Internationalisation Strategies BU51014

Omar Feraboli
Economic Studies
Email: o.feraboli@dundee.ac.uk

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 Syllabus:
(1) Business across borders
(2) The motives driving firms’ modes of
internationalisation: market access and factor
costs
(3) The proximity-concentration trade-off: exports
and multinational formation
(4) Contracts versus internalisation: outsourcing vs.
offshoring
(5) Challenges and opportunities of
internationalisation: the importance of firms’
characteristics
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READING

Main textbooks
• Keith Head, “Elements of Multinational Strategy”,
Springer, 2007
• Krugman P R, Obstfeld M, and Melitz, M.
“International Economics, Theory and Policy”,
Pearson International Edition, Nineth Edition,
2011

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 Assessment

• Coursework: 40%
• Online Class Test: 60%

Timetable

Tuesday 15:00-16:00 Weeks 3-11 Online Tutorial

Wednesday 9:00-10:00 Weeks 2-11 Online Lecture
Friday 11:00-12:00 Weeks 2-11 Online Lecture

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 Internationalisation

• Policy and technology-driven falls in trade and

investment costs
• Challenges and opportunities for firms and
countries:
o Tougher competition
o New market niches and/or larger markets
o Shorter product life cycles
o Geographical disintegration of vertical production chain:
off‐shoring, outsourcing
• Higher complexity in the decisions of firms

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 Internationalisation Decision

• Where to operate (produce)

• Which markets to target

• How

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 What makes a business transaction
“international”?

• Different criteria are used in different contexts

(income taxation, import tariffs)
• However, the balance of payment determines
nationality in a manner that allows us to apply it
non-arbitrarily to the full range of economic
transactions:
“A business transaction is considered to be
international if the entities involved reside in
different countries”
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 Internationalisation decisions

Production strategies of firms are diverse

• Q: “Where should we do the things we do?”
o At home: the country where top management is
based
o Abroad: in a foreign country
• A: “It all depends on 4 elements”:
(1) Trade costs
(2) Factor advantages
(3) Internal economies of scale
(4) Market sizes

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 (1) Trade costs
• Trade costs are:
o Distance related: e.g. transport, communication
costs
o Policy related: e.g. customs, tariffs, currency
conversion
o Transaction costs: distance and/or policy related,
“relational”
o Social and business networks are stronger within
national borders
o National business networks: sparse (scattered)
cross‐border linkages ⇒ higher transaction costs

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 Trade costs

• Trade costs tend to increase with distance (physical

as well as cultural)

• Trade costs reduce gains from international trade

• Bilateral trade flow fall with distance

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 (2) Factor advantages
• Countries differences:
- Technology
- Factor endowments (labour, capital, land)
• International trade enables countries to take
advantage of these differences:
o Differences in relative returns to factors
⇒ differences in relative production costs
- Relatively cheaper labour in relatively labour-
abundant countries
- Relatively cheaper labour in countries with
lower labour productivity
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 Factor advantages

• Breaking up the vertical production chain enables

firms to exploit differences in relative factor costs,
e.g.: offshore stages of production that use
intensively factors that are relatively cheaper
abroad

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 (3) Internal economies of scale

• Internal economies of scale imply that a firm’s

average cost of production decreases the more
output it produces

• Internal economies of scale imply that large firms

(plants) may be more efficient than small ones
⇒ large firms have a cost advantage over small ones

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 Total costs (TC) are
a function of
output (Q) and are
equal to fixed costs
(F) plus variable
costs (MC*Q)
⇒ Total costs
function:
TC(Q) = F + MC*Q

Average cost function:

𝑇𝑇𝑇𝑇 (𝑄𝑄) 𝐹𝐹
𝐴𝐴𝐴𝐴 (𝑄𝑄) = = + 𝑀𝑀𝑀𝑀
𝑄𝑄 𝑄𝑄
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 (4) Market sizes
• Economic sizes: domestic and foreign
• The larger the market, the more a firm can sell (and
reduce its average costs)
o Large domestic market: lower internationalisation incentive
o Large foreign market: incentive to access it
• Large market: external economies of scale:
o Cost per unit of output depends on the size of the industry
• A large foreign market ⇒ higher incentive to:
o Incur trade costs of export
o Incur costs of adaptation
o Jump trade costs and incur fixed costs of setting up plants
abroad

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Internationalisation and Internalisation decisions are entangled
Make-or-Buy: at home or abroad
Internationalisation
decision Domestic market only

Internalisation
National firm
“Home centralisation” Exports

Horizontal FDI
MNE Duplication strategy
HQ in one country
Multiple plants Vertical FDI
Fragmentation strategy

International International
Outsourcing fragmentation without
internalisation

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 Make-or-buy

• choice between making in-house or buying in

from an external supplier
• key decision area within manufacturing strategy
• has an impact on many aspects of a business
• decision making based purely on the basis of cost
can be risky
• by using a structured process to review all
relevant factors, in an objective manner, the
likelihood of making mistakes is reduced

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 Internationalisation decision

• Ultimate drivers

o Market access considerations

o Factor costs considerations

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 Vertical vs. horizontal
foreign direct investment (FDI)

• Horizontal FDI: multi-plant firms duplicate

roughly the same activities in multiple countries

• Vertical FDI: firms locate different stages of

production in different countries

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 Market access Factor costs

Exports Horizontal FDI Vertical FDI Outsourcing

Centralisation Duplication Fragmentation Fragmentation
• Scale • Jump distance • Exploit cost • Exploit cost
economies o Tariffs differences differences
• Market size o Transport between between
• Innovation o Exchange rate countries countries
• Distance: • Proximity to • Plant costs • Disintegration
o Trade costs consumers and • Disintegration costs:
o Distance from competitors costs: o Planning
consumers • Ease of o Planning o Coordination
o Distance from adaptation o Coordination o Trade costs
competitor • Plant costs: o Trade costs o Exchange rate
o Exchange rate foreign market o Monitoring
must be large o Agency
Domestic only ⇒ Centralisation benefits only, but no “insulation”

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 The way ahead

• Analyse the different modes of internationalisation

• Show how they ultimately depend on:
o Market access considerations
o Factor costs considerations
• See how the incentives behind firms’ mode of
internationalisation affect the geographic
agglomeration of industrial location still
characterising the world economy

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