Innovation Strategies of Emerging Russian Multinational Companies

Innovation Strategies of Emerging Russian Multinational Companies

Sergey Filippov

DelftUniversity of Technology (The Netherlands)

Alexander Settles

Higher School of Economics (Moscow, Russia)

Prepared for an international conference

‘Re-Assessing Emerging Market Multinationals’ Evolving Competitive Advantage’

(Cambridge, UK, 25-27 March 2011)

Date: 14-03-2011

Abstract

The paper explores innovation strategies and processes in emerging Russian multinational companies. Innovation is a major driver of corporate growth and determinant of competitiveness of western multinationals. Emerging Russian multinational companies have started to realise the value creating aspects of R&D and innovation. They devise various innovation strategies ranging often leading to acquisition of technology-intensive firms in advanced economies. Russian firms are unique since they operate in a society with a strong scientific tradition inherited from the Soviet system with limited success in translating these scientific inventions into innovative products. The paper provides an inventory of such strategies and provides empirical evidence to exemplify them. Finally, managerial and policy implications are formulated.

Key words: innovation, Russia, multinationals, acquisition, FDI

Introduction

Innovation is universally recognised as a competitive advantage and a key driver of the growth of multinational companies. Presently, innovation is not limited to western multinationals, emerging multinational companies start realising the strategic value of innovation too. As a vivid indication of the importance of this topic, in April 2010, The Economist published a special report on innovation in emerging markets, titled ‘The world turned upside down’. The report states that the emerging markets are developing their own distinctive management ideas, not simply imitating the western. It urges to recognise that the emerging world, long a source of cheap labour, can be a source of disruptive innovation as well.

Among emerging multinationals, Russian companies represent an interesting case.Russia has inherited the Soviet science and technology (S&T) complex that enjoyed leadership in many technological domains. However, the institutional collapse after the break-up of the Soviet Union has had a profound effect on innovation, science and technology. Dependency of the contemporary Russian economy on the international commodity markets is often acknowledged. The exports of oil and natural resources make up to 80 per cent of all Russian exports. Likewise, many emerging Russian multinational companies operate in the natural resources sectors.

Diversification of the national economy remains a top priority for the Russian political leadership. Russian president Dmitry Medvedev has consistently called for the ‘modernisation’ of Russia’s economy and appealed to Russian companies to design and implement innovation strategies.

Despite the general interest to this topic and its relevance, the role and place of innovation in emerging Russian multinationals remain under-researched (with some exceptions, e.g. Podmetina et al, 2009). The objective of this paper is to fill this gap. We seek to explore the nexus between innovation and internationalisation of Russian companies. More globally, we aim to reflect whether innovation represent a firm specific advantage - competitive advantage for Russian emerging multinationals. As the conventional wisdom about EMEs especially those from Russian fail to innovate even with the extensive state support of state corporations, scientific institutes, and now technology parks. While there is a lack of innovative activity of Russian based firms there are firms that operate both in the Russia market and internationally that have attempted to acquire technology assets or create innovative capacity in Russia. For example in the telecommunications industry Russian firms have developed significant competitive advantage in their home market and have extended these advantages to other emerging markets especially in the area of the former Soviet Union.

Innovation capability is often measured by patenting activity (Acs and Audretsch, 1989); however in the Russian context patents do not always provide meaningful representations of innovation process, as the efficiency of R&D measured by patents is low. Other standatd measures of innovation are not always readily available in Russia. Therefore, the paper relies on secondary data and circumstantial evidences.

The paper is structured as follows. Section 2 provides a theoretical background by reviewing academic literature on a number of relevant topics, such as emerging multinational companies and firm-specific advantages, innovation and internationalisation of R&D and absorptive capacities. Section 3 sets the context by providing a macro-view on innovation in Russian, the strategic intentions of the government’s policies and innovation in Russian (domestic) companies. Section 4 examines the interplay between innovation and internationalisation. Section 5 provides critical reflections and conclusions.

Theoretical background

2.1.Emerging multinational companies and firm-specific advantages

The rise of multinational companies originating from emerging economies has attracted a lot of attention among the business and economic literature. We start review of this literature by looking at the classic theories of internationalisation.

The ‘eclectic paradigm’ originally proposed by John Dunning (1981) yielded many useful insights that have informed subsequent research; it represent the most influential approach to study the international activities of multinational companies. This eclectic paradigm can be considered as an ‘envelope’ for the existing theories of internationalisation, with the addition of a new attention to the locational choice of investments (Dunning, 2000). Besides, according to Dunning (2006), the eclectic paradigm can be easily adapted to include new features emerging from the recent developments in globalised markets. In its essence, the eclectic paradigm postulates that the decision of firms to expand their activities abroad via FDI can be explained by three different advantages.Ownership (O) advantage represents the ownership of specific resources to be exploited externally. Location (L) advantage depends on the characteristics of the host country and opportunities it offers. Internalisation (I) advantage depends on the opportunity to internalise firm-specific advantages rather than to exploit them on the markets through other transactions.

Another fundamental contribution by John Dunning (1993) is a widely used typology of motivations drawing FDI. They are: (1) resources-seeking investments aimed at accessing unique resources specific to foreign locations (e.g. natural resources), (2) market-seeking investments aimed at entering new markets, (3) efficiency-seeking investments pursuing an efficient specialisation of firms, and (4) strategic asset-seeking investments aimed at augmenting the set of proprietary resources of firms.

The key precondition to become engaged in foreign investments is that a firm must possess some unique competitive advantage, or firm-specific advantages (FSA). The multinational company needs to build on some type of FSA that, at thesimplest level, is nonlocation-bound, i.e., easilytransferable across borders as an intermediateproduct. It can be either a functional,production-related proprietary asset, typicallytechnological, manufacturing or marketing know-how, or an organisationalcapability to efficiently coordinate and control the multinational company’s asset base.Hence, the FSA conceptcovers a very broad set of uniquecompany strengths (competencies and capabilities). The importance of FSA transfer to explain performance of the multinational company has become a pivotal in the international business literature (Rugman and Verbeke, 2001).

Alan Rugman also identifies country specific factors (CSA). The CSAs are the location-bound, exogenous factors in a multinational company’s home-market. TheCSAs result from the home country’s economic and institutional environments, such as labour force, factorendowments, government policies, national culture, productive reputation, or institutional framework. In fact, both FSA and CSA can be related to the O and L advantages of the OLI framework.

The OLI framework originally designed to explain internationalisation of companies from western economies does not directly address the pattern of internationalisation of firms from less advanced (or emerging) countries. Essentially, companies from emerging economies might not possess the same competitive advantages as companies from advanced economies do. As Goldstein (2007: 81) argues, ‘If they invest abroad, it is not on the basis of ‘O’, and the parameters that determine the degree of ‘I’ in their foreign operations are different’. These firms internationalise in order to get access to the strategic resources abroad they need. This idea is consistent with the classical Dunning’s typology of FDI motives. UNCTAD (2006) identify resource-seeking, market-seeking and efficiency-seeking factors as the main reasons for outward FDI from emerging countries to the emerging / developing countries. On the contrary, strategic asset-seeking motives are dominant for outward FDI from emerging economies to developed countries.

Reflecting on CSA, the domestic environment may be an important advantage for emerging multinationals, such as the low cost of factors (Barnard, 2008; Cuervo-Cazurra, 2007) and the monopolistic power at home (Andreff, 2002). The CSA may serve as a push factor; for instance, home country government policies may create a favourable framework for outward FDI.

Last but not least, cultural and psychic proximity (in line with the tenets of the Uppsala Model) is an essential factor is internationalisation of firms from emerging economies. Aykut and Goldstein (2006) report that that emerging multinationals successfully acquire companies in their home region since they are able to rely on cultural and ethnic affinities. In the same vein, Barnard (2008) shows that in knowledge-intensive services cultural and geographical proximity represent for emerging multinational a source of advantage over developed country multinationals.

2.2. Innovation and internationalisation of corporate R&D

The previous section outlined lack of ownership advantages as a reason for firms from emerging economies to internationalise. Strategic asset-seeking motive, entailing acquisition of technology-, or R&D-intensive firms, appears as dominant for expansion of emerging multinationals to developed countries.

A parallel trend is internationalisation of corporate R&D function when multinational companies engage in R&D at foreign locations. Motives, or location-specific factors,are divers – from characteristics of local or national markets to the properties of national or regional innovation systems. Establishing a presence in a foreign knowledge-intensive location is not a guarantee of success, and location-specific factors cannot be automatically captured (Narula and Zanfei, 2005). Tapping into localised knowledge base require strong linkages that are expensive and time-consuming to develop (Narula, 2002).

If the location-specific knowledge is internationalised by a foreign subsidiary, it is essential that it is then transferred to other units of the multinational company. Narula and Zanfei (2005:334) point out, ‘It is not sufficient for foreign affiliates to internalise spillovers if it cannot make these available to the rest of the MNE’. The multinational company must be able to co-ordinate and balance its structure, and stimulate and facilitate knowledge flows. As Narula and Zanfei (2005:334) claim, ‘a dispersion of R&D activities across the globe require extensive complex coordination if they are to provide optimal benefits. Such co-ordination requires expertise, managerial and financial resources’.

In its turn, the organisational structure is highly linked to the technological and sectorial nature of the company. Therefore, technological and sectorial differences can account for some of the differences of patterns of internationalisation and organisational structural adaptation (Narula, 2002).

A related question is the nature of technology involved, as it can explain specificities of internationalisation patterns. Technologies can be analytically split in two categories – mature or immature. In Narula’s (2002: 796-797) words, mature technologies ‘evolve slowly and demonstrate minor but consistent innovations over time. The technology is to a great extent codifiable, widely disseminated, and the property rights well-defined. Competition shifts towards price, economies of scale and downstream activities in order to add value, as the original product is priced as a commodity. On the other hand, immature technologies, widely present in emerging sectors, change rapidly and are difficult to codify.

The sectoral differences, or systematic knowledge base variations between industrial sectors is a classic argument (Pavitt, 1984). Understanding the specificities of involved knowledge bases is crucial in order to understand the prospects for, and challenges involved in, creating corporate learning networks that span different locations, and the need to link up involved knowledge actors.

Many emerging economies operate in mature technologies and low-tech sectors, and competition indeed shifts towards the price. For example, as shown by Barnard (2008), emerging multinationals tend to concentrate their M&A activities in low-tech traditional industries in which they have accumulated capabilities over time and in which they enjoy competitive advantages (compared to western multinationals) such as capital-intensive production, scale economies and assembly-based mass production.

2.3.Absorptive capacity – can emerging multinationals learn from their international investments?

The ability for emerging market firms to learn from their international technology acquisition remains unclear. The historical expansion of R&D activities of multinational companies from developed economies into new markets was shaped by a firm’s ability to transfer their R&D capacity into new situations to take advantage of localisational benefits for R&D, to access lower cost of labour for highly skilled workers, or to tap into country specific capabilities not available in the home country. In the case of emerging multinationals, especially those from Russia, it is unclear whether these firms have the know-how to benefit from their investments in developed market technology assets. The assumption has been to acquire developed market technology leaders and then transfer the technology to the Russia operations. Since multinational companies have been able to transfer their technologies to the Russian market it assumed that Russian may merely buy the technology and transfer it.

A firm’s ability to learn from it subsidiaries or cross border acquisitions is a function of its absorptive capacity. Cohen and Levinthal (1990) define absorptive capacity as the ability to exploit external knowledge which is predicated on its prior related knowledge built on an understanding of the most recent scientific or technological developments. This prior knowledge provide a framework for the firm to recognise the value of new technologies, knowledge or management innovation and apply them for profitable ends. Absorptive capacity is the moderator between firm level R&D spending, technology opportunity and appropriability of innovations for commercial uses. In the case of post-acquisition innovation performance the level of absorptive capacity will determine whether technology-seeking investments will pay off for emerging market firms.

The extant research in developed market firms indicates that learning from acquisitions is difficult as previous results indicate that in developed market that post-acquisition innovation performance has suffered (Hitt et al., 1994, 1996; Hoskisson et al., 1994; Ahuja and Katila 2001). A deeper understanding of the value of technology seeking behaviour was examined in the chemical industry by Ahuja and Katila (2001) where they found that the relative size of innovation output mattered. Innovation activity went up in the post-acquisition period when the absolute size of the knowledge base was large but was reduced when the relative size of the knowledge base was high. In case where firms try to absorb their target’s knowledge when the knowledge base is relatively large to their existing knowledge base this reduces innovation. Firms that purchase relatively large knowledge bases and those in unrelated fields have fallen into ‘competency traps’ (Levinthal and March, 1993) wherein they are able to properly utilise the innovation capacity of their acquisition. The extension of this model and results to emerging market firms brings into doubt about whether emerging multinationals will be able to integrate the existing technology competence of acquired firms into their home-market based operations.

Context: Innovation in Russia

3.1. Macro-view and public policy

The Soviet leadership regarded the S&T complex as a matter of national priority; and it was particularly crucial in the defence sector. The innovation was assessed from a technological, not economic perspective. Therefore, it is unsurprising that the situation in other sectors of the Soviet economy was rather disappointing. The command economy was inherently resistant to innovation. Introduction of innovation and new technologies would lead to (short-term) disruption of the existing structure. Because Soviet enterprise directors were not interested in profit maximisation, innovation and following reorganisation were considered as a burden. As Berliner (1988: 639) describes it, ‘management must always regard innovation as a secondary and potentially threatening activity’.

The transition to a market economy has not improved the situation, and even worsened it in many respects. While elimination of the command economy was a necessary condition for resistance to innovation to disappear, yet it was not the sufficient one (Berliner, 1988).

In the volatile transitional environment of the 1990s, innovation receded into the background. Most enterprises were struggling for survival in the new economic conditions, and innovation was perceived as luxury, a risky investment which would pay off in the long term. The situation has not radically changed in the 2000s. The potential for technology and innovation to drive Russia’s productivity growth is severely limited by several factors, such as a weak regulatory environment, weak intellectual property rights protection, low levels of collaboration between public and private sectors, and inadequate technological infrastructure.

The private sector remains reluctant to innovation, however. Apart from aforementioned problems, the fundamental issue is the structure of the Russian economy. It is heavily dominated by extractive and energy industries where the potential for innovation is limited by definition. In contrast, R&D-intensive sectors such as biotechnologies and electronics are under-developed.

The problem is recognised by the Russian leadership and the utmost attention is given at the top political level. The Governmental Commission on High Technologies and Innovations was established in 2007, and since March 2010 it is headed by the Prime Minister Vladimir Putin. Two years later, in May 2009, the Commission for Modernisation of and Technological Development of Russian Economy was established; it is headed by the President Dmitry Medvedev.The Russian government started to allocate funding to innovation through a number of state corporations, such as Rosnano (nanotechnologies), Rosatom (nuclear technologies), Rostekhnologii (hi-tech industrial products for civilian and military purposes), etc. In February 2011 the Russian government presented a draft of the National Innovation Strategy 2020. It aims to increase the number of Russian companies conducting technological innovations up to 40-50 per cent, and for Russia to reach some 5-10 per cent of the global market of high-tech products and services.