TOPIC 2B: MNE ENTRY AND EXPANSION STRATEGIES 1. By strategy, we mean a deliberate choice taken by the owners or managers of firms to organize the resources and capabilities within their control to achieve an objective or a set of objectives, over a specified time period, which extends beyond the day-to-day operations of the firm. 2. A strategy-driven internationalization of a firm, a process that may lead to an MNE creation and growth, involves the use of the concept of a value-added chain, or simply value chain, which identifies the various stages of economic activity that make up a production sequence of a specific product or service from start to finish. 3. At each stage, up to the point at which the product or service is sold to the final consumer, an intermediate product is produced, which then becomes an input into the next stage of the process. 4. This is subject to the qualification that some intermediate products are not used by the firm sequentially but jointly at various stages of the production process. 5. The process of an internationalization of a firm may be conveniently portrayed as that of an internationalization of its value-added activities, although this does not imply that any given firm necessarily follows it. 6. Phase 1: Exports and foreign sourcing. Firms initially engage in cross-border transactions for one or two reasons. 7. The first is to acquire income-generating assets, or inputs into their value chain, at a lower real cost than they can from domestic sources. 8. The second is to protect existing, or seek out new, markets for the output of their domestic value-adding activities. 9. In both cases, however, the decision to become international is normally just one of several strategic options a firm may pursue. 10. Although phase 1 does not involve any FDI, there are nevertheless a number of possible ways a firm may become linked to cross-border activity. Four examples are worth highlighting. 11. The first is where a firm wishes to outsource the production of intermediate inputs, or the final product itself, to a firm in a foreign country that enjoys a cost advantage as compared to domestic production. Indeed, the growth of contractual outsourcing is a hallmark of the contemporary form of globalization, and it encompasses not just the outsourcing of intermediate manufacturing inputs, such as components or subassemblies, but all that of services, such as call centers. 12. The second example is where a firm wishes to export its goods to a new market. However, because of its relative ignorance or the uncertainties about the local demand conditions, a new entrant, particularly if it is a small firm, may wish to avoid the risks in making an investment in a foreign sales or purchasing outlet. Instead, it may prefer to buy the services of a local sales agent, that is, to make use of an external market. 13. On the other hand, where a market has be created for a product, where the product needs to be adapted to the requirements of local buyers, where multiple products are being marketed and there are net benefits to coordinating the sales of these products, or where an efficient aftersales usage, repair, and maintenance service is a key ingredient of the product s appeal, the firm 1
may decide that the risk that a foreign sales agent would not adequately meet its needs is likely to outweigh any setting up costs of marketing and distribution facilities from the start. 14. The third example of value-added activity consists of the production of goods or services, the buying or selling of which requires a regular and continuing association between the parties to the exchange. This is the case where the product is idiosyncratic, is sold in small quantities, or is irregularly traded. Here, the initial market entry may take place directly with a supplier or a customer, even though the firm may use the services of a foreign broker to help it search for, or negotiate with, suppliers or customers. 15. The fourth example is one where the firm generates an output which is difficult or impossible to trade across space. Since some products and services cannot be transported over space, a foreign entry must take the form either of an FDI or, if the intermediate products are tradable, of a contractual agreement with a producing firm in that country. 16. Such contractual agreements include turnkey construction projects, licensing agreements, and franchising arrangements. In phase 1 entry, the construction company has no permanent presence in the foreign location, while the license or franchise owner has little or no involvement in the day-to-day management of its licenses or franchises, but instead earns income due to the exchange of an intermediate product (for example, codifiable knowledge). 17. However, if the construction company in the previous example set up a marketing office for the purposes of obtaining new contracts, this would constitute a Phase 2 entry, and if it set up an office that coordinated at least some aspects of project management for a variety of different projects, this would constitute a Phase 3, 4 or 5 entry, depending on the complexity and range of tasks handled by the local affiliate. 18. Similarly, whenever a franchiser actually owns and operates its affiliates abroad, this represents a Phase 3-5 entry. 19. In terms of resources transferred abroad, Phase 1 involves a minimal commitment, and relies heavily on contractual modes. 20. While a firm selling its output to intermediaries may, in due course, wish to expand its activities by investing in foreign marketing and distribution, or by expanding the stages of value added performed abroad, a firm sourcing inputs from abroad may be content with long-term contractual arrangements with suppliers, or it may wish to exert control and to invest in its own facilities for foreign production either via an acquisition or a greenfield investment. Much would depend on the characteristics of the targeted market, the kind of goods and services being produced and traded, the markets structures in which firms compete, and the nature of the cross-border transactional mechanisms. 21. Phase 2: Investment in marketing and distribution. Apart from firms for whom the purchasing or selling of their products may only be achieved through some kind of physical presence in a foreign market, those seeking to acquire an existing foreign company, or those who are selling or buying in specialized or unfamiliar markets where local expertise is particularly valuable, most firms regard the use of foreign agents and distributors as a first step toward both market- and resource-seeking (but usually not efficiency- or asset-seeking) FDI. The reasons why firms wish to internalize the market for selling the output of their value-added activities reduce to a trade- 2
off between the advantages of securing control over the form, the quality, and terms of those activities, and the risks associated with the commitment of the resources involved. 22. It is difficult to identify the internal and external factors affecting the strategies of firms which may cause to switch from using foreign sales or purchasing agents to setting up or acquiring marketing or purchasing facilities of their own. Clearly, if a firm did not choose the latter route in the first place, its post-entry country-specific learning experiences and its growth in sales or purchases might cause the balance of advantages between using an internal and external market to shift in favor of the former. While there is nothing inevitable about this process, it is likely that the more familiar and experienced a firm is, and the larger the buying or selling stake it has in a particular country (e.g., with respect to the volume and type of products traded), the more it might prefer to own its marketing and distribution networks. 23. One the other hand, it could be deterred from pursuing this course of action by the presence of switching costs, in the form of contractual restrictions and possible loss of customers ( takedown costs), as well as the cost of setting up an own marketing and distribution affiliate. 24. Trade- and marketing-related FDI covers a wide spectrum of functions, and a firm may choose different entry routes for organizing different functions. Advertising responsibilities, for example, might be subcontracted to a specialist foreign firm while after-sales servicing might be internalized. Broadly speaking, the greater the presence or likelihood of market failure in the various trading functions the more likely these are to be internalized within MNEs. 25. Another case of a Phase 2 entry is that of a firm which, in order to efficiently exploit any competitive advantage it may possess, must combine these advantages with others possessed by a firm or groups in a foreign country (e.g., access to appropriate distribution channels). 26. It should also be noted that investment in trade-related activities may sometimes be a first step to the foreign production of goods and services. Indeed, a firm may already be engaged in such activities in other countries. Warehousing is an example. It is only a small step from the storage of finished goods to the holding of intermediate products or kits of parts, which require some inspection, assembling, and packaging before being sold to the domestic or export market. 27. Moreover, a trade-related presence may provide a firm with a better idea of its own capacity for foreign production, or that of local firms to supply its intermediate inputs. 28. It might also offer the firm an insight into the kind of foreign technology, institutions, and organizational structures, and also the kind of product adaptations that need to be made to meet the demands of foreign customers. 29. At the same time, it is also possible that instead of the exporter expanding from the provision of goods and services such as warehousing, this might better be undertaken by other specialist firms in the exporting country. 30. It is also necessary to consider a type of global firm whose internationalization process has been accelerated, the so-called born global firm. These are often technology-intensive start-up firms serving niche markets that have adopted flexible structures that can reach suppliers and customers around the world from their very inception. 31. Judging the full-impact of such firms is complicated by the fact that there is no agreed-upon definition of what length of time born refers to, and how exactly the global nature of these firms is to be interpreted. To the extent that they normally supply a narrow range of goods or 3
services, have low level of resources committed outside their domestic borders, and engage in exports as their primary cross-border activity, such global firms have attributes associated with Phases 1-3 of the scheme relied upon here. Indeed, while born globals are typically earn a significant proportion of their revenue from abroad in the first few years, evidence suggests that, in many other ways, these firms are following a relatively conventional process of gradually increasing resource commitment to foreign markets, where the establishment of marketing affiliates abroad is an essential step in their internationalization process. 32. Phase 3: Foreign production of intermediate goods and services. While phase 2 is a critical step in the evolution of an MNE, both in its own right and because it may lead to further FDI, he amount of resources and capabilities committed is normally quite modest. This is likely to change quite dramatically as and when a firm starts to engage in the foreign production of goods and services, as opposed to facilitating the sale or purchase of goods and services already produced. 33. For many (but not all) manufacturing firms, initial greenfield (but not acquired) market-seeking activity tends to be in the comparatively low-value adding activities, which are normally at the final assembling or initial processing stage of the value-adding chain. As and when local or regional markets grow large, the economic viability of setting up or acquiring a foreign production facility is likely to increase. 34. The extent to which this actually leads to FDI largely depends on the types of intermediate or final products supplied, the nature of production processes utilized, and the quality of the local supply capabilities. 35. If the domestic production process is capital intensive, or demands much specialized equipment and highly trained labor, and if it cannot be easily scaled down, then it may be a long time before local production is started. 36. If the optimum scale of plant is modest and local inputs are readily and cheaply available, then foreign production may not only replace exports at an early stage but also be the initial modality of entry into the foreign market. 37. It should be noted that the optimum level and locational requirements of production are likely to vary between the different stages of value-added activity as, indeed, may the cross-border transport and transaction costs associated with these and other value-added activities. 38. Phase 4: Deepening and widening the value-added network. While firms in Phase 3 perform intermediate processing, such as assembly abroad, firms in Phase 4 undertake all the tasks related to producing a final good, and engage in in the marketing and distribution of the final product, whether in the host market or for export. 39. Using local technology and creative inputs to develop new products, the affiliate can gain what is known as a product mandate, giving it a more important role in the multinational network as compared to a simple assembly operation. 40. In Phase 4, foreign affiliates control most stages of the value chain, engage in their own sourcing, and may begin to develop the kinds of contractual and cooperative connections that make them insiders in the host in the host market. 4
41. In general, while Phase 4 internationalization is more focused on the capabilities of the affiliates themselves, in Phase 5 more attention is paid to the integration of the affiliates into the MNE network. 42. One factor that generally separates Phase 4 affiliates from those in Phase 5 is the role of innovative activities. Affiliates in Phase 4 would normally rely on R&D carried out in the home country of the MNE, or in an affiliate center of excellence in another host country. 43. Entry into Phase 4 often represents a continuation of the process of maturing of the foreign affiliate which was previously engaged in intermediate processing in Phase 3. Such activities normally require the least investment in in human competences, physical capital, and institutional infrastructure, and thus involve the least risk. 44. If successful, and if and when markets expand, local supply capabilities improve, or host governments offer more incentives, then more of the upstream higher value-added activities may be transferred from the home to the host country. 45. The more value-added activities may be adapted to the particular supply capabilities and market needs of the foreign country, and may benefit from a congenial innovative environment, the more foreign production is likely to start earlier than it otherwise would. 46. Moreover, over time, many of these capabilities may be elevated by improved training and education, upgrading the quality of resources, devolving more4 entrepreneurial responsibilities to local managers, networking with indigenous firms, as well as by the provision of appropriate support facilities (e.g., roads, utilities, telecommunications) and the development of more efficient production methods and organizational techniques. 47. If successful, an initial act of foreign production crates its own momentum, and is likely to lead to sequential investment in the form of either (or both) vertical integration or (and) horizontal diversification, as well as the encouragement of related and supporting activities. 48. A possible exception to this general statement is where one firm acquires another to gain certain strategic assets, but sheds others which add little to its competitive advantages. 49. Attention should also be drawn to a phenomenon that is the counterpart to the focus on international expansion. This is divestment, which may take place either as a result of the poor performance of a foreign affiliate, or due to a strategic reorganization within the MNE. 50. Phase 5: The integrated network multinational. In their foreign market entry and expansion strategies, most MNEs coordinate, at least to some extent, their foreign and domestic operations. If they did not, there would be no point in their undertaking the FDI in the first place. 51. In Phase 5, the parent and the foreign affiliate produce different products, each of which is sold in world or regional markets and, in practice, frequently traded within the MNE. 52. Part of the R&D for each product is also undertaken at the location of the subsequent stages of production. 53. This phase is thus different from the preceding four, each of which was concerned with the allocation of the stages of production of a particular product along the value chain. 54. Clearly, if and when this fifth phase in the evolution of an MNE is reached depends on a variety of factors. These include the range and types of products produced, the extent to which product or process specialization may lead to economies of scale or scope, the opportunities for such economies offered by countries in which such investment is currently being made, or 5
contemplated, the ease with which intermediate or final products can be traded across national boundaries, the intra-firm transaction costs involved, and the attitude and strategy of the MNE toward the management of its value-added activities. Such intra-firm product specialization and integration of markets is likely to be accompanied by a sharp increase in the trade between the various production units of the MNE. 55. An important component of Phase 5 activity is strategic asset-seeking investment, which may take the form of both joint ventures and M&As. 56. We may identify two strands of this type of FDI. 57. In the first case, which often combines efficiency- and strategic asset-seeking motivations, the acquiring firm desires to acquire control of an intact package of knowledge, capabilities, and productive assets that the target firm has to offer. 58. In the second case, asset-seeking investment is specifically related to the sourcing of knowledge abroad. Such investment is often prompted by the fact that many knowledge assets are geographically confined, and may only be accessed by having presence in the area. 59. If knowledge-seeking investment occurs via acquisitions, acquiring firms have to achieve integration within the firm, while in the case of joint ventures and strategic alliances integration is largely accomplished largely at the inter-firm level. 60. The general impression is that M&As seldom increase share-holder value in the long-run, and often contribute to ongoing managerial problems within the firm. 61. There are comparatively few MNEs that practice a globally integrated product and/or process strategy and hardly any of them have developed a genuine reciprocal resource and organizational relationship between their various production units. 62. Moreover, product strategy is likely to be based on intra- rather than interregional allocation of resources. The question of whether the regionalization of production by MNEs is a step toward globalization, or is a substitute for it in the presence, or likelihood, of intraregional trade and investment barriers, is still under investigation. 63. As noted, in Phase 4, some foreign affiliates acquire a special status within the MNE of which they are part by receiving a product mandate, and by virtue of having become insiders in the host market. 64. In Phase 5, such affiliates are more likely to achieve strategic importance as specialized centers of excellence. This means that the affiliate has global responsibility for developing and advancing excellence in one area of competence within the firm. However, transferring and utilizing the localized knowledge and institutions accessed or created by the affiliate to the rest of the firm strongly depends on the ability of the MNE to set appropriate incentives to achieve integration. 65. A novel solution to the question of knowledge integration is offered by the metanational firm, which is born in the wrong place and needs to break free of geography. While established competitors may try to redesign their existing organizations by cultivating centers of excellence and by investing heavily in in better information systems and in knowledge management, metanational firms are more likely to focus on identifying and accessing new technologies, turning them into innovative products, and finally scaling up the innovations globally. Their key 6
advantage is an unconventional process of prospecting for knowledge from everywhere in the firm s operating environment. 66. An idea similar to that of the metanational is that of the so-called dragon multinational, which uses its network connections for leverage. Several East Asia firms fall into this category. These latecomer firms have managed to overcome their peripheral locations and lack of specific capabilities by deftly identifying, accessing, and combining resources and capabilities globally and leveraging them within their operational ambits. What is distinctive about the dragon multinationals is their accelerated rate of internationalization, and although they are generally quite large, in this sense they are also akin to the born globals described earlier. These are firms that are very global and have grown to a substantial size in spite of a limited home market and severely restricted domestic resources and capabilities. They have accomplished this growth by maximizing the utility of their network relationships and by not expanding the core of the firm uncontrollably. 7