International Business Economics

Lecture Notes

Christos Pitelis
January 2004
 2

Contents

1. Introduction: Globalisation (Nature, Evolution,

Perspectives)
2. Why Multinational Corporations (MNCs) and
Foreign Direct Investment (FDI)?
3. Strategy and Strategic Options of MNCs
4. MNCs, Government Policy and (Inter)national
Competitiveness - Overall Conclusion and the
Future of MNCs
International Business Economics

Session 1
Introduction: ‘Globalisation’
(Nature, Evolution, Perspectives)
 4

Exhibit 1.1: A Framework

(INTERNATIONAL)
COMPETITIVENESS

FIRMS POLICY- GOVERNMENTS

(Business, (Competition,
Competitive) STRATEGY Industrial)

THEORY
 5
The Nature and Scope of
International Business
• International Business (IB) deals with the
nature, strategy and management of international
business enterprises and their effects on
business and national performance (e.g.,
efficiency, growth, profitability, employment).
• IB is interdisciplinary. It draws, among others, on
economics, politics, sociology, marketing,
management (human resources, strategic).
 6

Some definitions (i)

• FDI is the control of production which takes place
in one country (‘host country’) by a firm based in
another country (‘home country’). FDI is the
defining feature of the multinational corporation
(MNC).
• Globalisation refers to the increasing integration
of markets (exchange) and production, to include
the mobility of resources (capital, labour,
‘organization and knowledge’).
 7

Some definitions (ii)

• A firm is an organisation which produces
commodities for sale in the market for a profit,
and allocates resources (such as capital and
labour) without direct reliance on the price
mechanism (the market) on the basis of internal
entrepreneurial decisions (hierarchy).
• An MNC is a firm which controls production in
countries other than (and including) its home
base.
 8

Some definitions (iii)

• The market (price mechanism) is an institution of

resource allocation, based on voluntary
exchanges (transactions) by individuals,
motivated by preferences and market prices.
• The state is an institution which allocates
resources and influences the organization of
economic activity through a legal monopoly on
force.
 9

Origins of IB (i)
• IB is the result of the internationalisation of
production and the emergence of the
multinational corporations (MNCs), the subject
matter of IB.
• Internationalisation of production (‘globalisation’)
involves international capital flows, international
trade of commodities (exports-imports) and
Foreign Direct Investment (FDI) by MNCs.
 10

Origins of IB (ii)

• Until the 1980s, there has been a tendency towards concentration of

industry, and oligopolistic market structures. Firms have observed a
‘law of increasing size’ consisting of four stages:
– First, the owner managed and controlled small firm (nineteenth
century).
– Second, the public limited ‘national’ company (limited liability,
separation of ownership from management).
– Third, the multidivisional (M-form) organisation (division- based),
separation of strategic (long term) and operational (day-to-day)
decisions.
– Fourth, multinational corporations (MNCs) with production
activities outside (and including) their home-base.
 11

Exhibit 1.2: The unitary (U-form) firm

Chief Executive

Production Sales and Financial and Personnel

Development Marketing Accounting Department
Department Department
 12
Exhibit 1.3: A multidivisional (M-form)
structure
Head Office

Central Services (e.g., Finance)

Division A Division B Division C Division D Division E

Functions Functions Functions Functions Functions

 13
Exhibit 1.4: A holding company
structure
Parent Company
Head Office

Company A Company B Company C Company D Company E

(wholly owned) (wholly owned) (90% owned) (75% owned) (25% owned)
 14

Some facts and trends in IB (i)

• International trade inside the world’s largest 350 MNCs
accounts for almost 40 per cent of world merchandise
trade.
• The world’s largest MNCs (e.g., General Motors, Exxon,
Microsoft etc) have annual sales higher than the annual
gross national product (GNP) of all but around 15 nation
states.
• In the early 2000s in the USA, nearly half of
manufacturing exports and around two thirds of imports
were flowing within MNCs (intra-firm trade).
 15

Some facts and trends of IB (ii)

• FDI increased by over 20 per cent between 1985 and

2000, twice the growth rate of exports or output.
• In the period 1991-2000, 63 per cent of global FDI flows
was received by the developed countries (DCs) (down
from almost 80% in 1989), around 33 per cent by
developing countries and just over 3 per cent by Eastern
European countries.
• Among the developing countries, China receives the lion’s
share of FDI.
 16

Some facts and trends of IB (iii)

• Within the DCs, the US, the UK, Canada, France and
Germany are leading players.
• Since 1960 the relative importance of the US and the UK
as sources of outward FDI has been declining.
• In the ‘Triad’ (Europe, USA, Japan), total FDI between US
and the EU was almost one third of global FDI in 2000.
• European FDI is largely due to M&As.
• FDI declined sharply in 2001 (over 50%, the largest drop
in 30 years), 2002 and 2003.
 17

Some issues in IB (i)

• The main issues which arise from the facts and

trends of FDI concern the following:
– Why international production, FDI and MNCs?
– How do (should) MNCs conduct their business
strategies? (competitive and corporate strategies)
 18

Some issues in IB (ii)

• What is the relationship between MNCs, nation

states (in developed and developing countries)
and international organisations and what is the
impact of MNCs on growth and development?
• What is the link between MNCs and international
competitiveness?
Background 1 (pp 20-28, starts here):
Firms & Industries
 20
History
(U-form) Firm, Competitive Industry

Growth

Organic (Internal)-Vertical integration, External-Mergers and Acquisitions

‘National’ (Public Limited) Company, Industry Concentration, Oligopoly

(M-form) Firm, Diversification (Related, Unrelated-Conglomerate)

Foreign Direct Investment, Transnational Corporations (TNCs), Global Firms

 21

Firm integration “Strategies”

• Vertical Integration (VI): Backward (raw materials) and

forward (distribution).
• Mergers and acquisitions (M&A): coming together of two
or more firms.
• Conglomerate diversification: operations-expansion of
firms in ‘unrelated’ products-markets.
• Foreign Direct Investment (FDI) and MNCs.
• ‘Hybrid’ (networks, clusters, joint ventures, strategic
alliances …)
 22

Main perspectives

• (Market) Power: Firms pursue profit and/through

(market) power.
• Efficiency: Firms pursue profit through reduction
of production and transaction costs.
• Hybrid: Firms pursue profits through efficiency
and (market) power.
 23

Theories (i)

• Neoclassical: Firm is ‘a production function’, a ‘black box’; it is

concerned with the industry price-output ‘equilibrium’, which
maximizes profits. Price-output equilibria depend on market structure,
e.g., perfect competition, monopoly.
– Managerial: Firms maximize utility of managers, e.g., sales
revenue, growth. Based on alleged ‘separation of ownership from
control’.
– Transaction Costs: Firms are multi-person hierarchies which
result from, and give rise to reduced market transaction costs,
resulting in efficient industry structures.
 24

Theories (ii)

• Resource-Based: Firms are bundles of human

and non-human resources under administrative
co-ordination. There are internal and external
stimuli to growth which lead to industry
concentration.
• Behavioural: Given ‘bounded rationality’ and
different objectives of groups within them, firms
do not maximize, they ‘satisfice’.
 25

Theories (iii)

• ‘Austrian’ - Chicago School - Schumpeterian: Alert,

profit seeking entrepreneurs, enhance market co-
ordination and give rise to ephemeral monopoly profits,
eroded through competitive process of ‘creative
destruction’ (innovations).
• ‘Marxist’: Firms produce commodities for sale in the
market for a profit, under hierarchical control of capital
over labour. Dialectic link between competition and
monopoly, for maintenance of monopoly (power).
 26
Some critical elements for economic
analysis (DISCO) (i)
• Demand (D): The demand conditions firms face,
in the form of a Demand Curve, derived from
‘Theory of Demand’.
• Industry Structure (IS): The extent of industry
concentration, barriers to entry, etc, leading to
competitive, imperfectly competitive, oligopolistic,
or monopolistic industry structures.
 27
Some critical elements for economic
analysis (DISCO) (ii)
• Costs (C): The cost conditions faced by the firm, in the
shape of a Cost Curve, derived from ‘Theory of
Production and Costs’.
• Objectives (O): The firms’ aim. It allows the derivation of
price-output ‘equilibria’. Usual assumption is profit
maximization (Marginal Cost equals Marginal Revenue).
Others are maximization of sales revenue or growth.
Alternatives are ‘satisficing’, ‘entrepreneuring’…
 Exhibit 1.5: Monopoly versus 28

Competition
P

Q, minimum
efficient scale PM

PM monopoly
price
LAC = LMC
PC perfect PC

competition
price D

0
Q QM QC Q
MR
[End of Background 1]
 29

‘Globalization’: causes

• Firm growth because of

– Use of excess internal resources at near zero
marginal cost
– Sale of products to new markets at high profit
rates (due to high fixed costs).
 30

‘Globalization’: facilitators

• Reductions in transportation costs.

• Improvements in information and communication
technologies.
International Business Economics

Session 2
Why MNCs and FDI?
 32

The Multinational Corporation (MNC)

• Definition
– MNC = firm which controls production
across national boundaries through intra-firm
(non-market) operations.
• Question
– Why MNCs as opposed to exports,
franchising, licensing, etc. ?
Background 2 (pp 32-65, starts here):
Perspectives on the theory of firm
 34

The Neoclassical analysis (i)

Simple Market Structure Analysis (Perfect

Competition vs Monopoly)
• Perfect Competition defined: Market structure
characterised by a large number of profit
maximising buyers and sellers selling
homogeneous products, and no entry barriers.
• Result: Price taking behaviour, price at minimum
long run average cost (LAC) curve  ‘normal’
profits.
 35

The Neoclassical analysis (ii)

• Monopoly defined: market structure

characterised by a single profit maximising
producer and very high entry barriers (no entry).
• Result: monopoly prices exceeding minimum
LAC  ‘Excess’ (monopoly) profits.
• Conclusion: departures from perfect competition
result in increases in prices and reductions in
output. Also to ‘welfare losses’ due to ‘monopoly
power’.
 36
The Neoclassical analysis (iii) -
Oligopoly
• Defined: market structure characterised by
interdependence of (usually a small number of)
producers-firms. Duopoly is the case of two
firms.
 37
Exhibit 5: Industrial Organisation (IO) and the
SCP M odelmodel
S(tructure) - C(onduct) - P(erformance)

• IO Defined: Branch of economic Structure

theory analysing structure-conduct (Concentration, Barriers to Entry,etc )
and performance (SCP) of
oligopolistic industries (set of firms
producing similar products).
• SCP Model: Suggests there exists a
(initially unidirectional) link between Conduct
structure (S), conduct (C) and
performance (P) of industries. (Pricing, Advertising, R& D,etc )
Feedback relationships from conduct
and/or performance to structure later
allowed for.
• Main Focus: The concentration (S) -
Profitability (P) relationship assuming Performance
profit maximisation (C).
(Profitability, Efficiency, etc )
• ‘New IO’ analyses impact of conduct
on structure and performance in
oligopolistic games.
 38
Theoretical specification of industry
structures
1. Limit pricing
2. Unconstrained profit maximizing oligopoly
3. Contestable markets
 39

1. Limit Pricing
• Assumes constrained profit maximisation
(maximum profits subject to no entry), barriers to
entry (minimum efficiency scale) and that
incumbents leave post-entry output at pre-entry
levels and entrants know this.
• Result: Limit price derives from limit output found
by subtracting the minimum efficient scale level of
output from the perfect competition level.
 40
Exhibit 2.1: Derivation of the limit
price
P

PL

LAC
PC

Q Q
D

0
Q QL QC Q

• PL is determined by QL, i.e. the level to which, if the MES

was added, the competitive output would result, thus PC,
thus no ENTRY.
RULE: QL  QC  Q
 41
2. Unconstrained profit maximising
oligopoly
• Assumes blockaded entry and joint profit
maximising price-output levels (Monopoly). Entry
is blockaded through strategic entry barriers, e.g.,
investment in excess capacity.
 42

3. Contestable markets

• Assume free entry and costless exit. This

ensures perfectly competitive price-output levels,
even in the presence of economies of scale and
oligopolistic market structures, as any departures
from perfectly competitive prices lead to hit-and-
run entry and exit.
 43

IO models compared
• Main issue is the nature and importance of entry barriers,
both ‘innocent’/structural (scale economies) and
strategic (conscious actions by incumbents designed to
deter entry), e.g., excess capacity, product proliferation.
• Well analysed strategic entry deterrence strategy, the
investment in ‘excess capacity’. In the limit even
monopoly pricing is sustainable if incumbents have
excess capacity sufficient to produce full perfect
competition output. To be credible, excess capacity
investment should be optimal post-entry.
 44
Exhibit 2.2: An expository diagrammatic
framework to Industrial Organisation
P
Q
, minimum
efficient scale P
M

QS, strategic
capacity output
P L
PM monopoly price LAC = LMC
P
PL limit price C

PC perfect QS Q

competition D

price
0
Q QM QL QC Q

MR
 45
Firm-industry structures and
business strategy
• Oligopoly, crucial for (competitive) strategy, which is
absent in cases of both perfect competition and
monopoly. Emergence and effects of oligopoly analysed
by theory of Industrial Organization (IO), which is based
on and extends the Cournot/Bertrand models of oligopoly.
• M-Form organisation is important condition for
development of corporate strategy (existence of
multitude of business units).
 46
Theory of Firms & Industries:
Alternative Perspectives

• Transaction Costs, Markets and Hierarchies

• Resource-Based and related perspectives
 47
Transaction Costs, Markets &
Hierarchies (i)
• Origin: Coase (1937)
• Assumptions
i) Market is ‘original’ means of resource
allocation =>
ii) Existence of hierarchies (e.g., firms) due to
market failure
• Nature of market failure
– Cognitive (natural) not structural; i.e., due to
transaction costs and not monopoly power.
 48
Transaction Costs, Markets &
Hierarchies (ii)
• (Market) Transaction Costs are costs of information,
bargaining, contracting, policing and enforcing
agreements.
• Main Proposition (Coase, Williamson, etc.):
internalization of markets by hierarchies, i.e.,
replacement of voluntary exchanges with hierarchy =>
savings in transaction costs => hierarchy (firm) more
efficient way to allocate resources.
• Horizontal and vertical integration, the M-form, and
conglomeration result from pursuit of transaction cost
reductions.
 49
Transaction Costs, Markets &
Hierarchies (iii)
• Policy Implications
– In neoclassical approach departures from perfect
competition => market failure (structural) =>
=> need for government intervention.
– In transaction costs approach hierarchies (including
M-form conglomerates and MNCs) =
efficiency improving solutions to (natural) market
failure =>
=> less need to interfere with the markets.
 50
Resource-based & related
perspectives (i)
• Early work by Penrose (1959)
– Firm = “a collection of resources bound together in an
administrative framework, the boundaries of which are
determined by the ‘area of administrative co-ordination
and authorative communication’” (Penrose, 1995, p xi).
– Focus on ‘the internal resources of the firm’, then the
external environment. Latter is different for each firm
depending ‘on its specific collection of human and
other resources’. Environment can be manipulated by
firms to serve their objectives.
 51
Resource-based & related
perspectives (ii)
• Dynamic interaction between internal and perceived
external environment (‘image’, and ‘productive
opportunity’).
• Endogenous Growth, results from
i) resource indivisibility,
ii) knowledge creation within firms, which releases
resources.
• A firm’s prospects are in terms of existing and new
products; diversification as new markets become
relatively more attractive than existing ones.
 52
Resource-based & related
perspectives (iii)
• Knowledge is tacit.
• ‘History matters’, growth is an evolutionary process,
based on cumulative growth of collective knowledge in
the context of a purposeful firm.
• Rate of firm’s growth limited by growth of knowledge
within it, and a firm’s size by the extend to which
administrative effectiveness continues to reach expanding
boundaries.
 53
Resource-based & related
perspectives (iv)
• Firm strategies result of differential capability, e.g.,
– Vertical Integration, due to ability of firms to serve their
own needs better.
– Diversification, due to growth and multiple applicability
of resources.
– Mergers and Acquisitions; to acquire managerial
resources for expansion.
– MNCs, due to differential ability e.g., in transferring
tacit knowledge (Kogut-Zander).
 54
Resource-based & related
perspectives (v)
(Nelson & Winter, 1982)
• In Nelson and Winter’s evolutionary theory of the
firm, routines, search (changes in routines) and
competition are economic analogues to genes,
heredity and struggle for existence in biology.
 55
Resource-based & related
perspectives (vi)
(Capabilities-based)
• Use and develop hard to imitate and costly to
apply internal capabilities.
• Rents in equilibrium.
 56
Resource-based & related perspectives
(viii) (knowledge-based theories,
Penrose, etc.)
• Firms better than markets in using, preserving,
transferring and developing knowledge.
• Value creation – growth through knowledge and
value appropriation.
 Resource-based & related 57

perspectives (ix) (Richardson and co-

operation)
• “Dense network of co-operation and affiliation by which
firms are inter-related.”
• Markets, hierarchy and networks are a function of degree
of complementarity and similarity of activities
– weakly complementary activities => MARKET
– complementary and similar activities => HIERARCHY
– complementary and dissimilar activities => CO-
OPERATION

[End of Background 2}
 58

Theories of the MNC

• Two main types:

- Supply-side
- Demand-side
- Other factors – “theories”
• Supply-side theories. Mainly
- Monopolistic – ‘ownership’ advantage
- Transaction costs and internalisation
- Eclectic theory (or Ownership, Location, Internalisation - OLI
paradigm)
- Divide and rule
- Resource-based
 59

Supply-side theories:
Monopolistic ‘ownership’ advantage (i)
• Origin: Hymer’s 1960 PhD thesis
• Assume: ‘Law of increasing firm size’: Firms
growth leads to concentration and acquisition of
monopolistic advantages (MAs).
– Firms’ pursuit of (monopoly) profit => seeking
overseas markets.
– MAs allow firms to outcompete foreign rivals.
– MNCs aim at reducing conflict.
 60

Supply-side theories:
Monopolistic ‘ownership’ advantage (ii)
• Choice of FDI over market-based alternatives
due to control potential and oligopolistic
interaction.
• Collusion allows reduction of conflict and
maintenance of monopoly profits.
• Conclude: Structural market failure => MNCs =>
(international) structural market failure
 61
Supply-side theories:
Transaction costs - internalization (i)
• Existence of firms =>
Economising in transaction costs => Firms more
efficient than markets
• In case of MNCs, choice is between market
transactions, e.g., exporting, licensing and non-
market transactions, i.e. Foreign Direct
Investment (FDI).
 62
Supply-side theories:
Transaction costs - internalization (ii)
• Reasons for FDI
– Williamson: asset specificity => hold-up problems =>
need for fully owned subsidiaries (FDI).
– Buckley & Casson: intangible assets exhibit ‘public
goods’ attributes, thus result in appropriability
problems => market failure.
– Hennart: internalization of markets due to differential
ability to control (overseas) labour.
 63
Supply-side theories:
Transaction costs - internalization (iii)
• Conclusion
Internalization of markets through MNCs are
efficient solution to intrinsic (transaction costs-
related) market failure.
 64
Supply-side theories:
Eclectic theory (or ‘OLI paradigm’)
• Dunning, combined a and b as well as location
advantages to provide ‘eclectic theory’ or
O(ownership), L(ocation), I(nternalization)
paradigm.
• OLI explains internationalization of production,
not the MNC.
– O explains why firms are able to become MNCs.
– I explains why they benefit from internalizing markets
or advantages.
– L explains the choice of location.
 65
Supply-side theories:
Divide and Rule (Sugden)
• Builds on Marglin-Hymer
• Focuses on labour markets. He suggests that a
reason for MNCs is their ability to divide labour
(unions) in country specific groups => Reduce
their bargaining power => increase their profits.
 66
Supply-side theories:
Resource-based
(Penrose, Teece, Kogut-Zander)

• MNCs are due to endogenous growth and

differential capabilities vis-à-vis market and other
firms.
• Growth can be national (diversification) or
geographical (MNC).
• MNCs are better in transferring internationally
tacit knowledge than markets.
 67

Demand-side theory (i)

• Cowling & Sugden, Pitelis: increased

concentration => increased profits => reduced
consumers expenditure (because a lower
proportion of profit is consumed than of wage
income).
• As consumption decreases so does effective
demand => going overseas for demand outlets.
 68

Demand-side theory (ii)

• The MNC as an All Weather Company

– Diversified national firms can ride the industry
life cycle (Hymer).
– MNCs can ride the national business cycle,
becoming All Weather Companies.
 69

Other factors – ‘theories’

• Oligopolistic rivalry
– Present in most theories (except transaction costs).
– Can motivate - shape firms’ payoff matrix => crucial context within
which decisions are taken.
– Specifically oligopolistic interaction theories (e.g., Graham), build
on Hymer and emphasize role of threats and counter-threats.
• Competition between states
– Nation states may promote their own MNCs to affect their
international competitiveness – could explain some LDC MNCs.
 70

Synthesis (i)

• Context: Oligopolistic interaction

– Endogenous growth (Penrose) => monopolistic
advantages (Hymer).
– MAs are an inducement to innovation and further
growth (Penrose); they can help firms outcompete
foreign rivals (Hymer).
– Domestic diversification due to pull factors, e.g.,
multiple use of resources (Penrose), or push factors,
e.g., the product life cycle (Hymer).
 71

Synthesis (ii)

• Geographical diversification also due to national-regional

business cycles (all weather company).
• Mode of expansion due to differential firm capabilities
(Penrose, Teece, Kogut & Zander), (dynamic) transaction
costs (Teece, Buckley & Casson) and overall control
advantages (Hymer).
• Locational factors explain the choice of location.
• No general theory possible, but a general framework
within which each case can be examined.
 72

MNCs impact on welfare

• Monopolistic advantage theory => possibility of reduced competition

due to MNCs => (Pareto) inefficiency 
• Internalization hypothesis => transaction reductions => efficiency.
• Eclectic view => advantages and disadvantages => ‘trade-off’.
• Divide and rule hypothesis => reduced workers welfare => (Pareto)
inefficiency.
• Resource-based => efficiency and inefficiency may co-exist
• Synthesis => coexistence of efficiency and power => ‘trade-off’.
 73
The MNC
and ‘Uneven Development’(Hymer)
• For Hymer (1972), the operations of MNCs tend
to globalize the tendency towards concentration;
generate an uneven development between the
centre (developed countries) and the periphery
(less developed countries); erode the power of
labour unions and the nation state, and tend to
shape the world to their image by creating
‘superior’ and ‘inferior’ countries. They are
responsible for the dependent industrialization of
the Newly Industrialized Countries.
 International Business Economics

Session 3
Strategy and Strategic Options of MNCs
Background 3 (pp 83-99, starts here)
Business Strategy
 76
Business Strategy (i)
• Firms’ evolution – strategies
– Horizontal integration (mergers and acquisitions)
– Vertical integration (backward and forward)
– Multidivisional (M-) form (business units under central control)
– Conglomeration (unrelated business activities)
– Foreign Direct Investment - multinational corporations (foreign
direct investment)
– Networks, alliances clusters, joint ventures, etc.
All such strategies involve future cash flows, thus require
‘capital budgeting’.
 77

Business Strategy (ii)

• Types of strategy
– Competitive: Strategy of Business Units
– Corporate: Strategy of firm as a whole
 78

Competitive Strategy
Porter: based on IO
• ‘Five forces’ model (rivalry of existing
competitors, potential entrants, power of
suppliers-buyers, substitute products).
Rule: select and/or create ‘attractive industries’
(with weak forces of competition)
• Three generic competitive strategies (cost
leadership, differentiation, focus).
Rule: do not get stuck in the middle.
Exhibit 3.1: M. Porter’s five forces
79

model

POTENTIAL
ENTRANTS

Threat of entry

Power of Power of
suppliers INDUSTRY buyers
SUPPLIERS COMPETITORS BUYERS
Rivalry among existing
firms

Threat of substitutes

SUBSTITUTES
Exhibit 3.2: M. Porter’s three generic
80

strategies
Competitive advantage

Lower cost Differentiation

Broad Cost leadership Differentiation

Competitive
scope N arrow Cost focus Differentiation
focus
 81
Competitive Strategy
Porter (cont’d)
• Value chains: firm’s primary and support activities
that generate value (margin)
– primary: firm infrastructure, human resource
management, technology development,
procurement
– support: inbound logistics, operations,
outbound logistics, marketing and sales,
service
Rule: align value chain to generic strategy
 82

Exhibit 3.3: M. Porter’s value chain

Firm infra-structure
Human resource management Margin
Technology development
Procurement

Inbound Operations Outbound Marketing Service

logistics logistics & Sales
Margin
 83

Corporate Strategy

• Portfolio models - Boston Consulting Group, etc.

• Porter
• Resources-capabilities
 84
Corporate Strategy: Portfolio models
- The Boston Consulting Group (i)
• Learning and experience gives rise to reduced unit costs
as volume increases
• Market share increases profitability
• Portfolio matrix: to classify business units as stars, cash
cows, question marks and dogs on the basis of industry
growth rates and business units’ relative market share
Rule: cash-in cash cows, to invest in stars and selected
question marks, stars-to-be. Liquidate dogs.
 85
Corporate Strategy: Portfolio models-
The Boston Consulting Group (ii)
• BCG matrix related to the industry product life
cycle (introduction-question marks, growth-stars,
maturity/saturation-cash cows, decline-dogs).
• Portfolio Models: Shell, General Electric
– same principle as BCG, different criteria and
classifications
 86

Exhibit 3.4: The experience curve

Unit
cost

0 Cumulative volume of output

 87
Exhibit 3.5: The BCG growth/share
business portfolio matrix
Relative market share position
High (above 1.0) Low (below 1.0)

Stars Question marks

High (or problem children)
(faster
than the
economy
as a whole)
Industry
growth
rate Cash cows Dogs
Low
(slower
than the
economy
as a whole)
 88

Exhibit 3.6: The life cycle model

Industry
sales Introduction Growth Maturity Decline

0 Time
 89
Exhibit 3.7: The product life cycle and
the Boston matrix
Product life-cycle Boston M atrix

Introduction Question marks

Growth Stars

M aturity / Saturation Cash cows

Decline Dogs
 90
Corporate strategy:
The approach of M. Porter
• Four types of corporate strategy
– portfolio management (as in BCG matrix)
– restructuring (restructure and sell-off)
– transfer of skills
– sharing activities
Rule: select sharing activities or, if not possible,
transfer of skills. Other two hard to implement
with success.
 91
Corporate Strategy:
The resources – capabilities
perspective (Penrose, Teece, etc.)
• Diversification strategies are the result of
availability of resources with potential for
common use by apparently unrelated activities.
• Conglomerate diversification results from problem
of appropriating rents from intangible assets
and/or differential capabilities in transferring
knowledge.

• [End of Background 3]
 92

Strategy of MNCs (i)

• For Michael Porter industries are

– multidomestic (nationally responsive),
requiring locally focused strategy
– global (linked, integrated), requiring integrated
strategy
 93

Strategy of MNCs (ii)

• For Bartlett and Ghoshal: four basic strategies

emerge on the basis of cost pressures – local
responsiveness matrix:
– international (low, low)
– multidomestic (low, high)
– global (high, low)
– transnational (high, high)
 94

Exhibit 3.2: Bartlett and Ghoshal’s Options for MNCs

High Global Transnational

Cost
Pressures

Low International Multidomestic

Low High
Local
Responsiveness
Exhibit 3.9: A summary of theory and95
strategy
IO-Porter Transaction costs Resource-based
(TC)
Horizontal reduce rivalry reduce TC acquire (managerial)
integration resources
Vertical barrier to entry reduce TC differential ability for in-
integration house production
M-form facilitate unrelated internalize external facilitate unrelated
diversification capital market diversification (Chandler)
(Chandler) failures
Conglomerate reduce dependence high TC due to asset exploit common resource
diversification on product life cycle specificity- base, solve intangible
(Hymer) opportunism assets appropriability
problems
Foreign Direct exploit ownership high TC due to asset solve intangible assets
Investment advantages (Hymer) specificity- appropriability problems,
opportunism differential capabilities
Networks facilitate market optimal use of Derive knowledge-related
power market and benefits of co-opetition
hierarchy
 96
Application: A simple decision framework
Transport costs and tariffs Low Export

High

Suitability of know-how for No Horizontal FDI

licensing
Yes

Foreign operation requires

Yes Horizontal FDI
tight control

No

Know-how can be protected by

No Horizontal FDI
licensing contract

Yes

Licence Based on C. Hill (2003)

International Business Economics

Session 4
MNCs, Government Policy and
(Inter)national Competitiveness
 98

Competitiveness: definition

• Differential productivity, value-added – wealth

creation, relative to other economic units (firms,
regions, nations…)
• Can be achieved through
– Business policies
– Government (competition, industrial and
competitiveness) policies
 99

Competition and Industrial Policy

• Early competition-industrial policies in West

derive from IO theory, in particular the issue of
the welfare effects of monopoly (power). This
includes analysis of
i) Static effects (monopoly and reduced consumer
welfare, due to high prices);
ii) Dynamic effects (e.g., monopoly and innovation).
 100
Monopoly & international
competitiveness (i)
• Main claim that large firms can exploit economies of scale and scope,
therefore can compete with large firms from other countries.
• Idea particularly prevalent is 1960s and 1970s in Europe, in part as
response to the ‘American Challenge’, e.g., Servan-Schreiber’s
claim that US multinational corporations dominate technologically
European markets.
• If large size increases competitiveness (thus export surpluses) these
could offset any static losses.
• The international competitiveness idea is in part responsible for the
permissive (and even encouraging) attitude of European countries to
mergers and large size.
 101
Monopoly & international
competitiveness (ii)
• Counter arguments are:
– i) higher X-inefficiency
– ii) may suppress major inventions if they result in
major re-equipment
– iii) inflexibility
• Schumpeter’s ‘Differential Innovations
Hypothesis’, that large firms are large because
they have been more successful innovators to
start with.
 102

Monopoly and Welfare

Conclude
• An open question whether the dynamic gains
offset the static losses. Evidence inconclusive.
• Focus on efficient resource allocation limited.
Concentrate on resource creation?
 103
Practice
– The Western approach
Theoretical Basis
i) ‘Competition policy’ to correct market failure due
to monopoly (power) and its abuse: e.g., Treaty
of Rome, US Anti-Trust policies
ii) Trade through (static) comparative advantage,
lenient or encouraging attitude to multinational
corporations (MNCs)
 104
Practice
– The Western approach (EU) (i)
But in 1960s
• ‘Recognition’ in Europe of the ‘international
competitiveness’ advantages of ‘large size’
(American challenge thesis)
• Relatedly,
– ‘National Champions Policy’ (e.g., UK, France, Italy)
– Nationalizations of ‘strategic’ sectors
1970s
• ‘Lame Ducks’ policies
 105
Practice
– The Western approach (EU) (ii)
1980s
• Return to the market (privatisations etc) and
focus on ‘Government Failure’.
1990s
• Entrepreneurship and small firms
• Horizontal measures, technology and education,
tangible and intangible infrastructure, efficiency of
public sector.
 106
Practice
– The Western approach (USA)
• Hidden industrial policy in the form of defence
policy?
• revival of 1990s; clusters?

Conclude
• ‘Grant Theory’ but no industrial strategy
including adhocity, discontinuity, undue focus on
(dis)advantages of size and static comparative
advantage-based (free) trade.
 107
Practice
– The Far Eastern approach (Japan)
Basis: Industrial Strategy by Ministry of Trade & Industry
(MITI) involving:
i) Dynamic comparative advantage (created comparative
advantage).
ii) Managed trade, with initial focus on internal competition.
iii) Management of competition (the ‘Golden Mean’) and co-
operation.
iv) Dynamic competition through innovativeness, as in
Schumpeter - Hayek.
 Practice – The Four Tigers 108

(Singapore, Taiwan, South Korea, Hong Kong)

(i)
Basis: Similar to Japan, adaptive industrial
strategy involving
i) Import substitution.
ii) Export promotion based on labour intensive
manufacturing.
iii) Promotion of high technology/high value added
sectors.
iv) Attraction of FDI (Singapore, Taiwan), technology
transfer.
 109
Practice – The Four Tigers
(Singapore, Taiwan, South Korea, Hong
Kong) (ii)

• Relative success of ‘Far East’

– Result of multitude of complex factors which include
culture, high saving, effective public administration,
close relation between industry and finance,
consensus, new (strategic) management techniques,
etc.
• Question: Can we exclude role of industrial
strategy? Is it unrelated to the other factors?
 110

New theories

1. ‘New Trade Theory’

2. ‘New Competition’
3. New location economics
4. New (‘Endogenous’) Growth Theory
5. MNCs, deindustrialisdation and ‘Competitive
Bidding’
 111

1. New trade theory (i)

• Traditional focus of Western industrial policy, the welfare

effects of monopoly and the theory of (static)
comparative advantage. According to this countries
should specialize and trade in products in which they
enjoy a comparative advantage. Benefits from trade arise
when each country pursues such a strategy.
• Presence of monopolistic competition, economies of
scale, positive externalities and first mover advantages
led to conclusion that focus on high return industries can
affect the distribution of benefits (and even lead to losses,
Krugman) – Strategic Trade.
 112

1. New trade theory (ii)

• This led to concept of dynamic comparative

advantage; i.e., attempts by countries to create
(not accept the existing) comparative
advantages.
• Best known case of dynamic comparative
advantage policy is Japan.
 113

2. The New Competition (i)

• Based on observation of successful industrial districts, in North Italy,

Germany, USA, Cambridge UK, etc.
• Such districts consist of small and medium sized, highly innovative,
customer oriented firms, with a hands-on approach to management,
which cooperate on issues of infrastructure, technology etc and
compete in the market for customers. Often rely on support by
state/local authorities, are based more on trust than hierarchical
relations, try to ‘exploit’ the dispersed knowledge of their labour,
suppliers etc and use new production methods such as Just-in-Time,
etc.
 114

2. The New Competition (ii)

• Success of industrial districts questions benefits

of large size and provides a different (“Post-
Fordist”) model of industrial development.
However, such methods are also adopted by
major, particularly Japanese, MNCs, through e.g.,
subcontracting.
 115
3. New Location Economics
(Krugman, Porter)
• Importance of location in generating external
economies, reducing transaction costs through
trust, and further innovation.
 116
4. New Endogenous Growth Theory
(Lucas, Romer)
• Importance of human resources and
technological change in effecting (‘endogenous’)
macroeconomic growth.
 117
5. MNCs, Deindustrialization and
Competitive Bidding
• Link between multinational corporations and
deindustrialization questions link between large size and
international competitiveness
• Main idea is that countries like the UK which suffer from
deindustrialization tendencies are home bases of privately
successful MNCs. This questions the benefits of large
size for the case of MNCs home base.
• In era of multinational corporations ‘name of the game’
that of ‘competitive bidding’, i.e., attempt by governments
to attract investments by home and foreign firms (MNCs).
 118

Theory and Practice

• Question: New approaches support/explain ‘Far

Eastern’ miracle?
• ‘New Industrial Strategy for Democracy’ (Cowling
& Sugden)
– MNCs give rise to multinationalism, centipetalism and
short termism. Needed is a shift of power to
communities and regions, e.g., through appropriate
‘flexible specialization’ policies.
 119

Preliminary Conclusion

• Possibility for Machiavellian scenario i.e.,

adaptive industrial strategy (in partnership with
corporate sector) including
i) dynamic comparative advantage
ii) managed competition and co-operation
iii) managed trade
iv) playing the ‘competitive bidding game’ and/or
v) tackling the challenge of MNCs
vi) considering alternative forms of competitiveness, like
‘flexible specialization’
 120

Developing countries

• Some common features: small internal size of

market, lack of large ‘national’ MNC’s (over-)
reliance on small family run businesses, and
foreign MNCs, relatively underdeveloped
industry.
• Possible Strategy:
i) follow the ‘four tigers’ and
ii) consider ‘appropriate’ focus on small and medium
sized enterprise, flexible specialization, clustering.
• Main issue: selection, suitability, transferability
and feasibility of policies.
 121

The Importance of Institutions (i)

• Main problem of implementation, ‘government failure’.

Although a general problem, often more acute in
developing countries. Indeed underdevelopment may be
the effect of inefficient property rights, and incentive
mechanisms? (North)
• Culture, consensus, other institutional constraints.
• Need for promoting an institutional framework conducive
to development. This includes addressing the problem of
‘capture’ of the state by MNCs.
 122

The Importance of Institutions (ii)

• Government can be enabling (reduce private sector

transaction and production costs) to increase output. It
can also be developmental, i.e., try to improve the
revenue side.
• Analysis of the state suggests that problem of ‘capture’
reduced through pluralism of institutional forms (large
and small firms) and competition in the political
market.
• ‘Capture’ effects support a competitiveness strategy
favouring smaller firms (potential competition to
established giants).
 123

Conclusions (i)

• Possible and necessary to devise a

competitiveness strategy which learns from
economic theory and international practice and
addresses the issue of implementation (e.g.,
institutions and ‘capture’ of the ‘state’) and for the
EU its declared needs to promote Competition
and Convergence
 124

Conclusions (ii)

• Developing countries should consider their

policies in the above framework, striving for an
emphasis on dynamic competition, value
creation and supply-side convergence.
Internally they should address the issue of the
institutional constraints.
• Identification and development of distinct
capabilities and competencies of a nation and
governments important condition for effective,
implementable strategy.
 125

‘Anti-trust’ today: some problems

• Potential problems with current policies

i) Downplay lessons from the ‘Far East’ and the ‘new approaches’.
ii) Do not address the problem of MNCs (as a potential threat to
competition).
iii) Ignore distribution issues, intra-EU and between EU and ‘The
South’, which undermines sustainability.
iv) Fail to provide supply-side incentives for convergence.
v) Fail to distinguish between policies that re-distribute resources
and policies that generate resources.
• Need to move from competition to competitiveness policies
 126

From competition to competitiveness

policies: models of competitiveness
• Neoclassical model
– Competitive markets
– Free trade
• ‘Japanese’
• Porter’s ‘Diamond’
• Productivity-Competitiveness Wheel
 Exhibit 4.1: Competitiveness – the127
neoclassical model
P

Pm
A common
expository
diagrammatic
framework for PL
neo-classical
LAC1 = LMC1
Austrian and PC
Marxist E
approaches to LAC2 = LMC2
QS Q
industrial
organization.
D

0
Q Qm QL QC Q

MR
Q , minimum efficient scale; QS, strategic capacity output,
p, monopolist’s disincentive to invent; E, efficiency
gains; Pm monopoly price; PL limit price; PC perfect
competition price
 128

Competitiveness (i)

• The ‘Japanese’ approach ?

– High knowledge intensive sectors
 129
Exhibit 4.2: Knowledge-intensive industries
(computers, instruments, heavy machinery)

Competitivenes 100%

s – the West Germany (1974)

Japanese Japan (1985)

approach?
Japan (1974)

100% 100%
Medium capital-and labour-
intensive industries (light Medium capital- and raw-
machinery, motor cars) material-intensive industries
(Steel, plastics, fibers)

Japan (1959)

100%

Source: Best (1990) Unskilled-labour-intensive industries

 130

Competitiveness (ii)

• Porter’s ‘diamond’
– Factor and demand conditions, clusters
 Exhibit 4.3: The determinants of 131

national competitive advantage

(Porter’s ‘Diamond’)
STRATEGY
STRUCTURE
AND RIVALRY

FACTOR DEMAND
CONDITIONS CONDITIONS

RELATED AND
SUPPORTING
INDUSTRIES
 132

Problems with existing models

• Absence of commonly agreed upon conceptual

framework.
• Absence of links between competitiveness at the
firm-regional and national levels.
• Insufficient analysis of determinants of
productivity and competitiveness.
• Insufficient treatment of the issue of
sustainability.
 Sustainable Competitiveness and 133
Development: a conceptual
framework
• The Productivity-Competitiveness Model
– Competitiveness <=> Productivity - Value Creation
• Determinants of Productivity - Value
– Firm level
• infrastructure
• human resources
• technology and innovation
• unit costs economies
– Regional and National levels: As above plus
• Industry structure - conduct and regional - locational milieu
• macroeconomic environment - policy mix
• institutional environment - governance mix
“The Productivity - Competitiveness134-
Wheel” for Firms, Regions and
Nations Institutional context -
Governance mix

Macroeconomic environment -
Policy mix - Effective demand

Industry conduct - structure and

regional-locational milieu

Infrastructure

Unit Cost Productivity-Value- Human

Economies Wealth Resources

Technology &
Innovativeness
 135
Main routes to competitiveness

• Firm size & FDI by MNCs

• Clusters of Small and Medium-Sized Enterprises
(SMEs)
 136

What are Clusters?

• (Geographical) agglomerations of firms (and

other organizations-institutions) linked
horizontally (and/or vertically) intra- (and/or inter-)
sectorally, in a facilitatory socio-institutional and
cultural milieu, which compete & co-operate (co-
opete) in (inter)national markets.
 137

Clusters and the Wheel

• Clusters =>
– innovation
– reduced unit cost economies (economies of
scale, scope, transaction costs, learning,
external, diversity, etc.)
– better human resources
– strong regional infrastructure
– more facilitatory institutional context (through
co-opetition, etc.)
 138

Despite problems,
clusters are important
• Clusters improve innovation, productivity &
competitiveness at the regional & national levels,
they create employment and can lead to
convergence.
• Clusters are more bottom-up, thus help deepen
democracy.
• Problems include identifying nature, boundaries,
strategies for sustained successful performance.
 139
Foreign Direct Investment
and Clusters
• Large firms and (through) foreign direct investment
(FDI) can improve determinants of productivity,
yet:
– Hard for developing countries to attract FDI
– Risk of FDI flight, given options, and flexibility of
operations
• Clusters have advantage over large firms and FDI
because of local base and co-opetitive nature.
• Clusters attract FDI and embed it in localities.
 140
Three agents of productivity, value
and wealth creation
Large Institutional context - SMEs,
Governance mix
firms, Clusters
FDI Macroeconomic environment -
Policy mix - Effective demand

Industry conduct – structure and

regional-locational milieu

(Infra)structure
& Strategy

Productivity-Value- Human
Unit Cost
Economies Wealth Resources

Technology &
Innovativeness

Government
 141
Cluster Creation
versus Cluster Development
• Clusters are mainly the result of history, and
(thus) are hard to create ‘top-down’.
• However, theory and international experience
suggest that cluster development can be
facilitated
– Clusters can be upgraded at the individual, regional or
national levels.
– This presupposes cluster identification, (diagnosis),
audit, upgrading, control-evaluation, re-diagnosis…
 142
Strategy for Sustainable
Competitiveness
• According to the Productivity-Competitiveness model all
the following measures can improve productivity and
competitiveness
– horizontal measures (soft and hard infrastructure)
– inter- and intra-firm sectoral restructuring for innovative ‘value
for money’ products and services
– clusters of SMEs
• ‘Regions of Excellence’ (‘mega-clusters’) can encapsulate
all three aspects, thus serve as Strategy for Productivity
and Competitiveness.
 143

Prerequisites and Mechanisms

• Sustainability requires
– macro-policy - supply-side compatible
– institutional framework – remove
(anti)incentives
– competition policy co-opetition for
innovativeness
– environment
– distribution of income
 144

Conclusions

• Possible and desirable to identify and develop

(mega) clusters, for productivity,
competitiveness, regional development,
convergence and deepening of democracy.
• The state can be a catalyst and facilitator.
• Method and tools developed can help in this
direction.
 International Business
Economics

Overall Conclusion and the

Future of MNCs
 146

Conclusions

• Value creation, through

– firm productivity and competitiveness
– government enabling policies, national productivity and
competitiveness
• Under conditions, MNCs and FDI, SME clusters
and government policy can help achieve this
objective
 147

The Future

• The MNC, like ‘competition’ and co-operation

itself, is both ‘god and devil’.
• MNCs will be a great force of economic growth,
yet a threat to diversity, equity and democracy.
• Policy and polity should aim at identifying routes
that deliver the goods at least cost – this can
include painful ‘trade-offs’.