why operate internationnally? why are some firms more active internationnally than others? what are...
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Why operate internationnally?
• Why are some firms more active internationnally than others?
• What are the costs and benefits of being internationnally active?
• Why do we see more and more firms active internationnally?
• Is the trend towards greater internationalization likely to continue?
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Why Operate Internationnally?1. Compete with Foreign Firms in
one own’s country
• Get domestic prestige from selling abroad
• Learn about world class products and processes
• “Exchange of Hostages”
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Why Operate Internationnally?2. Sell to Foreign Customers
Two main strategies:
• Arbitrage
• Replication
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Arbitrage vs. Replication
• Arbitrage benefits from international heterogeneity
• Replication benefits from international homogeneity
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Arbitrage• = take advantage of international
differences in• availability of factors (including culture and
administrative infrastructure)• relative cost of factors (Comparative
advantage)laborcapitalnatural resources
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Replication
Exploit Scale Economies– Plant level
– Firm level
Exploit learning curve advantages
Exploit relational investments: Follow the customer
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Replication: Scale Economies
• Relationship between volume of production per unit of time and average cost of production
• Driven by fixed costs• The higher fixed cost, the higher the
volume of output for which costs are the lowest (the Minimum Efficient Scale)
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AC2
AC1
average cost
output/ time
MES1MES2
Economies of Scale
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Plant-level scale economies• The higher a plant’s fixed cost, the higher
its minimum efficient scale (MES)• The higher a plant’s MES, the lower its
costs at MES ouput• The higher a plant’s MES, the lower the
number of plants necessary to serve the market
• plant level scale economies are exploited internationally through exports
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Gillette’s Mach 3
• Highly automated, capital intensive process
• Two factories worldwide
• Sold in 100 countries within 18 months of launch
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Barriers to the exploitation of plant-level scale economies (1)
• Transportation costs
• Government barriers– Tariffs and quotas
– Standards and regulations
– National preferences
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Barriers to the exploitation of plant-level scale economies (2)
• Heterogeneous tastes due to
• environmental differences
• social differences
• economic differences
• Risk of concentrating production
• political risk
• foreign exchange risk
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AC2
AC1
average cost
output/ time
MES1MES2
Economies of Scale
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Firm-level scale economies• Due to high fixed cost of intangibles
• R&D, experience, know-how, reputation
• The higher the investment, the higher the firm’s MES
• The higher the firm’s MES, the higher the return on investment in intangibles
• Firm-level scale economies are compatible with multiplant operation
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Gillette’s Mach 3
• 6 years of R&D
• >$1b investment ($750m for R&D, $300m for launch)
• sold in 100 countries within 18 months (5 years for Sensor)
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0 2 4 6 8
Britain (BSkyB)
Spain (RTVE)
France (France 2)
Britain (BBC)
Germany (ZDF)
Britain (ITV)
Italy (RAI)
Denmark (DR)
Germany (ARD)
Ireland (RTE)
Cost of Original TV Programming as a Multiple Of Bought Programming
Source: Screen Digest
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Barriers to the exploitation of firm-level scale economies
• Heterogeneous tastes
• Government barriers
• Management costs
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Economies of scale
• Applicable to services as well as manufacturing
• Different activities in the value chain have different MES (ex: hotel management vs. reservation system)
• subcontracting, franchising, alliances and joint ventures
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0,00
0 50 100 150 200 250 300
0.30
0.25
0.20
0.15
0.10
0.05
Learning curve
Learning periodStandard time
Pro
cess
tim
e pe
r un
it (h
r)
Cumulative units produced
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AC1
average cost
output/ time
MES1MES2
USA Japan EU
A
Economies of Scale
AC2
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Scale economies and global competition (1)
• Firms expand abroad when MES is larger than domestic market
• plant-level scale economies = exports• firm-level scale economies = foreign
production and/or exports• When MES is large relative to the size of
the domestic market, expanding abroad lower costs
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Scale economies and global competition (2)
• A firm should sell abroad if its MES is large relative to its domestic market
• a firm can be large but remain domestic if its home market is large
• a firm can be small but international if it operates in a niche market
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Scale economies and global competition (3)
• A firm’s level of globalization results from the interplay between its scale economies and the barriers to their exploitation
Keeping barriers to exploitation constant…• Small plant and/or firm scale economies:
local• Medium plant and/or firm scale economies:
multidomestic• High plant and/or firm scale economies:
global
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Local Industries: beauty salons
• Factors pushing for replication-based globalization are low
• Very low plant-level scale economies • Very low firm-level scale economies• Factors hindering replication-based
globalization are high• Heterogeneous tastes• High transportation costs
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Multidomestic industries: coffee
• Factors pushing for replication-based globalization are medium low
• Low firm-level scale economies• Low plant-level scale economies• Factors hindering replication-based
globalization are medium high• Heterogeneous tastes• High transportation costs
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Kraft Coffee Brands
• United States• Canada• France• Scandinavia• Italy• Germany• U.K.• Japan
• Maxwell House, Sanka, Yuban• Maxwell House, Sanka, Nabob• J.Vabre, Grand’Mere, Carte Noire• Gevalia• Splendid• Jacobs, Jacobs Kronung, Onko, HAG• Maxwell House, Kenco, HAG• Blendy, Maxim
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Global industries: airframes (1)
• Factors pushing for replication-based globalization are very high
• High plant-level economies of scale
• High firm level economies of scale
• Steep experience curve
• Benefits to global reputation
• Need for worldwide service
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Global industries: airframes (2)
• Factors hindering replication-based globalization are low
• Homogeneous tastes
• Low transportation costs
• Low government barriers
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Scale economies and global competition (4)
• Plant-level and firm-level scale economies are drivers of globalization
• plant- level scale economies lead to tight configuration (few plants export worldwide)
• Firm-level scale economies lead to tight coordination (many plants but coordinated strategy)
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• Tight configuration maximizes plant-level scale economies (e.g. Boeing)
• Tight coordination maximizes firm-level scale economies
• speed of introduction to recoup R&D• global coverage to discourage imitation• to safeguard reputation (consistency in
quality and marketing)
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Types of International Strategies
Firm-level economies of
scale
=
Need for coordination
High
Low
Plant-level Economies of scale
=
Need for configuration
Low High
Global
(export-based)
Multidomestic
GlobalGlobal
(Multiplant)
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History of globalization (1)
• US: 1860-1910: from regional to national
• railroads and telegraph: transportation and communication costs fall, tastes homogenized
• no government barriers
• larger markets = higher fixed costs = higher MES = larger firms, expand abroad
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Scale economies in oil refining, 1880-1900
Before rationalization
After rationalization
Refinery Throughput
1500-2000 5000-6500
Price (c/gallon)
1.5 0.45
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History of globalization (2)• The Great Depression
• Post WWII: from national to global
• Jet airplane, telephone, TV, global media = lower communication costs, homogenized tastes
• containers, megaships = lower transportation costs
• lower tariffs
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Transport and communication costs1930=100, 1990 dollars
0
20
40
60
80
100
120
1930 40 50 60 70 80 90
Average ocean-freight and portcharges per short ton of cargo
Average air-transport cost perpassenger mile
Cost of three-minute telephonecall New York to London
Source: Institute for International Economics
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Post WWII
• Increased plant MES• (MES of cars x 3 between 1960 and
1975)• Increased scale of innovation• (average cost of developing drug x 4)• Result: globalization of firms through
exports and foreign production
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Transport costsRevenue per ton mile, cents*
1980 85 90 95 990
20
40
60
80
100
Air freight
Rail
*Revenue used as a proxy for prices; adjusted for inflation
Source: McKinsey Global Institute
Barge(inland waterways)
2
4
6
8
0
10
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Telecom costs
1996 1997 1998 1999 2000 20010
250
500
750
1.000
United States Ireland
Philippines
India
$’000 per year† for two Mbps fibre leased line, half circuit‡
†January figures ‡International leased line for India; long-distance domestic leased line in the US
Source: McKinsey Global Institute
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Decline in industrial tariff rates
0
10
20
30
40
50
1940 50 60 70 80 90 2000
Countries’ tariffs
Average tariffs, %
Sources: Centre for International Economics; GATT; IMF
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Future of Arbitrage
Reduction in transportation costs dissociates locus of production from that of consumption
Reduction in telecom costs will lead to dramatic increase in outsourcing of services
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Future of Replication• Factors pushing for globalization• Plant level scale economies• Firm level scale economies• Factors hindering globalization• Communication costs• Transportation costs• Government barriers • Globalization backlash
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Replication Strategies (1)
• Increase plant and firm-level scale economies
• Decrease factors that hinder globalization
• transportation cost
• taste differences
• government barriers
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Replication Strategies (2)
• Caterpillar
• L. M. Ericsson
• Honda Motorcycles
• Ikea
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IKEA’s Strategy of Replication• Factors Impeding
Globalization– labour intensive
production process
– high transportation costs of assembled furniture
– heterogeneous tastes
• IKEA’s Response
– capital intensive production of standard components assembled by customer
– ship components in flat packs carried and assembled by customer
– modern design; low cost
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Destruction of Replication
• Demand increases caused by MNE sales of standard products makes it economical to produce local variants
• Local producers are better able to produce these variants
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Arbitrage strategies
Discover and exploit international differences in culture, administrative infrastructure, and factor costs
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Most firms marry arbitrage and replication
Create global brand and source from lowest cost location
e.g. Acer, Dell
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Conclusions (1)
• Level of globalization is net result of factors pushing for and factors hindering it
• Varies across industries• Given the added cost of operating
abroad, not all firms should be global
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Conclusions (2)
• International activities are based on arbitrage and replication
• Arbitrage benefits from international heterogeneity
• Replication benefits from international homogeneity
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Conclusions (3)
• A firm can pursue successful replication by increasing firm and plant scale economies and decreasing the factors hindering globalization
• There is often a high payoff from being the first entrant in a new global industry