Methodological issues in the measurement of multinationality of US firms

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Alan M. Rugman Henley Business School, University of Reading, Reading, UK, and

Chang Hoon Oh Faculty of Business, Brock University, St Catharines, Canada Abstract Purpose – The purpose of this paper is to provide a critical discussion of the scope and correct scale metrics used in the measurement of multinationality. Design/methodology/approach – There are two ways of measuring the degree of multinationality (sometimes called the international diversification) of firms. The literature is reviewed using both types of metric, and then both are applied to tests of the regional nature of international business. Findings – It is found that the correct method is to use a scale metric which captures the degree of multinationality, such as the ratio of foreign to total sales. This paper provides empirical evidence that the scope metric, which counts the number of countries in which a firm has a foreign subsidiary, is unsatisfactory. Originality/value – The paper provides a new scale metric of the intra-regional activities of large US firms. Keywords United States of America, Large enterprises, Scope metric, Foreign to total sales, Multinationality, International diversification, Regional sales, Regional sales, Multinational companies Paper type Research paper

1. Introduction A critical nexus of research is the interaction between multinational enterprises (MNEs) and the geography of globalization. A rich literature has examined the organizational structures between parent MNEs and their overseas subsidiaries. This work originated in hierarchical, multidivisional (M Form), organizational structures, but moved towards the network (N Form). These firm-level interactions between parents and subsidiaries, or within MNE network linkages, need to be related to the nature of underlying firm-specific advantages (FSAs) of the MNE. These can either be non-location-bound FSAs or location-bound FSAs. Again, the literature has moved from early internalization theory with non-location-bound FSAs towards the more nuanced new internalization theory, which views FSAs as dynamic capabilities where there are resource recombinations taking place between units of the MNE and related actors in the home and host country environments (Rugman and Verbeke, 1992, 2001, 2004; Verbeke, 2009). This recent work on MNE networks and dynamic capabilities needs to be better related to recent parallel work on the geography of globalization. By geography is meant location factors. These, again, have moved on from an early focus on country-specific advantages The Multinational Business Review Vol. 19 No. 3, 2011 pp. 202-212 q Emerald Group Publishing Limited 1525-383X DOI 10.1108/15253831111172630

This is a revised version of a paper presented at St Louis University in February 2007. The authors thank the seminar participants for helpful comments and Quyen T.K. Nguyen for research assistance.

(CSAs) towards a new understanding of the nature of global economic activity as led by MNEs. This may usefully link to work on the double diamond (Asmussen et al., 2009). In particular, economic geography acts as a counter to earlier simplistic thinking on globalization, which assumed that worldwide economic integration would lead to homogenization of firm production and consumer demand. In reality, as Rugman (2005) has observed, the world’s largest 500 firms conduct most of their business within their large home-region markets, averaging about 75 per cent of their sales in their home region. This finding has been confirmed by five years of data, 2001-2005, by Rugman and Oh (2007). This startling empirical refutation of worldwide economic integration suggests that the three broad triad regions need to replace CSAs as the key units of analysis in research on location-specific advantages. Yet, to date, there has been almost no published research on the nature of region-specific advantages and the nature of the liability of interregional foreignness. Can research on country culture be expanded to regional level? What is a regional version of cultural, administrative, geographic and economic distance (CAGE; Ghemawat, 2007)? Finally, the relationship between the FSAs of MNEs and the regional nature of multinationality is only beginning to work its way into the literature on multinationality and performance (Rugman and Verbeke, 2008). Several important papers appear in Rugman and Oh (2007) on the regional aspects of multinationality and performance, and related work is beginning to be published by scholars such as Banalieva et al. (2010), Chen and Tan (2010), Goerzen and Asmussen (2007), Lee (2010), Oh (2010), Qian et al. (2010), Rugman and Oh (2010) and others. However, these recent encouraging empirical advances need to be better related to the core theory of the field. These unresolved theoretical issues have an impact on empirical research in this area. There are at least four methodological issues, which need to be resolved. First, it is essential that the data provided by firms in their annual reports on multinational activity be more carefully analyzed. Papers continue to be published using an inappropriate metric of multinationality, namely, counts of the number of countries in which an MNE has foreign subsidiaries, or counts of the number of subsidiaries in each foreign country. Both of these “scope” metrics present misleading information about the breadth of foreign activity, because they assume countries to be of equal size. More work needs to be done building on Asmussen (2009), in which the size of each country is measured by its gross domestic product in order to add a country size effect. Until a good country size metric is more widely accepted, researchers should continue to use scale metrics, such as foreign (F) to total (T) sales and/or assets, as magnitude measures of multinationality. These scale metrics can readily be applied to evaluate regional (R) to total sales (R/T). Second, in work on the extent of regional activity, more effort needs to be taken to produce longitudinal data sets, as in Rugman and Oh (2010, 2011). These will permit better analysis of possible changes over time in the components of F/T and R/T. In particular, sales in the home (H) region country of the MNE can be distinguished from sales in the rest of the region and the rest of the world. These metrics might usefully be extended to cultural indicators. Third, the underlying FSAs of an MNE, broadly classified into innovation assets and marketing assets, need to be treated as independent variables in regressions testing the impact of multinationality (F/T) on performance. In many studies, they are

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still treated as control variables. FSAs are important determinants of entry mode choice and firm performance, not multinationality per se (Rugman, 1981; Morck and Yeung, 1991; Verbeke and Brugman, 2009). Rugman and Verbeke (2008) argue that the basic regression between multinationality and performance is misspecified in light of the internalization theory. Multinationality is really an intermediate variable, not an independent variable. If performance is the dependent variable, the true independent variables are FSAs. These FSAs should not just be used as control variables, but as the true independent variables determining the performance of an MNE (Nguyen, 2011). In contrast, industry factors should be treated as control variables, despite the attempt by Peng to include industry factors as a third leg in his tripod framework (Peng et al., 2008). The other two legs of Peng’s tripod, the resource-based view of the firm and institutional factors, obviously correspond to the FSA and CSA framework. The latter remains the bedrock for analysis of the regional aspects of multinationality and performance. Finally, the functional form of the regression equation, which now incorporates a cubic fit, i.e. an S-curve relationship between multinationality and performance (Lu and Beamish, 2004; Contractor et al., 2003), can be usefully extended to examine potential M-curve fits, using a fourth degree polynomial relationship (Lee, 2010). It is also possible to conduct a variance components analysis, in which the regional effect can be distinguished from industry, firm and country effects. These issues are not independent but interlace each other. While not all of these topics can be examined, it is shown here that the basic methodology of the field can be improved by developing a consensus about which of the two conventional metrics of multinationality (i.e. scale and scope metrics) can be used. Both the scope and scale metrics are tested along with new measures of the regional nature of MNEs. The findings are then presented by comparing measures over the 2000-2007 period and across industry types for US MNEs. Finally, the summary of this study is provided. 2. Literature review A number of studies have analyzed the relationship between multinationality and performance. In this work, several measures of multinationality have been developed. In this paper, the focus is not on performance, only multinationality. Multinationality metrics can be divided into two broad types: scale metrics and scope metrics. Scale measures include foreign to total sales (FS) and foreign to total assets (FA). Such scale metrics have been used by Errunza and Senbet (1981), Siddharthan and Lall (1982), Kim and Lyn (1986), McDougall and Oviatt (1996), Christophe (1997), Denis et al. (2002), Qian (2002), Capar and Kotabe (2003), Rugman and Oh (2010) and others. Scope measures include counts based on the number of foreign countries; number of foreign subsidiaries (NOFB); ratio of foreign countries to total countries in which a firm has a subsidiary (FC); and the ratio of foreign subsidiaries to total subsidiaries (FB). Such scope metrics have been used by Morck and Yeung (1991), Delios and Beamish (1999), Pantzalis (2001), Zahra et al. (2000), Lu and Beamish (2001, 2004) and others. Some studies have used both types together, or developed an entropy index based on the NOFB (Errunza and Senbet, 1984; Tallman and Li, 1996; Ramirez-Aleson and Espitia-Escuer, 2001; Contractor et al., 2003; Christophe and Lee, 2005). A composite index of multinationality, as by Sullivan (1994), does not help, as it simply adds together scale and scope metrics to further confuse matters.

Recent empirical research has established that MNEs operate not globally but regionally. It was shown by Rugman and Verbeke (2004) that only nine of the world’s 500 largest firms operate globally, i.e. in all three regions of the broad triad of North America, Europe and Asia Pacific. In contrast, 320 of the 380 firms providing data for year 2001 on the geographic scope of their sales average 80 per cent of such sales in their home region. Subsequent research by Rugman and Oh (2007) showed that the regional nature of large MNEs was stable during the 2001-2005 period, using both geographic sales and assets. This suggests that country-level indexes, such as that of Kogut and Singh (1988) on culture, need to be rethought at regional level. Of the two metrics available to measure the multinationality of firms, a clear conceptual case can be made in favor of the scale metric over the scope metric. When a firm establishes foreign subsidiaries, the sales of those subsidiaries provide good information about the performance and success of the firm in such foreign markets. The F/T ratio is the basic metric showing the degree of foreign involvement. This F/T ratio has been used extensively in the literature of international business. One problem with the F/T ratio is that F sometimes includes exports from the home country, as well as sales by foreign subsidiaries (Bowen, 2007). It would be nice to unbundle the exports from the foreign subsidiaries, but accounting conventions make this difficult. The advantage of the F/T ratio is that it presents a clear indicator of international activity, separate from domestic activity. In this paper, the F/T ratio is referred to as FS. There are other variations of this FS metric. Data are available on foreign assets and the number of foreign employees. Therefore, it is possible to find the ratio of FA for a firm; it is called FA in this paper. The ratio of foreign to total employees could also be found, which would give information about the labor market. Sullivan (1994) simply computes a single factor from these metrics and other scope metrics. In contrast, the scope metric provides simplistic and potentially misleading information about the foreign involvement of the firm. If a firm operates in one hundred countries, it would seem to be more multinational than a firm operating in two countries. Yet, if this is a Canadian firm and its single foreign market is the USA, this firm is likely to have more foreign sales than a Canadian firm operating in all other countries outside of the USA. Indeed, data indicate that the 20 largest Canadian firms average about 80 per cent of their foreign sales in the USA, with the remainder in the rest of the world combined. This is a generic problem in the use of the scope measure. Basically, it counts each country of equal size; yet for any firm, sales in a large market such as the USA, Japan, Germany, the UK, etc. will be of much greater significance than sales to Jamaica, Luxemburg and Kazakhstan. In other words, selling in a large number of small countries does not indicate that the firm is multinational. Scholars, who use scope metrics argue that the presence of a firm in many countries provides some information on the depth of foreign involvement. They say that the F/T ratio provides information on the degree of foreign involvement. This first point is inaccurate. The scope measure adds no value to understanding the depth or extent of multinationality. Indeed, it provides misleading information. Using the scope metric, some firms may appear to be multinational if they have subsidiaries in several countries, when in practice they have a very low F/T ratio, well under 10 per cent. There is no theoretical justification for the scope metric. It appears to be popular with some researchers, because it is easy to attain from annual reports. Every firm lists the countries in which it operates. Some of them produce maps in which they highlight the


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countries in which they have a business. Serious scholars of international business need to improve on this simplistic interpretation of “global” business activity. Use of the scope metric needs to be discontinued, and the true extent of multinationality needs to be calculated using the F/T ratio or its variations. This involves more work by researchers, as well as careful definition and interpretation of the scale metric. As an example of the misuse of the scope measure, consider that all of the tests and results by Flores and Aguilera (2007) use a scope metric. This is defined as foreign direct investment (FDI) by a US MNE in a foreign country. This is a country scope metric. It is a biased measure of FDI, because it counts each country as of equal size. It thereby undervalues US FDI in large countries, such as Canada, and overemphasizes US FDI in small countries, such as Lesotho and Burkina Faso. Flores and Aguilera argue that between 1980 and 2000, the largest 100 US MNEs expanded more into non-home-region countries than into Canada and Mexico. In their Appendix, Table A.2, they define the number of countries by region as follows: Asia Pacific (20); EU (15); North America (2) and rest of the world (110). Given this definition, they find that US MNEs expand more in Asia Pacific and other regions rather than in Canada and Mexico. This finding is incorrect for the following reason. In 1980, most of the largest 100 US MNEs were already in Canada. Thus, there are few left to enter it in 2000. In contrast, in 1980, few US MNEs are in Vietnam, China, Uzbekistan, Kazakhstan, etc. mainly because these communist countries prohibited US FDI. Thus, in the Flores and Aguilera period, US MNEs would enter non-home-region countries due to a particular political institutional change called the collapse of communism. These two points suggest that US MNEs will expand into new countries and into countries beyond their home triad over time. It is obvious from this analysis that a scope measure giving equal weight to US FDI in each country is completely trivial and meaningless. Instead, it is necessary to evaluate the magnitude of US FDI in each country and by country. This would indicate that US FDI in Canada has increased dramatically between 1980 and 2000 (Rugman, 2000). It will also show that US FDI in Canada (and Mexico) has increased much more between 1980 and 2000 than has US FDI in small and peripheral countries, which made up the vast majority of entries in Appendix Table A.2. If Flores and Aguilera doubt the value of firm-level sales data, they would be better off calculating firm-level asset data, which is highly correlated with sales data. In any case, their use of this country-level scope metric yields unreliable results that can be deconstructed by any entry-level doctoral student. 3. Empirical results In this study, data are gathered on multinationality for both scale and scope measures: FS, FA, FC and FB. In addition to conventional multinationality measures, new intra-regional activity measures were supplemented in the light of recent development of international strategic management by Rugman and coauthors (Oh, 2009). Four new measures were developed as counterparts to the four conventional multinationality measures: (1) Intra-regional countries (IRC) is the ratio of the number of home region countries to total countries where a firm entered in. (2) Intra-regional subsidiaries (IRB) is the ratio of the subsidiaries in home region to total subsidiaries.

(3) Intra-regional sales (IRS) is the ratio of home region sales to total sales. (4) Intra-regional assets (IRA) is the ratio of home region assets to total assets. Among 255 US firms listed in the world’s largest 500 firms during 2000-2007, data are available for 246 US firms for any of these multinationality measures, but only 153 US firms reported all these measures. The data are compiled from the annual reports of these publicly traded companies. Table I provides information on the basic scale metric and scope metric for large US firms over the eight-year period 2000-2007. The use of these longitudinal data helps to reveal any trends towards greater or lesser multinationality by these important firms. The ratio of FS averages 25.2 per cent across this time period. There is some increase in this FS measure over time. In Table I, information is reported on the ratio of FA. These average 24.3 per cent over the eight-year period. Again, this ratio increases over the time period. The most interesting point is that both sales and asset measures are similar, showing that one-quarter of the sales and/or assets of US firms take place abroad. In contrast, the scope measures reported in Table I raise many questions. The country scope metric suggests that large US firms have nearly three-quarters of all their subsidiaries in foreign countries: the FC metric is 70.2 per cent. Obviously, this is a meaningless statistic. It suggests that US firms are far more multinational than they are. Indeed, US firms are much less multinational than the FC metric suggests, as they only average one-quarter of their sales abroad, in contrast to having three-quarters of all their subsidiaries in foreign countries. The second scope metric in Table I is also misleading. The average ratio of foreign subsidiaries to total subsidiaries (FB) is 36.3 per cent. Again, this vastly exaggerates the foreign content of US firms. Many of the foreign subsidiaries are in small countries, so it is misleading to think that US firms average a 35 per cent level of foreign involvement. Instead, it is 25 per cent according to the correct scale metrics. Although this paper is focused upon the data for US firms, it is well known that similar scope metrics for European and Asian firms also exaggerate the foreign involvement of such firms. Indeed, it is difficult to conceive of any use for such misleading scope metrics. Scale measures Sales (FS) Assets (FA) 2000 2001 2002 2003 2004 2005 2006 2007 Average

23.3 23.0 23.4 24.4 25.9 26.5 27.3 28.7 25.2

22.1 22.1 22.8 24.7 25.2 25.0 26.1 26.3 24.3


Scope measures Country (FC) Subsidiaries (FB) 68.9 69.0 70.2 69.6 70.0 69.9 70.3 70.4 70.2

46.3 36.4 35.3 35.7 36.0 36.3 37.1 37.6 36.3

Notes: 246 firms’ data are used in this table for 2000-2007, but numbers are various by year and measure; average is weighted average of each year

Table I. Multinationality metrics of large US firms

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Table II applies the same scale and scope metrics as in Table I, but to an examination of the intra-regional activities of the large US firms. This is a more refined aspect of overall multinationality, as developed by Rugman and Verbeke (2004), Rugman (2005) and others. Recent work by Ghemawat (2007) also emphasizes the regional nature of international business, which he calls semi-globalization. In Table II, the ratio of regional to total sales (IRS) averages 77.8 per cent over the period 2000-2007. The ratio of regional to total assets (IRA) is 78.7 per cent. Although both IRS and IRA are slightly declining over time, these scale metrics signify a robust amount of intra-regional activity for large US firms. These findings are virtually identical to those in Rugman and Oh (2007) and Oh (2009). In contrast, the scope metrics in Table II are misleading. The country measure (IRC) averages 44.1 per cent; this underrepresents the home-region nature of the activities of US firms. A US firm can only go to Canada or Mexico in its home region of North America. Yet, these two countries have an equal count with all others in the world. The scope metric for subsidiaries (IRB) reports the ratio of subsidiaries in North America to all subsidiaries. This averages 70.1 per cent over the 2000-2007 period. This is a somewhat better regional scope metric. It suggests that two-thirds of the subsidiaries of a US firm are in North America, with many of these, of course, in the USA itself. In a similar manner, but for a wider set of mostly smaller firms, Ghemawat (2007) reports that when a US firm first goes abroad, there is over a 60 per cent chance that the location of its first foreign subsidiary will be in Canada. Owing to the economic size of other North American countries, the US firms do not have substantial portions of sales and assets in the rest of the home region. However, the impact of US firms on other North American countries is much higher than that of European and Asia Pacific firms. For example, 12 US firms were listed in the 20 largest foreign-owned companies in Canada by revenue. According to the Financial Post (2005), these US firms generate 138 billion Canadian dollars in Canada, and this amount is comparable to half of the 12 largest Canadian firms’ revenue in Canada. In Table III, data are reported on multinationality across the major industries in which the large US firms are active. The sample is divided into seven manufacturing industries and four service industries. Other manufacturing industry includes household and personnel products, and forest and paper products manufacturers.

Scale measures Sales (IRS) Assets (IRA)

Table II. Intra-regional activities of large US firms

2000 2001 2002 2003 2004 2005 2006 2007 Average

81.0 80.3 79.6 78.4 77.1 76.3 75.6 74.0 77.8

81.4 80.5 80.0 78.9 77.9 77.5 76.5 76.8 78.7

Scope measures Country (IRC) Subsidiaries (IRB) 46.3 45.4 44.8 45.7 44.8 44.3 43.1 42.3 44.1

71.4 70.2 71.1 70.7 70.2 69.8 69.0 68.3 70.1

Notes: 246 firms’ data are used in this table for 2000-2007, but numbers are various by year and measure; average is weighted average of each year

Multinationality Intra-regional activity No of firms Sales (FS) Assets (FA) Sales (IRS) Assets (IRA) Total average Manufacturing Aerospace and defense Chemicals and pharmaceuticals Computer, office and electronics Energy, petroleum and refining Food and tobacco Motor vehicle and parts Other manufacturing Service Bank and financial service Merchandiser Telecommunication and utilities Other service

153 66 5 10 12 10 10 7 12 87 15 27 23 22

26.2 41.5 33.5 45.8 56.3 28.9 41.7 48.7 30.8 13.8 23.2 6.8 8.6 23.4

23.9 36.0 20.9 33.3 34.6 42.9 32.7 53.3 28.5 14.1 24.6 7.8 9.3 21.5

76.5 61.9 67.9 55.7 46.3 75.3 63.5 56.0 73.5 88.3 77.7 96.5 94.0 77.4

78.5 67.4 80.1 62.9 66.6 63.5 69.6 52.0 77.6 87.5 76.4 95.2 92.2 78.7

Notes: Owing to the comparison reason, 153 firms’ information is in this table; 153 firms reported FS and assets as well as IRS and assets

Other service industry includes health care, diversified outsourcing and delivery service providers. Owing to data availability for all four measures, data were used from 153 firms in this table. Variation of multinationality and regional activity across industry is higher than variation across year. In general, the service industry, with IRS at 88.3 per cent, is more regionalized than manufacturing industry, with IRS at 61.9 per cent. Looking at the FS and FA data, it is found that merchandising, telecommunication and utilities firms had less than 10 per cent of sales and assets in foreign region on average. In contrast, motor vehicle and parts firms had more than 40 per cent of sales and assets in foreign countries. Yet the latter firms still focus on their home region: more than 50 per cent of sales and assets were generated in the home region, mainly in the domestic market. 4. Conclusions In this paper, original data are reported on the scale and scope metrics of the multinationality of the largest 246 US firms (those listed in the Fortune Global 500) over the 2000-2007 period. It is found that the scope metrics greatly overestimate the foreign involvement of US firms. In general, the large US firms only have about one-quarter of their overall sales and assets taking place abroad. The scope metrics suggests a much higher ratio. The intense, intra-regional nature of the activities of large US firms is also examined, as are their geographic sales by major industry group, again with a home-region bias. Again it is found that scope metrics provide misleading information about the IRS and assets of large US firms. It is concluded that scope metrics should no longer be used in serious research in the field of international business. References Asmussen, C.G. (2009), “Local, regional, or global? Quantifying MNC geographic scope”, Journal of International Business Studies, Vol. 40 No. 7, pp. 1192-205.


Table III. Geographic sales and assets of large US firms by industry

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