Chapter 9: Foreign Market Entry and International Production An Introduction to International...

Chapter 9: Foreign Market Entry and International Production

An Introduction to International Economics: New Perspectives on the World Economy

© Kenneth A. Reinert, Cambridge University Press 2012


Analytical Elements

Countries Sectors Tasks Firms Factors of production


Introduction

Exports are just one way that firms can place their products in foreign markets, a process known as foreign market entry

Two other means are Contracting Foreign direct investment

Contracting and foreign direct investment are two types of international production

These are described in Table 9.1


Table 9.1: The Foreign Market Entry MenuCategory Mode Characteristics

Domestic None Purely domestic firm supplying home market

Exporting Indirect Exporting Another firm acts as sales agent

Exporting Direct Exporting Firm completes export transaction itself

Contractual Licensing License to foreign firm to produce abroad

Contractual Franchising License with conditions to ensure consistency

Contractual Subcontracting Contract with materials and specifications

Investment Joint Venture Jointly owned separate firm

Investment Mergers and Acquisitions

Purchase of part or whole of foreign firm

Investment Greenfield Brand-new production facility


Exporting

Indirect exporting The home-country firm relies on another firm

known as a sales agent or trading company to complete the export transaction

Direct exporting The home-country firm takes on the export

transaction itself This can include the research, marketing, finance,

and logistics requirements of the trade trasaction


Contractual

Licensing The home-country firm licenses a foreign firm to allow it to

use the home-country firm’s production process in the foreign country

Franchising The home-country firm licenses a foreign firm to allow it to

use the home-country firm’s production process in the foreign country but exerts more control over production and marketing to ensure consistency across foreign markets

Subcontracting The home-country firm contracts with a foreign firm to

produce a product to certain specifications


Investment

Joint venture (JV) The home-country firm establishes a separate firm in the

foreign country that is jointly-owned with a foreign-country firm

Mergers and acquisitions (M&A) The home-country firm buys part (merger) or all

(acquisition) of the shares of an already-existing production facility in the foreign country

Greenfield investment The home-country firm establishes a brand-new production

facility in the foreign country that it fully owns


Motivation for International Production Resource seeking

Gaining access to natural resources or human resources Market seeking

Locating near expected market growth, to better adapt a product to local needs, and to supply intermediate inputs to another firm

Efficiency seeking Rationalize the established structure of international

production for economies of scale and scope Strategic asset seeking

Part of a strategic game among global competitors in oligopolistic sectors


Strategic Asset Seeking

Insights from Dunning and Lundan (2008) Acquiring or collaborating with another to thwart a competitor

from doing so Merging with a foreign rivals to strengthen joint capabilities Acquiring a group of suppliers to corner the market for a

particular raw material Gaining access over distribution outlets to better promote its own

brand of products Buying out a firm producing a complementary range of goods or

services so it can offer its customers a more diversified range of products

Joining forces with a local firm in the belief that it is in a better position to secure contracts from the host government


Entry Mode Choice

Economic view A firm will chose the entry mode that will provide it with the

greatest risk-adjusted or expected return on the entry investment

Entry mode choice factors include Degree of control Level of resource commitment Dissemination risk

Dissemination risk the possibility of a foreign partner firm obtaining technology

or other know-how from the home-country firm and exploiting it for its own commercial advantage


Table 9.2: Factors Influencing Choice of Foreign Market Entry Mode

Source: Hill, Hwang and Kim (1990)

Mode Degree of Control

Level of resource commitment

Degree of dissemination risk

Trade Low Low Low

Contractual Low Low High

Investment- Joint Venture

Medium Medium Medium

Investment- M&A or greenfield

High High Low


Entry Mode Choice

If a firm’s most important concern was Degree of control over the production and marketing

process Lead the firm towards an investment mode of foreign market

entry based on a subsidiary obtained either through greenfield or acquisition investment

Limiting resource commitment to low levels Consider either trade or contractual modes of foreign market

entry Low degree of dissemination risk

Either trade or investment via a subsidiary would be the preferred mode of entry

In most instances, firms have more than one primary concern


The Rise of Multinational Enterprises and International Production Early MNEs were part of the colonization efforts

during the 16th and 17th centuries Included state-supported trading companies such as the British

East India Company, the Dutch East India Company, and the Royal African Company

Known as the age of merchant capitalism Industrial revolution in the 19th century led to

industrial capitalism British-based MNEs operating in India, China, Latin America, and

South Africa Involved in mining, plantation agriculture, finance, and shipping

Japan became involved in MNE activity after the Meiji Restoration


The Rise of Multinational Enterprises and International Production In the 20th century, industrial production grew more

capital intensive Role of the production line and associated economies of

scale grew more important Era of industrial capitalism gave way to managerial

capitalism or Fordism Center of innovative economic activity moved from Europe

to the United States Firm size increased Business success became based on the ability to

coordinate growing sets of complementary activities


The Rise of Multinational Enterprises and International Production Depression that began in 1929 and the Second

World War hurt most forms of international economic activity

Post-war recovery further strengthened the role of US-based MNEs Technological advantage of US-based MNEs during the

early post-war period was the point of reference of the product life cycle theory Production is confined to the home base MNE during the early

phases of product life cycle During later phases production can move to subsidiaries in

foreign countries in order to take advantage of lower labor costs


The Rise of Multinational Enterprises and International Production The 1970s had the rise of industrial output in the newly

industrializing countries (NICs) of East Asia Especially Japan, Taiwan, and South Korea Many see this as new economic era known as post-Fordism or

Toyotism Economies of scale have been replaced by flexibility as the

progressive element in manufacturing and the use of information and communication technology (ICT) to control production processes

Rise of industrial output was followed by a rise in FDI on the part of East-Asian based MNEs Especially those based in Japan


Table 9.3: Leading Sources of World FDI (percent of global, outward stocks)Source 1960 1980 1990 2000 2010

United States

47 43 24 22 24

United Kingdom

18 16 13 15 8

Germany 1 8 8 9 7

France 6 4 6 7 7

Japan 1 4 11 5 4

China 0 0 0 0 1

Brazil 0 0 0 1 1

All Developing

NA 3 8 14 15


Table 9.4: Leading Destinations of World FDI (percent of global, inward stocks)Destination 1980 1990 2000 2010

United States 16 20 22 18

United Kingdom

12 10 8 6

Germany 7 6 5 4

France 5 5 5 5

Japan 1 1 1 1

China 0 1 3 3

Brazil 3 2 2 2

All Developing 26 27 30 31


FDI and Comparative Advantage What difference does FDI make to the

comparative advantage model of Chapter 3? This is considered in Figure 9.1 An FDI flow from Japan to Vietnam changes the

relative factor/resource endowments of both countries Japan becomes less capital abundant Vietnam becomes more capital abundant

These changes shift the PPFs of the two countries


Figure 9.1: FDI and Comparative Advantage between Vietnam and Japan


FDI and Comparative Advantage Vietnam’s PPF shifts out in a manner biased

towards the capital intensive good Japan’s PPF shifts in biased away from the

capital intensive good These changes lessen the strength of

comparative advantage FDI can therefore be a substitute for trade In other more specific cases, however, FDI

can be a complement to trade

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