International Strategic Management

Part 1 (updated)
• Emergence and Growth of MNCs
• Factors behind growth of MNCs
• Process of internationalization
• The FDI Vocabulary
• OLI Advantages
• Benefits and Costs of FDI to Host and Home countries
EMERGENCE AND GROWTH OF MNCs
Growth of MNCs:
 Globalization is nothing new; MNEs have existed for more than two millennia –
traces in Assyrian, Phoenician and Roman empires.
 During colonial times, some MNEs like the Britain’s East India Company
possessed major economic and political influence.
 In 1903, when Ford Motor Company exported its sixth car, Ford immediately
engaged in FDI by having a factory in Canada by 1904.
 In 1970, there were approx. 7,000 MNEs worldwide. In 1990, there were
37,000 MNEs with 170,000 affiliates. By 2006, more than 77,000 MNEs
controlled 690,000 foreign affiliates.
 Clearly, there is a proliferation of FDI and MNEs in recent decades.
EMERGENCE AND GROWTH OF MNCs
Changing Political Views on Globalization:
 Radical View with its roots in Communism and Marxism, is hostile to FDI and treats
FDI as an instrument of imperialism, and as a vehicle for exploitation of domestic
resources, industries and people by foreign capitalists and firms. Governments which
embrace radical view ban or discourage inbound FDI.
 Between 1950s and 1980s, radical view prevailed in Africa, Asia, Eastern Europe and
Latin America. Communist countries such as China and former Soviet Union sought to
develop self-sufficiency. Non communist developing countries like Argentina, Brazil,
India, Mexico focussed on fostering and protecting domestic industries.
 However, this view is in decline because 1) economic development in these countries
was poor in absence of FDI and global trade, and 2) During same time, four developing
Asian economies– Hong Kong, Singapore, South Korea and Taiwan, (“the four tigers”),
participated in global economy and achieved significant economic progress and also
developed status by World Bank.
EMERGENCE AND GROWTH OF MNCs
Changing Political Views on Globalization: (contd.)
 Free Market View suggests that FDI unrestricted by government intervention, will
enable nations to tap into their absolute or comparative advantages by specializing in
production of certain goods and services. Similar to the win-win logic given by Adam
Smith, free market without govt. regulations will lead to win-win situation for both home
and host countries.
 Since 1980s, series of countries like Brazil, China, Hungary, India, Ireland and Russia,
have adopted more FDI-friendly policies. Even hard core countries that practiced the
radical view on FDI, such as Cuba and North Korea, are now experimenting with some
opening to FDI.
 As a result, globalization rapidly accelerated. Between 1990 and 2000, world output
grew by 23%, global trade expanded by 80% and total flow of FDI increased five times.
EMERGENCE AND GROWTH OF MNCs
Changing Political Views on Globalization: (contd.)
 There has also been backlash against globalization. Some fear developed when emerging
economies started to compete away not just low-end manufacturing jobs from
developed economies, but also some high end ones. Also, some people in developing
countries began to complain that MNEs destroy not just local companies but also local
cultures, values and environment.
 Examples were seen during 1997 Asian economic crisis when many people in Indonesia,
South Korea and Thailand resented free market view, during small scale attacks against
McDonald’s restaurants in various countries, the Dec 1999 anti-globalization protests in
Seattle and the September 2001 terrorist attacks in New York on World Trade Centre.
 As a result, most countries practice pragmantic nationalism – viewing FDI as having
both pros and cons and only approving FDI when the benefits outweigh the costs. Ex –
French govt. blocked many foreign companies takeover attempt of French companies,
Chinese govt. insistence of automotive FDI in form of JVs to facilitate domestic learning.
FACTORS BEHIND GROWTH OF MNCs

 As the world economy is opening up with a fall in regulatory barriers to foreign

investment, better transport and communications, freer capital move­ments,
etc., international companies are finding it easier to invest where they choose
to cheaply, and with less risk.
 Moreover, the developing countries no longer consider the presence of MNCs to
be synonymous with a loss of their sovereignty. It is now realized that MNCs
are merely a part of a much wider force that is integrating the world economy.
 Over the years, foreign direct investment by MNCs in the developing countries
has been steadily on the rise.
PROCESS OF INTERNATIONALIZATION

A company goes international for various reasons:

(1) Firstly, the MNC can sell its products in the vast global market.
(2) Secondly, it can raise money for its operations throughout the world.
(3) Thirdly, they are able to establish production facilities in countries where labour cost is
low and raw materials are abundant in supply. In fact, global firms have greater access to
various natural resources and raw materials than domestic firms. This enables them to
carry on production most effectively and efficiently.
(4) Finally, MNCs can employ efficient managers by being able to recruit the most
technically qualified and managerially efficient people from the whole world.
PROCESS OF INTERNATIONALIZATION
THE FDI VOCABULARY
foreign direct investment (FDI) - Investments in activities that
control and manage value creation in other countries

multinational enterprise (MNE) - A firm that engages in foreign

direct investment
THE FDI VOCABULARY
foreign portfolio investment (FPI) - Investment in a portfolio of
foreign securities such as stocks and bonds that do not entail the active
management of foreign assets

management control rights - The rights to appoint key managers

and establish control mechanisms
THE FDI VOCABULARY
FDI is direct - requires significant equity ownership and provides the
combination of equity ownership rights and management control rights

significant ownership rights provide much needed management control rights

FPI represents essentially insignificant ownership rights and no management

control rights

To compete successfully, firms need to deploy overwhelming resources and

capabilities to overcome their liabilities of foreignness; FDI provides one of the
best ways to facilitate extension of firm-specific resources and capabilities
abroad
OLI Advantages
A firm’s quest for ownership (O) advantages, location (L)
advantages, and internalization (I) advantages:

Ownership - Refers to MNEs’ possession and leveraging

of certain valuable, rare, hard-to-imitate, and
organizationally embedded (VRIO) assets overseas in the
context of FDI

Location - Refers to advantages enjoyed by firms

operating in certain areas

Internalization - Refers to the replacement of cross-

border markets (such as exporting and importing) with one
firm (the MNE) locating in two or more countries
OWNERSHIP ADVANTAGES

dissemination risks - risks associated with unauthorized diffusion of

firm-specific know-how

Examples of these 3 points by Pizza Hut, Starbucks, Walmart in next slide

OWNERSHIP ADVANTAGES

Examples
LOCATION ADVANTAGES
agglomeration - location advantages that arise
from the clustering of economic activities in certain
locations

knowledge spillovers - Knowledge diffused from

one firm to others among closely located firms that
attempt to hire individuals from competitors
 skilled labour force
 Specialized suppliers and buyers

Example: IT industry in Bangalore has offices of all major

IT players
INTERNALIZATION ADVANTAGES

international transaction costs - tend to be higher than domestic

costs - laws and regulations are typically enforced on a nation-state basis

If during alliance, one foreign partner indulges in opportunistic behavior,

example suddenly raises prices, etc., it becomes difficult to fight since laws
are country specific.
Hence firms can internalize i.e make foreign operations internal, instead of
contracts with other companies

intrafirm trade - international trade between two subsidiaries in two

countries controlled by the same MNE
Benefits and Costs of FDI to Host Countries
Benefits
Capital inflow- FDI can help improve a host country’s
balance of payments, earn foreign exchange, etc.
Benefits and Costs of FDI to Host Countries
Benefits (contd.)
technology spillovers - foreign technology
diffused domestically that benefits domestic firms and
industries. Local rivals observe such technology and try to
learn/ imitate it.

demonstration effect (contagion or imitation effect) –

stimulates competition in host countries
Benefits and Costs of FDI to Host Countries
Benefits (contd.)
job creation both directly and indirectly - direct jobs are
created when MNEs employ individuals locally. Indirect jobs
are created when companies supplying to MNE hire people,
more economic power results in more demand for other goods
and hence more development of other industries, goods and
services.

– Example, Toyota employed 32000 employees in US,

indirectly it created 386000 jobs
 Benefits and Costs of FDI to Host Countries
Costs
 Loss of sovereignty: Will foreign firms take adequate care of
national resources? Remember cases of Enron, Union Carbide
Bhopal gas tragedy in India
 Government needs to safeguard national interests with appropriate rules
 Negative effects on local competition eg. Fear from Walmart to
India’s local kirana stores

 Capital outflow: MNEs create profit and repatriate (send back)

these earnings to home countries. Hence, some countries have
restricted such outflow.
Benefits and Costs of FDI to Home Countries

Benefits
 Repatriated earnings of profits from FDI done in
foreign countries

 Increased exports of components and services to

other countries

 Learning via FDI from operations abroad

Benefits and Costs of FDI to Home Countries

Costs
 Capital loss

 Job loss to other countries

 Example: In countries like America, there are growing concerns of
the jobs flowing to countries like China and India through DI and
the resulting impact on home nationals.
Thank You