amid concurrent institutional constraints in less developed countries, B&S (in press); J. Levie & E. Autio, 2011, Regulatory burden, rule of law, and entry of strategic entrepreneurs, JMS, 48: 1392–1419; Y. Zhu, X. Wittman, & M. W. Peng, 2012, Institution-based barriers to innovation in SMEs in China, APJM, 29: 1131–1142.

11. J. Almandoz, 2012, Arriving at the starting line, AMJ, 55: 1381–1406; E. Autio, S. Pathak, & K. Wennberg, 2013, Consequences of cultural practices for entrepreneurial behaviors, JIBS, 44: 334–362; D. Kim, E. Morse, R. Mitchell, & K. Seawright, 2010, Institutional environment and entrepreneurial cognitions, ETP, 34: 491–516.

12. Economist, 2011, Son also rises, November 27: 71–72. 13. BW, 2011, In Russia, Facebook is more than a social network, January 3: 32–33. 14. M. Cardon, J. Wincent, J. Singh, & M. Drnovsek, 2009, The nature and experience of

entrepreneurial passion, AMR, 34: 511–532; J. Cerdin, M. Dine, & C. Brewster, 2014, Qualified immigrants’ success, JIBS, 45: 151–168; J. Clarke, 2011, Revitalizing entrepreneurship, JMS, 48: 1365–1391; 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; Y. Yamakawa, M. W. Peng, & D. Deeds, 2015, Rising from the ashes: Cognitive determinants of venture growth after entrepreneurial failure, ETP, 39: 209–236.

15. K. Boudreau & K. Lakhani, 2013, Using the crowd as an innovation partner, HBR, April: 62–69; R. Dugan & K. Gabriel, 2013, “Special Forces” innovation, HBR, October: 75–84; M. Eisenman, 2013, Understanding aesthetic innovation in the context of technological evolution, AMR, 38: 332–351; 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 orientation, JMS, 48: 1291–1313; E. Golovko & G. Valentini, 2011, Exploring the complementarity between innovation and export for SMEs’ growth, JIBS, 42: 362–380; S. Kotha, 2010, Spillovers, spill-ins, and strategic entrepreneurship, SEJ, 4: 284–306; R. Merton, 2013, Innovation risk, HBR, April: 48–56; M. Sytch & A. Tatarynowicz, 2014, Exploring the locus of invention, AMJ, 57: 249–279; M. Terziovski, 2010, Innovative practice and its performance implications in SMEs in the manufacturing sector, SMJ, 31: 892–902; W. Wales, V. Parida, & P. Patel, 2013, Too much of a good thing? SMJ, 34: 622–633.

16. C. Christensen, 1997, The Innovator’s Dilemma, Boston: Harvard Business School Press. 17. J. Broschak & E. Block, 2014, With or without you, AMJ, 57: 743–765; S. Jack,

2010, Approaches to studying networks, JBV, 25: 120–137; Y. Li, H. Chen, Y. Liu, &

Chapter 5 • Growing and Internationalizing the Entrepreneurial Firm 135

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M. W. Peng, 2014, Managerial ties, organizational learning, and opportunity capture, APJM, 31: 271–291; R. Ma, Y. Huang, & O. Shenkar, 2011, Social networks and opportunity recognition, SMJ, 32: 1183–1205; D. Sullivan & M. Marvel, 2011, Knowledge 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.

18. T. Manolova, I. Manev, & B. Gyoshev, 2010, In good company, JWB, 45: 257–265; M. Musteen, J. Francis, & D. Datta, 2010, The influence of international networks 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: 388–397; 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.

19. B. Batjargal, M. Hitt, A. Tsui, J. Arregle, J. Webb, & T. Miller, 2013, Institutional polycentrism, entrepreneurs’ social networks, and new venture growth, AMJ, 56: 1024–1049; M. W. Peng & Y. Luo, 2000, Managerial ties and firm performance in a transition economy, AMJ, 43: 486–501.

20. R. Burt, 1997, The contingent value of social capital, ASQ, 42: 339–365. 21. P. Vaaler, 2011, Immigrant remittances and the venture investment environment of

developing countries, JIBS, 42: 1121–1149. 22. R. Koth & G. George, 2012, Friends, family, or fools, JBV, 27: 525–543. 23. T. Dalziel, R. White, & J. Arthurs, 2011, Principal costs in initial public offerings, JMS,

48: 1346–1364; Y. Li & T. Chi, 2013, Venture capitalists’ decision to withdraw, SMJ, 34: 1351–1366.

24. G. Bruton, I. Filatotchev, S. Chahine, & M. Wright, 2010, Governance, ownership structure, and performance of IPO firms, SMJ, 31: 491–509; B. Hallen, R. Katila, & J. Rosenberger, 2014, How do social defenses work? AMJ, 57: 1078–1101; D. Ma, M. Rhee, & D. Yang, 2013, Power source mismatch and the effectiveness of interorganizational relations, AMJ, 56: 711–734; U. Ozmel, J. Reuer, & R. Gulati, 2013, Signals across multiple networks, AMJ, 56: 852–866.

25. D. Hope, D. Thomas, & D. Vyas, 2011, Financial credibility, ownership, and financing constraints in private firms, JIBS, 42: 935–951.

26. M. Minniti, W. Bygrave, & E. Autio, 2006, Global Entrepreneurship Monitor 2006, Wellesley, MA: Babson College.

27. M. Humphrey-Jenner & J. Suchard, 2013, Foreign venture capitalists and the internationalization of entrepreneurial companies: Evidence from China, JIBS, 44: 607–621.

28. HBR, 2012, Muhammad Yunus: Life’s work, December: 136. 29. Y. Yamakawa, S. Khavul, M. W. Peng, & D. Deeds, 2013, Venturing from emerging

economies, SEJ, 7: 181–196. 30. N. Hashai, 2011, Sequencing the expansion of geographic scope and foreign operations

by “born global” firms, JIBS, 42: 995–1015. 31. J. Mair, I. Marti, & M. Ventresca, 2012, Building inclusive markets in rural Bangladesh,

AMJ, 55: 819–850; H. Ndofor & R. Priem, 2011, Immigrant entrepreneurs, the ethnic enclave strategy, and venture performance, JM, 37: 790–818.

32. B. Maekelburger, C. Schwens, & R. Kabst, 2012, Asset specificity and foreign market entry mode choice of SMEs, JIBS, 43: 458–476.

33. M. W. Peng & A. York, 2001, Behind intermediary performance in export trade, JIBS, 32: 327–346.

34. FEER, 2002, Pepperoni power, November 14: 59–60. 35. V. Aggarwal & D. Hsu, 2009, Modes of cooperative R&D commercialization by

start-ups, SMJ, 30: 835–864. 36. M. Graebner, 2009, Caveat venditor, AMJ, 52: 435–472.

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37. 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.

38. M. W. Peng, 2014, Global Business, 3rd ed. (p. 294), Cincinnati: Cengage Learning. 39. 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.

40. Economist, 2013, A slow climb, October 5: 65–66; Economist, 2013, Les miserable, July 28: 19–22.

41. S. T. Cavusgil & G. Knight, 2015, The born global firm, JIBS, 46: 3–16; N. Coviello, 2015, Re-thinking research on born globals, JIBS, 46: 17–26; I. Zander, P. McDougall- Covin, & E. Rose, 2015, Born globals and international business, JIBS, 46: 27–35.

42. V. Govindarajan & A. Gupta, 2001, The Quest for Global Dominance, San Francisco: Jossey-Bass; L. Zhou & A. Wu, 2014, Earliness of internationalization and performance outcomes, JWB, 49: 132–142.

43. S. Nadkarni, P. Herrmann, & P. Perez, 2011, Domestic mindset and early international performance, SMJ, 32: 510–531.

44. S. Rangan & R. Adner, 2001, Profits and the Internet, SMR, summer: 44–53. 45. L. Lopez, S. Kundu, & L. Ciravegna, 2009, Born global or born regional? JIBS, 40:

1228–1238. 46. 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.

47. S. Lee, Y. Yamakawa, M. W. Peng, & J. Barney, 2011, How do bankruptcy laws affect entrepreneurship development around the world? JBV, 28: 505–520.

48. A. Knott & H. Posen, 2005, Is failure good? SMJ, 26: 617–641. 49. M. W. Peng, C. Hill, & D. Wang, 2000, Schumpeterian dynamics versus Williamsonian

considerations, JMS, 37: 167–184. 50. G. Bruton, D. Ahlstrom, & H. Li, 2010, Institutional theory and entrepreneurship, ETP,

34: 421–440; S. Puffer, D. McCarthy, & M. Boisot, 2010, Entrepreneurship in Russia and China, ETP, 34: 441–467; S. Zahra & M. Wright, 2011, Entrepreneurship’s next act, AMP, November: 67–83.

Chapter 5 • Growing and Internationalizing the Entrepreneurial Firm 137

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CHAPTER

6 KEY TERMS

liability of foreignness dissemination risks Regulatory risks obsolescing bargain expropriation sunk costs Trade barriers Tariff barriers Nontariff barriers local content

requirements Currency risks Currency hedging

Strategic hedging location-specific advantages

agglomeration first-mover advantages late-mover advantages scale of entry Non-equity modes equity modes ownership advantage internalization internalization advantage OLI advantages

turnkey projects build-operate-transfer

(BOT) agreement Research and

development (R&D) contracts

Co-marketing joint venture (JV) wholly owned subsidiary

(WOS) greenfield operations country-of-origin effect LLL advantages

KNOWLEDGE OBJECTIVES 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

138

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Entering Foreign Markets

OPENING CASE Emerging Markets: SABMiller in Nigeria

Founded in South Africa in 1895 as South African Breweries (SAB), SABMiller is currently the world’s second-largest beer company measured by revenues (behind the Belgian–Brazilian Anheuser-Busch InBev). In 1999, SAB moved its headquarters to London. In 2002, SAB changed its name to SABMiller after acquiring an American brewer, Miller. SABMiller’s brands include Fosters, Grolsch, Miller, Peroni Nastro Azzurro, and Pilsner Urquell. While SABMiller operates in 75 countries, lately it has found that its fastest-growing market is its birthplace: Africa. Among some 40 African countries in which SABMiller sells beers, Nigeria has stood out. Nigeria has the largest population (170 million) in Africa—approximately one in five of Sub-Saharan Africa’s 930 million people lives here.

Nigeria is also the largest beer market after South Africa. Further, the Nigerian population is young and growing—at an annual rate of 2%–3%. Nigeria is attractive to SABMiller not only because of its size, but also because of its influence—Nigerian music and movies are visible throughout Africa. A win in Nigeria may influence consumer behavior elsewhere on the continent. However, Nigeria is not an easy market to crack, because Guinness (owned by a British multinational Diageo) and Nigerian Breweries (owned by a Dutch giant, Heineken) had been strong incumbents prior to SABMiller’s entry.

In 2009, SABMiller entered Nigeria, not by going after Lagos, the country’s largest city where Guinness and Nigerian Breweries would definitely retaliate if attacked. Instead, SABMiller went to other cities away from Lagos. It acquired a rundown brewery in Port Harcourt and another one in Ilesha. In 2012 it built a brand new, greenfield plant in Onitsha. SABMiller developed a new beer specifically for the Onitsha plant: Hero. Its bottle features the rising sun, an icon of the local Igbo people. Undercutting the competitors, a 650 ml bottle of Hero sells for US$1, whereas a Guinness costs US$1.67 and a Star (from Nigerian Breweries) US$1.33. In Nigeria, SABMiller not only has to fight off rivals, but must also deal with a traditional substitute of its factory-made beer: home brews. But home brews can be unsafe or even toxic. To persuade the bottom end of the market to get away from home brews, SABMiller has also brought in chibuku, an even cheaper brew developed in Zambia that sells for half of Hero’s price.

While Nigeria is exciting, it is also challenging. Political risk is not far away. Boko Haram, a fundamentalist Islamist group, kills innocent people who engage in “un-Islamic” practices, such as drinking alcohol, resulting in hundreds of deaths. In April 2014, it kidnapped 276 schoolgirls. Health risk is also significant. In 2014, the outbreak of Ebola in western Africa spread to Lagos, which was later contained. The rules of the game for business can change quickly and for the worse. Land is expensive and disputes are frequent, making it hard to construct new factories or offices.

139

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Power outage is frequent. Transportation is perilous. Nigeria has one of the world’s highest rates of road deaths. Shipping beer to remote areas, thus, is both costly and dangerous.

In addition to the hazards above that every company doing business in Nigeria must confront, SABMiller has learned an important lesson the hard way. That is: be even more careful about what you are getting into. It succeeded in other African countries by acquiring struggling brewer- ies and fixing them up. Its Port Harcourt acquisition seemed to make sense. But it soon had to confront back pay and unpaid invoices that its pre-acquisition due diligence failed to uncover. In Africa, the business community has a vivid phrase to describe the necessary learning that is needed to overcome the initial challenges: paying school fees. “You have to persist through the school-fees stage and not lose your nerve,” noted one executive. In other words, persistency pays. Stay tuned on whether SABMiller will suffer from bitter brews or enjoy sweet profits in Nigeria and beyond.

SOURCES: Based on (1) Economist, 2014, Africa’s testing ground, August 23: 59–61; (2) Economist, 2014, The beer fron- tier, May 31: 55–56; (3) www.sabmiller.com.

How do firms such as SABMiller enter foreign markets? Why do they enter certain countries such as Nigeria but not others? Will SABMiller succeed in Nigeria? 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. Some of the rules are in favor of local firms. For example, after working for years to familiarize itself with US defense procurement rules, European Aeronautic Defence and Space (EADS), the maker of Airbus, in 2008 won a major US$35 bil- lion contract to supply the US Air Force with next-generation refueling tankers. Then EADS (along with its US partner, Northrop Grumman) was disappointed to find out that Boeing was able to twist the arms of politicians and change the rules. In 2010, Boeing emerged as the winner of this rich prize, and EADS had to drop out.4

Second, although customers in this age of globalization supposedly no longer discriminate against foreign firms, the reality is that foreign firms are often still discriminated against, sometimes formally and other times informally. For years, American rice and beef, suspected (although never proven) to contain long-term health hazards because of genetic modification, have been informally resisted by consumers in Japan and Europe, after formal discriminatory policies imposed by their governments were removed. In India, activists accused both Coca-Cola and PepsiCo that their products contained higher than permitted levels of pesticides but did not test any Indian-branded soft drinks, even though pesticide residues are pres- ent in virtually all groundwater in India. Although both Coca-Cola and PepsiCo denied these charges, their sales suffered.

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Against such significant odds, how do foreign firms crack new markets? The answer: to deploy overwhelming resources and capabilities that after offsetting the liability of foreignness, there is still some competitive advantage.5 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.6

Yet, two weeks after airing such high-profile complaints, GE still won a major con- tract to equip China’s all-new, 200-seat C919 jetliner with its advanced engines.7

Evidently, GE’s overwhelming capabilities in advanced engines were able to over- come its political incorrectness—an example of liability of foreignness.

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 detri- mental 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 frame- work (Figure 6.1). In Cell 1, large firms in a small domestic market are likely to be very enthusiastic internationalizers, because they can quickly exhaust opportu- nities in a small country. Consider Nestlé of Switzerland. Given Switzerland’s small population (seven 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 internationalizers,” 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 considerable number of small firms from small countries such as Austria, Denmark, Finland, New Zealand, Singapore, Sweden, and Taiwan are active overseas.

FIGURE 6.1 Firm Size, Domestic Market Size, and Propensity to Internationalize.

(Cell 1) Enthusiastic

internationalizer

(Cell 2) Follower

internationalizer

(Cell 4) Occasional

internationalizer

Size

of the

Domestic

Market

Size of the Firm

(Cell 3) Slow

internationalizer

Large Firm Small Firm

Small Domestic Market

Large Domestic Market

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In Cell 3, large firms in a large domestic market are labeled “slow internationali- zers,” because their overseas activities are usually (but not always) slower than those of enthusiastic internationalizers in Cell 1. For example, Wal-Mart’s pace of internationalization is slower when compared with its two global rivals based in rel- atively smaller countries, Carrefour of France and Metro of Germany.

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.

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. 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.

Rivalry among firms Entry barriers/scale economies Bargaining power of suppliers Bargaining power of buyers Substitute products/services

Value Rarity Imitability Organization

Regulatory risks Trade barriers Currency risks Cultural distances Institutional norms

Foreign

entry decisions

Where/When/How

Industry-based considerations on

the degree of competitiveness

Resource-based considerations

on firm-specific assets

Institution-based considerations

on country risks

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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 rea- son 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 attempt- ing 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 interna- tional 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 Argentina and Venezuela.

Fourth, the bargaining power of buyers may lead to certain foreign market entries, often called forward vertical integration. 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 Apple and Samsung incorporated the camera function within their devices, which substituted a lot of single-purpose digital cameras. In every round, producers 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 sig- nificantly 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 deci- sions (Figure 6.2).8 First, the value of firm-specific resources and capabilities plays a key role behind decisions to internationalize.9 It is often the superb value of firm- specific assets that allow foreign entrants such as SABMiller to overcome the liability of foreignness (see the Opening Case). In the absence of overwhelmingly valuable capabilities, Wal-Mart ends up struggling in Brazil, and had to exit Germany, India, and South Korea.

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

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products, such as cars and DVDs, are often aggressively marketed overseas. How- ever, 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, there- fore, 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.10 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.11 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 Exxon Mobil and BP.

In summary, the resource-based view suggests an important set of underlying considerations underpinning entry decisions. In the case of imitability and dissemi- nation 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 differ- ences 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 govern- ment policies. Some governments may demand that foreign entrants share tech- nology 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 pro- claimed goal has been to “encourage” local automakers to learn from their foreign partners.

A well-known regulatory risk is the obsolescing bargain, referring to the deal struck by MNEs and host governments, which change their requirements after the entry of MNEs. 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 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.

• 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, some- thing 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,

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unfortunately, was not unique. 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 nationaliza- tion of foreign MNE assets does not necessarily maximize their national inter- ests. While expropriation drives MNEs away, SOEs are often unable to run the operations as effectively as did MNEs and so 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 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 confronta- tional 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 in 2006, Venezuela, Bolivia, and Ecuador expropriated the oil fields run by some MNEs.

Trade barriers include (1) tariff and nontariff barriers, (2) local content require- ments, 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 facto- ries 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) 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 air- lines 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 government), 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.

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In response, firms can engage in currency heading or strategic hedging. Currency hedging protects firms from exposure to foreign exchange fluctuations. However, this is risky in 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 off- set the currency losses in certain regions through gains in other regions. This 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 cost less in the short run)—France is in the Euro zone that Britain has refused to join.

In addition to formal institutional constraints, firms also need to develop a sophisticated understanding of numerous informal aspects such as cultural dis- tances 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, “Institu- tions matter,” is magnified in foreign entry decisions.12 Rushing abroad without a solid understanding of institutional differences can be hazardous and even disastrous.

WHERE TO ENTER? Like real estate, the motto for international business (IB) is “Location, location, location.” In fact, such a spatial perspective (that is, doing business outside of one’s home country) is one of the defining features of IB.13 Two sets of considerations drive the location of foreign entries: strategic goals, and cultural and institutional dis- tances. Each is discussed next.

Location-Specific Advantages and Strategic Goals Favorable locations in certain countries may give firms operating in those countries location-specific advantages. These advantages are the benefits a firm reaps from fea- tures specific to a particular location.14 Certain locations simply possess geographi- cal features that are difficult for others to match. For example, Miami, the self-styled “Gateway of the Americas,” is an ideal location both for North American firms look- ing south and Latin American companies coming north. Vienna is an attractive site as multinational regional headquarters for Central and Eastern Europe. Dubai is a fan- tastic stopping point for air traffic between Asia and Europe, and between Asia and Africa. Emirates Airlines has been blessed by being based in Dubai.

Beyond geographic advantages, location-specific advantages also arise from the clustering of economic activities in certain locations, usually referred to as agglomeration. The basic idea dates back at least to Alfred Marshall, a British econo- mist who first published it in 1890. Essentially, location-specific advantages stem from (1) knowledge spillovers among closely located firms that attempt to hire indi- viduals 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.15 For 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, STMicroelectro- nics, and ZTE 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.

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• Natural resource-seeking firms have to go to particular foreign locations where those resources are found. For example, the Middle East, Russia, Argentina, and Venezuela are all rich in oil. Although the Argentine government nationalized Spanish firm Respol’s subsidiary YPF in 2012, Chevron (from the United States) and Total (from France) went ahead with multi-billion dollar joint ventures with YPF by 2014.16 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 pro- ducts 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. As demand for business avia- tion takes off in China, business jet makers are now intensely eyeing the new market.

• 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 manufac- tures 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 more than 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 has the highest cost 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 Denmark (in wind turbines). (See Chapter 10 for details.)

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 institu- tional 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, the Chinese govern- ment has raised minimum wages and tightened environmental regulations. Also, thanks to the “one child” policy that was first implemented in the 1980s, the number of low-skill youth entering the labor market has declined. These changes have eroded the location-specific advantages of coastal China centered on low costs.

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

Automakers and business jet producers enter 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; wind turbines in Denmark

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As a result, many labor-intensive, cost-conscious firms have either moved to inland China (where labor costs have remained relatively low) or Southeast Asian countries such as Indonesia, Malaysia, Thailand, and Vietnam (where labor costs are now lower than those in coastal China).

Cultural/Institutional Distances and Foreign Entry Locations In addition to strategic goals, another set of considerations centers on cultural/insti- tutional distances (see also Chapter 4). Cultural distance is the difference between two cultures along some identifiable dimensions (such as individualism).18 Consider- ing 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.”19 Many West- ern consumer products firms, such as L’Oreal and Victoria’s Secret, have shied away from Saudi Arabia, citing its stricter rules of personal behavior—in essence, its cul- tural and institutional distance from the West being too large.

Two schools of thought have emerged. The first is associated with stage mod- els, 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.20 This idea is intuitively appealing: It makes sense for Belgian firms to first enter France and for Mexican firms to first enter Texas, taking advantage of common cultural, language, and historical ties.21 Business between countries that share a language on average is three times greater than between countries without a common language. Firms from common-law coun- tries (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.

Citing numerous counter-examples, a second school of thought argues that con- siderations of strategic goals such as market and efficiency are more important than cultural/institutional considerations.22 For instance, natural resource-seeking firms have compelling reasons to enter culturally and institutionally distant countries (such as Papua New Guinea for bauxite, Venezuela for oil, and Zambia for copper). Because Western multinationals have few alternatives elsewhere, cultural, institu- tional, and geographic distance in this case does not seem relevant—they simply have to be there. Overall, in the complex calculus underpinning entry decisions, loca- tions represent but one of several important sets of considerations. As shown next, entry timing and modes are also crucial.

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.23 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

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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.24

• 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, 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 cus- tomers and governments. For example, Citigroup, JP Morgan Chase, and Metal- lurgical Corporation of China have entered Afghanistan, earning a good deal of goodwill from the Afghan government that is interested in wooing more FDI.25

The potential advantages of first movers may be counter-balanced by various disadvantages, which result in late-mover advantages (also listed in Table 6.2). Numer- ous 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, includ- ing the king, in order to help officials grasp the promise of the Internet in fueling economic development. But then Cisco lost out to late movers such as Ericsson that offered lower cost solutions. For instance, the brand new King Abdullah Economic City awarded an US$84 million citywide telecom project to Ericsson whose bid was more than 20% lower than Cisco’s—in part because Ericsson did

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

BMW, 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

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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.26

• First movers face greater technological and market uncertainties. Nissan, for example, launched the world’s first all-electric car, the Leaf, which could run without a single drop of gasoline. However, there were tremendous uncertainties. After some of these uncertainties were removed, late movers such as BMW, GM, and Toyota more recently joined 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 ill 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.

Overall, evidence points out both first-mover advantages and late-mover advantages. Unfortunately, a mountain of research is still unable to conclusively recommend a particular entry timing strategy.27 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 1980s, Volkswagen 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 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 inter- action 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 intro- duces 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 else- where 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 limit- ing the downside risk.28 For example, to enter the market of Islamic finance whereby no interest can be charged (per teaching of the Koran), Citibank set up a subsidiary Citibank Islamic Bank. It was designed to experiment with different interpretations of the Koran on how to make money while not committing religious sins. 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.

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Modes of Entry: The First Step on Equity versus Non-Equity Modes Managers are unlikely to consider the numerous modes of entry (methods used to enter a foreign market) simultaneously. Given the complexity of entry deci- sions, it is imperative that managers prioritize, by considering only a few man- ageable, 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.29

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 agreements) 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 independent organizations overseas (partially or wholly owned), while non-equity modes do not require such independent establishments. Overall, these modes differ significantly in terms of cost, commitment, risk, return, and control.

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

FIGURE 6.3 The Choice of Entry Modes: A Decision Model.

Direct exports

Exports

Indirect exports

Others

Turnkey projects

R&D contracts

Co-marketing

Licensing/ franchising

Contractual

agreements

Greenfields

Acquisitions

Others

Wholly owned

subsidiaries (WOS)

Choice of entry modes

Non-equity modes Equity (FDI) modes

Minority JVs

50/50 JVs

Majority JVs

Joint

ventures (JVs)

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.

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investing in the oil-producing country, instead of relying on the market mechanism by purchasing oil from an exporter in that country?

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

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 (Burger King and Hungry Jack’s in Australia)

• Low development costs • Low risk in overseas expansion

• Little control over technology and marketing

• May create competitors • Inability to engageinglobal coordination

Turnkey projects (Safi Energy in Morocco)

• 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

4. Equity modes: Wholly owned subsidiaries Greenfield operations (PRPG America; Japanese auto trans- plants 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

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and oil-producing countries, the MNE is better able to coordinate cross-border activ- ities, 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 let- ting 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 rea- son could be the importer’s inability to sell refined oil downstream (people may drive less due to recession). 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 inef- ficiencies 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 internalization advantage.

Relative to a non-MNE, an MNE, which operates in certain desirable locations, enjoys a combination of ownership (O), location (L), and internalization (I) advan- tages (Figure 6.4). These are collectively labeled as the OLI advantages by John Dunning, a leading MNE scholar.30 Overall, the first step in entry mode considera- tions 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 economies of scale in production concentrated in the home

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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country and providing better control over distribution. Pearl River, for example, exports its pianos from China to more than 80 countries. 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, it is 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 psychologically, to its customers, prompt- ing the firm to consider more intimate overseas involvement such as FDI. In addi- tion, 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 econ- omies of scale similar to direct exports, but is also relatively worry free. A signifi- cant amount of export trade in commodities such as textiles and meats, which compete primarily on price, is indirect through intermediaries.31 Indirect exports have some drawbacks. For example, third parties such as export trading compa- nies may not share the same objectives as exporters. Exporters choose intermediaries primarily because of information asymmetries concerning foreign markets.32 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 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 pro- vide such knowledge.

The next group of non-equity entry modes involves the following types of con- tractual agreement: (1) licensing or franchising, (2) turnkey projects, (3) research and development contracts, and (4) co-marketing. In licensing/franchising agree- ments, 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 expan- sion. On the other hand, the licensor/franchisor does not have tight control over pro- duction and marketing.33 For example, Burger King alleged that its Australian franchisee Hungry Jack’s violated conditions of the franchise agreement by failing to expand the chain at the rate defined in the contract.

In turnkey projects, clients pay contractors to design and construct new facilities and train personnel. At project completion, contractors hand clients the prover- bial 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 agree- ments 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, Safi Energy, a consortium among GDF Suez (France), Mitsui (Japan), and Nareva Holdings (Morocco), has been awarded a BOT power-generation project in Morocco.34

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 wind turbines research in Denmark. However, three drawbacks may emerge. First, given the uncertain and multidimensional nature of R&D, these

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contracts are often difficult to negotiate and enforce.35 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 pro- ducts 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, Sky Team, and Star Alliance engage in extensive co-marketing through code sharing. The advantages are the ability to reach more customers. The drawbacks center 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% 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 knowl- edge about the host country. The local firm, in turn, benefits from the MNE’s tech- nology, capital, and management. Third, JVs may be politically more acceptable in host countries.

In terms of disadvantages, JVs often involve partners from different back- grounds 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 coordina- tion. 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 sub- sidiary located in a foreign country that is entirely owned by the parent multina- tional. There are two primary means to set up a WOS.36 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. There are three advantages. First, a greenfield WOS gives an MNE complete equity and management control, thus eliminating the headaches associated with JVs. Sec- ond, this undivided control leads to better protection of proprietary technology. Third, a WOS allows for centrally coordinated global actions. Sometimes, a subsidi- ary (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 in Germany is a case in point. Acquisition shares all the benefits of greenfield WOS but enjoys two additional advantages: (1) adding no new capacity

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and (2) faster entry speed. In terms of drawbacks, acquisition shares all of the dis- advantages of greenfield WOS except adding new capacity and slow entry speed. But acquisition has a unique disadvantage: post-acquisition integration problems (see Chapter 9).

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 ver- sus asset of foreignness, (2) global versus regional geographic diversification, and (3) old-line versus emerging multinationals.

Liability versus Asset of Foreignness In terms of the “liability of foreignness,” one contrasting view argues that under cer- tain circumstances, being foreign can be an asset (that is, a competitive advan- tage).37 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 inferior to Made-in-France handbags and Made-in-Switzerland watches. 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—are considered hip in Southeast Asia.

Conceptually, this is known as the country-of-origin effect, which refers to the pos- itive or negative perception of firms and products from a certain country.38

Although IKEA is now registered and headquartered in Leiden, the Netherlands (and thus technically a Dutch company), it relentlessly shows off Swedish flags in front of its stores in an effort to leverage the positive country-of-origin effect of Sweden. 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. 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: Belgium, Denmark, Germany, Sweden, Switzerland, and other European countries. Sorry, all wrong. Häagen-Dazs is American since its founding.

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.

Global versus Regional Geographic Diversification In this age of globalization, debate continues on the optimal geographic scope for MNEs.39 Despite the widely held belief that MNEs expand “globally,” Alan Rugman and colleagues report that, surprisingly, even among the largest Fortune Global 500 MNEs, few are truly “global.”40 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), fewer than ten MNEs are found to be really “global” (Table 6.4).

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

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they can manage.41 Some of them may have already over-diversified and will need to downsize. Second, these data only capture a snapshot (the 2000s) and some MNEs may become more “globalized” over time. However, more recent data do not show major changes.42 While the debate goes on, it has at least taught us one reason: Be careful when using the word “global.” The majority 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 experience of MNEs headquartered in developed economies that typically possess high-caliber technology and management know-how. However, emerging multina- tionals, such as those from Brazil, Russia, India, China, and South Africa, are chal- lenging some of this conventional wisdom.43 While these emerging multinationals, like their old-line (established) counterparts, hunt for lucrative locations and inter- nalize transactions—conforming to the L and I parts of the OLI framework—they typically do not own world-class technology or management capabilities. 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.44 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 it has to confront. 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.

Leverage refers to emerging multinationals’ ability to take advantage of their unique resources and capabilities, which are typically based on a deep under- standing 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 under- standing 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 Chinese-American.” On a global scale, Naver’s skills obviously pale in comparison with Google’s capabilities. But in cer- tain 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 internationalization push of many emerging multinationals.45 Instead of the “I- will-tell-you-what-to-do” mentality typical of old-line MNEs from developed econo- mies, many MNEs from emerging economies openly profess that they go abroad to learn. When India’s Tata Motors acquired Jaguar and Land Rover and China’s Geely

TABLE 6.4 Only 8–9 Multinational Enterprises (MNEs) Are “Global” Measured by Sales.

1 2 3 4 5 6 7 8 9 2001 Canon Coca-Cola Flextronics IBM Intel LVMH Nokia Philips Sony 2008 Accenture Hochtief Holcim Nike Rio Tinto Schlumberger Unilever Visteon —

SOURCE: Adapted from (1) 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; (2) C. Oh & A. Rugman, 2014, The dynamics of regional and global multinationals, Multinational Business Review, 22: 108–117. “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.

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acquired Volvo, they expressed a strong interest in learning how to manage world- class brands. Additional skills they need to absorb range from basic English skills (for managers from non-English-speaking countries such as Brazil, China, and Russia) 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 jus- tify 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 prog- ress of these emerging multinationals, one thing for certain is that our learning and debate about them will not stop anytime soon.46

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 indus- try in a foreign market you are looking into. For example, in the early 2000s, a num- ber 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. The key word is “overwhelming.” Merely outstanding, but not overwhelming, capabilities cannot ensure success in the face of strong incumbents—a painful lesson that DHL learned when it withdrew from the United States. In short, being good enough is not good enough.

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 understand 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.

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, while admittedly painful, may be necessary (as Best Buy withdrew from China and Wal- Mart withdrew from Germany, India, and South Korea).

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.

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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 capabili- ties, 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 becoming MNEs are likely to have a broader scope overseas than those unwilling to do so. Finally, entry strategies obviously have some- thing to do with the international success and failure of firms (Question 4). Appropriate entry strategies, while certainly important, are only a beginning.47 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 decision model that guides specific steps for foreign market 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.

6. Participate in three leading debates on foreign market entries • (1) Liability versus asset of foreignness, (2) global versus regional geo-

graphic diversification, and (3) old-line versus emerging multinationals. 7. Draw strategic implications for action

• Grasp the dynamism underlying the industry in a host country. • 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.

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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 foreign- ness confronting MNEs from emerging economies interested in expanding over- seas. 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 recom- mendations as (1) MNE executives, (2) labor union leaders of your domestic (home country) labor forces, (3) host country officials, and (4) home country officials?

TOPICS FOR EXTENDED 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 asso- ciated with NAFTA membership, and (3) abundant, low-cost, and high-quality labor. None of these has changed much. Yet, by the 30th anniversary of NAFTA (2014), does Mexico still enjoy such advantages? Why or why not?

2. ON ETHICS: Foreign entrants are often criticized for destroying local firms and cultures. As CEO of a leading foreign entrant in a host country, you have been interviewed by a local TV reporter to comment on this issue on TV. What would you say?

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). How would you prepare a press release on this incident?

CLOSING CASE 6.1

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 bestselling 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 associ- ated with made-in-China goods, you probably would not associate a fine musical instru- ment 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 capabilities, 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

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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 edu- cation. 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 numer- ous new entrants, many of which compete at the low end in China. These over 140 com- petitors 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. Acknowledg- ing the importance of the US market and the limited international caliber of his own man- agerial rank, PRPG’s CEO, Tong Zhi Cheng, attracted Al Rich, an American with long experience in the piano industry, to head the subsidiary. In two years, the greenfield sub- sidiary 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 penetrate the high-end mar- ket, however, were still frustrated.

Despite the enviable progress made by PRPG itself in general and by its US subsidi- ary 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 purchasing 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 compo- sers Beethoven and Haydn. It was one of the first piano makers 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 piano making 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, Ritmüller 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 inter- national master piano designers to marry German precision craftsmanship with the latest piano making technology.

Sources: 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.pearlriverpiano.com; 5. Pearl River USA, 2012, www.pearlriverusa.com.

Questions 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 interna-

tionalization (beyond the direct export strategy)? 3. Why did Pearl River use different entry modes when entering different markets?

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CLOSING CASE 6.2

Emerging Markets: SABMiller in Nigeria Founded in South Africa in 1895 as South African Breweries (SAB), SABMiller is cur- rently the world’s second-largest beer company measured by revenues (behind the Belgian–Brazilian Anheuser-Busch InBev). In 1999, SAB moved its headquarters to London. In 2002, SAB changed its name to SABMiller after acquiring an American brewer, Miller. SABMiller’s brands include Fosters, Grolsch, Miller, Peroni Nastro Azzurro, and Pilsner Urquell. While SABMiller operates in 75 countries, lately it has found that its fastest-growing market is its birthplace: Africa. Among some 40 African countries in which SABMiller sells beers, Nigeria has stood out. Nigeria has the largest population (170 million) in Africa—approximately one in five of Sub-Saharan Africa’s 930 million people lives here.

Nigeria is also the largest beer market after South Africa. Further, the Nigerian population is young and growing—at an annual rate of 2%–3%. Nigeria is attractive to SABMiller not only because of its size, but also because of its influence—Nigerian music and movies are visible throughout Africa. A win in Nigeria may influence consumer behavior elsewhere on the continent. However, Nigeria is not an easy mar- ket to crack, because Guinness (owned by a British multinational Diageo) and Nigerian Breweries (owned by a Dutch giant Heineken) had been strong incumbents prior to SABMiller’s entry.

In 2009, SABMiller entered Nigeria, not by going after Lagos, the country’s largest city where Guinness and Nigerian Breweries would definitely retaliate if attacked. Instead, SABMiller went to other cities away from Lagos. It acquired a rundown brewery in Port Harcourt and another one in Ilesha. In 2012 it built a brand new, greenfield plant in Onitsha. SABMiller developed a new beer specifically for the Onitsha plant: Hero. Its bottle features the rising sun, an icon of the local Igbo people. Undercutting the competitors, a 650 ml bottle of Hero sells for US$1, whereas a Guinness costs US$1.67 and a Star (from Nigerian Breweries) US$1.33. In Nigeria, SABMiller not only has to fight off rivals, but also deal with a traditional substitute of its factory-made beer: home brews. But home brews can be unsafe or even toxic. To persuade the bottom end of the market to get away from home brews, SABMiller has also brought in chibuku, an even cheaper brew developed in Zambia that sells for half of Hero’s price.

While Nigeria is exciting, it is also challenging. Political risk is not far away. Boko Haram, a fundamentalist Islamist group, kills innocent people who engage in “un- Islamic” practices such as drinking alcohol, resulting in hundreds of deaths. In April 2014, it kidnapped 276 schoolgirls. Health risk is also significant. In 2014, the out- break of Ebola in western Africa spread to Lagos, which was later contained. The rules of the game for business can change quickly and for the worse. Land is expensive and disputes are frequent, making it hard to construct new factories or offices. Power outage is frequent. Transportation is perilous. Nigeria has one of the world’s highest rates of road deaths. Shipping beer to remote areas, thus, is both costly and dangerous.

In addition to the hazards above that every company doing business in Nigeria must confront, SABMiller has learned an important lesson the hard way. That is: be even more careful about what you are getting into. It succeeded in other African countries by acquir- ing struggling breweries and fixing them up. Its Port Harcourt acquisition seemed to make sense. But it soon had to confront back pay and unpaid invoices that its pre- acquisition due diligence failed to uncover. In Africa, the business community has a vivid phrase to describe the necessary learning that is needed to overcome the initial challenges: paying school fees. “You have to persist through the school-fees stage and not lose your nerve,” noted one executive. In other words, persistency pays. Stay tuned on whether SABMiller will suffer from bitter brews or enjoy sweet profits in Nigeria and beyond.

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Sources: 1. Economist, 2014, Africa’s testing ground, August 23: 59–61; 2. Economist, 2014, The beer frontier, May 31: 55–56; 3. www.sabmiller.com.

Questions 1. How do firms such as SABMiller enter foreign markets? 2. Will SABMiller succeed in Nigeria? 3. Will SABMiller succeed in Nigeria?

CLOSING CASE 6.3

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, Philadel- phia, 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 immigrants) 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 Stagecoach’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 opera- tions 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 management system, typically used by airlines, which offers early pas- sengers dirt-cheap deals and late passengers progressively higher prices. Although

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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 elim- inates 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. Interest- ingly, 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 sometimes 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 con- sumption by 11 million gallons a year, equivalent to taking 24,000 cars off the road. 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 infrastructure. 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: 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; 3. Bloomberg Businessweek, 2012, Magabus, www.megabus.com; 4. Stagecoach Group, 2012, www.stagecoachgroup.com.

Questions 1. How do firms such as Stagecoach Group enter foreign markets? 2. Why do they enter certain countries but not others? 3. Why was Stagecoach able to transform a lackluster travel mode to one that attracts a younger

and more educated crowd?

NOTES

[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 Business- week (since 2010); GSJ–Global Strategy Journal; IBR–International Business Review; IMR–International Marketing 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 Busi- ness; MIR–Management International Review; SCMP–South China Morning Post; SEJ–Strategic Entrepreneurship Journal; SMJ–Strategic Management Journal

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1. K. Meyer, S. Estrin, S. Bhaumik, & M. W. Peng, 2009, Institutions, resources, and entry strategies in emerging economies, SMJ, 30: 61–80; S. Sun, M. W. Peng, R. Lee, & W. Tan, 2015, Institutional open access at home and outward internationalization, JWB, 50: 234–246.

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, 2011, On the determinants of post-entry strategic positioning of foreign firms in a host market: A strategy tripod perspective, IBR, 20: 477–490.

3. C. Asmussen & A. Goerzen, 2013, Unpacking dimensions of foreignness, GSJ, 3: 127–149; B. Baik, J. Kang, J. Kim, & J. Lee, 2013, The liability of foreignness in international equity investments, JIBS, 44: 391–411; Z. Bhanji & J. Oxley, 2013, Overcoming the dual liability of foreignness and privateness in international corporate citizenship partnerships, JIBS, 44: 290–311; N. Denk, L. Kaufmann, & J. Roesch, 2012, Liabilities of foreignness revisited, JIM, 18: 322–334; J. Johanson & J. Vahlne, 2009, The Uppsala internationalization process model revisited, JIBS, 40: 1411–1431; H. Yildiz & C. Fey, 2012, The liability of foreignness reconsidered, IBR, 21: 269–280.

4. BW, 2010, Northrop gives up, March 22: 8; Economist, 2010, The best plane loses, March 13: 66.

5. S. Chang, J. Chung, & J. Moon, 2013, When do foreign subsidiaries outperform local firms? JIBS, 44: 853–860.

6. SCMP, 2010, GE’s problem with China, July 6: B14. See also C. Stevens, E. Xie, & M. W. Peng, 2015, Toward a legitimacy-based view of political risk, SMJ (in press).

7. SCMP, 2010, GE boards China’s jumbo jet program, July 13: B4. 8. A. Kirca, G. T. Hult, S. Deligonul, M. Perryy, & S. T. Cavusgil, 2012, A multilevel

examination of the drivers of firm multinationality, JM, 38: 502–530; M. W. Peng, 2001, The resource-based view and international business, JM, 27: 803–829; K. S. Powell, 2014, From M-P to MA-P, JIBS, 45: 211–226.

9. S. Lee & M. Makhija, 2009, Flexibility in internationalization, SMJ, 30: 537–555; Y. Yamakawa, S. Khavul, M. W. Peng, & D. Deeds, 2013, Venturing from emerging economies, SEJ, 7: 181–196.

10. X. Tian, 2010, Managing FDI technology spillovers, JWB, 45: 276–284. 11. W. Lin, K. Cheng, & Y. Liu, 2009, Organizational slack and firms’ internationalization,

JWB, 44: 397–406; N. Malhotra & C. Hinings, 2010, An organizational model for understanding internationalization process, JIBS, 41: 300–349.

12. L. Dau, 2013, Learning across geographic space, JIBS, 44: 235–262; 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 investments, SMJ, 32: 556–568; A. Slangen & S. Beugelsdijk, 2010, The impact of institutional hazards on foreign multinational activity, JIBS, 41; 980–995.

13. J. Alcacer, C. Dezso, & M. Zhao, 2013, Firm rivalry, knowledge accumulation, and MNE location choices, JIBS, 44: 504–520; R. Belderbos, W. Olffen, & J. Zou, 2011, Generic and specific social learning mechanisms in foreign entry location choice, SMJ, 32: 1309–1330; S. Beugelsdijk & R. Mudambi, 2013, MNEs as border-crossing multi-location enterprises, JIBS, 44: 413–426; J. Dunning, 2009, Location and the MNE: A neglected factor? JIBS, 40: 5–19; A. Goerzen, C. Asmussen, & B. Nielsen, 2013, Global cities and multinational enterprise location strategy, JIBS, 44: 427–450; M. Kim, 2013, Many roads lead to Rome, JIBS, 44: 898–921; S. Zaheer & L. Nachum, 2011, Sense of place, GSJ, 1: 96–108.

14. R. De Figueiredo, P. Meyer-Doyle, & E. Rawley, 2013, Inherited agglomeration effects in hedge fund spawns, SMJ, 34: 843–862; R. Funk, 2014, Making the most of where you are, AMJ, 57: 193–222; A. Lamin & G. Livanis, 2013, Agglomeration, catch-up and the liability of foreignness in emerging economies, JIBS, 44: 579–606; A. Schmitt & J. Van Biesebroeck, 2013, Proximity strategies in outsourcing relations, JIBS, 44: 475–503.

15. A. Arikan & M. Schilling, 2011, Structure and governance 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.

16. United Nations, 2014, World Investment Report 2014, New York & Geneva: UN.

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17. BW, 2007, Shanghai rising, February 19: 51–55. 18. S. Lee, O. Shenkar, & J. Li, 2008, Cultural distance, investment flow, and control in

cross-border cooperation, SMJ, 29: 1117–1125; R. Parente, B. Choi, A. Slangen, & S. Ketkar, 2010, Distribution system choice in a service industry, JIM, 16: 275–287.

19. D. Xu & O. Shenkar, 2002, Institutional distance and the multinational enterprise, 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.

20. T. Hutzschenreuter, J. Voll, & A. Verbeke, 2011, The impact of added cultural distance and cultural diversity on international expansion patterns, JMS, 48: 305–329.

21. S. Makino & E. Tsang, 2011, Historical ties and foreign direct investment, JIBS, 42: 545–557; J. Xia, 2011, Mutual dependence, partner substitutability, and repeated partnership, SMJ, 32: 229–253.

22. J. Steen & P. Liesch, 2007, A note on Penrosian growth, resource bundles, and the Uppsala model of internationalization, MIR, 47: 193–206.

23. A. Hawk, G. Pacheci-de-Almeida, & B. Yeung, 2013, First-mover advantages, SMJ, 34: 1531–1550.

24. M. W. Peng, S. Lee, & J. Tan, 2001, The keiretsu in Asia, JIM, 7: 253–276. 25. BW, 2011, Land of war and opportunity, January 10: 46–54. 26. BW, 2008, Cisco’s brave new world, November 24: 56–68. 27. 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; M. Semadeni & B. Anderson, 2010, The follower’s dilemma, AMJ, 53: 1175–1193; J. Woo, R. Reed, S. Shin, & D. Lemak, 2009, Strategic choice and performance in late movers, JMS, 46: 308–335.

28. J. Xia, K. Boal, & A. Delios, 2009, When experience meets national institutional environmental change, SMJ, 30: 1286–1309.

29. G. Benito, B. Petersen, & L. Welch, 2009, Towards more realistic conceptualizations of foreign operation modes, JIBS, 40: 1455–1470.

30. 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; K. Ito & E. Rose, 2010, The implicit return on domestic and international sales, JIBS, 41: 1074–1089.

31. M. W. Peng, Y. Zhou, & A. York, 2006, Behind make or buy decisions in export strategy, JWB, 41: 289–300.

32. M. W. Peng, 1998, Behind the Success and Failure of US Export Intermediaries, Westport, CT: Quorum.

33. A. Akremi, K. Mignonac, & R. Perrigot, 2011, Opportunistic behaviors in franchise chains, SMJ, 32: 930–948; I. Ater & O. Rigbi, 2015, Price control and advertising in franchising chains, SMJ, 36: 148–158; P. Aulakh, M. Jiang, & S. Li, 2013, Licensee technological potential and exclusive rights in international licensing, JIBS, 44: 699–718.

34. United Nations, 2014, World Investment Report 2014 (p. 81). 35. S. Carson & G. John, 2013, A theoretical and empirical investigation of property rights

sharing in outsourced research, development, and engineering relationships, SMJ, 34: 1065–1085.

36. A. Slangen, 2013, Greenfield or acquisition entry? GSJ, 3: 262–280. 37. D. Kronborg & S. Thomsen, 2009, Foreign ownership and long-term survival, SMJ, 30:

207–219; K. Laursen, F. Masciarelli, & A. Prencipe, 2012, Trapped or spurred by the home region? JIBS, 43: 783–807.

38. S. Samiee, 2011, Resolving the impasse regarding research on the origins of products and brands, IMR, 28: 473–485.

39. J. Arregle, T. Miller, M. Hitt, & P. Beamish, 2013, Do regions matter? SMJ, 34: 910–934; L. Cardinal, C. C. Miller, & L. Palich, 2011, Breaking the cycle of iteration, GSJ, 1: 175–186; J. Hennart, 2011, A theoretical assessment of the empirical literature on the impact of multinationality on performance, GSJ, 1: 135–151; 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,

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The relationship between international diversification and firm performance, GSJ, 1: 152–170.

40. S. Collinson & A. Rugman, 2007, The regional character of Asian multinational enterprises, APJM, 24: 429–446; A. Rugman & A. Verbeke, 2004, A perspective on regional and global strategies of multinational enterprises, JIBS, 35: 3–18.

41. G. Qian, L. Li, & A. Rugman, 2013, Liability of country foreignness and liability of regional foreignness, JIBS, 44: 635–647.

42. A. Rugman & C. Oh, 2013, Why the home region matters, BJM, 24: 463–473. 43. R. Hoskisson, M. Wright, I. Filatotchev, & M. W. Peng, 2013, Emerging multinationals

from mid-range economies, JMS, 50: 1295–1321; M. W. Peng, 2012, The global strategy of emerging multinationals from China, GSJ, 2: 97–107.

44. J. Mathews, 2006, Dragon multinationals: Emerging players in 21st-century globalization, APJM, 23: 5–27.

45. Y. Luo & R. Tung, 2007, International expansion of emerging market enterprises, JIBS, 38: 481–498.

46. A. Cuervo-Cazurra & M. Genc, 2011, Obligating, pressuring, and supporting dimensions of the environment and the non-market advantages of developing-country multinational companies, JMS, 48: 441–455; M. W. Peng, R. Bhagat, & S. Chang, 2010, Asia and global business, JIBS, 41: 373–376.

47. J.-F. Hennart & A. Slangen, 2015, Yes, we really do need more entry mode studies! JIBS, 46: 114–122; R. Jiang, P. Beamish, & S. Makino, 2014, Time compression diseconomies in foreign expansion, JWB, 49: 114–121; S. Li & S. Tallman, 2011, MNC strategies, exogenous shocks, and performance outcomes, SMJ, 32: 1119–1127; T. Pedersen & J. M. Shaver, 2011, Internationalization revisited, GSJ, 1: 263–274; J. M. Shaver, 2011, The benefits of geographic sales diversification, SMJ, 32: 1046–1060; J. M. Shaver, 2013, Do we really need more entry mode studies? JIBS, 44: 23–27.

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CHAPTER

7 KEY TERMS

Strategic alliances Contractual (non-

equity-based) alliances Equity-based alliances strategic investment cross-shareholding Strategic networks constellations horizontal alliances

upstream vertical alliances

downstream vertical alliances

real option learning race relational (or collaborative) capabilities

partner rarity network centrality due diligence learning by doing Exploitation exploration

KNOWLEDGE OBJECTIVES 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

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Making Strategic Alliances and Networks Work

OPENING CASE Emerging Markets: Etihad Airways’ Alliance Network

Founded in 2003 and based in Abu Dhabi, Etihad Airways is both inspired by Emirates Airlines and a direct competitor of Emirates, which is based in Dubai, a fellow emirate in the United Arab Emirates (UAE). Etihad, which means “union” in Arabic, has quickly become the fastest growing airline in the history of commercial aviation. Now with 101 aircraft, Etihad serves 11 million passengers to nearly 100 destinations around the world. Now the fourth-largest airline in the world, Emirates is a mam- moth that has 220 aircraft and carries 40 million passengers to more than 100 cities.

Etihad imitates the highly successful Emirates by (1) equipping itself with modern long-haul jets (such as Airbus A380 and Boeing 777 Extended Range [ER]) and (2) leveraging the enviable location of the Abu Dhabi International Airport, which is only an hour away by car from Dubai’s storied airport. Given the small local population (three million in Abu Dhabi vis-à-vis four million in Dubai), Etihad—like Emirates—can only grow by being a “super-connector” airline. In other words, most of the passengers travel neither from nor to Abu Dhabi. Blessed by its Middle East location, Abu Dhabi, just like Dubai, is an ideal stopping point for air traffic between Europe and Australasia and between Asia and Africa.

One area that Etihad has decisively deviated from its role model Emirates is an interest in weav- ing an alliance network. Other than a single alliance with Qantas, Emirates either has been very shy or does not care about collaboration. In an industry with three major multipartner networks— One World, Sky Team, and Star Alliance—airlines are no strangers to alliances. But Etihad’s alli- ances are not what you think. Its talks to join these three mega networks did not go anywhere, because none of them was interested in admitting an ambitious new member determined to eat their lunch. Instead, Etihad has built its own alliance network consisting of eight smaller airlines. In 2011, Etihad took a 29% equity in Air Berlin, Europe’s sixth-largest airline. Since then, through a series of equity-based strategic investments, Etihad acquired stakes in Dublin, Ireland-based Aer Lingus (4% equity); Rome, Italy-based Alitalia (49%)—the largest airline in Italy; Belgrade, Serbia- based Air Serbia (49%)—the largest airline in Serbia, formerly known as Jat Airways; Mahe, Seychelles-based Air Seychelles (40%); Lugano, Switzerland-based Darwin Airline (34%)—recently rebranded as Etihad Regional; Mumbai, India-based Jet Airways (24%); and Brisbane, Australia- based Virgin Australia (20%).

Etihad CEO James Hogan, who is an Australian, is viewed as a “white knight” who bailed out a bunch of money-losing or cash-poor airlines, including the struggling flag carriers of Ireland, Italy, Serbia, and Seychelles. Hogan has argued that his multibillion-dollar investments in airlines that serve smaller markets made economic sense by increasing Etihad’s passenger tally and securing

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economies of scale when competing with Emirates. But can Etihad turn such an alliance network profitable? The most challenging member is Alitalia, which lost €1.1 trillion (US$1.5 billion) in five years, and Etihad spent €560 million to breathe some new life into it.

Always known for using nasty language, Michael O’Leary, CEO of Ireland’s and Europe’s largest airline Ryanair, bluntly told journalists that Etihad “bought a lot of rubbish, and increasing their stake in Aer Lingus is consistent with that.” Indeed, no other airline in the world is doing what Etihad is doing at this scale. Does Etihad, despite its deep pockets, have what it takes to turn around a whole bunch of also-runs? Stay tuned…

SOURCES: Based on (1) Bloomberg Businessweek, 2014, Will Etihad’s flock of also-rans fly? April 14: 22–24; (2) CEO Middle East, 2013, Airline alliances: New world order, June: 36–42.

Why does Etihad Airways establish strategic alliances with so many partners? How do these partners navigate the complexities of such tricky multilateral relation- ships? 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 on 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 com- promise 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—see the Opening Case), 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.

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

170 Part 2 • Business-Level Strategies

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Strategic networks are strategic alliances formed by multiple firms to compete against other such groups and against traditional single firms.3 For example, the air- line industry has three multipartner alliances—Star Alliance (consisting of United Air- lines, Lufthansa, Air Canada, SAS, and others), Sky Team (Delta, Air France, Korean Air, and others), and One World (American Airlines, British Airways, Cathay Pacific, Qantas, Japan Airlines, and others). These strategic networks are sometimes called constellations. Such multilateral strategic networks are inherently more complex than single alliance relationships between two firms.4 Overall, we will use the terms “strate- gic alliances” and “strategic networks” to refer to cooperative interfirm relationships.

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 7.2 A Comprehensive Model of Strategic Alliances and Networks.

Formation/Evolution/ Performance

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

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)

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

Strategic alliances

and networks

Industry-based considerations Resource-based considerations

Institution-based considerations

Chapter 7 • Making Strategic Alliances and Networks Work 171

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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 indus- try are embedded in a number of competitive and/or collaborative relationships, thus necessitating considerations of their alliance and network ties if we are going to real- istically understand the dynamics of the five forces.5

First, because rivalry reduces profits, many competitors collaborate by forming strategic alliances (often called horizontal alliances).6 For example, BMW and Mercedes are collaborating on green car technology. GSK and Pfizer have pooled HIV/AIDS assets to create ViiV Healthcare, a specialized company focusing on HIV/AIDS drugs. Three telecommunications competitors—AT&T, T-Mobile, and Verizon— have teamed with VISA to set up a mobile payment alliance. This does not suggest that these rivals (BMW/Mercedes, Pfizer/GSK, AT&T/T-Mobile/Verizon) 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 com- bined strengths of these two giants once they formed an alliance. Overall, combin- ing 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 cen- tered 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 eight 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 compo- nents. 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. Numerous hotels, publishers, airlines, and car rental companies have set up alliances with leading Internet distributors such as Amazon, Expedia, Priceline, and Travelocity.

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 cen- tered on Google and its partners such as Samsung and HTC have now substituted some personal computers (PCs).

172 Part 2 • Business-Level Strategies

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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 identi- fies 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 to tap into complementary assets of partners and facilitate learning.12 When Renault entered Turkey via a JV, its Turkish partner that held 49% of the JV was Oyak (Turkish Armed Forces Pension Fund).13 When Singapore Airlines entered India via a JV Vistara, its Indian partner that held 51% of the JV was Tata Group. What complementary resources would Oyak bring to a JV that manufac- tures cars and Tata bring to a JV that competes with Indian domestic airlines? In Turkey, where the military enjoys a great deal of prestige, Oyak’s political connec- tions are certainly helpful. In India, a leading conglomerate such as Tata can make a lot of things happen.

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.

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 capabilities 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, then there is no obligation to pur- sue them. Overall, alliances have emerged as great instruments of real options because of their flexibility to sequentially scale up or scale down the investment.

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)

Chapter 7 • Making Strategic Alliances and Networks Work 173

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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 differen- tiated 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 espe- cially strong incentives for some (but not all) partners to be opportunistic. Coopera- tive relationships always entail some elements of trust, which may be easily abused.19

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 learn- ing the “tricks” from the other side as fast as possible.

Rarity The second component in the VRIO framework has two dimensions: (1) capabil- ity 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 “court- ship,” “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 own 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 suc- cessfully 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: indus- try structure and network position. First, from an industry structure stand- point, 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 indus- try (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 infor- mation, access, capital, goods, and services), and consequently may accumulate more power and influence.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 be more attractive part- ners.23 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.

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Imitabilility The issue of imitability pertains to two levels: firm level and alliance level. First, as noted earlier, one firm’s resources and capabilities may be imitated by partners. A second imitability issue refers to the trust and understanding among partners in suc- cessful alliances. Firms without such “chemistry” may have a hard time imitating such activities. CFM International, a JV set up by GE and Snecma to produce jet engines in France, has successfully operated for more than 40 years. Rivals would have a hard time imitating such a successful relationship.

Organization Similarly, the organizational issues affect two levels: firm level and alliance/network level. First, at the firm level, how firms are organized to benefit from alliances and networks is an important issue.24 When the number of such relationships is small, many firms adopt a trial-and-error approach. Not surprisingly, “misses” are often fre- quent. 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 net- works 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 manual on alliances, includ- ing 60 different tools and templates (such as alliance contracts, metrics, and check- lists). 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 frame- works.25 The impact of these formal institutions can be found along two dimensions: antitrust concerns and entry mode requirements. First, many firms establish alli- ances 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 alli- ances as opposed to acquisitions.26 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 become the multipartner One World. 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 and in mobile payments.

Chapter 7 • Making Strategic Alliances and Networks Work 175

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Second, formal requirements on market entry modes affect alliances and net- works. 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 airline sector to be 49%, forcing foreign entrants to set up alliances such as JVs with local firms. For example, AirAsia (of Malaysia) set up a JV called AirAsia India, in which it holds a 49% stake and its Indian partner the other 51%.

Recently, two characteristics have arisen concerning formal government policies on entry mode requirements. The 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.27 A second characteristic is that many governments still impose considerable 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, thus eliminating acquisitions as a choice.

Informal Institutions Supported by Normative and Cognitive Pillars The first set of informal institutions centers on collective norms, supported by a nor- mative 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. 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, as opposed to having no partner and, hence, no presence there. For the same reason unmarried adults tend to experience some social pres- sure 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 development programs would involve alliances, evidently believing that an alliance strategy 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—indivi- duals 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. The success and failure 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.

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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 is very demanding, even for resource-rich multinationals. Acquisitions have some unique drawbacks, leading many managers to conclude that alliances are the way to go (see the Opening Case). 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 is

FIGURE 7.3 Alliance Formation.

STAGE I

STAGE III

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 STAGE II

Specifying the

relationship

Contract

or equity? To cooperate

or not to cooperate?

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.

Chapter 7 • Making Strategic Alliances and Networks Work 177

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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 codified knowledge in books or reports is not enough. Much tacit knowledge can only be acquired via learning by doing, preferably with capable partners such as Toyota.

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 con- tinuing basis, whereas contractual relationships usually do not. In general, firms that fear that 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 con- tractual relationships, which can be viewed as real options (or stepping stones) for possible upgrading into equity alliances should the interactions turn out to be mutu- ally satisfactory.

Finally, the choice between contract and equity also boils down to institutional constraints. As noted earlier, some governments eager to help domestic firms climb the technology ladder either require or encourage the formation of JVs between for- eign and domestic firms.

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 inter- firm relationships, it is important to manage them as a corporate portfolio (or network) (see Table 7.3). The combination of several individually “optimal” relation- ships 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

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: Extracted from www.cisco.com

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)

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impact of each individual relationship prior to its formation on the firm’s other rela- tionships becomes increasingly important.

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 opportunistic. 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 technol- ogies not meant to be shared. For example, GE and Snecma cooperated to build jet engines in a JV called CFM International, 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 prenuptial agree- ments. As long as both sides are willing to live with these deals, these relation- ships can prosper. CFM International has been operating successfully for more than 40 years.

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 tech- nologies back, but also make credible commitments to hold each other as a “hostage.” Motorola, for instance, licensed its microprocessor technology to Toshiba, which, in turn, licensed its memory chip technology to Motorola. Setting up a parallel and reciprocal relationship may increase the incentives for both part- ners to cooperate.

In human marriage terms, mutual “hostage taking” is similar to the following commitment: “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 subma- rine 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 on strong ties among individuals and firms.

Defined as relationships characterized by infrequent interaction and low inti- macy, weak ties, paradoxically, are likely to provide more opportunities. Weak ties enjoy two advantages:

• Weak ties are less costly to maintain, requiring less time, energy, and money. • 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, such as your Facebook “friends”), firms at any given point in time are likely to have a combi- nation of strong ties and weak ties. Both ties are beneficial, but under different con- ditions. 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 “explo- ration” noted by James March, a leading organization theorist. Exploitation refers to “such things as refinement, choice, production, efficiency, selection, and execu- tion,” whereas exploration includes “things captured by terms such as search, varia- tion, risk taking, experimentation, play, flexibility, discovery, and innovation.”32

While both kinds of strategic activities are important and often occur simulta- neously, there is a trade-off between the two because of the limited resources firms possess. 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 environments suitable for exploration, weak ties may be preferred.

Many strong ties evolve to become weak ties. Examples from two contexts illus- trate 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 entre- preneur(s) to ensure its survival. In the next phase, having largely exploited (and exhausted) the initial set of opportunities, the firm must search for new opportu- nities. Therefore, it shifts to exploration in order to seek new opportunities, thus calling for more weak ties with greater diversity. Amazon’s changing alliance portfo- lio 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 (such as toys) and new business models (such as auctions), it formed numerous weak ties with a wider variety of large suppliers, small merchants, 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 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 their JV in Russia called TNK-BP, AAR, the Russian partner, was upset by the “extramarital” relationship that BP developed with Rosneft in a new alliance.

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From Corporate Marriage to Divorce33

Alliances are often described as corporate marriages and, when terminated, as cor- porate divorces. Figure 7.4 portrays an alliance dissolution model. To apply the met- aphor of divorce, we focus on the two-partner alliance such as the Danone–Wahaha case (and ignore multi-partner alliances such as One World). In the late 2000s, the ten-year JV (1996–2006) relationship between Danone and Wahaha deteriorated. Following the convention in research on human divorce, the party who begins the process of ending the alliance is labeled the “initiator,” and the other party is termed the “partner”—for lack of a better word.

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. In the Danone–Wahaha case, Danone seemed to be the initiator. After repeated requests to modify Wahaha’s behavior failed, Danone began to escalate its demands. At that point, its display of discontent became bolder. Initially, Wahaha, the partner, might simply not “get it.” The initiator’s “sudden” dis- satisfaction may confuse the partner. As a result, initiation tends to escalate.

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 Wahaha did. Eventually, both Danone and Wahaha were eager to air their grievances publicly.

The third phase is uncoupling. Like human divorce, alliance dissolution can be friendly or hostile. In uncontested divorces, both sides attribute the separation more to, say, a change in circumstances. For example, Eli Lilly and Ranbaxy phased

FIGURE 7.4 Alliance Dissolution.

Reconciliation

Mediation by third parties

Last minute salvage

Initiation

Going public

Uncoupling

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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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 the “death by a thousand cuts” inflicted by one party at every turn. A case in point are the numerous lawsuits and arbitrations against each other filed in many countries by Danone and Wahaha, not only in France and China, but also in the British Virgin Islands, Italy, Sweden, and the United States.

The last phase is aftermath. Like most divorced individuals, most (but not all) “divorced” firms, such as Chrysler after its divorce with Daimler, are likely to search for new partners. Understandably, the new alliance is often negotiated more exten- sively.34 However, excessive formalization may signal a lack of trust—in the same way that prenuptials may scare away some prospective human marriage partners.

PERFORMANCE Performance is a central focus for strategic alliances and networks. This section dis- cusses (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.35 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 perfor- mance: (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, experi- ence is often used as a proxy because it is relatively easy to measure.36 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.37

Third, nationality may affect performance. For the same reason that marriages where both parties have similar backgrounds are more stable, dissimilarities in national culture may create strains in alliances. Not surprisingly, international alli- ances tend to have more problems than domestic ones. Finally, alliance performance may fundamentally boil down to soft, difficult-to-measure relational capabilities.

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

Objective

• Financial performance (e.g., profitability) • Product market performance

(e.g., market share) • Stock market reaction

Subjective

• Level of top management satisfaction

Subjective

• Assessment of goal attainment

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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.38 While 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? This goes back to the value-added aspect of these relationships (discussed earlier). Compared with the relative 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 mea- sure of goal attainment as perceived by management (see Table 7.4).

A higher level of collaboration and shared technology is often associated with better profitability and product market share for parent firms. If the event window of a decision to enter or exit a relationship 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 experi- ence, and (3) ability to manage host country political risks.39 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.

FIGURE 7.5 What Is behind Alliance Performance?

Equity

Learning and experience

Nationality

Relational capabilities

Strategic

alliance performance

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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 implementation 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. Some advocate a 50/50 share of management control even when the MNE has majority equity. However, a 50/50 JV has its own headaches—everything must be negotiated or fought over.

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 addi- tional benefit alluded to earlier is exercising real options. In general, the more uncer- tain 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 inadvis- able, because the cost of failure may be tremendous. Therefore, minority JVs are recommended toehold investments, seen as possible stepping stones for future scaling up—if necessary.

Since the real options thinking is relatively new, its applicability is still being debated.40 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 upon price for one party to acquire the other’s assets. Most con- tracts 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 gen- erating potential.”41 As a result, how to reach an agreement on a “fair” price is tricky.

Alliances versus Acquisitions An alternative to alliances is mergers and acquisitions (M&As) (see Chapter 9).42

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.

Shown in Table 7.5, alliances, which tend to be loosely coordinated among part- ners, do not work well in a setting that requires a high degree of interdependence. 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.43

While these rules are not exactly “rocket science,” few companies adhere to them. 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 distribution system with P&G’s R&D capabilities. 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

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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 alli- ances, guided by a real options logic, can provide a great deal of flexibility to scale up or scale down investments.

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 consis- tent with the predictions made from standard network theory.44 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.45

Why are there such differences? Researchers speculate that due to the dynamic, fast-moving institutional transitions unfolding in China, any competitive advantage associated with high centrality is likely to erode very rapidly, prompting centrally located firms to quickly acquire alliance partners. In comparison, the pace of com- petitive dynamics in the United States is not as fast, thus enabling some centrally located firms to enjoy the benefits and not having to acquire alliance partners.46 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 Bra- zil 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 inter- ested 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.47

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.

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Whether rapidly acquiring alliance partners results in better parent firm perfor- mance 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.48

THE SAVVY STRATEGIST Instead of concentrating on competition only, a new generation of strategists must be savvy at both competition and cooperation—in other words, “co-opetition.”49 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 cor-

porations, both of which are important, both of which I care a lot about,

will remain pretty close. But Android was around earlier than iPhone. 50

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 busi- ness school curriculum often emphasizes competition at the expense of collabora- tion, 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 networks—both formal and informal—around the world. Formal rules dictating alli- ances 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 impor- tant. In the absence of a legal mandate for alliances, the norms for entering emerging economies used to be in favor of alliances. However, the recent trend has moved toward phasing out alliances and establishing stronger control over subsidiaries in emerging economies.

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 (discussed earlier). Considering alliances vis-à-vis acquisitions within an integrated decision framework may be necessary.

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.

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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 considerations drive alliance and network actions. What deter- mines the scope of the firm (Question 3)—or more specifically, the scope of the alli- ance in this context—can be found in the strategic goals. Some alliances may have a wide scope in anticipation of an eventual merger (such as the Renault–Nissan alli- ance), while other alliances may have a limited scope, keeping the partners fiercely competitive in other aspects (such as the GM–Toyota JV). Finally, the success and failure of strategic alliances and networks (Question 4) are fundamentally deter- mined by how firms develop, possess, and leverage “soft” relational capabilities when managing their 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 exter- nal 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.

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.

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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 alli- ance partners.

7. Draw strategic implications of action • Improve relational (collaborative) capabilities. • Understand and master the rules of the game governing alliances and net-

works around the world. • Carefully weigh the pros and cons of alliances vis-à-vis those of acquisitions.

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, espe- cially 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), stra-

tegic 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 entrepre- neurial start-ups, internal corporate ventures, new product launchs, and M&As. Therefore, such a failure rate is not of grave concern. What do you think?

2. Working in pairs, find the longest-running alliance relationship your research can find. Present its secrets for such longevity.

3. What are the similarities and differences between human marriages and inter- firm alliances? How can the lessons behind the success and failure of human marriages enhance the odds of alliance success?

CLOSING CASE 7.1

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

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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 partners: Mikhail Fridman (founder of Alfa Group and chairman 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 grievances. First, TNK-BP relied on too many BP’s expatriate (expat) consultants, whose fees were a “rip off”—extra dividends to BP but exces- sive 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 labelled 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 immigration officials regarding the proper number of visas for TNK-BP’s for- eign 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.

BP framed the dispute as oligarchs’ time-honored practice 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 dispute as “a traditional, commercial dispute about different ambitions of the stra- tegic development of the business” (see Emerging Markets 7.1). Accusing BP of being opportunistic, 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? Dudley’s ouster as TNK-BP’s CEO. Under such tremendous pressures, Dudley had to quickly flee the country. A Rus- sian 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 promoted to become the new BP CEO. As the new CEO, Dudley quickly flew to Moscow and became more accommodating to the Russian partners. With a changed attitude, BP now agreed that TNK-BP could expand abroad. In October 2010, BP sold assets worth $1.8 billion in Venezuela and Vietnam to TNK-BP—a mile- stone 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.

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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 (rela- tively) 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 second largest oil company, which produces 2.4 million barrels of oil a day (behind Gaz- prom 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 partners 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 violated. In sim- ple 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 Vladimir Putin. Basically, 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 part- ners. 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 pro- ceedings to block BP’s deal with Rosneft.* In March 2011 a Swedish arbitration tribunal sup- ported 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 “pri- mary business vehicle in Russia”—which, in human marriage terms, sounded like acknowledg- ing 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 govern- ment 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: 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;

190 Part 2 • Business-Level Strategies

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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, Exonerated, September 3: 64; 12. M. Fridman, 2008, BP has been treating Russians as subjects, Financial Times, July 7: 11.

Questions 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?

CLOSING CASE 7.2

Emerging Markets: Etihad Airways’ Alliance Network Founded in 2003 and based in Abu Dhabi, Etihad Airways is both inspired by Emirates Airlines and a direct competitor of Emirates, which is based in Dubai, a fellow emirate in the United Arab Emirates (UAE). Etihad, which means “union” in Arabic, has quickly become the fastest growing airline in the history of commercial aviation. Now with 101 aircraft Etihad serves 11 million passengers to nearly 100 destinations around the world. Now the fourth-largest airline in the world, Emirates is a mammoth that has 220 aircraft and carries 40 million passengers to more than 100 cities.

Etihad imitates the highly successful Emirates by (1) equipping itself with modern long-haul jets (such as Airbus A380 and Boeing 777 Extended Range [ER]) and (2) leveraging the enviable location of the Abu Dhabi International Airport, which is only an hour away by car from Dubai’s storied airport. Given the small local population (three million in Abu Dhabi vis-à-vis four million in Dubai), Etihad—like Emirates—can only grow by being a “super-connector” airline. In other words, most of the passengers travel neither from nor to Abu Dhabi. Blessed by its Middle East location, Abu Dhabi, just like Dubai, is an ideal stopping point for air traffic between Europe and Australasia and between Asia and Africa.

One area that Etihad has decisively deviated from its role model Emirates is an interest in weaving an alliance network. Other than a single alliance with Qantas, Emi- rates either has been very shy or does not care about collaboration. In an industry with three major multipartner networks—One World, Sky Team, and Star Alliance—airlines are no strangers to alliances. But Etihad’s alliances are not what you think. Its talks to join these three mega networks did not go anywhere, because none of them was inter- ested in admitting an ambitious new member determined to eat their lunch. Instead, Etihad has built its own alliance network consisting of eight smaller airlines. In 2011, Etihad took a 29% equity in Air Berlin, Europe’s sixth-largest airline. Since then, through a series of equity-based strategic investments, Etihad acquired stakes in Dublin, Ireland-based Aer Lingus (4% equity); Rome, Italy-based Alitalia (49%)—the largest airline in Italy; Belgrade, Serbia-based Air Serbia (49%)—the largest airline in

Chapter 7 • Making Strategic Alliances and Networks Work 191

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Serbia, formerly known as Jat Airways; Mahe, Seychelles-based Air Seychelles (40%); Lugano, Switzerland-based Darwin Airline (34%)—recently rebranded as Etihad Regional; Mumbai, India-based Jet Airways (24%); and Brisbane, Australia-based Virgin Australia (20%).

Etihad CEO James Hogan, who is an Australian, is viewed as a “white knight” who bailed out a bunch of money-losing or cash-poor airlines, including the struggling flag carriers of Ireland, Italy, Serbia, and Seychelles. Hogan has argued that his multibillion- dollar investments in airlines that serve smaller markets made economic sense by increasing Etihad’s passenger tally and securing economies of scale when competing with Emirates. But can Etihad turn such an alliance network profitable? The most chal- lenging member is Alitalia, which lost €1.1 trillion (US$1.5 billion) in five years, and Etihad spent €560 million to breathe some new life into it.

Always known for using nasty language, Michael O’Leary, CEO of Ireland’s and Europe’s largest airline Ryanair, bluntly told journalists that Etihad “bought a lot of rub- bish, and increasing their stake in Aer Lingus is consistent with that.” Indeed, no other airline in the world is doing what Etihad is doing at this scale. Does Etihad, despite its deep pockets, have what it takes to turn around a whole bunch of also-runs? Stay tuned…

Sources: 1. Bloomberg Businessweek, 2014, Will Etihad’s flock of also-rans fly? April 14: 22–24; 2. CEO Middle East, 2013, Airline alliances: New world order, June: 36–42.

Questions 1. Why does Etihad Airways establish strategic alliances with so many partners? 2. How do these partners navigate the complexities of such tricky multilateral relationships? 3. Will these alliances become successful or end up in divorce?

NOTES

[Journal acronyms] AME–Academy of Management Executive; AMJ–Academy of Management Journal; AMP–Academy of Management Perspectives; AMR–Acad- emy of Management Review; APJM–Asia Pacific Journal of Management; BW–BusinessWeek (before 2010) or Bloomberg Businessweek (since 2010); FT– Financial Times; GSJ–Global Strategy Journal; HBR–Harvard Business Review; IJHRM–International Journal of Human Resource Management; 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; OSc–Organization Science; SMJ–Strategic Manage- ment 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; A. Shipilov, R. Gulati, M. Kilduff, S. Li, & W. Tsai, 2014, Relational pluralism within and between organizations, AMJ, 57: 449–459.

3. S. Nambisan & M. Sawhney, 2011, Orchestration processes in network-centric innovation, AMP, August: 40–56.

4. D. Li, L. Eden, M. Hitt, R. D. Ireland, & R. Garrett, 2012, Governance in multilateral R&D alliances, OSc, 23: 1191–1210.

5. X. Yin & M. Shanley, 2008, Industry determinants of the “merger versus alliance” decision, AMR, 33: 473–491.

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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; F. Castellucci & G. Ertug, 2010, What’s in it for them? AMJ, 53: 149–166; L. Diestre & N. Rajagopalan, 2012, Are all “sharks” dangerous? SMJ, 33: 1115–1134; E. Fang, 2011, The effect of strategic alliance knowledge complementarity on new product innovativeness in China, OSc, 22: 158–172; A. Joshi & A. Nerkar, 2011, When do strategic alliances inhibit innovation by firms? SMJ, 32: 1139–1160; E. Klijn, J. Reuer, F. Van den Bosch, & H. Volberda, 2013, Performance implications of IJV boards, JMS, 50: 1245–1266; M. Srivastava & D. Gnyawali, 2011, When do relational resources matter? AMJ, 54: 797–810.

10. Economist, 2003, Open skies and flights of fancy, October 4: 65–67. 11. S. Ang, 2008, Competitive intensity and collaboration, SMJ, 29: 1057–1075; C. Wang,

S. Rodan, M. Fruin, & X. Xu, 2014, Knowledge networks, collaboration networks, and exploratory innovation, AMJ, 57: 484–514.

12. H. Mitsuhashi & H. Greve, 2009, A matching theory of alliance formation and organizational success, AMJ, 52: 975–995.

13. M. Koza, S. Tallman, & A. Ataay, 2011, The strategic assembly of global firms, GSJ, 1: 27–46.

14. A. Chintakananda & D. McIntyre, 2014, Market entry in the presence of network effects, JM, 40: 1535–1557; I. Cuypers & X. Martin, 2010, What makes and what does not make a real option? JIBS, 41: 47–69; T. Tong & S. Li, 2013, The assignment of call option rights between partners in IJVs, SMJ, 34: 1232–1243.

15. 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 perception and post-formation

governance in IJVs in Taiwan, JIM, 16: 288–303; M. Meuleman, A. Lockett, S. Manigart, & M. Wright, 2010, Partner selection decisions 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 strangers? 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; D. Zoogah, D. Vora, O. Richard, & M. W. Peng, 2011, Strategic alliance team diversity, coordination, and effectiveness, IJHRM, 22: 510–529.

21. B. Connelly, T. Miller, & C. Devers, 2012, Under a cloud of suspicion, SMJ, 33: 820–833; G. Ertug, I. Cuypers, N. Nooderhaven, & B. Bensaou, 2013, Trust between IJV partners, JIBS, 44: 263–282; 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; 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 biotechnology alliances, JIBS, 43: 61–83; J. Roy, 2012, IJV partner trustworthy behavior, JMS, 49: 332–355.

22. B. Koka & J. Prescott, 2008, Designing alliance networks, SMJ, 29: 639–661; C. Phelps, 2010, A longitudinal study of the influence of alliance network structure 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.

Chapter 7 • Making Strategic Alliances and Networks Work 193

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23. W. Shi, S. Sun, B. Pinkham, & M. W. Peng, 2014, Domestic alliance network to attract foreign partners, JIBS, 45: 338–362.

24. V. Aggarwal, N. Siggelkow, & H. Singh, 2011, Governing collaborative activity, SMJ, 32: 705–730.

25. 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, 2012, Sub-national institutional contingencies, network positions, and IJV partner selection, JMS, 49: 1221–1245.

26. Federal Trade Commission, 2000, Antitrust Guidelines for Collaborations among Competitors, Washington: FTC; T. Tong & J. Reuer, 2010, Competitive consequences of interfirm collaboration, JIBS, 41: 1056–1073.

27. M. W. Peng, 2006, Making M&As fly in China, HBR, March: 26–27; 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.

28. This section draws heavily from S. Tallman & O. Shenkar, 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. C. Beckman, C. Schoonhoven, R. Rottner, & S. Kim, 2014, Relational pluralism in de novo organizations, AMJ, 57: 460–483; N. Lahiri & S. Narayanan, 2013, Vertical integration, innovation, and alliance portfolio size, SMJ, 34: 1042–1064; U. Wassmer & P. Dussauge, 2011, Network resource stocks and flows, SMJ, 32: 871–883.

31. 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. J. March, 1991, Exploration and exploitation in organizational learning, OSc, 2: 71–87. 33. 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.

34. N. Pangarkar, 2009, Do firms learn from alliance terminations? JMS, 46: 982–1004. 35. 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.

36. 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; C. Liu, P. Ghauri, & R. Sinkovics, 2010, Understanding the impact of relational 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; B. Nielsen & S. Nielsen, 2009, Learning and innovation in international strategic alliances, JMS, 46: 1031–1058; S. Tallman & 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.

37. Y. Luo & M. W. Peng, 1999, Learning to compete in a transition economy, JIBS, 30: 269–296.

38. C. Chung & P. Beamish, 2010, The trap of continual ownership change in international equity JVs, OSc, 21: 995–1015; J. Xia, 2011, Mutual dependence, partner substitutability, and repeated partnership, SMJ, 32: 229–253.

39. M. Kumar, 2011, 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.

40. R. Ragozzino & C. Moschieri, 2014, When theory doesn’t meet practice, AMP, 28: 22–37.

41. T. Chi, 2000, Option to acquire or divest a JV, SMJ, 21: 665–687.

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42. J. Reuer & R. Ragozzino, 2012, The choice between JVs and acquisitions, OSc, 23: 1175–1190; J. Reuer, T. Tong, B. Tyler, & A. Arino, 2013, Executive preferences for governance modes and exchange partners, SMJ, 34: 1104–1122.

43. K. Brouthers & D. Dikova, 2010, Acquisitions and real options, JMS, 47: 1048–1070. 44. R. Burt, 1992, Structural Holes, Cambridge, MA: Harvard University Press; H. Yang,

Z. Lin, & M. W. Peng, 2011, Behind acquisitions of alliance partners, AMJ, 54: 1069–1080.

45. Z. Lin, M. W. Peng, H. Yang, & S. Sun, 2009, How do networks and learning drive M&As? SMJ, 30: 1113–1132.

46. H. Yang, S. Sun, Z. Lin, & M. W. Peng, 2011, Behind M&As in China and the United States, APJM, 28: 239–255.

47. S. Lebedev, M. W. Peng, E. Xia, & C. Stevens, 2015, Mergers and acquisitions in and out of emerging economies, JWB (in press); S. Sun, M. W. Peng, B. Ren, & D. Yan, 2012, A comparative ownership advantage framework for cross-border M&As, JWB, 47: 4–16.

48. M. W. Peng, 2012, The global strategy of emerging multinationals from China, GSJ, 2: 97–107.

49. A. Brandenburger & B. Nablebuff, 1996, Co-opetition, New York: Doubleday. 50. BW, 2010, Charlie Rose talks to Eric Schmidt, September 27: 39.

Chapter 7 • Making Strategic Alliances and Networks Work 195

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CHAPTER

8 KEY TERMS

competitive dynamics competitor analysis Multimarket competition mutual forbearance collusion tacit collusion Explicit collusion cartel trust antitrust laws prisoners’ dilemma game theory

concentration ratio price leader capacity to punish market commonality cross-market retaliation Resource similarity competition policy antitrust policy Collusive price setting predatory pricing extraterritoriality dumping

antidumping laws attack counterattack thrust feint gambit blue ocean strategy defender extender dodger contender

KNOWLEDGE OBJECTIVES 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

196

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Managing Global Competitive Dynamics

OPENING CASE Emerging Markets: Emirates Airlines Fights

Legacy Airlines

Launched in 1985 in Dubai, United Arab Emirates, Emirates Airlines has become one of the world’s most powerful airlines. Carrying 40 million passengers annually, it is now the fourth-largest interna- tional airline in the world. It has an all wide-body fleet of 220 planes and more on order (including 50 Airbus A380s). It flies to more than 100 cities in more than 60 countries. It is the largest customer of the ultra-long-range Boeing 777 ER and one of the earliest and largest users of the Airbus A380. With these capable jets, any two cities in the world can be linked with one stop via Dubai.

Emirates is blessed by its location. Geographically, Dubai International Airport (DXB) may be regarded as the center of the world, known as a natural “pinch point.” It is the ideal stopping point for air traffic between Europe and Australasia and between Africa and Asia. Four billion people can be reached within seven hours from DXB. Connecting 220 destinations, DXB handles more than 40 million passengers a year. New expansion will allow DXB to serve 60 million a year in the near future. Since Dubai’s own population is fewer than four million (most are expatriates), the majority of the passengers are connecting (transit) 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?

Firmly believing that connecting passengers will come, Emirates positions itself as a “super- connector” airline. It has directly challenged traditional long-haul carriers such as Air France-KLM, British Airways (BA), Lufthansa, Qantas, and Singapore Airlines. These legacy airlines fear that just like no-frills competitors squeeze their short-haul flights, Emirates can threaten their profitable long- haul business. This fear is understandable, as Emirates already has more intercontinental seats than Air France and BA combined. Emirates has launched services connecting Dubai with secondary (but still sizable) cities, such as Manchester, Hamburg, and Kolkata. These cities are, respectively, neglected by BA, Lufthansa, and Air India, which focus on their hubs in London Heathrow, Frankfurt, and Mumbai. Passengers flying, for example, from Hamburg to Sydney may prefer to change planes in Dubai instead of in Frankfurt. If they fly Lufthansa and connect in Frankfurt after a very short flight from Hamburg, they will have to endure an extremely long flight to Sydney. But if they fly from Hamburg to Dubai on Emirates, then the next leg to Sydney is not so intimidating. Emirates has made itself more attractive by flying newer and quieter planes, offering cheaper tickets, and provid- ing nicer amenities on board and at DXB. One of its open secrets of success is to fly super-sized planes—one A380 can carry 500 passengers—to reduce cost per passenger. The savings help it undercut fares of legacy airlines.

197

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While legacy airlines fight back with their own aggressive pricing, they have also complained that Emirates receives “unfair” subsidies ranging from cheaper fuel to lower airport fees. In fact, Emirates pays slightly more for fuel at home (DXB) than abroad, because of the lack of refining capacity in the Gulf. It and 129 other airlines at DXB pay the same airport fees. True, neither Emirates nor its employees pay taxes. But the upshot is that Dubai’s social services are poor for expatriates. Emirates ends up spending US$400 million a year to provide accommodation, health care, and schools for its staff—a huge expense none of its rivals has to cough up.

From an institution-based view, Emirates thrives on treaties that permit flights between two countries by an airline from a third country. The model works best on long-haul flights requiring refueling at DXB. As the complaints from its rivals grow, in theory if these rivals mobilize enough political muscle, they can convince European governments to deny route applications from Emirates. But chances are slim, because such a political decision would hurt Airbus and European jobs. So Emirates is in an advantageous position in its dog fights against legacy airlines.

SOURCES: Based on (1) Aviation News, 2011, Dubai International Airport, December: 34–39; (2) Bloomberg Businessweek, 2010, Emirates wins with big planes and low costs, July 5: 18–19; (3) CEO Middle East, 2013, New world order, June: 36–42; (4) Economist, 2010, Rulers of the new silk road, June 5: 75–77; (5) Economist, 2010, Super-duper-connectors from the Gulf, June 5: 21.

Why do competing airlines such as Emirates and its rivals firms take certain actions? Once one side initiates an action, how do others respond? These are some of the strategic questions 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 signaling 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 sug- gests 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 For example, General Motors (GM) runs a war game among its top 60 execu- tives. 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.” 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 opposi- tion. In a nutshell, business is simultaneously war and peace. Alternatively, most competitive dynamics concepts can also be explained in sports terms such as “offense” and “defense.”

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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 multimar- ket competitor 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 any attack. In other words, while firms “act local,” they must “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.

Because managers (and students) generally do not like to discuss collusion, another “C” word, coordination, is now frequently used in preference over collu- sion.7 However, given the legal battles centered on collusion, managers (and stu- dents) cannot shy away from it. Instead they must be aware of the 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

FIGURE 8.1 Strategy as Action.

ResponseAction Competitive

interaction

Competitive

advantage and

performance

SOURCE: C. M. Grimm & K. G. Smith, 1997, Strategy as Action: Industry Rivalry and Coordination (p. 62), Cincinnati: Cengage Learning.

Chapter 8 • Managing Global Competitive Dynamics 199

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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 “anti- competitive” 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 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

FIGURE 8.2 A Comprehensive Model of Global Competitive Dynamics.

Concentration Industry price leader Product homogeneity Entry barriers Market commonality with rivals

Valuable abilities to attack, deter, and retaliate Rarity of certain assets Imitability of competitive actions Organizational skills for actions Resource similarity with rivals

Domestic competition: Primarily competition/antitrust policy International competition: Primarily trade/antidumping policy

Attack/Counterattack/ Cooperation

Industry-based considerations Resource-based considerations

Institution-based considerations

Competitive

dynamics

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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 the other side to become a “sucker.” However, neither likes to be a “sucker.” Because both A and B want to chop prices, then, as in Cell 4, each still gets 100 passengers. But both firms as well as the industry end up with a 40% reduc- tion 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

Industry Characteristics and Collusion vis-à-vis Competition Given the benefits of collusion and incentives to cheat, what industries are condu- cive 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 telecommunica- tions 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

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

(Cell 3) A: 0

B: $60,000

Airline A

Airline B

Chapter 8 • Managing Global Competitive Dynamics 201

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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 with- out 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 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 must have both the willingness and the capability to carry out punishments and bear the costs. On the other hand, an indus- try 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 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. 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 ball bearings, car parts, shipping, and vitamins, have been convicted of price fixing.11

Fourth, an industry with high entry barriers for new entrants (such as shipbuild- ing) 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 loose cannons in otherwise tranquil industries. For example, SpaceX founder Elon Musk, who also founded Tesla, blasted the defense industry and the Pentagon for not using SpaceX’s cheaper rockets. He sued the US Air Force in federal court for using a monopoly for rocket launch, United Launch Alliance, which is a joint venture between Boeing and Lockheed Martin.13 Incumbents naturally have collective interest in resisting such new entrants.

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)

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Finally, market commonality, defined as the degree of overlap between two compe- titors’ markets, also has a significant bearing on the intensity of rivalry.14 Multimar- ket firms may respect rivals’ spheres of influence in certain markets, and their rivals may reciprocate, leading to tacit collusion. To make that happen, firms must estab- lish 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: deterrence and 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 competi- tive dynamics. IO economics has been influential in antitrust policy. For example, con- centration 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 con- siderations, while certainly insightful, are unable to tell the complete story, thus calling for contributions 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 For example, the ability to attack in multiple markets—of the sort Apple and Samsung possessed when launch- ing their smartphones in numerous countries simultaneously—throws rivals off bal- ance, 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 in and out of Dallas–Fort Worth for American Airlines). Such a strong sphere of influ- ence 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 in competitive dynamics. Emirates Airlines, in addition to

Chapter 8 • Managing Global Competitive Dynamics 203

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claiming one of the best locations as its home base, is a well-run organization sup- ported by a supportive government (see the Opening Case). Airlines elsewhere, such as British Airways (BA) at London Heathrow airport, cannot run certain flights at night and cannot expand the airport due to complaints from the surrounding com- munity. Emirates is unhindered by airport curfews in Dubai and is able to push through dramatic airport expansion proposals. Also, because Emirates primarily flies long-haul routes, its aircraft are in the air 18 hours a day—making its fleet one of the hardest working and most utilized in the industry. This combination of both geographic advantage and organizational advantage is rare, thus fueling Emirates to soar to become the world’s fourth largest airlines in terms of international passen- gers carried.

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 diffi- cult to do so. Many major airlines have sought to imitate discount carriers such as Southwest, Ryanair, and AirAsia, 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 and Ericsson’s leading challenger. It is difficult for slow- moving firms to suddenly wake up and become more aggressive.23

Resource Similarity Resource similarity is defined as “the extent to which a given competitor possesses stra- tegic endowment comparable, in terms of both type and amount, to those of the focal firm.”24 Firms with a high degree of resource similarity are likely to have similar competitive actions. For instance, IBM and Apple used to have a lot of resource sim- ilarity 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. Recently, IBM has to fight Amazon in cloud computing. Why? In the emerging market for cloud computing, both IBM and Amazon have a great deal of resource similarity.

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).25 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, Star- bucks seemed to go “down market” by offering cheaper drinks and instant coffee.

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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.

In another example, prior to Fox’s entry into the US TV broadcasting industries in the mid 1990s, the three incumbents—ABC, CBS, and NBC—enjoyed relatively tranquil and gentlemanly competition in Cell 2. However, Fox’s entry pulled com- petition down to Cell 4, whose rivalry is the most intense. The primary reason is that Fox is a wholly owned subsidiary of News Corporation, which is not only active in the United States, but also in Australia (its original country), Britain, Asia Pacific, and India. In other words, Fox/News Corporation had very little mar- ket commonality with the three incumbents, which were US-centric. Not afraid of retaliation elsewhere, Fox unleashed a series of relentless attacks on the incum- bents and rocketed ahead to become the leader in the US TV broadcasting indus- try. Overall, for any pair of rivals, conscientious mapping along the dimensions 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.

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 India’s IndiGo in discount air- lines. 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 must 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

FIGURE 8.4 A Framework for Competitor Analysis between a Pair of Rivals.

(Cell 1) Intensity of rivalry

Low

High

High

Low

(Cell 2) Intensity of rivalry

(Cell 4) Intensity of rivalry

(Cell 3) Intensity of rivalry

Resource Similarity

Market

Commonality

Lowest Second lowest

Second highest Highest

SOURCE: 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 multi- market environment: The role of strategic similarity and multimarket contact in competitive de-escalation (p. 338), Organi- zation Science, 7: 322–341.

Chapter 8 • Managing Global Competitive Dynamics 205

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countries (see the next section). From a resource-based view, in a race to the bot- tom, incumbents usually lose, because low-cost rivals have much better capabilities in the 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 dif- ferent airports). In the end, Southwest soared but American crash-landed into bank- ruptcy. One piece of advice for incumbents is to enhance differentiation and convince customers to pay for such benefits (see Chapter 2). Apple designs cool gad- gets. 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 mar- ket, 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 operations. In the 1990s, most major airlines launched no-frills

FIGURE 8.5 How to Fight a Low-Cost Rival.

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.

YES NO

NO

NO

YES

YES

Question to Ask

Will this company take away any of

my present or future customers?

Question to Ask

Are sufficient numbers of

consumers willing to pay more

for the benefits I offer?

Question to Ask

If I set up a low- cost business, will it generate synergies

with my existing business?

SOURCE: Adapted from N. Kumar, 2006, Strategies to fight low-cost rivals, Harvard Business Review (p. 107), December: 104–112.

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operations, such as BA’s Go, Continental Lite, Delta Express, SAS Snowflake, and United Shuttle. Since then, all of them have failed, indicating both a lack of organiza- tional capabilities and a lack of ability to learn “new tricks.”

Eventually, while incumbents may (hopefully) transform themselves to become successful 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 brand- ing capabilities.

INSTITUTION-BASED CONSIDERATIONS The institution-based view advises managers to be well versed in the “rules of the game” governing domestic and international competition. In a nutshell, 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, fair- ness 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 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 pol- icy 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. In general, because of stronger, pro- consumer antitrust laws, competitive forces have been stronger in the United States than in most other developed economies. As a result, on average, prices in the United States are lower than those in Japan.

Table 8.2 outlines the three major US antitrust laws and five landmark cases. Competition and antitrust policy focuses on collusive price setting and predatory pricing. Collusive price setting refers to price setting by monopolists or collusion parties at a level higher than the competitive level. The global vitamin cartel convicted in the 2000s artificially jacked up prices by 30% to 40%.

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.

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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 that was pursued by US antitrust authorities for six decades (between the 1940s and the 2000s). The case was settled in 2008.

Since the Reagan era, US antitrust enforcement has generally become more per- missive. It is no accident that strategic alliances among competitors have prolifer- ated since the 1980s (see Chapter 7). However, despite improved clarity and permissiveness, the legal standards are still ambiguous. In 1996, Boeing was allowed

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.

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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 nationwide 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 dif- ferent countries. (See the Debates and Extensions section for more discussion.)

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, benefit- ting consumers in both Texas and Indiana.

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 dump- ing. 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 anti- trust relief.”28 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 reports that 90% of the practices found to be unfairly dumping in Australia, Canada, the EU, and the US would never have been questioned under their own antitrust laws if used between domestic firms.29 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 Department 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, then the estimated data provided by the complainant become the evidence, and the complainant can easily win.

• If foreign firms do provide data, then the complainant 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 US$9 per week salary made by Chinese workers was a major point of contention.

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• 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 argu- ment goes, its cost data reflect “huge distortions” due to government interven- tion 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 reports that simply filing an antidumping petition (regardless of the outcome) may result in a nontrivial 1% increase in the stock price for US listed firms (a cool US$46 million increase in market value).30 Evidently, Wall Street knows that Uncle Sam favors US firms. Globally, this means that governments usu- ally protect their domestic firms in antidumping investigations. Not surprisingly, anti- dumping cases have proliferated throughout the world. The institution-based message to firms defending home markets is clear: Get to know your country’s anti- dumping 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. Do please drop the “F” word (free) in “free market” competition.

Overall, institutional elements such as antidumping protection are not just the “background.” They are part of a firm’s arsenal when waging competitive battles. Next, we outline two main action items.

ATTACK AND COUNTERATTACK In the form of price cuts, advertising campaigns, market entries, new product intro- ductions, and law suits, attack is defined as an initial set of actions to gain a competi- tive advantage. Consequently, counterattack is defined as a set of actions in response to an attack. This section focuses on: (1) What are the main types 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.31 Shown in Figure 8.6, thrust is the classic frontal attack with brute forces. In 2015, Singapore Air- lines entered the Indian domestic airline market via a joint venture with Tata, which is called Vistara. In an opening salvo, Vistara went head-to-head with incumbents in the most crowded New Delhi–Mumbai route.

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 8.7, 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. 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,

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1993, which became known as the “Marlboro Friday”). Confronting this ferocious move, RJR diverted substantial resources earmarked for CEE to defend its US mar- ket. Philip Morris thus rapidly established its dominance in CEE.

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 mar- ket to attract rivals to divert resources into it in order to capture a high-value market (Figure 8.8). For example, Gillette and Bic competed in both razors and lighters. Gillette was stronger in razors and Bic was stronger in lighters. Gillette withdrew

FIGURE 8.6 Thrust.

A massively attacks target market X

B engaged in A’s target market X

Target X

B

A

B withdraws from target market X

A’s sphere of influence in target market X is enhanced

Target X

B

A

First round 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 8.7 Feint.

Focal Y

A

Target X

B

B engaged in A’s target market X

A

Focal Y

Target X

B

B redeploys from target market X to defend focal market Y

A attacks focal market Y salient to B

A’s sphere of influence in target market X is enhanced

First round 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. 731), Academy of Management Review, 23: 724–740.

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entirely from lighters and devoted its attention to razors. Bic accepted the gambit and diverted razor resources to lighters. Such gambit can be regarded as an exchange of the spheres of influence.

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.32

• If an attack is so subtle that rivals are not aware of it, attacker’s objectives are likely to be attained. Consider how Haier entered the United States. Although Haier dominated China with a broad range of appliances, it chose to enter the US in a most non-threatening segment: mini-bars (compact refrigerators) for hotels and dorms. Do you 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 aware they were being attacked. Thanks in part to the incumbents’ lack of awareness, Haier now com- mands a 50% US market share in compact refrigerators and has built a factory in South Carolina to go after more lucrative product lines.

• Motivation is also crucial. If the attacked market is of marginal value, managers may decide not to counterattack. One interesting idea is the “blue ocean strategy” that endeavors to find a virgin market (a “blue ocean”) for yourself and that avoids attacking core markets defended by rivals. A thrust on rivals’ core mar- kets is likely to result in a bloody price war—in other words, a “red ocean.” A new airline startup Azul (which literally means “blue” in Portuguese) has deliber- ately avoided Brazil’s busiest route between São Paulo and Rio de Janeiro. The 45-minute trip between them is already the most-traveled route in the world, with an astounding 284 (!) daily flights dominated by two incumbents Gol

FIGURE 8.8 Gambit.

Focal Y

A

A withdraws from focal market Y salient to B

Target X

B

B engaged in A’s target market X

A

A’s sphere of influence in target market X is enhanced

Focal Y

Target X

B

B redeploys from target market X to enhance sphere of influence in focal market Y

First round 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. 733), Academy of Management Review, 23: 724–740.

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and Tam.33 Sticking Azul’s nose into such a crowded airspace will immediately attract retaliation, resulting in a “red ocean”—remember Cell 4 in Figure 8.4? Instead, Azul uses its limited slots at São Paulo’s and Rio’s airports to strengthen its service connecting these two cities and Brazil’s vast hinterland. Founded in 2008, Azul has risen to enjoy an 18% market share of Brazil’s growing air traffic by positioning itself as a small-town carrier. In three-quarters of the cities it serves, it is the only or dominant airline. Clearly, Brazil’s vast, underserved hin- terland is the “blue ocean” for the “blue airline.” While certainly being aware of Azul’s rise, the incumbents are not motivated to counterattack the markets that they did not bother to enter in the first place.

• 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 sec- tion on resources.

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 ille- gally 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 difficul- ties 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 talks 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.

• Strategic alliances with rivals can reduce cost. Although price fixing is illegal, reducing cost by 10% through an alliance, which is legal, has the same impact on financial performance as collusively raising price by 10%.

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 8.9, these factors suggest four strategic actions.34

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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. Local assets where MNEs are weak can be leveraged in a defender strategy. Facing an onslaught from multinational cosmetics firms, a number of 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. While Ahava ceded some markets (such as mainstream cosmetics) to MNEs, it built strongholds in narrower but deeper product markets (such as the “Dead Sea mud” product that has become popular around the world). In other words, this is an example of gambit.

Cell 4 shows industries where pressures for globalization are relatively low and where local firms 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, character- ized by thousands of small retailers serving numerous poor consumers who only want small quantities of paint in a single-use sachet (or pouch) 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, which typically focus on affluent customers in developed economies who buy paint by the bucket, 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 globalization. Thus, a dodger strategy is necessary. This is largely centered on coop- erating through joint ventures (JVs) with MNEs and sell-offs to MNEs. In the Chi- nese 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 firms are unable to successfully compete head-on against MNEs, cooperation becomes necessary. In other words, if you can’t beat them, join them!

FIGURE 8.9 How Local Firms in Emerging Economies Respond to Multinationals.

(Cell 1) High

Transferable abroad

Low

(Cell 2)

(Cell 3) (Cell 4)

Customized to home markets

Competitive Assets

Industry

Pressures

to Globalize

Dodger Contender

Defender Extender

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.

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Finally, in Cell 2, some local firms, through a contender strategy, engage in rapid learning and then expand overseas. A number of Chinese smartphone makers such as Huawei, Lenovo, TCL, Xiaomi, and ZTE rapidly caught up with global heavy- weights such as Apple and Samsung. First in China and then in India, Xiaomi (pro- nounced as “shee-owl-mee,” meant “Little Rice”) dethroned Samsung to become the market leader in these important emerging markets.

Particularly in emerging economies, how domestic firms respond is crucial. For example, in China, despite initial dominance, MNEs do not always stay on top. In numerous industries (such as sportswear, 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 strongest domestic firms rise to the challenge.35 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 sig- nificant 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. But antitrust officials, influenced by IO economics, often get in the way by accusing firms (such as Microsoft) of being “anticompetitive.” Most business school students do not study antitrust 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 under- standing 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 will last forever and monopoly will prevail. Managers know better: Given rapid technological changes, ambitious new entrants, and strong global competition, no competitive advantage lasts forever (see Chapter 3). It is possible that none of the antitrust officials has ever studied a strategy textbook like this one. But officials who have a static and unrealistic view of the sustainability of competi- tive advantage end up deciding and enforcing the rules governing competition. Such a disconnect naturally breeds mutual suspicion and frustration on both sides. Busi- ness 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 competitive conduct that made them successful in the first place? Because the United States has the world’s oldest antitrust frameworks (dating back to the 1890 Sherman Act), here we focus on the US debate as a case study that has global ramifications.

On behalf of managers, strategy and management scholars have made four argu- ments.36 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 danger- ous monopoly. The existence of foreign rivals (such as Airbus) forces the large domestic incumbent to be more competitive.

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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 vol- untarily helping its competitors. It is puzzling why Microsoft should have voluntar- ily helped its competitors. 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/her mind?

Third, US antitrust laws create strategic confusion (see Figure 8.10).37 Because the intention to destroy your firm’s rivals is the smoking gun of antitrust cases, man- agers are forced to use milder language and bland talking points. Don’t write a memo or talk on a smartphone: “We want to beat 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!” Hiroshi Mikitani, the third-richest man in Japan and founder of Rakuten, the world’s third-largest e-commerce marketplace behind Amazon and eBay, makes no secret of his desire to beat Amazon’s founder Jeff Bezos. Mikitani has given his subordinates T-shirts emblazoned with the words “Destroy Amazon.”38 In compari- son with such a laser-sharp focus embedded in such inspirational (and war-like) lan- guage, the inability to talk straight creates confusion in US firms. Confused firms are not likely to be aggressive or successful.

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. Ironi- cally, starting in 1983, GM was allowed to jointly make cars with Toyota. Now 30 years later, Toyota is the number-one 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: stop- ping the merger between GE and Honeywell, severely fining Microsoft and Intel, and threatening to dismantle Google.39 Learning from such actions, Chinese trust- busters now seem eager to punish (certain) foreign firms.40 While these actions provoked protests from the American side, they are at least understandable from a protectionist standpoint. 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 of T-Mobile, a wholly owned subsidiary of Deutsche Telekom (DT), and was forced to pay a US$3 bil- lion (!) 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 ramifi- cations 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 impor- tance of knowledge about this debate rises.

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 diffi- cult (if not impossible) to prove the case given the ambiguity concerning “cost.” The second argument 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

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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? Of course 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 inter- est 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 US, 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 repre- sents essentially an expanded notion of “us.” However, domestically, as noted ear- lier, a predation case is very difficult to make. Thus, by legalizing dumping, competition can be fostered, aggressiveness rewarded, and consumer welfare enhanced.

FIGURE 8.10 Confusion Stemming from Antitrust Enforcement.

SOURCE: NOTE FROM AUTHOR: This is from a student of mine, who grabbed it from Google. Source see above. Try to secure permission as I really love it!

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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 destruc- tion is unleashed. 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, soft- ware, and film industries, where digital piracy is accelerating. 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 must strengthen capabilities to compete and/or cooperate effectively. In attacks and counterattacks, subtlety, complexity, and unpre- dictability 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 like your opponents’.

Third, you need to understand the rules of the game governing competition around the world. Aggressive language such as “Let’s beat rivals” is not allowed in countries such as the United States. Remember: an email or a smartphone conversa- tion—like a diamond—is “forever.” “Deleted” emails and smartphone conversations are still stored on servers 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, more than 30 US supermarket chains declared bankruptcy since Wal-Mart charged into groceries in the 1990s—just a tragic coincidence (!).

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.

TABLE 8.4 Strategic Responses to Digital Piracy.

• Not only compete but also cooperate with pirates by adopting a permissive stance, espe- cially 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 Jour- nal of Management, 24: 9–25. For more recent research, see D. Bryce, J. Dyer, & N. Hatch, 2011, Competing against free, Harvard Business Review, June: 104–111.

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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.43 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 upsurge to hit 30% 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 com- petitive 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 inter- national success and failure of firms (Question 4), to a large extent, depends on how firms carry out their competitive and cooperative actions. 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) homogenous products, (4) high entry barriers, and (5) high market com- monality (mutual forbearance).

3. Explain how resources and capabilities influence competitive dynamics • Resource similarity and market commonality can yield a powerful frame-

work 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 com-

petition and/or cooperation.

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• Strengthen resources and capabilities to compete and/or cooperate more effectively.

• Understand the rules of the game governing domestic and international com- petition around the world.

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 inten- tionally 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 EXTENDED PROJECTS 1. Find some competitive moves made by some emerging multinationals from

emerging economies. How do the two frameworks in Figures 8.4 and 8.9 help you understand these moves?

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 8.1

Emerging Markets: Emirates Airlines Fights Legacy Airlines Launched in 1985 in Dubai, United Arab Emirates, Emirates Airlines has become one of the world’s most powerful airlines. Carrying 40 million passengers annually, it is now the fourth-largest international airline in the world. It has an all wide-body fleet of 220 planes and more on order (including 50 Airbus A380s). It flies to more than 100 cities in more than 60 countries. It is the largest customer of the ultra-long-range Boeing 777 ER and one of the earliest and largest users of the Airbus A380. With these capable jets, any two cities in the world can be linked with one stop via Dubai.

Emirates is blessed by its location. Geographically, Dubai International Airport (DXB) may be regarded as the center of the world, known as a natural “pinch point.” It is the

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ideal stopping point for air traffic between Europe and Australasia and between Africa and Asia. Four billion people can be reached within seven hours from DXB. Connecting 220 destinations, DXB handles more than 40 million passengers a year. New expansion will allow DXB to serve 60 million a year in the near future. Since Dubai’s own population is fewer than four million (most are expatriates), the majority of the passengers are connect- ing (transit) 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?

Firmly believing that connecting passengers will come, Emirates positions itself as a “super-connector” airline. It has directly challenged traditional long-haul carriers such as Air France-KLM, British Airways (BA), Lufthansa, Qantas, and Singapore Airlines. These legacy airlines fear that just like no-frills competitors squeeze their short-haul flights, Emi- rates can threaten their profitable long-haul business. This fear is understandable, as Emirates already has more intercontinental seats than Air France and BA combined. Emi- rates has launched services connecting Dubai with secondary (but still sizable) cities, such as Manchester, Hamburg, and Kolkata. These cities are, respectively, neglected by BA, Lufthansa, and Air India, which focus on their hubs in London Heathrow, Frankfurt, and Mumbai. Passengers flying, for example, from Hamburg to Sydney may prefer to change planes in Dubai instead of in Frankfurt. If they fly Lufthansa and connect in Frankfurt after a very short flight from Hamburg, they will have to endure an extremely long flight to Sydney. But if they fly from Hamburg to Dubai on Emirates, then the next leg to Sydney is not so intimidating. Emirates has made itself more attractive by flying newer and quieter planes, offering cheaper tickets, and providing nicer amenities on board and at DXB. One of its open secrets of success is to fly super-sized planes—one A380 can carry 500 passengers—to reduce cost per passenger. The savings help it undercut fares of legacy airlines.

While legacy airlines fight back with their own aggressive pricing, they have also complained that Emirates receives “unfair” subsidies ranging from cheaper fuel to lower airport fees. In fact, Emirates pays slightly more for fuel at home (DXB) than abroad, because of the lack of refining capacity in the Gulf. It and 129 other airlines at DXB pay the same airport fees. True, neither Emirates nor its employees pay taxes. But the upshot is that Dubai’s social services are poor for expatriates. Emirates ends up spending US$400 million a year to provide accommo- dation, health care, and schools for its staff—a huge expense none of its rivals has to cough up.

From an institution-based view, Emirates thrives on treaties that permit flights between two countries by an airline from a third country. The model works best on long-haul flights requiring refueling at DXB. As the complaints from its rivals grow, in the- ory if these rivals mobilize enough political muscle, they can convince European govern- ments to deny route applications from Emirates. But chances are slim, because such a political decision would hurt Airbus and European jobs. So Emirates is in an advantageous position in its dog fights against legacy airlines.

Sources: 1. Aviation News, 2011, Dubai International Airport, December: 34–39; 2. Bloomberg Businessweek, 2010, Emirates wins with big planes and low costs, July 5: 18–19; 3. CEO Middle East, 2013, New world order, June: 36–42; 4. Economist, 2010, Rulers of the new silk road, June 5: 75–77; 5. Economist, 2010, Super-duper-connectors from the Gulf, June 5: 21.

Questions 1. Why do competing airlines such as Emirates and its rivals firms take certain actions? 2. Once one side initiates an action, how do others respond?

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CLOSING CASE 8.2

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 commanded 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 companies 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 products. 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 brand- ing and (2) the loss of clients, which did not want to do business with an emerging rival. Such a “double whammy” forced many manufacturers to remain on the low-cost tread- mill. 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 capabili- ties. It began designing some of the world’s first touch screen and wireless handheld devices as early as in 1998.

Second, HTC was very skillful in collaborating with larger firms. Such successful col- laborations—in combination 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 corporate 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 for Western 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 innovation infrastructure of fast-moving development teams. Some of these teams

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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 top management 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 Goo- gle’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 inter- views, 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 vigor- ously competing on the product dimension, Apple sued HTC for 20 counts of patent violations in 2010. This was part of a broader Apple strategy to slow the ascendance of Android phones, which were not only made by HTC but also by Samsung and Motor- ola. Led by HTC, Android phones rocketed from less than 3% market share in 2009 to 48% in 2011. In addition to HTC, Apple also sued Samsung, Motorola, as well as Goo- gle itself. In response, HTC sued Apple for infringing on five of HTC’s patents and sought to ban Apple products imported into the United States from manufacturing facil- ities 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 law- suits 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: 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.

Questions 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?

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NOTES

[Journal acronyms] APJM–Asia Pacific Journal of Management; AMJ–Academy of Management Journal; AMR–Academy of Management Review; BW–Business- Week (before 2010) or Bloomberg Businessweek (since 2010); HBR–Harvard Busi- ness Review; JEP–Journal of Economic Perspectives; JIBS–Journal of International Business Studies; JMS–Journal of Management Studies; JWB– Journal of World Business; SMJ–Strategic Management Journal.

1. D. Ross, 2014, Taking a chance, AMR, 39: 202–226. 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. G. Markman, P. Gianiodis, & A. Buchholtz, 2009, Factor-market rivalry, AMR, 34: 423–441.

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 exploitation activities, AMJ, 52: 802–821; H. Greve, 2008, Multimarket contact and sales growth, SMJ, 29: 229–249; Z. Guedri & J. McGurie, 2011, Multimarket competition, mobility barriers, and firm performance, JMS, 48: 857–890; J. Prince & D. Simon, 2009, Multimarket contact and service quality, AMJ, 52: 336–354.

6. A. Bowers, H. Greve, H. Mitsuhashi, & J. Baum, 2014, Competitive parity, status disparity, and mutual forbearance, AMJ, 57: 38–62; 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 cartels, 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. Economist, 2014, Boring can still be bad, March 29: 16; Economist, 2014, Fixed

penalty, November 15: 78. 12. M. Benner, 2007, The incumbent discount, AMR, 32: 703–720. 13. BW, 2014, Fighting for a seat at the grown-ups’ table, June 2: 25–27. 14. M. Chen, 1996, Competitor analysis and interfirm rivalry, 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 psychology of rivalry, AMJ, 53: 943–969. 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 University Press. 20. D. Sirmon, S. Gove, & M. Hitt, 2009, Resource management in dynamic competitive

rivalry, AMJ, 51: 919–935. 21. H. Ndofor, D. Sirmon, & X. He, 2011, Firm resources, competitive actions, and

performance, SMJ, 32: 640–657. 22. R. Agarwal, M. Ganco, & R. Ziedonis, 2009, Reputations for toughness in patent

enforcement, SMJ, 30: 1349–1374; M. Chen, H. Lin, & J. Michel, 2010, Navigating in a hypercompetitive environment, SMJ, 31: 1410–1430; G. Vroom & J. Gimeno, 2007, Ownership form, managerial incentives, and the intensity of rivalry, 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. Chen, 1996, Competitor analysis and interfirm rivalry (p. 107). 25. J. Upson, D. Ketchen, B. Connelly, & A. Ranft, 2012, Competitor analysis and foothold

moves, AMJ, 55: 93–110. 26. N. Kumar, 2006, Strategies to fight low-cost rivals, HBR, December: 104–112.

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27. E. Graham & D. Richardson, 1997, Issue overview (p. 5), in E. Graham & D. Richardson (eds), Global Competition Policy, Washington: Institute for International Economics.

28. R. Lipstein, 1997, Using antitrust principles to reform antidumping law (p. 408, original italics), in E. Graham & D. Richardson (eds), Global Competition Policy, Washington: Institute for International Economics.

29. OECD, 1996, Trade and Competition: Frictions after the Uruguay Round (p. 18), Paris: OECD.

30. S. Marsh, 1998, Creating barriers for foreign competitors, SMJ, 19: 25–37. 31. R. McGrath, M. Chen, & I. MacMillan, 1998, Multimarket maneuvering in uncertain

spheres of influence, AMR, 23: 724–740. 32. 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. 33. BW, 2014, The carrier that avoids Brazil’s No. 1 air route, August 11: 24. 34. N. Dawar & T. Frost, 1999, Competing with giants, HBR, March: 119–129. 35. C. Mutlu, Z. Wu, M. W. Peng, & Z. Lin, 2015, Competing in (and out of) transition

economies, APJM (in press). 36. R. D’Aveni, 1994, Hypercompetition, New York: Free Press. 37. E. Rockefeller, 2007, The Antitrust Religion, Washington, DC: Cato Institute. 38. BW, 2013, Japan’s billionaire brawl, October 21: 42–43; H. Mikitani, 2013, Rakuten’s

CEO on humanizing e-commerce, HBR, November: 47–50. 39. Economist, 2014, Should digital monopolies be broken up? November 29: 11. 40. Economist, 2014, Trust-busting in China, August 23: 62–63. 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. M. Czinkota & M. Kotabe, 1997, A marketing perspective of the US International Trade

Commission’s antidumping actions, JWB, 32: 169–187.

Chapter 8 • Managing Global Competitive Dynamics 225

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PART 3 Corporate-Level Strategies

• Chapter 9 Diversifying and Managing Acquisitions Globally

• Chapter 10 Strategizing, Structuring, and Learning Around the World

• Chapter 11 Governing the Corporation Around the World

• Chapter 12 Strategizing with Corporate Social Responsibility

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CHAPTER

9 KEY TERMS corporate-level strategy

(or, in short, corporate strategy)

business-level strategy diversification product diversification geographic diversification single business strategy Product-related

diversification operational synergy scale economies or

economies of scale Product-unrelated

diversification conglomerates conglomeration financial synergy scope economies or

economies of scope internal capital market diversification premium

diversification discount international diversification anchored replicators multinational replicators far-flung conglomerates classic conglomerates strategic control (or behavior

control) financial control (or output

control) information overload business groups Economic benefits Bureaucratic costs marginal economic benefits

(MEB) marginal bureaucratic costs

(MBC) mergers and acquisitions

(M&As) acquisition

merger Horizontal M&As Vertical M&As Conglomerate M&As friendly M&As Hostile M&As (also known

as hostile takeovers) Hubris acquisition premium strategic fit due diligence organizational fit restructuring downsizing downscoping refocusing dominant logic institutional relatedness

KNOWLEDGE OBJECTIVES

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. Participate in two leading debates concerning diversification and acquisitions 5. Draw strategic implications for action

228

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Diversifying and Managing Acquisitions Globally

OPENING CASE Emerging Markets: Emerging Acquirers from China

and India

Multinational enterprises (MNEs) from emerging economies, especially China and India, have emerged as a new breed of acquirers around the world. Provoking “oohs” and “ahhs,” they have grabbed media headlines and caused controversies. Anecdotes aside, what are the patterns of these new global acquirers? How do they differ? Only recently has rigorous academic research been conducted to allow for systematic comparison (Table 9.1).

Overall, China’s stock of outward foreign direct investment (OFDI) (1.7% of the worldwide total) is more than three times that of India (0.5%). One visible similarity is that both Chinese and Indian MNEs seem to use acquisitions as their primary mode of OFDI. Throughout the 2000s, Chinese firms spent US$130 billion to engage in acquisitions overseas, whereas Indian firms made acquisition deals worth US$60 billion.

MNEs from China and India target industries to support and strengthen their own most compet- itive industries at home. Given China’s prowess in manufacturing, Chinese firms’ overseas acquisitions primarily target energy, minerals, and mining—crucial supply industries that feed their operations at home. Indian MNEs’ world-class 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 loca- tion. In other words, the geographic distribution of Chinese acquisitions 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 UK as the leading target country. For example, acquisitions made by Tata Motors (Jaguar Land Rover [JLR]) 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 acquisitions, and demonstrate a higher level of confidence and sophistication in making deals in developed economies.

From an institution-based view, the contrasts between the leading Chinese and Indian acquirers are significant. The primary 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 cross- border acquisitions 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

229

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shareholders. However, acquisitions by Chinese firms tend to destroy value for their shareholders— indicative of potential hubristic and managerial motives evidenced by empire building.

Announcing high-profile deals is one thing, but completing them is another matter. Chinese multinationals have a particularly poor record in completing the overseas acquisition deals they announce. Fewer than half (47%) of their announced acquisitions were completed, which compares unfavorably to Indian MNEs’ 67% completion rate and to a global average of 80%–90% 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 resistance they encounter, especially in developed economies. 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. 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 management experience and capabilities.

From a resource-based view, examples of emerging acquirers that can do a good job in inte- gration and deliver value are few. According to the Economist, Tata “worked wonders” at JLR by increasing 30% sales and keeping the factory at full capacity. This took place during a recession when European automakers were suffering. According to Bloomberg Businessweek, Lenovo was able to “find treasure in the PC industry’s trash” by turning around the former IBM PC division and using it to propel itself to become the biggest PC maker in the world. In ten years it grew from a US$3 billion company to a US$40 billion one. However, Lenovo knew that worldwide PC sales were going down, thanks to the rise of mobile devices. In response, it recently bought “the mobile phone industry’s trash”—Motorola Mobility division—from Google and endeavored to leverage the Motorola brand to become a top player in the smartphone world. This deal quickly made Lenovo the world’s third best-selling smartphone maker, after Samsung and Apple.

SOURCES: Based on (1) BBC News, 2014, Lenovo completes Motorola takeover after Google sale, October 30: www.bbc. co.uk; (2) Bloomberg Businessweek, 2014, Jackpot! How Lenovo found treasure in the PC industry’s trash, May 12: 46–51; (3) Y. Chen & M. Young, 2010, Cross-border M&As by Chinese listed companies, AsiaPacific Journal of Manage- ment, 27: 523–539; (4) Economist, 2012, The cat returns, September 29: 63; (5) S. Gubbi, P. Aulakh, S. Ray, M. Sarkar, & R. Chittoor, 2010, Do international acquisitions by emerging economy firms create shareholder value? Journal of Inter- national Business Studies, 41: 397–418; (6) O. Hope, W. Thomas, & D. Vyas, 2011, The cost of pride, Journal of Interna- tional Business Studies, 42: 128–151; (7) S. Lahiri, B. Elango, & S. Kundu, 2014, Cross-border acquisition in services, Journal of World Business, 49: 409–420; (8) S. Lebedev, M. W. Peng, E. Xie, & C. Stevens, 2015, Mergers and acquisi- tions in and out of emerging economies, Journal of World Business (in press); (9) 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, Jour- nal of World Business, 47: 4–16; (10) Y. Yang, 2014, “I came back because the company needed me,” Harvard Business Review, July: 104–108.

TABLE 9.1 Cross-Border Acquisitions Undertaken by Chinese and Indian MNEs.

Chinese MNEs 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: 4–16.

230 Part 3 • Corporate-Level Strategies

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Why have firms from emerging economies such as China and India significantly expanded their international footprint? Why do they focus on industries related to their existing areas of excellence? Why are they interested in using acquisitions as a mode of entry? How successful (or terrible) have their acquisitions been? These are some of the key questions driving this chapter.1

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) dealt with business-level strategy, defined as ways to build competitive advantage in an identifiable market. While business- level strategy is very important, for larger, multimarket firms, corporate-level strategy is equally or perhaps more important.2 In other words, an understanding 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.3 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 acquisitions.

We will first introduce product and geographic diversification. Then, we will develop a comprehensive model, drawing on the strategy tripod. Acquisitions 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 diversi- fication strategy, with two broad categories (related and unrelated), may be embarked on.

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. 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 prod- uct markets and/or activities separately. In other words, firms benefit from declining unit costs by leveraging product relatedness—that is, 2 þ 2 ¼ 5. The sources of oper- ational 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) are 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 inde- pendently as a stand-alone firm.

Chapter 9 • Diversifying and Managing Acquisitions Globally 231

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The mechanism to obtain financial synergy is different from operational syn- ergy. The key role of corporate headquarters is to identify and fund profitable investment opportunities, such as the new industries that Samsung Group has entered recently—solar panels, biotech drugs, and electric car batteries. In other words, a conglomerate serves as an internal capital market that channels financial resources to high-potential high-growth areas. Given there are active external capi- tal markets that try to do the same, a key issue is whether units affiliated with con- glomerates in various industries (such as GE’s aircraft engine division) outperform their stand-alone independent competitors in respective industries (such as Rolls- Royce). Stated differently, at issue is whether, by operating internal capital markets, 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 consistently do), then there is a diversification premium (or conglomerate advantage)—in other words, product- unrelated diversification adds value.5 Otherwise, there can be a diversification discount (or conglomerate disadvantage), when conglomerate units are better off by compet- ing as stand-alone entities.

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 busi- ness 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).6 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.

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. Hoskisson, M. Hitt, R. D. Ireland, & J. Harrison, 2008, Competing for Advantage, 2nd ed. (p. 214), Cincinnati: Cengage Learning.

232 Part 3 • Corporate-Level Strategies

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However, important caveats exist. Not all product-related diversifiers outper- form unrelated diversifiers. In an age of “core competencies,” the continuous exis- tence 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 devel- oped economies. In addition to its online retail roots, Amazon has marched into cloud computing, e-payment, reading devices, drones, and entertainment—clearly becoming a “new age” conglomerate. Moreover, in emerging economies, a conglom- eration 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) outper- forming stand-alone competitors.7

The reason many conglomerates fail is not because this strategy is inher- ently unsound, but because firms fail to implement it. Conglomeration calls for corporate managers at headquarters 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 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.8 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 perfor- mance 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 diversification—namely, the number and diversity of countries in which a firm com- petes (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 substantial presence beyond geographically and culturally neighboring countries. For example, the largest market for Yum! Brands (which operates KFC and Pizza Hut restaurants) is China. The largest market for Man- power (which provides part-time staff to employers) is France. While neighboring countries are not necessarily “easy” markets, success in distant countries obvi- ously calls for a stronger set of advantages to compensate for the liability of for- eignness there.

Geographic Diversification and Firm Performance In this age of globalization, we frequently hear the calls for greater geographic diversification: 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 are pre- sumably 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

Chapter 9 • Diversifying and Managing Acquisitions Globally 233

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geographic scope and firm performance, which suggests an initially negative effect of international expansion on performance before the positive returns can be real- ized. This stems from the well-known hazard of liability of foreignness (see Chap- ter 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 rela- tionship, because they only sample firms in the early to intermediate stages of inter- nationalization. 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 diversification. Many large multinational enterprises (MNEs) have a “flag planting” mentality, bragging about how many countries in which they have a presence. However, their performance, beyond a certain limit, often suffers, thus necessitating withdrawals. Wal-Mart, for example, had to withdraw from Germany, India, and South Korea.

Given this complexity, it is hardly surprising there is a great debate about geo- graphic diversification.9 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 internation- alization itself because geographic scope is found to be related to higher firm profitability.”10 However, other studies, which sample firms with a high level of geo- graphic scope, caution that “multinational diversification is apparently less valuable in practice than in theory.”11 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.12

FIGURE 9.2 Geographic Diversification and Firm Performance: An S Curve.

Limited Intermediate Extensive Level of geographic diversification

Pe rf

or m

an ce

SOURCES: Adapted from (1) F. Contractor, S. 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, International diversification and firm performance: The S-curve hypothesis (p. 600), Academy of Management Journal, 47: 598–609.

234 Part 3 • Corporate-Level Strategies

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COMBINING PRODUCT AND GEOGRAPHIC DIVERSIFICATION Although most studies focus on a single dimension of diversification (product or geo- graphic) that is already very complex, in practice, most firms (except single-business firms with no interest to internationalize) have to entertain both dimensions of diver- sification simultaneously.13 Figure 9.3 illustrates the four possible combinations. Firms in Cell 3 are anchored replicators, because they focus on product-related diversifi- cation 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 expan- sion on the other 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, which 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.

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 last two dec- ades is that many classic conglomerates, such as Denmark’s Danisco and Finland’s Nokia, which formerly dominated multiple unrelated industries in their home coun- tries, have reduced their product scope but significantly expanded their geographic scope—in other words, migrating from Cell 4 to Cell 1.14 In broad strategic terms, this means that the costs for doing business abroad have declined and that the costs for managing conglomeration have risen. In other words:

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)

FIGURE 9.3 Combining Product and Geographic Diversification.

(Cell 1)

Related

Extensive

Unrelated

Limited

(Cell 2)

(Cell 4)(Cell 3)

Geographic Scope

Product Scope

Multinational replicator

Far-flung conglomerate

Anchored replicator

Classic conglomerate

Chapter 9 • Diversifying and Managing Acquisitions Globally 235

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Further, asserting that firms in a particular cell will always 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 diversification (Figure 9.4) to answer this complex and important question.

Industry-Based Considerations A straightforward motivation for diversification is the growth opportunities in an industry. If an industry has substantial growth opportunities (such as biotechnol- ogy), most incumbents have an incentive to engage in product-related and/or interna- tional diversification. However, if it is a “sunset” industry (think of typewriters), many incumbents have to 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

FIGURE 9.4 A Comprehensive Model of Diversification.

Industry growth opportunities Interfirm rivalry Entry barriers Power of suppliers and buyers Threat of substitutes Possible conglomeration

Value (risk reduction and core competencies) Rarity Imitability Organization (different for related or unrelated diversifiers)

Formal institutions constrain or enable diversification Lack of formal institutions promotes conglomeration Informal norms and cognitions (managerial motives)

Product/Geographic

Industry-based considerations Resource-based considerations

Diversification

strategies

Institution-based considerations

236 Part 3 • Corporate-Level Strategies

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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, 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 new industries that Samsung has aggressively entered—such as solar panels and electric car batteries—share the same characteristics. The choices are not random. Samsung has deliberated targeted such capital-intensive 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 exam- ple, Coca-Cola recently acquired its leading bottlers.

The threat of substitutes also has a bearing on diversification. Kodak and Fuji have been broadsided by Canon, Samsung, and HP, which diversified into digital cameras—a substitute for films. 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 Value Does diversification create value?15 The answer is “Yes,” but only under certain con- ditions.16 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 and capabilities. Honda is renowned for its product-related diver- sification by leveraging its core competencies in internal combustion engines. It not only competes in automobiles and motorcycles, but also in boat engines and law- nmowers. HondaJet represents its most recent efforts. Will HondaJet fly high?

Rarity For diversification to add value, firms must have rare and unique skills. Although acquirers from emerging economies generally have a hard time delivering value from their acquisitions, Lenovo, according to Bloomberg Businessweek, was able to “find treasure in the PC industry’s trash” by turning around the former IBM PC divi- sion and using it to propel itself to become the biggest PC maker in the world (see the Opening Case).17 Such skills are not only rare among emerging acquirers, but also rare among many established acquirers—think of the DaimlerChrysler fiasco (1998–2007).

Imitability While many firms undertake acquisitions, a much smaller number of them have mas- tered the art of post-acquisition integration.18 Consequently, firms that excel in inte- gration possess hard-to-imitate capabilities. At Northrop, integrating acquired businesses has progressed to a “science.” Each must conform to a carefully orches- trated plan listing nearly 400 items, from how to issue press releases to which

Chapter 9 • Diversifying and Managing Acquisitions Globally 237

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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 costs.19 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 orga- nization, product-unrelated diversification can add value.

Shown in Table 9.2, 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 coordi- nate 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 merchandise divi- sions were ready to hawk related merchandise, such as books, DVDs, video games, onstage musicals, ice-skating shows, Valentine’s Day cards, blankets, and pillow cov- ers. 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 linked with over- all corporate profits, then movie managers would be happy to assist and coordinate with their merchandise colleagues and would not mind waiting for a while. Conse- quently, corporate headquarters should not evaluate division performance solely based on strict financial targets (such as sales). The principal control mechanism is strategic control (or behavior control), based on largely subjective criteria to monitor and evaluate units’ contributions with rich communication between corporate and divi- sional 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 corporate managers have experience in only one (or a few) industry 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 infor- mation to process). Consequently, the appropriate organizational structure is decen- tralization 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 competitive, 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

TABLE 9.2 Product-Related versus–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

238 Part 3 • Corporate-Level Strategies

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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 divisional man- agers “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 structure and control. Conglomerates often fail when corporate managers impose a more centralized structure undermining lower-level autonomy.

Institution-Based Considerations Formal Institutions Formal institutions affect diversification strategies.20 The rise of conglomerates in the 1950s and the 1960s in developed economies was inadvertently promoted by for- mal 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 (see Chapter 8). Thus, firms seeking growth were forced to look beyond their industry, triggering a great wave of con- glomeration. By the 1980s, the US government changed its mind and no longer criti- cally 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 underpinned by their governments’ protectionist policies. Conglomerates (often called business groups in emerging economies) can leverage connections with govern- ments 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. How- ever, when governments start to dismantle protectionist policies, competitive pres- sures from foreign multinationals (as well as domestic non-diversified rivals) may intensify. These changes may force conglomerates to improve performance by reducing their scope.21

Likewise, the significant rise of geographic diversification undertaken by numer- ous firms can be attributed, at least in part, to the gradual opening of many econo- mies initiated by formal marketing-supporting and market-opening policy changes (see Chapter 6).

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 conglomer- ation, 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.22 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. Managers may have motives to advance their personal interests that are not necessarily aligned with the interests

Chapter 9 • Diversifying and Managing Acquisitions Globally 239

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of the firm and its shareholders.23 These are called managerial motives for diversifi- cation, 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 incen- tives to over-diversify 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 institu- tional conditions directly shape diversification strategy.24 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 bureau- cratic costs. Economic benefits are the various forms of synergy (operational or finan- cial) discussed earlier. Bureaucratic costs are the additional costs associated with a larger, more diversified organization, such as more headcounts and more compli- cated 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 additional 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 diversifica- tion is D2, some economic benefits can be gained by moving up to D1. Conversely,

FIGURE 9.5 What Determines the Scope of the Firm?

Level of diversification

D2 D1 D3

A

Marginal bureaucratic costs (MBC)

Marginal economic benefits (MEB)

C os

ts /b

en efi

ts

SOURCE: Adapted from G. Jones & C. Hill, 1988, Transaction cost analysis of strategy-structure choices (p. 166), Strategic Management Journal, 9: 159–172.

240 Part 3 • Corporate-Level Strategies

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if a firm over-diversifies 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 the 1970s, if we hold MBC constant (an assumption relaxed later), the MEB curve shifted upward, result- ing 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 finan- cial synergy from conglomeration; and (3) the diffusion of these actions through imi- tation, 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 analy- sis suggests that given the VRIO hurdles, it would be extremely challenging—though not impossible—to derive competitive advantage from conglomeration (see Table 9.2). In other words, with an expanded scope of the firm, MBC also increased, often outpacing the increase in MEB (Figure 9.6). Many firms over-diversified and destroyed value by operating beyond D1 in Figure 9.5 (such as D3). Consequently, a dramatic reversal in US investor sentiment occurred toward conglomeration: posi- tive in the 1960s, neutral in the 1970s, and negative in the 1980s. Parallel to these developments, external capital markets became better developed, with more ana- lysts and more transparent and real-time reporting, all of which allowed for more

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

ts

SOURCE: M. W. Peng, S.-H. Lee, & D. Wang, 2005, What determines the scope of the firm over time? A focus on institu- tional relatedness (p. 627), Academy of Management Review, 30: 622–633.

Chapter 9 • Diversifying and Managing Acquisitions Globally 241

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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 as to why conglom- eration, which has been recently discredited in developed economies, is not only in vogue, but also in some (but not all) cases adds value in emerging economies. Figure 9.7 shows how conglomerates 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 primar- ily because underdeveloped external capital markets in emerging economies make conglomerates as internal capital markets more attractive.

A second assumption is that at a given level of diversification, MBCEmergingEcon < MBCDevelopedEcon. In emerging economies, because of the weak- nesses of formal institutions, informal constraints rise to play a larger role in regulat- ing economic exchanges (see Chapter 4). Most conglomerates in these countries are family firms, whose managers rely more on informal personal (and often family) rela- tionships to get things done. Relative to firms in developed economies, firms in emerging economies typically feature a lower level of bureaucratization, formaliza- tion, 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 ðD1Þ, whereas there is still room to gain for firms in emerging economies at point E, which can move up to point B ðD2Þ. However, bear in mind that conglomerates in emerging economies confront the same problem that plagues those in developed

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

E

C os

ts /b

en efi

ts

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.

242 Part 3 • Corporate-Level Strategies

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economies: The wider the scope, the harder it is for corporate headquarters to coor- dinate, control, and invest properly in different units. It seems evident that for conglomerates in emerging economies, there is also a point beyond which further diversification may backfire. In 1997, conglomerates in South Korea hit a wall, having diversified too much ranging from “missiles to noodles.” The painful financial crisis forced some much-needed restructuring, which essentially pushed these conglomerates that had operated in a zone right of D2 back to D2 in Figure 9.7 (or, alternatively from D3 to D1 in Figure 9.5). Since 1997, the restructured and down- scoped conglomerates such as Samsung and LG have been able to scale new perfor- mance heights.27

Overall, industry dynamics, resource repertoires, and institutional conditions are not static, nor are diversification strategies. The next two sections describe acquisi- tions as a primary means for expanding the scope of the firm.

ACQUISITIONS Setting the Terms Straight Although the term “mergers and acquisitions” (M&As) is often used, in reality, acquisitions 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. For example, Volvo is now a unit of Geely. A merger is the combina- tion of assets, operations, and management of two firms to establish a new legal entity. For instance, the merger of Fiat and Chrysler resulted in Fiat Chrysler Auto- mobiles (FCA), a new entity.

Although the phrase “mergers and acquisitions” (M&As) is often used, in reality, acquisitions dominate the scene. In the 2010s, approximately 40% of M&As are cross- border deals. Twenty years ago, only about one-sixth were cross-border deals.28 Of all cross-border M&As, only 3% are mergers. Even many so-called “mergers of equals” turn out to be one firm taking over another (such as DaimlerChrysler, 1998–2007). 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.

There are three primary categories of M&As: (1) horizontal, (2) vertical, and (3) conglomerate. Horizontal M&As refer to deals involving competing firms in the same industry (such as Nomura’s acquisition of Lehman Brothers’ assets).29

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 Enterprises).30 About 10% of cross-border M&As are vertical ones. Conglomerate M&As are transactions involving firms in product-unrelated industries (such as Siemens’s acquisition of Denmark’s Bonus Energy, which became Siemens Wind Power). 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 man- agement 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 manage- ment, 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 fewer than 0.2% of all deals and fewer than 5% of total value. The US$19 billion hostile takeover of Britain’s Cadbury by America’s Kraft in 2010 was a high-profile example of hostile cross-border M&A.

Chapter 9 • Diversifying and Managing Acquisitions Globally 243

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Motives for Mergers and Acquisitions What drives M&A? Table 9.3 shows three drivers: (1) synergistic, (2) hubris, and (3) managerial motives, which can be illustrated by the three leading perspectives. In terms of synergistic motives, the most frequently mentioned industry-based ratio- nale is to enhance and consolidate market power.31 For example, the merger of United and Continental created the world’s largest airline, which is called “United.”

From a resource-based view, the most important synergistic rationale is to lever- age superior resources.32 Shown in the Opening 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.33

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.34 It is not a coincidence that the number of cross-border M&As has sky- rocketed in the last two decades. This is the same period during which trade and investment barriers have gone down and FDI has risen.

While all the synergistic motives, in theory, add value, hubris and managerial motives reduce value. Hubris refers to managers’ overconfidence in their

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&As)

Acquisition

of a foreign

affiliate

Acquisition

of a local

firm

Acquisition of a

private local firm

Privatization

(acquisition of a public enterprise)

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capabilities.35 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!” 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).36 Acquirers of US firms on average pay a 20% to 30% pre- mium, and acquirers of EU firms pay a slightly lower premium (about 18%).37

This is essentially saying: “We are smarter than the market!” To the extent that the capital market is (relatively) efficient and that market

price of target firms reflects their intrinsic value,38 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 over- paid. This is especially true when multiple firms bid for the same target, the winning acquirer may suffer from the “winner’s curse” from auctions by overpaying. From an institution-based view, many managers join the acquisition “bandwagon,” after some first-movers start doing deals in an industry. The fact that M&As come in “waves” speaks volumes about such a herd behavior.39 Eager to catch up, late movers in such “waves” often 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 (although certainly not all) managers may have knowingly overpaid the acquisition premium for target firms. Driven by such norms and cognitions, some managers may have deliberately over-diversified their firms through M&As (see Chapter 11). After all, they use other people’s (shareholders’) money to fund acquisitions.

Overall, synergistic motives add value, and hubris and managerial motives destroy value. They may simultaneously coexist. The Opening Case uses emerging multinationals as a new breed of cross-border acquirers to illustrate these dynamics. Next, we discuss the performance of M&As.

Performance of Mergers and Acquisitions Despite the popularity of M&As, their performance record is rather sobering.40 As many as 70% of M&As reportedly fail. On average, the performance of acquiring firms does not improve after acquisitions.41 Target firms, after being acquired and becoming internal units, often perform worse than when they were independent, standalone firms. The only identifiable group of winners is the shareholders of target firms, who may experience on average a 25% increase in their stock value—thanks to

TABLE 9.3 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

Chapter 9 • Diversifying and Managing Acquisitions Globally 245

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acquisition premium.42 Shareholders of acquiring firms experience a 4% loss in their stock value during the same period. The combined wealth of shareholders of both acquiring and target firms is only marginally positive, less than 2%.43 Unfortunately, many M&As destroy value.

Why do many acquisitions fail? Problems can be identified in both pre- acquisition and post-acquisition phases (Table 9.4).44 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 US$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 willing- ness to pay for such a high premium was indicative of (1) strong managerial capabil- ities to derive synergy, (2) high levels of hubris, (3) significant managerial self- interests, or (4) all of the above. As it turned out, by the time Chrysler was sold in 2007, it only fetched US$7.4 billion, destroying four-fifths of the value. In 2010, Micro- soft paid US$8.5 billion to buy 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 underachieving Internet icon—how many people have paid money to Skype each other? Not surprisingly, this acquisition, Microsoft’s biggest, raised a lot of eyebrows.

Another primary pre-acquisition problem is inadequate screening and failure to achieve strategic fit, which is the effective matching of complementary strategic capabilities.45 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 US$50 billion. Not surprisingly, failure to do adequate homework—technically, due diligence (thorough investigation prior to signing contracts)—led to numerous problems cen- tered on the lack of strategic fit. Consequently, this acquisition was labeled by the Wall Street Journal as “a deal from hell.”46

Acquiring international assets can be even more problematic because institu- tional and cultural distances can be even larger, and nationalistic concerns over for- eign acquisitions may erupt (see the Opening Case). When Japanese firms acquired Rockefeller Center and movie studios in the 1980s and 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 polit- ical backlash.

Numerous integration problems may surface during the post-acquisition phase.47

Defined as similarity in cultures, systems, and structures, organizational fit is just as important as strategic fit. Many acquiring firms do not bother to analyze organiza- tional fit with targets. In 2008, when Nomura decided to acquire Lehman Brothers’

TABLE 9.4 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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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 employ- ment. 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 standardizing reporting and pay inadequate attention to people issues, which typically results in low morale and high turnover.48

In cross-border M&As, integration difficulties may be much worse because clashes of organizational cultures are compounded by clashes of national cul- tures.49 Due to cultural differences, Chinese acquirers (such as Geely) often have a hard time integrating Western firms (such as Volvo). 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 employees 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.”50

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 worst-executed activities of all.51

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 (1998) and then was engulfed in the divorce with Chrysler (2007), 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.

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

Chapter 9 • Diversifying and Managing Acquisitions Globally 247

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Restructuring Every acquisition deal entails at least two parties: an acquirer (buyer) and a seller. Why is the seller motivated to sell? A simple answer is that the seller is interested in restructuring by selling some of its units to an acquirer. 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,52

its most common definition is reduction of firm size and scope—we will adopt this more frequently used definition here. Using this definition, there are two pri- mary ways of restructuring: (1) downsizing (reducing the number of employees through lay-offs, early retirements, and outsourcing), and (2) downscoping (reducing the scope of the firm through divestitures and spin-offs). The flipside of downscop- ing is refocusing, namely, narrowing the scope of the firm to focus on a few areas.

DEBATES AND EXTENSIONS Diversification and acquisitions have no shortage of controversies. The two leading debates discussed here are (1) product relatedness versus other forms of related- ness, and (2) acquisitions versus alliances.

Product Relatedness versus Other Forms of Relatedness What exactly is relatedness? While product relatedness (such as HondaJet) is seem- ingly straightforward, it has attracted at least three significant points of contention. First, how to actually measure product relatedness remains debatable. Starbucks 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. 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). But all of the above make little or lose money in recent years. What has sus- tained 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 easy- Group, 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 Internet cafés rise as seats fill 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 economies) where such agencies control crucial resources such as licensing and financing, 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,

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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), whereas in emerging economies it is dominated by new units of old-line conglomerates (such as Hong Kong’s Wharf). It seems that despite the Western advice to downscope, some conglom- erates in emerging economies have recently expanded their scope by entering new industries such as solar panels. 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 alterna- tive to acquisitions (see Chapter 7). However, many firms seem to have plunged straight into “merger mania.” HP, IBM, Microsoft, and Oracle are known as “rapid- fire” acquirers, often swallowing a dozen firms in any given year. 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 DaimlerChrysler) would probably have been better off had firms pursued alliances first. On the other hand, Fiat and Chrysler, having worked together as alliance partners, may have better odds to have an enduring relationship together as Fiat Chrysler Automobiles.

THE SAVVY STRATEGIST Guided by the three leading perspectives underpinning the strategy tripod, the savvy strategist draws three important implications for action (Table 9.5). First, under- stand 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.

Second, you and your firm need to develop capabilities that facilitate successful diversification and acquisitions, by following the suggestions outlined in Table 9.6. These would include do not overpay for targets and focus on both strategic and orga- nizational fit. Refusing to let the bidding war go out of hand and admitting failure in proposed deals by walking away are painful but courageous. Around the world, between 10% and 20% of the proposed deals collapse.57 Despite the media hoopla about the “power” of emerging multinationals from China, in reality more than half of their announced deals end in tears. Indian multinationals do better, but still one- third of their deals cannot close (see the Opening Case). This is not a problem that only affects emerging acquirers. Experienced acquirers such as AT&T, News Corpo- ration, and Pfizer, respectively, withdrew from their multi-billion dollar deals to acquire T-Mobile, Time Warner, and AstraZeneca recently. Given that 70% of

TABLE 9.5 Strategic Implications for Action.

• Understand the nature of your industry that may call for diversification and acquisitions. • Develop capabilities that facilitate successful diversification and acquisitions. • Master the rules of the game governing diversification and acquisitions around the world.

Chapter 9 • Diversifying and Managing Acquisitions Globally 249

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acquisitions fail and that integration challenges loom large down the road even if deals close, acquisitions that fail to close may sometimes be a blessing in disguise.

Finally, you need to master the rules of the game governing acquisitions around the world.58 When negotiating its acquisition of IBM’s PC assets, Lenovo clearly understood and tapped into the Chinese government’s support for homegrown multi- nationals. IBM likewise understood the necessity for the new Lenovo to maintain an American image when it persuaded Lenovo to set up a second headquarters in the United States. This highly symbolic action made it easier to win approval from the US government. In contrast, GE and Honeywell proposed to merge and cleared US antitrust scrutiny, but failed to anticipate the EU antitrust authorities’ incentive to kill the deal.59 In the end, the EU torpedoed the deal. The upshot is that, in addition to the economics of diversification and acquisitions, managers must pay attention to the politics behind such high-stakes strategic moves.

In terms of the four most fundamental questions, this chapter directly answers Question 3: What determines the scope of the firm?60 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? The answer lies in whether they can suc- cessfully overcome the challenges associated with diversification and acquisitions.

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 syn- ergy and scope economies.

• Geographically diversified firms can have a limited or extensive interna- tional scope.

• Most firms pursue product and geographic diversification simultaneously.

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. • Restructuring involves downsizing, downscoping, and refocusing.

TABLE 9.6 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 orga-

nizational 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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4. Participate in two leading debates concerning diversification and acquisitions • (1) Product relatedness versus other forms of relatedness and (2) acquisi-

tions versus alliances. 5. Draw strategic implications for action

• Understand the nature of your industry that may call for diversification and acquisitions.

• Develop capabilities that facilitate successful diversification and acquisitions.

• Master the rules of the game governing diversification and acquisitions around the world.

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 for- eign takeover of our iconic company. How would you alleviate their concerns?”

3. ON ETHICS: CEOs’ pay is typically linked to the size of their firms. Some argue that CEOs have an inherent bias in favor of undertaking M&As using share- holders’ money. Do you agree or disagree with this view?

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”) should be returned to share- holders as dividends. Do you agree or disagree with this statement? Why?

2. Unrelated product diversification (conglomeration) is widely discredited in developed economies. However, in some cases it still seems to add value in emerging economies—think of Samsung and Tata. Is this interest in conglomera- tion likely to hold or decrease in emerging economies over time? Why?

3. ON ETHICS: As a CEO, 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 opportu- nities 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. How would you proceed?

CLOSING CASE 9.1

Emerging Markets: Emerging Acquirers from China and India Multinational enterprises (MNEs) from emerging economies, especially China and India, have emerged as a new breed of acquirers around the world. Provoking “oohs” and “ahhs,” they have grabbed media headlines and caused controversies. Anecdotes aside, what are the patterns of these new global acquirers? How do they differ? Only recently has rigorous academic research been conducted to allow for systematic compar- ison (Table 9.1).

Chapter 9 • Diversifying and Managing Acquisitions Globally 251

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Overall, China’s stock of outward foreign direct investment (OFDI) (1.7% of the world- wide total) is more than three times that of India (0.5%). One visible similarity is that both Chinese and Indian MNEs seem to use acquisitions as their primary mode of OFDI. Throughout the 2000s, Chinese firms spent US$130 billion to engage in acquisitions over- seas, whereas Indian firms made acquisition deals worth US$60 billion.

MNEs from China and India target industries to support and strengthen their own most competitive industries at home. Given China’s prowess in manufacturing, Chinese firms’ overseas acquisitions primarily target energy, minerals, and mining—crucial sup- ply industries that feed their operations at home. Indian MNEs’ world-class 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 acquisi- tions 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 UK as the leading target country. For example, acquisitions made by Tata Motors (Jaguar Land Rover [JLR]) 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 acquisitions, and demonstrate a higher level of confidence and sophistication in making deals in developed economies.

From an institution-based view, the contrasts between the leading Chinese and Indian acquirers are significant. The primary players from China are state-owned enter- prises (SOEs), which have their own advantages (such as strong support from the Chi- nese government) and trappings (such as resentment and suspicion from host-country governments). The movers and shakers of cross-border acquisitions from India are pri- vate business groups, which generally are not viewed with strong suspicion. The lim- ited evidence suggests that M&As by Indian firms tend to create value for their shareholders. However, acquisitions by Chinese firms tend to destroy value for their shareholders—indicative of potential hubristic and managerial motives evidenced by empire building.

Announcing high-profile deals is one thing, but completing them is another matter. Chinese multinationals have a particularly poor record in completing the overseas acqui- sition deals they announce. Fewer than half (47%) of their announced acquisitions were completed, which compares unfavorably to Indian MNEs’ 67% completion rate and to a global average of 80%–90% completion rate. Chinese MNEs’ lack of ability and experi- ence in due diligence and financing is one reason, but another reason is the political back- lash and resistance they encounter, especially in developed economies. The 2005 failure

TABLE 9.1 Cross-Border Acquisitions Undertaken by Chinese and Indian MNEs.

Chinese MNEs 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: 4–16.

252 Part 3 • Corporate-Level Strategies

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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. 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 management experience and capabilities.

From a resource-based view, examples of emerging acquirers that can do a good job in integration and deliver value are few. According to the Economist, Tata “worked won- ders” at JLR by increasing 30% sales and keeping the factory at full capacity. This took place during a recession when European automakers were suffering. According to Bloom- berg Businessweek, Lenovo was able to “find treasure in the PC industry’s trash” by turn- ing around the former IBM PC division and using it to propel itself to become the biggest PC maker in the world. In ten years it grew from a US$3 billion company to a US$40 billion one. However, Lenovo knew that worldwide PC sales were going down, thanks to the rise of mobile devices. In response, it recently bought “the mobile phone industry’s trash”— Motorola Mobility division—from Google and endeavored to leverage the Motorola brand to become a top player in the smartphone world. This deal quickly made Lenovo the world’s third best-selling smartphone maker, after Samsung and Apple.

Sources: 1. BBC News, 2014, Lenovo completes Motorola takeover after Google sale, October 30: www.

bbc.co.uk; 2. Bloomberg Businessweek, 2014, Jackpot! How Lenovo found treasure in the PC industry’s

trash, May 12: 46–51; 3. Y. Chen & M. Young, 2010, Cross-border M&As by Chinese listed companies, Asia Pacific Jour-

nal of Management, 27: 523–539; 4. Economist, 2012, The cat returns, September 29: 63; 5. 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;

6. O. Hope, W. Thomas, & D. Vyas, 2011, The cost of pride, Journal of International Business Studies, 42: 128–151;

7. S. Lahiri, B. Elango, & S. Kundu, 2014, Cross-border acquisition in services, Journal of World Business, 49: 409–420;

8. S. Lebedev, M. W. Peng, E. Xie, & C. Stevens, 2015, Mergers and acquisitions in and out of emerging economies, Journal of World Business (in press);

9. 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: 4–16;

10. Y. Yang, 2014, “I came back because the company needed me,” Harvard Business Review, July: 104–108.

Questions 1. Why have firms from emerging economies such as China and India significantly expanded their

international footprint? 2. Why do they focus on industries related to their existing areas of excellence? 3. Why are they interested in using acquisitions as a mode of entry? 4. How successful (or terrible) have their acquisitions been?

Chapter 9 • Diversifying and Managing Acquisitions Globally 253

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NOTES

[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); EJ–Economic Journal; JEL–Journal of Economic Literature; JEP–Journal of Economic Perspectives; JIBS– Journal of International Business Studies; JM–Journal of Management; JMS–Journal of Management Studies; JWB–Journal of World Business; OSc–Organization Science; SMJ–Strategic Management Journal; WSJ–Wall Street Journal.

1. S. Lebedev, M. W. Peng, E. Xie, & C. Stevens, 2015, Mergers and acquisitions in and out of emerging economies, JWB (in press).

2. E. Bowman & C. Helfat, 2001, Does corporate strategy matter? SMJ, 22: 1–23. 3. M. Nippa, U. Pidun, & H. Rubner, 2011, Corporate portfolio management, AMP,

November: 50–66. 4. D. Miller, M. Fern, & L. Cardinal, 2007, The use of knowledge for technological

innovation within diversified firms, AMJ, 50: 308–326. 5. K. B. Lee, M. W. Peng, & K. Lee, 2008, From diversification premium to diversification

discount during institutional transitions, JWB, 43: 47–65. 6. P. Chen, C. Williams, & R. Agarwal, 2012, Growing pains, SMJ, 33: 252–276. 7. 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; M. W. Peng & A. Delios, 2006, What determines the scope of the firm over time and around the world? APJM, 24: 385–405.

8. D. Lange, S. Boivie, & A. Henderson, 2009, The parenting paradox, AMJ, 52: 179–198. 9. A. Gande, C. Schenzler, & L. Senbert, 2009, Valuation effects of global diversification,

JIBS, 40: 1515–1532. 10. A. Delios & P. Beamish, 1999, Geographic scope, product diversification, and the

corporate performance of Japanese firms (p. 724), SMJ, 20: 711–727. 11. J. M. Geringer, S. Tallman, & D. Olsen, 2000, Product and international diversification

among Japanese multinational firms (p. 76), SMJ, 21: 51–80. 12. G. Qian, T. Khoury, M. W. Peng, & Z. Qian, 2010, The performance implications of

intra- and inter-regional geographic diversification, SMJ, 31: 1018–1030. 13. A. Goerzen & S. Makino, 2007, Multinational corporation internationalization in the

service sector, JIBS, 38: 1149–1169; M. Wiersema & H. Bowen, 2008, Corporate diversification, SMJ, 29: 115–132.

14. K. Meyer, 2006, Global focusing, JMS, 43: 1109–1144. 15. S. Malhotra & A. Gaur, 2014, Spatial geography and control in foreign acquisitions,

JIBS, 45: 191–210. 16. E. Doving & P. Gooderham, 2008, Dynamic capabilities as antecedents of the scope of

related diversification, SMJ, 29: 841–857; K. Ellis, T. Reus, B. Lamont, & A. Ranft, 2011, Transfer effects in large acquisitions, AMJ, 54: 1261–1276; A. Phene, S. Tallman, & P. Almeida, 2012, When do acquisitions facilitate technological exploration and exploitation? JM, 38: 753–783; A. Sleptsov, J. Anand, & G. Vasudeva, 2013, Relational configurations with information intermediaries, SMJ, 34: 957–977.

17. BW, 2014, Jackpot! How Lenovo found treasure in the PC industry’s trash, May 12: 46–51.

18. J. Kim & S. Finkelstein, 2009, The effects of strategic and market complementarity on acquisition performance, SMJ, 30: 617–646.

19. K. Ellis, T. Reus, & B. Lamont, 2009, The effects of procedural and informational justice in the integration of related acquisitions, SMJ, 30: 137–161.

20. C. Moschieri & J. Campa, 2009, The European M&A industry, AMP, 23: 71–87. 21. M. Dieleman, 2009, Shock imprinting, APJM, 27: 481–502. 22. J. Haleblian, G. McNamara, K. Kolev, & B. Dykes, 2012, Exploring firm characteristics

that differentiate leaders from followers in industry merger waves, SMJ, 33: 1037–1052.

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23. E. Matta & P. Beamish, 2008, The accentuated CEO career horizon problem, SMJ, 29: 683–700.

24. P. Brockman, O. Rui, & H. Zhou, 2013, Institutions and the performance of politically connected M&As, JIBS, 44: 833–852.

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 diversification choices, SMJ, 32: 624–639.

27. H. Kim, H. Kim, & R. Hoskisson, 2010, Does market-oriented institutional change in an emerging economy make business group-affiliated multinationals perform better? JIBS, 41: 1141–1160.

28. Economist, 2014, The new rules of attraction (p. 66), November 15: 66–67. 29. J. Clougherty & T. Duso, 2009, The impact of horizontal mergers on rival, JMS, 46:

1365–1395. 30. M. Jacobides, 2008, How capability differences, transaction costs, and learning curves

interact to shape vertical scope, OSc, 19: 306–326. 31. 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, Performance feedback, slack, and the timing of acquisitions, AMJ, 51: 808–822.

32. S. Chen, 2008, The motives for international acquisitions, JIBS, 39: 454–471. 33. H. Yang, Z. Lin, & M. W. Peng, 2011, Behind acquisitions of alliance partners, AMJ, 54:

1069–1080. 34. 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: 239–55.

35. P. Picone, G. Dagnino, & A. Mina, 2014, The origin of failure, AMP, 28: 447–468. 36. S. Malhotra & P. Zhu, 2013, Paying for cross-border acquisitions, JWB, 48: 271–281. 37. C. Moschieri & J. Campa, 2009, The European M&A industry (p. 82), AMP, November:

71–87. 38. A. Gaur, S. Malhotra, & P. Zhu, 2013, Acquisition announcements and stock market

valuations of acquiring firms’ rivals, SMJ, 34: 215–232. 39. G. McNamara, J. Haleblian, & B. Dykes, 2008, The performance implications of

participating in an acquisition wave, AMJ, 51: 113–130. 40. 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 performance, SMJ, 31: 903–916; G. Valentini, 2012, Measuring 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, 22: 55–77.

41. D. King, D. Dalton, C. Daily, & J. Covin, 2004, Meta-analyses of post-acquisition performance, SMJ, 25: 187–200.

42. Economist, 2014, Mergers and acquisitions: The new rules of attraction (p. 67), November 15: 66–67.

43. G. Andrade, M. Mitchell, & E. Stafford, 2001, New evidence and perspectives on mergers, JEP, 15: 103–120.

44. M. Lander & L. Kooning, 2013, Boarding the aircraft, JMS, 50: 1–30. 45. C. Meyer & E. Altenborg, 2008, Incompatible strategies in international mergers, JIBS,

39: 508–525. 46. WSJ, 2009, Bank of America-Merrill Lynch: A $50 billion deal from hell, January 22:

blogs.wsj.com. 47. J. Allatta & H. Singh, 2011, Evolving communication patterns in response to an

acquisition event, SMJ, 32: 1099–1118; M. Brannen & M. Peterson, 2009, Merging without alienating, JIBS, 40: 468–489; R. Chakrabarti, S. Gupta-Mukherjee, & N. Jayaraman, 2009, Mars-Venus marriages, JIBS, 40: 216–236; G. Chung, J. Du, & J. Choi, 2014, How do employees adapt to organizational change driven by cross-border M&As? JWB, 49: 78–86; S. Mantere, H. Schildt, & J. Sillince, 2012, Reversal of strategic change, AMJ, 55: 172–196; P. Monin, N. Noorderhaven, E. Vaara & D. Kroon, 2013, Giving sense to and making sense of justice in postmerger integration, AMJ, 56: 256–284; G. Stahl &

Chapter 9 • Diversifying and Managing Acquisitions Globally 255

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A. Voigt, 2008, Do cultural differences matter in M&As? OSc, 19: 160–176; J. Xia & S. Li, 2013, The divestiture of acquired subunits, SMJ, 34: 131–148.

48. M. Cording, J. Harrison, R. Hoskisson, & K. Jonsen, 2014, Walking the talk, AMP, 28: 38–56.

49. 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 explanations of knowledge transfer in international acquisitions, JIBS, 41: 1365–1390.

50. BW, 2011, Hi-yah! Alcatel-Lucent chops away at years of failure (p. 29), May 2: 29–31. 51. M. Cording, P. Christmann, & D. King, 2010, Reducing causal ambiguity in acquisition

integration, AMJ, 51: 744–767. 52. 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; E. G. Love & M. Kraatz, 2009, Character, conformity, or the bottom line? AMJ, 52: 314–335; T. Numagami, M. Karube, & T. Kato, 2010, Organizational deadweight, AMP, 24: 25–37.

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. 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. Economist, 2014, Coming unstuck, August 9: 53–54. 58. J. Clougherty, K. Gugler, L. Sorgard, & F. Szucs, 2014, Cross-border mergers and

domestic firm wages, JIBS, 45: 450–470. 59. N. Aktas, E. Bodt, & R. Roll, 2007, Is European M&A regulation protectionist? EJ, 117:

1096–1121. 60. M. W. Peng & W. Su, 2014, Cross-listing and the scope of the firm, JWB, 49: 42–50.

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CHAPTER

10 KEY TERMS

integration- responsiveness framework

local responsiveness Home replication strategy Localization

(multidomestic) strategy

global standardization strategy

centers of excellence

worldwide (or global) mandate

Transnational strategy International division Geographic area structure country (or regional) manager

Global product division global matrix organizational culture Knowledge management

Explicit knowledge Tacit knowledge open innovation global virtual teams absorptive capacity social capital micro-macro link subsidiary initiatives global account structure solutions-based structure

KNOWLEDGE OBJECTIVES

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 two leading debates concerning multinational strategy, structure, and learning

5. Draw strategic implications for action

258

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Strategizing, Structuring, and Learning Around the World

OPENING CASE Emerging Markets: GE Innovates from the Base

of the Pyramid

Multinationals such as General Electric (GE) historically innovate new products in developed econo- mies, and then localize these products by tweaking them for customers in emerging economies. Unfortunately, a lot of these expensive products, with well-off customers at the top of the global economic pyramid in mind, flop at the base of the pyramid (BoP). This is not only because of their price tag, but also because of their lack of consideration for the needs and wants of local customers. Being the exact opposite, reverse innovation, which is from BoP markets, 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 (up to $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 70% 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, thus, must go to the patients. Scaling down its existing bulky, expensive, and complex ultrasound machines was not going to serve that demand. GM 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 “good enough” ultrasound images. The machine sold for only $30,000. In 2008, GE introduced a new model that sold for $15,000, less than 15% of the price tag of its high-end conventional ultrasound models. While por- table ultrasounds have naturally become a hit in China, especially in rural clinics, they have also gener- ated 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.

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.

Such outstanding performance in and out of emerging economies, in combination with GE’s dismal recent experience in developed economies thanks to the Great Recession of 2008–2009,

259

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has rapidly transformed GE’s mental map of the world (Table 10.1). In 2000, it focused on the Triad and paid relatively minor attention to the “rest of the world.” Now strategic attention is on emerging economies and other resource-rich regions, and the Triad becomes the “rest of the world.” In an October 2009 Harvard Business Review article, Immelt wrote:

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, 2009, GE: Losing its magic touch, March 21: 73–75; (2) Economist, 2011, Frugal healing, January 22: 73–74: (3) Economist, 2011, Life should be cheap, January 22: 16; (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) A. Winter & V. Govindarajan, 2015, Engineering reverse innovation, Harvard Business Review, July: 80–89.

How can multinational enterprises (MNEs) such as GE strategically manage growth around the world so that they can be successful both locally and internationally? How can they learn country tastes, global trends, and market transitions? How can they improve the odds for better innovation? These are some of the key questions driving this chapter, which focuses 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 respon- siveness. These two sets of pressures are captured in the integration-responsiveness framework, which allows managers to deal with the pressures for both global

TABLE 10.1 GE’s Mental Map of the World.

2000 2010

• United States • Europe • Japan • Rest of the world

• People-rich regions, such as China and India • Resource-rich regions, such as the Middle East, Australia,

Brazil, Canada, and Russia • Rest of the world, such as the United States, Europe, and

Japan

SOURCE: Extracted from text in J. Immelt, V. Govindarajan, & C. Trimble, 2009, How GE is disrupting itself (p. 59), Harvard Business Review, October: 56–65.

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integration and local responsiveness. Cost pressures often call for global integra- tion, while local responsiveness pushes MNEs to adapt locally. In both domestic and international competition, pressures to reduce costs are universal. What is unique in international competition is the pressures for local responsiveness, which means reacting to different consumer preferences and host-country demands. Consumer preferences vary tremendously around the world. For example, McDo- nald’s beef-based hamburgers would obviously find few customers in India, a land where the Hindu majority hold cows as sacred. 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 manu- factures an Austrian version of railcars 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 governments happy, but it 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 movement 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 global success of Coke Classic, Levi Strauss jeans, and Sony TV. Levitt predicted that such convergence would characterize most product markets in the future.

Levitt’s idea has often become the intellectual force propelling many MNEs to globally integrate their offerings while minimizing local adaptation. Ford experimen- ted with “world car” designs. MTV pushed ahead with the belief that viewers would flock to global (essentially American) programming. Unfortunately, most of these experiments were not successful. Ford found that consumer tastes ranged widely around the globe. MTV eventually realized that there is no “global song.” In a nut- shell, one size does not fit all. 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 stra- tegic choices: (1) home replication, (2) localization, (3) global standardization, and (4) transnational. Each strategy has a set of pros and cons outlined in Table 10.2. (Their corresponding structures are discussed in the next section Four Organiza- tional Structures.)

Home replication strategy, often known as “international strategy,” duplicates home country-based competencies in foreign countries. Such competencies include pro- duction 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 responsive- ness 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. 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.

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Localization strategy is an extension of the home replication strategy.2 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 adapta- tion. While sacrificing global efficiencies, this strategy is effective when differences 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 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.3

TABLE 10.2 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

FIGURE 10.1 Multinational Strategies and Structures: The Integration-Responsive Framework.

Low High

Global product division Global matrix

International division Geographic area H

ig h

Lo w

Pressures for local responsiveness

P re

s s u

re s f

o r

c o s t

re d

u c ti

o n

s

Global

standardization strategy Transnational strategy

Localization strategy Home

replication strategy

NOTE: In some other textbooks, “home replication” may be referred to as “international” or “export” strategy, “localiza- tion” 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.

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In terms of disadvantages, the localization strategy has high costs due to duplica- tion of efforts in multiple countries. The costs of producing 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 reductions are not significant. Another drawback is too much local autonomy, which happens when each subsidiary regards its country as so unique that it is diffi- cult 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 the localization strategy, global standardization strategy is some- times 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 the 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 dis- seminated to other subsidiaries. Centers of excellence are often given a worldwide (or global) mandate—a charter to be responsible for one MNE function throughout the world. For example, Huawei’s Sweden subsidiary has a worldwide mandate in network consulting.

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 rela- tively minor (particularly in commodity industries, such as tires). However, as noted earlier, in industries 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 (standardiza- tion) strategy” are potentially misleading.

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 responsiveness, 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 (!). Underpinning the traditional one-way flow is the assumption that the home country is the best location for generating innovations. However, given that innova- tions are inherently risky and uncertain, there is no guarantee that the home country will generate the highest-quality innovations (see the Opening Case).

MNEs that engage in a transnational strategy promote global learning and diffu- sion of innovations in multiple ways. Innovations not only flow from the home coun- try to host countries (which is the traditional flow), but also flow from host countries to the home country and flow among subsidiaries in multiple host countries. Kia Motors, for example, designs cars not only in Seoul, but also in Los Angeles and Frankfurt, tapping into automotive innovations generated in North America and Europe.

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 respon- siveness, and global learning simultaneously places contradictory demands on MNEs (to be discussed in the next section Four Organizational Structures).

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 qual- ified with an understanding of its significant organizational challenges. This point leads to our next topic.

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Four Organizational Structures Figure 10.1 also shows four organizational structures that are appropriate for each strategic choice: (1) international division, (2) geographic area, (3) global product division, 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’s international division in addition to its four US-centric divisions. Although this structure is intui- tively appealing, it often leads to two problems. First, foreign subsidiary managers, whose input 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 illus- trates 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. Inter- estingly 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.

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 Airbus Group. This struc- ture treats each product division as a stand-alone entity with full worldwide responsi- bilities. 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 ineffi- cient 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, 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.4 In this hypothetical example, the

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 cof- feehouse company.

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country manager in charge of Japan—in short, the Japan manager—reports to Prod- uct 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 his 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 Japan manager increase his investment in the country. Facing these conflict- ing demands, the Japan manager, who prefers to be politically correct, does not want to make any move before consulting corporate headquarters. Eventually, headquar- ters may provide a resolution. But crucial time may be lost in the process, and impor- tant windows of opportunity for competitive actions may be missed.

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 10.4 Global Product Division Structure at Airbus Group.

Airbus

Defence and

Space

Division

Airbus

Helicopters

Division

Airbus

Division

Headquarters

SOURCE: Adapted from www.airbusgroup.com. Between 2000 and 2014, Airbus Group was known as the European Aeronautic Defence and Space Com- pany (EADS). Headquartered in Toulouse, France, Airbus Group is the largest commercial aircraft maker and the largest defense contractor in Europe.

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Despite its merits on paper, the matrix structure may add layers of management, slow down decision speed, and increase costs while not showing significant perfor- mance 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 team-

work, 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 eventually 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.

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. A misfit, such as combining a global standardization strategy with a geographic area structure, may have grave consequences.

FIGURE 10.5 A Hypothetical Global Matrix Structure.

Product Division 1

Europe

Headquarters

Product Division 2

Asia

Japan manager here

belongs to Asia Division

and Product Division 1

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• 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 transnational strategy.

• Neither strategy nor structure 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 headquar- ters to coordinate numerous activities within a large, complex, and important host country.7 Panasonic, for example, set up Panasonic Corporation of China to manage its over 40 operations in China. 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.8

A COMPREHENSIVE MODEL OF MULTINATIONAL STRATEGY, STRUCTURE, AND LEARNING Having outlined the basic strategy/structure configurations, let us introduce a com- prehensive 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 semicon- ductors) tend to adopt global product divisions, and consumer-goods companies (such as cosmetics) often rely on geographic area divisions. Industrial-products firms typically emphasize technological innovations, whereas consumer-goods com- panies 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).9

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. 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 consolidating production in a small number of world-scale facilities? One underly- ing 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 work- ers in Shenzhen, China.

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

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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 innova- tion. R&D often generates innovative substitutes. 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, imit- ability, and organization (VRIO) framework—adds a number of insights.10 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 organizational structures and

FIGURE 10.6 A Comprehensive Model of Multinational Strategy, Structure, and Learning.

Nature of industry

Interfirm rivalry on integration,

responsiveness, and learning

Entry barriers

Power of suppliers and buyers

Threat of substitutes

Formal/informal external

institutions governing MNEs

and home/host country

environments

Formal/informal internal

institutions on MNE governance

Value

Rarity

Imitability

Organization

Multinational

strategy, structure,

and learning

Industry-based considerations

Resource-based considerations

Institution-based considerations

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marketing muscles) to add value to innovation. Philips, for example, is a great innova- tor. It invented rotary shavers, videocassettes, and CDs. Still, its ability to profit from these innovations lags behind that of Panasonic, Samsung, and Sony.

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 Ora- cle. However, such packages are designed to be implemented widely and appeal to a broad range of firms, thus providing no firm-specific advantage for the particular 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 struc- tures. 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.”11 Obviously imi- tating an intangible mentality is harder than imitating a tangible structure.

The last hurdle is organization—namely, how MNEs are organized, both for- mally and informally, around the world.12 One elusive but important concept is orga- nizational 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 organiza- tional culture as the collective programming of the mind that distinguishes members of one organization from another. Huawei, for example, is known to have a distinc- tive “wolf” culture, which centers on “continuous hunting” and “relentless pursuit” with highly motivated employees 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.13 In order to protect domestic employment, the British government taxes the foreign earnings of British MNEs at a higher rate than their domestic earnings.

Host-country governments, on the other hand, often attract, encourage, or coerce MNEs into undertaking activities that they otherwise would not. For exam- ple, basic manufacturing generates low-paying jobs, does not provide sufficient tech- nology spillovers, and carries little prestige. Advanced manufacturing, R&D, and regional headquarters, 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.

In addition to formal institutions, MNEs also confront a series of informal institu- tions governing their relationships with home countries. 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. There- fore, managers contemplating such moves must consider the informal but vocal back- lash against such activities due to the associated losses in domestic jobs.

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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, 10.3, 10.4 and 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.

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 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 above) • 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, must 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 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 understanding of the informal workings of the firm and to be bet- ter socialized into its dominant norms and values. Consequently, the Japanese pro- pensity 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 argue that this “glass ceiling” reflects “corporate imperialism.”14 In response, BP, Citigroup, Coca-Cola, Electrolux, GSK, HP, Lenovo, Microsoft, Nissan, Nokia, PepsiCo, and Sony have appointed foreign-born executives to top posts. Nestlé boasts executive board members from eight countries other than Switzerland. Such foreign-born executives bring substantial diversity to the organization, which may be a plus. How- ever, 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, HP appointed Léo Apotheker, a native of Germany, to be its CEO. Unfortunately, HP lost $30 billion in market capi- talization during his short tenure (less than 11 months), thanks to his numerous

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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 conscientious 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 emerging interest in knowledge management.15 Knowledge management can be defined as the structures, processes, and systems that actively develop, leverage, and trans- fer knowledge.

Many managers regard knowledge management as simply information manage- ment. 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 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 codifiable—it can be written down and transferred with little loss of richness. Virtually all of the knowledge captured, stored, and trans- mitted by IT is explicit. Tacit knowledge is non-codifiable, and its acquisition and trans- fer require hands-on practice. For example, reading 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.

Knowledge Management in Four Types of Multinational Enterprises Shown in Table 10.3, differences in knowledge management among four types of MNEs in Figure 10.1 fundamentally stem from the interdependence (1) between the headquarters and subsidiaries and (2) among various subsidiaries.18 In MNEs pursu- ing a home-replication strategy, such interdependence is moderate and the role of subsidiaries 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. Knowl- edge 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 Japa- nese Deming Award for quality. The subsidiary was then charged with transferring

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such knowledge to the rest of HP, which resulted in a tenfold improvement in corpo- rate-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 the Opening Case).

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 internationalized—often known as innovation-seeking investment.19 The intensifica- tion of competition for innovation drives the globalization of R&D. Such R&D pro- vides a vehicle to access a foreign country’s local talents and expertise.20 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 advan- tage is innovation-based firm heterogeneity (being different). Decentralized R&D performed by different locations and teams around the world virtually guarantees

TABLE 10.3 Knowledge Management in Four Types of Multinational Enterprises.

Strategy Home Replication Localization Global Standardization Transnational Examples Apple, Baidu, Carrefour,

Google, Harley Davison, Kraft, P&G, Starbucks, Wal-Mart

Heinz, Johnson & John- son, KFC, McDonald’s, Nestlé, Pfizer, Unilever

Canon, Caterpillar, Haier, HP, Huawei, LVMH, Otis, Texas Instruments, Toyota

GE, Häagen-Dazs, IBM, Kikkoman, Panasonic, Tata, Zara

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 contribu- tions 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 knowl- edge 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 Manage- ment Review, 28 (2): 297–317. Examples are added by M. W. Peng.

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that there will be persistent heterogeneity in the solutions generated.21 GSK, for example, 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 innovation.22 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 (see the Opening Case).

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.23

Shown in Table 10.4, a number of informal “rules” can become problems in knowl- edge management. In knowledge acquisition, many MNEs prefer to invent every- thing internally. However, for large firms, R&D actually offers diminishing returns. Consequently, a new model, open innovation, is emerging.24 Open innova- tion is “the use of purposive inflows and outflows of knowledge to accelerate internal innovation and expand the markets for external use of innovation.”25

It relies on more collaborative research among various internal units, external firms, and university labs. Firms that skillfully share research outperform those that fail to do so.

In knowledge retention, the usual problems of employee turnover are com- pounded when such employees are key R&D personnel, whose departure will lead to knowledge leakage.26 In knowledge outflow, there is the “How does it help me?” syndrome. Specifically, 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.27

Even when certain subsidiaries are willing to share knowledge, inappropriate transmission channels may still torpedo effective sharing.28 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.29 Videoconferences can hardly show body language, and Skype often breaks down. Thus, face-to-face meetings 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.”30

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, (2) using high-powered corporate-based or unit-based incentives

TABLE 10.4 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.

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(as opposed to individual-based and single-subsidiary-based incentives), and (3) investing in codifying tacit knowledge (such as the codification of the Toyota Way). However, these formal policies fundamentally boil down to the very challeng- ing (if not impossible) task of how to accurately measure inflows and outflows of tacit knowledge. The nature of tacit knowledge simply resists such formal bureau- cratic 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 confer- ences; and (2) promoting strong organizational (that is, MNE-specific) cultures and shared values and norms for cooperation among subsidiaries. For example, Panaso- nic has facilitated the establishment of such networks among Japanese and Chinese managers and engineers in an effort to promote more knowledge sharing.

Instead of using traditional formal command-and-control structures that are often ineffective, 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. Because of the existence of social capital, indivi- duals are more likely to go out of their way to help friends and acquaintances. Con- sequently, managers of the Canada subsidiary are more likely to help managers of the China subsidiary with needed knowledge if they know each other and have some social relationship. Otherwise, managers of the Canada subsidiary may not be as enthusiastic to provide such help if the call for help comes from managers of the Colombia 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.31

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 two leading debates not previously discussed: (1) corporate controls versus subsidiary initiatives; and (2) customer-focused dimensions versus integra- tion, responsiveness, and learning.

Corporate Controls versus Subsidiary Initiatives One of the leading debates on how to manage large firms is centralization versus decentralization.32 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 ethics training), some subsidiaries may be in full compliance, others may pay lip service to them, and still others may simply refuse to adopt them, citing local differences.33

In addition to reacting to headquarters’ demands differently, some subsidiaries may actively pursue their own subsidiary-level strategies and agendas.34 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 bureau- cratic MNE.

However, from the perspective of corporate headquarters, it is hard to distin- guish between good-faith subsidiary initiative and opportunistic “empire-building.”35

A lot is at stake when determining which subsidiary initiatives are supported.36

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.

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However, these tendencies, although very understandable, are not necessarily con- sistent 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 MNE management is: “Let chaos reign, then reign in chaos—repeatedly.”37

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 that it is unworkable. However, instead of simplifying, many MNEs have added new dimen- sions. Often, new customer-focused dimensions of structure are placed on top of an existing structure, resulting in a four- or five-dimension matrix.38

Of the two primary customer-focused dimensions, the first is a global account structure to supply customers (which often are other MNEs) in a coordinated and con- sistent way across various countries.39 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 struc- ture. 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 sell- ing IBM products or rivals’ offerings.

The typical starting point is to put in place temporary solutions rather than cre- ate new layers or units. However, this ad hoc approach can quickly get out of con- trol, 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.

THE SAVVY STRATEGIST MNEs are the ultimate large, complex, and geographically dispersed business organi- zations. To manage effectively, four clear implications emerge for the savvy strate- gist (Table 10.5). 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 primarily exporting, Honda adopted a home replication strategy supported by an international division. However, as the industry evolved to become more geographically dispersed in terms of production and innovation, Hon- da’s strategy and structure had to adapt to keep up.

TABLE 10.5 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.

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Second, managers need to develop learning and innovation capabilities to lever- age multinational presence. A winning formula is “think global, act local.”40 For example, McDonald’s leveraged its global presence and learned from its European operations in order to solve a local problem—back home in the United States, custo- mers do not find McDonald’s food to be as fresh, healthy, and cool as those offered by rivals. The upshot? The McWrap, a ten-inch, chicken-filled tortilla.

Third, mastering the external rules of the game governing MNEs and home/ host country environments becomes a must.41 Google first entered China, know- ing that its searches would be censored. Google then demanded that the Chinese government change its censorship regulations. Otherwise, Google threatened to leave China. The Chinese government adamantly refused to change its rules. Despite Google’s threats to leave China, at the last minute it gave in—at the expense of its hard-fought online search market share. Having a better under- standing of the rules of the game, Google’s local competitor Baidu and its global competitor Microsoft Bing went to eat Google’s “lunch” by dividing up Google’s market share. With an alliance between Baidu and Microsoft, all English-language searches on Baidu would be routed through Bing—of course, subject to Chinese government censorship.

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 for- eigner as its CEO. Yet, as operations become more global, an MNE’s managerial out- look needs to be broadened as well.

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/inter-

national division structure, (2) localization strategy/geographic area struc- ture, (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 strat-

egy, 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 two leading debates on multinational structure, learning, and innovation • (1) Corporate controls versus subsidiary initiatives and (2) customer-focused

dimensions versus integration, responsiveness, and learning.

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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.

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?

TOPICS FOR EXPANDED PROJECTS 1. ON ETHICS: You are the head of the best-performing subsidiary in an MNE.

Because bonus is 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?

2. 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. Determine whether you are for or against the firm’s move, and present your research in a short paper or visual presentation.

3. ON ETHICS: You are a Peruvian national who serves as head of the Brazilian subsidiary of a large US multinational. While Brazil is theoretically attractive, the going has been tough and chances for becoming profitable in the next five years are not great. Headquarters has asked for your recommendation on whether to increase or decrease investment in Brazil. If a decision to cut invest- ment in Brazil is indeed made, it is possible to focus on other Latin American countries, such as Peru. Since your parents are aging, you personally would be interested in leading operations in Peru so that you can be closer to them. What would be your recommendation?

CLOSING CASE 10.1

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 Mate- rialScience North America (BMS NA) was Greg Babe. Contributing 25% of BMS’ global

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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 was the future of my position but the credibility of the entire regional operation in question.” 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 addi- tional 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 his- torically deemed by Bayer as a core competence. Babe proposed to outsource it, which would allow customers to give a 12 (rather than 72) hours’ notice for shipping. 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 impor- tant. By early 2009, BMS NA delivered on everything Babe had promised: it reduced SG&A costs by 25% ($100 million) and head count by 30%. It actually over-delivered: 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 transportation), 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 global leadership team took some significant risk. But in the end, the payoff was handsome.

Sources: 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.

Questions 1. While Bayer has a matrix structure, it has maintained some flavor of a geographic area struc-

ture. 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?

278 Part 3 • Corporate-Level Strategies

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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?

CLOSING CASE 10.2

Emerging Markets: GE Innovates from the Base of the Pyramid Multinationals such as General Electric (GE) historically innovate new products in devel- oped economies, and then localize these products by tweaking them for customers in emerging economies. Unfortunately, a lot of these expensive products, with well-off cus- tomers at the top of the global economic pyramid in mind, flop at the base of the pyramid (BoP). This is not only because of their price tag, but also because of their lack of consid- eration for the needs and wants of local customers. Being the exact opposite, reverse innovation, which is from BoP markets, 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 (up to $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 70% 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, thus, must go to the patients. Scal- ing down its existing bulky, expensive, and complex ultrasound machines was not going to serve that demand. GM 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 “good enough” ultrasound images. The machine sold for only $30,000. In 2008, GE introduced a new model 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 ultra- sound machines—portability—with an unbeatable price in developed economies where containing health care cost is increasingly paramount.

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.

Such outstanding performance in and out of emerging economies, in combination with GE’s dismal recent experience in developed economies thanks to the Great Reces- sion of 2008–2009, has rapidly transformed GE’s mental map of the world (Table 10.1). In 2000, it focused on the Triad and paid relatively minor attention to the “rest of the world.” Now strategic attention is on emerging economies and other resource-rich regions, and the Triad becomes the “rest of the world.” In an October 2009 Harvard Business Review article, Immelt wrote:

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

Chapter 10 • Strategizing, Structuring, and Learning Around the World 279

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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 intro- ducing products that create a new price-performance paradigm, however, the emerg- ing giants very well could. Reverse innovation isn’t optional; it’s oxygen.

Sources: 1. Economist, 2009, GE: Losing its magic touch, March 21: 73–75; 2. Economist, 2011, Frugal healing, January 22: 73–74: 3. Economist, 2011, Life should be cheap, January 22: 16; 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. A. Winter & V. Govindarajan, 2015, Engineering reverse innovation, Harvard Business Review,

July: 80–89.

Questions 1. How can multinational enterprises (MNEs) such as GE strategically manage growth around the

world so that they can be successful both locally and internationally? 2. How can they learn country tastes, global trends, and market transitions? 3. How can they improve the odds for better innovation?

NOTES

[Journal acronyms] AME–Academy of Management Executive; AMJ–Academy of Management Journal; AMP–Academy of Management Perspectives; APJM–Asia Pacific Journal of Management; ASQ–Administrative Science Quarterly; BW– BusinessWeek(before 2010) or Bloomberg Businessweek (since 2010); GSJ–Global Strategy Journal; HBR–Harvard Business Review; JIBS–Journal of Interna- tional 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; SMJ–Strategic Management Journal

1. T. Levitt, 1983, The globalization of markets, HBR, May: 92–102. 2. 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.

TABLE 10.1 GE’s Mental Map of the World.

2000 2010

• United States • Europe • Japan • Rest of the world

• People-rich regions, such as China and India • Resource-rich regions, such as the Middle East, Australia,

Brazil, Canada, and Russia • Rest of the world, such as the United States, Europe, and

Japan

SOURCE: Extracted from text in J. Immelt, V. Govindarajan, & C. Trimble,2009,How GE is disrupting itself (p. 59), Harvard Business Review, October: 56–65.

280 Part 3 • Corporate-Level Strategies

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3. BW, 2011, Disney gets a second chance in China, April 18: 21–22. 4. W. Egelhoff, J. Wolf, & M. Adzic, 2013, Designing matrix structures to fit MNC strategy,

GSJ, 3: 205–226. 5. R. Hodgetts, 1999, Dow Chemical CEO William Stavropoulos 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 continuing validity of the strategy-structure nexus, SMJ, 30: 1234–1243.

7. X. Ma, A. Delios, & C. Lau, 2013, Beijing or Shanghai? JIBS, 44: 953–961. 8. BW, 2008, Cisco’s brave new world, November 24: 56–66. 9. C. Bouquet, A. Morrison, & J. Birkinshaw, 2009, International attention and MNE

performance, JIBS, 40: 108–131. 10. S. Morris, R. Hammond, & S Snell, 2014, A microfoundations approach to transnational

capabilities, JIBS, 45: 405–427; J. Vahlne & I. Ivarsson, 2014, The globalization of Swedish MNEs, JIBS, 45: 227–247.

11. C. Bartlett & S. Ghoshal, 1989, Managing Across Borders (p. 209), Boston: Harvard Business School Press.

12. M. Hada, R. Grewal, & M. Chandrashekaran, 2013, MNC subsidiary channel relationships as extended links, JIBS, 44: 787–812; L. Nachum & S. Song, 2011, The MNE as a portfolio, JIBS, 42: 381–405; G. McDermott, R. Mudambi, & R. Parente, 2013, Strategic modularity and the architecture of multinational firm, GSJ, 3: 1–7; J. MacDuffie, 2013, Modularity-as-property, modularization-as-process, and ‘modularity’-as-frame, GSJ, 3: 8–40; C. Weigelt & D. Miller, 2013, Implications of internal organization structure for firm boundaries, SMJ, 34: 1411–1434.

13. E. Clark & M. Geppert, 2011, Subsidiary integration as identity construction and institution building, JMS, 48: 395–416; P. Regner & J. Edman, 2014, MNE institutional advantage, JIBS, 45: 275–302.

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 Pacific, 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; S. Tallman & A. Chacar, 2011, Knowledge accumulation and dissemination in MNEs, JMS, 48: 278–304; 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 technology 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, JM, 48: 123–150.

18. T. Ambos, P. Nell, & T. Pedersen, 2013, Combining stocks and flows of knowledge, GSJ, 3: 283–299.

19. K. Asakawa & A. Som, 2008, Internationalizing R&D in China and India, APJM, 25: 375–394; R. Belderbos, B. Leten, & S. Suzuki, 2013, How global is R&D, JIBS, 44: 765–786; D. Castellani, A. Jimenez, & A. Zanfei, 2013, How remote are R&D labs? JIBS, 44: 649–675; D. Hillier, J. Pindado, V. de Queiroz, & C. Torre, 2011, The impact of country-level corporate governance on research and development, 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.

20. S. Awate, M. Larsen, & R. Mudambi, 2015, Access vs sourcing knowledge, JIBS, 46: 63–86; N. Foss, J. Lyngsie, & S. Zahra, 2013, The role of external knowledge sources and organizational design in the process of opportunity exploitation, SMJ, 34: 1453–1471; M. W. Peng & D. Wang, 2000, Innovation capability and foreign direct investment, MIR, 40: 79–83.

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21. I. Guler & A. Nerkar, 2012, The impact of global and local cohesion on innovation in the pharmaceutical industry, SMJ, 33: 535–549; E. Tippmann, P. Scott, & V. Mangematin, 2012, Problem solving in MNCs, JIBS, 43: 746–771.

22. A. Witty, 2011, Research and develop (p. 140), The World in 2011, London: The Economist Group. Witty is CEO of GSK.

23. This section draws heavily from Gupta & Govindarajan, 2004, Global Strategy and Organization.

24. H. Hoang & F. Rothaermel, 2010, Leveraging internal and external experience, SMJ, 31: 734–758; P. Toh & F. Polidoro, 2013, A competition-based explanation of collaborative invention within the firm, SMJ, 34: 1186–1208.

25. H. Chesbrough, W. Vanhaverbeke, & J. West (eds.), 2006, Open Innovation (p. 1), Oxford, UK: Oxford University Press. See also P. Gianiodis, J. Ettlie, & J. Urbina, 2014, Open service innovation in the global banking industry, AMP, 28: 76–91.

26. M. Haas & J. Cummings, 2015, Barriers to knowledge seeking within MNC teams, JIBS, 46: 36–62; Q. Yang & C. Jiang, 2007, Location advantages and subsidiaries’ R&D activities, APJM, 24: 341–358.

27. Y. Chang, Y. Gong, & M. W. Peng, 2012, Expatriate knowledge transfer, subsidiary absorptive capacity, and subsidiary performance, AMJ, 55: 927–948.

28. A. Dinur, R. Hamilton, & A. Inkpen, 2009, Critical context and international intrafirm best-practice transfers, JIM, 15: 432–446; H. Gardner, F. Gino, & B. Staats, 2012, Dynamically integrating knowledge in teams, AMJ, 55: 998–1022; D. Gnyawali, M. Singal, & S. Mu, 2009, Knowledge ties among subsidiaries in MNCs, JIM, 15: 387–400; A. Pieterse, D. van Knippenberg, & D. van Dierendonck, 2013, Cultural diversity and team performance, AMJ, 56: 782–804.

29. M. Haas, 2010, The double-edged swords of autonomy and external knowledge, AMJ, 53: 989–1008; K. Raab, B. Ambos, & S. Tallman, 2014, Strong or invisible hands? JWB, 49: 32–41; Z. Sharp, 2010, From unilateral transfer to bilateral transition, JIM, 16: 304–313.

30. 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; L. Perez-Nordtvedt, E. Babakus, & B. Kedia, 2010, Learning from international business affiliates, JIM, 16: 262–274; S. Schleimer & T. Pedersen, 2014, The effects of MNC parent effort and social structure on subsidiary absorptive capacity, JIBS, 45: 303–320.

31. M. W. Peng & Y. Luo, 2000, Managerial ties and firm performance in a transition economy, AMJ, 43: 486–501. See also D. Levin & H. Barnard, 2013, Connections to distant knowledge, JIBS, 44: 676–698; 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; Z. Zhao & J. Anand, 2013, Beyond boundary spanners, SMJ, 34: 1513–1530.

32. S. Wang, Y. Luo, X. Lu, J. Sun, & V. Maksimov, 2014, Autonomy delegation to foreign subsidiaries, JIBS, 45: 111–130.

33. F. Ciabuschi, M. Forsgren, & O. Martin, 2011, Rationality versus ignorance, JIBS, 42: 958–970; A. Hoenen & T. Kostova, 2015, Utilizing the broader agency perspective for studying headquarters-subsidiary relations in multinational companies, JIBS, 46: 104–113.

34. C. Garcia-Pont, I. Canales, & F. Noboa, 2009, Subsidiary strategy, JMS, 46: 182–214. 35. T. Ambos, U. Andersson, & J. Birkinshaw, 2010, What are the consequences of

initiative-taking in multinational subsidiaries? JIBS, 41: 1099–1118; F. Ciabuschi, H. Dellestrand, & O. Martin, 2011, Internal embeddedness, headquarters involvement, and innovation importance in MNEs, JMS, 48: 1612–1638; I. Filatotchev & M. Wright, 2011, Agency perspectives on corporate governance of multinational enterprises, JMS, 48: 471–486; D. Vora, T. Kostova, & K. Roth, 2007, Roles of subsidiary managers in MNCs, MIR, 47: 595–620.

36. J. Balogun, P. Jarzabkowski, & E. Vaara, 2011, Selling, resistance, and reconciliation, JIBS, 42: 765–786; H. Dellestrand, 2011, Subsidiary embeddedness as a determinant 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; P. Scott, P. Gibbons, & J. Coughlan, 2010, Developing subsidiary contribution to the MNC-subsidiary entrepreneurship and

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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 determinants of global initiatives in MNCs, JIM, 15: 92–104.

37. R. Burgelman & A. Grove, 2007, Let chaos reign, then reign in chaos—repeatedly, SMJ, 28: 965–979.

38. S. Segal-Horn & A. Dean, 2009, Delivering “effortless” experience across borders, JWB, 44: 41–50.

39. L. Shi, C. White, S. Zou, & S. T. Cavusgil, 2010, Global account management strategies, JIBS, 41: 620–638.

40. S. Gould & A. Grein, 2009, Think glocally, act glocally, JIBS, 40: 237–254. 41. K. Meyer, R. Mudambi, & R. Narula, 2011, Multinational enterprises and local contexts,

JMS, 48: 235–252.

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CHAPTER

11 KEY TERMS

Corporate governance concentrated ownership

and control diffused ownership separation of ownership

and control state-owned enterprises

(SOEs) agency relationship Principals agents Agency theory principal–agent conflicts agency costs

information asymmetries principal–principal conflicts

expropriation tunneling related transactions Inside directors outside (independent) directors

CEO duality interlocking directorate Voice-based mechanisms Exit-based mechanisms

private equity leveraged buyouts (LBOs) shareholder capitalism managerial human capital Foreign portfolio

investment (FPI) stewardship theory cross-listing Washington Consensus moral hazard Beijing Consensus

KNOWLEDGE OBJECTIVES After studying this chapter, you should be able to 1. Differentiate various ownership patterns around the world 2. Articulate the role of managers in both principal–agent and principal–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 on how governance mechanisms vary around the world 6. Elaborate on a comprehensive model of corporate governance 7. Participate in three leading debates concerning corporate governance 8. Draw strategic implications for action

284

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Governing the Corporation Around the World

OPENING CASE Global Competition in How to Best Govern Large Firms

In global competition, large firms not only compete in product markets, but also in terms of how they are organized, financed, and governed. Definitions of what consists of a “large firm” vary around the world. A reasonable definition is that if a firm is large enough to be publicly listed, then it would be a “large firm” in that country. Almost all large firms started as small firms. Small firms typically feature concentration of ownership and control—the founders own, manage, and control them. There was a time that many small firms aspired to become large enough so that they could become publicly listed, which would be an awesome hallmark that these firms have “made it.” As firms grow larger, the founding families may run out of money so that introducing outside shareholders would be nec- essary. The founding families may also run out of sons, daughters, in-laws, and relatives to staff key positions so that employing non-family, professional managers would be a must—so the theory goes. This theory was first published in a 1932 book The Modern Corporation and Private Property by law school professor Adolf Berle and economist Gardiner Means. Generalizing from several dec- ades of transformation at leading American firms in which founding families such as the Carnegies and the Rockefellers gradually reduced their holdings and introduced outside shareholders and pro- fessional managers, Berle and Means argued that such transformation would be inevitable. In brief, their theory predicted separation of ownership and control as firms grow larger. What if the founding families refused to let go? In 1983, economists Eugene Fama (who won a Nobel prize in economics in 2013) and Michael Jensen asserted that failure to separate ownership and control “tends to penalize the corporation in the competition for survival.”

The question is: Really? The other two major forms of corporate governance are family owner- ship and state ownership. While the Berle and Means theory does a good job characterizing the evo- lution of large firms in the United States (and, to a lesser extent, Britain), the theory ends up not explaining the ownership and control pattern in the rest of the world very well. Numerous publicly listed firms continue to feature concentration of ownership and control in the hands of families. At present, about 85% of $1 billion-plus firms in Southeast Asia are in family hands, 75% in Latin America, 67% in India, and 40% in China. In Europe, families control 40% of listed firms. In the United States, 15% of the largest firms—those in the Fortune Global 500—are family owned and controlled. While there is no shortage of family drama and intrigue—remember the TV show Dallas?—evidently family ownership and control have no problem surviving and prospering.

The Fama and Jensen prediction that large firms with concentration of ownership and control would suffer from terrible performance cannot really be supported. In South Korea, Samsung Group, led by the capable Lee Kun-hee family, has marched from victory to victory, contributing 20% of GDP. In India, Tata Group, in the hands of the House of Tata, contributes 5% of GDP. An extension

285

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of the Fama and Jensen prediction is that while some large family firms may do well domestically, once they go overseas they would surely fail to become world-class in global competition. Again, this conjecture can be refuted. For example, Tata Group has emerged as one of the leaders of Indian firms’ globalization. In Britain, Tata Group is now the single largest private sector employer, proudly supporting 50,000 jobs—an accomplishment none of the UK-owned (and non-family-managed) firms can match. In the United States, some of the best-performing and largest firms, such as Wal- Mart, Ford, and McKesson, are family owned and controlled. Newly listed high-tech firms such as Google and Facebook have carried on this tradition.

In addition to family ownership, state ownership remains a rival form of corporate governance. Despite privatization around the world between the 1980s and the 2000s, during the Great Reces- sion of 2008–2009, Western governments in an effort to rescue ailing firms nationalized numerous private firms and turned them into state-owned enterprises (SOEs). Today SOEs represent approxi- mately 10% of global GDP. Even in developed economies, they command 5% of GDP. Anchored by SOEs, China over the past three decades has grown its GDP by 9.5% per year. SOEs represent 80% of China’s stock market capitalization. But China is not alone. In Russia, the figure is 62%, in Brazil 38%, and in Norway 38%. SOEs include some of the largest oil and gas companies (such as Sino- pec), the biggest telecom service provider (China Mobile), and the biggest ports operator (Dubai Ports). In 2014, they also represented six of the top ten most-profitable firms globally (measured by the amount of profits): Fannie Mae and Freddie Mac of the United States, ICBC of China, Gazprom of Russia, China Construction Bank, and Agricultural Bank of China (in descending order). In short, SOEs as an organizational form can be both large and successful.

Recently what seems to be under siege is the publicly listed corporation. In 1997, the number of US listed firms reached a high watermark: 7,888. Since 1997, their number has dropped dramatically—by 38% in the United States and by 48% in Britain. The hassles associated with pub- lic ownership have facilitated the rise of private equity. Michael Dell, for example, has taken Dell (the corporation) private, because private ownership would give the firm “more time, investment, and patience.” Private equity deals now routinely represent 25% of all mergers and acquisitions (M&As) in the world (and 35% in the United States). While existing firms can go private, many aspiring new firms do not bother to list at all. As a result, there is now a severe initial public offering (IPO) famine: between 1980 and 2000, on average there were 311 IPOs a year in the United States. The average went down to a mere 99 a year between 2001 and 2011. In short, going public is no longer as sexy as it was before. Commenting on the global competition in terms of how to best organize, finance, and govern large firms, the Economist suggests that “there is every reason to celebrate the fact that businesses have more corporate forms to choose from.”

SOURCES: Based on (1) Bloomberg Businessweek, 2014, Private equity discover deals in the Middle East, September 29: 47–48; (2) G. Bruton, M. W. Peng, D. Ahlstrom, C. Stan, & K. Xu, 2015, State-owned enterprises around the world as hybrid organizations, Academy of Management Perspectives, 29: 92–114; (3) Economist, 2012, The endangered public company, May 19: 13; (4) Economist, 2012, The big engine that couldn’t, May 9: 27–30; (5) Economist, 2013, Dell goes private, February 9: 63–64; (6) Economist, 2014, Business in the blood, November 1: 59–63; (7) Economist, 2014, Relative success, November 1: 12–13; (8) Fortune, 2014, Global 500, July 21: F-13; (9) E. Fama & M. Jensen, 1983, Separation of ownership and control, Journal of Law and Economics, 26: 301–326; (10) Y. Jiang & M. W. Peng, 2011, Are family ownership and control in large firms good, bad, or irrelevant? Asia Pacific Journal of Management, 28: 15–39.

What are the advantages and disadvantages of the public listed corporation? Why is there an IPO famine lately? What are the advantages and disadvantages of family ownership? What about state ownership and private equity? While each type of organizing, financing, and governing a firm has its attractiveness and drawbacks, three fundamental question are: (1) What is the most optimal way to govern corporations so that investors will reap returns? (2) What is the proper role of the board of directors? (3) How can top managers such as chief executive officers (CEOs) be properly motivated and compensated?

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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 perfor- mance 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 participants. 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 fam- ily hands may have to accommodate the arrival of other shareholders. Approxi- mately 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 As predicted by Adolf Berle and Gardiner Means in The Modern Corporation and Private Property (1932), there is a separation of ownership and control in such firms. Specifically, ownership is dispersed among many small share- holders and control is largely concentrated in the hands of salaried professional managers who own little (or no) equity (see the Opening Case). 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

FIGURE 11.1 The Primary Participants in Corporate Governance.

Managers

Board of Directors

Owners

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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 (see the Opening Case). Most large firms are typically owned and con- trolled 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.6 On the positive side, family ownership and control may provide better incentives for firms to focus on long-term performance. It may also minimize the conflicts between owners and pro- fessional managers 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 foun- ders), 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 ownership and control on the performance of large firms.7

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 own- ers, in 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, SOE managers and employees have little incentive to improve performance, which they can hardly benefit from personally. In a most cyn- ical 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 swept 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.

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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 proposi- tion: To the extent that the interests of principals and agents do not completely over- lap, 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).8

In a corporate setting, when shareholders (principals) are interested in maxi- mizing the long-term value of their stock, managers (agents) may be more inter- ested in maximizing their own power, income, and perks. For example, in 2001 HP’s chairman and CEO Carly Fiorina, in an effort to acquire a PC maker Compaq, clashed with dissenting shareholders led by co-founder Bill Hewlett’s son Walter Hewlett. Fiorina won the battle, but shareholders ended up footing the bill for the performance mess afterwards. Overall, 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). • Empire-building (such as value-destroying acquisitions). • Excess CEO returns (CEO financial returns in excess of shareholder returns).9

Consider executive compensation. In 1980, the average US CEO earned approxi- mately 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 CEO improved his/her productivity ten times faster than his/her workers since 1980. 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.10 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.

A 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.11 While it is possible to reduce information asymmetries through governance mechanisms, it is not realis- tic 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 concentrated 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.12

In continental Europe, the ratio is 68%.13 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.

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The Murdochs 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 princi- pals: controlling shareholders and minority shareholders—in other words, principal–principal conflicts (Figure 11.2 and Table 11.1).14 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 controlling shareholders at the expense of minority share- holders. For example, managers from the controlling family may simply divert resources from the firm for personal or family use. This activity is vividly nick- named “tunneling”—digging a tunnel to sneak resources out. While such “tunneling” (often known as “corporate theft”) is illegal, expropriation can be legally done

FIGURE 11.2 Principal–Agent Conflicts and Principal–Principal Conflicts

Professional managers

Family managers

Controlling shareholders

Minority 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.

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through related transactions, whereby controlling owners buy firm assets from another firm they own at above-market prices or spin off the most profitable part of a pub- lic firm and merge it with another private firm of theirs.

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 impor- tance 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.

Board Composition Otherwise known as the insider/outsider mix, board composition has attracted sig- nificant 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 outsider/insider ratio and firm performance.15 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 gover- nance 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.16 It is possible that some of these outside directors are affiliated directors who may

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).

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

SOURCE: Adapted from M. Young, M. W. Peng, D. Ahlstrom, G. Bruton, & Y. Jiang, 2008, Corporate governance in emerg- ing economies: A review of the principal-principal perspective (p. 202), Journal of Management Studies, 45: 196–220.

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have family, business, and/or professional relationships with the firm or firm man- agement. 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 school- boy 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 con- flicts. As a powerful executive, a CEO obviously does not appreciate being con- stantly 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.17 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 2010.18

Board Interlocks Directors tend to be economic and social elites who share a sense of camaraderie and reciprocity.19 When one person affiliated with one firm sits on the board of another firm, an interlocking directorate has been created.20 Firms often establish rela- tionships 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.

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. 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 direc-

tors 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.21

• 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.

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• 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.22 Finally, another crucial board function is resource acquisition for the focal firm, often through interlocking directorates.

Overall, until recently, many boards of directors simply “rubber stamp” (approve without scrutiny) managerial actions. Prior to the 1997 economic crisis, many South Korean boards did not bother to hold meetings and so board decisions were literally “rubber stamped”—not even by directors themselves, but by secretar- ies 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.23

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.24 How directors strategically prioritize 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 acquisition role, although important in practice, tends to be criticized by policymakers, activists, and the media, who often regard activities such as interlock- ing directorates as “collusive.” Consequently, recent US regulations, especially the Sarbanes-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, as the competition between Apple and Google (which launched its own Android phone) heated up recently, Schmidt had to give up his Apple board membership.

Since outside directors are not likely to have enough first-hand 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 shareholder

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 first-hand knowledge

about the firm. • Good at strategic control.

• Non-CEO inside directors (executives) may not be able to control and challenge the CEO.

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interests (such as maximizing current earnings by reducing R&D). Therefore, inside directors, who are executives, can bring first-hand knowledge to board delib- erations, 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 insi- ders and outsiders.25

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 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 characterized 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.26 The underlying idea is pay for performance, which seeks to link execu- tive compensation with firm performance. 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.27

Boards are likely to use “carrots” before considering “sticks.” However, when facing continued performance failures, boards may have to dismiss the CEO.28

Among the world’s largest 2,500 listed firms, CEO tenure has decreased from 8.1 years in 2000 to 6.3 years in 2012.29 In brief, boards seem to be more “trigger- happy” recently.30 In 2011, Léo Apotheker served only ten months as CEO before HP’s board fired him.

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 rap- idly rising levels of executive compensation.31

External (Exit-Based) Governance Mechanisms There are three external governance mechanisms: (1) market for product com- petition, (2) market for corporate control, and (3) market for private equity. Product market competition is a powerful force compelling managers to maxi- mize profits and, in turn, shareholder value. However, from a corporate gover- nance perspective, product market competition complements the market for corporate control and the market for private equity, each of which is outlined next.

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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 essen- tially 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 sug- gests that when managers engage in self-interested actions and internal governance mechanisms fail, firm stock will be undervalued by investors. Under these circum- stances, other management teams, which recognize an opportunity to create new value, bid for the rights to manage the firm (see Chapter 9). How effective is the mar- ket 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.32

In summary, while internal mechanisms aim at “fine-tuning,” the market for cor- porate 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,33 and the long-term profitability of post-merger firms is not particularly impressive (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’ diver- gence from shareholder wealth maximization—as recently reported in Japan.34

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) compa- nies (see the Opening Case). Private equity is primarily invested through leveraged buyouts (LBOs). In an LBO, private investors, often in partnership with incumbent man- agers, issue bonds and use the cash raised to buy the firm’s stock—in essence repla- cing shareholders with bondholders and transforming the firm from a public to a private entity.35 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 corpo- rate governance:36

• 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.37 The picture is less clear regarding the long run, because LBOs may have forced managers to reduce investments in long-term R&D. Recent research reports that private equity- backed firms do not suffer from a reduction of R&D in the long run.38

Internal Mechanisms + External Mechanisms = Governance Package Taken together, the internal and external mechanisms can be considered a “package.”39 Michael Jensen, a leading agency theorist, argues that in the United States, failures of internal governance mechanisms in the 1970s activated the market

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for corporate control in the 1980s.40 Managers initially resisted. However, over time, many firms that are not takeover targets or that have successfully defended them- selves 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 mechan- isms. 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.41

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 man- agers significant de facto control power (see the Opening Case).

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 concentrated ownership and control.

Overall, the Anglo–American and continental European–Japanese (otherwise known as German–Japanese) systems represent the two primary corporate gover- nance 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.

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 governance mechanisms

SOURCE: Cells 1, 2, and 4 are adapted from E. Gedajlovic & D. 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 M. W. Peng.

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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 larg- est Canadian firms are controlled by a single shareholder.42 Canadian managers thus face powerful internal and external constraints.

Finally, SOEs (of all nationalities) are typically in a position of both weak exter- nal and internal governance mechanisms (Cell 3). Externally, the market for corpo- rate control usually 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 par- tially 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 sec- tion discusses the model.

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. Having more outside directors on the board is often regarded as a performance- enhancing practice. However, such thinking ignores industry differences. In indus- tries characterized by a rapid pace of innovation requiring significant R&D invest- ments (such as IT), outside directors often have a negative impact on firm performance.43 This is because of the necessity for directors to have intimate knowledge about these industries, which require more strategic control. Inexperi- enced outside directors often focus on financial control—inappropriate in these industries.

Another example is the widely noted link between inside management owner- ship and firm performance. However, such relationship may not exist in low-growth stable industries. Only in relatively high-growth turbulent industries has this relation- ship been found. While increased insider ownership is designed to encourage man- agers to take more risks, opportunities to profitably take such risks probably may be more likely in high-growth turbulent industries.

A third example is the often-criticized practice of CEO duality. In industries experiencing 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.

TABLE 11.3 Two Primary Families of Corporate Governance Systems.

Corporations in the United States and 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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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 cer- tain “best” practices.

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.44 Some of these capabilities are highly unique, such as international experiences. Executives without such first-hand experience are often handicapped when they try to expand overseas. In addition, the social networks of these execu- tives, often through board interlocks, are likely to add value, highly unique, and hard to imitate.45

In another example, the abilities to successfully list on a high-profile exchange such as New York Stock Exchange (NYSE) and London Stock Exchange (LSE) are 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.46 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.47 London-listed foreign firms do not enjoy such high valuations.48

This is classic resource-based logic at work: Precisely because it is much more chal- lenging 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.

FIGURE 11.4 A Comprehensive Model of Corporate Governance.

Outside directors Inside ownership CEO duality

Value Rarity Imitability Organizational capabilities

Formal frameworks Informal frameworks

Industry-based considerations Resource-based considerations

Institution-based considerations

Corporate governance

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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.49 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 The institution-based view posits that differences around the world are affected on the one hand by formal securities laws, corporate charters, and codes, and on the other hand by informal conventions, norms, and values—collectively known as “institutions.”50 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 (see the Opening Case). Why is there such a dif- ference? While explanations abound, a leading answer is an institutional one. In brief, better formal legal protection of shareholder rights in the United States and the United Kingdom, especially those held by minority shareholders, encourages founding families to dilute their equity to attract minority shareholders and delegate day-to-day management to professional managers.51 Given reasonable investor pro- tection, 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 that the weaker the formal legal and regulatory institu- tions 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 concentration of corporate ownership.52 Among common-law countries, such own- ership 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, unfortu- nately, introduces more principal–principal conflicts. Consequently, many potential minority shareholders may refuse to invest. “How does one avoid being expropriated as a minority shareholder?” one popular saying suggests, “Don’t be one!” If minority shareholders are informed enough to be aware of principal-principal conflicts 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 perfor- mance has trailed behind that of its rivals such as Time Warner, Walt Disney, and Viacom. 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 development, it seems puzzling why strong investor protection is not universally embraced. This is because corporate governance ultimately is a choice about politi- cal 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

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political decisions made by postwar German governments. If German firms had US/UK-style dispersed ownership and still allowed employees to control 50% of the votes on supervisory boards, these firms would end up becoming employee- dominated firms. Thus, concentrated ownership and control becomes a natural response.

Changing political choices, although not impossible, will encounter significant resistance, especially from incumbents (such as German labor unions or Asian fami- lies) who benefit from the present system. Some of the leading families not only have great connections with the government, sometimes they are the government. Three recent prime ministers of Italy and Thailand—Silvio Berlusconi, Thaksin Shinawatra, and Yingluck Shinawatra—came from leading families and were the richest indivi- duals in these countries.

Only when extraordinary events erupt would some politicians muster sufficient political will to initiate major corporate governance reforms.53 The spectacular cor- porate governance 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 shareholders to cast proxy votes on executive compensation—in short, “say on pay.”

Informal Institutional Frameworks In the last three decades around the world, why have informal norms and values con- cerning corporate governance changed to such a great extent?54 As the idea of share- holder capitalism rapidly spreads, three underlying sources can be identified: (1) the rise of capitalism, (2) the impact of globalization, and (3) the global diffusion of “best practices.”

First, recent changes in corporate governance around the world are part of the greater political, economic, and social movement embracing capitalism. The triumph of capitalism naturally boils down to the triumph of capitalists (also known as share- holders). 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 corpo- rate 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.

• Foreign portfolio investment (FPI)—foreigners purchasing stocks and bonds—has scaled new heights. These investors naturally demand better shareholder protec- tion before committing their funds.

• The global thirst for capital has prompted many firms to pay attention to corpo- rate 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 dif- fusion of “best practices” in the form of corporate governance codes.55 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 Code of Corporate Conduct is voluntary, firms not adopting it have to publicly explain why, essentially naming and shaming themselves. The Organization for Economic Cooper- ation and Development (OECD)—a rich countries’ club—has spearheaded efforts to globally diffuse “best practices” through the OECD Principles of Corporate Gover- nance. The Principles are non-binding even for the 34 OECD member countries. Nevertheless, the global norms seem to be moving toward the Principles.

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For example, China and Taiwan, both are 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 tremen- dous 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 Corporate governance often generates intense debates.56 This section discusses three major debates: (1) opportunistic agents versus managerial stewards, (2) global convergence versus divergence, and (3) state ownership versus private ownership.

Opportunistic Agents versus Managerial Stewards Agency theory assumes managers to be agents who may engage in self-serving opportunistic 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 not be fair to characterize all managers as opportu- nistic agents. Although very influential, agency theory has been criticized as an “anti-management theory of management.”57 A “pro-management” theory, stewardship theory, has emerged recently. It suggests that most managers can be viewed as owners’ stewards. Safeguarding shareholders’ interests and advancing organiza- tional goals will maximize (most) managers’ own utility functions.58

If all principals view all managers as self-serving agents with control mechan- isms 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 Globally, is corporate governance converging or diverging? 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.59 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, result- ing in higher valuations.

Critics contend that governance practices will continue to diverge throughout the world.60 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

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world may be counterproductive or even disastrous.61 This is because the main prob- lem 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.62 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.”63

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.64

State Ownership versus Private Ownership65

Private ownership is good. State ownership is bad. Although crude, these two state- ments 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 (see the Opening Case).

The debate on private versus state ownership underpinned 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 Soviet-style

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 Entry is determined by entrepreneurs, owners, and investors.

Entry is determined by government officials.

Financing 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 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, 2015, Theories of the (state-owned) firm, working paper, University of Texas at Dallas.

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socialism centered on state 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 effi- ciency. 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.

Britain’s prime minister Margaret Thatcher privatized a majority of British SOEs in the 1980s. SOEs throughout Central and Eastern Europe soon followed suit. After the former Soviet Union collapsed, the new Russian government unleashed some of the most aggressive privatization schemes in the 1990s. Eventually, the pri- vatization 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 the US government and the two Washington-based international organizations: the International Monetary Fund (IMF) and the World Bank. A core value of the Washington Consensus is the unques- tioned belief in the superiority of private ownership over state ownership. The wide- spread 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 unprecedented Great Recession, many governments in developed economies, led by the US government, bailed out numerous failing private firms using public funds, effectively turning them into SOEs (see the Opening Case). As a result, the argu- ments 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 accu- rately 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 government 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 compensa- tion 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 govern- ments) do not have to face the full consequences of their actions.66 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.67 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.

Although the worst fear about the recession is now over, debates continue to rage. From the ashes of the Washington Consensus emerged a Beijing Consensus, which cen- ters on state ownership and government intervention. Anchored by SOEs, China’s economy has emerged to become the second largest in the world. But China is

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not alone.68 Overall, SOEs not only occupy four spots among the top ten largest firms worldwide (measured by sales), but also represent six of the top ten most-profitable firms globally (measured by amount of profits) (see Table 11.5). While some SOEs have become large and profitable, the majority of them have continued to be ineffi- cient. Despite the hoopla about the alleged “muscle” of Chinese SOEs, as a group their return on assets (ROA) since 2008 has been barely 3%.69 In summary, some SOEs do well, most muddle through, but they are unlikely to disappear any time soon.70

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. 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 con- strain the action of the first controlling shareholder.71

Second, savvy strategists need to develop firm-specific capabilities to differenti- ate on governance dimensions. In India, a leading IT firm Infosys has emerged as an exemplar. It is the first Indian firm to follow US generally accepted accounting prin- ciples (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 NASDAQ 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.

TABLE 11.5 Top Ten Largest and Top Ten Most Profitable Firms in the World.

Top ten largest firms measured by sales Top ten firms with the largest profits 1 Wal-Mart (USA) 1 Vodafone Group (UK) 2 Royal Dutch Shell (Netherlands) 2 Fannie Mae (USA)—SOE 3 SINOPEC (China)—SOE 3 Freddie Mac (USA)—SOE 4 China National Petroleum Corporation

(China)—SOE 4 Industrial & Commercial Bank of China

(China)—SOE 5 Exxon Mobil (USA) 5 Apple (USA) 6 BP (UK) 6 Gazprom (Russia)—SOE 7 State Grid (China)—SOE 7 China Construction Bank (China)—SOE 8 Volkswagen (Germany)—SOE 8 Exxon Mobil (USA) 9 Toyota (Japan) 9 Samsung Electronics (South Korea) 10 Glencore (Switzerland) 10 Agricultural Bank of China (China)—SOE

SOURCE: Adapted from Fortune, 2014, Global 500, July 21: F-1 and F-13.

TABLE 11.6 Strategic Implications for Action.

• Understand the nature of principal–agent and principal–principal conflicts to create better gov- ernance mechanisms.

• Develop firm-specific capabilities to differentiate a firm on corporate governance dimensions. • Master the rules affecting corporate governance and anticipate changes.

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The primary reason is to gain credibility with Western customers. In other words, excellent governance practices make Infosys stand out in the product market.

Third, savvy strategists need to understand the formal and informal rules, antici- pate changes, and be prepared.72 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.73 While shareholders only rejected executive pay at fewer than 2% of public firms, this practice of significantly increasing CEO com- pensation 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 cor- porate 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 simi- lar basic components of corporate governance (owners, managers, and boards), the primary sources of differences stem from how these components relate and interact with each other. 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 better firm performance.74

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 often feature concentrated ownership and control in the

hands of families or governments.

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 combina- tion as a package • Internal voice-based mechanisms and external exit-based mechanisms com-

bine 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 consider-

able light on governance issues.

7. Participate in three leading debates concerning corporate governance • (1) Opportunistic agents versus managerial stewards, (2) global conver-

gence 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.

CRITICAL DISCUSSION QUESTIONS 1. If you can choose to list your firm anywhere in the world, which country would

you prefer? Why?

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?

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. Starting from Berle and Means (see the Opening Case), some argue that the

Anglo-American style separation of ownership and control is an inevitable out- come in corporate governance for large firms. 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. How do you participate in the debate on state ownership versus private ownership?

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 on whose board you have served 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?

CLOSING CASE 11.1

Emerging Markets: The Private Equity Challenge Private equity is one of the hottest and most controversial buzzwords in corporate gover- nance. 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

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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 deadwood managers who destroyed share- holder 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 equity deals now routinely rep- resent 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 Daimler- Chrysler (now Daimler) for $7.4 billion. APAX Partners spent $7.75 billion to buy Thomson Learning—the publisher of this book—from The Thomson Corporation now Thomson- Reuters) listed in New York and Toronto. However, private equity suffered a tremendous 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. Proponents 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 (typ-

ically 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. Man- agers’ 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 same managers, 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 espe- cially crushing load thanks to SOX), and better yet, no more disclosure in excruciating detail of their pay (an inevitable invitation to be labelled “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. However,

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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 out- look is grim. Is private equity “Monsters, Inc.?” asked an Economist editorial. Thus, pri- vate equity firms have increasingly targeted emerging economies, especially China, for future growth. The following quote is from a 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 pro- testing me. I’ve got everybody telling me that I didn’t do something right. In China, peo- ple want my 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 cap- italism 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: 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 institu- tional environments, Strategic Management Journal, 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 Economic

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.

Questions 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?

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CLOSING CASE 11.2

Emerging Markets: GE Innovates from the Base of the Pyramid In global competition, large firms not only compete in product markets, but also in terms of how they are organized, financed, and governed. Definitions of what con- sists of a “large firm” vary around the world. A reasonable definition is that if a firm is large enough to be publicly listed, then it would be a “large firm” in that country. Almost all large firms started as small firms. Small firms typically feature concen- tration of ownership and control—the founders own, manage, and control them. There was a time that many small firms aspired to become large enough so that they could become publicly listed, which would be an awesome hallmark that these firms have “made it.” As firms grow larger, the founding families may run out of money so that introducing outside shareholders would be necessary. The founding families may also run out of sons, daughters, in-laws, and relatives to staff key positions so that employing non-family, professional managers would be a must—so the theory goes. This theory was first published in a 1932 book The Modern Corporation and Private Property by law school professor Adolf Berle and economist Gardiner Means. Generalizing from several decades of transformation at leading American firms in which founding families such as the Carnegies and the Rockefellers gradually reduced their holdings and introduced outside shareholders and professional managers, Berle and Means argued that such transformation would be inevitable. In brief, their theory predicted separation of ownership and control as firms grow larger. What if the founding families refused to let go? In 1983, economists Eugene Fama (who won a Nobel prize in economics in 2013) and Michael Jensen asserted that failure to separate ownership and control “tends to penalize the corporation in the competition for survival.”

The question is: Really? The other two major forms of corporate governance are fam- ily ownership and state ownership. While the Berle and Means theory does a good job characterizing the evolution of large firms in the United States (and, to a lesser extent, Britain), the theory ends up not explaining the ownership and control pattern in the rest of the world very well. Numerous publicly listed firms continue to feature concentration of ownership and control in the hands of families. At present, about 85% of $1 billion-plus firms in Southeast Asia are in family hands, 75% in Latin America, 67% in India, and 40% in China. In Europe, families control 40% of listed firms. In the United States, 15% of the largest firms—those in the Fortune Global 500—are family owned and controlled. While there is no shortage of family drama and intrigue—remember the TV show Dallas?—evidently family ownership and control have no problem surviving and prospering.

The Fama and Jensen prediction that large firms with concentration of ownership and control would suffer from terrible performance cannot really be supported. In South Korea, Samsung Group, led by the capable Lee Kun-hee family, has marched from victory to victory, contributing 20% of GDP. In India, Tata Group, in the hands of the House of Tata, contributes 5% of GDP. An extension of the Fama and Jensen prediction is that while some large family firms may do well domestically, once they go overseas they would surely fail to become world-class in global competition. Again, this conjec- ture can be refuted. For example, Tata Group has emerged as one of the leaders of Indian firms’ globalization. In Britain, Tata Group is now the single largest private sector employer, proudly supporting 50,000 jobs—an accomplishment none of the UK-owned (and non-family-managed) firms can match. In the United States, some of the best- performing and largest firms, such as Wal-Mart, Ford, and McKesson, are family owned and controlled. Newly listed high-tech firms such as Google and Facebook have carried on this tradition.

In addition to family ownership, state ownership remains a rival form of corporate governance. Despite privatization around the world between the 1980s and the 2000s,

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during the Great Recession of 2008–2009, Western governments in an effort to rescue ailing firms nationalized numerous private firms and turned them into state-owned enter- prises (SOEs). Today SOEs represent approximately 10% of global GDP. Even in developed economies, they command 5% of GDP. Anchored by SOEs, China over the past three dec- ades has grown its GDP by 9.5% per year. SOEs represent 80% of China’s stock market capitalization. But China is not alone. In Russia, the figure is 62%, in Brazil 38%, and in Norway 38%. SOEs include some of the largest oil and gas companies (such as Sinopec), the biggest telecom service provider (China Mobile), and the biggest ports operator (Dubai Ports). In 2014, they also represented six of the top ten most-profitable firms globally (measured by the amount of profits): Fannie Mae and Freddie Mac of the United States, ICBC of China, Gazprom of Russia, China Construction Bank, and Agricultural Bank of China (in descending order). In short, SOEs as an organizational form can be both large and successful.

Recently what seems to be under siege is the publicly listed corporation. In 1997, the number of US listed firms reached a high watermark: 7,888. Since 1997, their number has dropped dramatically—by 38% in the United States and by 48% in Britain. The has- sles associated with public ownership have facilitated the rise of private equity. Michael Dell, for example, has taken Dell (the corporation) private, because private ownership would give the firm “more time, investment, and patience.” Private equity deals now rou- tinely represent 25% of all mergers and acquisitions (M&As) in the world (and 35% in the United States). While existing firms can go private, many aspiring new firms do not bother to list at all. As a result, there is now a severe initial public offering (IPO) famine: between 1980 and 2000, on average there were 311 IPOs a year in the United States. The average went down to a mere 99 a year between 2001 and 2011. In short, going public is no longer as sexy as it was before. Commenting on the global competition in terms of how to best organize, finance, and govern large firms, the Economist suggests that “there is every reason to celebrate the fact that businesses have more corporate forms to choose from.”

Sources: 1. Bloomberg Businessweek, 2014, Private equity discover deals in the Middle East, September

29: 47–48; 2. G. Bruton, M. W. Peng, D. Ahlstrom, C. Stan, & K. Xu, 2015, State-owned enterprises around

the world as hybrid organizations, Academy of Management Perspectives, 29: 92–114; 3. Economist, 2012, The endangered public company, May 19: 13; 4. Economist, 2012, The big engine that couldn’t, May 9: 27–30; 5. Economist, 2013, Dell goes private, February 9: 63–64; 6. Economist, 2014, Business in the blood, November 1: 59–63; 7. Economist, 2014, Relative success, November 1: 12–13; 8. Fortune, 2014, Global 500, July 21: F-13; 9. E. Fama & M. Jensen, 1983, Separation of ownership and control, Journal of Law and Econom-

ics, 26: 301–326; 10. Y. Jiang & M. W. Peng, 2011, Are family ownership and control in large firms good, bad, or

irrelevant? Asia Pacific Journal of Management, 28: 15–39.

Questions 1. What are the advantages and disadvantages of the public listed corporation? 2. Why is there an IPO famine lately? 3. What are the advantages and disadvantages of family ownership? 4. What about state ownership and private equity?

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NOTES [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); EMR–Emerging Markets Review; HBR–Harvard Business Review; JAE–Journal of Accounting and Economics; JBE–Journal of Business Ethics; JCF–Journal of Corporate Finance; JEP–Journal of Economic Perspectives; JF–Journal of Finance; JFE–Journal of Financial Economics; JIBS–Journal of International Business Studies; JM–Journal of Management; JMS–Journal of Management Studies; JWB–Journal of World Business; OSc– Organization Science; RES–Review of Economics and Statistics; RFS–Review of Financial Studies; SMJ–Strategic Management Journal; WSJ–Wall Street Journal

1. R. Monks & N. Minow, 2001, Corporate Governance (p. 1), Oxford, UK: Blackwell. 2. B. Connelly, R. Hoskisson, L. Tihanyi, & S. T. Certo, 2010, Ownership as a form of

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18. Economist, 2012, The shackled boss, January 21: 76.

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19. M. Geletkanycz & B. Boyd, 2011, CEO outside directorships and firm performance, AMJ, 54: 335–352.

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35. R. Hoskisson, W. Shi, X. Yi, & J. Jin, 2013, The evolution and strategic positioning of private equity firms, AMP, 27: 22–38.

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& S. Nielsen, 2013, Top management team nationality diversity and firm performance, SMJ, 34: 373–382; L. Oxelheim, A. Gregoric, T. Randoy, & S. Thomsen, 2013, On the internationalization of corporate boards, JIBS, 44: 173–194; 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.

45. A. Alexiev, J. Jansen, F. Van den Bosch, & H. Volberda, 2010, Top management team advice seeking and exploratory innovation, JMS, 47: 1343–1364; C. Chung & R. Luo, 2013, Leadership succession and firm performance in an emerging economy, SMJ, 34: 338–357.

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48. 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.

49. S. Boivie, D. Lange, M. McDonald, & J. Westphal, 2011, Me or we, AMJ, 54: 551–576; C. Devers, G. McNamara, J. Haleblian, & M. Yoder, 2013, Do they walk the talk? AMJ, 56: 1679–1702; D. Hambrick & T. Quigley, 2014, Toward more accurate contextualization of the CEO effect on firm performance, SMJ, 35: 473–491; J. He & Z. Huang, 2011, Board informal hierarchy and firm financial performance, AMJ, 54: 1119–1139; A. Karaevli & E. Zajac, 2013, When do outside CEOs generate strategic change? JMS, 50: 1267–1294; A. Mackey, 2008, The effect of CEOs on firm performance, SMJ, 29: 1357–1367; S. Nadkarni & J. Chen, 2014, Bridging yesterday, today, and tomorrow, AMJ, 57: 1810–1833; 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; C. Tuggle, K. Schnatterly, & R. Johnson, 2010, Attention patterns in the boardroom, AMJ, 53: 550–571; A. Wowak, D. Hambrick, & A. Henderson, 2011, Do CEOs encounter within-tenure settling up? AMJ, 54: 719–739.

50. N. Boubakri, S. Mansi, & W. Saffar, 2013, Political institutions, connectedness, and corporate risk-taking, JIBS, 44: 195–215; I. Filatotchev & D. Allcock, 2010, Corporate governance and executive remuneration, AMP, 24: 20–33; L. Shao, C. Kwok, & R. Zhang, 2013, National culture and corporate investment, JIBS, 44: 745–763; M. Van Essen, P. Heugens, J. Otten, & J. van Oosterhout, 2012, An institution-based view of executive compensation, JIBS, 43: 396–423; K. Weber, G. Davis, & M. Lounsbury, 2009, Policy as myth and ceremony? AMJ, 52: 1319–1347.

51. R. D. McLean, T. Zhang, & M. Zhao, 2012, Why does the law matter? JF, 67: 313–350. 52. A. Bris & C. Cabolis, 2008, The value of investor protection, RFS, 21: 605–648. 53. G. Davis, 2009, The rise and fall of finance and the end of the society of organizations,

AMP, August: 27–44. 54. S. Estrin & M. Prevezer, 2011, The role of informal institutions in corporate

governance, APJM, 28: 41–67. 55. I. Haxhi & H. van Ees, 2010, Explaining diversity in the worldwide diffusion of codes of

good governance, JIBS, 41: 710–726. 56. M. Bednar, 2012, Watchdog or lapdog? AMJ, 55: 131–150; T. Donaldson, 2012, The

epitemic fault line in corporate governance, AMR, 37: 256–271; L. Lan & L. Heracleous, 2010, Rethinking agency theory, AMR, 35: 294–314.

57. L. Donaldson, 1995, American Anti-management Theories of Management, Cambridge, UK: Cambridge University Press.

58. M. Hernandez, 2012, Toward an understanding of the psychology of stewardship, AMR, 37: 172–193.

59. M. W. Peng & W. Su, 2014, Cross-listing and the scope of the firm, JWB, 49: 42–50. 60. Y. Shi, M. Magnan, & J. Kim, 2012, Do countries matter for voluntary disclosure? JIBS,

43: 143–165. 61. M. Van Essen, J. van Oosterhout, & P. Heugens, 2013, Competition and cooperation in

corporate governance, OSc 24: 530–551. 62. P. Rejchrt & M. Higgs, 2015, When in Rome, JBE (in press). 63. J. Siegel, 2009, Is there a better commitment mechanism than cross-listings for

emerging-economy firms? JIBS, 40: 1171–1191.

Chapter 11 • Governing the Corporation Around the World 313

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64. A. Chizema & Y. Shinozawa, 2012, The “company with committees,” JMS, 49: 77–101. 65. State ownership is also often referred to as “public ownership.” However, since a lot of

privately owned firms are publicly listed and traded that can cause confusion, I have decided to use “state ownership” here to minimize confusion.

66. P. Bernstein, 2009, The moral hazard economy, HBR, July-August: 101–102. 67. C. Stan, M. W. Peng, & G. Bruton, 2014, Slack and the performance of state-owned

enterprises, APJM, 31: 473–495. 68. Economist, 2012, The rise of state capitalism, January 21: 11. 69. A. Batson, 2013, The SOE irritant in US—China relations, WSJ, July 8: 13. 70. G. Bruton, M. W. Peng, D. Ahlstrom, C. Stan, & K. Xu, 2015, State-owned enterprises as

hybrid organizations around the world, AMP, 32: 748–770. 71. Y. Jiang & M. W. Peng, 2011, Principal-principal conflicts during crisis, APJM, 28:

683–695. 72. 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; D. Gomulya & W. Boeker, 2014, How firms respond to financial restatement, AMJ, 57: 1759–1785; M. Goranova & L. Ryan, 2014, Shareholder activism, JM, 40: 1230–1268; J. Kang & J. Kim, 2010, Do foreign investors exhibit a corporate governance disadvantage? JIBS, 41: 1415–1438; I. Larkin, L. Pierce, & F. Gino, 2012, The psychological costs of pay-for-performance, SMJ, 33: 1194–1214; A. Pe’er & O. Gottschalg, 2011, Red and blue, SMJ, 32: 1356–1367; E. Rhee & P. Fiss, 2014, Framing controversial actions, AMJ, 57: 1734–1756.

73. BW, 2011, After much hoopla, investor “say on pay” is a bust, June 20: 23–24. 74. J. Ho, A. Wu, & S. Xu, 2011, Corporate governance and returns on information

technology investment, SMJ, 32: 595–623.

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CHAPTER

12 KEY TERMS

Corporate social responsibility (CSR)

global sustainability Primary stakeholder

groups

Secondary stakeholder groups

social issue participation reactive strategy

defensive strategy accommodative strategy proactive strategy

KNOWLEDGE OBJECTIVES 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

316

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Strategizing with Corporate Social Responsibility

OPENING CASE Emerging Markets: The Ebola Challenge

First reported in 1976 in Sudan and Zaire (now called the Democratic Republic of the Congo [DRC]), Ebola has been a known virus for four decades. Yet, there is still no effective vaccine or medicine. Between 1976 and 2013, there were 24 outbreaks in Sub-Saharan Africa, with 1,716 cases. What really put Ebola on the center stage of global media—and on the pages of this book—was the 2014 outbreak, which was the most devastating outbreak with 15,000 reported cases and 6,000 deaths. Starting in Guinea, Liberia, and Sierra Leone, the disease quickly diffused to other West African countries such as the DRC, Nigeria, and Senegal. By September 2014, a Liberian man who travelled to Dallas, Texas, was diagnosed to have Ebola. He died there in early October. Two American nurses who treated the patient became the first confirmed cases to be infected by Ebola in the United States, triggering panic and chaos not only in Texas, but also in other parts of the country. State governments in Connecticut, Illinois, New Jersey, and New York demanded that anyone who traveled from affected West African countries be subject to 21 days of quarantine—the longest period the Ebola virus was thought to need to incubate. In mid-October 2014, President Obama appointed a national Ebola response coordinator. All passengers arriving from affected African countries now had to go through screening, and all patients showing up at a US health care establishment had to answer a questionnaire regarding whether they traveled from these countries.

In the absence of effective vaccine or medicine, treatment was indirect. It centered on early supportive care with rehydration and symptomatic treatment. The measures would include manage- ment of pain, nausea, fever, and anxiety, as well as rehydration via the oral or intravenous (IV) route. Blood products such as packed red blood cells, platelets or fresh frozen plasma might also be used. Intensive care was often used in the developed world. This might include maintaining blood volume and electrolytes (salts) balance as well as treating any bacterial infections. Thankfully, the two Amer- ican nurses recovered after several weeks of treatment, so did the other six American health care workers who went to Africa and came home with Ebola. By December 2014, there had been ten Ebola cases in the United States, and only two resulted in death—the second case of death was an African doctor who was contaminated by his patients in an Ebola-infested country.

Throughout the crisis, the initial silence of the pharmaceutical industry was conspicuous. Dr. Margaret Chan, Director-General of the World Health Organization (WHO), criticized the industry for failing to develop a vaccine for Ebola over the four decades during which the virus threatened poor African countries. She complained that “a profit-driven industry does not invest in products for mar- kets that cannot pay.” Initially reluctant, some pharmaceutical firms jumped in. In October 2014, British drugmaker GlaxoSmithKline (GSK) announced that it expedited its R&D in search of a vaccine. In 2010, the Canadian government developed an experimental vaccine VSV-EBOV and licensed it to

317

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a small, virtually unknown biotech firm, NewLink Genetics in Ames, Iowa, for clinical trials. However, progress was slow and funding tight. In November 2014, a US giant, Merck, paid NewLink $50 mil- lion to buy the rights to the vaccine and to expedite R&D, and the Canadian government retained non-commercial rights to it. Also in November 2014, a French Big Pharma player Sanofi announced its intention to work with industry partners to combat Ebola. Another experimental drug ZMapp, developed by a small San Diego, California-based biopharmaceutical firm Mapp, showed encourag- ing results on primates, and had been used on at least seven (human) patients in Africa in 2014. But ZMapp had not received FDA approval. In the absence of the financial, technological, and production capabilities of Big Pharma, ZMapp’s stocks quickly ran out. The US government had to provide it with $25 million to scale up production.

The reason that until recently, pharmaceutical firms—especially Big Pharma firms—had been reluctant to apply their significant resources to find a cure for Ebola was simple. Even if successful, these efforts, which would mostly benefit African countries, would not be profitable. In other words, there was “no compelling business case.” Now that the disease came to the United States (and a few Western European countries), firms felt compelled to move. Debates continued to rage. One side argued that pharmaceutical firms only focused on markets and products from which they could profit—with “Botox, baldness, and bonus” as their guiding light. Tropical diseases such as malaria and Ebola naturally would receive little (or no) attention. Another side argued that given limited resources, pharmaceutical firms rightly and strategically ignored (relatively) smaller-scale diseases such as Ebola, because there were other diseases such as HIV/AIDS that impact a lot more people than Ebola. A number of pharmaceutical firms jumped onto the “Ebola bandwagon” simply to earn kudos for corporate social responsibility, knowing that they would be unlikely to make any profits for their efforts. Or they were simply driven to do so due to public pressure—the series of eager announcements made in October and November 2014 were defensive in nature. Given the long lead time to develop any effective vaccine and the urgency to have a vaccine at hand when confront- ing an outbreak of Ebola (and other contagious diseases), how pharmaceutical firms manage their quest for the triple bottom line remains one of the leading strategic challenges they face.

SOURCES: Based on (1) C. Campos, C. Cole, & J. Steele, 2014, Ebola and corporate social responsibility, EMBA strategy class term project, Jindal School of Management, University of Texas at Dallas; (2) CBC, 2014, Canada should cancel NewLink Ebola vaccine contract, November 19: www.cbc.ca; (3) Independent, 2014, Ebola outbreak: Why has ‘Big Pharma’ failed deadly virus’ victims? September 7: www.independent.co.uk; (4) National Public Radio, 2014, Merck part- ners with NewLink to speed up work on Ebola vaccine, November 24: www.npr.org; (5) Time, 2014, WHO pillories drug industry for failure to develop Ebola vaccine, November 4: time.com; (6) World Health Organization, 2014, Ebola virus disease fact sheet, November: www.who.int.

Why until recently had pharmaceutical firms been reluctant to find a cure for Ebola? What motivated them to jump onto the “Ebola bandwagon” lately? Did they really want to solve a major public health problem around the world, or just want to earn some kudos for corporate social responsibility? Corporate social responsibility (CSR) refers 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 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.2

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.3 The sensitive and 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.”4 Shown in Figure 12.1, while shareholders certainly are an important group of stakeholders, other stakeholders include managers, non-managerial

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employees (hereafter “employees”), suppliers, customers, communities, govern- ments, and social and environmental groups. Since Chapter 11 has already dealt with shareholders at length, this chapter focuses on non-shareholder stakeholders, which we term “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.5 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 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 genera- tions to meet their needs.”6 It not only refers to a sustainable social and natural envi- ronment, but also sustainable capitalism.7 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

FIGURE 12.1 A Stakeholder View of the Firm.

Managers

Employees

Shareholders

Customers

Governments

Communities

Suppliers

Environmental groups

Social groups

THE FIRM

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.

Chapter 12 • Strategizing with Corporate Social Responsibility 319

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stakeholders have increasingly assumed the role of monitor and in some cases enforcer of social and environmental standards.

• 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. To be able to do that, primary and secondary stakeholders must be identified.10

Primary and Secondary Stakeholder Groups Primary stakeholder groups are constituents the firm relies on for its continuous survival and prosperity. Shareholders, managers, employees, suppliers, and 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 consid- ered primary stakeholders.

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 firms do not depend on secondary stakeholder groups for their survival, such groups may have the potential to cause significant embarrassment and damage—think of Nike and sweatshops in the 1990s.

A key proposition of the stakeholder view of the firm is that instead of only pur- suing 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 (see the Opening Case). 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 busi- ness 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 1970 article mentioned earlier. This free market school of thought draws upon Adam Smith’s idea that pur- suit of economic self-interest (within legal and ethical bounds) leads to efficient mar- kets. Free market advocates believe that the first and foremost stakeholder group is shareholders, whose interests managers have a fiduciary duty (duty required by law) to look after. To the extent that the hallmark of our economic system remains capital- ism, the providers of capital—namely, capitalists or shareholders—deserve a com- manding height in managerial attention. 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).

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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 character as capitalistic enterprises and become socialist orga- nizations. 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 underpin- ning for globalization spearheaded by MNEs.

It is against such a formidable and influential school of thought that the CSR movement 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 con- strained 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 vehe- mently 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.”17 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.18 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 wid- ened. 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%.19 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 dis- asters and scandals.20 In 2002, scandals of Enron, WorldCom, Royal Ahold, and Par- malat rocked the world. In 2009, excessive amounts of Wall Street bonuses distributed by financial services firms receiving government bailout funds were criti- cized 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.21

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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.22 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 tra- ditional 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 (see the Opening Case). When facing mounting

FIGURE 12.2 A Comprehensive Model of Corporate Social Responsibility.

Rivalry among competitors Threat of potential entry Bargaining power of suppliers Bargaining power of buyers Threat of substitutes

Value Rarity Imitability Organizational capabilities

Reactive strategy Defensive strategy Accommodative strategy Proactive strategy

Scale and scope of

corporate social

responsibility activities

Resource-based considerations Industry-based considerations

Institution-based considerations

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pressures to reduce emission levels, the automobile industry lobbied politicians, chal- lenged the science of global climatic change, and pointed to the high costs of reduc- ing 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.

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 tech- nologies have their differences. The first is for more proactive pollution prevention. Like defects, pollution typically reveals flaws in product design or production. Pollu- tion prevention technologies reduce or eliminate pollutants by using cleaner alterna- tives, often resulting in superior products. The second pollution control area is more reactive, “end-of-pipe” pollution reduction, often added as a final step to capture pol- lutants prior to their 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 substan- tial. For example, Coca-Cola is the sole provider of Coke syrup to its bottlers around the world. 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 vic- tims in China and Japan, and promoting reading among school children in 42 coun- tries, 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 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 fac- tories, 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 doc- umentation and hosting of auditors as well as extra costs. For “sweatshop” opera- tors, 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 govern- ments 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.

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Threat of Substitutes If substitutes are superior to existing products and costs are reasonable, they may attract more customers. 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 gov- ernment subsidies in order to become commercially viable. However, its future is likely to be promising, given the increasing depletion of fossil fuel, the fluctuating oil prices, and the growing awareness of the risks associated with conventional tech- nologies (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, not all indus- tries are equal in terms of their exposure to CSR challenges. Energy-intensive and materials-intensive industries (such as chemicals) are more vulnerable to environ- mental scrutiny. Labor-intensive industries (such as apparel) are more likely to be challenged on fair labor practice grounds. However, despite varying degrees of expo- sure, no industry may be completely immune from CSR. Table 12.1 shows the widen- ing 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 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 Whole Foods) 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.23

Resource-Based Considerations CSR-related resources can include tangible technologies and processes as well as intan- gible skills and attitudes.24 The VRIO framework can shed considerable light on CSR.

Value Do CSR-related resources and capabilities add value?25 This is the litmus test for CSR work. 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 refuse to do business with countries that engage in human rights abuses. Such 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 pri- mary stakeholders. Research suggests that these activities may actually reduce shareholder value.26 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

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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

TABLE 12.1 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 Tires Tobacco Tourism Toxic waste Transport Tropical hardwoods Water

SOURCE: 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.

Chapter 12 • Strategizing with Corporate Social Responsibility 325

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with NGOs for external verification, and disseminating such information to stake- holders. 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 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 tem- porary) competitive advantage. At some firms, CSR-related capabilities are deeply embedded in idiosyncratic managerial and employee skills and attitudes. 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.

Organization Does the firm have organizational capabilities to do a good job 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, comple- mentary assets, when combined with valuable, rare, and hard-to-imitate capabilities, may enable a firm to fully utilize its CSR potential.

The CSR-Economic Performance Puzzle The resource-based view helps solve a major puzzle in the CSR debate: the CSR- economic performance puzzle. While there is consistent evidence that corporate social irresponsibility (evidenced by environmental disasters and violations—see Table 12.2) destroys shareholder value (a major measure of economic performance), 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. Some studies do indeed report a positive relation- ship.27 Others find a negative relationship28 or no relationship.29 Viewed together, “CSR does not hurt [economic] performance, but there is no concrete support to believe that it leads to supranormal [economic] returns.”30

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.31 Since all studies have some sampling bias (no study is perfect), studies

TABLE 12.2 How Much Shareholder Value is Destroyed by Environmental Disasters and Violations.

Countries Event Window (Days Before the Event, Days After the Event)

Reduction of Shareholder Wealth (Cumulative Average Returns)

Argentina, Chile, Mexico, and the Philippines1 (−5, 5) −6.29% Canada2 (−1, 1) −2% China3 (−8, 8) −2.7% India4 (1, 5) / (1, 10) −2.97%/−5.02% South Korea5 (−3, 3) −9.7% United States6 (−1, 1) −1.5%

SOURCES: Extracted from findings reported in (1) S. Dasgupta, B. Laplante, & N. Mamingi, 2001, Pollution and capital markets in developing countries, Journal of Environmental Economics and Management, 42: 310–335; (2) P. Lanoie, B. Laplante, & M. Roy, 1998, Can capital markets create incentives for pollution control? Ecological Economics, 26: 31–41; (3) X. Xu, S. Zeng, & C. Tam, 2012, Stock market’s reaction to disclosure of environmental violation: Evidence from China, Journal of Business Ethics, 107: 227–237; (4) S. Gupta & B. Goldar, 2005, Do stock markets penalize environment-unfriendly behav- ior? Evidence from India, Ecological Economics, 52: 81–95; (5) S. Dasgupta, J. Hong, B. Laplante, & N. Mamingi, 2006, Disclosure of environmental viola- tions and stock market in the Republic of Korea, Ecological Economics, 58: 759–777; (6) R. Klassen & C. McLaughlin, 1996, The impact of environmental management on firm performance, Management Science, 42: 1199–1214.

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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 ben- efit 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.32 At the most fundamental level, regulatory pressures underpin formal institutions, whereas normative and cog- nitive pressures support informal institutions.33 As first introduced in Chapter 4 (see Table 4.6), a strategic response framework consists of (1) reactive, (2) defensive, (3) accommodative, and (4) proactive strategies. 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 for 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 now take for granted were fought by food and drug companies in the early 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 progressively 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.

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 indepen- dently through the industry’s technological prowess.

1971–82 Defensive “Congress seems determined to add one more regu- lation to the already 27 health and safety regulations we must answer to. This will make the EPA [Environ- mental 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).

SOURCE: 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.

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A defensive strategy focuses on regulatory compliance. Top management involve- ment 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.

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.34 A key insight of the institution-based view is that individuals 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 competitiveness, 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 “internalizing 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.35 For example, a Japanese law set standards to make products easier to dis- assemble. 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 eas- ier 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 emer- gence of some new industry norms. Further, new managers who are passionate about or sympathetic toward CSR causes may join the organization, or some tradi- tional managers may change their outlook, leading to increasingly strong cognitive beliefs that CSR is the right thing to do.36 In other words, from both normative and cognitive standpoints, it becomes legitimate or a matter of social obligation to accept responsibility and do all that is required.37 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 Green- peace’s demands and dumped Sinar Mars as a supplier, leading to a new industry norm that is more earth-friendly.38

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 to appear sensitive to CSR, following what others are doing, but have not truly and genuinely internalized CSR concerns.39 For example, in 2009, BP implemented a new safety-oriented operating management system.40 But after BP’s 2010 oil spill in the

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Gulf of Mexico, it became apparent that this system had not been seriously implemen- ted, and the result was a huge catastrophe. Second, an instrumental view suggests that CSR activities simply represent a useful instrument to make good profits.41

Firms are not necessarily becoming more ethical. For example, after the 2010 oil spill, BP reshuffled management 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.42 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.43 Regardless of actual motive, the fact that firms are practicing CSR is indica- tive of the rising legitimacy of CSR on the management agenda.44 Even firms that adopt a code of conduct simply as window dressing open doors for more scrutiny by 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. 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 engag- ing in CSR, constantly anticipating responsibility and endeavoring to do more than is required.45 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:

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. 46

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.”47

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 interna- tional policy and standards discussions.48 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 poli- ticians to engage in policy and legislative discussions. These are not merely defen- sive 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.49

Second, proactive firms often build alliances with stakeholder groups. For exam- ple, many firms collaborate with NGOs.50 Because of the historical tension and dis- trust, 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.

Chapter 12 • Strategizing with Corporate Social Responsibility 329

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Third, proactive firms often engage in voluntary activities that go beyond what is required by regulations.51 While examples of industry-specific self-regulation abound, an area of intense global interest is the pursuit of the International Stan- dards 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.52 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 pres- ent, 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 sus- tained pressures along regulatory, normative, and cognitive dimensions may push and pull more firms to do more. After publicizing its CSR plan, 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 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 sta- keholders. 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, CSR is about debates. It is not far-fetched to suggest that there is a big debate between this chapter (focusing on stakeholder capitalism) and Chapter 11 (focusing on shareholder capitalism). Here, we discuss three recent, previously unex- plored 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 for domestic CSR. Consider two primary stakeholder groups: domestic employees and communities. Expanding overseas,

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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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 seem to have noble CSR dimensions (see Chapter 1). However, this is often done at the expense of domestic employees and communities. For example, 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 Repub- lic, Poland, and South Africa.53 However, such labor deals will probably only slow down, not stop, the outgoing tide of jobs from developed economies. The wage dif- ferentials are just too great.

To the extent that few (or no) laid-off German employees would move to neigh- boring countries such as the Czech Republic and Poland to seek work (and forget about moving to China, India, or South Africa), most of them end up being social wel- fare 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 perspective, 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 soci- ety, it is shareholders (otherwise known as capitalists) who matter at the end of the day. According to Jack Welch, GE’s former 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. 54

When firms have enough resources, it would be nice to take care of domestic employees 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.55 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.56 However, such well-intentioned calls for greater CSR engagement are in direct conflict with a long-standing principle governing the relationship 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 workforce. While many MNEs withdrew, those that remained (such as BP)

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challenged the apartheid regime by desegregating their employees and thus under- mining the government’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 particular in the human rights area. Shell, after its widely criti- cized (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 objectionable. 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.

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 shift pollution-intensive production to developing countries with lower environ-mental 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.57 Most MNEs reportedly outperform local firms in environmental management. The underly- ing 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) requirements of MNE headquarters for worldwide com- pliance 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.58 Some MNEs, such as Dow, have facilitated the diffusion of better environmental technologies to countries such as China.

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

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.

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as part of the core activities of the firm—instead of “faking it,” making cosmetic changes, or just giving away some money.59 Many managers 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 out- lines some suggestions made by Porter on how to create shared social value via eco- nomic value creation, instead of just narrowly focusing on CSR.

Second, savvy managers need to pick CSR battles carefully.60 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 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 disap- pointment. Instead of always chasing the newest best practices, firms are advised to select CSR practices that fit with their existing resources, capabilities, and espe- cially 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 govern- ment refused to ratify the 1997 Kyoto Protocol and only signed the nonbinding 2009 Copenhagen Accord, many US firms such as Chevron, Dow Chemical, DuPont, ExxonMobil, Google, and Microsoft voluntarily participate in CSR activities (such as being prepared to pay “green” taxes for carbon emissions—known as carbon pric- ing) not (yet) mandated by law, in anticipation of more stringent environmental requirements down the road.61

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 struc- tures, (2) resource repertoire, and (3) formal and informal institutional pressures.

Second, how do firms behave in the CSR arena? Some are reactive and defen- sive, others are accommodative, and still others are proactive. Third, what deter- mines 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 percent- age 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? Undoubtedly, CSR

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 from M. Porter & M. Kramer, 2011, Creating shared value (p. 76), Harvard Business Review, January: 62–77.

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will increasingly become an important part of the answer. The best performing firms are likely to be those that can integrate CSR activities into their core economic func- tions 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. In the post–Great Recession and post–Occupy Wall Street world, managers, as a unique group of stake- holders, have an important and challenging responsibility. From a CSR standpoint, this means building more humane, more inclusive, and fairer firms that not only gen- erate wealth and develop economies, but also respond to changing societal expecta- tions concerning firms’ social and environmental roles around the world.62

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 share- holder capitalism variant, the CSR movement has now become a more cen- tral 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.

CRITICAL DISCUSSION QUESTIONS

1. ON ETHICS: Between the two opposing views in terms of stakeholder capital- ism (Chapter 12) and shareholder capitalism (Chapter 11), 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 unfin- ished 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 doesn’t it 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

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do a better job than I would.” What are you going to say to her? (Your colleague makes $146,000 a year and on a per-day basis she makes $400.)

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 organization is organized and carried on pri- marily for the profits of the stockholders.” If the court in your country were to decide on this case in 2019, what do you think would be the likely outcome?

2. ON ETHICS: Some argue that investing in emerging economies greatly facili- tates economic 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 gov- ernment 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?

CLOSING CASE 12.1

Emerging Markets: The Ebola Challenge First reported in 1976 in Sudan and Zaire (now called the Democratic Republic of the Congo [DRC]), Ebola has been a known virus for four decades. Yet, there is still no effective vaccine or medicine. Between 1976 and 2013, there were 24 outbreaks in Sub-Saharan Africa, with 1,716 cases. What really put Ebola on the center stage of global media—and on the pages of this book—was the 2014 outbreak, which was the most devastating outbreak with 15,000 reported cases and 6,000 deaths. Starting in Guinea, Liberia, and Sierra Leone, the disease quickly diffused to other West African countries such as the DRC, Nigeria, and Senegal. By September 2014, a Liberian man who travelled to Dallas, Texas, was diagnosed to have Ebola. He died there in early October. Two American nurses who treated the patient became the first confirmed cases to be infected by Ebola in the United States, triggering panic and chaos not only in Texas, but also in other parts of the country. State governments in Connecticut, Illinois, New Jersey, and New York demanded that anyone who traveled from affected West African countries be subject to 21 days of quarantine—the longest period the

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Ebola virus was thought to need to incubate. In mid-October 2014, President Obama appointed a national Ebola response coordinator. All passengers arriving from affected African countries now had to go through screening, and all patients showing up at a US health care establishment had to answer a questionnaire regarding whether they traveled from these countries.

In the absence of effective vaccine or medicine, treatment was indirect. It centered on early supportive care with rehydration and symptomatic treatment. The measures would include management of pain, nausea, fever, and anxiety, as well as rehydration via the oral or intravenous (IV) route. Blood products such as packed red blood cells, platelets or fresh frozen plasma might also be used. Intensive care was often used in the developed world. This might include maintaining blood volume and electrolytes (salts) balance as well as treating any bacterial infections. Thankfully, the two Ameri- can nurses recovered after several weeks of treatment, so did the other six American health care workers who went to Africa and came home with Ebola. By December 2014, there had been ten Ebola cases in the United States, and only two resulted in death—the second case of death was an African doctor who was contaminated by his patients in an Ebola-infested country.

Throughout the crisis, the initial silence of the pharmaceutical industry was conspic- uous. Dr. Margaret Chan, Director-General of the World Health Organization (WHO), criti- cized the industry for failing to develop a vaccine for Ebola over the four decades during which the virus threatened poor African countries. She complained that “a profit-driven industry does not invest in products for markets that cannot pay.” Initially reluctant, some pharmaceutical firms jumped in. In October 2014, British drug maker GlaxoSmithKline (GSK) announced that it expedited its R&D in search of a vaccine. In 2010, the Canadian government developed an experimental vaccine VSV-EBOV and licensed it to a small, vir- tually unknown biotech firm, NewLink Genetics in Ames, Iowa, for clinical trials. However, progress was slow and funding tight. In November 2014, a US giant, Merck, paid NewLink $50 million to buy the rights to the vaccine and to expedite R&D, and the Canadian gov- ernment retained non-commercial rights to it. Also in November 2014, a French Big Pharma player Sanofi announced its intention to work with industry partners to combat Ebola. Another experimental drug ZMapp, developed by a small San Diego, California- based biopharmaceutical firm Mapp, showed encouraging results on primates, and had been used on at least seven (human) patients in Africa in 2014. But ZMapp had not received FDA approval. In the absence of the financial, technological, and production capabilities of Big Pharma, ZMapp’s stocks quickly ran out. The US government had to provide it with $25 million to scale up production.

The reason that until recently, pharmaceutical firms—especially Big Pharma firms— had been reluctant to apply their significant resources to find a cure for Ebola was simple. Even if successful, these efforts, which would mostly benefit African countries, would not be profitable. In other words, there was “no compelling business case.” Now that the disease came to the United States (and a few Western European countries), firms felt compelled to move. Debates continued to rage. One side argued that pharmaceutical firms only focused on markets and products from which they could profit—with “Botox, baldness, and bonus” as their guiding light. Tropical diseases such as malaria and Ebola naturally would receive little (or no) attention. Another side argued that given limited resources, pharmaceutical firms rightly and strategically ignored (relatively) smaller- scale diseases such as Ebola, because there were other diseases such as HIV/AIDS that impact a lot more people than Ebola. A number of pharmaceutical firms jumped onto the “Ebola bandwagon” simply to earn kudos for corporate social responsibility, knowing that they would be unlikely to make any profits for their efforts. Or they were simply driven to do so due to public pressure—the series of eager announcements made in October and November 2014 were defensive in nature. Given the long lead time to develop any effec- tive vaccine and the urgency to have a vaccine at hand when confronting an outbreak of Ebola (and other contagious diseases), how pharmaceutical firms manage their quest for the triple bottom line remains one of the leading strategic challenges they face.

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Sources: 1. C. Campos, C. Cole, & J. Steele, 2014, Ebola and corporate social responsibility, EMBA strategy

class term project, Jindal School of Management, University of Texas at Dallas; 2. CBC, 2014, Canada should cancel NewLink Ebola vaccine contract, November 19: www.cbc.ca; 3. Independent, 2014, Ebola outbreak: Why has ‘Big Pharma’ failed deadly virus’ victims? Sep-

tember 7: www.independent.co.uk; 4. National Public Radio, 2014, Merck partners with NewLink to speed up work on Ebola vaccine,

November 24: www.npr.org; 5. Time, 2014, WHO pillories drug industry for failure to develop Ebola vaccine, November 4: time.

com; 6. World Health Organization, 2014, Ebola virus disease fact sheet, November: www.who.int.

Questions 1. Why until recently had pharmaceutical firms been reluctant to find a cure for Ebola? 2. What motivated them to jump onto the “Ebola bandwagon” lately? 3. Did they really want to solve a major public health problem around the world, or just want to

earn some kudos for corporate social responsibility?

CLOSING CASE 12.2

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” vehi- cle, 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 technological, 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 convenient 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. Psychologically, since public charging sta- tions are few and far between (and nonexistent in many communities), drivers will expe- rience “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 expen- sive globally (see Table 12.1). Elsewhere, the EV costs between $44,600 and $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?

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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 intro- duce the first EV.

Second, from a resource-based view, Nissan has accumulated significant capabilities in the crucial lithium-ion 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 projects 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 variety of stakeholders, such as government officials, utili- ties, 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 mar- keting, but also from government affairs, product planning, and communications. In the United States, the team focused on seven environmentally progressive states: Arizona, California, Hawaii, Oregon, Tennessee, Texas, and Washington (state). By limiting the launch to just seven states, Nissan can achieve a critical mass of charging stations. The team visited government officials to urge them to offer more incentives to buyers and utilities to encourage 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 meet- ings. 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 equiv- alent) in the United States, the Leaf costs about 2 cents per mile to drive, far more

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

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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 environment, 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: 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.

Questions 1. Why is an EV the “dream car” for many environmentalists? 2. Why do many automakers not bother to offer it? 3. Why does Nissan, the first firm that has mass-produced an EV, earn so many kudos?

NOTES

[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 Business-week (since 2010); GSJ–Global Strategy Journal; HBR–Harvard Busi- ness 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; OSc–Organization Science; OSt–Organization Studies; SMJ–Strategic Management Journal.

1. K. Davis, 1973, The case for and against business assumption of social responsibilities, AMJ, 16: 312–322. See also R. Aguilera, R. Rupp, C. Williams, & J. Ganapathi, 2007, Putting the S back in CSR, AMR, 32: 836–863; J. Campbell, L. Eden, & S. Miller, 2012, Multinationals and CSR in host countries, JIBS, 43: 84106; D. Matten & J. Moon, 2008, “Implicit” and “explicit” CSR, AMR, 33: 404–424.

2. T. Devinney, A. McGahan, & M. Zollo, 2013, A research agenda for global stakeholder strategy, GSJ, 3: 325–337; C. Egri & D. Ralston, 2008, Corporate responsibility, JIM, 14: 319–339; T. London, 2009, Making better investments at the base of the pyramid, HBR, May: 106–113.

3. K. O’Shaughnessy, E. Gedajlovic, & P. Reinmoeller, 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.

4. 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; 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.

5. J. Harrison, D. Bosse, & R. Phillips, 2010, Managing for stakeholders, stakeholder utility functions, and competitive advantage, SMJ, 31: 58–74.

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6. World Commission on Environment and Development, 1987, Our Common Future (p. 8), Oxford: Oxford University Press.

7. S. Hart, 2005, Capitalism at the Crossroads, Philadelphia: Wharton School Publishing; R. Rajan, 2010, Fault Lines, Princeton, NJ: Princeton University Press.

8. J. Howard-Grenville, S. Buckle, B. Hoskins, & G. George, 2014, Climate change and management, AMJ, 57: 615–623; J. Pinkse & A. Kolk, 2012, Multinational enterprises and climate change, JIBS, 43: 332–341; G. Whiteman, B. Walker, & P. Perego, 2013, Planetary boundaries, JMS, 50; 307–336.

9. J. Surroca, J. Tribo, & S. Zahra, 2013, Stakeholder pressure on MNEs and the transfer of socially irresponsible practices to subsidiaries, AMJ, 56: 549–572.

10. J. Bundy, C. Shropshire, & A. Buchholtz, 2013, Strategic cognition and issue salience, AMR, 38: 352–376; J. Vergne, 2012, Stigmatized categories and public disapproval of organizations, AMJ, 55: 1027–1052.

11. M. Clarkson, 1995, A stakeholder framework for analyzing and evaluating corporate social performance (p. 107), AMR, 20: 92–117. See also S. Waddock, 2008, Building 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. Elkington, 1997, Cannibals with Forks: The Triple Bottom Line of 21st Century Business, New York: Wiley.

13. M. Friedman, 1970, The social responsibility of business is to increase its profits, NYTM, September 13: 32–33.

14. D. Ahlstrom, 2010, Innovation and growth, AMP, August: 11–24. 15. A. Delios, 2010, How can organizations be competitive but dare to care? AMP, August:

25–36; M. Hollerer, 2013, From taken-for-granted to explicit commitment, JMS, 50: 573–606.

16. A. Mackey, T. Mackey, & J. Barney, 2007, CSR and firm performance, AMR, 32: 817–835.

17. M. Porter & M. Kramer, 2011, Creating shared value (p. 76), HBR, January: 62–77. 18. G. Bruton, 2010, Business and the world’s poorest billion, AMP, August: 6–10. 19. Economist, 2011, Rage against the machine, October 22: 13. 20. 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.

21. D. Lange & N. Washburn, 2012, Understanding attributions of corporate social irresponsibility, AMJ, 37: 300–326.

22. K. Basu & G. Palazzo, 2008, Corporate social responsibility, AMR, 33: 122–136; L. Christensen, A. Mackey, & D. Whetten, 2014, Taking responsibility for CSR, AMP, 28: 164–178; B. King, T. Fellin, & D. Whetten, 2010, Finding the organization in organization theory, OSc, 21: 290–305.

23. W. Su, M. W. Peng, W. Tan, & Y. Cheung, 2015, The signaling effect of corporate social responsibility in emerging economies, JBE (in press).

24. L. Berchicci, G. Dowell, & A. King, 2012, Environmental capabilities and corporate strategy, SMJ, 33: 1053–1071; A. Kolk & J. Pinkse, 2008, A perspective on MNEs and climate change, JIBS, 39: 1359–1378.

25. C. Flammer, 2013, CSR and shareholder reaction, AMJ, 56: 758–781. 26. A. Hillman & G. Keim, 2001, Shareholder value, stakeholder management, and social

issues, SMJ, 22: 125–139. 27. 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. Godfrey, 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, Environmental risk management and the cost of capital, SMJ, 29: 569–592; H. Wang & C. Qian, 2011, Corporate philanthropy and corporate financial performance, AMJ, 54: 1159–1181.

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28. S. Ambec & P. Lanoie, 2008, Does it pay to be green? AMP, November: 45–62; T. Wang & P. Bansal, 2012, Social responsibility in new ventures, SMJ, 33: 1135–1153.

29. 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.

30. T. Devinney, 2009, Is the socially responsible corporation a myth? AMP, May: 53. 31. 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.

32. J. Murillo-Luna, C. Garces-Ayerbe, & P. Rivera-Torres, 2008, Why do patterns of environmental response differ? SMJ, 29: 1225–1240; F. Wijen, 2014, Means versus ends in opaque institutional fields, AMJ, 39: 302–323; S. Young & M. Makhija, 2014, Firms’ CSR behavior, JIBS, 45: 670–698.

33. B. Gifford, A. Kestler, & S. Anand, 2010, Building local legitimacy into CSR, JWB, 45: 304–311.

34. A. Doshi, G. Dowell, & M. Toffel, 2013, How firms respond to mandatory information disclosure, SMJ, 34: 1209–1231.

35. A. Gore, 2006, An Inconvenient Truth, Emmaus, PA: Rodale Press. 36. D. Crilly & P. Sloan, 2012, Enterprise logic, SMJ, 33: 1174–1193. 37. P. M. Bal, D. Kooij, & S. Jong, 2013, How do developmental and accommodative HRM

enhance employee engagement and commitment? JMS, 50: 545–572; F. Briscoe, M. Chen, & D. Hambrick, 2014, CEO ideology as an element of the corporate opportunity for social activists, AMJ, 57: 1786–1809; D. Jones, C. Willness, & S. Madey, 2014, Why are job seekers attracted by corporate social performance? AMJ, 57: 383–404; A. Muller & A. Kolk, 2010, Extrinsic and intrinsic drivers of corporate social performance, JMS, 47: 1–26.

38. Economist, 2010, The other oil spill, June 26: 71–73. 39. J. Janney & S. Gove, 2011, Reputation and CSR aberrations, trends, and hypocrisy,

JMS, 48: 1562–1584. 40. BW, 2010, Nine questions (and provisional answers) about the spill, June 14: 62. 41. D. Siegel, 2009, Green management matters only if it yields more green, AMP, August:

5–16. 42. A. Marcus & A. Fremeth, 2009, Green management matters regardless, AMP, August:

17–26. 43. P. Berrone, A. Fosfuri, L. Gelabert, & L. Gomez-Mejia, 2013, Necessity as the mother of

“green” inventions, SMJ, 34: 891–909. 44. V. Hoffmann, T. Trautmann, & J. Hemprecht, 2009, Regulatory uncertainty, JMS, 46:

1227–1253. 45. N. Darnall, I. Henriques, & P. Sadorsky, 2010, Adopting proactive environmental

strategy, JMS, 47: 1072–1094. 46. J. Mackey, 2011, What is it that only I can do? HBR, January: 119–123. Mackey is a

co-founder of Whole Foods. 47. Starbucks Global Responsibility Report 2010, 2011, Message from Howard Schultz,

www.starbucks.com. 48. G. Unruh & R. Ettenson, 2010, Winning in the green frenzy, HBR, November: 110–116. 49. BW, 2010, The smooth-talking king of coal—and climate change, June 7: 65. 50. A. Kourula, 2010, Corporate engagement with NGOs in different institutional contexts,

JWB, 45: 395–404; J. Nebus & C. Rufin, 2010, Extending the bargaining power model, JIBS, 41: 996–1015.

51. 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.

52. B. Arya & G. Zhang, 2009, Institutional reforms and investor reactions to CSR announcements, JMS, 46: 1089–1112; M. Delmas & M. Toffel, 2008, Organizational responses to environmental demands, SMJ, 29: 1027–1055; I. Montiel, B. Husted, & P. Christmann, 2012, Using private management standard certification to reduce information asymmetries in corrupt environments, SMJ, 33: 1103–1113; E. Reid & M. Toffel, 2009, Responding to public and private politics, SMJ, 30: 1157–1178; E. Wong, M. Ormiston, & P. Tetlock, 2011, The effects of top management team

Chapter 12 • Strategizing with Corporate Social Responsibility 341

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integrative complexity and decentralized decision making on corporate social performance, AMJ, 54: 1207–1228.

53. BW, 2004, European workers’ losing battle (p. 41), August 9: 41. 54. J. Welch & S. Welch, 2006, Whose company is it anyway? BW, October 9: 122. 55. 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.

56. Economist, 2009, Spilling forever, June 13: 51. 57. P. Christmann & G. Taylor, 2006, Firm self-regulation through international certifiable

standards, JIBS, 37: 863–878. 58. P. Madsen, 2009, Does corporate investment drive a “race to the bottom” in

environmental protection? AMJ, 52: 1297–1318. 59. D. Crilly, M. Zollo, & M. Hansen, 2012, Faking it or muddling through? AMJ, 55:

1429–1448. 60. T. Waldron, C. Navis, & G. Fisher, 2013, Explaining differences in firms’ responses to

activism, AMJ, 38: 397–417; M. Zhao, S. Park, & N. Zhou, 2014, MNC strategy and social adaptation in emerging markets, JIBS, 45: 842–861.

61. BW, 2014, If it’s good enough for Big Oil … November 17: 10–11. 62. I. Filatotchev & C. Nakajima, 2014, Corporate governance, responsible managerial

behavior, and CSR, AMP, 28: 289–306; S. Khavul & G. Bruton, 2013, Harnessing innovation for change, JMS, 50: 285–306; C. Kock, J. Santalo, & L. Diestre, 2012, Corporate governance and the environment, JMS, 49: 492–514; A. Scherr, G. Palazzo, & D. Seidl, 2013, Managing legitimacy in complex and heterogenous environments, JMS, 50: 259–284.

342 Part 3 • Corporate-Level Strategies

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Glossary A

Absorptive capacity The ability to absorb new knowledge by recognizing the value of new infor- mation, assimilating it, and applying it.

Accommodative strategy A strategy that tries to accommodate corporate social responsibility con- siderations into decision making.

Acquisition premium The difference between the acquisition price and the market value of target firms.

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.

Additive manufacturing (or 3D printing) Manufactur- ing three-dimensional products from a digital model by using additive processes, where pro- ducts are created by adding successive layers of material. This contrasts traditional manufacturing, which can be labeled “subtractive” processes cen- tered on removing material by methods such as cutting and drilling.

Agency costs The costs associated with principal– agent relationships. They are the sum of (1) the principals’ costs of monitoring and controlling agents and (2) the agents’ costs of bonding.

Agency relationship The relationship between prin- cipals and agents.

Agency theory The theory about principal–agent relationships (or agency relationships in short).

Agents Person (such as manager) to whom author- ity is delegated.

Agglomeration Clustering economic activities in certain locations.

Ambidexterity Ability to use one’s both hands equally well. In management jargon, this term has been used to describe capabilities to simulta- neously deal with paradoxes (such as exploration versus exploitation).

Anchored replicators 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 Law that punishs foreign com- panies that engage in dumping in a domestic market.

Antitrust laws Law that attempts to curtail anticom- petitive business practices such as cartels and trusts.

Antitrust policy Competition policy designed to combat monopolies, cartels, and trusts.

Arm’s-length transaction Transaction in which par- ties keep a distance (see also A way of economic exchange based on formal transactions in which parties keep a distance (see also arm’s-length transactions)).

Attack An initial set of actions to gain competitive advantage.

B Backward integration Acquiring and owning upstream 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 demand quality improvement of goods and services.

Bargaining power of suppliers The ability of suppli- ers 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 US$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 partic- ular activity in a manner superior to competitors.

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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Born global firms (or international new ventures) 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

Brazil, Russia, India, and China (BRIC) Brazil, Russia, India, and China.

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 cost associated with a larger, more diversified organization.

Business groups A term to describe a conglomer- ate, 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 compet- itive advantage in a discrete and identifiable market.

C Capabilities 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 identical 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.

Centers of excellence MNE subsidiary 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 conglomerates 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 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 com- petitive 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 institu- tional 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.

Complementary assets Noncore asset that comple- ments and supports the value-adding activities of core assets.

Complementors 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.

344 Glossary

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Conglomerate M&As An M&A deal involving firms in product-unrelated industries.

Conglomerates Product-unrelated diversifier.

Conglomeration A strategy of product-unrelated diversification.

Constellations A multipartner strategic alliances (also known as strategic network).

Contender A strategy that centers on rapid learning and then expanding overseas.

Contractual (non-equity-based) alliances A strategic alliance that is based on contracts and does not involve the sharing of ownership.

Corporate governance The relationship among vari- ous participants in determining the direction and performance of corporations.

Corporate social responsibility (CSR) The social responsibility of corporations. It pertains to con- sideration of, and response to, issues beyond the narrow economic, technical, and legal require- ments of the firm to accomplish social benefits along with the traditional economic gains that the firm seeks.

Corporate-level strategy (or, in short, corporate strat- egy) Strategy about how a firm creates value through the configuration 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 costs and prices.

Counterattack A set of actions in response to attacks.

Country (or 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 mar- kets 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 cul- tures 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 tra- ders and investors from exposure to the fluctua- tions 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 valu- able 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.

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).

Diversification Adding new businesses to the firm that are distinct from its existing operations.

Dodger A strategy that centers on cooperating through joint ventures with MNEs and/or sell-offs to MNEs.

Domestic demand Demand for products and ser- vices 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.

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Downsizing Reducing the number of employees through layoffs, early retirements, and outsourcing.

Downstream vertical alliances A strategic alliance with firms in distribution (downstream).

Due diligence Investigation prior to signing contracts.

Due diligence Thorough investigation prior to sign- ing 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 Benefit 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 out- come of a stream of smaller decisions from the “bottom up.”

“Emerging economies” (or “emerging markets”) A label that describes fast-growing developing econ- omies since the 1990s.

Entrepreneurs Individual who identifies and explores previously unexplored opportunities.

Entrepreneurship The identification and exploita- tion 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 alliances A strategic alliance that involves the use of equity.

Ethical imperialism The imperialistic thinking that one’s own ethical standards should be applied uni- versally 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 unethical behaviors.

Ethics The norms, principles, and standards of conduct governing individual and firm behavior.

Excess capacity Additional production capacity currently underutilized or not utilized.

Exit-based mechanisms Corporate governance mechanism that focuses on exit, indicating that shareholders no longer have patience and are will- ing to “exit” by selling their shares.

Explicit collusion Firms directly negotiate output, fix pricing, and divide markets.

Explicit knowledge Knowledge that is codifiable (can be written down and transferred without los- ing much of its richness).

Exploitation Actions captured by terms such as refinement, choice, production, efficiency, selec- tion, and execution.

Exploration Actions captured by terms such as search, variation, risk taking, experimentation, play, flexibility, discovery, and innovation.

Export intermediaries A firm that performs an important middleman function by linking domes- tic sellers and foreign buyers that otherwise would not have been connected.

Expropriation (1) of foreign assets: Activities that enrich the controlling shareholders at the expense of minority shareholders. (2) of minority share- holders: Confiscation of foreign assets invested in one country.

Expropriation (1) of foreign assets: Confiscation of foreign assets invested in one country. (2) of minority shareholders: Activities that enrich the controlling shareholders at the expense of minor- ity shareholders.

Extender A strategy that centers on leveraging homegrown competencies abroad by expanding into similar markets.

Extraterritoriality The reach of one country’s laws to other countries.

F Factor endowments The endowment of production factors such as land, water, and people in one country.

Far-flung conglomerates A conglomerate firm that pursues both extensive product-unrelated diversification and extensive geographic diversification.

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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 (or output control) Controlling sub- sidiary/unit operations strictly based on whether they meet financial/output criteria.

Financial synergy The increase in competitiveness for each individual unit that is financially con- trolled by the corporate headquarters beyond what can be achieved by each unit competing independently as stand-alone firms.

Firm strategy, structure, and rivalry How industry structure and firm strategy interact to affect inter- firm 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 inten- sity of rivalry among competitors, (2) the threat of potential entry, (3) the bargaining power of suppliers, (4) the bargaining power of buyers, and (5) the threat of substitutes.

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

Focus A strategy that serves the needs of a partic- ular 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 Institution represented by laws, regulations, and rules.

Formal, rule-based, impersonal exchange with third- party enforcement A way of economic exchange based on formal transactions in which parties keep a distance (see also Transaction in which

parties keep a distance (see also formal, rule- based, impersonal exchange)).

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 is typically used in service industries.

Friendly M&As 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 mar- ket to attract rival firms to divert resources into the low-value market so that the original with- drawing firm can capture a high-value market.

Game theory A theory that focuses on competitive and cooperative interaction (such as in a prison- ers’ 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.

Geographic area structure An organizational struc- ture 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 dimen- sion that supplies customers (often other MNEs) in a coordinated and consistent way across vari- ous countries.

Global matrix An organizational structure often used to alleviate the disadvantages associated with both geographic area and global product divi- sion 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.

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Global strategy (1) Strategy of firms around the globe. (2) A particular form of international strat- egy, characterized by the production and distribu- tion of standardized 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 Team whose members are physically 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 operations 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 alliances A strategic alliance formed by competitors.

Horizontal M&As An M&A deal involving competing firms in the same industry.

Hostile M&As (also known as hostile takeovers) 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 rival’s 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 (or industrial economics) A branch of economics that seeks to better understand how firms in an industry com- pete and then how to regulate them.

Industry positioning Ways to position a firm within an industry in order to minimize the threats pre- sented by the five forces.

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

Informal institutions Institutions represented by norms, cultures, and ethics.

Informal, relationship-based, personalized exchange A way of economic exchange based on informal relationships among transaction parties. Also known as relational contracting.

Information asymmetries Asymmetric distribution of information between two sides.

Information overload Too much information to process.

Initial public offering (IPO) The first round of public trading of company stock.

Inside directors A director serving on a corporate board who is also a full-time manager of the company.

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.

Institutional distance The extent of similarity or dis- similarity between the regulatory, normative, and cognitive 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 organiza- tions as players.

Institutions Humanly devised constraints that structure human interaction—informally known as the “rules of the game.”

Integration-responsiveness framework A framework of MNE management on how to simultaneously

348 Glossary

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deal with two sets of pressures for global integra- tion and local responsiveness.

Intended strategy A strategy that is deliberately planned 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 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).

Internalization The process of replacing a market relationship with a single multinational organiza- tion spanning both countries.

International diversification The number and diver- sity of countries in which a firm competes.

International division A structure typically set up when firms initially expand abroad, often engag- ing 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 buyouts (LBOs) 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.

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 is typically used in manufacturing industries.

LLL advantages Linkage, leverage, and learning advantages, which are typically associated with MNEs from emerging economies.

Local content requirements Government require- ments that certain products be subject to higher import tariffs and taxes unless a given percentage of their value is produced domestically.

Local responsiveness The necessity to be respon- sive to different customer preferences around the world.

Localization (multidomestic) strategy An MNE strat- egy that focuses on a number of foreign countries/ regions, each of which is regarded as a stand- alone local (domestic) market worthy of signifi- cant attention and adaptation.

Location-specific advantages Advantages associated with operating in a specific location.

Long-term orientation A perspective that empha- sizes perseverance and savings for future betterment.

M Managerial human capital The skills and abilities acquired by top managers.

Marginal bureaucratic costs (MBC) The bureaucratic cost 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.

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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.

Mergers and acquisitions (M&As) Merging with or acquiring other firms.

Micro-macro link The link between micro, informal interpersonal relationships among managers of various units and macro, interorganizational coop- eration among various units.

Microfinance A practice to provide microloans (US$50–US$300) to start small businesses with the intention of ultimately lifting the entrepre- neurs out of poverty.

Mobility barriers 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 orga- nizations (including firms and governments) do not have to face the full consequences of their actions.

Multimarket competition Firms engage the same riv- als in multiple markets.

Multinational enterprises (MNEs) A firm that engages in foreign direct investment (FDI) by directly con- trolling and managing value-adding activities in other countries.

Multinational replicators 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.

Network externalities The value a user derives from a product increases with the number (or the net- work) 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 advantage that is not derived from the economies of scale.

Nongovernmental organizations (NGOs) 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.

Normative pillar How the values, beliefs, and norms of other relevant players influence the behavior of individuals and firms.

Norms The prevailing practice of relevant players that affect the focal individuals 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 inno- vation 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 organization from another.

Organizational fit The complementarity of partner firms’ “soft” organizational traits, such as goals, experiences, and behaviors, that facilitate cooperation.

Original brand manufacturers (OBMs) A firm that designs, manufactures, and markets branded products.

Original design manufacturers (ODMs) A firm that both designs and manufactures products.

350 Glossary

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Original equipment manufacturers (OEMs) 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) directors 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 enterprise (the other two are location and inter- nalization 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.

Principal–agent conflicts Conflict of interests between principals (such as shareholders) and agents (such as professional managers).

Principal–principal conflicts Conflict of interests between two classes of principals: controlling shareholders and minority shareholders.

Principals Person (such as owner) who delegates authority.

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 (nonpublic) companies.

Proactive strategy A strategy that focuses on proac- tive engagement in corporate social responsibility.

Product differentiation The uniqueness of products that customers value.

Product diversification Entries into new product markets.

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

Product-related diversification Entries into new product 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 connec- tions to the firm’s current lines of business.

R Reactive strategy A strategy that is passive about corporate 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 regu- lations 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 transactions 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 pri- vate firms.

Relational (or collaborative) capabilities The capabili- ties to successfully manage interfirm relationships.

Relational contracting Contracting based on infor- mal relationships (see also A way of economic exchange based on informal relationships among

Glossary 351

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transaction parties. Also known as relational con- tracting.).

Replication Repeated testing of theory under a variety of conditions to establish its applicable boundaries.

Research and development (R&D) contracts Outsour- cing agreements in R&D between firms (that is, Firm A agrees to perform certain R&D work for Firm B).

Reshoring Moving formerly offshored activities back to the home country of the focal firm.

Resource similarity The extent to which a given competitor possesses strategic endowments com- parable to those of the focal firm.

Resource-based view A leading perspective of strat- egy that suggests that differences in firm per- formance are most fundamentally driven by differences in firm resources and capabilities.

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

Restructuring (1) Adjusting firm size and scope through diversification (expansion or entry), divestiture (contraction or exit), or both. (2) Reducing firm size and scope.

Reverse innovation (or frugal innovation) Low-cost innovation from emerging economies that has potential in developed economies.

Risk management The identification and assess- ment of risks and the preparation to minimize the impact of high-risk, unfortunate events.

S Scale economies or 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 Advantage 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 or economies of scope Reduction in per unit costs and increases in competitiveness by enlarging the scope of the firm.

Secondary stakeholder groups Stakeholders 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.

Semiglobalization A perspective that suggests that barriers to market integration at borders are high but not high enough to completely insulate coun- tries 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 entrepreneurs Individual who starts, grows, and sells several businesses throughout their careers.

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 enterprises (SMEs) 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 organizing typical of many firms.

Social issue participation Firms’ participation in social causes not directly related to managing pri- mary stakeholders.

Solutions-based structure A customer-focused solu- tion in which a provider sells whatever combina- tion of goods and services the customers prefer, including rivals’ offerings.

Stage models Model that suggests that firms inter- nationalize by going through predictable stages from simple steps to complex operations.

Stakeholders Any group or individual who can affect or is affected by the achievement of the organization’s objectives.

State-owned enterprises (SOEs) A firm owned and controlled by the state (government).

352 Glossary

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Stewardship theory A theory that suggests that man- agers should be regarded as stewards of owners’ interests.

Strategic alliances A voluntary agreement of coop- eration between firms.

Strategic control (or behavior control) Controlling subsidiary/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 A group of firms within a broad industry.

Strategic hedging Spreading out activities in a num- ber of countries in different currency zones to off- set any currency losses in one region through gains in other regions.

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 networks 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’ pattern 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 per- spectives: industry-based, resource-based, and institution-based views.

Strong ties More durable, reliable, and trustworthy relationships cultivated over a long period of time.

Structure-conduct-performance (scp) model An industrial organization economics model that suggests industry structure determines firm con- duct (strategy), which in turn determines firm performance.

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

Subsidiary initiatives The proactive and deliberate pursuit of new business opportunities by an MNE’s subsidiary to expand its scope of responsibility.

Substitutes Product of different industries that sat- isfy 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 inter- nal strengths (S) and weaknesses (W) and the external 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 competitive levels.

Tacit knowledge Knowledge that is not codifiable (that is, hard to be written down and transmitted without losing much of its richness).

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 Cost associated with economic transaction—or more broadly, cost of doing business.

Transnational strategy An MNE strategy that endea- vors to be cost efficient, locally responsive, and learning driven simultaneously.

Triad Three primary regions of developed econo- mies: North America, Europe, and Japan.

Triple bottom line A performance yardstick consist- ing of economic, social, and environmental performance.

Glossary 353

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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.

U Uncertainty avoidance The extent to which mem- bers in different cultures accept ambiguous situa- tions and tolerate uncertainty.

Upstream vertical alliances 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 capitalists (VCs) Investors who invest capi- tal in early-stage, high-potential start-ups.

Vertical M&As An M&A deal involving suppliers (upstream) and/or buyers (downstream).

Voice-based mechanisms Corporate governance mechanism that focuses 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 pol- icy making, which is often spearheaded by the US government and two Washington-based interna- tional 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 (or global) mandate The charter to be responsible for one MNE function throughout the world.

354 Glossary

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Index Page numbers followed by f indicate figures; and those followed by t indicate tables.

2W1H foreign market entry model how, 150–156 when, 148–150 where, 146–148

3D printing, 47 5 forces framework, 35–37, 115 bargaining power of buyers, 39–40 bargaining power of suppliers, 39 foreign market entries and, 143 intensity of rivalry among competitors, 35–37 threat of potential entry, 37–39 threat of substitutes, 40–41

A AAR, 180, 188–190 ABC, 45 ABN Amro, 158 Absorptive capacity, 273 Accommodative strategies, 100, 101, 328

Acer, 78, 81 Acquisition premiums, 245 Acquisitions, 243. See also Diversification, acquisition and restructuring versus alliances, 249 establishing WOSs, 155 versus market transactions, 177

Active CSR engagement overseas, 331–332

Additive manufacturing, 47 Agency costs, 289 Agency relationships, 289 Agency theory, 289 Agents, 289 Agglomeration, 146 Agricultural Bank of China, 304t

Ahava, 214

Airbus, 5, 38, 39, 41, 47, 68, 115, 270

Airline industry, 42, 171, 200–201, 206

Alcatel-Lucent, 146 Alibaba, rise of, 113–114 Alliance dissolution, 181 Alliance formation, 177–179, 183

Alliances. See Strategic alliances and networks

Aluminum Company of America (ALCOA), 208t

Amazon, 27, 37, 45, 46, 50, 180 Ambidexterity, 69 American Airlines (AA), 175 Amtrak, 164 Anchored replicators, 235 Android alliance, 172 Anglo-American capitalism, 13 Anglo-American governance systems, 301

Anna Karenina (Tolstoy), 175 Anti-failure bias, 127–128 Anti-globalization protests, 19, 20

Antidumping, 209–210, 216–217 Antitrust enforcement, confusion stemming from, 217f

Antitrust issues, 200, 207 Apax Partners, 27, 307 Apple, 39, 45, 71, 81, 122, 143, 148, 186, 222–223, 293, 304t

Arab Spring, 25 Arm’s-length transaction, 91 The Art of War (Sun Tzu), 8 Asian Paints, 214 AT&T, 45, 146, 201, 208t Attacks, 210–212 Australia, 55 Austria, 99 Automobile industry electric cars, 337–339 mass market cars, 47 strategic groups, 47

Avon Products, 265f Azul, 125

B Backward integration, 40 BAE Systems, 176 Baidu, 25, 114, 134 Balanced scorecard, 16 Bank of America, 246 Bankruptcy, 127 Barbarians at the Gate, 307 Bargaining power of buyers, 39–40, 116 of suppliers, 39, 115

Barnes and Noble, 37, 46 Base of the pyramid (BOP), 5–6 Bayer CropScience, 277 Bayer Group, 277 Bayer MaterialScience, 277–278 Behavior controls, 238 Beijing Consensus, 303 Benchmarking, 63 BenQ, 74 Bentley, 44 Best practices, 300 Best Price, 55 Bharti, 55 Bic, 211 Big ticket items, 36, 38 Bing, 25 Blackwater, 117 Blue ocean strategy, 212 Blurred boundaries, 44–46 BMW, 38, 40, 43, 101, 104, 149, 150, 172

Boards of directors composition of, 291–292 directing strategically, 293–294 interlocks, 292 leadership structure, 292 role of, 292–293

Boeing, 5, 38, 39, 41, 64, 68, 115 Borders, 46 Born global firms, 123 BOT (build-operate-transfer) agreements, 154

Bounded rationality, 94 BP, 144, 180, 188–190, 304t, 321, 328, 329

355

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Brazil, 5, 95 Bribes, 99 BRIC (Brazil, Russia, India, China), 5, 16

Britain, 13, 40 British Airways (BA), 47, 175 Build-operate-transfer (BOT) agreement, 154

Burberry, 56, 62 Bureaucratic costs, 240 Burger King, 328 Burundi, 117 Business groups, 239 Business-level strategies, 231 for competitive dynamics attacks and counterattacks, 210–213 comprehensive model for, 199–203 cooperation and signaling, 213 debates and extensions for, 215–217 implications for action, 218–219 local firms versus multinational enterprises, 213–215 strategy as action concept, 198–199

for entrepreneurial firm growth and internationalization comprehensive model for, 115–118 debates and extensions for, 125–128 entrepreneurial firms and, 114–115 financing and governance, 120–121 growth, 118 harvest and exit, 121–122 implications for action, 128 innovation, 118–119 internationalization, 123–125 network, 119–120

for foreign market entries comprehensive model for, 142–146 debates and extensions for, 156–158 implications for action, 158

liability of foreignness, 140–141 propensity to internationalize, 141–142

savvy strategist, 158–159 for strategic alliances and networks comprehensive model for, 171–176 debates and extensions for, 183–186 defined, 170 evolution of, 179–182 formation of, 177–178 implications for action, 186–187 performance of, 182–183

Business process outsourcing (BPO), 73

BusinessWeek, 13 “Buy American” policy, 19 Buyers, bargaining power, 39–40, 115

BYD, 78

C Cambridge, 27 Canon, 143, 157 Capabilities. See also Resource capabilities and leverage defined, 62

Capacity to punish concept, 202 Captive sourcing, 66 Carlyle Group, 308 Carrefour, 54, 75, 142 Cartels, 200 Caterpillar, 143 Causal ambiguity, 68 Cemex, 78 Cengage Learning, 27, 28 Centers of excellence, 263 Central Intelligence Agency, 331

CEO duality, 292 CFM International, 175 Chapter 11 bankruptcy, 127, 163 Chevy Volt, 339 Chief executive officer (CEO), 12

China, 13, 19, 99, 141, 251 automobile industry, 79, 150, 176 BRIC, 5, 16 computer industry, 23–25

electronics industry, 47 global strategy in, 5 human rights in, 25 luxury goods industry, 57 mergers and acquisitions (M&As), 170, 176 multinational enterprises (MNEs) and, 251 piano companies, 160 smartphone, 215 state-owned enterprises (SOEs), 303

China Construction Bank, 304t China National Offshore Oil Corporation (CNOOC), 158

China National Petroleum Corporation (China), 304, 304t

“Chinatown buses,” 163–164 Christian Lacroix, 56 Chrysler, 68, 150, 246 Cisco, 45, 149, 150, 178t, 213 Citibank Islamic Bank, 150 Citigroup, 99, 149 Classic conglomerates, 235 Clayton Act (1914), 208 Clear boundaries, 44–46 CNN, 45 Co-marketing, 154, 155, 170 Coach, 56 Coach USA, 163 Coca-Cola Company, 5, 7, 39, 140, 144–145, 157, 172, 184, 186, 261, 323

Code of Corporate Conduct 2002, 300

Codes of conduct, 97, 300, 328–329 of corporate governance, 300

Cognitive pillars, 88, 176 Colgate, 148 Collaborative capabilities, 174 Collectivism, 96 Collusion, 199–201, 207 Collusive price setting, 207 Commoditization, 63 Competition management versus antidumping, 209–210 versus collusion, 199–201 debates and extensions for, 44 clear versus blurred boundaries of industry, 44–46 five forces versus a sixth force, 46

356 Index

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industry rivalry versus strategic groups, 47–49 industry-specific versus firm-specific and institution-specific determinants of performance, 50 integration versus outsourcing, 49–50 stuck in the middle versus all rounder, 46–47 threats versus opportunities, 46

five forces framework, 35–37 bargaining power of buyers, 39–40 bargaining power of suppliers, 39 intensity of rivalry among competitors, 35–37 lessons from, 41, 41t threat of potential entry, 37–39 threat of substitutes, 40–41

generic strategies, 41–44 cost leadership, 42 differentiation, 42–44 focus, 44 lessons from, 44

Competition policy, 207 Competitive dynamics management attacks and counterattacks, 210–213 comprehensive model for industry-based considerations, 199–203 institution-based considerations, 207–210 resource-based considerations, 203–207

cooperationandsignaling,213 debates and extensions for competition versus antidumping, 216–217 strategy versus IO economics and antitrust policy, 215–216

defined, 198 implications for action, 218–219 local firms versus multinational enterprises, 213–215 strategy as action, 198–199

Competitor analysis, 198, 204 Competitor rivalry, 35–37, 322–323

Complementary assets, 69 Complementors, 46 Concentrated ownership and control, 287

Concentration ratios, 201 Conduct codes, 34, 300 Confusion stemming from antitrust enforcement, 217f

Conglomerate M&A’s, 243 Conglomerates and conglomeration, 231, 243

Conscious capitalism, 326 Constellations, 171 Contender strategies, 215 Contractual agreements, 151, 155

Contractual alliances, 170 Cooperation and signaling, 213 Copenhagen Accord, 333 Corporate divorce, 181 Corporate governance (CG) boards of directors composition of, 291–292 directing strategically, 293–294 interlocks, 292 leadership structure, 292 role of, 292–293

comprehensive model for industry-based considerations, 297–298 institution-based considerations, 299–301 resource-based considerations, 298–299

debates and extensions for convergence versus divergence, 301–302 opportunistic agents versus managerial stewards, 301 overview, 301 state ownership versus private ownership, 302–304

defined, 287 governance combination of mechanisms, 295–296 external mechanisms, 294–295

global perspective on, 296–297 internal mechanisms, 294 overview, 294

implications for action, 304–305 managers principle-agent conflicts, 289–291 principle-principle conflicts, 289–291

ownership concentrated versus diffused ownership, 287–288 family ownership, 288 state ownership, 288

private equity, 295 privatization, 302–303

Corporate-level strategies, 231 for corporate governance boards of directors, 292–293 comprehensive model for, 297–301 debates and extensions for, 301–314 governance, 294–296 implications for action, 304–305 managers, 288–291 ownership, 287–288 private equity, 295 privatization, 302–303

for corporate social responsibility comprehensive model for, 322–330 debates and extensions for, 330–332 implications for action, 332–334 stakeholders and, 319–322

for diversification, acquisition, and restructuring, 249–250 combinatorial diversification, 235–236 comprehensive model for, 237–240 debates and extensions for, 248–249 evolution of, 240 geographic diversification, 233–234

Index 357

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Corporate-level strategies (Continued)

implications for action, 249–250 motives for, 244–245 performance of, 245–247 product diversification, 231–233 terminology, 240, 248

for multinational strategies and structures comprehensive model for, 267–271 cost reduction and local responsiveness, 260–261 debates and extensions for, 274–275 implications for action, 275–276 knowledge management, 271–274 organizational structures, 264–266 reciprocal relationship between strategy and structure, 266–267 research & development (R&D), 272–273 strategic choices, 261–263

Corporate marriage, 176, 181–182

Corporate social responsibility (CSR) comprehensive model for industry-based considerations, 322–324 institution-based considerations, 327–330 resource-based considerations, 324–327

debates and extensions for active versus inactive CSR engagement overseas, 331–332 domestic versus overseas social responsibility, 330–331 pollution haven debate, 332

economic performance puzzle, 326–327 implications for action, 332–334 stakeholders and big picture perspective, 319–320

debate, 320–322 primary stakeholder groups, 320 secondary stakeholder groups, 320

Corruption, 99 Cost leadership, 42 COSTCO, 40 Counterattacks, 210–213 Country managers, 264 Country-of-origin effect, 156 Croma, 55 Cross-borderM&As,243,247,252 Cross-cultural blunders, 98t Cross-listing, 301 Cross-market retaliation, 203 Cross-shareholding, 170 CSR. See Corporate social responsibility (CSR)

Cultural distance, 102, 103, 148 Cultural emphases. See Institutional, cultural, and ethical emphases

Culture, defined, 95 Currency hedging, 146 Currency risks, 145

D DaimlerChrysler, 331 Danone, 181 De Beers, 36 Debates and extensions, 44–51

for business-level strategies competitive dynamics management, 215–217 entrepreneurial firm growth and internationalization, 125–128 foreign market entries, 156–158 strategic alliances and networks, 183–186

for corporate-level strategies corporate governance, 301–304 corporate social responsibility, 330–332 diversification, acquisition, and restructuring, 248–249

for foundation-level strategies industry competition management, 44–51

institutional, ethical, and cultural emphases, 102–103 resource capabilities and leverage, 70–75

for multinational strategies and structures multinational strategies and structures, 274–275

Decision model, 63, 150–151 Deere & Company, 6 Defender strategies, 214 Defensive strategies, 100, 101, 328

Dell, 39, 45, 67, 74, 81 DHL, 64, 143 “Diamond model” by M. Porter, 92

Differentiation, 42–44 Diffused ownership, 287–288 Digital piracy, 218 Direct exports, 124, 152, 153 Discovery, 44 Disney, 43, 262 Dissemination risks, 144 Distance, cultural versus institutional, 103

Diversification, acquisition and restructuring, 248 combining product and geographic, 235–236 comprehensive model for industry-based considerations, 236–237 institution-based considerations, 239–240 resource-based considerations, 237–239

debates and extensions for acquisitions versus alliances, 249 product relatedness versus other forms, 248–249

evolution of, 240 geographic diversification firm performance and, 233–234 limited versus extensive international scope, 233

implications for action, 249–250 motives for, 244–245 performance of, 245–247

358 Index

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product diversification firm performance and, 232–233 product-related, 231 product-unrelated, 231–232

terminology, 243, 248 Diversification discount, 232 Diversification premium, 232 Dodd-Frank Act of 2010, 300 Dodger strategies, 214 Doing Business (World Bank Survey), 117

Domestic demands, 92 Domestic in-house activity, 66 Domestic markets, 141–142 Dominance, 36 Dominant logic, 248 Dow Chemical, 89 Downscoping, 248 Downsizing, 248 Downstream vertical alliances, 172

Dubai, 146 Dubai International Airport (DXB), 197, 198

Dubai Ports World (DP World), 158

Due diligence, 176, 246 Dumping, 209 Duopolies, 35 Dynamic capabilities, 72

E Ebola bandwagon, 318 Ebola challenge, 317–318 Economic benefits, 240 Economies of scale, 38, 231 Economies of scope, 231 The Economist, 13, 44, 55, 99 Efficiency-seeking firms, 147 Electric vehicle (EV), 337–339 Electrolux, 98 Eli Lilly, 181, 186 Embraer, 5, 78 Emergent strategy, 8 Emerging economies, 5–9, 23–25, 54–56 China, 57 India, 56–57

Emerging markets. See Emerging economies

EMI, 149 Emirates Airlines, 146, 197–198

eModeration, 117 Energy Future Holdings, 307 Energy Independence and Security Act (2007), 338

Enron, 88 Entering foreign markets. See Foreign market entries

Enterprise resource planning (ERP), 119

Entrepreneur-friendly bankruptcy laws, 127–128

Entrepreneurial firm growth and internationalization, 113–137 Alibaba, rise of, 113–114 comprehensive model for, 116f industry-based considerations, 115–116 institution-based considerations, 117–118 resource-based considerations, 116–117

debates and extensions for anti-failure biases versus entrepreneur-friendly bankruptcy laws, 127–128 entrepreneurial firms, 114–115 slow internationalizers versus born global start-ups, 126–127 traits versus institutions, 125–126

financing and governance, 120–121 growth, 118 harvest and exit, 121–122 innovation, 118–119 network, 119–120

implications for action, 128 internationalization strategies for entering foreign markets, 123–124 strategies for staying in domestic markets, 124–125 transaction costs, 123

savvy entrepreneur, 128–129

Entrepreneurs, 115 Entrepreneurship, defined, 115 Entry barriers, 38, 115 Environment management system (EMS), 330

Environmental disasters and violations shareholder value destroyed by, 326t

Environmental Protection Agency (EPA), 328

Environmentalist challenges, 325

Epson, 149 Equity-based alliances, 170, 178t Equity modes, 151–153 Ericsson, 146, 149 Ermenegildo Zegna, 43, 56 Escada, 57 Ethical emphases. See Institutional, cultural, and ethical emphases

Ethical imperialism, 98 Ethical relativism, 98 Ethics, defined, 97 Etihad Airways, 169–170 Europe Euro zone, 146

European Union (EU), 114 euro crisis, 20

Excess capacity, 38 Exit-based governance mechanisms, 294

Explicit collusion, 200 Explicit knowledge, 271 Exploitation, 180 Exploration, 180 Export intermediaries, 124 Exports, 152, 154 Expropriation, 144, 290 Extender strategies, 214 Extensions. See Debates and extensions

External governance mechanisms, 295

Extraterritoriality, 208 Exxon Mobil, 144, 304, 304t

F Facebook, 9, 91, 118, 127, 130 Factor endowments, 92 Fair Labor Association, 320 Family ownership, 289, 290 Fannie Mae (USA), 304t Far-flung conglomerate, 235 Fashion industry, 56–57 Fast-moving industries, 72 FCPA (Foreign Corrupt Practices Act), 99

Index 359

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FDA (Food and Drug Administration), 327

FDI (Foreign Direct Investment), 4

FedEx, 119, 143, 148 Feints, 210, 211f Femininity, 96 Ferrari, 35 Fiat Chrysler Automobiles, 249 Financial control, 238, 293 Financial resources and capabilities, 62

Financial synergy, 231 Firestone Tires, 101 Firm-specific determinants of performance, 50

Firm strategy, structure, and rivalry, 92

Firms, 13–17 behavior of, 14–16 scope of, 16 strategic choices, 92 success and failure of, 16–17 why differ, 13–14

First-mover advantages, 148 Five dimensions of culture, 95 Five forces framework, 35–41, 46, 115 bargaining power of buyers, 39–40 bargaining power of suppliers, 39 foreignmarketentriesand,143 intensity of rivalry among competitors, 35–37 threat of potential entry, 37–39 threat of substitutes, 40–41

Flexible manufacturing technology, 47

Flextronics, 74, 157 Focus, 44 Food and Drug Administration (FDA), 327

Forbearance, mutual, 199 Ford, 40, 64, 101, 174, 176 Foreign Corrupt Practices Act (FCPA), 99

Foreign direct investment (FDI), 4, 55, 66, 123, 153

Foreign market entries, 138–167 2W1H aspects how, 150–156 when, 148–150 where, 146–148

comprehensive model for industry-based considerations, 143 institution-based considerations, 144–146 overview, 142 resource-based considerations, 143–144

debates and extensions global versus regional geographic diversification, 156–157 liability versus asset of foreignness, 156 old-line versus emerging multinationals, 157–158

implications for action, 158 liability of foreignness, 140–141 propensity to internationalize, 141–142 strategic goals and, 146

Foreign portfolio investment (FPI), 300

Foreignness liability concept, 140–141

Forest Stewardship Council (FSC), 324–325

Formal, rule-based, impersonal exchanges, 91

Formal institutions, 88 competitive dynamics management, 207–210 corporate governance, 299–300 corporate social responsibility, 327 diversification, 239 foreign market entries, 148 multinational strategies and structures, 269 strategic alliances and networks, 175–176

Forward integration, 39 Foundation, 51 Foundation-level strategies. See also Five forces framework fundamental topics for firms, 13–17 global nature of, 4–7 global strategy, 17–18 globalization, 18 strategy issues, 7–13

for industry competition management debates and extensions, 44–51 defined, 34–35 generic strategies, 41–44 implications for action, 51

for institutional, cultural, and ethical emphases corruption and, 99–100 debates and extensions for, 102–103 defined, 88 five dimensions of, 95–97 implications for action, 103–104 managing overseas, 98–99 reduction of uncertainty, 90–92 rock formation, 87 role of, 88 strategic choices and, 97, 100 strategic response framework for, 100–101 view of business strategy, 92–94

for resource capabilities and leverage debates and extensions for, 70–75 implications for action, 75 understanding, 62–63 value chain and, 63–67 VRIO framework, 67–70

Four Tigers, 19 Fox, 45 Foxconn, 64, 74, 78 FPI (foreign portfolio investment), 300

France, 13, 40, 99 Franchising, 124, 154, 170 Freddie Mac (USA), 304t Friendly M&As, 243 Frito-Lay, 40 Frugal innovation. See Reverse innovation

Fuji, 143 Fujitsu, 146 Fukushima nuclear power station, 321

360 Index

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G GAAP (generally accepted accounting principles), 209

Gambits, 211, 212f Game theory, 200 Gazprom (Russia), 304t Geely, 78 General Electric (GE), 78–79, 149, 175, 179, 203, 233, 259–260, 273

General Motors (GM), 6, 46, 49, 64, 68, 127, 147, 150, 202, 213, 216

Generally accepted accounting principles (GAAP), 209

Generic strategies, 41–44 cost leadership, 42 differentiation, 42–44 focus, 44 lessons from, 44

Geographic area structures, 264 Geographic diversification, 231, 233–234

Germany, 9, 11, 13, 38, 99 bankruptcy in, 37, 127

Gillette, 211 Glencore (Switzerland), 304, 304t

Global account structures, 275 Global competition in how to best govern large firms, 285

Global mandate, 263 Global matrix, 264–265 Global product division, 264 Global standardization strategy, 262–263, 271

Global strategies, 7, 17–18, 27 business-level strategies for competitive dynamics, 198–199 for entrepreneurial firm growth and internationalization, 113–129 for strategic alliances and networks, 170–187

corporate-level strategies for corporate governance, 285–304 for corporate social responsibility, 318–334 for diversification, acquisition, and restructuring, 235–249

for multinational strategies and structures, 260–276

for foreign market entries, 142–159 foundation-level strategies fundamental topics for, 4–22 for industry competition management, 32–59 for institutional, cultural, and ethical emphases, 87–104 for resource capabilities and leverage, 62–82

Global sustainability, 319 Global virtual teams, 273 Globalization, 18 debate about, 18 overview, 18 pendulum view on, 18–20 semiglobalization, 20 views of, 21t

Goldwind, 78 Google, 25, 45, 114, 117, 127, 134, 148, 157, 172, 173, 223, 293

Government sponsored enterprises (GSEs), 303

Grameen Bank, 131–132 Grameen Project, 131 Great Depression, 302 Great Recession, 19, 44, 56, 81, 89, 127, 158, 334

Greenfield operations, 152, 155, 161

Greenpeace, 320, 323, 328 Greyhound, 149, 150, 163 Growth strategies, 118 GSK, 172, 273 Gucci Group, 56

H Häagen-Dazs, 156, 272 Haier, 212 Hart-Scott-Rodino (HSR) Act of 1976, 208

Harvest strategies, 121–122 Hawaii, 41 Hedging, 146 Hewlett-Packard (HP), 39, 45, 74, 175, 269

High School Musical, 238 High-volume low-margin approach, 42

Hitachi, 328 HIV/AIDS drugs, 172, 323 Hofstede dimensions of cultures, 95

Home replication strategies, 261–262, 271

Honda, 48, 78, 149–150, 237, 275 Hong Kong, 19 Horizontal alliances, 172 Horizontal M&As, 243 Hostile M&A’s, 243 Hostile takeovers, 243 HSBC, 5, 158 HSR (Hart-Scott-Rodino) Act of 1976, 208

HTC, 78, 222–223 Huawei, 46, 74, 146, 213, 269 Hubris, 244–245 Human resource management (HRM), 63

The Hunt for Red October, 179 Hypercompetition, 73 Hyundai, 48, 150

I IBM, 45, 64, 67–68, 76, 78, 81–82, 119, 157, 208t

ICUC Moderation, 117 IKEA, 75, 122, 126 Imitability competitive dynamics management, 204 corporate social responsibility, 326 diversification, 237–238 foreign market entries and, 144 multinational strategies and structures, 269 resource capabilities and leverage, 68–69 strategic alliances and networks, 175

Imperialism, ethical, 98 Implications for action, 51 for business-level strategies strategic alliances and networks, 186–187

competitive dynamics management, 198–199 for corporate-level strategies corporate governance, 304–305

Index 361

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Implications for action (Continued)

diversification, acquisition, and restructuring, 249–250 multinational strategies and structures, 275–276

entrepreneurial firm growth and internationalization, 128 foreign market entries and, 158 for foundation-level strategies industry competition management, 51 resource capabilities and leverage, 75

for institutional, cultural, and ethical emphases, 103–104

In-group members, 102 In-house production, 64 Inactive CSR engagement overseas, 331–332

Incumbents, 37, 50 Independent directors, 291 India, 5, 79, 251 airline industry in, 33–34, 53–54 automobile market in, 5 BRIC, 5, 16 business acquisitions in, 251–253 multinational enterprises (MNEs) and, 251 offshoring to, 73 retail industry in, 54–56

Indian airline industry, 33–34, 53–54

Indirect exports, 124, 153 Individualism, 96 Industrial & Commercial Bank of China, 304t

Industrial organization (IO) economics, 34, 215–216

Industry, 34 defined, 34

Industry-based considerations for business-level strategies competitive dynamics management, 199–203 entrepreneurial firm growth and internationalization, 115–116 foreign market entries, 143

strategic alliances and networks, 172

for corporate-level strategies corporate governance, 297–298 corporate social responsibility, 322–324 diversification, acquisition and restructuring, 236–237 multinational strategies and structures, 267–268

Industry-based view, 49 debates and extensions for five forces versus a sixth force, 46 industry-specific versus firm-specific and institution-specific determinants of performance, 50 integration versus outsourcing, 49–50 stuck in the middle versus all rounder, 46–47 threats versus opportunities, 46

Industry competition management, 32–59 debates and extensions for, 44 clear versus blurred boundaries of industry, 44–46 five forces versus a sixth force, 46 industry rivalry versus strategic groups, 47–49 industry-specific versus firm-specific and institution-specific determinants of performance, 50 integration versus outsourcing, 49–50 stuck in the middle versus all rounder, 46–47 threats versus opportunities, 46

emerging markets Indian airline industry, 33–34, 53–54

five forces framework, 35–37 bargaining power of buyers, 39–40

bargaining power of suppliers, 39 intensity of rivalry among competitors, 35–37 lessons from, 41, 41t threat of potential entry, 37–39 threat of substitutes, 40–41

generic strategies, 41–44 cost leadership, 42 differentiation, 42–44 focus, 44 lessons from, 44

Industry positioning, 41 Industry rivalry, 47 Industry-specific determinants of performance, 50

Industry-specific restrictions, 55 Informal, relationship-based, personalized exchange, 90, 90f

Informal institutions, 88 corporate governance, 300–301 corporate social responsibility, 327 diversification, acquisition and restructuring, 239–240 entrepreneurial firm growth and internationalization, 117 multinational strategies and structures, 269 strategic alliances and networks, 176

Information asymmetries, 289 Information overload, 17, 238 Infosys, 64, 73, 304 ING Group, 158 Initialpublicofferings(IPOs),132 Innovation, 78 Innovation entrepreneurship strategies, 118–119

Innovation resources and capabilities, 63

Innovation-seeking firms, 147 Inside directors, 291, 293t Institution-based considerations for business-level strategies competitive dynamics management, 207–210 entrepreneurial firm growth and internationalization, 117–118

362 Index

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foreign market entries, 144–146 strategic alliances and networks, 176

for corporate-level strategies corporate governance, 299–301 corporate social responsibility, 327–330 diversification, acquisition and restructuring, 239–240 multinational strategies and structures, 269–271

Institution-based views, 88, 94t Institution-specific determinants of performance, 50

Institutional, cultural, and ethical emphases corruption and, 99–100 debates and extensions for cultural distance versus institutional distance, 103 opportunism versus individualism/collectivism, 102–103 origin of unethical business behavior, 102–103

defined, 88 five dimensions of, 95–97 implications for action, 103–104 institution-based views core propositions of, 94–95 overview, 92–94

managing overseas, 98–99 reduction of uncertainty, 90–92 role of, 88 strategic choices and, 97 strategic response framework for, 100–101

Institutional distance, 103, 148 Institutional framework, 88 Institutional relatedness, 248 Institutional transitions, 92 Institutions, 88 dimensions of, 88t reduction of uncertainty, 90–92 strategic choices, 92 versus traits, 125–126

Intangible resources and capabilities, 63

Integration, 49–50

Integration-responsiveness framework, 260, 262

Intel, 157 Intellectual property rights (IPR), 24, 144

Intelligentsia, 44 Intended strategies, 8 Intercity bus travel, 163–164 Interfirm rivalry, 115 Interlocking directorates, 292 Internal capital markets, 232 Internal governance mechanisms, 295

Internalization, 152, 153 Internalization advantage, 153 International diversification, 233

International division structure, 264

International entrepreneurship, 115

International new ventures, 123 International Standards Organization (ISO), 330

Internationalization. See Entrepreneurial firm growth and internationalization

IO (industrial organization) economics, 34, 215–216

IPOs (initial public offerings), 132

IPR (intellectual property rights), 24, 144

Iraq, 38 Islamic finance, 150 ISO (International Standards Organization), 330

IT industry, 66, 81 Italy, 13 ITT, 331

J Japan, 13, 38, 49, 56, 95 airline industry, 171 automobile industry, 172 bankruptcy in, 37, 127 bookselling industry in, 50 collectivism, 96 earthquake in, 20, 321, 323 internet commerce in, 130 layoffs and, 96 luxury goods industry, 57

Jasmine Revolution, 25

JetBlue, 125 Johnson & Johnson, 40 Joint ventures (JVs), 151, 155, 170, 214

JP Morgan Chase, 149, 150

K K-Mart, 206 Keiretsu, 13, 49, 149, 172 Knowledge management, 271 Kodak, 74, 143 Komatsu, 143 Korea, 14, 38 Korea Exchange Bank, 308 Kraft, 328 Kraft Foods, 44 Kroger, 40 Kung Fu Panda, 78 Kyoto Protocol (2007), 333

L Lamborghini, 35 Late-mover advantages, 149 Latin America, 19 Learning. See Multinational strategies and structures

Learning by doing, 177 Learning race view, 174 Legacy airlines, 197–198 Lenovo, 39, 67, 78, 81, 230 Leveraged buyouts (LBOs), 295 Levi Strauss jeans, 261 Lexmark, 82 Liability of foreignness, 140–141 Liability of newness, 119 Licensing, 124, 154, 170 Linkage, leverage, and learning (LLL) framework, 157, 158

LINUX, 23, 24 Local content requirements, 145

Local firms, 213–215 Local responsiveness, 261 Localization strategies, 262, 271 Location-specific advantages and goals, 146–148

Logitech, 126 London Stock Exchange, 130 Lone Star Funds, 307, 308 Long-term orientation, 97 L’Oreal, 148

Index 363

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Low-cost rivals, 205–207, 222–223

Low-volume high-margin approach, 43

Luxury automobiles, 47 Luxury goods industry, 56–57 LVMH, 56, 157

M Macy’s, 56 Mahindra, 78 Mahindra & Mahindra, 6 Managerial human capital, 298

Managerial stewards, 301 Manpower, 64 Marginal bureaucratic costs (MBCs), 240

Marginal economic benefits (MEBs), 240

Market commonalities, 203 Market-seeking firms, 147 Marks & Spencer, 40, 330 M&As. See Mergers and acquisitions (M&As)

Masculinity, 96 Mass customization, 47 Matsushita, 149 Maxwell House, 44 Mazda, 48 MBCs (marginal bureaucratic costs), 240

McDonald’s, 44, 124, 152, 155, 204, 261

McGraw-Hill, 27 MEBs (marginal economic benefits), 240

Megabus, 117, 149, 150, 163–164 Mercedes-Benz, 172 Merchant of Venice

(Shakespeare), 127 Merger, 243 Mergers and acquisitions (M&As), 170, 243, 295, 307 in China, 251–253 defined, 243 performance of, 245–247

Metro, 54, 142 Mexico, 17 Micro-macro link, 274 Microfinance, 121, 131–132 Microfinance institutions (MFIs), 132

Microsoft, 23–25, 38, 39, 45, 81, 149, 173, 208t, 222

Middle-of-the-road approaches, 99

Military strategy, 8 Minor Group, 125 Minority shareholders, 290, 299

MNEs. See Multinational enterprises (MNEs)

Mobility barriers, 48 The Modern Corporation and

Private Property, 285 Modes of entry, 153–156 Monopolies, 35 Moral hazard, 303 Morris Air, 125 Motorola, 179 MTV, 5, 261 Multi-brand stores, 55 Multidomestic strategies, 262, 272

Multimarket competition, 199 Multinational enterprises (MNEs), 19, 78, 79t, 153, 234, 251–253, 331, 332 defined, 4 emerging, 78–79 geographic diversification by sales, 157 versus local firms, 213–215

Multinational replicators, 235 Multinational strategies and structures comprehensive model for industry-based considerations, 267–268 institution-based considerations, 269–271 resource-based considerations, 268–269

cost reduction and local responsiveness, 260–261 debates and extensions for corporate controls versus subsidiary initiatives, 274–275 integration, responsiveness, and learning, 275 overview, 274

implications for action, 275–276 knowledge management, 271, 273–274

organizational structures, 264–266 reciprocal relationship between strategy and structure, 266–267 research & development (R&D), 272–273 strategic choices, 261–263

Music industry, 40 Mutual forbearance, 199

N NAFTA markets, 233 NASDAQ, 130, 304 National Medal of Science, 81 National Medals of Technology, 81

Natural resource-seeking firms, 147

Naver, 157 NBC, 45 NEC, 143, 149 Nestlé, 141, 172, 328 Netherlands, 40, 99 Netscape, 149 Network centrality, 174 Network externalities, 38 Networks. See Strategic alliances and networks

New York Stock Exchange, 298 New Zealand, 41 Newness liability concept, 120 NGOs (nongovernmental organizations), 21, 324, 326, 330, 331

Nike, 55, 64, 101, 323, 329 Nissan, 48, 149, 150, 337–339 Nissan Leaf, 337–339 Nokia, 55, 74, 81, 157 Non-equity based alliances, 170, 178t

Non-equity modes, 151 Non-scale-based advantages, 38 Non-shareholder stakeholders, 319

Nongovernmental organizations (NGOs), 21, 324, 326, 330, 331

Nontariff barriers, 145 Normative pillars, 88, 176 Norms, 88 Northrop, 237, 238 Nutrasweet, 41

364 Index

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O Obsolescing bargain, 144 Occupy London, 301 Occupy Wall Street, 20, 301, 308, 321, 334

OECD (Organization for Economic Cooperation and Development), 99, 300

OEMs (original equipment manufacturers), 74

Offshoring, 66, 73 OLI (ownership- location-internalization) advantages, 153

Oligopolies, 35 OMERS Capital Partners, 27 One World, 175 Online media, 40 Online moderators, 117 Onshoring, 66 Open innovation, 273 Operational synergy, 231 Opportunism, 89, 174, 179 Organization competitive dynamics management, 204 corporate social responsibility, 326 diversification, 238–239 multinational strategies and structures, 269 resource capabilities and leverage, 69–70 strategic alliances and networks, 175

Organization for Economic Cooperation and Development (OECD), 300

Organizational culture, 269 Organizational fit, 246 Origin of strategy, 7–8 Original brand manufacturers (OBMs), 74

Original design manufacturers (ODMs), 74

Original equipment manufacturers (OEMs), 74

Out-group, 102 Output control, 238 Outside directors, 291, 293t Outsourcing, 64–66, 154 defined, 64 versus integration, 49–50

Ownership, 48

Ownership advantage, 153 Ownership-location- internalization (OLI) advantages, 153

Oxford University Press, 27 Oyak (Turkish Armed Forces Pension Fund), 173

Ozon.ru, 130

P Pakistan, 97 Paris Disneyland, 156 Partner opportunism, 174 Partner rarity, 174 Patenting, 222–223 Pearl River, 152, 154, 155, 156, 157, 160–161

Pearl River Piano Group (PRPG), 160–161

Pearson, 27 Pendulum view on globalization, 18–20

Pepsi, 5, 40 PepsiCo, 140, 237 Perfect competition, 34 Performance, 17, 34, 182–183 Petrobras, 145 Peugeot, 150 Pfizer, 172 Philip Morris, 210 Philips, 157 Physical resources and capabilities, 62

Piano companies, 160 Pinch point, 197 Piracy, digital, 218 The Pizza Company, 125 Pizza Hut, 125 Plan 17, 9 Poland, 149 Political deadlocks, 89 Pollution, 323, 328, 332 Porter diamond model, 92 Power distance, 95 Predatory pricing, 207 Price leaders, 202 PricewaterhouseCoopers (PwC), 67, 82

Primary stakeholder groups, 320 Principals, 289 Principle-agent conflicts, 289 Principle-principle conflicts, 289–291

Prisoner’s dilemma, 199–201 Private equity, 295, 302, 306–308

Proactive strategies, 100, 329 Procter & Gamble (P&G), 12, 40, 42, 184, 186

Product differentiation, 38 Product diversification, 231 combining with geographic diversification, 235–236 defined, 231 firm performance and, 232–233 product-related, 231 product-unrelated, 231–232

Product proliferation, 38 Product-related diversification, 231

Product-related versus unrelated diversification, 231–232

Profitable firms in world, top ten, 304t

Proprietary technology, 38 PRPG America, 152 Pyramid, base of the (BOP), 5–6

R Race to the bottom debate, 332 Races, learning, 174 Ranbaxy, 181 Rarity competitive dynamics management, 203–204 corporate social responsibility, 324–326 diversification, 237 multinational strategies and structures, 269 resource capabilities and leverage, 68 strategic alliances and networks, 173–175

Raytheon, 146 RCA, 73 Reactive strategies, 100, 327 Real options, 173 Reduction of uncertainty, 89 Refocusing, 248 Regional geographic diversification, 156–157

Regional managers, 264

Index 365

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Regulatory pillars, 88, 175–176 Regulatory risks, 144 Related and supporting industries, 92

Related transactions, 291 Relational capabilities, 174 Relational contracting, 90 Relationships. See Strategic alliances and networks

Relativism, ethical, 98 Reliance Group, 54 Replication, 11 Reputation resources and capabilities, 63

Research and development (R&D) contracts, 43, 154–155, 170

Reshoring, 75 Resource-based considerations for business-level strategies competitive dynamics management, 203–207 entrepreneurial firm growth and internationalization, 116–117 foreign market entries, 143–144 strategic alliances and networks, 173–175

for corporate-level strategies corporate governance, 298–299 corporate social responsibility, 324–327 diversification, acquisition and restructuring, 237–239 multinational strategies and structures, 268–269

Resource-based view, 62 Resource capabilities and leverage debates and extensions for domestic resources versus international (cross- border) capabilities, 75 firm-specific versus industry-specific determinants of performance, 71–72 offshoring versus non- offshoring, 73–75 static resources versus dynamic capabilities, 72–73

implications for action, 75 understanding, 62–63 value chain and, 63–67 VRIO framework imitability, 68–69 organization, 69–70 rarity, 68 value, 67–68

Resource similarity, 204–205 Resources, 62 Restructuring. See Diversification, acquisition and restructuring

Reverse innovation, 6–7 Richemont, 56 Risk management, 19 Ritmuller, 152, 155, 156, 157, 161 R.J. Reynolds, 210 RJR Nabisco, 307 Rolls Royce, 35 Rosneft, 180, 190 Royal Dutch Shell (Netherlands), 304, 304t

Russia, 14, 176, 300 BRIC, 5, 16 internet commerce in, 130–131 oil industry, 176 state-owned enterprises (SOEs), 303

Ryanair, 42, 50, 71

S SABMiller, 139–140 SABRE, 81 Safeway, 40 Samsung, 143, 222–223, 237, 285, 304t

SAP, 119 Sarbanes-Oxley (SOX) Act of 2002, 293, 298, 300, 307

Savvy entrepreneur, 128–129 Scale-based advantages, 38 Scale economies, 231 Scale of foreign market entries, 150

Scenario planning, 19 Schlieffen Plan, 9 Scope economies, 231 Seattle Coffee, 125 Secondary stakeholder groups, 320

Semiglobalization, 20

Separation of ownership and control, 287

September 2001 terrorist attacks, 19, 102

Serial entrepreneurs, 125 Sex role differentiation, 96 Shanghai Disneyland, 156 Shanghai Volkswagen, 152, 155 Shareholder capitalism, 296, 300, 320

Shareholder value destroyed by environmental disasters and violations, 326t

Shareholders, 290 Shell, 323, 331 Sherman Act of 1890, 200, 208, 215

Siemens, 78, 146 Sierra Leone, 117 Singapore, 19 Singapore Airlines, 46–47, 50 Single business strategies, 231 SINOPEC (China), 304, 304t Sky Team, 171 Skype, 246 SkyTV, 45 Slow-moving industries, 72 Small and medium-sized enterprises (SMEs), 114, 119, 124

Smartphones, 40, 222–223 SMEs (small and medium-sized enterprises), 119, 124

Snecma, 179 Social capital, 274 Social complexity, 70 Social issue participation, 324 SOEs (state-owned enterprises), 145, 252, 288, 302–304

Solutions-based structures, 275 Sony, 45, 81, 149, 157, 248, 261 South African Breweries (SAB), 139

South Korea, 11, 19 South-Western Cengage Learning, 27

Southwest Airlines, 42, 50 Soviet Union (former), 19. See also Russia

SOX (Sarbanes-Oxley) Act of 2002, 293, 298, 300, 307

Spain, 40 Stage models, 126 Stagecoach Group, 163

366 Index

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Stakeholders, 16 Standard & Poor, 89 Standard Oil, 208t Star Alliance, 155, 171 Starbucks, 44, 55, 125, 204, 264, 271, 329

State Grid (China), 304, 304t State-owned enterprises (SOEs), 145, 252, 286, 288, 302–304

Steinway, 160, 207 Stewardship theory, 301 STMicroelectronics, 146 Strategic alliances and networks, 170 comprehensive model for industry-based considerations, 172 institution-based considerations, 175–176 resource-based considerations, 173–175

debates and extensions for acquiring versus not acquiring alliance partners, 185–186 alliances versus acquisitions, 184–185 majority versus minority JVs, 184

defined, 170–171 evolution of combating opportunism, 179 from corporate marriage to divorce, 181–182 overview, 176 from strong ties to weak ties, 179–180

formation of contract or equity, 177–178 market transactions versus acquisitions, 177 positioning relationships, 178–179

implications for action, 186–187 performance of overview, 182–183 parent firms, 183

Strategic choices, 92, 97 Strategic control, 238 Strategic fit, 246 Strategic groups, 47, 48 Strategic hedging, 146

Strategicimplicationsforaction. See Implications for action

Strategic investment, 170 Strategic management, 8 Strategic networks, 171 Strategic response framework, 100–101

Strategies, 7–8. See also names of specific strategies

fundamental questions in, 13 versus IO economics and antitrust policy, 215–216 localization, 262, 272 overview, 10f tripod of, 14, 15, 15f

Strategy as action school, 8, 9, 199f

Strategy as integration school, 8, 9

Strategy as plan school, 8 Strategy as theory, 9 Strategy formulation, 9 Strategy implementation, 9 Strong ties, 119–120 Structure-conduct-performance (SCP) model, 34

Stumptown, 44 Subsidiaries partially owned, 152 wholly owned, 152

Subsidiary initiatives, 274, 277–278

Substitutes, 40, 116 threat of, 40–41, 56

Subway, 124 Sunk costs, 144 Suntory, 172 Super connector airline, 197 Suppliers, bargaining power of, 39

Survival rates, start-up businesses, 120

Sustainable capitalism, 319 Suzlon, 78 Switzerland, 141 SWOT analysis, 9, 32, 34 Synergy financial, 231 operational, 231

T Tacit collusion, 199 Tacit knowledge, 271 Taiwan, 19

Taj Mahal Palace Hotel, 98 Tangible resources and capabilities, 62

Tariff barriers, 145 Tata Group, 55, 229, 286 Tata Motors, 6, 78 Technological resources and capabilities, 63

Terrorism, 19, 102 Tesco, 40, 54 Texas Instruments (TI), 143, 146

Texas Pacific Group (TPG Capital), 307

Textbook publishing industry, 27

Third-party enforcement, 91 Thomson Corporation, 307 Thomson Learning, 307 Threats (T) of potential entry, 37 of substitutes, 40–41

Thrusts, 210, 211f Tiffany, 56 TNK-BP, 180, 188–190 Tokyo Disneyland, 156 Top management teams (TMTs), 12, 289–291

Toshiba, 143 Toyota, 40, 42, 46, 48, 49–50, 146, 149, 213, 216, 304t, 337–339

Trade barriers, 145 Traits, 125–126 Transaction costs, 89 Transnational strategy, 262, 263, 272

Triad, 5 Triple bottom line, 16 Trump Holdings, 89 Trust, 200 Tunneling, 290 Turnkey projects, 154, 170

U Ultra-luxury car market, 47 UN Declaration on Human Rights, 332

Uncertainty, 89, 90–92, 96, 97 Unilever, 148, 328 United Airlines, 47 United Arab Emirates, 146 United Kingdom, 7 United Nations, 331

Index 367

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United States, 13, 40, 95 antitrust laws in, 207, 208, 216 chemical industry, 328 Department of Commerce, 209 Department of Justice, 201 intercity bus travel in, 163–164 International Trade Administration, 209 International Trade Commission, 209 State Department, 189

Universal Product Code (UPC), 81

Upstream vertical alliances, 172

V Value, 117 competitive dynamics management, 203 corporate social responsibility, 324, 329, 333 creating shared, 321 diversification, 237 foreign market entries, 143 multinational strategies and structures, 268 resource capabilities and leverage, 67–68 strategic alliances and networks, 173–174

Value chains, 63–67 Venture capitalists (VCs), 120 Verizon, 146 Vertical M&As, 243 Victoria’s Secret, 43 ViiV Healthcare, 172 Vkontakte, 118 VMware, 45 Vodafone Group (UK), 304t Voice-based mechanisms, 294 Volkswagen (Germany), 304, 304t

VRIO framework, 67, 67t, 70, 75, 117, 298 competitive dynamics management, 203 corporate social responsibility, 324–326 diversification, acquisition and restructuring, 237–239 foreign market entries, 143 multinational strategies and structures, 268 resource capabilities and leverage, 67–70 strategic alliances and networks, 173–175

W Wahaha, 181 Wal-mart, 5, 11, 12, 17, 42, 54, 55 “Wal-Mart effect,” 55

Wal-Mart (USA), 304, 304t Wall Street Journal, 13 Walmart, 39, 47, 75, 142, 145, 261

Washington Consensus, 303 Watson artificial intelligence, 81

Weak ties, 119–120 Wealth of Nations (Smith), 199

WestJet, 125 Wholly owned subsidiary (WOS), 155

Wipro, 73 Woolworths, 55 World Bank, 19, 117, 303 World War II, 18 Worldwide mandate, 263

X Xerox, 148 Xiaomi smartphone, 7

Y Yamaha, 160, 161 Y2K problem, 78 YKK, 122 Yokogawa Hewlett-Packard (HP), 271

YouTube, 45

368 Index

Copyright 2017 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.

Copyright 2017 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.

Copyright 2017 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.

Copyright 2017 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.

Copyright 2017 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.

Copyright 2017 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.

Copyright 2017 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.