This document provides an overview of international business economics and the rise of multinational corporations. It begins with definitions of key terms like foreign direct investment, globalization, and multinational corporations. It then discusses the origins and evolution of international business, from nationally-focused firms to multinationals. The document presents facts about the increasing scale and scope of multinational activity. Finally, it introduces some of the main issues debated in international business economics, such as why firms become multinationals and how their strategies are shaped by interactions with governments and international competitiveness.

1. International Business Economics
Lecture Notes
Christos Pitelis
January 2004

2. 2
Contents
1. Introduction: Globalisation (Nature, Evolution,
Perspectives)
2. Why Multinational Corporations (MNCs) and
Foreign Direct Investment (FDI)?
3. Strategy and Strategic Options of MNCs
4. MNCs, Government Policy and (Inter)national
Competitiveness - Overall Conclusion and the
Future of MNCs

3. International Business Economics
Session 1
Introduction: ‘Globalisation’
(Nature, Evolution, Perspectives)

4. 4
Exhibit 1.1: A Framework
POLICY-
STRATEGY
(INTERNATIONAL)
COMPETITIVENESS
FIRMS
(Business,
Competitive)
GOVERNMENTS
(Competition,
Industrial)
THEORY

5. 5
The Nature and Scope of
International Business
• International Business (IB) deals with the
nature, strategy and management of international
business enterprises and their effects on
business and national performance (e.g.,
efficiency, growth, profitability, employment).
• IB is interdisciplinary. It draws, among others, on
economics, politics, sociology, marketing,
management (human resources, strategic).

6. 6
Some definitions (i)
• FDI is the control of production which takes
place in one country (‘host country’) by a firm
based in another country (‘home country’). FDI is
the defining feature of the multinational
corporation (MNC).
• Globalisation refers to the increasing
integration of markets (exchange) and
production, to include the mobility of resources
(capital, labour, ‘organization and knowledge’).

7. 7
Some definitions (ii)
• A firm is an organisation which produces
commodities for sale in the market for a profit,
and allocates resources (such as capital and
labour) without direct reliance on the price
mechanism (the market) on the basis of internal
entrepreneurial decisions (hierarchy).
• An MNC is a firm which controls production in
countries other than (and including) its home
base.

8. 8
Some definitions (iii)
• The market (price mechanism) is an institution
of resource allocation, based on voluntary
exchanges (transactions) by individuals,
motivated by preferences and market prices.
• The state is an institution which allocates
resources and influences the organization of
economic activity through a legal monopoly on
force.

9. 9
Origins of IB (i)
• IB is the result of the internationalisation of
production and the emergence of the
multinational corporations (MNCs), the
subject matter of IB.
• Internationalisation of production (‘globalisation’)
involves international capital flows, international
trade of commodities (exports-imports) and
Foreign Direct Investment (FDI) by MNCs.

10. 10
Origins of IB (ii)
• Until the 1980s, there has been a tendency towards concentration of
industry, and oligopolistic market structures. Firms have observed a
‘law of increasing size’ consisting of four stages:
– First, the owner managed and controlled small firm (nineteenth
century).
– Second, the public limited ‘national’ company (limited liability,
separation of ownership from management).
– Third, the multidivisional (M-form) organisation (division- based),
separation of strategic (long term) and operational (day-to-day)
decisions.
– Fourth, multinational corporations (MNCs) with production
activities outside (and including) their home-base.

11. 11
Exhibit 1.2: The unitary (U-form)
firm
Chief Executive
Financial and
Accounting
Department
Personnel
Department
Sales and
Marketing
Department
Production
Development

12. 12
Exhibit 1.3: A multidivisional (M-
form) structure
Head Office
Division A
Functions
Division C
Functions
Division E
Functions
Division B
Functions
Division D
Functions
Central Services (e.g., Finance)

13. 13
Exhibit 1.4: A holding company
structure
Parent Company
Head Office
Company A
(wholly owned)
Company C
(90% owned)
Company E
(25% owned)
Company B
(wholly owned)
Company D
(75% owned)

14. 14
Some facts and trends in IB (i)
• International trade inside the world’s largest 350 MNCs
accounts for almost 40 per cent of world merchandise
trade.
• The world’s largest MNCs (e.g., General Motors, Exxon,
Microsoft etc) have annual sales higher than the annual
gross national product (GNP) of all but around 15 nation
states.
• In the early 2000s in the USA, nearly half of
manufacturing exports and around two thirds of imports
were flowing within MNCs (intra-firm trade).

15. 15
Some facts and trends of IB (ii)
• FDI increased by over 20 per cent between 1985 and
2000, twice the growth rate of exports or output.
• In the period 1991-2000, 63 per cent of global FDI flows
was received by the developed countries (DCs) (down
from almost 80% in 1989), around 33 per cent by
developing countries and just over 3 per cent by Eastern
European countries.
• Among the developing countries, China receives the lion’s
share of FDI.

16. 16
Some facts and trends of IB (iii)
• Within the DCs, the US, the UK, Canada, France and
Germany are leading players.
• Since 1960 the relative importance of the US and the UK
as sources of outward FDI has been declining.
• In the ‘Triad’ (Europe, USA, Japan), total FDI between US
and the EU was almost one third of global FDI in 2000.
• European FDI is largely due to M&As.
• FDI declined sharply in 2001 (over 50%, the largest drop
in 30 years), 2002 and 2003.

17. 17
Some issues in IB (i)
• The main issues which arise from the facts and
trends of FDI concern the following:
– Why international production, FDI and MNCs?
– How do (should) MNCs conduct their business
strategies? (competitive and corporate strategies)

18. 18
Some issues in IB (ii)
• What is the relationship between MNCs, nation
states (in developed and developing countries)
and international organisations and what is the
impact of MNCs on growth and development?
• What is the link between MNCs and international
competitiveness?

19. Background 1 (pp 20-28, starts
here):
Firms & Industries

20. 20
History
Growth
(U-form) Firm, Competitive Industry
Organic (Internal)-Vertical integration, External-Mergers and Acquisitions
‘National’ (Public Limited) Company, Industry Concentration, Oligopoly
(M-form) Firm, Diversification (Related, Unrelated-Conglomerate)
Foreign Direct Investment, Transnational Corporations (TNCs), Global Firms

21. 21
Firm integration “Strategies”
• Vertical Integration (VI): Backward (raw materials) and
forward (distribution).
• Mergers and acquisitions (M&A): coming together of two
or more firms.
• Conglomerate diversification: operations-expansion of
firms in ‘unrelated’ products-markets.
• Foreign Direct Investment (FDI) and MNCs.
• ‘Hybrid’ (networks, clusters, joint ventures, strategic
alliances …)

22. 22
Main perspectives
• (Market) Power: Firms pursue profit
and/through (market) power.
• Efficiency: Firms pursue profit through reduction
of production and transaction costs.
• Hybrid: Firms pursue profits through efficiency
and (market) power.

23. 23
Theories (i)
• Neoclassical: Firm is ‘a production function’, a ‘black box’; it is
concerned with the industry price-output ‘equilibrium’, which
maximizes profits. Price-output equilibria depend on market structure,
e.g., perfect competition, monopoly.
– Managerial: Firms maximize utility of managers, e.g., sales
revenue, growth. Based on alleged ‘separation of ownership from
control’.
– Transaction Costs: Firms are multi-person hierarchies which
result from, and give rise to reduced market transaction costs,
resulting in efficient industry structures.

24. 24
Theories (ii)
• Resource-Based: Firms are bundles of human
and non-human resources under administrative
co-ordination. There are internal and external
stimuli to growth which lead to industry
concentration.
• Behavioural: Given ‘bounded rationality’ and
different objectives of groups within them, firms
do not maximize, they ‘satisfice’.

25. 25
Theories (iii)
• ‘Austrian’ - Chicago School - Schumpeterian: Alert,
profit seeking entrepreneurs, enhance market co-
ordination and give rise to ephemeral monopoly profits,
eroded through competitive process of ‘creative
destruction’ (innovations).
• ‘Marxist’: Firms produce commodities for sale in the
market for a profit, under hierarchical control of capital
over labour. Dialectic link between competition and
monopoly, for maintenance of monopoly (power).

26. 26
Some critical elements for
economic analysis (DISCO) (i)
• Demand (D): The demand conditions firms face,
in the form of a Demand Curve, derived from
‘Theory of Demand’.
• Industry Structure (IS): The extent of industry
concentration, barriers to entry, etc, leading to
competitive, imperfectly competitive, oligopolistic,
or monopolistic industry structures.

27. 27
Some critical elements for
economic analysis (DISCO) (ii)
• Costs (C): The cost conditions faced by the firm, in the
shape of a Cost Curve, derived from ‘Theory of
Production and Costs’.
• Objectives (O): The firms’ aim. It allows the derivation of
price-output ‘equilibria’. Usual assumption is profit
maximization (Marginal Cost equals Marginal Revenue).
Others are maximization of sales revenue or growth.
Alternatives are ‘satisficing’, ‘entrepreneuring’…

28. 28
Exhibit 1.5: Monopoly versus
Competition
, minimum
efficient scale
PM monopoly
price
PC perfect
competition
price
Q
P
PM
PC
LAC = LMC
QM
MR
D
QCQ
0
Q
[End of Background 1]

29. 29
‘Globalization’: causes
• Firm growth because of
– Use of excess internal resources at near zero
marginal cost
– Sale of products to new markets at high profit
rates (due to high fixed costs).

30. 30
‘Globalization’: facilitators
• Reductions in transportation costs.
• Improvements in information and communication
technologies.

31. International Business Economics
Session 2
Why MNCs and FDI?

32. 32
The Multinational Corporation
(MNC)
• Definition
– MNC = firm which controls production
across national boundaries through intra-firm
(non-market) operations.
• Question
– Why MNCs as opposed to exports,
franchising, licensing, etc. ?

33. Background 2 (pp 32-65, starts
here): Perspectives on the theory of
firm

34. 34
The Neoclassical analysis (i)
Simple Market Structure Analysis (Perfect
Competition vs Monopoly)
• Perfect Competition defined: Market
structure characterised by a large number of
profit maximising buyers and sellers selling
homogeneous products, and no entry barriers.
• Result: Price taking behaviour, price at
minimum long run average cost (LAC) curve ⇒
‘normal’ profits.

35. 35
The Neoclassical analysis (ii)
• Monopoly defined: market structure
characterised by a single profit maximising
producer and very high entry barriers (no entry).
• Result: monopoly prices exceeding minimum
LAC ⇒ ‘Excess’ (monopoly) profits.
• Conclusion: departures from perfect competition
result in increases in prices and reductions in
output. Also to ‘welfare losses’ due to ‘monopoly
power’.

36. 36
The Neoclassical analysis (iii) -
Oligopoly
• Defined: market structure characterised by
interdependence of (usually a small number of)
producers-firms. Duopoly is the case of two
firms.

37. 37Exhibit 5: Industrial Organisation (IO) and
the
S(tructure) - C(onduct) - P(erformance) model
• IO Defined: Branch of economic theory
analysing structure-conduct and
performance (SCP) of oligopolistic
industries (set of firms producing similar
products).
• SCP Model: Suggests there exists a
(initially unidirectional) link between
structure (S), conduct (C) and performance
(P) of industries. Feedback relationships
from conduct and/or performance to
structure later allowed for.
• Main Focus: The concentration (S) -
Profitability (P) relationship assuming
profit maximisation (C).
• ‘New IO’ analyses impact of conduct on
structure and performance in oligopolistic
games.

38. 38
Theoretical specification of
industry structures
1. Limit pricing
2. Unconstrained profit maximizing oligopoly
3. Contestable markets

39. 39
1. Limit Pricing
• Assumes constrained profit maximisation
(maximum profits subject to no entry), barriers to
entry (minimum efficiency scale) and that
incumbents leave post-entry output at pre-entry
levels and entrants know this.
• Result: Limit price derives from limit output found
by subtracting the minimum efficient scale level of
output from the perfect competition level.

40. 40
Exhibit 2.1: Derivation of the limit
price
• PL is determined by QL, i.e. the level to which, if the MES
was added, the competitive output would result, thus PC,
thus no ENTRY.
RULE:
Q Q
P
PL
PC
QL QQC
D
Q
LAC
0
Q Q QL C= −

41. 41
2. Unconstrained profit
maximising oligopoly
• Assumes blockaded entry and joint profit
maximising price-output levels (Monopoly). Entry
is blockaded through strategic entry barriers, e.g.,
investment in excess capacity.

42. 42
3. Contestable markets
• Assume free entry and costless exit. This
ensures perfectly competitive price-output levels,
even in the presence of economies of scale and
oligopolistic market structures, as any departures
from perfectly competitive prices lead to hit-and-
run entry and exit.

43. 43
IO models compared
• Main issue is the nature and importance of entry barriers,
both ‘innocent’/structural (scale economies) and
strategic (conscious actions by incumbents designed to
deter entry), e.g., excess capacity, product proliferation.
• Well analysed strategic entry deterrence strategy, the
investment in ‘excess capacity’. In the limit even
monopoly pricing is sustainable if incumbents have
excess capacity sufficient to produce full perfect
competition output. To be credible, excess capacity
investment should be optimal post-entry.

44. 44Exhibit 2.2: An expository
diagrammatic framework to Industrial
Organisation
, minimum
efficient scale
QS, strategic
capacity output
PM monopoly price
PL limit price
PC perfect
competition
price
Q
P
PM
PL
PC
LAC = LMC
QM
MR
QS
D
QL QCQ
Q
0
Q

45. 45
Firm-industry structures and
business strategy
• Oligopoly, crucial for (competitive) strategy, which is
absent in cases of both perfect competition and
monopoly. Emergence and effects of oligopoly analysed
by theory of Industrial Organization (IO), which is based
on and extends the Cournot/Bertrand models of oligopoly.
• M-Form organisation is important condition for
development of corporate strategy (existence of
multitude of business units).

46. 46
Theory of Firms & Industries:
Alternative Perspectives
• Transaction Costs, Markets and Hierarchies
• Resource-Based and related perspectives

47. 47
Transaction Costs, Markets &
Hierarchies (i)
• Origin: Coase (1937)
• Assumptions
i) Market is ‘original’ means of resource
allocation =>
ii) Existence of hierarchies (e.g., firms) due to
market failure
• Nature of market failure
– Cognitive (natural) not structural; i.e., due
to transaction costs and not monopoly power.

48. 48
Transaction Costs, Markets &
Hierarchies (ii)
• (Market) Transaction Costs are costs of information,
bargaining, contracting, policing and enforcing
agreements.
• Main Proposition (Coase, Williamson, etc.):
internalization of markets by hierarchies, i.e.,
replacement of voluntary exchanges with hierarchy =>
savings in transaction costs => hierarchy (firm) more
efficient way to allocate resources.
• Horizontal and vertical integration, the M-form, and
conglomeration result from pursuit of transaction cost
reductions.

49. 49
Transaction Costs, Markets &
Hierarchies (iii)
• Policy Implications
– In neoclassical approach departures from perfect
competition => market failure (structural) =>
=> need for government intervention.
– In transaction costs approach hierarchies (including
M-form conglomerates and MNCs) =
efficiency improving solutions to (natural)
market failure =>
=> less need to interfere with the markets.

50. 50
Resource-based & related
perspectives (i)
• Early work by Penrose (1959)
– Firm = “a collection of resources bound together in an
administrative framework, the boundaries of which are
determined by the ‘area of administrative co-ordination
and authorative communication’” (Penrose, 1995, p xi).
– Focus on ‘the internal resources of the firm’, then the
external environment. Latter is different for each firm
depending ‘on its specific collection of human and
other resources’. Environment can be manipulated by
firms to serve their objectives.

51. 51
Resource-based & related
perspectives (ii)
• Dynamic interaction between internal and perceived
external environment (‘image’, and ‘productive
opportunity’).
• Endogenous Growth, results from
i) resource indivisibility,
ii) knowledge creation within firms, which releases
resources.
• A firm’s prospects are in terms of existing and new
products; diversification as new markets become
relatively more attractive than existing ones.

52. 52
Resource-based & related
perspectives (iii)
• Knowledge is tacit.
• ‘History matters’, growth is an evolutionary process,
based on cumulative growth of collective knowledge in the
context of a purposeful firm.
• Rate of firm’s growth limited by growth of knowledge
within it, and a firm’s size by the extend to which
administrative effectiveness continues to reach expanding
boundaries.

53. 53
Resource-based & related
perspectives (iv)
• Firm strategies result of differential capability, e.g.,
– Vertical Integration, due to ability of firms to serve their
own needs better.
– Diversification, due to growth and multiple applicability
of resources.
– Mergers and Acquisitions; to acquire managerial
resources for expansion.
– MNCs, due to differential ability e.g., in transferring
tacit knowledge (Kogut-Zander).

54. 54
Resource-based & related
perspectives (v)
(Nelson & Winter, 1982)
• In Nelson and Winter’s evolutionary theory of the
firm, routines, search (changes in routines) and
competition are economic analogues to genes,
heredity and struggle for existence in biology.

55. 55
Resource-based & related
perspectives (vi)
(Capabilities-based)
• Use and develop hard to imitate and costly to
apply internal capabilities.
• Rents in equilibrium.

56. 56
Resource-based & related
perspectives (viii) (knowledge-based
theories, Penrose, etc.)
• Firms better than markets in using, preserving,
transferring and developing knowledge.
• Value creation – growth through knowledge and
value appropriation.

57. 57Resource-based & related
perspectives (ix) (Richardson and
co-operation)
• “Dense network of co-operation and affiliation by which
firms are inter-related.”
• Markets, hierarchy and networks are a function of degree
of complementarity and similarity of activities
– weakly complementary activities => MARKET
– complementary and similar activities => HIERARCHY
– complementary and dissimilar activities => CO-
OPERATION
[End of Background 2}

58. 58
Theories of the MNC
• Two main types:
- Supply-side
- Demand-side
- Other factors – “theories”
• Supply-side theories. Mainly
- Monopolistic – ‘ownership’ advantage
- Transaction costs and internalisation
- Eclectic theory (or Ownership, Location, Internalisation - OLI
paradigm)
- Divide and rule
- Resource-based

59. 59
Supply-side theories:
Monopolistic ‘ownership’ advantage
(i)
• Origin: Hymer’s 1960 PhD thesis
• Assume: ‘Law of increasing firm size’: Firms
growth leads to concentration and acquisition of
monopolistic advantages (MAs).
– Firms’ pursuit of (monopoly) profit => seeking
overseas markets.
– MAs allow firms to outcompete foreign rivals.
– MNCs aim at reducing conflict.

60. 60
Supply-side theories:
Monopolistic ‘ownership’ advantage
(ii)
• Choice of FDI over market-based alternatives
due to control potential and oligopolistic
interaction.
• Collusion allows reduction of conflict and
maintenance of monopoly profits.
• Conclude: Structural market failure => MNCs =>
(international) structural market failure

61. 61Supply-side theories:
Transaction costs - internalization
(i)
• Existence of firms =>
Economising in transaction costs => Firms
more efficient than markets
• In case of MNCs, choice is between market
transactions, e.g., exporting, licensing and non-
market transactions, i.e. Foreign Direct
Investment (FDI).

62. 62Supply-side theories:
Transaction costs - internalization
(ii)
• Reasons for FDI
– Williamson: asset specificity => hold-up problems =>
need for fully owned subsidiaries (FDI).
– Buckley & Casson: intangible assets exhibit ‘public
goods’ attributes, thus result in appropriability
problems => market failure.
– Hennart: internalization of markets due to differential
ability to control (overseas) labour.

63. 63Supply-side theories:
Transaction costs - internalization
(iii)
• Conclusion
Internalization of markets through MNCs are
efficient solution to intrinsic (transaction costs-
related) market failure.

64. 64
Supply-side theories:
Eclectic theory (or ‘OLI paradigm’)
• Dunning, combined a and b as well as location
advantages to provide ‘eclectic theory’ or
O(ownership), L(ocation), I(nternalization)
paradigm.
• OLI explains internationalization of production,
not the MNC.
– O explains why firms are able to become MNCs.
– I explains why they benefit from internalizing markets
or advantages.
– L explains the choice of location.

65. 65
Supply-side theories:
Divide and Rule (Sugden)
• Builds on Marglin-Hymer
• Focuses on labour markets. He suggests that a
reason for MNCs is their ability to divide labour
(unions) in country specific groups => Reduce
their bargaining power => increase their profits.

66. 66
Supply-side theories:
Resource-based
(Penrose, Teece, Kogut-Zander)
• MNCs are due to endogenous growth and
differential capabilities vis-à-vis market and other
firms.
• Growth can be national (diversification) or
geographical (MNC).
• MNCs are better in transferring internationally
tacit knowledge than markets.

67. 67
Demand-side theory (i)
• Cowling & Sugden, Pitelis: increased
concentration => increased profits => reduced
consumers expenditure (because a lower
proportion of profit is consumed than of wage
income).
• As consumption decreases so does effective
demand => going overseas for demand outlets.

68. 68
Demand-side theory (ii)
• The MNC as an All Weather Company
– Diversified national firms can ride the industry
life cycle (Hymer).
– MNCs can ride the national business cycle,
becoming All Weather Companies.

69. 69
Other factors – ‘theories’
• Oligopolistic rivalry
– Present in most theories (except transaction costs).
– Can motivate - shape firms’ payoff matrix => crucial context within
which decisions are taken.
– Specifically oligopolistic interaction theories (e.g., Graham), build
on Hymer and emphasize role of threats and counter-threats.
• Competition between states
– Nation states may promote their own MNCs to affect their
international competitiveness – could explain some LDC MNCs.

70. 70
Synthesis (i)
• Context: Oligopolistic interaction
– Endogenous growth (Penrose) => monopolistic
advantages (Hymer).
– MAs are an inducement to innovation and further
growth (Penrose); they can help firms outcompete
foreign rivals (Hymer).
– Domestic diversification due to pull factors, e.g.,
multiple use of resources (Penrose), or push factors,
e.g., the product life cycle (Hymer).

71. 71
Synthesis (ii)
• Geographical diversification also due to national-regional
business cycles (all weather company).
• Mode of expansion due to differential firm capabilities
(Penrose, Teece, Kogut & Zander), (dynamic) transaction
costs (Teece, Buckley & Casson) and overall control
advantages (Hymer).
• Locational factors explain the choice of location.
• No general theory possible, but a general framework
within which each case can be examined.

72. 72
MNCs impact on welfare
• Monopolistic advantage theory => possibility of reduced
competition due to MNCs => (Pareto) inefficiency 
• Internalization hypothesis => transaction reductions => efficiency.
• Eclectic view => advantages and disadvantages => ‘trade-off’.
• Divide and rule hypothesis => reduced workers welfare =>
(Pareto) inefficiency.
• Resource-based => efficiency and inefficiency may co-exist
• Synthesis => coexistence of efficiency and power => ‘trade-off’.

73. 73
The MNC
and ‘Uneven Development’(Hymer)
• For Hymer (1972), the operations of MNCs tend
to globalize the tendency towards concentration;
generate an uneven development between the
centre (developed countries) and the periphery
(less developed countries); erode the power of
labour unions and the nation state, and tend to
shape the world to their image by creating
‘superior’ and ‘inferior’ countries. They are
responsible for the dependent industrialization of
the Newly Industrialized Countries.

74. International Business Economics
Session 3
Strategy and Strategic Options of MNCs

75. Background 3 (pp 83-99, starts
here)
Business Strategy

76. 76
Business Strategy (i)
• Firms’ evolution – strategies
– Horizontal integration (mergers and acquisitions)
– Vertical integration (backward and forward)
– Multidivisional (M-) form (business units under central control)
– Conglomeration (unrelated business activities)
– Foreign Direct Investment - multinational corporations (foreign
direct investment)
– Networks, alliances clusters, joint ventures, etc.
All such strategies involve future cash flows, thus require
‘capital budgeting’.

77. 77
Business Strategy (ii)
• Types of strategy
– Competitive: Strategy of Business Units
– Corporate: Strategy of firm as a whole

78. 78
Competitive Strategy
Porter: based on IO
• ‘Five forces’ model (rivalry of existing
competitors, potential entrants, power of
suppliers-buyers, substitute products).
Rule: select and/or create ‘attractive industries’
(with weak forces of competition)
• Three generic competitive strategies (cost
leadership, differentiation, focus).
Rule: do not get stuck in the middle.

79. 79
Exhibit 3.1: M. Porter’s five forces
model
INDUSTRY
COMPETITORS
Rivalry among existing
firms
SUBSTITUTES
Threat of entry
POTENTIAL
ENTRANTS
Threat of substitutes
Power of
suppliers
SUPPLIERS
Power of
buyers
BUYERS

80. 80
Exhibit 3.2: M. Porter’s three
generic strategies
Competitive advantage
Lower cost Differentiation
Competitive
Broad Cost leadership Differentiation
scope
Narrow Cost focus Differentiation
focus

81. 81
Competitive Strategy
Porter (cont’d)
• Value chains: firm’s primary and support activities
that generate value (margin)
– primary: firm infrastructure, human resource
management, technology development,
procurement
– support: inbound logistics, operations,
outbound logistics, marketing and sales,
service
Rule: align value chain to generic strategy

82. 82
Exhibit 3.3: M. Porter’s value
chain
Inbound
logistics
Operations Outbound
logistics
Marketing
& Sales
Margin
Margin
Service
Procurement
Human resource management
Technology development
Firm infra-structure

83. 83
Corporate Strategy
• Portfolio models - Boston Consulting Group, etc.
• Porter
• Resources-capabilities

84. 84Corporate Strategy: Portfolio
models
- The Boston Consulting Group (i)
• Learning and experience gives rise to reduced unit costs
as volume increases
• Market share increases profitability
• Portfolio matrix: to classify business units as stars, cash
cows, question marks and dogs on the basis of industry
growth rates and business units’ relative market share
Rule: cash-in cash cows, to invest in stars and selected
question marks, stars-to-be. Liquidate dogs.

85. 85Corporate Strategy: Portfolio
models-
The Boston Consulting Group (ii)
• BCG matrix related to the industry product life
cycle (introduction-question marks, growth-stars,
maturity/saturation-cash cows, decline-dogs).
• Portfolio Models: Shell, General Electric
– same principle as BCG, different criteria and
classifications

86. 86
Exhibit 3.4: The experience curve
Unit
cost
Cumulative volume of output0

87. 87Exhibit 3.5: The BCG
growth/share business portfolio
matrix
Question marks
(or problem children)
Relative market share position
Low (below 1.0)High (above 1.0)
Cash cows Dogs
Stars
Low
(slower
than the
economy
as a whole)
Industry
growth
rate
High
(faster
than the
economy
as a whole)

88. 88
Exhibit 3.6: The life cycle model
Industry
sales GrowthIntroduction DeclineMaturity
Time0

89. 89
Exhibit 3.7: The product life cycle
and the Boston matrix
Product life-cycle Boston Matrix
Introduction Question marks
Growth Stars
M aturity / Saturation Cash cows
Decline Dogs

90. 90
Corporate strategy:
The approach of M. Porter
• Four types of corporate strategy
– portfolio management (as in BCG matrix)
– restructuring (restructure and sell-off)
– transfer of skills
– sharing activities
Rule: select sharing activities or, if not possible,
transfer of skills. Other two hard to implement
with success.

91. 91
Corporate Strategy:
The resources – capabilities
perspective (Penrose, Teece, etc.)
• Diversification strategies are the result of
availability of resources with potential for
common use by apparently unrelated activities.
• Conglomerate diversification results from problem
of appropriating rents from intangible assets
and/or differential capabilities in transferring
knowledge.
• [End of Background 3]

92. 92
Strategy of MNCs (i)
• For Michael Porter industries are
– multidomestic (nationally responsive),
requiring locally focused strategy
– global (linked, integrated), requiring integrated
strategy

93. 93
Strategy of MNCs (ii)
• For Bartlett and Ghoshal: four basic strategies
emerge on the basis of cost pressures – local
responsiveness matrix:
– international (low, low)
– multidomestic (low, high)
– global (high, low)
– transnational (high, high)

94. 94
Exhibit 3.2: Bartlett and Ghoshal’s Options for
MNCs
High Global Transnational
Cost
Pressures
Low International Multidomestic
Low High
Local
Responsiveness

95. 95Exhibit 3.9: A summary of theory
and strategy
IO-Porter Transaction costs
(TC)
Resource-based
Horizontal
integration
reduce rivalry reduce TC acquire (managerial)
resources
Vertical
integration
barrier to entry reduce TC differential ability for in-
house production
M-form facilitate unrelated
diversification
(Chandler)
internalize external
capital market
failures
facilitate unrelated
diversification (Chandler)
Conglomerate
diversification
reduce dependence
on product life cycle
(Hymer)
high TC due to asset
specificity-
opportunism
exploit common resource
base, solve intangible
assets appropriability
problems
Foreign Direct
Investment
exploit ownership
advantages (Hymer)
high TC due to asset
specificity-
opportunism
solve intangible assets
appropriability problems,
differential capabilities
Networks facilitate market
power
optimal use of
market and
hierarchy
Derive knowledge-related
benefits of co-opetition

96. 96Application: A simple decision
frameworkLowTransport costs and tariffs
Suitability of know-how for
licensing
Foreign operation requires
tight control
Know-how can be protected by
licensing contract
High
Yes
No
No
Yes
No
Export
Horizontal FDI
Horizontal FDI
Horizontal FDI
Yes
Licence Based on C. Hill (2003)

97. International Business Economics
Session 4
MNCs, Government Policy and
(Inter)national Competitiveness

98. 98
Competitiveness: definition
• Differential productivity, value-added – wealth
creation, relative to other economic units (firms,
regions, nations…)
• Can be achieved through
– Business policies
– Government (competition, industrial and
competitiveness) policies

99. 99
Competition and Industrial Policy
• Early competition-industrial policies in West
derive from IO theory, in particular the issue of
the welfare effects of monopoly (power). This
includes analysis of
i) Static effects (monopoly and reduced consumer
welfare, due to high prices);
ii) Dynamic effects (e.g., monopoly and innovation).

100. 100
Monopoly & international
competitiveness (i)
• Main claim that large firms can exploit economies of scale and scope,
therefore can compete with large firms from other countries.
• Idea particularly prevalent is 1960s and 1970s in Europe, in part as
response to the ‘American Challenge’, e.g., Servan-Schreiber’s
claim that US multinational corporations dominate technologically
European markets.
• If large size increases competitiveness (thus export surpluses) these
could offset any static losses.
• The international competitiveness idea is in part responsible for the
permissive (and even encouraging) attitude of European countries to
mergers and large size.

101. 101
Monopoly & international
competitiveness (ii)
• Counter arguments are:
– i) higher X-inefficiency
– ii) may suppress major inventions if they result in
major re-equipment
– iii) inflexibility
• Schumpeter’s ‘Differential Innovations
Hypothesis’, that large firms are large because
they have been more successful innovators to
start with.

102. 102
Monopoly and Welfare
Conclude
• An open question whether the dynamic gains
offset the static losses. Evidence inconclusive.
• Focus on efficient resource allocation limited.
Concentrate on resource creation?

103. 103
Practice
– The Western approach
Theoretical Basis
i) ‘Competition policy’ to correct market failure due
to monopoly (power) and its abuse: e.g., Treaty
of Rome, US Anti-Trust policies
ii) Trade through (static) comparative advantage,
lenient or encouraging attitude to multinational
corporations (MNCs)

104. 104
Practice
– The Western approach (EU) (i)
But in 1960s
• ‘Recognition’ in Europe of the ‘international
competitiveness’ advantages of ‘large size’
(American challenge thesis)
• Relatedly,
– ‘National Champions Policy’ (e.g., UK, France, Italy)
– Nationalizations of ‘strategic’ sectors
1970s
• ‘Lame Ducks’ policies

105. 105
Practice
– The Western approach (EU) (ii)
1980s
• Return to the market (privatisations etc) and
focus on ‘Government Failure’.
1990s
• Entrepreneurship and small firms
• Horizontal measures, technology and education,
tangible and intangible infrastructure, efficiency of
public sector.

106. 106
Practice
– The Western approach (USA)
• Hidden industrial policy in the form of defence
policy?
• revival of 1990s; clusters?
Conclude
• ‘Grant Theory’ but no industrial strategy
including adhocity, discontinuity, undue focus on
(dis)advantages of size and static comparative
advantage-based (free) trade.

107. 107Practice
– The Far Eastern approach
(Japan)
Basis: Industrial Strategy by Ministry of Trade & Industry
(MITI) involving:
i) Dynamic comparative advantage (created comparative
advantage).
ii) Managed trade, with initial focus on internal competition.
iii) Management of competition (the ‘Golden Mean’) and co-
operation.
iv) Dynamic competition through innovativeness, as in
Schumpeter - Hayek.

108. 108
Practice – The Four Tigers
(Singapore, Taiwan, South Korea, Hong
Kong) (i)
Basis: Similar to Japan, adaptive industrial
strategy involving
i) Import substitution.
ii) Export promotion based on labour intensive
manufacturing.
iii) Promotion of high technology/high value added
sectors.
iv) Attraction of FDI (Singapore, Taiwan),
technology transfer.

109. 109
Practice – The Four Tigers
(Singapore, Taiwan, South Korea, Hong
Kong) (ii)
• Relative success of ‘Far East’
– Result of multitude of complex factors which include
culture, high saving, effective public administration,
close relation between industry and finance,
consensus, new (strategic) management techniques,
etc.
• Question: Can we exclude role of industrial
strategy? Is it unrelated to the other factors?

110. 110
New theories
1. ‘New Trade Theory’
2. ‘New Competition’
3. New location economics
4. New (‘Endogenous’) Growth Theory
5. MNCs, deindustrialisdation and ‘Competitive
Bidding’

111. 111
1. New trade theory (i)
• Traditional focus of Western industrial policy, the welfare
effects of monopoly and the theory of (static)
comparative advantage. According to this countries
should specialize and trade in products in which they
enjoy a comparative advantage. Benefits from trade arise
when each country pursues such a strategy.
• Presence of monopolistic competition, economies of
scale, positive externalities and first mover advantages
led to conclusion that focus on high return industries
can affect the distribution of benefits (and even lead to
losses, Krugman) – Strategic Trade.

112. 112
1. New trade theory (ii)
• This led to concept of dynamic comparative
advantage; i.e., attempts by countries to create
(not accept the existing) comparative
advantages.
• Best known case of dynamic comparative
advantage policy is Japan.

113. 113
2. The New Competition (i)
• Based on observation of successful industrial districts, in North Italy,
Germany, USA, Cambridge UK, etc.
• Such districts consist of small and medium sized, highly innovative,
customer oriented firms, with a hands-on approach to management,
which cooperate on issues of infrastructure, technology etc and
compete in the market for customers. Often rely on support by
state/local authorities, are based more on trust than hierarchical
relations, try to ‘exploit’ the dispersed knowledge of their labour,
suppliers etc and use new production methods such as Just-in-Time,
etc.

114. 114
2. The New Competition (ii)
• Success of industrial districts questions benefits
of large size and provides a different (“Post-
Fordist”) model of industrial development.
However, such methods are also adopted by
major, particularly Japanese, MNCs, through e.g.,
subcontracting.

115. 115
3. New Location Economics
(Krugman, Porter)
• Importance of location in generating external
economies, reducing transaction costs through
trust, and further innovation.

116. 1164. New Endogenous Growth
Theory
(Lucas, Romer)
• Importance of human resources and
technological change in effecting (‘endogenous’)
macroeconomic growth.

117. 117
5. MNCs, Deindustrialization and
Competitive Bidding
• Link between multinational corporations and
deindustrialization questions link between large size and
international competitiveness
• Main idea is that countries like the UK which suffer from
deindustrialization tendencies are home bases of privately
successful MNCs. This questions the benefits of large
size for the case of MNCs home base.
• In era of multinational corporations ‘name of the game’
that of ‘competitive bidding’, i.e., attempt by governments
to attract investments by home and foreign firms (MNCs).

118. 118
Theory and Practice
• Question: New approaches support/explain ‘Far
Eastern’ miracle?
• ‘New Industrial Strategy for Democracy’ (Cowling
& Sugden)
– MNCs give rise to multinationalism, centipetalism and
short termism. Needed is a shift of power to
communities and regions, e.g., through appropriate
‘flexible specialization’ policies.

119. 119
Preliminary Conclusion
• Possibility for Machiavellian scenario i.e.,
adaptive industrial strategy (in partnership with
corporate sector) including
i) dynamic comparative advantage
ii) managed competition and co-operation
iii) managed trade
iv) playing the ‘competitive bidding game’ and/or
v) tackling the challenge of MNCs
vi) considering alternative forms of competitiveness, like
‘flexible specialization’

120. 120
Developing countries
• Some common features: small internal size of
market, lack of large ‘national’ MNC’s (over-)
reliance on small family run businesses, and
foreign MNCs, relatively underdeveloped
industry.
• Possible Strategy:
i) follow the ‘four tigers’ and
ii) consider ‘appropriate’ focus on small and medium
sized enterprise, flexible specialization, clustering.
• Main issue: selection, suitability, transferability
and feasibility of policies.

121. 121
The Importance of Institutions (i)
• Main problem of implementation, ‘government failure’.
Although a general problem, often more acute in
developing countries. Indeed underdevelopment may be
the effect of inefficient property rights, and incentive
mechanisms? (North)
• Culture, consensus, other institutional constraints.
• Need for promoting an institutional framework conducive
to development. This includes addressing the problem of
‘capture’ of the state by MNCs.

122. 122
The Importance of Institutions (ii)
• Government can be enabling (reduce private sector
transaction and production costs) to increase output. It
can also be developmental, i.e., try to improve the
revenue side.
• Analysis of the state suggests that problem of ‘capture’
reduced through pluralism of institutional forms
(large and small firms) and competition in the
political market.
• ‘Capture’ effects support a competitiveness strategy
favouring smaller firms (potential competition to
established giants).

123. 123
Conclusions (i)
• Possible and necessary to devise a
competitiveness strategy which learns from
economic theory and international practice and
addresses the issue of implementation (e.g.,
institutions and ‘capture’ of the ‘state’) and for the
EU its declared needs to promote Competition
and Convergence

124. 124
Conclusions (ii)
• Developing countries should consider their
policies in the above framework, striving for an
emphasis on dynamic competition, value
creation and supply-side convergence.
Internally they should address the issue of the
institutional constraints.
• Identification and development of distinct
capabilities and competencies of a nation and
governments important condition for effective,
implementable strategy.

125. 125
‘Anti-trust’ today: some problems
• Potential problems with current policies
i) Downplay lessons from the ‘Far East’ and the ‘new approaches’.
ii) Do not address the problem of MNCs (as a potential threat to
competition).
iii) Ignore distribution issues, intra-EU and between EU and ‘The
South’, which undermines sustainability.
iv) Fail to provide supply-side incentives for convergence.
v) Fail to distinguish between policies that re-distribute resources
and policies that generate resources.
• Need to move from competition to competitiveness policies

126. 126
From competition to
competitiveness policies: models of
competitiveness
• Neoclassical model
– Competitive markets
– Free trade
• ‘Japanese’
• Porter’s ‘Diamond’
• Productivity-Competitiveness Wheel

127. 127Exhibit 4.1: Competitiveness – the
neoclassical model
, minimum efficient scale; QS, strategic capacity output, π,
monopolist’s disincentive to invent; E, efficiency gains;
Pm monopoly price; PL limit price; PC perfect competition
price
Q
P
E
Pm
PL
PC
LAC1 = LMC1
LAC2 = LMC2
Qm Q
MR
QS
D
QL QCQ
Q
0
A common
expository
diagrammatic
framework for neo-
classical
Austrian and
Marxist approaches
to industrial
organization.

128. 128
Competitiveness (i)
• The ‘Japanese’ approach ?
– High knowledge intensive sectors

129. 129
Exhibit 4.2:
Competitivene
ss – the
Japanese
approach?
Source: Best (1990)
Knowledge-intensive industries
(computers, instruments, heavy machinery)
Medium capital-and labour-
intensive industries (light
machinery, motor cars)
Medium capital- and raw-
material-intensive industries
(Steel, plastics, fibers)
Unskilled-labour-intensive industries
100% 100%
100%
100%
West Germany (1974)
Japan (1985)
Japan (1974)
Japan (1959)

130. 130
Competitiveness (ii)
• Porter’s ‘diamond’
– Factor and demand conditions, clusters

131. 131Exhibit 4.3: The determinants of
national competitive advantage
(Porter’s ‘Diamond’)
STRATEGY
STRUCTURE
AND RIVALRY
FACTOR
CONDITIONS
DEMAND
CONDITIONS
RELATED AND
SUPPORTING
INDUSTRIES

132. 132
Problems with existing models
• Absence of commonly agreed upon conceptual
framework.
• Absence of links between competitiveness at the
firm-regional and national levels.
• Insufficient analysis of determinants of
productivity and competitiveness.
• Insufficient treatment of the issue of
sustainability.

133. 133Sustainable Competitiveness and
Development: a conceptual
framework
• The Productivity-Competitiveness Model
– Competitiveness <=> Productivity - Value Creation
• Determinants of Productivity - Value
– Firm level
• infrastructure
• human resources
• technology and innovation
• unit costs economies
– Regional and National levels: As above plus
• Industry structure - conduct and regional - locational milieu
• macroeconomic environment - policy mix
• institutional environment - governance mix

134. 134
“The Productivity -
Competitiveness -
Wheel” for Firms, Regions and
Nations
Institutional context -
Governance mix
Macroeconomic environment -
Policy mix - Effective demand
Productivity-Value-
Wealth
Unit Cost
Economies
Technology &
Innovativeness
Human
Resources
Infrastructure
Industry conduct - structure and
regional-locational milieu

135. 135
Main routes to competitiveness
• Firm size & FDI by MNCs
• Clusters of Small and Medium-Sized Enterprises
(SMEs)

136. 136
What are Clusters?
• (Geographical) agglomerations of firms (and
other organizations-institutions) linked
horizontally (and/or vertically) intra- (and/or inter-)
sectorally, in a facilitatory socio-institutional and
cultural milieu, which compete & co-operate (co-
opete) in (inter)national markets.

137. 137
Clusters and the Wheel
• Clusters =>
– innovation
– reduced unit cost economies (economies of
scale, scope, transaction costs, learning,
external, diversity, etc.)
– better human resources
– strong regional infrastructure
– more facilitatory institutional context (through
co-opetition, etc.)

138. 138
Despite problems,
clusters are important
• Clusters improve innovation, productivity &
competitiveness at the regional & national levels,
they create employment and can lead to
convergence.
• Clusters are more bottom-up, thus help deepen
democracy.
• Problems include identifying nature, boundaries,
strategies for sustained successful performance.

139. 139
Foreign Direct Investment
and Clusters
• Large firms and (through) foreign direct investment
(FDI) can improve determinants of productivity,
yet:
– Hard for developing countries to attract FDI
– Risk of FDI flight, given options, and flexibility of
operations
• Clusters have advantage over large firms and FDI
because of local base and co-opetitive nature.
• Clusters attract FDI and embed it in localities.

140. 140
Three agents of productivity, value
and wealth creation
Large
firms,
FDI
SMEs,
Clusters
Government
Institutional context -
Governance mix
Macroeconomic environment -
Policy mix - Effective demand
Productivity-Value-
Wealth
Unit Cost
Economies
Technology &
Innovativeness
Human
Resources
(Infra)structure
& Strategy
Industry conduct – structure and
regional-locational milieu

141. 141
Cluster Creation
versus Cluster Development
• Clusters are mainly the result of history, and
(thus) are hard to create ‘top-down’.
• However, theory and international experience
suggest that cluster development can be
facilitated
– Clusters can be upgraded at the individual, regional or
national levels.
– This presupposes cluster identification, (diagnosis),
audit, upgrading, control-evaluation, re-diagnosis…

142. 142
Strategy for Sustainable
Competitiveness
• According to the Productivity-Competitiveness model all
the following measures can improve productivity and
competitiveness
– horizontal measures (soft and hard infrastructure)
– inter- and intra-firm sectoral restructuring for innovative ‘value
for money’ products and services
– clusters of SMEs
• ‘Regions of Excellence’ (‘mega-clusters’) can encapsulate
all three aspects, thus serve as Strategy for Productivity
and Competitiveness.

143. 143
Prerequisites and Mechanisms
• Sustainability requires
– macro-policy - supply-side compatible
– institutional framework – remove
(anti)incentives
– competition policy co-opetition for
innovativeness
– environment
– distribution of income

144. 144
Conclusions
• Possible and desirable to identify and develop
(mega) clusters, for productivity,
competitiveness, regional development,
convergence and deepening of democracy.
• The state can be a catalyst and facilitator.
• Method and tools developed can help in this
direction.

145. International Business
Economics
Overall Conclusion and the
Future of MNCs

146. 146
Conclusions
• Value creation, through
– firm productivity and competitiveness
– government enabling policies, national productivity and
competitiveness
• Under conditions, MNCs and FDI, SME clusters
and government policy can help achieve this
objective

147. 147
The Future
• The MNC, like ‘competition’ and co-operation
itself, is both ‘god and devil’.
• MNCs will be a great force of economic growth,
yet a threat to diversity, equity and democracy.
• Policy and polity should aim at identifying routes
that deliver the goods at least cost – this can
include painful ‘trade-offs’.