Dimensions of Global Marketing Risk Benefits and Opportunities.

Chapter Coverage

Types of Global Marketing firms. Multinational Corporations: Conceptual Frame work of MNCs; MNCs and host and home country relations; Technology transfers – importance and types.

MNCs and World TradeWays of defining an MNC

1. Enterprise that controls and manages production establishments in 2 or more countries.

2. A corporation that owns controls and manages income generating assets in more than 1 country

3. Enterprise that controls and manages production establishments in more than 1 countries.

Common points

1. Owns productive assets in more than 1 country2. Exercises managerial control over affiliate industry. Eg. Royal dutch

co, BAT

Other definitions that overseas activities of a company must be as great as domestic activities for a company to constitute a MNC.

Major growth in MNC after 2nd world war.1. International travel2. communication, postal system, internet3. peace, 4.multilateral trading system,5. stable yet adjustable exchange rates, 6. currencies convertibility, 7.Regional trading blocks,8. WTO, 9. IMF, world Banks: . International economic

institutions

US companies played lead role. 1. Dollar was short and European nations were keen to attract U.S. investment2. US wanted larger markets to ensure adequate expansion and capitalize on

technological lead it acquired.3. Domestic markets saturated 4. Exports faced steep tariffs and non tariff barriers.5. Anti- trust laws prevented rapid expansion in domestic market within US6. Oligopolistic character of market- Companies didn’t risk upsetting competitors.

Main market was West Europe since :consumer with similar tastes available, Hi per capita, Establishment of EC meant removal of intra European tariff removal, common external tariff plus non tariff barriers, transport costs – It was better to produce in Europe than to export for the US companies.

In 70s Locations for US FDI changed.- US MNCs sought new locations in Latin America and middle/ Far East. Europe was not that attractive cos of Equalizing wage rates, employment protection methods, social security, European trade unions who resented American way of working, fall in value of Dollar against European currencies , challenging competition from European producers. US products had lost their novelty value in Europe. Low cost locations looked in favour as base for exporting back to Europe or US.

Europeans sought low cost locations to compete but ironically Europeans set many MNCs mainly in other European countries even as tariffs were being cut between them. However continuance of Non tariff barriers and consumer preferences kept European market fragmented. They now sought distant locations.

Discovering their ability to challenge US dominance, at one time EU FDI in North America was 4 times of US in EU then began to decline

Japan traditionally preferred exporting to investing abroad. Now in 80s they followed the European model. Then invested in SE Asia to overcome rising wage rates in Japan. Restrictions to outward investments were lowered and investments were made in NA and west Europe to circumvent trade restriction imposed by these countries against Japanese products.

Yen appreciated- lowering export from Japan. Japanese FDI increased. Recently the FDI from Japan in growing proportion went to east and South East Asia. Reasons: low cost of production + markets.

As exchange controls were lifted S. Korea, Taiwan became net exporters of FDI to relocate production to lower cost of production and to bypass trade restrictions. Mainly to SE Asia and China. In west mainly as ‘screwdriver’ companies

Majority of MNCs from developed worldMNCs from developing countries growing in percentage.Majority of foreign affiliates in developing world 45%, china- 17%,Us and Canada-8%

Trends:

  Inward Outward

UK Primary sector Primary sector

Canada Manufacturing Manufacturing

Japan Manufacturing Services

Germany /US Services  

Increase in FDI in services because services have to be physically present in foreign country as they cannot be stored

Determinants of FDIHorizontal

Co. locates same product or group of products in many countries.

Reason – Market imperfections

Vertical Co. locates different stages in

production or marketing of a single product or group of related products in different countries.

Backward: when new subsidiary produces at an earlier stage in production or marketing: refinery takes to extraction.

Forward: when new subsidiary produces at an later stage in production or marketing: driller to set up refinery

Reason : Factor proportions at various stages differ significantly.

Conglomerate: co. acquires controlling interest in or amalgamates with foreign co. which produces entirely unrelated product to diversify

Vertical disintegration 1. One form may be that MNC sets up subsidiary to perform specific stage in

chain of production and distribution eg offshore assembly.2. Another that separates production activities from non production or

headquarter activities eg finance, R&D managerial. Maximum use of difference in in factor proportions required at each stage of production. Factor prices are different reflecting factor endowmwnts, so cost advantage is gained. NIDL requires much better division of labor than in past.

3. Eg: Textile and consumer electronics industry. As per stages:1. conception and development- Industrialised nations2. Production of components- capital intensive, specialist plants -Industrialised nations3. Assembly and testing-: cost of labor: Developing nations

First Japanese pioneered off-shore processing., then U.S and then west Europe followed suit

Factors that favor vertical disintegration1. Technological:

1. Products as assemblies of standardized components.2. With ease subset of components could be varied in many versatile products.3. Large scale component products allows economy of scale.

2. Transport: containerization made shipping cheaper besides other factors.

3. Rural –urban migration: As rural worker move to urban areas availability of cheap labor increases.

4. Lower co-ordination costs: Telecom revolution, management education spread.

5. Reduced trade barriers: regional and multilateral liberalization through trade blocks and WTO. Offshore imports of assembled goods using components from importing country need only pay tariff on the value added abroad.

6. Low cost sites: created by developing nations: SEZ, EPZ give foreign investors specially designed infrastructure like port facilities subsidized electricity. Also allow tax privileges and import of components and parts without paying import duty.

7. Rising incomes increased demand for finished and intermediate goods

Factors favoring Horizontal rationalization

• Same as those of vertical Disintegration plus-1. Need for long production runs for each differentiated

product that an MNC deals in.2. Advantages of specialization. Better to make 3 types of

products in 3 different specialized plants in 3 markets and export ;than to produce all 3 in each plant with restricting market size.

3. Cost saved by specialization must offset additional cost incurred in transporting the goods.

4. Harmonization of technical standards and regulations.

Net effect

• Both horizontal and vertical rationalization enhance trade and are nor trade displacing.

Types of Foreign investments1. FDI – investment to set up new overseas subsidiary or controlling

interest in another overseas co. 2. Portfolio investment: purchase of interest bearing securities by

individuals & companies3. While Portfolio investment comes in form of dividend nor fixed interest

because of differences in yield of interest; FDI motive is not higher yield but to establish operations abroad.

4. Portfolio investments exceed FDI – Desire of investors to spread risk combined with higher returns and quicker financial gains. Also taking advantage of exchange rate fluctuations or to cover risk thereof.

5. While Portfolio investment entails financial or money transfers FDI is a package of which financial or money transfers is just a part of the bundle, others being

Ownership.Provision of management expertise.Exercise of controlPossibly technology transfers.

FDI

• Flow of direct investment abroad is a measure of new direct investment activity taking place each year

• Net flow = difference between gross outflows – net inflows

• Unremitted profits and reinvested profits of an affiliate are included in Outflow.

• Expansion abroad by raising funds abroad are not included in measure of flow of investment though it adds to the stock of investment held abroad.

• FDI growth has been happening in both stock and flow terms

FDI’s reasons

1. Substitute to exporting2. Efficiency seeking reasons in production of product or a

stage in production.3. Growth in intra firm trade for opportunities in transfer prices

where MNC choose to use prices for internal sales which are significantly from market determined prices.

4. Growth in intra industry FDI. 1. To enjoy certain firm specific advantages not possible

by exporting or licensing etc.2. Transferring to parent firm intangible firm specific asset

like knowledge.3. Enjoy location specific advantages.4. Different countries enjoy different firm specific

advantages exploitable in other similar markets.

5. Innovation needs R&D. PLC short so need to maximize returns on R&D quickly. Even patents are circumventable so there is incentive to internalize markets.

6. Strategic Advantage: high levels of intra industry FDI will lead to oligopoly. Uncertainty increases. Firms cartelize but don’t allow rivals to get any competitive advantage.

• Backward integration ensures that rivals cant cut supplies through taking over main supplier.

• Early entry to stop rival from first mover advantage.• Early entrant may also exert pressure on govt to restrict import

thus depriving rivals of access to market.• Fearful of being pre-empted rivals follow suit.• counter attack by leading firms of a country when foreign

companies set up subsidiaries in home countries.• Technological listening points: MNCs set up subsidiaries to keep

abreast of changes in market environments eg: Japanese fuel efficient cars

FDI’s reasons

How FDI is done

• Establish distribution outlets• Production plants• FDI may substitute trade so it could be described as

trade displacing.• Also may seek to integrate activities in different countries

to improve efficiency –then they result in increased trade.

• Breaking production process in series of different stages, each of which is located in different countries – vertical disintegration or NIDL (New international division of labour). Other being horizontal basis.

FDI- modes of doing it

• Greenfield venture: setting up entirely new subsidiary abroad.

• M&A: acquiring controlling interest in existing foreign company by buying shares.

Intra Firm Trade

Majority of world trade carried on by MNCsIn this sizeable proportion of Intra firm trade

• Intra-firm – Trade between MNC parent company and it’s affiliate

• Intra-affiliate- Trade between 2 or more affiliates of same parent company.

Arms length trade is trade between buyer and seller who are unrelated in ownership.

• Affiliates are defined as companies in which parent company has 10% or more stake

• Subsidiary is an affiliate company in which parent company owns majority stake. Also called MOFA (majority owned foreign affiliate)

• Intra firm trade was higher in manufacturing than semi manufacturing and Semi Manufacturing intra firm trade was higher than Raw materials.

• Intra firm was higher for industrialized nations.

Intra firm trade was dependent on following factors:• Technological intensity or degree of product specificity-

direct relationship. Incase of intermediate products specificity stimulates internalization through vertical integration.

• Divisibility of production process- direct relationship• The degree to which the industry is diversified globally

(ratio of foreign to domestic investment): direct relationship

• Need for after sales: direct relationship• Pollution sensitive products: direct relationship for

developed countries• R&D industry: Internalization greater if asset to be

transferred is Knowledge.• Transfer pricing

Factors affecting Intra Firm trade

Transfer pricing

• MNC uses prices on intra firm trade that diverge from prices used in equivalent arm length transactions. Prices thus may not be market determined.

• May happen even in case of licensing agreements, subcontracting etc but the prices may not be as much manipulated as in wholly or largely owned MNC

• Transfer price may just not be linked to trade transactions. MNC may divert funds through non trade channels like payment of fees to parent company, payment of royalties for licenses covering patents, or interest on loans.

Motives for Transfer prices

• Differences in taxes. Developing nations cannot get a fair share of profits because they cannot maintain a policy of hi taxation.

• Prevent double taxation: policy of industrialized nations to deduct taxes paid in host countries from tax payable when the profits are remitted back to the developed country.

• A built in incentive to retain profits abroad: Any profits earned abroad but not repatriated are not subject to reassessment for tax. Eg US. Known as deferral rule it applies to OECD (organization for economic co-operation and development.) (Mainly western industrialized nations)

Other ways of global presence

• Govt may not allow acquisition by MNC but may be prepared to allow on joint venture basis.

• Licensing: local firm pays share of profit to foreign firm. Popular because the MNC does’nt have to risk of making actual investment in foreign country.

• Pooling efforts to become more competitive may be a reason rather than access to market. So they can go for strategic alliance for limited time in agreed areas of activity.

• Counter trading or barter trading: Due to lack of foreign currency countries may pay partly for imports and the rest by supplying other goods or services.

Licensing

• Does’nt involve transfer of equity capital.• Agreement between owner of body of some knowledge (Brand,

Patent, Design, trademark etc.) with a potential user.• potential user may pay lump sum or Percentage of profit to owner of

body of some knowledge as royalty or fees.• Means for MNC to earn profits on an asset with incurring risk of

investment.• potential user may be independent firm or subsidiary of latter

company.• Where licensee is unrelated licensor may also acquire equity stake

in the licensee to gain higher control over the use of technology sold.

• Licensing agreements may involve accompanying management services and provision of technical info ancillary to the technology involved.

Licensing (cont.)• Clauses are designed so that the proprietor has some control

over use of technology or at least cost of losing control are minimized.– Information may not be passed on to another company.– Restricted to a geographical area.– Product produced may be of standard quality.– Requirement to purchase components or further technology from

licensor.– However home countries may intervene to outlaw some of these

restrictions.– Licensee may disregard some clauses if penalties are low.– Where control over technology is important FDI is preferred to Licensing.– Where knowledge is mature and likely to be shortly obsolete licensing is

preferred.– Important where host country prevents setting up or acquiring

subsidiaries.– New entrant not prepared to undertake investment can gain initial

access to foreign market.– Very common for West European and US companies to gain access to

Japan after Japan imposed tough restrictions on FDI

Strategic Alliances.

• Common to buy minor equity stakes in each others companies but it is not about capital transfers.

• Form of international collaboration which links aspects of business.

• Contract for providing some co-operation for some period of time.

Strategic Alliances.

• Technological collaboration – to spread cost of R&D and development.

• PLC short so advantages must be increased from global co-operation.

• Joint sourcing of components • Joint marketing.• To gain entry into some markets.• Synergy savings when firms in alliance have strengths in

different areas.• Cost of setting up and administering an alliance is much

lesser than Joint Venture.• Less risky and can be terminated at any time.• To reduce competition as defensive reaction of each rival-

sometimes

Counter trade

• Form of trade that involves element of reciprocity.

• Pure barter is rarely the case.

• Transactions may be separated in time.

• Aims to equalize or partially balance Foreign exchange expenditures.

Forms of Counter Trade

1. Pure Barter: – Usually less as percentage of counter trade– Generally between governments– Involves double co-incidence of wants.– Both transactions must be exactly of equal value.

2. Counter purchase:– Reciprocal purchase agreements.– Also called compensation Trade.– Import value may not match export value.– 2 separate contracts.– Usually within a specified time period.– Main reason is not lack of convertible currency but to balance

Import and export.

Forms of Counter Trade

• Buyback: supplier of capital goods is paid back by part of resultant output.– Usually for longer periods- common in

process plants or mining equipment.– Control over quality of output is a concern.- so

insistence to be allowed to exercise quality control.

Forms of Counter Trade

• Co-production agreements: Developed country produces sophisticated goods and developing produces less sophisticated goods.

• Both gain access to each others’ markets.

• Developed country company takes advantage of low cost Developing gains access to hi –technology.

Forms of Counter Trade

• Bilateral agreements and clearings:– Variety of agreements between countries that attempt

to roughly balance exchange od goods and services over a specified period of time.

– Special account is opened in each country’s central bank.

– Each country is paid in credits for exports.– These credits are used for imports.– Clearing currency is specified for settling the balance.

Forms of Counter Trade

• Switch trading: Long term payment imbalances may accrue.

• Large unused credit balances accumulated by one country may be resold to third country for convertible currency.

• Certain banks and trading houses with specialist knowledge act as switch agents

Importance of counter trading

• Mainly done by developing countries:

– To ensure increased export sales for their products.– Important for centrally planned economies like

eastern block and China to control Balance of payments. (State exercises monopoly control of foreign trade)

– Used as method of trade finance by countries with lack of foreign exchange.

– Developing and obtaining vital technology: • 1. Developing country pays for capital goods by products.• 2. Agrees to buy certain products on receiving development

aid from developed country.