Most complex issues in international business strategy revolve around seven concepts:
See page 5, figure 1.1
MNE’s (Multinational Enterprise) need certain internal strengths to overcome additional costs of doing business abroad, those are called: internationally transferable, or non-location bound FSAs (Firm Specific Advantages)
These FSAs will keep their value when an MNE is crossing borders.
There is a paradox of an internationally transferable FSA. When a FSA exists of easily codifiable knowledge, it is cheap and easily to transfer, but it can also be easily imitated by other firms. This makes the transfer costs low, but also the value that can be derived from it, may also be low. On the other hand, when a FSA exists of tacit knowledge, which requires person-to-person communication and sending human resources abroad to build up experience over time by learning, it will be expensive and time-consuming, but also difficult to imitate and thus a valuable FSA.
The most important bundle of tacit knowledge is contained in the MNEs heritage (the key routines developed by the firm since its inception). There are four archetypes of administrative heritage:
Centralized exporter: standardized products manufactured at home, embody the firm’s FSAs and make the exporting firm successful in international markets. This all happens without doing any activity in the host country, so no development of new FSAs in the host country. So this is only exporting the product.
International projector: FSAs from home country are copied. Only the internationally transferable FSAs are taken to the host country. No development of location bound FSAs in the host country.
International coordinator: efficiency seeking MNE which is specialized in specific value-added activities and forming vertical value chains abroad. Is doing different parts of the production process in different countries.
Multi-centred MNE: does everything (produce, sell, etc) in the host country. Adapts to the host country, so local responsiveness is its foundation. Transfers only the key routines from the home country and builds up new Location-Bound FSAs in the host country.
See page 35 and 36, figure 1.3, 1.4, 1.5 and 1.6 for the visualization of the four archetypes.
Exists of four main types:
Stand-alone resources: linked to location advantages, such as a certain market or a network, which are immobile.
Other resources: do not have the same value abroad, because they are not applicable to the host country or they are not as valuable as in the home country. Such as local knowledge or reputations.
Local best practices: routines which are highly effective and efficient in the home country, but which might not be the same abroad.
Recombination capability: engaging in product diversification or innovation, taking the FSAs and/or product from the home country and recombine it to adapt to the host country.
With location-bound FSAs, the corresponding FSA in each host country will need to be created or acquired from third parties operating in the foreign market.
Represent the strengths of a specific location, useable for all the firms operation in that location, the reason why an MNE would go there.
FDI (Foreign Direct Investment): the allocation of resource bundles by an MNE in a host country, with the purpose of performing business activities over which the MNE contains strategic control there.
4 motivations to perform activities rather abroad:
Natural resource seeking: contains the location advantage of the host country, it’s the search for physical, financial of human resources. Precondition, is that access is needed.
Market seeking: the search for customers. Not for the centralized exporter, because this involves business activities in the host country.
Strategic resource seeking: searching for access to advanced resources such as upstream knowledge (product- and process related technological knowledge), downstream knowledge (critical for interface with customers), administrative knowledge (knowledge regarding the functioning of the organisation) and reputational sources.
Efficiency seeking: desire to capitalize on environmental changes that make specific locations more attractive.
Recombination: being able to grow by innovating and diversifying, means combining existing resources with newly accessed resources. Recombination capability is the MNEs highest order FSA, because this helps the MNE to transfer its existing set of FSAs, it creates new knowledge, integrates this with the existing knowledge, and exploit the resulting.
By going abroad some ingredients may be missing, those can be provided by external actors (provider, distributors, licensees, partners, etc from the host country), this will help to overcome the distance.
Two problems by going abroad:
The problem is the access to information and even if they have the right information, another problem is the capability to process complex information bundles. Information is partial and incomplete, cognitive limitations of managers, and differences in cognitive decision making between home and host country.
Agents do not always carry through on their expressed intentions to try to achieve a particular outcome or performance level. One source is opportunism which involves false promises. The second source is benevolent preference reversal, the actor’s promise is made in good faith but preferences change overtime.
To summarize:
Bounded rationality is about the imperfect assessment of a present or future state of affairs, thereby leading to incorrect beliefs, caused by a lack of information. Bounded reliability is about imperfect effort, leading to incomplete fulfilment.
C.K Prahalad and Gary Hamel have the idea that core competencies (company’s most important FSA, its vital routines and recombination capabilities) constitute the most important source of an MNEs success. Core competencies include shared knowledge, organized in routines, and the ability to integrate multiple technologies, or recombination capabilities, carried by the key employees.
Core competencies produce core products; technological leadership in the form of key components from which end products are developed and created.
There are 3 characteristics to identify core competencies, a core competence should:
Be difficult for competitors to imitate
Provide potential access to a wide variety of markets
Make a significant contribution to the perceived customer benefits of the end product
The extra fourth one is especially important for a large MNE:
The loss of the core competence would have an important negative effect on the firm’s present and future performance
Strategic management is needed to develop a strategic architecture to allow this. Thus, to develop a road map of the future that identifies core competencies to build the required technologies.
Key critique on core competence approach is that Prahalad and Hamel do not include country factors in their analysis. They overestimate’ the role of strategic management and underestimate role of (host) country location factors.
This is where Porter comes in, see chapter C: Porter’s diamond of national competitive advantage.
Michael Porter argues that a company’s ability to compete abroad is based on a set of location advantages in its home country. The idea is that when a company experiences a high level of pressure in the home country it will push the firm to innovate and upgrade systematically. This will create new FSAs, which will be the instruments for the expansion to foreign markets. A nation’s competitiveness depends on the capacity of its industry to innovate and upgrade.
So Porter says that the most important aspect of international business strategy is the four key home country location advantages. Those are combined in Porter’s Diamond. The four key sets of country attributes are:
Factor conditions: like natural resources and created factor conditions (such as skilled labor, knowledge, and infrastructure). These are particularly valuable when specialized, so when they are customized towards effective deployment in specific economic activities and companies. Firms need to continuously develop new skills, like continuous learning of employees and ccontinuous innovation of machines
Demand conditions: not only domestic market size, but also domestic buyer sophistication. When buyers are demanding, the external pressure on the firm increases and so the competitiveness increases.
Related and supporting industries: the need for high-quality suppliers.
Firm strategy, industry structure and rivalry: a competitive industry, not-sheltered protective markets and a well-functioning industry may help the firm in that industry to become more internationally competitive.
Those 4 variables plus 2 external variables (government and chance) determine the competitiveness in international markets.
See page 109, figure 3.1 for the visualization of Porter’s Diamond
To get a strong diamond, there are certain requirements per country attribute:
Factor conditions: the company needs to be continuously upgraded through the development of skills and the creation of new knowledge.
Demand conditions: companies must respond to new customer demands by pushing the envelope of existing technology and by designing new features.
Related and supporting industries: high competitive firms at home, especially suppliers, are crucial to enhance innovation. Needed for the ongoing exchange of ideas, timely feedback and short lines of communications.
Firm strategy, industry structure and rivalry: rivalry forces companies to develop unique FSAs, beyond the generally available location advantages in their home base. In this way companies get motivated to enter international markets and exploit these FSAs
When having a strong diamond, the creation of non-location bound FSAs will be stimulated. With those non-location bound FSAs, a company can go abroad.
Key concern: FSAs are in Porter’s theory completely domestically determined. Porter places too much emphasis on the home country as the appropriate level of analysis.
Pankaj Ghemawat has the idea that the distance between two countries, gives extra risks and cost to entering new markets. He concludes that higher inter-country distance correspond with lower inter-country trade levels, implying a lower profitability of success.
There are 4 basic categories of distance:
Cultural distance: results from differences in national cultural attributes.
Administrative/institutional distance: differences in societal institutions. This distance is low when there is a shared history, political ties, trading between the two or synchronized politics.
Geographic/ spatial distance: the physical distance, taking into account the ease of transport between both. Is high when there are differences in topography and climate. Is low when there is a good transportation and communication network.
Economic distance: differences in wealth, income level, infrastructures and costs and quality of natural, financial and human resources.
The higher those distances, the lower the trade levels will be.
Details of the distance, by what it can be affected and which industries are being affected:
Cultural distance: is higher when there is a preference for locally produced products or when there are no tolerances or copyright infringements. Affected industries: soft items, such as food, which are selected on taste, are more sensitive for this distance than hard items such as machinery and bulk items.
Administrative/institutional distance: governments can raise barriers for protecting domestic industries, there can be a higher distance through unilateral measures, like forbidding certain things. Distance can be higher through institutional infrastructure, such as corruption. Affected industries: industries with large numbers of employees which are producing essential goods and the ones that exploit a host country’s key natural resources.
Geographic distance: also man-made elements such as transportation networks and communication infrastructure can make the distance higher. Affected industries: low-value-to-weight products, perishable products and trade in services and capital, because of information and infrastructure.
Economic distance: there are two broad approaches to expanding abroad. Replicating existing competitive advantages, building upon scale and scope economies, which is typical for the centralized exporter and the international projector. This is more effective with small economic distance, it requires standardization. The second approach is exploiting differences in input costs or prices between markets through economic arbitrage, which is typical for international coordinators. Vertical intergraded MNEs embrace economic distance, because that possesses FSAs that allow it to exploit and link the diverse location advantages of high distance countries.
Macro level distance, does not always hold for all firms (distance for a firm ≠ distance for all firms)
A firm’s FSA can be that it is able to deal with these distances
Impact of distance differs for part of the value chain
G assumes that FSAs are developed in the home market, but firms may also develop FSA in a host country
G does not discuss cooperative entry modes (like JV or strategic alliance) and how they may help to reduce distance (because they are complementary resources).
CD (the cultural distance) is important because it increases complexity to deal with foreign workforce, hence more risky investments, as a result: relatively small investments or low level of commitment or no local partners. When CD is high, then local knowledge is required and firm from country A investing in culturally distant country B may wish to cooperate with another firm from country B as complementary resource.
When CD increases:
Level of investment in culturally distant country decreases.
Type of investment changes from high to low level of commitment.
The investing firm will not want to cooperate with a local partner.
Counterargument:
The investing firm needs to cooperate with local partner because host country is so different from home that all help is needed.
The measurement of culture is done by Geert Hofstede in a 4 (or 5) dimensional framework; people from different societies differ on several key dimensions:
Uncertainty avoidance
Power distance
Individualism-collectivism
Masculinity-femininity
Long term orientation, later uncovered than the above 4.
Kogut & Singh’s calculation for CD
- CDj is the cultural distance between country j and the home country
- Iij is country j’s score on the ith cultural dimension,
- IiUS is the score of the home country on this dimension,
- Vi is the variance of the score of the dimension
The illusion of symmetry; assumes that the CD is the same as the distance between the two countries, which is not true.
The illusion of stability: CD and its measures change over time, because cultures and the role of CD change.
The illusion of linearity: the effect of CD may depend on a firm’s learning curve, hence is not linear as assumed.
The illusion of causality: distance does not only consist of CD, but it should also be measured together with geographic distance and institutional distance.
The illusion of discordance: some dimensions of a culture matter more than others, this is not taken into account in the calculation, where all the dimensions have the same weight.
The assumption of corporate homogeneity: the calculation only incorporates variances at the national level, whilst there are also differences at corporate level.
The assumption of spatial homogeneity: in the calculation, the exact location of a firm in a country is not measured.
Chris Bartlett and Sumantra Ghoshal suggest that large MNEs are making a mistake when they adopt
Homogenization: treating all subsidiaries the same
Centralization: all strategic decisions at the headquarters
These MNEs do not see, that the subsidiary can develop their own unique strengths and augment further the MNEs existing FSA bundles. Strategic decision making and control in the home country can lead to enormous bounded reliability and rationality challenges. Bartlett and Sumantra argue that giving subsidiaries more power and decision making authority may help in building a FSA in the host country
Senior management frequently adopts two simplifying strategies:
Universal/ United Nations model of multinational management: the mistake of homogenization, giving each subsidiary the same roles and responsibilities. This approach involves subsidiary independence (as in multi-centered MNEs) or complete dependence (as in centralized exporters and international projectors). Universal response helps to deal with the coordination problem, but sometimes it is better to allow limited subs authorization.
Headquarters hierarchy syndrome: the mistake of centralization, where the subsidiaries are seen as units that act as implementers and adapters. Views that the organization consists of two levels, the dominant layer and the subordinates that will implement.
Those two strategies cause tensions between the headquarters and the subsidiaries, which want to fight for more interdependence. Next to that, opportunities are missed by local subs because the headquarters may kill entrepreneurial spirit in subsidiaries.
To decide how much authority to give a subsidiary, Bartlett and Ghoshal decided that subsidiary autonomy depends on:
The strategic importance of each market
How strong are the subs’ resources like labor, technology, marketing achievements, R&D.
Therefore, they made a subsidiary classification system which distinguishes four types:
Black hole: weak in resources, but located in a strategically important market. Being used to maintain a presence in this key market to keep ahead of new innovations by competitors. In the long run this unit wants to commit more resources to build up.
Implementer: weak in resources and low in the strategic importance of the market. Most subsidiaries fit in this type. This unit is the key to a firm’s overall success, because it generates a steady stream of cash flow and it may help to build competitive advantage by contributing to company-wide scale and scope economics
Strategic leader: high in resources and high in the strategic importance of the market. The role of this unit is to assist the headquarters in identifying industry trends and developing new FSAs in response to emerging opportunities and threats.
Contributor: high in resources, but low on importance of strategically local market. This unit is typically for developing new FSAs. Its subsidiary specific, specialized resource base might benefit other units, if the headquarters understand its potential economic value for the entire MNE
See page 155, figure 5.1 for the visualization of this classification
There are three types of modes for entering a host country; foreign distributors, strategic alliances and merger and acquisition. The first one has the lowest level of commitment and the last one the highest.
David Arnold has the idea that, when selling in foreign markets, MNEs should maintain relationships with local distributors over the long term, even when they already established their own local network. The first step in internationalization is often establishing a relation with a foreign distributor, because:
They have the knowledge about the local market, regulations and business practices
They know where to hire the appropriate staff
They know potential customers
Their FSA is location bound and helps overcome the distance that the internationalizing firm has to deal with
Local distributors often serve as a beachhead in the first stage of internationalization. A beachhead strategy means that when you go into the host country, you need to focus your strength and concentrate on winning a small area, which is the beachhead, that becomes the stronghold from which you will have advance into the rest of the market.
The distribution strategy often follows a pattern:
1st stage: initial success. Success is easy to capture as the low hanging fruit. A new product in a new market sells itself. There are new and enthusiastic partners.
2nd stage: flattening success and sometimes even declining. After the first success, the market becomes more difficult, because there are new entrants and the competition increases.
3rd stage: the MNE starts questioning its local partner and may
Take over control of distribution channel
Build a self owned distribution channel
Because it thinks it is better to do it yourself. As a result, the local partner and MNE will not invest in each other anymore. The solution to these common problem s between MNEs and their foreign distributors according to Arnold is to recognize that the phases are predictable and that MNEs should plan for them in a way that is less disruptive and costly than the beachhead strategy. Successful firms often go from a beachhead strategy into developing a long term relationship with the local partner, in combination with direct distribution by the MNE itself.
The key for the MNE is to find the balance between three competing objectives:
To maintain strategic control over important customers
To benefit from the local partner’s market knowledge and market access
To reduce risk associated with high demand uncertainty in the host market
Arnold’s list of seven guidelines for MNEs when dealing with local distributors:
Proactively select locations and only then suitable distributors; select your distributors, do not let them select you.
Focus on distributors’ market development capabilities; look for distributors capable of developing markets, rather than those with a few obvious customer contacts.
Manage distributors as long-term partners; this will make distributors willing to invest more in strategic marketing and long-term development.
Provide resources (managerial, financial and knowledge-based) to support distributors for market development purposes.
Do not delegate marketing strategy to distributors; distributors should be able to adapt to the MNEs marketing strategy, but the MNE should hold clear leadership.
Secure shared access to the distributors’ critical market and financial intelligence; this will reduce the MNEs bounded rationality problems, because it improves its understanding of the local market.
Link national distributors with each other, especially at the regional level (spanning several countries).
All this is especially relevant to the centralized exporter.
(Hamel et al.)
The second entry mode implies you start to cooperate with a rival, in forming a strategic alliance. The challenge here is to learn as much as possible from this partner, while giving away as few of your own FSAs as possible. The advantage is that you share risks and costs (R&D), you learn from your partner’s complementary resources, and there is quicker development of capabilities to deliver products and services.
While some companies gain competitive strength from alliances, others fall behind. The costs of an alliance are:
The own FSA could be appropriated by the alliance partner (so it is important to develop safeguards against such reverse knowledge flows).
A risky learning race starts; how to learn more from your partner than your partner learns from you.
Knowledge sharing becomes dysfunctional because of bounded reliability; partners want to contribute as little as possible.
Managers pay too much attention to the learning race and forget about the goal of the strategic alliance in the first place.
When an MNE has too many strategic alliances, this reduces coherence and increases management problems.
The challenge of a strategic alliance is to share enough skills to create advantage vis-à-vis companies outside the alliance, whilst preventing the transfer of core skills to the partner. The goal is to limit the transparency of their operations. The nature of the FSAs contributed by an MNE to an international alliance affects how easily these FSAs will diffuse to a partner. Two important variables:
Mobility: the ease of moving the complete physical constructions of how to duplicate an FSA. The more mobile, the easier it may diffuse.
Embeddedness: an FSA is embedded if it cannot easily be shared through actors outside the firm, without problems of interpretation or absorption across cultures. The more embedded the FSA, the less easily it is to diffuse.
The entry modes with the highest level of commitment are mergers and acquisitions. Those are done to create larger firms that are supposedly better able to deal with globalized markets. Next to that, when a firm is active in a mature industry with low growth, an M&A can be a strategic move to break the mould. An M&A serves as a radical break that changes the organization radically, which sometimes, is needed.
M&A is not easy because of:
Pre – and post integration obstacles: each firm has its own FSA, which are partly location bound. If the distance is large, it will be more difficult to integrate these FSAs. Plus even for FSAs that are transferable, it is not easy to integrate these.
Purchase price premiums: as a result of firms competing for a firm that can be taken over, the price increases.
Ghemawat and Ghader provide a list of six senior management biases, why managers like M&A. Those can all be interpreted as reflections of bounded rationality and, in some cases, also bounded reliability:
Top line obsession: focus on growth of sales, not profits. The bounded reliability problem here is that managers only pursue their own interests.
Stock price exploitation: in case of overvalued stock prices, managers would like to benefit from that. Here the bounded reliability problem is opportunistic behavior.
Grooved thinking: “this is the way we always did it”.
Herd behavior: copy paste behavior of managers, doing what the competitor does. The bounded reliability lies in the senior managers engaging primarily in self-serving behavior.
Personal commitments:
Trust in interested parties: Investment banks can push firms out of own interests. Here the source of bounded reliability problems resided with the external parties to the transaction; these parties act in their own interests instead of the interests of the firm that hired them.
SA (strategic alliance) versus M&A (merger and acquisition)
Alliance preferred over M&A when:
Each firm only needs a subset of the FSAs of the partner
It is difficult to dispose of the prospective partner’s unusable resources because they are firm specific: if you buy the whole firm and cannot sell the parts of it you do not like
The advantage of SA is that you only get those parts of the FSA of a partner that are really needed. That is why it is called a strategic alliance. But, there are also legal issues involved. Not every country allows in every industry to establish a SA or a merger. For example in the defense industry, or nuclear industry. Exactly because foreign firms should not be able to learn from the local firm. That is perceived by politicians as giving away knowledge to foreign partners.
Walter Kuemmerle’s idea: many MNEs, particularly international projectors, are wisely decentralizing their R&D by building worldwide networks of R&D labs. Instead of keeping all their R&D activities in their home country, they are building international networks in which foreign R&D laboratories fulfill specific roles within the firm. Two reasons for this trend:
Many MNEs want to have presence in the host country, in order to monitor and absorb new developments.
MNEs must integrate their R&D facilities more closely to the host country, because of the commercial requirement of moving quickly from innovation to market.
Kuemmerle identified two distinct types of host country R&D facilities:
Home-base exploiting sites: those are supporting manufacturing facilities in the foreign country, to adapt standard products to the demand there. Information flows to the foreign laboratory from the central lab at home. Those sites should be located closely to key markets and the MNEs own foreign manufacturing units so that the firm’s technological innovations can be rapidly adapted to host country requirements.
Key challenge: overcome the distance between home & host and manage info flow.
Solution: put managers in charge in foreign lab that know the firm and the central lab.
Home-base augmenting sites: acts as the firm’s eyes and ears in the host country, accessing knowledge from rivals and research institutions there. Information flows from the foreign laboratory to the central lab at home. Should be located in critical knowledge clusters, where it will be well positioned to tap into new sources of innovations.
Key challenge: access local knowledge and use while not being an insider is difficult. So they should strengthen ties with local community, but also make sure knowledge is useable and relevant for manufacturing operations.
See page 187, figure 6.1 for the visualization of both types.
3 key limitations of Kuemmerle’s model on R&D capabilities abroad:
Ignores tension between host country lab(s) and central headquarters’ lab in setting the research agenda: subsidiaries’ managers versus central top management team.
He does not include the possibility of joint venture or strategic alliance as options to tap into foreign country’s knowledge
He does not take in account the hidden (and rising) costs of off shoring
Kasra Ferdow has the idea that senior MNE managers should try to upgrade their host country factories, so they can develop FSAs. Managers should give certain subsidiaries more control and decision making power depending on their strengths and the importance of the market, in order to get the subsidiary to contribute to FSA of the entire MNE in other markets. Production subsidiaries get a new role; not just cheap production, but overall added value for the firm.
Ferdow: 3 major changes that leads production subsidiaries to become more than just cheap production locations:
International tariffs went down: (GATT/WTO), need to establish plants to overcome trade barriers are not that important anymore.
Production is more complex in terms of supply chain management and planning: not just low wages, but overall productivity counts, including technology and infrastructure.
Time to go from manufacturing to marketing has become shorter: MNEs increasingly co-locate development & manufacturing (broad mandate for subsidiaries).
There are six possible roles for foreign manufacturing facilities based upon two parameters:
The strategic purpose of the plant, so the host country location advantages it wants to access; proximity to market, access to low-cost production or access to knowledge and skills.
The level of distinct FSAs, so the additional strengths added by the plant itself; weak or strong.
See page 202 figure 7.1 for de visualization of the six roles of foreign manufacturing plants:
Offshore factory: access to low-cost production, low level of distinct FSAs. Typically does not develop new FSAs and receives minimum autonomy.
Server factory: primary purpose is to manufacture goods and supply proximate markets. Market imperfections (trade barriers, costs) usually explain the establishment of such factories. This factory may engage in some FSA development, but has little autonomy.
Outpost factory: similar to the ‘black hole’ type subsidiaries, purpose is to gather access to valuable knowledge and skills. This role is usually combined with that of an offshore (input market driven) or server (output market driven).
Source factory: purpose to access low-cost production on the input side, but it also engages in resource recombination and developing FSAs. Has more autonomy. Will be put up in locations with good infrastructure and a skilled workforce.
Contributor factory: oriented primarily towards the host country output market. Supplies proximate markets, and being at the upstream end of the value chain, it is responsible for resource recombination in the form of process improvements, new product development, customizations, etc.
Lead factory: the most important one in terms of resource recombination and new FSA development. Access valuable inputs from the local cluster and plays a key role in localized manufacturing innovation.
Ferdow says that an MNE should aim to upgrade its offshore, server and outpost factories so that they gain the ability to develop FSAs. This upgrading process requires a high level of commitment and it involves resource recombination spread over 3 stages:
Enhancing internal performance
Accessing & developing external resources
Developing new knowledge that can benefit the overall network
But, this often does not take place, because
Fear of relying on foreign subs by HQ
Treating overseas factories like cash cows neglecting LT investment
Creating instability by shifting production in reaction to X rates and wage costs
Government entices MNEs to locate in sometimes unattractive locations
Critique on Ferdows:
Ferdows believes that management should upgrade all factories; not necessarily true.
Ferdows underestimates the value of low cost (highly efficient) factories in host countries. This may still be important.
The choice for permanent off shoring can be a good one if the firm’s FSA is the capability to flexibly offshore activities.
Economic/ operating exposure: the impact of changes in real exchange rates relative to the MNEs competitors, so what the effect is on the net present value of the MNE’s future income streams. D.R Lessard and J.B Lightstone made recommendations to minimize this impact, senior managers should strive to:
Have a flexible sourcing structure; which means being able to shift production from one to another country quickly and efficiently.
Attain the capability to engage in exchange rate pass through; which means the capability to raise prices in response to exchange rate fluctuations without losing sales volume.
Transaction exposure: the risk of financial losses resulting from outstanding but unfulfilled contractual commitments.
Translation exposure: risk of losses resulting from the translation of accounting statements expressed in foreign currencies into the home country currency at consolidation date.
Economic exposure is about the negative effects of large unexpected changes in exchanges rates on a firm’s competitiveness related to rivals. This is affected by the geographic configuration of its input and output markets. Firms with the strongest market position, the most differentiated products and the greatest flexibility to shift production will have the lowest negative impact of the fluctuations on its future income stream.
Nominal exchange rates: the direct exchange ratios between currencies.
Real exchange rates: changes in the nominal exchange rate minus the difference in inflation rates between the two countries. This is the rate which affects the level of economic exposure.
Economic exposure is important to think about because:
May result in negative effects on MNE income compared to rivals
Adds uncertainty to value of a firm’s location advantages
MNEs are active in multiple countries, and need to look at their overall economic exposure: not just one country, but the overall risk (country diversification)
It affects the strategic decision to locate in a certain country
Not all MNEs suffer to the same extent because they all are exposed to different risks (related to country presence) and because of different strategies.
In terms of the books framework (figure 1.2, page 34), three things are important concerning economic exposure:
Economic exposure should be viewed as a parameter that adds uncertainty to the value of a firm’s location advantages.
Economic exposure also implies that the location advantages benefiting an MNE should be considered not only positively, but also as a portfolio of potential risks for future cash flows.
MNEs can choose to develop specific FSAs allowing risk mitigation in the foreign currency, by immunizing their products to economic exposure, by allowing full exchange rate pass through.
Figure 8.1, page 222, describes the situation faced by each MNE unit in terms of two parameters.
The 3rd quadrant (strong exposure absorption capability on the input market side and strong exchange rate pass through on the output market side), is the most desirable situation because economic exposure effects are absent. This MNE is able to make the necessary adjustments on the input market side, and has such a strong market position that any cost increases can be translated into price increases for customers without a loss of business.
The 2nd quadrant (weak exposure absorption capability on the input market side and weak exchange rate pass through on the output market side) is the least favorable. This MNE typically sells products which are greatly affected by small price increases.
The 1st and 4th quadrants are intermediate causes.
Lessard and Lightstone suggest that companies manage economic exposure through one of the next approaches. Three non-financial strategies:
Separate business unit model: each subsidiary configures its own operations to reduce its specific operating exposure.
Companywide portfolio model: country diversification, exchange rate may go up in one country and down in other, on balance total lower rate of economic exposure (even though individual units may have higher risk). All the operational structures together balance each other.
Flexible operational planning model: production transfer, if X-rate goes up/down, move production from one plant / country to another. Problem: you need excess capacity.
Problem is that MNEs in different countries are exposed to exchange rate risks; risk of net present value reduction of the firm’s future income streams
According to Levitt, globalizations of markets do not need to locally adapt: there should be one uniform marketing approach. This approach is increasingly being criticized because of cultural differences persistent. But this does not mean that all companies can follow the same marketing strategy:“There is no one right answer – no one formula…What works well for one company or one place may fail for another in precisely the same place, depending on the capabilities, histories, reputations, resources, and even the cultures of both” (Levitt, page 245)
FSA matters: routines and recombination capabilities still count. The key remains to develop FSAs to deal with these contingencies (different environmental aspects)
Concluding: according to Levitt, MNEs should not worry very much about customizing to cultural preferences. Technology has largely homogenized consumer preferences; everyone wants quantity, reliability and low price. So MNEs should focus on such products and standardize their products and services worldwide to achieve economies of scale.
J.S Black and H.B studied expatriate management and found four common problems in how firms manage their expatriates:
Senior managers in the home country often underestimate the impact of cultural distance on organizational function, and as result, do not invest sufficiently in training programs.
The responsibility for expatriates is often assigned to human resource managers which have no international experience, so they do not have any insight in the problems expatriates face.
Senior management view expatriates as being well paid and well looked after, and therefore as having little to complain about.
In many MNEs, a common misconception persists that expatriates do not need help readjusting after having returned home.
Black and Gregersen put up three best practices when it comes to successfully managing expatriate managers:
Creating knowledge and developing global leadership skills: a key component here is that both senior management in the home country and the expatriate should share a clear understanding of the expatriate’s purpose and related expectations. This needs careful planning, which yields far more long-term benefits for both.
Making sure that candidates have cross-cultural skills to match their technical abilities: effective resource combination requires a mix of technical and social skills.
Devoting attention the re-integrating expatriates into their home country after their assignment.
Black and Gregersen suggest that all the MNE’s expatriate selection processes entail a trade-off between accuracy and cost. The assessment process formed by carefully routines is costly in the beginning, but also very accurate with selecting the right individuals for expatriation. This reduces the risk of costs resulting from failed expatriate assignments. In the end ‘the key to success is having a systematic way of assessing the cross-cultural aptitudes of people you may want to send abroad’. (page 226)
Emerging economies (which historically where called ‘less developed’ or ‘third world countries’) have been providing the world’s fastest growing markets for most products and services. They play an important role in the world economy and MNE strategic activity. Those countries offer potential cost and innovation advantages and they represent new output markets, this makes them attractive for MNEs:
They have relatively inexpensive skilled labor and trained managers, this offers MNEs lower manufacturing and service costs.
They can give MNEs access to a new kind of innovation, than the one that will be found in the mature markets.
They can be used as a counter-strategy to the increasing expansion of emerging economy MNEs into the world’s developed markets.
Tarun Khanna, Krishna Palepu and Jayant Sinha have the idea that emerging economies are characterized by important institutional voids, so the biggest challenge for MNEs operating in those economies is to understand and deal with those voids. They suggest that MNEs face difficulties due to the unavailability of two kinds of institutions that can facilitate business:
Efficient local intermediary firms
Broader macro-level institutions
In the home country, these would be often taken for granted and being considered as generally available location advantages. In the emerging economies there are absent.
Institutional voids: lack of well functioning firms, or mostly state owned enterprises. Lack of macro-level institutions, so no courts, difficult to get contracts, lack of well functioning financial markets. It is difficult to deal with this uncertainty.
If so difficult, why do MNEs go to emerging markets?
Market seeking: home markets and other developed markets saturated, new markets that are developing rapidly
Efficiency seeking: these markets may be developing rapidly, but still relatively cheap to produce locally.
Disadvantages: still low levels of development, high growth figures, but also associated with high volatility (hence risky). High levels of corruption, low levels of trust, difficult to do business, networking is important.
MNEs should customize their approaches, so they can fit the host country’s institutional context, to reduce the institutional distance. So these voids in the emerging economies, require MNEs to invest in the creation of compensating location-bound FSAs. The key bounded rationality problem though, is that many analyses of host country location advantages do not account for the unique institutional makeup of the individual emerging economies.
There are five components of the institutional context that are the most relevant to MNEs. With those, MNE senior managers, are able to create a map of the country’s institutional context and this shows the extent in which the MNE would need to invest in location-bound FSAs in each context:
Macro-level political and social context; managers should identify a country’s power centers, and decide whether there are checks and balances in place.
Macro-level openness (the extent to which the country welcomes FDI, ideas and travels) of the economy; this level of openness affects the markets directly relevant to firms. Open economies are more likely to attract global intermediaries. Too much openness though, reduces the strength of the MNEs FSAs relative to the host country firms.
Product markets; these are becoming more attractive, but MNEs still have difficulties with getting reliable information about the consumers in these markets.
Labor markets; in this sphere, emerging economies are often characterized by large labor pools, but there is often a lack of managerial and skilled workers. Difficult in these labor markets is the difficulty in assessing the quality of talent available. MNE managers should measure the education infrastructure to sort out the quality of the educational institutions.
Capital markets; the capital markets from emerging economies are largely inefficient and they lack the specialized intermediaries in areas such as credit rating, investment analysis, banking services, etc. Because of this, it may be difficult for MNEs to raise capital, evaluate worthiness and enforce contracts. MNEs senior managers should therefore assess the capital market’s inefficiencies in a wide variety of areas.
After laying out those five components of an emerging economy’s institutional context, MNE managers need to choose among three options:
Adapt the business model to the host country whilst keeping its core dominant logic constant.
Change the emerging economy’s institutional context, by for example, creating more efficient markets.
Stay out of emerging economies where the requirements for new FSA development are too high.
Corporate social responsibility (CSR): good citizenship by the firm, by its obligations to society, especially when this is affected by the firm’s strategies and practices. With expanding abroad, MNEs are expected to show CSR in their host country. This requires a manager to consider his acts in terms of a whole social system, and holds him responsible for the effects of his acts anywhere in that system.
Debra Dunn and Keith Yamashita suggest that MNEs can engage in initiatives that benefit their stakeholders and the firm’s corporate citizenship obligations to society at the same time. So an MNE can do well and do good at the same time. Dunn and Yamashita detail seven business practices in citizenship efforts:
Unearthing customer needs; divining the needs of customers by investigating at underlying problems and transferring this understanding to the innovation process.
Fielding a diversely talented team; this means getting involved with human and other resources of the host country, which are the core of the firm’s more conventional FSAs. This gives the firm development skills with a broader range of knowledge, including line management knowledge, expertise in government affairs, and a rich understanding of culture.
Adopting a systems approach; this does not attempt to optimize individual parts, but it views these parts in a broader context and wants to optimize the whole.
Creating a leading platform;
Building an ecosystem of partners; most sustainable communities have different stakeholders with an interest in a long-term solution. The alignment of interests offer protection from hazards associated with each partner’s bounded reliability. The ecosystem of partners bring their complementary resources to the initiative and are all dedicated to solving problems.
Set a deadline for the project; deadlines create a sense of urgency, this keeps all participants focused.
Solving, stitching and scaling; this eliminates the bounded rationality challenge of trying to figure out all the possible forms the solution will eventually take and customizes a solution for a single customer.
There are three CSR areas: privacy, the environment and e-inclusion (which means using technology to reduce economic and social divides).
For an MNE manager, the business value of a project is the routine from which the project was developed. There are four key phases of project development:
Quick start; this phase tries to establish credibility and momentum by achieving a few quick successes.
Ramp up; characterized by gathering resources for prototyping, evaluating solutions and training stakeholders so they can take ownership of the initiative. The key to this phase is to bring the ecosystem of international and local partners together.
Consolidation phase; evaluating the intellectual property generated to date, helping local partners deciding which solutions to deploy and stopping sub-projects unlikely to reach their goals.
Transition phase: identifying leaders and transferring knowledge and power to local participants.
Unfortunately, it is unlikely that doing good and doing well could be combined in the world’s extremely poor regions. The activity of an MNE is not able to replace the role of a government, in terms of taking care of public goods. Foreign investments get really costly because they are being forced to provide such public goods on a large scale. Next to that, it will force an MNE into a role it is not meant to fulfill, and it is unlikely that it will be fulfilled effectively and efficiently. For changes, it is important that there is a capable network to support it, which is missing in those extremely poor regions.
Richard Locke and Monica Romis (authors who provided a complementary perspective on CSR) argue that MNEs need to go beyond monitoring suppliers for compliance with labor codes of conduct and should instead collaborate closely with suppliers to attack problems of poor working conditions at their source. As the main problem in developing countries is a bounded rationality one, only monitoring will not measure the real workplace conditions, as suppliers can hide relevant information.
Sushil Vachani and N. Craig Smith’s (second complementary perspective on CSR) suggest that socially responsible pricing affects the bottom line immediately and directly. Social responsible pricing can mean fair trade; agreeing on paying a higher price on the input side, or on the output market side it can mean lowering prices. There are three main approaches used by MNEs to improve access to drugs in developing countries:
The drug donation approach: increases the access to drugs by giving them free of charge. This approach gives the MNE tax benefits and the country social welfare benefits. A problem with this approach are the hidden costs in host countries, and the fact that this approach will not work for diseases that require extensive and long-term treatments.
The out-licensing approach: this is the same as an international projector strategy of licensing. The host country manufacturer produces the drug under license. The advantage of this approach is that it gives the MNE distance from the lower prices in the developing country, this reduces the potential for price referencing, in which downward pressure on prices in developed markets is caused by reference to the lower price charged in developing economies. Another advantage is the positive media attention for the MNE. The problem with this approach though, is the limited complementary resource availability. Next to that, drug access may still be limited as the price may not be low enough, and the referencing problem is unlikely to disappear completely.
Differential pricing: this is the most common approach and it means selling the same product at different prices in different markets. Advantage of this approach is that is provides the flexibility to balance pharmaceutical MNE revenues and social welfare. Problems with this approach are product diversion risks, price referencing, and high administrative overhead costs. Next to that, a risk of the drugs not taken as prescribed because of the lack of good infrastructure. The last problem is a bounded reliability one; MNE price reductions can reduce host government and donor efforts to provide appropriate financial support for drug access.
According to Porter and van der Linde, environmental regulation can trigger two broad forms of innovation:
The first form involves technologies that reduce the costs of dealing with pollution.
The second form addresses the root cause of pollution by improving resource productivity. This leads to better utilization of inputs, better product yields and better products.
There are five major features that make good for environmental regulations:
Good environmental regulations create maximum opportunity for innovation by letting industries discover how to solve their own problems. The regulations do not specify the means, only the requirements on which results should be achieved.
Regulations should be strict, which encourages real behavioral change in industry through innovations.
Regulations should allow for a phasing-in period, this reflects the realities of researching, developing and adopting new technologies.
Regulations should encourage a resource productivity approach rather than a conventional pollution control approach. So it should encourage environmental improvements as close as possible to the source of the pollution, like early in the value chain.
Countries should develop regulations before other countries. This allows domestic industries to gain first-mover advantages on the international stage.
Environmental management is playing an important role in MNE corporate responsibility approaches. The global warming concerns have put the environment at the forefront of consumer and non-governmental organization advocacy efforts. Stakeholders examine MNEs carefully at their environmental footprints.
Stuart Hart and Mark Milstein (who provide a social activist perspective complementing Porter and van der Linde) distinguish three types of economies:
Developed or consumer market: represents an economy of one billion wealthy consumers with an advanced infrastructure. Within this market, an MNEs ecological footprint should be reduced by reinventing products and processes.
Emerging economies: roughly two billion people, customers who can meet their basic needs but have minimum purchasing power. MNEs should keep the expanding demand for products by population growth, in balance with the limited physical capacity of these countries to provide necessary infrastructure and institutional context.
Survival economies: three billion potential customers, largely rural, individuals not meeting their basic needs, minimal infrastructure. MNEs should recognize the opportunity presented by this group.
Ans Kolk and Jonathan Pinkse (second complement to Porter and van der Linde) focus on climate change and classify and analyze the strategies that firms can use to mitigate their climate change impact. They focus on two strategic goals at firm level:
Innovation: means that firms can improve their business performance through FSA development. This will be driving the reduction of emissions. This is an approach for managers who see the potential business opportunities of climate change policy.
Compensation: transferring or trading emissions or emission-generating activities. This is an approach that managers who see climate change as a business risk, tend to.
Kolk and Pinkse suggest that firms fall into six broad types:
Cautious planners: firms preparing for action but who show little activity related to any of the potential climate change strategic options. This firm mention measures to reduce greenhouse emissions, but does not provide any specific details on what might be used to achieve this goal.
Emergent planners: do not have implemented climate change measures yet. However, they have set targets for the greenhouse gas reduction. So it has well-developed targets, but no long-term plans to reach those.
Internal explorers: firms with a strong internal focus, bringing as a result a combination of targets and improvements in their production process.
Vertical explorers: firms with a strong focus on environmental measures within their supply chains. The reason for this company to focus on upstream and downstream activities: it relies on natural resources that are vulnerable to extreme weather conditions and/or its manufacturing process had low climatic impact compared to the consumption of its products.
Horizontal explorers: firms that seek opportunities to mitigate their climate change impact in markets outside their current business scope.
Emission traders: these firms trade on emission markets and participate in offset projects.
In the end, both corporate social responsibility and corporate environmental sustainability may lead to new FSAs. Done by local adaptation (one unit or one country) or by universal approach (multiple countries, one approach). The question is to adapt or not, and if so how, is particularly relevant for emerging markets where institutions (law and government) are often weak. It is especially relevant in emerging markets because of the so-called institutional voids that create uncertainty.
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