A Dynamic Model of the Choice of Mode for Exploiting Complementary Capabilities

Abstract

This paper examines the choice of mode for an MNC and a local firm to exploit their complementary capabilities. We develop a combined real options and game-theoretic model of modal choice by incorporating a range of factors drawn from the dynamic capabilities theory and transaction cost or organizational economics. The factors scrutinized in the model include the parties’ absorptive capacities, frictions in knowledge and asset markets and associated incentive problems, cost of switching from one mode to another and cost associated with power-jockeying. The model uses simulation to examine how these factors interact to influence the choice of mode. The results identify a number of conditions for one factor to dominate another and help to reconcile different theories that have made contradicting predictions with regard to the effects of such factors as uncertainty and capability divergence on the optimal choice of mode.