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chapter 2PERSPECTIVES ON GLOBALIZATION

chapter outline

Introduction

What is globalization?

Globalization of markets

Globalization of production

Methods of internationalizing operations

Outsourcing

Foreign direct investment (FDI)

Teories of international business expansion

Early theories of FDI

Teory of incremental internationalization

Dunnings eclectic paradigm

Changing patterns of FDI

Destinations of FDIOutward investors

Impact of globalization on societies

Economic impacts

Diffusion of technology

Global financial markets

Culture change and globalization

Environmental impacts

MNEs and social impacts

Conclusions

learning objectives

o evaluate contrasting views on

globalization and its transformational

effects on businesses and societies

o gain an overview of the means by which

organizations expand internationally, in

both markets and production

o appreciate leading theories of

internationalization and foreign direct

investment (FDI)

o examine critically the impacts of

globalization on societies

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part 1 THE INTERNATIONAL DIMENSION AND THE ORGANIZATION

Introduction

Impending closure of a car components factory in the province of Cdiz in Spain

in 2007, by its American owner, Delphi, led to a wave of protests at the site,

supported by political leaders, including the Spanish prime minister and the EU

Commission president. Te workers trade union organized a two-day general

strike, which paralysed business and transport across the region, achievingglobal media attention. In the end, the factory closed, affecting not just the

1,600 employees, but an estimated 4,000 people in the region who depended on

Delphi for business. By 2008, Delphi had relocated to Morocco, where wages are

one-fifth of Spanish levels. Scenarios like this have become commonplace, and

are closely identified with globalization, the topic of this chapter.

Almost every aspect of modern life is shaped to some extent by processes ofglobalization. With relative ease, the consumer can enjoy worldwide travel,the internet and access to goods and services from around the world. Forinternational businesses, three features stand out: the need to think about

markets in numerous countries in a joined-up way; the importance ofglobal brands; and the imperative to seek the most advantageous locationfor production of their products. Tis chapter will examine all these aspectsof globalization, but it aims also to look critically at the various processestaking place behind the scenes, as it were, including their impact on socie-ties, highlighted in the opening vignette. Discourse on globalization some-times takes the form of presenting arguments of those who support it,

weighed against objections put forward by those who oppose it. Tatapproach tends to rest on the assumption that we are confronted with asingle global phenomenon. Te approach adopted here, in contrast, looks atglobalization as a number of strands which, when unbundled, exhibitdifferent effects in different contexts.

Te chapter begins by identifying the core features of globalization. Ithighlights the distinctions between the globalization of markets and ofproduction, the latter having progressed to a greater extent than the former.Key theories of internationalization are examined from the perspective ofthe firm, focusing on trends in the expansion of markets and internationalproduction. As these processes encompass more and more countries, partic-ularly developing countries, globalizations impact on societies raises issues

WEBCHECK

Delphis website is

http://delphi.com.

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Perspectives on globalization chapter 2

for businesses and governments. Tese issuesare explored in the remainder of the chapter.It emerges that, while benefits such as new

jobs in manufacturing are bringing wealth tocountries which have received significant

FDI, industrialization has been a mixedblessing, often associated with poor workingconditions and environmental pollution.

Workers in manufacturing jobs in high-costcountries are among the most vulnerable tothe effects of globalization, challenging firmsand governments in the developed world toadapt to global competition.

What is globalization?

It has become commonplace to observe that we all now live in a globalizedworld, transforming the way we live and work. Aspects frequently high-lighted include global media and telecommunications, global brands, world-

wide production and integrated financial markets. At the forefront of thesephenomena are MNEs, benefiting from the opening of markets across theglobe, and from advances in computing and internet technology, whichmake it possible to link far-flung activities in global networks.

In his book, Te Lexus and the Olive ree, Tomas Friedman (1999: xvii)describes the world as being tied together into a single globalized market-

place and village, driven by the spread of free-market capitalism to virtuallyevery country in the world (p. 8). Tis picture of a thoroughly globalized

world, sometimes referred to as one of hyperglobalization, has becomerather contentious. aking issue with the hyperglobalizers, some academicshave argued that the extent ofglobalization has been exaggerated and that,in fact, markets and organizations function more along national and regionallines (Rugman and Verbeke, 2004).

Somewhere between these two approaches is the view adopted here, thatglobal processes are taking place, but that these processes can be differenti-ated, proceeding more rapidly in some spheres than in others, and alsodiffering in intensity and effects from place to place (Ietto-Gillies, 2003).

Tese processes are depicted in Figure 2.1. Global capital markets and growing

economic integration vary significantly between countries. rade andeconomic integration have surged ahead in the developed world and in somedeveloping countries, but countries in much of Africa have seen little benefit.Some globalization theorists predicted the demise of the nation-state, butnational economies and national governments remain important players.

Tey have undergone changes, however, as they have become more interde-

plate 2.1 Mobile phones are now partof everyday life for people the worldover, such as this user in India.

Globalization: Increasing anddeepening interactions betweenindividuals and organizations acrossthe globe.

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pendent with each other and withcorporate players. In the sphere ofculture, there is cultural convergenceas industrialization and modernurban lifestyles have spread to many

countries, but cultural foundations ofdivergent societies persist. Accordingto this more tentative view, gradualchanges in nation-states and innational cultures indicate that globali-zation is more akin to a series oftransformations, rather than a single,all-encompassing system.

Several defining characteristics ofglobalization emerge from thedebate. Four are highlighted here:

Growth in capitalist market economies worldwide, reducing barriers to

trade and investment Growing interconnectedness between firms, governments and individuals

worldwide Advances in information and communications technology and transport Qualitative changes in organizations and societies as a consequence of

new global interactions.

Bringing these elements together, we can define globalization as processes ofincreasing and deepening interactions between individuals and organiza-tions across the globe, facilitated by advancing communications technologyand the opening of markets to trade and investment. Tis definition reflectsthe primacy of extended interactions between countries and continents, andalso highlights the importance of technological innovation in transforming

communications. It notes deepening interactions, implying that qualitativechanges are taking place, but it does not go so far as to suggest convergenceamong societies in terms of economic, social and cultural spheres.

Aspect Businesses Societies Governments

Markets argeting consumers inall markets

Access to products fromacross the globe

Lowering barriers to imports;encouraging domestic exporters

Production Worldwide scanning forproduction capacity

Benefits in employmentand technology from FDI

Incentives to attract FDI

I Intra-firm and inter-firm I networks

Integration into globalcommunicationsnetworks

Investment in infrastructure,education, R&D

Finance Seeking sources of capital worldwide

Openness to outsidecapital; integration intoglobal capital markets

Interdependence with regionaland global financial systems

Qualitativechanges

Internationalizedcorporate structure andculture

Culture changesassociated withindustrialization andurbanization

Co-operation with othergovernments in dealing withglobal issues

Table 2.1 What doesglobalization mean forbusiness, society andgovernment?

Figure 2.1 Globalization

Markets

Production

Globalization

International

distributor

Global sourcing

Co-ordination between

different locations

Global

brands

Culture convergences

Global capital markets

Economic integration

Interdependence

among states

Trade liberalization

IT, computing

and internet

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Te implications of globalization for business, society and government arehighlighted in able 2.1. For businesses, organizational structures and cultureevolve with the changes taking place in their operations, markets and finance.For governments, greater interaction leads to interdependencies, implyingthat governments have less scope for autonomous policies. However, national

policies are clearly influential: investment in education and technology facil-itates strong domestic industries as well as attracting FDI. From a societyperspective, consumers benefit, as do workers in sectors which have becomeintegrated into the global economy. However, these benefits may well notreach all in a society. Moreover, new industrial and urban environments oftenhave a downside of poor living and working conditions, as well as environ-mental pollution. Tese are examined in detail in a later section.

Globalization of marketsIn 1983, Teodore Levitt published an article entitled Te globalization ofmarkets, in which he predicted the merging of existing national markets forgoods into a single global market, where standardized consumer productsare sold in the same manner everywhere, the tastes and preferences ofconsumers everywhere having become irrevocably homogenized (Levitt,[1983] 1995). Peering into the future, he saw global companies, such asCoca-Cola and McDonalds, leading the way, although at the time he wrotethe article, many markets were closed to outsiders and nearly a third of the

worlds population lived under communism.By 1990, when McDonalds opened in Moscow and communist govern-

ments were crumbling, it looked as if Levitts predictions of the globalizationof marketsmight be coming true. But the picture had changed by the late1990s: global brands were losing their lustre; consciousness of cultural roots

was on the rise; and the large global companies were facing serious competi-tion from smaller agile competitors. However, we should not be too hasty toconclude that Levitt simply got it wrong. Te companies he highlighted havegrown into even larger global organizations, expanding into many more coun-tries. Levitts article drew attention to the fact that global companies are in aposition to co-ordinate activities across continents, leading to greater effi -ciency and economies of scale. Te trend that Levitt failed to foresee was thepersisting diversity of consumers and markets. MNEs have undergone shiftsin strategy, away from the one-size-fits-all view of markets towards localresponsiveness. A paradox of globalization has been that technology has notonly facilitated the effi cient delivery of standardized products, it has facili-tated ranges of customized products for different markets.

Te growth of global markets, as Levitt foresaw, has been most pronouncedin sectors which rely on a standardized product or service for all customers.

Tese are mainly in industrial products such as microchips and enginecomponents; commodities such as agricultural produce, oil and other fuels;shipping; telecommunications and financial products. However, markets forconsumer products in which tastes and preferences are influenced by culturehave not become as homogenized as envisaged by Levitt.

Consumers now have more choice than ever. In previous eras, the localcompany provided goods and services produced locally for people in its own

TO REC AP

Global transformations

Globalizations hallmarks are

increasing and deepening amongorganizations and individuals

across the globe. H owever, thereare differing views on the extent

of the changes taking place. The

hyperglobalization view ofconvergence towards a global

system has been somewhat

blunted by the evidence offragmentation in markets and

societies, as well as nation-centric policies of governments.

The less radical view sees global

transformations taking place inbusinesses, governments and

societies through increasinginteractions and evolving

changes.

Globalization of markets: Temelding of national markets into asingle global market; applies tostandardized products, such asindustrial goods and commodities,but for most consumer products,national markets remain distinct.

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geographic area, and enjoyed a stable market in which it had knowledge oflocal tastes and spoke the same language as consumers. A trickle of foreignimports did not disturb it unduly, as these were too expensive for mostpeople. Te position in many markets, especially in advanced economies, isnow reversed. Imports of standard products are often cheaper than the local

equivalent. Domestic manufacturing companies may struggle to competewith multinationals, which benefit from economies of scale and greaterresources. Tree main factors are at work: falling tariffs and other tradebarriers; falling transport costs; and the shift of production to lower costlocations. Tese factors, underpinned by new technologies, are all facets ofglobalization. Te successful company in todays world is able to sourcecomponents globally and deliver finished products to diverse markets,providing consumers in each with products adapted to their tastes at compet-itive prices. Te globalization of production, therefore, has been crucial tomarket success.

Globalization of productionA more recent trend than expanding markets has been the shift from home-country production of goods, particularly manufactured goods, to produc-tion in other countries. Products may be destined for consumers in the homemarket, the host market or other parts of the world. Companies may co-ordinate the sourcing of materials, components and know-how from manycountries to produce a complex product like a car. By breaking down themanufacturing process into its separate stages, each phase takes place in themost advantageous location. Hence, research, design, sourcing of compo-nents and assembly of the final product may all take place in different loca-tions, co-ordinated through high-tech networks.

In particular, manufacturing of mass-produced goods has largely shiftedto low-cost countries. Every country has economic conditions which attractdifferent types of business. Te differences which are particularly relevant forproduction decisions are associated with levels of economic development.

Tese are discussed in the next chapter, but for present purposes, it is usefulto identify the broad groupings:

Developed countries are those whose economies have become industrial-ized and technologically advanced, with high levels of income and pros-perity. Tese are mainly in North America and Europe, with the additionof Japan in Asia.

Developing countries cover a wide range of countries in the process ofchange from economies based on agriculture and natural resources toindustrial production. For labour-intensive industries, those countries

with abundant numbers of low-cost workers are said to enjoy comparative

advantage over high-wage economies. Te transition economyrefers to the countries moving from communist or

state-planned systems to market-based systems. Many have become indus-trialized during communism, but they overlap with developing countriesin many respects, as they are now focusing on economic growth to generatethe wealth needed to bring the prosperity of the developed countries.

Globalization of production: Atrend in manufacturing industries,in particular, of shifting operationsto countries where conditions andenvironment are moreadvantageous for the firm than theyare in its current location; usually

involving cost reductions.

TO REC AP

Globalized markets

Although the modern MNE is notlikely to come up with a model of

the global car which is a hit withall consumers in all markets, it is

certain to have a global

marketing strategy, targetingparticular markets with products

from its portfolio which it hasreason to believe will be suited to

needs and tastes in each market.

ransition economy: Economywhich is shifting from stateplanning to market orientation.

Developed country: Country whoseeconomy has become industrializedand technologically advanced.

Developing country: Country in theprocess of industrialization andbuilding technological capacity.

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A further category which is often used is the emerging economy or market.Tis term refers to fast-growing developing and transition economies, whichattract foreign investors and offer prospects of expanding consumer markets.

Te main emerging markets are India (developing), Brazil (developing),Russia (transition), and China (both developing and transition).

As with national differences between markets, differences between coun-tries and regions come into play in the location of production facilities andthe forms those operations take. Tese are called location-specific advan-tages, or just location advantages. For example, India has nurtured a strongI capacity, and has attracted global companies outsourcing I and relatedservices. Indias economic development has most often been compared withthat of China, where export-oriented manufacturing industries have flour-ished, mostly in mass-produced goods, from textiles to standardizedconsumer electrical goods. Both countries offer location-specific advan-tages: China offers abundant cheap labour, and India, skilled labour forknowledge-intensive industries. However, each is looking to diversify, asIndia is broadening its policies to attract manufacturing FDI (highlightedin CF2.2), and China is seeking to move up the value chain, to more high-tech activities. As the worlds two most populouscountries, each with populations of over abillion, they are also, potentially, the worldslargest markets. Not surprisingly, therefore,many companies eye the market potentialthey offer, in addition to their location-specific advantages in production.

Methods of internationalizing operationsA variety of arrangements have been adopted by firms wishing to internation-alize some or all of their operations. Figure 2.2 depicts these options in termsof the degrees of internationalization and ownership. Foreign directinvestment (FDI) involves ownership and control of foreign operations,including setting up a subsidiary in a greenfield site greenfield investment and outright purchase of a company in the desired location. Because theseinvolve a high degree of ownership and control, they appear on the right inFigure 2.2. Similarly, they involve deepening international commitment, andare therefore at the top of the figure. FDI also includes joint ventures wherethe ownership stake is suffi cient to give management control, thus positioning

joint ventures at the midway point in the figure. A company not wishing to

own foreign operations may license a foreign company to produce goods to itsrequirements and bearing its trademarks. Tis type of arrangement can broadlybe described as outsourcing. Involving no equity stake, it ranks at the lowestpoint on the ownership axis. In recent years, outsourcing has become a popularchoice, largely because it offers an enticing combination of cost savings and arelatively modest, initial capital outlay as compared to FDI. Some companies

Emerging economy or market: Fast-growing developing or transitioneconomy.

TO REC AP

Globalized production

Globalization of productionallows companies to break down

the manufacturing process intoits separate stages, each in the

most advantageous location.

MNEs see developing countries asattractive locations for operations

which depend on abundant low-

cost labour. PAUSETOREFLECT

Globalization:myth and reality

In what respects does it makesense to speak of globalization of

markets? Why has globalization ofproduction proceeded more

rapidly than globalization

of markets?

Foreign direct investment (FDI):Investment by an organization in abusiness in another country with aview to establishing production inthe host country.

Greenfield investment: FDI whichinvolves the investor in setting upan operation from scratch in a newlocation.

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seeking the advantages of outsourcing, but with the control that comes withownership, set up a subsidiary specifically to carry out an outsourced function,such as a call centre. Tis captive outsourcing operation thus falls under FDI,

as it is owned by the investor. Each of these internationalization methods willnow be discussed in turn.

OutsourcingOutsourcingis a broad term which covers any contractual arrangement by

which an organization (the client company) obtains goods or services itneeds from another organization (the outsourcing company), rather thanproviding them itself in-house. Both the outsourcing contractor and theclient company may be in the same country, but it is the growth in cross-border outsourcing which is highlighted as an indicator of globalization.

A company may outsource some or even all its manufacturing process toone or more other firms. When it outsources the entire process, it becomes, in

effect, a virtual manufacturer. Te manufacturing may be carried out under anagreed licence, by which the manufacturers are allowed to legally use the trade-mark of the client company. Te licence may also provide for oversight of theprocess with respect to quality. ypically, these arrangements are adopted bycompanies in the developed world to make use of outsourced manufacturingin developing countries with a view to exporting the products to their homeconsumers or consumers in other developed markets. Contract manufacturershave prospered from outsourcing, growing into large, co-ordinated operations,able to shift factory production among different locations to achieve econo-mies of scale (Buckley and Ghauri, 2004).

Nike is an example of outsourced manufacturing. It contracts for its trainersand other sports goods to be made by hundreds of companies in foreign loca-

tions, mainly in China and Indonesia. Te attraction of these locations is theirabundance of workers available for relatively low-skilled manufacturing jobs atwages a fraction of what they would be in the developed world. In all, some660,000 workers are employed to make products bearing the Nike logo, almostall by independent companies subcontracted to Nike (see CS14.2).

Nike and other companies have been criticized for the sweatshopconditions which occur in the factories producing their products, raising

Figure 2.2 Methods ofinternationalizing operations

Outsourced

production

Joint

venture

Outsourced function

Greenfield

investment

Acquired

business

Captive

outsource

Ownership

Internationalization

Outsourcing: Shifting of anoperation or process by oneorganization to another, under acontractual agreement, usuallydesigned to reduce costs for theorganization shedding the activity.

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2 .1

Puma on top of the world

When Italy lifted the football World Cup in 2006, there werecelebrations in the town of Herzogenaurach, Germany. Puma,the sportswear company sponsoring Italy, could celebrate atriumph for their brand. Adidas, also based in the town, spon-sored the largest number of teams, including France, therunners-up. Puma sponsored all five African teams in the finalsof the competition, using the logo, United for Africa, lookingahead four years, when Africa will host the finals. Pumasmarketing, which cost a fraction of the marketing budgets ofits larger rivals, Adidas and Nike, is indicative of the freshapproach of its entrepreneurial CEO, Jochen Zeitz, who tookover the company in 1993. Ten, the company was losingmoney, and its products were more likely to be found indiscount stores than in the kit of sports personalities. He was29 at the time, becoming Germanys youngest chief executive.His twin strategy to revive the company involved cutting costs

and building the brand. Production was moved out of Europeto Asia. He is aware that his competitors, who also outsource in

Asia, have faced criticisms for sweatshop conditions in sports-wear manufacturing, but he points to the fact that Puma usesindependent NGOs to monitor conditions, and has had nocomplaints for years.

Zeitz has transformed Puma into a global brand by focusingon sports lifestyle, rather than getting leading athletes to wearits products, as Nike and Adidas have done. It aimed to add afashion element, to excite the consumer, paying less attentionto matching competitors products head on. Puma now hasannual sales of 2 billion, and enjoys the highest profit marginsin the industry. It has added two other headquarters, one inBoston, USA, and one in Hong Kong. Its workers come from allover the world. Zeitz says of Puma: We are a global companynow, no longer German. I mean, can you imagine, when I gothere we had what was called an export manager and hecouldnt speak English (Milne, 12 June 2006). As indicated inthe figure, the Americas and Asia together now account for aslightly larger proportion of Pumas revenue than Europe, theMiddle East and Africa.

FigurePercentages ofPumas globalrevenue by region

Source:Financial Times,4 August 2006

Te Puma brand today relies in large measure on trends infashion, which can be ephemeral and are notoriously hard topredict. Te leaping cat logo has become widely recognized, but

Adidas and Nike are also seeking to win over consumers withexciting new products. Adidas has hired Stella McCartney, thefashion designer, to design new sportswear. Pumas potentialin sports fashion caught the attention of PPR, the Frenchgroup which owns Gucci and other upmarket labels, as well aslarge retailers. Having taken a 27 stake in Puma, PPR is

contemplating taking it over, with a view to exploiting thegrowing luxury sports sector. Puma would gain from increasedcapital investment, helping to boost its sports products as wellas luxury fashion products. In the past, Zeitz has been scepticalabout mergers, but the backing of a strong luxury and retailinggroup should strengthen Pumas competitive position.

Questions How did Puma manage to recover its profitability?What is distinc tive about Pumas brand strategy in global markets?

Sources:Birchall, J., US group targets a wider market, Financial Times, 4 August 2005; Milne, R., Giantleap forward for the sportswear outsider, Financial Times, 12 June 2006; Garrahan, M., Adidas earns itssell-faster fashion stripes, Financial Times, 3 May 2005; Milne, R., World Cup puts Puma out in front,Financial Times, 4 August 2006; Milne, R., Puma ponders next step in luxury sport sector, Financial

Times, 11 April 2007.

STRATEGIC CROSSROADS

Europe

Middle East

Africa

48%

Asia Pacific

19%

Americas

33%

CSR issues for management. Critics point to the fact that health andsafety, environmental and employment law in developing countries giveonly weak protection, and enforcement is patchy. Moreover, governmentsare not likely to raise regulatory barriers which might discourage futureinvestment. Puma, a rival of Nike, featured in SX2.1, has made use of

monitoring by NGOs to satisfy consumer concerns over poor conditionsin outsourcing factories.

W E B C H E C K

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Business process outsourcing (BPO) has become common, usually due tothe cost savings envisaged. For client companies, the rationale is that anyfunction which is not core to its business can be shifted to an outside provider.In addition to I services, back-offi ce administration, call centres and helplines are candidates for outsourcing. Te outsourcer is usually a specialist in

the particular activity, and is able to achieve economies of scale, as it servesother customers as well. Te client organization may well feel that handingthese functions over to experts will give managers more time to focus on thecompanys main business. Outsourcing I and accounting has thrived, and,as these are largely technical processes, they lend themselves to outsourcing.Outsourcing of HR functions has become popular, following BPs examplein 1999. Its programme proved to be rather ambitious and had to be scaledback, but it has proceeded on an incremental basis since then. Te outsourcingcompany may be in the same geographical region as the client company, butshifting functions abroad to a lower cost location, which is often calledoffshoring, is also taking place.

Te term offshoringis applied to the contracting out of a function specif-ically to a low-cost country. Te practice has grown dramatically, particularlyin the services sector (UN, 2005). India has been a popular offshore locationfor companies from the US and the UK. In addition to call centres, Indianoutsourcing companies now offer a range of back-offi ce services to interna-tional companies. Offshoring has come to have negative connotations,implying that cost is the only factor in the decision to outsource and that thefirm will inevitably cut jobs in the home country. Neither of these implica-tions may apply to a particular outsourcing decision, but both are closelylinked to the phenomenon in general. Not all outsourcing is offshoring. HRand public sector outsourcing in the UK, for example, have tended to go tospecialist domestic companies. In an ironic twist, half a million workers inIndias state-owned banks went on strike in 2006, in protest at the outsourcingof back-offi ce tasks to the countrys own private outsourcing companies,

which have prospered through offering just these services to global MNEs.Outsourcing is sometimes

criticized for its alleged transfer-ring of jobs from advanced econ-omies to cheaper locations,contributing to an internationaldivision of labour. It is arguedthat, while the company and itsshareholders benefit, theemployees in the home countrylose out, as their jobs migrate tolower cost locations. In fact, the

situation is much more complexthan the critics suggest. Costsavings can be ploughed intoupgrading the skills of workers,

who are then able to take onmore skilled jobs. Te most

plate 2.2 Football has becomepopular in Africa, boosted byhosting the World Cup in 2010.

Offshoring: Contracting out of abusiness process to another

country, the main motivationusually being to benefit from itslow-cost environment.

Business process outsourcing (BPO):Te shifting of particular businessfunctions or processes to a specialistcompany, usually for cost savings.

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vulnerable workers are in low-skilled jobs in which the tasks are notdependent on being in the same location as the consumer. Researchers,however, face diffi culties in quantifying the number of lost jobs. Millionsof US jobs were lost due to the shift of manufacturing to East Asia andMexico in the 1980s. It is estimated that the loss of jobs due to outsourcing

is of a much lower magnitude, estimated at 473,000 in 2004 (Luce andMerchant, 2004).Of greater significance has been the political impact of occurrences like

large factory closures due to a shift to foreign production. When a commu-nity loses a large employer, there may be considerable effects, as the closurecan adversely affect all aspects of the local economy, including retailers andproviders of services of all types, from building to leisure centres. On theother side of the coin, outsourcing is likely to be seen by the host country asbeneficial. It brings in jobs and rising demand for consumer goods and serv-ices which bring prosperity to communities. However, the new jobs may notbe very secure. Outsourcers continually seek cheaper locations elsewhere,leading to accusations that a downward spiral, or race to the bottom willensue. Te same phenomenon is also associated with FDI, although to alesser extent, as these investors have a greater stake in the local economy.

TO REC AP

OutsourcingOutsourcing offers a means bywhich a company can contract

out almost any of its activities,

from a single process such as acall centre to an entire

production chain, to anothercompany, often across national

borders. Business process

outsourcing is also popular,yielding cost savings, but

outsourcing has acquired

negative connotations as it isperceived to be linked with loss

of jobs in the home country.

Georgia

Ohio

Michigan

Michigan

Maine

IndianaIllinois

MissouriKansas

Nebraska

Montana

Wyoming

UtahNevada

Arizona

California

Iowa

Minnesota

WisconsinIdahoOregon

Washington

Colorado

SouthCarolina

WestVirginia

New YorkMass.

Conn. Rhode. I.

Verm.

N.H.

Virginia

Pennsylvania

North Carolina

North Dakota

South Dakota

New

Mexico

Florida

Alabama

Tennessee

Kentucky

Mississippi

Louisiana

ArkansasOklahoma

Texas

Md.Del.

N.J.

Washington, DC

NewOrleans

Los Angeles

LasVegas

San Francisco

Miami

New YorkPhiladelphia

Chicago

Atlanta

Cincinnati

Boston

Houston

Detroit

MEX IC O

C A N A D AAlaska

(reduced)

Hawaii

COUNTRY FOCUS 2.1 THE USA

Te traditional picture of American manufacturing is that ofthe blue-collar worker on the assembly line in one of the manycar factories in the Detroit area of Michigan, known asMotown. However, Motown and other large swathes of

American manufacturing have declined into rust-belt areas,

their industries uncompetitive in todays global economy. From2000 to 2005, Michigan, with a total population of 9.9 million,saw the disappearance of 218,000 manufacturing jobs, mostlyin the car industry, with knock-on effects in the local economy.For the states inhabitants, this translated into a median fall in

What has happened to American manufacturing jobs?

THE USA

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household income of 19, the largest fall in the US. A senioreconomist at the Federal Reserve Bank described Michigan as abasket case (Cameron et al., 2005).

Te plight of General Motors (GM) and its subsidiary, Delphi,is indicative of the industrys problems, and reflects those of

Americas traditional blue-collar workers in general. In 1999,

GM floated off its components operations in a new publiccompany, Delphi. Although Delphi became independent of itsformer parent, most of its sales were to GM, and its 180,000workers, who were unionized, brought with them the generousterms of GM employment contracts, including pensions andretirement healthcare, which weigh on company finances. Forevery vehicle GM produces in North America, $2,200 in costsgoes into healthcare and pensions, more than the cost of rawmaterials. Moreover, GM and Delphi guaranteed wages andbenefits, so that, when orders fell and there was no work, thecompany had to continue paying full wages and benefits to laid-off workers, in a jobs bank. Delphi sank to losses of $2.8 billionin 2004. In the same year, its unfunded pension and retirementhealthcare liabilities reached $10.4 billion. In 2005, it filed forprotection under Chapter 11 of the US bankruptcy code, becom-ing the biggest US manufacturer ever to file for bankruptcy. Tecompany could continue to operate, but it needed urgently torenegotiate its labour contracts.

Generous pensions and healthcare packages were a feature ofUS industries during their heyday in the post-war period. Incontrast to European countries which have some form ofuniversal national health provision, the US model has beenthat the state provides only minimal safety-net provision, andthat large employers and insurance schemes shoulder the mainburdens. Tese costs have grown dramatically, as Figure 1shows. GM is Americas largest private purchaser of healthcare,spending $4.8 billion in 2006, to cover healthcare of 1.1 millionpeople. Tey include employees, dependants and retiredemployees (who number 432,000).

Figure 1 Percentage changes in US employment costs (civilianworkers)

7

6

5

4

3

2

1

01998 1999 2000 2001 2002 2003

Wages and salaries Benefit costs

Source:Financial Times, 20 January 2004

Te trend is now for companies to scale back these benefits,but workers may be left feeling vulnerable. Low-income workerswho do not work for large companies with health schemes areincreasingly unable to afford the rising costs of insuranceschemes. A worrying consequence is the growing number ofworkers with no health cover at all, which has increased by 6

million since 2000, reaching 45.8 million in 2006. Tese peopleare at risk from treatable illnesses, and could see long-termeffects on their quality of life and ability to work.

Figure 2 US market share of major car manufacturers

30

25

20

15

10

5

02001 2002 2003 2004 2005 2006 2007 2008

GM Ford Toyota Honda

Percent

Source:Financial Times, 18 January 2008

As Figure 1 shows, wages rose at only 2.9, but benefit costsrose at over 6 in 2003. For workers in companies with healthcover, inter-generational tension is emerging. Current workers

may face wage cuts to pay for health bills of retired workers.Current workers know they will not enjoy equivalent benefitswhen they themselves retire. Furthermore, stagnating wagesfor low-skilled jobs contrast sharply with the income growth ofthe richest Americans. Te differential between the earnings ofchief executives and the average American was 26 in 1973. In2004, it was 300.

Te past 20 years have seen the growth of car factories in theUS owned by the Japanese companies, oyota, Honda andNissan, as well as the Korean company, Hyundai. Tese newcompetitors have eaten into American manufacturers marketshare, as Figure 2 shows. Te foreign manufacturers bypassedthe traditional old economy regions of Michigan and Ohio,going to southern states such as Alabama and ennessee, oftenaided by FDI incentives from local governments. Teir work-forces are not unionized, and they do not enjoy the lavishbenefit packages.

Delphis CEO says: What is happening at Delphi [is] simply aflashpoint, a test case, for all the economic and social trends thatare on a collision course in our country and around the globe(Simon, 22 May 2006). Delphi hopes to restructure its way backto profitability, partly by rewriting its labour contracts. It is

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Foreign direct investment (FDI)FDI can be defined as investment by an organization in a business in anothercountry, with a view to establishing production in the host country. Teorganization aims to gain control over this foreign production. Tere are

various methods it can use to achieve its goals. It may simply buy a foreignbusiness, becoming the new owner. Assuming the business is a going concern,production continues under the new owners, who are likely to have newideas on how to manage the business more effi ciently. Alternatively, thecompany may take the bolder step of buying a greenfield site in the foreignlocation and setting up a production unit to its own specification. Tisprocess will be longer and more complex for the company, but it will benefit

from a unit designed specifically for its purposes and to its own specifica-tions, and where its own technology can be incorporated from the outset.Te greenfield option is often seen as the ideal, but this type of strategy is ahigh-risk one. In particular, it involves dealing directly with authorities inthe host country for numerous permissions and services. As these processesare likely to be quite different from those in the home country of the investor,communication diffi culties, delays and costs could mount before the projectcomes on stream. SX2.2 on Dyson, later in this chapter, provides an exampleof this type of investment. Te Dyson factory in Malaysia had been oper-ating for two years before production was shifted there entirely.

A less radical type of investment is through the joint venture, whereby theinvesting company joins up with a partner organization in the host country

to form a new organization, specifically designed for the investment envis-aged. Te joint venture combines the advantages of the host partners localknowledge and expertise with the know-how and capital of the investingcompany. Clearly, success depends largely on whether the partners share thesame goals and how well the partners knit together in practice. In somecountries, such as China, joint ventures have predominated, as the retentionof an element of local control has been government policy. It is only in recent

diversifying into high-tech businesses. Its new satellite radio hasproved popular, and it is a world leader in this market. Tecompany has attracted private equity investors (see Chapter 11for an explanation), and is emerging from bankruptcy. It hasannounced plans to sell or close all but eight of its 28 US plants,and to shift manufacturing to overseas locations, highlighted in

the opening vignette of this chapter. Te closures will be afurther blow to the communities in Michigan, where car andcomponents factories have dominated the local economy fordecades. Te mayor of Lansing, Michigan, is philosophical. Hiscommunity has seen the death of a way of life. Looking to thefuture, he says: Te theme of my government is going to bediversify, diversify, diversify (Chaffi n, 25 November 2005).

Sources:Chaffi n, J., GM workers see th e good life fiz zle away, Financial Times, 25 November 2005;Cameron, D., Drohan, M. and Ward, A., Job cuts mean fresh blow to heart of US car industry,FinancialTimes, 25 November 2005; Roberts, D., Americas dilemma, Financial Times, 13 January 2006; Luce, E.,Out on a limb, Financial Times, 3 May, 2006; Simon, B., Motown blues, Financial Times, 19 September2005; Mackintosh, J., How the wheels fell off at General Motors,Financial Times, 10 January 2005;

Simon, B., A generation of working-class Americans under pressure, Financial Times, 22 May 2006;Simon, B., End of the road for thousands of car workers, Financial Times, 23 June 2006; Simon, B.,Delphi aided by 2.5 equity deal, Financial Times, 19 July 2007; Simon, B., Stalled in Detroit, FinancialTimes, 18 January 2008.

Questions

In what ways are the problems at GM and Delphi illustrative of theproblems for manufacturing workers in the US generally? In the quote from Delphi s CEO, what trends is he referring to? Assess the strengths and weakne sses of Delphis survival plan.

W E B C H E C K

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years that Chinese authorities have allowed foreign investors to own morethan 50% of a joint venture. In general, joint ventures may be preferred inlocations where the investing company has little local knowledge and expe-rience of business practices, and where the cultural environment is verydifferent from that of its home country.

A key aspect of FDI is the control which the investing company exertsover the overseas production. Te joint venture involves give and take betweenpartners, whereas the greenfield investor and the investor who has bought anexisting company have the control which goes with ownership of their newassets. In all these cases, the investor establishes relations within the hostenvironment. Hence, the investment is termed direct. CS2.1 on Nokia illus-trates expansion by FDI, transforming Nokia into a global company.

By comparison, investors who wish neither to have their products manu-factured abroad nor to own and control foreign assets may still wish to investoverseas, for example by buying shares in a foreign company which seems tohave good growth prospects. Tis type of investment is called portfolioinvestment, and is a financial investment only, not aimed at running thebusiness. However, distinctions between the different types of investmentmay become blurred. A company may acquire a wholly owned subsidiaryoverseas, and leave the existing management to run the business, whereasanother company may acquire only a minority stake in a foreign companysequity and proceed to exert control. Te acquisition by Renault of a 37%stake in Nissan in 1999 is an example. New management introduced byRenault carried out radical changes, signifying a shift in control to the Frenchcompany. It should also be remembered that ownership of shares in itselfinvolves a role in decision-making, and even a stake of under 10% may belooked on as worthy of a seat on the board of directors. An investor mayacquire such a stake with a view to raising it in future, or even making atakeover bid. Key theories, discussed in the next section, help to provide aclearer overall picture of the links between location, ownership and controlin the growth of international businesses.

Portfolio investment: Financialinvestment in an overseas companywithout a view to obtaining controlover management decision-making.

TO REC AP

FDI options

FDI, entailing a significant

ownership stake andmanagement role in foreign

operations, involves deeperinteractions with the hostlocation than either outsourcing

or portfolio investment. Investingin a greenfield site is slower than

acquiring a foreign company in

the same type of operation. Forthe company with little

experience of the foreignenvironment, the joint venture is

an obvious entry mode, but its

success depends heavily on asmooth relationship between the

investor and the local partner in

the host country.

Te global mobile phone market, althoughrelatively young, has matured rapidly, present-ing both opportunities and challenges forhandset makers and network operators. Tegrowth of Nokia, the Finnish conglomeratewhich shifted its strategic focus to mobilephones in the early 1990s, coincides with the growth of the marketitself. Nokia became the biggest maker of mobile phones in 1998,and has maintained its position as market leader (see figure), evenduring the downturn in the telecommunications sector from 2001to 2003. Even so, it has often found itself outmanoeuvred bycompetitors, responding belatedly to changing consumer trends,

and having to sacrifice profit margins in order to hang on tomarket share. With the departure in 2006 of key executives whohad guided the company for over a decade, could changes in strat-egy be taking place?

Nokia has prided itself on the quality of its product portfolio,which has been the strength of its brand. It spends more on R&Dthan any other handset maker, investing particularly in softwaredevelopment and handset innovations. While many of its

competitors outsource manufacturing, Nokiamanufactures 7080 of its phones itself. Ithas been confident that the strength of itsbrand and the quality of its products wouldenable it to maintain both high market shareand high profit margins, but costs and changes

in its markets have caused managers to rethink.In Western Europe, which has been Nokias main market,

consumers have been looking for eye-catching, innovative prod-ucts. Samsung, with its folding clamshell models, and SonyEricsson, with its larger colour screens and camera phones, havecombined style with reasonable price, making inroads into Nokias

market share. Nokia seemed to be caught without attractive prod-ucts in these segments, and although it has fought back with newmodels, it has had to cut prices, damaging margins. Te companysrevenues peaked in 2000, at 30.4 billion. In that year it sold 128million phones. Revenues in 2003 were 29.5 billion from sales of179 million phones.

Was Nokia becoming out of touch with what consumers werewanting? It seemed not to appreciate the importance of style in

Case study 2.1:

Nokia keeps

competitors at bay

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the consumers mind. More generally, the company had failed toadjust its strategy for the fragmentation which was occurring inthe market. It was being attacked by Samsung at the high end ofthe market, Sony Ericsson in the middle range, and Siemens atthe lower end, where the basic entry-level phone is the key

product. A corporate restructuring followed in 2004, in whichtwo new business units were created. Te multimedia divisionfocuses on the high-end consumer products, including advancedimaging, music and gaming. Te enterprise solutions divisionaims to serve the business smart phone market. Tus, thesespecialist units are now separate from its mainstream mobilephone business. Te company is now focusing on emergingmarkets such as China andIndia, but in these verycompetitive markets for basicphones, margins are tight.Nokias handset sales in Chinagrew by a third in 2006, helpingthe company to claim 35 ofChinas mobile phone market.Tis impressive performance

reflected the companys drive toattract new subscribers withlow-cost handsets.

In 2008, Nokia announced itwas closing its German plant inBochum, with the loss of 2,300

jobs, and moving production toRomania, where wages are one-tenth the levels in Germany.

Regional German offi cials were dismayedby the decision, especially as the planthad received 88 million in subsidiesand research grants. Tey intended tohold Nokia responsible for the retrain-ing and job-seeking activities for thesacked workers.

Nokia is by far the most successfulcompany in Finland, accounting for20 of the countrys exports, andemploying 22,400 people in Finland.Te Nokia brand enjoys extraordinary

customer loyalty in its home market, where it has had a marketshare as high as 93. Tis share slipped to 80 in 2003, as domes-tic retailers found that even highly loyal Finnish customerspreferred Samsungs colour-screen models and clamshell designs.

Nokias corporate culture has been highly homogeneous andclosely knit, most of its executives being long-serving and Finnish.But the company has become global in its geographic reach. Somehead-offi ce functions, such as finance, have moved to New York,and New York is the location of the new enterprise solutions divi-sion. Following the restructuring, its new board still has only fournon-Finnish members out of 12. Some Finns are concerned that

the company might move away,particularly because of highFinnish taxes. On the otherhand, some would argue that amore diverse perspective is justwhat is needed if Nokia is tomaintain its position in globalmarkets.

Questions1 Why did Nokia miss consumer trends, belatedly having to match

competitors offerings?2 How do you explain Nokias continuing dominance of the mobile phone

market?3 Assess Nokias current competitive position in global markets, particularly

the likelihood of retaining its large market share.4 To what extent is Nokia a global company?

Sources:Brown-Humes, C., Nokia chases growth with major shake-up, Financial Times, 27September 2003; Brown-Humes, C. and Budden, R., Not so mobile, Financial Times, 7 May2004; George, N., Nokia answers the call for fresh leadership, Financial Times, 20 December2004; Odell, M. and Munter, P., Pivotal figure hands over in a period of great change, FinancialTimes, 10 October 2005; George, N., Nokia wins back market share to bolster top spot, FinancialTimes, 28 January 2005; Munter, P., Buoyant Nokia beats forecasts, Financial Times, 21 April2006; Song, J., LG hopes phone will sweeten its outlook, Financial Times, 28 June 2006; Dickie,M., Nokia cultivates China lead, Financial Times, 12 December 2007; Anderson, R. andWilliamson, H., Nokia to shift German jobs to Romania, Financial Times, 16 January 2008.

Figure Nokias percentage share of theglobal mobile phone market

Sources:Financial Times, 7 May 2004; 28 January 2005;28 June 2006

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

40

35

30

25

20

15

10

5

0

PAUSETOREFLECT

New economic geographyof manufacturing

For a company wishing to manufacture a standard

consumer product (such as basic mobile phones), comparethe advantages and disadvantages of FDI and outsourcing

production. Does the particular FDI entry mode matter,

for example acquisition of a business, greenfieldinvestment or joint venture?

W E B C H E C K

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Theories of international business expansion

Teorists of international business have sought to explain why and howbusinesses have gone about geographical outreach in their activities andmarkets. In the main, they have focused on the MNE, FDI and trade, high-lighting the interactions between the different types of international expan-sion. Key theorists in the areas of MNE expansion and FDI are discussedbelow. Among the most influential early theorists are Stephen Hymer andRaymond Vernon, who is noted for his theory of product life cycle. Scandi-navian theorists devised a model of internationalization, which reflectsVernons influence and provides an incremental approach to internationali-zation. Teir contribution, taking in social and cultural factors, contrasts withmost other international business theories, which have been economics-based. Influential in the latter group has been internalization theory, whichanalyses the MNE in the context of FDI. John Dunning incorporated thisapproach in his paradigm of ownership, location and internalization, knownas the eclectic (or OLI) paradigm. His is the most comprehensive theoreticalexplanation with specific focus on FDI.

Early theories of FDIStephen Hymer sought to explain how FDI differed from portfolio invest-ment. Writing in the 1960s, he observed the relatively new phenomenon offirms establishing production facilities abroad. Why would they undertakesuch an apparently risky strategy, given that they would be competing againstlocal firms in the host country, who had inherent advantages of local knowl-edge? While portfolio theorists had focused on the financial capital thatforeign investors contribute, Hymer found that FDI involved bringing in arange of other resources, including technology, managerial skills andmarketing skills. Tese resources were not likely to be evident in the domesticbusinesses in developing countries, and hence these countries possessedlocation advantages. In addition, as these resources were specific to the firm,they could be said to be ownership advantages. Te foreign firm was able toorganize production more effi ciently and was therefore able to competeagainst local firms. However, the fact that a firm possesses advantages overother firms in any particular type of activity does not necessarily imply thatit should set up its own enterprises in other countries. It could choose insteadto license a local manufacturer to make the product. Te key to FDI, heargued, was the ability to exert control over the advantages, giving the ownermonopoly power, and this could only be exploited in situations of marketfailure. In emphasizing the need to gain market power as central to FDI,Hymer underestimated other factors such as transaction costs, and tended toconfuse location and ownership advantages (Yamin, 1991). However, his

attempts to predict the future effects of the growth of multidivisional compa-nies show remarkable insight. Writing in the 1970s, Hymer foresaw that by2000, the large MNEs, with highly developed centralized structures, wouldbe able to co-ordinate international production in locations across the globe.

Although differing local circumstances would seem to indicate the need fordecentralized decision-making, it was likely that developing countries would

Location advantages: Factorendowments of a particular countryor area within a country, whichoffers specific benefits to thepotential foreign investor.

Ownership advantages: Resourcesspecific to the firm, such astechnology, managing skills andmarketing skills.

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become branch-plant countries, being restricted in their scope for inde-pendent activity and the ability to pursue their own goals (Hymer, 1975: 55).Conflicts, he felt, were possible between national planning by governmentsand international planning by corporations (Hymer, 1975: 60). Tese areissues which we recognize today as central to the globalization debate, but

which had not been identified as such in Hymers day.Another early theorist of international production is Raymond Vernon,whose theory of the product li fe cycle is relevant both to theories of FDIand international trade. Here we look specifically at its importance to

theories of FDI, leaving his contri-bution on international trade toChapter 6. Writing in the 1960s,Vernon ([1966] 1999) took theperspective of US companies, whoenjoyed innovatory superiority tocompetitors in both products andprocesses. Tese could be consideredownership advantages, althoughVernon was concerned more withlocation than organizational matters.

Vernon envisaged the life cycle of anew consumer product originating inthe US, such as a washing machine or

television. Initially, the product is produced in the US for American consumers(1), as shown on the right in Figure 2.3. Proceeding clockwise, the next step inthe cycle is export of the product to countries with a similar level of consumerdemand, such as European countries (2). As the product becomes more wide-spread and standardized, however, and imitators start to produce similar prod-ucts, the need to reduce costs becomes paramount. At the same time, foreignmarkets for the product expand, and the firm decides to site production in aforeign location by establishing a subsidiary there (3). Not only will produc-tion be near the new markets, but labour costs will be reduced. In the finalstage of the product cycle, subsidiaries are established in less developed coun-tries, from which they export to the new markets and even back to the homecountry (4).

Vernons theory was limited in the factors it took into account, and itassumed that all innovation stemmed from US firms. Te life cycle envis-aged by his theory spanned a rather longer period than one would encountertoday: now, an innovative product may become standardized and widelydistributed in a matter of months, rather than years. Production in a low-cost location is now envisaged from the outset, serving all markets simulta-neously, as firms are keen to maximize returns, knowing that the product

may well be superseded by new technology in a short space of time. Despitethese limitations, however, the life cycle theory offered a new explanation offoreign production and was innovative in showing the links between tradeand FDI.

Figure 2.3 Product life cycle

(1)

Home production

Home market

Product life cycle

(2)Home producer exports

to foreign markets

(3)

Growth in foreign markets

Foreign production

(subsidiaries close to

markets)

(4)

Production by subsidiaries

in less developed countries

for all markets

TO REC AP

Early theories of FDI

Hymer identified the importance

of location and ownership

advantages in the FDI decision-making process. Vernons p roduct

life cycle theory, while US-centric, is noteworthy for its

insight in showing howinnovative products becomestandardized and cheaper over

time. Production moves to lowercost locations, from which they

are exported to all markets.

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Theory of incremental internationalizationScandinavian theorists have devised a model of incremental internationali-zation, based on their research in the 1970s on selected Scandinavian compa-nies (Johanson and Wiedersheim-Paul, 1999). Like Vernons, this modelenvisages a series of stages in the process and sees the use of exports as the

initial entry mode into international markets. However, this research focuseson the organizations themselves, highlighting how the knowledge which

they gain about foreign markets and operations in each stageimpacts on their future commitments in those markets( Johanson and Vahlne, 1999). Te stages they envisage movefrom export via an independent agent, to the establishmentof a sales subsidiary and then to the establishment of aproduction or manufacturing facility in the foreign location(Figure 2.4). Tey utilize the concept of psychic distance,also commonly referred to as cultural distance, which focuseson cultural factors such as language and education (see furtherdiscussion in Chapter 4). Tey find that, while businesses are

often advised to prioritize the size of the potential market,decisions in the early stages of internationalization tend to betowards those countries which are culturally proximate totheir own, such as countries in the same geographical area orones which share the same language.

Te entire process involves incremental adjustments which take accountof the changes experienced by the firm and changes which it finds in theenvironment. CS2.1 on Nokia provides an illustration of this process. As itshows, the company has focused on markets close to home, only entering thelarge emerging markets of China and India much later. Gaining knowledgeof the new market is a major factor in its success (or failure). Much of thisknowledge is objective, and can be transmitted by conventional teaching and

learning. However, the knowledge that is gleaned through working with newpartners, known as experiential knowledge, is the key to success (Barkemaet al., 1996). Tis type of knowledge is based on evolving relations betweenindividuals, and is particularly important in management and marketing.

Tese theorists conclude that the better the firms knowledge of the market,in both objective and experiential knowledge, the deeper will be the commit-ment to that market.

Dunnings eclectic paradigmIn his eclectic paradigm, John Dunning (1993a) sought to construct ageneral theory explaining foreign-owned production, drawing on contri-butions of earlier theorists, including theorists of MNEs and international

trade. He called the paradigm eclectic, as it brought together conceptsfrom diverse research strands, which included ownership advantages (O),location advantages (L) and internalization theory of the MNE (I), toform the OLI paradigm. Te paradigm covers all forms of foreign produc-tion by firms in all countries. It views the three elements as conceptuallydistinct, although in practice they interact with each other (see Figure 2.5).First, the firm contemplating foreign production will have ownership

Factors affecting

market commitment

Psychic distance

Market knowledge

Experiential knowledge

Size of market

Stages

Export

Sales

subsidiaries

Production/manufacturing

Figure 2.4 Incrementalinternationalization

Eclectic paradigm: Dunnings theoryof FDI, based on ownershipadvantages, location advantagesand internalization.

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advantages unique to itself. Teseare ownership-specific assets

which give it advantages overother firms, home or abroad.

Tey may be tangible, for

example new products, or intan-gible, for example know-how.Tey may be capacities and abili-ties to generate innovations, as

well as the innovative productsthemselves. Included are prop-erty rights in patents, researchcapacity (including skilled staff),financial know-how, ability to

realize economies of scale, and marketing and management skills. Owner-ship advantages are likely to occur in particular countries, where there arehigh levels of technological skills, from which all the countrys firms areable to benefit.

Te firm which possesses O advantages could choose to sell them orsell the right to use them. A company which licenses a foreign firm tomanufacture its patented product does the latter. Alternatively, it couldseek to add value by exploiting them itself, realizing the advantages ofinternalization. Dunning drew on internalization theory, which examined

why firms would choose to own and control value-added activities ratherthan rely on the market. Firms are likely to perceive that cost benefits willarise in their cross-border activities if they own or control them throughorganizational means, thus internalizing the activity and reducing trans-action costs which would otherwise arise. Te greater the firm perceivesits O advantages to be, the greater its incentive to internalize their use.For example, ownership advantages are critical to a company such asDyson, featured in SX2.2 below. Hence, its own designs and patentedproducts are kept in-house.

Apart from avoiding transaction costs, the firm may wish to internalizeactivities for other reasons: it may fear that suppliers of products or services

will not produce to the right quality or to contract specifications; it may wishto control market outlets; it may wish to control conditions of sale; or it may

wish to avoid tariff barriers imposed by governments. Te firm may also fearthat its technology will be transferred to rivals or potential rivals, as in the

joint venture operations of Volkswagen highlighted in CS1.2. As theseconsiderations show, there are many risks associated with foreign produc-tion, making the case for internalization look compelling.

Te final element, location advantages, highlights comparisons between

the home country and possible host countries. Factors which the firm takesinto account in looking for L advantages include: resource endowments;costs of labour, materials and energy; presence of support services; andinvestment incentives which might be offered by governments. If thecompany is looking to sell its products in the foreign location, then marketsize and characteristics are also important.

Figure 2.5 Dunnings eclecticparadigm

Ownership advantages

Tangible assets

Patents and designs

Organizational efficiencies

Location advantages

Low-cost labour

Low-cost raw materials

Government incentives to

foreign direct investors

Internalization advantages

Reduction in transaction costs

Control over operations

Avoidance of tariffs and

other barriers

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Te eclectic paradigm provides an analytic framework designed to explainwhat is in terms of foreign value-added activities, rather than the normativeissues of what should be (Dunning, 1993a: 76). Nonetheless, it does considerMNE strategies and strategic goals. It argues that:

at any given moment of time, a firm is faced with a configuration of OLI

variables and strategic objectives to which it will respond by engaging ina variety of actions relating to technology creation, market positioning,the formation of corporate alliances, organizational structures, politicallobbying, intra-firm pricing, etc. Tese actions, together with changes inthe value of exogenous variables it faces, will influence its overall compet-itive position. (Dunning, 1993a: 87)

Te OLI paradigm serves chiefly as an aid to assess the costs and benefitsof foreign production, but its concepts can be helpful in looking at thebroader issues of the impacts of MNE activity in host countries. Dunninghimself delved into the economic consequences of FDI and the behaviourof MNEs, particularly economic development (Dunning, 1993a, Chapter10). He predicted that the outward FDI of a countrys firms would vary in

type and level with the countrys level of development. A general trend isthat firms of all countries will become internationalized over time. More-over, todays developing economies will probably embark on internationalexpansion at an earlier stage in their development than did the early indus-trializing countries. However, recalling the elements of globalization listedabove, we would now probably take a broader view of the effects of FDI,extending beyond the economic, to include social, political, cultural andenvironmental impacts.

TO REC AP

The OLI paradigm

Dunnings eclectic paradigm

forms a framework for evaluatingFDI from the perspective of the

firm, focusing on ownership,

location and internalizationadvantages. While location and

ownership advantages had beenhighlighted by earlier theorists,

the addition of internalization

advantages based on transactioncost analysis, added a new

element to form a more

comprehensive framework.

STRATEGIC CROSSROADS

2 . 2

Dyson cleans up

James Dyson, the British inventor and entrepreneur, hasbecome known mainly for his distinctive bagless vacuumcleaners, whose brightly coloured plastic shapes stand outamong the more staid models of competitors. For Dyson

Appliances, the company he founded in Malmesbury inEngland in 1993, success in the British market led to expan-sion in Europe, where Dyson claims a fifth of the market byvalue. Perhaps his most stunning achievement has been tocapture 20 of the American market in 2005, after only two

years endeavours. Here, Dyson fronts his own advertisementsfor the product, but attributes his success more to the technol-ogy than marketing. He feels that the dual cyclone technologysells the machines, even though prices are more than doublethat of competitors machines. Te Dyson machine has alsobeen a success in Japan, where consumers are noted for beingespecially hard to please. Te model designed for the Japanesemarket is small and light, ideal for small apartments, and is

equipped with a powerful digital motor. He is planning toenter the Chinese market, which is perhaps ironic, as China isthe preferred location for most of the worlds manufacturersof household appliances.

As an entrepreneur, Dyson has never lacked confidence,but he faced serious obstacles in getting his inventions offthe ground, coming close to bankruptcy several times. Froman engineering background, he worked for five years, from1979 to 1984, to perfect his new vacuum cleaner, goingthrough over 5,000 prototypes. He tried to sell it to largemanufacturers, but was turned down by Philips, Electroluxand Black & Decker. He formed his own company, of whichhe is the sole shareholder, and has protected his inventionswith patents. Still, he has had to fight numerous legal battleswith Hoover, which has a similar machine. During hard times,he had sold technology rights to his machines in the US andJapan, and had to buy them back before he could launch inthese markets.

In 2002, Dyson took the step many engineering companiesbefore him have taken, shifting production to Asia, where heset up a factory in Malaysia. wo years later, all productionwas shifted to the new factory, resulting in the loss of 800

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PAUSETOREFLECT

Theories ofinternationalization

In light of companies you know and those featured so

far in this book, which of the theories presented herebest explains the internationalization process?

Changing patterns of FDI

Among the key features of globalization identified above are growingeconomic integration; interconnectedness between organizations; and thegrowing importance of I, advanced communications and transport.

Although economic integration through trade has been occurring forcenturies, it is only in the post-war period that FDI has grown dramati-cally, outstripping growth in trade. FDI is measured in terms of inflowsand outflows. FDI inflows represent the aggregate value of FDI into arecipient country f rom all foreign investors, usually referred to as an annualsum. FDI outflows are the aggregate value of the foreign direct invest-ments made by a countrys firms over a period, usually a year. FDI stockrefers to the accumulated value of all foreign investments within a country,

which represents flows over a number of years. In Figure 2.6, we can see

the strong growth in inward investment stock. Healthy inflows suggestthat the country offers location advantages or a large market which is bestserviced by locating in the country. Te investor may also serve otherregional markets as a bloc, such as the EU. Large outflows suggest thatthe countrys companies are competing successfully on the global stage.Some countries, most notably Japan, have strong outflows, but little inwardinvestment, as its policy environment has discouraged inward investors.

jobs in Malmesbur y. Many in Britain were dismayed over themove, but cost reductions of 30 in Malaysia gave Dyson thebudget to expand in the US. A local council leader said of themove: We have good employment here, but what we need isa balance; we have lots of service sector jobs but the Dysonmanufacturing jobs were vital to that balance (Marsh andPickard, 2002). Dyson still employs 1,200 people in R&D anddesign in Malmesbury. He is unrepentant, blaming thegovernment for failing to give suffi cient incentives for inno-vation and doing too little to promote design and engineer-ing in schools: Te government is trying but we have acultural problem with manufacturing because our schoolstell us that if we do not study we will end up in a factory(Guthrie, 2004). In the past 30 years, British manufacturing

jobs have halved, now representing only 12 of the work-force. Dyson feels the answer is to develop added-valuemanufacturing: If thats the model for modern Britain, thatsOK. He goes on to say, however, that he fears the entiresector will be driven offshore: It absolutely could happen.But were a British company, Im British, I like living here. I

just hope the government makes life easier, not more diffi -cult (Eaglesham, 2005).

QuestionsAt what points in the growth of Dysons business did it face strategic crossroads?

What factors influenced the companys choice of direction at these crucialjunctures? Do you agree with Dysons predictions on the British manufacturing

sector generally?

Sources:Marsh, P. and Pickard, J., Dismay at job losses as Dyson shifts production to Malaysia,Financial Times, 6 February 2002; Urquhart, L., Carpets of US moving into D ysons sights, FinancialTimes, 30 June 2002; Guthrie, J., Dyson rails at cultural spanner in the works, Financial Times, 1 October2004; Eaglesham, J., Dyson seeks to brush up industrys image, Financial Times, 19 November 2005;Guthrie, J. and Roberts, D., A Brit who cleaned up, Financial Times, 26 February 2005.

FDI inflows: Value of FDI whichflows into a recipient country fromall foreign investors.

FDI outflows: Value of all foreigndirect investments made by acountrys firms over a period,usually a year.

FDI stock: Accumulated value of allforeign investments within acountry.

W E B C H E C K

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Japans rather insular perspective is unusual. Te trend has been for coun-tries, both developed and developing, to become more open to FDI.

Destinations of FDI

Most of the developed world has attracted high levels of FDI, as Figure 2.7shows. A major factor is that foreign investors seek to set up production inor near their largest markets, which tend to be in the advanced economies ofNorth America and Europe. Another factor is that mergers and acquisitionsof businesses make up as much as half of all FDI, and that deals between

very large companies, so-called mega-deals, tend to be between MNEs inthe developed countries. Tese have been facilitated in recent years by thegrowth in debt financing and the active role of private equity groups andhedge funds in corporate financing and acquisitions (discussed further inChapter 11). An earlier peak, in the late 1990s, saw a number of such deals,including the ExxonMobil merger and the merger of GlaxoSmithKline.

With a downturn in the availability of credit late in 2007, such deals became

more diffi cult to finance. FDI flows to developed countries have been influ-

Figure 2.7 FDI inflows,19942006Source: UN, World Investment Reports2004, 2005 and 2007 (Geneva: UN) World Developed economies Developing economies

1600000

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0

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1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Figure 2.6 Growth in value ofglobal FDI stockSource: UN, World Investment Reports 2005 and2007 (Geneva: UN)

1982 1990 2000 2006

14000

12000

10000

8000

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Billions

ofdollars

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enced by government trade policies which set limits on imports. Largeforeign manufacturers have been able to circumvent the restrictions bysetting up production in the country of their target consumers. Japanesemotor manufacturers successfully pursued this strategy in the US, and havereaped the benefits in terms of American market share (see CS10.1 on

oyota).FDI grew strongly in the late 1980s, at an annual rate of 26%, while worldexports grew at 15% (Dicken, 2003: 52). After a decline in the early 1990s,FDI surged again until 2000, but declined in the new millennium, affectedby the global economic downturn (see Figure 2.7). Flows resumed growingagain in 2004, to both developed and developing countries. Teir impressivegrowth in developed countries has stemmed largely from mergers and acqui-sitions, combined with high stock market values.

FDI flows to the developing world have been rising steadily since 2004.wo factors can be highlighted. First, companies are seeking opportunitiesfor production effi ciencies and market growth in the developing world. Tishas led to an FDI boom, in which greenfield investments are prominent. Afew very successful developing economies have received the bulk of FDI.China is the largest recipient, and India, Mexico and Brazil are also attractinglarge flows. Second, the rise in prices of many commodities, such as oil andminerals, has benefited countries rich in these natural resources, many of

which are in the developing world. Resource-rich African countries havegained, seeing FDI flows double between 2004 and 2006. Countries richthese resources, including Angola, Equatorial Guinea, Nigeria and Sudan,have all benefited from foreign investment, and account for half of all theFDI flows to Africa. Apart from these sectors, FDI flows to Africa are low,reflecting weak industrial and technological environments.

FDI flows to developing countries drive economic growth, encouragingmany governments to actively court foreign investors. In China, overseasinvestors have been welcomed, providing capital and modern technology.

echnology transfer and the acquisition of management expertise gleanedfrom foreign investors can also benefit the growth of indigenous businesses.On the other hand, governments may display ambivalence towards foreigninvestors, particularly if an industry is perceived as strategic. Te Indiangovernment has been lukewarm towards FDI, accounting in large part forIndias low inward flows (see CF2.2). Recently, Chinese authorities havebeen reluctant to allow takeovers of domestic firms by foreign companies inindustries such as construction and banking, indicating a possible cooling insentiment towards foreign investors. At the same time, Chinese companiesare branching out to become internationalized themselves, as the closingcase study in this chapter shows.

Outward investorsMNEs have been at the forefront of the globalization processes described inthis chapter. As large companies have internationalized, companies of allsizes have followed their example. otal MNEs numbered 37,000 globallyin the early 1990s, with 170,000 foreign affi liates. By 2006, their numberhad climbed to 78,000, with 780,000 foreign affi liates (UN, 2007a). Particu-

TO REC AP

Destinations of FDI

The gap between FDI flows todeveloped and developingcountries seems to be closing, as

global competitive pressures leadcompanies to seek lower cost

locations. However, flows are

directed mainly towards a fewmajor developing countries, most

notably China, while manypoorer countries in the

developing world have attracted

little FDI, unless they areendowed with keenly sought

natural resources.

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larly notable has been the increase in the number of MNEs based in devel-oping countries, shown in Figure 2.8.

MNEs based in the developed world represented 84% of total outflows in2006 (UN, 2007a). Looking back, in the 1950s and 60s, half of all FDI flows

originated in the US. In the 1970s, Japanese and European

firms started investing abroad, resulting in the decline inAmericas share of the total to about one-third. As MNEsfrom developing countries expand internationally, they arebecoming active in FDI. Recall Dunnings observations aboveon the likely increase in outward FDI f rom developing coun-tries. While it hardly existed in 1980, these outflows hadreached $174 billion in 2006, 14% of the worlds total, givingdeveloping countries 12.8% of global FDI stock. Figure 2.9indicates that Asian firms account for the bulk of this growth.

Te transition economies of the CIS (Commonwealth ofIndependent States, which includes the Russian Federationand countries which were part of the former Soviet Union) areinternationalizing, particularly in the oil and gas industries(see CS15.1 on Gazprom and CF15.1 on Kazakhstan). Much

of this FDI is in the form of merger and acquisition (M&A) activity withfirms in other developing countries, as well as with firms in developed coun-tries. Te acquisition of IBMs PC business by Lenovo of China, whichfeatures in CS2.2, falls into this category. Te takeover in 2006 of a Canadiannickel mining company by the Brazilian company Companhia Vale do RioDoce (CVRD, now known as Vale) is also indicative of the growing impor-tance of natural resources in the global economy. Vale is the worlds leadingproducer and exporter of iron ore, and has enjoyed huge profits due to growingdemand, particularly f rom China.

Many outward investors, such as those in the CIS, are wholly or partiallystate owned. Tese national champions often target emerging markets

where they invest in resources to build market share. French companies,including many state enterprises, have been particularly acquisitive interna-tionally. In 2005, French companies spent $115 billion on purchases of

Asia Developing countries and the CIS

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Billionsofdollars

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Figure 2.9 FDI outflows fromdeveloping and transition countriesSource: UN, World Investment Reports, 2005,2006 and 2007 (Geneva: UN)

Figure 2.8 Number of MNEs basedin developed, developing andtransition economiesSource: UN, World Investment Report 2007(Geneva: UN)

1992 2000 2006

90

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50

perspectives on globalization

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