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Chapter 1

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Chapter 1

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Introduction Chapter

References:
1.Jeff Madhura.
Define Multinational Corporation
 Multinational corporations (MNCs) are defined as
firms that engage in some form of international
business. Their managers conduct international
financial management, which involves international
investing and financing decisions that are intended to
maximize the value of the MNC. The goal of these
managers is to maximize their firm’s value, which is
the same goal pursued by managers employed by
A multinational corporation (MNC) or transnational
corporation (TNC) is a company engaged in producing and
selling goods or services in more than one country. It
ordinarily consists of a parent company located in the home
country and a number of foreign subsidiaries, typically with
a high degree of strategic interaction among the units. The
United Nations Conference on Trade and Development
(UNCTAD) defines such a firm as: “…an enterprise
comprising entities in more than one country which operate
under a system of decision-making that permits coherent
policies and a common strategy.”
 Some MNCs have upward of 100 foreign subsidiaries
scattered around the world. The United Nations
estimated in 2012 that over 82,000 parent
companies around the world (with over 800,000
foreign subsidiaries employing 72 million workers)
can be classified as multinational firms.
How Business Disciplines Are Used to Manage the MNC

 Various business disciplines are integrated to manage


the MNC in a manner that maximizes shareholder
wealth. Management is used to develop strategies that
will motivate and guide employees who work in an MNC
and to organize resources so that they can efficiently
produce products or services. Marketing is used to
increase consumer awareness about the products and to
monitor changes in consumer preferences. Accounting
and information systems are used to record financial
information about revenue and expenses of the MNC,
which can be used to report financial information to
investors and to evaluate the outcomes of various
strategies implemented by the MNC.
 Finance is used to make investment and financing
decisions for the MNC. Common finance decisions
include:
 ■ whether to discontinue operations in a particular
country,
 ■ whether to pursue new business in a particular
country,
 ■ whether to expand business in a particular
country, and
 ■ how to finance expansion in a particular country.
MNCs Pursue International Business

 Multinational business has generally increased over


time. Three commonly held theories to explain why
MNCs are motivated to expand their business
internationally are the:

(1) theory of comparative advantage,

(2) imperfect markets theory, and

(3) product cycle theory.


Comparative Advantage Theory
 Based in part on the development of modern
communications and transportation technologies,
the rise of the multinational corporation was
unanticipated by the classical theory of
international trade as first developed by Adam
Smith and David Ricardo. According to this theory,
which rests on the doctrine of comparative
advantage, each nation should specialize in the
production and export of those goods that it can
produce with highest relative efficiency and import
those goods that other nations can produce
relatively more efficiently.
 Underlying this theory is the assumption that goods
and services can move internationally but factors of
production, such as capital, labor, and land, are
relatively immobile. Furthermore, the theory deals
only with trade in commodities—that is,
undifferentiated products; it ignores the roles of
uncertainty, economies of scale, transportation
costs, and technology in international trade; and it
is static rather than dynamic. For all these defects,
however, it is a valuable theory, and it still provides
 a well-reasoned theoretical foundation for free trade
arguments.
Imperfect Markets Theory
 If each country’s markets were closed to all other countries,
then there would be no international business. At the other
extreme, if markets were perfect and thus the factors of
production (such as labor) easily transferable, then labor and
other resources would flow wherever they were in demand.
Such unrestricted mobility of factors would create equality in
both costs and returns and thus would remove the
comparative cost advantage, which is the rationale for
international trade and investment.
 However, the real world suffers from imperfect market conditions
where factors of production are somewhat immobile. There are costs
and often restrictions related to the transfer of labor and other
resources used for production. There also may be restrictions on
transferring funds and other resources among countries. Because
markets for the various resources used in production are “imperfect,”
MNCs such as the Gap and Nike often capitalize on a foreign country’s
particular resources. Imperfect markets provide an incentive for firms
to seek out foreign opportunities.
Product Cycle Theory
 One of the more popular explanations as to why
firms evolve into MNCs is the product cycle theory.
According to this theory, firms become established
in the home market as a result of some perceived
advantage over existing competitors, such as a
need by the market for at least one more supplier of
the product. Because information about markets
and competition is more readily available at home,
a firm is likely to establish itself first in its home
country.
 Foreign demand for the firm’s product will initially
be accommodated by exporting. As time passes, the
firm may feel the only way to retain its advantage
over competition in foreign countries is to produce
the product in foreign markets, thereby reducing its
transportation costs.

 The competition in those foreign markets may increase as


other producers become more familiar with the firm’s product.
The firm may develop strategies to prolong the foreign
demand for its product. One frequently used approach is to
differentiate the product so that competitors cannot duplicate
it exactly
Methods to Conduct International
Business
Firms use several methods to conduct international business. The
most common methods are:
 ■ international trade,
 ■ licensing,
 ■ franchising,
■ joint ventures,
■ acquisitions of existing operations, and
■ establishment of new foreign subsidiaries.
International Trade
 International trade is a relatively conservative approach that
can be used by firms to penetrate markets (by exporting) or to
obtain supplies at a low cost (by importing). This approach
entails minimal risk because the firm does not place any of its
capital at risk. If the firm experiences a decline in its exporting
or importing, it can normally reduce or discontinue that part of
its business at a low cost.
 Many large U.S.-based MNCs, including Boeing, DuPont,
General Electric, and IBM, generate more than $4 billion in
annual sales from exporting.
Licensing
 Licensing is an arrangement whereby one firm
provides its technology (copyrights, patents,
trademarks, or trade names) in exchange for fees or
other considerations.
Many producers of software allow foreign companies
to use their software for a fee. In this way, they can
generate revenue from foreign countries without
establishing any production plants in foreign
countries, or transporting goods to foreign countries.
Franchising
 Under a franchising arrangement, one firm
provides a specialized sales or service
strategy, support assistance, and possibly an
initial investment in the franchise in
exchange for periodic fees, allowing local
residents to own and manage the units. For
example,
 McDonald’s, Pizza Hut, Subway, and Dairy Queen have
franchises that are owned and managed by local residents in
many foreign countries. As an example, McDonald’s typically
purchases the land and establishes the building. It then leases
the building to a franchisee and allows the franchisee to
operate the business in the building for a specified number of
years (such as 20 years), but the franchisee must follow
standards set by McDonald’s when operating the business.
Because franchising by an MNC often requires a direct
investment in foreign operations, this is referred to as a direct
foreign investment (DFI).
Joint Ventures
 A joint venture is a venture that is jointly owned and operated
by two or more firms. Many firms enter foreign markets by
engaging in a joint venture with firms that already reside in
those markets. Most joint ventures allow two firms to apply
their respective comparative advantages in a given project.
Joint ventures often require some degree of DFI, while the
other parties involved in the joint ventures also participate in
the investment.
 For instance, General Mills, Inc., joined in a venture with Nestlé
SA so that the cereals produced by General Mills could be sold
through the overseas sales distribution network established by
Nestlé. Xerox Corp. and Fuji Co. (of Japan) engaged in a joint
venture that allowed Xerox to penetrate the Japanese market
while allowing Fuji to enter the photocopying business. Kellogg
Co. and Wilmar International Ltd. have established a joint
venture to manufacture and distribute cereals and snack
products in China. Wilmar already has a wholly owned
subsidiary in China, and it is participating in the venture. Joint
ventures between automobile manufacturers are numerous
because each manufacturer can offer its own technological
advantages. General Motors has ongoing joint ventures with
Acquisitions of Existing Operations
 Firms frequently acquire other firms in foreign
countries as a means of penetrating foreign markets.
Such acquisitions give firms full control over their
foreign businesses and enable the MNC to quickly
obtain a large portion of foreign market share.
Acquisitions represent direct foreign investment
because MNCs directly invest in a foreign country by
purchasing the operations of target companies.
 EXAMPLE

 Google, Inc., has made major international acquisitions to expand its


business and improve its technology. It has acquired businesses in
Australia (search engines), Brazil (search engines), Canada (mobile
browser), China (search engines), Finland (micro-blogging), Germany
(mobile software), Russia (online advertising), South Korea (weblog
software), Spain (photo sharing), and Sweden (videoconferencing
 However, the acquisition of an existing
corporation could lead to large losses
because of the large investment required. In
addition, if the foreign operations perform
poorly then it may be difficult to sell the
operations at a reasonable price
Establishment of New Foreign
Subsidiaries
 Firms can also penetrate foreign markets by establishing new

operations in foreign countries to produce and sell their


products. Like a foreign acquisition, this method requires a
large direct foreign investment. Establishing new subsidiaries
may be preferred to foreign acquisitions because the
operations can be tailored exactly to the firm’s needs. In
addition, a smaller investment may be required than would be
needed to purchase existing operations. However, the firm will
not reap any rewards from the investment until the subsidiary
is built and a customer base established.
Summary of Methods
 The methods of increasing international business
extend from the relatively simple approach of
international trade to the more complex approach of
acquiring foreign firms or establishing new subsidiaries.
International trade and licensing are usually not viewed
as examples of DFI because they do not involve direct
investment in foreign operations. Franchising and joint
ventures tend to require some investment in foreign
operations but only to a limited degree. Foreign
acquisitions and the establishment of new foreign
subsidiaries require substantial investment in foreign
operations and account for the largest portion of DFI.
 .
 Many MNCs use a combination of methods to
increase international business. For example, IBM
and PepsiCo engage in substantial direct foreign
investment yet also derive some of their foreign
revenue from various licensing agreements, which
require less DFI to generate revenue
 International Trade by the MNC
 Licensing, Franchising, Joint Ventures by the MNC
 Investment in Foreign Subsidiaries by the MNC
 Foreign Importers
 Foreign Exporters

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