Why Firms Become Multinational Enterprises - Literature review Example

Why Firms Become Multinational Enterprises Introduction The era of globalization has ushered a new drive for enterprises to expand into foreign countries. In order to explore the motives behind the internationalization of firms it is imperative to understand the concept of multinational firms. A firm would be considered as a multinational enterprise if it is incorporated in one country and has subsidiaries operating in other countries which means that these firms operates in more than one geographical location. The entire process of evolution of multinational companies can be divided into two broad periods (Tallman, 2004). The first one was the expansion of the companies from the developed countries and the second one which is currently evolving is the expansion of companies from the less developed countries. Dunning’s eclectic paradigm has become one of the strongest theoretical tools in explaining the process of internationalization of companies. The new wave of firms seeking international expansion from developing countries has created sufficient interest among researchers in the present times. Researchers have agreed that there are certain factors which motivate firms to expand namely a desire to expand their market, gain higher market share, government incentives, avoid trade barriers and reduced cost of labour (BBC News, 2014. The essay is divided into three main sections. The first section provides an understanding of the theoretical framework that motivates firms to expand into other markets, the second section provides empirical evidences of expansion of firms and the third section briefly summarizes the topic. Theoretical Framework The research work of Dunning (1988) had produced the OLI framework that had been widely accepted as the theoretical model for internationalization of firms. The OLI framework stands for ownership specific advantages, location specific advantages and advantages of internationalization. Dunning had explained ownership advantages as monopolistic advantages enjoyed by firms in the home country which allows them to expand to other countries. Location specific advantages on the other hand relates to the specific advantages that can be accomplished by shifting production to the host country. Dunning had identified that there are certain factors which are immobile and these are owned only by a specific country (Dunning, 1988). These factors can be low labour cost, high costs of shipping products and a local demand that can help the firms in acquiring a higher market share abroad. The final advantage is the internationalization factor and this refers to the fact that firms do not lose their creative control when they are expanding production to other countries. The main reason behind this factor is that firm believes if they transfer ownership advantages to other firms then it can lead to market failure (Dunning, 1988). Dunning’s eclectic paradigm has been modified a number of times depending on the market dynamics. The research of Tallman (2004) had shown that the paradigm developed by Dunning was a ground breaking one because it was the primary research that had separated the international business studies from the studies of international economics and trade. In another research conducted by Dunning (1993 cited in Dunning, 2000) he was successful in pointing out the main motives that made firms to take up foreign direct investment abroad. Four objectives have been discovered namely market seeking objective, efficiency seeking, objective of seeking strategic resource and finally a resource seeking objective. Most of the researchers working on the theory of internationalization of firms have shown that the expansion of markets is one of the very first motivations for a firm to expand production (Dunning, 2000). Older firms which are already operating in the foreign markets are highly motivated by the objectives of efficiency seeking and strategic resource seeking. The research of Karagozoglu and Lindell (1998) had pointed out that the main reason behind firms crossing national borders are host of opportunities that were present in the foreign market. Their research had also shown that when sales were particularly poor in the local markets firms had very few options other than to expand operations in the foreign markets. It has also been observed in case of small and medium sized enterprises that the key to improvement business was in signing up strategic partnerships and alliances with other firms abroad. The rationale behind this was that small and medium sized enterprises often lacked the resource of competing with larger firms by themselves as they did not have enough resources (Karagozoglu and Lindell, 1998). On the other hand having strategic partners in foreign soil was a prudent way of overcoming the shortcomings. In another research that was conducted by UNCTAD (1998) it was found that the macroeconomic situation, the efforts of the government in promoting investment and the regulatory framework of FDI rampant in the country are also factors that can encourage and discover firms to enter other countries. The role of information technology was also crucial in accelerating the pace of expansion of firms in the foreign countries. Researchers have also pointed out that the easier access to capital is one of the strongest factors that are driving the process of globalization of firms (UNCTAD, 1998). The role of the governments of countries is also crucial in helping firms to cross borders. Examples of foreign government aid includes provision of subsidized labour, removing barriers of trade and giving concessions of tax rates are popular methods of attracting foreign investments. The synthesis of the existing literature points out that there are a number of reasons for which firms relocate their production to other countries. This essay has filtered four of the most dominant factors after undertaking an extensive reading on the topic. The four factors are a desire to improve market share abroad, to reduce the costs of production by locating countries having cheap labour, to take the advantages provided by the foreign governments and economies of scale enjoyed by the firms when to chose to go global (BBC News, 2014). Empirical Evidences It has been well established that business enterprises face immense competition in their domestic markets after a certain period of time when the markets are saturated. The most common way in which companies achieve this goal is by exporting their products in the foreign markets. Once they have an understanding about the foreign markets they take up other measures like licensing and joint ventures in order to capture higher market share. For instance, Coca-Cola is one of the biggest multinational companies that had used this strategy to expand into foreign markets. The reason to relocate comes from factors like avoiding high transportation cost. Coca-Cola has different production units in different countries to ensure that the operations cost are minimized (Rugman and Verbeke, 2004). Most of the American companies have realized that about 90% of the population resides outside America and opportunity for expansion practically lies outside the continent. McDonald’s for instance had quickly realized that the domestic markets had become highly saturated as other major players like KFC and Burger King were seeking active expansion within the U.S. markets. Therefore, the desire to capture greater market share had allowed McDonalds to venture outside America. Researchers working on the concept of American branded fast foods had shown that exploitation of international markets was one of the key strategies employed by the fast food giants to diversify existing risks and escape the domestic market saturation (Moore, Fernie and Burt, 2000). Secondly, use of semi-skilled and unskilled labour force in the production process has a huge impact on the operating expenditure of firms. It has been observed that the manufacturing companies have a high tendency to use this type of a strategy when they want to reduce their costs of production. Labour costs constitute the maximum proportion of costs for manufacturing companies and they are very keen on reducing the labour costs. Biggest names in the apparel industries like Zara and Gap has been following this strategy ever since they considered foreign expansion (Dawson, Larke and Mukoyama, 2006). In a research that was conducted by Bruce and Daly (2006) it was pointed out that the fashion retailing industry is highly driven by factors like reduction of labour costs to maximize labour costs. Zara had been able to take the advantage of low labour costs by outsourcing their production to Asian countries like China where labour costs were relatively lower compared to other countries. Another example can be provided for the foreign based software companies. For instance, IBM a U.S. based multinational had realized that it can gain significant cost benefits by outsourcing its customer support services. IBM had outsourced its process of customer support to a Chinese programmer for which it had to pay only $12.50 per hour (Parker, 2005). The comparable age in the U.S. was $56 per hour which is considerably higher. It has been pointed out that outsourcing not only reduces the direct cost but also helps in the reduction of indirect costs. Labour subcontracting reduces the cost of human resource management for the company and resources are freed up for investment in more productive activities like research and development. Thirdly, there is no denying the fact that many companies choose to expand the foreign market because they are motivated by the actions of the government. Government of countries have a huge responsibility towards the well being of the population of the country. They have an incentive to attract the foreign companies which will be able to generate employment for the people in the country and foster economic growth. Foreign Direct Investment is one of the most popular methods that serve as a means to this end. Economists argue that government can provide incentive to private companies in three different ways namely fiscal measures, financial measures and non-financial measures (Czinkota and Ronkainen, 2012). Fiscal stimulus on the part of the government includes activities like provision of tax credits, tax breaks and deductions on capital expenditure. Financial incentives on the part of government involves activities like provision of land, guarantees and wage subsidies which attracts firms to shift production to countries which are offering these facilities (Czinkota and Ronkainen, 2012). Non financial help from the government includes activities like guaranteed purchases from the government, reduction of tariffs and import quotas in order to improve the profitability of the firms. The automobile industry in the Asian countries is one of the prime examples which show that the efforts by the government can be quite helpful. Companies like General Motors and Ford have signed contracts with the local companies as China had significantly reduced the trade barriers allowing them to enter. The effort of the Japanese government in the 60’s can also be considered as a major drive that had allowed the Japanese company to export abroad (Czinkota and Ronkainen, 2012). The government had considerably reduced the taxes that had provided a major incentive to these companies to take up production abroad. Companies like Toyota and Nissan had taken up this opportunity and had explored to the North American Market (Czinkota and Ronkainen, 2012). Governments of the developed countries like the U.S.A. and the U.K. have a number of export assistance centres that helps small and medium sized companies when they wish to venture into foreign markets ((Parker, 2005). Governments influence the motivation of the companies by using a wide variety of taxation techniques. These taxes have a huge impact on the economic activities by stimulating the foreign direct investment. These Tax incentives and rebates provided by the U.S. government like Foreign Sales Corporation provides a major incentive for firms to take up exports mainly by providing tax deferrals to the exporters (Bureau of Economic Analysis, 2006). The major advantage of this tax deferral is that it allows firms to significantly reduce the cost of production if they take up investments in foreign countries thereby improving the margin of overall profit. The U.S. government has also allowed multinational firms to claim the portion of foreign corporate tax that are paid by them to motivate them (Bureau of Economic Analysis, 2006). Developing countries like China are hugely attracting the U.K. and U.S. based firms by providing a less complicated tax structure. The country has a considerably lower environmental tax making it a major destination for European companies which are plagued by high environmental tax adding up to their production costs (Ernst & Young, 2006). Finally, the economies of scale that can be enjoyed from the expansion of multinational companies are also one of the biggest advantages fuelling their desire to venture into foreign soil. It has been observed that the cost per unit of production can be successfully brought down through specialization of jobs. Economies of scale come from a wide range of activities like production, marketing, distribution and management. Global firms can enjoy competitive advantage over their local counterparts by standardizing their process of production through a centrally managed corporate strategy. Researchers are also of the opinion that the strongest economies of scale can be obtained by relocating production to points which have a strong competitive advantage over other locations (Nuttall and Waters, 2004). There are numerous examples where multinational firms have been enjoying huge economies of scale. In a recent article published in the Financial Times it was reported that the largest internet based companies in the U.S. enjoy huge economies of scale over their counterpart who has only domestic production. For instance, companies like Amazon and E-bay have shown that the share of profits earned by them through foreign ventures is much higher compared to the revenue earned by their domestic operations. The chief rationale behind this expansion is the desire to utilize the information technology to tap scale economies. Internet based companies can easily sell the products without opening stores abroad allowing them to earn huge profits (Nuttall and Waters, 2004). Conclusion The existing study had shown that there may be multiple reasons for firms to consider investment in foreign countries and it is difficult to point to a singular factor per se. A comprehensive framework for the desire to venture abroad can be well explained through the work of Dunning. Later a variety of researchers have added their valuable insight to the topic. This study has highlighted that four of the most important factors that have caused firms to go multinational are saturation of domestic market and the desire to gain a higher market share; the availability of cheap labour and other immobile resources in the foreign oil; the various forms of government incentives provided to the companies to encourage them to take up exporting and finally the economies of scale that can be enjoyed by foreign expansion. The process of internationalization of most of the firms like Coca-Cola, McDonalds, Ford and more recently Amazon and E-bay can be well explained with the help of these motives. Though these factors are not mutually exclusive and there may be a variety of other factors, this study has limited itself to only these four factors and described them in details. All of these factors have been found to be extremely crucial in affecting the decision to venture outside home. Reference List BBC News, 2014. Multinational organisations. [online] Available at: [Accessed 10 January 2014]. Bruce, M. and Daly, L., 2006. Buyer behaviour for fast fashion. Journal of Fashion Marketing and Management, 10(3), pp.329-344. Bureau of Economic Analysis, 2006. Survey of current business. California: U.S. Department of Commerce. Czinkota, M. and Ronkainen, I., 2012. International marketing. Connecticut: Cengage Learning. Dawson, J., Larke, R. and Mukoyama, M. 2006. Strategic issues in international retailing. London: Routledge. Dunning, J.H., 1988. The eclectic paradigm of international production: a restatement and some possible extensions. Journal of International Business Studies, pp.1-31. Dunning, J.H., 2000. The eclectic paradigm as an envelope for economic and business theories of MNE activity. International Business Review, 9(2), pp.163-190. Ernst & Young, 2006. Tax implications of operating in China. [pdf] Ernst & Young. Available at: < https://www2.eycom.ch/publications/items/china/tax_implications/en.pdf> [Accessed 10 January 2014]. Karagozoglu, N. and Lindell, M., 1998. Internationalization of small and medium-sized technology-based firms: An exploratory study. Journal of Small Business Management, 36, pp.44-59. Moore, C.M., Fernie, J. and Burt, S., 2000. Brands without boundaries–the internationalisation of the designer retailer’s brand. European Journal of Marketing, 34(8), pp.919-937. Nuttall, C. and Waters, R., 2004. The biggest US internet companies enjoy huge economies of scale. Financial Times, [online] 10 June. Available at: [Accessed 10 January 2014]. Parker, B., 2005. Introduction to globalization and business: relationships and responsibilities. London: Sage. Rugman, A. M. and Verbeke, A., 2004. A perspective on regional and global strategies of multinational enterprises. Journal of International Business Studies, 35(1), 3-18. Tallman, S., 2004. John Dunning’s eclectic model and the beginnings of global strategy. Managing Multinationals in a Knowledge Economy: Economics, Culture and Human Resources. Advances in International Management, 15, pp.43-55. UNCTAD, 2006. World investment report. [pdf] United Nations Conference on Trade and Development. Available at: [Accessed 10 January 2014]. Read More