A multinational company or enterprise is one which owns or controls production facilities or subsidiaries or service facilities outside the country in which it is based. A company does not become “multinational” simply by virtue of exporting or importing products: ownership and control of facilities abroad is involved.
Multinational enterprises range from medium sized companies having only a few facilities (or affiliates) abroad to giant companies having an annual turnover larger than the gross national product (GNP) of some smaller countries of the world. Indeed, the largest- the us multinationals like ford, General motors and Exxon Mobil each have a turnover larger than the turnover of all but 14 countries of the world.
Foreign Direct investments FDI
Foreign direct investment refers to a lasting interest in an enterprise in another economy where the investor’s purpose is to have an effective voice in the management of the enterprise. Such direct investment usually involves acquisition of a controlling interest in an overseas business or the setting up of an overseas branch or subsidiary. Firms which invest overseas are examples of multinational corporations.
FDI provides an alternative to growth restricted to a firm’s domestic market. A firm might develop horizontally in different countries, repeating its existing operations on a global basis. Vertical integration might have an international dimension through FDI to acquire raw materials or component services overseas (backward integration) or to establish final production and distribution in other countries (forward integration).
Foreign portfolio investment
This refers to participation in overseas investment without any control over the running of the business. It involves the purchase of shares or loan stock in an overseas business organization.
Forms of expansion overseas
Different forms of expansion overseas are available to meet various strategic objectives. They include:
- Start-up investment: firms may expand by means of new start up investments, for example in manufacturing plants. This does allow flexibility although it may be slow to achieve, expensive to maintain and slow to yield satisfactory results.
- Takeover or merger: A firm might take over or merge with established firms abroad. This provides a means of purchasing market information, market share and distribution channels. If speed of entry into the overseas market is a high priority, then acquisition may be preferred to start-up. However, enterprises available for takeover tend to be those which have debt gearing, poor marker performance and poor management. The better acquisitions would only be available at a premium
- Joint venture: A joint venture with a local overseas partner might be entered into. A joint venture may be defined as the commitment for more than a very short duration, of funds, facilities and services by two or more legally separate interests to an enterprise for their mutual benefit.
The two distinct types of joint ventures are:
- Industrial co-operation (contractual)
- Joint equity
A contractual joint venture is for a fixed period and the duties and responsibilities of the parties are contractually defined. A joint venture involves investment. It is of no fixed duration and continually evolves.
Contractual joint ventures have become a common means of establishing a presence in the newly emerging mixed economies of Eastern Europe. As well as in the car industry, this form of joint venture is common in the aerospace industry.
A joint equity venture may be however be the only way of establishing a presence in countries where full foreign ownership is discouraged, such as Nigeria, Japan and some Middle Eastern countries.
Alternatives to FDI
Exporting and licensing stand as alternatives to FDI.
- Exporting may be direct selling by the firm’s own export division into the overseas market, or it may be indirect through agents, distributors, trading companies and various other such channels.
- Licensing involves conferring rights to make use of the licensor company’ s production process on producers located in the overseas market in return for royalty payments.
Exporting may be unattractive because of tariffs, quotas or other import restrictions in overseas markets, and local production may be the only feasible option in the case off bulky products such as cement and flat glass. Licensing can allow fairly rapid penetration of overseas markets and has the advantage that substantial financial resources will not be required. Many multinationals use a combination of various methods of servicing international markets, depending on the particular circumstances.
The basic structures of many multinationals consist of a parent company (a holding company) with subsidiaries in several countries. The subsidiaries may be wholly owned or just partly owned, and some may be owned, and some may be owned through other subsidiaries in a large number of different countries and many of them are household name, for example ford and unilever.
The purpose of setting up subsidiaries abroad.
The following are some reasons why a parent company might want to set up subsidiary companies in other countries.
- The location of markets : If, say, there is a big market in Australia for the products of a U.K company, it might be cheaper for the UK company to establish a manufacturing subsidiary in Australia, in order to save the cost of shipping finished goods from the UK to Australia.
- The need for a sales organization: Some subsidiaries are not manufacturing subsidiaries but provide a sales and marketing organization in their country for the parent company’s goods. For example, a US parent company might set up a subsidiary in the UK, in order to sell goods in the UK which are shipped over from the USA
- The opportunity to produce goods more cheaply. : If labour costs are much lower in one country than in another, it might be profitable for a multinational to set up a manufacturing subsidiary in the low-cost country, provided that the labour force in that country has the skills that are needed to produce good quality output. For example, a UK company might design a new type of computer and setup a subsidiary in the Far East where labour costs are lower, to manufacture the computers. They would then be shipped to the um for sale in the UK market.
- The need to avoid import controls: When a country has regulations which restrict the import of certain goods, or impose high tariffs on imports, a multinational might decide to set up a manufacturing subsidiary in that country.
- The need to obtain access to raw materials particularly in less developed countries (LDCs)
- The availability of grants and tax concessions.
Note: whatever the reason for setting up subsidiaries abroad, the aim is to increase the profits of the multinational’s parent company. However, there are different approaches to increasing profits that the multinational might take. They include:
- At one extreme, the parent company might choose to get as much money as it can from the subsidiary, and as quickly as it can. This would involve the transfer of all or most of the subsidiary’s profits to the parent company.
- At the other extreme, the parent company might encourage growth; the subsidiary would be allowed to retain a large proportion of its profits, instead of remitting the profits to the parent company. A further consequence is that the economy of the country in which the subsidiary operates should be improved, with higher output adding to the country’s gross domestic product and increasing employment.
The risks of multinationals
Multinational companies, like any other companies, must accept the normal risk of business. However, compared with companies that trade entirely within one country? And even with companies that export from their base in one country, multinationals face additional risks. The main additional risks are as follows:
- Foreign exchange risks.
- Any country that exports or imports faces the risk of higher costs or lower revenues because of adverse moments in foreign exchange rates. Multinationals that trade between one country and another therefore face this risk.
- A company that owns assets in different countries (subsidiaries abroad) faces the risk of accounting losses due to adverse movements in exchange rates causing a fall in the value of those assets, as expressed in domestic currency.
- Political risks and country risks: A multinational can face risks of economic or political measures being taken by governments, affecting the operations of its subsidiaries abroad.
- Geographical separation: The geographical separation of the parent company from its subsidiaries adds to the problems of management control of the group of companies as a whole.
Political risks for multinationals
The government of a country will almost certainly want to encourage the development and growth of commerce and industry, but it might also be suspicious of the motives of multinationals which set up subsidiaries in their country, perhaps fearing exploitation.
The government might offer incentives to encourage new investments from abroad, for example by offering cash grants towards the building of facilities or the purchase of equipment.
On the other hand, the government might try to prevent the exploitation of the country by multinationals and the various measures it might take include:
- Import quotas could be used to limit the quantities of goods that a subsidiary can buy from its parent company and import for resale in its domestic markets
- Import tariffs could make imports (such as from parent companies) more expensive and domestically produced goods therefore more competitive.
- Legal standards of safety or quality could be imposed on imported goods to prevent multinationals from selling goods through their subsidiaries which have been banned as dangerous in other countries.
- Exchange control regulations could be applied
- A government could restrict the ability of foreign companies to buy domestic companies especially those that operate in politically sensitive industries such as defence contracting, communications, energy supply and so on.
- A government could nationalise foreign owned companies and their assets (with or without compensation to the parent company).
- A government could insist on a minimum shareholding in companies by residents. This would force a multinational to offer some of the equity in a subsidiary to investors in the country where the subsidiary operates.
John B cullen., Praveen Parboteeah., Multinational Management (6th Edition)
Alan C. Shapiro., Multinational financial management