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
re ned into plastic pellets in oil re neries 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 In uential 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
in uence 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 pro t maximizing when production is at home? Abroad?
When pro t 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: re ning and marketing
Owns 46 re neries, 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) Bene ts 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:
Re nery in one country, sourcing crude oil from multiple
drilling sites (in dierent countries)
Nike's network strategy in shoe manufacturing Bene ts 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
Insu cient 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
signi cant 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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