1 the Emergence of Competence Creating Subsidiaries in UK

The emergence of competence creating subsidiaries in UK pharmaceuticals in the 20th century ABSTRACT The evolutionary model of the MNE emphasizes that subsidiary specialization is the consequence of the transition from market- to efficiency-seeking FDI. But over 40% of subsidiaries in UK pharmaceuticals had acquired competence creating mandates by 1963, when market- seeking strategies were universal. The paper finds that none of the determinants of the rise of competence creativity in UK pharmaceuticals in recent years can explain what was at least as significant a rise between 1945 and 1963. The paper concludes that the evolution of competence creating subsidiaries is probably more dependent on subsidiary manager agency and path dependency that commonly allowed. Word count (not including abstract): 13,916. Keywords: History of FDI and the MNE; Historical Adaptation; Evolution of subsidiaries and headquarters; R&D; Historic FDI in UK pharmaceuticals. 1 What drives creativity? The emergence of competence creating subsidiaries in UK pharmaceuticals in the 20th century. Introduction: From market-seeking to efficiency-seeking FDI and the emergence of competence creating subsidiaries. One of the most significant developments in the last twenty years or more of scholarship in international business has been the recognition of how the overarching purpose of foreign direct investment (FDI) by multinational enterprises (MNEs) has switched from being market-seeking to efficiency-seeking, which has transformed the understanding of the role of subsidiaries and the organizational structures of MNEs (Dunning and Lundan, 2008, e.g. p. 190).1 In the earlier market-seeking stage of MNE evolution, MNEs typically had multi-domestic structures, where the ‘parent firm undertakes the first stage of production, for example, the R&D and design work for each of their products in the home country’, and then manufactures overseas (Dunning and Lundan 2008, p. 209 and fig. 7.1). The most explicit statement regarding the relative inferiority of subsidiary status in new product development came through Vernon’s product cycle theory, where subsidiary R&D was deemed unimportant and qualitatively restricted to adapting products for local markets (Vernon 1966). The Uppsala stage theory also assumes that ‘knowledge creation in foreign markets occurs at a late stage’ (Cantwell and Mudambi 2004, p. 40, Johansen and Vahnle 1977). The switch to efficiency-seeking strategies was associated first, with much greater levels of FDI around the world, and then second, far greater specialization among subsidiaries as they utilized the endowments of their host economies. The subsidiaries best placed to exploit the most valuable knowledge-intensive local endowments were research and development (R&D) facilities, and so, in accordance with this emerging body of theory, the shift to efficiency-seeking investment has led both to a growing geographic dispersal of R&D functions generally, and the growing likelihood that some overseas R&D subsidiaries acquire sufficient capabilities that they are able to acquire greater levels of responsibility for product innovation from the parent company. From the late 1970s foreign affiliate expenditure on R&D increased rapidly, first in the US and then in Europe (Dunning and Narula 1995, Holm and Pederson 2000). The idea of the world product mandate, or competence creation mandate2, began to take shape in the early 1980s among a few leading MNEs (Dunning and Lundan 2008 p. 738, Dunning and Narula 1995 p. 69, Pearce and Papanastassiou 2009, Cantwell and Mudambi 2005), where those few subsidiaries that had displayed sufficient competence were given a charter to contribute to parent company strategic innovation. 2 By the end of the 1980s the globalization of R&D had become an unmistakeable aspect of this evolving strategic behavior (Feinberg and Gupta 2004). It is difficult to overemphasize its significance for the prevailing understanding of the role of MNEs in the world economy. A market-seeking environment understands MNEs essentially as institutions responsible for the transfer of certain kinds of technology, technology sufficiently complex or tacit that other forms of internationalization (such as licensing) failed (Buckley and Casson 1976). The current model, by contrast, no longer sees an MNE as a fairly passive child of market failure, but rather as a far more dynamic organization, increasingly able to combine parent company innovations with those emerging in different subsidiaries to produce wholly new and better products and services that can be sold in ever more locations around the world (Cantwell, 1995; Cantwell and Piscitello, 1999; Cantwell and Janne, 1999; Pearce, 1999). As the transition from market-seeking to efficiency-seeking FDI has transformed the role of the subsidiary, so correspondingly it has also been the catalyst for a change in the structure of the MNE. Outside a few pioneers, multi-domestic or ethnocentric organisations were universal and, moreover, in a market-seeking environment subsidiaries were able to operate under some considerable autonomy with ‘minimal parental interference’ (Dunning and Lundan 2008, p. 187). After all their primary function was simply to place a given product into the host market. By contrast, in an efficiency-seeking environment, parents have to reconfigure the entire multinational organisation away from a series of dyadic HQ- subsidiary relationships into an increasingly differentiated network. Here the flows of knowledge are no longer necessarily from the centre to subsidiaries, but increasingly from subsidiaries to all other nodes on the network (Kuemmerle, 1999; Nohria and Ghoshal, 1994; Birkinshaw and Hood, 1998). By the early 2000s the large MNE was ‘evolving into… the role of an orchestrator of production… the decision-making nexus of the MNE has come to resemble the central nervous system of a much larger group of interdependent… activities’ (Dunning and Lundan, 2008, p. 739). The imperative for better internal co-ordination of resources and information has prompted many MNEs to become polycentric or geocentric organisations (Hedlund 1986). Underpinning this explanation of the specialization and orchestration of subsidiary R&D activities around the world was a renewed emphasis on the importance of location advantages. Efficiency-seeking MNEs became increasingly aware of the potential advantages for new technology creation available to them in different locations around the world (Dunning 1998, Cantwell 2009), so encouraging subsidiaries to adapt, ‘tapping into local sources of competence’ (Ensign, Birkinshaw and Frost 2000, p. 149-50). The central tenets of the evolutionary model of the MNE can thus be summarized as follows: a shift from market- to efficiency-seeking investment strategies precipitated a move to a much greater level of FDI 3 overall, with vastly increased specialization among subsidiaries, the most important of which was the emergence of competence creating subsidiaries. The increased specialization of subsidiaries and, for some, their growing contribution to parent new product development, in turn co- evolved with the emergence of new organizational forms, notably the move from ethnocentric to geocentric structures. The shift from market- to efficiency-seeking strategies is thus central to understanding the emergence of the modern MNE. This shift can in turn be explained by the change in the wider global economic environment, where a series of institutional changes introduced the liberal world trade order increasingly from the late 1960s onwards which had the effect of increasing competition. This was made ‘possible by the reduction of barriers to trade between countries’ (Dunning and Lundan, 2008, p. 192). Pearce and Papanastassiou (2009) are even more explicit about this historical process. The multidomestic hierarchy with its centralization of R&D emerged because of tariffs and other restraints on trade from the 1930s onwards, reaching its ‚apotheosis… in perhaps the mid-1960s‛ (p. 5), and it was only after that subsidiary specialization began. The key historical event here was the Kennedy Round of General Agreement on Tariffs and Trade (GATT), which began in 1964 and was the first multilateral trade agreement to remove any trade barriers after World War Two. The 1967 Kennedy Agreement was supported by other, near contemporaneous but less significant events (the European Economic Community formed a partial free-trade area among six nations in 1958, for instance), and was ultimately superceded by the more far-reaching removal of trade barriers in GATT’s Tokyo Round from 1980. But the opening of the Kennedy Round discussions meant that 1964 was when the era of de- globalisation began to draw to a close (Jones, 2005). So with the increasing removal of trade barriers initially after 1967, and then more clearly from 1980, global competition increased. There has emerged therefore a consensus that the evolution of the MNE in the last thirty to forty years ,with its associated increase in the scale and specialization of subsidiary activities, and all co-ordinated by a geocentric organizational structure, has been driven by increasing levels of international competition. And while no single indicator of levels of competition exists that would cover such a global transformation of international business, the conventional proxy of looking at trends in international trade (as an indicator of an economy’s relative openness to international competition [Cantwell and Piscitello

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