Corporations financially handcuff subsidiaries to reduce aggressive competition

A “first of its kind” study of multiple-subsidiary corporations suggests they limit the financial decision-making of their subsidiaries so they cannot aggressively pursue market share, and that they do this in order to maintain tacit agreements with other corporations in an attitude of cooperation that the researchers term “mutual forbearance”.

Study co-author Metin Sengul, Assistant Professor of the Boston College Carroll School of Management in the US, says:

“We showed how large multi-unit firms manage competition across markets which no study before has showed.”

Corporations handcuff subsidiaries to get along with competitors

Writing in the September issue of Administrative Science Quarterly, he and co-author Javier Gimeno, Professor of Strategy at INSEAD in France, found that corporations sometimes leave money on the table in an effort to “get along” with and not upset their competitors.

They say heads of corporations “selectively intervene” in the day to day business of their subsidiaries to deliberately divert decisions that could shift the balance of power in the marketplace to their favor.

Prof. Sengul:

“There are two ways a corporation head can ensure a subsidiary plays nice. One is to watch over its subsidiary’s shoulder everyday, which is very difficult for headquarters, especially if it has lots of different units. It’s very costly and impractical.”

The other, way, he says, is the subject of their paper, and “that is to delegate decisions that will not trigger competitive aggressiveness to your units.”

Corporations want subsidiaries to succeed, but within limits

He says it is not a matter of corporations not wanting their subsidiaries to succeed, but only to do so within limits – so long as the unit’s individual success does not upset the tacit understanding the umbrella organization has with others operating in the same range of markets.

A corporate head might instruct a subsidiary as follows, he says:

“I don’t want you to anger my multimarket rivals so that we are hurt overall. Other than that, I want you to make money. Go, do good business. But whenever you are making big investment decisions – increasing your capacity by 30%, for example ñ stop. Come and ask me. Let’s talk. And then I will tell you to do it or not. Don’t decide on your own.”

The corporations aren’t interested in centralizing all the decision-making, he says, just the big decisions.

But in order to keep them in check, he says corporations not only limit their subsidiaries’ decision-making: they also financially restrict them.

Prof. Sengul:

“If you’re one of those units that I want to behave, I don’t leave lots of cash to your discretion because I don’t want to come back next year and see that you created new factories because you had the cash and you had the autonomy. It’s not good for the corporation if we are competing with the same rivals in multiple different businesses.”

An independent company would typically pursue the competition aggressively when there is an attractive opportunity in the market, and will try to secure as much market share as possible.

But corporations that operate in more than one market don’t do this, say the authors. They try to balance what is happening across all markets that they know other corporations also operate in. In other words, if they are competing with the same firms in multiple markets, they aren’t as aggressive at the subsidiary level as independent firms operating in just that market are.

The goal, says Prof. Sengul, is to get along across all industries that they share and avoid “competitive spillovers.”

He says their study shows this happens across all industries, especially those dominated by large firms.

He describes a hypothetical scenario where say a corporation might cut its light bulb prices and increase production in a bid to secure larger market share. But this might hurt a competitor in the same market. So instead of matching the price drop and hurting its own profits in the light bulb industry, the second “competitor” might instead go after the first one by attacking it in another market, say a medical devices one, a space both firms compete in.

Prof. Sengal:

“Whenever corporate heads realize, ‘OK my unit competes with other firms that can respond in other markets, then they tell those units, don’t be too aggressive. You are part of my corporate umbrella, my corporate empire. Behave. Don’t focus on market share, don’t cut prices. Be nice. Focus on profits, focus on increasing the margins.'”

“You step back, I step back. If you don’t step back, I don’t step back. That is called ‘mutual forbearance.’ We both forbear. We both take a step back.”

Corporate collusion is bad for consumers

But while this collusion makes things nice and cosy for the corporations, it restricts growth in certain markets.

“I’m intervening not to push my units to grow, I’m intervening basically to reduce their competitive aggressiveness,” Prof. Sengal explains, “That is the objective. Because that is the objective and my units are getting less aggressive, that’s why they are growing relatively less.”

In the end, it’s the consumers that get the rough end of the deal.

“Collusive behavior rarely helps consumers. Profits go up usually at their expense. Mutual forbearance reduces competitive aggressiveness in the market place and less competition usually hurts consumers,” he explains.

The study only used data on French companies. The authors managed to collect data on every single subsidiary of every single firm in France, starting in 2005.

Prof. Sengal:

“You can’t get that kind of data in the United States, the laws are more restrictive here. Mutual forbearance happens in the US every day, no doubt about it.”

Sources:

  1. Constrained Delegation: Limiting Subsidiariesí Decision Rights and Resources in Firms That Compete across Multiple Industries (abstract), Metin Sengul and Javier Gimeno; Administrative Science Quarterly September 2013 vol. 58 no. 3 420-471, DOI: 10.1177/0001839213500272.
  2. Boston College news release via EurekAlert. 23 October 2013.

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