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)

Smith-Corona argued that Brothers is a foreign corporation (51% is owned by Japanese), but Brothers maintained that Smith-Corona is a foreign corporation because their products are made in Asia. Ownership does not really matter. For tax purposes, Honda of America Manufacturing (OH) is an American company. Only foreign firms pay tariffs and are subject to import quotas.

Nationality mix of headquawrters managers

An international company is multinational if the managers of the parent company are nationals of several countries. Usually, managers of the headquarters (e.g., GM, Toyota) are nationals of the home country. This may be a transitional phenomenon.

Japan's New Business Language (Rakuten, Japan's largest online firm with 100 million users, Amazon.com has 330 million users.)

Very few companies pass this test currently.

Business Strategy

Sabvei(Subway) in Moscow.

Global profit maximization:

some are home country oriented,

others are host country oriented.

Successful firms: world-oriented , but must adapt to local markets.

How to say Stop in Russian

Root's definition

 


Starkbucks in Qian Men street, Beijing

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 transnational business strategies in production, marketing, finance and staffing in a way 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 export.

(ii) Initially, firms rely on export agents. ⇒ expansion of export sales

(iii) ⇒ foreign sales branch or assembly operations are established (to save transportation costs)

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) Environmental regulations may be lax in LDCs (e.g., China). Itai-Itai (meaning: ouch ouch) disease in Japan since the 1920s was caused by cadmium poisoning. Contaminated effluents leaked into rice paddies and water source.) Watch the movie, Erin Brochovich. (Hexavalent Chromium)

(iv) meet Consumer demands in the foreign countries

(v) mining industry is often located at the source.

 

FDI 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.

In order to deter entry of copycat producers, MacDonalds may supply American ingredients or raw materials (e.g., beef)

Foreign Direct Investment (FDI)

 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). When yen is weak, exports become more important that foreign production.)

 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 is 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

21 of top fifty firms are located in the U.S.

12 are in China

3 in Japan (shrinking)

 

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)
  Anecdote on Sunzi, who wrote "The Art of War." Sunzi (544-496 BC) was a native of Ch'i, but served under King of Wu during the Spring and Autumn period (771- 476 BC).
   New MNCs do not pop up randomly in foreign nations. They are the product of conscious planning by corporate managers. Investment flows from regions of low 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 Union: imposed common external tariff against outsiders. Multinational companies circumvented these barriers by setting up subsidiaries . JBS USA is a subsidiary of a Brazilian company, the world's largest meat processor of beef and pork. (It kills 5000 heads of cattle per day.)

(ii) Japanese corporations built auto assembly plants in the US, to bypass VERs.

3. avoid high corporate tax US corporate tax = 35% if income exceeds $335,000, Greece = 29%, France = 33%. Corporate tax rates are much lower in most other countries.
 4. avoid high transport costs

Build factories where consumers are.

 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) are better off establishing factories where consumers are located than shipping goods to faraway counries.

 5 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 (in addition to Tianjin and Guangzhou) 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.

komatsu

A Komatsu machine used in ethanol production in Ida Grove, Iowa.

 6 reduce 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, Nissan, and Volkswagen. Subsequently, they became competitors. Toyota is #1 in the car industry at present. Market shares of car companies are:

Toyota: 12%, GM = Volkswagen: 11%, Hyundai-Kia: 9%.
World = 90 million cars. China = 24 million, US =12 million.

7 secure essential inputs A foreign country may have the necessary resources (e.g., rare earth minerals). Since 1995, China is the dominant owner of REMs.
 8 cheap labor 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 FDI
  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 and transportation costs are not high, 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.

   
  If demand is less than MES, do not build a foreign production plant.
   
 
  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) = Shanghai GM.

(iii) joint venture includes local government.

Anglo-Iranian Oil Company => was nationalized in 1951:
National Iranian Oil Company
Suez Canal was built by Suez Canal Company (opened in 1869), which was to operate it for 99 years. Nasser nationalized it 1956, 12 years before the lease expired.
 Why form JV?

(i) Large capital costs - costs are too high 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.

 Problem  Control is divided. The venture serves "two masters"
 Welfare effects

(i) The new venture increases production, lowers price to consumers.

(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.