Class

Notes 7
Multinational Formation

Momo Deretic
Sauder School of Business
 Main points
Where should we do the things we do?

At home: the country where top mgmt is based.

Abroad: offshore, overseas, in a foreign country

The answer: It all depends on the 4

elements of MNE strategy: trade costs, factor
advantages, PLEoS, market sizes.
 Levels of Multinational Strategy
Who is the we in Where should we do it?
An individual business unit business strategy
A collection of business units under the same
ownership corporate strategy
A collection of business units linked through a mix
of equity ties and long term contractual
arrangements network strategy
 Multinational (single) Business Strategy
Home Country Foreign Country
Home Centralization
(Exporting)

H-form

Replication

R-form

Foreign Centralization
(Importing)

F-form
 Examples of Centralization
Home Centralization:
Boeing commercial aircraft assembly in U.S.
(mainly Seattle)
Airbus commercial aircraft assembly in EU (mainly
Toulouse)
Foreign Centralization:
Mattels Barbie dolls (2 factories in Dongguan,
China +1 in Malaysia +1 in Indon.)
Matsushitas TVs (Malaysia)
 Nestle, the Replicator
254,000 Employees in 508 Factories in 85 Countries
(2002 Management Report)

Area Sales Factories Employees

Americas 40% 32% 41%

Europe 40% 41% 34%

(Switz.) (1.6%) (1.8%) (2.6%)
Asia, Africa 20% 27% 25%
& Oceania
 Definitions:
WH, WF, - Factor costs of productions
(labor/wage)
MH, MF - Market size (home and foreign)
KH, KF Fixed costs of production (home and
foreign)
TH, TF Trade costs (F exporting, H
importing)
T = BF+ dDF
B- border effects
d trade cost per kilometer
D total distance to the foreign market
 Some assumptions
WH and WH are factor costs that are mainly
made up of labor costs (wage)
MH and MF are given (number of customers in
home and in foreign)
KH and KF are assumed to be about equal
When incurring foreign centralization costs
(shutting down home plant and relocating it
to foreign country), part of KH has low salvage
value (close to zero)
 The costs of centralization versus
replication
Costs of home centralization:
CH= wH MH + (wH + TF)MF + KH

Costs of foreign centralization:

CF= wFMF + (wF + TH)MH + KF

Costs of replication:
CR= wHMH+ wFMF + KH + KF
Critical Foreign Market Size to Justify Overseas
Replication
Critical Distance to Justify Overseas Replication
Home Centralization benefits from
Strong PLEoS
Low trade costs to export to foreign country
Large home market
Home country has factor advantages
 Foreign Centralization benefits from
Strong PLEoS
Low trade costs to import from foreign
country
Large foreign market
Foreign country has factor advantages
 Replication Form benefits from
Weak PLEoS
Both markets are large
High trade costs impede exports & imports
Unimportant factor advantages: costs of
production similar across countries.
 Multi-product Multinationals
Corporate multinational strategy considers
best form for firms operating in more than
one business (product).
Relationships between products:
Unrelated
Vertical (intermediate inputs vs final outputs)
Horizontal (complements vs substitutes)
Joint products
 Multinational Forms: Vertically Related
Products
Upstream (U) creates inputs
Downstream (D) uses U inputs to create outputs
Examples:
Teaching: U is PPT preparation, D is presentation to
students
Movies: U is writing & casting, D is filming & editing
(or U is movie production and D is movie exhibition)
Steel: U is blast furnace, D is steel furnace & rolling
mill
 ExxonMobil
Upstream: exploration in 37 countries and
production in 26 countries
Downstream: refining and marketing
Owns 45 refineries, located in 25 countries
Operates 37,000 retail sites in 100+ countries
presence in about 200 countries
 Vertical Specialization good if
Strong PLEoS
Low trade costs to export U to foreign
country
Low trade costs to import D from foreign
country
Home country has factor adv. for U
Foreign country has factor adv. for D
 Major takeaways
Multinationals that produce/sell several
products will adopt an organizational form
that maximizes their overall revenues and
profits. In practice today, it means
Less Replication
More Vertical Specialization
Please note that different MNCs face very
different industry conditions and thus
different organizational challenges. (One size
does not fit all).