Today, Marqués de Cáceres is among the most popular Spanish wines in the United States. But the now-global brand’s journey west wasn’t forged alone. In 2001, Allied Domecq, a multinational beverage company, purchased the high-performing winemaker. Upon acquisition, the subsidiary both upgraded its production processes and began to export the wine worldwide through Allied’s established distribution systems, and soon enough, the wine was a hit in the US market.
The Marqués de Cáceres story is typical of foreign companies that acquire lesser-known subsidiaries, and economists — and much research — generally agree that the highest performing firms are often subsidiaries of multinational corporations. “If you just look across the world, subsidiaries of multinational firms tend to be the most productive firms in a particular industry within a country,” Professor Catherine Thomas says.
But which comes first — performance or acquisition? “Usually, when a foreign company invests directly in a firm in a developed economy, it purchases an existing entity rather than building a new facility from scratch,” says Thomas. “We know that multinationals choose to buy the best firms, but we don’t know whether subsidiaries become better firms after — and because — they have been purchased by multinationals.”
To answer these questions, Thomas, working with Professor Maria Guadalupe and doctoral student Olga Kuzmina, examined data from a survey of managers of Spanish manufacturing firms that asked questions about not only revenue and profits, but also product and process innovations. For instance, managers were asked if a process innovation occurred in the last year, whether it required new machines, and if a new organization of production was introduced. “By innovation, we don’t necessarily mean groundbreaking technology, but changes that improve the efficiency and productivity of the firm in question,” Thomas explains.
The results? Performance comes first — multinationals are buying firms that are already high performers — but acquisition makes these great firms even better, and in more ways than one. When process innovation is associated with the purchase of a firm by a multinational, two types of major changes happen following the acquisition: new technology is introduced, and new management practices are implemented. Acquisition is also associated with increased firm productivity. This finding complements other recent economics research that attributes superior management practices at multinationals to be one of the main drivers of improved performance at subsidiaries.
“We show that when a firm becomes a subsidiary of a multinational, management does improve within the organization, but those things improve alongside the introduction of new machines and technology,” Thomas notes.
The researchers found that innovation is even more likely if and when the subsidiary begins to export their product to another part of the multinational parent, for example, through the multinational’s international distribution channels. With the increased market access offered by the foreign parent company, the benefits of improving production processes and technology are more likely to outweigh the investment costs associated with innovation for the acquired firm.
Not only is this a boon to the subsidiary, Thomas says, but it also explains how multinationals choose which firms to acquire, and leads to the somewhat unexpected conclusion that there is more to be gained from improving a strong firm rather than a poorly performing firm. “There is an incentive for multinationals to buy the most prominent firms in a given economy because they have the most to offer in terms of potential productivity gains from being part of a multinational production system. The same improvements in productivity will lead to larger rewards in a firm that was already high-performing than in a low-performing firm.”
Lack of market access can also explain why comparable competing firms that remain under domestic control don’t just mimic the innovations of the subsidiary, even if the technology or information is available to them, and suggests one reason why productivity differences may persist in an industry.
“The other firms still don’t have incentive to upgrade their own technology or processes because they don’t have the larger market that makes it worthwhile for the subsidiary to do so,” Thomas says. “It looks like they are unable to access that market unless they’re part of that multinational.”
Thomas also notes that the model might help explain why foreign-direct investment across different industries is associated with technology upgrading in the acquired subsidiary, even if the production technologies used in the parent and subsidiary are quite different, such as in the case where a car company acquires a rubber manufacturer. Even if the acquisition does not provide the subsidiary with access to relevant proprietary technologies, the complementary relationship between the market size of the parent multinational and the technology upgrades in the subsidiary explains why the subsidiary invests in technology upon acquisition. This mutual benefit is even larger when the subsidiary is relatively good to start with, Thomas says. “It’s a win-win situation for both multinationals and their new subsidiaries.”
Maria Guadalupe is the Sanford C. Bernstein & Co. Associate Professor of Leadership and Ethics in the Finance and Economics Division and a senior scholar at the Jerome A. Chazen Institute of International Business at Columbia Business School.
Catherine Thomas is assistant professor of finance and economics at Columbia Business School.
Catherine Thomas was a Columbia Business School faculty member from 2006 to 2012.
Maria Guadalupe was a Columbia Business School faculty member from 2004 to 2012.