Why Firms become Multinational Enterprises

Keywords: why do firms become multinational

Introduction

One of the important aspects of globalization is the international transformation of the companies around the world. The companies have evolved from being a domestic firm to a multinational corporation and being present almost everywhere in the world either physically or via internet. These international companies are regarded as true MNCs only if they have made substantial direct investment in foreign countries and have actively and continuously taken part in the management of these assets (Barlett, Ghoshal, p2). Though the companies had started the internationalization process as early as in the seventeenth and the eighteenth century when the developed nations moved towards the under developed ones for acquiring key resources and in search for markets, but the latter part of the twentieth century and the beginning of twenty-first century witnessed a huge expansion in the extent to which the firms go international (Barlett, ghoshal, p1). The internationalization process has transformed greatly due to the evolution of the motives and the way firms integrate and expand their businesses around the world. There are both proactive and reactive motivations for a firm to go international. Proactive motivations are evident in firms that see a need for a strategic change and want to go international; whereas reactive firms are those that go international because they have to in order to deal with the competition from the domestic firms growing internationally as well as the foreign players entering the domestic market. (Czinkota, The Export Marketing Imperative, 2004, pg 4). This essay discusses these motives for firms to become MNEs and how they go about it.

Why firms become Multinational Enterprises

In the increasingly global business environment, many companies cannot afford to be under the assumption that their domestic markets will always be profitable. For this reason, many companies start with selling their existing products to the countries which have more number of consumers (e.g. China and India) or where consumers have more purchasing power (e.g., USA) (Rennie, Michael W, 193). This arises from the primary profit-seeking motive of the companies but also helps them to increase their brand identity and global presence (Czinkota, p4). These companies then customize their product line according to the country in which they are selling in order to expand their customer base and tackle the competition from the domestic players. So increased sales are a major motive for a company’s expansion, and in fact, many of the world’s largest companies – including Volkswagen (Germany), Ericsson (Sweden), IBM (United States), Michelin (France), Nestle (Switzerland), and Sony (Japan) – derive more than half their sales from outside their home countries (UN Conference: Promoting Linkages, 2001).

Another motive, which arose from the firms going international, was seeking cost effective resources to propel production for local and foreign markets. As the firms expanded geographically, they needed to attain competitive advantage over other foreign as well as the domestic companies. This drove them to invest abroad in countries where resources needed for production were available at low cost (Cosmin Sabau). In the earlier days, these resources included mainly the natural resources like rubber, steel, aluminum, etc., for example, crude oil was sourced from gulf countries to meet the shortfall in the domestic supply of crude oil. Today, it includes low cost land, labor and capital as well. This helped in lowering their cost of production and offering competitive prices to the customer. Sports good companies like Rawlings rely largely on labor in Costa Rica, a country that hardly plays baseball, to produce baseballs (Philip Hersh, 2009).

The motivations to expand internationally however changed gradually in response to the great organizational and technological forces (Barlett, ghoshal, p6). One of the major contemporary motives is achieving economies of scale. It was first noted by manufacturers in the military aircraft industry in the 1920’s and 1930’s that direct labor costs decreased by a constant percentage as the cumulative number of aircraft produced doubled. By increasing the cumulative output and exporting to a larger market, the companies can bring down their cost of production by 20-30 percent (Ghemawat).

Many companies establish foreign research and development (R&D) facilities to tap additional scientific resources, sometimes acquiring useful knowledge in the process (Heather Berry, 2006, p 151-168). Avon, for instance, applies know-how from its Latin American marketing experience to help sell to the US Hispanic market (Nery Ynclan, July 23, 2002:EI). Yet another motive for companies going international was shortening PLCs (Barlett, ghoshal, p6). As the life of a product became shorter, adequate returns for all the research and development done for the product could be made only by introducing the product to multiple larger markets. In addition companies nowadays aim to launch the product simultaneously in as many markets as possible to enjoy the maximum returns before more firms start producing substitutes.

How firms become Multinational Enterprises

Internationalization is a very crucial and strategic decision that a company takes in its lifetime. Certain prerequisites need to be met before a firm can think of nationalizing and becoming an MNC. The first one is high country attractiveness. The country should be able to offer something that will promise a competitive advantage for the company or something that can help the company sustain its existing competitive advantage. Another prerequisite is the ownership of strategic competencies. The company should have some competencies that will help it counter balance the incognizance of foreign markets and environmental conditions. Also, the company should have some organizational capabilities that will increase the ROI by leveraging the company’s strategic strengths intensively. These three prerequisites are essential for selecting the mode of internationalization and the mode of country entry that will help the company compete in world business. (Barlett, Ghoshal)

There are many methods adopted by companies to internationalize and conquer foreign markets. The earliest method used by firms in their process of becoming MNEs was exports and imports. This may include both merchandise exports and imports and service exports and imports. Service exports and imports may be tourism and transportation, service performance and asset use. Some services earn payment for the companies for the performance of those services. For example, the companies may pay fees for turnkey projects which are transferred to the owner once they are operational. Management contracts also earn the companies fees for the performance of general and specialized management functions for another. Asset use includes Licensing, Franchising, etc. Licensing is the process of allowing another company to use its intangible assets like patents, trademarks, copyrights, or expertise, under contracts known as licensing agreements for which they earn royalties. Example. Franchising is the process of business in which a company permits another company to use the trademark as an asset of the franchisee’s business. The franchisor will help the franchisee by supplying raw materials, management services etc. and also will lay down guidelines and standards that are to be followed by the franchisee. For example, McDonald’s has franchised its outlets in many countries like UK, India, etc. In many circumstances, a multinational with an exclusive technology may fear that a licensing contract lead to dissipation of its proprietary knowledge. In that case, setting up a foreign subsidiary is a preferable strategy. (http://cep.lse.ac.uk/pubs/download/CP167.pdf)

Another method of expanding globally is by making investments on the foreign countries. Foreign investment implies ownership of foreign property in exchange for a financial return. There are two forms of foreign investment: direct and portfolio. The foreign direct investments (FDIs) confer the investor with a controlling stake in the company. For example, when Nintendo’s CEP bought the Seattle Mariners, the baseball team became a Japanese FDI in the US. Although the control in the foreign company need not be full; even with a minority stake and the remaining ownership widely dispersed, the foreign investor can take decisions that cannot be vetoed by any other owner. When the ownership of the company is taken by more than one company, it is called as a joint venture. Today, at least 61,000 companies worldwide control over 900,000 FDIs in every industry (UN Conference: FDI from Developing and Transition Economies, 2006, p 30-31). On the other hand, the foreign portfolio investment is a non controlling interest in a company or ownership of a loan made to another party. This can be in the form of stocks in a company or loans to a company in the forms of bonds, bills, or notes purchased by the investor. They are comparatively safer than FDI’s in terms of risk.

Conclusion

The changing extent, character and geography of MNE activity over the past two decades is itself a reflection of a series of path-breaking technological, economic and political events. But internationalization is not a “one size fits all approach” have different motives to go global and do it in the way that best suits their business models and gives them maximum returns. Whichever method a company adopts, it goes through a learning process and increases its knowledge throughout the process. Internationalization has indeed become the need of the hour for companies to sustain their businesses in the long run and develop company’s strategic and organizational capabilities.