The Nature of International Business
Welcome to the second session of the International Socio-Economic Context Course. This Chapter titled An Introduction to International Business and Multinational Corporations is focused on operating the advantages and disadvantages of a MNC.
This is important because for a future/present business professional, the identification of the strengths and opportunities of the management of a MNC is the first step in order to make profit or overcome them. Of course each enterprise is different so this session will provide a general framework to understand the common characteristics while keeping in mind that this is not a restrictive list but an orientative approach.
So, by the end of this class you will be able to distinguish between the challenges that every MNC face and the distinctive resources that usually these kind of companies have so it will become clear that both are faces of the same coin and rather that a separation between them, it is useful to learn how to manage the positive aspects to aboard the disadvantageous situations.
Firstly, the usual advantages gained by MNC will be presented as proposed by Ajami R., & Goddard J. G. (2015):
Superior Technical Know-How
Perhaps the most important advantage that MNCs enjoy is patented technical know- how, which enables them to compete internationally. Most large MNCs have access to advanced levels of technology that was either developed or acquired by the corporation. Such technology is patented and held quite closely. It can be in the areas of production, management, services, or processes. Widespread application of such technology gives the MNC a strong competitive advantage in the international market, because it results in the production of efficient, hi-tech, and low-priced products and services that command a large international market following. The Banamex Tricolor card technology developed by Citigroup is an example of how an MNC can obtain a competitive advantage by developing, patenting, and then exploiting advanced technology. Apple and Microsoft Corporation in computers, Boeing in aviation, and BASF in chemicals are further examples.
Large Size and Economies of Scale
Most MNCs tend to be large. Some of them, such as Walmart or Exxon Mobil, have sales that are larger than the gross national products of many countries. The large size confers significant advantages of economies of scale to MNCs. The high volume of production lowers per-unit fixed costs for the company’s products, which is reflected in lower final costs. Competitors who produce smaller volumes of goods must price them higher in order to recover higher fixed costs. This situation is especially true in such capital-intensive industries as steel, petrochemicals, and automobiles, in which the fixed costs form a substantial proportion of total costs. Thus, an MNC such as Nippon Steel & Sumitomo Metal Corporation of Japan can sell its products at much cheaper prices than those of companies with smaller plants.
Lower Input Costs Due to Large Size
The large production levels of multinationals necessitate the purchase of incommensurately large volumes. Bulk purchases of inputs enable MNCs to bargain for lower input costs, and they are able to obtain substantial volume discounts. The lowered input costs imply less expensive and, therefore, more competitive finished products. Nestlé, which buys huge quantities of coffee on the market, can command much lower prices than smaller buyers. Walmart is able to sell its products at low prices relative to its competition due to both its bulk purchasing and effective inventory control. By understanding which products are selling effectively, Walmart combines low-cost purchasing with the effective movement of inventory to achieve competitive advantage in the retail consumer products market.
Ability to Access Raw Materials Overseas
Many MNCs lower input and production costs by accessing raw materials in foreign countries. In many of these cases, MNCs supply the technology to extract and/or refine the raw materials. In addition to lowering costs, such access can give them monopolistic control over the raw materials because they often supply technology only in exchange for such monopolistic control. This control allows them to manipulate the supply of the raw materials or even to deny access to their competitors.
Ability to Shift Production Overseas
The ability to shift production overseas is another advantage enjoyed by MNCs. In order to increase their international competitiveness, MNCs relocate their production facilities overseas to take advantage of lower costs for labor, raw materials, and other inputs, and, often, incen- tives offered by host countries. The reduced costs achieved at these locations are exploited by exporting lower-cost goods to foreign markets. Several major MNCs have set up factories in such low-cost locations as China, India, and Mexico, to name only a few. This advantage is unique to MNCs, and it gives them a distinct edge over purely domestic corporations.
Scale Economies in Shipment, Distribution, and Promotion
Scale economies allow MNCs to achieve lower costs in shipment expenses. The large volumes of freight they ship across nations permit them to negotiate lower rates with the shippers. Some of the very large corporations, especially the oil giants, have operations that are large enough to justify the purchase of their own ships, which is an even more effective way to reduce costs.
Distribution and promotion costs are also lowered for MNCs because of their high volumes of production. The distributors in different countries charge lower commis- sions to move the products because they are able to make substantial profits on their high volumes. A similar lowering of costs accrues with promotional expenses. MNCs have large advertising budgets and are valuable clients for advertising agencies and the media. Consequently, they are able to obtain cheaper rates. More importantly, MNCs are often able to standardize a promotional message and use it in different countries (e.g., the Marlboro cigarette advertisements or several Coca-Cola promotions that have been released in different countries using standardized messages).
Brand Image and Goodwill Advantage
Many of the MNCs possess product lines that have established a good reputation for qual- ity, performance, value, and service. This reputation spreads abroad through exports and promotion, adding to the arsenal of potent weapons of the MNC in the form of brand image or goodwill, which it is able to use to differentiate its own products from others in its genre. The MNC is able to leverage this goodwill or brand image by standardizing its product line in different countries and achieving economies of scale. For example, Sony Playstations do not have any special modifications for different countries (except for voltage) and the home- based plant churns out standardized products for the world market. Similarly, Levi Strauss & Company is able to market its standard denim jeans around the globe even though clothing fashions vary widely within different cultures. Moreover, goodwill and brand names allow the company to charge premium prices for its products (e.g, Sony) because the customers are convinced that the products are good value even at premium prices.
Access to Low-Cost Financing
As a result of their size, MNCs require large amounts of financing, and generally, they are excellent credit risks. Therefore, they are the favored customers of the financial in- stitutions that lend to them at their best rates. The lower cost of financing for the MNCs adds to their competitive strength. MNCs also have the additional advantage of access to different financial markets, which allows them to borrow from the source offering the best deal; the funds are then transferred internally to required locations. This access enables MNCs to avoid credit rationing in some countries and to obtain financing at costs lower than those available to their domestic-oriented competitors.
MNCs also have an advantage in being able to manipulate their profits and shift them to lower tax locations. This greater financial leverage can be used to artificially lower prices to enter new markets or increase market shares in existing ones. The manipulation of profits to save taxes is generally accomplished through transfer pricing, where the overseas subsidiaries are charged artificially higher prices for products supplied to them by the parent company. There are also several financial mechanisms with the objectives of shifting profits and manipulating taxes.
Multinationals have a global market view and are able to collect, process, analyze, and exploit their in-depth knowledge of worldwide markets. They use this knowledge to create new openings for their existing products or create new products for potential market niches. Their special knowledge is used to diversify and expand the market coverage of their products and to design strategies to counter the marketing efforts of their competi- tors. Moreover, excess production can be sold off, as the company can quickly find new markets through its global search and marketing mechanism.
The information-gathering abilities of an MNC are an advantage not only in marketing, but also in all other aspects of its operation. The MNC is able to gather commercial intelligence, forecast government controls, and assess political and other risks through its information network. The network also provides valuable information about changing market and economic conditions, demographics, social and cultural changes, and many other variables that affect the business of MNEs in different countries. Access to this information provides the MNE with the opportunity to position itself appropriately to respond to any contingencies and exploit any opportunities.
Managerial Experience and Expertise
Because MNCs function simultaneously in a large number of very different countries, they are able to assimilate a wealth of valuable managerial experience. This experience provides insights into dealing with different business situations and problems around the globe. The MNC also acquires expertise in different ways of approaching business problems and can effectively apply this knowledge to its other locations. For example, a multinational located in Japan can acquire in-depth knowledge of Japanese management methods and apply them successfully elsewhere. MNCs also develop expertise in multi-country operations management as their executives gather experience working in different countries on their way to senior management positions.
Diversification of Risks
The simultaneous presence of MNCs in different countries allows them to more effectively bear the risk of cyclic economic declines. Generally these cycles are not the same in different countries. Thus, if operations in one country suffer losses, these losses can be offset by gains in other countries. Simultaneous operations also provide considerable flexibility, enabling MNCs to diversify the political, economic, and other risks that they face in different countries. Thus, if an MNC is not able to keep up production levels in one country, it can still retain its market share by serving the market with products from a factory located in a different country. In another instance, if raw material supply is stopped from one source, the global presence of the MNC assures supplies from alternative sources. In the oil market, for example, if a Russian pipeline is shut down unexpectedly, nations such as Saudi Arabia have the necessary spare capacity to temporarily increase the supply of oil on the world markets in an effort to stabilize prices over the short term. In this second analysis phase the disadvantages of MNC will be explained, also considered the authors Ajami R., & Goddard J. G. (2015):
MNCs have to bear several serious risks that are not borne by companies whose operations are purely domestic in nature. Since MNCs do business outside the borders of their own countries, they deal with the currencies of other countries, which render them vulnerable to fluctuations in exchange rates. Violent movements in exchange rates can wipe out the entire profit of a particular business activity. Over the long run, MNCs have to live with this risk because it is extremely difficult to eliminate it. Over the short run, however, there are market mechanisms such as currency swaps and forward contracts that allow an MNC to minimize the movement of exchange rates for a particular business transaction. Companies that engage in these forms of financial contracts understand that they are not in the currency-risk business and that it makes sense to minimize this risk when at all possible.
Operating in different countries subjects MNCs to a myriad of host-country regulations that vary from country to country and, in most cases, are quite different from those of the home country. The MNC has the difficult task of familiarizing itself with these regulations and modifying its operations to ensure that it does not overstep them. Regulations are often changed, and such changes can have adverse implications for MNCs. For example, a country may ban the import of a certain raw material or restrict the availability of bank credit. Such constraints can have serious effects on production levels. In many developing countries national controls are quite pervasive and almost every facet of private business activity is subject to government approval. The MNCs of developed countries are not used to such controls, and their methods of doing business are not geared to work in this type of environment.
Different Legal Systems
MNCs must operate under the different legal systems of different countries. In some countries the legislative and judicial processes are extremely cumbersome and contain many nuances that are not easily understood by outsiders. Some legislation can also prohibit the type of business activity the MNC would regard as normal in its home country.
Host countries are sovereign entities and their actions normally do not admit any appeals. There is little that an MNC can do if a host country is determined to take actions that are inimical to its interest. This political risk, as it is known, increases in countries whose governments are unstable and tend to change frequently.
Multinational firms work in wide varieties of business environments which create sub- stantial operational difficulties. Unwritten business practices and market conventions often prevail in host countries. MNCs that lack familiarity with such conventions will find it difficult to conduct business in accordance with them. Often the normal methods of operation of an MNC can be quite contrary to a country’s business practices. A typical example is informal credit. In many countries retailers agree to stock goods of a manufacturing company only if they are offered a market-determined period of credit that is not covered by a written document. The accounting and sales policies of an MNC may not permit such arrangements. On the other hand, doing business in a certain country may not be at all possible without such arrangements. The multinational must therefore adjust its business practices or lose business entirely.
Cultural differences often lead to major problems for MNCs. Many find that their expatriate executives are not able to turn in optimal performance because they are not able to adjust to the local culture, both personally as well as professionally. On the other hand, local managers of MNCs often have difficulties in dealing with the home office of an MNC because of culturally based mutual communication and understanding problems. Inability to understand and respond appropriately to local cultures has often led MNC products to fail. Misunderstanding of local cultures, work ethics, and social norms often leads to problems between MNCs and their local customers, business associates, government officials, and even their own employees.
Many of the problems and challenges of doing international business involve overcoming disadvantages and capitalizing on advantages that arise when corporations go international. These problems and challenges will be discussed in detail in subsequent chapters.
As it was explained in this session, in general, there are two types of typical MNCs characteristics: advantages and disadvantages. Both of course affect the external environment and internal management of the companies. These positive and negative effects however are not a source of conflict but an opportunity to manage them in a complimentary way to enable and potentialize the growth of the corporations.
From a simple comparison of the number of advantages and disadvantages it is clear that the number of the first group is considerably bigger. This is a strong reason for Managers of MNC to continue working in the global arena and for domestic-oriented Managers to shift to that. However, it must not be omitted the implications of the disadvantages since it might become a problem for the successful operation of any MNC, it might be minor in number but with great negatives consequences if there is no paid attention to them.
So, the final balance of this chapter is that all elements must be considered in a holistic way for the best comprehension of the MNC nature and such analysis is not limited to the enumeration of characteristics but the real comprehension of them in order to get the best benefits for the enterprise.
- Ajami R., & Goddard J. G. (2015). International Business: Theory and Practice. Routledge (10-21)
- Gaille, L. (April 30th, 2018). 11 Multinational Corporations Pros and Cons. Vittana org.
- Tedx Talks (February 20th, 2015). The transformational power of multinational business by Mayer, C. [Video File]. Youtube. https://www.youtube.com/watch?v=XLdiBNYGd-Y&t=19s