How and Why Do Firms Internationalise - Essay Example

How and why do firms internationalise? Table of Contents Introduction 3 Concept of Internationalization 3 Reasons leading to Internationalization 4 Internal and external factors 4 Monetary Union influencing internationalization of firms 6 Advantages of economic integration in internationalization 7 Process of Internationalization 7 Methods of internationalization 8 Conclusion 10 References 11 Introduction Organizations across the world have moved their business across domestic boundaries. Businesses have moved from local to global. Business and trade have changed owing to such transition. This has helped organizational growth, but has also posed many challenges that have led businesses to strategically design their operational processes. Globalization witnessed the rise of transnational and multinational companies. Transnational companies have their business functions in different regions, but sell products and render services across the globe. For example raw materials are procured from Africa, assembly is done in Middle East and the final products are sold in Europe, UK, Asia, etc. A multinational company produces and sells in the country in which it operates. This has led organizations to leverage cost advantage. Though this is one of the important factors why firms want to expand their presence beyond national boundaries, but other reasons might be greater market access, new market opportunities, saturated domestic market, etc (Vaidya, 2006). Concept of Internationalization It is found that the basic premise of trade was similar in earlier context and even today. Today firms and companies i.e. collection of people and resources working towards a common goal, want to access better and cheap resources to increase effectiveness that will help them gain cost advantage. Similarly earlier civilizations would grow followed by discovery of new trade routes and lands that were fertile and conducive for harvesting crops. The concept is similar, but the growth rate of trade and speed has witnessed rapid change. Technology holds the key for such change. Rapid technological innovation and international policies have led to increased growth of trade and business. Technology has been the facilitator of change that has provided firms and business with opportunities. It simplified the process of trade and made it cost effective across national borders. International policies also led to open economies that led to better trade practices where trade became mutually beneficial (Stearns, 2009). Reasons leading to Internationalization Different characteristics of nations influence MNEs to develop strategic functions that will meet the desired standards and regulatory requirements of that nation. Different nations have different cultures and social norms that shape their values and beliefs. This shapes their perception and influences their behaviour. Firms have to take decisions after considering all the factors in producing and goods and services in emerging nations. Customer personality and buying behaviour are different this serves an opportunity for international firms to create more value for its goods and services. Firms in order to be globally competitive have to leverage low cost or economies of scale. This will be achieved only when they are able to stimulate demand of their goods and services in foreign nations that will lead to increased production (Heinecke, 2011). Internal and external factors Firms have internationalised owing to various market opportunities and trade facilitators. Firms have moved to a global platform owing to internal and external factors. Internal factors are firm specific i.e. it refers to internal reasons why firms expand their business operations across domestic boundaries. External factors are market opportunities and factors that have facilitated the globalization process. Firms would globalize if such external factors complement its internal reasons. The external factors that facilitate firms to internationalise are: • Reduced trade barriers – Some countries provide tax breaks and special subsidies to foreign companies that invest in other countries. Such perks are provided as the domestic companies and the economy are benefitted from foreign investment. • Capital and labour mobility – After the formation of World Trade Organization, trade across nations was simplified that allowed greater access to foreign capital and labour. The increased mobility of such factors of production has led firms to internationalise. • Improved transportation – The transportation cost over the years have decreased owing to large cargo ships and air transport. This has led to rapid growth in air travel that facilitated greater movement of goods and people globally. Large shipments benefit firms from low cost of transportation. The transportation cost per unit will reduce with the volume of transport. Lower transportation cost will lead to low operating cost for firms. • Technological innovation – Improvements in technology like the advent of internet and mobile telephony has facilitated free flow of information and integrated trade through effective communication. Countries have better access to products and services of foreign companies through web media that serves opportunities for foreign investment (Martell, 2010). The internal factors that are firm specific are as follows: • Greater access to resource and competitive advantage – Cheap labour and low interest rate influence firms to set up businesses in such countries that provide such opportunities. The domestic country might have high wage rate and cost of capital that will provide competitive advantage to firms that will benefit from low labour and capital cost. Developed nations like UK and US outsource labour for their products and services. Major software service exporters are the developing countries and the importers are the developed countries. This increases the foreign exchange reserve of the domestic country. • Economies of scale – Better opportunities in the foreign market led to increased production owing to high demand for foreign and high value products. Increased production will lead to lower per unit cost. Thus, this will allow companies to expand the scale of operations. • Increased growth – The domestic market might be saturated owing to increased competition. Firms seek newer markets where there are business opportunities. Opportunities can influence strategic decisions which include high demand of goods and services, cheap labour, low cost capital, low cost of technology, etc. Such factors complement the growth opportunities for firms under globalization (Campbell, 2004). Moreover firms invest overseas as a strategy to globalise. The reasons are invariably same if they were to expand their business operations in the domestic country. The above factor can be clubbed under four broad heads i.e. efficiency seeking, market seeking, resource seeking and strategic asset seeking. Monetary Union influencing internationalization of firms Currency fluctuations have impacted the business of transnational companies and Multinational companies. As there is no uniform currency or standard of exchange that is accepted by firms across the globe, thus demand and supply situations will affect the exchange rate. Exchange rate fluctuations influence the real earnings of international firms. Currency devaluation will lead to decreasing transaction value of subsidiary companies. Subsidiary companies usually import value added items from its parent company at the market exchange rate. Currency devaluation will make the import expensive and reduce the earning. This will result in the fall in group earnings. US based Mc Donald sales grew in Europe in the year 2011, but its annual profit was low owing to weak Euro. Thus, currency zones influence the business of TNC’s and MNC’s. The new monetary regime has led to economic integration i.e. monetary union that has facilitated trade across national boundaries and has served investment avenues for firms that aim to internationalise (Holroyd, 2002). Advantages of economic integration in internationalization Single currency area under the new regime of economic and monetary union benefits the MNE’s from various factors that lead to increased trade facilitation. There is uniform interest rate across the member countries that eliminate the risk of high cost of capital. This influences the borrowing of firms that is needed to fund their expansion plans. It leads to increased transparency as firms can compare the goods and services of other international firms operating in the currency zone. International firms enjoy low transaction costs owing to single currency. The currency risk is eliminated that gives greater flexibility for firms to operate in the currency zone. This will lead to increased trade volume between the member countries of the monetary union. Currency union will allow increased mobility of labour and capital across the member countries. This will benefit the MNE’s from increased trade relations between the member nations (Molyneux, 2001). Process of Internationalization Firms cannot internationalize overnight. It requires strategic plans that will lead to successful integration of resource and business processes. The process of globalization invariably extends the value chain of firms. The value chain comprises various internal and external stakeholders. Globalisation leads to restructuring business operating model. Many firms have restructured their value chain to align it with the needs and requirements of the foreign country. For example, General Motors of US builds nearly 90% of its cars based on the central-global framework. The rest is shipped to local plants where the final car is manufactured considering the local tastes and preferences of the customer. Thus, centrally managed supply chains are subject to high risk exposure like the case of General Motors. If any of the stakeholders in the supply chain defaults, this will lead to a chain of effects and will create supply bottlenecks. Thus, following the recent trends firms have become multinational from transnational. Transnational firms have different functions in different regions of the world, owing to low cost of capital and labour. They have a centralised supply chain, where value added inputs are procured from different regions and are assembled in their core plant and later the final product is shipped across the globe. This helps firms with low cost of operations, standardised product and quality consistency. Multinational companies on other hand have decentralised supply chain. They produce and sell goods in the same country in which it operates. It reduces the risk of centralised value chain which is less flexible compared to the latter. Usually firms internationalise by mobilising capital and labour across domestic boundaries i.e. through foreign direct investment (Hackmann, 2005). Foreign direct investment refers to investments made by a company or firm of a country in another country’s firm or company in the aim of exercising high degree of control and influence over the firm. Economies which are open and are characterised by high growth prospects and cheap factor inputs attracts foreign investments than economies which have high degree of regulation and high cost of factor inputs like capital and labour (Kiggundu, 2002). Methods of internationalization Firms can make overseas investment or internationalise in many ways i.e. horizontal integration, vertical integration, conglomerate, greenfield entry or mergers/acquisitions. Horizontal integration – This refers to an investment by an entity in one country in another country’s entity which is in the same business as the investing company. In other words where firms invest in the same business abroad. For example Japanese car manufacturer Toyota assembling cars in Japan as well as in UK. Vertical integration – It means when a firm or a company invests in one of its stakeholders in the value chain or supply chain. In context of vertical integration there are two more types’ i.e. forward and backward integration. Forward integration refers to the vertical integration where investments made by the firm or company allow it to reach the end market or its customers easily. For example in the above case of the Japanese car manufacturer Toyota, if it buys a distributor in UK to sell its product. Distributors in the supply chain lie close to the customers and thus through forward integration allow companies to enjoy easy market access. On the contrary backward integration is when Toyota acquires a car glass manufacturer. Conglomeration – This is when a company or a firm acquires or invests in a company which belongs to a different industry than the industry of the investing company. Firms try to form conglomerates in the aim of entering new markets and industries. It is characterised by high risk exposure of investing firm. Greenfield investment – Refers to the investment where a firm or company makes investment in foreign country from the scratch. It builds its own factories and plants. It operates in the foreign country with its fully owned subsidiary. For Example where car manufacturer Honda had set up its operations in UK by building its own manufacturing plant through greenfield investment. Brownfield investment – The strategic partnering and acquisitions of foreign entities as a strategy of internationalization is known as brownfield investment. Usually large corporations acquire small firms to gain competitive advantage abroad. Strategic alliance takes place between companies in the same industry or cross industry where companies or firms want to venture in a new business. In strategic alliances firms usually leverage each other’s resources i.e. capital and labour in their new venture. For example, the acquisition of Land rover and Jaguar from Ford by Tata Motors of India. Tata did not have to build high technology plants to manufacture luxury cars and SUVs; it bought Ford’s plant and machinery to meet its strategic plan of venturing in the luxury car market (Vaidya, 2006.). Conclusion Globalization has increased the risk exposure of firms. Firms are subject to market risk, foreign exchange risk, and environmental risk, economic, political and technological risks. Social and cultural diversity are other two critical factors that influences the strategic decisions of firms that want to access the foreign market. Globalization has not only benefitted businesses, but has also increased capital inflow in emerging economies, developed local communities, generated employment, etc. Firms can internationalise in many ways i.e. strategic alliance, merger and acquisition, wholly or partly owned subsidiary. Merger and acquisition are inorganic growth strategies of a firm, whereas having its own subsidiary leads to organic growth. Though the benefits of globalization outweigh the negatives, it can be detrimental for various economies. It might lead to increased competition that will drive the small firms out of business. This will lead to unemployment problems and further create other macro economical imbalances (Tiplady, 2003). References Campbell, L. J., 2004. Institutional change and globalization. USA: Princeton University Press. Hackmann, R., 2005. Globalization: myth, miracle, mirage. USA: University Press of America. Heinecke, P., 2011. Success factors of regional strategies for multinational corporations: appropriate degrees of management autonomy and product adaptation. USA: Springer Science & Business Media. Holroyd, C., 2002. Government, international trade, and laissez-faire capitalism. Canada: McGill-Queens Press. Kiggundu, N.M., 2002. Managing globalization in developing countries and transition economies: building capacities for a changing world. USA: Greenwood Publishing Group. Martell, L., 2010. The sociology of globalization. UK: Polity. Molyneux, G.T.C., 2001. Domestic structures and international trade: the unfair trade instruments of the united states and the european union. USA: Hart Publishing Stearns, N. P., 2009. Globalization in world history. USA: Routledge Tiplady, R., 2003. One world or many?: the impact of globalisation on mission. USA: William Carey Library. Vaidya, K. A., 2006. Globalization: encyclopedia of trade, labor, and politics, volume 1. USA: ABC-CLIO. Read More