Taking craft beer global : accelerating the internationalization process for newly formed subsidiaries : a company project for Lagunitas Brewing Company

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Taking Craft Beer Global

Accelerating the Internationalization Process for Newly

Formed Subsidiaries

A company project for:

The Amsterdam MBA Company Project

University of Amsterdam

Student: Jacob Collier

Student ID: 11352809

Email: jacob.h.collier@gmail.com

Supervisor: Markus Paukku

Email: M.P.Paukku@uva.nl

Submission Date: 31/08/2017

Please handle this thesis in a confidential matter as the company information shall not be published for a period of six years.

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Accelerating the Internationalization Process - Subsidiary Accelerating the Internationalization Process - Subsidiary

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Accelerating the Internationalization Process - Subsidiary Accelerating the Internationalization Process - Subsidiary Executive Summary

The explosion of craft beer in the United States over the past decade has allowed for an entire industry to be re-thought, re-tooled, and reinvigorated with a passion that hasn’t been seen in over one hundred years. This market is now experiencing a tipping point, a state of over saturation, that is placing pressure on the breweries to increase quality, expand distribution, improve marketing strategies, all while providing a product at a price that appeals to the consumer. Breweries are having to make the difficult decision on how to support further growth to maintain competitive whether it be internal reinvestment, taking outside money, or leveraging debt through a financial institution.

The company at focus of this research project is a California based brewery, The Lagunitas Brewing Company. Lagunitas has grown over the past twenty years to become a top ten brewery in the United States with ambitions to take their products across the globe. In doing so, Lagunitas first created a joint venture with Heineken, the second largest brewer in the world, and two years later became a wholly owned subsidiary of Heineken. Lagunitas is now operating under the control of a multinational and must efficiently navigate this new corporate environment by capitalizing on the opportunities that it provides for globalization.

Hence, this study concentrates and analyzes how firms go about internationalization and the various foreign direct investments that will enhance the experience. Moreover, in order to boost the involvement within a multinational corporation, this paper dives into the effects and resulting relationships a subsidiary has when they take on additional initiative. Additionally, the study concentrates on the significant of knowledge flow and how becoming an outsider can affect overall performance.

The results of this paper originate from the secondary research, interviews and, experiences from both Lagunitas and Heineken’s different business units including operations, sales, and export. The findings are presented as recommendations for Lagunitas so they can successfully operate and grow while maintaining a strong relationship with their new parent company. The findings cover subsidiary behavior, vertical and horizontal communication, and the access of knowledge.

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Table of Figures

Figure 1. US Beer Production in 2016 ...13

Figure 2. US Brewery Count in 2016 ...14

Figure 3. Uppsala Model of Internationalization ...21

Figure 4. Learning Engagement Strategies ...23

Figure 5. CAGE Framework Distance Descriptors ...24

Figure 6. Mode of Entry Determinants ...27

Figure 7. Asset Specificity and Frequency in Entry Mode Choice ...28

Figure 8. OLI Framework ...31

Figure 9. Subsidiary Research over Time...33

Figure 10. Knowledge Flow ...35

Figure 11. Subsidiary Capabilities Affect on Knowledge Flow ...36

Figure 12. Subsidiary Resources and MNC’s firm-specific advantage...37

Figure 13. Process Model of Subsidiary Activities and Resources...39

Figure 14: Lagunitas CAGE Factors...42

Figure 15: Lagunitas International Expansion Strategy...43

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Accelerating the Internationalization Process - Subsidiary Accelerating the Internationalization Process - Subsidiary I. Introduction

This thesis discusses internationalization strategy and theories of entry mode in foreign markets in the context of the alcoholic beverage industry. Additionally, it elucidates how the focus company, Lagunitas Brewing Company, can maintain a competitive advantage after becoming a wholly owned subsidiary through initiative, access to knowledge, and interaction within a multinational corporation.

A. Background

The competitive nature of the business environment forces organizations to continuously look at opportunities to improve and adjust their business strategies in order to maintain a competitive advantage over the industry at hand. When industries or markets within that industry become increasingly competitive, businesses are forced to make decisions that are foreign and complicated in order to succeed in the long term. This increased competition occurs when an industry becomes attractive, drawing interest and capital from outsiders. This competition can come from many sides and without much anticipation.

This competitive environment has been growing at an exponential rate within the beer, specifically craft beer, industry in the United States over the past one to two decades. This competition has generated a flurry of new entries into the market, with the overall brewery count in the United States doubling in the past four years (Brewbound, 2016). The new entries have chipped away at established brands sales in the overcrowded shelves at supermarkets as well as the limited draft selections at pubs and restaurants. The revenue that craft beer is accumulated has also drawn the interest of larger financial players with private equity firms and large multinational corporations (MNC) acquiring handfuls of breweries every year. Every brewery is experiencing and reacting to this changing landscape in their own, personalized method that they believe to be in the best interest of their business.

The business of focus for this company project, The Lagunitas Brewing Company, has chosen the latter option; becoming the target of an acquisition from a large MNC, Heineken. A primary reason behind the move to become a subsidiary was to gain access and knowledge into the route

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and success lies outside of their home market. They see opportunity abroad as they mature locally, along with the entire American craft beer market. As Lagunitas enters a new phase of growth and expansion, the company will have plenty of obstacles and difficulties along the road to a successful global footprint.

The internationalization process will be a focus for Lagunitas in the immediate future. Globalization has become attainable for many businesses, so it is now about how to succeed in the most efficient and effective manner. There are many decisions to be made along the road, but understanding the determinants of entry mode based of each foreign market might just be the decisions that lead to longevity within the industry. Furthermore, Lagunitas is now operating as a wholly owned subsidiary, which provides another litany of new opportunities, restrictions, and ways of working. These will all test the company's culture and drive when up against the many barriers of entry and acceptance in their new life.

Today, there are a wide array of papers, articles, and frameworks that discuss in detail the ramifications of proper and improper internationalization techniques. The research also is quite significant ito entry mode choice, foreign direct investment, and strategies for subsidiary success. All of this research will be used to provide a comprehensive understanding as well as guidance for Lagunitas as they move forward with their goal of globalization.

B. Research Objective

The objective of this thesis is to provide recommendations and strategy for Lagunitas that shapes their internationalization approach as well as how to have excelled performance as a wholly owned subsidiary in the immediate future. Hence the key questions for this research that the strategy and recommendations should answer are:

● How should Lagunitas decide where and when to expand and what mode of entry to choose?

● What are the key ways to actively initiate within a corporation and what are goals of such initiatives?

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The main deliverables for this project therefore are: ● Regional entry mode selection criteria;

● Guidelines of how operate as a wholly owned subsidiary and

● Set of recommendations for maximizing and leveraging knowledge of parent company. Lagunitas Brewing Company is well underway into its’ internalization process as well as integrating into the larger holding company of Heineken. These next few years will have significant impact into the longevity and success of the subsidiary; therefore it is critical that this research provides appropriate recommendations for the imminent decision making process for Lagunitas.

C. Research Approach

The process used to collect the information for this company project, in order to provide data and research based recommendations, is a combination of a collection of literary and empirical papers (secondary research), as well as drawing on numerous interviews and personal experience within the organizations involved in this study: Lagunitas and Heineken.

Owing to the fact that their has been a detailed and diverse research history on the topics of internationalization, the secondary research provides substantial theories and frameworks around these concepts. The research behind subsidiary involvement and interactions with other subsidiaries as well as the holding company is more of a newer topic of interest for academics. For years the research on subsidiaries was limited to the setup, control, management, and human resources aspects of the business. Fortunately, and what makes this project so interesting is that research recently has focused on the subsidiary roles and flow of knowledge, which will be the beating heart for Lagunitas.

Naturally, secondary research is not enough to provide the necessary recommendations required for this project. Information was gathered from individual interviews at both companies from a range of experts in order to build an appropriate understanding of the current setup and goals of the new partnership. Moreover, the interviews are necessary to ensure that the recommendations and strategies given at the end of this paper are aligned with the organization and easily

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comprehended and translated into successful execution. Interviews, however time consuming, are essential to the research and provide an internal viewpoint of how the current business operations are managed.

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Accelerating the Internationalization Process - Subsidiary Accelerating the Internationalization Process - Subsidiary II. Case Stakeholders

A. Company Overview

The Lagunitas Brewing Company began on a kitchen stove in 1993 in Lagunitas, California. The brewery operations were moved quickly to Forest Knolls after Tony caught the stove on fire and his wife evicted him. After only a year in Forest Knolls, after Tony ruined the community septic system by pouring his spent raw materials down the drain, Lagunitas moved down the road to Petaluma, California. The company currently still operates its’ corporate headquarters from the Petaluma facility.

Since the mid 2000s, Lagunitas has been one of the fastest growing and most popular craft breweries in the United States. The brewery increased its’ production from 27,000 barrels in 2004 to just over 100,000 barrels in 2010 and announced a $9.5 million expansion in 2012 in Petaluma that would raise capacity to 600,000 barrels annually (BeerPulse, 2011). Lagunitas opened a second production facility in Chicago, Illinois in 2014 with an ultimate capacity of 600,000 barrels annually as well. The Chicago brewery supplies the Eastern Unites States and Europe with beer currently (Chicago Tribune, 2014). The brewery announced a third location in 2015 in Azusa, California that is slated to open in 2018 with a potential capacity reaching almost 1,000,000 barrels annually (Los Angeles Times, 2015).

Lagunitas has continued to outperform the United States beer market, where craft beer now represents about 11% of total volume (Brewers Association, 2015). Lagunitas is the market leader in the IPA segment, the fastest growing sub-segment within craft. The brewery leads the way with the number one and number two six packs in the segment and had sold over 1,000,000 barrels overall in 2016. The brewery is planning to expand globally since it began a joint venture with Heineken in 2015 with the remaining shares being acquired in 2017 (see Strategic Partnership section).

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B. Strategic Competitiveness

Lagunitas has grown its’ beer depletions and distribution over the years by making strategic decisions that have allowed them to enjoy a competitive advantage over the craft market in the United States.

Lagunitas brewed its’ first batch of “IPA” in 1995 quickly becoming year round offering in their product range. Since California competitor, Sierra Nevada, already dominated the pale ale segment of the market, Lagunitas decided to make the IPA their flagship offering, the first brewery in the country to do so. The label still reads “Lagunitas IPA” distinguishing itself in the popular sub-segment of craft.

The brewery from early on has made it a priority to build great partnerships with its’ suppliers. Lagunitas was the first in the industry to build a risk sharing and economic sustainability model where the suppliers handle quality control. They have invested and partnered with a hand full of hop producers that guarantees them quantities and pricing for highly sought after hop varieties. The brewery has also signed long term contracts with barley farmers, foreseeing the coming scarcity of the key ingredient in craft beer. The contracts offer protection against inflation as well as quality incentives.

Lagunitas invested early on in the importance of a data driven sales department. In the attempt to standardize their sales distribution data due to the growing list of regional distributors, the brewery designed a digital, proprietary CRM platform for the sales team. The management tool has allowed them to better control the conversation with its’ distributor partners as well as making the sales force more efficient on the ground.

The brewery was built on personal, meaningful connections with its’ consumers and these connections continue to drive their route to market. This culture begins in the workplace and pours over into the community. It is the only brewery that has a Cultural Team that continue to bring the original feeling of the brewery in an engaging way to customers around the globe.

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C. Strategic Partnership

The Lagunitas Brewing Company has enjoyed a successful partnership with Heineken since 2015, when it sold a 50% stake of the company. The joint venture began on September 8th, 2015. Since then, Lagunitas has continued to outperform the US beer market, where craft beer now represents about 11% of total volume. Heineken announced that it acquired all the remaining shares of Lagunitas on May 4th, 2017. Heineken has assisted Lagunitas' international expansion, including entry into new markets such as France, Mexico, Italy and Spain, and increased the availability of products in markets including the United Kingdom, Canada, The Netherlands, Sweden and Japan. Following this transaction Heineken plans to accelerate the export of Lagunitas to many more markets around the world (Heineken, 2017).

To maintain the Lagunitas free spirit and company culture, the business will continue to operate as an independent subsidiary within Heineken International and will report to the Heineken Americas Region. Tony Magee, the founder of Lagunitas, will remain active as Executive Chairman of the company along with no changes to the current management team. In addition, Tony will take a leading advisory role to Heineken and its Executive Team on the global and local craft strategy (Heineken, 2017).

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Accelerating the Internationalization Process - Subsidiary Accelerating the Internationalization Process - Subsidiary III. Market Analysis

A. Industry Overview

The global beer consumption fell in 2016 by 1.4% to 1.6 billion barrels of beer. Yet because the age population of the world grew by 1% in that time, beer consumption per drinking-age adult declined even more, by 3.2%. The overall decline is almost entirely due to downturns in China, Brazil and Russia, three of the five biggest markets. These markets accounted for 99.6% of the global decrease in the volume of beer drunk in 2016 (The Economist, 2017).

The industry is in the midst of a consolidation phase of growth. The largest multinational beverage and brewing company, Anheuser-Busch InBev (AB Inbev), recently completed a $107 billion dollar buyout of the world’s second largest brewer, SABMiller (Forbes, 2017). The new AB InBev has estimated annual sales of $55 billion and the company will have an estimated global market share of 28%. Combining AB Inbev's market share with the next two largest breweries, Heineken and Carlsberg, the top three breweries control more than 50% of the global beer market.

Figure 1: US Beer Production in 2016

Source: Brewers Association The United States overall saw zero growth in 2016 maintaining production of 196 million barrels of beer, see Figure 1. The craft beer segment continues to grow within the United States, with now over 24 million barrels or 12.3% of all sales collected from craft brewers (Brewers Association, 2017). Regional breweries produce the majority of craft beer, the IPA segment and

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its’ many sub-segments in the craft category account for over 25% of total craft volume. Craft beer export in the United States experienced 16.3% volume growth totaling 446,000 barrels worth $116 million in 2016.

B. Competition

The beer industry has historically been competitive with multiple players in the fast moving consumer goods business. There exists many levels of competition within the robust industry and as The Lagunitas Brewing Company continues to grow and expand, it is always attracting new competitors. The competitors can be broken down as the local and regional brewers, national brewers, and the international brewing conglomerates.

Lagunitas began as a small, independent brewery selling to local accounts in small geographical footprint. Lagunitas has grown and matured, while many more breweries are following their path in hopes of similar success. The number of operating US breweries in 2012 was 2,475. In 2016, the brewery count surpassed 5,000 operating companies with another 2,000 in the process of securing licenses and permits. Of these, 99% are small and independent craft brewers (Brewers

Figure 2: US Brewery Count in 2016

Source: Brewers Association

Association, 2016). By comparison, there are 10,000 wineries in the US. Consumer trends indicate that craft beer consumers in 2017 will value locally produced and independent brewers

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over quality as well as the historically significance and brand power of a brewery. The competition at the local level is becoming over saturated with the growth beginning to cannibalize each other all while continuing to chip away market share from the large brewers. The second level of competition that Lagunitas faces are the national craft brands in the United States. The major competitors at this level are Boston Beer (Sam Adams), Sierra Nevada, New Belgium, Ballast Point, Goose Island, Oskar Blues, Founders, and Firestone Walker. These brewers are, or are close to, national distributed with some beginning to export their beer to Asian and European markets. The breweries range from 100,000 to 6,000,000 barrels of beer produced a year; Lagunitas is the fourth largest brewer in this category. This level of competition has been exposed to a wave of outside funding in recent years. External investors have included the large international brewery community, private investment firms, other food and beverage companies, as well a few employee stock ownership plans. Breweries that have secured funding have been able to expand capacity and increase their sales force more rapidly than the majority of other brewers.

Lagunitas is now on the international stage and therefore has gained the attention of the large, international brewing conglomerates. Breweries like AB Inbev, Carlsberg, Diageo, Kirin, Sapporo, and Asahi have all made plays in the craft beer market. Strategies range from acquiring national and regional craft brands to creating new product lines within their existing product ranges to compete with the rise of craft. Some breweries are actively attacking Lagunitas in markets that Lagunitas currently operates in, while others are working to establish market share in emerging craft beer markets. The focus of these efforts is to establish and educate consumers on the IPA style and to create brand loyalty within the category. These competitors bring an additional type of challenge to Lagunitas. The buying power of these brewers is tremendous. In many markets they create duopolies with limited space for any other brewery. For example, in Mexico, AB Inbev and Heineken now control over 90% of the total market or in Brazil where AB Inbev alone controls 70% of the market share.These breweries have the ability to limit the number of new entries by making the barriers of entry to high. Moreover, breweries are

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beginning to acquire pub groups to control the entire route to market for their products in some key growth markets.

In the regions where Heineken is apart of such duopolies or holds significant market share, it will be fairly easy to launch and build up the Lagunitas brand. Lagunitas sought out Heineken during the beginning, which lead to the joint venture, because of market share they had in prominent beer drinking countries. Countries like The Netherlands, France, and the U.K. have very strong Heineken subsidiaries that control a portion, if not all, of the route to market. The markets with the distribution channel should direct the initial international expansion for Lagunitas and build a track record of success when looking to expand to markets with higher competitive barriers to entry. They will use this success to build a business case when working to convince skeptical markets where Heineken and craft beer do not have such strong roots to begin working with Lagunitas.

C. Innovation

Across the entire market, beer drinkers are moving towards beer that skews to either the high or low end of the beer spectrum. The trends for most markets show the shift away from the traditional core lager range towards either premium beer options or the value-based brands. The shift towards the high end side of the spectrum is occurring mostly in mature beer drinking markets like Western Europe, United States, Brazil, and Australia (Rutishauser, 2015). Value brands are becoming increasingly important in the retail segment of the market where price has become the differentiating factor for most consumers. With this drastical change from the decades old norm of lager drinking, breweries are competing to innovate in order to gain or maintain a competitive advantage in the changing landscape.

To become an innovative company, breweries are reworking their businesses from the ground up. First they must provide a platform for this innovation to grow. Next, they need to be able to be agile enough to take the successful innovations and scale them rapidly to national and international distribution. There are several innovations that have occurred in the past two to five years that have resulted in gaining substantial market share.

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The addition of fruit, citrus, and other flavors became a popular trend in earnest in 2013 with the release of Ballast Point Grapefruit Sculpin. Ballast Point saw an opportunity to build off the success of their flagship brand Sculpin, by creating an entire product line of variants. Subsequent releases included Pineapple Sculpin and Habanero Sculpin as well as other beers featuring mango, orange, peppermint, and watermelon flavoring. Riding off the innovation of Ballast Point, many more breweries quickly followed with their own fruit releases. The beer industry has welcomed this innovation with open arms even listing this as a new category in many international beer competitions.

A second innovation within the alcohol industry in recent years has been the emergence of beverages that go beyond the classical definition of beer. In an attempt to reach a larger customer base, breweries are innovating with malt flavored beverages that they can release on a large scale. Such innovations include many “hard soda” varieties like root beer with an alcohol content of around 5%, equivalent to standard beer. Another innovation in this category are “hard seltzer waters” that are marketing as low in calories and also have the ability to mix with spirits. All of these innovations have worked towards disrupting the current beer space and making it more competitive to gain market share at the local retailers’ shelves.

A final innovation that has seen a shift in consumer preference has been the proliferation of non-alcoholic beverages replacing the standard lager selection. In an era where drinking responsible is applauded and there's public outcry in regards to drunk driving; breweries are embracing the switch to lower and zero alcoholic beverages. Major brands like Carlsberg and Heineken have released 0.0% variants on their classic lagers in the past few years with many craft brands following suit. European craft brewers, Brewdog and Mikkeller both have non-alcoholic offerings that are now available in multiple countries.

The degree at which these innovations are taking place vary from region to region and is why Heineken felt it necessary to bring an American craft brewery into its’ portfolio. Lagunitas has been constantly innovating in the IPA sub-segment of craft beer for the past two decades. From

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releasing a peach beer in the 1990’s to their secondary flagship, a wheat IPA. Heineken/Lagunitas will be able to capitalize in regions where the consumers have an increased interest in this innovation by being first to the market with an American IPA.

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Accelerating the Internationalization Process - Subsidiary Accelerating the Internationalization Process - Subsidiary IV. Literature Review/Underlying Theory

In this research, I will reference different areas of literature, theories, frameworks, and authors that are relevant to the research question. The frameworks and theories are summarized into three sections; the internationalization process, foreign direct investments (FDI), and the business of operating as a subsidiary.

The first element of the research is the process at which companies go about attempting to become a global player in their industry. This section brings together theories and frameworks relating to understanding the initial desire to go international, the stages of internationalization, the liability of foreignness, and the idea that “distance still matters.” It is relevant, as it will help understand the international industry in the current era. The focus is on the problems and hurdles firms face when leaving the comforts of their home markets. Furthermore, it explains what companies can do to mitigate costly mistakes when deciding when and where to export and expand their global footprint. The section concludes with the CAGE framework, a comprehensive tool to understand what markets to enter and which to avoid based on four different distance dimensions.

The progression of research continues as we learn about the different modes of entry and the determinants that guide this decision making process. The section first seeks to define and to understand the multiple options the firm has when deciding on the type of foreign direct investment that is best for that specific market. Second, the research dives into the multiple theories that attempt to represent the reasoning behind choosing that particular mode of entry. These theories are important to help focus in on what the important considerations that need to be thought of before the decision is made. The theories take many different approaches at illustrating the factors that the firm should be focusing on, but taken as a whole they provide the comprehensive knowledge that is needed to make the correct decision. The final theory lays out the useful and easily applicable OLE Eclectic framework, a tool to measure the value added by a FDI based on three advantages it provides to the business.

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The last section of the research dives into the “business of doing business” as a subsidiary. The section first sets out to understand what are the key roles and expectations of a subsidiary from the viewpoint of a multinational corporation (MNC). Drawing on the research from the past fifty years, the review will work towards the focus of knowledge flow and transfer between parent and business unit. It is important because we must understand the different methods that allow knowledge to flow as well as the effects on subsidiaries when that flow has slowed or even stopped. The research also looks into the control of flow and why some subsidiaries are successful as a result of this knowledge transfer while others find themselves on the outside. Finally, we look into the pros and cons of subsidiary initiative. Of specific importance is how a subsidiary can contribute to the overall performance of the MNC as well as the limitations the subsidiary may face when trying to initiate activity.

Part I: The Internationalization Process

A. The Strategic Choice of Internationalization

There is no one agreed upon definition of internationalization, however it is commonly thought of as the increase in involvement and business in international markets. The decision to grow outside of a firm's’ home market is based off its’ ability to manage the complexity and uncertainty that comes with cross border activity. These activities bring new challenges including political and currency based risk's as well as variations in everything from institutional and ethical business practices.

The success of businesses that want to go the international route relies on their willingness to think from a global perspective as well as understanding the variations in international cultures that lie ahead. If the company has this vision in place, then it is possible that internationalization is the correct strategic choice for the business. The business must have control and drive in terms of innovation, keeping a high standard of quality, best business practices, and also seek out to participate in corporate social responsibility (CSR) programs in every new market they enter. There are many factors that go into the strategic choice of moving into the realm of the global marketplace, the following sections will outline tools and methods to help steer a business through all of the uncertainty that lies between the present and future success.

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Accelerating the Internationalization Process - Subsidiary Accelerating the Internationalization Process - Subsidiary B. Uppsala Model

The first theory on which the company project relies on is the one developed by Jan Johanson and Jan-Erik Vahlne in 1977 at respectively, Uppsala University and Gothenburg University. The Uppsala model has become the benchmark tool in understanding the internationalization process of companies. Therefore, it is important to start here to first learn about the characteristics of the process and the underlying reasons for this approach to global expansion. Even though the theory was based off business practices from forty years ago, there are valuable lessons to still be learned from the structure of their research.

Before Johanson and Vahlne published their study, the established economics and international business literature at the time stated that firms choose, or should choose, the ideal mode for entering a foreign market by analyzing their costs and risks based on market characteristics and taking into consideration their own resources (Hood & Young, 1979). The two Swedish researchers struggled to accept these theories explaining the process of internationalization. The researchers believed that cultural differences were being ignored and did not focus on the foreign investment needed to set up internal controls for internationalization. As a result, they developed their own model that laid out internationalisation into four sequential steps leading up to globalization. The steps are:

● Step 1: No regular export activities (sporadic export)

● Step 2: Export via independent representative (export modes) ● Step 3: Establishment of a foreign sales subsidiary

● Step 4: Foreign production/manufacturing operations

The model states that most firms begin internationalization via impromptu or makeshift exporting where available and willing. If successful, the firm then attempts to formalize these agreements by contracting intermediates or agents that are familiar with local markets. As sales improve and diversify, the company can replace the agents with their own sales organization and as sales continue to increase they will finally begin manufacturing in the foreign market. This

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Figure 3: Uppsala Model of Internationalization

Source: Johanson, J. & Vahlne, J.-E. (1977)

dimension of the internationalization pattern is referred to as the “establishment chain” (Johanson & Vahlne, 2009). Another aspect of the Uppsala model is that organizations typically choose foreign markets that are close to the home market in terms of “psychic distance,” or factors making it easier to understand and operate in that specific market. Once the company enters the markets that are psychologically close they will then gradually move outwards basing decisions off firm-specific advantages relating to the liabilities of the new market, known as the “liability of foreignness” (Hymer, 1976).

Finally, it is important to understand the assumptions that were made in creating the Uppsala model. The underlying assumptions of the 1977 model are uncertainty and bounded rationality. Firms make decisions based on experiences, and as they learn from these experiences they becomes less uncertainty, Additionally, when large commitments are made in foreign markets, companies become dedicated to making sure they meet customers ongoing needs.

C. Liability of Foreignness

The liability of foreignness concept was first introduced by Stephen Hymer in 1976. Hymer observed new entrants to be at a disadvantage compared to local firms due to the uncertainties

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and risk exchange with the business conditions in a foreign market. He studied the choices of firms to either “make” or “sell” their proprietary knowledge, that is to say they would either have production subsidiaries or license out the work to a local firm. Naturally, if the firms that attempted to “make” their goods in a foreign market did not engage in learnings beforehand, they would face a high liability of foreignness on the outset (Hymer, 1976). However, Hymer did not discuss how firms reduce their liability of foreignness.

An empirical study by Zaheer and Mosakowski in 1997 suggested that liability of foreignness would diminish over time. These learnings were especially important when firms were determining the costs of investing in a foreign market. Firms should not consider the costs of doing business abroad as static costs, but rather as declining costs as the firm gains more knowledge and experience in the market (Zaheer & Mosakowski, 1997). The Uppsala model also provides suggestions on how to reduce liability of foreignness based on the establishment chain and the psychic distance as mentioned previously.

The research conducted by Petersen and Pedersen in 2002 helps better explain how firms can reduce liability of foreignness based off the different learning engagement paths their managers choose. It is the argument of this study that as a repercussion of managerial decisions, such as unwillingness to undertake local changes for products and marketing as well as the adoption of standardized international business practices, that firms will have a low learning engagement. Firms can conceivably improve their ability to learn through experiences, in essence, they can

learn how to learn. However, even more important than the ability to learn, is the managerial

decision of the effort to want to learn. If the firm has a desire to engage in learning, this can take place either before (pre-entry) or after (post-entry) the entry. The three learning engagement strategies that are outlined by Petersen and Pedersen in Figure 4 and are related to (1) the perceived familiarity of the foreign market, and (2) the time of doing business in the foreign market. The result of the study finds that the firms’ decision in learning engagement has a direct effect on the time and cost of the liability of foreignness it will experience during their

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Figure 4: Learning Engagement Strategies

Source: Petersen and Pedersen, 2002

internationalization process. In the case of engagement in pre-entry learning, the familiarity with the foreign business is expectedly high while in post-entry learning, the initial familiarity will be low. The key takeaway is that in the case of low, or no, learning engagement is that the firm will remain unfamiliarized and continue to struggle with a high liability of foreignness (Pedersen & Petersen, 2002).

Finally, there are few additional ways to decrease the LOF and control high costs in regards to emerging markets through risk mitigation. The three controls or procedures are (1) forgoing short-term profits in favor of long-term reputation, (2) avoiding locations where compliance is a moving target, and (3) vetting managers and subcontractors for a culture of compliance (Hochberg, 2015).

D. CAGE Framework

Research lead by Pankaj Ghemawat in 2001 set out to understand why some companies have failed so spectacularly at trying to expand globally due to the unforeseen high levels of liability of foreignness. He recognized that companies consistently exaggerated the attractiveness of foreign markets leading to costly mistakes and set out to create a framework can could be used to have a more rational approach in deciding international opportunities. So how to avoid this fate?

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Ghemawat says to look beyond the country’s sales potential (as expressed by GDP or consumer spending) and assess the impact of distance.

The underlying message from his studies is that there is more than one dimension of distance and that companies should not focus only on distance’s geographical dimension. The firm must consider three other dimensions as well: cultural factors (religion, race, social norms, language);

administrative factors (colony-colonizer links, currencies, trading arrangements); and economic factors (income, distribution-channel quality) (Ghemawat, 2001).

Figure 5: CAGE Framework Distance Descriptors

Source: Ghemawat, 2001

The conclusion of this research is that the more two countries differ across all four distance dimensions, the higher the liability of foreignness and therefore the riskier the foreign market is to enter. On the other side, if the firm finds significant similarities along all four distance

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dimensions, there is a great opportunity for success in the foreign market. Common currency, for example, can increase likliness of trade by up to 300% (Ghemawat, 2001).

Part II: Foreign Direct Investment

According to the widely accepted Uppsala model for internationalization, as a firm matures in foreign markets it must decide whether to implement their own sales and production units abroad. At this decision-making point, the firm is already a multinational enterprise (MNE), that is, it is engaging in international economic activity. In order for the MNE to continue to grow, the business must do its’ due diligence and make its’ first foreign direct investment (FDI). A FDI is the route to market for MNE’s by establishing or purchasing income-generating assets abroad. These FDIs are motivated by “market seeking,” resource seeking,” “innovation seeking,” or “efficiency seeking” tactics. How, why, and the route of entry for these firms is what is important, as there are several options to consider when looking to participate in a FDI.

A. Joint Venture or Wholly Owned Subsidiary

A foreign direct investment is essentially an equity investment whether it be selling or buying equity to enter the market. The result of this investment, among others, is the managerial control that comes with ownership. There are other advantages that come with equity investments: the internalization and protecting of assets, demonstrating strategic commitment to the market, and it may also deter others from from also entering that space. The three primary modes of entry are Greenfield, Joint Venture, and Acquisition. For the sake of this research, we will focus on joint ventures and wholly-owned subsidiaries (acquisitions) and compare the two. The greenfield mode for reference, is where a firm establishes a brand new subsidiary in a foreign market. The definition of a joint venture (JV) is a business arrangement in where two or more partners pool their resources together in order to achieve a goal or create something new. According to James Foley’s 1999 work, there are five typical objectives of a JV: entry to foreign market, risk/reward sharing, technology sharing, sharing of production and development, and assistance in conforming to local governments (Foley, 1999). Joint ventures exist when their are similar strategic goals while having limited competitive overlap. Typically in JV’s, company patents and

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proprietary knowledge is not shared. Determinants that are the primary consideration for JV’s are ownership stake, control stake, length and terms of agreement, pricing measures, as well as the local firms resources and knowledge. All of these issues are built in contractually, ensuring that the partners have a set understanding of expectations of the new venture.

Joint ventures are created from cash investment or a combination together with public capital or leveraging bank debt. Joint ventures can when a local firm invests in a foreign firm or vice versa, they also can be created by both local or foreign firms. The process of finding an ideal partner can also be exacerbating. From screening prospects to creating a short list and doing to the proper due diligence, this can be the most labor, time, and cost heavy part of the process. Finally, a few problems that may occur during the venture: conflicts with unequal future investments, profit sharing, mistrust, cultural issues, and the unpleasant conversation when it is time to terminate the joint venture.

A wholly owned subsidiary (WOS) is a company that is completely owned by another company. The owning company is referred to as the parent or holding company. In order for a company to be a WOS, all common stock must be owned by the parent company. The subsidiary operates under the direction and permission of the parent company. Typically, the subsidiary differentiates from the parent company by having its own senior management structure, product line, and own client base. Subsidiaries are sought out when trying to merge the gap of large geographical business interests over multiple industries. As firms get larger, these tactics are a proven way at hedging against specific political or economic shifts that negatively affect markets and sectors.

There are many advantages for a company to fully acquire another business. The ability to integrate administrative and financial teams as well asl implement an overall marketing strategy across the businesses will greatly decrease operating costs. These savings are recorded as synergies, synergies are a driving force behind many acquisitions. However, a parent company may face issues when taking over an established, successful business. Working with current leadership can be more complicated than implementing their own management team. Time will

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be the biggest obstacle, as transitioning and changing the mentality and standard operating procedures of people is difficult. Another risk of acquiring a firm is the chance of paying too much for assets especially after entering a bidding war. This risk is exemplified when dealing a CEO is attempting to make an impact or leave a legacy.

Figure 6: Mode of Entry Determinants

Source: Meyer, 2008

“Modes of entry allow firms to overcome different kinds of market inefficiencies related to both characteristics of the resources and to the institutional context. In a weaker institutional framework, JVs are used to access many resources, but in a stronger institutional framework, JVs become less important while acquisitions can play a more important role in accessing resources that are intangible and organizationally embedded” (Meyer, 2009). In general, ownership can be considered as a means to conformity to both economic and cultural environments, or simply be a business based conformity.

B. Theories of Entry Mode

As previously stated, the mode at which a firm decides to enter a foreign market is a crucial turning point in the future of the company. There are a few options to choose from, which we just went into detail into, but it is also important to understand the determinants that guide these decisions. The idea of globalization is no longer so distant or too inaccessible, instead it is now an inevitability in the progression of the firm's’ growth. So if the question is no longer if and

when, it is now focused purely on how to do it. The following sections will outline the theoretical

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using entry modes based off the predictions of theories perform significantly better than those that do not.

i. Transaction Cost Theory

The most common theory regarding entry mode decisions originated with the economic work of Williamson in 1981. The theory is based off whether a firm should “make” or “buy” its’ products in a foreign market. In entry mode research, transaction costs are generally identified with the three dimensions widely discussed by Williamson: asset specificity, uncertainty, and frequency. The asset specificity is without a doubt one of the most crucial dimensions of the transaction. It enables the company to fully comprehend whether the contract requires individually-tailored solutions or quite standardised investments (Williamson 1985). This is the first test in deciding to “make” or “buy”. It is understood that uncertainty exists throughout the decision making process

Figure 7: Asset Specificity and Frequency in Entry Mode Choice

Source: Williamson, 1985

of internationalization, right now we will focus on the two types of uncertainty affecting entry mode: behavioral and external . Behavioural uncertainty is the imperfect information firms have when operating abroad as well as the risk that their partners may act in a way that is opportunistic only towards themselves. External uncertainties range from economical to cultural

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to political uncertainty. Finally, the frequency is in reference to the forecasted and contracted upon sales volumes that can be expected in the foreign market. Simply put, if there is a high repeatability of product being demanded in a market, the higher the chance for a FDI to take place.

To summarize, the basic unit of research in the transaction cost theory, as stated before, is the transaction itself (Mroczek-Dąbrowska, 2014). And using the three dimensions of the theory, a firm can have a much better understanding of which entry mode to choose as seen in Figure 7 above.

ii. Resource-Based Theory

A second theory to analyze the determinants in entry mode options, is focusing on the strategic resources a firm has, and if these provide a competitive advantage in the marketplace. The theory was formalized by Barney in 1991 and states that a “firm's’ resources include all assets, capabilities, organizational processes, firm attributes, information, knowledge, etc. controlled by a firm that enable the firm to conceive of and implement strategies that improve its efficiency and effectiveness” (Barney, 1991). The resource-based theory is best applied by asking questions based on the VRIO framework that was also developed by Barney. The framework focuses on asking four questions regarding each of the resources the firm believes provides a competitive advantage to that market.

● The Question of Value: "Is the firm able to exploit an opportunity or neutralize an

external threat with the resource/capability?"

● The Question of Rarity: "Is control of the resource/capability in the hands of a relative

few?"

● The Question of Imitability: "Is it difficult to imitate, and will there be significant cost

disadvantage to a firm trying to obtain, develop, or duplicate the resource/capability?" ● The Question of Organization: "Is the firm organized, ready, and able to exploit the

resource/capability?" "Is the firm organized to capture value?" (Barney, 1991). Two additional resources that Barney didn’t explicitly state in his initial research are the experiences a firm or members of the firm have gained as well as intangible resources. Intangible resources include that under the umbrella of corporate intellectual property as well as goodwill

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and brand recognition. There is still a debate as to whether these intangible resources truly provide a competitive advantage when deciding on entry mode.

iii. Institutional Theory

A third theory to gain knowledge on the determinants of entry modes for firms focuses on the institutional factors of business. The theory can be traced back to Douglas North’s 1990 book in which he states that “institutions are the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interaction” (North, 1990). Therefore, the institutional theory is heavily based upon the limitations, laws, and legal statutes that have been created by politicians and businessman in previous generations. From an opposite viewpoint, the institutional theory can be used to examine the opportunities in a market. “Institutions, together with the standard constraints of economic theory, determine the opportunities in a society. Organizations are created to take advantage of those opportunities, and, as the organizations evolve, they alter the institutions” (North, 1990).

When firms are determining what entry mode to use it is critical to make sure that their organization is built and operates in a manner that will be cohesive with the targeted foreign market. “Although formal rules may change overnight as the result of political or judicial decisions, informal constraints embodied in customs, traditions, and codes of conduct are much more impervious to deliberate policies.” (North, 1990). The theory states that learning and understanding the cultural and social traditions of a market are as important as being aligned with the formal laws that govern the business environment. To recap, the institutional theory is applied when firms are typically entering markets that do not have similar “rules of the game,” making these constraints the largest barrier to entry.

iv. OLI Eclectic Framework

The OLI Model or Eclectic Framework was developed by John H. Dunning in 1979 as further academic development in the understanding of the internationalization theory. The framework is split into three distinct advantages of deciding whether to proceed with a FDI, and only if all

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three provide to be truly advantageous should the confirm proceed with the investment. The three elements or advantages are ownership, location, and internalization.

Figure 8: OLI Framework

Source: Dunning, 1979

The ownership advantage states that in order for a firm to own an asset in a foreign market the asset must generate enough profit to outweigh the extra financial and emotional costs of multinational production. Some examples of ownership advantages include patents and ownership rights, innovation capacity, accumulated experience, and exclusive access to certain inputs. The more the ownership advantages are possessed by an enterprise, the greater the likelihood that the enterprise, given the incentive to do so, will engage in international production (Dunning, 1979).

The location-based advantage is rooted in the very nature of why a multinational is created in the first place. In order to be doing business, with physical assets in place, means that their most be some advantage of being there. A great example of a location-based advantage would be the

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saving on transportation and tariff costs, also known as horizontal foreign direct investment,. This is especially important for products that are difficult to ship due to weight, climate control, or shelf live. Another example of a location-based example is the variability in production costs from one country to another, which can be considered vertical foreign direct investment. The price for low-skilled labor fluctuates from region to region.

The internalization advantage states that there must be an advantage to keeping the expansion internally or within the firm, opposed to licensing or outsourcing the work to a local firm. If the firm's’ core competencies are easy to copy or the production procedure is simple to replicate, it is advantageous for the firm to protect their patents. A second example of an advantage would be the cross-boundary differences make it difficult to negotiate and create contracts. In this instance, it can be more efficient to produce yourself and avoid any sort of hold-ups.

Part III: Subsidiary Operations

The past five decades have provided a substantial amount of research into the roles and relationships between parent companies, or headquarters, and subsidiaries based around the world. The focus of this research has varied over time placing importance at different elements as globalization has evolved. Figure 8 shows the five dominant themes over time: (1) organizational design and control systems; (2) home and host country context; (3) subsidiary roles and regional structures; (4) knowledge creation and transfer; and (5) expatriate management and global human resource management (HRM) (Kostovo, 2015). As depicted in Figure 8, the focus has shifted to subsidiary roles as well as the creation and transfer of knowledge with the larger corporation. For this section of literature, we will focus on these two elements to better understand how a firm can succeed as a subsidiary in the modern business environment. Additionally, we will look into the current research at how subsidiary initiative is viewed and the roles it plays in the opportunities and threats for the business unit.

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Figure 9: Subsidiary Research over Time

Source: Kostovo, 2015

A. Knowledge Flow

One of the great advantages of having a parent company is the ability to access the knowledge and experience from its’ vast learnings. The flow of knowledge from a multinational corporation (MNC) to a subsidiary can be recognized as intangible assets. Typical downstream or traditional knowledge transfers include sales, services and assembly while more recent flows are that of R&D and strategic marketing campaigns. Knowledge flow is critical for subsidiaries that are entering new markets or new industries as it gives them a competitive advantage with the potential to be the first to market or first to penetrate the market effectively.

Growth, synergies, and innovation all stem from the collaboration and sharing of knowledge. The flow of knowledge is crucial to the success of a MNC and in order to make the flow effective they must champion the three issues with knowledge: acquiring the information,

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coordinating its’ dispersal, and finally the motivation for units to share this knowledge. If knowledge is considered a one way path with a source and a receiver then we can identify four separate ways knowledge can flow based on the research by Mudambi and Navarra in 2004.

Flow 1: Flows from subsidiary to parent. These flows may be called knowledge transfer and

form the basis of the MNC’s network leverage.

Flow 2: Flows from location to subsidiary. These flows consist of the subsidiary’s learning, local

competence exploitation, and local resource utilization. This is the pod or ‘listening post’ role of the subsidiary.

Flow 3: Flows from subsidiary to location. These flows are part of what have been termed

spillovers. Spillovers include both intended and unintended elements , for instance the local adaptation or imitation could be considered an unintended spillover of knowledge.

Flow 4: Flows from the parent (and other MNC units) to the subsidiary. This knowledge flow

from the parent to the subsidiary is the traditional flow, where the subsidiary exploits a home-base knowledge advantage (Mudambi and Navarra, 2004).

As we can see, subsidiaries are involved in every step of the knowledge flow. Therefore, how they manage this flow will have a direct effect on their performance within the MNC. The degree at which subsidiaries obtain and utilize this knowledge will be analyzed in the next section. Recent trends point at increasing responsibilities for individual subsidiaries along with the dispersal of knowledge from within the MNC turning these MNCs more into political coalitions than the formal military formations of previous years (Holm, 2000). The new political environment has resulted in some interesting power related side effects that have been studied in depth. The division of subsidiary power is at the crux of the issue with rent-seeking subsidiaries constantly at battle for power while other subsidiaries experience isolation and outsidership. Both types of subsidiaries are important to understand to grasp the essence of subsidiary behavior. The access to and ability to participate in the act of knowledge flow is a key factor in the bargaining power of many subsidiaries. Therefore, it is likely that the occasional subsidiary manager will attempt to exploit this power to pursuit achievements that benefit themselves in the

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Figure 10: Knowledge Flow

Source: Mudambi & Navarra, 2004

classic principal-agent paradigm. Managers can both aim to be profit seeking, maximizing shareholders’ value in the firm, as well as rent seeking, profits earned by the MNC, but available in transfer to individual subsidiaries. “Thus subsidiary strategic independence, designed to enhance the competitiveness of outputs (market knowledge) and inputs (asset-seeking and learning), can be corroded when the pursuit of subsidiary objectives encourage rent-seeking” (Mudambi and Navarra, 2004). Rent-seeking subsidiary managers can be a drag on corporate performance as the opportunism behavior will destroy value for the firm. However, it is important for firms to earn rent as that allows for them to receive this knowledge flow, which in turn provides them with bargaining power. One particular way for a firm to maintain a high level of rent is by controlling a significant share of a corporation's R&D budget and focus,which can be consider the firm’s ‘crown jewels’.

While some subsidiaries are fighting over the majority of the available profit rent and receiving the bulk of the knowledge flow, there are as many subsidiaries that are suffering on the other side

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of spectrum. These firms are experiencing what Johanson and Vahlne have referred to as liability

of outsidership. But how does a firm find itself on the outside, isolated from the inner workings

of the parent company? The research conducted by Monteiro et. al in 2008 concludes that isolation is a direct effect of the ability of the subsidiary to be involved in the MNC's knowledge

Figure 11: Subsidiary Capabilities Affect on Knowledge Flow

Source: Monteiro, 2008

flow. They found that “knowledge flows from units that are perceived to be highly capable to units that perceive themselves to be highly capable. Knowledge flows are also associated with existing levels of communication and reciprocity” (Monteiro, 2008). So the research indicates that subsidiaries that are skillful and successful, or the “in crowd,” routinely participate in the transfer knowledge while the less capable subsidiaries are left in isolation. The key takeaway from this research, is that there is a link between the evaluation of capabilities (both by the source and the receiver) and the expectation of receiving knowledge. It is also interesting that these MNC’s allow this isolation to occur, as these outside subsidiaries typically underperform and bring down the overall performance of the business.

Subsidiaries are becoming more important as MNC’s look to expand globally and it is important that they manage and maximize all of their units to the best of their ability. The business environment is also viewed as a web of relationships, a network, rather than as a neoclassical market with many independent suppliers and clients. Finally, it is critical to remember that

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“outsidership, in relation to the relevant network, more than physical distance, is the root of uncertainty” (Johanson and Vahlne, 2009).

B. Subsidiary Initiatives

Besides the knowledge that the firm brings to the MNC, it is also expected that the subsidiary contribute in other ways via firm-specific advantages. Firm-specific advantages used to be the concern of only the MNC, the mentality is shifting towards more of a collective responsibility in which, subsidiaries should have firm-specific advantages that allow them to improve the overall performance of the MNC. Additionally, “rather than simply seeing subsidiaries as contributors to the development of firm-specific advantages, research shows that they can also drive the process through their own initiative” (Birkinshaw, 1998).

Figure 12: Subsidiary Resources and MNC’s firm-specific advantage

Source: Birkinshaw et. al, 1998

The research indicates that there are three key determinants in order for the subsidiary to have a productive impact through initiative and a significant relationship and contribution with the parent company. The successful elements according to Birkinshaw et. al are “(1) internal subsidiary resources in combination with initiative have a strong positive impact on the subsidiary’s contributory role; (2) subsidiary initiative is strongly associated with the leadership and entrepreneurial culture in the subsidiary; and (3) contributory role is strongly associated with subsidiary autonomy and a low level of local competition.” Developing the third element more gives us a great insight into two dynamic characteristics of a successful subsidiary. First, that autonomous subsidiaries thrive, is a follow up on the notion discussed earlier that subsidiaries that view themselves as capable and proactive will be more successful. The second fact is more

Taking craft beer global : accelerating the internationalization process for newly formed subsidiaries : a company project for Lagunitas Brewing Company