The current issue and full text archive of this journal is available at                                        www.emerald...
MBR    utilize seven complementary theories from economics, psychology and sociology to20,2   develop a set of proposition...
Rationale forComplementary social science theory Corresponding internalization theory concepts (core or co-opted(Wolf et a...
MBR    inter-regional investment. It should also be noted that most region-based liberalization20,2   policies are reactio...
H2 (based on the theory of new economic geography)                                              Rationale forThe theory of...
MBR    Extant empirical literature supports this internalization-theory-based proposition.20,2   Nachum and Wymbs’s (2007)...
Wolf et al. (2012) further suggest that different activities within the MNE are associated    Rationale forwith different ...
MBR    reality, downstream activities require an expert recombination of complex bundles of20,2   knowledge related, inter...
located in Asia and Latin America (Rugman et al., 2011). Second, the foreign entry           Rationale formotive may also ...
MBR    language and cultural heritage). Second, it is not clear how international experience is20,2   defined (e.g. the num...
performance factors are unlikely to drive the MNE’s commitment towards a specific            Rationale forgeographic scope,...
MBR       H6. Internalization theory version. An MNE’s development from a home-region20,2          orientation towards a g...
depends on the transactional features of the buyer-supplier relationship. A large MNE           Rationale forwith strong F...
MBR       We should, however, not lose sight of methodological limitations of statistical tests,20,2   and should keep in ...
and co-evolution (see Table I). Internalization theory’s broader and more nuanced view                   Rationale forof t...
MBR    Dicken, P. and Malmberg, A. (2001), “Firms in territories: a relational perspective”, Economic             Geograph...
Marshall, A. (1922), Principles of Economics: An Introductory Volume, 8th ed., Macmillan,              Rationale for     L...
MBR    Tolbert, P.S. and Zucker, L.G. (1983), “Institutional sources of change in the formal structure of             orga...
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An internalization theory rationale for mne regional strategy

  1. 1. The current issue and full text archive of this journal is available at Rationale for An internalization theory MNE regional rationale for MNE regional strategy strategy 135 Alain Verbeke Haskayne School of Business, University of Calgary, Calgary, Canada andSolvay Business School, University of Brussels (VUB), Brussels, Belgium, and Liena Kano Department of Management and International Business, Haskayne School of Business, University of Calgary, Calgary, CanadaAbstractPurpose – This paper seeks to demonstrate that internalization theory, as a “complete” theory of thefirm, is particularly well equipped to analyze multinational enterprise (MNE) regional strategies,thanks to its joint transaction cost economics and resource-based foundations.Design/methodology/approach – This paper builds on recent work by Wolf, Egelhoff, andDunemann to show that internalization theory’s predictions on MNE regional strategy are superior tothose suggested by several other conceptual frameworks. For each of the 11 hypotheses formulated byWolf and his co-authors, an alternative is proposed here that is consistent with internalization theorypredictions.Findings – MNE regional strategy is an important empirical phenomenon. Internalization theory, asa powerful conceptual framework with general applicability, simplicity and accuracy, allows in-depthanalysis of MNE regional strategies.Research limitations/implications – Internalization theory scholars need to find new ways ofoperationalizing MNE firm-specific advantages (FSAs), as well as MNE resource recombinationtrajectories, to predict accurately when and how MNEs will pursue regional versus global strategies.Practical implications – MNE senior management should rethink international expansionstrategies and realize that most large MNEs actually pursue regional, not global strategies.Social implications – Even the world’s largest MNEs have great difficulty engaging in novel resourcerecombination across the globe, and their alleged market power should therefore not be overestimated.Originality/value – International business scholars should embrace internalization theory as thegeneral theory of the MNE, rather than looking for insight from theories not intended – nor properlyequipped – to study strategies of the world’s most complex entrepreneurial organizations.Keywords Multinational enterprise, Regional strategy, Global strategy, Internalization theory,Transaction costs, Resource based view, Firm specific advantages, Location advantages, Distance,Resource recombination, Multinational companies, Corporate strategyPaper type Conceptual paperIntroductionWolf et al. (2012), in a provocative piece published in The Multinational BusinessReview (MBR), have argued that the phenomenon of multinational enterprise (MNE)regionalization, defined as the concentration of foreign sales in the home region as Multinational Business Review Vol. 20 No. 2, 2012opposed to a more balanced distribution across the globe, cannot be explained fully pp. 135-152through transaction cost economics reasoning. In their view, a broader and more q Emerald Group Publishing Limited 1525-383Xmulti-faceted explanation is required of the regionalization phenomenon. The authors DOI 10.1108/15253831211238212
  2. 2. MBR utilize seven complementary theories from economics, psychology and sociology to20,2 develop a set of propositions explaining the MNEs’ home-region orientation. We agree with Wolf et al. (2012) that the study of MNE internationalization patterns, and regional strategy/structure choices in particular, requires more than a mere focus on conventional transaction cost economics parameters (Verbeke, 2003). However, Wolf ´ et al.’s (2012) perspective represents an incomplete expose on the regionalization136 phenomenon as advanced by Rugman (2005) and Rugman and Verbeke (2004, 2005). First, Rugman and Verbeke’s theory of regionalization is not based on conventional, Williamsonian transaction cost economics (TCE) (Coase, 1937; Williamson, 1975, 1981a, b, 1996), but rather on the theory’s “international version”, called transaction cost internalization (TCI) or internalization theory, which was developed largely independently of the Williamsonian version. First formulated in the classic work of Buckley and Casson (1976), contemporary internalization theory goes beyond concentrating on transaction cost economizing to recognize a variety of strategic and managerial issues involved in internationalization, and to focus on managing the innovation process in its entirety. This broad focus, as compared to Williamsonian TCE and early internalization thinking, is achieved by infusing a “dynamic capabilities”-like perspective into TCE thinking, with an emphasis on generating, exploiting and rejuvenating firm-specific advantages (FSAs) and matching these with country-specific advantages (CSAs) of host countries. Contemporary internalization theory explains the choice of MNE boundaries, as well as the firm’s internal governance and its interactions with external environmental forces (Rugman et al., 2011; Verbeke, 2009). Second, Wolf et al.’s (2012) description of the TCE foundational assumptions is not entirely accurate. Contrary to the authors’ claim (see Table I in Wolf et al., 2012), TCE explicitly rejects the conventional notion of “homo economicus” in favor of the bounded rationality behavioral assumption (Simon, 1959; see Williamson, 1996). The concept of bounded rationality is central to internalization theory and to the explanation of the regionalization phenomenon, as bounded rationality of MNE managers is largely responsible for difficulties in transferring, deploying and recombining FSAs across regional borders. Further, also contrary to what the authors imply, TCE acknowledges the level of uncertainty as a principal characteristic of transactions (Williamson, 1996), as does internalization theory. Consequently, internalization theory does not view international expansion decisions as choices among well-specified, discrete alternatives even if much empirical work has been based on this assumption (Benito et al., 2009). Nor does internalization theory assume hyper-rational, MNE-centric decision processes (Hennart, 2009). As a general theory of the MNE, internalization theory is actually able to explain MNE behavior while encompassing the spatial, behavioral and social considerations explored by Wolf et al. (2012) through complementary theories (see Table I). In the following section, we explore how the authors’ propositions can be reinterpreted through an internalization theory lens, and, where necessary, restated. We conclude by discussing internalization theory’s capacity to explain the phenomenon of regionalization, and by assessing the value of Wolf et al.’s contribution to the current explanation. Alternative interpretation of regionalization propositions H1 (based on the theory of new regionalism) New regionalism refers to the politically induced process that started in the early 1990s, characterized by trade liberalization of regions through reduction of
  3. 3. Rationale forComplementary social science theory Corresponding internalization theory concepts (core or co-opted(Wolf et al., 2012 concepts) MNE regionalNew regionalism Institutional, geographic, and economic distance (proxies for strategy additional costs of doing business abroad) Government-imposed market imperfections (trade barriers)New economic geography Location advantages – CSAs 137 Geographic distanceKnowledge economy Markets for intermediate products (various types of knowledge) Complementary resources of external actors Location advantages (LAs) – CSAs Geographic distancePsychic distance Compounded distance Cultural distance Bounded rationality Bounded reliability LB versus NLB FSAsEscalating commitment Bounded rationality Bounded reliability Resource recombination trajectories Administrative archetype (reflected in higher order FSAs, namely routines)Population ecology Resource recombination trajectories Table I. Co-evolution of FSA-CSA bundles Complementary social Administrative archetype science theoriesNeo-institutional theory Co-evolution of FSA-CSA bundles embedded in transaction Complementary resources cost internalization (TCI) Institutional distance theory’s conceptsintra-regional trade barriers (Hettne et al., 1999). The authors argue, following the logicof new regionalism, that MNEs are incentivized to concentrate the bulk of theirbusiness activities within the boundaries of a regional integration agreement. Theypropose the following (for purposes of consistency in the present paper, we will alwaysuse the words multinational enterprise – MNE, instead of multinational corporation –MNC): H1. A multinational enterprise’s (MNE’s) degree of home-region orientation will be positively related to the degree of economic liberalization which existed in its home region at the time foreign investment decisions were made.From the internalization theory perspective, macro-level liberalization policies bythemselves will not determine the scope of the MNE’s geographic expansion; rather,this scope will be determined by the MNE’s ability to link its FSAs with CSAs oflocations within or outside of its host region. Regional integration agreements mayinfluence this ability: they promote intra-regional coherence and thereby reduce theMNE’s need to develop new location-bound FSAs or adapt existing FSAs tohost-country CSAs if a host country is located within the home region (Rugman andVerbeke, 2005), thus indeed providing an incentive for intra-regional rather than
  4. 4. MBR inter-regional investment. It should also be noted that most region-based liberalization20,2 policies are reactions to a history of collaboration within the region and to geographic proximity and/or cultural/economic/institutional similarities among countries in the region; they can be interpreted as the removal of unnatural market imperfections (Rugman, 1981; Buckley et al., 2003) to further the ease of FSA adaptation, which was already partially enabled by comparatively low cultural, geographic, economic and/or138 institutional distance (Ghemawat, 2001). An MNE home-regional focus is thus merely facilitated by region-based liberalization. In addition, this “incentive” for home-region firms will not necessarily act as a deterrent for outsider firms whose international expansion is motivated by strategic resource seeking, if these strategic resources cannot be obtained within their own home region. Consider, for example, an emerging economy MNE expanding into a developed economy (i.e. a host region), in order to access technological know-how (Guillen and Garcia-Canal, 2009), or a developed economy MNE entering an emerging economy (e.g. China – again, located in a host region) in search of cheap labor. The point here is that region-based liberalization policies may indeed affect the regional scope of MNE international activities, but will not determine such scope. The key determinant of the MNE’s geographic scope is the firm’s ability to recombine FSAs with CSAs in order to reach its strategic goals. H1 can therefore be restated as follows: H1. Internalization theory version. While region-based liberalization provides incentives for intra-regional FDI, each particular MNE’s international expansion pattern will be determined mainly by micro-level parameters, including the firm’s internationalization motives and the nature of its FSAs. Therefore, no fixed, generalized relationship can be proposed between a region’s level of economic liberalization and the home-region orientation of this region’s MNEs. Wolf et al.’s (2012) hypothesis is, in fact, disproved by Rugman and Verbeke’s (2004) empirical data. Among the three regions of the Triad (defined as Europe, North America and Asia-Pacific), Europe can be seen as the most integrated, as it is characterized by far-reaching administrative and political harmonization in addition to economic integration, whereas North America and Asia only benefit from the latter. Therefore, if Wolf et al.’s prediction were true, European MNEs would be underrepresented in the group of truly global and host-region oriented companies, and would account for the majority of home-region oriented firms. The empirical data, however, show that the opposite is true: European MNEs account for the lowest percentage of home-region firms and the highest percentage of host-region ones, while the nine truly global MNEs are evenly distributed among the three regions of the Triad (Rugman, 2005). A relevant point in this context is that internalization theory does implicitly consider the phenomenon of new regionalism, but it does so in the context of MNE strategic positioning and its ability to link its FSAs with host country CSAs. Thus, internalization theory provides a deeper, more firm-centric, and therefore more strategically and managerially relevant perspective than the theory of new regionalism, while the latter considered in isolation yields an incorrect prediction that contradicts the empirical evidence.
  5. 5. H2 (based on the theory of new economic geography) Rationale forThe theory of new economic geography stems from Marshall’s (1922) work on the MNE regionalphysical concentration of business firms, and attempts to explain the occurrence ofeconomic agglomeration. According to the new economic geography, two opposing strategyforces cause the spatial agglomeration of business. First is the force of agglomeration,fed by market size effects, condensed labor market effects, and effects stemming fromincreasing returns in production. Second is the force of dispersion, driven by the 139immobility of resources and the costs of increased economic activity in a particularlocation (Krugman, 1998). The authors adapt the theory of new economic geography,particularly the agglomeration side of the argument, to the Triad region level, andsuggest the following: H2. MNEs from regions with a greater level of relevant agglomeration will tend to be more home-region oriented than MNEs from regions with a lower level of relevant agglomeration.We agree with the authors’ view that a Triad region is too broad a geographic contextwithin which to consider agglomeration, and that relevant clusters need to be investigatedwithin each Triad region. Industrial clusters, such as Silicon Valley or Boston’s Route 128,would provide a better unit of analysis. From an internalization theory viewpoint, suchindustrial clusters offer incumbent MNEs a variety of CSAs, or, in this case, location-rather than country-specific advantages, such as easy access to a highly skilledprofessional labor pool and state-of-the-art technical knowledge due to a superioreducational infrastructure (e.g. proximity to leading technical universities and businessschools), easy access to venture capital, and access to knowledge held by industry leaders.If these location advantages (LAs) are relevant to MNEs from the home region and theseMNEs have comparatively easy access to them, a home-region orientation may result.Potential availability of complementary resources of external actors (e.g. existing suppliernetworks; partnership opportunities) may also encourage expansion inside a cluster.However, whether or not the expansion in fact occurs (and is successful) will bedetermined not by the MNE’s location near a particular innovation cluster, but by itsability to gain access to the region’s LAs that may be held by local actors (Hennart, 2009),and then to establish a match between its own FSAs and the region’s LAs. The dispersion side of the argument also needs to be considered: for example, firmsthat possess FSAs superior to those of competitors and are vulnerable to appropriationby competitors or third parties may shy away from locating in agglomeration clustersin order to avoid proprietary knowledge dissipation. Further, there is an industry effecton the level of clustering: e.g. firms in industries where knowledge is highlyidiosyncratic (e.g. financial and professional service firms) may not have a great needto learn from competitors (Nachum and Wymbs, 2007). It should also be noted thatrelevant LAs are likely to attract investment not only from home region MNEs, butalso from MNEs outside of the region – consider, for example, inward FDI in SiliconValley by Japanese MNEs (Teece, 1992). The above leads to the following prediction: H2. Internalization theory version. Strong agglomeration in a region will not by itself attract investment from MNEs, whether from within or outside the region. Whether or not a home-region MNE chooses the region’s agglomeration cluster as an expansion target depends on the potential synergies of melding the MNE’s FSAs with the LAs of the region.
  6. 6. MBR Extant empirical literature supports this internalization-theory-based proposition.20,2 Nachum and Wymbs’s (2007) study on the location choices of financial and professional services firms shows that LAs, including relevant agglomeration, do not determine MNE location choices – rather, location choices are influenced by the interaction between LAs and the MNE’s FSAs.140 H3a and 3b (based on the theory of the knowledge economy) The theory of the knowledge economy argues that contemporary firms rely on intellectual capabilities to a greater extent than on physical inputs and natural resources (Powell and Snellman, 2004), and therefore sourcing, processing and exploiting knowledge are critical tasks for these firms (Dunning, 2000). The label “knowledge economy” covers a wide variety of research streams (Powell and Snellman, 2004). It includes literature on knowledge networks, which argues that knowledge is rarely possessed by a single firm and resides within networks of firms and institutions in a particular environment (Dicken, 1999), and literature on knowledge spillovers, which studies the effects of inter-firm, intra-industry knowledge spillovers on R&D and innovation (Cohen and Levinthal, 1989). Wolf et al. (2012) combine knowledge networks and knowledge spillover arguments to hypothesize a strong linkage between low geographic distance and various types of effective knowledge transfer: H3a. The more knowledge intensive an MNE is, the more it will pursue a home-region orientation. Even if only strategic asset seeking expansion is pursued, the above proposition may hold solely in cases whereby the home region of the knowledge-intensive MNE considered has relevant knowledge clusters, so that valuable knowledge recombination can occur inside the region. If not, the MNE may undertake an expansion into host regions where desired knowledge is located, as illustrated by Japanese FDI in Silicon Valley, as discussed in the previous section. From an internalization theory perspective, this expansion serves the purpose of accessing relevant LAs, either within or outside the home region. In addition, in case of market seeking expansion, a higher knowledge intensity could foster more globalization rather than regionalization, depending on the non-location boundedness of the knowledge at hand. In any case, access to proximate knowledge clusters does not guarantee innovative performance. The development of new economic theories, such as the new economic geography and the theory of the knowledge economy, has led to a tendency to overemphasize the importance of the region at the expense of the firm-level factors (Dicken and Malmberg, 2001; Maskell, 2001). Empirical evidence in the strategic management literature suggests that FSAs remain ultimately more important for an MNE’s ability to produce innovations than the regional environment (Beugelsdijk, 2007). Related to this point, different firms will benefit from LAs offered by knowledge clusters to a different extent. Firms possessing the most advanced technologies may have incentives to locate away from clusters in order to protect their core capabilities from dissemination to weaker competitors (Nachum and Wymbs, 2007). Microsoft’s location in Seattle rather in Silicon Valley is a case in point. Taking the above elements into account, we can restate H3a as follows: H3a. Internalization theory version. Higher knowledge intensity of an MNE will not result in a stronger home-region orientation.
  7. 7. Wolf et al. (2012) further suggest that different activities within the MNE are associated Rationale forwith different requirements for knowledge transfer, with the knowledge generated in MNE regionalthe upstream parts of the value chain (such as R&D) being more valuable thanknowledge generated in the downstream parts (such as sales and marketing). strategyCombined with the previous reasoning on intra-regional knowledge transfer, this led tothe following proposition (where upstream value chain activities are considered moreknowledge-interdependent than downstream value chain activities): 141 H3b. The more knowledge-interdependent [i.e. upstream] activities of an MNE will pursue more of a home-region orientation than the less knowledge-interdependent [downstream] activities.Internalization theory suggests that the extent of home-region orientation can bedifferent for different value chain activities, namely downstream vs. upstream activities,but offers a reverse prediction: globalization, when it does occur, happens predominantlyin the upstream end of the value chain, with the downstream activities maintaining astronger home region focus. This proposition is empirically supported by the data inRugman and Verbeke’s (2004) flagship study, which shows that many large MNEs dohave a strong geographic dispersion of their R&D, sourcing and production, but are notcapable of achieving a global distribution of sales. The reason is that FSAs required inupstream activities to achieve global sourcing of R&D outputs, raw materials,intermediate inputs, labor and capital, and production are very different from the FSAsrequired in downstream activities to achieve global distribution of sales. Adaptation ofdownstream activities requires a higher level of local responsiveness, as the knowledgebundles that have to be accessed and deployed at the downstream end in a host regionare likely quite different from the knowledge combinations effective in the home region(which does not necessarily hold for more upstream activities). Upstream activities, onthe other hand, provide the greatest potential for scale economies, whereby aconcentration of these activities often can be achieved in home regions (Verbeke, 2009). Further, MNEs differ in their ability to adapt upstream and downstream activitiesseparately, i.e. in their decoupling flexibility (Rugman and Verbeke, 2008a). Strongdecoupling flexibility means that upstream and downstream activities can be easilyadapted separately; most brand-named goods fall into this category. Weak decouplingflexibility means that upstream and downstream activities have to be performedsimultaneously/cannot be separated, as is the case in many professionalknowledge-intensive services, such as engineering services or managementconsulting. This distinction is partially responsible for a comparatively higherhome-region orientation of knowledge-based services vs. manufacturing MNEs, asdemonstrated in Rugman and Verbeke’s (2008a) empirical study, which shows thatservices MNEs’ decoupling flexibility is usually considerably weaker than that ofmanufacturing MNEs. Building upon the above, H3b can be restated as follows: H3b. Internalization theory version. Assuming strong decoupling flexibility, i.e. being able to separate upstream and downstream adaptation, MNE downstream value chain activities will tend toward home-region orientation more than upstream activities.Perhaps part of the problem with Wolf et al.’s (2012) proposition is that they viewupstream activities as more knowledge-interdependent than downstream activities. In
  8. 8. MBR reality, downstream activities require an expert recombination of complex bundles of20,2 knowledge related, inter alia, to foreign cultures, customer preferences and institutions. Propositions 4a, 4b and 4c (based on psychic distance theory) Psychic distance, when applied in the international business context, reflects MNE managers’ perceptions of differences in business-relevant characteristics between142 home and host countries (Brewer, 2007). Psychic distance is influenced by a variety of cultural, political, economic, as well as personal factors (e.g. language, religion, education, etc.). As psychic distance is believed to vary systematically with the geographic distance between countries, the authors propose the following: H4a. The greater managers’ perception of the psychic distance between the home region and other regions, the more the respective MNE will be home-region oriented. Observing that Asian countries are likely more psychically distant from European and North American countries than the latter are from each other, they further predict that: H4b. When other factors are controlled for, Asian MNEs will tend to be more home-region oriented than European and North American MNEs. The concept of psychic distance is somewhat similar to the four distance dimensions between the home and host country – cultural, administrative (or institutional), geographic (or spatial) and economic (Ghemawat, 2001) – that is central to internalization theory. From the internalization theory perspective, distance is a critical concept that affects the transferability, deployability, recombination and exploitation of FSAs across borders. If any dimension of distance increases, so do the costs of doing business abroad, as well as the challenges of effectively deploying FSAs in a host environment. Distance creates new bounded rationality challenges for managers who must understand drastically different subsidiary environments, as well as bounded reliability problems (Verbeke and Greidanus, 2009) to the extent that it becomes difficult for the head office to achieve proper monitoring and goal alignment with the subsidiary. To add to the complexity of the notion of distance, the various distance dimensions are not independent of each other, but rather intertwined and interdependent. For example, regional economic integration fosters institutional coordination, which in turn may contribute to decreasing cultural distance through improved mobility of labor and managerial best practices. It is then the compounded distance, defined as the need to manage various distance dimensions simultaneously, that has the most substantial effect on the firm’s ability to deploy successfully and efficiently its FSAs abroad (Rugman et al., 2011). The concept of compounded distance is essentially equivalent to psychic distance. The assumption that greater compounded distance between regions might lead to a greater home-region orientation may seem plausible at first sight. However, a general statement about a positive relationship between inter-regional distance and MNE home-region orientation would appear somewhat simplistic. First, macro-level distance may be different in different parts of the value chains, e.g. upstream vs. downstream, as discussed in the previous section. Consider North American Levi Strauss: its sales are strongly home-region oriented, yet the entire bundle of upstream activities is
  9. 9. located in Asia and Latin America (Rugman et al., 2011). Second, the foreign entry Rationale formotive may also moderate the influence of distance on the MNE’s decision to make an MNE regionalinvestment abroad. A strategic resource seeking MNE may find a high-distance marketparticularly instrumental to learning opportunities potentially unavailable in strategylow-distance locations (Verbeke, 2009). Similarly, a natural resource seeking MNEmay expand into a distant country/region due to unavailability of sought resources inthe home region, or in more proximate regions, as shown in Benito and Gripsrud’s 143(1992) analysis of FDI by Norwegian MNEs. The internalization perspective suggests,again, that the level of the MNE’s geographic scope will be determined by the extent towhich the MNE is able to deploy and recombine its FSAs to cope with compoundeddistance between the home and host countries while reaching its strategic goals. Similarly, the influence of the home region itself on the propensity toward ahome-region orientation, as hypothesized in H4b, is a macro-level observation thatignores firm-specificity (Verbeke, 2009). In reality, firm-level distance could be smallerthan macro-level distance due to, for example, senior management’s extensive businessexperience in the host region or a presence of relevant business and/or governmentconnections. Rugman and Verbeke’s (2004) empirical results confirm the above reasoning.Contrary to Wolf et al.’s prediction, Asian MNEs do not tend to be the mosthome-region oriented – while they are more home-region oriented than their Europeancounterparts, they are significantly less home-region oriented than North Americancompanies (Rugman, 2005). Granted that “all other factors” were not necessarilycontrolled for, but this nevertheless points at limitations of macro-level distanceanalysis. We therefore propose the following: H4a,b. Internalization theory version. There is no generalized relationship between compound inter-regional distance and the degree of MNE’s home-region orientation. Decisions on expansion into a high-distance host region are moderated by: † the MNE’s foreign entry motives; † the specific activities in the value chain for which expansion is considered; † the micro-level distance between the firm and the host region; and † the MNE’s command of requisite recombination capabilities necessary to overcome distance.Exploring psychic distance theory further, the authors combine it with the Uppsalamodel, which focuses on the internationalization process. The Uppsala model proposesthat international expansion is a function of the MNE’s past international experienceand knowledge base (Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne,1977, 1990; Luostarinen, 1979), and postulates that firms undertake internationalexpansion in an incremental and path-dependent manner. The following propositionresults: H4c. The greater the international experience of an MNE, the more global will be its orientation and the less it will exhibit a home-region orientation.Here, the logical flow from theoretical assumptions to the proposition is not entirelyclear. First, host region expansion targets are not necessarily distant on all dimensions(e.g. Spain and Mexico are located in different regions of the Triad but share a common
  10. 10. MBR language and cultural heritage). Second, it is not clear how international experience is20,2 defined (e.g. the number of countries where the MNE has a presence, the extant diversity of subsidiaries, the number of employees in different countries, etc.). The level of international experience alone would not necessarily lead to a greater ease in entering a distant region, as the MNE ultimately needs to address incremental, or added, distance (Hutzschenreuter et al., 2011). Even a higher level of diversification of144 the MNE’s current locations does not necessarily imply a greater incentive for – and ease of further expansion into – distant countries, as the ease of further expansion (meaning, really, ease of FSA adaptation and recombination) depends on a particular expansion target, as well as the presence of recombination capabilities and relevant experience within the MNE’s current international portfolio. Further, empirical evidence suggests that extant cultural diversity of the MNE’s subsidiary network will actually reduce the rate of subsequent internationalization, because heterogeneity among subsidiaries increases complexity and ties up managerial resources that could otherwise be dedicated to further international expansion (Hutzschenreuter et al., 2011). With the above considerations in mind, we suggest the following: H4c. For internalization theory. There is no generalized relationship between the MNE’s level of international experience and its home-region orientation. H5 (based on escalating-commitment theory) Escalating-commitment theory draws on behavioral aspects of managerial decision-making to describe situations whereby managers hold on to – and continue to reinvest in – certain actions (i.e. “escalate” their commitment to these actions) even if these actions have failed to achieve strategic goals in the past and are unlikely to do so in the future (Brockner, 1992). The authors blend escalating-commitment theory with two IB concepts: administrative heritage and the multinationality-performance relationship. Administrative heritage describes the firms’ key routines and tacit knowledge that often develop at the time of inception and are influenced by the vision of the founder and the firm’s set of external circumstances. The literature distinguishes among four archetypes of administrative heritage: centralized exporter, international projector, international coordinator and multi-centered MNE (Verbeke, 2009). The literature on the multinationality-performance relationship suggests that a systematic, fixed relationship exists between the MNE’s degree of multinationality and its performance. In this context, Wolf et al. (2012) cite evidence that home-region oriented MNEs typically perform worse than global, bi-regional or host-region oriented MNEs. The blending of the implications of the above research streams results in the following: H5. MNEs’ development from a home-region orientation towards a global orientation is a slow (longsome) process. The effect of the amount of a MNE’s international experience on its home-region orientation is low. It should be noted that this directly contradicts H4c. Internalization theory rejects the notion that a fixed, systematic relationship should exist between the MNE’s geographic scope and its performance (Hennart, 2007; Verbeke and Brugman, 2009; Verbeke et al., 2009) and consequently between its degree of regionalization and performance, as domestic and international success will be determined by the firm’s ability to develop, transfer, deploy and exploit its FSAs rather than by its geographic scope per se. As such, contrary to Wolf et al.’s reasoning,
  11. 11. performance factors are unlikely to drive the MNE’s commitment towards a specific Rationale forgeographic scope, whether this entails maintaining home-region orientation or moving MNE regionaltoward globalization. This notwithstanding, internalization theory adopts a Penrosean (Penrose, 1959) strategyview of MNE international expansion being a path-dependent process, with thepath-dependency being driven by the availability of resources and the need for newFSA development and current FSA adaptation possibilities. Further, an MNE’s extant 145international experience does not necessarily influence its home-region orientation, asdiscussed in the previous section. Internalization theory thus yields the followingprediction, very similar to Wolf et al.’s (2012), but following a different logic: H5. Internalization theory version. MNE’s development from a home-region orientation towards a global orientation depends upon its resource recombination trajectory. There is no systematic effect of the level of an MNE’s international experience on its home-region orientation.H6 (based on population ecology)Developed in Hannan and Freeman’s (1977) classic article, population ecology theoryemphasizes the influence of selection pressures from the external environment on afirm’s survival. The argument is that profit maximizers are selected, while the abilityitself to maximize profits depends on the organization’s ability to adapt to theenvironment. This explains persistence of organizational forms over time. Wolf et al.develop a population ecology argument for regionalization, proposing the following: H6. If, in the population of MNEs, the degree of home-region orientation decreases over time, this will rather be the consequence of a selection process than an assimilation process.Internalization scholars agree that regionalization is an open-ended phenomenon overtime, in the sense that there is nothing deterministic about the international expansiontrajectory followed by individual MNEs (Rugman and Verbeke, 2004). The reality of amultinational firm, however, is such that globalization by selection appears to be asimplification, since a combination of environmental factors and firm-specific factorsinfluence firm-level action. In fact, globalization may never occur, as regionalizationmay be chosen as the preferred strategic alternative, based on cost-benefit calculus(Rugman and Verbeke, 2004). Alternatively, globalization may occur suddenly as aresult of a strategic acquisition. Internalization theory focuses on the interactionbetween firm-level strategies and the environment, whereas population ecologyemphasizes selection pressures by the external environment, thereby neglectingfirm-specific factors. When globalization does occur, it will likely be driven by a combination of changesoccurring at the level of the population of relevant firms, and adaptation at the firmlevel. Koza and Lewin (1998) argue that new organizational forms resulting from MNEinternationalization are an outcome of the co-evolution of the competitive andinstitutional environments, and firm intentionality. Rugman and Verbeke (2004) applythis thinking to the regionalization phenomenon and argue that MNE regionalstrategies are embedded in – and co-evolve with – the broader competitive,organizational and institutional contexts at the regional level. This suggests thefollowing proposition:
  12. 12. MBR H6. Internalization theory version. An MNE’s development from a home-region20,2 orientation towards a global orientation results from firm-level strategy and environmental factors; therefore, globalization may never occur, may occur slowly or may occur suddenly. When globalization does occur, it is driven by a combination of selection and adaptation processes.146 H7a and 7b (based on neo-institutional theory) Institutional theory’s basic tenet is that a firm’s behavior is largely driven by isomorphic pressures from the social and institutional environment, in which the firm is embedded (DiMaggio and Powell, 1983; Haveman, 1993; Meyer and Rowan, 1997; Tolbert and Zucker, 1983). While institutional theory pays little attention to firm-specific drivers of behavior, neo-institutional theory ascribes a more active role to the firm as an active carrier of change and innovation (Dacin et al., 2002; Leblebici et al., 1991; Sherer and Lee, 2002). Applying neo-institutional theory to the regionalization phenomenon, Wolf et al. argue that different industries are subject to different institutional pressures, which leads to the following prediction: H7a. MNEs from different industries vary in terms of their degree of home-region orientation. The authors further suggest that competitors and suppliers are highly relevant to the MNE’s legitimization process, and therefore: H7b. If the competitors and suppliers of an MNE are home-region oriented, this firm will also have a relatively strong tendency towards the home region. Internalization theory, with its focus on blending firm-specific and environment-specific factors, supports institutional theory’s key assumption of firms’ social and institutional embeddedness. As argued in the previous section, MNE strategic choices, including regional strategy, are believed to evolve interdependently with changes in prevailing industry practices, legitimate organizational forms, government regulations, etc. (Rugman and Verbeke, 2004), and therefore MNEs from different industries may indeed vary in their regional strategies. Further, MNEs from different industries differ in their inter-regional expansion potential, which depends largely on their ability to de-couple upstream and downstream activities (as discussed under H3b), and on the extent of their supply-side autonomy of location choices (Rugman and Verbeke, 2008a). As such, internalization theory supports H7a: H7a. Internalization theory version. MNEs from different industries vary in terms of their degree of home-region orientation. Much empirical support can be found for this proposition in extant literature. Rugman’s (2005) classic text on regionalization offers a break-down of regionalization levels by industry; studies conducted by Oh and Rugman (2006) and Rugman and Girod (2003) explore regionalization in specific industry contexts, and Rugman and Verbeke (2008a) present empirical evidence of different levels of regionalization in service industries versus manufacturing. MNEs are likely to strive to maintain proximity to relevant supplier networks. However, suppliers’ locations will not necessarily dictate MNE location choices. Whether or not an MNE will be compelled to follow a supplier’s geographic strategy
  13. 13. depends on the transactional features of the buyer-supplier relationship. A large MNE Rationale forwith strong FSAs and significant purchasing power (Porter, 1980) may in fact be MNE regionalfollowed by a supplier, rather than being a follower itself. In terms of competitors,MNEs may indeed attempt to gain access to relevant knowledge spillovers and strategytherefore locate close to competitors; however, they may also choose to put somedistance between themselves and competitors in order to avoid dissipation of their owncompetitively relevant knowledge. This, again, is particularly true for large MNEs with 147strong FSAs that are vulnerable to appropriation by other firms due to their publicgoods’ nature (Grøgaard and Verbeke, 2012). Whether or not the MNE follows itscompetitors geographically depends on the extent to which the firm’s technologicalknowledge is critical to its existence, and more generally on the nature of the firm’sFSAs as discussed under H2. Location choices depend on the interaction of LAs (in thiscase, availability of supplier networks and proximity of relevant competitiveknowledge) with the firm’s FSAs. Wolf et al.’s H7b thus appears at odds withinternalization theory: H7b. Internalization theory version. There is no systematic relationship between the MNE’s home-region orientation and that of its suppliers and competitors.As discussed under H2, current empirical evidence supports this proposition.Existing empirical support and potential empirical testsAs noted above, some of our new propositions formulated from the internalization theoryperspective have already been empirically tested in extant research. For example,Rugman’s (2005) book contains an analysis of intra-regional sales by region thatsupports the lack of a relationship between the region’s level of economic liberalizationand the degree of home-region orientation of firms headquartered in this region, ashypothesized in H1. The same data support the lack of a higher degree of home-regionorientation of Asian MNEs suggested by H4b. A study by Nachum and Wymbs (2007)demonstrates that MNE location choices are not determined solely by LAs, including thepresence of relevant agglomeration, but rather by an interaction of those LAs with thefirm’s FSAs; their results provide support for our H2 and H7b. H3b is supported byRugman and Verbeke’s (2004) data showing asymmetry between upstream anddownstream regionalization. Studies conducted by Oh and Rugman (2006), Rugman(2005), Rugman and Girod (2003) and Rugman and Verbeke (2008a) present empiricalevidence of different levels of regionalization in different industries hypothesized in H7a. H3a can be tested using Rugman and Verbeke’s (2004) data by assigning variouslevels of knowledge intensity to companies based on three sources of economicknowledge – industry R&D, skilled labor, and the size of the pool of basic science for aspecific industry (Audretsch and Feldman, 1996), and by regressing home-regionorientation on knowledge intensity. Similarly, H4c and H5 on the lack of a systematicrelationship between MNE international experience and its home-region orientationcould be statistically tested using data from Rugman and Verbeke’s (2004) study, withthe level of international experience operationalized as the number of countries wherethe MNE has a presence (a more sophisticated test would involve a measure of theMNE’s extant diversity; extant diversity could be operationalized as the sum of thecultural distances between the countries of every pair of subsidiaries, consistent withHutzschenreuter et al., 2011).
  14. 14. MBR We should, however, not lose sight of methodological limitations of statistical tests,20,2 and should keep in mind Yair Aharoni’s (1993) warning against relying solely on databases and industry averages in explaining MNE performance and behavior. According to Aharoni (1993), statistical tests do not capture the MNE’s uniqueness, which could reside, for example, in the MNE’s absorptive capacity to digest different cultures and to employ productively managers of many nationalities, or in its148 managerial experience and entrepreneurial qualities. These higher-order FSAs are often at the heart of achieving superior performance, yet are not easily measured in quantitative terms. In our case, this is particularly true for H4, H5 and H6, which deal with such complex and multidimensional constructs as foreign entry motivation, micro-level distance, recombination capabilities, path dependence, experience and FSA adaptation. These constructs are difficult to operationalize accurately, without losing valuable rich data that are unique to each particular MNE. Here, in-depth case analyses would likely be more helpful than quantitative methods in uncovering the linkages among the MNE international expansion targets, its FSAs and its regionalization strategies. Conclusion Wolf et al. (2012) have usefully suggested that a multifaceted, interdisciplinary approach can enrich our understanding of MNE regional strategy and structure. Indeed, in a field as complex and multidimensional as international strategic management, interdisciplinary reflection can add much value by facilitating the cross-pollination of ideas, broadening the scope of available methodologies, and increasing the pool of knowledge and experience on an important subject matter. This is precisely why internalization theory has been so influential as a general theory of the MNE. Internalization theory implicitly but powerfully blends key ingredients from paradigms used in strategic management, such as TCE, RBV and the dynamic capabilities approach, and is tied to broader concepts from disciplines beyond strategic management, such as psychology, cultural anthropology, geography, history, political science and sociology. Even mainstream TCE, upon which the economic argument of internalization theory is based, is not a “pure-play” economic theory, but rather a comprehensive blend of economics, law and organization science (Williamson, 1996). Wolf et al. (2012) appropriately recognize the need for a broad social focus when explaining regionalization and offer much needed support for this phenomenon. However, we need to evaluate the substantive value added beyond the extant internalization theory explanation. They offer a list of hypotheses, but the question arises whether these hypotheses really constitute theory (Sutton and Staw, 1996) – especially when considering that some hypotheses contradict each other (e.g. H4a and H5), or offer essentially the same prediction but from a different angle (e.g. H2 and H3a) Ultimately, the authors have formulated a set of somewhat disconnected propositions analyzing the regionalization phenomenon through seven separate conceptual lenses. It could be argued that enriching extant theory would require the various conceptual lenses adopted to be used in a complementary fashion. Internalization theory already achieves this goal: it relies on multiple “neighboring” concepts and in fact embeds, in its own logic, all of the theories described by Wolf et al. (2012), as reflected in the core concepts of bounded rationality, bounded reliability, compounded distance, FSAs, CSAs, LAs, recombination, complementary resources
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