International Economics and Multinational Corporations

have long dreamed of buying an island owned by no nation and of establishing the world headquarters of the Dow company on the truly neutral ground of such an island, beholden to no nation or society Carl A
Gerstacker-Chaiman of the Dow Chemical Compny

The Nature of MNCs

Multinational Corporations (MNCs) are economic organisations engaged in productive activities in two or more countries. Typically have Headquarters (HQ) in the country of origin Build or acquire affiliates or subsidiaries in other countries (the host nation) This kind of expansion is referred to as Foreign Direct Investment (FDI)

What is a MNC?
Definition A corporation that owns and operates production facilities in two or more countries A corporation with power to coordinate and control operations in two or more countries without owning them.

What is a MNC?

MNCs can develop through mergers and acquisitions (example: Tata Steel and Corus, $13,2 billion acquisition) Or they can evolve through strategic alliances (TPCA)

Scale of International Production

In 2003, MNCs numbered 64,000 parent firms controlling 870,000 foreign affiliates. MNCs employed 53 million people abroad. Sales of foreign affiliates ($18 trillion in 2002) are two times global exports
Global sales of MNCs in 2002 reached $18 trillion, compared with world exports of $8 trillion.
UNCTAD, World Investment Report, 2003.

FDI proliferation

Which region in the world has consistently experienced the highest inflow of FDI in last decade? Which region has recently experienced the highest growth of inflow of FDI?

(and its trade consequences)

Spatial Fragmentation

Horizontal MNCs Firms replicate production process at home and abroad Most common between equally developed countries Vertical MNCs Firms divide production into stages and undertake each stage where it is relatively cheaper Most common between countries at different levels of development Intra-firm trade Trade between affiliates of the same MNC Accounts for one-third of total world trade

The Internationalisation of Production

International Product Life Cycle Theory (IPLC)

1) Release: As competition in Industrialised countries tends to be fierce, Manufactures are therefore forced to search constantly for better ways to satisfy their customer needs. (Ball et al, 1999). The core elements in new product design are gained from customer feedback from previous models Once the product enters the domestic market and begins to create a positive reputation, the demand increases and hence we come to an end of the first stage of the IPLC

2)Exports
As the product receives positive customer response, the international demand for the product begins. The manufacturer begins exporting to increase its market share Example: personal computer (PC) craze of the 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)

3)Foreign Production begins

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

4)Foreign Competition in exports markets

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 to look elsewhere (i.e.. other nations) to promote their product If this other nation/producer had a competitive advantage threatening to the initial producers own domestic market share

5)Import Competition in Home Market

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 quality product 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 its price are likely to diminish (Lendrum, 1995).

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.

Everybody likes FDI?

National Regulatory Changes (Number of countries making changes and number of changes made.

UNCTAD, World Investment Report, 2003

Sources and Distribution of FDI are Highly Concentrated

Developed

countries account for about twothirds of world FDI stock (both ownership and location) 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 countriesUNCTAD, World Investment Report, 2003

FDI Inflows, by Region (millions of dollars)

UNCTAD, World Investment Report, 2003

Regional Shares of FDI Flows, 2001

What Influences Growth of FDI Inflow

Technological
Laws

environment

hosts

and regulations of potential to capital flows

Openness

Exchange

rate regime
security, stability

International

Why Locate Production Abroad?

Competition

forces MNC to seek new markets (horizontal expansion) and lower costs of production (vertical expansion). cycle theory: MNC may possess an ownership-specific advantage; seeks to realize greatest profit by internalizing the use of its advantage; and
factors make it more profitable for firm to exploit its asset abroad than at home.

Product

location-specific

Negative effects of outsourcing for the home market? (economic and social impact) Is vertical expansion more harmful than horizontal one? How can be the negative effects on home market moderated?

What makes a corporation truly multinational?

Ownership criterion

Some

economists argue that ownership is a key criterion. A firm becomes multinational only when the headquarter or parent company is effectively owned by nationals of two or more countries. For example, Shell and Unilever, controlled by British and Dutch interests, are good examples. However, by ownership test, very few multinationals are multinational.

Nationality mix of headquarter managers:

Others

argue that an international company is multinational if the managers of the parent company are nationals of several countries. Usually, managers of the headquarters are nationals of the home country. This may be a transitional phenomenon. Very few companies pass this test currently.

Business Strategy
Usually assumed to be global profit maximization According to Howard Perlmutter (1969)*: Multinational companies may pursue policies that are home country-oriented. or host country-oriented or world-oriented. Perlmutter uses such terms as ethnocentric, polycentric and geocentric. However, "ethnocentric" is misleading because it focuses on race or ethnicity, especially when the home country itself is populated by many different races (example: HP), whereas "polycentric" loses its meaning when the MNCs operate only in one or two foreign countries.

Business Strategy
Franklin Root (1994), an MNC is a parent company that 1. engages in foreign production through its affiliates located 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 in which they are incorporated.

*Howard V. Perlmutter, "The Tortuous Evolution of the Multinational

Corporation," Columbia Journal of World Business, 1969, pp. 9-18.

Evolution of MNCs

Three Stages of Evolution

1.

Export stage initial inquiries => firms rely on export agents expansion of export sales further expansion of foreign sales branch or assembly operations (to save transport cost)

Three Stages of Evolution

2. Foreign Production Stage There is a limit to foreign sales (tariffs, NTBs) FDI versus Licensing Once the firm chooses foreign production as a method of delivering goods to foreign markets, it must decide whether to establish a foreign production subsidiary or license the technology to a foreign firm.

Three Stages of Evolution

Licensing

Licensing is usually first experience (because it is easy) e.g.: Kentucky Fried Chicken in the U.K. it does not require any capital expenditure it is not risky payment = a fixed % of sales Problem: the mother firm cannot exercise any managerial control over the licensee (it is independent) The licensee may transfer industrial secrets to another independent firm, thereby creating a rival.

Three Stages of Evolution

Direct Investment It requires the decision of top management because it is a critical step. it is risky (lack of information) (US Canada vs. Toyota Czech Rep.) plants are established in several countries licensing is switched from independent producers to its subsidiaries. export continues

Three Stages of Evolution

3. Multinational Stage The company becomes a multinational enterprise when it begins to plan, organize and coordinate production, marketing, R&D, financing, and staffing internationally. For each of these operations, the firm must find the best location.
Rule of Thumb A company whose foreign affiliates sales are 25% or more of total sales. Examples: Manufacturing MNCs 24 of top fifty firms are located in the U.S. 9 in Japan 6 in Germany. Petroleum companies: 6/10 located in the U.S.

Motives for Direct Foreign Investment

New MNCs do not pop up randomly in foreign nations. It is the result of conscious planning by corporate managers. Investment flows from regions of low anticipated profits to those of high returns.
Growth motive: A company may have reached a plateau satisfying domestic demand, which is not growing. Looking for new markets.

Motives for Direct Foreign Investment

Protection in the importing countries Foreign direct investment is one way to expand bypassing protective instruments in the importing country EU: imposed common external tariff against outsiders. US companies circumvent these barriers by setting up subsidiariesDell in Ireland etc. Japanese corporations located auto assembly plants in the US, to bypass non-tariff barriers

Motives for Direct Foreign Investment

1.

Market competition The most certain method of preventing actual or potential competition is to acquire foreign businesses. GM purchased Monarch (GM Canada) and Opel (GM Germany). It did not buy Toyota, Datsun (Nissan) and Volkswagen. They later became competitors.

Motives for Direct Foreign Investment

1.

2.

Cost reduction United Fruit has established banana-producing facilities in Honduras. Cheap foreign labour. Labour costs tend to differ among nations. MNCs can hold down costs by locating part of all their productive facilities abroad. (Maquildoras)

Supplying Products to Foreign Buyers

Export versus Direct Foreign Investment Minimum Efficient Scale (MES) is the minimum rate of output at which Average Cost (AC) is minimized. If minimum efficient scale (MES) is not achieved, then firms will export

In other words, if there exists excess capacity, why not utilize it and export outputs to other countries? There is no point in creating another plant overseas when domestic capacity is not fully utilized. If, however, foreign demand exceeds the minimum efficient scale, then FDI will be the favoured option

International Joint Ventures (IJVs)

An IJV is a business organization established by two or more companies that combines their skills and assets. 1. A JV is formed by two businesses that conduct business in a third country (French firm + Japanese firm jointly operate in the Central 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 + National Iranian Oil Company

International Joint Ventures (IJVs)

Why? Large capital costs - costs are too large for a single company Protection - LDC governments close their borders to foreign companies bypass protectionism. e.g.: US workers assemble Japanese parts. The finished goods are sold to the US consumers. Share know-how Problems.Control is divided. The venture serves "two masters"

International Joint Ventures (IJVs)

Welfare Effects of IJVs The new venture increases production, lowers prices to consumers The new business is able to enter the market that neither parent could have entered separately Cost reductions (otherwise, no joint ventures will be formed) increased market power => not necessarily good

Critique of MNCs

Exploitation of bargaining power (especially vis--vis weak governments) Exploitation of local labour force (usually due to non-existing or poorly enforced labour laws; example: Haas Fertigbau)

Disregard to environment (same reasons)

Exploitation of brand-power (often ignored)

Naomi Klein NO LOGO- a critique of MNCs

Naomi Klein argues in her book No Logo: Taking Aim at the Brand Bullies that the astronomical growth of the wealth and cultural influence of multinational companies over the last 15 years can be traced back to an idea developed by management theorists in the mid-1980s: 'successful corporations must primarily produce brands, as opposed to products'

NO LOGO CRITIQUE

MNCs real work, lay in marketing and not manufacturing things Corporations had to concentrate their resources on building up their brand through sponsorships, advertising, packaging, innovation and expansion Importance of synergies buying up distribution and retail networks to get MNCs brands to as wide a market as possible. The brand image is primary, the product secondary. Compare with Globalisation of media

NO LOGO CRITIQUE

Phil Knight, Chief Executive Officer (CEO) of Nike sums up their rationale:

'There is no value in making things any more. The value is added by careful research, by innovation and marketing'

Competition, therefore, comes down to a fierce battle between brands not products

NO LOGO CRITIQUE

Advertising often more expensive than production US spending on marketing in 1998 at $196.5bn was nearly four times that of 1979 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

NO LOGO CRITIQUE

Marketing, advertising, and buying up brands, however, produce no value a point Phil Knight from 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 real producers of the wealth) constitute an evershrinking slice of corporate budgets Marketing/sales personnel, not the production and design experts, are becoming the best paid people in MNCs (just after the top managers)

COUNTER-CRITIQUE

Activities of multinationals result of rational-actor thinking Utilization of all possible comparative advantages As long as consumers are willing to pay for brands, no reason to change strategy