Introduction
In this chapter, we look at how firms can increase their profitability by expanding their operations in foreign markets. We discuss the different strategies that firms pursue when competing internationally, consider the pros and cons of these strategies, discuss the various factors that affect a firm's choice of strategy, and look at the tactics firms adopt when competing head to head across various national markets.
The Firm as a Value Chain
Primary Activities
The primary activities of a firm have to do with creating the product, marketing and delivering the product to buyers, and providing support and after-sale service to the buyers of the product. We consider the activities involved in the physical creation of the product as production and those involved in marketing, delivery, and after-sale service as marketing.
Support Activities
Support activities provide the inputs that allow the primary activities of production and marketing to occur. The materials management function controls the transmission of physical materials through the value chain--from procurement through production and into distribution. The efficiency with which this is carried out can significantly reduce the cost of creating value. In addition, an effective materials management function can monitor the quality of inputs into the production process. This results in improved quality of the firm's outputs, which adds value and thus facilitates premium pricing.
An effective human resource function ensures that the firm has an optimal mix of people to perform its primary production and marketing activities, that the staffing requirements of the support activities are met, and that employees are well trained for their tasks and compensated accordingly. The information systems function makes certain that management has the information it needs to maximize the efficiency of its value chain and to exploit information-based competitive advantages in the marketplace. Firm infrastructure--consisting of such factors as organizational structure, general management, planning, finance, and legal and government affairs--embraces all other activities of the firm and establishes the context for them. An efficient infrastructure helps both to create value and to reduce the costs of creating value.
The Role of Strategy
A firm's strategy can be defined as the actions managers take to attain the goals of the firm. For most firms, a principal goal is to be highly profitable. To be profitable in a competitive global environment, a firm must pay continual attention to both reducing the costs of value creation and to differentiating its product offering so that consumers are willing to pay more for the product than it costs to produce it. Consider the case of Clear Vision, which is profiled in the accompanying Management Focus.
Profiting from Global Expansion
Transferring Core Competencies
The term core competence refers to skills within the firm that competitors cannot easily match or imitate.4 These skills may exist in any of the firm's value creation activities--production, marketing, R&D, human resources, general management, and so on. Such skills are typically expressed in product offerings that other firms find difficult to match or imitate; thus, the core competencies are the bedrock of a firm's competitive advantage. They enable a firm to reduce the costs of value creation and/or to create value in such a way that premium pricing is possible. For such firms, global expansion is a way to further exploit the value creation potential of their skills and product offerings by applying those skills and products in a larger market. The potential for creating value from such a strategy is greatest when the skills and products of the firm are most unique, when the value placed on them by consumers is great, and when there are very few capable competitors with similar skills and/or products in foreign markets. Firms with unique and valuable skills can often realize enormous returns by applying those skills, and the products they produce, to foreign markets where indigenous competitors lack similar skills and products.
Realizing Location Economies
We know from earlier chapters that countries differ along a whole range of dimensions, including the economic, political, legal, and cultural, and that these differences can either raise or lower the costs of doing business. We also know from the theory of international trade that because of differences in factor costs, certain countries have a comparative advantage in the production of certain products. For example, Japan excels in the production of automobiles and consumer electronics. The United States excels in the production of computer software, pharmaceuticals, biotechnology products, and financial services. Switzerland excels in the production of precision instruments and pharmaceuticals.
Firms that pursue such a strategy can realize what we refer to as location economies. We can define location economies as the economies that arise from performing a value creation activity in the optimal location for that activity, wherever in the world that might be (transportation costs and trade barriers permitting). Locating a value creation activity in the optimal location for that activity can have one or two effects. It can lower the costs of value creation and help the firm to achieve a low-cost position, and/or it can enable a firm to differentiate its product offering from that of competitors. Both of these considerations were at work in the case of Clear Vision, which was profiled in the Management Focus. Clear Vision moved its manufacturing operations out of the US.
Creating a Global Web
One result of Clear Vision's kind of thinking is the creation of a global web of value creation activities, with different stages of the value chain being dispersed to those locations around the globe where value added is maximized or where the costs of value creation are minimized. Consider the case of General Motors' (GM) Pontiac Le Mans cited in Robert Reich's The Work of Nations. Marketed primarily in the United States, the car was designed in Germany; key components were manufactured in Japan, Taiwan, and Singapore; assembly was performed in South Korea; and the advertising strategy was formulated in Great Britain. The car was designed in Germany because GM believed the designers in its German subsidiary had the skills most suited to the job.
In theory, a firm that realizes location economies by dispersing each of its value creation activities to its optimal location should have a competitive advantage vis-à-vis a firm that bases all its value creation activities at a single location. It should be able to better differentiate its product offering and lower its cost structure than its single-location competitor. In a world where competitive pressures are increasing, such a strategy may become an imperative for survival .
Some Caveats
Introducing transportation costs and trade barriers complicates this picture somewhat. Due to favorable factor endowments, New Zealand may have a comparative advantage for automobile assembly operations, but high transportation costs would make it an uneconomical location for them. Transportation costs and trade barriers explain why many US firms are shifting their production from Asia to Mexico. Second, Mexico's proximity to the United States reduces transportation costs. This is particularly important for products with high weight-to-value ratios . Third, the North American Free Trade Agreement has removed many trade barriers between Mexico, the United States, and Canada, increasing Mexico's attractiveness as a production site for the North American market.
Another caveat concerns the importance of assessing political and economic risks when making location decisions.
Realizing Experience Curve Economies
The experience curve refers to the systematic reductions in production costs that have been observed to occur over the life of a product. A number of studies have observed that a product's production costs decline by some characteristic each time accumulated output doubles. The relationship was first observed in the aircraft industry, where each time accumulated output of airframes was doubled…
Learning Effects
Learning effects refer to cost savings that come from learning by doing. Labor, for example, learns by repetition how to carry out a task, such as assembling airframes, most efficiently. Labor productivity increases over time as individuals learn the most efficient ways to perform particular tasks. Equally important, in new production facilities, management typically learns how to manage the new operation more efficiently over time. Hence, production costs eventually decline due to increasing labor productivity and management efficiency.
Economies of Scale
The term economies of scale refers to the reductions in unit cost achieved by producing a large volume of a product. Economies of scale have a number of sources, one of the most important of which seems to be the ability to spread fixed costs over a large volume.11 Fixed costs are the costs required to set up a production facility, develop a new product, and the like, and they can be substantial. Another source of scale economies arises from the ability of large firms to employ increasingly specialized equipment or personnel. The machine can be purchased in a customized form, which is optimized for the production of a particular type of body part, or a general purpose form, which will produce any kind of body part. The general form is less efficient and costs more to purchase than the customized form, but it is more flexible. Since these machines cost millions of dollars each, they have to be used continually to recoup a return on their costs.
Strategic Significance
The strategic significance of the experience curve is clear. Moving down the experience curve allows a firm to reduce its cost of creating value. The firm that moves down the experience curve most rapidly will have a cost advantage vis-à-vis its competitors.
Many of the underlying sources of experience-based cost economies are plant based. This is true for most learning effects as well as for the economies of scale derived by spreading the fixed costs of building productive capacity over a large output.
Pressures for Cost Reductions and Local Responsiveness
Pressures for Cost Reductions
Increasingly, international businesses face pressures for cost reductions. This requires a firm to try to lower the costs of value creation by mass producing a standardized product at the optimal location in the world to try to realize location and experience curve economies. Pressures for cost reductions can be particularly intense in industries producing commodity products where meaningful differentiation on nonprice factors is difficult and price is the main competitive weapon. This tends to be the case for products that serve universal needs. Universal needs exist when the tastes and preferences of consumers in different nations are similar. This is the case for conventional commodity products such as bulk chemicals, petroleum, steel, sugar, and the like. It also tends to be the case for many industrial and consumer products. Cost pressures have been intense in the global tire industry in recent years. Tires are essentially a commodity product where meaningful differentiation is difficult and price is the main competitive weapon. The major buyers of tires, automobile firms, are powerful and face low switching costs, so they play tire firms against each other to get lower prices.
Pressures for Local Responsiveness
Differences in Consumer Tastes and Preferences
Strong pressures for local responsiveness emerge when consumer tastes and preferences differ significantly between countries--as they may for historic or cultural reasons. In such cases, product and/or marketing messages have to be customized to appeal to the tastes and preferences of local consumers. This typically prompts delegating production and marketing functions to national subsidiaries.
Differences in Infrastructure and Traditional Practices
Pressures for local responsiveness emerge when there are differences in infrastructure and/or traditional practices between countries. In such circumstances, customizing the product to the distinctive infra-structure and practices of different nations may necessitate delegating manufacturing and production functions to foreign subsidiaries.
Differences in Distribution Channels
A firm's marketing strategies may have to be responsive to differences in distribution channels between countries. This may necessitate the delegation of marketing functions to national subsidiaries. In laundry detergents, for example, five retail chains control 65 percent of the market in Germany, but no chain controls more than 2 percent of the market in neighboring Italy.
Host Government Demands
Economic and political demands imposed by host-country governments may necessitate local responsiveness. For example, the politics of health care around the world requires that pharmaceutical firms manufacture in multiple locations. Pharmaceutical firms are subject to local clinical testing, registration procedures, and pricing restrictions, all of which demand that the manufacturing and marketing of a drug meet local requirements. Also, because governments and government agencies control a significant portion of the health care budget in most countries, they can demand a high level of local responsiveness.
Threats of protectionism, economic nationalism, and local content rules all dictate that international businesses manufacture locally. Consider Bombardier, the Canadian-based manufacturer of railcars, aircraft, jet boats, and snowmobiles. To sell railcars in Germany, they claim, you must manufacture in Germany. The same goes for Belgium, Austria, and France. To address its cost structure in Europe, Bombardier has centralized its engineering and purchasing functions, but it has no plans to centralize manufacturing.
Strategic Choice
International Strategy
Firms that pursue an international strategy try to create value by transferring valuable skills and products to foreign markets where indigenous competitors lack those skills and products. Most international firms have created value by transferring differentiated product offerings developed at home to new markets overseas
An international strategy makes sense if a firm has a valuable core competence that indigenous competitors in foreign markets lack, and if the firm faces relatively weak pressures for local responsiveness and cost reductions . In such circumstances, an international strategy can be very profitable. However, when pressures for local responsiveness are high, firms pursuing this strategy lose out to firms that place a greater emphasis on customizing the product offering and market strategy to local conditions. Due to the duplication of manufacturing facilities, firms that pursue an international strategy tend to suffer from high operating costs. This makes the strategy inappropriate in manufacturing industries where cost pressures are high.
Multidomestic Strategy
Firms pursuing a multidomestic strategy orient themselves toward achieving maximum local responsiveness. Multidomestic firms extensively customize both their product offering and their marketing strategy to match different national conditions. They also tend to establish a complete set of value creation activities--including production, marketing, and R&D--in each major national market in which they do business. As a consequence, they generally fail to realize value from experience curve effects and location economies. Accordingly, many multidomestic firms have a high cost structure. They also tend to do a poor job of leveraging core competencies within the firm. General Motors, profiled in the opening case, is a good example of a company that has historically functioned as a multidomestic corporation, particularly with regard to its extensive European operations, which are largely self-contained entities.
A multidomestic strategy makes most sense when there are high pressures for local responsiveness and low pressures for cost reductions.
Global Strategy
Firms that pursue a global strategy focus on increasing profitability by reaping the cost reductions that come from experience curve effects and location economies. They are pursuing a low-cost strategy. The production, marketing, and R&D activities of firms pursuing a global strategy are concentrated in a few favorable locations. Global firms tend not to customize their product offering and marketing strategy to local conditions because customization raises costs (
Transnational Strategy
Christopher Bartlett and Sumantra Ghoshal have argued that in today's environment, competitive conditions are so intense that to survive in the global marketplace, firms must exploit experience-based cost economies and location economies, they must transfer core competencies within the firm, and they must do all this while paying attention to pressures for local responsiveness. They note that in the modern multinational enterprise, core competencies do not reside just in the home country. They can develop in any of the firm's worldwide operations. Thus, they maintain that the flow of skills and product offerings should not be all one way, from home firm to foreign subsidiary, as in the case of firms pursuing an international strategy. Rather, the flow should also be from foreign subsidiary to home country, and from foreign subsidiary to foreign subsidiary--a process they refer to as global learning.
A transnational strategy makes sense when a firm faces high pressures for cost reductions and high pressures for local responsiveness. Firms that pursue a transnational strategy are trying to simultaneously achieve low-cost and differentiation advantages. As attractive as this sounds, the strategy is not an easy one to pursue. Pressures for local responsiveness and cost reductions place conflicting demands on a firm.
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