Various reasons for the emergence of multinational firms:

SEARCH FOR RAW MATERIALS. Some firms become MNCs to exploit the raw materials that can be found overseas, such as oil, coal, minerals, and other natural resources.

MARKET SEEKING. Some firms become MNCs to exploit foreign markets for their products. Since the same product may be demanded in different countries, MNCs not only take advantage of the marketing opportunities, but also gain from the economies of scale obtained by selling large volumes across different foreign markets.

COST MINIMIZATION. Companies also become MNCs to seek out lower-production-cost sites. Specific skills needed for production may be available at lower costs in some countries, and MNCs may locate plants specializing in specific aspects of production, such as assembly or fabrication, in those countries.

KNOWLEDGE SEEKING. Some firms enter foreign markets to gain information and experience that are expected to prove useful elsewhere. Especially in industries characterized by rapid product innovation and technical breakthroughs, firms obtain technical product and process knowledge, which they leverage in other countries.

KEEPING DOMESTIC CUSTOMERS. Suppliers of goods or services to MNCs often follow their customers abroad to guarantee them a continuing product flow. In the process, these firms also become MNCs.

EXPLOITING FINANCIAL MARKET IMPERFECTIONS. Companies may find it advantageous to reduce taxes and circumvent currency controls when operating in multiple foreign markets. Doing so enables them to obtain greater project cash flows and lower costs of funds compared to a purely domestic firm.

Various ways in which domestic firms enter international markets:

Entry Benefits Risks

Exporting Minimal capital requirements and start-up costs

Risk is low Profits are immediate Learn about present and future supply

and demand, competition, distribution channels, payment conventions, financial institutions, and financial techniques in host country

Relatively low risk compared to other entry strategies

Full sales potential of the product is not realized

Foreign importer is in greater control of marketing, and thus the image, of the firm’s branded products in the foreign country

Licensing Minimal investment requirements Faster market-entry time Fewer financial and legal risks

Cash flow is relatively low May be problems in maintaining

product quality standards Foreign licensee may engage in

unauthorized exports of the firm’s products, resulting in loss of future revenues for the licensing firm

Foreign licensee may become a strong competitor when license agreement ends

Overseas The firm can more easily stay abreast Tremendous capital and top

Production of market developments, adapt its products and production schedules to changing local tastes and conditions, fill orders faster, and provide more comprehensive after-sales service

Firm can exploit local skills, including R&D

Signals a greater commitment to the local market, which in turn increases sales and assurance of supply stability

management commitment is required Financial and operational risks are

greater than those for other entry strategies

Companies face greater political risks, including the risk of expropriation of plants and facilities

Factors that help determine whether a firm will export its output, license foreign companies to manufacture its products, or set up its own production or service facilities abroad:

i) PRODUCTION ECONOMIES OF SCALE. If these are important, then exporting might be appropriate.

ii) TRADE BARRIERS. Companies that might otherwise export to a market may be forced by regulations to produce abroad, either in a wholly owned operation, a joint venture, or through a licensing arrangement with a local manufacturer.

iii) TRANSPORTATION COSTS. These have the same effect as trade barriers. The more expensive it is to ship a product to a market, the more likely it is that local production will take place.

iv) SIZE OF THE FOREIGN MARKET. The larger the local market, the more likely local production will take place, particularly if significant production economies of scale exist. Conversely, with smaller markets, exporting is more likely to take place.

v) PRODUCTION COSTS. The real exchange rate, wage rates, and other cost factors will also play a part in determining whether exporting or local production takes place.

vi) INTANGIBLE CAPITAL. If the MNC’s intangible capital is embodied in the form of products, exporting will generally be preferred. If intangible capital takes the form of specific product or process technologies that can be written down and transmitted objectively, foreign expansion will usually take the licensing route. If intangible capital takes the form of organizational skills that are inseparable from the firm itself, then the firm is likely to expand overseas via direct investment.

vii) NECESSITY OF A FOREIGN MARKET PRESENCE. By investing in fixed assets abroad, companies can demonstrate to local customers their commitment to the market. This can enhance sales prospects.