Various entry modes into foreign markets: advantages and disadvantages Entry modeAdvantageDisadvantage NO OWNERSHIP INVOLVED Exporting from home production scale economy;trade barriers; trade secrets kepttransportation cost; local marketing: by whom? Turnkeylittle financial risk;may create efficient contractspossible where competitors; FDI prohibitedno long-term presence Licensing low cost, low risks lack of control over your own technology Franchisinglow cost, riskslack of control over quality; global strategic coordination difficult

Entry modeAdvantageDisadvantage OWNERSHIP INVOLVED Joint venturesaccess to local lack of control partner's knowhow over technology; in marketing, slow decision making personnel management, local government; shared risks and cost Fully owned protection ofhigh risks and high cost subsidiarytechnology; fast decisions BUSINESS DECISION: which mode of foreign entry?; what share of ownership, if ownership involved?

SOME THEORIES ON FDI Efficiency considerations lead to various forms of FDI organizations HORIZONTAL FDI: your FDI in the host country is in the same industry as in home country (e.g. following customers) BACKWARD VERTICAL FDI: provides inputs into your home operation (e.g. resource FDI) FORWARD VERTICAL FDI: receives from you the inputs produced in home country (e.g. sales/distribution channel FDI) Vertical and horizontal integration often increases production efficiency due to scale economies. Sometimes distinction between horizontal and vertical FDI is unclear MANY THEORIES try to explain why firms prefer FDI to pure "purchasing/selling arrangements"

IMPORTANT FACTORS WHICH AFFECT FDI DECISIONS: - TRANSPORTATION COSTS ($3-12 per auto tire) - MARKET SIZE (e.g. economies of scale) - MARKET IMPERFECTIONS (e.g. tariffs, quotas,.....) - FEAR OF TECHNOLOGY/KNOW-HOW SPILLOVER (problems with technical licensing without ownership; but how much ownership?) - FOLLOW-THE-LEADER AND/OR CUSTOMER, ME-TOO BEHAVIOUR (e.g. firms in Toyota/Honda/Nissan capital keiretsu firms) - PLC STAGES... AT SOME STAGE OF A PLC, YOU HAVE TO EXPLOIT FOREIGN MARKETS AND/OR SOURCE FROM FOREIGN LOW-COST PRODUCERS - CORPORATE POLICY (to become multinational by policy?) VARIOUS FORMS OF FOREIGN EXPANSIONS (ref. Head ( )) below

Home Centralization: – Boeing commercial aircraft assembly in U.S. (mainly Seattle) – Airbus commercial aircraft assembly in EU (mainly Toulouse) Foreign Centralization: – Mattel’s Barbie dolls (Dongguan, China) – Matsushita’s TVs (Malaysia)

AreaSalesFactoriesEmployees Americas40%32%41% Europe (Switz.) 40% (1.6%) 41% (1.8%) 34% (2.6%) Asia, Africa & Oceania 20%27%25% Nestle (replicator) had 254,000 Employees in 508 Factories in 85 Countries in 2002.

Strong economies of scale, that is plant-level fixed costs are high Low trade costs to export to foreign country Large home market Home country has comparative advantage in production costs The benefits of Home Centralization: Strong economies of scale, that is plant-level fixed costs are high Low trade costs to import from foreign country Large foreign market Foreign country has comparative advantage in production costs The benefits of Foreign Centralization:

Absence of economies of scale, that is plant-level fixed costs should be low Both markets are large High trade costs impede exports & imports Unimportant comparative advantages, that is costs of production similar across countries. The benefits of Replication Form: The following graphs show the tradeoffs between 'Home Centralization" and "Replication" strategies in terms of the foreign market size and distance W H = home factory unit cost of production W F = foreign factory unit cost of production K = capital cost of building a new factory T = transportation and trade costs M F = foreign market size (e.g. # of consumers)

Forms of multinational firms with multiple products Upstream (U) creates inputs Downstream (D) uses U inputs to create outputs Example: ExxonMobil Upstream: exploration and “production” in 40 countries Downstream: refining and “marketing” Owns 46 refineries, located in 26 countries Operates 42,000 retail sites in 118 countries The maps below show ExxonMobil's Upstream and Downstream operations.

Various forms of multinational operations for producing 2 vertically related products (various combinations of U and D) E.g. U: auto parts D: passenger car The firm wants to sell 2 related models of cars

Reasons for "vertical specialization": Strong economies of scale, that is plant-level fixed costs are high Low trade costs to export U to foreign country Low trade costs to import D from foreign country Home country has comparative advantage in production costs for U Foreign country has comparative advantage in production costs for D "Branching form" examples: Coca Cola’s concentrate (U) and bottling (D) Honda's engines (U) and car assembly (D) Reasons for "branching form": Low trade costs on U, high on D Low scale economies on D, high on U Home comp. adv. in U, weak comp. advs. in D

"Multi-sourcing form" examples: Refinery in one country, sourcing crude oil from multiple drilling sites (in different countries); Nike’s strategy of shoe manufacturing Reasons for "multi-sourcing form": Low trade costs (for U & D) Diseconomies of scale for U Uncertain comp. adv. for U. More figures are found on Head, p.125.

Currently we are experiencing: (1)Falling trade costs - more efficient transportation (containers, use of air transport) - lower tariffs, WTO oversight of disguised protection - technology-powered improvements in long distance communication (2)This may be leading to increased "economies of scale" The implications of (1) and (2) for multinational firms: Optimal configuration of your FDI network requires continuingly changing efficiency calculations; in particular “Less Replication”, and more “Vertical Specialization” But we also need to pay attention to industry-specific conditions: Example: Compare various companies' foreign expansion strategies: Nestle, Boeing, Mattel Their strategies are not likely to converge. (They will continue to pursue divergent strategies)