Global Business Strategy
MODULE 8 UNIT 3
Global Business Strategy
2021 LSE
All Rights Reserved
789305104076500
Table of contents
Introduction3Global integration3Applying global integration4Advantages of global integration4Local responsiveness4Local responsiveness drivers5Conducting a CAGE analysis5Leveraging local knowledge and skills5Integration-responsiveness framework6The AAA framework6Aggregation7Adaptation7Arbitrage8Comparing global strategies8Conclusion9Bibliography9Learning outcome:
LO6: Compare how global integration, local responsiveness, or the AAA framework can be applied to global business strategy.
Learning outcome:
LO6: Compare how global integration, local responsiveness, or the AAA framework can be applied to global business strategy.
Introduction
Not all firms have the potential to enter the global market. However, once a firm has determined that it has the necessary advantages to go global (Dunning, 1981), the next important consideration is to determine what business strategy would work best. This set of notes will explore three international business strategies, namely global integration, local responsiveness, and the aggregation, adaptation, and arbitrage (AAA) framework.
Global integration
Global integration is a strategy that proposes that for a firm to be successful, it needs to integrate components into an integrated production process for a standardised product supplied across the globe. This will ensure consistency and increase efficiency levels. Theodore Levitt, a leading academic on business strategy, argued that global integration was a key component of successful international expansion corporations geared to this reality benefit from enormous economies of scale in production, distribution, marketing, and management (Levitt, 1983:25). Global integration strategies, therefore, take advantage of economies of scale, which reduces the cost of several different functions, as illustrated in Figure 1.
1542710110506
Figure 1: Business function costs that are reduced through global integration strategies.
This approach is particularly useful for firms that have a product offering with universal appeal. For example, Samsung has adopted a global integration strategy because there is only a limited need to adapt their electrical products to any particular needs of the local market. This lowers costs and increases efficiencies by allowing Samsung to take advantage of economies of scale. Global integration leads to is homogeneity and standardisation of products and processes (Levitt, 1983).
Applying global integration
Standardisation also involves supplying the same product in every country, thus avoiding costly adaptation costs to satisfy local needs. To adopt a global integration strategy, firms need to:
Standardise all aspects of the business including products, value chain, and resources;
Align activities by cross-border coordination to achieve better results; and
Centralise operations by integrating activities at a single location.
Advantages of global integration
There are several advantages associated with global integration. These are:
Strategic synergy: A firm can outmanoeuvre locally-oriented rivals by coordinating its competitive efforts and focusing global power on specific markets.
Economies of scale: A firm can reap the benefits of standardisation, including lower costs for research and development, production, distributions, marketing, and procurement.
Exploit location advantages: A firm can exploit certain location advantages by centralising their operations in one location. For example, firms can take advantage of low costs of labour, skills, and raw material.
Leverage resources: A firm can leverage their resources by transferring capital, skilled labour, and technologies to areas of higher profitability.
Leverage intangible assets: A firm, through standardisation, can take advantage of key intangible assets such as brand, managerial know-how, and capabilities of replication.
Local responsiveness
However, global integration is not always the best strategy for companies operating on global markets. This is because certain local contexts require that firms adapt business practices to meet domestic market preferences. As a result, management experts Chris Bartlett and Sumantra Ghoshal argue that firms need to consider local differences, or develop local responsiveness (Bartlett & Ghoshal, 1986).
This is because, in some cases, companies will be at a competitive disadvantage to their local rivals if they cannot respond to local conditions. This issue becomes more serious as differences between the home market and the host market become larger. For instance, the differences between the US and the UK markets are much smaller than the differences between the UK and the Chinese market. It is, therefore, more likely that a US firm would
have to have to adapt its operations more aggressively when entering the Asian market as opposed to the European market because of greater levels of difference.
By adopting a local responsiveness strategy, a firm reduces these risks by considering the heterogeneity of the host country.
Local responsiveness drivers
The need for local responsiveness can be driven by several factors, as illustrated in Figure 2.
1442960231761
Figure 2: Drivers of local responsiveness strategies.
Conducting a CAGE analysis
To assess changes that need to be made depending on market conditions, firms can conduct a CAGE analysis as discussed in Unit 2s notes.
Cultural: What cultural differences are apparent that would influence consumer tastes and needs?
Administrative: What administrative differences are present and how would this impact the existing business model?
Geographical: How will geographic differences influence a firms profitability?
Economic: What economic differences including taxation and institutional differences might hinder global expansion?
Based on a CAGE analysis, firms can determine to what extent their existing business models and processes will need to adapt to local contexts.
Leveraging local knowledge and skills
Local responsiveness also involves taking advantage of regional and national skills and knowledge about the local context that are present in local subsidiaries. Making use of these knowledge repositories and skills can be a valuable exercise for firms as it will allow them to strategically position their product according to local needs.
By tapping into the knowledge of subsidiaries Bartlett and Ghoshal (1986) argue that:
national companies must not be regarded as just pipelines but recognised as sources of information and expertise that can build competitive advantage. The best way to exploit this resource is not through centralized direction and control but through a cooperative effort and co- option of dispersed capabilities. In such a relationship, the entrepreneurial spark plugs in the national units flourish.
Integration-responsiveness framework
As a result of these differing pressures to either increase global integration or adopt strategies that call for local responsiveness, there are four organisational strategies an MNE can use to enter the global market, as illustrated in Figure 3.
1450060221899
Figure 3: The four organisational strategies available to MNEs.
The AAA framework
While Theodore Levitt, a proponent of global integration, argued that global corporations succeed by selling a standardised product everywhere, Penkaj Ghemawat sees global strategy as being far more complex in the real world. Ghemawat argues that the world is not global, but semi-global - globalisation will never be total and there will always be local differences. For firms attempting to operate globally, Ghemawat argues, it is therefore
wrong to create a focused global organisation along the lines of the global integration strategy. Rather, he suggests the differences and similarities between countries must be considered using elements in the concept of distance, which we have already outlined in the CAGE framework.
Ghemawat has gone on to develop the adaptation, aggregation, and arbitrage framework (AAA framework) to analyse company strategy for operating in a semi-globalised economy. Bringing together the need for global integration and local responsiveness, this framework describes three approaches to global strategy. The combination and extent to which each of these approaches is adopted varies across industries and firms.
Aggregation
An aggregation strategy not only focuses on achieving economies of scale, it also integrates operations to maximise the sharing of resources, knowledge, and processes. Aggregation, therefore, encourages innovation and knowledge sharing, which makes this strategy a good option for companies that focus on research and development (R&D).
Levels of aggregation can also vary to optimise synergy. For example, a firm can choose to pursue global R&D, while the supply chain is managed regionally. Aggregation strategies, therefore, do not have to be exclusively global. For example, Dell and Toyota have developed regional supply chains.
Adaptation
Adaptation strategies attempt to meet the needs of the local market by adopting local responsiveness. Nevertheless, for a firm to successfully adopt an adaptation strategy, they need to optimise their use of global organisational structures. Ghemawat has identified four methods of optimising adaptation:
Focus on minimum adaptation: A firm can choose to focus on creating products that need minimal adaptation. They can also identify steps in the value chain that require less adaptation.
Share costs with local firms: A firm can reduce the risks of adaptation by partnering with local firms that provide local knowledge. Franchise models that encourage local adaptation is one approach.
Encourage local innovation: A firm can capitalise on local innovation by combining the knowledge and services of the MNE and local firm.
Flexible business models: A firm can design a flexible business model that allows for important points of standardisation while allowing for independent adaptation to account for regional differences.
(Ghemawat, 2007:144-156; Peng & Meyer, 2016:395-396)
By adopting an adaptation strategy, firms increase their local relevance and market share. Firms that offer a service that needs to cater to specific consumer tastes should adopt
adaptation strategies. Examples of this are Unilever and Starbucks, which both adapt to local conditions while also reaping the benefits of global integration.
Arbitrage
Arbitrage strategies refer to the exploitation of comparative advantages across regions. These can involve fragmenting the supply chain to leverage location advantages in different areas. MNEs can take advantage of arbitrage through their local subsidiaries that have access to local markets. Firms that have high labour or resource costs should focus on arbitrage. Apple is an example of this, where the manufacturing of Apple components is done in China to take advantage of cheap labour costs, while R&D is conducted in America.
A firm will generally choose to focus on one of these approaches at different points in time. They may also choose to change strategy as the firm evolves. Firms can also integrate two strategies as Procter & Gamble Co., the American consumer goods corporation, has done. Recognising the need to become more locally responsive during the 1990s, Procter & Gamble Co. adopted a transnational global strategy that accounted for local differences. This allowed the company to take advantage of certain economies of scale while at simultaneously making necessary changes to products based on local needs.
Comparing global strategies
The type of global strategy a firm adopts will be based on unique contextual and organisational factors. The Figure 4 illustrates the important contribution Ghemawat has made to Bartlett and Ghoshals initial integration-responsiveness framework and is a useful visualisation of the three strategies, as illustrated in Figure 4.
Figure 4: The AAA framework. (Source: Bartlett & Ghoshal, 1986; Ghemawat, 2007b)
Firms may choose to adopt elements of all three strategies in different degrees. In this respect, the AAA framework is a tool that allows a firm to determine which strategy best suits their business model.
Conclusion
This set of notes explored three theories of global business strategy global integration, local responsiveness, and the aggregation, adaptation, and arbitrage (AAA) framework. It is important to remember that firms can use elements of all three strategies, but, in a semi- global world, business leaders need to understand which strategy to adopt based on their own unique context.
Bibliography
Bartlett, C. & Ghoshal, S. 1986. Tap your subsidiaries for global reach. Available: https://hbr.org/1986/11/tap-your-subsidiaries-for-global-reach [2017, September
26].
Ghemawat, P. 2007a. Managing differences: The central challenge of global strategy.
Available: https://hbr.org/2007/03/managing-differences-the-central-challenge-of- global-strategy [2017, September 26].
Ghemawat, P. 2007b. Redefining global strategy. Boston: Harvard Business School Press.
Levitt, T. 1983. The globalisation of markets. Harvard Business Review. May-June: 25- 28.
Peng, M. & Meyer, K. 2016. International business. 2nd ed. Hampshire: Cengage Learning.
MODULE 8 UNIT 2
Determining whether to enter the global market
2021 LSE
All Rights Reserved
789305104076500
Table of contents
Introduction3Drivers of economic globalisation3MNEs and multinational entrepreneurs4Characteristics of MNEs5Defining FDI5Determinants of FDI6Determining whether to pursue FDI6OLI framework7Ownership advantage7Location advantage8Internalisation advantages9Transaction costs9The cost of using the market10The advantages of internalisation12The disadvantages of internalisation12The MNE decision process13CAGE framework14Institutions and international trade16The importance of institutions17Institutions in emerging economies17How states regulate FDI18Conclusion19Bibliography19Learning outcomes:
LO2: Identify the drivers of economic globalisation and the characteristics of multinational enterprises.
LO3: Interpret the OLI and CAGE frameworks and the importance of transaction costs in global trade.
LO4: Illustrate how states and government institutions impact international trade and investment.
LO5: Illustrate how indicators associated with the economy and government institutions impact international trade and investment.
Learning outcomes:
LO2: Identify the drivers of economic globalisation and the characteristics of multinational enterprises.
LO3: Interpret the OLI and CAGE frameworks and the importance of transaction costs in global trade.
LO4: Illustrate how states and government institutions impact international trade and investment.
LO5: Illustrate how indicators associated with the economy and government institutions impact international trade and investment.
Introduction
Economic globalisation, as presented in Module 2, can be thought of as a process leading the expansion and integration of markets beyond national boundaries. Companies that supply goods and services for a global rather than a national population have become ubiquitous increasing capital investment across national boundaries and globalising their supply chains through foreign direct investment (FDI), outsourcing production, and offshoring certain business processes, all in the pursuit of their corporate objective - profits.
Nevertheless, it is important to remember that not all firms currently have the capabilities to expand beyond their local or domestic market and enter this global market to internationalise. Nor is internationalisation easily profitable from all possible locations. This set of notes unpacks some of the important factors firms need to consider before deciding to pursue activities abroad. Unit 3 will then examine some important strategies that firms can adopt when entering the international market.
First, these notes examine the drivers of economic globalisation and the characteristics of firms operating in that context; they will also investigate multinational enterprises (MNEs) (see Caves, 1996; Dunning, 1988). You will then explore two modules - the OLI framework and the CAGE framework to determine if and under what conditions it is advantageous to invest internationally. Finally, these notes reflect on the importance of institutions for successful internationalisation, and how they regulate international trade and investment.
Drivers of economic globalisation
Economic globalisation has several drivers, as has been discussed in Module 2. Not only have governments supported trade agreements that favour global integration, but advances in technology, transport, and communication have transformed the way business is conducted worldwide in the 21st century. To recap, some of these drivers include:
Increased and rapidly diffusing technological innovation;
The decline in the costs of operating international, that is to say transaction costs, especially concerning transport of goods and people.
National, bilateral and multilateral policies that encourage global integration; and
Ideologies and political parties that support market-based economic development and growth.
These drivers have allowed for greater global economic integration between nations, stimulating the flow of goods, capital and labour, as well as encouraging the sharing of technology and ideas, across borders.
1153160156210Is economic globalisation in decline?
There is growing concern that economic globalisation is in decline. This is supported by the fact that cross-border capital flows have declined by 65 per cent since their peak before the recession in 2007, and FDI declined by 46% in the first six months after the COVID-19 pandemic began. Nevertheless, it is unlikely that economic globalisation is headed for a complete halt. Not only has the changing balance of world economic power increased the number of players (important countries) within the system, but the world trade system showed remarkable resilience after the 2008 recession leaving the fundamental determinants of global economic integration largely unaffected. The biggest threat to economic globalisation may actually be political, manifested in the rise of protectionism. The growing rise of protectionism is associated with the rise of populism covered in Module 3.
00Is economic globalisation in decline?
There is growing concern that economic globalisation is in decline. This is supported by the fact that cross-border capital flows have declined by 65 per cent since their peak before the recession in 2007, and FDI declined by 46% in the first six months after the COVID-19 pandemic began. Nevertheless, it is unlikely that economic globalisation is headed for a complete halt. Not only has the changing balance of world economic power increased the number of players (important countries) within the system, but the world trade system showed remarkable resilience after the 2008 recession leaving the fundamental determinants of global economic integration largely unaffected. The biggest threat to economic globalisation may actually be political, manifested in the rise of protectionism. The growing rise of protectionism is associated with the rise of populism covered in Module 3.
MNEs and multinational entrepreneurs
Multinational enterprises (MNEs), and multinational entrepreneurs have thrived in this era of global economic expansion. As discussed in Module 2, MNEs are firms that own a significant equity share of another company (subsidiary) located in a foreign country. They engage in international business through foreign direct investment (FDI) by directly investing in, controlling and managing value added activities in other countries (Caves, 1996:1). Examples of MNEs include Adidas, Alibaba, Apple, Exxon, Amazon, Citigroup, Google, Huawei, Kia Motors, KPMG Sasol, and Uber. As this list suggests, MNEs can span a wide range of industries, but the largest MNEs tend to be involved in the following industries:
Information technology and the internet
Oil and resource extraction
Automobile
Finance
Consumer electronics
Pharmaceuticals
Characteristics of MNEs
While each MNE has unique operational and organisational features, they tend to share certain key characteristics:
Industry: MNEs are most common in oligopolistic industries where marketing and innovation are key drivers of differentiation. Oligopolies arise when a small number of firms have almost total control over supply in an industry. They may also have a competitive advantage that they can exploit in other locations. These firms, while competitors, may cooperate to influence market prices. This joint ability to set prices allows oligopolistic firms to exercise monopoly power, increasing their profit margins in ways that would not be possible within a perfect free market system. Industries that are oligopolistic might include the airline, pharmaceutical, oil and gas, and automobile industries.
Production: Their methods of production tend to focus on advanced and highly capital-intensive methods.
Scale and size: Their size has also sometimes given MNE leaders considerable socio-political power both in their home country (the firms country or origin) and host country (the country where the MNE has chosen to establish operations). For example, whether Amazon is a threat to open competition in non-US markets..
Strategy: MNEs tend to develop sophisticated strategies to shift profits between jurisdictions (transfer pricing) leverage local gearing (a companys debt levels in relation to its equity capital), and actively manage their assets and liabilities to maximise profits on a global scale in the face of similarly international competitors.
Defining FDI
(Lall, 1976:16-17)
MNEs conduct international business to enter new markets and to take advantage of access to resources and skills that are unavailable in their home market. A key mechanism to do this is via purchasing and operating companies abroad, Foreign Direct Investment (FDI). According to the World Bank, FDI is defined as:
a category of cross-border investment associated with a resident enterprise in one economy having control or a significant degree of influence on the management of an enterprise that is resident in another economy. FDI net inflows are the value of inward direct investment made by non-resident investors in the reporting economy. FDI net outflows are the value of outward direct investment made by the residents of the reporting economy to external economies.
(The World Bank Group, n.d.d)
Every country can choose to regulate levels of FDI according to its own economic objectives. As a result, some countries may choose to attract FDI by incentivising investment in a region to stimulate economic growth and development, while others actively attempt to deter it. Entirely in what are viewed as strategic sectors.
Determinants of FDI
The motivation that drives the MNEs decision to pursue FDI will vary depending on the resources and capabilities of the investing firm and the unique advantages associated with the host country. In consequence, there are three major types of FDI, as illustrated by Table 1.
Table 1: The three determinants of FDI.
Type of FDI Determinants of FDI Examples
Market seeking FDI is motivated by the market size and growth rate, as well as access to global and regional markets. The entry of McDonalds into the Asian market.
Resource seeking FDI is motivated by access to raw materials such as gas, oil, minerals, and timber. BPs operations in Saudi Arabia.
Efficiency seeking FDI is motivated by access to cheap resources and assets such as labour, technology, and skills.
Access to cheap input costs also motivate efficiency-seeking FDI, such as low transportation and communication costs. Apples fragmented supply chain, which takes advantage of access to low wages in China.
Determining whether to pursue FDI
Not all firms have the capabilities to enter the global market. A key determinant is a firms level of productivity. Only firms with the highest levels of productivity can manage the higher costs associated with operating abroad. This means that:
low-productivity firms produce only for the home market; medium- productivity firms choose to pay the fixed costs of exporting; but only the most productive firms choose to pay the higher fixed costs of engaging in FDI.
(Neary, n.d.:2)
Business leaders need to consider their unique organisational structures and the nature of the global market, and analyse their firm-specific advantages to determine whether they should engage in FDI. The following sections explore some of the frameworks that have been developed to help firms establish whether they should pursue FDI.
An important concept that encapsulates this issue, and that firms wishing to pursue FDI need to understand is the liability of foreignness. One of the most significant problems associated with entering a global market is the natural disadvantage of being an outsider in an unfamiliar market a liability of foreignness. Most firms that seek to enter new markets have not yet established local networks and may also be unfamiliar with the needs of the local consumer, which puts them at a disadvantage to their local competitors. Added to this, they tend to be unfamiliar with local languages, cultural practices, institutional dynamics, and location-specific regulations. All of these factors make it more expensive to operate in overseas locations thatn at home and these differences vary according to the location. In order to operate abroad, firms need to have a productivity (or cost) advantage to offset the liability of foreigness.Firms need to consider liabilities of foreignness before pursuing FDI.
OLI framework
One way of analysing whether to engage in FDI is by using the OLI framework, also referred to as the eclectic paradigm, developed by John Dunning (1981; 1988). Dunnings research led him to conclude that three conditions must hold simultaneously in order for FDI to be the most appropriate method of engaging in international business. These conditions are:
Ownership advantages;
Location advantages; and
Internalisation advantages.
The following sections examine these three areas in greater detail.
Ownership advantage
Ownership advantage refers to certain firm-specific advantages that generate a profit or competitive advantage to the firm, allowing it to overcome liabilities of foreignness. These firm-specific advantages must be transferable across borders, which allows the MNE to become competitive despite the challenges it may face when competing in a foreign country. Examples of ownership advantage include:
The ownership of firm-specific assets and technology that can be exploited abroad;
The company brand, which is transferable across borders;
Managerial knowledge and experience;
Company culture, such a creating a learning environment; and
Organisational structures, including the capacity to innovate and change.
(Peng & Meyer, 2016:158-159)
For example, the unique technical knowledge and managerial structures of Volkswagen (VW) have allowed the firm to successfully compete abroad by supplying cars that are popular in different continents and countries. IKEAs unique style of flat-packed furniture has also proved to have global appeal, allowing it to compete in foreign markets where it is at a natural disadvantage due to liabilities of foreignness (Peng & Meyer, 2016:160).
Location advantage
Location advantage refers to advantages that can be gained from combining the resources of the firm (ownership advantages) with the resources available in the host economy. Thus, FDI allows firms access to profitable resources or skills they would not have access to within their home market. Location advantages can include:
Access to skilled labour;
New or rapidly expanding product markets;
Natural resources; and
Government incentive schemes designed to encourage FDI.
Locating operations in a foreign market can allow a firm to overcome several obstacles, including government protectionist policies and transportation costs, while also giving it the advantage of being close to the customer base (Peng & Meyer, 2016:161). The location of these unique advantages will determine where the firm chooses to establish operations abroad. For example, Apple has fragmented its supply chain to take advantage of low wages in China.
1153160154940Agglomeration as a form of location advantage:
Agglomeration refers to the clustering of similar businesses or industries in the same location. Agglomeration is considered a location advantage for several reasons. Firstly, agglomeration results in knowledge spillovers and the clustering of a skilled labour force in one region. The region may also develop a group of specialised suppliers who can service competing businesses (Peng & Meyer, 2016:163). This has been the case in San Francisco and Silicon Valley, which have become regional hubs for the technology industry.
00Agglomeration as a form of location advantage:
Agglomeration refers to the clustering of similar businesses or industries in the same location. Agglomeration is considered a location advantage for several reasons. Firstly, agglomeration results in knowledge spillovers and the clustering of a skilled labour force in one region. The region may also develop a group of specialised suppliers who can service competing businesses (Peng & Meyer, 2016:163). This has been the case in San Francisco and Silicon Valley, which have become regional hubs for the technology industry.
Internalisation advantages
Internalisation advantages occur when it is more beneficial for a firm to establish and manage its own production and sales operations in a foreign location as opposed to exporting or licensing their products to firms in the host economy (Rugman, 2010). For instance, a firm may have acquired the necessary capital and assets that makes it profitable for them to control and manage the entire production process instead of outsourcing production to local manufacturers. Internalisation, therefore, allows a firm greater control of firm-specific knowledge and management skills, replacing external market relationships with internal supply processes. Nevertheless, to understand the advantages of internalisation, it is necessary to understand the importance of transaction costs. This section will first examine the importance of transaction costs and the cost of using the market, before examining the advantages of internalisation. Finally, this section will investigate some of the disadvantages of internalisation.
Transaction costs
Transaction costs are the [costs] incurred during the process of buying or selling, on top of the price of whatever is changing hands (The Economist Newspaper Limited, n.d.). In the context of FDI, it is a type of market failure that can cause firms to abandon market transactions because trading costs and risks are too high, and contracts designed to offset these risks are too costly or difficult to write and enforce. For example, a local supplier or manufacturer may behave opportunistically by increasing prices after a contract has been signed, which would put a firms profitability at risk. Transaction costs can vary, but include the costs of:
Bargaining;
Searching for appropriate trading partners;
Monitoring, and ensuring contracts are enforced;
Establishing terms, specifications, and prices;
Due diligence.
(Coase, 1960:850)
Transaction costs are a critically important factor to consider for firms exploring whether to go global. Cross-border trade can lead transaction costs to dramatically increase, because it becomes more difficult for a firm to ensure contracts are complied with, and that productions standards are met.
If a firm cannot protect itself via contractual agreements, external market relationships for example firms trading with each other up and down supply chains - can be replaced by internal hierarchies, in which the firm owns the entire supply chain itself and allocates resources through the management chain of command. Thus, when the transaction costs, usually associated with some forms of market failure, are high, the cost of market transactions may exceed the benefits, and firms respond by internalising transactions to the enterprise itself. For example, a firm may choose FDI and selling goods manufactured
themselves in the host economy rather than exporting their goods there from the home economy or licensing their products to foreign suppliers.
1153160155575Licensing:
An alternative approach to going global is for a firm to license their product or service. Licensing agreements give another party permission to produce or perform an activity that is owned by another party. Licenses can be obtained for both tangible and intangible assets; for example, a firm may license the rights to produce a particular good or technology.
00Licensing:
An alternative approach to going global is for a firm to license their product or service. Licensing agreements give another party permission to produce or perform an activity that is owned by another party. Licenses can be obtained for both tangible and intangible assets; for example, a firm may license the rights to produce a particular good or technology.
The cost of using the market
As has been mentioned, engaging in cross-border market relationships can result in high transaction costs. These costs often result from the need to protect transactions from opportunistic behaviour that occurs when local partners attempt to leverage their position. The greater the possibility of opportunism, and the more difficult it is to write a contract protecting the transaction, the more likely it is that a market solution will not be chosen, and the firm will choose internalisation strategies such as FDI. Nevertheless, firms that wish to establish market relationships with local suppliers in foreign countries should be aware of potential contractual problems that can arise. Table 2 illustrates some of these problems.
Table 2: The risks associated with incomplete contracts.
Complete contracts are harder to write and enforce. All contracts are subject to human-bounded rationality (the limited ability of people to foresee all possible contingencies, and the limited ability to specify contracts unambiguously), so most contracts are incomplete. This is more often the case when specific assets are involved. Specific assets are capital goods that have a restricted purpose, and cannot easily be converted to another activity. For example, a machine making aircraft wings is a specific asset with finite uses. Such assets are particularly valuable in specific transactions, for example as part of an aircraft supply chain, but do not have many alternative uses. Once firms have invested in such assets, they are vulnerable to opportunistic behaviour if they are dependent on one supplier or manufacturer.
Opportunism is more likely and costly. Self-interested individuals may take advantage of incomplete contracts to maximise personal advantage by withholding, distorting, or misrepresenting information. Since most contracts are incomplete to various degrees, the possibility exists for various types of opportunistic behaviour exploiting
contractual ambiguities for personal gain, either pre- or post- contract. For example, a supplier of coffee may demand
higher prices if the price of coffee on the open market increases.
A bilateral monopoly can be created. Although there may be competition for the contract, after the contract is signed, a bilateral monopoly can be created.
Bilateral monopolies give rise to the possibility of a hold-up, whereby contractual terms are renegotiated under threat. A hold-up will occur when a buyer or seller makes new contractual demands that a firm is forced to comply with. For example, a supplier of a unique automobile component may demand higher prices. The automobile firm may have to comply if no alternative manufacturers are available.
The risks associated with incomplete contracts, and the fact that these risks are often difficult to avoid, demonstrate the high transaction costs involved in pursuing market relationships abroad. These high transaction costs can lead to distrust and under- investment in specific assets, and high costs of writing and enforcing contractual terms. When these costs exceed their benefits, a firm will either:
Pursue long-run contracts;
Establish joint ventures;
Create strategic alliances;
Vertically integrate with local producers; or
Pursue FDI.
If we consider the mode of entry, majority ownership tends to be chosen over joint ventures (where two or more parties , one usually a firm based in the host economy, agree to cooperate and share resources to pursue a new business activity) when the costs of negotiating agreements that protect strategic assets are higher than the benefits provided by a foreign partner, for example from their greater knowledge of the local business environment.
1153160154940Pursuing market relationships:
If a firm chooses to make use of the market, a detailed contractual agreement is important. The Organisation of Economic Co-operation and Development (OECD), whose members are largely developed economies within Europe and North America, outlines several key considerations investors need to be cognisant of to ensure that the institutional requirements are in place to ensure effective contract enforcement and mechanisms for dispute resolution (OECD, n.d.).
00Pursuing market relationships:
If a firm chooses to make use of the market, a detailed contractual agreement is important. The Organisation of Economic Co-operation and Development (OECD), whose members are largely developed economies within Europe and North America, outlines several key considerations investors need to be cognisant of to ensure that the institutional requirements are in place to ensure effective contract enforcement and mechanisms for dispute resolution (OECD, n.d.).
The advantages of internalisation
Having examined the importance of transaction costs, it is necessary to consider the ways internalisation can resolve the issue of high transaction costs. The following points outline the advantages of internalisation:
Reduce external market relationships: By removing external market relationships and establishing a single firm, an MNE can overcome market failures and reduce transaction costs. This is because trade is conducted between subsidiaries controlled and operated within a single firm. Strategic and operational objectives are therefore aligned, and opportunistic behaviour is reduced.
Greater management control: By pursuing FDI, a firm increases its management control, which lessens the threat of the opportunistic dissemination of important firm-specific resources, processes, skills, and information. For firms whose ownership advantages lie in knowledge-intensive resources, pursuing FDI reduces dissemination risk the risk that firm-specific knowledge or organisational and managerial know-how are disseminated to competitors. For example, Google, Facebook and Apple all pursue an internalisation strategy to protect their unique technology and business models from the risk of dissemination.
Protect a firms reputation: If a firms competitive advantage lies in implicit knowledge gained through experience, internalisation will ensure its reputation is protected and that quality is maintained. For example, a consulting firm cannot license its services, because their competitive advantage lies with their skilled staff and experience. Internalisation therefore allows the firm to protect its competitive advantage and reputation.
Increased organisational control: By pursuing FDI, a firm will have greater control of the strategies used within the foreign country than it will when licensing to local producers. This is because the MNE will be able to directly influence the marketing and business strategies of subsidiary companies. This would not be possible if a licensing agreement was made.
Ensure compliance: Firms that outsource production to foreign countries may choose to pursue FDI to ensure that certain managerial or ethical codes of conduct are complied with. By setting up internal production plants in foreign countries, the firm also reduces dissemination of key product design features or valuable firm- specific knowledge.
(Peng & Meyer, 2016:165-168)
The disadvantages of internalisation
It must also be noted that there are several disadvantages attached to internalisation. Table 3 illustrates three of these disadvantages.
Table 3: The disadvantages of internalisation.
Loss of high- powered incentives When a firm makes use of market transactions, suppliers have strong incentives to hold down costs and innovate to increase profits. When a firm internalises, it undermines the potential to harness this competition. For example, a manufacturer of batteries may invest in improving their product in the hope of growing their business and increasing profits. When internalisation is pursued, and batteries are part as a component within a firm focused on a product further down the supply chain, management does not have this same incentive to innovate.
Reduced scale, scope, and learning The market can aggregate demands to achieve economies of scale, scope, and learning. A firm may be unable to achieve the minimum efficient scale if it produces its own inputs. For example, a manufacturer of automobile tyres that supplies multiple automobile firms can lower costs and achieve economies of scale, which would be unachievable if each automobile firm chose to produce their tyres internally.
Agency costs Hierarchies also create agency costs (costs associated with slack efforts by employees and the monitoring and administering of those problems). It also increases influence costs (costs of activities aimed at influencing the distribution of organisational resources). By removing the benefits of free market competition, which allows a firm greater flexibility to change suppliers, internalisation may result in high agency costs.
The OLI framework is a useful tool for firms to use when establishing whether or not it is advisable to pursue FDI. Firstly, a firm using the OLI framework can clearly identify the ownership advantages they have that are unique to their business and also transferable across borders. Secondly, by examining the resource advantages attached to a particular location and how they can be combined with the firms own resources, a firm can determine where it should establish foreign operations. Finally, by considering transaction costs associated with international business, a firm can determine what internalisation advantages would be realised if FDI was pursued.
The MNE decision process
Firms investigating the possibility of FDI can use the following decision tree, which considers the factors accounted for in the OLI framework.
Figure 1: The way MNEs decide how to enter the international market.
CAGE framework
Another useful framework firms can use to understand location advantages, and in particular to determine whether and where to pursue FDI is the CAGE framework. The CAGE framework was developed by Professor Pankaj Ghemawat to address the levels of costs attached to different locations in terms of liabilities of foreignness (discussed in Section 3). The framework is designed to help a firm establish the similarities and differences between the home and the host country along cultural, administrative, geographic, and economic dimensions. Watch Video 1, in which Ghemawat briefly describes the way firms can use the CAGE framework to evaluate international trade opportunities.
Video 1: The importance of establishing cultural, administrative, geographic, and economic differences and similarities. (Source: https://www.youtube.com/watch?v=7FpUJaG7uMk)
As Ghemawat illustrates, the similarities and differences between two states have a significant bearing on the levels of trade between them. States that share cultural, administrative, geographic, and economic similarities are far more likely to achieve successful trading relationships than those that do not, for example. Table 4 illustrates how the CAGE framework might be used, and what factors would need to be considered when conducting a CAGE analysis.
Table 4: How to apply the CAGE framework.
Type of distance Factors to consider Examples
Cultural distance Language, cultural norms, unique societal practices What cultural factors would Google need to consider when conducting operations in Russia?
Administrative distance Country-specific rules and regulation, as well as policy frameworks What country-specific regulations would Walmart face when establishing operations in Saudi Arabia?
Geographic distance The cost of management, information transfer, and time differences How would eBay, based in California, overcome geographic differences when operating in Europe?
Economic distance The level of economic development and sophistication of a host country How would Amazon overcome the economic challenges of setting up operations in Kenya?
As the CAGE framework illustrates, moving from a domestic to an international context will require changes that could impact a firms comparative advantage. For instance, when entering a foreign market, a firm will be faced with external market challenges such as new consumer tastes, different legal systems, and changes in fiscal regimes. In addition, the firm will face internal challenges such as different labour relations structures, language and skills gaps, and different distribution networks and supply channels. The source of good performance in a domestic economy therefore does not guarantee success in other economic environments.
1153160155575Explore further:
Explore this article to learn more about the four categories of the CAGE framework.
00Explore further:
Explore this article to learn more about the four categories of the CAGE framework.
Institutions and international trade
As the OLI and CAGE frameworks suggest, it is important for a firm to consider the legal and regulatory environment of a host country. Strong institutions, discussed in Module 2, are therefore a key determinant of a firms success in particular locations. Nevertheless, traditionally within academia, what determined a firms success was answered by two popular perspectives. On the one hand, Michael Porter (1980) argued that it was industry conditions that determined a firms success. This approach has become known as the industry-based view. On the other hand, Jay Barneys (1991) argument that success was determined by effective exploitation of the firms own capabilities and resources is illustrative of an alternative academic view. This approach has become known as the resource-based view. However, insightful as the industry- and resource-based views are, they can be criticised for largely ignoring the formal and informal institutional underpinning that provides the context for competition among industries (Peng, Wang & Jiang, 2008:920); this leads us to the institutional view.
Institutions are therefore a crucial determinant of a firms success in international business, because they establish the rules of the game, regulate the market, and create trust between parties (North, 1990:3). Business strategy can therefore be viewed as being determined by industry conditions, resource constraints, and institutional conditions, as illustrated in Figure 2.
Figure 2: The strategy tripod. (Adapted from Peng, Wang & Jiang, 2008:923)
The importance of institutions
Institutions, or the rules of the game, are important because they establish the rules and legal structures that determine the way the market functions (North, 1990:3). Strong institutions, typically underpinned by state structures, can better facilitate trade, protect property rights, and provide the legal structures necessary to conduct business, to create an environment where business can thrive. As a result, institutions impact transaction costs, as they determine the ease of doing business in a given context. Institutions play a fundamental role within an economy, as they:
Can provide stability, establishing acceptable behaviour;
Are intended to reduce the possibility of opportunistic behaviour;
Provide frameworks that promote trust between parties;
Provide legal frameworks to enforce contracts; and
Protect property rights.
Without strong institutions that promote stability and trust, the cost and risk of doing business can be high, to the degree that business is not conducted at all. Firms entering from other countries to locations where they do not understand or know how to manage the host economy institutions face higher liabilities of foreigness.
Institutions in emerging economies
As research into emerging economies has grown, the importance of institutions as a key pillar of international business has gained acceptance. This is because the quality of institutions significantly impacts levels of international trade and investment. For example,
if a country is unable to ensure the protection of property rights, a firm is unlikely to invest large sums of money through FDI, especially if its ownership advantage stems from intellectual property Business leaders need to be able to assess the institutional conditions of a host country before engaging in foreign business, because international trade must operate within institutional boundaries.
Nevertheless, emerging economies also tend to experience institutional transitions. This occurs when institutions change in significant ways that impact the ease of doing business in a region. For example, the gradual transformation of the Chinese economy from a communist to a more capitalist one has directly impacted levels of international trade and investment. These transitions tend to be more prominent within emerging economies that experience fundamental and comprehensive changes introduced to the formal and informal rules of the game that affect firms as players (Peng, 2003:275). Firms need to be cognisant of these shifts when analysing whether to engage in international FDI in emerging economies.
1153160155575Measuring institutions:
Various indexes have been created in an attempt to measure the strength of institutions. Two popular indexes include:
Doing Business, which provides objective measures of business regulations in 190 countries and select cities.
The Global Competitiveness Report, which offers an alternative measure that focuses on the competitiveness landscape of various countries.
00Measuring institutions:
Various indexes have been created in an attempt to measure the strength of institutions. Two popular indexes include:
Doing Business, which provides objective measures of business regulations in 190 countries and select cities.
The Global Competitiveness Report, which offers an alternative measure that focuses on the competitiveness landscape of various countries.
How states regulate FDI
The increase in international trade and global integration has meant that many countries have chosen to create institutions designed to manage and influence FDI. These institutions aim to regulate and control the nature of FDI to ensure an institutional structure that allows for mutual benefit between the firm and host country. FDI can be mutually beneficial by allowing a firm access to new markets and resources while exposing the host country to the benefits of job creation, technology spillover, and local contracting opportunities (Fontagn, 1999:5). Nevertheless, institutions regulate FDI in two ways:
Total ban on FDI: While rare, some countries choose to ban FDI outright, or in a particular sector or industry. For example, India chose to ban FDI in the cigarette manufacturing industry in 2013 due to pressure from the Indian Ministry of Health.
Individual approval of FDI: Countries can choose to regulate FDI by evaluating the merits of each case. This allows a government to impose certain conditions of approval, giving them greater control. For example, a country can impose ownership restrictions.
(Peng & Meyer, 2016:170-171; Business Insider, 2013)
192341550482500It is important to remember that even when FDI is encouraged, firms need to meet certain institutional requirements to operate in a host country. For example, the firm will need to meet certain legal and regulatory requirements that govern all business operations in the host country (The World Bank Group, n.d.b). In addition, states may also require a firm to meet certain production quotas. For instance, governments may require firms to source a certain percentage of its raw material within the host country. These restrictions are called local content requirements and will vary depending on the country (Peng & Meyer, 2016:172). Firms will also have to pay corporate tax in a host country. Having said this, some governments deliberately reduce levels of corporate tax through tax relief schemes or duty-free importing to encourage FDI. For example, the United Arab Emirates offers discounts on land, and has created free zones, which offer low import duties and protect firms from capital gains tax.
Conclusion
Only firms large enough and efficient enough to manage the high costs of entering a foreign market should consider going global. Firms need to remember that a comparative advantage in a local or domestic market does not necessarily guarantee success in another country. This is in large part due to liabilities of foreignness, which put foreign firms at a natural disadvantage to their local counterparts who are more familiar with the local context. Nevertheless, it is possible for firms to be successful internationally by choosing appropriate locations for expansion and by adopting the right global business strategy.
In consequence, these notes have explored some of the important considerations firms need to consider before going global. Not only have these notes outlined the characteristics of MNEs and the nature of FDI, they have also outlined frameworks firms can use to determine their comparative advantage in the international market. By using the OLI and CAGE frameworks as tools for strategic analysis, firms will be in a better position to assess how their strengths and weaknesses would impact their performance within the global market. Finally, these notes have examined the importance of institutions that provide the contextual underpinnings determining how the market functions.
Bibliography
Barney, J.B. 1991. Firm resources and sustained competitive advantage. Journal of Management. 17(1):99-121.
Business Insider. 2013. Govt bans FDI in cigarette manufacturing. Available: http://www.business-standard.com/article/economy-policy/govt-bans-fdi-in- cigarette-manufacturing-110040900076_1.html [2017, October 7].
Caves, R. 1996. Multinational enterprises and economic analysis. 2nd ed. Cambridge, MA: Cambridge University Press.
Coase, R.H. 1960. The problem of social cost. Journal of Law and Economics. 56:837- 877.
J. Dunning, 1981. International Production and the Multinational Enterprise, London: Allen and Unwin.
J. Dunning, 1988. The Eclectic Paradigm, Journal of International Business Studies,
No. 1.
Dickinson, E. 2010. Shell oil infiltrates Nigerias government ministries. Available: http://foreignpolicy.com/2010/12/09/shell-oil-infiltrates-nigerias-government- ministries/ [2017, October 6].
Fontagn, L. 1999. Foreign direct investment and international trade: Complements or substitutes? OECD Science, Technology and Industry Working Papers, 1999/03, Paris: OECD Publishing.
Gilani, N. n.d. The four types of industry infrastructures. Available: http://smallbusiness.chron.com/four-types-industry-infrastructures-24729.html [2017, October 6].
Green, D. 2016. The worlds top 100 economies: 31 countries; 69 corporations.
Available: https://blogs.worldbank.org/publicsphere/world-s-top-100-economies- 31-countries-69-corporations [2017, September 19].
Lall, S. 1976. Developing countries and multinational corporations: Effects on host countries welfare and the role of government policy. Commonwealth Economic Paper. 5. London: Commonwealth Secretariat Publications.
Lund, S., Windhagen, E., Manyika, J., Hrle, Woetzel, J. & Goldshtein, D. 2017. The new dynamics of financial globalization. Available: http://www.mckinsey.com/industries/financial-services/our-insights/the-new- dynamics-of-financial-globalization?cid=other-eml-nsl-mgi-mck-oth-1709- nts&hlkid=07f1f1740d314ef583b0fe536436e452&hctky=9909634&hdpid=7a9106 10-f920-4ac7-aff8-320bd99a9ee3 [2017, September 19].
Neary, J. n.d. World economy FDI: The OLI framework. Available: http://users.ox.ac.uk/~econ0211/papers/pdf/fdiprinceton.pdf [2017, September
19].
North, D. 1990. Institutions, institutional change, and economic performance. Cambridge MA: Harvard University Press.
OECD. n.d. Contract enforcement and dispute resolution. Available: https://www.oecd.org/investment/toolkit/policyareas/investmentpolicy/contractenf orcementanddisputeresolution.htm [2017, September 21].
Peng, M. & Meyer, K. 2016. International business. 2nd ed. Hampshire: Cengage Learning.
Peng, M.W. 2003. Institutional transitions and strategic choices. Academy of Management Review. 28(1):275-296.
Peng, M., Wang, D. & Jiang, Y. 2008. An institution-based view of international business strategy: A focus on emerging economies. Journal of International Business Studies. Vol. 39:290 936.
Porter, M.E. 1980. Competitive strategy. New York: Free Press.
Rugman, A. 2010. Reconciling internalization theory and the eclectic paradigm.
Multinational Business Review. 18(2):1-12.
Scott, W.R. 1995. Institutions and organizations. Thousand Oaks CA: Sage. The Economist Newspaper Limited. n.d. Economics A-Z terms beginning with T.
Available: http://www.economist.com/economics-a-to-z/t#node-21529380 [2017,
October 25].
United Nations. 2016. World investment report 2016, investor nationality: Policy changes.
Available: http://unctad.org/en/PublicationsLibrary/wir2016_en.pdf [2017,
September 21].
The World Bank Group. n.d.a. About doing business. Available: http://www.doingbusiness.org/about-us [2017, October 25].
The World Bank Group. n.d.b Doing business 2016. Available: http://www.doingbusiness.org/reports/global-reports/doing-business-2016 [2017,
October 7].
The World Bank Group. n.d.c. The global competitiveness report 2017-2018. Available: http://reports.weforum.org/global-competitiveness-index-2017-2018/ [2017,
October 25].
The World Bank Group. n.d.d What is the difference between foreign direct investment (FDI) net inflows and net outflows? Available: https://datahelpdesk.worldbank.org/knowledgebase/articles/114954-what-is-the- difference [2017, September 21].
Essay writing guidelines
This course requires you to write short essays for every weekly module. These essays, or mini written responses, are designed to test your understanding of the course content and your ability to critically engage with the material by considering real-world scenarios and problems. They are also designed to test your ability to write clearly about the themes, issues, and theories covered in the modules.
These essays form a large portion of your overall grade, and your writing will need to adhere to the minimum and maximum length requirements. It is therefore important that you write clearly and succinctly. This guidebook will show you how to:
Plan your written response;
Structure your essay effectively;
Consult rubrics for guidance; and
Reference sources correctly.
Planning your written response
In planning your essay its important to first analyse the question, then outline your response by means of a mind map, and finally create a thesis statement, as explained in the sections to follow.
Analyse the question
Before writing your response, it is important to consider the question being asked, as you need to ensure your answer reflects what is being asked of you. One way to do this is to find the task word being used. For example, you may be asked the following question:
Applying the information covered in this module, compare the difference between China and Americas responses to trade liberalisation in the 21st century.
In this example, the task word is compare. As a result, your answer requires you to examine the differences between America and Chinas response to trade liberalisation in the 21st century and compare their responses with examples.
Other task words that may be used include discuss, examine, identify, contrast, analyse, evaluate, propose, assess, articulate, and investigate.
Outline your response
Once you have established what is being asked of you, the next step is to plan your written response. One method of approaching this is to sketch out a quick mind map of your ideas. This mind map should also include evidence that you will use to support your claims.
2239277129285
Figure 1: Creating a mind map or rough outline is a good way to plan your essay before you begin to write.
Create a thesis statement
Having created an outline or mind map, you should now have an idea of your thesis statement. A thesis statement is a sentence (or two) that summarises the main point you will be making throughout your written response. It should directly address the question and show your marker that you have a clear argument or point. For example, based on the previous example question, the thesis statement may be as follows:
While China and America have both embraced trade liberalisation in the 21st century, China is adopting policies that encourage greater trade liberalisation, and America, under Donald Trump, is considering adopting protectionist policies.
The above thesis statement clearly addresses the question by comparing China and Americas trade policies in the 21st century. It also expresses the writers argument, which will be expanded upon in the body of the essay.
Structure your essay
Once youve planned your essay, you are ready to begin writing. A well-crafted essay should always be broken down into an introduction, a body, and a conclusion.
Introduction
Your introduction sets the stage for the rest of your essay and should be written in an interesting and appealing way that will encourage your reader to engage with your written assignment. The introduction should:
Briefly introduce the context of the essay;
Redefine the problem being addressed; and
Include your thesis statement.
Body
The body of your essay will explore your argument in greater detail by providing sub-points that support your argument as well as evidence to back up your claims. You should also logically break up the body of your essay into well-defined paragraphs. Each paragraph should include the following:
A topic sentence that summarises the main point of the paragraph. This sentence should support or contribute to your main thesis statement.
The topic sentence should then be followed by supporting evidence from your own research that backs up your claims.
The paragraph should end with an explanatory sentence that shows your reader how the paragraph links to your main argument.
Conclusion
Every written assignment should finish with a clearly written conclusion. The conclusion should summarise your main argument and illustrate how you have proven your thesis statement.
Question
Module 8 has explored the considerations that need to be made before a firm decides to enter the international market. Not only will firms need to consider liabilities of foreignness, ownership advantages, and location advantages, they will also need to consider the advantages of internalisation. By making use of the OLI and the CAGE frameworks, firms will be in a better position to consider these factors and assess their comparative advantage in the international market.
Having established whether it is beneficial to go global, firms will then need to determine which business strategy to use. As a result, this module has unpacked three global business strategies, namely global integration, local responsiveness, and Ghemawats AAA global strategy framework.
For this assignment answer the following question:
Select a company and evaluate their global business strategy by assessing how their strategy aligns with at least one of the strategic frameworks discussed in this module. Support your argument by using an example of a product or service that the company has implemented as part of its global business strategy.
When writing your essay, you are required to make reference to the course material and any other sources consulted as part of independent research, as indicated in the rubric below. Your submission, excluding in-text citations and list of references, may not exceed 600 words.
Use any global company
USE Ghemawats AAA framework.
