INBUST ✓ Michael Porter’s theory

Chapter 6: International Trade Theory ▪ Country factors explain a nation’s dominance in

the production and export of certain products
Introduction
▪ Economists argue that free trade stimulates economic Trade Theory and Government Policy
growth and raising the standard of living ✓ Mercantilism makes a case for government involvement
▪ Many theories explain why free trade is beneficial in promoting exports and limiting imports
✓Smith, Ricardo, and Heckscher-Ohlin promote
AN OVERVIEW OF TRADE THEORY
unrestricted free trade
✓New trade theory and Porter justify limited and selective
Free trade refers to a situation where a government does
government intervention to support the development of
not attempt to influence through quotas or duties what its
certain export-oriented industries
citizens can buy from another country or what they can
produce and sell to another country
MERCANTILISM
• Mercantilism (16th and 17th centuries)
Mercantilism (mid-16th century): it is in a country’s best
encouraged exports and discouraged imports
interest to maintain a trade surplus - to export more than it
• Adam Smith (1776) promoted unrestricted free
imports
trade
• David Ricardo (19th century) built on Smith ideas ✓Advocated government intervention to achieve a
• Eli Heckscher and Bertil Ohlin (20th century ) surplus in the balance of trade
refined Ricardo’s work ✓Viewed trade as a zero-sum game: one in
which a gain by one country results in a loss by
The Benefits of Trade another
• Specialize in the manufacture and export of products that
can be produced most efficiently in that country Absolute Advantage
• Import products that can be produced more efficiently in ▪ Smith (1776) - countries differ in their ability to produce
other countries goods efficiently
• Gains arise because international trade allows a country ▪ A country has an absolute advantage in the production
to specialize in the manufacture and export of products of a product when it is more efficient than any other
country in producing it
▪ According to Smith
Did you know that sugar prices in the United States are ✓Trade is not a zero-sum game
much higher than sugar prices in the rest of the world? ✓Countries should specialize in the production of
goods for which they have an absolute advantage
The Pattern of International Trade and then trade these goods for the goods
✓Ricardo’s theory of comparative advantage produced by other countries
▪ Trade patterns reflect differences in labor
productivity
✓Heckscher and Ohlin
▪ Trade reflects the interplay between the
proportions in which the factors of production are
available in different countries and the proportions
in which they are need for producing particular
goods
✓Ray Vernon
▪ Trade patterns reflect a product’s life cycle
✓Paul Krugman’s new trade theory
▪ The world market can only support a limited
number of firms in some industries
▪ Trade will skew toward those countries that have
firms that were able to capture first mover
advantages
 COMPARATIVE ADVANTAGE quality and different goods use resources in
The Gains from Trade different proportions
▪ The theory of comparative advantage - trade is a positive ✓Dynamic Effects and Economic Growth
sum game in which all gain ▪ Trade might increase a country's stock of
✓ Potential world production is greater with resources as increased supplies become available
unrestricted free trade than it is with restricted from abroad
trade ▪ Free trade might increase the efficiency of
✓ Provides a strong rationale for encouraging free resource utilization, and free up resources for
trade other uses
✓ The Samuelson Critique
▪ Dynamic gains can lead to less beneficial
outcomes
▪ Free trade has historically benefitted rich
counties
✓ Evidence for the Link between Trade and Growth
▪ Countries that are open to trade have higher
growth rates than countries that close their
economies to trade
▪ Higher growth rates raise income levels and
living standards

HECKSCHER-OHLIN THEORY
Heckscher and Ohlin: Comparative advantage reflects
differences in national factor endowments: the extent to
which a country is endowed with resources such as land,
Qualifications and Assumptions labor, and capital
1. Only two countries and two goods ✓This theory has commonsense appeal
2. Zero transportation costs ▪ Export goods that make intensive use of those
3. Similar prices and values factors that are locally abundant
4. Resources are mobile between goods within ▪ Import goods that make intensive use of factors
countries, but not across countries that are locally scarce
5. Constant returns to scale
6. Fixed stocks of resources The Leontief Paradox
7. No effects on income distribution within
✓Leontief (1953): Since the U.S. was relatively
countries
abundant in capital, it would export capital intensive
goods and import labor-intensive goods
Extensions of the Ricardian Model
▪ Leontief found that U.S. exports were less
✓Suppose the following assumptions are relaxed capital intensive than U.S. imports
1. Resources move freely from the production of
✓Possible explanations
one good to another within a country
▪ The U.S. has a special advantage in producing
2. There are constant returns to scale
products made with innovative technologies that
3. Trade does not change a country’s stock of
are less capital intensive
resources or the efficiency with which those
▪ Differences in technology lead to differences in
resources are utilized
productivity which then drives trade patterns
✓Immobile Resources
▪ Resources do not always move freely from one
economic activity to another Should Factor Endowments or Productivity Drive
▪ Governments may help retrain displaced workers Trade? Ricardo’s theory of trade suggests that it makes
✓Diminishing Returns sense for a country to specialize in production of those
▪ The simple model assumes constant returns to products that it produces most efficiently and to buy the
specialization: the units of resources required to products that it produces less efficiently from other
produce a good are assumed to remain constant countries, even if this means that the country is buying
▪ An assumption of diminishing returns is more products that in reality it could produce more efficiently
realistic since not all resources are of the same itself. This means that Ricardo showed that a country can
derive advantages by trade even though it has an absolute
advantage in producing all products. The Heckscher-Ohlin Economies of Scale, First-Mover Advantages, and the
theory of trade suggests that comparative advantage for a Pattern of Trade
country arises from differences in national factor ✓Firms with first mover advantages (the economic
endowments (i.e., the extent to which a country is and strategic advantages that accrue to many
endowed with such resources as land, labor, and capital). entrants into an industry) will develop economies of
Ricardo’s argument focused on relative productivity, while scale and create barriers to entry for other firms
Heckscher-Ohlin’s argument focused on having important ▪ The pattern of trade we observe in the world
resources. If you can only have one of the two— better economy may be the result of first mover
relative productivity or lots of resources such as land, advantages and economies of scale
labor, and capital—which would you prefer, any why?
Implications of New Trade Theory
✓Nations may benefit from trade even when they
THE PRODUCT LIFE CYCLE THEORY do not differ in resource endowments or
Vernon (mid-1960s ) proposed product life-cycle theory technology
✓As products mature both the location of sales and ✓A country may predominate in the export of a
the optimal production location will change affecting good simply because it was lucky enough to have
the flow and direction of trade one or more firms among the first to produce that
▪ At the time, the wealth and size of the U.S. good
market gave a strong incentive to U.S. firms to ✓New trade theory at a variance with Heckscher-
develop new products
Ohlin theory
✓New trade theory useful in explaining trade
Product Life-Cycle Theory in the 21st Century
patterns
✓The product life cycle may not be as relevant today
▪ New trade theory provides an economic rationale for a
▪ Many products are now introduced in Japan or
proactive trade policy that is at variance with other free
South Korea
trade theories
▪ Many new products are also introduced
simultaneously into the U.S., Europe, and Asia
➢Firms use globally dispersed production NATIONAL COMPETITIVE ADVANTAGE: PORTER’S
from the start DIAMOND
▪ Porter believed existing theories of international trade
only told part of the story
NEW TRADE THEORY ▪ Wanted to explain why a nation achieves international
▪ Trade can increase the variety of goods available and success in a particular industry
decrease the average cost of those goods because of ▪ Four attributes of a nation that shape the environment in
economies of scale: unit cost reductions associated with a which local firms compete – Porter’s Diamond
large scale of output ▪ Chance and government can influence the national
▪ When the output required to attain economies of scale diamond
represents a significant proportion of total world demand,
the global market may only be able to support a small
number of firms

Increasing Product Variety and Reducing Costs

✓ Without trade
▪ A small nation may not be able to support the
demand necessary for producers to realize
required economies of scale, and so certain
products may not be produced
✓ With trade
▪ A nation may be able to specialize in producing a
narrower range of products and then buy the
goods that it does not make from other countries
▪ Each nation then simultaneously increases the
variety of goods available to its consumers and
lowers the costs of those goods
Factor Endowments How Important is Education?
✓Hierarchies among factors Both the Heckscher-Ohlin and Michael Porter theories of
▪ Basic: natural resources, climate, location, trade focus to a large degree on “factor endowments.” The
demographics Heckscher-Ohlin theory specifies endowments such as
▪ Advanced: communication infrastructure, skilled resources as land, labor, and capital as being critical,
labor, technological know-how while the Porter theory recognizes hierarchies among
▪ Advanced factors more significant for these factor endowments. Education- related endowments
competitive advantage such as skilled labor, research facilities, and technological
▪ Basic factors can provide an initial advantage know-how are what Porter calls “advanced factors.” A
that is extended by investment in advanced long-standing argument across multiple governmental
factors organizations, research studies, and prominent individuals
is that education drives economic, social, and
Demand Conditions environmental well-being of countries. The extension of
✓The nature of home demand for an industry’s this argument is that education helps people become
product or service better citizens of a country. But, what do you think
education does to a customer’s product needs and wants?
✓Influence the development of capabilities
Do they want more foreign products if they have more
▪ Sophisticated and demanding customers pressure firms
years of education (e.g., graduate degree) compared with
to be more competitive and to produce high quality,
fewer years of education (e.g., high school)? Or does
innovative products
education not influence the type of products bought by
customers (i.e., foreign-made or home-country made)?
Related and supporting industries
✓The presence of supplier industries and related
industries that are internationally competitive Focus on Managerial Implications
✓Investing in these industries can spill over and LOCATION, FIRST-MOVER ADVANTAGES, AND
contribute to success in other industries GOVERNMENT POLICY
▪ Successful industries tend to be grouped in clusters in There are at least three main implications for international
countries which then prompts knowledge flows between businesses
firms 1. Location
▪ This is an underlying thought in most of the
Firm strategy, Structure, and Rivalry theories
✓Different nations are characterized by different 2. First-mover advantages
management ideologies which either help them or ▪ Particularly true in industries where global
do not help them build national competitive market can profitably support limited number
advantage of firms
✓There is a strong association between vigorous 3. Government policy
domestic rivalry and the creation and persistence of ▪ Businesses can exert a strong influence on
competitive advantage in an industry government trade policy

Evaluating Porter’s Theory

✓ If Porter is correct, his model should predict the pattern
of international trade in the real world
• Countries should export products from industries
where the diamond is favorable
• Countries should import products from areas
where the diamond is not favorable
✓ So, far there has been little empirical testing of the
theory
Chapter 7: Government Policy and International Trade Import Quotas and Voluntary Export Restraints
✓Import quota
Introduction ▪ A direct restriction on the quantity of some good
Free trade refers to a situation where a government does that may be imported into a country
not attempt to restrict what its citizens can buy from ✓Tariff rate quota
another country or what they can sell to another country ▪ A hybrid of a quota and a tariff where a lower
✓ While many nations are nominally committed to tariff is applied to imports within the quota than to
free trade, they tend to intervene in international those over the quota
trade to protect the interests of politically important ✓Voluntary export restraint (VER)
groups ▪ Quota on trade imposed by the exporting
country, typically at the request of the importing
INSTRUMENTS OF TRADE POLICY country’s government
Seven main instruments of trade policy
✓Quota rent
1. Tariffs
▪ The extra profit that producers make when
2. Subsidies
supply is artificially limited by an import quota
3. Import quotas
4. Voluntary export restraints
Export Tariffs and Bans
5. Local content requirements
✓Export tariff is a tax placed on the export of a good
6. Administrative policies
7. Antidumping duties ▪ Goal is to discriminate against exporting
✓Export ban is a policy that partially or entirely restricts
Nontariff barriers include the export of a good
1. Subsidies ▪ Ban of exports of U.S. crude oil in 1975 to
2. Quotas ensure sufficient supply of domestic oil at home
3. Voluntary export restraints
4. Antidumping duties
Local Content Requirements (LCR)
Tariffs ✓A local content requirement demands that some
✓A tariff is a tax levied on imports that effectively raises specific fraction of a good be produced domestically
the cost of imported products relative to domestic products ▪ Can be in physical terms or in value terms
▪ Specific tariffs: levied as a fixed charge for each ✓Local content requirements benefit domestic
unit of a good imported producers and jobs, but consumers face higher prices
▪ Ad valorem tariffs: levied as a proportion of the
value of the imported good
• Increase government revenues Is Having a Local Content Requirement a Good Idea?
• Provide protection to domestic producers against Local content requirements refer to a specific fraction of a
foreign competitors by increasing the cost of product that needs to be manufactured domestically.
imported foreign goods Basically, LCRs establish a minimum level of local content
• Force consumers to pay more for certain imports required under trade law when giving foreign companies
• Tariffs are generally pro-producer and the right to manufacture in a particular place. In the wake
anticonsumer of the economic downturn in 2008, many economists
• Import tariffs reduce the overall efficiency of the feared that some governments would institute protectionist
world economy policies similar to the tariff escalations during the Great
Depression of the 1930s. However, most public policy
officials avoided traditional forms of protection (e.g., tariffs,
Subsidies quotas). This led some observers to underestimate the
✓Subsidy: a government payment to a domestic degree of protectionism. Instead, what had happened was
producer that so-called nontariff barriers in the form of local content
✓Subsidies help domestic producers requirements had become increasingly popular. As a (1)
▪ Compete against low-cost foreign imports citizen of a specific country and (2) as a global customer,
▪ Gain export markets do you think local content requirements help you as a
citizen of a country, as a global customer, as both, or as
✓Consumers typically absorb the costs of subsidies
neither?
Administrative Policies Economic Arguments for Intervention
✓Administrative trade polices: bureaucratic rules that are ✓The infant industry argument
designed to make it difficult for imports to enter a country ▪ An industry should be protected until it can
✓These polices hurt consumers by denying access to develop and be viable and competitive
possibly superior foreign products internationally
▪ This argument has been criticized because
Antidumping Policies ▪ It is useless unless it makes the industry
✓Dumping: selling goods in a foreign market below their more efficient
cost of production, or selling goods in a foreign market at ▪ If a country has the potential to develop
below their “fair” market value a viable competitive position, its firms
▪ Objective is to protect domestic producers from should be capable of raising necessary
unfair foreign competition funds
▪ May be predatory behavior, with producers using ✓Strategic trade policy
substantial profits from their home markets to ▪ By appropriate actions, government can help
subsidize prices in a foreign market with a goal of raise national income if it can ensure first-mover
driving indigenous competitors out, and later advantages in an industry are domestic
raising prices and earning substantial profits ▪ Might be beneficial for a government to intervene
✓U.S. firms that believe a foreign firm is dumping can file in an industry by helping domestic firms overcome
a complaint with the government barriers to entry created by foreign firms with first-
▪ If the complaint has merit, antidumping duties, mover advantages
also known as countervailing duties may be
imposed
Trading with Cuba Even though the United States holds
trade sanctions with Cuba, other Western countries
THE CASE FOR GOVERNMENT INTERVENTION continue to trade with the island nation.
Political arguments
✓Concerned with protecting the interests of THE REVISED CASE FOR FREE TRADE
certain groups within a nation (normally
▪ New trade theorists believe government intervention in
producers), often at the expense of other groups
international trade is justified
(normally consumers)
Economic arguments ✓Classical trade theorists disagree
✓Concerned with boosting the overall wealth of a ▪ Some new trade theorists believe that while strategic
nation (to the benefit of all, both producers and trade theory is appealing in theory, it may not be workable
consumers) in practice – they suggest a revised case for free trade

Political Arguments for Intervention Retaliation and Trade War

✓ Protecting jobs and industries ✓Krugman: strategic trade policies to establish domestic
firms in a dominant position in a global industry are
✓ Protecting national security
beggar-thy-neighbor policies that boost national income at
✓ Retaliating the expense of other countries
▪ Use intervention as a bargaining tool and ▪ A country that attempts to use such policies will
force trading partners to “play by the rules probably provoke retaliation
of the game” ▪ A trade war could leave both countries worse off
✓ Protecting consumers ▪ Don’t engage in retaliation but help establish
▪ Ban unsafe products rules to minimize the use of trade-distorting
✓ Furthering foreign policy objectives subsidies
▪ Grant preferential trade terms to a country
it wants to build relations with Domestic Policies
▪ Pressure or punish “rogue” states ✓Governments can be influenced by special interest
✓ Protecting human rights groups
▪ A government’s decision to intervene in a market
may appease a certain group, but not necessarily
support the interests of the country as a whole
▪ Krugman sees this as a further reason for not
embracing strategic trade policy
 DEVELOPMENT OF THE WORLD TRADING SYSTEM ▪ Trade issues related to services and intellectual
Since World War II, an international trading framework has property and agriculture were emphasized
evolved to govern world trade ▪ Dragged on for seven years
✓In its first fifty years, the framework was known ✓ The World Trade Organization
as the General Agreement on Tariffs and Trade ▪ The WTO encompassed GATT, the General
(GATT) Agreement on Trade in Services (GATS), and the
✓Since 1995, the framework has been known as Agreement on Trade Related Aspects of
the World Trade Organization (WTO) Intellectual Property Rights (TRIPS)
▪ Procedures subject to strict time limits
Do You Believe in Free Trade Agreements?
The benefits of free trade agreements are often hard to
see. At the same time, the benefits of protecting certain WTO: Experience to Date
industries and/ or companies from foreign competition are ✓ Members account for 98% of world trade
often very visible. Given these scenarios, many people ✓ It was hoped that it would emerge as an effective
often argue that free trade agreements are bad for their advocate and facilitator of future trade deals
country. Perhaps as a result, many governments impose ✓ So far, most countries have adopted WTO
many tariffs, quotas, and other nontariff barriers to trade. recommendations for trade disputes
For example, the common perception is that by
✓ In general, countries involved in disputes accept WTO
establishing trade barriers, a country keeps the jobs at
recommendations
home instead of jobs being shipped overseas. But is this
really true? ✓Global telecommunication and financial service
industries targeted for reform
From Smith to the Great Depression
The Future of the WTO: Unresolved issues and the
✓Up until the Great Depression of the 1930s, most
Doha Round
countries had some degree of protectionism
✓ Anti-dumping actions
✓The U.S. enacted the Smoot-Hawley Act (1930):
▪ Encourage members to strengthen the
created
regulations governing the imposition of
significant import tariffs on foreign goods
antidumping duties
✓Other nations took similar steps and as the depression
✓ Protectionism in agriculture
deepened, world trade fell further
▪ Concerned with the high level of tariffs and
subsidies in the agricultural sector of many
1947-1979: GATT, Trade Liberalization, and Economic
economies
Growth
✓ Protecting intellectual property
✓The General Agreement on Tariffs and Trade (GATT)
▪ Members believe that the protection of
was
intellectual property rights is essential to the
established in 1947
international trading system
✓ Multilateral agreement to liberalize trade and gradually
eliminate barriers to trade Protecting Agriculture
✓Tariff reduction was spread over eight rounds Removing barriers to trade and subsidies in agricultural
✓Very successful in early rounds products should benefit consumers. Protecting Agriculture
Removing barriers to trade and subsidies in agricultural
1980-1993: Protectionist Trends products should benefit consumers.
✓Japan’s economic success strained what had been more
equal trading patterns The Future of the WTO: Unresolved issues and the
✓Persistent trade deficits by the U.S caused significant Doha Round
problems in some industries and political problems for ✓ Market access for nonagricultural goods and services
the government ▪ Tariffs on services remain higher than on
✓ Many countries found that although GATT limited the industrial goods
use of tariffs, there were many other forms of ✓ A new round of talks Doha
intervention that had the same effect that did not ▪ Have been ongoing since 2001 concerned with
technically violate GATT cutting tariffs on industrial goods and services,
phasing out subsidies to agricultural producers,
The Uruguay Round and the World Trade Organization reducing barriers to cross-border investment,
✓ Uruguay Round emphasized services, intellectual limiting the use of antidumping laws
property, and agricultural subsidies ✓ Multilateral and Bilateral Trade Agreements
 ▪ Designed to capture gain from trade beyond
those agreements currently attainable under WTO
treaties
▪ Tariff barriers raise the costs of exporting
products to a country
▪ Quotas may limit a firm’s ability to serve a CHAPTER 13: THE STRATEGY OF INTERNATIONAL
country from locations outside that country BUSINESS
▪ A firm may have to locate more production
activities in a given market than it would Opening Case: Sony's Global Strategy
otherwise. ▪ Most well known company (Japan, 1946), strong brand
▪ The threat of antidumping action limits the ability value (world class)
of a firm to use aggressive pricing to gain market ▪ 13 core business segments (internet enabled products)
share in a country ▪ Vision: Passion for technology, content and services
▪ Mission: Inspires and fulfills curiosity (fosters dream)
✓ Policy Implications
▪ Global initiatives
▪ Accelerating R&D (innovation and quality)
FOCUS ON MANAGERIAL IMPLICATIONS
▪ New business ventures
Trade barriers, firm strategy, and policy implications
• Trade barriers impact firm strategy Introduction
• Tariff barriers raise the costs of exporting Managers must consider
• Quotas may limit a firm’s ability to serve a • The benefits of expanding into foreign markets
country • Which strategies to pursue in foreign markets
• Firms may need to conform to local content • The value of collaboration with global competitors
requirements • The advantages of strategic alliances
• Future trade barriers can influence firm strategy •
Firms can play a role in promoting free trade or trade
barriers STRATEGY AND THE FIRM
Strategy: the actions taken by managers to attain the
Policy Implications goals of the firm
✓International firms have an incentive to lobby for free ✓ Profitability: the rate of return the firm makes
trade, and keep protectionist pressures from causing them on its invested capital
to have to change strategies ✓ Profit growth: the percentage increase in net
✓Three drawbacks to government intervention profits over time
▪ Self-defeating as it protects the inefficient
▪ Dangerous as it might invite retaliation
▪ Unlikely to be well-executed as can be captured
by special interest groups

Value Creation
✓ The difference between V (the price that the firm can
charge for that product given competitive pressures)
and C (the costs of producing that product)
✓ Two basic strategies
1. Differentiation
2. Low cost
 Is Education Creating Value for You?
The concept of a value chain can be used to examine the
role your education plays in your life plans, if you look
closely at your personal development plans (education,
internship, work, physical and emotional fitness, and
extracurricular activities) and think about them in terms of
primary and support activities. If we use the logic that the
amount of value you receive from your education is the
Strategic Positioning difference between the costs (e.g., tuition, time, lost
✓ Pick a position on the efficiency frontier that is viable income) and what you receive in the form of education
(enough demand to support the choice) (e.g., knowledge, tools, networks), how does your choice
✓ Configure internal operations to support the position of major area of focus in your education fit into your
personal development strategy? How do your choices of
✓ Have the right organization structure in place to
how you spend your time fit into your value chain? Do you
execute the strategy
ever spend time doing things that do not support the
strategic goals of your personal value chain? But, most
importantly, what is the one thing you should do more of to
drive the value higher for yourself today and in the future?

Operations: The Firm as a Value Chain

✓ Primary Activities
Organization: The Implementation of Strategy
▪ Involves the design, creation, and delivery of the
✓ Organization architecture:
product; its marketing; and its support and after-
the totality of a firm’s organization - formal
sale service.
organizational structure, control systems and
▪ Divided into: research and development,
incentives, organizational culture, processes, and
production, marketing and sales, customer service
people
✓ Support Activities
✓ Organizational structure:
▪ Provides the inputs that allow the primary
▪ The formal division of the organization into
activities to occur
subunits
▪ Divided into: information systems, company
▪ The location of decision-making responsibilities
infrastructure, logistics, human resources
within that structure
▪ The establishment of integrating mechanisms to
coordinate the activities of subunits including
cross functional teams and or pan-regional
committees
 3. Realize greater cost economies from
experience effects by serving an expanded global
market from a central location, thereby reducing
the costs of value creation
4. Earn a greater return by leveraging any
Organization: The Implementation of Strategy continued valuable skills developed in foreign operations and
✓Controls: transferring them to other entities within the firm’s
metrics used to measure the performance of global network of operations
subunits and make judgments about how well the
subunits are run ▪ Expanding the Market: Leveraging Products and
✓Incentives: Competencies
devices used to reward appropriate managerial ▪ To increase growth, a firm can sell products or services
behavior developed at home in foreign markets
✓Processes: ✓Success depends on the type of goods and
manner in which decisions are made and work is services, and the firm’s core competencies (skills
performed within the firm that competitors cannot easily
✓Organizational culture: match or imitate)
norms and value systems that are shared among ▪ Enable the firm to reduce the costs of value
the employees creation
✓People: ▪ Create perceived value so that premium
pricing is possible
employees and the strategy used to recruit,
▪ They are the source of a firm’s competitive
compensate, and retain those individuals
advantage
In Sum: Strategic Fit
Core Competencies
✓ The operations of the firm must support the firm’s
P&G’s core competency in marketing is evidenced in this
strategy photo of Olay men’s skin care products for sale in a
✓ The organizational architecture of the firm must match Shanghai, China, supermarket.
the firm’s operations and strategy
✓ If market conditions shift, so must the firm’s strategy, Location Economies
operations, and organization ✓ Firms should locate value creation activities where
economic, political, and cultural conditions are most
conducive to the performance of that activity
▪ Firms that successfully do this can realize
location economies: economies that arise from
performing a value creation activity in the optimal
location for that activity, wherever in the world that
might be
✓ Locating value creation activities in optimal locations
▪ Can lower the costs of value creation
▪ Can enable a firm to differentiate its product
offering from those of competitors

Creating a Global Web

✓ Multinationals that take advantage of location
economies create a global web of value creation activities
GLOBAL EXPANSION, PROFITABILITY AND PROFIT
GROWTH ✓ Under this strategy, different stages of the value chain
are dispersed to those locations around the globe where
Firms that operate internationally perceived value is maximized or where the costs of value
1. Expand the market for their domestic product creation are minimized
offerings by selling those products in international ▪ Introducing transportation costs and trade
markets barriers complicates this picture
2. Realize location economies by dispersing ▪ Political and economic risks must be assessed
individual value creation activities to locations when making location decisions
around the globe where they can be performed
most efficiently and effectively Experience Effects
 ✓The experience curve: systematic reductions in ✓ Act as facilitators to transfer valuable skills within the
production costs that have been observed to occur firm
over the life of a product Profitability and Profit Growth Summary
✓A product’s production costs decline by some ✓ Firms that expand internationally can increase their
quantity about each time cumulative output profitability and profit growth by:
doubles 1. Entering markets where competitors lack similar
✓Learning effects: cost savings that come from competencies
learning by doing 2. Realizing location economies
▪ Labor productivity increases when 3. Exploiting experience curve effects
individuals learn the most efficient ways to 4. Transferring valuable skills within the
perform particular tasks and management organization
learns how to manage the new operation
more efficiently
COST PRESSURES AND PRESSURES FOR LOCAL
RESPONSIVENESS

Pressures for Cost Reductions

✓ In industries producing commodity type products that fill
universal needs: needs that exist when the tastes and
preferences of consumers in different nations are similar if
not identical
▪ When major competitors are based in low cost
locations
▪ Where there is persistent excess capacity
▪ Where consumers are powerful and face low
switching costs

Experience Effects continued

✓Economies of scale:
reductions in unit cost achieved by producing a large
volume of a product
▪ The ability to spread fixed costs over a large
volume
▪ Not able to attain efficient scale of production
unless served global markets Pressures for Local Responsiveness
▪ Bargaining power increases with suppliers which 1. Differences in consumer tastes and preferences
may allow economies of scale in purchasing 2. Differences in traditional practices and infrastructure
✓Strategic Significance 3. Differences in distribution channels
▪ Moving down experience curve allows firm to 4. Host government demands
reduce its cost of creating value and increase its 5. The rise of regionalism
profitability
▪ Once firm has established low-cost position it ▪ Firms facing these pressures need to differentiate their
can act as a barrier to new competition products and marketing strategy in each country

Leveraging Subsidiary Skills 1. Differences in Consumer Tastes and Preferences

✓ Recognize that valuable skills can be developed ✓ When consumer tastes and preferences differ
anywhere within the firm’s global network (not just at the significantly between countries, firms face strong
corporate center) pressures for local responsiveness
✓ Use incentive systems to encourage local employees to 2. Differences in Infrastructure and Traditional
acquire new skills Practices
✓ Develop a process to identify when new skills have
been created
 ✓ When there are differences in infrastructure inspired by local flavors and textures. Toward the end of
and/or traditional practices, a need to customize 2004, Minute Maid released Minute Maid Pulpy, which
products emerges contained less than 24 percent actual fruit juice, but TCCC
was able to retail the product at a much lower price point
3. Differences in Distribution Channels than products with a higher content of fruit juice. In China
✓ A firm’s marketing strategies may be influenced and throughout the Asia-Pacific region, consumer notions
by differences in distribution channels between of freshness and health are connected much more to the
countries which may necessitate delegation of consumption of actual fruit. Minute Maid Pulpy
marketing functions to national subsidiaries acknowledged this by including pieces of fruit in the drink,
4. Host Government Demands thereby creating a thicker texture that would not appeal to
most North American consumers but has proven very
✓ Economic and political demands imposed by
popular in this region of the world. In customizing the
host country governments may necessitate a
product, Minute Maid Pulpy went from the 10th most
degree of local responsiveness
popular fruit/vegetable juice brand in China in 2004 to first
5. The Rise of Regionalism
by the time it had achieved $1 billion in total sales in 2011.
✓ Regional convergence of tastes and
But isn’t the world becoming more globalized? Do we still
preferences can influence product offerings within
need large multinational corporations customizing their
a bloc of nations
products to local markets?

CHOOSING A STRATEGY
A localization strategy focuses on increasing profitability
by customizing the firm’s goods or services so that they
Firms use four basic strategies in global markets
provide a good match to tastes and preferences in
1. Global standardization
different national markets
2. Localization
• Makes sense when there are substantial
3. Transnational
differences across nations with regard to
4. International
consumer tastes and preferences, and where cost
pressures are not too intense

A transnational strategy tries to simultaneously

• Achieve low costs through location economies,
economies of scale, and learning effects
• Differentiate the product offering across
geographic markets to account for local
differences
• Foster a multidirectional flow of skills between
different subsidiaries
• Makes sense when there are both high cost
pressures and high pressures for local
A global standardization strategy focuses on increasing
responsiveness
profitability and profit growth by reaping the cost
reductions that come from economies of scale, learning
An international strategy involves taking products first
effects, and location economies
produced for the domestic market and then selling them
• The goal is to pursue a low-cost strategy on a
internationally with only minimal local customization
global scale
• Makes sense when there are low cost pressures
• Makes sense when there are strong pressures
and low pressures for local responsiveness
for cost reductions and demands for local
responsiveness are minimal
The Evolution of Strategy
• As competition increases, international and
localization strategies become less viable
More Customized Products in the Global Marketplace?
• To survive, firms may need to shift to a global
The Coca-Cola Company’s (TCCC) Minute Maid Pulpy
standardization strategy or a transnational
became the cola giant’s 14th brand to reach $1 billion in
strategy in advance of competitors
global retail sales (in 2011). As opposed to cola
carbonates, which often rely on global brand recognition
and crossgenerational formulas for success, Minute Maid
Pulpy has relied on product development and innovations
 ✓ Alliance Structure
• Can be designed to make it difficult to transfer
technology meant to be transferred
• Contractual safeguards can be written into
alliance agreement to guard against risk of
opportunism
• Both parties can agree in advance to swap skills
and technologies that the other covets

✓ Managing the Alliance

▪ Requires managers from both companies to
build interpersonal relationships (relational capital)
▪ Should promote learning from alliance partners
STRATEGIC ALLIANCES ▪ Should promote the diffusion of learned
knowledge throughout the organization
Strategic alliances are cooperative agreements between
potential or actual competitors
✓Examples include formal joint ventures and short
term contractual arrangements
✓The number of international strategic alliances
has risen significantly in recent decades

The Advantages of Strategic Alliances

✓ Facilitate entry into a foreign market
✓ Allow firms to share the fixed costs and risks of
developing new products or processes
✓ Bring together complementary skills and assets
that neither partner could easily develop on its
own
✓ Can help establish technological standards for
the industry that will benefit the firm

A Strategic Alliance
A moviegoer walks past a poster of the Warner Bros
movie Gravity in Shanghai, China. The strategic alliance
between Warner Brothers and their Chinese partners has
helped streamline the process for film distribution.

The Disadvantages of Strategic Alliances

✓ Strategic alliances can give competitors low-
cost routes to new technology and markets
✓ Unless a firm is careful, it can give away more
in a strategic alliance than it receives

Making Alliances Work

✓ Partner Selection
• Collect as much information as possible
• Gather data from informed third parties
• Get to know the potential partner well before
committing
 ➢ Organizational structure has three dimensions
1. Vertical differentiation - location of
decisionmaking responsibilities within a structure
Chapter 14: The Organization of International ➢ Centralized decision-making
Business ➢ Decentralized decision-making
2. Horizontal differentiation - formal division of
the organization into sub-units

3. Integrating mechanisms - the mechanisms for

coordinating sub-units

Why Is Horizontal Differentiation Important?

➢ Initially, most firms have no formal structure, but as
they grow, develop a functional structure

➢ Firms may switch to a product divisional structure

where each division is responsible for a distinct product
line

➢ When firms expand internationally, they often group all

What Is Organizational Architecture?
of their international activities into an international
➢ Organizational architecture is the totality of a firm’s
division
organization including
1. Organizational structure
2. Control systems and incentives
3. Processes, organizational culture, and people

➢ To be the most profitable

➢ the elements of the organizational architecture
must be internally consistent
➢ the organizational architecture must fit the
strategy
➢ the strategy and architecture must be
consistent with each other, and consistent with
competitive conditions

What Are The Dimensions Of Organizational

Structure?
What Happens Next?
➢ Firms that continue to expand will move to either a
1. Worldwide product divisional structure - adopted by
firms that are reasonably diversified
2. Worldwide area structure - favored by firms with low
degree of diversification and a domestic structure based
on function
3. The global matrix structure – tries to minimize the
limitations of the worldwide area structure and the
worldwide product divisional structure

How Can Subunits Be Integrated?

➢ Regardless of the type of structure, firms need a
mechanism to integrate subunits
➢ Many firms use informal integrating mechanisms
➢ a knowledge network
➢ Formal integrating mechanisms include
1. Personal controls
2. Bureaucratic controls
3. Output controls
4. Cultural controls

What Is Organizational Culture?

➢ Organizational culture - the values and norms that
employees are encouraged to follow
➢ Evolves from
➢founders and important leaders
➢national social culture
➢the history of the enterprise
➢decisions that resulted in high performance
➢ Managers in companies with a “strong” culture share a
relatively consistent set of values and norms that have a
clear impact on the way work is performed
 1. Unfreeze the organization through shock
therapy 2. Move the organization to a new state
through proactive change in architecture
3. Refreeze the organization in its new state

What Is The Link Between Strategy And Architecture?

1. Firms pursuing a localization strategy focus on

local responsiveness

2. Firms pursuing an international strategy create

value by transferring core competencies from
home to foreign subsidiaries

3. Firms pursuing a global standardization

strategy focus on the realization of location and
experience curve economies

4. Firms pursuing a transnational strategy focus on

simultaneously attaining location and experience
curve economies, local responsiveness, and
global learning

How Can Firms Implement Organizational Change?

➢ For a firm to succeed

1. The firm’s strategy must be consistent with the
environment in which the firm operates
2. The firm’s organization architecture must be
consistent with its strategy

➢ To implement organization change