MULTINATIONAL ENTERPRISES

Lecture Notes 1
1) INTRODUCTIONModes of entry
In terms of underlying motive:
A) HORIZONTAL FOREIGN DIRECT INVESTMENTS (HFDI)
Concerns operations that belong to the same ‘ring’ of the value chain.
Substitutes for International trade (“substitutability relation”)
Motive=“Market-seeking FDI” Chosen when it is too expensive to
exportyou do FDI in order to avoid to export(1)Localizaition question:
should I produce abroad? § (2)Licencing?
Home country Host country
ADMINISTRATION HEADQUARTERS
(upstream of production)

(downstrem)U duplicate HOME AFFILIATE FOREIGN AFFILIATE

activities horizontally
[both refer 2 the same headquarter]
The services provided by headquarter
to foreign affiliates cross the border
B) VERTICAL FOREIGN DIRECT INVESTMENTS (VFDI)
Concerns operations that belong to different ‘rings’ of the value chain
 “Cost-saving FDI”: complements International trade (“complementarity”)
FDI makes sense only if I’m able to trade. 2 decisions: (1)Do we want 2
produce intermediate abroad? (2)Internalization or Outsourcing?
EX:Im’ producing in Mexico because it’s cheaperI’m not interested in
serving Mexico

Home country Host country

ADMINISTRATION HEADQUARTERS
(upstream of production)

INTERMEDIATE FOREIGN AFFILIATE

PRODUTION
HOME AFFILIATE
FINAL PRODUCTION

HFDI VFDI
Location choice Produce home & export Produce intermediate home
VS MNE VS Prod.Interm abroad
Internaliztion choice Licensign(NE) VS MNE Outsourcing(NE) VS MNE
(Internalization choice1) OUTSOURCING (VFDI)
Vertical multinational enterprise (V-MNE) National enterprise (NE)
HEDQUARTER
(Fixed cost H)
FOR AFFILIATE
(components)
MargCost=c*
HOM AFILIATE
(Assembly)
Marg Cost=a

Let us simplify the analysis:

• Firms have no market power • There are no trade barriers
• Intermediate quantity sold and final quantity sold are constant and equal to 1.
• Choice according to: MIN total costMAX prof; taking into account :
• Constant intermediate&final quantities• Production costs• Contractual costs
Source:contrctual incompleteness;4 a contract be complete it should specify:
• all possible contingencis•the actions that parties should take under each case
 This is possible only when all contingencies are identifiable not only by the
parties involved but also by third parties (ex court)
Contractual incompleteness does hence usually arise,specificaly when when it
is costly: • to write down all the details of the contract (“material costs”)
• to observe some contingencies o parties’ actions (information costs)
• to execute the contract when disagreement (implementation costs)[corruption]
Three interesting cases:
1.Relationspecific investment(“hold up”):after the constrtion of very
specific(tailored)pdts or assembly lines, parties hold each other up in case of
disagreement=need each other.
2.Dissipation of specific capital (“intangible assets”) :It arises when the supplier
learns the “secrets” of the final producer and becomes a competitor.[China
copying]
3.Principal-agent problem (“hidden action, hidden information”) : In the
presence of diverging objectives between the intermediate supplier (“agent”)
and the final producer (“principal”), the latter is unable to pursue shareholders’
interests. [EX oraangina & coca-cola distributor in France; the agent was
pushing more on orangina coca-cola started its own distributiom]
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ALL OF THIS GENERATES CONTACTUAL COSTS