The transaction-cost based view on global strategy – the impact of changing developments society. Essay Example
INTERNATIONAL MARKETING 12
Transaction-Cost Based View of Multinational Companies
Table of Contents
31.1 Eclectic theory of Multinational Companies: The OLI model
The aim of this essay is to establish how changes in social development variables affect the ownership structure, location and internationalization dimensions of Dunning’s OLI model of a firm. As behavior of consumers change among the population, it potentially influences internalization dimension of an international company. As well, companies are likely to reduce search and information costs where information is available online to millions of customers who are educated. While those firms engaging foreign operational structures desire lower transactional costs, sustainability issues affect transaction cost of a global strategy adopted by firms expanding their operations abroad. Most Multinational Companies (MNCs) have adopted Foreign Direct Investment (FDI) strategies to overcome export difficulties, get high rate of return and access cheaper capital when transaction costs are kept to the minimum. Although MNCs are there to maximize profits, changes in consumer behavior, government policies, education of employees and consumers and sustainability issues influence mode of entry firms operate in the host country. As a result, corporate managers will be interested in the level of transaction costs that determine the optimal mode of entry strategy. Consequently, as the firm expands to the foreign market, the transaction costs will depend on the response of the country host social development variables.
1.1 Eclectic theory of Multinational Companies: The OLI model
Changes in social development, specifically government policies on taxation and tariffs, have increased specific advantages for FDIs from developed countries to invest in emerging economies. Multinational companies invest overseas by using firm specific advantages to acquire higher profits. When referring to Dunning’s OLI model, 1shows that ownership, location and internalization impact on corporate strategies of firms to invest abroad. Firms have ownership advantages if they have differentiated products or services, technology intensity, international experience and adaptability of service or product2. For example, Chinese government policies on liberalization have changed leading to reduced regulations on foreign companies3. Although the country relaxed its position on privatization and liberalization, tax structure and intellectual property protection has worsened hence affecting the ownership of the FDIs.
Conversely, increase in corporate taxation and tariffs makes MNCs firms to reconsider their ownership structures4. Previously, firms needed to possess superior skills and assets to compete against high taxation and tariffs that host country firms enjoy5. With increased funding from governments, the differentiated products or multinational experience and size of firm changes. For example, the decision by the government of South Korea to finance Samsung Semiconductors increased the equity of the government in the company6. Similarly, transaction costs in the firm have been reduced as they achieve more on economies of scale, and enforcement of contracts and patents. Firm size influences absorption of these costs and positively affects Foreign Direct Investment. Nonetheless, the concern on choice of joint venture among larger firms is reduced as the possibility of exploitation by host country partner is diminished7.
On the same note, firms with multinational experience prefer investment modes of entry while those with less experience choose non-investment modes. Changes in tariffs and increased regional integration and cooperation in similar markets has increased levels of trade and understanding. For example, Mazda Motors of Japan did not have to create an FDI in Malaysia but opted for a joint venture with Bermaz Motors of Malaysia in 2012 because the government has more respect for partnerships8. However, management of foreign operations in some firms may attract high transaction costs if a multinational lacks foreign market experience9. This shows that increased integration in regional market affects ownership structure and in turn determines the level of transaction costs involved.
Investment risk and market potential affects the attractiveness of a market10. Size and growth that signifies market potential are essential determinants of overseas investment. On the contrary, changes in consumer behavior and business models such as B2B to B2C has create increased reach by multinational firms to markets11. For example, General Electric (GE) made FDIs of Ultra Sound machines in India once it found out that not only retailers but clinics were demanding the machines12. Fortunately, the decision lowered transportation costs from the US to India. Location advantages are not only limited to access to raw materials but also markets for the products or services produced13. Increased concerns on Climate Change and environmental protection have led to increase budget for Corporate Social Responsibility (CSR) and carbon taxes14. For example, BHP Billiton presently in South Africa may have to relocate to Democratic Republic of Congo (DRC) for its precious metals as the former is introducing carbon taxes on its mining operations15. Similarly, concerns on emissions in Saudi Arabia make the country to impose high tariffs on motor vehicles which may affect the choice of Rolls Royce to locate its operations in Riyadh. To obtain better returns in attractive markets, favor entry and selective strategies are advisable in order to service foreign markets.
Australia is a high market potential country over which consumers have more preference for local brands than foreign brands. However, the trend has shown increasing tastes and liking for foreign products. For instance, Apple seeking lower marginal cost of production and achieve economies of scale is exporting directly to Australia16. Although economies of scale may be insignificant, firms can still choose investment modes because they enjoy market presence in the long-term.
Government policies especially changes in political and economic conditions create uncertainty in the form of investment risk17. Changes in government policies affect the profitability and survival of a firm operating in a different country. Inward foreign investments are impeded by restrictive policies of governments of host countries. Alternatively, better education of employees and customers on quality has compelled firms entering restrictive market environments to adopt non-investment options. For example, increased education on quality among employees of Vietnamese Footwear makers such as Hai Phong allowed the company to create its first FDI in Singapore18. Location theory can be demand oriented or supply oriented19. When factors of distribution and production are the lowest, production takes place.
Location of competitors and market determines location of the firm because of transportation costs, untapped and protected markets, cheap labor and raw materials20. On the contrary, interference by the government over control of foreign assets and repatriation of profits is subject to government’s investment policies and international trade21. This means that education of employees and customers on the superiority of production methods in host countries will increase access to communication search.
Internalization advantages are benefits MNCs enjoy when they opt to invest in a country instead of engaging in joint ventures, licensing or exporting22. Despite firms locating their production based on resources, creation of Free Trade Zones (FTZ), improved education and increased consumer knowledge of healthy living has change internationalization advantages of firms. Furthermore, emergence of social media and new technologies has changed how firms search for information on markets, policing and enforcement, and bargaining. On the other hand, sale of technology to one firm may be less profitable than opening a new enterprise in a foreign country23. For example, Nestle foods may not consider exporting to New Zealand because the population are more concerned about cholesterol and sugar rich foods now unlike before24. Moreover, pharmaceutical firms from India may opt to invest in United Arab Emirates (UAE) as they have reduced their taxes and tariffs25. This reduces on policing and enforcement costs as well as bargaining costs between governments and FDIs. Firms intending to invest in foreign countries develop managerial perceptions on stability of economic, social and political conditions, expropriation of assets and repatriation and conversion of profits26.
According to internalization theory multinational corporations can use licensing or leasing methods for product sale abroad or produce overseas through FDI27. Improvement in education standards among customers and proficiency in international languages among employees has reduced policing and enforcement costs as well as information asymmetries between buyers and sellers28. For example, French companies such as L’Oreal has created an FDI in East Africa especially Kenya since many people have working knowledge of the French language29. Earlier, inadequate foreign market information had increased transaction-cost such as translation and interpretation of L’Oreal products. This allows the firms to penetrate into markets originally seen as culturally distant to the home country of the firm30.
Motivations for foreign market expansion are client following activities, cost-reduction seeking, technology seeking and resource and market seeking. However, technology-seeking and resource-seeking activities may not motivate foreign investment because the country of origin may have superior technological advancement and best-trained resources31. For example, education of customers on use of online stores for software and hardware products firms such as Symantec of US reduces the search and information costs as well as bargaining costs32. Since the main industry concern is cost, software development firms through highly skilled personnel will chat with prospective customers which lower bargaining costs. Similarly, as consumers shift to online marketing, internalization has physical contractual relationship and creates virtual market where it did not exist earlier. Firms no longer have to engage in FDIs to deliver the products to the random customers around the world33.
Despite transaction costs diverting attention from market power, internal markets of the firms are efficiently functioning. Similarly, lack of partners in foreign countries makes enforcement of contracts inefficient and meaningless34. Internalization provides the advantages of locating specific advantages, coordinating ownership and controlling operations in the multinational company35. Change in consumer behavior influences internalization as does location and ownership advantages36. If a host country’s population warm up to another country in trading terms, it is likely to experience a cultural shift. For example, Chinese FDIs in Australia is increasing due presence of more Chinese migrants in the country37. This implies that the shift will not only reduce cultural distance for lowered policing and enforcement costs but will also allow for Chinese firms to make direct FDIs in Australia.
The essay showed that changes in business models such as from B2B to B2C over which consumers’ access to firm products may consider FDI to reduce policing and enforcement costs. Educated employees improve quality of services and products leading to reduction of bargaining costs as the difference between ask and the bid is reduced. In addition, it is linked to the transaction cost of global strategy of a company. The essay found that certain government policies such as increase in tariff system and taxation will force firms to engage in joint ventures instead of FDI or exporting. On the other hand, introduction of carbon taxes and pressure for ways to address climate change compels firms to alter their location of the firm or internalize through exporting. Finally, the essay found that internalization strategies where countries introducing free trade zones will make firms to create FDIs in the host countries where enforcement and policing costs are low.
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1 Sonmez (2013), p. 72
2 Brouthers et al. (1996), p. 382
3 Hsueh (2008)
Demsetz (2003), p. 53
5 Brouthers et al. (1996), p. 383
6 Gupta et al. (2013) p. 5
7 Zahra (2003), p. 502
8 Chan (2012)
Klaes, M. (2008), p. 54
Dunning and Lundan (2008), p. 575
Demirbag et al., (2010), p. 212
12 INSEAD (2011), p. 8
Cui, L., & Jiang, F. (2012), p. 268
Demirbag et al., (2010), p. 210
15 EYGM Ltd (2014), p. 25
16 Baidya (2015)
Hennart (2012), p.183
18 CNET (2015)
Douma & Schreuder (2012), p. 84
Peng (2009), p. 62
Demsetz (2003), p. 55
22 Johanson and Vahlne, (2003), p. 94
23 Sonmez (2013), p. 77
24 Nestle (2015)
25 Oxford Business Group (2015)
Arslan and Larimo (2010), p. 184
27 George et al., (2005), p.219
28 Brouthers et al. (1996), p. 384
29 Nganga (2010)
30 Yaw & Jautch (2009), p. 56
31 George et al., (2005), p.220
32 Sexton (2013)
33 Johanson and Vahlne, (2003), p. 97
Klaes, M. (2008), p. 57
Demsetz (2003), p. 54
36 Brouthers et al. (1996), p. 385
37 Spasic (2015)
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