Scholarly article on topic 'Emerging threats for MNC subsidiaries and the cycle of decline'

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Academic research paper on topic "Emerging threats for MNC subsidiaries and the cycle of decline"

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Journal of Business Strategy

Emerging threats for MNC subsidiaries and the cycle of decline Pamela Scott Patrick T. Gibbons

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Pamela Scott Patrick T. Gibbons, (2011),"Emerging threats for MNC subsidiaries and the cycle of decline", Journal of Business Strategy, Vol. 32 Iss 1 pp. 34 - 41 Permanent link to this document: http://dx.doi.org/10.1108/02756661111100300

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Emerging threats for MNC subsidiaries and the cycle of decline

Pamela Scott and Patrick T. Gibbons

Pamela Scott is a Research Fellow at the Dublin Institute of Technology, Dublin, Ireland. Patrick T. Gibbons is the Smurfit Professor of Corporate Planning at the UCD Michael Smurfit School of Business, Blackrock, Ireland.

ne of the primary threats evidenced in both the academic and practitioner press is the potential for multinational corporations (MNC) to shift their domestic and foreign subsidiary operations to lower cost locations, including China, India and the Eastern Bloc. We argue that as a result of the emphasis on cost-driven relocation risk, managers have largely overlooked increasing environmental pressures from other sources. We demonstrate how these threats potentially create a cycle of subsidiary decline as they combine to undermine managers' abilities to achieve the knowledge-sharing and strategic perspective required to add value. While our study focused on MNC subsidiaries, these threats have similar implications for divisions and departments of all large organizations. Identifying these emerging dangers enables unit management to prepare an effective strategic response to protect their operation from decline.

We recently completed a multifaceted project that combined an extensive literature search, a series of interviews with directors of major subsidiaries, and a survey targeted at the total population of Irish subsidiaries (see Box 1, ''How the research was conducted''). The purpose of the project was to identify the emerging pressures in subsidiaries of large organizations operating in today's dynamic business environment. As a research site, Ireland's history of attracting high levels of foreign direct investment from MNCs, combined with its vulnerable location on the periphery of Europe, renders it particularly suitable for identifying shifts in organizational behavior. Through integrating our key findings, we identified that, aside from ongoing cost driven relocation, three new threats are emerging to change the competitive landscape:

1. Erosion of geographic and trade barriers - More of the world is now accessible to trade, which provides organizations with access to new markets and to cheaper inputs, including similarly skilled labor (Mudambi, 2008). The former EU Accession countries now offer a pool of skilled and ambitious workers often available at a fraction of comparable Western wages within a similar infrastructure. Free and reciprocal trade agreements and active promotion of inter-regional trade is increasing. In particular, the inclusion of China into the WTO provides access to its burgeoning consumer market, but Western organizations are only beginning to appreciate that reciprocal free trade means reciprocal competition in their home countries.

2. Complex corporate governance and compliance issues - Large corporations are increasingly vulnerable to any failure of their dispersed units to comply with rigorous and intricate corporate governance requirements. This has led some formerly federal type organizations to re-evaluate the risks of their decentralized strategy. For example, the failure of its Eastern Bloc operation to meet compliance regulations led to the imposition of financial penalties and negative publicity for a major international building corporation. Exposure to compliance risks prompts centralization of more decision making in headquarters.

PAGE 34 JOURNAL OF BUSINESS STRATEGY VOL. 32 NO. 1 2011, pp. 34-41, © Emerald Group Publishing Limited, ISSN 0275-6668

DOI 10.1108/02756661111100300

Box 1: How the research was conducted

In response to the needs of both practitioners and policymakers, Dublin Institute of Technology and University College Dublin jointly undertook a major review of senior management practices in Irish subsidiaries of foreign MNCs. Designed to combine capturing the rich insights of practitioners with achieving the required generalizability of findings, the study incorporated both a survey targeted at the total population of Irish subsidiaries (c. 1,100) and an interview program of subsidiary CEOs and senior executives. The survey achieved a strong response rate of 24 percent largely from CEO's/General Managers (88 percent), and the respondent profiles confirmed that both a diversified country of MNC origin (USA 41 percent, UK 16 percent, other EU 31 percent), and range of industries, including pharmaceutical (9 percent) and ICT (21 percent) are represented. The objective of the survey was to capture variations in subsidiary autonomy, entrepreneurship, strategy development processes, networks, initiative generation, international responsibility, performance and the role of the subsidiary CEO.

The interview program comprised a series of in-depth interviews with CEOs and their top management executives in eight subsidiaries, selected to provide diversity in terms of both industry and geographical origin of the parent operation. The interviews provided insights into the real experiences behind the survey data, and described the constant fight for survival and growth in the face of increasing relocation risk. While both the survey and interview program were set in a particular geographic location, the results are generalizable to any MNC subsidiary and offer unique insights into their increasingly complex internal and external operating environments.

£ 3. Increasing sophistication and declining costs of information and communication

¡jo technology (ICT) systems - ICT is applauded for its multiple benefits in terms of

S promoting inter and intra organizational collaboration, and facilitating continuous

§ improvement to products which can then be delivered faster and cheaper. In particular,

for large organizations ICT enables greater integration and communication with both g sister operations and headquarters, enhancing information sourcing, sharing and access

to opportunities in multiple locations. However, the potentially negative implications of ^ technological driven developments are often underplayed, sometimes to reduce

Sí resistance to their introduction.

From our interview program with senior management, we are convinced of the need to ° highlight how these threats have significant implications for large organizations, and

2 particularly subsidiary units of MNCs. The potential direct implications of these challenges

are presented here as distinct and separately identifiable for clarity, but in reality the ^ outcomes collectively reinforce the emerging threats and drive further changes themselves.

£ For example, the breaking down of value chains into distinct activities facilitated by more

sophisticated ICT systems and the erosion of trade barriers is both a result and a driver of 1 further change within the organization as it blurs subsidiary boundaries and erodes the

^ subsidiary as a distinct entity. While acknowledging the overlapping influences of the

challenges and their effects, we categorize the implications in terms of increasing headquarters monitoring and control and disaggregating value chains, and discuss their implications for the ability of business units to compete.

Increasing headquarters monitoring and control

Over the last two decades, headquarters has increasingly granted greater freedom to its operations to benefit from the local learning of its independent subsidiaries, access to local resources and competencies to achieve learning and dynamism throughout the MNC (Andersson et al., 2007). Many national subsidiaries are like ''miniature replicas'' (Young et al., 1988) of their parent and encompass a range of value chain activities to serve their local and nearby markets. However, increasingly sophisticated and relatively cheap ICT facilitate greater monitoring and control. It is argued that this has the benefit of reducing agency costs, or the risk of unit managers acting in their own or the subsidiary's interest rather than in the best interests of the overall organization, but we argue that there is potentially a high price to be paid in terms of stifling the potential for unit contribution. Our research suggests the following implications.

' It can be expected that increased monitoring will reduce the subsidiary's ability to act in response to local opportunities in two ways.''

Exposure of subsidiary networks

One of the benefits of the "miniature replica'' form of subsidiary is that its breadth of activities encourages the subsidiary to engage in network building within the local environment as well as with its sister subsidiaries. This increases the subsidiary's access to local knowledge and opportunities. Subsidiary external networks embrace local institutions such as universities and government agencies, as well as suppliers and competitors (Lee et al., 2001). Headquarters' enhanced ability to access subsidiary information systems now allows it to monitor its ''live'' contacts, and increases its knowledge of subsidiary activities and contacts. This effectively reduces the exclusivity of the subsidiary's contacts, and significantly enhances headquarters' ability to be involved in key subsidiary network relationships, and to control and co-ordinate these relationships from a distance. This ultimately enables any potential takeover of subsidiary relationships by headquarters, reducing the subsidiary's ability to build a strong position for itself within a particular location.

Limited potential for distinctiveness

Increasing international visibility requires organizations to ensure their dispersed activities comply with both local and international regulatory and competition rules. This encourages standardization of internal routines and procedures. However, greater standardization reduces flexibility and makes it more difficult for subsidiaries to achieve distinctiveness within the organization. Subsidiary management aim to make their subsidiary distinctive from the headquarters' perspective, as this is pivotal to their developing a more prominent role within the MNC. It also provides a platform for them to engage with headquarters and influence how the strategy for their subsidiary, if not the broader MNC, will be developed. Without distinctiveness to achieve headquarters recognition, subsidiary activities are more likely to be perceived on a purely cost/contribution basis. This has an increasingly negative effect as the less distinctive a unit becomes the less likely it is to be perceived as adding value to the organization.

Reduced subsidiary discretion

It can be expected that increased monitoring will reduce the subsidiary's ability to act in response to local opportunities in two ways. Firstly, it will reduce subsidiary autonomy, or the unit's freedom to act in response to opportunity without first obtaining headquarters' permission. Studies to date have connected autonomy with initiative generation (Birkinshaw etal., 1998) indicating that any reduction in a subsidiary's ability to make decisions at a local level will negatively impact its potential to contribute to the MNC. The local autonomy offered by a federally structured organization supports access to local knowledge and generation of initiatives by the subsidiary. This knowledge and initiative can then be transferred across the MNC to create competitive advantage (Andersson et al., 2007). Secondly, increased monitoring by headquarters will reduce the level of slack or unused available resources in the subsidiary system. Both anecdotal evidence and empirical studies (e.g. Nohria and Gulati, 1996) support the role of slack resources in generating subsidiary initiatives. Effectively, both the subsidiary's ability to make decisions and the resources to support the decisions are being continually eroded. This has potentially critical implications for subsidiary contribution. For example, units will no longer be able to decide if it is worth road testing a potential innovation with preliminary market research, and then finance the testing through slack time or financial resources. Innovation is challenging under any

circumstances, but within a restricted and watchful organization it will be even more difficult to achieve.

Disaggregating value chains

It must be acknowledged that ICT has many positive benefits, including the elimination of redundancy and duplication of effort, but its potentially negative implications must also be acknowledged. From a subsidiary perspective, ICT sophistication has transformed headquarters' ability to orchestrate its value chain activities, both within the organization and with other firms (Buckley, 2009). ICT increasingly connects end-to-end products globally within and across organizations, allowing firms in separate value chains to communicate and co-ordinate their activities. The effectively reduces the risk of slicing value chain activities into separate and often unrelated strands across organizational units. Following our research, we expect this to have the following impact within large organizations.

Transactional attitude to subsidiary strategy

Breaking the value chain down into strands of activities enables packages of activities to be separately assessed and priced. This facilitates the allocation of a package to the lowest cost producer, either inside or outside the organization (Buckley, 2009; Mudambi, 2008). As information and virtual products can be transported seamlessly from almost anywhere, the impact of distance is increasingly minimized, enabling manufacturing and increasingly R&D to shift to geographically remote locations. Infrastructural improvements in many of the ''new'' markets including China and India facilitate their bids to win more value-added activities, further undermining the competitive advantage of Western-based units. More worryingly, this fragmentation of organisational activities encourages headquarters to adopt a short-term, transaction-based perspective rather than to focus on the long-term strategy for that subsidiary. One unit director lamented, ''We need a vision for our future, not another spread sheet analysis!''

Erosion of synergy potential

While headquarters may have the ''big picture'' and be able to co-ordinate distribution of packages of activities across subsidiary units, this approach reduces the potential of individual subsidiaries to achieve synergies. The different packages of activity may originate from different value chains with different reporting structures, and the individual subsidiary units will not be aware of their role within the ''big picture''. This reduces the subsidiary's ability to identify synergies and enhancements at the ground level. Without knowledge of an entire process, the subsidiary's capacity for innovation is severely constrained.

In addition, non-routine problems experienced by different units engaged in similar but disjointed activities, even potentially within the same unit, may separately engage in solving similar problems. Information is often not valuable in isolation and needs the insights provided by awareness of the bigger picture. Without an overall picture of how the subsidiary's activities relate to the wider organization units, we only have separate pieces of a jigsaw, no box!

'While headquarters may have the 'big picture' and be able to co-ordinate distribution of packages of activities across subsidiary units, this approach reduces the potential of individual subsidiaries to achieve synergies.''

Control and command HQs

As mentioned earlier, the emergence of the federal view of the MNC recognizes the potential of the diverse units within the MNCs to contribute to competitive advantage through knowledge-sharing and opportunity identification in dispersed operations (Anderson et al., 2007). This implies that subsidiary operations have the strategic perspective and the autonomy to recognize opportunities and generate initiatives in response (Birkinshaw et al., 1998). Often these initiatives are generated without the parent's consent or even knowledge, as it is often easier to be forgiven afterwards than achieve permission in advance. For example, Bailey's Irish Cream was developed by Gilbey's of Ireland (now owned by Diageo) to use locally-based product (cream) which would embed the subsidiary in its location (Delaney, 2001).

The parent dilemma within the federal approach to subsidiary management is how best to communicate and co-ordinate activities to leverage the local knowledge and innovative capacities of subsidiaries (Ghoshal and Bartlett, 1988). Tight control by headquarters restrains the MNC from ''realizing the many well-documented benefits of strategically independent subsidiaries [...] learning from local systems of innovation, using and integrating local resources and competencies, and generally introducing a heightened level of dynamism into the parents' MNC'' (Mudambi and Navarra, 2004, p. 387). Our interviews with subsidiary CEOs and directors indicate that disaggregating value chains into separate strands is shifting this perspective to a more active controlling and commanding role. This has negative impact on the potential for the MNC to learn and benefit from its subsidiary network.

Cycle of subsidiary decline

The cycle of subsidiary decline is summarized in Figure 1.

Headquarters' enhanced ability to relocate strands of activities from across the value chain and across nations means that what constitutes a subsidiary within a particular location is likely to be increasingly less defined. Strands or packages of activities do not have the same cohesiveness, structure and embeddedness in a location as a ''national subsidiary'' or miniature replica of the parent operation. For example, the Irish operation of a particular

''... the cycle of subsidiary decline will only be a potential threat for some, a real and present danger for others.''

MNC employing only 1,200 people constituted 17 different packages of activities, integrated with six separate value chains with different matrix reporting structures.

The breakdown of subsidiary businesses into combinations of possibly randomly assigned value chain activities, closely monitored and with little autonomy, substantially reduces subsidiary ability to adopt a strategic perspective and to identify how its operation fits within the organization. This has critical implications for organizations as subsidiary role is increasingly limited to achieving cost efficiently and quality levels on a narrow range of value chain activities. The potential for initiative generation demonstrating the subsidiary's value to the MNC, and enhancing its position with the organization, will continually decline. This in turn increases the likelihood that allocation of future investments will be on a cost basis only and the potential for the subsidiary to engage in strategically significant activities will be further undermined. We propose that these factors will combine to lead to a cycle of subsidiary decline.

We are not suggesting that all MNCs are moving from a federative structure, but we propose that there is a continuum of MNC organizational approaches, anchored by the federative structure on one side and the global factory (Buckley, 2009) on the other. From an MNC perspective, most organizations would see themselves as lying somewhere in the middle. However, given that subsidiaries vary in their contribution and their role within their organization (Birkinshaw et al., 1998), we propose that the impact of the organizational approach will vary for each specific subsidiary. As a result, the cycle of subsidiary decline will only be a potential threat for some, a real and present danger for others.

It is difficult to identify a starting point for discussing the cycle of subsidiary decline, but we begin at the erosion of the subsidiary's ability to develop those combinative capabilities which are the foundation of its capacity to contribute to the MNC.

Combinative capabilities

The MNC exists to exploit synergies between its subsidiary units. Knowledge may have little value in isolation, but when combined within a framework the subsidiary can understand how it relates to other organizational activities, and how these activities relate to each other. The subsidiary's combinative capabilities enable the subsidiary to use its locally-based knowledge and opportunities to generate initiatives for exploitation across the organization. Slicing activities into packages and reducing the related knowledge into randomly unconnected nuggets reduces the ability of management at both the subsidiary and at headquarters level to achieve locational synergies.

The MNC's ability to achieve competitive advantages, as summarized by Ghoshal and Bartlett (1988), is through subsidiary exploitation of the unique opportunities in their local environments to generate innovations. Now, however, formerly national subsidiaries where the MNC locates all of the activities associated with a particular value chain within each country and which act as distinct strategic entities may shift to become centers of unrelated packages of activities. These packages of activities may encompass not just one but several value chains attached to different organizational divisions and departments. If, as Kogut and Zander (1992) argue, individuals recombine their current skills by transferring information across the organization's social network then, we propose that, like the guerrilla warfare approach of using cell structures to minimize leaking of information, dispersed strands of value chains will lead to corals of disjoint information. This will ultimately inhibit the subsidiary ability to identify and build the combinative competencies it needs to contribute to the organization.

Subsidiary units normally exploit headquarters' reliance on their operation to win resource allocations, particularly to build next generation competencies.''

Position and contribution

A subsidiary's position within the MNC will depend on the contribution to the organization generated by its combinative capabilities. If, as we argue, the subsidiary's combinative capabilities will be reduced as a result of the erosion of the federal structure, this will in turn lead to a decline in the subsidiary's ability to contribute to the organization through the generation of innovations and knowledge flows.

Reduction of unit bargaining power

A subsidiary's bargaining power arises from intra-MNC knowledge flows and its position within the MNC (Mudambi and Navarra, 2004). The ability to package activities and effectively force subsidiaries and external competitors to bid for them provides headquarters with a wider range of options in terms of its location of routine operations and reduces its reliance on specific units within its organization. This erosion of the federal structure combined with the decline in the subsidiary's combinative capabilities and its lack of visibility within the organization due to decline in its contribution, will reduce the unit's bargaining power with headquarters.

Resource allocation

Subsidiary units normally exploit headquarters' reliance on their operation to win resource allocations, particularly to build next generation competencies. Subsidiaries need to win current resources to position for the challenges of tomorrow. Without the resources to build tomorrows competencies their activities will slip further down the value chain, and they will become trapped with the cycle of subsidiary decline.

Keywords:

Multinational companies,

Subsidiaries,

Value chain,

Resources,

Innovation

Conclusion

Subsidiary managers are critically aware of the need for their unit to demonstrate its value within their organization, to challenge for resources to exploit the present and position for the future. Our study identifies emerging threats that combine to undermine subsidiary potential to contribute to the MNC. The erosion of barriers of trade, increasing complexities of corporate governance and developing ICT capabilities are driving changes in how subsidiaries are managed. Headquarters can increasingly disaggregate value chains across and outside the organization, reducing their reliance on individual subsidiary operations. In addition, increasingly sophisticated ICT enables greater subsidiary monitoring and control, reducing subsidiary ability to differentiate its activities and to generate innovations.

We demonstrate how these emerging threats combine to reduce subsidiary bargaining power. This in turn undermines subsidiary ability to challenge for access to organizational resources which will determine its capacity to create combinative capabilities to position for future opportunities. Deteriorating combinative capabilities will in turn constrain subsidiary potential to contribute to the MNC. This creates a cycle of subsidiary decline. A key task of subsidiary managers will be to develop effective strategic responses to protect their operations if they are to demonstrate their unit's value to the organization and position for future growth and avoid falling into the cycle of subsidiary decline.

References

Andersson, U., Forsgren, M. and Holm, U. (2007), ''Balancing subsidiary influence in the federative MNC: a business network view'', Journal of International Business Studies, Vol. 38, pp. 802-18.

Birkinshaw, J., Hood, N. and Jonsson, S. (1998), ''Building firm-specific advantages in multinational corporations: the role of subsidiary initiative", Strategic Management Journal, Vol. 19, pp. 221-41.

Buckley, P.J. (2009), ''Internalisation thinking: from the multinational enterprise to the global factory'', International Business Review, Vol. 18, pp. 224-35.

Delaney, E. (2000), ''Strategic development of the multinational subsidiary through subsidiary initiative-taking'', Long Range Planning, Vol. 33, pp. 220-44.

Ghoshal, S. and Bartlett, C. (1988), ''Creation, adoption and diffusion of innovations by subsidiaries of multinational corporations'', Journal of International Business Studies, Vol. 19, pp. 365-88.

Kogut, B. and Zander, U. (1992), ''Knowledge of the firm, combinative capabilities, and the replication of technology'', Organization Science, Vol. 3 No. 3, pp. 383-97.

Lee, C., Lee, K. and Pennings, J. (2001), ''Internal capabilities, external networks, and performance: a study on technology-based ventures'', Strategic Management Journal, Vol. 22, pp. 615-40.

Mudambi, R. (2008), ''Location, control and innovation in knowledge-intensive industries'', Journal of Economic Geography, Vol. 8, pp. 669-725.

Mudambi, R. and Navarra, P. (2004), ''Is knowledge power? Knowledge flows, subsidiary power and rent-seeking within MNCs'', Journal of International Business Studies, Vol. 35, pp. 385-406.

Nohria, N. and Gulati, R. (1996), ''Is slack good or bad for innovation?'', Academy of Management Journal, Vol. 39 No. 5, pp. 1245-64.

Young, S., Hood, N. and Dunlop, S. (1988), ''Global strategies, multinational subsidiary roles and economic impact in Scotland'', Regional Studies, Vol. 22 No. 6, pp. 487-97.

About the authors

Pamela Scott is a Research Fellow on the Faculty of Business, Dublin Institute of Technology, Ireland. Her research interests are strategy development, entrepreneurship and leadership in multinational subsidiaries. Pamela Scott is the corresponding author and can be contacted at: pamela.sharkeyscott@dit.ie

Patrick Gibbons is a Professor of Strategic Management at UCD Michael Smurfit Graduate Business School, Dublin, Ireland with research interests in control practices of MNCs, the impact of strategic planning systems on organizational behavior and performance, and the application of social theory to strategic process research.

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