The major uncertainty facing the world today is not the Euro but the future direction of China. The growth model for its rapid rise has run out of steam.

George Soros (writing at the end of 2013)¹

In a nutshell

When your daily work is dominated by tactical thinking, globalisation and international business can seem like remote concerns. Don’t be deceived though. You are already part of the global economy, even if you work in a small organisation with no apparent multinational involvement.

This chapter looks at two things. First, macroeconomics and the terms used in policy making for nations, groups of nations and institutions that regulate international trade. Then, a survey of multinational enterprises (MNEs), which are corporations with headquarters in one country and networks of subsidiary, affiliate or acquired companies that are hosted in others.

In this chapter you will:

• define key macroeconomic terms and theories
• look at the nature of the international business environment
• understand how the global market forces and firms shape strategic thinking
• see how organisations measure international competitive advantage and choose channels for growth

How beautiful is big?

Take a look at Table 9.1 showing Fortune’s top 20 global companies ranked by 2013 turnover. Do you recognise all the names? If not, you may want to look them up. Once you have found out who they all are, what strikes you about the list?

TABLE 9.1 Fortune’s top 20 global companies ranked by 2013 turnover

Source: Fortune Global 500, 2013

You may have noticed the number of energy companies represented (7 of the top 10). Not long ago, this top 20 would have been a balance of oil and gas producers, manufacturers and financial institutions. That’s one aspect, and here is another: the 2005 Fortune 500 Global list contained a total of 16 Chinese companies; in 2013 it contained 89. The balance of the world economy is shifting – new markets are not just opening up, they represent whole new ways of doing business.

In number and in magnitude, MNEs have ballooned in the last 60 years, thanks to regional waves of privatisation, economic liberalisation and market deregulation. In fact, MNEs now account for the majority of the economic activity in the world and embody in practice much of what is taught on an MBA. They embody power, too, driving foreign direct investment and supporting first and second tiers of supplier companies. Multinationals have clout, so when international companies fail, the fallout can be spectacular. Here are three examples:

• When Enron imploded in 2001, it was standing on a pedestal in the top 10 of US companies. Many investors, staff and customers were left with nothing.
• By 2014 the cost to BP of the 2010 disaster on the Deepwater Horizon platform, on which 11 lives were lost and from which 5 million barrels of oil spilled into the Gulf of Mexico, had passed the $42 billion mark. The company, the sixth largest in the world, has faced severe criticism of its response, governance structure and leadership.
• The credit crunch of 2008–9 that was precipitated by the US subprime mortgage collapse in 2007 threatened many of the word’s global banking institutions. US bank Lehman Brothers filed for bankruptcy in 2008, triggering a banking crisis and prompting national and regional governments around the world to begin a lengthy and painful series of measures to intervene and bail out a series of private, global banks.

Corporate failure happens all the time, of course. Most new ventures fail, and many businesses go through a life cycle that results in maturity and decline (or acquisition). Despite the enormous number of companies in the world, we mostly examine either the big (too big to fail?) survivor stories (and base our management theories on them, too) or the spectacular failure stories. Little attention is paid to what lies in the middle.

Even less attention is paid to the dynamics of the ecology of the whole population of organisations. Corporate failure, even among multinational giants, can have positive repercussions. When Nokia, at one time the world’s largest supplier of mobile phone handsets, was surpassed by its competitors and went into decline, the company cut its global workforce by 24,000 and sold its mobile phone business to Microsoft in a deal worth more than $7 billion. The aftermath of this turmoil and headcount reduction in Nokia’s home country of Finland has been a resurgence of high-tech company start-ups.

The question posed for managers by globalisation is to understand the role and purpose of business as it relates to the macroeconomic environment. Later in this chapter I want to consider how firms act in the international business environment, but first let’s take a look at some macro-level economic principles.

Macroeconomics

Macroeconomics is the study of the economy as a whole. It is the basis for long-term policies and interventions that promote development (growth) and limit the impact of economic cycles. Like all aspects of economics it is concerned with scarcity of resources, but on a much wider scale than the micro world of the organisation.

Several hundred years ago, wealth creation meant the wealth of nations rather than shareholders. The nation-state preceded the corporation as the unit of analysis. The idea was first developed by Adam Smith in 1776, and still has an attraction for some economists who study at the comparative advantage of one country over another in the production and trade of various types of goods or commodities. The metric (and rule of thumb) most often used for the economic activity of a country is its gross domestic product (GDP), the total output of goods and services for a given territory and time. Simplified, GDP looks at household spending, investment and consumer confidence, government spending, and volumes of exports/imports. Regional aggregates of GDP are telling. In 2012 the combined GDP of the G7² economies was $33,932 billion (47 per cent of the world total). By comparison, the same figure for the whole of sub-Saharan Africa (49 countries) was $1,273 billion (1.8 per cent of total).³

Macroeconomists are as interested in supply and demand, pricing and the supply of money as are microeconomists, but at an aggregated level. Money supply and demand/supply of goods are the basic ingredients for inflation and are all connected in complex flows of rise and fall in outputs, prices and international trade.

National competitiveness and economic growth

The modern corporation did not begin to emerge until the end of the nineteenth century. Historically, large and powerful trading corporations, such as the British East India Company, grew from the patronage of state, monarchy and colonial military ambition. In the 17th and 18th centuries, amid powerful advancements in science, production and economics in Europe following the Enlightenment, East India trading companies were set up to exploit Austrian, Dutch, Danish, French, Portuguese and Swedish national ambitions of trade with Asia.

The World Trade Organization (WTO) was set up in 1995 and coordinates trade agreements and negotiations among 159 member countries. It has promoted the removal of many barriers to trade and (controlled) freedom of movement of capital and labour has superseded the protectionist outlook that dominated before the 1970s. In fact, few countries can now afford to act in their own interests without being part of international (regional) trade agreements such as NAFTA (North American Free Trade Association), the EU (European Union) or ASEAN (Association of Southeast Asian Nations). Economically everyone is connected. In 2001 former Goldman Sachs chairman Jim O’Neill coined the acronym BRIC to highlight the importance of four emerging economies (Brazil, Russia, India and China) to the global economy in the coming 50 years. Recently he has come up with MINT, four countries (Mexico, Indonesia, Nigeria and Turkey) identified as the next centres of economic growth. Transnational organisations such as the IMF or the World Bank act as checks and balances on the flow and supply of money:

• Fiscal policy (demand side): the tactical or strategic use by governments of revenues and taxes in public expenditure to influence key macroeconomic factors such as employment, investment and industrial output.
• Monetary policy (supply side): the use (most typically) by central banks of interest rates to influence inflation, with the aim of maintaining economic stability in the medium and long term.
• Trade and exchange rate policy: increasingly being coordinated by members of the trading blocs, though severely under scrutiny following the subprime mortgage collapse in the US, the euro crisis in the EU and a decade of stagnation in Japan.

It’s worth restating that most of the world’s economies are based on capitalism, albeit in several forms. China, with a communist political system, has been fairly clear about the role of market capital in the economy since the 1990s.

The international business environment

Senior management needs to look at the macro factors in their environment that can influence their primary goals, or that might advantage their competitors. In the previous chapter we looked at this through the lens of a PESTEL. This is usually applied from the point of view of a single organisation as it looks outwards, but for the student of international business, a PESTEL is applied to the whole industry or sector, as in the example in Figure 9.1 for the airline industry.

A PESTEL must recognise the importance of the political and technological factors in the past, but really hints at the importance of social shifts and macroeconomic trends that will bring volatility for the future. For example, margins in the airline industry have been wafer-thin for some years, so identifying the right market to ensure a higher marginal return may be the primary task.

FIGURE 9.1 PESTEL analysis of the international airline industry

There are three sets of questions to ask about international business:

1. Why do businesses move outside their original national borders? What is the motivation?
2. How do they enable themselves to do this? What channels are available?
3. Which is the right channel to become international? Why do different firms choose different ways?

It is estimated that the world’s largest 500 MNEs now account for about 80 per cent of the world’s foreign direct investment (FDI) and that 75 per cent of these companies are headquartered somewhere in the ‘triad’ of the US, the EU or Japan.⁴ Why might this be so? Michael Porter looks to answer this question using an extension of his thinking on industry competitive advantage. The Porter diamond in Figure 9.2 is the result of research into what appeared to be the reasons for success among companies in clusters of industry types and locations.

The six aspects form an overall framework for analysis. Four are potential determinants of advantage and they interact and influence each other, while the two external variables of government and chance act on these determinants:

• Factor conditions: include those human, physical and capital resources available as supply of inputs in a location.
• Demand conditions: include market size, segmentation and access to consumers.
• Related/supporting industries: mainly seen in terms of partners in the supply chain of inputs.
• Structure of firms and rivalry: Porter believed that the presence of intense rivalry was the most important aspect driving the others.

FIGURE 9.2 Porter’s diamond model of competitive advantage
Source: Porter, M.E. (1990) The Competitive Advantage of Nations, Free Press. With the permission of The Free Press, a Division of Simon & Schuster, Inc., all rights reserved.

The main criticism of Porter’s diamond is that it analyses a situation using only the conditions in the host country. American academic Alan Rugman doubled the diamond in order to include determinants from both the home and host country. He suggested that the firm should consider both as one if you want a strong basis for building a regional or even a global business.⁵

Globalisation is sometimes confused with international business, but it is a bit more than that. It is the concept of a completely integrated, homogeneous and open worldwide economic system in which inequalities are gradually removed by economic development. Not only is that going to be very hard to measure, even as an ideal it is far from current reality because it is evident that large parts of the world, and most notably Africa, are comparatively poor. Globalisation is a study (by optimists or by pessimists) of barriers, tariffs and segmentation, and of the exploitation of economic or political inequalities for economic gain, and is therefore an aspect we will consider in Chapter 11.

For now, on closer inspection the majority of the world’s MNEs may be said to have regional strategies, not truly global ones.

Toyota’s decision is indicative of the ebb and flow of international trade and investment. Returning to the main question of why and how domestic organisations become international ones in the first place, two perspectives provide some answers.

The macroeconomic approach

FDI was once seen as the rational search by a company for a superior return on its capital employed by making an investment overseas. In practice, it’s often a lot more than capital that is invested, and in a lot more than just equity. Investment involves expanding a portfolio of business interests, blurring the boundaries between domestic and international:

• Supply-side reasons may explain MNEs moving location to where it costs less to produce.
• Equally, a demand-side wish to exploit untapped markets may be the reason.
• An MNE can take advantage of lower material costs in one place while out-supplying local competitors in their own market somewhere else.
• The removal of, or special exemption from, tariffs and trade barriers may be a key driver as large firms then move in.
• MNEs are often able to access much cheaper financing than local firms and their capital structure allows low-cost debt in strong currencies to trade in markets with weak ones. Because capital markets and national economies are cyclical and volatile, this may explain short-term cycles of takeovers.

Macroeconomic theory suggests that MNEs can also be explained by comparative advantage, that is, countries exporting and importing to capitalise on relative strengths and weaknesses in their available national resources or markets. For this reason, MNEs go where there is an efficient supply (for that country) of resource or labour.

The microeconomic approach

This tries to explain the MNE more in terms of the thinking that goes on inside the organisation. Senior management teams:

• are duty-bound to re-invest for growth wherever there is a better net return to be found, or they will physically follow where their market is growing. What starts out as a success in one market then moves to export to another, which in turn leads to competition and the need to adopt a suitable strategy for internationalisation
• are culturally better informed by their experience of foreign markets in general and this encourages MNEs to spread
• are trained to look for opportunities where a monopolistic or oligopolistic competitive advantage can be gained. This follows the idea that perfect competition cannot really ever exist – there will (even only for historical reasons) always be differentiation and inequalities in markets. The organisation that is best attuned to these is the one best placed to grow and expand, taking advantage of the economies of scale being an MNE can provide.

Economies of scale become standardisation, which in turn allows localisation of a central idea with adaptation (at a lower cost than a local provider can match) of goods and services in new markets. In short, managers use their knowledge of business administration principles to create value by choosing the lowest-cost location for any activity and grow by direct ownership of these assets (as long as the benefits outweigh the costs). Here we begin to understand the activities of MNEs as just an extension of the efficient management of resources outlined in all the chapters of Part 2.

Managing the two levels

This tension between seeing things from either a national or an organisational perspective is expressed in terms of one framework, the CSA–FSA matrix. CSA stands for country-specific advantages, which are those strengths such as geographic location, government policies, natural resources, human resources or levels of technology that nation-states may be said to possess or have access to. FSA refers to firm-specific advantages, or factors traditionally counted as strengths within a company or organisation (many of which we have been looking at in earlier chapters). Occasionally, the boundaries between the two become confused. The East India Company, Russian natural gas provider Gazprom and (at least until 2009) General Motors might all claim to represent something at both levels of structure and strategy.

John Dunning, a leading authority on the theory of the multinational firm, summed up many of these aspects into three types of advantages that determine why and how firms go international – ownership, location or internalisation (OLI).⁶ Ownership advantages are basically the same as the FSA features, while location advantages map closely to CSA. Internalisation advantages reflect how an organisation chooses to act on those perceived sets of advantages. Which routes or channels a firm should use to internationalise was, for Dunning, a question of best net return once all risk factors have been taken into account (as we saw in Chapter 8). Just because you can, it doesn’t mean you have to – expansion should not be a matter simply of a rush into new markets with capital investment unless alternatives can be shown to be less effective.

Putting it together: four routes to internationalisation

There are four main routes that an organisation can use to move its scope beyond the borders of its home country:

• Export. Usually the first channel to try, this form of trade is ‘as old as the hills’. Exporting represents the lowest risk but is susceptible to government tariff policies, the power that any intermediaries might exert and exchange rate risk as currencies move in relation to each other.
• Licence: Permission or rights given to a partner in the host country, in return for a fee, to trade in the (intellectual) property of the home company. The licensee often carries the majority of the costs and risk, but may also take a larger proportion of the margin than a distributor for an export.
• Contractual agreements/joint venture (JV): A JV may be the most sensible step into new markets in territories that are developing or emerging, or towards the sharing of know-how in preparation for closer cooperation. Finding a good match with a JV partner in terms of size, ambition and culture is really important. High levels of patience and trust are required. Many JVs fail because the time horizons set for them are too short to build a relationship.
• Foreign direct investment: Ownership of the entity and its assets in the host country, with consequent transfer and flow of home capital, know-how and (at least to begin with) management personnel. FDI may be via acquisition or green-field investment and gives the highest level of control – at the expense of agility or flexibility in exit. FDI is the most costly strategy, so any such transaction costs associated with the extra need to be less than the net advantage gained.

In reality, firms may employ more than one route or strategy, and the intricacies of international trade and tax regulation mean things are rarely as clear-cut as the theory would suggest.

Further reading

Notes

1 Soros, G (2013) The Shifting World Economy, Reversing Gears: year in review 2013, Project Syndicate.

2 Canada, France, the US, Italy, Japan, the UK and Germany.

3 The Economist Yearbook, 2014.

4 http://unctad.org/en/Pages/DIAE/World%20Investment%20Report/World_Investment_Report.aspx

5 Rugman, A.M. and Collinson, S. (2012) International Business, 6th Edition, Pearson.

6 Dunning, J.H. (1977) ‘Trade, location of economic activity and the MNE: A search for an eclectic approach’, in Ohlin, B. Hesselborn, P and Magnus, P. (eds), The International Allocation of Economic Activity, Macmillan.