The United Nations has identified over 60,000 MNEs, but the largest 500 account for 80 per cent of the world’s foreign direct investment.1Table 2.1 shows the distribution of the world’s largest 500 MNEs. Of these, 424 are from the “triad.” There are 189 from the United States, 153 from the EU, and 82 from Japan. The fact that over 80 per cent of the world’s largest 500 MNEs are from the core triad is highly significant. It means that the triad is the basic unit of analysis for MNE strategy. Also, about 80–85 per cent of the world’s top MNEs have been from the triad for the last 20–30 years.2Total annual sales of these 500 firms are in excess of
$14.9 trillion.3 These firms are engaged in a wide variety of operations including autos, chemicals, computers, consumer goods, financial services, industrial equipment, and oil and steel production.
The names of the largest triad-based MNEs, as well as those from non-triad countries, are listed in Appendixes 2A–2E. Students should become familiar with at least some of these MNEs as we proceed through this book. We provide the websites for all the MNEs we discuss in the case boxes.
Characteristics of multinational enterprises
One way of identifying the characteristics of MNEs is by looking at the environment in which they operate. Figure 2.1 shows some of the major forces in this environment. Notice that an MNE has two major areas of concern: the home country of its headquarters and the
Figure 2.1 The multinational enterprise and its environment
host countries in which it does business. Stakeholders are not included within these two areas of Figure 2.1 because they can come from anywhere in the world. For example, an investor in Switzerland can purchase stock in Sears Roebuck even though the company does not do business in Switzerland.
One characteristic of MNEs is that their affiliates must be responsive to a number of important environmental forces, including competitors, customers, suppliers, financial institutions, and government (again see Figure 2.1). In some cases the same forces are at work in both the home and host-country environments. For example, many of General Motors’ competitors in the US market are the same as those in Europe: BMW, Ford, DaimlerChrysler, Honda, and Volkswagen, among others. Similarly, MNEs often use the same suppliers overseas that they employ domestically, and it is common to find home- country-based suppliers following their MNE customer to other geographic locales in order to provide the same types of services worldwide. In other cases, however, these same environmental factors can be very different on each of the markets in which the firm operates.
A second characteristic of an MNE is that it draws on a common pool of resources, including assets, patents, trademarks, information, and human resources. Because the affiliates are all part of the same company, they have access to assets that are often not available to outsiders. For example, both Ford and General Motors compete vigorously in Europe and many of the design and styling changes developed for their European cars have now been introduced in US models. The flow of information and technology between European and US affiliates has led to success in the worldwide market for many MNEs. Similarly, if an affiliate needs expansion funds, an MNE will often help out by work- ing with the affiliate to raise the money. If a loan is needed, the affiliate is likely to find many financial institutions that are willing to provide the money because the MNE will back the loan.
A third characteristic of an MNE is that it links together the affiliates and business part- ners with a common strategic vision. Simply put, all of the firms with whom the MNE works fit into the company’s overall plan of what it wants to do and how it intends to go about implementing this strategy. General Motors (GM) is a good example. The auto giant has announced that it is now going to rely heavily on partnerships to help it grow.4GM realizes that no auto maker has all of the resources for achieving leadership in every region of the world or in every product segment. As a result, the company has formed a manu- facturing partnership with Toyota to conduct research and development on fuel cell and gas-electric hybrid vehicles. GM also has created an alliance with Fuji Heavy Industries and its Subaru brand that allows GM to benefit from Fuji’s strengths in small sport utility vehicles, continuously variable transmissions, and all-wheel-drive systems and, in turn, gives Fuji access to GM’s vehicle platforms and other important manufacturing technol- ogies. These types of arrangements are part of GM’s new strategic vision—one that is not
limited just to building cars. Today the company is looking into ways of providing cus- tomers with other auto-related services as seen by its Onstar communications program with wireless phone service that allows drivers to be in constant contact with someone who can give them information and assistance.
✔ Active learning check
Review your answer to Active Learning Case question 1 and make any changes you like. Then compare your answer with the one below.
1 What are some of the characteristics of multinational enterprises that are displayed by the Walt Disney Company?
One of the characteristics of a multinational enterprise is that ties of common ownership link affiliated firms. In this case the Walt Disney Company holds a substantial interest in Disneyland Paris, in addition to its ownership of Disneyland and Disneyworld in the United States. A second characteristic is that the MNE draws on a common pool of resources. One way Euro Disney does this is through the use of trademarks and characters (Mickey Mouse, Goofy, Donald Duck) and the experience of the Disney team in setting up and running similar theme parks in the United States. A third characteristic is that MNEs have a common strategy for linking together the affiliates. The Walt Disney Company does this through its overall plan such as the one it used for deciding where to set up Euro Disney and how to manage the park.
The internationalization process
Not all international business is done by MNEs. Indeed, setting up a wholly-owned sub- sidiary is usually the last stage of doing business abroad, as is shown in Figure 2.2.
Figure 2.2 outlines the typical process by which a firm producing a standardized product will seek to involve itself in a foreign market.5This, however, is a generalization as firms ultimately make decisions depending on their particular circumstances. The
Figure 2.2 Entry into foreign markets: the internationalization process
Internationalization The process by which a company enters a foreign market
License
A contractual arrangement in which one firm (the licensor) provides access to some of its patents, trade- marks, or technology to another firm in exchange for a fee or royalty Licensor
A company that provides access to some of its patents, trademarks, or technology to another firm in exchange for a fee or royalty
process we illustrate here, however, is important because it is based on how the firm perceives risk and how it deals with it. In this internationalizationprocess the firm re- gards foreign markets as risky due to the fact that, as these markets are unknown to it, the firm faces export marketing costs. To avoid such information costs and risk, its strat- egy is to go abroad at a slow and cautious pace, often using the services of specialists in international trade outside the firm. Over time, familiarity with the foreign envir- onment will reduce the information costs and help to alleviate the perceived risk of foreign involvement. There is a “learning” effect as firms become familiar with a foreign market.6
Initially the firm may seek to avoid the risks of foreign involvement by arranging a joint venture or a license. A licenseis a contractual arrangement in which one firm, the licensor, provides access to some of its patents, trademarks, or technology to another firm, the licensee, in exchange for a fee or royalty. This fee often involves a fixed amount upon signing the contract and then a royalty of 2–5 per cent on sales generated by the agreement. A typical licensing contract will run from five to seven years and be renewable at the option of either or both parties. This strategy is most suitable for a standardized product where there is no risk of dissipation of the firm’s technological or managerial advantages. Otherwise, licensing will be reserved for a much later stage of entry. Indeed, when it is important for the firm to retain control over its firm-specific advantage in technology (as in internalization theory),7 licensing will be the last stage of entry. The firms involved in the process of internationalization, on the other hand, typically are not concerned about losing their firm-specific advantages. Rather, they want to avoid expos- ure to an uncertain foreign environment. Abstracting from the licensing option (and the more complex problem of joint ventures), the major types of foreign entry for a firm are as follows:
1 The firm sees potential extra sales by exportingand uses a local agent or distributor to enter a particular market. Often the firm uses exporting as a “vent” for its surplus pro- duction and may have no long-run commitment to the international market. If it does well abroad, however, it may then set up its own local sales representative or marketing subsidiary, in the hope of securing a more stable stream of export sales.
2 As exports come to represent a larger share of sales, the firm may increase its capacity to serve the export market. It will set an office for its sales representativein a major market, or set up a sales subsidiary. This stage marks an important departure for the firm from simply viewing exports as a marginal contributor to sales volume or as a vent for sur- plus in times of excess capacity. At this stage the firm will often set up a separate export departmentto manage foreign sales and production for such markets and product de- sign and the production process itself may be modified to tailor products for export markets.
3 After the firm has become more familiar with the local market, some of the uncertainty associated with foreign involvement has been overcome. Now the firm may begin to move on the foreign production side. Initially it may start to use host-country workers to engage in local assembly and packagingof its product lines. This is a crucial step, because the firm is now involved in the host-country factor market and must deal with such environmental variables as wage rates, cultural attitudes, and worker expectations in its new labor force.
4 The final stage of foreign involvement comes when the firm has generated sufficient knowledge about the host country to overcome its perceptions of risk. Because it is more familiar with the host-country environment, it may now consider a foreign direct investment activity. In this it produces the entire product line in the host nation and sells its output Licensee
A firm given access to some of the patents, trademarks, or technology of another firm in exchange for a fee or royalty
there, or it may even be able to re-export back to the home country. These decisions de- pend on the relative country-specific costs; for example, if labor is inexpensive in the host nation (as in Southeast Asia), more exporting takes place than if it is expensive (as in Western Europe and the United States).
It has become clear that the internationalization process is more complicated than it seems at first glance. Like all generalizations, this schematic path of export commitment relies on simplifications. In reality, the process of foreign entry is sufficiently complicated to depend on a careful weighing of many firm-specific and country-specific factors. A framework to model these firm-specific advantages (FSAs) and country-specific advan- tages (CSAs) is developed in the next section.
✔ Active learning check
Review your answer to Active Learning Case question 2 and make any changes you like. Then compare your answer with the one below.
2 Why did Disney take an ownership position in the firm rather than simply licensing some other firm to build and operate the park and settling for a royalty on all sales?
Disney believed that the theme park was too lucrative a venture to settle for just a royalty on sales. The company felt that it would be giving up too much to simply “take the money and run” when by remaining and managing the operation it could garner a great deal more revenue. Moreover, not only is the revenue potential of the park extremely high, but Disney’s initial investment of $160 million was extremely low given the amount of control it maintains and the fees and profits that would be generated should the park prove as highly attractive as company executives were forecasting. Disney also wanted to retain control over its brand name products and services in order to prevent imitation by substandard rivals, and this is best done with an ownership position.
Why firms become multinational enterprises
Companies become MNEs for a number of reasons. One is to diversifythemselves against the risks and uncertainties of the domestic business cycle. By setting up operations in an- other country, multinationals can often diminish the negative effects of economic swings in the home country. This is a form of international diversification, and it has been widely used by Japanese MNEs, for example, which have found that, while their home economy has been in an economic slump since the 1990s, their US operations have done quite well.
A second reason is to tap the growing world market for goods and services. For example, many MNEs have targeted the United States because of its large population and high per capita income. It is the world’s single largest market in terms of gross domestic product.
And since Americans have both a desire for new goods and services and the money to buy them, the United States can be an ideal market. MNEs are also targeting China. Although per capita gross domestic product is not very high, the country’s large population and growing economy make it very attractive to multinationals. In 2001, China entered the World Trade Organization, and this acceptance of international rules made China more attractive for MNEs.
Firms also become MNEs in response to increased foreign competition and a desire to protect their home market share. Using a “follow the competitor” strategy, a growing
number of MNEs now set up operations in the home countries of their major competitors.
This approach serves a dual purpose: (1) it takes away business from their competitors by offering customers other choices, and (2) it lets competitors know that, if they attack the MNE’s home market, they will face a similar response. This strategy of staking out global market shares is particularly important when MNEs want to communicate the conditions under which they will retaliate.
A fourth reason why companies become an MNE is to reduce costs. By setting up oper- ations close to the foreign customer, these firms can eliminate transportation expenses, avoid the overhead associated with having intermediaries handle the product, respond more accurately and rapidly to customer needs, and take advantage of local resources.
This process, known as “internalization” of control within the MNE, can help to reduce overall costs.
A fifth reason is to overcome protectivedevices such as tariff and non-tariff barriers by serving a foreign market from within. The EU provides an excellent example. Firms outside
Italian family firms
In Italy more than 90 per cent of all small and medium-sized companies and some of the largest enterprises are family owned. In the fashion industry, for example, Versace, Missoni, and Benetton are family-held firms. In addition, Italian families own important manufacturers and hold oper- ating control of some of the major banks and transportation companies in the country. For example, the Fiat Group grosses more than $47.3 billion euros annually and employs more than 160,000 people. It does this through the Fiat Group, a conglomerate consisting of 777 firms with hold- ings in agricultural and construction equipment, automo- biles, aviation, commercial vehicles, communications, insurance services, metallurgical products, production systems, and publishing.
Another large family-owned Italian company is Pirelli, which, in recent years, has had annual revenues of around
$8.4 billion and employs about 36,000 people. Most of the firm’s revenues are generated from its tire and cable busi- nesses. Along with Benetton, Pirelli has bought a controlling interest in Olivetti, the giant Italian computer and telecommu- nications corporation. As a result of this acquisition, Pirelli now has a 27 per cent stake in Telecom Italia, a telecom- munications, information, and communication technology company with annual revenues of $30 billion euros and a workforce of around 93,000 people. This acquisition has also brought both Benetton and Pirelli into the wireless telecommunications business.
These two examples, Fiat and Pirelli, are typical of the hold- ings and influence of large Italian families in the country.
Through their vast holdings and political power, they have been able to maintain a tight rein on various sectors of the economy. In addition, these family firms are protected against foreign investment by a secretive banking system that is headed by the Milan Bank, Mediobanca. This bank has fi- nanced nearly all of the takeover deals in Italy during the last 35 years. The bank also holds board positions on many of the country’s conglomerates.
On a macro basis, the Italian business system reflects the twin pressures of local family culture and the increasing de- mands of international business. Like their larger counter- parts, small and medium-sized family businesses are now using their personal and business networks to create MNEs that are branching out into the EU, as well as putting to- gether deals in both North America and Asia.
Websites: www.olivetti.com; www.versace.com; www.missoni.it;
www.benetton.com; www.fiat.com; www.pirelli.com;
www.montedison.it; and www.mediobanca.it.
Sources: Fred Kapner, “Pirelli Seeks Rumour Probe,” Financial Times, September 11, 2000, p. 18; Paul Meller, “European Panel Approves Takeover of Montedison,” New York Times, August 29, 2001, p. W 1; Richard Owen, Clive Mathieson, and Caroline Merrell, London Times, August 4, 2001, p. 43; “Flattering to Deceive,” Economist, August 2, 2001; www.olivetti.com;
Pirelli, Annual Report, 2000; and Juliana Ratner, Krishna Guha, and Fred Kapner, “Small Stake Won Control of Telecom Italia,” Financial Times, July 31, 2001.
INTERNATIONAL BUSINESS STRATEGY IN ACTION
the EU are subject to tariffs on goods exported to EU countries. Firms producing the goods within the EU, however, can transport them to any other country in the bloc without pay- ing tariffs. The same is now occurring in North America, thanks to the North American Free Trade Agreement (NAFTA), which has eliminated tariffs among Canada, the United States, and Mexico.
A sixth reason for becoming an MNE is to take advantage of technological expert- ise by manufacturing goods directly (by FDI) rather than allowing others to do it under a license. Although the benefits of a licensing agreement are obvious, in recent years some MNEs have concluded that it is unwise to give another firm access to proprietary information such as patents, trademarks, or technological expertise, and they have allowed current licensing agreements to lapse. This has allowed them to reclaim their exclusive rights and then to manufacture and directly sell the products in overseas markets.
Firms become multinational enterprises for the same reasons they engage in FDI. The next chapter will provide a more detailed examination of some of the reasons introduced in this chapter.
The strategic philosophy of multinational enterprises
Multinational enterprises make decisions based on what is best for the overall company, even if this means transferring jobs to other countries and cutting back the local workforce.
In the last decade IBM, ABB, and Sony, for example, have spent considerable sums of money to train and develop local managers to handle overseas operations because the com- panies are finding that these managers are often much more effective than those sent from the home country. MNEs also hire large numbers of non-managerial workers in overseas countries. For example, US-based GM employs 66,000 workers in Europe and 11,000 workers in the Asia-Pacific region; and European Siemens has 83,400 workers in North America and 46,000 in the Asia-Pacific region.8
As a result there is a great deal of economic interaction in the international arena, giv- ing business firms headquartered in one country a significant impact on the economies of other countries. This is true both when things are going well as well as when they are not.
For example, with the recent slowdown of the world economy more and more MNEs are now trimming their workforces. Alcatel, the giant French telecommunications equipment maker, announced plans to cut 29 per cent of its workforce and to reduce its factories to a dozen, using outsourcing to handle all other production needs.9Philips, the giant Dutch electronics firm, reacted to a severe slowdown in demand for mobile phones and semicon- ductors, and eliminated more than 7,000 jobs;10and Disney cut 4,000 positions, about 3 per cent of its worldwide workforce.11These decisions were made to improve the situ- ation of the company as a unit.
This same worldwide approach to operations can be seen in the way MNEs team up to get things done. One example is Embraer of Brazil, the fourth largest airplane manufac- turer in the world. The company teamed up with 22 of its main suppliers, many of which are Japanese, to introduce a new family of aircraft. Suppliers became risk investors and by funding Embraer’s plan secured future contracts from the company.12 For more on Embraer, see the Real Case in Chapter 4. Another example is provided by the production of the V2500 engine by a consortium led by US Pratt & Whitney and British Rolls Royce.
Other partners are Japanese Aero Engines and Germany’s MTU Aero Engines.13Simply put, MNEs make whatever agreements are in their best interests, even if this means bring- ing in firms from three or four different countries.