U. Washington, Geog. 349: Organization of I.B.

University of Washington
Geography 349, Geography of International Trade
Professor Harrington
Organization of International Business

So far in the course, "control" over a foreign operation has been implied by the degree of ownership. The U.S. considers 10% or greater foreign ownership to define FDI, implying that such an identifiable but minority stake allows some control of resource and allocation decisions. In the past, most U.S. FDI abroad entailed majority or sole ownership. This is changing, as companies worldwide engage in joint ventures and project-specific strategic alliances. What determines the appropriate level and organization of control?

Contents:

Defining "control"

Location of decision making

Models for international organization

DEFINING "CONTROL"
Daniels and Radebaugh (p. 613) give an almost cybernetic definition of control:

the planning, implementation, evaluation, and correction of performance to ensure that organizational objectives are achieved. For example, if the business strategy for a foreign investment is to become the low-cost producer in the foreign market, control systems need to be in place to plan the tactics of cost control, devise measures of cost and relative cost, regularly evaluate the costs, and seek to correct problems.

LOCATION OF DECISION MAKING
Generally, allocation and operations decisions should be decentralized as far as possible, so that the decision is made as close as possible to the source of information and the level of implementation. However, decisions about resources shared across parts of an organization generally benefit from being made (or at least ratified) at a level above the individual parts of the organization.

The table below gives some illustration of these principles; the table establishes a dichotomy between "centralized" decisions for the corporation (or international operations) as a whole versus "decentralized" decisions in the hand of country- (or region-) specific subsidiaries. Can you add examples or principles?

CENTRALIZE	DECENTRALIZE
very large investment decisions, which implicitly or explicitly allocate resources across subsidiaries	country-specific operational decisions
production decisions, when the product is standardized across national markets	production decisions, when different products are offered in different national markets
research and development that would be costly to duplicate across locations	development activity geared toward matching products or processes to local conditions
key input sourcing or quality control procedures, in cases where quality is difficult to maintain and is central to the corporate advantage or image
many management operations, when managers are scarce in the host countries	management operations, to create a larger, worldwide pool of seasoned managers; or to maintain morale among the subsidiaries' managers

MODELS FOR INTERNATIONAL ORGANIZATION

Organizational forms: foreign branches versus subsidiaries
The choice between establishing foreign branches, which are legally parts of the "parent" organization, and foreign subsidiaries, which are legally separate corporations, depends on:

regulations (in some sectors in some countries, foreign-owned branches vs. subsidiaries are treated differently)
management purpose (how distinct does the foreign operation need to be)
concerns for legal liability (the subsidiary may limit the liability of the parent company to losses by or lawsuits of the foreign operation)
ownership status (joint ownership generally requires establishing a division of shares of ownership in a subsidiary)
tax liability in the home and host country (branch income or losses are applied to domestic taxable income immediately)

Organizational forms: top-level divisions of the global company
The first tier of top management in an international company determines the kinds of issues or portfolios that get attention and specialization at the highest levels. Should these portfolios be divided according to:

regions of the world
functional aspects of the corporation (e.g., development and production, marketing and distribution, finance)
major product lines

The answer generally depends on what division represents the greatest distinctions in the company overall:

differential product lines and marketing needs around the world?
variations in the global functions of a company producing a uniform product?
different production and marketing needs among vastly different product lines in a conglomerate company operating in similar kinds of countries?

Ownership versus other forms
Our treatment of the FDI decision (organizational, locational, and internalization advantages) relied on the imprecise calculus of transactions economics to determine whether a foreign operation needs to be internalized within the "parent" firm, rather than organized through contractual arrangements such as licensing, franchising, management contracts, etc. Internalization is the preferred option when the expected profit is great or when contractual arrangements are difficult to organize.

Some contracts (e.g., for proprietary technology) are difficult to negotiate because one side does not want to provide overly precise information to the other side.
Some contracts (e.g., for a new and untried operation) are difficult to negotiate because there are too many unknown contingencies to consider.

On the other hand, contracts are the preferred option when the expected profit doesn't warrant substantial foreign investment, or when foreign ownership is not allowed.

There are certainly alternative arrangements: joint ventures, strategic alliances, and networked arrangements.

Joint ventures and strategic alliances may entail joint ownership (e.g., of corporations from different companies) of a specialized operation or project, even as the venture partners continue to compete in other arenas, perhaps in the same country.
Networks share the characteristic of repeated contractual arrangements among pairs or larger numbers of the same set of firms. While each arrangement stands on its own, the firms gain a set of expectations about behavior based on past interactions and the expectations of future interactions. These repeated interactions can establish a level of trust among the firms in the network -- regulated by the expectations of behavior (the norms established among participants) and by the threat of no further interactions.