Why operate internationnally?
• Why are some firms more active
internationnally than others?
• What are the costs and benefits of
being internationnally active?
• Why do we see more and more firms
active internationnally?
• Is the trend towards greater
internationalization likely to continue?
Why Operate Internationnally?
1. Compete with Foreign Firms in
one own’s country
• Get domestic prestige from selling
abroad
• Learn about world class products
and processes
• “Exchange of Hostages”
Why Operate Internationnally?
2. Sell to Foreign Customers
Two main strategies:
• Arbitrage
• Replication
Arbitrage vs. Replication
• Arbitrage benefits from
international heterogeneity
• Replication benefits from
international homogeneity
Arbitrage
• = take advantage of international
differences in
• availability of factors (including culture and
administrative infrastructure)
• relative cost of factors (Comparative
advantage)
labor
capital
natural resources
Replication
Exploit Scale Economies
– Plant level
– Firm level
Exploit learning curve advantages
Exploit relational investments: Follow
the customer
Replication: Scale Economies
• Relationship between volume of
production per unit of time and average
cost of production
• Driven by fixed costs
• The higher fixed cost, the higher the
volume of output for which costs are
the lowest (the Minimum Efficient
Scale)
average
cost
AC2
AC1
MES2
MES1
Economies of Scale
output/
time
Plant-level scale economies
• The higher a plant’s fixed cost, the higher
its minimum efficient scale (MES)
• The higher a plant’s MES, the lower its
costs at MES ouput
• The higher a plant’s MES, the lower the
number of plants necessary to serve the
market
• plant level scale economies are exploited
internationally through exports
Gillette’s Mach 3
• Highly automated, capital intensive
process
• Two factories worldwide
• Sold in 100 countries within 18
months of launch
Barriers to the exploitation of
plant-level scale economies (1)
• Transportation costs
• Government barriers
– Tariffs and quotas
– Standards and regulations
– National preferences
Barriers to the exploitation of
plant-level scale economies (2)
•
•
•
•
•
•
•
Heterogeneous tastes due to
environmental differences
social differences
economic differences
Risk of concentrating production
political risk
foreign exchange risk
average
cost
AC2
AC1
MES2
MES1
Economies of Scale
output/
time
Firm-level scale economies
• Due to high fixed cost of intangibles
• R&D, experience, know-how, reputation
• The higher the investment, the higher the
firm’s MES
• The higher the firm’s MES, the higher the
return on investment in intangibles
• Firm-level scale economies are compatible
with multiplant operation
Gillette’s Mach 3
• 6 years of R&D
• >$1b investment ($750m for R&D, $300m
for launch)
• sold in 100 countries within 18 months (5
years for Sensor)
Cost of Original TV Programming as a Multiple Of Bought Programming
0
Ireland (RTE)
Germany (ARD)
Denmark (DR)
Italy (RAI)
Britain (ITV)
Germany (ZDF)
Britain (BBC)
France (France 2)
Spain (RTVE)
Britain (BSkyB)　Source: Screen Digest
2
4
6
8
Barriers to the exploitation of
firm-level scale economies
• Heterogeneous tastes
• Government barriers
• Management costs
Economies of scale
• Applicable to services as well as
manufacturing
• Different activities in the value chain have
different MES (ex: hotel management vs.
reservation system)
• subcontracting, franchising, alliances and
joint ventures
Process time per unit (hr)
0.30
0.25
0.20
Learning curve
0.15
0.10
Learning period
Standard time
0.05
0,00
0
50
100
150
200
Cumulative units produced
250
300
average
cost
AC2
AC1
MES2
USA
A
MES1
Japan
Economies of Scale
EU
output/
time
Scale economies and global
competition (1)
• Firms expand abroad when MES is larger
than domestic market
• plant-level scale economies = exports
• firm-level scale economies = foreign
production and/or exports
• When MES is large relative to the size of
the domestic market, expanding abroad
lower costs
Scale economies and global
competition (2)
• A firm should sell abroad if its MES is
large relative to its domestic market
• a firm can be large but remain
domestic if its home market is large
• a firm can be small but international if
it operates in a niche market
Scale economies and global competition (3)
• A firm’s level of globalization results from
the interplay between its scale economies
and the barriers to their exploitation
Keeping barriers to exploitation constant…
• Small plant and/or firm scale economies:
local
• Medium plant and/or firm scale economies:
multidomestic
• High plant and/or firm scale economies:
global
Local Industries: beauty salons
• Factors pushing for replication-based
globalization are low
• Very low plant-level scale economies
• Very low firm-level scale economies
• Factors hindering replication-based
globalization are high
• Heterogeneous tastes
• High transportation costs
Multidomestic industries: coffee
• Factors pushing for replication-based
globalization are medium low
• Low firm-level scale economies
• Low plant-level scale economies
• Factors hindering replication-based
globalization are medium high
• Heterogeneous tastes
• High transportation costs
Kraft Coffee Brands
•
•
•
•
•
•
•
•
United States
Canada
France
Scandinavia
Italy
Germany
U.K.
Japan
•
•
•
•
•
•
•
•
Maxwell House, Sanka, Yuban
Maxwell House, Sanka, Nabob
J.Vabre, Grand’Mere, Carte Noire
Gevalia
Splendid
Jacobs, Jacobs Kronung, Onko, HAG
Maxwell House, Kenco, HAG
Blendy, Maxim
Global industries: airframes (1)
• Factors pushing for replication-based
globalization are very high
• High plant-level economies of scale
• High firm level economies of scale
• Steep experience curve
• Benefits to global reputation
• Need for worldwide service
Global industries: airframes (2)
• Factors hindering replication-based
globalization are low
• Homogeneous tastes
• Low transportation costs
• Low government barriers
Scale economies and global
competition (4)
• Plant-level and firm-level scale economies
are drivers of globalization
• plant- level scale economies lead to tight
configuration (few plants export worldwide)
• Firm-level scale economies lead to tight
coordination (many plants but coordinated
strategy)
• Tight configuration maximizes plant-level
scale economies (e.g. Boeing)
• Tight coordination maximizes firm-level
scale economies
• speed of introduction to recoup R&D
• global coverage to discourage imitation
• to safeguard reputation (consistency in
quality and marketing)
Types of International Strategies
Firm-level
economies of
scale
High
=
Need for
coordination
Global
(Multiplant)
Global
Multidomestic
Global
(export-based)
Low
Low
High
Plant-level Economies of scale
=
Need for configuration
History of globalization (1)
• US: 1860-1910: from regional to national
• railroads and telegraph: transportation and
communication costs fall, tastes
homogenized
• no government barriers
• larger markets = higher fixed costs = higher
MES = larger firms, expand abroad
Scale economies in oil refining,
1880-1900
Before
After
rationalization rationalization
Refinery
Throughput
1500-2000
5000-6500
Price
(c/gallon)
1.5
0.45
History of globalization (2)
• The Great Depression
• Post WWII: from national to global
• Jet airplane, telephone, TV, global media =
lower communication costs, homogenized
tastes
• containers, megaships = lower
transportation costs
• lower tariffs
Transport and communication costs
1930=100, 1990 dollars
120
100
80
Average ocean-freight and port
charges per short ton of cargo
60
Average air-transport cost per
passenger mile
40
Cost of three-minute telephone
call New York to London
20
0
1930
40
50
60
70
Source: Institute for International Economics
80
90
Post WWII
• Increased plant MES
• (MES of cars x 3 between 1960 and
1975)
• Increased scale of innovation
• (average cost of developing drug x 4)
• Result: globalization of firms through
exports and foreign production
Transport costs
Revenue per ton mile, cents*
10
100
8
80
Air freight
Rail
6
60
4
40
2
Barge
(inland waterways)
20
0
0
1980
85
*Revenue used as a proxy for prices; adjusted for inflation
Source: McKinsey Global Institute
90
95
99
Telecom costs
$’000 per year† for two Mbps fibre leased line, half circuit‡
1.000
750
India
500
Philippines
250
United States
Ireland
0
1996
1997
†January
1998
1999
figures ‡International leased line for India; long-distance
domestic leased line in the US
Source: McKinsey Global Institute
2000
2001
Decline in industrial tariff rates
Countries’ tariffs
Average tariffs, %
50
40
30
20
10
0
1940
50
60
Sources: Centre for International Economics; GATT; IMF
70
80
90
2000
Future of Arbitrage
Reduction in transportation costs
dissociates locus of production
from that of consumption
Reduction in telecom costs will lead
to dramatic increase in outsourcing
of services
Future of Replication
•
•
•
•
•
•
•
•
Factors pushing for globalization
Plant level scale economies
Firm level scale economies
Factors hindering globalization
Communication costs
Transportation costs
Government barriers
Globalization backlash
Replication Strategies (1)
• Increase plant and firm-level scale
economies
• Decrease factors that hinder globalization
• transportation cost
• taste differences
• government barriers
Replication Strategies (2)
•
•
•
•
Caterpillar
L. M. Ericsson
Honda Motorcycles
Ikea
IKEA’s Strategy of Replication
• Factors Impeding
Globalization
• IKEA’s Response
– labour intensive
production process
– capital intensive production
of standard components
assembled by customer
– high transportation
costs of assembled
furniture
– ship components in flat
packs carried and
assembled by customer
– heterogeneous tastes
– modern design; low cost
Destruction of Replication
• Demand increases caused by MNE
sales of standard products makes it
economical to produce local
variants
• Local producers are better able to
produce these variants
Arbitrage strategies
Discover and exploit
international differences in
culture, administrative
infrastructure, and factor costs
Most firms marry arbitrage and
replication
Create global brand and source from
lowest cost location
e.g. Acer, Dell
Conclusions (1)
• Level of globalization is net result
of factors pushing for and factors
hindering it
• Varies across industries
• Given the added cost of operating
abroad, not all firms should be
global
Conclusions (2)
• International activities are based on
arbitrage and replication
• Arbitrage benefits from international
heterogeneity
• Replication benefits from international
homogeneity
Conclusions (3)
• A firm can pursue successful replication by
increasing firm and plant scale economies
and decreasing the factors hindering
globalization
• There is often a high payoff from being the
first entrant in a new global industry