Abstract
This paper provides a theoretical model of the trade-offs that an MNE faces when organising its R&D as decentralised or centralised. R&D decentralisation avoids having to adapt centrally developed innovations to local markets, being able to use the specific know-how of the subsidiary. In addition R&D subsidiaries can be used to source locally available external know-how. At the same time, however, R&D internationalisation intensifies the spillover of valuable know-how to competitors located in the foreign markets. The analysis demonstrates the importance of the intensity of competition in the local market in determining the size of both the benefits and costs of R&D decentralisation. It shows that when R&D is undertaken abroad in association with production, the local knowledge base is not unequivocally a pulling factor attracting R&D investments by foreign MNEs, depending on the level of local competition. The paper also shows that efficiency in reverse intra-company technology transfers is a critical factor in benefiting from technology sourcing. The results thus illustrate the complementarity of efficient internal and external knowledge management systems. In addition the model suggests that, with a fall in the cost of intra-company technology transfers, relative market size loses importance as a locational factor for R&D decentralisation.
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Notes
Gersbach and Schmutzler (1999) consider two types of external spillover: external spillovers when rival production units are co-localised with own R&D sites, and knowledge complementarities among co-localised R&D sites. In addition, the firms also need to consider that internal spillovers are required when R&D is located separately from production.
The case of research outposts devoted to basic research, generally located abroad separately from production, can be considered as a special case of our model (see below).
The literature has amply dealt with the choice of the optimal amount of R&D done by MNEs (Petit and Sanna-Randaccio, 2000, and references cited therein). Here we treat the R&D budget choice as given, and consider the decision on how to spend the R&D resources rather than the decision on how much to spend. In view of the high adjustment costs, particularly in personnel recruitment, and given that the major part of the R&D budget typically goes to personnel expenses, we can take R&D budgets as fixed, at least in the short run.
Note that not only are R&D resources fixed for each firm, but also the total R&D resources are assumed to be the same in the case of either centralisation or decentralisation.
As the MNE can locate its R&D resources at either the parent or the subsidiary level, both R&D units are considered to be substitutable mechanisms to generate innovation. Within a given R&D budget in the short run, both units are competing for the same MNE resources. However, at the same time, the model takes both R&D units to have specialised and unique R&D capabilities such that the know-how that is generated by one unit can also be used elsewhere if properly adapted.
That centralisation can perfectly prevent leakage is obviously a simplification. But what is important for the model results is that the scope for external spillovers in the case of centralisation are smaller than in the case of decentralisation. This follows from the localised nature of spillovers, which are mostly associated with personal, informal contacts and mobility of personnel, which is typically geographically restricted (see the empirical literature quoted above).
Note that we consider absorptive capacity only for external spillovers, not for internal spillovers.
We impose the restriction that (βXlαx̄ m ≤1) and βXsx̄ l ≤1.
However, given the specifications of the model, the effect of the external spillovers (βXsαx̄ m )x̄ l and (βXsx̄ l )αx̄ m will be the same in the case where βX is similar across firms.
We have that π̂ s d=b II (q̄ s d)2. With ˆ we indicate the equilibrium value of the variable.
The last term in Eq. (17) accounts for the ‘own R&D effect’, which is certainly positive since βXsx̄ l ≤1. Hence the subsidiary will always benefit from having more own R&D resources allocated.
Disentangling parent and affiliate profits from the decentralisation choice is interesting when considering the bargaining process internally within the MNE. For instance, if the decision to decentralise R&D will be taken only if at least each party benefits, this implies that (π̂ d d−π̂ p c)>0 and (π̂ s d−π̂ s c)>0 need to hold in addition to Eq. (19).
If the products made by the two firms in the host market are strategic complements (instead of substitutes as assumed here), decentralisation will certainly enhance the subsidiary's profitability. In fact, with decentralisation, both producers will benefit not only from incoming external spillovers but also from outgoing external spillovers. Thus in such a context the incentive to locate R&D abroad will be stronger.
Note that, in this case, the extent to which external knowledge will be sourced ((βXαx m ) or (βXx l )) is still firm specific, because each firm may differ in terms of absorptive capacity.
If βXl=βXs, this implies that, since βXlx l ≤1, condition (26) does not hold for βIs≤0.5.
The pool of knowledge generated by research institutions and by local firms operating in other sectors (as discussed earlier) will have a positive effect on the profits from R&D investment by a foreign MNE due to incoming spillovers, while not generating negative repercussions due to outgoing spillovers or market-stealing effect as there is no interaction in the product market.
For the full expression see equation (B3).
This will be the case with T=(γ/2)(αx m )2∀α.
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Acknowledgements
Veugelers acknowledges support from DWTC(P5/26.A) and KUL (VIS/02/001 and OT04/07A). Sanna-Randaccio acknowledges support from Università di Roma ‘La Sapienza’ and MIUR. We also gratefully acknowledge the comments from two anonymous referees, from the Departmental Editor, P. Ghemawat, from R. Belderbos and B. Yeung, from members of the EU MESIAS network, and from participants at the EIBA conference in Paris, the CEPR conference in Hydra, the EARIE conference in Madrid, the IESE conference on ‘Creating Value through Global Strategy’, in Barcelona, the AIB conference in Monterey, and from the Stern Business School, NYU (Global Business Institute). An earlier version of the paper appeared as CEPR Discussion Paper DP3151 and was selected as first runner-up in the AIB Best Paper Award, 2003.
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Accepted by Pankaj Ghemawat, Departmental Editor, 5 August 2006. This paper has been with the authors for two revisions.
Appendices
Appendix A
Equations (26) and (23) are sufficient conditions to have some degree of decentralisation, because, when they are satisfied, for α=0 we have that ∂(Π̂ m d−Π̂ m c)/∂α>0, which means that a marginal increase in α increases the MNE's profitability, and thus the optimal value of α is positive. To obtain the optimal value of α, we should compare the marginal effect of an increase in α on the MNE's variable profits (MRd, i.e., the terms in square brackets in (A1)) with the marginal effect on additional R&D cost (MCd, i.e., the second term in (A1)):
We find that
where
i.e., LHS of Equation (26)
i.e., LHS of Equation (23)
and
sgn(B1)=sgn(L(26)), sgn(B2)=sgn(L(23)), C1>0, C2>0
Thus with α=0, when Eq. (26) and (23) hold, we have that
Appendix B
The overall effect of the local know-how base x̄ l on the incentive for a foreign MNE to decentralise its R&D is given by
As to internal transfer of know-how from parent to subsidiary, we have
The interaction between external and internal know-how transfers is indicated by
Appendix C
Given βXl=βXs, βIp=1, βIs=0 and ϕ=1, we have that
and thus the necessary and sufficient condition for ∂(Π m d−Π m c)/∂x̄ l <0 is given by
and since 0≤βXαx̄ m ≤1, we have that (2−βXαx̄ m )=k∈[1, 2].
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Sanna-Randaccio, F., Veugelers, R. Multinational knowledge spillovers with decentralised R&D: a game-theoretic approach. J Int Bus Stud 38, 47–63 (2007). https://doi.org/10.1057/palgrave.jibs.8400249
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DOI: https://doi.org/10.1057/palgrave.jibs.8400249