To start off this essay on why and how firms become multinational enterprises the definition of a multinational enterprises should be looked at which can be defined simply as a company with production and/or sales operations in more than one country (Begg & Ward 2007). To truly understand why firms become multinational a look at trade across international borders has to be taken into account. Adam Smith's (1776) work on the absolute advantage stating that a country must be more efficient than any other country at producing a given good or service. This theory is simply saying that a firm should always seek out the cheapest way to produce or deliver a service and seek out where it can produce the same product overseas with lower production costs. This was modified by David Ricardo (comparative trade) saying that even when absolute advantage exists countries should still produce themselves and trade internationally as they can benefit from the international trade.
Heckscher-Ohlin theory takes the work of Ricardo even further that "traded commodities are really bundles of factors (land, labour and capital).the exchange of commodities internationally is therefore indirect factor arbitrage, transferring the services of otherwise immobile factors of production from locations where these factors are abundant to locations where they are scarce"(Leamer 1995). This brings us closer to understanding why firms become multinational because it shows us that products and services can be delivered at a lower cost to the global market.
Another reason put forward as to why firms become multinational can be looked at through the works of Vernon (1966). He talks about the product life cycle of items from conception to maturity. According to Vernon (1966) initial parts and labour costs are derived in the home country and once it has saturate the home market its price will fall increasing demand in foreign countries which leads to the exportation of the products. As the firm seeks to sale its products in the new markets it looks at locations where it can produce at lower costs for parts and labour (transportation also been looked at). Once this has been established it gradually shifts its base of production from the home country to that of lower costs. This carries on throughout the various stages of the product-life cycle which in turn will encourage firms to become multinational. This is because they all want to increase the length of their product life cycle and the one way of doing this is by trading internationally, understanding the ever changing markets in various countries. Also it's been used to reduce the barriers to entry into certain continents by setting up a base of operations in that country.
There however is a theory that merges both the why and the how firms become multinational enterprises which brings us to internalization. This theory firstly takes advantage of the various imperfections that occur within the global market place. It also looks at the Ownership specific advantages (OSAs) which involves the ownership of certain intangible asset (e.g brand name) in a country outside it home country. This intangible asset should be one that will give them a competitive advantage over their competitors in the same industry in the new country. The final condition for internalization to occur is the Location specific advantages. These are said to be the advantages that an organization gets from having a base of operations in another country where it can derive lower costs of production (such as labour costs, natural resources etc). A combination of all this will allow internalization to occur as the firm will like to exploit itself to achieve a competitive advantage against others in the same industry across borders. A further look at the works of Dunning (1993) where he talks about the types of multinationals enterprises. The first of the multinationals is the resource seeker which crosses the borders of its home country in the search of resources that are cheaper abroad or does not have readily in its home country. Within the resource seekers Dunning further categorized them into those firms that are seeking physical raw materials. The other been the resource seekers looking for cheaper labour (skilled and unskilled) as they have higher labour rates in their home countries whilst the final resource seeker looking for technological advancements through collaborations (mergers and acquisitions included) with other firms in foreign countries.
The second type of multinational according to Dunning is the market seeker. It establishes itself in a country solely to supply its goods and services to that country whilst still having its competitive advantage. He (Dunning) states that this is done for various reasons such as variation in cultures of home country and the new country, its competitors might have also moved into that new market so as not to lose market share it also does the same, might want to have a presence in the main markets around the globe. This type of market seeking is also done because some governments encourage it by giving them various types of grants.
The third type of multinational is the efficiency seeker which rationalizes the foreign direct investment that has been put in place by the previously mentioned types of multinationals. The final type according to Dunning is the Strategic asset seeker which buys up assets abroad to increase its international competitiveness. A final note as to why organizations become multinational enterprises is due to various barriers to entry and government policies that might be in place in that country.
Now this part of the essay will look at how firms become multinational enterprises. This can occur in a number of ways with the first and most popular been Foreign Direct Investment (FDI). According to Hill (2001) he says that FDI occurs when a firm decides to invest in a production plant to manufacture or market good/services in a location outside its home country. The next route that can be used would be through the use of a licensing agreement. An agreement is setup between the firm and the licensee allowing them use the firms intangible asset (potentially brand name) for a predetermined period of time. This is done when the market conditions in the new country are not certain and too much financial risk is involved. With this agreement the company limits its risks whilst collecting royalties.
Some firms become multinationals through strategic alliances with other firms which may not necessarily be in the same industry but one which could give them a competitive advantage of the local firms. Another way would be through the acquisition of an already existing organization in that country. This organization might be one that is not performing at its optimum levels given room for a takeover bid. A joint venture is another route to becoming a multinational enterprise which involves setting up a business with another owned equally between them. Each firm will be bringing their various strengths into the new business venture. This reduces the risks on both sides and they both share the profits made. In this case if the second firm is a local firm (generally the case) it will have the understanding of the local knowledge and me able to produce and market accordingly.
To bring this whole essay and to answer the initial question asked as to why firms become multinational. This can be said to have come about due to the lack of perfect market conditions. This imperfect conditions gives rise to resources not been shared equally across borders. To save productions cost and to stay competitive firms need to seek out these alternate sources for the resources required in the production or delivery of their service. This is clearly pointed out through the work of Dunning pointing out the various types of multinationals. Also it can be said to be done to extend the life cycle of the firm. The second part of the question asking about how firms become multinational enterprises which revolves around the market entry strategy that is adopted by the firm that wishes to become multinational. As organizations vary so each organization will require a different entry mode to becoming a multinational.
