Competing in Global Markets - Chapter 8 in
Strategic Thinking
A Strategic Management Textbook
Gordon Walker
Professor
Cox School of Business
Southern Methodist University
Dallas TX 75275
Introduction. A casual observer of competition across a broad range of industries
over the past twenty years would see an increasing trend towards the global integration of
markets and technologies. The number of companies whose brands have become solidly
international over this time period is astonishing. In addition to the large U.S. and
European companies, such as Citibank, Ford, IBM, Mercedes-Benz and Philips, whose
businesses have traditionally been global, we can add MacDonalds, Nike, Intel,
Microsoft, Disney, Gap, Sony, Panasonic, Toshiba, and a host of others. Not only do
consumers worldwide buy similar products made by global firms, but these firms develop
their ideas and manufacture their products wherever the results are best, in California,
China, Ireland, or Mexico.
Global markets present opportunities for growth and financial performance as
well as place significant pressures on domestic industries to compete more intensely. A
firm can experience these opportunities and pressures simultaneously, turning
participation in international markets into a necessary but strenuous part of the firm's
overall strategy. Further, for the firm to perform effectively within its worldwide market
position, the financial and operating nuances of global competition must be learned. This
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experience can be costly, and the lessons learned almost always increase the complexity
of strategic decision-making. Yet it is disastrous for a firm to avoid trends towards a
global market. Avoidance inevitably produces a weakened market position as the firm’s
customer base switches to global competitors that are able to leverage their worldwide
scope into lower cost or stronger innovation.
In this chapter we will discuss global competition. We will examine the basic
theories of regional and country advantage. Our focus will first be on why regions within
countries are differentiated, and then why countries matter. In fact, without regional
differentiation, country advantages cease to exist. A host of examples are available to
illustrate how these theories relate to practice.
Second, we will look at how firms overcome country differences to establish a
global business and compete successfully against local rivals. Inevitably, becoming a
global firm requires innovation in important business activities. However, firms
competing in global markets typically vary in how they locate their activities across
countries. In some industries, this variation will contribute substantially to performance
differences; in other industries, the contribution may not be so great.
Third, it is important to look at how firms organize their activities to compete
globally. Initially, companies whose international sales are a small proportion of total
revenues will assign responsibility for all of their global business to an administrative
unit that stands alone. Later, as these international sales grow, responsibility for them
becomes integrated with the rest of the line organization.
Fourth, global competition over time entails the entry and exit of firms into and
out of geographical regions. The dynamics of inter-regional entry and exit are important
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since they determine in part how firms locate their activities worldwide. These dynamics
need to be well understood because of the costs incurred when a firm enters a country and
the costs of sacrificing goodwill when a firm exits.
Last, we will discuss models for competing across multiple regions. This type of
competition, frequently called multi-point, can also occur across products in a product
line. Multi-point competition, for example between Coca-Cola and Pepsi-Cola across
countries and regions world-wide, complicates the economics of investments in activities
and frequently implies the centralization of marketing in a global unit to streamline the
coordination of interregional strategies. It is useful and important then to outline in some
detail this type of competition as a frequent consequence of globalization.
Why do regions matter?
Before we can understand how nations differ economically and how these
differences affect strategy, it is important to discuss why geographical regions, frequently
quite small in size, emerge as centers of production for specific industries. The standard
explanation of regional advantage is based on the unequal geographical distribution of
resources. Some regions are well endowed and others less fortunate. But this explanation
does not apply to industries whose major inputs are intangible, or where there is little
need to locate near raw material sources. Silicon Valley is not a hub of high technology
because of an abnormally large lode of silicon there. Consequently, we need an additional
perspective based on how managers and their workers make decisions over time about
where to locate their activities geographically. This perspective has broader applicability
since it does not rely on fixed endowments on which regions differ.
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Alfred Marshall in his classic exposition of economic theory in 1920 laid out a
careful and strikingly current set of arguments explaining why the firms in many
industries tend to cluster together geographically, often within a few miles of each other.1
Marshall suggested that there were three reasons why geographical clusters appear: 1) the
advantages of pooling a common labor force by firms in the industry; 2) the gains from
inputs from local specialized suppliers; and 3) the benefits from technological spillovers
in the region.
Very often in cases of localized industries it is critical to have an event that acts as
a seed, establishing a nascent hub of firms that can grow into the major location of
industry activity. In such a case, economic forces reinforce the initial tendencies towards
localization and the industry becomes geographically centralized. If this does not happen,
economic conditions do not lead to geographic concentration, and the industry becomes
geographically decentralized. As we will see, decentralized or fragmented industries are
prime targets for another kind of consolidation, this time not based on regional clustering,
but on process innovation by firms.
Labor Pooling. It seems obvious to argue that a major reason firms will locate in
a region is to benefit from a large pool of workers whose skills are specific to the firms’
needs. But it is important to understand when pooling adds value. For example, if a firm’s
labor requirements were stable, then it could attract a fixed number of workers and move
with them wherever it found favorable conditions. Labor pooling would not increase
efficiency since the firm employed the same dedicated workers over time. However, if a
firm experiences some uncertainty in its need for workers over time, locating in a region
with additional workers to fill unexpected demand for labor would be valuable.
1
See Marshall, 1920.
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Specialized Local Suppliers. Clearly, when firms in the same industry locate in
the same region, they can support a larger number of local suppliers that are specialized
to their customers' requirements. There are a variety of obvious conditions for the rise of
this supplier base. Some of these conditions are very similar to those leading their
customers to localize. Others conditions are based on the benefits of co-location for the
coordination of transferring specialized goods and services.
One must assume that the customer industry and the supplier industry are
concentrating their operations in the region at about the same pace as they develop. With
regional demand for their output increasing, supplier firms increase their production, and
the number of supplier firms rises. If there is demand for their output outside the region,
which is quite possible, locating near customers in one region may restrict the suppliers’
ability to set up facilities close to customers in another region, assuming some constraints
on firm expansion rates. The location decisions of suppliers are therefore very important
for regional development.
The second condition concerns the tradeability of the intermediate inputs. The
more specialized these inputs, the more closely coordinated the relationship between
buyer and supplier needs to be. Local design and production may facilitate close
coordination if the customer’s changes require frequent communication with technical
units and the changes are complex. As the supplier’s inputs become more specialized to
local customers, it becomes less able to sell outside the region. The supplier base within
the region therefore grows.
Technological Spillovers. One of the most obvious reasons firms in the same
industry concentrate in the same region is the benefit they receive from sharing
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technological information. Even though firms in the same industry are competitors,
location in the same region offers opportunities for mutual observation and learning that
are more frequent and more intense than would be available at a distance. These
opportunities give co-located firms an economic advantage as long as the major
innovations in the industry arise in the region or there are no strong first-mover
advantages to innovating competitors outside the region.
Both product and process innovations are more likely to diffuse more quickly
within a region for a variety of reasons. First, both managers and workers are connected
through interpersonal networks outside of work. This network, in addition to contacts
through regional industry associations, facilitates the flow of technical and strategic
information. The strength of these flows obviously depends on how strongly innovating
firms protect their ideas and inventions. The greater the protection, the weaker the flows
from that firm.
One explanation of the success of Silicon Valley as a regional center for high
technology industries, especially computer hardware and software, is the relative
openness of incumbent firms to establishing partnerships with new firms. The interesting
comparison is the region around Boston centered on the two beltway roads, Route 128
and Interstate 495. This region also had a large concentration of high technology firms in
the 1970’s and 1980’s but has not grown at the same rate as Silicon Valley. There are
undoubtedly a variety of reasons for the difference in the success of the two regions.
However, Saxenian has proposed that the hierarchical and highly controlled system of
interfirm relationships, with Digital Equipment at its head, in the Boston area was not as
conducive for technology spillovers as the more decentralized and less controlled
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network that developed in Silicon Valley. The advantages of decentralization, which
Saxenian's theory proposes for innovation, are obviously analogous to the resource
allocation benefits economists identify with free markets. However, her idea has several
additional nuances that are useful for understanding competition among regions.
Regional markets for technological innovation are highly imperfect; they are structured
around a set of core firms, mostly large incumbents; and they are dependent on the
policies of these firms regarding how technological innovation should diffuse throughout
the region. Saxenian's insight is that the key to achieving a regional advantage due to
technological spillovers is a set of policies, some formal, some ad hoc, in the powerful,
central firms that promote the spread of innovative ideas among firms. Digital Equipment
was simply less interested in building a regional technology base around Boston than the
core firms were in Northern California.
Second, technology spillovers are also achieved from the transfer of managers and
professionals across firms in the region. There are two obvious types of transfer, the first
involving startups by ex-employees of incumbents, and the second involving mobility
among existing firms. Startup activity can be especially critical for regional growth
within an industry sector when there is a high rate of technological innovation that
stretches the capabilities of incumbents. An active entrepreneurial sector within an
industry increases the likelihood that new ideas will be developed and commercialized.
Spillovers through the transfer of personnel between existing firms are an obvious
extension of the benefits of labor pooling. Although managers are typically enjoined from
sharing technical information developed during their previous employment, the skills
they learned are portable and can be applied to new projects. Also, some process
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innovations, such as the details of quality and cost control processes, are protected from
imitation primarily by the fact that they are difficult to observe from outside the firm.
Once described by a practitioner, these details can be customized to another firm’s
processes to produce substantial economic gains.
Third, regional associations, which meet to match people to jobs and resources,
are essential for increasing the local concentration of the industry, both through growing
incumbents and developing startups. The ability to meet face-to-face helps entrepreneurs,
venture capitalists, managers, engineers, and marketing professionals to build
relationships that form the basis of new business growth. This growth is more often than
not founded on technical or commercial concepts that were developed in the region. The
association thus is a forum in which technological spillovers can occur.
Finally, the location of firms in a region presents opportunities for informal
communication that is likely to bear on technological issues. As managers and other
employees from different firms associate outside of work, they often talk about common
problems in dealing with suppliers, customers, regulators and other competition. Sharing
information in this way may not directly produce technological innovation. However,
there may be indirect effects as new information frames issues in novel ways, raises
questions that had not been asked before or stimulates a search for answers to problems
that were seen as intractable.
The development of systematic technological benefits from regional co-location
thus ultimately depends on the repeated exchange of ideas across firms. Achieving an
effective rate of exchange requires the recognition that more cooperation among firms in
the region leads to greater returns than less cooperation. Obviously, there are limits on the
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degree to which competitors can share information directly. In many cases, sharing of
this kind is simply impossible, given the importance of protecting proprietary technology
from imitation. However, these firms may cooperate within the region in other ways that
lead to increasing returns from co-location. Managing the tension between cooperation
for the purposes of increasing the regional growth rate and competition for the purpose of
increasing the firm’s growth rate is therefore a critical task for local firms. No region can
succeed as a hub of industry activity without a consistent balance between these two
forces.
Why do countries matter?
Although firms in the same industry often cluster in regions, we often understand
competition among firms in the context of world geography as occurring among
countries. Because of the effects of national laws and regulations on investment, on the
shape and scale of demand for products and services, and on trade, it is common to think
about nations as discrete economic entities, whatever the regional clustering of industries
within a country. As sovereign states, nations have the right to regulate economic
behavior through legal sanctions. There are strong arguments that competitive markets
(which are an important assumption in the field of strategy) cannot be developed without
a strong rule of law within which disputes are resolved fairly and constructively. But laws
are malleable, and so governments are the targets of firms and their agents, such as
lobbyists, who try to influence the substance and trends of policies that affect their
interests.
National governments frequently intervene in industries and markets to shape the
intensity and direction of investment behavior. Investment may be encouraged through
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government subsidies to promote innovation or lower costs. Or it may be discouraged
through high taxes or lengthy and arduous certification procedures. Government policy
can also influence the demand for goods and services through raising or lowering taxes
on final and intermediate goods. Demand and investment behavior can also obviously be
affected by macroeconomic policy manifested in industry regulation and the management
of interest rates by central banks.
Finally, governments vary substantially in their trade policies. Some countries
remain highly protectionist for selected industries, while others have moved strongly
towards policies of free trade. Protectionism can take a number of forms, including high
tariffs on imported goods; restrictions on certain kinds of imports; regulatory barriers to
certification in certain markets; laws precluding the procurement of non-domestic goods
and services; and the regulation of industries, such as distribution, which raises the costs
of foreign entrants. Trade policy may be used to help domestic firms grow in local
markets as regulation hobbles foreign entrants. The growth of domestic competitors in
the home economy strengthens their cost structures and capability to innovate, thereby
increasing their competitiveness internationally first as exporters and then as entrants into
foreign markets.
National Cultures. In addition to their governing role as makers of policies and
regulations to guide economic behavior, nations are also geographical locations with
identifiable cultural traits and orientations. A broad range of factors determine a nation’s
culture including geography, climate, languages, religions, martial history and
orientation, arts, political systems, family and social traditions, and economic mores.
Each of these influences may significantly affect the growth and profitability
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opportunities for indigenous firms and for foreign entrants. Differences in consumer
tastes across countries are frequently attributed to cultural differences rooted in a
complex of traditions regarding how the use of goods and services are consumed or used.
Examples of these cultural differences extend across a spectrum of markets from food
and clothing products to medical care, entertainment and transportation.
But in addition to its contribution to national differences in buying habits, culture may
also have a powerful influence on the competitive strength of firms across a variety of
industrial sectors. Some nations have developed systematic orientations towards specific
kinds of work that differentiate its quality and efficiency from competitors in other
countries. Whether this advantage is due to social, cognitive, affective or physical factors
is never completely clear in any case.
An interesting and instructive example of national differences in the workplace is
given by Hugh Whittaker in a study of the introduction of advanced numerical machine
tool technology in Britain and Japan. 2 The approach and understanding of the British and
Japanese workers to the same technology were quite different. British workers interpreted
the problems posed by the technology as primarily hardware-oriented, while the Japanese
saw these problems as software-driven. These interpretations were primarily due to the
emphasis Japanese firms had placed on software programming as an essential skill for
manufacturing operations. The British firms, on the other hand, had maintained a strong
focus on traditional craft skills in manufacturing operations. Although there is validity to
both perspectives, the differences in problem interpretation have obvious and important
consequences for how future innovations are developed.
see D. Hugh Whittaker, “ New Technology and the Organization of Work: British and Japanese
Factories” in Country Competitiveness, Bruce Kogut (ed.), 1993, New York: Oxford.
2
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Natural Resources and Geography. The last factors to create national
advantages in an industry, and perhaps one of the most obvious, are the country’s natural
resources and geographical location. Many countries are rich in natural resources such as
oil, minerals, and arable land, while others lack one or more of these to a significant
degree. Further, some nations have been lucky enough to be located on major trade
routes, offering opportunities to build mercantile expertise. Others are off the beaten path.
However, it is common to find countries with few natural resources building
strong global economies and countries with abundant resource stocks lagging behind
their neighbors. Japan is one the best examples of the former case. Japan has almost no
oil or minerals and so must import stocks from other countries for its needs. Yet this
country has the second largest economy in the world, even though it has been growing
very slowly since the early 1990’s. In contrast, Russia has tremendous reserves of oil and
minerals. Yet these resources are just beginning to be developed, and there are significant
political and organizational impediments to this development effort. Thus although
natural resources are undoubtedly a potential advantage for a country, in that they can
provide revenues to build national economic infrastructure, they are not always managed
effectively. Poor management decreases the benefit a country can receive from its
endowments and perhaps lowers the potential benefit it can receive in the future as
competing resources are discovered and used in other countries with more effective
economic systems.
National Institutions and Diversification Among Industries. Another way to
think about a country's institutions is in terms of the opportunities entrepreneurs face in
trying to expand their firms into different industries. Entrepreneurs typically have to deal
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with a number of institutional factors in order to extend their organizations into new
markets, especially when expansion means acquiring another firm. For example,
expansion may entail getting the approval of regulatory agencies, negotiating with the
boards of directors of both the acquiring and target firms as well as perhaps their owners who may be many or few - and finding new sources of capital through the existing
networks of firms providing resources. Countries may differ on each of these institutional
factors so that an entrepreneur in one nation faces one set of diversification opportunities
while a counterpart in another country faces another set. How countries differ in the
institutions governing interfirm competition and allocating resources across firms
therefore is likely to have an effect on the diversification patterns across nations.
It is important to note, however, where institutional differences among countries
may have less of an effect. One must be careful to distinguish between resistance that is
highly specific to an organization and resistance that is determined by organizational and
technical factors that are pervasive throughout the country. As we have discussed above,
countries can differ substantially in their work practices, and these differences can
accelerate or slow the rate and direction of administrative and technical innovations
worldwide. But when managers can justify the adoption of a technological innovation in
terms of its contribution to the organization's performance, that innovation is likely to
diffuse rather widely. When there is a lag in innovation adoption, the resistance may
come from inertial factors within the managerial ranks more often than from institutional
factors within the society.
For example, one administrative innovation that has diffused throughout major
countries with capitalist economies is the multi-divisional form for managing multiple
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businesses, each with a distinct product line. This form originated in the United States in
the early 1920's and spread throughout the country over the next forty years. After World
War II it also spread more generally to other capitalist countries, although firms in some
of these countries had adopted it in the earlier decade. By 1970, the percentage of
diversified firms that had adopted the "M-form" in the top five industrialized countries
(France, Germany, Japan, the United Kingdom, and the United States) was about the
same and quite high. The convergence of those percentages is likely to be even higher
today. The point here is that this form increases the overall performance of diversified
enterprises; so it is rational to adopt it if the firm has product lines that need to be
institutionally separated. Thus, to summarize, although there are significant country
effects on the path firms take in expanding across industries, there remains an incentive
common to firms in all countries to adopt innovations that improve organizational
performance.
Porter's Diamond Model
Michael Porter has extended these observations about comparative advantage to
include the value of having leading edge customers, the competitive dynamics of an
industry within a country and the norms of organization-building.3 Figure 1 shows the
Diamond model of national advantage Porter and his colleagues developed.
As we have discussed, factor conditions such as natural resources and
geographical location represent the traditional sources of comparative advantage. Porter
makes the important point that although these may provide a favorable baseline for a
3
See Michael Porter, The Competititive Advantage of Nations, 1990, New York: the Free Press.
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Figure 1
Porter’s Diamond Model
Firm Strategy,
Structure,
and Rivalry
Factor
Conditions
Demand
Conditions
Related and
Supporting Industries
home firm's global competitive advantage, they are neither necessary nor sufficient,
especially as industries where specialized knowledge is critical for successful product
commercialization.
The importance of related and supporting industries in the home country of a firm
reflects the points made above about the clustering of buyers and suppliers in the same
region. The key again is the effectiveness of specialized relationships between firms in
the adjacent industries. These relationships are developed to create benefits for both
industries over competitors, typically by information sharing, improved coordination of
product flows and service, and the joint development of projects designed to improve
performance, especially in cost and quality. Without cooperative relationships of this
kind between industries, there is little reason to be co-located in the same country.
The diamond model's third element involves the common modes of competition
in a country. One or more ways of organizing or competing within a nation may become
common as innovations diffuse throughout the economy. The suggestion here is that the
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cultural and legal constraints associated with national boundaries are sufficient to bound
the diffusion of competitive and administrative practices initiated by local firms. Over
time, of course, these practices may transcend these boundaries if non-domestic firms can
gain from implementing them. But initially in the diffusion process of these innovations,
domestic firms have the advantage as first movers. National advantages based on these
innovations are thus a form of spillover that pertains to administrative innovations
focused on strategy and organization.
An excellent example here is the rise of an emphasis on quality in manufactured
goods in Japan, beginning in the 1950's with Deming's introduction of statistical
procedures and associated managerial practices aimed at improving what was then a
strikingly low level of quality. The Deming award for excellence in quality-oriented
processes became a highly desired and recognized achievement among Japanese
companies from its inception in the late 1950s through the 1990s. Winners built small
shrines outside corporate headquarters commemorating the honor. But the major benefit
to Japanese industry was the intensity with which firms competed for the prize. This
competition produced a remarkable range of process innovations in almost every activity
in the value chain, each innovation oriented towards improving the customer's experience
with the product. As a national movement, the "quality revolution" in Japan reflected a
form of competition that helped to raise the country's industrial expertise to world
prominence.
Finally, a nation may develop a distinctive set of customer preferences that force
firms in an industry to develop specific strategies and structures that lead to greater
competitiveness worldwide. The more demanding customers in a firm’s home country
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are, the stronger the firm’s practices must be to succeed in the home market. If the firm
can use these practices to compete internationally, then it will have an advantage over
companies from other countries where customers placed fewer requirements on their
suppliers.
Again, one of the best examples of country-specific demand characteristics is
Japan. As the Japanese economy grew in the 1950’s and 1960’s, businesses and
consumers became notoriously picky about quality and did not like to pay more for
higher quality goods. These buying practices forced Japanese firms to learn how to
produce more functional and more durable goods more efficiently. Developing these
practices may have been made more intuitive by the fact that these firms were run by
Japanese managers and workers who understood their buyers well. After all, they were
customers, too. When these firms began to export their goods and then to produce these
goods overseas, they found that customers outside Japan were hungry for the type of
products Japanese customers had become used to. Consequently, Japanese firms
increased their worldwide market shares in a variety of consumer and industrial durable
goods industries and were able to sustain their positions, since it took some time for nonJapanese companies to imitate the practices Japanese firms had developed.
Kogut's Global Competition Framework 4
If global competition was only a matter of firms competing against each other on
the basis of their country of origin and the choice of other countries as markets, we could
reduce this kind of rivalry to a comparison of national economic policies and cultures. In
fact, there has been much debate about whether the global success of Japanese firms in
See Bruce Kogut, 1985, “Designing Global Strategies: Comparative and Competitive Value-Added
Chains,” Sloan Management Review, pp. 15-27.
4
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consumer and industrial durable goods industries over the past twenty years is due to
their initial location in Japan or to their strategic acumen. The truth is undoubtedly a
combination of these two factors. Honda, Mitsubishi and Sony are truly global
companies, producing and selling their products around the world. Their success is due
both to the advantages of starting off with Japan as the home market and to their expertise
at global competition.
Global strategy is thus more than simply leveraging the benefits of the firm's
country of origin. It means leveraging the firm's capabilities across national markets. It is
hard to deny that many firms have been quite successful at building strong positions in
markets outside their home countries through the effective coordination of worldwide
activities including R & D, operations, logistics, procurement and brand management.
Kogut distinguishes between two types of advantage: comparative advantage,
which is associated with benefits due to a firm's home country; and competitive
advantage, which is due to the capabilities of the firm itself (see Figure 2). Competitive
advantage occurs when a firm can aggregate one or more activities in the value chain of a
business to achieve economies of scale across national markets, giving
Figure 2
Kogut’s Global Strategy Framework
Comparative Advantage
Low
Low
High
Nationally
Segmented
Industry
Vertically
Integrated
Industry across
Borders
Horizontally
Integrated
Industry across
Borders
Horizontally and
Vertically
Integrated
Industry across
Borders
Competitive
Advantage
High
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the firm lower costs compared to local competitors. It also occurs when a firm can
achieve lower costs through economies of scope, so that multiple products are sold across
local markets more cheaply than local rivals. A firm may also benefit from competing
across national markets when it can diffuse practices learned in one market to others
where they add significant value. These three types of competitive advantage - economies
of scale, economies of scope, and learning - give global firms superior economic
performance in local markets compared to their non-global rivals.
To understand how comparative and competitive advantage are related to each
other, it is useful first to think of them as applying to industries rather than firms. Table 1
outlines how this works through four types of industry. Each type represents a highly
stylized but useful way to think about competition in local and global markets.
Nationally Segmented Industries. The first type of industry is isolated within
each country, for all countries worldwide. No country has a special advantage over any
other in providing critical resources to the industry so there is nothing for a firm to
leverage across borders. Further, no firm has a special advantage over any other firm
across borders in achieving economies of scale, economies of scope or the transfer of
knowledge from one country to another. Kogut calls this type of industry "nationally
segmented."
What kind of industry might this be? First of all, there can be no cost benefits
from aggregating activities across countries so the minimum efficient scale in each
activity must be small enough so that local firms can be competitive in their cost
structures. Second, whatever economies of scope are available should be attainable by
local as well as global competitors. Last, since no country has a comparative advantage
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over any other, there are no learning benefits for firms competing across national
markets. In other words, there is apparently no global franchising opportunity for firms in
any country, nor is there any economic basis for firms in one country to dominate
worldwide markets.
In this era of extensive global positioning by firms in almost all markets, it is hard
to find examples of nationally segmented industries. However, until the late 1970’s it was
common for a number of professional service industries, such as law firms and
advertising firms, to be local rather than global firms. There were several obvious reasons
for the national segmentation of these markets. First, professional service firms have very
low fixed costs, leading to few, if any, scale or scope economies in everyday business
activities. Also, as they grow, this type of firm typically becomes increasingly
fragmented internally, making it more difficult to transfer specialized service innovations
across units in different countries. Since professional service firms make their money by
selling know-how, the absence of an ability to transfer innovations effectively across
national boundaries is a major impediment to globalization. Third, these firms typically
provide services that are specialized to specific customer needs, which were commonly
related to national regulations and market idiosyncrasies. The high frequency of
specialized services made it easier for local firms to compete on the basis of knowledge
of the regional or national market.
These technological and market barriers to globalization became clear when
Maurice and Charles Saatchi tried to globalize the advertising industry in the 1980’s.
Since there were no available economies across the acquired companies in Europe and
the U. S., the brothers’ initial attempt failed as costs outstripped revenues. It soon became
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evident, however, that the Saatchi’s had focused on the wrong model for
internationalizing the industry. Their failure had as much to do with the timing of their
strategy as with their execution. Once global customers understood that it would be
possible to buy advertising services in more than one country from a single agency, the
door opened for further attempts at establishing multinational advertising firms, many of
which are in existence today. These firms focus on serving a global customer base rather
than on competing with local advertising firms for local business. Although the latter can
be a significant part of their business, it is not the economic rationale behind their
multinational organization. Rather, their ability to offer one account to a multinational
customer and to coordinate advertising across markets differentiates them from local
firms and adds value when such coordination is necessary to the customer’s worldwide
marketing strategy.
It would be wrong, however, to assume that there were no international
professional service firms prior to 1980. McKinsey, the management consulting firm, has
had an global practice since the early part of the 20th century. In many countries,
McKinsey established a first mover advantage as a highly differentiated consulting firm
and overcame the difficulties of transferring specialized knowledge across borders by
hiring innovative, energetic professionals with a high capacity for learning. The network
of these consultants was more cohesive than that of less endowed firms and was able to
diffuse major administrative innovations, such as the multidivisional form, to
industrialized nations worldwide.
Thus, competing successfully as a global firm means achieving economic
performance that is higher than indigenous competitors in each local market. To do so
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repeatedly, even as national policies shift towards and away from the interests of the
global firm, requires an understanding within the firm of how local markets around the
world can be served together with a higher economic contribution than competitors. We
have seen that firms compete domestically along a broad spectrum of market positions.
Competing successfully in a position depends on executing the strategy consistently with
superior resources and capabilities. The same logic extends to global competition. Firms
with successful global strategies extend their domestic positions to international markets
and compete against local rivals both at home and abroad.
Industries that are Vertically Integrated Across Countries. The second kind of
industry in Kogut’s scheme is vertically integrated across countries. In this case, one
country possesses resources that are relatively unique and valuable to other countries,
leading to intercountry trade. If there is a benefit to coordinating both upstream
operations in one country and downstream marketing in another country, firms are likely
to appear which own operations both in the nation that has rich resources and in the
nations where customers buy the end products. This pattern of international integration is
typical of extractive industries such as aluminum, oil and gas, and copper. However, for
this type of industry there is little advantage to combining activities, such as technology
development, procurement or operations, across countries to achieve economies of scale
or scope.
Note that again we encounter the key question of how different stages in the value
chain should be governed. In this case, the two stages of interest are the one dedicated to
exploiting the resources one country is rich in and the one dedicated to selling in other
countries the products based on the resources. One might ask why one firm should own
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both these activities? The answer is that there are economic advantages to controlling
them both, based on the logic regarding organizational boundaries that was presented in
Chapter 5. However, there is a special twist to that logic in this case. In Chapter 5, we
discussed how firms might differ in their competence to execute an activity. But here the
requisite competence to produce the upstream input is based on a country-specific
advantage, for example, a natural resource. So joining up- and down-stream stages under
the governance of a single firm must be due to control issues alone. If there are no
coordination benefits to joint ownership, then the industry remains nationally segmented.
Horizontally Integrated Industries. The third type of industry in Kogut's
framework is horizontally integrated in one or more activities across countries. Firms
integrate their activities across countries in some instances to achieve lower costs through
economies of scale or scope. For example, it may be less costly to centralize production
in a single location and export to local markets worldwide. This location may be chosen
more for its closeness to global distribution channels, or to other activities in the firm
with which co-location might provide some benefit, than for an inherent country-specific
advantage related specifically to the activity’s quality or cost.
Which activity in the value chain should be centralized in one or a few locations
to improve worldwide performance is often a critical question that determines the
direction of industry globalization. In some industries, centralized technology
development brings substantial productivity benefits. For example, global pharmaceutical
companies have tended to locate R & D activities in a few facilities to increase potential
innovation due to the interchange of ideas among a larger group of scientists. Were these
professionals dispersed in offices throughout the world, their interaction would be less
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frequent and probably less productive as a whole. In other industries, the key activity to
centralize is operations to lower costs. This policy is especially evident in industries that
were traditionally decentralized by country as a result of the growth strategies of firms in
the industry, particularly European firms. For example, during the 1970’s and 1980’s, as
customers across local markets slowly became more similar in their tastes and needs,
companies in consumer products industries, e.g., Proctor and Gamble, began to centralize
the production of their goods to lower costs. This trend has continued as an increasing
number of products can be sold with little alteration for local language and customs in a
growing number of countries. A last activity that might be centralized to improve
performance is marketing. In this case, firms in an industry might develop worldwide
marketing strategies to direct local managers in how they compete. Centralized marketing
has become prevalent in the soft drink industry, especially as Coca-Cola and Pepsi-Cola
compete globally for worldwide market penetration and market share.
Vertically and Horizontally Integrated Industries. The last kind of industry is
one where both comparative and competitive advantages are important. Country
differences are a significant influence on the location of business activities, and
opportunities for economies of scale and scope are available to raise global productivity
levels. As consumers worldwide are increasingly exposed to a common media which
purveys a core set of goods, the benefits from aggregating activities across the value
chain increase relative to locating country-by-country. It is in fact rare for an industry not
to have some activities that are globally centralized. Further, the benefits of locating
activities, especially technology development, in highly productive regions, have become
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clearly recognized. Thus firms in many industries compete by exploiting both
comparative and competitive advantage simultaneously.
The Global Configuration of Firms. Kogut calls a firm’s location of activities,
both locally and globally, to take advantage of aggregation and regional benefits
“configuration.” All firms that compete in more than one country have a configuration
which is represented by where the activities in their value chains are located. More
importantly, firms in the same global industry may have different configurations. There
are a variety of important reasons why this is so.
First, firms in the same industry may differ because of the comparative advantage
associated with their country of origin. A firm originating in a country with a strong
comparative advantage in one or more value chain activities, such as operations or R &
D, are likely to keep these activities located at home rather than dispersing it to host
nations. A good example of this phenomenon is the use of Japan as a hub of operations
by firms producing consumer and industrial durables in the late 20th century.
One notable case is Komatsu, a producer of earth moving equipment. Komatsu
was originally a weak, second tier firm in Japan. Threatened by the entry into the
Japanese market in the late 1960’s by Caterpillar, the dominant global competitor,
Komatsu struggled to improve its domestic market position by improving its cost
structure and product quality. During this period, Japanese manufacturing firms
developed a range of innovations in operations, procurement, R & D, logistics and human
resource management that led the world in effectiveness. Komatsu participated in this
wave of innovation and benefited from it substantially. Also, labor, materials and capital
costs were quite a bit lower than costs in other industrialized countries. These country-
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specific advantages motivated Komatsu to keep operations, particularly component
fabrication and the assembly of the firm's products, in Japan. These products were then
exported worldwide.
The relevant comparison is Caterpillar. Caterpillar was the primary EME
contractor for the United States during World War II. When the war ended, its equipment
was strewn around the globe and used for rebuilding the physical infrastructures of the
nations whose lands had been battlefields. Also, the home U.S. market was the largest in
the world. Caterpillar therefore maintained local sales and distribution dealerships to
serve national markets. It also set up decentralized production facilities to economize on
transportation costs and on shifts in exchange rates, since there was no inherent
advantage to keeping operations within the U.S.
In the 1970's, Komatsu began to export to less-developed countries and the
Eastern bloc. These markets did not require local service, which could be best provided
by local dealer, allowing Komatsu to invest more in building its centralized
manufacturing capability. Over time, Komatsu succeeded in producing a broader product
line whose quality was roughly equal to Caterpillar's and whose cost was substantially
lower. Only when it entered the U.S. and European markets aggressively was Komatsu
forced to consider decentralizing some its operations and build local dealer networks.
Even with this shift in configuration, however, its operations remain much more centered
in Japan than Caterpillar's are in the U.S.
Second, firms will differ in their configurations because they occupy different
strategic positions in the world market. Global firms competing in local markets will be
positioned differently on the dimensions that customers use to value products. For
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example, in some markets some firms will emphasize delivery, others technology or
quality. Still other firms will offer products that are a broad mix of characteristics.
Whatever position a firm has chosen acts as a constraint on where and how it locates its
activities globally. For example, a firm that competes heavily on price against local firms
and other global rivals will probably configure its activities to achieve economies of scale
through centralization in those locations with the lowest costs. Alternatively, a firm that
competes through advanced design or functionality is likely to locate its technology
development in a region where the most current expertise is continuously generated. Or a
firm that sells customized as opposed to standard products will locate more of its
activities locally to be able to coordinate design and production more efficiently with
local customers. Further, a firm that sells to global rather than local customers will be
likely to centralize marketing to improve the coordination of sales and sales support
efforts. These links between the dimensions on which a firm competes and its
configuration of value chain activities across the world do not mean, however, that all
firms in a position are configured the same. Firms will differ depending on several other
factors, as explained below.
Third, a firm's configuration is determined to an extent by its size. Smaller firms
are less able to build local businesses that are large enough to achieve economies of scale
in key activities and so are forced to centralize globally. For example, Ford is about one
third the size of General Motors in sales and yet competes against GM in all world
markets. Because of its large size, GM has traditionally had almost completely separate
units for Europe and for North America, and each unit has sufficient volume to achieve
economies of scale in design and production. Ford, because of its smaller size, does not
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have these economies and so is forced to construct "world cars", such as the Mondeo
(Contour). These cars are designed in one location, Europe or Michigan, and built in
plants around the world. GM's cars in Europe and the U.S., however, are distinctly
different.
Fourth, firms will differ in their configurations because of the entry opportunities
available to them when they expand into the world market. The example given above
regarding the global diffusion of Caterpillar Tractor’s equipment after World War II is
apt here. Caterpillar’s opportunity at that time was incomparably greater than that
experienced by any other since. As we said, Komatsu also took advantage of Japan’s rise
to world prominence in manufactured goods, but the firm’s global dealer network
remained much smaller than Caterpillar’s primarily due to this firm’s extensive early
market penetration. So one reason Komatsu’s marketing and distribution remains more
centralized than Caterpillar’s is the difference in opportunities each firm faced when it
began to sell overseas.
Another example is Citibank, part of Citigroup. Beginning in the early 20th
century, Citibank (in its previous incarnation as First National Bank of New York)
expanded its global operations to serve U.S. firms that were investing overseas. The
network of branches the bank established was carefully extended and maintained
throughout the world over time so that the bank became able to serve clients in almost
every industry in almost every part of the globe. This network itself constitutes a
significant entry barrier to other banks, such as Deutschebank and HSBC, which are
expanding their global presence. The open playing field that was offered to Citibank is
gone.
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In both the Caterpillar and Citibank examples, the opportunities available in the
initial stages of globalization allowed the development of a more extensive configuration.
Late entrants into the global market are generally unable to match the geographical reach
of firms that entered earlier. Of course, as we discussed in Chapters 3 and 8, this entry
barrier remains powerful only if there has been no significant innovation that older firms
cannot imitate. Such an innovation brought by late entrants would indicate a change in
the way firms compete and potentially open markets to innovators, lowering the
incumbents’ entry barriers and raising the potential for entrants to achieve comparable
configurations with incumbents.
Change in Configuration. As market forces change, so do firm configurations.
These shifts in structure and location are due to changes in country specific advantages,
changes in strategy and technological and administrative innovations. The key point here
is that a firm’s configuration is an important element of its ability to execute its global
strategy. Firms within the same market position but with different configurations
therefore compete on the basis of how their activities are organized and located across the
world. Further, the sustainability of a firm’s market position depends on how well it has
configured these activities compared to competitors. When innovations occur which alter
the benefits of particular locations or centralized structures, firms will be forced to
reconfigure how their activities are organized in order to remain economically viable.
One example of such an innovation is the rise of the internet as a pervasive
medium allowing the simplification of communication among individuals and
organizations worldwide. Along with the rise of English as the common language of
business worldwide, connectivity through the internet increases the ability of buyers and
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suppliers to engage in relatively complex transactions more efficiently an so may reduce
the need for co-location and lower economies of scale in some activities. As businesses
around the world are connected electronically through the internet, how firms configure
their activities, such as distribution, in order to achieve greater speed of delivery and
lower costs will be a critical question for maintaining sustainable market positions.
Modes of Entering Foreign Markets
As with any expansion, firms commonly enter non-domestic markets with low
levels of investment and build their presence as demand for their goods or services
increases. Initially, it is usual for the firm to export its product to a host country
distributor for sale or to license technology to a host country firm for production.
Typically, as the volume of demand rises, the firm increases its level of investment in the
new market. This occurs through both raising the firm’s share of ownership in the nondomestic business and increasing control over the business’s operations. So, for example,
a licensing agreement may be changed to a joint venture, and over time a joint venture
acquired. Further, after selling through export, a firm may set up a complete set of
activities in a foreign market to meet the specialized needs of local large customers.
This process of increasing control over international operations is typically called
internalization. Interestingly, the theory of internalization is not very different from the
theory of managing firm boundaries we examined in Chapter 5. The motivation of a firm
to raise its level of investment rises when the firm can realize the economic returns to
specialized elements of the product more efficiently than the host country supplier of
downstream services. In fact, it is the returns to the firm that are raised by increasing
control, not necessarily the returns overall, although these may rise as well. The host
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country supplier, whether of production, sales or distribution, may be extracting
economic returns for itself at higher levels than the firm is willing to accept for the
services offered. Moreover, this situation may be predicted for any supplier in similar
circumstances. So the firm replaces the supplier by vertically integrating into the
activities it performs.
There are several key points to recognize about such an internalization decision.
First, such a decision is viable only if the firm is able to perform the supplier’s activity.
So the competence of the firm is critical, just as it is for vertical integration decisions in
general. Second, however, in the case of international expansion, the firm may be able to
increase its chances of being sufficiently competent in an activity by using its experience
in executing an activity elsewhere in the world. So once a firm has established an
integrated business in one new country, it may find it easier to establish such a fully
fledged business in other countries. This is a “process” version of both learning across
countries and economies of scope, both of which we discussed in terms of their effect on
configuration in general above.
Organizing for Global Competition
Competing in more than one country therefore complicates how a firm is
organized. Competing abroad usually entails the development of specialized units at
higher levels in the organizational hierarchy than are typically found for regional
divisions domestically. The reason for the high salience of international units is that they
often require top management oversight if they are to grow effectively. Why might this
be so?
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Single business firms, such as we are concerned with here, are most often
organized according to functions, as discussed in Chapter 4. When international
expansion begins, with low levels of investment, global business is frequently organized
either under marketing or as a staff unit. But as investment in international operations
grows and the firm brings more of its non-domestic business within its institutional
boundaries, resource allocation decisions become both more complex and more
integrated with the rest of the organization. At this point the firm has three options for
organizing its global and domestic business.
The first option is the formation of an international division in addition to the
existing functional units of marketing, operations and R & D. The advantage of such a
unit is that it allows the development of managers focused on increasing international
growth as distinct from competition in the domestic market. Typically, the international
division is divided into units assigned to each global region in which the firm competes.
The disadvantage of this structure is that responsibility for international competition is
separated from the core line organization. The coordination of international and domestic
operations must therefore be done by the firm's top management, assisted by liaison
between the units.
A second option is to subordinate international operations within the functions
themselves. In this case, activities in the firm's value chain may organized by region so
that marketing, for example, contains a separate unit for each global region in which the
firm competes. This option allows the firm to coordinate each value chain activity
globally while allowing the regions a degree of autonomy necessary for specialized local
needs and constraints. Worldwide coordination within functions may be especially
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important when the firm sells to global customers, as is common in service industries
such as financial services and telecommunications, or when the firm competes against
global competitors whose strategies are multi-regional, as in products industries such as
soft drinks and soap. However, this option creates problems for coordinating activities
across the value chain, for example between marketing and operations, since conflicts
between functions within region must again be resolved at the top of the firm.
A third option is organizing first on the global regions the firm competes in and
second on the functions that make up the business. Here the regional managers control
how the firm competes in their particular geographical areas rather than the functional
managers. Each regional manager acts virtually as an independent general manager,
directing the value chain activities to address local constraints. Clearly, this way of
organizing for global competition is appropriate when the regions are sufficiently
different in their competitive characteristics that the advantages of local control over the
firm's activities are greater than the advantages of globally centralized control in each
function. An example of the benefits of regional control might be the ability to compete
more effectively against differentiated local firms for customers with special
requirements. In general, the more specialized local needs, the more likely the firm is to
give regional managers greater control.
Finally, many firms adopt a combination of these options, centralizing globally
some activities in the value chain and decentralizing others by region. For example, as
mentioned above, technology development may be centralized in a region, such as
Silicon Valley for semiconductor design or Southern California for automobile design,
which has a distinct comparative advantage. Operations and marketing, however, may be
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decentralized by region, so that the basic designs created centrally are modified, built into
products and sold according to the needs of local customers.
A second form of hybrid structure is the elevation of one or more countries in the
firm's hierarchy in conjunction with a functional structure within which the other global
regions are subordinated. In this case, the country is an extremely important and highly
specialized market which requires top management attention. Japan has frequently been
positioned in this way in the organization of U.S. firms, and it is likely that China will
achieve a similar importance as its acceptance of foreign goods and services grows.
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Summary
1. Global markets present opportunities for growth and financial performance as well as
place significant pressures on domestic industries to compete more intensely.
2. The standard explanation of regional advantage is based on the unequal geographical
distribution of resources.
3. Marshall suggested that there were three reasons why geographical clusters appear: 1)
the advantages of pooling a common labor force by firms in the industry; 2) the gains
from inputs from local specialized suppliers; and 3) the benefits from technological
spillovers in the region.
4. Very often in cases of localized industries it is critical to have an event that acts as a
seed, establishing a nascent hub of firms that can grow into the major location of industry
activity.
5. Regional markets for technological innovation are highly imperfect; they are structured
around a set of core firms, mostly large incumbents; and they are dependent on the
policies of these firms regarding how technological innovation should diffuse throughout
the region.
6. Saxenian's insight is that the key to achieving a regional advantage due to
technological spillovers is a set of policies, some formal, some ad hoc, in powerful,
central firms that promote the spread of innovative ideas among firms in the region.
7. Startup activity can be especially critical for regional growth within an industry sector
when there is a high rate of technological innovation that stretches the capabilities of
incumbents.
8. Managing the tension between cooperation for the purposes of increasing the regional
growth rate and competition for the purpose of increasing the firm’s growth rate is
therefore a critical task for local firms.
9. Because of the effects of national laws and regulations on investment, on the shape and
scale of demand for products and services, and on trade, it is common to think about
nations as discrete economic entities, whatever the regional clustering of industries within
a country.
10. In addition to their governing role as makers of policies and regulations to guide
economic behavior, nations are also geographical locations with identifiable cultural
traits and orientations.
11. Differences in consumer tastes across countries are frequently attributed to cultural
differences rooted in a complex of traditions regarding how the use of goods and services
are consumed or used.
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12. It is common to find countries with few natural resources building strong global
economies and countries with abundant resource stocks lagging behind their neighbors.
13. Porter’s diamond model includes resource arguments for comparative advantage, the
value of having leading edge customers, the competitive dynamics of an industry within a
country, and the norms of organization-building.
14. Global strategy is thus more than simply leveraging the benefits of the firm's country
of origin; it also means leveraging the firm's capabilities across national markets.
15. Kogut distinguishes between two types of advantage: comparative advantage, which
is associated with benefits due to a firm's home country; and competitive advantage,
which is due to the capabilities of the firm itself.
16. Competitive advantage occurs when a firm can aggregate one or more activities in the
value chain of a business to achieve economies of scale across national markets, giving
the firm lower costs compared to local competitors.
17. These three types of competitive advantage - economies of scale, economies of scope,
and learning - give global firms superior economic performance in local markets
compared to their non-global rivals.
18. Nationally segmented industries are those where no country has a special advantage
over any other in providing critical resources to the industry so there is nothing for a firm
to leverage across borders and no firm has a special advantage over any other firm across
borders in achieving economies of scale, economies of scope or the transfer of knowledge
from one country to another.
19. Competing successfully as a global firm means achieving economic performance that
is higher than indigenous competitors in each local market.
20. Industries that vertically integrated across countries occur when there is a benefit to
coordinating upstream operations in a resource-rich country and downstream marketing
in another country.
21. In horizontally integrated industries across countries, firms integrate their activities
across countries to achieve lower costs through economies of scale or scope.
22. Vertically and Horizontally Integrated Industries are those where both comparative
and competitive advantages are important.
23. Kogut calls a firm’s location of activities, both locally and globally, to take advantage
of aggregation and regional benefits “configuration.”
24. A firm’s configuration is an important element of its ability to execute its global
strategy.
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25. The process of increasing control over international operations is typically called
internalization.
26. Competing abroad usually entails the development of specialized units at higher
levels in the organizational hierarchy than are typically found for regional divisions
domestically.
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