North American Firms in East Asia: HSBC Bank Canada Papers on Asia, Volume 5 9781442677777

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HSBC Bank Canada Papers on Asia

Editor A.E. Safarian University of Toronto

Managing Editor Wendy Dobson University of Toronto

Editorial Advisory Board David E. Bond, David E. Bond and Associates, Vancouver Edward K.Y. Chen, Lingnan College, Hong Kong Chia Siow Yue, Institute of Southeast Asian Studies, Singapore Farid Harianto, Financial Restructuring Agency, Jakarta Ralph W. Huenemann, University of Victoria Lawrence B. Krause, University of California, San Diego Karen Minden, Asian Business Consortium, Toronto Eleanor Westney, Massachusetts Institute of Technology, Cambridge, Mass. Ippei Yamazawa, Institute of Developing Economies, Tokyo

Institute for International Business University of Toronto

HSBC Bank Cananda

Other titles in this series

Benchmarking the Canadian business presence in East Asia (Volume 1) East Asian capitalism: Diversity and dynamism (Volume 2) The people link: Human resource linkages across the Pacific (Volume 3) Fiscal frameworks and financial systems in East Asia: How much do they matter? (Volume 4)

North American firms in East Asia

Paul W. Beamish andA.E. Safarian, Editors

UNIVERSITY OF TORONTO PRESS Toronto Buffalo London

www.utppublishing.com © University of Toronto Press Incorporated 1999 Toronto Buffalo London Printed in Canada ISBN 0-8020-4762-9 (cloth) ISBN 0-8020-8316-1 (paper)

Printed on acid-free paper

Canadian Cataloguing in Publication Data Main entry under title: North American firms in East Asia (HSBC Bank Canada papers on Asia ; v. 5) ISBN 0-8020-4762-9 (bound) ISBN 0-8020-8316-1 (pbk.) I. Corporations, Canadian - East Asia - case studies. I. Beamish, Paul W., 1953- . II. Safarian, A.E., 1924- . III. Series: Hongkong Bank of Canada papers on Asia ; v. 5. HD2906.N67 1999

338.8'897105

C99-932358-X

University of Toronto Press acknowledges the financial assistance to its publishing program of the Canada Council for the Arts and the Ontario Arts Council. University of Toronto Press acknowledges the financial support for its publishing activities of the Government of Canada through the Book Publishing Industry Development Program (BPIDP).

Canada

Contents

Preface vii Challenge and response: North American firms in East Asia A.E. Safarian

1

Persistent adaptability as survival strategy for MNCs in emerging markets: The case of Nortel Networks in China 17 Tony S. Frost Establishing a successful joint venture: Moore Business Forms in Japan 49 Paul W. Beamish Employee development in emerging markets: Lessons from Black & Decker Eastern Hemisphere 73 Allen J. Morrison Regional expansion in Asia-Pacific: CIBC Wood Gundy to Malaysia 95 Paul W. Beamish Building effective business relationships in China: The case of Richmond Engineering 119 Neil R. Abramson

vi Contents

"Interstitial opportunities" and the paradox of country risk: The case of Siam Canadian Foods, Inc. 147 Tony S. Frost Communicating across cultures: The case of Midstream and PetroVietnam 169 Kathleen E. Slaughter The foreign investment location decision: transactions costs, product life cycles, and psychic distance 187 Anthony Goerzen About the authors

213

Institute for International Business 217

Preface

The present volume is the fifth in a series that examines Canada's business and economic relations with East Asia. Aimed primarily at business and government decision makers, the series is designed to increase their knowledge of and familiarity with the East Asian economies. The Canadian business presence in East Asia has traditionally been small and has even declined in some respects, despite the fact that until recently the area was economically the most dynamic in the world. The East Asian market presents different challenges from those encountered in the more familiar markets of western Europe and North America, and the Asian financial crisis of the past two years has added to the risks involved in investment in the region. At the same time, however, East Asia offers potentially high rewards for latecomers or those interested in expanding their investments. The first four volumes in this series have attempted to reduce the information and other obstacles to entry and effective operation by Canadian firms in East Asia. Volume 1 spelled out the strategies of both firms and governments in a number of East Asian countries, while volume 2 examined business systems in East Asia, stressing their diversity. In the third volume a key aspect of business systems, their human resources and cultural characteristics, was examined more fully. Volume 4 carried further the understanding of the Asian business environment by presenting comparative analyses of tax frameworks and financial systems.

viii Preface

In volume 5 we turn to studies of company experience in order to delineate more precisely the types of obstacles faced and how they were met by various firms. This volume is especially timely, coming as it does when Canadian businesses are expanding rapidly abroad and when many countries in East Asia are showing signs of revival after the financial crises that shook the region. The case study approach adopted, which deals in depth with specific situations, participants, and choices, helps to illuminate general business principles dealt with elsewhere. The various cases described in this volume can be used in conjunction with more general research considered in earlier volumes in the series to draw conclusions about how the challenges of operating in East Asia might successfully be met. This volume was co-edited by Professor Paul W. Beamish, Director of the Asian Management Institute at the University of Western Ontario. Professor Beamish and his colleagues at the Richard Ivey School of Business have produced a large number of case studies on Asia, particularly for teaching purposes. All of the cases in this volume can be obtained in their decision-oriented format by contacting Ivey Publishing at www.ivey.uwo.ca/cases. It is a pleasure to have teamed up with them for this volume. We agreed from the beginning that the needs of our business, government, and research audiences required something different from the traditional case study. We needed to balance the analysis in the broader literature that would appeal to the researcher with the rich detail required by the practitioner. The eight company studies which follow were selected to reflect different types of firms and industries and a wide range of challenges. The international exposure of these companies varies considerably: one is based in the United States and two have major assets there, while some of the smaller Canadian firms have limited international experience. Five of the studies focus on the critical issue of entry to the East Asian region or expansion of a firm already established there; the remaining three studies consider issues involved in ongoing operations. Among the studies of larger firms, Tony Frost looks at the competitive interaction between local firms (both domestic and foreignowned) and a large Canadian multinational firm in China over time,

Preface ix

examining in particular how the Canadian firm reversed its initial decision to stay out of the market. Paul Beamish follows the largely successful experience of another large Canadian multinational as it establishes and works within a joint venture in Japan over many years; in a second study he examines the range of variables considered by a firm already established in East Asia when choosing to expand in a country and between sites in that country. Allen Morrison outlines the problems encountered when human resource systems suitable to the home country are extended to emerging Asian markets. As for the studies of smaller firms, Neil Abramson underlines the importance of building close business and personal relationships, using the example of a difficult set of negotiations involving a joint venture in China, while Tony Frost argues that there is often a negative relationship between country risk and competitive risk in emerging markets, so that a nimble smaller firm may have a unique business opportunity. Kathleen Slaughter's chapter describes the problems encountered by a consortium attempting to enter Vietnam with inadequate communication both across cultures and within the consortium. In the final study Anthony Goerzen emphasizes that firms choose between regional locations - Mexico and China in this case - and examines the influences that bear on such choices. These studies show that Canadian and North American firms can and do succeed in East Asia, thanks to a variety of skills that help to overcome the obstacles to such investment. They also reveal that firms pay a high price if they fail to invest adequately in the knowledge needed to enter and operate in distant and unfamiliar markets. Governments need to know that some of these firms made little if any direct use of the information and contacts available in public agencies. Another point of interest is that foreign direct investment, trade, technology transfer, and cooperative forms of business such as joint ventures are largely complementary: promoting the first is very likely to promote the rest. The HSBC Bank Canada has provided generous support for this project. The series Editor, Professor A.E. Safarian, leads a distinguished international Editorial Advisory Board that provides peer

x Preface

review and editorial advice. Professor Wendy Dobson, Managing Editor of the series, has provided valuable comments on a number of the studies in this volume. To stimulate high-quality research, the editors seek out top researchers and encourage them to write on subjects central to the Papers' mission. Manuscripts are commissioned and symposium and conference contributions solicited. In addition, events are organized by the Institute for International Business to ensure timely dissemination to interested audiences. The University of Toronto Press cooperates in this project through its Scholarly Publishing Division. Support is also provided by Heather Munroe-Blum, Vice-President, Research and International Relations, and Roger Martin, Dean of the Joseph L. Rotman School of Management at the University of Toronto. This volume was prepared with the assistance of staff at the Institute for International Business. Liza Tham prepared the manuscript and Vivien Choy ably looked after all logistical arrangements. The manuscript was expertly prepared and brought to publication with the editorial assistance of Allyson N. May. A.E. Safarian July 1999

Challenge and response: North American firms in East Asia A.E. SAFARIAN 1

Moving into foreign markets is risky because of the costs of learning and adapting to a different business and cultural setting. This book is about the successes and failures of eight North American firms as they attempted to locate, expand, or operate in various East Asian countries. Entry and operation in East Asian markets presents a challenge, as the low Canadian business presence suggests. Potential rewards are high but so are the accompanying risks. Previous volumes in this series have contributed information and analysis that may help to reduce some of the learning costs of entry and operation in East Asian markets. The company studies in this volume were selected over other possibilities in order to portray a range of challenges in different types of firms and their responses. East Asian markets present some particular challenges for firms from elsewhere. These include the need to develop relationships based on trust and a long-term commitment, an approach that can be severely tested in a period of financial crisis, and an appreciation of both the differences from traditional markets and the diversity of business organizations within Asia. Some of the studies in this volume reflect the high cost of failure to develop trust relationships before settling formal agreements, or even to being well informed on local circumstances more generally (Rich-

1 I would like to acknowledge helpful comments by Wendy Dobson and Paul Beamish.

2 A.E. Safarian

mond Engineering and Midstream, respectively). By contrast, both small and large firms can benefit from examining existing sources of information carefully (CIBC Wood Gundy) and by paying attention to the dynamics of the changing local business opportunities (Siam, Nortel Networks). While the Toppan Moore study demonstrates how acceptance of a high degree of local autonomy can contribute to the success of a major joint venture, the experience of Black & Decker shows there are circumstances in which overriding some local traditions may be necessary for effective human resources development. The Palliser study examines the factors determining a firm's choice between East Asia and alternative sites, specifically China and Mexico. Before we embark on these company studies, however, it is useful to consider what the business and economics literature has to say on business decisions to invest abroad, including the role of public policy. Determinants of multinational investment The literature on business investment abroad can be grouped under four headings for present purposes. Three relate to the initial decision regarding entry into a foreign market or subsequent expansion there, deciding in which country or region to locate and determining which organizational form to use in the new market. These choices are often referred to as the OLI explanation for international business.2 In addition, a variety of managerial and strategic issues arise in any established firm that is geographically decentralized, especially one that cuts across countries and cultures. Ownership-specific advantages The first question to ask is why firms go abroad so often. A firm that chooses to produce in foreign markets encounters significant difficul2 OLI stands for owership-specific advantages, location choices and internalization or choice of organizational form, as explained more fully in Dunning (1993, chapters 3 and 6).

Challenge and response: North American firms in East Asia 3

ties as it confronts different laws and customary ways of doing business, the need to deal with a different workforce and set of suppliers, and problems of policy and operational coordination across national boundaries and cultures. There are also alternatives to establishing a business abroad, including exports and a variety of alliance modes, such as licences, subcontracts, and equity joint ventures. The short answer to the question of why firms go abroad is that ownership-specific assets can overcome the costs of operating abroad, and the returns from these assets are sometimes larger with subsidiaries than with exports or alliance forms. Firms possess particular assets that form the bases of their profitability and even their very existence. These can cover a wide range of capabilities or properties, such as a particular set of management or labour skills, knowledge of production processes or distribution or financial systems, intellectual property, natural resource rights, and political connections. Such knowledge is firm specific in that it has involved a considerable investment by the firm and is not easily emulated by others. Locational choices At the end of 1997, 68 percent of the world's inward stock of direct investment capital was located in the developed countries, compared with 72 percent in 1985. East and Southeast Asia had received 15 percent of this capital, compared with 9 percent in 1985, while Latin America and the Caribbean had about 10 percent in each year. In each year all other countries had less than 10 percent of the world's inward stock. Canada's stock of outward foreign direct investment (FDI) is now about the same in dollar terms as her inward FDI stock. About 55 percent of Canada's outward stock is located in the United States, roughly the same percentage as in 1970. The European Union share

3 In book value terms. The outward stock, which is of more recent vintage, would probably still be lower in terms of market values. Estimates refer to the end of 1996.

4 A.E. Safarian

has risen over this period, from 16 to 20 percent, 'the Latin American share fell from 11 to 3 percent,' and the East Asian share rose from 1 to 5 percent. What determines where firms locate, expand, or restrict their foreign production? The focus on this question in most of the specific studies contained in this volume suggests a general statement would be helpful. Six points in particular are worth noting: 1 Distance - geographic and cultural ("psychic distance") - is a factor Reduced costs and increased speed of transportation and communication have sharply reduced the importance of geographic distance, yet there is still a tendency for FDI to favour adjoining countries most notably Canada and the United States, but also intra-European and intra-Asian FDI. Taking cultural differences into account was a frequent theme of earlier volumes (for example, Westwood, 1997) and it reappears in this one. 2 Demand is a major factor in most studies. Firms prefer to invest in markets that are large in income terms, growing, and (if possible) adjacent to their own countries. Smaller markets may be entered by licences, subcontracts, turnkey projects, and a variety of other forms requiring less investment commitment than FDI. 3 A wide range of supply-side factors can influence country choice, depending on other motives and the sector of industry. Some examples are the availability of natural resources; low-cost labour for standardized products; skilled labour for other types of products; industrial and social infrastructure, such as transport and education systems; and agglomeration economies, such as the quality and variety of suppliers and of financial institutions. 4 A high degree of political instability is not conducive to FDI, except for those firms expecting a high and quick pay-off and those few counting on not being sideswiped by rapid political change. More generally, the quality of institutions in a broad sense, including

4 See Dunning (1998) for detail on the determinants of location decision by MNEs.

Challenge and response: North American firms in East Asia 5

effective recourse to law and dispute settlement and the pervasiveness of outright corruption, can affect long-term investment commitment to a country. 5 Government policies can affect the expected profits from FDI in both positive and negative ways. Macro- fiscal and financial stability had an important positive effect in attracting FDI into the Asia Pacific region (World Bank, 1993). Maintaining or moving towards an economy more open to trade and investment, policies aimed at privatization or restructuring of older sectors, industrial promotion schemes, and tax and other incentives - these all tend to attract FDI, with some qualifications. By contrast, profitability tends to be reduced by investment review mechanisms designed to promote local development, discrimination against foreign ownership in certain sensitive sectors, or policies that favour local partners. Not all such restrictions are effective, however; some are intended to appear to regulate multinational firms in a context in which there are various social and political concerns about such firms but also a desire to attract them for economic gains (Safarian, 1993, chap. 11; Kudrle, 1995). 6 Finally, there are some strategic considerations designed to reduce risk in a long-term context. Many multinational enterprise (MNE) markets are oligopolistic in the sense that each firm's actions significantly affect those of competitors. Staying out of a substantial and growing market while competitors move in could affect an MNE's ability to compete elsewhere; for example, some types of unit costs could fall for your competitors, and their ability to compete in other markets could rise. Another example is the acquisition of or collaboration with firms that have knowledge-based assets such as R&D, in order to protect or enhance the specific advantages that may be the very bases for your firm's profitability. Internalization Firms need not go abroad through subsidiaries, as noted earlier. Going abroad involves a large investment commitment and ongoing coordination problems over what are often large geographic and cultural dis-

6 A.E. Safarian

tances. Some of these problems can be minimized via exports or various forms of cooperative ventures with firms already located abroad. What determines the choice between these different organizational forms, and particularly the decision to 'internalize' production within the MNE? 5 One answer is that, for many products and processes, the organizational form of the firm is the most profitable way to capitalize on that firm's specific assets or skills, despite the coordination problems involved. The non-codified knowledge the firm possesses can be utilized abroad more effectively through its own employees and under its own management control. Arm's-length transfer, even with training and codified knowledge, is simply too costly or ineffective, given that much of the knowledge is embedded in the skills of its staff. Moreover, higher returns on the firm's knowledge can result if it is imitated less quickly by others. A licensee or joint venture partner may be able to operate effectively on its own at some point, unless a better product or process is developed by the MNE. Effective management control (whatever the distribution of equity) can assure the maintenance of standards. It also limits opportunistic behaviour by partners while increasing the possibility of such behaviour by the firm in pricing, tax minimization, and other respects. A variety of factors affect the decision to internalize. Basically there is a trade-off between the advantages of being close to the local market and the advantages of achieving scale economies by production at home. Thus higher transport costs and barriers to trade would favour FDI (if it is forthcoming at all, given size of market, quality of infrastructure, and so on) while economies of plant scale at home and higher barriers to investment abroad would tend to favour exports (Brainard, 1997). To some extent the differences between modes of serving a foreign

5 Firms must also decide whether to go abroad by greenfields investment or acquisition of an existing firm. The latter has become the dominant method for FDI in many developed countries, although Japan is an exception (Beamish etal., 1997). Acquisition is less prominent in developing countries.

Challenge and response: North American firms in East Asia 7

market have been collapsing. The data suggest that FDI and production in MNEs, foreign trade, and international alliances have all been increasing together. For example, Hejazi and Safarian (1998) use a gravity model to show the link between outward FDI and Canadian exports for 35 countries in the period 1970-96. This approach first accounts for the volume of exports as determined by a standard set of variables developed in theories of foreign trade, then factors in FDI. Outward FDI and exports are complementary overall, although not for all industries. This analysis has been extended to U.S. experience with trade and FDI with 51 countries in the period 1982-94, with similar results (Hejazi and Safarian, 1999). A further study has shown that a variety of alliance forms of doing business abroad have increased rapidly but also that MNEs are involved in most of these. Alliances are not necessarily substitutes for MNEs, as some have argued (Safarian, 1997). Ongoing managerial and strategic decisions Once the decision to establish is made, of course, a whole range of ongoing decisions arises. The organizational structure involved, especially the locus of decision making between parent and subsidiary, can have far-reaching consequences. In recent decades there has been a move away from a system in which some decisions were centralized and others decentralized to a more interactive network type of process (Malnight, 1996). Where to locate production and other activities in such a network organization - where and how to deepen and widen the value chain - is an ongoing activity that interests governments and suppliers as much as firms and their managers and employees. Finally, a critical question is how to locate, train, retain, and motivate both managers and other employees, for the success of the operation will eventually depend in good part on this issue. Challenge and response: what the studies show The eight firms in these studies were chosen to reflect a range of characteristics and topics, described in Table 1. Three are smaller-sized,

Table 1: Summary of studies

Sector

Country

Entry/expansion or ongoing operation

Nortel Networks Moore Business Forms CIBC Wood Gundy

Telecoms Business forms Investment banking

China Japan Malaysia

Ongoing operation Ongoing operation Expansion

Black & Decker Eastern Hemisphere Richmond Engineering

Power tools and others Engineering steel products Seafood brokering

Singapore and region China

Ongoing operation

Adaptation to changing opportunities Successful JV design and operation Framework and information tools for choice of site Transfer of management program

Entry

Importance of trust in negotiation

Burma

Expansion

Oil and gas construction Furniture

Vietnam

Entry

Divergence of country and competitive risk can favour small firms Costs of poor communication

Mexico and China

Entry

Siam Canadian Foods Midstream Palliser Furniture

Topic

Choice between Chinese and Mexican location

Challenge and response: North American firms in East Asia 9

one is intermediate though important in the Canadian market, four are large firms with considerable experience abroad. While only one firm is headquartered in the United States, two others have substantial parts of their assets in that country. Richmond and Midstream are not the actual names of these companies. What types of challenges were faced by these firms in the East Asian market and how did they respond to them? It was noted above that various firm-specific assets help the MNE to surmount the obstacles involved in operating subsidiaries abroad. The firms in this study have a diverse set of assets, ranging from production and engineering skills (for example, Richmond) to these skills plus R&D intensity (notably Nortel) to financial innovation (CIBC) and marketing skills (Siam).

To some degree, every firm is affected by all of the influences noted above on the choice of location and the ongoing management problems. Demand factors, for example, were clearly important in all cases, whether reflected in Nortel's view that it could not afford to stay out of the growing Chinese market or Siam's desire to capitalize on the growing export market for seafood. The same is true of various supply factors. In what follows we will concentrate on some of the issues that were most significant in individual firms. The role of host governments was particularly important at the time

6 Previous research, including the earlier volumes in this series, points to a variety of obstacles to doing business in Asia. One study notes the following as the most significant obstacles, in the order shown: lack of local market information, dealing with local bureaucracy, cultural differences, tariffs and trade regulations, language differences, economic infrastructure, availability of financing, recruitment of local personnel, uncompetitive product price, and geographic barriers (Conference Board, 1994). Almost all of these play a role in the company studies in this volume. A study of Canadian small and medium-sized enterprises in Asia suggests that, relative to large firms, their disadvantages are significant in four areas: availability of capital at a reasonable cost, market intelligence, international experience, and managerial depth and dynamism (Rao and Ahmad, 1996). 7 Several studies have suggested that Canadian MNEs' advantages are less concentrated in R&D intensity, unlike those of many other home countries, and more likely to include also marketing, organization, engineering and other skills (Rugman, 1987; McFetridge, 1994).

10 A.E. Safarian

of initial entry. This was evident in the difficult negotiations with government entities in the Richmond, Midstream, and Siam studies. It also stands out in the negative view taken by the national government towards subsequent entry when Nortel decided to defer entry. The need to understand cultural differences, both in the initial entry negotiations and subsequently, stands out sharply. Richmond paid a price for failing to develop a trust-based relationship early in its negotiations with other major shareholders: it got a joint venture, but the outcome was successful only after it developed such a relationship. Midstream paid a higher price. The Canadian negotiating efforts were beset by failures to communicate effectively across the language and other cultural barriers with the Vietnamese. The loose organization within the consortium in terms of objectives, leadership, and roles contributed to a weak negotiating stance and ultimate failure. In the case of Palliser, a Mexican site was chosen over one in China, in part because of NAFTA but also because the psychic distance was perceived to be larger in the latter case. By contrast, Moore and its Japanese joint venture partners maintained a long and profitable relationship. Some of the factors that led to this result were the relatively few cultural misconceptions and a stable policy towards the subsidiary which allowed it considerable autonomy. Given the emphasis on joint ventures by many governments and the doubts expressed in the early literature about their stability over time, this example suggests they can have a long life if well designed. In the Black & Decker case, management decided it had to override concerns about perceived cultural differences. The Black & Decker study examines the challenge involved in the company's decision to import a North American employee appraisal and development system into its Eastern Hemisphere operations. This approach overrode Asian cultural differences by use of a standardized system developed elsewhere, in an attempt to quickly improve the human resources of the firm. Political instability, policy risk, and competitive risks all played important roles in the experience of a number of companies. Planning for these is obviously difficult but it is feasible, as several examples

Challenge and response: North American firms in East Asia 11

show. The chapter on Siam Foods argues that country risk, reflecting the political-economic environment, is frequently inversely related to competitive risk. The strongest firms can afford to wait, since their competitive advantages are not dissipated if they postpone investing in volatile foreign environments. This creates an opportunity for smaller, more nimble firms. The experience of CIBC Wood Gundy demonstrates how a firm can draw on a wide variety of public sources as well as firm-specific data to plan carefully the selection of particular countries and sites within countries. Both this firm's experience and that of Black & Decker demonstrates how systems risk, in the form of the Asian financial crisis, can affect carefully drawn plans. In the case of Nortel Networks, however, 'persistent adaptability' allowed a firm to take advantage of changes in the external environment to alter its fortunes in a given market. Frozen out of the main public switch market in the early 1980s, Nortel was able to grow by subsequently taking advantage of the increase in private sector demands and the deregulation of services. As noted earlier, there is considerable evidence that foreign trade, FDI, and alliance forms of market penetration are complementary overall, although not for all sectors (Hejazi and Safarian, 1998, 1999). For example, FDI by Nortel, Moore, and Richmond involved working out very different types of joint ventures, while Moore exported machinery to Japan and Siam and Palliser exported from the host countries. In every case where an investment was undertaken, moreover, there is evidence of a range of firm-specific capabilities, which was reflected in technology transfer to the host country. Policy towards outward FDI should reflect the increasing reality that it largely accompanies increased trade, an increase in cooperative forms of business activity, and more technology sales abroad. In summary, these studies add to our understanding of how firms respond to a number of the challenges outlined in earlier volumes. There are some gaps, however. For example, the various Asian business systems are not reflected sharply in these studies; volume 2 of this series is thus an important complement to this volume. The issue of corruption is discussed only in the Richmond case, but it appears that

12 A.E. Safarian

uncertainty induced by corruption has a significant negative effect on FDI. It has been estimated that an increase in the uncertainty level related to corruption from that of Singapore to that of Mexico is equivalent to increasing the tax rate on MNEs by 32 percentage points (Shang-Jin Wei, 1997). A surprising omission in the studies is the utilization of Canadian governmental services, whether in Canada or in East Asia. Only the Midstream case refers to these. The four large MNEs might be more likely to rely on their own resources, although hardly to the exclusion of government services. It is harder to explain why only one of the studies of smaller firms refers to government resources.

Conclusions The first volume in this series, Benchmarking the Canadian Business Presence in East Asia, began by outlining in some detail a paradox: East Asian economies had been growing very rapidly for some time but Canada's economic presence in East Asia was small and declining. The objective evidence of this trend in the data on trade and investment was matched by subjective (and often unflattering) measures of Asian perceptions of Canadian business abilities. Two issues have continually resurfaced in that and subsequent volumes and in the conferences organized in connection with their publication. One explanation suggested for the paradox is the relative ease of access to the U.S. market. The second explanation points to the difficulties in doing business in what is not only an unfamiliar environment but one which is quite diverse. Both of these points have some merit, and both need to be qualified. To begin with, many Canadian businesses have learned to their cost that the U.S. market is neither easily penetrated nor highly profitable; a long list of retailers that failed to penetrate that market and now face severe competition at home will attest to this truth (O'Grady and Lane, 1996). Second, there have been periods of sectoral excess capacity in Canada in the past few decades, during which one might have expected renewed efforts to penetrate the booming Asian markets.

Challenge and response: North American firms in East Asia 13

Third, businesses in the United States and western Europe which faced similar problems in developing Asian trade and investment have often done better than their Canadian competitors. Finally, and most important, the obstacles to doing business in Asia - the cost of developing trade, technical contacts and direct investment over long distances, both geographically and culturally - are a matter of investing in knowledge, relationships, and appropriate public policies. This is precisely what Canadian firms, individuals, and governments have done over long periods of time with respect to the United States and, more recently, Mexico. Such efforts are far from absent in Asia, but they are not found on the same scale. Canadian and North American firms can and do succeed in Asia and a number of the companies in this volume have demonstrated a variety of skills in this regard. They have shown how to manage risk to their advantage, coped with changing opportunities and government policies, worked well within a joint venture, utilized information sources effectively, and otherwise demonstrated operational and strategic skills going well beyond their more obvious firm-specific assets. It is also true, however, that the international environment in general and Asia in particular is less forgiving of mistakes. The impact of errors can be exaggerated not just because of country risk factors but also because of systems risk, such as the Asian financial collapse. At least two of the firms in this study paid heavily for their failure to invest adequately in knowledge, which is the essential prerequisite for reducing the costs of FDI abroad. That knowledge includes basic information in terms of knowledge of the market, of supply conditions, and of government policies. It also includes more complex knowledge, such as how to organize for investment abroad; how to deal with differences in languages, business environments, and customary practices; what sorts of strategies are likely to work, given the characteristics of the firm and the particular country and competitive circumstances it faces; and what types of accommodation a particular type of joint venture will require. Much of this knowledge is costly to acquire and to act on effectively, but this is what firms do in the domestic aspects of their activities and

14 A.E. Safarian

in markets closer to home. There are many ways to acquire and evaluate such knowledge, ranging from taking advantage of a variety of public sources to utilizing the firm's own research. Two important sources of information are worth noting if only to highlight their absence from the studies. First, Canadian governments are a mine of information, analysis, and contacts, both at home and in representation abroad. Many firms have utilized these to their advantage. In the studies presented in this volume, however, only one small firm noted the availability of. such contacts while one large firm mentioned some support in passing. There may be scope for improving this kind of interaction. It is also surprising to discover that some smaller firms utilized intermediaries who lacked contacts and communication skills, or who even had a conflict of interest, instead of skilled intermediaries such as local trade and investment lawyers, Canadian banks abroad, and agents (including skilled immigrants) in their home base. One further point on public policy is worth comment. Foreign direct investment, foreign trade, alliance formation, and technology transfer are increasingly a package of organizational modes. In most cases they reinforce one another in helping to assure successful penetration abroad. Public policies designed to support such success should reflect this complementarity.

REFERENCES Beamish, Paul W., Andrew Delios and Donald Lecraw. 1997. Japanese Multinationals in the Global Economy. Cheltenham, U.K.: Edward Elgar. Brainard, S. Lael. 1997. "An Empirical Assessment of the Proximity-Concentration Trade-off Between Multinational Sales and Trade," American Economic Review, 87, 3: 520-544. Conference Board of Canada. 1994. Canadian Trade Policy Options in the Asia Pacific Region: A Business View. Ottawa: The Conference Board. Dunning, John H. 1998. "Location and the Multinational Enterprise: a Neglected Factor?" journal of International Business Studies, 29, 1: 45-66. Dunning, John H. 1993. Multinational Enterprises and the Global Economy. Wokingham, U.K.: Addison-Wesley.

Challenge and response: North American firms in East Asia 15 Hejazi, W., and A.E. Safarian. 1999. "The Complementarity Between US Outward FDI and Trade." Presented to the annual meeting of the Canadian Economics Association, University of Toronto, June 14. Hejazi, W., and A.E. Safarian. 1998. "Modelling Links between Canadian Trade and Foreign Direct Investment." Industry Canada Working paper. Kudrle, Robert T. 1995. "Canada's Foreign Investment Review Agency and United States Direct Investment in Canada," Transnational Corporations, 4, 2: 58-92. Malnight, Thomas W. 1996. "The Transition from Decentralized to NetworkBased MNC Structures: an Evolutionary Perspective." Journal of International Business Studies, 26, 1: 43-65. McFetridge, Donald G. 1994. "Canadian Foreign Direct Investment, R&D and Technology Transfer." In Steven Globerman, ed., Canadian-Based Multinationals. Calgary: University of Calgary Press. O'Grady, Shawna, and Henry W. Lane. 1996. "The Psychic Distance Paradox," Journal of International Business Studies, 27, 2: 309-33. Rao, Sumeshwar, and Ashfaq Ahmad. 1996. "Canadian Small and Medium-sized Enterprises: Opportunities and Challenges in the Asia Pacific Region." In Richard G. Harris, ed., The Asia Pacific Region in the Global Economy: a Canadian Perspective. Calgary: University of Calgary Press. Rugman, A. 1987. Outward Bound. Toronto: C.D. Howe Institute. Safarian, A.E. 1997. "Trends in the Forms of International Business Organization." In L. Waverman, William S. Comanor and Akira Goto, eds., Competition Policy in the Global Economy: Modalities for Co-operation. London and New York: Routlege, 40-65. Safarian, A.E. 1993. Multinational Enterprise and Public Policy. Aldershot: Edward Elgar. Shang-Jin, Wei. 1997. "Why Is Corruption So Much More Taxing than Tax? Arbitrariness Kills." Working Paper No. 6255. Cambridge, Mass., National Bureau of Economic Research. Westwood, Robert. 1997. "Culture, Business Organization and Managerial Behaviour in East Asia." In A.E. Safarian and Wendy Dobson, eds., The People Link: Human Resource Linkages across the Pacific. Toronto: University of Toronto Press. World Bank. 1993. The East Asian Miracle: Economic Growth and Public Policy. New York: Oxford University Press.

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Persistent adaptability as survival strategy for MNCs in emerging markets: The case of Nortel Networks in China TONY S. FROST

This chapter demonstrates how "persistent adaptability" can help a multinational firm to survive in critical markets. Changes in a subsidiary's external environment provide opportunities for it to change its fortunes in a given market. Success in exploiting such opportunities depends significantly on the ability of the local subsidiary to draw on its parent's resources while maintaining its strategic autonomy. Nortel Networks is a major Canadian-based MNC which has long been a leader in technical innovation in telecommunications. It found itself frozen out of the main public switch market in China in the early 1980s because of an earlier decision to delay investment there. As a global competitor, it felt compelled to grow in a market where its main rivals were involved. Several "revival points" occurred; the growing private sector opened a potentially large market for private branch exchanges, for example, and in the early 1990s there was a growing demand for cellular networks. More recently, the deregulation of the services sector led to further opportunities through the emergence of new service providers. The policy of localization - local production, local partners, local R&D - has been critical to Nortel's success. In effect, persistent adaptability allowed the company to overcome its initial handicap and also offered it a broader range of strategies in reconciling the demands for globalization with those of localization. Introduction This chapter examines the experience of Nortel Networks in China. It

18 Tony S. Frost

traces the fortunes of the company over a 27-year period in the Chinese market, one of the largest and fastest growing telecoms markets in the world. The chapter is designed to provide a detailed look at an extremely challenging situation in the context of global strategy and the management of the multinational enterprise. The unfolding experience of Nortel in China illustrates the necessity of what I term "persistent adaptability" as a survival strategy for multinational corporations (MNCs) in emerging markets. Persistent adaptability recognizes two factors that have, to date, not featured prominently in the existing global strategy literature. First, the realization that changes in the external environment (political, economic, technological) may lead to periodic "revival points" - opportunities for a company to change its fortunes in a particular market context, perhaps, but not necessarily, with an accompanying change in strategy. Revival points are particularly common in emerging markets, where political-economic institutions tend to be more fluid and variable than those found in the developed markets of the West. Changes in government policy, restructuring of government ministries, deregulation, macroeconomic crises, pressure from international regimes, shifts in industry structure - these kinds of events can lead to revival points for firms that have previously found themselves shut out of or floundering in a particular market setting. Revival points are also particularly common in high technology industries where competition tends to occur within and across sequential generations of product and technology standards. In the Nortel case, both types of revival point are operative, and both are important to understanding the company's history and outlook in China. The second point of departure from the general thrust of the existing literature is the notion that foreign subsidiaries often possess a much broader array of strategic options - and the capacity to pursue them - than is commonly supposed in the multinational literature. Conditions in a particular market context may produce strategic imperatives that are quite different from those at home, or in other markets in which the firm competes. Again, this is especially likely in emerging market settings, where key assumptions underpinning com-

Nortel Networks in China 19

petitive success elsewhere may not hold. In such cases, success hinges importantly upon the ability of the local subsidiary to access resources of the parent firm (products, technologies, knowledge, connections) and at the same maintain strategic autonomy. In this sense, the role of the parent firm can be conceptualized as providing a suite of "options" for the subsidiary organization to exercise and augment based on its knowledge of conditions in the evolving local context. The chapter first tells the story of Nortel in China up to the present period. It then uses the case study to take a broader look at global strategy issues in the context of dynamic emerging market environments. The concept of persistent adaptability is then illustrated through the lens of the Nortel case. The chapter concludes by pointing out several implications for strategy and the management of subsidiary-headquarters relations.

The situation in spring 1999 On April 19, 1999, Chinese Premier Zhu Rongji's plane touched down in Ottawa, Ontario, the capital city of Canada. Together with a delegation of senior Chinese ministers, officials, and diplomats, Premier Zhu was welcomed by officials from the Government of Canada, including the Honourable Sergio Marchi, Minister for International Trade. Premier Zhu's visit to Canada was part of a more extensive North American tour, a key goal of which had been to secure China's accession into the World Trade Organization (WTO). As it turned out, that goal had not been achieved. Just days earlier in Washington, U.S. President Bill Clinton had gone against the urgings of top trade, security, and diplomatic officials by not signing off on China's WTO entry. Instead, the President had sided with several close advisers who had warned him that WTO membership for China was a politically risky proposition amid concerns in the U.S. Congress about alleged nuclear spying, campaign finance transgressions, and a mounting U.S. trade deficit with China, which had reached over US$ 50 billion in 1998. As part of the Chinese delegation's visit to Canada, Premier Zhu was

20 Tony S. Frost

scheduled to tour the largest R&D campus of Nortel Networks, Canada's flagship technology company and a major player in the worldwide telecommunications equipment market. The Premier's visit was intended to mark the company's 27-year involvement in the Chinese market. Nortel also planned to use the visit to showcase some of its latest telecoms technology, including the world's first public demonstration of CDMA2000, a third generation (3G) wireless standard for delivery of high speed voice, data, video, and Internet services.1 It was well known that China was actively considering alternative systems for migrating the country's wireless network to third generation technology - and CDMA2000 was one of the competing standards. In fact, developments in the Chinese telecommunications industry had never been far from the agenda leading up to Premier Zhu's North American visit. Two weeks earlier, U.S. Commerce Secretary William Daley had led a trade mission to China accompanied by 32 telecom companies - members of the U.S.-based Telecommunications Industry Association - including Nortel. One of the fruits of Daley's mission had been to secure an agreement to allow deployment in China of the current generation of CDMA technology, which had been developed in the United States and was the de facto standard in North America. China, on the other hand, had overwhelmingly adopted the rival European-based GSM standard, although it had permitted a few small-scale trials of CDMA. Many analysts believed that the introduction of CDMA technology on a nationwide basis in China would be particularly advantageous for North American-based companies such as Motorola, Lucent, and Nortel, who were world leaders in the technology. Now, with China's WTO bid on hold, the future of CDMA in China was once again in doubt. Reflecting on these developments, Stephen Tsui, Managing Director of Nortel Networks China was still optimistic. China's telecoms market was one of the largest and fastest growing in the world. Spend-

1 Third generation technology would allow phones to have more capabilities in terms of handling faxes, e-mail, and other computerlike functions, including Internet access!

Nortel Networks in China 21

ing on network infrastructure was expected to reach US$ 16 billion in 1999 and industry estimates suggested similar levels right through the early years of the next century. In 1998, Nortel Networks had enjoyed its best year ever in China. Sales in the region had grown substantially, especially in wireless systems. But growth was not the only factor on Tsui's mind. He also realized that the business environment for telecorns in China, both regulatory and competitive, was once again in a period of flux. As always, the exact nature of the changes sweeping through the Chinese telecoms industry would be difficult to predict. At stake for Nortel was not only a potentially vast market for the company's products, but also a key competitive arena for the major telecoms players who vied for worldwide market share in the rapidly evolving industry. Nortel Networks Nortel Networks was incorporated in 1895 as Northern Electric and Manufacturing Company, an international joint venture between Bell Canada and AT&T. In 1956, after regulatory changes in the United States forced AT&T to divest its portion of the company, Northern Electric became solely owned by Bell Canada. In 1999, Nortel Networks, as the company was now known, was 41 percent owned by Bell Canada Enterprises (BCE Inc.) and 59 percent publicly held. In 1998, the company had sales of just under US$ 18 billion. It employed 75,000 people and had operations in over 150 countries. The United States was by far the company's largest market, accounting for slightly less than half of global sales (Figure 1). Canada accounted for about 8 percent of total revenues, a proportion that had declined steadily over time. In fact, Canada was one of the few geographic markets in which the company's sales had declined between 1997 and 1998. U.S. revenues had grown by 19 percent; Europe, Africa, and the Middle East had grown by 7 percent; and even Asia-Pacific and Latin America had grown by 15 percent, despite financial and macroeconomic problems associated with the Asian financial crisis and its aftermath.

22 Tony S. Frost Figure 1: Nortel Networks: revenues by geographic origin, 1998

Over the years, Nortel had developed a worldwide reputation for its products and technologies. It had long been at the forefront of technological innovation in telecommunications, especially in the areas of software design and the development of the microcircuitry used in switching. In 1972, the company had developed the world's first costeffective digital switch, a major technological breakthrough and the springboard for the company's subsequent expansion into the top tier of telecoms equipment companies worldwide. In 1998, Network World magazine ranked Nortel Networks as one of the five most powerful companies in the global networking industry. The company participated in a broad spectrum of market segments within the telecoms equipment industry. Broadly speaking, Nortel sold its products and services to two kinds of customers, known in the industry as carrier customers and enterprise customers. Carrier customers were the traditional telephone utilities which operated local and long distance telephone networks - often under governmentsanctioned monopoly. Enterprise customers purchased private branch

Nortel Networks in China 23 Figure 2: Nortel Networks: products by customer segment, 1998

exchanges (PBXs) and other networking equipment for their internal switchboards and data communications functions. In 1998, enterprise customers accounted for approximately 30 percent of Nortel's total revenues (Figure 2). However, by 1999 the distinction between carrier networks and enterprise networks was blurring as a wave of deregulation around the globe allowed alternative phone companies such as Sprint and MCI to enter the traditional domain of the monopoly carriers. Analysts estimated that deregulation had spawned over a thousand new phone companies worldwide, most of whom were actively engaged in the process of upgrading and expanding their telecoms networks with the kind of equipment sold by Nortel. Deregulation and new competition were not the only forces driving change in the telecoms industry. The rapid development of the Internet as a key communications and business medium had led to an explosion in data communications traffic in the mid- to late 1990s. By 1999 the volume of data traffic was outstripping the volume of voice

24 Tony S. Frost

traffic, leaving many telecoms operators scrambling to upgrade, expand, and optimize their networks. Industry estimates suggested that data traffic would continue to grow exponentially and would account for fully 80 percent of global telecoms traffic by the turn of the century. One bi-product of this shift in technology was the emergence of new competitors in the telecoms industry. Increasingly, Nortel found itself competing head-to-head with data networking companies such as Cisco Systems and 3Com, as well as its more traditional rivals, AT&T, Sweden's Ericsson, Germany's Siemens, and France's Alcatel. In addition to the Internet, consumers the world over also seemed ever more committed to mobility, leading to rapid growth in the market for wireless communications. In fact, many telecoms equipment firms, including Nortel and its arch-rival Ericsson, were seeking to position themselves as providers of "wireless Internet" networks. Such networks would combine integrated voice, data, and video services using the Internet Protocol (IP) - the language of the Internet - and would do so over fixed line or wireless (cellular) devices. In short, changes in communications technology sweeping through the industry were driving the convergence of data and telephony, as well as wireless and wireline technologies. As part of its strategic move into IP networking, Nortel had made several key acquisitions in 1998, including a US$ 6.9 billion purchase of San Francisco-based Bay Networks, the third largest maker of data networking equipment for the Web. In fact, acquisitions, both large and small, were increasingly common in the industry. Virtually all of Nortel's major competitors had embarked on shopping expeditions to shore up their ability to convert their traditional telecommunications equipment to the needs of the Web and an increasingly diverse customer base. Nortel Networks in China In 1998, Nortel employed nearly 3,000 people in Greater China, including operations in the PRC, Hong Kong, and Taiwan. Over 90 percent of Nortel China employees were locally hired. In addition, the

Nortel Networks in China 25

company also had seven joint ventures in the PRC, including manufacturing (five JVs), customer training, and technical support (one JV) and R&D (one JV). The mainland accounted for approximately half of Nortel's Greater China business, with the remainder split between Hong Kong and Taiwan, Hong Kong controlling a somewhat larger share. Although the company had been selling equipment in China since 1972, its participation in the Chinese market was marked by several distinct episodes.

1970s After establishing a Hong Kong office to serve the China region in 1976, the company entered negotiations with the Ministry of Posts and Telecoms (MPT) to begin manufacturing switches and PBX equipment with a local joint venture partner. The protracted discussions stretched out several years before finally stalling. On the Chinese side, the government's nascent moves towards economic reform had run into difficulties from more conservative members of China's ruling party elite. The late 1970s were also the period in which Nortel saw an unparalleled opportunity to break into the huge U.S. market, which was in the throws of the deregulatory process that would eventually lead to the break up of AT&T. Nortel, at the time not yet a global giant, chose to focus its scarce marketing, technology, and management resources at the geographically and culturally more proximate U.S. market. For the time being, Nortel's China strategy would remain in a holding pattern and sales in the region would be sought more or less opportunistically from the company's base in Hong Kong.

1980s In one sense Nortel's decision to delay further expansion into China turned out to be a prescient one: during this period Nortel successfully established itself in the lucrative United States market, then and still the largest and most demanding telecoms market in the world. The U.S. easily became Nortel's largest geographic market and the com-

26 Tony S. Frost

pany adopted a conscious strategy of becoming an "insider" in the U.S. market by establishing a major U.S. manufacturing and R&D presence. Many people outside the industry - frequently including the press - referred to Nortel as a "U.S. company." However, by the mid-1980s Nortel saw events changing in China. The reform process now appeared to be more firmly entrenched and, economically at least, on an irrevocable path forward. Moreover, the government of China had embarked upon an ambitious policy of expanding and modernizing the country's telecommunications infrastructure. A series of Five-Year Plans called for vast numbers of new telephone lines to be installed, as well as the initiation of new telecoms services and technologies, including paging, mobile telephony, and data communications. The government also emphasized technology transfer and local content objectives as key elements of its Five Year Plans for the sector. Attracted by the country's aggressive expansion plans, foreign telecommunications firms, including Nortel, rushed into the country seeking a slice of the large and growing pie. It was only then that Nortel discovered the full impact of its 1979 decision to delay further investment in China. The MPT, which still exerted a huge influence over telecoms buying decisions at the national, regional and local levels, had apparently closed the door on the company. Snubbed by both Nortel and AT&T in its initial efforts to establish a local manufacturing base in telecoms, the MPT had turned to ITT Belgium (later Alcatel) to form a joint venture for the manufacture of telecoms switches for the Chinese market. Although Shanghai Bell, as the venture became known, lost money for a number of years due to the MPT's subsequent decision to import cheap switches from Japan, it eventually became the dominant player in China's public switching market, controlling around half of total sales by the mid-1990s. The main boost to Alcatel's China business came in the wake of the 1989 Tiananmen Square incident, when the flow of imports from Japan and the United States dried up. Also around this time the State Council, China's cabinet, issued "Directive 56," which stipulated that provincial agencies could only buy switches from three vendors: Alcatel, Siemens, and NEC.

Nortel Networks in China 27

Even while Nortel's public switching business was floundering in China, the company continued to seek alternative markets for its products. Shut out by the MPT and the regional ministries, Nortel looked to the private sector for business, particularly the sale of PBXs, which at the time accounted for a large proportion of Nortel's worldwide revenues. As it turned out, Nortel found considerable success in the private sector PBX market selling to hotels and other private companies, and by 1984 the company had begun to look for a joint venture partner for local manufacturing. Nortel believed that localization would both lower costs and open additional channels in the country. Four years later, after another lengthy and difficult negotiations process, a contract was signed establishing Tong Guang Nortel. The joint venture, based in Guandgdong province in the fast growing Shenzhen Special Economic Zone, would manufacture PBX systems for the Chinese market. Although not an overnight success, Nortel's Guandgdong JV eventually found its footing and was able to capture a leading market position, supplying nearly 20 percent of the entire Chinese PBX market. The venture substantially increased Nortel's presence and visibility in China, although, overall, the company still lagged well behind its major competitors, especially the approved switch vendors Alcatel, Siemens, and NEC. During the mid-1980s, the company had managed to sell a few switches to the MPTs in the poorer inland provinces due, in part, to assistance from the Canadian government in the form of soft loans that helped to finance these sales. By 1987, the company had signed sales and installation contracts with five provincial MPTs, although, tellingly, none of these was in the wealthy and rapidly growing coastal provinces. As China's massive telecoms development plans began to take off, Nortel realized that it had to find some way to penetrate the mainstream market for public network equipment. The opportunity was simply too large and too important. As one Nortel manager stated: "If you are not in China, you are not a global player. If you're not a global player, you're not in this business." 2 High growth market, ambitious MPT lure industry to China," Telephony, November 30, 1992,223,22,9.

28 Tony S. Frost

1990s The 1990s started out badly for Nortel in China. Failing to be included on the MPT's "Switch List" was a severe blow. To get back into the public carrier market, Nortel repeatedly sought to engage Chinese officials in negotiations. One Nortel manager recalled: "MPT officials refused to meet with us in the beginning ... our representatives pleaded with and begged the Chinese to give us an opportunity and let us in. Nortel's persistence eventually paid off. Unlike AT&T, which was also engaged in a furious lobbying campaign to gain membership on the approved list of switch vendors, Nortel's approach was to first establish partnerships with local cities and provinces and then present its case to the central authorities. AT&T, on the other hand, employed high-profile figures such as Henry Kissinger and Caspar Weinberger to lobby the central government and the MPT to reconsider their decision. In any event, both Nortel and AT&T argued that the MPT would be ill-advised from a strategic, technological, and geo-political standpoint to exclude all North American vendors from the list. Both companies feted Chinese dignitaries and arranged for high-profile officials such as Zou Jiahua, China's Vice Premier, to visit their North American facilities. Although a Canadian company, Nortel had even sought to leverage its large U.S. presence during the negotiations with the Chinese by seeking lobbying assistance from the U.S. Commerce Department, which was also campaigning on behalf of AT&T. By early 1993, Nortel had received word that Chinese officials were intending to expand the approved list, as it turned out to include both AT&T and Nortel. Finally, in June 1993, Nortel signed an MOU covering "a broad range of manufacturing, R&D, technical and training projects to participate in evolving China's telecommunications infra-

3 "Northern Telecom in China, 1972 to 1994," Richard Ivey School of Business, Case #9A97G005.

Nortel Networks in China 29

structure." In all, the arrangement called for an investment by Nortel of US$ 150 million over a four-year period. Three new joint ventures would be formed along with a cooperative agreement for the establishment of an R&D centre at the Beijing University of Posts and Telecommunications. At the time, Nortel's CEO Jean Monty had compared the company's breakthrough in China to its earlier breakthrough in the United States: "China is a long-term investment for us. We believe it holds the same significance as looking at the United States market in the early 1970s ... in terms of growth potential for the company."4 From China's perspective, the deal reflected the government's desire to establish a strong local manufacturing presence in telecommunications and to ensure that none of the major foreign competitors gained a monopoly position in the market. As one Nortel manager put it at the time: "No one company is going to absolutely dominate and China is not going to turn over its market to an exclusive operator ... I think there is room for several large global suppliers to take active roles in China."5 The deal also highlighted the growing importance of another objective of China's telecoms policy, namely the development of a technologically advanced indigenous industry. For foreign multinationals like Nortel and AT&T, the writing was on the wall: local technology development and technology transfer to local partners would be preconditions for participating in China's telecoms boom. The telecoms industry in China Since the late 1970s, when China began to move towards a more market-oriented economy, the Chinese telecommunications industry had experienced rapid growth and development. Viewed as central to the

4 "Nortel in billion-dollar mainland telecom deal," South China Morning Post, June 20, 1993. 5 Ibid.

30 Tony S. Frost Table 1: China's telecom infrastructure: main lines and penetration rates, 1994-2002

Main lines (m) Penetration rate (%)

1994

1995

1996

1997 1998* 1999* 2000* 2001* 2002*

27.3 2.3

40.1 3.3

54.9 4.5

70.3 5.7

87.4 7.0

105.5 8.4

123.9 142.1 160.0 9.8 11.1 12.3

*Fo recast Source: "Who needs competition," Business China, October 1 998, 4-5. Table 2: China's telecoms network infrastructure spending, 1994-2002 US$ million

Switching Transmission Access network Wireless local loop Local cable/outside plant Public data network Terminal equipment Other Total

1997 1998* 1999* 2000* 2001* 2002*

1994

1995

1996

3297 3651 1272

2944 3294 1156

2159 1264 3076 2590 1266 1209

1503 2899 1271

1544 2957 1325

1517 2920 1325

1440 1852 1283

1413 2749 1235

0

0

0

91

97

130

153

176

0

6548 5958 6526 6335 6836 7019 6974 6831 6555 104 14 243 319 218 266 40 433 395 993 1628 1578 1697 1860 1927 2003 945 1426 1258 1185 1143 1050 1152 1191 1204 1191 1165 16985 16003 15429 14180 15548 16073 16249 15072 15729

*Forecast Source: Business China - October 12, 1998

country's modernization ambitions, telecommunications was early on targeted by Deng Xiaoping's reform-minded policy-makers as a strategic sector. As such, the industry had received massive levels of government investment over the 20-year period following the launch of the reforms. By 1999 China possessed one of the largest telephone subscriber bases in the world, although penetration rates still remained low by international standards (Table 1). Under the government's Ninth Five-Year Plan, 1996-2000, development of the sector was set to continue at a rapid pace (Table 2). The telecoms services market in China Broadly speaking, the telecoms industry in China could be divided

Nortel Networks in China 31

into two distinct markets, equipment and services. Service providers were also, of course, the main purchasers of telecoms equipment. Prior to 1993, the MPT was the sole provider of all public telecommunications services in China through the 33 provincial Post and Telecommunications Authorities (PTAs) and over 2,000 municipal and county Post and Telecommunications Bureaus (PTBs). These carriers all provided services under the name of China Telecom. In 1993, the State Council had introduced limited competition into the telecommunications services sector by permitting private domestic companies to enter non-basic telecommunications services and, in 1994, by licensing a second carrier, China Unicom, which was granted the right to build and operate nationwide cellular and fixed line networks. Foreign firms were still strictly prohibited from operating in the services sector, although many had found innovative ways to gain back-door involvement, mostly through so-called CCF (Chinese-Chinese-Foreign) ventures. Under the terms of a CCF venture, a foreign firm would partner with a Chinese firm to fund a joint venture, which in turn would form another joint venture. The foreign firm would then receive a return on its investment for "consulting services." China Unicom had been one of the innovators in this regard and had used CCF ventures to fund the development of its cellular network. For the major foreign manufacturers that had long dominated the equipment side of the telecoms business, the unravelling of the MPT's monopoly on telecoms services was heralded as a potential boon. In other countries, deregulation and privatization of telecoms services had led to an explosion in demand for telecoms equipment, as alternative carriers sought to build competing networks. In China that dynamic was already in evidence. Early on in the country's liberalization process the State Council had permitted several ministries as well as the People's Liberation Army (PLA) to develop their own private telecommu-

6 China Unicom was controlled by several government ministries and various other private and quasi-public entities. The most important shareholder was the Ministry of the Electronics Industry (MEI), whose power and influence in China rivaled that of the MPT.

32 Tony S. Frost

nications networks as a way of overcoming the limitations of the country's main public network. Although the MPT protested vehemently, such private networks had flourished and by 1993 accounted for nearly 40 percent of China's total network capacity. Eventually the PLA and some of the ministries had begun selling excess network capacity to the public, further undermining the MPT's control over the telecoms services market. For these ministries as well as the local PTAs, the ability to sell fixed line, mobile, and paging services became an important source of funds. Telecoms networks expanded accordingly, especially in the wealthy coastal provinces, where demand for services was high. For its part, China Unicom had decided to launch its foray into public telecoms by entering the cellular market. As part of its entry strategy, China Unicom had chosen to be an early adopter of digital cellular technology, something it felt would give it immediate visibility and prestige. In July 1996, the company launched its mobile services operation in Beijing, selecting technology based on the European cellular standard, GSM. As it turned out, Unicom largely failed to live up to initial expectations, in no small part because the MPT, fearing the upstart competitor, had managed to prevent Unicom from effectively connecting its cellular network to the country's fixed line network, which the MPT still controlled. Perhaps the biggest change arising from Unicorn's entry was the reaction by China Telecom. Soon after Unicorn's Beijing launch, China Telecom rushed to construct its own cellular network on a nationwide basis. In the end, China Telecom also chose the GSM standard, in part to ensure that Unicom had no basis for competitive differentiation. To attract new cellular subscribers, China Telecom also cut prices, which Unicom was reluctantly forced to follow. A year after its launch, Unicom had signed up only about 100,000 subscribers nationwide. During the same period, China Telecom had signed up more than 4 million subscribers. In 1999, China Telecom still controlled over 95 percent of the mobile market in China, which by this time had developed into the third largest subscriber base in the world.

Nortel Networks in China 33

The telecoms equipment market in China Although foreign firms still controlled the lion's share of the Chinese equipment market, by the mid-1990s the days of importing gear into China from the home market were largely over. As part of the State Council's strategic targeting of the sector, China had encouraged the establishment of joint ventures between foreign firms and domestic Chinese companies. Just as Nortel had done following the government's about face on the "Switch List," the major foreign vendors had rushed to establish JVs with local partners to demonstrate their commitment to local production and to build connections, or guanxi, with the local and provincial governments who purchased the bulk of the switching equipment sold in China. From 1992 to 1996 over 70 joint ventures had been established, mostly with partners that had varying degrees of association with government ministries, typically the powerful MPT or its chief rival, the MEI. The list of foreign firms establishing joint ventures during this period reads like the Who's Who of the global telecoms industry: Motorola, Alcatel, Ericsson, Siemens, AT&T, Lucent, and Nortel, among others. By 1996, over 85 percent of the central office lines installed in China were supplied by locally manufactured products. At the same time that the Chinese government was encouraging local production and R&D by foreign firms it was also taking steps to ensure the development of a strong indigenous (i.e., Chinese owned) sector in the telecommunications equipment industry. By the late 1990s, that strategy appeared to be bearing fruit. Indeed, one of the most widely noted developments in the industry during this period was the emergence of technologically sophisticated Chinese firms as important competitors to the foreign majors. The impact of the local firms was felt by the foreign vendors in several ways. First, the foreign share of the fixed line switching market - the largest segment in the industry - had fallen precipitously. From virtually the entire market in the early 1990s, foreign firms had seen their share of public switches fall to less than half in 1998. Second, even where foreign firms managed to obtain contracts, prices were being pushed down dramatically

34 Tony S. Frost by intense competition and cut-throat bidding for telecoms contracts. Prices were rumored to be half of what they were in other markets. The head of Alcatel China remarked that China was "the most competitive market in the world, with the lowest pricing." 7 The emergence of strong local competitors had many explanations, including preferential buying by provincial operators, restrictions on foreign exchange that limited the ability to pay for imports and, more prosaically, a better value proposition for customers in China, at least in the mainstream fixed line market. Local firms such as Huawei and Zhongxing offered reasonably sophisticated technology (which, it was often claimed, better fit with local needs) at prices that were as much as 20 percent below those of their foreign counterparts. The local firms could afford to undercut the competition on price, paying as they did only about one-tenth the cost for engineering talent compared to their foreign rivals, who still performed the bulk of their R&D in high-cost western countries. To break into the industry, local Chinese firms had invested heavily in technology development, often plowing back 20 percent of revenues or more into R&D. Some had gained knowledge from collaborative R&D efforts with foreign venture partners; others had hired expats with strong technical backgrounds; still others had established R&D facilities in Silicon Valley as a way of learning about the latest western technologies. In 1998, Huawei, the largest Chinese telecoms manufacturer with 1999 sales predicted to reach US$ 1 billion, had begun to venture outside of the Chinese market, as did several of its smaller peers. Although not yet more than a blip on the international telecoms radar screen, several of the upstart Chinese firms had found success selling switches to various markets in Asia, Africa, and Eastern Europe. As a result of fierce competition and low prices in the fixed line business, several foreign manufacturers, including NEC, had scaled back their China operations. Press reports rumored that others were likely to follow and some analysts openly questioned the returns being

7 "Silicon Valley, PRC," The Economist, June 27', 1998,64-65.

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earned by many of the foreign firms operating in the country, especially those still struggling to break into the top tier of equipment providers. For the time being, however, most of the major companies, including Nortel, were in the process of expanding their investments in the country and were publicly stating their commitment to being in China "for the long haul." The cellular communications market Increasingly, the most attractive market for foreign manufacturers was seen to be in cellular communications, the second largest equipment segment in China after fixed line. In 1998, approximately half of Nortel's Greater China sales had come from wireless products, a market that was expanding at a rate of 1 million subscribers a month. The mobile systems market was also Ericsson's largest source of revenue in China and, thanks to China Telecom's rapid network expansion, the Swedish company had seen its 1998 China sales rise by 43 percent from the previous year to over US$ 2 billion. Ericsson, which had been one of the early developers of GSM technology, held over 40 percent of the market for mobile systems in China. Like Nortel, Ericsson had invested heavily in joint ventures and local production in China during the 1990s, as part of its attempt to ensure that it received preferred treatment as a local supplier. In 1993, China had been Ericsson's fifth largest market. In 1998 China had surpassed the United States as Ericsson's single biggest market worldwide, accounting for 12 percent of the company's total sales. Although Nortel, like Ericsson, had sold GSM equipment to China Telecom, it had also experienced substantial success selling equipment to China Unicom and, to a lesser extent, the People's Liberation Army through its Great Wall cellular venture. In 1998, Nortel had sold GSM cellular technology to several China Unicom branches in the provinces of Shandong, Ningxia, Heilongjiang, and Zhejiang and it was so far the only provider of Unicorn's GSM network in Zhejiang. Nortel was thought to have avoided selling to Unicom and the provincial PTAs in the same region as a way of preserving its delicate rela-

36 Tony S. Frost

tionship with the MPT. Other competitors, notably Siemens, had run afoul of the MPT for supplying large amounts of product to Unicom and had been summarily dropped to the bottom of the MPT's switch list. For its part, Great Wall had chosen to adopt the U.S.-developed CDMA standard, where, together with Lucent and Motorola, Nortel was a worldwide technology leader. Nortel had constructed several CDMA trial networks for Great Wall in various Chinese cities. Whether and to what extent these trial networks would be expanded in the future was the subject of considerable debate in the industry. Moreover, Great Wall's PLA affiliation (it was a 50-50 venture between the PLA and the MPT) had become the cause for some concern after the State Council decreed in August 1998 that the military drop all of its commercial operations. Although by early 1999 Great Wall continued to exist, it was widely believed that bureaucratic infighting, including the struggle over the commercial aspirations of the PLA, was holding CDMA hostage. Recent events Reflecting on the various changes underway in China's telecoms sector, Stephen Tsui pondered his company's position in the region. He was quite sure that Nortel's success in China would depend on a continuation and deepening of its current strategy of localization - i.e., local production, local R&D, and local partners. Especially with the rise of serious domestic competition, Nortel would very much need to position itself as an insider in China - just as the company had done years earlier in the United States. And that in all likelihood meant further investment. Tsui also knew that Nortel's chief competitors were not standing still. Ericsson, a key rival in the cellular market, had seen its sales take off in China over the last few years. Another European cellular provider, Finland's Nokia, had also experienced rapid growth in the Chinese market. Its share of cellular equipment was estimated to have reached 30 percent in 1998. Motorola, on the other hand, had seen its

Nortel Networks in China 37

networking sales decline rapidly after China switched to the digital GSM standard, a technology in which Motorola had lagged behind the Europeans. For Tsui, a key question was where exactly the best opportunities resided for Nortel in China. Which customers to target, in which regions, and with which products and technologies? And what would be the time frame for payback on the investments that would undoubtedly be needed to succeed in the Chinese market? Like Motorola, Nortel was hoping that the CDMA trials that had been underway in China for a couple of years would move to regular service operations. A full-fledged expansion of the CDMA network in China would be a major blow for Ericsson and would also position the next generation of CDMA technology as a possible standard in the Chinese market. The Internet opened up yet another set of possibilities for Nortel in China. Internet usage was predicted to grow rapidly in the coming years in China, although it remained to be seen how the Chinese government would regulate the free flow of information that characterized the Internet in other countries. Moreover, the explosion of Internet usage in western markets had typically gone hand-in-hand with deregulation of the telco monopolies - a development that was, at best, in the early stages in China. Finally, it was increasingly apparent to Tsui and other industry insiders that several of the upstart Chinese telecommunications companies were set to make a serious run at the mobile communications market in China. Already companies such as Datang, Great Dragon, and Huawei had received orders for GSM switching lines from several provincial operators. Within China's new Ministry of Information Industry (formed in 1998 through the merger of the old MPT and MEI), bureaucrats were signalling their willingness to buy local in the mobile market, even though the systems developed by local firms were not thought to be as robust and stable as those developed by foreign companies. That willingness was made explicit in late 1998, when the government signed a document calling for provincial telecoms to purchase domestic equipment instead of foreign products as long as the domestic products were adequate. In the context of these develop-

38 Tony S. Frost

ments, Tsui couldn't help but wonder how the future would unfold for Nortel Networks in China. Strategy and competition in global industries Over the years, research in the field of international business has provided a rich set of ideas and frameworks for diagnosing, formulating, and implementing strategy in a global context (see for example: Bartlett, 1986, Bartlett and Ghosal, 1989, Pralahad and Doz, 1987, Yip, 1992). The analysis of Nortel's situation and options in China can be understood through reference to three interrelated concepts from this literature: global competition, critical markets, and local responsiveness. Global competition A starting point for analyzing Nortel's situation is the concept of global competition, defined as the situation in which a firm's competitive position in one market is influenced by its competitive position in other markets. Why (and under what conditions) might such a situation of competitive interdependence across national boundaries exist? To answer this question, researchers have devoted considerable attention to studying the underlying characteristics of industries (Porter, 1986; Yip, 1989). The main finding from this work is that industries differ significantly in the extent to which structural characteristics (1) reward competitors who sell or produce outside of their home base, and (2) facilitate or constrain their ability to do so. Industries can thus be arrayed along a continuum from "global" at one end to "multidomestic" at the other end. Researchers have also been able to identify major factors that shape an industry's position on that continuum (Appendix). Understanding the nature of a particular industry, especially the industry's globalization potential, is an important starting point for the formulation of strategy in an international context. In Nortel's case, the analysis of the company's situation in China cannot be divorced from the overall strategic imperative of the firm, namely, that it com-

Nortel Networks in China 39

petes in a classic global industry with a high degree of interdependence across national markets. A quick snap shot of the industry reveals: • It is characterized by huge fixed costs in R&D. Profitability is thus dependent to an important degree upon the ability of the firm to amortize those costs over multiple markets. • Customer needs are fairly uniform across countries and some of the same customers (MNCs) exist across markets. • The same few firms compete head-to-head in most major markets. • Part of the competitive interdependence between firms is a battle for standards, both in the current generation cellular technology (GSM vs. CDMA) and in the upcoming transition to third generation systems. Critical markets Related to the concept of global competition is the notion of critical markets. Prahalad and Doz (1987: 61) define critical markets as: 1. Markets that are the profit sanctuaries of the key competitors in that business. 2. Markets that provide volume and include state-of-the-art customers. 3. Markets in which the competitive intensity allows reasonable margins. China possesses at least some of these characteristics, although the extent to which the market is hugely profitable for any of the firms operating there is questionable, given the pricing pressures noted in the case. However: • China is a critical market simply by virtue of its size and the potential volume effects. • Ericsson is currently doing US$ 2 billion in sales in China, over 12 percent of its total sales. Another key rival, Cisco Systems, has started penetrating the Chinese market in a big way. Key competi-

40 Tony S. Frost

tors may indeed be earning significant profits there, especially those who have managed to lower their cost structures significantly through local production. • As noted earlier, the Chinese market is so large that it is possible that developments there will influence the ongoing global battle to set the next generation of mobile communications standards. In this sense, although China is probably not state of the art in terms of customer needs, customers there may influence the adoption of particular state-of-the-art standards. The main implication of the above analysis is as straightforward as it is essential: Nortel is clearly committed to being in China for the long haul. The company needs to find a way to succeed and grow in China. It cannot let major competitors like Ericsson, Nokia, and Motorola have a free ride in China, and it cannot afford to be at arm's length from an important arena in the looming 3G standards battle. Moreover, multinational customers, many of whom will have operations in China, will undoubtedly demand a China presence from any would-be telecoms supplier. In this sense, NEC's recent decision to scale back its China operations clearly has important implications for the success of that company's global telecoms business. Local responsiveness Finally, the concept of local responsiveness is critical to understanding the strategic dilemma (and available options) for Nortel in China. Local responsiveness refers to the extent to which management must respond to specific conditions in particular countries in order to succeed there. Pressures for local responsiveness come from multiple sources, including: • Idiosyncratic customer needs that necessitate product adaptation or customization of other variables in the marketing mix. • Competitive conditions in the local market that necessitate a local response (e.g., price pressures stemming from low-cost local competitors)

Nortel Networks in China 41

• "Non-market" conditions, including host government policies, regulatory requirements, and other institutional hurdles that may require local responses from management. Obviously, China must be classified as a "high need for local responsiveness" market, particularly in the telecoms business, where governments are the key buyers and the State Council has targeted local industry development and technology transfer as a strategic priority. Summary of Nortel's situation in China The situation facing Nortel Networks in China must be understood as an extreme example — and thus a very interesting one — of the complexity of global strategy and multinational management. The organization faces, simultaneously, pressures for efficiency, scale, and integration on a global basis and pressures to be highly responsive to local market (mostly institutional) conditions. This in the context of a critical market, one in which competitive success or failure has implications beyond the specific market - that is for the firm as a whole. A simple, visual way of summing up Nortel's situation in China, especially as described in the early time period of the case, is via Bartlett and Ghoshal's (1989) matrix showing "generic roles" played by foreign subsidiaries (Figure 3). Clearly, after Nortel was shut out of the main market for public switches, the company's situation in China could be described as a "black hole," that is, a strategically important market in which the company had minimal position and capabilities. As Bartlett and Ghoshal (1989: 109) state, "the black hole is not an acceptable position." Out of the black hole: "persistent adaptability" as survival strategy How do foreign subsidiaries caught in a "black hole" situation succeed? Bartlett and Ghoshal provide few clues and even fewer success stories. The authors document two strategies that appear to frequently fail: (1) the creation of a small "scanning" unit to monitor technologies, market trends, and competitors; and (2) massive investments in

42 Tony S. Frost

figure 3

Source: Bartlett and Ghoshal (1989)

marketing, production, and other value activities, in other words, a full frontal assault on the market. The former appears to be a case of underinvestment (which never has the critical mass to go anywhere), the latter a case of overinvestment or perhaps misinvestment, with the attendant risk of never being able to earn a return. The broader multinational literature is also noticeably silent on situations in which foreign subsidiaries face both strong pressures for global scale/efficiency and strong pressures for responsiveness and adaptation to local conditions. Most authors, including Prahalad and Doz (1987: 37), point to structural solutions involving some form of matrix organization: "Businesses that are high on both dimensions (e.g., telecommunications, ethical drugs) may require a complex structure that accommodates the pressures of both integration and responsiveness." In fact, the Nortel case illustrates a path out of the black hole that may be available in other contexts in which broadly similar country and industry conditions exist. I refer to this strategy as "persistent adaptability." Persistent adaptability recognizes and takes advantage of two conditions that have, to date, not featured prominently in the existing global strategy literature on multinational firms: (1) the

Nortel Networks in China 43

notion that changes in the external environment may lead to "revival points" or situations in which the firm has an opportunity to regain its footing in a particular market; and (2) the notion that foreign subsidiaries often have a much wider variety of strategic options available to them than is commonly supposed in the multinational literature. In the remainder of the chapter I highlight the interplay between these two conditions in the context of the unfolding Nortel case. In the early 1980s, Nortel was effectively banished from the main public switch market in China. But the firm did not give up. Rather, it recognized that conditions in China were changing, in particular that inflows of foreign investment and the related emergence of a burgeoning private sector had opened up a potentially large market for PBXs in the country. Nortel adapted its product strategy and seized the PBX opportunity, eventually capturing a significant portion of the market in China. At around the same time, Nortel recognized another revival point, this time in the public switching market. In particular, some of the inland provinces were beginning to build up their public switching networks, following the lead of the wealthier coastal provinces - where Nortel had been largely shut out by the MPT. However, many of the inland provinces lacked the funds to build these networks. Nortel, with help from the Canadian government, was able to provide soft loans to finance its equipment sales to these local PTAs. Its success in these markets was one reason (of several) for Nortel eventually finding its way back onto the list of approved vendors. In the early 1990s, the growing demand for cellular networks had created yet another revival point for Nortel. The company once again adapted its product strategy to take advantage of the opportunity in mobile networks. Several of the major switch vendors, such as NEC and Alacatel, proved to be less adaptable and saw their share of the telecoms market decline when the competitive environment shifted and local firms began to win contracts in the mainstream public network market. More recently, movements towards deregulation of the services sector created a revival point for Nortel through the emergence of two

44 Tony S. Frost

new service providers in China: China Unicom and Great Wall. In this case, changes in the regulatory environment created a new set of customers and a new selling opportunity for Nortel. Looking ahead, several current developments look to be creating potential revival points in China: the possible roll-out of a national CDMA network; the growth of data networks and the emergence of the Web as an important medium of communication and commerce in China; the combining of old MPT and MEI into a single ministry responsible for the industry, the Mil; the transition to 3G cellular technology; and the eventual accession of China to the WTO and, with it, further deregulation of the industry. Implications for global strategy and subsidiary-HQ relations Stepping back from the specifics of the Nortel case, it is apparent that revival points can occur in virtually all of the major elements of firm's external environment: regulatory, economic, technological, and competitive. Thus a key implication of this case is that local managers need to be on the lookout for these "junctures" — basically any situation that may presage an opportunity to target a new customer or market segment, to sell a different product or technology, or to get back into a market from which the firm was previously shut out. Spotting the opportunities, however, is only half the battle. To take advantage of them, the organization must also be adaptable. This adaptability derives from many sources, not the least of which is the quality of management in place within the local organization (see the Morrison chapter). But the Nortel case illustrates at least two additional required factors: 1. Headquarters needs to ensure that the local organization is aware of and has available to it a broad suite of "options" (products, technologies, knowledge, connections) that can be leveraged locally as revival points occur. This is where organizational structure and process (i.e., the kind of solutions proposed in the existing literature) are important. Obviously, extensive links and direct lines of com-

Nortel Networks in China 45

munication between headquarters and subsidiary are key to understanding what options are available and then being able to exercise them. 2. The subsidiary must have a considerable degree of autonomy to act in the context of emergent revival points. Notice that Nortel China was altering variables that can only be described as major elements of strategy: products, technologies, customers, partnerships, value activities in place. Finally, perhaps the most basic lesson from the Nortel case is "it's not over until it's over." The firm has persisted in China for 27 years and has ridden the various ups and downs that are an inevitable part of the experience there. The old adage that success in China requires a longterm perspective is undoubtedly true. But it is equally true that a longterm perspective does not imply steadfastly holding onto an unsuccessful strategy. To succeed in China, firms in most industries will need to adapt their strategies - persistently and appropriately - as the situation there continues to evolve.

APPENDIX: THE "4Cs" OF INDUSTRY GLOBALIZATION* Broadly speaking, four major categories of variables influencing industry globalization characteristics have been identified by researchers. Although terminology differs across researchers to some extent, I refer to these variables as the four Cs: Costs: High fixed costs are probably the chief driver of industry globalization. They can be located in any of the major value activities: R&D, manufacturing, marketing, or distribution. In recent years, rising product development costs have pushed firms in many industries to develop strategies based on global markets. Aircraft, DRAMs, and telecommunications switches are excellent examples of industries characterized by extremely high fixed costs - and thus global scale economies. The other main cost-related factor that pushes industry globalization is labour. In industries such as apparel and assembly manufacturing, in which labour is an important component of total costs, firms will be attracted to locations where

46 Tony S. Frost labour costs are low. Of course, it is not just the cost of labour that drives location decisions. Skills also play a major role. For example, labour costs are not yet an important globalization driver for the labour-intensive software industry, which depends upon skills found predominately in high-income (and high-cost) countries. Customers: In industries where customer preferences are similar across national markets, firms are able to develop and sell standardized products on a global basis. Homogenous demand conditions reward global strategies since firms do not have to incur product development costs for each market they enter. Consumer electronics such as VCRs, TVs, and stereos are good examples of products sold globally with only minor adaptations across countries. Marketing costs may also be saved to the extent that products can be positioned similarly across countries in terms of usage and appeal. De Beers, for example, has capitalized on universal themes of love and marital commitment in its global marketing strategy. The other main customer consideration that may drive industry globalization is the importance of major multinational firms as buyers. When multinationals demand standard products and services in support of their own global strategies, suppliers often need to go global themselves. This has been a major driver of globalization in the autoparts industry, where the major automobile manufacturers have pushed their core suppliers to follow them into international markets. Competitors: In some industries, competitors themselves have altered industry dynamics by pre-preemptively launching international expansion strategies. Even if remaining industry globalization drivers are relatively weak, firms are typically reluctant to let key competitors have a free ride in key foreign markets. One reason is that a weak position in one country may affect a firm's competitive position in other countries if, for example, consumers perceive such weaknesses as indicators of poor quality or low status. In some industries, early movers into a market may also be able to establish consumer expectations and preferences, creating an uphill battle for late entrants. Constraints: In addition to factors that facilitate or drive industry globalization, there are several that can act to impede it. The three most important constraints are governments, logistics, and standards. Governments are the most direct and obvious constraint. Protectionist trade and industrial policies may impede global integration by raising the cost of market entry. Ironically, government policies such as tax and other investment incentives have actually been a spur to global integration in recent years. Transportation and communication logistics are another major constraint on industry globalization. Where transportation costs represent a high portion of value-added, as in the glass bottle industry, competi-

Nortel Networks in China 47 tion tends to proceed on a country, or even regional, basis. Finally, differences in product and technology standards across countries constrain the ability of firms to develop globally integrated strategies by necessitating additional expenditures on product development, safety and environmental testing, and lobbying.

REFERENCES Bartlett, C.A. 1986. "Managing and Building the Transnational: The New Organizational Challenge." In M.E. Porter, ed., Competition in Global Industries. Boston, Mass.: Harvard Business School Press, 367-401. Bartlett, C.A., and S. Ghoshal. 1989. Managing Across Borders: The Transnational Solution. Boston, Mass.: Harvard Business School Press. Levitt, T. "The globalization of markets." Harvard Business Review, May-June 1983:92-102. Porter, M.E. 1986. "Competition in global industries: A conceptual framework." In M.E. Porter, ed. Competition in Global Industries, Boston: Harvard Business School Press. Prahalad, C.K., and Y.L. Doz. 1987. The Multinational Mission: Balancing Local

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Establishing a successful joint venture: Moore Business Forms in Japan PAUL W. B E A M I S H

This chapter examines the successful operation of a major joint venture over a 30-year period in Japan. The Canadian parent, Moore Corporation, is one of the world's largest manufacturers of business forms. While both the Canadian and Japanese parents contributed to the success of the joint venture, it also took on a life of its own and contributed to the parents' development. The author argues that the earlier views on the instability of joint ventures need to be reconsidered. He goes on to note both the reasons for the particular success of this joint venture and also what needs to be considered in general in designing and managing international joint ventures if they are to succeed. Introduction This chapter explores how Moore Business Forms of Toronto set up and maintained what came to be viewed as one of the largest and most successful joint ventures ever established by a foreign company in Japan (Beamish and Makino, 1992). The joint venture, between Moore and Toppan Printing of Japan, was known as Toppan Moore and lasted for 30 years, with annual sales eventually exceeding US$ 1.2 billion. Although a new CEO at Moore decided in 1995 to divest its stake in Toppan Moore (to the surprise of their partner), this nonetheless remains a model of successful joint venturing in Asia Pacific by a Canadian company.

50 Paul W. Beamish

The operating joint venture The parent companies: Toppan Printing Founded in 1900, Toppan Printing was one of the world's largest printing companies, with 1997 revenues of US$ 10.5 billion. At that point it ranked number 432 in the 1998 Fortune Global 500 Rankings and number four within the publishing/printing industry. The organization, which has been listed on the Tokyo Stock Exchange since 1908, expanded through merging small printing companies and vertically integrating operations. By 1942, Toppan had established a number of wholly-owned subsidiaries in China and southeast Asia. Company practice was first to establish a plant and then to find clients. Although Toppan Printing's growth was halted during the Second World War, when air raids by the Allied forces caused extensive damage and destroyed its head office and several major plants, the company recovered its momentum in the post-war period, when the demand for general printing increased dramatically. With its superior technology and full line of printing methods, Toppan Printing was able to capture the bulk of orders in Japan for colour printing. The company subsequently founded a Technology Institute to create innovative printing technologies, and it established the Toppan Service Centre in 1961 to enhance customer service. Over the following decades, Toppan Printing strengthened its marketing channels throughout Japan and aggressively expanded its business to direct mail, point-of-purchase displays, magnetic printing for credit cards, and so on. By 1991, Toppan Printing operated nine plants in Japan and had subsidiaries in Australia, England, Hong Kong, Indonesia, Korea, Singapore, and the United States. Founded as a conventional printing company, Toppan Printing expanded and diversified its operations to include printing securities and integrated circuit cards, producing packaging materials for industry, and making wallpaper and flooring. It also produced photomasks, printed wiring boards, and other electronics equipment, as well as multimedia products such as compact discs. By the late 1990s Top-

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pan's operation in Japan included 28 plants and factories, 58 sales offices, and 11 branch and business offices. It also had operations in Asia, Australia, Europe, and the United States. Moore Corporation Toronto-based Moore Corporation was the world's largest manufacturer of business forms and a leader in new product development. The company was founded in 1882, when Samuel J. Moore acquired the rights to produce a "manifold copying" book that he thought would revolutionize sales management. Inserting a carbon sheet into the binding of accounting books provided receipts for both the customer and the store. This ensured the accurate recording of transactions and represented the birth of the modern business forms industry. In the 1960s and 1970s, the business forms industry in North America enjoyed high real growth rates, due largely to purchases by business and government of computers that used continuous feeding forms. Numerous small printing companies began producing forms, particularly low value added stock items. In the 1980s, the industry's growth slowed with the increased penetration of computers, together with the shift towards personal computers and workstations that used fewer conventional forms products. New printing technologies, plain paper substitution, computer output onto microfilm, and electronic data storage also worked to displace the demand for conventional business forms. The North American forms industry became highly fragmented and was characterized by persistent overcapacity. There were some hundreds of companies in the United States alone (in 1991, 18 were national in scope) manufacturing and selling over US$ 7 billion worth of these products. Increasingly, the industry had become more oriented towards satisfying changing customer needs and less towards producing traditional forms products. Moore responded to the gradual maturing of the North American forms industry by emphasizing high value added products and diversifying into ancillary fields. While conventional business forms still accounted for the lion's share of sales, a small but increasing portion of

52 Paul W. Beamish

the Corporation's revenues were generated from sales of direct marketing products, printing equipment, and database services.

The birth ofToppan Moore Saburota Yamada, Toppan Printing's Managing Director, first became interested in the business forms area in 1953. At the time, Toppan's R&D division concluded that the company did not have the technology to manufacture a product of comparable quality. A few years later, Toppan Printing purchased forms processing equipment from a German firm and began producing simple business forms in a range of sizes, largely for banks and security companies. One such company, Daiwa Security, subsequently established a subsidiary called Asia Business Forms (ABF) to produce its own forms. In 1962, Toppan Printing obtained a 55 percent share in ABF. In 1963, Yamada travelled to North America with two of his managers to research the business forms industry, which was then worth about US$ 500 million. Analysts estimated that the Japanese market had the potential to grow to at least "one-tenth the size of the American market." After visiting several business forms producers, Yamada approached Moore Corporation, the industry's leading manufacturer, about negotiating a joint venture. Yamada believed that the companies had complementary interests. Such an arrangement would enable Toppan Printing to introduce new products into an existing market, while Moore would be able to create a new market with its existing products. At first, it was envisioned that a joint venture would use Moore's technology and equipment to produce business forms, which Toppan Printing's sales force would sell in Japan and other Asian markets. Toppan Printing contended that it had an extensive distribution network, knowledge of the market, and a well-qualified sales staff. Moore countered that the sales force of the new company should be independent from Toppan Printing because Moore intended to bring its own sales methods into the venture. Upon further discussion, Toppan Printing acknowledged that the marketing of new products would be quite dif-

Moore Business Forms in Japan 53

ferent from that of existing products. However, Moore recognized that consumer behaviour in Japan might be very different from that in North America and that its methods could not always be applied. In the end, an agreement was reached whereby the sales method and production planning would be independent of both parent companies, while cost and pricing principles would generally follow Moore's methods. In June 1965, Toppan Moore was established as a 55:45 joint venture between Toppan Printing and Moore Corporation. Although Moore had initially insisted on an equal partnership, Japan's Ministry of International Trade and Industry (MITI) favoured Japanese-controlled joint ventures and was reluctant to allow a foreign company's ownership to reach 50 percent. The capital structure chosen reflected the agreement that the venture would use Toppan Printing's sales force (initially) and sell products to Toppan Printing's major customers. Development of the internal organization Yamada assumed the presidency of Toppan Moore after retiring from his position as Managing Director at Toppan Printing in 1965. His management team was drawn almost exclusively from Toppan Printing. While a vice-president was appointed from Moore, this person remained in Toronto and had no substantive responsibility for managing the venture; he merely acted as a "communications pipeline" between Moore and Toppan Moore. This position was stipulated as part of the joint venture agreement, and the vice-president's role was to review the venture's results semi-annually, independent of Toppan Moore's management, and present a report to the board. He was one of Moore's five voting members on a board dominated by Toppan Moore people. There were even fewer representatives on the board from Toppan Printing than from Moore. Moore accepted not having a larger formal role in the joint venture because the company initially knew little about the Japanese market. It realized that for Toppan Printing, the joint venture was an outgrowth of what they were doing with Asia Business Forms. Moore saw its role as bringing proven sales and production methods into the venture, and it was willing to allow

54 Paul W. Beamish

Toppan Moore to operate fairly autonomously. Because of the royalty arrangement, it was confident that the people in the joint venture would feel compelled to make it a success. In the initial stage of operation, Yamada saw the joint venture as being two to three decades behind Moore in terms of technological development. To bridge this gap, Toppan Moore asked its Canadian parent to provide it with a business forms processor. Moore had developed proprietary technology, and both its equipment and production system were highly regarded within the industry. The company sent its newest machine, a high performance press that cost almost Yen 75 million, more than the cash assets (Yen 70 million) of the whole joint venture company, instead of a cheaper, lower performance model. The Japanese general managers were very impressed by this gesture. In the end, the joint venture did somehow raise enough money to pay for the machine. Moore was generous with its technology and over the years it made a great contribution to Toppan Moore's production technology and production management skills. The company was also committed to developing strong human relationships, according to Yamada. Everyone knew the 1941 story about Moore sending a letter to one of its Japanese salesmen who was incarcerated during the war saying "don't worry, we are watching over you; Moore will remain your friend." This was symbolic of the way Moore had always worked. Developing the human element was the most important key to business success, according to Yamada. Forms-processing technology and equipment were transferred from Moore to Toppan Moore under a technology assistance agreement signed in 1965. This agreement also stipulated shared budgets for common R&D activities. Joint efforts on product design, quality, and the manufacturing process resulted in frequent communication at every level between the companies on a whole range of issues. On occasion, engineers were exchanged between the two companies for short periods of time. Moore had particular ideas that it wanted to bring into the joint venture, with respect to both sales and production methods. The company wanted the sales force to work under a territory coverage system

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based on commissions, and it also wanted to introduce a three-shift system and to control production using cost-based pricing. Toppan Moore realized there was much to learn from Moore, a well-established company with good standing in the industry. There were some early disagreements over pricing, however. Moore used a highly disciplined pricing scheme based on formal planning and costbenefit analysis. In Japan, many companies put priority on expanding market share, and prices tended to fluctuate. Under Moore's system, Toppan Moore did much less price cutting. This is just one example of Toppan Moore adapting its operating methods. Toppan Moore was never forced to accept a particular method; as the company developed, it was able to select which methods it wanted to incorporate into it own practices. Toppan Printing's contribution to the joint venture was somewhat different, more in the way of intangible assets, the social credit associated with the Toppan name. By comparison, Toppan Moore had less interaction with its Japanese parent. "In a sense, there was nothing to learn from Toppan Printing," according to a Toppan Moore manager. Jiro Miyazawa, who succeeded Yamada as President in 1967, was seen as having a strong role in inspiring a philosophy of social community, company and personal happiness both inside and outside of the company. Moore's Vice President remarked: "Miyazawa was a natural leader and he thrived on being a public figure. In fact, over time, he garnered something akin to a cult following in Japan. Miyazawa was an inspiration to many people. He was an extraordinary man, and he was quite driven. He had an eye for detail, and he was very skilled interpersonally. Miyazawa was employee-oriented, and he understood and rewarded superior behaviour. He often gave out awards, not for years of service, but to those people who went the extra mile by working on the weekend or calling a customer from home."

The division control department and project teams Since its formation, Toppan Moore had focused on expanding its market share and concentrated its capital on establishing plants and merg-

56 Paul W. Beamish ing small, local printing firms. Initially, all sales and production activities were controlled by headquarters in Tokyo. Sections were subsequently established in each plant to coordinate conflicts between the production and sales divisions. By 1969, Toppan Moore had 850 employees, twice as many as when the venture was established. Development of the sales organization Early on, Toppan Moore sent several employees to its Canadian parent company as short-term trainees. Moore provided them with information on effective promotion and sales strategy. Moore's sales director subsequently conducted a training seminar at Toppan Moore for the sales force and managers. One of the participants explained: We were not familiar with selling forms. A business form was quite a new product to us. We saw this as an expendable supply for a computer system and focused just on its price. I must admit that we didn't have the attitude that we should join in the customer's form-producing process. We learned that we needed much more "thinking," in our sales activity. Moore emphasized that they did not sell a "thing," but rather the company sold the "value" of a product. They believed that a person selling business forms should, therefore, be a consultant, not merely an order taker. Moore's sales methods emphasized product knowledge, and the company concentrated on educating its salesforce. Generally, Toppan Moore continued using the sales methods brought over from Toppan Printing, but with Moore's help, they changed the tools that their salespeople went out with. A period of growth When Toppan Moore was established, the Japanese economy was in a period of unprecedented prosperity. The demand for business forms increased dramatically and, over time, developments in information technology created a need for higher quality forms and more diverse

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products. Because commercial customs varied across regions, the Japanese forms industry became highly fragmented, with many family companies responding to local needs. Toppan Moore succeeded, to some degree, in standardizing the specifications for business forms and was essentially the only company in the industry that operated on a national scale. Given the strength of the Toppan name in Japan, the salespeople saved time and effort explaining who Toppan Moore was, and they could gain the trust of new prospects more readily. The company experienced a dramatic growth in sales. Local offices were added and three regional sales departments were formed. A changing environment Toppan Moore's sales growth slowed in the early 1970s due to the "Dollar Shock." The uncertainty created by U.S. President Nixon's announcement that the U.S. dollar would no longer be linked to the gold standard resulted in an appreciation of the Japanese yen. The strong yen (against the dollar) acted as a brake on the Japanese economy, and the country experienced its first recession in the post-war era. During this time, Toppan Moore's orders and sales fell far short of plan, and the company took emergency measures that had never been used before. All employees who had sales experience, including senior managers, were asked to call on clients. By March 1972, the company finally saw orders increase. In the following year, however, a pulp shortage increased the price of paper. This set off a chain reaction in the other basic materials used to produce forms, such as inks, and Toppan Moore was again obliged to raise the price of its products. The early 1970s was also a time of rising oil prices, commonly referred to as "Oil Shock." Japan had no domestic energy source and the economy was highly dependent on oil imports. Product prices increased across the board. Toppan Moore's prices were soon three times the level they had been a year earlier. In 1974, the Japanese government implemented a "Total Demand Control Policy" aimed at controlling price increases. Although this policy reduced inflation, it also dampened demand and increased inventories. At this time,

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Miyazawa appealed to all Toppan Moore employees to "provide customers with more valuable products than a price increase." A sales manager reflected: "Miyazawa kept telling us that the hard times wouldn't last and that the customer had to be the priority for all actions. A lot of business forms users looked to Toppan Moore to provide a stable supply, but this was something no manufacturer could guarantee. Many forms makers were, in fact, breaking up with some clients to satisfy the demands of others on more favourable terms. We made a great effort to keep our existing clients. The sales managers, and even board members, called clients to explain the situation we faced and request a 10-20 percent reduction in orders. Most of our clients agreed to this. In daily meetings, our salespeople were told never to show arrogance to the customer, the kind of arrogance that can come from being in a seller's market." Toppan Moore subsequently established several subsidiaries to disperse headquarter functions and to increase the responsiveness to local markets. Toppan Moore had also entered into a number of joint ventures in southeast Asia and became an important link in the global product/service network of Toppan Printing and Moore Corporation. Once each year, managers from Toppan Moore and Moore met for an open sharing of technical information. Although the joint venture had initially depended heavily on Moore's forms production technology, and still did to some degree, it had altered products to meet the specific requirements of Japanese customers, "developed its own production know-how," and was bringing new products to market, such as magnetic forms, single cut forms, set forms, delivery forms, nonimpact printing forms, envelopes, postcards, and labels. A notable example of new product innovation was the development by Toppan Moore in cooperation with Moore of a hand-held, intelligent data entry terminal that has been highly successful in eliminating paperwork in the North American parcel delivery market. Over the years, Toppan Moore aggressively integrated its operations and automated its manufacturing process. Its system facilitated small lot production without sacrificing product quality, and the company was able to satisfy diverse customer requirements. Toppan Moore also

Moore Business Forms in Japan 59 began manufacturing business forms processors and computer supply equipment. In fact, Moore purchased a forms-processing machine developed by Toppan Moore. The company had also built up a strong service business, which involved dispatching computer operators to customer sites, developing computer software, and processing output forms. A fully automated Distribution Centre was established near Tokyo in 1982. The centre was connected with every sales department to enhance the company's delivery capability. By 1990, more than 30 such centres operated throughout Japan, and Toppan Moore had reached over US$ 1 billion in sales. At this time, the company had about 70,000 customers, although 80 percent of its business was generated by 150 accounts. A new president In 1990, Miyazawa retired as Chairman (Mr. Kinami became President in 1987), but he continued to hold an advisory function within the company. This was a common practice in Japan for retiring executives. Mr. Ogura, who had been Toppan Moore's Managing Director since 1968, took over as President. There was a great deal of consultation with Moore over Miyazawa's successor. Although Ogura was less of a public figure than Miyazawa had been, he knew the organization and worked well within the company. Ogura considered that he "managed by logic and by developing a network within the company." He had some strong ideas about the continued evolution of Toppan Moore: So far, Toppan Moore has enjoyed immense success. This is not the norm for many joint ventures in Japan. One of the reasons is that Moore provided good circumstances for the development of the company. Moore is a very caring parent. They made a sincere effort to launch the company. They gave us a lot of autonomy. They didn't interfere. We were able to adopt certain managerial methods and arrange them to fit with Japanese business customs. Moore looks at Toppan Moore as a young company, and they have a long-term view of its growth. For instance, Moore has never asked us to have a detailed

60 Paul W. Beamish strategic plan. We make decisions on personnel, investment, and fund raising without detailed consultation. We are able to manage freely, and we have adopted many Japanese principles, such as a long-term focus, interdependence among companies, business diversification, and a management style based on loyalty and human feeling. Toppan Moore is very much a traditional Japanese company. Our good relationship with Moore is based on personal communication. A formal agreement is not enough without having good intentions behind it. I believe that the most important way to develop a good relationship is to make the partner company a personal friend. We always try to find opportunities to shake hands with our parent companies. Shaking hands and communicating with partners are the first steps for making a good friend. There are many examples where Moore and Toppan Printing are learning from Toppan Moore, and we are still learning from our partners. James Saunders, the President and Chief Operating Officer of Moore International Latin America and Pacific, was regularly in Tokyo for the semi-annual meeting of Toppan Moore's board. Saunders first visited Toppan Moore in 1970 and from 1980 forward he made at least two trips a year to Japan. He shared Ogura's concern for ensuring the venture's continued prosperity. It had been an enormously successful partnership. Saunders retired in 1994. In early 1995, Moore received US$ 350 million when it reduced its stake in Toppan Moore from 45 to 10 percent. At that time, Moore's CFO said the company wanted to "spread its bets in Asia." In 1997, it sold the remaining 10 percent to Toppan Printing for US$ 100 million rather than take shares in the initial public offering Toppan Moore planned for later that year. By this point Moore was looking at a variety of acquisition candidates, as it had a large pool of cash. A hostile takeover of Wallace Computer Services Inc. was eventually dropped. During the 1993-98 period, three major restructurings occurred at Moore. In mid-1998, amid falling earnings and share prices, Moore announced the closing of 10 of its 100 plants, the cutting of 1,900 of its 20,000 employees, and the appointment of a new CEO.

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Why was Toppan Moore so successful? From a practitioner's perspective, the reasons for international joint venture failure include the following: (1) the parents' policy towards the joint venture changes (Kobayashi, 1991); (2) the foreign parent wants greater control over the joint venture operation (Ono, 1991); (3) cultural misperceptions arise between the parents (Phillips, 1989); (4) the parents enter into the joint venture with different agendas (Phillips, 1989); and (5) the parents achieve their original objective from the joint venture, and no further benefits are possible (Abegglen and Stalk, 1985). Unlike many international joint ventures, Toppan Moore (TM) successfully avoided the five conditions that might lead the venture to failure. (1) The parents maintained a stable policy toward the joint venture. The parents' policy toward TM was stable because: (i) Toppan Moore was faced with fewer major competitors in Japan than in other industries; (ii) Toppan Moore was given a great deal of autonomy by both parents in adopting management methods, rather than being forced to adopt their management policy. The parents assisted TM (e.g., technology transfer from Moore), but did not force the company to accept their assistance if it did not match TM's management practice (e.g., Moore's marketing method). (iii) An excellent leader led TM. Miyazawa's leadership enabled TM to overcome recession, restructure the organization, integrate employees, and explore future business opportunities. Miyazawa convinced stakeholders both inside and outside the company that TM could be managed by its own management team without conscious instruction from the parents. On the Moore side, Jim Saunders provided almost 20 years of constant attention to the joint venture, which played an important function in allowing trust to develop.

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(2) Neither of the parents tried to exert control over the joint venture operation. The reasons for this include: (i) The cooperative relationship between TM and its parents was necessary for TM to be successful in the business-forms industry. Business forms are technology-driven as well as custom-made or market-driven products, and these two traits are inseparable factors for keeping the products competitive. To achieve an effective alignment between technology development and marketing activity, the relationship between TM (who knew the market) and Moore (who had the technology) had to be cooperative. (ii) Toppan Moore is regarded more as an individual company rather than a "mosaic" of two different companies. Since TM was given a great deal of autonomy, it operated as if it were an independent Japanese company. Toppan Moore was able to do many things without regular consultation with the parents. (iii) Toppan Moore had grown enough and no longer needed substantial support from its parents. Toppan Moore developed its own production system and new products, and it transfered technology to Moore. Also, since TM had established its own reputation, it no longer had to count on Toppan's brand-name to exploit the market. Toppan Moore was no longer a child but an important partner for the parent. (3) There were relatively few cultural misperceptions between the parents. The reasons why cultural misperceptions were unlikely to occur at TM include the follow: (i) Toppan Moore was operating very much like a traditional Japanese company. It adopted many Japanese principles, such as a management style based on loyalty and human feeling. In addition, there were only a few managers from Moore working at TM. Thus, the venture's organization was almost oneculture (Japanese) dominant. Immediate cultural misperception was consequently less likely to occur. (ii) Toppan Moore developed a hybrid-management that belonged neither to Moore's nor to Toppan's original manage-

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ment style. The joint venture initially adopted the parents' management methods that might best fit with TM's management practice and subsequently developed an original management style. Toppan Moore bridged the cultural perception gap by combining both of the parents' management methods and developing its own way of management. (iii) Personal communication of employees between TM and Moore was highly encouraged. Toppan Moore and the parents shared the idea that developing strong human relationships (at every level of the organization) was the most important key to business success. The joint venture's encouragement of communication with Moore enabled the company to facilitate mutual understanding. (4) Similar and straightforward parent company agendas were in place. (i) Toppan Moore was formed to satisfy complementary interests of its parents. The venture would enable Toppan to introduce new products into an existing market and Moore would be able to create a new market with its existing products. (ii) The parents agreed to exert minimum control and provide maximum support to TM. To satisfy both parents' interests, they decided to provide the venture with autonomy in adopting the sales methods and production planning, rather than to assign these managerial roles to each parent. (5) Further benefits were possible. The joint venture continued to be profitable, owned valuable real estate in Japan, and became a source of new products. The design and management of international joint ventures1 An international joint venture is a company owned by two or more 1 This section is drawn in part from the chapter on joint ventures in Beamish, etal. 2000. For analyses and examples of cooperative strategies, see Beamish and Killing, eds., 1996, 1997.

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firms of different nationality. International joint ventures may be formed from a starting (or green field) basis or may be the result of several established companies deciding to merge existing divisions. However they are formed, the purpose of most international joint ventures is to allow partners to pool resources and coordinate their efforts to achieve results that neither could obtain acting alone. International joint ventures and other forms of corporate alliances have become increasingly popular. Joint ventures have moved from being a way to enter foreign markets of peripheral interest to become a part of the mainstream of corporate activity. Virtually all MNEs are using international joint ventures, many as a key element of their corporate strategies. Even firms that have traditionally operated independently around the world are increasingly turning to joint ventures. The popularity and use of international joint ventures and cooperative alliances remained strong through the 1990s; the rate of joint venture use varies little from year to year. In general, joint ventures are the FDI mode of choice about 35 percent of the time by U.S. multinationals and in 40 to 45 percent of foreign subsidiaries formed by Japanese multinationals. While early surveys suggested that as many as half the companies with international joint ventures were dissatisfied with their ventures' performance, there is reason to believe that some of the earlier concern can be now ameliorated. This is primarily because there is far greater alliance experience and insight on which to draw. There is now widespread appreciation that for many organizations joint ventures are the mode of choice. This represents a major rethinking from the days when the view was "JVs with Japan give away our future" (Reich and Mankin, 1986), "Collaboration is competition in a different form" (Hamel, Doz and Prahalad, 1989), and "Alliances are frequently transitional organization devices" (Porter and Fuller, 1986). As subsequent, much larger sample research was to discover (Beamish, Delios and Lecraw, 1997), the average age of Japanese international joint ventures was over 11 years, and the Japanese preferred JVs over any other mode, because it was here they had the highest performance. Why do managers keep creating new joint ventures? The reasons are

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presented in the remainder of this section, together with some guidelines for international joint venture success. Why companies create international joint ventures International joint ventures can be used to achieve one of four basic goals: to strengthen the firm's existing business, to take the firm's existing products into new markets, to obtain new products that can be sold in the firm's existing markets, and to diversify into a new business. Companies using joint ventures for each of these purposes will have different concerns and will be looking for partners with different characteristics. Firms wanting to strengthen their existing business, for example, will most likely look for partners among their current competitors, while those wanting to enter new geographic markets will look for overseas firms in related businesses with good local market knowledge. Firms with domestic products that they believe will be successful in foreign markets face a choice. They can produce the product at home and export it, license the technology to local firms around the world, establish wholly owned subsidiaries in foreign countries, or form joint ventures with local partners. Many firms conclude that exporting is unlikely to lead to significant market penetration, building wholly owned subsidiaries is too slow and requires too many resources, and licensing does not offer an adequate financial return. The result is that an international joint venture, while seldom seen as an ideal choice, often proves to be the most attractive compromise. Moving into foreign markets entails a degree of risk, and most firms that decide to form a joint venture with a local firm do so to reduce the risk associated with their new market entry. Very often, they look for a partner that deals with a related product line and, thus, has a good feel for the local market. Requirements for international joint venture success The checklist in Exhibit 1 presents many of the items that a manager

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should consider when establishing an international joint venture. Each of these is discussed below. Exhibit 1: Joint venture checklist 1. Test the strategic logic. • Do you really need a partner? For how long? Does your partner? • How big is the pay-off for both parties? How likely is success? • Is a joint venture the best option? • Do congruent performance measures exist? 2. Partnership and fit. • Does the partner share your objectives for the venture? • Does the partner have the necessary skills and resources? Will you get access to them? • Will you be compatible? • Can you arrange an "engagement period"? • Is there a comfort versus competence trade-off? 3. Shape and design. • Define the venture's scope of activity and its strategic freedom vis-a-vis its parents. • Lay out each parent's duties and pay-offs to create a win-win situation. Ensure that there are comparable contributions over time. • Establish the managerial role of each partner. 4. Doing the deal. • How much paperwork is enough? Trust versus legal considerations? • Agree on an endgame. 5. Making the venture work. • Give the venture continuing top management attention. • Manage cultural differences. • Watch out for inequities. • Be flexible.

Testing the strategic logic The decision to enter a joint venture should not be taken lightly. Joint ventures require a great deal of management attention and, in spite of the care and attention they receive, many prove unsatisfactory to their parents. Firms considering entering a joint venture should satisfy themselves that there is no simpler way, such as a nonequity alliance, to get what they need. They should also carefully consider the time period for which they are likely to need help. Joint ventures have been labelled

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"permanent solutions to temporary problems" by firms that entered a venture to get help on some aspect of their business. When they no longer needed the help, they were still stuck with the joint venture. The same tough questions a firm might ask itself before forming a joint venture should also be asked of its partner. How long will the partner need the joint venture? Is the added potential pay-off high enough to both partners to compensate for the increased coordination/communications costs that accompany the formation of a joint venture? A major issue in the discussion of strategic logic is to determine whether congruent measures of performance exist. In many joint ventures, incongruity exists, and while each partner's performance objectives may seem defensible, any venture would need to resolve several major problem areas in order to succeed. First, each partner needs to make explicit its primary performance objectives. Implicit measures are a source of latent disagreement/misunderstanding. Second, the explicit versus implicit measures of each partner must not be internally inconsistent. Partnership and fit Joint ventures are sometimes formed to satisfy complementary needs. But when one partner acquires (learns) another's capabilities, the joint venture becomes unstable. The acquisition of a partner's capabilities means that the partner is no longer needed. If capabilities are only accessed, the joint venture is more stable. It is not easy, before a venture begins, to determine many of the things a manager would most like to know about a potential partner, such as the true extent of its capabilities, what its objectives are in forming the venture, and whether it will be easy to work with. A hasty answer to such questions may lead a firm into a bad relationship or cause it to pass up a good opportunity. For these reasons, it is often best if companies begin a relationship in a small way, with a simple agreement which, while important, is not a matter of life and death for either parent. As confidence between the firms grows, the scope of the business activities can broaden. When assessing issues around partnership and fit, it is useful to consider whether the partner not only shares the same objectives for the

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venture, but also has a similar appetite for risk. In practice this often results in joint ventures having parents of roughly comparable size. It is difficult for parent firms of very different size to establish sustainable joint ventures due to varying resource sets, payback period requirements, and corporate cultures. Corporate culture similarity - or compatibility - can be a make-orbreak issue in many joint ventures. It is not enough to find a partner with the necessary skills, you need to be able to access them, and to be compatible. Managers are constantly told that they should choose a joint venture partner they trust. As the Toppan Moore example suggests, however, trust between partners is something that can only be developed over time, as a result of shared experiences. You cannot start with trust. Shape and design In the excitement of setting up a new operation in a foreign country, or acquiring access to technology provided by an overseas partner, it is important not to lose sight of the basic strategic requirements to be met if a joint venture is to be successful. The questions that must be addressed are the same as those that arise when any new business is proposed. Is the market attractive? How strong is the competition? How will the new company compete? Will it have the required resources? And so on. In addition to these concerns, three others are particularly relevant to joint venture design. One is the question of strategic freedom, which has to do with the relationship between the venture and its parents. How much freedom will the venture be given to do as it wishes with respect to choosing suppliers, a product line, and customers? The second issue of importance is that the joint venture be a winwin situation. This means that the pay-off to each parent if the venture is successful should be a big one, because this will keep both parents working for the success of the venture when times are tough. If the strategic analysis suggests that the return to either parent over time will be marginal, the venture should be restructured or abandoned. Finally, it is critical to decide on the management roles that each parent company will play. The venture will be easier to manage if one parent plays a dominant role and has a lot of influence over both the

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strategic and the day-to-day operations of the venture, or if one parent plays a lead role in the day-to-day operation of the joint venture. More difficult to manage are shared management ventures, in which both parents have a significant input into both strategic decisions and the everyday operations of the venture. A middle ground is split management decisions, where each partner has primary influence over different functional areas. This is the most common form. In some ventures, the partners place too much emphasis on competing with each other over which one will have management control. They lose sight of the fact that the intent of the joint venture is to capture benefits from two partners that will allow the venture (not one of the partners) to better compete in the market, than would have been possible by going it alone. The objective of most joint ventures is superior performance. Thus the fact that dominant-parent ventures are easier to manage than shared-management ventures does not mean they are the appropriate type of venture to establish. Dominant parent ventures are most likely to be effective when one partner has the knowledge and skill to make the venture a success and the other party is contributing simply money, a trademark, or perhaps a one-time transfer of technology. Such a venture, however, begs the question "What are the unique continuing contributions of the partner?" Shared-management ventures are necessary when the venture needs active consultation between members of each parent company, as when deciding how to modify a product supplied by one parent for the local market that is well known by the other, or how to modify a production process designed by one parent to a workforce and working conditions well known to the other. A joint venture is headed for trouble when a parent tries to play a larger role in its management than makes sense. Doing the deal Experienced managers argue that it is the relationship between the partners that is of key importance in a joint venture, not the legal agreement that binds them together. Nevertheless, most are careful to ensure that they have a good agreement in place, one that they understand and are comfortable with.

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Making the venture work Joint ventures need close and continued attention, particularly in their early months. In addition to establishing a healthy working relationship between the parents and the venture general manager, managers should be on the lookout for the impact of cultural differences on the venture and for the emergence of unforeseen inequities. International joint ventures, like any type of international activity, require that managers of different national cultures work together. This requires the selection of capable people in key roles. Unless managers have been sensitized to the characteristics of the culture they are dealing with, misunderstandings and serious problems can and do arise. Many western managers, for instance, are frustrated by the slow, consensus-oriented decision-making style of the Japanese. Equally, the Japanese find American individualistic decision making surprising: decisions are made quickly, but implementation is often slow. Firms with some experience of international joint ventures are well aware of such problems and take action to minimize them. A very common joint venture problem is that the objectives of the parents, which coincided when the venture was formed, diverge over time. Such divergences can be brought on by changes in the fortunes of the partners. A final note concerns the unintended inequities that may arise during the life of a venture. Due to an unforeseen circumstance, one parent may be winning from the venture while the other is losing. Many experienced venture managers advise that, in such a situation, a change in the original agreement should be made, so the hardship is shared between the parents.

REFERENCES Abegglen, James C., and George Stalk, Jr. 1985. Kaisha, The Japanese Corporation. New York: Basic Books, Inc. Beamish, Paul W., Andrew Delios and Donald Lecraw. 1997'. Japanese Multinationals in the Global Economy. Cheltenham, U.K.: Edward Elgar.

Moore Business Forms in Japan 71 Beamish, Paul W., Allen J. Morrison, Philip M. Rosenzweig and Andrew C. Inkpen, eds. 2000. International Management: Texts and Cases. 4th ed. Burr Ridge, 111.: McGraw Hill. Beamish, Paul W., and J. Peter Killing eds. 1997. Cooperative Strategies: European Perspectives, Cooperative Strategies: North American Perspectives, and Cooperative Strategies: Asian Perspectives. San Francisco: New Lexington Press. Beamish, Paul W., and J. Peter Killing, eds. 1996. Special Issue on Cooperative Strategies, Journal of International Business Studies, 27, 5. Beamish, Paul W., and Shigefumi Makino. 1992. "Toppan Moore," RichardIvey School of Business, Case Study #9-92-G001. Hamel, Gary, Yves Doz, and C.K. Prahalad. 1989. "Collaborate with Your Competitors - and Win," Harvard Business Review, January-February: 133-39. Kobayashi, Yotaro, of Fuji Xerox. 1991. "Managing a Cross-Border Joint Venture," CEO Interview in Institutional Investor, September: 29-32. Ono, Yumiko. 1991. "Borden's Breakup with Meiji Milk Shows How a Japanese Partnership Can Curdle," Wall Street Journal, February 21: Bl, B6. Porter, Michael, and M.B. Fuller. 1986. "Coalitions and Global Strategy." In M.E. Porter, ed., Competition in Global Industries, Boston, Mass.: Harvard Business School Press, 315-44. Reich, Robert W., and E.D. Mankin. 1986. "Joint Ventures with Japan Give Away our Future," Harvard Business Review, March-April 78-86.

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Employee development in emerging markets: lessons from Black & Decker Eastern Hemisphere ALLEN J. MORRISON

Management development is an important issue for a company with international operations. This chapter examines the experience of a large U.S. MNE as it extends into its Eastern Hemisphere operations an appraisal and development system designed for employees in North America. The author examines the relative advantages of training staff, hiring the best local managers, and bringing in expatriates. In particular, he notes the problems and the opportunities involved in a decision to import a standardized procedure into East Asia, thus overriding cultural barriers, in order to improve quickly the critical human resources of the firm. Introduction This chapter examines Black & Decker Eastern Hemisphere's attempts to import a North American employee appraisal and development system into its Eastern Hemisphere operations.1 After successfully using the system in the United States, the new president of the Singaporebased Eastern Hemisphere overcame considerable opposition to introduce the system in Asia. The chapter explores the Black & Decker initiative in depth and then moves to a broader consideration of 1 Much of the background material for this paper is based on the case study "Black & Decker-Eastern Hemisphere and the ADP Initiative (A)" published by the Richard Ivey School of Business, University of Western Ontario, 9A98G006.

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employee development in emerging markets. Developing and maintaining management "bench strength" has become a major challenge throughout much of Asia and Black & Decker's efforts in the region provide several important insights. In conclusion, the chapter discusses the general challenge of globalizing business systems and addresses the question of how and when human resource development systems should be globalized. Black & Decker Eastern Hemisphere's ADP initiative Historical background Duncan Black and Alonzo Decker founded Black & Decker in 1910, investing $1,200 to start a company that manufactured industrial machinery. The partners' 1914 patent, a drill with a pistol grip and trigger switch, revolutionized the power tool industry. Black & Decker's expansion continued almost uninterrupted for the next 80 years. By 1996, it led the world, producing more power tools, electric lawn and garden tools, and related accessories than any other company. From its headquarters in Towson, Maryland (just outside Baltimore), Black & Decker directed operations that spanned the globe, with sales offices in 109 countries. The company boasted sales of $4.9 billion, with a net income of $229.6 million, and it employed nearly 30,000 people. The company's brand recognition grew throughout the 1980s, and by the early 1990s, Black & Decker was ranked seventh in the United States and nineteenth in Europe in a survey of 6,000 brands. The company's well-known brands included DeWalt™ and Black & Decker power tools, Dustbuster™ portable vacuums, Kwikset™ (locks and security hardware), Price Pfister™ (faucets), Emhart (glass and fasteners), and Black & Decker brand household products (irons, mixers, food processors, coffee makers, toasters, and toaster ovens). With its success in North America and Europe, Black & Decker's senior corporate executives began to look for ways to strengthen the company's position in the emerging Asian and Latin American markets. In the early 1990s, the company's operations were organized into

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three geographical segments: the North American Group, operating out of company headquarters in Towson; the European Group, located in London; and the International Group, which included all other operations and also operated out of Towson. A senior manager described the company's attitude towards international operations as "mostly an opportunistic export business." The company's presence in the entire Asian region consisted of a small team in Singapore. Black & Decker was being outsold by its competitors in this rapidly emerging market, claiming only a weak fifth-place market share. International operations reorganized In 1993 Black & Decker reorganized its operations, splitting the International Group into Latin America and Eastern Hemisphere. The Latin America group was headquartered in Miami, and the Eastern Hemisphere group was relocated to Singapore. The territory covered by the Eastern Hemisphere office included all of Asia-Pacific, including China, Japan, Korea, the Philippines, Indonesia, Malaysia, Thailand, Singapore, Australia, and New Zealand. The territory also included the Middle East, Africa, India, and Pakistan. Both new offices reported to Black & Decker's Worldwide Power Tools Group, the company's largest single business. About 70 percent of sales in the Eastern Hemisphere were power tools and accessories. The remainder of sales included small appliances, fasteners, and security hardware. Establishing multiple business headquarters in the Eastern Hemisphere would entail costly duplication of infrastructure. Reporting all operations through Power Tools effectively streamlined operations. Black & Decker Eastern Hemisphere Between 1994 and 1996, Black & Decker invested nearly US$ 80 million in Eastern Hemisphere. The company invested in a joint venture in India, two new joint ventures in China, and a new manufacturing plant and renovations in Singapore. Sales offices were established in

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countries throughout the region. By early 1996, the Eastern Hemisphere had close to a thousand employees and growth plans called for employment to increase significantly by 2001. It was anticipated that a large percentage of these new employees would be new managers. Despite the growth and considerable investment, Eastern Hemisphere was not performing as well as many had hoped. Sales were disappointing, market demand was softer than projected, and the new plants were operating far below capacity. Competition had been brutal. Typical practices of competitors included dramatic price cuts and blocking strategies that would be illegal in Black & Decker's traditional markets. For example, one common practice was to shut off supplies to distributors that added competing products. This made adding Black & Decker products prohibitively expensive. In an effort to make the Eastern Hemisphere profitable, the president of Worldwide Power Tools personally asked one of his closest and most trusted associates to take over as president of Black & Decker Eastern Hemisphere. These two managers had worked closely together to develop Black & Decker's successful DeWalt professional power tool line in North America. The newly appointed manager's creative marketing strategy had taken DeWalt sales in North American from zero to $300 million in about two years. He was highly regarded throughout the company and attracted the best and brightest to his DeWalt team. Now he was asked to bring those skills to bear on the company's flailing Eastern Hemisphere operations. A new president's assessment When the new President arrived in Singapore in October of 1995, he was aware of the poor performance of the organization he had inherited. He spent time talking to employees throughout the organization, starting with the Management Advisory Council (MAC). The MAC was composed of eight vice-presidents, all expatriates save one. He also visited with rank-and-file employees throughout the entire Eastern Hemisphere organization. He found much to concern him regarding the health of the organization.

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Management quality throughout the organization was highly variable. The new president found managers who embraced employee empowerment and others who operated with authoritarian styles. In his words, "Some, quite frankly, were bad managers." He found that managerial depth and experience was lacking and that many employees did not fully trust their managers. Many people had been doing the same jobs for five or more years with no growth and development opportunities. About 70 percent of management and supervisory jobs were filled by outsiders rather than employees from within the organization. "Something wasn't right about this," he explained. "We weren't growing our own people and needed to do something about it." He also found that since the organization was very young, many employees were new to Black & Decker. Particularly in Southeast Asia, it was difficult to keep good employees because the competition among MNCs for good local managers was fierce. Further complicating any attempts at growing a healthy organization was the fact that the Eastern Hemisphere covered a vast geographical area, encompassing many diverse cultures. Each culture had its own management norms and employee needs. The new president knew that the Eastern Hemisphere would never overcome its performance deficiencies without a unified team of highly committed, competent managers. His experience with DeWalt in North America had taught him to rely on Black & Decker's relatively new assessment tool, the appraisal and development plan or ADR He believed that this tool had helped him mentor managers towards developing the competencies they needed to excel in his U.S. marketing organization and that, as a result, ADP had contributed largely to his success with DeWalt. It was the only tool he was familiar with that had the potential to develop large numbers of existing managers. Management appraisal and development Black &c Decker first introduced ADP in the United States in 1992. It replaced the company's management by objective (MBO) plan. MBO systems have been widely used by western businesses; during the late

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1980s, slightly less than half of all Fortune 500 companies were using MBO-type systems. Black & Decker's MBO plan consisted of the following: • Superiors met individually with each subordinate to discuss his/her performance and set comprehensive objectives for the subordinate for the coming year. • A review session with the subordinate was held to establish criteria to assess the subordinate's progress on the agreed-upon objectives. • Managers would hold at least one follow-up session throughout the year to review progress and provide coaching. In the words of a Black & Decker senior brand manager, "An MBO system has the advantage of making you responsible to your boss. He knows you best and best understands the business objectives." But other managers felt differently. The entire burden of performance reviews was on the superior's shoulders. Input from others in the organization was not sought. One manager stated, "I was only seeing my subordinates doing their job maybe 10 percent of the time. Either I was gone or they were gone." He continued, "If someone wasn't making their numbers, I often wouldn't really know why ... Sometimes the sessions got contentious. People would argue against my assessment, saying that I didn't know enough about what they were doing to form an accurate opinion. Maybe they were right." In contrast, the ADP system Black & Decker adopted used a 360degree feedback system. It included six major steps. 1. The appraising manager requested input from three to six of the employee's peers using a standardized form. 2. The appraising manager requested input from three to six of the employee's subordinates using a standardized form. 3. The appraising manager asked the employee to submit a self-review form, which covers the employee's background, past year's performance, job function, and other feedback. The employee also summarized his/her objectives and accomplishments for the year.

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4. The appraising manager reviewed all of the forms and prepared a formal assessment of the employee, measuring his/her performance across 14 factors: • achievement orientation • interpersonal communication • conceptual thinking • analytical thinking • initiative • decisiveness • job knowledge • teamwork • customer-focused • focus on quality • organization commitment • leadership • developing others • adaptability Upon completing the written appraisal, the manager destroyed all written peer and subordinate reviews. 5. The manager and employee met together and discussed the written report. The appraising manager and the employee agreed in writing on the employee's performance objectives, measurement criteria, and future career development plans. 6. Summaries of the written plans, including comments from the employee, the appraising manager, and the manager's boss, were kept on file in the local human resource manager's office. The entire ADP process ran from November 1 to the end of February each year. When Black & Decker introduced ADP in the United States, it received enthusiastic support at senior levels. One marketing vice-president found the peer reviews were invaluable to the U.S. managers. His experience was that managers do not see their subordinates as often as peers do. "Under the ADP," he explained, "about 80 per cent of evaluating subordinates is done for the manager. As a manager I like that.

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But it is also good for employees. For example, the emphasis on selfassessments and career planning is a great development exercise and tool for building future leaders." Farther down in the organization, ADP was not as heartily embraced. Managers were concerned that the 360-degree feedback would open up the evaluation process to bias. Some felt that "popularity" may play a role and subordinates could gang up on them if they were not well liked. The other major concern about ADP was the amount of paperwork involved. For example, a manager with ten subordinates would have 120 forms to process and evaluate. Management also heard complaints that there were no rewards for doing a good job at ADP. Despite these concerns, ADP had earned wide support and acceptance in the United States Abuses failed to materialize and the process was refined to accommodate the additional time required to make the plan work. While managing at DeWalt in the United States Eastern Hemisphere's new president had embraced ADP and found it remarkably effective. Not only did ADP provide him with a wealth of feedback, giving him an opportunity to add "real value" in the review sessions, he discovered even greater benefits: "ADP was designed as a tool to develop people. Another big benefit that came from ADP was the potential to build a highly functional, high performance team. ADP encouraged people to work together, to build one another. People who were good at managing ADP also got noticed. People wanted to work for them because they saw how successful they were at building people and strengthening a team." ADP for Eastern Hemisphere? Eastern Hemisphere's president believed his organization's most pressing need was well-developed professional managers. He believed that ADP's 14 performance measures reflected exactly the skills and values needed to shore up his organization's shaky performance and to continue to expand market share and operations in the future. At the time, the Eastern Hemisphere was using a hybrid MBO sys-

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tern that incorporated parts of the old U.S. MBO and a simple rating scale completed by the appraising manager. The process was not being used for joint goal setting; managers were using it solely as a performance evaluation instrument. Within a few months of his arrival in Singapore, the Eastern Hemisphere president presented a plan for introducing ADP into Eastern Hemisphere's organization to his Singapore-based Manager of Human Resources (HR). The HR manager had been with Black & Decker for six years, rising from an entry-level position to one of considerable authority in Asia Pacific. She had a reputation for critical insight into the mindsets of Asian workers. The HR manager was convinced that ADP would never work in Asia. She opposed introducing the U.S. version, primarily as the result of cultural concerns. She claimed Asian people would not give candid feedback the way Americans do. "They are likely to say something polite," she said, "but won't be critical." Second, she assured "the president that Asians would never believe in the confidentiality of the system. "No matter what a boss says about feedback being anonymous, Asians won't believe him or her. Somehow he or she will find out who said what and there will be negative consequences for that person." Finally, she felt Asians could not cope with the radical change that would be brought about by ADP. Another Singaporean HR officer felt differently. She explained that she was "shocked" when she joined Black & Decker by the inadequacy of the existing appraisal and development tool and welcomed a change to something better. "Many of the people being hired at Black & Decker are young," she explained. "We are the MTV generation. We can be a lot franker than the earlier generation ... I think if you have gone to university or spent much time overseas, you are much more likely to accept ADP. For me personally, it would not be that big of a deal." Considerable opposition The president surveyed the MAC for their input. Those managers who had experienced ADP in the United States, like he had, were excited

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and supportive of the change. But managers who had come from Europe, where ADP had not yet been implemented, were doubtful. "I heard someone say," he recalls, "that only 'an act of God' would convince people that ADP results would be confidential." The president continued to meet with managers in Singapore and wherever he travelled. He continued to receive mixed reactions. A commercial director in Singapore and Malaysia recognized ADP's potential to help build new managers, but also foresaw cultural drawbacks. "The problem is in Asian cultures, people don't tend to open up. They will never say that their career's ambition is to have their boss's job. As a result, while ADP is designed to build commitment and develop managers, it may backfire." He felt some employees would quit, knowing full well they could easily get another job, rather than "open up in ways that make them uncomfortable." A finance director with responsibilities for offices in China felt that communicating ADP would be almost impossible in the country offices. Beyond the language barriers, he wondered if there was even a need for management development. He said, "We are so focused on building sales that I wonder if it is important or even possible to really develop people with broader skills. If you are making the numbers, some people believe that's all that is important." A brand manager worried about the time it would take to fill out all the forms. "I think it will take me three to four hours per person to do an appraisal. And I have five people who report to me. That's almost twenty hours of work. And it comes at the end of the year when we are busiest." A Malaysian national Methods & Process manager who had worked for a large Japanese MNC contrasted ADP with his experience with Japanese management. "The only way I found out I was doing a good job was by the size of the pay raise I got. There, if you question your boss, it is a lose-lose situation. My worry about ADP is that if, in your peer review, you criticize someone who your boss likes, you are really criticizing your boss." This manager explained that he would be able to use the system if he reported to an American manager, but he could never disagree with a Japanese boss.

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An Indian national who worked for Eastern Hemisphere as an MIS manager felt peer reviews would never work in India. "There is so much more competition between peers that peer reviews would be very suspect. Everyone is competing for that one job." He also complained about the paper work that would be involved, and he felt that ADP would be ineffective in Singapore. The tight job market forced the company to give everyone a 7-8 percent raise to prevent employees from simply "quitting] and taking another job." Given this situation, would "all the work associated with ADP really ... be worth it?" The Eastern Hemisphere president found the feedback he received sobering. He was still relatively new in his position, facing brutal competition throughout the region, and he knew he needed more and better managers. He was convinced that "ADP could work wonders in the Eastern Hemisphere," but was repeatedly told "that ADP may not be the way to go at the present time." ADP implementation In March 1996, the Eastern Hemisphere president asked his human resources manager to develop a full ADP implementation plan. A month later she presented him with something quite different, a hybrid plan that incorporated career planning and goal setting but relied on 180-degree feedback - it lacked peer and subordinate reviews. She suggested using the partial plan for a year, giving people time to test it and to get used to it. If after a year it was accepted, then the company could add peer reviews, wait another year, and finally add subordinate reviews. She was sure a step-wise introduction of the plan would allow people to become comfortable with the change and provide time for revisions as cultural realities demanded. The human resources manager knew that no other company in Asia had introduced 360-degree feedback. IBM had tried, but ended up reverting to a 180-degree plan. "Most Asians don't like criticism or praise," a colleague explained. "Peer reviews are particularly unpopular because we are competing with each other for the same promotion." By April of 1996, the Eastern Hemisphere president knew the time

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had come to act. His superior at Worldwide Power Tools was pushing him hard for results in Eastern Hemisphere. Faced with disappointing 1995 year-end results, he knew he needed to shake up the region if he had any hope of establishing a high performance culture. A new leader has a brief window of opportunity to make significant change, and his was quickly closing. He believed that ADP could raise core skills and values to levels Eastern Hemisphere needed now and in the future. But he was also aware that the program would be a difficult sell. In the end, the president was faced with the reality that he needed management strength quickly. Waiting an indefinite period of time or struggling through the hybrid plan's three-year-step-by-step process would not give him the results he needed quickly enough. Besides, by this point the organization was expecting change. He would also "lose face" if he failed to act decisively. He firmly believed that implementing ADP was the best tool he had to develop managers as quickly as possible. Furthermore, he wanted to attract and support employees who embraced change rather than shunned it. The Eastern Hemisphere president decided that the time was right to move. He replaced his human resource manager with an expatriate manager well trained in ADP, thereby signalling to his entire organization that he was serious about making ADP a success. His replacement was ideal for the job; she championed ADP and went right to work to implement the plan. Working closely with the management committee and the training manager, the new manager of HR modified the U.S. version of the plan for Eastern Hemisphere. They designed separate instruments for management and professional personnel, nonunion employees and union employees. Management and professional employees received the full ADP measures, including peer and subordinate feedback. Non-union staff employees received the full ADP measures but no subordinate feedback (they had no subordinates). Uunion employees continued to be evaluated by their supervisors. The Eastern Hemisphere president agreed to exempt factory workers from ADP in order to avoid battles with numerous unions, conceding that the 14 ADP criteria had little application for factory workers. By late 1996, the Eastern Hemisphere president announced the

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change to ADP in a senior management meeting. Keeping in mind that confidentiality had been the biggest fear among those he had surveyed, he stated unequivocally that "if any manager compromised the sanctity of the program, they would suffer the consequences." This message was repeated wherever he or the MAC members went. The first iteration of ADP was with MAC members and their direct reports. The human resources staff ran a two-day training program to familiarize the managers with the mechanics of the program and emphasize the development aspects. Country-based human resource staffs were also extensively trained. The manager of human resources planned to introduce ADP within each country to successive layers of employees from one year to the next. The instruments were translated for each country, but no other modifications were made to reflect regional cultural differences. Throughout its first year, members of the MAC hammered away at the importance of ADP. It was discussed at every important meeting involving middle managers. MAC members dedicated themselves to flawless execution of appraisals involving their direct reports. No one wanted to be blamed for weak execution. The example and commitment of MAC members seemed to go a long way to convince middle managers that ADP would be around for a long time and that career success in the Eastern Hemisphere would require a demonstrated track record of successfully using ADP in developing others. ADP's impact After its first year, ADP was generally well accepted by senior managers. An Asian manager found that being able to talk openly about his career objectives was particularly rewarding. Another manager found that his subordinates gave the program broad support. "They don't just give minimal responses - they add pages to the forms." He felt that the experience of going through ADP made his team much more committed to the process. A human resources manager explained, "ADP opens communication channels. As a result, it decreases the likelihood that people will be dissatisfied with their jobs." A few were concerned that because of the time involved in the assess-

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ments, ADP would gradually become less effective. "My worry is that interest in ADP might die down over time," one stated. "People will just think of it as just another system." There was also concern about integrating second- and third-tier managers into the plan. Some felt they would not be able to grasp the development objectives of ADP. Despite the concerns and the formidable task of championing ADP, by the summer of 1997 it was widely credited with substantially improving the skill and commitment levels of employees. Major progress had been made to strengthen the management team in the Eastern Hemisphere.

After ADP's launch In the fall of 1997, Eastern Hemisphere faced more, this time unexpected, change. Headquarters reorganized the region, pulling out the Middle East, Africa, Australia, and New Zealand. As a result, Eastern Hemisphere became a much smaller "Asia" group. Unfortunately, Eastern Hemisphere's president left Black & Decker after accepting an attractive offer at a major U.S.-based multinational organization. The former head of operations in Hong Kong, China, and India was then promoted to president of the Asia group. Several management committee members were sent back to the United States including the ADP-trained manager of human resources. As a result of the ongoing economic trials in the region, Black & Decker has found itself facing an uphill battle to fill its order books. With sales lagging and with the departure of the original members of the MAC, the original fervor associated with ADP's launch has declined somewhat. Still, the program has been a major success and has assisted Black & Decker considerably as it seeks to accelerate the development of a new generation of leaders for the Eastern Hemisphere. Globalizing management processes It took considerable effort for Black & Decker's Eastern Hemisphere president to effectively globalize the company's assessment and devel-

Black & Decker Eastern Hemisphere 87 Table 1: Employee reaction to ADP People who tend to favour ADP

People who tend to oppose ADP

• Those who have been exposed to U.S. management systems - educated in U.S. or travelled in U.S. Professionals whose skills are in high demand • Those who are popular with their peers and subordinates • Those who generally believe management is there to help • Those who are eager for self-development opportunities

• Those who have not been exposed to U.S. management system • The underskilled or those who worry about their competitiveness in the job market • Those who are unpopular • Those who compete with peers for promotions, development opportunities • Those who are generally suspicious of management • Those who are threatened by the need for self-development

opment management process. Despite negative feedback and the fears of his subordinates, he went ahead with the new assessment tool. He basically decided that Black & Decker management processes must override cultural barriers. Globalization involves standardizing not only products but management processes as well. Global leaders must be constantly vigilant in differentiating between those processes that should be globally standardized and those that should be localized. The Eastern Hemisphere president had experience with this management development tool and was aware of its rich development potential. He knew the 360-degree feedback frightened many of the workers, but he also knew it could result in manifold benefits. He found that the employees who needed development the most were the most likely to oppose the new system (see Table 1). The insecure, underskilled, suspicious workers are those most troubled by 360-degree feedback. But the Eastern Hemisphere president believed ADP had the potential to develop large numbers of existing managers. ADP could • • • •

Enable managers to develop a better understanding of employees; Encourage employees to assess their own performance; Encourage employees to take greater control over their careers; Promote accountability;

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• Provide a vehicle whereby managers and employees can map out an employee development plan; • Promote teamwork; • Provide the infrastructure to help inexperienced managers think systematically about the key capabilities of effective managers; • Promote trust by increasing the sources of input in employee assessments; and • Encourage employees to be committed to Black & Decker by developing long-term career plans. The Eastern Hemisphere president came to the conclusion that professionalizing management in the Eastern Hemisphere could not be done by consensus or by allowing existing management to dictate what would or would not work. Effective leaders in global corporations often need to impose standards and processes on local organizations. Once those processes have been imposed, leaders must champion them: people make processes work. In this instance, the president championed ADP personally and brought in a human resources professional to further support the effort. He removed the manager who would not support the initiative and made it clear to all in the organization that the confidentiality of the process must be maintained. As the organization was restructured, the new president and management committee's challenge was to continue emphasizing the development and team-building aspects of ADP. If Black & Decker, or any company, expects to be successful in Asia-Pacific and other developing markets, management development must be central to the organization's culture. The management development challenge As seen from Black & Decker's experience in its Eastern Hemisphere organization, management development is a huge challenge in fast growing, developing markets Adler and Bartholomew, 1992; Black, Gregersen and Morrison, 1999). These markets are often seen as the last frontier of competition. Many global competitors feel they are

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forced to enter these markets to protect market share in the mature North American and European markets. If they leave developing markets to their competitors, they risk letting the competition develop enough strength in new, dynamic growth markets such as Asia-Pacific to subsidize costly market share battles in mature markets (Kim and Mauborgne, 1993). The lack of talented local managers threatened Black & Decker's success and is an ongoing problem for companies competing in developing markets. People are a critical resource and a potential source of competitive advantage for the companies they work for (Pfepper, 1994). The Eastern Hemisphere president recognized this need and used Black & Decker's world-class management system, the ADP tool, to accelerate the development of new managers and to gain advantage in the global power tools industry. Organizations have basically three ways to increase their bench strength in a developing market. They can attempt to train existing staff and develop managers from their existing management pool. Alternatively, they can hire the best local managers they can find - the "hired gun" option. The third option is to bring in expatriates to fill critical management positions (Black, Gregersen and Morrison, 1999). Each of these options is examined below. Train existing local staff The advantages of training locals from within are many. Host country nationals speak the language, know the local cultures, and can develop relationships with other locals easily. As with Black & Decker, many companies' cultures are based on grooming managers from within. In many countries, local salaries are comparatively low, making this a cost-effective option. Also, loyalty and commitment to the organization often rise as managers recognize the investment a company is making in them. Training from within also has several potential drawbacks. First, a company must have or be able to find the right people for its developmental pool. This involves maintaining an extensive up-to-date data-

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base of potential new hires. Developing quality managers is also time consuming. It takes many North American companies ten or more years to train people who already hold university degrees. Training locals in a developing country may take even longer (Gudykunst et al., 1996). On the job training also involves more costs than the trainee's salary. Unlike North American managers, locals often expect the company to arrange and pay for training. The number of expensive expatriate trainers/supervisors must be increased. The potential hidden costs may be even greater. Can a company accept the cost of failures as its managers are trained? Once managers are trained, there is absolutely no guarantee that they will remain with the organization. One company lost 23 out of 24 Chinese managers it had sent to an expensive European course. Within two years of returning to China, almost all of them were poached by other companies. Does it make sense to spend large sums of money on employees who have little loyalty? Cultural factors may also complicate the development process (Gudykunst et al., 1996; Roberts et al., 1988). For example, Asian employees are reluctant or unable to move to another country. The typical North American development plan moves managers from place to place to effectively expose them to many facets of the company's operations. Use hired guns Paying top dollar for the best and brightest local managers has the distinct advantage of getting trained managers into an organization quickly at a cost well below that of bringing in expatriates. Top local people, or hired guns, know the language, local culture, and often the industry. They are more presentable than other local hires (i.e., "the suit") to major buyers, and can be role models for rank-and-file employees. A major disadvantage of this option is uncertainty. A company that pays top dollar to hire an experienced local manager may get less than it pays for. Often a "star" looks good on paper only because past employers gave that person superior reviews simply to get rid of him or her. If a company expects a new hire to know its industry and company culture, it may be disappointed. One manager explained that hiring someone who "looked" like they

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could do the job — someone who wore a suit and had a good education • did not always result in hiring the best person for the job. Hired guns are also hard to find and difficult to attract to a developing operation. Many have little loyalty and will leave if a better offer comes their way, making it difficult over time to build a cohesive organization. Rank-and-file employees, in many cases, tend to resent hired guns and do not like to report to them. Expatriate managers Bringing in expatriate managers sends a sharp signal to the competition that the market is critical for a company. Expatriates understand the company's products and processes and know the industry. This is critical for most companies, which invest ten years or more indoctrinating its managers in company and industry specifics. Expatriates often have superior technical skills (marketing, finance, sales, etc.) and are loyal and hard working. They can train and mentor local employees, and local employees prefer reporting to them (Black, Mendenhall, Gregersen and Stroh, 1999). Of course, expatriates are the most expensive employees. They also suffer from language and cultural barriers that may interfere with relationship building. Companies have a difficult time finding managers in their organizations who will move to developing countries, and even if they succeed, can a company spare large numbers of leaders from its existing operations? Also, five years down the road, when the expatriates leave, who will they turn operations over to? New expatriates or trained locals? Manager competencies Each group of potential managers has specific strengths. The following competencies are typically what a company competing in a new market requires. Its managers will need: • industry-specific competencies; • company-specific competencies;

92 Allen J. Morrison Table 2: Typical competency levels

Industry competency Company competency Functional competency Country-culture competency Interpersonal competency

Local staff

Hired guns

Expatriates

Medium Medium-Low Low-Medium High Variable

Low or High Low High High Variable

High High High Low Variable

• functional competencies; • country/culture-specific competencies; and • interpersonal competencies. Table 2 indicates the competency levels of the three types of employees a company can choose from to build a stronger management base. Each of these competencies includes knowledge and skills that can be learned. While some people are better at learning certain competencies than others, each competency has a learning curve. In building bench strength, leaders must make some fundamental decisions about what is and what is not important. Local staff members usually have a considerable amount to learn about marketing, finance, operations, and the like. They also have a lot to learn about the company they work for and the industry. Hired guns have a great deal to learn about the company - its products, systems, philosophy, culture, history, how it makes decisions, etc. - whereas expatriates have a lot to learn about local conditions, cultures, languages, politics, customers, etc. Of vital importance for a decision maker is a grasp of which competencies are most important in each market and how long it takes to develop a high level of competency in each area (Brake, 1997). Pursue multiple development strategies Ultimately, companies should pursue multiple management development strategies in a market like Asia-Pacific (Black, Gregersen and Morrison, 1999). Hiring top local talent and developing incentives for them to remain with the company, training existing employees with

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potential, and effectively using expatriates as needed are all critical strategies. Effective leaders not only acquire people who can manage current operations, they must also develop human resources for the future. A company that can develop managers quickly has a major competitive advantage in rapidly growing/developing markets. Expatriates are most effective in training and mentoring local talent. For example, Black & Decker's Eastern Hemisphere president brought in a hand-picked expatriate HR manager specifically because she had expertise in the company's training system. He felt the effectiveness of ADP was worth losing the Asian perspective of his old manager and worth the cost of bringing over a top U.S. manager. Despite the booming markets in Asia, many MNCs lack the trained managers necessary to effectively exploit opportunities. Companies may formulate brilliant strategies that are impossible to implement because they fail to consider the management talent needed to pull it off (Kim and Mauborgne, 1993). Management strength is not only a local issue. Trusted managers with the cultural and language competencies necessary to play leadership roles in vital markets are a rare commodity in most organizations. If a company has global aspirations, training a generation of global leaders must become a head office priority (Black, Gregersen and Morrison, 1999).

REFERENCES Adler, N., and S. Bartholomew. 1992. "Managing Globally Competent People," Academy of Management Executive, 6: 52-65. Black, S., H. Gregersen, M. Mendenhall and L. Stroh. 1999. Globalizing People Through International Assignments. New York: Addison-Wesley Longman. Black, S., A. Morrison and H. Gregersen. 1999. Global Explorers: The Next Generation of Leaders. New York: Routledge. Brake, T. 1997. The Global Leader: Critical Factors for Creating the World Class Organization. Chicago: Irwin Professional Publishing. Gudykunst, W., R. Guzley and M. Hammer. 1996. "Designing Intercultural Training." In D. Landis and R. Bhagat, eds., Handbook of Intercultural Training. Thousand Oaks, Cal.: Sage.

94 Allen J. Morrison Kim, C., and R. Mauborgne. 1993. "Making Global Strategies Work," Sloan Management Review, Spring: 11-27. Pfeffer, J. 1994. "Competitive Advantage Through People," California Management Review, Winter: 9-28. Roberts, K., E. Kossek and C. Ozeki 1988. "Managing the Global Workforce: Challenges and Strategies," Academy of Management Executive, 12: 93-106.

Regional expansion in Asia-Pacific: CISC Wood Gundy to Malaysia PAUL W. B E A M I S H

This chapter demonstrates the types of issues facing a large financial services firm already well-established in Asia, as it decides whether to expand in the area, which country and city to select, and how to address the issue of staffing. The author presents some of the frameworks and tools available to a company that undertakes initial or regional internationalization. An expansion team can draw on or develop a considerable range of publicly available statistics and qualitative information. In addition, a significant amount of firm-specific information must be accumulated on the particular country chosen, the competing sites within it, and the balance of costs and benefits involved. Such firm-specific information is costly, but this study demonstrates that it is feasible and, indeed, imperative for informed choice. In the event, the Asian financial crisis appeared just as the firm had carefully chosen a site and set up an office. The firm's decision to stay on rather than to close a subsidiary indicates a long-term approach to investment in the region. Introduction This chapter documents the decision process of a Canadian investment bank, CIBC Wood Gundy, as it undertook regional expansion in Asia-Pacific. CIBC Wood Gundy had existing Asian operations in Australia, China, Hong Kong, Japan, Singapore, and Taiwan when, in late 1996, it was assessing whether to expand to Malaysia.

96 Paul W. Beamish

figur 1

Unlike some of the other chapters in this volume, which have dealt with the initial foreign subsidiary location decision, this chapter emphasizes the ongoing internationalization process that even experienced MNEs must work through. While this and the Palliser Furniture chapter both consider the market choice questions (albeit from different perspectives), the emphasis here is also on the more micro questions of choosing the city to invest in (once the country choice has been made), and some of the staffing questions that require resolution, as shown in Figure 1. After providing detailed background information on the questions (in late 1996/early 1997) of whether CIBC Wood Gundy should expand into Malaysia, if so in which city, and how the new subsidiary might be staffed, the chapter reviews some of the frameworks and tools available to any company undertaking either initial or regional internationalization. A discussion of the actions CIBC Wood Gundy undertook then follows. Expand to Malaysia?1 In late December 1996, Russell Cranwell, the Singapore-based manag-

1 This section draws on Beamish and Moore (1998).

CIBC Wood Gundy in Malaysia 97

ing director of Origination and Structuring for CIBC CEF, pondered how expansion opportunities in Asia fit with the firm's Asia-Pacific strategy and what recommendation he would make at the monthly senior management meeting regarding expansion into Malaysia. Cranwell, one of the architects of CIBC Wood Gundy's strategy in Europe, knew that making decisions about expansion in Asia required extensive research. The firm's understanding of Asian opportunities was still developing, and the constant challenge Cranwell and his counterparts in Asia faced was the ongoing education of their colleagues in North America and Europe. Reviewing the expansion team's analysis, Cranwell confirmed that there were numerous opportunities; growth rates in the region outstripped those of all the G-7 countries and infrastructure spending over the next five years was estimated to be in excess of US$ 1 trillion. Presenting tables of growth rates was the easy part, deciding on the details of an expansion was much harder. Was the firm ready for another expansion? Did CIBC CEF have the right products and people to be successful in Malaysia? In the event that Malaysian expansion was pursued, should the office be located in the capital of KL (Kuala Lumpur), or in the newly developing International Offshore Financial Centre in Labuan? The discussion at the management meetings had focused on how the firm could best capitalize on the growth prospects in the region, including developing new products and expanding the current number of locations. The approval process for increasing investments in Asia was the joint responsibility of senior management in the region and CIBC Wood Gundy in Canada.

CIBC In 1996 the Canadian Imperial Bank of Commerce (CIBC) was Canada's second largest financial institution and the ninth largest bank in North America. CIBC Wood Gundy, 85 percent owned by CIBC, operated as the bank's investment banking arm. CIBC Wood Gundy

2 Labuan is a small Malaysian island off the coast of Borneo.

98 Paul W. Beamish

was a fully integrated global investment firm with offices in Toronto, New York, London, Singapore, Hong Kong, Tokyo and principal cities across North America. The market had recognized CIBC Wood Gundy's world-class capabilities, awarding the firm top industry ranking for derivatives, sales and trading, high yield finance, public and structured finance, mergers and acquisitions, global loan underwriting and syndication, and economics research. Of particular note was CIBC Wood Gundy's recognition by the investment banking periodical, International Financing Review (IFR), as the lead project finance arranger in the Americas and a recent announcement about the Global Finances Project Finance All Star Team for its innovative work in supporting airport construction projects. CIBC Wood Gundy was aligned in three main regions: North America, Europe, and Asia-Pacific. The breakdown of the size by employees was approximately as follows: North America, 70 percent; Europe, 20 percent; and Asia-Pacific, 10 percent. The firm remained primarily a North American investment bank with a clear focus on providing clients with a true global partner that would deliver financial solutions around the world. Over the past two years, CIBC Wood Gundy had taken an aggressive stance in increasing its franchise. It had been highly successful. In 1996, CIBC Wood Gundy recorded its best results ever with net income in excess of $500 million (unless otherwise stated, all figures are in Canadian dollars).

CIBC in Asia-Pacific CIBC and CIBC Wood Gundy operated in non-Japan Asia under the name CIBC CEF (CIBC Wood Gundy operated under its own name in Japan). CEF was a joint venture between CIBC and Cheung Kong (Holdings) Ltd. of Hong Kong. Cheung Kong's principal activities were investment holding and project management; its subsidiaries were active in the field of property development and investment, real estate agency and management, the production of cement and readymixed concrete, quarry operation, and investment holding. The

CIBC Wood Gundy in Malaysia 99

CIBC-Cheung Kong joint venture had been operating in Asia for over 25 years and the CIBC CEF partnership provided a combination of local market knowledge and global financial expertise. CIBC CEF had a significant presence throughout Asia as a leading expert in the aerospace, energy, media, and telecommunication industries, and for derivatives and structured finance. CIBC Wood Gundy had become Taiwan's preferred source of finance for the energy industry and was regarded as the leading house for Asian airline financing. CIBC Wood Gundy attributed its growing successes in Asia to the transferability of its North American reputation, concentrating on a limited number of businesses, and having the support of senior management to fully develop the key businesses. More recently, CIBC Wood Gundy had been transferring significant resources to the Asia-Pacific region. Over the last two years, the firm's regional employment had increased by 50 percent to approximately 500 employees, the Taipei office was experiencing similar growth, new products (derivatives, project finance) had been added, and large numbers of highly skilled employees had been transferred from offices outside Asia or hired directly by the regional office(s). The firm was in a phase of dramatic growth. Over the past year, management had made decisions on three expansion opportunities: Australia, India, and China. Strategy CIBC Wood Gundy was positioned in Asia-Pacific as a niche, regional player providing expertise in selected products and services to clients in selected markets. Specifically, the firm had chosen products and services that offered an immediate competitive advantage. The recent awards in Project Finance and Financial Products offered excellent opportunities to generate further revenues. Furthermore, the firm did not intend to replicate the large infrastructure investments that direct competitors such as ABN-Amro and Deutsche Morgan Grenfell had created in Asia. Products/services CIBC Wood Gundy's major business activities in Asia are described below.

100 Paul W. Beamish

Global Capital Markets (GCM). Commonly known as the trading floor, GCM combined traditional trading and sales activities in fixed income, money markets, and foreign exchange with the research activities supporting these areas and the development of new products, including securitization, private placements, and structured products. The group concentrated on large corporate clients and central banks. Financial Products (FP). FP developed and marketed innovative financial structures for regional governments, fund managers, financial institutions, corporations, and wealthy individuals. Products included over-the-counter interest rate, currency, and equity derivatives (including swaps, forwards, and futures transactions) as well as options contracts and other similar types of contracts and commitments based on interest rates, currency rates, the price of equities, and other financial market variables. Project Finance. The group had focused primarily on energy and commodity-based industries (mining and forestry), and now was actively involved in telecommunication, electric power, natural gas storage and transmission businesses. In 1996, the group was the lead on a US$ 600 million telecommunications project in Java, Indonesia. The deal was considered to be a major success and was named "Asian Deal of the Year" by Project Finance International. The key skill that the group provided to clients was the unique combination of engineering and financial expertise. The success of Project Finance often resulted in additional business for the FP and GCM groups. The group, based in Singapore, was a collection of various nationalities, with representation from India, the United States, England, the Philippines, Australia, Singapore, and Taiwan and it included one Canadian. The CEF Group. The CEF group, a pre-eminent Asian holding and financial services group of companies, serviced strategic local, regional, and overseas clients. CEF's capabilities included mergers and acquisitions, equity underwriting, and debt underwriting. The group also comanaged a number of CIBC CEF-originated transactions.

CIBC Wood Gundy in Malaysia 101

These four product/service groups accounted for more than 90 percent of gross revenues. Other Products included securitization and structured trade finance. Locations in the Asia-Pacific Region The firm had just under 500 employees in the region. The offices ranged in size from approximately 250 employees at the regional head office in Singapore to the six-person mining team in Sydney. The other locations included Hong Kong, Tokyo, Taipei, and Beijing. The decision Cranwell reviewed an analysis prepared by his Expansion Team and noted the group's inclination to recommend expansion into Labuan, Malaysia. Expanding into Malaysia would provide the firm with the opportunity to compete for significant transactions. Cranwell recollected an ongoing Malaysian deal that continued to offer project finance opportunities, the US$ 10 billion Bakun project, a hydroelectric dam and transmission system in Sarawak, East Malaysia. The firm had an excellent reputation in energy financing, but without a Malaysian presence it was virtually shut out. Finally, Cranwell reflected on the expectations of CIBC CEF's key stakeholder, CIBC Wood Gundy in Toronto. CIBC Wood Gundy had invested considerable resources (both financial and human) in the Asia-Pacific region and expectations were high that the current fiscal year would generate exceptional returns. Expansion team's analysis Asian overview The opportunities in Asia were numerous. In an effort to summarize some key points the team developed a table outlining the basic strengths and weaknesses of the potential markets for expansion (see Table 1). They concluded from their analysis, and given the firm's existing locations in Asia, that CIBC Wood Gundy's attention should be focused on opportunities in Southeast Asia.

102 Paul W. Beamish Table 1 : Asian overview, 1 996 Country

Strengths

Weaknesses

China

Consumer demand growing Private sector growing and more open to foreign investment Improving investment climate Currency and banking sector less regulated Access to foreign exchange improving

Potential leadership struggle in 1997 Pace of economic reform subject to change Piracy rampant Tax incentives being remove

Hong Kong

Good location Excellent communications and transportation infrastructure Low government interference or red tape Stable government Low corporate and personal taxes

Political uncertainty High inflation, high cost of living Pollution High turnover of labour

India

Democracy with independent and fair courts making contractual agreements secure Foreign investment usually welcome Good capital markets English widely spoken Well-educated workforce

Poor infrastructure Business hurdles are complicated Support services are very poor Duty rates are high

Indonesia

Growing economy requiring a multitude of product and services Foreign investment is welcome Tax incentives Few foreign exchange controls Low labour costs

Potential for political upheaval Weak judiciary High red tape and corruption Poor infrastructure Shortage of skilled labour, especially managers

Japan

Independent and high quality judiciary Efficient civil service Infrastructure Labour supply Reducing market barriers

Highly regulated economy Immense power of bureaucrats Operation and property costs are high Harsh attitudes towards transfer pricing

Malaysia

Competitiveness ranked very high Infrastructure English widespread

Lack of technical knowledge Acute shortage of labour coupled with pressure on wages

CIBC Wood Gundy in Malaysia 103 Table 1 (Concluded) Country

Strengths

Malaysia (Cont.)

Low labour costs relative to skill level Ethnic quotas in jobs and equity Liberal exchange controls ownership Government incentives increasing Location Political stability, widespread support growing for UNMO (government)

Weaknesses

Isolated location with small New Zealand Efficient civil service Absence of corruption population Very open and competitive economy Absence of investment and tax Encourages foreign investment incentives Good economic conditions Skill shortages in some areas Weak trade unions Low labour costs Low corporate and personal taxes South Korea

Fast growing domestic economy Bureaucracy not overly welcoming Ever improving level of technological of foreign investors ability Chaebol continue to dominate the Well-educated and young workforce economy Labour costs are increasing

Thailand

High economic growth Trade liberalization increasing Good investment incentives

Coalition politics undermines government efforts Poor infrastructure, especially Bangkok Frequent labour disputes Shortage of skilled workers

Taiwan

Advanced democracy with developing judiciary Commitment to free enterprise High-tech industries developing quickly Well-educated workforce

Ongoing dispute with China, recent withdrawal of support by South Africa Infrastructure problems Intellectual piracy Labour costs high

Source: Economist Intelligence Unit.

104 Paul W. Beamish Table 2: Infrastructure and growth rates

Country Malaysia Indonesia Singapore Philippines Vietnam Thailand Brunei

Expected GDP growth rate 1997(%)

GDP per capita (US$)

Infrastructure investment 1 995-2004 (US$ billion)

8.5 8.0

3,160 730 19,310 830 170 2,040 NA

55 190 Negligible 55 NA 150 Negligible

6.1 6.0 4.8 8.0 NA

Sources: World Bank and Economist Intelligence Unit.

The Association of Southeast Asian Nations (ASEAN)3 economies were estimated to continue to record high real growth rates. The upgrading of key infrastructure investments such as roads, telecommunication systems, and power grids were critical to sustaining these growth rates (see Table 2).

Malaysia* Politics!external relations The political scene has been dominated by the United Malays National Organization (UMNO) party headed by the Prime Minister, Dr. Mahathir Mohamad. Dr. Mahathir has retained the post since 1981. The party had widespread support throughout the country and retained control over all 13 of the Malaysian states, with the exception of Kelantan. The Parti Islam SeMalaya (PAS) is the main opposition party. The issues of central importance in Malaysian politics are the achievement of developed nation status by 2020, continued economic growth, and the inclusion of Islamic principles in daily life.

3 Burma (Myanmar), Cambodia, and Laos were expected to be admitted to ASEAN in 1997 or 1998. 4 Internal CIBC CEF document.

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In terms of external relations, Malaysia's most important affiliations are with ASEAN and the Asia-Pacific Economic Community (APEC). Malaysia is also a member of the United Nations and a shareholder in the World Bank and the International Monetary Fund (IMF). Industrial policy The National Development Policy (1991) set out a 30-year vision that defines how the Malaysian economy will reach developed status by 2020. Included in the policy are plans to increase privatization of a number of government-owned entities. Government policies are also directed towards attracting foreign investment, with a view to further developing the industrial base of the country. The current focus is on infrastructure industries (for example, telecommunications, power, ports, roads, airports) with total spending from 1996-2000 estimated at M$ 68.3 billion 5 (Can$ 37.6 billion). Of great importance to CIBC CEF is that the government's focus on developing all aspects of the economy has resulted in banks with Malaysian branches being heavily favoured to win deals over those with no infrastructure in Malaysia. Monetary policy The inflation target for 1997 is under 4 percent, compared to an actual rate of 3.5 percent for 1996. This number is high for Malaysia, as a number of items included in the index are controlled. The indications are that the government is having difficulty controlling inflation. The outstanding feature of the economy has been a very high growth rate, with growth of 8.2 percent for 1996 and average annual growth from 1990 to 1995 of 8.7 percent. The target for the next five years is 8 percent per annum. The plan is also aiming to transform the economy from one that is investment driven to one that is productivity led through increased investment in human capital. Price pressures and the current account deficit are the two main areas of concern, and the central bank (Bank Negara) is addressing the overheating.

5 Exchange rate: 1$US = 2.52 Ringgit or 1RM = 0.39 US as at December 10, 1996.

106 Paul W. Beamish

Foreign investment The government's ambitious plans require a substantial flow of foreign investment. As an example, a number of incentives have been created to lure foreign investors to the new multimedia super corridor, which encompasses three of Malaysia's megaprojects: the Kuala Lumpur City Centre, the new KL airport, and the new administrative centre, Putrajaya. Location alternatives Labuan The island of Labuan is located off the northwest coast of Borneo, not far from the Kingdom of Brunei Darussalam. The island is 92 square kilometres, with a population of approximately 60,000. It is located on the major shipping and air routes of the ASEAN region, being roughly equidistant from Bangkok, Hong Kong, Jakarta, Kuala Lumpur, Manila, and Singapore. It is a free port where no sales tax, surtax, excise, or import and export duties are levied. The Malaysian government established Labuan as an International Offshore Financial Centre (IOFC) to enhance the flow of capital into Malaysia. The island is intended to be the Channel Islands or Cayman Islands of Asia. Labuan has the necessary conditions for a successful IOFC: political stability; a stable currency with limited exchange controls; banking secrecy; minimum rules and regulations; good infrastructure support facilities such as excellent communication with other financial centres; and access to a professionally qualified and experienced workforce. The government's commitment to the development of Labuan as an IOFC is reflected in the preferential tax treatment of banking, trust and fund management, offshore insurance, and offshore investment holding companies. The reduced corporation tax rate is 3 percent of audited net profits, or a flat tax of M$ 20,000 (Can$ 11,000). Costs/benefits The principal benefit to offshore banks operating from Labuan is the opportunity to deal directly with Malaysian corporations and govern-

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mem-related companies. Currently, foreign banks without a Malaysian presence are subject to various restrictions, including outright exclusion from government transactions. The establishment of an office in Labuan is often a prerequisite for bidding on infrastructure projects. The increase of intra-Asian and intra-ASEAN trade enhances the attractiveness of investing in Malaysia. The five biggest investors in Malaysia included four Asian countries: Taiwan ($1150 million); Japan ($706 million); the United States ($501 million); Singapore ($425 million); and Hong Kong ($350 million). Based on interviews with existing offshore banks in Labuan, local government authorities, the landlord of the Financial Park (office space), and KPMG of Kuala Lumpur, the estimated annual costs for operating a six-person office are US$ 652,800 (see Table 3). The biggest cost differentials between Singapore and Labuan are the salaries for administrative staff. In Singapore a mid-level administrative employee earns approximately US$ 40,000. In comparison, the same person would earn US$ 25,000 in Labuan. Infrastructure and competition The Labuan government indicates that projects totalling M$ 4 billion (Can$ 2.2 billion) are under development, including 4,000 housing units, road upgrades, a new airport, a new international school, a light industrial park, and improvements to the power supply. The Financial Park, the main business centre, has adequate facilities, including dedicated telephone lines. Labuan has attracted over 40 other foreign banks, including the Chase Manhattan Bank, the ABN-AMRO Bank, the Bank of America, Citibank Malaysia, and the Bank of Nova Scotia. Kuala Lumpur The capital of Malaysia, Kuala Lumpur, is located on the west coast of the Malaysian peninsula. With a population of approximately three million, it is Malaysia's largest city. The surrounding area is home to the majority of Malaysia's largest domestic- and foreign-controlled corporations. The city is undergoing numerous projects in preparation for

108 Paul W. Beamish Table 3: Estimated expansion costs (