classical country-based trade theories and modern firm-based trade theories

1. Table of ContentsAbstract................................................................................................................31. Introduction..................................................................................................3

1.1 Overview of Trade Theory................................................................................................42. Analysis of Classical country-based and Modern firm-based Trade Theories................................................................................................................5

2.1 Mercantilism.....................................................................................................................52.2 Absolute Advantage (Adam Smith, 1776)........................................................................62.3 Comparative Advantage (David Ricardo, 1817)...............................................................72.4 Heckscher-Ohlin Theory (Eli Heckscher (1919) and Beril Ohlin (1933)).......................72.5 The Product Life Cycle Theory (Vernon, mid-1960s)......................................................82.6 New Trade Theory: Economies of Scale & First Mover Advantage (Paul Krugman).....92.7 National Competitive Advantage......................................................................................9

2.7.1 Factor endowments (factors of production).............................................................102.7.2 Demand conditions..................................................................................................112.7.3 Relating and supporting industries..........................................................................112.7.4 Firm strategy, structure, and rivalry........................................................................11

3. Critiques – Mercantilism vs National Competitiveness..........................113.1 Mercantilism and Neo-Mercantilism..............................................................................12

3.1.1 Currency manipulation............................................................................................123.1.2 Increase conflict between nations............................................................................133.1.3 Unemployment........................................................................................................13

3.2 National competitive advantage – Porter’s Diamond Model..........................................133.2.1 Government interventions and Policies...................................................................143.2.2 Competitive strategy................................................................................................14

4. Global Strategy - Manufacturing industry..............................................154.1 Product quality and innovation “Kaizen”.......................................................................164.2 Mode of Entering Foreign Markets and Government Policies.......................................17

4.2.1 Penetrating the US Market through JV....................................................................174.2.2 Penetrating the Asian Market through FDI – Economies of Scale and “TPS”.......18

5. Conclusion...................................................................................................19References..........................................................................................................21

BMIB5103 - Assignment Nor Helmee Bin Abd Halim

Abstract

This paper presents an analysis of classical country-based theories and modern firm-based

theories. Subsequently, further critical analysis is presented based on Mercantilism, being the

least favorable theory and The National Competitive – Porter’s Diamond theory being the most

appealing theory. This paper concludes with a case study of Toyota Motor Corporation’s global

strategy in the international trade.

1. Introduction

It is quite a normal experience to see labels like “Made in Vietnam” on a pair of Adidas running

shoes, a German multinational company, a Hard Rock Café T-shirt collector getting “Made in

Bangladesh” Hard Rock Café Tokyo city-tee, or thinking of buying a famous Japanese electrical

appliance, chances are that the item has been manufactured in Thailand or assembled in Malaysia

instead of its home country. It is also quite often seen “Made in China” label or toys imported

from China when we walk into a toy shop. These experiences depict the effects of international

trade. In a nutshell, international trade is defined as an exchange of goods and services across

international borders (Barot, 2015).

International trade exposes consumers and countries to the international market that

enables exchange of goods and services between countries. Product that is bought from the

global market is called an import and product that is sold to the global market is called an export.

Simply put, it allows countries to trade globally as well as enable consumers to choose and shop

goods and services that suits their own preferences in terms of quality and price which are not

available in their own countries. This notion is supported by Wood (1993) where he mentioned

“… the greatest part of international trade is when some goods can be produced better or cheaper

in one country rather in another”.

Many researchers, analysts and academia, including Barot (2015); Hill et al (2015)

discuss and highlight the importance of a country to engage in international trade. Their

arguments are mainly based on popular international trade theories. International trade theory

refers to patterns of international trade between countries and the volume of trade among goods

(Barot, 2015). For decades, these theories have shaped the economic development and

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government policies of many nations and firms globally. The formation of World Trade

Organization, the European Union and the North American Free Trade Agreement (NAFTA)

were resulted from the development of these international trade theories. The development was

then expanded to ASEAN countries when ASEAN Free Trade Area (AFTA) was formed and

agreed at the 1992 Singapore ASEAN summit. The objective is to leverage the potentials and

strengthen intra-ASEAN market (MITI, 2015).

In the 1990s, the influence of these international trade theories has resulted in significant

changes in the global free trade (Hill et al, 2015). The theories are 1) Mercantilism, 2) Absolute

Advantage (by Adam Smith, 1776), 3) Comparative Advantage (by Ricardo, 1817), 4)

Heckscher-Ohlin Theory (by Eli Heckscher and Beril Ohlin), 5) The Product Life Cycle Theory

(by Vernon, mid-1960s), 6) New Trade Theory: Economies of Scale & First mover Advantage

(by Paul Krugman), and 7) National Competitive Advantage (by Michael Porter).

1.1 Overview of Trade Theory

Mercantilism is the first classical country-based theory propagated in the sixteenth and

seventeenth centuries. The theory is about three hundred years old, but it has been one of the

most debated theories until today. Mercantilist suggested countries to encourage exports and

discourage imports. The next classical theory which was proposed by Adam Smith in 1776 is

known as Absolute Advantage theory. The theory explains the benefits of unrestricted free trade.

Adam Smith highlights that in order to raise richness is to embrace free trade between states. In

the 1817, David Ricardo refined the theory and suggested Comparative Advantage theory where

he indicates that countries can gain from trade even if one of them is less productive (Barot,

2015).

In the 1920s and 1930s, two Swedish economists, Eli Heckscher and Bertil Ohlin set a

framework known as Heckshcer-Ohlin theory. This theory is the extension of the previous

theories of Adam Smith and David Ricardo. Hill et al (2015) highlight that Smith, Ricardo and

Heckscher-Ohlin theories suggest if local citizens buy products from other countries, it will

improve the economy of the country although the products could be produced locally. In other

words, international trade allows countries to specialize in one particular or many industries and

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export the products. At the same time they import products from other countries of which they

are specialized in.

In 1960s, Raymond Vernon developed the first modern firm-based theory called Product

Life Cycle theory. The theory suggests that a country exports products that they have developed

in other countries, and as the products mature and well accepted globally, other countries which

have greater factor endowments will start producing locally and export back to other countries

including the original country of the products. In the 1980s, more economists such as Paul

Krugman developed a New Trade Theory – Economies of Scales and First mover Advantage.

As the name of the theory explains a country or firm that has a specialty in the production of

products and pre-dominate the market (first-mover) and able to spread the fixed costs over a

large volume (economies of scale) will have the competitive advantage over its competitors (Hill

et al, 2015). In another research related to new trade theory, Michael Porter developed a theory

called as National Competitive Advantage. The theory explains the attributes of competitive

advantages for countries and firms to be successful in the international trade. According to Porter

(1990), there are four attributes which formed a diamond, hence the name Porter’s Diamond

model.

2. Analysis of Classical country-based and Modern firm-based Trade Theories

As briefly discussed, classical country-based theories refer to Mercantilism, Absolute

Advantage, Comparative Advantage and Heckscher-Ohlin theories, while the modern firm-based

theories refer to The Product Life Cycle, New Trade Theory – Economies of scale and first

mover advantage and lastly National Competitive Advantage. The following will discuss in

details the differences between classical country-based and modern firm-based theories.

2.1 Mercantilism

This theory emerged in England in the mid-sixteenth century as the first theory of international

trade. It suggests that the quantity of metals (Barot, 2015) which refers to gold and silver (Hill et

al, 2015) owned by countries represent the country’s richness. Gold and silver were used as a

currency of trade between countries and countries could earn more gold and silver by exporting

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more and restrict imports transactions. In other words, a country must promote export

transactions than its import transactions to improve the country’s balance of payments (BOP) or

economy’s transactions between countries (Barot, 2015). As a result, the country accumulates

more gold and silver, which subsequently increase the country’s richness, power and reputation.

According to Hill et al (2015), mercantilists are supported by the government through the

implementation of protectionism policies. These policies include imposing import tariffs,

restrictive quotas, other government regulations, and at the same time promoting export subsidy.

Mercantilist policy, however, has been argued by many economists (Barot, 2015; Hill et al,

2015). The theory has been argued for being unjust to others or known as a zero-sum game. It is

only beneficial to one party (country) while the other is at a loss. This theory is then refined by

Adam Smith and David Ricardo and demonstrate that trade should be a positive-sum game or a

win-win situation. In a modern business world today, many economists and academia (Kowalski,

2011; Barot, 2015; Hill et al, 2015), believe that some countries are adapting mercantilist policy

or known as neo-mercantilism. China and Germany, for example, have been argued as a

supporter of neo-mercantilism policy. This allegation will be further discussed in the later part of

this paper.

2.2 Absolute Advantage (Adam Smith, 1776)

As mercantilist policies give a bad impact to a country’s economic growth (Barot, 2015), Adam

Smith in 1776 challenges the zero-sum game by arguing that the policy is only beneficial to the

mercantilist country and does not give a positive advantage to consumers (Hill et al, 2015). He

suggests the notion of a positive-sum game where it is more profitable export transactions if a

country imports goods that will also benefit others, including the consumers.

During that period, England is known for its specialty in textile manufacturing while

France is known for its world’s best wine production. How these specializations of England and

France illustrate this theory is when both countries exchange its product with each other.

England in this case, has an absolute advantage by producing textile products efficiently than

France, whereby France has an absolute advantage of producing the wine.

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By exchanging products via international trade, both England and France can have both

clothing and wine at the same time. England does not need to produce wine, where they are not

good at producing it and vice versa. Essentially, Smith’s theory indicates that a country should

never produce a product locally when there is another country that can produce it efficiently and

cheaper as compared to producing the same product locally. By engaging in trade, both countries

will enjoy the benefits thus explains the positive-sum game concept.

2.3 Comparative Advantage (David Ricardo, 1817)

Adam Smith’s absolute advantage theory, however, does not explain situations where countries

which do not have absolute advantage in any of the product or have the absolute advantages in

all of the products. Based on that argument, David Ricardo in 1817 develops a comparative

advantage theory. According to Hill et al (2015), Ricardo suggests that countries should

specialize in the production of those goods they produce most efficiently and buy good that they

produce less efficiently from other countries, or, at the same time buying goods from other

countries that they could produce more efficiently at home.

This notion can be illustrated by an example where Ghana is more efficient in the

production of both cocoa and rice. In Ghana, it takes 10 resources to produce one ton of cocoa

and 131/3 resources to produce one ton of rice. Given its 200 units of resources, Ghana could

produce 20 tons of cocoa and no rice. 15 tons of rice and no cocoa, or some combination of the

two based on 200 units of resources. While in South Korea, it takes 40 resources to produce one

ton of cocoa and 20 resources to produce one ton of rice. With the same units of resources, South

Korea could produce 5 tons of cocoa and no rice, 10 tons of rice and no cocoa, or some

combination of the two.

Based on the above scenario, Ghana is more efficient in producing cocoa as compared to

South Korea or comparatively more efficient at producing cocoa than it is at producing rice. If

both countries engaging in trade, they can increase their combined production of rice and cocoa,

thus benefiting consumers in both countries as they can consume more of both goods.

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2.4 Heckscher-Ohlin Theory (Eli Heckscher (1919) and Beril Ohlin (1933))

Kowalski (2011) and Hill et al (2015), discuss the different explanation of comparative

advantage developed by Swedish economists Eli Heckscher in 1919 and Bertil Ohlin in 1933.

According to Heckscher and Ohlin, the comparative advantages arise from differences based on

national factor endowments which are land, labor cost and capital. These differences in factor

endowments translate to differences in factor costs, it means more favorable a factor lead to a

lower cost. As such, Heckscher-Ohlin predict that countries will export goods that make

intensive use of locally abundant factors, and import goods that make intensive use of factors

which are locally scarce.

Hill et al (2015) highlight the notion of this theory that every nation have a varying factor

of endowments which explains differences in factor costs, while Kowalski (2011) stresses the

greater impact of this theory is the possibility of accommodating various combinations of factors

of production such as land, capital, technology, skilled, and unskilled labor. The theory suggests

that countries will export goods that intensive use of factors that are locally strong and importing

goods that make intensive use of factors that are locally weak. The key point in this theory

emphasizes the interaction between product and country characteristics that together form the

basis of comparative advantage.

2.5 The Product Life Cycle Theory (Vernon, mid-1960s)

The Produce Life Cycle theory is the first modern firm-based theories. This theory was

developed by Raymond Vernon in the mid-1960s. According to Barot (2015), the theory

emphasizes on creativity, markets extension, comparative advantages and strategic answer of the

global rivals in decisions related to the production, trade and international investments. The

Product Life Cycle theory consists of three phases, 1) a new product, 2) mature product, and 3)

standardized product.

Hill et al (2015) cited that Vernon argues in the early stage of a new product, the market

is limited to the home country and the demand from other countries is limited to a certain group

of people. The limited demand in those countries does not make it worthwhile for firm in those

countries to start producing the new product, but it does encourage exports from the original

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producer of the product. Over time, as the demand starts to grow in other countries, it becomes

mature and worthwhile for foreign producers to begin producing for their home markets. The

firm starts globalizing by setting up production facilities abroad, thus limiting export from the

country of origin.

As the product becomes standardized, pricing (Hill et al, 2015) becomes the key

marketing strategy. Cost considerations play an important role in firm to stay competitive in the

market. The firm is forced to reduce their cost (Barot, 2015) and the country of the original

producer begin to import the goods which they initially export to other countries. In this case,

from countries with having lower labor costs. The imports, eventually, replace the internal

production of the home country.

2.6 New Trade Theory: Economies of Scale & First Mover Advantage (Paul Krugman)

In the 1980s, economists such as Paul Krugman and Kevin Lancaster (Barot, 2015), develop a

theory which is called the New Trade Theory – Economies of Scale and First Mover Advantage.

The theory stresses out that any firm that able to achieve better economies of scale (unit cost

reductions associated with a large scale of output) would give a positive impact to international

trade (Hill et al, 2015) by increasing the variety of goods available to consumers and decrease

the average cost of those goods (economies of scale).

First mover advantages (the economic and strategic advantages that accrue to many

entrants into an industry) will promote economies of scale and introduce barriers to entry for

other firms (Hill, 2009). The key elements of being a first mover advantage is the ability for

firms to achieve economies of scale (lower cost structure) before of later entrants. Hill (2009)

argues that when products where economies of scale are significant and represent a substantial

proportion of world demand, the first movers in an industry can gain a scale-based cost

advantage which later entrants find it difficult to compete. In sum, countries may dominate in the

export of certain goods when they are able to achieve economies of scale in their production, and

at the same time located in countries which offer lower production cost that will give them the

first mover advantage.

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2.7 National Competitive Advantage

In 1990, Michael Porter revealed the results of his research in his book The Competitive

Advantage of Nations, why some nations achieve international success and some failed to

survive (Hill, 2009; Hill et al, 2015 and Barot 2015). He emphasizes on company strategy and

competition. Competition differ significantly from country to country and from one industry to

another. For example, the reason why Japan is doing so well in automobile industry, and

Germany and the United States are best in the chemical industry. These questions can’t be

answered by previous theories, but Porter’s theory tries to provide some explanations to these

questions.

In this theory, Porter identified four attributes of which he calls the diamond that promote

the creation of a competitive advantage. These attributes are 1) Factor endowments (factors of

production), 2) Demand conditions, 3) Related and supporting industries, and 4) Firm strategy,

structure, and rivalry. Porter (1990) suggests that the presence of all four components of the

diamond will boost up competitive performance. At the same time, he suggested that government

interventions such as policies, subsidies and regulations can influence each of the four

components of the diamond.

Figure 1.1 – Porter’s Diamond framework

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2.7.1 Factor endowments (factors of production)

These factors can be either basic natural resources, climate, location, or advanced factors such as

skilled labor, communication infrastructure, research facilities and technological know-how.

Factor endowments are based on Heckscher-Ohlin theory which Porter did not propose anything

new. These factors can provide an initial advantage that is then reinforced and extended by

investment in advanced factors. According to Porter, advanced factors are the most significant

for competitive advantage (Hill et al, 2015).

2.7.2 Demand conditions

It refers to the nature of home demand for an industry’s product or service. Demand conditions

influence the development of capabilities. For example, sophisticated, knowledgeable and

demanding customers pressure firm to be more competitive and to produce high quality and

innovative products.

2.7.3 Relating and supporting industries

This attribute refers to the presence supplier industries and related industries that are

internationally competitive. According to Porter, investing in these industries can spill over and

contribute to success in other industries. The most important findings are that successful

industries within a country tend to be grouped into clusters of related industries which then

prompt knowledge flow between firms. As a result, it benefits all firms within that cluster.

2.7.4 Firm strategy, structure, and rivalry

The last attribute refers to the condition in the nation governing how companies are created,

organized and managed, and the nature of rivalry within a nation. The two important points made

by Porter highlight that different nations are characterized by different management ideologies

which influence the ability of firms to build national competitive advantage. Porter’s second

point is that there is a strong association between vigorous domestic rivalry and the creation and

persistence of competitive advantage in an industry.

Vigorous domestic rivalry induces firms to look for ways to improve efficiency, which

makes them a better international competitor. They create pressures to innovate, to improve

quality, to reduce costs and to invest in upgrading advanced factors. All these create intense

competition in the market (Hill, 2009, Hill et al, 2015).

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3. Critiques – Mercantilism vs National Competitiveness

The world economy and economic policies of many nations today are the result of the

international trade theories which have been developed and reviewed since mid-sixteenth century

by many economists and researchers. Although these theories have not gone through detailed

empirical testing (Hill et al, 2015), the framework has been used as a guidance to shape the

patterns of international trade. These theories continue to be debated and argued until today.

3.1 Mercantilism and Neo-Mercantilism

Although Mercantilism theory existed since three hundred years ago, the doctrine is still being

debated until today. Despite being argued and refined by many economists such as Adam Smith

and Ricardo, the theory has several commonalities. According to Cwik (2011) and Hill et al,

(2015), mercantilist believes that exports are beneficial to the nation while imports are

detrimental. The trade surplus brings the nation's wealth and power. For example, Hill et al,

(2015) highlight China’s outstanding economic performance has been led by this ideology.

China has been using its cheap labor advantage to produce goods based on raw material

imported from other countries and sell to developed nations such as the United States.

Throughout 2005 to 2008, the exports have been growing faster than its import which

economists have raised a concern over China pursuing a neo-mercantilist policy. The country

has been deliberately discouraging imports and encouraging exports to grow its trade surplus and

accumulate foreign exchange reserves which eventually develop its economic power.

3.1.1 Currency manipulation

Hill et al (2015) highlight that the USA and the UK have been on trade deficit with China for

over a decade. From a neo-mercantilist perspective, trade deficits are harmful. Cwik (2011)

expresses the situation as “..if we import more than we export then ‘they’ are taking our ‘job’

and ‘our’ profits. Trade is reduced to a zero-sum game in which winning comes at the expense of

the ‘losers’”. In relation to this strategy, the Chinese purposely keep its currency below the

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market rate to make their country’s exports cheaper on the foreign markets. Cwik (2011) in his

journal highlights that this strategy led to another issue of protectionism through currency

manipulation by the Chinese Central Bank. Technically, the Chinese government pegged the

yuan to the dollar to keep the prices of China’s goods artificially low.

The immediate impact of China is they have a competitive advantage over other

developed nations, especially the USA (Hill, 2009). This advantage is then translated into

increased employment, development of new technologies and products, and positive cultural

exchanges as the Chinese seek new markets and raw material sources (Cwik, 2011).

3.1.2 Increase conflict between nations

Apart from currency manipulation as highlighted by Cwik (2011), neo-mercantilist policies have

also increased conflict between nations. The earlier scenario between China and the USA on

currency manipulation itself has created a conflict between these two nations. American

economists have been accusing the Chinese for unfairly manipulating its currency against the

dollar to promote its exports. The Americans put a pressure by imposing tariffs on Chinese

imports into the US, but, China unlikely to back down (Will Hutton, 2010). The conflict has been

going to the extent that the US will declare economic war against China.

3.1.3 Unemployment

Neo-mercantilists policies increase employment opportunity in the local market, at the same time

reduce employment opportunities in the other country. China in its efforts to increase production,

it creates more domestic jobs to fulfill the export demands from the US. Conversely, an

unemployment rate increase in the US, especially in the manufacturing sectors since the country

is no longer producing its own textile products but import the products from China. The conflict

creates domestic problems such as unemployment, social issues and poverty (Cwik, 2011).

3.2 National competitive advantage – Porter’s Diamond Model

The most appealing theory centered on The National Competitive Advantage – Porter’s diamond

model (1990). It represents a different paradigm to assess national sources of competitive

12


advantages. In the early development of international trade theories, the focus for national

competitiveness were on natural resources and factors of production – land, labor cost and

capital (Porter, 1990). Over time, in the advent of technology and globalization, these theories

are not able to justify country’s success primarily based on factors of production, and countries

with or lack of natural resources. Based on these elements, Porter developed The Diamond

Model that consists of four attributes to the national competition.

Porter (1990) suggests that all four components of the diamond will determine the

competitiveness of a nation and this notion has been supported by many economists and

researchers, including Grant, (1991) and Hill et al, (2015). Grant (1991) highlights that Porter

has built “a bridge between strategic management and international economics” as economists

usually study a country as whole based on factors such as GDP, interest rate, inflation rate, while

strategists or academia study firms, managers and national cultures. Porter’s diamond model has

influenced the international trade in many ways, such as government interventions, policy

recommendation as well as a competitive strategy.

3.2.1 Government interventions and Policies

According to Porter (1990), influences and support from the government is necessary for the

diamond model to be effective. For example, government regulations, laws, subsidies, policies

and educations (Hill et al, 2015), has greater effect on the factor endowments. Through Porter’s

analysis in his theory has convinced the governments to provide support and develop a plan to

for firms to be competitive in the marketplace.

In a different perspective, Grant, (1991) and Hill et al, (2015) highlight that through

demand conditions, the government can shape domestic demand through local product standards

or with regulations that mandate or influence buyer needs. Through governance and policies such

as tax policy and antitrust law can influence related and supporting industries. In relation to this,

Porter’s notable findings is the “clusters” that has spillover benefits to all firms in the related and

supporting industries. Firms and industries are being internalized within the industry cluster

(Grant, 1991).

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3.2.2 Competitive strategy

In relation to the fourth attributes of the diamond – firm strategy, structure and rivalry, Porter

(1991) argues the different management ideologies from different nations which affect the

national competitive advantage. He compares top management team of Germans and Japanese

firms with the top management team of many US firms. The Germans and Japanese firms are

occupied by experienced engineers whereby the top management of US firms is occupied by

leaders with finance backgrounds. The findings indicate that the Germans and Japanese

companies continue improving their manufacturing and product design, but the US firms are too

focused on short-term financial returns. The consequence of the different management ideologies

has shown why the US firms is not competitive in those engineering-based industries as

compared to its rivals in Germany and Japan. As such, Porter’s findings on firm strategy and

organization structure play an important role to ensure firms are relevant in the marketplace.

At the same time, Porter (1990) emphasizes on innovation, creativeness as well as

efficiency as sources of competitive advantages to compete in the market. The notion educates

firms to be innovative, creative and efficient in its internal processes in order to be at a

competitive advantage. In sum, The National Competitive Advantage theory has led to the

development of the world economy. At the corporate level, it has transformed many firm’s

processes, and educate firms to operate, manage and utilize all resources and sources of

competitive advantage to compete with other competitors. At the industry level, the theory has

accelerated technical change, compressed product life cycles and increased the geographical

concentration of industries. Lastly, at the national level, the theory has reduced the gaps between

nations in terms of their economic development (Grant, 1991).

4. Global Strategy - Manufacturing industry

Based on the presented theories especially from modern firm-based theories, some key

takeaways can be concluded into a few main areas such as; 1) product quality, 2) economies of

scale, and 3) FDI, 4) government policies and regulations, and 5) sources of competitive

advantages. In this section, a large Japanese based automobile manufacturer, Toyota Motor

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Corporation will be used to illustrate how a firm develops a global strategy using its

resource-based capabilities to enter international market.

Toyota Motor Corporation or “TMC” is one of the largest automobile manufacturers in

the world. The firm was established back in 1937 and headquartered in Toyota City, Japan. The

firm has operations in Japan, North America, Europe and Asia and it has approximately 345, 000

employees around the globe. The firm is engaged in the design, manufacture and sales of many

variants of cars. The company and its affiliates produce automobiles and related parts and

components through more than 50 overseas manufacturing companies in 28 countries and

regions besides its home country, Japan. The firm sells its products through approximately 170

distributors in more than 190 countries and regions. During the 2015’s financial year, the firm

recorded revenues of JPY27, 234,521 million or USD248, 923.5 million and the net profit is

JPY2, 173,338 million or USD19, 864.3 million (Toyota “Company Profile”, 2016).

Based on the background of TMC, it shows how successful the firm in the global market.

From an international trade perspective, there are a number of factors and strategies that

contribute to the success of the firm in entering and competing in the international market. The

following pages will analyze strategies adopted by TMC.

4.1 Product quality and innovation “Kaizen”

One of the key success factors for TMC in both Japanese market and international market is

primarily due to its capabilities in producing a high quality and reliable products. Additionally,

the firm’s culture towards “continuous improvement” or known as “Kaizen” in Japanese has won

the trust of consumers and named as the top brand name under the car industry category by

BrandZ, the world’s largest brand equity database (BrandZ, 2016). These attributes have led to a

strong market position specifically in domestic market, North America and Asia.

This product development strategy has attracted many existing and new customers to

experience its new innovations. The greatest product innovation of TMC is through Toyota

Prius, the first full hybrid electric car (Toyota, 2016). The car has been the top-choice car for

eco-friendly consumers around the world. As discussed by many economists and researchers

15


such as Vernon and Porter, this strategy has significant impact on international trade, and at the

same time considered as one of the resource-based capabilities that build firm’s competitive

advantages. These capabilities and competitive advantages possessed by TMC have been the

core elements that positioned the company in the global market today.

4.2 Mode of Entering Foreign Markets and Government Policies

Today, TMC has local presence in 190 countries globally. The driver for this success is TMC’s

vision to become the leading global player. Traditionally, there are three modes of entering

foreign markets by 1) export, 2) joint venture, and 3) direct investments (FDI). In the 1950s,

TMC began its foreign market penetration by exporting its products.

4.2.1 Penetrating the US Market through JV

According to Toyota (2016), TMC entered the American market in 1957 under the name of

Toyota Motor Sales, USA Inc. It began sales with Toyopet Crown Sedans and Land Cruiser.

Although consumers agree on the quality of the car, it was not a good start as consumer

complaint about the car being underpowered. In 1961, the sales stalled and the model was

discontinued. Instead, the Land Cruiser began to gain a reputation as a durable vehicle. It was the

flagship model until 1965 when then Toyota Corona arrived. The sales continued to soar as more

Americans discovered the quality and reliability of the TMC’s vehicles. In 1975, TMC surpassed

Volkswagen to become the No. 1 import brand in the United States.

Meanwhile, domestic competition between TMC and local carmakers such as Nissan is

getting more intense which leading to a great cost advantage (Das & Das, 2012) for TMC to

pursue joint venture or “JV” strategy. In 1984, the US Federal Trade Commission approved a

“JV” proposal between Generals Motors and Toyota Motor Corporation. The two automotive

giants jointly manufacture compact cars in the US (Henne et al, 1985). According to Henne et al,

(1985), the Japanese view “JV” as a less costly to enter the American market, while the

American often view “JV” as an inexpensive way to enter a potentially lucrative market, (Robert

and Eric, 1986). Additionally, “JV” allows US companies and consumers buy Japanese products

16


at a lower price when producing it locally, at the same time it allows knowledge transfer and

increase market reputation (Das & Das, 2012).

4.2.1.1 Roles of Government – Policy, Human and Infrastructure Investment

On a relevant subject, part of a mitigation plan against government policies in protecting the

local market is to pursue “JV”. Economists and researcher include Das & Das (2012) suggest

that it is a feasible strategy to reduce or even removing the trade barriers such as import tariffs,

tax structure, quota restrictions, and other various laws and regulations. By removing the

barriers, it will promote better free trade across the nations. In Asia, for example, the

introduction of ASEAN Free Trade Area (AFTA) is to promote goods to flow freely among

ASEAN countries without incurring taxes. The apparent result of this initiative is a significant

reduction in car prices to the consumers.

Apart from policies, Robert and Eric (1986), highlight the roles of government in terms

of providing support of human resource development (technical training) as well as investing in

technology infrastructure that will enhance factor endowments in line with Porter’s diamond

model. In relation to TMC’s success in America, during the initial phase of “JV” with General

Motors, it was opposed and heavily criticized by other local carmakers such as Chrysler and

Ford. It was the US government roles and responsibilities via Federal Trade Commission that

explains the objectives and the benefits of “JV” to US auto industry (Henne et al, 1985).

4.2.2 Penetrating the Asian Market through FDI – Economies of Scale and “TPS”

Apart from North America, TMC has a large market share in Asia. The primary driver for the

invasion to the Asian market is due to high demand of pickup trucks and Multipurpose Vehicle

“MPV” especially in Thailand, Indonesia and Malaysia. In this space, TMC directly invests by

forming a subsidiary of TMC and setting up major manufacturing facilities in these two countries

including Malaysia. According to Porter (1990), there are three kinds of FDI motivations to enter

foreign markets, resource-based sourcing, market access, and shifting the core decisions to the

host country. In the case of Asia’s countries, resource-based is the main motivation factor and

followed by market demand and support from the local government in promoting international

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trade and free trade. TMC is this situation, indulge in FDI as they can operate with much lower

cost, which in a long-term will increase its overall bottom line.

On the other hand, FDI improves economies of scale. In 2015, TMC globally produced

10.08 million units of cars around the world beating all other car manufacturers. Practically,

Indonesia, Thailand and Malaysia provide a large pool of low-cost labor to support the

production factories of TMC. TMC, in this case has been utilizing the factor endowments of low-

cost labor in those countries (Toyota, 2016) to support the operation of its factories and to

achieve economies of scale. Additionally, by engaging FDI, technology transfer occurs from

home country to the pool of resource in the host country (Das & Das, 2012). It’s strengthen the

factor endowments in terms of skilled-labor, which eventually improve efficiency and

productivity. As a result, it enables TMC to achieve bigger economies of scale, and deploy

competitive pricing strategy in the marketplace.

4.2.2.1 Toyota Production System – “TPS”

The success of the FDI strategy to global markets by TMC is also supported by their strong

internal process known as Toyota Production System or “TPS” (Toyota, 2016). The system was

established since 1970 covering about continuous improvement and lean manufacturing concept.

The system acts as an integrator with all TMC business strategies and its business practices. The

“Kaizen” culture which was discussed earlier is part of this process. According to Toyota (2016),

this system has become one of its firm-based capabilities which has led to the success of the

company and has given TMC a sustainable brand name and market leader position.

In summary, TMC emphasis is on its product quality and reliability as their main source

of competitiveness before confidently invading the global markets. With their strong capital and

technologically advanced, together with strong organizational culture especially the “Kaizen”

and “TPS”, TMC embraces foreign direct investment by forming affiliates, joint ventures and

subsidiaries to strengthen their global market presence.

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5. Conclusion

In general, the international trade theories have developed different views between economists.

In the early days, mercantilists argue the advantages of exports rather than import from other

countries, while other economists argue that all forms of trade as equally advantageous. Over

time, the modern firm-based theories advocate the notions of various factors that affect the

performance of a country and firm competing with each other in the marketplace. The

international trade theories also have some implications such as location implications, first-

mover implications and policy implications. Location implications are quite obvious referring to

the notion of many theories about different countries or locations have different advantages such

as capabilities, human resource, natural resource and culture. While the notion of being the first-

mover in the any particular industry will subsequently lead to dominating global trade in that

particular product. Lastly, government intervention and policies have a paramount impact on the

international trade as a policy maker to promote or become a barrier for businesses.

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classical country-based trade theories and modern firm-based trade theories

Economy & Finance