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Opinion pieces on business & economic issues

KIM Deuk-Kab

Multinationals and Centers of Excellence

KIM Deuk-Kab

Apr. 13, 2005

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According to United Nations statistics, there were 61,000 multinational companies (MNCs) operating more than 900,000 overseas subsidiaries around the world at the end of 2003. These corporations build and link massive production systems to establish a global value chain that maximizes profits. The profitability of the MNCs depends on the efficient operation of the subsidiaries within the value chain.

In the early stage of a company's globalization, the headquarters serve as the nerve center for worldwide operations. The performance of overseas operations is evaluated against the execution of headquarters' business plans. As internationalization progresses, however, the organizational system of multinational companies shifts. The loosely connected global chain becomes a more sophisticated and integrated global network.

When a subsidiary's role becomes more defined or specialized based on advantages of location, its relationship with headquarters also changes. Power will shift from the head office to the specialized subsidiary. For example, one subsidiary will produce a certain good that cannot be matched by other subsidiaries, while another subsidiary may focus on sales and marketing. At this point, overseas subsidiaries no longer passively receive instructions from the home office. The overseas office will make and execute business plans independently, eventually functioning as a strategic node in a global multinational network. This is what makes the role of multinational subsidiaries important. They determine the competitiveness of a multinational company, making the discovering and fostering of subsidiaries' capabilities within a global network a critical task.

The concept arising from the need to identify critical subsidiaries is the "Center of Excellence." The concept is becoming increasingly important to multinational companies in this regard. Companies adopting this concept nurture and utilize overseas multinational subsidiaries. A center of excellence is a subsidiary that has the greatest competitive edge among all subsidiaries operating in an MNC's global network. Through this paradigm, MNCs can enhance corporate competitiveness by identifying competencies in its network and share it with all subsidiaries. According to Fratocchi and Holm [1998], an MNC's level of internationalization relates closely to the number of key centers it has. The more centers of excellence a company has, the higher its level of globalization and management performance. P&G Canada, Ericsson Canada, HP Singapore, GE Hungary, and Nokia Korea are examples of centers of excellence.

The issue then is how a company can obtain such a center. In most industrial companies, these centers only account for 10% of the entire network. There are two conditions for a multinational subsidiary to serve as a center of excellence. First, it must have a competitive edge over all other overseas operations. Second, other subsidiaries should be able to utilize this subsidiary's capability. The subsidiary's external environment, internal factors, and relationship to headquarters will effect its formation.

The external environment is important because companies need to make inroads into countries or regions that have a vital diamond-shape industrial structure. Overseas subsidiaries will be able to secure a competitive edge only when they operate in this environment. A successful subsidiary will also have to strengthen its internal ability by actively taking initiative. Headquarters needs to delegate greater decision-making to, as well as instill a strong entrepreneurial spirit in the overseas office. Support from headquarters will help a subsidiary gain a competitive edge. The two must maintain a close relationship prior to the overseas office receiving greater independence.

Strengthening the strategic role of an MNC's subsidiaries is a crucial task. The head office should seek to secure as many centers of excellence as possible. Many overseas operations have superior competitiveness, but headquarters is unable to leverage the subsidiaries' capabilities properly. The home office can gain greater results from subsidiaries by introducing systems that disseminate timely knowledge and information on overseas benchmarks. Within their global network, subsidiaries may fiercely compete with each other to become a center for excellence. Overseas managers must be proactive in strengthening the internal capabilities of their operations. Once the head office's focus is placed on one rival subsidiary over another office, the latter usually has its role reduced or eventually loses its ground.

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