MULTINATIONAL CORPORATIONS

Text 1. WHY DO MULTINATIONAL ENTERPRISES EXIST?

Why do multinational enterprises (MNEs) exist? This seems to be a silly question.

The answer seems to be simple – because they are profitable! But the issue is more
complicated than it sounds.
There is some agreement that five different pieces together provide a good
explanation of why multinational firms exist (and why they are as large as they are. The
combination of these five pieces into a framework for understanding multinationals is often
called the eclectic approach with credit for the synthesis going to John Dunning.
Inherent disadvantages
Our first step is to recognize that there are good reasons why MNEs should not exist.
An MNE has inherent disadvantages in trying to compete with foreign rivals on their own
turf. The MNE is at a disadvantage in this foreign environment because it does not initially
have the native understanding of local laws, customs, procedures, practices, and
relationships. In addition, the firm has the extra costs of maintaining management control. It
is expensive to operate at a distance, expensive in travel and communications, and especially
expensive in misunderstanding. Furthermore, the MNEs may lack useful connections with
political leaders in the foreign country, or it could feel actual or potential hostility from the
foreign country’s government.
Firm-Specific Advantages
To be successful, the MNE must have one or more firm-specific advantages – that is,
one or more assets of the MME that are not assets held by its local competitors in the host
country (or, perhaps, by any other firm in the world). A firm’s secret technology or its
patents are a firm-specific advantage (IBM, Hitachi). Or the advantage may inhere in the
MNE’s access to very large amounts of capital, amounts larger than an ordinary national firm
can command (General Motors). Or, as in the case of petroleum refining (Royal Dutch Shell)
or metal processing (Alcoa), the firm may gain advantage by coordinating operations and
capital investments at various stages in a vertical production process. Or the firm may have
marketing advantages based on skillful use of advertising and other promotional methods that
establish product differentiation for instance, through highly regarded brand names (Nestle,
Proctor and Gamble). Or it may have truly superior management techniques (General
Electric). The challenge to the firm is to maximize its returns on these assets.
We now have an enterprise that has firm-specific advantages such that it could
operate profitably as a multinational. But should it? Even for the firm that has firm-specific
advantages, it must also consider alternatives to FDI for earning profits from activities in a
foreign market. It must be more profitable for an MNE to own and manage a foreign
operation rather than adopting some other way of earning profits.
Here are two questions for the firm’s managers:
1. Should the firm sell to foreign buyers by exporting from its
home country, or should the firm set up local production in the foreign country to produce the
products that are sold to the foreign buyers?
2. Should the firm license local firms in the foreign country to
use its advantages in their own operations that serve the foreign buyers, or should the firm set up
foreign operations that it owns and controls?
The answers to these questions bring location factors and internalization advantages into
the explanation.
Location Factors
Location factors are all of the advantages and disadvantages of producing in one
country (the home country) or in another country (the foreign country). Here are four key
location factors:
 • Comparative advantage: the effects of resource availability
(labor, land and so forth) on the costs of producing in different countries.
• Economies of scale: conditions that favor concentrating
production in a few locations and serving other national markets by exporting.
• Governmental barriers to importing into the foreign country:
tariffs and non-tariff barriers that make it difficult to export from the home country.
• Trade blocs: setups that favor FDI if the foreign country is a
member of a free-trade area (or similar arrangement) but the home country is not a member,
because production in the foreign country can also be used to serve buyers in the other member
countries.
There are many other location factors that are important in some industries. High costs
of transporting a product favor FDI to locate production units close to foreign buyers, rather than
serving faraway buyers by exporting. Government taxes and subsidies affect the profitability
of producing in different countries. The need to adapt products to the specific tastes of foreign
buyers can favor FDI, because it is more effective to have close links between the local
marketing group, the product redesign group, and the operations group that must produce the
redesigned products at acceptable costs.
Location factors are key to answering the question "Export or FDI?" Note that the
answer could go either way for a specific firm and product. In some cases it is more profitable
to export from the home country, for instance, because the home country has a comparative
advantage in the availability and low cost of the most important resource needed in producing
the product. In other cases foreign production in an affiliate established by direct investment is
more profitable, for instance, because the foreign country has high tariffs on imports of the
product.
Internalization Advantages
Even if the firm rules out exporting as a way of serving the foreign market, it still has
alternatives for earning profits from that foreign market. Instead of using FDI to set up an
affiliate, the firm could sell or rent its firm-specific advantages to foreign firms for them to use
in their own production. For instance, if the advantages are based on superior technology, a
strong brand name, or better management practices, the firm could license one or more foreign
firms to use these assets.
An important advantage of licensing foreign firms is that the firm avoids (most of) the
inherent disadvantages of establishing and managing its own foreign operations, as we
discussed above. On the other side there are advantages to keeping the use of the firm-specific
advantages within (internal to) the enterprise. Internalization advantages are the advantages of
using an asset within the firm rather than finding other firms that will buy, rent, or license the
asset. Internalization advantages exist because there are drawbacks to using the market for
many firm-specific advantages, particularly intangible assets like technology, brand names,
marketing techniques, and management practices.
Internalization advantages arise from avoiding the transaction costs and risks of
licensing an independent firm. Negotiating the license is often costly and difficult. The licensor
wants a high payment, and the licensee wants a low payment. The licensor also wants to put
various restrictions on how the licensee can use the asset, but the licensee wants to have as
few restrictions as possible. Then, even if the license agreement can be negotiated, the licensor
still faces some important risks. The licensee may not be as careful with the asset as the
licensor would be. For instance, the licensee may let secret technology leak out to other
competitors, or the licensee may itself apply the technology to other activities not covered by
the license. Or the licensee may fail to maintain product quality.
FDI keeps the use of the assets under the control of the enterprise itself. It avoids many
of the drawbacks of using the market for these kinds of assets. The advantages of
internalization are based on the ability of the MNE's management to set the terms for the use of
the assets in its foreign affiliates. The returns to the use of the assets are part of the profits earned
by the affiliate, and the enterprise can enforce policies to safeguard the ongoing value of its
intangible assets. The MNE uses FDI to better appropriate the returns to its intangible assets.
The importance of internalized use of firm-specific intangible assets explains why FDI
occurs to a greater extent in high-technology industries (electronic products or
pharmaceuticals, for example) and marketing-intensive industries (food products or
automobiles, for example), than it does in standard-technology industries (clothing, for example)
or less-marketing-intensive industries (paper products, for example).
Oligopolistic Rivalry
Many MNEs are not the tiny firms that populate perfectly competitive markets. Instead,
they are large firms that often compete among themselves for market shares and profits. They
have used their intangible assets (like new technologies and strong brand names) to obtain
large market shares. These same intangible assets drive their FDI. These multinationals are
involved in global oligopolistic rivalry of the sort that we discussed in Chapters 5 and 10.
Multinationals can use their decisions about FDI as part of their strategies for competing.
For instance, multinationals compete for location. A multinational sometimes seems to set up an
affiliate that looks only marginally profitable, yet it does so with the stated purpose of beating its
main competitors to the same national market. Kodak may set up a foreign affiliate mainly
because it fears that if it doesn't Fuji will. Ford and GM seem to have set up automaking firms in
developing countries to try to shut each other out. With some regularity other multinational rivals
then quickly respond by setting up their own affiliates in this country, to prevent the first mover
from gaining any lasting advantage. Such follow-the-leader behavior results in a bunching of the
timing of entries by rival multinationals into a host country. Most of the affiliates may have a tough
time earning profits.
Multinationals can also use FDI to try to mute competition and enhance their market
power. First, a multinational may acquire foreign firms that are beginning to challenge their
international market position. Second, a multinational may set up an affiliate in the home
country of one its rivals, to establish a competitive threat to this rival. The message is "Don't
compete too vigorously against me in other countries, or I will make life tough for you in your
own home market."
(From: T. Pugel. International Economics. McGraw-Hill. 2004)

1. READING AND DISCUSSION

1a Read the text and answer the following questions:
 What are the inherent disadvantages MNEs have in trying to compete against
foreign rivals? Provide examples of disadvantages that MNEs may suffer while competing
with Russian domestic firms on their own turf.
 What is a firm-specific advantage? Provide examples of foreign firms operating in
Russia and utilizing firm-specific advantages mentioned in the text.
 What is a location factor? Provide examples of location factors that may drive (or
are driving) FDI to Russia.
 What is internalization advantage? Can you provide evidence proving that MNEs
in Russia prefer to invest in high-technology or market-intensive industries as opposed to
standard-technology or market-intensive industries?
 What is transaction cost? Provide examples illustrating the definition.
 What are the advantages and disadvantages of licensing? Analyze a case
involving a foreign licensor and a Russian licensee.
 Provide examples of FDI inflows into Russia driven by oligopolistic rivalry.
1b Translate into Russian the section on oligopolistic rivalry.
1c. Name the “five different pieces (that) together provide a good explanation of why
MNEs exist” and explain the role of each.
1d. Discuss the eclectic approach to understanding the MNE.
 2. TERMS AND VOCABULARY
2a Explain the meaning of the following phrases:
inherent disadvantages; command (large amounts of fiscal capital); firm-specific
advantages; maximize returns on assets; adapt products to specific tastes; avoid transaction
costs; let secret technology leak out to competitors; activities (not) covered by a license.
2b Find all cases when the word “advantage” or other words derived from it are used,
translate the sentences. Use the same words and expressions with their immediate context
(such as prepositions, etc.) in sentences of your own.
2c Complete the following sentences describing MNE strategies and activities:
 There is some agreement that….
 There are good reasons why …….
 As in the case of Enron’s tax evasion, …
 Microsoft has firm-specific advantages such that…
 Rather than adopting some other way of increasing profit, MNEs …
 There are drawbacks to using economies of scale, particularly …
 With the purpose of beating competitors to the same market, MNEs…
2d Translate into English:
A
1. По многим причинам ТНК склонны минимизировать налоги путем
трансфертного ценообразования.
2. Внутренне присущие каждой конкретной ТНК конкурентные
преимущества используются ей для завоевания новых рынков.
3. Крупные ТНК имеют в своем распоряжении огромные объемы
финансового капитала.
4. Как в случае с экономией от масштаба, ТНК обязаны многими
преимуществами своему размеру.
5. У российских менеджеров есть конкурентные преимущества, такие как
умение гибко ориентироваться на развивающихся рынках.
6. Лицензирование имеет серьезные недостатки, прежде всего высокий
риск утечки производственных секретов.
B
Термин многонациональная корпорация, сокращенно МНК, используется для обозначения
компаний, активно вовлеченных в международный бизнес. Многонациональная
корпорация — это компания, которая осуществляет прямые зарубежные инвестиции, а
также владеет предприятиями, расположенными в зарубежных странах, и контролирует
процесс создания ценности на этих предприятиях. Помимо владения иностранными
активами и осуществления контроля над ними, многонациональные корпорации, как
правило, покупают ресурсы и производят товары или услуги во многих странах, а затем
продают эти товары и услуги потребителям в разные страны мира. Многонациональные
корпорации координируют свою деятельность через свои штаб-квартиры в стране
происхождения, однако они могут предоставлять своим филиалам и дочерним компаниям,
действующим на иностранных рынках, значительную свободу действий по адаптации к
местным условиям.