As globalization progresses, an increasing number of businesses are expanding across national borders, becoming multinational enterprises in the process. A multinationalenterprise (MNE) is any business that has productive activities in two or more countries. There are four main reasons why the managers of many enterprises, both large and small, seek to expand their operations across national borders: Doing so lets a firm expand the market for its products, realize scale and location economies, and benefit from global learning.
EXPANDING THE MARKET
International expansion enlarges the market a firm can address, enabling it to increase its sales and profits faster. The growth of Starbucks, for example, owes much to the rapid international expansion of the company. Starbucks opened its first international store in 1996, when it was operating some 700 stores in the United States. By 2005 the company had over 3,200 locations in 34 countries outside the United States (plus 7,000 more in the United States).
In just a decade Starbucks grew from a midsized national company to a world entity with a powerful world brand. Going forward, Starbucks sees continued international expansion as a major engine of growth. The company’s aim is to make Starbucks as ubiquitous internationally as other great American consumer brands, such as McDonald’s and Coca-Cola.
More generally, many enterprises develop a core skill at home and then try to earn greater returns from that competency by applying it to foreign markets where indigenous competitors lack the same skills. Thus McDonald’s developed a core competency in managing fast-food franchise operations in the United States, and then earned greater returns from that competency by entering foreign markets that lacked American-style fast-food restaurants.
Similarly, Procter &Gamble established core competencies in the development and mass marketing of household consumer products, including shampoos, detergents, and diapers, and it has earned greater returns from those competencies by applying them to foreign markets that lacked enterprises with the same skill set. In short, when the managers at a firm have built a valuable competency or skill, going global is often the best way to maximize the return on their investment in that skill.
REALIZING SCALE ECONOMIES
The larger sales base associated with serving a global market can allow enterprises to attain economies of scale, lower their costs, and boost their profits. In the automobile industry, for example, an efficiently scaled factory is one designed to produce about 200,000 units a year. Automobile firms would prefer to produce a single model from each factory because this eliminates the costs associated with switching production from one model to another.
If domestic demand for a particular model is only 100,000 units a year, the inability to attain a 200,000-unit output will drive up average unit costs. However, by serving international markets and exporting some production, the firm may be able to push production volume up to 200,000 units a year, thereby reaping greater scale economies.
More generally, by serving domestic and international markets a firm may be able to utilize its production facilities more intensively. For example, if Intel sold microprocessors only in the United States, it might be able to keep its factories open for only one shift, five days a week. By serving international markets from the same factories, Intel can run three shifts seven days a week for lower costs and greater profitability.
REALIZING LOCATION ECONOMIES
Different locations around the world are more or less suitable for performing different business activities. For example, China is a good location for making textiles due to the combination of low labor costs (textile manufacturing is labor-intensive) and good infrastructure. The United States is not as good for making textiles due to relative high labor costs; so textile manufacturing has been migrating out of the United States for the last 20 years.
On the other hand, New York, Paris, and Rome are all good locations for fashion design due to the high concentration of successful design firms and design schools and the abundant supply of skilled designers. Similarly, the United States is a good place for developing new software products because of its many skilled software programmers and the high rate of innovation in the U.S. computer industry.
By the same token, Bangalore is a great location for performing software testing and debugging due to a high supply of software engineers, relatively low wage rates, the widespread use of English, and the fact that Bangalore is 12 time zones away from the American West Coast, where many software firms are concentrated. Thus softwarecode written during the day on the West Coast can be tested and debugged by engineers at night in Bangalore and sent back to programmers in America in the morning. As a result of these factors, Bangalore is home to India’s rapidly developing software industry and its two largest high-technology firms: Wipro and Infosys.
Location economies arise from exploiting such differences; they are the economies that arise from performing a business activity in the optimal location for that activity, wherever in the world that might be (transportation costs and trade barriers permitting). Locating a business activity in the optimal location can have one of two effects. It can lower the costs of performing that activity, and it can enable the firm to add value to its final product offering and thus better differentiate its offering from that of competitors. The task facing managers in a global economy is to look at the various activities of a firm and decide where in the world they should be located to realize location economies.
For illustration, consider IBM’s ThinkPad X31 laptop computer (this business was acquired by China’s Lenovo in 2005). The ThinkPad was designed in the United States by IBM engineers because IBM believed that the United States was the best location in the world to do the basic design work. The case, keyboard, and hard drive were made in Thailand; the display screen and memory were made in South Korea; the built-in wireless card was made in Malaysia; and the microprocessor was manufactured in the United States. These components were manufactured in the optimal locations given managers’ assessment of the relative costs of performing each activity at different locations.
These components were shipped to an IBM operation in Mexico, where the product was assembled before being shipped to the United States for final sale. IBM assembled the ThinkPad in Mexico because IBM’s managers calculated that due to low labor costs, the costs of assembly could be minimized there. The marketing and sales strategy for North America was developed by IBM personnel in the United States, primarily because IBM believed that due to their knowledge of the local market, U.S. personnel would add more value to the product through their marketing efforts than personnel based elsewhere.
In theory, a firm that realizes location economies by dispersing each of its different activities to the optimal location should have a competitive advantage over a firm that bases all of its value creation activities at a single location. It should be able to better differentiate its products and keep its cost structure lower than its single-location competitor. In a world where competitive pressures are increasing, such a strategy may become imperative for survival.
Implicit in our discussion so far is the idea that valuable skills are developed first at home and then transferred to foreign operations. Thus Wal-Mart developed its retailing skills in the United States before transferring them to foreign locations. However, for more mature multinationals that have already established a network of subsidiary operations in foreign markets, the development of valuable skills can just as well occur in foreign subsidiaries.
Skills can be created anywhere within a multinational’s global network of operations, wherever people have the opportunity and incentive to try new ways of doing things. The creation of skills that help lower the costs of production, enhance perceived value, and support higher product pricing is not the monopoly of the corporate center.
Leveraging the skills created within subsidiaries and applying them to other operations within a firm’s global network may create value. For example, McDonald’s increasingly is finding that its foreign franchisees are a source of valuable new ideas. Facing slow growth in France, its local franchisees have begun to experiment not only with the menu but also with the layout and theme of restaurants. Gone are the ubiquitous golden arches, as well as many of the utilitarian chairs and tables and other plastic features of the fast-food giant.
Many McDonald’s restaurants in France now have hardwood floors, exposed brick walls, and even armchairs. Half of the 930 or so outlets in France have been upgraded to a level that would make them unrecognizable to an American. The menu, too, has been changed to include premier sandwiches, such as a chicken on focaccia bread, priced some 30 percent higher than the average hamburger. In France the strategy seems to be working. Following the changes, increasesin same-store sales rose from 1 percent annually to 3.4 percent. Impressed with the impact, McDonald’s executives are now considering adopting similar changes at other McDonald’s restaurants in markets where same-store sales growth is sluggish, including the United States.
For the managers of a multinational enterprise, this phenomenon creates important new challenges. First, they must have enough humility to recognize that valuable skills and competencies can arise anywhere within the firm’s global network—not just at the corporate center. Second, they must establish an incentive system that encourages local employees to acquire new skills, which is not as easy as it sounds. Creating new skills involves a degree of risk: Not all new skills add value. For every valuable idea created by a McDonald’s subsidiary in a foreign country, there may be several failures.
The management of the multinational firm must install incentives that encourage employees to take the necessary risks. The company must reward people for successes and not sanction them unnecessarily for taking risks that did not pan out. Third, managers must have a process for identifying when valuable new skills have been created in a subsidiary. Finally, they need to act as facilitators, helping to transfer valuable skills within the firm.
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