MGX5181

International Business

Strategy

Week Two

The Multinational Corporation MNC

International trade theories and

their impact on the

internationalising organisation

2 2

Week 2 objectives

• Assess the role of the MNC in international

strategy

• Brief review of the impact of international trade

theories on the internationalising organisation.

The World’s Multinational’s

• Many have sales larger than their host nations GDP.

• According to one estimate, the 500 largest industrial corporations account for 80% of the world’s direct investment and ownership of foreign affiliates.

• Corporate Headquarters for the 500 largest industrial corporations are in 32 different nations.

• One third of world exports consist of goods flowing between different parts of same companies.

• Often created by mergers and acquisitions

Ownership

• Mostly owned by pension funds, banks or

insurance companies. Often run by

powerful people.

• Ownership becoming global as foreign

capital transfers to shares in local markets.

(e.g. foreign institutions own more of Aust

sharemarket than locals. Australian

institutions invest approx 20% of their

funds overseas).

Global 500 by Revenue Global Ranking

08 10 12

Company Revenue USD$Mil

3 2 1 Royal Dutch Shell 484,489

2 3 2 Exxon Mobil 452,926

1 1 3 Wal-Mart Stores 446,950

4 4 4 BP 386,463

5 5 Sinopec (China Oil) 375,214

6 6 China National Petroleum 352,338

7 7 State Grid (China Power) 259,142

6 10 8 Chevron (Oil) 245,621

10 12 9 ConocoPhillips (Oil) 237,272

5 8 10 Toyota 235,364

8 11 11 Total (Oil) 231,580

12 Volkswagen 221,551

Australian Companies in Global 500 (2012) Aust Rank

08 10 12

Company Global

Rank

10 12

Revenue

USD Mil

Head

Office

1 1 1 BHP Billiton 159 108 71,739 Melb

4 2 2 Wesfarmers (Coles) 183 171 54,147 Perth

3 3 3 Woolworths 184 175 53,559 Sydney

5 4 4 CBA (Bank) 249 227 44,306 Sydney

7 5 5 Westpac (Bank) 254 229 44,112 Sydney

2 6 6 National Aust Bank 266 254 40,521 Melb

6 7 7 ANZ (Bank) 338 291 36,731 Melb

8 8 8 Telstra 441 438 24,968 Melb

9 Caltex Australia 486 22,810 Sydney

Global 500 Most Profit Global Ranking

2008 10 12

Company Profit 2012 USD$Mil

5 2 1 Gazprom (Russia , Energy) 44,459

1 3 2 Exxon Mobil 41,060

4 3 ICBC – Industrial & Commercial

Bank of China

32,214

2 5 4 Royal Dutch Shell 30,918

7 9 5 Chevron 26,895

6 6 China Construction Bank 26,180

7 Apple 25,922

8 BP 25,700

9 BHP Billiton 23,648

10 10 Microsoft 23,150

11 Vale (Brazil, Mining) 22,885

8 11 12 Petronas 21915

National Composition of the Largest MNCs Country Of top 260

(1973)

Of top 500

(2008)

Of top 500

(2010)

Of Top 500

(2012)

USA 126 (48.5%) 153 (30.6%) 133 132

Japan 9 (3.5%) 64 (12.8%) 68 68

Britain 49 (18.8%) 34 (6.8%) 30 27

France 19 (7.3%) 39 (7.8%) 35 32

Germany 21 (8.1%) 37 (7.4%) 34 32

China 11 (2003) 29 (5.8%) 61 73

Canada 4 (1.5%) 14 (2.8%) 11 11

Switzerland 15 15

South Korea 15 (3%) 14 13

Netherlands 13 (2.6%) 13 13

Australia 8 (1.6%) 8 9

Malaysia 1 1

Features of MNC’s

• Annual Revenue

Typically sales in hundreds of millions of

dollars. Around 2000 MNC’s have annual sales

over US$1 billion.

Many MNC’s have higher annual revenue than

the GNP of various countries. About half the

world’s 100 largest economies are companies.

• Character

MNCs are predominantly oligopolistic (operate

in markets where there are few sellers)

Features of MNC’s

• Affiliates

Most MNCs have a sizeable number of

affiliates. Top 500 own over 50% of worlds

productive assets.

• Areas of operation

MNC’s are the product of developed countries.

Almost 3/4 of the operations are in developed

market economies.

Features of MNC’s

• Structure & Control

By and large control is via complete or majority

ownership. Usually there is a common global

strategy.

Parent can control foreign affiliates via

resources eg: capital, technology, trademarks,

patents and manpower, plus long and short term

budgets.

Are there any really Global

Companies? • Research by Alan Rugman & Alain Verbeke

(2004):

Assessed world’s 500 largest companies. They found

they represent over 90% of all foreign direct investment

and about half of all world trade.

380 gave data on a regional basis. Found that 320 had

an average of 80.3% of sales in their home region.

Therefore concluded that most were really only

regionally based.

Found most only global at “back end” of value chain –

some connection in functional areas such as financial

capital, HR capital, R&D, knowledge or components to

serve home region clients.

Are there any really Global Cos?

• Rugman and Verbeck found there was really only nine global companies in their study: 1. IBM 2. Sony

3. Royal Philips Electronics

4. Nokia 5. Intel

6. Canon 7. Coca-Cola

8. Flextronics Intl

9. LVMH (Moet Hennessy Louis Vuitton)

• Common themes The application of scientific technical knowledge in the

marketplace (7)

Masters of using branding in consumer markets (2)

All offer products that appeal across cultural and national boundaries ie products people wanted, sheer availability or status allure

Multinational’s and Foreign

Direct Investment

• Multinationals achieve managerial control over their assets abroad through foreign direct investment (FDI).

• FDI is direct investment in business operations in a foreign country, including establishment of new operations as well as purchases of more than 10% of existing companies.

Foreign direct investment

• Basic types of affiliates:

A controlled affiliate is an enterprise in

which the investor has control of more

than 50% of the voting power.

A non-controlled affiliate is an enterprise

in which the investor has control of at

least 10% of the voting power and no

more than 50%.

• Source: OECD 2012

FDI by type

• M&As

• Non-resident purchase of existing equity (10% to 100%

of the voting power)

– Sub-category (above 50% of the voting power)

• Other types of FDI • Issuance of new equity

– Greenfield (New) investment

– Extension of capital

• Financial Restructuring

• Source OECD 2012

FDI Inflows 2003-2012 OECD 2013

Multinational’s and Foreign

Direct Investment

• Motivation for FDI is diverse:

Marketing factors

Barriers to trade

Cost factors

Investment climate

Major Determinants of Direct F.D.I. Marketing Factors:

• Size of market

• Market growth

• Desire to maintain share of market

• Desire to advance exports of parent company

• Need to maintain close customer contact

• Dissatisfaction with existing market

arrangements

• Export base

• Desire to follow customers

• Desire to follow competition

Barriers to Trade:

• Government erected barriers to trade

• Preference of local customers for local products

General:

• Expected higher profits

• Other

Major Determinants of Direct F.D.I. Cost Factors:

• Desire to be near source of supply

• Availability of labour

• Availability of raw materials

• Availability of capital/technology

• Lower labour costs

• Lower other production costs

• Lower transport costs

• Financial (and other) inducements by government

• More favourable cost levels

Investment Climate:

• General attitude toward foreign investment

• Political stability

• Limitation on ownership

• Currency exchange regulations

• Stability of foreign exchange

• Tax structure

• Familiarity with country

MNCs and the

Host Country • Positive Impact:

Capital Formation

Technology Transfer

Regional & Sectoral Development

Internal Competition & Entrepreneurship

Favourable Effect on Balance of Payments

Increased Employment

MNCs and the Host Country • Negative Impact

Industrial dominance

Exploitation of raw materials and cheap labour

Bribery and corruption

Interference in political matters

Technological dependence

Disturbance of economic plans

Cultural change

Interference by home government through

MNC

Degree of government control may be less than

intended

MNCs

The Home Country Perspective

• Improves Gross Domestic Product via

repatriation of profits, royalties & fees.

• Increases export opportunities.

• Political advantages.

• Job losses.

• Net effect on imports & exports.

• Creating competitors.

Allegations Against MNC’s

• In transferring technology to less developed

countries, prices are set too stringently.

• If a country attempts regulation, MNC’s merely

divest and move where regulations are less

stringent.

• The centralisation and control of key functions of

MNC’s in their home countries perpetuate a

neocolonial dependence of less-developed

countries.

Allegations Against MNC’s

• Sensitive country information is

disseminated internationally by MNC’s

global intelligence networks.

• MNC’s introduce superfluous products that

do not contribute to social needs and

perpetuate class distinctions.

• National labour interests are undermined

because of global activities of MNCs.

Allegations Against MNC’s

• MNC’s avoid paying taxes. Through

artificial transfer pricing, MNC’s undermine

attempts by Governments to manage their

economic affairs.

• The best jobs are given to citizens of the

nation in which the MNC’s have their

headquarters.

Allegations Against MNC’s

• Inappropriate technology is introduced by

MNC’s to less developed countries.

• National labour interests are underminded

because of the global activity of MNEs.

MNC

“Code of Conduct” • In the 1990s the United Nations set up a Code of

Conduct on Transnational Corporations in respect of their international dealings.

• Intended to create a stable business environment conducive to foreign direct investment and other company activities that stimulate economic development.

• UN Centre on Transnational Corporations closed down by USA pressure in 1998 as US MNCs complained about scrutiny.

• Replaced in 1999 by UN “Global Compact” which has no teeth as no penalties.

Global Compact

This is a voluntary initiative to promote good

corporate citizenship (according to UN)

UN request to world business.

Has 10 Principles:

Human Rights

• Principle 1: Support and respect the protection of

international human rights within their sphere of

influence

• Principle 2: Make sure their own corporations are

not complicit in human rights abuses

Global Compact Labour

• Principle 3: Freedom of association and the effective recognition of the right to collective bargaining;

• Principle 4: The elimination of all forms of forced and compulsory labour.;

• Principle 5: The effective abolition of child labour; and

• Principle 6: The elimination of discrimination in respect of employment and occupation.

Environment

• Principle 7: Support a precautionary approach to environmental challenges;

• Principle 8: Undertake initiatives to promote greater environmental responsibility; and

• Principle 9: Encourage the development and diffusion of environmentally friendly technologies.

Global Compact

Anti-Corruption

• Principle 10: Businesses should work against all

forms of corruption, including extortion and bribery.

Economic Theories For

International Trade

Traditional Trade Theories

and

Modern Trade Theories

Traditional Trade Theories

• Review your knowledge on the following

economic theories for international trade:

Mercantilism

Absolute Advantage – Adam Smith

Comparative Advantage – David Ricardo

Factor Proportions Theory – Heckscher &

Ohlin

Modern Trade Theories

• Country Similarity Theory

In 1961 Steffan Linder suggested that most

trade in manufactured goods is between

countries of similar per capita income.

ie consumers have a similarity of preference

when at the same stage of economic

development.

Global Horizons Theory

• As part of a firm’s growth, their

• geographical horizons change.

• Change is caused by:

• INTERNAL

Executives, Technology, Product, Raw Material

Supply

• EXTERNAL

Customer, Government

Product Life Cycle (Vernon, 1966) • Concept is related to product life cycle and concerns

the role of innovation in trade patterns.

• Phase 1: New Product., Domestic Market

• Phase 2: Export Mature Product., Other

Industrialised Countries

• Phase 3: Foreign Production

Export to Developing Countries

• Phase 4: Move Production to Developing

Countries

• Phase 5: Export of Product Back to Home

Country

New Trade Theory • Emerged in 1970’s (see Helpman and Krugman)

• Proposed key driver for internationalisation

was to obtain economies of scale

Increase in range of goods available to

consumers

Decrease average cost of goods

• Certain products may be dominated by

countries whose firms were first movers in

their production

Ownership Advantage

Theory S.Hymer, 1976

• Company must have a compensating advantage that offsets innate advantages of local firm

• Advantages are either firm specific or ownership specific

E.g.: Technology, Product Differentiation, Economies of Scale, Access to Capital Markets, Entry Restrictions.

Internationalisation Approach

Buckley and Casson,1976 • Seeks to explain why foreign direct investment is a more

effective way of exploiting resources and markets than

indirect methods like exporting or licensing.

• Emphasis is on extending direct operations. Company

needs a competitive advantage or a unique asset to

expand. Incentive depends on the relationship of:

Industry specific factors

• E.g.: Product, Industry Structure

Regional Specific

• Geographical, Social

Nation Specific

• Political & Fiscal

Firm Specific

• Management Ability

Global Strategic Rivalry theory

• In the 1980s economists such as Paul Krugman

and Kelvin Lancaster developed a new way of

looking at the growth of MNCs. According to these

theories firms struggle for a sustainable competitive

advantage to exploit to dominate the global

marketplace.

Global Strategic Rivalry theory

cont.

• Focus is on strategic decisions adopted as firms

compete globally. Sustainable competitive

advantage is achieved by:

owning intellectual property rights

investing in research and development

achieving economies of scale or scope

exploiting the experience curve

Porter’s National Competitive

Advantage theory (Porter’s diamond)

• In 1990 Michael Porter stated that success in

international trade came from the interaction of four

country and firm specific factors:

factor conditions

• land, labour, capital, education, infrastructure etc.

• International rivals will differ in the mix and cost of available factors

and the rate of factor creation.

demand conditions

• Competitors from other nations face differing segment structures to

home demand, differing buyer needs and differing levels of buyer

sophistication.

• Large sophisticated domestic consumer base often stimulates

innovative products.

• Understanding competitors home demand conditions helps you

predict their foreign strategies and product development.

Porter’s National Competitive Advantage

theory (Porter’s diamond) Cont Related and supporting industries

• Competitors based in other nations will differ in availability of

domestic suppliers, quality of interaction with suppliers, and presence

of related industries.

• being close to local suppliers leads to improved communication, cost-

savings, innovations transferable overseas.

Firm strategy, structure and rivalry

• the domestic environment shapes firms ability to compete

internationally. According to Porter you need vigorous competition,

and strong local investment in areas that provide sustainable

advantages e.g. R&D, quality control, brand imaging, employee

training).

Other diamond components

• Chance

• Government

44

Context for

firm strategy

and rivalry

Demand

conditions

Related and

supporting

industries

Factors

(input)

conditions

• A local context that

encourages appropriate

forms of investments and

sustained upgrading

• Vigorous competition

• Sophisticated and

demanding customers

• Customers needs that

anticipate those elsewhere

• Unusual demand in

specialized segments that

can be served globally

• A critical mass of

capable local suppliers

• Presence of clusters

• Factors inputs quality and cost:

- Natural resources

- Human resources

- capital

- Physical infrastructure

- Administrative infrastructure

- Information infrastructure

- Scientific and technological

infrastructure

Porter’s Country Diamond

Lasserre Fig 6.11, p.176

Porter’s National Competitive

Advantage theory (Porter’s diamond)

Cont

• Porter’s rules for innovation:

Sell to the most sophisticated and demanding

buyers and channels

• Stimulates fast improvement

• Sets valuable benchmarks

• Challenges ability to compete

Seek out the buyers with the most difficult needs

• Enhances ability to deal with pressure

• Encourages research and development

Porter’s National Competitive Advantage

theory (Porter’s diamond) Cont

Establish norms of exceeding the toughest regulatory hurdles or product standards

• Encourages early upgrading

Source from the most advanced and international home-based suppliers

• Deal with those with a competitive advantage and insights that may assist you

Treat employees as permanent

• Requires focus to improve productivity via training and rewards

Establish outstanding competitors as motivators

• Provide benchmarks to compare and exceed

Porter’s National Competitive Advantage

theory (Porter’s diamond) Cont

• Developing clusters

Use home nation clusters of buyers, suppliers and

related industries to gain competitive advantages.

Use home based suppliers and buyers as

international allies

• Regular senior management contact

• R&D interchanges

• Reciprocity in serving as test sites for new products and

services

• Cooperation in penetrating international markets

Internalisation Theory • Relies heavily on the concept of transaction

costs.

Transaction costs are the costs of entering into

a transaction such as negotiating, monitoring

and enforcing a contract.

The firm must decide whether it is better to

own its own factory overseas or contract others

to undertake the work e.g. license, franchise,

supply agreement.

When transaction costs are high it is better to

internalise production i.e. direct foreign

investment

Eclectic Theory • John Dunning (1988) combined location advantage,

ownership advantage and internalisation advantage

to form a unified theory of FDI.

• According to Dunning FDI will occur when 3

conditions are satisfied:

Location advantage

• Must be more profitable to operate in foreign market than

domestic

Ownership advantage

• Firm must have unique competitive advantage over local firms

e.g. technology, marketing or management capabilities)

Internalisation advantage

• Benefit of establishing own production facilities (control) must

outweigh using a local independent firm (licensing) to provide the

service