THE GROWTH OF MULTINATIONAL FIRMSVirginie Baron, Stefan Hinterberger

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Introduction control manufacturing establishments in at

least two national jurisdictions home or donor economy – host economy three main parts

general trends in direct foreign investment (DFI), branch plants, recognizing alternative ways

competitive or entry advantage to overcome problems of doing business in unfamiliar environments

how foreign firms behave in host countries following entry, DFI, equity investment

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Historical Background (1) traced back 17th century

ownership profit receiving risk taking decision making innovationconcentrated among a few individuals

beginning of the Industrial Revolution limited by the small scale nature of production customized or local nature of technology financing problems owner-management difficulties of transportation and communication

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Historical Background (2) technological and institutional innovations

facilitated the growth of international organizations increasing number of industries scale of production transportation networks communication systems

innovation of limited liability and the public corporation

separation of ownership from control organization and the managerial division of labor

became a factor of production

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Changes in the last 100 years branch plants created by

relocation of skilled workers and managers operated in a largely autonomous manner limited communication and integration with their parents

since 1950, branch plants closely integrated within the overall parent company strategy

centralization of policy making

integration of facilities across national boundaries

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Internationalization Internationalization defined as "the process of

increasing involvement in international operations” exporting selling licenses strategic alliances DFI procuring foreign sources of raw materials and other

inputs alternatives substitute for one another,

complement each other (significant between trade and DFI)

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Exports (1) first internationalization

exporting export wholesaler export association foreign based sales agent

little or not direct contact with the foreign market limited understandings of foreign market

dynamics such as arise from changes in taste and new competition

establishment of direct contacts in foreign markets and more control of sales channels

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Exports (2) difficult process, contact with distant and

unknown customers financing and insurance complete the necessary protocols and documentation arrange for transportation and distribution absorb the risks of costs incurred prior to payment

firms grow in size, markets must be enlarged exporting and DFI are alternatives, often

complementary exports prepare the way for DFI, establishing

business contacts, sources of information, better understanding of foreign markets

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UK, medium size and large tools and steel firms

substantial exports, as measured by the export-sales ratio

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Direct foreign investment (1) places the firm already has export or sourcing

connections secure inputs, designed to institutionalize

established trade links or create new ones complex learning and bargaining processes,

comprising long run strategic decisions DFI types

owned and controlled subsidiaries and branch plants share ownership and control with local firms,

governments, other international firms (joint ventures)

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Direct foreign investment (2) international firms grown massively

throughout the 20th century, by 1914 accumulated DFI was already substantial

comparing the major sources or host economies of DFI in 1914 with 1988 origins of DFI in 1988 remained highly

concentrated among leading industrialized countries, if slightly less in 1914

among leading industrialized countries, origins of DFI remained concentrated in 1988 but notably less than in 1914

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DFI by countries of origin 1914 - US, UK, France and Germany,

87% of DFI 1988 - US, UK, Germany and Japan,

65.6% of DFI

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DFI by countries of destination more diverse and developing countries

are important (20% of DFI) majority among already industrialized

countries

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Reasons for DFI

scale access to markets primary manufacturing sectors, access

to resources access cheap, pliable labor country's vast market potential (China,

India) historically firm based in OECD countries

most important foreign investors in recent decades

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a theory of locational entry firms internationalize their operations to

exploit some internally generated entry or competitive advantages e.g. marketing, production or technological know-how

entry advantages are of sufficient strength to overcome various spatial 'barriers to entry,' defined ultimately by the problems of competing with local firms in foreign markets

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a theory of locational entry

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oligopolistic advantage/ advantages for geographical inquiry

general framework to understand the internationalization of individual firms, learning or bargaining process

no a priori assumptions about the contributions of the international firm to local development, efficient resource allocators or as exploiters reinforcing local dependency

industrial location studies, behavioral and institutional perspective, greater significance than is commonly supposed

explicitly incorporates alternative forms of internationalization, notably the export behavior of firms

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Spatial entry barriers entry or competitive advantage vis-à-vis potential local

competitors, compensate for various spatial ‘barriers to entry’ local entrepreneurs – no communication problems across national

boundaries, less costs for information pertaining to local legal, cultural, political, economic and physical conditions

spatial entry barriers are defined for  behaviouralists by the costs, time and uncertainties involved in

attempts to reduce the ‘knowledge gap’ in making locational choices institutionalists by the costs, time and uncertainties in negotiating

locational choices practice, both information search and bargaining processes are closely

intertwined, e.g. managerial costs and the price of consultant studies knowledge gaps cannot be defined precisely, behaviour of others

cannot be controlled, locational search and bargaining processes are uncertain

a priori assessment of spatial entry barriers is necessarily judgmental, barriers should not be underestimated

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Psychological distance (1) 'psychological distance' defined as 'the sum of factors preventing the

flow of information from and to the market, e.g. differences in language, education, business practices, culture and industrial development

different kinds of cultural, institutional and economic environments, differences have physical, social, political and economic foundations which are reinforced by varying degrees of geographic separation

distance 19th century – geographic distance recent decades – distances created by different languages and business

culture corporate preferences for investment in nearby similar environments

are not only ‘conservative’ but economically rational corporate support, free trade, common market agreements,

metrification and related measures – facilitating movement and reducing regional differences

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Psychological distance (2) significant differences in language, culture and business

philosophy widen the psychological distance, e.g. Chinese and Japanese economies formidable entry barriers

Japan – reverse engineering, indigenous enterprise, restricted opportunities for foreign firms, policy restrictions on DFI, distinctive culture, language and market preferences, most foreign firms face significant learning and bargaining costs, high tariff and non-tariff barriers, deeply embedded inter-firm relations and complex distribution systems controlled by powerful enterprise groups (keiretsu) and giant trading companies (sogo shosha)

China, welcomed DFI since late 1970s, western firms find the political, social and economic system, ways business transactions are conducted extremely difficult

Singapore government established an agency to help western firms and Chinese authorities negotiate with each other

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Method of entry firms vary in competence and willingness to substitute a higher (lower)

degree of uncertainty for lower (higher) costs of collecting information on new environments

spatial entry barriers facing firms vary wholly owned new site, branch plants joint venture with local firms acquisitions of existing firms

acquisition – fewer uncertainties compared to building new plant, foreign firms inherit both existing locations (accumulated capital resources) and existing management and workers (accumulated human resources)

‘instant’ and possibly cheap way of understanding local conditions especially if local owners of capital underestimate the importance of such geographical knowledge

local ‘know-how’ may well be underestimated, reinforced by fears among management and workers over job security

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Host government policy governments vary in their openness to DFI Canada, Australia, UK, US favored relatively liberal ‘wide open’ door

policies to DFI Sweden, South Korea, Japan limited the possibilities for DFI change, most significant China, former USSR its satellite east

European countries restricted DFI, allowing DFI, offering monetary incentives, other

forms of inducements, regional and local governments actively seek incentives, tax breaks, cash grants, low resource royalties, favorable

profit repatriation schemes, attractive investment depreciation allowances, range of services including provision of low cost buildings, free information on the local economy

influenced by political stability – for international business rules and regulations affecting business will not change in unanticipated ways

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Size of firm barriers are greater for small compared to large firms international investment involves relatively high and fixed

planning costs, high level of uncertainty large firms are powerful because they are big economies of size, bargaining advantages, ability to

locate somewhere else, under-utilized managerial resources

large corporations dominant in domestic markets, enjoy broader spatial planning horizons, draw on past experience in adapting organizational structures to growth

DFI dominated by large firms, size of branch plants tends to be much larger than industry averages

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Spatial entry advantages Strategic motivations to international

expansion: Profitability and efficiency Control of markets & resources

Entry competitive advantages depend on the kind of integration (horizontal or vertical) of the firm

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Horizontal integration When a firm expands in its existing line of

business or a closely related one The firm has its own internally developed

expertise related to technique production organization marketing financing human skills

Associated entry advantages: less fixed (initial development) costs and distinctive assets hard to be imitated by local entrepreneurs.

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Vertical integration (1) Investing in facilities which provide a

market for existing products or supply inputs to existing activities

Associated entry advantages: supplanting the market mechanism (less cost and more control over linked stages in the production process in terms of timing, quantity, quality of flows of goods)

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Vertical integration (2)Why vertical integration: Efficiency reasons: reducing the

transaction costs of utilizing markets (searching information about markets and supplies, negotiating contracts, costs of potential failures by independent subcontractor firms)

Reduce uncertainty in supply and marketing chains, greater stability & security of operation

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The American model US-based multinational firms were a

model form of corporations in the 1950s-1960s

Core assets: technology (product cycle model) marketing (market linkage model)

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First asset: technology (1) Causes:

large pools of scientists, engineers, skilled labour

huge & rich domestic market Consequences: according to the product

cycle model, shift to mass production, implying the need for unskilled labour and internationalization

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First asset: technology (2) The product cycle model

A firm exports to a rich country When innovations make it possible, they

rely on mass production and relocate to “poor” countries

Donor economy

Rich hostexportsManufacturing

Stage 1

Donor economy

Poor country Rich host

Manufacturing

Stage 2

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Second asset: marketing (1) Market linkage model: the market

knowledge comes first and directs the R&D investments (so that innovations meet the consumer expectations)…

… which in turn lead to investments in marketing (distribution channels, advertising…) to influence consumer demands

Over time, increase in exports and marketing infrastructures (and the higher market power and information it implies) prepare the way for international investments

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Second asset: marketing (2) The market linkage model: DFI replaces

previously established exports (the “rich host” becomes a manufacturing place)

Donor economy

Rich hostexportsManufacturing

Stage 1

Donor economy

Rich host

Manufacturing

Stage 2

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The German & Japanese model German and Japanese firms become a

model in the 1980s-1990s Firms organized as learning systems Most important characteristics:

Continuing development of worker skills More effective integration of workers in the

operation of factories

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Different ways: Apprenticeship system (Germany) on-the-job training (Japan)

Same aims: Enhance productivity High-quality work

Even more American-Japanese joint-ventures

Development of worker skills

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Integration of workers Labour-management interaction

(involvement of workers in supervision, monitoring, design, promotion of polyvalent skills)

Aims: thin management ranks, improved quality & design, enhanced workers motivation and morale, ability to serve quality-conscious markets

Recent difficulties to meet the costs of high skilled workforce (increased competition)

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Exports: barriers and need for specific advantages are the same as for DFI

Tendency to export first to the psychology closest country

Licensing: complement / substitute for exports and DFI

Causes: products expensive to transport (export) or small firms not willing to establish a branch plant abroad

Cross-licensing arrangements: two firms serving distinct but related market niches selling licenses to each other

Exports & licensing

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Independent or parents companies: organizational structures follow strategy

Foreign-controlled subsidiaries: strategy follows structure

Characteristics determining the degree of influence in strategy of the subsidiary: autonomy (decision-making discretion) and mandate (functions)

Post-entry behaviour of foreign-controlled activities

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Decision-making autonomy of branch plants

Depends on: Nature of equity ownership (wholly owned

subsidiary / joint-venture) Size of the subsidiary Nationality of the parent company Distance between parent and subsidiaries Degree of product specialization Stability of product markets

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Importance of autonomy Too much autonomy: duplication,

contradictory decisions, threat on the integrity of the corporation

Not enough autonomy: dampening of initiative, discarding of local opportunities, failure to recognize key trends

Forms of control of the subsidiaries: Flows of information (reports) Creation of a corporate culture Investments, budget… subject to parents

company control Changes over time

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The obsolescing bargain Changing in the initial bargain negotiated

between a host-country government and a multinational corporation

Before the investment: the corporation would be favored (it has more information about the profitability of the investment and alternative locations)

Once the investment is established: the host country gains information & experience and more bargaining power

Renegotiation: higher taxes, hiring more locals, higher share of domestic ownership…

Still, corporations have a know-how and worldwide marketing connections which ensure them a certain power over host countries

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The accumulating bargain Spatial entry barriers become

obsolescent while access to the parent-company expertise & resources remains

Growth can even be supported by domestic sources of funds (subsidies, banks, shareholders)

DFI are usually extremely profitable

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Conclusion Enhanced mobility of capital But still new places to invest in (China,

Russia…) And still medium-sized firms investing

for the first time