International Strategy and Organization (ISO) (Advanced Topics: Networks of the MNC) Josef...

International Strategy and Organization (ISO) (Advanced Topics: Networks of the MNC)

Josef WindspergerProfessor of Organization and Management

International Strategy and Organization (ISO) (Advanced Topics: Networks of the MNC)

Lecturer: Josef Windsperger

E-mail: josef.windsperger@univie.ac.at

Homepage: www.univie.ac.at/IMPhone: 00431-4277-38180

The course consists of two parts (Hs. 4):A.Lectures on ISO: 7. 4. , 28. 4., 5.5. 2006, 9.00 – 13.00 (course material is published on the web page: www.univie.ac.at/im under ‘Lehrveranstaltungen’).B.Case Studies on ISO: 12.5. (9-13.00) , 19. 5. (9 – 14.30) and 16.6. 2006 (9.00 – 13.00) and 17. 6. 2006 (9 – 13.00)

The public lectures are on Friday (11.00 – 12.30); for details see www.univie.ac.at/im.1. Public Lecture: May 5, 2006: 11.00, Hs. 4Headquarter-Advantages of Vienna in CEE (Mag. Thumser, CEO Henkel Austria 2. Public Lecture: May 19, 2006: 11.00, Hs. 4 International Market Entry through Franchising (Mag. W.Martius, Synchon International)

ContentPart I

1 MNC as Global Network: Existence and Evolution1.1 Product Life Cycle Theory1.2 Transaction Cost Theory1.3 Eclectic Theory1.4 Network Approach

2 Culture, Strategy and Organization of the MNC2.1 Country and Organization Culture2.2 Strategy and Organization Design

3. Theoretical Foundations of Networks3.1 Economic Approaches of Networks3.2 Efficiency of Network Design3.3 Networks, Trust and IT

Content

Part II

4 Design und Management of Networks of the MNC

4.1 International Licensing

4.2 International Strategic Alliances, Joint Ventures and Consortia

4.3 International Franchising-Networks

4.4 Networks and M&As

4.5 Market Entry through Networks: An Integrative Approach

4.6 Internationalization through Countertrade

4.7 International Clusters

5 Networks versus Hierarchies of the MNC of the Future

4.1. International Licensing

Market for Technology Licensing

low market entry barriers

increase of competition

short product life cycles

in-house R&D too expensive

Licensing vs. Internalization

Complementary and contractible assets Licensing possible when

• easy to replicate• property rights are well defined• difficult to imitate

TC and Licensing

TC

Specifity,Know-how Complexity

Licensing Network Hierarchy

S1 S2 S3

Property Rights-Explanation

ContractibleKnow-how

Non-contractible Know-how

Contractible Know-how Non-contractible Know-how

B

A

NetworkA to B:

Licensing

B to A:Licensing

Market Contract

Licensing as Coordination Form for Technological Innovations (1)

„Innovation is the engine that drives competition in capitalist economies.“

Schumpeter (1942)

process of „creative destruction“

should the innovating firm license its technology to competitors or not?

what factors determine the appropriate choice?

Licensing as Coordination Form for Technological Innovations (2)

Strategic RENTS generated from innovations = function of the RATE OF IMITATION by rivals

RATE OF IMITATION depends on

1. incentive to imitate

2. barriers to imitation

3. rivals’ ability to imitate

Licensing as Coordination Form (3) Incentive to Imitate

competitive intensity

– benign environment weak incentive to imitate » strong demand» substantial entry barriers» high concentration» product ≠ commodity

– hostile environment high incentive to imitate» weak demand» high exit barriers» high fixed costs» low concentration» product = commodity

Licensing as Coordination Form (4) Barriers to Imitation

= factors that inhibit rivals from imitating a firm’s innovation

patents

R&D in secrete

causal ambiguity – ambiguity concerning the nature of the causal connections between

actions (development of an innovation) and results (profitable exploitation)

Licensing as Coordination Form (4) Rivals’ Ability to Imitate

R&D skills

– ability to reverse engineer an innovation and quickly develop a new product

access to complementary assets

– key determinant of the rate of imitation

STRATEGIC OPTIONS

Licensing and National Culture

Does the national culture influence the choice between licensing and foreign direct investments?

“The national differences in levels of trust impact the choice of foreign market entry mode” (Shane, 1994)

Results - High Trust Countries → Licensing - Low Trust Countries → Foreign Direct Investment

“Resorting to hierarchies is less common where trust among people is greater.” (Shane, 1994)

4. 2 International Joint Ventures, Strategic Alliances and Consortia as stable Networks

JV

A B

Joint Venture

Strategic alliance

A B

a b

a, b

Consortium: NewPC-Consortium in Taiwan

Stable Networks

Characteristics:– High transaction-specific investments, high

uncertainty and/or– Complemetary firm-specific resources and

organizational capabilities– Joint Ventures: Allocation of decision and

ownership rights– Strategic alliances: Allocation of decision rights,

no ownership rights– Weak Ties:

Trust instead of formal coordination mechanisms

Motives for Joint Ventures

New markets To take existing products to foreign markets

To diversify into a new business

Existing markets To strenghten the existing business

To bring foreign products to local

markets

Existing products

New products

Determinants of Residual Decision and Ownership Rights

Hennart 1988: „When knowledge is tacit, it cannot be effectively transferred in codified form; its exchange must rely on intimate human contact“ (366)

- According to the PR-theory, the contractibility of assets determines the governance structure.- Noncontractible assets require the transfer of residual decision and ownership rights.- Intangible Assets refer to organizational, marketing, courtry-specific and technological know how.

Property Rights-Explanation

ContractibleKnow-how

Non-contractible Know-how

Contractible Know-how Non-contractible Know-how

B

A

Joint VentureA to B:

Licensing

B to A:Licensing

Market Contract

Markt Entry through Joint Venture

- Licensing

- Joint venture

- Wholly-owned subsidiary

Market Entry and Control

Licensing: low control Joint Ventures: shared control Subsidiary (WOS): Decision and ownership

rights have the foreign headquarter

Licensing: Low

Joint Venture: Medium

Wholly-owned Subsidiary: High

Market Entry and Resource Commitments

Market Entry and Diffusion Risk

Licensing: High

Joint Venture: Medium

Wholly-owned Subsidiary: Low

Form of Market Entry

Strategic Variables

1. National Differences

2. Scale Economies

3. Global Concentration

4. Market Potential

Environmental Variables

1. Counrtry Risks

2. Cultural Distances

3. Demand Uncertainty

4. Competitive Dynamics

Resource Variables

1. Value of the Firm-specific KH

2. Tacit Knowledge

3. International Experience

Eclectic Theory: Hill et al. 1990

Latin „consortium“: association, society

= a temporary collaboration to perform a certain task or to provide a spedific service or product more efficiently

= association of two or more individuals, companies, universities, or governments (or any combination)

Separate legal status Control over each participant is generally limited to

activities involving the joint endeavor

Consortia

Consortia vs. Internalization

Firms have to decide how much of the R&D they should internally procured

- not possible to procure all R&D from outside - in-house R&D is necessary for implementation- absorptive capacity

This decision depends on a number of factors:- transaction costs- technological and organizational capabilities

Transaction Cost Explanation (1)

Transaction costs arise out of market imperfections

- asymmetric information distribution- opportunistic behaviour

internal transactions less costly through hierarchy and authority

but influence costs are higher

Transaction Cost Explanation (2)

Organization has to balance transaction costs with incentives

– Firm is more likely to integrate R&D activities (in-house) where transaction costs are high

– Firm is more likely to procure R&D from external partners where incentives can be enhanced with market competition

Organizational Capability Theory (1)

Schumpeter (1912, 1942) and Penrose(1959)

resource based viewcapabilities of the firm result in competitive

advantagescapabilities have to be enhanced through innovation

and learning

-

Organizational Capability Theory (2)

R&D transactions: companies acquire scientific knowledge from outside and form alliances with other firms with different capabilities.

Organizational Capability theory Organizational Capability theory - lack of knowledge and sufficient capabilities of the firms- advantage of utilizing the higher/new capabilities of

external partners can exceed the coordinaton cost disadvantages

Sakakibara‘s ModelMotives

Economic View Economic View Cost-sharing MotivesCost-sharing Motives

- Assumptions– symmetrical firms in terms of capabilities or knowledge – same industry & outcome– one efficient way

Organizational View Organizational View Skill-Sharing Motives Skill-Sharing Motives- Assumptions

– heterogeneous capabilities – direct competitors in the product market – cooperation ≈ portfolio of core competencies– knowledge base

tacit knowledge difficult to transmit complementary knowledge

Sakakibara‘s Model

Conditions

Transaction costs conditionTransaction costs condition» investments in transaction-specific or relation-specific assets» uncertainties regarding R&D outcomes » execution and monitoring of the agreement» exclusion of knowledge creation

Appropriability conditionAppropriability condition» industries with high spillovers » alternatives to improve appropriability

Capability heterogeneity conditionCapability heterogeneity condition» breadth of technological capabilities that firms possess» skill-sharing vs cost-sharing

Sakakibara‘s ModelEffects on R&D

(1) increase in R&D efficiency(1) increase in R&D efficiency economies of scale and avoidance of wasteful duplications (cost-

sharing) easier acquisition of complementary resources for R&D (skill-

sharing)

(2) spillover of a firm’s own R&D on others’ R&D (2) spillover of a firm’s own R&D on others’ R&D productivityproductivity

internalizing the externality

((3) learning capability3) learning capability large for skill-sharing motivated firms small for cost-sharing motivated firms

Sakakibara‘s ModelSummary

Motives Motives Cost-sharingCost-sharing Skill-sharingSkill-sharingcompetition in R&D consortia

single-industry competition

wide industry participation

firm capabilities in R&D consortia

homogeneous, substitutable

heterogeneous, complementary

role of R&D consortia

divide tasks create/transfer knowledge

private R&D spending

can decrease can increase

constraints firms face

financial resources Research capabilities

Sakakibara‘s Empirical Results (1)

Hypothesis 1: The skill-sharing motive is relatively more important where the participants possess more heterogeneous capabilities

Hypothesis 2: The importance of the cost-sharing motive is positively associated with project size

Hypothesis 3: Firms which are motivated relatively more by skill-sharing concerns to participate in cooperative R&D are likely to increase R&D spending as a result of their participation, while firms whose relatively greater motivation is cost-sharing will likely decrease their R&D spending

Sakakibara‘s Empirical Results (2)

consortia with government involvement 5753 observations Cox’s maximum-likelihood proportional hazard model Pattern of R&D consortia participation varies from firm to firm Example:

0

2

4

6

8

10

12

14

59 62 65 68 71 74 77 80 83 86 89 92

Toshiba

Sony

Sakakibara‘s Empirical Results (3)

Positive relation between the R&D consortia formation rate and– weak appropriability conditions – the degree of a firm’s R&D insensitivity – the number of companies a firm encounters in product markets

Negative relation between the R&D consortia formation rate and– the degree of industry competition

No clear relation between the R&D consortia formation rate and the experience of past participation

4. 3 Franchising-Networks

to

Franchisor: System-specific Know-howFranchisee: Initial FeeSpecific Investments

t

Royalties

Characteristics:-Franchisees and franchisor are entrepreneurs.- Intangible Assets: FG‘s brand name, systemspecific KHFN‘s local market KH-Incentive system:Royalties and intial fees

Explanations

Agency-Theory: The franchisor has high agency cost under internal organization. Franchisees are more motivated than outlet managers.Signalling-Theory: High initial fees and specific investments signal a strong brand name.Screening-Theory: High initial fees and royalties attract franchisees with high capabilities.Search cost theory: The franchisor has not enough knowledge of the local market at the beginning of the contract period. The franchisees have this local market knowledge.Property rights-theory: The distribution of decision and ownership rights depends on the distribution of intangible assets.

Transaction Cost Theory

TC

Specifity,Uncertainty

Licensing FranchisingCompany-owned Subsidiaríes

S1 S2 S3

‚Hostage Model‘

A Property Rights View

The more important the fanchisor´s intangible assets relative to the franchisee´s for the creation of residual income, the more PR must be transferred to him, and the higher is the franchisor‘s portion of residual decision and ownership rights (PCO and royalties).

Intangible assetsSystem-specific und local market knowledge

Residual decision rights

Proportion ofcompany-owned Outlets (PCO)

Royalties/Initial Fees

‚Governance Structure‘ of the Franchising Firm

Ownership rights (Residual income rights)

H1

H2

H3

How is the knowledge distrubutedBetween the franchisor and the franchisee?

Who is the residual decision maker (whose decisions influences the residual income)?

How are the ownership rights allocated?

Direct Mode

Market Entry through Franchising

Choice of International Franchising

Level of Equity

Direct orIndirect mode

Equity franchisingmodes

Limited equityFranchising modes

Direct FranchisingArea Development

AgreementSubsidiary Master FranchisingJoint Venture

(Duniach-Smith, 2004)

Entry Forms

Choice of Market Entry

Choice of International Franchising

Level of Equity

Direct orIndirect mode

Equity franchisingmodes

Limited equityFranchising modes

Environmentaldeterminants

Environmentaldeterminants

Organizationaldeterminants

Organizationaldeterminants

Direct FranchisingArea Development

AgreementSubsidiary Master FranchisingJoint Venture

(Duniach-Smith, 2004)

Determinants: Environmental and Organisational Factors

- Geographic distance- Cultural distance

- Country risk

- Political risk

- Market volume and growth

- Resouces of the partner- Brand name assets- International experience

- Financial situation of the FG

Efficiency Comparison

Subsidiary (WO)High resource commitmentsCentral controlProtection of the system-specific KH Appropriate:

– High cultural and geographic distance– Strong brand name– Important system-specific KH – High market potential and growth– International experience

Area Development AgreementLower resource commitmentRelatively strong central controlFast market entry

Appropriate:– High geographic and cultural distances– Uncertain market development– Instable legal environment– Local market knowledge is very important– No international experience

Direct FranchisingHigh control and agency costs

Appropriate:– Low geographic and cultural differences

– Strong local market KH of the franchisees

– Relatively small market potential and growth

Joint VentureShared control

Know-how diffusion risk

Lower risk

Appropriate:

– Franchisor has not enough local market knowledge

– Uncertain market development

– High legal and political uncertainty

– Relatively high cultural differences

– Legal barriers

Master Franchising Lower central control

Appropriate:– High geografic and cultural differences– No international experience – High political risk– Strong market growth– High market uncertainty– Local market know-how is very important.

4.4 Networks and M&A

Unrelated M&A– NPV(A+B) = NPV(A) + NPV(B)– P = NPV(A+B) – NPV(A)– Only generates normal economic profit

Related M&A– NPV(A+B) > NPV(A) + NPV(B)– Generates strategic rents

The Related Case

Jensen and Ruback (1983):– To reduce production or distribution costs

1. Through economies of scale

2. Through vertical integration

3. Through the adoption of more efficient production or organizational technology

4. Through the increased utilization of the bidder’s management team

5. Through a reduction of agency costs by integrating organization-specific assets under common ownership

The Related Case (2)

Jensen and Ruback (1983) (cont.):– Financial motivations

1. To gain access to underutilized tax shields

2. To avoid bankruptcy costs

3. To increase leverage opportunities

4. To gain other tax advantages

– To gain market power in product markets– To eliminate inefficient target management

Networks versus M&A (1)

Alliances allow simultaneous and fast entering into multiple countries

Objective: achieve complementary capabilities or economies of scale

Do not have high risks of failure and high transaction costs

Networks versus M&A (2)

Acquisitions allow for a greater organizational integration than alliances

In alliances all decisions must be made by consensus among the partner firms

Alliances are transient in nature and must remain reversible

Networks versus M&A (3)

Future alliances might be formed as a first step toward a merger

Alliances make it possible to avoid the culture shock in the wake of an acquisition

Acquisitions versus Greenfield Investments

G > A

Know-how advantage of the MNC

High market potential

Longterm market growth

Few competitiors

Stable legal and political institutional factors

International Strategy: Impact onM&A and Network Form (1)

Choice depends on the pursued strategy: Global versus Multidomestic Strategy

Global Strategy: Subsidiaries are pipelines for headquarters & little/no response to local market conditions

Multidomestic Strategy:

Decentralized network & subsidiaries responsible for local market demands

International Strategy: Impact onM&A and Network Form (2)

Hypotheses:- Companies following Global Strategy higher proportion of Greenfield Investments- Companies following Multidomestic Strategy higher proportion of Acquisitions and Alliances

Synergy realization

Organizational integration

Combination potential

Employees‘

resistance

Postmerger-Integrations-Model

+

+

+

+

+

-

• The higher the combination potential, the larger the

synergy realisation.

• The stronger the organizational integration, the larger

the synergy realisation.

• The higher the employee resistance, the lower the

synergy realisation.

•The higher the combination potential, the greater the

organizational integration.

• Je higher the combination potential, the larger the

employee resistance.

• Je greater the organizational integration, the larger

the employee resistance.

Hypotheses

4. 6 Internationalization through Countertrade

- Explanation:Market failure at the international product and financial markets

Advantages for the MNC: Realization of a higher market potential

- Informal coordination mechanisms (reputation capital, trust) instead of formal coordination mechanisms

Forms of Counter Trade (1)

Countertrade

IndustrialCountertrade

CommercialCountertrade

Barter Counterpurchase

Offsets BuybacksEvidenceAccounts

BilateralClearing

Swaps Switch

DirectOffset

IndirectOffset

FullCompensation

PartialCompensation

ExportProcessing

CooperativeVentures

Forms of Counter Trade (2)

Classical barterClearing arrangementSwitch Trading

Buy-BackLoan and Import

Counterpurchase Offset

Use of Counter Trade

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Barter Offset Buyback Counterpurchase Switches

Barter

Clearing arrangement:

- purchase equal value of goods and services

- long time periods

- a large number of goods

Switch-trading:

goods that are useless to the trading country can be sold or transferred to a third country

Buy-Back (1)

Transfer of technology, plant, equipment and technical assistance

Purchase of a certain percentage of the output Long-term orientation

Buy-Back (2)

Loan and Import Seller of an input provides financing or

equipment Development of a new source of supply Borrower repays this loan with his revenue

TC and Countertrade (1)

Technology

Very high buyer uncertainty-> buy-back contract Loan & Import

Markets with high transportation costs, scale economies or transaction specific investments -> loan and import

Distribution

Reducing costs of international marketing of products

TC and Counter Trade (2)

Narrow market- Scale economies

- Need to make transaction-specific investments

> solution: loan and import

TC and Counter Trade (3)

Distribution- costs for arranging international marketing

- Seller has no commitment to the product

- No quality guarantee

- No after-sale services

> solution: counter purchase

Hostage Model of Countertrade (Williamson 1983)

TC

Specifity,Uncertainty

Licensing Countertrade Hierarchy: DI

S1 S2 S3

‚Hostage-effect‘

Foreign subsidiary characteristics

subsidiary strategy

level of technology

training (formal, informal)

international interdependence

Nation-level resources

skilled workforce

innovative capability

National competitiveness

unemployment rate

standard of living

competitiveness of local firms

Firm level resources

technical and managerial skills

product and process technology

Which factors influence a host country’s national competitiveness?

Published in: S. O’Donnel, T.Blumentritt/Journal of International Management 5 (1999)

4. 7 Internationalization through Clusters

Firm Strategy, Structure and

Rivalry

Factor Conditions

Related and Supporting Industries

Demand Conditions

Chance

Government

Porter‘s Diamond Model

Diamond Model - Factor conditions

Sophisticated/high-tech industries are the backbone of any economy

•Skilled human resources

•Scientific base

Diamond Model - Demand conditions

Character of demand

sophisticated buyers and

buyers who anticipate or shape needs of buyers abroad prepare companies for operating in foreign markets

Diamond Model -

Related and supporting industries

Competitiveness of supporting industries is important because they provide

Cost-effective inputs

Innovation and upgrading

Diamond Model –

Firm Strategy, Structure and Rivalry

Strong local rivals motivate the company to build competitive advantage

Competitive Advantage through Clusters

They include an array of linked industries and other entities important to competition.

Many clusters include governmental and other institutions that provide specialized training, education, information, research and technical support.

Clusters can be extended downstream, horizontally and laterally.

„Clusters are geographic concentrations of interconnected companies and institutions in a particular field.“ (Michael E.Porter)

Organisation Design of Clusters

Characteristics:

– Stable network based on the core competencies of partner firms

– Location-bound

– Institutional support Configuration:

– Less formal coordination

- Exclusive brand name at the market

- Stable pool of cooperation partners Soft Integration Factors:

– Trust as coordination mechanism IT-supported network relations

Advantages of clusters (I)

Clusters have a better access to employees and suppliers:

Can recruit from a pool of specialized and experienced employees lowers search and transactions costs

Offer a specialized supplier base minimizes the need for inventory eliminates delays lowers the opportunism risk

Advantages of clusters (II)

Preferred access to specialized information: Extensive market, technical and competitive

information accumulates within a cluster

Access to institutions and public goods: Investments by government or other public

institutions and universities can enhance a company’s productivity

Advantages of clusters (III)

Higher motivation and easier performance measurement:

Local rivalry is highly motivating Peer pressure leads to competitive pressure Easier to compare and measure performances

because of local competition

Location-specific Competitive Advantage

Innovation und Know-How-Upgrading

Strong local

competition

Suppliers with high

capabilities

Sophisticated demand

Specific

resources

5. Networks or Hierarchies: Organization Design of the ‘MNC of the Future’

Theses:

I. Evolution of ‘virtual countries’

II. Evolution of networks

„Shifting Networks“ „Virtual Countries“

Processes External Internal

Employment Ad hoc projects with independent partners

Employees

Marketing Partner-specific branding Umbrella branding

OrganisationSelf-organizing teams and networks

Hierarchy with decentralized structures