Modes of Governance and Engagement Between Domestic Firms and MNEs
There is a continuum of governance modes available to MNEs. At one extreme, MNEs may engage with actors in a host country through complete internalization, by the use of wholly owned subsidiaries (WOS). That is to say, it engages in direct ownership to achieve control. At the other extreme, it may engage with local actors by not engaging directly through a local presence, but through international markets. That is to say, it engages in neither control nor ownership, and relies on markets to function efficiently.
One of the hallmarks of globalization has been the decline in the use of WOS (Collinson et al. 2016), and a growing popularity of NEMs, whereby firms are able to achieve control of the outputs and internal operating characteristics of their suppliers without engaging in full internalization, but do so without ownership. NEMs include all sorts of cooperative arrangements such as licensing, subcontracting, networking, and alliances that MNEs establish along the agro-food GVCs in lieu of vertical integration or market transaction. Figure 4.2 suggests that MNEs can engage in NEMs either directly with the domestic actors in the host country or indirectly through intermediaries.
The primary objective of an MNE in engaging with a developing country—either through WOS or through the market—remains the same. That is, it wishes to achieve reliable and competitively priced supplies of inputs, and where it can achieve price, quality, and reliability through market means (by outsourcing) it will naturally prefer to do so, but this requires little or no investment of its own resources, and greatly achieves its primary goal of improving its own profitability.
Fig. 4.2 Linking Host Countries to Agro-Food GVCs. Source: Authors
However, where there is an absence of domestic actors who meet the necessary requirements to be arm’s-length suppliers, firms are obliged to engage in FDI and full internalization through WOS. It is a precondition that suitable domestic actors exist who are competent enough to meet the standards of the MNEs. Indeed, in many developing countries, there are few domestic actors that have the complementary O advantages to act as partners within the MNE-controlled GVC. The lack of resources in many underdeveloped countries means that there are few firms with sufficient financial or knowledge capital at the threshold level to meet the standards that are set by the MNEs.
Where firms that meet the criteria do exist, the question of choice of governance mode becomes germane. The degree to which firms may prefer to use NEMs within an MNE-controlled network is determined by a combination of two factors. First, there are cost-related reasons. That is, firms seek to minimize their net transaction costs, and this includes the costs of monitoring such agreements and the ability (and cost) of enforcing contracts made with external actors. The alternative— using a WOS—has its own costs. Second, there are strategic considerations, associated with the potential loss of proprietary knowledge to potential (or actual) competitors, and the danger of creating potential competitors (Narula 2001). Although there are no studies that confirm this, the growing use of GVCs and NEMs is indicative of the fact that the costs of enforcing and managing non-equity agreements have declined quite considerably over the last few decades (Dicken 2003). Standards are central to the governance process of agro-food GVCs. MNEs use their own set of comprehensive standards as an effective tool to govern their respective agro-food GVCs. Actors who are unable or unwilling to act as per the standards or other rules of agro-food GVCs face various kinds of sanctions. As a result, no actor along these agro-food GVCs can afford to ignore the standards, instructions, and rules set by the lead firms. This is how the MNEs eventually integrate various external actors, along the agro-food GVCs, who are dispersed in several parts of the world, to act as if all of them are acting as the MNEs’ own internal units. This reflects the usual tendency of MNEs to control every nontrivial aspect of their businesses, whether or not they own it.
Even the upgrading of various external actors along the agro-food GVCs is also subject to approval of the flagship MNE. Although the entrepreneurial, managerial, technological, and financial capabilities of the external actors are important preconditions for such upgrading to take place, they can rarely make their upgrading decisions independently. It is usually the MNEs that control key matters related to upgrading through the GVC governance mechanism—who will upgrade up to what level, when, and how—along GVCs or beyond.
MNEs are no longer limited to controlling and monitoring only the first-tier suppliers. Nowadays, the second- and third-tier suppliers are also traced back to monitor inputs, the production process, labor conditions, and environmental compliance. This phenomenon of looking beyond the first-tier actors is referred to in GVC literature as ‘The Whole Chain Approach’ (Humphrey 2014: 104).