Intra-firm Integration through Knowledge and Product Flows*
HEATHER BERRY
Department of Management
The Wharton School
2022 Steinberg Hall-Dietrich Hall
University of Pennsylvania
Philadelphia, PA 19104-6370
Tel: (215) 898-0990
Fax: (215) 898-0401
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May, 2008 Draft
Comments Welcome
* I would like to thank Mauro Guillen, Vit Hensiz, Steve Kobrin, Evan Rawley and Jordan Siegel for their comments on an earlier draft. The statistical analysis of this data was conducted at the International Investment Division, Bureau of Economic Analysis (BEA), US Department of Commerce under arrangements that maintain legal confidentiality requirements. Views expressed in this paper do not reflect those of the BEA or the Department of Commerce. I sincerely thank Ray Mataloni and Bill Zeile, both at the BEA, for their numerous responses to my questions about the BEA data. Finally, I would like to thank the Mack Center at the Wharton School for funding this research.
Intra-firm Integration through Knowledge and Product Flows
Abstract
An understudied issue on the integration of large and complex organizations concerns how firms use knowledge throughout their operations and how knowledge impacts integration across firm operations. In this paper, I focus on several mechanisms that firms use to exploit and create their knowledge assets and examine how these mechanisms impact production integration across firm operations. Results from a comprehensive panel dataset containing the worldwide operations of US manufacturing firms show different influences on production linkages depending on how firms exploit and develop their knowledge, and highlight an important role for people in encouraging intra-firm integration across all firm operations.
Keywords: Knowledge flows, Integration, Intra-firm trade, Expats, MNCs
Introduction:
Over four decades ago, Lawrence and Lorsch (1967) argued that all large and complex organizations must integrate their operations to minimize overlap and conflict among subunits and to bind them into an operational whole. Subsequent studies on integration have focused on both the formal and informal mechanisms through which firms can build, control and link the various subunits of their organization. One of the more complex organizations that has been studied is the multinational corporation (Bartlett and Ghoshal, 1989, 1990, Hedlund, 1986, Doz and Prahalad, 1993, and Hansen, 1999). Numerous studies on multinational corporations (MNCs) show that these types of firms can benefit from the linkages they establish across their subsidiaries (Bartlett and Ghoshal, 1989, 1990, Ghoshal and Westney, 1993, Doz and Prahalad, 1993, Malnight, 2001) by achieving cross-regional integration, exploiting firm knowledge and tapping into clusters of expertise across geographically dispersed operations (Hedlund, 1986, Birkinshaw, 1997, Frost et al. 2002, Feinburg and Gupta, 2003).
An understudied issue on the integration of large and complex organizations concerns how firms use their knowledge throughout their operations and how knowledge and information flows impact production integration across firm operations. A primary reason why MNCs exist is because of their ability to transfer and exploit knowledge more efficiently through internal expansion than through external market mechanisms (Hymer, 1960, Buckley and Casson, 1974, Teece, 1977, Gupta and Govindarajan, 2000). In addition, firms create competitive advantages when they integrate their knowledge in their production processes for goods and services (Ghoshal and Moran, 1996, Grant, 1996). However, while the importance of integrating knowledge in large-scale enterprises is fairly well established theoretically (Kogut and Zander, 1992, Hansen, 1999 and McEvily et al., 2004), empirical evidence of how firms exploit and develop their knowledge assets throughout their operations is scarce. To date, there has been little empirical investigation of the determinants of intra-firm knowledge transfers (Gupta and Govindarajan, 2000, Singh, 2008), or linkages across firm operations more generally (Malnight, 2001).
In this paper, I examine several knowledge flow mechanisms that MNCs can use to exploit and create their knowledge assets throughout their organization, including transferring technology to subsidiaries, sending parent firm products to subsidiaries, sending home country personnel to subsidiaries and creating knowledge through R&D employees in subsidiaries. I consider how these knowledge flows through people, products and technology licensing impact the production integration of firm operations. Unlike recent research that focuses on knowledge flows through patent citations (Zhou, 2006, Singh, 2008), I intentionally focus on a larger set of firm operations and examine how knowledge flows throughout a firm’s operations can impact the integration of production activities. Given the importance of both knowledge and production for manufacturing firms (and the linkages between these activities), I seek to analyze how large and complex manufacturing firms use both knowledge and production flows in all markets in which they operate. Importantly, I control for multiple host country, parent firm, industry and subsidiary characteristics when examining how knowledge and information flows impact the integration of firm production activities. Further, I make use of propensity score matching techniques to control for other unobservable characteristics.
The results from a panel dataset based on survey data from the Bureau of Economic Analysis (BEA) on the operations of US manufacturing firms that have foreign investments from 1989-2005 offer several interesting findings about both knowledge and production linkages across firm operations. First, the results show how a comprehensive set of US manufacturing firms use people, products and licensing mechanisms throughout their wholly-owned operations and further, how these firms link their production operations. These knowledge flow and production linkages are discussed below in both the results and conclusion sections. Second, the results show how people, product and licensing knowledge flow mechanisms impact production linkages across firm operations. People play an important role in all types of subsidiary linkages – whether a subsidiary is exporting its products back to parent operations or other subsidiary operations. However, there are interesting differences based on whether a subsidiary’s production operations are linked with parent firm operations or with other subsidiary operations. Regarding subsidiary to parent firm production linkages, subsidiaries that have higher levels of R&D employees, higher levels of expat employees and that receive more imports from their parents are significantly likely to have higher production integration with parent operations. For subsidiary to other subsidiary production linkages, subsidiaries that license technology from parent firms and have higher levels of R&D employees are significantly likely to have higher production integration with other subsidiary operations. Taken together, these results show how different knowledge flow mechanisms impact production integration across MNC internal operations. Overall, the results highlight the important role of people in encouraging production linkages across all types of intra-firm manufacturing operations.
Integration and Firm Knowledge:
Organizations must address how they will divide and subsequently coordinate activities across their subunits. To be successful, they must balance differentiation and integration across their operations (Lawrence and Lorsch, 1967, 1986). Differentiation refers to segmentation of organizational systems into subsystems while integration involves combining these separate parts so that they work together or form a whole. For complex organizations like multinational corporations, extant literature depicts these firm structures as containing internally differentiated operations that leverage interdependencies across subunits (Bartlett and Ghoshal, 1989, Ghoshal and Westney, 1993 and Prahalad and Doz, 1987). To respond effectively to environmental heterogeneity across its subunits, an MNC must differentiate the activities of its subsidiaries to take advantage of diverse local environments while simultaneously integrating these activities to leverage interdependencies across these subunits (Ghoshal and Nohria, 1989). These studies suggest that benefits arise not only from the strength of dispersed units, but also from the linkages that firms create across their subunits (Malnight, 2001).
Much of the early literature in organization theory on multinational corporations focuses on how firms deal with pressures to reduce costs or be locally responsive across the markets in which they operate. The integration-responsiveness framework (Prahalad and Doz, 1987) considers the structures that firms choose as they expand their worldwide operations (including international, multi-domestic, global and transnational strategies and structures of MNCs). While early studies argue for distinct roles for subsidiaries to either respond to cost or local adaptation pressures, Bartlett and Ghoshal (1987) emphasized the need for firms to be simultaneously responsive to different environments while also integrating operations to gain efficiency advantages. Bartlett (1986) criticized the notion that all subsidiaries are likely to play the same role within an MNC. He argued that subsidiaries can differ in terms of competencies that reside in them and the strategic importance of the local environment. More recent research on the organizational structures of MNCs has increasingly moved away from hierarchical models that focus on one dimension (ie, responsiveness) at the expense of the other (integration). Instead, an MNC is often conceptualized as an “inter-organizational network” with multiple vertical and horizontal relations, and with diverse resources that can be found throughout the subunits of the organization to allow firms to respond to both integration and responsiveness dimensions (Ghoshal and Bartlett, 1990, Bartlett and Ghoshal, 2002, Gupta and Govindarajan, 1991, 2000, and Hedlund, 1986). For example, Jarillo and Martinez (1990) classified a firm’s subsidiaries according to configuration and coordination. Further, several scholars have advanced the notion that MNCs can create centers of excellence across locations to create knowledge that can be used throughout a firm’s network of operations (see Cantwell, 1989, Birkinshaw and Hood, 1998, Taggart, 1998 and Frost et al., 2002, for example). The “combinative capacity” (Kogut and Zander, 1992) of a firm’s network of operations can allow multinational corporations to both exploit and combine distributed knowledge, resources and capabilities throughout their operations. Rather than respond to either local responsiveness or integration pressures, the network view of multinational firms provides a much richer view of both the multiple roles that subsidiaries can play and the importance of coordination, integration and knowledge flows throughout firm operations.
The idea that subsidiaries can have multiple relationships and play multiple roles across a firm’s network of operations fits well with research that focuses on the role of firm capabilities and knowledge in explaining firm growth (Penrose, 1959, Wernerfelt, 1984). Firm knowledge assets play an important role in firm growth because firms can transfer, augment and build their technological capabilities as they grow (Penrose, 1959, Hymer, 1976, Dunning, 1980, Buckley and Casson, 1974, Caves, 1996). A knowledge based view of the firm emphasizes how a firm’s accumulated knowledge provides firms with key competitive advantages, including resources and capabilities to compete and continually innovate to respond to dynamic markets (Buckley and Casson, 1976, Caves, 1982, Ghoshal, 1987, Teece, 1981, Grant, 1996, Dosi et al., 2000). For manufacturing firms in particular, deploying knowledge assets across firm operations can provide firms with competitive advantages in products and production processes across their operations (Ghoshal and Moran, 1996, Grant, 1996). Several studies confirm that firms will respond to imperfect markets for knowledge and establish wholly owned subsidiaries as they internalize cross-border flows of technology (Buckley and Casson, 1974, Teece, 1977, Doz, 1987). However, while these studies focus on the importance of establishing wholly-owned subsidiaries to protect and extend knowledge assets, there has been much less focus on the linkages that firms with knowledge assets create after they have expanded and established wholly-owned subsidiaries.
To better understand the linkages that firms establish throughout their internal operations, I examine how different types of knowledge and information flows impact the production linkages that firms establish across their operations. Below, I consider why firms with knowledge assets are likely to benefit from integrated production activities. The mere existence of parent firm knowledge, however, does not tell us much about how firms use and develop their knowledge throughout their operations. I then consider how different types of knowledge flows through technology transfer, parent products and subsidiary knowledge creation can impact integration across subsidiary production activities. Finally, given several arguments about the difficulty of transferring knowledge across organizations (intra- and inter-firm), I consider how R&D and home country personnel can also impact linkages and integration across firm production operations. I start by considering the aggregate influence of parent firm knowledge on integration across firm operations.
Parent Firm Knowledge and Integration
There are several benefits that firms with knowledge assets can achieve from integrating their operations. First, firms can benefit from specialization and scale. Firms may be able to achieve both higher quality and more efficient production by separating their production processes of individual components or parts of products and benefit from specialization and scale (Feenstra, Hanson and Swenson, 2000). Through product integration, firms with proprietary assets can more successfully transfer and exploit their knowledge in an efficient way throughout their operations. Increases in the technological intensity of the production processes across firms (Kobrin, 1991) also suggest that there is an important role for product integration. Further, Kobrin suggests that in many knowledge-intensive industries, companies need to integrate their production transnationally to support the level of R&D expenditures needed to develop and produce products. Second, firms can benefit from interchange across their production operations. Given many arguments about the difficulty of transferring complex knowledge (Teece, 1977, Szulanski, 1996 and Hansen, 1999), integrating operations may be the only way to exploit and apply knowledge in new products and market settings (Kogut and Zander, 1992). At a minimum, by integrating operations and increasing linkages across subunits, it is more likely that firm knowledge will successfully flow across these operations from increased linkages on multiple levels across operations. In addition, integration across operations could encourage new sources of improvements about proprietary knowledge of the firm due to additional employees being involved in the production process. Finally, Kogut (1984) and Ghemawat (2003) have proposed that firms can benefit by arbitraging differences across countries, including national resource endowments or capital market conditions. These arguments suggest that firms can combine inputs from different operations to achieve competitive advantages across all markets. This arbitrage and leverage approach to international markets suggests that firms can benefit from integration across their operations on several levels, including production. While there have not been many studies that consider how firms link and integrate their production activities across their multinational operations, Kobrin (1991) used industry level data to show that firm knowledge is a primary determinant of the integration of firm activities across borders. Taken together, these arguments and findings suggest that firms with proprietary assets will exploit, replicate and integrate their organizational knowledge (Kogut and Zander, 1992) and production activities as they grow.