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MULTINATIONAL ENTERPRISES

Lecture Notes 1

1) INTRODUCTIONModes of entryIn terms of underlying motive:

A) HORIZONTAL FOREIGN DIRECT INVESTMENTS (HFDI)Concerns operations that belong to the same ring of the value chain.

Substitutes for International trade (substitutability relation)

Motive=Market-seeking FDI Chosen when it is too expensive to

exportyou do FDI in order to avoid to export(1)Localizaition question:

should I produce abroad? (2)Licencing?

Home country Host country

ADMINISTRATION

(upstream of production)

HEADQUARTERS

(downstrem)U duplicate

activities horizontally

HOME AFFILIATE FOREIGN AFFILIATE

[both refer 2 the same headquarter]

The services provided by headquarter

to foreign affiliates cross the border

B) VERTICAL FOREIGN DIRECT INVESTMENTS (VFDI)

Concerns operations that belong to different rings of the value chain

Cost-saving FDI: complements International trade (complementarity)FDI makes sense only if Im able to trade. 2 decisions: (1)Do we want 2

produce intermediate abroad? (2)Internalization or Outsourcing?

EX:Im producing in Mexico because its cheaperIm not interested in

serving Mexico

Home country Host country

ADMINISTRATION

(upstream of production)

HEADQUARTERS

INTERMEDIATE

PRODUTION

FOREIGN AFFILIATE

FINAL PRODUCTION

HOME AFFILIATE

HFDI VFDI

Location choice Produce home & export

VS MNE

Produce intermediate home

VS Prod.Interm abroad

Internaliztion choice Licensign(NE) VS MNE Outsourcing(NE) VS MNE

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(Internalization choice1) OUTSOURCING (VFDI)

Vertical multinational enterprise (V-MNE) National enterprise (NE)

Let us simplify the analysis:

Firms have no market power There are no trade barriers

Intermediate quantity sold and final quantity sold are constant and equal to 1.

Choice according to: MIN total costMAX prof; taking into account :

Constant intermediate&final quantities Production costs Contractual costs

Source:contrctual incompleteness;4 a contract be complete it should specify:

all possible contingencisthe actions that parties should take under each case

This is possible only when all contingencies are identifiable not only by the

parties involved but also by third parties (ex court)

Contractual incompleteness does hence usually arise,specificaly when when itis costly: to write down all the details of the contract (material costs)

to observe some contingencies o parties actions (information costs)

to execute the contract when disagreement (implementation costs)[corruption]

Three interesting cases:

1.Relationspecific investment(hold up):after the constrtion of very

specific(tailored)pdts or assembly lines, parties hold each other up in case of

disagreement=need each other.

2.Dissipation of specific capital (intangible assets) :It arises when the supplier

learns the secrets of the final producer and becomes a competitor.[China

copying]

3.Principal-agent problem (hidden action, hidden information) : In the

presence of diverging objectives between the intermediate supplier (agent)

and the final producer (principal), the latter is unable to pursue shareholders

interests. [EX oraangina & coca-cola distributor in France; the agent was

pushing more on orangina coca-cola started its own distributiom]

ALL OF THIS GENERATES CONTACTUAL COSTS

HEDQUARTER

(Fixed cost H) FOR AFFILIATE

(components)

MargCost=c*

HOM AFILIATE

(Assembly)

Marg Cost=a