Why Do Firms Become Multinational Enterprises?

Why Do Firms Become Multinational Enterprises?

A multinational enterprise (hereafter ME) is a firm that engages directly in investment activities overseas by establishing subsidiaries or affiliates in the host country (Krist 2009, p. 4). The ME produces goods and services for sale as finished or intermediate products to different markets within and/or outside the host country. An example of a multinational is Toyota, which has affiliates in different countries to serve various purposes in the production process including design, component production and assembly. Other multinationals have standardized production processes that are replicated by subsidiaries in different countries. An example is Coca-Cola.  The paper discusses the motivations behind a firm’s decision to go multinational. Since firms are for-profit organizations, their motivations to engage in foreign investment contribute directly or indirectly to increasing sales and returns.

Motivations for Firms to Go Multinational

The primary motivations behind multinational enterprise activity include market seeking, resource diversification, efficiency seeking and strategic asset seeking (Castellani, & Zanfei 2006, p. 13). The bulk of this paper will consist of a detailed analysis of each of these four motivations. However, it should be noted that not every ME strictly falls into either of these motives. Large MEs often pursue two or more of the four major motivations. In addition, ME activity may be described as aggressive (when the ME invests purely to achieve its strategic goals) or defensive (when the ME invests in response to its competitors’ actions or to adapt to changes in the regulatory environment) (Dunning & Lundan 2008, p. 68). Moreover, a ME may change its objectives upon gaining foothold in foreign investment business. Primarily, firms go multinational to expand their markets and resource base. However, as their multinational activity increases, they may focus more on consolidating their position in the global market by improving efficiency and competitive edge.

Market Expansion

Firms that engage in foreign investment mainly to expand their customer base by penetrating new markets are classified as market seekers. More often than not, the market seeking ME pursues local production in markets it previously serviced through exports (Urata, Yue & Kimura 2006, p. 7). Local production may prove to be more profitable than exporting because it cuts down cost-barriers such as transportation and import tariffs in the destination countries. In some cases, a firm my still retain its export activity but relocate its production country to render exportation more profitable and convenient (Beugelsdijk et al. 2013, chap. 3). In fact, most multinational enterprises were initially exporting their products to the countries in which they eventually established subsidiaries. Not only do MEs invest in foreign countries to find new markets, but also to protect or sustain existing markets.

While the promise of a larger market remains the primary motive of market seeking ME activity, several other objectives may drive firms into market seeking foreign investment. First, an ME whose customers or suppliers go multinational will have to follow suit to keep up with the customers’ demands and benefit more from suppliers (Dunning & Lundan 2008, p. 70). This explains why many Japanese auto-component firms set up branches in the United States to supply locally to Japanese auto assembly firms. Similarly, hundreds of thousands of mergers and acquisition deals involving law, advertising, accounting and other service firms have been completed since the 1990s as these firms attempt to draw near their clients and strengthen their positions in the global market scene (Dunning & Lundan 2008, p. 70). Dunning & Lundan (2008) observes that the service sector has been more vibrant than the manufacturing industry in terms of engagement in international mergers and acquisitions aimed at increasing client base and securing strategic market advantage.

Second, market-seeking firms establish subsidiaries in foreign markets to enable them to incorporate the needs of local customers in product design and customer relations (Dunning & Lundan 2008, p. 70). Insensitivity to the cultures, needs and preferences of potential customers can limit product’s penetration into a foreign market. In addition, the firm must familiarize itself with local language, legal environment, and business customs in the host country in order to compete fairly with local firms especially if the firm deals in consumer goods such as electronics, cosmetics, cleaning equipment, food and beverages, as well as intermediate products such as petrochemicals, construction equipment, and financial services. Cultural factors explain the success of Spanish firms in Latin America (Cassanova 2004, p. 14). The best way to achieve such familiarity and gain competitive advantage over local firms is to establish subsidiaries in the host country and adjust production processes and products to local needs and preferences.

Third, market seekers establish subsidiaries in foreign markets to cut down costs incurred in supplying their products through other routes. While it may not be the case for all countries, establishing production facilities in the host country can substantially cut down on transaction and production costs (Franco, Rentocchini & Marzetti 2008, p. 5). For example, goods that are economical to produce in small scale but are expensive to transport can be produced more profitably in close proximity to the target market rather than be exported.  In contrast, firms might find it more profitable to export goods that are cheaper to transport and can be produced economically rather than engage in local production in the destination country.

Furthermore, Proximity to major markets seems to influence market seeking foreign investment behavior. Firms that are geographically far from the main markets are more likely to engage in market seeking ME activity. For example, United States firms have more subsidiaries in Germany than French firms (Dunning & Lundan 2008, p. 69). Other factors including government regulations and trade policies can influence ME market-seeking activity. For example, favorable political relations between Japan and the United states in the 1980s profited telecommunication firms based in the United States, which prompted Northern Telecom, a Canadian firm, to establish subsidiaries in the United States in order to supply telecommunication equipment to Japan.

Another reason for engaging in market seeking ME activity is competition. Large MEs such as oil producers, auto companies, rubber producers and advertising firms often establish local facilities in major market centers globally to compete fairly and gain strategic market advantage (Kudina & Jakubiak 2008, p. 4). Such ME activity may be aggressive or defensive depending on whether it is influenced by customer behavior or competitor behavior. For instance, the opening up of China for foreign investment has attracted many investors some of which are pursuing customers while others are responding to the actions of their top competitors (Luo & Park 2001, p. 142).

To Gain Access to Natural Resources

Some firms engage in ME activity to obtain cheaper and higher quality natural resources that may or may not be available at their home countries under such circumstances. Such firms are convinced that investing in a foreign country that has the required natural resources would be more profitable than operating from the home country (Urata, Yue & Kimura 2006, p. 195). Most resource-seeking firms produce intermediate or finished goods for export in developed countries and thus their main concern is the location of raw materials. Resource-seekers fall into three main categories. The first category includes those interested in physical resources such as manufacturing firms (Dunning & Lundan 2008, p. 68). Their main motive is to minimize production costs and acquire reliable sources of raw materials. MEs in this category include oil, natural gas and coal dealers, metal fabricators, and food manufacturers. Examples of this kind of investors include Indian and Chinese companies involved in mining, oil extraction, tourism, education, and medical services provision in Africa. This type of resource-seeking investment is capital intensive and is limited to a specific physical location.

The second category of resource-seekers consists of firms that engage in labor-intensive investments and thus are in need of large sources of cheap labor, mainly semi-skilled and unskilled (Dunning & Lundan 2008, p. 69). Service firms and manufacturing companies in countries where labor is costly normally prefer to establish local production facilities in countries with cheaper and plentiful labor supply where they produce intermediate or finished products for sale abroad. Labor seeking ME activity is high in developing countries such as Malaysia, Mexico, Eastern and Central Europe. Due to rising labor costs however, labor-intensive ME activity has been shifting to other areas including China, Morocco, Vietnam and Mauritius (Dunning & Lundan 2008, p.70). Policies such as the establishment of export processing zones are aimed at attracting labor-intensive foreign investment. India, for example, has attracted labor-intensive telecommunication services in the recent past leading to the establishment of many call centers across the country.

The third group of resource-seekers includes firms that need to obtain specific technologies and expertise in various areas of commercial interest such as marketing and management (Franco, Rentocchini & Marzetti 2008, p. 6). In most cases, this form of resource seeking involves collaboration among firms in the production and application of advanced technologies and products requiring specialized knowledge and skill. For example, Taiwanese and Korean firms have formed alliances with firms in the United States and the United Kingdom in financial and information technology sectors ((Dunning & Lundan 2008, p. 69). Similarly, Chemical firms in the UK have subsidiaries in Japan to enable collaboration in high-tech research and development. The intensity of these different forms of resource-seeking activities is ever changing because of government policy, labor factors and the overall business environment. For instance, governments that nationalize primary sectors such as oil and metal production reduce capital-intensive resource-seeking investment in their countries. In addition, manufacturing activities are now becoming less-labor intensive due to the development of advanced technology, leading to the decline in labor-intensive ME activity. However, MEs’ interest in acquiring high technology, knowledge and expertise in various fields especially management has grown significantly. Firms in both developing and developing countries are engaging substantially in knowledge seeking ME activity (Kedia, Gaffney & Clampit 2012, p. 156).

To Improve Efficiency and Maximize Profits

Some firms engage in ME activity to improve efficiency. In other words, these firms are interested in restructuring their market and resource investments to maximize profits and retain strategic market advantage (Kudina & Jakubiak 2008, p. 4). Efficiency seekers tend to be large MEs that have already engaged in resource and market-seeking activities and thus enjoy the economies of scale. In addition, such MEs already have experience in doing business in different environments and cultures, and have experimented with various cost reduction, pricing and marketing strategies. Efficiency seekers aim at maintaining a limited number of subsidiaries while harnessing the various factors of production including demand, market structures, cultural factors, government and institutional factors to supply their products and services to multiple markets effectively. In most cases, firms seeking efficiency are large and well-established, and provide relatively standardized goods according to internationally recognized methods (Dunning & Lundan 2008, p. 72). Traditionally, firms would postpone efficiency seeking until they meet their market and resource seeking goals. However, newer MEs based in Korea, Japan and India are entering into foreign investment with efficiency goals as a priority. Such companies adopt a product-by-product efficiency strategy rather than a holistic approach. Since efficiency improvement is dependent on a clear understanding of all relevant market factors, MEs can only pursue efficiency effectively if the markets are open and well integrated. In fact, MEs are highly efficient in highly integrated markets.

Efficiency seeking ME activities are of two main types. The fist type includes strategies aimed at maximizing production based on country specific cost and resource factors (Dunning & Lundan 2008, p. 72). MEs locate their subsidiaries based on resource availability and the relative cost of production in different countries. As a result, production activities with high capital, information and technology demands are located in developed countries where these resources are readily available while activities requiring relatively cheap labor and a high volume of natural resources are located in developing countries. The second form of efficiency-seeking activities is that aimed at maximizing the benefits of large-scale production in large well-integrated markets where resource endowment offers insignificant market advantage. In such as scenario, MEs focus on improving their sensitivity to customer preferences, capability for large-scale supply, compliance with relevant authorities, and the effectiveness of supporting institutions.

To Acquire Strategic Assets and Strategic Position in the Market

Another reason for firms to go multinational is so they can acquire strategic advantage and the critical assets they need to achieve specific long-term goals such as competitive advantage and sustainability. New firms that are attempting to enter in the international markets as well as existing MEs engage in strategic asset-seeking activities (Pradhan 2010, p. 9). Most firms acquire strategic assets to expand their assets inventory and human capital, thus boosting their ownership advantages and strength against their competitors. These firms also engage in efficiency seeking as they redistribute their assets to achieve various objectives. Firms located in both developing and developed worlds demonstrate asset-seeking behavior. Examples include the purchase of IBM’s PC (American ME) and Corus (a UK company) by Lenovo (a Chinese company) and Tata (an Indian company) in 2005 and 2007 respectively (Dunning & Lundan 2008, p. 73). Asset-seekers are similar to efficiency-seekers because they aim at capitalizing on gains associated with owning diversified resources within a given market or similar resources in different markets. The acquiring company may not interrupt the day-to-day operations of the acquired facility, but can implement managerial and organizational modifications.

Firms engaging in asset acquisition anticipate significant gains from such a move in the long-term. Indeed, acquiring strategic assets can be beneficial by increasing market power, increasing access to organizational skills, reducing transaction costs and spreading risks (Pradhan 2010, p. 9). These benefits of assets acquisition arises from the existence of gaps in the interactions among the various MEs operating in a common market. MEs that engage in asset-seeking activity tend to be involved in multiple types of foreign direct investment activities including efficiency seeking, market seeking and resource seeking. However, companies may merge or acquire others for strategic advantages such as avoiding competition in the future, strengthening competitive power against a common rival, or acquiring dominion or monopoly in a given market.

Conclusion

A firm’s motivation to enter into foreign direct investment is most likely to fall into the four main motives discussed in this paper: search for new markets, access to natural resources, improvement of efficiency and the acquisition of strategic assets. All multinational enterprise investment activities serve a common purpose of enhancing the firm’s output, cost efficiency and prospects for higher returns on investment. This categorization of motives, however, is neither strict nor adequate. Some firms enter into foreign investment with a combination of motives and thus cannot fit in any category properly. In addition, some firms may invest in foreign countries for reasons that cannot fit perfectly in the four categories of motives described. For example, a firm that invests outside its home country to escape strict regulations at home may not properly fit in any of the four categorizations of MEs.

 

References

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