Why operate internationnally?

1. 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?

2. 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”

3. Why Operate Internationnally?2. Sell to Foreign Customers Two main strategies: • Arbitrage • Replication

4. Arbitrage vs. Replication • Arbitrage benefits from international heterogeneity • Replication benefits from international homogeneity

5. 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

6. Replication Exploit Scale Economies • Plant level • Firm level Exploit learning curve advantages Exploit relational investments: Follow the customer

7. 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)

8. AC2 AC1 average cost MES2 MES1 output/ time Economies of Scale

9. 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

11. Gillette’s Mach 3 • Highly automated, capital intensive process • Two factories worldwide • Sold in 100 countries within 18 months of launch

12. Barriers to the exploitation of plant-level scale economies (1) • Transportation costs • Government barriers • Tariffs and quotas • Standards and regulations • National preferences

13. 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

14. AC2 AC1 average cost MES2 MES1 output/ time Economies of Scale

15. 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

16. 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)

17. Cost of Original TV Programming as a Multiple Of Bought Programming Source: Screen Digest

18. Barriers to the exploitation of firm-level scale economies • Heterogeneous tastes • Government barriers • Management costs

19. 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

20. 0.30 0.25 0.20 Process time per unit (hr) Learning curve 0.15 0.10 Learning period Standard time 0.05 Cumulative units produced

21. average cost AC2 AC1 A MES2 MES1 output/ time Japan EU USA Economies of Scale

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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 Kraft Coffee Brands

28. 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

29. Global industries: airframes (2) • Factors hindering replication-based globalization are low • Homogeneous tastes • Low transportation costs • Low government barriers

30. 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)

31. 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)

32. Types of International Strategies Firm-level economies of scale = Need for coordination High Low Global (Multiplant) Global Multidomestic Global (export-based) Low High Plant-level Economies of scale = Need for configuration

33. 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

34. Scale economies in oil refining, 1880-1900

35. 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

36. Transport and communication costs1930=100, 1990 dollars Source: Institute for International Economics

37. 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

38. Transport costsRevenue per ton mile, cents* 10 8 Air freight Rail 6 4 Barge (inland waterways) 2 0 *Revenue used as a proxy for prices; adjusted for inflation Source: McKinsey Global Institute

39. Telecom costs $’000 per year† for two Mbps fibre leased line, half circuit‡ India Philippines United States Ireland †January figures ‡International leased line for India; long-distance domestic leased line in the US Source: McKinsey Global Institute

40. Decline in industrial tariff rates Countries’ tariffs Average tariffs, % Sources: Centre for International Economics; GATT; IMF

41. 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

42. 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

43. Replication Strategies (1) • Increase plant and firm-level scale economies • Decrease factors that hinder globalization • transportation cost • taste differences • government barriers

44. Replication Strategies (2) • Caterpillar • L. M. Ericsson • Honda Motorcycles • Ikea

45. Factors Impeding Globalization labour intensive production process high transportation costs of assembled furniture heterogeneous tastes IKEA’s Response capital intensive production of standard components assembled by customer ship components in flat packs carried and assembled by customer modern design; low cost IKEA’s Strategy of Replication

46. 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

47. Arbitrage strategies Discover and exploit international differences in culture, administrative infrastructure, and factor costs

48. Most firms marry arbitrage and replication Create global brand and source from lowest cost location e.g. Acer, Dell

49. 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

50. Conclusions (2) • International activities are based on arbitrage and replication • Arbitrage benefits from international heterogeneity • Replication benefits from international homogeneity