8/2/2019 Ppt. 2 Module 13 (IE)

1/49

8/2/2019 Ppt. 2 Module 13 (IE)

2/49

Multinational Corporations (MNCs) areeconomic organisations engaged inproductive activities in two or morecountries. Typically have Headquarters (HQ) in thecountry of origin Build or acquire affiliates or subsidiaries in

other countries (the host nation) This kind of expansion is referred to asForeign Direct Investment (FDI)

8/2/2019 Ppt. 2 Module 13 (IE)

3/49

DefinitionA corporation that owns and operates productionfacilities in two or more countriesA corporation with power to coordinate and control

operations in two or more countries withoutowning them.

8/2/2019 Ppt. 2 Module 13 (IE)

4/49

MNCs can develop through mergers andacquisitions (example: Tata Steel and Corus,$13,2 billion acquisition)

Or they can evolve through strategic alliances(TPCA)

8/2/2019 Ppt. 2 Module 13 (IE)

5/49

In 2003, MNCs numbered 64,000 parentfirms controlling 870,000 foreign affiliates.MNCs employed 53 million people abroad.Sales of foreign affiliates ($18 trillion in2002) are two times global exports

Global sales of MNCs in 2002 reached $18trillion, compared with world exports of $8

trillion.UNCTAD, World Investment Report, 2003.

8/2/2019 Ppt. 2 Module 13 (IE)

6/49

Which region in the world has consistentlyexperienced the highest inflow of FDI in lastdecade?

Which region has recently experienced thehighest growth of inflow of FDI?

8/2/2019 Ppt. 2 Module 13 (IE)

7/49

Horizontal MNCsFirms replicate production process at home andabroadMost common between equally developedcountriesVertical MNCsFirms divide production into stages and undertakeeach stage where it is relatively cheaperMost common between countries at different levelsof development

Intra-firm tradeTrade between affiliates of the same MNCAccounts for one-third of total world trade

8/2/2019 Ppt. 2 Module 13 (IE)

8/49

8/2/2019 Ppt. 2 Module 13 (IE)

9/49

1) Release: As competition in Industrialisedcountries tends to be fierce, Manufacturesare therefore forced to search constantly forbetter ways to satisfy their customer needs.(Ball et al, 1999).

The core elements in new product designare gained from customer feedback fromprevious models

Once the product enters the domesticmarket and begins to create a positive

reputation, the demand increases andhence we come to an end of the first stageof the IPLC

8/2/2019 Ppt. 2 Module 13 (IE)

10/49

As the product receives positive customerresponse, the international demand for theproduct begins. The manufacturer beginsexporting to increase its market share

Example: personal computer (PC) craze ofthe early 1980s

In 1980, 55,000 PCs sold in the US

By 1984 the industry experienced a 136-fold increase to 7 million PCs (Richter-Buttery, 1998)

8/2/2019 Ppt. 2 Module 13 (IE)

11/49

As demand increases with the new global market, it

becomes economically feasible to begin local

production in various nations

By sharing technology on the manufacturing of the

product, the company has lost an advantage

The end of this stage signifies the highest point in the

International Product Life Cycle Theory

8/2/2019 Ppt. 2 Module 13 (IE)

12/49

Threatening stage for the company

Local manufactures gained experience in producing

and selling their product their costs have fallen

Once saturated their initial market, they may begin tolook elsewhere (i.e.. other nations) to promote their

product

If this other nation/producer had a competitive

advantage threatening to the initialproducers owndomestic market share

8/2/2019 Ppt. 2 Module 13 (IE)

13/49

If the new competitors have a competitive advantage,

or they reach the economies of scale needed, they

will enter the original home market

At this stage the competitors will have a qualityproduct which will be able to undersell the original

manufactures.

With future innovations and new products and

services the eventuality is that its value and hence itsprice are likely to diminish (Lendrum, 1995).

8/2/2019 Ppt. 2 Module 13 (IE)

14/49

The IPLC theory does have its disadvantages.

Perhaps the most recognisable is the assumption that

products are released initially in the domestic markets.

Many globalized companies tend to release their new

product lines internationally, not domestically.

8/2/2019 Ppt. 2 Module 13 (IE)

15/49

8/2/2019 Ppt. 2 Module 13 (IE)

16/49

UNCTAD, World Investment Report, 2003

8/2/2019 Ppt. 2 Module 13 (IE)

17/49

Developed countries account for about two-thirds of world FDI stock (both ownership andlocation)

About 3/4 of world total FDI flows to developed

countries each year Ten developing countries annually receive about

80% of total FDI flows to the developing world(SE Asia, Mexico)

China in 2002 received one-third of all FDI

flowing to the developing countries-

UNCTAD, World Investment Report, 2003

8/2/2019 Ppt. 2 Module 13 (IE)

18/49

UNCTAD, World Investment Report, 2003

8/2/2019 Ppt. 2 Module 13 (IE)

19/49

8/2/2019 Ppt. 2 Module 13 (IE)

20/49

Technological environment

Laws and regulations of potential

hosts

Openness to capital flows

Exchange rate regime

International security, stability

8/2/2019 Ppt. 2 Module 13 (IE)

21/49

Competition forces MNC to seek new markets(horizontal expansion) and lower costs of production(vertical expansion).

Product cycle theory: MNC may possess

anownership-specific advantage

; seeks to realizegreatest profit by internalizing the use of itsadvantage; and

location-specific factors make it more profitable forfirm to exploit its asset abroad than at home.

8/2/2019 Ppt. 2 Module 13 (IE)

22/49

Negative effects of outsourcing for the homemarket? (economic and social impact)

Is vertical expansion more harmful thanhorizontal one?

How can be the negative effects on homemarket moderated?

8/2/2019 Ppt. 2 Module 13 (IE)

23/49

8/2/2019 Ppt. 2 Module 13 (IE)

24/49

Some economists argue thatownership is a key criterion. A firmbecomes multinational only when the

headquarter or parent company iseffectively owned by nationals of twoor more countries.

For example, Shell and Unilever,controlled by British and Dutchinterests, are good examples.However, by ownership test, very fewmultinationals are multinational.

8/2/2019 Ppt. 2 Module 13 (IE)

25/49

Others argue that an internationalcompany is multinational if themanagers of the parent company are

nationals of several countries. Usually, managers of the headquarters

are nationals of the home country.This may be a transitionalphenomenon.

Very few companies pass this testcurrently.

8/2/2019 Ppt. 2 Module 13 (IE)

26/49

Usually assumed to be global profit maximizationAccording to Howard Perlmutter (1969)*:

Multinational companies may pursue policies that arehome country-oriented. or host country-oriented or world-oriented. Perlmutter

uses such terms as ethnocentric, polycentric andgeocentric.

However, "ethnocentric" is misleading because itfocuses on race or ethnicity, especially when the homecountry itself is populated by many different races(example: HP), whereas "polycentric" loses its meaning

when the MNCs operate only in one or two foreigncountries.

8/2/2019 Ppt. 2 Module 13 (IE)

27/49

Franklin Root (1994), an MNC is a parent company that1. engages in foreign production through its affiliateslocated in several countries,

2. exercises direct control over the policies of its affiliates,

3. implements business strategies in production, marketing,finance and staffing that transcend national boundaries

(geocentric).In other words, MNCs exhibit no loyalty to the country inwhich they are incorporated.

*Howard V. Perlmutter, "The Tortuous Evolution of the MultinationalCorporation," Columbia Journal of World Business, 1969, pp. 9-18.

8/2/2019 Ppt. 2 Module 13 (IE)

28/49

8/2/2019 Ppt. 2 Module 13 (IE)

29/49

1. Export stage initial inquiries => firms rely on

export agents

expansion of export sales

further expansion of foreignsales branch or assembly

operations (to save transportcost)

8/2/2019 Ppt. 2 Module 13 (IE)

30/49

2. Foreign Production StageThere is a limit to foreign sales (tariffs,

NTBs)

FDI versus LicensingOnce the firm chooses foreign

production as a method of deliveringgoods to foreign markets, it must

decide whether to establish a foreignproduction subsidiary or license thetechnology to a foreign firm.

8/2/2019 Ppt. 2 Module 13 (IE)

31/49

8/2/2019 Ppt. 2 Module 13 (IE)

32/49

Direct InvestmentIt requires the decision of top

management because it is a criticalstep.

it is risky (lack of information) (US Canada vs. Toyota Czech Rep.)

plants are established in severalcountries

licensing is switched from independentproducers to its subsidiaries.

export continues

8/2/2019 Ppt. 2 Module 13 (IE)

33/49

3. Multinational Stage

The company becomes a multinational enterprise when it beginsto plan, organize and coordinate production, marketing, R&D,financing, and staffing internationally. For each of theseoperations, the firm must find the best location.Rule of Thumb

A company whose foreign affiliates sales are 25% or more oftotal sales.Examples: Manufacturing MNCs24 of top fifty firms are located in the U.S.9 in Japan6 in Germany.Petroleum companies: 6/10 located in the U.S.

8/2/2019 Ppt. 2 Module 13 (IE)

34/49

New MNCs do not pop up randomly in foreignnations. It is the result of conscious planning bycorporate managers. Investment flows fromregions of low anticipated profits to those ofhigh returns.

Growth motive: A company may have reached aplateau satisfying domestic demand, which isnot growing. Looking for new markets.

8/2/2019 Ppt. 2 Module 13 (IE)

35/49

Protection in the importing countriesForeign direct investment is one way to expandbypassing protective instruments in theimporting country

EU: imposed common external tariff againstoutsiders. US companies circumvent thesebarriers by setting up subsidiariesDell inIreland etc. Japanese corporations located auto assemblyplants in the US, to bypass non-tariff barriers

8/2/2019 Ppt. 2 Module 13 (IE)

36/49

1. Market competitionThe most certain method ofpreventing actual or potentialcompetition is to acquire foreignbusinesses. GM purchasedMonarch (GM Canada) and Opel(GM Germany). It did not buyToyota, Datsun (Nissan) andVolkswagen. They later becamecompetitors.

8/2/2019 Ppt. 2 Module 13 (IE)

37/49

1. Cost reductionUnited Fruit has establishedbanana-producing facilities inHonduras. Cheap foreign labour.2. Labour costs tend to differamong nations. MNCs can holddown costs by locating part of alltheir productive facilities abroad.(Maquildoras)

8/2/2019 Ppt. 2 Module 13 (IE)

38/49

Export versus Direct Foreign Investment

Minimum Efficient Scale (MES) is the minimum

rate of output at which Average Cost (AC) isminimized. If minimum efficient scale (MES) isnot achieved, then firms will export

In other words, if there exists excess capacity,why not utilize it and export outputs to othercountries? There is no point in creating anotherplant overseas when domestic capacity is not fullyutilized.

If, however, foreign demand exceeds theminimum efficient scale, then FDI will be thefavoured option

8/2/2019 Ppt. 2 Module 13 (IE)

39/49

An IJV is a business organization established bytwo or more companies that combines their

skills and assets.1. A JV is formed by two businesses that

conduct business in a third country (Frenchfirm + Japanese firm jointly operate in theCentral Europe - TPCA)

2.joint venture with a local firm (Copirisco[POR] + Cautor [CZ]

3.joint venture includes local government(Messerschmitt-Boelkow-Blom, Germany =>

Iran Oil Investment Company + NationalIranian Oil Company

8/2/2019 Ppt. 2 Module 13 (IE)

40/49

Why? Large capital costs - costs are too

large for a single company Protection - LDC governments closetheir borders to foreign companies bypass protectionism. e.g.: US workers

assemble Japanese parts. The finishedgoods are sold to the US consumers. Share know-how

Problems.Control is divided. The venture serves"two masters"

8/2/2019 Ppt. 2 Module 13 (IE)

41/49

Welfare Effects of IJVs The new venture increasesproduction, lowers prices toconsumers The new business is able to enterthe market that neither parentcould have entered separately Cost reductions (otherwise, nojoint ventures will be formed)

increased market power => notnecessarily good

8/2/2019 Ppt. 2 Module 13 (IE)

42/49

8/2/2019 Ppt. 2 Module 13 (IE)

43/49

Exploitation of bargaining power (especiallyvis--vis weak governments)

Exploitation of local labor force (usually dueto non-existing or poorly enforced laborlaws; example: Haas Fertigbau)

Disregard to environment (same reasons)

Exploitation of brand-power (often ignored)

8/2/2019 Ppt. 2 Module 13 (IE)

44/49

Naomi Klein argues in her book No Logo:Taking Aim at the Brand Bullies that theastronomical growth of the wealth and

cultural influence of multinationalcompanies over the last 15 years can betraced back to an idea developed bymanagement theorists in the mid-1980s:'successful corporations must primarily

produce brands, as opposed to products'

8/2/2019 Ppt. 2 Module 13 (IE)

45/49

MNCs real work, lay in marketing andnot manufacturing things

Corporations had to concentrate theirresources on building up their brandthrough sponsorships, advertising,

packaging, innovation and expansion Importance of synergies buying up

distribution and retail networks to getMNCs brands to as wide a market aspossible. The brand image is primary,

the product secondary. Compare with Globalisation of media

8/2/2019 Ppt. 2 Module 13 (IE)

46/49

Phil Knight, Chief ExecutiveOfficer (CEO) of Nike sums uptheir rationale:

'There is no value in making things

any more. The value is added bycareful research, by innovationand marketing'

Competition, therefore, comesdown to a fierce battle betweenbrands not products

8/2/2019 Ppt. 2 Module 13 (IE)

47/49

Advertising often more expensive thanproduction

US spending on marketing in 1998 at$196.5bn was nearly four times that of1979

Global spending on marketing reached$435bn in 1996, up sevenfold since 1950,growing a third faster than the world

economy

Little wonder that brands are expensive

8/2/2019 Ppt. 2 Module 13 (IE)

48/49

Marketing, advertising, and buying up brands,however, produce no value a point Phil Knightfrom Nike cannot grasp and No Logo fails to make

They are paid for out of the consumer price

increase and workers wage depression

The wages of the factory workers, (the realproducers of the wealth) constitute an ever-shrinking slice of corporate budgets

Marketing/sales personnel, not the production anddesign experts, are becoming the best paid peoplein MNCs (just after the top managers)

8/2/2019 Ppt. 2 Module 13 (IE)

49/49

Activities of multinationals result of rational-actor thinking

Utilization of all possible comparativeadvantages

As long as consumers are willing to pay forbrands, no reason to change strategy