Multinational Corporations (MNCs) are businesses that extend outside of their own country, whether they are located throughout the world or only in a couple other countries, they are considered multinational. The value adding activities which are owned by these companies are used to produce tangible goods or intangible services or the combination of both. There are many reasons as to why firms become multinational and there are various strategies for a firm to become multinational.
The immediate motives of the Firms can be to expand business, to seek new market, or for additional profits and revenues. It may also be to concentrate on the economics of scale that a larger international demand can bring. The motive behind market seeking activities is strong among firms who have some advantage related to technology or brand which gives them a competitive advantage over domestic rival. Another reason for firms to become multinationals is to secure key supplies. A secure and privileged access to inputs and/or distribution outlets and market access afford many firms especially those in manufacturing, to have a competitive advantage over their less favored rivals.
A firm might also become multinational to have access to low cost factors of production. Factors of production like labor is a major cost factor in Europe and US and gives a competitive disadvantage compared to imports. So firms can offshore production to the host countries and become competitive. Low cost capital through government subsidies is also a strong force to become a multinational corporation.
The discussed factors have been well captured in product cycle theory developed by Professor Raymond Vernon. The theory suggests that the first phase starts with product development and innovation in home country as to maintain close linkage between research and production as well as the assumption that similar demand will be created in other similar market. The second stage assumes the product to be matured and production standardized as well as good demand from other market and an important form of revenues from the new business. Also, Competitors will observe the growing demand and try to establish themselves in the markets by setting up production in the importing country and becoming a MNC rather than an exporter. Finally in the last stage many competitors enter the market and focus is more on cost and resource seeking activities.
The above discussed factors are traditional motives and the theory lost its power in 80s itself as the business environment became more complex. In the emerging motives the above forces that originally triggered firm to become a MNC became secondary. Increasing Scale of economies, R&D investments and shortening product life cycles were not the choices for a firm to become MNC but rather a prerequisite for companies to survive in the business environment. Now the major motive for a firm to become a MNC is to capitalize on competitive positioning in multiple markets and leverage global information access.
The above motives are purely reactive and opportunistic to the proactive business decision which sees international markets as major strategic opportunity. The decisions to become a MNC can be purely defensive, for example as a reaction to pressures in domestic markets. Overseas demand can help to offset seasonal or cyclical downturns in domestic demand. It can also be that the domestic market has become saturated or the product is coming to the end of its domestic life cycle.
The above discussed motives are rational, logical and there are strategies used to become a MNC but on other hand the motive of firm to expand might be personal ego of managers and also for personal monetary benefit of business managers who want to expand at any cost as the salary might be attached to the volume of the business. These irrational motives create principal agent problem in the future.
Having explored why the firms become Multinational Corporations we now look at how firms become MNC. The prerequisites for being an MNC might be to have a distinctive competency to overcome the liability of foreignness and the firm must also have some organizational capability to operate in the global market. Moreover, the host country should also provide some location specific advantages so that the firm have strong reasons to invest there. These prerequisites are very important as they help to define the strategic options available to compete worldwide.
The process of firm becoming a MNC starts with a combination of developing strategies, rational analysis and opportunism. Some firms may follow an internationalization model which was developed by Swedish academics from Uppsala. The model describes how a firm enters a foreign market and gains market knowledge by means of commitment of resources and how it gradually develops local capability and market knowledge to become an effective competitor in foreign market through several investment cycles.
The firms may use the eclectic paradigm and transaction cost analysis approach which explains the extent, form and pattern of international production and how it is founded on juxtaposition of the ownership specific advantages of firms contemplating foreign production, the propensity to internalize the cross border markets for these and the attractions of the foreign market for production. So the entry decision is taken in a rational manner based on the costs of transactions.
The firms may also choose to enter the international market by low commitment and low control mode such as by exporting or subcontracting. Exporting is selling goods and services from one country to another. Exporting can be direct and indirect. Direct exporting can be done through agents and distributors. Direct exporting helps to proactively enter the foreign market. Indirect exporting can be done by export houses and confirming houses who are just the intermediaries. There are many contractual forms for international business like management contracts, Turnkey operations, manufacturing contracts, etc.
Licensing and franchising can also be an option for a firm to become a MNC. Licensing means there is an agreement that one party can utilize or sell intellectual property in return for compensation. The problem with licensing is that there is a risk of “leak” of knowledge and intellectual property and after the licensing agreement is over the partner can become a powerful competitor. Franchising which is also a form of licensing, gives certain rights to do business in a prescribed manner to other party in return for royalties or fees. Franchising can take form of manufacture- retailer franchise or wholesaler-retailer franchise and have similar risks that of licensing. There has been a tremendous growth in franchising especially in US AND UK.
If the firm wants to penetrate deep in the market and wants fuller involvement and control, the firm can go for a joint venture or foreign direct investment (FDI). Joint venture which is a collaboration of two or more parties can be contractual or equity based. It has the means to overcome restrictions on foreign investments or imports. Firms have to share costs and/or technology and the shared approach permits economies of scale and a potential to enter market. Some joint ventures are formed but the true reason behind it is FDI. FDI might also face problems of disagreements over strategic direction, managerial functions or use of appropriate profits. Cultural difference can also be a major barrier in the joint venture.
FDI which is a very high risk strategy can be explained as the establishment or acquisition of income generating assets in the host country over which the investing firm has control. It involves either taking control over established business in overseas market or developing a tailor made business operation. FDI can be broadly classified into two types, outward FDIs and inward FDIs. This classification is based on the types of restrictions imposed, and the various prerequisites required for these investments. The reasons for considering FDI are tariff quotas, tax breaks, grants, subsidies, and the removal of restrictions and limitations.
Before opting for FDI a firm might also consider counter-trade which is described as the most important trend in international business of emerging economies. It involves an agreement between two parties to pay in goods and services. There are many types of counter-trade like barter, clearing agreement, compensation, etc. counter-trade can open up trade where there are strict exchange controls or where the countries faces shortage of currency.
In conclusion companies can become Multinational Corporations by gradually moving up the scale from exporting and licensing to high commitment foreign direct investment. Some firms can directly adopt the high commitment strategy due to the maturity of market. In short, none of the approaches are necessarily right or wrong but should be consistent with the overall strategic intentions and motivations of the firm. The firms can start with one option and then by experience move towards another in light of degree of commitment and risk involved, set against the level of control and closeness to market.