Challenges to the Theory of the MNE

1. Changing Nature of International Business

In recent decades, increased globalization, and in particular out- sourcing and offshoring, appear to have gained momentum. This can be exemplified by industries from clothing to electronics. As a consequence, international trade in intermediate products has increased, enabled by the global dispersion of knowledge and capa- bilities, as well as by progress in transportation and communica- tion. The existence of some degree of industry maturity and the emerging of standards has also played an important role. The later development facilitates specialization through modularity; modu- larity in turn lowers entry barriers for both domestic and foreign firms.

Table 5.1. Imports into the USA by trade categories, as percentage of total imports

Intrafirm trade can include both intermediate goods and final goods. Table 5.1 (from Bardhan et al., 2003) shows that in 1997, 37 percent of all US goods imported were intermediate goods. More importantly, intrafirm imports had risen from 43 percent in 1992 to 52 percent in 1997. For home-based (US) multinationals, the increase was much larger, from 17 percent in 1992 to 30 percent in 1997. Such data are merely suggestive—but there seems to be more than a hint in the data that intermediate product flows are an increasing proportion of all trade, at least for US-based MNEs operating in the USA.

Not surprisingly, the activities of MNEs have changed dramat- ically too. In particular, the nature and national origin of MNEs have changed. US and European MNEs haven’t grown as fast as MNEs from Japan and the Asian newly industrializing countries (NICs) (e.g. Samsung, Hyundai, TSMC, and CNOOC). It appears that the geographic as well as the organizational locus of manu- facturing has changed—away from the USA and Europe toward Asia (especially Japan, Korea, and China), and away from the MNE itself, that is, what has occurred is both “offshoring” and “outsourcing”. Especially from the US perspective, there has not only been a change in the geographic location of production in many industries (offshoring); there has also been a change in the organizational locus of production (“outsourcing”).

Two key developments relevant to the nature and scope of MNEs would appear to include: (i) the simultaneous increase in both the outsourcing and the offshoring of production; (ii) the emergence of a distributed and open innovation model, that is, not only is production or manufacturing being outsourced, so is innovation. These trends aren’t that well addressed or explained by internalization theories alone. However, the Dunning (1981) and Teece (1986b) frameworks,25 with their explicit recognition of the dynamic interplay of asset positioning and internaliza- tion factors, are able to explain these developments better than some.

First, using the definitions of the Dunning eclectic framework, it appears that the (relative) locational advantages of some incum- bent MNEs in the USA and Europe have deteriorated. The logic of the framework suggests that as the capacity for both globally com- petitive R&D and globally competitive production migrates away from the USA and Europe and toward Asia, then incumbent MNEs would, ceteris paribus, experience some degree of erosion of their competitive advantage. This could well, in the first instance, mani- fest itself in outsourcing (of R&D and production, respectively). Put differently, even if there is no deterioration in the internalization advantages of the MNE, the amount by which an MNE could rely on its own in-house capabilities in order to compete would tend to decline.

In an earlier paper (Teece, 1986b) I made the point as follows:

Setting aside for the moment the question of whether production should be controlled by a multinational or a domestic firm, it ought to be apparent that if production techniques and knowledge are uniformly distributed internationally, the location of production will simply depend on differ- ences in factor costs, tariffs, taxes, transportation costs, and the size of markets.26

This could have been presented from the opposite perspective too. Namely, if technology isn’t ubiquitously available, and a firm has a sustainable difference in a superior manufacturing technology, then the MNE may be able to continue to utilize its domestic manufacturing. The relevance here is that large multinational business enterprises in the USA and Europe have both expanded outsourcing and offshoring. However, this “hollowing out”, as some have put it, does not mean that the incentives for MNE activity have declined. Indeed, they may well have increased. However, the direct investment component may have declined as offshore producers establish their ability to engage in compet- itive supply. The fact that US companies have moved produc- tion offshore, to both subsidiaries and to nonaffiliated suppliers, is fully consistent with what both the Dunning and Teece frame- works would suggest. It doesn’t mean that internalization/vertical integration benefits per se have declined. It may simply indicate that the locus of certain organizational capabilities has migrated offshore.

I do not mean to suggest, however, that the Dunning, Teece, and related approaches are robust enough to explain all relevant developments. In particular, one element missing from both is an understanding of the role of standards and modularization. The emergence of standards, for example the GSM standard in wire- less communications, the RDRAM and DDR SDRAM standards for semiconductor memory devices, have facilitated the modulariza- tion of systems, which in turn have untethered the location of product development from the location of production.

With standardization, innovation can occur at the modular level, that is, so long as the standard is adhered to, designers and developers are free to engage in innovation at the subsystem/module level, and then either “bolt it on” or let others bolt it on to other (compatible) modules. Compatibility standards can allow a plethora of new entrants into an industry; large multinationals in turn need to somehow access this innovation. Put differently, MNEs need to “manage” not only their own assets, but the assets of others too. Frequently such assets external to the firm are complements to what the firm has internally. Increasingly, firms must manage assets inside the firm, and, as best they can, assets that lie external to the firm too. The management approaches which can be utilized are rarely hierarchical—although sometimes acquisitions can be used to secure control of critical complementary assets. Frequently, however, this isn’t possible; and the challenges to MNE management are considerable.

2. Implications for MNE Theory

How have globalization, outsourcing, and offshoring factors impacted the nature of MNE, and the requirements for a theory of MNE? With the growth in intermediate markets, with coordination and communication costs lowering, and with the distribution of production capabilities dispersing globally, it appears that the forces favoring internalization are weakening,27 at least in some indus- tries. As intermediate markets have expanded, outsourcing (and in-sourcing) opportunities have expanded. Moreover, increased uncertainty has enhanced the pay-off to the ability of firms to be flexible and entrepreneurial. This in turn has changed the way in which the multinational firm has manifested its presence. General Motors may today source its Pontiac engines in Mexico, its wheels in Taiwan, and its brakes from Germany; but tomorrow the sourc- ing pattern may need to be different. Supply-chain management has emerged as an important factor in the competitive success of MNEs.

With globalization, the extent of vertical integration appears to be diminishing—not because internalization is inherently flawed— but because of the shifting geographic locus of production capabil- ities. The (American) system of twentieth century production and innovation, which relied heavily on in-house R&D and vertically integrated production, is yielding in many industries to a system which is less integrated. Chesbrough (2003) has referred to this as “open innovation”, inasmuch as it is based on sourcing innovation from suppliers external to the firm as well as from in-house R&D programs. Of course, there is still a critical role that the enterprise plays in combining technologies in order to create customer solu- tions.

The semiconductor industry is a case in point. Fabless semi- conductor companies are now common. These are firms that design and sell chips globally, but they depend on (offshore) fabs to manufacture their products. The auto industry has likewise engaged in considerable outsourcing, aided by the modulariza- tion of design. Modularization is facilitated by standards and stan- dardization. Industry-level standardization allows for specialization and the emergence of intermediate markets. Internal designs can proceed without deep knowledge of all aspects of a system. For example, the highly standardized nature of the PC allows for man- ufacturers to specialize in subsystems such as CPUs, keyboards, screens, and software.

Indeed, it was a key insight from Williamson that the firm’s boundaries are determined by the interaction between “produc- tion” costs and “governance” costs.28 As noted earlier (Teece, 1986a: 395), “differences amongst countries in comparative costs will cause the international specialization of production and con- comitant trade”. This framework (by referencing production costs) would imply that country-level capabilities and costs would be a factor in the location decisions of MNE. For example, if the USA is no longer competitive in textiles, then the locus of production will migrate offshore. With hindsight, I would emphasize firm- level as well as country-level costs, as wide differentials in costs can open up amongst firms in the same industry and in the same country.

Source: Teece David J. (2009), Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth, Oxford University Press; 1st edition.

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