INBUST ✓ Michael Porter’s theory

Chapter 6: International Trade Theory ▪ Country factors explain a nation’s dominance in

the production and export of certain products
Introduction
▪ Economists argue that free trade stimulates economic Trade Theory and Government Policy
growth and raising the standard of living ✓ Mercantilism makes a case for government involvement
▪ Many theories explain why free trade is beneficial in promoting exports and limiting imports
✓Smith, Ricardo, and Heckscher-Ohlin promote
AN OVERVIEW OF TRADE THEORY
unrestricted free trade
✓New trade theory and Porter justify limited and selective
Free trade refers to a situation where a government does
government intervention to support the development of
not attempt to influence through quotas or duties what its
certain export-oriented industries
citizens can buy from another country or what they can
produce and sell to another country
MERCANTILISM
• Mercantilism (16th and 17th centuries)
Mercantilism (mid-16th century): it is in a country’s best
encouraged exports and discouraged imports
interest to maintain a trade surplus - to export more than it
• Adam Smith (1776) promoted unrestricted free
imports
trade
• David Ricardo (19th century) built on Smith ideas ✓Advocated government intervention to achieve a
• Eli Heckscher and Bertil Ohlin (20th century ) surplus in the balance of trade
refined Ricardo’s work ✓Viewed trade as a zero-sum game: one in
which a gain by one country results in a loss by
The Benefits of Trade another
• Specialize in the manufacture and export of products that
can be produced most efficiently in that country Absolute Advantage
• Import products that can be produced more efficiently in ▪ Smith (1776) - countries differ in their ability to produce
other countries goods efficiently
• Gains arise because international trade allows a country ▪ A country has an absolute advantage in the production
to specialize in the manufacture and export of products of a product when it is more efficient than any other
country in producing it
▪ According to Smith
Did you know that sugar prices in the United States are ✓Trade is not a zero-sum game
much higher than sugar prices in the rest of the world? ✓Countries should specialize in the production of
goods for which they have an absolute advantage
The Pattern of International Trade and then trade these goods for the goods
✓Ricardo’s theory of comparative advantage produced by other countries
▪ Trade patterns reflect differences in labor
productivity
✓Heckscher and Ohlin
▪ Trade reflects the interplay between the
proportions in which the factors of production are
available in different countries and the proportions
in which they are need for producing particular
goods
✓Ray Vernon
▪ Trade patterns reflect a product’s life cycle
✓Paul Krugman’s new trade theory
▪ The world market can only support a limited
number of firms in some industries
▪ Trade will skew toward those countries that have
firms that were able to capture first mover
advantages
 COMPARATIVE ADVANTAGE
The Gains from Trade
▪ The theory of comparative advantage - trade is a positive
sum game in which all gain
✓ Potential world production is greater with
unrestricted free trade than it is with restricted
trade
✓ Provides a strong rationale for encouraging free
trade
Qualifications and Assumptions
1. Only two countries and two goods
2. Zero transportation costs
3. Similar prices and values
4. Resources are mobile between goods within
countries, but not across countries
5. Constant returns to scale
6. Fixed stocks of resources
7. No effects on income distribution within
countries
Extensions of the Ricardian Model
✓Suppose the following assumptions are relaxed
1. Resources move freely from the production of
one good to another within a country
2. There are constant returns to scale
3. Trade does not change a country’s stock of
resources or the efficiency with which those
resources are utilized
✓Immobile Resources
▪ Resources do not always move freely from one
economic activity to another
▪ Governments may help retrain displaced workers
✓Diminishing Returns
▪ The simple model assumes constant returns to
specialization: the units of resources required to
produce a good are assumed to remain constant
▪ An assumption of diminishing returns is more
realistic since not all resources are of the same
quality and different goods use resources in
different proportions
✓Dynamic Effects and Economic Growth
▪ Trade might increase a country's stock of
resources as increased supplies become available
from abroad
▪ Free trade might increase the efficiency of
resource utilization, and free up resources for
other uses
✓ The Samuelson Critique
▪ Dynamic gains can lead to less beneficial
outcomes
▪ Free trade has historically benefitted rich
counties
✓ Evidence for the Link between Trade and Growth
▪ Countries that are open to trade have higher
growth rates than countries that close their
economies to trade
▪ Higher growth rates raise income levels and
living standards
HECKSCHER-OHLIN THEORY
Heckscher and Ohlin: Comparative advantage reflects
differences in national factor endowments: the extent to
which a country is endowed with resources such as land,
labor, and capital
✓This theory has commonsense appeal
▪ Export goods that make intensive use of those
factors that are locally abundant
▪ Import goods that make intensive use of factors
that are locally scarce
The Leontief Paradox
✓Leontief (1953): Since the U.S. was relatively
abundant in capital, it would export capital intensive
goods and import labor-intensive goods
▪ Leontief found that U.S. exports were less
capital intensive than U.S. imports
✓Possible explanations
▪ The U.S. has a special advantage in producing
products made with innovative technologies that
are less capital intensive
▪ Differences in technology lead to differences in
productivity which then drives trade patterns
Should Factor Endowments or Productivity Drive
Trade? Ricardo’s theory of trade suggests that it makes
sense for a country to specialize in production of those
products that it produces most efficiently and to buy the
products that it produces less efficiently from other
countries, even if this means that the country is buying
products that in reality it could produce more efficiently
itself. This means that Ricardo showed that a country can
derive advantages by trade even though it has an absolute
advantage in producing all products. The Heckscher-Ohlin
theory of trade suggests that comparative advantage for a
country arises from differences in national factor
endowments (i.e., the extent to which a country is
endowed with such resources as land, labor, and capital).
Ricardo’s argument focused on relative productivity, while
Heckscher-Ohlin’s argument focused on having important
resources. If you can only have one of the two— better
relative productivity or lots of resources such as land,
labor, and capital—which would you prefer, any why?
THE PRODUCT LIFE CYCLE THEORY
Vernon (mid-1960s ) proposed product life-cycle theory
✓As products mature both the location of sales and
the optimal production location will change affecting
the flow and direction of trade
▪ At the time, the wealth and size of the U.S.
market gave a strong incentive to U.S. firms to
develop new products
Product Life-Cycle Theory in the 21st Century
✓The product life cycle may not be as relevant today
▪ Many products are now introduced in Japan or
South Korea
▪ Many new products are also introduced
simultaneously into the U.S., Europe, and Asia
➢Firms use globally dispersed production
from the start
NEW TRADE THEORY
▪ Trade can increase the variety of goods available and
decrease the average cost of those goods because of
economies of scale: unit cost reductions associated with a
large scale of output
▪ When the output required to attain economies of scale
represents a significant proportion of total world demand,
the global market may only be able to support a small
number of firms
Economies of Scale, First-Mover Advantages, and the
Pattern of Trade
✓Firms with first mover advantages (the economic
and strategic advantages that accrue to many
entrants into an industry) will develop economies of
scale and create barriers to entry for other firms
▪ The pattern of trade we observe in the world
economy may be the result of first mover
advantages and economies of scale
Implications of New Trade Theory
✓Nations may benefit from trade even when they
do not differ in resource endowments or
technology
✓A country may predominate in the export of a
good simply because it was lucky enough to have
one or more firms among the first to produce that
good
✓New trade theory at a variance with Heckscher-
Ohlin theory
✓New trade theory useful in explaining trade
patterns
▪ New trade theory provides an economic rationale for a
proactive trade policy that is at variance with other free
trade theories
NATIONAL COMPETITIVE ADVANTAGE: PORTER’S
DIAMOND
▪ Porter believed existing theories of international trade
only told part of the story
▪ Wanted to explain why a nation achieves international
success in a particular industry
▪ Four attributes of a nation that shape the environment in
which local firms compete – Porter’s Diamond
▪ Chance and government can influence the national
diamond

Increasing Product Variety and Reducing Costs

✓ Without trade
▪ A small nation may not be able to support the
demand necessary for producers to realize
required economies of scale, and so certain
products may not be produced
✓ With trade
▪ A nation may be able to specialize in producing a
narrower range of products and then buy the
goods that it does not make from other countries
▪ Each nation then simultaneously increases the
variety of goods available to its consumers and
lowers the costs of those goods
Factor Endowments
✓Hierarchies among factors
▪ Basic: natural resources, climate, location,
demographics
▪ Advanced: communication infrastructure, skilled
labor, technological know-how
▪ Advanced factors more significant for
competitive advantage
▪ Basic factors can provide an initial advantage
that is extended by investment in advanced
factors
Demand Conditions
✓The nature of home demand for an industry’s
product or service
✓Influence the development of capabilities
▪ Sophisticated and demanding customers pressure firms
to be more competitive and to produce high quality,
innovative products
Related and supporting industries
✓The presence of supplier industries and related
industries that are internationally competitive
✓Investing in these industries can spill over and
contribute to success in other industries
▪ Successful industries tend to be grouped in clusters in
countries which then prompts knowledge flows between
firms
Firm strategy, Structure, and Rivalry
✓Different nations are characterized by different
management ideologies which either help them or
do not help them build national competitive
advantage
✓There is a strong association between vigorous
domestic rivalry and the creation and persistence of
competitive advantage in an industry
Evaluating Porter’s Theory
✓ If Porter is correct, his model should predict the pattern
of international trade in the real world
• Countries should export products from industries
where the diamond is favorable
• Countries should import products from areas
where the diamond is not favorable
✓ So, far there has been little empirical testing of the
theory
How Important is Education?
Both the Heckscher-Ohlin and Michael Porter theories of
trade focus to a large degree on “factor endowments.” The
Heckscher-Ohlin theory specifies endowments such as
resources as land, labor, and capital as being critical,
while the Porter theory recognizes hierarchies among
these factor endowments. Education- related endowments
such as skilled labor, research facilities, and technological
know-how are what Porter calls “advanced factors.” A
long-standing argument across multiple governmental
organizations, research studies, and prominent individuals
is that education drives economic, social, and
environmental well-being of countries. The extension of
this argument is that education helps people become
better citizens of a country. But, what do you think
education does to a customer’s product needs and wants?
Do they want more foreign products if they have more
years of education (e.g., graduate degree) compared with
fewer years of education (e.g., high school)? Or does
education not influence the type of products bought by
customers (i.e., foreign-made or home-country made)?
Focus on Managerial Implications
LOCATION, FIRST-MOVER ADVANTAGES, AND
GOVERNMENT POLICY
There are at least three main implications for international
businesses
1. Location
▪ This is an underlying thought in most of the
theories
2. First-mover advantages
▪ Particularly true in industries where global
market can profitably support limited number
of firms
3. Government policy
▪ Businesses can exert a strong influence on
government trade policy
Chapter 7: Government Policy and International Trade
Introduction
Free trade refers to a situation where a government does
not attempt to restrict what its citizens can buy from
another country or what they can sell to another country
✓ While many nations are nominally committed to
free trade, they tend to intervene in international
trade to protect the interests of politically important
groups
INSTRUMENTS OF TRADE POLICY
Seven main instruments of trade policy
1. Tariffs
2. Subsidies
3. Import quotas
4. Voluntary export restraints
5. Local content requirements
6. Administrative policies
7. Antidumping duties
Nontariff barriers include
1. Subsidies
2. Quotas
3. Voluntary export restraints
4. Antidumping duties
Tariffs
✓A tariff is a tax levied on imports that effectively raises
the cost of imported products relative to domestic products
▪ Specific tariffs: levied as a fixed charge for each
unit of a good imported
▪ Ad valorem tariffs: levied as a proportion of the
value of the imported good
• Increase government revenues
• Provide protection to domestic producers against
foreign competitors by increasing the cost of
imported foreign goods
• Force consumers to pay more for certain imports
• Tariffs are generally pro-producer and
anticonsumer
• Import tariffs reduce the overall efficiency of the
world economy
Subsidies
✓Subsidy: a government payment to a domestic
producer
✓Subsidies help domestic producers
▪ Compete against low-cost foreign imports
▪ Gain export markets
✓Consumers typically absorb the costs of subsidies
Import Quotas and Voluntary Export Restraints
✓Import quota
▪ A direct restriction on the quantity of some good
that may be imported into a country
✓Tariff rate quota
▪ A hybrid of a quota and a tariff where a lower
tariff is applied to imports within the quota than to
those over the quota
✓Voluntary export restraint (VER)
▪ Quota on trade imposed by the exporting
country, typically at the request of the importing
country’s government
✓Quota rent
▪ The extra profit that producers make when
supply is artificially limited by an import quota
Export Tariffs and Bans
✓Export tariff is a tax placed on the export of a good
▪ Goal is to discriminate against exporting
✓Export ban is a policy that partially or entirely restricts
the export of a good
▪ Ban of exports of U.S. crude oil in 1975 to
ensure sufficient supply of domestic oil at home
Local Content Requirements (LCR)
✓A local content requirement demands that some
specific fraction of a good be produced domestically
▪ Can be in physical terms or in value terms
✓Local content requirements benefit domestic
producers and jobs, but consumers face higher prices
Is Having a Local Content Requirement a Good Idea?
Local content requirements refer to a specific fraction of a
product that needs to be manufactured domestically.
Basically, LCRs establish a minimum level of local content
required under trade law when giving foreign companies
the right to manufacture in a particular place. In the wake
of the economic downturn in 2008, many economists
feared that some governments would institute protectionist
policies similar to the tariff escalations during the Great
Depression of the 1930s. However, most public policy
officials avoided traditional forms of protection (e.g., tariffs,
quotas). This led some observers to underestimate the
degree of protectionism. Instead, what had happened was
that so-called nontariff barriers in the form of local content
requirements had become increasingly popular. As a (1)
citizen of a specific country and (2) as a global customer,
do you think local content requirements help you as a
citizen of a country, as a global customer, as both, or as
neither?
Administrative Policies
✓Administrative trade polices: bureaucratic rules that are
designed to make it difficult for imports to enter a country
✓These polices hurt consumers by denying access to
possibly superior foreign products
Antidumping Policies
✓Dumping: selling goods in a foreign market below their
cost of production, or selling goods in a foreign market at
below their “fair” market value
▪ Objective is to protect domestic producers from
unfair foreign competition
▪ May be predatory behavior, with producers using
substantial profits from their home markets to
subsidize prices in a foreign market with a goal of
driving indigenous competitors out, and later
raising prices and earning substantial profits
✓U.S. firms that believe a foreign firm is dumping can file
a complaint with the government
▪ If the complaint has merit, antidumping duties,
also known as countervailing duties may be
imposed
THE CASE FOR GOVERNMENT INTERVENTION
Political arguments
✓Concerned with protecting the interests of
certain groups within a nation (normally
producers), often at the expense of other groups
(normally consumers)
Economic arguments
✓Concerned with boosting the overall wealth of a
nation (to the benefit of all, both producers and
consumers)
Political Arguments for Intervention
✓ Protecting jobs and industries
✓ Protecting national security
✓ Retaliating
▪ Use intervention as a bargaining tool and
force trading partners to “play by the rules
of the game”
✓ Protecting consumers
▪ Ban unsafe products
✓ Furthering foreign policy objectives
▪ Grant preferential trade terms to a country
it wants to build relations with
▪ Pressure or punish “rogue” states
✓ Protecting human rights
Economic Arguments for Intervention
✓The infant industry argument
▪ An industry should be protected until it can
develop and be viable and competitive
internationally
▪ This argument has been criticized because
▪ It is useless unless it makes the industry
more efficient
▪ If a country has the potential to develop
a viable competitive position, its firms
should be capable of raising necessary
funds
✓Strategic trade policy
▪ By appropriate actions, government can help
raise national income if it can ensure first-mover
advantages in an industry are domestic
▪ Might be beneficial for a government to intervene
in an industry by helping domestic firms overcome
barriers to entry created by foreign firms with first-
mover advantages
Trading with Cuba Even though the United States holds
trade sanctions with Cuba, other Western countries
continue to trade with the island nation.
THE REVISED CASE FOR FREE TRADE
▪ New trade theorists believe government intervention in
international trade is justified
✓Classical trade theorists disagree
▪ Some new trade theorists believe that while strategic
trade theory is appealing in theory, it may not be workable
in practice – they suggest a revised case for free trade
Retaliation and Trade War
✓Krugman: strategic trade policies to establish domestic
firms in a dominant position in a global industry are
beggar-thy-neighbor policies that boost national income at
the expense of other countries
▪ A country that attempts to use such policies will
probably provoke retaliation
▪ A trade war could leave both countries worse off
▪ Don’t engage in retaliation but help establish
rules to minimize the use of trade-distorting
subsidies
Domestic Policies
✓Governments can be influenced by special interest
groups
▪ A government’s decision to intervene in a market
may appease a certain group, but not necessarily
support the interests of the country as a whole
▪ Krugman sees this as a further reason for not
embracing strategic trade policy
 DEVELOPMENT OF THE WORLD TRADING SYSTEM
Since World War II, an international trading framework has
evolved to govern world trade
✓In its first fifty years, the framework was known
as the General Agreement on Tariffs and Trade
(GATT)
✓Since 1995, the framework has been known as
the World Trade Organization (WTO)
Do You Believe in Free Trade Agreements?
The benefits of free trade agreements are often hard to
see. At the same time, the benefits of protecting certain
industries and/ or companies from foreign competition are
often very visible. Given these scenarios, many people
often argue that free trade agreements are bad for their
country. Perhaps as a result, many governments impose
many tariffs, quotas, and other nontariff barriers to trade.
For example, the common perception is that by
establishing trade barriers, a country keeps the jobs at
home instead of jobs being shipped overseas. But is this
really true?
From Smith to the Great Depression
✓Up until the Great Depression of the 1930s, most
countries had some degree of protectionism
✓The U.S. enacted the Smoot-Hawley Act (1930):
created
significant import tariffs on foreign goods
✓Other nations took similar steps and as the depression
deepened, world trade fell further
1947-1979: GATT, Trade Liberalization, and Economic
Growth
✓The General Agreement on Tariffs and Trade (GATT)
was
established in 1947
✓ Multilateral agreement to liberalize trade and gradually
eliminate barriers to trade
✓Tariff reduction was spread over eight rounds
✓Very successful in early rounds
1980-1993: Protectionist Trends
✓Japan’s economic success strained what had been more
equal trading patterns
✓Persistent trade deficits by the U.S caused significant
problems in some industries and political problems for
the government
✓ Many countries found that although GATT limited the
use of tariffs, there were many other forms of
intervention that had the same effect that did not
technically violate GATT
The Uruguay Round and the World Trade Organization
✓ Uruguay Round emphasized services, intellectual
property, and agricultural subsidies
▪ Trade issues related to services and intellectual
property and agriculture were emphasized
▪ Dragged on for seven years
✓ The World Trade Organization
▪ The WTO encompassed GATT, the General
Agreement on Trade in Services (GATS), and the
Agreement on Trade Related Aspects of
Intellectual Property Rights (TRIPS)
▪ Procedures subject to strict time limits
WTO: Experience to Date
✓ Members account for 98% of world trade
✓ It was hoped that it would emerge as an effective
advocate and facilitator of future trade deals
✓ So far, most countries have adopted WTO
recommendations for trade disputes
✓ In general, countries involved in disputes accept WTO
recommendations
✓Global telecommunication and financial service
industries targeted for reform
The Future of the WTO: Unresolved issues and the
Doha Round
✓ Anti-dumping actions
▪ Encourage members to strengthen the
regulations governing the imposition of
antidumping duties
✓ Protectionism in agriculture
▪ Concerned with the high level of tariffs and
subsidies in the agricultural sector of many
economies
✓ Protecting intellectual property
▪ Members believe that the protection of
intellectual property rights is essential to the
international trading system
Protecting Agriculture
Removing barriers to trade and subsidies in agricultural
products should benefit consumers. Protecting Agriculture
Removing barriers to trade and subsidies in agricultural
products should benefit consumers.
The Future of the WTO: Unresolved issues and the
Doha Round
✓ Market access for nonagricultural goods and services
▪ Tariffs on services remain higher than on
industrial goods
✓ A new round of talks Doha
▪ Have been ongoing since 2001 concerned with
cutting tariffs on industrial goods and services,
phasing out subsidies to agricultural producers,
reducing barriers to cross-border investment,
limiting the use of antidumping laws
✓ Multilateral and Bilateral Trade Agreements
 ▪ Designed to capture gain from trade beyond
those agreements currently attainable under WTO
treaties
▪ Tariff barriers raise the costs of exporting
products to a country
▪ Quotas may limit a firm’s ability to serve a
country from locations outside that country
▪ A firm may have to locate more production
activities in a given market than it would
otherwise.
▪ The threat of antidumping action limits the ability
of a firm to use aggressive pricing to gain market
share in a country
✓ Policy Implications
FOCUS ON MANAGERIAL IMPLICATIONS
Trade barriers, firm strategy, and policy implications
• Trade barriers impact firm strategy
• Tariff barriers raise the costs of exporting
• Quotas may limit a firm’s ability to serve a
country
• Firms may need to conform to local content
requirements
• Future trade barriers can influence firm strategy •
Firms can play a role in promoting free trade or trade
barriers
Policy Implications
✓International firms have an incentive to lobby for free
trade, and keep protectionist pressures from causing them
to have to change strategies
✓Three drawbacks to government intervention
▪ Self-defeating as it protects the inefficient
▪ Dangerous as it might invite retaliation
▪ Unlikely to be well-executed as can be captured
by special interest groups
CHAPTER 13: THE STRATEGY OF INTERNATIONAL
BUSINESS
Opening Case: Sony's Global Strategy
▪ Most well known company (Japan, 1946), strong brand
value (world class)
▪ 13 core business segments (internet enabled products)
▪ Vision: Passion for technology, content and services
▪ Mission: Inspires and fulfills curiosity (fosters dream)
▪ Global initiatives
▪ Accelerating R&D (innovation and quality)
▪ New business ventures
Introduction
Managers must consider
• The benefits of expanding into foreign markets
• Which strategies to pursue in foreign markets
• The value of collaboration with global competitors
• The advantages of strategic alliances
STRATEGY AND THE FIRM
Strategy: the actions taken by managers to attain the
goals of the firm
✓ Profitability: the rate of return the firm makes
on its invested capital
✓ Profit growth: the percentage increase in net
profits over time
Value Creation
✓ The difference between V (the price that the firm can
charge for that product given competitive pressures)
and C (the costs of producing that product)
✓ Two basic strategies
1. Differentiation
2. Low cost

Strategic Positioning
✓ Pick a position on the efficiency frontier that is viable
(enough demand to support the choice)
✓ Configure internal operations to support the position
✓ Have the right organization structure in place to
execute the strategy
Operations: The Firm as a Value Chain
✓ Primary Activities
▪ Involves the design, creation, and delivery of the
product; its marketing; and its support and after-
sale service.
▪ Divided into: research and development,
production, marketing and sales, customer service
✓ Support Activities
▪ Provides the inputs that allow the primary
activities to occur
▪ Divided into: information systems, company
infrastructure, logistics, human resources
Is Education Creating Value for You?
The concept of a value chain can be used to examine the
role your education plays in your life plans, if you look
closely at your personal development plans (education,
internship, work, physical and emotional fitness, and
extracurricular activities) and think about them in terms of
primary and support activities. If we use the logic that the
amount of value you receive from your education is the
difference between the costs (e.g., tuition, time, lost
income) and what you receive in the form of education
(e.g., knowledge, tools, networks), how does your choice
of major area of focus in your education fit into your
personal development strategy? How do your choices of
how you spend your time fit into your value chain? Do you
ever spend time doing things that do not support the
strategic goals of your personal value chain? But, most
importantly, what is the one thing you should do more of to
drive the value higher for yourself today and in the future?
Organization: The Implementation of Strategy
✓ Organization architecture:
the totality of a firm’s organization - formal
organizational structure, control systems and
incentives, organizational culture, processes, and
people
✓ Organizational structure:
▪ The formal division of the organization into
subunits
▪ The location of decision-making responsibilities
within that structure
▪ The establishment of integrating mechanisms to
coordinate the activities of subunits including
cross functional teams and or pan-regional
committees

Organization: The Implementation of Strategy continued
✓Controls:
metrics used to measure the performance of
subunits and make judgments about how well the
subunits are run
✓Incentives:
devices used to reward appropriate managerial
behavior
✓Processes:
manner in which decisions are made and work is
performed
✓Organizational culture:
norms and value systems that are shared among
the employees
✓People:
employees and the strategy used to recruit,
compensate, and retain those individuals
In Sum: Strategic Fit
✓ The operations of the firm must support the firm’s
strategy
✓ The organizational architecture of the firm must match
the firm’s operations and strategy
✓ If market conditions shift, so must the firm’s strategy,
operations, and organization
GLOBAL EXPANSION, PROFITABILITY AND PROFIT
GROWTH
Firms that operate internationally
1. Expand the market for their domestic product
offerings by selling those products in international
markets
2. Realize location economies by dispersing
individual value creation activities to locations
around the globe where they can be performed
most efficiently and effectively
3. Realize greater cost economies from
experience effects by serving an expanded global
market from a central location, thereby reducing
the costs of value creation
4. Earn a greater return by leveraging any
valuable skills developed in foreign operations and
transferring them to other entities within the firm’s
global network of operations
▪ Expanding the Market: Leveraging Products and
Competencies
▪ To increase growth, a firm can sell products or services
developed at home in foreign markets
✓Success depends on the type of goods and
services, and the firm’s core competencies (skills
within the firm that competitors cannot easily
match or imitate)
▪ Enable the firm to reduce the costs of value
creation
▪ Create perceived value so that premium
pricing is possible
▪ They are the source of a firm’s competitive
advantage
Core Competencies
P&G’s core competency in marketing is evidenced in this
photo of Olay men’s skin care products for sale in a
Shanghai, China, supermarket.
Location Economies
✓ Firms should locate value creation activities where
economic, political, and cultural conditions are most
conducive to the performance of that activity
▪ Firms that successfully do this can realize
location economies: economies that arise from
performing a value creation activity in the optimal
location for that activity, wherever in the world that
might be
✓ Locating value creation activities in optimal locations
▪ Can lower the costs of value creation
▪ Can enable a firm to differentiate its product
offering from those of competitors
Creating a Global Web
✓ Multinationals that take advantage of location
economies create a global web of value creation activities
✓ Under this strategy, different stages of the value chain
are dispersed to those locations around the globe where
perceived value is maximized or where the costs of value
creation are minimized
▪ Introducing transportation costs and trade
barriers complicates this picture
▪ Political and economic risks must be assessed
when making location decisions
Experience Effects
 ✓The experience curve: systematic reductions in
production costs that have been observed to occur
over the life of a product
✓A product’s production costs decline by some
quantity about each time cumulative output
doubles
✓Learning effects: cost savings that come from
learning by doing
▪ Labor productivity increases when
individuals learn the most efficient ways to
perform particular tasks and management
learns how to manage the new operation
more efficiently
Experience Effects continued
✓Economies of scale:
reductions in unit cost achieved by producing a large
volume of a product
▪ The ability to spread fixed costs over a large
volume
▪ Not able to attain efficient scale of production
unless served global markets
▪ Bargaining power increases with suppliers which
may allow economies of scale in purchasing
✓Strategic Significance
▪ Moving down experience curve allows firm to
reduce its cost of creating value and increase its
profitability
▪ Once firm has established low-cost position it
can act as a barrier to new competition
Leveraging Subsidiary Skills
✓ Recognize that valuable skills can be developed
anywhere within the firm’s global network (not just at the
corporate center)
✓ Use incentive systems to encourage local employees to
acquire new skills
✓ Develop a process to identify when new skills have
been created
✓ Act as facilitators to transfer valuable skills within the
firm
Profitability and Profit Growth Summary
✓ Firms that expand internationally can increase their
profitability and profit growth by:
1. Entering markets where competitors lack similar
competencies
2. Realizing location economies
3. Exploiting experience curve effects
4. Transferring valuable skills within the
organization
COST PRESSURES AND PRESSURES FOR LOCAL
RESPONSIVENESS
Pressures for Cost Reductions
✓ In industries producing commodity type products that fill
universal needs: needs that exist when the tastes and
preferences of consumers in different nations are similar if
not identical
▪ When major competitors are based in low cost
locations
▪ Where there is persistent excess capacity
▪ Where consumers are powerful and face low
switching costs
Pressures for Local Responsiveness
1. Differences in consumer tastes and preferences
2. Differences in traditional practices and infrastructure
3. Differences in distribution channels
4. Host government demands
5. The rise of regionalism
▪ Firms facing these pressures need to differentiate their
products and marketing strategy in each country
1. Differences in Consumer Tastes and Preferences
✓ When consumer tastes and preferences differ
significantly between countries, firms face strong
pressures for local responsiveness
2. Differences in Infrastructure and Traditional
Practices
 ✓ When there are differences in infrastructure
and/or traditional practices, a need to customize
products emerges
3. Differences in Distribution Channels
✓ A firm’s marketing strategies may be influenced
by differences in distribution channels between
countries which may necessitate delegation of
marketing functions to national subsidiaries
4. Host Government Demands
✓ Economic and political demands imposed by
host country governments may necessitate a
degree of local responsiveness
5. The Rise of Regionalism
✓ Regional convergence of tastes and
preferences can influence product offerings within
a bloc of nations
CHOOSING A STRATEGY
Firms use four basic strategies in global markets
1. Global standardization
2. Localization
3. Transnational
4. International
A global standardization strategy focuses on increasing
profitability and profit growth by reaping the cost
reductions that come from economies of scale, learning
effects, and location economies
• The goal is to pursue a low-cost strategy on a
global scale
• Makes sense when there are strong pressures
for cost reductions and demands for local
responsiveness are minimal
More Customized Products in the Global Marketplace?
The Coca-Cola Company’s (TCCC) Minute Maid Pulpy
became the cola giant’s 14th brand to reach $1 billion in
global retail sales (in 2011). As opposed to cola
carbonates, which often rely on global brand recognition
and crossgenerational formulas for success, Minute Maid
Pulpy has relied on product development and innovations
inspired by local flavors and textures. Toward the end of
2004, Minute Maid released Minute Maid Pulpy, which
contained less than 24 percent actual fruit juice, but TCCC
was able to retail the product at a much lower price point
than products with a higher content of fruit juice. In China
and throughout the Asia-Pacific region, consumer notions
of freshness and health are connected much more to the
consumption of actual fruit. Minute Maid Pulpy
acknowledged this by including pieces of fruit in the drink,
thereby creating a thicker texture that would not appeal to
most North American consumers but has proven very
popular in this region of the world. In customizing the
product, Minute Maid Pulpy went from the 10th most
popular fruit/vegetable juice brand in China in 2004 to first
by the time it had achieved $1 billion in total sales in 2011.
But isn’t the world becoming more globalized? Do we still
need large multinational corporations customizing their
products to local markets?
A localization strategy focuses on increasing profitability
by customizing the firm’s goods or services so that they
provide a good match to tastes and preferences in
different national markets
• Makes sense when there are substantial
differences across nations with regard to
consumer tastes and preferences, and where cost
pressures are not too intense
A transnational strategy tries to simultaneously
• Achieve low costs through location economies,
economies of scale, and learning effects
• Differentiate the product offering across
geographic markets to account for local
differences
• Foster a multidirectional flow of skills between
different subsidiaries
• Makes sense when there are both high cost
pressures and high pressures for local
responsiveness
An international strategy involves taking products first
produced for the domestic market and then selling them
internationally with only minimal local customization
• Makes sense when there are low cost pressures
and low pressures for local responsiveness
The Evolution of Strategy
• As competition increases, international and
localization strategies become less viable
• To survive, firms may need to shift to a global
standardization strategy or a transnational
strategy in advance of competitors
 ✓ Alliance Structure
• Can be designed to make it difficult to transfer
technology meant to be transferred
• Contractual safeguards can be written into
alliance agreement to guard against risk of
opportunism
• Both parties can agree in advance to swap skills
and technologies that the other covets

✓ Managing the Alliance

▪ Requires managers from both companies to
build interpersonal relationships (relational capital)
▪ Should promote learning from alliance partners
STRATEGIC ALLIANCES ▪ Should promote the diffusion of learned
knowledge throughout the organization
Strategic alliances are cooperative agreements between
potential or actual competitors
✓Examples include formal joint ventures and short
term contractual arrangements
✓The number of international strategic alliances
has risen significantly in recent decades

The Advantages of Strategic Alliances

✓ Facilitate entry into a foreign market
✓ Allow firms to share the fixed costs and risks of
developing new products or processes
✓ Bring together complementary skills and assets
that neither partner could easily develop on its
own
✓ Can help establish technological standards for
the industry that will benefit the firm

A Strategic Alliance
A moviegoer walks past a poster of the Warner Bros
movie Gravity in Shanghai, China. The strategic alliance
between Warner Brothers and their Chinese partners has
helped streamline the process for film distribution.

The Disadvantages of Strategic Alliances

✓ Strategic alliances can give competitors low-
cost routes to new technology and markets
✓ Unless a firm is careful, it can give away more
in a strategic alliance than it receives

Making Alliances Work

✓ Partner Selection
• Collect as much information as possible
• Gather data from informed third parties
• Get to know the potential partner well before
committing
 ➢ Organizational structure has three dimensions
1. Vertical differentiation - location of
decisionmaking responsibilities within a structure
Chapter 14: The Organization of International ➢ Centralized decision-making
Business ➢ Decentralized decision-making
2. Horizontal differentiation - formal division of
the organization into sub-units

3. Integrating mechanisms - the mechanisms for

coordinating sub-units

Why Is Horizontal Differentiation Important?

➢ Initially, most firms have no formal structure, but as
they grow, develop a functional structure

➢ Firms may switch to a product divisional structure

where each division is responsible for a distinct product
line

➢ When firms expand internationally, they often group all

What Is Organizational Architecture?
of their international activities into an international
➢ Organizational architecture is the totality of a firm’s
division
organization including
1. Organizational structure
2. Control systems and incentives
3. Processes, organizational culture, and people

➢ To be the most profitable

➢ the elements of the organizational architecture
must be internally consistent
➢ the organizational architecture must fit the
strategy
➢ the strategy and architecture must be
consistent with each other, and consistent with
competitive conditions

What Are The Dimensions Of Organizational

Structure?
What Happens Next?
➢ Firms that continue to expand will move to either a
1. Worldwide product divisional structure - adopted by
firms that are reasonably diversified
2. Worldwide area structure - favored by firms with low
degree of diversification and a domestic structure based
on function
3. The global matrix structure – tries to minimize the
limitations of the worldwide area structure and the
worldwide product divisional structure

How Can Subunits Be Integrated?

➢ Regardless of the type of structure, firms need a
mechanism to integrate subunits
➢ Many firms use informal integrating mechanisms
➢ a knowledge network
➢ Formal integrating mechanisms include
1. Personal controls
2. Bureaucratic controls
3. Output controls
4. Cultural controls

What Is Organizational Culture?

➢ Organizational culture - the values and norms that
employees are encouraged to follow
➢ Evolves from
➢founders and important leaders
➢national social culture
➢the history of the enterprise
➢decisions that resulted in high performance
➢ Managers in companies with a “strong” culture share a
relatively consistent set of values and norms that have a
clear impact on the way work is performed
 1. Unfreeze the organization through shock
therapy 2. Move the organization to a new state
through proactive change in architecture
3. Refreeze the organization in its new state

What Is The Link Between Strategy And Architecture?

1. Firms pursuing a localization strategy focus on

local responsiveness

2. Firms pursuing an international strategy create

value by transferring core competencies from
home to foreign subsidiaries

3. Firms pursuing a global standardization

strategy focus on the realization of location and
experience curve economies

4. Firms pursuing a transnational strategy focus on

simultaneously attaining location and experience
curve economies, local responsiveness, and
global learning

How Can Firms Implement Organizational Change?

➢ For a firm to succeed

1. The firm’s strategy must be consistent with the
environment in which the firm operates
2. The firm’s organization architecture must be
consistent with its strategy

➢ To implement organization change