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)laborcapitalnatural 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)

AC2

AC1

average cost

output/ time

MES1MES2

Economies of Scale

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

AC2

AC1

average cost

output/ time

MES1MES2

Economies of Scale

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)

0 2 4 6 8

Britain (BSkyB)　

Spain (RTVE)

France (France 2)

Britain (BBC)

Germany (ZDF)

Britain (ITV)

Italy (RAI)

Denmark (DR)

Germany (ARD)

Ireland (RTE)

Cost of Original TV Programming as a Multiple Of Bought Programming

Source: Screen Digest　　　　　　　　　　　　　　　

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

0,00

0 50 100 150 200 250 300

0.30

0.25

0.20

0.15

0.10

0.05

Learning curve

Learning periodStandard time

Pro

cess

tim

e pe

r un

it (h

r)

Cumulative units produced

AC1

average cost

output/ time

MES1MES2

USA Japan EU

A

Economies of Scale

AC2

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

=

Need for coordination

High

Low

Plant-level Economies of scale

=

Need for configuration

Low High

Global

(export-based)

Multidomestic

GlobalGlobal

(Multiplant)

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 rationalization

After 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 costs1930=100, 1990 dollars

0

20

40

60

80

100

120

1930 40 50 60 70 80 90

Average ocean-freight and portcharges per short ton of cargo

Average air-transport cost perpassenger mile

Cost of three-minute telephonecall New York to London

Source: Institute for International Economics

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 costsRevenue per ton mile, cents*

1980 85 90 95 990

20

40

60

80

100

Air freight

Rail

*Revenue used as a proxy for prices; adjusted for inflation

Source: McKinsey Global Institute

Barge(inland waterways)

2

4

6

8

0

10

Telecom costs

1996 1997 1998 1999 2000 20010

250

500

750

1.000

United States Ireland

Philippines

India

$’000 per year† for two Mbps fibre leased line, half circuit‡

†January figures ‡International leased line for India; long-distance domestic leased line in the US

Source: McKinsey Global Institute

Decline in industrial tariff rates

0

10

20

30

40

50

1940 50 60 70 80 90 2000

Countries’ tariffs

Average tariffs, %

Sources: Centre for International Economics; GATT; IMF

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– 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

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