Why should the Firm go Abroad?

There are both organizational &

environmental reasons:
Organizational Reasons are:
1. Exploiting worldwide market imperfections:
Since there is no perfect market exist in the real
world, therefore, the essence of competitive
advantage is a firms ability to create and sustain
economic profits in an imperfect marketplace for
products & factors.
For Products: to produce differentiated products
For Factors: cheaper inputs in foreign locations (p.11)

2. Exploiting the Opportunities that arise along

the life cycle of a firms product:
As Raymond Vernon suggests that there are three stages
of Business Life Cycle- i.e. Introduction/ growth;
maturity and standardization/ decline
Therefore , the product life cycle theory predicts that
initially the comparative advantage will exist in the
innovating country with export based MNEs. However
over time, as the product becomes standardized, the
country of comparative advantage will shift to lower cost
locations by increasing move towards direct investment
abroad. (p.12)

 Environmental or External reasons

are:
Responding to the Macro-economic
imperatives for globalization:
MNE & Macro forces of Globalization
There are three main macro forces:
1.
2.

3.

Globalization of capital markets (including the growth and

volatility of current markets and interest rates);
The decline costs of transportation and communication &
the growth and reach of Information Technology; (pp.1314)
The growth of regional and international trading
arrangements

2.

Exploiting the competitive

advantage of Nations

Michael Porter argued that comparative advantage

and factor endowments are not just inherited or
given at the country level, rather created by the
firms that undertake innovation in these countries.
He identified four determinants of this competitive
advantage of nations:
1. Factor conditions:
. Do the nations factor of production help a firm
compete successfully in a given industry?
. Does the nation provide a platform in which
these factors can be continuously upgraded and
deployed in new ways? (pp.16-17)

2. Demand conditions:

Are local markets highly demanding of the firm in terms of

price & non-price factors as well as in the quality of what it
produces and sells?

3. Related & Supporting Industries: (pp.18-19)

Are there related and supporting industries as well suppliers

that enable the firm to maintain close working relationships,
have proximity to those suppliers and ensure timeliness of
product and information flows?

4. Firm structure, strategy and rivalry:

Do the firms in the domestic economy have structures and

strategies that make them flexible and effective
competitors?
Is there vigorous rivalry among firms in various industries,
and local laws and institutions encourage such rivalry?

Porter further argues that any country who fulfils

these conditions may emerge as globally
competitive and will flourish. While there are as
yet no comprehensive empirical tests of whether
and the degree to which each of these factor
affects a firms ability to compete globally.
However, there are many industries which
support Porters hypothesis. Example include the
semiconductor and the software industries in the
U.S.; Automotive & electronics industries in Japan
and footwear industry in Italy to name few.

MNE: THE MODE OF FOREIGN ENTRY

EXPLOIT COMPETITIVE
ADVANTAGE THROUGH
ENTRY ABROAD

PRODUCE ABROAD

PRODUCT AT HOME AND

EXPORT

LICENSING OR
MANAGEMENT
CONTRACT

JOINT VENTURE

MAINTAIN CONTROL
OVER ASSET ABROAD

MAJORITY OR WHOLLY
OWNED AFFILIATE

BUILD FROM SCRATCH

ACQUIRE OR MERGE

There are two sets of ideas that

provide guidelines for firms in
making their foreign entry decision:
1. The Theory of Internalization based on
the economics of Transaction Costs of
activities undertaken by the firm.
2. The impact of the two environmental
variables that are unique to the MNE i.e.
Multiple Sources of External Authority
(MA) and Multiple Denominations of
Value(MV)

MNE & Internalization of Transactions in

the Choice of Mode of Entry
The theory of Transaction Cost Economics(TCS) argues that
transactions (defined to be transfers of goods and services
across a technologically separable interface) in market
settings may be prone to friction & failure, resulting in
transaction costs for firms undertaking them. Transaction or
exchanges that are more likely to entail such costs are
characterized by three attributes:
1. They have asset specificity- the asset involved in the
transaction cannot be redeployed to alternative uses or
users without loss in value;
2. There is likelihood of a greater frequency of
interaction between the parties to the transaction and
3. There is uncertainty surrounding the outcome of an
arms-length transaction

The greater the asset specificity, the higher the

frequency of interaction, or the greater the
uncertainty, the greater the transaction cost.
The TCE logic is that the MNE will internalize
through direct foreign investment (i.e. ownership
and control of assets abroad) in situations where
arms-length contracting modes( i.e. export or
contractual modes of entry) are prone to failures. In
particular, the MNE will internalize through DFI entry
mode when its investment abroad is primarily in the
form of knowledge-based assets such as technology,
managerial skills, corporate culture/shared value,
organizational structure that result in high asset
specificity.

 To sum up:
A firm will have the incentives to enter abroad
through FDI when the basis of its competitive
advantage is derived from non-transferable or nonmarketable sources, such as technology, brand
equity,
R&D
and
innovation,
proprietary
information about a product or process. In such
instances, there is likelihood that exporting or
licensing may not be effective in transferring the
competitive advantage or even if it were, there is
the likelihood that the knowledge embodied in the
asset or the product may be diffused too easily,
without the firm being able to capture any profit
from it.

MNE and the Role of MA and MV in the

choice of Mode of Entry:
MA Multiple Sources of External Authority:
The overriding
principle underlying cross-border
relationships is that of sovereignty. The sovereignty of a
nation-state is embodied in its authority to influence
events within its legal territory and its choice to be
relatively immune to outside influences. This authority
generally manifests itself in terms of laws and regulatory
institutions, political institutions, official language(s),
norms of behavior, culture. The MNE has exposure to
multiple (often conflicting) sources of external authority.
There are three aspects of MA that merits consideration:
1. The number of geographic locations that the firm
operates in; (21-22)

2. The variance in country environments resulting from

operating in different geographic locations and (pp.22-23)
3. The lack of a superstructure to mediate threats or
opportunities that arise at the intersections of the variances
in country environments.
Similarly, under MV (Multiple Denominations of Value) :which
means the firms cash flows are denominated in different
exchange rates. This in turn, results in three effects on the
MNE: (1). translation exposure, which is the problem of
ex-post settling up and valuations already undertaken
across multiple currencies; (2) transaction exposure ,
which is the problem of hedging known or anticipated cash
flows against future exchange rate shifts; and (3)
economic exposure, which is the problem of the impact
of unanticipated changes in real exchange rates on the
firms competitive position.
Therefore, when MA is high, the MNE should choose export of
contractual modes of entry and when MA is low, the MNE
should choose the DFI mode of entry.

MV , however, has the opposite set of implications. When the degree

of MV is high, MNE would favor the DFI mode of entry , in order to
take advantage of the benefits from asset diversification. However,
if MV is low, there is little value to asset diversification and
therefore, MNE would prefer export and contractual mode of entry
in order to avoid the costs of carrying excess capacity worldwide.

The Complex MNE: Nonsequential Entry :

In the
present era of globalization, many MNEs are complex
organizations- multidivisional, multiproduct firms competing
simultaneously in multiple-industry categories. Therefore, MNE
may make particular choices of entry mode. For example an MNE
is having three industries A,B & C may export product A from
country X, license product B in country Y and decide to produce C
in country Z, where these choices may be determined by a set of
firm or industry specific factors relevant to products A,B, & C.
Hence, how firms go abroad or their mode of entry is also
determined by location or host country specific factors, notably MA
and MV. In other words, entry can be nonsequential, depending on
the characteristics of the location. (pp.24-25)