Research in the European Journal of International Management, has looked at the connection between economic distance and the survival of foreign subsidiaries. The findings, based on a sample of 1771 Finnish foreign direct investments, shed light on the non-linear relationship between these factors and underscore the role of focused strategy in ensuring the success of a company’s foreign subsidiary operations.
As a concept, economic distance refers to the disparities in economic conditions and factors between a company’s home nation and foreign countries that host its subsidiaries. It is a major focus of international management research. In the paper by Pratik Arte of the Newcastle Business School at Northumbria University, UK and his late colleague Jorma Larimo who was at the University of Vaasa, Finland, it is argued that economic distance, when combined with arbitrage opportunities and associated costs, can shape the fate of foreign subsidiaries.
The researchers constructed an index to measure economic distance, drawing upon international production and organizational learning theory and using the statistical Mahalanobis method to calculate economic distance based on various factors. They tested their hypothesis using Cox’s proportional hazard model to analyzing the sample of Finnish foreign direct investments. The analysis showed an inverted U-shaped relationship between economic distance and the survival of subsidiaries. Initially, as economic distance increases, subsidiary survival improves but beyond a threshold, survival rates begin to decline as operating costs outweigh the benefits of operating in countries that are even more economically distant.
The study also highlights the role of prior experience and ownership in coping with the challenges in economically distant countries. Firms that have experience with foreign host countries, as well as wholly owned subsidiaries, could cope much better with the requisite operating costs. In contrast, joint ventures worked best between economically similar countries, where the costs and challenges were relatively lower.
This research could have implications for companies attempting to venture into foreign markets. While an economically distant country might be enticing because it presents lucrative arbitrage opportunities, the study shows that companies need to work strategically lest they fall fowl of that U-shaped curve! Prior experience and an appropriate ownership structure can mitigate some of the challenges, the research suggests.
Arte, P. and Larimo, J. (2023) ‘Revisiting economic distance and its role in foreign subsidiary survival’, European J. International Management, Vol. 20, No. 3, pp.369–407.