why do companies globalise_

BUS3035 Molly Anna Bennett 22nd January 2016 Word count: 2,114

1

Why do companies globalize? Discuss with reference to key theories in this area.

Introduction

This paper will critically discuss why companies choose to globalize by looking at four key theories in

particular, providing relevant examples to demonstrate this. There is no official definition of globalization,

however, there are three main ideas that share a common concept. The first is the economic phenomenon in

that a widely used globalization definition is ‘the increasing interaction, or integration, of national

economic systems through the growth in international trade, investment and capital flows’ (Talloo, 2007).

This is generally the idea that companies buy from one another overseas and set up subsidiaries away from

their home country. The sociological perspective focuses on the process of globalization in that there is a

‘rapid increase in cross-border social, cultural and technological exchange’ (Cohen, 2015) primarily

concerning the human and cultural element. A more conceptual approach is to look globalization as ‘time-

space distanciation’ where social systems are stretched across time and space and those two factors are less

important when communicating (Giddens, 1984). All three have an underlying foundation that time and

space are no longer obstacles in human interaction, partly due to the introduction of various technologies.

Critically discussing and analyzing why companies globalize, this paper will take a viewpoint from neo-

classical economic, market power, product life cycle, and eclectic theory.

Neo-classical economic theory:

Primarily concerned with profit maximization, neo-classical economic theory has three main underlying

principles regarding why companies globalize. These are to efficiently allocate resources to retrieve the

best return on investment, respond to consumer demand and not manipulate the markets themselves and

choose locations based on low production and labour costs.


2

According to Buckley and Casson (1976), a concept of foreign direct investment is ‘to choose locations for

their constituent activities that minimize the overall costs of their operations’. Dunning (1993) also follows

this and notes that there are three main primary motivations of FDI, one of which is efficiency, where

investors seek lower cost locations for operations, in particular the search for lower cost labour. In the

years 2002 to 2003, Dyson increased its profits from £18m to £40m. James Dyson puts this down to the

fact they moved their operations from the UK where wages were high, to Malaysia, where they were

significantly lower (The Guardian, 2003), proving that this can be a reason why companies globalize.

However, this ideology fails to acknowledge the fact that some countries are clearly more attractive to

investors than others. For example, China has often been described as ‘sucking away’ jobs from other

South Eastern economies such as Taiwan, Hong Kong and Korea. There is often a ‘race to the bottom’

where developing countries compete with one another to charge low labor costs and attract FDI in the first

place (Greider, 2001). Some countries in the South East specialise in different industries; China is often

known for its manufacturing sector, and India has a reputable status within the services sector. This idea

isn’t taken into account with neo-classical economic theory as the focus is solely on profit, not competitive

advantages that countries may have.

This theory identifies that instead of companies bulldozing into countries, they follow demand where

necessary and appropriate. India’s disposable income per person has increased recently; with a growing

middle class and wealth per person they are now able to afford more luxury goods and now demand these

types of products. In 2013, 30,000 units of luxury cars sold in India (Ahuja, 2014) with brands such as

Aston Martin and Bentley competing with one another, proving they have moved into countries to meet

this need; following neo-classical economic theory. The idea of FDI flowing from developed to developing

countries, where costs are low, can be undermined when referring to regionalization. Creation of the

European Union in 1993, and the North America Free Trade Agreement in 1994 proves that this is not the

case, and capital can move from developed to developed countries. Instead of countries operating


3

individually, the structure of the global economy is changing; states are collaborating and promoting trade

liberalization. Argued by some, these regions are seen to divert trade from low cost non-member countries

back to where costs are higher (Krugman, 1991).

Market power theory:

Hymer’s (1960) market power theory is one centered around imperfect competition in a market that not

everybody is operating at an equal level, as the local businesses have advantages in terms of culture,

language and legal system. Overseas companies also have the risk in terms of foreign exchange and trading

in different currencies. Companies globalize to offset these disadvantages using market power to make the

investment profitable. It is suggested that companies from Western countries often superior technology or

managerial expertise (Kindleberger, 1969) and globalizing meant they didn’t have to compete in their

domestic market and could fully exploit this. In addition, from a Marxist’s perspective, the market power

theory could be interpreted that once a company has saturated its domestic country, it then moves overseas

to exploit others.

There are many advantages that multinational and transnational companies would have over those in

developing countries. One of which, a vital element in order to obtain other advantageous aspects, is access

to capital. More developed countries, typically in the West, have a lot of methods to retrieve capital for

their business and take advantage of these. Atkinson et al. (2010) argues that we are at a time of increasing

number and complexity products on offer within the UK, meaning businesses are likely to find a facility

that matches their operations. Generally, finance in developed countries is much cheaper because of lower

interest rates attracting potential businesses to facilities in order to grow. Having a resource such as capital

allows a business to build on other advantages to enter a market such as branding and marketing strategy

and also utilising economies of scale. There are many benefits to being able to use and afford economies of

scale. One is that goods can be purchased in large volumes, reducing the cost per unit to either pass this

saving onto the customer and offer a lower price, or have a good profit margin. Even though purchasing


4

large amounts of products would mean spending some capital on a stock inventory, the company would be

able to replenish stock on a continual basis and meet customer demands. Capital can also be spent on

branding to increase recognition and hopefully establish loyalty.

Like the neo-classical economic theory, the market power concept demonstrates the flow of investment

from developed to developing countries; not from developed to developed, which as established, happens

on a regular basis because of regionalization. The market power theory ignores why some developing

countries are chosen over others. A major factor contributing to these decisions is market access and tariff

rates that are placed on products. Fugazza and Nicita (2013) addresses this as some market access

conditions have been affected by bilateral trading agreements where tariffs are lowered for trading partners,

below the most favoured nation’s rate. This means that FDI could be attracted to particular countries

because they are being given preferential market access.

Product life cycle theory:

Vernon (1966) has pioneered a chronological and linear theory that shows why and when companies

globalize in relation to the product life cycle. There are four main stages to this cycle, introduction, growth,

maturity and decline, the first two of which shows demand increasing, and the last two beginning to fall.

The concept in terms of globalization is that at the introductory stage, companies keep production of their

products close in the domestic countries. Generally, new products are mostly introduced in the developed

economies, and are then exported to developed economies, as the infrastructure is not complete to produce

on a mass scale. As demand increases through the growth stage the product life cycle begins to hit its peak

and enter maturity, where it levels and decreases into decline. Similar to the Marxist’s view of market

power theory, once this market has saturated, trade will then move into developing countries, as tariffs may

be lower. From 1995 to their accession to the WTO, China’s tariffs fell from over 40% to 10% in some

cases (Branstetter and Lardy, 2008), clearly a pull factor for companies looking to globalize.


5

The biggest flaw with this theory is that it does not apply to the globalization of service firms. Insurance,

consultancy, accountancy firms and more have all globalized and opened offshore operations to serve the

local market, which is to date the dominant form of service globalization (Borga, 2005). The dominant

model of service globalization also undermines neo-classical economic theory in that the primary reason

for moving overseas was not to reduce production and labor costs, but to extend operations.

This particular theory is too linear and prescriptive, suggesting that products take an evolutionary and

gradual journey through the product life cycle. There are many products that might not even reach the

growth stage of the cycle, or even enter the decline process such as commodity products. The elasticity of

oil means that as price fluctuates, demand doesn’t change, as it is a necessity for businesses across the

world. This product will never hit saturation, and never hit decline, unless it were to run out.

Eclectic theory:

First developed by John Dunning (1980), the eclectic theory synthesizes different concepts to take a

broader perspective as to why companies globalize. The three ideas he takes into account are the ownership

of assets, internalisation benefits and location benefits. The idea of the ownership of assets is that an

organisation may have developed a particular competitive advantage in the domestic market. For example,

the Ford production line was praised for its efficiency, eliminating waste along the production line (Bowen

and Youngdahl, 1998) and has now been developed and utilized across the world. If these companies

possess such competitive advantages, they should be able to use them overseas, whether that be, similar to

the market theory to balance markets, or to compete within the market.

It has been debated that the costs of FDI in the long term are less than maintaining a license with a third

party, and this is a reason as to why companies globalize. The assumption is that it is more beneficial to

produce internally than outsource. There are many risks when outsourcing services; some are jeopardising

knowledge of the product, quality offered and reputational risk if something unethical occurs (Kliem,

1999).


6

Closely related to neo-classical economic theory, and some aspects of market power, the third aspect of

eclectic theory is location benefits. If a company moves some of its operations abroad, and possesses an

efficiency motivation towards FDI (Dunning, 1993), then as proven with the case of Dyson, reduced

production and labor costs could prevail. This also touches on the market access aspect in that when

companies move operations they are able to trade with reduced levies. For example, Toyota and Nissan

moving their productions to the UK allowed them to then trade within the European Union.

The eclectic theory is clearly very useful and a fundamental tool for analysis taking into account neo-

classical economic, market power and product life cycle theory. However, like all the theories discussed,

its primary concern is regarding efficiency benefits in the form of economic sanction. Any political power

that companies may have over governments or sources of capital such as banks, mentioned briefly in

market power theory and the idea of preferential market access, are not addressed (Cantwell and Narula,

2003).

Conclusion:

To conclude, this paper has clearly demonstrated why companies globalize using four prominent

ideologies. There are several different definition of globalization depending on what viewpoint is taken,

whether that be an economic, social or structural perspective. Which ever used, the common foundation

through all is that time and space are no longer obstacles to human interaction, largely with the help of

technology. We can communicate, trade and move quicker as a society. It is assumed that neo-classical

economic theory is primarily concerned with economic benefit from globalizing. This occurs by companies

rationally making decisions to outsource some services to countries with a lower production and labor cost;

maximizing profit for the business. Market power theory conveys that imperfect competition occurs in

foreign markets because of advantages such as local knowledge and language skills. To offset these, FDI

occurs in the form of market power. Marxists often identify that the sole reason to globalize in this case is

that the domestic market has saturated, and now they are pursuing other countries. Product life cycle theory


7

takes a chronological viewpoint that products initially develop in the domestic country and this location of

production changes over the product life cycle. Production will often be moved overseas so the process

becomes simpler and more standardised, as a result, the unit cost drops dramatically. Eclectic theory a

much broader concept taking into account the ownership of assets, internalizing costs and location benefits.

It is important to acknowledge that every company globalizes for different reasons, it could be based on

one of these theories, or a mixture of all of them.


8

Reference list

- Ahuja, P., 2014. Luxury cars: A new definition of necessity in India. International Journal of

Commerce, Business and Management, 3(2), pp. 260-268.

- Atkinson, A., Collard, S., Kempson, E., and McKay, S., 2010. Levels of Financial Capability in the UK. Journal of Public Money and Management. 27(1), pp. 29-36.

- Borga, M., 2005. Trends in employment at US multinational companies: evidence from firm level data. Washington DC: Brookings Institution.

- Bowen, D. E. and Youngdahl, W. E., 1998. Lean service: in defence of a ‘production line’ approach.

International Journey of Service Industry Management. 9(3), pp. 207-225.

- Branstetter, L. and Lardy, N. H., 2008. China’s Great Economic Transformation. New York: Cambridge University Press.

- Buckley, P. J, Casson, M., 1976. The future of the multi-national enterprise, London: Macmillan.

- Cantwell, J. and Narula, R. 2003. International Business and the Eclectic Paradigm, Developing the

OLI Framework.

- Cohen, I. K., 2015. Economics for business: A guide to decision making in a complex global macroeconomy. London: Kogan Page Limited.

- Dunning, J. H., 1980. Towards an eclectic theory of international production: in defence of eclectic theory. Oxford Bulletin of Economics and Statistics. 41(4), pp.

- Dunning, J. H., 1993. Multi National Enterprises and the Global Economy. Wokingham: Addison-

Wesley.

- Fugazza, M. and Nicita, A., 2013. The direct and relative effects of preferential market access. Journal of International Economics. 89(2), pp. 357-368.

- Giddens, A., 1984. Constitution of society. California: University of California Press.

- Greider, W., 2001. A New Giant Sucking Sound. The Nation. [online] Available at: <

http://www.thenation.com/article/new-giant-sucking-sound/> [Accessed 5 January 2016].

- Hymer, S. H., 1976. The International Operation of National Firms: A study of foreign direct investment. Cambridge: MIT Press.

- Kindleberger, C. P., 1969. American Business Abroad. New Haven: Yale University Press.


9

- Kliem, R. L., 1999. Managing the risks of outsourcing agreements. Information Systems Management. 16(3), pp. 91-93.

- Krugman, P., 1991. Is Bilateralism bad? International Trade and Trade Policy. Cambridge: MIT Press.

- Talloo, T. J., 2007. Business Organisation and Management. New Delhi: Tata McGraw Hill Publishing

- The Guardian, 2003. Dyson profits from Malaysian move. [Online] Available at: <

http://www.theguardian.com/business/2003/nov/08/4> [Accessed 5 January 2016]

- Vernon, R., 1966. International Investment and International Trade in the Product Cycle. Quarterly Journal of Economics, 80(2), pp. 190-207.

why do companies globalise_

Documents