Sources of Strength in MNC Subsidiary Firms

Transcription

1 International Business Review 8 (1999) Accounting for the strengths of MNC subsidiaries: the case of foreign-owned firms in Denmark Mats Forsgren a, Torben Pedersen a,*, Nicolai J. Foss b a Department of International Economics and Management, Copenhagen Business School, Nansensgade 19, 7, DK-1366, Copenhagen K, Denmark b Department of Industrial Economics and Strategy, Copenhagen Business School, Nansensgade 19, 6, DK-1366, Copenhagen K, Denmark Abstract This paper links up with recent work on the role of subsidiaries in multinational corporations as well as with recent work in the strategy and business network literature. We discuss the sources of organizational strengths of subsidiaries in the larger multinational corporation, and argue that organizational strength can to some extent be proxied by strength in the market place. Based on analysis of data on foreign-owned production firms in Denmark, we test three hypotheses: 1) that internal factors (capabilities, patents...) are positively related to the organizational strengths of MNC subsidiaries, 2) business network factors (network relations) are positively related to the organizational strengths of MNC subsidiaries, and 3) there is an interaction effect between internal factors and business network factors when explaining the organizational strengths of MNC subsidiaries. Hypothesis 1 but not Hypothesis 2 is supported. But the testing also supports Hypothesis 3, that is there seems to be an interaction effect between the two factors Elsevier Science Ltd. All rights reserved. Keywords: Role of subsidiaries; Sources of subsidiary strength 1. Introduction An important body of literature on multinational corporations deals with their organization, and particularly with the role of the subsidiaries within the multi- * Corresponding author. Tel.: ; fax: ; tp.int@cbs.dk /99/$ - see front matter 1999 Elsevier Science Ltd. All rights reserved. PII: S (98)

2 182 M. Forsgren et al. / International Business Review 8 (1999) national organization (see, for example, Doz & Pralahad (1981); Egelhoff (1988); Bartlett & Ghoshal (1989); Forsgren (1989); Ghoshal & Nohria (1989); Ghoshal & Bartlett (1990); Gupta & Govindarajan (1991); Gupta & Govindarajan, (1994); Forsgren & Johanson (1992)). An increasingly important theme in recent writings has to do with the observed changes in the relation between headquarters and subsidiaries, and with the presumed need to effect these changes, given intensifying competitive pressure, and more pronounced changes in underlying technologies, preferences, and regulatory institutions. More specifically, the changes in question refer to the change from a situation where the firm is a set of headquarters-subsidiary relationships, with the headquarters possessing the greater part of authority and initiative, to a more complicated system with stronger reciprocal interdependencies between units in different countries (Hedlund, 1986; Bartlett, Doz & Hedlund, 1990). In this new relation, the role of the headquarters may be more of that of the orchestrator and arbiter rather than that of the authoritarian planner (cf. Ghoshal, Moran & Almeida-Costa, 1995). And since subsidiaries in the new type of relation may be sources of, for example, important knowledge of potential use for other parts of the MNC, and in general exhibit considerable independent strategic initiative, authority relations are much more unclear. (For a general discussion of the connection between information and authority, see Aghion & Tirole, 1997). Closely connected to this view is the assumption that the sustainability of the competitive advantage of the modern MNC is less a matter of leveraging initial proprietary knowledge and brand labels and more a matter of the continuous exploration and exploitation of the new knowledge generated by international activities. For example, network contacts with firms in multiple countries may help generate the variety that fosters evolutionary MNC-wide learning processes. Because of the modern MNC s role as a knowledge-based network that operates on the basis of at least some shared heuristics and cognitive frames (see Ghoshal, Moran & Almeida-Costa (1995) on ABB), the MNC may be a low-cost (relative to the market ) mechanism for combining, generating, and transmitting valuable knowledge across subsidiaries. Thus, the rationale of the modern MNC is not just a matter of exploiting some initial knowledge assets; it is just as much a matter of continuous exploration in the dimension of knowledge. 1 Indeed, one may construct an argument that MNCs by virtue of the spread of their operations and their consequent exposure to many different bases of knowledge, possess potential learning advantages that are superior to those possessed by domestic firms. A common assumption in the recent literature on headquarters-subsidiaries relations is that some subsidiaries in the MNC will have, or ought to have, a strategic role in the organization which goes beyond their local undertakings and is quite different from the traditional role of a mere implementer of the parent company s 1 Thus, there has been a change of emphasis in the literature on this point, one that is echoed in the broader strategy literature, in which the emphasis has increasingly moved away from free-standing and tangible resources to an emphasis on the ability to renew knowledge resources. See, for example, Teece, Shuen and Pisano (1997).

3 M. Forsgren et al. / International Business Review 8 (1999) decisions. However, a closer look at this literature reveals that the models and perspectives, as well as the characteristics of this new creature, differ quite significantly. For example, there is no agreement on what ultimately causes one subsidiary to increase in importance in the multinational organization. To argue that this is because it possesses some strength is merely to beg the question, for we wish to know about the nature of this strength. For example, to refer to a perennially important debate in strategy thinking, is the ultimate source of the subsidiaries strength located in the environment or is it something intrinsic to the subsidiary firm? The aim of the paper is to link up with this general discussion in the context of the MNC. Specifically, we shall provide a discussion of the factors that may constitute the competitive (and therefore also, ex hypothesis, organizational) strength of a subsidiary within a MNC (Section 2, The Strengths and Strategic Roles of MNC Subsidiaries ), from which we derive propositions that are tested on data about foreign-owned firms in Denmark (Section 3, Empirical Analysis ). Although we are in the first instance interested in understanding the sources of subsidiary strength, we believe our discussions have implications for not only issues relating to sustained competitive advantage but also to more organizational issues. Thus, there may be a rather direct causal link between the competitive strength of a subsidiary and its organizational strength. 2. The competitive and organizational strengths of MNC subsidiaries 2.1. Sources of MNC subsidiary strength In some of the literature on headquarters-subsidiaries relations, the subsidiaries are seen as obtaining strategic roles within the MNC depending on their local resource level (Ghoshal & Nohria, 1989), product mandates (Roth & Morrison, 1992), innovation processes (Bartlett & Ghoshal, 1989), knowledge integration with the rest of the MNC (Gupta & Govindarajan, 1991), business networks (Forsgren, Holm & Thilenius, 1997) etc. Thus, it clearly emerges from the literature that the basis for obtaining a strategic role/organizational strength within the overall MNC organization is the control of some strategic resource, 2 be it privileged access to localized scarce and valuable inputs (e.g., natural resources, particular type of skills in the labor force, etc.), network contacts or superior technological knowledge. The work on product mandates and subsidiary mandates (i.e. subsidiaries which has responsibilities beyond its national market) indicate that resources like relative subsidiary competence and relative managerial expertise are important drivers when subsidiaries are striving to gain a broader mandate in the multinational organization 2 In the resource-based approach to strategy (see Foss, 1997), resources are strategic when they are scarce, valuable and hard to imitate. While the first two conditions can also be accepted here, the assumption of resources being hard to imitate needs some qualification, since it may be precisely the ability to imitate, or, what comes to the same thing, absorb, the important knowledge on the part of other subsidiaries that makes the relevant knowledge important to the whole MNC.

4 184 M. Forsgren et al. / International Business Review 8 (1999) (Birkinshaw, 1996; Roth & Morrison, 1992). According to Birkinshaw (1996, p. 491) the real engine of subsidiary growth is its distinctive capabilities, and that for a mandate to be effective it must built on those capabilities. In particular, one may conjecture that the more important the resources in question are to the rest of the organization for example, because their transfer (in the case of knowledge resources) to other subsidiaries may substantially increase the valueadded in these other subsidiaries the more pronounced will be the overall strategic role of the subsidiary that controls the relevant resources. To put it in economic terms, the larger the potential for MNC-wide economies of scope (Teece, 1982) or complementarities (Milgrom & Roberts, 1995), the stronger the role of the subsidiary in the MNC. Of course, even if there are virtually no economies of scope or complementarities, a subsidiary may still possess significant organizational strength in cases where it generates large revenues. 3 Thus, it is clearly an interesting question (and the one that will primarily occupy our attention in the following) from which basis the subsidiary can reach a certain favorable position within the MNC in the first place. If we assume, and the work we have cited so far makes this assumption plausible, that a subsidiary s strategic role is not only, and perhaps not primarily, a consequence of a formal decision at the headquarters level, then it is interesting to inquire into the underlying forces leading to some subsidiaries becoming more important and influential than other subsidiaries in the MNC. Without going too deeply into the literature about the differentiated MNC, it is possible to distinguish between three basic groups of sources of strength which, we suggest, may eventually lead to one subsidiary becoming more important than others Internal sources of strength: capabilities The first group can be labeled the subsidiary s capabilities a concept inspired by resource-based theories of the firm (Wernerfelt, 1984; Madhok, 1996; Foss, 1997). In this literature, the firm is conceptualized in four different, albeit closely related, roles. These are the firm as 1) a seeker of (sustained) competitive advantage, 2) an entity that grows most efficiently through related diversification, 3) a learning entity, and 4) an innovating entity (Teece, Shuen & Pisano, 1997). Arguably, the common theme that runs through these four conceptualizations is that of capability: firms achieve competitive advantage and grow on the basis of their capabilities, and they make competitive advantage and growth sustainable to the extent that they engage in continuous learning and innovative activity. Capabilities, in turn, are normally seen as productive bundles of routines of a highly tacit and social nature; they are operated by teams of individuals for some strategic purpose. They may be seen as constituting the firm s problem-solving ability, and they incrementally change 3 However, in that case a pertinent question is whether the subsidiary should be owned by the MNC or rather be spun off to either a stand-alone basis or ownership by another firm that has more potential for synergies with the subsidiary.

5 M. Forsgren et al. / International Business Review 8 (1999) through application to actual problems. Since capabilities are different across firms, they are associated with different efficiencies, and therefore yield differential rents when deployed to product markets that is, they provide the basis for competitive advantage. Moreover, because of their characteristics, capabilities are strongly intertwined with the organization itself and are therefore hard (meaning very costly) to trade in the market (Foss, 1993; Conner & Prahalad, 1996; Teece, Shuen & Pisano, 1997). However, in some cases, capabilities may be transferable inside firms, such as MNCs. 4 Thus, the basic idea in this approach is that a firm possesses and develops resources/capabilities that make it more or less unique compared with other firms. Even though different types of resources are allowed for, the main interest is on intangible, organizational resources that are all located at the core of the firm rather than in the environment. Unique ways of combining human resources (e.g., in professional firms), logistic systems that are intertwined with a good deal of tacit knowledge (e.g., IKEA), brand label capital (e.g., Coca Cola) or (production, marketing, sales...) experience (reflected e.g. in size and/or age) are examples of such capabilities. This group of resources has much in common with ownership or firm-specific advantages as these are described in mainstream foreign direct investment theory (Dunning, 1992) External sources of strengths: country, industry and network factors Whereas capabilities are clearly something intrinsic to subsidiaries, the two other groups that we here consider are more directly related to the subsidiaries environment in a broad sense. One of these groups may be labeled country/industry factors and has more to do with the location of the subsidiary and the surrounding environment. Factors such as the size of the local market, the country s endowment of production factors, its level of competition, industrial organization, etc. are examples of country factors that can differ between subsidiaries within an MNC and therefore also, in principle, provide different bases of subsidiary strength. These factors have much in common with Porter s analysis of the competitive advantage of nations (Porter, 1990), with Dunning s discussion of location-specific factors (Dunning, 1992), or Foss and Eriksen s concept of industry capabilities (Foss & Eriksen (1995), which they defined as capabilities that are shared by industry incumbents (e.g., industry-specific know-how or trust relations) and which can only be accessed by outsiders through substantial complementary investments. It is characteristic of these resources that they apply equally to all incumbents, for example, to all national firms or all firms in an industry, or at least to a significant subset of these. Clearly, tapping into such industry- or region-specific factors may be a motive for foreign direct investment 4 This points to the possibility of rationalizing the existence of the MNC in terms of capabilities and learning rather than transaction costs, incentives and property rights.

6 186 M. Forsgren et al. / International Business Review 8 (1999) and, in turn, a source of strength for a MNC subsidiary. For example, when Japanese computer and electronics firms establish themselves in Silicon Valley, it is because they wish to have access to Silicon Valley industry capabilities (Foss & Eriksen, 1995). But there is another group of factors that also has to do with characteristics of the environment, but is more a matter of business relationships with specific counterparts. The underlying theme behind these writings is that a firm s market context first of all consists of long-lasting relationships with certain customers, suppliers and other specific counterparts, rather than with an anonymous market (Ford, 1997; Håkansson & Snehota, 1995; Forsgren, Håkansson, Hägg, Johanson & Mattsson, 1995; Axelsson & Easton, 1992; Grabher, 1993). Moreover, firms are embedded in, and partly constituted by, these relationships, and, consequently, firms capabilities cannot really be analyzed independently of these relationships (Nohria & Eccles, 1992). Through firms accumulation of ties with other firms, a network gradually forms over time, and this network defines and constrains the opportunities that are available to individual firms. As a further implication, the sources of the competitive advantage of a firm cannot be understood without going into a detailed analysis of its specific business relationships. Although the two views are clearly markedly different, it is not necessarily the case that this network view is completely opposed to the capabilities view that we presented in the previous section. Simply think, as a starting point, of a firm s network connections as part of its resource portfolio, and as being given to the standard evaluation of resources in terms of whether these are scarce, valuable, hard to imitate, etc. (cf. Foss & Eriksen, 1995; Ring, 1996). Moreover, one may think of the firm s portfolio of network connections as being determined, in the first place, by its capabilities, although a prime motive for entering networks may lie in the wish to upgrade capabilities. However, in the resource-based perspective, one will still tend to see the ultimate determinants of organizational strength of a subsidiary as being located inside the unit it achieved a valuable portfolio of network connections because its own (complementary) capabilities allowed it to do so whereas in the network perspective (and other perspectives emphasizing the firm s environment), one tends to see these determinants as being located in the environment of the subsidiary The problem of the sources of subsidiary strength To sum up, we have identified two crucial sets of determinants of subsidiary (and per implication also organizational) strength, one set located in in-house capabilities (what we call Internal Factors) and another set located in the environment, that is, in either broad national factors (Country Factors) or in relationships with other firms in the market (although supported by in-house development activities) (Business Network Factors). The question which one of these have the upper hand in the determination of strength refers to what Michael Porter (1994) has called the longitudinal problem, that is to say, the problem of accounting for the ultimate determinants of firms competitive strengths. Porter argues that there are two main answers to the question of causality, one focusing on initial conditions that are either located in the

7 M. Forsgren et al. / International Business Review 8 (1999) firm (such as patents, initial reputations, capabilities, etc.) or in the environment, and one focusing on managerial choices, which are made under uncertainty and define the firm s positioning, configuration of activities and supporting investments in assets and skills. What we have called Internal Factors, Country Factors and Business Network Factor are all part of the initial conditions, so what we are interested in is ascertaining which types of initial conditions are the most important and whether there is any interaction between these different conditions, as both resource-based reasoning, the reasoning and reasoning from network theory (Porter, 1994; Foss, 1998) may suggest that there is. Capability and learning are crucial concepts in the resource-based theory as well as in the business network theory. The latter theory emphasizes that the capability of a company reflects not only the knowledge of its personnel and the bundles of routines within the organization but also the capabilities of other companies to which it is connected through business relationships. This means not only that much of the capability put in use in a company is derived from its relationships to others outside the company, but also that the development of capabilities is to a large degree taking place in those relationships (Håkansson & Snehota, 1995). From this follows also that the knowledge development process in the firm contains an (never ending) interaction between know-how linked to its personnel and know-how linked to relationships with business partners. Based on network theory, therefore, we would expect that the market performance of a firm is dependent on its business relationships with other firms. However, we would also expect that it is in reality difficult to make a sharp distinction between internal capabilities and external sources in terms of network relationships as these are reinforcing each other in an interacting way. Thus, Business Network Factors may influence Internal Factors because firms acquire network contacts in order to assist the process of upgrading their capabilities. And network factors, in turn, partly emerge from the interaction of firms, each possessing separate and different capabilities. Although there may thus be significant interaction effects between the two sets of explanatory factors, one of them may of course still be empirically much more significant than the other one as a determinant of subsidiary strength and the influence of the other one only manifesting itself indirectly. For example, if Internal Factors turn out to be the most explanatorily important determinants, it is still possible for Business Network Factors to exert an indirect influence, namely through Internal Factors. As a starting point one may suggest that factors within all the groups have an impact on the relative strength of the subsidiary within the MNC. In the following section, we use data on foreign-owned subsidiaries in Denmark to examine the determinants of the organizational strengths of the subsidiaries. We shall restrict our attention to Internal Factors and Business Network Factors only, for the very simple reason that our data set only refers to a single country, Denmark, and does not include data about regions or industries. The three hypotheses that we examine may, on the basis of the above reasoning, be formulated as:

8 188 M. Forsgren et al. / International Business Review 8 (1999) Hypothesis 1: Internal factors are positively related to the organizational strengths of MNC subsidiaries. Hypothesis 2: Business Network Factors are positively related to the organizational strengths of MNC subsidiaries. Hypothesis 3: There is an interaction effect between Internal Factors and Business Network Factors when explaining the organizational strengths of MNC subsidiaries. The expected relationship among the two independent variables (the Internal Factor and the Business Network Factor) and the dependent variable (the Organizational Strength) is shown graphically in Fig Empirical analysis The sample analyzed in this study comprises foreign-owned production firms in Denmark. It is based on a survey conducted in 1991 among all foreign-owned manufacturing subsidiaries in Denmark. The database contains detailed information on a total of 141 firms, corresponding to 55% of all foreign-owned manufacturing subsidiaries in Denmark with at least 20 employees. Among the 141 foreign-owned subsidiaries in Denmark, 40 were green-field investments, whereas 101 were established as acquisitions. Table 1 lists the basic characteristics of the sample of foreign-owned subsidiaries in Denmark in 1991 (for a more detailed description of the sample, see Pedersen & Valentin, 1996). On average, the foreign-owned subsidiaries have a relatively high R and D intensity compared with other Danish firms. Their R and D intensity (measured as R and Fig. 1. Graphical presentation of the three hypotheses.

9 M. Forsgren et al. / International Business Review 8 (1999) Table 1 Characteristics of the foreign-owned subsidiaries in Denmark Characteristics Mean Std. Dev. Average turnover in millions DKK Sales in Denmark as share of total turnover Export as share of total turnover Internal export in MNC as share of total turnover External export as share of total turnover R and D expenses as share of total turnover Average number of employees Engineers as share of total staff Skilled workers as share of total staff R and D staff as share of total staff D staff as proportion of total staff) is 4.9 which is almost twice as high as the average in Danish industry. Almost fifty percent of the total turnover is exported to other countries. The relatively high export intensity is probably due to the small Danish home market Firm-specific properties In order to test the hypotheses in the preceding section we need to estimate the Internal Factor and the Business Network Factor of the 141 foreign-owned subsidiaries. The Internal Factor has to do with capabilities that are specifically linked to the individual subsidiary as such rather than the environment of the subsidiary, while the Business Network Factor refers to relationship with specific counterparts in the network context as well as attributes of the specific country. In order to obtain an understanding of the importance of the Internal Factor and Business Network Factor the subsidiaries were asked to evaluate their strength and weaknesses, as perceived by the parent company. More precisely the following questions were used: Please, indicate on a scale ranging from 5 to 5 to what extent the given firm-specific property is a strength ( 5) or a weakness ( 5). The following six firm-specific properties were listed: Product development expertise, technological expertise, knowledge among professional staff, supplier relationships, advanced user contact and insight into competitors. Some of these firm-specific properties can be expected to reflect general knowledge and competencies rooted in the company s own organization and personnel while the others have to do with sources of competence based on relationships with the main actors in the business environment, that is customers, suppliers and competitors. In order to verify whether these firm-specific properties can be grouped into different categories a factor analysis was made. The six firm-specific properties were analyzed in factor-analyses where only the

10 190 M. Forsgren et al. / International Business Review 8 (1999) factors having eigenvalues greater than 1 are considered significant. The rationale for the eigenvalue criterion is that any individual factor should account for the variance of at least a single variable if it is to be retained for interpretation. In this case each factor should at least account for one sixths of the total variance among the six firm-specific properties. Only two factors fulfilled the eigenvalue criterion. The factor loadings (correlation-coefficient) and communalities of the six firm-specific properties on the two factors are shown in Table 2. The two factors describe almost two thirds of the total variation among the six firm-specific properties. The table shows that in Factor 1 the factor loadings are much higher for Product development expertise, Technological expertise and Knowledge among professional staff while in Factor 2 the loadings are higher for Supplier relationships, Advanced user contact and Insight into competitors. The factor analysis supports the assumption that the first three firm-specific properties belong to the same category and together reflect the internal capabilities of the subsidiary while the others are more related to capabilities based on external factors. Therefore, these two factors will be employed in the analysis below as proxies for the Internal factor and the Business Network factor, respectively Measuring the organizational strength of MNC subsidiaries The organizational strength of a subsidiary is a complex concept containing many different dimensions. However, one basic dimension is the subsidairy s strength in the market-place, that is, its competitive strength. There are strong reasons to assume that the more successful, in economic terms, the subsidiary is, the stronger its position within the MNC. Therefore, indicators of organizational strength should reflect the subsidiary s ability to grow and generate profits. In the following we will use the subsidiary s strength in the market as a proxy for its organizational strength in the MNC. As our possibilities to construct reliable estimations of the profit rate are limited (only accounting profits are available), we have chosen to use growth as one indicator of competitive strength. But there is also reasons to assume that, due to the roles played by the subsidiaries in the relatively limited Danish market Table 2 Factor-analysis of six firm-specific properties. Factor loadings and communality Factor 1 Factor 2 Community Product development expertise Technological expertise Knowledge among professional staff Supplier relationships Advanced user contact Insight into competitors Eigenvalue Percent variance explained 41.0% 19.4% 61.4%

11 M. Forsgren et al. / International Business Review 8 (1999) (Pedersen & Valentin, 1996), the extent to which the subsidiary manages to export its production to countries outside Denmark can also be considered to reflect strength in the market-place. More specifically, therefore, we have used two different proxies for the organizational strength of a subsidiary 5 : 1. The yearly employment growth in the subsidiary in the last ten years ( ) (GROWTH); and 2. The export intensity of the subsidiary in Another argument for using these proxies for organizational strength is that when we have perceptual indicators (managers perception of strength and weaknesses) for the independent variables it is preferable to use more objective data for the dependent variables (avoid biases in the data-set). Our basic model contains the relationships between three latent variables; Organizational Strength, Internal Factors and Business Network Factors. Lisrel permits the simultaneous estimation of such variables and their casual linkages (Jöreskog & Sörbom, 1993) by employing indicators of the true variables. It uses the empirical pattern of relationships between these indicators in order to define linear indexes representing the latent variables. The discrimant validity (the extent of separation between latent variables) and convergent validity (the homogeneity of the latent variables) are judged by studying the t-values and R 2 -values of each relation in the model. The R 2 -values is a measure of the strength of a linear relationship estimate and as a test of significance, the t-values are studied (Jöreskog & Sörbom, 1993). To assess the validity of the variables, a model with no causal relations between the latent variables (a measurement model) is created. The results of the validity test of our latent variables are shown in Table 3. All the t-values are above 3.5 and therefore highly significant. This indicate that the indicators are in fact measuring the same underlying latent variable (either Table 3 The Latent variables and their indicators Latent variables Indicators R 2 t Internal factors Product development Technological expertise Knowledge among professional staff Business network Supplier relationships factors Advanced user contact Insight into the competitors Organizational Growth in Employment strength Export-intensity The return on equity in the subsidiary was tested as well, but the results was rather poor (uncorrelated with the other performance measures). The reason for this is probably that the (publicly announced) return of the subsidiary is not reliable, because of managed transfer pricing inside the MNC.

12 192 M. Forsgren et al. / International Business Review 8 (1999) Internal Factors, Business Network Factors or Organizational Strength). Except for one, all the R 2 -values are also above The R 2 -value for the indicator, growth in employment, is just below This is all in all indicating that our latent variables are discriminantly valid. We have therefore conducted a structural equation model based on Lisrel, in which the different indicators described above have been applied. The way the model has been constructed allows for testing of both direct and indirect effects of H1 H3. The model and the results of the test are shown in Fig. 2. The Chi-square value of the model is 25.8 with d.f. 16 (p 0.05) indicating that the model fits the observed values rather well (the model is significant). The NFI is 0.85 which indicates that the model is able to explain more than four fifths of the variance and covariance in the data. All the paths connecting the indicators with the latent variables were found to have significant values. All indicators are highly significant with p The analysis confirmed the consistency of the measures of the latent variables. Also, the analysis confirmed that individually the latent variables did include the connected indicators. The coefficient estimates for the path connecting Internal Factors and Business Network Factors with Organizational Strength were 0.58 and 0.14 and t- values were 5.11 (p 0.01) and 0.66 (p > 0.10), respectively. In general the two factors both positively influence organizational strength. However, while Internal Factors have a significant positive effect on the performance measure, Business Network Factors have an insignificant effect. Finally the covariance between the Internal Factor and the Business Network Factor is highly significant. Therefore, the overall result of the model testing is that Fig. 2. Lisrel-model of Organizational strength of MNC subsidiaries.

13 M. Forsgren et al. / International Business Review 8 (1999) Hypothesis 1 but not Hypothesis 2 is supported, that is, the Internal Factor has the upper hand and are more important than the Business Network Factor in influencing the organizational strength of the subsidiary. But the testing also supports Hypothesis 3, that is there seems to be an interaction effect between the two factors. Thus, compared to our basic model in Fig. 1, we can tentatively conclude that the Business Network Factor may affect the organizational strength of the company, but only indirectly and through the Internal Factor. A possible interpretation we can make is that organizational capabilities are crucial for the performance in the market place, but that the existence and development of these capabilities are dependent on the organization s long-lasting relationships with customers, suppliers and competitors. 4. Conclusion In this paper, we have taken some stabs at a classic problem in strategy research which we, following Porter (1994), have called the longitudinal problem: which are the ultimate determinants of organizational strength of MNC subsidiaries? Do factors that are internal to subsidiaries have the upper hand or is rather factors that can be located in the environment? On the basis of data on foreign-owned subsidiaries in Denmark, we have concluded that Internal Factors seem to be the more important explanatory variables, but that there may be important interaction effects between Internal Factors and Business Network Factors. The interplay between the two groups of factors is certainly interesting in its own right. For example, it is an indication that the perennial question of where the ultimate determinants of competitive strength are located should be somewhat rephrased to the turn on the question of what we really mean by the resource or capabilities boundaries of a company. A possible outcome of such an analysis could be that a sharp distinction between Internal Factors and Business Network Factors is more misleading than productive when sources of strength are inquired into. At least, our analysis suggests that there is a direct link between strength and internal capabilities, but that an analysis of the sources of the internal capabilities should include the capabilities connected to business relationships with suppliers, customers etc., that is to say, capabilities that are really properties of relations rather than unambiguously lying inside the firm (whatever that may mean). If this is so, the resource-based perspective and work on business networks should be combined, and used to deal with questions concerning how the two groups of factors interact and reinforce (or sometimes weaken) each other. At any rate, the findings can be read as a call for further theorizing with respect to these two complementary perspectives. Further theorizing must also consider the issue of the link between market (competitive) strength of a subsidiary and its organizational strength in the MNC. In our empirical test we have used indicators reflecting a subsidiary s market strength rather than its organizational strength. Although we can assume that a subsidiary s economic performance has a positive influence on its organizational strength within the MNC, we can not expect a one-to-one relationship between these variables. The latter concept reflects the position of a subsidiary relative to other subsidiaries within

14 194 M. Forsgren et al. / International Business Review 8 (1999) the group rather than performance in an absolute sense. For instance, a low market growth of a subsidiary does not always have to be linked to a low organizational strength if other subsidiaries within the MNC have lower growth rates. Further measurements of organizational strength should take these factors into account. The causal link between market strength and organizational strength may also be complicated by the fact that there are different sources of the strength of a subsidiary, for example, both Internal Factors and Business Network Factors. And it is not a priori given that a subsidiary that primarily bases its strength on Internal Factors (e.g., intellectual capital that is proprietary to the MNC) will have the same organizational strength as a subsidiary that bases its strength on Business Network Factors. However, we leave these issues open for future research. Acknowledgement The comments of an anonymous reviewer are gratefully acknowledged. All errors, obscurities, etc. are entirely our responsibility. References Aghion, P., & Tirole, J. (1997). Formal and real authority in organizations. Journal of Political Economy, 105, Axelsson, B., & Easton, G. (1992). Industrial networks. A new view of reality. London: Routledge. Bartlett, C. A., Doz, Y., & Hedlund, G. (1990). Managing the global firm. London: Routledge. Bartlett, C. A., & Ghoshal, S. (1989). Managing across borders. The transnational solution. Boston: Harvard Business School Press. Birkinshaw, J. (1996). How multinational subsidiary mandates are gained and lost. Journal of International Business Studies, Third Quarter, Conner, K. R., & Prahalad, C. K. (1996). A resource-based theory of the firm: knowledge versus opportunism. Organization Science, 7, Doz, Y., & Pralahad, C. K. (1981). Headquarters Influence and Strategic Control in MNCs. Sloan Management Review, Fall, Dunning, J. (1992). Multinational enterprises and the global economy. Wokingham: Addison-Wesley. Egelhoff, W. G. (1988). Organizing the multinational entreprise an information-processing perspective. Cambridge, MA: Ballinger Publishers Company. Ford, D. (1997). Understanding business markets. London: The Dryden Press. Forsgren, M. (1989). Managing the internationalization process. The Swedish case. London: Routledge. Forsgren, M., & Johanson, J. (1992). Managing in International Multi-Centre Firms. In M. Forsgren, & J. Johanson, Managing networks in international business. Philadelphia: Gordon and Breach. Forsgren, M., Holm, U., & Thilenius, P. (1997). Network Infusion in the Multinational Corporation. In I. Björkman, & M. Forsgren, The nature of the international firm. Nordic contributions to international business research. Copenhagen: Handelshøjskolen Forlag. Forsgren, M., Håkansson, H., Hägg, I., Johanson, J., & Mattsson, L.-G. (1995). Firms in networks. Uppsala: Acta Universitatis Upsaliensis. Foss, N. J. (1993). Theories of the firm: contractual and competence perspectives. Journal of Evolutionary Economics, 3, Foss, N. J. (1997). Resources, firms, and strategies: a reader in the resource-based perspective. Oxford: Oxford University Press.

15 M. Forsgren et al. / International Business Review 8 (1999) Foss, N. J. (1998). Networks, capabilities, and competitive. Forthcoming in Scandinavian Journal of Management. Foss, N. J., & Eriksen, B. (1995). Competitive advantage and industry capabilities. In C. A. Montgomery, Evolutionary and resource-based theories of the firm. Boston: Kluwer. Ghoshal, S., & Bartlett, C.A. (1990). The multinational corporation as an interorganizational network. Academy of Management Review, 15, Ghoshal, S., & Nohria, N. (1989). Internal differentiation within multinational corporations. Strategic Management Journal, 10, Ghoshal, S., Moran, P., & Almeida-Costa, L. (1995). The essence of the megacorporation. Journal of Institutional and Theoretical Economics, 151, Grabher, G. (1993). The embedded firm. On the socioeconomics of industrial networks. London: Routledge. Gupta, A. K., & Govindarajan, V. (1991). Knowledge flows and the structure of control within multinational corporations. Academy of Management Review, 16(4), Gupta, A. K., & Govindarajan, V. (1994). Organizing for knowledge flows within MNCs. International Business Review, 4, Hedlund, G. (1986). The hypermodern MNC a heterarchy? Human Resource Management, 25, Håkansson, H., & Snehota, I. (1995). Developing relationships in networks. London: Routledge. Jöreskog, K.-G., & Sörbom, D. (1993). LISREL 8: structural equation modelling with SIMPLIS command language. Chicago: Scientific Software International. Madhok, A. (1996). The organization of economic activity: transaction costs, firm capabilities and the nature of governance. Organization Science, 5, Milgrom, P., & Roberts, J. (1995). Complementarities and fit: strategy, structure, and organizational change in manufacturing. Journal of Accounting and Economics, 19, Nohria, N., & Eccles, R. G. (1992). Networks and organizations: structure, form and action. Boston: Harvard Business School Press. Pedersen, T., & Valentin, F. (1996). The impact of foreign acquisition on the evolution of Danish firms: a competence-based perspective. In N. J. Foss, & C. Knudsen, Towards a competence theory of the firm. London: Routledge. Porter, M. (1990). The competitive advantage of nations. New York: The Free Press. Porter, M. (1994). Towards a dynamic theory of strategy. In R. P. Rumelt, D. Schendel, & D. J. Teece, Fundamental issues in strategy. Boston: Harvard Business School Press. Ring, P. S. (1996). Networked organization. Uppsala: Acta Universitatis Upsaliensis. Roth, K., & Morrison, A. J. (1992). Implementing global strategy: characteristics of global subsidiary mandates. Journal of International Business Studies, Fourth Quarter, Teece, D.J. (1982). Towards an economic theory of the multiproduct firm. Journal of Economic Behavior and Organization, 3, Teece, D. J., Shuen, A., & Pisano, G. (1997). Dynamic capabilities and strategic management. In N. J. Foss, Resources, firms, and strategies: a reader in the resource-based perspective. Oxford: Oxford University Press. Wernerfelt, B. (1984). A resource-based view of the firm. Strategic Management Journal, 5, Mats Forsgren is Professor of International Business at the Department of International Economics and Management, Copenhagen Business School. He has published several books and articles on international business, for instance Managing the Internationalization Process (1989, Routledge), Managing Networks in International Business (1992, Gordon and Breach), Divisional Headquarters og Abroad (1995, Journal of Management Studies) and Embeddedness and Subsidiary Control in the Multinational Corporation (1996, International Business Review). Torben Pedersen, Ph.d. is Associate Professor at the Department of International Economics and Management, Copenhagen Business School. He has published several articles on the internationalization process of firms, MNE strategies, and International Corporate Governance in journals such as Journal of International Business Studies, International Review of Law and Economics, Management International Review and International Journal of Economics of Business.

16 196 M. Forsgren et al. / International Business Review 8 (1999) Nicolai J Foss, Ph.d. is Professor of Strategy and Economic Organization, Department of Industrial Economics and Strategy, Copenhagen Business School. He has contributed to and edited several books on the theory of the firm, strategy, and doctrinal history, and published numerous papers in journals such as Organization Science, Journal of Management Studies, Journal of Evolutionary Economics and Cambridge Journal of Economics.