What should leaders pay attention to as companies go global rapidly?

Text/Benjamin Laker

Image source: Visual China

Multinational corporations (EMNE) in emerging markets need to carefully weigh their options when deciding how much control over their foreign subsidiaries. They should take into account the institutional gap between their countries and target markets, as well as their motivations for globalization. This is the message of a recent study conducted by an international team of academics from the UK, China, Singapore and Finland.

After studying rapidly internationalizing Chinese companies, the study's authors — including Professor Martin Meyer from Innolab at the University of Vaasa and Professors Zaheer Khan and Jie Wu from the University of Aberdeen Business School — argue that Successful global expansion depends on a match between the institutional gap between local and foreign markets and the appropriate level of equity in subsidiaries of emerging-market firms. The motivation behind the expansion will determine the degree of control such a company has over its subsidiaries.

This assertion challenges the traditional view in transaction cost economics. For example, a widely accepted view in the past is that when establishing subsidiaries in a foreign market with considerable institutional gaps, the rapidly internationalizing EMNE faces the challenges of effective operations, communications, integration and cross-border coordination, all of which lead to high transaction costs. To minimize transaction costs and ensure long-term growth of foreign business, assuming an appropriate (high) level of ownership can help businesses achieve their goals. However, we have also seen this tendency provoke a lot of negative public opinion in many ways, as exemplified by foreign direct investment from China, as exemplified by the skepticism and distrust of expansion by many OECD governments. So how exactly should this problem be solved?

To date, scholars have paid little attention to the role of the specific motivations of FDI. A group of business school researchers at the University of Aberdeen, Tongji University, Nanyang Technological University, and researchers at The InnoLab at Vaasa University provided managers and policymakers with a critical but long-neglected insight into reconsidering appropriate ownership strategies when deciding to enter a particular foreign market, as the institutional gap in such a market is greater than that of similar markets. They put forward a new perspective to solve this fundamental and important problem, that is, the considerable institutional gap provides an opportunity for institutional arbitrage for focus companies.

They then introduce the motivation for FDI to understand how different reasons can enable them to take advantage of this institutional arbitrage. For example, if a company wants to achieve rapid growth in a foreign market with a considerable institutional gap, "it can rely on the institutional relationship between the host country and the home country to seek special treatment and strong protection of its business and property by the host Government." This is well reflected in "the investment of Chinese multinational enterprises in Pakistan is well protected by the local government due to the strong long-term relationship between the two countries", which greatly alleviates the high costs and uncertainties caused by institutional gaps.

Therefore, in the case of a low level of ownership of subsidiaries, foreign operations should be empowered and localized as much as possible to reduce the negative impact of institutional gaps. This strategy is particularly applicable to foreign markets where local regulations and policies require foreign companies to "have to reinvest the bulk of their profits in host markets," making these market-seeking EMNE less likely to incur exchange rate risks associated with larger institutional gaps.

But how can an emerging-market firm pursuing an intellectually-seeking goal (or motivation) in a country with large institutional gaps (e.g., the UK, the US) choose appropriate control over its overseas subsidiaries?" A high level of ownership of foreign subsidiaries helps EMNE to improve the efficiency of knowledge transfer within its global network and avoid knowledge distortion, especially when transferring highly complex and implicit knowledge from host countries with large institutional gaps. ”

As a result, high control enables emerging market companies that are internationalizing to gain much-needed critical knowledge, which is critical for these firms to strengthen their weak capabilities that may not be available through a low-commitment business model. Thus, for an emerging-market company motivated by the search for knowledge, increasing control over foreign operations is a sensible strategy that can effectively manage access to knowledge and move operations to a host country that is very far from the home country's system.

A central message of the study is that specific FDI motivations are critical to successful internationalization, and it involves the appropriate selection of equity in subsidiaries and a careful assessment of the nature and extent of cross-border distance.

When developing appropriate strategies for successful internationalization, managers need to be aware of the specific implications of these motivations, i.e. to strive for an appropriate match between subsidiary control and cross-border distance. For example, if an EMNE's primary goal is the growth of the international market, then it must authorize and localize foreign businesses as much as possible with a low level of ownership of subsidiaries. However, assuming that an EMNE pursues the goal of knowledge seeking in a country with a large institutional gap, then in this case it needs to maximize control over foreign operations to manage effective knowledge acquisition and transfer.

The author of this article is a Forbes contributor and the content of this article represents the views of the author only.

Translated by Vivian School Li Yongqiang