Chapter 9: Foreign Market Entry
and International Production
An Introduction to International
Economics: New Perspectives on the
World Economy
© Kenneth A. Reinert, Cambridge University
Press 2012
Analytical Elements
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Countries
Sectors
Tasks
Firms
Factors of production
© Kenneth A. Reinert, Cambridge University
Press 2012
Introduction
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Exports are just one way that firms can place
their products in foreign markets, a process
known as foreign market entry
Two other means are
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Contracting
Foreign direct investment
Contracting and foreign direct investment are
two types of international production
These are described in Table 9.1
© Kenneth A. Reinert, Cambridge University
Press 2012
Table 9.1: The Foreign Market Entry Menu
Category
Mode
Characteristics
Domestic
None
Purely domestic firm supplying home market
Exporting
Indirect Exporting Another firm acts as sales agent
Exporting
Direct Exporting
Firm completes export transaction itself
Contractual Licensing
License to foreign firm to produce abroad
Contractual Franchising
License with conditions to ensure consistency
Contractual Subcontracting
Contract with materials and specifications
Investment
Joint Venture
Jointly owned separate firm
Investment
Mergers and
Acquisitions
Purchase of part or whole of foreign firm
Investment
Greenfield
Brand-new production facility
© Kenneth A. Reinert, Cambridge University
Press 2012
Exporting
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Indirect exporting
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The home-country firm relies on another firm
known as a sales agent or trading company to
complete the export transaction
Direct exporting
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The home-country firm takes on the export
transaction itself
This can include the research, marketing, finance,
and logistics requirements of the trade trasaction
© Kenneth A. Reinert, Cambridge University
Press 2012
Contractual
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Licensing
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Franchising
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The home-country firm licenses a foreign firm to allow it to
use the home-country firm’s production process in the
foreign country
The home-country firm licenses a foreign firm to allow it to
use the home-country firm’s production process in the
foreign country but exerts more control over production and
marketing to ensure consistency across foreign markets
Subcontracting
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The home-country firm contracts with a foreign firm to
produce a product to certain specifications
© Kenneth A. Reinert, Cambridge University
Press 2012
Investment
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Joint venture (JV)
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Mergers and acquisitions (M&A)
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The home-country firm establishes a separate firm in the
foreign country that is jointly-owned with a foreign-country
firm
The home-country firm buys part (merger) or all
(acquisition) of the shares of an already-existing production
facility in the foreign country
Greenfield investment
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The home-country firm establishes a brand-new production
facility in the foreign country that it fully owns
© Kenneth A. Reinert, Cambridge University
Press 2012
Motivation for International Production
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Resource seeking
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Market seeking
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Locating near expected market growth, to better adapt a
product to local needs, and to supply intermediate inputs to
another firm
Efficiency seeking
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Gaining access to natural resources or human resources
Rationalize the established structure of international
production for economies of scale and scope
Strategic asset seeking
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Part of a strategic game among global competitors in
oligopolistic sectors
© Kenneth A. Reinert, Cambridge University
Press 2012
Strategic Asset Seeking
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Insights from Dunning and Lundan (2008)
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Acquiring or collaborating with another to thwart a competitor
from doing so
Merging with a foreign rivals to strengthen joint capabilities
Acquiring a group of suppliers to corner the market for a
particular raw material
Gaining access over distribution outlets to better promote its own
brand of products
Buying out a firm producing a complementary range of goods or
services so it can offer its customers a more diversified range of
products
Joining forces with a local firm in the belief that it is in a better
position to secure contracts from the host government
© Kenneth A. Reinert, Cambridge University
Press 2012
Entry Mode Choice
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Economic view
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Entry mode choice factors include
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A firm will chose the entry mode that will provide it with the
greatest risk-adjusted or expected return on the entry
investment
Degree of control
Level of resource commitment
Dissemination risk
Dissemination risk
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the possibility of a foreign partner firm obtaining technology
or other know-how from the home-country firm and
exploiting it for its own commercial advantage
© Kenneth A. Reinert, Cambridge University
Press 2012
Table 9.2: Factors Influencing Choice of
Foreign Market Entry Mode
Mode
Degree of
Control
Level of
resource
commitment
Degree of
dissemination
risk
Trade
Low
Low
Low
Contractual
Low
Low
High
InvestmentJoint Venture
Medium
Medium
Medium
InvestmentM&A or
greenfield
High
High
Low
Source: Hill, Hwang and Kim (1990)
© Kenneth A. Reinert, Cambridge University
Press 2012
Entry Mode Choice
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If a firm’s most important concern was
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Degree of control over the production and marketing
process
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Limiting resource commitment to low levels
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Consider either trade or contractual modes of foreign market
entry
Low degree of dissemination risk
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Lead the firm towards an investment mode of foreign market
entry based on a subsidiary obtained either through greenfield
or acquisition investment
Either trade or investment via a subsidiary would be the
preferred mode of entry
In most instances, firms have more than one
primary concern
© Kenneth A. Reinert, Cambridge University
Press 2012
The Rise of Multinational Enterprises and
International Production
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Early MNEs were part of the colonization efforts
during the 16th and 17th centuries
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Included state-supported trading companies such as the British
East India Company, the Dutch East India Company, and the
Royal African Company
Known as the age of merchant capitalism
Industrial revolution in the 19th century led to
industrial capitalism
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British-based MNEs operating in India, China, Latin America, and
South Africa
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Involved in mining, plantation agriculture, finance, and shipping
Japan became involved in MNE activity after the Meiji
Restoration
© Kenneth A. Reinert, Cambridge University
Press 2012
The Rise of Multinational Enterprises and
International Production
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In the 20th century, industrial production grew more
capital intensive
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Role of the production line and associated economies of
scale grew more important
Era of industrial capitalism gave way to managerial
capitalism or Fordism
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Center of innovative economic activity moved from Europe
to the United States
Firm size increased
Business success became based on the ability to
coordinate growing sets of complementary activities
© Kenneth A. Reinert, Cambridge University
Press 2012
The Rise of Multinational Enterprises and
International Production
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Depression that began in 1929 and the Second
World War hurt most forms of international
economic activity
Post-war recovery further strengthened the role of
US-based MNEs
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Technological advantage of US-based MNEs during the
early post-war period was the point of reference of the
product life cycle theory
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Production is confined to the home base MNE during the early
phases of product life cycle
During later phases production can move to subsidiaries in
foreign countries in order to take advantage of lower labor
costs
© Kenneth A. Reinert, Cambridge University
Press 2012
The Rise of Multinational Enterprises and
International Production
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The 1970s had the rise of industrial output in the newly
industrializing countries (NICs) of East Asia
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Especially Japan, Taiwan, and South Korea
Many see this as new economic era known as post-Fordism or
Toyotism
Economies of scale have been replaced by flexibility as the
progressive element in manufacturing and the use of information
and communication technology (ICT) to control production
processes
Rise of industrial output was followed by a rise in FDI on
the part of East-Asian based MNEs
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Especially those based in Japan
© Kenneth A. Reinert, Cambridge University
Press 2012
Table 9.3: Leading Sources of World FDI
(percent of global, outward stocks)
Source
1960
1980
1990
2000
2008
United
States
47
43
24
22
20
United
Kingdom
18
16
13
15
9
Germany
1
8
8
9
9
France
6
4
6
7
9
Japan
1
4
11
5
4
China
0
0
0
0
1
Brazil
0
0
0
1
1
All
Developing
NA
3
8
14
15
© Kenneth A. Reinert, Cambridge University
Press 2012
Table 9.4: Leading Destinations of World
FDI (percent of global, inward stocks)
Destination
1980
1990
2000
2008
United States
16
20
22
15
United
Kingdom
12
10
8
7
Germany
7
6
5
5
France
5
5
5
7
Japan
1
1
1
1
China
0
1
3
3
Brazil
3
2
2
2
27
30
29
All Developing 26
© Kenneth A. Reinert, Cambridge University
Press 2012
FDI and Comparative Advantage
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What difference does FDI make to the
comparative advantage model of Chapter 3?
This is considered in Figure 9.1
An FDI flow from Japan to Vietnam changes the
relative factor/resource endowments of both
countries
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Japan becomes less capital abundant
Vietnam becomes more capital abundant
These changes shift the PPFs of the two
countries
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 9.1: FDI and Comparative
Advantage between Vietnam and Japan
© Kenneth A. Reinert, Cambridge University
Press 2012
FDI and Comparative Advantage
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Vietnam’s PPF shifts out in a manner biased
towards the capital intensive good
Japan’s PPF shifts in biased away from the
capital intensive good
These changes lessen the strength of
comparative advantage
FDI can therefore be a substitute for trade
In other more specific cases, however, FDI
can be a complement to trade
© Kenneth A. Reinert, Cambridge University
Press 2012