Why do Firms become Multinationals

Why do Firms become Multinationals

            Multinational enterprises are companies that operate in two or more countries, although the management is centralized in a specific country. In the world today, multinational corporations control a substantial market share in many manufacturing and online shopping companies. Notably, globalization is what attributes to the most significant impact on the rise of multinationals. Through globalization, many corporations are able to expand their scope of production to a multinational level through the provided efficient means of transport and communication. The rise in multinationals began to increase rapidly after the end of the Second World War. The trends of new multinationals continue to increase up to date with the emergence of peace and political stability in different countries. Currently, many organizations are embracing multinational operation to enjoy the array of benefits to the company, the general public, and the government of the countries involved. This essay will delve into the motivations driving many firms to become multinationals.

The principal reason behind the expansion of many corporations

and companies into multinationals is the desire to maximize the sales and hence the profit margin (Hoskisson et al., 2012). Besides, there seems to be an enjoyment that is attached to the ownership of the multinational operation of corporations. Many companies do this by ensuring product patents, having specific production secrets, and ensuring the uniqueness of brands from other competitive markets. Although the whole idea of the multinational operation is very attractive to many, some necessary standards and requirements must be met by the companies. These standards depend on the host country and the other countries in which the multinational operates. Despite the presence of strict rules and standards, multinationals continue to increase from year to year. For instance, companies like Nike and Coca-cola, although they are American based, have been able to establish operations in all the countries in the world today(Hennart, 2012). In addition, the rise in the multinational operation of companies is stimulated by political backgrounds, the need for more extensive market shares, the need to reduce costs, better skills, or the variation in technological advancement in different countries.

The rate of globalization has had an acceleration in the last twenty years. Also, there is more to globalization than just foreign trade; there has been an increase in Foreign investment in the previous twenty years (Wang & Mathur, 2011). The increase is acute in emerging nations. The acceleration of globalization is reflected in many companies, which are establishing an operation in a different country and coming to direct competition with overseas markets. The ease in tariffs, trade barriers, and ICT revolution are believed to be facilitators of globalization. It has now become a common thing to seeing companies based in emerging countries having an influence on the global market. Additionally, in international multinational companies, emergent nations record an increase in the quantity of new multinational companies in the last six years. Besides, the rise of new multinationals from emerging countries has opened up many opportunities for business-to-business companies such as IT companies and telecoms. The location of manufacturing facilities and offices around the globe has resulted in a higher demand for local services and infrastructural facilities by multinationals (Wang & Mathur, 2011).

Moreover, firms seek to become multinationals to access cheap labour force. Multinational operations source labor at a more reasonable cost as compared to ordinary firms. Their ability to operate in different countries enables them to capitalize on cheap labour markets. The multinational footprint is evident in nations with more significant forces of labor and willing to operate at a cheaper cost. This facilitates the maximization of profits as well as the delivery of goods and markets at a low cost.  Notably, for local economies, the rise of multinationals symbolizes a supply of jobs to the depressed area; therefore, a stimulation to them. Additionally, regions of cheap but abundant labor have a poor regulation; therefore, multinationals are able to take advantage of the situation.

The need to access much larger markets is a significant motivation in many firms to become multinationals. A multinational business model is able to access a broader market as compared to a national model. This has resulted in the fact that many organizations operating nationally are seeking to venture into newer operations in a different country for additional returns. It has generally been known that entry into newer markets, as well as the expansion of single brands, creates a global brand influence. Multinational mode of operation enables different arms to operate under a specific brand but still with the flexibility of changing products to suit local settings. Besides, in a progressively planetary concern environment, companies cannot afford to be under domestic markets that are never sufficiently profitable. For this reason, firms prefer to sell their merchandise in countries with more prominent market figures or where consumers have more purchasing power (Hennart, 2012). Behind this is the motivation of profit-seeking besides helping the firms to build a more prominent trade name.

Furthermore, firms decide to invest abroad to secure the principal supplies they require for smooth operations. Companies are nowadays investing in countries where there are constant and cheap resources. The reason behind this initiative is the quest to lower the costs of production and therefore increase the profit margins. For instance, many tire-manufacturing countries ventured abroad in pursuit of cheap rubber plantations. Also, oil-based continue to secure cheaper oil fields in the Middle East, Canada, and Venezuela to access the factors of low production costs. Equally important, the rise in globalization and abolishment of trade barriers in the world has caused a great interest in many firms to secure markets in foreign countries (“The growth of the multinational corporation,” 2020). Firms that experience the most significant competitive advantage in the respective home country are the most motivated to become multinationals in order to exploit the economies of scale in the foreign markets. Additionally, some companies invest in different countries to evade the strict regulations in domestic markets and reduce the seasonal and cyclical nature of the market demands. Moreover, firms seek to become internationals after the demand for their products reaches a point of saturation in the local market. Others do focus on the economies of scale associated with the great demands in foreign countries. Governments also play a significant role in attracting international firms to invest in their countries. One way is through the provision of information to exporter about the nature of foreign markets. In addition, there are instances when the government finances business opportunities, which is an enticement to many firms to b become multinationals. Moreover, Raymond Verrmon, in his product life cycle theory, explained how different motives encouraged US-based firms to become multinationals (Lee & Suh, 2009). In his report, he notes that the process of internalization for a firm begins with innovation in the home country. He pointed out that the preference of firms is always inclined to develop local products with their primary target markets, therefore, allowing them to synchronize research and product activities. In the same phase, the foreign country’s demand is met through exports. What follows is that the product demand in foreign countries increases as the product approaches its maturity stage. In the long run, the firm is pushed to provide production facilities in foreign countries and ensure a good rapport with the market to deny the local competitors a chance. This way, the firm gets transformed into a multinational. Once the products become uniform, the new multinational then find cost effective means to reduce the value in the production process and therefore maintain an advantage. It then follows that the company will seek to establish an operation in the developed countries where there is cheap access to resources required for the production process (Wang & Mathur, 2011).

Similarly, the need to establish escape and support investments is the other motivation for firms to become multinationals. Firms establish Foreign Domestic Investments (FDI) when the government policies in home countries are under strict regulation and are less suitable for the operation of firms-It is commonly referred to as escape investments. On the other hand, support investments are conducted by firms for the support of major company activities. Then, the affiliates created in foreign nations become beneficial to the multinational entirely- not only acting as self-profit centers. The activities vary from facilitating imports, marketing, and distribution in foreign countries. Multinationals are usually large and often have competitive power in the market place and a bargaining power making arena in smaller developing countries. Additionally, the multinationals are able to circumvent local policies and regulations in an easier way than national firms are. Similarly, the multinationals are able to produce standardized products massively; therefore, jeopardizing product variety (Lee & Suh, 2009).

John Dunning explained the foreign activities of multinationals through his electric framework of 1976(“The growth of the multinational corporation,” 2020). He stated that the extent of foreign investment by multinationals are dependent on three variables. First is the competitive advantage of the firm, which has ownership advantages to the owner. Secondly, is specific-location related advantages that a firm pursues in foreign countries, for instance, cheap resources. Policies and regulations, exchange rates, and contacts with local entities. Lastly, is the internalization benefits in the foreign markets. Additionally, he states that four activities that attract firms to foreign countries and become multinationals. One is the pursuit of markets to meet product demands in markets of countries like China. Two is the resource seeking behavior where firms target natural resources such as minerals as well as the cheap skilled labor in foreign countries. Similarly, it is the strategic asset seeking foreign direct investments by firms that promote competitive advantages in the foreign market through the acquisition of assets from foreign corporations. Lastly, Dunning indicates that firms seek efficiency and therefore engage in cross border specialization in order to gain the advantages of economies of scale and the spreading of risks of foreign investment(“The growth of the multinational corporation”, 2020).

Also, firms engage in cross border amalgamations to gain resources and free access to wider capability, the power to control the markets, and lower production costs to stop the monopoly of competitors. The theory of internalization states that firms engage in foreign direct investments upon the recognition of net benefits in ownership of foreign activity as well as the related transaction cost. Consequently, this provides advantages to the investing firm to evade negotiation costs and wrong selection, which in turn protects the firm’s reputation. Furthermore, according to Robert Aliber, the imperfect nature of foreign exchange markets attracts multinational operations of firms (Ruggie, 2017). He asserts that those multinationals arise from hard currency zones to borrow and raise capital in domestic/foreign markets and capitalize at different interest rates in weak and developing countries (Ruggie, 2017).  Moreover, firms seek to become multinationals to take advantage of imperfect markets in other countries. It is the custom of many firms to establish foreign subsidiaries to stop competition between them and the firms located in foreign countries. Once a firm has become multinational, it is able to gain control over the assets in the other countries and therefore, an extra advantage of risk reduction and an increased market power.

A learning process describes the transformation of firms into multinationals. One way that a firm can take to become multinational is the sale of its license to manufacturers based in foreign countries. Franchisees can then be established with their brand name. Alternatively, the firm could also sell products through trade companies or local distributors without necessarily have its uniquely owned operation in a foreign country. There are also instances of companies, which invest in local partners in a bid to maximize operations. For example, Walmart became a multinational in the United Kingdom by buying ASDA supermarkets instead of developing individual stores (Miroux, 2020). On the other hand, companies like Amazon usually contract local partners, therefore, giving them the ability to set up operations internationally without local employees.

Additionally, through franchising, exporting, licensing, and joint ventures, firms are also able to invest in foreign markets (Vatsyayan, 2010). To determine which choice to take, firms have to balance the available options as well as consider the available information, their risk-taking ability, and their level of commitments. For exports, they can be either direct, indirect, or both. However, indirect exports require intermediaries hence turn to be more expensive though it’s beneficial to new exporters. Similarly, direct exportation requires agent, therefore, requires more involvement. When it comes to franchising, the franchisee firm uses the competitive advantage of another firm. Such benefits include the application of modern technology, patents, trademark, management support, as well as training procedures. The company then pays a fee or royalty. Similarly, some companies create joint ventures with a separate company in a foreign country with the intention of expanding their operations. Furthermore, companies can expand their operation through foreign direct investment. Here, firms establish assets in a different country so that they can carry out operations. Notably, foreign direct investments arise from bigger multinationals as it requires a long-term commitment from the firm. Firms commonly take this form of investment to avoid the restriction by the government for direct exports such as tariffs. In addition, when foreign direct investments are made expertly, the firm is able to stay closer to the market; therefore, it can have a competitive advantage and also enjoy a secure availability of resources plus a favorable government policy in the host country.

The other strategy is licensing, which entails the sharing of technology-based innovation with a foreign company for a royalty- usually a specific percentage of sales. Licensing is generally easier to implement at earlier stages as it needs no significant capital expenditure. For example, Kentucky Fried Chicken in the United Kingdom uses the scheme of licensing rather than direct investment. In contrast, McDonald’s operates only a quarter of its brand hotels directly (“KFC multinational enterprise,” 2020). However, licensing denies the parent firm a chance to exercise the entire managerial function over the licensee; therefore, it poses a danger of secret, industrial transfer. This further results in very high competition and loss of the initial competitive advantage, thus, stunted growth of the firm.

In addition, there are marketing firms that invest in foreign markets in order to secure goods from different countries, which results in a reduction of material costs. The firm could also have the ability to supply its product to its home country seeing that the local markets are saturated. Notably, the firm is required to act accordingly for more significant profitability and growth. A perfect example of this is the case of dominos who have explored new markets after become saturated with the UK market. Firms desiring to have a multinational operation usually concentrate on a few issues and a variety of success strategies (Lee & Suh, 2009).

Moreover, firms consider becoming multinationals to spread risk. When a firm has arms in different nations, then each arm of the multinational is able to mitigate risks (Klimek, 2016). This happens to be the case since capital and power become distributed in various individual locations where each is accountable for its returns. The different locations are all-independent and hence are expendable in case returns are not realized. Similarly, there is a flexibility that comes with the distribution of power, capital, and power, which acts as an advantage for multinational firms. I resemble a chess game, where the pieces are removed or added depending on the performance and the returns.

In addition, firms also opt to become multinationals to have access to lower tax rates. Multinational businesses have corporate offices, although each arm of the business is autonomous and independent too. This way, the different arms of the business are able to operate independently with tax shelter or lower taxes. The intentional location of manufacturing companies in developing companies with cheap labor and lower export and import costs. This is usually a significant advantage to multinational firms. On the other hand, firms are also focusing on the localization advantage to become multinationals. Occasionally, multinationals aim to build facilities that produce and sell products in locations close to the consumer—for instance, the consumers of Coke in Poland. The advantage of this is the reduced transportation cost and facilitation of the company to fit in well with the local taste and needs. Besides, closeness to demand enables firms to adapt their services and goods to various markets. Furthermore, the companies are able to enjoy lower production costs, a variety of production factors such as expertise engineering, and greater raw materials. For example, the affiliate of Coca Cola in Poland is the same owner of Beskidy mountains, a company that makes mineral water and manufactures a variety of beverages (“Multinational Model Strategies Used By Coca Cola Company,” 2020). Lastly, companies have become multinationals in the quest to internalize the benefits of ownership of a particular brand, technology, or even expertise that they do not want to assign other firms through licensing or other means whatsoever. In addition, the process of enforcing international contracts could be ineffective or expensive in countries of a weaker law; therefore, firms would not risk losing the ownership advantage that was not easily established.

In conclusion, the global economy continues to witness rapid growth in multinational companies due to the benefits associated with their operations. Access to lower tax rates, accessibility of a cheap labor force, the need for a much larger market, and the ability to spread risks are some of the main reasons why firms are becoming multinationals.

References

Hennart, J. (2012). Emerging market multinationals and the theory of the multinational enterprise. Global Strategy Journal, 2(3), 168-187. https://doi.org/10.1111/j.2042-5805.2012.01038.x

Hoskisson, R., Wright, M., Filatotchev, I., & Peng, M. (2012). Emerging Multinationals from Mid-Range Economies: The Influence of Institutions and Factor Markets. Journal Of Management Studies, n/a-n/a. https://doi.org/10.1111/j.1467-6486.2012.01085.x

KFC multinational enterprise. prezi.com. (2020). Retrieved 22 March 2020, from https://prezi.com/h5k2d3aq446o/kfc-multinational-enterprise/.

Klimek, A. (2016). Integration strategies of emerging multinational corporations: Theoretical approach. International Journal Of Economic Theory, 12(2), 183-196. https://doi.org/10.1111/ijet.12088

Lee, B., & Suh, J. (2009). Exchange Rate Changes and the Operating Performance of Multinationals. European Financial Management, 18(1), 88-116. https://doi.org/10.1111/j.1468-036x.2009.00522.x

Miroux, A. (2020). Here’s how emerging market multinationals can become global industry leaders. World Economic Forum. Retrieved 22 March 2020, from https://www.weforum.org/agenda/2016/12/emerging-market-multinationals/.

Multinational Model Strategies Used By Coca Cola Company. Small becomes Giant. (2020). Retrieved 22 March 2020, from https://smallbecomesgiant.wordpress.com/2013/04/04/multinational-model-strategies-used-by-coca-cola-company/.

Ruggie, J. (2017). Multinationals as a global institution: Power, authority, and relative autonomy. Regulation & Governance, 12(3), 317-333. https://doi.org/10.1111/rego.12154

The growth of the multinational corporation. FutureLearn. (2020). Retrieved 22 March 2020, from https://www.futurelearn.com/courses/business-environment/0/steps/39431.

Vatsyayan, A. (2010). Multinational Companies from Emerging Economies. Development In Practice, 20(6), 744-745. https://doi.org/10.1080/09614524.2010.491539

Wang, Z., & Mathur, I. (2011). Return on capital analysis: U.S.-based multinational corporations versus U.S. domestic corporations. Journal Of Multinational Financial Management, 21(4), 191-207. https://doi.org/10.1016/j.mulfin.2011.04.003