The Growth of Multinational Firms

1. The Growth of Multinational Firms Virginie Baron, Stefan Hinterberger

2. 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

3. Historical Background (1) • traced back 17th century • ownership • profit receiving • risk taking • decision making • innovation concentrated 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

4. 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

5. 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

6. 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)

7. 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

8. 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

9. UK, medium size and large tools and steel firms • substantial exports, as measured by the export-sales ratio

10. 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)

11. 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

12. DFI by countries of origin • 1914 - US, UK, France and Germany, 87% of DFI • 1988 - US, UK, Germany and Japan, 65.6% of DFI

13. DFI by countries of destination • more diverse and developing countries are important (20% of DFI) • majority among already industrialized countries

14. 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

15. 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

16. a theory of locational entry

17. 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

18. 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

19. 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

20. 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 (sogoshosha) • 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

21. 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

22. 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

23. 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

24. 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

25. 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.

26. 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)

27. 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

28. 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)

29. 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

30. Richhost Donor economy exports Stage 1 Manufacturing Rich host Stage 2 Poor country Donor economy Manufacturing 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

31. 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

32. Richhost Donor economy exports Stage 1 Manufacturing Stage 2 Donor economy Rich host Manufacturing Second asset: marketing (2) • The market linkage model: DFI replaces previously established exports (the “rich host” becomes a manufacturing place)

33. 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

34. Development of worker skills • Different ways: • Apprenticeship system (Germany) • on-the-job training (Japan) • Same aims: • Enhance productivity • High-quality work • Even more American-Japanese joint-ventures

35. 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)

36. Exports & licensing • 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

37. Post-entry behaviour of foreign-controlled activities • 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)

38. 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

39. 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

40. 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

41. 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

42. Conclusion • Enhanced mobility of capital • But still new places to invest in (China, Russia…) • And still medium-sized firms investing for the first time