Discussion Paper Series

Fifty Years of International Business Theory and Beyond

FIFTY YEARS OF INTERNATIONAL BUSINESS THEORY

AND BEYOND

A. Rugman
University of Reading, UK
A. Verbeke
University of Calgary, Canada
Q. Nguyen
University of Reading, UK

The aim of this series is to disseminate new research of academic distinction in the fields of international business and strategy.
Papers are preliminary drafts, circulated to stimulate discussion and critical comment. Publication in the series does not imply that
the content of the paper reflects the views of Henley Business School, the John H. Dunning Centre or the University of Reading.

John H. Dunning Centre for International Business

Discussion Paper No. 2011-001 June 2011

dunning@henley.reading.ac.uk
www.henley.reading.ac.uk/dunn
1

FIFTY YEARS OF INTERNATIONAL BUSINESS THEORY

AND BEYOND

Alan M. Rugman (Corresponding author)

Professor of International Business
Henley Business School, School of Management
University of Reading
Henley on Thames, Oxon, RG9 3AU, England
E-mail: a.rugman@henley.reading.ac.uk

Alain Verbeke
Professor of Strategy and Global Management
McCaig Chair in Management
Haskayne School of Business
University of Calgary

Quyen T.K. Nguyen

Henley Business School, School of Management
University of Reading

Submitted to Global Strategy Journal

Acknowledgements: we are pleased to acknowledge helpful comments from two
referees, and from Professors Peter Buckley, Mark Casson, Michael-Joerg Oesterle, and
Joachim Wolf. We also received helpful comments from participants at seminars at the
University of Leeds, York University and the University of Reading.
Version: March 31, 2011
Accepted for publication in Management International Review, volume 51, 2011
2

ABSTRACT

As the field of international business has matured, there have been shifts in the core
unit of analysis. First, there was analysis at country level, using national statistics on
trade and foreign direct investment (FDI).

Next, the focus shifted to the

multinational enterprise (MNE) and the parents firm specific advantages (FSAs).
Eventually the MNE was analysed as a network and the subsidiary became a unit of
analysis.
We untangle the last fifty years of international business theory using a classification
by these three units of analysis. This is the country-specific advantage (CSA) and firmspecific advantage (FSA) matrix. Will this integrative framework continue to be useful
in the future? We demonstrate that this is likely as the CSA/FSA matrix permits
integration of potentially useful alternative units of analysis, including the broad
region of the triad.
Looking forward, we develop a new framework, visualized in two matrices, to show
how distance really matters and how FSAs function in international business. Key to
this are the concepts of compounded distance and resource recombination barriers
facing MNEs when operating across national borders.

Keywords: multinational enterprises (MNEs); firm specific advantages (FSAs); country

specific advantages (CSAs); compounded distance; subsidiary; network; regions; resource
recombination barriers; theory

INTRODUCTION
In this paper, we examine the literature on international business (IB) over the last fifty
years. We do this in the first three sections. In the second half of the paper, we develop
new frameworks to analyze unresolved issues in the theoretical and empirical literature
of IB that will require research in the future.
As the field of IB has matured, there have been shifts in the core unit of analysis. In the
pre-Hymer (1960) era, international economists dominated the field and focused on
national competitiveness at the country level, using national statistics on trade and
foreign investment. During the 1970s, the focus shifted to foreign direct investment by
the multinational enterprise (MNE) and the transfer across borders of its firm specific
advantages (FSAs), both stand-alone competences (such as patented R&D knowledge and
brand names) and higher-order capabilities. As of the 1980s, more attention was devoted
to the MNE as a differentiated network with the MNE subsidiary as the unit of analysis.
In addition, inside the MNE, substantial academic work was performed focusing on
entrepreneurial growth in specific cultural, economic and institutional contexts. Finally,
a number of studies focused more on clusters and networks of independent companies.
The IB literature during the past 50 years has used various units of analysis. Mainstream
neoclassical international economics builds upon the strong assumption that differences
in factor endowments across borders will lead to international transactions, whether
transfers of capital or goods. In other words, it is assumed that there is not really an
organizational challenge to be addressed in creating an efficient system of international
exchange. Vernon (1966) and Dunning (1958) extend this work, but recognize the
importance of firms in their pioneering IB studies, which represent the first stage of
modern IB analysis. Vernons product life cycle framework, published in 1966, basically
argue that the United States has a technology-related, country specific advantage (CSA)
embedded in US owned multinational enterprises (MNEs). These US parent firms create
miniature replicas (branch plants) in Canada and Western Europe such that technology
would be transferred from the parent firm to these foreign subsidiaries. This leads to an
indirect transfer of technology to host countries and to other benefits of foreign
ownership. In the UK context, Dunning (1958) observes that the UK subsidiaries of US
MNEs upgrade the macroeconomic infrastructure as they manufacture technologically
intensive products and services; they upgrade UK jobs; they pay taxes; they increase
productivity and otherwise improve the CSAs of the United Kingdom. Rugman (1980b)
4

confirms this outcome in a Canadian context, with Canadian subsidiaries of US MNEs

providing net economic benefits to Canada.
Clearly, the underlying unit of analysis in the work by Vernon (1966), Dunning (1958)
and Rugman (1980b) is the country factors, even though their analyses really focus on
how these country factors interact with MNE activity as a conduit for their absorption at
the

micro-level

in

the

home

country,

and

subsequent

diffusion/exploitation

internationally.
Hymer (1960), as the intellectual father of the second stage in modern IB studies,
pioneered a fundamental change in the unit of analysis adopted in IB studies: he
positions the MNE and its FSAs at the core of his analytical approach. Hymers great
insight is his recognition of the MNEs possession of FSAs, required to offset the liability
of foreignness (LOF) when operating abroad (Hymer, 1960; Zaheer, 1995). Unfortunately,
Hymer (1960) exaggerates the potential of MNEs to exploit their FSAs as monopolists by
exerting efforts to close markets and exercising excessive market power. Structural
market imperfections as a result of government regulation and MNEs creating entry
barriers, ultimately at the expense of consumer welfare, may exist but are now less
common (Dunning and Rugman, 1985). The reality today is that few MNEs, even among
the worlds largest ones, actually benefit from uncontestable and uncontested
monopolies. The absence of such market power is demonstrated by the relatively
uncommon occurrence of truly global firms, with a balanced distribution of their sales
and assets across the triad of North America, Europe and Asia: few firms appear able to
emulate their home region success in the host regions of the triad (Rugman, 2005;
Rugman and Verbeke, 2004, 2008a,b,c).
The liability of foreignness, meaning the impact of various forms of distance (cultural,
economic, institutional and geographic), explains why MNEs have difficulties operating
in foreign markets, especially when facing rivals not hindered by such distance. The
Uppsala model of international expansion proposed by Johanson and Vahlne (1977)
essentially provides the mirror image of Hymers analysis. The Uppsala model suggests
that there are stages of internationalisation, whereby the potential benefits of exploiting
FSAs abroad need to be weighted against the risks of operating in unknown foreign
environments and the costs of learning to do business there. Consequently, according to
the original 1977 model, firms initially expand in nearby geographic countries that may
have similar CSAs. As the firm learns to overcome the LOF it then expands into more
5

distant country markets, at which stage the unfamiliar cultural, economic, and political
environment will be offset against the firms ability of recombining its FSAs with host
country CSAs.
Recent work by Hennart (2009b) rethinks the nature of such recombinations of FSAs and
host country CSAs, and demonstrates that in many cases the boundary between CSAs
and FSAs becomes somewhat blurred. Indeed, if some of the CSAs leading to
international expansion are actually not freely accessible, but access is controlled by host
country actors (e.g., closed distribution networks preventing sales to customers or local
monopolies on natural resources ownership and exploitation preventing purchasing
these resources), then the challenge for the MNE is to develop relationships, i.e., a type of
location bound (LB) FSA with powerful local actors to open up access to the desired CSAs.
We define LB FSAs later.
The Uppsala model represents one intellectual approach to explain MNE entry mode
selection. Here the firm can choose to exploit its FSAs abroad, either through exporting,
FDI with wholly owned subsidiaries, licensing, or international joint ventures. In this
literature, the country remains as a co-unit of analysis, along with the MNE. However,
the nature of this research places more emphasis on MNE strategic management process
issues and the roles of managers in the parent firm.
In the third stage of contemporary work in IB, the unit of analysis has become the
subsidiary of the MNE and the subsidiary manager. The clearest expression of this
approach can be found in Birkinshaw (1996, 1997, 2000). Refining work by Rugman and
Bennett (1982), and Rugman (1983b) on world product mandates in a Canadian context,
Birkinshaw (1996) has developed the concept of subsidiary initiatives, whereby the focus
is really on innovative recombinations of both home and host country CSAs, and the
FSAs held (or being newly developed) by the MNEs units in these countries. He observes
that such innovative recombinations can ultimately generate new types of FSAs across
the MNE network and strengthen the MNEs overall competitive advantage.
In summary, over the last fifty years, the literature of IB has developed from a somewhat
basic focus on CSAs and FSAs that are clearly separate and distinguishable from each
other (Rugman, 1981) towards a more nuanced understanding of the linkages between
them and the manner in which MNE managers in the home and host economies will
interact to develop novel recombinations of home and host CSAs and the FSAs held by
6

various MNE units, dispersed across borders. Overall, the unit of analysis has shifted
from the country-level, to the parent MNE, and now increasingly to the subsidiary level,
often with a focus of the subsidiarys role in the internal MNE network. Below, we
expand on the implications of adopting alternative units of analysis in IB research.
FROM COUNTRY LEVEL TO FIRM LEVEL ANALYSIS
Several theoretical approaches have been used to explain the MNEs strategic investment
motives, foreign entry mode, ownership, structure decisions and performance. This
section provides a reflective review and synthesis of the literature at firm level and the
interactions between country and firm level. Hymer (1960) explains why a firm engages
in international operations by bringing the focus from the country level to the firm level.
Hymer moves towards an analysis of the MNE based upon industrial organization
theories by showing that the MNE is an institution for international production rather
than international exchange. He distinguishes between FDI and portfolio investment in
terms of the presence of firm-level control in the former and the absence thereof in the
latter. Hymer rejects country level portfolio investment theory with its simplifying (and
empirically incorrect) assumptions of the movements of capital as an explanation for
FDI, Dunning and Rugman (1985).
For Hymer, two conditions have to be fulfilled to explain the existence of FDI: (i) foreign
firms must possess a countervailing advantage over local firms to make such investment
viable, and (ii) the market for selling this advantage must be imperfect. Hymer argues
that for firms to own and control value-adding activities, they must possess some kind of
monopolistic advantages sufficient to outweigh the liability of foreignness (LOF), arising
from lack of knowledge about local customs, differences in local tastes, and unfamiliar
legal systems, when competing with indigenous firms in host country production. The
MNEs proprietary FSAs typically include elements such as product differentiation ability,
superior marketing and distribution skills, trade marks or brand names, access to raw
materials, economies of scale, access to capital, intangible assets such as proprietary
technology, patents, management skills, the ability to achieve vertical and horizontal
integration, etc. Hymer focuses on imperfections in final output markets, as expressed in
monopolistic advantages held by individual MNEs and entry barriers leading to
reductions in consumer welfare. Hymers pioneering views have been recognized as an
influential contribution to the theory of the MNE and FDI. He was the first to contrast
such firm-level FDI with the prevailing orthodoxy by economists who explain FDI as a
7

country level financial (portfolio) investment decision determined by interest rate

differentials across national borders. Hymer recognizes that FDI is a firm-level strategy
decision rather than a capital-market financial decision (Dunning and Rugman, 1985).
Hence, FDI will occur mainly in imperfect markets.
Though also focusing on the firm as the unit of analysis, internalization theory has its
origins in the work of various scholars associated with the Reading School: Buckley
and Casson (1976, 2009), Rugman (1981), and Hennart (1982). Here, the MNEs existence
is not caused by monopolistic advantages leading to entry barriers and consumer
exploitation, but by its efficiency properties, i.e., its capacity to reduce transaction costs
when replacing an inefficient or non-feasible arms length transaction in the market by
an internal transaction, inside the firm, especially in the context of transferring
intermediate (mostly knowledge-based) outputs across borders (Rugman, 1980a,b;
Rugman, Lecraw and Booth, 1985; Grubaugh, 1987).

The MNEs activities typically

enhance rather than reduce consumer welfare because efficiently coordinated

transactions substitute for inefficient ones.
Internalization theory economists (Buckley and Casson, 1976; Rugman, 1981) explain
why firms become involved in international production. Here, the emphasis switches
from the conventional act of FDI at the country level, to the level of the institution
making the investment, i.e. the MNE. The essential argument of internalization theory is
that firms aim at maximizing profit by internalizing their intermediate markets
(typically the markets for intangible assets such as technology, production knowhow,
brands, etc.,) across national borders in the face of various market imperfections (such as
the public goods externality associated with pricing an intermediate product like
knowledge, the lack of future markets, information asymmetries between buyers and
sellers, government intervention in the form of trade barriers or the ineffective
application of the national patent system).
Internalization theory extends to the MNE the central ideas of Coasian transaction cost
economics theory (Coase, 1937), developed in a domestic context. Rugman (1980b, 1981)
indicates that while Hymer (1960), Kindleberger (1969) and Caves (1971, 1982) make
market imperfections in final output markets the centre of their theory, none of these
authors specifically identify internalization of intermediate product markets as the core
of a theory to explain FDI and the existence of MNEs, in contrast to Buckley and Casson
(1976) and Casson (1979). Buckley and Casson (1976) show that when markets for
8

intermediate products are imperfect, there is an incentive to bypass them by creating

internal markets. Here, interdependent activities are brought under common ownership
and control. The internalization of markets across national boundaries de facto generates
an MNE.
Rugman (1981) argues that internalization theory is a general theory of the MNE. He
demonstrates that internalization encompasses within itself the reasons for international
(as well as) domestic production.

He emphasizes the role of MNEs in overcoming

imperfections in various external markets, as well as the policy implications thereof

(Hennart, 2009a). Rugman applies the theory of internalization to the public debate on
foreign ownership in Canada and he sharply criticizes the inappropriate regulation of
MNEs (Rugman, 1980b, 1981). Rugman argues that the efficiencies resulting from
internalization are not acknowledged to their full extent, and instead regulatory
measures imposed by government result from the unfounded assumption, in line with
Hymers view, that MNEs normally command monopolistic positions that they will
systematically use to exploit the consumer.
Eden (2005) suggests that Rugmans most important contribution to internalization
theory revolves around two elements: first, his role in building the theory of
internalization as a general theory of the MNE and second, his bridging of the gap
between internalization theory with strategic management thinking, by developing the
concepts of location bound (LB) and non-location bound (NLB) firm specific advantages
(FSAs) (Rugman and Verbeke, 1992, 2001, 2003),
Rugman (1981) emphasizes that each MNE commands an idiosyncratic set of FSAs, which
give it a competitive advantage relative to other firms. These FSAs arise when the MNE
has developed special knowhow or a capability that is unavailable to others and cannot
be duplicated by them, except in the long run at high costs. This thinking anticipates the
modern resource based view (RBV) of the firm (Prahalad and Hamel, 1990; Barney, 1991)
developed a full decade later. In many cases, such FSAs arise from upstream research
and development (R&D) expenditures that lead to new products or production processes.
In other cases, innovation occurs at the more downstream level, and can lead to
differentiated product lines, thereby generating an FSA in marketing or distribution. The
critical capability of the MNE can also be some unique element of its management
structure or core routines that confer an FSA (Rugman, 1983a, 1985; Rugman and
McIlveen, 1985).
9

However, Rugman (1980b, 1981) notes that possessing FSAs is a necessary but not a
sufficient condition for FDI to take place.

One MNE objective may be to establish

property rights over its FSAs so that these would not be dissipated to other firms. To the
extent that national institutional regimes, such as patent protection systems, are
considered insufficient to prevent unwanted dissipation, then internal markets replace
external ones. The MNE transfers, deploys and exploits its FSAs through the use of
foreign subsidiaries that monitor, meter and regulate the use of FSAs abroad. The
internal market of the MNE permits it to maximize its worldwide earnings without
incurring the risks of FSA dissipation by external actors such as licensing agents,
franchisees, etc. (Rugman, 1981). The great strength of the MNE is that it replaces
exogenous coordination systems prevailing in external markets (usually with pricing at
their core) by coordination through a balanced mix of hierarchical control, socialization
and internal prices. In short, Rugman (1981) shows that MNEs develop in response to
imperfections in the goods and factor markets. The CSAs of a nation that provide a basic
level of comparative advantage are augmented by FSAs, internal to the MNE, and
conferring competitive advantage.
Hennart (1982) developed a slightly different version of internalization theory as
compared to Buckley and Casson (1976) and Rugman (1981). He shows that for
international expansion to take place, setting up facilities abroad must be more efficient
than exporting to foreign markets (which entails domestic internalization) and a firm
must find it desirable to own the foreign facilities. This is the case if the MNE can
organize inter-dependencies between economic actors located in different countries
more efficiently than markets. Three conditions must be satisfied: first, interdependent
actors must be located in different countries (otherwise, only domestic economic activity
would occur); second, the MNE must be the most efficient governance system to organize
these interdependencies (otherwise, only domestic actors located in different countries
would be involved in international transactions, and not an MNE); third, the costs
incurred by MNEs to organize these interdependencies in the market (as in the case of
licensing) must be higher than those of organizing them within MNEs (see Hennart,
2009a).
Managing interdependencies refers to (a) accessing, (b) recombining, and (c) orchestrating
the productive usage of various sets of resources that are dispersed geographically. Such
resources may involve knowhow, raw materials and components, marketing and
10

distribution services, financial capital, etc. FDI takes place when firms internalize
markets for these resources. For example, an MNE that wants to exploit abroad its firmspecific knowledge will choose to transfer this knowledge internally rather than license
it to foreign producers if the market for this knowledge is subject to high transaction
costs (Hennart, 1982), but the final decision on entry mode choice does not only depend
on the MNEs FSAs. It also very much depends on the complementary resources needed
by the MNE from foreign actors to make the exploitation of its own FSAs feasible and
potentially profitable (which explains why IB is always concerned with managing
interdependencies), Hennart (2009b)
The eclectic paradigm, developed and subsequently extended into five versions by
Dunning (1977, 1988, 1998), integrates several theory streams on cross border activities
at the country and firm levels to explain FDI (see Eden and Dai, 2010 for a review of five
versions of the eclectic paradigm). Dunning proposes that three types of advantages
influence FDI: (i) ownership (O) advantages, (ii) location (L) advantages and (iii)
internalization (I) advantages.
Ownership advantages can be divided into asset advantages (Oa) and transactional
variables (Ot). Oa include various tangible and intangible assets such as patented
technology, brand names, etc., whereas Ot refers to strengths in coordinating and
taking advantage of operating a network of geographically dispersed affiliates.
Location (L) advantages reflect foreign countries having some country-specific advantages
(CSAs) vis--vis other countries, in terms of natural resources, factors of production,
demand conditions, etc. Location advantages also include elements of the cultural, legal,
political and broad institutional environment in which the firm operates, and that make
some countries more attractive than other ones. In addition, Dunning (1977) identifies
the market structure at the country level and government policies as being potential
location advantages. He also argues that the determinants of FDI may differ from one
industry to another.
Internalization (I) advantages refer to benefits of creating, transferring, deploying,
recombining and exploiting FSAs internally instead of via contractual arrangements with
outside parties. Here, the common governance of geographically dispersed value-added
activities within a single firm is comparatively more efficient and effective than
governance by independent market actors or even by an equity joint venture where
11

more than one firm is the residual claimant. Firms decide to operate in foreign countries
by considering the particular set of ownership and location advantages they face. The
entry modes are selected on the basis of internalization advantages (or the lack thereof).
In addition to its contribution as a synthesizing framework, the OLI paradigm allows
identifying the key location advantages of four types of international production: natural
resource seeking, market seeking, efficiency seeking, and strategic asset seeking
(Dunning, 1998). In contrast to the Hymer Kindleberger Caves approach, Dunning
devotes some attention to managerial issues related to the FDI process, especially in
terms of the complex trade-offs to be made when weighing alternative modes of
operating in foreign countries and assessing the benefits thereof for the MNE itself and
its various stakeholders in geographically dispersed jurisdictions.
Dunnings eclectic paradigm, however, struggles to integrate country and firm level
interactions. From the firms viewpoint, the (O) and (I) are not independent parameters
in managerial decision making but need to be considered jointly, with (I) being the
dominant consideration. The existence of the MNE itself, resulting from FDI, implies that
(O) needed to be internalized in terms of the processes of (O) creation, transfer,
deployment, recombination and profitable exploitation (Rugman, 1985; 2010; Casson,
1987).

In this context, Itaki (1991) has voiced the strongest criticism of the eclectic

paradigm, and has claimed that an (O) advantage could actually be derived from an (I)
advantage, in which case it would be redundant to consider these two variables as
separate determinants. Itaki has further pointed out the inseparability of the (O)
advantage from the (L) advantage. He argues that the (O) advantage in economic terms is
unavoidably influenced by - and inseparable from - location factors. Hence, (L) and (O) are
simultaneously determined. Despite the above shortcomings, which reflect a relative
lack of theoretical parsimony, Dunnings eclectic paradigm undoubtedly represents the
most comprehensive framework to explain foreign entry mode choices and the
economic efficiency implications thereof.
In parallel with the development of internalization theory, a group of Scandinavian
researchers, including scholars from Uppsala University, Sweden (Johanson and Vahlne,
1977) and the Helsinki School of Economics, Finland (Luostarinnen, 1979) have
attempted to explain the process by which firms from small, domestic markets such as
the Scandinavian countries, internationalize their activities.

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Drawing upon the classic works of Cyert and March (1963), and Aharoni (1966), the
Scandinavian model proposes that internationalization is a cumulative, path-dependent
process whereby a firms international expansion pattern is a function of its past
international experience and knowledge base (Johanson and Wiedersheim, 1975;
Johanson and Vahlne, 1977, 1990). Internationalization theory argues that a firm with
little or no international experience, typically enters a foreign market by exporting. It
progresses to establish a sales subsidiary and eventually to invest in production facilities.
The driving force of this internationalization process is experiential market knowledge
(Johanson and Vahlne, 1990).
Johanson and Vahlne (1977) also introduced the concept of psychic distance. Psychic
distance refers to the degree to which a firm is uncertain of the characteristics of a
foreign market (Johanson and Wiedersheim, 1975). Following the psychic distance
concept, firms undertake international expansion in an incremental manner. Here, the
internationalization model postulates that firms will first enter the foreign markets with
which they are relatively familiar (i.e. geographically, culturally and institutionally
proximate), and then, capitalizing on the knowledge acquired from exporting to - or
investing in - those markets, successively progress to psychically and culturally more
distant environments (Johanson and Wiedersheim, 1975; Johnson and Vahlne, 1977).
Several empirical studies have indeed shown that the MNEs level of foreign experience
directly influences its selection of a market entry mode, see for example, Loree and
Guisingers (1995) and Li (1994).
However, internationalization theory can be better aligned with the arguments of
internalization theory. Rugman (1980a), and Fina and Rugman (1996) have pointed out
that an MNE engages in foreign production in order to avoid dissipation of the rents
derived from its FSAs that were created at considerable effort and costs. Therefore,
internalization theory suggests that a firm consider explicitly the relative costs of
servicing foreign markets by first, exporting to foreign markets with the FSAs embodied
in final products, second, engaging in FDI or third, licensing a foreign producer. This last
option becomes attractive especially when the technology licensed is not any longer the
technology on which the firms survival and future growth depends.
The mode of entry changes over time as the relative costs and benefits associated with
each of these strategies change. The above stages in serving foreign markets are almost
13

the reverse of the internationalization stages, or the Aharoni (1966) approach, which use
(1) licensing as the first step, (2) exporting, (3) establishment of local warehouse and
direct local sales, (4) local assembly and packaging, (5) formation of joint venture, (6)
foreign direct investment (that is, full scale local production and marketing by a wholly
owned subsidiary). Furthermore, Rugman (2005) also questions internationalization
theory in that it lacks serious conceptual grounding and generalizability, especially in
term of what exactly constitutes geographic proximity or experiental learning, and the
mechanisms through which these concepts influence FDI decisions and geographic sales
dispersion.
Similarly, Ruigrok and Wagner (2003) also question internationalization theory in their
study of German manufacturing companies. They argue that according to the principle
of initial foreign location based on the psychic distance premise, German firms are
likely to target Switzerland and Austria (German speaking countries). However, both
countries are very small markets and they have never been able to attract substantial
German FDI. Instead, the typical German firm expands early into other European, North
American and Asian countries. These nations are characterized by higher psychic
distance. Thus, German firms appear to have pursued high distance expansion
strategies from the outset, driven by the nature of the location advantages of these larger
(high distance) markets and possibly by the complementary resources offered by local
actors in those environments.
The overall problem with the internationalization theory approach is that it largely
neglects two critical elements. First, the nature of the MNE FSAs, which determines to a
large extent the potential net benefits of internalization vis--vis alternative modes of
operating in foreign markets (e.g., the importance of tacit versus fully codified
knowledge). Second, the presence or absence of natural and government-imposed
market imperfections (e.g., an ineffective patent protection system), which may make
the use of external markets a non-starter. For example, exporting usually takes place in
the absence of government-imposed market imperfections, i.e., when there are no
barriers to free trade, whereas FDI precisely occurs when such barriers exist. In turn,
licensing takes place when foreign markets are fully segmented, the firm no longer has
much to lose by sharing its FSAs, and credible licensees can be found with the requisite
resources that complement the MNEs FSAs.

14

FROM FIRM LEVEL TO SUBSIDIARY LEVEL ANALYSIS

Birkinshaw and Pedersen (2009) have summarized the research applying FDI theory and
theories of the MNE to the subsidiary level and the interactions between MNE head
office and its subsidiaries. Today, we recognize that while the relevant unit of analysis
for most IB theory is still the MNE as a whole, because most key strategic decisions are
taken at that level, there is often a problem in translating and applying firm-level theory
to the subsidiary unit. The subsidiary becomes the key building block of the MNE, which
is viewed as a differentiated network rather than a monolithic hierarchy. In other words,
no serious MNE network analysis can be conducted without understanding each
subsidiarys idiosyncratic resource base, strategy, assigned role inside the MNE, and
linkages with other subsidiaries. In this context, Birkinshaw (1997, 1998) has shifted
focus to the subsidiary manager and the possibility of having subsidiary initiatives
instrumental to FSA development. The shift in focus from the parent firm to the
subsidiary as a unit of analysis has several origins.
First, a stream of research in Canada examined the extent to which Canadian
subsidiaries of foreign MNEs can act autonomously with world product mandates (WPM).
This is partly a host country level interaction with subsidiary level management, but
vetted by the MNEs head office in the home country. In particular, the Canadian
government wanted to see more R&D in the Canadian subsidiaries of US MNEs, Rugman
and Bennett (1982), Poynter and Rugman (1982), Rugman (1983b), Rugman and Douglas
(1986), DCruz (1986). In a public policy context, Rugman (1980b, 1981) criticizes the lack
of effectiveness and efficiency associated with policy efforts to boost R&D spending in
Canadian subsidiaries. He finds that the Canadian subsidiaries of US MNEs indeed do
only half of the R&D per unit of sales as compared to their parent firms. However, the
R&D expenditures of a set of Canadian owned companies of similar size is also well
under half those of US parent MNEs. In other words, the relative lack of R&D found in
Canadian subsidiaries of foreign MNEs is largely due to country factors rather than firm
factors. Canada has poor CSAs as a location for R&D, and Canadian owned firms as well
as US subsidiaries in Canada both lack FSAs related to R&D outputs. Rugmans
conclusions on the inefficiency of attempts to boost artificial national R&D expenditures
(which always reflect a cost, but not necessarily any benefit to the firms and country
involved) have subsequently been validated by Moore (1996), Birkinshaw (1997) and
others.
15

Second, research on the strategy and structure of the MNE moved from a focus upon the
centralized, hierarchical multidivisional form typology of the 1960s and 1970s (Stopford
and Wells, 1972; Williamson, 1981; Egelhoff, 1982) towards an understanding of the
linkages between the parent firm and its subsidiaries. This was a parent firm interaction
with subsidiary managers. In particular, the popularization of the Prahalad and Doz
(1981, 1987) integration - responsiveness framework by Bartlett and Ghoshal (1989)
established the intellectual foundation for a differentiated internal network perspective
as the relevant organizational structure. This work builds on the conceptual insights of
Prahalad and Doz (1981, 1987) who show that subsidiaries can develop LB FSAs, albeit
sometimes associated with negative outcomes for the MNE, and therefore requiring recentralization, see Verbeke (2009) and also Mudambi and Navarra (2004) for an analysis
of dysfunctionalities. Much subsequent work on MNE networks was performed in
Scandinavia. Perhaps the best-known network framework is Hedlunds (1986). He argues
that the M-form, parent driven MNE would be replaced by the N-form, or network based,
MNE. The Scandinavian and Canadian interest in the subsidiary is a useful counterpoint
to the earlier US-led focus on centralized and hierarchical MNEs from large economies.
The most influential exponent of the view that subsidiary managers can develop FSAs
through subsidiary initiatives is Birkinshaw (1996, 1997, see also Birkinshaw and Hood,
1998, 2001; Birkinshaw, Hood and Jonsson, 1998; Moore 2001; Moore and Birkinshaw,
1998). Birkinshaw demonstrates that the subsidiary - and in some cases even the
subsidiary manager as driver/facilitator of subsidiary initiatives - may represent a useful
unit of analysis when trying to understand innovation processes inside the MNE. Many
strategic decisions critical to innovation may be taken at the subsidiary level and can
lead to new FSA generation.
In this context, Rugman and Verbeke (2009a) have suggested that CSAs of host countries
may be used in a leveraged way. MNEs make dual use of CSAs from the home and host
countries, and subsidiaries throughout the MNE network may be critical in resource
recombination efforts, a view consistent with the double diamond framework of
Rugman and Verbeke (1993). If MNE operations in various countries can be instrumental
to new knowledge generation, this opens the door for two-way flows of FDI,
sophisticated forms of parent-subsidiary relationships and complex network functioning
inside MNEs (Rugman and Verbeke, 2001; Rugman and DCruz, 2000).

16

Rugman and Verbeke (1992, 2001, 2003) have argued that FSAs can be created anywhere
in the MNE network, both in the parent company at home and in the foreign
subsidiaries. FSAs can be location-bound (LB) or non-location bound (NLB). The LB FSAs
reflect strengths deployable and exploitable in a limited geographic area, such as a single
country or a limited set of countries or region, but cannot be profitably exploited outside
of this area, whether as an intermediate output (e.g. managerial skills, R&D knowledge)
or embodied in final products. LB FSAs may include an excellent local reputation, a wellpositioned retail network, privileged relationships with domestic economic actors, etc. In
contrast, NLB FSAs represent company strengths that can easily be transferred across
locations at low cost, deployed and profitably exploited, with only limited need for
resource recombination.

Such NLB FSAs typically include the upstream patented

technological knowledge, and the downstream brand names. The actual transfer across
borders can again occur in the form of intermediate products or embodied in final
outputs.
Rugman and Verbeke (2001) have shown that subsidiary initiatives may lead to the
development of LB FSAs (a resource-based expression of host country national
responsiveness) but these can be transformed into non-location bound (NLB) FSAs,
namely when being augmented with best practice attributes inside the MNE network
(e.g, as a result of productivity increases and added differentiation). Indeed, in
synthesizing the literature on subsidiary initiatives, Rugman and Verbeke (2001) find ten
generic types of capability development processes inside MNEs, of which Birkinshaw had
identified those whereby subsidiary initiatives are critical.
This framework incorporates the thinking of Birkinshaw and Pedersen (2009) who align
the resource based view (RBV) of the firm with the resources and capabilities developed
and held in an MNE (Wernerfelt, 1984; Rumelt, 1984, 1997; Barney, 1991; Mahoney and
Pandian, 1992; Peteraf, 1993; Teece, Pisano and Shuen, 1997; Rugman and Verbeke,
2002). Some FSAs are likely to be held at MNE parent firm level while others are held at
subsidiary level.
Birkinshaw and Pedersen (2009) argue that if the subsidiary is a valid unit of analysis in
its own right, it should be possible to unbundle resources and capabilities between the
subsidiary and the MNE. Considering basic resources first, most tangible resources (plant,
equipment and people) are held primarily at the subsidiary level, while most intangible
17

resources (financial, organizational, and reputational) are held at the firm level.
Capabilities are much harder to unbundle between firm and subsidiary levels of analysis.
Some are clearly held at the firm level and shared across subsidiaries, such as a particular
organizational culture. Others are more likely to be specific to a particular subsidiary,
such as a particularly effective way of handling local labour relations or privileged
relationships with government agencies to secure commercial contracts. Most
capabilities, however, sit somewhere between the two levels.

The criteria used to

evaluate resources in the RBV in terms of their contribution to competitive advantage

(valuable, rare, non-imitable, non-substitutable) are not necessarily the most relevant at
the subsidiary level. Thus, Birkinshaw and Pedersen (2009) suggest that rather than
simply analyzing subsidiary level resources in terms of their potential for competitive
advantage, it is necessary to consider recombining them with other resources, or
leveraging them on a worldwide basis. This process could generate NLB FSAs, in the
spirit of Rugman and Verbeke (1992).
Essentially, Birkinshaw argues that subsidiary managers can develop both host country,
LB FSAs but also NLB FSAs, through subsidiary initiatives. Subsidiary initiatives that lead
to NLB knowledge reflect the subsidiary and its managers moving beyond their assigned
charter, and gaining world product mandates or critical roles in international value
added chains inside the MNEs internal network, or developing subsidiary specific
advantages (SSAs) (Rugman and Verbeke, 2001).
Related work examining the role and function of subsidiary managers has been
undertaken by Holm and Pedersen (2000), Andersson, Forsgren and Holm (2002,2007),
Forsgren, Holm, and Johanson, (1995), Foss and Pedersen (2002), Holm and Pedersen
(2000), Malnight (1996) among others.
The above analysis suggests that research in the IB field has evolved over the last fifty
years. The unit of analysis has shifted from the country level to the firm level and finally
to the subsidiary level. MNE subsidiary strategy has received significant attention,
especially in the context of the MNE as a differentiated network. Now we move on to
explore the evolution of IB theories from an equilibrium oriented theoretical focus to a
more dynamic oriented conceptualization. We show that the basic conceptual
foundations of IB theory remain as logical developments of internalization theory and its
offshoots.
18

THE CLASSIC FRAMEWORK FOR IB THEORY

The three basic units of analysis can be analyzed in the classic CSA/FSA matrix of Figure
1, derived from Rugman (1981). Here the impact of country factors is depicted on the
vertical axis, ranging from weak to strong CSA impact on IB transactions (see Rugman
and Verbeke, 2009a for a comprehensive overview on location, competitiveness and the
MNEs). Conversely, on the horizontal axis, we depict the importance of the firm factors,
i.e., the FSAs, ranging again from a weak to a strong impact.
Figure 1 here
In cell 1 of Figure 1, only CSAs matter to explain the scope and direction of IB activities.
In cell 1, mainstream international economics explains how comparative advantage will
lead the home country to export goods and services which build upon its relatively
abundant factor inputs of labour, capital and natural resources. For example, Canada will
export newsprint, Saudi Arabia will export oil, and China will attract manufacturing
assembly through its abundant cheap labour. Cell 1 also captures cultural stereotypes, as
popularized by Hofstede (1983) and the GLOBE (2006) studies by House and others (2004),
whereby cultural characteristics and cultural distance vis--vis other nations are viewed
as instrumental or detrimental to a countrys success in IB. In addition, cell 1 includes
situations whereby political and administrative rules greatly affect IB transactions. For
example, host governments may restrict and regulate both imports and exports, as well
as inward and outward FDI (Rugman, 1980b; Rugman and Verbeke, 2009b). In such cases,
varied and complex interactions may occur between MNEs and host governments
(Vernon, 1971, 1991; see Rugman and Verbeke, 2009b for a comprehensive overview)
In cell 4, the opposite situation prevails: here, country factors do not matter much, and
competitive advantage results solely from FSAs unaffected by geography, in terms of
locational impacts on their development, transfer across borders, deployability,
recombination requirements and profitable exploitation. This situation is consistent with
the view espoused by most mainstream resource based view (RBV) scholars in strategic
management.

These authors focus on FSAs only (referred to, inter alia, as core

competences and capabilities), and do not recognize the importance of location and
CSAs. Indeed, authors such as Wernerfelt (1984), Rumelt (1984, 1997) and Barney (1991)
developed the RBV in isolation of country effects. Examples of strong FSAs in cell 4
19

include the allegedly location-independent brand equity of the firm, and the managerial
resources and capabilities of the top management team to grow the firm (Penrose, 1959).
In cell 3, both CSAs and FSAs matter. This is the unique stage for IB theory. Here, the
firm being studied is an MNE, operating across multiple countries, and trying to
coordinate various resource dependencies across borders. Both home and host country
CSAs may be important in terms of how the FSAs are managed. CSAs affect the processes
of developing, transferring across borders, deploying, recombining with other resources
and profitably exploiting FSAs, which are always internalized to some extent. Such FSAs
can include higher order governance capabilities and core operating routines following
the firms dominant logic.
Cell 3 situations also allow for complex intra-MNE network linkages, sometimes with
sophisticated value chain relationships among the various subsidiaries involved, each
holding specific sets of FSAs in particular value chain functions and benefiting from
particular CSA bundles (Rugman,Verbeke and Yuan, 2011). In each of these situations it
is recombining resources across borders that matters, see Rugman and Verbeke (2001)
and Verbeke (2009). Importantly, the three units of analysis intersect and overlap here.
The main focus when studying resource recombination patterns may be the MNE, but
useful analysis also requires an understanding of which CSAs in the home and host
countries can be leveraged by the firm, as well as sufficient appreciation for the
geographical dispersion of MNE FSAs across the multiple units and subsidiaries in its
internal network.
This CSA/FSA matrix is consistent with Meyer, Estrin, Kumar and Peng (2009), who have
advocated a combination of institutional analysis (focusing on a subset of CSAs) and RBV
thinking (with the resource based view providing tools for studying the nature and
strength of FSAs). It is also consistent with the latest version of internationalization
theory (Johanson and Vahlne, 2009), which is now focused on understanding the liability
of outsidership rather than the liability of foreignness. Outsidership is concerned with
access to resources or rather the lack of such access, mainly because of relational
shortcomings. Resources are needed to develop the requisite LB FSAs so as to link these
with the MNEs extant NLB FSAs, and to take full benefit of the CSAs of the host
countries entered. We now turn to issues in the literature less resolved than discussed so
far. These new issues are likely to be the basis for future research.
20

THE FUTURE OF DISTANCE IN INTRA-FIRM AND INTER-FIRM NETWORKS

The key scholarly and managerial challenge in IB, irrespective of the unit of analysis
selected, is to understand properly how distance affects the transferability,
deployability, recombination and profitable exploitation across borders of (quasi-)
proprietary know-how, whether in the form of stand-alone competences or higher-order
capabilities. The main weakness of many scholarly analyses is the incorrect assessment
of what distance really means when performing IB transactions. This leads to
overestimates of the non-location boundedness of extant FSAs and underestimates of the
need for melding investments in host environments, so as to create new, LB FSAs, often
in concert with other economic actors. The outcome of such incorrect assessment in the
IB literature is structurally flawed theories of how MNEs really operate across borders.
Basically, there are three types of FSAs: stand alone FSAs (such as patented knowledge or
a brand name), routines (i.e., the way things are done inside the firm), and
recombination capabilities (i.e., the capacity to augment in a productive fashion the
MNEs existing resource base with newly accessible resources) (Verbeke, 2009).
Traditional thinking is that each of these builds upon home country CSAs. Drawing upon
home country CSAs typically leads to LB FSAs, tied to the home country. A portion of
these

stand-alone

FSAs,

routines

and

recombination

capabilities

can

become

internationally transferrable, deployable and profitably exploitable, i.e. this portion

becomes non-location bound (NLB).

FSAs in the NLB category typically include R&D

knowledge, system integration capabilities, managerial capabilities, easy access to

capital, and sometimes brand names, to the extent that foreign consumers confer value
to these. However, upstream FSAs are usually much more NLB than downstream ones.
NLB FSAs can be transferred internationally through the MNE intra-firm network.
However, in most cases, these must be complemented with investments in new LB FSAs
in the host countries where they are to be exploited. The MNE may need to draw upon
complementary resources held by external actors in the host country. It is only through
these complementary resources, and the ensuing LB FSAs that the MNE is able to access
host country CSAs (e.g., access to a large consumer market). If these resources can be
freely purchased on the market, the MNE will develop the new LB FSAs on its own. In
contrast, if these resources cannot be purchased, joint ventures and other types of
alliances may result, especially if the MNE wishes to keep some direct control over its
21

own NLB FSAs transferred abroad. In the case when there are strong imperfections in
the markets for resources and no satisfactory joint venture partners can be found, the
only option is a merger or acquisition. Here the MNE is forced to purchase not only the
resources required for accessing the host country market, but a local firm in its entirety,
including possible substantial unwanted assets and capabilities. Obviously, if the MNE
can simply augment its internationally transferrable NLB FSAs with self-created LB FSAs,
fully controlled by the MNE through its internal network, then FSA dissipation risks can
be avoided.
However, host country subsidiaries may do much more than simply augment homebased, NLB FSAs with requisite local strengths. They may develop subsidiary specific
advantages (SSAs) as a result of their autonomous initiatives. Rugman and Verbeke (2001)
define SSAs as idiosyncratic strengths developed by host country subsidiary managers
building upon host country CSAs. However, SSAs may represent not just LB knowledge
but new, NLB strengths in the sense of having profit potential abroad. The challenge
associated with SSAs is that the actual capability (or more specifically the capability
carrier, such as the management team mastering the relevant knowledge) cannot be
simply transferred across borders.

In other words, the underlying knowledge is

embedded in the subsidiary and its linkages with local actors. As Rugman and Verbeke
(2001) point out, SSAs are often viewed with great skepticism by the corporate head
office, as they do not constitute network knowledge by definition. An unresolved
question is whether SSAs can somehow be upgraded (e.g., through codifying knowledge
and sending expatriates to the subsidiary to learn about the new capability), so that they
would become relevant to the entire MNE subsidiary network.
Future research on geographic distance and SSAs might be usefully linked to recent
empirical and theoretical work analyzing the regional nature of MNEs (Rugman and
Verbeke, 2004; Rugman, 2005). Given that the empirical data show that the worlds
largest 500 firms operate mainly within their home region of the triad, it is apparent
that SSAs, as well as more conventional NLB FSAs, are difficult to exploit profitably
outside of their home region. The problem may not reside solely in technical difficulties
associated with international FSA transfer, but also in challenges of (a) effective
deployment in a host environment, depending upon the recipients absorptive capacity;
(b) appropriate recombination of the NLB FSAs with newly created or newly accessed LB

22

FSAs; and (c) managerial effectiveness in profitably exploiting the newly created FSA
bundles.
These challenges become compounded as distance increases, whether economic,
cultural, institutional, or merely geographic. It becomes more difficult for senior MNE
managers at the head office to understand critical success factors and to act upon related
challenges (a bounded rationality problem). It also becomes more difficult to engage in
proper monitoring and correction of human behavior, especially when efforts are
diverted from engagement towards achieving company goals; this is a bounded reliability
problem (Verbeke and Greidanus, 2009). Regional boundaries such as in NAFTA and the
EU, as well the boundaries separating Asia from the rest of the world, represent a useful
first cut at separating lower distance, intra-regional environments from higher distance,
inter-regional ones. In other words, the location boundedness of FSAs is often mainly
intra-regional in nature: FSAs can be relatively easily transferred, deployed, recombined
and profitably exploited throughout the home region compared to between regions. The
comparatively easier resource recombination challenge, as compared to what prevails in
host regions, is especially critical.
It remains somewhat of a puzzle as to why inter-regional distance remains so important,
whereas the world economy otherwise appears to be moving towards greater integration
with supporting political and institutional standardization being driven by improved
information technology and information accessing capabilities. In our view it is the
compounded distance, more specifically the need to manage various distance dimensions
simultaneously, that really explains the regional nature of the world economy. The
compounded distance is insufficiently captured in efforts to simply add or otherwise
aggregate various types of distance. Ghemawat (2001, 2007) has an introductory
discussion of this, though still adopting a largely additive approach. Future research
should engage in further careful reflection and testing of the compounded distance
concept.
The key insight here is that the various distance dimensions typically measured in IB
studies are not independent of each other. For example, regional economic integration
fosters institutional coordination, and may contribute to lowering actual cultural
distance by increasing mobility of labour and managerial best practices. At the same
time, improving the common transport infrastructure, adding transport connections
23

(e.g., in air travel) in terms of frequency and quality may reduce the impact of
geographical distance. In addition, one specific parameter related to distance dimension
has been neglected systematically in large-scale studies analyzing the geographic scope
of international expansion patterns. This is the presence and the strength of the
relationships between the MNE and relevant actors operating in the host environment.
As noted earlier, Johanson and Vahlne (2009) have argued in their extension of
internationalization theory that being an outsider in foreign networks may explain the
absence of competitive success. The liability of host region outsidership, meaning simply
that most MNEs have few if any powerful relationships with actors in host regions, may
go a long way in explaining the absence of international success in these host regions.
Relationships may well be the key missing factor (as a LB FSA) to overcome compounded
distance and to allow access to coveted CSAs in host regions.
At this time, it remains unclear as to the extent to which forces of global integration can
actually overcome the currently triad region barriers observed by Rugman (2005).
Researchers will need to continue to examine carefully the extent to which region-bound
FSAs, including SSAs held by MNE subsidiaries, can be transformed from their apparent
current regional exploitability into NLB FSAs with a truly global reach, meaning that
they can easily be transferred, deployed, and recombined with other resources to the
extent necessary, and profitably exploited around the world.
The above analysis can be related to the earlier Figure 1. The most interesting aspect of
Figure 1 lies in cell 3, whereby the MNE successfully accesses and leverages CSAs in
home and host environments, and is able to put together bundles of LB and NLB FSAs to
achieve success in a variety of host environments. The requirements of this approach go
far beyond merely adapting homegrown FSAs to the host country environment, as in the
national responsiveness strategy of Bartlett and Ghoshal (1989). For example, in the case
where a Birkinshaw type SSA held by an MNE subsidiary in cell 3 is critical to MNE
international growth and profitability, the challenge for the MNE head office is to
provide sufficient resources to the subsidiary to allow global deployment and
exploitation (by allowing a world product mandate or providing the status of global
centre of excellence). Alternatively, investments must be made to turn the SSA into a
strength that can be transferred inside the MNE network (e.g., through codifying
knowledge, or by sending subsidiary experts to other units to provide training, or by

24

allowing direct interaction and knowledge transfers among subsidiaries, etc.) and the
subsequent, dispersed exploitation out of many units.
Essentially this section has discussed potential combinations of home and host country
CSAs and associated FSAs. All of this provides sophisticated substance to cell 3 of Figure
1. The future for research in IB needs to expand upon this type of deep analysis of cell 3
in Figure 1. In particular, efforts are still in their infancy to understand the nature and
extent of recombination efforts, whereby extant FSA bundles are melded with
complementary resources in host environments, so as to access host country CSAs.
A critical feature of internalization theory is its focus on governance. In other words,
disciplined execution of the FSA-CSA recombination processes described above requires
much more than suggested by the rather simplistic case-based analysis of Bartlett and
Ghoshal (1989) and their broad integration responsiveness framework. This framework
provides little guidance in terms of proper governance beyond some general suggestions
on how to improve normative integration, i.e., socialization, Rugman, Verbeke and Yuan
(2011).
Similarly, limited case analysis on the so-called metanational by Doz, Santos and
Williamson (2001), in terms of building globally deployable NLB FSAs based on the CSAs
of peripheral host country environments, is not particularly useful. Doz and his coauthors place the future of the MNE in the hands of small sensing and magnet units,
almost the equivalent of US Army Delta Force units. These units are supposed to work
outside of the realm of the MNEs operating divisions. Sensors are supposed to identify
and seek out geographically dispersed, unique, and hitherto fully ignored bodies of
valuable knowledge. Magnets are then supposed to follow up the sensors activities, and
to recombine the various unique pieces of knowledge identified by the sensors into
commercially viable products. In a final stage, the MNEs operating divisions must then
implement the new solutions put forward by the sensors and magnets. The operating
divisions role is simply to engage in scaling up and ensuring the commercial viability of
the products pushed onto the MNE network by the sensors and magnets.
Verbeke and Kenworthy (2008) have argued, however, that the metanational form of
governance is unlikely to displace the conventional, hierarchical, M-form organizational
structure, especially in terms of how novel resource recombinations are turned into
actual non-location bound FSAs.

They have focused on the need to view resource

25

recombination, i.e., the innovation process, in its entirety. This means that R&D or
other efforts to develop/access new knowledge cannot be structurally divorced from
production and marketing/sales. This is broadly consistent with the thinking of Buckley
(2009) on the global factory.
There are good reasons why most large MNEs are organized in divisions (typically
geographic and product divisions) and into national units with specific mandates in
tightly coordinated, international value chains: such governance is comparatively more
efficient and effective than alternative forms of organization. The modern M-form allows
economizing on bounded rationality and bounded reliability, and implementing
innovation processes in their entirety, from technological FSA development to after sales
service to customers, a view consistent with Wolf and Egelhoffs (2010) critical analysis of
various forms of network organizations proposed by IB scholars who neglect the
limitations of networks as compared to, for example, modern matrix structures. Using an
information processing approach, Wolf and Egelhoff (2011) convincingly argue that
decentralized network organizations simply do not work as compared to M-form
structures such as matrix organizations, when the MNE operates in multiple high
distance environments, needs to focus at least partly on the efficiency of existing
operations, and must balance the exploitation of NLB FSAs with developing LB FSAs.
In other words, much of the traditional international management strategy literature
still makes simplistic assumptions that global strategies are feasible, and can be
implemented without much attention devoted to governance. In fact, global strategies
and truly global NLB FSA bundles are likely to be extremely rare, as demonstrated, inter
alia, by the regional nature of MNEs in terms of their (limited) sales and asset dispersion,
and the regional elements in their governance structures (Rugman and Verbeke, 2008a).
Future research will likely build upon the theoretical and empirical insights of Rugman
and Verbeke (2004) and hopefully recognize regional strategy and structure as an
efficient alternative to non-feasible global approaches, especially in the context of
internal governance. Global governance sometimes does appear possible in the context
of global alliances such as in the airline industry, where individual airlines perform
largely regional roles, and select particular, narrow value chain activities where
resources can be pooled and recombined to create NLB alliance specific advantages
(ASAs), which unfortunately are lost to an airline when it decides to leave the alliance.

26

OTHER UNITS OF ANALYSIS AND THE ROLE OF DISTANCE IN IB

In focused, contemporary IB studies, nine other units of analysis have been adopted, in
addition to the big three discussed in earlier sections. These sets include: first, the
entrepreneur; the MNE head office and the top management team; and the value chain;
Second, the expatriate; the centre of excellence; and the model factory. Third, the
outsourcing agreement; the joint venture/strategic alliance and the cluster.
The first three additional units of analysis are really subsets of the firm as the main unit
of analysis, but with a focus on, respectively, who established the firm, what governance
mechanism leads the firm and how the firms value added functions are dispersed across
space. The second set of three additional units is concerned mainly with what occurs at
the subsidiary level, but with a focus on, respectively, who is sent by the head office to
perform a number of tasks in the subsidiary, what unique role the subsidiary can
perform inside the MNE network and how it can be a model for exceptional value
creation. The third set explicitly looks at the complementary resources provided by
external actors that can be productively recombined with extant FSAs.
Here, the critical point to remember is that any serious IB analysis always considers the
CSAs of home and host countries, as well as bundles of LB and NL FSAs. The challenge is
always to explain, predict or guide how competitive success can be achieved outside of
the home nation, or how such success is hampered by a variety of internal and external
constraints. For example, the strategic challenges facing an entrepreneur with
international expansion ambitions are similar to those facing a large MNE, especially in
terms of the bounded rationality and bounded reliability constraints to be overcome, and
the transaction costs related to these constraints (Casson, 1982).
The above also holds for the analysis of networks.

The problem with some of the

strategy and IB literature is an exaggerated focus on the benefits of networks, but a

relative neglect of its costs. Network theory needs to be applied to IB with caution. When
there are intra-firm alignments the network approach is fully consistent with analysis at
the parent and subsidiary level, as discussed above. However, inter-firm linkages, which
include joint ventures and strategic alliances do not relate easily to basic IB theory,
especially internalization theory. Here, the network literature largely ignores the
ownership issue, in the sense of required FSA protection against dissipation and the
27

appropriate distribution of the cooperation benefits and costs among the partners, who
are all residual claimants (Narula and Hagedoorn, 1999; Gulati, Nohria and Zaheer, 2006).
In more general terms, the main challenge associated with the myriad of alternative
units of analysis adopted in the IB literature is that the authors sometimes lose track of
the continued relevance of distance and its various dimensions. One example is the study
of so-called born globals whereby authors often simply assume that cell 3 of Figure 1
opportunities are available to them across the world without understanding the
challenges of international expansion, especially outside of the home region. In many
ways, a simplistic use of cell 3 in Figure 1 thinking represents a born global illusion for
international entrepreneurship, Rugman and Almodovar (2011).
Studies on another unit of analysis, namely the value chain, are often also associated
with a rather shallow understanding of the compounded distance concept. A value chain
dispersed across borders equates to a firm making strategic decisions to access particular
home and host country CSAs by deploying idiosyncratic FSA bundles in each country and
then coordinating these bundles. In this context, the often expressed view that MNEs
pursue global sourcing and are engaged in a global race for talent, rather than
pursuing more focused and selective initiatives in these areas, such as regional sourcing
or local sourcing, often leads to absurd conclusions, (Rugman, Li and Oh, 2009). More
specifically, most of the literature on offshoring and outsourcing is largely a cell 1 in
Figure 1 phenomenon. Western firms have offshored manufacturing to China due to
Chinas CSA in cheap labour. Similarly, IT has been offshored to India due to Indias
relatively cheap, skilled and educated labour.
The relevant insight is that offshoring is difficult. The distance to countries such as China
and India may be large for Western MNEs, and therefore offshoring efforts are not
deployed globally but are very targeted, often towards large cosmopolitan centres.
Within these centres, widely available knowledge of business best practices, competent
legal and financial counselling, and a pool of experienced managers may alleviate the
bounded rationality and bounded reliability challenges to be overcome. In most cases,
substantial melding investments must be performed for the MNE to be successful in
recombining the MNEs extant NLB FSAs with the FSAs of local resource providers. Here,
the additional distance challenge is that outside suppliers of offshoring services may
want to work up the smiling curve, i.e, move towards both more upstream and
28

downstream value chain activities as compared to typical component supply or basic ICT
services, thereby creating more value added per unit delivered, Mudambi (2008).
However, there is a danger for the MNE in that it may ultimately lose its competitive
edge in some of these activities vis--vis offshoring services providers, especially in
higher distance, peripheral markets.
Fortunately, much of the work on the global factory, which looks at the production side
of the value chain is consistent with the complexities of cell 3 in Figure 1 thinking, see
Buckley and Ghauri (2004), Buckley and Hashai (2005), Buckley (2009). In examining the
changing location and ownership strategies of MNEs, namely, the hub and spoke and
the global factory, Buckley and Ghauri (2004) show the increasingly sophisticated
decision making of managers in MNEs to slice more finely the value added activities of
firms. In finding optimum locations for each closely defined activity, they are deepening
the international division of labour. Ownership strategies are also becoming increasingly
complex, leading many MNEs to apply a control matrix, whereby operating strategies are
decided upon location by location, and can range from wholly owned subsidiary units via
FDI to market relationships such as subcontracting, with joint ventures as options on
subsequent decisions in a dynamic pattern, Li and Rugman (2008). However, fully
understanding cell 3 complexities, probably means that here again the so-called global
factory may be an illusion, and that the reality may be more one of regional factories.
Figure 2 here
The implication of the above is not only that distance still matters, but should never be
underestimated in IB studies (especially not the compounded distance), as suggested by
Figure 2. The vertical axis of Figure 2 lists the various possible units of analysis, whereby
we include here, for illustrative purposes only, four units of analysis, consistent with cell
3 in Figure 1: the entrepreneur, the MNE, the MNE subsidiary with intra-firm networks,
and inter-firm arrangements. The horizontal axis dichotomizes the reach of MNE
FSAs/capabilities into global NLB FSAs versus limited NLB FSAs.
The relevance of Figure 2 is that we can position a substantial number of contemporary
IB concepts on the left hand side. Cell 1 represents the so-called born global firm with
an ambitious entrepreneur at its core who has worldwide growth ambitions. Cell 2
represents the global MNE with sales and assets dispersed in a balanced fashion across
the globe, of which there are only nine examples, Rugman (2005), or the metanational
with its sensors and magnets gathering knowledge from the far corners of the planet.
29

Cell 3 represents the MNE subsidiary with a global mandate. Finally, cell 4 represents
global outsourcing networks and global alliances.
Unfortunately, the real world cases that can actually be placed in cells 1 to 4 are few and
far between due to the tyranny of compounded distance. Most born globals are really
born regionals in cell 5. Most large MNEs have a home region sales and asset
concentration, and operate with geographic divisions in cell 6, Rugman and Verbeke
(2004, 2008a,b,c). Most MNE subsidiaries perform a regional mandate role in the internal
MNE network in cell 7. Finally, most outsourcing networks and alliances, even those
designed by the largest MNEs in the world, are again very selective in terms of
geographic coverage, placing them in cell 8. Global outsourcing/offshoring in cell 4 is
largely a non-starter, because of the transaction costs associated with it. In short, in the
future, much more research needs to be done on the right hand side of Figure 2; the IB
field needs to move beyond the left field of Figure 2. We need to focus instead on the
limits to globalization, resulting from two sets of parameters, as shown in Figure 3.
Figure 3 here
The essence of explaining the literature on global versus regional strategies can be
divined with reference to Figure 3. As explained above, much of the literature in IB
ignores the complexity of geographic distance. Therefore, we place the complexity of the
cultural, institutional, economic, and geographic components of compounded distance
on the vertical axis. Essentially, each MNE needs to identify the relevant weighting of the
components of the compounded distance it faces. It then needs to build on its extant
FSAs base to further develop new FSAs which will overcome the resource recombination
barriers it faces. Therefore, on the horizontal axis of Figure 3, we place the resource
recombination barriers to the growth of the MNE.
The presence of compounded distance means that it is not sufficient to add the isolated
effects of cultural, institutional, economic and geographic distance components. There
may be multiplicative effects arising from these distance dimensions, especially in
interregional as opposed to intraregional settings. In other words, rather than looking at
CSAs as sources of net benefits to the MNE, as suggested by Figure 1, the focus should
shift instead to the challenge of accessing these CSAs.
The existence of resource recombination barriers demonstrates the difficulties of
creating the right mix of FSAs that would guarantee competitiveness in, for example, a
host region market. In other words, it is important not simply to assume the presence of
30

FSAs in the MNE that would almost automatically confer competitive advantage, as
suggested by Figure 1, but instead to recognize that, typically, NLB FSAs need to be
melded with LB FSAs, a process that may encounter severe implementation problems,
inter alia, when each segment of the firms value chain requires idiosyncratic resource
recombination efforts, Rugman, Verbeke and Yuan (2011). A similar approach to finding,
and testing, several types of LB FSAs appears in Lo, Mahoney and Tan (2010).
In cell 1, there is a mix of high compounded distance and low resource recombination
barriers: this is the assumption of a complex world, combined with the MNEs ability to
create the right FSA mix without too much difficulty. This is the main assumption
adopted in, for example the transnational and metanational illusions. In cell 2, a low
compounded distance and low resource recombination barriers suggest a simple world
where all is global (global firms, born globals, global mandates, etc.). Cell 3 in turn shows
the regional solution, whereby firms face high compounded distance, and at the same
times struggle with important resource recombination barriers when entering into host
regions. Finally, cell 4 describes the often-observed position of smaller firms with mainly
LB FSAs because of high resource recombination barriers. Such firms have great difficulty
overcoming even limited compounded distance (across the national borders of the home
region). These firms operate mostly on a local level.
In conclusion, Figure 3 helps us to build upon the tension between the literature on
simplistic aspects of globalization and global strategies, as compared to the realities of
more complex decision making required by MNEs dealing with the realities of
compounded distance and resource recombination barriers. In cell 1 of Figure 3, the
world is complex, in terms of compounded distance but the literature on metanationals
and transnationals simply assumes that firms can overcome this. In reality, there are
complexities facing the firm in developing new FSAs to overcome resource
recombination barriers. In the future, IB research needs to engage with cell 3 rather than
continuing to be bogged down in cell 1. In a similar manner, much of the literature over
the last fifty years has dealt with cell 2 of Figure 3. This has led to simplistic work on
global firms, global mandates and born global firms which basically assume that the
world is simple as both compounded distance and resource recombination barriers are
ignored. In reality, even if compounded distance is not a critical challenge, there remain
firms that operate in cell 4, developing mainly LB FSAs, and operating domestically.
These firms lack the motivation to expand internationally, for example, because of an
31

uncontested domestic market. In summary, future research in IB needs to distinguish

much more carefully between the four cells of Figure 3. In the concluding section, we
suggest that such future research may well benefit from a focus upon the regional nature
of IB.
CONCLUSIONS REGIONAL VERSUS GLOBAL STRATEGIES
We have shown that the three key units of analysis in IB theory over the past fifty years
have been the country, the firm (MNE) and the subsidiary. The most promising area for
further IB theory development is in essence the study of the interactions among these
three parameters, with the subsidiary as the key building block. In particular, we have
shown that the subsidiary has emerged as a new unit of analysis due to the importance
of network thinking from strategic management. Here, the SSA concept represents the
culmination of fifty years of IB analysis. An SSA results from (a) recombining knowledge
transferred from the network with newly created knowledge; (b) autonomously assumed
(extended) subsidiary roles; and (c) subsidiary knowledge embedded in idiosyncratic host
country locations. Paradoxically, the SSA concept is conceptually almost the opposite to
conventional network thinking in mainstream strategy, with its exaggerated focus on
knowledge sharing.
Looking ahead, it is apparent that, irrespective of the unit of analysis chosen, the region
as an expression of how distance matters in IB - has emerged as an important
parameter. Here, theoretical work is in its infancy as the focus of recent research on the
nature and extent of regional versus global activity by MNEs has been largely empirical.
This research only became possible due to changes in accounting standards in the late
1990s, which required firms to identify the broad regions of the triad in which their sales
and assets take place, Rugman (2000, 2005). There is confirmation of the lack of global
firms and the importance of the region as a unit of analysis in Fisch and Oesterle (2003);
Asmussen (2008); Collinson and Rugman (2008); Rugman and Oh (2008); Hejazi (2007);
Kolk (2010); Sethi (2009); Yin and Choi (2005); Rugman and Verbeke (2008a,b,c); Grosse
(2005).
There needs to be more conceptually driven inquiry to solve the empirical puzzle that
most of even the largest MNEs appear unable to move beyond their home region and go
global. A transaction cost economics (TCE) based analysis may be particularly useful here,
Rugman and Verbeke (2005). Such analysis would recognize the barriers to recombining
32

extant NLB FSAs held by the MNE, with LB FSAs to be provided by third parties (in the
absence of well functioning external markets for the resources underlying these LB
FSAs). This resource recombination process, in turn, may be a precondition to accessing
the coveted CSAs in host markets, such as a large customer base at the downstream end
or a highly skilled and productive workforce at the upstream end of the value chain, but
requires overcoming resource recombination barriers.
Currently there appears to be a liability of interregional foreignness facing even the
largest MNEs, though this concept has only been sketched by Rugman and Verbeke
(2004, 2007). If the great majority of the worlds 500 largest firms grow their sales and
assets mainly within their home region, this suggests that their business models and
strategies are home region based. There must be prohibitive resource recombination
barriers associated with adapting or changing their business models to achieve truly
global sales in the other two regions of the triad. Thus, IB theory must redirect thinking
at the country level on the liability of inter-regional foreignness caused by compounded
distance and move this towards a focus upon regional strategy. In other words, the
country level of analysis may need to move towards a regional level when assessing the
impacts of differences in culture, political regulation, economic and financial institutions
etc. New research on the multinationality and performance relationship needs to
incorporate this regional dimension, Rugman and Oh (2007, 2010), Lee (2010); Oh (2010);
Wolf et al. (2008); Li and Li (2007), while avoiding the pitfalls of the past research on this
topic (Verbeke and Brugman, 2009)
In related work, Fisch and Oesterle (2003) point out that the term globalization has
become overused, and has apparently replaced the term internationalization. There are
both conceptual research gaps concerning the difference between globalization and
internationalization, and a lack of empirical knowledge about the actual level of
globalization of MNEs. In the spirit of Rugman (2000), Fisch and Oesterle (2003) present a
new quantitative tool, which combines geographic spread and cultural diversity
measures, so as to integrate multiple dimensions of internationalization into a
globalization index instead of a simple internationalization measure. Fisch and Oesterle
(2003) apply this measure to assess the globalization of the most internationalized
German MNEs, among the top 100 non -financial MNEs from developed economies. The
results suggest that these MNEs are neither globalized nor show a straightforward path
towards globalization in the past decade. This outcome contradicts the common
33

assumption of global MNEs. This new construct can be operationalized to measure the
degree of internationalization (Glaum and Oesterle, 2007). More research like this needs
to be undertaken on the metrics of internationalization, not globalization.
In terms of international human resource development and cross-cultural studies, a
regional focus will require fundamental rethinking of the traditional country focus. If
MNEs operate regionally, then what is the use of Hofstede (1983), House et al. (2004),
GLOBE (2006) and the Kogut and Singh (1980) metrics?

These traditional empirical

shortcuts for cross-cultural analysis may need to be revised at a regional level. For
example, Tung and Verbeke (2010) have suggested recently that analysis of expatriates
and the training of senior executives for Chinese firms may be subject to an inverse
resonance and that there may be a need to adopt a regional focus, e.g. an Asian-Asian
perspective rather than the traditional Western-Asian perspective. In many ways, the ten
theoretical problems in cross-cultural research identified by Shenkar (2001) remain
unresolved, mainly because research in this area is poorly embedded in IB theory. In this
context, Wolf, Dunemann and Egelhoff (2008) examine the economic, psychological, and
sociological reasons for home-region oriented MNEs (Rugman and Verbeke, 2004;
Rugman, 2005).
In terms of political integration, the experiment of the EU offers many insights into the
benefits of economic integration on a regional level with common institutions and
regulations. But does this apply to NAFTA, in which the extent of social and political
integration is much less than in the EU? Or to Asia, where at best a NAFTA type set of
loose integration is more likely to arise than the tightly regulatory structure of the EU?
Why is it that North American and Asian MNEs are nearly as home region based as
European ones, without the same degree of political and social integration?
A final example of the need for better theoretical analysis, building upon the regional
phenomenon, is the work on international entrepreneurship and so-called born global
firms.

Close scrutiny of the born global phenomenon, whereby companies

internationalize near or at their founding (Knight and Cavusgil, 1996), suggests that
these firms actually achieve their exports sales largely within the home region. For
example, Knight, Madsen and Servais (2004) investigate the 292 born global firms in
Denmark and the United States. Their findings are that Danish firms generate on average
of 71 percent of their total sales from abroad, mainly in Europe, compared to 47 percent
34

for the American sample. This reflects the small size of the Danish domestic market and
Denmarks proximity to numerous neighbouring countries in Europe, of which Germany
accounts for 50 percent of their sales. The American firms generate 53 percent of their
total sales in the United States. To be more accurate, these firms can be described as
born regional, not born global, (Rugman, 2000; Fisch and Oesterle, 2003).
There appears to be no robust empirical evidence of any born global firms other than a
few IT firms from India and possibly some small firms from Israel, Rugman and
Almodvar, (2011).

Instead, there are born regionals (Lee, 2010; Lopez et al., 2009).

Further, when a small firm makes opportunistic foreign sales, these are usually in the
form of exports, not FDI. Yet, the classic article on international new venture (born
globals) by Oviatt and McDougall (1994) uses Dunnings OLI framework of MNEs to
explain born global activity, instead of maintaining a more appropriate focus upon
exports and international marketing. Again, this area of research is still very weakly
embedded in basic IB theory.
In conclusion, future theoretical work in IB must continue to study the linkages among
the key units of analysis adopted in the previous fifty years, with a focus on the
subsidiary as the key building block, taking into account the reality of regional strategy
and structure for most MNEs. We need to avoid being sidetracked by ill-conceived
concepts such as the metanational and empirically illiterate subfields of research such as
the born global literature, which ignores the costs of distance. We should focus instead
on the limits to globalization, resulting from severe frictions, i.e. resource recombination
barriers, occurring when attempts are made to conduct business beyond the home
region, where compounded distance may be high. It is only by linking brave new
empirical work on emerging issues, such as the regional solution, with good basic
theory,

i.e.

sophisticated,

comparative

institutional

analysis,

as

provided

by

internalization theory, that the field of international business will continue to prosper in
the future.

35

Figure 1: The CSA/ FSA Matrix.

Firm-Specific Advantages (FSAs)

Weak

Strong

Strong

CountrySpecific
Advantages
(CSAs)

Weak

Source: Adapted from Chapter 8 in Rugman, Inside the Multinationals, New York: Columbia
University Press, 1981; 25th anniversary edition, Basingstoke, UK and New York: Palgrave
Macmillan, 2006.

36

Figure 2: Distance and the Nature of International Business Studies

Reach of Firm-Specific Advantages (FSAs)

Global NLB FSAs

Limited NLB FSAs

ENTREPRENEUR
BORN GLOBAL

2
MNE
Unit of

BORN REGIONAL

6
GLOBAL MNE

REGIONAL MNE

METANATIONAL

GEOGRAPHIC
DIVISIONS

analysis

MNE SUBSIDIARY
INTRA-FIRM

GLOBAL MANDATE

NETWORK

REGIONAL MANDATE

INTER-FIRM
NETWORK

GLOBAL NETWORK

37

REGIONAL NETWORK

Figure 3: MNE Strategies for Growth in a Complex World

Resource Recombination Barriers to Growth

Low
1

High

High
3

METANATIONAL

REGIONAL

TRANSNATIONAL
Compounded
Distance in
International

Expansion

Low

GLOBAL

38

LOCAL

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50

The John H. Dunning Centre Discussion Paper Series in International Business

2011
2011-001

Rajneesh Narula and Quyen Nguyen

Emerging country MNEs and the role of home

countries: separating fact from irrational
expectations

2011-002

Alan M. Rugman, Alain Verbeke and

Quyen T.K. Nguyen

Fifty Years Of International Business Theory and

Beyond

51