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17

THE FIRM AS A DIFFERENTIATED NETWORK AND ECONOMIC GEOGRAPHY

Jens Gammelgaard and Frank McDonald

Introduction

Economic Geography deals with spatial analysis and focuses on the placement or localization of objects in the ‘landscape’ and how they relate to each other. There is a long tradition in International Business of considering issues connected to the spatial distribution of assets, markets and interaction between these distributions by cross-frontier transactions including foreign trade and foreign direct investment (FDI). Early studies in International Business considered cross-frontier transactions, analysing the importance of access to raw materials, costs of transport, trade and investment obstacles, market conditions, and developments in labour forces that make locations attractive (Hymer, 1972; Knickerbocker, 1973; Vernon, 1979). Recent studies of multinational corporations (MNC) by International Business scholars focus on the distribution and interaction across space of economic activity in nations, regions and cities. Such studies consider the spatially determined factors that make location in developed urban areas and in more peripheral places attractive for MNCs (Buckley & Ghauri, 2004; McCann & Mudambi, 2004; Beugelsdijk, Mudambi & McCann, 2010). Spatial factors are integral although often not explicitly in International Business research.

Important distinctions in Economic Geography are the concepts of place (physical and political locations), space (interaction between places) and scale (size of agencies involved in interacting in space – local, regional, national and global). In the International Business literature, specific attributes of place such as resource endowments, and economic, social and institutional environments are normally investigated in relation to the location choices of MNCs. These issues are normally examined by consideration of the impact of geographical, economic, political, institutional and cultural distance between home and host country (Beugelsdijk, Mudambi & McCann, 2010; Dau, 2013). The focus on space in International Business centres on how MNCs deal with issues arising from geographical distance that creates spatially related costs of the control and coordination of activities to achieve global value chain objectives (Jiang, Holburn & Beamish, 2016). These costs relate to additional expenditures arising from the need to obtain information on business environments in distant locations, costs of transport and complying with tariff and non-tariff barriers. In the International Business literature, scale normally relates to the organizational strategy of MNCs for control and coordination at local, regional, national and global levels.

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In a perfect setting, MNCs manage place and space factors by designing organization systems that facilitate the optimal control and coordination over place and space, thereby arriving at effective decisions on when, where and how to internationalize (Dau, 2013). Alternative approaches examine the organizational means of effectively crossing the various spatial boundaries in ways that permit MNCs to develop and sustain effective global objectives (Beugelsdijk, Pedersen & Petersen, 2009; Meyer, Mudambi & Narula, 2011; Buckley & Strange, 2015). International Business theory therefore considers the three fundamental aspects of place, space and scale, but predominately uses political boundaries based on nation states, although there are some studies on sub-national locations (Meyer & Nguyen, 2005; Goerzen, Asmussen & Nielsen, 2013). Most International Business theory focuses on strategic issues connected to location, make or buy and entry mode decisions and often does not explicitly examine the nature of the organizational forms used by MNCs to secure these strategic objectives. The issue investigated in this chapter is therefore the relationship between a particular organization form, the ‘Differentiated Network’ (Nohria & Ghoshal, 1997) and Economic Geography factors.

The common held conceptualization of firms by business and management scholars is often somewhat different from how economic geographers regard firms. The relationship school among economic geographers view the firm as a type of network (Taylor & Asheim, 2001). In this view, firms are primarily networks with relationships between economic actors over space that are reciprocal, interdependent and often characterized by unequal distribution of power. Locations (place) have different social, political and institutional structures, and the firm is a type of a network system managing these differences across space by organizational systems that relate to a variety of scale factors (global, national, sub-national and local) in global value chains. Other economic geographers that take a relationship view of interactions across global space highlight the importance of the external and internal networks of firms as having a crucial role in how global value chains develop. Some of this literature includes reference to network views of the MNC (Morgan, 2001; Beaverstock, 2004; Jones, 2005; Yeung, 2005). These Economic Geography views of firms as networks have similarities to the MNCs as a differentiated network, but do not explicitly consider how firms use these networks to create and develop their global value chains.

This chapter analyses Nohria and Ghoshal’s (1997) concept of the differentiated network in the context of concepts related to Economic Geography contingences. The differentiated network approach does not explicitly consider Economic Geography factors, but they are implicit in the concept of the MNC as a differentiated network. The chapter starts by outlining the key characteristics of the differentiated network paradigm. The chapter then examines the relationship of the MNC as a differentiated network in the context of key Economic Geography factors. The concluding part of the chapter suggests how Economic Geography perspectives might be further integrated into differentiated network analysis.

The differentiated network paradigm

In Nohria and Ghoshal’s (1997) view, MNCs organize their activities so they can secure the benefits of innovations in multiple locations. In their description of such an organization, Nohria and Ghoshal position themselves away from transaction cost theory, because they regard this as a negative theory and prefer to focus on the organization’s ability to promote knowledge creation. The competitive landscape they draw upon is MNCs competing against a few other MNCs, comparable in size, international resource access and worldwide market position. In this competitive scenario, some host country markets and resource bases tend to have different attractions as means to achieve global value chain objectives. In locations with features that are compatible with key global value chain objectives, subsidiaries become more important and therefore become more focal in the pursuit of strategic objectives. From this view, Nohria and Ghoshal hypothesize that the organizational form of a traditional hierarchy will be inferior because strong vertical control and coordination systems hinder the potential of subsidiaries to make important contributions to the overall strategic objectives of the MNC. The solution to obtaining competitive advantages are organizational systems based on differentiated networks to achieve effective control and coordination that is superior to hierarchical systems.

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The differentiated network approach departs from an Economic Geography notion that differences arising from nation-states are of little importance in the interactions across space. In the differentiated network approach, an MNC consists of diverse subsidiaries that operate in distinct national environments that have different economic conditions, formal and informal institutional systems, cultures and time zones. Therefore, it is advantageous to have different relationships in the various national locations of MNCs. Thus, network relationships differ between headquarters and subsidiaries, between different subsidiaries and in the external linkages of subsidiaries. The differentiation within the MNC’s network relationships is an outcome therefore of variation in business environmental conditions of the subsidiary. This leads to a constellation of three elements being relevant to define the network relationship for each subsidiary within the MNC:

Global linkages across the diverse national locations of companies and customers are based on linking centres of expertise and desirable resources to areas with high volume and/or priced market demand. This leads to a need for a differentiated organizational form that can draw effectively on competencies across the geographical dispersal of subsidiaries of the MNC to utilize effectively the geographically dispersed resource pools and market demands. This has similarities to the combinative capacity across national space suggested by Kogut and Zander (1992). Local innovation processes where subsidiaries use indigenous-based innovations, however, are prominent in Nohria and Ghoshal’s analysis. They use the case of Unilever to highlight these host-based innovation effects. Unilever could not utilize its homegrown expertise in laundry detergents because washing in streams rather than using washing machines prevailed in India. The development of a solid tablet using a detergent derived from vegetable oil rather than clarified butter created a superior alternative to the traditional soap bar. This example of locally based innovation emphasizes the usefulness of network relationships within organizational systems that effectively weaves together local knowledge with the MNC-wide advantages to help satisfy strategic objectives.

Organizational complexity may arise in differentiated networks because of the interactions between diverse business environments. The importance for an MNC to access and exploit local knowledge may call for higher local autonomy of subsidiaries, but this can lead to a need for organizational forms that ensure the weaving together of locally obtained knowledge with the overall objectives of the MNC (Gammelgaard et al., 2012). Increased formalization of the organization system is often necessary when reducing centralization by granting local autonomy to subsidiaries. Formalization provides rules and procedures to ensure that subsidiaries embed into the overall strategic objectives of the MNC. Normative integration processes may further encourage the sharing of organizational goals by key players in the MNC thereby helping to fulfil strategic objective. As MNCs operate in many different business environments, diversity in organizational systems is often necessary to ensure satisfaction of strategic objectives. In principle, business environment conditions that require greater autonomy for subsidiaries lead to reduced centralization and an enhanced need for formalization and normative integration. Nohria and Ghoshal, however, depart from this simple framework by using the notion of contingency theory from Drazin and van de Ven (1985). This views the required type of organizational forms as being contingent on the key characteristics in the various business environments in which MNCs operate.

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As the complexity of business environments increases, there is a need for a variety of constellations of centralization/formalization/socialization to manage effectively the operations of MNCs. Nohria and Ghoshal measure environmental complexity by two major factors: (a) technological dynamism, and (b) competition. The major driver of the development of complex organizational forms is technological dynamism that involves fast-changing technologies requiring access to intangible assets that enable the gathering of information and the development of knowledge to use effectively evolving technologies. High technological dynamism combined with strong competition based primarily on the qualities of products leads to complex business environments requiring a careful balance of the three key elements in the differentiated network of MNCs. In cases of a high level of business environment complexity, centralization is likely to be low to permit innovative behaviour by subsidiaries to cater for local conditions. With subsidiaries with low quality local resources, moderate relaxation of centralization is required to reduce the risk of futile innovation by subsidiaries that lack the necessary resources to provide innovations useful to the overall objectives of the MNC. Subsidiaries with limited valuable resource will, therefore, have little autonomy especially in cases where environmental complexity is low, but will have higher levels of autonomy if they possess valuable resources. Strong formalization is required in cases where subsidiaries control valuable resources and is strongest in cases of low environmental complexity. In cases of high complexity business environments moderation of formalization is necessary to prevent delay in innovation processes due to bureaucratic procedures that limited innovative behaviour. Normative integration is in principle always a good idea. The costs of engaging in such integration, however, renders this approach most useful in cases of highly complex business environments where there is a need to encourage innovation and entrepreneurship while harnessing subsidiaries to the overall objectives of the MNC.

Using the seminal work by Bartlett and Ghoshal (1989) on transnational companies, Nohria and Ghoshal (1997) divided large West European MNCs into categories. They found significant numbers of companies strong in only one of the key elements in the differentiated network (either centralization or formalization or socialization), other companies strong in two, and a few in all three (e.g. Digital Equipment, Siemens and Honeywell). Some companies are not strong in any of the categories. An MNC, however, does not necessarily need to be strong in all categories. Only in cases with high environmental complexity and valuable local resources in subsidiaries are the network connections of MNCs likely to make significant use of all three elements. In other words, differentiated networks (with integration of key components necessary for structural integration) are only necessary where business environments in host locations are complex and local resources are valuable.

Nohria and Ghoshal (1997) address the importance of some Economic Geography contingencies, as environmental complexity and value of resources in host locations relate to place characteristics. The geographical location of fast-changing, technological, market conditions and of valuable (often intangible) resources pay an important role in the requirement for differentiated networks. The differentiated network approach views headquarters as primarily an information processing unit that involves space characteristics associated with interconnections between places and scale issues in deciding at what level – global, national or local (Forsgren, 2004). Egelhoff (2010) finds that the differentiated network structure is helpful for bringing knowledge from different places together. The success in these circumstances depends on headquarters’ ability to understand diffuse pieces of information from a variety of places, and translate them into meaningful evaluations in terms of strategy making. Further, Egelhoff highlights that Nohria and Ghoshal’s conceptualization of differentiated networks focuses on the internal – or intra-organizational – relationships leading to a neglect of subsidiary relationships to external or inter-organizational relationships. Arvidsson and Birkinshaw (2004) address this gap in the Nohria and Ghoshal model and acknowledge that the basis of variation of capabilities across subsidiaries is a function of characteristics of how subsidiaries embed in local networks. In contrast to Nohria and Ghoshal, they argue that stickiness and complexities of transferring knowledge and managerial capabilities within the organization by formalization and/or normalization causes subsidiaries to remain ‘different’ instead of aligned. Rugman and Verbeke (2001) develop this idea in their work on location bound and non-location bound resources. The ideal of an MNC with a high presence of ‘shared values’ was moreover not confirmed in a survey by Forsgren, Holm and Johanson (2007), that found only 7 per cent of the cases of 97 subsidiaries of Swedish MNCs had a high degree of shared values. This study also found that issues of power and resource dependencies do not integrate well into the differentiated network framework. These studies indicate problems with control and coordination activities in differentiated networks connected to issues involving space (effectively interacting between different places) and with scale (finding the correct type of agents in locations for decision-making and to develop innovations, etc.).

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In the final section of their book, Nohria and Ghoshal (1997) indicate the importance of issues connected to external networks and the high degree of connectedness between various stakeholders. This includes issues related to the development of clusters and global value chains. Here, Nohria and Ghoshal hint at the need to better integrate Economic Geography elements connected to communication and transportation infrastructures by referring to Chandler’s work (1986). An industry like telecommunications, for instance, departed in many countries from being a national regulated industry with the need of local knowledge creation and implementation, but due to deregulation it evolved to become an industry of growing technological standardization and cross-national integration. Consequently, the MNC organizational systems for managing these kinds of industry contingencies were significant different according to place, requiring organizational systems of MNCs to be amenable to managing effectively across space and at differing scales. This often requires reallocation of mandates and decision-making rights among subsidiaries within the MNC (Dörrenbächer & Gammelgaard, 2010). The importance of place, space and scale in connection to the MNC as a differentiated network is therefore apparent, but not normally explicitly considered in the literature.

Much of the elaboration on the differentiated network paradigm of Nohria and Ghoshal, and later scholars referring to their work, has addressed the need of further investigating of the effects of host location networks and the effective embedding of subsidiaries into the strategic objectives of MNCs. The spatial effects have however been less emphasized. The next section outlines these attempts to better incorporate spatial issues into the concept of the MNC as a differentiated network.

Economic Geography and the differentiated network

International Business literature that considers spatial issues focuses on the importance of place (location) as a major driver of foreign direct investment (FDI), including the attractiveness of clusters (McCann, Arita & Gordon, 2002; Majocchi & Presutti, 2009). This literature tends to focus on the attractiveness of locations for FDI and the effect of such investment on host location productivity, and on how transfers of knowledge are affected by location (Teece, 1977; Biggiero, 2002; De Propris & Driffield, 2005; Dunning, 2009). Issues connected to securing strategic objectives involving cross-border transactions are examined, but normally in the context of entry modes and the need for learning strategies to obtain and process information over space to enable the fulfilment of strategic objectives (Buckley & Ghauri, 2004; Dunning, 2009; Beugelsdijk, Mudambi & McCann, 2010). The space issues involved with securing strategic objectives from internationalization are normally linked to costs associated with liabilities of foreignness and outsidership. These liabilities stem from additional costs in foreign operations arising from economic distance (including market and technology differences) and institutional distance (embracing both formal and informal institutional factors) between home and host locations (Eden & Miller, 2004; Johanson & Vahlne, 2009). The nature of the problems caused by space between places is therefore seen as being largely due to activities rather than cross-national borders, leading to the need to manage costs and risks associated with differences in economic and institutional systems from those that prevail in the home base. Most studies are conducted at national level, with a few studies examining cross-border issues from the perspective of sub-national or city location (Nachum, 2000; Goerzen, Asmussen & Nielsen, 2013). The organization structures (involving space and scale issues) that MNCs need to be able secure advantages in their various host location are often not explicitly examined in this literature.

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Costs associated with space between locations (geographical distance) affect organizational forms such as differentiated networks. These costs include acquisition and transfer of information about host environments, transport/distribution costs and compliance with tariffs, non-tariff barriers and regulatory requirements. These spatially associated costs can be significant if a high degree of interaction between subsidiaries arises due to the complexity of business environments (Jiang, Holburn & Beamish, 2016). These spatially driven costs normally increase as proximity declines. This is obvious for transport and distribution costs, but there is also often a high degree of correlation between geographical distance and economic and institutional distance. The additional costs associated with distance provide incentives to reduce these costs by locating subsidiaries in close geographical proximity. This proximity incentive is also seen as encouraging location in specific region areas such as Europe or South Asia. The tendency for a regional area focus of subsidiary location is reinforced by economic factors connected to competition and consumer preferences (Rugman, 2005). These costs affect not only incentives for proximity between headquarters and subsidiaries but also between subsidiaries (Adler & Hashai, 2015). Tests of the effect of geographical distance on innovation transfers between subsidiaries find the further away headquarters are from subsidiaries, the lower are such transfers. The internal embeddedness of subsidiaries within their MNC structures, however, appears to mitigate the space-related costs (Dellestrand & Kappen, 2012). This also holds, albeit with lower influence, for subsidiary embeddedness in its host location. This literature on the effects of geographical distance therefore provides explanations of why linkages between headquarters and subsidiaries (including external network connections) in host locations alleviates the spatial costs that affect innovation-related FDI.

The role of headquarter relationships with subsidiaries affects subsidiary strategy (Pearce, 2001). This study does not investigate the differentiated network as such, but analyses the long-term effects of new FDI on the development of subsidiary roles. These factors include geographical factors that can lead to changes in subsidiary mandates. Pearce uses three types of subsidiary mandates:

The PM mandate types have the widest strategic responsibilities and are likely to be more common in complex business environments requiring a differentiated network approach to enable MNCs to achieve their strategic objectives, especially in cases with high spatial costs due to geographic distance. Given the increasing differences in specialized technological capabilities in countries and the heterogeneity of consumer demands, Pearce (2001) argues that many, often geographically distant countries, are prime candidates for subsidiaries with PM mandates. Subsidiaries of this type are likely to be best managed using some type of differentiated network.

The contribution of Pearce improves understanding of the links between differentiated network and Economic Geography factors. Pearce connects the development of subsidiaries and the embedding of them in overall MNC objectives to Economic Geography contingencies connected to economic, market and institutional developments in the places where PM type subsidiaries may be located. The importance of the relationship between the scope of what subsidiaries do and spatial factors includes aspects of regional bloc integration (Benito, Grøgaard & Narula, 2003). This study found that subsidiary development differs in the otherwise comparable countries of Denmark, Norway and Finland, because Denmark and Finland are EU members, whereas Norway is more peripherally connected to the EU. This study also found that ‘country size’ is important with subsidiaries in small countries being more marginal in the organizational systems of MNC organization.

The evolution of subsidiaries from TMR to PM is also considered by Pearce, and geographical factors play an important role in such developments. Trade agreements and market-based reforms in countries reduce place-related tariff and non-tariff barriers, making it easier to locate product manufacturing where it is most efficient. Location of production facilities in new places can lead to labour specialization and improved skills to address the technological demands of these RPS type subsidiaries. In host countries that develop highly skilled specialized labour forces with the necessary supporting infrastructures and institutional systems, the potential exists for the development of PM subsidiaries. Places that do not develop specialized labour forces face competition from other places for the location of TMR type subsidiaries. What is needed for a subsidiary development into a PM type, is that the host country supports and invest in its human capital and supporting infrastructures and institutional systems to provide places conducive to subsidiaries of the PM type. Buckley and Ghauri (2004) elaborate on this aspect of how MNC subsidiary policies connected to spatial factors have led to a deepening of the spatial division of labour. Changes in the attractiveness of places and costs associated with space between home and host locations can therefore lead to the alteration of the geographical proximity and characteristics of subsidiary development in differentiated networks.

The role of country specific assets (CSA) for subsidiary development (Rugman & Verbeke, 2003) provides other insights into differentiated network organizational structures as the outcome of the resource bases of the host countries. The sources of CSA arise from the resource base of countries and aspects of the economic, social and institutional systems that confer cost advantages and/or access to scarce and valuable assets (often intangible assets) that are not available or are only available at higher cost and risk in other countries. Access to CSA is not necessarily available (or is equally available) in all parts of a country, therefore selection of best sub-national locations is often an important factor in acquiring CSA (Meyer & Nguyen, 2005; Goerzen, Asmussen & Nielsen, 2013). The value of the resources normally increases with spatial proximity (due to reduced spatial associated costs) and the subsidiary’s ability to embed into host country innovation systems to provide access to local innovations. This tends to increase the location bound nature of CSA. This may, however, create strong embeddedness into host locations that can lock in MNCs’ global value chains into host locations. This can be counterproductive if subsidiaries pursue policies and practices that do not fit well with global value chain objectives. This risk provides incentives for the MNC to seek to make activities that are crucial for fulfilling the global value chain objectives less location bound. A differentiated network system may therefore encourage locations with desirable CSA and with low spatial associated costs due to geographical proximity, but which result in undesirable embedding into host locations. This leads to ‘isolating mechanisms’ arising from ‘routines’ shared by cluster participants that are difficult to replicate, imitate or otherwise acquire by outsiders’ that leads to ‘diseconomies, inter-organizational asset stock inter-connectedness, partner scarcity, resource indivisibility, and a specific institutional environment’ (Rugman & Verbeke, 2003, p. 132). Strong embeddedness in host locations may therefore hinder MNCs from utilizing economies of scale and scope. This risk may be mitigated by careful balance of the decision on the centralization/formalization/normative nexus that lessens the chances of locking into activities by subsidiaries that are harmful for achieving the strategic objectives of MNCs.

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The acquisition of CSA by location strategies is desirable if this leads to the enhancing of firm specific advantages (FSA) that give rise to competitive advantages (Rugman, 1981). The tendency for MNCs to concentrate their major activities in specific regional areas in the world leads Rugman to set his CSA-FSA model in a regional area context. This adds a regional specific advantage (RSA) component to the CSA-FSA model (Rugman, 2005). Trade and FDI flows appear to be strongly influenced by geographical distance, with proximity and size exercising a strong influence on these flows (Disdier & Head, 2008; Brun et al., 2005). The control and coordination costs across space also favour geographical proximity because market and institutional systems are often more similar in countries that are geographically close (Eden & Miller, 2004; Berry, Guillén & Zhou, 2010). Regional integration bodies and regional trade agreements can also reduce institutional obstacles to trade and FDI by reducing trading costs through reducing or eliminating tariffs/quotas and harmonizing regulatory frameworks. Membership of such bodies reinforces the proximity and size effects of trade and FDI flows. A major part of the attractiveness of CSA is often therefore the trade relationships of countries with their regional areas, especially membership of regional trade bodies and regionally based trade agreements (Rugman, 2014).

These geographically driven considerations may lead, in differentiated network structures, to low centralization to promote the ability to innovate in complex business environments, but with strong formalization and normative integration to limit unhelpful development from location bound assets. In this type of scenario, difficult spatially connected trade-offs can arise to balance securing innovations to help to prosper in complex business environments, but which have low spatially associated control and coordination costs. Trade-offs emerge from three key issues: (1) place issues connected to decisions about the location and relocation and types of mandates given to subsidiaries to obtain resources and innovations to enhance FSA; (2) space issues relating to choices about control and coordination of geographically dispersed activities that minimize spatially related costs; and (3) scale issues linked to the adoption of organizational structures that link different types of agents in network systems that weave the geographically scattered subsidiaries to enable the creation and sustaining of FSA. Locations may provide attractive features that would be helpful for achieving global value chain objectives, but they may be associated with high control and coordination costs due to large geographical distances. Linking subsidiaries across space with minimum interference by headquarters can promote innovations, but may lead to undesirable outcomes by, for example, promoting the locking-in to host locations that leads to higher costs or qualities of products that do not fit with global value chain objectives. In differentiated networks the decisions on the centralization/formalization/normative nexus are crucial in the search for trade-offs between such conflicting outcomes from choices about place, space and scale in global value chains.

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Locations with desirable CSA and RSA are attractive, but these must be examined in the context of spatially associated costs (often favouring geographical proximity) and the dangers of the development of location bound assets that are not amenable to fulfilling the strategic objectives of the MNC. The overall objective is to develop organizational structures that enable MNCs to create and sustain firm FSA that lead to competitive advantages (Rugman, 1981; Rugman & Verbeke, 2001). This requires securing CSA and RSA and weaving them over space into FSA that have low spatially associated costs and with little prospects of lock-in to host locations that do not contribute to FSA at a global level. The addition of an evolutionary process for subsidiary strategy, as proposed by Pearce (2001), to the Rugman and Verbeke concept of obtaining FSA from CSA and RSA indicates that differentiated networks are likely to be involved in dynamic processes involving consideration of all three of the key elements of place, space and scale. This process is illustrated in Figure 17.1.

Place factors – location decisions including entry mode relating to CSA and RSA to secure desired assets and innovations to create and sustain FSA, relocation decisions as business environment changes to ensure locations continue to provide desired assets and innovations.

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Space factors – selecting headquarters to subsidiaries and subsidiaries to subsidiaries network relationships (and developing them as business environment complexity changes) to minimize spatially associated costs of control and coordination while also securing desired assets and innovations.

Scale factors – selecting mandates for subsidiaries and their development as business environments change, and creating and developing networks (both internal and external) between headquarters and subsidiaries (and between subsidiaries) that weave together the various parts of the MNC to secure the necessary resources and innovations to create and sustain FSA.

Complicated decisions need to be made in selecting locations and the network relationships between these locations to create and sustain FSA. Attributes of CSA and RSA may encourage location in countries (or sub-national locations within countries) to secure resources and capacities for developing innovations. Proximity and size effects as well as spatially associated control and coordination costs may also encourage locations with low geographical distance. In these circumstances, concentration of large parts of global value chains may be found in regional areas such as Europe or South East Asia, with operations outside of these vicinities being restricted to the availability of scarce and valuable resources that are not available in the main region of operations. Major changes to these regional area locations would arise in cases of major changes in business environments, for example the rise of the emerging economies that provide resource benefits that outweigh the costs associated with geographical distance. These types of complicated outcomes in location and network relationships accord with the views that regard proximity and size benefits and spatially associated costs as major drivers of MNC operations (Ghemawat, 2001; Rugman & Verbeke, 2003; Jiang, Holburn & Beamish, 2016).

The benefit-cost outcomes of weaving together these geographically dispersed parts of the MNC may lead to difficult trade-offs in network relationships. The availability of desirable markets, resources and innovation capacity in countries in certain regional areas may call for reduced centralization, but with increased formalization and/or normative integration to offset undesirable actions by subsidiaries that may lock in the MNC to these locations. In fast-changing and complex business environments, these locking-in effects may be harmful to the sustainability of FSA, further increasing the need for formalization and/or normative integration to mitigate these harmful outcomes of decreasing centralization. Securing innovations may encourage subsidiaries to embed in their host locations and to share valuable assets and knowledge via a host of complicated intra and inter-organizational networks. These networks may, however, encourage the development of routines and practices that are counterproductive to the overall development of FSA that accord with the strategy of the MNC. To mitigate these kinds of potentially harmful effects requires carefully balancing and rebalancing of the centralization, formalization and normative nexus in the differentiated network. The dynamic nature of complex business environments further increases the need for careful development of these balances in network relationships as major changes in technologies and the determinants of competitive environments change.

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Increasing internationalization by firms leads to views that MNCs may become too internationally diversified. These concerns arise because the costs of operating complex global operations in a wide range of geographically dispersed locations may exceed the benefits of developing global value chains. Differing views on the issue of the possibilities of over internationalization are evident in the literature. These include u-shaped relationships that indicate initial performance losses until the firm learns how to operate in many diverse locations (Gaur & Kumar, 2009) and an inverted u-shaped relationship indicating rising performance as learning takes place, but which eventually declines as control and coordination costs of increasing internationalization exceed the performance benefits (Contractor et al., 2003). A more sophisticated view is of a horizontal s-shaped relationship (Lu & Beamish, 2004) where firms initially face negative performance that moves into performance gains as firms learn how to engage effectively in internationalization processes, but where eventually diminishing performance returns. These issues are illustrated in Figure 17.2.

The net benefits of internationalization are the gross benefits (improvements in FSA) minus the costs of internationalization. These costs arise from geographical, economic, social and institutional distance (leading to liabilities of foreignness and outsidership), tariff/non-tariff costs, and transport and distribution costs. In addition, there are costs of control and coordination connected to managing interactions over the space between the different locations of the MNC. These are primarily the costs of achieving and managing balance in differentiated networks composed of geographically dispersed subsidiaries. These costs are associated with the selection and maintenance of an appropriate centralization/formalization/normative nexus that permits MNCs to weave together geographically dispersed subsidiaries to enhance FSA. Costs of internationalization rise as business environment complexity increases and as proximity declines. Increasing business complexity induces a need to secure additional resources and innovations, often requiring an escalating number of locations and deeper involvement in host locations. This tends to increase control and coordination costs. Decreasing proximity between the different parts of the MNC has a propensity to increase costs due to problems of communication and, in many cases, from increased institutional and cultural distance between home and host locations that hinders understanding of what headquarters require from subsidiaries.

Stage I

Early period of differentiated network – the benefits of internationalization minus the costs initially lead to negative net benefits. Learning how to mitigate costs of liabilities of foreignness and outsidership, however, leads to movement towards positive net benefits. Transport and distribution costs are unlikely to be significantly reduced as internationalization proceeds unless there are significant improvements in transport and distribution infrastructures and technologies. Reductions in tariff and non-tariff barriers will only transpire if there are bilateral and/or multilateral trade agreements, or from membership of effective regional integration bodies. In most cases, it is likely therefore that the move towards positive net benefits will mainly come from learning how to mitigate liabilities of foreignness and outsidership.

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Stage II

Mature phase – the net benefits are positive as the networks of MNCs attain high-level effectiveness in weaving the various parts of the global value chains to enhance FSA. The net benefits, however, begin to decline as internationalization processes become wider and deeper, leading to new liabilities of foreignness and outsidership as new locations come online, and from rising control and coordination costs from increases in geographical dispersion and the multifaceted nature of global value chains.

Stage III

Declining net benefits phase – continuing internationalization leads to negative net benefits as the costs of widening and deepening internationalization exceed the benefits of enhanced FSA.

It is likely that an MNC in the downward part of Stage II and certainly by Stage III would revise its internationalization strategy. This could involve a radical reassessment of locations that involves divestment, relocation, abandoning of low return operations in some locations and changes to control processes, for example reducing ownership stake in subsidiaries. The centralization/formative/normative nexus of network relationships could also be simplified, or radically overhauled, to reduce control and coordination costs. These changes to control and coordination of network relationships would also follow from any reduction in the scale and scope of internationalization processes. In some cases, especially if Stage III is reached, MNCs may withdraw altogether from all or part of the places it operates in, or from some of the markets that it supplies. This would involve a move towards greater proximity in the important networks of the MNC. In some locations subsidiary mandates may move to simpler functions such as TMR or RPS. The overall effect would be to rationalize to a simpler and less costly internationalization process, often involving reduced geographical dispersion of subsidiaries and a moving away from deep internationalization in areas with high spatially associated costs. In other words, a relentless march to ever wider and deeper internationalization is not inevitable, even for what are MNCs with highly developed differentiated networks.

Many MNC that find themselves in the downward section of Stage II, or are in Stage III, may seek to introduce new products and/or develop existing products, create radical new technologies and change regional area focus to boost the benefits from developing FSA by use of internationalization processes. This would, if successful, reverse the downward section in Stage II and perhaps even lead to an upturn in Stage III. Investment in innovative centralization policies and/or greatly improved formalization and normative integration elements in the control and coordination of networks may also prevent costs from exceeding the benefits of internationalization. Changes that are external to the MNC in the complexity of business environments by improvements in technology and/or alterations in competitive conditions could also alter the shape of the relationship between net benefits and internationalization processes. Similarly, external developments in infrastructures, technologies and government policies associated with locational costs and benefits could affect the relationship. New or extended trade agreements and developments within regional integration blocs would have similar effects. The nature of the relationships between net benefits and internationalization processes are therefore likely to be dynamic and influenced by many internal and external factors. The development of the internationalization processes of the differentiated networks of MNCs is therefore likely to be a complex process of evolution that is driven in large part by issues connected to developments in geographical factors.

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The firm in Economic Geography

Economic geographers that take a relationship view on the link between territory and firms in global production networks regard the nature of the firm in ways that have similarities to the transnational MNC and the differentiated network view (Nohria & Ghoshal, 1997; Bartlett & Ghoshal, 1989). The firm is viewed as a type of social network not as a production function, as in neo-classical economics, or as a transaction cost minimizing entity (Yeung, 2005). These studies examine control and coordination processes across space by use of expatriates (Beaverstock, 2004) and the use of formal and informal systems to manage interactions in network relationships (Morgan, 2001). These approaches to how firms manage network relationships in global production networks echo the formative and normative integration analyses of the differentiated network view of the MNC. In an interesting study the relationship between firms and territorial spaces is viewed as being controlled and coordinated by social networks that due to complex and dynamic economic and institutional environments lead to non-scalar outcomes (Jones, 2005). This view of firms in global production networks sees the association between the network relationships of firms and internationalization as being dynamic and with a variety of possible outcomes. Changes in business environments, economic and institutional conditions can therefore generate several possible paths for the internationalization processes of firms that are embedded in global production networks. This approach has similarities to the view of the development of differentiated networks outlined in Figure 17.2 above.

There are two major differences between how relationship economic geographers view MNCs in global production networks and the approach of the MNC as a differentiated network. First, the global production network approach tends to focus on firms in territories and in interactions with other territories. These territories are often sub-national (city regions, industrial clusters, free trade zones, etc). The relationships between regional area, national and sub-national locations as drivers of the location decisions of MNCs (as outlined above in Figure 17.1) tend therefore to be underplayed. This leads to a tendency to understate the influence of national and regional area aspects of locations for the nature of the network relationships of MNCs. The importance of these national and regional area aspects for location and therefore for the role of headquarters and subsidiaries in MNC networks is illustrated by the debate on location and relocation decisions of MNCs because of the UK exiting from the EU. The withdrawal of the UK could lead to the significant relocation of some headquarters and all or some of the activities of subsidiaries. Changes at national and regional level can therefore have profound effects on the nature of the networks of MNCs. The differentiated network view places these national and regional area influences at the heart of the analysis of network relationships. In the relational Economic Geography approach these drivers of network development are often not centre stage in the analysis. Second, analysis using the differentiated network approach places the securing of competitive advantages by developing FSA as the core of what drives MNCs. The use of network relationships to achieve this aim is therefore fundamental in the analysis. In other words, the focus is on how networks are created and sustained over space to develop FSA. In relationship Economic Geography approaches, analysis tends to emphasize the nature of social networks and how they are influenced primarily by changes in social, economic, political and institutional factors. In short, analysis in relationship Economic Geography is on how global production networks affect the development of territories and the interactions between territories. In the differentiated network the focus is on how the characteristics of national (including sub-national) and regional areas affect the network relationships of MNCs in the context of the overarching strategic aim of enhancing FSA.

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These differences tend to lead to relationship Economic Geography analysis underemphasizing the role of the driving strategic force behind the decisions of MNCs, i.e. the securing of FSA, and the role of country and regional area characteristics. Analysis based on the differentiated network approach on the other hand normally has a poor understanding of the complexities of place, space and scale that often results in naïve views that may mean little more than that, somehow or other, proximity matters. This leads to a rather simplistic reliance on institutional, cultural and economic distance measures to capture what are complex issues connected to place, space and scale. The strengths and weaknesses of the relationship Economic Geography and differentiated network approaches call for greater integration of the strengths of each approach to reduce the weakness in these approaches to understanding the links between global value chains of MNCs and global production networks. The concluding part of this chapter therefore considers how integrating key issues from Economic Geography’s analysis of global production networks may provide a better understanding of how the network relationships of MNCs help to manage global value chains in ways that enhance FSA.

Economic Geography and networks for managing global value chains

In the differentiated network approach, the purpose of creating and developing global value chains is to enhance FSA to obtain competitive advantages. In complex business environments, this requires designing and sustaining network relationships that facilitate this overriding strategic objective. This requires establishing in places that provide the resources and innovations that can help to achieve this objective and to link these sites over space and in the different scale dimension of these locations in an effective differentiated set of network relationships. This requires careful balance of the centralization/formalization/socialization nexus that provides at low cost, effective control and coordination and that can effectively manage the evolution of locations and interaction over space of these networks in the face of factors that alter the benefits and costs from internationalization. How Economic Geography contingencies affect the managing of global value chains is currently not well incorporated into studies using a differentiated network approach. These contingencies, however, exercise significant influence on the benefits and costs arising from the selection of places to locate, network relationships to manage interaction over the space between locations and the scale at which the components of the global value chain engage with these networks.

Currently, most research in International Business (including research using a differentiated network approach) assesses the costs arising from space between locations using national measures of economic, geographic, cultural and institutional distance. There are some studies that examine sub-national locations (Nachum, 2000; Meyer & Nguyen, 2005; Goerzen, Asmussen & Nielsen, 2013). There are also theoretical pieces on costs and benefits of crossing various national and sub-national borders (Beugelsdijk & Mudambi, 2013). These studies highlight the importance of geographical contingencies, but the means to measure these spatially related factors are few and often of poor quality. Consideration of differences in the costs of control and coordination of the various locations, spaces and scale in which cross-border transactions take place are necessary in global value chains. Improved knowledge in these areas would help to improve the choices made in the centralization/formalization/socialization nexus to enable global value chains to deliver FSA in the face of dynamic environments. Improved methods for evaluating the benefits associated with the place, space and scale of locations would also help to arrive at the net benefits of weaving together the various locations of the different parts of the MNC’s global value chain. These costs and benefits need to be analysed in dynamic and evolutionary ways to assess how internationalization may develop in ways that prevent the costs of internationalization exceeding the benefits. Consideration should be given to how changes in factors that are internal and external to MNCs affect the internationalization processes of firms. Assessing the benefits and costs of altering proximity in network relationships is required. This involves the examination of location and relocation decisions (including subsidiary mandate changes) and the developing of the centralization/formalization/socialization nexus for creating and sustaining effective network relationships. This requires consideration of place, space and scale relationships and their associated costs and benefits in the face of complex business environments for MNCs and changing economic, political, technological, social and institutional environments in the various places in which the MNC’s global value chain is located. Relationship Economic Geography approaches provide good insights into the environmental conditions and connections between locations in global production networks. This knowledge needs to be incorporated more fully into the core of the differentiated network approach to provide greater understanding of how internationalization processes of differentiated networks work and evolve.

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