Want to lure R&D? Investing in tech capabilities trumps financial incentives

Where a multinational corporation (MNC) decides to put its manufacturing and research and development (R&D) facilities is important both for the MNC and for the host country. An MNC that makes the right move can gain a significant technological advantage over competitors, while the wrong decision can deal a major setback to its innovation efforts. The location choices of MNCs are the subject of a recent study by W. P. Carey management professor Robert Hoskisson. Hoskisson and his co-authors conclude that companies locating manufacturing and R&D facilities in more technologically advanced locations are better able to gain technological advantages. Countries that want to attract foreign investment often hold out tax breaks as a lure, but this study suggests that developing technical assets at home may be more important.

Where a multinational corporation (MNC) decides to put its manufacturing and research and development (R&D) facilities is important both for the MNC and for the host country. An MNC that makes the right move can gain a significant technological advantage over competitors, while the wrong decision can deal a major setback to its innovation efforts.

For the host country, investments by MNCs add to the dynamism of the local economy, bring in high-paying jobs, and may help local firms develop technological advantage. The location choices of MNCs are the subject of a recent study by management professor Robert Hoskisson and doctoral candidate Heechun Kim of the W. P. Carey School, and Korea University Business School professor Hicheon Kim.

In a detailed examination of the behavior of 136 South Korean manufacturing firms over a six-year period in the 1990s, the researchers conclude in a white paper that companies locating manufacturing and R&D facilities in more technologically advanced locations are better able to gain technological advantages. And countries that want to attract foreign investment in technology may need to develop their technological assets at home first.

"Many government policies have been focused extensively on financial incentives such as a reduction in taxes to attract foreign direct investment," the researchers state in the paper. "However, this study suggests that local governments in host countries should take country-level technological environments more seriously."

Market size matters — and so do technological environments

The project examined the foreign direct investment decisions of Korean multinational corporations, including some well-known names — Samsung Electronics, LG Electronics, and Hyundai Motor Co. During the 1990s, these corporations opened manufacturing and R&D facilities in the United States and Europe, as well as in less advanced countries, including China and India.

The researchers compiled corporate financial information for the firms, all of which were listed on the Korea Stock Exchange, and used the data to produce a comprehensive picture of the companies' foreign direct investment decisions. Then the research team analyzed those corporate decisions in the context of the level of technological development of the country where the manufacturing and R&D facilities were located.

Using an econometric model that controls for a number of factors, including the size and age of firms, the researchers were able to identify patterns of technological investment. The findings challenge the conventional wisdom that the investment decisions of multinational corporations are determined largely by the size of the market that companies are targeting.

A key conclusion of the study is that for investments in technology, the level of technological development in the host country plays a major role in determining where a multinational corporation invests. "In the past, people only considered market size," said Heechun Kim.

"They assumed that if the market size is large enough, companies can recoup their R&D investment by expanding into different markets. We are arguing that of course market size is important, but you also have to look at the characteristics of the host country environment."

Finding an edge

The researchers discovered that MNCs tended to open their manufacturing and R&D facilities in places where they had ready access to advanced technological knowledge. "What we find in this research is that these companies go into the developed countries both to exploit the markets and to learn, especially if these countries have a strong base of R&D intensity," Hoskisson said.

How does a Korean firm get a technological edge by placing manufacturing and R&D facilities in the United States or Europe? One obvious way is by acquiring local competitors or hiring skilled local employees, many of whom have been trained at the facility of a local competitor.

While they were not part of the study, Chinese firms today appear to be exhibiting the same behavior as the Korean companies, according to the W. P. Carey School's Kim. He cited the acquisition of IBM's personal computer business by the Chinese company Lenovo Group in 2004.

"By acquiring a piece of business of IBM, they now have a chance to learn how IBM actually produced computers," said Kim. "Even Chinese companies are coming to the United States. In their home country it is very challenging for them to develop new technological assets."

"In the Korean market, it is very hard to get good human resources," said Kim. "But if you come to the United States you can get really good talent." Korean manufacturing firms represent a valuable subject for this type of project, according to the researchers. Since the 1990s, Korean companies have invested aggressively in technology and have been expanding into other countries.

Also, South Korea is roughly in the middle of the technological development scale — below the United States and Japan but above India and China. Thus, it is a clear-cut matter to determine whether the multinationals' technological investments are going to countries that are more or less advanced than the firms' home country.

Risky environments

For the Korean multinationals, investing in less technologically advanced countries carries significant risks, according to the researchers. In many of these countries, patent and contract laws are weak, and there are many local competitors eager to acquire the technologies brought by the MNC. "Emerging markets are not really aggressive about patent protections," said Kim.

"Microsoft had a lot of problems in China because they essentially copied the software without paying." Said Hoskisson, "The reason multinational firms don't go to the less developed countries with significant R&D operations is that they are worried about exposing their intellectual property. They may even prefer to locate in a country where their intellectual property is protected to locating in their home country."

For countries that want to attract multinational investments in technology, patent protection is a critical step, according to the researchers. Kim notes that companies do have to walk a fine line. "If the local countries improve their patent laws too much, the local firms may not be able to learn from the multinationals. That’s why they hesitate to do so," he said.

According to the researchers, the larger lesson for national policymakers is that foreign direct investment cannot be attracted with financial incentives or relaxed regulations alone. Overall technological capabilities in the society also may need to be upgraded — something not accomplished quickly or easily. Said Kim, "It takes time but people need to get the message they need to do that."

Bottom Line:

• An important consideration for multinational corporations (MNCs) in deciding where to locate their manufacturing and R&D facilities is the level of technological development in the country. A high level of development can give an MNC a chance to enhance a competitive edge, while a low level carries risks for the company.
• In a study of Korean manufacturing companies, researchers found that companies that made foreign direct investments in more technologically advanced countries gained technological capabilities by acquiring technological assets present in host countries. This often happens through acquiring local firms or hiring skilled workers from local firms.
• Investments in less technologically advanced countries that have weak protections for intellectual property can hurt MNCs. Without these protections, MNCs can quickly spill over their technological advantages to local firms.
• Financial incentives alone are not enough to attract multinational investments to a country. MNCs also are looking for strong technological environments when choosing sites for manufacturing and R&D facilities.