GLOBAL DIMENSIONS OF BUSINESS
Why Study Global Strategy?
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Knowing the concepts and components of global strategy will improve job
and career aspiration opportunities, build awareness of what is occurring in
the world, and avoid the downside risks of globalization.
The most sought-after and highest paid business school graduates (both
MBAs and undergraduates) are typically management consultants with
expertise in global strategy. Outside of the consulting industry, joining the
top ranks of many large firms will require knowledge in global strategy.
Most business school graduates will eventually be interacting with foreign-
owned suppliers, buyers, and customers; competing with foreign-invested
firms in home markets; and perhaps even selling and investing overseas.
Approximately 80 million people worldwide are directly employed by foreign-
owned firms.
Likewise, many graduates will end up working for a foreign-owned
corporation, and some may experience economic downsizing due to global
consolidation. Understanding global business may help graduates to
minimize or avoid such downside aspects due to globalization.
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What Is an Insightful and Accurate Definition
of a Global Strategy?
One popular definition of a “global strategy” is a firm’s intention to provide
standardized products and/or services on a world-wide basis. Another
definition suggests that global strategy is any strategy outside one’s home
country. However, the best definition is that “global strategy” is each firm’s
theory about how to compete successfully in whatever global markets the
firm chooses to compete.
The narrow, “one-size fits all” version of global strategy advocated during
the past twenty years is incomplete and unbalanced. Too often, the search
for worldwide cost reduction, re-design consolidation, and restructuring
sacrificed local responsiveness and global learning.
This traditional, narrow notion of global strategy ignores how domestic firms
compete with each other and with foreign entrants. It is dangerous (for a
global strategy) to ignore less-developed economies.
What Is Strategy?
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The Greek word (strategos) is the origin of the word strategy that we use
today and means “art of the general.” The term was purported to be used by
Sun Tzu, a Chinese military strategist in 500 B.C. His 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, is a more recent
phenomenon developed since the 1960s. What defines strategy has been the
subject of intense debate.
The first school of thought is the “strategy as plan.” This school is the oldest
and is based on the work of Carl von Clausewitz, a Prussian (German)
military strategist. This school suggests that strategy is embodied in the
same explicit rigorous formal planning as in the military. The planning school
has been challenged by Liddell Hart, a British military strategist. Hart argues
that the key to strategy is a set of flexible goal-oriented actions. He favored
an indirect approach, which seeks rapid flexible actions to avoid clashing
with opponents head-on. This “strategy as action” perspective suggests that
strategy is most fundamentally reflected by firms’ patterns of action.
Henry Mintzberg, a Canadian scholar, 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 that is the
outcome of a stream of smaller decisions from the “bottom up.”
Strategy As Theory
Although the debate between the planning school and action school is
difficult to resolve, many scholars and managers have realized that the
essence of strategy is likely to be a combination of both planned deliberate
actions and unplanned emergent activities, thus leading to a “strategy as
integration” school. This school defines strategy as “a firm’s theory about
how to compete successfully.” In other words, if we have to define strategy
with one word, our choice is neither plan nor action – it is theory. A theory
serves two purposes: explanation and prediction.
Strategy as a theory describes how to compete successfully in a global
market. Firms have both intended and emergent strategies, meaning some
strategies are defined from the outset while others develop with the firm’s
participation in the marketplace. One firm’s strategies may not work in all
situations, so firms are constantly evaluating, evolving and revising
strategies. Firms may not rely on past success because the changing
markets do not guarantee future success with the same strategy. It is often
difficult to change strategy, so firms must guard against total adherence to a
strategy because to do so would hamper adaptation in new situations.
Strategy should continue to give coherence to decisions and actions.
Managers must exert effective strategic leadership both in a global and a
local perspective.
Theory building and development requires replication and experimentation
to establish the temporal (time-related) and geographic limits of an existing
theory. The strategy as theory perspective helps us understand why it is
often difficult to change strategy.
The Essence of Strategy
This diagram demonstrates the correlation between performance and time,
as well as the connection between intended strategies and emergent
strategies. 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.
Fundamental Questions in Strategy
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Firms Differ?
Why do firms differ? The largest influences are a reflection of the cultural
differences between Western and Japanese companies. In Western firms, the
competition among companies drives the process. In other companies, like
the Japanese, networks of relationships have powerful effects.
Most of our knowledge of firms is based on Anglo-American capitalism.
Instead of using costly acquisitions typically found in the West, Japanese
firms extensively employ a network form of supplier management, giving
rise to the termkeiretsu(inter-firm network). The Chinese
favorguanxi(interpersonal networks), cultivated by managers, that may
serve as informal substitutes for formal institutional support. In other words,
interpersonal relationships among managers are translated into an inter-firm
strategy of relying on networks and alliances to grow the firm, which, in the
aggregate, contributes to the growth of the economy.
Similarly, the Korean wordchaebol(large business group) and the Russian
wordblat(relationships) have entered the English vocabulary. Today’s
readers of Bloomberg Businessweek or The Wall Street Journal would know
these terms. Behind each of these deceptively simple words lies some
fundamental differences on how to compete around the world.
How Do Firms Behave?
How do firms behave? Companies that embrace the industry-based view
focus on competitive forces within an industry that impact all firms.
According to this perspective, a firm’s success in the Indian IT industry
depends on the unique attributes of the IT industry, its knowledge-intensive
nature, and non-location based boundaries.
Those firms that adhere to the resource-based (capabilities) view focus on
internal strengths and weaknesses, that is, firm-specific resources and
capabilities. For example, successful Indian IT firms tend to have capabilities
that are valuable, unique, and hard for rivals to imitate or replicate.
On the other hand, those companies who choose the institution-based view
focus on government and societal forces. For example, the pro-market
reforms in India have opened the door for many Indian IT companies to win
foreign contracts, while at the same time, legislation by various states in the
U.S. has banned Indian IT firms from winning contracts.
Obviously, these unique views will have a profound effect on how a firm acts
in its global strategy. All three perspectives provide insight into the forces
that determine a firm’s performance.
The “Strategy Tripod”: Three Leading
Perspectives on Strategy
If a firm wants to become a true “global leader,” it is necessary to create a
strong competitive position in each of theTriad markets(North America,
Europe, and Japan), as well as a strong presence in emerging markets like
Brazil, Russia, India, and China (referred to asBRIC). This diagram clearly
shows how the three views will lead to a strategy that ultimately must
address the firm’s performance.
What Determines the Scope of the Firm?
What determines the scope of the firm? A firm’s scope pertains to its growth
as well as its contraction, that is, the way it curtails and alters its business
practices through downsizing, downscoping, and withdrawals. Obviously,
though, the primary focus is on the growth of the firm. In developed
countries, the widespread use of unrelated product diversification
(conglomerate diversification) in the 1960s and 1970s was found to destroy
value and was largely discredited in the 1980s and 1990s – witness how
many firms are still trying to divest and downsize (or “right-size”) in the
West.
However, this strategy seems to be alive and well in many emerging
economies because of its relatively positive link with performance that may
be a function of the level of institutional (under)development in these
countries.
In addition to the scope of products offered, it is also important to choose the
company’s geographic scope. On the one hand, for companies aspiring to
become global leaders, a strong presence in each of the three Triad markets
is often necessary. But, on the other hand, it is not realistic that all
companies can, or should, “go global.” Many firms have tried to enter too
many countries too quickly and have been forced to withdraw.
What Determines the Success and Failure of
Firms Around the Globe?
What determines the success and failure of firms around the globe? The
focus on performance, more than anything else, defines the field of strategic
management and international business. Businesses are not only interested
in acquiring and leveraging competitive advantage, but also in sustaining
such advantages over time and across regions. All three major perspectives
that form the “strategy tripod” ultimately seek to answer this question.
The international success or failure of firms is determined by three views of
the marketplace and how the firm responds to each of those views. The
industry-based view attends to the degree of competitiveness in the
industry. The resource-based view evaluates success or failure on firm-
specific differences in capabilities and the resulting performance differences.
The institution-based view attends to institutional forces, such as economic
reforms and government policy, which may affect a firm’s success or failure.
Overall, although there are many debates among the different schools of
thought, the true determinants of firm performance probably involve a
combination of these three-pronged forces. While these three views present
relatively straightforward answers, the reality of global competition often
makes these answers more complex and murky.
What Is Global Strategy?
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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 world-wide basis. This strategy,
obviously, is only relevant for large multinational enterprises (MNEs) active in
many countries.
The second most popular definition of global strategy is similar to the term
“international strategy” that refers to any strategy outside one’s home
country. This is not an accurate view as it is narrow and one-directional in
terms of business relationships.
The most accurate and insightful definition of global strategy in college texts
and classrooms is the strategy of firms around the world; each firm’s theory
about how to compete successfully in whatever country’s markets the firm
chooses to compete. This perspective offers a broad and encompassing view
of the topic. This definition deals 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. International business involves
two sides: domestic firms and foreign entrants.
What Is Globalization?
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Three different views of globalization are suggested. The first view sees
globalization as a recent phenomenon driven by technological innovations in
transportation and communication. The second view recognizes the early
historical roots of globalization. The third view is likened to a pendulum that
swings from one extreme to the other. Semi-globalization chooses a middle
ground between opposition and unconditional acceptance of globalization.
Globalization could be a new force sweeping through the world in recent
years. Opponents of globalization often argue that it needs to be slowed
down, if not stopped, because of the tendency of MNEs to exploit and
dominate the world. This view argues that globalization has undermined
wages in rich countries, exploited workers in poor countries, devastated the
environment, compromised human rights, diminished national sovereignty,
and given large MNEs too much power.
A second view contends that globalization has always been part and parcel
of human history with earliest traces discovered in the Assyrian, Phoenician,
and Roman empires. In a nutshell, this view suggests that globalization is
nothing new and will always march on.
A third view argues that enormous reductions in transportation and
communication costs have allowed countries and people around the world to
be more closely integrated and dismantled many artificial barriers to the flow
of goods, services, capital, knowledge, and labor across country borders.
Consequently, globalization is neither a recent occurrence nor one
directional. Instead, globalization is a process similar to the swing of a
pendulum.
Global Strategy and Globalization at a Crossroads
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The current state of globalization can be summarized as semi-globalization
because barriers to market integration at borders are high, but not high
enough to completely insulate countries from each other. Likewise,
globalization has both dark and rosy sides, yet companies must still find
ways to productively engage in globalization efforts.
Strategists face an enormous challenge as they look for viable ways to
compete in the world of semi-globalization. In order to develop successful
strategies, managers must understand the world economy and recent events
that have changed the competitive landscape.
At the dawn of the 21st century, three sets of sudden high-profile events
have occurred that have significant ramifications for companies and
strategists around the world:
1. anti-globalization protests – lost jobs, downward pressure on wages for
unskilled labor, and environmental destruction
2. terrorist attacks resulting in reduced freedom of international
movement, enhanced security checkpoints which reduce transit speed
and efficiency, and cancelled or scaled down foreign direct investment
(FDI) projects and trade deals, especially in high risk regions
3. the corporate governance crisis triggered by the 1997 Asian financial
crisis and the scandals of Enron and WorldCom in the United States.
Know Yourself, Know Your Opponents
In order for firms to make decisions at this strategic crossroads, strategists
must begin to change and improve their thinking and practices. Self-
evaluation is the first step, but savvy awareness and scrutiny of the
competition are also essential. A firm must understand strengths AND
weaknesses of itself and opponents. Firms must recognize the social,
political, and environmental costs associated with globalization. Current
business school students exhibit values and beliefs that favor globalization
which may be different from the general public. Firms must be aware of bias
and strategic blind spots; nothing is sacred. Firms cannot ignore non-
government organizations (NGOs) but must view them as partners in the
process.
Strategy As Action
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Strategy as action is the perspective that suggests the key is interaction,
where actions and responses can yield competitive advantage. Firms,
compared to militaries with actions and responses, often compete
aggressively as noted in the tone of terms such as “attacks,”
“counterattacks,” and “price wars.” Yet military principles cannot be
completely applied in business because there are win-wins in business.
Brand new lands (product-market space) and supply routes (distribution and
technology) can be created in business, unlike in international relations.
In addition, militaries fight over territories, waters, and air spaces while firms
compete in markets defined along product dimensions and geographic lines.
Multi-market competitionoccurs when firms engage the same rivals in
multiple markets. Because firms recognize their rivals’ ability to retaliate in
multiple markets, such multi-market competition may result in reduction of
competitive intensity among rivals, an outcome known asmutual
forbearance.
The three legs of the strategy tripod include industry-based considerations,
resource-based considerations, and institution-based considerations. An
understanding of those considerations is essential to strategies which result
in action and response.
Industry-Based Considerations
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Industry-based considerationsare always concerned with inter-firm
rivalry. Most firms in an industry, if given a choice, would probably prefer a
reduced level of competition. But faced with an alternative, the competing
firms may have an incentive to engage incollusion, defined as collective
attempts to reduce competition.Tacit collusionoccurs when firms
indirectly coordinate actions by signaling their intention to reduce output and
maintain pricing above competitive levels. Explicit collusionexists when
firms directly negotiate output and pricing and divide markets; ultimately
this type of collusion leads to the formation of acartel, which is an output
and price-fixing entity involving multiple competitors. A cartel is also known
as a trust because members have to trust each other for honoring their
agreements, e.g. OPEC.
A firm’s decision to participate in collusion is determined by several factors:
concentration ratio, i.e., the percentage of the total number of firms involved
in the market; the existence of an industry price leader; the homogeneous or
heterogeneous nature of products; high entry barriers; the stability of
demand, supply, and technology for the firm’s products; the requirements of
the specific industry when a firm initiates its production; the existence (or
lack of) friendly social relationships among rival managers; and high market
commonality or mutual forbearance.
Overall, the industry-based perspective has generated a voluminous body of
insights on competitive dynamics. However, industry-based considerations
are unable to tell the complete story, thus calling for contributions for
resource- and institution-based perspectives to shed light on competitive
dynamics.
Resource-Based Considerations
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Resource-based considerations include the following:
VALUEmeans a firm’s resources must create value when engaging in
strategic actions. For example, Gillette’s simultaneous launch of its Sensor
razors in 23 countries demonstrated its capacity to attack in multiple
markets. Gillette threw all its rivals off balance, thus adding value.
RARITYoccurs either by nature or nurture, or both, when certain assets are
very rare and thus generate significant advantage. Saudi Arabia’s vast oil
reserves enable it to become the enforcer of OPEC cartel agreements.
Singapore Airlines, in addition to claiming one of the best locations
connecting Europe/Indian Ocean Basin and East Asia/Australia as its home
base, has often been rated as the world’s best airline.
IMITABILITYhappens because most rival firms 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 some of the more successful rivals. For example, rivals that are
competitively aggressive, carry out complex actions (that is, a variety of
difficult to execute maneuvers), and move quickly often have better financial
and market performance. Even when armed with this knowledge,
competitively passive, single-action-based (such as cost-cutting), and slow-
moving firms will find it exceedingly difficult to imitate rivals’ actions.
ORGANIZATIONis required if a firm is to be prepared to engage in desirable
actions. Some firms are better organized for competitive actions, such as
stealth attacks, rapid responses, and willingness to answer challenges “tit-
for-tat.” This intensely competitive, “warrior-like” culture not only requires
top management commitment, but also employee involvement down to the
“soldiers in the trenches.”
RESOURCE SIMILARITYis defined as “the extent to which a given
competitor possesses strategic endowment comparable, in terms of both
type and amount, to those of the focal firm.” Firms which have a high degree
of resource similarity are likely to have similar strengths and weaknesses
which results in similar competitive actions, e.g., Coca-Cola and PepsiCo.
FIGHTING LOW-COST RIVALSis a challenge for incumbents who must
learn to deal with rivals. By the early 1990s, Costco, Dell, Southwest Airlines,
and Wal-Mart showed their low-cost teeth. For incumbents, ignoring the new
rivals could be dangerous; but incumbents need to resist the urge to initiate
price wars in an effort to drive out rivals.
Keeping these resource-based considerations in mind will help a firm identify
and act upon a strategy for staying competitive. However, the firm must also
think about institution-based considerations.
Institution-Based Considerations
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In a nutshell, institution-based considerations advise managers to be well
versed in the “rules of the game” governing domestic and international
competition. Formal institutions governing domestic competition are broadly
guided by competition and cooperation that give rise to the market system;
of particular relevance are anti-trust policies designed to combat monopolies
and cartels. In the U.S., fairness means equal opportunities for incumbents
and new entrants. It is “unfair” for incumbents to 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 deserve to be protected from the
intrusion brought by new entrants. Institution-based considerations are often
discounted by firms hot on the trail of a competitive edge, but Microsoft
taught the market-place that institutions can significantly impact a firm and
its strategies. Overall, the American anti-trust policy ispro-consumer,
whereas the Japanese approach ispro-incumbent.
The U.S. has some of the oldest anti-trust laws governing competition: The
Sherman Act of 1890, The Clayton Act of 1914, and Hart-Scott-Rodino (HSR)
Act of 1976. Specifically, anti-trust policies focus on collusive price setting,
predatory pricing, and extraterritoriality.
U.S. Anti-trust Laws
Three major U.S. anti-trust laws and five landmark cases reflect on three
areas of concern for anti-trust laws:
Collusive Price Settingrefers to monopolists or collusion parties setting
prices at a level higher than the competitive level.
Predatory Pricingrefers to practices of first setting prices below costs in
the short run to destroy rivals with the intent of raising prices to cover losses
in the long run after eliminating rivals (legally referred to as “an attempt to
monopolize”). This is an area of contention. First, it is not clear what exactly
“cost” is. Second, even when firms are found to be selling below cost, U.S.
courts have ruled that if rivals are too numerous to eliminate, one firm
cannot recoup losses due to low prices by jacking up prices so its pricing
cannot be labeled “predatory.”
Extraterritorialityis defined as the reach of one country’s laws to other
countries. U.S. courts have taken it upon themselves to unilaterally punish
non-U.S. cartels (some of which may be legal elsewhere) that have a
substantial adverse impact on U.S. markets.
Despite improved clarity and permissiveness, the legal standards for inter-
firm cooperation are still ambiguous. It is crucial that firms be aware of
ambiguities when planning their actions, especially when operating under
the jurisdiction of multiple governments.
Dumping and International Competition
Dumping is defined as an exporter selling below cost abroad and planning to
raise prices after eliminating local rivals in an attempt to manipulate
international competition. Interestingly, while domestic predation is usually
labeled “anti-competitive,” cross-border dumping is often emotionally
accused of being “unfair.” With the exploding global market-place in the last
two decades, we have also seen a rising proliferation of anti-dumping cases.
The message to firms interested in doing business abroad is clear: their
degree of freedom in overseas pricing is significantly less than in domestic
pricing.
Another formal institution governing international competition is regulations
permitting domestic firms to organize export cartels, defined as alliances of
firms that cooperate in exporting (including quota- and price-fixing). To the
extent that export cartels do not spill over to domestic competition,
competition laws in virtually all countries legalize such collusion.
In summary, the institution-based view suggests that institutional conditions
such as the availability of anti-dumping protection are not just the
“background.” They directly determine what weapons a firm has in its
arsenal to wage competitive battles.
Attack and Counterattack
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In the form of price cuts, advertising campaigns, market entries, and new
product introductions,attackcan be defined as an initial set of actions to
gain competitive advantage, andcounterattackis consequently defined as
a set of actions in response to attacks.
Three main types of attack can be observed in the market: (1)Thrust: the
classic frontal attack with brute force; (2)Feint: a firm’s attack on a focal
arena important to a competitor, but not the attacker’s true target area;
(3)Gambit: a move that sacrifices a low-value piece in order to capture a
high-value piece or improve one’s position significantly.
Counterattack is driven by three distinct elements: (1) Awareness: to be
aware of competition, market commonality, and resource similarity. If an
attack is so subtle that rivals are not aware of it, then the attacker’s
objectives are likely to be attained. (2)Motivation: to choose wisely—not
every attack must be answered, so managers need to choose the important
markets to address. If the attacked market is of marginal value, managers
may decide not to counterattack. (3)Capabilities: managers must know
strengths and use them; identify weaknesses and address them—be ready
for the changing market. Even if an attack is identified and a firm is
motivated to respond, it requires strong capabilities to carry out
counterattacks, so managers must always keep resources in mind.
Competitive Actions
To the extent that firms often fight like “cats and dogs,” an interesting
typology of competitive actions has emerged: puppy dog, top dog, lean and
hungry, and fat cats. These different actions differ in their subtlety,
frequency, complexity, and predictability. Each action has different odds of
provoking counterattacks.
A subtle, “puppy dog“ or indirect attack, on average, is expected to be more
effective than a brute force attack. The well-known example of Honda
successfully entering the U.S. market with a small 50cc, $250 motorbike that
looked more like a bicycle than a motorcycle is a good example of such an
indirect attack on Harley Davidson’s bigger, more powerful motorcycles.
Contrast Honda’s indirect, subtle attack on Harley in the 1950s and 1960s
with that of Netscape on Microsoft in the 1990s. Netscape’s name-calling,
“top dog” attack on Microsoft in the mid-1990s drew tremendous publicity by
labeling Microsoft the “Death Star” and predicting that the Internet would
make Windows obsolete. Although Microsoft had not viewed Netscape as a
main rival, such a challenge helped make Netscape Microsoft’s enemy
number one, leading to the demise of Netscape. An underdog openly and
directly challenging a top dog, not surprisingly, is likely to be crushed by the
top dog. Sun Microsystems suffered from the same hubris in its regular
attacks on Microsoft and its chairman, Bill Gates.
Unpredictability increases the odds for successful attacks, whereas
predictability destroys the element of surprise. When Kmart predictably
advertised its weekly specials through expensive direct mailing, Walmart,
which was reluctant to follow because of its “every day low price” policy,
creatively posted Kmart’s weekly circulars at the front of Walmart stores and
promised to match or beat Kmart’s specials. The word of mouth quickly
spread, creating a dilemma for Kmart: the more it advertised, the more it
drove customers to Walmart.
Cooperation and Signaling
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Some firms choose to compete, and others choose to cooperate. How does a
firm signal its intention to cooperate in order to reduce competitive
intensity? Short of illegally talking directly to rivals, firms have to resort to
four types of signaling—that is, “While you can’t talk to your competitors
about pricing, you can always “wink” at them.”
Four legal means of such winking include the following strategies: (1) Non-
aggression (also known as the “fat cat”) is a strategy that refers to active
investment in non-threatening ways so as not to provoke attack on a firm’s
core markets. (2) Market entry has the same effect as firms may enter new
markets, not really to challenge incumbents but to seek mutual forbearance
by establishing multi-market contact. (3) Firms can send an open signal for a
truce which Toyota did in 2005 when its chairman told the media that Toyota
would “help GM” by raising Toyota prices in the U.S. (4) Sometimes firms can
send a signal to rivals by enlisting the help of governments; for example,
filing an anti-dumping petition does not necessarily indicate a totally hostile
intent – sometimes it signals to the other side: “We don’t like what you are
doing; it’s time to talk.”
Reduced to its core, cooperation among competitors fundamentally boils
down to a repeated game in which players accommodate each other to avoid
conflict. To the extent that business is both war and peace, strategists need
to pay as much attention to making peace with rivals as fighting wars
against them.
Local Firms Versus Multinational Enterprises (MNEs)
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Local firms will, inevitably, find themselves in competition with multinational
enterprises in the competitive dynamics of the marketplace. Local firms
cannot match the expertise, experience, and endowments of MNEs
(multinational enterprises), but local firms can still be successful.
Be aDODGER: Local firms may find that they need to cooperate with MNEs
through joint ventures (JVs), sell-offs to MNEs, and/or becoming MNE
suppliers and service providers. Rather than closing a business, re-align the
firm’s products or processes to be used in new ways. In the Chinese
automobile industry, all major local automakers have entered JVs with MNEs.
In the Czech Republic, Skoda, the leading state-owned automaker, was sold
by the government to Volkswagen.
Be aCONTENDER: Contender firms engage in rapid learning to approach
the capabilities of the MNEs and then expand overseas. The Chinese cellular
phone makers (TCL and Bird) have caught up with global heavyweights
(Motorola and Nokia) by first using foreign suppliers for their hand-set
modules and then engaging in design innovations such as diamond-studded
phone casings and fish skin surfaces which appeal to local tastes in China.
Be aDEFENDER: In some industries, the pressures to globalize are
relatively low and local firms’ primary strengths lie in a deep understanding
of local markets. Therefore, a defender strategy that leverages local assets
that MNEs are either weak in or unaware of is often called for. A local
Mexican bakery can compete with PepsiCo by selling its products via a
corner store distribution network tapping into Mexican consumers’
preference for freshness and shopping daily at a nearby location.
Be anEXTENDER: In some industries where pressures for globalization are
relatively low, local firms may possess some skills and assets that are
transferable overseas, thus leading to the extender strategy. This strategy
centers on leveraging home-grown competencies abroad by expanding into
similar markets. For instance, Jollibee, a fast food chain in the Philippines, not
only survived an invasion from McDonald’s, but prospered while expanding
to Hong Kong, the Middle East, and California where large Filipino
populations reside.
Debates and Extensions
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Strategy Versus Industrial Organization
Economics and Anti-trust Policy
This debate is between strategy and industrial organization (IO) economics
and its public policy brainchild, competition/anti-trust policy. Modern ideas of
strategy, pioneered by Michael Porter, have turned IO economics “on its
head.” While IO economics attempts to prevent any firm from gaining
sustained competitive advantage, the very purpose of strategy is to gain a
sustainable advantage. Intended to encourage competition and “fair play,”
anti-trust laws are based on the assumption that large firms are especially
capable of building sustainable advantage through a monopoly or oligopoly.
In this debate,strategists make five arguments:
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First, strategists argue that dominated by IO economics, anti-
trust laws were created in response to the old realities of
mostly domestic competition. Richard D’ Aveni argues that
“applying traditional U.S. anti-trust enforcement in an
environment of hyper competition is like driving a Model T on
the expressway.”
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Second, to the extent that competition is increasingly global
and that foreign anti-trust laws are more permissive, U.S.
anti-trust laws may become “a self-imposed impediment to
U.S. economic performance.”
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Third, the very actions accused of being “anti-competitive”
may actually be highly “competitive” or “hypercompetitive.”
In 1972, the U.S. government accused Kellogg, General Mills,
General Foods, and Quaker Oats of product proliferation, that
is, too much competition. Today, the cereal firms face
competition from a number of new breakfast options as well
as significant demographic changes in the U.S. that have
changed the way people consume their first meal of the day.
4
4
Fourth, U.S. anti-trust laws create strategic confusion.
Because the intent to destroy rivals is a smoking gun of anti-
trust cases, the U.S. thus has become a “fantasyland” in
which many firms go bankrupt, but ideally, none is destroyed
by a competitor. Strategists are forced to use milder
language; otherwise, they may end up in court.
5
5
Fifth, U.S. anti-trust laws designed to combat “unfair”
practice, may be unfair. First, the laws are ambiguous. If a
firm’s prices are viewed as too low, it can be charged for
predatory pricing. Conversely, if prices are seen as too high,
a firm can be sued for tacit collusion with rivals.
Overall, strategists argue that monopolization, feared in the nineteenth
century America, is not likely in most industries in the global economy of the
twenty-first century. This view, however, has not yet been fully accepted by
anti-trust policymakers.
Competition Versus Anti-dumping
In international business, there are two arguments against anti-dumping.
First, because dumping centers on selling “below cost,” it is often difficult (if
not impossible) to prove the case given the ambiguity concerning “cost.” The
second 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 one. Until some point in the
future when the firm breaks even, it will lose money because it sells below
cost. Given the competitive nature of most industries, it is often difficult (if
not impossible) to eliminate all rivals and recoup dumping losses by charging
higher monopoly prices.
Anti-dumping laws, therefore, are fundamentally at odds with the spirit of
promoting competition, which underpins competition/anti-trust laws in the
first place. Anti-dumping laws are also at odds with the recent trends toward
more globalization. Joseph Stiglitz states that anti-dumping duties “are
simply naked protectionism” and one country’s “fair trade laws” are often
known elsewhere as “unfair trade laws.”
One solution is to phase out anti-dumping laws and use the same standards
against domestic predatory pricing when dealing with foreign firms. Such a
waiver of anti-dumping charges against each other has been in place
between Australia and New Zealand, between Canada and the United States,
and within the European Union. That is, a Canadian firm, essentially treated
as a U.S. firm, can be accused of predatory pricing, but cannot be accused of
dumping within the United States.
The Savvy Strategist
Lesson20of46
Today’s global competition demands people with insight and a work ethic
that brings about change. If you and your firm want to be successful, you
must follow some basic strategies. First, you need to thoroughly understand
how the nature of your industry may facilitate competition or cooperation.
Second, you and your firm need to strengthen capabilities to more effectively
compete and/or cooperate. In attacks and counterattacks, subtlety,
frequency, complexity, and unpredictability are helpful. In cooperation,
market similarity and mutual forbearance may be better. Third, you need to
understand the rules of the game governing competition around the world.
What is legal domestically may be illegal elsewhere.
In terms of the four fundamental questions, why firms differ (question 1) and
how firms behave (question 2) boil down to how industry-, resource-, and
institution-based considerations influence their competitive/cooperative
actions. What determines the scope of the firm (question 3) is driven, in part,
by an interest to establish mutual forbearance with multi-market rivals.
Finally, what determines the international success and failure of firms
(question 4), to a large extent, depends on how firms carry out their
competitive and cooperative actions around the world.
Multinational Strategies and Structures
Lesson22of46
Pressures for Cost Reductions and Local
Responsiveness
Firms seeking to expand on a global scale must consider the needs and
concerns of the new markets and must learn to simultaneously deal with two
sets of pressures – to reduce costs and to develop local responsiveness.
Pressures for cost reductions are almost universal, especially for firms
competing on cost leadership. For example, MNEs' aggressive outsourcing of
call center functions to India and Ireland is indicative of how companies
respond to pressures for cost reductions.
However, the pressures for local responsiveness are unique to international
competition and these pressures are reflected in consumer preferences,
distribution channels, and host country demands. Consumer preferences
vary tremendously around the world. For example, beef-based hamburgers
sold by McDonald’s would find no customers in India, a land where cows are
sacred. Being locally responsive certainly makes local customers and
governments happy, but these actions, unfortunately, increase costs.
MNEs can pay attention to both dimensions of cost and local responsiveness.
Based on the integration-responsiveness framework, the four strategic
choices for MNEs are (1) home replication, (2) localization (multi-domestic),
(3) global standardization, and (4) transnational.
Integration-Responsiveness Framework
The cost reduction and local responsiveness pressures impact the strategic
choices as seen in this diagram:
Strategic Choices for MNEs
Home replication strategy, often known as “international” or “export”
strategy, emphasizes the international replication of the home country-based
competencies such as the scale of production, 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. It is
relatively easy to implement and usually the first one adopted for global
ventures.
Localization (multi-domestic) strategyis an extension of the home
replication strategy and focuses on a number of foreign countries/regions,
each of which is regarded as a stand-alone “domestic” market worthy of
attention and adaptation. Although this choice sacrifices global efficiencies, it
is effective when there are clear differences among national and regional
markets and low pressures for cost reductions; a multi-domestic strategy
comes at higher costs.
Global standardization strategyis the opposite of the multi-domestic
strategy and is sometimes referred to 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. The MNE may
designate “centers of excellence,” subsidiaries recognized as a source of
important capabilities, so these capabilities can be leveraged and/or
disseminated to other subsidiaries.
Transnational strategyaims to capture “the best of both worlds” by
endeavoring to be both cost efficient and locally responsive. In addition, this
choice also facilitates global learning and diffusion of innovations.
Four Organizational Structures
To deal with these pressures and choices, MNEs must select an
organizational structure that will encompass their choice of strategy:
TheInternational Division Structureis typically set up when firms initially
expand abroad, often engaging in a home replication strategy. Problems
inherent in this organizational structure are two-fold: (1) Foreign subsidiary
managers in the international division are not given sufficient voice relative
to the heads of domestic divisions. (2) The “silo” effect appears because
international division activities are not coordinated with the rest of the firm,
which focuses on domestic activities. Firms often phase out this structure
after their initial overseas expansion.
TheGeographic Area Structureis the most appropriate structure for a
multi-domestic strategy. This structure organizes the MNE according to
different geographic areas (countries and regions) where its ability to
facilitate local responsiveness is both a strength and a weakness. Since
being locally responsive can be a virtue, it may also encourage the
fragmentation of the MNE into highly autonomous, hard-to-control
“fiefdoms.”
TheGlobal Product Division Structure, which is the opposite of the
geographic area structure, supports a global strategy in treating each
product division as a stand-alone entity with full worldwide—as opposed to
domestic—responsibilities for its activities. This structure helps firms focus
attention on pressures for cost efficiencies in allowing for consolidation on a
worldwide (or regional) basis and reduction of inefficient duplication in
multiple countries but has little local responsiveness. For example, Unilever
reduced the number of its soap-producing factories in Europe from ten to two
after adopting this structure.
Some MNEs choose theGlobal Matrix Structure,which is often used to
alleviate the disadvantages associated with both geographic area and global
product division structures. Its hallmark is sharing and coordinating
responsibilities between product divisions and geographic areas to be both
cost efficient and locally responsive. It is intended to support the goals of the
transnational strategy; in practice, it is often difficult to deliver because it
may add layers of management, slow down decision speed, and increase
costs while not showing significant performance improvement. Many MNEs
have tried to build a “flexible” matrix structure. No conclusive evidence
supports the superiority of the matrix structure.
Reciprocal Relationships
The positioning of the four structures is not random. Over time, these
structures may evolve from the relatively simple international division
through either geographic area or global product division structures and may
finally reach the more complex global matrix stage. These paths represent
the possible evolutionary trajectories of MNEs, which may grow from having
a limited international presence to being sophisticated global players.
The reciprocal relationship between strategies and structures can be vividly
portrayed within MNEs. Three key ideas stand out when reviewing
multinational strategies and structures:
1. Strategy drives structure. A mismatch, such as
combining a global strategy with a geographic area
structure, may have poor performance consequences.
2. The relationship between the two is two-way. To the
extent that certain strategies facilitate certain structures, a
given structure also supports a particular strategy.
3. Strategies and structures are not static. The constant
changes in industry conditions, firm capabilities, and
institutional environments often require strategies,
structures, or both to change.
A Comprehensive Model of Multinational Strategy, Structure, and
Learning
Lesson23of46
Industry-Based Considerations
Why are MNEs structured differently? For example, industrial-products firms,
such as the semiconductor industry, tend to adopt global product divisions,
whereas consumer-goods companies, such as cosmetics producers, often
rely on geographic area divisions. Industrial-products firms typically
emphasize technological innovations, while consumer-goods companies
place premiums on learning consumer trends and generating repackaged
and recombined products as marketing innovations.
Industrial-products firms value technological and engineering knowledge,
which is not location-specific, such as how to most efficiently make
semiconductor chips. Consumer-goods industries, on the other hand, must
develop intimate knowledge about consumer tastes, which are location-
specific.
Michael Porter’s Five Forces help explain the issue. Within a given industry,
as competitors increasingly match each other in cost efficiencies and local
responsiveness, their rivalry naturally focuses on learning and innovation.
The height of entry barriers also shapes MNE structure, learning, and
innovation. Why do many MNEs phase out the multi-domestic strategy and
geographic structure by consolidating production in a smaller number of
world-scale facilities? One underlying motivation is that smaller, sub-optimal
production facilities scattered in a variety of countries do not effectively
deter potential entrants. Massive, world-scale facilities in strategic locations
can serve as more formidable deterrents.
Bargaining power of suppliers and buyers also has a bearing on MNE
structure, learning, and innovation. When buyer firms move internationally,
they increasingly demand that suppliers provide integrated offerings, that is,
buyer firms want to purchase the same supplies at the same price and
quality in every country in which they operate. Components suppliers are
thus often forced, or at least encouraged, to internationalize. Otherwise,
suppliers run the risk of losing a substantial chunk of business. Not
surprisingly, as Toyota invested in China recently, all of its top 30 suppliers
set up factories in adjacent areas at their own expense.
The threat of substitute products has a relatively small impact on the MNE
structure, but has a direct bearing on learning and innovation. R&D often
generate innovative substitutes that can be competitive in lower end and
developing markets and change competition in those markets. 3M’s Post-It
Notes, for example, can partially substitute for glue and tape. Personal
computers have made typewriters obsolete.
A Summary of the Five Forces Framework
The industry-based view of strategy is underpinned by the five forces
framework advocated by Michael Porter. 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.
Resource-Based Considerations
The resource-based view, exemplified by theVRIO framework(Value,
Rarity, Imitability, and Organization), adds a number of insights. First, the
question of value must be confronted. When making structural changes it is
crucial to determine whether the new structure, such as matrix, adds
concrete value. The value of innovation is important because the vast
majority of innovations simply fail to reach the market, and most new
products that do reach the market end up being financial failures. Profitable
innovators need plenty of good ideas, but also a lot of complementary assets
such as appropriate organizational structures and marketing muscles, as well
as complementary technologies.
Rarity is also important. Certain strategies or structures may be in vogue at
one point in time. When all competitors are moving toward a global
standardization strategy, this strategy, in itself, cannot be a source of
differentiation. Off-the-shelf technology does not confer differentiation as it
can be acquired too easily. To improve global coordination, many MNEs
spend millions of dollars on enterprise resource planning (ERP) packages
provided by SAP and Oracle. However, such packages are designed for
broad-appeal implementation, thus providing no firm-specific advantage for
the adopting firm.
Even when capabilities are valuable and rare, they have to pass a third
hurdle, namely, imitability. They must be hard to imitate. Formal structures
are easier to observe and imitate than informal structures. This is one of the
reasons why the informal, flexible matrix is in vogue now.
What exactly is an elusive informal, flexible matrix? Christopher Bartlett and
Sumantra Ghoshal suggest that the informal, flexible matrix is less a
structural classification than a broad organizational concept or philosophy,
manifested in organizational capability and management mentality. It is a lot
harder, if not impossible, to imitate an intangible philosophy or mentality
than to imitate a tangible structure.
The last hurdle is organization, namely how MNEs are organized, both
formally and informally, around the world. If MNEs are able to drive the
organizational benefits of the matrix structure without being burdened by a
formal matrix structure (that is, building an informal, flexible, invisible
matrix), they are likely to outperform rivals.
Institution-Based Considerations: Formal and
Informal External Institutions
Externally, MNEs are subject to the formal institutional frameworks erected
by various home- and host-country governments. For instance, to protect
domestic employment, home-country governments may manipulate tax rules
to encourage MNEs to invest at home.
Host-country governments, on the other hand, often encourage or coerce
MNEs into undertaking activities that they may otherwise abdicate.
Advanced manufacturing moves up the value chain, generates better jobs,
provides more technology spillovers, and leads to better reputations.
Therefore, host-country governments often use a combination of “carrots”—
tax incentives, matching grants, and free infrastructure upgrades—and
“sticks”—threats to block market access domestically—to attract MNE
investments in advanced manufacturing and higher value-added areas.
MNEs also confront a series of informal institutions governing their
relationships with home- and host-country environments. In the U.S., few
laws actually ban U.S. MNEs from aggressively setting up overseas
structures. Strategists weigh the informal backlash against activities that
could result in domestic job losses. Reciprocity norms may be important in
foreign investment. If Boeing has major supply relationships in Japan, Airbus
would feel compelled to do the same. Airbus may increasingly feel that such
subcontracting is the right thing to do, not only politically, but also
economically.
Institution-Based Considerations: Formal and
Informal Internal Institutions
The internal rules of the game determine how MNEs are governed. Formally,
the organizational charts specify the primary scope of responsibilities.
However, the formal organization charts do not reveal the informal rules of
the game, such as organizational norms, values, and networks. The
nationality of the head of foreign subsidiaries is such an example.
MNEs from different countries have different norms when making these
appointments. Most Japanese MNEs seem to follow an informal rule: Heads of
foreign subsidiaries, at least initially, need to be Japanese nationals. In
comparison, European MNEs are more likely to appoint host and third-
country nationals to lead subsidiaries. As a group, U.S. MNEs’ practices seem
to be between the Japanese and European practices. The Japanese
propensity to appoint home-country nationals is conducive for their preferred
global standardization strategy that values globally coordinated actions.
European comfort in appointing host and third-country nationals is indicative
of European MNEs' preference for a localization or multi-domestic strategy.
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. Some critics argue that this reflects
“corporate imperialism.” Consequently, some leading MNEs have appointed
non-home-country nationals to top posts. Informal internal rules are often
taken for granted and deeply embedded in administrative heritages, thus
making them difficult to change.
Knowledge Management in Four Types of
Multinational Enterprises (MNEs)
Worldwide Learning, Innovation, and Knowledge Management
Lesson24of46
Knowledge Management in Four Types of
MNEs
Knowledge management can be defined as the structures, processes, and
systems that actively develop, leverage, and transfer knowledge. Some
argue that knowledge management is the defining feature of MNEs. The two
types of knowledge are explicit and tacit knowledge. Explicit knowledge is
codifiable; that is, it can be written down and transferred without losing
much of its richness. Tacit knowledge is non-codifiable and its acquisition
and transfer require hands-on practice. Tacit knowledge is more important
and harder to transfer and learn. 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 is significantly impacted by the interdependence of
the MNE. In MNEs pursuing ahome replication strategy, such
interdependence is moderate and the role of subsidiaries is largely to adapt
and leverage parent company competencies. Thus, knowledge of new
products, processes, and technologies is mostly developed at the center and
flows to subsidiaries, representing the traditional one-way flow. Starbucks,
for instance, insists on replicating its U.S. coffee shop concept around the
world, down to the elusive “atmosphere.”
In MNEs adopting alocalization strategy, the interdependence is low.
Knowledge management centers on developing knowledge that can best
tackle local markets. Ford of Europe used this strategy to develop cars for
Europe, with limited flow of knowledge from and toward headquarters.
In MNEs pursuing aglobal standardization strategy, the interdependence
is increased. Knowledge is developed and retained at the center and a few
“centers of excellence.” Consequently, there is an extensive flow of
knowledge and people from headquarters and these centers to other
subsidiaries. Yokogawa Hewlett-Packard, HP’s subsidiary in Japan, won a
coveted Japanese Deming Award for quality. The subsidiary was then
charged with transferring such knowledge to the rest of HP, which resulted in
a ten-fold improvement in corporate-wide quality in ten years.
A hallmark oftransnationalMNEs is a high degree of interdependence and
extensive bidirectional flows of knowledge. For example, extending a popular
ice cream developed in Argentina based on a locally popular caramelized
milk dessert, Haagen-Dazs introduced the flavor, Dulce De Leche, throughout
the United States and Europe. Within one year, it became the second most
popular Haagen-Dazs ice cream. Particularly fundamental to transnational
MNEs are knowledge flows among dispersed subsidiaries, each not only
developing locally relevant knowledge but also aspiring to contribute globally
beneficial knowledge that enhances corporate-wide competitiveness of the
MNE as a whole.
Globalizing Research and Development
While virtually all MNE functions need to better managed and extend their
knowledge, R&D represents an especially crucial arena for knowledge
management. R&D is driven by the intensification of competition for
innovation. Relative to production and marketing, R&D has more recently
emerged as an important function to be internationalized, often known as
innovation-seeking investment. It provides a vehicle for access to—or extract
benefits from—a foreign country’s local talents and expertise. The
intensification of competition for innovation drives the globalization of R&D.
The resource-based view states that a fundamental source for competitive
advantage is being different (the assumption of heterogeneity).
Decentralized R&D work performed by different locations and teams around
the world means that there will be persistent heterogeneity (differences) in
the solutions generated. Many IT firms such as Samsung have R&D
subsidiaries in Silicon Valley and India.
The theory of agglomeration, or clusters of high caliber, innovative
businesses within a country or region can be used by firms in making foreign
direct investment decisions. For foreign firms, an effective way to access a
cluster not present in their home markets is to locate there through foreign
direct investment.
Problems and Solutions in Knowledge
Management
Institutionally, how MNEs employ formal and informal rules of the game has
a significant bearing on the success or failure of knowledge management. In
knowledge acquisition, many MNEs prefer to invent everything internally.
However, for large firms, there are actually economies of diminishing returns
for R&D.
Consequently, a new model, open innovation, is emerging. This model relies
on more collaborative research, among various internal units, with external
firms (through R&D contracts, alliances, and outsourcing), and with
university labs. Evidence shows that firms that skillfully share research
(including publishing results in the public domain) outperform those that fail
to do so.
In knowledge retention, the usual problem of employee turnover is
compounded when the employees are key R&D personnel whose departure
will lead to knowledge leakage. 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. Some managers and employees believe that “knowledge is
power” and will monopolize certain useful knowledge and not share it with
others or codify it.
Even when certain subsidiaries are willing to share knowledge, inappropriate
transmission channels may still torpedo effective knowledge sharing. Given
the advancement in IT, it is tempting to establish global virtual teams, which
do not meet face to face, to transfer knowledge. Unfortunately, such teams
often have to confront tremendous communication and relationship barriers,
ranging from language and cultural differences to less-than-perfect
communication technology.
Finally, recipient subsidiaries may present two pathologies that block
successful knowledge inflows. First, the “not invented here” (NIH) syndrome
causes some managers to resist accepting ideas from other units. Second,
recipient subsidiaries’ absorptive capacity, the ability to recognize the value
of new information, assimilate it, and apply it, may be limited.
To combat these problems, corporate headquarters can manipulate the
formal rules of the game, such as (1) tying bonuses with measurable
knowledge outflows and inflows, (2) using high-powered, corporate or
business unit based incentives (as opposed to individual and single
subsidiary-based incentives), and (3) investing in codifying tacit knowledge.
However, these formal policies fundamentally boil down to the very
challenging, if not impossible, task of how to accurately measure inflows and
outflows of tacit knowledge.
The nature of tacit knowledge simply resists formal bureaucratic practices;
consequently, MNEs often have to rely on a great deal of informal integrating
mechanisms. Facilitating management and R&D personnel networks among
various subsidiaries through joint teamwork, training and conferences, and
promoting strong organizational (that is, MNE-specific) cultures and shared
values and norms for cooperation among subsidiaries can also help.
Thus, 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, individuals are more likely to go out of their way to help friends and
acquaintances. Consequently, managers of the China subsidiary are more
likely to provide managers of the Chile subsidiary with needed knowledge if
they know each other and have some social relationship.
Debates and Extensions
Lesson25of46
Corporate Controls Versus Subsidiary
Initiatives
One of the leading debates on how to manage large firms is the
centralization versus decentralization debate.
Management decisions from a main/global office rather than from a local firm
have consequences. Arguments in favor of centralization are based on three
considerations: the capability to facilitate corporate-wide coordination, the
consistency in decision-making, and the given power for corporate-level
managers to initiate necessary actions.
Arguments in favor of decentralization assert that decentralization reduces
corporate-level managers’ overload of responsibilities and improves decision
quality, that decentralization better motivates subsidiary-level managers and
employees through empowerment, and that this approach permits greater
speed, flexibility, and innovation.
In an MNE setting, the debate boils down to central controls versus
subsidiary initiatives. Subsidiaries are not necessarily at the receiving end of
commands from headquarters. For example, when headquarters requires
that certain practices, such as quality circles, be adopted, some subsidiaries
may be in full compliance, others engage in “ceremonial adoption,” and
others simply may refuse to adopt.
Some subsidiaries may actively pursue their own subsidiary-level strategies
and agendas, thus contributing to entrepreneurship or empire building. The
ideal relationship between headquarters and subsidiaries and among
subsidiaries themselves would follow a model that leverages business and
cultural diversity. This relationship is called an “integrated network”
model or the “N-form.”
Customer-Focused Dimensions Versus
Integration, Responsiveness, and Learning
Many MNEs have added new dimensions that make their structure more
complex. Often, new, customer-focused dimensions of structure are placed
on top of an existing structure, resulting in a four or five dimension matrix.
Three primary customer-focused dimensions are to be considered. The first
dimension is aglobal account structureto supply customers (often other
MNEs) in a coordinated and consistent way across various countries. The
emphasis is to give large customers dedicated support teams that report
exclusively to a global account executive. Most original equipment
manufacturers (OEMs), namely, contract manufacturers that produce goods
that do not carry their own brands (the makers of Nike shoes and Microsoft
Xbox), use this structure.
The second customer-focused dimension is anindustry sector
structurethat is common for professional service firms. Accenture (formerly
Andersen Consulting) has focused on four industries and eight service
functions (such as supply chain management).
The third customer-service dimension, asolutions-based structure, is
often used. For example, IBM would sell whatever combination of hardware,
software, and services that customers prefer, whether that means selling
IBM products or selling rivals’ offerings. MNEs such as IBM and HP have
recently reorganized themselves along “front-end” and “back-end”
dimensions, with the more diverse “front-end” units dealing with customers
directly and more integrated “back-end” units focusing on production and
support functions.
To handle a global customer, the first stage usually entails appointing a
global account manager who informally coordinates all the different
subsidiaries that sell to the customer. Next, the firm would assemble a
temporary, cross-division and cross-subsidiary team. However, this ad hoc
approach can quickly run out of control, resulting in subsidiary managers’
additional duties to report to three or four informal bosses in addition to
doing their “day jobs.” Eventually, new formal structures may be needed,
resulting in inevitable bureaucracy.
Customer-focused dimensions cut across all three existing “mainstream”
dimensions, integrating on a global basis, responding to customers in single
and multiple markets, and learning how to best meet customers’ needs and
wants.
What then is the solution when confronted with the value-added potential of
adding customer-focused dimensions and their associated complexity,
bureaucracy, and cost? One recommendation is to simplify both product and
geographic scope to add the customer-focused dimensions.
The Savvy Strategist
Lesson26of46
MNEs are the ultimate large, complex, and geographically dispersed
business organizations. To manage effectively, four clear implications
emerge for the savvy strategist:
First, strategists should understand the nature and evolution of their industry
in order to come up with the right strategy-structure configurations.
Second, managers need to actively develop learning and innovation
capabilities to leverage multinational presence. A winning formula is “think
global, act local.”
Third, mastering the external rules of the game governing MNEs and
home/host country environments becomes a must.
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.
Overcoming the Liability of Foreignness
Lesson28of46
P Video
Entering foreign markets is crucial for global strategy. Focusing on the
necessity to overcome the liability of foreignness, a comprehensive model is
developed based on the "strategy tripod“—namely, industry-based,
resource-based, and institution-based views.
Why is it so challenging to succeed overseas? This is primarily because of
theliability of foreignness, which is the inherent disadvantage foreign
firms experience in host countries because of their non-native status. Such a
liability is manifested in at least two dimensions. First, numerous differences
exist in formal and informal institutions governing the rules of the game
(such as regulatory, language, and cultural differences). While local firms are
already well versed in these rules, foreign firms have to quickly learn them.
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.
The primary weapon foreign firms use is to deploy overwhelming resources
and capabilities in the hope of offsetting the liability of foreignness, while still
leaving them some competitive advantage.
Despite recent preaching by some gurus that every firm should go abroad,
the reality is that not every firm is ready for it. Prematurely venturing
overseas may be detrimental to overall firm performance, especially for
smaller firms whose margin for error is very small.
Understanding the Propensity to Internationalize
Lesson29of46
Strategists need to carefully decide whether doing business abroad is
warranted. So 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 X 2 framework.
In Cell 1, large firms in a small domestic market are likely to be very
“enthusiastic internationalizers,” because they can quickly exhaust
opportunities in a small market.
In Cell 2, many small firms in a small domestic market are labeled "follower
internationalizers,” because they often follow their larger counterparts
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.
In Cell 3, large firms in a large domestic market are labeled "slow
internationalizers,” because their overseas activities are usually (but not
always) slower than those of enthusiastic internationalizers in Cell 1.
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 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" (that is, if they have any international business at all).
A Comprehensive Model of Foreign Market Entries
Lesson30of46
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 which form a comprehensive
model.
Industry-Based Considerations
Industry-based considerations are primarily drawn from the five forces
framework. First, rivalry among established firms may prompt certain moves.
Firms, especially those in oligopolistic industries, often match each other in
foreign entries. If Komatsu and FedEX enter a new country - let's say
Afghanistan - Caterpillar and DHL, respectively, probably would feel
compelled to follow. Sometimes firms may enter foreign markets to retaliate.
For example, Texas Instruments (TI) entered Japan not to make money but to
lose money. The reason was that TI faced the low price Japanese challenge in
many markets, whereas rival such as NEC and Toshiba were able to charge
high prices in Japan and use domestic profits to cross-subsidize their
overseas expansion. By entering Japan and slashing prices there, TI
retaliated by incurring a loss. This forced the Japanese firms to defend their
profit sanctuary at home, whereby they had more to lose.
Second, the higher the entry barriers, the more intense firms will be in
attempting to compete abroad. A strong presence overseas in itself can be
seen as a major entry barrier. By tapping into wider and bigger markets,
international sales can increase scale economies and deter entry.
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 overseas (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.
Fourth, the bargaining power of buyers may lead to certain foreign market
entries, often called forward vertical integration. Sony, for example, has
entered downstream activities abroad through the acquisition of Columbia
Pictures and Sony Music. Despite the huge financial costs, it is often believed
that the benefits outweigh the costs under certain circumstances.
Finally, the market potential of substitute products may encourage firms to
bring them abroad. If the third-generation (3G) wireless technology, in
addition to being a cell phone, can indeed substitute for videoconferencing,
cameras, camcorders, e-mails, and game machines, people in a variety of
countries may demand it.
Overall, how an industry is structured and how its five forces are played out
significantly affect foreign entry decisions.
Resource-Based Considerations
The VRIO framework sheds considerable light on entry decisions, with a focus
on their value, rarity, imitability, and organization aspects. First, the value of
firm-specific resources and capabilities plays a key role behind decisions to
internationalize. The higher the value of firm-specific resources and
capabilities (especially intangible assets such as brands, know-how, and
software), the more likely firms will aggressively leverage them overseas.
Second, the rarity of firm-specific assets encourages firms that possess them
to leverage such assets overseas. Patents, brands, and trademarks legally
protect the rarity of certain product features. It is not surprising that
patented and branded products are often aggressively marketed overseas.
Third, if firms are concerned that their imitable assets might 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. If a foreign company grants a license to a
local firm to manufacture or market a product, "it runs the risk of the
licensee, or an employee of the licensee, disseminating the know-how or
using it for purposes other than those originally intended.”
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. Many MNEs
are organized to protect them against entry and favors them as entrants into
other markets.
In summary, the resource-based view suggests there are an important set of
underlying considerations underpinning entry decisions. In the case of
imitability and dissemination risk, it is obvious that these issues are related
to property rights protection.
Institution-Based Considerations
Regulatory Risks
The government's tactics include removing incentives, demanding a higher
share of profits and taxes, and even confiscating foreign assets—known as
expropriation. 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.
Numerous 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). It is not surprising that
foreign firms do not appreciate the risk associated with such obsolescing
bargains.
Recently, some decisive changes have occurred around the world in favor of
foreign entries. Many governments increasingly realize that nationalization of
foreign MNE assets does not necessarily maximize their national interests.
While expropriation drives MNEs away, SOEs are often unable to run the
operations as effectively as did MNEs and 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. Interestingly, many private bidders are
MNEs. MNEs often push for the transparency and predictability in host-
government decision making before committing to new deals.
Overall, there is a global competition among host governments (especially
those in the developing world) to transform their relationship with MNEs from
a confrontational to a 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.
Trade Barriers
Trade barriers include:
1. Tariff and nontariff barriers
2. Local content requirements
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. These barriers effectively encourage
foreign entrants to produce locally and discourage them from exporting.
However, even after foreign entrants set up factories locally, they can still
export completely knocked down (CKD) kits to be assembled in host
countries. Such factories are nicknamed "screwdriver plants" - only
screwdrivers 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.
Certain entry modes have restrictions. Many countries limit or even ban
wholly foreign-owned subsidiaries.
Currency Risks
Currency risks stem from unfavorable movements of the currencies to which
firms are exposed. Nestle's sales volume in Brazil grew by 10% during 2002.
But because of currency deterioration, its Brazil revenues in Swiss francs
actually went down by 30% during the same period.
In response, firms can speculate or hedge.Speculationinvolves
commitments to stable currencies. However, this is risky in case of wrong
bets of currency movements. For example, Japan Airlines (JAL) needed U.S.
dollars to purchase Boeing aircraft but its revenues were mostly in yen. This
looked like a great deal given the 1985 exchange rate of $1 to 240 yen.
However, by the time 1994 the yen had surged against the dollar to $1 to 99
yen. Because JAL was bound by the contract to purchase dollars at the rate
of $1 to 185 yen, it was paying 86% more than it needed to for every Boeing
aircraft it bought.Hedgingmeans spreading out activities in a number of
countries in different currency zones in order to offset the currency losses in
certain regions through gains in other regions. This was one of the key
motivations behind Toyota's 1998 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 Eurozone that the British refused to join.
In addition to formal institutional constraints, firms also need to develop a
sophisticated understanding of numerous informal aspects such as cultural
distances and institutional norms. Overall, the value of the core proposition
of the institution-based perspective on strategy, "institutions matter," is
magnified in foreign entry decisions. Rushing abroad without a solid
understanding of institutional differences can be hazardous and even
disastrous.
Where to Enter?
Lesson31of46
Location-Specific Advantages
Like real estate, the motto for international business is "Location, location,
location." In fact, such a spatial perspective (that is, doing business outside
of one's home country) is a defining feature of international business. Two
sets of considerations drive the location of foreign entries:
1. Strategic goals
2. Cultural and institutional distances.
Favorable locations in certain countries may give firms operating there what
are called location-specific advantages. Certain locations simply possess
geographical features that are difficult to match by others. Miami, which
advertises itself as the "Gateway of the Americas," is an ideal location both
for North American firms looking south and Latin American companies
coming north.
Beyond geographical advantages, location-specific advantages also arise
from the clustering of economic activities in certain locations, usually
referred to as agglomeration. Essentially, location-specific advantages stem
from (1) knowledge spillovers among closely located firms that attempt to
hire individuals from competitors, (2) industry demand that creates a skilled
labor force whose members may work for different firms without having to
move out of the region, and (3) industry demand that facilitates a pool of
specialized suppliers and buyers to also locate in the region. Because, due to
agglomeration, certain cities and regions can develop a cluster of related
businesses in the absence of obvious geographic advantages, this idea has
great appeal to policymakers.
Strategic Goals
Given that different locations offer different benefits, it is imperative that
strategic goals be matched with locations. Firms interested in seeking
natural resources have to go to particular foreign locations where those
resources can be found, such as oil in the Middle East, Russia, and
Venezuela.
Market seeking firms go after countries that offer strong demand for their
products and services. For example, the Japanese appetite and willingness to
pay for seafood has motivated seafood exporters around the world - ranging
from the nearby China and Korea to the distant Norway and Peru - to ship
their catch to Japan in order to fetch top dollar (or yen).
Efficiency seeking firms often single out the most efficient locations featuring
a combination of scale economies and low-cost factors. Numerous MNEs
have entered China. Its attractiveness lies in its ability to enhance foreign
entrants' efficiency by lowering total costs. Since the key efficiency concern
is lowest total costs, it is also not surprising that some nominally "high cost"
countries (such as the United States) continue to attract significant foreign
direct investment (FDI). For instance, Grupo Mexico, the world's third largest
copper producer, has moved some of its energy-thirsty refining operations
from "high cost" Mexico to "low cost" Texas, where electricity costs 4 cents
per kilowatt hour as opposed to 8.5 cents in Mexico.
Innovation-seeking firms target countries and regions renowned for
generating world-class innovations, such as Silicon Valley and Bangalore (for
IT), New York and London (for financial services), and Russia (for aerospace).
Such entries can be viewed as "an option to maintain access to innovations
resident in the host country, thus generating information spillovers that may
lead to opportunities for future organizational learning and growth.” - (Mike
Peng, Global Strategy, 2008)
Overall, these four strategic goals, while analytically distinct, are not
mutually exclusive. These location-specific advantages may grow, evolve,
and/or decline. If policymakers fail to maintain the institutional attractiveness
(for example, by raising taxes) and if companies overcrowd and bid up factor
costs such as land and talents, some firms may move out of locations
previously considered advantageous.
Cultural and Institutional Distances
In addition to strategic goals, another set of considerations centers on
cultural/institutional distances. Cultural distance is the difference between
two cultures along some identifiable dimensions (such as individualism).
Considering culture as an informal part of institutional frameworks governing
a particular country, institutional distance is "the extent of similarity or
dissimilarity between the regulatory, normative, and cognitive institutions of
two countries." Many Western consumer products firms have shied away
from Saudi Arabia, citing its stricter rules of personal behavior—in essence,
its cultural and institutional distance being too large.
Two schools of thought have emerged. The first is associated with stage
models, arguing that firms will enter culturally similar countries during their
first stage of internationalization, and that they may gain more confidence to
enter culturally distant countries in later stages. In general, MNEs from
emerging economies perform better in other developing countries,
presumably because of their closer institutional distance and similar stages
of economic development. There is some evidence documenting certain
performance benefits of competing in culturally and institutionally adjacent
countries.
A second school of thought argues that considerations of strategic goals such
as market and efficiency are more important than cultural/institutional
considerations. For instance, natural resource seeking firms have some
compelling reasons to enter culturally and institutionally distant countries
(such as Papua New Guinea for bauxite, Zambia for copper, and Nigeria for
oil).
When to Enter?
Lesson32of46
Unless a firm is approached by unsolicited foreign customers that may lead
to "passive" entries, conscientious entry timing considerations center on
whether there are compelling reasons to be early or late entrants in certain
countries. There is often a quest for first mover advantages, defined as the
advantages that first movers obtain and that later movers do not enjoy. First
mover advantages include:
1. Developing proprietary, technological leadership
2. Preempting scarce assets
3. Establishing entry barriers for late entrants
4. Avoiding clashes with dominant firms in domestic markets
5. Creating good relationships with key stakeholders, such as
customers and governments
However, first movers may also encounter significant disadvantages, which
in turn become late mover advantages. Late mover advantages include:
1. Taking a free ride on first movers’ investments
2. Joining the game with massive firepower when some of the
uncertainties, such as technological and market
uncertainties, are dampened or removed after the
explorations of first movers
3. Taking advantage of first movers’ difficulty to adapt to
market change
Entry timing cannot be viewed in isolation, and entry timing per se is not the
sole determinant of success and failure of foreign entries. It is through
interaction with other strategic variables that entry timing has an impact on
performance.
How to Enter?
Lesson33of46
Scale of Entry
One key dimension in foreign entry decisions is the scale of entry. A number
of European financial services firms, such as ABN Amro, HSBC, and ING
Group, have recently spent several billion dollars to enter the United States
by making a series of acquisitions. The benefits of these 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 other potential entrants. The drawbacks are:
1. Limited strategic flexibility elsewhere
2. Huge losses if these large-scale "bets" turn out to be wrong—
this was the case in the U.S. subprime mess
Small-scale entries are less costly. They focus on organizational learning by
getting firms' "feet" wet - "learning by doing" - while limiting the downside
risk. Overall, there is evidence that the longer foreign firms stay in host
countries, the less liability of foreignness they experience. The drawbacks of
small-scale entries are a lack of strong commitment, which may lead to
difficulties in building market share and in capturing first mover advantages.
Modes of Entry
There are numerous modes of entry, so managers are unlikely to consider all
of them simultaneously. Given the complexity of entry decisions, it is
imperative that managers prioritize, by considering only a few manageable
key variables first and then contemplating other variables later. Therefore, a
decision model is helpful.
First Step
In the first step, considerations for small-scale versus large-scale entries
usually comes 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 controlled), while
non-equity modes do not require such independent establishments.
The distinction between equity and non-equity modes is not trivial. In fact, it
is what defines an MNE: the MNE enters foreign markets via equity modes
through foreign direct investment (FDI). A firm that merely exports/imports
with no FDI is usually not regarded as an MNE. Why would a firm, for
example an oil importer, want to become an MNE by directly investing in the
oil-producing country instead of relying on the market mechanism by
purchasing oil from an exporter in that country?
Relative to a non-MNE, the MNE has three principal advantages: ownership
(O), location (L), and internationalization (I). By owning assets in both oil-
importing and oil-producing countries, the MNE is better able to manage and
coordinate crossborder activities, such as delivering crude oil to the oil
refinery in the importing country right at the moment its processing capacity
becomes available (just-in-time delivery), instead of letting crude oil sit in
expensive ships or storage tanks for a long time. This advantage is therefore
calledownership 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 must be negotiated, prices agreed
upon, and deliveries verified, all of which entail significant costs. What is
costlier is the possibility of opportunism on both sides. For instance, the oil
importer may refuse to accept a shipment after its arrival citing
unsatisfactory quality, but the real reason could be the importer's inability to
sell refined oil downstream (people may drive less due to high oil prices in
the region). The exporter is thus forced to find a new buyer for a boatload of
crude oil on a last-minute "fire sale" basis. The example best describes
location-specific market features and/or factors of production that influence
either firms' ability to improve their financial outcomes. The firms make
provisions for the same product or services on the basis of finding an
alternative or more suitable location based on the region they are operating.
This advantage is calledlocation advantage.
On the other hand, the oil exporter may demand higher-than-agreed-upon
prices, citing a variety of reasons ranging from inflation to natural disasters.
The importer thus has to either (1) pay more or (2) refuse to pay and suffer
from the huge costs of keeping expensive refinery facilities idle. These
transaction costs increase international market inefficiencies and
imperfections. By replacing such a market relationship with a single
organization spanning both countries (a process called internationalization,
basically transforming external markets with in-house links), the MNE thus
reduces cross-border transaction costs and increases efficiencies. This
advantage is calledinternationalization advantage.
Relative to a non-MNE, the MNE, which operates in certain desirable
locations, enjoys a combination of ownership(O), location (L), and
internationalization (I) advantages. These are collectively labeled
theOLI advantagesby John Dunning, a leading MNE scholar.
Overall, the first step in entry mode considerations is extremely critical. A
strategic decision must be made in terms of whether to undertake FDI and
become an MNE by selecting equity modes.
Second Step
During the second step, managers consider variables within each group of
non-equity and equity modes. Looking first at the non-equity mode options, if
the decision is to export, then next on the agenda would be direct exports or
indirect exports. Direct exports represent the most basic mode, capitalizing
on economies of scale in production concentrated in the home country and
affording better control over distribution. 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, prompting
the firm to consider more intimate overseas involvement such as FDI. In
addition, direct exports may provoke protectionism.
Another export strategy is indirect exports through export intermediaries.
This strategy not only enjoys the economies of scale in domestic production
(similar to direct exports), it is also relatively worry-free. A significant amount
of export trade in commodities (such as textiles, woods, and meats), which
compete primarily on price, is indirect through intermediaries. Indirect
exports have some drawbacks because of the introduction of third parties,
such as export trading companies with their own agendas and objectives
that are not necessarily the same as the exporter's.
The next group of non-equity entry modes is contractual agreements
consisting of
1. Licensing/franchising
2. Turnkey projects
3. R&D contracts
4. Co-marketing.
First, in licensing/franchising, the licensor/franchisor sells the rights to
intellectual property such as patents and know-how to the
licensee/franchisee for a royalty fee. The licensor/franchisor, thus, does not
have to bear the full costs and risks associated with foreign expansion. On
the other hand, the licensor/franchisor does not have control over production
and marketing.
Turnkey projects refer to projects in which clients pay contractors to design
and construct new facilities and train personnel. At project completion,
contractors will hand clients the proverbial "key" to facilities ready for
operations—hence the term "turnkey." The advantages entail the ability to
earn returns from process technology in countries where FDI is restricted
(such as power generation). The drawbacks are twofold. First, if foreign
clients are competitors, selling them state-of-the-art technology through
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 (BOT) agreements are
now often used, instead of the traditional ”build-transfer” type of turnkey
projects.
R&D contracts refer to outsourcing agreements in R&D between firms (firm A
agrees to perform certain R&D work for firm B). They allow firms to tap into
the best locations for certain innovations at relatively low costs. However,
three drawbacks may emerge. First, given the uncertain and
multidimensional nature of R&D, these contracts are often difficult to
negotiate and enforce. While delivery time and costs are relatively easy to
negotiate, quality is often difficult to assess. Second, such contracts may
nurture competitors. Finally, firms that rely on outsiders to perform R&D
may, in the long run, lose some of their core R&D capabilities.
Co-marketing refers to efforts among a number of firms to jointly market
their products and services. Fast-food chains such as McDonald's often
launch co-marketing campaigns with movie studios and toy makers to sell
toys based on certain movie characters. The advantages are the ability to
reach more customers. The drawbacks center on limited control and
coordination.
The next group is equity modes, all of which entail some FDI, transforming
the firm into an MNE. A joint venture (JV) is a "corporate child" - that is, a
new entity given birth and jointly owned by two or more parent companies.
JVs have three advantages:
1. The MNE shares costs, risks, and profits with a local partner,
possessing a certain degree of control while limiting risk
exposure
2. The MNE gains access to knowledge about the host country;
the local firm, in turn, benefits from the MNE's capabilities
3. JVs may be politically more acceptable than wholly owned
subsidiaries
In terms of disadvantages, first, JVs often involve partners from different
backgrounds and goals, so conflicts are natural. Second, effective equity and
operational control may be difficult to achieve since everything has to be
negotiated. Finally, the nature of the JV does not give the MNE control over a
foreign subsidiary that it may need for global coordination (such as
simultaneously launching new products around the world). Overall, all sorts
of non-equity-based contractual agreements and equity-based JVs can be
broadly considered as strategic alliances.
The last group of entry modes refers towholly owned subsidiaries
(WOSs). A WOS can be set up in two primary ways. The first is to establish
“greenfield” operations from scratch (on a proverbial piece of "greenfield"
formerly used for agricultural purposes). This has three advantages. First, a
greenfield WOS gives an MNE complete control, thus eliminating the
headaches associated with JVs. Second, this undivided control leads to better
protection of proprietary technology. Third, a WOS allows for centrally
coordinated global actions. Sometimes, a subsidiary will be ordered to launch
actions that by design will lose money. Local licensees/franchisees or JV
partners are unlikely to accept such a subservient role—being ordered to
lose money. In terms of drawbacks, a greenfield WOS tends to be expensive
and risky, not only financially but also politically. The conspicuous
foreignness embodied in such a WOS 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—think
of all the greenfield Japanese automobile transplants built in the United
States. Finally, greenfield operations suffer from a slow market entry speed
(relative to acquisitions).
The second way to establish a WOS is through an acquisition. It is probably
the most important mode in terms of the amount of capital involved
(representing approximately 70% of worldwide FDI). In addition to sharing all
the benefits of greenfield WOS, acquisitions also enjoy two additional
advantages, namely, (1) adding no new capacity and (2) faster market entry
speed. In terms of drawbacks, acquisitions share all the disadvantages of
greenfield WOS, except adding new capacity and slow market entry speed.
In addition, acquisitions have to confront a unique and potentially
devastating disadvantage—post-acquisition integration problems.
Debates and Extensions
Lesson34of46
Global Versus Regional Geographic
Diversification
In this age of globalization, debate continues on the optimal geographic
scope for MNEs. Despite the widely held belief (and frequently voiced
criticism from anti-globalization activists) that MNEs are expanding
”globally,” Alan Rugman and Alain Verbeke report that, surprisingly, even
among the largest Fortune Global 500 MNEs, few are truly ”global.” Using
some reasonable criteria (at least 20% 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), they find a total of only nine MNEs to be “global.”
Should most MNEs further ”globalize”? There are two answers. First, most
MNEs know what they are doing and their current geographic scope is the
maximum they can manage. Some of them may have already over-
diversified and will need to downscope. Second, the data only capture a
snapshot (in the 2000s) and some MNEs may become more ”globalized” over
time. While the debate goes on, it has at least taught us one important
reason: Be careful when using the word ”global.” The majority of the largest
MNEs are not necessarily very ”global” in their geographic scope.
Cyberspace Versus Conventional Entries
From an institution-based view, the arrival of the Internet has sparked a new
debate: Whose rules of the game should e-commerce follow? While pundits
argue that globalization is undermining the power of national governments,
there is little evidence the modern nation-state system is retreating. Legally,
one can argue that a multinational enterprise is a total fiction that does not
exist. Since incorporation is only possible under national law, every MNE is
essentially a bunch of national companies (subsidiaries) registered in various
countries.
Although some suggest that geographic jurisdiction may be meaningless in
cyberspace, others argue that the Internet is ”no more a borderless medium
than the telephone, the telegraph, postal service, facsimile, or smoke signal
[of the ancient times]" (Mike Peng, Global Business, 2009). According to this
view, the Chinese authorities could legitimately demand that Yahoo! China
provide information on a dissident journalist who allegedly threatened
China’s national security by leaking “state secrets” and who was eventually
jailed. However, by complying with the Chinese request, Yahoo! found itself
being labeled “unethical” in the United States, with its CEO and general
counsel being dragged to a Congressional hearing in 2007. In the absence of
harmonization among formal national regulations and informal norms (to
cooperate with versus to resist local security authorities demanding sensitive
information) concerning cyberspace, clashes seem inevitable.
The Savvy Strategist
Lesson35of46
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. First, from an industry-based view, the strategist needs to thoroughly
understand the dynamism underlying the industries in a foreign market.
Second, from a resource-based view, the strategist needs to develop
overwhelming capabilities to offset the liability of foreignness. In 2003,
Britain’s highly capable HSBC bought Household to enter U.S. subprime
mortgage market, and later proved it did not have such capabilities.
Third, from an institution-based view, the strategist needs to understand the
rules of the game, both formal and informal, governing competition in
foreign markets. Failure to understand these rules can be costly. Managers
at Yahoo! initially ignored the rules in France and ended up with bad press as
“defender of Nazi violence.” Finally, the savvy strategist matches entries
with strategic goals. If the goal is to deter rivals in their home markets by
slashing prices there, then be prepared to fight a nasty price war and lose
money. If the goal is to generate decent returns, then withdrawing from
some tough nuts to crack may be necessary (as Walmart did when it
withdrew from Germany.)
Considerable light has been shed on the four fundamental questions. Why
firms differ in their propensity to internationalize (Question 1) boils down to
the size of the firm and that of the domestic market. How firms behave
(Question 2) depends on how considerations for industry competition, firm
capabilities, and institutional differences influence their foreign 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 certainly have something to do with the international
success and failure of firms (Question 4) since inappropriate entry strategies
will torpedo overseas ventures. However, appropriate entry strategies, while
certainly important, are only a beginning. It takes a lot more to succeed
overseas.
Product Diversification
Lesson37of46
Corporate-level strategy is how a firm guides and creates value through the
configuration and coordination of its multimarket activities. While business-
level strategy is very important, for larger, multimarket firms, corporate-level
strategy is equally or perhaps more important.
A key aspect of corporate-level strategy,diversification, 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 strategy. It can be accomplished along two dimensions. The
first isproduct diversification—through entries into different industries.
The second isgeographic diversification—through entries into different
countries.
Most firms start as small businesses focusing on a single product or service
with little diversification, known as a single business strategy. Over time, a
product diversification strategy, with two broad categories (whether related
or unrelated), may be embarked upon.
Product-related diversificationrefers to entries into new product markets
and/or activities that are related to a firm's existing markets and/or
activities. The emphasis is onoperational synergy(also known as scale
economies or economies of scale), defined as increases in competitiveness
beyond what can be achieved by engaging in two product markets and/or
activities separately. In other words, firms benefit from declining unit costs
by leveraging product relatedness. The sources of operational synergy can
be:
1. Technologies (such as common platforms),
2. Marketing (such as common brands), and/or
3. Manufacturing and distribution (such as common logistics).
Product-unrelated diversificationrefers to entries into industries that
have no obvious product-related connections to the firm's current lines of
business. For example, General Electric (GE) competes in appliances, lighting
fixtures, aircraft engines, broadcasting, and financial services. Product-
unrelated diversifiers (such as GE) are calledconglomerates, and their
strategy is known as conglomeration. Instead of operational synergy,
conglomerates focus onfinancial synergy(also known as scope economies
or economies of scope)—namely, increases in competitiveness for each
individual unit financially controlled by the corporate headquarters beyond
what can be achieved by each unit competing independently as standalone
firms.
The mechanism to obtain financial synergy is different from that for
obtaining operational synergy. The key role of corporate headquarters is to
identify and fund profitable investment opportunities. 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 capital markets that try to do the same, a key issue is whether units
affiliated with conglomerates in various industries outperform their
standalone independent competitors in respective industries.
Stated differently, the issue is whether corporate headquarters can do a
better job in identifying and taking advantage of profitable opportunities
than external capital markets. If conglomerate units beat standalone 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. Otherwise, there can be a
diversification discount (or conglomerate disadvantage), when conglomerate
units are better off by competing as standalone 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
business strategies to product-related diversification, but performance may
decrease as firms change from product-related to product-unrelated
diversification—in other words, the linkage seems to be an inverted U shape.
“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 diversificationmay reduce risk, but its
successful execution requires strong organizational capabilities that many
firms lack. Consequently,product-related diversification, essentially
"putting your eggs in similar baskets," has emerged as a balanced way to
both reduce risk and leverage synergy since the 1970s.
However, important caveats exist. Not all product-related diversifiers
outperform unrelated diversifiers. In an age of "core competence," the
continuous existence and prosperity of the likes of GE, Siemens, and Virgin
Group suggest that for a small group of highly capable firms, conglomeration
may still add value in developed economies. Moreover, in emerging
economies, a conglomeration strategy seems to be persisting, with some
units (such as those affiliated with South Korea's Samsung Group, India's
Tata Group, and Turkey's Koc Group) outperforming standalone competitors.
The reason many conglomerates fail is not because this strategy is
inherently unsound, but because firms fail to implement it.
Conglomeration calls for corporate managers to impose a strict financial
discipline on constituent units and hold unit managers accountable.
However, corporate managers may tolerate poor performance of some units,
which can be subsidized by better units. By robbing the better units to aid
the poor ones, corporate managers in essence practice “socialism.” As a
result, over time better units may lose their incentive to do well and
eventually corporate performance suffers.
Geographic Diversification
Lesson38of46
Geographic diversification can be done within one country (expanding from
one city or state to another).International diversificationis the number
and diversity of countries in which a firm competes. Two broad categories of
geographic diversification can be identified. The first islimited
international scope, such as U.S. 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.
The second category isextensive international scope, maintaining a
substantial presence beyond geographically and culturally neighboring
countries. For example, the largest market for Honda is North America,
accounting for 54% of its sales (twice as large as 27% of its sales in its home
region, Asia). While neighboring countries are not necessarily ”easy”
markets, success in distant countries obviously calls for a stronger set of
advantages to compensate for the liability of foreignness 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 presumably are grave. However, the evidence is
not fully supportive of this popular view as shown in the S curve.
As captured by the S curve, two findings emerge. First, at a low level of
internationalization, there is a U-shaped relationship between geographic
scope and firm performance, which suggests an initially negative effect of
international expansion on performance before the positive returns are
realized. This stems from the well-known hazard of liability of foreignness.
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.
There indeed is an intermediate range within which firm performance
increases with geographic scope, leading some studies that sample firms in
this range to conclude that ”there is value in internationalization itself
because geographic scope is found to be related to higher firm profitability.”
However, other studies, which sample firms with a high level of geographic
scope, caution that ”multinational diversification is apparently less valuable
in practice than in theory.” 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.
Combining Product and Geographic Diversification
Lesson39of46
Although most studies focus on a single dimension of diversification (product
or geographic) that is already very complex, in practice, most firms (except
single business firms with no interest to internationalize) have to entertain
both dimensions of diversification simultaneously. There are four possible
combinations.
Firms in Cell 3 are anchored replicators, because they focus on product-
related diversification and a limited geographic scope. They seek to replicate
a set of activities in related industries in a small number of countries
anchored by the home country. Cardinal Health, a leading U.S.
pharmaceutical distributor, pursues such a strategy. Firms in Cell 1 can be
called multinational replicators because they engage in product-related
diversification on one hand and far-flung multinational expansion on the
other. Most automakers, such as 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 GE, Mitsui, Samsung, and Siemens 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. Examples include India’s Tata Group, Turkey’s Koc
Group, and China’s Hope Group.
Overall, migrating from one cell to another, although difficult, is possible. For
instance, most of the current multinational replicators (Cell 1) can trace their
roots as anchored replicators (Cell 3). One interesting migratory pattern in
the past two decades is that many classic conglomerates, such as Finland's
Nokia and South Korea's Samsung, that formerly dominated multiple
unrelated industries in their home countries, have reduced their product
scope but significantly expanded their geographic scope—in other words,
migrating from Cell 4 to Cell 1. 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 every cell, we can find both highly
successful and highly unsuccessful firms.
A Comprehensive Model of Diversification
Lesson40of46
Why do firms diversify? The "strategy tripod" suggests a comprehensive
model of diversification 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
biotechnology), most incumbents have an incentive to engage in product-
related and/or international diversification. However, if it is a "sunset"
industry (think of typewriters for example), many incumbents may exit and
pursue opportunities elsewhere.
In addition to growth opportunities, the structural attractiveness of an
industry, captured by the five forces framework, also has a significant
bearing on diversification. The first force, inter-firm rivalry, is primarily
manifested through two competitive strategies: cost leadership and
differentiation. Pursuing each of them may motivate firms to diversify. A cost
leadership strategy may encourage firms to seek opportunities for product-
related diversification. For example, PepsiCo, a cost leader, recently
diversified into sports drinks. When demand for carbonated beverages, such
as Mountain Dew, flattened out (at least in the United States), PepsiCo’s
considerable distribution capabilities could find some synergy by adding
newly acquired Gatorade products.
A differentiation strategy can also lead to product-related diversification.
Most of us saw the one-and-only (differentiated) Disney movie The Lion King.
Little did we know that Disney unleashed a total of 150 related products
based on The Lion King (such as children's books and toys) and made $3
billion.
Second, entry barriers do not always deter new entrants. For entrants
determined to march into the focal industry or country, high entry barriers
often result in acquisitions, as opposed to green-field entries. For MNEs,
acquiring incumbents to gain immediate market access is an efficient way to
overcome entry barriers.
The bargaining power of suppliers and buyers may prompt firms to broaden
their scope, by acquiring suppliers upstream and/or buyers downstream. For
example, Sony, diversifying downstream, has now become a leading player
in movies and music.
The threat of substitutes also has a bearing on diversification. Kodak and Fuji
have been threatened by Canon, Samsung, and HP, which diversified into
digital cameras—a substitute for photographic 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).
Resource-Based Considerations
The resource-based view—outlined by the VRIO framework—has a set of
complementary considerations underpinning diversification strategies.
Value: Does diversification create value? The answer is "Yes," but only under
certain conditions. Compared with non-diversified single business firms,
diversified firms are able to spread risk. Even for over-diversified firms that
have to restructure, no one is returning to a single business with no
diversification. The most optimal point tends to be some moderate level of
diversification. Beyond risk reduction, diversification can create value by
leveraging certain core competencies, resources, and capabilities. Honda, for
instance, is renowned for its product-related diversification by leveraging its
core competence in internal combustion engines. It not only competes in
automobiles and motorcycles, but also in boat engines, lawnmowers, and its
own clothing line.
Rarity: For diversification to add value, firms must have unique skills to
execute such a strategy. In 2004, an executive team at China's Lenovo
planned to acquire IBM's PC division—a significant move in geographic
diversification. The team confronted Lenovo's suspicious board that raised a
crucial question: if a venerable American technology company had failed to
profit from the PC business, did Lenovo have what it takes to do better when
managing such a complex global business? The answer was actually "No."
The board gave its blessing to the plan only after the acquisition team
agreed to not only acquire the business, but also to recruit top American
executives.
Imitability: While many firms undertake acquisitions, a much smaller
number of them have mastered the art of post-acquisition integration.
Consequently, firms that excel in integration possess hard-to-imitate
capabilities. At Northrop, integrating acquired businesses has progressed to
a "science." Each must conform to a carefully orchestrated plan listing nearly
400 items, from how to issue press releases to which accounting software to
use. Unlike its bigger defense rivals such as Boeing and Raytheon, Northrop
thus far has not stumbled with any of the acquisitions.
Organization: Fundamentally, whether diversification adds value comes
down to how firms are organized to take advantage of the benefits while
minimizing the costs. Given the recent popularity of product-related
diversification, many people believe that product-unrelated diversification is
an inherently value-destroying strategy. However, this is not true. With
proper organization, product- unrelated diversification can add value.
Product-related diversifiers need to foster a centralized organizational
structure with a cooperative culture. The key is to explore operational
linkages among various units, and some units may need to be pulled back to
coordinate with other units. For example, to maximize corporate profits,
Disney’s animation division producing the movie The Lion King had to wait
before launching the movie until its merchandise divisions were ready to
market and sell related merchandise. If animation managers’ bonuses were
linked to the annual box-office receipts of the movie, they would obviously
be eager to release the movie. But if bonuses were linked with overall
corporate profits, then animation managers would be happy to assist and
coordinate with their merchandise colleagues and would not mind waiting for
a while.
Consequently, corporate headquarters should not evaluate division
performance solely based on strict financial targets (such as sales). The
principal control mechanism is strategic control (or behavior control), based
on largely subjective criteria to monitor and evaluate units' contributions
with rich communication between corporate and divisional managers.
However, the best way to organize conglomerates is exactly the opposite.
The emphasis is on financial control (or output control), based on largely
objective criteria (such as return on investment) to monitor and evaluate
units' performance. Because most corporate managers have experience in
only one industry (or a few industries) and none realistically can be an expert
in the wide variety of unrelated industries represented in a conglomerate,
corporate headquarters is forced to focus on financial control, which does not
require a lot of rich industry-specific knowledge. Otherwise, corporate
managers will experience a tremendous information overload (too much
information to process).
Consequently, the appropriate organizational structure is decentralization
with substantial divisional autonomy—in other words, structurally separate
units. To keep divisional managers focused on financial performance, their
compensation should be directly linked with quantifiable unit performance.
Thus, the relationship among various divisions is competitive, each trying to
attract a larger share of corporate investments. Such competition within an
internal capital market is similar to standalone firms competing for more
funds from the external capital market.
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
The comprehensive model of diversification included institution-based
considerations, an important component of the “strategy tripod.” The
institution-based view suggests that formal and informal institutional
conditions directly shape diversification strategy. Formal institutions affect
both product and geographic diversification. Informal institutions can be
found along normative and cognitive dimensions.
Formal institutions affect diversification strategies. The rise of conglomerates
in the 1950s and 1960s in developed economies was inadvertently promoted
by formal constraints designed to curtail product-related diversification. In
the United States, the post-1950 anti-trust authorities viewed product-
related diversification (especially mergers), designed to enhance firms'
market power within an industry, as "anti-competitive" and challenged them.
Thus, firms seeking growth were forced to look beyond their industry,
triggering a great wave of conglomeration. By the 1980s, the U.S.
government changed its mind and no longer critically scrutinized related
mergers within the same industry. It is not a coincidence that the movement
to dismantle conglomerates and focus on core competencies has taken off
since the 1980s.
Similarly, the popularity of conglomeration in emerging economies is often
underpinned by their governments' protectionist policies. Conglomerates
(often called business groups in emerging economies) can leverage
connections with governments by obtaining licenses, arranging financing
(often from state-owned or state-controlled banks), and securing technology.
As long as protectionist policies prevent significant foreign entries,
conglomerates can dominate domestic economies. However, when
governments start to dismantle protectionist policies, competitive pressures
from foreign multinationals (as well as domestic non-diversified rivals) may
intensify. These changes may force conglomerates to improve performance
by reducing their scope.
Likewise, the significant rise of geographic diversification undertaken by
numerous firms can be attributed, at least in part, to the gradual opening of
many economies initiated by formal market-supporting and market-opening
policy changes.
Informal institutions can be found along normative and cognitive dimensions.
Normatively, managers often seek to behave in ways that will not cause
them to be noticed as different and consequently singled out for criticism by
shareholders, board directors, and the media. Therefore, when the norm is to
engage in conglomeration, more and more managers may simply follow such
a norm. Poorly performing firms are especially under such normative
pressures.
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 of the firm and its shareholders. These
are called managerial motives for diversification, such as:
1. Reduction of managers' employment risk
2. Pursuit of power, prestige, and income.
Because single business firms are vulnerable to economy-wide ups and
downs (such as recessions), managers' jobs and careers may be at risk.
Thus, managers may have an interest to diversify their firms in order to
reduce their own employment risk. In addition, since power, prestige, and
income are typically associated with a larger firm size, some managers may
have self-interested incentives to over-diversify their firms, resulting in value
destruction. Such excessive diversification is known as empire building.
The Evolution of the Scope of the Firm
The institution-based view suggests that formal and informal institutional
conditions directly shape diversification strategy. Taken together, the
industry-based, resource-based, and institution-based views collectively
explain how the scope of the firm evolves around the world.
At its core, diversification is essentially driven by economic benefits and
bureaucratic costs. Economic benefits are the various forms of operational or
financial synergy. Bureaucratic costs are the additional costs associated
with a larger, more diversified organization, such as more headcounts and
more complicated information systems. Overall, it is the difference between
the benefits and costs that leads to certain diversification strategies.
Since the economic benefits of the last unit of growth (such as the last
acquisition) can be defined as marginal economic benefits (MEB) and the
additional bureaucratic costs incurred as marginal bureaucratic costs (MBC),
the scope of the firm is thus determined by a comparison between MEB and
MBC.
What Determines the Scope of the Firm?
The optimal scope is at point A, where the appropriate level of diversification
should be D1. If the level of diversification is D2, some economic benefits can
be gained by moving up to D1. Conversely, if a firm 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 MED and MBC.
The Evolution of the Scope of the Firm
In the United States, between the 1950s and 1970s, if we hold MBC constant,
the MEB curve shifted upward, resulting in an expanded scope of the firm on
average (moving from D1to D2). Today, the economic benefits continue to
move to the right, while the costs move to the left.
The MEB curve shifted upward because of:
1. Growth opportunities within the same industry through
product-related diversification, especially for large firms,
were blocked by formal institutions such as anti-trust
policies,
2. The emergence of organizational capabilities to derive
financial synergy from conglomeration
3. The diffusion of these actions through imitation, leading to an
informal but visible norm among managers that such
product-unrelated growth was legitimate.
During that time, external capital markets, which were less sophisticated,
were supportive, believing that conglomerates had an advantage in
allocating capital.
However, by the early 1980s, significant transitions occurred along industry,
resource, and institutional dimensions. First, mergers and acquisitions
(M&As) within the same industry were no longer critically scrutinized by the
government, making it unnecessary to focus on unrelated diversification in
different industries. Second, a resource-based analysis suggests that given
the VRIO hurdles, it would be extremely challenging, though not impossible,
to derive competitive advantage from conglomeration. In other words, with
an expanded scope of the firm, MBC also increased, often outpacing the
increase in MEB. Many firms over-diversified and destroyed value.
Consequently, a dramatic reversal in U.S. investor sentiment occurred
toward conglomeration: Positive in the 1960s, neutral in the 1970s, and
negative in the 1980s. Parallel to these developments, external capital
markets became better developed, with more analysts and more transparent
and real-time reporting, all of which allowed for more efficient channeling of
financial resources to high-potential firms. As a result, the conglomerate
advantage serving as an internal capital market became less attractive.
Finally, informal norms and cognitions changed, as managers increasingly
became more disciplined and focused on shareholder value maximization
and believed that reducing the scope of the firm was the "right" thing to do.
All these combined to push the appropriate scope of the firm from D2to D3by
the 1990s and early 2000s.
The Optimal Scope of the Firm: Developed
Versus Emerging Economies
Globally, an interesting extension is to understand the puzzle as to why
conglomeration, 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. 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> MEBDevelopingEcon. This is
primarily 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<
MBCDevelopingEcon. In emerging economies, because of the weakness of formal
institutions, informal constraints rise to play a larger role in regulating
economic exchanges. Most conglomerates in these countries are family
firms, whose managers rely more on informal personal (and often family)
relationships to get things done. Relative to firms in developed economies,
firms in emerging economies typically feature a lower level of
bureaucratization, formalization, and professionalization, which may result in
lower bureaucratic costs.
Consequently, for any scope between D1and D2(such as D3), firms in
developed economies at point C need to be downscoped toward point A (D1),
whereas there is still room to gain for firms in emerging economies at point
E, which can move up to point B (D2). However, bear in mind that
conglomerates in emerging economies confront the same problem that
plagues those in developed economies: The wider the scope, the harder it is
for corporate headquarters to coordinate, control, and invest properly in
different units. For conglomerates in emerging economies, there is also a
point beyond which further diversification may backfire. Overall, industry
dynamics, resource repertoires, and institutional conditions are not static,
nor are diversification strategies.
Acquisitions
Lesson41of46
Although the term mergers and acquisitions (M&As) is often used, in reality,
acquisitions dominate the scene. Anacquisitionis transfer of the control of
assets, operations, and management from one firm (target) to another
(acquirer), the former becoming a unit of the latter. Amergeris the
combination of assets, operations, and management of two firms to establish
a new legal entity. Only approximately 3% of cross-border M&As are
mergers. Even many so-called "mergers of equals" turn out to be one firm
taking over another.
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 BP/Amoco). 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
suppliers (upstream) and/or buyers (downstream) (such as Sony/Columbia
Pictures). About 10% of cross-border M&As are vertical ones. Conglomerate
M&As are transactions involving firms in product-unrelated industries (such
as Vivendi/Universal). Roughly 20% of cross-border M&As are conglomerate
deals.
The terms of M&As can be friendly or hostile. In friendly M&As, the board and
management of a target firm agree to the transaction. Hostile M&As (also
known as hostile takeovers) are undertaken against the wishes of the target
firm's board and management, who reject M&A offers. In the United States,
hostile M&As are more frequent; internationally, hostile M&As are very rare.
Understanding Cross-Border M&As
The various types of cross-border (international) M&As are illustrated below.
Cross-border activities represent approximately 30% of all M&As, and M&As
represent the largest proportion (about 70%) of FDI flows.
Motives for Mergers and Acquisitions
What drives M&As? Three drivers are(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 rationale is to enhance and consolidate market power. From a
resource-based view, the most important synergistic rationale is to leverage
superior resources. Another motive is to gain access to complementary
resources. 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. It is not a coincidence that the number of
cross-border M&As has skyrocketed 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
capabilities. While the hubris motives suggest that managers may
unknowingly overpay for targets, managerial motives posit that for self-
interested reasons, some managers may have knowingly overpaid the
acquisition premium for target firms. Driven by such norms and cognitions,
some managers may have deliberately over-diversified their firms through
M&As.
Performance of Mergers and Acquisitions
Despite the popularity of M&As, their performance record is rather sobering.
As many as 70% of M&As reportedly fail. On average, acquiring firms'
performance does not improve after acquisitions and is often negatively
affected. Target firms, after being acquired, often perform worse than when
they were independent standalone firms. The only identifiable group of
winners is shareholders of target firms, who may experience, on average, a
24% increase in their stock value during the period of the transaction (thanks
to the acquisition premium, an above-the-market price to acquire another
firm). Shareholders of acquiring firms experience a 4% loss of their stock
value during the same period.
Why do many acquisitions fail? Problems can be identified in both pre-
acquisition and post-acquisition phases. 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.” Another
primary pre-acquisition problem is inadequate screening and failure to
achieve strategic fit, which is the effective match of complementary strategic
capabilities.
During the post-acquisition phase, numerous integration problems may pop
up. Even when the acquiring firms have paid attention to strategic fit, it is
important to also consider organizational fit, which is the similarity in
cultures, systems, and structures. One study reports that a striking 80% of
acquiring firms do not analyze organizational fit with targets.
Another issue is the failure to address multiple stakeholders' concerns during
integration, which involves job losses, restructured responsibilities,
diminished power, and much else that is stressful. Substantial concerns
arise among a variety of stakeholders, such as investors and customers, as
well as employees at all levels. Most companies focus on task issues (such as
standardizing financial reporting) first, and pay inadequate attention to
people issues, resulting in low morale and high turnover, especially among
its best talents.
In cross-border M&As, integration difficulties may be much worse, because
clashes of organizational cultures are compounded by clashes of national
cultures. Overall, although acquisitions are often the largest capital
expenditures most firms ever make, they are frequently the worst planned
and executed activities of all. Unfortunately, when merging firms try to sort
out the mess, competitors are likely to launch aggressive attacks to take
advantage of the chaos.
Stakeholders’ Concerns During Mergers and
Acquisitions
Investors Will synergy benefits be
downscaled?
Optimistic view of return
on investment?
Will efficiency & short-term
revenues fall?
Top
Management
Synergies difficult to
attain
Internal conflicts: factious
management groups, key
staff leave
Unrealistic euphoria
Middle
Management
Concern over job
security
Expected to do M&A +
day jobs at the same time
Overwhelmed by scale and
scope
Front-line
Employees
What should I tell my
customers? When do lay-offs begin? Who is setting my
priorities and objectives?
Customers So what? Service quality dips,
relationship suffers
No one is listening to me.
Do I still matter?
Restructuring
Lesson42of46
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, its most common definition is reduction of firm
size and scope. There are two primary 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). Another side of downscoping is refocusing,
namely, narrowing the scope of the firm to focus on a few areas.
We can draw on industry-based, resource-based, and institution-based views
to understand the motives for restructuring. From an industry-based view,
restructuring is often triggered by a rising level of competition within an
industry (such as telecommunications). The resource-based view suggests
that while restructuring may bring some benefits, significant costs also arise
(such as organizational chaos, anxiety, and low morale). When most rivals
restructure, these activities may not generate sustainable value, are not
rare, and cause organizational problems. In short, it is "not possible for firms
to ‘save’ or ‘shrink’ their way to prosperity.”
From an institution-based perspective, by the 1980s and 1990s, firms in
developed economies increasingly felt pressure from capital markets to
restructure. Managers increasingly accepted restructuring to be a part of
legitimate business undertaking. However, strong institutional pressures
against restructuring also exist. In the United States, restructuring, job loss,
and outsourcing have been controversial issues in every presidential election
since the 1990s. Overall, corporate restructuring is not widely embraced
around the world.
Debates and Extensions
Lesson43of46
Product Relatedness Versus Other Forms of
Relatedness
What exactly is relatedness? While the idea of product relatedness is
seemingly straightforward, it has attracted at least three significant points of
contention. First, how to actually measure product relatedness remains
debatable. Starbucks now sells music CDs in its coffee shops. Are coffee and
music related? The answer would be both ”yes” and ”no,” depending on how
you measure relatedness. Second, beyond measurement issues, an
important school of thought, known as the “dominant logic” school, argues
that it is not only the visible product linkages that can count as ”product
relatedness.” Rather, it is a set of common underlying dominant logic that
connects various businesses in a diversified firm. Consider Britain's
easyGroup, which operates easyJet (airline), easyCinema, and
easylnternetcafe, 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.
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 which
confer resources and legitimacy” (Mike Peng, Global Strategy, 2008). For
example, sound informal relationships with government agencies, in
countries (usually emerging economies) where such agencies control crucial
resources such as licensing, financing, and labor pools, would encourage
firms to leverage such relationships by entering multiple industries. In
emerging economies, solid connections with banks may help raise financing
to enter multiple industries, whereas standalone entrepreneurial start-ups
without such connections often have a hard time securing financing.
Acquisitions Versus Alliances
Despite the proliferation of acquisitions, their lackluster performance has led
to a debate regarding whether they have been overused. Strategic alliances
are an alternative to acquisitions. However, many firms seem to have
plunged straight into ”merger mania.” Even when many firms pursue M&As
and alliances, they are often undertaken in isolation. While many large MNEs
have an M&A function and some have set up an alliance function, virtually no
firm has established a combined ”mergers, acquisitions, and alliance”
function. In practice, it may be advisable to explicitly compare and contrast
acquisitions vis-á-vis alliances.
Compared with acquisitions, strategic 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 would
probably have been better off had firms pursued alliances first. At present it
is inconclusive whether alliances are actually better than acquisitions.
Nevertheless, it seems imperative that firms seriously and thoroughly
investigate alliances as an alternative to acquisitions.
The Savvy Strategist
Lesson44of46
Guided by the three leading perspectives that lead to the "strategy tripod,"
the savvy strategist draws three important implications for action. First, the
strategist must understand the nature of the industry that may call for
diversification, acquisitions, and restructuring. In some "sunset" industries,
diversification 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, the strategist and the firm need to develop capabilities that
facilitate successful acquisitions and restructuring. These would include do
not overpay for targets and focus on both strategic and organizational fit.
Finally, the strategist needs to master the rules of the game—both formal
and informal—governing acquisitions around the world.
What determines the scope of the firm? Industry conditions, resource
repertoire, and institutional frameworks shape corporate scope. In addition,
why firms differ and how firms behave boil down to why and how they
choose different diversification strategies. Finally, what determines the
success and failure of firms around the globe? The answer lies in whether
they can successfully overcome the challenges associated with
diversification, acquisitions, and restructuring.
