How and why firms go international or multinational
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Published: Mon, 5 Dec 2016
One of the most modern approaches followed by almost all corporations in the 21st is internationalization, where a successful firm ventures into the foreign markets and decides to go global in approach, which in turn converts these flourishing domestic businesses into Multinational enterprises (MNE’s) and improves sales and build brand reputation. One of the key features of an MNE is that although it has the company headquarters in one country, the production and operational activities are set up in more than one country for a number of reasons such as cheap labour sources, obtaining raw materials, advantage of tax differences and the protectionist barriers.
There are several important characteristics that are adopted by MNE’s such as large size of the firms and itsinternational activities which are centrally governed by the parent firms. Such organisations, as a result of their experience, are also better able to adapt and respond to micro and macro environmental factors such as suppliers, competitors, customers, the government and other stakeholders as well as the political setup of a country, its economic policies and systems and the local culture. It also aims to gain access to the natural resources of new, potentially unexplored markets as well as to assets, patents, human resource and technical and managerial knowhow. These aims are fulfilled through strategic alliances with local, domestic companies ready to share and work towards a common goal.
Why do firms go Multinational?
There are various reasons as to why a company decides to go international.The Dunning Eclectic theory or the OLI paradigm highlights the advantages of these multinational corporations going overseas. Some of these have been outlined in detail as follows:
Ownership Advantages: Ownership advantages are usually intangible and can be transferred within the multinational firms at a cheaper price. The firm would possess monopolistic advantages as they would get easy access to the resources which are scarce in the home country of the firm. The barriers to entry would also be high, due to high setup costs of the business. They also possess the share of technology and information from the countries in which the expansion takes place that helps the firm.
Besides gains for the MNE, the host economies are also at a benefit. These MNC’s generate large amounts of employment opportunities and bring with them high levels of managerial skill and globally employed advanced technology. Since the firm has high buying power, the advantages of economies of scale also become realistic and thus, very prominent.
Location Advantages can be broken down into three major categories:
Economic advantages: Relate to all cost and revenue related factors such as low costs of raw materials, low transportation, storage and distribution, and the resulting development of economies of scale and scope, the large size of an unexplored market, and so on.
Political advantages include the nature of an economy, the government’s policies, systems and the overall bureaucratic setup. Lenient policies affect and encourage inward Foreign Direct Investment (FDI) flow, intra-firm trade and international production.
Socio-cultural advantages include the ability to adapt to the culture the firm wishes to operate in in terms of overcoming language and cultural barriers (such as, it may be easier for an American firm to expand into the UK rather than into China), distance barriers (it may be easier to invest in a neighbouring country rather than otherwise), general attitude towards foreigners and so on.
Internalisation Advantages: Internalisation is the process by which the activities are kept directly within the firm’s control. The key advantage is that it would reduce the transactional costs and no threat of principle agent problem to the organisation.
Another reason why companies expand is to gain access to knowhow regarding the international business environment and facilitate innovationand generate ideas. Novel ideas and concepts help organizations adapt to new markets and grow into other areas as well as diversify their product and service offerings, thus, minimizing risk and instability.
Internalisation is the process by which a firm’s activities are kept within the umbrella of the firm. The process of expansion in other markets of the world involves different factors. A business which fulfils all these criteria can also in some cases be advised against expansion. There are numerous advantages of internalisation, such as secrecy of research and no leakage of information.
Global investments are valuable because sometimes these firms or establishments manage to gain more profits in the host countries than their own home countries. One of the main reasons for this is that the masses of these countries are ready to explorenew flavours and experiment new products since they would be imported. Also there are some people who want to buy these products but couldn’t do earlier as ordering them online were not very popular then.
How do Firms go Multinational?
Multinational firms seeking for an opportunity to explore International markets have to consider crucialentry decisions as these markets involve high risk and uncertainties. The three basic decisions that a company contemplates before expanding into the foreign markets include the decision as to which market to step into. Another important issue is to understand the political and economic issues that eventually affect the attractiveness of a foreign market. It is also vital to lookout for factors such as the market size with respect to the demographics, the purchasing power of the consumers and the expected growth of the country in the future. Time of entry into these markets plays a key role, for example it may not be practical to expand or enter new markets during times of recession and vice versa during periods of economic boom. Lastly, the multinational enterprise has to consider the mode of entry besides deciding on whether to enter the market on a large scale or a small scale basis. Not many firms have the resources to enter a particular foreign market on a large scale. Firms that are established in large scale in their home country prefer to enter at a small scale into other nations which enable them to build brand reputation later on.
The options with regard to the mode of entry include the following:
Indirect and Direct Export: Companies usually start with indirect exporting as they have potential advantages like less risk as the independent intermediaries brings in experience and services to the relationship, therefore seller will make lesser errors. Direct exporting where firms handle their own exporting activities and the initial investment and risk are much higher but high returns are more likely.
Licencing & Franchising: Licencing involves one firm permitting another firm license for a limited period to use its patent, trade secrets or other item for a fee or royalty.
Franchising is very similar to licensing, involving an agreement between two firm in which one firm allows other to use its brand name, technology, methods to market and produce the product.
For example: Mercedes-Benz, from the family Daimler AG in Germany has setup its headquarters in Dubai in the UAE.The Multi-national giantshave franchised their operations to the locals in the host countries operating in the Middle-East. The company Gargash Enterprises L.L.C has obtained a dealership as a sole distributor, through franchise agreements with Daimler AG to sell Mercedes-Benz vehicles in Dubai and Northern Emirates. The strategy was adopted keeping in mind the local image and the cultural adaptability of Gargash Enterprises L.L.C. in the Middle-East.
Joint Ventures: Joint ventures (JV) are contracts or agreements between firms often setup in different countries to operate in cooperation with each other as a single corporate entity and share profits and losses through the execution of a business or undertaking. The core issues JV should take into account before entering would be ownership, length of contract, control and pricing agreements etc. The best example for joint venture operations in India would be Marks & Spencer with Reliance Retail Ltd. The prime advantage would be easy access to enter the market, joint product development, local knowledge and technology, consumer behaviour and cultural adaptability.
Direct Investments can also be categorised as Foreign Direct Investment (FDI). Here, the multinational enterprise directly enters the market and owns the facility of the target country. FDI can also be made in the form of an acquisition of an existing firm or by setting up an entirely new enterprise. It basically comprises transfer of technology, resources which include capital and also skilled labour.
The firm looking to directly invest into a foreign market should possess high level of resources and the ability to understand the consumers and their competitive environment. Nevertheless, it is essential for them to bring in high degree of control and commitment to showcase their strength in the new markets.
Multinational corporation- The Journey continues…
Companies nowadays are always on the lookout for potential internationalization opportunities in new unexplored markets like China, India and the Middle East. Such expansions are aimed at accessing the domestic country’s natural resources, availing the advantages of cheap labour, sale of products for profit maximization, and the overall growth and development of the business. However, the irony of the condition is with the recession that has hit globally, will we see the birth of internationalization of firms or would we witness companies that will be ready to take up the challenge of universal growth?
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