Multinational Advantages of Chinese Business Groups: A Theoretical Explorationmore_

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1 Management and Organization Review 7: doi: /j x Multinational Advantages of Chinese Business Groups: A Theoretical Explorationmore_ Daphne W. Yiu Chinese University of Hong Kong, China ABSTRACT Prior research on the internationalization of emerging market firms focused either on established incumbent firms or peripheral latecomer firms. However, an increase in outward foreign direct investment from emerging markets such as China has benefitted from a new organizational form business groups. Given that new organizational forms pose fundamental challenges to existing theories on multinational enterprise, an examination of business group internationalization will bring the literature of multinational enterprise theories forward. Adopting an organizational approach, I propose that business groups, an organizational form that emerged to substitute market imperfections in China, constitute a micro-institutional environment for generating ownership, location, and internalization advantages, as well as for capitalizing on the linkage, leverage, and learning opportunities for internationalization. I posit that Chinese business groups facilitate such an internationalization process via their unique attributes including internal market, inward linkages, and institutional support. The article aims to provide a theoretical framework that generates insights for China s policy makers and managers, and to guide future research. KEYWORDS business groups, Chinese multinationals, emerging markets, internationalization, multinational advantages INTRODUCTION The rise of emerging market multinational enterprises (MNEs) has captured much attention in the field of international business in recent years. While some researchers have focused on modifying or extending traditional international business theories or frameworks (e.g., Dunning & Lundan, 2008; Erdener & Shapiro, 2005), others are proposing alternative explanations or new perspectives to describe new phenomena that seem to differ from past MNEs as described in the literature (e.g., Luo & Tung, 2007; Mathews, 2002; 2006a). To settle the debate on whether a new theory for emerging market MNEs is needed, Collinson and Rugman (2007) highlighted that most previous studies on emerging market MNEs drew

2 250 D. W. Yiu conclusions based on a small number of case studies or unrepresentative samples. In a similar vein, Narula (2006) clarified that Dunning s ownership, location, and internalization (OLI) framework applies to global incumbents while Mathews s (2002; 2006a) perspective focuses mainly on peripheral or latecomer firms and dragon multinationals from developing countries. This indicates that the scope of firms matters. In addition, all of these frameworks focus on individual firms. Here I focus on the globalization of a new organizational form in the largest emerging market China s business groups. A business group is defined as a collection of legally independent entities that are bound by formal and informal ties (Granovetter, 1994). According to the State Council of China, a key objective of the formation of business groups is to restructure large state enterprises into cross-industry, cross-region business groups and transform them into national champions that can compete in both the domestic and global markets (Nolan, 2001). Chinese business groups contribute a significant amount of China s outward foreign direct investment (OFDI). Business groups accounted for 74 percent of China s total OFDI in 2003 (China s Large Enterprise Business Groups, 2003; Ministry of Commerce, 2004). Also, 36 of the 40 top multinational firms (in terms of OFDI stock) in China from 2006 through 2008 are group-affiliated firms. Despite the significant role of business groups in contributing to China s OFDI, there is little understanding of the internationalization of Chinese business groups. How can this phenomenon be explained and how will this new organizational form present a challenge to existing theories of MNEs such as the OLI paradigm (Dunning, 1980)? In this article I aim to answer these questions. Primarily drawing on an institutional economics perspective, I posit that business groups constitute a micro-institutional environment for generating unique ownership, location, and internalization advantages, as well as for capitalizing on the linkage, leverage, and learning (LLL) opportunities, for internationalization. Through their internal capital market, inward linkages, and institutional support, Chinese business groups generate unique OLI advantages and attract LLL opportunities that facilitate both asset-exploitation and asset-augmentation internationalization strategies that are found in the global marketplace. The objective of this article is to develop a theoretical framework of the multinational advantages and internationalization strategies of Chinese business groups. This article seeks to offer several contributions. First, it highlights that existing theories of the MNE are fundamentally challenged by new forms of organization (Dunning & Lundan, 2008). The proposed framework describes how business groups, as a new organizational form in China, can be incorporated into the OLI framework and other theories of emerging market MNEs. Second, the adoption of the institutional economics perspective helps explain how organizational innovations given by Chinese business groups act as strategic responses to market failures in emerging markets, which then provide group-affiliated firms with different multinational advantages for internationalization. Third, Chinese business groups

3 Chinese Business Group Multinationals 251 have captured researchers attention in international business and management literatures (Keister, 2000; Lu & Ma, 2008; Yiu, Bruton, & Lu, 2005). This article fills a research gap by examining the multinational advantages generated by business groups in China. Finally, the article also offers implications to MNE managers in China and emerging economies with similar institutional environments on the choice of internationalization strategies. I will first provide a background on the internationalization theories of firms from emerging markets, which is followed by a description of Chinese business groups. I then present the conceptual framework including a set of propositions. The article ends with discussions of how the propositions relate to the existing literature and a research agenda to further our understanding of the internationalization of business groups. THEORETICAL BACKGROUND The presence of emerging market MNEs no doubt has brought challenges to our existing knowledge of MNEs. In the efforts to develop, modify, and improve MNE theories or frameworks, researchers have mainly diverged into two camps. One camp tends to build on existing frameworks and make extensions or modifications in order to fit the new phenomenon into their frameworks, while the other camp aims to generate new theoretical perspectives and frameworks for the new phenomenon. Below, I review the modifications of the traditional OLI framework and continue with a discussion of a number of so-called alternative perspectives for emerging market MNEs. Extension or Modification of the OLI Framework Traditional FDI theory, such as Dunning s OLI framework, draws on the assumption that firms pursuing international expansion should possess an internally transferable advantage to be successful. It is through the possession of such proprietary resources and capabilities that MNEs can generate a monopolistic or competitive advantage over indigenous firms in the host countries and, at the same time, offset the disadvantages of operating in a foreign country (Buckley & Casson, 1976; Caves, 1971; Hymer, 1976). Dunning (1980) identified three kinds of strategic advantages that can be realized from a firm s international expansion into a foreign market. First, the O (ownership) advantage refers to the spatially transferrable intangible assets of the parent firm such that they can outperform the MNE s indigenous competitors and help compensate the costs of setting up a foreign operation. Second, the L (location) advantage refers to the non-transferable advantages specific to the location of the foreign operation. Third, the I (internalization) advantage refers to the advantages arising from common ownership and governance of the foreign value-added activities of the

4 252 D. W. Yiu MNE. This last advantage helps to explain why the MNE opted to generate and exploit its ownership advantages internally rather than to acquire them through the open market. The emergence and prominence of emerging market MNEs has also posed a fundamental challenge to the OLI framework (Dunning, 1980) and calls have been made to refine or extend the framework. In a study of OFDI by firms from Argentina, Brazil, Hong Kong, and India, Lall (1983) found that firms from these emerging markets outperformed counterparts from developed markets when entering other emerging markets. This is due to their resource endowments of lower cost inputs, affiliation with a business group, ethnic connections in the host country, and technology and management that are adapted to the host country conditions. Thomas, Eden, and Hitt (2002) similarly identified that the unique resources of firms from emerging markets include technological capabilities, business group membership, previous state ownership, plus international and alliance experience. Khanna and Palepu (2006) also highlighted that many successful emerging market MNEs exploit their knowledge of local resource and product markets and seize opportunities from institutional voids at home. This knowledge and resulting capabilities help MNEs to build prominence in their own markets first before they expand abroad. Applying the OLI framework to Chinese family firms, Erdener and Shapiro (2005) argued that the competitive advantages of Chinese family firms are based mainly on relational advantages resulting from the deployment of their relational skills to link to different networks, including family members, suppliers and distributors, and political institutions, the distinctive environment of China and ethnicity, and the smaller size and tightly centralized control of the family firms that facilitates leverage of resources within the firm. In his later writings, Dunning (1996; 2000; 2006) concurred that the competitive advantages of Third-world multinational firms are likely to be very different from those of the First-world ones. Also, he acknowledged that Third-world MNEs might be prompted to invest in more developed countries for accessing or augmenting, rather than exploiting, their competitive advantages. However, he insisted that these asset-augmenting foreign direct investments also require that MNEs possess some initial capabilities in order to access the foreign markets to augment or to protect acquired resources. In addition, in re-appraising the OLI paradigm (e.g., Dunning, 1995; 2004), Dunning s proposal of alliance capitalism, relational assets, and the interdependent and dynamic relationships among the three legs of the OLI paradigm also provide important implications for emerging market MNEs. Alternative Perspectives on OFDI of Emerging Market Firms Seeing that emerging market firms behave somewhat differently from traditional multinational theories that are based primarily on an asset-exploitation assumption, researchers have begun to formulate alternative perspectives that draw from

5 Chinese Business Group Multinationals 253 an asset-augmentation assumption (Yiu, Lau, & Bruton, 2007a). A notable example is the work done by Mathews (2002; 2006a). Mathews captures the unique features of emerging market MNEs like those Asian multinationals in terms of the way that these latecomers leverage various kinds of strategic and organizational innovations for catching up in the global market. Mathews argued that these latecomer MNEs are faced with new opportunities for linking up with global networks. Through such linkages, emerging market MNEs can tap the resources of incumbents from more developed countries for advanced knowledge, technology, and market access. The capacity to secure resources from this relationship is referred to as leverage. Then the linkage and leverage opportunities can be repeated over time and generate industrial learning for firms, which subsequently helps enhance their capabilities to become advanced players. This LLL framework is a reversal of the traditional OLI framework because it argues that latecomer MNEs internationalize in order to build their advantages, rather than possessing advantages for exploitation in foreign markets. It also contrasts the traditional OLI framework that latecomer MNEs devise strategic innovations (that is, linkage, leverage, and learning) such that they can then exploit their latecomer and peripheral statuses to a competitive advantage. On the other hand, the OLI paradigm focuses mainly on firms with a prominent status at home for exploiting advantages abroad. Additionally, the LLL framework helps explain the rapid, accelerated foreign expansion of emerging market MNEs, whereas the OLI model assumes a gradual accumulation of OLI advantages for international expansion. The emphasis on an asset-augmentation perspective similar to Mathews has also been found in other studies on emerging market MNEs. For example, Makino, Lau, and Yeh (2002) adopted organizational learning and asset-seeking perspectives and argued that firms from newly industrialized countries engage in FDI to seek technology-based resources and skills that are not available in their home country environments. Child and Rodrigues (2005) echoed this view and pointed out that one important motivation for China s OFDI is that Chinese firms are seeking technological and brand assets to create a competitive position in international markets. Other researchers focus on how emerging market MNEs overcome their competitive disadvantages at home via expanding into more developed countries. For instance, Luo and Tung (2007) adopted a springboard perspective to suggest that emerging market firms use international expansion to acquire sophisticated technology, advanced manufacturing know-how, and brands in developed countries. By doing so, it helps these MNEs to compensate for, or avoid having, competitive disadvantages at home. Similarly, Rui and Yip (2008) adopted a strategic intent perspective to suggest that Chinese firms strategically use cross-border acquisitions to acquire strategic capabilities. This is done in order to compensate for their competitive disadvantages and leverage their unique ownership advantages, while making use of institutional incentives and minimizing institutional constraints. Using an institutional arbitrage

6 254 D. W. Yiu perspective, Boisot and Meyer (2008) argued that Chinese firms expand internationally to pursue more efficient institutions and exploit differences between different institutional arrangements operating in the home and host countries. In this way, Chinese firms seek out institutions capable of supporting international operations while at the same time neutralizing the location advantages of foreign firms in China s market. Extending or Refuting Existing Perspectives? There is no doubt that both the modifications of the traditional OLI paradigm and the development of alternative theories for emerging market MNEs aim to provide a better explanatory framework for addressing new and seemingly different strategic behaviours of emerging market MNEs. In fact, both kinds of research efforts have made significant contributions to our understanding of emerging market MNEs. There are both similarities and complementarities between the two camps of research. In regard to similarities, both the OLI paradigm and LLL framework emphasize the use of relational assets (Dunning, 2004) or linkages with external parties (Mathews, 2006a) for accessing resources and leverage opportunities given by the network form of organization. This helps to address emerging market MNEs salient use of networks and alliances in developing their strategic advantages. Moreover, Dunning s later modification that ownership advantages can be acquired coincides with Mathews s emphasis on the asset-augmentation strategic motives behind the LLL framework. Both frameworks help to address the rapid, accelerated internationalization process of emerging market MNEs. Although seemingly different, both Dunning (2006) and Mathews (2006b) concur that OLI and LLL frameworks are complementary with each other. First, the OLI framework originally focuses on established incumbent firms that possessed ownership and internalization advantages before their internationalization, while the LLL framework targets the less resourceful peripheral latecomer firms that develop their advantages through or even after the internationalization process. Thus, while it is criticized that the OLI framework does not apply to the peripheral latecomer firms such as dragon multinationals (Mathews, 2006b), the LLL framework is also criticized for being applicable to only a group of firms that are hard to classify either in terms of industry, technology, size, age or organization (Narula, 2006: 149). Second, while the OLI framework mainly accounts for strategic advantages for asset-exploitation FDI, the LLL model differentiates itself by accounting for asset-augmentation FDI by the peripheral latecomer firms. Nonetheless, it is commonly found that emerging market firms pursue both assetexploitation FDI in other emerging markets and asset-seeking FDI in more advanced countries (Buckley, Clegg, Cross, Liu, Voss, & Zheng, 2007; Dunning, 2006). In a related vein, although the OLI and LLL frameworks seem to be complementary, with the OLI framework emphasizing the possession of ownership

7 Chinese Business Group Multinationals 255 advantages and the LLL framework emphasizing the strategic ways of mitigating the lack of ownership advantages, both frameworks, in fact, focus on different types of firm capabilities. For instance, some researchers have criticized that the latecomer firms still need to possess some capabilities for establishing linkages, leveraging, and learning from their advanced partners, and protecting capabilities and knowledge learned (Dunning, 2006; Narula, 2006). However, such kinds of capabilities have not been explicitly addressed in both frameworks. Additionally, there remain issues regarding emerging market MNEs not having been resolved in the existing alternative perspectives mentioned above. For example, if emerging market firms enter developed markets for the sake of learning and asset-seeking, how could one explain subsequent foreign entries in the same developed markets undertaken by such emerging market firms? If emerging market firms enter foreign markets for institutional arbitrage, would emerging market firms stop their international entries when their home institutional environments become more developed? Like the LLL framework, these alternative perspectives may explain why emerging market firms internationalize, especially into developed markets, but they have not provided an answer on how emerging market firms develop and sustain competitive advantages in the global market. Taken together, although both modified traditional MNE frameworks and alternative perspectives help address the new phenomenon of the internationalization of emerging market firms, a dilemma arises: while one question of whether new theories of MNEs based on regional relevance is needed or whether emerging market MNEs are a new species (Collinson & Rugman, 2007; Narula, 2006), another concern is whether the modifications of traditional established frameworks will deviate away from the original intention of the framework (Mathews, 2006b). In particular, from the above discussion about the limitations of traditional MNE frameworks and alternative perspectives, I identified two major missing links. First, organizational form matters. The debate of Dunning and Mathews, to a certain extent, rests on which type of firms they focus on, be it resourceful incumbents or less resourceful peripheral latecomers. However, both of them focused on individual firms and omitted an important organizational form that is prevalent in emerging markets and a major player in global markets nowadays business groups. Business groups should possess some unique attributes and capabilities for sustaining their advantages in the global markets, but they were not examined in the literature. Second, the OLI and LLL frameworks have either focused on possessing advantages before internationalization or enhancing capabilities by accessing resources through internationalization. However, there is a missing link between these two steps. For those MNEs that possess advantages for internationalization, there is still an important intermediate step for them to mitigate institutional constraints and capitalize on institutional opportunities in the home markets for successful

8 256 D. W. Yiu internationalization. For those MNEs that succeed in acquiring advanced resources from abroad, they still require capabilities from adapting those acquired resources to the unique local context of the emerging markets. Therefore, it is of critical importance to examine if and how emerging market MNEs realize benefits from developing or acquiring resources and capabilities. I argue that business groups constitute a micro-institutional framework for enhancing the competitiveness of emerging market MNEs. In this article, I examine this question by delineating the unique multinational advantages enhanced by business groups a new organizational form for globalization in emerging markets. By doing so, I aim to re-specify existing MNE frameworks such as the OLI framework and the LLL framework, thus extending such traditional FDI theory in the context of emerging markets. CHINESE BUSINESS GROUPS According to the National Statistics Bureau of China, a business group is a group of legally independent entities that are partly or wholly owned by a parent firm and that are registered as the affiliate firms of that parent firm. Business groups in China are characterized by a core firm known as the group company, which has equity, debt, personnel, and trading links with affiliate firms (Carney, Shapiro, & Tang, 2009). They are cross-industry, cross-regional entities with strong ties to the state (Keister, 1998; White, Hoskisson, Yiu, & Bruton, 2008). There are also strong social connections such as family and school ties among member firms in Chinese business groups (Keister, 2000; Luo & Chung, 2005), thus closely adhering to Granovetter s (1994) definition of a business group. A business group is different from a multidivisional firm because its group affiliates are all independent legal entities. It is also different from a network of firms because it has strong central coordination and strategic and financial controls among affiliates in the group (Yiu et al., 2007a). In China, a key aspect of the economic reform is to transform and restructure state enterprises into large business groups that can compete in domestic and global markets. Starting in the 1980s the Chinese government dismantled state bureaus that oversaw firms before the economic reform and transferred them into business groups (Keister, 2000). The government selected groups of firms from the same bureau, designated a core firm, and provided support in developing the group s administrative structure. In addition to state-designed business groups, there are also business groups formed voluntarily by private parties but they are usually outside strategic industries such as defence (Carney et al., 2009). Although business groups are comprised mostly of state firms from previous bureaus (e.g., Shougang Group), there are also groups that originated from collectives (e.g., Haier Group) and private owners (e.g., Huawei Group). Over the years, state-owned business groups continue to transform shareholdings and distribute

9 Chinese Business Group Multinationals 257 shares to outside parties such as joint venture partners and foreign firms. A number of business groups are now listed in China s Shanghai and Shenzhen stock exchanges and foreign stock exchanges in Hong Kong, the U.K., and the U.S. Table 1 summarizes the number, asset size, and OFDI amount of the different types of business groups (in terms of ownership) in China in 2006 and By 2006, there were 2,926 business groups with about 30,000 first-tier group affiliates (China Statistics Yearbook, 2007). Business groups serve as the primary economic engine for the development of the economy in China (Keister, 1998; Nolan, 2001). Over the past two decades business groups in China have grown from being non-existent to a point where the revenues of the largest 500 business groups contributed percent of the nation s industrial output in (China s Large Enterprise Business Groups, 2005; 2006; 2007; China Statistical Yearbook, 2005; 2006; 2007). Moreover, the 11th Five-Year Plan of China s Economic and Country Development in 2001 stated that the Chinese government leaders aimed to develop large business groups as multinational corporations with their own property rights, strong global brands, and global competitiveness. Next, I will focus on illustrating the role of business groups in China s OFDI. Outward FDI of Chinese Business Groups As mentioned above, Chinese business groups are designed to become giants in the global competitive landscape. The Chinese government selected about 100 or so of the largest business groups as trial business groups for internationalization. These business groups are collectively referred to as the national teams (Nolan, 2001; Sutherland, 2009). In the 11th Five-Year Plan, the Chinese leaders specified that the national teams should have the following characteristics: strong innovation and technological capabilities, an outstanding core business, well-known brands and property rights, strong marketing capabilities and developed distribution networks, sustained growth in market share, ability to take risk, economies of scale, management capabilities, executive teams with high adaptability to the global environment, and major financial indicators reaching international counterparts in the same industry. The national teams are mostly state-owned and directly overseen by the State Council. The State Council also set up the State-Owned Assets Supervision and Administration Commission (SASAC) to nurture these national teams and encourage them to go global. The national teams received certain special treatment for internationalization such as a relaxing and speeding up of their applications for OFDI projects, access to foreign currency (low-interest funding from state-owned banks), direct and indirect subsidies, and domestic tax breaks. Because of the above special treatments, business groups play a significant role in China s OFDI. In sum, 74 percent of the nation s OFDI is contributed by business groups (US$2.15 billion and total OFDI by China is US$2.9 billion) and

10 258 D. W. Yiu Table 1. Classifications of Chinese business groups Business group classifications No. of business groups Total assets* OFDI amount* No. of business groups Total assets* OFDI amount* Total 2, , , , By ownership type: State-owned 1, , , , Collective-owned , , Private-owned 1,089 23, ,212 30, Owned by Hong Kong, Macau, and Taiwan parties Foreign-owned 37 1, , By industry type of group s core business: Farming, forestry, animal husbandry, and fishery 31 3, , Mining 98 28, , Manufacturing 1,619 96, , , Production and distribution of electricity, gas, and water 89 37, , Construction , , Transportation, storage, and post 97 19, , Information transfer, computer services, and software 12 17, , Wholesale and retail trade , , Hotels and catering services , Finance 12 22, , Real estate 166 7, , Other , , Notes: * Dollar amount is in million RMB. Source: Annual Report on the Development of China s Large Enterprise Groups 2006; OFDI, outward foreign direct investment.

11 Chinese Business Group Multinationals 259 Table 2. Top 40 Multinational corporations in China (in terms of and ranked by OFDI stock as of 2008) 1 China National Petroleum Corporation* 21 Lenovo Holdings Ltd.* 2 China Petrochemical Corporation* 22 China National Travel Service (Hong Kong) Group Corporation* 3 Aluminum corporation of China* 23 GDH Limited 4 China Resources (Holdings) Co. Ltd.* 24 China National Foreign Trade Transportation (Group) Corporation* 5 China Ocean Shipping (Group) Company* 25 China Metallurgical Group Corporation* 6 China National Offshore Oil 26 Huawei Technologies* Corporation* 7 China National Cereals, Oils & 27 Shanghai Baosteel Group Corporation* Foodstuffs Corp.* 8 Sinochem Corporation* 28 Shanghai Automotive Industry Corporation* 9 CITIC Group* 29 China Power Investment Corporation* 10 China Merchants Group* 30 State Grid Corporation of China* 11 Sino Steel Corporation* 31 Shougang Corporation* 12 China Shipping (Group) Company* 32 ZTE Corporation* 13 China National Aviation Holding 33 Shenzhen Investment Holdings Co. Ltd. Corporation* 14 China Minerals Corporation* 34 Guangzhou Yuexiu Holdings Limited* 15 China National Chemical Corporation* 35 China Nonferrous Metal Mining & Construction (group) Co. Ltd.* 16 China State Construction Engineering Corporation* 36 Beijing Foreign Trade & Economy Holding Co. Ltd. 17 China Mobile Communications Corporation* 37 Shanghai Overseas United Investment Co. Ltd. 18 China Huaneng Group* 38 Anshan Iron & Steel Group Corporation* 19 China Unicom Corporation* 39 Haier electrical Appliance Corp. Ltd.* 20 Shum Yip Holdings Company Limited* 40 Jinchuan Group Ltd.* Notes: Source: Ministry of Commerce, * Business group affiliates according to the official list of Chinese business groups that is published annually by the State-owned Asset Supervision and Administration Commission (SASAC) of the State Council and the Annual Report on the Development of China s Large Enterprise Groups published by the National Statistics Bureau Association percent by the national teams alone in 2003 (China Statistical Yearbook, 2004; Sutherland, 2009). By 2006, business groups OFDI amounted to US$3.7 billion. Also, as shown in Table 1, OFDI conducted by Chinese business groups is predominantly contributed from state-owned business groups. Thirty-six (90 percent) of the largest 40 multinational corporations in China (in terms of OFDI stock in 2008) are business group affiliates (see Table 2). In addition, there are 30 Chinese firms ranked on the global 500 list, in which business groups like China

12 260 D. W. Yiu Figure 1. Geographical distribution of China s outward foreign direct investment (OFDI) in 2008 Latin America 5% Australia 4% North America 11% Europe 16% Asia 51% Africa 13% Petroleum and Chemical Corporation (Sinopec Group), China National Petroleum Corporation, and State Power Corporation of China were ranked 17th, 24th, and 29th (respectively) in Although the top 500 Chinese firms were 9.32 percent of the Global 500 firms in terms of total sales in 2006, they are growing much faster than the Global 500 firms (29.98 percent vs percent in 2003; 21.5 percent vs percent in 2006) according to the National Statistics Bureau and Ministry of Commerce of China. Figure 1 shows the geographical distribution of OFDI conducted by Chinese firms in According to the Ministry of Commerce, 2008, the geographical distribution of China s OFDI is as follows: 51.2 percent in Asian countries such as Hong Kong, Japan, Korea, and Vietnam; 16.3 percent in Europe; 12.9 percent in Africa; 11.3 percent in North America; 4.8 percent in Latin America; and 3.5 percent in Australia. The majority of China s OFDI goes to other emerging markets, although OFDI in developed markets has been steadily increasing. Appendix I lists the countries that received China s OFDI between 2003 and Finally, in terms of internationalization performance, 79.9 percent of the 136 business groups (with 1,791 foreign subsidiaries in 127 countries as of 2008) under the State Asset Management Bureau made profits, 2.5 percent broke even, and 17.6 percent reported a loss (China s Large Enterprise Business Groups, 2007). Given the significant role of business groups in China s OFDI, I next examine the multinational advantages given by Chinese business groups that contribute to

13 Chinese Business Group Multinationals 261 their success in globalization. The unit of analysis is business group affiliates as compared with non-group independent firms in China. Multinational Advantages of Chinese Business Groups Drawing from the institutional economics perspective, I conceptualize business groups as a new organizational form that constitutes a micro-institutional framework for mitigating market imperfections in the home market of China s emerging economy. Further, I propose that business groups, relative to generic firms, possess unique multinational advantages to stay competitive in both developed and emerging foreign markets. These group-specific advantages help group affiliates to either exploit their home-developed advantages in other emerging markets and cost advantages for staying at the lower end of the value chain in developed markets (Khanna & Palepu, 2006), or to acquire capabilities for staying competitive in both the home and host markets (Mathews, 2006a). In general, I posit that business groups possess three unique attributes: internal market or market internalization, inward linkages, and institutional support. These attributes help generate specific OLI advantages and attract opportunities for linkages, leverage, and learning for business groups to successfully pursue both asset-exploitation and assetaugmentation internationalization strategies. Figure 2 summarizes the proposed conceptual framework. Internal Market The institutional economics perspective suggests that organization innovations emerge to fill institutional voids in response to market failures in emerging economies (Caves & Uekusa, 1976; Khanna & Palepu, 2000; Leff, 1978; Stark, 1996). The incompleteness of markets is also said to provide arbitrage opportunities for an organization to discover new ways of combining resources (Boisot & Meyer, 2008; Denrell, Fang, & Winter, 2003). Extant research (Chang & Choi, 1988; Khanna & Palepu, 2000) found evidence that business groups substitute the imperfect markets in emerging economies by lowering transaction costs for their affiliate firms through the internal market and group management that coordinates the allocation and exchange of resources and products. Leff (1978: 667) explained that business groups are a mechanism for dealing with deficiencies in the markets for primary factors, risk, and intermediate products in the developing countries. On the one hand, business groups are substitutes for market failures in mobilizing capital. On the other hand, they are substitutes for organizational failures in allocating resources efficiently without expanding the scale of operation internally in less developed countries (Leff, 1978). Extending these arguments, Khanna and Palepu (2000) specify the substitution roles of business groups in emerging economies by highlighting that business groups create economic value and fill the

14 262 D. W. Yiu Figure 2. Business group attributes, MNE advantages, and internationalization strategies of Chinese firms Chinese Business Group Attributes Multinational Advantages Internationalization Strategies Internal market Ownership and internalization advantages Intra-group linkage and leverage opportunities Inward linkages Location advantages Linkage and learning opportunities Asset-exploitation in emerging markets and lower-end market of advanced countries Asset-augmentation in advanced countries Institutional support Ownership advantages Linkage and learning opportunities institutional voids in emerging economies. Business groups create an internal capital market for transferring funds and underwriting security issues, rotate managerial talent to member firms in need, invest in an umbrella brand name and a reputation for fair dealing, and assimilate foreign technology through cooperative arrangements. In other words, business groups act as a strategic response to strategic market imperfections in emerging markets (Khanna & Palepu, 2000). Below I will elaborate how the internal market of business groups generates both OLI advantages and LLL opportunities for Chinese firms to undertake both asset-exploitation and asset-seeking internationalization activities. In China, a major objective of the formation of business groups is to make use of business groups internal capital market for generating scope economies and central coordination, which are essential for developing ownership advantages such as brand development and technological innovations. I have mentioned in previous sections that the national teams (large trial business groups selected by the Chinese government in the 11th Five-year Plan) possess strong innovation and technological capabilities, well-known brands, strong marketing capabilities, and developed distribution networks, scale economies, management capabilities, sustained performance in domestic market, etc. These capabilities serve as ownership advantages for business groups to compete globally. Table 3 lists the ownership

15 Chinese Business Group Multinationals 263 Table 3. Ownership advantages and scale of internationalization of six Chinese business groups National teams Size and diversity of the group Ownership advantages Scale of internationalization Sinopec Group 79 1st tiered affiliates 7 business sectors: oil exploration and production; oil refining and sales; chemical products; R&D; foreign trade & technology cooperation; environment & safety; IT application Ranked 17th in Global 500 and 1st in China 500 Listed in China, Hong Kong, New York, and London stock exchanges Well-developed distribution networks 7 registered trademarks under its branding consolidation strategy 6 research institutes, 572 domestic patents, and 173 foreign patents Has operations in U.S., U.K., East and middle Asia, the Soviet Union, Saudi Arabia, the Middle East, North Africa, and Europe Acquisitions in Australia and Canada 12,011 foreign employees as of 2008 China National Petroleum Corporation 169 affiliate firms Businesses: oil and gas upstream and downstream operations, oilfield services, engineering and construction, petroleum material and equipment manufacturing and supply, capital management, finance and insurance services, to new energy operations Ranked the 24th in Global research institutes and training centres Top brands in China Listed in Shanghai, Hong Kong, and New York stock exchanges 7,010 patents CNPC had 17 Chinese Academy of Sciences and Chinese Academy of Engineering academicians, 176 CNPC experts, and 16,000 technicians and senior technicians Has operations in 27 countries such as Azerbaijan, Canada, Kazakhstan, Indonesia, Myanmar, Oman, Peru, Russia, Sudan, Thailand, Turkmenistan, and Venezuela Shougang Group 42 affiliated firms 20 related and unrelated business segments including steel, mining, machinery, electronics, construction, real estate, services, overseas trade and other industries. Ranked 36th in the China 500 1/3 domestic market share in the steel industry National patents Considered as national brand with exemption for export inspection 920,000 employees, 50% of which are bachelors or above Set up ShougangNEC the heart of Shougang s electronics capability Acquired the U.S. Mesta Engineering Co. in overseas enterprises in 13 countries and regions including America, Europe, Southeast Asia, the Middle East, and the Soviet Union Foreign sales and overseas assets amounted to a quarter of its total sales and assets

16 264 D. W. Yiu Table 3. (cont.) National teams Size and diversity of the group Ownership advantages Scale of internationalization ChemChina Group Corporation 9 affiliate firms and 118 production cooperatives more than 10 listed firms 6 related business segments: advanced specialty chemicals, oil processing, agrochemicals, chlor-alkali chemicals, rubber processing & equipment, and R&D Ranked 35th in the China listed companies in Shanghai and Shenzhen stock exchanges Global and national awards State-of-the-art production units and R&D institutions for high-tech and value-added products Acquired firms in France and Australia Built production plants and R&D bases in 140 countries worldwide China Ocean Shipping (Group) Company Over 300 affiliate firms In addition to the shipping and logistics services, COSCo diversifies into ship-building and repairing, marine engineering, terminal operation, trade, financial and IT services The containers fleet ranks No. 1 in China and No. 6 in the world; the dry bulk fleet ranks the top in the world 7 listed companies in Shanghai and Hong Kong stock exchanges Awarded ISO9001, ISO14000, and OHSASI patents and copyrights More than 1,000 business entities in over 160 countries including Hong Kong, Japan, Singapore, the U.S., Europe, Australia, Korea, South Africa, and the West Asian regions. Sinochem Group More than 200 affiliate firms 5 business segments including agricultural, energy, chemical, real estate, and finance Ranked 170th in Global 500 Ranked the 5th in China s 500 Most Valuable Brand 3 listed companies in Shanghai and Hong Kong stock exchanges 21 foreign subsidiaries in Asia, Europe, Africa, North and South America Acquired Emerald Energy (UK-based) and Nufarm (Australian generic crop protection company) Notes: Source: Company websites and annual reports.

17 Chinese Business Group Multinationals 265 advantages and scale of globalization of six exemplar Chinese business groups. These six business groups are selected by the Chinese government as trial business groups or national teams to become competitive global players. They are also among the top 30 Chinese firms in terms of outward FDI. In particular, business groups scope economies resulting from market internalization enable business groups such as Haier and BOE Technology Group (formerly named as Beijing Orient Electronics Group) to adopt low-cost, niche-market strategy to enter the lower-end of the global value chain (Kang, 2009). Some of the Chinese business groups are listed in domestic and foreign stock exchanges, thus providing other sources of financial capital for member firms through the internal market to pursue asset-seeking international strategy. As illustrated in Table 3, most of the national teams are listed in foreign stock exchanges and obtained foreign patents in order to capitalize on the more advanced capital markets and legal systems abroad. TCL s acquisition of Thomson, Shougang s acquisition of Mesta Engineering, and CNOOC s acquisition of Unocal are examples of asset-augmentation, while Lenovo s entry into Hong-Kong for mitigating the administrative constraints of applying a computer manufacturer license is an example of institutional arbitrage. In these cases, business groups provide the initial financial and managerial capital for such acquisitions through a strong internal capital market. Internal capital markets also generate opportunities for vertical and horizontal linkages among member firms in a business group. Vertical linkages help control price variations in factor markets, thus controlling production costs. Horizontal linkages facilitate resource and information sharing as well as joint R&D and technological innovations. Such internalization allows the transfer of assets or knowledge acquired by member firms to the rest of the members without incurring high coordination costs (Yiu et al., 2007b), thus realizing the benefits of internalization. For instance, Baosteel Group has a strong vertical integration in the group: Upwardly, the group has ten overseas subsidiaries controlling key mineral resources in Australia and Brazil. The group also cultivated partnerships with the suppliers of minerals, coal, and shipping services to secure long-term supplies and efficient logistics. Downwardly, the group developed a distribution and sales network throughout China and ten foreign countries. The group also undertakes specialization among its affiliate firms. Taken together, the group is highly integrated, which helps strengthen its global competitiveness in the core iron and steel business. The realization of internalization advantages is further facilitated by the strong group culture developed through an internal market. The sustainability of a wellfunctioning internal market requires high levels of trusts. Business groups are characterized by solidarity norms and codes of behaviour (Granovetter, 1994; White et al., 2008). Such solidarity norms and codes of behaviours foster a strong group culture or a moral economy, which refers to the extent to which economic

18 266 D. W. Yiu actions within a business group presuppose a moral community where trustworthy behaviours are expected, normative standards are met, and opportunism is foregone (Granovetter, 1994). Accordingly, business groups can govern member firms effectively, which then facilitate the sharing and transfer of knowledge and resources among member firms both domestically and globally. In particular, business groups can benefit the most from asset-seeking FDI in which overseas affiliates transfer assets and knowledge back to the group at home. Scope economies and a long-term, trustful network also generate a great absorptive capacity for member firms to learn. This is particularly important to leverage the knowledge learned from abroad for further upgrade of member firms ownership advantages. Taken together, I posit the following: Proposition 1: Chinese firms in business groups, as compared with non-group firms, are more likely to accumulate unique ownership and internalization advantages and provide linkage and leverage opportunities for both asset-exploiting and asset-seeking internationalization through the group s internal market. Inward Linkages As highlighted in the literature, global latecomers such as emerging market firms can accelerate their internationalization process by capitalizing on opportunities given by their home country institutional environment and learning through inward internationalization. Business groups offer a good example in illustrating how their linkages with inward foreign entrants enable their member firms to accelerate the internationalization process. In emerging markets, market liberalization has attracted many foreign firms to enter. The reputation and close tie with local institutions possessed by business groups makes them especially appealing to foreign entrants. This home location advantage allows business groups to develop their capability to compete in domestic and global markets, because foreign partners can channel resources and factors that are not available in emerging economies. In this way, Chinese business groups can overcome their initial resource hurdles that arise as a result of technological gaps and late-mover disadvantages in global markets by learning from their foreign partners at home. Empirical evidence found that inward FDI benefited stateowned enterprises and collective enterprises in China (Buckley, Clegg, & Wang, 2004). Thus, I propose that Chinese business groups can capitalize on the home location advantages and learning opportunities from inward linkages (linkages set up with foreign partners in the home country) as a precondition for their outward internationalization. Such home location advantages will subsequently be transformed into ownership advantages for asset exploitation in other foreign markets. Also, the inward linkages set up with foreign partners at home can be leveraged to partners home markets for further asset acquisition.

19 Chinese Business Group Multinationals 267 In China, business group firms have greater opportunities to collaborate with foreign partners at home than non-group counterparts. Given their resource pools, established brands and market legitimacy as well as government support, Chinese business groups become popular indigenous partner targets for foreign firms entering China. Lu and Ma (2008) found that strategic alliances with Chinese business groups outperform those with partners that are not group-affiliated. By working with foreign partners in alliances or joint ventures at home, Chinese business groups are able to build an inimitable capability to combine domestic and foreign resources to expand quickly (Guillén, 2000). Examples to illustrate how Chinese business groups learned from their foreign partners at home for internationalization include: Haier s joint venture with Mitsubishi Heavy Industry to produce air conditioners in China before entering foreign markets in Southeast Asia; Shougang formed joint ventures with Sweden s Kanthal and Japan s NEC for production technology and management knowhow; and the Shanghai Electric Group formed 125 joint ventures including Westinghouse, Carrier Siemens, Mitsubishi, Hitachi, and Schneider before entering Japan. Combining the above arguments, I propose: Proposition 2: Chinese firms in business groups, as compared with non-group firms, are more likely to accumulate location advantages and attract linkage and learning opportunities for both asset-exploitation and asset-augmentation internationalization through the group s inward linkages at home. Institutional Support The final unique multinational advantage possessed by Chinese business groups is institutional support, in particular, support from the government. Governments in emerging markets see the need to promote outward FDI (Sauvant, 2008). In China, seeing that large firms are central to the growth of late industrializing economies, the Chinese government implemented the enterprise reform that aims at transforming large state-owned enterprises into giant multinational corporations (national teams) that can compete in the global market. The national teams receive a variety of government special treatments for internationalization, such as speeding up their applications for OFDI projects, access to foreign currency (low-interest funding from state-owned banks), direct and indirect subsidies, domestic tax breaks, and access to research institutions (Keister, 2000; Yiu et al., 2007a). New institutions such as the China Investment Corporation and China Development Bank also provide special loans and other financial assistance for their overseas expansion. For example, Haier received a number of financially ailing firms for free from local govern-