Exploring the Paradox of Competence-creating Subsidiaries: Balancing Bandwidth and Dispersion in MNEs
Introduction
MNEs have become increasingly knowledge driven, and growing cross-border competition has led many to seek and develop knowledge assets through a wider variety of means. Competences are increasingly developed at the subsidiary level (Birkinshaw and Hood, 2001, Andersson et al., 2002; Rugman and Verbeke, 2001, Cantwell and Mudambi, 2005), although the extent to which this occurs is dependent upon a variety of factors, such as the degree of the subsidiary's embeddedness within the MNE's internal network as well as its external environment (Meyer et al., 2011). The subsidiary's ability to play this dual role of tapping into local knowledge and engaging in knowledge exchange with other units is further influenced by the nature of its own mandate, the MNE's corporate strategy and the aspect of the value chain the subsidiary is engaged in (Rugman et al., 2011).
But to what extent does the subsidiary's competence creation benefit the MNE at large, and how does this activity happen most effectively? The literature over the last two or three decades took two different views of the subsidiary-parent relationship (Foss et al., 2012). The ‘traditional’ view was that the MNE was essentially a hierarchy with subsidiaries acting at the behest of the parent. Strategic activities such as R&D were largely concentrated at, by or close to other strategically significant activities such as HQ functions, and major markets (or customers). Major markets/customers tended to be located close to the MNE's home country or region, so too were R&D facilities, particularly those that were engaged in systematic creation of new competences for the MNE as a whole. Headquarters functioned as the primary hub in a hub-and-spoke structure, providing centralised strategic decision-making, able to exercise fiat as needed. An alternative approach took the view that all MNE units share a common set of goals and objectives, but sees the MNE as a network of subsidiaries which ultimately act as a fraternity (a ‘federal’ structure).
Although later studies reconciled these two views (see Andersson et al., 2007), earlier work underplayed the conflict and struggle for power within the MNE (Mudambi et al., 2013). Indeed, the terms ‘subsidiary’ and ‘headquarters’ are themselves increasingly problematic, just as ‘home country’ and ‘host country’ are suggestive of an earlier era. As several of the papers in this special issue illustrate, subsidiaries and headquarters do not always share the same goals and objectives, and while subsidiaries may generate new competences, it is by no means assured that these are accessible to the parent, or other subsidiaries. That is, competence creating subsidiaries must be ‘willing and able’ to make their assets available to other MNE units, and in other cases they may either not be ‘willing’ or not ‘able’ to do so. This is not as radical as one might believe. Establishments may not have a mandate, or may be unwilling to accept a change in mandate: they may have enjoyed complete operational and strategic opportunity autonomy in the past, which they are loathe to lose. Likewise, parents (or other subsidiaries) must ‘want’ what the subsidiary has, but internal markets suffer from imperfections as well, particularly as MNEs become geographically dispersed and individual operations become specialised in scope and competences (Mudambi, 2011; Najafi-Tavani et al., 2013).
It may appear that discussions on HQ-subsidiary interactions, and in particular, those involving a central corporate headquarters, are increasingly archaic and irrelevant. This is indeed so when we speak of large MNEs that are a complex combination of hierarchies and networks, interspersed by a (spatially dispersed) variety of functional and geographical headquarters (Benito et al., 2011). Nonetheless, the corporate HQ – just as the concept of a home country – is not yet a vestige of the past. Beyond a certain cadre of large MNEs typical of the Fortune 500, the dispersion of the strategic activities of the majority of MNEs remains modest.
To what extent has this state of affairs got to do with globalization? There is plenty of evidence to indicate that MNEs have expanded their competence-creating activities both geographically and technologically, the first to take advantage of a plethora of innovation systems available to them, and the second to respond to the growing multi-technology nature of products and processes (Narula, 2003). Additionally, political pressure by influential host country governments has also played an important role. Governments have sought to promote local R&D and manufacturing by MNEs as a condition for market access. However, there is no clear evidence that this growing geographical expansion has led to a commensurate growth in their competence portfolios (Singh, 2008). Indeed, there are suggestions that firms may be better off restricting new knowledge creation to a limited number of units: there is a non-linear relationship between spread and benefits to innovation (Lahiri, 2010).
Meyer et al. (2011) argued that MNEs need to balance the internal embeddedness of the subsidiary within the MNE network against its external embeddedness in the host milieu. Achieving this balance between the subsidiary's strategic role within the MNE with its local identity and its domestic linkages represents a special challenge because of the nature of the trade-offs that it can create. Multiple embeddedness implies a greater degree of collaboration, both with external actors, and within the MNE. Innovation-related knowledge flows require greater bandwidth, even in the absence of geographical expansion. We draw on arguments from sociology that highlights the dispersion-bandwidth paradox, which argue that firms tend to shrink bandwidth when they become more dispersed, because they are cognitive limits to their coordination and integration capacity. Bandwidth becomes more expensive (both financially, and crucially, in terms of human resources) as distances (technological, organisational, physical) become greater, implying that there are decreasing returns to MNE spread.
In the following section, I expand on the nature of firm specific advantages (FSAs) and location advantages, emphasising the different advantages that are essential for optimal external and internal embeddedness. Section 3 examines the complexities and challenges of external embeddedness for competence-creation, while Section 4 takes a closer look at the MNE's internal embeddedness, and the difficulties in optimising the benefits from their growing portfolio of competence-creating subsidiaries. Generating competences through innovation activities is only part of the task, as these assets need to be successfully made available to (and integrated with) other MNE units. Section 5 examines the bandwidth-dispersion paradox. While MNEs have rapidly expanded over the last few decades, they have sometimes struggled to reconcile growing geographical and technological dispersion with the commensurate greater bandwidth required for effective intra-MNE knowledge exchange within these larger networks. A larger number of competence-creating subsidiaries require much more sophisticated means to acquire, coordinate and integrate these assets within the MNE.
Section snippets
Competence-creation and FSAs in the modern MNE
The focus of this paper (and the special issue) is the competence creating subsidiary (CCS), which individually may consist of one or many establishments in the same location. We are interested in subsidiaries that are in aggregate systematically and deliberately engaged in creating new competences. Few subsidiaries (whether an agglomeration of many establishments, or a single establishment) are clearly competence-creating or competence-exploiting. Both subsidiaries and establishments will tend
FSAs and external embeddedness
Let us first take the case of external embeddedness. The subsidiary's ability to create new competences depends on the ability to recombine (or ‘bundle’) the FSAs of collocated firms and/or the location-specific assets associated with the host location's innovation system with its existing FSAs (Verbeke, 2009). Such bundling requires a rather specific set of knowledge assets, and ownership of these skills determines the ability of the subsidiary to act as a ‘mechanism’ to convert
Constraints on internal embeddedness
HQ-subsidiary relationships in a MNE are complex, and much of the research in this area presumes highly stylised sets of interactions (Rugman and Verbeke, 2001). At the very least, there is a principal-agent problem, and even wholly-owned subsidiaries do not always act in the best interests of the parent. This relates to the classic centralization/autonomy paradox (Young and Tavares, 2004). A competence-creating subsidiary does not necessarily imply that its competences are available to the
The perils of growing too fast: The MNE and the dispersion-bandwidth paradox
That internal embeddedness is crucial for the MNE, particularly in the area of innovation, has always been uncontroversial (Kogut and Zander, 1993; Frost and Zhou, 2005). We know that strong internal linkages are a mechanism to ensure that the various units of the MNE maintain similar priorities, and coordinate activities so that there is an internal interdependence. These challenges are further exacerbated – even where MNE units want to cooperate – in more tacit/less codifiable activities,
Acknowledgements
Comments on earlier drafts from Paola Criscuolo, Gabriel Benito, Sam MacAulay, Katarina Blomkvist, Phillip Nell, Grazia Santangelo and Alan Rugman are much appreciated. All errors and omissions are (of course) my own.
Rajneesh Narula is Professor of International Business Regulation, and Director of the John H. Dunning Centre for International Business at the Henley Business School, University of Reading, UK. E-mail: [email protected]
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