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Why do Multinational Companies Exist?

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Published: Mon, 17 Jul 2017

According to Needle (2010), Multinational enterprises are those enterprises which carry its production activities in more than one country. These companies make sure of the supply of raw material to the other country they are operating in. As per Buckley and Casson (2009) many of the multinational operate in different country because of many reasons such as low labour costs, serving a huge market, cutting of their taxes and production costs, innovation in technology and exploitation of resources.

According to Dickens (2011), today we are living in borderless world as there are no boundaries that exist between the countries or nations. Globalisation is the new trend changing the political and cultural order of the world (Buckley and Ghauri,2004). Every operation that has been carried out by companies goes around the world. Innovation is growing very fast and so do competitiveness.

Globalisation can be define as “the increase in the frequency and duration of linkages between countries leading to similarities in activities of individuals, practices of companies, and policies of governments” (Czinkota 2005). From the statement we can say that companies go global because of many reasons as now the countries are linking to each other to share the information and wealth.

As said by Rugman and Verbeke (2005), Firms become multinational because they want to grow, expand and diversify their operations. Operating in their home country won’t satisfy them so they go global. Using the resources of their home country make it obsolete or bound them in a limit to not to go further. Then firm decides to go global by making investment on their further growth.

As argued by Madura (2008) following are the theories which a firm follows when it globalises such as:

  • Theory of Comparative Advantage
  • The Imperfect Markets Theory
  • The Product Cycle Theory

As explained by Madura (2008), Comparative advantage theory says that when countries specializes or have expertise knowledge in one field than they don’t waste their resources or energy on research of other field, they share or trade with other countries to share their expertise field. They take advantage of their expertise knowledge and become a head in comparison with others. Labour force is skilled and lower in cost in India and China as compared to western countries. They can be transported or hired for the operations for other companies. Companies such as Intel, IBM, Wipro operate in different countries because to utilise their efficient resources. These companies are operating in India, having their call centres outsource sharing the expertise knowledge in the field of Information Technology as India produces a large amount of IT experts.

Imperfect market theory says that if the markets of a country stop trading with other countries than there will be no international trade. As per Dewey (1969), if the markets of the countries were perfect then there would be an easy transfer of resources from one country to another. Factors of production like labour, raw material, machines and capital can be transferred wherever they are demanded. This temperament of deal between the countries creates a similarity in costs and removes the relative cost of advantage, global trade and investment. In today’s world there are situation when imperfect market conditions arises, where transfer of labour and other factors of production is restricted at some level. For example, MNE’s such as Gap and Nike take advantage of the resources related countries. Imperfect market offers these companies to exploit their market and cross the trade barriers of import and export.

According to Madura (2008), in Product Cycle theory, firms establish first in their home country by utilising all the resources available in the market. In home market they have an advantage over competitors. After operating in home market firm feels to expand their operations by entering into foreign market and producing their products overseas, reducing their transportation cost and other cost of production. There are existing competitors in the global market and to compete with them they introduces new technology and products in the market. For example, Dell, Lenovo, Toshiba are the companies who spent lot of their resources in their research and development for the latest technology.

As argued by Kapoor and Grub (1973), firms motivate themselves to become multinational enterprises because of the foreign direct investment that helps in crossing the trade barriers to other countries. They also explore different cultures and management structure followed in different countries. Firms become multinationals in order to reduce the risk of foreign trade and become politically and economically well established. By going global they create a good relationship between the nations and create a name and goodwill to the firm. For example, many of the American companies are going global as they now operating their activities in the growing economy of different countries such as Brazil, China, India, Russia etc. Many of the emerging market companies such as HTC, Samsung, Nokia etc. are also spending on their research and development and sharing the information on technology sector.

According to Markusen (1995), as he explains the Dunning’s OLI framework that there are three advantages in which a company can have direct investment. Firstly, Ownership advantage is when a company has trademarks and copyrights of producing a product line and no other company can duplicate their product. Secondly, Location advantage is there when a firm creates his monopoly in a particular region serving a large amount of society. It is done as the foreign market offers the low cost of production to firms which make it profitable for the firm to serve that region. Thirdly, Internationalisation advantage says that if there is a market to cater than instead of going out there and start a new production unit, it’s better to license and sell your technology to a company and they will produce units for you.

As stated by Madura (2008), there are some ways by which firms become multinational enterprises.

  • International Trade
  • Licensing
  • Franchising
  • Joint Ventures
  • Acquisitions of existing operations
  • Establishing new foreign subsidiaries

According to Hill (1994), International trade means exporting and importing of goods and services between different nations and different companies. If a company start facing losses that it can reduce or stop exporting or importing from different countries as there is no huge investment involved in it. For example, many of the U.S. firms such as Microsoft, IBM, General Electric generates there huge amount of revenue from import export.

As argued by Needle (2010), Licensing means that a firm uses several modes such as copyrights, trademarks, patents etc. to register their process of operations or the technology they use. They can transfer or share their technology with others according to their wish with low capital involved in it. For example, in India all the parts of telephone communications are manufacture by AT&T and Verizon Communications as they have a licensed agreement. All the drugs that are produced and exported to Hungary and other countries are made by Eli Lilly & Company.

It has been argued (Spinelli et al. 2004) that Franchising means when a company authorizes its residents of the same country or other country to open an outlet using the brand of the company. Its market policies, product line and the franchisee have to follow the protocol of the parent company. In return to this the franchisee has to pay a royalty fee to the company periodically. For example, McDonald, Pizza Hut, Subway sandwiches have many outlets in many countries that are operated by the local residents of the respective countries.

As per Yan and Luo (2007), in Joint Ventures two firms come together to achieve their common goal in the competitive market. In ventures risk sharing ratio is equally divided for the defined project and there should be a mutually understanding between them. These enterprises are also politically acceptable in different nations. For example, Nestle has a wide distribution of its home products throughout the world. So there has been a joint venture between General Mills Inc. and Nestle to distribute the cereals produced by the General Mills by using the distribution channel of the Nestle.

It has been argued (Reed et al. 2007) that acquisition of existing operations means that the company acquires the existing competitors in the local market or in the foreign market. A company takes over another organisation as they incur heavy losses and cannot operate in the competitive market and also to vertically or horizontally integrate. A company explores the resources of another company and take advantage of the already setup done by that company. For example, Procter and Gamble acquired a bleach company situated in Panama.

According to Rugman and Verbeke (2005), another way of entering in global world is by establishing new subsidiaries. The large organisations create or distribute its departments into different companies and are wholly or partially controlled by the parent company. The main organisations are called the parent company and the other is known as holding companies. If the company is totally owned by the parent company that their stock is also owned by the parent company. There is always a protection of technology as the information is not leaked out. At the same time it also involves high costs and risks in the foreign market. For example, a truck company called Overnite Transportation is a totally purchased subsidiary of Union Pacific Corporation.

Conclusion

At last it can be said that, the role of MNC in developing itself and the nations are very important. It in one way helps to build and economy by various advantages. At the same time it can have different repercussions if not properly strategized.

The above description gives all the major points in making of an MNC. Also the essay describes the various parameters needed in making of an MNC.


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