Chapter 1

Introduction: Multinational Enterprise and Multinational Financial Management

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Chapter 1 Outline

A. Catalysts for Globalization

B. Implications of Globalization for Businesses

C. Consequences of Globalization

D. Multinational Corporations

E. Rational for Multinational Corporations

F. Process of Overseas Expansion by Multinationals

G. Appendix

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1.A Catalysts for Globalization

Massive deregulation

Collapse of Communism

Worldwide sale of state-owned firms in privatizations

Revolution in information technologies

Rise in the market for corporate control

Replacement of statist policies by free-market policies in many Third-World economies

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1.B Implications of Globalization for Businesses

Companies must be able to quickly adapt their policies to respond to new global market opportunities and challenges.

The international mobility of capital has provided more financial options while simultaneously increasing complexity.

Global managers need in-depth knowledge of their operations.

– How their products are made

– Their supply chain, alternatives

– Where the funds come from

– How their changing relative values affect the bottom line.

Global managers must understand the political and economic choices facing key nations and how those choices affect the outcomes of their decisions.

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1.C Consequences of Globalization

The global rationalization of production is driven by global competition.

Free trade allocates resources to their highest valued use.

Globalization fosters creative destruction – continuous change-out with the old, in with the new; i.e.:

– Some industries advance, others recede;

– Jobs are gained and lost;

– Businesses boom and go bust; and

– Some workers must change jobs and occupations.

Consumers benefit from lower prices and expanded choices.

Globalization enables nations to get richer together (i.e., expands the economic pie for all parties).

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1.D Multinational Corporations

Multinational corporations (MNCs) produce and sell goods or services in more than one country.

MNCs emphasize group performance over performance of individual parts.

ForeignSubsidiary 1

ForeignSubsidiary 2

ForeignSubsidiary 3

ForeignSubsidiary 4

ForeignSubsidiary 5

MNCHome Country

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.

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High degree of strategic interaction

What differentiates MNCs from other firms engaged in international business is the globally coordinated allocation of resources by a single centralized management.

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1.E Rationale for MNCs (1)

The classical theory of international trade based on comparative advantage states that

– Each nation should specialize in the production and export of those goods it can produce with the highest relative efficiency and import those goods that other nations can produce relatively more efficiently; and

– Goods and services can move internationally but factors of production, i.e., land, labor, and capital, are relatively immobile.

This theory is becoming increasingly irrelevant as differences among corporations are becoming more important than aggregate differences among countries and countries move their factors of production more rapidly in search of higher returns.

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1.E Rationale for MNCs (2)

The role of natural resources has diminished in national specialization as advanced, knowledge-based societies move rapidly toward artificial materials and genetic engineering.

Capital moves instantaneously around the world.

Labor skills are no longer fundamentally different – i.e., many foreign students attend American universities.

Technology and know-how are rapidly becoming a global pool.

The ability of MNCs to use these globally available factors of production fosters international competitiveness to a far greater degree than macroeconomic differences among countries.

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1.E Rationale for MNCs (3)

Search for raw materials – MNCs aim to exploit raw materials found in foreign countries.

Market Seeking

– MNCs’ firm-specific advantages can be profitably applied to foreign markets.

• Products/processes

• Technologies

• Patents

• Specific rights, knowledge, and skills

– Exploitation of foreign markets may be possible at considerably lower costs.

– Foreign markets provide opportunities for MNCs to achieve economies of scale and exploit premiums associated with strong brand names.

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1.E Rationale for MNCs (4)

Cost Minimization. Costs can be minimized by combining production shifts with rationalization and integration of the firm’s global manufacturing facilities; i.e., plants specialize in different stages of production.

Knowledge Seeking. Some firms enter foreign markets to gain information and experience to use in other markets.

Keeping Domestic Customers. MNC suppliers follow customers abroad to guarantee them a continuing product flow and reduce the risk that their customers will find an alternative local supplier.

Exploiting Financial Market Imperfections. Operating in numerous countries with different economic cycles reduces systematic risk and risk relating to exchange rate fluctuations, currency controls, expropriation, and other foreign government interventions (“diversification effect”).

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1.F Process of Overseas Expansion by MNCs (1)

Firms become MNCs by degree – globalization does not initially occur through conscious design but is the inevitable outcome of the competitive pressures in oligopolistic industries.

Typical sequence of transitioning from a domestic firm to an MNC

1. Exporting

2. Setting up a foreign sales subsidiary

3. Securing license agreements

4. Establishing foreign production

Each sequence enables firms to move from a low-risk, low-return export strategy to a higher-risk, higher-return strategy emphasizing international production.

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1.F Process of Overseas Expansion by MNCs (2)

1. Exporting

– Advantages

• Low capital requirements and start-up costs

• Low risk

• Immediate profits

• Firms learn about present and future market conditions, local competition, distribution channels, payment conventions, financial institutions, and financial techniques.

– Disadvantages

• Inability to realize full sales potential

– As increased communication with customers reduces uncertainty, the firm might establish its own sales subsidiary.

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1.F Process of Overseas Expansion by MNCs (3)

2. Overseas Production – Advantages

• Keep abreast of market conditions and adapt products to changing local tastes and conditions

• Faster order fulfillment

• Ability to provide more comprehensive after-sales service

• Conveys commitment to local market

• Ensures certainty of supply

– Key Decision – Create own affiliate or acquire going concern

• Acquisition: Speedy transfer of parent skills, ready-made marketing network, and local market/technology knowledge; but may be more costly than creating affiliate.

– Generally, the larger and more experienced the firm, the less it relies on acquisitions.

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1.F Process of Overseas Expansion by MNCs (4)

3. Licensing – alternative or precursor to overseas production

– Advantages

• Minimal investment

• Faster market-entry time

• Fewer financial and legal risks

– Disadvantages

• Cash flow relatively low

• Risk of product quality problems

• Difficulty controlling exports by the licensee; licensee may become a competitor

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1.F Process of Overseas Expansion by MNCs (5)

General circumstances that drive selection of mode of overseas expansion

– If MNC’s intangible capital

• Can be incorporated into standardized products: Export

• Is a product/process technology that can be codified: License

• Is organizational capital that is not easily separable from the firm: Establish overseas production IF the benefits of circumventing market imperfections outweigh the costs of central control.

– Types of overseas investment

• Vertical integration

• Horizontal integration

Dear IFM students,

IFM Test 1 will be conducted on Monday, 2 July 2012 from 8.30 - 10.30 pm at Test Room, Block N.

There will be 9 Questions but as usual after counting all the details, it totalled up to 38 questions that you have to answer.

Question 1 is MCQs with 20 questions. 5 nos questions are stand alone and 3 nos. questions have 4 to 5 sub-questions.

The pattern of the questions are the same that is comprehension, application and calculation.

Comprehension is on your understanding about the subject matter, application is on your ability to use

your understanding to reason or argue your point on cases presented and calculation. Even though there seem to

be a lot of comprehension and application question, if you can do your calculation good and the MCQs, you

will have ample time to write a good answer on the comprehension and application.

Area to be focused on (Chapters 1 - 4)::

the rise of multinationals and why they go global

theory of comparative and competitive advantage

global competition and challenges to corporation

factors affecting exchange rate

foreign exchange market intervention

history of international monetary system

arbitrage and the law of one

mechanism to establish exchange rate

Theoretical relationship of spot rate, inflation, exchange rate and interest rate particularly on PPP ans Fisher Effect

techniques of currency forecasting

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