The Nature of the Transnational Firm

Christos Pitelis, Roger Sugden

• Publisher: Routledge
• Year: 2005
• ISBN:
  9781134933068
• Edition: 2
• Topic: Business
• Subtopic: Business General
• Index: Business

The Nature of the Transnational Firm brings together the major approaches to the transnational firm in one volume. Leading thinkers present overviews of a vibrant theoretical literature and assess the current state of analysis. Thoroughly revised and updated to take account the explosive growth of foreign direct investment in the 1990s, this volume will be welcomed by students and researchers of international business, international economics and business economics. Contributors include: John Cantwell, John H. Dunning, Edward M. Graham, Jean-Francois Hennart, Neil Kay.

1
The (theory of the) transnational firm

The 1990s and beyond

Christos N.Pitelis and Roger Sugden

The introductory chapter of the first edition of this book was written almost a decade ago. At the time we felt that the continuing expansion of the activities of transnational corporations (TNCs), alongside the emergence and swift acquisition of near dominance by the ‘internalization’ perspective on the TNC, generated a need for: first, recognition by internalization-transaction costs theorists outside the area of the TNC of the important contribution on this issue by contributors in the TNC literature, such as Buckley and Casson (1976) and Hennart (see this volume); second, a redress of the balance to account for the significance of early contributions to the theory, such as Stephen Hymer’s advantage cum oligopolistic interactionbased approach, as well as an integration of industrial organization (IO) and internalization-type theory of the TNC; third, filling a gap in the market by presenting all major (and not only) approaches to the TNC in one volume, and by some of their major proponents.

While the volume was not meant to be a textbook per se, it appears that it gradually acquired such a role, thus pointing to an apparent success of our third objective as stated above. This second edition is in response to this role.

Nor did our other stimuli and objectives let us down. The 1990s have witnessed an explosive growth of foreign direct investment (FDI), far exceeding the growth of both incomes and international trade. The strategies and locational choices of TNCs have also undergone significant shifts.¹ Arguably, the term ‘globalization’ (a broad indication of the significance of FDI and TNC activities in the world economy) has been one of the trendiest in the 1990s, and it seems likely to remain so in the next decade.

On the issue of mutual learning, progress has been made, albeit arguably onesided. Buckley (1990) and Buckley and Casson (1998a) have both acknowledged the need for incorporating advantage and oligopolistic interaction-based issues in their analyses. Learning from the other side seems to have been slower. In the transaction costs literature the Williamsonian, asset specificity-based perspective still seems to dominate the scene, despite extensive criticism; see, among others Demsetz (1995), Holmström and Roberts (1998). In part, this is due to the paucity of any empirical evidence in direct support of the other mainstream perspective, the incomplete contracts theory of Hart and Moore (1990) and Grossman and Hart (1986). Both these perspectives, however, have been slow in incorporating insights from the TNC-related internalization school of the Buckley-Casson type. In this perspective, TNCs internalize markets which fail because of intangible assets exhibiting public goods characteristics. As Kay (1991) observed, these need not be specific assets, in contrast to the Williamsonian approach. The pervasive influence of ‘asset specificity’ in the Williamsonian theory and its extensive empirical tests (see, for example, Seth and Thomas, 1994), with the associated difficulties of dealing with non-specific assets in this context, may partly explain failure of progress. Similarly slow has been the mainstream IO theory, which, despite acknowledgment of asset specificity and incomplete contract-based perspectives on the firm (see Tirole, 1988), has not been equally open to non-specific assets-based theories. More progress is needed on this front, and we hope this volume will help to contribute in this direction.

At the time of our writing for the first edition, we were able to claim that ‘in the theory of the transnational, transaction cost analysis has arguably attained dominance, and has done so fairly quickly’ (p. 10). This view is now widely accepted; see, for example, Caves (1996), Dunning (1998), Dunning (this volume). In view of the critiques of the transaction costs model already in place by then, we had felt that ‘such dominance was unsatisfactory’ (p. 11). Much more criticism has emerged since, as have alternatives justifying this view; see, for example, Kogut and Zander (1993), Demsetz (1995), Dunning (1998), Ostry (1998), among others. As already noted, many proponents of the internalization theory have been open-minded and ready to acknowledge such critiques and alternatives; see notably Buckley and Casson (1998b). However, critiques, alternatives and overall new developments on the theory of the firm in general and the TNC in particular pose challenges to this volume too, which this edition needs to tackle.

First, critiques and alternatives. When writing the introduction to the first edition, some problems and confusion within the internalization school were becoming apparent. One is that there is simply not one internalization approach. As already noted, the Williamson version and Buckley-Casson’s are in fact quite distinct. Both have received further criticism. Williamson’s almost exclusive focus on specific assets has been criticized by no less than Coase (1993) and Demsetz (1995).² Buckley and Casson’s version relies on the alleged public good nature of intermediate products, such as technology, know-how and more generally knowledge-related ‘intangible assets’. Building on earlier work by Teece (1977), Kogut and Zander (1993) raised doubts about this. In their view, much of knowledge is tacit, and hard and expensive to transfer. This is far from it being a public good. If so, it is arguable that TNCs (exist because they) are better in transferring tacit knowledge than are either markets or other firms. This differential efficiency in the transfer of knowledge can explain TNCs, they claim, not (transaction costs-related) market failure.

Kogut and Zander’s (1993) approach to the TNC is most interesting. It reads as very Penrosean, although it has been developed independently (Penrose is not referred to in the paper). Resurrection of the Penrosean contribution to the theory of the firm has surely been the big news of the 1990s. Edith Penrose’s classic The Theory of the Growth of the Firm was published in 1959, although the main arguments behind the book were already in print in Penrose (1955). In her book, Penrose defines the firm as a bundle of resources under administrative co-ordination, producing for profit realized through sale in the market. Among the tangible and intangible resources most important are the latter, notably the human resources and, amongst these, management. The cohesive shell of the administrative structure called a firm gives rise to knowledge through teamwork, learning by doing, learning to work with others, etc. Learning and indivisibilities of resources give rise to endogenous growth. The availability of (firm-specific) managerial resources in particular puts a limit to the rate of growth but not to the size of the firm. Unused resources provide an incentive for expansion but also determine in part the direction of expansion (where such resources are most suitably of use). They also provide an incentive for innovations. There is a dynamic interaction between the internal and external environment, the latter being an ‘image’ of management’s perceptions. This dynamic interaction results in internal and external growth—horizontal, vertical and diversified. Diversification is the natural result of the process of growth. This applies to both intra-national and inter-national diversification. In this sense, the TNC is the outcome of an (endogenous) growth process.

Penrose’s focus on endogenous growth and the role of knowledge has currently given rise to an industry of writings in the theory of the firm. Resource, competence and knowledge-based theories of the firm are arguably now dominant, at least in the strategic management literature. While not always drawing explicitly on Penrose, her motherhood of such theories now seems to be very widely acknowledged; see, for example, Foss (1997) for extensive coverage. However, with the notable exception of Kogut and Zander (1993), this extensive literature has found very little application indeed in the theory of the TNC. That was a major issue to be addressed in this edition, and a major objective of it.

One can hazard various reasons why the Penrosean perspective, while arguably dominant on the issue of diversification (see Foss, 1997), has failed to make inroads so far on the theory of the TNC. While Penrose spent a lot of time and effort analysing TNCs, she did not make much effort in showing the links between her analysis of the theory of the growth of the firm and the TNC itself. In part, this is owing to her view that once up and running, a subsidiary could usefully be regarded as a separate entity (Penrose, 1956). In the preface to the 1995 edition of her classic, Penrose suggests that all she said on firm growth is directly applicable to the TNC, leaving it, however, to the reader to perform the task! In addition to the above, as Kay (this volume) observes, Penrose’s choice of (the oil) industry was hardly the best case study of her theory of growth, exhibiting scarcely any (internal resource-related) diversification strategies.

There are additional reasons that might explain the failure of the Penrosean approach to make inroads into the theory of the TNC. Arguably, her theory is more amenable in explaining the direction of expansion, but not the mode (see Kay, this volume). When it comes to understanding the mode, transaction costs-related arguments may well be indispensable. Another reason may be the result of strength, not weaknesses. The Penrosean approach is arguably fully compatible with the Hymer story. It complements the latter by providing an endogenous growth theory cum (relatedly) an explanation of the direction of diversification. Other than these, the resource-based related, firm-specific advantages can be easily translated as monopolistic or ownership advantages. This affinity is not really surprising, given Penrose’s own recognition of the close links between her work and that of Chandler (1962); see Penrose (1995) and the fact that Hymer’s own account of the historical evolution of firms and the related acquisition of advantages drew explicitly on Chandler’s work (Hymer, 1972). The link between Hymer’s work and that of Penrose is also noted in Buckley and Casson (1998b). Sanna Randaccio integrates Penrose’s work with oligopolistic interaction; see Cantwell (this volume), who also notes the links between the Penrosean perspective and the technological accumulation approach to TNCs. Finally, the links between the Buckley-Casson approach to internalization and the Penrosean theory are simply too obvious to be missed. It could well be that Penrose’s theory could prove to be the glue to bind everything together. To that point, however, no explicitly Penrose-based theory of the TNC has yet been developed.

In this edition we address this problem by killing two birds with one stone. In the previous edition there were, in effect, two chapters on internalization: one in favour (Hennart’s), one partially critical (Kay’s). Whilst in line with the lack of a unified approach on this issue, as already mentioned, that was also rather unbalanced. In this edition, we have asked Neil Kay, who was already working on a resource-based approach to the TNC (see Kay, 1997), to link his work explicitly with that of Penrose, and develop what he considers an explicitly Penrose-based theory of the TNC. Kay’s earlier arguments also feature here, while the issue of a potential synthesis with transaction costs-related arguments is also addressed.

Chapter 6 by Kay, then, represents a major change in this edition. Moreover, whilst it is the only explicitly resource-based approach in the volume (and quite independently of any design on the part of the editors), Penrose and resources feature extensively in this edition (in stark contrast to the previous one), notably in the chapters by Cantwell and Yamin, but also in those by Dunning and Pitelis.

The other major development since the last edition concerns the role of inter-firm relations. This also links with Penrose’s contribution, but arguably owes more to the work of George Richardson (1960, 1972). In Richardson’s now classic 1972 Economic Journal article, the conventional distinction between market and hierarchy is put to task, given the ‘dense network of co-operation and affiliation by which firms are inter-related’ (1972:884, emphasis added). Echoing Penrose, albeit independently, Richardson attributes such inter-relationships to production-side related capabilities, as well as informational interdependence; see Richardson (1999). Cooperation provides an alternative to integration and it is pursued when there exist complementary but dissimilar activities. When activities are complementary but similar, integration is more likely, while weakly complementary activities are more amenable to market co-ordination. The now immense literature on inter-firm relations, joint ventures, alliances, subcontracting, clusters, industrial districts, networks, relational contracting and many such others, arguably owe their modern theoretical justification to Richardson’s work.

It is well beyond the scope of this introductory chapter to review developments in this field; for surveys see, among others You (1995), and more recently Holmström and Roberts (1998). For our purposes, such developments as they impact on the theory of the TNC are covered in this volume mainly by Dunning and, from an internalization perspective, by Hennart. For Dunning, the significance of such interfirm relations today is large enough to have led to what he calls ‘alliance capitalism’; see also Dunning (1998). Dunning attributes many of these relationships to the need to acquire complementary capabilities, in line with Richardson.

A particularly significant aspect of inter-firm relations are clusters, networks, webs and/or industrial districts. These represent inter-firm linkages, often with a territorial dimension. They have been hailed in recent years as the major alternative to integration, in that they can achieve unit cost economies, normally associated with large size, through co-operation. At the same time, further such economies can be achieved due to the development of trust (which reduces transaction costs) and ‘external economies’, which further reduce unit costs. Clusters are also arguably more bottom-up, a seedbed of larger firms and a source of innovation and competition for large firms. Members of a cluster also compete, often fiercely, while maintaining co-operation for joint inputs, marketing and innovation; see, for example, Best (1990), Porter (1990) and, more recently, You (1995), Porter (1998).

There is a particularly interesting aspect of clusters which pertains to this volume. For many years, Dunning was among the very few (arguably lonely) champions of locational factors in explaining the TNC. The resurgence of interest in clusters has greatly facilitated the reappearance of geography and location in economics. Porter (1990) and Krugman (1991), among others, have led this resurgence. Models of the TNC building explicitly on geographical issues have also been developed; see for example Markusen (1995). As Dunning (1998), however, observes, such models still fail to account for multinationalism as opposed to multi-dimensionality; they help explain a different location, but not necessarily a different nation. For this one needs to build also on, at least, ownership and internalization advantages. This takes us back to Dunning’s OLI (Ownership-Location-Internalization) paradigm, which is worth rereading in a fresher light. Far from being the poor relative, L may well turn out to be the prince. Dunning (1998) does not quite say as much, but the return of space has certainly done much to vindicate his long-held position. Cantwell (this volume) also covers location-related issues, mainly in the context of OLI.

Whilst resources, knowledge, inter-firm relationships, clusters and location (all related) represent the ‘news’, much of the most welcome Catholicism in the literature of the TNC remains. Indeed, it has gone a step further. Despite repeated claims concerning the difficulties, and for some the impossibility, of constructing a general theory of the TNC (Cantwell, this volume; Buckley and Casson, 1998b), and almost in contradiction to this claim, the 1990s have experienced a (welcome in our view) trend for pluralism and synthesis. Besides Dunning, major contributors in the field have recognized the need for synthesis, e.g. between transaction costs and monopolistic advantages (Buckley, 1990); ownership advantages and capabilities (Kogut and Zander, 1993); resources, capabilities and transaction costs (Buckley and Casson, 1998b); location and ownership advantages (Dunning, 1998); oligopoly and resources (Cantwell, this volume); transaction costs and oligopolistic interaction (Buckley and Casson, 1998a); location and resources (Ostry, 1998). Indeed, much like the 1982 edition, Caves’ 1996 edition of his classic book on the TNC reads like a synthesis of resource-based and transaction costs arguments, despite Caves’ own phrasing in terms of transaction costs. Last, but not least, and in recognition of the static character of transaction costs economics, Buckley and Casson (1998b) identify ‘flexibility’ as the hallmark of recent modeling on the TNC. Flexibility is taken to be the ability to reallocate resources quickly and smoothly in response to change. Interestingly, flexibility is claimed to discourage integration, thus partially explaining subcontracting and other neo-market-based firm strategies, notably export over FDI and licensing over internalization. Flexible firms should exploit the relative advantage of market, hierarchy and co-operation. Although it is too early to predict where these new developments will lead, the focus on syntheses and dynamics is most welcome.

The above summarizes what we consider to be the main issues of the 1990s on The Nature of the Transnational Firm. Although we have already referred to some of the main additions and changes to the volume,...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contributors
• Figures and tables
• 1: The (theory of the) transnational firm
• 2: A survey of theories of international production
• 3: A critical re-evaluation of Hymer’s contribution to the theory of the transnational corporation
• 4: Transaction costs theory and the multinational enterprise
• 5: The eclectic paradigm of international production
• 6: The resource-based approach to multinational enterprise
• 7: Strategic management and transnational firm behaviour
• 8: Divide and rule by transnational corporations
• 9: The TNC: An all-weather company