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6

THE DYNAMICS OF MULTINATIONAL ENTERPRISE SUBSIDIARY ROLES IN AN ERA OF REGIONALIZATION

Alain Verbeke and Wenlong Yuan

Introduction

Multinational enterprise (MNE) subsidiaries can take on various responsibilities and roles, due to corporate role assignment, subsidiary choice, and external environmental changes (Birkinshaw et al., 1998; Birkinshaw, 2000; Rugman & Verbeke, 2001). Internal changes or external environmental shifts may drive these roles to evolve over time. The literature on subsidiary dynamics has focused most of its attention on the impact of internal, organizational changes, while largely ignoring the influence of supranational, environmental changes (Rugman, Verbeke & Yuan, 2011; Verbeke & Yuan, 2013). Even when environmental characteristics are considered, researchers tend to limit themselves to parameters such as local competition at the level of single country (Birkinshaw et al., 1998). Meyer’s co-authored study in 2009 called for the analysis of direct linkages between macro-level institutional environments and firm-level strategies; however, broader environmental factors, especially regional integration schemes, have been underemphasized and occupy only a minor position in most mainstream theoretical frameworks (Rugman, 2000, 2005).

Recently, a limited number of MNEs have implemented regional integration schemes to integrate their activities along regional lines, and to transform their locational strategic focus by adopting regional strategies (Hoenen, Nell & Ambos, 2014; Verbeke & Kano, 2016). This has resulted in increased internal competition among subsidiaries and business units, especially in cases whereby different subsidiaries command similar resource bundles. However, no general framework has yet been put forward to examine the effects of regional integration schemes, such as the EU and NAFTA, on subsidiary roles, in spite of regional agreements becoming increasingly instrumental to ‘deep integration’ (Buckley et al., 2001).

In this chapter, we analyze the impact of regional integration schemes on subsidiary role dynamics. We also present eight patterns of MNE subsidiary role dynamics, as a combination of changes in the subsidiary’s scope of product offerings/value chain activities and geographic scope. Finally, we adopt a subsidiary perspective on region-based, organizational change by investigating subsidiaries’ discretion, given their level of unused productive resources and management competences.

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Regional integration as an economic determinant of subsidiary roles

The missing linkage between subsidiary roles and regional integration

Regional integration influences activities of MNEs both in terms of new investment into the region and the reorganization of existing activities in the region (Rugman & Verbeke, 2004). For example, Hogenbirk and van Kranenburg (2006) found that in the Dutch electronics and electrical appliances industry, regionally product-mandated hubs account for 25% of foreign-owned subsidiaries and export platforms account for another 24% (as regards to the remainder, 8% are miniature replicas and 43% are single activity satellites). The regional product hubs and export platforms were generally established after the implementation of the Single European Act, thus suggesting that regionalization leads to new types of subsidiary roles, with some subsidiaries taking on broader responsibilities at the European level.

Regarding existing activities, researchers have tended to focus on ‘rationalization’ or ‘reorganization’ as the major outcome of regionalization in MNEs (Rugman, Verbeke & Yuan, 2011). For example, the widely held prediction regarding free trade has been that lowering long-established tariffs would lead to an exodus of foreign investment and manufacturing jobs in some smaller countries in the region, e.g., Canada in the NAFTA area (Luxmore, Rugman & Verbeke, 1991). Since smaller miniature replica plants are less efficient than larger factories with greater economies of scale and lower labor costs per unit, MNEs would transfer production to lower-cost plants, in this case located in the United States. More generally, MNEs would reassess and consolidate their production network within the region as a consequence of trade creation effects, seeking to exploit the comparative advantages of countries or areas within the trading bloc and to maximize production efficiencies. This kind of reasoning suggests that MNEs would rationalize their production capabilities in the region with local plants manufacturing or assembling final products made primarily from core components produced in core locations for the entire region (Cohen & Zysman, 1987). Alternatively, the primary purpose of foreign-owned subsidiaries would be to market and sell products imported from abroad throughout the region (McFetridge, 1995).

The extant literature on the impact of regional integration on trade, FDI, and subsidiary roles misses the heterogeneous impact of regional integration on both markets and MNEs by assuming a homogeneous rationalization strategy adopted by MNEs as the sole response to regional integration. Many of the extant studies on MNE responses to regional integration have indeed assumed that MNEs adopt similar strategies, while missing the varied impacts of regional integration on perceived national market importance, on the evolution of subsidiary competences, and more generally on multinational managers’ cognitive understanding of this macro-level phenomenon (Verbeke & Kano, 2016).

But in reality, strategic responses will be firm-specific. Krajewski noted in a 1992 Conference Board of Canada Report, that the substance of rationalization efforts, and related changes in subsidiary roles, were firm-specific. In a similar vein, Buckley and his co-authors argued in 2003 that “even if protectionism were the initial impetus to FDI, MNEs accrue intangible benefits from operating in host markets over time, which confer advantages on foreign-owned firms, fueling future competitiveness, and expansion of their operations in the host country” (Buckley et al., 2003, p. 855). The reality of persisting national non-tariff barriers together with the geographic size of niched submarkets within the overall NAFTA market, is likely to prevent most firms from effectively adopting a single regional strategy based on scale economies and exclusive of national considerations. The establishment of a regional free trade and investment area can lead MNEs to move from a multidomestic (or traditional “multinational”) strategy towards a regional strategy, but this is likely to involve multidimensional reorganizing and rationalizing to exploit various location advantages through more specialized factories with larger production runs and less product diversification.

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The impact of regional integration on subsidiary roles

We have developed a general framework (see Figure 6.1) to analyze the impact of regional integration on both the strategic importance of host country markets and subsidiary competences as compared to sister subsidiaries by relying on Bartlett and Ghoshal’s (1986) typology of subsidiary roles. Among the many subsidiary role classifications published since the 1980s (White & Poynter, 1984; Bartlett & Ghoshal, 1986; Jarillo & Martinez, 1990; Gupta & Govindarajan, 1991; Birkinshaw & Morrison, 1995; Taggart, 1997a, 1997b, 1998; Homburg, Krohmer & Workman, 1999; Delany, 2000; Benito, Grogaard & Narula, 2003; Hogenbirk & van Kranenburg, 2006), the most influential classification has undoubtedly been the one developed by Bartlett and Ghoshal (1986). The Bartlett and Ghoshal (1986) typology is based on two dimensions, strategic importance of the local environment (location advantages) and the competences (firm-specific advantages or FSAs) held by the local organization. The strategic importance of the local environment depends on its significance to the MNE’s overall strategy. Markets that are either large, particularly sophisticated, or technologically advanced, are the most likely to have high strategic importance to an MNE. As regards FSAs at the local level, these subsidiary competences can be in “technology, production, marketing, or any other area” (Bartlett & Ghoshal, 1986, p. 90).

We argue that the impact of regional integration on the strategic importance of host country markets depends on the extent of distance reduction engendered, and that the impact of regional integration on subsidiary competences is contingent upon the characteristics of these competences. Moreover, MNE managers’ cognitive understanding of the two types of impact moderates the dynamics of subsidiary roles.

First, on the market side, as a result of regional integration, the regionally unified market becomes a new geographic level relevant to multinational strategic management, in addition to the global and national levels. In 2001, Ghemawat analyzed how distance can affect business and unbundled the concept into four dimensions, including cultural, geographic, economic, and administrative distance. Cultural distance represents differences in language, social norms, and religion; geographic distance refers to the physical distance and lack of communication links between countries; economic distance includes differences in consumer income, and in costs and quality of natural resources, human resources, and infrastructure; and administrative distance includes not only differences in public policy, but also differences (or lack thereof) in preferential trade arrangements and political associations. The greater the overall distance between a potential host country and the home country, the less attractive that host country becomes.

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Deep integration schemes, such as the EU and NAFTA, represent deliberate efforts to reduce one of these distance components, namely the administrative distance within the region, given that the other types of distance are not simply changeable through public policy. For example, in the case of NAFTA, tariff and non-tariff barriers have largely been removed to promote the free flow of goods, services, and capital; national treatment has been applied to foreign investors; and national tax policies have also been harmonized through bilateral tax treaties (Eden, 1996). For MNEs, the NAFTA region, as an integrated investment regime, allows them to pursue more integrated strategies through rationalized production plants and marketing strategies, see Rugman and Verbeke (2005). In the EU case, integration efforts have gone even further, as expressed in the single market and the widely applied principle of mutual recognition whereby rules of origin prevail, the creation of a single currency, and the harmonizing of fiscal and monetary policies (Malhotra, Agarwal & Baalbaki, 1998).

Although regional integration intends to overcome structural market distortions/imperfections (Dunning & Robson, 1987), it does not have an equal impact on all upstream/downstream markets. For example, Cantwell (1987) found that the British membership of the EC affected manufacturing and R&D activities in the pharmaceuticals sectors differently, with MNEs’ European R&D programs becoming much more integrated than production. In case of a low impact, either regional market unification does not occur, or regional market unification already occurred before regional integration schemes. On the one hand, intrinsic differences among markets in the region may persist, even with regional integration, such as the heterogeneity in European food cultures (Askegaard & Madsen, 1998). On the other, the 1965 auto pact and tariff reductions under GATT created significant integration of auto trade and production in North America by the 1980s (UNCTAD, 1992). Therefore, the impact of NAFTA on comparative advantages for auto firms in the region was rather limited.

A high impact, however, reveals either the increasing overlap between the markets served by the subsidiaries or the location advantages recalibrated as a result of regional integration. On the downstream market side, removal of cross-border barriers may indicate the convergence of consumer behavior within the region and the expanded, similar downstream markets which were protected by barriers and which now morph into an integrated regional market. At the upstream market side, regional integration may also amplify location advantages, such as cheap labor, which previously was more difficult to access because of trade/FDI barriers. Put in other words, location advantages in the realm of factor endowments may become more accessible.

The above analysis suggests that there is no single, ubiquitous impact of regional integration on subsidiary dynamics. The impact depends on the comparison of the market conditions before and after regional integration, and on whether or not substantive changes in the market occur as a result of regional integration. Therefore, we propose the following:

Proposition 1. A stronger distance reduction because of regional integration, will amplify the impact of regional integration on subsidiary roles.

Second, regional integration also initiates changes in MNEs’ strategies (Verbeke, Kano & Yuan, 2016). Many MNE strategies, expressed publicly by their senior executives or in their firms’ official documentation, appear to include a regional factor. For example, Fujio Cho, Vice Chairman of Toyota, stated: “We intend to continue moving forward with globalization . . . by further enhancing the localization and independence of our operations in each region” (Ghemawat, 2005, p. 100). Furthermore, Nestlé’s management often explicitly differentiates among global, regional, and local business components of corporate strategy and organization (Nestlé, 2006). The expanded regional market opens up new opportunities for MNEs to exploit new location advantages in the region (Hoenen, Nell & Ambos, 2014). Owing to the similarity of consumer needs, the expanded regional market allows MNEs to adopt an aggregation strategy so as to reap more scale and scope economies (Ghemawat, 2003), thereby exploiting the similarities across countries within the region. The expanded regional market also facilitates an arbitrage strategy (Ghemawat, 2003), namely to exploit different location advantages in the region, for example by concentrating labor-intensive activities in the cheaper labor economies within the region. The large economic differences between the United States and Mexico, together with the reduced administrative differences and the geographic proximity, have encouraged many U.S. firms to ‘nearshore’ production facilities to Mexico.

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The potential to exploit the integrated market through aggregation or arbitrage has to be matched with appropriate subsidiary competences in the region. What matters here is subsidiary competences’ similarity with those of other subsidiaries, the extent of subsidiary competences’ fungibility, and the extent to which subsidiary competences are location-bound.

Similar competences refer to those competences that allow the subsidiary to undertake the same functional activities or fulfill the same mandates as other subsidiaries. For example, if several subsidiaries in the region perform similar activities, such as manufacturing quasi-identical products, they may enter into competition with each other and regional integration will facilitate parent-driven changes in subsidiary mandates to improve efficiency. Subsidiary competences can also be fungible (Birkinshaw & Lingblad, 2005), in the sense that they could be used to exploit new business opportunities. The fungibility of subsidiary competences may increase the subsidiary’s ability to search for – and enter into – new markets, thereby allowing easy resource reallocation towards new business opportunities, when the corporate head office changes the subsidiary’s formal mandate. Finally, subsidiary competences can be location-bound. Even with the integrated regional market, some subsidiary activities still have to be performed locally. For example, sales activities for some consumer goods often require proximity to the customers, and therefore may leave less room for regional integration at the firm level. Thus, the impact of regional integration on such subsidiaries is likely to be very small.

Proposition 2. More similarity and fungibility of the subsidiary’s competences will increase the impact of regional integration schemes.

Proposition 3. More location-boundedness of the subsidiary’s competences will reduce the impact of regional integration schemes

An often forgotten factor when discussing the impact of regionalization on subsidiary roles is the cognition of MNE managers, especially at the head office. As we argued earlier in this chapter, regional integration only reduces administrative distance, and other types of distance are likely to remain, even with regional integration. Thus, MNE managers’ perceptions of the overall impact of regional integration may moderate the impact of market changes on subsidiary charter changes and dynamics.

For example, European appliances producers have exhibited a variety of behaviors to address regional integration (Stopford & Baden-Fuller, 1987). Italian managers believed that the European market was becoming more integrated and therefore increased efforts at UK market penetration, while most British producers believed that with non-tariff trade barriers and turbulence of demand, a lesser focus on exporting would better protect their market niches.

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Such perceptions of market changes also affected investments by Japanese manufacturing firms in Europe (Hood & Young, 1987, p. 199). Due to the relatively recent nature of these firms’ investments in Europe, they established operations with the prospect of serving the future integrated single European market. In this particular case, the Japanese MNEs applied a proactive strategy to address the expected impact of regional integration.

Therefore, we argue that cognition of MNE managers moderates the impact of regional integration on subsidiary role dynamics.

Proposition 4. MNE managers’ cognition moderates the impact of regional integration on the dynamics of subsidiary roles.

Patterns of subsidiary role dynamics as responses to regional integration schemes

Eight patterns of subsidiary role dynamics

With the unbalanced impact of regional integration on the strategic importance of individual national markets and on the level of individual subsidiary competences, and the moderating effect of MNE executives’ cognition of this impact, MNEs respond to regional integration in many different ways. In this section, we develop a framework (see Figure 6.2) to investigate the various alternative rationalization strategies available to MNEs. Further, we present eight patterns of subsidiary dynamics brought by regional integration schemes and describe the resulting effects on subsidiary competences, in line with Rugman, Verbeke and Yuan (2011).

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We apply two observable parameters to describe the impact of regional integration on subsidiary dynamics: changes in the subsidiary’s scope of product offerings/value chain activities, and changes in the subsidiary’s geographic scope. These two visible parameters are related to subsidiary competences, which are more difficult to assess directly, but the two observable parameters do not necessarily match the ‘invisible’ subsidiary competences (Birkinshaw & Hood, 1998). Any change in the two observable parameters may reflect either actual subsidiary competences or the MNE headquarters’ intention to develop new subsidiary competences, without these having yet materialized (Phelps & Fuller, 2015).

For example, historically, tariffs led MNEs to design each national subsidiary as a replica of the parent firm, so as to serve separate foreign markets. As a result, subsidiaries from different countries often bear high levels of similarity in their product scope and value chain functions, though sometimes they may differ in terms of resulting subsidiary competences. Once regional integration occurs, similar subsidiary resource bundles, dispersed across different subsidiaries in the same region, often become redundant and reduce the potential to earn scale economies. A rationalization program could be implemented, with some subsidiaries being closed down and others given extended charters, as recognition of their competences. Another rationalization program could entail reorganizing subsidiaries in the region towards more specialized product offerings, thereby developing some subsidiary competences in the associated product markets. Therefore, changing the two observable parameters may reflect either a formal way to recognize subsidiary competences that have been developed already, or the strategic intent to develop such subsidiary competences in the future.

Pattern 1. The first pattern implies a subsidiary shutdown: the strong reduction of distance among markets in the region, combined with a high resource similarity, fungibility, and non-location-boundedness of competences among competing MNE units in the region, makes the subsidiary unnecessary. The possibility of subsidiary closure usually represents a major source of uneasiness for small open economies, when contemplating whether or not to join a regional economic integration scheme. For example, two U.S. headquarters’ respondents in the Blank and Haar’s (1998) survey on the impact of regional integration had closed their operations in Canada.

However, the rationale for shutdowns of such plants may range “from poor performance . . . to adverse governmental action and inability to fulfill the expected benefits of diversification moves, acquisitions, and cooperative ventures” (Benito & Welch, 1997, p. 21). Internal competition or simple rationalization considerations themselves, without the presence of other factors, often do not lead to withdrawal. Little evidence supports the assertion that MNEs are likely to shut down their operations in a country, solely based on a free trade and investment agreement.

Pattern 2. The second pattern indicates that regional integration has no impact on subsidiary roles, generally as the outcome of only a limited reduction of distance among the markets in the region and the location-bound characteristics of extant subsidiary competences. For example, the UK’s membership in the EC had a weak impact on MNE production networks in pharmaceuticals in the EC (Cantwell, 1987). In spite of the single EC market, various trade barriers, including government controls over prices and registration of new products, continued to divide the EC into distinct national markets. Therefore, regional integration did not really affect pharmaceutical production and MNEs were not incentivized to rationalize their regional production networks. Hood and Young (1987) also noted that the limited inter-plant product flows and subsidiaries’ perceived level of corporate integration did not offer much evidence of integration across borders, though the large group of miniature-replica subsidiaries would suggest country-centered or region-centered strategies.

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Pattern 3. Pattern 3 describes subsidiary specialization as the outcome of regional integration. For example, national plants, which manufactured similar products for the domestic market only, specialize in a narrower set of products or in distinct value-added activities for the regional market. Here, the plants typically need to augment extant competences to be successful in the regional market. In other words, expanded charters are granted before the full development of the relevant competences.

Subsidiary specialization cases have not been particularly well documented yet in the literature, but charter losses and gains at the product level provide some understanding of the processes at hand (Birkinshaw, 2000). One example is the investment in the London, Ontario, plant by 3M Canada that entailed a regional mandate for micro-encapsulation (Birkinshaw, 1995, pp. 295–260). This product line used to be manufactured in several plants. Although the London plant had not exhibited truly stronger competences than other, similar plants within the firm, the intent of the rationalization was to allocate the charter to a single subsidiary and subsequently to strengthen its competences in the relevant product domain.

Another example of this type of rationalization process is provided by Honeywell Home’s, North American regional strategy formation. Among the overlapping product lines manufactured by both Canadian and U.S. plants, the Zone Valves line was moved to Canada, whereas regional mandates for other products were moved to the United States. Thus, each production site specialized in a narrower range of products, which resulted in improved efficiency of all sites (Birkinshaw, 1995, pp. 92–93).

Pattern 4. In Pattern 4, the focal subsidiary’s extant product scope does not change, but its charter for the existing product lines is expanded to cover the entire regional market, with the expectation that the subsidiary will develop competences allowing it to be successful throughout this entire market. When MNEs apply Pattern 4, this reduces potential internal frictions related to internal competition, at least as compared to Pattern 3. At the same time, expanded mandates that cover the region can offer growth opportunities for all subsidiaries in the region.

For example, when the Asia/Oceania division of Nestlé sought growth through pursuing opportunities in the ASEAN (Association of Southeast Asian Nations) region, the non-dairy creamer operations of Nestlé in Thailand were allocated the charter to produce non-dairy creamer for the entire ASEAN region (Taucher & Toh, 2003). The Nestlé operation in Thailand not only needed to increase its production capacity, but also had to learn how to manufacture non-dairy creamer for other ASEAN countries with different preferences. In this case, the focal subsidiary was given the opportunity to expand its geographic scope, but had to develop new competences to meet this goal.

Pattern 5. Pattern 5 refers to the case of subsidiaries that are given an expanded regional geographic charter, covering extant product lines as was the case with Pattern 4, but with pre-existing competences to serve this regional market, largely as a result of the subsidiary’s historical trajectory.

For example, many of the Japanese manufacturing investments in Europe were made close to the establishment of the single market. Japanese manufacturers set up their European operations with the prospect of serving the future, integrated single European market (Hood & Young, 1987, p. 199). Regional integration simply meant the unfolding of the opportunity expected by these firms when making their initial investments. In this case, gains in scope of product offering and market domain at the subsidiary level were typically not associated with charter losses for other subsidiaries.

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Pattern 6. Pattern 6 reflects the focal subsidiary expanding both its product scope/value chain activities and its geographic scope. The focal subsidiary still serves the initial national market, but adds additional products for the regional market. Similar to Pattern 4, the subsidiary must develop new competences to match its expanded charter.

This was the case with the regional project of Nestlé in ASEAN. Nestlé selected a few regional products and established new plants to cater to the broader regional market without closing down existing plants except one (Taucher & Toh, 2003). For example, Nestlé decided to add a production facility for soya source powder in Singapore. Functioning as the only soya source powder plant in ASEAN for Nestlé, the Singapore subsidiary expanded both its product offering and geographic scope.

Pattern 7. Pattern 7 and Pattern 8 represent the importance of location specificity and the strength of location-bound FSAs held by subsidiaries respectively. With Pattern 7, subsidiaries are not affected directly by regional integration. Moreover, these subsidiaries can even seek further growth opportunities in the national markets where they are located. For example, foreign subsidiaries in the food industry in the UK that were highly committed to this market (Pearce & Papanastassiou, 1997) implies that these subsidiaries could further expand their product offering in the UK market.

Pattern 8. In contrast to Pattern 7, Pattern 8 represents a ‘pure loss’ for the focal subsidiary, in the sense that mandates are removed from it and reallocated to another unit. Pattern 8 is often the mirror image of Pattern 3: the responsibility for some regional products having been allocated to another unit, the focal subsidiary ends up with a reduced product scope in its own national market. Unique location-bound competences may allow the focal subsidiary to continue serving the local market for some product lines.

A final note about the patterns of subsidiary dynamics is that such changes can be either competitive or cooperative, and either incremental or disruptive. First, subsidiary dynamics can be competitive or cooperative (Phelps & Fuller, 2000; Houston et al., 2001; Birkinshaw & Lingblad, 2005; Luo, 2005; Cerrato, 2006; Fong et al., 2007). Competitive subsidiary dynamics approximate a market mechanism, with any gain for one subsidiary meaning a loss for another unit. In contrast, cooperation-based subsidiary dynamics reflect the strategic intent to strengthen some subsidiaries without reallocating charters held by other units. Second, subsidiary dynamics can be incremental or disruptive. Incremental subsidiary dynamics are the outcome of subsidiary initiatives, through which subsidiaries gradually assume more responsibilities. In contrast, disruptive subsidiary dynamics typically entail reallocating major responsibilities, such as major production lines or value chain functions, from one subsidiary to another.

Major regional integration programs directed by corporate headquarters are likely to be competitive and disruptive. For example, with the restructuring of 3M in Europe (Ackenhusen, Muzyka & Churchill, 1996a, 1996b), spare parts management was reassigned to a single depot for the whole of Europe, from the initial 17 depots, thus leading to the closure of several units. As another example, regional customers may be similar to such an extent that a regionally designed marketing strategy may be justified. Such strategy entails concentrating several marketing activities in a single, regional centre, thereby helping the MNE to earn scope economies, in the sense that similar, local marketing planning activities at different subsidiaries become redundant and are taken over by the new, regional marketing centre. In contrast, subsidiary dynamics can be cooperative and incremental, as was the case with Nestlé’s regionalization project in ASEAN (Taucher & Toh, 2003), whereby most national subsidiaries were not only allowed to retain their extant production lines, but were also selected as champions for producing specific new products for the entire region.

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As another example, cooperative and disruptive subsidiary dynamics can be the result of an ‘exchange of mandates’ among competing subsidiaries, rather than the removal of mandates from one subsidiary, and the reallocation thereof to another unit. Here, all the affected subsidiaries become more specialized so as to achieve a comparatively more optimal scale of operations in a static sense, and a more effective accumulation of experience and know-how in a dynamic sense. With this pattern, all subsidiaries can strengthen their competences as compared with their initial position – there are no losers. The rationalization process at Honeywell Home’s North American operations reflects precisely this phenomenon. Among the overlapping products by both the Canadian and U.S. plants, Zone Valves were moved to Canada, and the other products were moved to the United States. Thus, each production site concentrated on a narrower range of products, which resulted in improved efficiency of all sites (Birkinshaw, 1995, pp. 92–93).

Effects of regional integration on subsidiary competences

The above analysis of subsidiary dynamics has emphasized both scale economies and scope economies through which MNEs may attempt to improve their competitive position in an era of regional integration. However, the effect of regional integration on changes in subsidiary competences may be differentiated in terms of impacts on new competence creation and impacts on competence exploitation (Cantwell & Mudambi, 2005).

First, the MNE rationalization process may increase competence creation responsibility at the regional business unit level, as documented by the fact that 70% of respondents in a questionnaire survey administered with the headquarters of U.S.-based companies had adopted or considered adopting a North American focus in their corporate strategy and structure, as early as 1994 (Blank & Haar, 1998). Similar results for Europe were suggested by Bleackley and Williamson (1997), who surveyed 41 EU companies.

In these regionally organized companies such as 3M Europe (Ackenhusen et al., 1996a, 1996b), regional product line organizations (e.g., European business centers or North American business centers) are responsible for developing and implementing their own business plans. They also have extensive responsibilities in manufacturing, R&D, technical services, as well as profit and loss responsibilities. This organizational design thus allocates the competence creation, and often, entrepreneurial resources, to the regionally based subunits. Interestingly, the former national subsidiaries, if not functioning as regional business centers for specific product lines, will take a less important role in the search for – and pursuit of – new business opportunities, i.e., they will lose competence creation mandates.

Second, the efficiency focus, as a result of MNE rationalization at the regional level, will tend to increase national subsidiaries’ responsibility for competence exploitation, even if they have lost some of their competence creation responsibility (including the loss of subsidiary autonomy and organizational slack at the subsidiary level). Indeed, on the competence creation side, national subsidiaries without region-wide responsibilities are likely to become more horizontally or vertically coordinated through a regional center, and will find themselves at the losing end of bundling (e.g., concentration) of some resources for the regional market. This implies a reduction in autonomy, for example in terms of the subsidiary’s roles in product planning, as occurred in many Canadian operations after the implementation of NAFTA (Blank & Haar, 1998, pp. 50–51), and in international procurement as observed in many MNE subsidiaries in the EU (Tavares & Young, 2006). In addition, the increased operational efficiency is accompanied by a reduction of organizational slack at the subsidiary level, thereby constraining the pursuit of new business opportunities.

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Third, there may be stronger effects of regional integration on upstream subsidiary competences than on downstream competences. On the one hand, there may be substantial potential to integrate upstream activities on a regional level, through concentrating production activities and sourcing inputs for the region as a whole. On the other, the need for localization is likely to prevail for downstream activities, as suggested by Bleackley and Williamson (1997). A somewhat extreme example is the case of Petrofina (now part of TotalFinaElf), an oil and chemicals company (Bleackley & Williamson, 1997), which “centralized the management of all those activities that were not directly ‘seen’ by customers and decentralized those that are” (Bleackley & Williamson, 1997, p. 492). Therefore, regional integration may bring more changes to the subsidiary upstream competences than the downstream competences.

A Penrosean perspective of subsidiary-driven evolution

Foundations of Penrosean analysis

Given the eight observed patterns of subsidiary role dynamics, what are the underlying parameters explaining whether and how subsidiaries will be able to influence their own development trajectories, especially in terms of expanding their activity scope and the geographic reach thereof? Below, we first discuss the underlying determinants of subsidiary trajectories in generic terms and subsequently apply this thinking to the regional integration context.

Birkinshaw and his co-authors (Birkinshaw, 1997; Birkinshaw & Hood, 1998; Birkinshaw, Hood & Jonsson, 1998) provide useful insights on subsidiary evolution and thus the dynamics of subsidiary roles. They make a stylized distinction between two phases of growth, and among three drivers of development and five subsidiary role trajectories. First, the two major phases of growth taken into account are: establishing viability and building sustainability. During the first phase, induced strategic behavior prevails. The subsidiary is mainly concerned with fulfilling its basic mandate and achieving satisfactory performance, through such activities as securing an expected market share (at the customer-end) and reducing production costs to a pre-specified standard (at the back-end). In the second stage, the subsidiary may pursue a mix of induced and autonomous activities to ensure its long-term sustainability, thereby attempting to earn a world product mandate or product specialist charter inside the MNE.

Second, three drivers of subsidiary development are recognized: host country characteristics, parent company management, and subsidiary management (Birkinshaw & Hood, 1998). All three factors affect the level of resources in the subsidiary, its mandate, and the scope of its functional activities.

Third, five subsidiary role trajectories are proposed, namely: parent-driven investment, subsidiary-driven charter extension, parent-driven divestment, atrophy through subsidiary neglect, and subsidiary-driven charter reinforcement. Of particular interest here is subsidiary-driven charter extension, meaning that subsidiary management engages in entrepreneurial activities and responds autonomously to new opportunities in its environment.

Interestingly, and perhaps surprisingly, the above work on subsidiary evolution refers to Penrose (1959) by drawing an analogy between subsidiary evolution and the growth of an independent firm (Birkinshaw & Hood, 1998), but without an in-depth analysis of the implications of Penrose’s (1959) seminal work for the study of subsidiary evolution. Rather, the above work on subsidiary dynamics is grounded more in current International Business thinking, such as White and Poynter (1984), Bartlett and Ghoshal (1986), and Rugman and Verbeke (1992).

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However, Birkinshaw argues that “[subsidiary] evolution and growth can be modeled in a way that is analogous to Edith Penrose’s (1995) seminal treatise on the ‘theory of the growth of the firm’” (Birkinshaw, 2000, p. 11). Furthermore, he states that “the evolution of the subsidiary can be modeled in a way that parallels Penrose’s Theory of the Growth of the Firm (1959), and the dynamic capabilities perspective in general” (Birkinshaw, 2000, p. 96). Finally, Birkinshaw adds that “the subsidiary can be modeled as a semiautonomous entity whose development is analogous to that of an independent firm (cf. Penrose)” (Birkinshaw & Hood, 1998, p. 339).

In other places, Penrose is recognized for her association with the resource-based view, such as in the statement that “this literature can be traced back to Penrose’s (1959) Theory of the Growth of the Firm” (Birkinshaw, 2000, p. 83).

Given the rather vague and non-specific nature of the above statements, the question could be raised as to what insights we can really infer from Penrose (1959), so as to understand better subsidiary evolution, especially against the backdrop of regional integration as described in this chapter. In the following, we examine Penrose’s (1959) perspective on growth, with a focus on three elements: the ‘enterprise of management’ (entrepreneurial strength), the ‘competence of management’ (operational strength), and unused productive resources.

Assumptions in Penrosean analysis

Penrose carefully states that her theory explains the growth of successful firms only, as shown in the following statement:

The firms with which we shall be concerned are enterprising and possess competent management; our analysis of the processes, possibilities, and direction of growth proceeds on the assumption that these qualities are present in the firm. (Penrose, 1959, p. 32)

In other words, the proposed relationships among the parameters described in the book are valid only when the above qualities are present in the firm. To put it differently, the framework is not generalizable to all firms, and any extensions of Penrose’s theory should take this into account.

In this context, an important question needs to be raised as to the well-accepted linkage between slack and innovation (e.g., Bansal, 2003), or between what Penrose calls “unused productive resources” and innovation. Although the terms slack and unused productive resources are used interchangeably, there is actually a minor difference between them. At first sight, it would appear that Penrose suggests a causal relationship between slack and innovation, which may be inferred from statements, such as: “internal inducements to expansion arise largely from the existence of a pool of unused productive services, resources, and specialized knowledge” (Penrose, 1959, p. 66), and “so long as any resources are not used fully in current operations, there is an incentive for a firm to find a way of using them more fully” (Penrose, 1959, p. 67), and “Unused productive services are, for the enterprising firm, at the same time a challenge to innovate, an incentive to expand, and a source of competitive advantage” (Penrose, 1959, p. 85).

The last of the above references is used in Kor and Mahoney (2000) to support their argument that “unused productive services or resources can be a source of innovation” (Kor & Mahoney, 2000, p. 118). However, Penrose’s last statement above hints at the importance of the “enterprising” characteristic, i.e., an entrepreneurial strength, as a pre-condition for the deployment of unused productive services. This begs the question what would happen with these unused services in an “un-enterprising firm”. Penrose does not provide a clear answer to this question herself, but does emphasize that “failure to grow is often incorrectly attributed to demand conditions rather than to the limited nature of entrepreneurial resources” (Penrose, 1971, p. 38).

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Penrose appears to focus on the importance of unused productive resources versus entrepreneurial services at different places in the book (1959), but her discussion of entrepreneurial services has, so far, attracted little attention. However, Penrose always made sure that readers of her work would understand the importance of entrepreneurial strengths, concluding her case study of the Hercules Powder Company by stating that “the entrepreneurship of a firm will largely determine how imaginatively and how rapidly it exploits its potentialities” (Penrose, 1971, p. 63). Penrose thus suggests it is the joint effect on innovation of an entrepreneurial strength and unused productive resources, rather than solely the impact of unused productive resources, that should be assessed.

Similar interactions have been suggested in the literature between slack and other organizational characteristics, when studying how firms respond to environmental parameters (e.g., Cheng & Kesner, 1997; Bansal, 2003). More specifically, slack has been proposed as a moderator of the relationship between organizational values and the scale of the firm’s responses to new or important issues (Bansal, 2003). Cheng and Kesner (1997, p. 5) even suggest that:

Organizational slack does not have an inherent positive or negative effect on the extent of an organization’s response to changing environmental conditions . . . Rather, the exact nature of this effect depends on a firm’s resource allocation pattern, as influenced by its strategic orientation.

Following Penrose (1959) and the above research on the interactions between slack and other parameters, it appears appropriate to assess unused productive resources in terms of their moderating effect on the relationship between the firm that possesses an entrepreneurial strength, and growth, rather than to view it as the key source of growth by itself. In the context of subsidiary-driven evolution, this approach suggests the need to consider the interactions between the volume of unused productive resources at the subsidiary level and the presence of a subsidiary entrepreneurial strength.

The enterprise of management and the competence of management

Penrose (1959) distinguishes between two specific management characteristics: the “competence of management” and the “enterprise of management”. The former “refers to the way in which the managerial function is carried out” (Penrose, 1959, p. 32), e.g., to the firm’s operational strengths, while the latter “refers to the entrepreneurial function” (Penrose, 1959, p. 32), e.g., to the firm’s entrepreneurial strengths. The “enterprise of management” provides entrepreneurial services, such as those “which (are) related to the introduction and acceptance on behalf of the firm of new ideas, particularly with respect to products, location, and significant changes in technology” (Penrose, 1959, p. 31). In contrast, the “competence of management” relates to “the execution of entrepreneurial ideas and proposals and to the supervision of existing operations” (Penrose, 1959, p. 32). The same individuals may well provide both types of services, but each type is nevertheless conceptually distinct, as they have very different consequences. Penrose noted that “even if a firm is not very ambitious, it may nevertheless be competently managed” (Penrose, 1959, p. 34), and

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[s]uch men may have a high degree of managerial skill and imagination; they may be hard and efficient workers, but the ambition that would drive other men in the same circumstances to expand their operations in an unending search for more profit, and perhaps greater prestige, may be lacking. . . . a good businessman need not be a particularly ambitious one.

(Penrose, 1959, p. 35)

The above distinction is also crucial for subsidiary evolution. Obviously, the operational strength of subsidiary management alone, even it is high, will not lead to a stream of subsidiary initiatives, if subsidiary managers do not have an entrepreneurial strength. They may be good implementers of corporate strategy, but an entrepreneurial strength suggests another growth route, namely subsidiary managers looking for new opportunities.

A Penrosean perspective of critical determinants of subsidiary-driven evolution

The analysis above has suggested that, from a Penrosean perspective, the level of unused productive resources, as well as the presence of two other parameters, namely the ‘enterprise’ (entrepreneurial strengths) and the ‘competence’ of management (operational strengths) at the subsidiary level, all affect the subsidiary’s growth trajectory.

Figure 6.3 can now be constructed to illustrate the four alternative subsidiary evolution possibilities in a regional context.

Subsidiaries in quadrant 1 are those with a high potential for extensive subsidiary initiatives, as illustrated by Birkinshaw’s case studies (2000). IBM Scotland can be viewed as a useful example. The management of the IBM Scotland factory successfully attracted the European production of PCs in the early 1980s, and thus grew rapidly. However, “the management were keen not to stop here” (Birkinshaw, 2000, p. 56). They sequentially and successfully proposed the transfer of monitor development to the plant, the consolidation of all order-fulfillment in Scotland, and the creation of a single European PC help center. The key point here is that entrepreneurial managers invest energy to search for new business opportunities, and that the presence of unused productive resources facilitates this search process, thereby supporting Patterns 3 to 6 from our framework described in Figure 6.2.

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In quadrant 2, the entrepreneurial managers at the subsidiary level do not have access to sufficient resources to implement their ideas. In some cases, they simply do not have enough time or energy to consider new opportunities, because of their participation in current operations, which absorb all of their services. In other cases, they may still be willing to embrace new ideas (e.g., act as entrepreneurs), but limited resources available to them hamper the actual application of these ideas, thus reinforcing Patterns 2 and 7 from our framework in Figure 6.2. In the best-case scenario, a broadening of the business in the subsidiary’s country of location materializes, based on the entrepreneurial approach of the subsidiary’s managers.

Quadrant 3 helps us to understand the importance of entrepreneurial strengths for subsidiary-driven evolution. Here the subsidiary is characterized by the presence of local management with operational strengths, but lacking in entrepreneurship, in the sense that subsidiary managers focus mainly on the current subsidiary operations. This quadrant will not lead to subsidiary initiatives and related subsidiary-driven charter extension. Rather, any changes in subsidiary roles will be assigned by corporate headquarters. An example documented in Phelps and Fuller (2000) is EngineCo’s Welsh affiliate, in which “for the first five to six years, local managers were content with the initial investment” (Phelps & Fuller, 2000, p. 238). Only recently has the affiliate started to search for internal opportunities, as a result of local and parent company pressures. This passive attitude in the pursuit of internal opportunities in spite of the presence of unused productive resources indicates a relative lack of entrepreneurship.

The difference between quadrants 1 and 3 again highlights the interaction between unused productive resources and the “enterprise of management” on subsidiary-driven evolution. Subsidiaries characterized by entrepreneurial strengths will allocate unused productive resources in a proactive way, while those characterized by operational strengths only, will not, thus leading to pattern 2 and in the best case scenario, Pattern 8 in Figure 6.2, with an efficiency focus on expanding extant product lines domestically.

Quadrant 4 reflects efficiently operating subsidiaries with few unused productive resources. In the textbook design of transnational firms, this is the expected role of “implementers”, as suggested by Bartlett and Ghoshal (1986), “without access to critical information, and having to control scarce resources, these national organizations lack the potential to become contributors to the company’s strategic planning” (Bartlett & Ghoshal, 1986, p. 91). An example is the launching of Vizir by Procter & Gamble. Austria, Spain, Holland, and Belgium “took the refined strategy and made it work in their markets” (Bartlett & Ghoshal, 1986, p. 91). Unlike “strategic leaders” or “contributors”, which are guided by entrepreneurial leaders, these subsidiary managers are expected only to generate funds for the parent company, following efficiency objectives. This type of organizational design precludes the emergence of subsidiary initiatives and thereby subsidiary-driven charter enhancement. They are especially vulnerable to regional integration, if other units command an equivalent resource base, which may lead to charter losses, as exemplified by Pattern 1 in Figure 6.2: the absence of both entrepreneurial skills of subsidiary management and slack resources in the subsidiary, creates the conditions for losing from regional integration.

Conclusion

In this chapter, we have developed a general framework to understand the influence of regional integration on the dynamics of subsidiary roles. We have also presented eight patterns of subsidiary role evolution, and have examined the key driving factors at the subsidiary level that may influence which subsidiary dynamics will prevail.

First, we highlighted regional integration as an important determinant of subsidiary role dynamics. Though we acknowledge the strategic importance of the local environment, we moved away from a sole focus on the host country and made clear that increasingly, regional integration schemes may make obsolete the concept of the national environment being the main external determinant of subsidiary roles. We emphasized the intraregional reconfiguration of subsidiary activities because of increased competition in similar value chain activities within the region. This regional scope of subsidiary roles corresponds to recent theorizing on internationalization decisions in a semi-globalized world, whereby subsidiaries engage mainly in exploiting and recombining knowledge at the intraregional level, and exploring new business opportunities at the interregional level (Kim & Aguilera, 2015).

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Second, at the subsidiary level, we provided a Penrosean analysis of the key, micro-level determinants of changes in subsidiary roles. Here, we made a critical distinction between subsidiary capabilities to manage efficiently current operations and entrepreneurial capabilities. An important implication of linking subsidiary entrepreneurial capabilities with regional integration schemes is that subsidiaries may assume new responsibilities at the regional level, thereby becoming intermediate-level units located between the corporate headquarters and local subsidiaries. They may perform entrepreneurial tasks that are different from traditional corporate-level entrepreneurship and subsidiary-level initiatives (Hoenen, Nell & Ambos, 2014). Future research should examine under which conditions subsidiaries are more likely develop into such intermediate-level, region-based units.

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