Multinational Firm Organizational Strategies for Headquarters and Subsidiaries – Valutrics
A foreign multinational company facing local competition needs to overcome its liability of foreignness and gain competitive advantage by makinguse of the big company network. At the same time, the local subsidiary needs to react individually to the local competitive forces.
When firms broaden their geographical scope, they frequently go through three different stages:
1. Prepare for cross-border activities through national consolidation
2. Set up (or buy) international operations that are run on arm’s length principles after an initial phase of restructuring
3. Consolidate the international network of subsidiaries through increased central coordination and control
The order in which these stages occur depends on, among other factors, the nature of the business (i.e. how local it is) and the structure of the home market.
Headquarters may perform the following activities:
1. Portfolio strategy: The centre decides upon the composition of businesses (e.g. vertical integration and diversification); the corporate headquarters acts as an investor in businesses and manages the fund allocation process among subsidiaries. Headquarters evaluates profit prospects of each business unit, steers corporate resources into the most attractive strategic opportunities, and divests businesses that are not profitable or fit poorly with the overall firm.
2. Negotiation and control of business unit performance: The centre supports the formulation of subsidiary strategies, discusses past business performance with subsidiary managers, and defines new targets and incentive schemes together with the subsidiary management; the centre periodically controls the performance of the foreign units.
3. Directly contribute to the resource and capability endowment of the business units: Headquarters, for example, assigns key management positions and performs certain activities for which single subsidiaries do not have the scale or experience (such as ICT services or stakeholder management).
4. Initiate coordination and collaboration within the network of subsidiaries:
When firms enter the third phase of value creation, they aim at consolidating the international network of subsidiaries through increased central coordination and control; since all subsidiaries are in internal competition for financial resources and management attention, it is not very likely that they will attempt to create cross-border synergies spontaneously. Corporate headquarters has the responsibility to detect opportunities for collaboration and create systems that favour such initiatives.
Corporate strategy for diversified multi-business companies is intimately linked to competitive advantage at the business unit level. Competition occurs at the business unit level. Diversified companies do not compete— only their business units do. By implication, successful corporate strategy must grow out of and reinforce competitive strategy on a subsidiary level.
If the corporate HQ is to enhance subsidiary performance, it must find ways to encourage subsidiaries to make decisions and contributions, which they would not make if they focused solely on the business of their own unit, that increase the firm’s overall performance. For example, one business unit might acquire a system for inventory management that could be expanded to handle inventory in another business with little incremental cost. A product innovation in one unit might confer a first mover advantage on another unit that produces a complementary product in the Multinational Firm. Beneficial as such value creation opportunities might seem, unless corporate headquarters intervenes, subsidiaries will not engage in behaviour that contributes to other subsidiaries performance for two reasons.
First, as subsidiaries are specialized and focused on their own business, they lack an overview of business needs of other units. Most managers within a business unit care most about their own business, but do not know how their actions and investments could affect the performance of other units. Thus, it is corporate managers responsible for overseeing a number of business units who can recognize that investments made in one unit might have a payoff in another unit.
Second, unless corporate headquarters intervenes, subsidiaries have little incentive to share their assets, even if they would understand and know who else could use them in the Multinational Firm. It is the responsibility of corporate management to establish the appropriate organizational context and design appropriate cross-unit linkages to unlock profit potentials available in the multi-business firm.
To illustrate the HQ’s function in a multinational bank has seven key responsibilities:
• Define and set the strategy and targets
• Choose and develop key people
• Facilitate integration within the Group
• Ensure key project implementation
• Support creation of synergies and sharing of best practices
• Support the local banks in reaching key objectives
• Monitor the achievement of targets
In summary, corporate-level interventions that add value to a family of business units in the modern corporation result from (a) the ability to identify, select, and leverage valuable knowledge11as well as (b) corporate systems of planning and control that seek to tailor headquarters’ interventions according to their own characteristics in relation to the needs of subsidiaries.
The Changing Role of Subsidiaries
Subsidiary roles have changed from mere sales outlets to active contributors to the resource endowment of the Multinational Firm. In early stages of international presence, ownership-specific advantages are mainly developed at the headquarters site and leveraged abroad. It becomes increasingly evident that these subsidiaries develop distinctive resources and competences as they grow in size. Competitive advantage, therefore, does not come from the corporate headquarters alone but from a network of subsidiaries that interact with each other and their headquarters. Although this phenomenon is more recent in financial services, we can observe that decentralized competence centres emerge that take up a strongly contributing role within the network of operating units.
As financial services firms become more international, subsidiaries have increasingly gained importance as sources of competitive advantage in the Multinational Firm, and as a consequence of their growth, we can observe the emergence of various subsidiary types. The multinational financial services firm does not rely solely on sources of competitive advantage created in the home country, but facilitates the peripheral development of knowledge, competences, or other sources of competitive advantage. Knowledge transfer among subsidiaries provides opportunities to improve an Multinational Firm performance. In the first half of the twentieth century, the dominant model for knowledge sharing in the Multinational m was to govern the subsidiaries in a ‘paternalistic’ way to make sure that home-country innovations would be introduced across affiliated subsidiaries. As Multinational Firms grew, subsidiaries were not only used as mere sales units but also tasked to scan their environment for new ideas and technologies. ‘Competence Centres’ were created that signalled to other units that they had the mission (to the exclusion of other subsidiaries) to innovate in a certain area. While this second model of organizing the Multinational Firm worked well during the 1970s and 1980s, new governance models based on a more liberal management philosophy later emerged. The basic idea was that new knowledge could emerge from everywhere in the Multinational Firm and the headquarters needs to pursue a more democratic approach to the pursuit of new opportunities. In contrast to this centre-dominated view of the Multinational Firm, the liberal perspective purports that subsidiaries are capable, encouraged to develop strategies on their own, and do not exclusively rely on the role assigned by the headquarters.17This discussion hints at the eternal trade-off between centralizing decision power and the delegation of authority to decentralized units.
As a result, most financial services firms are not confronted with the choice between a paternalistic and a liberal model, but rather an issue of combining the two. In other words, knowledge exploration and knowledge exploitation have to be carefully balanced. Knowledge exploration is about developing options for the organization by activities such as search, variation, risk-taking, experimentation, play, flexibility, discovery, and innovation. Exploitation, on the other hand, aims at ensuring survival by using existing resources for rent creation. Traditional managerial activities such as planning, organizing, controlling, or product-market positioning are in the foreground. Balancing the need for a democratic and liberal approach to facilitate innovation and exploration with the need for a more paternalistic approach to ensure operational efficiency, survival, and exploitation implies two fundamentally different ways in which power is distributed and used in the Multinational Firm. Autonomous strategic behaviour of subsidiaries creates new knowledge and hence new entrepreneurial options for the Multinational Firm. However, for the innovative idea to be successfully implemented in the organization, it has to be integrated into its concept of strategy.
Control Mechanisms in the Multinational Firm
To structure the relationship with headquarters and subsidiaries within an international financial services firm, various approaches beyond the mere design of line functions may be used. Such control systems allow senior management to determine whether a business unit is performing satisfactorily. They also provide sufficient motivation for local management to see that the business unit continues to do so. As such, the activity of controlling involves negotiating objectives, measuring performance against those objectives, feedback on the results achieved with corresponding incentives or sanctions.
Control systems not only coordinate business unit activities in complex organizations and motivate managers to achieve performance targets but also give corporate headquarters management an idea of when to intervene.
Control systems ensure that strategic decisions are made based on relevant data; they create the conditions for a consensus among key decision-makers by managing relative power among managers. Corporate headquarters may use behavioural control mechanisms that monitor and reward inputs into strategic decision-making through supervision and approval as well as output control, which manages the performance outcomes of decisions. Controlling structures in the Multinational Firm increasingly refer to the ends of strategy making but not the means. Corporate headquarters of successfully operating multinational firms increasingly delegate the responsibility of strategy making to the local subsidiaries while insisting on tight performance controls.
Control mechanisms in the Multinational Firm need to take differences in subsidiary evolution into account. As a consequence, while designing control mechanisms, one may need to take into account that in the same Multinational Firm a broader variety of control mechanisms may be used according to the subsidiary context (e.g. subsidiary charter, market size, geographical distance) as well as the headquarters’ characteristics (e.g. their business understanding, availability of complementary resources and capabilities, historical relationships with key subsidiary managers). While multiple control mechanisms and performance measurement procedures may vary, corporate headquarters nevertheless attempt to exercise procedural justice to avoid de-motivation of subsidiary management teams.
However, the design of control structures does not only vary according to subsidiary characteristics. Most Multinational Firms are complex organizations with different subsidiary types and various product divisions. Control systems have to reflect that complexity. It is therefore essential for corporate headquarters to design the control systems in a way that does not harm the mutual trust and motivation of subsidiary management teams. Differences in input, process, or output control systems may be well accepted by subsidiary management teams if procedural justice27—the extent to which the dynamics of the decision process are judged to be fair—is guaranteed by headquarters. Procedural justice contributes to obtaining voluntary cooperation of individuals during strategy formation and implementation processes.
Aligning Interests between Headquarters and Subsidiaries
To address problems of incentive alignment and achieve better coordination, headquarters can engage in several interventions. For example, corporate headquarters may devise a way for the investing or contributing unit to get ‘credit’ for the value their investment creates in other units (e.g. providing incentives). The headquarters can also intervene through providing public acknowledgement and support for subsidiary concerns, and by influencing corporate career paths in the Multinational Firm for subsidiary managers (e.g. non-monetary incentives). Vertical linkages are established by headquarters through personal supervision of the subsidiary manager by HQs (e.g. sending expatriate managers as monitors) and establishing bureaucratic mechanisms including rules, programmes, and planning procedures to achieve coordination and to monitor subsidiaries. HQs can also influence mutual understanding by establishing cross-linkages in vertical HQs-subsidiary as well as inter-subsidiary relations. For example, HQs may offer subsidiary managers headquarters-based training programmes, executive development programmes that include participants from headquarters, and headquarters mentors for managers of foreign subsidiaries (e.g. vertical linkages). In addition, corporate management may sponsor and encourage inter-subsidiary linkages, for example, through joint decision-making using inter-unit committees and supervisory boards consisting of subsidiary managers to evaluate threats to corporate technology. Alternatively, centralizing investments in a valuable asset such as a brand name or shared R&D facilities by creating a unit that manages the assets for several business units (e.g. designing an organizational context) might create opportunities to realize economies of scale and scope in addition to making appropriate investments that individual subsidiaries would not be willing to bear.
Headquarters need to critically evaluate when such interventions add value. For example, to monitor a subsidiary, top management needs to understand the business of the subsidiary and its current situation. To apply financial incentives, there should be a strong positive correlation between the behaviour of subsidiary managers and subsidiary results. If this relation is weak, financial incentives might be reducing subsidiary performance. If financial performance-based incentives work well, they may undermine appeals to common goals as attempted by vertical integration mechanisms. Financial incentives force subsidiary managers to focus on their businesses, but this focus might lead to the neglect of common goals. Therefore, HQs should select appropriate interventions and apply them with care to add value, taking interactions between interventions into account.
Knowledge Flows within the Multinational Firm
The role of the corporate parent in the Multinational Firm as argued in the last section is more complex as compared to locally operating firms, and corporate interventions have to vary according to subsidiary characteristics. Corporate interventions also need to vary according to the degree of their respective knowledge inflow and outflow, which shows the degree of interdependence between a subsidiary and other Multinational Firm units. Different subsidiaries call for differences in the application of, for example, vertical and horizontal integration mechanisms, as well as incentives. ‘Local innovators’ are characterized by few knowledge transactions between other units of the Multinational Firm. Consequently, local innovators will most likely have a low need for vertical integrative mechanisms and a low level of horizontal linkages with other units. Because local innovators are most likely not responsible for other units’ businesses, the performance bonus of local innovators will most likely not depend on a larger cluster of subsidiaries. Within the general trend towards outcome measures, it is more likely that local innovators will be measured on performance outcomes than on behaviour controls. Multinational Firm headquarters are simply not likely to fully understand all of the subsidiary’s businesses and required behaviour well enough. In contrast, ‘integrated player’ subsidiaries need more support from headquarters in terms of a horizontal integration mechanism. ‘Implementors’ just apply knowledge received from other units. In a multinational financial services firm, it is not necessary that all units contribute as competence centres with specific knowledge. If units are small, operating in a specific context, or with no relevant competences for the group, it may make sense to limit the units’ knowledge outflow. ‘Global innovators’ are typically self-sufficient in their own knowledge creation, but have a great responsibility to share their knowledge with other units. Citigroup’s software development subsidiary in Bangalore is such a case. For these units, the creation of horizontal integration mechanisms like socialization opportunities is the most important corporate intervention. To the extent that headquarters understands little of what the subsidiary does, the value-adding influence of headquarters is to enable the subsidiary to share its knowledge.
To summarize, the likelihood of corporate interventions to be successful depends on both subsidiary and headquarters characteristics. In particular, the smaller the gap between what a subsidiary needs and what headquarters can provide, the greater the likelihood of successful direct interventions. In some situations, however, it will be beneficial for headquarters not to intervene directly, but rather act as a parent, providing a value-adding infrastructure to otherwise relatively autonomous subsidiaries (e.g. local innovators, subsidiaries outside the heartland). The next section is concerned with intervention styles (direct vs. indirect) and degrees of intervention (hands-off, hands-on, or selectively).
Towards Increased Standardization?
A relevant managerial issue is to understand where and how standardization of services increases leads to competitive advantage. While it is tempting to assume that Wal-Mart offers a standardized set of products in all of its outlets this is simply not the case. Each store manager has the responsibility for selecting and stocking the items most in demand in his or her region. On reflection, this is not that surprising given the vast diversity that we know exists on the American continent. For instance, winter clothing and snow equipment will be in much greater demand in the chilly northern states than the milder western and southern regions of the country. Wal-Mart’s success, therefore, does not arise from providing a standardized and consistent menu of products like McDonald’s. Rather, a large degree of Wal-Mart’s success can be attributed to back-office or logistical integration. Wal-Mart derives great efficiencies through the integration of warehousing, transport, ordering, and information systems. Information from thousands of stores flows immediately back to central warehouses enabling shelves to be replenished within hours and extra inventory automatically ordered from suppliers. Thus, the use of common systems and centralized warehousing enables significant economies of scale to be realized. Well-developed relationships also exist with suppliers and elaborate IT systems enable ‘cross-docking’ to occur—the ability to unload supplier deliveries directly onto trucks bound for individual stores, thus saving on warehouse storage and unloading/reloading expenses.
Similarly, Amazon.com provides a highly customized service to millions of Americans, literally being able to deliver a personal selection from the world’s largest catalogue of books directly to a customer’s door within a few days.
Once again, the key to the system is not so much standardization as logistical integration. Amazon operates its own servers and warehouses which enable over 95 per cent of orders to be dispatched the same business day. The use of a common carrier, UPS, enables a high degree of efficiency in delivery (not to mention an impressive diversity of delivery options) as well as the ability for customers to track their orders. While Amazon and Wal-Mart represent a high level of logistical integration, we also see relatively simple levels of continental integration in North America that are currently unachievable in Europe. For instance, it is relatively simple (even trivial) for an American business to set up a toll-free (800/888) number that will operate across the United States and Canada. Tariffs exist not only for continental-range numbers but also for tollfree numbers operating in one or a few states. Thus, a company like British Airways is able to offer a single contact number for all its customers flying throughout North America (with separate numbers for its business class and frequent flyers). British Airways cannot offer this level of integration in Europe, relying instead on a separate set of numbers for each country in Europe. It is clear that there are substantial economies of scale involved in achieving logistical (or back-office) integration in the service industry. We have managed to illustrate a couple of the better known examples. However, it should be noted that American companies have made great strides in integrating a wide range of service businesses, including banking services, information technology, retailing, and health services at the continental level.
A similar trend can be observed in financial services. There is an increase in the number of firms that create regional product factories and operational back-office centres that develop and process the financial services products from various countries.
Recognizing Market Differences
The way companies are organized should reflect the magnitude and type of differences of the countries they operate in. To participate in multiple national markets complicates corporate strategy. The key challenge is to understand the degrees of similarity and difference across markets, and to exploit these similarities and differences through an adequate organizational design. It is, for example, a corporate strategy task to decide whether subsidiary units should cater for variations in preferences for products or services sold in different markets, which would in turn compromise benefits of standardizing products across various national operations. However, it is not only customers that have different tastes and habits; employees cannot be treated equally all over the world. Another central issue is consequently whether a multinational financial services firm should apply a set of common processes across all its geographically dispersed units or alternatively grant autonomy to regional units to accommodate local customs and norms. Organization design is the top management task that must accommodate the specific challenges in operating across national boundaries. These challenges can be grouped into two opposing forces: local responsiveness, global efficiency.
Organizational design geared to achieve global efficiency is appropriate if country markets exhibit similarities. The potential to use similarities of market has increased due to three driving forces:
• Improvements in both international and national transportation infrastructures have reduced the costs of transporting goods and people.
• Diffusion of telecommunication technologies and Internet-based systems has enhanced the ability of firms to coordinate a dispersed network of businesses.
• Efforts to harmonize intellectual property law, contract law, and other forms of the legal infrastructure have also facilitated convergence in the economic organization of industries and markets.
• The music channel MTV started its international operations with a global approach, airing its content developed in the United States in Europe without significant adaptations, until local competitors emerged and disputed MTV’s supremacy.
In Germany, the local television station Viva started in 1993 to broadcast German songs and shows moderated by Germans for Germans. Two years later, Viva Zwei (‘Viva Two’) was launched. MTV reacted to this threat by adding regional content to its global programme and finally decided to forge alliances with local TV channels to better customize its content. This battle for local customers ended by Viacom—MTV’s parent company—buying 98 per cent of Viva and thereby virtually creating a monopoly for music television in Germany.
The organizational challenge is to become globally efficient by reaping economies of scale and scope in processes, transferring best practices from one place to another, tapping into location advantages, and leveraging firmspecific advantages across countries through similar processes. Organizational processes need to be designed to take advantage of cross-country similarities to the greatest extent.
On the other hand, many characteristics of doing business internationally remain localized. Country variations reflect, for example, differing needs of consumers in different regions of the world. Such differences in consumer tastes are one issue among others that require local responsiveness in the Multinational Firm’s processes in addition to providing the chance to engage in arbitrage.
If different countries served have special social, institutional, and economic features, MNCs must accommodate country-specific practices that deviate from other processes in the Multinational Firm. A key complication of corporate strategy is then to grant subsidiaries autonomy without losing control or acquire the necessary knowledge that makes a particular subsidiary locally successful.
A Multinational Firm entering a new market may confront unfamiliar laws, regulations, and institutional procedures. Foreign firms partnering with a domestic partner seek to use their local knowledge. Firms also must adapt to how buyers or governments will respond to establishing local production facilities or using local suppliers. In addition, informal requirements that local culture, customs, and beliefs impose are often less obvious to the foreign Multinational Firm. Even if the firm’s existing strategy remains useful in the new country, the processes and capabilities that supported it in the home country may not work in the new environment.
The extent to which local differences will matter for a particular Multinational Firm also depends on the type of business pursued by the Multinational Firm. Cross-border flows of cement are more sensitive to the effects of geographical distance than crossborder flows of satellite TV programming, but less subject to cultural (as in linguistic) differences or administrative restraints due to political sensitivity.
Balancing Local Responsiveness versus Global Efficiency
Addressing the challenges of local responsiveness and global efficiency is demanding because it requires coordination and aligning of headquarters’ interests with the interests of subsidiaries. A multinational financial institution must distinguish between knowledge that can add value in other locations and knowledge that is idiosyncratic to one particular location only.
The more subsidiary knowledge creation is specific to the local context, the greater the difficulties, and hence costs, in inter-subsidiary knowledge sharing. The same variety that produces innovation locally makes it difficult for headquarters to recognize which innovations could have value for the firm as a whole. There are three issues that Multinational Firm headquarters need to address with respect to learning processes in the tension field between global efficiency and local responsiveness.
A multinational firm needs to be able to create mechanisms for variety creation including identifying novel ideas and knowledge, selecting them according to local, regional, or global usefulness, and diffusing the innovation throughout the company.
• Variety: The greater the country differences, the greater the exposure to a variety of new innovative knowledge, but the greater the costs of sharing such knowledge across other units.
• Selection: The more centralized the process of selecting valuable knowledge, appropriate for the Multinational Firm (e.g. located at the HQ), the more difficult it is for decision-makers to know what local innovations have occurred and their usefulness beyond the region of discovery.
• Exploitation: The more similar country markets are, the greater the likelihood that knowledge valuable in one location will be useful in another
location.
If local differences between countries are large, the Multinational Firm faces a great deal of variety of external learning opportunities. Because exposure to new knowledge is great, learning processes need to focus on selecting knowledge that can be locally, regionally, or globally exploited. The greater local differences are, the less likely it is that corporate headquarters will be able to distinguish purely locally specific knowledge from more generally applicable knowledge.
Accordingly, the selection process in the Multinational Firm cannot be completely centralized, but requires the active involvement of regional managers and decision- making units. If differences between country units are small, the Multinational Firm faces a low variety of external learning opportunities, and accordingly, new knowledge development stems largely from knowledge combination between internal units. Due to greater levels of similarity, the selection process can be much more centralized, and achieving economies of scale and scope through knowledge sharing becomes possible.
To conclude, creating an effective organizational design in a multinational firm is more challenging compared to a purely domestic operation. This is largely due to similarities and differences in the country contexts in which the Multinational Firm operates. Similarities between country operations provide the chance for headquarters to achieve global efficiency that cannot be matched by locally competing firms; differences in market contexts provide opportunities for market segmentation and arbitrage. However, profiting from international presence should not be taken for granted, but has to be achieved through an adequate organizational design. Multinational firms need to identify the trade-off between local responsiveness and global efficiency for their operations and align their corporate intervention mechanism accordingly. The likelihood of successful deployment of corporate interventions depends not only on the diversity of contexts in which the Multinational Firm operates, but more importantly, on the relationship between corporate headquarters and their subsidiaries.