After the World War II, there has been rapid growth in international trade in both goods and services, resulting in various transactions across national borders for the purpose of satisfying the needs of individuals and organisations. The result of this global competition has forced organisations to expand their business by finding out new markets at home and foreign countries making them ‘Transnational firms’. Transnational Corporations (TNC) is defined as a firm that has power to co-ordinate and control operations in more than one country, even if it does not own them. The significance of TNC lies mainly in its ability to co-ordinate and control different transactions within transnational production networks, ability to take advantage of distribution factors of production and ability to be flexible in locations.
The growing TNCs led to various patterns and trends in international business like rapid growth in world trade and investment, cross border mergers and acquisitions resulting in the process of Internationalization. Internationalization is the process of increasing involvement in international operations across national borders which comprises both changed perspectives and positions.
Internationalization is one potential strategy that is being used increasingly by business firms to maximize size of the firm, increase their profitability, increasing their market share and becoming industry leader. It is a major attribute of the current strategy process of most business firms which determines the ongoing development and change in the international firm in terms of values, scope, principles, business ideas, action orientation, nature of work and converging norms. The internationalization dimension is related to all these aspects of the strategy process and thus making the firms become ‘Transnational’. In this global competition, it is important for the firm to become transnational and internationalization process focuses mainly on the development of the individual firm on its gradual acquisition, integration, and use of knowledge about foreign markets and operations.
Theories of Firm Internationalization
Firms internationalization decision is mainly to acquire profits. The origins of the internationalization of the industry are described by both macroeconomics approach, regarded as a general-system approach which is focused on the capitalist system as a whole, and microeconomics approach, based upon a firm-specific level. In a macroeconomics approach, the expansions of firms’ activities into foreign countries are explained by the circuits of capital and the theory of new international division of labor. A microeconomics approach entails the Dunning’s eclectic paradigm and the theory of product life cycle. As most TNC’s are capitalist enterprises, they behave according to basic rules of capitalism, the ways in which firm acquires profits along with various motives like increasing their market share, becoming industry leader or simply making firm bigger. But above all, the most important factor for internationalization is the pursuit of profits. In this competitive economy, competition between firms is becoming increasingly global and much more volatile not just confining them to national level but with firms across the world. Thus TNCs simply explain the need for internationalization at macro level in pursuit of profits and performance better in the global competitive economy.
The new international division of labor, proposed by Stephen Hymer, is used to explain the shift of industrial production from the core (the industrialized countries) to the periphery (the developing countries). Firms in developed countries due to increasing wages in their home countries are forced to seek the alternative locations providing cheap labor, which are the third world countries. Even though this concept has some validity in explanation of internationalization process, it also contains several drawbacks as it is excessively narrow and one-dimensional and it overstates the extent to which industrial production has been relocated to the global periphery.
Micro level approach is an approach to understand the internationalization of economic activity through the TNC which is much as firm specific. The decision to become global firm is made by individual firms or more by decision makers in the firm rather than focusing upon the decisions at capitalist system as a whole like in macro level approach. According to Hymer’s pioneering study in 1960, domestic firms will have natural advantage over foreign firms in terms of better understanding of local market conditions and business environment. But, a foreign firm wishing to produce in any other market would have to posses some firm specific assets which overcome the natural advantages of domestic firm. These firm specific assets are like size of the firm and economies of scale, access to raw materials, marketing skills, technological expertise, reduced transaction costs or access to cheaper sources of finance, which makes a foreign firm to compete domestic firm in its home country. Hymer’s study expressed that the firm wishing in transnational production would have its own set of qualifying principles specific to ownership which overcome the advantages of indigenous firms in the country of production.
In 1966, Vernon developed the product life cycle to explain the observed pattern of international trade. The theory suggests that in the earlier stages of product’s life cycle all the production activities of a product is done in the place in which it was invented. Once the product is used in the markets, production gradually moves away from the point of origin to the places with low production costs and high market activity, in order to acquire high profits by the firm. There are four stages in product life cycle: Introduction, growth, maturity and decline. The location of production depends on the stage of the cycle. In the introduction stage the firm seeks to build product awareness and develop a market for the product. In the growth stage, the firm tries to increase brand preference and market share. At maturity stage, the strong growth in sales decreases due to heavy competition between similar products. At this stage the primary objective of the firm is to defend the market shares by expanding into new markets or low developing countries (LDCs) to maximize profits. In the final stage, due to decline in the sales, the firm tries to maintain the product by adding new features and targeting new markets.
According to Dunning’s Eclectic Paradigm, a firm will engage in international production when each of the following three conditions is present: 1. Owner specific advantages, 2. Location specific advantages and 3. Internalization advantages. As the three principles are derived from variety of theoretical approaches such as the theory of the firm, organization theory, trade theory and location theory, dunning labelled his approach as ‘eclectic’ which integrates various strands of explanation of international production.
- Owner specific advantages or Firm specific advantages are assets which are internal to firm. Every firm must possess certain ownership specific advantages which are unique compared to their competing firms from other countries. These firm specific advantages are intangible and transferred within the TNC at low cost (e.g., technology, brand name, and benefits of economies of scale) which either provides higher revenues or lower costs that can reduce operating costs compared to its competitors in a foreign country.
- A firm must possess location specific advantages to exploit its assets in foreign rather than domestic country. Therefore the location specific advantages of different countries are important in determining which will become host countries for the transnational corporations. They constitute economic, political and socio-cultural advantages which are important factors in the context of transnational production.
- Transnational corporations choose internalization where the market does not exist or functions poorly. There must be internalization advantages to the firm from exploiting its advantages itself, rather than selling them or leasing them. The more uncertain the environment faced by the firm (which may be due to price, quality and availability of raw materials) the more likely a firm internalize its operations. Internalization occurs in the case of knowledge and technology, where many firms spend huge sums of money on various research and development. To ensure satisfactory returns on the investment without selling or leasing the technology to other foreign firms, the firm itself exploits its technological advantage directly by setting up its own production facilities.
Under ‘eclectic theory’ other theories of internationalization are more concerned with the processes that a firm must go through. Sequential theory of internationalization is a process in which a firm enters into the foreign market. It is also called as ‘Uppsala model‘ and the firm enters other markets through four discrete stages: Intermittent exports, exports via agents and through licensing, overseas sales through knowledge agreements with local firms (example franchising) and foreign direct investment (FDI) in the foreign market.
Initially, the firm is purely a domestic firm in terms of both production and markets. Once the firm reaches saturation point in its domestic market, it looks into foreign markets in order to maintain growth and profitability. During early stages, the firm does this through exports using the services of overseas sales agent, who are independent of the exporting firm. In the second stage, the process of gaining control over its foreign sales is achieved by setting up its own sales outlets. This can be done in two ways, either by setting up an entirely new outlet or by acquiring local firm. When the firm performs better and acquires good profits, it decides on establishment of entire production facilities with consideration of its favorable factors in a foreign market.
In a network perspective, the process of internationalization is like creating new relationships or building on existing relationships in international markets, with the focus shifting from the organizational to that of social. It is people who make decisions and take the actions. The series of networks are considered at three levels: Macro, Inter-organizational and Intra-organizational. In network theory, the business environment is seen as a set of diverse interests, powers, characteristics which advances on national and international business decisions. At macro- level, a firm has to break old relationships or add new ones to enter new markets. A new entrant finds difficult to break into a market that already has stable relationship. Such firms are able to reconfigure the existing networks, thus more successful in internationalization process. At Inter-organizational level, firms are good in different relationships to one another in different markets. They may be competitors in one market, collaborators in other and ‘suppliers and customers’ to each other in a third. Thus, if one firm internationalizes it draws other firms into international production. At intra-organizational level, relations within the organization influence the decision making process. If a transnational corporation has its subsidiaries in other countries, decisions taken at the subsidiary level increases the degree of international involvement of the parent TNC, depending on the degree of decentralization of decision making by the firm.
The various theories explain the process of internationalization and results in the firm’s motivation for engaging in transnational operations. When a firm decides to establish a production facility in the foreign market it mainly focuses its interests in terms of size of the market and availability of requirements which are useful for the production facility. Though firm’s motivation in transnational production is highly individual, still it can be broadly classified into two categories: Market Orientation and Asset Orientation.
- Most foreign direct investment in the process of transnational production is designed to serve a specific location market by taking consideration of market size and other conditions. The goods and services produced in the foreign country are almost identical to that being produced in the firm’s home country but the firm modifies its products slightly in order to gain the tastes and preferences of the local market. Market oriented investment is a form of horizontal expansion across national boundaries which concentrates on three factors in making up the decision of the location. The most important factor is a size of the market measured in terms of per-capita income rather than in terms of population. For example, countries in Europe and US, though they have less population, their per-capita income is high. Population in countries with low income levels spend larger portion of their income on basic necessities while people in countries with high income levels spend higher portion of their income on higher order manufacture goods and services. The last important factor for market oriented production is accessibility into the markets (transportation) and other political barriers.
- The choice of strategy for transnational production will be influenced by the reasons for becoming transnational. Foreign direct investment is designed to take advantage of the fact that the various assets that a firm needs to produce are not available in the same quantity and quality everywhere. So, it is important for a firm to consider about asset orientated production when it becomes transnational. It is broadly classified into two ways: Technology and labor. Firm benefits from the production costs if there are low labor costs along with high technology. Variations in wage costs, labor productivity and knowledge and skills constitute asset based advantages to the firm becoming transnational.