Topic 6:

Transnational corporations

A transnational corporation is an enterprise that manages production or delivers services in more than one country. A TNC is a corporation that has its headquarters in one country, known as the home country, and operates in several other countries, known as host countries.
MNCs: Royal Dutch Shell Group (Netherlands/United Kingdom) DaimlerChrysler AG (Germany/USA) Unilever (Netherlands/United Kingdom) Rio Tinto Plc (Australia/United Kingdom)

TNCs in world economy

UNCTAD estimates that TNCs worldwide, in their operations both at home and abroad, generated value added of approximately $16 trillion in 2010, accounting for more than a quarter of global GDP. In 2010, foreign affiliates accounted for more than one-tenth of global GDP and one-third of world exports.

2011 TNC trends

The lingering effects of the crisis and subdued prospects in developed countries forced many of their TNCs to invest in emerging markets in an effort to keep their markets and profits: in 2010 almost half of total investment (cross-border M&A and greenfield FDI projects) from developed countries took place in developing and transition economies, compared to only 32 per cent in 2007 Many TNCs in developing and transition economies are investing in other emerging markets, where recovery is strong and the economic outlook better. Indeed, in 2010, 70 per cent of FDI projects (crossborder M&A and greenfield FDI projects) from these economies were invested within the same regions.

After two years of slump, profits of TNCs picked up significantly in 2010, and have continued to rise in2011

Global 500 Most profitable 2010

Rank Company 1. 2. 3. 4. 5. Nestle Gazprom Exxon Mobil Industrial & Commercial Bank of China Royal Dutch Shell Profits ($ Million) 32843 31895 30460 24398 20127

Global 500 Most profitable 2010

Rank Company 1. 2. Volkswagen Nestle Profits % change from 2009 578,4 242,0

3.
4. 5.

Vale
RioTintoGroup Intel

222,8
194,0 162,4

Company/Country
Wal-Mart Stores Norway Austria Royal Dutch Shell Argentina Exxon Mobil Denmark British Petroleum United Arab Emirates

2011 Revenues ($ billions) / 2010 GDP (current USD)

422 413 379 378 369 355 310 309 298

Sinopec Group

273

Company/Country
Hong Kong Toyota Volkswagen Algeria General Electric Ukraine General Motors Samsung Electronics Vietnam

2011 Revenues ($ billions) / 2010 GDP (current USD)

224 222 168 159 152 138 136 134 106

Siemens

103

Home countries of top 100 TNCs

Rep. of Korea Spain Switzerland Netherlands Japan Germany United Kingdom France USA
0 5 10 15

3 3 4 4 10 12 12 14 18
20

Norway, Sweden, Italy 2 Luxembourg, Hong Kong, Mexico, Finland, Australia, Ireland, China, Canada, Malaysia - 1

Top 100 TNCs by industry

Motor vehicles - 13 Petroleum expl./ref./distr. - 10 Pharmaceuticals - 9 Electrical & electronic equipment - 9 Food, beverages and tobacco - 9 Telecommunications - 8
Diversified; Non-metallic mineral products; Other business services - 5 Wholesale trade; Mining & quarrying - 4 Metals and metal products; Aircrafts and parts; Chemicals; Retail 3

Top 5 non-financial TNC, ranked by foreign assets, 2008 (million USD)

Rank

Corporation Home economy

Industry

Assets Foreign Total

797769 222593 282401

1 2 3

General Electric Vodafone Group Royal Dutch/Shell Group British Petroleum Company Exxon Mobil

USA UK

Electrical and electronic equipment Telecommunications

400400 204920 222324

Netherlands Petroleum expl./ref./dist. /UK UK Petroleum expl./ref./dist.

187544

228238

USA

Petroleum expl./ref./dist.

161245

228052

Top 5 non-financial TNC, ranked by foreign sales, 2008 (million USD)

Rank

Corporation Home economy

Industry

Sales Foreign Total

459 579 365 700

1 2

ExxonMobil British Petroleum Company Plc

Royal Dutch/Shell Group Total Chevron Corporation

United States United Kingdom

Petroleum expl./ref./distr. Petroleum expl./ref./distr.

321 964 283 876

Netherlands Petroleum expl./ref./distr. /United Kingdom France United States Petroleum expl./ref./distr. Petroleum expl./ref./distr.

261 393

458 361

4 5

189 784 153 854

250 489 273 005

Top 5 non-financial TNC, ranked by foreign employment, 2008 (million USD)

Rank

Corporation Home economy

Wal-Mart Stores Carrefour SA Siemens AG United States France Germany

Industry

Employment Foreign Total

2100 000

Retail

648 905

2 3 4 5

Retail Electrical & electronic equipment Transport and storage Electrical & electronic equipment

342 764 295 000 283 699 283 455

495 287 427 000 451 515 398 455

Deutsche Post Germany AG IBM United States

Company/Country
Latvia Wal-Mart Stores

2010 Number of Employees / 2010 Population

2 242 916 2 100 000

Slovenia
Malta Siemens McDonalds

2 052 821
412 961 402 700 400 000

Gazprom
Hewlett-Packard Iceland Pepsi Co Nestle Barbados

393 000
324 600 317 398 294 000 281 000 273 331

Transnationality index
TNI is calculated as the average of the following three ratios: - foreign assets to total assets - foreign sales to total sales - foreign employment to total employment

Top 5 non-financial TNC, ranked by TNI, 2008 (%)

Rank

Corporation

Home economy

Industry

TNI

1 2 3 4 5

Xstrata Arcelor Mittal WPP Group Linde Pemod Ricard

UK Luxembourg UK Germany France

Mining Metals and metal products Business Services Chemicals Food, beverages, tobaco

93,2 91,4 88,9 88,3 -

 GSI, the Geographical Spread Index, is calculated as the square root of the Internationalization Index multiplied by the number of host countries

II, theInternationalization Index, is calculated as the number of foreign affiliates divided by the number of all affiliates

Top financial TNC ranked by GSI

TNCs Management Strategic Predispositions

Philosophies of Ethnocentric predisposition Management
Ethnocentric predisposition

ETHNOCENTRIC MANAGEMENT ORIENTATION centralized

Management holding an ethnocentric orientation believes that its home country is superior to any other country in the world regardless of any evidence to the contrary. Ethnocentrically oriented international companies believe that anything that has worked at home must also work abroad. A company holding this viewpoint would be likely to ignore local managers within different countries who voiced an opinion contrary to the norm of the home-country. For example, a local manager may wish to change an advertisements background-color from white to red since, in his country, white signifies death whereas red signifies wealth. An ethnocentrically oriented company might ignore this valuable piece of information. (Nissan, IKEA, Procter&Gamble initially)

At Royal Dutch Shell, for instance most financial officers around the world are Dutch nationals. Reasons given for ethnocentric staffing policies include: - lack of qualified host country senior management talent - a desire to maintain a unified corporate culture - unwillingness to transfer the parent firms core competencies (for instance, a specialized manufacturing skill) to a foreign subsidiary.

It has been estimated that an expatriate executive can cost a firm up to three times as much as a domestic executive because of relocation expenses and other expenses such as schooling for children annual home leave and the need to pay income taxes in two countries.

Strategic Predispositions
Philosophies of Management
Ethnocentric predisposition Polycentric predisposition

Polycentric predisposition

POLYCENTRIC MANAGEMENT ORIENTATION

decentralized Management holding a polycentric orientation believes that each country is unique and therefore it allows its subsidiaries to have more control in developing strategies that will work in a particular country. As long as these subsidiaries are profitable, headquarters is apt to leave them alone. A purely polycentric orientation implies that headquarters and subsidiaries are somewhat cut off from one another. Headquarters steps aside in the belief that it can not possibly understand local business processes and foreign subsidiaries are glad that headquarters does not interfere as they can not possibly understand the local market. So while a polycentric viewpoint is an improvement over an ethnocentric one in that a company realizes that strategies should be tailored for specific markets, it does not take into account the potential benefits of taking a more active role in the running of subsidiaries in those differing markets. (Philips, Johnson&Johnson,)

Strategic Predispositions
Philosophies of Management
Ethnocentric predisposition Polycentric predisposition

Regiocentric predisposition

Regiocentric predisposition

Strategic Predispositions
Philosophies of Management
Ethnocentric predisposition Polycentric predisposition

Geocentric predisposition

Regiocentric predisposition
Geocentric predisposition

GEOCENTRIC MANAGEMENT ORIENTATION

integrated at global level

Management holding a geocentric orientation believes that the entire world is a potential market and strives to develop strategies that will work in every market. Instead of stating that things are inherently different in each market and thus must be handled in a distinctive manner, a geocentrically oriented company will look for universal as well as local best practices to help a company thrive in all markets. In geocentrically oriented companies, authority is not simply placed with headquarters at home or with subsidiaries abroad, but rather a is dispersed more equally between the two so that a collaboration is formed. Also, a view of superiority is not based on nationality. Geocentrism involves a collaborative effort between subsidiaries and headquarters to establish universal standards and permissible local variations, to make key allocation decisions on new products, new plants, new laboratories (Wirlpool - regiocentric) (Microsoft, Coca Cola, most corporations)

Orientation of an MNC

Orientation of an MNC

The Reasons for International Expansion

Increasing sales and finding new markets - By expanding operations to an international scale means that business can increase their total sales. - The product may also differ in its life cycle in other countries. It is quite possible that a mature product in Australia is only an emerging product in another oversees country. Business can take advantage of this.

The Reasons for International Expansion

Acquiring New Resources - Other markets in the global economy may have extra resources towards which the business needs to expand. - These same resources may also be less productive or more expensive than that of the domestic operations of the business.

The Reasons for International Expansion

Diversification - Business may engage in expanding its operations in order to diversify its suppliers and markets. - This avoids volatile swings in market prices and sales in any one market, allowing other markets tosupport these occurrences. - If a business has a range of suppliers from different countries, then the business is less likely to come under threat from supply shortages or price increases.

The Reasons for International Expansion

Minimising Competitive Risk - The operation of a business in many countries means that it is less likely that a competitor will have a crucial impact on the business operations in one particular market.

The Reasons for International Expansion

Gaining Economies of Scale - Where a business endures cost savings by increasing the scale or size of its operations. - Through international expansion, business obtain a better economies of scale by selling worldwide or establishing production opportunities in low cost labour localities. - Through this increase in the size of the market, the price per unit of output falls, allowing for a reduction in price or an increase in profits.

The Reasons for International Expansion

Regulatory Differences - Some countries of the word have more lenient stances towards regulations involving environmental emissions and award rates for workers. - Business may use this to their advantage, and set up operations where it will cost them less to operate due to the nature of government regulations in a particular country.

The Reasons for International Expansion

Minimising Tax - Taxes in various countries around the world differ. Therefore business may take advantage of countries with lower taxation rates, saving on the costs of production. These types of countries are known as tax havens - countries having little or no corporate income taxes. Three types of tax havens include: Tax Paradises - No corporate taxation Tax shelters - No tax at all or very little tax occurs. Financial Centres - Give special tax privileges to certain types of companies or operations.

The Costs and Benefits of TNC Activity

While it is clear that MNCs are motivated to engage in foreign direct investment to raise their profitability, it is less obvious what impact these investments have on the countries that receive them

TNC activity is sometimes beneficial for host country economic development, and at other times is detrimental to such development. One might suggest that natural resource investments are the least likely to offer substantial benefits to host countries, while efficiency oriented investments are the most likely to offer substantial benefits to host countries. Market oriented investments are likely to fall somewhere in between these two types, sometimes offering benefits, and at other times imposing costs. TNC activity has historically been subject to political considerations. As a consequence, the impact of any particular investment on any particular host country is shaped by the particular agreement between the firm and thehost country government. (bargaining power)

Benefits
1. TNCs can make a significant contribution to economic development. FDI is an important mechanism through which savings are transferred from the advanced industrialized world to the developing world. TNCs create fixed investments which dont generate boom and bust cycles. In addition, because TNCs invest by creating affiliates, FDI does not raise host countries external indebtedness. Of the many possible ways in which savings can be transferred to the developing world, therefore, FDI might be the most stable and least burdensome for the recipient countries.

Benefits
2. TNCs are important vehicles for the transfer of technology to host countries. Because TNCs control proprietary assets, which are often based on specialized knowledge, the investments they make in developing countries often lead to this knowledge being transferred to indigenous firms. In the absence of the technology transfer, the indigenous firm would not have been able to produce certain products. Technology transfer can in turn generate significant positive externalities with wider implications for development. Externalities arise when economic actors in the host country that are not directly involved in the TNC-local affiliate technology transfer also gain from this transaction.

Benefits
3. In addition to transferring technology TNCs transfer managerial expertise. Greater experience at managing large firms allows TNC personnel to organize production and coordinate the activities of multiple enterprises more efficiently than host country managers. This knowledge is applied to the host country affiliates, allowing them to operate more efficiently as well. Indigenous managers in these affiliates can then move to indigenous firms, spreading managerial expertise into the host country.

Benefits
4. TNCs enable developing country producers to gain access to marketing networks. When direct investments are made as part of a global production strategy, the local affiliates of the TNC and the domestic firms that supply the TNC affiliate become integrated into a global marketing chain. This opens up export opportunities that indigenous producers would not otherwise have.

Costs
1. Rather than transferring savings to developing countries, TNCs reduce domestic savings. Savings are reduced in two ways. First, it is argued that TNCs often borrow on the host country capital market rather than bring capital from their home country. TNC investment therefore crowds out rather than adding to domestic investment. Second, it is suggested that TNCs earn rents above normal profits on their products and repatriate most of these earnings. Host country consumers therefore pay too much for the goods they buy, with negative consequences on individual savings, while TNC profits, which could potentially be a source of savings and investment in the host country, are transferred back to the home country. The amount of domestic savings available to finance projects therefore falls.

Costs
2. TNCs exert tight control over technology and managerial positions, preventing the transfer of both. The logic here is simple. As we saw above, one of the principal reasons for TNC investment arises from the desire to maintain control over proprietary assets. Given this, it is indeed hard to understand why a TNC would make a large fixed investment in order to retain control over proprietary technology, and then once having done so begin to transfer this technology to host country firms. Managerial expertise is not readily transferred either, in large part because TNCs are reluctant to hire host-country residents into top-level managerial positions. Thus, the second purported benefit of TNC the transfer of technology and managerial expertise can be stymied by the very logic that causes TNCs to undertake FDI.

Costs
3. TNCs can drive domestic producers out of business. This can happen in one of two ways. On the one hand, domestic firms producing in the same sector will face increased competition once a TNC begins selling in the domestic market. Using best practices for management and state of the art technology, MNCs can often under-price local firms, thereby driving them out of business. Second, TNCs often desire to assemble their finished goods from imported components. As a result, domestic input producers in the same industry will find that as the domestic producers they supply are driven out of business, they have no one to sell their intermediate goods. Thus, local input suppliers can also be driven out of business by TNCs.

DEFINITION OF ENTRY MODE

An international market entry mode is supposed to create the possibility to enter into a foreign country by arranging companys products, technology, human skills, management or other resources. Entry modes help companies to determine goals, resources and policy in order to channel their international activities toward a sustainable international expansion.

In the past, TNCs primarily built their international production networks through FDI (equity holdings), creating an internalized system of affiliates in host countries owned and managed by the parent firm.

Over time, TNCs have also externalized activities throughout their global value chains. They have built interdependent networks of operations involving both their affiliates and partner firms in home and host countries.

Depending on their overall objectives and strategy, the industry in which they operate, and the specific circumstances of individual markets, TNCs increasingly control and coordinate the operations of independent or, rather, loosely dependent partner firms, through various mechanisms.
These mechanisms or levers of control range from partial ownership or joint ventures, through various contractual forms, to control based on bargaining power arising from TNCs strategic assets such as technology, market access and standards. Such mechanisms are not mutually exclusive and they can be as much complements as substitutes to FDI.

TNCs, like all firms, can decide to conduct activities inhouse (internalization) or they can entrust them to other firms (externalization) a choice analogous to a make or buy decision. Internalization, where there is a cross-border dimension, results in FDI, whereby the international flows of goods, services, information and other assets are intra-firm and under the full control of the TNC. Externalization results either in trade, where the TNC exercises no control over other firms, or in non-equity inter-firm arrangements in which contractual agreements condition the operations and behaviour of host country partner firms.

Costs of internalization
Internalization of cross-border activities brings with it the costs of running complex, multi-plant, multicurrency operations, which tend to increase the greater the social, cultural and political differences between locations. It also implies internalizing the full extent of risk associated with the activity, including capital exposure and business uncertainty. Finally, it assumes that the technical capability, skills and know-how required to perform the activity are either present in the firm, or not prohibitively expensive or time-consuming to acquire.

Benefits of internalization
To start with, TNCs will want to maximize value capture externalization clearly implies giving up part of the profits generated along the chain. Secondly, internalization avoids the transaction costs associated with finding suitable third parties and then stipulating contractual arrangements that tend to become more complex the greater the perceived risks associated with loss of control over parts of the value chain and over assets and valuable intellectual property (IP). Finally, internalization also eliminates the costs of managing relationships with NEM partners on a continuous basis, including flows of knowledge, goods and services; communication and information flows; and monitoring and control of compliance with contractual obligations.

Advantages of externalization
Externalization has a number of intrinsic advantages. These include shifting of certain costs and risks to third parties, as well as gaining rapid access to the assets and resources third parties may bring to the partnership. These can be hard assets, such as plants and equipment, access to low-cost resources, technological capability and knowhow, or often equally important soft assets, such as networks and relationships in host countries. Externalization allows the TNC to establish a more effective internal division of labour, freeing scarce resources to be used in other segments of its value chain in other words, it allows a focus on core business.

M&As versus Greenfield

The value of cross-border M&A deals increased by 36 per cent in 2010, to $339 billion, though it was still roughly one-third of the previous peak in 2007 On the other hand, greenfield investment the other mode of FDI declined in 2010. Differing trends between cross-border M&As and greenfield FDI are not surprising, as to some extent companies tend to consider the two modes of market entry as alternative options. However, the total project value of greenfield investments has been much higher than that of cross-border M&As since the crisis.

Developing and transition economies tend to host greenfield investment rather than crossborder M&As.

More than two-thirds of the total value of greenfield investment is directed to these economies, while only 25 per cent of cross-border M&As are undertaken there.
At the same time, investors from these economies are becoming increasingly important players in crossborder M&A markets, which previously were dominated by developed country players.

Mega deals
In 2010 there were seven mega-deals (over $3 billion) involving developing and transition economies (or 12 per cent of the total), compared to only two (or 3 per cent of the total) in 2009.

Horizontal
In many cases, TNCs conduct horizontal FDI activities in order to expand their operations into another market. If a multinational corporation is structured horizontally, it manages production facilities in different countries that all produce the same product. Each facility performs the same operations, from beginning of production to completion of the finished product. For example, an American retailer that builds a store in China is trying to earn more money by exploring the Chinese market. (GAP, motor vehicle companies)

Vertical
Vertical FDI, on the other hand, occurs when a multinational decides to acquire or build an operation that either fulfills the role of a supplier (backward vertical FDI) or the role of a distributor (forward vertical FDI).

Vertically structured multinationals manage facilities in different countries that perform usually only one part of the production process. The facility produces a part or good that will be used in another facility to continue the manufacture of the product or receives a part or good from another facility that it will use to continue the manufacturing process.

Backward vertical FDI

Companies that seek to enter into a backward vertical FDI typically seek to improve to the cost of raw materials or the supply of certain key components. For example, one of the major materials used for car manufacturing is steel. An American car manufacturer would prefer that steel be as cheap as possible, but the price of steel can fluctuate dramatically depending on overall supply and demand. Furthermore, the foreign steel supplier would prefer to sell steel for as high as possible in order to please its owners or shareholders. If the car manufacturer acquires the foreign steel supplier, the car manufacturer would no longer need to deal with the steel supplier and its market-driven prices.
(Starbucks coffee shop in China)

Forward vertical FDI

On the other hand, the need for a forward vertical FDI stems from the problem of finding distributors for a specific market. For example, assume that the beforementioned American car manufacturer wants to sell its cars in the Japanese auto market. Since many Japanese auto dealers do not wish to carry foreign brand vehicles, the American car manufacturer may have a very difficult time finding a distributor. In this case, the manufacturer would build its own distribution network in Japan to fulfill this niche. (Exxon Mobil, BP)

Diversified structure (conglomerate)

TNCs that have a diversified structure produce a variety of products. The various facilities in the different countries are not integrated either horizontally or vertically.

- Mitsubishi (Japan) - Unilever (Netherlands/UK)

Non-equity modes of entry

Cross-border NEM activity worldwide is estimated to have generated over $2 trillion of sales in 2010. Of this amount: -contract manufacturing and services outsourcing accounted for $1.11.3 trillion, -franchising for $330350 billion, -licensing for $340360 billion, -management contracts for around $100 billion.

Contract manufacturing / Services outsourcing

Contractual relationships whereby an international firm contracts out to a host-country firm production, service or processing elements of its GVC (extending even to aspects of product development). All go under the general rubric of "outsourcing". Services outsourcing commonly entails the externalization of support processes including IT, business and knowledge functions.

Ex
The use of contract manufacturing varies considerably across industries.

For instance, the toys and sporting goods, electronics and automotive industry are major users of contract manufacturing, outsourcing more than 50 per cent of production by cost of goods sold.
Contract manufacturing, in industries such as pharmaceuticals, on the other hand, is relatively new and is still small measured as a percentage of cost of goods sold.

Ex
In some industries such as electronics, contract manufacturers are very large operators and TNCs in their own right. For example, Inventec (Taiwan Province of China) designs, builds and internationally distributes electronics products for lead TNCs such as Apple (United States), Fujitsu-Siemens (Japan), and Lenovo (China); and it does this from production affiliates in countries such as Malaysia, Czech Republic and Mexico

Route to market
NEMs are inextricably linked with international trade and FDI, shaping global patterns of trade in many sectors. In industry segments such as automotive components, consumer electronics, garments, hotels and IT and business process services, contract manufacturing and services outsourcing represent a very large share of total trade. NEMs are thus a major route-to-market for countries aiming at export-led growth, and a major point of access to TNC global value chains.

Contract farming
Contractual relationship between an international buyer and (associations of) hostcountry farmers (including through intermediaries), which establishes conditions for the farming and marketing of agricultural products.

Ex
In contract farming, the numbers of individual suppliers are so great that arrangements with TNCs are made by intermediaries. For example, in 2008 Olam (Singapore) sourced 17 agricultural commodities from approximately 200,000 suppliers in 60 countries (most of them developing countries). Similarly, in 2008 food manufacturer Nestle (Switzerland) had more than 600,000 contract farmers in over 80 developing and transition economies as direct suppliers of various agricultural commodities

Licensing
Contractual relationship in which an international firm (licensor) grants to a host country firm (licensee) the right to use an intellectual property (e.g. copyrights, trade marks, patents, industrial design rights, trade secrets) in exchange for payment (a royalty). Licensing can take various forms, including brand licensing, product licensing and process licensing. In-licensing refers to a company acquiring a licence from another firm; out-licensing entails sale of intellectual property to other firms.

Royalties and license payments (billion dollars)

Franchising
Contractual relationship in which an international firm (franchisor) permits a host country firm (franchisee) to run a business modelled on the system developed by the franchisor in exchange for a fee. Franchising includes international master franchising, with a single equity owner of all outlets in a market, and unit franchising, with individual entrepreneurs owning one or more outlets.

Management contracts
Contractual relationship under which operational control of an asset in a host country is vested to an international firm, the contractor, which manages the asset in return for a fee. Management contracts involve not just selling a method of doing things but involves actually doing them

Management contracts are often formed where there is a

lack of local skills to run a project (hotel)

Strategic alliances Contractual joint ventures

Contractual relationship between two or more firms to pursue a joint business objective. Partners may provide the alliance with products, distribution channels, manufacturing capability, capital equipment, knowledge, expertise, or intellectual property. Strategic alliances involve intellectual property transfer, specialization, shared expenses and risk. Contracts set forth terms, obligations, and liabilities of the parties but do not entail the creation of a new legal entity.

NEM versus FDI

The various forms of NEM can be compared to FDI in terms of their motivation. contract farming - resource-seeking; contract manufacturing, outsourcing - efficiency-seeking brand licensing, franchising - market-seeking Some types of NEMare similar to FDI in that they entail a package of assets, resources, technology and knowhow to be put in the care of host-country firms, as in the case of contract manufacturing, outsourcing, franchising. Other NEM types are more narrow asset transfers, as in the case of licensing, management contracts, or some sub-types of franchising such as distributorships or agencies.