International business notes

1. International Business Notes
Global Strategy1
Quick Overview of Strategy
Definition of Strategy
- There are literally hundreds of definitions of “strategy” in the business literature. My
personal favourite: “Strategy is … a firm’s theory about how to compete
successfully” (by Jay B. Barney).
- In Barney’s definition:
- The term “theory” conveys a couple of concepts:
- A firm does not know with absolute certainty, which is the best
strategy. However, some alternatives are better than others. That is,
some are more likely to work than others are.
- Developing a strategy is a creative act.
- The term “compete” is also a critical part of the definition. A firm must make
its choices, taking into account the fact that it is in a competitive environment.
Consequently, strategy goes beyond simply minimizing your costs or
optimizing quality. If your rivals do the same thing, then you have no
competitive advantage, and you therefore have no ability to make an attractive
profit.
- In our strategy course, we focus on creating value and capturing value.
Creating Value
- A firm creates value by producing a product for which customers are willing to pay
more than the full cost of delivering the product to that customer.
- Thus, an important question in strategy is how to generate a healthy gap between the
amount customers are willing to pay, and costs.
- Since customers differ in their preferences, part of this process involves selecting
target customers and tailoring the product for those customers.
- Strategic choices normally involve a trade-off between willingness-to-pay and costs.
You want to adopt activities that raise willingness-to-pay more than they raise costs
(for your target customers), and you want to scale back activities if the cost savings
are larger than the loss of willingness-to-pay (for your target customers).
Capturing Value
- Capturing value involves securing profits from the value that the company creates. If
a firm creates value but doesn’t capture it, then the benefits from the value creation all
go to customers and/or suppliers, and not the firm itself.
- Our strategy course pays a lot of attention to capturing value, but in this course
(international business) we will not focus on this concept.
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By Don Wagner, UPEI, January 23, 2007.
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2. Location Choice as a Part of Strategy
Reasons for Going International
- There are two primary reasons for going international, and a third less common
reason.
1. to expand sales by accessing new markets,
2. to reduce costs, and/or
3. to reduce risk.
- When going international to access new markets, a critical issue is the degree to
which you adapt the product for the foreign market. The choice on how you adapt the
product should be driven by the cost versus willingness-to-pay trade-off.
- When going international to save costs, you normally want to pick a place that has a
cost advantage. However, a firm should not necessarily carry out each activity
precisely where it can be done cheapest. This is because each activity within the firm
interacts with other activities, and there is a cost to interacting at a distance. For
example, the R&D group interacts with the marketing group to know what the
market’s needs are, and the marketing group wants to know what is coming down the
pipeline from R&D. Interaction is less effective and less efficient if these groups are
physically in different places.
- When a firm goes international to cut risks (e.g. exchange risk, political risk), all of
the above issues still apply.
- Name some firms that have gone international to access new markets. Have they
adapted their products?
- Name some firms that have gone international to cut costs.
- Do you know of any firms that have gone international to reduce risks?
The Cost versus Willingness-to-Pay Trade-off
- The strategy decision this course addresses is the choice on where to locate each
activity of the firm. The key factors in making those choices are the effects on cost,
and the effects on customers’ willingness-to-pay.
- Key cost concerns include:
- labour costs
- costs of supplies (raw materials, real estate, energy, local services, etc.)
- transportation costs
- communication/coordination costs within the firm
- tariffs and trade barriers
- economies of scale
- Key willingness-to-pay concerns include:
- product adaptations
- responsiveness to customers’ orders and service requirements
- communications with customers
- reputation
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3. Broad Categories of Strategies
- There are three broad strategies – “exporting”, “multidomestic” and “global”.
Additional variations and hybrids of these three basic strategies include the
“transnational”, “branching” and “offshore outsourcing strategies.
- While the location decisions can be done on an activity-by-activity basis, it is
sometimes helpful to identify a general approach – for two reasons:
- Once the first activity is placed in a foreign location, it becomes less costly to
add a second activity to the same location. Thus, whether a firm selects a
particular location for a particular activity depends quite heavily on whether
the firm already has an international presence in that location. When a firm
chooses to place one activity in a new location, several other activities may
then become feasible there too.
- When the location choices follow a basic theme, it becomes easier to build an
easily-understood organization structure and to draw understandable lines of
accountability.
- The main categories of strategies are briefly described below.
Exporting Strategy
- Under this approach, everything is done in one place – typically the home country.
Foreign markets are served by exporting. In a sense “centralization” would be a
better name for this strategy, since several of the other strategies involve exports too –
albeit not all from the home country.
- An exporting strategy would normally be adopted by companies that exhibit some of
the following traits:
- large fixed costs
- high internal communication costs
- low transportation costs, low border costs
- the home country is the major market, even in the long run
- the home country has a cost advantage
- Name some companies that follow an exporting strategy. Do those companies have
the traits described above?
Multidomestic Strategy
- In a pure multidomestic organization, each subsidiary is a self-sufficient entity. Each
subsidiary obtains its own inputs and provides all its own supporting services. The
firm’s activities are replicated in each location.
- A multidomestic strategy would normally be adopted by companies that exhibit some
of the following traits:
- high transportation costs, high border costs
- low fixed costs
- no substantial cost differences between countries
- Name some multidomestic companies. Do those companies have the traits listed
above?
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4. Global Strategy
- Under a global strategy, each function is performed in one place, but the functions are
not all performed in the same place. For example, a firm following this strategy
might do all its finance in the US, all its R&D functions in Germany, all its
production of components in the U.S. and all its final assembly in the Philippines.
- The global strategy could also be called a “specialization” strategy.
- A specialization strategy would normally be adopted by companies that exhibit some
of the following traits:
- costs vary substantially across countries for different kinds of production and
services
- low transportation costs, low border costs
- fixed costs are large
- We sometimes observe companies switching to a specialization strategy when facing
competitive pressures.
Branching Strategy
- The “branching” strategy is a hybrid of the exporting and multidomestic strategies.
Some functions are centralized and other functions are decentralized.
- For example, R&D, finance, and key component production may be centralized,
while final assembly and marketing may be decentralized.
- Examples include some of the Japanese automakers, who tend to make their key
components in Japan, but do final assembly and marketing in North America, Europe
and Asia.
- (Final assembly plants in a branching strategy are sometimes called screwdriver
factories.)
- A branching strategy would normally be adopted by companies that exhibit some of
the following traits:
- high transportation costs on final goods and low transportation costs on parts
- high border costs on final goods and low border costs on parts
- low fixed costs on final assembly and high fixed costs on parts
- large economies of scale in engineering, design, strategic management and the
manufacture of key components, and high communication costs between these
functions
- home country has cost advantage on parts, but there are no substantial cost
differences between countries on final assembly
- large foreign markets
Offshore Outsourcing Strategy
- Under this strategy, the firm contracts other firms to carry out its foreign operations.
- In a sense, this is a combination of the exporting and global strategy. The functions
are carried out according to the global pattern, but the firm itself does not carry out
the offshore activities. Thus, the firm’s own activities are centralized.
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5. - An example is Nike, whose products are manufactured by independent companies in
various Asian countries.
Transnational Strategy
- The transnational strategy is another strategy often identified as one of the main
strategies. Proponents of the transnational strategy sometimes claim that this strategy
has the advantages that both the multidomestic and global strategies have. But they
gloss over the disadvantages of these strategies. For example, if a firm has high fixed
costs, then replication is expensive. If the transnational strategy involves a presence
in each market, then it has to bear the cost of replication. There is no way around that
problem.
- In effect, it appears that the transnational strategy is really a hybrid of the other
strategies, and that the firm uses a multidomestic strategy only for those activities
where that strategy makes the most sense, and uses the global strategy for the
activities where the global strategy makes the most sense.
Specific Issues – Cost Related
Costs of Inputs
- Labour
- Nowadays total cost is the issue; labour in one company is usually a small
percentage of the total costs.
- As we noted when we looked at the theory of comparative advantage, wages
tend to approximately reflect average productivity levels. Lower wages do
not necessarily imply lower wage costs.
- Each location is going to have cost advantages in some industries and cost
disadvantages in other industries.
- How do you determine whether a location will have a cost advantage in
labour for a particular industry?
- Components/Raw Materials
- The issues here are:
- the cost of getting goods to your door, and
- the responsiveness of suppliers (delays can shut down your
production).
- Services
- Important services usually include financing, legal, and computer support.
- The importance of local service providers depends on how relevant the local
rules/environment are and the nature of the services.
- Energy
- In some countries, energy may be subsidized.
- Some countries still suffer from frequent black outs. (Some companies set up
their own generation plant to solve this problem.)
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6. - Generalizations:
- If cost differences are substantial across countries then:
- if one place dominates across all key functions – use the exporting
strategy
- if optimal locations vary across functions – use the global strategy
- If highly responsive suppliers are needed – the firm may need to be close to a
well integrated economy
Shipping Costs
- Whether shipping costs are high usually depends on the value-to-weight ratio.
- But many people doubt shipping costs amount to much.
- Besides weight, what factors affect shipping costs?
- Generalizations:
- the greater the shipping costs the more likely the multidomestic strategy will
be chosen
- if the product has low shipping costs for certain components but high shipping
costs for the final good, the company may pursue a branching strategy
Communication Costs within the Firm
- Communication and interaction within a company are exceptionally important. This
point is driven home by the surprisingly low success rate of mergers and takeovers.
Despite the low success rate, firms continue to do mergers and acquisitions, probably
because they are lured by the benefits of economies of scale. However, the managers
who decide to do a merger appear to consistently underestimate the costs associated
with integrating two companies. It seems reasonable to conclude that communication
within the company is more important than managers realize.
- Peter Drucker (a famous management guru) has said, “if you can’t measure it, you
can’t manage it”. This idea may point to the reason many managers do not appreciate
the costs and benefits of communication issues. Communication is intangible and
hard (impossible?) to measure. However, as Einstein observed, “not everything that
can be counted counts, and not everything that counts can be counted.”
- Some generalizations on whether communication can be done across long distances:
- the more interactive the communication needs to be, the more important
proximity is (whereas one-way communication can more easily be at a
distance)
- the more standardized issues are, the less important proximity is
- e.g. if there are standard issues and standard ways of communicating
- The greater the importance of trust, the more important direct personal contact
is. Why?
- Generalizations on strategy:
- international and multidomestic strategies are best if communication across
functions is important (and if proximity is important to that communication)
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7. - the global and exporting strategies are best if communication within a
function (company-wide) is important (and if proximity is important to that
communication)
Border Costs
- What types of border costs are there?
- government barriers (e.g. tariffs, administrative barriers)
- currency exchange
- Generalizations:
- the greater the border costs, the more likely the multidomestic strategy will be
chosen for a function
- but border costs can vary for different components and so replication may be
done for certain components (or assembly) and not others
Fixed Costs
- An obvious generalization is that if a function is characterized by high fixed costs
associated with a location, it is advantageous to have that function done in only one
place to avoid incurring duplicate fixed costs. Here we will dig a little deeper by
examining the nature of economies that firms enjoy.
- Economies of Scale:
- Economies of scale exist where an expansion of output by x% raises the total
costs by less than x%.
- With economies of scale, the larger the current output, the lower the average
cost.
- There are several reasons why economies of scale exist.
- Indivisibilities: This term refers to the situation where a minimum
fixed level of capital or labour must be deployed to produce any
positive amount of output in a location. For example, when a
purchasing department must purchase 1,000 units of an input versus
2,000 units of an input, the cost of processing the transaction is the
same, regardless of the size.
- Scale Dependent Technologies: Some technologies only get feasible
once the level of output exceeds some critical value. For example, if
you were only building one car, you would not construct an auto-
manufacturing plant. If you were building 100 cars, you might set up
an operation that is more substantial than just a garage, but would still
not employ the technologies used in the mass-production auto plants.
- Physics: By the laws of physics, doubling size often does not require a
doubling of materials required to increase to that size. For example, a
building of a particular square footage is usually less than twice the
cost of the same building of half the square footage. A simple
example illustrates this concept; the cost of fencing an area of 1
hectare (shaped in a square) requires 400 metres of fencing, while an
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8. area of 4 hectares requires 800 metres. Four times the area requires
only double the fencing.
- Diseconomies of scale also exist, though it is harder to see why they should
exist. (This failure to understand diseconomies is shared both by academics –
who have not come up with a compelling explanation for diseconomies of
scale – and by businesspeople – who persistently undertake mergers to exploit
economies of scale, only to have most of them fail.) The best explanations for
diseconomies of scale that I am aware of are:
- Monitoring/control problems: There appears to be a tension between a
“tall” organization structure (with many levels of supervisors) and a
“flat” organization structure (with few levels of supervisors). The
disadvantage of a tall structure is that decisions typically have to go
through a number managers, which tends to waste time and be costly.
The disadvantage of a flat structure is that middle managers have a
broad span of responsibilities, but there is a limit to how much a
person can monitor. These disadvantages increase as a plant gets
larger.
- Hold-up problems: The larger the operation, the more costly a
disruption gets. People or firms who are part of the chain, can exploit
this by demanding more wages (or higher prices). For this reason,
employees in large plants tend to be able to secure higher wages than
what employees in smaller plants get. Similarly, suppliers may be able
to extract higher prices from managers who place a high value on their
own time and therefore choose to forego longer negotiations to secure
better prices.
- Economies of Scope:
- Economies of scope exist where one firm can produce two or more products at
a lower cost than separate firms can produce those products independently.
- What are some causes of economies of scope?
- Experience Curve Economies:
- “Experience curve economies” is also known as “learning-by-doing”.
- For a firm with experience curve economies, the larger the firm’s output in the
past, the lower the average cost.
- Experience curve economies arise because employees and managers figure
out how to improve their procedures the more experience they have at
producing a good. They may also calibrate the firm’s machines better.
- Can experience curve economies at one location be exploited in another
location?
- Generalizations:
- If production has substantial economies of scale, you will tend to use the
exporting or global strategy, or possibly outsourcing.
- If certain components involve substantial economies of scale, while final
assembly and marketing do not involve substantial economies of scale, you
will tend towards branching.
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9. - If there are strong economies of scope in producing 2 or more products, you
will tend to use the exporting or global strategy.
- How would experience curve economies affect a firm’s strategy?
Specific Issues – Willingness-to-Pay Related
Product Design/Adaptation
- Gist of popular reasoning:
- design should be geographically close to the customers
- design should be geographically close to manufacturing
- ergo – manufacturing should be close to the customers
- Does design really have to be close to the customers?
- Does manufacturing really have to be close to design?
- Generalizations:
- There may be ways to achieve effective product development without close
proximity
- If proximity is important in the design / customer relationship
- centralize R&D if customers are close to home
- replicate R&D if customers are spread out and demands differ across
regions
- If proximity is important in design / manufacturing
- centralize or replicate
Response Time – Order to Delivery
- For some products, customers want their product very soon after ordering it. For
example, customers ordering a Big Mac want to receive it within minutes. Similarly,
a firm producing machinery parts may find that its customers are willing to pay a
premium to receive their product more quickly, since they need the part to operate
their machinery. Down time is too costly.
- With the popularity of JIT, responsiveness is more important than ever.
- Do you really have to be geographically close to have quick delivery?
- Generalizations:
- If order-to-delivery time is important – the multidomestic strategy may be best
if fast transportation is too expensive.
Communication with Customers
- The issues described above for communication within a firm also apply to
communication with customers. For some types of products, it is important that the
customer can communicate with a local representative.
- Generalization:
- The multidomestic strategy or branching strategy is best if frequent face-to-
face communication with customers is important.
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10. Perceptions
- Perceptions about quality matter most in the manufacturing and design functions.
- Quality perceptions:
- Which countries hold a reputation for high quality?
- Which countries suffer from a reputation for low quality?
- Specific products:
- Which countries enjoy a good reputation for wine?
- Which countries enjoy a good reputation for automobiles?
- In some areas, patriotism/bias play a role in people’s buying patterns.
- Wal-Mart under Sam Walton’s leadership actively gave preference to
American made goods.
- Japanese markets seem to prefer Japanese-made goods.
- In auto-producing areas of North America – specifically Michigan and
Ontario – people tend to buy more North American autos.
- Generalizations:
- if quality is an issue – global strategy / exporting strategy
- if patriotism is at issue – multidomestic strategy
- alternative: brand name trickery
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