Why do some organisations become multinational enterprises instead of exporting from their home country
Pugel (2007) states that a multinational enterprise is ‘a firm that owns and controls operations in more than one country’. The home country of a multinational enterprise is where its headquarters is located, and then there will be branches located in one or more host countries. Multinational enterprises use foreign direct investment in order to finance their subsidiaries or branches abroad and to set up new affiliates in other countries.
Dunning (1992) described a multinational enterprise as one ‘that engages in foreign direct investment and owns and controls value-adding activities in more than one country’. Multinational enterprises don’t just provide finance to their all their subsidiaries though, but they also provide an array of intangible assets which the subsidiaries are able to use. The intangible assets which will be available for use could range from a strong brand name to trade secrets or managerial practices.
Multinationals are a big part of our society and Salvatore (2007) actually states that they account for around 25% of world output and intrafirm trade, this shows how important multinational enterprises are to our society. John Dunning’s eclectic paradigm sets out a framework to show why multinationals exist. First of all there are ‘firm-specific advantages’, these are
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These can include the use of secret technology within the firm, for example Dyson vacuums, or the use of highly regarded and developed brand names, such as Coca Cola, which is known to be one of the most recognizable phrases in the world. Other firm-specific advantages can include more effective management techniques, which will in turn have a positive effect on the productivity of the workforce; also a business may have marketing advantages over other firms if they focus a lot of skill towards highly effective advertising and promotional work.
Within Dunning’s eclectic paradigm the location factors are very important to try to determine as to whether or not a firm should export or become a multinational and use flows of foreign direct investment. David Ricardo’s theory of comparative advantage states that ‘a country will export the goods and services that it can produce at a low opportunity cost and import the good and services that it would otherwise produce at a high opportunity cost’. The theory of comparative advantage is a location factor because the availability of resources such as labour, land and capital differ from country to country.
For example it would not make sense for a multinational enterprise to produce capital abundant goods in a developing country and export them to lets say the United States or England where capital is more abundant; it would make more sense to produce those goods in the United States or England. Something that can have a big effect on firms is governmental barriers to trade. These can be in the form of tariffs and non-tariff barriers which could make it more difficult for a firm to export from their home country and more difficult to export into a host country.
For example, if lets say the UK government put a tariff on the amount of French cars the country can import, then it would be better for the French car manufactures to move production to England in order to release as many cars as they wanted into the English market. Or the local government could impose non-tariff barriers to trade, one example of which could be to set up technical and product standards which support local products and discriminate against foreign products.
Another location factor affecting multinational enterprises is trade blocs. A trade bloc is defined as a number of countries which allow free or cheap imports between members, while at the same time they impose barriers on imports from non-member countries. Trade blocs can favour the multinational enterprise as if a multinational has one of its affiliates located within a trade bloc then exports and imports will be able to move more freely. Speculation and oligopolistic rivalry can drive foreign direct investment.
Multinational enterprises may choose to set up an affiliate in another country just in order to do it before a competitor can, thus giving them more power and staying ahead of their competitors. Instead of exporting a business could simply sell or rent its firm-specific advantages to foreign firms for use at their manufacturing and production sites. This would solve the problem of high transportation costs, and reduce risk significantly. In some cases however this can be just as costly if not more so. In this case foreign direct investment in favoured into the host country.
If a business can be confident that it will have firm-specific advantages, internalisation advantages and location advantages from producing in another country then it should expand production into that other country, as opposed to exporting from the home country. However, when a firm becomes a multinational it will face such difficulties as language barriers. Language barriers are faced because of the movement into a foreign country, language barriers could cause communication problems between countries. This could result in poor coordination of the business and an unorganised workforce.
Another problem a multinational enterprise may face will be the knowledge of all the local markets which it operates in. This factor can give local firms an advantage because the multinational may not know the consumers wants and needs as well as local suppliers. They may also be unaware of any seasonal changes and trends that take place within that market place. The local government’s attitude can also play a part in the multinational enterprise. For example some governments may oppose them but others may encourage them to enter their market by luring them in with low corporate taxes.
Governments may encourage multinational corporations to enter their market because they will bring more capital to that country through foreign direct investment. They may also bring with them their technology and skills. Ranging from computer technology to highly regarded managerial skills. The multinational firm will also bring increased employment in the short-term, however could also bring more unemployment in the long-term if the multinational puts too much pressure on local businesses and forces them to close.
Governments in developing countries both fear and want the multinational enterprise to locate to their country. They need the multinational corporation to bring valuable flow for capital and foreign direct investment, however they oppose them because of the power that they have and can influence to government to make decisions which may benefit the organisation but harm the local people. As to whether or not a business should export or become a multinational enterprise it really depends on the business and the product.
If a business is operating within an environment which does not suit the manufacture of its product, for example if the business is highly dependent on labour and the home country is not labour abundant, then it would make more sense for that business to expand its production into a foreign host country where labour is abundant. Also if I firm can be fully confident that its overall costs will be lower by locating production to a foreign country then it should do so even though there may be high finance costs in the short-term, because in the long-term they will make back the initial money lost through lower costs.
Another factor a business must weigh up is the environmental one. If environmental pressures are very heavy in one country, and there are strict rules on pollution then capacity may be increased by producing in another foreign host country where environmental pressures are more relaxed. This is the reason for some multinational corporations to locate to developing countries where they can have more power over the governments and can influence them more than what they would be able to in developed countries.