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Multinational Corporations

1. Multinational Corporations
Definition of MNC Multinational firms arise because capital is much more mobile than labor. Since cheap labor and raw material inputs are located in other countries, multinational firms establish subsidiaries there. They are often criticized as being runaway corporations. Economists are not in agreement as to how multinational or transnational corporations should be defined. Multinational corporations have many dimensions and can be viewed from several perspectives (ownership, management, strategy and structural, etc.) The following is an excerpt from Franklin Root, International Trade and Investment Ownership criterion Some argue that ownership is a key criterion. A firm becomes multinational only when the headquarter or parent company is effectively owned by nationals of two or more countries. For example, Shell and Unilever, controlled by British and Dutch interests, are good examples. However, by ownership test, very few multinationals are multinational. The ownership of most MNCs are uninational. (e.g., the Smith-Corona versus Brothers case)

Depending on the case, each is considered an American multinational company in one case, and each is considered a foreign multinational in another case. Thus, ownership does not really matter. Nationality mix of headquarters managers

An international company is multinational if the managers of the parent company are nationals of several countries. Usually, managers of the headquarters are nationals of the home country. This may be a transitional phenomenon. Very few companies pass this test currently. Business Strategy

global profit maximization some are home country oriented, others are host country oriented. Successful firms: world-oriented, but must adapt to local markets. Root's definition

According to Franklin Root (1994), an MNC is a parent company that (i) engages in foreign production through its affiliates located in several countries, (ii) exercises direct control over the policies of its affiliates, and

(iii) implements business strategies in production, marketing, finance and staffing that transcend national boundaries. In other words, MNCs exhibit no loyalty to the country in which they are incorporated. Example Barilla has plants and offices in Greece, France, Germany, Norway, Russia, Sweden, Turkey, US, and Mexico. Wheat is purchased from around the world. Reference Howard V. Perlmutter, "The Tortuous Evolution of the Multinational Corporation," Columbia Journal of World Business, 1969, pp. 9-18. 2. Three Stages of Evolution Export Stage (i) initial inquiries result in first exports.

(ii) Initially, firms rely on export agents. expansion of export sales Foreign production stage Why? (i) There is a limit to foreign exports, due to tariffs, quotas and transportation costs. (ii) Wage rates may be lower in LDCs.

(iii) foreign sales branch or assembly operations are established (to save transport cost)

(iii) Environmental regulations may be lax in LDCs (e.g., China). Itai-Itai disease in Japan since the 1920s was caused by cadmium poisoning. Contaminated effluents flowed into rice paddies and water source.) Watch the movie, Erin Brochovich. (iv) meet Consumer demands in the foreign countries DFI versus Licensing Once the firm chooses foreign production as a method of delivering goods to foreign markets, it must decide whether to establish a foreign production subsidiary or license the technology to a foreign firm. Licensing

MacDonalds in Moscow Licensing is usually the first experience (because it is easy) e.g.: Kentucky Fried Chicken in the U.K. Licensing does not require any capital expenditure Financial risk is zero. royalty payment = a fixed % of sales licensor may provide training, equipment, etc.

Problem: the parent firm cannot exercise any managerial control over the licensee (it is independent)

The licensee may transfer industrial secrets to other independent firms, thereby creating rivals. Direct Investment It requires the decision of top management because it is a critical step. (i) it is risky (lack of information, large capital requirement) US firms tend to establish subsidiaries in Canada first. Singer Manufacturing Company established its foreign plants in Scotland and Australia in the 1850s. (ii) plants are established in several countries (iii) licensing is switched from independent producers to its subsidiaries. (iv) export continues (exports and FDI may be substitues or complements) Multinational Stage The company becomes a multinational enterprise when it begins to plan, organize and coordinate production, marketing, R&D, financing, and staffing. For each of these operations, the firm must find the best location. Global 500 (2008) The World's Biggest Public Companies (by sales) A lion's share of MNCs are headquartered in the US: Wall-Mart Exxon Mobil Royal dutch Shell BP Toyota Chevron

ING Total General Motors ConocoPhillips How to tell whether a firm is multinational? Rule of Thumb A company whose foreign sales are 25% or more of total sales. This ratio is high for small countries, but low for large countries, e.g. Nestle (98%: Dutch), Phillips (94%: Swiss). Examples: Manufacturing MNCs 24 of top fifty firms are located in the U.S. 9 in Japan (shrinking) 6 in Germany. Petroleum companies: 6/10 located in the U.S. Food/Restaurant Chains. 10/10 are headquartered in the U.S. US Multinational Corporations: Exxon, GM, Ford, etc.

3. Motives for Foreign Direct Investment (FDI) New MNCs do not pop up randomly in foreign nations. It is the result of conscious planning by corporate managers. Investment flows from regions of low anticipated profits to those of high returns. 1 Growth motive A company may have reached a plateau satisfying domestic demand, which is not growing. Looking for new markets.

2 Bypass protection in importing countries Foreign direct investment is one way to expand. FDI is a means to bypassing protective instruments in the importing country. Examples: (i) European Community: imposed common external tariff against outsiders. US companies circumvented these barriers by setting up subsidiaries. (ii) Japanese corporations located auto assembly plants in the US, to bypass VERs. 3 avoid high transport costs Transportation costs are like tariffs in that they are barriers which raise consumer prices. When transportation costs are high, multinational firms want to build production plants close to either the input source or to the market in order to save transportation costs. Multinational firms (e.g. Toyota) that invest and build production plants in the United States are better off selling products directly to American consumers than the exporting firms that utilize the New Orleans port to ship and distribute products through New Orleans.

4 avoid Exchange Rate fluctuations Japanese firms (e.g., Komatsu) invest here to produce heavy construction machines to avoid excessive exchange rate fluctuations. Also, Japanese automobile firms have plants to

produce automobile parts. For instance, Toyota imports engines and transmissions from Japanese plants, and produce the rest in the U.S. Toyota is behind GM and Volkswagen in China, and plans to expand its production in China and has no plans to build more plants in North America. (China's autoparts are cheaper.) It may have been a mistake for Toyota to overexpand its plants in the US. GM and Volkswagen have expanded their production plants in Shanghai.

A Komatsu machine used in ethanol production in Ida Grove, Iowa. 5 competition The most certain method of preventing actual or potential competition is to acquire foreign businesses. GM purchased Monarch (GM Canada) and Opel (GM Germany). It did not buy Toyota, Datsun (Nissan) and Volkswagen. Subsequently, they later became competitors. Toyota is #1 in the car industry. 6 reduce costs A foreign country may have cheap labor or land. United Fruit has established banana-producing facilities in Honduras. Due to high transportation costs, FPE does not hold. Cheap foreign labor. Labor costs tend to differ among nations. MNCs can hold down costs by locating part of all their productive facilities abroad. (Maquildoras) Komatsu first established its European factory in Belgium in 1967, and its American subsidiary in 1970. Over the years it established

many other subsidiaries throughout Europe, Russia, America and Asia. 4. Export versus Foreign Direct Investment Foreign production is not always an answer. Foreign markets can be better served by exporting, rather than by creating a foreign subsidiary if there are economies of scale. If large scale production reduces unit cost, it is better to concentrate production in one place. MES MES is the minimum rate of output at which Average Cost (AC) is minimized. If minimum efficient scale (MES) is not achieved, then export. In other words, if there exists excess capacity, why not utilize it and export outputs to other countries? There is no point in creating another plant overseas when domestic capacity is not fully utilized. If foreign demand exceeds the minimum efficient scale, then FDI.

5. International Joint Ventures What is JV? JV is a business organization established by two or more companies that combines their skills and assets. Three forms

Pudong (i) A JV is formed by two businesses that conduct business in a third country. (US firm + British firm jointly operate in the Middle East) (ii) joint venture with a local firm, e.g., GM + Shanghai Automotive Industry Corporation (SAIC) (iii) joint venture includes local government. Bechtel Company, US Messerschmitt-Boelkow-Blom, Germany => Iran Oil Investment Company National Iranian Oil Company Why form JV? (i) Large capital costs - costs are too large for a single company (ii) Protection - LDC governments close their borders to foreign companies. JV bypasses protectionism. e.g.: US workers assemble Japanese parts. The finished goods are sold to the US consumers.


Control is divided. The venture serves "two masters"e.g.: US workers assemble Japanese parts. The finished goods are sold to the US consumers. Welfare effects (i) The new consumers. venture increases production, lowers price to

(ii) The new business is able to enter the market that neither parent could have entered singly. (iii) Cost reductions (otherwise, no joint ventures will be formed) (iv) increased market power => not necessarily good for consumers. 6. Where are MNCs? Their offices are located in major international cities, metropolitan areas, and port cities to meet local consumer demands and to acquire resources such as materials and laborers.