International business is defined as a business (or firm) that engages in international (cross border) economic activities and/or doing business abroad.
The most frequently discussed foreign entrant is the multinational enterprise (MNE). This is a firm that engages in foreign direct investment (FDI).
Foreign direct investment is investment in, controlling, and managing value-added activities in other countries.
What is global business? Global business included both international business activities covered by traditional IB books and also domestic business activities.
Emerging markets (same as emerging economies): A term that has gradually replaced the term ‘developing countries’ since the 1990s.
GDP: Gross domestic product: The sum of value added by resident firms, households and government operating in the economy. Another parameter is the purchasing power parity, which is an adjustment to reflect the differences in cost of living.
PPP: Purchasing Power Parity is a conversion that determines the equivalent amount of goods and services different currencies can purchase.
Important emerging economies: BRIC: This stands for Brazil, Russia, India and China. As a group, they generate 28% of world GDP ( on a PPP basis ).
Difference between GNP (Gross national Product) and GNI (Gross national Income):
GNP is the gross domestic product + income from nonresident sources abroad.
GNI: Gross domestic product plus income from income from nonresident sources abroad. GNI is the term used by the world bank and other international organizations to supersede the term GNI.
The global economy can be viewed as a pyramid. The top consists of about one billion people with per capita annual income of $20000. These are mostly people who live in the developed economies in the Triad.
Triad: North America, Western Europe and Japan.
Second tier: $2000-$20000
Base of the pyramid: Economies where people make less than $2000,- a year.
There are 3 reasons why it is important to study global business:
1. enhance your employability and advance your career in the global economy
2. better preparation for possible expatriate assignments abroad
3. stronger competence in interacting with foreign suppliers, partners, and competitors and in working for foreign-owned employers in your own country
G-20: group of 19 major countries plus the EU whose leaders meet on a biannual basis to solve global economic problems
Bi-annual means 2 times a year.
Expatriate manager(expat): a manager who works abroad
International premium: a significant pay raise when working overseas. So a compensation for people when they work overseas.
Global business is a vast subject area. The study of global business is very interdisciplinary.
What determines the success and failure of firms around the globe? This fundamental question can be answered and determined with 2 different views:
1. First core perspective: an institution-Based view
An institution based view suggests that the success and failure of firms are enabled and constrained by institutions. Institutions are rules of the game.
formal rules: laws
informal rules: values
Formal institutions include regulations and laws
Informal institutions include cultures, ethics, and norms.
Overall, an institution-based view suggests that institutions shed a great deal of light on what drives firm performance around the globe.
2. Second core perspective: a resource-Based view
The resourced based view has emerged to overcome this drawback. Although the institution based view primarily deals with the external environment, the resource-based
view focuses on a firms internal resources and capabilities.
Liability of foreignness: the inherent disadvantage that foreign firms experience in host countries because of their nonnative status.
This is a key theme of the resource-based view, which focuses on how winning firms acquire and develop such unique and enviable resources and capabilities and how
competitor firms imitate and then innovate in an effort to outcompete the winning firms.
What is globalization?
Globalization is the close integration of countries and peoples of the world.
It is important that there are three ways of understanding globalization.
Depending on what sources you read, globalization could be:
Thee views, namely:
1. a new force sweeping through the world in recent time
2. a long run historical evolution since the dawn of human history
3. a pendulum that swings from one extreme to another from time to time
The pendulum view on globalization:
Most sense because it can help us understand the ups-and-downs of globalization.
The pendulum view suggests that globalization is unable to keep going in one direction.
The recession and crisis reminds all firms and managers of the importance of risk management.
Risk management: the identification and assessment of risks and the preparation to minimize the impact of high-risk, unfortunate events.
As a technique to prepare and plan for multiple scenarios (either high risk or low risk). Scenario planning is now extensively used by firms around the world.
Scenario planning: A technique to prepare and plan for multiple scenarios(either high or low risk)
Despite the debate over the far-reaching impact of globalization, globalization is not complete. Most measures of market integration have recently scaled new heights, but still fall far short of a single , globally integrated market.
Semi globalization is more complex than extremes of total isolation and total globalization.
Semi globalization: A perspective that suggests that barriers to market integration at
borders are high, but not high enough to completely insulate countries from each other.
Nongovernmental organizations(NGOs): organizations that are not affiliated with governments
Understanding institutions
Institutions: formal and informal rules of the game
Institutional transitions: Fundamental and comprehensive changes introduced to the forma land informal rules of the game that affect firms as players
Institution based view: A leading perspective in global business that suggests that the success and failure of firms are enabled and constrained by institutions.
Institutional framework: forma land informal institutions governing individual and firm behaviour.
Important for understanding institutions is to understand the institutional framework.
Institutional framework: formal and informal institutions governing individual and firm behavior.
Formal institutions include laws, regulations and rules.
Examples:
· laws
· Regulations
· Rules
Supportive pillars:
· Regulatory(coercive)(the coercive power of governments)
Informal institutions:
Examples:
· Norms
· Cultures
· Ethics
Supportive pillars:
· Normative: the mechanism through which norms influence individual and firm behavior.
· Cognitive: the internalized (or taken for granted) values and beliefs that guide individual and firm behavior.
What do institutions do?
Institutions reduce uncertainty! Important in international business is that you get how institutions reduce uncertainty. Specifically, institutions influence the decision-making process of both individuals and firms by signaling what conduct is legitimate and acceptable and what.
Without stable institutional frameworks, transaction costs may become prohibitively high,to a extent that certain transactions simply would not take place
Transaction costs: the costs associated with economic transactions or, more broadly, the costs of doing business
An important source of transaction costs is opportunism.
Opportunism: the act of seeking self interest with guile Examples include misleading, cheating, and confusing other parties in transactions that will increase transaction costs.
An institution- based view of global business
An institution-based view of global business, focuses on the dynamic interaction between institutions and firms and considers firm behavior as the outcome of such an interaction.
It is important that the two core propositions can be identified that are underpinning an institution based view of global business.
Proposition 1: managers and firms pursue their interests and make choices rationally within the form and informal constraints in a given institutional framework
Proposition 2: although formal and informal institutions combine to govern firm behavior, in situations where formal constraints are unclear or fail, informal constraints
will play a larger role in reducing uncertainty and providing constancy to managers and firms
The formal institutions:
Political systems: the rules of the game on how a country is governed politically.
What are the differences between democracy and totalitarianism?
· Democracy: is a political system in which citizen elect representatives to govern the country on their behalf. A fundamental aspect of democracy that is relevant to
global business is an individual’s right to freedom of expression and organization.
In most modern democracies, the right to organize economically has been extended not only to domestic individuals and firms, but also to foreign individuals and firms that come to do business.
· Totalitarianism (dictatorship): a political system in which one person or party exercises absolute political control over the population.
There are 4 types of totalitarianism namely:
1. Communist totalitarianism centers on a communist party
2. Right-wing totalitarianism is characterized by its intense hatred of communism.
One party, typically backed by the military, restricts political freedom because its members believe that such freedom would lead to communism.
3. Theocratic totalitarianism refers to the monopolization of political power in the hands of one religious party or group.
4. Tribal totalitarianism refers to one tribe or ethic group(which may or may not be the majority of the population monopolizing political power and oppressing
other tribes or ethnic groups
Political risk: risk associated with political changes that may negatively impact domestic and foreign firms.
Although the degree of hostility toward business varies among different types of totalitarianism, totalitarianism in general is not as good for business as democracy. Totalitarian countries often experience wars, riots, protests, chaos and breakdowns, which result in higher political risk.
The most extreme political risk may lead to the nationalization (expropriation) of foreign assets (activa). Firms operating in democracies also confront political risk. However, such risk is qualitatively lower than that in totalitarian states. In 1990 globalization took off, in this time the democracy expanded around the world.
Legal systems: the rules of the game on how a country’s laws are enacted and enforced. By specifying the do’s and don’ts, a legal system reduces transaction costs by minimizing uncertainty and combating opportunism.
· Civil law: a legal tradition that uses comprehensive statutes and codes as a
primary means to form legal judgments. Civil law is less confrontational because comprehensive statutes and codes serve to guide judges
·Common law: A legal tradition that is shaped by precedents and traditions from previous judicial decisions. Common law is more confrontational because plaintiffs and defendants must argue and help judges to favorably interpret the law largely based on precedents.
So, common law has more flexibility because judges have to resolve specific disputes based on their interpretation of the law, and such interpretation may give new meaning to the law, which will in turn shape future cases.
· Theocratic law: A legal system based on religious teachings
Overall, legal systems are a crucial component of the institutional framework because they form the first, regulatory pillar that supports institutions. They directly impose the do’s and don’ts on businesses around the globe
What are property rights and why are these rights such important?
One fundamental economic function that a legal system serves is to protect property rights.
Property rights: the legal rights to use an economic property(resource) and to derive income and benefits from it. Examples include homes, offices and factories.
When a legal system is stable and predictable, tangible property also makes other, less tangible economic activities possible. For example, property can be used as collateral for credit.
What the developing world lacks and desperately needs is formal protection of property
rights in order to facilitate economic growth.
Although the term ‘property’ traditionally refers to tangible pieces of property, such as land, intellectual property specifically refers to intangible property that is a result of intellectual activity (such as books, videos and websites).
Intellectual property: intangible property that is the result of intellectual activity
Intellectual property rights: rights associated with the ownership of intellectual Property.
Examples:
· Patents: exclusive legal rights of inventors of new products or processes to derive income from such inventions. The inventors are given exclusive (monopoly) rights to derive income from such inventions through activities such as manufacturing, licensing or selling.
· Copyrights: exclusive legal rights of authors and publishers to publish and disseminate their work. Good example is this book.
· Trademarks: exclusive legal rights of firms to use specific names, brands, and designs to differentiate their products from others.
Overall, an institution based view suggests that the key to understanding IPR violation is realizing that IPR violaters are not amoral monster, but ordinary people and firms.
IPR need to be asserted and enforced through a formal system, which is designed to punish violators and to provide an incentive for people and firms to innovate.
IPR: Intellectual property rights.
Economic systems: Rules of the game on how a country is governed economically.
At the two ends of a spectrum, we can find a market economy and a command economy.
· Market economy: an economy that is characterized by the invisible hand of market forces. All factors of production should thus be privately owned. Lassez faire.
· Command economy: an economy that is characterized by government ownership and control of factors of production. All factors of production should be owned and controlled by the government.
· Mixed economy: an economy that has elements of both a market economy and a command economy.
No country has ever had a complete command economy, and no country has ever completely embraced lassez faire (total market economy).
Conclusion: most economy’s are mixed economy.
Debates and extensions
Drivers of economic development: culture, geography, or institutions?
· The culture side argues that rich countries tend to have a smarter rand harderworking population driven by a stronger motivation for ecnomic success. This
line of thinking, bordering on racism, is no longer acceptable in the 21st century.
· The geography school of thought in this debate suggests that rich countries tend to be well endowed with natural resources. This argument is not convincing
either. Geography is important, but not destiny.
· Institutional scholars argue that institutions are ‘the basic determinants of the performance of an economy’. Rich countries are rich because they have developed better market supporting institutional frameworks.
1. It is economically advantageous for individuals and firms to grow and specialize in order to capture the gains from trade.
2. A lack of strong formal market supporting institutions forces individuals to trade on an informal basis with a small neighboring group and forces firms to remain small, thus foregoing the gains from a sharper division of labor by trading on a larger scale with distant partners.
3. Emergence of formal, market supporting institutions encourages individuals to specialize and firms to grow in size to capture the gains from complicated long distance trade.
4. When formal market supporting institutions protect property rights, they fuel more innovation, entrepreneurship, and thus economic growth.
These arguments are the backbone of the institution based view of global business.
Private ownership versus state ownership
Washington consensus: a view centered on the unquestioned belief in the superiority of private ownership over state ownership in economic policy making, which is often
spearheaded by two Washington based international organizations: the international monetary fund and the world bank.
Despite noble goals to rescue the economy, protect jobs and fight recession, government bailouts serve to heighten moral hazard.
Moral hazard: recklessness when people and organizations(including firms and governments) do not have to face the full consequences of their actions.
Where do informal institutions come from?
Informal institutions primarily come from socially transmitted information and are a part of the heritage that we call cultures, ethics and norms.
Ethnocentrism: a self-centered mentality held by a group of people who perceive their own culture ethics and norms as natural, rational end morally right.
Culture
Definition of culture: Culture is the collective programming of the mind that distinguishes the members of one group or category of people from another.
First, no strict one to one correspondence between cultures and nation states exists.
Second, culture has many layers.
Language
Lingua franca: a global business language. Yet, the dominance of English as a global business language.
Managers and firms ignorant of foreign languages and religious traditions may end up with embarrassments and, worse, disasters when doing business around the
globe.
Important for firms: Know the lingua franca!
First, English speaking countries contribute the largest share of global output.
Second, recent globalization has called for the use of one common language.
On the other hand, the dominance of English may also lead to a disadvantage.
Religion: Religion is another major manifestation of culture. Approximately, 85% of the world’s population reportedly have some religious belief.
The four leading religions are Christianity, Islam, Hinduism, and Buddhism.
Because religious differences have led to numerous challenges, knowledge about
religions is crucial even for non religious managers.
Overall, managers and firms ignorant of religious traditions and differences may end up with embarrassments and, worse, disasters.
Social structure refers to how a society broadly organizes its members with rigidity or flexibility. Two terms are key to this discussion.
1. Social stratification: the hierarchical arrangement of individuals into social categories such as classes, castes, or divisions within a society
2. Social mobility: the degree to which members from a lower social category can rise to a higher status.
Social structure is the outcome of a society’s formal and informal rules of the game that give birth to its norms and values.
MNEs operating in highly socially stratified countries need to be sensitive to local hiring and staffing norms. The most suitable person for a job may not necessarily
be the most technically qualified individual.
Education
Education is an important component of any culture. From an early age, schools teach children the mainstream values and norms and foster a sense of cultural identity.
In collectivistic societies, schools oftern foster collectivistic values and ephasize the ‘right’ answers in learning.
In individualistic societies, school emphasize individual initiatives and encourage more independent thinking, emphasizing questions with no right or wrong answer’
In socially rigid societies, education(especially access to a small number of elite schools and universities) is one of the primary means to maintain social stratification.
On the other hand, in socially mobile societies, education is typically one of the leading forces in breaking down social barriers.
Overall, the dramatic expansion of higher education around the world in the postwar decades has increased social mobility.
In addition to language, religion, social structure, and education, culture is manifested in numerous other ways.
Cultural differences:
The context approach
Context: the underlying background upon which social interaction takes place.
Of the three main approaches probing into cultural differences, the context approach is the most straightforward, because it relies on a single dimension.
Low context culture: A culture in which communication is usually taken at face value without much reliance on unspoken text. No means no. Western countries
High context culture: A culture in which communication relies a lot on the underlying unspoken context, which is as important as the word used. No does
not necessarily mean no.
Context is important because failure to understand the differences in interaction styles may lead to misunderstanding. In high context countries, initial rounds of negotiations are supposed to create the ‘context’ for mutual trust and friendship.
The cluster approach: The cluster approach groups countries that share similar cultures together as one cluster.
Cluster: countries that share similar cutures
Cultural clusters:
1. Ronen and shenkar cluster
2. GLOBE clusters
3. Huntington civilizations
Civilization: the highest cultural grouping of people and the broadest level of cultural identity people have.
We do need to appreciate the underlying idea that people and firms are more comfortable doing business with other countries within the same cluster/civilization.
This is because common language history religion and customs within the same cluster reduce the liability of foreignness when operating abroad
The dimension approach: although both the context and cluster approaches are interesting, the dimension approach is more influential. The reasons for such influence are probably twofold.
Why?
- First: Insightful as the context approach is, context only represents one dimension.
- Second, the cluster approach has relatively little to offer regarding differences between countries within one cluster.
Hofstede and his colleagues have proposed five dimensions:
1. Power distance
Power distance is the extent to which less powerful members within a country expect and accept that power is distributed unequally.
2. Individualism
Individualism is the idea that an individual’s identity is fundamentally his or her own, whereas collectivism is the opposite.
Collectivism is the idea that an individual’s identity is fundamentally tied to the identity of his or her collective group.
In individualistic societies ties between individuals are relatively loose and individual achievement and freedom are highly valued.
In collectivist societies, ties between individuals are Nongovernmental organizations(NGOs): organizations that are not affiliated with governments are often sought after.
3. Masculinity versus Femininity
Masculinity: a relatively strong form of societal-level sex role differentiation whereby men tend to have occupations that reward assertiveness and women tend to work in caring professions.
Femininity: a relatively weak form of societal-level sex role differentiation whereby more women occupy positions that reward assertiveness and more men work in caring professions.
4. Uncertainty avoidance
Uncertainty avoidance refers to the extent to which members in a culture accept or avoid ambiguous situations an uncertainty.
Members of high uncertainty avoidance cultures place a premium on job security and retirement benefits. They also tend to resist change, which often creates uncertainty. A good example is Greece.
Low uncertainty avoidance cultures are characterized by a greater willingness to take risk and less resistance to change. A good example is Singapore.
5. Long term orientation
Long term orientation: dimension of how much emphasis is placed on perseverance and savings for future betterment.
Members of short term orientation societies prefer quick results and instant gratification.(Pakistan)
Culture and global business.
Overall, there is strong evidence pointing out the importance of culture. Sensitivity to cultural differences does not guarantee success but can at least help to avoid blunders.
A great deal of global business activity is consistent with the context, cluster, and dimension approaches to cultural differences. Firms are a lot more serious in preparation when doing business with countries in other clusters compared to how they deal with fellow countries within the same cluster.
Individualism and collectivism also affect business activities. Likewise, masculinity and
femininity affect managerial behavior. Managers in low uncertainty avoidance countries such as Britain rely more on experience and training , whereas managers in high uncertainty avoidance countries such as china rely more on rules. Managers in high power distance countries such as France have a greater penchant for centralized authority.
Ethics refers to the principles, standards, and norms of conduct that govern individual and firm behavior.
Code of conduct: a set of guidelines for making ethical decisions.
Three views:
1. A negative view suggest that firms may simply jump onto the ethics bandwagon under social pressure to appear more legitimate without necessarily becoming better.
2. A positive view maintains that some firms may be self-motivated to do thing right regardless of social pressure.
3. An instrumental view believes that good ethics may simply be a useful instrument to help make money.
Perhaps the best way to appreciate the value of ethics is to examine what happens after some crisis.
Managing ethics overseas is challenging because what is ethical in one country may be unethical elsewhere.
There are 2 schools of thoughts
1. Ethical relativism: a perspective that suggests that all ethical standards are relative.
2. Ethical imperialism: a perspective that suggests that ‘there is one set of ethics and we have it’
In practice neither of these schools of thought is realistic.
Three middle of the road guiding principles are:
1. Respect for human dignity and basic rights should determine the absolute, minimal ethical thresholds for all operations around the world
2. Respect for local traditions.
3. Respect for institutional context calls for a careful understanding of local institutions. Codes of conduct banning bribery are not very useful unless
accompanied by guidelines for the scale and scope of appropriate gift giving/receiving
Ethics and corruption
Ehtics help to combat corruption.
Corruption: the abuse of public power for private benefits usually in the form of bribery.
Competition should be based on products and services, but corruption distorts that basis, causing misallocation of resources and slowing economic development.
Foreign corrupt practices act (FCPA): a US law enacted in 1977 that bans bribery of foreign officials.
Overall, the FCPA can be regarded as an institutional weapon in the global fight against corruption.
Corruption and poverty go together. Some evidence indicates that corruption discourages foreign direct investment. However there are exceptions.
Norms and ethical challenges: How firms respond to ethical challenges is often driven, at least in part, by norms. Four broad strategic responses are:
Four broad strategic responses:
- Reactive is passive: Deny responsibility: do less than required
- Defensive: focusses on regulatory compliance, Admit responsibility but fight it; do the least that is required
- Accomodative: Accept responsibility; do all that is required
- Proactive: Anticipate responsibility; do more than is required
Companies can change their strategic response.
Overall, although there is probably a certain element of window dressing in proactive strategies, the fact that pro active firms go beyond the current regulatory requirements
is indicative of the normative and cognitive beliefs held by many managers at these firms on the importance of doing the right thing.
Management savvy
What is cultural intelligence and what are the five profiles of cultural Cultural intelligence: an individual’s ability to understand and adjust to new cultures.
Five profiles: (3.6)
1. The local: a person who works well with people from similar backgrounds but does not work effectively with people from different cultural backgrounds.
2. The analyst: a person who observes and learn from others and plans a strategy for interacting with people from different cultural backgrounds
3. The natural: a person who relies on intuition rather han on a systematic learning style when interacting with people fomr different cultural backgrounds
4. The mimic: a person who creates a comfort zone for people from different cultural backgrounds by adopting their general posture and communication style.
This is not pure imitation, which may be regarded as mocking
5. The chameleon: a person who may be mistaken for a native of the foreign country. He/she may achieve results that natives cannot, due to his/her insider
skills and outsider perspective. This is very rare.
Implications for action (3.7): six rules of thumb when venturing overseas
· Be prepared
· Slow down
· Establish trust
· Understand the importance of language
· Respect cultural differences
· Understand that no culture is inherently superior in all aspects
The institution based view emphasizes the importance of informal institutions in propelling or constraining business around the globe. The institution based view argues
that firm performances is determined by the informal cultures, ethics, and norms governing firm behavior
For savvy managers around the globe the emphasis on informal institutions suggests to broad implications. First, it is necessary to enhance cultural intelligence. Acquisition of cultural intelligence passes through three phases:
- Awareness refers to the recognition of both the pros and cons of your ‘mental software’ and the appreciation of people from other cultures.
- Knowledge refers to the ability to identify the symbols, rituals, and taboos in other cultures, also known as cross-cultural literacy.
- Skills are based on awareness and knowledge, plus good practice.
Second, managers need to be aware of the prevailing norms and their transitions globally.
The best managers expect norms to shift over time and constantly decipher the
changes in the informal rules of the game and take advantage of new opportunities.
Although skills can be taught, the most effective way to gain cultural intelligence is total
immersion within a foreign culture. Culture is not everything but it is very important
Understanding resources and capabilities:
Resource based view: a leading perspective in global business that posits that firm performance is fundamentally driven by differences in firm-specific resources and
capabilities.
One leading tool in global business is SWOT analysis.
SWOT analysis: An analytical tool for determining a firms:
- Strengths
- Weaknesses
- Opportunities
- Threats
Resourced based view: internal S and W
Institution based view: external O and T
You also have a VRIO framework. A VRIO framework focuses on:
- Value
- Rarity
- Imitability
- Organizational aspects of resource and capabilities.
Resources are defined as: the tangible and intangible assets a firm uses to choose and implement its strategies.
Capability: the tangible and intangible assets a firm uses to choose an implement its strategies.
Capabilities = Resources in this book!
Tangible resources and capabilities: Assets that are observable and easily quantified:
· Financial: ability to generate internal funds or raise external capital
· Physical: Location of plants, offices and equipment.
· Technological: Possession of patents, trademarks, copyrights and trade secrets.
· Organizational: Format planning command and control systems.
Intangible resources and capabilities: Assets that are hard to observe and difficult(if not impossible) to quantify:
· Human: managerial talents, organizational culture
· Innovation: Research and development capabilities.
· Reputational: Perceptions of product quality, durability and reliability.
Resources, capabilities, and the value chain: in house versus outsourcing
Value chain: A chain of vertical activities used in the production of goods and services that add value. It consists of two areas: primary and support activities.
Each activity requires a number of resources and capabilities. Value chain analysis forces managers to think about resources and capabilities at a very micro activity based level.
Benchmarking: an examination on whether a firm has resources and capabilities to perform a particular activity in a manner superior to competitors. Is your performance better than that of your competitor?
As a product loses its ability to command high prices and high margins through market competition, it undergoes a process known as Commoditization.
Commoditization: A process of market competition through which unique products that command high prices and high margins gradually lose their ability to do so thus become commodities.
Outsourcing is defined as: turning over an organizational activity to an outside supplier that will perform it on behalf of the focal firm.
There are 4 terms based on locations and modes:
- Captive sourcing: setting up subsidiaries abroad so that the work done is in house but the location is foreign. Also known as foreign direct investment FDI.
- Offshoring: outsourcing to an international or foreign firm.
- Inshoring: outsourcing to a domestic firm
- Domestic in house activity
Important => Look at figure 4.3 and 4.4 for an overall scheme of the locations.
Analyzing resources and capabilities with a VRIO Framework. This was the resource-based framework that focuses on the value, rarity, imitability and organizational aspects of resources and capabilities.
Only value adding resources can possibly lead to competitive advantage, whereas
non value adding capabilities may lead to competitive disadvantage.
If firms are unable to get rid of non-value-adding resources and capabilities, they
are likely to suffer below average performance
At best, valuable but common resources and capabilities will lead to competitive parity but no advantage. Resources and capabilities must both be valuable and rare to have the potential to provide some temporary competitive advantage.
Valuable and rare resources and capabilities can be a source of competitive
advantage only if they are also difficult to imitate by competitors. It is easier to imitate a firms tangible resources than to imitate intangible capabilities such as knowledge.
Causal ambiguity: the difficulty of identifying the causal determinants of successful firm performance. That’s the reason why imitation is such difficult.
If insiders have a hard time figuring out what unambiguously contributes to their firms performance, it is not surprising that outsiders efforts in understanding
and imitating these capabilities are usually flawed and often fail.
Overall: valuable and rare but imitable resources and capabilities may give firms some temporary competitive advantage, leading to above average performance for some time. But such an advantage is not likely to be sustainable
Organization
Even valuable, rare, and hard to imitate resources and capabilities may not give a firm sustained competitive advantage if the firm is not properly organized. Thus, organization is very important!
Overall: only valuable, rare, and hard to imitate resources and capabilities that are organizationally embedded and exploited can possibly lead to persistently
above average performance. VRIO come together as one package!
Complementary assets: The combination of numerous resources and assets that enable a firm to gain a competitive advantage.
Another idea is social complexity: the socially intricate and interdependent ways firms are typically organized. Many multinationals consist of thousands of people scattered throughout many different countries.
Debates and extensions
1. Domestic resources verses international(cross border) capabilities
Some domestically successful firms continue to succeed overseas. This question is very important for companies and business schools. However, there is no right
or wrong answer.
2. Offshoring versus Not offshoring
Offshoring or (international outsourcing) has emerged as a leading corporate movement in the 21st century.
Proponents argue that offshoring creates enormous value for firms and economies. Western firms are able to tap into low-costs yet high quality labor, translating into significant cost savings. Firms can also focus on their core capabilities, which may add more value than dealing with non core activities.
Critics of offshoring make three points on strategic, economic and political grounds. Strategically, according to some outsourcing gurus, if everything is moved out,
what is left of the firm. Economically, critics contend that they are not sure whether developed economies actually gain more.
- Original equipment manufacturer(OEM): A firm that executes design blueprints provided by other firms and manufactures such products
- Original design manufacturer (ODM): a firm that both designs and manufactures products.
- Original brand manufacturer(OBM): A firm that designs, manufactures, and markets branded products.
For firms in developed economies, the choice is not really offshoring versus not offshoring, but where to draw the line on offshoring. It is important to note that
this debate primarily takes place in developed economies. There is relatively little debate in emerging economies because they clearly stand to gain from such
offshoring to them.
Management savvy
Fundamentally, some firms outperform others because they possess some valuable rare, hard to imitate, and organizationally embedded resources and capabilities that
competitors don’t have.
The resourced based view thus suggests four implications for action:
1:Managers need to build firm strengths based on the VRIO framework
2:Relentless imitation or benchmarking, while important, is not likely to be a
successful strategy
3:Managers need to build up resources and capabilities for future competition
4:Students need to make yourself into an ‘untouchable’ whose job cannot be easily
outsourced.
Why do nations trade?
International trade consists of exporting and importing.
Some important definitions:
- Exporting: selling abroad
- Importing: buying from abroad
- Merchandise: tangible products being traded
- Services: intangible services being traded.
As a country, it can occur that you have a trade deficit or a trade surplus:
- Trade deficit: An economic condition in which a nation imports more than it exports.
- Trade surplus: an economic condition in which a nation exports more than it imports.
The aggregation of such buying (importing) and selling (exporting) by both sides leads to the country-level balance of trade.
Balance of trade: the aggregation of importing and exporting that leads to the country level trade surplus or deficit.
Overall, why are there economic gains from international trade?
According to the resource-based view, it is because some firms in one nation generate exports that are valuable, unique, and hard to imitate that firms from other nations find it beneficial to import.
According to the institution based view, different rules governing trade are designed to determine how such gains are shared.
Theories of international trade => Page 143 of the book for a total scheme.
It is important to understand the classical and modern theories of international trade.
Classical trade theories: the major theories of international trade that were advanced before the 20th century, which consist of: (1): mercantilism, (2): absolute advantage, (3): comparative advantage.
Modern trade theories: the major theories of international trade that were advanced in the 20th century, which consist of (1): product life cycle, (2): strategic trade, (3): national competitive advantage of industries.
1. Mercantilism: Jean Baptiste Coberd
Theory of mercantilism: a theory that suggests that the wealth of the world is fixed and that a nation that exports more and imports less will be richer.
Although mercantilism is the oldest theory in international trade, it is not an extinct dinosaur. Very much alive, mercantilism is the direct intellectual ancestor
of modern day protectionism, which is the idea that governments should actively protect domestic industries from imports and vigorously promote exports.
Protectionism: the idea that governments should actively protect domestic industries from import and vigorously promote exports.
2. Absolute advantage: Adam Smith
Thus, the principles of a market economy should apply for international trade as they apply for domestic trade. By trying to be self-sufficient and to produce a wide range of goods, mercantilist policies reduce the overall wealth of a nation in the long run.
Free trade: the idea that free market forces should determine how much to trade with little or no government intervention.
Theory of absolute advantage: a theory that suggests that under free trade, a nation gains by specializing in economic activities in which it has an absolute
advantage.
Absolute advantage: the economic advantage one nation enjoys that is absolutely superior to other nations.
Adam Smith’s two greatest insights are: (1) by specializing in the production
of goods for which each has an absolute advantage, both can produce more. (2)both can benefit more by trading.
3. Comparative advantage: David Ricardo.
Theory of comparative advantage: a theory that focuses on the relative (not absolute) advantage in one economic activity that one nation enjoys in comparison
with other nations.
Comparative advantage: relative advantage in one economic activity that one nations enjoys in comparison with other nations One crucial concept is opportunity cost: cost of pursuing one activity at the expense of another activity, given the alternatives(other opportunities). Example is investment in something, but you can also receive the interest of the bank.
Where do absolute and comparative advantages come from? Productivity! What leads to such different productivity differents? => Factor endowment.
Factor endowment: the extent to which different countries possess various factors of production such as labor land, and technology.
Factor endowment theory (Heckscher-Ohlin theory): a theory that suggests that nations will develop comparative advantages based on their locally abundant factors
4. Product life cycle: Raymond Vernon
Product life cycle theory: A theory that accounts for changes in the patterns of trade over time by focusing on product life cycles.
Vernon divided the world into three categories:
- The lead innovation nation(according to him the USA)
- Other developed nations
- Developing nations.
Every product has three life cycle stages:
- New: this first stage involves production of a new product that commands a price premium
- Maturing: in the second maturing stage, demand and ability to produce grow in other developed nations, so it becomes worthwhile to produce there.
- Standardized: In this third stage, the previously new product is standardized. Therefore, much production will move now to low cost developing nations that export to developed nations.
5. Strategic trade
Strategic trade theory: A theory that suggests that strategic intervention by governments in certain industries scan enhance their odds for international successes.
They tend to be highly capital intensive industries with high barriers to entry where domestic firms may have little chance of entering and succeeding without government assistance.
Subsidy: government payment to domestic firms.
Strategic trade policy: government policy that provides companies a strategic advantage in international trade through subsidies and other supports.
Strategic trade theorists do not advocate a mercantilist policy to promote all industries. They propose to help only a few strategically important industries.
But there are 2 accounts
- First, many scholars and policymakers are uncomfortable with government intervention
- Second, many industries claim that they are strategically important
Overall, where to draw the line between strategic and nonstrategic industries is tricky.
6. National competitive advantage of industries: Michael Porter
The most recent theory is known as the theory of national competitive advantage of industries: A theory that suggests that the competitive advantage of certain industries in different nations depends on four aspects that form a ‘diamond’
1. First, factor endowments, which refer to the nature land human resources as noted by the Heckscher-Ohlin theory.
2. Second, tough domestic demand propels firms to scale new heights. Thus, the ability to satisfy a tough domestic crowd may make it possible to successfully
deal with less demanding overseas customers.
3. Third, domestic firm strategy, structure, and rivalry in one industry play a huge role in its international success or failure.
4. Finally, related and supporting industries provide the foundation upon which key industry scan excel.
Overall, Michael Porter argues that the dynamic interaction of these four aspects explains what is behind the competitive advantage of leading industries in different nations. This theory is the first multilevel theory to realistically connect firms, industries and nations, whereas previous theories work on only one or two levels. However, it has
not been comprehensively tested. Some critics argue that the diamond places too much emphasis on domestic conditions.
Resource mobility: Assumption that a resource used in producing a product for one industry can be shifted and put to use in another industry. Realities of international trade
A tariff barrier is a means of discouraging imports by placing a tariff on imported goods.
Tariff barrier: trade barrier that relies on tariffs to discourage imports Import tariff: A tax imposed on imports.
Deadweight cost. Net losses that occur in an economy as a result of tariffs.
- Nontariff barriers: trade barrier that relies on nontariff means to discourage imports.
Today, tariff barriers are often criticized around the world, and nontariff barriers are now increasingly the weapon of choice in trade wars.
1. Subsidies, government payments to domestic firms.
2. Import quota’s : restriction on the quantity of imports
3. Voluntary export restraint (VER): an international agreement that shows that exporting countries voluntarily agree to restrict their exports
4. Local content requirement: A requirement stipulating that a certain proportion of the value of the goods made in one country must orginate from that country
5. Administrative policy: bureaucratic rules that make it harder to import foreign goods.
6. Antidumping duty: tariffs levied on imports that have been dumped’(selling below costs to unfairly drive domestic firms out of business)
- Economic arguments against free trade
Taken together, trade barriers undermine international trade. Although certain domestic industries and firms benefit from them,
a large part of the country suffers from them.
2 prominent economic arguments against free trade:
- 1. The need to protect domestic industries (protectionism): urge to protect domestic industries, firms, jobs from allegedly foreign competition.
- 2. The need to shield infant industries infant industry argument: the argument that if domestic firms are as young as ‘infants’ in the absence of government intervention, they stand no chances of surviving and will be crushed by mature foreign rivals.
Political arguments against free trade:
- National security: This concerns are often invoked to protect defense related
industries.
- Consumer protection: has frequently been used as argument for nations to erect trade barriers.
- Foreign policy
- Environmental and social responsibility.
What is the role of global institutions such as the International Monetary Fund?
IMF: international monetary fund: an international organization that was established to promote international monetary cooperation, exchange stability and orderly exchange
arrangements.
What determines foreign exchange rates?
Foreign exchange rate: the price of one currency in terms of another.
Basic economic theory suggests that a commodity’s price is fundamentally determined by its supply and demand. The concept of an exchange rate as the price of a commodity helps us understand its determinants.
What determines the supply and demand of foreign exchange:
There are five underlying building blocks that are determining the supply and demand of foreign exchange:
- 1: Relative price differences and purchasing power parity (PPP)
PPP is essentially the ‘law of one price’. Purchasing power parity is a conversion that determines the equivalent amount of goods and services different currencies can purchase. This conversion is usually used to capture the differences in cost of living between countries.
The theory suggests that, in the absence of trade barriers, the price of identical products sold in different countries must be the same. Otherwise, traders may
buy low and sell high, eventually driving prices for identical products to the same level around the world. The PPP theory argues that in the long run, exchange
rates should move towards levels that would equalize the prices of an identical basket of goods in any two countries.
- 2: Interest rates and money supply
In the short run, variations in interest rates have a powerful effect. If one country’s interest rate is high relative to other countries, the country will attract
foreign funds. In addition, a country’s rate of inflation, relative tot hat prevailing abroad affect sits ability to attract foreign funds and hence its exchange rate.
A high level of inflation is essentially too much money chasing too few goods in an economy. Technically, it is an expansion of a country money supply.
Governments print more money, currency to depreciate.
- 3: Productivity and balance of payments
In international trade, the rise of a country’s productivity relative to other countries will improve its competitive position.
Balance of payments: a countries international transaction statement, which includes merchandise trade, service trade and capital movement.
A country experiencing a current account surplus will see its currency appreciate.
A country experiencing a current account deficit will see its currency depreciate.
A current account deficit has to be financed by financial account consisting of purchases and sales of assets. This because a country needs to balance its
accounts the same way as a family deals with its finances.
There are two major exchange rate policies:
1: floating rate: a government policy to let supply and demand conditions to determine exchange rates. Free market believers.
- Clean (free) float: a pure market solution to determine exchange rates
- Dirty (managed) float: using selective government intervention to determine exchange rates
Target exchange rates (crawling bands): specified upper or lower bounds
within which an exchange rate is allowed to fluctuate.
2. fixed rate policy: a government policy to set the exchange rate of a currency relative to other currencies.
Investor psychology:
Peg: a stabilizing policy of linking a developing country’s currency to a key currency.
This policy has two benefits:
1: A peg stabilizes the import and export prices for developing countries.
2: Many countries with high inflation have pegged their currencies to the dollar in order to restrain domestic inflation because the US has relatively low inflation.
Short run movements are largely driven by investor psychology, some of which is fickle and thus very hard to predict.
Bandwagon effect: the effect of investors moving in the same direction at the same time, like a herd
Capital flight: a phenomenon in which a large number of individuals and companies exchange domestic currency for a foreign currency.
This capital flight pushed the demand for down, and thus the value of domestic currencies.
Overall, economics, politics, and psychology are all at play. The stakes are high, yet consensus is rare regarding the determinants of foreign exchange rates.
Evolution of the International Monetary system: The history of the three eras of the evolution of the international monetary system.
1: The gold standard 1870-1914
The gold system : A system in which the value of most major currencies was
maintained by fixing their prices in terms of gold
Common denominator The gold standard: a currency or commodity to which the value of all currencies are pegged. This was essentially a global peg system with little volatility and every bit of
predictability and stability.
2: The Bretton Woods system 1944-1973
The gold standard was abandoned in 1914 when world war 1 broke out.
Bretten Woods System: A system in which all currencies were pegged at a fixed rate to the US dollar.
3: The Post Bretton Woods System 1973-present
Post Bretton Woods system: A system of flexible exchange rate regimes with no official common denominator.
This system is built on two conditions:
- The US inflation rate has to be low
- The US could not run a trade deficit.
When both of these conditions were violated, the demise of the system became inevitable.
The Bretton Woods System also became a pain in the neck for the US because the exchange rate of the dollar was not allowed to unilaterally change.
Founded in 1944 as a Bretton Woods institution. Its mandate is to promote international monetary cooperation and provide temporary financial assistance to
member countries in order to help overcome balance of payments problem. The IMF can be viewed as a lender of last resort to help member countries should
they get into financial difficulty. The IMF makes loans, not free gains. The IMF could step in and inject funds in the short term to help stabilize the financial
system. Although an IMF loan provides short term financial resources, it also comes with strings attached: long term policy reforms that recipient countries
must undertake as conditions of receiving the loan.
Quota: the weight a member country carriers within the IMF, which determines the amount of its financial contribution its capacity to borrow from the IMF, and
its voting power. The quota is broadly based on a countries relative size in the global economy.
Strategic responses to foreign exchange movements
- Strategies for financial companies
One of the leading strategic goals for financial companies is to profit from the foreign exchange market. Foreign exchange market: the market where individuals,
firms, governments, and banks buy and sell foreign currencies.
This market is truly global and transparent. Buyers and sellers are geographically dispersed but constantly linked, and quoted prices change as often as 20 times a minute. Operating on a 24/7 basis, the foreign exchange market is the largest and most active market in the world.
The market has 2 functions:
1. to service the needs of trade and FDI
2. To trade in its own commodity, namely foreign exchange.
There are 3 primary types of foreign exchange transactions:
1: spot transactions (within 2 business days): the classic single shot exchange of one currency for another
2. forward transactions: A foreign exchange transaction in which participants buy and sell currencies now for future delivery.
Primary benefit of forward transactions is to protect traders and investors from being exposed to the fluctuations of the spot rate, an act known as
currency hedging.
Forward discount: A condition under which the forward rate of one currency relative to another currency is higher than the spot rate.
Forward premium: A condition under which the forward rate of one currency relative or another currency is lower than the spot rate.
3. Swaps
Currency swap is a foreign exchange transaction between two firms in which one currency is converted into another at time 1, with an agreement to revert
it back to the original currency at a specified time 2 in the future.
- Offer rate: the price to sell a currency.
- Bid rate: The price to buy a currency.
- Spread: the difference between the offer price and the bid price.
Offer rate: the price to sell a currency
Bid rate: the price to buy a currency
Spread: the difference between the offer price and the bid price
- Strategies for non-financial companies
There are different strategies for non-financial companies:
1: Currency hedging: A transaction that protects traders and investors from exposure to the fluctuations of the spot rate.
2: Strategic hedging: spreading out activities in a number of countries in different currency zones to offset any currency losses in one region through gains in other regions.
Strategic hedging can be considered as currency diversification.
Currency hedging focuses on using forward contracts ad swap to contain currency risks, a financial management activity that can be performed by in house financial specialists or outside experts.
Strategic hedging refers to geographically dispersing operations in multiple currency zones.
Currency risk: the potential for loss associated with fluctuations in the foreign exchange market
Overall, the importance of foreign exchange management for firms of all stripes
interested in doing business abroad cannot be over stressed. Firms whose performance is otherwise stellar can be devastated by unfavorable currency movements.
Although MNE subsidiary managers in certain countries may believe that there are lucrative opportunities to expand production, if these countries suffer from high
currency risks, it may be better of the multinational as a whole to curtail such expansion and channel resources to other countries whose currency risks are more manageable.
Developing such expertise is no small accomplishment because, as noted earlier, prediction of currency movements remains an art or highly imprecise science. These
challenges mean that firms able to profit from unfavorable currency movements will possess some valuable, rare, and hard to imitate capabilities that are the envy of rivals.
From a resource based view, it seems imperative that firms develop resources and capabilities that can combat currency risks in addition to striving for excellence in areas
such as operating and marketing.
Competitive dynamics: Actions and responses undertaken by competing firms.
Competitor analysis: the process of anticipating rivals actions in order to both revise a firms plan and prepare to deal with rivals response.
Important subjects: interaction, competition, cooperation and collusion:
Interaction: how firms interact with rivals
Cooperation and collusion.
Beyond antitrust laws, collusion often collapses under the weight of its won incentive problems.
Collusion: collective attempts between competing firms to reduce competition
There are 2 different types of collusion:
- Tactic collusion: firms indirectly coordinate actions by signaling their intention to reduce output and maintain prices above competitive levels
- Explicit collusion: firms directly negotiate output and pricing and divide markets
Cartel(trust): an output-and price- fixing entity involving multiple competitors
Due to collusion and cartels: less fair competition.
Antitrust laws: laws in various countries that outlaw cartels(trusts)
Prisoners dilemma: in game theory, a type of game in which the outcome depends on two parties deciding whether to cooperate or to defect.
Game theory: a theory that studies the interactions between two parties that compete and or cooperate with eachother.
Collusion possible:
Collusion difficult
Few firms(high concentration) Many firms(low concentration)
Existence of an industry price leader No industry price leader/few firms
Collusion possible:
1. Few firms
Concentration ratio: the percentage of total industry sales accounted for by the top four, eight, or twenty firms.
2. Price leader
Price leader: A firm that had a dominant market share and sets ‘acceptable’ prices and margins in the industry.
The price leader needs to posses the capacity to punish defectors, which requires sufficient resources to deter and combat defection. The most frequently used punishment is to undercut the defector by flooding the market, thus making defection fruitless. Such punishment is costly because it brings significant short run financial losses to the price leader. The price leader needs to be willing and able to!
Capacity to punish: sufficient resources possessed by a price leader to deter and combat defection
3. Collusion is likely in an industry with homogeneous product where rivals are forced to compete on price rather than differentiation.
4. Existing firms may collude to keep new firms from disrupting the market
5. Market commonality: the overlap between two rival’s markets
Multimarket competition: firms engage the same rivals in multiple markets For example: Philips meets Samsung in the TV market but also in the telephone market.
Mutual forbearance: multimarket firms respect their rivals spheres of influence in certain markets and their rivals reciprocate leading to tacit collusion.
Cross market retaliation: retaliatory attacks on a competitor’s other markets if these competitor attacks a firms original market.
Overall, the effectiveness of a firms actions depends significantly on the domestic and international institutions governing competitive dynamics as well as firm specific resources and capabilities.
Institutions governing domestic and international competition.
- Formal institutions: governing domestic competition: A focus on antitrust
Competition policy: government policy governing the rules of the game in competition.
Antitrust policy: govenment policy designed to combat monopolies and cartels. Purpose: more fair competition.
Overall, the American antitrust policy is pro competition and pro consumer, whereas the Japanese approach is pro incumbent and pro procurer.
Competition and antitrust policy focuses on:
- Collusive price setting: price setting by monopolists or collusion parties at a level higher than the competitive level
- Predatory pricing: an attempt to monopolize a market by setting prices below cost and intending to raise prices to cover losses in the long run after eliminating rivals.
Formal institutions governing international competition:
This section primarily deals with antidumping. In the same spirit of predatory pricing, dumping is defined as:
- An exporter selling below cost abroad and planning to raise prices after eliminating local rivals.
Discrimination is also evident in the actual antidumping investigations. A case is usually filed by a domestic firm with the relevant government authorities.
Antidumping laws: laws that make it illegal for an exporter to sell goods below cost abroad with the intent to raise prices after eliminating local rivals.
Overall, institutional conditions such as availability of antidumping protection are not just the background. They determine directly what weapons a firm has in its arsenal to wage competitive battles. In addition to formal institutions,informal norms and beliefs also play a significant role.
- Resources and capabilities influencing competitive dynamics
Again important to look at: VRIO framework
1: Value
Firms resources must create value when engaging rivals. The ability to attack in multiple markets throws rivals of balance. Likewise, the ability to respond
rapidly to challenges also add value. Another way to add value is patenting. The proliferation of patents makes it easy for one firm to inadvertently defensive.
2: Rarity
Either by nature or nurture(or both), certain assets are rare, thus generating significant advantage.
3: Imitability
Most rivals watch each other and probably have a fairly comprehensive (although not necessarily accurate) picture of how their rivals compete. However, the next
hurdle is how to imitate successful rivals. It is well known that fast moving rivals tend to perform better.
Competitive passive and slow moving firms find it difficult to imitate rivals actions.
4: Organization
Some firms are better organized for competitive actions, such as stealth attacks and a willingness to answer challenges ‘tit fort at’.
The intense ’warrior-like’ culture not only requires top management commitment, but also employee involvement down to the ‘soldiers in the trenches’. it is difficult for slow moving firms to suddenly become more aggressive. More centrally coordinated firms may be better mutual forbearers than firms whose units are loosely controlled.
Conversely, if a firm has competitive reward systems and structures, unit mangers may be unwilling to give up market gains for the greater benefits of
other units and the whole firm, thus undermining mutual forbearance. Resource similarity: 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 with a high degree of resource similarity are likely to have similar
competitive actions
- Attack, counterattack and signaling
Attack and counter attack
Attack: an intention set of actions to gain competitive advantage.
Counterattack: a set of actions in response to attack.
Blue ocean strategy: strategy that focuses on developing new markets(blue ocean) and avoids attacking core markets defended by rivals, which is likely to
result in a bloody price war or a ‘red ocean’.
Drivers for Counterattacks:
1. Awareness is a prerequisite for any counterattack. If an attack is so subtle that rivals are nota ware of it, then the attackers objectives are likely to be
attained. Blue ocean strategy.
2. Motivation is also crucial. If the attacked market is of marginal value, managers may decide not to counterattack.
3. Capabilities: even if an attack is identified and a firm is motivated to respond, it requires strong capabilities to carry out counterattacks.
Overall, minimizing opponents awareness, motivation and capabilities is more likely to result in successful attacks. Frontal, infrequent, and predictable
attacks typically find rivals well prepared. Winning firms excess at making subtle frequent but unpredictable moves
Some firms choose to compete and attack, whereas others choose to cooperate.
Although you cant talk to your competitors on pricing, you can always wink at them.
1. Firms may enter new markets, not necessarily to challenge incumbents
but to seek mutual forbearance by establishing multimarket contact. Thus,
MNEs often chase each other, entering one country after another.
2. Firms can send open signal for a truce.
3. Sometimes firms can send a signal to rivals by enlisting the help of
governments.
Although it is illegal to hold direct negotiations with rivals on what constitutes fair pricing, holding such discussions is legal under the auspices of government investigations.
4. Finally, firms can organize strategic alliances with rivals for cost reduction.
Although price fixing is illegal, reducing cost by 10% through an alliance which is legal has the same impact on the financial bottom line as collusively raising prices by 10%.
- Local firms versus multinational enterprises
Given the broad choices of competing and/or cooperating, local firms can adopt one of four strategic postures, depending on
1: The industry conditions.
2: The nature of competitive assets.
The four strategic postures:
- Defender(strategy that centers on local assets in areas in which MNEs are weak.
- Extender: strategy that centers on leveraging homegrown competencies abroad
- Dodger: strategy that centers on cooperating through joint ventures with MNEs and sell offs to MNEs
- Contender: strategy that centers on a firm engaging in rapid learning and the expand overseas.
Chapter H: Investing abroad directly
Understanding the FDI vocabulary
FPI: investment in a portfolio of foreign securities such as stocks and bonds.
Management control rights: The rights to appoint key managers and establish control mechanisms
International investment takes place in two basic ways: FDI and FPI.
- FPI refers to holding securities, such as stocks and bonds of companies in countries outside one’s own but down not entail the active management of foreign assets. FPI is indirect!
- FDI is direct! Namely, the direct, hands on management of foreign operations. For statistical purposes, UN defines FDI as an equity stake of 10% or more in a foreign based enterprise. A lower percentage invested in a foreign firm is FPI.
There are 4 different types of foreign direct investment:
1: Horizontal FDI: a type of FDI in which a firm duplicates its home country based activities at the same value chain stage in a host country.
2: Vertical FDI: A type of FDI in which a firm moves upstream or downstream at different value chain stages in a host country.
3:Upstream vertical FDI: A type of vertical FDI in which a firm engages in an upstream stage of the value chain in a host country.
4: Downstream vertical FDI: A type of vertical FDI in which a firm engages in a downstream stage of the value chain in a host country.
To describe FDI the terms FDI flow and FDI stock are often used:
- FDI flow: The amount of FDI moving in a given period(usually a year) in a certain direction.
- FDI inflow: inbound FDI moving into a country in a year.
- FDI outflow: Outbound FDI moving out of a country in a year.
- FDI stock: Total accumulation of inbound FDI in a country or outbound FDI from a country across a given period (usually several years)
MNE versus non MNE
An MNE, by definition, is a firm that engages in FDI when doing business abroad.
Difference between MNE and non MNE is FDI!
Why do firms become MNEs by engaging in FDI?
Due to FDI firms get OLI advantages:
- Ownership, Location and Internalization advantages.
1: Ownership: an MNE’s possession and leveraging of certain valuable, rare, hard to imitate, and organizationally embedded (VRIO) assets oversea in the context of FDI
2: Location: advantages enjoyed by firms operating in a certain location.
3:Internalization: the replacement of cross border markets(such as exporting and importing) withe one firm locating and operating in two or more countries.
From an institution based view, internalization is a response to the imperfect rules
governing international transactions known as market imperfections
Market imperfections: the imperfect rules governing international transactions.
Ownership advantages
The benefits of ownership
Direct is the keyword in FDI. FDI requires a significant equity ownership position.
The benefits of direct ownership lie in the combination of equity ownership
rights and management control rights. In contrast, FPI represents essentially insignificant ownership rights and no management control rights. To compete
successfully, firms need to deploy overwhelming resources and capabilities to overcome their liability of foreignness. FDI provides one of the best ways to
facilitate such extension of firm specific resources and capabilities.
FDI versus licensing.
FDI preferred to licensing:
1. FDI reduces dissemination risks. First, FDI afford a high degree of direct management control that reduces the risk of firm specific resources and capabilities being taken advantage of.
Dissemination risk: the risk associated with unauthorized diffusion of firm specific know how. FDI is better than licensing because licensing does not provide such
management control.
2. FDI provides tight control over foreign operations
Even when licensees harbor no opportunistic intention to take away secrets, they may not always follow the wishes of the foreign firm that provides the knowhow. Without FDI, the foreign firm cannot control its licensee.
3. FDI facilitates the transfer of tacit knowledge through ‘learning by doing’
Two basic categories of knowledge: explicit and implicit.
- Explicit knowledge is codifiable and can be written and transferred without losing much of its richness.
- Tacit knowledge, on the other hand, is non-codifiable and its acquisition and transfer requires hand on practice. Tacit knowledge is clearly more important and harder to transfer and learn. It can only be acquired through learning by doing.
Overall, ownership advantages enable the firm, now becoming an MNE, to more effectively extend, transfer and leverage firm specific capabilities abroad.
Location advantages:
Certain locations possess geographical features that are difficult to match by
others. Beyond natural geographical advantages, location advantages also arise from the clustering of economic activities in certain locations referred to as
agglomeration Overall, agglomeration advantages stem from:
1. Knowledge spillover: the diffusion of knowledge from firm to others 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 moving out of the region
3. Industry demand that facilitates a pool of specialized suppliers and buyers also located in the region
Beyond the quest for geographical and agglomeration advantages, sometimes firms undertake FDI in search of markets.
Agglomeration: clustering of economic activities in certain locations.
Acquiring and neutralizing location advantages Location advantages refer to the advantages one firm obtains when operating in a
location due to its firm specific capabilities. Firms do not operate in vacuum.
When one firm enters a foreign country through FDI, its rivals are likely to increase FDI in that host country either to acquire location advantages
themselves or to at least neutralize the firms mover’s location advantages.
These actions to imitate and follow competitors are especially likely in Oligopolies (industry dominated by a small number of players).
Overall, competitive rivalry and imitation, especially in oligopolistic industries, underscores the importance of acquiring and neutralizing location advantages around the world.
Internalization advantages
International transaction costs tend to be higher than domestic transaction costs. Because laws and regulations are typically enforced on a nation state basis,
enforcement can be problematic at the international level. High transaction costs can result in market failure. The imperfections of het market mechanisms make
transactions unable to take place.
- Overcoming market failure through FDI
Overall, once one side in a market(import/export) transaction behaves opportunistically, the other side will not be happy and will threaten or initiate law
suits. But the legal and regulatory frameworks governing such international transactions are generally not as effective as those governing domestic transactions.
In response, FDI combats such market failure through internalization, which involves replacing the external market with in house links. The MNE reduces cross
border transaction costs and increases efficiencies by replacing an external market relationship with single organization spanning both countries.
FDI essentially transforms the international trade between two independent firms in two countries controlled by the same MNE. The MNE is thus able to coordinate
cross border activities better and achieve an internalization advantage.
Overall, the motivations for FDI are complex. The quest for OLI advantages, although analytically distinct as discussed above, may overlap in practice.
Based on the institutional based view and resourced based view, we can see FDI as a reflection of both a firms motivation to extend its firm specific capabilities abroad and its responses to overcome market imperfections and failures.
There are 3 primary political views on FDI
1. First, the radical view is hostile to FDI. Tracing its roots to Marxism, the radical view on FDI treats FDI as an instrument of imperialism and a vehicle
for exploiting domestic resources and people by foreign capitalists and firms. Governments embracing the radical view often nationalize MNE
assets or simply ban inbound FDI.
2. On the other hand, the free market view on FDI suggests that FDI, unrestricted by government intervention, will enable countries to tap into
their absolute or comparative advantages by specializing in the production of certain goods and services. 3. However, a totally free market view on FDI does not really exist in practice. Most countries practice pragmatic nationalism on FDI, considering both the pros and cons of FDI and approving FDI only when its benefits outweigh its costs.
Overall, more and more countries in recent years have changed their policies to be more favorable to FDI. Restrictive policies toward FDI succeed only in driving out
MNEs to countries with more favorable policies. Even hard core countries that had a radical view on FDI are now experimenting with opening up to some FDI. This
openness is indicative of the emerging pragmatic nationalism in their thinking. more favorable to FDI. Restrictive policies toward FDI succeed only in driving out
Radical view: a political view that is hostile to FDI
Free market view: A political view that suggests that FDI unrestricted by government intervention is the best.
Pragmatic nationalism on FDI: a political view that only approves FDI when its benefits outweigh its success.
- Benefits and costs of FDI to host countries
Underpinning pragmatic nationalism is the need to assess the various benefits and costs of FDI to host (recipient) and home(source) countries.
For total scheme: look at page 176.
1: Capital inflow can help improve a host country’s balance of payments.
2:Technology, can create technology spillovers that benefit domestic firms and industries. Local rivals, after observing such technology, may recognize
its feasibility and strive to imitate it. It underscores the important role that MNEs play in stimulating competition in host countries.
3: Advanced management know how may be highly valued. In many developing countries, it is often difficult for the development of management
know how to reach a world class level if it is only domestic and not influenced by FDI.
4:FDI creates jobs.
Technology spillover: technology diffused from foreign firms to domestic firms.
Demonstration effect: the reaction of local firms to rise to the challenge demonstrated by MNEs through learning and imitation.
Negative effects:
1: Loss of sovereignty. Because of FDI, decisions to inves, produce and market products and services in a host country are being made by foreigners.
According to the radical view, such deep suspicion of MNEs leads to policies that discourage or even ban FDI.
On the other hand, countries embracing free market and pragmatic nationalism views agree that, despite some acknowledged differences between foreign and
host country interests, the interests of MNEs and host countries overlap sufficiently. Host countries are therefore willing to live with some loss of
sovereignty.
2: Adverse effects on competition, a second concern is associated with the negative effects on local competition. It is possible that some MNEs drive some
domestic firms out of business. Having driven domestic firms out of business, in theory, MNEs may be able to monopolize local markets. This is a concern in less
developed countries.
3: Capital outflow. When MNEs make profits in host countries and repatriate such earnings to headquarters in home countries, host countries experience a net outflow in the capital account in their balance of payments. As a result, some countries have restricted the ability of MNEs to repatriate funds. Another issue arises when MNE subsidiaries spend a lot of money to import components and services from abroad, which also results in capital outflow.
- Benefits and costs of FDI to home countries:
1: repatriated earnings from profits from FDI
2: increased exports of components and sevices to host countries
3: learning via FDI from operations abroad.
Negative effects:
1 First, since host countries enjoy capital inflow because of FDI, home countries naturally suffer from some capital outflow. Less confident home country governments often impose capital controls to prevent or reduce FDI from flowing abroad.
2: The second concern is job loss. Many MNEs invest abroad and increase employment overseas but lay off domestic employees.
- Home MNes and host government bargain
MNEs react to various policies by bargaining with host governments. The outcome of the MNE-host government relationship, namely, the scale and cope of FDI in host country, is a function of the relative bargaining power of each side. MNes typically prefer to minimize host government intervention while maximizing the incentives provided by the host government.
Typically, FDI bargaining is not a one round affair. After the initial FDi entry, both sides may continue to exercise bargaining power. A well known phenomenon is the
obsolescing bargain, in which the requirements of the deal previously struck between MNEs and host governments is changed after the initial FDI entry.
This process has three rounds:
· In round one, the MNE and government negotiate a deal. The MNE usually is not willing to enter in the absence of some government assurance of property rights
and incentives.
· In round two, the MNE enters and, if all goes well, earns profits that may become visible
· In round three, the government often pressured by domestic political groups ,
may demand renegotiations of the deal because it seems to yield profits to the foreign firms. The previous deal becomes obsolete. The government’s tactics
include removing incentives, demanding a higher share of profits and taxes and even expropriation.
At this time, the MNE has already invested substantial sums of resources and often has to accommodate some new demands. Otherwise, it may face expropriation or exit at a glue loss.
Not surprisingly, MNEs do not appreciate the risk associated with such obsolescing bargains.
Bargaining power: ability to extract favorable outcome from negotiations due to one party’s strengths.
Obsolescing bargain: the deal struck by MNEs and host governments, which change their requirements after the initial FDI entry.
Expropriation: governments confiscation of foreign assets.
Sunk costs: cost that a firm has to endure even when its investment turns out to be unsatisfactory.
Sovereign wealth fund(SWF): a state owned investment fund composed of financial assets such as stocks bonds, real estate, or other financial instruments funded by foreign exchange assets.
- Overcoming the liability of foreignness
It is not easy to succeed in an unfamiliar environment. Such a liability is manifested in at least two ways:
- First, numerous differences in forma land informal institutions govern the rules of the game in different countries. Although local firms are already well versed in these rules, foreign firms have to learn the rules.
- 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. In government procurement is often required. In consumer products, the discrimination against foreign firms is less, but still far from disappearing.
Two core perspective:
- Institution based view suggests that firms need to undertake actions deemed legitimate and appropriate by the various forma land informal institutions governing market entries. Regulatory risks, trade and investment barriers, differences in norms, cultures and values.
- Recourse based view argues that foreign firms need to deploy overwhelming resources and capabilities to offset the liability of foreignness. Applying the VRIO framework.
Important question: Where to enter?
- Location specific advantages and strategic goals
Favorable locations in certain countries may give firms operating there what are called location specific advantages Location specific advantages: the benefits a firm reaps from the features specific to a place. Certain locations simply possess geographical features that are difficult for
others to match. Process for achieving location specific advantages:
1. First, firms seeking natural resources have to go to particular foreign locations where those resources are found.
2. Second, market seeking firms go to countries that have a strong demand for their products and services.
3. Third, efficiency seeking firms often single out the most efficient locations featuring a combination of scale economies and low cost factors
4. Finally, innovation seeking firms target countries and regions renowned for generating world class innovations.
It is important to note that these four strategic goals, although analytically distinct are not mutually exclusive. A firm may have to weigh more than one
concern as it decides where to locate.
Also, location specific advantages may grow, change, and or decline, prompting a firm to relocate. If policymakers fail to maintain the institutional attractiveness and if companies overcrowd and bid up factor costs such as land and talents, some firms may move out of certain locations previously considered advantageous.
- Cultural/institutional distances and foreign entry locations
Cultural distance: the difference between two cultures along identifiable dimensions such as individualism
Institutional distance: the extent of similarity or dissimilarity between the regulatory, normative and cognitive institutions of two countries
Two schools of thought have emerged in terms of where to enter:
1. The first is associated with the stage model. According to the stage model, firms will enter culturally similar countries during their first stage of
internationalization and will then gain more confidence to enter culturally distant countries in later stages.
Overall, some evidence documents certain performance benefits of competing in culturally and institutionally adjacent countries
2. Citing numerous counterexamples, a second school of thought argues that it is more important to consider strategic goals such as market and
efficiency rather than culture and institutions.
Overall, in the complex calculus underpinning entry decisions, location represents only one of several important considerations.
Also as much important as the question where to enter is: When to enter?
Entry timing refers to whether there are compelling reasons to be an early or late entrant in a particular country.
First mover advantages: benefits that accrue to firms that enter the market first and that late entrants do not enjoy.
Late mover advantages: benefits that accrue to firms that enter the market later and that early entrants do not enjoy.
For total scheme of advantages of when to enter: PAGE 269
First movers may gain advantage through:
- Proprietary technology.
- They also ride the learning curve in pursuit of scale and scope economies in new countries.
- Preemption of scare resources.
- In addition, first mover may erect significant entry barriers for late entrants, such as high switching costs due to brand loyalty.
- Intense domestic competition may drive some no dominant firms abroad to
avoid clashing with dominant firms head on in their home market.
- Finally, first movers may build precious relationships with key stakeholders such as customers and governments. (very important advantage)
Late mover advantages:
- Opportunity to free ride on first mover investments
- Resolution of technological and market uncertainty
- First mover’s difficulty to adapt to market changes
Overall, some evidence points out first mover advantages, and other evidence point out late mover advantages. Unfortunately, a mountain of research is still unable to
conclusively recommend a particular entry timing strategy. Although first movers may have an opportunity to win, their pioneering status is not a guarantee of success. It is through interaction with other strategic variables that entry timing has an impact on performance.
How to enter?
- Scale of entry: commitment and experience.
One key dimension in foreign entry decisions is the scale of entry. Such large scale entries demonstrate a strategic commitment to certain markets. This helps
assure local customers and suppliers as well as deterring potential entrants. The drawbacks of such a hard to reverse strategic commitment are (1)limited
strategic flexibility elsewhere and (2) huge losses if these large scale bets turn out to be wrong.
Small scale entries are less costly. They focus on organizational learning by getting a 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 is
a lack of strong commitment, which may lead to difficulties in building market share and capturing first mover advantages.
Scale of entry: the amount of resources committed to entering a foreign market
- Modes of entry: the first step on equity versus non-equity modes
Mode of entry: method used to enter a foreign market.
Given the complexity of entry decisions, it is imperative that managers prioritize and consider only a few key variable first and then consider other variables later.
In the first step, considerations of small scale versus large scale entries usually boil down the equity(ownership) issue.
Non-equity mode: a mode of entry(exports and contractual agreements) that tends to reflect relatively smaller commitments to oversea markets.
Equity mode: a mode of entry(JV and WOS) that indicate as relatively larger, harder to reverse commitment.
Equity modes call for the establishment of independent organizations overseas(partially or wholly controlled) non-equity modes do not require such
independent establishments.
Overall, these modes differ significantly in terms of cost, commitment, risk, return and control. The distinction between equity and non-equity modes is not trivial. In fact, it is what defines an MNE: an MNE enters foreign markets via equity modes through foreign direct investment. A firm merely exports/imports with no FDI is usually not regarded as an MNE.
Overall, the first step in entry mode considerations is crucial. A strategic decision has to be made in terms of whether or not to undertake FDI and to become an MNE.
- Modes of entry: the second step on making actual selections
During the second step, managers consider variables within each group of non-equity and equity modes.
Turnkey project: a project in which clients pay contractors to design and construct new facilities and train personnel
Build operate transfer agreement(BOT): a non-equity mode of entry used to build a longer term presence by building and then operating a facility for a period of
time before transferring operations to a domestic agency or firm R&D contract: outsourcing agreement in R&D between firms Co-marketing: efforts among a number of firms to jointly market their products and services.
Joint venture (JV) a new corporate entity crated and joint owned by two or more parent companies.
Wholly owned subsidiary(WOS): A subsidiary located in a foreign country that is entirely owned by the parent multinational
Green field operations building factories and offices from scratch used for agricultural purposes.
Small and medium sized enterprises(SMEs): firms with fewer than 500 employees in the United State and with fewer than 250 in the European union.
- Entrepreneurship and entrepreneurial firms
Although entrepreneurship is often associated with smaller and younger firms, no rule bans large rand older firms from being entrepreneurial. In fact, many large firms, are often urged to become more entrepreneurial.
Entrepreneurship: the identification and exploitation of previously unexplored opportunities. Specifically, it is concerned with the sources of opportunities: the process
of discovery, evaluation, and exploitation of previously unexplored opportunities.
Entrepreneurs: founders and/or owners of new businesses or managers of existing firms who identify and exploit new opportunities.
International entrepreneurship: a combination of innovative, proactive, and risk seeking behavior that crosses national borders (= international) and is intended to create wealth in organizations
- Institutions, resources, and entrepreneurship
Institutions and entrepreneurship
Formal institutions affect entrepreneurship. Formal institutions that govern how entrepreneurs start up new firms either help or hinder the growth of new SMEs.
Overall, it isn’t surprising that when formal institutional requirements are more entrepreneur friendly, entrepreneurship flourishes, and in turn the economy develops. As a result, more and more developing economies are reforming their formal institutions to become more entrepreneur friendly.
In addition to formal institutions, informal institutions such as culture values and norms also affect entrepreneurship.
Resources and entrepreneurship
An entrepreneurial firm must take the VRIO framework into account as it considers how to develop and leverage its resources.
- First, entrepreneurial resources must create value
- Second, entrepreneurial resources must be rare.
- Third, resources must be inimitable
- Fourth, resources must be organizationally embedded.
In sum, the resourced based view suggests that firm specific resources largely determine entrepreneurial success and failure.
Growing the entrepreneurial firms
Growth
The growth of an entrepreneurial firm can thus be viewed as an attempt to more fully utilize currently under utilized resources and capabilities. An entrepreneurial firms can leverage its vision, drive, and leadership in order to grow, even though it may be short on resources such as financial capital.
A hallmark of entrepreneurial growth is a dynamic, flexible, guerrilla
strategy. As underdogs, entrepreneurial SMEs cannot compete against their large rand more stabilized rivals head on. Going for the crumbs: smaller firms often
engage in indirect and subtle attacks that lire rival may not immediately recognize as competitive challenges.
Innovation
Innovation is at the heart of entrepreneurship. Evidence generally shows a positive relationship between a high degree of innovation and superior
profitability. Innovation allows for a more sustainable basis for competitive advantage. Entrepreneurial firms are uniquely ready for innovation. Owners,
managers, and employees at entrepreneurial firms tend to be more innovative and risk taking than those at large firms.
Innovators at entrepreneurial firms are better able to reap the financial gains associated with innovation(large firms goes to corporation because of property rights), thus fueling their motivation to charge ahead.
Financing
All start ups need to raise capital. In reality, most outside, strategic investors, who can be wealthy individual investors, venture capitalist, banks, foreign entrants and
government agencies, are not fools. They often demand some assurance, examine business plans, and require a strong management team.
Micro finance: a practice to provide micro loans(50-300 dollar) used to start small business with the intention of ultimate lifting the entrepreneurs out of poverty.
Internationalizing the entrepreneurial firm
Born global: start up companies that attempt to do business abroad from inception.
- Transaction costs and entrepreneurial opportunities
International transaction costs are higher than domestic transaction costs due:
1: Differences in institutions.
2: High level of deliberate opportunism that is hard to detect and remedy.
- International strategies for entering foreign markets
1. Direct exports
Direct exports: the sale of products made by firms in their home country to customers in other countries.
This strategy is attractive because entrepreneurial firms are able to reach foreign customers directly. When domestic markets experience some
downturns, sales abroad may compensate for such drops. However, a major drawback is that SMEs may not have enough resources to turn overseas opportunities into profits, and that some opportunities have to be given up due to potentially high transaction costs.
Export transactions are complicated. One concern is how to overcome the lack of trust.
Letter of credit(L/C): A financial contract that states that the importers bank will pay a specific sum of money to the exporter upon delivery of the
merchandise.
In short, instead of having unknown exports and importers deal with each other, transactions are facilitated by banks on both sides that have known
each other quite well because of numerous such dealings.
In other words, the L/C reduces transaction costs.
2. Franchising/licensing
Often used in manufacturing industries.
Licensing: firm A’s agreement to give firm B the rights to use A’s proprietary technology(such as a patent) or trademark(such as a corporate logo) for a royalty fee paid to A by B. This is typically done in
manufacturing industries.
Franchising: firm A’s agreement to give firm B the rights to use A’s proprietary assets for a royalty fee paid to A by B. This is typically done in service industries. A great advantage is that SME licensors and franchisors can expand abroad while risking relatively little capital of their own.
Licensors and franchisors also take a risk because they may suffer a loss of control over how their technology and brand names are used.
If foreign licensees produce sub standard products that damage the brand and refuse to improve quality, licensors are left with the difficult choices. They
can (1) sue licensees in an unfamiliar foreign court or (2) discontinue the relationship. Either choice is complicated and costly.
3. Foreign direct investment through strategic alliances, green field wholly owned subsidiaries, and or foreign acquisitions A third entry mode is FDI. FDI has several distinct advantages.
By planting some roots abroad, a firm becomes more committed to serving foreign markets. It is physically and psychologically close to foreign customers.
Relative to licensing/franchising, a firm is better able to control ho wits proprietary technology and brand name are used.
However, FDI has a major drawback: its cost and complexity. It requires both a nontrivial sum of capita land a significant managerial commitment.
Many SME scant engage in FDI. However, some evidence indicates hat in the long run, FDI by SMEs may lead to higher performance, and that some entrepreneurial SME scan come up with sufficient resources to engage in FDI.
Stage model: model of internationalization that portrays the slow step by step process an SME must go through to internationalize its business.
Given that most SMEs still fit the stereotype of slow(or no) internationalization but some entrepreneurial SMEs seem to be born global.
Important question: What leads to rapid internationalization?
The key differentiator between rapidly and slowly internationalizing SMEs seems to be the international experience of entrepreneurs. Although many entrepreneurial
firms have aggressively gone abroad, it is probably true that a majority of SMEs will be unable to do so, they have problems with domestic things.
International strategies for staying in domestic markets:
1. Indirect exports
Indirect exports: A way to reach overseas customers by exporting through domestic based exports intermediaries. Export intermediaries: A firm that performs an important middleman function by linking domestic sellers and foreign buyers that otherwise would not have been connected. Indirect exports for fimrs who dont have the money.
2. Supplier of foreign firms
Most foreign firms, in order to save costs are interested in looking for local suppliers. SME suppliers thus may be able to internationalize by piggybacking on the larger foreign entrants.
3. Franchisee/licensee of foreign brands
Foreign licensors and franchisors provide training and technology transfer-for a fee of course. An SME can liar a great deal about how to
operate at world class standards. Furthermore, licensees or franchisees do not have to be permanently under the control of licensors and franchisors.
After enough learning and enough capital has been accumulated it is possible to discontinue the relationship and reap greater entrepreneurial profits.
4. Alliance partner of FDI investors
Facing an onslaught of aggressive MNEs, many entrepreneurial firms may be unable to successfully defend their market positions. Then it makes
great sense to follow the old adage’ if you can\ t beat them, join them’. Although dancing with the giants is tricky it seems to be a much better
outcome than being crushed by the giants.
5. Harvest and exit(through sell off to and acquisition by foreign entrants)
In light of the high failure rates of start ups, being acquired by foreign
entrants may help preserve the business in the long run.
Defining alliances and acquisitions Fig 11.1 +11.2
Strategic alliance: a voluntary agreement between firms involving exchange, sharing, or Co-developing of products, technologies, or services
Contractual (non equity based) alliances: alliances between firms that are based on contracts and do not involve the sharing of ownership
Equity based alliance: alliances based on ownership or financial interest between firms
· strategic investment: one firm invests in another as a strategic investor
· cross-shareholding: both firms invest in each other to become cross-shareholders
· JV
Acquisition: transfer of control of operations and management from one firm(target) to another (acquirer), the former becoming a unit of the latter
Merger: the combination of operations and management of two firms to establish a new legal entity.
M&A: mergers and acquisitions
Institutions, resources, alliances and acquisitions
The institution based view suggests that, as rules of the game, institutions affect how a firm chooses between alliances and acquisitions in terms of its strategy.
However, rules are not made just for one firm. The resource based view argues that, although a number of firms may be governed by the same set of rules, some excel more than others because of the differences in firm specific capabilities that make alliances and acquisitions..
- Institutions, alliances and acquisitions
1. Formal institutions: (1) antitrust concerns and (2) entry mode requirements.
First, many firms establish alliances with competitors. Antitrust authorities suspect at least some tacit collusion when competitors cooperate. However, because integration within alliances is usually not as tight as acquisitions, antitrust authorities are more likely to approve alliances as opposed to acquisitions.
Second, formal requirements on market entry modes. In many countries, governments discourage or simply ban acquisitions to establish wholly owned subsidiaries(WOS), thereby leaving some sort of alliance with local firms as the only choice.
Recent, two trends have emerged in the entry mode requirements dictated by formal government policies:
First, there is a general trend toward more liberal policies. More countries allow WOS.
Second, a trend is that many governments still impose considerable requirements, especially when foreign firms acquire domestic assets.
2. Informal institutions: (1) normative pillar and (2) cognitive pillar
The first set of informal institutions centers on collective norms, supported by a normative pillar. A core idea of the institution based view is that,
because firms want to enhance or protect their legitimacy, copying what other reputable organizations are doing-without even knowing what they are doing- may be a low cost way to gain legitimacy
Firms just jump on the bandwagon. The flipside is that many firms rush into alliances and acquisitions without adequate due diligence and then get burned big time.
A second set of informal institutions emphasizes the cognitive pillar, which is centered on internalized, taken for granted values and beliefs that
guide alliances and acquisitions.
- Resources and alliances
- Value
Alliances must create value.
Real options: an investment in real operations as opposed to financial capital. A real options view suggest two proportions: (1) in the first phase, an investor
makes a small, initial investment to buy an option, which leads to the right to future investment without being obligated to do so. (2) the investor then
holds the option until a decision point arrives in the second phase and then decides between exercising the option or abandoning it.
For firms interested in eventually acquiring other companies but uncertain about such moves, working together in alliances thus affords an insider view
to the capabilities of these partners. Since acquisitions are not only costly but also very likely to fail, alliances permit firms to sequentially increase their
investment should they decide to pursue acquisitions.
If after working together as partners, a firm finds that an acquisition is not a good idea, there is no obligation to pursue it. Overall, alliances have emerged
as great instruments of real options because of their flexibility to sequentially scale the investment up or down.
Relational capability: capability to successfully manage interfere relationships
1. firm level (2) alliance level
Alliances between rivals can be dangerous because they may help competitors. Another imitability issue is the trust and understanding among partners in successful alliances.
Learning race: a situation in which alliance partners aim to outrun each other by learning the ‘tricks’ from the other side as fast as possible.
Some successful alliance relationships are organized in a way that is difficult to replicate.
- Value: Do acquisitions create value?
Overall, their performance record is sobering.
Acquisition premium: the difference between the acquisition price and the market value of target firms
- rarity
rare skills that enhance the overall strategy
- imitability
although 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.
- Organization
Strategic fit: the effective matching of complementary strategic capabilities between firms
Organizational fit: the similarity in cultures, systems and structures between firms.
Formation of alliances
In stage one, a firms must decide if growth can be achieved strictly through market transactions, through acquisitions or through cooperative alliances. To grow by pure
market transactions, the firms has to confront competitive challenges independently. This is highly demanding, even for resource rich multinationals.
In stage two, a firm must decide whether to take a contractual or an equity approach.
1. Shared capabilities
The more tacit(that is, hard to describe and codify) the capabilities, the greater the preference for equity involvement. The most effective way to
learn complex processes is through learning by doing. A lot of tacit knowledge dealing with complex skills and know how is embedded in specific organizational settings and is ‘strictly’(that is, hard to be isolated out of the particular firm that possesses such knowledge).
2. Importance of direct monitoring and control. Equity relationships allow firms to have some direct control over joint activities on a continuing basis, whereas contractual relationships usually do not. Firms that fear their intellectual property may be expropriated prefer equity alliances.
3. Options thinking
Some firms prefer to first establish contractual relationships, which can be viewed as real options for possible upgrading into equity alliances should the interactions turn out to be mutually satisfactory.
4. Contract and equity also boils down to institutional constraints. Some governments eager to help domestic firms climb the technology ladder either require or actively encourage the formation of JVs between foreign and domestic firms.
Evolution and dissolution of alliances
The threat of opportunism looms large on the horizon. Most firms want to make their relationship work, but also want to protect themselves in case the other
side is opportunistic. It is possible to minimize its threat by (1) walling off critical capabilities or (2) swapping critical capabilities through credible commitments.
First, both sides can contractually agree to wall off critical skills and technology snot meant to be shared.
This type of relationship, in human terms, is like married couple whose premarital seats are protected by prenuptial agreements.
Second, swapping skills and technologies, is the exact opposite of the first approach. Both sides not only agree not to hold critical skills and technologies
back, but also make credible commitments to hold each other as a ‘hostage’.
Performance of alliances
1. Equity
This may be crucial. A greater equity stake may indicate a higher level commitment, which is likely to result in higher performance
2. Learning by doing
Whether firms have successfully learned from partners is important when assessing alliance performance. Since learning is abstract, experience is
often used as a proxy because it is relatively easy to measure. There is a limit beyond which further increase in experience may not enhance performance.
3. Nationality
This may also affect performance. For the SMAE reason that marriages where both parties have similar backgrounds are more stable, dissimilarities in national culture may create strains in alliances. International alliances tend to have more problems than domestic ones.
4. Relational capabilities.
The art of relational capabilities, which are firms specific and difficult to codify and transfer, may make or break alliances.
Overall, it is their combination that jointly increases the odds for the success of strategic alliances.
Motives for acquisitions table 11.3
1. Synergistic
2. Hubristic: over confidence in one’s capabilities
3. Managerial motives: managers desire for power prestige and money which may lead to decisions that do not benefit the firm overall in the long run. Performance of acquisitions
Many acquisitions fail because managers fail to address pre and post acquisition problems.
Integration-responsiveness framework: A framework of MNE management on how to simultaneously deal with two sets of pressures for global integration and local
responsiveness.
Local responsiveness: The necessity to be responsive to different customers preferences around the world. → Being locally responsive certainly makes local
costumers and governments happy, but unfortunately increases costs.
Based on the integration-responsiveness framework, there are four strategic choices
for MNE's. Fig 13.1!
- Home replication strategy: Emphasizes the replication of home country based competencies in foreign countries.
- Localization strategy: Focuses on a number of foreign countries/regions, each of which is regarded as a stand-alone domestic market worthy of significant attention and adaptation.
- Global standardization strategy: A strategy that focuses on development and distribution of standardized products worldwide in order to reap the maximum benefits from low-cost advantages.
Because the MNE's in this strategy are not limited to its major operations at home, they may designate centers of excellence. Centers of excellence (an MNE
subsidiary explicitly recognized as a source of important capabilities, with the intention that these capabilities be leveraged by and/or disseminated to other subsidiaries) are often given a global mandate, namely, a charter to be responsible for one MNE function throughout the world.
- Transnational strategy: Endeavors to be cost efficient, locally responsive and learning driven simultaneously around the world.
The four strategic choices for MNE's.
Strategy Advantages Disadvantages
Home
Replication
- Leverages home country-based advantages
- relatively easy to implement
- Lack of local responsiveness
- May result in foreign costumers alienation
Localization has as advantage: Maximizes local responsiveness and as disadvantage high costs due to duplication of efforts in multiple countries and too much local autonomy
Global standardization
- Leverages low-cost advantages · Lack of local responsiveness
- Too much centralized control
Transnational · Cost efficient while being locally responsive
- Engages in global learning and diffusion of
Innovations
- Organizationally complex
- Difficult to implement
Strategy and organizational structures Fig 13.2 tm 13.5:
Home replication → International division: A structure that is typically set up when firms initially expand abroad, often engaging in a home replication strategy.
Localization → Geographic area structure: A structure that organizes the MNE according to different geographic areas. Such an area (country/region) is led by a country or regional manager.
Global standardization → Global product division structure: A structure that assigns global responsibilities to each product division
Transnational Global matrix: a structure often used to alleviate the disadvantages associated with both geographic area and global product division structures, especially
for MNEs adopting a transnational strategy. Sharing and coordination of responsibilities between product divisions and geographic areas in order to be both cost efficient and
locally responsive. The positioning of the four structures is not random. They develop from the relatively simple international division through either geographic area or global product division structures and may finally reach the more complex global matrix stage.
Institution-Based considerations for multinational strategies, structures and learning
External institutions: MNEs are subject to the formal institutional frameworks erected by various home-country and host-country governments. MNEs also confront informal
institutions governing their relationship with the governments of host- and home countries.
Internal institutions governing MNE management. How MNEs are governed internally is also determined by various formal and informal rules of the game.
Overall, although formal internal rules on how the MNE is governed may reflect strategic choices, informal internal rules are often taken for granted and deeply embedded in administrative heritages, thus making them difficult to change.
Resource-Based considerations for multinational strategies, structures and learning
The VRIO-framework adds a number of insights
- Looking at structural changes, it is critical to consider if a new structure adds concrete value.
- Certain strategies or structures may be in vogue at a given point in theme. At this point, such strategies and structures will not provide specific advantage for a firm. So strategies and structures have to be rare.
- Informal structures are harder to observe and therefore harder to imitate than formal structures.
- MNEs have to be managed in a right way. Organization in relationship to the
institutions is very important. A specific MNE may have an organizational culture:
The collective programming of the mind that distinguishes the members of one organization from another.
Knowledge management: The structures, processes and systems that actively develop, leverage and transfer knowledge. Knowledge management depend on information technology and on informal social relationships within the MNE.
- Explicit knowledge: Knowledge that is codifiable (can be written down and transferred with little loss of richness).
- Tacit knowledge: Knowledge that is non-codifiable, and it acquisition and transfer require hand-on practice.
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.
Concepts than can be problems and solutions in knowledge management
- Global virtual team: A team whose members are physically dispersed in multiple locations in the world and often operate on a virtual basis
- Absorptive capacity: The ability to recognize the value of new information, assimilate it and apply it.
- Social capital: The informal benefits individuals and organizations derive from their social structures and networks.
- Micro-macro link: The micro, informal interpersonal relationships among managers of units that may greatly facilitate macro, intersubsidiary cooperation among these units.
Subsidiary initiative: The proactive and deliberate pursuit of new opportunities by a subsidiary to expand its scope of responsibility.
Global account structure: A customer-focused dimension that supplies customers in a coordinated and consistent way across various countries.
Solution-based structure: A customer-focused dimension in which a provider sells whatever combination of goods and services the customers prefer, including rivals' offerings.
Marketing: Efforts to create, develop and defend markets that satisfy the needs and wants of individual and business customers. (identifying want)
Supply chain: The flow of products, services, finances and information that passes through a set of entities from a source to a customer.
Supply chain management: Plan, organize, lead and control the supply chain.
Supply network → Producer/manufacturer → Distribution network → Customers
The marketing mix: Product, price, promotion and place.
- Products: The offerings that customers purchase
Market segmentation: Identifying segments of consumers who differ from others in purchasing behavior. (Pros and cons to globalization and international sales)
- Price: The expenditures that customers are willing to pay for a product. Total cost of ownership: Total cost needed to own a product, consisting of
initial purchase cost and follow-up maintenance/service cost. Promotion: Communications that marketers insert into marketplace Country of origin effect: The positive/negative perception of firms and products from a certain country.
- Place: The location where products and services are provided. Also referred to as the distribution channel: the set of firms that facilitates the movement of goods from producers to consumers. So the place is actually the distribution channel, which is the supply chain.
The three A's of supply chain management:
- Agility: The ability to react quickly to unexpected shifts in supply and demand. Agility thus focuses on flexibility that can overcome short-term fluctuation in the supply chain. → To reduce inventory, many firms now use their suppliers and carriers' trucks, ships and planes as their warehouse.
- Adaptability: The ability to change supply chain configurations in response to
longer-term changes in the environment and technology. Adaptability is often enhanced through a series of make-or-buy decisions: To produce in-house (make) or to outsource (buy).
- Alignment: Alignment of interests of various players. Each supply chain is a strategic alliance involving a variety of players. These firms must collaborate
to succeed. Introducing a Third party logistics: A neutral, third party intermediary in the supply chain that provides logistics and other support services, may more effectively align the interests of all parties in the supply chain.
Institutions, resources, marketing and supply chain management
- Government restrictions by the formal rules of the game.
- Firms have to understand the differences in informal institutions
- Marketing and supply chain management can be evaluated by the VRIO framework.
Market orientation: a philosophy or way of thinking taht places the highest priority on the creation of superior customer value in the marketplace.
Relationship orientation: a focus to establish maintain and enhance relationships with customers.
Financing: how a firm’s money, banking, investments, and credit are managed.
Corporate governance: the relationship among various participants in determine the direction and performance of corporations
Tripod: consist of owners, managers and board of directors.
Financing decisions
Equity: the stock in a firm(usually expressed in shares), which represents the owners rights.
Shareholders: firm owner
4Fs: founders, family, friends and ‘fools’(outside investor)
Firms issue equity to attract investors to become shareholders so that firms can access a larger pool of capita land use it at management discretion. Shareholders
often gain from investments.
Debt: a loan that the firm needs to pay back at a given time with an interest.
Bond: loan issued by the firm and held by creditors.
Bondholder: buyer of bonds
Default: a firm’s failure to satisfy the terms of a loan obligation.
- Reducing the cost of capital
Cost of capital: the rate of return that a firm needs to pay to capital providers
Cross listing: listing shares on a foreign stock exchange.
Owners
- Concentrated versus diffused ownership
- Family ownership
- State ownership
Managers
- Principal agent conflicts
- Principal-principal conflicts
Board of directors
- Board composition
- Leadership structure
- The role of board of directors
Governance mechanism as a package
- Internal(voice- based) governance mechanisms
- External(exit based) governance mechanisms
- Internal mechanisms+ external mechanisms= governance package
A global perspective on corporate governance
Institutions, resources and cooperate finance and governance
Corporate social responsibility: Consideration of and response to, issues beyond the narrow economic, technical, and legal requirements of the firm to accomplish social benefits along with the traditional economic gains which the firm seeks.
At the heart of CSR is the concept of the stakeholder, which is “any group or individual who can affect or is affected by the achievement of the organizations objectives.”
A key goal for CSR is global sustainability, which is defined as the ability to meet the needs of the present without compromising the ability of future generations to meet their needs around the world.
Primary and Secondary stakeholder groups:
Primary stakeholder groups are constituents on which the firm relies for its continuous survival and prosperity.
Secondary stakeholder groups are defined as those who influence or affect or are influenced or affected by, the corporation, but they are not engaged in transactions with the corporation and are not essential for its survival.
Firms should pursue a more balanced set of criteria called the triple bottom line.
Triple bottom line: economic, social and environmental performance that simultaneously satisfies the demands of all stakeholder groups.
Institutions, resources, and corporate social responsibility.
The strategic response framework consists of:
1: Reactive: A strategy that would only respond to CSR causes when required by disasters and outcries.
2: Defensive: A strategy that focuses on regulatory compliance, but with little actual commitment to CSR by top management.
3: Accommodative: A strategy characterized by some support from top managers, who may increasingly view CSR as a worthwhile endeavor.
4: Proactive: A strategy that endeavors to do more than is required in CSR.
Social issue participation: firms participation in social causes not directly related to the management of primary stakeholders.
- This summary is first made in 2014
- See for later years below.
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