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COMM498_Lecture 9 - Lecture 9: Multinational Formation...

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Unformatted text preview: Lecture 9: Multinational Formation International Business Management Vanessa Alviarez Sauder School of Business University of British Columbia February 26, 2015 Alviarez (Sauder) COMM 498 Lecture 9 1 / 55 Examples of MNE Formation: Daimler / Mercedes Benz Original base: Germany; Daimler-Chrysler 1998-2007  merger Started manufacturing trucks and buses in Brazil in 1956 Since then has established commercial vehicle production in 7 other locations (USA, Canada, Mexico, Argentina, South Africa, Spain, and Turkeyare these countries `strategic' choices?) In 1999, rst foreign car plant opens in Juiz da Fora, Brazil, originally for A-class compact cars Mercedes also begins to produce right-hand-drive cars of the C-class cars in South Africa, exporting to Australia and eventually to UK, Ireland, Japan, HK, NZ, and other destinations In 2001 Mercedes starts producing `Smart' cars in Hambach, France. Alviarez (Sauder) COMM 498 Lecture 9 2 / 55 Examples of MNE Formation: Nestle Alviarez (Sauder) COMM 498 Lecture 9 3 / 55 Examples of MNE Formation: Mattel Barbie Doll is now over 40 years old Has always been produced in Asia, rst in Japan, and now in Indonesia and China. `Value Chain' of producing a Barbie Doll starts out as petroleum in the Middle East rened into plastic pellets in oil reneries in Taiwan pellets are melted in China and are injected into forms through molding equipment made in the U.S. Japanese-made nylon hair is added clothes are added from Chinese-made cotton The nished doll cost $2 to manufacture, of which 32 cents went to Chinese workers, 65 cents to material providers, and $1 to the Hong-Kong managers. The doll retails for $10 in the U.S. and generates $2bn in revenues through sales in 140 countries. Alviarez (Sauder) COMM 498 Lecture 9 4 / 55 Types of FDI What are the reasons for choosing either type of FDI? What are the limitations and risks of each FDI strategy? Alviarez (Sauder) COMM 498 Lecture 9 5 / 55 The Three Primary Forms Alviarez (Sauder) COMM 498 Lecture 9 6 / 55 The Three Advantages 1 Proximity Advantages favor replication better market intelligence quicker customer service reduction of distance-related costs 2 Comparative Advantages favor specialization match factor intensities of production to factor abundance of countries 3 Scale Advantages favor centralization xed costs invisibilities experience curve eects Alviarez (Sauder) COMM 498 Lecture 9 7 / 55 Export, FDI and Import, or Replicate? Export centralize production at home export to foreign market also serve local market Replicate operate two plants serve each market locally no exports or imports FDI and Import centralize production abroad shut down plant at home (incurs sunk costs) invest in new plant abroad import goods from new plants abroad also serve foreign market directly Alviarez (Sauder) COMM 498 Lecture 9 8 / 55 Export, FDI and Import, or Replicate? Alviarez (Sauder) COMM 498 Lecture 9 9 / 55 Export, FDI and Import, or Replicate? wH : marginal cost of production in home country wF : marginal cost of production in foreign country MH : market demand in home country MF : market demand in foreign country t: per-unit trade cost depend on distance K: s: (t = a + bD) capital cost of a new plant fraction of Alviarez (Sauder) K that is  sunk cost at existing location COMM 498 Lecture 9 10 / 55 Export, FDI and Import, or Replicate? Export CH = K + wH MH + (wH + t)MF Replicate CR = 2K + wH MH + wF MF FDI and Import CF = (1 + s)K + (wF + t)MH + wF MF Alviarez (Sauder) COMM 498 Lecture 9 11 / 55 Export, FDI and Import, or Replicate? Export CH = K + w H MH cost of domestic sales + (wH + t)MF cost of foreign sales Replicate CR = 2K + wH MH + wF MF CR = K + wH M H cost of domestic sales Alviarez (Sauder) COMM 498 + K + w F MF cost of foreign sales Lecture 9 12 / 55 Comparing the Cost of Foreign Sales Export (wH + t)MF = wH + t MF Replicate K + wF M F K = + wF MF MF Replicate if: K + wF < wH + t MF Alviarez (Sauder) COMM 498 Lecture 9 13 / 55 Export or Replicate? Critical Foreign Market Size Alviarez (Sauder) COMM 498 Lecture 9 14 / 55 Inuential Factors Re-expressing condition for replication to be optimal: Replicate if: (wH − wF ) − K +t>0 MF Factors Comparative adv.: wH − wF PLEoS (scale economies) relative to market size: Trade costs: Alviarez (Sauder) K MF t COMM 498 Lecture 9 15 / 55 What does the algebra tell us? Replication preferred to home centralization if Home has comparative advantage: yes or no? PLEoS (xed costs) are: high or low? Trade costs are: high or low? Foreign market size is: small or large? Alviarez (Sauder) COMM 498 Lecture 9 16 / 55 Breaking down trade costs, t Per unit trade costs consist of a component that is constant (border costs) and one that varies with distance: t = a + bD From before, if replication optimal: K + wF < wH + (a + bD) MF t t is increasing in D, so the left-hand side is increasing D, allowing us to identify the critical D where Now in replication is optimal. Alviarez (Sauder) COMM 498 Lecture 9 17 / 55 Critical Distance to Justify Overseas  Replication Alviarez (Sauder) COMM 498 Lecture 9 18 / 55 Numerical Example MF =50; K =$1000; wH =$15; wF =$5 If t=$10, is centralization or replication preferred? If t=$10, what is the critical level of MF that makes to rm indierent between either choice? What is the critical level of t that makes the rm indierent? Alviarez (Sauder) COMM 498 Lecture 9 19 / 55 Example Continued Would we expect a rm with market power (ability to inuence price) to set dierent levels of output depending on variable costs Suppose PF = 125 − MF ; K = 1000; wH = 15; wF = 5; t = 10 Looking at marginal costs, would we expect the rm to produce more at home or abroad? Is MF = 50 prot maximizing when production is at home? Abroad? When prot maximizing output is chosen, is centralization preferred to replication? Alviarez (Sauder) COMM 498 Lecture 9 20 / 55 Foreign versus Home Centralization: The role of relative market sizes So far, we have ignored the size of the home market since we assumed the home factory will continue to sell to home consumers Now consider the option of closing down the home factory. Firms may want to produce where there are the most consumers or replicate if the markets are equal sizes Alviarez (Sauder) COMM 498 Lecture 9 21 / 55 Export, FDI and Import, or Replicate? World Market: M ≡ MH + MF Home Market Share: m ≡ MH /M Calculate Unit Costs: Exports cH ≡ CH /M = K/M + wH + t(1 − m) Replicate cR ≡ CR /M = 2K/M + wH m + wF (1 − m) FDI and Import cF ≡ CF /M = (1 + s)K/M + wF + tm Alviarez (Sauder) COMM 498 Lecture 9 22 / 55 Calculation: an example Exports CH = K + wH MH + (wH + t)MF cH ≡ CH /M = K/M + wH MH MF +(wH + t) M M (m) (1 − m) cH = K/M + wH m + (wH + t)(1 − m) cH = K/M + wH m + wH − wH m + (1 − m)t cH = K/M + wH + (1 − m)t Alviarez (Sauder) COMM 498 Lecture 9 23 / 55 Export, FDI and Import, or Replicate? Assume that there is no comparative advantage: Assume that sunk costs are half of capital costs: Exports: cH = 1.0(K/M ) + w + t(1 − m) Replicate: cR = 2.0(K/M ) + w FDI and Imports: cF = 1.5(K/M ) + w + tm Importance of home market share cH cR cF wH = wF s = 0.5 m: decreases with home market share m remains unchanged by home market share increases with home market share m m Replication strategy is only feasible when cR < min{cH , cF } ⇒ K/M < t · min{2m, 1 − m} - xed cost component must be small relative to trade costs - home market share must be in an intermediate range Alviarez (Sauder) COMM 498 Lecture 9 24 / 55 Calculation Replication strategy is only feasible when cR < min{cH , cF } cR < cH 2.0(K/M ) + w < 1.0(K/M ) + w + t(1 − m) K/M < (1 − m)(t − wF + wH ) K/M < (1-m)t because wF = wH cR < cF 2.0(K/M ) + w < 1.5(K/M ) + w + tm K/M < 2mt ⇒ K/M < t · min{2m, 1-m} Alviarez (Sauder) COMM 498 Lecture 9 25 / 55 Critical Home Market Share Alviarez (Sauder) COMM 498 Lecture 9 26 / 55 Multiproduct Multinationals Corporate multinational strategy considers best form for rms operating in more than one business (product) Relationships between products: Unrelated Vertical (intermediate inputs vs. nal outputs) Horizontal (complements vs substitutes) Alviarez (Sauder) COMM 498 Lecture 9 27 / 55 Multinational Forms: Vertically Related Products (Upstream/Downstream) Upstream (U) creates inputs Downstream (D) uses U inputs to create outputs Examples: Teaching: U is PPT/Latex preparation, D is presentation to students Movies: U is writing & casting, D is lming & editing (or U is movie production and D is movie exhibition) Steel: U is blast furnace, D is steel furnace & rolling mill Alviarez (Sauder) COMM 498 Lecture 9 28 / 55 Two-Stage Multinational Enterprises Alviarez (Sauder) COMM 498 Lecture 9 29 / 55 ExxonMobil Upstream: exploration and  production in 40 countries Downstream: rening and  marketing Owns 46 reneries, located in 26 countries Operates 42,000 retail sites in 118 countries Alviarez (Sauder) COMM 498 Lecture 9 30 / 55 ExxonMobil's Upstream Sites Alviarez (Sauder) COMM 498 Lecture 9 31 / 55 ExxonMobil's Downstream Sites Alviarez (Sauder) COMM 498 Lecture 9 32 / 55 Two-Stage MNEs: CENTRALIZATION Important plant-level economies of scale Proximity advantages of the upscale stage are large Proximity advantages for the downstream stage are low Home base is the major market Taris and NTBs are low Alviarez (Sauder) COMM 498 Lecture 9 33 / 55 Two-Stage MNEs: REPLICATION Proximity advantages are high both upstream and downstream Scale advantages are small Countries do not have strong comparative advantages Alviarez (Sauder) COMM 498 Lecture 9 34 / 55 Two-Stage MNEs: VERTICAL SPECIALIZATION Dierent countries have important comparative advantages in dierent stages of production (ie, the two stages dier strongly in factor intensity, and the countries dier strongly in factor abundance) Proximity advantages are small High scale advantages at each stage Alviarez (Sauder) COMM 498 Lecture 9 35 / 55 Two-Stage MNEs: VERTICAL SPECIALIZATION Vertical Specialization good if: Economies of scale (plant-level xed costs): high or low? Trade costs to export U to foreign country: high or low? Trade costs to import D from foreign country: high or low? Home country has comparative advantage in production costs for U: yes or no? Foreign country has comparative advantage in production costs for D: yes or no? Alviarez (Sauder) COMM 498 Lecture 9 36 / 55 Two-Stage MNEs: BRANCHING Strong proximity advantages at the downstream stage Weak proximity advantages at the upstream stage Scale advantages small at the downstream stage Scale advantages large at the upstream stage Home country has comparative advantage in the upstream stage Alviarez (Sauder) COMM 498 Lecture 9 37 / 55 Two-Stage MNEs: BRANCHING Examples: Coca Cola's concentrate (U) and bottling (D) Subaru's engines (U) and car assembly (D) Benets from Low trade costs on U, high on D Low scale economies on D, high on U Home comp. adv. in U, weak comp. advs. in D Alviarez (Sauder) COMM 498 Lecture 9 38 / 55 Two-Stage MNEs: MULTI-SOURCING Scale advantages are large at the downstream stage Proximity advantages are small at all stages Home country has comparative advantage in downstream stage Comparative advantages at the upstream stage if upstream units are dierent and require specialization Alviarez (Sauder) COMM 498 Lecture 9 39 / 55 Two-Stage MNEs: MULTI-SOURCING Examples: Renery in one country, sourcing crude oil from multiple drilling sites (in dierent countries) Nike's  network strategy in shoe manufacturing Benets from Low trade costs (for U & D) Dis-economies of scale for U Uncertain comp. adv./business conditions for U Alviarez (Sauder) COMM 498 Lecture 9 40 / 55 Two Product Forms: Consider two downstream activities The decision to invest abroad depends on the nature of the relationship between the downstream activities Joint Outputs are created at the same time through technological linkage in the production process (e.g. slaughter of cattle produces beef and leather) ⇒ inter-product proximity advantages are high Substitutes are goods that consumers treat as alternatives ⇒ if foreign and domestic goods are substitutable, and trade costs are high, downstream units will not export Complements are goods that consumers use in conjunction. Example: razors, razor blades, shaving cream, after-shave. ⇒ consumers need to buy both products; downstream units need to export to markets abroad Alviarez (Sauder) COMM 498 Lecture 9 41 / 55 Two Product Forms: Consider two downstream activities The decision to invest abroad depends on the nature of the relationship between the downstream activities Joint Outputs are created at the same time through technological linkage in the production process (e.g. slaughter of cattle produces beef and leather) ⇒ inter-product proximity advantages are high Substitutes are goods that consumers treat as alternatives ⇒ if foreign and domestic goods are substitutable, and trade costs are high, downstream units will not export Complements are goods that consumers use in conjunction. Example: razors, razor blades, shaving cream, after-shave. ⇒ consumers need to buy both products; downstream units need to export to markets abroad Alviarez (Sauder) COMM 498 Lecture 9 41 / 55 Two Product Forms: Consider two downstream activities The decision to invest abroad depends on the nature of the relationship between the downstream activities Joint Outputs are created at the same time through technological linkage in the production process (e.g. slaughter of cattle produces beef and leather) ⇒ inter-product proximity advantages are high Substitutes are goods that consumers treat as alternatives ⇒ if foreign and domestic goods are substitutable, and trade costs are high, downstream units will not export Complements are goods that consumers use in conjunction. Example: razors, razor blades, shaving cream, after-shave. ⇒ consumers need to buy both products; downstream units need to export to markets abroad Alviarez (Sauder) COMM 498 Lecture 9 41 / 55 Two Product Forms: Consider two downstream activities The decision to invest abroad depends on the nature of the relationship between the downstream activities Joint Outputs are created at the same time through technological linkage in the production process (e.g. slaughter of cattle produces beef and leather) ⇒ inter-product proximity advantages are high Substitutes are goods that consumers treat as alternatives ⇒ if foreign and domestic goods are substitutable, and trade costs are high, downstream units will not export Complements are goods that consumers use in conjunction. Example: razors, razor blades, shaving cream, after-shave. ⇒ consumers need to buy both products; downstream units need to export to markets abroad Alviarez (Sauder) COMM 498 Lecture 9 41 / 55 Two-Stage MNEs: MONOCENTRIC Strong economies of scale keep all production at home Insucient factor intensity dierences to exploit comparative advantages of foreign country Proximity advantages are weak Alviarez (Sauder) COMM 498 Lecture 9 42 / 55 Two-Stage MNEs: POLYCENTRIC Mixture of centralization [downstream units] and replication strategy [upstream unit] Exploit comparative advantage when goods 1 and 2 have dierent factor intensities If countries dier too much in factor abundances, replicating upstream unit may not be desirable Alviarez (Sauder) COMM 498 Lecture 9 43 / 55 Two-Stage MNEs: VERTICAL SPECIALIZATION Home country has comparative advantage in upstream activity Foreign country has comparative advantage in downstream activity Alviarez (Sauder) COMM 498 Lecture 9 44 / 55 Two-Stage MNEs: VERTICAL SPECIALIZATION factor intensity of product changes over its life cycle  old good 1 is shifted to foreign country whose factor abundance matches the product's factor intensity when it becomes standardized  new good 2 is kept at home due to learning-by-doing and process innovation Alviarez (Sauder) COMM 498 Lecture 9 45 / 55 Video Cases: Volvo in Brazil Alviarez (Sauder) COMM 498 Lecture 9 46 / 55 Video Case: Volvo in Brazil Why did Volvo invest in Brazil? Volvo's decision to invest in Brazil was a classic case of  tari jumping FDI, as Brazil and other South American countries have had signicant import restrictions. By investing in Brazil, Volvo also got access to Mercosur, the South American FTA. In addition, the volatility of the local currencies made investing in Brazil a safer bet Why did Volvo choose Curitiba as the production location? Government incentives promoted decentralization away from Rio de Janeiro, Curitiba has an ethnic mix of immigrants with strong European ties, and Curitiba is close to a major port, Paranagua Alviarez (Sauder) COMM 498 Lecture 9 47 / 55 Video Case: Volvo in Brazil How does Volvo transfer its brand image to South America? Volvo's brand image is built on safety and quality, and thus Volvo stresses these values through public safety campaigns and by paying higher wages to workers in order to maintain higher quality How/Why did Curitiba turn into an automotive cluster? The cluster of suppliers also became attractive to other automakers investing in Brazil, reinforcing the clustering Alviarez (Sauder) COMM 498 Lecture 9 48 / 55 Video Case: Volvo in Brazil Why did Volvo choose to built a plant (rather than buy one)? Starting from scratch allowed Volvo to start with the most modern equipment and ensure quality standards Why does Volvo pay a wage premium to its workers? Paying a slightly higher wage rate than comparable companies in the area allows Volvo to reduce worker turnover, improve employee loyalty, and invest more into workers' training Alviarez (Sauder) COMM 498 Lecture 9 49 / 55 ...
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