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MULTINATIONAL PERFORMANCE AND THE GEOGRAPHY OF FDI
Issues of embeddedness, strategic fit and the dimensions of distance
Ioana R. Bedreaga, Raquel Ortega Argilés and Philip McCann
Introduction
This chapter examines the ideas and insights emerging from the Economic Geography and International Business literatures on the strategic fit and embeddedness of multinationals, their subsidiaries and their affiliates in host economies. While the core material is mainly evident in the International Business and Economic Geography, the relevant literature also spans various different disciplines and draws insights from quite different fields, including sociology, political science, management science, urban studies, strategy and economics. However, the locational setting of the multinational subsidiary turns out to be the context in which many different influences and dimensions are drawn together in a manner which heavily shapes corporate decision-making. These issues are discussed here from various perspectives, with a central organising framework of Economic Geography underpinning each. The rest of the chapter is organised as follows: the next section reviews the concepts and definitions linking the multinational to its location or place; then we examine the empirical evidence on embeddedness and strategic fit, followed by a discussion on the dimensions of distance, as they pertain to the Economic Geography of multinational investment decisions. The final section provides some brief conclusions.
Concepts and definitions linking the multinational to its location and place
Many scholars have tried to understand the development of internationalisation patterns, particularly in terms of foreign direct investment as they assume great additional costs, financial risk and strategic impact (Hymer, 1976). Theoretical mechanisms mainly imply a positive relationship between internationalisation strategies and performance based on economies of scale and scope (Kogut, 1985; Ghoshal, 1987), location-specific advantages (Dunning, 1980), new opportunities for learning and value creation (Barkema & Vermeulen, 1998) as well as the spread of risks and costs over larger markets (Contractor, Kundu & Hsu, 2003). Indeed, on almost every indicator of internationalisation, multinational activities and investments tend to out-perform their domestic equivalents (Iammarino & McCann, 2013). At the same time, however, at an empirical level, the cost-benefit trade-off of internationalisation has yielded mixed and often contradictory results (Bausch & Krist, 2007), suggesting that the relationship between internationalisation and performance is neither unidirectional nor monotonic, but instead appears also to be heavily moderated by contextual factors that can produce differential performance effects. These contextual factors can operate at the national, regional or local scales, depending on the issues in question. Importantly, geography moderates and shapes the impacts and performance of multinational activities in different ways and over different spatial scales, pervading all aspects of multinationalisation.
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In general, operational performance has been theorised to depend on the interplay between the internal resources that are under the ‘direct, real time control of the manager’ and the environmental variables that ‘are not subject to direct or positive real time control’ (Luthans & Stewart, 1978, pp. 686–687) and thus, ‘the best way to organize depends on the nature of the environment to which the organization relates’ (Scott, 1992, p. 89). These ideas borrow from the schema first proposed by Alchian (1950), and imply that successful internationalisation depends heavily on the extent to which firms are able to adjust their operational behaviour to the exogenous characteristics of the foreign environments in which they operate. This extent to which the firm’s actions and activities are adjusted to the firm’s environment is often discussed in terms of the ‘strategic fit’ or the quality and degree of ‘embeddedness’ between the firm and its local environment. At the micro level these ideas underpin questions regarding the firm strategy, while at the meso or macro levels these ideas underpin the relationships between Economic Geography and multinational activities. In particular, there is now a growing awareness of the role played by systems of cities, and in particular key global cities, in reflecting, mediating and shaping the geography of multinationalism and globalisation. Taking their early analytical arguments to their logical conclusions led both Hymer (1972) and Vernon (1966) to originally conclude that there will be a close match between the international urban hierarchy and the international corporate hierarchy, with the observed long-run distribution of multinational activities and investments closely mirroring spatial structures. Part of the argument here relates exactly to the goodness of fit concept, in that the returns to global investments are likely to be maximised where the strategic fit between the specific investment and its local host environment is optimised. Different countries and cities offer different sets of resources, opportunities, challenges and complexities, and multinational investments which most appropriately reflect and build on these particular dimensions are those which are most likely to earn maximum returns.
The concepts of ‘strategic fit’ and ‘embeddedness’ which exist in the economic sociology and business strategy literatures are particularly relevant for understanding how multinational firms may increase the performance of their investments. Generically, these concepts are both based on the idea that organisational behaviour and performance cannot be understood as being independent of the social and institutional contexts surrounding the firm. Embeddedness relates to the scale, variety and depth of the firm’s knowledge, monetary and institutional linkages with its host context and also that these tend to be related to the longevity of the firm in the context. Moreover, these linkages are likely to be two-way, implying mutual commitments both on the part of the foreign investor as well as the host country or region. Meanwhile, the closely related concept of strategic fit relates to the efficacy and efficiency of the matching and dovetailing which takes place between the points of contact on the part of the foreign investor and the host region. These two concepts are interrelated, in the sense that embeddedness acts as a mechanism to obtain strategic fit in various settings while, conversely, strategic fit acts so as to deepen and enrich a firm’s embeddedness in its environment. In these two literatures, organisational performance is therefore understood to be dependent on the opportunities of the firms to better embed themselves in the socio-political environments of the host countries, and to develop two-way flows of knowledge and technology (Cantwell & Iammarino, 2003). As each individual host country carries different potential for embedding their foreign affiliates, it is expected that organisational performance will also vary depending on the idiosyncrasies of the local environments in which the firms operate.
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The concept of ‘embeddedness’ has attracted extensive academic attention in a variety of fields. Economic sociologists originally developed the concept to capture the inherent dynamics between market structures and the surrounding environment, both in terms of the social interactions across business actors and also in terms of political, regulatory and institutional mechanisms (Krippner & Alvarez, 2007). Polanyi (1944) first introduced the concept of embeddedness to demonstrate that economic exchanges do not occur in isolation as the principles of market self-regulation prevailed at that time, but instead are entangled in economic and non-economic institutional settings, which in turn are entangled in the market relations. Later researchers changed the direction of the interpretation and suggested that economic action is effectively embedded into broader institutional and social frameworks. The turning point in the embeddedness literature was Granovetter’s (1985) analysis, which shifted the analytical focus of transactions away from general market economies towards more specific scales of actors and relational networks defined by interpersonal relationships (Uzzi, 1997). In essence, the concept of embeddedness has broadly captured the integration of the economic action into the broader social and institutional environment, yet up to this point its applications have been flexible and spanned across multiple levels of analysis depending on the purpose of the study. Theoretical frameworks have ranged from social, cultural and institutional embeddedness (Granovetter, 1985; DiMaggio & Zukin, 1990), to geographic, spatial and also temporal forms of embeddedness (Halinen & Tornroos, 1998; Henderson et al., 2002), and multiple other variations exist along the embeddedness spectrum, depending on the academic sub-fields in which the concept has proliferated (Krippner & Alvarez, 2007). Arguments about ‘network embeddedness’ originally captured only inter-firm relationships with partners involved in the business processes, although some authors extended a firm’s networks to its non-business partners and other institutional representatives such as governmental and non-governmental organisations as well as to broader themes of space and geography (Johannisson & Ramirez-Pasillas, 2002).
Embeddedness is therefore a multifaceted concept that captures the dynamics between various relational and institutional factors. At the same time, however, this multifaceted concept is also used in different fields in different ways, and despite the plethora of theoretical developments, little overall consensus currently exists as to its exact conceptualisation. Embeddedness still remains a somewhat fuzzy concept (Oinas, 1997; Markusen, 1999), with different meanings in different contexts, and capturing its complexity within a single approach is rather challenging.
Yet, understanding these different conceptualisations and understandings of embeddedness is important because more recently scholars have also adopted, adapted and applied the concept to spatial issues. Embeddedness is one of the key concepts which has helped to fuse together many strands of the International Business and economy geography literatures. In particular, scholars have used embeddedness as a lens through which they can better observe the locational strategies of multinational firms.
For our purposes, in the context of Economic Geography the phenomena of internationalisation and the emergence of the multinational firm, defined as a company which ‘engages in foreign direct investment . . . and owns or controls value-adding activities in more than one country’ (Dunning, 1993, p. 3), has turned the idea of ‘embeddedness’ into a largely spatial concept (Hess, 2004, p. 165). For instance, Economic Geography scholars have used the notion of embeddedness to investigate how foreign direct investment affects local development through additional employment and technological spillovers (Phelps et al., 2003), while in the business literature the focus has been on the multinational relocation of different corporate activities in different national or regional contexts (Heidenreich, 2012). In Economic Geography more generally, the idea of embeddedness has tended to be used in the sense of the depth, variety, strength and longevity of the linkages between a firm or establishment and its local context, and these ideas have also been reflected in the regional policy literature (McCann & Ortega-Argilés, 2015). As such, in terms of conceptions of space, the central idea behind the concept of embeddedness, at least as it is articulated within the setting of geography, relates to the nature and scale of the different forms of ties that position and bind the firm or establishment to its local and regional context.
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In the case of the International Business literature focusing on multinational investments, the emphasis has been on the embeddedness of the foreign affiliates within business networks (Cantwell & Iammarino, 2003). For many years, the analysis of multinational firms and their foreign direct investments tended to be examined via the lens of the vertical or horizontal integration of activities (Caves, 1982) within the overall eclectic schema of Dunning’s (1979) OLI paradigm of Ownership, Location and Internalisation (Beugelsdijk, McCann & Mudambi, 2010). However, the logic of these analytical approaches was inherently top-down in nature, reflecting the largely top-down architecture of the multinational corporate structures of the first half of the twentieth century, and failed to reflect many of the subsequently emerging features of multinationals. In particular, as multinationals evolved in the post-war era, increasingly they created value by establishing technological relationships with local business partners and qualified employees that helped to facilitate two-way organisational learning and the creation of new knowledge (Cantwell & Iammarino 2003; Cantwell & Mudambi, 2005; Iammarino & McCann, 2013) in which affiliates and subsidiaries increasingly played a critical learning and knowledge-generating role. And here again, there are differences of interpretation and understanding. For instance, Forsgren, Holm and Johanson (2005) attributed the concept of embeddedness only to those multinationals whose subsidiaries operate in dense and strong networks of local business relationships. Similarly, for Andersson, Forsgren and Holm (2002), firms’ embeddedness refers to the co-evolution of technical products and production processes across business partners, as well as to the relationships with suppliers and customers.
In order to better capture these themes in an explicitly geographic or regional setting Halinen and Tornroos (1998) used the term ‘spatial embeddedness’ to emphasise the importance of location and geography in business networks and highlighted the dissimilarities of the various types of networks in which actors are engaged based on different spatial levels – be they international, national, regional or local territories. Generally, these ideas are also captured by the notion of ‘territorial embeddedness’, which ‘considers the extent to which an actor is anchored in particular territories and places’ (Hess, 2004, p. 178) and is largely moderated by the economic systems and social dynamics prevailing in those places. Specifically, it relates to local inter-firm relations, designated in particular by linkages with local suppliers (Henderson et al., 2002) and has been particularly relevant in Economic Geography and regional development studies (Turok, 1993; McCann, 1997; Phelps & Fuller, 2000; Phelps et al., 2003). Broadly, embeddedness is generally assumed to be beneficial both for the host regions, as local firms access new technological knowledge, create additional employment and promote economic growth, and also for the investors, as multinationals gain access to knowledge of local market conditions as well as to new and complementary resources that would enhance their overall performance (Henderson et al., 2002). In this sense, network embeddedness can be regarded as being a key factor in regional economic growth and in capturing global opportunities (Henderson et al., 2002). At the same time, however, the arguments underpinning the concept of ‘strategic fit’ also suggest that the extent to which organisations can exploit these benefits depends on their internal organisational trajectory or what Halinen and Tornroos defined as ‘temporal embeddedness’:
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[c]ompanies are bound to past, present and future modes of time . . . they have their own histories during which they have evolved; they are also in the midst of their own present, and have objectives and expectations about the future which affect their present decisions and actions.
(1998, p. 195)
Further refinements or extensions to the idea of multinational embeddedness in geography also concern questions of the nature, quality and roles of the local institutional settings and networks (Beckert, 2003, 2007; Heidenreich 2012). Institutions encompass both formal frameworks, such as the regulatory, political and economic systems that establish market principles and dictate the interaction between economic actors and non-market societal institutions (DiMaggio & Zukin, 1990; Liu, 2000), as well as the informal mechanisms motivated and mediated by cognition and culture (DiMaggio & Zukin, 1990; Nooteboom, 2000). Meanwhile, Andersson, Forsgren and Holm (2002), Holm, Malmberg and Solvell (2003), and Forsgren, Holm and Johanson (2005) perceived network embeddedness as a strategic resource that increases a firm’s expected performance via improving the scale, variety, intensity and speed of knowledge flows into and out of the firm. Similar views building upon the network theory paradigm are also employed by authors such as Ghoshal and Bartlett (1990), Hakansson and Snehota (1995), Dyer and Singh (1998), Ahuja (2000), Gulati, Nohria and Zaheer (2000) and Gilsing et al. (2008), and, as such, the related constructs of ‘spatial embeddedness’, ‘societal embeddedness’ (Hess, 2004) and ‘network embeddedness’ all heavily overlap. This is important, because the Economic Geography of the multinational affiliate represents one of the most sharply delineated contexts in which these overlapping dimensions critically determine the economic performance of the establishment (Cantwell & Iammarino, 2003; Iammarino & McCann, 2013). In general, the different notions of embeddedness come together when we discuss the nature, role and behaviour of the multinational subsidiary in an explicitly geographical or regional setting, and these settings also provide possibilities for extending empirical research on the topic.
Empirical research on embeddedness and strategic fit
Intuitively, embeddedness and strategic fit in their various forms have been assumed to affect organisational performance, although the empirical evidence on these issues is rather scarce. In part this may be due to measurement difficulties, due to either a lack of clear definitions or a ‘confusing variety of meanings’ (Hess, 2004, p. 176) that has prevented researchers from operationalising these concepts on a standard generally agreed basis amenable to empirical testing. Nevertheless, some empirical evidence is available, and Uzzi (1997) was the first to empirically study and operationalise embeddedness, restricting his research to the relational dimension of the concept. Uzzi (1997) identified three main aspects that underlined the quality of structural embeddedness, namely: trust, fine-grained information transfer and joint problem-solving arrangements that in conjunction promoted economies of time, integrative agreements, allocative efficiency and complex adaptation. These dimensions closely reflect the modern understandings of the key knowledge-based roles played by multinational subsidiaries and affiliates in helping to drive the overall performance of multinational firms (Cantwell & Iammarino, 2003; Iammarino & McCann, 2013). They also link closely to other empirical work in this arena such as that by Andersson, Forsgren and Holm (2002), who gathered survey-based data to operationalise the embeddedness of subsidiaries by their relationships with suppliers, customers and competitors, and explicitly excluded larger institutional structures and non-business partners from their analysis. Taking the multinational and multi-plant subsidiary as the unit of analysis, Andersson, Forsgren and Holm (2002) demonstrated that the higher the degree to which a subsidiary is engaged in external business networks, the higher its own market performance and the higher its contribution to the overall development of the multinational’s technological competencies (Forsgren, Holm & Johanson, 2005; Nell & Ambos, 2013). In a comparable manner, Johannisson and Ramirez-Passilas (2002) used a survey-based methodology to operationalise embeddedness in terms of an actor’s relationships both with related business partners and with more general non-economic, institutional and political constituents and proved its ‘leverage for business creation’. The authors particularly stressed the benefits of institutional elements as ‘without institutions the embeddedness of the business community is incomplete since a considerable number of business persons remain disconnected, i.e. they are not directly related’ (Johannisson & Ramirez-Passilas, 2002, p. 304). Other researchers have also considered the impact of cultural or institutional factors on business strategy – particularly the choice of entry modes – and more rarely on organisational performance (Halkos & Tzeremes, 2008).
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One last stream of empirical studies which uses case study and qualitative research approaches has shifted the focus of analysis away from the corporate towards the mechanisms of regional development through ‘territorial embeddedness’. Hardy, Currie and Ye (2005) employed a case-study approach in their evaluation of embeddedness, yet unlike previous studies that concentrated specifically on firm network embeddedness, the authors shifted the emphasis onto cultural and political embeddedness and evaluated how dissimilar political and cultural contexts convey different choices of strategic fit. Meanwhile Phelps et al. (2003) used five indicators to operationalise embeddedness: (1) corporate status and functions; (2) research, development and design activity; (3) supply chain and local purchases; (4) skills and training demands; and (5) repeated investment. By employing a case-study survey-based methodology, they found little evidence of foreign firms’ embeddedness. In a comparable manner, White (2004) applied a case-study methodology to investigate the local embeddedness of the foreign software sector in Ireland and its impact on local development. This research suggested that embeddedness is moderated by the ‘conditionalities of space’ (White, 2004), which reflect the local conditions not directly related to inter-firm or institutional relations, such as growing spatial concentration of employment in an industry. Many other studies have also indirectly built upon the rationale of territorial embeddedness and evaluated whether foreign firms have an impact on regional development by establishing links with local suppliers and customers, but their findings have tended to be rather inconsistent (McCann, 1997; Javorcik, 2004; Crespo & Fontoura, 2007; Barrios, Gorg & Strobl, 2011; Giroud, Jindra & Marek, 2012). In part, this may be due to the fact that the geographical and regional contexts differ so much, but it may also be due to the fact that the concept itself is still somewhat broadly defined.
Yet, while each of these literatures has so far emphasised the positive aspect of embeddedness and strategic fit in the regional context, there is also a somewhat smaller literature that highlights the potentially negative aspects of these phenomena. Indeed, Uzzi (1997) also acknowledged the risks of ‘over-embeddedness’, underlying the potentially adverse ‘lock-in’ (David, 1985) effects and hysteresis which can frustrate performance ‘if the social aspects of exchange supersede the economic imperatives’ (Uzzi, 1997, p. 59). The dangers of adverse lock-in are well-known in the literatures on technology and science policy as well as in political science and economics, and the enhancement of local embeddedness is therefore not without its risks. Subsequent studies also highlighted the costs of embeddedness which might arise from over-reliance on a limited number of business partners, persistence of redundant ties and continuous exchange of homogenous information (Gargiulo & Benassi, 2000; Rowley, Behrens & Krackhardt, 2000; Masciarelli, Laursen & Prencipe, 2009). However, arguments from agency theory suggest that embeddedness reflects a dynamic (Hess, 2004; Heidenreich, 2012) two-way process because firms can adjust to and influence the institutional environment in which they operate: ‘firms have an important agency role . . . they must make sense of, manipulate, negotiate, and partially construct their institutional environments’ (Kostova, Roth & Dacin, 2008 p. 1001). The extent to which the embedded agency of organisations allows them to strategically involve themselves in local business networks and to effectively adapt to the institutional settings of their host countries is an important determinant in their success. This view puts into perspective embeddedness as a strategic alternative that multinationals can exploit, rather than a taken-for-granted situation. Multinationals opt for embedded strategies in their global undertakings depending on the degree of strategic fit between the firms’ needs and business purposes and their regional conditions (Teece, 2006; Mattes, 2010).
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Thus, insights from the agency theory underlie the potential of embeddedness as a contingent factor in explaining organisational performance, which also permits the overcoming of problems of lock-in. In this respect, embeddedness and strategic fit underlie the importance of multinationals to gain and retain legitimacy (Suchman, 1995) in the markets in which they are operating. When firms enter new foreign markets, they have to overcome the ‘liability of foreignness’ that stems from unfamiliarity with the local environment and comprises informational disadvantage, higher transactional uncertainty and lack of connections with local agents that lead to higher managerial costs and decreased subsidiary performance (Zaheer, 1995; Zaheer & Mosakowski, 1997). Foreign affiliates of multinationals need to adjust to a complex set of rules and values that dictate local behavioural norms and business routines (Johanson & Vahlne, 1977; Kostova & Roth, 2002) in order to embed them in the new socio-institutional context and minimise the costs born out of the liability of foreignness. If firms fail to adapt their organisational structures to be consistent with the isomorphic pressures from the local environment, they cannot earn the operational legitimacy necessary to integrate and succeed in the new context (Meyer & Rowan, 1977). Taken together, the basic expectation of these various arguments is therefore that the higher levels of embeddedness and the better the strategic fit of the multinational subsidiary in the host region and host country, generally leads to a higher level of performance of the multinational subsidiary, and therefore higher overall corporate performance.
There remains, however, one further key notion linking strategic fit to embeddedness, and this is the notion of distance. One might expect that, in general, a greater geographical distance might make it more difficult to achieve a good strategic fit between a multinational corporation’s goals and the performance of its subsidiaries, primarily because distance may make management coordination processes more challenging. Yet, when it comes to international investment activities, geographical distance is only one relevant notion of distance. The performance of multinational affiliate investments also depends on other notions or dimensions of distance which mediate, enhance or attenuate the effects of geographical distance. These dimensions of distance are institutional distance, relational distance, and cultural or cognitive distance, and individually or together they can heavily shape the relationships between geographical distance, strategic fit and embeddedness.
Multinational investment and the dimensions of distance
Countries and regions vary enormously in terms of their levels of economic development and the nature and quality of their institutional systems. Moreover, as well as enormous differences between countries and regions in the global south and the global north, these differences also exist even within integrated trade areas such as the European Union or NAFTA (Hoskisson et al., 2000; Meyer & Peng, 2005). Operating in unfamiliar institutional settings raises transaction costs, increases uncertainty and limits the ability of multinational affiliates from engaging in complex operations (Meyer, 2001), so institutional proximity (Kostova, 1999; Xu & Shenkar, 2002) between the parent country or parent region and the host country or region, tends to facilitate engagement with more complex activities, while greater differences tend to delay or limit such activities. In contrast, institutional distance tends to reinforce liabilities of foreignness and decrease performance (Gaur & Lu, 2007; Dow & Larimo, 2009). In particular, because the foreign subsidiary is subject to an ‘institutional dualism’ (Kostova & Roth, 2002), it has to accommodate internal pressures imposed by the parent firm, as well as external pressures from the local environment. This implies that subsidiaries must implement business practices that often differ from those of the local organisations, and the mismatch in organisational behaviour becomes more evident as large institutional distance effectively inhibits the foreign subsidiaries from understanding and applying the formal institutional guidelines of the host country (Kostova & Zaheer, 1999). As a consequence, institutional distance can constrain the interaction of the subsidiaries with the local business partners and affects their pursuit for legitimacy in the host environment. In this respect, organisations must develop managerial and commercial practices that suit the variations in institutions, and the higher the variation, the more difficult the adaptation (Luo, 2001; Meyer, 2001; Xu & Shenkar, 2002). Institutional proximity tends to enhance both institutional embeddedness and local strategic fit in the foreign environment, and thereby increases the chances that subsidiaries align their business operations to the foreign institutional environment and, ultimately, implement the most efficient profit-maximisation strategies. In particular, multinational subsidiaries that are highly embedded in their local environments can more easily exploit localisation advantages (Jensen & Pedersen, 2011; Rugman, Verbeke & Yuan, 2011) and enhance their task-specific knowledge by accessing unique resources (Figueiredo, 2011) by more effectively building on local knowledge, social capital and networks (Granovetter, 1985; Uzzi, 1997; Dyer & Singh, 1998; Lin & Wan, 2008).
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These social and network dimensions are critical because for multinational subsidiaries and foreign affiliates trust is at the core of social interaction and network embeddedness with local actors. Operating in high trust societies is of particular benefit in lowering uncertainty of doing business in unknown environments, as trust enhances the formation of social links which can carry valuable information about market characteristics, production technologies and potential trade partners. Trust also facilitates and encourages risk taking, which is essential in the context of business transactions between new foreign subsidiaries and local partners (Nahapiet & Ghoshal, 1998). Trust is indispensable for ensuring cooperation among strangers and individuals that encounter each other irregularly (LaPorta et al., 1996). In high-trust societies people develop generalised expectations about the trustworthiness of other people and engage in trust-based social interactions regardless of the level of familiarity between actors (Rotter, 1971). This is a vital benefit for foreign entrants in new markets, as they are lacking market legitimacy, and it provides the primary means to gain recognition from local actors and pursue business goals with unfamiliar customers and suppliers.
Cooperation and coordination with multinational subsidiaries and host regions in culturally distant countries are much more difficult as their perception and understanding of how organisational processes should unfold is different (Kostova & Roth, 2002). Thus, cultural-cognitive distance increases operational difficulties as firms often fail to understand the norms and values that afford social exchange and, therefore, their ability to operate effectively in the host market decreases (Hennart & Larimo, 1998). In addition, managing interaction across distinct cultures implies higher transaction costs in terms of training, monitoring and control, so it is expected that performance will decrease in culturally distant environments. In general, institutional environments with higher levels of trust and closer cultural and relational proximity between the parent and host regions make information exchanges between local actors easier, facilitate the establishment of denser local business networks, ensure an easier adaptation to the host regional environments and encourage more cooperative behaviour between local firms. This is because the critical cultural and cognitive knowledge for subsidiary and management and operations is often tacit and difficult to comprehend, and parent headquarter functions generally exert an overwhelming pressure on the ability of foreign subsidiaries to gain local legitimacy (Oliver, 1991; Boyacigiller, Goodman & Philips, 2004). Therefore, cultural distance, expressed in terms of cultural dissimilarities between countries (Kogut & Singh, 1988), can be a critical factor in moderating subsidiary embeddedness and implementing profit-maximisation strategies in the host environment. When subsidiaries are established in foreign countries, they need to be calibrated to different national cultures, which creates complexities both at a firm and at an individual level (Barkema, Bell & Pennings, 1996).
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As mentioned earlier, for multinational investment patterns, each of these institutional, relational and cognitive dimensions of distance heavily moderate the shape of the effects of pure geographic distance on innovation performance (Boschma, 2007) and the levels of embeddedness and strategic fit of the multinational’s affiliates and subsidiaries (Deadorff, 1998; Ghemawat, 2001; Ragozzino, 2009). Intuitively, a larger geographic distance inevitably assumes increasing costs in transportation, communication and coordination due to the more complex principal-agent problems inherent in managing across larger geographical distances with reduced face-to-face interactions between subsidiary managers and higher level corporate decision-makers (Zaheer, 1995; Dow, 2000; Hinds & Bailey, 2003). These distance-related difficulties are especially challenging when multinational firms are entering a new market, as they incur high knowledge-related transaction costs when first setting up new establishments and developing new business networks (Zaheer, 1995). However, accumulation of experience can serve as an accelerator for the foreign firm to acquire knowledge and understand the dynamics in the new markets they are entering, leading to better performance and higher success (Johanson & Vahlne, 1977; Delios & Beamish, 2001). Over time, and with experience, firms advance along the learning curve and become more comfortable with the new context, therefore reducing the effects of distance (Shenkar, 2001). In addition, the more foreign firms operate in the host environment, the more they start interacting and building ties with local external parties such as customers, suppliers and regulators so that they gradually become accepted as legitimate actors (Zaheer & Mosakowski, 1997; Li, Poppo & Zhou, 2010). As foreign firms accumulate greater local knowledge and gain legitimacy, the uncertainty induced by institutional and cultural distances reduces, giving them the opportunity to find and implement the most efficient profit-maximising strategies (Salomon and Wu, 2012). The more experienced a firm becomes in a foreign market, the more it learns to do business there and higher profitability is expected (Johanson & Vahlne, 1977). Importantly, geographical proximity has traditionally also been associated with longstanding FDI experience, and today, the role of proximity in facilitating FDI appears to be greater than ever, in spite of the advent of new information and communications technologies (Iammarino & McCann, 2013). A wide array of evidence suggests that over recent decades, geographic proximity has actually become even more associated with relational, institutional and cognitive proximity than in earlier periods, and therefore taken together, each of these dimensions of distance tends to favour strong geographic regionalisation patterns of foreign direct investment (Rugman, 2000, 2005; Rugman & Verbeke, 2004, 2005).
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Conclusion
The Economic Geography of the multinational is the context in which spatial embeddedness, societal embeddedness and network embeddedness all interact and overlap in a critical manner. In general, greater embeddedness and strategic fit generate improved corporate performance, such that the goodness of fit associated with corporate investment decisions, and therefore the success of multinational strategies, are heavily shaped by these different embeddedness dimensions. However, there are also conditions under which high levels of local embeddedness can lead to challenges. Therefore, in order to identify the strengths and weaknesses as well as the opportunities and challenges associated with embeddedness and strategic fit, it is important to develop a detailed understanding of the different dimensions of distance as they impact on multinationals. Obviously geographical distance heavily influences the performance of corporate affiliates and subsidiaries, because geographical distance impacts on a firm’s ability to align the goals and behaviour of the affiliate with that of the overall corporation. On the other hand, greater geographical distance is not necessarily indicative of reduced performance. This is because other notions of distance also shape the relationships between geographical distance and subsidiary performance by influencing the links between strategic fit and embeddedness. These additional notions of distance include institutional distance, cultural distance, cognitive distance and relational distance. These additional notions of distance also tend to favour geographical proximity, but they also imply some major discontinuities in these patterns. In general, the interactions between strategic fit, embeddedness and the different notions of distance tend to favour international proximity, but this is not always the case. Greater global regionalisation rather than globalisation per se, appears to be the key to modern corporate success, but these patterns are also seen to differ in different contexts, depending on the various dimensions of distance. If greater protectionism emerges in the global economy in the coming years, it remains to be seen how the various relationships described in this chapter will be affected.
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